[Senate Hearing 109-089]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 109-089

   TO CONSIDER THE REAUTHORIZATION OF THE COMMODITY FUTURES TRADING 
                               COMMISSION

=======================================================================

                                HEARING

                               before the

                       COMMITTEE ON AGRICULTURE,
                        NUTRITION, AND FORESTRY

                          UNITED STATES SENATE


                       ONE HUNDRED NINTH CONGRESS

                             FIRST SESSION


                               __________

                           MARCH 8 & 10, 2005

                               __________

                       Printed for the use of the
           Committee on Agriculture, Nutrition, and Forestry


  Available via the World Wide Web: http://www.agriculture.senate.gov


                                 ______

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           COMMITTEE ON AGRICULTURE, NUTRITION, AND FORESTRY



                   SAXBY CHAMBLISS, Georgia, Chairman

RICHARD G. LUGAR, Indiana            TOM HARKIN, Iowa
THAD COCHRAN, Mississippi            PATRICK J. LEAHY, Vermont
MITCH McCONNELL, Kentucky            KENT CONRAD, North Dakota
PAT ROBERTS, Kansas                  MAX BAUCUS, Montana
JAMES M. TALENT, Missouri            BLANCHE L. LINCOLN, Arkansas
CRAIG THOMAS, Wyoming                DEBBIE A. STABENOW, Michigan
RICK SANTORUM, Pennsylvania          E. BENJAMIN NELSON, Nebraska
NORM COLEMAN, Minnesota              MARK DAYTON, Minnesota
MICHEAL D. CRAPO, Idaho              KEN SALAZAR, Colorado
CHARLES E. GRASSLEY, Iowa

            Martha Scott Poindexter, Majority Staff Director

                David L. Johnson, Majority Chief Counsel

              Steven Meeks, Majority Legislative Director

                      Robert E. Sturm, Chief Clerk

                Mark Halverson, Minority Staff Director

                                  (ii)

  
                            C O N T E N T S

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                                                                   Page

Hearing(s):

To Consider the Reauthorization of the Commodity Futures Trading 
  Commission.....................................................    01

                              ----------                              

                         Tuesday, March 8, 2005
                    STATEMENTS PRESENTED BY SENATORS

Chambliss, Hon. Saxby, a U.S. Senator from Georgia, Chairman, 
  Committee on Agriculture, Nutrition, and Forestry..............    01
Harkin, Hon. Tom, a U.S. Senator from Iowa, Ranking Member, 
  Committee on Agriculture, Nutrition, and Forestry..............    11
Conrad, Hon. Kent, a U.S. Senator from North Dakota..............    17
Leahy, Hon. Patrick, a U.S. Senator from Vermont.................    20
Lugar, Hon. Richard G., a U.S. Senator from Indiana..............    07
Salazar, Hon. Ken, a U.S. Senator from Colorado..................    17
                              ----------                              

                               WITNESSES

Brown-Hruska, Sharon, Chairman, Commodity Futures Trading 
  Commission, Washington, DC.....................................    02

                                Panel I

Carey, Charles P., Chairman, Chicago Board of Trade, Chicago, 
  Illinois.......................................................    22
Damgard, John M., President, Futures Industry Association, 
  Washington, DC.................................................    31
Duffy, Terrence A., Chairman, Chicago Mercantile Exchange, 
  Chicago, 
  Illinois.......................................................    24
Nandapurkar, Satish, Chief Executive Officer, Eurex US, Chicago, 
  Illinois.......................................................    29
Newsome, James, President, New York Mercantile Exchange, Inc., 
  New York, New York.............................................    26
Schoenhut, Frederick W., Chairman, New York Board of Trade, New 
  York, New York.................................................    28
                              ----------                              

                                APPENDIX

Prepared Statements:
    Harkin, Hon. Tom.............................................    42
    Brown-Hruska, Sharon.........................................    46
    Carey, Charles P.............................................    51
    Damgard, John M..............................................    93
    Duffy, Terrence..............................................    60
    Leahy, Hon. Patrick..........................................    44
    Newsome, James...............................................    69
    Shoenhut, Frederick W........................................    82
    Nandapurkar, Satish..........................................    88
Document(s) Submitted for the Record:
    A Review of Recent Hedge Fund Participation in NYMEX Natural 
      Gas and Crude Oil Futures Markets, submitted by James 
      Newsome....................................................   106
    The Governance of Self Regulatory Organizations 69 Fed. Reg. 
      32326 (June 9, 2004), submitted by John Damgard............   119
Questions and Answers Submitted for the Record:
    Chambliss, Hon. Saxby........................................   139
    Harkin, Hon. Tom.............................................   148
    Santorum, Hon. Rick (answers not provided: questions to Mr. 
      Terence Duffy).............................................   158

                              ----------                              

                        Thursday, March 10, 2005
                    STATEMENTS PRESENTED BY SENATORS

Chambliss, Hon. Saxby, a U.S. Senator from Georgia, Chairman, 
  Committee on Agriculture, Nutrition, and Forestry..............   163
Salazar, Hon. Ken, a U.S. Senator from Colorado..................   173
                              ----------                              

                               WITNESSES
                                Panel I

Ireland, Oliver I., Partner, Morrison & Foerster, LLP, 
  Washington, DC, on behalf of Huntsman Corporation and 
  Industrial Energy Consumers of America.........................   167
Pickel, Robert G., Executive Director and Chief Executive 
  Officer, 
  International Swaps and Derivatives Association, Inc., New 
  York, NY.......................................................   165
Sprecher, Jeffrey C., Chairman and Chief Executive Officer, 
  InterContinentalExchange, Atlanta, GA..........................   164

                                Panel II

Gaine, John G., President and Chief Executive Officer, National 
  Futures Association, Chicago, IL...............................   178
Green, Micah S., President, The Bond Market Association, 
  Washington, DC.................................................   180
Roth, Daniel J., President and Chief Executive Officer, National 
  Futures Association, Chicago, IL...............................   176
                              ----------                              

                                APPENDIX

Prepared Statements:
    Gaine, John G................................................   224
    Green, Micah S...............................................   231
    Ireland, Oliver I............................................   213
    Pickel, Robert G.............................................   199
    Roth, Daniel J...............................................   218
    Sprecher, Jeffrey............................................   188
Document(s) Submitted for the Record:
    Cochran, Hon. Thad...........................................   238
    Martin Doyle, President, OneChicago, LLC.....................   245
    National Grain and Feed Association..........................   254
    The National Grain Trade Council on Reauthorization of the 
      Commodity Futures Trading Commission.......................   240


 
    TO CONSIDER THE REAUTHORIZATION OF THE COMMODITY FUTURES TRADING
                               COMMISSION

                              ----------                              


                        TUESDAY, MARCH 8, 2005,

                                      U.S. Senate,,
        Committee on Agriculture, Nutrition, and Forestry,,
                                                     Washington, DC
    The Committee met, pursuant to notice, at 10:02 a.m., in 
room SD-106, Dirksen Senate Office Building, Hon. Saxby 
Chambliss, [Chairman of the Committee], presiding.
    Present or submitting a statement: Senators Chambliss, 
Lugar, Harkin, Leahy, Conrad, and Salazar.

STATEMENT OF HON. SAXBY CHAMBLISS, A U.S. SENATOR FROM GEORGIA, 
  CHAIRMAN, COMMITTEE ON AGRICULTURE, NUTRITION, AND FORESTRY

    The Chairman. The committee will come to order. Good 
morning.
    The authorization of the Commodity Futures Trading 
Commission, the Federal agency responsible for overseeing the 
trading of commodity futures contracts, will expire on 
September 30, 2005. Commodity futures contracts are traded on 
agricultural, energy, and metal commodities and increasingly on 
financial instruments, such as instrument rates and foreign 
currencies. Reauthorizing the CFTC is an important task before 
the committee this year.
    The Commodity Exchange Act is the basic law that empowers 
CFTC to oversee commodity futures markets. In 2000, as part of 
the last CFTC reauthorization, the Congress made what most 
experts agree were landmark reforms in the Commodity Exchange 
Act by passing the Commodities Futures Modernization Act. The 
CFMA provided legal certainty for the over-the-counter swaps 
market and also streamlined the regulatory process for exchange 
traded futures markets. The CFMA shifted the CFTC away from a 
prescriptive, rules-based regulatory approach to a more 
flexible market-oriented approach based on broad core 
principles.
    Since the passage of the CFMA, the industry has seen 
tremendous growth in trading volume on both the exchange traded 
futures markets and over-the-counter derivatives markets. This 
year, as part of the reauthorization process, the committee 
will review the Commodity Exchange Act, as amended by CFMA, to 
determine whether additional changes in the law are needed to 
help CFTC continue to foster open, competitive, and financially 
sound commodity futures markets and to protect the market users 
and the public from fraud and manipulation.
    Most of the folks I have met with are generally pleased 
with the Commodity Exchange Act, as amended by the CFMA Act of 
2000 and are not seeking many, if any, changes in the 
legislation this year. We will take in thoughts and suggestions 
on this important question from a wide array of witnesses over 
the course of two hearings the committee is holding on CFTC 
reauthorization this week.
    Today, I am pleased to welcome Commodity Futures Trading 
Commission Acting Chairman Sharon Brown-Hruska and a group of 
outstanding people from the private sector representing U.S. 
futures exchanges and the futures industry. I look forward to 
hearing your testimony.
    Senator Harkin has let us know that he will be here. He is 
running behind, and we have a number of other Senators who have 
indicated their intention to attend. They will likely arrive as 
we proceed through the course of this hearing.
    Madam Chairman, it is again a pleasure to have you with us 
this morning. We look forward to your comments and we will take 
those comments at this time. Thank you.

