Alert November 20, 2012

Foreign Exchange Swaps and Foreign Exchange Forwards Excluded from “Swap” Definition

The Secretary of the Treasury issued a final written determination exempting foreign exchange swaps and foreign exchange forwards from the definition of “swap.” The Commodity Exchange Act, as amended by the Dodd-Frank Act, authorizes the Secretary of the Treasury to determine that foreign exchange swaps and/or foreign exchange forwards should not be regulated as swaps under the Commodity Exchange Act and are not structured to evade the Dodd-Frank Act.  The determination, which is summarized in an accompanying fact sheet, includes a discussion of the Secretary of the Treasury’s analysis of the various factors statutorily required to be considered in determining whether to exempt foreign exchange swaps and foreign exchange forwards from the swap definition. 

The two terms are defined in Section 1a of the Commodity Exchange Act as follows:

(24) Foreign exchange forward

The term “foreign exchange forward” means 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.

(25) Foreign exchange swap

The term “foreign exchange swap” means 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 the 2 currencies described in subparagraph (A) at a later date and at a fixed rate that is agreed upon on the inception of the contract covering the exchange.

The determination notes that the Secretary of the Treasury does not have the authority to exclude other types of derivatives, including foreign exchange options, currency swaps, and non-deliverable forwards, which therefore remain within the “swap” definition.  The determination notes that a material distinction between foreign exchange swaps and foreign exchange forwards, on the one hand, and instruments such as currency swaps, on the other, is that the payment obligations of the latter instruments are variable and change due fluctuations in underlying references such as interest rates, with the result that payment obligations cannot be accurately predicted at the inception of the instrument.  The payment obligations arising under foreign exchange swaps and foreign exchange forwards, on the other hand, are fixed and known to all parties when the instruments are first executed. 

The determination notes that foreign exchange swaps and foreign exchange forwards remain subject to certain CFTC reporting and anti-evasion rules as well as business conduct standards.