Treasury Talk & Forex Factor: Volume-6 (Forex Hedging Compliances)

Forex Hedging Compliance Requirements for Importers and Exporters

Introduction

In today's globalized economy, managing foreign exchange risks is crucial for importers and exporters. Forex hedging is a strategic tool used by businesses to mitigate the risks associated with currency fluctuations. However, it is essential to comply with various regulatory requirements laid down by the Reserve Bank of India (RBI) and individual banks. This article outlines the key compliances importers and exporters must adhere to in India.

1. Know Your Customer (KYC) Compliance

Banks require importers and exporters to complete the KYC process to verify their identity and financial standing. Documents required include the Company PAN Card, Certificate of Incorporation, Memorandum & Articles of Association, List of Directors, Board Resolution for Authorized Signatories, and Address Proof (Utility Bills, Rent Agreement, etc.). This prevents money laundering and ensures the legitimacy of the business.

2. Import Export Code (IEC)

The IEC is a mandatory identification number issued by the Directorate General of Foreign Trade (DGFT) for all importers and exporters. It facilitates tracking and monitoring of cross-border trade transactions.

3. Legal Entity Identifier (LEI) Certificate

An LEI is a 20-character alphanumeric code that uniquely identifies legal entities participating in financial transactions. It is required for forex hedging to ensure transparency and accountability in financial markets. The LEI is used globally to identify counterparties in financial transactions, aiding regulatory oversight and risk management.

4. Forward Contract Limit Compliance

Importers and exporters must adhere to the forward contract limits set by the RBI. Banks require documentation to substantiate the exposure for which the forward contract is booked. Regular monitoring and reporting of outstanding forward contracts are necessary.

5. Hedging Declaration

A formal declaration by the business stating the purpose and amount of hedging is required. The declaration must include information about the underlying exposure and the specific hedging instrument used. Businesses must confirm that the hedging transactions are genuine and in line with actual exposure.

6. Foreign Exchange Management Act (FEMA) Compliance

Adherence to the rules and regulations stipulated under FEMA for forex transactions is essential. Importers and exporters must report their forex exposures and hedging strategies to the RBI. FEMA guidelines also dictate the permissible instruments and methods for hedging.

7. Import and Export Documentation

Proper documentation is required to validate the import and export transactions. Necessary documents include the Bill of Entry, Commercial Invoice, Shipping Bill, Bill of Lading, Packing List, and Letter of Credit or Bank Guarantee.

8. Annual Performance Report (APR)

Submission of an APR to the RBI by exporters regarding their foreign exchange earnings is mandatory. The report includes details of the forex earnings, outstanding dues, and hedging activities. It is essential for monitoring the performance of export-oriented units.

9. ECB and Trade Credit Reporting

Reporting of External Commercial Borrowings (ECB) and trade credits to the RBI is necessary. Importers must provide details of any ECB or trade credits utilized for financing imports. Regular updates on repayment and utilization are required.

10. Utilization Certificate

A certificate confirming the utilization of funds for the intended purpose may be required by banks for forward contracts and other hedging instruments.

11. Derivative Contracts Compliance

Compliance with RBI guidelines on derivative contracts is crucial. Businesses must report their derivative positions and ensure adherence to prescribed limits and terms. Proper documentation and record-keeping are essential.

12. Annexures Required for Forex Hedging

• Annexure I: Details of the underlying exposure, such as contracts, invoices, and other supporting documents that justify the need for hedging.
• Annexure II: Declaration by the company stating that the hedging transaction is in line with RBI guidelines and corporate policies.
• Annexure III: Bank's internal approval document for the hedging transaction, including risk assessment and compliance checks.

13. Unhedged Foreign Currency Exposure (UFCE)

UFCE refers to the portion of foreign currency exposure that is not hedged against currency fluctuations. Companies must disclose their UFCE to the RBI and banks regularly. The UFCE assessment must include a detailed analysis of the company's ability to absorb potential losses due to currency movements. Higher UFCE may lead to increased borrowing costs, as banks may charge higher interest rates to mitigate the risk.

14. Statement of Exposure to Foreign Exchange Derivatives

Importers and exporters must submit a statement detailing their exposure to foreign exchange derivatives, including options and forwards. This statement is required to assess the extent of exposure and ensure that hedging activities are aligned with underlying risks.

15. Margin Requirements for Derivative Transactions

For certain derivative transactions, importers and exporters may need to maintain margin money as per the bank's requirement. This acts as collateral to cover potential losses and is essential for mitigating counterparty risk.

16. Board Resolution for Hedging Activities

A board resolution authorizing specific personnel to engage in forex hedging activities on behalf of the company is often required. This document confirms that the company has the necessary internal approvals to engage in hedging transactions.

Conclusion

Adhering to these compliance requirements is vital for importers and exporters engaged in forex hedging. Ensuring proper documentation and timely reporting helps businesses mitigate risks while maintaining transparency and trust with regulatory authorities. By following these guidelines, companies can effectively manage their foreign exchange exposure and contribute to a more stable financial environment.

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