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Offshore Parent MNC Role in the Indian Derivative Market

The commencement of Derivative trading in India dates back to the year 2000 when it first obtained the final approval of SEBI. Though initially the permission was granted for index futures contracts only. Later it was allowed for options and individual securities as well.

In this blog, we would be discussing the role of offshore parent MNC in the Indian Derivative Market. So let’s begin our journey.

Developments in the Indian Derivative market:

Since its commencement, the Indian Derivative Market has witnessed tremendous growth in terms of trading value and contracts. Despite witnessing such encouraging growth, many analysts believe that the Derivative Market was not able to realize its full potential in terms of growth & trading. There were various reasons for this phenomenon. One of such reasons is the lack of participation and flexibility for Offshore MNCs, which indulge in derivative trading through their Indian subsidiaries.

What is an Offshore Parent MNC under Derivative Market?

Offshore Parent MNC can be defined as an entity incorporated in a foreign country having one or more subsidiary companies in India through which they enter into trading transactions in the Derivative Market.

What was the scenario of the Indian Derivative Market before the greater participation of Offshore Parent MNC was allowed?

These offshore MNCs and their Indian subsidiaries engaged in current account transactions in India are exposed to a number of currency risks.  Due to numerous restrictions and prohibitions imposed by RBI on foreign investment transactions and cross-currency transactions, the options to involve in hedge transactions by the Parent MNCs were very limited.

• There was ambiguity in the decision-making power and involvement of the Parent MNC in the derivative transactions entered into by the Indian Subsidiary. Due to this, the Parent MNC was allowed limited scope in the decision making task.
• Also, the actionable role of the Parent MNC in the Indian Derivative Market on behalf of its subsidiaries was not clearly defined.

Due to these reasons, the Derivative Market was suffering greatly. It was high time the offshore MNCs were allowed to play their role in the development of the Indian Derivative Market. Keeping this in view, the foreign entities and their subsidiaries have been requesting RBI from a long time to relax these conditions and allow greater flexibility.

Finally, after many deliberations, the Reserve Bank of India through a circular dated 21^st March 2017 allowed the participation of offshore Parent MNC in the Indian Derivative Market through their Indian subsidiaries.

Greater operational flexibility was allowed to Offshore MNCs and their Indian subsidiaries, which are exposed to currency risk arising out of current account transactions carried on in India.

What is the role of Offshore Parent MNCs in the Indian Derivative Market?

The circular further allowed the following role/advantages to the Offshore Parent MNCs:

a) Right to entry into Indian Derivative

Offshore Parent MNCs or their central treasury or regional treasury, which are located outside India can now directly enter into the Indian Derivative Market through their subsidiaries without any restrictions.

b) Permission for carrying on hedge activities by the Parent MNC

With this circular, the offshore Parent MNC of the Indian Subsidiary is allowed to carry on hedging activities on behalf of the transaction risks that the Indian subsidiary is exposed to for dealing in derivative transactions.

c) Permission to take on other activities on behalf of its subsidiary

On behalf of their Indian subsidiaries, the Offshore Parent MNCs are allowed to undertake all those activities which are allowed to be undertaken by the subsidiary itself.

d) Other permissions:

Other permissions include the following:

• Offshore MNCs are allowed to enter into Over-the-Counter (OTC) and exchange-traded transactions on behalf of the subsidiary
• The offshore Parent MNC is now allowed to join in currency derivative transactions too.

Following conditions are to be fulfilled for enjoying the relaxations:

• There should be a tripartite agreement between the Indian subsidiary, its non-resident parent/treasury and the AD bank.
• This agreement shall clearly set out the relationship, roles, and responsibilities of the parties, and the procedure of the transactions. The tripartite agreement should be distinct from the ISDA agreement between the AD bank and the offshore Parent MNC.
• The country in which the Offshore Parent Company/treasury is incorporated should be a member of the Financial Action Task Force (FATF) or member of a FATF-Style Regional body.
• The AD Bank shall obtain KYC/ AML certification as per the guidelines mentioned in RBI’s Master Direction on Risk Management and Inter Bank Dealings. With every amendment of the guidelines, the format of the KYC/AML shall also be amended, if required.
• The Offshore Parent MNC can contract with any product. The route should be either the contracted route or past performance basis depending on what the Indian subsidiary is eligible to use.
• FEMA 1999 and all other applicable rules and regulations have to be complied with by the Indian subsidiary.
• The profit/ loss arising out of the hedge transactions shall be reflected in the bank account and books of accounts of the Indian subsidiary.
• The Indian subsidiary shall submit an annual certificate to the AD Bank. The certificate shall be certified by the Statutory Auditors of the Subsidiary.
• All the hedge transactions carried on by the Offshore MNC will be monitored by the AD Bank
• The Indian subsidiary should have all the necessary underlying exposure required for hedge transactions.
• AD banks shall report hedge contracts booked under this facility by the non-resident related entity to CCIL’s trade repository with a special identification tag.

Conclusion

As a result of the relaxation of norms by RBI^[1], the performance of the Subsidiaries in the Derivative Market has considerably improved. They enjoy greater support from their Parent MNCs. Also, the Parent MNCs can perform various transactions on behalf of their subsidiaries and can also keep a close eye on the derivative transactions of its subsidiaries. As a result, the Indian Companies are able to involve in hedging transactions with the help of their MNCs. Consequently, trading is becoming more professional thus contributing towards the growth and development of the Indian Derivative Market.