           STATEMENT OF SHARON BROWN-HRUSKA, ACTING 
 CHAIRMAN, COMMODITY FUTURES TRADING COMMISSION, WASHINGTON, DC

    Ms. Brown-Hruska. Thank you, Chairman Chambliss. Good 
morning. I am pleased to be here to appear on behalf of the 
Commodity Futures Trading Commission to discuss the important 
issues surrounding the reauthorization of the Commission.
    Before I begin my testimony, I would like to recognize and 
introduce my fellow colleagues on the Commission who join me 
here today. First is Commissioner Walt Lukken, who is certainly 
no stranger to many of you on the Hill because of his years of 
experience working for Senator Lugar and the Agriculture 
Committee. I would also like to introduce the two newest 
members of the Commission, Commissioner Fred Hatfield and 
Commissioner Mike Dunn, both of whom I had the honor of 
swearing in this past December. I look forward to continuing to 
work with them and drawing on their considerable insights and 
experiences. I have solicited input from all the Commissioners 
in preparing this testimony.
    Finally, I would like to recognize and commend the staff of 
the CFTC. Many of them are behind me. Without their energy and 
dedication, much of the innovation that the Commodity Futures 
Modernization Act of 2000 enabled would not have been possible.
    Well, it has been just over 4 years since Congress passed 
the CFMA. While this may seem like a short time, the amount of 
change that has occurred in the futures and derivatives 
industry over that period has been extraordinary, and much of 
that change has been facilitated by the flexibility and 
innovative foresight of that legislation and Congress for 
passing that legislation.
    Overall, the Act, as amended by the CFMA, functions 
exceptionally well. The CFMA has provided flexibility to the 
derivatives industry and legal certainty to much of the over-
the-counter derivatives market. This flexibility has allowed 
the industry to innovate with respect to the design of 
contracts, the formation of trading platforms, and the clearing 
of both on-exchange and off-exchange products. The industry is 
no longer over-burdened with prescriptive legal requirements 
and it is able to operate using its best business judgment 
rather than that of its regulator. At the same time, economic 
and financial integrity have been safeguarded and the 
Commission has been able to maintain its ability to take action 
against fraud and abuse in the markets it oversees.
    When Congress adopted the CFMA, it put in place a practical 
principles-based model and gave the CFTC the tools to regulate 
markets that were challenged by competition, brought about by 
technology and an increasingly global marketplace. Since that 
time when the CFMA was passed, the futures industry, as you 
noted, has experienced phenomenal growth and innovation. The 
markets have also become more global. There is more access than 
ever for U.S. customers wanting to trade on foreign exchanges, 
as well as for foreign customers wanting to trade on U.S. 
markets.
    One of the benefits that has come from all this innovation 
and globalization has been increased competition and a lowering 
of trading costs and an increase in the market quality overall. 
In addition, new products and new amendment certification 
procedures in the CFMA have also lowered regulatory barriers 
and fostered innovation by providing exchanges greater 
flexibility in listing contracting and in providing them with 
an ability to react to developments in the cash markets and the 
competitive markets in which they operate.
    We at the Commission are committed to ensuring that our 
regulatory policies are similarly responsive and that the 
implementation of the CFMA fulfills the intent of Congress. 
Competition and innovation must be realized in such a way that 
customer protection is not compromised and that the financial 
and economic integrity of our markets is preserved. In that 
regard, there remains more that we can do as a regulatory 
agency to move the ball forward even within the current 
statutory model.
    As we begin the reauthorization process, any change should 
come with careful consideration of potential outcomes as well 
as unintended consequences that may present themselves. With 
that in mind, let me highlight three areas of concern on which 
Congress may wish to focus as it deliberates during the 
reauthorization process.
    First, Congress may wish to evaluate whether clarifications 
are necessary to the legal framework provided for exempt 
markets.
    Second, Congress may wish to suggest ways that we can more 
effectively avoid duplicative burdens on the markets and, going 
forward, provide us with guidance and support as we seek to 
work with other agencies and with other jurisdictions.
    Finally, we at the Commission are cognizant of Congress's 
firm commitment to ensuring that customers are protected from 
fraud and manipulation, and to that end, Congress may wish to 
review whether the CFTC has clear and adequate authority to 
police retail fraud, particularly in the foreign exchange 
markets.
    In the wake of the Enron collapse and in response to recent 
run-ups in prices of natural gas and crude oil, there have been 
calls to increase the CFTC's regulatory authority in the energy 
sector. Some have called for retrenchment and a return to the 
prescriptive forms of regulation, like adoptions of federally 
determined price limits and position limits. Others have called 
for more sweeping legislative changes that would give the 
Commission greater reach into the proprietary and bilateral 
markets.
    As you consider the appropriateness of such proposals, I 
would ask that you keep in mind that the CFTC has responded 
decisively to prosecute wrongdoing in the energy markets. The 
Commission has acted resolutely in the energy markets, 
demonstrating that its authority is significant and that it 
intends to use it. The CFTC successfully pursued a complaint 
against Enron for manipulation of the natural gas markets. In 
addition, the Commission has filed and continues to pursue 
various actions and investigations in the energy sector against 
both companies and individuals.
    In addition, the CFTC has recently promulgated regulations 
clarifying and detailing its authority regarding exempt 
markets, including certain energy transactions, to better 
ensure that these markets remain free from fraud and 
manipulation.
    We are aware that last year's energy bill contained several 
provisions that would directly affect the CFTC's oversight 
responsibilities and we believe that it is appropriate and 
timely for our authorizing committee in Congress to consider 
and weigh in on those proposed changes.
    In the security future products area, as you know, the CFMA 
was noteworthy, in part because of Congress's decision to 
permit the trading of futures on single securities under the 
joint jurisdiction of the CFTC and the SEC. However, more than 
4 years after the CFMA's passage, the growth of single-stock 
futures trading continues to be modest, at best. In December, 
the NQLX exchange, one of the two exchanges that had been 
offering single-stock futures, suspended trading.
    Now, it has been a source of some concern that this sector 
has not been more successful, and despite the best efforts of 
the Commission, the CFTC, and the SEC, has not really fully 
achieved the goals of the CFMA. In many areas, however, I am 
pleased to say that the two agencies continue to work together 
to establish regulatory approaches that avoid duplicative 
regulation and registration.
    The CFMA also clarified that the CFTC has jurisdiction over 
retail foreign currency futures and options contracts, whether 
transacted on-exchange or over-the-counter, as long as they are 
not otherwise regulated by another agency. However, as 
demonstrated in the recent adverse Zelener decision, a case 
litigated by the Commission, the CFTC continues to face 
challenges to its jurisdiction based on how retail forex 
transactions are characterized.
    We at the Commission have been and remain committed to 
protecting retail customers against the kind of egregious fraud 
we see in the forex area. Our track record in the forex area is 
favorable. Of the 70 cases that we filed thus far, the 
Commission has lost only three.
    As noted, it has only been just 4 years since Congress 
enacted and the Commission began implementing the CFMA. Given 
the progress made and the lessons learned, Congress may 
determine that it is premature to open the Act to significant 
changes. The Commission has been able to effectively work 
within the current structure of the Act to police markets, to 
ensure the integrity of the price discovery mechanism, and to 
maintain the financial integrity of the markets and to protect 
customers.
    The Commission stands ready to offer its assistance as 
Congress moves through the reauthorization process and 
considers the range of potential options.
    In conclusion, let me say that my fellow Commissioners and 
I welcome this opportunity to work with you on the 
reauthorization of the CFTC. I greatly appreciate the 
opportunity to testify before you today on this important 
matter, and I would be pleased to answer any questions that the 
Commission may have. Thank you, sir.
    The Chairman. Thank you very much, Madam Chairman.
    [The prepared statement of Ms. Brown-Hruska can be found in 
the appendix on page 46.]
    The Chairman. You detailed several areas of concern that 
exist between the jurisdiction of CFTC and the SEC. How big is 
this problem and is it appropriate to try to legislatively 
resolve these areas of concern? Do you have an ongoing dialog 
with the SEC to such an extent that you think that is the best 
way to resolve these concerns?
    Ms. Brown-Hruska. Thank you for that question, sir. 
Actually, in many respects, we have attempted to work within 
the CFMA to resolve a number of outstanding issues. The SEC and 
the CFTC fundamentally disagree on some sections of the Act in 
terms of what is required of us. For example, on foreign 
security indices and allowing them to be offered to U.S. 
customers, and what constitutes a narrow-based versus a broad 
index, the SEC has basically come to a position that they want 
a very high level of scrutiny. They have to be a certain 
liquidity and a certain size, and ultimately, what that means 
is there are a number of market participants who are unwilling 
under those conditions to offer those foreign security indices.
    On other areas, we have, in many cases, been limited. In 
many cases, the SEC and the CFTC have done the best they can to 
come to agreement on some difficult issues. Some of it is 
fundamental differences between the way futures markets and 
security markets are regulated and are in many ways the systems 
that we use to ensure performance and operational efficiency in 
the market.
    One of those areas is in margins. We looked at the CFMA. If 
you look at certain sections where SFPs are discussed, it says 
that margins in security futures have to be consistent with 
those in the security options market. Certainly, that is fine. 
I understand that that would help to avoid any kind of 
regulatory arbitrage. In another section of the SEA, it says 
that margins are supposed to be no lower than the lowest level 
for security options.
    Well, security options, if you sell an option, there is 
nothing but downside risk on that position. The margin level is 
set at a fixed rate--it is a floor. If you look at a position 
in a security futures product, it has both down-side and up-
side risk. From a risk perspective, you look at the risk that 
that position poses to the marketplace, it is much lower than, 
say, an option--the option position that I described, the short 
option.
    Our problem is that in the futures area, we usually use 
risk as a basis for determining what margins are. It has been 
very successful and we have had very few problems in the area 
of futures because, in general, the margin levels are set to 
ensure contract performance and that the individuals who make 
these contracts will, in fat, follow through. The financial 
integrity has been protected and we have had a lot of success.
    In the securities market, they have yet to come around to 
the risk-based margining system. They have yet to adopt and 
embrace portfolio margining as we have in the futures area.
    I guess I gave you a very detailed answer, but I would say 
that there is some language in the CFMA that drove us to not 
adopt the more risk-based approach that I believe is more 
sophisticated, it is a proven methodology for determining 
margins, and we have a lot of confidence in it at the CFTC. 
There may be some areas within the CFMA where we could tweak 
that language that would provide some guidance or some movement 
on the part of the SEC and the CFTC to get to a more 
sophisticated risk-based margining approach.
    The Chairman. Have you had any dialog with the SEC about 
any proposed changes of that nature?
    Ms. Brown-Hruska. We haven't specifically. I have had a 
very good conversation with Chairman Donaldson about security 
futures and about commodity pools that are registered with the 
CFTC, and many of them would also fall under the recent hedge 
fund registration requirement that the SEC has promulgated. We 
have talked about security futures products and I have talked 
with him about margining and portfolio margining. They have 
some very competent people over there that they have recently 
hired that are very interested in portfolio margining.
    Fundamentally, Chairman Donaldson is very concerned about 
ensuring that his markets and our markets are free from fraud 
and manipulation, are full of financial integrity, and my gut 
feeling is that he would be very open to a discussion and a 
dialog going forward to make it possible that we can get the 
regulatory model for SFPs into a better place.
    The Chairman. You made a very correct statement when you 
said that we want to make sure that there are no unintended 
consequences that come out of this legislation, particularly 
any changes that might be made to the existing legislation. 
That is always a concern and is a real problem, unfortunately, 
with a lot of legislation that comes off the Hill. Can you 
think of any unintended consequences that came out of the CFMA 
that you are having to deal with now?
    Ms. Brown-Hruska. That is a very good question. You know, I 
would say I can't think of any in general. The CFMA has 
performed extremely well. Usually, when we think of unintended 
consequences, we think of negative impacts on the market, and I 
can generally think of only positive impacts. The CFMA did 
enable innovation and it did give the CFTC significant 
authority to go after fraud and manipulation. We have done so. 
Even when we have seen some problems in the marketplace, some 
bad actors who are intent upon breaking the law, that is what 
they did. They broke the law. The law as enumerated in the 
CFMA, we were able to go after those individuals and entities 
and have had a very successful enforcement record in that area.
    The Chairman. I have some other questions, but I want to 
give Senator Lugar an opportunity to proceed, so Senator Lugar.

