A
few days back a news article on RBI's proposal (in the discussion
stage) of uplifting the ban on exotic currency derivatives caught my attention.
Since then various opinions on this have cropped up.
I
believe the proposal of allowing firms to trade exotic derivatives may create
more problems than solutions for the broader financial ecosystem in India due
to followings factors;
1.
Poor understanding of the majority of Indian corporates regarding usages of
exotic derivatives (exotic currency derivatives gets more complicated)
Note:
I believe plain-vanilla derivatives are good enough in normal-case scenarios
for the purpose of hedging the financial risk, the creation of exotic
derivatives is done to cater the complex and customized transaction requirement
which may be needed by a small fraction of Indian corporates. And of course, the
creation of exotic derivatives is to earn big fat commission!
2.
Mis-selling & burning figures: 2008 financial crisis and post-crisis time
period has witnessed many entities burning figures (also by foreign currency
convertible bond issuance) with the initial intention of making some cool profit
out of currency swings. When the product is exotic mis-selling is rampant.
Opening up of exotic currency derivatives to firms will lead to heighten
mis-selling from many broking/consultancy/advisory companies. Amidst this hyped
mis-selling, hardly corproates realize that they may not need such ‘exotic’ derivatives
at all!
3.
The greed rules: moving from hedging to speculation: By my own trading
experience and losses, I reckon that there is a very thin line between hedging
(primarily done to protect the downside risk or loss) and speculation (done
with the intention of making a profit by undertaking risk )! It is extremely
difficult for the company (decision makers/treasury department) to control the
urge to move from hedging to speculation. Companies don’t know when they
silently get tilted from hedging to speculation and get addicted to speculation
after the initial taste of profit! Many cases such as Barings bank ,
Metallgesellschaft AG
derivative debacle, Sumitomo Corporation
more are examples of mismanaged hedging or firm’s entry into speculation
without much realization.
Standard
derivatives are forward, futures, options, swaps and so on. Exotic derivatives
can be any combination or hybrid of any standard derivatives, differently designed/structured
derivatives to meet customized requirements and so on.
My
advisory:
1. Strictly NO–NO for
MSME & mid-sized cooperates: Runway
ASAP if you hear exotic currency derivatives words uttered by some super
formally dressed smart looking executive, trying to convince you how cool it
is! Profit-creator! & it has no big risk! Plain-vanilla currency
derivatives are suitable enough for the varied requirement, provided
cost-benefit analysis is in your favor.
2. Big
corporates but not truly MNCs: As you have war chest you may try these exotic
currency derivatives (many times pushed by overconfident treasury department
and of course ego- boosted by consultants/banks/advisory firms etc.) only to
realize later on that this misadventure has burnt the hole in the pocket.
Plain-vanilla currency derivatives are suitable enough for the varied
requirement.
3. MNC
giants: Exotic currency derivatives are more suitable if they have complicated
and customized transactions requirements and may have better resources to play
in the currency market.
