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A Brief Survey of CFTC Regulation of Select FX Products

Introduction

The scope of Commodity Futures Trading Commission (“CFTC”) regulation of foreign exchange-related (“FX”) products varies widely depending on the nature of the FX transaction. This is driven primarily by the dictates of the Commodity Exchange Act (“CEA”) but in some cases stems from policy choices made by the Commission. This article discusses, and compares and contrasts select elements of and interesting relationships among,2 the CFTC’s regulation of various

FX transactions. The article covers, among other FX products, spot (unregulated, but residual enforcement authority exists),3 foreign exchange forwards (“FXFs”) and foreign exchange swaps (“FXSs”) (more lightly regulated than other swaps involving FX), retail FX (“retail forex”) (subject to its own regulatory regime) and swaps overlying FX or FX rates, in all their various forms, including FX options (subject to robust regulation under the Dodd-Frank Wall Street Transparency and Accountability Act of 20104 (“Dodd-Frank”)).

I. The Swap Definition

The CEA (as modified by Dodd-Frank) expressly grants the CFTC jurisdiction over currency swaps and FXSs, which are enumerated in CEA §§ 1a(47)(A)(iii)(VII) and (VIII), respectively, although, as discussed below, CFTC jurisdiction over FXSs is limited. The CFTC also has jurisdiction over FX options because CEA § 1a(47)(A)(i) (added by Dodd-Frank) clearly renders most FX options (both options to purchase currency and cash-settled options on exchange rates) swaps,5 a result

by David Aron1

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the CFTC enshrined in regulation 1.3(xxx)(2)(B).6

These changes to the CEA wrought by Dodd-Frank and the related CFTC-SEC rulemaking departed from the historically light regulatory touch applicable to FX products under the CEA/CFTC regulations as compared to most other asset classes.

II. Sources of CFTC FX Options Authority

The starting point for determining CFTC jurisdiction generally is CEA § 2(a)(1)(A),7 which grants the CFTC exclusive jurisdiction, except as otherwise provided in, among other CEA and Dodd-Frank sections, CEA § 2(c),8 over swaps, futures and options on futures traded on designated contract markets (“DCMs”) and over swaps traded on swap execution facilities (“SEFs”) or any other board of trade, exchange or

market. CEA § 4c(b)9 also grants the CFTC plenary authority over options not otherwise carved out of the CFTC’s jurisdiction.10 To avoid the perception by some that all options subject to CFTC jurisdiction would become illegal (notwithstanding

that Dodd-Frank made them swaps and subjected them as such to a comprehensive regulatory scheme) unless the CFTC authorized them using its CEA § 4c(b) authority,11 the CFTC promulgated regulation 32.2, which makes options lawful “if conducted in compliance with and subject to the provisions of the [CEA] . . . otherwise applicable to any other swap.”12 However, the CFTC’s jurisdiction over foreign currency

transactions, including FX options, historically has been relatively circumscribed.

III. The Treasury Amendment and FX Options

In particular, CEA § 2(c)(1) (known as the “Treasury A me nd me nt ”) states that, with limited exceptions not relevant here, nothing in the CEA applies to an agreement, contract or t r a n s a c t i o n

in, among other things, foreign currency.13 Congress enacted the Treasury Amendment as a part of the Commodity Futures Trading Commission Act of 1974,14 which, among other things, created the CFTC. In the words of the Supreme Court in Dunn v. CFTC (“Dunn”):

The amendment was enacted on the suggestion of the Treasury Department at the time of a dramatic expansion

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1David Aron is Counsel in the Office of General Counsel (and temporarily detailed to the Division of Market Oversight) at the Commodity Futures Trading Commission, where he was one of the principal draftsmen of the joint CFTC-Securities and Exchange Commission (“SEC”) rulemaking further defining the term swap (Further Definition of “Swap,” “Security-Based Swap,” and “Security-Based Swap Agreement”; Mixed Swaps; Security-Based Swap Agreement Recordkeeping, 77 Fed. Reg. 48,207 (Aug. 13, 2012) (“Swap Adopting Release”)), including the FX sections thereof. The research for this paper was conducted, and the paper was written by, David Aron in his personal capacity and not in his official capacity as an employee of the Commodity Futures Trading Commission (“CFTC”). The analyses and conclusions expressed in this paper are those of Mr. Aron, and do not reflect the views of other employees of the CFTC Office of General Counsel, the CFTC Division of Market

Oversight, other CFTC staff, the Commission itself, or the United States government. The author wishes to thank Guy C. Dempsey, Jr., a partner in Katten Muchin Rosenman LLP’s Futures and Derivatives practice, for his helpful comments and suggestions on this article. Any errors, however, are the author’s alone.2The article is not intended to provide a full treatment of the CFTC/CEA FX regulatory scheme.3See CEA §§ 9(a)(2) (making it a felony “to manipulate or attempt to manipulate the price of any commodity in interstate commerce, or for future delivery on or subject to the rules of any registered entity, or of any swap . . . .”) (emphasis added), 6(c)(1) (rendering it unlawful to engage in any of the same activity outlawed by 9(a)(2) if such activity is “in contravention of such rules . . . as the Commission . . . promulgate[s] . . . [within] 1 year . . . of enactment of . . . Dodd-Frank . . . .”) sand 6(c)(3) (making it illegal to manipulate or attempt to manipulate the price of

