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Foreign Exchange

Foreign exchange: FX clearing exemption could increase risk

On April 29 the US Treasury proposed exempting foreign exchange forwards and swaps from clearing and trading rules contained in the Dodd-Frank Act. The Global FX Division, a trade group representing the biggest users of foreign exchange, mainly banks, said at the time. "We very much welcome the US Treasury ‘proposed determination’, as moving FX swaps and forwards to centralized clearing will not only create additional costs for business users, but could also increase systemic risk." However, one influential financial market academic argues that the proposal to exempt FX might be a mistake, and could indeed foster systemic risk.

Darrell Duffie, professor of finance at Stanford University’s business school, believes the arguments for an exemption are "not sufficient".

Duffie says the idea that FX swaps and forwards exposures are small is unfounded. Indeed he goes as far as saying: "A failure to further regulate the control of counterparty risk in the foreign exchange derivatives market could be a significant mistake", based on his analysis of data on FX volatilities, gross market value positions, volumes of derivatives trading by maturity and the total outstanding notional amounts.

For instance, he says, there is no public disclosure of the total outstanding notional amount of FX derivatives that exist at maturities of over one month, which would allow a more detailed analysis of market-wide counterparty risk.

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