Regulatory Framework for Exchange Traded Currency Derivatives

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More units in NISM Series I

• Introduction to Currency Markets16
• Foreign Exchange Derivatives13
• Exchange Traded Currency Futures15
• Exchange Traded Currency Options20
• Strategies Using Exchange Traded Currency Derivatives19
• Trading Mechanism in Exchange Traded Currency Derivatives13
• Clearing, Settlement and Risk Management in Exchange Traded Currency Derivatives18
• Accounting and Taxation11
• Codes of Conduct and Investor Protection Measures13

Practise all of NISM Series I

Exam format

All 12 questions on Regulatory Framework for Exchange Traded Currency Derivatives, with answers

1. Q1Which Indian law provides the foreign-exchange management framework under which RBI regulates permitted foreign-exchange transactions and related currency-derivative participation?

   • A

     Option A. Depositories Act, 1996

     Why it is wrong: The Depositories Act covers depositories. It is not the source of foreign-exchange permissions.

   • B

     Option B. Securities Contracts (Regulation) Act, 1956

     Why it is wrong: SCRA covers securities contracts and stock exchanges. It is not the foreign-exchange law.

   • C

     Option C. Foreign Exchange Management Act, 1999 — Correct answer

   • D

     Option D. Payment and Settlement Systems Act, 2007

     Why it is wrong: This Act covers payment and settlement systems, not permission to take foreign-exchange exposure.

   Answer: C. FEMA, the Foreign Exchange Management Act, 1999, is the law behind RBI's foreign-exchange rules. RBI's rules and directions for currency derivatives are made under it. Securities rules may also apply to an exchange-traded contract, but they do not replace FEMA. Remember: Match the legal question to the specific regulatory function instead of choosing any financial-market law.

   Hint, shown before you answer in practice mode: Common mistake: Assuming that exchange trading makes SEBI-related securities law the only applicable legal framework.

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2. Q2Which function was included in the published mandate of the RBI-SEBI Standing Technical Committee on exchange-traded currency and interest-rate derivatives?

   • A

     Option A. Coordinating the regulators and reviewing product design and risk controls — Correct answer

   • B

     Option B. Determining the income-tax liability arising on every derivatives trade

     Why it is wrong: Working out a person's income tax is not part of this committee's market mandate.

   • C

     Option C. Transferring daily margin payments between client and clearing bank accounts

     Why it is wrong: Moving margin money is a clearing and banking task, not this committee's job.

   • D

     Option D. Executing customer hedge trades on the exchange on behalf of authorised dealers

     Why it is wrong: Placing a client's hedge is a dealing job, not the committee's role.

   Answer: A. The committee's published mandate includes coordinating RBI and SEBI and reviewing product design, margins, risk controls and surveillance. It sets the framework. It does not deal for clients, assess tax or move margin money. Remember: Distinguish regulatory coordination from trade execution and settlement operations.

   Hint, shown before you answer in practice mode: Common mistake: Confusing a framework-setting committee with the exchange, clearing corporation or tax authority.

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3. Q3A resident user holds INR-pair positions of USD 60 million equivalent on Exchange X and USD 30 million equivalent on Exchange Y. The user proposes another USD 15 million equivalent on X in a different INR pair. How does RBI’s USD 100 million threshold for not establishing exposure upfront apply?

   • A

     Option A. Apply the threshold separately to each currency pair and accept the addition under that dispensation.

     Why it is wrong: The threshold covers all INR currency pairs together, not each pair on its own.

   • B

     Option B. Ignore Exchange Y and apply the threshold only to the USD 75 million equivalent on Exchange X.

     Why it is wrong: RBI's directions add up positions on all recognised exchanges. Leaving out the USD 30 million on Y gives too small a total.

   • C

     Option C. Reject the addition permanently because USD 100 million is an absolute aggregate position ceiling.

     Why it is wrong: USD 100 million is the limit for not showing exposure upfront. It is not a hard cap on positions.