a commodity in interstate commerce, a swap, or a futures contract on or subject to the rules of a registered entity) and CFTC regulations 180.1 (rendering it unlawful to “intentionally or recklessly” engage in any one of four enumerated types of misconduct “in connection with any swap, or contract of sale of any commodity in interstate commerce, or contract for future delivery on or subject to the rules of any registered entity. . . .”) (emphasis added) and 180.2 ([“i]t shall be unlawful for any person, directly or indirectly, to manipulate or attempt to manipulate the price of any swap, or of any commodity in interstate commerce, or for future delivery on or subject to the rules of any registered entity[]”)(emphasis added) promulgated under the authority granted to the CFTC in 6(c). Regulation 180.1 implemented 6(c)(1), and regulation 180.2 implemented 6(c)(3).4Public Law 111–203, 124 Stat. 1376 (2010).5CEA § 1a(47)(A) states, in relevant part, that: the term “swap” means

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in the scope of federal commodities regulation. The Department expressed concerns in a letter to the relevant congressional committee that this development might lead, inter alia, to the unintended regulation of the off-exchange market in foreign currency futures. See S. Rep. No. 93–1131, pp. 49–50 (1974) (“The D e p a r t m e n t feels strongly that foreign c u r r e n c y futures trading, other than on organized e x c h a n g e s , should not be regulated by the new agency”) (letter of Donald Ritger, Acting General Counsel). The Treasury Amendment, which tracks almost verbatim the language proposed by the Department . . . was included in the legislation to respond to these concerns.15

In Dunn, the Supreme Court held

that the CFTC had no jurisdiction over over-the-counter (“OTC”) FX options, interpreting the operative exclusionary language (i.e., “[n]othing in this Act shall be deemed to govern or in any way be applicable to transactions in foreign currency . . .”)16

contained in the forerunner to CEA § 2(c)(1) as covering FX options, on the basis that FX options are “transactions in” FX. At the time Dunn was decided, there was nothing bringing OTC FX options back into the CFTC’s jurisdiction: that is, CEA § 2(a)(1)(A)(ii) contained

no language limiting the exclusion from CFTC jurisdiction comparable to current CEA § 2(c)(1)(A)’s “[e]xcept as provided in paragraph (2) . . .” In the wake of Dunn, however, the Commodity Futures Modernization Act of 2000 (“CFMA”)17 added two

express carve-outs from the Treasury A m e n d m e n t and moved the Treasury Amendment from CEA § 2(a)(1)(A)(ii) to CEA § 2(c)(1).18

The first carve-out (current CEA § 2(c)(2)(A)(i)) codified that options (as well as futures and options on

futures) on any commodity (other than FX or securities) executed or traded on an organized exchange19 were subject to the CEA and CFTC jurisdiction. The second carve-out codified that options (as well as futures and options on futures) on FX were subject to CEA and CFTC

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any agreement, contract, or transaction—(i) that is a put, call, cap, floor, collar, or similar option of any kind that is for the purchase or sale, or based on the value, of 1 or more interest or other rates[] [or] currencies . . . The “for the purchase or sale . . . of ” language captures physically settled options; the “based on the value[] of ” language captures cash settled options. But see CEA §§ 1a(47)(B)(i) (excluding from the swap definition agreements, contracts, and transactions described in CEA § 2(c)(2)(C)(i) (which includes retail forex options)) and 1a(47)(B)(iv) (excluding from the swap definition FX-related options entered into on a registered national securities exchange).6CFTC regulation § 1.3(xxx)(2)(B) states:(2) Inclusion of particular products. (i) The term swap includes, without limiting the meaning set forth in section 1a(47) of the Commodity Exchange Act, the following agreements, contracts, and transactions:

. . .(B) A currency option, foreign currency option, foreign exchange option and foreign exchange rate option[.]See also the FX options discussion in the Swap Adopting Release at 48,254.7CEA § 2(a)(1)(A) provides that:(A) IN GENERAL.—The Commission shall have exclusive jurisdiction, except to the extent otherwise provided in the Wall Street Transparency and Accountability Act of 2010 (including an amendment made by that Act) and subparagraphs (C), (D), and (I) of this paragraph and subsections (c) and (f), with respect to accounts, agreements (including any transaction which is of the character of, or is commonly known to the trade as, an “option”, “privilege”, “ indemnity”, “ bid”, “offer”, “put”, “call”, “advance guaranty”, or “ decline guaranty”), and transactions involving swaps

or contracts of sale of a commodity for future delivery (including significant price discovery contracts), traded or executed on a contract market designated pursuant to section 5 or a swap execution facility pursuant to section 5h or any other board of trade, exchange, or market, and transactions subject to regulation by the Commission pursuant to section 19 of this Act.8CEA § 2(c) provides the following:AGREEMENTS, CONTRACTS, AND TRANSACTIONS IN FOREIGN CURRENCY, GOVERNMENT SECURITIES, AND CERTAIN OTHER COMMODITIES.—(1) IN GENERAL.—Except as provided in paragraph (2), nothing in this Act (other than section . . . 5b[] or 12(e)(2)(B)) governs or applies to an agreement, contract, or transaction in—(A) foreign currency . . . .CEA § 2(c)(2)(A) provides that:(2) COMMISSION JURISDICTION.—

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jurisdiction when executed or traded on organized exchanges (other than national securities exchanges registered with the SEC pursuant to Securities and Exchange Act of 1934 § 6(a)).20 As a result, because (1) “transactions in” FX, which Dunn had held includes FX options, were excluded from the CEA and CFTC jurisdiction by the Treasury A m e n d m e n t and (2) neither of the carve-outs therefrom added by the CFMA brought OTC FX options back within the coverage of the CEA and CFTC j u r i s d i c t i o n , the CFMA did not change Dunn’s holding that OTC FX options were excluded from the CEA and CFTC jurisdiction.

