[Federal Register Volume 77, Number 224 (Tuesday, November 20, 2012)]
[Notices]
[Pages 69694-69705]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-28319]


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DEPARTMENT OF THE TREASURY


Determination of Foreign Exchange Swaps and Foreign Exchange 
Forwards Under the Commodity Exchange Act

AGENCY: Department of the Treasury, Departmental Offices.

ACTION: Final determination.

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SUMMARY: 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. The Secretary is issuing a determination that 
exempts both foreign exchange swaps and foreign exchange forwards from 
the definition of ``swap,'' in accordance with the applicable 
provisions of the CEA.

DATES: Effective November 20, 2012.

FOR FURTHER INFORMATION CONTACT: Office of Financial Markets, 1500 
Pennsylvania Avenue NW., Washington, DC 20220, (202) 622-2000; Thomas 
E. Scanlon, Office of the General Counsel, 1500 Pennsylvania Avenue 
NW., Washington, DC 20220, (202) 622-8170.

SUPPLEMENTARY INFORMATION: Title VII of the Dodd-Frank Act \1\ amends 
the CEA, as well as Federal securities laws, to provide a comprehensive 
regulatory regime for swaps. Section 721 of the Dodd-Frank Act amends 
section 1a of the CEA, which, in relevant part, defines the term 
``swap'' and includes foreign exchange swaps and foreign exchange 
forwards in the definition.\2\ Section 1a(47)(E) of the CEA authorizes 
the Secretary to make a written determination that ``foreign exchange 
swaps'' \3\ or ``foreign exchange forwards,'' \4\ or both-- (I) should 
not be regulated as swaps under the CEA; and (II) are not structured to 
evade the Dodd-Frank Act in violation of any rule promulgated by the 
Commodity Futures Trading Commission (``CFTC'') pursuant to section 
721(c) of the Dodd-Frank Act.\5\
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    \1\ Public Law 111-203, title VII.
    \2\ 7 U.S.C. 1a(47).
    \3\ 7 U.S.C. 1a(25).
    \4\ 7 U.S.C. 1a(24).
    \5\ 7 U.S.C. 1(a)(47)(E)(i).
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    On October 28, 2010, the Department of the Treasury (``Treasury'') 
published in the Federal Register a Notice and Request for Comments 
(``October 2010 Notice'') to solicit public comment on a wide range of 
issues relating to whether foreign exchange swaps and foreign exchange 
forwards should be exempt from the definition of the term ``swap'' 
under the CEA.\6\
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    \6\ 75 FR 66,426 (Oct. 28, 2010). Thirty comments were submitted 
in response to the October 2010 Notice.
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    On May 5, 2011, Treasury published a notice of proposed 
determination (``NPD'') seeking comment on a proposed determination 
that would exempt both foreign exchange swaps and foreign exchange 
forwards from the definition of ``swap,'' as well as on the factors 
that would support such a determination.
    In addition, Treasury staff has engaged in a broad outreach to 
representatives from multiple market segments, as well as market 
regulators and the Federal regulatory agencies. After assessing the 
comments in response to the October 2010 Notice and the NPD, consulting 
with Federal regulators, and considering the factors set forth in 
section 1b(a) of the CEA, as discussed below, the Secretary finds that 
a determination pursuant to sections 1a(47)(E) and 1b that ``foreign 
exchange swaps'' and ``foreign exchange forwards'' should not be 
regulated as swaps under the CEA, and therefore should be exempted from 
the definition of the term ``swap'' under the CEA, is appropriate.
    In making a determination pursuant to sections 1a(47)(E) and 1b of 
the CEA, the Secretary must consider, and has considered, 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.\7\
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    \7\ 7 U.S.C. 1b(a). In addition, section 1b(b) of the CEA 
provides that, ``[i]f the Secretary makes a determination to exempt 
foreign exchange swaps and foreign exchange forwards from the 
definition of the term `swap','' the Secretary must submit a 
separate ``determination'' to the appropriate committees of 
Congress, which contains (1) an explanation as to why foreign 
exchange swaps and foreign exchange forwards are ``qualitatively 
different from other classes of swaps'' such that foreign exchange 
swaps and foreign exchange forwards are ``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.'' The Secretary 
has submitted this determination to the appropriate committees of 
Congress, and, therefore, this determination is effective, pursuant 
to section 1a(47)(E)(ii) of the CEA.
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I. Summary of Final Determination

    The CEA, as amended by the Dodd-Frank Act, provides a comprehensive 
regulatory regime for swaps and derivatives, including a wide range of 
foreign exchange derivatives, such as foreign exchange options, 
currency swaps, or non-deliverable forwards (``NDFs''). Among other 
measures, this regulatory regime provides for clearing and exchange-
trading requirements that are designed to mitigate risks, promote price 
transparency, and facilitate more stable, liquid markets for derivative 
instruments.
    In general, swaps, including foreign exchange derivatives, carry 
three types of risks: (i) Counterparty credit risk prior to settlement; 
(ii) market risk; and (iii) settlement risk. Counterparty credit risk 
prior to settlement is the risk that a party to the transaction 
potentially could default prior to the settlement date, which could 
result in the non-defaulting party suffering an economic loss 
associated with having to replace the defaulted contract with another 
transaction at the then-current terms.

[[Page 69695]]

Market risk is the risk that the value of the contract changes over the 
term of the transaction. In this context, market risk is intertwined 
with counterparty credit risk prior to settlement because the non-
defaulting party (who thus bears the credit risk) also bears the risk 
that the value of the prior contract might have declined when that 
party seeks to replace the defaulted contract with another transaction. 
Settlement risk, particularly in the context of a foreign exchange swap 
or forward transaction, is the risk that the contract will not be 
settled in accordance with the initial terms, including when one party 
to the transaction delivers the currency it owes the counterparty, but 
does not receive the other currency from that counterparty.
    The payment obligations on currency swaps, interest rate swaps, 
credit default swaps, commodity swaps and other derivatives fluctuate 
in response to changes in the value of the underlying variables on 
which those derivatives contracts are based. As a result, for most 
types of swaps, the full extent of the future payments to be exchanged 
is not known at the outset of the contract and is determined throughout 
the life of the contract. Moreover, as the term of a swap or derivative 
contract increases, a party generally is exposed to greater 
counterparty credit risk and market risk prior to settlement. 
Settlement of most types of swaps and derivatives involves only 
payments of net amounts that are based on the changes in the value of 
the variables underlying the derivatives contracts. Given the features 
of most swaps and derivatives, including some types of foreign exchange 
derivatives, the clearing and exchange-trading requirements under the 
CEA, where applicable, would mitigate the relevant risks, notably 
counterparty credit risks prior to settlement.
    By contrast, foreign exchange swap and forward participants know 
their own and their counterparties' payment obligations and the full 
extent of their exposures at settlement throughout the life of the 
contract. Thus, while the mark-to-market value of a position in a 
foreign exchange swap or forward may vary based on changes in the 
exchange rate or interest rates, the actual settlement amounts do not.
    Under the regulatory regime enacted by the Dodd-Frank Act, foreign 
exchange swaps and forwards generally are subject to the requirements 
of the CEA and, in particular, would be subject to central clearing and 
exchange trading,\8\ unless the Secretary determines that foreign 
exchange swaps and forwards ``(I) should not be regulated as swaps 
under [the CEA]; and (II) are not structured to evade [the Dodd-Frank 
Act] in violation of any rules promulgated by the [CFTC] pursuant to 
section 721(c) of the [Dodd-Frank Act].'' \9\
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    \8\ 7 U.S.C. 2(h)(1)-(2). In general, section 2(h)(1) of the 
CEA, as added by the Dodd-Frank Act, prohibits a person from 
engaging in a swap unless the person submits such swap for clearing 
to a derivatives clearing organization that is registered under the 
CEA if the CFTC requires the swap, or a category of swaps, to be 
cleared. 7 U.S.C. 2(h)(1). In addition, section 2(h)(8) of the CEA 
provides that any swap required to be cleared is subject to trade-
execution requirements. 7 U.S.C. 2(h)(8). Pursuant to section 4s(e) 
of the CEA, uncleared swaps are subject to margin requirements under 
the CEA. 7 U.S.C. 6s(e). Thus, as a result of this determination 
pursuant to sections 1a(47)(E) and 1b of the CEA, foreign exchange 
swaps and forwards would not be subject to margin requirements under 
the CEA.
    \9\ 7 U.S.C. 1a(47)(E)(i).
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    Under the CEA, a ``foreign exchange swap'' is narrowly defined as 
``a transaction that solely involves-- (A) an exchange of 2 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 [those two currencies] at a later date and at a 
fixed rate that is agreed upon on the inception of the contract 
covering the exchange.'' \10\ Likewise, the CEA narrowly defines a 
``foreign exchange forward'' as ``a transaction that solely involves 
the exchange of 2 different currencies on a specific future date at a 
fixed rate agreed upon on the inception of the contract covering the 
exchange.'' \11\
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    \10\ 7 U.S.C. 1a(25).
    \11\ 7 U.S.C. 1a(24).
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    The Secretary's authority to issue a determination is limited to 
foreign exchange swaps and forwards and does not extend to other 
foreign exchange derivatives. Foreign exchange options, currency swaps, 
and NDFs (as discussed below) may not be exempted from the CEA's 
definition of ``swap'' because they do not satisfy the statutory 
definitions of a foreign exchange swap or forward.
    After considering the statutory factors and the comments on the 
NPD, the Secretary is issuing this determination to exempt foreign 
exchange swaps and forwards because of the distinctive characteristics 
of these instruments. Unlike most other swaps, foreign exchange swaps 
and forwards have fixed payment obligations, are settled by the 
exchange of actual currency, and are predominantly short-term 
instruments.
    Counterparty credit risk prior to settlement is significantly 
reduced by the structure of a foreign exchange swap or forward 
transaction, particularly because the term for each type of transaction 
generally is very short. For the vast majority of foreign exchange swap 
or forward contracts, the risk profile is centered on settlement risk. 
Settlement risk often is addressed in foreign exchange swaps and 
forwards through the use of payment-versus-payment (``PVP'') settlement 
arrangements,\12\ particularly with large financial institutions.
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    \12\ PVP settlement arrangements permit the final transfer of 
one currency to take place only if the final transfer of the other 
currency also takes place, thereby virtually eliminating settlement 
risk.
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    Treasury believes, as do several commenters,\13\ that requiring 
central clearing and trading under the CEA on foreign exchange swaps 
and forwards would potentially introduce operational risks and 
challenges to the current settlement process. If central clearing were 
to be required, the central clearing facility would be effectively 
guaranteeing both settlement and market exposure to replacement cost. 
As a result, combining clearing and settlement in a market that 
involves settlement of the full principal amounts of the contracts 
would require capital backing, in a very large number of currencies, 
well in excess of what will be required for swaps that are settled on a 
``net'' basis. Treasury believes that requiring foreign exchange swaps 
and forwards to be cleared and settled through the use of new systems 
and technologies could introduce new, unforeseen risks in this market.
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    \13\ See, e.g., American Express Co., at 1; American Bankers 
Ass'n et al., at 3; FX Investor Group, at 1; Global FX Division of 
SIFMA, et al. (``Global FX Division''), at 1-2.
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II. Overview of the Comments on the NPD

