Treasury announced that it has issued a final determination providing that a limited class of transactions related to foreign exchange is not within the definition of a swap and is therefore exempt from certain aspects of swap regulation. The effect of the exemption is quite limited in two major respects: (i) the transactions as to which the exemption applies; and (ii) the scope of requirements as to which the exemption serves as a carve-out.
Types of Transactions. The exemption applies to two types of transactions: First, a transaction that solely involves an exchange of two different currencies on a specific date at a fixed rate agreed at the start of the trade coupled with a reverse exchange of those two currencies at a later date at a fixed rate agreed at the start of the trade (a “foreign currency forward”). Second, a transaction that involves the exchange of two different currencies on a specific date at a fixed rate agreed at the start of the trade (a “foreign currency swap”).
The exemption is not available to trades such as currency options, currency swaps (that do not involve a full exchange of principal) and non-deliverable forwards (trades in which payments are made in only a single currency).
Scope of Exemption. The exemption still leaves foreign currency forwards and swaps subject to certain requirements under Dodd-Frank including (i) trade reporting (but not real-time reporting); (ii) the CFTC’s anti-evasion authority; and (iii) business conduct rules.
Justifications. In order to justify this determination, Treasury had to distinguish between the exempted trades and other fully-regulated swaps. Of the justifications given, (i) some were quite compelling (the absence of any sufficient clearing mechanism; the potential disruption to international commerce); (ii) some seemed a little weak (the claim that credit risk is limited because the final settlement payments are known); and (iii) some raised doubts as to Title VII generally (the risk of pushing such a volume of trades through novel clearance systems).
Calculations. For firms determining their regulatory status as swap dealers, major swap participants and commodity pool operators, the narrowed definition of “swap” may be material in performing the relevant calculations.
Lofchie Comment: Why exactly did this determination take so long to issue? In light of the volume of these transactions and their importance to international commerce, I personally can not imagine that Treasury ever could have reached a different result. In fact, although some of the arguments in the determination are mediocre, others are so strong and practical (that is, the tremendous risks that would have been introduced into the financial markets under any other decision), it seems obvious that the result of Treasury’s determination was never in doubt. So why did it take so long to publish? In the meantime, huge amounts of time and effort were spent preparing for a contingency that was never going to be.
