The issue first came to light in late November when software firm Hexaware Technology Ltd announced that it had made provisions of $20-25 million (Rs78.8-98.25 crore then) to cover exposure from unauthorized deals entered into by an employee that involved derivatives. The company later reported a net loss of Rs81 crore for the quarter ended December after the actual damage on account of these transactions ended up being Rs103 crore.
Among the companies that have hired law firms to battle the banks are Sundaram Brake Linings Ltd, Rajshree Sugars and Chemicals Ltd and Sundaram Multi Pap Ltd, according to bankers and law firms.
Among foreign banks, Citi is a major player in the derivatives market. Deutsche Bank AG, Standard Chartered Bank and Barclays Bank Plc. have also sold their share of derivatives as have some large and mid-sized public sector banks.
According to Berjis Desai, managing director of J Sagar Associates, whose firm is advising around a dozen affected companies, such transactions are worse than betting on horse races or playing slot machines in Las Vegas.
“Banks can say that the contracts are fine but, under section 30 of the Indian Contracts Act, wagering is not permitted. Nobody can punt on any currency under RBI norms,” Desai said, adding that his clients had entered into such transactions with ICICI Bank, Axis Bank and Yes Bank.
Cyril Shroff, managing partner of Amarchand and Mangaldas and Suresh A Shroff and Co., said there is enough jurisprudence on derivatives contracts all over the world and they are not wagering contracts.
“Firms are coming up with specious arguments to get out of genuine obligations,” added Shroff, who has been advising several banks. Zia Modi, senior partner of AZB and Partners was not immediately available for comment.
The derivatives involved include swaps and options that are a sort of insurance that firms with exposure to dollars or other currencies buy as a protection against any adverse movement in these currencies that can hurt their income (for exporters) or increase their liabilities (for those companies that have borrowed overseas).
Theoretically, a swap is a financial transaction in which two counterparties agree to exchange a stream of payments over time at an agreed price. An option is an agreement between two parties in which one grants to the other the right to buy or sell an asset under specified conditions. Thus, in case of a currency swap, both parties have the right and obligation to exchange currencies. And in the case of options, the buyer has the right but no obligation and the seller, the obligation but not the right to exchange currencies.
Black swan
Bankers claim there is nothing wrong in such transactions. “Both the buyer and the seller understood the products well but who would have anticipated that dollar would touch 100 yen? It’s a black swan phenomenon...,” said Dipak Gupta, executive director, Kotak Mahindra Bank.
A black swan is a large-impact, hard-to-predict and rare event beyond the realm of normal expectations.
According to Yes Bank’s managing director Rana Kapoor, banking is all about taking calculated business risks and regardless of current market conditions, corporations will continue to use derivatives contracts to manage their market risks.