The determination by the Secretary of the Treasury to exempt foreign exchange swaps and foreign exchange forwards from regulation under the Dodd-Frank Act is unjustifiable on legal, policy, and pragmatic grounds. From a legal perspective, the decision does not come close to satisfying the statutory criteria that Congress established to control the Secretary’s decision-making process. As a matter of policy, the exemption is a repudiation of the principles of risk mitigation, transparency, and accountability that are the very foundation of the Dodd-Frank Act. On a practical level, the decision entirely ignores a dramatic lesson from the past—the near collapse of the foreign exchange market during the financial crisis—thus perpetuating an opaque market that promises future systemic instability or even crisis. Both foreign exchange swaps and forwards should be fully subject to regulation in accordance with the Dodd-Frank Act and the regulations promulgated thereunder.
Data released by the Federal Reserve Bank prove that the foreign exchange markets were on the verge of collapse days after the financial crisis began in September of 2008. The new data also prove that only massive, emergency and unlimited Fed intervention in the foreign exchange markets prevented a collapse. Thus, the data refute the claim that the foreign exchange markets performed well during the financial crisis and should be exempt from regulation. The new data show that the foreign exchange markets in the fall of 2008 froze and were likely to collapse. The same counterparty distrust that threatened those other markets also froze the foreign exchange markets and liquidity quickly evaporated. As in those markets, the Fed had to bail out the foreign exchange markets with more than $2.9 trillion in October 2008 alone and with more than $5.4 trillion of foreign exchange swaps in the three months following the Lehman Brothers bankruptcy. Based on this incontrovertible information from the Fed, any exemption for foreign exchange swaps or forwards is clearly impermissible under the statutory requirements. Moreover, in light of the Fed’s extraordinary emergency intervention required to prevent the foreign exchange markets from collapsing, it would be irresponsible to permit such markets to continue operating in the shadows without transparency or regulation, which is what an exemption would do.
Further, foreign exchange swaps and forwards are not qualitatively different from other classes of swaps in a way that would make them ill-suited for regulation as swaps. There are no objective differences between foreign exchange swaps and forwards and standard swaps that would warrant exempted status. The exemption will undermine the goals of the Dodd-Frank Act, by preventing much-needed transparency and risk controls from being applied to foreign exchange swaps and forwards. The intensity of those who favor exemption, fueled by a desire to preserve this profitable marketplace in its current form, regardless of the risk, must not be allowed to frustrate the goals of the Dodd-Frank Act. The exemption of foreign exchange swaps and forwards should not be granted.