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Derivatives

Appeals Court FX Ruling Clarifies Definitions For Whole Mart

A recent decision by a U.S. court of appeals in a case challenging whether certain foreign exchange trades are derivatives clarifies the definitions for the whole market.

A recent decision by a U.S. court of appeals in a case challenging whether certain foreign exchange trades are derivatives clarifies the definitions for the whole market. The rationale given to differentiate between financial transactions termed as spot or cash or as futures is equally applicable to virtually all derivatives instruments, including metals, energy and government securities, said Scott Early, partner at law firm Foley & Lardner in Chicago, who represented one of the defendants in the case, Chicago-based fx market maker AFX.

The appeals court upheld a decision of a U.S. District Court from October of last year, that ruled that certain foreign exchange trades contested by the Commodity Futures Trading Commission as being derivatives contracts, are in fact spot transactions and do not fall within the CFTC's regulatory jurisdiction. This decision addresses a long-standing debate over the regulation of foreign exchange trades wherein fx futures and options fall within the CFTC's jurisdiction while fx spot or cash is essentially unregulated.

Arguments over how the fx trades should be defined concentrated on whether the contracts constituted a sale of a commodity for future delivery. The CFTC stated that because AlaronFX, AFX's parent organization, rolled forward fx transactions two days at a time client's positions were held open indefinitely and as such gains and losses depended on price movements in the future. However, the United States Court of Appeals For the Seventh Circuit, which tried the case, ruled that the transactions were "spot sales for delivery within 48 hours. Rollover, and the magnification of gain or loss over a longer period, does not turn sales into futures contracts," it said.

The decision greatly clarifies the distinction between spot and cash from futures trades and will allow market makers greater clarity going forward in business planning, said Early. Alan Sobba, head of external affairs at the CFTC in Washington, said the commission is contemplating the decision.

The decision dates from attempts initiated by the CFTC in 2003 to charge the California-based British Capital Group with defrauding clients in an alleged foreign exchange scam, according to a release issued by the CFTC in June of last year.

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