Derivative losses

There has been lot of news of Indian companies suffering huge losses on OTC derivative transactions. The losses first surfaced after Swiss Frank hit a decade high, then when Japanese yen went through the roof and now when the rupee is depreciating. Jamal Mecklai, chief executive officer of Mumbai-based risk- management consulting firm Mecklai Financial, said this month that Indian companies may have as much as $5billion in marked-to- market losses on their currency positions. Rating major Fitch puts a more conservative figure at $3billion.

Motive for Derivative trades
The growth in cross border trade, globalisation of Indian Co's and attractive nature of Indian market to foreign investors created new risks in many forms. Indian companies borrowed huge money from the overseas market to take advantage of the lower interest rate. Others aquired overseas assets and still many found new export markets. All of these activities exposed the firms to Foreign exchange risks to the magnitude never seen before. Companies resorted to Over The Counter (OTC) foreign exchange derivative transaction to hedge their risk as foreign exchange futures are not present in India. Banks sold their clints Exotic (Toxic) and structured trades as the margin in plain vanilla is very low. Lot of Indian co's got themselves into exotic trades which they could not comprehend and even worse these derivative transactions were not a perfect hedge to their already existing exposures. Some companies say they were misled, they did not understand what they were getting into and have taken their bankers to court.
Recent problems
Last year Rupee appreciated form 44 levels to 39 per US $. many exporters expecting the trend to continue booked deals around 40 - 40.5. But high domestic inflation, money being pulled out by FIIs, growing fiscal deficit and high oil prices have hammered rupee. The rupee is back at 42levels and the central bank is out in the streets selling dollar to support rupee. Thos with deals at strike price of Re40 per US$ now have an opportunity cost. They now have face losses on their derivative positions. Axis bank, ICICI and HDFC have booked mark to market losses on their positions and are faced with clients defaulting on their payments. losses of some of the co's are staggering. Hexawares losses exceeded its previous financial years profit. Bangalore based textile firm, Himatsinga Siede's losses on FX derivative trade is above its annual turnover.

Reforms
Faced with this problem RBI has allowed FX futures on domestic exchanges. SEBI Chairman Bhave says Exchange traded Currency contracts will debut in three months. Domestic co's need to shore up their risk management systems to manage Foreign Exchange risks more prudently. Banks should be more involved in clients risk needs and provide appropriate hedging transactions.