Dodd-Frank § 722(c)(3) added a third carveout (for swaps) from the

Treasury Amendment.21 As a result, the Dodd-Frank swap definition, the CFTC’s and SEC’s further definition of “swap” and the CEA § 2(c)(2)(A)(ii) carve-out from the Treasury Amendment added by Dodd-Frank all work together to subject OTC

FX options to the CEA and CFTC oversight.

IV. Treatment of Certain Other FX Products

The CFTC showed great flexibility

in its approach to FX products, other than OTC FX options, in the Swap Adopting Release, as did Congress, by providing a very light regulatory touch (vis-à-vis swaps fully regulated under Dodd-Frank) for foreign exchange forwards (“FXFs”) and

foreign exchange swaps (“FXSs”) in Dodd-Frank. Dodd-Frank § 721(a)(21) added to the CEA, among other provisions, § 1a(47)(E). CEA § 1a(47)(E) provides, among other things, that if the Treasury S e c r e t a r y determines that FXFs and/or FXSs should not be treated

as swaps and were not structured to evade Dodd-Frank in violation of any CFTC regulation promulgated for that purpose, then such products would not be treated as swaps22 and would be subject only to a few reserved provisions of the CEA and Dodd-

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(A) AGREEMENTS, CONTRACTS, AND TRANSACTIONS TRADED ON AN ORGANIZED EXCHANGE.—This Act applies to, and the Commission shall have jurisdiction over, an agreement, contract, or transaction described in paragraph (1) that is—(i) a contract of sale of a commodity for future delivery (or an option on such a contract), or an option on a commodity (other than foreign currency or a security or a group or index of securities), that is executed or traded on an organized exchange; (ii) a swap; or (iii) an option on foreign currency executed or traded on an organized exchange that is not a national securities exchange registered pursuant to section 6(a) of the Securities Exchange Act of 1934.9CEA § 4c(b) provides that:No person shall offer to enter into, enter into or confirm the execution of, any transaction involving any commodity regulated under this Act which is of the character of, or is commonly known to the trade

as, an “option”, “privilege”, “ indemnity”, “ bid”, “offer”, “put”, “call”, “advance guaranty”, or “ decline guaranty”, contrary to any rule, regulation, or order of the Commission prohibiting any such transaction or allowing any such transaction under such terms and conditions as the Commission shall prescribe. Any such order, rule, or regulation may be made only after notice and opportunity for hearing, and the Commission may set different terms and conditions for different markets.10See, e.g., CEA § 2(a)(1)(C)(i)(I) (example of an option over which the CFTC does not have jurisdiction), which states that:[e]xcept as provided in [CEA § 2(a)(1)(C)(i)](II), this Act shall not apply to and the Commission shall have no jurisdiction to designate a board of trade as a contract market for any transaction whereby any party to such transaction acquires any put, call, or other option on one or more securities (as defined in section 2(1) of the Securities Act

of 1933 or section 3(a)(10) of the Securities Exchange Act of 1934 on the date of enactment of the Futures Trading Act of 1982), including any group or index of such securities, or any interest therein or based on the value thereof.CEA § 2(a)(1)(C)(i)(II) grants the CFTC jurisdiction over such options if the SEC exempts them on the condition that the CFTC exercise concurrent jurisdiction.11The CFTC explained in the preamble to the final Commodity Options rule that it promulgated § 32.2 to “remove[] any uncertainty as to whether CEA section § 4c(b) would otherwise prohibit . . . commodity options” that are swaps. Commodity Options, 77 FR 25,320, 25,326 (Apr. 27, 2012).12See 17 C.F.R. § 32.2, stating, in relevant part:[s]ubject to §§ 32.1, 32.4, and 32.5, which shall in any event apply to all commodity option transactions, it shall be unlawful for any

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Frank. Those reserved provisions are: (1) its business conduct provisions (for swap dealers (“SDs”) and major swap participants (“MSPs”));23 (2) its swap data repository reporting requirements;24 and (3) with respect to FXFs and FXSs listed and traded on or subject to the rules of a DCM or a SEF, or cleared by a DCO, CEA and Dodd-Frank anti-fraud and anti-ma nipu lat ion p r o v i s i o n s . 2 5 The Treasury S e c r e t a r y made that determination in 2012.26

A. Retail FX Options

In one case, in analyzing a conflict among three different provisions of the CEA raising a question regarding the Commission’s FX options authority, the CFTC preserved the legality of certain FX products when the agency could have instead outlawed them. CEA § 1a(47)(A)(i) defines

