Risk Protection for Trading in the World Money Market - dummies

Risk Protection for Trading in the World Money Market

By Michael Griffis, Lita Epstein

Although trading in foreign currencies often is called the modern-day Wild West, forces are in place that can help you minimize the risks — provided you take advantage of them and trade within their boundaries. The primary monitors of foreign currency trading are the world’s central banks. They monitor the flow of money between countries and the balance of payments between governments and banking institutions.

In the United States, these types of transactions are regulated by the U.S. Treasury Department and the Federal Reserve Banks. Similar regulatory authorities exist in most major currency markets, but if you decide to do business with a nonbanking institution, you’re transacting your business in unprotected waters outside the safe harbor of regulatory oversight and must do so under the often fateful guise of caveat emptor: let the buyer beware.

Internationally, the Bank for International Settlement (BIS) is the leading independent agency for evaluating foreign exchange trading institutions on a global basis. BIS created risk-weighted evaluation and capital requirements for institutions that trade in foreign currencies and money market transactions. Be certain that any institution outside the United States with which you plan to conduct trades meets BIS standards.

A number of common clearing systems assist with the transfer of foreign currencies. The two best-known ones are the Clearing House Interbank Payments System, or CHIPS, and the Society for Worldwide Interbank Financial Telecommunication, or S.W.I.F.T.

Be sure you’re using one of these systems when you trade, because they code transactions to avoid defaults and help you identify the creditworthiness of transactions. CHIPS is privately owned and operated by the New York Clearing House.

If you’re trading in foreign currency futures, your risks are much less, because the futures industry is highly regulated. Clearinghouses for futures are efficient, and futures transactions usually are cleared hourly or in some cases even minute-by-minute.