Large companies may get margin breather on derivatives deals with banks for hedges

Large corporates may be spared from forking out margins for derivative deals with banks as long as such transactions are done to ‘hedge’, or cover risks arising from fluctuations in interest and foreign exchange rates.

At a meeting with banks last week, the Reserve Bank of India (RBI) said the regulator was examining a proposal to confine the margin mechanism to only derivatives entered for trading positions, a senior banker told ET.

The margin framework, which owes its origin to the financial meltdown of 2008, is aimed to reduce risks and contagion damages of volatility and default in over-the-counter, or one-to-one that banks cut with companies and other banks. Under this arrangement, a corporate would either pay (or, receive from) the bank a variation margin (VM), calculated daily, depending how the value of the derivative contract changes.

For instance, if a corporate that has covered its imports, will be ‘out of money’ – and therefore, has to pay the bank the margin amount – when dollar weakens against the rupee. Or, a company, which has hedged its fixed rate loan by swapping it to floating rate will be ‘in the money’ – and thus, will receive margin from the bank when interest rate falls.

The VM mechanism has been activated from May 1, 2023 in line with the RBI guidelines of June 2022.

“However, calculating and collecting margins for multiple trades is a pain. So, banks as well as a few corporates have proposed whether the VM can be done away with for hedging transactions. This is practised in many other markets as well. RBI has not committed but said that it would consider. RBI has also taken feedback from overseas bodies of market participants,” said another person.Besides bank treasuries which have to pay or receive margins on a regular basis from multiple counterparties, the proposal would also help large corporates like Reliance Industries, L&T, TCS, HDFC, PFC and REC.

“Besides the hassle of arriving at the daily margin, coughing up margin money everyday has a cost. However, since May 1, most of the large corporates to whom the VM system would be applicable have put in place the systems,” said a bank treasury official. “Most of the derivatives entered into by corporates are towards hedging,” he said.

The margin arrangement is not required for plain forex forwards or cash or spot transactions. It comes into play when a company or banks enters into contracts like currency swaps, cross-currency deals, and interest rate swaps (where fixed rate loan is swapped to a floating rate, or vice-versa, based on the parties’ views on the future interest rate movements).

Several MNC banks have been following the VM system for inter-bank deals involving non-centrally cleared derivatives that are cleared and settled by the parties themselves.