India: Financial Perspective On Foreign Exchange Derivatives: India And Abroad


One of the most significant developments in the securities market has been through development and expansion of financial Derivatives. Derivates are the contract which derives its values from the underlying assets and has no independent value of its own. The contract in the derivatives prescribes the conditions which are required to be followed by the parties. The condition in the contract varies from transaction to transaction, although, some common clauses includes dates, the parties to the contract, resulting values, details of the underlying assets etc. The Derivatives are of four type's namely forward, future, Options and Swaps.

It is quite difficult to trace the origin of Derivatives but according to a publication of 1984 of Futures Industry Association on "An Introduction to the Futures markets", it is said that derivative trading dates back to 2000 B.C. It was during that period the merchants made consignment transaction for goods to be sold in India. The writing of Aristotle also depicts that during 350 B.C there was a trading in options contract. Therefore it can be found that Derivatives market was prevalent before the time of Christ. The Royal Exchange of London was the first exchange which permitted forward contracting. However it was Mr. Edmund Eddie O'Connor who is believed to be the person who introduced the instrument of Derivative in the modern market.

The performance of another entity outlines the value of derivatives. These entities are known as "underlying" which are in the form of commodities, stocks, assets, bonds, indexes, interest rates, currencies etc. The change in value of these assets over the period of time over which derivatives run denotes the maturity value of derivatives. Although the underlying assets in derivatives contract is not limited to the above mentioned variables, it can include any component which has some monetary value and which fluctuates with change in market conditions. However, those underlings might add up to complexity in valuation of these instruments.

The derivatives are traded through Over the Counter (OTC) or Exchange Traded Derivatives (ETD). The OTC derivatives are privately traded contracts which do not have any intermediary or any derivatives exchange but ETD are traded only in a derivatives exchange or some other exchange and it is the exchange which controls the regulatory aspect of these derivatives. The swaps and forward are the examples of OTC. The OTC market constitutes the largest market for derivatives and has banks and hedge funds other highly sophisticated parties as the parties. This type of trading is preferred because it does not require any disclosure to be made to any external body and can be concluded through private arrangement between the traders.

The Derivatives trading has been significant in the modern era because people are finding it to be one of the best methods in risk management. It is a tool to hedge against risk and is deemed to be a kind of insurance. Certain other people find it to be a profitable source of investment through short-term fluctuations in the market prices.

But, according to Raghuram Rajan, Governor of RBI and a former chief economist of the International Monetary Fund (IMF) "... it may well be that the managers of these firms [investment funds] have figured out the correlations between the various instruments they hold and believe they are hedged. Yet as Chan and others (2005) point out, the lessons of summer 1998 following the default on Russian government debt is that correlations that are zero or negative in normal times can turn overnight to one — a phenomenon they term "phase lock-in." A hedged position can become un-hedged at the worst times, inflicting substantial losses on those who mistakenly believe they are protected.1"

More rightly pointed out by Warren Buffett, these are nothing but financial instruments of mass destruction. Large losses can follow because of the use of leverage, or borrowings as small movements in the underlying asset's price can allow investors to earn large returns.

But due to, substantial fluctuation of price against them can make the investors lose large amounts. Several instances of massive losses in derivative markets have resulted in erosion of $39.5 billion in the last decade. Starting 1994, the derivatives world was hit with a series of large losses on derivatives trading announced by some well-known and highly experienced firms, such as Procter and Gamble and Metallgesellschaft. Orange County, in California, declared bankruptcy, allegedly due to the use of leverage in a portfolio of short- term Treasury securities.

Unlimited Counter-party risk and huge notional value has also been the criticism factor in Derivatives contract.

Bad turned Worst

According to Forex Derivative Consumers' Forum (FDCF) president Raja M Shanmugam, "It was during the first half of 2007 when there was a steep appreciation of the rupee against the US dollar whereby rupee fell to 39 per dollar from 46 per dollar within a short span of time. During that time, several banks approached the exporters claiming that they had sophisticated derivative products that would save the exporter by making profits which would offset the loss suffered on account of rupee appreciation. The promise made by the banks was that they would look after the fluctuation part of the deal and take care of it so that there are no losses in transactions."

However, by the end of FY2007-08, several exporters across the country started facing huge mark-to-market losses when the bankers started quoting the global financial crisis as the reason behind the fallout. It was also quoted by Mr Raja that only due to the intervention of the Orissa High Court did all these issues came to limelight, whereby the country came to know that the loss projected by the RBI on a particular date was around Rs 31,700 Crore.

As a matter of convention, exporters generally use Plain Vanilla Forward Contracts to hedge their currency risk due to export business but it was in 2007 that these exporters were approached by several banks stating that it was time for them to switch over to more sophisticated hedge instruments such as exotic derivative products to effectively deal with currency risk. The banks in unembroidered sense went on to their doorsteps stating that there was no need for any collateral securities or NOCs – and was just a matter of signature in the ISDA master agreement that would suffice and assuring the rest. Claiming to be centuries old it was banks who have portrayed and promised that they had a well equipped treasury department that would take care of the fluctuations part of the contract so that there will be no loss to the investor's account.

