Update: Dodd-Frank Rules Impact End-Users of Foreign Exchange Derivatives - Companies That Hedge Foreign Exchange Exposures Need to Take Action by End of Year

Background

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) was enacted. Title VII of Dodd-Frank amends the Commodity Exchange Act (CEA) and other federal securities laws to provide a comprehensive new regulatory framework for the treatment of derivatives, which generally are defined as "swaps" under Section 721. Among other things, Dodd-Frank provides for:

• the registration and regulation of swaps dealers and major swap participants;
• the implementation of clearing and trade execution requirements for swaps; and
• the establishment of recordkeeping and reporting requirements for swaps.

The definition of "swaps" under the Dodd-Frank Act is quite broad and includes a wide variety of foreign exchange (FX) derivatives, such as FX swaps, FX forwards, currency swaps, cross-currency swaps, foreign currency options (including collared options), and non-deliverable FX forward contracts (NDFs). In July 2012, the U.S. Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) issued an interpretation that certain FX spot transactions are not FX forwards under the CEA, including FX transactions entered into in connection with a foreign securities transaction that are settled within the settlement cycle of the related securities transaction.¹

For corporate end-users of FX derivatives, there are two proposed key exemptions from the clearing and trading requirements of Dodd-Frank. First, the Secretary of the Department of the Treasury has been authorized under the CEA to make a written determination of whether or not FX swaps and FX forwards should be regulated as swaps under the CEA. The first section of this alert, titled "Department of Treasury Proposal," summarizes the proposed Treasury release that provides for the exemption of certain specified types of FX swaps and FX forwards from the definition of swaps under the CEA (other than with respect to certain external business conduct, reporting, and anti-manipulation provisions under the CEA). For corporate end-users of FX derivatives other than the physically settled FX swaps and FX forwards described below, there is a second exemption from the clearing and trading requirements of Dodd-Frank provided by the so-called "end-user exception."

The second section of this alert, titled "The End-User Exception," sets forth the final rules that will be applicable to an FX derivative entered into by a corporate end-user to the extent that such FX derivative is not subject to the trading and clearing exemption provided by the Treasury proposal. Finally, the remainder of this alert summarizes a variety of other rules and regulations (in both final and proposed form) that will be applicable to corporate end-users of FX derivatives under Dodd-Frank, as well as timelines for action items that must be taken by corporate end-users of FX derivatives. Note that a number of the rules discussed in this alert are in proposed form and therefore may be subject to significant modification or revision prior to final adoption.

Please note that the External Business Conduct Rules described in the "Documentation Requirements" section of this alert will become effective by January 1, 2013, and corporate end-users will be required by swap dealers to modify their existing FX derivative documentation prior to executing any new FX derivative transactions after that date.

Department of Treasury Proposal

On April 29, 2011, the Treasury issued a notice of proposed determination pursuant to which the Treasury would exempt both FX swaps and FX forwards (as currently defined under the CEA) from the definitions of swaps under the CEA going forward.

An "FX swap" is defined narrowly by the CEA and the Treasury's proposed determination as a transaction that solely involves:

• an exchange of different currencies on a specified date at a fixed rate that is agreed upon at the inception of the contract covering the exchange, or
• a reverse exchange of those two currencies at a later date and at a fixed rate that is agreed upon at the inception of the contract covering the exchange.

The definition of an "FX forward" also is defined narrowly under the CEA to be "a transaction that solely involves the exchange of two different currencies on a specified future date at a fixed rate agreed upon on the inception of the contract covering the exchange."

The Treasury clearly states in the proposed determination that the secretary's authority to exempt FX swaps and FX forwards from the definition of swaps under the CEA is limited solely to FX derivative transactions that fit within the above definitions, and that it does not extend to any other type of FX derivative transaction. As a result, FX derivative transactions such as foreign currency options, currency swaps, cross-currency swaps, and NDFs will not be exempt from the definition of swaps under the CEA pursuant to the Treasury's exception, as these instruments do not fit within the statutory definitions of FX swaps and FX forwards set forth previously. These FX derivatives will be subject to the clearing and trading requirements of Dodd-Frank discussed below unless another exemption, such as the end-user exception described in the next section, is available.

