The Foreign Exchange Professionals Association (FXPA) has submitted a letter outlining its comments to the Securities and Exchange Commission (SEC) on its proposed rules governing the “Use of Derivatives by Registered Investment Companies and Business Development Companies”.
In its letter, the FXPA calls for an exemption from the proposed new rules for FX swaps and forwards. The association is accompanied by a number of asset management firms in drawing attention to the unique characteristics of the FX market.
The FXPA clearly states its appreciation of the SEC’s aims in reviewing and analyzing funds’ use of derivatives products, and praises the “underlying motivation to require funds to implement risk management measures for better investor protections”.
Although essentially in agreement with the SEC’s goals, the association’s view is that FX forwards and FX swaps should be exempt from the developing rules on derivatives. It argues against the inclusion of FX products on the basis that introducing regulation would be both impractical and self-defeating from a risk mitigation point of view.
The association highlights the fact that “Impediments to asset managers’ use of FX derivatives to hedge commercial risk from global investment strategies could reduce asset managers’ abilities to deploy capital around the world, restricting investment strategies, tying asset managers’ systemic stability to US dollar-denominated investments, and could restrict long-term investment capital to businesses around the world.”
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The FXPA also points to the fact that the US Treasury exempted FX swaps and FX forwards from being regulated as swaps under the Commodity Exchange Act, and the fact that “unlike currency swaps, FX forwards and FX swaps are different because ‘the amount of the cash flow exchanged by the party is known at the onset of the transaction’, resulting in minimal settlement risk.”
The comments put forward in the letter go on to highlight the risk-mitigation function that is often played by FX derivatives in the context of asset management, pointing out that these “risk mitigating activities are the same activities identified by the US Treasury Department in its Determination to exempt these products from…regulation pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act”.
In support of its comments, the association makes reference to the US Treasury Department’s finding that settlement risk associated with FX swaps and forwards is “virtually eliminated” through the use of payment-versus-payment settlement arrangements.
The FXPA further argues that FX futures and non-deliverable forwards (NDFs) should also be exempt from the SEC’s proposed rules, suggesting that “these products are similarly relied upon by funds to reduce currency risk and promote cross-border investment by asset managers. Like FX swaps and FX forwards, these products pose relatively low risk to the financial system due to their liquidity and settlement dynamics and their short dated tenors”.
Overall, the association contends that from a systemic risk standpoint, “reliance on short-term FX derivatives to hedge currency risk and promote global investment activity raises fewer concerns than the risks associated with restricting funds’ investment strategies to any one currency”. Additionally, from a global capital markets perspective, FXPA argues that “limiting the use of FX derivatives may also prevent non-US companies from attracting US funds’ capital to grow their businesses and benefit from any comparative advantage they may possess.”
Regulation of these products would overall, in the FXPA’s opinion, create outcomes that are antithetical to the competitive, liquid and stable global capital markets that the SEC seeks to promote.