Those Basel proposals could be finalized in November. Arguments against parts of the proposals from the FX industry via its trade group, the Global Financial Markets Association (GFMA), are expected to be released on the group’s website next week. At the heart of industry debate around this issue is recommendations made by the BCBS, published in August, that all uncleared derivatives under the EU’s European Market Infrastructure Regulation (EMIR) be subject to mandatory variable margin (VM) and initial margin (IM) across all product types, including foreign exchange. FX participants are concerned about how these requirements will be applied globally and consistently to enable a level playing field across jurisdictions, primarily between the US and EU. The current state of affairs As things stand in the US, there is the expectation that FX swaps will be exempted from clearing and therefore a common margin rule will not apply. The exemption is yet to be officially approved by the US Treasury Department, but expectations are that it will receive final approval. The US Treasury indicated in the last couple of days that it is likely to announce its decision on the exemption for FX products in early 2013. However, in the EU, no such exemption exists, and it is not anticipated, according to FX industry trade groups, whose members trading in the EU will be subject to mandatory clearing for some currencies products, and margin requirements for others. From the industry’s point of view, there is something of a contradiction here. On the one hand, industry officials in Europe point out that US regulators are saying that FX over-the-counter (OTC) futures and swaps, at least from a US treasury perspective, should be exempt from being cleared through a clearing house because they are deemed “not systemically risky”. At the same time, EU regulators through the BCBS process will be able to charge market participants with a potential 6% margin for trades on several classes of OTC FX products, say industry officials. While the industry accepts it has not dealt with every part of risk in the FX market, recent studies conducted by GFMA found that regulators should examine the risk of leaving OTC FX forwards and swaps unregulated as a whole for the good of the FX market. GFMA argues that the majority of the structural risk associated with these products is settlement risk and that, via CLS and other settlement methods, the risk is reduced by 94% – with just 6% left in the form of mark-to-market risk. This 6% of mark-to-market risk is managed by credit support annex (CSAs) agreements, says GFMA. GFMA response In an interview with EuromoneyFXNews, GFMA global FX division managing director James Kemp says it is important for regulators to realize that the key risk in foreign exchange is settlement risk, which his group says comprises 94% of estimated maximum loss exposure in a trade for FX instruments with a maturity of six months. The FX industry has moved to manage this settlement risk in a number of ways, including the build out and usage of the CLS settlement system.
| James Kemp:|
"It would be
their FX risk."
According to Stanford University professor Darrell Duffie, the black and white, go/no-go potential of the treasury exemption means the FX market has it all to play for.
“We have heard nothing that differs from the proposed determination in April 2011, so we believe the exemption will still stand,” says Kemp.