    In response to the NPD, Treasury received 26 comment letters. Of 
these, 15 expressed support for the proposed determination, while 11 
were generally opposed. Several commenters who support the proposed 
determination filed letters that incorporated by reference--as well as 
reconfirmed--statements and arguments they made in response to the 
October 2010 Notice.\14\
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    \14\ References made herein to the comment letters are to those 
submitted in response to the NPD, unless otherwise noted.
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A. Comments Supporting Proposed Determination

    Commenters who support issuing an exemption generally argue that 
foreign exchange swaps and forwards are functionally different from 
other over-the-counter (``OTC'') derivatives because foreign exchange 
swaps and forwards involve an actual exchange of principal, are 
predominantly very short in

[[Page 69696]]

duration and have high turnover rates.\15\ These commenters note that 
this market functions predominantly as a global payments market and is 
used significantly by end-users for hedging purposes.\16\ Many 
corporate participants have expressed concern that the additional costs 
and operational difficulty associated with clearing foreign exchange 
swaps and forwards would adversely affect their business activities and 
discourage hedging activity.\17\ Commenters also have cautioned that 
imposing mandatory clearing and exchange trading requirements on the 
foreign exchange market would increase systemic risk by concentrating 
risk in one or more clearinghouses.\18\
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    \15\ See, e.g., Alternative Investment Management Ass'n 
(``AIMA''), at 2; BlackRock, Inc., at 2.
    \16\ See comment on October 2010 Notice by 3M, Cargill Inc. et 
al., at 2.
    \17\ See Coalition for Derivatives End-Users, at 2.
    \18\ See, e.g., BlackRock, at 2; FX Alliance, Inc. (``FXall''), 
at 1.
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    Commenters supporting the proposed determination argue that 
settlement risk is the primary risk associated with foreign exchange 
swaps and forwards, and they state that the settlement of trades 
through CLS Bank International (``CLS''), has largely addressed these 
concerns.19, 20
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    \19\ See, e.g., comment on October 2010 Notice by Global FX 
Division, at 12-14; Global FX Division comment on NPD, at 3; Thomson 
Reuters, at 2.
    \20\ CLS, which began operations in September 2002 and is the 
predominant global PVP settlement system, currently provides 
settlement services for 17 currencies that represent 93 percent of 
the total daily value of foreign exchange swaps and forwards traded 
globally; See date and figures issued by CLS, available at http://www.cls-group.com/About/Pages/History.aspx.
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    Given the particular characteristics of foreign exchange swaps and 
forwards, most commenters emphasize that counterparty credit risk is 
not as significant a risk for these transactions, relative to other 
derivative transactions, and that the widespread use of credit support 
annexes (``CSAs'') and standard ISDA documentation mitigates this risk.
    Moreover, commenters who favor an exemption maintain that foreign 
exchange swaps and forwards generally trade in a highly liquid, 
efficient, and transparent inter-bank market that is characterized by a 
high degree of electronic trading.\21\ The major participants in the 
foreign exchange swaps and forwards market predominantly are either 
depository institutions or affiliates of depository institutions, over 
which banking regulators have substantial visibility and exercise 
strong regulatory oversight. A few of these commenters also observe 
that the Federal Reserve Board has authority to craft appropriate 
regulations governing systemically important financial market utilities 
and payment, clearing, and settlement activities, as designated under 
Title VIII of the Dodd-Frank Act.\22\
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    \21\ Thomson Reuters, at 2 (supporting Treasury's statement 
regarding the extent to which foreign exchange forwards trade on 
electronic platforms and noting that ``these figures rise steadily 
each year'').
    \22\ See, e.g., BlackRock, Inc., at 2.
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B. Comments Opposing Proposed Determination

    By contrast, commenters who urge Treasury not to issue a 
determination to exempt foreign exchange swaps and forwards, as 
proposed, criticize several aspects of Treasury's proposal. Some 
commenters who oppose an exemption for foreign exchange swaps and 
forwards raise a general concern that the exemption would create an 
``enormous'' loophole, citing the large size of this market, as well as 
the lack of a fundamental economic difference, in their view, between 
foreign exchange swaps and forwards and other derivative products.\23\ 
In light of the recent financial crisis, these commenters argue that 
such loopholes can play a significant role in undermining financial 
stability by preserving an opaque, unregulated and under-capitalized 
market. Opponents also express concerns that an exemption could be used 
to mask complex transactions in an effort to avoid subjecting them to 
clearing and trading requirements.\24\
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    \23\ Quantitative Investment Management, at 1; see also, e.g., 
Council of Institutional Investors, at 1-2; Americans for Financial 
Reform, at 13.
    \24\ Americans for Financial Reform, at 13; Better Markets, 
Inc., at 11-13.
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    One commenter, for example, contends that ``foreign exchange swaps 
and forwards have all of the relevant characteristics of other 
categories of derivatives that are subject to the clearing and exchange 
trading requirements of the Dodd-Frank Act,'' and states that the 
``case for the exemption [presented in the NPD] is especially weak 
since the [NPD] concedes that many critical measures that support such 
an exemption simply do not exist.'' \25\
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    \25\ Better Markets, Inc., at 2.
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    In addition, several commenters \26\ contend that foreign exchange 
swap and forward contracts pose significant counterparty credit risk 
which, as one commenter states, arises precisely because these 
transactions entail fixed payment obligations.\27\ In this regard, some 
commenters have outlined potential techniques, systems ``analogous to 
traditional central counterparty clearing'' \28\ that, in their view, 
could be developed in order to conduct foreign exchange swap and 
forward transactions that can be subject to initial and variation 
margin payments designed to minimize the credit risk exposures to the 
parties.\29\
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    \26\ See, e.g., Duffie, at 3-5; Better Markets, Inc., at 14-15.
    \27\ Better Markets, Inc., at 14.
    \28\ Better Markets, at 17.
    \29\ Better Markets, Inc., at 16-19; Duffie at 5-9.
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III. Analysis, Consideration of Statutory Factors, and Implications of 
Final Determination and Treatment of NDFs

A. Analysis of Why Foreign Exchange Swaps and Forwards Should Not Be 
Regulated as Swaps Under the CEA

(i) Foreign Exchange Swaps and Forwards Differ in Significant Ways From 
Other Classes of Swaps
    Foreign exchange swaps and forwards are particular types of 
transactions that are qualitatively different from other classes of 
derivatives covered under the definition of ``swap'' in the CEA. The 
distinctive structural characteristics of foreign exchange swaps and 
forwards, particularly the certainty of payment amounts and shorter 
maturities, as well as the market characteristics of these instruments, 
merit different regulatory treatment pursuant to this determination. 
Moreover, largely due to the required exchange of principal amounts, 
foreign exchange swaps and forwards are not structured to evade the 
requirements of the Dodd-Frank Act or regulations prescribed by the 
CFTC.
    First, foreign exchange swaps and forwards involve the actual 
exchange of the principal amounts of the two currencies in the contract 
(i.e., they are settled on a physical basis). Unlike many other 
derivative instruments whose payment obligations fluctuate frequently 
in response to changes in the value of the underlying variables on 
which those derivatives contracts are based, the payment obligations of 
foreign exchange swaps and foreign exchange forwards, as defined by the 
CEA, are fixed at the inception of the agreement and involve the 
exchange of full principal for settlement. A currency swap, also known 
as a cross-currency basis swap, differs significantly from a foreign 
exchange swap or forward because the actual amount of the cash flow 
exchanged by a party is unknown at the onset of the transaction; 
instead, in a currency swap, a payment obligation on either party is 
dependent on the fluctuation of one or more floating interest rates 
during the term of the transaction. As a result, the cash flows 
underlying the transaction can be

