Christmas Comes Early For Hedgers of FX Swaps & Forwards Under Dodd-Frank

At long last, the U.S. Treasury Department on Friday came out with the final determination that FX swaps and FX forwards will be exempt from mandatory trading and clearing under Dodd-Frank.

As stated in the Treasury’s press release: This final determination is narrowly tailored. FX swaps and forwards will remain subject to the Dodd-Frank Act’s new requirement to report trades to repositories and rigorous business conduct standards. Additionally, the Dodd-Frank Act makes it illegal to use these instruments to evade other derivatives reforms. Importantly, the final determination does not extend to other FX derivatives, such as FX options, currency swaps, and non-deliverable forwards. These other FX derivatives will be subject to mandatory clearing and exchange-trading requirements.

Most corporate treasury departments have largely assumed that the exemption would be passed, but many are not aware or too concerned about the reporting requirements, which are not exempted.  According to current reporting rules “all” swaps have to be reported to SDRs, so the question remains on inter-affiliate swap transactions that are currently required to be reported.   In a recent survey we conducted, 36% of companies said they enter into back-to-back swaps for centralization of hedging and efficiency, so these companies would be required to report their inter-affiliate trades.

The determination does not exempt FX swaps and FX forwards from margining and makes a point that prudential regulators have done an effective job of minimizing risk through the use of capital and margin requirements.  Therefore, corporates should not expect to avoid posting margin because of this Treasury exemption.

A global issue is also brewing as the European Securities and Markets Authority (ESMA) and other G-20 countries do not have this exemption of Fx swaps and Fx forwards.  This lack of harmonization could drive plain vanilla FX business to the U.S., and if there is not harmonization on this “obvious” gap, then it’s hard to see how other less obvious gaps would be closed.

For now anyway, let’s take one of the few victories from Dodd-Frank and, on behalf of many beneficiaries of this exemption, thank Secretary Geithner for coming through with this farewell gift before he leaves office.