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May 2017 ▪ Volume 37 ▪ Issue 5 REPORT

REGULATION OF U.S. Notwithstanding the broad reach of the current U.S. regulatory regime governing CURRENCY foreign exchange, there are still issues that TRANSACTIONS are open to interpretation. For example, language in regulatory releases suggests By David Aron, P. Georgia Bullitt and Jed Doench that there is uncertainty about whether a physically-settled currency contract4 David Aron is Special Counsel in the Division of Market Oversight (“DMO”) could be recharacterized as a swap if it is at the Commodity Futures Trading Com- settled through an offsetting physically- mission (“CFTC”). P. Georgia Bullitt is settled contract rather than an exchange of a partner, and Jed Doench is an associ- the designated currencies. Such a charac- ate, in the Asset Management Group of Willkie Farr & Gallagher LLP.* terization would result in substantially dif- ferent regulatory and operational treat- Introduction ment, including with respect to mandatory Currency transactions, which prior to clearing, margin, trade execution on a the market disruption of 2008 were among designated contract market (“DCM”) or the least regulated transactions in the U.S. swap execution facility (“SEF”) and re- financial markets, are now highly regu- porting requirements.5 There is also uncer- lated and are subject to one of the most tainty with respect to the applicability and complex regulatory regimes. The Dodd- scope of margin requirements as a result Frank Wall Street Transparency and Ac- of a supervisory policy issued by the countability Act of 2010 (“Dodd-Frank”)1 Board of Governors of the Federal Re- made substantial changes to the Commod- serve System (“Federal Reserve”) that ity Exchange Act (“CEA”) relating to cur- suggests that banking institutions under rency trading, some of which are still be- the supervision of the Federal Reserve,

The Journal on the Law of Investment & Risk Management Products ing implemented and defined. The current which includes the largest foreign ex- regulatory architecture imposes different change dealers, may be expected to post requirements on currency transactions and collect variation margin in connection depending upon factors including: the with OTC physically-settled foreign ex- type of product being traded; whether the change derivatives, even though such transaction is physically or cash-settled; products are otherwise excepted from the the type of person trading the product (i.e., margin requirements under Dodd-Frank whether institutional or retail investors are as a result of the determination made by the counterparties);2 and whether the in- the U.S. Department of the Treasury (the strument is traded on a securities or futures “Treasury”).6 There also continue to be ar- exchange or in the over-the-counter eas of uncertainty in the retail context. For Futures & Derivatives Law (“OTC”) market.3 example, under the current guidance, it is May 2017 | Volume 37 | Issue 5 Futures and Derivatives Law Report

not clear how an OTC transaction with a retail into with persons who are not ECPs and that are investor should be treated at unwind if that inves- regulated pursuant to CEA Sections 2(c)(2)(B), tor has, since the trade commenced, attained (C) and (E), which we refer to as “Retail Forex.”10 institutional status by qualifying as an ECP. We We do not discuss regulation of (i) currency op- discuss each of the issues in greater detail in Sec- tions traded on regulated securities exchanges,11 tion III of this article. which are regulated by the SEC and margined, traded, cleared and settled in substantially the Most foreign exchange and currency transac- same way as U.S. listed securities options,12 or tions (“Currency Transactions”) conducted in the U.S. market are subject to the CEA and the rules (ii) currency futures and options on currency of the CFTC and the National Futures Associa- futures, which are regulated, margined, traded, tion (“NFA”). Other financial regulators, such as cleared and settled in substantially the same way the federal banking regulators and the SEC, also as other U.S. financial futures contracts and op- play a significant role. This article provides an tions thereon. overview of the history of the regulation of Cur- I. History of Foreign Exchange rency Transactions in the United States, includ- and Currency Regulation ing the patterns of bad conduct and aberrations in that market that have led to the increase in The regulation of Currency Transactions has regulation. We summarize below the existing evolved significantly over time as Congress, the regulatory framework and focus on the regula- CFTC, NFA and other regulators have attempted tion of both retail and institutional OTC Currency to curb various forms of misconduct and respond Transactions by the CFTC. In terms of the scope to market disruptions, while still preserving the of Currency Transactions discussed in this article, liquidity and robustness of the market. The most we consider: (i) swaps and options on foreign comprehensive change to the regulation of Cur- exchange, including non-deliverable forwards rency Transactions came in 2010 with the adop- (“NDFs”), which are primarily traded in the OTC tion of Dodd-Frank. Under Dodd-Frank, Con- market between ECPs but which Dodd-Frank gress enacted a new regulatory framework for contemplates migrating to trading on a DCM or institutional OTC Currency Transactions (among SEF and being subject to central clearing through other products) entered into between ECPs. This a derivatives clearing organization (“DCO”) if framework distinguishes between cash-settled the transactions become sufficiently commod- and physically-settled Currency Transactions and itized; (ii) physically-settled currency forwards contemplates that physically-settled Currency defined as “foreign exchange forwards” under the Transactions may be eligible for exemption from CEA7 (“Currency Forwards”) and physically- many of the regulatory requirements applicable settled foreign exchange swaps defined as “for- to cash-settled Currency Transactions that are eign exchange swaps” under the CEA fully regulated as “swaps.” Dodd-Frank also (“Physically-Settled FX Swaps”)8 traded be- enhanced regulation of Retail Forex by requiring tween ECPs; (iii) spot transactions that result in those regulators that oversee entities conducting an exchange of currencies within two days;9 and Retail Forex to adopt substantive regulations ap- (iv) off-exchange Currency Transactions entered plicable to such entities addressing disclosures,

2 K 2017 Thomson Reuters Futures and Derivatives Law Report May 2017 | Volume 37 | Issue 5 recordkeeping, capital and margin, reporting, eign currency transactions in the Treasury business conduct, documentation and other re- Amendment broadly and significantly limited the quirements deemed to be necessary by such CFTC’s jurisdiction over OTC Currency regulators.13 Transactions. The debate around the scope of the Treasury Amendment culminated in a U.S. Su- A. Regulation Prior to Dodd-Frank preme Court decision in Dunn v. CFTC in 1997.20 Federal regulation of Currency Transactions In that case, the U.S. Supreme Court held that dates back to the passage of the Commodity OTC foreign currency options were among the Futures Trading Commission Act of 1974, which products excluded from CFTC jurisdiction by the created the CFTC. When the bill was being Treasury Amendment, noting that “[t]he legisla- considered, the Treasury expressed concerns that tive history strongly suggests ... that Congress’ the CFTC’s jurisdiction as proposed in the bill broad purpose in enacting the Treasury Amend- would overreach and capture the OTC foreign ment was to provide a general exemption from currency market, which was characterized by CFTC regulation for sophisticated off exchange foreign currency trading, which had previously trading between banks and large institutional developed entirely free from supervision under customers and viewed by the Treasury as being the commodities laws.”21 In an even more sweep- more properly regulated by federal banking ing decision, the U.S. Court of Appeals for the regulators.14 The bill was amended to include Ninth Circuit held that the Treasury Amendment language proposed by the Treasury (the “Trea- precluded the CFTC’s jurisdiction over OTC sury Amendment”)15 that excluded from regula- Currency Transactions because the Treasury tion under the CEA specified transactions involv- Amendment was intended to apply to all OTC ing foreign currency, which were not transactions Currency Transactions.22 These judicially- “for future delivery conducted on a board of imposed restrictions on the CFTC’s jurisdiction trade.” The CFTC generally interpreted the Trea- impeded the ability of the CFTC to bring enforce- sury Amendment narrowly to exclude from ment actions against foreign exchange “bucket CFTC oversight only those Currency Transac- shops,” a proliferating group of foreign exchange tions conducted in the OTC market between dealers that targeted retail investors with fraudu- banks and other institutional market lent practices. This situation prompted calls for participants.16 In the years that followed, the Congress to rethink the Treasury Amendment to CFTC bolstered its jurisdiction over retail Cur- provide necessary protections to retail investors.23 rency Transactions in various interpretive ac- tions,17 while still recognizing the limits of its In 2000, Congress stepped forward to provide jurisdiction over Currency Transactions in the the CFTC with clearer jurisdiction over Retail institutional OTC market.18 The scope of the Forex, while also clarifying that OTC institu- Treasury Amendment was subject to substantial tional transactions remained outside the scope of litigation between 1974 and 2000. Although CFTC regulation. The Commodity Futures Mod- courts upheld the CFTC’s jurisdiction over OTC ernization Act of 2000 (the “CFMA”)24 required Currency Transactions in many cases,19 several Retail Forex trades to be conducted through key decisions interpreted the exclusion for for- otherwise regulated entities, including futures

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commission merchants (“FCMs”), affiliated The CFTC’s ability to regulate Retail Forex persons of FCMs satisfying specified recordkeep- was further limited by court decisions that con- ing requirements, registered broker-dealers, in- strued the scope of the CFTC’s jurisdiction surance companies and banking institutions.25 narrowly. Notably, in CFTC v. Zelener,33 the U.S. OTC Currency Transactions between institutional Court of Appeals for the Seventh Circuit consid- traders qualifying as ECPs,26 on the other hand, ered the applicability of the CEA to foreign were largely exempted from CFTC jurisdiction exchange contracts with retail customers that by the CFMA.27 were documented as “spot” contracts but that were, in practice, rolled on a continuous basis. The period after the adoption of the CFMA The market referred to these transactions as “roll- was marked by an increasing number of regula- ing spot.” In Zelener, Judge Easterbrook, writing tory enforcement actions involving fraudulent on behalf of the court, interpreted the provision conduct in the Retail Forex market. As of 2005, in Section 2(c) of the CEA related to Retail Forex the CFTC had brought over 70 cases involving in a limited manner. The court held that the allegations of misconduct in the Retail Forex CFTC’s jurisdiction over Retail Forex under Sec- market and had imposed over $240 million in tion 2(c) was limited to fungible futures con- 28 penalties and claims for restitution. The NFA, 34 tracts and that, although rolling spot transac- which had adopted rules in 2003 applicable to tions provided investors with economic exposure NFA members who engaged in Retail Forex that was similar to the exposure provided by transactions29 (often firms that had registered as futures contracts, the transactions were not fu- FCMs solely for the purpose of engaging in tures contracts, primarily because they were non- Retail Forex),30 also brought a number of enforce- standardized and did not provide the customer ment actions against Retail Forex dealers alleg- with a right to execute an offsetting contract.35 As ing fraudulent conduct.31 The ability of the CFTC a result, the court held that the CFTC’s jurisdic- and NFA to combat fraud in the Retail Forex mar- tion over Retail Forex did not include rolling spot ket, however, was limited by several aspects of transactions.36 the CFMA. The CFMA did not provide the CFTC with rulemaking authority with respect to Retail Congress addressed the Zelener decision in Forex, and the CFTC had not exercised its gen- 2008 with adoption of the Commodity Futures eral rulemaking authority under Section 8a(5) of Trading Commission Reauthorization Act the CEA in this area. Further, because the entities (“CRA”).37 The CRA provided the CFTC with that were permitted to engage in Retail Forex express authority to regulate entities that engage transactions included affiliated persons of in rolling spot transactions with non-ECPs. In ad- FCMs,32 many firms formed “shell FCMs” that dition, the CRA expanded CFTC jurisdiction registered as FCMs but engaged in Retail Forex over Retail Forex transactions by (i) subjecting activities through unregistered affiliates. As a FCM affiliates to CFTC jurisdiction and requir- practical matter, these entities were difficult to ing them to register as retail foreign exchange police because they were not subject to a compre- dealers (“RFEDs”)38 if they did not fall within hensive set of rules governing the Retail Forex any other regulated entity type listed in CEA Sec- business. tion 2(c)(2)(B) and (ii) giving the CFTC jurisdic-

