Firms settle out of court with banks DERIVATIVE TRUCE

 AYEAR ago, many firms were up in arms against their bankers when their derivative deals backfired. It was the first big encounter of Indian companies with a brutal currency market and complex derivatives — the kind of stuff that were till then confined to the pages of Liar's Poker and Bonfire of the Vanities. Today, a working capital crunch and trade downturn have pushed them to the negotiating table.
    Sundaram Multi Pap, a Mumbai-based firm which was the first to move court, has unconditionally withdrawn the case, preferring instead to settle the entire loss with its banker ICICI — the most aggressive derivatives player. The settlement happened some weeks ago.
    Some other firms that have agreed to resolve the derivative losses out of court are Avanti Seeds, Ramdev Rice, Sumeet Industries and Nitin Spinners. A month ago, Bangalore-based silk fabrics exporter Himatsingka Seiden opted for a settlement with HDFC Bank, while an European bank recently resolved its dispute with a Tirupur exporter. Settlements are also being negotiated with companies which did not move court. "Nearly 40 clients of ICICI have signed MoUs with the bank to resolve the derivatives issues," said a senior official.
    Two things have made such agreements possible. First, the fall in Swiss franc against the dollar has cut the mark-to-market losses in these cross-currency derivatives, making the positions less risky and easier to settle. Secondly, some companies were left with little choice after banks froze their working capital lines. Yen appreciation could spell trouble for cos
    ACCORDING to a senior lawyer, some banks had obtained orders prohibiting the promoters of companies — which had entered into derivatives — from disposing assets, particularly in cases where the promoter is a guarantor. "These orders restricted their ability to raise funds as securing loans against assets would have been construed as disposal of assets," he said.
    Indian exporters and other companies had entered into cross-currency derivative transactions with banks to either get a better exchange rate on their export receivables or convert more expensive rupee loans into Swiss franc or yen which carry a much lower interest rate. The deals went haywire when the Swiss franc and yen began to rise unexpectedly against the dollar and the exchange-risk protections derived from option contracts got knocked off.
    Today, a different story is unfolding. "The pain is in the dollar-rupee deals. After exporters who were hit by the earlier derivatives walked out of the contracts, they sold their expected dollar receivables in the plain rupee-dollar foward market. Some of these deals stretch for as long as two to three years. Now, with the dollar rising against the rupee, they feel they have lost out," said a treasurer of a foreign bank. For these firms, it could be more than an opportunity loss. If the export market slumps, overseas buyers will ask for a better rate and that's when exports contracted at less attractive exchange rates may feel the pinch. However, there is a distinct feeling that the dollar surge is overdone and the next few months could see the greenback sliding against the rupee.
    Another currency to watch out for is the yen. Some companies — and bankers feel the number would not exceed 30 — may be feeling the jitters due to the recent appreciation of yen. Having breached 90 to a dollar, the Japanese currency may touch 85 in a thin December market. These corporates had bought yen protections at levels ranging from 90 and 85 to reduce the risks arising from a rising yen. Under the contracts, better known as American knock-out options, the protection will vanish once yen touches that mark.
    These are synthetic deals to swap rupee loans into yen, where corporates pay the interest and repay the loan principal in yen. To hedge against yen volatility, many companies had bought currency options which give them the right to purchase yen at a pre-decided rate.
    So, even if yen appreciates, they would be in a position to buy the currency at a rate that is cheaper than the prevailing market rate. However, such options do not give absolute protection irrespective of the level at which the yen trades against the dollar. There are conditions: in some contracts, protection vanishes after the yen touches 90 or various levels between 90 and 85 a dollar. So, even if the yen recedes after touching 90, the companies will not enjoy the protection (or the option to buy yen at the agreed level).
    Corporates that have bought European options are better placed. For them, the exchange rate on the date of interest or principal payment is what matters. So if the yen shoots above the preagreed mark on those days, the protection would disappear.
    sugata.ghosh@timesgroup.com