FX options (among other options) as swaps. CEA § 2(e) makes it illegal for retail counterparties (i.e., non-eligible contract participants (“ECPs”)) to enter into swaps (implicitly including FX options because FX options are swaps pursuant to CEA § 1a(47)(A)(i)) other than on or subject to the

rules of a DCM. While CEA § 1a(47)(B)(i) excludes CEA § 2(c)(2)(C)(i) retail forex products (which could include retail forex options) from the swap definition, CEA § 1a(47)(B)(i) does not contain a parallel swap definition exclusion for CEA § 2(c)(2)(B)(i) (which expressly includes retail forex options). CEA § 2(c)(2)(B)(i) subjects FX options involving

a retail party to the CEA’s/CFTC’s retail forex regime,27 implicitly rendering them legal but for the fact that such options at the same time seemingly became swaps pursuant to new CEA § 1a(47)(A)(i), and various activity related to such swaps apparently became

illegal under the new CEA § 2(e) added by D o d d - F r a n k . In resolving this conf lict among the a forementioned CEA sections, the CFTC could have favored CEA §§ 1a(47)(B)(i) and 2(e) over CEA § 2(c)(2)(B), thereby

rendering FX options involving non-ECP counterparties illegal, but chose instead to permit such FX options, subject to CEA § 2(c)(2)(B) and Part 5 of the CFTC’s regulations, stating “[t]he CFTC believes that Congress did not intend to overrule and effectively repeal another provision of the CEA in such an oblique fashion.”28

person or group of persons to offer to enter into, enter into, confirm the execution of, maintain a position in, or otherwise conduct activity related to any transaction in interstate commerce that is a commodity option transaction, unless:(a) [s]uch transaction is conducted in compliance with and subject to the provisions of the Act, including any Commission rule, regulation, or order thereunder, otherwise applicable to any other swap . . . .13See supra note 8.14Public Law 93-463, 88 Stat. 1389.15519 U.S. 465, 471 n.8 (1997).16CEA § 2(a)(1)(A)(ii) was the forerunner of CEA § 2(c)(1)(A) and stated: “[n]othing in this Act shall be deemed to govern or in any way be applicable to transactions in foreign currency . . unless such transactions involve the sale thereof for future delivery conducted on a board of trade.”

17Public Law 105–554, 114 Stat. 2763.18See CFMA § 102.19The term “organized exchange” is defined in CEA § 1a(37) as: a trading facility that—(A) permits trading—(i) by or on behalf of a person that is not an eligible contract participant; or (ii) by persons other than on a principal-to-principal basis; or (B) has adopted (directly or through another nongovernmental entity) rules that—(i) govern the conduct of participants, other than rules that govern the submission of orders or execution of transactions on the trading facility; and (ii) include disciplinary sanctions other than the exclusion of participants from trading.20The carveout currently is in CEA § 2(c)(2)(A)(iii); it was in CEA § 2(c)(2)(A)(ii) when the CFMA added it to the CEA.21See Dodd-Frank § 722(c)(3) (adding swaps to the list of agreements, contracts and transactions that are excepted from the Treasury

Amendment’s exclusion of FX from the Commission’s jurisdiction). See supra note 8 for the text of the change/CEA § 2(c)(2)(A)(ii).22See CEA § 1a(47)(E)(i).23See CEA § 1a(47)(E)(iv).24See CEA § 1a(47)(E)(iii).25See CEA § 1a(47)(F)(i). See also CEA § 1b(c) (stating that “[a] determination by the Secretary [that FXFs and FXSs should not be regulated as swaps] . . . shall not exempt any [FXFs] and [FXFs] traded on a [DCM] or [SEF] from any applicable antifraud and antimanipulation provision under this chapter.”).26See Determination of Foreign Exchange Swaps and Foreign Exchange Forwards Under the Commodity Exchange Act, 77 Fed. Reg. 69,694 (Nov. 20, 2012) (final determination) (“Treasury Determination”).27The CFTC’s retail forex regime is set forth in CEA §§ 2(c)(2)(B)

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B. Securities Conversion Transactions

1. Foreign Exchange Forwards Relief

In another example of the CFTC p r o v i d i n g relief through interpretation, the CFTC and SEC interpreted “ s e c u r i t i e s c o n v e r s i o n transactions”29 out of not one but two potential CEA r e g u l a t o r y schemes: FXFs and retail forex. The FXFs issue implicated by securities conversion transactions was that, were securities conversion transactions considered foreign exchange forwards, securities conversion transactions “would [have] be[en] subject to the CEA reporting and business conduct standards requirements applicable to FXFs, even if the [Treasury

Secretary] determine[d] to exempt foreign exchange forwards from the definition of “swap.”30 Because such transactions routinely included delaying the otherwise applicable FX settlement deadline beyond the

typical FX settlement timeline (i.e., T+2) in transactions involving the use of FX to purchase foreign securities/the receipt of FX from the sale of foreign securities, the possibility of securities conversion transactions having been characterized as foreign exchange forwards was real31 (and securities conversion transactions

being considered evasive was an outside possibility).32 Stating that they “do not believe that Congress intended, solely with respect to foreign exchange transactions, to extend the reach of the CEA to

t r a n s a c t i o n s that historically have been considered spot transactions[,]”33 the Commissions provided an i nt e r pr e t a t i o n that “a bona fide foreign exchange spot transaction, i.e., a foreign exchange transaction that is settled on the customary timeline of the relevant spot

