The U.S. Treasury Department exempted foreign-exchange swaps andforwards from Dodd-Frank Act regulations intended to reduce riskand increase transparency in the derivatives market.

Foreign-exchange swaps and forwards are short-term transactionsthat already have high-levels of transparency and risk management,the department said in a statement late Friday announcing the exemption. Deutsche BankAG, Bank of New York Mellon Corp., UBS AG and other banks urgedTreasury Secretary Timothy F. Geithner to exempt the market. Theexemption had been resisted by some regulators, Democraticlawmakers and advocates of tighter rules.

“Unlike other derivatives, FX swaps and forwards already tradein a highly-transparent, liquid and efficient market,” the TreasuryDepartment said. “This final determination is narrowlytailored.”

Foreign exchange contracts were the second-largest source ofderivatives trading revenue for U.S. bank holding companies in thesecond quarter, according to the U.S. Office of the Comptroller ofthe Currency. The companies recorded $3.1 billion in revenue ontrading of foreign exchange derivatives.

Foreign-exchange swaps and forwards are part of a $4 trillionglobal daily market for foreign exchange, according to theBasel-based Bank for International Settlements.

Dodd-Frank would move most swaps to clearinghouses that collectcollateral from buyers and sellers to reduce the risk that oneparty's default would disrupt the broader market. The measure wasenacted in response to the 2008 credit crisis that regulators andlawmakers said was fueled in part by largely unregulated swaps.

“Moving FX swaps and forwards to centralized clearing would notonly have created additional costs for businesses and investors,but also increased systemic risk,” James Kemp, managing director ofthe Global Financial Markets Association's foreign-exchangedivision, said in an e-mail statement. “This final decision fromthe U.S. Treasury provides the clarity the industry needs to nowfurther develop the infrastructure of the future.”

In comment letters to Treasury in 2010, Democratic Senators CarlLevin of Michigan and Maria Cantwell of Washington discouraged thedepartment from granting the exemption.

The Commodity Markets Council, a lobbying group for energy andagriculture companies and derivatives exchanges, said in a June2011 letter that the exemption could undermine the regulatoryoverhaul. The council “believes exempting foreign exchange forwardsand swaps at this time from the clearing and trading requirementsof Dodd-Frank could increase systemic risk at a time whenregulators around the globe are trying to reduce it,” according tothe letter, which was submitted in response to Treasury's proposedexemption.

'Unjustified' Loophole

The council includes the CME Group Inc., the Chicago-based ownerof the world's largest futures exchange; Intercontinental ExchangeInc., the Atlanta-based futures market operator; and Decatur,Illinois-based Archer-Daniels-Midland Corp., the largest U.S. grainprocessor.

“Wall Street fought hard to convince Treasury to grant thisloophole, which is unjustified by independent research,” DennisKelleher, president and chief executive officer of Better Markets,an organization advocating stricter financial regulation, said inan e-mail statement. “That may be why, after two years ofconsideration, the United States Treasury announced such animportant financial regulation decision on a Friday night at 5 p.m.when Congress is on recess and on the eve of the Thanksgivingholiday.”

The U.S. Commodity Futures Trading Commission and Securities andExchange Commission are required to write rules to reduce risk andincrease transparency for interest-rate, credit and other swaps inthe $648 trillion global over-the- counter derivatives market.

The Treasury exempted foreign-exchange swaps and forwards fromthose rules. The exemptions don't apply to Dodd-Frank's reportingrequirements and business conduct standards. The exemption alsodoesn't apply to foreign-exchange options, currency swaps andnon-deliverable forwards.

The foreign-exchange swaps and forwards market and itsparticipants “have been subject to strong, comprehensive, andinternationally coordinated oversight by central banks for morethan three decades,” Treasury said in the announcement. Theexemption takes effect when it is published in the FederalRegister.

“Treasury believes that requiring foreign exchange swaps andforwards to be cleared and settled through the use of new systemsand technologies could introduce new, unforeseen risks in thismarket,” the department said in the final exemption order.

Darrell Duffie, a professor at Stanford University's businessschool, said the foreign-exchange swaps and forwards market hastaken voluntary steps to curb risks. “But the remaining amount ofcounter-party risk in the FX derivatives market is enormous,”Duffie said in an e-mail after the Treasury announcement. “Does thelogic of this exemption imply that credit default swaps or interestrate swaps should also be exempted from regulation once practicesimprove in those markets? Surely that should not be the case.”

During the congressional debate over Dodd-Frank, the TreasuryDepartment fought unsuccessfully to exclude foreign exchange fromregulation over the objections of CFTC Chairman Gary Gensler.

An exclusion threatened to “swallow up the regulation” ofderivatives if interest-rate or credit swaps are structured asforeign exchange swaps to benefit from the exemption, Gensler wrotein an August 2009 letter.

Steve Adamske, the CFTC's spokesman, declined to comment on thefinal Treasury exemption.

Bloomberg News

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