Mumbai, March 7, 2018

Sebi says the new limit cannot be implemented until there is a mechanism in place to verify a potential breach by clients

The Reserve Bank of India’s (RBI) latest proposal to enhance clients’ position limit to $100 million in exchange-traded currency derivatives has hit a regulatory wall at the Securities and Exchange Board of India or Sebi.

Sebi has said the new limit cannot be implemented until there is a mechanism in place to verify a potential breach by clients, two people with direct knowledge of the ongoing discussions said, requesting anonymity.

Position limit is the maximum ownership in derivative contracts that an individual or an entity cannot exceed.

After raising the limit on 7 February with an aim to attract currency derivatives business to domestic exchanges from the over-the-counter (OTC) market and offshore exchanges, RBI said in a circular last week that stock exchanges and clients themselves will be responsible for monitoring the limits.

However, Sebi has to specify whether the $100 million limit will be applicable on the client in terms of their overall market exposure or if the amount will be split to specific exchange-level position limits. Three exchanges—National Stock Exchange Ltd, BSE Ltd and MSEI Ltd—allow trading in currency derivatives and the current limit for every client is $15 million per exchange.

If the new enhanced limit is split, it may make monitoring easier for exchanges but will defeat the purpose of the RBI allowing clients to trade freely on any domestic exchange of their choice, said one of the two people cited above.

If the limit is not split, monitoring will be a challenge because there is no centralized mechanism through which one exchange can detect on a real-time basis if any of its clients are breaching limits by additional trading on other exchanges.

“Sebi is examining the issue closely; it is a bit complex,” said the first person, adding that in the next few days Sebi should be able to put out the enabling norms.

“If the limit is breached, there has to be a tool to take fair action against any defaulter. It may be the client or the broker or the exchange,” said the first person.

The new norms will not only stipulate an appropriate monitoring mechanism but also relax a few key norms related to trading in currency pairs other than dollar-rupee, which are gradually gaining prominence.

“Even if we have adequate monitoring mechanism under the existing rules, participants cannot increase their positions much in contracts such as EUR-INR, GBP-INR, JPY-INR. This may be relaxed,” said the second person.

In such contracts, the total open position cannot exceed 6% of the total open interest or $5 million, whichever is higher.

The total open position in EUR-INR and GBP-INR contracts is typically around $200-300 million, which means one client can take positions of only around $12-18 million. “Sebi may now make it on a par the OTC (over-the-counter) market, which is around $25 million, or just specify one single upper limit for all currency pairs, which is $100 million,” said the first person.

An email sent to Sebi on the matter remained unanswered, while BSE and NSE spokespersons declined to comment.

Kamlesh Rao, managing director and CEO of Kotak Securities Ltd, said, “The RBI’s move can attract business from the OTC market and boost volumes on exchanges by 40-50% in the next one year, on the condition that the limit is not split across exchanges.”

“Currently, every time a client reaches the small limit of $15 million on one exchange, he has to run to another exchange and pay the impact cost there too for taking position. If we really want to attract volumes we should let market players decide on which exchange they want to trade. Whichever exchange offers the best liquidity and minimal impact cost, will attract the market and this will resolve the issue of monitoring also automatically,” added Rao.

In any investment, gross open position means the total value of any trade that is yet to be closed. Open interest is the total number of outstanding (not closed or delivered) options or futures contracts that exist on an exchange on a certain trading day.