Foreign Exchange Management

All about the Latest Foreign Exchange Management Regulations 2022

The Reserve Bank of India, on 12^th December 2022, released Master Directions on Foreign Exchange Management (Hedging of Commodity Price Risk and Freight Risk in Overseas Markets) for all the Authorised Dealers Category-I (AD Cat –I). Also within the contours of these regulations, the apex bank also directs the Authorised Persons as defined under Section 11 of the FEMA Act 1999. These Directions are issued under the relevant sections FEMA Act to lay down the modalities for AD Cat-I banks to facilitate hedging of commodity price and freight risks in the overseas market. The AD (cat I) and the authorised persons may bring the constituents of these notices to the knowledge of their concerned constituents and customers. This blog aims to jot down the key definitions and other important details that are updated in the latest Foreign Exchange Management Regulations 2022.

Introduction

Reserve Bank of India, exercising the powers conferred to it under Foreign Exchange Management Act, sections 10(4) and 11(1) , has issued the following directions. All the contents and guidelines mentioned in these Master directions shall come into effect from 12^th December 2022.

Key definitions

Following are the key definitions as defined by the regulations

Hedging

Hedging has been defined as making any derivative transaction to reduce measurable and identifiable risks by the entities. For the purpose of these regulations, risks include commodity price risks and freight risks.

Eligible Entities

For the purpose of these guidelines, eligible entities refer to residents other than individuals.

Direct exposure to Commodity Risk Price

Any eligible entity will be directly exposed to commodity price risk if

• It sells/purchases any commodity whose rate is fixed with banks reference to any international benchmark; or
• It purchases/sells any product that contains a commodity, and the price of such product is linked to any international benchmark of the commodity involved in the product.
• These involved products that are bought or sold in India or Aboard

Indirect Exposure to Commodity Price Risk

Any eligible entity that will have indirect exposure to commodity price risk if its sells/purchases a product in India or abroad which has the commodity and price is not linked to the international benchmark of the commodity.

Banks

For the purpose of these guidelines, Banks refers to the Authorised Dealers Category I (AD Cat –I) under section 10 of the Foreign Exchange Management Act, 1999.

Eligible Commodities under the Latest Foreign Exchange Management Regulations 2022

The commodities whose prices might be needed to be hedged are as follows;

1. In the cases involving direct exposures to the commodity price risk, it involves all the commodities except gems and precious stones. Prices of gold have to be hedged as per Para 5(ii) of these directions.
2. In cases of Indirect Exposure to commodity price risk, the following commodities are included;
   • Cooper
   • Lead
   • Zinc
   • Aluminium
   • Tin
   • Nickel

This list of items is to be reviewed annually for revisions and additions by the authority.

Permitted Products

For the purpose of this act, permitted products to include the following:

Generic Products

1. Vanilla options (Put option and Call option)
2. Swaps
3. Futures and Forwards

Structured Products

Structured products can be defined in the following manner

1. Combination of either cash instruments and one or more generic products
2. Products that are formed by combining two or more generic products

Hedging of Commodity Price Risk

1. Using any permitted products, the Eligible Entities that have exposure to commodity price risk for any eligible commodity may hedge such risks in the overseas market.
2. Eligible Entities that have exposure to price risk in gold may hedge such exposure only on exchanges in the IFSC (International Financial Service Centres) recognised by the IFSCA.

Hedging of freight risk

Using the permitted products, the Eligible Entities with any exposure to Freight Risks may hedge those risks.

Other Operational Guidelines under the latest Latest Foreign Exchange Management Regulations 2022

• Banks have the power to grant permissions to eligible entities to hedge freight risk and commodity price risk overseas, including IFSC, by using permitted products and remitting foreign exchange management in those transactions after duly considering the following:
  • The entity has contracted or anticipated exposure to commodity price risk or freight risk
  • The quantity and tenor proposed for the hedged are similar to such exposure
  • In the case of OTC derivatives, the requirement of OTC hedges is justified.
  • In case hedging with a benchmark price of the product other than that of the exposed commodity, all the requirement to undertake such hedge is justified.
  • The entity’s management takes up the hedging under any policy which the Board approves of directors of the Eligible Entities.
  • Risk management policies must be working and in place for the entity
  • The entity has a sound knowledge and reasonable understanding of the likely risks associated with the products proposed for hedging.
• All the OTC contracts must be booked with a bank or non-bank entity that has the required permission to offer such derivatives to such derivatives by their respective regulators. FEDAI shall, in due time for this purpose shall specify a list of acceptable jurisdictions.
• Structured products may be permitted to all the eligible entities that are:
  • Listed on recognised stock exchanges in India
  • Are wholly owned subsidiary of such entity
  • Entities that are not listed but whose net worth is higher than 200 Cr. Subject to the condition that such product is used for hedging as defined.
• The payments/receipts of such hedging of exposure commodity risk price shall route through a particular bank account.
• Banks are required to record full details of all the hedge transactions and related remittances by the entity.
• Banks must obtain an annual certificate from statutory auditors of the entity should confirm that the hedge transactions and remittances are in line or equivalent to the entity’s exposure. The Auditor is obliged to comment on the management’s risk management policy for commodity price and freight risk.

Additional regulations under the Latest Foreign Exchange Management Regulations 2022

SBLC (Standby Letters of Credit)/ Guarantee

The banks are allowed to use the standby letter of credit/guarantee for a period of one year o behalf of their clients for creating a remittance of the margin money for commodity hedging transactions made by their customers.

Realisation and repatriation of Foreign exchange

The realisation and repatriation of foreign exchange due or accruing on an eligible entity resulting from a permitted transaction is to be done according to procedure set in Foreign Exchange Management (Realisation, repatriation and surrender of foreign exchange) Regulations, 2015

Report to the Reserve Bank

The banks are obligated to submit a quarterly report to the Reserve Bank India in the new age Extensive Business Reporting Language (XBRL). The reports are to be prepared according to the format attached with the notification and to be provided to the office of the General Manager, Financial Marker Regulation Department, Government of India. It is pertinent to mention here in case the reporting entity does not have any transaction to show in their records, in that case, the Bank shall submit a Nil report.

Conclusion

The Reserve Bank of India, through the latest Master Directions Foreign Exchange Management (Hedging of Commodity Price Risk and Freight Risk in Overseas Markets) Directions, 2022, as issued on 12/12/2022, have made significant regulatory changes in the hedging of Commodity Price Risk and Freight Risks. The modalities laid down in the directions aim to establish a guiding principle for hedging commodity and freight risks and remittances for the eligible entities subject to those risks.

Read Our Article: Analysis of the Foreign Exchange Management (Overseas Investment) Rules, 2022