To view the Determination of
Foreign Exchange Swaps and Foreign Exchange Forwards under the Commodity
Exchange Act, visit link.
WASHINGTON - The Dodd-Frank Act
put in place a comprehensive set of reforms to help build stronger, safer, and
more efficient financial markets. The Obama Administration fought hard
for and strongly supports the Dodd-Frank Act’s comprehensive reforms to the
derivatives market, which will reduce risk, increase transparency, and provide
accountability for market participants.
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
Act’s objectives for reform – including high levels of transparency, effective
risk management, and financial stability.
The FX swaps and forwards market is markedly different from other
derivatives markets. Existing procedures
in the FX swaps and forwards market mitigate risk and help ensure stability. 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. This market plays an important role in
helping businesses manage their everyday funding and investment needs
throughout the world, and disruptions to its operations could have serious
negative economic consequences. Furthermore,
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.
Given these considerations, Treasury has issued a final determination providing
that certain mandatory derivatives requirements, including central clearing and
exchange trading, will not apply to FX swaps and forwards.
This final determination is narrowly tailored. FX swaps and forwards will remain subject to the
Dodd-Frank Act’s 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. Importantly, the final 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.
The FX Swaps and Forwards Market Operates with High
Levels of Transparency, and the Dodd-Frank Act Will Further Increase
Transparency
Market
Pricing Transparent and Readily Available. Unlike other
derivatives, FX swaps and forwards already trade in a highly transparent,
liquid, and efficient market. FX swaps
and forwards are heavily traded on electronic platforms, and market pricing information
is readily available from a number of sources. These factors reduce the potential benefits of
mandatory exchange trading.
Additional
Transparency through the Dodd-Frank Act. The Dodd-Frank
Act’s trade-reporting requirements for FX swap and forward transactions will
further improve the information available to regulators and their ability to
oversee this market and its participants.
A Number of Unique Factors Mitigate Risk in FX
Swaps and Forwards Market
Fixed Terms, Physical Exchange of Currency. In
contrast to other derivatives, FX swaps and forwards always require both
parties to physically exchange the full amount of currency on fixed terms
that are set at the outset of the contract. Market participants know the full extent of their own payment
obligations to the other party to a trade throughout the life of the
contract.
Well-functioning Settlement Process. Because
FX transactions involve the actual exchange of currency, settlement risk (the
risk that one party to an FX transaction will pay the currency it sold but
not receive the currency it bought), is the main source of risk in these
transactions. The strong,
internationally coordinated oversight of this market led to the
establishment of a well-functioning
settlement process that effectively addresses this risk for a majority of
transactions. There is
extensive use of payment systems that permit the transfer of one currency
to take place only if the final transfer of the other currency also takes
place.
Shorter
Duration Contracts. FX swaps and forwards are predominantly
short-term transactions (68 percent of the market matures in one week or less
and 98 percent in one year or less). Other
derivatives have much longer average maturity terms, ranging from two to 30
years. Because of their short duration,
FX swaps and forwards pose significantly less counterparty credit risk than
other derivatives, reducing the potential benefits of central clearing for
these instruments.
FX Swaps and Forwards are subject to a Strong,
Comprehensive Oversight Framework that the Dodd-Frank Act further Strengthens
Subject
to Strong, Comprehensive Oversight for Three Decades. The FX swaps and forwards market and its key
participants have been subject to strong, comprehensive, and internationally
coordinated oversight by central banks for more than three decades. Prudential
regulators impose capital and margin requirements and monitor the use of
FX-related settlement arrangements and other measures to reduce counterparty
credit risk. Through the Basel Committee
on Banking Supervision and the Committee on Payment and Settlement Systems,
central banks and prudential regulators continue to strengthen already robust
risk management and settlement practices of FX market participants.
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