MFX Solutions, Inc. 

~W..mfx ~ 

1050 17th Street NW, Suite 550 

Washington, DC 20036 

Tel: 202 527-9947 

Fax: 202 280-1212 

Email: brian.cox@mfxsolutions.com 

Mary J. Miller 

Assistant Secretaty for Financial Markets 

Office of Financial Institutions Policy 

1500 Pennsylvania Avenue, NW. 

Washington, DC 20220 

MICROFINANCE 

CURRENCY RJSK SOLUTIONS 

November 29, 20 10 

Re: Determination of Foreign Exchange Swaps and Forwards - Request for Comment 

Dear Assistant Sccrctmy Miller: 

MFX Solutions. Inc. (MFX) is wntmg to provide comments in response to the Department of the 

Treasllly's norice and request for comments dated October 28, 20 I 0 in connection with Section 721 of the 

Dodd-Frank Wall Street Rcfonn and Consumer Protection Act (the Dodd-Frank Act). Section 721 

permits the Secretary of the Treaswy to make a written determination that "foreign exchange swaps" or 

"foreign exchange forwards" , or both, should be exempted from the definition of "swap" under the US 

Commodity Exchange Act, as amended by the Dodd-Frank Act (the CEA), and arc not strucnu·cd to 

evade the Dodd-Frank Act in violation of any rule promulgated by the Commodity Funu·es Trading 

Commission (CFTC). 

As discussed in greater detail below, MFX believes that exempting "foreign exchange swaps" and 

"foreign exchange forwards" from the definition of "swap" in the CEA, as amended by the Dodd-Frank 

Act. is warranted. Granting such an exemption is imp011ant not only to MFX's business and its 

microfinance clients, but also to the functioning of the broader currency exchange market, both globally 

and in the United States. Subjecting MFX's currency hedging transactions to the clearing and collateral 

requircme111s of the Dodd-Frank Act would make it more diffi cult for MFX to carry out its development 

mission and would ultimately impact the micro-entrepreneurs that benefit from the loans MFX's clients 

provide. 

Please find below MFX's preliminaty comments regarding the factors and detenninations relcvam to the 

exemption of "foreign exchange swaps" and "foreign exchange forwa rds" from the definition of "s\vap" 

under the CEA. 

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1. BACKGROUND 

Section 721 of the Dodd-Frank Act authorizes the Secretary of the Treasury to make a written 

determination that "foreign exchange swaps"' or "foreign exchange forwards", or both, should not be 

regulated as "swaps" under the CEA and arc not structured to evade the Dodd-Frank Act in violation of 

any rule promulgated by the CFTC.

1 Should the Secretary of the Treasury dctcm1inc to usc its exempti ve 

authotity, foreign exchange swaps and foreign exchange forwards would be exempted from many of the 

substanti ve provisions of the Dodd-Frank Act, including the clearing and designated contract market or 

swap execution facility transacting requirements (any such requirement, a Trading Facility 

Requirement) for standardized swaps. All foreign exchange swaps and foreign exchange forwards 

exempted by the Secretaty of the Treasllly , however. would under the Dodd-Frank Act be required to be 

reponed to a "swap data rcposiwty", or to the CFTC if no such swap data repository exists . . In addition, 

any party to a foreign exchange swap or foreign exchange fo rward that is a "swap dealer" or "major swap 

participant" will remain subject to the business conduct standards set out in the CEA as introduced by the 

Dodd-Frank Act. 

2. MFX'S BUSINESS AND MODEL 

MFX was fOillled in 2008 by a group of microfinancc organizations, including lenders, investors, raters, 

networks. and foundations, seeking to minimize curTency risk in the microfmance industry. MFX operates 

as a non-profit micro finance industry cooperative dedicated to providing microfinance lenders with: (I) 

the knowledge to quantify cun·ency tisk; and (2) afTordable and accessible hedging instruments designed 

to mitigate currency risk. MFX has partnered with the U.S. government's Overseas Private Investment 

Corporation (OPIC) and the Cun·cncy Exchange Fund (TCX), an initiative of the Dutch Development 

Bank FMO and the Dutch government, to serve microfinance investment funds and institutions that 

provide microfinance loans to microbusincsscs in developing and newly industrialized countries. 

M FX has the unique mission to reduce currency risk for small micro fi nance lenders so that they can 

cominue to serve poor entrepreneurs with very small loans to support microbusinesses. MFX gives 

lenders in the United States and Europe with the ability to make loans to microfinancc institutions in local 

currency by providing foreign exchange swaps and foreign exchange forwards and oprions to such 

lenders. The currencies in which MFX provides hedging fac ilities are typically exotic (for exampl e subSaharan Africa, Central America and Central Asia), where hedging instruments arc not avail able from 

commercial financial institutions. A typical foreign exchange swap or foreign exchange forward entered 

into by MFX has a notional value of U.S.$1-2 million. MFX expects its notional hedging ponfolio to 

reach a value of U.S.$400 million after two to three more years of operation. 

