Master Direction – Foreign Exchange Management (Hedging of Commodity Price Risk and Freight Risk in Overseas Markets) Directions, 2022 (Updated as on April 15, 2024)
UR
- Applies toBanks that handle foreign money
- StatusIn force
- ImportanceMUST READ
- IssuedDec 12, 2022
- Amendmentsnone tracked
- Length36 points in 5 sections · 4 min read
The four dates on this rule
- PublishedDec 12, 2022The day RBI put this document out.
- Starts to applyDecember 12, 2022The day this rule starts to apply, as RBI's own text states it.
- Time to get readyNoneIt starts to apply on the day it was published.
- Last date to actNot statedNo date to act by was found in this document. Other dates may sit inside single paragraphs.
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31 of the 36 points name no product and bind every product. All products.
What it says
Must know
1. Misuse must be acted on
The bank must act at once on any irregularity and report it to the Reserve Bank.
2. One year at most
Such a guarantee may run for a maximum period of one year.
BankPulse example. A bank gives a guarantee instead of sending margin money abroad for a client's commodity hedge. The guarantee may run for a maximum period of one year. A guarantee written for two years is not allowed.
3. A quarterly report
The bank must report to the Reserve Bank by the fifteenth of the month after each quarter.
Do it
1. Banks must tell customers
An authorised dealer bank must bring these rules to the notice of the customers concerned.
2. The exposure must be real
The bank must satisfy itself the firm has the risk, whether contracted or expected.
3. Size and term must match
The quantity hedged and the period of the hedge must both match the exposure.
4. A risk policy must exist
The firm must already have the necessary risk management policies in place.
5. The firm must understand it
The firm must reasonably understand the use and the risks of the product it is buying.
6. One special account
Every payment and receipt on these hedges must pass through one special account at the bank.
7. Full records kept
The bank must keep full details of every hedge and every remittance made for it.
8. An auditor certificate each year
The bank must obtain a yearly certificate from the firm's statutory auditors.
9. The auditor judges the policy
That auditor must also comment on the firm's risk policy and how it sized its exposure.
Background
1. What this book does
This book says how a resident firm may hedge commodity price risk and freight risk abroad.
2. Under which law
RBI issued them under sections 10(4) and 11(1) of the Foreign Exchange Management Act.
3. Start date
These rules came into force on 12 December 2022.
4. What hedging means
Hedging here means a derivative taken to reduce a risk that can be identified and measured.
5. Who may hedge
Every resident other than an individual may hedge under these rules.
6. Direct exposure by price
A firm has direct exposure if it buys or sells a commodity priced against an international benchmark.
7. Indirect exposure
Exposure is indirect where the product contains the commodity but is not priced against the benchmark.
8. Freight risk defined
A firm has freight risk only if it refines oil or is in the shipping business.
9. Which banks may permit it
Only a bank licensed as an authorised dealer of the first category may permit these hedges.
10. Gold is treated apart
Gold price risk may be hedged only in the way this book separately allows.
11. Six metals, for indirect risk
Indirect exposure may be hedged only for aluminium, copper, lead, zinc, nickel and tin.
12. The list is reviewed yearly
That list of eligible commodities is reviewed once a year.
13. Plain products allowed
Futures, forwards, plain call and put options and swaps are the generic products allowed.
14. Options are named
Only plain call and put options count as generic products here.
15. Structured with cash
A structured product may combine a cash instrument with one or more generic products.
16. Structured from generics
It may instead combine two or more generic products together.
17. Commodity risk hedged abroad
A firm with commodity price risk may hedge it in overseas markets with any permitted product.
18. Gold hedged in the centre
Gold price risk may be hedged in an International Financial Services Centre.
19. Freight risk hedged abroad
A firm with freight risk may hedge it in overseas markets with any permitted product.
20. Which countries are acceptable
The list of acceptable jurisdictions is specified by the foreign exchange dealers association.
21. Who may use structured products
Only a listed firm, its wholly owned subsidiary, or a large unlisted firm may use them.
22. Only for hedging
A structured product may be used for hedging as defined here and for nothing else.
23. A guarantee instead of margin
A bank may issue a standby letter of credit in place of remitting margin money.
24. What it replaces
Two earlier circulars on this subject stood repealed when these rules began.