Quelle Surprise! Geithner Gutting Dodd Frank via Intent to Exempt Foreign Exchange –

A publication from Naked Capitalism

I have mixed feelings about an article by Robert Kuttner, “Blowing a Hole in Dodd-Frank.” On the one hand, he’s found an important example of the Administration’s lack of interest in meaningful financial reforms, which is its intent to exempt foreign exchange derivatives from the implementation of Dodd-Frank. But his discussion of what this matters at critical junctures confuses foreign exchange cash market trading with derivatives and thus leaves the piece open to criticism.

Kuttner warns that Geithner has signaled strongly his preference to exempt foreign exchange from Dodd Frank implementation:

Treasury Secretary Timothy Geithner is close to a decision to exempt the $4 trillion-a-day foreign-currency market from key provisions of the Dodd-Frank Act requiring greater transparency in the trading of derivatives. In the horse-trading over the final conference version of that legislation last year, both Geithner and financial-industry executives lobbied extensively to give the Treasury secretary the right to create this loophole.

We need to be clear: Dodd Frank was never intended to cover the cash (spot) foreign exchange market, which is where the bulk of the $4 trillion of FX trading takes place. There is an open question as to whether simple forwards, which are not exchange traded and hence not typically margined, would be considered to be “standardized” derivatives and hence moved to an exchange. Not that I sympathize with the Treasury’s position, but London has long been the biggest foreign exchange trading center in the world, both for historical reasons and due to its time zone advantage. In theory, requiring forwards and other simple FX derivatives to be exchange trades would lead dealers to try to shift activity to London. The flip side is some customers would no doubt prefer the greater transparency of exchange prices.

Geithner is clearly using the spot/forward issue to muddy the discussion:

In testimony before the Senate Agricultural Committee in December 2009, he declared that the foreign-exchange market needed no special regulation. “The FX [foreign exchange] markets are different,” he said. “They are not really derivative in a sense, and they don’t present the same sort of risk, and there is an elaborate framework in place already to limit settlement risk.”

And unfortunately Kuttner falls into Geithner’s trap by discussing the intervention of the Fed in FX markets post the Lehman collapse (in fairness, he later cites some bad practices in derivatives land, like the Greek government using foreign exchange derivatives to mask the magnitude of its borrowing). This was actually a dollar market intervention. The regulatory regime we have, per Basel II, is home/host. The home country regulator is responsible for capital adequacy. That’s why the US was responsible for bailing out AIG and Citigroup even though both have globe-straddingly operations. The idea is that the bank is also subject to host country regulations, which means it normally doesn’t have to keep a lot of capital in the host country, but if the host country gets nervous, it can tell the local sub to ring the mother ship and get some capital injected.

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