4 K 2017 Thomson Reuters Futures and Derivatives Law Report May 2017 | Volume 37 | Issue 5 tion over foreign exchange contracts offered on a In the Retail Forex context, Dodd-Frank leveraged or margined basis, regardless of amended the CEA to provide that the group of whether the contracts are traded on an exchange entities permitted to engage in Retail Forex or considered to be a futures contract.39 The CRA transactions could do so only pursuant to rules continued to exclude from CFTC jurisdiction adopted by their federal regulators.44 As a result, bona fide spot contracts that result in an exchange the statute conditioned the ability of an entity to of currencies within two days.40 carry out a Retail Forex business on the adoption of comprehensive regulations by its federal B. Dodd-Frank regulator(s), many of which had had no experi- In 2010, following the broader financial crisis ence regulating Retail Forex. Dodd-Frank also of 2008, Dodd-Frank was enacted. Title VII of made changes to the ECP definition related to Dodd-Frank41 implemented sweeping changes to Retail Forex, as described below. the regulation of derivatives by eliminating the broad exemptions for institutional derivatives C. Other Recent Developments created by the CFMA. The new legislation en- Since the adoption of Dodd-Frank, enforce- acted, for the first time, a comprehensive regula- ment actions and market events have continued tory framework for OTC derivatives, including to shape the regulatory environment in both the Currency Transactions. Although the institutional retail and institutional markets. In November provisions of Title VII of Dodd-Frank were 2014, the CFTC settled charges against five large motivated primarily by concerns regarding sys- banks for attempted manipulation of global temic risk caused by OTC derivatives,42 Title VII foreign exchange benchmark rates. The CFTC included provisions that specifically addressed found that foreign exchange traders at the five Currency Transactions. In the institutional for- banks colluded with traders at other banks via eign exchange market, the regulatory regime set out in Dodd-Frank distinguishes between cash- private chat rooms to alter trading positions with settled and physically-settled Currency the aim and result of setting benchmark rates in a 45 Transactions. The regulations define the institu- way that benefited the traders. In the chat tional market for Currency Transactions as com- rooms, the currency traders allegedly shared prised of transactions between ECPs. Cash- confidential information regarding client orders, settled transactions between ECPs were classified which provided the traders with a more compre- as “swaps” and made subject to all of the atten- hensive view of order flows, and then allegedly dant regulatory requirements. Physically-settled colluded to alter their own currency trading posi- transactions (i.e., Currency Forwards and tions prior to executing client orders in order to Physically-Settled FX Swaps) were made eligible drive the benchmark price up or down at or for an exclusion from full regulation as swaps, around the time of the daily “fix.”46 The CFTC which exclusion was subsequently implemented imposed an aggregate civil penalty of over $1.4 by the Treasury.43 Dodd-Frank enhanced the billion on the banks whose traders were found to CFTC’s anti-fraud and anti-manipulation author- be complicit in the wrongdoing and stressed the ity over Currency Transactions and derivatives culpability of the banks themselves, finding that generally. they had failed to implement internal controls and

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procedures regarding training and oversight of tions to such clients. Plaintiffs alleged that State the foreign exchange traders. Another group of Street traders would execute a transaction for a banks pleaded guilty in May 2015 to felony client at the actual market exchange rate and then violations of U.S. antitrust laws for similar later mark the rate up or down to benefit the manipulative behavior affecting foreign currency bank.50 According to the complaints, the monthly exchange rates.47 reports provided to custodial clients by State Street detailed only the marked-up or marked- Currency Transactions were also a focal point down exchange rates entered by State Street’s for pension funds and institutional investors as a electronic system and not the more favorable result of fiduciary breach allegations against ma- rates achieved at the time of the transaction.51 As jor custodial banks. In the spring of 2015, the part of the settlement, State Street was ordered to Bank of New York Mellon (“BNYM”) agreed to distribute price reports to customers regarding settle civil lawsuits and federal investigations in spot conversions. connection with allegations that the bank had engaged in fraudulent foreign exchange trading The Retail Forex market experienced a major practices.48 According to the allegations, BNYM shock in January 2015 when the Swiss National misled institutional customers participating in Bank ended its policy of capping the Swiss franc BNYM’s “Standing Instruction Program,” which at 1.20 francs per Euro. The change in policy provided a conversion service in connection with caused the price of the Swiss franc to increase 52 the purchase or sale of foreign securities, by almost 30% in value against the Euro and representing to customers that they would resulted in significant losses to market participants.53 These events caused NFA to achieve execution at the “best rates,” in accor- tighten margin requirements for Retail Forex dance with “best execution standards,” when in transactions involving specified foreign curren- reality execution was provided at the highest cies54 and prompted calls for the CFTC to con- reported interbank rate of the day (for clients sider increased requirements for Retail Forex.55 purchasing foreign currency) or at the lowest The CFTC ultimately approved rule amendments reported interbank rate of the day (for clients sell- that (i) increased capital requirements for Retail ing foreign currency). BNYM’s practices were Forex dealers registered as Forex Dealer Mem- also alleged to be materially misleading because bers (“FDMs”),56 (ii) required FDMs to collect statements provided to customers did not disclose security deposits for off-exchange foreign ex- how the prices obtained were determined. BNYM change transactions from ECP counterparties in settled the actions for $714 million. addition to retail counterparties, (iii) required Similar actions were brought against State FDMs to adopt and implement rigorous risk Street Bank and Trust Company (“State Street”) management programs, and (iv) required FDMs in connection with currency conversion services, to provide additional market disclosures and which State Street settled.49 State Street was al- firm-specific information on their websites to leged to have misled custodial clients by provid- permit current and potential counterparties to bet- ing them with conversions at a spread from the ter assess the risks of engaging in off-exchange prevailing interbank rates, contrary to representa- FX transactions and conducting business with a

6 K 2017 Thomson Reuters Futures and Derivatives Law Report May 2017 | Volume 37 | Issue 5 particular FDM.57 NFA has continued to respond $7 million and were permanently barred from to volatility in the foreign exchange markets by acting in any capacity requiring registration with changing its minimum security deposit require- the CFTC or exemption from registration or as- ments for affected currencies.58 sociating with any firm registered with the CFTC or exempt from registration with the CFTC. In February 2017, the CFTC brought an en- forcement action against Forex Capital Markets, The CFTC, other regulators and prosecutors LLC (“FXCM”), a registered FCM and RFED continue to bring actions against participants in that was previously the largest Retail Forex bro- both the retail and institutional markets.61 ker in the United States,59 and two of its principals for alleged fraudulent conduct in connection with The Bank for International Settlement (“BIS”), FXCM’s Retail Forex platform.60 The CFTC’s an organization of 60 central banks, is in the pro- settlement order alleged that FXCM had repre- cess of finalizing a Global Code of Conduct for sented to customers that it executed customer the foreign exchange market that is intended to trades through its “No Dealing Desk” on strictly promote integrity and effective functioning of the foreign exchange market. BIS published an initial an agency or riskless principal basis through draft of the Global Code of Conduct in 2016 that external market makers, thus eliminating the set forth standards regarding ethics, governance, conflict of interest resulting from FXCM taking a information sharing, execution, risk management principal position opposite its customers. Accord- ing to the settlement order, however, a significant and compliance and confirmation and settlement number of customer trades were actually exe- processes. The Global Code of Conduct will be a cuted through a related high frequency trading voluntary code and will not have the force of firm (“HFT Co”) that had been founded by regulation, but BIS and the working group re- FXCM. Although HFT Co had been spun off by sponsible for the Code are working to promote FXCM and was owned by a former FXCM em- widespread adoption of the Code, including ployee rather than FXCM during the period in among buyside firms, sellside firms and other 62 question, FXCM and HFT Co maintained a num- foreign exchange market participants. Although ber of significant ongoing ties, including sharing BIS is expected to finalize the Global Code of employees. FXCM also provided HFT Co with Conduct in May 2017, it remains to be seen how priority order routing, and HFT Co made order quickly and broadly the Code will be adopted. flow payments to FXCM that were found to be II. Current State of the Regulation profit-sharing payments related to HFT Co’s exe- of OTC Currency Transactions cution of trades in respect to FXCM’s customers. The CFTC alleged that FXCM misled customers A. Currency Transactions as well as NFA examination staff about this rela- Regulated as Swaps tionship with HFT Co. The CFTC found that Dodd-Frank established a comprehensive FXCM violated Section 4b(a)(2) of the CEA and regulatory regime for those derivatives that fall CFTC Rule 5.2(b) and that both FXCM and the within the definition of “swap” under Section two principals violated Section 9(a)(4) of the 1a(47) of the CEA. The definition of “swap” is CEA. FXCM and the two principals were fined broad and includes most OTC Currency Transac-

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tions other than spot transactions. The following changed in different currencies.68 Currency Currency Transactions would be included in the swaps are expressly included within the definition when executed between ECPs: statutory swap definition.69

