‘Regulatory risk…the biggest risk’: Zerodha’s Nithin Kamath on RBI’s latest guidelines on currency derivatives

As the Reserve Bank of India restricts unhedged currency derivatives, Nithin Kamath, co-founder of Zerodha, on Wednesday said that it would mean the death of currency derivative trading and that regulatory risk is the biggest risk for stock brokers.

Taking to X (formerly Twitter), Nithin Kamath wrote: “I have said this before, regulatory risk is by far the biggest risk for stock brokers.”

“The RBI has its own reasons for restricting unhedged currency derivatives, but this means the death of currency derivative trading on stock exchanges by retail traders,” he added.

According to a 5 January RBI circular, starting 5 April, the traders have been mandated to demonstrate contracted or prospective currency exposure to participate in the currency derivatives segments provided by exchanges such as the NSE (National Stock Exchange) and the BSE (formerly Bombay Stock Exchange).

Accordingly, if a trader has an exposure greater than $100 million (i.e. notional contract value), they will be required to appoint a custodian participant or an authorised dealer. However, according to the new rule, traders with a smaller exposure will only need a declaration stating that they are trading currencies to hedge contracted exposure.

‘Contracted exposure’, as defined by the RBI, means currency risk arising on account of current or capital account transactions permissible under the Foreign Exchange Management Act (FEMA), 1999 or any rules or regulations made thereunder, that have been entered into.

While the RBI defined ‘currency risk’ as the potential for loss on account of movement in exchange rates of Indian rupee against a foreign currency or on account of movement in exchange rates of one foreign currency against another or on account of movement of interest rate applicable to a foreign currency.

The RBI said: “Recognized stock exchanges shall inform users that while they are not required to establish the existence of underlying exposure, they must ensure the existence of a valid underlying contracted exposure which has been not hedged using any other derivative contract and should be in a position to establish the same, if required.”

If the declaration is not provided, traders will not be allowed to take any fresh positions in the currency segment from April 4. However, the traders will be able to exit their existing positions.

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