  STATEMENT OF HON. RICHARD LUGAR, A U.S. SENATOR FROM INDIANA

    Senator Lugar. Thank you very much, Mr. Chairman. I 
appreciate your testimony. I would just say, as an historical 
anecdote, that when I came on the committee in 1977, Senator 
Herman Talmadge, who was our chairman, another distinguished 
Georgian, pointed to Senator Leahy of Vermont and to me to 
shepherd CFTC and FIFRA, the Fungicide, Insecticide, 
Rodenticide Act. These were the areas in which no other member 
of the committee had particular interest, nor did, the 
Chairman.
    [Laughter.]
    Senator Lugar. In any event, in these uncertain fledgling 
hands, all this came, and so I appreciate especially your 
tracing the history and, of course, what I think of as the 
culmination of this in the Act that was passed 4 years ago. 
Around this table, many members of the industry came a year 
before that just simply to philosophize about, in the best of 
all worlds, what the regulatory act and its reauthorization 
should look like. Members devoted a lot of time to it, as did 
members of the Banking Committee, and there was active 
consideration, as you recall, with the SEC and their interest.
    When the Chairman asked, were there unintended 
consequences, and you pondered and could not think of any, this 
is reassuring 4 years down the trail.
    I pay tribute to one of your colleagues, Walt Lukken, who 
was a member of our staff and certainly a vital factor in that 
legislation and I appreciate his presence this morning.
    Let me return to a point that you took up because it has 
been a source of comment in various post-mortems of the Act and 
that is the whole area of energy regulation. Fairly early in 
the game, energy was taken off the table, at least in terms of 
CFTC jurisdiction, and has, by and large, not remained that 
way. You pointed out that there are powers under the Act now 
and you have successfully prosecuted a large number of 
individuals. You have taken a look at the Enron company 
specifically, as you mentioned.
    Energy, obviously, in all of its aspects, is different from 
corn and soybeans or various other things with which you have 
dealt successfully. I have always continued to be one to raise 
the issue of energy because prior to Enron, it appeared to me, 
at least from testimony that we were getting, that the 
potentialities for severe damage to the American economy were 
there. Perhaps CFTC was not responsible and should not be. 
Others might have taken this up, but others didn't. As you read 
the 20th book on Enron and all of the lack of regulatory 
responsibility, this is a severe indictment of government 
generally that cost a lot of people their jobs and their 
capital, leaving aside prosecutions that are still underway.
    I hope you will continue. I am not going to make a 
suggestion for amendment of the Act because the complexities 
technically of doing this, I understand, having heard a lot of 
testimony on it. At the same time, I would just simply be 
remiss not to echo that concern that we have suggested in the 
past, because I am not certain that area is quite tied and 
bolted down in a way that is satisfying. By that, I don't mean 
in a way that stultifies in any way the energy markets, 
entrepreneurship, careful of resources, but those 
considerations are there for every commodity that you are 
dealing with. Energy commodities are likely to be an 
increasingly competitive and difficult area.
    In my Foreign Relations Committee work, we are hearing 
testimony, for example--these are not unique situations--of 
China and India seeking almost every last Btu of reserves 
anywhere in the world for dynamic economies that are going to 
have huge demands, with a third of the world's population 
heating homes sometimes for the first time and driving cars, 
quite apart from manufacturing. These are other alternative 
energy sources than the ones that you might be regulating, but 
I just sense that this is going to become a much more 
competitive situation, politically more volatile as the prices 
rise. Then there are charges of spiking or that people are 
speculating on political unrest or suppositions. This may be an 
area that is within your purview and maybe not, but I simply, 
as a friend of CFTC, mention that I hope that you will be 
observant, along with the Commissioners, of this particular 
area.
    Let me just ask as a housekeeping question, is your budget 
OK? Do you have enough money to run the agency? Are you 
employing successfully and finding the people that you need for 
this increasingly sophisticated work, because the industries 
involved want to have confidence that in your hands, you have 
the best people and that they are adequately taken care of.
    Ms. Brown-Hruska. Thank you so much for your comments, 
Senator Lugar. I also appreciate having Commission Walt Lukken 
now in my camp. He is tremendous good help and a great 
colleague.
    In response to your question, I would say that on the 
budgetary front, we had some problems retaining and keeping 
good staff. One thing about derivatives, futures, and options 
markets, it is a complex business and there are lots of 
different types of markets and some of them are based on 
interest rate products. It is a sophisticated pricing 
mechanism, and some are based on currencies, and then we have 
pork bellies and the whole gamut.
    It has been the case that we would sometimes train and 
bring along very good, qualified people and they would go and 
leave and go to other agencies. As a way to stem that loss of 
good people to other financial agencies, we implemented pay 
parity and that is in thanks to Congress for providing us with 
our authority to do that. We are able to raise the pay levels 
to that of the other FIRREA agencies. That is, to raise salary 
levels to the other financial regulators, even though we are 
still somewhat behind the Fed and Treasury and the other 
agencies. We have caught up enough where we have stemmed that 
loss, of individuals.
    Well, when we implemented that, that cost money, and so we 
have had to really tighten up on our use of resources. We have 
become extremely efficient to ensure that we maximize our 
resources.
    That said, Congress has been very supportive. The 
President's budget has delivered for us some sensible numbers 
that will enable us to operate next year, again in a very 
tight, efficient way. We appreciate your support and your 
interest and we thank you for your continued support as we work 
to try to get the level that the President has requested, 
because we feel that that will enable us to perform 
successfully in the future.
    Senator Lugar. Just one more question that goes back also 
historically to a trauma in the financial community, the long-
term capital management difficulties, as you have mentioned, 
derivatives. All of us around the Agriculture Committee table 
got an education in derivatives in a hurry. We had regular 
appearances by Alan Greenspan and other persons who are not 
usually a part of the agricultural community or even the CFTC 
community trying to explain how this could happen and how we 
tried as a world to unravel it once it did without grievous 
harm.
    You have confidence that a long-term capital management 
scheme, granted, if it is the first time through, always 
difficult say, well, historically we know what we are doing, 
but are the controls that you have now, the people that cite 
these situations, you believe adequate to give assurances? I 
ask this because rumor mongers last year getting worried about 
hedge fund operations of all sorts felt maybe bubbles, as they 
were terming it, might be happening in various places, nothing 
of the scale of long-term capital management, which we were 
advised that Nobel Prize winners were busy working on 
mathematical models that were absolutely certain to work, until 
they didn't.
    I just wonder, what is your confidence level with regard to 
derivatives, at least on the grand scale of that entire 
economies?
    Ms. Brown-Hruska. Well, I would say that Long-Term Capital 
Management did speculate in some very illiquid assets globally. 
They were very aggressive. The problem--and much of this 
doesn't really fall within the CFTC's purview. Just looking at 
it--having been one of those rocket scientists myself as a 
professor--I would look at this and what was going on, and part 
of the problem, was that the banking institutions were 
extending a significant amount of credit.
    Senator Leahy. There were several misjudgments here.
    Ms. Brown-Hruska In looking at it, that a lot of the over-
leverage that was in Long-Term Capital Management--at least I 
have it on fairly good authority from, as you mentioned, 
Chairman Greenspan and others--that that now is not the case. 
Banking institutions have greater controls to ensure that the 
credit quality and the credit offered to these types of funds 
is well within their tolerance level and that the risks that 
are being taken are monitored and that they have controls, 
risk-management controls.
    From the CFTC's perspective, we do regulate Commodity Pool 
Operators and Commodity Trading Advisors, and have since 1974. 
They started as basically futures funds that came together to 
combine investors' money, and institutions who are usually 
sophisticated, usually wealthy who take these kinds of risks. 
These investors and institutions are usually what we call 
credited investors or qualified purchasers that meet high 
standards set by the Securities and Exchange Commission. What 
we have seen is that those CPOs and CTAs have generally 
performed well. They are subject to the NFA, National Futures 
Association, and the CFTC's recordkeeping requirements, 
reporting requirements, and they must have internal controls in 
place.
    From our perspective, looking at our experience with 
regulating Commodity Pool Operators and Commodity Trading 
Advisors, which are constituted usually as limited 
partnerships, that would fall under the SEC's definition of a 
hedge fund--our experience has been that the type of oversight 
that we have has been successful and has been able to help 
uncover wrongdoing and misrepresentations. Our experience has 
been very good and I would suggest that when Dan Roth of the 
NFA testifies, he will probably also talk about that.
    From our perspective, at least that piece of it which are, 
at least, defined as hedge funds by the SEC, we feel we have a 
good regulatory program and we feel it has been effective. Our 
only issue there is that we would try to avoid duplicating our 
regulatory program over at the SEC. In general, that they have 
a similar program in mind for hedge funds and it is something 
that should be considered carefully and we are in discussions.
    Senator Lugar. I thank you for recognizing the alliances 
you have. NFA, of course, is very important within the 
industry, but likewise, good friends on the Senate Banking 
Committee working with this committee. The SEC and the CFTC are 
not adversaries. When it comes to these global situations, the 
importance of that communication and common work is so 
important. I thank you very much.
    Thank you, Mr. Chairman.
    The Chairman. Thank you, Senator Lugar. Once again, I have 
always been impressed with the intellect and the public 
commitment of Senator Lugar, but now that I know that as a 
young Senator you were given the issue of swaps and derivatives 
and FIFRA to deal with, I am impressed that you ran for 
reelection----
    [Laughter.]
    The Chairman [continuing]. and stayed on the Agriculture 
Committee, too, Dick.
    You mentioned the budget issue. I know one thing we talked 
about with your predecessor, Chairman Newsome, who obviously 
happens to be here today, was the issue of pay parity. I 
understood from Jim, and I would just like your comments very 
quickly on how you think that has affected your ability to 
recruit and retain some of the top people, which you obviously 
need, dealing with the very complex issues that you do.
    Ms. Brown-Hruska. Well, thank you very much, Chairman. It 
was critical to stop the bleeding, in many respects, at the 
CFTC and to help us get young, well-trained, or older, well-
trained, vibrant individuals to come to work at the CFTC, to 
come to Washington. It has been very successful in many 
respects and I am delighted to say that we are very close to a 
point where we can actually go out and hire some new people, 
and I suspect that where we are right now, we will have a 
greater pool of talent to draw from. That it has worked very 
well.
    Again, we have to be very efficient in the use of our 
resources to ensure that we can continue to keep up with the 
pay levels that we see in other financial regulatory agencies, 
but by and large, it is working very well. Again, I would thank 
Congress for their support on this issue and it has been very 
successful.
    The Chairman. Thank you.
    Senator Harkin.

STATEMENT OF HON. TOM HARKIN, A U.S. SENATOR FROM IOWA, RANKING 
   MEMBER, COMMITTEE ON AGRICULTURE, NUTRITION, AND FORESTRY

    Senator Harkin. Thank you very much, Mr. Chairman. I 
apologize for being late. I don't know if you have seen the 
weather out there lately, but it took me an hour and a half to 
go 12 miles this morning. If someone would run for President of 
the United States on a platform of getting rid of traffic jams, 
you would win hands-down. I don't care what party they are in. 
I would vote for them.
    [Laughter.]
    Senator Harkin. Thank you, Mr. Chairman.
    In the 4 years since the passage of the Commodity Futures 
Modernization Act, the options and derivatives industry has 
seen record volumes and unprecedented competition, leading to 
new products and lower prices for users of these markets. I 
want to welcome Chairman Sharon Brown-Hruska, Commissioner Walt 
Lukken, and our two newest Commissioners, Mike Dunn and Fred 
Hatfield. Of course, I have to mention that Mike is from 
Keokuk, Iowa, and has had a long record of service in 
agriculture and, of course, worked a long time with Fred 
Hatfield here on the Hill, both when he was here on the Hill 
and off the Hill, and then with some California agriculture and 
things like that, so it is good to see you, also, Fred.
    Anyway, I look forward to working with all of you on the 
reauthorization of the CEA. I want to commend you, Chairman 
Brown-Hruska, for the CFTC's work in implementing and enforcing 
the CFMA. It addressed some of the critical issues that faced 
the futures and derivatives markets in the 1990's. We sought to 
improve the competitive footing of our futures and derivatives 
industry by reducing regulatory burdens. We clarified some of 
the legal status of our over-the-counter derivatives 
transactions, reforming Shadd-Johnson, and some other things.
    It has been largely successful in achieving these 
objectives. However, there are a few areas noted in some of the 
witnesses that will be here in the next panel, some of their 
testimony, and some of my own observations.
    This country has been rocked by several serious financial 
scandals the past few years. These scandals have shown that 
perhaps no segment of the futures and derivatives markets are 
safe from manipulation. Additionally, with the large expansion 
in futures and derivatives volume, we need to consider whether 
the CFTC needs additional tools to keep tabs on the over-the-
counter trade in derivatives.
    Given the impact that large pension funds, banks, and other 
financial institutions have on our economy, we should consider 
whether the CFTC should have the authority to ask for 
information from those institutions even regarding over-the-
counter activities if it might help prevent a financial 
calamity down the road.
    I continue to be particularly concerned whether the CFTC 
has adequate authority to oversee energy markets. Energy swaps 
and derivatives have a far more direct linkage to consumers' 
pocketbooks than other exempt commodities, such as the metals, 
for example. The 46 energy enforcement cases settled by the 
CFTC so far for over $300 million in fines demonstrates that 
the CFTC has the authority to punish wrongdoing, which you have 
done, and that the Commission is using that authority. I 
congratulate you for that.
    Still, we need to make sure that Federal agencies have the 
authority and tools needed to detect and prevent these abuses 
from occurring in the first place, especially given the fallout 
they can have for consumers. We need to review the Commission's 
anti-fraud and anti-manipulation authorities, as well as its 
enforcement resources, to make sure they are up to the 
challenge of regulating existing markets. Particularly, I 
believe we need to consider whether anti-fraud and anti-
manipulation authority should be applied to principal-to-
principal trades.
    Now, in the past, I have said no. I have been on the side 
of those that said no because these are principal-to-principal. 
These are, as we said in the past, these are big boys and 
girls. They know what is going on, and it affects a small 
segment, large deals. Then again, some of those affect 
consumers directly in the fallout of those.
    Again, we need to consider that again. We had in the past. 
We didn't, but now, maybe we should, especially since we are 
having so many dealings taking place on the electronics markets 
now, as well as broker trades. We have these going on in the 
electronics markets.
    It seems to me that all similar markets, whether they are 
brokered, electronic, or what, should be held to the same 
standards of transparency and openness, and so this is what I 
am going to be looking at as we look ahead on the CEA 
reauthorization. We would like to have--I would hope that we 
could have your input on that.
    I did read your testimony. I had a lot of time this 
morning, driving in----
    [Laughter.]
    Senator Harkin [continuing]. I did read your testimony. I 
am just wondering why you aren't yet making any recommendations 
to us about what changes in the law or tools that the CFTC 
needs to make sure that it can do its job as effectively as 
possible. You are the experts, not us. You have the firsthand 
knowledge, based on experience. As I said, you have already 
levied over $300 million in fines, so you have a good insight 
as to what is happening out there. Where is the CEA falling 
short?
    I guess I would just ask, will the Commission be providing 
this committee with any specific recommendations for CEA 
reauthorization this year? Will you be providing us with some 
recommendations?
    Ms. Brown-Hruska. We would be delighted to do so. What I 
wanted to outline in my testimony were the areas of concern 
that we had, and I am sure that they are the same areas of 
concern that you have. We have in the past--for example in the 
energy area--reached out to this committee to try to provide it 
with a number of briefings and background on how our cases are 
going and where we have had difficulties in bringing those 
cases. I really appreciate the fact that this committee has 
been so open to our views and I appreciate your mentioning our 
expertise in this area.
    The reason that I didn't come out of the blocks bringing 
specific recommendations is that I thought it would be of value 
to hear from the industry. In terms of for example, you 
mentioned principal-to-principal energy transactions--
ultimately, it is Congress that needs to decide whether or not 
the CFTC should be in the middle of a dispute between Royal 
Dutch Shell and Goldman Sachs. When you have the big boys that 
are doing these large transactions, that they have a lot of 
facility and a lot of ability to protect themselves against 
each other. They wouldn't agree to do the transaction if they 
didn't think that the price was a fair one. They wouldn't 
transact with each other if they didn't know what they were 
getting into.
    In many respects, the reason that the Commission hasn't 
brought to you a specific recommendation in this regard is we 
think that this is an area that Congress should provide us with 
guidance. Now, we can give you some language. In fact, the 
energy bill, as I mentioned before, had some language that we 
felt, by and large, provided some clarification that would on a 
marginal basis help us ensure that we can succeed in court if 
we should bring a case. For the 2(h) markets specifically, 
which are not intermediated, if you will look at our fraud 
authority in the 4b area, it says fairly clearly that our fraud 
authority applies to intermediated transactions.
    We thought there is a question of whether it is clear that 
Congress reserved fraud authority for the Commission in the 
energy markets in the 2(h) language. Those markets are 
multilateral, or bilateral markets, and as you mentioned, 
electronic. They are not intermediated. The 4b fraud statute 
applies to intermediated transactions. We wanted to lay it out 
and provide you with our views and we will be glad to circle 
back to you and to this committee with our assessment of those 
changes.
    Senator Harkin. I look forward to getting that and looking 
at it and discussing with you and other Commissioners as we 
proceed on this reauthorization.
    Like I said, I don't know myself. I am still a little 
uncertain about this myself. I thought I knew where I was 
before, but I am not certain about it right now with some of 
the fallout on some of these things as it affects consumers, 
which brings me to my next question.
    We are very sensitive in the Midwest about natural gas 
prices, both in terms of heating in the winter, but also for 
fertilizer production, and there has been great volatility in 
the natural gas markets recently. I have heard a lot of 
complaints from our fertilizer industry, especially, on this.
    I don't know what has caused all this. It seems to me that 
information regarding supplies are inadequate, that for some 
reason, the natural gas industry is not as openly transparent, 
perhaps, maybe even as the oil industry is as far as the 
different sources of supply and things like that.
    It just seems to me that we have a situation here where the 
CFTC might want to look at some of the limits on trading on 
natural gas, whether they are set too high. I am told the price 
limit is now $3 per day. Actually, I am told it is more than 
just per day. It is just for a few minutes or something like 
that, like 15 minutes. In other words, if the limit was 
reached, unlike commodities, some other commodities, which 
close it for the day, this only does it for a short amount of 
time. I could be wrong on that, but that is what I am informed, 
anyway. That limit has never been reached on that.
    I am just wondering if we need better limits and if this is 
some area where the CFTC should be paying some more attention, 
I guess, on the volatility, what is happening in the natural 
gas markets.
    Ms. Brown-Hruska. That price limits are an imperfect way of 
controlling volatility. That is one of----
    Senator Harkin. It is just for cooling. It is just to let 
things cool off a little bit, right?
    Ms. Brown-Hruska. Yes. I guess that that is the theory.
    Senator Harkin. That is the theory.
    Ms. Brown-Hruska. What it does is if you shut down trading, 
if you have a price limit that is extraordinarily tight, if you 
make them tighter such that they are constantly--or if it is 
such that they are being kicked in frequently, it does have the 
effect of stopping trading in just the regulated futures 
markets rather than in, say, the over-the-counter markets and 
in the cash markets. A lot of the trading will continue to take 
place, in many cases, in those other markets and the markets 
get disconnected. It actually creates some underlying 
inefficiencies in the regulated market, which are very 
transparent in their publication of the prices on an inter-
minute basis. You can see streaming quotes of prices in natural 
gas on your computer at any given time.
    I would say that--generally, you mentioned about volatility 
and high prices, and I agree completely with you that nobody is 
enjoying the high prices that we have been seeing in the 
natural gas area because it does cost important segments of our 
economy greater--it raises their cost and then it makes it not 
feasible to do some of their activity and so it does have a 
negative effect.
    Senator Harkin. It is not just the high price, it is the 
volatility of those prices that causes so much uncertainty in 
the industry out there, even for any kind of forward 
contracting or anything. There is just this huge volatility.
    While I agree with you that if you set limits too low, that 
stifles the--it stifles all kinds of innovations and everything 
else. Then if you have them too far apart, then you get this 
huge volatility swing all the time. Surely there is some middle 
ground someplace that we could reach on this. I don't know.
    Ms. Brown-Hruska. Well, there has been a substantial amount 
of research that has looked at this. To see whether price 
limits do, in fact, help control volatility. Sometimes it 
actually leads to an increase in volatility because traders 
anticipate that they are getting closer to the limit and they 
will start to trade out more rapidly of their position because 
they don't want to be caught with an open position when that 
price limit comes in because then they can't get out. They are 
actually stuck with risk, so it creates risk. It creates some 
systemic risk for the markets. It is not clear that, in some 
cases, the limits, actually increases volatility.
    Senator Harkin. Good observation. That is why I said we 
need to look at this some more.
    Ms. Brown-Hruska. Well, we are looking at it.
    Senator Harkin. I haven't really seen much from CFTC on 
natural gas, though. I just really haven't seen a lot. Maybe 
there is and I am just not that aware of it. I am really taking 
a look at some of the----
    Ms. Brown-Hruska. Well, we certainly have looked at a lot 
of individual episodes of volatility recently where we have 
seen huge run-ups.
    Senator Harkin. Yes.
    Ms. Brown-Hruska. Then I would say that we do that in a lot 
of markets. We do that in other markets that are important to 
you and your constituents. I know we look at cattle. We look at 
grains. Sometimes we have big run-ups in grains and we have to 
look at those. I would say that a lot of the evidence and what 
we have seen in these markets are consistent with the energy 
complex, as well. We see similar situations where when there is 
uncertainty about supply and demand, that we see greater 
volatility. Really, in the energy space, we have very tight 
supply and demand conditions.
    We have a problem with not enough supply, and storing 
natural gas is a problem, and providing it in the seasonal way 
that it is demanded has also been an issue, where we see that 
reflected in the prices. We see a lot of market fundamentals 
creating this volatility.
    Senator Harkin. You put----
    The Chairman. Senator, can I interject something quickly? 
This is a critical area. Your questions have been right on 
point, Tom. One of the criticisms that has been directed at the 
Act itself is that it allows the natural gas market to be 
manipulated rather than supply and demand forces work their 
way. I know CFTC did an investigation a year or so ago, or you 
have been doing it over the last year, relative to this issue. 
Can you give us some of your comments regarding manipulation 
versus supply and demand creating these volatile highs and lows 
that Senator Harkin is talking about?
    Ms. Brown-Hruska. Well, I can speak generally. We have 
completed our investigations that have looked in those 
episodes. We had one last fall. We had one the year before 
that. In every case we look at, we are grateful that we have, 
in fact, a significant amount of information on the positions 
of large traders, of energy market participants, of users, to 
determine what their intentions are and what their trading 
activity is. It is our Large Trader Reporting System. We 
evaluate that trade. We evaluate the audit trail and the prices 
that we see to determine if there was any strategic 
manipulative behavior.
    In both those investigations, we found a lot of supply and 
demand-type explanations for the volatility and the prices that 
we saw. For example, we could link it directly to, in some 
cases, unrest. If you look at crude oil, we could look at 
situations in the Middle East where we had some concerns about 
supply there. If we look at natural gas, it is the winter 
heating season. In this last fall, uncertainty about what the 
weather would be like and whether or not supplies would be able 
to keep up with those weather conditions clearly predicted some 
of the price patterns that we saw.
    We use all the data that we have at our disposal and all 
the information that we can get, and you mentioned, Senator 
Harkin, over-the-counter market positions. If we suspect that 
somebody is trying to manipulate the futures markets so that 
they can benefit themselves in their over-the-counter market or 
their cash market position, we can get that information. We can 
do a special call, and we do them all the time to get the 
information that we need to ensure that they are not using the 
concert of two markets to manipulate our markets.
    I would say, by and large, that we have and we will 
continue to investigate unusual price activity. We will tie 
that in with our significant resources in the enforcement and 
in the surveillance area to ensure that the markets are not 
manipulated and we do that in a very proactive way, I would 
add. We see it on a day-to-day basis. If something is going on 
in the markets that is a concern to us, we immediately start 
watching those markets. We are in touch with the regulatory 
officials at the exchanges to try to get an understanding of 
what is going on. We work with them. If they want to raise 
their margin levels due to the increases in volatility and 
concerns that they have, we support that. We work with them to 
identify who the traders are and what their intentions are.
    I would say, by and large, we have been very successful, 
and part and parcel to that is because of a good working 
relationship that we have with the markets, with the exchanges, 
particularly, but even in the over-the-counter markets, that we 
do have special call authority and we don't hesitate to use it.
    Senator Harkin. Thank you, Mr. Chairman. Thank you for 
asking that question. You can see that--I was listening to 
Senator Lugar's questions, also. As we go down this path on the 
reauthorization of the CEA, energy markets are going to be one 
big thing that we are going to have to wrestle here as to what 
authority CFTC, if any--I am not even certain about that--what 
additional authority you may need to get data. If you say 
supplies are tight, do you really have the tools that you need 
to get that kind of information to know whether or not the 
markets are transparent, really transparent or not?
    I am not convinced of that right now, and so my questions 
as we go forward are going to be around that area. Of course, I 
focused a little bit on natural gas. I just might focus on 
other things. It seemed that we had great volatility there. The 
spreads are too wide. There is great uncertainty as to what the 
data shows in terms of supplies out there. Again, I just 
wonder, Mr. Chairman, whether or not CFTC might need some 
additional authorities in that area. Like I said, I don't know 
the answer to that question, but we are going to have to pursue 
it.
    Thank you, Mr. Chairman.
    [The prepared statement of Senator Harkin can be found in 
the appendix on page 42.]
    The Chairman. You are absolutely right. As we go through 
this process, we have to wrestle with this issue. Madam 
Chairman, those of us on this committee can pretty easily 
follow what the planting season portends, what the harvest is, 
and what the drought situation is, so we can follow 
commodities, agricultural commodities. Something like natural 
gas that doesn't have an annual harvest season, it is obviously 
much more difficult for us to give any oversight. That is why 
we have CFTC. We would urge you to continue to be proactive and 
to keep us advised and to dialog with us as we go through this 
process to make sure we are doing the right thing 
legislatively.
    Senator Salazar.