In support of its decision to exempt FX swaps and FX forwards from the definition of swaps under Dodd-Frank, the Treasury set forth a series of justifications in support of its position, including the fact that FX swaps and FX forwards have fixed-payment obligations, are settled physically, and typically have short-term maturities for which the settlement risk already is addressed through a highly developed payment-versus-payment settlement system.

It is important to note that while the proposed determination would exempt FX swaps and FX forwards from Dodd-Frank's clearing and trading requirements, these types of transactions still would be subject to the following Dodd-Frank provisions: (1) the requirement to report swap-trade data to swap repositories, (2) the business-conduct standards proposed for swap dealers and major swap participants, and (3) anti-evasion provisions.

Corporate end-users of FX derivatives will be required to rely on the end-user exception to avoid the clearing and trading requirements if the Treasury proposal is not finalized and adopted prior to the time that the clearing and trading requirements become applicable. We generally recommend that corporations trading FX derivatives avail themselves of the end-user exception even if certain of their FX derivatives may be exempt from the clearing and trading requirements of Dodd-Frank if and when such a Treasury proposal is finalized.

The End-User Exception

If your corporation trades FX derivatives other than physically settled FX swaps and FX forwards that do not qualify for the proposed Treasury exemption, you may be able to rely on the exemption from Dodd-Frank's clearing and trading requirements provided to corporate entities that meet specified requirements set forth by the CFTC. This exemption commonly is referred to as the "end-user exception."

The Dodd-Frank Act amended the CEA to require, among other things, that swaps be cleared through a derivatives clearing organization (DCO) if the CFTC determines that the swap is the type that is subject to the CEA clearing requirements (unless an exception to mandatory clearing is available). It also required that any swap determined to be subject to the clearing requirement be executed on a registered trading platform.

However, the CEA provides for an elective exception to the mandatory clearing requirement for a non-financial entity that uses swaps to hedge or mitigate its commercial risk and that also complies with certain notification requirements to be determined by the CFTC under the CEA.

On July 19, 2012, the CFTC published a final rulemaking release titled "End-User Exception to the Mandatory Clearing of Swaps" (End-User Final Release) that sets forth in greater detail the rules for the end-user exception. According to the release, in order to qualify for the clearing exception, a corporate end-user of FX derivatives needs to meet the following conditions:

• Non-Financial Entity. The end-user exception is available only to counterparties that are not financial entities.² Most corporations that use FX derivatives to hedge their FX exposures should meet this requirement. Note that each direct and indirect subsidiary of the parent corporation that enters into a swap transaction will need to determine that it is not a financial entity for purposes of the end-user exception, including any treasury affiliates that are separate legal entities.³
• Hedging or Mitigating Commercial Risk. Under the final rule, a swap must meet one of the following three conditions for the purpose of hedging or mitigating commercial risk:
  • The swap is economically appropriate to the reduction of risks in the conduct and management of a commercial enterprise where the risks arise from:
    • the potential change in the value of assets that a person owns, produces, manufactures, processes, or merchandises, or reasonably anticipates owning, producing, manufacturing, processing, or merchandising in the ordinary course of business of the enterprise;
    • the potential change in the value of liabilities that a person has incurred or reasonably anticipates incurring in the ordinary course of business of the enterprise;
    • the potential change in the value of services that a person provides, purchases, or reasonably anticipates providing or purchasing in the ordinary course of business of the enterprise;
    • the potential change in the value of assets, services, inputs, products, or commodities that a person owns, produces, manufactures, processes, merchandises, leases, or sells, or reasonably anticipates owning, producing, manufacturing, processing, merchandising, leasing, or selling in the ordinary course of business of the enterprise;
    • any potential change in value related to any of the foregoing arising from interest, currency, or foreign exchange-rate movements associated with such assets, liabilities, services, inputs, products, or commodities; or
    • any fluctuation in interest, currency, or foreign exchange-rate exposures arising from a person's current or anticipated assets or liabilities.
  • The swap qualifies as a bona fide hedging for purposes of an exemption from position limits under the CEA.
  • The swap qualifies for hedging treatment under Financial Accounting Standards Board Accounting Standards Codification Topic 815, Derivatives and Hedging (formerly known as Statement No. 133) or Governmental Accounting Standards Board Statement 53, Accounting and Financial Reporting for Derivative Instruments.

