Forex Derivatives & Hedging: Product Framework & User Categories

On May 3, 2000 — the day FEMA came into force — the RBI issued FEMA 25/RB-2000, a single notification that defined the entire universe of permissible forex derivative contracts in India. Its opening line set the tone for the next quarter century: "No person in India shall enter into a foreign exchange derivative contract without the prior permission of the Reserve Bank." Everything that followed — 165 circulars, two major overhauls, and one Master Direction updated thirteen times — was the gradual expansion of what "permission" meant.

The framework moved from a regime where every hedge required documentary proof of an underlying exposure and cancelled forward contracts could never be rebooked, to one where users can hedge anticipated exposures up to $10 million without any documentation, take exchange-traded positions up to $100 million without proving an underlying, and freely cancel and rebook contracts. That journey took twenty years.

See also: Foreign Exchange Regulation in India — The Complete Timeline

For the story of the 20-year rebooking ban and how India liberalised forex hedging — see The $10 Million Question: How India Liberalised Forex Hedging.

The Foundation: FEMA 25/2000-RB

FEMA 25/RB-2000 (Foreign Exchange Management (Foreign exchange deri) — 60 downstream references — defined the basic architecture.

What Counts as a Derivative

"'Foreign exchange derivative contract' means a financial transaction or an arrangement in whatever form and by whatever name called, whose value is derived from price movement in one or more underlying assets, and includes (a) a transaction which involves at least one foreign currency other than currency of Nepal or Bhutan, or (b) a transaction which involves at least one interest rate applicable to a foreign currency, or (c) a forward contract, but does not include foreign exchange transaction for Cash or Tom or Spot deliveries." (RBI_179, Regulation 2(v))

Residents: The Documentation Requirement

The original regime required documentary proof for every hedge:

"The authorised dealer through verification of documentary evidence is satisfied about the genuineness of the underlying exposure." (Schedule I, para A.1(a))

"The maturity of the hedge does not exceed the maturity of the underlying transaction." (Schedule I, para A.1(b))

The Rebooking Ban

The most restrictive provision — cancelled rupee forward contracts could not be rebooked:

"Contracts involving rupee as one of the currencies, once cancelled shall not be re-booked although they can be rolled over at ongoing rates on or before maturity. This restriction shall not apply to contracts covering export transactions which may be cancelled, rebooked or rolled over." (Schedule I, para A.1(h))

Exporters got an exception. Everyone else was stuck — if you cancelled a forward, you couldn't re-enter the market at a better rate. This was meant to prevent speculative position-taking disguised as hedging.

Products Available

For trade hedgers: Forwards and options (with a no-premium condition for structures):

"In respect of cost effective risk reduction strategies like range forwards, ratio-range forwards or any other variable there shall not be any net inflow of premium." (Schedule I, para 3)

For borrowers: A wider menu, but only for non-rupee hedges:

"A person resident in India who has borrowed foreign exchange may enter into an Interest rate swap or Currency swap or Coupon Swap or Foreign Currency Option or Interest rate cap or collar or Forward Rate Agreement (FRA) contract with an authorised dealer, provided that the contract does not involve rupee." (Schedule I, para B.2)

For FIIs: Hedging permitted, but capped:

"The value of the hedge does not exceed 15% of the market value of the equity as at the close of business on 31st March 1999." (Schedule II, para 1(b))

The 2010 Overhaul: Comprehensive OTC Guidelines

The December 28, 2010 circular RBI/2010-11/338 (32 downstream refs) was the first major revision, responding to the 2008 financial crisis and the derivatives mis-selling scandals that followed:

"In the light of developments in the domestic and international financial markets, the extant guidelines on OTC foreign exchange derivatives, commodity price and freight risks have been revised in consultation with the banks, corporates and other stake holders." Comprehensive Guidelines on Over the Counter (OTC) Foreign E...

The revised guidelines (effective February 1, 2011) applied the broader derivatives suitability framework to forex products: "All the guidelines given in the Comprehensive Guidelines on Derivatives issued vide Circular DBOD.No.BP.BC. 86/21.04.157/2006-07 dated April 20, 2007 would also apply, mutatis mutandis, to the foreign exchange derivatives."

The 2020 Reform: Hedging Liberalised

The April 7, 2020 circular RBI/2019-20/210 (39 downstream refs) was the most significant liberalisation in the derivatives framework's history. It replaced the existing hedging directions with a new framework that came into effect on June 1, 2020.

New Definitions

For the first time, the RBI formally defined what hedging means in the Indian context:

"Anticipated exposure — An exposure to the exchange rate of INR against a foreign currency on account of current and capital account transactions permissible under FEMA, which are expected to be entered into in future." (RBI/2019-20/210, Annex-I)

"Contracted exposure — An exposure which has already been entered into." Risk Management and Inter-bank Dealings – Hedging of foreign...

