By Ryan Tracy, Victoria McGrane and Andrew Ackerman
The ripple effect of wild swings in the price of Switzerland's
currency is a reminder the next threat to today's highly
interconnected financial system could come from an unexpected
place.
The sudden decision by the Swiss National Bank on Thursday to
remove a cap on the Swiss franc's value posed a threat to the
solvency of currency brokers, many of whom sit outside the banking
system that has received the brunt of new regulations since the
2008 financial crisis. The market volatility also spilled over into
losses at big global banks that trade in currencies as a core part
of their business, such as Citigroup, Inc., Deutsche Bank AG and
Barclays PLC. Citigroup also provided prime brokerage services to a
large U.S. currency broker caught up in the volatility, FXCM,
Inc.
Regulatory officials said Friday they didn't see any immediate
threats to U.S. financial stability. U.S. agencies were talking
among themselves and to market participants as they sought to
understand the extent to which big banks, clearing houses that
guarantee some currency trades and other market players are exposed
to the troubled brokerages or to the currency itself, and how their
actions could ripple across the financial system in unexpected
ways.
Spokesmen for the Securities and Exchange Commission and
Commodity Futures Trading Commission said their agencies were
"monitoring" developments. Staff of the Financial Stability
Oversight Council, a group of senior U.S. regulators, were also
watching the situation, a person familiar with the matter said
Friday. A spokeswoman for the Treasury Department, which chairs the
council, declined to comment.
At the Federal Reserve, officials are looking into losses major
global banks are taking and likely investigating whether any
highly-leveraged hedge funds have found themselves on the wrong
side of a trade that could trigger broader consequences. Another
area of potential focus is how the various firms that operate the
financial plumbing for foreign-exchange and other markets are
reacting to events.
The Fed created a new postcrisis Office of Financial Stability
Policy and Research in 2010 to investigate weak links in the
financial system.
One mitigating factor from a financial stability standpoint is
that the Swiss action didn't come amid broader market turmoil.
The events were a "reminder [of] how dependent market stability
is on government action and how even one seemingly small move can
unsettle everything really quickly," said Karen Shaw Petrou,
managing partner of the policy analysis firm Federal Financial
Analytics, Inc.
Regulators say the financial system is stronger thanks to the
reforms implemented since 2008, in particular rules that forced the
largest, most interconnected banks to maintain far higher levels of
capital to absorb unexpected losses.
"Significantly more capital in banks is a good thing and they're
likely to be more resilient," former Federal Reserve Governor
Jeremy Stein said in an interview with The Wall Street Journal
earlier this week. "There's less worry, I would say, about the
banking system being at the center of something."
But Mr. Stein and others acknowledge that by bulletproofing
banks' balance sheets, policy makers may be pushing activity
outside the banking system into areas where risks are more
difficult to monitor.
In the interview, Mr. Stein pointed to the "very, very rapid
growth of issuance of corporate bonds" held by nonbank entities as
one area where potential risks should be investigated.
The events of Thursday and Friday put activities by less-heavily
regulated exchange brokers on regulators' radar as well. Capital
requirements for those firms aren't as high as for banks, meaning
they are less able to weather unexpected losses.
Another potential area of concern is that capital rules for
foreign-exchange brokers don't currently exist in Europe, where
regulators have consistently lagged behind their U.S. counterparts
on postcrisis rules.
While European policy makers have floated proposed rules, they
would likely revisit them in light of the FXCM tumult, said Bart
Chilton, a senior policy adviser at DLA Piper LLP and former CFTC
commissioner.
One of the key reforms of the 2010 Dodd-Frank law was to move
trading in relatively opaque financial products, like derivatives,
onto centralized clearinghouses, which take fees to guarantee
trades and force traders to post collateral known as margin. The
potential downside: Those clearinghouses have become increasingly
important parts of the financial system, meaning that their own
actions could have broad ripple effects.
Banks and others have raised concerns with regulators that
clearinghouses now pose a new threat to financial stability and
have called for actions to beef up their resiliency. The Financial
Stability Oversight Council is probing the issue in an effort to
evaluate what risks clearinghouses might pose.
Write to Ryan Tracy at ryan.tracy@wsj.com, Victoria McGrane at
victoria.mcgrane@wsj.com and Andrew Ackerman at
andrew.ackerman@wsj.com
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