   • D

     Option D. Apply the above-threshold exposure-verification process because the combined amount would be USD 105 million. — Correct answer

   Answer: D. Add the positions across both exchanges and all INR pairs: USD 60 million + USD 30 million + USD 15 million = USD 105 million. That is above the USD 100 million threshold, so the user must follow the process for positions above it. Even below the threshold, the user needs a real contracted exposure that is not hedged elsewhere. Exchange position limits still apply. Remember: Keep three checks separate: valid contracted exposure, the combined documentation threshold and exchange position limits.

   Hint, shown before you answer in practice mode: Common mistake: Treating the USD 100 million provision as a separate allowance per pair or exchange, or as a waiver of underlying exposure.

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4. Q4A resident importer’s USD payable is already fully hedged by an outstanding forward. It has no other unhedged exposure and proposes an additional INR-pair futures hedge against the same payable while retaining the forward. Which statement follows from the RBI contracted-exposure requirement?

   • A

     Option A. Using a different exchange makes the additional hedge acceptable.

     Why it is wrong: Using another exchange does not create a second unhedged exposure.

   • B

     Option B. A later futures expiry makes the already-hedged payable unhedged.

     Why it is wrong: A different expiry does not undo the forward or let the same payable be used twice.

   • C

     Option C. The same fully hedged payable cannot also support the proposed additional hedge. — Correct answer

   • D

     Option D. The payable can support another hedge whenever documents are not requested upfront.

     Why it is wrong: The need for a real unhedged exposure stays even when documents are not collected upfront.

   Answer: C. The payable is already fully hedged by the forward, so it cannot support a second hedge. RBI's directions for INR exchange-traded contracts need a contracted exposure that is not already hedged with another derivative. This holds even when documents are not asked for upfront. Remember: Check both that the contracted exposure exists and that it is not already fully hedged elsewhere.

   Hint, shown before you answer in practice mode: Common mistake: Treating an invoice as reusable support for multiple full hedges or confusing documentation relief with exposure relief.

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5. Q5An institution holds professional clearing membership, but no trading membership, in the currency-derivatives segment. Which activity follows from that status alone?

   • A

     Option A. Clear and settle eligible trades of trading members — Correct answer

   • B

     Option B. Execute client orders without separate trading membership

     Why it is wrong: Clearing membership does not give the trading rights the question says are missing.

   • C

     Option C. Execute proprietary trades without separate trading membership

     Why it is wrong: Trading for its own account needs trading rights. Clearing status alone does not give them.

   • D

     Option D. Grant exchange trading rights to the members it clears

     Why it is wrong: Clearing another member's trades gives no power to grant exchange trading membership.

   Answer: A. A professional clearing member clears and settles the eligible trades of trading members. NSE Clearing's rules treat it as different from a trading member. On its own, this status gives no right to trade for clients or for itself, and no power to grant trading membership. Remember: Match the permitted function to the actual membership category rather than to the institution’s size or reputation.

   Hint, shown before you answer in practice mode: Common mistake: Assuming an institution that can clear trades automatically has authority to execute them as a trading member.

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6. Q6A recognised stock exchange proposes to start foreign-exchange derivative business but does not hold the relevant RBI authorisation. Under RBI’s directions, is its stock-exchange recognition alone sufficient?

   • A

     Option A. No. Relevant RBI authorisation under FEMA is also required — Correct answer

   • B

     Option B. Yes. Stock-exchange recognition automatically supplies that RBI authorisation

     Why it is wrong: Recognition and RBI authorisation are two separate requirements.

   • C

     Option C. Yes, provided every contract is settled only in INR

     Why it is wrong: The settlement currency does not remove the need for authorisation.

   • D

     Option D. Yes, provided the exchange initially serves only resident clients

     Why it is wrong: Serving only residents does not replace the authorisation.

   Answer: A. Recognition as a stock exchange is not enough. RBI's directions also require authorisation under section 10(1) of FEMA before an exchange or clearing corporation starts foreign-exchange derivative business. Settling only in INR or serving only residents does not change this. Remember: Do not treat permission under one regulatory framework as automatic permission under another.