  STATEMENT OF HON. KEN SALAZAR, A U.S. SENATOR FROM COLORADO

    Senator Salazar. Thank you, Mr. Chairman, and thank you, 
Senator Harkin. Congratulations to you, Chairman Brown-Hruska, 
on the fine job that you are doing.
    I realize that CFMA has a relatively short life span. You 
have only been working with the reauthorization for the last 
four or 5 years. I appreciate the great work that you and the 
staff and the Commissioners have been doing.
    I also am going to be a supporter of the reauthorization, 
because you have been doing a great job. Following along the 
same lines of questions that were being asked by Senator 
Harkin, it would be a good time for you and the Commissioners 
to look back to see whether or not there are lessons to be 
learned from the last 5 years of what has happened with respect 
to some of the scandals that we have seen in other aspects of 
our financial markets and if there is anything that we ought to 
be doing as a Congress to try to address those issues.
    I come from a background, for the last 6 years, I spent my 
life as Attorney General. In that regard, I was very involved 
in investigations and prosecutions relating to the mutual fund 
industry as well as talking to some of my colleagues about some 
of the improprieties that occurred on Wall Street.
    You have been doing a very good job with respect to the 
kind of reauthorization and the right kind of enforcement and I 
very much appreciate that. It would be very useful for us as a 
Congress to have your thoughts, as the Chairman of the 
Commission, on whether or not there are any changes that ought 
to be made to avoid the kinds of problems that we saw, for 
example, in the mutual fund industry. My own view of what 
happened in the mutual fund industry is that we had regulation 
and we had regulators, but we didn't have the right kind of 
enforcement so that we ended up having the kind of preferential 
treatment that allowed the market timers to come in and to 
basically take advantage of the ordinary mom-and-pop Americans 
that were investing in their 401(k)s and in their mutual funds.
    My own request of you is that you think long and hard, now 
that we are going through this reauthorization process, and use 
it as an opportunity to make sure that among commodities 
trading, that we don't have the same kinds of problems that we 
had in other aspects of our financial markets here in America.
    Thank you very much. Thank you, Mr. Chairman.
    The Chairman. Thank you, Senator Salazar.
    Senator Conrad.
    Senator Conrad. Thank you, Mr. Chairman. Thank you, Ms. 
Chairman. Is that the appropriate appellation, Ms. Chairman?
    Ms. Brown-Hruska. Madam Chairman.
    [Laughter.]

STATEMENT OF HON. KENT CONRAD, A U.S. SENATOR FROM NORTH DAKOTA

    Senator Conrad. Thank you very much for being here. Let me, 
first of all, associate myself with the questions of Senator 
Harkin, because they were right on target.
    Let me just say that I had an opportunity to meet with 
industry experts on natural gas in the last day and a half and 
they tell me they think we are poised to have very substantial 
upward movements in the natural gas market. We look at what is 
happening with the snowpack out our way. That means--the 
snowpack is way down. That means production from our main stem 
dams on the reservoirs is going to be down. That means more 
pressure on natural gas. We have, as you know, lots of other 
pressures on that market.
    Senator Harkin was absolutely right to be focusing on 
volatility in natural gas. I want to make clear that I share 
his concern.
    I want to turn to another area of concern and that is 
exchange rate contracts and how much risk is being run there. 
What I am most interested in is what would happen, in your 
judgment, if there were a precipitous fall in the dollar? The 
reason I ask is we have already seen the dollar come off the 
Euro about 30 percent in the last 2 years. There seems to be 
continuing pressure on the dollar as we continue to run massive 
trade deficit. As you know, the trade deficit was over $600 
billion last year. The operating deficit of the United States 
was over $600 billion last year. That includes the money that 
we are borrowing from Social Security and have to pay back that 
is not included in what the press defines as the deficit. On an 
operating deficit, the truth is, we are running about a $600 
billion shortfall there, as well.
    Much of that is being funded now externally. Over the last 
3 years, our foreign indebtedness has gone up 91 percent, quite 
stunning. We had, 3 years ago, a trillion dollars of foreign 
indebtedness. Now, we are approaching two trillion of foreign 
indebtedness.
    We saw 2 weeks ago, South Korea sent shudders through the 
market by announcing they were going to diversify out of 
dollar-denominated debt and dollar-denominated securities, that 
they thought the risk was growing unacceptably given our budget 
and trade deficits.
    We have had Warren Buffet, one of the most successful 
investors in our country, indicate that he is placing major 
bets against the U.S. currency. We have seen others similarly 
indicate growing concern. I understand there was a delegation 
from Japan here last week warning the United States that we 
could not continue to run these massive deficits. As you know, 
we have already borrowed over $700 billion from Japan alone.
    The vulnerability and the risk here, it strikes me, in 
these exchange rate contracts is if there were a precipitous 
fall in the dollar, and many economists are warning us that 
that could occur. What are the protections in place against the 
chaos that would ensue if there were a precipitous fall in the 
dollar?
    Ms. Brown-Hruska. Well, I would say that the last time I 
taught this--I taught international finance, so I remember the 
data of the last time I looked at it, and your data sounds much 
more up-to-date than mine--but I remember that, in fact, the 
vast majority of the foreign currency traded in the world used 
to be about $4 trillion a day, in the interbank currency 
markets and largely outside of our jurisdiction.
    A lot of that is hedged in forward and swap transactions. 
In the forex area, the swaps transactions are largely designed 
to help companies manage the mismatch between their foreign 
currency cash inflows and their foreign currency cash outflows 
that they have as a part of doing business.
    What typically is the case is that to swing back to your 
question, of the regulated foreign currency transactions that 
we have oversight of. They are probably on the order of two or 
3 percent of the total foreign currency transactions that take 
place.
    I am very confident in our market's ability to continue to 
provide risk management regardless of the direction of the U.S. 
dollar. That is the key thing. Derivatives provide a way to 
manage that uncertainty about where the dollar is going, and so 
it is vitally important that they be allowed to function so 
that businesses, from the smallest operation to the largest, be 
able to rely upon those marketplaces to hedge those risks.
    Senator Conrad. Let me interrupt you there because I am 
running out of time. In fact, I am out of time, Mr. Chairman. 
If I could just conclude with one question?
    The Chairman. Sure. Go ahead.
    Senator Conrad. Let me just--I am told that this recent 
court case, the Zelener case, that the court held that these 
exchange rate contracts are not futures contracts and therefore 
not subject to CFTC regulation. Is that an accurate depiction?
    Ms. Brown-Hruska. That they are not futures contracts? Yes, 
that is accurate.
    Senator Conrad. Yes, and so not subject to CFTC regulation.
    Ms. Brown-Hruska. Yes.
    Senator Conrad. Who does regulate them?
    Ms. Brown-Hruska. Well, in fact, we brought a case for 
fraud in that particular case, so obviously we believe that we 
regulate them.
    Senator Conrad. Yes, but the court says no.
    Ms. Brown-Hruska. Again, yes, this has been a very 
difficult court case. In fact, we appealed it all the way up to 
the Supreme Court. It is one of those situations where they 
focused on the language of----
    Senator Conrad. I know, but I don't want to go into the 
detail. I want to know where we are now. What concerns me, and 
what has to concern this committee, I would say to my chairman, 
is if you all don't regulate these contracts, who does? You say 
you are confident of where we are. Well, I will tell you, if 
nobody is regulating these things, I am not confident, and 
there is too much risk out there to be confident, it seems to 
me, if we have a court decision that says you can't regulate 
these contracts.
    Ms. Brown-Hruska. Well----
    Senator Conrad. That is the court determination, right?
    Ms. Brown-Hruska. It was one court, yes. We are----
    Senator Conrad. We are stuck with that until some other 
court makes some other determination or, perhaps, until we act. 
Is there any requirement that Congress respond to this, or can 
you give advice to us? It doesn't have to be now. Perhaps you 
need to consult with others.
    What I want to make sure we get on the record here, Mr. 
Chairman, is does Congress need to act in response to this 
court decision to make certain that CFTC has jurisdiction in 
this area? Do we need to do that?
    Ms. Brown-Hruska. Well, I would say that yes, we are 
looking at it and our intention is to continue to bring these 
cases. I just signed three of them yesterday, where we were 
taking action against----
    Senator Conrad. I appreciate that, but we have a problem 
here, don't we? We have a court that said, these are not 
futures contracts. My time is--I have gone over my time. Let me 
just conclude by saying, Mr. Chairman, we need to really insist 
that we get a recommendation on what action we might need to 
take in response to that court determination. I don't want to 
leave you without the authority to be examining these 
contracts. The risk is simply too great.
    Ms. Brown-Hruska. Thank you, sir.
    Senator Conrad. I thank the Chairman.
    The Chairman. Very good question. Let me just suggest, 
Madam Chairman, that you have your staff put together the issue 
that now you are faced with after the decision in this case and 
give us your recommendation on that issue.
    Ms. Brown-Hruska. Thank you, sir. We would be happy to.

