Complying with Dodd Frank’s recordkeeping and mandatory clearing requirements for certain OTC products has remained a top priority for market participants, and efforts to do so have included working with regulators to clarify initial product definitions and classifications. Towards that end, a group of financial services trade associations has recently been engaged with the Act’s distinctions between deliverable and non-deliverable currency forward products. As background, non-deliverable forwards (NDFs) are positions settled by counterparty payments based on changes in relative currency values during a period, but which do not require actual/physical delivery of currency units. In a November, 2012 rulemaking determination, the CFTC stipulated that while certain currency forward and swap products would essentially be exempt from the definition of “swap” transactions that would be subject to Dodd Frank clearing provisions, NDFs would not be similarly exempt. That determination resulted in a February, 2013 petition from a group of trade associations seeking to engage the CFTC to reconsider whether NDFs would be subject to mandatory clearing; a March, 2013 notice from the Senate Agricultural Committee inviting further public comment on concerns over CFTC jurisdiction and rulemaking efforts; and most recently a May 2013 follow up recommendation (in response to the Senate Ag Committees invitation for further input) from the same trade association group reiterating the request to exempt NDFs from the relevant Dodd Frank “swap” definition and associated clearing requirements
The February and May 2013 trade association letters address a wide range of background issues, but primarily focus on the following in support of their calls for NDFs to be exempt from mandatory clearing: 1)That FX markets are characterized by degrees of price transparency and availability of pricing data that exchange trading would not necessarily improve (citing Treasury Department comments on the FX market and FX pricing data during previous rulemaking sessions); 2)That NDFs would be subject to Dodd Frank’s recordkeeping and swap reporting requirements even if exempt from clearing, which would further the aforementioned price transparency and pricing data characteristics of the FX market even absent a clearing requirement; 3)That mandatory clearing would impose undue capital costs (in the form of the additional margin, capital and documentation requirements that would be associated with clearing) on a market that is largely short term in nature (citing that over 68% of foreign exchange swaps and forwards mature within one week, and over 98% mature within one year), and hence could result in operational challenges that deter trading; and 4)That mandatory clearing requirements could have global economic implications to the extent they could deter certain types of emerging market transactions (which may be less likely to allow for physical/deliverable settlement due to local law or other regulations limiting international movement of physical currency units).
To a large extent, these four points represent themes that have become increasingly familiar as efforts to transition certain OTC markets to exchanges have continued, and which will likely continue to be debated by market participants and regulators in the context of NDFs as well as other products. In addition, certain NDF positions may also be affected by ongoing regulations defining hedge accounting, as transactions that meet certain hedging definitions laid out under Generally Accepted Accounting Principles may also be exempt from mandatory clearing. In the meantime, no formal reply to the Trade Association letters has yet been issued by the CFTC, and the Senate Agricultural Committee has continued to hold hearings to follow up on public comments in response to its March 2013 notice. Any ultimate determinations will impact a number of areas, including how entities document NDF trades as well as how they report cleared and non-cleared transactions internally and to regulators and investors, and thus will be watched closely; this space will continue to monitor further developments as they occur.