Major source of money for big banks may get exemption from regs

A major source of revenue for big banks may ultimately be exempt from new regulations under financial reform legislation in Congress. 

Lawmakers are looking to crack down on the multitrillion-dollar derivatives market that some blame for worsening the financial crisis. 

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But they appear on the verge of handing power to the Treasury Department to decide whether to exempt foreign exchange derivatives from tougher governmental oversight.

If approved, the language would be a win for the banking industry, which has argued the foreign exchange derivatives had no role in the financial crisis and therefore should not be subject to new regulations. 

An earlier version of financial reform legislation in the Senate had more stringent regulations of those derivatives. Treasury could choose not to exempt the derivatives or pursue a more limited carve-out.

Tied to the value of a currency or its exchange rate, foreign exchange derivatives are among the biggest drivers of business in a market dominated by big banks. 

Commercial banks reported $5.6 billion in revenue on foreign exchange derivatives in 2009 and $11.4 billion in 2008, according to the Office of the Comptroller of the Currency.

Legislation that passed the House and is now pending in the Senate would put the burden largely on the Treasury to decide whether to exempt foreign exchange derivatives from new regulations. 

The new regulations are meant to bring transparency and oversight to a broad and shadowy market. 

The $50 trillion market for foreign exchange derivatives represents roughly 8 percent of the $605 trillion face value of the overall derivatives market as of June 2009, according to the Bank for International Settlements.

Many lawmakers and outside critics have argued derivatives, financial instruments companies use to hedge a variety of risks, exacerbated the crisis in 2008. 

“I think to a certain extent FX [as foreign exchange is known] has always been treated different,” said Larry Tabb, founder of the TABB Group. Tabb said the market is much more international and tied to central-bank policymaking than other types of derivatives.

“Treasury is probably the right one to deal with it,” he said. 

The Treasury Department did not respond to a request for comment.

A group of banks, including HSBC, UBS, Citigroup, Credit Suisse, State Street, Bank of New York Mellon, Goldman Sachs and Morgan Stanley, have been working closely on the issue in Washington, according to a source familiar with the work.

Foreign exchange derivatives were the biggest source of revenue from derivatives during the last two years. Other derivatives include those tied to interest rates or the potential for a company to default.

The legislation that passed the House would give regulators and the Treasury secretary power to decide whether foreign exchange swaps and forwards should be regulated in the same way as other derivatives.

Treasury and the regulators could move to exempt them.

In the Senate, the issue has taken several recent twists and turns.

Senate Agriculture Committee Chairwoman Blanche Lincoln (D-Ark.) originally was going to require foreign exchange derivatives to be regulated like other derivatives.

On Monday, Lincoln and Senate Banking Committee Chairman Chris Dodd (D-Conn.) released compromise legislation requiring the Treasury secretary to decide whether to exempt the derivatives from the new rules.