Singapore: The Reserve Bank of India (RBI) may ban over-the-counter (OTC) oil swaps and options trading in an attempt to prevent losses that could bankrupt companies.
Reliance Industries Ltd (RBI), India’s most valuable company, and state-owned Indian Oil Corp. Ltd (IOC), the country’s largest refiner, are among those that may only deal in derivatives through bourses such as the New York Mercantile Exchange or ICE Futures Europe, the central bank said in draft guidelines issued on 12 November. They also won’t be allowed to sell options on these exchanges.
This could affect the banks because they lose the captive audience for their exotics, said Jonathan Kornafel, a director for Asia at options traders Hudson Capital Energy in Singapore. Moving from the bilateral model to the exchange cleared does entail putting up some margin or some premium to trade but you do get something in return.
Indian regulators want to prevent losses at airlines and refiners akin to the $675 million that Ceylon Petroleum Ltd suffered in 2008 on adverse OTC options trading. JPMorgan Chase and Co. and Deutsche Bank AG, among the biggest banks dealing in energy risk derivatives, could lose out on income from offering complex swaps and options to processors and consumers in a country that may become the fourth largest oil importer by 2025.
A clearinghouse eliminates some of the risks of OTC trading as it acts as the counterparty for the swap or option that is bought through the exchange. Participants put up funds, or margin, as collateral in the event of a default. An OTC deal depends on credit agreements worked out directly between the two sides.
India’s proposed changes reflect moves in the US and Europe to increase regulation of the $600 trillion derivatives market amid allegations that speculation in swaps and options drove crude oil prices to a record $147.27 a barrel in 2008. Commodity Futures Trading Commission chairman Gary Gensler has asked lawmakers to require more transactions go through clearinghouses which underwrites such deals.
“The margin requirement may increase costs but you get thousands of counterparties to work with and you don’t have to worry about counterparty risk,” said Hudson’s Kornafel.
A move to exchanges could mean a loss in profits for the banks that are active in this market.
An analyst at Sanford C. Bernstein and Co. calculated in a 2 December report that JPMorgan Chase and Co., the second largest US bank, may lose as much as $3 billion should most derivatives trades, including such deals as interest-rate swaps and energy options, be moved to exchanges.
That loss will come as a result of a narrowing in the difference in the buy and sell price of a swap, known as the bid-ask spread, said Anthony Nunan, an assistant general manager for risk management at Mitsubishi Corp. in Tokyo.
Banks could charge a greater margin on the bilateral deals that were done, said Nunan. Their profit margin will be reduced. Moving to exchanges will increase the transparency so it should reduce the bid-offer spreads.
Requiring companies to trade on exchanges may restrict the ability of energy end-users to enter into some types of hedges as they are limited to the products offered.
RBI proposed rules would limit the amount of anticipated imports a refiner could hedge to 50% of the average imports over the past three years.
Central bank officials declined to respond to calls for comment. RIL also didn’t respond to calls while a spokesman for IOC said it has studied the guidelines and given feedback to the central bank.
Natalie Obiko Pearson in Mumbai contributed to this story.