The U.S. Treasury finallyannounced late last week that it was exempting foreign exchangeforwards and swaps from Dodd-Frank clearing requirements, but thereare still several issues outstanding that could affect corporateend users of derivatives.

FX forwards and swaps remain subject to requirements includingtrade reporting, the Commodity Futures Trading Commission'santi-evasion authority, which aims to keep Wall Street fromtweaking cleared FX products to receive exempt status, andDodd-Frank's business conduct rules, according to an analysis byCadwalader Wickersham & Taft.

In its announcement, Treasury said participants in FX forwardsand swaps know their own and their counterparties' paymentobligations and their full exposures through the life of thecontract, which distinguishes them from a handful of other FXderivatives that most likely will have to be cleared, including FXoptions, currency swaps, cross-currency swaps, contracts fordifferences, foreign-rate agreements and non-deliverable forwards(NDFs)

End users are hoping to get NDFs exempted from clearing as well.NDFs are used predominately by multinationals doing business indeveloping countries, such as China and Brazil, that havesignificant currency controls and restrict investments by foreignfirms, making it hard to use deliverable forwards.

Tom Deas, treasurer at FMC Corp. and chairman of theNational Association of Corporate Treasurers (NACT), notes thatTreasury's rule says FX options, currency swaps and NDFs are notexempted from the Commodity Exchange Act's definition of a“swap.” Presumably that language was crafted in conjunction withthe Commodity Futures Trading Commission and represents thegovernment's position.

“However, in August, in response to a question from CFTCCommissioner Jill Sommers, the [CFTC] staff responded that they dohave the authority to exempt NDFs, which would put them in the samecategory as FX spot and forward trades,” says Deas, picturedabove. “The ball is now in the CFTC's court, at least to defineNDFs as being exempt.”

Luke Zubrod, director atChatham Financial, says the CFTC staff's acknowledgement that theagency could exempt NDFs raised a spark of hope, especially sinceNDFs resemble deliverable forwards and are really the only optionfor companies hedging the risk of somecurrencies.

“Market participants need to assume that the current state ofaffairs will likely remain,” Zubrod says. “But there will probablybe a debate in the background raising at least the possibility thatNDFs could gain consideration for also being exempted.”

Another uncertainty involves companies' central treasury centersand whether their hedging activities will be exempt from clearingrequirements. That issue was partly resolved by CFTC guidanceclarifying that trades between a company's affiliates to hedge riskare exempt from clearing, Zubrod says. However, because centraltreasury centers typically seek to hedge their netted exposureswith an outside party, the market-facing transaction with theoutside party may be subject to clearing unless the CFTC opts toexempt such transactions.

Another open issue involves margin requirements, and whetherbanking regulators will carry through on indications they've giventhat they will require banks to impose margin requirements on endusers, or exempt end users from margin as well as clearingrequirements. Deas notes that NACT, as part of the Coalition forDerivatives End-Users, submitted a comment letter to the CFTC onSept. 14 requesting a broad exemption from margin requirements forend users.

Even if corporate end users can avoid posting margin, however,it appears likely that their costs for engaging in FX transactionswill rise, since Basel III capital requirements that start to takeeffect next year will increase costs for banks that they are almostcertain to pass on to customers.

Some corporates may even decide that clearing transactions isthe better option.

“If treatment of over-the-counter swaps is more costly, thendealers will offer preferential terms and better pricing on cleareddeals, even if they could be exempt,” says Craig Pirrong, financeprofessor at the University of Houston's Bauer College ofBusiness.

For previous coverage, see Treasury Exempts FX Swaps from Dodd-Frank. See theTreasury's announcement here.