"Non-deliverable derivative contract (NDDC) means a foreign exchange derivative contract involving the Rupee, entered into with a person resident outside India and which is settled without involving delivery of the Rupee." Risk Management and Inter-bank Dealings – Hedging of foreign...

User Classification

The reform introduced a two-tier user classification:

Retail users get a restricted product menu — forwards, purchased options (European only), call/put spreads, swaps.

Non-retail users (net worth ≥ Rs 500 crore, regulated financial entities, non-resident non-individuals) get access to any derivative the bank can independently price and value:

"Any derivative contract, including covered options, which the Authorised Dealer can price and value independently and is approved by the board of the Authorised Dealer, provided that the potential loss from the derivative transaction to the user, in any scenario, does not exceed the loss that the user would face if he had left the position unhedged." Risk Management and Inter-bank Dealings – Hedging of foreign...

That last condition — the "no worse than unhedged" test — is the suitability guardrail replacing the old product-by-product approval approach. The RBI announced these final directions in December 2019, concluding a consultation process that had begun earlier that year — see Hedging of Foreign Exchange Risk - Final Directions (PR_49640).

The $10 Million No-Documentation Threshold

The most practical liberalisation:

"Authorised Dealers shall allow a user to book derivative contracts up to USD 10 million equivalent of notional value (outstanding at any point in time) without the need to establish the existence of underlying exposure." (RBI/2019-20/210, Annex-I, para 2.B)

The $100 Million Exchange-Traded Threshold

"Users may take positions (long or short), without having to establish existence of underlying exposure, upto a single limit of USD 100 million equivalent across all currency pairs involving INR, put together, and combined across all exchanges." (RBI/2019-20/210, Annex-I, para 3)

Cancel and Rebook — Finally Freed

The twenty-year rebooking ban was lifted:

"Authorised Dealers shall allow users to freely cancel and rebook derivative contracts. However, net gains on contracts booked to hedge an anticipated exposure shall be passed on to the eligible user only at the time of the cash flow of the anticipated transaction." Risk Management and Inter-bank Dealings – Hedging of foreign...

Transparency

"All forward contracts with retail clients shall be executed at the ongoing interbank/market rates and shall be time stamped. For all other derivative contracts, the mid-market mark of the derivative shall be disclosed to the client before entering into the contract." Risk Management and Inter-bank Dealings – Hedging of foreign...

The Current Master Direction (Updated September 2025)

The Master Direction on Risk Management and Inter-Bank Dealings RBI/2014-15/533 (61 downstream refs) consolidates all derivatives directions. Updated thirteen times since its July 2016 issuance, it now incorporates the 2020 hedging reform and subsequent refinements.

Product Menu (Current)

Retail users:

"Foreign exchange forward; foreign exchange swap; currency swap; purchase of foreign exchange call option (European); purchase of foreign exchange put option (European); purchase of foreign exchange call spread; purchase of foreign exchange put spread." (RBI/2014-15/533, para 2.2(ii))

Non-retail users — everything retail users get, plus:

"Covered foreign exchange call option; covered foreign exchange put option; option to undertake/cancel a forward/swap/option; and any other foreign exchange derivative contract including derivatives having cash instrument(s) and/or permitted derivative(s) as components, but excluding leveraged derivatives." (RBI/2014-15/533, para 2.2(iii))

NDDCs — The Offshore Onshoring

"NDDCs involving INR can be offered to residents and non-residents by an Authorised Dealer Category-I bank, provided the bank has an operating International Financial Services Centre (IFSC) Banking Unit." (RBI/2014-15/533, para 2.2(vi))

"NDDCs involving INR offered to resident users shall be cash-settled in INR. Such derivatives offered to non-resident users shall be cash-settled in INR or any foreign currency." (RBI/2014-15/533, para 2.2(vii))

Simplified Hedging — $100 Million Threshold

The Master Direction raised the no-documentation contracted exposure threshold:

"Authorised Dealers shall permit users to take position up to USD 100 million equivalent of notional value (outstanding at any point of time), across all Authorised Dealers, for hedging contracted exposure without the requirement to establish the existence of underlying exposure." (RBI/2014-15/533, para 2.4 proviso)

INR Liability Conversion

"Authorised Dealers may offer currency swaps to resident users, other than individuals, for the purpose of converting their INR liability into a foreign currency liability. In case of resident retail users, such conversion shall be subject to the existence of a natural hedge." (RBI/2014-15/533, para 2.3(vi))

Key Thresholds

Last updated: April 2026

For the full narrative, see The $10 Million Question.