[[Page 69697]]

affected by market volatility or illiquidity. By contrast, foreign 
exchange swap and forward participants know their own and their 
counterparties' payment obligations and the full extent of their 
exposure at settlement throughout the life of the contract. Thus, while 
the mark-to-market value of a position in a foreign exchange swap or 
forward may vary based on changes in the exchange rate or interest 
rates, the actual settlement amounts do not. The requirement to 
exchange the full principal amounts of two different currencies 
qualitatively distinguishes foreign exchange swaps and forwards from 
other swaps, and contributes to a risk profile that is largely 
concentrated on settlement risk.
    Second, foreign exchange swaps and forwards typically have much 
shorter maturities as compared to other derivatives. For example, 
interest rate swaps and credit default swaps generally have maturity 
terms between two and thirty years, and five to ten years, 
respectively.\30\ In stark contrast, over 98 percent of foreign 
exchange swaps and forwards mature in less than one year, and 68 
percent mature in less than one week.\31\ BIS data since 1998, 
collected on a triennial basis, generally show that foreign exchange 
swaps and forwards consistently have had shorter maturities, in line 
with the current levels (i.e., prior reports also show approximately 98 
percent of these transactions maturing in less than one year, and 
approximately 68 percent maturing in less than one week).\32\ Since 
counterparty credit risk increases as the term of a contract increases, 
foreign exchange swaps and forwards carry significantly lower levels of 
counterparty credit risk, relative to other swaps and derivatives. 
Correspondingly, the market risk associated with foreign exchange swaps 
and forwards is relatively lower because these transactions have 
shorter maturities.
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    \30\ Foreign Exchange Committee (``FXC''), comment on October 
2010 Notice (``FXC Letter''), at 3.
    \31\ FXC Letter, at 3; FXJSC survey data; Bank for International 
Settlements (``BIS'') Triennial Central Bank Survey of Foreign 
Exchange and Derivatives Market Activity, available at http://www.bis.org/publ/rpfxf10t.htm.
    \32\ BIS Triennial Central Bank Survey of Foreign Exchange and 
Derivatives Market Activity, available at http://www.bis.org/publ/rpfxf10t.htm.
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    Third, foreign exchange swaps and forwards are not structured to 
evade regulatory requirements that apply to other types of swaps. 
Rather, the uses of foreign exchange swaps and forwards are distinct 
from other swaps. Because of their unique structure and duration, as 
outlined above, foreign exchange swaps and forwards are predominantly 
used as a source of funding to hedge risk associated with short-term 
fluctuations in foreign currency values and to manage global cash-flow 
needs. For example, businesses that sell goods in international trade, 
or that make investments in foreign countries, frequently ask their 
banks to arrange foreign exchange swaps and forwards to control the 
risk that their own country's currency will rise or fall against the 
other country's currency while a sale or investment is pending.\33\ 
Other derivatives, such as currency swaps or interest rate swaps, are 
used for a broader range of purposes. For example, a business that 
conducts transactions in several countries, each with a different 
currency, could use currency swaps to stabilize the value of its sales 
revenue (or costs), instead of actually obtaining those currencies to 
fund transactions to parties located in those countries. Likewise, a 
business that obtains a syndicated loan with a floating interest rate 
could use an interest rate swap to stabilize the level of its loan 
payments.
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    \33\ AIMA, at 2.
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    Fourth, foreign exchange swaps and forwards already trade in a 
highly transparent and liquid market. Market participants have access 
to readily available pricing information through multiple sources,\34\ 
and one commenter noted that these developments have lowered 
transactions costs.\35\ Today, it is estimated that approximately 41and 
72 percent of foreign exchange swaps and forwards, respectively, 
already trade across a range of electronic platforms.\36\ As a result, 
mandatory exchange trading requirements under the CEA would be unlikely 
to improve price transparency significantly. Additionally, the 
Depository Trust and Clearing Corporation (``DTCC'') has submitted an 
application to register with the CFTC as a swap data repository 
(``SDR''), and is testing a foreign exchange trade repository service 
through which DTCC intends to provide both public and regulatory 
reporting, as early as the first quarter of 2013.\37\
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    \34\ See, e.g., comment on October 2010 Notice by Global FX 
Division of the Securities Industry and Financial Markets Ass'n, 
Association for Financial Markets in Europe, and the Asia Securities 
Industry and Financial Markets Ass'n (``Global FX Division''), at 
11.
    \35\ Global FX Division, comment on NPD, at 2 (noting that these 
developments have ``resulted in tight spreads'').
    \36\ NPD, 76 FR at 25,777; BIS, Greenwich Associates, Oliver 
Wyman analysis.
    \37\ See DTCC release, ``DTCC Begins User Testing on Foreign 
Exchange Repository,'' May 3, 2012, available at http://www.dtcc.com/news/press/releases/2012/press_release_dtcc_begins_user_testing.php.
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(ii) Settlement Risk Is the Main Risk and Is Effectively Mitigated 
Through Various Measures
    As discussed above, counterparties to foreign exchange swaps and 
forwards face three distinct risks: (i) Counterparty credit risk prior 
to settlement; (ii) market risk; and (iii) settlement risk. 
Counterparty credit risk and market risk prior to settlement exist in 
foreign exchange swaps and forwards transactions, but the risk of 
economic loss largely is attributable to the fluctuating exchange rate 
or interest rate of the two currencies. For example, if a counterparty 
defaults on a foreign exchange forward prior to the settlement date 
(e.g., as a consequence of bankruptcy) and the exchange rate of the two 
specified currencies were to have moved during that period, the non-
defaulting party would be exposed to market risk if that party were to 
be required to replace that contract (i.e., actually obtain the 
currency desired in the original forward contract) at a higher price.
    Settlement risk, in the context of a foreign exchange swap or 
forward transaction, is the risk that the contract will not be settled 
in accordance with the initial terms, including when one party to the 
transaction delivers the currency it owes the counterparty, but does 
not receive the other currency due from that counterparty.
    The key distinction between counterparty credit risk prior to 
settlement and settlement risk is that, with the latter, a party's 
failure to deliver a currency under a foreign exchange swap or forward 
agreement entails a risk to the non-defaulting party of the loss of 
principal as a result of the non-defaulting party's delivery of the 
underlying principal sum of currency under the agreement coupled with 
the other party's failure to deliver its required principal payment.
    In contrast to other derivatives, including other foreign exchange 
derivatives, the parties' ultimate payment obligations on a foreign 
exchange swap or forward are known and fixed from the beginning of the 
contract and involve the actual ``exchange'' of a predetermined amount 
of principal at settlement.\38\
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    \38\ By contrast, the payment obligations of most other 
derivatives occur on an interim basis (e.g., monthly or quarterly), 
based on the incremental profit or loss on a transaction and either 
party's payment may be made with a common currency.
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    The distinguishing characteristics of foreign exchange swaps and 
forwards, as described above, result in a risk profile that is largely 
concentrated on

[[Page 69698]]

settlement risk, rather than counterparty credit risk prior to 
settlement.
    The foreign exchange swap and forward market relies on the 
extensive use of PVP settlement arrangements, which permit the final 
transfer of one currency to take place only if the final transfer of 
the other currency also takes place, thereby virtually eliminating 
settlement risk. Even though these settlement arrangements do not 
guarantee performance on the contract, they do prevent principal 
payment flows from occurring if either party defaults.
    As noted above, CLS, which began operations in September 2002 and 
is the predominant global PVP settlement system, currently provides 
settlement services for 17 currencies that represent 93 percent of the 
total daily value of foreign exchange swaps and forwards traded 
globally. CLS is a specialized settlement system that operates a 
multilateral PVP settlement system to reduce foreign exchange 
settlement risk (but not credit risk, which is mitigated by other 
measures). CLS estimates that it settles 68 percent of global foreign 
exchange trading, through 63 settlement member banks and approximately 
15,000 third-party users.\39\ In the foreign exchange swaps and 
forwards market in particular (exclusive of other transactions 
involving currencies), CLS estimates that it settles more than 50 
percent of foreign exchange swap and forward transactions that are 
subject to settlement risk.
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    \39\ See figures issued by CLS, available at http://www.cls-group.com/About/Pages/History.aspx.
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    According to a September 2010 Foreign Exchange Committee (``FXC'') 
survey, roughly 75 percent of foreign exchange transactions are settled 
without settlement risk to either party.\40\ This figure includes 
trades settled by CLS, settled between affiliates of the same 
corporation, and settled across a single bank's books for its clients. 
(Transactions that are internally settled between corporate affiliates, 
cash settled, or settled across a single-bank's books for its clients 
are not subject to settlement risk.) The extensive use of CLS and 
privately negotiated PVP settlement arrangements between banks, 
financial intermediaries, and their clients largely addresses 
settlement risk in the market for foreign exchange swaps and forwards, 
and, as a result, constitutes an important, objective difference 
between foreign exchange swaps and forwards and swaps that otherwise 
are subject to regulation under the CEA.\41\
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    \40\ FXC Letter, at 5. Formed in 1978 under the sponsorship of 
the Federal Reserve Bank of New York, the FXC is an industry group 
that produces best practice recommendations for the foreign exchange 
industry, addressing topics such as management of risk in operations 
and trading.
    \41\ Additionally, the vast majority of foreign exchange swap 
and forward transactions are transacted by well-capitalized and 
regulated financial institutions; the financial and operational 
safeguards used by these financial institutions mitigates the 
settlement risk that a counterparty otherwise would face in a 
foreign exchange swap or forward.
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(iii) Foreign Exchange Swaps and Forwards Are Subject to Less 
Counterparty Credit Risk Prior To Settlement Than Other Derivatives
    Counterparty credit risk increases with the length of a contract 
because that increases the length of time during which a counterparty 
could suffer from adverse developments. Foreign exchange swap and 
forward contracts have a very short average length. As noted above, 68 
percent of foreign exchange swap and forward contracts mature in less 
than a week, and 98 percent mature in less than a year. Other 
derivatives, such as interest rate swaps, generally have much longer 
maturity terms (e.g., between two and thirty years) than foreign 
exchange swaps and forwards, and thus pose significantly more 
counterparty credit risk than foreign exchange swaps and forwards.\42\
---------------------------------------------------------------------------

    \42\ As noted above, some commenters contend that counterparty 
credit risk ``remains a significant concern in the foreign exchange 
markets,'' even though ``non-crisis risk is more concentrated in 
longer-duration contracts.'' Better Markets, Inc., at 14-15.
---------------------------------------------------------------------------

