The US Treasury has decided to exempt FX forwards and swaps from mandatory clearing. In its final determination on the matter last week, it said existing procedures in the FX swaps and forwards market mitigate risk and help ensure stability.
Congress provided the Secretary of the Treasury with the authority to determine whether certain derivatives requirements, including central clearing and exchange trading, should apply to foreign exchange (FX) swaps and forwards, based on the recognition within Congress that the unique characteristics and pre-existing oversight of the FX swaps and forwards market already reflect many of the Dodd-Frank Acts objectives for reform including high levels of transparency, effective risk management, and financial stability.
Treasury said its final determination was based on considerations that the FX swaps and forwards market is markedly different from other derivatives markets. While central clearing requirements will strengthen the rest of the derivatives market, the potential benefit is reduced in the FX swaps and forwards market because existing practices already help limit risk and also ensure that the market functions effectively, it said.
The proposed determination does not extend to other FX derivatives, such as FX options, currency swaps, and non-deliverable forwards. These other FX derivatives will be subject to mandatory clearing and exchange-trading requirements.
Furthermore, Treasury found the settlement of the full principal amounts of the contracts would require substantial capital backing in a very large number of currencies, representing a much greater commitment for a potential clearinghouse in the FX swaps and forwards market than for any other type of derivatives market.
FX swaps and forwards will remain subject to the Dodd-Frank Acts new requirement to report trades to repositories and rigorous business conduct standards. Additionally, the Dodd-Frank Act makes it illegal to use these instruments to evade other derivatives reforms.
Treasury recognised the FX industrys efforts along with DTCC to develop a global trade repository to store FX trade information, thereby providing additional oversight for regulators and transparency for users. The global build out of this repository, already in testing, will increase its effectiveness for regulators and efficiency for participants, said the Treasury.
The Global Financial Markets Associations Global FX Division, whose members are thought to represent more than 90% of the FX Market, welcomed the Treasurys decision, saying the exemption of FX swaps and forwards is a critical step in ensuring the safe functioning of a well performing market and in promoting clarity in the international regulatory regime.
The Global FX Division cited research carried out by Oliver Wyman in October 2010, which found that the key risk in foreign exchange is settlement risk, comprising 94% of the estimated maximum loss exposure in a trade for FX instruments with a maturity of six months and 89% for instruments with a maturity of two years. The Division said settlement risk is already managed effectively through the existing CLS settlement system, which covers 17 currencies and is regulated by the Federal Reserve Bank of New York – who also Chair the joint oversight committee with 21 other Central Banks.
James Kemp, managing director of GFMAs Global FX Division, commented: We very much welcome the US Treasury final determination. Moving FX swaps and forwards to centralized clearing would not only have created additional costs for businesses and investors, but also increased systemic risk. After such a detailed consultation period, this final decision from the US Treasury provides the clarity the industry needs to now further develop the infrastructure of the future.
(JDC)