EU Council leans towards special treatment for FX

Industry's concerns starting to be reflected in legislation proposals

The Council of the European Union continues to recognise the unique nature of foreign exchange contracts, but stresses it is not advocating a full exemption from mandatory clearing requirements under new rules for over-the-counter derivatives.

On March 17, the Council published its latest compromise proposal on the European Commission's (EC) proposed regulation, which acknowledges clearing contracts through central counterparties (CCPs) might not be the best solution for dealing with settlement risk.

"CCP clearing specifically addresses counterparty risk, and might not be the optimal solution for dealing with settlement risk," the proposal states. That concession is an addition to an explanatory paragraph that had appeared in previous versions of the Council's compromise proposal earlier this year.

But according to a source close to the Council's working party of financial services attachés, European member states are not advocating a full exemption for foreign exchange contracts. Rather, they are simply emphasising their unique nature.

"We have to be careful with this wording. There is no exemption for FX products, only reference to their specific nature, short-dated maturities and existing infrastructure arrangement to address their main risk," he said.

While a full exemption would have been preferable, lobbyists say the latest Council proposal is a step in the right direction. "As they stand at the moment, those proposed amendments suggest some of the industry's points have been understood and they're starting to be reflected in the legislation," said James Kemp, London-based managing director of the global FX division at the Association for Financial Markets in Europe.

Others suggest the Council is still a long way from answering the specific concerns raised by the FX industry. Jonathan Herbst, partner at law firm Norton Rose in London, believes the latest amendments simply recognise the importance of settlement risk, which has sometimes been neglected in political circles.

"Central clearing is about one set of risks but doesn't deal with whether you can actually settle or not. The CCP has still got the settlement risk for a forex transaction, so the decision over how to mitigate that is separate to the decision over whether or not to clear," said Herbst.

The Council working party met to discuss the proposed amendments on March 21, and is scheduled to meet again on March 28. Meanwhile the EC and the European Parliament must ultimately agree with the Council on an identical text of the regulation before it passes into European law.

The EC made no mention of specific asset classes in its initial text last September, and members of the European Parliament (MEPs) say FX has barely been discussed so far. MEPs had until March 14 to submit their proposed amendments, and are scheduled to discuss them on April 4. Amendments submitted by British MEP Kay Swinburne would go further than the Council in favour of exempting FX from clearing requirements.

"For certain classes of derivatives involving exchange of principal, such as foreign exchange, settlement risk might be the predominant risk, which is already addressed through existing market infrastructure. This should be taken into account when considering which classes of derivatives should be mandated for central clearing," Swinburne proposed.

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