FX dealers seek harmony in margin row

A group of 22 global foreign exchange dealers are appealing to Asian regulators not to impose margin requirements on FX swaps and forwards.

Together the dealers represent 90% of the world’s FX market, says the Global Financial Markets Association (GFMA) – a coalition of three international bodies* that is representing them.

The GFMA is preparing to submit objections in response to a consultation paper from the Bank of International Settlements (BIS), which has set up a working group co-chaired by Alexa Lam, deputy chief of Hong Kong’s Securities and Futures Commission. The consultation process ends on September 28.

It comes after the GFMA made direct submissions to regulators in Taiwan, Hong Kong, Japan, Singapore and Australia to underline the importance of harmony in FX regulation.

In Asia, regulators including the HKMA and MAS have been readying laws to bring over-the-counter (OTC) derivatives into a central clearing and reporting process, in accordance with an accord by the Group of 20 nations in 2009 in response to the global financial crisis.

The HKMA and MAS have already stated they would exempt FX forwards and FX swaps from the obligation of central clearing.

That mirrors a proposal put forward by the US treasury department in April 2011 on the grounds that the Dodd-Frank Act excludes FX swaps and FX forwards from the definition of “swap”.

But while the US treasury department is also proposing that financial institutions not be required to post margins on non-cleared trades, in Asia some regulators have yet to follow suit.

Both the HKMA and the MAS, for example, have taken a wait-and-see approach, in anticipation of bodies such as BIS stating their stance on margin requirements.

James Kemp, managing director of GFMA’s global FX division, says it appears regulators are in sync globally about not requiring central clearing for these instruments, so it would seem counterintuitive then to require the posting of margins on FX swaps and forwards. 

To give an idea of the market’s size, Singapore recorded $158 billion of outright forwards and $174 billion of FX swaps transactions in 2010, representing 91% of all of its non-spot FX activity in the year, according to BIS data.

The BIS has been busy seeking industry views on whether swaps and forwards, with maturities ranging from a month to a year, should be exempted from the posting of margins (this might suggest any exemption may not apply to tenors outside of that maturity).

If margin-posting is required, banks and asset managers will need to stump up additional cash, or highly liquid collateral, during the lifespan of an OTC trade to backstop any declines in mark-to-market value as a safeguard against default.

The GFMA argues that introducing clearing for FX products may actually increase systemic risk by pushing liquidity risk back onto the central counterparty clearing house.

“There has to be appropriate margin treatment that looks at the specific risk profile for a product class, so we will be making these points in our response,” says Kemp. “At the same time, we have to take on board what different jurisdictions are trying to achieve, and discuss whether or not simply applying a blanket margin calculation is the right approach for the FX market.”

Because FX transactions involve the swapping of the principal currencies at maturity, market players have argued for years that settlement risk is the chief consideration.

Therefore they say that while central clearing could address counterparty credit risk in a bilateral OTC trade, bringing FX transactions to central clearing would not address the main risk.

“The BIS consultation paper proposes that for derivatives that remain non-cleared, regulators should impose the use of margin as a tool to create incentives for clearing,” explains Kemp.

“But having assessed that the main risk for FX products is settlement risk, and that many jurisdictions have decided FX swaps and outright forwards should not be subject to mandatory clearing, it seems incongruous to then impose what appears to be a slightly punitive margin regime on these transactions that effectively tries to force them back to clearing.”

Many industry bodies argue that existing infrastructure and agreements between financial institutions including the global settlement bank already address settlement risk; while credit support annexes signed between parties of an FX trade cover counterparty credit risk.

The GFMA conducted an analysis of FX dealers and found at least 85% of the mark-to-market exposure related to financial counterparties have CSAs already in place. The residual, uncovered risk on these short-term instruments does not warrant additional requirements, it argues.

*The GFMA comprises the Asia Securities Industry & Financial Markets Association based in Hong Kong, its New York-based counterpart Securities Industry and Financial Markets Association, and the European Association for Financial Markets in London.