E NDFs. An NDF is a forward contract in E Window forwards. A foreign exchange foreign exchange63 that is settled through a window forward (also called “window FX net payment of a single currency at matu- forward,” or “window contract”) is a con- rity (in contrast to a Currency Forward, tract that counterparties enter into to physi- which is settled through an exchange of two cally exchange two currencies at a price currencies at maturity).64 The CFTC and agreed upon upfront on one or more dates SEC (which share rulemaking authority during an agreed time period (“window”). over the swap definition) have classified These contracts involve the exchange of NDFs as swaps.65 Several industry associa- currency on one or more dates within the 70 tions petitioned the CFTC to provide relief window. The optionality as to the timing under CEA Section 4(c) to permit NDFs to of the delivery of the currency means that be regulated as Currency Forwards66 argu- foreign exchange window forwards gener- ing that they are economically equivalent ally do not constitute “foreign exchange to Currency Forwards and are often used forwards” under the CEA (defined as “Cur- 71 by market participants for transactions rency Forwards” in this article), which are 72 involving currencies that are restricted from exempt from the swap definition. delivery. To date, the CFTC has not re- Currency Transactions that fall within the sponded to the petition. swap definition (“Currency Swap Transactions”) E Foreign Currency Options. The swap defi- are subject to the full range of transactional nition includes any agreement, contract, or requirements applicable to swaps, if no exclusion transaction that “is a put, call, cap, floor, or exemption is available, including: (i) manda- 73 collar, or similar option of any kind that is tory clearing (if designated for clearing), (ii) for the purchase or sale, or based on the mandatory execution on a SEF or DCM (if desig- value of, 1 or more . . . currencies.” Thus, nated for clearing and made available for trading 74 foreign currency options (but not foreign on a SEF or DCM), (iii) reporting, including currency options traded on a securities public real-time reporting, of swaps to swap data 75 exchange), fall within the swap definition repositories (“SDRs”), (iv) margin require- 76 and have been interpreted by the CFTC and ments for uncleared swaps, (v) business conduct 77 67 standards and swap trading documentation re- SEC to constitute “swaps.” quirements78 for swap dealers and major swap E Currency Swaps and Cross-Currency participants,79 and (vi) recordkeeping Swaps. Currency swaps and cross-currency requirements.80 Counterparties that are not ECPs swaps can generally be described as swaps are prohibited from entering into Currency Swap in which the fixed legs or floating legs Transactions,81 unless those transactions are based on various interest rates are ex- entered into on or subject to the rules of a DCM

8 K 2017 Thomson Reuters Futures and Derivatives Law Report May 2017 | Volume 37 | Issue 5 or can be executed in accordance with the Retail ments are being phased in. Initial margin require- Forex rules. ments for swaps between registered swap dealers and financial end users whose swap exposures From an operational and cost perspective, the exceed applicable thresholds are being phased in most significant requirements imposed by Dodd- from September 2016 through September 1, Frank are the clearing, trade execution, and 2020. Variation margin requirements for swaps margin requirements. While the CFTC has imple- between registered swap dealers and financial mented clearing requirements for a number of end users went into effect on March 1, 2017.88 interest rate swaps and index credit default swaps, The CFTC issued limited relief from compliance no foreign exchange or currency products are with these variation margin requirements until currently subject to mandatory clearing or to the September 1, 2017, subject to a swap dealer us- trading requirement. The CFTC staff has, as ing best efforts to implement compliance and recently as October 2014, considered issuing a other conditions.89 Separately, the applicable clearing determination applicable to NDFs.82 federal prudential regulators provided guidance However, the CFTC has not yet taken action on indicating that swap dealers subject to their such a proposal.83 supervision must comply with the variation margin requirements as of March 1, 2017 for Notwithstanding the lack of a regulatory man- counterparties that present significant exposures date, market participants have been voluntarily and, with respect to other counterparties, must 84 clearing some currency products. Some of the undertake good faith efforts to comply with the contracts are also voluntarily traded on SEFs or requirements as soon as possible, and in no case DCMs.85 Market participants that trade on a later than September 1, 2017.90 DCM or SEF on a voluntary basis are subject to the rules and jurisdiction of the applicable DCM The business conduct standards and swap trad- or SEF. ing documentation rules under Dodd-Frank ap- ply only to swap dealers. However, these rules Swap dealers that enter into uncleared Cur- indirectly affect other market participants that rency Swap Transactions are subject to the un- trade Currency Swap Transactions, as swap deal- cleared swap margin rules adopted by the CFTC ers generally require their counterparties to enter or federal prudential regulators, as applicable. into agreements and protocols, such as the Dodd- The margin regulations require swap dealers to Frank protocols published by the International post and collect margin for swaps with financial Swaps and Derivatives Association (“ISDA”), in end users, such as funds, although swap dealers order to facilitate compliance by the dealers with are generally not required to post or collect varia- the rules. The swap trading documentation rules tion margin for swaps with non-financial end us- require swap dealers that enter into Currency ers86 or entities eligible for an exception from Swap Transactions to document such transactions clearing.87 As a result, financial end users that under written relationship documentation, such trade with such swap dealers are also generally as the ISDA Master Agreement, that meet the required to post and collect margin on their Cur- requirements of those rules.91 Prior to Dodd- rency Swap Transactions. These margin require- Frank, many Currency Transactions were not

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documented under master relationship Master Agreements and the ISDA Dodd-Frank documentation.92 protocols. A significant benefit to trading Cur- rency Forwards and Physically-Settled FX B. Currency Forwards and Swaps, however, is that these transactions were Physically-Settled FX Swaps exempted, through the Treasury Determina- The swap definition includes an exclusion for tion,100 from the margin requirements for swaps Currency Forwards and Physically-Settled FX adopted by the CFTC and prudential Swaps from a number of the regulatory require- regulators.101 A supervisory letter issued by the 93 ments for swaps that was implemented by the Federal Reserve in 2013, however, could be 94 Treasury Determination in 2012. As a result, interpreted multiple ways, which creates ambi- Currency Forwards, which involve the exchange guity regarding applicability of the margin of currencies on a specific future date at an agreed requirements.102 The letter suggests that banks 95 rate, and Physically-Settled FX Swaps, which subject to the Federal Reserve’s jurisdiction involve an exchange of two different currencies should collect and post variation margin on on a specific date, at a fixed rate and a reverse physically-settled foreign exchange transactions exchange of the two currencies at a later date at a with “financial institution” counterparties. The fixed rate, are not subject to the clearing, trading term “financial institution,” however, is not and margin requirements otherwise applicable to specifically defined in the letter. As a result, the swaps under Dodd-Frank. Currency Forwards application of the guidance remains unclear. and Physically-Settled FX Swaps are, however, subject to (i) the business conduct standards96 and C. Investment Funds swap trading documentation rules97 for swap The ECP definition, as amended by Dodd- dealers and major swap participants, (ii) the SDR Frank, provides that a commodity pool that enters reporting requirements (but not the real-time into OTC Currency Transactions described in the reporting requirements),98 and (iii) with respect Retail Forex rules103 (an “FX Pool”) is not an to Currency Forwards and Physically-Settled FX ECP for the purposes of such transactions if the Swaps listed and traded on or subject to the rules FX Pool has one or more investors that are not of a DCM or SEF, or cleared by a DCO, those ECPs.104 This look-through requirement could provisions of the CEA and Dodd-Frank prohibit- have had the disruptive effect of subjecting many ing fraud or manipulation.99 investment funds, which generally do not screen Because Currency Forwards and Physically- investors for ECP status, to the Retail Forex Settled FX Swaps are subject to the business rules.105 However, the CFTC adopted a safe conduct standards, swap trading documentation harbor from the look-through requirement that rules, and most of the reporting requirements for has provided important relief to the currency swaps, market participants that trade Currency markets. The safe harbor exempts from the look- Forwards and Physically-Settled FX Swaps with through requirement an FX Pool that (i) was not registered swap dealers are required to complete formed for the purpose of evading the Retail the same documentation that is required for mar- Forex requirements under the CEA or any related ket participants trading swaps, including ISDA CFTC rules, regulations or orders, (ii) has total

10 K 2017 Thomson Reuters Futures and Derivatives Law Report May 2017 | Volume 37 | Issue 5 assets exceeding $10 million and (iii) was formed permitted counterparty with a person that is not and is operated by a registered commodity pool an ECP and that is (i) a contract of sale of a com- operator (“CPO”) or by a CPO that is exempt modity for future delivery (or an option on such from registration under CFTC Rule 4.13(a)(3).106 contract) or an option that is not executed or The CFTC also indicated that the look-through traded on a securities exchange,114 or (ii) offered rule does not apply to investors that are them- on a leveraged, margined or financed basis.115 selves investment funds.107 Retail Forex transactions exclude (i) spot transac- tions that result in actual delivery within two D. Spot Transactions days,116 (ii) forward-like contracts that create an The CFTC has indicated that a bona fide spot enforceable obligation to make or take delivery,117 transaction that is settled through delivery of the (iii) options that are executed or traded on a secu- relevant currencies within two business days is rities exchange,118 and (iv) securities conversion not a swap or Currency Forward.108 A Currency transactions.119 Transaction with a longer settlement period The CEA provides that only registered FCMs concluding with the actual delivery of the rele- and RFEDs, registered broker-dealers, and bank- vant currencies may also be considered a bona ing entities are permitted to engage in Retail fide spot transaction if it is settled on the custom- Forex transactions, and they may only do so pur- ary timeline of the relevant spot market.109 The suant to rules adopted by their applicable federal CFTC and SEC have stated that they will con- regulator.120 The CFTC has adopted Retail Forex sider securities conversion transactions110 to be rules that apply to registered FCMs (but not bona fide spot transactions,111 which are gener- FCMs that are dually registered as broker- ally exempt from regulation.112 Although the dealers) and RFEDs,121 and the FDIC,122 OCC,123 CFTC does not have substantive regulatory juris- and the Federal Reserve124 have adopted Retail diction over spot transactions, the CFTC has anti- Forex rules that apply to banking entities. Nota- manipulation authority that would be applicable bly, the SEC had adopted interim rules that to spot transactions because it covers the manipu- permitted registered broker-dealers to engage in lation of “any commodity in interstate Retail Forex transactions,125 but the SEC allowed commerce.”113 The cases against the custodial those rules to expire as of July 31, 2016,126 after banks regarding their spot mark-up practices previously expressing concerns about the risks should also serve as a warning that, although spot associated with Retail Forex.127 As a result, Retail transactions are not subject to direct substantive Forex may not be offered through broker-dealers regulations, they do not fall outside of regulation (including broker-dealers dually registered as for fraud. FCMs).

