FX Swaps Regulation

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Gavel.png FINAL DETERMINATION: The Treasury Department issued its final determination on foreign exchange swaps and forwards on November 12, 2012.
Dodd-Frank Timeline, FX Swaps Exception to Swaps Regulation, Treasury Department
Proposal Date Comment Deadline Proposed Determination Final Determination
October 28, 2010 November 29, 2010 April 29, 2011 November 16, 2012

The Dodd-Frank Act requires most swaps to be traded on an exchange or on a similar system and then guaranteed by a clearinghouse, where the parties would be required to post collateral. However, the act allows the Secretary of the Treasury to make a final determination as to whether foreign exchange transactions should be granted an exemption from the Dodd-Frank definition of swaps. On November 16, 2012, the U.S. Department of the Treasury issued it final determination that effectively exempts FX swaps and forwards from mandatory derivatives requirements, including central clearing and exchange trading.

FX swaps and forwards will remain subject to the Dodd-Frank Act’s new requirement to report trades to swap data repositories and business conduct standards. [1] Additionally, the Dodd-Frank Act makes it illegal to use these instruments to evade other derivatives reforms. The final determination does not extend to other FX derivatives:

  • FX options,
  • currency swaps, and
  • non-deliverable forwards.

These other derivative instruments will still be subject to mandatory clearing as well as the requirement that they be traded on either a designated contract market (DCM) or a swap execution facility (SEF). [2]

Note: Additional requirements for off-exchange retail forex transactions were addressed in a previous CFTC ruling on September 10, 2010.


Contents

Background

Title VII of the Dodd-Frank Act includes Foreign Exchange Swaps and Forward Contracts in its definition of swaps under the Commodity Exchange Act. However, the Act allows the Secretary of the Treasury to determine whether to allow an exemption for such contracts. On October 29, 2010, the Department of the Treasury issued a notice and request for comments regarding the proposed exemption. The notice included a list of questions regarding, among other things:

  • the appropriateness of exempting foreign exchange from the swaps definition;
  • the adequacy of the regulatory structure surrounding foreign exchange;
  • industry risks, including credit risk, counterparty risk, and other systemic risks; and
  • the likely effects of mandatory clearing of FX swaps.

On April 29, 2011, the Treasury Department issued its notice of proposed determination of foreign exchange swaps and forwards. [3][4] Under the proposed determination, FX swaps and forwards would be exempt from clearing, registration, and real-time reporting requirements, but would still be required to be submitted to a swap data repository.[5]

The proposed determination entered the Federal Register on May 5, 2011. The deadline for public comment was June 6, 2011.

Summary of the Final Determination, November 2012

According to the Treasury Department, the foreign exchange swap and forward exemption was based on several factors, including:

  • The forex market has certain unique characteristics and pre-existing oversight functions which already reflect many of the Dodd-Frank Act’s objectives for reform – including high levels of transparency, effective risk management, and financial stability:
    • FX swaps and forwards always require both parties to physically exchange the full amount of currency on fixed terms that are set at the outset of the contract.
    • Market participants know the full extent of their own payment obligations to the other party to a trade throughout the life of the contract.
    • FX swaps and forwards are predominantly short-term transactions (68 percent of the market matures in one week or less and 98 percent in one year or less). This greatly reduces the counterparty credit risk prevalent in other swaps contracts.
  • Settlement of the full principal amounts of the contracts would require substantial capital backing in a very large number of currencies, representing a much greater commitment for a potential clearinghouse in the FX swaps and forwards market than for any other type of derivatives market.

Related Documents: Proposal and Request for Comment (October 2010); Proposed Determination (April 2011); Final Determination (November 2012)

References

  1. Fact Sheet: Final Determination on Foreign Exchange Swaps and Forwards. U.S. Department of the Treasury. Retrieved on November 18, 2012.
  2. U.S. Treasury Exempts Foreign Exchange Swaps From Dodd-Frank. Bloomberg. Retrieved on November 19, 2012.
  3. Wall Street Banks Seek Exemption From Dodd-Frank on Foreign-Exchange Swaps. Bloomberg.com. Retrieved on November 23, 2010.
  4. US Treasury grants exemption for forex swaps. FT.com. Retrieved on May 17, 2011.
  5. U.S. Department of the Treasury. Federal Register. Retrieved on May 2, 2011.

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