In the same year that Indian president Narendra Modi caused chaos with an overnight demonetisation that instantly made 500 and 1,000 rupee notes worthless, the country’s capital markets have been a relative oasis of calm.
Major change may have been avoided since the Indian derivatives market is subject to close observation by regulators that are wary of these instruments. One key regulatory restriction is the requirement for all corporates to have an underlying economic exposure in order to prevent speculative activity disrupting domestic financial markets.
One unique Indian structure to enable local corporates to access non-rupee funding is the external commercial borrowing (ECB) facility, which allows non-resident lenders to provide local corporates with foreign currency loans. Although the dollar/rupee exchange rate had been in a period of stability, the prospect of a US rate raise has caused a lot of anxiety for Indian corporate treasurers, with the result that ICICI saw a rise in hedging activity, either in the form of pure dollar interest rate swaps, or simply swapping back into rupee.
Among this rise in activity was one corporate in the oil and gas industry that had an ECB disbursement maturing in five years but, because it expected to be able to repay the loan in three years, did not want to hedge the full tenor.
Because of the client’s particular view on the rupee/dollar market, ICICI persuaded that this hedge could best be executed via a dollar/rupee call spread foreign exchange option.
By the standards of advanced markets a three-year dollar/rupee call spread is a relatively vanilla product, but in India the forex markets tend to be liquid only out to about one year. Nevertheless, ICICI is able to quote in much longer tenors and has even quoted out to 10 years. The Indian bank is able to do this because it warehouses all risk internally.
“Only a few players will quote long tenor options and ICICI Bank is one of them,” says B Prasanna, head of the global markets group and proprietary trading group at the bank. “Since we run one of the largest onshore dollar/rupee option books, we are able to manage the lack of liquidity and significant hedging costs.”
The retreat of global banks from Asia has been a notable trend ever since the financial crisis and India has been no exception to this. Previously major players in the market such as UBS and RBS shut up shop several years ago but according to Prasanna in the past two years international banks have been actively reducing either their total Indian exposure, or their activity in certain sectors. And this has presented an opportunity for ICICI.
“A lot of foreign banks are revaluating their exposure and are considering novating trades to other banks. ICICI Bank, being an Indian bank, is comfortable with the credit risk and is able to novate these trades. This leads to a win-win situation for all parties involved,” says Prasanna.
In one case, a foreign bank had done a derivative deal with an Indian financial institution but wanted to novate the trade to ICICI because of internal business reasons. ICICI was comfortable itself with both the risk and its ability to price the trade but it had to persuade the corporate to allow the novation to go through – which it was eventually able to do, thanks to its track record for strong risk management.
ICICI has also made structural changes to its forex booking systems which allow teams based in different geographies to automatically flow their trades into the internal booking system. It has also installed a forex options platform that allows the front-office sales team to price deals themselves.