Ta Analysis Key To Derivatives Deals, Says Rajwade

Forex expert A V Rajwade, partner, A V Rajwade and Company, brought out the need for banks and corporates to assess transaction appropriateness (TA) before opting for derivative mechanisms in their policy towards managing foreign exchange risk. He stressed on corporates using derivatives as a means to hedge against risk rather than as instruments on which profits can be made.

Rajwade was speaking on Derivatives & Risk Management in the Indian scenario, at the International Conference on Global Finance organised by Association of Development Finance Institutions in Asia and The Pacific (ADIFAP) and Icra . TA analysis is important from the end users (corporates) point of view as well as the banks point of view, Rajwade said. While assessing the TA of a derivative contract, the following points have to be kept in mind: Will the contract meet the customers needs; how much risk is involved; is it consistent with the customers business risk management policies as known to the bank; and what are the legal risks involved from the banks point of view.

Further, he felt that banks, before selling such a contract to the corporate should understand the nature of the corporates business, its ability to assess and manage its own financial risk, its operational capabilities, and whether the companys board is in the know of its treasurys activities. While corporates increasingly opt for derivative products as they are exposed more and more to the local and international currency risks, Rajwade suggested the board and management of a company lay down policies with regard to the level of risk exposure the corporate might take and management of that risk.

Rajwade also spoke of the use of derivative mechanisms in the commodities market. The use of derivatives for hedging in the commodities market is expected to gain increased importance over the next few years as corporates involved in purchase of commodities such as metals, petro products, etc, increasingly find themselves exposed to risks on account of changes in the exchange rate as well as risks related to changes in international prices of these products.

The RBI is already examining issues related towards the development of this market. Rajwade suggested permitting corporates to buy or sell contracts on the London Metals Exchange or the Oil Futures Exchange.