Foreign Exchange dealers, hedgers, SEFs and DCOs eagerly awaited clarification on whether or not FX swaps and forwards would be classified as a Swap under the CFTC definitional rule passed on July 10th. Almost two years ago, the U.S. Treasury secretary had received the option under Dodd-Frank to determine if these commonly used derivatives should be fully regulated under Dodd-Frank along with CDS, Rates and other OTC derivatives or if they should be exempted as they are of minimal risk to the financial system. It was hoped that the Swap definition rule would at long last confirm that FX swaps and forwards would not be forced to be cleared and fall under the margin and capital rules that will impact the instruments that were defined as Swaps within the 585 page rule. With the exclusion, end-users would not have to bother with declaring them exempt from clearing or worry about being forced into margining with banks. Note, non-deliverable forwards and FX options would not be exempted and will fall under full regulation.
Well, unfortunately the FX market has to still wait for the official Treasury department determination as ruled by the CFTC last week. The Secretary had closed the comment period on June 6, 2011 on the Proposed Determination 76 FR 25774 (May 5, 2011) http://www.gpo.gov/fdsys/pkg/FR-2011-05-05/pdf/2011-10927.pdf and unclear as to when the final determination will made.
However, no matter what the outcome of the final word from Treasury, FX swaps and forwards will still have to be reported to the SDR and comply with any business conduct rules applied to Swap Dealers who sell these instruments.
So certainly this will add reporting and compliance costs for Swap Dealers, who may then pass these costs on to the market. But what remains unclear is if end-users who enter into back-to-back FX swaps or forwards will have to report their inter-affiliate hedges to SDRs. For example, in the case where a corporate executes a $100MM three month FX forward under one legal entity with a Swap Dealer and then breaks that up into ten $10MM FX forwards for ten subsidiaries, the rules may require the reporting of those ten swaps by the corporate, despite the appearance of double counting.
The CFTC is working on guidance on addressing affiliate transactions, which is especially complicated for financial institutions. Assuming then that these back-to-back trades fall under reporting rules, corporates may have to start reporting their affiliate FX swaps and forwards to SDRs starting April of 2013.