Wednesday, November 18, 2009

Forex bankers alarmed by clearing plans

Posted in the Financial Times by Jennifer Hughes, Joanna Chung and Tom Braithwaite:

Foreign exchange bankers reacted with alarm on Wednesday to proposals from Barney Frank, the powerful chairman of the House financial services committee, that would require trades in currency derivatives to be processed through a centralised clearing system.

Bankers said the proposals would introduce new systemic risks into the financial system and that the sheer size of the market would dwarf the risk that could be sustained by any clearing house.

About $3,200bn of currency is traded daily around the world. About two-thirds of that trade is in derivatives that are used frequently by companies during the normal course of business to hedge the risk that currencies move sharply between a deal being struck and completed.

Bankers say that companies would face higher costs for these hedges under centralised clearing and that potentially they could be required to post extra collateral.

But some large users of currency hedging said on Wednesday they were unconcerned by the putative change, having calculated that the potential increase in cost would be “marginal” and outweighed by greater security and price transparency.

The proposals by Mr Frank, outlined in an interview with Risk magazine, come as lawmakers and regulators tussle over the detail of legislative proposals governing the vast over-the-counter derivatives market.

Some companies have shrugged off entreaties from their banks to lobby members of Congress over derivatives reform, concluding that their interests could be better served by the broad shift to central clearing and exchange trading.

Others – such as Caterpillar this week – have argued they face costly margin requirements under some versions of the regulatory reforms now under way.

Mr Frank said that mooted exemptions for foreign exchange trades from the OTC market reforms being considered by Congress would not be adopted, despite extensive lobbying from bankers.

“The administration had asked for that amendment, but we are going to take away the exemption for foreign currency [swaps and forwards],” he said.

It is far from clear whether the proposals would survive the legislative process.

Bankers lobbied Congress to get an exemption for foreign exchange trading, arguing that it is essentially the glue that holds the financial system together.

“This isn’t about us protecting our business, central clearing is about deliberately introducing concentration risk into the market – its nuts,” said the head of foreign exchange at one of the largest forex banks.

One senior official at a large US bank added: “Companies are already baffled why they’re caught up at all in this given that what they do here didn’t contribute to the crisis. Now they’ll be baffled squared.”

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