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In modern times, market conditions are dynamically volatile as business entities which are involved in buying, selling and producing commodities need to deal with equal instability in profitability figures. One effective method to manage this unpredictability is to indulge in commodity hedging techniques to reduce potential risks. Commodity Hedging is a risk management activity that invariably helps companies to reduce their exposure to unwarranted and unwanted risks.
Typically Hedgers are either manufacturers of a product / commodity or they have to buy a commodity in the future. Hence they want to keep the potential risks as low as possible by indulging in hedging in the commodities market. Hedging comes with associated costs and the reason why investors’ hedge is not because they want to earn money or profits but because they want to safe-guard against probable losses.
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The Reserve Bank of India has been very vigilant of this particular market. In 2003, it allowed for limited hedging activities to resident Indians, interested in cross border commodity trading. As per the directive only those Indians were allowed who have had relevant exposure in the export/import market after receiving approval from RBI on the same. Later the approach was made more flexible when people having exposure in commodity trading in the domestic scenarios could enter into such transactions. In 2012, Authorised dealer category I banks in India were granted permission to facilitate such hedging related transactions.
In 2016 realizing that the commodity hedging market needed much more progressive reforms in terms of new products and new participants who can be involved in commodity derivative transactions, it formed a Working Group Committee to work on building a refined framework in this context.
On 12th March, 2018, the RBI issued the Hedging of Commodity Price Risk and Freight Risk in Overseas Market Directions that came into force from 1st April, 2018.
There are number of modifications that can be summarized as follows:-
The Working Group prepared a report based on which draft guidelines were issued on 12th January 2018. Only after receiving conclusive feedback on the draft, the Directions were finalized.
In the same breath in September 2018, the SEBI took a decision to allow foreign companies that have risk exposure in the physical commodity market in India to indulge in commodity hedging excluding sensitive commodities and commodities wherein they do not have exposure.
While the industry and trade experts have rationalized the reason behind the issuance of these guidelines, many are seeing this as positive move towards developing the Indian as well as the foreign commodity derivative segment. The RBI decided to tighten the hedging guidelines in the overseas market after the largest banking fraud in the country in the past few decades was exposed. The limit on the tenure of banking instrument, necessity of banks to obtain audit certificates on an annual basis from statutory auditors and the directive that banks need to take corrective actions on immediate basis when irregularities or misuses are highlighted are seen in good light by the industry.
The move by SEBI is definitely going to edge more foreign investments in the country, as per trade experts. In this context, foreign entities working in the agriculture industry, auto components, metal and textiles will now be able to hedge in the Indian market under the Eligible Foreign Entities. This particular category will encompass only overseas residents and their net worth need to be $ 500,000 to hedge in the commodity derivates market.
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