  STATMENT OF HON. PATRICK LEAHY, A U.S. SENATOR FROM VERMONT

    The Chairman. Senator Leahy.
    Senator Leahy. Thank you, Mr. Chairman.
    The CFTC is one of the few Commissions where I have worked 
with a majority of the Commissioners, most of them former Hill 
staffers. I also want to commend the Acting Chair, Ms. Brown-
Hruska. She has done a great job in her leadership role, and I 
know a number of these issues have been raised already.
    As I look around, I see Mike Dunn, who worked extensively 
on agriculture credit and banking issues when I was chairman. 
Commissioner Walt Lukken did a fantastic job on the last 
reauthorization of the Commodity Exchange Act. Fred Hatfield 
worked with Senator Breaux, and Doug Leslie, who was on loan to 
me and Senator Lugar for around 2 years assisted this 
committee.
    I know that former Chairman Lugar has talked already about 
when he and I volunteered--that is the day we arrived 1 minute 
late, Dick----
    [Laughter.]
    Senator Lugar Senator Talmadge volunteered us to take on 
the CFTC thing. I ended up learning more in a short time than I 
ever thought I would.
    Senator Leahy Madam Chairman, I appreciate your effort to 
close down some of these boiler room operations. What they do, 
and usually to the most--what they bilk people out of, and they 
are usually the people who can least afford it. People who deal 
on a professional basis on commodities know the risks. They 
deal with millions of dollars, sometimes hundreds of millions 
of dollars back and forth, but that is a business. They know 
how to deal with the risk. They know how to handle it.
    When you are a person on a fixed income or you are a person 
who gets a call from one of these boiler rooms, it doesn't work 
that way, and especially if you have a family who is desperate. 
They may have both parents holding down jobs, trying to make 
ends meet. They get some of these calls, and you have heard 
probably more of them than I have, but I have listened to some 
of the recordings and being lured into foreign exchange 
markets. You and I know enough to hang up on it from our own 
past experience, but a lot of people don't and they just go 
into ruin. They have to be closed down totally.
    I have worked on both the Appropriations Committee and the 
Judiciary Committee to give funding to the Justice Department 
for people designated to work on specific issues and I am happy 
to work on this.
    Now, there are other areas, the Enron collapse. I am very 
concerned about energy markets. We see the price of oil going 
up. This could affect, whether it is in a rural area like mine 
or a major population area, the energy markets make a 
determination whether they are going to make it or not, whether 
they are going to have jobs or not. It is vital to be able to 
protect us on these markets, especially in the anti-fraud, 
anti-manipulation efforts.
    The CFTC needs a stronger oversight role regarding over-
the-counter foreign exchange and options contracts. I know it 
is a complicated issue. When I came in, somebody mentioned the 
Seventh Circuit case, Zelener. Let us work together. Let us 
work together on this.
    My question would be about the over-the-counter forex, the 
foreign currency exchange. Are you getting the kind of help you 
want from the Department of Justice in putting these people out 
of business?
    Ms. Brown-Hruska. Well, thank you for your comments. You 
know, we have a number of open forex investigations with the 
Department of Justice now and we very much appreciate it. We 
have been very well received by Justice and our cooperative 
efforts have paid off, not only in forex, but in the energy 
investigations that we brought, as well.
    The Division of Enforcement at the CFTC and the Department 
of Justice together brought Operation Wooden Nickel last year, 
one of the largest undercover operations in the history of our 
agency. In that action alone, over 30 people were arrested. In 
sum, our relations with Justice have been very good and our 
markets benefit from that work.
    You mentioned also, or someone mentioned States' Attorney 
Generals. We have also worked with those individuals and their 
offices as well, to bring a lot of our cases in the energy and 
forex area.
    I said that we might like some clarification in our forex 
authority, given the Zelener case, the States do also have 
significant authority, the Attorneys General and so does 
Justice, so does the Federal Trade Commission, if they want to 
take up some of these cases. In many respects, by cooperative 
enforcement, we are able to ensure that those late-night cold 
callers and those Internet fraudsters are tracked down and put 
out of business.
    Senator Leahy. I am sure you agree with me. We want 
commodities markets to work. Obviously, when you have an 
economy like ours, especially one that uses so much from energy 
to food and everything in between, we want them to be able to 
work. Everything gets tarnished, at least in the view of the 
average person, if these illegal groups are working. I want you 
to be able to bring the hammer down.
    Incidentally, Senator Feinstein has again introduced a bill 
to regulate over-the-counter energy trading. Have you had a 
chance to look at that?
    Ms. Brown-Hruska. No, I haven't seen the specifics. I know 
that it--I have seen her past legislation and some of it was 
well received in terms of its intent.
    Senator Leahy. We may want our staffs to talk more on that. 
It is another area, especially after some of the past things, 
and as energy prices go up, it is something a lot of us here 
are very concerned about.
    Mr. Chairman, I will have other questions for this and the 
other panel. I will just introduce those for the record. We 
have a Judiciary meeting going on. I wanted to come down to 
give my compliments to the Chairman, but also to emphasize, 
like Senator Lugar already has, that a lot of us, and I know 
this includes the two of you, we want commodities trading to 
work. We also want to make sure that those who try to cash in 
on unsuspecting Americans, that we bring the hammer down pretty 
hard.
    The Chairman. Thank you, Senator Leahy.
    [The prepared statement of Senator Leahy can be found in 
the appendix on page 44.]
    TheChairman. We have already publicly stated our admiration 
for you and Senator Lugar for taking this on early and staying 
on the committee.
    Madam Chairman, thank you very much. We appreciate your 
testimony and your very frank discussion that we have had here 
today, and we look forward to staying in touch as we move 
through this process.
    Ms. Brown-Hruska. Thank you, Mr. Chairman.
    The Chairman. Thank you. We will now ask our second panel 
of very distinguished members of the industry to come forward.
    Gentlemen, welcome this morning. We are very pleased to 
have with us Mr. Charles P. Carey, Chairman of the Board, 
Chicago Board of Trade, from Chicago; Mr. Terrence A. Duffy, 
Chairman of the Board, Chicago Mercantile Exchange, also 
Chicago; Dr. James Newsome, President, New York Mercantile 
Exchange, New York, and obviously the former Chairman of the 
CFTC; Mr. Frederick W. Schoenhut, Chairman of the Board, New 
York Board of Trade, of course, New York; Mr. Satish 
Nandapurkar, President and CEO of Eurex US, Chicago; and Mr. 
John Damgard, President, Futures Industry Association, located 
here in Washington.
    Gentlemen, we welcome you here this morning. We look 
forward to your testimony and to your dialog. Mr. Carey, we 
will start with you. I would encourage all of you to submit 
your statements for the record. Limit your comments to 5 
minutes. Thank you.

   STATEMENT OF CHARLES P. CAREY, CHAIRMAN, CHICAGO BOARD OF 
                    TRADE, CHICAGO, ILLINOIS

    Mr. Carey. Thank you, Mr. Chairman and members of the 
committee. My name is Charles Carey. I am Chairman of the 
Chicago Board of Trade. It is an honor for me to be here today 
to present the Board of Trade's views. As you have requested, 
we have submitted our written testimony for the record.
    We commend Congress for passing the Commodity Futures 
Modernization Act and the careful and thoughtful way in which 
the Commodity Futures Trading Commission has implemented its 
provisions. The CFMA gave the Commission needed flexibility to 
deal with innovation and brought legal certainty to many 
products while preserving regulatory concepts that are 
essential to our industry. The Commission and its staff have 
shown great insight in using this authority to reduce 
regulatory burdens without sacrificing vital customer 
protections.
    In my written testimony, I call attention to several issues 
that deserve discussion, but major changes to the law appear 
unnecessary at this time.
    For example, security futures, which were allowed for the 
first time by the 2000 Act, have yet to reach their potential. 
Dual regulation by the CFTC and the Securities and Exchange 
Commission has created challenges. We hope the two Commissions 
work together to relieve these, such as the unfair and 
unnecessary margin in equities that inhibit the growth of stock 
futures and their usefulness as risk management tools.
    A Federal court decision holding that the CFTC has no anti-
fraud jurisdiction over retail foreign currency transactions 
could lead to increased opportunities for fraud. The potential 
impact of this decision is a matter of concern across the 
futures industry. Congress may find that this issue warrants a 
legislative response. If that is the case, the CBOT will, as 
always, be happy to work with the committee, the Commission, 
and other industry representatives in creating a solution.
    Since the CFMA, a major trend in the industry has emerged 
toward international expansion and cross-border business 
arrangements. This trend presents interesting challenges for 
regulators both at home and abroad.
    In one such initiative, Eurex soon will ask the CFTC to 
approve a plan to approve trades on its U.S. subsidiary 
contract market through a clearinghouse located in Frankfurt, 
beyond the regulatory control of the CFTC. The prior Chairman 
of the Commission told the House Agriculture Committee that 
such a non-domestic clearinghouse must register with the CFTC 
as a designated clearing organization. The CBOT believes this 
is good regulatory policy and will preserve for U.S. citizens 
trading on Eurex US the protections available under U.S. 
regulation and bankruptcy law in the event of a default or 
insolvency.
    Recent actions of a handful of traders in London selling 
and buying bonds through a European electronic trading system 
are being investigated by four European governments for 
possible price manipulation. This incident illustrates the 
potentially destabilizing effect that market behavior can have 
across borders and between exchanges and marketplaces. 
Comparable regulation and information collection among 
regulators of different countries is essential to help detect 
and prevent systemic harm from such activities.
    The Chicago Board of Trade is pleased that the CFTC 
recently began discussions with the Committee of European 
Securities Regulators and hopes those discussions will be 
productive in resolving issues of regulatory disparities and 
gaps in a manner consistent with the CFMA.
    In addition to customer protection issues, unequal 
regulatory treatment can also result in uneven regulatory 
costs, thereby creating unfair competitive advantages. 
Decisions being made now with regard to policies and protocols 
for cross-border business are setting critically important 
precedents that will impact the global derivatives industry for 
years to come.
    The Chicago Board of Trade, the oldest and one of the 
largest futures exchanges in the world, had its best year ever, 
trading over 600 million contracts last year, a volume increase 
of over 31 percent over the prior year. The success of the 
Chicago Board of Trade over the years reflects the confidence 
that market participants around the globe have in our 
commitment to vigorous, even-handed self-regulation.
    Self-regulation with Commission oversight continues to work 
well. There have been questions raised concerning the move by 
exchanges to become for-profit organizations and whether they 
can avoid conflicts of interest. A for-profit exchange has an 
even greater incentive to maintain and increase public 
confidence. Experience has shown that investors prefer markets 
that have demonstrated integrity through self-regulation.
    The Chicago Board of Trade is presently going through the 
process of becoming a for-profit organization. I assure the 
committee that this new status, while enabling us to compete 
more efficiently with other exchanges from around the globe, 
will not lessen our dedication to fair and forceful self-
regulation. We hope and expect that regulators will keep in 
mind the advantages of knowledgeable and experienced self-
regulation and not impose rigid definitions that, for example, 
may preclude a member of an exchange with no other ties to the 
exchange from becoming an independent director or committee 
member.
    Again, thank you for the opportunity to testify today. The 
Chicago Board of Trade is pleased to respond to questions and 
provide any assistance the committee may deem necessary. Thank 
you.
    The Chairman. Thank you very much.
    [The prepared statement of Mr. Carey can be found in the 
appendix on page 51.]
    The Chairman. Mr. Duffy.

