An industry-wide outcry sparked by the Reserve Bank of India's (RBI) draft derivatives rules seems to have persuaded the regulator to drop its most controversial plans. But the RBI looks likely to ignore certain other complaints, notably those concerning the restructuring of derivatives deals and the policing of customer activity.
The draft rules, published on December 12, would have completely shut down the active onshore markets for swaptions and short-term currency hedging. They would also have prevented the sale of more complex products, unless the customer was among the handful of Indian corporates that has voluntarily adopted mark-to-market accounting standards - a provision that one dealer says would have been "disastrous".
None of these plans are now expected to appear in the final version of the rules, largely because of the intense opposition registered during the comment period, which closed on January 22.
"We weren't surprised at the level of interest, but the quality of the input was quite incredible," says a London-based lawyer, who helped one industry association submit comments to the RBI. "All the big banks had two or three people dedicated to this."
Some 20 separate institutions contributed to the 16-page comment submitted by the International Swaps and Derivatives Association (Isda), says Angela Papesch, the Singapore-based head of Isda's Asia-Pacific office. Isda spoke to the RBI soon after filing its concerns on the last day of the comment period, and Papesch believes the industry's effort will pay off. "It's our understanding that RBI will likely make a number of amendments following comments received from Isda and others," she says.
India's domestic trade body, the Fixed Income Money Market and Derivatives Association (Fimmda), filed a 22-page comment of its own after members met with the RBI in late December to seek some early clarifications about the "underlying objectives" of the draft rules.
The Hong Kong-based colleague of one of Fimmda's senior members says early feedback suggests "the industry's worst fears have been allayed". He doesn't expect the RBI to follow through on its proposed bans. Nor does he believe the mark-to-market accounting restrictions on more complex products will appear in the final rules.
However, accounting considerations are expected to scupper one of the industry's other complaints. The comments filed by Isda and Fimmda both criticise the RBI's stance on derivatives restructuring - a common practice in other markets, which allows firms on the losing end of a swap or other trade to strike new terms in an attempt to prevent further losses.
Ordinarily, the notional loss on the previous transaction is carried over to the new deal, so that the company begins with a loss at inception, says the regional head of derivatives sales at one large dealer in Singapore. Under mark-to-market accounting regimes, this notional loss would have an impact on earnings. But under current Indian standards, it would not be recognised.
The RBI appears to be concerned that restructurings could be used to avoid recognising snowballing losses, so the draft rules would force companies to settle any losses in cash before entering into a new transaction. The Singapore-based head of derivatives sales expects the RBI to dig its heels in on this point.
Banks also complained about the extent to which the RBI rules call for them to supervise their clients' activities - for example, by vetting a client's in-house approval procedures and risk-monitoring tools. These 'suitability and appropriateness' obligations, laid out in detail in the draft, may be watered down, but are expected to remain substantially intact.
"Everyone understood where the RBI was coming from, but felt the requirements were too rigid - they would almost give market-makers a fiduciary responsibility," says the London-based lawyer.
The head of derivatives sales doesn't expect the RBI to give much ground in this area. "It wants banks to become more responsible on suitability and appropriateness," he says. "It might mean that our local compliance people become involved in vetting products."
The final shape of the rules is still unclear - as is the RBI's timetable. Isda has asked to see a revised version of the rules, followed by a second comment period, but Papesch says she has had no indication the RBI will agree.
Instead, the regulator could choose to issue a final version of the rules with no further consultation.
The only comment offered by the RBI seems to suggest that this is the likely outcome. "We are examining the comments received on the draft guidelines on derivatives and are in the process of finalising them," says the regulator.
RBI staff would not comment on the time line for publication or the content of the final rules.
The week in Risk.net, May 19-25 2017Receive this by email