Currency Chapter Notes

Chapter 8: Regulatory Framework for Exchange Traded Currency Derivatives

NISM Series I — Currency Derivatives | ~8% weightage | ~52 questions

What this chapter is about

The biggest difference between Series I and Series VIII — currency derivatives are regulated by BOTH RBI AND SEBI jointly. Equity derivatives have only SEBI. This dual regulation creates a unique set of rules around who can trade, what committees exist, and how permissions work. The exam tests the AD Category I bank eligibility criteria obsessively — know all four conditions cold.

The dual regulator — what it means

SEBI regulates the exchange and trading members (same as equity). RBI regulates the foreign exchange aspect — who can hold, deal in, and trade foreign exchange under FEMA.

FEMA (Foreign Exchange Management Act): Under Section 10 of FEMA, stock exchanges and clearing corporations must get RBI permission to deal in currency futures. This is unique to currency derivatives.

SEBI Act 1992: Establishes SEBI, gives it powers to regulate, investigate, penalise.

SC(R)A 1956: Securities Contracts (Regulation) Act — governs trading of securities (foundational legislation).

Key committees — most tested regulatory fact

Committee on Fuller Capital Account Convertibility: → FIRST recommended introducing exchange-traded currency futures in India

SEBI-RBI Standing Technical Committee on Exchange Traded Currency: → Recommends product design, margin requirements, membership norms, surveillance mechanism, dissemination of market information on an ongoing basis → This is the JOINT committee — not "SEBI special committee" or "RBI internal committee"

RBI Working Group on Currency Futures: → Set up by RBI in 2007-08 following the Annual Policy Statement → Studied international experience, suggested implementation framework

AD Category I Banks — the most tested section

Authorised Dealer Category I banks are permitted to become trading AND clearing members of currency derivatives exchanges.

All FOUR conditions must be met:

1. Minimum net worth of Rs 500 crores
2. Minimum Capital Adequacy Ratio (CRAR/CAR) of 10%
3. Net NPA must not exceed 3%
4. Net profit for last 3 years

What they can do: Trade on own account (proprietary) AND on behalf of clients.

What disqualifies them: Net NPA > 3% is the most commonly tested disqualifier.

Common trap: "Minimum networth Rs 300 crores" → FALSE. It's Rs 500 crores. "Maximum net NPA 2%" → FALSE. It's 3%.

Who can trade currency derivatives

Without underlying exposure: Residents and FPIs can take positions up to USD 100 million equivalent across all INR-based currency pairs (combined across all exchanges) without proving underlying FX exposure. Beyond this, underlying exposure must be demonstrated.

Exchange eligibility (recognised currency exchange)

Minimum networth for a company to be eligible to become a recognised currency exchange: Rs 100 crores

RBI intervention

RBI CAN intervene in the Exchange Traded Currency Derivatives (ETCD) segment "as and when required" to maintain orderly market conditions and reduce excessive volatility. (RBI press release 2015-16, December 2015.)

Membership requirements

Separate membership required: Currency derivatives segment membership is SEPARATE from equity/cash segment. An equity broker cannot automatically trade currency derivatives without separate registration.

For non-bank members (individuals/corporates): Same SEBI registration process as equity segment but specifically for currency derivatives.

OTC forward market — underlying exposure requirement

For OTC forward contracts (with banks), residents need to demonstrate underlying FX exposure. The forward can be booked only up to the amount AND maturity of the underlying exposure.

Example: Export order for USD 25 million with payment due in 3 months → can book OTC forward up to USD 25 million for maximum 3 months maturity.

FBIL — benchmark rate administrator

FBIL (Financial Benchmarks India Private Limited):

• Recognised by RBI as independent benchmark administrator
• Publishes USDINR, EURINR, GBPINR, JPYINR reference rates daily
• Published at approximately 1:30 PM on all Mumbai business days
• Used as final settlement price for currency futures/options

Trap Alert

Trap 1: "SEBI-RBI special committee recommends norms" — WRONG It's the "SEBI-RBI Standing Technical Committee" — not a "special committee formed by SEBI."

Trap 2: "AD Category I banks need net worth of Rs 300 crore" — FALSE Rs 500 crores minimum. This trap appears repeatedly.

Trap 3: "Currency futures regulated only by SEBI" — FALSE Both RBI AND SEBI regulate — dual regulation is the defining feature of Series I.

Trap 4: "Equity broker can trade currency derivatives without additional registration" — FALSE Separate registration required for currency derivatives segment.

Trap 5: "Fuller Capital Account Convertibility Committee = SEBI committee" — FALSE It was an independent government committee. The SEBI-RBI Standing Technical Committee is the ongoing body that recommends norms.

Must-remember rules

• Currency derivatives = RBI + SEBI joint regulation (not SEBI alone)
• FEMA Section 10 = exchanges need RBI permission for currency futures
• Fuller Capital Account Convertibility Committee = first recommended FX futures
• SEBI-RBI Standing Technical Committee = recommends product design, margins, membership
• AD Category I banks: Rs 500 crore networth, 10% CRAR, NPA ≤3%, profit last 3 years
• AD banks can trade own account + client account
• All 4 AD conditions must be met simultaneously
• Exchange minimum networth = Rs 100 crore
• Positions without underlying exposure: up to USD 100 million equivalent
• FBIL publishes reference rates at ~1:30 PM
• Separate membership required for currency derivatives
• RBI can intervene in ETCD when required

Weightage note

~8% = ~52 questions. AD Category I conditions appear in 3-4 questions per exam — sometimes as "all of the above" and sometimes testing individual conditions. The Fuller Capital Account Convertibility vs SEBI-RBI committee distinction appears 2-3 times. FEMA and dual regulation appears 2-3 times. Know every number precisely.

Quick revision — 60 second scan

• Dual regulation: RBI + SEBI
• FEMA Section 10: exchanges need RBI permission
• Fuller Capital Account: first recommended FX futures
• SEBI-RBI Standing Technical Committee: ongoing recommendations
• AD Category I: Rs 500Cr networth + 10% CRAR + NPA ≤3% + 3yr profit (ALL FOUR)
• AD banks: own + client trading
• No underlying needed up to USD 100mn equivalent
• Exchange minimum: Rs 100 crore
• FBIL: reference rates at ~1:30 PM
• Separate registration for currency derivatives