 STATEMENT OF TERRENCE A. DUFFY, CHAIRMAN, CHICAGO MERCANTILE 
                  EXCHANGE, CHICAGO, ILLINOIS

    Mr. Duffy. Thank you very much, Mr. Chairman. I am Terry 
Duffy. I am the Chairman of Chicago Mercantile Exchange 
Holdings, Incorporated, which owns and operates the largest 
U.S. futures exchange. I am happy to appear before you, 
Chairman Chambliss, to offer you and the committee the CME's 
view as to what the committee should be considering as it 
undertakes reauthorization of the CFTC.
    In the judgment of the CME, the Commodity Futures 
Modernization Act of 2000 represents successful landmark 
legislation that materially and beneficially transformed the 
nation's futures markets. The CFMA's reduction of high-cost 
regulation has been an unqualified success, making futures 
trading more efficient and useful to a wide range of customers.
    Throughout its over 100-year history and especially so in 
the past three decades, the CME has earned a reputation as a 
premier innovator and industry pace setter. A very clear 
demonstration of our leadership in the global derivatives 
industry is the historic clearing link between the CME and the 
Chicago Board of Trade, which has delivered on the efficiencies 
and the $1.8 billion in savings just as promised.
    Within our organization, the initials ``CME'' stand for 
Customers Mean Everything, and that customer-driven perspective 
explains much in terms of our success since the enactment of 
the CFMA.
    While the CME enthusiastically applauds the success of the 
CFMA and recommends that we retain this historic statutory 
framework, the upcoming Congressional reauthorization process 
offers a valuable opportunity to fine-tune that statutory 
regime based on industry experience gained since the CFMA's 
enactment in 2000.
    The first area in need of fine-tuning involves retail 
foreign exchange futures. There have been massive continuing 
frauds against retail customers in the OTC FX market. A 
loophole in the Act permits unregistered known offenders to 
sell foreign currency futures to naive retail customers. This 
loophole can and should be closed.
    Compounding this problem is the recent unfortunate decision 
of the Seventh Circuit Court of Appeals in CFTC v. Zelener, 
where the court adopted an extremely narrow definition of 
futures contracts. Zelener held that a futures contract stops 
being a futures contract if the seller inserts a meaningless 
disclaimer. The ruling permits OTC dealers to easily offer 
futures-like contracts to unsophisticated customers without the 
CFTC's jurisdiction or registration requirements. As noted in 
recent testimony by Acting CFTC Chairman Brown-Hruska, this 
retail fraud has spread from foreign currency scams to heating 
oil and orange juice. This can and should be stopped by closing 
the loophole created by Zelener.
    Unless the loophole is closed, the committee should be 
concerned with the very real prospect that, before long, the 
CFTC's jurisdiction and its retail customer protections may be 
reduced to irrelevance. The challenge for the committee and the 
futures industry is to find an effective solution that will 
politically survive the reauthorization process.
    The second area in which the CFMA needs to be modified 
deals with single-stock futures. Inter-exchange competitive 
concerns combined with regulatory and legislative turf contests 
ended the hope for this product long before it was launched. It 
is time to let futures exchanges trade the product as a pure 
futures contract and to let the security exchanges trade it as 
a securities contract. Let the relevant exchanges deal solely 
with the irrespective regulator, whether the CFTC or the SEC, 
which is what I believe Congress initially intended in 2000 in 
authorizing single-stock futures. I would urge the committee to 
prevail upon the respective regulatory agencies to eliminate 
all undue regulatory impediments.
    Before concluding, Mr. Chairman, I noted that one of the 
witnesses called for Congress to force exchanges that innovate 
and pioneer new contracts to freely give up their benefits of 
the investment and innovation to competitors. That idea is 
utterly contrary to every viable economic principle that has 
made the U.S. economy work.
    A number of other issues have been raised in written 
testimony. I will be pleased to explain why self-regulation in 
the futures industry works, how our corporate governance meets 
the highest standards, and why the rulemaking process under the 
CFMA is not broken in response to your questions or in 
supplemental testimony.
    In conclusion, I want to thank you, Mr. Chairman, for 
allowing me to participate in this hearing. The CME, its 
customers, and the industry have benefited greatly under the 
CFMA. The CME looks forward to participating in the 
reauthorization process, helping the committee craft amendments 
that preserve the original intent of the CEA, amendments that 
protect retail customers and that improve the efficiency, the 
competitiveness, and the fairness of futures trading for all 
market participants.
    I would be very pleased to answer any questions the 
committee may have. Thank you, sir.
    The Chairman. Thank you, Mr. Duffy.
    [The prepared statement of Mr. Duffy can be found in the 
appendix on page 60.]
    The Chairman. Dr. Newsome, welcome back.

  STATEMENT OF JAMES NEWSOME, PRESIDENT, NEW YORK MERCANTILE 
               EXCHANGE, INC., NEW YORK, NEW YORK

    Mr. Newsome. Thank you, Mr. Chairman.
    The Chairman. This is the first time you have been here in 
this capacity, I believe.
    Mr. Newsome. Yes, sir, it is.
    The Chairman. We congratulate you again and welcome. We 
look forward to your testimony.
    Mr. Newsome. Thank you very much. Mr. Chairman, members of 
the committee, it is an honor to be here as President of the 
New York Mercantile Exchange today. It is certainly an honor to 
see friends on this committee and former colleagues at the 
CFTC, as well.
    NYMEX is the world's largest forum for trading and clearing 
physical commodity-based futures contracts, primarily energy 
and metals. The Commodity Futures Modernization Act of 2000 was 
landmark legislation that provided critically needed legal 
certainty and regulatory flexibility to U.S. futures and 
derivatives markets. It is our view that the current structure 
is providing a reasonable, workable, and effective oversight 
regime for regulated exchanges.
    Prior to the CFMA, the CFTC operated under a one-size-fits-
all regulatory approach. Regulatory inequities, particularly 
prior approval requirements for rule and contract changes, 
imposed unreasonable constraints on domestic exchanges 
competing with international and unregulated exchanges. This 
committee and the Congress agreed that the orientation of the 
CFTC should be shifted to a more flexible oversight role.
    To address these issues, Congress established market tiers 
so that a marketplace could now select a level of regulation 
according to the product types offered, and even more 
importantly, eligible participants for the facility.
    NYMEX operates by choice at the highest level of regulation 
by the CFTC. It has consistently been deemed by the CFTC staff 
reviews to have maintained adequate regulatory oversight and 
programs. As a result of Congress's foresight and innovation, 
NYMEX, acting subject to CFTC review and oversight, can now 
bring new products and services to market promptly to meet 
customer needs.
    Although NYMEX is largely a marketplace used by commercial 
participants for hedging, the benefits also accrue more broadly 
to consumers, who receive prices based on open and fair 
competition. Prices for the commodities traded in U.S. futures 
markets are vital to our national economy and are recognized as 
reliable, global benchmarks.
    As a note, the CFMA maintained the CFTC's exclusive 
jurisdiction over futures and options on futures. NYMEX 
supported and continues to support this approach, which would 
be maintained by several savings clauses contained in last 
year's energy bill.
    It is important to point out that contrary to what some 
have suggested, the CFMA did not diminish the regulatory 
oversight responsibilities of the CFTC. Although regulated 
exchanges may self-certify new contracts and rule changes, the 
CFTC retains the responsibility to assure that all changes are 
in accordance with the guidelines of the Act. In practice, 
there is always prior discussion with the CFTC on any 
substantive change.
    Regulatory flexibility was vital in responding to the 
financial failure of Enron. In the aftermath, other energy 
trading companies lost credit ratings. Stock prices plummeted, 
and liquidity crises began to develop because market 
participants lacked confidence in each other's abilities to 
perform transactions.
    In response, NYMEX addressed these issues by rapidly 
implementing a number of important measures to migrate 
positions from the over-the-counter marketplace to NYMEX and 
the protections provided by its AA-Plus rated clearinghouse. 
NYMEX also began launching a slate of products appealing to OTC 
participants which are executed off the exchange but brought to 
NYMEX for clearing. In doing so, 130 products that are 
traditionally traded OTC have been brought under the umbrella 
of a regulated exchange, which establishes the identity of 
participants, a transaction audit trail, daily position 
surveillance, and credit security, none of which would have 
been available prior to the CFMA.
    NYMEX's safeguards allowed us to maintain solid footing 
during this challenging time, and thanks to the flexibility 
permitted under the CFMA, NYMEX adapted and provided the 
necessary tools to help stabilize impacted businesses.
    We recently completed an analysis of hedge fund 
participation in several NYMEX markets during 2004, which is 
being submitted to the committee, Mr. Chairman, for the record. 
As you review this report, I believe you will agree, as our 
research suggests, that hedge funds serve an overall 
constructive role in our markets. While hedge fund 
participation has not made up a large portion of our markets to 
date, we continue to monitor this market segment closely.
    Market integrity continues to be effectively safeguarded on 
the regulated exchanges through stringent adherence to the CFMA 
core principles. As a self-regulatory organization, NYMEX 
devotes significant resources to the oversight of all of its 
markets.
    With regard to CFTC oversight responsibilities, the agency 
has been, by all accounts, quite vigorous in exercising the 
scope of its current authority to police abuses in OTC markets, 
including energy markets. Nonetheless, there remain open 
questions respecting CFTC anti-fraud authority over principal-
to-principal transactions involving exempt commodities executed 
bilaterally or on electronic platform. Congress may wish to 
consider whether clarification or guidance in this area is 
needed.
    As my time is out, Mr. Chairman, I would just say that I 
appreciate having the opportunity to be here today and I look 
forward to answering any questions that the committee might 
have.
    The Chairman. Thank you, Dr. Newsome.
    [The prepared statement of Mr. Newsome can be found in the 
appendix on page 69.]
    The Chairman. Mr. Schoenhut, we are pleased to have you 
with us.

 STATEMENT OF FREDERICK W. SCHOENHUT, CHAIRMAN, NEW YORK BOARD 
                  OF TRADE, NEW YORK, NEW YORK

    Mr. Schoenhut. Mr. Chairman and members of the committee, 
thank you for this opportunity to testify on behalf of the New 
York Board of Trade regarding the reauthorization of the 
Commodity Futures Trading Commission. My name is Fred Schoenhut 
and I am Chairman of the Board of the New York Board of Trade.
    In 2004, the Coffee, Sugar, and Cocoa Exchange, founded in 
1882, and the New York Cotton Exchange, founded in 1870, 
formally became one exchange, the New York Board of Trade. Like 
its predecessor exchanges, NYBOT is a not-for-profit membership 
organization established under New York law. NYBOT is the 
premier world market for futures and options in cocoa, coffee, 
cotton, orange juice, and sugar. The exchange also has markets 
in currency rates and equity indexes. While the financial 
markets exhibit different underlying characteristics than the 
agricultural commodities that dominate the exchange, they all 
provide reliable tools for price discovery, price risk 
management and investment.
    In 1994, NYBOT established a trading floor in Dublin, which 
is the first open outcry trading facility in Europe owned by a 
U.S. exchange.
    The concept of self-regulation long embodied in the CEA was 
strongly reinforced and expanded by the Commodity Futures 
Modernization Act of 2000. The CFMA was the culmination of 4 
years of work by the Congress. It provided the flexibility for 
exchanges to decide how best to structure their businesses 
around a set of core principles.
    The CFTC provides oversight rather than promulgating 
prescriptive regulations and second-guessing exchange 
decisions.
    We believe the CFMA is working as intended, allowing 
markets to be competitive by modernization and streamlining the 
regulatory system. We, therefore, support a reauthorization 
bill that continues this current regulatory structure. In this 
regard, we wish to point out three areas of the exchange self-
regulatory structure that are important to maintain.
    First, each exchange should continue to be allowed to 
determine the composition of its governing board. NYBOT finds 
that diversification of board membership is beneficial to 
protect the public interest and the economic self-interest of 
the markets. It allows each exchange to have a range of 
expertise on its board, including people who are actively 
engaged in the trading of exchange products. How board members 
are chosen and how representation of various exchange 
communities should be allocated are matters for each exchange 
to determine for itself in light of its own particular 
circumstances.
    Second, the structure for exchange compliance and 
disciplinary functions should also remain unchanged. Currently, 
each exchange is required to have procedures in place for 
monitoring and enforcing contract market rules. The CFTC 
conducts regular rule enforcement reviews to determine whether 
an exchange is meeting this requirement. We believe this 
current system works well and additional requirements regarding 
the makeup or functions of the disciplinary committees are not 
needed.
    Third, exchanges are required to establish and to enforce 
rules that minimize conflicts of interest in the decision-
making process. There is a flexibility for each exchange to 
determine how to meet this requirement, recognizing that each 
exchange has a different governing structure. At NYBOT, we 
disqualify board members from participating in a decision if 
they have potential conflicts. However, if a person with a 
potential conflict has a useful expertise, we may ask that that 
person provide information to the board to inform our 
deliberations.
    In closing, on behalf of the exchange, its trading 
community, and users, I would like to thank the CFTC, this 
committee, and the Congress for the support they gave NYBOT 
after 9/11. NYBOT was the only exchange completely destroyed in 
the World Trade Center terrorist attack. Fortunately, we had a 
backup trading floor facility in Long Island City, and using 
this site, we opened up 6 days later. Thanks to the assistance 
Congress provided, we were able to rebuild in lower Manhattan 
and move into our new facilities in September of 2003. In 2004, 
we hit a record trading volume of approximately 32 million 
contracts, representing a 32 percent increase over the 2003 
volume.
    Mr. Chairman, I would be happy to answer any questions you 
or the committee members may have. Thank you.
    The Chairman. Thank you very much.
    [The prepared statement of Mr. Schoenhut can be found in 
the appendix on page 82.]
    The Chairman. Mr. Nandapurkar.

