CFTC Eyes Clearing Mandate for Some Currency Derivatives

Foreign-exchange traders, already subject to a global probe over alleged manipulation, may face U.S. restrictions on derivatives contracts for some currencies.

Commodity Futures Trading Commission members and staff are weighing whether to require that contracts for non-deliverable forwards be guaranteed at clearinghouses that accept collateral from buyers and sellers. The regulation would apply the clearing rule to contracts for a dozen currencies, including China's yuan, South Korea's won and Brazil's real.

The CFTC's global markets advisory committee, led by Commissioner Mark P. Wetjen, plans to discuss the matter at an Oct. 9 meeting that is scheduled to include agency staff and David Bailey, director of financial markets infrastructure supervision at the Bank of England. A new rule would expand on CFTC mandates that require clearing for interest-rate and credit-default swaps.

“There appears to be a consensus view based on what I've heard and learned over the last number of months that a clearing mandate for the NDF asset class would lead to an improved market structure,” Wetjen said in a telephone interview yesterday. “But there are a number of lingering questions around readiness and other market structure issues that we hope to learn more about.”

Non-deliverable forwards are contracts to buy or sell a currency in the future that are settled with cash rather than delivery of the currency. The contracts, typically settled in U.S. dollars, are used to hedge or speculate on the future price of a currency facing capital controls or restrictions that make delivery outside of its country difficult.

A requirement to guarantee them at clearinghouses owned by LCH.Clearnet Group Ltd., CME Group Inc., Intercontinental Exchange Inc. and Singapore Exchange Ltd. could accelerate electronic trading of the contracts on CFTC-regulated platforms and threaten profits in the $5.3 trillion daily market.

There were $7.4 trillion in contracts between October 2013 and April in the dozen currencies the agency is weighing for the requirement, according to a CFTC document prepared for this week's discussion. Ninety-nine percent of the $7.4 trillion wasn't guaranteed at a clearinghouse, according to the document.

“The division of clearing and risk is confident those uncleared NDFs are of the type that” the four registered clearinghouses “are capable of clearing,” the document said.

Treasury Exemption
The CFTC has adopted rules under the 2010 Dodd-Frank Act to reduce risk and boost transparency in the $700 trillion derivatives market after largely unregulated credit-default swaps helped fuel the 2008 credit crisis. While the Treasury Department exempted foreign exchange swaps and forwards from the agency's clearing requirements, the exclusion doesn't apply to non-deliverable forwards.

The Investment Company Institute, which represents mutual funds, and the American Bankers Association have pressed regulators and lawmakers to keep the non-deliverable contracts outside of the new requirements. Treating non-deliverable contracts differently than the exempt forwards may confuse the market and increase U.S. investors' costs, the groups have said.

“Any of these clearing mandate decisions have to take into account both the downstream implications linking into any trading requirement as well as the international coordination needed to avoid fragmentation,” James Kemp, managing director of the Global Financial Markets Association's foreign-exchange division, said yesterday in a telephone interview.

A study by the Bank for International Settlements said non-deliverable forwards represent $127 billion of the $5.3 trillion daily currency markets. The study of 2013 data showed trading in the contracts has grown, with turnover in some Asian contracts at least 10 times turnover from about a decade ago.

The European Securities and Markets Authority on Oct. 1 sought comment from the public on a possible clearing obligation for the contracts.

“We are encouraged that regulators on both sides of the Atlantic are engaging with market participants on the important issue of NDF clearing on a similar timeframe and look forward to regular efforts at harmonization,” the Foreign Exchange Professionals Association, a trade group that includes LCH.Clearnet, CME Group, Citadel LLC and Virtu Financial Inc. among its members, said yesterday in a statement.

A proposal to require clearing would come amid a global probe, by agencies including the CFTC, into alleged rigging of currency benchmarks.

The world's biggest banks are changing how they trade currencies after authorities on three continents opened probes of claims that dealers leaked confidential client information to counterparts at other firms and colluded to rig currency benchmarks used by money managers. U.S. and U.K. regulators are in talks to settle some of the probes as soon as November.

The CFTC meeting this week is also scheduled to include a discussion of derivatives tied to Bitcoin, a software protocol created anonymously in 2009 under the name Satoshi Nakamoto.

Bloomberg News

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