    Central clearing could provide foreign exchange swap and forward 
participants with protection against the risk of default by their 
counterparties (i.e., the replacement cost of a transaction if a 
counterparty fails to perform). However, as noted in the NPD, imposing 
a central clearing requirement on the foreign exchange swaps and 
forwards market raises two concerns. First, requiring central clearing 
may lead to combining clearing and settlement in one facility, which 
would create large currency and capital needs for that entity due to: 
(i) The sheer size and volume of the foreign exchange swaps and 
forwards market; and (ii) the fact that the central clearing facility 
would be effectively guaranteeing both settlement and market exposure 
to replacement cost. Treasury believes that it is unlikely a central 
counterparty (``CCP'') would be able to provide the settlement services 
required by this market, either directly or in conjunction with another 
service provider, such as CLS.
    Providing central clearing separately from settlement presents the 
second concern, namely: required clearing likely would disrupt the 
existing settlement process by introducing additional steps between 
trade execution and settlement that pose significant operational 
challenges. The existing settlement process for this market functions 
well and has been critical to mitigating this market's main source of 
risk. The operational challenges associated with the addition of a 
central clearing requirement, one that is very different from the core 
clearing functions currently handled by CCPs, and the potentially 
disruptive effects on transactions in the large market of foreign 
exchange swaps and forwards, outweigh the benefits that central 
clearing would provide, thus making these instruments ill-suited for 
regulation as swaps.
(iv) Foreign Exchange Swaps and Forwards Transacted by Banks in the 
Foreign Exchange Market Already Are Subject to Oversight
    The foreign exchange market itself has long been subject to 
extensive and coordinated oversight, reflecting its unique 
characteristics and functioning. Since the introduction of floating 
exchange rates in the early 1970s, the largest central banks and 
regulators have undertaken strong and coordinated oversight measures 
for the foreign exchange market, given its critical role in monetary 
policy and the global payments system. This global strategy, led by the 
Committee on Payment and Settlement Systems (``CPSS''), resulted in the 
design and implementation of CLS and other PVP settlement arrangements. 
The Federal Reserve regularly conducts reviews of the risk management 
and operational processes of major foreign exchange market 
participants. These reviews inform Basel Committee on Banking 
Supervision (``BCBS'') and CPSS updates to bank supervisory guidelines 
on managing foreign exchange settlement risk.\43\
---------------------------------------------------------------------------

    \43\ See Bank for Int'l Settlements, Supervisory guidance for 
managing risks associated with the settlement of foreign exchange 
transactions, (Aug. 2012), available at http://www.bis.org/publ/bcbs229.htm.
---------------------------------------------------------------------------

    As referenced above, banks, affiliates in bank holding companies in 
the U.S., and banking organizations operating in other jurisdictions 
are the key players in the foreign exchange swaps and forwards market. 
Roughly 95 percent of foreign exchange swaps and forwards transactions 
occur between banks acting either on their own behalf or on behalf of 
their clients.\44\ More specifically, the clients of banks that 
typically engage in foreign exchange swaps and forwards are companies, 
particularly multi-

[[Page 69699]]

national corporations, that engage in cross-border investments or other 
commercial transactions that require payments in the local 
currency.\45\ Banks are subject to ongoing consolidated supervision, 
and supervisors regularly monitor their foreign exchange related 
exposures, internal controls, risk management systems, and settlement 
practices.
---------------------------------------------------------------------------

    \44\ American Bankers Ass'n et al., at 1.
    \45\ For example, a U.S.-based company seeking to acquire 
specialized brewery equipment from a manufacturer in Germany could 
agree to pay for the purchase in euros, on a specified future date 
(e.g., the delivery date of the equipment). If the U.S.-based 
company needs to fix its payment of euros based on the current 
exchange rate (to control the risk that the price of the euro will 
rise while the sale is pending), then the company could enter into a 
foreign exchange forward with its bank under which, on the specified 
date, (i) the company would deliver the dollars to its bank and (ii) 
the bank would deliver the euros to the company, payable to the 
manufacturer.
---------------------------------------------------------------------------

(v) The Foreign Exchange Swaps and Forwards Market Already Is Highly 
Transparent and Traded Over Electronic Trading Platforms
    Foreign exchange swaps and forwards already trade in a highly 
transparent market. Market participants have access to readily 
available pricing information through multiple sources. Approximately 
41 percent and 72 percent of foreign exchange swaps and forwards, 
respectively, already trade across a range of electronic platforms and 
the use of such platforms has been steadily increasing in recent 
years.\46\ The use of electronic trading platforms provides a high 
level of pre- and post-trade transparency within the foreign exchange 
swaps and forwards market.\47\ Thus, mandatory exchange trading 
requirements would not significantly improve price transparency or 
reduce trading costs within this market.
---------------------------------------------------------------------------

    \46\ BIS, Greenwich Associates, Oliver Wyman analysis.
    \47\ American Bankers Ass'n et al., at 3.
---------------------------------------------------------------------------

(vi) Foreign Exchange Swaps and Forwards Will Be Subject to Oversight 
Under the CEA
    The Secretary's determination that foreign exchange swaps and 
forwards should not be regulated as ``swaps'' under the CEA does not 
affect the application of relevant provisions of the CEA that are 
designed to prevent evasion and improve market transparency. Commenters 
who oppose an exemption argue that the exemption would create a large 
regulatory loophole that could exacerbate systemic risk.\48\ However, 
all foreign exchange transactions would remain subject to the CFTC's 
new trade-reporting (but not the real-time reporting) requirements,\49\ 
enhanced anti-evasion authority,\50\ and strengthened business-conduct 
standards.\51\ As noted above, the creation of a global foreign 
exchange trade repository, such as the SDR created by DTCC, will expand 
reporting to regulators and the public more broadly.
---------------------------------------------------------------------------

    \48\ For example, Better Markets, Inc., at 3, states: 
``[Exchange-trading and clearing systems] offer the only feasible 
way to create a marketplace that is relatively free from the 
[information] asymmetry that can convert inevitable market 
disturbances into catastrophes. An exemption for the large and 
diverse foreign exchange market undercuts that essential goal.''
    \49\ 7 U.S.C. 1a(47)(E)(iii). See also Swap Data Recordkeeping 
and Reporting Requirements, 77 FR 2136 (Jan. 13, 2012); Swap Data 
Recordkeeping and Reporting Requirements: Pre-Enactment and 
Transition Swaps, 77 FR 35200 (June 12, 2012).
    \50\ See note 77, infra.
    \51\ 7 U.S.C. 1a(47)(E)(iv). See also Business Conduct Standards 
for Swap Dealers and Major Swap Participants with Counterparties, 77 
FR 9734 (Feb. 17, 2012); Swap Dealer and Major Swap Participant 
Recordkeeping, Reporting, and Duties Rules; Futures Commission 
Merchant and Introducing Broker Conflicts of Interest Rules; and 
Chief Compliance Officer Rules for Swap Dealers, Major Swap 
Participants, and Futures Commission Merchants, 77 FR 20128 (Apr. 3, 
2012); Confirmation, Portfolio Reconciliation, Portfolio 
Compression, and Swap Trading Relationship Documentation 
Requirements for Swap Dealers and Major Swap Participants, 77 FR 
55904 (Sept. 11, 2012).
---------------------------------------------------------------------------

B. Statutory Considerations

    In considering whether to exempt foreign exchange swaps and 
forwards from the definition of the term ``swap,'' the Secretary must 
consider, and has considered (including in light of the comments 
received), five factors, as follows.
(i) Systemic Risk, Transparency, Financial Stability
    Treasury has considered several factors to assess 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. As stated in the 
NPD, given the reduced counterparty credit risk profile of this market 
as compared to the markets for other swaps and derivatives, the 
logistical challenges of implementing central clearing within this 
market significantly outweigh the marginal benefits that central 
clearing and exchange trading might provide.
    Several commenters have challenged Treasury's consideration of this 
statutory factor, contending, for example, that Treasury's proposed 
analysis regarding the ``operational challenges'' that would arise by 
interposing a CCP into the settlement process ``carries no weight under 
the statutory test.'' \52\ One commenter offers its belief that 
``exempting foreign exchange forwards and swaps at this time from the 
clearing and trading requirements of [the Dodd-Frank Act] could 
increase systemic risk at a time when regulators around the globe are 
trying to reduce it.'' \53\
---------------------------------------------------------------------------

    \52\ Better Markets, Inc., at 8. Separately, Americans for 
Financial Reform (``AFR'') contends that, under section 721 of the 
Dodd-Frank Act, ``Treasury must present an actual independent 
analysis which clearly demonstrates that this risk is not 
significant.'' AFR, at 8. Sections 1a(47)(E) and 1b of the CEA do 
not require Treasury to conduct an ``independent'' analysis of each 
of the statutory factors, as AFR contends. Rather, section 1b(a) of 
the CEA plainly requires the Secretary to ``consider'' each of the 
five factors, and does not contain any provision that suggests that 
any one or more of those factors may be pivotal in reaching any 
determination. Furthermore, subsection 1b(b) of the CEA requires the 
Secretary to ``submit to the appropriate committees of Congress a 
determination that contains--(1) an explanation [regarding 
qualitative differences between foreign exchange swaps and forwards 
and other classes of 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.'' A ``determination'' that explains those ``qualitative'' 
differences and identifies those ``objective'' differences satisfies 
the law; neither subsection 1b(b)(1) or 1b(b)(2) requires Treasury 
to conduct an ``independent'' analysis of the type that AFR 
describes in its comment letter.
    \53\ Commodity Markets Council, at 1-2.
---------------------------------------------------------------------------

    Regulating foreign exchange swaps and forwards under the CEA would 
require insertion of a CCP into an already well-functioning settlement 
process. Currently, no entity or system exists that can efficiently 
clear and settle the thousands of foreign exchange swaps and forwards 
transactions that are executed on a daily basis, and Treasury is not 
aware of any proposal to build sufficient capabilities in this area. 
Requiring the use of new systems and technologies could introduce new 
risks and challenges for the settlement process of foreign exchange 
swaps and forwards. Other derivative transactions, such as interest 
rate swaps and credit default swaps, create settlement obligations that 
equal only the change in the market price or other financial variable 
relative to a fixed or predefined amount--not the full principal 
amounts--and, thus, result in materially smaller daily payment 
obligations for those markets. While the existing CLS and other PVP 
settlement systems protect against the risk of principal loss in the 
foreign exchange swaps and forwards market, central clearing would 
further protect a participant against the economic loss of profit on a 
transaction if the counterparty to the transaction defaults before 
final settlement. However, combining these two functions in a market 
that involves settlement of the full principal amounts

[[Page 69700]]

of the contracts would require massive capital backing in a very large 
number of currencies, representing a much greater commitment for a 
potential CCP in the foreign exchange swaps and forwards market than 
for any other type of derivatives market.
    The CPSS and the Technical Committee of the International 
Organization of Securities Commissions (``IOSCO'') recently issued 
principles for financial market infrastructures (``FMIs'') (herein 
``FMI Principles'') that highlight the close connection between 
clearing systems and settlement systems.\54\ The FMI Principles are 
intended to apply to several types of FMIs, including a CCP, and 
establish heightened risk-management standards for the relevant FMIs in 
the jurisdictions of the CPSS-IOSCO members.\55\ In particular, the FMI 
Principles state:
---------------------------------------------------------------------------

    \54\ Bank for Int'l Settlements, ``Principles for financial 
market infrastructures,'' Apr. 2012, available at http://www.bis.org/publ/cpss101a.pdf. The FMI Principles were issued 
following a proposal, issued in April 2011, and public comment. The 
Federal Reserve Board and the Federal Reserve Bank of New York are 
members of the CPSS, and the CFTC and Securities and Exchange 
Commission (``SEC'') are members of the Technical Committee of 
IOSCO. Treasury expects that the FMI Principles will be applied 
through rules and regulatory guidance issued, as appropriate, by the 
Federal agencies that supervise the relevant FMIs which are subject 
to their jurisdiction. Accordingly, Treasury believes that the FMI 
Principles reasonably should be taken into account with respect to 
the consideration of clearing and settlement systems for foreign 
exchange swaps and forwards.
    \55\ FMI Principles, at 5-7, 12.

