IT IS AN “OVER-THE-COUNTER” MARKETWITH AN “EXCHANGE-TRADED”SEGMENT

Until the 1970s, all foreign exchange trading in the United States (and elsewhere) was handled “over-the-counter,” (OTC) by banks in different locations making deals via telephone and telex.In the United States, the OTC market was then, and is now, largely unregulated as a market.

Buying and selling foreign currencies is considered the exercise of an express banking power. Thus, a commercial bank in the United States does not need any special authorization to trade or deal in foreign exchange.
Similarly, securities firms and brokerage firms do not need permission from the Securities and Exchange Commission (SEC) or any other body to engage in foreign exchange activity.
Transactions can be carried out on whatever terms and with whatever provisions are permitted by law and acceptable to the two counter parties, subject to the standard commercial law governing business transactions in the United States.

There are no official rules or restrictions in the United States governing the hours or conditions of trading. The trading conventions have been developed mostly by market participants. There is no official code prescribing what constitutes good market practice.

However, the Foreign Exchange Committee, an independent body sponsored by the Federal Reserve Bank of New York and composed of representatives from institutions participating in the market, produces and regularly updates its report on Guidelines for Foreign Exchange Trading. These Guidelines seek to clarify common market practices and offer “best practice recommendations” with respect to trading activities, relationships, and other matters. The report is a purely advisory document designed to foster the healthy functioning and development of the foreign exchange market in the United States.

Although the OTC market is not regulated as a market in the way that the organized exchanges are regulated, regulatory authorities examine the foreign exchange market activities of banks and certain other institutions participating in the OTC market. As with other business activities in which these institutions are engaged, examiners look at trading systems, activities, and exposure, focusing on the safety and soundness of the institution and its activities.Examinations deal with such matters as capital adequacy, control systems, disclosure, sound banking practice, legal compliance, and other factors relating to the safety and soundness of the institution.

The OTC market accounts for well over 90 percent of total U.S. foreign exchange market activity, covering both the traditional (pre-1970) products (spot,outright forwards,and FX swaps) as well as the more recently introduced (post-1970) OTC products (currency options and currency swaps). On the “organized exchanges,” foreign exchange products traded are currency futures and certain currency options.

Trading practices on the organized exchanges, and the regulatory arrangements covering the exchanges, are markedly different from those in the OTC market. In the exchanges, trading takes place publicly in a centralized location.

Hours, trading practices, and other matters are regulated by the particular exchange; products are standardized.
There are margin payments, daily marking to market, and cash settlements through a central clearinghouse.