CFTC staff published a no-action letter Oct. 12 (Letter 12-21) providing relief to certain firms that might currently be considering whether they have to register with the CFTC as swap dealers and/or be considered "major swap participants" under the Commodities Exchange Act and regulations -- specifically, firms that deal exclusively or primarily in "foreign exchange forwards and "foreign exchange swaps" (see box, below, for definitions). The U.S. Treasury Secretary has proposed to exempt those types of transactions from almost all of the CEA, but has not yet issued a final determination to that effect. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 added CEA Section 1a(47)(E)(1), which gave the exemption power to the Treasury Secretary. However, the Secretary's authority in this regard is limited to the two narrowly defined types of transactions known as foreign exchange forwards and foreign exchange swaps (see box); most currency-related instruments used by investment managers have already been classified as swaps subject to the full panopoly of Dodd-Frank regulations under the joint CFTC/SEC regulations further defining the term "swap," which became effect Oct. 12.

The CFTC has proposed a roadmap for cross-border application of the financial reform law, and has been working with other countries' regulators on implementing OTC derivatives reform. Some foreign banks have balked at U.S. regulators' cross-border application of the CEA and regulations.

International Response
The CFTC has proposed a roadmap for cross-border application of the financial reform law, and has been working with other countries' regulators on implementing OTC derivatives reform. Foreign banks and regulators have expressed concerns over U.S. regulators' actions. Some banks have indicated they will not register with the CFTC, including Singapore-based DBS Group. But responding to speculation that it might shift trading to avoid U.S. registration, a spokesman for the bank said, "We will continue to trade with U.S. counterparties. However, we do not intend to register as a swap dealer in the U.S. because we expect our trading volumes with U.S.-based counterparties to stay below the threshold which triggers the CFTC registration requirement."

Treasury's Role
On May 5, 2011, Treasury issued a proposed determination to exempt both "foreign exchange forwards" and "foreign exchange swaps "from the definition of the term "swap" in the CEA, but the action has not become final under the federal rulemaking process. Treasury's original request for comments came on Oct. 28, 2010.

Notably, Treasury's proposal did not become final before Oct. 12; that was the effective date of new joint swaps rules written by the CFTC and the SEC under the Dodd-Frank Act, intended to rein in the massive over-the-counter derivatives market in the wake of the 2008 financial crisis. The SEC's jurisdiction in the derivatives arena is over securities-based swaps. It is widely anticipated that the Treasury Secretary will act before the year's end to finalize the proposed determination to exempt "foreign exchange forwards" and "foreign exchange swaps" from almost all of the Dodd-Frank requirements.

Registration and ‘Major Swap Participant' Relief
The CFTC no-action letter states that if the Treasury Secretary issues a final determination that "foreign exchange forwards" and "foreign exchange swaps" are exempt from the CEA under Section 1a(47)(E)(1), the CFTC staff will not pursue enforcement action against a firm for failure to include such instruments in the calculation of its "gross notional amount of swaps connected with its swap dealing activity" for to determine whether it must register with the CFTC as a swap dealer, before Dec. 31, 2012 -- that is, provided the firm doesn't engage in other types of swaps transactions before then. If it does enter into other types of swaps before that time, and those transactions take the firm over the de minimis exception in CFTC Regulation 1.3(ggg)(4), the firm must begin counting those transactions in its determination of the date by which it must apply to be registered as a swap dealer. The same relief applies to these firms' calculations to determine whether they are a "major swap participant" under CFTC Regulation 1.3(hhh).

But the Oct. 12 CFTC relief does not extend to firms that engage in other types of derivatives trading whose "foreign exchange forwards" and "foreign exchange swaps" happen to put them over the de minimis threshold as of Oct. 12, despite industry efforts to get a temporary reprieve pending the Treasury Secretary's final determination. The CFTC staff wrote in No-action Letter No. 12-21 that it "does not believe it is appropriate that this limited no-action relief would delay the date by which an entity must register as a swap dealer, if the entity enters into other types of swaps in connection with its swap dealing activities in excess of the de minimis thresholds."

Collective Investment Vehicles
The CFTC extended the no-action relief to operators of collective investment vehicles "that trade foreign exchange swaps and forwards and persons who provide advice concerning foreign exchange swaps and forwards, and would have to register with the commission as commodity pool operators or commodity trading advisors solely as a result of these respective activities," subject to the same conditions that apply to firms that engage exclusively or primarily in foreign exchange swap and foreign exchange forward dealing. 

Definition of FOREX Swaps and FOREX Forwards

The Dodd-Frank Act established definitions of "foreign exchange forward" and "foreign exchange swap."

Foreign Exchange Forward means "a transaction that solely involves the exchange of two different currencies on a specific future date at a fixed rate agreed upon on the inception of the contract covering the exchange."

Foreign Exchange Swap means "a transaction that solely involves (A) an exchange of two different currencies on a specific date at a fixed rate that is agreed upon on the inception of the contract covering the exchange; and (B) a reverse exchange of the two currencies described in subparagraph (A) at a later date and at a fixed rate that is agreed upon on the inception of the contract covering the exchange." Commodity Exchange Act Sections 1a(24) and (25). 

The key to these defined terms is the exchange of two different currencies. The CFTC has already classified the following transactions as swaps: other instruments that are based on currency, but are settled in a single currency (usually, U.S. Dollars) rather than resulting in an  exchange of different currencies, such as "non-deliverable forwards;' and foreign currency options (other than foreign currency options traded on a national security exchange), or that otherwise do not come within the definitions of "foreign exchange forward" or "foreign exchange swap," such as currency swaps and cross-currency swaps.