In addition, the swap must not be used (1) for a purpose that is in the nature of speculation, investing, or trading, or (2) to hedge or mitigate the risk of another swap or security-based swap position, unless that other position itself is used to hedge or mitigate commercial risk.

• Board of Directors Approval for SEC-Registered Corporations. In order for a public company registered under the Securities Exchange Act of 1934 (Exchange Act) to utilize the end-user exception, an "appropriate committee" of the company's board of directors would need to review and approve the decision to enter into swaps that are subject to the clearing and trading exception. The CFTC states in the End-User Final Release that an "appropriate committee" is one that is "specifically authorized to review and approve the SEC Filer's decisions to enter into swaps." Subsidiaries of SEC-registered corporations also will be subject to the requirement to obtain committee approval to use the end-user exception. According to the CFTC, the "SEC Filer's board would have reasonable discretion to determine the appropriate committee for approving swaps for its subsidiaries or affiliates." In the End-User Final Release, the CFTC notes that such committee approval to rely on the end-user exception may occur on an annual basis (versus a swap-by-swap basis). The CFTC expects the appropriate committee to set policies for the use of the end-user exception and to review these policies at least annually or more often upon a triggering event, such as the adoption of a new hedging strategy not previously contemplated by the committee. Committee approval must cover both the exception from the clearing requirement and the exception from the exchange trading requirement. In addition to this committee approval requirement, any public company seeking to use the end-user exception must provide the corporation's SEC Central Index Key information and notification that the committee of the board of directors has approved the decision not to clear the swap or require the swap to be traded on an exchange in the manner described below.
  
  We expect that most public companies would designate their audit committee as the "appropriate committee" for making the determination to utilize the end-user exception. If this were the case, the board of directors of the public company will need to approve a resolution or amend the audit committee charter to provide that the audit committee is "specifically authorized to review and approve decisions to enter into swaps." The audit committee then would need to review, at least on an annual basis or more often if there were a change in strategy or the use of additional types of swaps by the company, the corporation's policies for use of the end-user exception and the current and prospective hedging strategy and use of swaps by the company. The audit committee then would weigh the costs and benefits of electing to use the end-user exception. After this review, the committee would need to approve the use of the end-user exception for both the clearing and trading requirements. Each particular swap, however, still would need to comply with the requirements of the end-user exception.
• Notification Requirements. In order for the end-user exception to be elected with respect to a swap, the following information must be provided to a swap data repository or, if no swap data repository is available, to the CFTC:
  • The following information must be provided by the reporting counterparty to the swap (typically, for corporate end-users, the reporting counterparty will be the swap dealer) on a swap-by-swap basis:
    • Notice of the election of the end-user exception
    • Identification of the electing counterparty (i.e., the end-user of the FX derivatives)
    • Whether the electing party already has provided the additional information set forth below through an annual filing
  • The following information must be provided on a swap-by-swap basis by the reporting counterparty if the information has not been provided by the corporation as the electing counterparty in its current annual filing:
    • Whether the electing counterparty is a "financial entity" as defined in CEA Section 2(h)(7)(C)(i), and, if the electing counterparty is a "financial entity," whether it is:
      • Electing the exception in accordance with CEA Section 2(h)(7)(C)(iii) (i.e., captive finance entity exception) or CEA Section 2(h)(7)(D) (i.e., executed as agent to a non-financial entity eligible for the exception), or
      • Exempt from the definition of financial entity under CEA Section 2(h)(7)(C)(ii) and CFTC regulation ?39.6(d) (i.e., small bank exemption)
    • Whether the swap hedges or mitigates commercial risk
    • How the electing counterparty generally meets its financial obligations associated with entering into non-cleared swaps by identifying one or more of the following categories:
      • A written credit support agreement
      • Pledged or segregated assets (including posting or receiving margin pursuant to a credit support agreement or otherwise)
      • A written third-party guarantee
      • The electing counterparty's available financial resources
      • Means other than those described immediately above
    • Whether the electing counterparty is an entity that is an issuer of securities registered under Section 12 or is required to file reports under Section 15(d) of the Exchange Act, and, if so:
      • The relevant SEC Central Index Key number for that counterparty, and
      • Whether an appropriate committee of that counterparty's board of directors (or equivalent body) has reviewed and approved the decision to enter into swaps that are exempt from the clearing and execution requirements

