The Commodity Exchange Act (‘‘CEA’’), as amended by Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (‘‘Dodd-Frank Act’’), authorizes the Secretary of the Treasury (‘‘Secretary’’) to issue a written determination that foreign exchange swaps, foreign exchange forwards, or both, should not be regulated as swaps under the CEA. On November 20th, the Secretary decided to do just that, and used its power to exclude foreign exchange swaps and foreign exchange forwards from the definition of a swap. Thus, this decision removes these securities from the new swap regulatory regime set up by Dodd-Frank (as discussed in the previous blog entitled “Will You Need to Register as a “CTA” in the New Year?”).
In response to their request for comments on the subject, the Treasury received 26 comment letters with 15 expressing support for the proposed exclusion, while 11 were generally opposed. Those who support issuing an exemption generally argue that foreign exchange swaps and forwards are functionally different from other over-the-counter (‘‘OTC’’) derivatives and already “trade in a highly transparentand liquid market” where the banking regulators have substantial visibility and exercise strong regulatory oversight. Furthermore, because foreign exchange swaps and forwards involve an actual exchange of principal and are predominantly very short in duration and have high turnover rates, the additional costs and operational difficulty associated with clearing foreign exchange swaps and forwards would adversely affect their business activities and discourage hedging activity.
Opponents argued that any exclusion would create an “enormous” loophole that could undermine “financial stability by preserving an opaque, unregulated and undercapitalized market.” Additionally, this loophole could be used to mask complex transactions in an effort to avoid subjecting them to clearing and trading requirements.
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