market, is not within the definition of the term ‘swap.’34 The CFTC stated that it would consider securities conversion transactions to be bona fide spot transactions, thus effectively equating the foreign securities and related FX spot settlement deadlines in the context of securities conversion transactions.35

and (C) and Part 5 of the CFTC’s regulations (17 C.F.R. Part 5).28Swap Adopting Release at 48,258.29Generally, a “securities conversion transaction” is a transaction in which (1) FX is used to purchase a foreign security or received from the sale of a foreign security and (2) the settlement timing of the FX leg of the transaction is delayed (beyond what it would have been absent being used to buy, or being received from the sale of, a foreign security) to match the longer settlement timeframe of the securities leg so that the transactions as a whole can settle on a delivery-versus-payment basis. The CFTC (and SEC) defined a securities conversion transaction as:[a]n agreement, contract or transaction for the purchase or sale of an amount of foreign currency equal to the price of a foreign security with respect to which (i) the security and related foreign currency transactions are executed contemporaneously in order to effect

delivery by the relevant securities settlement deadline and (ii) actual delivery of the foreign security and foreign currency occurs by such deadline . . . Swap Adopting Release at 48,257.30Id.31This is because the intentional delay aspects of securities conversion transactions could have been viewed as falling within the “specific future date” element of the FXF definition. See FXF discussion infra § IV.C.; FXF definition infra note 40.32The Commissions stated that:[t]he Commissions do not want to enable market participants simply to label as “spot” foreign exchange transactions that regularly settle after the relevant foreign exchange spot market settlement deadline, or with respect to which the parties intentionally delay settlement, both of which would be properly categorized as foreign exchange forwards, or CEA section 2(c)(2) transactions (discussed separately

below), in order to avoid applicable foreign exchange regulatory requirements.” Swap Adopting Release at 48,257.33Id.34Id.35See id. at text accompanying n.567.36Swap Adopting Release at 48,257.37Id.38Securities are commodities for CEA purposes. See CEA §§ 1a(9) (defining the word “commodity” broadly enough to include securities); 1a(19)(i) (defining the term “excluded commodity” to include, among other things, securities and security indexes). But see, e.g., CEA §§ 2(a)(1)(A) (“[e]xcept as hereinabove provided, nothing contained in this section shall (I) supersede or limit the jurisdiction at any time conferred on the [SEC] . . . (II) restrict the [SEC] . . . from

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2. Relief from the Retail Forex Regime for Security Conversion Transactions

The CFTC provided additional certainty to securities conversion transactions by interpreting securities conversion transactions as “not leveraged, margined or financed within the meaning of [CEA] section 2(c)(2)(C)[,]” adding that:

[w]hile it is possible to view the fact that the buyer of a currency in such a transaction does not pay for the currency until it is delivered as leverage (in that the buyer puts nothing down until taking delivery, thus achieving 100% leverage) or a financing arrangement, the CFTC does not interpret it as such for purposes of CEA section 2(c)(2)(C).36

The CFTC added that, just because “Congress recognized that settlement of bona fide spot foreign exchange transactions typically takes two days . . . [and] expressly excluded these types of bona fide spot foreign exchange transactions does not mean that Congress intended to subject Security Conversion Transactions to regulation under the retail foreign

exchange regime[,]”37 pointing out that:

Congress recognized that settlement in various spot markets in commodities other than foreign exchange [e.g., the securities leg of a Security Conversion Transaction]38 can be longer than two days. See CEA section 2(c)(2)(D)(ii)(III)(aa) (disapplying the DCM-trading requirement for certain commodity transactions with non-ECPs when the contract “results in actual delivery within 28 days or such other longer period as the [CFTC] may determine by rule or regulation based on the typical commercial practice in cash or spot markets for the commodity involved”).”39

C. FXFs and FXSs

As alluded to above, Congress also provided for reduced swap regulation of 2 types of FX transactions settled by exchanging different currencies—FXFs40 and FXSs41 — by providing that such products would not be considered swaps if the Treasury Secretary determined that FXFs and FXSs should not be regulated as swaps,42 which, as noted above, he did in 2012.43 That treatment is in accord

with the historically lighter touch CEA regulation of FX products. However, in light of the financial crisis, Congress expressed a desire44 to provide a high bar to regulating FXFs and FXSs substantially less than other swaps.45

D. Spot and Forward-like FX Transactions vs. Retail Forex

CEA § 2(c)(2)(C)(i)(II) provides still another example of a deregulatory approach to FX. Rather than cover all FX transactions with retail counterparties under the retail forex regime, Congress provided that that regime would not apply to a leveraged, margined or financed “contract of sale that—(AA) results in actual delivery within 2 days; or (BB) creates an enforceable obligation to deliver between a seller and buyer that have the ability to deliver and accept delivery, respectively, in connection with their line of business.”46 This starkly contrasts with CEA § 2(c)(2)(D), which, subject to several important exceptions,47 renders it illegal to enter into, or offer to enter into, leveraged, margined or financed transactions in commodities other