The CFTC also requires that a reporting counterparty have a "reasonable basis" to believe that the electing counterparty meets the requirements for the end-user exception and, as a result, the end-user should expect the reporting counterparty to seek representations from the end-user to support this reasonable belief.

Please note that the decision to use the end-user exception is at the election of the non-financial user, which still can decide to clear the FX derivative to the extent that there is a clearing entity willing to do so.

Margin Requirements for Uncleared Swaps

Both the CFTC and the prudential regulators⁴ have issued separate proposed releases setting forth the margin requirements for uncleared swaps for swap dealers and major swap participants. Both sets of proposed rules will require that swap dealers and major swap participants collect margin from their respective counterparties, subject to certain exceptions. The margin requirements applicable to a corporate end-user of FX derivatives will depend on whether its counterparty is a swap dealer or major swap participant that is governed by either the prudential regulators or the CFTC. If the counterparty for a corporate end-user of FX derivatives is a financial institution such as a bank, which is often the case with corporate end-users of FX derivatives (particularly if that corporate end-user has a credit agreement in place with that same financial institution), then the corporate end-user will be subject to the margin requirements specified by the prudential regulators. If a corporate end-user enters into an FX derivative with a swap dealer or major swap participant that is not subject to oversight by the prudential regulators, then the corporate end-user will be subject to the margin requirements for uncleared swaps specified by the CFTC.

While the proposed rules are similar in a number of respects, the proposed margin requirements for non-financial end-user counterparties present one key difference. The prudential regulators propose requiring that swap dealers and major swap participants collect initial and variation margin from non-financial end-users of swaps to the extent that the exposure of the swap dealer or major swap participant to the end-user exceeds credit limits or threshold amounts, as determined by the swap dealer counterparty. The swap entity would be required to collect the excess initial margin or variation margin over the specified threshold amounts when the cumulative required initial margin or variation margin for transactions with the non-financial end-user exceeds the initial margin or variation margin threshold amount, respectively. If this rule is adopted as proposed, it essentially would eliminate much of the benefit of the end-user exception from the clearing requirements because corporate end-users of swaps still would be subject to margin requirements if their respective counterparties were financial institutions subject to regulation by the prudential regulators.

The CFTC's proposal would exempt non-financial end-users from the margin requirements. Therefore, any uncleared FX derivatives entered into by a corporate end-user would not be subject to margin requirements if the swap entity counterparty were not subject to the prudential regulators' regulatory regime. However, under the CFTC proposal, all swap dealers and major swap participants would be required to have in place a credit support arrangement. The proposal does not specify any requirements as to the terms of such credit support agreements or margin arrangements other than to state that a swap entity may accept as margin from a non-financial entity only those assets for which the value is "reasonably ascertainable on a periodic basis in a manner agreed to by the parties in the credit support arrangements." Corporate end-users of FX derivatives should be able to meet the requirement to have some form of credit support arrangement to the extent that they currently have in place an International Securities Dealers Association (ISDA) Credit Support Annex (CSA), although the form of such a CSA is likely to be modified prior to the required implementation period of the various Dodd-Frank initiatives. If an end-user elects to clear its swaps, that action will be subject to the margin requirements specified for cleared swaps.

