FX participants concerned Volcker Rule could hurt market liquidity

Financial market participants recently warned against the implementation of the Volcker Rule, saying that the rule could lead to increased transaction costs and possibly threaten the liquidity of the foreign exchange market.

The Volcker Rule, named after former Federal Reserve chairman Paul Volcker, prohibits banks from engaging in proprietary trading — or risky investments with client funds. The rule further prohibits banks from sponsoring, owning or investing in private equity or hedge funds, FX Week reports.

Some lobbyists, however, believe that FX products should be exempt from the controversial rule.

“The rules set out at present have proposed to exempt proprietary trading on FX spot but have asked us whether the same exemption should be extended to FX swaps and forwards,” Mandy Lam, the managing director for North America at the Global Financial Markets Association’s global FX division, said, according to FX Week. “FX spot, swap and forward markets are all heavily interlinked, so restrictions on forwards and swaps could impede liquidity on spot too, further hurting the end-user.”

Some market participants argue that the Volcker Rule could force some firms to relocate their activities offshore.

While FX swaps and forwards are exempt from the Dodd-Frank Act’s Title VII, the Volcker Rule explicitly includes FX swaps and forwards, though the rule is not included under Title VII. The U.S. Treasury was granted the authority under Dodd-Frank to exempt FX swaps and forwards from Title VII.

“We do not believe that FX swaps and forwards, like FX spot, should be subjected to the same regime as derivatives, because they are different and they present different risks,” Lam said, according to FX Week. “If they don’t [become exempt], there will be significant impacts on the FX market as a whole, and participants’ real costs will increase unnecessarily.”

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