   Hint, shown before you answer in practice mode: Common mistake: Assuming that INR cash settlement takes currency-derivative business outside the stated FEMA authorisation requirement.

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7. Q7An Authorised Dealer trades permitted exchange-traded currency derivatives on its own account. Under RBI’s directions, which limit framework must it observe?

   • A

     Option A. Only its Net Open Position Limit, because exchange limits apply only to clients

     Why it is wrong: RBI's directions also make the dealer follow the exchange's limits.

   • B

     Option B. Only exchange position limits, because the NOPL excludes exchange-traded derivatives

     Why it is wrong: RBI's directions keep the NOPL limit for this trading.

   • C

     Option C. Only the dealing desk’s internal limit, because the trades are proprietary

     Why it is wrong: An internal desk limit does not replace the RBI and exchange limits.

   • D

     Option D. Its Net Open Position Limit together with the applicable exchange limits — Correct answer

   Answer: D. An Authorised Dealer trading on its own account must stay within its Net Open Position Limit (NOPL) and also within the exchange's limits. RBI's directions apply both. Meeting one limit does not excuse breaking the other. Remember: Check all applicable participant and venue limits rather than selecting only one.

   Hint, shown before you answer in practice mode: Common mistake: Assuming that proprietary trading status overrides either the NOPL or exchange-level risk limits.

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8. Q8Which SEBI regulatory instrument specifically concerns stock exchanges and clearing corporations, rather than the separate regulation of stock brokers or KYC registration agencies?

   • A

     Option A. Securities Contracts (Regulation) (Stock Exchanges and Clearing Corporations) Regulations, 2018 — Correct answer

   • B

     Option B. Securities and Exchange Board of India (Stock Brokers) Regulations, 2026

     Why it is wrong: These rules are for stock brokers, not for exchanges and clearing corporations.

   • C

     Option C. Securities and Exchange Board of India (KYC Registration Agency) Regulations, 2011

     Why it is wrong: These rules are for KYC registration agencies.

   • D

     Option D. Securities and Exchange Board of India (Depositories and Participants) Regulations, 2018

     Why it is wrong: These rules are for depositories and their participants.

   Answer: A. The SECC Regulations, 2018 are the rules for stock exchanges and clearing corporations. Their full title names both of them. Remember: Match the category of regulated institution to the corresponding instrument before looking for a detailed rule.

   Hint, shown before you answer in practice mode: Common mistake: Using a broker or KYC-agency regulation as though it were the exchange and clearing-corporation framework.

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9. Q9A user’s INR-currency derivative hedge portfolio is USD 150 million equivalent under designated Authorised Dealer monitoring. A genuine partial cancellation reduces its contracted exposure to USD 110 million. No other unhedged exposure is available, and the dealer regards the change as material. Assuming other limits are met, what adjustment is required?

   • A

     Option A. Retain the entire hedge because it was valid when booked.

     Why it is wrong: Initial compliance does not remove the requirement to adjust a later material cancellation.

   • B

     Option B. Reduce the excess hedge by USD 40 million equivalent. — Correct answer

   • C

     Option C. Cancel the entire USD 150 million hedge despite the remaining exposure.

     Why it is wrong: The supplied cancellation is partial. Cancelling the entire hedge would ignore the remaining USD 110 million exposure.

   • D

     Option D. Retain the excess because any reduction in exposure is a market-value exception.

     Why it is wrong: A genuine cancellation is not the same as a change only in market value, so that stated exception does not justify retaining the excess.

   Answer: B. This answer removes the mismatch while preserving the hedge for the remaining contracted exposure. The remaining contracted exposure is USD 110 million against a USD 150 million hedge, leaving USD 40 million excess. The supplied facts exclude reassignment to another unhedged exposure and an immaterial-change exception. The reduction is a real cancellation, not merely a market-value fluctuation. The appropriate adjustment is to reduce the excess USD 40 million. The remaining USD 110 million of exposure is not stated to have disappeared. Remember: When exposure is genuinely reduced, check the remaining notional, reassignment possibility and applicable exceptions.

