SPDs Prudential Regulations dated 11th October 2022

Prudential Regulation

The Standalone Primary Dealers (SPD) are the entities registered with the RBI and entrusted with the responsibility of purchasing and selling government securities. The entities buy government securities from the RBI directly so that the securities can be offered to other buyers. Through this arrangement of buying and selling, the primary dealers create the demand for government securities in the other markets, including treasury bills and bonds. Henceforth, to regulate the structure of SPDs in the securities market and to strengthen their role as market makers, the RBI issues prudential regulation from time to time. The RBI issues one such prudential regulation on 11th October 2022, which is discussed below.

Expansion of activities of SPDs

The RBI allowed the SPDs to offer forex products to its clients through a circular “Diversification of activities of Standalone Primary Dealers-Foreign Exchange Business”dated 27th July 2018. The step was taken to facilitate the SPDs in providing comprehensive service to their Foreign Portfolio Investors. The RBI has decided that the SPDs can offer foreign exchange products to their foreign portfolio investors according to the RBI’s terms and conditions from time to time, and such offering shall be considered a part of their non-core activity.

Moreover, all the SPDs shall obtain an Authorised Dealer license from RBI if they want to offer foreign exchange products to their Foreign Portfolio Investors. Further, while operating the business of forex products, SPDs shall adhere to the FEMA 1999 and otherprudential regulations as prescribed by the RBI.

Prudential Regulations 

The RBI, through a circular “Diversification of activities by SPDs – Review of permissible non-core activities”dated 11th October 2022, has expanded the activities of SPDsoffering foreign currency business for limited purposes. In order to strengthen the role of SPDs and make them stand at par with the Category–I Authorised dealers, they are allowed to offer all foreign exchange market-making facilities to all their clients. However, while offering the forex services, the SPDs shall adhere to the prudential regulation issued by RBI in reference to the current circular.

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The circular “Diversification of activities by SPDs – Review of permissible non-core activities – Prudential regulations and other instructions” states that the RBI shall hold the right to impose restrictions or withdraw permission of SPDs offering Foreign Exchange Business[1] services if they are found violating the regulations.

The prudential regulations that shall be adhered to by the SPDs are:

  1. As per the existing capital adequacy guidelines, it is required that the market risk capital charge for foreign exchange exposure shall be more than the charges calculated through a standardised approach and the internal risk management framework based on VaR (Value at Risk) model. The main changes bought by the prudential regulation are:
  2. The SPDs shall maintain a market risk capital charge at 15% for net open positions arising out of forex business with a risk weight of 100% under a standardised approach.
  3. The net open position shall be calculated in accordance with Para 8.5 of “Master Circular – Basel III Capital Regulations dated 1st April 2022”.
  4. The capital charge for market risk shall be over the capital charge of the credit risk of 15%.
  5. The market risk capital charge for all non-core activities shall not be higher than 20% of SPD’s Net-owned fund. Further, the charge shall be calculated from the last audited balance sheet of SPD.
  6. The SPDs are now authorised to under take equity and equity market derivatives transactions.Further, the SPDs are required to get trading and self-clearing membership from SEBI-recognised stock exchange and clearing corporations. In obtaining membership, the SPD must comply with all the regulatory provisions governing the stock exchanges and clearing corporations.
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The expansion of Standalone Primary Dealers has enabled them to deal in government securities and increase the movement of securities in the other markets. Expanding the activities of primary dealers has strengthened their role as market makers. Further, the government securities will be circulated more promptly in foreign as well as in other markets. This measure would provide foreign portfolio investors with diverse options to choose from the market makers for the purpose of handling their currency risk. At the same time, it aids in increasing the depth of the foreign exchange market in India. Moreover, the broader presence of SPDs in the market will enable them to deal effortlessly in the primary issuance and secondary market activities in government securities. Therefore, compliance with prudential regulation issued by the RBI shall be mandatorily adhered to by the SPDs.

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