STATEMENT OF SATISH NANDAPURKAR, CHIEF EXECUTIVE OFFICER, EUREX 
                     US, CHICAGO, ILLINOIS

    Mr. Nandapurkar. Thank you. Chairman Chambliss, Senator 
Lugar, thank you for the opportunity to testify. I am Satish 
Nandapurkar, CEO of Eurex US. Eurex US is grateful today to be 
invited to participate in these hearings and to be able to 
present our views as a relative new entrant in these markets.
    I am in agreement with the others on this panel that, in 
our opinion, the CFMA has been a tremendous success. It is 
working as Congress intended, namely by giving exchanges more 
freedom to innovate and by making it more attractive to operate 
in the U.S. as a U.S. registered and regulated futures 
exchange.
    The CFMA has facilitated an unprecedented level of 
competition in the United States, resulting in greater 
innovation, greater efficiency, and greater choice for market 
participants. The numbers speak for themselves. In 2000, total 
volume on U.S. futures exchanges was 600 million contracts. 
Last year, total volume ballooned to 1.6 billion.
    We are also of the opinion that the CFTC has done an 
outstanding job in putting into practice this groundbreaking 
legislation, starting with former Chairman Newsome and now 
continuing with Acting Chairman Brown-Hruska. The CFTC has 
moved expeditiously, yet prudently, in implementing the new 
streamlined regulatory structure while ensuring that 
participants are adequately protected.
    Since enactment of the CFMA, the CFTC has designated eight 
new futures markets and eight new clearinghouses. Not 
surprisingly, the increase in competition has been accompanied 
by new products, new services, lower costs, and increased 
efficiency. Six hundred new products have been filed since 
enactment of the CFTC, and as exchanges compete, fees drop, and 
sometimes dramatically. When we came into the market for 
Treasury futures products, the incumbent exchange, the CBOT, 
dropped their fees 80 percent, in some cases dropped their fees 
to zero. That resulted in substantial savings for end users.
    Competition has also forced exchanges to finally respond to 
customers' preferences for the transparency, immediacy, and 
efficiency of electronic trading. The majority of futures 
traded in the United States are now traded electronic. That was 
certainly not the case in 2000. Thanks to electronic trading, a 
trader in Georgia or a trader in Indiana has the access to the 
same information, is on the same playing field that was once 
reserved for exchange members that stood in the pits in 
Chicago.
    We at Eurex US are particularly indebted to the committee, 
for without the committee and without the CFMA, there would be 
no Eurex US. If I may, I would like to tell you a little bit 
about my exchange.
    We are a new futures exchange registered with the CFTC and 
regulated fully by the CFTC. We are headquartered in Chicago 
with a U.S. management team based in Chicago. Our clearing is 
handled by the Clearing Corporation, a 70-year-plus institution 
based in Chicago. All our market surveillance and trade 
practice surveillance is provided by the not-for-profit 
National Futures Association, also based in Chicago.
    We launched last February with futures and options on two-, 
five-, 10-year Treasury Notes and 30-year Treasury Bonds. We 
have expanded our product line this year to include equity 
indexed products, namely the Russell 1000 and 2000 futures.
    Our approach to derivative markets is quite 
straightforward. We believe that all customers should get the 
benefit of a fully electronic trading system, equal access to 
information on a level playing field, and low fees for 
everyone. We believe that no one should have to pay for a 
membership to be able to get these benefits.
    Our goal here is not just to compete in the United States, 
but to expand the market in doing so. As markets continue to 
globalize, we plan to be on the forefront of facilitating 
cross-border trade, making it easier for European participants 
to access U.S. markets and U.S. participants to access European 
markets. We have had extensive discussions with the CFTC on the 
implementation of the next phases of our global business plans.
    In enacting the CFMA, Congress placed great faith in 
competition and that faith has been rewarded. Greater 
innovation and greater efficiency has been the engine of growth 
in the futures industry over the past few years. In our way, we 
are trying to realize the potential created by the CFMA. We 
offer the U.S. marketplace open and equal access, an all-
electronic venue, competitive trading in existing products, new 
products, and low fees for everyone. Our course forward is to 
build on this foundation, to bring greater business into the 
United States.
    The CFMA has greatly facilitated our ability to do this. We 
urge Congress to stay the course. You have done your part. Now 
it is our turn to do our part. Continued reliance on the 
benefits of competition will transform this industry even 
further for the benefit of everyone and preserve the U.S.'s 
leadership role in the global futures markets. Thank you.
    The Chairman. Thank you, Mr. Nandapurkar.
    [The prepared statement of Mr. Nandapurkar can be found in 
the appendix on page 88.]
    The Chairman. Mr. Damgard.