E. Retail Forex The Retail Forex rules adopted by the CFTC Retail Forex transactions are defined under the and banking regulators are not identical, but both CEA and regulators’ Retail Forex rules to consist sets of regulations establish requirements regard- of any account, agreement, contract or transac- ing disclosure,128 margin,129 statements and tion in foreign currency that is entered into by a confirmations.130 The regulations also include

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anti-fraud provisions.131 FCMs and RFEDs that on or subject to the rules of a registered entity (a enter into Retail Forex transactions are regulated SEF or DCM) that violates bids or offers, inten- by NFA as FDMs and are subject to NFA’s Retail tionally or recklessly disregards orderly execu- Forex rules.132 tion of transactions during the closing period, or would be considered “spoofing” (bidding or of- F. Anti-Fraud and Anti-Manipulation fering with an intent to cancel prior to While the substantive regulation of Currency execution).136 Section 4c(a)(7) makes it unlawful Transactions differs depending upon the product, for any person to knowingly or recklessly enter the CFTC’s anti-fraud and anti-manipulation into a swap where such person’s counterparty authority under the CEA generally applies will use the swap to defraud a third party.137 Sec- broadly across products regulated by the CFTC, tion 9(a)(2) of the CEA provides that any manipu- including futures contracts, swaps and Retail lation or attempted manipulation of the price of Forex transactions. The CFTC’s anti-fraud and any swap or any commodity in interstate com- anti-manipulation authority also potentially merce, or for future delivery on or subject to the extends to products that otherwise do not fall rules of any registered entity, is a felony punish- within the CFTC’s rulemaking authority, includ- able by up to $1,000,000 in fines and/or ten years ing potentially to Currency Transactions that are imprisonment, along with the costs of not substantively regulated, such as spot prosecution.138 transactions. Section 753 of Dodd-Frank further expanded The CEA contains a number of anti-fraud and the CFTC’s anti-fraud and anti-manipulation anti-manipulation provisions that may be applied authority by amending Section 6(c) of the CEA. to Currency Transactions. Section 4b of the CEA New CEA Section 6(c)(1) and CFTC Rule 180.1 is a broad anti-fraud provision that makes it (which was adopted pursuant to Section unlawful for a party to a futures contract or swap 6(c)(1))139 prohibits various forms of fraudulent to cheat or defraud, make false reports or state- and manipulative conduct and, significantly, ap- ments to, or willfully deceive, such person’s plies to conduct that is merely “reckless,” which counterparty (or attempt any of the foregoing).133 is lower than the scienter standard under Section Section 2(c)(2)(C)(iv) of the CEA extends this 9(a)(2).140 Section 6(c)(1) and Rule 180.1 also anti-fraud authority under Section 4b to lever- have a broad reach to “all manipulative or decep- aged Retail Forex transactions (including rolling tive conduct in connection with the purchase, spot transactions), regardless of whether they sale, solicitation, execution, pendency, or termi- qualify as futures contracts.134 Section 4c of the nation of any swap, or contract of sale of any CEA proscribes various forms of fraudulent and commodity in interstate commerce, or for future manipulative activity. Section 4c(a)(2) applies to delivery on or subject to the rules of any regis- any futures contract (or option on a futures tered entity.”141 New Section 6(c)(3) of the CEA contract) or swap and prohibits wash sales, ficti- and CFTC Rule 180.2 (which was adopted pur- tious sales and transactions resulting in false suant to Section 6(c)(3)) prohibit the manipula- price reporting.135 Section 4c(a)(5) prevents any tion, or attempted manipulation, of the price of person from engaging in trading or other conduct any swap, or contract of sale of any commodity

12 K 2017 Thomson Reuters Futures and Derivatives Law Report May 2017 | Volume 37 | Issue 5 in interstate commerce, or for future delivery on III. Current Issues or subject to the rules of any registered entity. A. Treatment of Offsetting CEA Section 6(c)(3) and CFTC Rule 180.2 do Currency Forwards not require proof of fraud, but do require proof of The current regulatory framework distin- specific intent to manipulate, whether directly or guishes between NDFs and Currency Forwards, indirectly.142 The CEA and the CFTC’s rules do with the former being subject to full regulation as not define manipulation, but courts have gener- “swaps” and the latter being subject to lighter ally utilized the following four-prong test for regulation. While this distinction has been in establishing manipulation: (i) the accused had the place for several years, there continues to be ability to influence market prices; (ii) the accused uncertainty regarding whether transactions that specifically intended to create or effect a price or are documented as Currency Forwards could be prices trend that does not reflect legitimate recharacterized as swaps because they are settled sources of supply and demand; (iii) artificial through entry into an offsetting Currency For- 147 prices existed; and (iv) the accused caused the ward or spot transaction. In many cases, offset- artificial prices.143 Although the CFTC has gener- ting transactions provide the most efficient way to close out a Currency Forward. If these offset- ally acknowledged the validity of this test,144 in a ting transactions were to cause the Currency recent case in which a defendant had acknowl- Forwards to be deemed to be “cash-settled,” then edged engaging in conduct with an intent to af- the Currency Transactions could be deemed to be fect market prices, the CFTC moved for sum- swaps and the counterparties could be found to mary judgment on the basis that manipulation have failed to comply with the requirements ap- could be established merely by the “intent to af- plicable to swaps. fect market prices.”145 The court ultimately re- jected the CFTC’s motion for summary judgment Regulatory guidance regarding characteriza- and upheld the four-prong test, stating that there tion of offsetting Currency Transactions is is “no manipulation without intent to cause ambiguous. The Swap Adopting Release states that transactions that are initially “styled as or artificial prices.”146 intended to be” Currency Forwards but are subse- The broad provisions in CEA Sections 6(c)(1) quently “modified” to be settled in a single refer- and 6(c)(3) and CFTC Rules 180.1 and 180.2 ap- ence currency will be treated as swaps, and this ply to fraudulent conduct that is in connection language could be read to say that reliance on an with or that attempts to manipulate the price of offsetting transaction to settle a Currency For- 148 any “commodity in interstate commerce,” and ward causes the transaction to become a swap. arguably provide the CFTC with enforcement Another reading of this language is that it is authority over otherwise unregulated Currency limited to situations in which the terms of a trans- Transactions. This authority may extend to spot action itself are modified (e.g., the written confir- transactions, for example, depending on the cir- mation of a Currency Forward is amended to cumstances of the relevant conduct. provide for cash settlement) and does not apply to situations in which parties execute a separate

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offsetting transaction (e.g., execute a separate lation Letter (“SR 13-24”),153 which incorporated written confirmation for a new Currency guidelines issued by the Basel Committee on Forward). Guidance from the CFTC in the con- Banking Supervision (the “BCBS Guidelines”). text of commodity forwards could support the The BCBS Guidelines apply to “banking institu- reading that the execution of an offsetting Cur- tions”154 and provide for collection and posting rency Forward does not result in recharacteriza- of variation margin on physically-settled foreign 155 tion of the Currency Forward as a swap. Specifi- exchange transactions with “financial institu- cally, the CFTC has interpreted the exclusion tions and systemically important non-financial 156 from regulation as a futures contract applicable entities.” Because the largest swap dealers are to nonfinancial commodity forwards to apply to generally subject to the Federal Reserve’s juris- contracts that allow the parties to “book-out” the diction, it is possible that SR 13-24 could be forward to avoid delivery.149 Although the exclu- interpreted to negate the plain language in the swap margin regulations that excludes Currency sion depends, among other factors, on the par- Forwards and Physically-Settled FX Swaps. ties’ intention to make and accept physical deliv- Given that variation margin has historically not ery, in the context of nonfinancial forwards, the been collected on many Currency Forwards and CFTC reasoned that the forward exclusion should Physically-Settled FX Swaps, if SR 13-24 were still apply to contracts having a “book-out” applied as a regulatory requirement (notwith- feature because no party would be under any standing that the guidance was not subjected to obligation to execute a book-out and each party notice and comments), the application could cre- could unilaterally require settlement through ate material operational and financial obligations 150 physical delivery. In the Swap Adopting Re- for both dealers and end users that are deemed to lease, the CFTC indicated that this guidance be “financial institutions” for purposes of the would apply to forwards in all nonfinancial guidance. SR 13-24 and the BCBS Guidelines 151 commodities. Although the CFTC did not also state that spot transactions fall under the extend the guidance to financial derivatives, the guidance. underlying rationale—that a transaction should not be recharacterized because of a subsequent SR 13-24 has also been a source of confusion action that the parties are not obligated to take— among both banking institutions and their non- arguably applies equally to offsetting Currency bank counterparties because of the lack of formal Forwards. guidance provided by the Federal Reserve regard- ing the scope or details of the margin B. Margin Requirements for requirements. It is unclear why the Federal Re- Physically-Settled Foreign serve adopted these requirements through a Exchange Products Supervision and Regulation Letter rather than a Although the uncleared swap margin rules formal rulemaking, particularly given that it adopted by the CFTC and the prudential regula- adopted detailed margin rules for other tors do not apply to Currency Forwards and derivatives. Among the details that are addressed Physically-Settled FX Swaps,152 in 2013, the specifically in the Prudential Regulator Margin Federal Reserve issued a Supervision and Regu- Rules but that are left unanswered in SR 13-24