Please note that these margin requirements do not require the swap dealer or major swap participant to post margin or collateral to a non-financial end-user. The margin collection requirements work in only one direction.

Timetable

General

Predicting the timetable for the implementation of these various Dodd-Frank initiatives is very difficult in light of the large number of proposed rules and the number of regulators involved in the rulemaking process. On September 20, 2011, the CFTC issued a proposed rule that specified the proposed timeline and schedule with respect to the clearing, exchange trading, documentation, and margin requirements, also known as the "Clearing Timetable Rules." In the September 2011 proposal, the CFTC noted that the phase-in periods for the Clearing Timetable Rules would not commence until a large number of conditions precedent were satisfied, along with the adoption of a number of final rules that are prerequisites to the implementation of the rules, particularly the finalization of releases with respect to (1) the definition of key swap terms (approved in July 2012), (2) the end-user exception (approved in July 2012), and (3) rules relating to the protection of cleared swaps' customer contracts and collateral.

In July 2011, the CFTC adopted a final rule that set forth the procedures and process with respect to the CFTC's review of swaps for mandatory clearing. In the September 2011 proposal, the CFTC stated that it initially will consider mandatory clearing determinations for swaps that currently are being cleared by derivatives clearing organizations, such as interest-rate swaps, credit-default swaps, and commodity swaps. In that release, there was no mention of FX swaps among the types of swaps that would be evaluated first with respect to a mandatory clearing requirement. The CFTC stated in the release that it planned in the "near term" to begin the review process for issuing mandatory clearing determinations with respect to these types of swap arrangements. The September 2011 proposal provided that the CFTC would have discretion to phase in the implementation of any clearing requirements for 90, 180, or 270 days, depending on the types of entities that are party to the swap. Non-financial entities, such as corporate end-users of FX derivatives, would be granted the longest phase-in period of 270 days. The trigger for the implementation of the phase-in period would be the finalization of all the prerequisites specified in the release and the CTFC's notification that this particular type of swap is subject to the clearing mandate.

FX derivatives that are subject to the clearing requirement but do not meet either the requirements of the Treasury exception or the end-user exception would be required to be traded on a designated contract market (DCM) or a swap-execution facility (referred to as "SEF," a newly created category of trading facilities under Dodd-Frank). If no DCM or SEF makes the swap available for trading, the requirement for the swap to be traded on an exchange would not apply. A swap that is subject to the clearing requirement would be subject to the exchange trading requirement either (1) on the same timetable as the clearing requirements or (2) 30 days after the first date on which the swap is made available for trading on a DCM or SEF.

Key Upcoming Deadlines

The end-user exception to the mandatory clearing requirements becomes final on September 17, 2012. However, under the CFTC's final implementation schedule for mandatory clearing (published on July 30, 2012), a non-financial end-user is not subject to the mandatory clearing requirements until 270 days after mandatory clearing determinations are effective. Accordingly, a corporate end-user will not need to elect or comply with the end-user exception until the end-user becomes subject to the mandatory clearing requirements governing a particular swap. On July 24, 2012, the CFTC approved proposed clearing determinations for certain credit-default swaps and interest-rate swaps. End-users will have 270 days after the final versions of these clearing determinations are published to meet the requirements of the end-user exception with respect to these swaps. We generally expect that most corporate end-users that wish to rely on the end-user exception will obtain appropriate committee approval by the end of 2012 to qualify for the exception prior to the time that any of their swaps would become subject to the clearing and trading requirements.

On October 12, 2012, the CFTC's final rule on real-time public reporting and regulatory reporting will become effective, and reporting entities likely will begin collecting information from corporate counterparties prior to this date. For most corporate end-users of swaps, the reporting parties for the real-time public reporting and regulatory reporting will be their swap dealer counterparties.