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carrying out . . . [its] duties and responsibilities . . .”); 2(a)(1)(C)(i)(I) (“[e]xcept as provided in subclause (II), . . . [the CEA] shall not apply to and the [CFTC] shall have no jurisdiction to designate a board of trade as a contract market for any transaction whereby any party to such transaction acquires any put, call, or other option on one or more securities”). Other portions of CEA § 2 also circumscribe the CFTC’s jurisdiction with respect to securities-related derivatives.39Id. at n. 571.40An FXF is defined in CEA § 1a(24) as “a transaction that solely involves the exchange of 2 different currencies on a specific future date at a fixed rate agreed upon on the inception of the contract covering the exchange.” Interestingly, FXFs are not expressly defined as swaps, although FXSs are. See CEA § 1a(47)(A)(iii)(VIII) (enumerating an FXS as a swap). But see written statement by Sen. Blanche Lincoln, 156 Cong. Rec. S. 5920 (July 15, 2010) (stating “[o]ne

should note that foreign exchange forwards are treated as swaps under the CEA.”). Senator Lincoln’s statement referred to the general state of affairs under the CEA prior to the Treasury Secretary making a determination as to whether FXFs should be treated as swaps. See CEA § 1a(47)(E)(i).41An FXS is defined in CEA § 1a(25) as: a transaction that solely involves—(A) an exchange of 2 different currencies on a specific date at a fixed rate that is agreed upon on the inception of the contract covering the exchange; and(B) a reverse exchange of the 2 currencies described in subparagraph (A) at a later date and at a fixed rate that is agreed upon on the inception of the contract covering the exchange.42See CEA § 1a(47)(E)(i).43See Treasury Determination, supra note 26.

44See, e.g., written statement by Sen. Blanche Lincoln, 156 Cong. Rec. S. 5920 (July 15, 2010) (stating that “[t]hese provisions [that the Treasury Secretary must meet to conclude FXFs/FXSs should not be regulated as swaps] and this process related to exempting [FXSs] and [FXFs] from swaps regulation will be, and should be, difficult for the Secretary of the Treasury to meet.”). CEA § 1b(a) lists 5 issues that the Secretary of the Treasury had to consider when determining whether FXFs/FXSs should be regulated as swaps. CEA § 1b(b) further required the Treasury Secretary to explain to Congress why such products are not suited for swap regulation and why they should be exempt. 45See notes 22-25 supra and accompanying text for a discussion of the CEA provisions to which FXFs and FXSs remain subject.46CEA § 2(c)(2)(C)(i)(II)(bb).47The exceptions, including for transactions overlying securities, are

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than FX with persons who are neither ECPs nor eligible commercial entities (a more restrictive standard), other than on or subject to the rules of a DCM (“2(c)(2)(D) Transactions”).48

2 ( c ) ( 2 ) ( D ) Transactions are rendered illegal by virtue of § 2(c)(2)(D)(iii), which applies CEA § 4(a) to 2(c)(2)(D) Transactions as if they were futures.49

V. Non-Deliverable Forwards (“NDFs”)

The CFTC has categorized NDFs as swaps.50 As the Commissions explained in the Swap Adopting Release, NDFs are swaps pursuant to CEA § 1a(47)(A)(iii) because they “provide for a future (executory) payment based on an exchange rate, which is an ‘interest or other rate[ ]’ within the meaning of [CEA § 1a(47)](A)(iii).”51 The Commission

added that “[e]ach party to an NDF transfers to its counterparty the risk of the exchange rate moving against the counterparty, thus satisfying the requirement that there be a transfer

of financial risk associated with a future change in rate[, which] . . . transfer . . . is not accompanied by a transfer of an ownership interest in any asset or liability.”52 The Commissions also supported their determination that NDFs are swaps by citing the fact that “at least some market participants view NDFs as

swaps today, and thus NDFs also may fall within clause (A)(iv) of the swap definition as ‘an agreement, contract, or transaction that is, or in the future becomes, commonly

known to the trade as a swap’”53 and that the T r e a s u r y S e c r e t a r y a g r e e d — i n the notice of proposed determination that FXFs and FXSs should not be regulated as s w a p s — t h a t “his authority to issue a determination

‘is limited to foreign exchange swaps and forwards and does not extend to other foreign exchange derivatives’ and noted that ‘NDFs may not be exempted from the CEA’s definition of ‘swap’ because they do not satisfy the statutory definitions of a foreign exchange swap or forward.’”54

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listed in CEA § 2(c)(2)(D)(ii).48The term “eligible commercial entity” is defined in CEA § 1a(17).49CEA § 4(a) makes it illegal, unless exempted by the CFTC under CEA § 4(c) or exempted under CEA § 4(e) (certain transactions entered into on foreign boards of trade) to enter into a futures contract other than on or subject to the rules of a DCM.50See 17 C.F.R. 1.3(xxx)(2)(i)(F). See also Swap Adopting Release at 48,254-48,256.51Swap Adopting Release at 48,254-48,255.52Id. at 48,255.53Id. n.537.54Id. n.538. The Secretary reiterated those sentiments with respect to NDFs in Treasury’s final determination. See Treasury Determination at 69695.55See Swap Adopting Release at 48,255-48,256 (discussing and

