The lit fuse on a derivatives time bomb in India is getting shorter.
It appears that hundreds of Indian companies that bought these complex cross-currency options and structured products to seemingly protect themselves from foreign exchange risk are now staring at significant losses. And many of them are starting to cry foul.
As a result, banks that sold such products are gearing up for legal battles with clients turned adversaries, predominantly small and medium Indian companies, many with unsophisticated internal risk management practices, who are questioning the very legality of such products.
(Clockwise from top left) K.V. Kamath’s ICICI Bank; Uday Kotak’s Kotak Mahindra Bank; Aditya Puri’s HDFC Bank;Rana Kapoor’s Yes Bank; and P.J. Nayak’s Axis Bank are some of the big derivatives sellers in India
On one side of this battle are some of the fastest growing and most aggressive banks in India—Yes Bank Ltd, Kotak Mahindra Bank Ltd, Axis Bank Ltd, ICICI Bank Ltd, HDFC Bank Ltd, among others—and powerful law firms, such as Amarchand and Mangaldas and Suresh A Shroff and Co., and AZB and Partners.
Arrayed against them are a growing list of small companies, some publicly traded, as well as the well-regarded law firm of J Sagar Associates, a crack team of investigators at auditor KPMG and independent consultants such as A.V. Rajwade, perhaps India’s leading expert when it comes to derivatives.
Because Indian accounting laws do not require companies to report notional losses on account of derivatives contracts, details of losses are just beginning to come in. Experts say that many companies are aware of the losses—indeed, in several cases, the chief financial officer (CFO) has been quietly axed—but will only report them in coming quarters on closing out their contracts.
The implications are significant for companies that have resorted to such instruments to hedge their foreign exchange exposure as well as for a country that considers itself insulated against most global financial risks.
The banks and their lawyers claim the derivatives—a financial term used to describe an instrument whose value is a function of an underlying commodity, bond, stock, or currency (also simply called underlying) and which is used as a risk management and mitigation tool—are legal.
Lawyers and consultants advising the affected firms say the products that were sold violate the country’s Foreign Exchange Management Act, which regulates all foreign currency transactions, and the Reserve Bank of India (RBI) guidelines. At the core of the battle is a debate over whether these were sold for hedging or speculation.
Law firms that Mint spoke to say that at least six companies have filed suits in various courts across India and add that many more such cases are on their way.