On January 1, 2013, the CFTC's final rules on external business-conduct standards that apply to swap dealers will become effective. As a result, counterparties will be required to amend their existing ISDA documents to comply with the requirements discussed in further detail below or potentially risk not being able to enter into new swaps after this date.

Documentation Requirements

As noted above, the CFTC has promulgated final rules that impose various documentation requirements on swap dealers and major swap participants under the external business conduct standards and swap data reporting requirements that will become effective by the middle of October 2012. As a result, existing swap documentation should be amended prior to such date for swap dealers to meet these regulatory requirements. While the parties to a swap could amend the documentation individually for each swap transaction on a one-by-one basis, ISDA has created a protocol in response to these new rules that allows parties to amend their existing documentation by agreeing to certain supplements published by the ISDA. We generally expect that most corporate end-users will adhere to the protocol for the SEC-registered parent entity and each of its subsidiaries that enter into swaps.

An end-user will be able to use the protocol to supplement its existing swap documentation with a counterparty by (1) agreeing to an adherence letter that will be published by the ISDA for viewing by other swap participants and (2) delivering questionnaires to each counterparty. The end-user will submit the adherence letter via an online form and it will contain the end-user's agreement to the protocol and delivery instructions for delivery of a questionnaire by the counterparty. After the submission of the adherence letter and the delivery by each counterparty of a questionnaire to the other counterparty, the existing swap documentation will be amended. The protocol can be used to supplement both ISDA master agreements and other FX derivative documentation between the parties.

The questionnaire will contain various representations to be made by the end-user, such as status, power, no violations or conflicts, consents, and the binding nature of its obligations under the protocol. It also will include the required "know your counterparty" information, which features the end-user's name, legal identifier (obtained through the Depository Trust Company for each legal entity in the corporate group using swaps) and address, and the identity of any guarantors and any person exercising control over the end-user. The questionnaire will require the end-user to verify that it is an "eligible contract participant" under the CEA and will permit the end-user to specify whether it is a "specified entity" or "financial entity." An end-user will be required to notify its counterparty of any material change in the information provided pursuant to the protocol, including if any representation has become untrue or misleading in any material respect. The end-user also must provide notice of any "life-cycle event."⁵ We expect most corporate end-users to incorporate Schedules 1 through 3 of the ISDA DF Supplement when completing the questionnaire. In order to make certain representations set forth in Schedule 3 of the ISDA DF Supplement, the corporate end-user should have in place written policies and procedures that are reasonably designed to ensure that the person evaluating swap recommendations from the swap dealer and making trading decisions for the corporate end-user has the requisite capabilities.

We expect that the ISDA eventually will provide a new form of the ISDA master agreement and schedule only after all of the relevant applicable Dodd-Frank rules have been finalized, which means that it could be quite some time before such a form is available. In addition, corporate end-users that seek to rely on the clearing exceptions may need to enter into a credit support agreement (such as an ISDA CSA) if their respective counterparties are subject to CFTC regulation, or if their counterparties are subject to the prudential regulators and the end-users' credit profiles exceed internal limits set by the financial institution counterparties, assuming these proposed rules are adopted in their current form.

Finally, if a corporate end-user elects to have its FX derivatives cleared notwithstanding the Treasury exception or the end-user exception because it provides better economic terms, greater liquidity, or other benefits, then such corporate end-user will need to select a clearinghouse to clear its trades and establish a relationship with a participant who can provide access to the clearing process. The end-user most likely will be required to enter into documentation provided by the futures commission merchant to determine who could provide such service. The ISDA, in conjunction with the Futures Industry Association, has published a standard form of agreement that is designed to provide for the clearing and trading of over-the-counter derivatives that are required to be cleared under Dodd-Frank. We expect the documentation for cleared swaps to be subject to more limited negotiation than the bilateral ISDA master agreement, schedule, and related ISDA documentation.

