Geithner to decide on regulation of foreign-exchange swaps

Timothy F. Geithner soon will announce a decision that underscores just how much power last year’s far-reaching financial overhaul legislation ceded to the Treasury secretary.

The Dodd-Frank bill signed into law in July allows Geithner to decide whether the vast market in foreign-exchange swaps — a type of financial instrument that businesses often use to guard against fluctuations in foreign-exchange rates — should be subject to heightened regulations as other derivatives are.

“It will be very significant,” Karen Shaw Petrou, managing partner at Federal Financial Analytics, said of Geithner’s decision, adding that it will have major implications for the global, multitrillion-dollar foreign-exchange market.

The coming determination is one element of Geithner’s broad new authority granted by the law. For example, Geithner now chairs the new Financial Stability Oversight Council, a group of top regulators that has power to seek additional regulation for large, complex financial companies whose failure could threaten the nation’s financial stability.

Geithner is also in charge of the creation of the Consumer Financial Protection Bureau until the Senate confirms a permanent director.

Although Harvard professor Elizabeth Warren has overseen much of that work, Geithner ultimately has the reins over the powerful new watchdog until it becomes an independent bureau aimed at protecting borrowers from abuses by lenders.

Meanwhile, the decision about foreign-exchange swaps, which could come this week, has placed Geithner at the crossroads between big banks, which argue that such deals do not require additional oversight, and some regulators and lawmakers who believe they do.

In an effort to provide greater transparency, the Dodd-Frank law requires that most swaps be traded on exchanges and be backed by clearinghouses that would ensure parties set aside enough collateral to pay off any bets that go bad. The debate over how to handle foreign-exchange swaps was part of a much larger fight over how to create oversight of various kinds of derivatives, some of which helped exacerbate the financial crisis by amplifying risks.

The Treasury sought comment last fall on whether foreign-exchange swaps should be subject to the new rules and received nearly 70 letters from those on both sides of the issue.

Many financial companies argue that foreign-exchange swaps did not contribute to the financial crisis and that they are far less risky than other types of derivatives transactions — and that they would still be subject to certain reporting and business-conduct standards if exempted from the new rules. In addition, they note that the Dodd-Frank law defined foreign-exchange swaps very narrowly in an effort to avoid creating loopholes that other types of derivatives dealers could exploit.

“Today’s foreign exchange markets operate with high levels of transparency . . . and have performed extremely well throughout the recent market crisis,” wrote officials from the Financial Services Roundtable and Institute of International Bankers, whose organizations represent companies that participate heavily in the market.

“[Foreign-exchange] trades are not the traditional derivatives trade,” said Bob Pickel, executive vice chairman of the International Swaps and Derivatives Association. He said that foreign exchange swaps consist largely of short-dated transactions and that forcing the industry to go through the expense and effort of setting up a clearinghouse would be costly and unnecessary for a market that has operated relatively peacefully for decades.

“I don’t think there’s any indication that those markets froze up or shut down in any way” during the financial crisis, Pickel said. “There was greater volatility, but people could still hedge” their risks.

On the flip side, some nonprofit groups, lawmakers and regulators, such as Gary Gensler, chairman of the Commodity Futures Trading Commission, which is in the process of writing new derivatives rules, have urged the Treasury to include foreign-exchange swaps in the new rules.

Sens. Maria Cantwell (D-Wash.) and Tom Harkin (D-Iowa) wrote to Geithner and insisted that exempting foreign-exchange swaps from the new rules would result in a “huge unwarranted hole” in oversight.

“No justification for an exemption is evident,” they wrote. “Any broad exclusion from the law will weaken comprehensive regulation of the derivatives market and create opportunities to structure swap transactions to evade regulation.”

Although Gensler has remained largely silent on the issue since Dodd-Frank passed last year, he wrote in the lead-up to the new legislation that he believed the law “must cover the entire marketplace without exception.”

In the past, Geithner has shown an inclination toward exempting foreign-exchange deals, saying they pose less risk to the financial system than some other kinds of derivatives.

“There is an elaborate framework in place already, put in place starting 20 years ago, to limit settlement risk and the other sets of risks that occur. And these markets have actually worked quite well,” he told the Senate Agriculture Committee in late 2009. “So, like in anything, we’ve got a basic obligation to do no harm, to make sure, as we reform, we don’t make things worse.”

The Treasury declined to comment because Geithner’s decision is pending.

Brady Dennis is a national reporter for The Washington Post, focusing on food and drug issues.
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