Hedging of Commodity Price Risk and Freight Risk in Overseas Markets

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The revised directions shall come into force from April 1, 2018.

However, residents hedging such risk based on the previous set of guidelines would be permitted to continue till June 30, 2018 or the last date specified in the approval, whichever is earlier.

All existing guidelines stand withdrawn as on April 1, 2018:

Definitions:

i. Hedging is the activity of undertaking a derivative transaction to reduce an identifiable and measurable risk.

ii. Eligible entities refers to residents other than Individuals.

iii. An eligible entity will be said to have direct exposure to commodity price risk if

·        It purchases/sells a commodity, the price of which is fixed by reference to an international benchmark ; or

·        It purchases/sells a product which contains a commodity and the price of the product is linked to an international benchmark of the commodity.

iv. An eligible entity will be said to have indirect exposure to commodity price risk if it purchases/sells a product which contains the commodity and the price of the product is not linked to an international benchmark of the commodity.

v. An eligible entity will be said to have exposure to freight risk if it is engaged in the business of refining oil or in the business of shipping.

vi. Bank(s) refer to banks licensed as Authorised Dealer – Category I.

Eligible Commodities are :

·        All commodities (except Gold, Gems and precious stones) in case of direct exposures to commodity price risk:

·        Aluminum, Copper, Lead, Zinc, Nickel, and Tin In case of indirect exposures to commodity price risk:

This list of eligible commodities would be reviewed annually.

Permitted Products - Permitted products refer to the following:

a. Generic Products

·        Futures and forwards

·        Vanilla options (call option and put option)

·        Swaps

b. Structured Products

·        Products which are combination of either cash instrument and one or more generic products

·        Products which are combination of two or more generic products

Hedging of Commodity Price Risk: Eligible entities, having exposure to commodity price risk, may hedge such exposure in overseas markets, using any of the permitted products.

Hedging of Freight Risk: Eligible entities, having exposure to freight risk, may hedge such exposure in overseas markets, by using any of the permitted products.

Other Operational Guidelines:

i. Banks may permit eligible entities to hedge risk and may remit foreign exchange outside India in respect of such transactions after satisfying themselves that :

·        The entity has exposure to such risk, contracted or anticipated.

·        The quantity proposed to be hedged and the tenor of the hedge are in line with the exposure.

·        In case of OTC derivatives, the requirement to undertake OTC hedges is justified.

·        In case of hedging using a benchmark price other than that of the commodity exposed to, the requirement to undertake such hedges is justified.

·        Such hedging is taken up by the management of the entity under a policy approved by the Board of Directors of a company or equivalent forum for others.

·        The entity has the necessary risk management policies in place.

·        The entity has reasonable understanding of the utility and likely risks associated with the products proposed to be used for hedging.

ii. OTC contracts shall be booked with a bank or with non-bank entities which are permitted to offer such derivatives. For this purpose, a list of acceptable jurisdictions shall be specified by FEDAI.

iii. Structured products may be permitted to eligible entities who are

·        listed on recognized domestic stock exchanges or

·        fully owned subsidiaries of such entities or

·        unlisted entities whose net worth is higher than Rs. 200 crores, subject to the condition that such product are used for the purpose of hedging as defined under these directions.

iv. All transactions related to hedging shall be routed through a special account for this purpose.

v. Banks shall keep on their records full details of all hedge transactions and related remittances made by the entity.

vi. Banks shall obtain an annual certificate from the statutory auditors of the entity confirming that the hedge transactions and the margin remittances are in line with the exposure of the entity. The statutory auditor shall also comment on the risk management policy of the entity for hedging exposure to commodity price risk and freight risk and the appropriateness of the methodology to arrive at the quantum of these exposures.

vii. Banks shall undertake immediate corrective action in case of any irregularity or misuse of these directions. All such cases should be reported to Chief General Manager, Financial Markets Regulation Department, Reserve Bank of India.

Standby Letters of Credit (SBLC) / Guarantees - Banks are permitted to issue Standby Letters of Credit (SBLC) / Guarantees, for a maximum period of one year, in lieu of making a remittance of margin money for commodity hedging transactions. Banks should ensure that these SBLCs / Guarantees are used by their clients for the intended purposes.

Realisation and repatriation of foreign exchange - Realisation and repatriation of foreign exchange resulting from permitted transactions shall be guided by the provisions of the Foreign Exchange Management (Realisation, repatriation and surrender of foreign exchange) Regulations, 2015.

Report to Reserve Bank - Banks shall submit a quarterly report Reserve Bank of India. In case of no transactions, a “Nil” report may be submitted.

Based on RBI master direction dated 12^th March 2018. For further clarification please visit www.rbi.org.in .............. Poppy