Administration of Relationships with Foreign Exchange Counterparties
February 11, 2003

The Federal Reserve Bank of New York (FRBNY) is updating its practices with regard to the administration of its foreign exchange counterparty relationships. The FRBNY engages in trading relationships with counterparties in order to conduct foreign exchange operations for the U.S. monetary authorities and to execute transactions for foreign central banks, U.S. government agencies, and multinational development organizations. The FRBNY also relies on these relationships to keep the U.S. monetary authorities informed about developments in the foreign exchange and broader global financial markets.

The FRBNY last amended its eligibility and performance criteria for foreign exchange trading relationships in 1992. Since that time, financial markets have evolved substantially and certain market practices have changed. Taking into account these developments, the FRBNY is updating the criteria for eligibility and performance as a foreign exchange counterparty, with the continued objectives of effectively conducting transactions in the foreign exchange market and gathering information that is useful to the U.S. monetary authorities.

In general, the changes in the administration of foreign exchange counterparty relationships will not have an immediate effect on existing relationships. New counterparties will be eligible on the basis of criteria listed below. The number of foreign exchange counterparties at any given time will be determined by the FRBNY in its sole discretion based upon its business needs. As in the past, all foreign exchange counterparties will be expected to perform consistently and reliably in the following ways:

Business Criteria

  • Make reasonably good markets in their trading relationship with the FRBNY trading desk in the currencies in which the FRBNY has an interest. Execution should be efficient and professional, and prices should be competitive.
  • Provide the trading desk with market information and analysis that is useful to the U.S. monetary authorities and is based upon a meaningful presence in the markets in which the FRBNY has an interest. Counterparties are expected to maintain a dialogue with the trading desk and to provide access to the expertise within their firms.
  • Have and maintain settlement procedures that are in line with industry best practices and are acceptable to the FRBNY for the paying and receiving of currencies. Confirmation, matching and settlement should take place in a timely and accurate manner.

In evaluating a firm's market-making performance with the trading desk, the FRBNY will consider the business transacted and observations regarding pricing, execution, confirmation and settlement. The frequency and quality of the firm's market commentary, research, and firm-wide access will also be assessed. Each counterparty's performance will be reviewed on an ongoing basis. We envision providing management of counterparty firms with formal feedback on an annual basis beginning in 2004. If a dealer's performance is unsatisfactory to the FRBNY, that dealer will be asked to improve its performance and will be re-evaluated within six months. The FRBNY may suspend or discontinue its dealing relationships with any foreign exchange trading counterparty that fails to meet its standards.

Creditworthiness

The FRBNY will monitor the creditworthiness of its foreign exchange trading counterparties on an ongoing basis. Should a firm's creditworthiness fall below minimum standards as determined by the FRBNY, the FRBNY may suspend its trading relationship until the firm's creditworthiness improves.

Criteria for Accepting New Dealers

Under the eligibility guidelines set forth in 1992, trading counterparties were required to be either commercial banking organizations subject to official supervision by U.S. Federal bank supervisors or broker/dealers registered with the Securities and Exchange Commission. In recent years, changing legislation has blurred the distinction between different types of financial institutions. As a result, the FRBNY has expanded its eligibility criteria to include any financial institution that meets this Bank's business criteria as outlined above and meets additional creditworthiness standards as described below.

The FRBNY recognizes that, like any other market participant, it will assume certain risks when trading and settling foreign exchange transactions with private sector counterparties. FRBNY intends to manage these risks, in part, by establishing minimum creditworthiness standards for foreign exchange counterparties. When assessing a potential counterparty's creditworthiness, FRBNY may consider many factors including, but not limited to, whether the counterparty:

  • Has been assigned an investment grade rating by a nationally recognized statistical rating organization or has been assigned an industry specific rating that is equivalent to investment grade
  • Is subject to formal regulation and adheres to the principles of transparent financial reporting
  • Meets minimum capital standards set forth by the firm's primary regulator
  • Has sufficient capital to absorb risks inherent in its business and to participate meaningfully in the FRBNY's foreign currency operations
  • Has adequate liquidity to comfortably meet obligations during adverse market events

A financial institution wishing to become a foreign exchange trading counterparty must inform the FRBNY in writing. As a part of that notification, a prospective counterparty must also provide sufficient financial information to enable the FRBNY to make a determination of creditworthiness. As stated above, the FRBNY will determine its need for additional foreign exchange counterparties based on its business activity.