The Foreign Exchange Management Act (FEMA) is an Indian law which regulates the activities related to foreign exchange. The main objective of the law is to facilitate external trade and payments and for promoting the orderly development and maintenance of foreign exchange market in India.
Foreign Exchange Derivative Contracts are governed by FEMA Notification No. FEMA 25/RB-2000 dated May 3, 2000 and subsequent amendments thereto. The relevant RBI Master Directions for forex transactions are as follows:
Risk Management and Inter-Bank Dealings
Reserve Bank of India (Market-makers in OTC Derivatives) Directions, 2021. External Commercial Borrowings, Trade Credits and Structured Derivatives
A person resident in India (as defined in FEMA) can transact in OTC forex market on declaration of the underlying exposure (contractual and probable). While for transacting on exchange traded currency derivatives instrument the declaration is not required. However, there are pre-set limits for transacting in currency derivatives.
The companies need to submit the Board resolution and if required, board approval Risk Management Policy. Besides, depending upon the type of exposures (contractual and probable) quarterly and annual declaration / certificate is also requires to be submitted.
Following are some general guidelines to be followed while entering into OTC currency derivatives transaction:
The purpose of FX derivatives should be hedging
The notional and tenor of the contract does not exceed the value and tenor of the exposure.
The same exposure has not been hedged using any another derivative contract.
In case the exposure ceases to exist, in full or in part, the user has appropriately adjusted the hedge – notional/ other unhedged position.
In cases where the value of the exposure falls below the notional of the derivative, the notional should be suitably adjusted unless such divergence has
occurred on account of change in market value of the exposure, in which case the user may, at his discretion, continue with the derivative contract till its original maturity.
Where the value of the exposure is not ascertainable with certainty, derivative contracts may be booked on the basis of reasonable estimates. Such estimates should be reviewed periodically.
only one hedge transaction can be booked against a particular exposure/ part thereof for a given time period;
Currently, EEFC balances need to be converted in rupee by the end of next calendar month (i.e. maximum 60 days). Balances in the EEFC accounts can be sold forward by the account-holders provided they remain earmarked for delivery. Such contracts cannot, be cancelled.
