Forward exchange contract is a device which can afford adequate protection to an importer or an exporter against exchange risk. Under a forward exchange contract a banker and a customer or another banker enter into a contract to buy or sell a fixed amount of foreign currency on a specified future date as a predetermined rate of exchange. Our exporter, for instance, instead of groping in the dark or making a wild guess about what the future rate would be, enters into a contract with his banker immediately. He agrees to sell foreign exchange of specified amount and currency at a specified future date. The banker on his part agrees to buy this at a specified rate of exchange. The exporter is thus assured of his price in the local currency. In our example, the exporter may enter into a forward contract with the bank for 3 months delivery at Rs.49.50. This rate, as on the date of contract, is known as 3 months forward rate. When the exporter submits his bill under the contract, the banker would purchase it at the rate of Rs.49.50 irrespective of the spot rate then prevailing.
According to Rule 7 of FEDAI, a ‘forward contract’ is deliverable at a future date, duration of the contract being computed from the spot value date of the transactions. Thus the 3 months forward contract is booked on 12th February, the period of two months should commence from 14th February and the forward contract will fall due on 14th April.
Date of delivery under forward contract will be:
- In case of bills/documents negotiated purchased or discounted: date of negotiations/purchase/discount and payment of rupees of customers.
- In case of bills/document sent for collection: date of payment of rupees to the customer on realisation.
- In case of retirement/crystallization of import bills/documents: the date of retirement or crystallization of liability whichever is earlier.
Booking of Forward Contracts
1. The transactions of booking of forward contract is initiated with the customer enquiring of his bank the rate at which the required forward currency is available. Before quoting a rate the bank should get details about (i) the currency, (ii) the period of forward cover, including the particulars of option, and (iii) the nature and tenor of the instrument.
2. The branch may not be fed with forward rates of all currencies by the Dealing Room. Even for major currencies forward rates for standard delivery periods may only to available at the branch.
3. If the rate quoted by the bank is acceptable to the customer, he is required to submit an application to the bank along with documentary evidence to support the application, such as the sale contract.
4. After verification of the application and the documentary evidence submitted, the bank prepares a ‘Forward Exchange Contract’.
5. While preparing the contract, the following points are to be noted:
- The branch may give a serial number to the contract, so that further reference to if becomes easy.
- Contracts must state the first and last dates of delivery. It is not permissible to state in contracts ‘delivery one week’ or ‘delivery one month’ or ‘delivery three months forward’, etc.
- When more than one rate for bills with different delivers are mentioned, the contract must state the amount and delivery against each rate.
- No usance option may be stated in any contract for the purchase of bills. That is, the contract should not give option to the customer to tender sight bill or in the alternative 30 days bill, etc. It can be either sight bill or a usance bill of a specified usance as mentioned in the contract.
- The first portion of the contract is relevant for booking of the contract. The second portion is used for recording deliveries under the contract.
- The contract should be complete in all respects.
6. The number of copies of the contract prepared will depend upon the requirements of the bank. The original of the contract duly signed by the bank, along with the duplicate, is sent to the customer.
7. The details of the contract are entered are entered in a Forward Contract Register. The resister also provides for recording of details of documentary evidence verified.
8. The documents are verified and marked with the bank stamp and signature of the bank official, after entering the particulars of the forward contract booked. It is returned to the customer.
9. The due date of the contract should be diarised in a regular and followed up on the due date.
10. Charges for booking the forward contract as prescribed by the bank concerned is recovered from the customer.
11. When the customer delivers foreign exchange on the due date, the transactions is done at the rate agreed.
Exchange Control Regulations
While booking forward contracts for customers, banks are required to observe that the exchange control regulations are complied with. Foreign Exchange Management (Foreign Exchange Derivative Contracts) Regulations, 2000 govern forward exchange contract in India. The terms and conditions relate to booking, cancellation, rebooking etc. of forward exchange contracts are given below:
- The authorized dealer, through verification of documentary evidence, should be satisfied about the genuineness of the underlying exposure.
- The maturity of the hedge should not exceed the maturity of the underlying transaction.
- The currency of hedge and tenor are left to the choice of the customer.
- Where the exact amount of the underlying transaction is not ascertainable the contract can be booked on the basis of the reasonable estimate.
- Foreign currency loans/bonds will be eligible for hedge only after final approval is accorded by the Reserve bank, where such approval is necessary.
- In case of Global Depository Receipts (GDRs), the issue price should have been finalized.
- Substitution of contracts for hedging trade transactions may be permitted by an authorized dealer on being satisfied with the circumstances under which such substitution has become necessary.
The operational aspects of the Forward Contract conditions are given below:
1. Forward contracts can be booked for resident customers who are exposed to exchange risk in respect of genuine transactions permitted under current regulations.
2. Before entering into a forward contract, it should be ensured that the customer is in fact, exposed to exchange risk in a permitted currency in the underlying transaction. The choice of the currency in which the forward contract is entered into is left to the customer.
3. While booking forward contracts, irrespective of the underlying transaction being a current account transaction or a capital account transaction, the bank should verify suitable documents to ensure the authenticity and the amount of the permitted currency of the underlying transaction.
4. Forward contacts may be booked for exporters/importers, without production of documents, up to the average of past three years export/import turnover. However, at any point of time, the outstanding contracts shall not exceed 25% of eligible limit, subject to a cap of USD 100 million.
5. Forward contract may be booked for the whole or part amount of the underlying transaction. Ordinarily the maturity of the forward contract should match that of the underlying transaction.
6. The bank may permit the customer to substitute an import/export order under a forward contract provided it is satisfied after verifying the documentary evidence that a genuine exposure to the extent of the amount of the original forward contract subsists under the substituted order.