- The RBI clarified rupee-linked forex derivative transactions are subject to FERR rules
- FERR applies to authorised dealers maintaining reserves against certain forex derivative contracts
- Transactions must exceed $2 million and involve rupee to foreign currency purchase
The Reserve Bank of India (RBI) has clarified which rupee-linked foreign exchange derivative transactions will attract its Foreign Exchange Risk Reserve (FERR) requirement, specifying when banks and other authorised dealers must set aside reserves against these contracts.
The clarification follows two circulars issued on October 10 and 12, which laid down the conditions under which the reserve requirement will apply.
What is the Foreign Exchange Risk Reserve (FERR)?
FERR is a reserve that authorised dealers are required to maintain with the RBI against certain foreign exchange derivative contracts.
These include eligible transactions undertaken with users and specific contracts entered into by authorised dealers to hedge currency risks arising from their own assets and liabilities.
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The requirement also covers situations where an authorised dealer purchases foreign currency against the Indian rupee to hedge its own currency exposure.
Which transactions are covered under the new rules?
According to the RBI's October 10 circular, the FERR requirement applies to foreign exchange derivative contracts undertaken by authorised dealers with users when specified conditions are met.
First, the contract must involve the Indian rupee and be entered into with a user. Second, the user must be purchasing foreign currency against the rupee.
The transaction must also have a notional value exceeding the equivalent of $2 million and be undertaken to hedge current account transactions.
Contracts that do not meet these specified conditions would not fall within this particular category of FERR requirements, although other applicable RBI regulations may still apply.
Who qualifies as a user?
Under the RBI's Master Direction on Risk Management and Inter-Bank Dealings, the term ‘user' is defined under Section 2(u) of the Foreign Exchange Management Act, 1999. It covers eligible individuals and entities residing in India or abroad, but excludes authorised dealers.
What should borrowers and importers know?
Importers and other businesses using foreign exchange derivatives to hedge eligible current account exposures should assess whether their contracts meet the prescribed threshold and other conditions.
The reserve requirement is imposed on authorised dealers, rather than directly on borrowers or importers.
However, businesses should consult their banks to understand whether the rules could affect the availability, pricing or terms of eligible hedging transactions.
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