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September 20, 2011

Financial Times: US Treasury grants exemption for forex swaps

By Tom Braithwaite in Washington

The US Treasury has opted to exempt foreign exchange swaps from sweeping new derivatives rules, providing a big victory for dealers and a defeat for the proponents of more far-reaching market reforms.

Last year’s Dodd-Frank regulatory overhaul gave Tim Geithner, the Treasury secretary, the power to decide that over-the-counter forex swaps and forwards did not need to be subject to the same requirements for clearing and exchange trading as other derivatives.

The decision to exempt them was widely supported by both banks and users of the instruments. Dealers, including Deutsche Bank, and non-financial groups, such as Caterpillar, submitted letters in support of the move, arguing that foreign exchange swaps were qualitatively different from other derivatives.

The issue has achieved totemic significance for reformers who believe that the instruments should be included in the regime and leaving them out creates a loophole. Democratic senators Carl Levin, Maria Cantwell and Tom Harkin all argued strongly against the exemption.

But the Treasury sided with the industry, deciding that the market was “markedly different” from other derivatives – “highly transparent, liquid and efficient”.

It said fixed terms of shorter duration, physical exchange of currency and an existing well-functioning settlement process meant there was no need to drag the instruments into a more restrictive regime. However, they will be subject to the same reporting standards as other derivatives.

“Congress recognised that the foreign exchange swaps and forwards market already reflects many of the Dodd-Frank act’s goals, including high levels of price transparency, effective risk management and electronic trading,” said Mary Miller, assistant Treasury secretary. “We think this narrow slice should be exempted.

“Throughout the financial crisis the foreign exchange swaps and forward markets continued to operate.”

Dennis Kelleher, chief executive of Better Markets, which advocates tougher financial reforms, said the Treasury’s exemption was the “starting gun for the financial wizards on Wall Street to let their creative juices flow and figure out how many products they can cram through the loophole”.

Some observers have suggested that it might be possible to disguise different contracts as foreign exchange swaps to benefit from the lighter-touch regulatory regime. Ms Miller said it would be highly difficult “and illegal” to try to use the determination as a loophole for other types of derivative.

The “proposed determination” gives another opportunity for public comment but it is widely expected to be the final word on the issue.

Richard Prager, head of global trading at BlackRock, said the “very sensible and balanced decision” was welcome. Clearing for foreign exchange swaps did not make sense as they were not “credit intensive and [did not include] a lot of long dated maturities”, he said.

James Kemp, head of the Global FX Division, an industry lobby group, said European regulators should follow the lead of the US in exempting the instruments

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