OTC Derivatives

OTC stands for “Over the Counter”. OTC Derivatives are the contracts that are traded directly between the buyer and seller without any intermediate exchange. Stocks that trade through OTC are usually smaller companies that cannot meet the listing requirements of the exchange.

Key Points for UPSC Prelims

  • The Reserve Bank of India has defined the OTC derivative as any derivative other than those which are traded on exchanges and will include those traded on electronic trading platforms (ETPs).
  • Important money market instruments like swaps, forward rate agreements are generally traded on OTC mode.
  • Till recently, the OTC transactions in India were highly unregulated with respect to due diligence, governance, sharing of information, reporting to SEBI / RBI, Pricing and valuation.
  • Under the powers conferred by Section 45W of the Reserve Bank of India Act, 1934 and under the provisions of Foreign Exchange Management Act, 1999, the RBI has recently issued the “Draft Directions on OTC Derivatives”

Draft Directions on OTC Derivatives

  • RBI provided definitions related to OTC in the draft directions.
  • The Board of Directors (or equivalent forum) and senior management of the market-maker shall ensure effective risk management, appropriate organization structure, and establish policies for OTC derivative products.
  • The policy for introducing new OTC derivative products should comprise of the process for evaluation and approval of new products. Additionally, all the new products should be approved by the Board of Directors.
  • Chief Compliance Officer (CCO) and the Chief Risk Officer (CRO) should also be involved in the approval of new products.
  • Other directions include terms related to an internal audit, Internal control, Risk Management, Post-trade conduct, Pre-trade contract, preservation of records, etc.

Banks, market participants, and other interested people can submit their feedback on the draft guidelines till January 15, 2021.

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