    An FMI's processes should be designed to complete final 
settlement, at a minimum no later than the end of the value date. 
This means that any payment, transfer instruction, or other 
obligation that has been submitted to and accepted by an FMI in 
accordance with its risk management and other relevant acceptance 
criteria should be settled on the intended value date. An FMI that 
is not designed to provide final settlement on the value date (or 
same-day settlement) would not satisfy this principle, even if the 
transaction's settlement date is adjusted back to the value date 
after settlement * * *. [D]eferral of final settlement to the next-
business day can entail overnight risk exposures. For example, if a 
[central securities depository] or CCP conducts its money 
settlements using instruments or arrangements that involve next-day 
settlement, a participant's default on its settlement obligations 
between the initiation and finality of settlement could pose 
significant credit and liquidity risks to the FMI and its other 
participants.\56\
---------------------------------------------------------------------------

    \56\ FMI Principles, at 65.

    Consistent with the FMI Principles, considering whether the 
required clearing for foreign exchange swaps and forwards would create 
systemic risk, pursuant to section 1b(a)(1) of the CEA, entails 
considering whether the required clearing can prudently be undertaken 
in conjunction with the settlement systems necessary for the foreign 
exchange swaps and forwards market.
    To date, no CCP has developed a practical solution to guarantee the 
timely settlement of the payment obligations of the extraordinarily 
large volumes of transactions in foreign exchange swaps and forwards, 
including the provision of or coordination with the settlement services 
that are essential to the market.\57\ Introducing a central clearing 
facility without settlement capabilities would be inconsistent with the 
standards being developed by regulators through CPSS-IOSCO, and would 
not improve market functioning. Instead, requiring central clearing 
would raise unnecessary operational challenges by introducing 
additional steps between trade execution and settlement. Given that any 
risks created through the increased complexity would be magnified by 
the number of currencies involved, among other factors, requiring the 
use of a CCP for clearing foreign exchange swaps and forwards is not 
warranted.
---------------------------------------------------------------------------

    \57\ In addition, even though a few commenters have outlined 
mechanisms for clearing foreign exchange swaps and forwards, none of 
these mechanisms clearly contemplate a system for clearing that 
would also settle those foreign exchange swaps and forwards, 
particularly given the scale and complexity for physical settlement 
of multiple currencies in the current market for foreign exchange 
swaps and forwards. See, e.g., Better Markets, Inc., at 16-19 (This 
commenter outlines two mechanisms for clearing involving the use of 
a derivatives clearing organization (``DCO''). Under one option, the 
DCO apparently would conduct both the clearing and settlement 
functions (but the outline does not describe how the DCO itself 
would establish the systems necessary to settle the massive volume 
of currencies flowing through the foreign exchange swaps and 
forwards contracts); the second option stipulates that the DCO would 
clear transactions, but settlement would be conducted through ``CLS 
or a similar institution [that is] a PVP provider'' or through an 
alternative mechanism.); Duffie, at 7-9 (outlining a scheme using a 
``financial utility'' that operates as a ``quasi-CCP,'' only to 
compute and collect margin payments, and that operates independently 
of, yet coordinated with, a PVP provider (such as CLS), which 
settles the foreign exchange swaps and forwards).
---------------------------------------------------------------------------

    In response to the October 2010 Notice, end-users of foreign 
exchange swaps and forwards have expressed significant concern that 
requiring centralized clearing would substantially increase the costs 
of hedging foreign exchange risks. Commenters argue that additional 
costs associated with collateral, margin, and capital requirements 
required by the CCP would potentially reduce their incentives to manage 
foreign exchange risks.\58\ Such additional costs borne by non-
financial end-users could lead to lower cash flows or earnings, which 
would divert financial resources from investment and discourage 
international trade, thereby limiting the growth of U.S. 
businesses.\59\ Several commenters also suggest that requiring 
centralized clearing of foreign exchange swaps and forwards could lead 
non-financial end-users to move production facilities overseas in order 
to establish ``natural hedges'' through the consistent use of local 
currencies and force them to reconsider the use of CLS in light of the 
additional costs associated with central clearing.\60\
---------------------------------------------------------------------------

    \58\ See, e.g., comment on October 2010 Notice by National Ass'n 
of Manufacturers, at 4.
    \59\ See, e.g., comment on October 2010 Notice by 3M, Cargill 
Inc. et al., at 6.
    \60\ See, e.g., comment on October 2010 Notice by Coalition for 
Derivatives End-Users, at 16-17.
---------------------------------------------------------------------------

    As noted above, the market for foreign exchange transactions is one 
of the most transparent and liquid global trading markets. Pricing is 
readily available through multiple sources and a large portion of 
foreign exchange trades currently are executed through electronic 
trading platforms.\61\
---------------------------------------------------------------------------

    \61\ See, e.g., comment on NPD by Coalition for Derivatives End-
Users, at 1-2 (``[T]he [foreign exchange] market has pioneered the 
adoption of more transparent electronic trading platforms. Because 
the market is highly liquid and decentralized, liquidity can exist 
more easily on multiple electronic platforms and pricing 
transparency is more readily available. Applying the clearing and 
exchange trading requirements to these transactions would not 
improve pricing transparency to any notable degree.'').
    Furthermore, Treasury understands that at least one global 
foreign exchange trading repository has been created pursuant to 
section 21 of the CEA (7 U.S.C. 24a, as added by section 728 of the 
Dodd-Frank Act), which will expand reporting coverage for swaps, 
including foreign exchange swaps and forwards, regardless of whether 
the Secretary issues a determination that these transactions should 
not be regulated as ``swaps'' under the CEA. See DTCC release, 
available at http://www.dtcc.com/news/press/releases/2012/press_release_dtcc_begins_user_testing.php. The CFTC has adopted final 
rules relating to the registration and regulation of SDRs. 17 CFR 
Part 49. See CFTC, Final Rule on Swap Data Repositories: 
Registration Standards, Duties, and Core Principles, 76 FR 5453 
(Sept. 1, 2011)).
---------------------------------------------------------------------------

    In light of these and similar factors raised by the commenters, 
mandating centralized clearing and exchange trading under the CEA for 
foreign exchange swaps and foreign exchange forwards would actually 
introduce operational challenges. These challenges and risks could 
potentially lead to disruptive effects in this market which likely 
would outweigh any benefits associated with mandated clearing and 
exchange trading.\62\
---------------------------------------------------------------------------

    \62\ See also comment by FXall, at 1.

---------------------------------------------------------------------------

[[Page 69701]]

(ii) Regulatory Scheme Comparable to That of the CEA
    Treasury has considered several factors to assess 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.
    One commenter has noted that foreign exchange swaps and forwards 
will not fall outside of the scope of regulatory oversight under the 
CEA; ``[o]n the contrary, foreign exchange swaps and forwards will be 
required to be reported to swap data repositories and regulated swaps 
market actors (i.e., swap dealers and major swap participants) will be 
required to comply with applicable conduct of business rules when 
engaging in foreign exchange swaps and forwards transactions.'' \63\ 
Other commenters, however, have stated that currently there is no 
``regulatory regime'' that is ``comparable to the framework mandated 
under the Dodd-Frank Act.'' \64\
---------------------------------------------------------------------------

    \63\ AIMA, at 2. See also Thomson Reuters, at 2 (commenting on 
the presence of ``enhanced oversight'').
    \64\ See Better Markets, at 8.
---------------------------------------------------------------------------

    Since the introduction of floating exchange rates in the early 
1970s, central banks and regulators have undertaken strong and 
coordinated oversight measures for the foreign exchange market because 
of the critical role this market plays in the conduct of countries' 
monetary policy. More specifically, in 1996, the CPSS launched a 
globally coordinated strategy on behalf of central banks, calling for 
specific actions by individual banks, industry groups and central banks 
to address and reduce risk in the foreign exchange market. This 
strategy has resulted in specific actions undertaken to address 
settlement risk, to mitigate counterparty credit risk and, in 
conjunction with the BCBS, to develop global supervisory guidelines on 
managing foreign exchange risk. Largely as a result of these measures, 
liquidity in the foreign exchange market was maintained during the 
recent financial crisis, and, as noted by many market observers, the 
foreign exchange market was one of the few parts of the financial 
market that remained liquid throughout the financial crisis.\65\
---------------------------------------------------------------------------

    \65\ See, e.g., Global FX Division, at 11-12. But see Better 
Markets, Inc. at 19-28.
---------------------------------------------------------------------------