rejecting commenters’ arguments).56See Petition for Exemptive Relief for Non-Deliverable Foreign Exchange Forwards (Feb. 26, 2013), available at https://www.aba .com/Advocacy/LetterstoCong ress/ Documents/2-26-13PetitionforExemptiveRelief.pdf. The petitioners were the Investment Company Institute, ICI Global, the American Bankers Association (“ABA”) and the ABA Securities Association.57See, e.g., Joe Parsons, CFTC eyes NDF clearing mandate, Futures and Options Week (Sept. 26, 2014) (noting that the CFTC was considering mandating clearing NDFs despite lingering cross-border and other issues), available at http://www.fow.com/3384467/CFTC-eyes-NDF-clearing-mandate.html. The Commission’s Global Markets Advisory Committee (“GMAC”) held a meeting to discuss NDF clearing on October 9, 2014. GMAC’s FX Markets Subcommittee subsequently provided GMAC a memorandum

essentially advocating a “go slow” approach. See Response to request for recommendation on an FX NDF mandate (Dec. 5, 2014) (recommending that “[s]hould the . . . Commission . . . decide to proceed with a clearing mandate for NDFs, such mandate should contain a clear timeline and method of implementation to ensure that market participants have appropriate opportunity to address the issues outlined in this paper.”), available at http://www.cftc.gov/ucm/groups/public/@aboutcftc/documents/f ile/gmac_fxndfmandate122214.pdf.58See ESMA Feedback Statement on the Consultation on the Clearing Obligation for Non-Deliverable Forwards (Feb. 4, 2015), available at http://www.esma.europa.eu/system/files/2015-esma-234_-_ feedback_statement_on_the_clearing _obligation_of _non_deliverable_ forward.pdf (stating “[b]ased on the feedback received to this consultation, ESMA is not proposing a clearing

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obligation on the NDF classes at this stage.”). 59See letter from the Coalition of Physical Energy Companies (“COPE”) dated July 22, 2011, available at http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=47917&SearchText=Coalition%20of%20Physical%20Energy%20Companies.60Swap Adopting Release at 48,240.61See U.S. Bank Web site at https://www.usbank.com/fxweb/help/basic_spot-forward.pdf.62See, e.g., California Bank & Trust Web site at https://www.calbanktrust.com/business-banking/international-banking/foreig n-exchange-services/window-forward-contracts .html (noting that “ it’s often challenging to determine exactly when a payment will take place. Production or shipment dates, the conclusion of legal matters, and invoice discounting all can impact when payments are released.”).

63CEA § 1a(19) (defining an FXF). Emphasis added.64See CEA § 1a(19) (stating that “[t]he term “excluded commodity” means—(i) an . . .exchange rate . . . [or] currency . . .”).65CEA § 1a(47)(B)(ii) (emphasis added).66Swap Adopting Release at 48,232. See also CEA § 1a(20) (defining an “exempt commodity” as “a commodity that is not an excluded commodity or an agricultural commodity”; CFTC regulation 1.3(zz) (defining “agricultural commodity”).67See Section 309 (Relief for End-Users Who Use Physical Contracts With Volumetric Optionality) of H.R. 2289 (the “Commodity End-User Relief Act”).68See Forward Contracts With Embedded Volumetric Optionality, 80 Fed. Reg. 28,239 (May 18, 2015).69See written statement by Sen. Blanche Lincoln, 156 Cong. Rec.

S. 5920 (July 15, 2010) (observing that “[t]he foreign exchange swaps and foreign exchange forward market is approximately $65 trillion and the second largest part of the swaps market.”).70But see CFTC Approves National Futures Association [(“NFA”)] Rules Enhancing Protections for Retail Forex Customers, CFTC Press Release PR7219-15 (Aug. 27, 2015), available at http://www.cftc.gov/PressRoom/PressReleases/pr7219-15 (noting that the NFA rule amendments and interpretive notice enhance protections for retail customers of NFA Forex Dealer Members (“FDMs”) by, among other things: (1) imposing additional capital requirements on FDMs; (2) requiring FDMs to collect security deposits from eligible contract participants for retail forex transactions; (3) requiring FDMs to adopt risk management programs; and (4) requiring FDMs to provide additional disclosure to assist potential

While commenters on the proposed further definition of swap rulemaking made several arguments why NDFs should be considered FXFs, the Commissions rejected all of them.55 Subsequently, several industry associations petitioned the CFTC for CEA § 4(c) relief to permit NDFs to be regulated as FXFs and FXSs.56 To date, the CFTC has not taken action on the petition. While the Commission was considering issuing a clearing determination for NDFs not long ago,57 ESMA thereafter decided to shelve such a requirement in Europe for the foreseeable future.58

VI. Delivery Timing with respect to Physically Settled Transactions

The CFTC said in the Swap Adopting Release, in response to a letter from a commenter59 that embedded optionality as to the timing of delivery would not cause a transaction that otherwise is a forward to be considered an option. More specifically, the CFTC stated that:

embedded optionality as to delivery

points and delivery dates will not cause a transaction that otherwise qualifies as a forward contract to be considered a swap. The CFTC emphasizes, however, that delivery must occur at some delivery point and on some date, or the lack of delivery must be due to the transaction being booked out or otherwise be consistent with the CFTC’s interpretation regarding the forward exclusions from the swap and future delivery definitions.60

