LEADER
under the CEA would impose a mandatory central clearing and exchange or swap execution facility (SEF) trading regime for FX, regulated by the CFTC. Tese requirements could introduce significant new risks into the FX market.
Because the FX market is an integral part of the global payment system, the failure of an FX CCP could be catastrophic, with destabilising effects on foreign exchange and the global economy as a whole. Mandatory exchange trading is also inappropriate for a market that functions as an integral component of the global payment system, in which financial instruments are specifically designed (particularly as to tenors) to match the commercial needs of market participants.
85% of FX transactions involve the U.S. dollar, yet only 18% of FX transactions occur within US borders. US-mandated
Getting the message across
AFME’s Global FX Division has recently hosted events in Brussels, providing a forum for its case to be heard by MEPs, regulators and market participants. Te debate has been engaging and hard- hitting; particularly noteworthy was the ‘corporate’ perspective, which highlighted serious repercussions that could arise from a one-size fits all regulatory approach. Bayer’s head of corporate treasury noted that should the regulatory threat materialise, it could force corporates to move production away from Europe and into the countries in which they sell.
Te proposed
“It is crucial that regulation identifies the most appropriate risk in the market. For the FX
sector, this is settlement risk and CLS represents a highly effective system.”
clearing and trading requirements would likely drive the US 18% of FX market share further offshore, reducing the Federal Reserve’s ability to exercise effective oversight of the FX market. Given the importance of the FX market to the US economy, this would be an undesirable result.
Mandatory clearing would also present unique difficulties and complexities. It would introduce the danger of concentration risk, creating a potential single point of failure where none exists today, simply to address limited residual credit risk exposure. Such a change could not be implemented successfully without significant cooperation and consensus among the central banks responsible for all the world’s major currencies. Before embracing mandatory clearing and trading requirements for the FX market, central banks are likely to require significant evidence that it can be implemented without imposing greater risk upon the financial system and would want to understand how a CCP model would interact with CLS Bank.
30 | april 2011 e-FOREX
legislation would also have a significant negative impact on pension fund activity. Pension funds have internationalised and when they invest abroad, they hedge out all or part of their international FX exposure. Making pension funds post collateral (under proposed EMIR legislation) will
disrupt this hedging and, given that pension funds do not like retaining large cash holdings, the potential level of disinvestment would amount to a fall from 100% to around 90-95%, according to experts. It is crucial that regulation identifies the most appropriate risk in the market. For the FX sector, this is settlement risk and CLS represents a highly effective system. Furthermore, moving the FX market to a centrally cleared model raises the possibility of amplifying risk by deflecting efforts away from the expansion of CLS and by introducing concentration risk within the clearing house.
Finally, requiring central clearing runs the risk of increasing costs for corporates and for pension funds, leaving little doubt that the industry finds itself at a critical juncture. Unless US Treasury Secretary Geithner announces the FX exemptions by June 2011, the effect of new regulations on the FX market could have serious repercussions that will live on for decades to come.
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