    One of the key goals of this work was to expand the use of PVP 
settlement systems. Such systems largely eliminate settlement risk, 
which is the predominant risk in a foreign exchange swap or forward. As 
noted, PVP settlement ensures that the final transfer of one currency 
occurs only if a final transfer of the other currency or currencies 
takes place, thereby virtually eliminating settlement risk. In order to 
support such PVP arrangements, central banks undertook significant 
actions by extending operating hours of payment systems, providing 
cross-border access to central bank accounts and enhancing the legal 
certainty around such settlement arrangements.
    The creation of CLS was an important outcome of this work. CLS is 
the predominant PVP settlement system, settling the majority of all 
global foreign exchange transactions in 17 currencies, through 63 
settlement member banks and approximately 15,000 third party users.
    A comparable regulatory scheme applies to the settlement system 
conducted through CLS. While the Federal Reserve is the primary 
regulator for CLS, a CLS Oversight Committee \66\ consisting of 22 
central banks was established to provide coordinated oversight of CLS 
by all central banks whose currencies are settled through its system. 
As a result of this group's efforts, each participating central bank 
now maintains accounts for CLS and has created a window period during 
which real-time gross settlement systems are open to accommodate the 
funding necessary for the settlement of payment instructions. CLS also 
has developed a set of risk management tests that it applies to each 
instruction it submits for settlement to mitigate the associated 
credit, market and liquidity risks.
---------------------------------------------------------------------------

    \66\ Federal Reserve Board, ``Protocol for Cooperative Oversight 
Arrangement for CLS,'' Nov. 25, 2008, available at http://www.federalreserve.gov/paymentsystems/cls_protocol.html.
---------------------------------------------------------------------------

    On July 18, 2012, the Financial Stability Oversight Council 
(``Council'') designated CLS as a financial market utility that is 
systemically important, pursuant to section 804 of the Dodd-Frank 
Act.\67\ The designation of CLS by the Council subjects CLS to 
requirements under Title VIII of the Dodd-Frank Act, including risk-
management standards, reporting and recordkeeping requirements, and 
examinations (as well as potential enforcement actions) by the Federal 
Reserve.
---------------------------------------------------------------------------

    \67\ 12 U.S.C. 5463; 12 CFR part 1320 (Designation of Financial 
Market Utilities).
---------------------------------------------------------------------------

    Participants in the foreign exchange swaps and forwards market 
largely consist of banks that are subject to prudential supervision, 
including comprehensive risk-management oversight. In addition, 
Treasury notes that the vast majority of established regulatory schemes 
also actively encourage the use of CSAs and master netting agreements 
to reduce counterparty credit risk exposures.\68\ Similar to changes 
made to enable the use of PVP settlement arrangements, central banks 
and governments worked to strengthen the legal foundations of bilateral 
and multilateral netting. Master netting agreements mitigate credit 
risk by enabling closeout netting in the event of a default or 
bankruptcy. CSAs can also be negotiated as a supplement to master 
agreements to further reduce and mitigate exposures to counterparties 
by collateralizing transactions.
---------------------------------------------------------------------------

    \68\ With respect to this factor, one commenter states that 
``the `encouraged' use of private contractual provisions is not a 
credible substitute for mandatory clearing mechanisms operated by 
entities that are registered and subject to a host of core 
principles covering virtually every aspect of a clearing 
operation.'' Better Markets, at 9.
---------------------------------------------------------------------------

(iii) Adequacy of Supervision by Bank Regulators, Including Capital and 
Margin Requirements
    Treasury has assessed the extent to which bank regulators supervise 
participants in the foreign exchange market, including by imposing 
capital and margin requirements.
    The predominant participants in the foreign exchange swaps and 
forwards market are banks that long have been subject to prudential 
supervision. In fact, nearly all trading within the foreign exchange 
market involves bank counterparties.\69\ Roughly 95 percent of foreign 
exchange trading involves banks acting in the capacity of either 
principal or agent. For a number of structural reasons, banks have 
distinct advantages to provide the liquidity and funding necessary to 
conduct foreign exchange swaps and forwards, which involve the exchange 
of principal, rather than just interim variable cash flows. In 
conjunction with providing the liquidity, funding, and foreign exchange 
risk-management needed to conduct these transactions, banks have 
efficient and ready access to CLS to settle transactions on a PVP 
basis. Prudential supervisors regularly monitor the activities, 
exposures, internal controls and risk management systems of these 
banks.\70\ In order to meet safety-and-

[[Page 69702]]

soundness requirements, banks have implemented monitoring systems, 
limits, internal controls, hedging techniques, and similar risk-
management measures. Furthermore, counterparty credit risk management 
is a fundamental issue for banking supervisors and is extensively 
addressed in bank supervisory guidelines as well as under the Basel 
Accords.
---------------------------------------------------------------------------

    \69\ One commenter takes issue with this point, noting that 
while the ``vast majority of trading in foreign exchange swaps and 
forwards may involve banks,'' not all such transactions do. This 
commenter further argues that, in the absence of ``mandatory, 
uniform, and transparent margin requirements,'' there is ``an ad hoc 
assortment of voluntary `banking' practices aimed at `risk 
management.' '' Better Markets, at 10.
    \70\ See, e.g., supervisory and examination standards for 
wholesale payments systems developed by the Federal Financial 
Institutions Examination Council, available at http://ithandbook.ffiec.gov/it-booklets/wholesale-payment-systems/wholesale-payment-systems-risk-management.aspx.
---------------------------------------------------------------------------

    In addition to the supervisory measures discussed above, the OTC 
Derivatives Supervisors Group, which includes market and bank 
regulators from the U.S., France, Germany, Japan, Switzerland and the 
U.K., has been securing commitments from market participants since 2005 
to strengthen market infrastructure, risk management practices, and 
transparency in the OTC derivatives market.
(iv) Adequacy of Payment and Settlement Systems
    Treasury also has assessed the extent of adequate payment and 
settlement systems for foreign exchange swaps and forwards. With 
respect to this factor, as noted, the strategy developed by central 
banks successfully resulted in the establishment of PVP settlement 
systems to virtually eliminate the settlement risk associated with 
foreign exchange swaps and forwards, with CLS being the primary example 
of this work. Central banks undertook significant actions to support 
these robust PVP settlement arrangements. As a result, roughly 75 
percent of notional foreign exchange is either settled through CLS or 
otherwise settled without risk, including trades that are settled 
between affiliates of the same corporation or across a single bank's 
books for its clients.\71\ In the foreign exchange swaps and forwards 
market in particular, CLS estimates that it settles more than 50 
percent of foreign exchange swap and forward transactions that are 
subject to settlement risk.\72\ CLS also has announced a multi-year 
strategic objective to expand settlement services to include additional 
currencies, increase volume capacity, and add additional settlement 
times. Treasury understands that the Federal Reserve and the CLS 
Oversight Committee are currently reviewing these plans, as well as 
encouraging the expansion of other PVP settlement services. 
Furthermore, the vast majority of foreign exchange swaps and forwards 
that are not settled with CLS, or through some other internal netting 
mechanism, have a regulated banking entity as one (or both) of the 
counterparties. In light of the prudential supervision of these 
entities, particularly the controls that must be applied to meet the 
expectations of their regulators, these financial institutions must 
maintain adequate payment and settlement arrangements.
---------------------------------------------------------------------------

    \71\ One commenter disputes this position, stating that ``[t]he 
CLS system completely disregards the counterparty credit risk.'' 
Americans for Financial Reform, at 12. This commenter asserts that 
``CLS merely settles transactions between the parties by collecting 
payments from each party and distributing payments once all parties 
meet their obligations.'' Id.
    \72\ In this regard, one commenter notes that, notwithstanding 
the settlement of more than 50 percent of foreign exchange swaps and 
forwards transactions by CLS, a ``significant volume'' of those 
transactions are not settled by CLS, and asserts that ``[t]his state 
of affairs is not `adequate' under any reasonable interpretation.'' 
Better Markets, at 11.
---------------------------------------------------------------------------

(v) Possible Use of Exemption To Evade Requirements
    Treasury has considered several factors to assess whether the use 
of an exemption for foreign exchange swaps and foreign exchange 
forwards could be used to evade otherwise applicable regulatory 
requirements. Treasury shares the concern, expressed by several 
commenters,\73\ that issuing an exemption for foreign exchange swaps 
and forwards potentially could be exploited by some market participants 
to evade regulatory requirements that otherwise would apply to the 
substance of a transaction. Nonetheless, the nature of foreign exchange 
swaps and forwards transactions (as defined by the CEA) makes it 
difficult for these products to be structured to replicate the cash 
flows associated with currency or interest rate swaps to evade 
regulatory requirements under the CEA. The likelihood that foreign 
exchange swaps and forwards might be structured to evade other 
regulatory requirements is further reduced by the extensive oversight 
by regulators, particularly the supervision of banks which are the main 
participants in this market.
---------------------------------------------------------------------------

    \73\ As one commenter contends, for example, ``market 
participants have a boundless ingenuity for developing new products 
and strategies that fall within the interstices of any regulatory 
framework.'' Better Markets, Inc. at 11.
---------------------------------------------------------------------------

    Unlike other types of swaps, foreign exchange swaps and forwards 
are distinct because, as defined by the CEA, these transactions must 
(1) involve the exchange of the principal amounts of the two currencies 
exchanged, as opposed to a set of cash flows based upon some floating 
reference rate, and (2) be settled on a physical basis.\74\
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    \74\ In this regard, Treasury notes that, in other swaps 
transactions, the parties may, by agreement, physically settle their 
obligations.
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    A ``swap'' regulated under the CEA, such as a currency swap, 
interest rate swap, or other derivative, generally involves a periodic 
exchange of a floating amount of cash flows between the counterparties 
based on the value of the underlying variable(s) on which the 
derivative contract is based. In contrast, a foreign exchange swap 
(which will be exempt from the definition of ``swap'' under this 
determination) involves a simple exchange of principal at one point in 
time and a reversal of that exchange at some later date. For example, a 
user of a currency swap could seek funding advantages by obtaining 
financing in a foreign currency and swapping those cash flows back to 
the user's locally denominated currency. This would then entail paying 
or receiving a series of floating interest rate payments (i.e., based 
on prevailing interest rates) over the life of the transaction. This 
ability to receive periodic payments during the term of a transaction 
is a significant feature of ``swaps'' that will be regulated under the 
CEA, which is absent from a foreign exchange swap or foreign exchange 
forward.
    As discussed above, in a foreign exchange swap transaction, the 
payment obligations are fixed at the onset of the transaction--with the 
prices of both legs of the transaction set by highly transparent and 
liquid markets--and the payments must be made in the currencies 
involved in the swap. In contrast, the actual amount of the cash flow 
exchanged by a party to a currency swap (or other derivatives 
transaction) is unknown at the onset of the transaction. Instead, a 
payment obligation on either party is dependent on the future value of 
one or more rates or some future event. The price of the payment itself 
can be hindered by market volatility or illiquidity, which could affect 
the value of the transaction.
    While foreign exchange swaps could be used by some market 
participants to speculate on the short-term path of interest rates in 
some contexts, the operational challenges and transaction costs 
associated with transforming these instruments to replicate currency or 
interest rate swaps significantly reduce the likelihood that market 
participants would do so in order to evade regulatory requirements 
under the CEA.\75\
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    \75\ Some commenters share this view. Thomson Reuters, for 
example, states: ``Although transactions costs are becoming lower 
each year, transforming an interest rate swap into a foreign 
exchange swap would entail operational challenges and transactions 
costs. Thomson Reuters believes that increased reporting obligations 
for all swaps and the enhanced CFTC anti-evasion authority will 
deter participants from overbroad use of the FX exemption under 
consideration.'' See also FX Investor Group, at 2.

