In a potential victory for the forex industry, the U.S. Treasury Department issued a proposal on April 29 to exempt foreign exchange swaps and forwards from clearing requirements being placed on other over-the-counter (OTC) products by the Dodd-Frank Act.
The exemption applies to 5% of the $600 trillion FX market. Dodd-Frank gave the Treasury secretary the power to determine if this narrow subset of FX derivatives should be regulated.
"Unlike most other derivatives, foreign exchange swaps and forwards have fixed payment obligations, are physically settled, and are predominantly short-term instruments," Treasury wrote in its proposal. "This results in a risk profile that is different from other derivatives, as it is centered on settlement risk, rather than counterparty credit risk."
The exemption has met with both praise and criticism.
Robert McKeon, senior vice president of markets and liquidity at FXDD, is among those commending the exemption, partly because he says this market has become too large and complex to properly regulate. "[It is] large in the sense of number of trades, dollar volume and globally based participants. Complex in terms of regulation, as to how the rules can apply cross-border — if the other governing bodies create different operating rules, the market could move in many different directions," he says.
Most criticism of the proposal has been leveled at the perceived loophole this would create in the OTC market. "Given the size of the foreign exchange market, it must be regulated in a manner that can provide complete transparency and reduce credit and default risks," said Michael Greenberger, professor at the University of Maryland School of Law in a comment letter.
The proposal is nearing the end of a 30-day comment period, after which Treasury Secretary Timothy Geithner will make his final decision.