FX Forwards and Swaps to be initial margin free

The WGMR[1] has told Risk magazine that their rules for non-centrally cleared derivatives will be published within weeks. A member of the working group said, “Publication is expected by the end of the month. A specific treatment [i.e. an exemption] for forex swaps and forwards is indeed likely”. Market participants have lobbied hard over the 14 month consultation period for these instruments[2] to be exempted from the initial margin requirements for non-centrally cleared derivatives. Their argument has been that the FX forward and swap market is too important to disrupt and is not a potential source of systemic risk. The WGMR decision will echo that of the US Treasury, which exempted FX swaps and forwards from Dodd-Frank clearing, execution and margin requirements[3] in November 2012. The near-final rules consultative document estimated the cost of initial margin in these markets to be approximately €0.7 trillion in collateral, making the final decision of some significance. It is likely that the dispensation with respect to initial margin, will result in enhanced supervision over variation margin.

While it is true that the FX swap and forward markets are highly liquid, relatively (price) transparent and may not tend to long duration; both the earlier US Treasury decision and the well-flagged initial margin exemption by the WGMR look like large and unjustified loopholes in the regulatory structure. If the regulators fear a collateral shock caused by the consistent application of their own rules, to such an extent that they are prepared to introduce inconsistency, perhaps the rules need a fundamental redesign.

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