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[[Page 69703]]

    To begin with, the transactions costs associated with replicating 
currency swaps through the use of foreign exchange swaps likely would 
be significant because a market participant would need to regularly 
roll over its foreign exchange swap position as it seeks to replicate a 
currency swap. For example, a participant would need to consider the 
costs associated with the series of separate bid-ask spreads 
accompanying each of the foreign exchange swap transactions, as well as 
the costs of monitoring those positions. Thus, whether a participant 
would structure foreign exchange swap transactions in order to 
replicate other, non-exempt swaps that are subject to central clearing 
requirements would be highly dependent on the costs associated with the 
operational or systems arrangements necessary to execute the foreign 
exchange swap transactions, relative to the costs imposed by CCPs to 
clear the other, non-exempt swap transactions, which could vary among 
market participants. Moreover, as discussed above, approximately 95 
percent of foreign exchange swaps and forwards transactions occur 
between banks. The systems that banks use to conduct foreign exchange 
swaps and forwards transactions are subject to consolidated 
supervision, including oversight of the internal controls used to 
monitor foreign exchange swaps and forwards. Treasury believes, as one 
commenter similarly noted, that because regulated banks conduct the 
bulk of foreign exchange swaps and forwards transactions, the risk of 
using these transactions to evade otherwise applicable regulatory 
requirements is relatively lower.\76\
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    \76\ FX Investor Group, at 2 (observing that ``there is little 
risk of such institutions not ensuring that the spirit of this rule 
is met'').
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    Importantly, a determination to exempt foreign exchange swaps and 
forwards from regulation as ``swaps'' under the CEA will not affect the 
application of other provisions that are designed to prevent evasion by 
market participants and improve market transparency. In particular, 
under the Dodd-Frank Act all foreign exchange swaps and forwards will 
remain subject to the CFTC's new trade-reporting requirements, enhanced 
anti-evasion authority, and strengthened business-conduct standards for 
swaps dealers and major swap participants.\77\ Furthermore, the planned 
opening of global foreign exchange trade repositories will expand 
reporting to regulators and the public more broadly. This additional 
reporting will also provide regulators with enhanced information that 
can be used to detect attempts by market participants to use foreign 
exchange swaps or forwards to replicate the cash flows associated with 
currency, interest rate swaps, or other derivatives in order to evade 
regulatory requirements.
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    \77\ See CEA section 1a(47)(E)(iii) (reporting) and (iv) 
(business conduct standards), 7 U.S.C 1a(47)(E)(iii) and (iv). See 
also Further Definition of ``Swap,'' ``Security-Based Swap,'' and 
``Security-Based Swap Agreement''; Mixed Swaps; Security-Based Swap 
Agreement Recordkeeping, 77 FR 48,208, 48,253 (``CFTC-SEC Joint 
Products Rule'') (addressing the application of certain reporting 
requirements and business-conduct standards). In addition, Treasury 
notes that: (i) CEA section 1a(47)(F)(i), 7 U.S.C. 1a(47)(F)(i), 
provides that foreign exchange swaps and forwards that are listed 
and traded on or subject to the rules of a designated contract 
market or swap execution facility, or are cleared by a derivatives 
clearing organization, shall not be exempt from the fraud and 
manipulation provisions of the CEA; and (ii) section 753 of the 
Dodd-Frank Act amends section 6(c) of the CEA to provide, in 
relevant part, that ``it shall be unlawful for any person, directly 
or indirectly, to manipulate or attempt to manipulate the price of 
any swap, or of any commodity in interstate commerce, or for future 
delivery on or subject to the rules of any registered entity.'' 7 
U.S.C. 9, 15. See also CFTC-SEC Joint Products Rule, 77 FR at 
48,253, n. 512.
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C. Implications of Determination; Treatment of NDFs

(i) Implications of a Determination To Exempt Foreign Exchange Swaps 
and Forwards From the Term ``Swap'' Under the CEA
    Because the Secretary is issuing a written determination to exempt 
both foreign exchange swaps and forwards from the definition of a 
``swap'' under the CEA, these transactions, as well as certain parties 
that engage in these transactions, will not be subject to some 
requirements under the CEA, notably the clearing and exchange-trading 
requirements.
    However, foreign exchange swaps and forwards and the parties to 
such transactions will still be subject to trade-reporting 
requirements, business conduct standards (including the anti-fraud 
provision) in section 4s(h) of the CEA and the rules promulgated 
thereunder by the CFTC, and anti-evasion requirements promulgated by 
the CFTC. In this regard, section (c) of the determination--which 
reflects the language of sections 1a(47)(E)(iii)-(iv) and 1b(c) of the 
CEA--provides that, notwithstanding this determination, certain 
requirements under the CEA will apply to any foreign exchange swap or 
foreign exchange forward, or to any party engaged in such a 
transaction, to the extent provided by such requirements.
    Under section 1a(47)(F) of the CEA, a foreign exchange swap or 
foreign exchange forward that is ``listed and traded on or subject to 
the rules of a designated contract market or a swap execution facility, 
or that is cleared by a derivatives clearing organization, shall not be 
exempt from any provision of [CEA], or the amendments under [Title VII 
of the Dodd-Frank Act] prohibiting fraud or manipulation.'' \78\ 
Additionally, a determination issued by the Secretary shall not 
``affect, or be construed to affect, the applicability of [the CEA] or 
the jurisdiction of the [CFTC] with respect to agreements, contracts, 
or transactions in foreign currency pursuant to section 2(c)(2) [of the 
CEA, regarding retail transactions].'' \79\
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    \78\ 7 U.S.C. 1a(47)(F)(i).
    \79\ 7 U.S.C. 1a(47)(F)(ii) (referring, in turn, to 7 U.S.C. 
2(c)(2)).
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(ii) Treatment of NDFs Under the Determination
    Several commenters who support issuing a determination to exempt 
foreign exchange swaps and forwards urge Treasury to extend the 
determination to apply to NDFs involving foreign exchange.
    In general, an NDF is a swap that is cash-settled between two 
counterparties, with the value of the contract determined by the 
movement of exchange rates between two currencies. On the contracted 
settlement date, the profit to one party is paid by the other based on 
the difference between the contracted NDF rate (set at the trade's 
inception) and the prevailing NDF fix (usually a close approximation of 
the spot foreign exchange rate) on an agreed notional amount. NDF 
contracts do not involve an exchange of the agreed-upon notional 
amounts of the currencies involved. Instead, NDFs are cash settled in a 
single currency, usually a reserve currency. NDFs generally are used 
when international trading of a physical currency is relatively 
difficult or prohibited.\80\
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    \80\ See CFTC-SEC Joint Products Rule, 77 FR at 48,254-255.
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    Several commenters acknowledge the distinction between NDFs and 
foreign exchange swaps and forwards, as defined by the CEA. One 
commenter, for example, states that ``NDFs are cash-settled, short-term 
forward contracts in a foreign currency, in which the profit or loss is 
calculated as the difference between the contractually agreed upon 
[foreign exchange] rate and the [foreign exchange] rate on the date of 
settlement.'' \81\ Nonetheless,

[[Page 69704]]

