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April 20, 2014

Treasury Issues Final Determination on Foreign Exchange Swaps and Forwards

Foreign exchange swaps and foreign exchange forwards are exempted from the definition of "swap" under the Commodity Exchange Act.

On November 16, the Secretary of the U.S. Department of the Treasury (Secretary) issued a final determination (Determination) exempting foreign exchange swaps (FX Swaps) and foreign exchange forwards (FX Forwards) from the definition of "swap" under the Commodity Exchange Act (CEA), thereby relieving them from the central clearing and exchange-trading requirements that apply to other types of swaps.[1] The Determination will become effective upon publication in the Federal Register.

Exemption for FX Swaps and FX Forwards from "Swap" Definition

FX Swaps are defined in the CEA to include (1) an exchange of two different currencies on a specific date at a fixed rate that is agreed upon at the inception of the contract covering the exchange and (2) a reverse exchange of those two currencies at a later date and at a fixed rate that is agreed upon at the inception of the contract covering the exchange. FX Forwards are defined in the CEA to include a transaction that solely involves the exchange of two different currencies on a specific future date at a fixed rate agreed upon at the inception of the contract involving the exchange.

Under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), the definition of "swap" included FX Swaps and FX Forwards, which therefore made them subject to all of the Dodd-Frank Act requirements applicable to swaps, such as the central clearing and exchange-trading requirements, reporting obligations, business conduct standards, and margin requirements. The Dodd-Frank Act, however, also gave the Secretary the authority to make a determination that FX Swaps and FX Forwards should be exempted from the definition of "swap," and thus the Dodd-Frank Act requirements applicable to swaps, other than anti-evasion provisions, reporting to a swap data repository and business conduct standards for swap dealers and major swap participants (MSPs).

In the Determination, the Secretary noted that FX Swaps and FX Forwards differ from other swap transactions in that they generally have fixed payment obligations, are physically settled, and are predominantly short term. The Secretary noted that these characteristics obviate the need for the central clearing and exchange-trading requirements that apply for other types of swaps.

The Secretary specifically noted that the Treasury Department's authority to issue the Determination was limited to FX Swaps and FX Forwards and did not extend to other types of foreign exchange derivatives. Specifically, foreign exchange options, currency swaps, and non-deliverable foreign exchange forwards (NDFs) are not covered by the Determination and, therefore, remain within the definition of "swap" and thus are subject to all of the CEA's swap requirements.

Implications

Despite the Determination, transactions in FX Swaps and FX Forwards still must comply with the CEA's general reporting requirements (but not real-time reporting requirements), and swap dealers and MSPs that are parties to a transaction involving FX Swaps or FX Forwards still must comply with external business conduct standards. FX Swaps and FX Forwards also are subject to the Commodity Futures Trading Commission's (CFTC's) anti-evasion authority.

FX Swaps and FX Forwards do not need to be included in calculating whether an entity must register as a swap dealer or an MSP or considered in determining whether an entity's activities involve commodity interests requiring registration as a futures commission merchant, introducing broker, commodity pool operator (CPO), or commodity trading advisor (CTA). Additionally, FX Swaps and FX Forwards will not be subject to the mandatory clearing and exchange-trading requirements established as part of the new swap regulatory framework.

The Determination also eliminates the need for the relief provided by the CFTC Division of Swap Dealer and Intermediary Oversight's October 12 No-Action Letter,[2] which allowed entities to exclude FX Swaps and FX Forwards from threshold calculations for determining if swap-dealer or MSP registration was required, or if CPO or CTA registration was required, because of an entity's swaps activity (No-Action Relief). As a result of the Determination, the No-Action Relief is moot.


[1]. View the Determination here.

[2]. For more information, read our October 12, 2012, LawFlash, "Temporary Relief from Registration for Swaps Intermediaries," availablehere.

Copyright © 2014 by Morgan, Lewis & Bockius LLP. All Rights Reserved.

About the Author

Of Counsel

Michael A. Piracci is of counsel in Morgan Lewis's Investment Management and Securities Industry Practice. Mr. Piracci focuses his practice on exchange traded futures, foreign exchange, and matters related to futures commission merchants, introducing brokers, commodity pool operators, and commodity trading advisors. He provides advice and counsel relating to a broad range of regulatory issues, including compliance under the Commodity Exchange Act, regulatory examinations, and trading and market practices.

212.309.6385

About the Author

Associate

Dana D.C. Westfall is an associate in Morgan Lewis's Investment Management and Securities Industry Practice. Mr. Westfall focuses his practice on investment management, futures and securities transactions, and derivatives regulation and compliance matters.

Mr. Westfall counsels domestic and foreign futures exchanges and clearing organizations, investment managers, brokerage firms, and end-users in connection with exchange-traded and over-the-counter derivative instruments. He also counsels investment managers with structuring and forming private...

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