FX Swap Regulation in Limbo – October 12th and Beyond

Numerix Video Blog: FX Swap Regulation inLimbo – October 12th and Beyond Jim Jockle (Host): Hi welcome to Numerix videoblog, Iím Jim Jockle your host.

October 12 circle the calendars banks have to start countingswaps transactions to see whether theyíll register in December as swaps dealers.

Nowwith me today ñ 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 outwith a proposal to exempt Forex swaps yet we are pressing on the October 12 date.

Giveus a little background of whatís going on and why specifically FX swaps are proposedfor exemption.

Sela: Sure, so we of course know that postthe subprime crisis the main issue is how to regulate the derivatives market in a waythat incidents like the Lehman Brothers case will not reappear.

Specifically looking atthe FX market one of the most frequently traded instruments is FX swaps.

These swaps are mostlyused for funding.

The big question is, if banks are required to report the FX swapspositions if they have more than 8 billion dollars of nominal amount, and probably beliable to capital charges.

This may have an impact on the trading of FX swaps and thecost for the end clients.

Important to mention and I guess this is the main reason for exemptingthe swaps is that FX swaps are used mostly for funding and not to execute a view on themarket.

When I say funding, it could be funding ofan open position or just funding the balances of banks.

So just to be clear if Iím an Americanbank and I have balances in Euros, Brazilian Real and so forth typically I would use FXswaps in order to cover my balances.

And when I use FX swaps Iím not changing the counterposition of the bank.

So one may ask why I should be liable to additional capital chargeswhen I cover my balances when Iím performing a funding operation.

Jockle: So we hit the date itís now October13 weíre running towards December whatís going on in the bank if the exemption is notpassed by that point.

Sela: That would imply that banks would startregistering the swaps and assuming those large market makers would have additional costsfirst of all capital costs as well as operational costs.

Banks we know do not operate in a vacuumso they would like to charge the banks for this additional cost that would imply thatcorporations, investment firms, ect.

would have to pay a higher price for funding operations.

Jockle: So the cost gets passed through.

Whatabout the market implications itself.

You had a webinar a few weeks ago proposing severalstrategies given the low vol environment of many pairs in the market right now what ifany market moves would happen based on the lack of exemption going forward.

Sela: I would think if the regulations gothrough that weíd see less operations in the market because people would be reluctantto execute trades because they would understand that the trade actually has an additionalcost now which is the funding cost.

So why should I enter in to a position or investmentdecision 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 particularvideo blog for the day and Iím looking at a Reuters article from earlier this week coveringthe issue and one of the things that has been tied to this as putting political risk aroundthis has been LIBOR and its consequences and one of things that struck me quoted in thearticle is ìÖThe LIBOR scandal, which a key input to FX swaps valuation was shownto be fraudulent and manipulated by participating banks, shows exactly how problematic thisisÖî give us the role of LIBOR in valuation for FX swaps.

Sela: So I have to admit that I was very surprisedwhen I saw that too because personally I donít see what is the connection between LIBOR andFX swaps.

Iíve traded FX for many years and never priced FX swaps off LIBOR rates.

LIBORrepresents the offering rates London and has nothing to do with pricing FX swaps all alongthe day so that was kind of surprising.

Thereís enough to be said about LIBOR and regulatingand governing in a way that people do not misconduct but it has nothing to do with FXswaps.

Jockle: So maybe Iíll put you in the hotseat and weíll go through another case study around proper valuation in the role of FXswaps going forward.

So thank you Udi I appreciate your time today.

That will conclude todayísvideo blog.

Feedback? ñ Let us know.

Questions you want to hear answered weíll definitelyaddress them and please following us at @nxanalytics on Twitter.

Com and on our blog at Numerix.

Com.

Thank you and see you soon.

Udi: Thanks Jim.

Source: Youtube

FX Swap Regulation in Limbo - October 12th and Beyond

http://blog.numerix.com | www.numerix.com As the Oct. 12 deadline looms, our Numerix FX Derivatives expert sits down to discuss evolving regulation around FX Swaps. He breaks down reasons financial institutions are increasingly anxious about the new rules, despite some assurances from the Treasury Department that foreign exchange swaps would be exempt, as well as the logic for the potential FX Swap exemption and what these rules would mean going forward.