FX news: Europe rules on OTC derivatives
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Foreign Exchange

FX news: Europe rules on OTC derivatives

Kenan Maciel pointed out to me that it is “option 3” in his article for the FiX that best describes the EU rules on OTC derivatives that were released on Wednesday – that of reporting trades to repositories and central clearing for standardized derivatives.

But it is still unclear to me whether, under the European regulations, FX swaps come under the heading of derivatives. Yesterday’s press release actually defines a derivative as “a contract between two parties linked to the future value or status of the underlying to which it refers (eg, the development of interest rates or of a currency value, or the possible bankruptcy of a debtor).” There is no contingency in an FX swap and no doubts about the contracted payments, and it should be relatively simple to argue that it does not fit that definition. FX options and NDFs are, however, in a completely different situation. For FX options, it could be that the interesting days are over – contracts will evolve to a simple, standardized form so that they can be centrally cleared (only “non-financial firms [such as manufacturers] who use OTC derivatives to mitigate risk arising from their core business activities” are exempt from the central counterparty requirement) and structures that cannot fit a form acceptable to central clearing will remain OTC but “different risk management techniques must be applied (such as requirements to hold more capital)” so much so that they will become less viable.

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