The recent exemption of ‘fx swaps and forwards’ from clearing under Dodd-Frank by the U.S. Treasury has left derivatives players scratching their heads. There’s potential for overlap, they say, between fx swaps and currency swaps, which are not exempted. Although market participants are not prepared to storm Washington just yet, and some even think currency swaps on exchanges could be a good thing, the sloppy terminology has others opining that it could take a team effort from compliance folks and traders together to be 100% certain their fx’s aren’t considered currencies. In a world where chemistry is everything, some are concerned that this team could end up resembling Kobe & Shaq’s L.A. Lakers or Terry & Bridge’s England football team before all is said and done, especially in working with such an ambiguous definition.
An FX swap is a spot transaction matched by a forward transaction, usually short-dated and continuously rolled. A currency swap essentially represents a fixed/floating interest rate trade where the rates are determined by the currency cross. It appears the lawmakers and Treasury’s goal was to make sure that derivatives traders don’t substitute clearing large interest rate swaps with over-the-counter bespoke currency swaps. Fair enough, say players, but this distinction has never truly ‘mattered’ before, so the eventual adjustment could be earth-shaking.
A true enough point made to me by a derivatives lawyer was that the Treasury only had so much breadth to work with. “The lawmakers just kept talking, making definitions narrower and narrower,” he said. “At the end of the day, the Treasury only had say over ‘fx swaps and forwards,’ which are defined in incredibly simplistic terms in the law.”
We’re still waiting for more regulatory interpretation, of course, which will sound like a familiar story to anyone with a derivatives-related RSS feed into their work email account. The Commodities Futures Trading Commission will be in charge of determining if there are any gray lines, likely in conjunction with the Treasury. When that time comes, compliance and trading can come together and discuss how problematic this issue really will be, but in the meantime, they may want to consider blocking off a weekend next year for some team-building exercises.
