With the Dodd Frank Act stirring debate on the exemption for FX forwards and swaps and the European Commission to follow the US lead under two separate legislative umbrellas, EMIR and MiFID, time is running out to make the case for FX exclusion from mandatory clearing.

The first panel session chronicled the evolution of the FX market, with the introduction of electronic trading partly responsible for the increase in trades from $500 billion per day to today’s estimated $4 trillion. In the context of this dramatic market rise, the European Central Bank (ECB) is regularly examining how the market is handling growth and how the trades are executed, according to Holger Neuhaus, D-G of the ECB’s Market Operations.

The second session featured a comprehensive examination of CLS. Owned by the major FX banks, CLS settles 70% of the market and has a unique oversight arrangement with 22 central banks. The key market benefit of CLS, however, is that it eliminates settlement risk, which, according to an AFME/Oliver Wyman study in October 2010, accounts for 94% of maximum loss exposure on FX trades for products with a maturity of six months and 89% for two-year maturities. FX market credit risk is short-term (less than 75% of CLS trades settle in four months or less and liquidity requirements are reduced by 98%.

The final session of the day saw Patrick Pearson, head of Financial Markets Infrastructure at the European Commission and Kay Swinburne MEP give their views on the FX market, acknowledging that FX is bespoke and not necessarily appropriate for clearing. “Many of these products cannot be standardised,” said Pearson, “but should we clear FX derivatives? It’s open to debate. Should we exempt FX outright? The US isn’t going to and it’s too early to take a dramatic and outright decision.” Kay Swinburne noted that, whilst it was hard to separate the clearing aspects of EMIR legislation and trading aspects of MiFID, the FX market has worked well for years and there is little more to add in terms of transparency.

The AFME’s FX event aired industry concerns that, firstly, regulation needs to identify the most appropriate risk in the market – for the FX sector, this is settlement risk and the already-developed CLS represents a highly effective system, backed by 22 central banks and overseen by the Federal Bank of New York. Secondly, moving the FX market to a centrally cleared model raises the possibility of amplifying risk, according to the industry, by deflecting efforts away from the expansion of CLS and by introducing concentration risk within the clearing house. Finally, the call was made loudly and clearly that requiring central clearing runs the risk of increasing costs for corporates and for pensions funds. With corporates considering relocating production operations, and pension funds threatening to disinvest whilst employing a greater domestic investment focus, there is little doubt that the industry finds itself at a critical juncture. The effect of imposing new regulations on the FX market could have serious repercussions that will live on for decades to come.

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