14 K 2017 Thomson Reuters Futures and Derivatives Law Report May 2017 | Volume 37 | Issue 5 are: (i) the definition of the term “financial insti- Currency Transactions conducted with ECPs tutions,” with whom the banking institutions are (including swap transactions). Thus, there are required to post and collect variation margin,157 significant legal and operational obstacles to (ii) the minimum transfer amount that will apply switching between compliance with the two dif- to margin transfers,158 (iii) the types of collateral ferent rule sets. Further, if a dealer entered into a that are permitted as variation margin, and what Currency Transaction with a person when the haircuts may apply to such collateral,159 and (iv) person was an ECP, but that person later became the effective date of the requirements. a retail investor, there is uncertainty as to whether or how the dealer could subsequently amend or C. Shifting ECP Status close out that transaction. While the CFTC has As discussed above, Currency Transactions confirmed that a party’s ECP status only needs to entered into with non-ECPs are subject to the be confirmed prior the execution of a swap and 161 Retail Forex rules, and Currency Transactions be- not throughout the life of the swap, the CFTC has not specifically addressed whether the close tween ECPs are subject to the swap rules unless, out or amendment of a swap could be deemed to in either case, the applicable transaction is ex- be a new “swap” that requires both parties to be cluded from regulation. There are several prongs ECPs at the time of such close out or of the ECP definition through which a person can amendment.162 qualify as an ECP; however, a natural person (other than floor brokers or associated persons of Some market participants have suggested that broker-dealers) will qualify as an ECP only if he a financial institution should have the right to or she has assets invested on a discretionary basis opt-in to the Retail Forex rules rather than the in excess of $10,000,000, or in excess of swaps rules for transactions with ECPs.163 On this $5,000,000 if he or she is using the transactions point, the Federal Reserve has indicated that a to manage risk associated with his or her assets banking institution subject to its jurisdiction may or liabilities.160 Because ECP status generally comply with its Retail Forex rules when transact- depends upon the amount of a person’s assets, a ing with a Retail Forex customer who later be- person’s status can shift over time, and a financial comes an ECP,164 but the CFTC has not provided institution transacting with such a person would additional guidance on this point. be required to change which rules they are com- plying with depending on the person’s ECP Conclusion status. Due to the significant differences between The regulation of Currency Transactions is one the requirements of the rules applicable to Retail of the most nuanced areas of financial regulation Forex transactions and those applicable to swaps, and has evolved substantially in recent years. financial institutions use different systems, docu- Given continued instances of abuses in currency mentation and legal entities to comply with the trading, including claims of undisclosed markups two sets of rules. Retail Forex transactions are by custodial banks, large-scale losses by retail generally executed on separate platforms, pursu- investors and retail currency trading firms, and ant to separate documentation and customer manipulation of exchange rates, it would seem reporting and different margining systems from likely that, notwithstanding the new administra-

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tion’s potential focus on paring back unwieldy 2Generally, foreign exchange and currency regulation, Currency Transactions will remain derivatives entered into with institutional inves- tors that qualify as eligible contract participants subject to significant regulatory oversight in the (“ECPs”) under Section 1a(18) of the CEA are United States. We also believe, however, that regulated as swaps subject to the jurisdiction of there are useful areas within the current frame- the CFTC, whereas foreign exchange and cur- work of regulations, which we have highlighted rency derivatives entered into with retail custom- ers that do not qualify as ECPs are subject to a in this article, that could be rationalized in order separate set of rules applicable to retail foreign to provide greater certainty to the currency exchange. While the retail foreign exchange rules markets. all originate from the CEA, jurisdiction over retail foreign exchange transactions varies de- pending on the financial institution trading with ENDNOTES: the retail counterparty, as discussed later in this article. *David Aron was one of the principal drafts- 3FX options that are listed on a national secu- men of the joint CFTC-Securities and Exchange rities exchange registered under Section 6(a) of Commission (“SEC”) rulemaking further defin- the Securities Exchange Act of 1934, as amended ing the term swap (Further Definition of “Swap,” (the “Exchange Act”), are regulated as securities “Security-Based Swap,” and “Security-Based under the Exchange Act and are subject to the Swap Agreement”; Mixed Swaps; Security- jurisdiction of the SEC, whereas foreign ex- Based Swap Agreement Recordkeeping, 77 Fed. change futures products listed on designated Reg. 48,207 (Aug. 13, 2012) (“Swap Adopting contract markets are subject to the jurisdiction of Release”)), including the foreign exchange and the CFTC under the CEA. Over-the-counter currency sections thereof. Mr. Aron was also the foreign exchange transactions executed between principal draftsman of the joint CFTC-SEC ECPs are generally subject to the jurisdiction of rulemaking further defining the term “eligible the CFTC. contract participant.” See Further Definition of 4 “Swap Dealer,” “Security-Based Swap Dealer,” In this article, we use the term “physically- “Major Swap Participant,” “Major Security- settled” to describe foreign exchange and cur- Based Swap Participant” and “Eligible Contract rency transactions that are settled via an exchange Participant,” 77 Fed. Reg. 30,596 (May 23, 2012) of two settlement payments, each in a different (“Swap Entity Definition Release”). The research currency. Such transactions are also referred to in for this paper conducted by Mr. Aron was done the market as “deliverable” transactions and are in his personal capacity and not in his official distinguished from “non-deliverable” transac- capacity as an employee of the CFTC. The analy- tions that are settled via one payment in a single ses and the conclusions expressed in this paper currency. References to physical settlement in are those of Mr. Aron, and do not reflect the views this article do not relate to a transaction’s eligibil- of other DMO employees, other CFTC staff, the ity for the forward contract exclusion for futures CFTC itself, or the United States government. P. and swaps pursuant to CEA Sections 1a(27) and Georgia Bullitt and Jed Doench assisted in the 1a(47)(B)(ii), respectively, which are separate preparation of this article and in formulating the exclusions that incorporate concepts of physical conclusions. The authors would like to thank An- settlement or delivery. nie Fox, an associate at Willkie Farr & Gallagher 5Certain exclusions and exemptions from LLP, whose research efforts were invaluable. some of these requirements are available. 1Wall Street Transparency and Account- 6See Determination of Foreign Exchange ability Act of 2010, Pub. L. No. 111-203, 124 Swaps and Foreign Exchange Forwards Under Stat. 1641. the Commodity Exchange Act, 77 Fed. Reg.

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69,694 (Nov. 20, 2012) (“Treasury Determina- ture Delivery, 50 Fed. Reg. 42,983, 42,984 (Oct. tion”) (issued pursuant to Section 1a(47)(E) of 23, 1985) (“The [CFTC] has, since its creation, the CEA). consistently been of the view that the Treasury 7CEA § 1a(24). Amendment which, as more fully discussed below, excludes from the [CFTC’s] exclusive 8 CEA § 1a(25). jurisdiction over futures contracts, certain off- 9See CEA § 2(c)(2)(C)(i)(II)(bb)(AA). exchange transactions in foreign currencies and 10Retail Forex transactions includes “rolling other enumerated financial instruments, applies spot” transactions, which are Currency Transac- only when such transactions are entered into by tions that are nominally booked as spot transac- and between banks and certain other sophisti- tions but that are continually rolled over, and thus cated and informed institutional participants.”) are economically similar to forward or futures (internal citations omitted). transactions. 17Id.; CFTC Fraud Advisories: Foreign Cur- 11Securities exchanges that list currency op- rency Trading (Forex) Fraud, CFTC, http://ww tions include NASDAQ PHLX LLC and Interna- w.cftc.gov/ConsumerProtection/FraudAwareness tional Securities Exchange, LLC. Prevention/CFTCFraudAdvisories/fraudadv_f orex (last visited Dec. 5, 2016). 12CEA §§ 2(c)(2)(A)(i) and (iii). 18See Exemption for Certain Swap Agree- 13 CEA § 2(c)(2)(E)(iii)(I). ments, 58 Fed. Reg. 5587 (Jan. 22, 1993) (adopt- 14See Letter from Donald L. E. Ritger, Acting ing Part 35 of the CFTC’s regulations, which General Counsel, Department of the Treasury, to implemented a safe harbor from regulation for the Hon. Herman E. Talmadge (July 30, 1974), certain swap agreements (including FX swap reprinted in 1974 U.S.C.C.A.N. 5843, 5887-88 agreements) between “eligible swap partici- (“The Department feels strongly that foreign cur- pants”). rency futures trading, other than on organized ex- 19See, e.g., CFTC v. Baragosh, 278 F.3d 319 changes, should not be regulated by the new (4th Cir. 2002) (“Transactions in foreign currency agency. Virtually all futures trading in foreign were not subject to [CFTC] jurisdiction in the pe- currencies in the United States is carried out riod at issue in this case if they were ‘large-scale, through an informal network of banks and deal- customized, negotiated, bilateral transactions be- ers. . . . The participants in this market are so- tween sophisticated financial professionals.’ But phisticated and informed institutions, unlike the they were subject to its jurisdiction if they were participants on organized exchanges, which, in small, standardized, offered as-is, and mass some cases, include individuals and small traders marketed to individuals.”) (internal citations who may need to be protected by some form of omitted); CFTC v. Standard Forex, No. cv-93- governmental regulation. . . . Where the need 0088, 1993 WL 809966 (E.D.N.Y. 1993) (defer- for regulation of transactions on other than orga- ring to the interpretation of the CFTC that the nized exchanges does exist, this should be done Treasury Amendment does not limit the CFTC’s through strengthening existing regulatory respon- jurisdiction over off-exchange foreign currency sibilities now lodged in the Comptroller of the transactions to the general public). See also Salo- Currency and the Federal Reserve.”). mon Forex, Inc. v. Tauber, 8 F.3d 966, 978 (4th 15The Treasury Amendment provided: “Noth- Cir. 1993) (“We hold only that individually- ing in this Act shall be deemed to govern or in negotiated foreign currency option and futures any way be applicable to transactions in foreign transactions between sophisticated, large-scale currency . . . unless such transactions involve foreign currency traders fall within the Treasury the sale thereof for future delivery conducted on Amendment’s exclusion from CEA coverage.”) a board of trade.” 88 Stat. 1395, 7 U.S.C. § 2(ii). (emphasis added). 16See Trading in Foreign Currencies for Fu- 20Dunn v. CFTC, 519 U.S. 465 (1997).

