The Reserve Bank of India (RBI) on Thursday issued a set of frequently asked questions (FAQs) to clarify the scope and calculation of its 20 per cent Foreign Exchange Risk Reserve (FERR), including exemptions for certain hedges and the treatment of options and rolled-over contracts.

The RBI said the FERR would apply to user contracts exceeding $2 million equivalent in which users purchase foreign currency against the rupee to hedge current-account transactions. The requirement excludes contracts in which users sell foreign currency against the rupee, as well as contracts that hedge capital-account transactions.

“The FERR requirement applies to specified derivative contracts undertaken by authorised dealers with users having a notional value exceeding USD 2 million equivalent. Accordingly, a derivative contract having a notional value of USD 2 million equivalent or less undertaken by an authorised dealer with a user is not subject to the requirement. However, the authorised dealers shall guard against any attempt towards structuring of derivative transactions for avoidance of these provisions,” the FAQs state.

The RBI also clarified that the FERR would not apply to derivative contracts that users enter into to hedge current-account outflows arising from capital-account transactions.

These include interest payments on External Commercial Borrowings (ECBs), coupon payments on resident debt instruments held by non-residents, and dividends payable to non-resident investors. Under the Foreign Exchange Management Act (FEMA) rules, these payments qualify as current-account transactions.

The FERR requirement covers only foreign exchange derivative contracts involving the Indian rupee. It does not cover derivative contracts that do not involve the rupee, the RBI said.

However, banks must continue to maintain the reserve against their own qualifying hedges of currency risks arising from these exposures.

The RBI clarified that authorised dealers must maintain FERR equal to 20 per cent of the rupee equivalent of the notional amount of each applicable derivative contract. For example, a derivative contract worth $10 million against the rupee at a contracted rate of Rs 95 per US dollar has a notional value of Rs 95 crore. The applicable FERR would amount to Rs 19 crore.

Authorised dealers must deposit and maintain the FERR in their current accounts with the Reserve Bank. They must maintain the reserve daily, starting on the working day immediately after entering into each applicable derivative contract. The RBI requires authorised dealers to maintain the reserve on a gross basis for every qualifying transaction.

Authorised dealers must also maintain detailed records of qualifying transactions and their associated FERR amounts and submit those records for audit, the RBI said.

The RBI further clarified that authorised dealers would not earn interest on the FERR they maintain with the central bank. They must retain the reserve for each applicable derivative contract until the day after the contract terminates.