commenters who urge Treasury to extend the proposed determination to 
cover NDFs contend that ``NDFs are economically and functionally 
identical to [foreign exchange] forwards, despite the fact that they 
are cash settled in just one currency and do not involve the exchange 
of underlying currencies because of currency controls or local law 
restrictions in certain foreign jurisdictions.'' \82\ These commenters 
argue, therefore, that the grounds that Treasury identified in the NPD 
for issuing an exemption for foreign exchange forwards likewise should 
apply to NDFs.\83\ Moreover, one commenter argues that the definition 
of a ``foreign exchange forward'' in the CEA does not require the 
``physical exchange'' of the two currencies and, thus, this term should 
not be interpreted as precluding the inclusion of an NDF within the 
scope of an exemption.\84\
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    \81\ Coalition for Derivatives End-Users (``Coalition''), at 3. 
See also Covington & Burling, LLP, at 2 (``in an NDF, the trade 
closes out at maturity upon delivery of the net value of the 
underlying exchange, denominated in a pre-determined currency 
(usually the deliverable currency in the currency pair)'').
    \82\ Investment Company Institute, at 4.
    \83\ Investment Company Institute, at 4 (contending that ``the 
minimal benefits to overseeing systemic risk from including NDFs 
within the central clearing and exchange trading regime do not 
justify the costs of narrowly interpreting the definition of 
[foreign exchange] forward to exclude NDFs'').
    \84\ MFX Solutions, Inc., at 2 (``[The definitions of foreign 
exchange forward and foreign exchange swap] set limits on the scope 
of Treasury's exemptive authority under Section 721 of the Dodd-
Frank Act and as such seem to rule out an exemption from the 
definition of `swap' for non-fixed rate foreign exchange swaps and 
forwards. The definitions, however, do not appear to preclude 
exemption of non-deliverable swaps and forwards since the need for a 
`physical exchange' is not specified in the CEA's definitions.'').
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    The statutory provisions that limit a ``foreign exchange forward'' 
or a ``foreign exchange swap'' to an ``exchange'' of two different 
currencies entail the actual delivery of those currencies as an 
integral part of the transaction, rather than simply a transfer of the 
value corresponding to the difference in the prices of the two 
currencies on a specified date.\85\ Treasury observes that, recognizing 
the foregoing, the CFTC and Securities and Exchange Commission 
(collectively, the ``Commissions'') have defined the term ``swap'' to 
include an NDF.\86\ Correspondingly, the Commissions have determined 
that ``foreign exchange forward'' or ``foreign exchange swap'' do not 
encompass an NDF.\87\ In the preamble to the CFTC-SEC Joint Products 
Rule, the Commissions explain that ``NDFs do not meet the definitions 
of `foreign exchange forward' or `foreign exchange swap' set forth in 
the CEA [because] NDFs do not involve an `exchange' of two different 
currencies (an element of the definition of both a foreign exchange 
forward and a foreign exchange swap); instead, they are settled by 
payment in one currency (usually U.S. dollars).'' \88\ Accordingly, 
Treasury concludes that an NDF would not meet either definition under 
the CEA for the purposes of this determination.\89\
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    \85\ Accord Further Definition of ``Swap''; ``Security-Based 
Swap''; and ``Security-Based Swap Agreement''; Mixed Swaps; 
Security-Based Swap Agreement Recordkeeping, 77 FR at 48,256 (Aug. 
13, 2012) (``CFTC-SEC Joint Products Rules'').
    \86\ 17 CFR 1.3(xxx)(3)(v)(C).
    \87\ 17 CFR 1.3(xxx)(3)(iii) (defining the term foreign exchange 
forward); 17 CFR 1.3(xxx)(3)(iv) (defining the term foreign exchange 
swap).
    \88\ CFTC-SEC Joint Products Rule, 77 FR at 48,255.
    \89\ Under section 712(d)(1) of the Dodd-Frank Act, 15 U.S.C. 
8302(d)(1), the Commissions are authorized to further define the 
term ``swap'' under the CEA, and Treasury does not intend that the 
Commissions' joint rules in respect of the status of NDFs as swaps 
be affected by this written determination issued under other 
provisions of the CEA.
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    The requirement in the definitions of ``foreign exchange forward'' 
and ``foreign exchange swap,'' respectively, to ``exchange'' the two 
currencies should not be interpreted as requiring each foreign exchange 
swap or forward transaction to be settled independently. Rather, an 
entity, such as CLS or any other operator of a multilateral PVP 
settlement system, that settles a series of foreign exchange swap and 
forward transactions may use appropriate mechanisms to net transactions 
involving the same parties and the same currencies, and deliver each of 
the currencies to the respective parties. Applying appropriate 
mechanisms during the settlement process to net qualifying foreign 
exchange swap and forward transactions conducted by a group of parties 
should satisfy the limitations under the CEA because the essential 
elements of each of those transactions--namely, an exchange of two 
different currencies at a predefined, fixed rate--are left intact.\90\
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    \90\ Nothing in this paragraph is intended to: (1) Address 
transactions described in footnote 539 of the CFTC-SEC Joint 
Products Rule; or (2) establish a ``bookout'' right allowing parties 
to avoid exchanging currencies, each of which, depending on the 
relevant facts and circumstances, may fall within CFTC regulation 
1.3(xxx)(6)(ii). Regarding the former, in the CFTC-SEC Joint 
Products Rule, the Commissions stated:
    [l]ikewise, the Commissions have determined that a foreign 
exchange transaction, which initially is styled as or intended to be 
a ``foreign exchange forward,'' and which is modified so that the 
parties settle in a reference currency (rather than settle through 
the exchange of the 2 specified currencies), does not conform with 
the definition of ``foreign exchange forward'' in the CEA.
    See CFTC-SEC Joint Products Rule at 48255 n.539 (internal 
citation omitted).
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III. Procedural Analysis

A. Executive Order 12866 and Executive Order 13563

    Executive Orders 13563 and 12866 direct an agency to assess all 
costs and benefits of available regulatory alternatives and, if 
regulation is necessary, to select regulatory approaches that maximize 
net benefits (including potential economic, environmental, public 
health and safety effects, distributive impacts, and equity). Executive 
Order 13563 emphasizes the importance of quantifying both costs and 
benefits, of reducing costs, of harmonizing rules, and of promoting 
flexibility. This rule has been designated a ``significant regulatory 
action'' although not economically significant, under section 3(f) of 
Executive Order 12866. Accordingly, the rule has been reviewed by the 
Office of Management and Budget.

B. Regulatory Flexibility Act

    The Regulatory Flexibility Act (5 U.S.C. 601 et seq.) generally 
requires an agency to prepare a regulatory flexibility analysis unless 
the agency certifies that the rule will not have a significant economic 
impact on a substantial number of small entities. It is hereby 
certified that this determination would not have a significant economic 
impact on a substantial number of small entities. This certification is 
based on the fact that entities that engage in foreign exchange swaps 
and forwards, as defined by the CEA and as described in this 
determination, tend to be large entities. Accordingly, a regulatory 
flexibility analysis is not required.

IV. Final Determination

    Pursuant to section 1a(47)(E)(ii), the Secretary will submit this 
final determination to the appropriate committees of Congress as of 
November 20, 2012. For the reasons set forth in sections I and II, 
which are incorporated into and made part of this section IV, the 
Secretary issues a determination, as follows:
    (a) Definitions.
    For the purposes of this determination, the following definitions 
apply:
    (1) Act means the Commodity Exchange Act.
    (2) Commission means the Commodity Futures Trading Commission.
    (3) Dodd-Frank Act means the Dodd-Frank Wall Street Reform and 
Consumer Protection Act.

[[Page 69705]]

    (4) Foreign exchange forward shall have the same meaning as in 
section 1a(24) of the Act.
    (5) Foreign exchange swap shall have the same meaning as in section 
1a(25) of the Act.
    (6) Swap shall have the same meaning as in section 1a(47) of the 
Act.
    (b) Authority and purpose. This determination is issued under 
sections 1a(47)(E) and 1b of the Act in order to implement the 
provisions of the Act relating to the treatment of foreign exchange 
swaps and foreign exchange forwards as swaps under the Act.
    (c) Findings and exemption. (1) Considerations. The Secretary has 
considered--
    (i) 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, 
and finds that the required trading and clearing of these instruments 
would introduce new challenges and could result in negative 
consequences, without improving transparency;
    (ii) Whether foreign exchange swaps and foreign exchange forwards 
are already subject to a regulatory scheme that is materially 
comparable to that established by this Act for other classes of swaps, 
and finds that the regulatory scheme for foreign exchange swaps and 
foreign exchange forwards applicable in the U.S., as well as the 
regulatory schemes in other jurisdictions, have required specific 
actions that address settlement risk, mitigate counterparty credit 
risk, and manage other risks associated with foreign exchange swaps and 
forwards;
    (iii) The extent to which bank regulators of participants in the 
foreign exchange market provide adequate supervision, including capital 
and margin requirements, and finds that regulators are adequately 
supervising these participants, in part by requiring the implementation 
of risk-management and operational processes, including the use of 
payment-versus-payment settlement arrangements for settling 
transactions and the adoption of credit support annexes with 
counterparties;
    (iv) The extent of adequate payment and settlement systems, and 
finds that these systems are adequate for foreign exchange swaps and 
foreign exchange forwards, particularly because a specialized 
settlement system, which is subject to Federal oversight, has proven 
capabilities to settle the majority of all global foreign exchange 
transactions in multiple currencies; and
    (v) The use of a potential exemption of foreign exchange swaps and 
foreign exchange forwards to evade otherwise applicable regulatory 
requirements, and finds that foreign exchange swaps and foreign 
exchange forwards, as defined under the Act, are distinguished from 
other derivatives, widely used by supervised banks for bona fide 
funding transactions, and not likely to be used to evade otherwise 
applicable regulatory requirements because of operational and 
transactions costs associated with potentially transforming these 
instruments into other derivatives that are subject to regulatory 
requirements under the Act.
    (2) Exemption. Upon consideration of each of the factors set forth 
in section 1b of the Act, the Secretary finds that--
    (i) Foreign exchange swaps and foreign exchange forwards should not 
be regulated as swaps under the Act; and
    (ii) Foreign exchange swaps and foreign exchange forwards are not 
structured to evade the requirements of the Dodd-Frank Act, in 
violation of any rule promulgated by the Commission, pursuant to 
section 721(c) of the Dodd-Frank Act (15 U.S.C. 8321)--and, 
accordingly, hereby determines that any foreign exchange swap or 
foreign exchange forward hereby is exempt from the definition of the 
term ``swap'' under the Act.
    (d) Scope--As provided in sections 1a(47)(E) and 1b(c) of the Act--
    (1) Reporting. Notwithstanding this determination, all foreign 
exchange swaps and foreign exchange forwards shall be reported to a 
either a swap data repository or, if there is no swap data repository 
that would accept such swaps or forwards, to the Commission, pursuant 
to section 4r of the Act (7 U.S.C. 6r) within such time period as the 
Commission may by rule or regulation prescribe.
    (2) Business standards. Notwithstanding this determination, any 
party to a foreign exchange swap or forward that is a swap dealer or 
major swap participant (as such terms are defined under the Act or 
under section 721(c) of the Dodd-Frank Act (15 U.S.C. 8321)) shall 
conform to the business conduct standards contained in section 4s(h) of 
the Act (7 U.S.C. 6s(h)).
    (3) Effect of determination. This determination shall not exempt 
any foreign exchange swap or foreign exchange forward traded on a 
designated contract market or swap execution facility from any 
applicable anti-manipulation provision of the Act.

    Dated: November 16, 2012.
Timothy F. Geithner,
Secretary.
[FR Doc. 2012-28319 Filed 11-19-12; 8:45 am]
BILLING CODE 4810-25-P