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21See id. at 473. ECPs and that is not executed on a trading facil- 22CFTC v. Frankwell Bullion Ltd., 99 F.3d ity. CFMA Section 105 added a broader exclu- 299, 305 (9th Cir. 1996) (“We hold, as the legisla- sion to Section 2(g) of the CEA, which generally tive history indicates, that Congress intended the excluded from regulation under the CEA any Treasury Amendment to exempt all off-exchange swap transactions that were entered into between transactions in foreign currency.”). ECPs, subject to individual negotiation, and not 23See The President’s Working Group on executed or traded on a trading facility. Financial Markets, Over-the-Counter Derivatives 28See Testimony of Sharon Brown-Hruska, and the Commodity Exchange Act (1999) (“PWG Acting Chairman CFTC, Before the House Sub- Report”) at 26-27. committee on General Farm Commodities and 24Pub. L. No. 106-554, 114 Stat. 2763. Risk Management Committee on Agriculture, 25 U.S. House of Representatives, CFTC (Mar. 3, CEA § 2(c)(2)(B)(ii) (2001) (amended 2005), http://www.cftc.gov/opa/speeches05/opab 2008 and 2010). rown-hruska-27.htm. 26The CFMA added a definition of an ECP in 29See NFA Notice I-03-14, New Forex Rules Section 1a(12) of the CEA (subsequently renum- Will Become Effective on December 1, 2003, Nat. bered as 1a(18) by Dodd-Frank). The definition Futures Ass’n (Oct. 2, 2003), https://www.nfa.fut is very similar to the current definition and con- ures.org/news/newsNotice.asp?ArticleID=1169 tained a list of different persons qualifying as (announcing CFTC approval of NFA Compliance ECPs including, among others, financial institu- Rule 2-36, Sections 11 and 12 of the NFA Finan- tions, regulated insurance companies, registered cial Requirements, NFA Interpretive Notice investment companies, commodity pools with 9053, and related rules regarding Retail Forex total assets exceeding $5,000,000 and operated that are applicable to “Forex Dealer Members”). by a person subject to regulation by the CFTC or a similar foreign regulator, entities and individu- 30The Commodity Futures Modernization Act als with total assets exceeding $10,000,000, em- of 2000 and Recent Market Developments: Hear- ployee benefit plans subject to the Employee ing Before the Comm. On Banking, Housing, and Retirement Income Security Act of 1974 with Urban Affairs, 109th Cong. 1 (2005) (prepared total assets exceeding $5,000,000 or managed by statement of Daniel J. Roth, President and Chief a registered investment adviser, governmental Executive Officer, National Futures Association) entities, registered broker-dealers and registered (“Since passage of the CFMA, a number of FCMs. firms—that do not engage in any other regulated 27Prior to the adoption of the CFMA, there business—have nonetheless registered as FCMs had been concerns that OTC derivatives, includ- to qualify to be an otherwise regulated entity and ing OTC currency derivatives, could be deemed have become NFA Forex Dealer Members for the illegal off-exchange futures contracts. See PWG sole purpose of acting as counterparties to retail Report at 10-13. Section 102 of the CFMA re- customers in these transactions.”). vised Section 2(c) of the CEA to exclude from 31Id. (“Though less than 1 percent of our the CEA foreign currency transactions, other than member firms, forex dealers have accounted for transactions conducted on an “organized ex- 50 percent of our emergency enforcement actions change” or securities exchange, where organized and over 10 percent of our arbitration docket.”). exchange was defined to include a trading facil- 32CEA § 2(c)(2)(B)(ii)(III) (prior to subse- ity that permits trading by persons who are not quent amendments). ECPs. CFMA Section 103 added Section 2(d) to 33 the CEA, which generally provided that the CEA CFTC v. Zelener, 373 F.3d 861 (7th Cir. would not govern any transaction in an excluded 2004). See also CFTC v. Erskine, 512 F.3d 309 commodity (which was defined to include any (6th Cir. 2008). exchange rate or currency) entered into between 34Zelener, 373 F.3d at 867-68 (“Our decision

18 K 2017 Thomson Reuters Futures and Derivatives Law Report May 2017 | Volume 37 | Issue 5 in Nagel observed that in the great majority of 00078 (D. Conn. 2015); Plea Agreement, U.S. v. situations even opinions emphasizing ‘the total- JPMorgan Chase & Co., Case No. 3:15-cr-00079 ity of the circumstances’ boil down to whether (D. Conn. 2015); U.S. v. The Royal Bank of trading has occurred in fungible contracts.”). Scotland PLC, Case No. 3:15-cr-00080 (D. Conn. 35Id. at 868. 2015). See also Five Major Banks Agree to Parent-Level Guilty Pleas, Dep’t of Just. (May 36 Id. at 868-69. 20, 2015), https://www.justice.gov/opa/pr/five-m 37Food, Conservation, and Energy Act of ajor-banks-agree-parent-level-guilty-pleas. 2008, Public Law 110-246, 122 Stat. 1651, 2189- 48 Manhattan U.S. Attorney and New York 2204 (2008). State Attorney General Announce $714 Million 38See CEA § 2(c)(2)(B)(i)(II). The CRA also Proposed Settlement with the Bank of New York created a $20 million minimum capital require- Mellon Over Fraudulent Foreign Exchange Trad- ment for FCMs and RFEDs that offer Retail ing Practices, Dep’t of Just. U.S. Att’y’s Off. Forex. S.D.N.Y. (Mar. 19, 2015), https://www.justice.go 39CEA § 2(c)(2)(C)(i)(I)(bb). v/usao-sdny/pr/manhattan-us-attorney-and-new- york-state-attorney-general-announce-714-millio 40 CEA § 2(c)(2)(C)(i)(II)(bb)(AA). n-proposed. See also In the Matter of The Bank 41Wall Street Transparency and Account- of New York Mellon, Investment Company Act ability Act of 2010 (“Title VII”). Release No. 32151 (June 13, 2016) (The SEC 42See S. Rep. No. 111-176 (2010) at 29-35. concluded that BNYM willfully violated Section 34(b) of the Investment Company Act, which 43 See Treasury Determination. prohibits both untrue statements of material facts 44See CEA § 2(c)(2)(E)(ii)-(iii) (requiring and fraudulent omission of material facts in docu- disclosure, recordkeeping, capital and margin, ments such as registration statements, applica- reporting, business conduct, documentation and tions, reports and accounts. The SEC also con- other standards). cluded that BNYM violated Section 31(a) of the 45See CFTC Release PR7056-14, CFTC Or- Investment Company Act and the corresponding ders Five Banks to Pay over $1.4 Billion in Rule 31a-1(b), both of which specify that regis- Penalties for Attempted Manipulation of Foreign tered investment companies must keep records of Exchange Benchmark Rates (Nov. 12, 2014), htt certain transaction information.). p://www.cftc.gov/PressRoom/PressReleases/pr 49See State Street Bank to Pay $382 Million 7056-14. See also In re Citibank, N.A., CFTC to Settle Allegations of Fraudulent Foreign Cur- Docket No. 15-03 (Nov. 11, 2014); In re JPMor- rency Exchange Practices, Dep’t of Just. (July gan Chase Bank, N.A., CFTC Docket No. 15-04 26, 2016), https://www.justice.gov/opa/pr/state-s (Nov. 11, 2014); In re The Royal Bank of Scot- treet-bank-pay-382-million-settle-allegations-fra land plc, CFTC Docket No. 15-05 (Nov. 11, udulent-foreign-currency-exchange. See also In 2014); In re UBS AG, CFTC Docket No. 15- 06 the Matter of State Street Bank and Trust Com- (Nov. 11, 2014); In re HSBC Bank plc, CFTC pany, Investment Company Act Release No. Docket No. 15-07 (Nov. 11, 2014). 32390 (Dec. 12, 2016). 46See Daniel Schäfer, Alice Ross and Del- 50Hill. v. State Street Corporation, Fed. Sec. phine Strauss, Foreign Exchange: The Big Fix, L. Rep. (CCH) ¶ 96,504 (D. Mass. 2011). Financial Times (Nov. 12, 2013), https://www.ft. 51Id. com/content/7a9b85b4-4af8-11e3-8c4c-00144fe 52Patrick Graham, Swiss Franc Jumps 30 abdc0. Percent After Swiss National Bank Dumps Euro 47See Plea Agreement, U.S. v. Barclays PLC, Ceiling, Reuters (Jan. 15, 2015), http://www.reut Case No. 3:15-cr-00077 (D. Conn. 2015); Plea ers.com/article/us-markets-franc-idUSKBN0KO Agreement, U.S. v. Citicorp, Case No. 3:15-cr- 16Y20150115.

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53Ira Iosebashvili, Andrew Ackerman and Case No. 1:17-cr-00026 (S.D.N.Y. 2017); Plea Alexandra Wexler, Surge of Swiss Franc Trig- Agreement, U.S. v. Katz, Case No. 1:17-cr-00003 gers Hundreds of Millions in Losses, Wall St. J. (S.D.N.Y. 2017). (Jan. 16, 2015), http://www.wsj.com/articles/swi 62FX Global Code Public Update on Adher- ss-franc-move-cripples-currency-brokers- ence (May 2016), http://www.bis.org/mktc/fxwg/ 1421371654. am_may16.pdf. 54 See NFA Notice I-16-27 (Jan. 21, 2015) 63In this context, the term “forward contract” (increasing the security deposit requirements is not intended to connote any connection to the under Section 12 of the NFA Financial Require- forward contract exclusion from the swap defini- ments for transactions for Retail Forex transac- tion in Section 1a(47)(B)(ii) of the CEA, which tions in the Swiss franc, Swedish krona and Nor- is not available for foreign exchange transactions, wegian krone). or to Section 1a(27) of the CEA, which, as noted 55Andrew Ackerman, CFTC Reviews Retail above, incorporates concepts of physical settle- Forex Trading Rule Following FXCM Debacle, ment or delivery. Wall St. J. (Jan. 16, 2015), http://www.wsj.com/a 64NDFs were described in greater detail by rticles/cftc-reviewing-retail-forex-trading-rules-f the CFTC as follows: “An NDF generally is sim- ollowing-fxcm-debacle-1423673421. ilar to a forward foreign exchange contract, 56A Forex Dealer Member is defined in NFA except that at maturity, the NDF does not require Bylaw 306 as any NFA member that enters into physical delivery of currencies and is typically Retail Forex transactions, and generally includes settled in U.S. dollars. The other currency, usu- RFEDs as well as FCMs that enter into Retail ally an emerging market currency subject to Forex transactions but that are not required to capital controls, is therefore said to be ‘nondeliv- register as RFEDs. erable.’ If the spot market exchange rate on the 57See CFTC Release PR7219-15, CFTC Ap- settlement date is greater (in foreign currency per proves National Futures Association Rules En- dollar terms) than the previously agreed forward hancing Protections for Retail Forex Customers exchange rate, the party to the contract that is (Aug. 27, 2015), http://www.cftc.gov/PressRoo long the emerging market currency must pay its m/PressReleases/pr7219-15. counterparty the difference between the con- tracted forward price and the spot market rate, 58 See NFA Notice I-15-04 (Jan. 21, 2015) multiplied by the notional amount.” Further Def- (increasing the security deposit requirements inition of “Swap,” “Security-Based Swap,” and under Section 12 of the NFA Financial Require- “Security-Based Swap Agreement”; Mixed ments for transactions for Retail Forex transac- Swaps; Security-Based Swap Agreement Record- tions in the Mexican peso, Japanese yen and New keeping, 76 Fed. Reg. 29,818, 29,836 (May 23, Zealand dollar). 2011) (citations omitted). 59 See Lananh Nguyen, Gain Capital Is Set to 65See CFTC Rule 1.3(xxx)(2)(i)(F) and Ex- Become the Biggest U.S. Retail FX Provider, change Act Rule 3a69-2(b)(1)(vi) (2016); Swap Bloomberg (Feb. 24, 2017), https://www.bloomb Adopting Release at 48,254-56. The Swap Adopt- erg.com/news/articles/2017-02-24/gain-capital-t ing Release indicated that NDFs are swaps pur- o-take-top-slot-in-u-s-retail-fx-as-fxcm-exits. suant to Section 1a(47)(A)(iii) of the CEA be- 60Forex Capital Markets, LLC, CFTC Docket cause they provide for a future payment based on No. 17-09 (Feb. 6, 2017). an exchange rate, which is an “interest or other 61Recently, two former currency traders at [rate]” within the meaning of clause (A)(iii). two large banks pleaded guilty to engaging in 66See Petition from the Investment Company criminal violations of U.S. antitrust law by con- Institute, ICI Global, ABA Securities Associa- spiring to manipulate foreign currency transac- tion, and American Bankers Association, Petition tions. See Plea Agreement, U.S. v. Cummins, for Exemptive Relief for Non-Deliverable For-