Investors particularly in the nature of hedgers (including exporter making garments, spices, etc for the rest of the world), they had little exposure to these complex products. They have entered into these contracts purely on the advice of the banks that sold them. But they were appalled to find that the banks absolved themselves from any responsibility when losses in crores of rupees started to accumulate. They changed their stance, saying, 'you have signed the contract, so you have to bear the losses'."

Scams that were brewing

Following the onset of the global financial crisis of 2007–2008, Barclays manipulated LIBOR downward by telling LIBOR calculators that it could borrow money at relatively inexpensive rates to make the bank appear less risky and insulate itself. The artificially low rates submitted by Barclays came during an "unprecedented period of disruption."

British Bankers Association (BBA) explains LIBOR as the rate used by many banks worldwide as a base rate for setting interest rates on consumer and corporate loans. According to U.S. Commodities Futures Trading Commission, hundreds of trillions of dollars in securities and loans are linked to LIBOR, including auto and home loans. When LIBOR rises, rates and payments on loans often increase; likewise, they fall when LIBOR goes down. LIBOR "is used for an increasing range of retail products such as mortgages and college loans," while also being used as "the basis for settlement of interest rate contracts on many of the world's major futures and options exchanges,". 2

Many UK-based banks accused of massive mis-selling in Italy estimated to the tune of 35 billion Euros and also in rest of the world including India.

It came in December last year that European Union antitrust regulators fined six financial institutions including Deutsche Bank, Royal Bank of Scotland and Citigroup a record total of 1.71 billion Euros (US$2.3 billion) for rigging financial benchmarks.3

The news on Financial Post also states that authorities around the world have so far handed down a total of $3.7 billion in fines to UBS, RBS, Barclays, Rabobank and ICAP for manipulating rates, while seven individuals face criminal charges.

UBS paid a record fine of $1.5 billion late last year to the U.S. Department of Justice and the UK's Financial Services Authority for rate-rigging.

Whereas In India, 19 banks were penalized to a mere amount of Rs. 5 lac until Rs. 15 lac in India including SBI, ICICI Bank, HDFC Bank, Axis Bank and several foreign banks operating in India, including Citibank, Standard Chartered, HSBC and Deutsche Bank for violating the guidelines of Derivatives. It is to be noted that this violation led to cost India for about Rs. 25L Crore.4

Common features of the deadly Weapons

As quoted by Satyajit das, a famous risk consultant and author of 'Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives' in his article in the Financial Times "How to design derivatives that dazzle and obfuscate'5 , "The process is deliberate. Efficiency and transparency are not consistent with high profit margins on Wall Street and in the City. Financial products must be opaque and priced inefficiently to produce excessive profits."

The profit centric minds of the derivative desk's heads of the investment banks started on to utilize their innovation power at the full capacity, when in 2006 in India there were events from RBI tweaking the regulations, which turned in favor of the banks rather for the investors. The year was July, 2006, when RBI amended its previous Master Circulars on Derivatives by way of allowing 'Zero Cost Option Structures' for the use by the banks and other financial entities. The period often remembered as the "Derivatives Mis-selling Era" that started from July 2006 until the midst of 2008, was a period in which false sale of derivatives begins by the means of rampant marketing and false sale of exotic derivative products, mostly zero cost option structures, to unsophisticated investors across the country begins. The deals were happening whilst enjoying the backwaters massages offered to the Chief Financial Officers and Forex heads of the corporate as a gesture from the selling banks.

"The unique feature about all these exotic contracts then traded in India was that when profits arose, they would be only in small amounts say $10,000, but when losses surface, they would run into crores of rupees. In many cases, the "maximum to investors" to "actual profit ratio for the banks" works out in the range of 1:1000 or 1:5000.

One of the most famous instruments preferred by banks back in 2007-2008 were the contracts, known as knock-in/knock-out, or KIKO, options, that involves two currency levels. Under KIKO, corporate stood to profit from the bank as long as the first currency they are long on strengthened until the capped "knock-out" price. If the currency rose above that value, they have a right to sell second currency at a favorable exchange rate to the bank would be knocked out, ceasing to exist. If the first currency fell below the other capped level, the "knock-in" price, corporate would have to sell more of the second currency to the bank at an unfavorable rate, taking a loss.

Similar case happened with Koreans in 2008, whereby KIKO led the Korean corporation to bankruptcy whereas on the other hand the eight banks that sold the most KIKO contracts reported 2.57 trillion won of profits at market price from outstanding currencyoption contracts as of Sept. 30, 2008, according to the FSC. Those contracts included the currency options contracts the banks sold to their corporate clients as well as those traded among the banks themselves said an article on Bloomberg dated 24th March, 2009.6


1. Raghuram G. Rajan (September 2006). "Has Financial Development Made the World Riskier?"


3. penalty-yet-for-rigging-lending-benchmarks/


5. Article by Satyajit Das in Financial Times: "How to design derivatives that dazzle and obfuscate'", dated 8th July, 2009

6. Article on "Korean Corporations Court Bankruptcy With Suicidal KIKO Options" published on Bloomberg

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Topics
Related Articles
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions