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Summary of the Decision to Exempt Foreign Exchange Swaps

WHAT’S THE ISSUE? The Treasury secretary was given authority under the Dodd-Frank Act to exempt foreign exchange swaps and forwards from regulation, most notably to be traded on exchanges and go through third-party clearinghouses. Treasury would have to determine that these products should not be regulated as swaps and are not structured to evade the Dodd-Frank Act.  In October 2010 Treasury requested comment on whether the exemption should be granted.    

WHY IS IT IMPORTANT? The issue goes to the heart of financial reform as the unregulated derivatives market played a key role in triggering the 2008 financial crisis.  Subjecting all swaps to regulation, including foreign-exchange swaps and forwards, is essential to limit systemic risk and increase transparency. The market is very large, involving average turnover of $4 trillion per day.  Banking groups lobbied heavily for the exemption, as the profitable business brought in $4.3 billion in revenue for U.S. firms during the second quarter 2010.

WHAT DID BETTER MARKETS ARGUE?  We presented several key points.  First, the near collapse of the foreign-exchange swaps market during the financial crisis of 2008 demonstrated these derivatives must be fully regulated.  In fact, those markets froze, and the Federal Reserve had to establish a parallel market of central-bank swap lines to satisfy the foreign demand for U.S. dollars because they could not be obtained elsewhere.  Better Markets crunched Fed data showing that the central bank pumped $5.4 trillion into those swap lines in the three months after Lehman’s failure. 

We also argued these products are qualitatively no different from other types of swaps. Accordingly, the regulation of these products as swaps is necessary to mitigate systemic risk. They are not subject to an alternative, comparable regulatory scheme; and the exemption will be used to evade regulation of other types of derivatives. 

WHAT DID TREASURY DO?  On April 29, Treasury announced it would grant the exemption.  Ignoring all available evidence, a top official noted that the market had “high levels of price transparency, effective risk management, and electronic trading.” In reality, the determination failed to satisfy any of the statutory criteria that Congress established for the decision-making process.  Better Markets strongly disagreed with Treasury’s heavy reliance on data reporting systems and other measures that are not even in place yet for foreign-exchange swaps and forwards. Those systems will depend on voluntary industry implementation before they ever come to pass. Unfortunately, the exemption will expose our markets to continuing and unnecessary systemic risk and a lack of transparency.  

Notice for comment on the decision-making


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