On October 28, 2010, the Department of the Treasury (the “Treasury”) published in the Federal Register1 a notice and request for comments (the “Notice”) relating to the authority of the Secretary of the Treasury (the “Secretary”) to make a written determination that foreign exchange swaps, foreign exchange forwards, or both, should not be regulated as swaps under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).2 In the Notice, the Treasury states that the Secretary has made no determination yet as to whether an exemption is warranted. The Treasury solicited comments on whether an exemption for foreign exchange swaps, foreign exchange forwards, or both, is warranted and on the application of the factors described below that the Secretary is required to consider in making any such determination. The Treasury also solicited comments on the questions attached as Appendix A to this client alert (click here to see the Appendix A) and encouraged commenters to submit supporting materials, including relevant transactional data, that would assist the Secretary’s consideration of the issues relating to any exemption. Written comments must be received by the Treasury on or before November 29, 2010 to be assured of consideration.
Foreign Exchange Swaps and Foreign Exchange Forwards Under the Dodd-Frank Act
Section 721 of the Dodd-Frank Act amends section 1a of the Commodity Exchange Act (the “CEA”)3 to include, among other things, the new definitions of “swap,” “foreign exchange swap,” and “foreign exchange forward.”4 Foreign exchange swaps and foreign exchange forwards are expressly included in the definition of swap. However, the Secretary may make a written determination that either foreign exchange swaps or foreign exchange forwards, or both, should not be regulated as swaps under the CEA and are not structured to evade the Dodd- Frank Act in violation of any rule promulgated by the Commodity Futures Trading Commission.5 In making any such determination, the Secretary must consider the following factors:
1. Whether the required trading and clearing of foreign exchange swaps and foreign exchange forwards would create systemic risk, lower transparency, or threaten the financial stability of the United States;
2. Whether foreign exchange swaps and foreign exchange forwards are already subject to a regulatory scheme that is materially comparable to that established by the CEA for other classes of swaps;
3. The extent to which bank regulators of participants in the foreign exchange market provide adequate supervision, including capital and margin requirements;
4. The extent of adequate payment and settlement systems; and
5. The use of a potential exemption of foreign exchange swaps and foreign exchange forwards to evade otherwise applicable regulatory requirements.6
If the Secretary determines to exempt foreign exchange swaps and foreign exchange forwards from the swap definition, the Secretary must submit a detailed written determination to the appropriate Congressional committees, including the Committee on Agriculture, Nutrition, and Forestry of the Senate and the Committee on Agriculture of the House of Representatives. Specifically, the Secretary’s determination must contain the following information:
1. An explanation regarding why foreign exchange swaps and foreign exchange forwards are qualitatively different from other classes of swaps in a way that would make the foreign exchange swaps and foreign exchange forwards ill-suited for regulation as swaps; and
2. An identification of the objective differences of foreign exchange swaps and foreign exchange forwards with respect to standard swaps that warrant an exempted status.7
Note, however, that there is no requirement that the appropriate Congressional committees approve or otherwise affirm the Secretary’s determination. Section 1a(47)(E)(ii) of the CEA provides that the Secretary’s determination is not effective until it is submitted to the appropriate Congressional committees. Thus, although the process for preparing and submitting a determination to exempt foreign exchange swaps and foreign exchange forwards from regulation as swaps may be somewhat burdensome for the Secretary, it appears that once the written determination is submitted to the appropriate Congressional committees, it becomes effective and any exemption contained in the determination will apply.
Notwithstanding any written determination that the Secretary makes under section 1a(47)(E)(i) of the CEA, the swap reporting obligations and, to the extent that a counterparty to a foreign exchange swap or a foreign exchange forward is a swap dealer or major swap participant, the business conduct standards under the Dodd-Frank Act will apply to foreign exchange swaps and foreign exchange forwards.8