As the Dodd-Frank act continues to make inroads into every corner of financial markets, the area of forex forwards, non-deliverable forwards (NDFs) and forex swaps may undergo a particularly dramatic transformation.
Historically dominated by large banks and other institutional counterparties, the sector was slower than others to automate, and a great deal of settlement risk still exists for non-spot FX due to the rarity of central clearing. The non-standardized nature of FX forwards and swaps makes them ideal for customizing to fit counterparties’ needs, but also means that there is no set structure regulation terms such as confirmation and payment.
There was initially doubt whether FX forwards and swaps would be included under the Dodd-Frank umbrella, but despite opposition, this has indeed turned out to be the case. Within a few years, and possibly sooner, centralized clearing will be a reality. While this may initially cause costs to rise, long-term effects include greater transparency, reduced counterparty risk and standardized margin requirements leading to increased liquidity and more efficient price discovery. While critics certainly remain, it is easy to be optimistic about the brave new world of FX forwards and swaps.