VII. Window Forwards

An FX window forward (also called “window FX forward,” “window contract” and, in at least one case, “Forward option-dated transaction”61) is a contract that counterparties enter into to physically exchange two currencies at an price agreed upon upfront on one or more dates during an agreed time period (aka “window”). These contracts require exchanging physical currency on one or more dates within the window. FX window forwards are used when entities do not know the specific date on which they will need the currency (for example because they do not know when, within a certain

date range, a foreign supplier will ship a particular shipment).62 The optionality as to the delivery timing means that FX window forwards are not FXFs because they do not satisfy the “specific future date” element of the FXF definition (an FXF is “a transaction that solely involves the exchange of 2 different currencies on a specific future date at a fixed rate agreed upon on the inception of the contract covering the exchange.”).63

Were a window forward based on an exempt or agricultural commodity, then, based on the CFTC statement, cited above, that “embedded optionality as to . . . delivery dates will not cause a transaction that otherwise qualifies as a forward contract to be considered a swap[,]” FX window forwards likely would be within the forward exclusion from the swap definition. Both currency itself and exchange rates, however, are excluded commodities,64 which cannot be the basis of an agreement, contract or transaction that is within the forward exclusion from the swap definition. That is because the forward exclusion from the swap definition states that “[t]he term “swap” does not include . . . (ii) any

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counterparties in their FDM due diligence); Keynote Speech of CFTC Commissioner Sharon Y. Bowen before the Quadrilateral Meeting at the European Central Bank (Frankfurt, Germany) (June 24, 2015) (stating that “ it makes absolutely no sense to me that retail fx trading is the least regulated part of the over-the-counter swaps market . . . [because] [r]etail f[ore]x caters directly to retail investors unlike the bulk of the swaps market, which is traded by sophisticated financial and commercial institutions[]”), available at http://www.cftc.gov/PressRoom/SpeechesTestimony/opabowen-5. Commissioner Bowen contended that “[t]he time has come to comprehensively regulate this market[]” and [r]etail commodity trading should occur on regulated exchanges[.]” Id. Commissioner Bowen added that “I do not think these ideas require new legislation – instead, we can implement these proposals within our current

rulemaking authority.” Id. In that regard, note the authority provided to the CFTC in CEA §§ 2(c)(2)(B)(v) (granting the CFTC the authority to “make, promulgate, and enforce such rules and regulations as, in the judgment of the Commission, are reasonably necessary to effectuate any of the provisions of, or to accomplish any of the purposes of, this chapter in connection with agreements, contracts, or transactions described in clause (i) which are offered, or entered into, by a [futures commission merchant, an affiliated person thereof or a retail forex exchange dealer]” and 2(c)(2)(C)(iii)(III) (providing that “[t]he Commission may make, promulgate, and enforce such rules and regulations as, in the judgment of the Commission, are reasonably necessary to effectuate any of the provisions of, or to accomplish any of the purposes of, this chapter in connection with [leveraged, margined or financed retail forex]”). See also CEA

§ 8a(5) (granting the Commission the authority to “make and promulgate such rules and regulations as, in the judgment of the Commission, are reasonably necessary to effectuate any of the provisions or to accomplish any of the purposes of this chapter[.]”).71See, e.g., Working group to strengthen code of conduct standards and principles in foreign exchange markets has commenced work, July 24, 2015 BIS Press Release, available at https://www.bis.org/press/p150724.htm; Bank of England Codes of Best Market Practice and Shared Global Principles, available at http://www.bankofengland .co.uk/markets/Documents/forex/fxjsc/codes_best_ practice.pdf. See also Katie Martin, Banking Lobby Backs Stricter Codes of Conduct for Currency Traders, Wall Street Journal (Aug. 13, 2014), available at http://www.wsj.com/articles/banking-lobby-backs-stricter-codes-of-conduct-for-currency-traders-1407924653.

sale of a nonfinancial commodity . . . for deferred shipment or delivery, so long as the transaction is intended to be physically settled[,]”65 and the CFTC interpreted the term “nonfinancial commodity” to mean “a commodity that can be physically delivered and that is an exempt commodity or an agricultural commodity.”66

Given that (1) the optionality in window f o r w a r d s extends solely to the timing of delivery, unlike forwards with embedded v o l u m e t r i c o p t i o n a l i t y (where delivery may never occur) and (2) Congress appears focused on providing,67 and the CFTC has provided,68 relief for forwards with embedded volumetric optionality, it is interesting that FX window forwards and FXFs are treated so differently. It’s particularly interesting given that Congress was

comfortable, subject to a number of conditions, largely excluding FXFs/FXSs (which constituted a large percentage of the swaps market) from swap regulation, as discussed above.69 H.R. 2289, which passed the House 246-171 on June 9, 2015, doesn’t include a provision changing

the status of FX window forwards as swaps.

Conclusion

FX is one of the most nuanced and dynamic areas of CFTC regulation. FX regulation under the CEA has evolved quite a bit over the years from

the Treasury Amendment’s “hands off ” approach (punctuated by Dunn v. CFTC) to the establishment of the “futures-lite” retail forex regime to the more recent “swaps-lite” FXF/FXS regime70 and the comprehensive regulation of other FX swaps under Dodd-Frank. Given the widespread

manipulation of exchange rates in recent years, which, among other things had a hand (as did LIBOR ma n ipu lat ion) in prompting Europe to propose to r e g u l a t e b e n c h m a r k providers, it would seem that,

notwithstanding its freewheeling past, FX products in general are heading for more regulation (and self-regulation).71

David AronCounsel, Division of Market

OversightCFTC