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FX Swaps and Forwards Exempted from Dodd-Frank Clearing and Exchange Trading Requirements
Practical Law Legal Update 1-522-5211 (Approx. 3 pages)
FX Swaps and Forwards Exempted from Dodd-Frank Clearing and Exchange Trading Requirements
by Practical Law Finance
| Published on 20 Nov 2012 • USA (National/Federal) |
The US Department of the Treasury released a final determination stating that foreign exchange swaps and foreign exchange forwards are not subject to central clearing and exchange trading under the Commodity Exchange Act (CEA), as amended by Title VII of the Dodd-Frank Act.
On November 16, 2012, the US Department of the Treasury released a final determination stating that foreign exchange (FX) swaps and FX forwards are exempt from the definition of "swap" under the Commodity Exchange Act (CEA), as amended by Title VII of the Dodd-Frank Act. As a result, FX swaps and forwards are not subject to Dodd-Frank central clearing and exchange trading requirements.
The final determination exempts from the central clearing and exchange trading requirements of Title VII of the Dodd-Frank Act:
- FX swaps. An FX swap is defined as:
- an exchange of two different currencies on a specific date at a fixed rate that is agreed on at the inception of the contract covering the exchange; and
- a reverse exchange of those two currencies at a later date at a fixed rate that is agreed on at the inception of the contract covering the exchange.
- FX forwards. An FX forward is defined as a transaction that solely involves the exchange of two different currencies on a specific future date at a fixed rate agreed on at the inception of the contract covering the exchange.
Other FX derivatives are not exempted from the central clearing and exchange trading requirements. For example, FX options, currency swaps and non-deliverable forwards (NDFs) are not exempted if they are not captured by the above definitions.
The exemption is based on the Treasury's determination that the central clearing and exchange trading requirement would do little to mitigate risk associated with FX swaps and forwards. While centralized clearing mitigates risk for most derivatives, it does little to mitigate the risk for FX swaps and forwards. This is because parties to FX swaps and forwards:
- Know the full extent of their payment obligations upon entering into a contract.
- Settle contracts through the exchange of actual currency.
- Deal predominately in short-term instruments.
Requiring central clearing and exchange trading of FX swaps and forwards would also potentially introduce unknown operational risks into a market already effectively managed through an existing settlement system.
The final exemption is substantially the same as the proposed exemption. FX swaps and forwards remain subject to mandatory Title VII data reporting and business conduct rules applicable to swap dealers and major swap participants.
Note that CFTC has issued no-action letters permitting parties to exclude their FX swaps and FX forwards when determining if they must register as:
- A swap dealer or major swap participant (MSP).
- A CPO or CTA.
These exclusions are contingent upon the issuance of this final FX swaps and forwards exemption, provided the exemption is effective by December 31, 2012 (see Legal Update, No-action Guidance on SD, MSP and CPO Rules under Dodd-Frank Issued by CFTC: Conditional exclusion of FX swaps from SD, MSP, CPO and CTA calculations). Though it is assumed this FX exemption will be sufficient for these purposes, its effective date has not yet been established.
For more information on swaps and derivatives regulation under Dodd-Frank, see Practice Notes, Summary of the Dodd-Frank Act: Swaps and Derivatives and Road Map to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.
For more information on how FX and currency swaps are used see Practice Notes, Derivatives: Overview (US): Currency Swaps and Derivatives: Commercial Uses (US): Managing Currency Risk.