To manage its market risk, MFX fully off.c;ets the foreign exchange risk from its clients via a matching 

hedge. generally a foreign exchange swap or a fo reign exchange forward, with a counterparty, which can 

be either TCX or a commercial bank. As an intermediary, MFX retains a small margin, covering costs and 

business viability. on the two transactions that, in all other respects, mirror one another. MFX therefore 

carries no foreign exchange market risk. 

A key aspect of MFX's model is its collateral aJTangcmcnt which is designed to reduce the burden of 

collateral on smaller development lenders while ensuring that all transacti ons arc appropriately 

collateralized. MFX docs so pursuant to a guarantee from OPIC, which guarantees the default of MFX's 

;\ s used in this leiter. "foreign cxchang.: forwnrd" and "foreign exchange swap" refer to the transactions ddincd in Sections Ja(24) and 

la( 25l. respec ti vely. of the CEA. 

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micro finance indusuy clients. M FX then assigns this guarantee as collateral on hedges with its offsetting 

countcrparty (TCX or a commercial bank) to whom MFX offloads its foreign exchange market risk. 

Despite being a very small, low risk enterprise, MFX has several peculiarities that would make it difficult 

for M FX to operate if fore ign exchange swaps and foreign exchange forwards arc not exempt from the 

Dodd-Frank Act's clearing requirements and Trading Facility Requirements. MFX serves a specialized 

market niche with clients who need foreign exchange products tailored to hedge their specific loan 

products. In particular, the fo reign exchange swaps and forward exchange forwards MFX enters into with 

its clients arc not of the type tor which a liquid market already exists and such contracts would be eli fficult 

if not impossible to clear and comply with applicable Trading Facility Requirements. MFX's business also 

utilizes a specialized collateral regime based on its OPIC guarantee rather than cash or securities. I r 

MFX's foreign exchange swaps and foreign exchange forwards arc required to be cleared, it is unlikely 

that any centra l clearing house would accept MFX's OPIC guarantee as collateral. MFX would therefore 

probably be required to post cash or securities as collateral, increasing its costs and the costs fo r its clients 

and ultimately possibly rendering MFX's services too ex pensive for its microfinancc institution clients. 

In addition, if foreign exchange swaps and foreign exchange fonvarcls arc not exempted from the 

definition of "swap" by the Secretary, MFX believes that it could be considered a "swap dealer". 

Compliance with the registration, reporting, and margin and capital requirements implemented pursunnt 

to the Dodd-Frank Act will likely impose significant additional costs on MFX. As with the requirements 

imposed by clearing and other Trading Facility Requirements, the increased costs of compliance could 

render MFX's services too expensive for the micro finance institutions which rely on M FX's services. 

3. ANALYSIS 

ivlFX believes the Secrctmy of the Treaswy should consider the following factors when determining 

whether to exempt foreign exchange swaps and foreign exchange fo rwards from the definition of "swap" 

in the CEA. 

3.1 Driving foreign excha nge swaps and forwa rds business offshore 

MFX concurs with the letter of STFMA, AFME and ASI FMA dated November 15, 20 I 0 (the SIFMA 

Letter) and in particular with the concern ex pressed in the SIFMA Lellcr that applying the Dodd-Frank 

Act to US-sourced foreign exchange swaps and foreign exchange forwards will drive the foreign 

exchange business offshore. As a US-based provider to clients in Europe and an ex porter of financial 

services, MFX is keenly aware of how its business could be disrupted if clearing is applied to illiquid, 

customized products or if' certain legitimate collateral arrangements arc disallowed in the United States. 

The fo reign exchange swap and fore ign exchange forward markets for major currencies arc historically 

the most robust swaps markets. These markets neither contributed to nor were substantially disrupted by 

the global financial crisis. Eliminating US-based suppliers of these products and, in MFX's case, 

eliminating the only specialized supplier of hcdgi.ng to the microfinancc industry, would be a steep price 

to pay, particularly because doing so would fai l to address the main sources of systemic risk caused by 

other types of deri vative transactions. 

3.2 T he need fo r swaps that ma tch the hed ging needs of MFX's clients 

Foreign exchange swaps and fore ign exchange forwards arc, when used for hedging purposes, 

fundamentally designed to help a business plan future cash flows. Organizations must be able to structure 

their hedging speci ftcally to match cash flows. M FX dea ls with lenders who provide loans to small 

institutions that serve the global poor. Most of these microfinancc lenders do not price currency risk into 

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the microfinancc loans they provide and therefore need hedging products that fully match their foreign 

currency cash nows. The loans provided by microfinance lenders can be either fixed or floating rate loans 

and have vatying repayment and amortization schedules. They also are in a wide variety of currencies, 

few of which have liquid prices available fo r fo reign exchange swaps or fo reign exchange forwards. A 

cleating requirement that requires standardized products for case of trading and clearing rather than 

customi7.cd products that meet the needs of clients would result in the inability of micro finance lenders to 

effectively manage their risk. 

