Oct 17, 2012

FX Swap Regulation in Limbo: October 12th and Beyond

Numerix Video Blog - FX Swap Regulation in Limbo: October 12th and Beyond

On October 12th, 2012 banks will have to start counting their swaps transactions to see whether they will need to register in December with US regulators as swap dealers, and be hit with higher costs. However, at this point industry players are still in the dark about whether to count their foreign exchange swaps and forwards towards the threshold.

In this video blog, we will delve into this issue with Numerix Host James Jockle, SVP of Marketing, and Udi Sela, 20-year FX veteran and Vice President of Client Solutions, discussing why financial institutions are increasingly anxious about the new rules, despite some assurances from the Treasury Department that foreign exchange swaps would be exempt.

What do you think?
What is your take on the October 12th swap dealer registration requirements with regards to FX Swaps? Should FX Swaps be exempt? How do you see this impacting the market if the exemption does not come to fruition?

Weigh in and continue the conversation on Twitter @nxanalytics, LinkedIn, or in the comments section below.


Numerix Video Blog Transcript - FX Swap Regulation in Limbo: October 12th and Beyond:

Jim Jockle (Host): Hi welcome to Numerix video blog, I’m Jim Jockle your host. October 12 circle the calendars banks have to start counting swaps transactions to see whether they’ll register in December as swaps dealers. Now with me today – 20 year FX vet and Vice President of Numerix Client Solutions Group, Udi Sela. Welcome.

Udi Sela (Guest): Thank you Jim.

Jockle: So April 2011 US Treasury comes out with a proposal to exempt Forex swaps yet we are pressing on the October 12 date. Give us a little background of what’s going on and why specifically FX swaps are proposed for exemption.

Sela: Sure, so we of course know that post the subprime crisis the main issue is how to regulate the derivatives market in a way that incidents like the Lehman Brothers case will not reappear. Specifically looking at the FX market one of the most frequently traded instruments is FX swaps. These swaps are mostly used for funding. The big question is, if banks are required to report the FX swaps positions if they have more than 8 billion dollars of nominal amount, and probably be liable to capital charges. This may have an impact on the trading of FX swaps and the cost for the end clients. Important to mention and I guess this is the main reason for exempting the swaps is that FX swaps are used mostly for funding and not to execute a view on the market.

When I say funding, it could be funding of an open position or just funding the balances of banks. So just to be clear if I’m an American bank and I have balances in Euros, Brazilian Real and so forth typically I would use FX swaps in order to cover my balances. And when I use FX swaps I’m not changing the counter position of the bank. So one may ask why I should be liable to additional capital charges when I cover my balances when I’m performing a funding operation.

Jockle: So we hit the date it’s now October 13th we’re running towards December what’s going on in the bank if the exemption is not passed by that point.

Sela: That would imply that banks would start registering the swaps and assuming those large market makers would have additional costs first of all capital costs as well as operational costs. Banks we know do not operate in a vacuum so they would like to charge the banks for this additional cost that would imply that corporations, investment firms, ect. would have to pay a higher price for funding operations.

Jockle: So the cost gets passed through. What about the market implications itself. You had a webinar a few weeks ago proposing several strategies given the low vol environment of many pairs in the market right now what if any market moves would happen based on the lack of exemption going forward.

Sela: I would think if the regulations go through that we’d see less operations in the market because people would be reluctant to execute trades because they would understand that the trade actually has an additional cost now which is the funding cost. So why should I enter in to a position or investment decision if I know that I have to make more in order to cover my additional funding costs. So I would suspect that volatility was decrease further.

Jockle: One last question in this particular video blog for the day and I’m looking at a Reuters article from earlier (Sept 17th) covering the issue and one of the things that has been tied to this as putting political risk around this has been LIBOR and its consequences and one of things that struck me quoted in the article is “…The LIBOR scandal, which a key input to FX swaps valuation was shown to be fraudulent and manipulated by participating banks, shows exactly how problematic this is…” give us the role of LIBOR in valuation for FX swaps.

Sela: So I have to admit that I was very surprised when I saw that too because personally I don’t see what is the connection between LIBOR and FX swaps. I’ve traded FX for many years and never priced FX swaps off LIBOR rates. LIBOR represents the offering rates London and has nothing to do with pricing FX swaps all along the day so that was kind of surprising. There’s enough to be said about LIBOR and regulating and governing in a way that people do not misconduct but it has nothing to do with FX swaps.

Jockle: So maybe I’ll put you in the hot seat and we’ll go through another case study around proper valuation in the role of FX swaps going forward.

So thank you Udi I appreciate your time today. That will conclude today’s video blog.

Feedback? – Let us know. Questions you want to hear answered we’ll definitely address them and please following us at @nxanalytics on Twitter and on our blog at blog.Numerix.com.

Thank you and see you soon.

Udi: Thanks Jim.

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