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U.S. Treasury Proposes Exemptions for Foreign-Exchange Swaps

Assistant Treasury Secretary Mary Miller
Mary Miller, assistant secretary of the U.S. Treasury. Photographer: Andrew Harrer/Bloomberg

The U.S. Treasury Department proposed exempting foreign exchange swaps and forwards from most of the derivatives rules required under the Dodd-Frank Act, saying the market already meets many of the law’s objectives.

“Congress recognized 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,” Assistant Treasury Secretary Mary Miller said today at a briefing for reporters in Washington. “We think this narrow slice should be exempted.”

Under Dodd-Frank, foreign exchange swaps and forwards are subject to the same clearing and trading rules as other swaps unless the Treasury secretary determines they are different. Today’s proposal will be released for 30 days of public comment.

Swaps and forwards are part of a $4 trillion global daily turnover in the foreign exchange market, according to the Basel-based Bank for International Settlements. A coalition of 20 firms, including Deutsche Bank AG, Bank of New York Mellon Corp. and UBS AG, asked Treasury Secretary Timothy F. Geithner to grant an exemption in a November letter.

“Our companies, with well established global footprints, have financial transactions in dozens of currencies and rely on the FX market to help manage receipts and payments,” firms including Cargill Inc., Caterpillar Inc. and 3M Co. said in a letter urging an exemption.

Trading Revenue

Foreign exchange contracts were the largest source of trading revenue for banks’ derivatives and cash positions in 2010, according to the U.S. Office of the Comptroller of the Currency. U.S. commercial banks recorded $9.1 billion in revenue on trading of foreign exchange derivatives.

“Our investors are increasingly more interested in global investment products and hence a greater need to be able to hedge in a variety of currencies,” Richard Prager, managing director and head of global trading at BlackRock Inc., said today in an interview. “It is one of the most global, 24-hour markets.”

Miller, the Treasury Department’s assistant secretary for financial markets, said foreign exchange swaps and forwards present significantly less counterparty credit risk than other derivatives and there are procedures to mitigate risk.

“Central clearing could actually jeopardize the practices in the FX swaps and forwards market,” Miller said.


In comment letters to Treasury last year, Democratic Senators Carl Levin of Michigan and Maria Cantwell of Washington discouraged the department from granting the exemption.

“The secretary attempted to strike a balance in his proposal to exempt foreign exchange swaps and forwards from some of the recent reforms,” Levin said in a statement released today. “I have concerns that his proposed exemption relies on current industry practices that are inadequate and could be changed by the industry unless the exemption is conditioned upon their remaining in place.”

The Treasury proposal doesn’t exempt foreign-exchange derivatives from Dodd-Frank’s reporting requirements and business conduct standards. And the proposed exemption doesn’t cover foreign exchange options, currency swaps and non-deliverable forwards, which will be subject to clearing and trading requirements, Treasury officials said in a statement.

‘Swallow Up’

During the congressional debate over Dodd-Frank, the Treasury Department fought unsuccessfully to exclude foreign exchange from regulation over the objections of Commodity Futures Trading Commission Chairman Gary Gensler

An exclusion threatened to “swallow up the regulation” of derivatives if interest rate or credit swaps are structured as foreign exchange swaps to benefit from the exemption, Gensler wrote in an August 2009 letter.

The CFTC proposed rules on April 27 designed to give regulators “anti-evasion” authority to regulate as swaps transactions that may be “willfully structured” to benefit from an exemption of foreign exchange swaps and forwards.

“Clearly things can be structured to look like something else,” BlackRock’s Prager said. “There is a lot of financial engineering and those can happen. Our regulators would see that for what it is and I think could be very responsive to that.”

The 20-bank coalition said making currency derivative traders post margin in the U.S. -- a requirement for mandatory clearing -- would drive the remaining domestic market offshore. The letter was filed by three associations on behalf of 20 banks they termed the “Global FX Division.”

The group said in a statement today that the Treasury proposal “is a major step in ensuring the continued availability of cost-effective hedging for corporate and investors.”

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