3.3 The need to exempt a ll cu rrency swaps that arc economically equivalent to fo reign exchange 

forwa rds 

The need for businesses to be able to access curTency swaps and other curTcncy transactions that match 

their business risk means that it is irnportant that an exemption for foreign exchange swaps and foreign 

exchange forwards clearly i11cludcs related and economically equi valent products that are commonly used 

in the foreign exchange market, notably cross-currency swaps. Section I a(24) of the CEA defines a 

foreign exchange forward as "a transaction that solely involves the exchange of [two] different currencies 

on a specific future date at a fixed rare agreed upon on the inception of the contract covering the 

exchange". Section la(25) of the CEA defines a foreign exchange swap as "a transaction that solely 

involves (A) an exchange of [two] different Clmcncics on a specific date at a fixed rate that is agreed 

upon on the inception of the contract covering lhc exchange and (B) a reverse exchange of the two 

currencies described in subparagraph (A) at a later date and at a fixed rate that is agreed upon on the 

inception of the contract covering the exchange". 

What is notable about these definitions is that a foreign exchange swap can also be defined as two foreign 

exchange forwards packaged together. 1\ cross-cun·ency swap, by contrast, exchanges a cash flow in one 

currency for a cash flow in another, which makes cross-currency swaps ideal for hedging the series of 

interest and principal payments in typical standard loan products. Like a foreign exchange swap, any 

cross-currency swap, whether it involves exchanging fixed or floating implied interest rates, can be 

constructed from a series of simple foreign exchange forward contracts. 

It wou ld therefore be impractical to try to draw a line between foreign exchange swaps and foreign 

exchange forwards and other products like cross-currency swaps that arc simply bundles of foreig11 

exchange forward contracts for purposes of any exemption the Secretary of the Treasury provides for 

such transactions. If cross-currency swaps were to be treated differently, there would be an incentive for 

providers to unbundle such cross-currency swap contracts fo r regulatory purposes. "Unbundling" would 

decrease the transparency of reporting such foreign exchange swaps and foreign exchange forwards 

making these products more confusing for customers, including MFX's clients. In addition, treating crossctllTency swaps diffe rently from its component foreign exchange forwards could also promote arbitrage 

between markets where foreign exchange swap products arc unbundled and those where they arc bundled. 

In addition, by adding complexity and uncenainty to the market. such a distinction between crosscmTency swaps and foreign exchange swaps and foreign exchange forwards could drive business offshore 

without actually achieving the goal of regulation and risk reduction. As such, MFX urges the Secretary of 

the Treasury to ensure that products such as cross currency swaps and other similar currency transactions 

arc treated the same for purposes of any exemption for foreign exchange transactions from the CE/\. 

3.4 T he d ifficu lty of standardizing collateral in a clea ring house 

Ccnrralizcd clearing would establish indusuy-widc benchmarks for coll ateral requirements but with 

significant constraints on the fl exibility of organizations to price and strucl\lrc dcnls to suit individual 

requirements. MFX trades in highly illiquid currencies which would be difficult to standardize for 

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collateral purposes. Also, as part of its public policy mission, MFX uses an open guarantee from OPIC in 

lieu of collateral. The availability of this OPIC guarantee as collateral is the key to making the foreign 

exchange swaps and foreign exchange fo rwards affo rdable for microfinancc lenders while insuring the 

san1e risk reduction as standard cash collatcralization. However, in a standardized clearing house 

environmcm this innovation would likely not be tolerated. Looking beyond the lack of nexibility, 

ccnrralized clearing would add a fw1hcr significant cost to many of MFX's transactions and could 

undermine MFX's mission to help development lenders adopt better risk management practices using 

hedging. This is because highly illiquid markets with few participants willing to carry market risk could 

have vcty volatile valuations and require very high levels of collateral that arc not commensurate with the 

actual risk in a di versified, netted portfolio of positions. 

It should be noted that MFX docs not oppose basic standards for collateral levels as long as such 

standards take into account the effect of netting and currency diversification on reducing potential 

countcrparty exposure. However, given the difficulty of implementing a one-size-fits-all collateral regime 

via a clearing system and the strong record of collatcra lization in these markets to date, MFX believes that 

it is not necessary to include foreign exchange swaps and foreign exchange forwards in the sections of the 

CEA which apply to collateral. 

* * 

MFX appreciates the ability to provide its comments on "foreign exchange swaps" and "foreign exchange 

forwards" in respect of the Secretary of the Trcasuty's authority to exempt such transactions from the 

definition of "swap" in the CEA. Please feel free to contact me or others at MFX at your convenience 

with any questions. 

Sincerely, 

Brian Cox 

Executive Director 

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