Treasury soon to decide whether FX swaps and forwards should be exempt from derivative rules; Kraft Foods lobbies CFTC.
Treasury Secretary Timothy Geithner is expected to rule soon on whether corporate FX hedgers will get their exemption from derivative rules, according to reports.
So far, most signs point to a thumbs-up as Secretary Geithner already has said that the currency swaps, forwards and options used to manage foreign exchange risks don’t pose as big a risk to the financial system as others. Nor were they major players in the financial crisis in the same way mortgage-backed securities and the credit-derivative swaps were. Although the Commodities Futures Trading Commission is writing the rules, Mr. Geithner has the authority to give the exemption. The CFTC will have its final rules written by July.
CFTC head Gary Gensler, prior to the passage of Dodd-Frank, had expressed his desire to see FX swaps included in the regulation. And to combat his view, companies have been lobbying the CFTC hard since the law was passed. Just last week the CFTC met with Kraft Foods, which laid out its argument for the exemption.
The Kraft-CFTC meeting report gives a good view into Kraft Foods’ operations, including its use of subsidiary Kraft Foods Finance Europe (KFFE), which acts as an in-house treasury that also centralizes global cash management. In the meeting, Kraft explained how two subsidiaries “act as centralized hedging centers with respect to Kraft Foods’ operations outside of North America.” The other subsidiary, Taloca GmbH, is a centralized procurement unit for globally-managed commodities. Kraft said KFFE uses currency swaps, forwards and options to manage foreign exchange risks and that Taloca uses commodity futures, forwards and options to manage price and supply risks. Here’s why Kraft is concerned it will get swept up in the regulation since the activities of KFFE and Taloca could be considered to be “financial in nature” as referred to in the definitions for a financial entity. Of course, Kraft Foods does not believe its activities were intended to be considered financial and here’s why:
“KFFE and Taloca each enter into swaps with third-party dealers as necessary to lay off the risks of the consolidated group. (Kraft Foods also uses interest-rate swaps, but this activity is not consolidated in hedging centers.) Kraft Foods emphasized [in the meeting] that KFFE and Taloca enter into swaps only up to the extent of actual currency and commodity positions of the consolidated group; that is, each hedge is with respect to an actual position. The swaps between KFFE or Taloca and third-party dealers are mirrored by transactions between KFFE or Taloca and their affiliates, which have identical terms. (In some cases, KFFE acts as agent and the affiliate is actually the legal party to the swap with the third-party dealer.) Kraft Foods believes that KFFE and Taloca should not be treated as a “financial entity” for purposes of the end-user exception from clearing in new section 2(h)(7) of the Commodity Exchange Act (CEA). Kraft Foods is concerned that KFFE and Taloca are not actually agents for their affiliates. Kraft Foods believes the exemption should apply to KFFE and Taloca because they enter into swaps on behalf of and at the instruction of their affiliates.”
These sound like good arguments and it seems Secretary Geithner has every intention to exclude FX swaps – he was also a strong proponent of exclusion leading up to the final passage of Dodd-Frank. Still, there is the political angle, although at the moment its atmosphere is not quite as heated as it was when Dodd-Frank was passed (see related story here).