On Friday, the witching hour of government press releases they want no one to read, the Treasury Department announced they will block regulation of large classes of derivatives:
Treasury is today issuing a Notice of Proposed Determination providing that central clearing and exchange trading requirements would not apply to FX swaps and forwards.
This proposed determination is narrowly tailored. FX swaps and forwards will remain subject to Dodd-Frank’s rigorous new trade reporting requirements and business conduct standards. Additionally, the Dodd-Frank Act makes it illegal to use these instruments to evade other derivatives reforms. Importantly, the proposed determination does not extend to other FX derivatives, such as FX options, currency swaps, and non-deliverable forwards. These other FX derivatives will be subject to clearing and exchange requirements.
The entire press release is almost burying the announcement for no regulation of FX swaps and forwards. Multinational corporations use FX swaps to hedge on currency fluctuations. According to Better Markets, this will bring out the financial engineers for some sort of derivative trickery fiction:
“The one thing we know for sure is that anytime there is an exemption from a regulatory rule, the financial engineers on Wall Street figure out how to cram as many new financial instruments through the loophole as possible,” said Dennis Kelleher, president of progressive watchdog group Better Markets Inc. “The area where the profits are the greatest is where there is the least transparency.”
He added, “for those people who think Wall Street is not going to come up with a whole sweep of products to fit into this exemption have missed what was going on for the past 30 years.”
Supposedly FX swaps can also be used mimic interest rate swaps and thus can be used as a speculative bet.
This 2009 study by the BIS shows the foreign currency exchange market had dislocations during the financial crisis, i.e. currency default swaps were part of the problem.
An Op-Ed, Geithner's Loophole sums it up nicely on Treasury's claim these derivatives aren't the bad guys:
For instruments to be relatively safer than the derivatives that blew up in the crisis, necessitating huge bailouts, hardly makes them safe. Worse, dealers could probably find ways to manipulate the exempted transactions so as to hedge and speculate in ways that the law is intended to regulate.
The Treasury Department insists its exemption is narrow and regulators will have the power to detect unlawful manipulation. In their spare time, perhaps? The financial crisis made clear what happens when everyone doesn’t have to play by the same rules. And it made clear that the taxpayers are the ones who pay the price.
The department has also said that because the market works well today, new rules could actually increase instability. That is perhaps the worst argument of all. It validates the antiregulatory ethos that led to the crisis and still threatens to block reform.
Wall Street Wins Again! What a surprise.