24x7 Forex market ops: Some NDF volume to move onshore, say experts

The cause for concern for the RBI in this regard is that it has no control over the NDF market, whereas, the onshore market is under direct supervision of the regulator

The move to allow Indian banks to offer derivatives quotes 24/7 is likely to divert some of the volume from the offshore markets to onshore ones, but it would still be a long way to go before the offshore non-deliverable forwards (NDF) markets are challenged seriously, say experts.

The reason for such a move is that the NDF market, being operated from locations such as Singapore, London, Dubai and New York, has garnered more volume than the Indian market in rupee. According to a survey in London in October 2018, the daily average turnover in the NDF market was $23 billion against $21.4 billion in the domestic market.

The cause for concern for the Reserve Bank of India (RBI) in this regard is that it has no control over the NDF market, whereas, the onshore market is under direct supervision of the regulator. The central bank can intervene in the case of unruly movement in the local currency, which is not the case in the offshore market.

“It is a good move by the RBI. It is not that all the volume in NDF is speculative. There are genuine buyers of such currency derivatives who need to hedge, but their timings don’t match ours,” said Ananth Narayan, associate professor at S P Jain Institute of Management and Research, Mumbai.

Besides, during important global developments, such as US Fed meetings, and in the case of sudden developments like the US-Iran conflict, overseas investors would want to hedge. It is important that in such times the investors can hedge their exposure to India.

According to Narayan, there would be enough volume in the onshore market as banks can trade between themselves even when the onshore market is officially closed. And therefore, there won’t be a problem for them to offer competitive pricing for their clients.

“Foreign and private banks will latch on to this opportunity. Volume won’t be a problem,” said Narayan, who was the regional head of markets for Standard Chartered Bank.

To begin with, banks will have to now quote to companies until 5 pm compared to 4:30 pm at present, but whether banks will commit resources round the clock remained to be seen, according to IFA Global.

But liquidity can be seen during the times of major market moving data or events such as payroll, or US Fed meetings. Implied volatility should come down if the offshore and onshore markets are on the same page.

“This move can be seen as one which is intended at making rupee more tradeable, hedgeable for FPIs (foreign portfolio investors),” IFA Global said.

However, it is not always that FPIs would like to disclose their hedging strategy to the Indian authorities, especially when the needs are also for speculative purposes. But clients, too, prefer to have more flexibility in their choice of the markets.

“There will always be subjectivity in it. Offshore gives you more flexibility for derivatives.  There will always be an element of diversification in investor portfolios. And it really does depend on the regulatory regime, the specific domicile of the client, and where the client would like his transactions process,” said Dixit Joshi, global treasurer of Deutsche Bank AG, in an interview with Business Standard last month.

The NDF and onshore markets are interlinked to a large extent and influence each other.

In period of stress, though, the speculative movements offshore can destabilise local exchange rate.

“This also, prime facie, reduced the efficacy of foreign currency intervention by the central bank, because intervention was used to shape the spot exchange rate at the end of India’s business day,” the report of the task force on offshore rupee markets, submitted in August last year said.

Because NDF is a 24-hour market, the NDF rates evolved overnight and when the Indian market opened the next day, onshore rates were influenced by NDF developments overnight, which rendered ineffective the previous day’s intervention “because there was often little correlation between the closing exchange rate of the previous day and the opening rate of the next day, and therefore necessitated additional intervention the next day”, the panel found.

This always resulted in the “gap-up” movements of the exchange rate when the Indian market opened — vis-à-vis the previous day’s close — during period of stress, such as those witnessed during the taper tantrums after June 2013.

“Relative volumes across these markets are very dynamic and vary significantly. When the bulk of the volumes flow through the onshore market, it becomes the locus of price discovery. The converse is true when the bulk of volumes are routed through the NDF market, which then becomes the principle pole of price discovery,” the report said.