The Wall Street Transparency and Accountability Act – Foreign Currency, Government Securities, and the Treasury Amendment

I have been looking at the derivatives language that the Senate Agriculture Committee has contributed to what will be called if it is enacted “The Wall Street Transparency and Accountability Act of 2010.”  Particularly, I have been trying to figure out what the legislation does to the foreign exchange and government securities market, which had been excluded from CFTC jurisdiction except for transactions conducted on an organized exchange.  (The SEC has jurisdiction on foreign currency options trading on a securities exchanges, and the exclusion does not apply to retail transactions in foreign currency.)

As way of background, one of the reasons the Treasury and the CFTC battled each other during the 80s and 90s had to do with a provision of the Commodity Exchange Act (“CEA”) known as the Treasury Amendment.  Except for certain transactions conducted on a “board of trade,” this amendment to the 1974 legislation creating the CFTC excluded transactions in government securities, foreign currency, and some other items from CFTC jurisdiction.  In the 80s and 90s, the CFTC had two areas of concern which, from Treasury’s point of view, could compromise the Treasury Amendment.  First, the CFTC was going after foreign currency scams in the U.S., which often targeted immigrant communities in the U.S.  Second, it at times took a broad view of what constituted a “futures contract” because of the growing swaps market and “hybrid instruments,” such as securities with embedded derivatives (for example, indexation to the price of oil.)

The Treasury had two principal concerns.  First, the Treasury wanted to keep the when-issued (“wi”) market for Treasury securities free from CFTC regulation.  This market is important for Treasury in auctioning its securities.  Moreover, in 1986, Treasury had been given the responsibility by the Government Securities Act to write rules for all government securities dealers and brokers (including commercial banks), with the rules being enforced by the appropriate regulatory agency (the SEC and the bank regulators).  If the CFTC had authority over the wi market, this would cut into Treasury’s authority, since, under the CEA, the CFTC has “exclusive jurisdiction.”

In addition, the Treasury did not want the CFTC asserting authority over portions of the foreign exchange market.  The Treasury has the responsibility to establish U.S. foreign exchange policy.

One of the legal theories that the CFTC was using in the retail foreign currency cases was that the operators were “boards of trade” and thus the transactions in questions were not excluded by the Treasury Amendment.  (The CEA at the time did not distinguish between retail and wholesale transactions for these purposes.)  If these entities were boards of trade, the interdealer brokers, through which government securities dealers trade could also be viewed as boards of trade, and wi trades might not be eligible for the exclusion for forward contracts, since many of the wi trades are offset.  Even though the CFTC never made any move to assert jurisdiction over this market, the Treasury was concerned that there was a legal argument that could be made that the Treasury Amendment did not apply to this market.  Treasury offered to work with the CFTC to craft language explicitly giving it authority over retail foreign currency options and futures, but the CFTC spurned these suggestions until it lost a 1997 Supreme Court case on the Treasury Amendment (Dunn v. CFTC).

That case involved options on foreign currency.  The CFTC argued that options were not covered by the Treasury Amendment because they were not transactions “in” foreign currency but transactions “involving” foreign currency.  The Supreme Court disagreed with this argument 9 to 0.

The current legislation before the Senate whittles away at what remains of the Treasury Amendment by subjecting foreign exchange transactions to CFTC regulation unless the Secretary of the Treasury explicitly exempts them.  The legislation appears to keep in place the exclusion from most provisions of the CEA for foreign currency transactions.  I have not found language that differentiates between foreign currency and foreign exchange.

Concerning government securities, the legislation also appears to keep in place the exclusion from most provisions of the CEA if not conducted on an exchange.  I am not sure, though, whether the interdealer brokers and the Fixed Income Clearing Corporation might be potentially affected by their activities with respect to wi trades, which can be said to resemble traditional futures contracts.

There are a myriad more details that interested parties need, including government agencies, need to keep on top of as the legislation progresses.  When something is enacted, as seems likely, there will probably be a need for a “technical corrections” bill to correct the mistakes.