Using Derivatives in India - A Snapshot

February 7, 2000

February 7, 2000

Mumbai

Salient Features
Purpose
To be used to hedge underlying loans or trade transactions

Participants
Professional- Foreign & new Private sector banks and Financial ProfessionalInstitutions Corporate- large to medium companies with FX loan exposures Corporate-

Products
FX, Structured and Vanilla Cross-Currency and FCY interest rate CrossOptions, Interest Rate Swaps, FRAs, Currency/ Coupon swaps, Gold and Commodity derivative

February 7, 2000

Mumbai

Down memory lane

Globalization p greater long term exposures Deregulation p greater market risks Demand for hedging through derivatives. Foreign Bank facilitators Transactions against specific regulatory approvals

February 7, 2000

Mumbai

Regulatory Response
Progressive relaxation on curbs Introduction of new derivative products Initiatives to strengthen and develop the market

February 7, 2000

Mumbai

Regulatory response- Landmark developments responseJan94Jan94- Cross Currency Options Mid95Mid95- 3rd Currency Hedging Mid96Mid96- Structured Cross Currency Options Aug96Aug96- FCY Interest rate Derivatives Apr97Apr97- Rupee Swaps Sep98Sep98- Commodity hedging May99May99- Gold hedges and Commodity derivatives July99- Interest Rate Derivatives in INR July99-

February 7, 2000

Mumbai

At the same time..

Simultaneous efforts to develop a yield curve - removal of CRR on interbank liabilities. Increased freedom to banks to set and manage their AssetAssetliability, FX positions. Focus on risk monitoring and risk management- Capital managementadequacy norms, Value at Risk Steps to deepen the market- increase market participants marketTransparent and market friendly profile while fostering a low interest rate, stable rupee environment

February 7, 2000

Mumbai

Market response
Leap in transaction volumes. More participants - Public and Private Sector Banks, Financial Institutions Steps to self-regulate: FEDAI, FIMMDA selfSome way to go:
Understanding of products, risks and control still inadequate Documentation and Accounting standards not fully developed No retail interest until Equity derivatives scheduled for next month Market not yet integrated, nascent yield curve

February 7, 2000

Mumbai

The Market- Turnover * MarketInterest Rate Swaps (3 mo to 5 years) FCY - USD 1 Billion INR - USD 1-2 Billion (nascent) 1Currency Options (up to 2 years) Only FCY/FCY- USD 500 Million FCY/FCYCurrency Swaps (1 - 5 years) USD/INR - USD 500- 750 Million 500 FCY/FCY - USD 250- 500 Million 250Commodity Derivatives - USD 50 Million BIS Stastics Outstanding OTC contracts of $81.5 trillion at end-June 1999 end IRS (66%), FX (18%), Equities (2%) and commodities (0.5%) Slowdown in growth- hit by Euro introduction growth-

* Turnover includes cancellation of deals

February 7, 2000 Mumbai

Derivative Turnover
00 0 00 0
Derivative Volumes (USD Million)
m i y e ai e m ri rea

0 40 USD/INR Spot
Mumbai

40 0 0 30 0 0 20 00 00 0 0 a 2

a r u y i , rre 7 e ai e a e ri

30 2 0 0 0 a 7 a0 0

a 3

a 4

0 a

February 7, 2000

e ai e u e ri m

The Participants
th e rs P u b ic ect r an s

F in a n c ia n s titu ti n s

F re i n an s

February 7, 2000

P ri a te an s

Mumbai

RBI Guidelines
Derivatives as hedges - Suitable documentary evidence NonNon-rupee derivatives through Authorized Dealers only. Appropriate Authorizations - Board Resolutions Back office infrastructure and risk management capability (e.g. for Commodity risk) Option writing - Principle of Limited risk - No receipt of premiums by any market participant including banks. Rupee stability paramount - No linkage between interest rate and rupee forward premia.

February 7, 2000

Mumbai

Documentation Issues
ISDA/Rupee ISDA/ICOM is the standard documentation to be signed between various counterparts Confirmation can handle most of the basic requirements ISDA required for
events of default set-off, etc. set-

ISDAs signed with corporate counterparts

Hardly any between banks None at all with Public Sector Banks Both FEDAI/ FIMMDA looking at the issue closely

February 7, 2000

Mumbai

Legal issues
SCRA FEMA Wagering act Tax implications No legal derivative disputes so far.

February 7, 2000

Mumbai

New products on the horizon

Issuance and investment in foreign currency denominated bonds with rupee settlement USD/INR options- awaiting RBI approval optionsStructured deposits linked to the Rupee CreditCredit-default Swaps Derivatives with payoffs linked to commodities Equity derivatives- Exchange & OTC derivativesHybrids

February 7, 2000

Mumbai

Other Emerging Markets

Large capital inflows after exchange controls and local markets were significantly de-regulated deDeregulation has enabled local companies and offshore investors to hedge away exchange risks Benchmark interest rates have developed from the foreign exchange swap market Unbundling of price, credit and liquidity risks made possible by the development of :
Liquid markets for underlying instruments Unsegmented markets to allow free access to underlying hedge instruments Derivative instruments to hedge individual elements of risk
February 7, 2000 Mumbai

Disclaimer
Although the information contained herein is believed to be reliable, Citibank makes no representation as to the accuracy or completeness of any information contained herein or otherwise provided by Citibank. The ultimate decision to proceed with any transaction rests solely with the customer. Citibank N.A. is not acting as your advisor. Therefore, prior to entering into any proposed transaction, you should determine the economic risks and merits, as well as the legal, tax and accounting characterizations and consequences of the transaction, and that you are able to assume these RISKS. The contents of this presentation are proprietary in nature, and may not disseminated in whole or in part without Citibank's written consent.

February 7, 2000

Mumbai