   Hint, shown before you answer in practice mode: Common mistake: Treating every originally valid hedge as exempt from later exposure monitoring.

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10. Q10A firm has approved a budget for a possible USD import next year, but has not entered into the import transaction and has no other FX exposure. Does the budget alone establish contracted exposure for an INR-involving exchange-traded currency derivative under RBI’s purpose rule?

    • A

      Option A. No. A proposed future transaction is not made contracted merely by budget approval — Correct answer

    • B

      Option B. Yes. Internal budget approval is equivalent to entering the foreign-currency transaction

      Why it is wrong: Approving a budget does not show that the import has been entered into.

    • C

      Option C. Yes. Any expected payment qualifies as contracted once its currency is identified

      Why it is wrong: Knowing the currency or expecting a payment does not turn an anticipated exposure into a contracted one.

    • D

      Option D. No. Only an exposure arising from an already completed payment can be contracted

      Why it is wrong: A contracted payment creates exposure before it is paid. Completion is not the test.

    Answer: A. A budget for a possible import is only a plan. The import has not been entered into, so there is no contracted exposure yet. A planned transaction can create anticipated exposure, but RBI's purpose rule for these INR contracts is about contracted exposure. Remember: Identify whether the underlying transaction has been entered into before applying the contracted-exposure requirement.

    Hint, shown before you answer in practice mode: Common mistake: Treating a budget or forecast as an entered transaction, or going to the opposite extreme and requiring payment completion.

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11. Q11For an otherwise eligible user of an exchange-traded EUR-USD derivative, which statement reflects RBI’s specific purpose provision for contracts not involving INR?

    • A

      Option A. It imposes the same contracted-INR-exposure purpose condition as USD-INR

      Why it is wrong: The rule about a real rupee exposure is written for contracts that involve INR.

    • B

      Option B. It permits use only against an underlying INR-denominated trade invoice

      Why it is wrong: The rule for contracts without INR does not ask for a rupee trade invoice.

    • C

      Option C. It also removes all requirements relating to membership, position limits and margin

      Why it is wrong: No purpose limit in one rule does not remove all the other rules.

    • D

      Option D. It does not restrict purpose, while other applicable requirements still apply — Correct answer

    Answer: D. For a contract with no rupee leg, such as EUR-USD, RBI's rule does not limit the purpose of the trade. All the other rules still apply, such as who may trade, position limits and margins. Remember: Read the currency scope of a purpose rule, and do not extend one clause into a blanket exemption.

    Hint, shown before you answer in practice mode: Common mistake: Applying the INR-specific purpose condition to every pair, or assuming no purpose restriction means no regulation.

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12. Q12A recognised stock exchange plans to undertake foreign-exchange-derivative business. Under RBI’s exchange-derivative directions, which authorisation is additionally required for that business?

    • A

      Option A. A member broker’s permission to operate an equity terminal

      Why it is wrong: A broker's terminal permission does not cover the exchange's own foreign-exchange business.

    • B

      Option B. RBI authorisation under section 10(1) of FEMA — Correct answer

    • C

      Option C. An importer’s approval of a proposed hedge

      Why it is wrong: A client's approval of a hedge cannot give an exchange a legal authorisation.

    • D

      Option D. A clearing bank’s routine settlement-account confirmation

      Why it is wrong: Confirming a settlement account does not replace the FEMA authorisation.

    Answer: B. The exchange needs RBI authorisation under section 10(1) of FEMA. RBI's directions say a recognised stock exchange or clearing corporation cannot start foreign-exchange derivative business without it. Being a recognised exchange is not enough on its own. Remember: Distinguish recognition of the market institution from the foreign-exchange authorisation needed for its currency business.

    Hint, shown before you answer in practice mode: Common mistake: Assuming a recognised exchange is automatically authorised for every financial product.

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Accounting and Taxation

11 questions on Accounting and Taxation. Its quiz opens on that unit.