RBI eases FEMA regulations to facilitate foreign investment in derivatives

Foreign investors will find it easy to invest in derivative investment as the Reserve Bank of India has amended the FEMA (Foreign Exchange Management Act) regulation to facilitate margin management for trading in permitted derivatives. This will be applicable for transactions taking place in or outside India.

The central bank has issued two notifications. The first notification aims to expand the permission for Authorised Dealer (AD). These dealers can now post and collect margin in and outside India for a permitted derivative contract entered into with a person resident outside India and receive and pay interest on such margin. This will also be applicable for derivative contract between two ADs, provided one of them is a branch of foreign bank.

Similar arrangement will be for derivative transactions undertaken through overseas branches and International Financial Services Centre Banking Units. Authorised dealers will also be permitted to post and collect margin, in India or abroad for their customer doing derivative transaction with a non-resident.

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Decoding this notification, Anindya Ghosh, Partner with INDUSLAW, said it provides clarity and operational flexibility, subject to RBI’s oversight and directions. “It is important to note that the amendment may be accompanied by additional guidelines, circulars, or directions from the RBI, which would need to be examined carefully to understand the full scope and implications of the regulatory changes,” he said.

The second notification permits an AD in India to allow a person resident outside India to open, hold and maintain an interest-bearing account in Indian Rupees and/or foreign currency for the purpose of posting and collecting margin in India for a permitted derivative contract.

At present, RBI lists Interest rate derivatives (interest rate swap, forward rate agreement, and interest rate future and foreign currency derivatives (foreign currency forward, currency swap and currency option) as permitted derivative contract. Similarly in equity, for four types of derivatives include forward contracts, future contracts, options contracts and swap contracts.

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Will help NRIs

For second notification, Ghosh said this will help non-residents in various ways. First, non-residents who wish to participate in derivative contracts permitted under Indian regulations will be able to open and maintain interest-bearing accounts with authorized dealers in India specifically for posting and collecting margins related to these derivative contracts. Second they can earn interest on the funds they maintain in these accounts for margin purposes, instead of keeping the funds idle.

“Having a dedicated account for margin requirements will make it easier for non-residents to manage their margin obligations and funds related to their permitted derivative contracts in India,” he said.

It may be noted that under derivative trading, one needs to keep a specific percentage of the value of outstanding position as cash in his trading account. This specific percentage is commonly referred to as ‘margin money’. This helps minimise the risk exposure for the stock exchanges one is trading on.