At lunch the other day with two senior FX faces, it was impressed upon me how much management time is taken up with education. Not the education of juniors but of politicians and representatives of regulatory bodies.
It is little surprise that those charged with determining regulation for the financial markets are not always clued-up with the detail of the products that they want to oversee.
As a result, senior staff at major financial institutions are spending lots of time bringing the regulators up to speed. And rightly so: it will take keen thought to arrive at equitable regulation that both makes sense and complies with the vague but comprehensive proposals from Dodd-Frank and the European Commission.
A few particular regulatory questions were pondered during my lunch. Prime among these was whether FX swaps would have to be CCP’d or cleared. I answered an emphatic: “No”. The counter argument came back: “There is no logic in FX swaps being out and NDFs, with their comparatively negligible settlement risk, being in”.
That stumped me at the time but I have since thought of an answer: Being net-settled, non-deliverable forwards are a good fit for being exchange-traded. FX swaps on the other hand, despite being the principle vehicle of liquidity transference, can be broken down into a spot trade and an outright – indeed that’s all they truly are. And given that it is unanimously agreed that spot FX will not be affected by the regulation (show me the clearing house that is capable of dealing with that volume), it seems clear that FX swaps should be likewise exempted.
The question of currency options – that they are included under the regulation, but related spot delta hedges will not be – is awkward. The market will cope: the option will be booked under a CCP and cleared, while the initial spot or forward delta hedge will be booked with the true counterparty. Getting a holistic overview of the risk in the option book will be scarcely more difficult than it already is.
The most interesting point was about geographic jurisdiction. For example, it is hard to imagine the Monetary Authority of Singapore allowing an SGD trade to be cleared anywhere but Singapore isn’t it? Perhaps some headway will be made on this sort of question at the G20 in Seoul, but if the recent Brazilian ‘currency wars’ comments by finance minister Guido Mantega are anything to go by, there could be division of opinion between mature and emerging jurisdictions.
That difference was underlined by the apparent exclusivity of the meeting between CFTC chairman Gary Gensler and European commissioner Michel Barnier this week. The press release after affirmed that the regulators are mindful “that the United States and Europe move in parallel and that we don’t create new space for regulatory arbitrage”. Notice how the rest of the world doesn’t seem to count.
The release also contained the usual helping of fatuous nonsense. My personal favourite was that Gensler and Barnier “discussed the utility of position limits as a critical element in the regulatory toolkit for the oversight of physical commodity markets as well as other derivatives products, as such limits can promote fair and orderly markets and restrict the ability of a trader to hold an excessively concentrated position.”
I’m glad they sorted that out.
