Under the current scenario, the forward / option booking is bifurcated into 2 categories; Past Performance basis & Contracted Exposure basis. Under the contracted exposure, the company can freely book & cancel and are eligible for profits in case any. In case of booking under past performance, the company can cancel upto 75% of available limits and the banks can pass on the profits arising if any.
As per the updated master circular Master Direction - Risk Management and Inter-Bank Dealings dated 18th May 2020 read with RBI/2019-20/210 A.P.(DIR Series) Circular No. 29 dated 7th April 2020, applicable from 01st September 2020, the exposure will be bifurcated into 3 parts as follows:
1) Contracted Exposure
2) Probable Exposure / Anticipated Exposure
3) Special Dispensation (Ad hoc Limit)
Now let us understand how is the treatment of contracted vs anticipated exposure at the time of maturity.
Let us assume that in September 2020, an exporter covers USD 50 million at the spot of 75 and the forward rate of the contract is 76 maturing in December 2020 and simultaneously covers USD 100 million at the forward rate of 77.50 under anticipated exposure maturing in July 2021. In December, the client received only 80% of the contracted exposure i.e USD 40 million. If the spot rate on maturity is 74.00, there will be a Rs. 2 profit in the balance forwards of USD 10 million which were to be cancelled on the due date; bank will pass on the profit of Rs. 2 crore to the client.
Now in the case of anticipated exposure suppose the client receives only 75% of the anticipated exposure i.e. USD 75 million. Hence, the excess cover of USD 25 million will have to be cancelled. On the date of cancellation, if the spot rate is 76, here the bank would have not passed the profit earned of Rs 1.5, which is the unrealised profit. This profit will be passed on only at the time balance USD 25 million is received. Conversely, if the rate is 78.00 on the cancellation date, then the bank would have charged 50 paise on the forwards that is to be cancelled.
What can be done to avoid such scenarios?
Anticipated exposure should be covered for long term maturity as it will provide the exporter the time to deliver the contract in that tenure. On a month on month basis, the anticipated exposure hedging should be such that the client can deliver that much amount of foreign currency. The ratio will depend from company to company.
Some of the key differences are as follows:
Old Guidelines upto 31 August 2020
New Guidelines applicable from 01 September 2020
Past Performance Limits / Anticipated Exposure limits
PP limits were defined based on previous year annual turnover or average turnover of last 3 years; whichever is higher
Probable exposure limit is defined by the bank at its own discretion based on the projection provided by the company.
Quantum of Cancellation
Upto 75% of the contracts booked under PP limit can be cancelled. Banks can pass on the profit if any on cancellation
There is no limit on cancellation of bookings that can be done. However, banks will pass on the profits only on actual cash flow accrual
Special Dispensation Limit
No Ad hoc limit
Ad hoc limit is provided of USD 10 Million across all banks
The contracts booked based on underlying contract can be cancelled anytime and the bank pass on the profit to company
No Change in existing guideline
We answer a few FAQs based on our interpretation of the guidelines:
1. Do I have to designate the hedge at inception?
Yes. The hedge would have to be classified as booked under contracted exposure or anticipated exposure at the outset.
2. Can a hedge booked on anticipated exposure basis be rolled over?
Yes. However, the gain if any shall be withheld by the bank while the loss would have to be borne by the company. The gain would only be passed at the time cash flow is realized against the particular hedge booked under anticipated exposure.
The client would have to inform the bank to map a realized cash flow against a specific anticipated exposure hedge for gains to be passed on. If partial cash flow is realized and mapped, gain if any shall be passed on a pro rata basis. Cash flow in some other bank can be mapped against anticipated exposure hedge booked in any other bank. Only under certain exceptional circumstances, if the bank is convinced about the genuineness of anticipated exposure not materializing, the bank may pass on the gain if any on cancellation of contract booked under anticipated exposure.
3. Can a hedge booked as anticipated exposure be converted to contractual exposure on furnishing relevant underlying documents?
No. A hedge designated as anticipated would continue to remain as anticipated exposure.
4. Can a loss on one hedge booked under anticipated exposure be offset through gain on other hedge booked under anticipated exposure? Is netting possible?
No. Each anticipated exposure hedge would be treated separately, not at portfolio level. For example, there is a gain of Rs. 1.5 crore on one contract and loss of Rs. 90 lakhs on another contract then in that case, bank will withheld the profit of Rs. 1.5 crores and ask the client to pay Rs. 90 lakhs loss separately. Each anticipated exposure hedge would be treated separately, not at portfolio level.
5. What is the limit under special dispensation?
The limit under special dispensation is upto USD 10 million which can be hedged across banks without furnishing underlying documents. The limit would be reinstated once the hedge is cancelled/ utilised. Gain if any on cancellation will be passed on to the client. The limit of 10 million is across banks and not for each bank.
6. Is early delivery permitted for contracts booked under anticipated exposure?
Yes. The hedge booked under anticipated can be utilised before the maturity date. In that case, the bank would credit the account after deducting early delivery charges. For example, if a forward is booked for USD 20 million maturing in the month of Dec-2020 and the client receives USD 12 million in Oct-2020 then the client can pre-utilise the anticipated exposure contract by paying the early delivery charges (EDC).
7. Can a contract booked under anticipated exposure be used for Bill discounting or availing a PCFC?
No. An anticipated exposure contract has to be compulsorily delivered through external cash flow.
8. Is there any limitation on number of times a user can rollover the contracts booked under anticipated exposure?
No. There is no limitation on number of times a company can rollover the contracts.
9. How will the USD 10 million limit be tracked under this relaxation?
Each Bank will keep track of contracts booked with it. Monitoring of limit across Banks will be done by AD Banks based on the declaration from the company that it is complying with the requirements of the guideline. Hence, the onus is on the company to ensure that the 10 million limit is not surpassed.
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