Derivatives fiasco: Companies blame misinformation

Open any financial daily from the past few months and chances are you will see a news report or editorial on litigation concerning foreign exchange and currency linked derivative contracts between banks and companies.

While some companies at this point have already gone to court, it is feared that hundreds of others (mostly small and medium-sized) could face significant losses arising from such transactions. Although market reports have estimated potential losses in excess of US$3 billion for corporates, the Reserve Bank of India (RBI), recently stated it does not perceive any systemic risks from such transactions.

The controversy primarily surrounds over the counter (OTC) derivatives (as distinguished from exchange traded derivative contracts). Simply put, OTC derivatives are bilateral contracts in which the parties to the contract agree on how a particular trade or agreement is to be settled in the future, as opposed to an exchange determined settlement mechanism, as in the case of exchange traded derivatives. Futures or options are the most common examples of such exchange traded derivatives in the Indian scenario. The term “derivatives” has been defined (retrospectively per a 2006 amendment to the RBI Act, 1934) as follows:

Sawant Singh is a partner, Ameya Khandge is a senior associate and Arun Madhu is an associate at Trilegal in Mumbai. Trilegal is a full service law firm that advises on corporate and commercial law in India and provides commercially oriented legal advice and services in relation to all sectors of the economy. The firm has offices in Delhi, Mumbai, Bangalore and Hyderabad and has over 80 lawyers, some of whom have experience with law firms in the United States, the United Kingdom and Japan.