Reporting and Recordkeeping Requirements

The recordkeeping and reporting requirements for swaps (including FX derivatives) are quite complex. End-users will be required to keep full, complete, and systematic records, together with all pertinent data and memoranda, with respect to each swap to which it is a counterparty, including (without limitation) all records demonstrating that it is entitled with respect to any swap to elect the end-user exception to the clearing requirement. The records must be retained for the life of the swap and for at least five years following the termination of the swap.

There are three basic categories of reporting requirements:

• Real-Time Reporting: Provides for real-time reporting and public dissemination of certain swap data, including pricing data for certain newly executed swaps and amendments to existing swaps
• Regulatory Reporting: Provides for reporting to SDRs of primary economic terms and confirmation data of swaps, lifecycle data, and valuation data, but the information will not become publicly available
• Historical Reporting: Provides for similar reporting requirements as regulatory reporting to SDRs of historical swap information

For each historical swap that terminated or expired prior to April 25, 2011, end-users must retain for five years after the termination or expiration date records that were in their possession as of either October 14, 2010 (in the case of pre-enactment swaps) or December 17, 2010 (in the case of transition swaps) indicating the primary economic terms of the swap. They also must retain copies of (1) any confirmation executed by the parties, (2) any master agreement governing the swap and any amendment or modification thereof, and (3) any credit support agreement relating to the swap and any amendment or modification thereof. Records of current and historical swaps may be kept in paper or electronic form and must be retrievable within five business days.

Dodd-Frank requires all transactions in swaps to be reported to a swap data repository or, if no swap data repository is available, to the relevant commission. These reporting requirements are applicable to you as a corporate end-user of FX derivatives only in the event that your counterparty is neither (1) a clearinghouse in the case of a cleared swap or (2) a swap dealer or major swap participant in the case of an uncleared swap. As a result, you will be subject to these reporting requirements only if your counterparty is another end-user, which will be extremely unlikely for most corporate end-users of FX derivatives.

What You Should Do Now

Corporate end-users of FX derivatives should take the following steps, among others, before the end of 2012 in order to comply with the regulations described in this alert:

• Confirm that the corporation may avail itself of the end-user exception and prepare board and audit committee resolutions and policies that will permit compliance with the exception.
• Amend existing ISDA documents by reviewing and completing the ISDA protocol documentation

If you have any questions about the information in this alert, please contact Michael Occhiolini at (650) 320-4688 or mocchiolini@wsgr.com, Erik Franks at (650) 565-3879 or efranks@wsgr.com, or your regular Wilson Sonsini Goodrich & Rosati contact.

¹ In the CFTC 17 CFR Part 1 release, the commissions stated that "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.' In general, a foreign exchange transaction will be considered a bona fide spot transaction if it settles via an actual delivery of the relevant currencies within two business days. In certain circumstances, however, a foreign exchange transaction with a longer settlement period concluding with the actual delivery of the relevant currencies may be considered a bona fide spot transaction depending on the customary timeline of the relevant market."

² Subject to limited exceptions, financial entities include swap dealers, major swap participants, commodity pools, private funds such as hedge funds, employee benefit plans under ERISA, and entities that are engaged predominately in the business of banking or activities that are financial in nature (as defined in Section 4(k) of the Bank Holding Company Act).

³ Under the End-User Final Release, the Treasury affiliates that are separate legal entities that are acting as agent and not principal for another affiliate in the corporate structure will be able to rely on the end-user exception if such affiliate can itself rely on the end-user exception and the swap is being undertaken to hedge or mitigate commercial risk of the affiliate that qualifies for the end-user exception. Treasury affiliates that are separate legal entities, are acting on a principal basis for their own account, and that would qualify as "financial entities" under the CEA may not rely on the end-user exception.

⁴ The prudential regulators consist of the Federal Reserve Board, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Farm Credit Administration, and the Federal Housing Finance Agency.

⁵ "Life-cycle events" include any event that changes the primary economic terms of the swap or the primary economic terms previously reported to a swap data repository.