20 K 2017 Thomson Reuters Futures and Derivatives Law Report May 2017 | Volume 37 | Issue 5 eign Exchange Forwards to CFTC (Feb. 26, tion and Federal Housing Finance Agency margin 2013), https://www.aba.com/Advocacy/Lettersto rules, which are nearly identical, as the “Pruden- Congress/Documents/2-26-13PetitionforExempt tial Regulator Margin Rules” and cite generically iveRelief.pdf. to the subsections of the rules (e.g., § —.1). 67CFTC Rule 1.3(xxx)(2)(i)(B) and Exchange 77CFTC Rules 23.400 through 23.451. Act Rule 3a69-2(b)(1)(ii) (2016); Swap Adopt- 78CFTC Rules 23.500 through 23.506. ing Release at 48,254. 79Swaps dealers and major swap participants 68See Swap Adopting Release at 48,256. are generally subject to the same requirements 69CEA § 1a(47)(A)(iii)(VII). under Dodd-Frank. Because there are not any major swap participants currently registered with 70FX window forwards are used when parties to the contract do not know the specific date on the CFTC, for brevity we will just refer to swap which they will need the currency (for example, dealers. because they do not know when, within a certain 80CFTC Rule 45.2. date range, a foreign supplier will ship a particu- 81See CEA § 2(e) (“It shall be unlawful for lar shipment). See, e.g., Window Forward Con- any person, other than an eligible contract partic- tracts, California Bank & Trust, https://www.cal ipant, to enter into a swap unless the swap is banktrust.com/business-banking/international-ba entered into on, or subject to the rules of, a board nking/foreign-exchange-services/window-forwar of trade designated as a contract market under d-contracts.html (last visited Dec. 6, 2016) section 5.”). (noting that “it’s often challenging to determine 82The CFTC’s Global Markets Advisory exactly when a payment will take place. Produc- Committee (“GMAC”) held a meeting to discuss tion or shipment dates, the conclusion of legal NDF clearing on October 9, 2014. At that meet- matters, and invoice discounting all can impact ing, Brian O’Keefe, then a Deputy Director in when payments are released.”). the CFTC’s Division of Clearing and Risk, said 71See CEA § 1a(19) (defining a foreign ex- that the staff is evaluating a request for manda- change forward as “a transaction that solely tory clearing for cash-settled non-deliverable involves the exchange of 2 different currencies forwards in 12 currency pairs with tenors of up to on a specific future date at a fixed rate agreed two years. FIA Special Report: CFTC Examines upon on the inception of the contract covering FX Clearing Mandate, https://fia.org/articles/fia- the exchange”) (emphasis added). special-report-cftc-examines-fx-clearing-mand 72See Treasury Determination (issued pursu- ate. ant to Section 1a(47)(E) of the CEA). 83After the October 9, 2014 GMAC meeting, 73CEA § 2(h). GMAC’s FX Markets Subcommittee provided GMAC a memorandum essentially advocating a 74CEA § 2(h)(8). “go slow” approach. See Memorandum from the 7517 C.F.R. Parts 43, 45 and 46 (2016). Foreign Exchange Markets Subcomm. on Re- sponse to Request for Recommendation on an FX 7617 C.F.R. §§ 23.150-23.161 (2016); 12 NDF Mandate to Global Markets Advisory C.F.R. Part 45 (2016) (Office of the Comptroller Comm. (Dec. 5, 2014) (on file with CFTC), htt of the Currency (“OCC”) Rules); 12 C.F.R. Part p://www.cftc.gov/idc/groups/public/@aboutcftc/ 237 (2016) (Federal Reserve Rules); 12 C.F.R. documents/file/gmac_fxndfmandate122214.pdf. Part 349 (2016) (Federal Deposit Insurance Corporation (“FDIC”) Rules); 12 C.F.R. Part 624 84See Chris Barnes, NDF Volumes—It’s all (2016) (Farm Credit Administration Rules); 12 about Clearing, Clarus Financial Technology C.F.R. Part 1221 (2016) (Federal Housing Fi- (Dec. 21, 2016), https://www.clarusft.com/ndf-v nance Agency Rules). We refer to the OCC, olumes-its-all-about-clearing/. Federal Reserve, FDIC, Farm Credit Administra- 85The SEFs that offer foreign exchange and

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currency products include ICAP SEF (US) LLC, 100Treasury Determination at 69,695 n.8 BGC Derivatives Markets, L.P., tpSEF Inc., GFI (“Thus, as a result of this determination pursuant Swaps Exchange LLC and Tradition SEF, Inc., to sections 1a(47)(E) and 1b of the CEA, foreign among others. The Futures Industry Association exchange swaps and forwards would not be (“FIA”) has made available an interactive online subject to margin requirements under the CEA.”). tool that provides detailed information about SEF 101See Margin Requirements for Uncleared trading activity. SEF Tracker Overview, FIA, htt Swaps for Swap Dealers and Major Swap Partici- ps://fia.org/sef-tracker-overview. pants, 81 Fed. Reg. 636, 638 (Jan. 6, 2016) (to be 86See CFTC Rules 23.153 and 23.154; Pru- codified at 17 C.F.R. pts. 23 and 140) (“CFTC dential Regulator Margin Rules §§ ———.3 and Margin Adopting Release”); Margin and Capital ———.4. Requirements for Covered Swap Entities, 80 Fed. 87CEA § 4s(e)(4) (2015). Reg. 74,840, 74,842 (Nov. 30, 2015) (to be codi- fied at 12 C.F.R. pts. 45, 237, 349, 624 and 1221). 88 CFTC 23.161(a)(2); Prudential Regulator Nevertheless, both the CFTC’s and the prudential Margin Rules § —.1. regulators’ margin rules take into account Cur- 89See CFTC Letter No. 17-11 (Feb. 13, 2017). rency Forwards and Physically-Settled FX Swaps 90See Initial Examinations for Compliance for the purposes of certain thresholds within the with Minimum Variation Margin Requirements rules. For example, the compliance dates for the for Non-Cleared Swaps and Non-Cleared Secu- initial margin requirements within the rules rity Based Swaps, SR 17-3 (Feb. 22, 2017); depend upon the size of a counterparty’s posi- Initial Examinations for Compliance With Final tions, and include Currency Forward and Rule Establishing Margin Requirements for Non- Physically-Settled FX Swap positions in this Cleared Swaps and Non-Cleared Security-Based calculation. See CFTC Margin Adopting Release Swaps, OCC Bulletin 2017-12 (Feb. 23, 2017). at 675-76; Prudential Regulator Margin Rules § —.1(e). 91See CFTC Rules 23.500 through 23.506. 102See Managing Foreign Exchange Settle- 92 See Letter from the Global Financial Mar- ment Risks for Physically Settled Transactions, ket Association’s Global Foreign Exchange Divi- SR 13-24 (Dec. 23, 2013). sion and The Financial Services Roundtable to 103 Gary Barnett, Director, Division of Swap Dealer See CEA §§ 2(c)(2)(B)(i) and 2(c)(2)(C)(i) and Intermediary Oversight, CFTC (June 5, (providing that the Retail Forex provisions of the 2013). CEA apply to any agreement, contract, or trans- action in foreign currency with a person that is 93 CEA § 1a(47)(E)(i). not an ECP that is a contract of sale of a com- 94See Treasury Determination. modity for future delivery (or an option on such 95CEA § 1a(24). contract), an option (other than an option traded 96 on a securities exchange), or entered into on a CEA § 1a(47)(E)(iv). leveraged, margined or financed basis). 97Although Section 1a(47)(E)(iv) of the CEA 104CEA § 1a(18)(A)(iv). only references Currency Forwards and Physically-Settled FX Swaps being subject to the 105See, e.g., Comment Letter from Willkie “business conduct standards,” the CFTC has Farr & Gallagher LLP re: Further Definition of interpreted this to include its swap trading docu- “Swap Dealer,” “Security-Based Swap Dealer,” mentation rules. See Treasury Determination at “Major Swap Participant” and “Eligible Contract 69,699 n.51; CFTC Letter No. 13-38 (June 27, Participant” (Feb. 22, 2011). 2013). 106See CFTC Rule 1.3(m)(8); Swap Entity 98Id. § 1a(47)(E)(iii). Definition Release at 30,659. 99Id. § 1a(47)(F)(i). See also CEA § 1b(c). 107The rule provides that an FX Pool is not

