U.S. plans to exempt forex swaps from new rules

A foreign currency dealer of the Korea Exchange Bank walks past a screen displaying the exchange rate between the U.S. dollar and the Korean won at the bank's headquarters in Seoul October 8, 2009.

WASHINGTON (Reuters) - In a big win for business, the Treasury proposed on Friday to exempt commonly used foreign exchange swaps and forwards from the most onerous new rules for the derivatives market.

The Treasury Department said that forcing these financial products through clearinghouses and onto exchanges was not necessary because existing procedures in the foreign exchange market mitigate risk and ensure stability.

Any disruptions to this market "could have serious negative economic consequences," the department said.

The business community applauded Treasury's decision and said the government recognized that the products did not pose a risk to the financial system.

Foreign exchange swaps and forwards, which represent about 5 percent of the $600 trillion over-the-counter derivatives market, are used by a wide range of companies to lock in prices as protection against exchange rate fluctuations.

Businesses, big banks and the securities industry had furiously lobbied the Obama administration to exempt the financial instruments from the new rules. They argued, among other things, that clearing requirements would drive up costs and were unnecessary given that most contracts expired after one week.

The Treasury agreed.

"You would be putting more steps into the settlement process for trades that are largely short-term in nature," Mary Miller, the Treasury's assistant secretary for financial markets, told reporters.

CONCERNS WITH EXEMPTION

Democratic Senator Carl Levin said he was concerned the exemption relied on current industry practices that were inadequate and could be changed by the industry unless the exemption was "conditioned upon their remaining in place."

The proposal is open for comment for 30 days. The Treasury's final decision will be issued after that period. Officials said they would not speculate on whether the proposal would change.

Under the Dodd-Frank financial reform legislation enacted last year, the Treasury secretary was given the power to determine whether the narrow subset of foreign exchange derivatives should be tightly regulated.

The rest of the over-the-counter derivatives market will be forced through clearinghouses, which will stand between two parties and assume the risk if one party defaults.

The country's biggest labor federation, the AFL-CIO, criticized the Treasury's plan and said it would create a loophole that could be exploited.

The legislation was aimed, in part, at trying to ensure derivatives no longer pose the type of threat they did during the 2007-2009 credit crisis. Credit derivatives were implicated in the downfall of troubled financial giants Lehman Brothers and AIG.

The Treasury's Miller said the foreign exchange swaps market was different from other derivatives markets and that under Dodd-Frank it would be illegal to use the instruments to evade tougher scrutiny that applies to other derivatives.

The swaps and forwards would also be subject to trade reporting requirements and business conduct standards.

The long-awaited decision was hardly a surprise given Treasury Secretary Timothy Geithner has said the foreign exchange swaps and forwards did not present the same type of risk as other derivatives.

(Additional Gertrude Chavez-Dreyfuss and Wanfeng Zhou in New York, and Dave Clarke and Glenn Somerville in Washington; Editing by Andrew Hay and Dan Grebler)