22 K 2017 Thomson Reuters Futures and Derivatives Law Report May 2017 | Volume 37 | Issue 5 required to look through to the ECP status of 119See supra note 110 for a description of se- investors in any feeder fund that invests in the curities conversion transactions. See also Swap FX Pool (an “Investor Pool”), provided that none Adopting Release at 48,257. of the FX Pool, any Investor Pool, or any other 120CEA §§2(c)(2)(B)(i)(II) and pool in which the FX Pool holds a direct or 2(c)(2)(E)(ii)(I). indirect interest was structured to evade the Retail Forex rules by permitting non-ECPs to 121See Regulation of Off-Exchange Retail participate in OTC FX transactions. See CFTC Foreign Exchange Transactions and Intermediar- Rule § 1.3(m)(5)(ii) (2016); Swap Entity Defini- ies, 75 Fed. Reg. 55,410 (Sep. 10, 2010); Retail tion Release at 30,651-52. Foreign Exchange Transactions; Conforming 108 Changes to Existing Regulations in Response to See Swap Adopting Release at 48,256-57. the Dodd-Frank Wall Street Reform and Con- 109Id. at 48,257. sumer Protection Act, 76 Fed. Reg. 56,103 (Sep. 110The CFTC and SEC described a “securi- 12, 2011). ties conversion transaction” as an agreement, 122See Retail Foreign Exchange Transactions, contract or transaction for the purchase or sale of 76 Fed. Reg. 40,779 (July 12, 2011). The FDIC’s an amount of foreign currency equal to the price rules apply to FDIC-supervised insured deposi- of a foreign security with respect to which (i) the tory institutions, which include state nonmember security and related foreign currency transactions banks and state savings associations. are executed contemporaneously in order to ef- 123See Retail Foreign Exchange Transactions, fect delivery by the relevant securities settlement 76 Fed. Reg. 41,375 (July 14, 2011). The OCC’s deadline and (ii) actual delivery of the foreign se- rules apply to national banks, federal branches or curity and foreign currency occurs by such dead- agencies of foreign banks, and their operating line. Id. subsidiaries, and federal savings associations. 111Id. 124See Retail Foreign Exchange Transactions 112Id. at 48,256-57. (Regulation NN), 78 Fed. Reg. 21,019 (Apr. 9, 113Swap Adopting Release at 48,229 n.226 2013). The Federal Reserve’s rules apply to state (citing 7 U.S.C. §§ 6(c), 6(d) and 9(a)(2) and 17 member banks, uninsured state-licensed branches C.F.R. § 180.1). of foreign banks, financial holding companies, 114CEA § 2(c)(2)(B)(i). See also Swap Adopt- bank holding companies, savings and loan hold- ing Release at 48,258. ing companies, agreement corporations and Edge Act corporations. 115CEA § 2(c)(2)(C)(i)(I)(bb). 125 116 See Retail Foreign Exchange Transactions, CEA § 2(c)(2)(C)(i)(II)(bb)(AA). 76 Fed. Reg. 41,676 (July 15, 2011); Retail 117Provided that the seller and buyer must Foreign Exchange Transactions, 78 Fed. Reg. have the ability to deliver and accept delivery, 42,439 (July 16, 2013). respectively, in connection with their line of busi- 126See Retail Foreign Exchange Transactions, ness. CEA § 2(c)(2)(C)(i)(II)(bb)(BB). 81 Fed. Reg. 33,374 (May 26, 2016). 118 CEA § 2(c)(2)(B)(i)(I). Further, Section 127 2(c)(2)(C)(i)(II)(aa) exempts from the CFTC’s See Retail Foreign Exchange Transactions, jurisdiction any “security that is not a security 78 Fed. Reg. at 42,439, 42,443 (July 16, 2013) futures product.” The definition of security in (noting certain “key risks” including the lack of a Section 3(a)(10) of the Exchange Act includes central marketplace for Retail Forex, uncertainty “any put, call, straddle, option, or privilege about transaction costs, and the possibility for entered into on a national securities exchange re- investors to lose more than their original invest- lating to foreign currency.” 15 U.S.C. ment). § 78c(a)(10) (2015). 128See 17 C.F.R. § 5.5 (2016); 12 C.F.R.

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§ 349.6 (2016) (FDIC Rule); 12 C.F.R. § 48.6 lease at 41,407 (“In response to the comments (2016) (OCC Rule); 12 C.F.R. § 240.6 (2016) received regarding this matter, the Commission (Federal Reserve Rule). reiterates that, in applying final Rule 180.2, it will 129See 17 C.F.R. § 5.9(a) (2016); 12 C.F.R. be guided by the traditional four-part test for § 349.9(a) (2016); 12 C.F.R. § 48.9 (2016); 12 manipulation that has developed in case law aris- C.F.R. § 240.9. NFA Financial Requirements, ing under 6(c) and 9(a)(2). . . .”). Section 12. 145CFTC Reply Memorandum in Support of 130See 17 C.F.R. § 5.13 (2016); 12 C.F.R. its Motion for Summary Judgment at 4, CFTC v. § 349.10 (2016); 12 C.F.R. § 48.10 (2016); 12 Wilson, No. 13-cv-7884 (S.D.N.Y. Jan. 12, 2016). C.F.R. § 240.10 (2016). 146Memorandum and Order, CFTC v. Wilson 131See 17 C.F.R. § 5.2(b) (2016); 12 C.F.R. and DRW Investments, No. 13-cv-7884 (S.D.N.Y. § 349.3(a) (2016); 12 C.F.R. § 48.3(a) (2016); 12 Sept. 30, 2016) at 26 (quoting In re Amaranth C.F.R. § 240.3(a) (2016). Natural Gas Commodities Litig., 730 F.3d 170, 183 (2d Cir. 2013)). 132See NFA Compliance Rule 2-36, Sections 147 11 and 12 to NFA Financial Requirements, and For example, on June 1 two parties could related rules and interpretive materials. execute a Currency Forward in which Party A will pay 100 GBP in exchange for Party B pay- 133 7 U.S.C. § 6b (2015). ing 120 USD on July 31. If, on July 15, the 134Id. § 2(c)(2)(c)(iv). expected GBP/USD exchange rate for July 31 has 135Id. § 6c(a)(2). moved to 1.15, the parties could close out the trade by executing an offsetting Currency For- 136 Id. § 6c(a)(5). ward in which Party B pays 100 GBP and Party 137Id. § 6c(a)(7). A pays 115 USD on July 31. The second Cur- 138Id. § 13(a)(2). rency Forward would, if documented under a master netting agreement, result in an effective 139 See Prohibition on the Employment, or At- net settlement on July 31 of Party A receiving 5 tempted Employment, of Manipulative and De- USD (because Party B receives 100 GBP under ceptive Devices and Prohibition on Price Ma- the first transaction and pays 100 GBP on second nipulation, 76 Fed. Reg. 41,398 (July 14, 2011) transaction, while Party A receives 120 USD (“Rule 180.1 and 180.2 Adopting Release”). under the first transaction and pays 115 USD 140Id. at 41,404. under the second transaction). 141Id. at 41,405-06 (emphasis added). The 148Swap Adopting Release at 48,255 n.539 CFTC has stated that it intends to interpret the (“[A] foreign exchange transaction, which ini- “in connection with” requirement broadly, rather tially is styled as or intended to be a ‘[Currency than restrictively. CFTC Fact Sheet: Anti- Forward],’ and which is modified so that the par- Manipulation and Anti-Fraud Final Rules, CFTC ties settle in a reference currency (rather than Off. of P.Aff., http://www.cftc.gov/idc/groups/pu settle through the exchange of the 2 specified cur- blic/@newsroom/documents/file/amaf_factshee rencies), does not conform with the definition of t_final.pdf. ‘[Currency Forward]’ in the CEA.”). 142Id. at 41,407-08. 149See Statutory Interpretation Concerning Forward Transactions, 55 Fed. Reg. 39,188, 143See In re Amaranth Natural Gas Commodi- ties Litig., 730 F.3d 170, 173 (2d Cir. 2013); 39,190 (Sep. 25, 1990) (known as the “Brent In- DiPlacido v. CFTC, 364 F. App’x 657, 661 (2d terpretation”). Cir. 2009); In re Cox, CFTC No. 75-16, 1987 WL 150Id. 106879, at *4 (July 15, 1987). 151Swap Adopting Release at 48,229. 144See Rule 180.1 and 180.2 Adopting Re- 152See supra note 94.

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153See Managing Foreign Exchange Settle- not required to collect or post margin with a par- ment Risks for Physically Settled Transactions, ticular counterparty unless and until the com- SR 13-24 (Dec. 23, 2013). bined amount of initial and variation margin that 154SR 13-24 states that its requirements apply is required to be collected or posted is greater to entities defined in SR letter 12-17 as Large than $500,000. See Prudential Regulator Margin Institution Supervision Coordinating Committee Rules § —.5(b). firms, large banking organizations, and U.S. 159The BCBS Guidelines provide that cov- operations of large foreign banking organiza- ered firms should have collateral management tions, as well as any other banking organization policies and procedures that address collateral that engages in significant foreign exchange ac- eligibility, collateral substitution, and collateral tivities. valuation. The prudential regulators’ margin rules 155SR 13-24 states: “The guidance applies to set forth specific types of permitted collateral and foreign exchange transactions that consist of two haircut rates. See Prudential Regulator Margin settlement payment flows. This includes spot Rules § —.8. transactions, forwards, swaps, deliverable op- 160See CEA § 1a(18)(A)(xi)(I). tions and currency swaps involving exchange of 161See Business Conduct Standards for Swap principal. It excludes instruments that involve Dealers and Major Swap Participants With Coun- one-way settlement payments, such as non- terparties, 77 Fed. Reg. 9734, 9757 (Feb. 17, deliverable forwards, non-deliverable options 2012). and contracts for difference.” 162Commenters had requested guidance on 156See Basel Committee on Banking Supervi- this issue, but the CFTC did not specifically ad- sion, Supervisory Guidance for Managing Risks dress the issue. See id. at 9756 n.314 (“[T]he Associated with the Settlement of Foreign Ex- commenter questioned whether the loss of ECP change Transactions (2013). status would limit the counterparty’s ability to 157The prudential regulators’ uncleared swap terminate, modify or novate the swap.”). margin rules contain a detailed definition of a 163See Letter from Timothy W. Cameron, “financial end user,” but it is unclear whether a Managing Director, Asset Mgmt. Group, SIMFA, “financial institution” under SR 13-24 is intended to Jennifer J. Johnson, Secretary, Board of Gover- to be synonymous with a financial end user. See nors of the Fed. Res. Sys., John Walsh, Acting Prudential Regulator Margin Rules § —.2. Comptroller of the Currency, OCC, and Robert 158The BCBS Guidelines adopted through SR E. Feldman, Exec. Secretary, FDIC (Dec. 20, 13-24 merely provide that margin transfers 2011). should be subject to a “low” minimum transfer 164See Retail Foreign Exchange Transactions amount. The prudential regulators’ uncleared (Regulation NN), 78 Fed. Reg. 21,019, 21,022 swap margin rules provide that a swap dealer is (Apr. 9, 2013).

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