   STATEMENT OF JOHN M. DAMGARD, PRESIDENT, FUTURES INDUSTRY 
                  ASSOCIATION, WASHINGTON, DC

    Mr. Damgard. Thank you very much, Chairman Chambliss, 
Senator Lugar. I am pleased to appear with my friends from the 
exchange community. On behalf of the Futures Industry 
Association, I want to thank you very much for appearing here 
today.
    I have one advantage over the others at the table, if it is 
an advantage, and that is that I have been involved in every 
CFTC reauthorization since the agency was created in 1974. I 
remember well, Senator Lugar, those discussions in 1978 at the 
first reauthorization. Along with Leo Melomed, who is here and 
needs no introduction, we were the only ones that go back quite 
that far.
    I know firsthand the historic and vital role this committee 
has played in periodically reviewing the CFTC's operations and 
reforming the Commodity Exchange Act when warranted. This 
committee's work on the Commodity Futures Modernization Act of 
2000 is only the latest example of your significant 
contribution to our mutual goals of strong, competitive, 
innovative, and honest futures and options markets. Your 
longstanding commitment is greatly appreciated by this 
industry.
    In light of that expertise, we would make a specific 
recommendation to this committee. As you know, last year's 
energy bill contained amendments to the Commodity Exchange Act. 
If similar efforts to amend the Act are made this year, we 
believe they should be part of this committee's consideration 
of CFTC reauthorization instead of in the energy bill.
    The CFMA was a piece of landmark legislation which left the 
Commission with a very ambitious agenda. Under strong 
leadership, the Commission has implemented the new regulatory 
design authored by this committee. They are to be commended for 
their efforts.
    CFTC reauthorization provides an opportunity to reconsider 
the regulatory program for the futures markets to see what is 
working and what is not. In FIA's view, the list of what is 
working is long and the list of what is not is quite short. My 
written testimony goes over those lists in more detail, but let 
me just summarize some of the high points.
    The fundamental changes enacted in the CFMA have worked 
well. We are not in favor of any change to the basic statutory 
design. In particular, FIA would be concerned with any plan to 
expand dramatically the jurisdiction of the CFTC. In our view, 
when the CFTC's mission strays from its oversight of exchange 
traded futures and options, it distracts from the Commission's 
ability to achieve the Act's essential regulatory purposes.
    That is why we have concerns about any proposal to expand 
the CFTC's jurisdiction as a response to the ongoing problem of 
fraud against retail customers in OTC FX transactions. The CFTC 
was not set up to become a national consumer protection agency 
for commodity transactions, a fact that this committee 
recognized in 1982 when it wrote, quote, ``The Commission by 
itself cannot be primarily responsible for policing every 
enterprise operating under a commodity theme.''
    Consistent with this committee's reasoning, our approach to 
retail FX fraud would be twofold. First, give the CFTC specific 
targeted authority to pursue fraud claims against otherwise 
unregulated persons, and second, encourage law enforcement 
officials to take action against, and if need be, put behind 
bars, those who con retail customers in FX transactions. The 
only proven way to deter and end retail FX fraud is a strong, 
cooperative, Federal, State, and local law enforcement campaign 
to lock up those responsible and keep them from bouncing from 
one jurisdiction to another when they get caught.
    Fair competition, transparency in exchange rulemaking, and 
true SRO independence continue to be areas where the FIA would 
support improvements. The CFMA has sparked efforts to introduce 
more direct competition among exchanges, as we had hoped. Thus 
far, the challenger markets have not been successful in doing 
more than chipping away at the entrenched markets' dominance. 
Further action by Congress and/or the Commission may be needed 
to accomplish the real purpose and the real promise of 
competition by affording our customers a choice of efficient, 
low-cost market platforms from which to select the best price 
available for any trade.
    No one wants to go back to the days when all exchange rules 
required costly and time consuming CFTC approval. Our concern 
is that the current regime works to shut out our members and 
their customers from both the exchange internal approval 
process and any subsequent CFTC review. For example, a 3-day 
private comment period on whether the Commission should approve 
an important exchange rule is no substitute for the kind of due 
process anyone would expect from a fully informed agency 
deliberation. We look forward to working with this committee, 
the Commission, and the exchanges to make exchange rule makings 
more open to public comment and input.
    SROs have an important job to do, making sure that the 
public has confidence in our markets. Independent directors 
signal to market users around the world that our SROs are 
serious about self-policing and put the public interest above 
their business interest. While some exchanges, notably the 
Chicago Mercantile Exchange, have made real strides in this 
area, others have not. We want to work with all interested 
parties to strengthen this aspect of SRO operations.
    Our last concern is product availability. Our members serve 
a sophisticated customer base that use futures markets all over 
the world to manage price risks in their business or investment 
activity. When U.S. law or regulation prevents our customers 
from obtaining access to exchange-traded products either in 
this country or overseas, it has the perverse effect of forcing 
our customers to use other less transparently priced 
instruments to manage those risks, often without the clearing 
protection exchange trading affords. While those anomalies do 
not occur often, where they do, we ask this committee's help in 
removing them.
    In conclusion, Mr. Chairman, FIA looks forward to working 
with this committee and its staff and the rest of the industry. 
We believe that with a handful of changes, we can make an 
excellent regulatory system even better. Thank you very much, 
and I am pleased to answer any questions.
    The Chairman. Thank you, Mr. Damgard.
    [The prepared statement of Mr. Damgard can be found in the 
appendix on page 93.]
    The Chairman. Let me just say to all of you, as we did with 
the Chairman of CFTC, we would like to request that you give us 
any recommendations for proposed changes that you might have in 
writing so that all members of the committee can review any 
suggestions that you have as we move forward with this 
reauthorization.
    Mr. Nandapurkar, your testimony mentions the proposed 
Global Clearing Link. Could you explain in a little more detail 
what this is, how it works, and its effect--what effects it 
might have on the markets?
    Mr. Nandapurkar. Mr. Chairman, I would be glad to. The 
Global Clearing Link is a mechanism that links our 
clearinghouse, the Clearing Corp. in Chicago, with the 
clearinghouse of Eurex in Frankfort, Eurex Clearing. We believe 
it is similar to other clearing arrangements that have been in 
place before, namely the CME link with Singapore, their MOS 
link, and the CME link with MEFF. We are trying to provide 
benefits to members and benefits to customers where we can 
lower their costs and provide greater efficiencies in them 
doing cross-border trades.
    We have already gotten phase one of the Global Clearing 
Link approved, and in phase one of the Global Clearing Link, 
the real benefit is that it allows U.S. customers to repatriate 
their funds from overseas back into the U.S. What happens today 
when people trade or when traders trade, they can trade all 
over the world, as Mr. Damgard just said. There are traders 
here in the U.S. that trade in Europe. There are traders in 
Europe that trade in the U.S.
    For Eurex, about 20 percent of Eurex's business comes from 
the U.S., and when a trader in the U.S. trades on Eurex, they 
trade on the exchange, they leave their funds at Eurex 
Clearing, and that is where they put their margin. Thanks to 
the first phase of the Global Clearing Link and the link 
between the Clearing Corp. and Eurex Clearing, now those same 
U.S. traders can repatriate their funds out of Europe and back 
into the U.S. and hold their margins and hold their positions 
back with their clearing firm here in the United States. We can 
get the money out of Europe and back here and it gives them the 
opportunity to do that with their U.S. relationship.
    The second phase of the Clearing Link is a phase where new 
European customers--what we hope we can do with the second 
phase is to allow a new set of market users in Europe, namely 
small and mid-sized European customers, to have better access 
to U.S. products. What we are going to hope to allow them to do 
is to trade U.S. products, but use their existing clearing 
relationships in Europe to be able to clear those products. By 
doing that, we hope to bring a lot of new business into the 
U.S., and that is probably the biggest benefit, is the type of 
business that we are going to get and the new business that is 
going to come in.
    We are working with the CFTC. We have had extensive 
discussions with the CFTC. One of the things I should mention 
is we have committed in our exchange application and our 
approval that we will not go forward with the Global Clearing 
Link in any way without full approval of the CFTC of that 
Global Clearing Link. We expect to be filing how we plan to do 
this fairly soon and we also expect that there will be a public 
comment period in terms of the details of the Global Clearing 
Link.
    The Chairman. Mr. Carey, in your written testimony, you 
seem to have some concerns relative to the Global Clearing 
Link. Do you care to comment?
    Mr. Carey. Yes. Thank you, Mr. Chairman. We believe if they 
go forward, the Frankfurt Clearing House should register as a 
DCO. It is the best way to ensure consistent protection for 
U.S. customers. We haven't seen the application for the Link 
itself, so we are not sure how it is going to function.
    The Chairman. Mr. Duffy, in his written testimony, and Mr. 
Damgard referred to it somewhat, the FIA appears to raise some 
concerns of possible problems with regard to the SRO structures 
of the exchanges that may create conflicts of interest for the 
exchanges and allow them to impose rules which benefit 
themselves but have anti-competitive consequences for competing 
exchanges and the users of exchanges. Would you care to give me 
your response to this concern, please, sir?
    Mr. Duffy. Well, the Chicago Mercantile Exchange today has 
rules on its book that have been approved by the CFTC for many 
years and we just are upholding all of our rules to make sure 
that the centralized marketplace is not fractured. What we are 
doing is making certain that wash trades, which already are 
prohibited trades under the Commission's rules, don't happen at 
our institution. I believe that is what Mr. Damgard is 
referring to.
    The Chairman. Mr. Damgard, any comment you wish to make?
    Mr. Damgard. We have watched carefully what has gone on in 
the securities industry and we are certainly not sold on the 
idea that the New York Stock Exchange has the right model, 
where 100 percent of the directors have to be independent. Our 
members believe that at least 50 percent of the members of a 
board ought to be independent directors, and that leaves plenty 
of people left on their board who would have industry 
knowledge. It comes down to a definition of what is 
independent.
    We would argue that floor traders subject to the regulatory 
authority of their SRO's, who can be disciplined, by those 
SRO's, do not qualify as independent. To say otherwise, simply 
doesn't meet the laugh test. The Chicago exchanges have had 
many, many qualified independent directors, such as Dan 
Glickman and Myron Scholes. Floor traders who historically 
looked out only for the interest of the floor, should not 
qualify as independent. In the old days, when there was no 
competition among the exchanges, the floor traders didn't 
really have to be concerned about what the customer thought 
because there was only one place to go with the trade. I 
believe such a policy of drawing independent directions from 
the ranks of the floor trading population would hurt the 
reputation of our industry. We need to make sure that customer 
confidence in these exchanges remains very, very high.
    Mr. Duffy. Mr. Chairman, if I may respond, I thought you 
were referring to some rules that we have enforced at our 
institution. As far as the independence issue related to the 
governance of the SRO, the Chicago Mercantile Exchange is a 
publicly traded entity and our board and all of its members do 
comply with the listing standards of the New York Stock 
Exchange and the SEC. We have an independent board, which we 
are required to have by law, with a majority made up of 
independent directors. We do comply with all NYSE and all SEC 
requirements as far as our independence.
    Mr. Damgard. I would only respond by saying the New York 
Stock Exchange does not consider local market makers as 
independent.
    The Chairman. Mr. Schoenhut, what are your views of the 
current structure of CFTC oversight of exchange governing 
bodies and disciplinary committees?
    Mr. Schoenhut. Thank you, Mr. Chairman, for that question. 
NYBOT is quite satisfied with the CFTC oversight functionality. 
In our experience with the CFTC with respect to our board, I 
should point out that we have five independent or public 
directors and then people of expertise from several trade 
areas, futures commission merchants both large and small, as 
well as floor traders comprising the balance of our board. We 
feel that this system has worked successfully for years, as is 
evidenced by the fact that the New York Board of Trade has 
received many favorable commentaries by the CFTC. We feel that 
our board and the issues that come to our board at times can be 
very technical in nature, and to have expertises such as what 
we have is very important to our business.
    The Chairman. Thank you. Senator Lugar.
    Senator Lugar. Mr. Chairman, in carrying on a little 
further this current inquiry, certainly, an enormous amount has 
been written in the financial press about boards of directors. 
Both Fortune and Business Week, as I recall, in recent issues 
have surveyed Sarbanes-Oxley and what it has meant to many 
corporations, and still, a minority of New York Stock Exchange 
listed stocks seem to have something that appears to meet the 
standards of Sarbanes-Oxley, although there are a good number 
of rationalizations why this is not so.
    It is important, and each one of you have said it in your 
own way, that this industry really exemplify confidence levels 
with regards to the directors. This is a serious issue, but a 
difficult political issue within each company, or maybe even 
within each exchange. Really, it is beyond our--well, we are 
not going to get into it exchange by exchange today as to what 
these circumstances have been and how reforms have been made, 
but I would just say that at a time when things are moving 
well, and each of you are testifying that way and we feel that 
way, this is a time to make certain we are in consonance with 
the general business community, and it is still one of reform. 
A good number of corporations in America, not hopefully any 
here today, are resisting that reform. They are hoping it will 
blow over as an enthusiasm that came after the stock market 
bubble and what have you.
    I am hopeful that you will work with us as we try to boost 
you. This is not a mutual admiration society, but nevertheless, 
this committee has taken a strong interest in the strengthening 
of the industry and in ensuring people of the integrity of it, 
both at home and abroad, and so have you. I simply see 
something here that is important to maybe examine more 
carefully. I really have not, and so I am intrigued, really, by 
the discussion.
    Let me just ask you, Dr. Newsome, because you have seen 
historical memory from your own standpoint as Chairman, why do 
you believe the volume of transactions has risen so 
dramatically on some of the exchanges that have been testifying 
here today? What is happening in our economy or in the world or 
maybe in the structure of these markets and trading practices 
that would lead to that kind of dynamic increase?
    Mr. Newsome. Thank you, Senator Lugar. I would respond in a 
couple of ways. One goes directly to the flexibility afforded 
by the Commodity Futures Modernization Act and that leads to 
part of the discussion we are having here about corporate 
structure.
    Senator Lugar. Yes.
    Mr. Newsome. One of the things that the Act did that was 
most important from this committee and the Congress was to 
allow the exchanges to all get outside of the box that they 
were required to serve in prior to the passage of the CFMA. 
With that new flexibility, we have seen exchanges go in 
different directions in terms of the types of products they 
offer, the types of services that they offer to their members 
and to their customers, and differences in corporate governance 
structure, as well. We all have rules and regulations, some 
just by the CFTC, others, as NYMEX and the CME, with regard to 
the SEC. Even though we are not a publicly traded company, we 
are an SEC registered company and have to abide by all of the 
Sarbanes-Oxley rules, which we have implemented over the past 
year.
    While there certainly are some constants, the flexibility 
to come up with differing products and differing services to 
customers was certainly a key component of this increase in 
volume. I don't think it is a coincidence that it all happened 
at the same time.
    The second component of that, I believe, is really a 
maturing of the futures industry. If you look at futures on 
agricultural products, obviously, that goes back many, many 
years. Over the last 25 years, there has been an explosion in 
the development of new products within the futures industry to 
allow customers in other service areas to manage their risk, 
from the financial products very successfully offered by both 
the Chicago exchanges to the energy contracts that NYMEX and 
other products in all the exchanges.
    Customers, end users, have developed more and more comfort 
with how to utilize these products to manage risk. As the banks 
have expanded, as the companies, the underlying producers or 
processors of these products have matured and developed more of 
a comfort level, they have realized the opportunities to 
utilize futures products to manage risk and therefore, the 
explosion that we have seen over the last few years.
    Senator Lugar. No one could----
    Mr. Damgard. May I add a word?
    Senator Lugar. Yes, Mr. Damgard.
    Mr. Damgard. I also think it is competition. The 
competition has caused the existing exchanges to reduce their 
fees. We all knew that they knew how to compete, and they 
certainly have done so. The explosion in volume is clearly a 
result of more and more people utilizing these risk management 
devices. There is no question in my mind but what, even though 
it was resisted by some 4 years ago, this committee deserves an 
awful lot of credit for making sure that competition now exists 
in our markets.
    Senator Lugar. I appreciate that comment, especially from 
the standpoint of farmers in the country. The committee maybe 
is an improbable committee to be regulating all of this, 
although it grew from our interest in the agriculture 
commodities some time ago. The same principles have worked, as 
you all have illustrated, for a lot of different situations, 
different markets.
    One of the problems of testimony of farmers and farm groups 
over the years has been how few farmers either understood these 
markets and their importance, and sadly, how few really took 
advantage of those opportunities. It appears to me that there 
probably is a greater participation by people in the 
agriculture community, producers, in these markets. In part, we 
have had long discussions of crop insurance at various levels, 
tried to think through with farmers who, at a typical meeting, 
say in my State would have said, we plant the crop, we harvest 
the crop and take the price that you get. God willing, we 
survive.
    Unfortunately, this kind of faith did not lead to survival. 
The need to have crop insurance against catastrophe, but even 
more, to be thinking in terms of forward contracts, to be 
making some disciplined sales, is all the difference in a very 
low-margin business, and for many farmers, the only difference 
between a loss that is very severe and the possibilities of 
staying alive.
    The educational process still is an important one, and 
although many of the farmers now are larger, perhaps, a lot of 
younger farmers have come along who do not see what you are 
doing today as gambling, and that used to be the charge, that 
you folks are simply countenancing almost a vast casino 
situation, many younger farmers coming through their own 
educational process financially have seen the value and, in 
fact, the importance of what is occurring here, quite apart 
from all sorts of other users in industry or other people 
throughout the world may see this, and I hope that will 
continue.
    It may be a small part of the picture in terms of volume as 
we now look at what was surveyed today, but it is very 
important to this committee. It is very important to our 
country that our farmers be successful and that they have these 
opportunities, they have confidence in these markets. To the 
extent that you have enhanced that, we really appreciate it 
very much.
    Mr. Chairman, I would just ask a final request that I put a 
short opening statement I had that I did not deliver in the 
record. I appreciate your indulgence in that.
    The Chairman. Certainly. Without objection, that will be 
done.
    Senator Lugar. Thank you, sir.
    The Chairman. You are absolutely right. Mr. Damgard made a 
very good point, that it is critically important that the 
integrity of the markets be maintained. Otherwise, that 
confidence will not be there. While you might still be somewhat 
identified as solely a part of the agriculture community, we 
know otherwise. The agriculture part of it is so vitally 
important. You don't find a successful farmer today who doesn't 
have a computer sitting on his desk, and they utilize those 
computers on a daily basis to bring up the markets relative to 
their particular products that each of you deal with.
    Dr. Newsome, in your testimony, you made reference to a new 
NYMEX study of hedge fund participation in NYMEX natural gas 
and crude oil futures markets. Would you very quickly summarize 
that study's findings for us, please?
    Mr. Newsome. Yes, sir, Mr. Chairman. Not long after coming 
to NYMEX, we experienced some pretty drastic volatility in 
energy markets. The press and many others were quick to point 
the finger at speculators, particularly hedge funds and their 
involvement in the markets. As an exchange with access to the 
actual data of who was trading, I felt that it was very 
important for us to look at that data and actually analyze the 
role of hedge funds with regard to some of our key markets 
because no one else had that data, and even though we had it, 
we didn't know the answer to the question.
    In the beginning of August, we undertook a study. We 
actually expanded that study a couple of times to include the 
whole year from January through December of 2004, specifically 
looking at the level of activity of hedge funds in natural gas 
and crude oil contracts in NYMEX.
    The findings would be somewhat surprising to a number of 
people, particularly the low level of activity in hedge funds 
in those two markets. With regard to the crude oil market, 
hedge fund trading was less than 3 percent. In crude oil, hedge 
fund trading was just a hair over 9 percent. Those indicate 
relatively low levels of trading activity, certainly from our 
standpoint, not large enough levels of trading in which they 
could potentially move the marketplace.
    The second thing that we found is that the open interest in 
both of those contracts by hedge funds was quite a bit larger 
than most market participants, indicating that hedge funds tend 
to hold on to their positions for a longer period of time as 
regard to other market participants, therefore actually 
decreasing volatility because of holding onto those positions.
    We go into detail, Mr. Chairman, in terms of that report. 
The fact that we are making it available to this committee 
today as part of the record is actually the first time that 
anyone has seen that report, as we just finished it. I am sure 
that as you read it, there may be other questions that arise 
and certainly we look forward to working with you to explain 
our findings in the report.
    The Chairman. Thank you very much.
    Let me say to each of you, as well as to Chairman Brown-
Hruska, we appreciate your being here to give us your views on 
where we are with respect to the reauthorization of CFTC and 
what changes we should consider relative to the CFMA. Again, I 
will just ask each of you to give us in writing any suggested 
changes and your reasoning therefore. We will look forward to 
continuing a dialog with you.
    It is truly amazing to sit on the outside of your markets 
and see the true growth and the competition. You are right, Mr. 
Damgard, has probably expanded this, but the sophistication of 
the investor because of the education of your particular 
institutions has contributed greatly to that, also. We 
appreciate your continuing work with this committee as well as 
your continuing cooperation with the CFTC.
    We will leave the record open for an additional 5 days for 
written questions to be submitted to any of you and we would 
hope that you would immediately get those responses back to us.
    We have another hearing set on Thursday, after which we 
will begin our deliberations as to what direction we are 
heading.
    Again, gentlemen, thank you very much, and this hearing is 
concluded.
    [Whereupon, at 12:22 p.m., the committee was adjourned.]
      
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                   DOCUMENTS SUBMITTED FOR THE RECORD

                             March 8, 2005



      
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                         QUESTIONS AND ANSWERS

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    TO CONSIDER THE REAUTHORIZATION OF THE COMMODITY FUTURES TRADING
                               COMMISSION

                              ----------                              


                       THURSDAY, MARCH 10, 2005,

                                      U.S. Senate,,
        Committee on Agriculture, Nutrition, and Forestry,,
                                                    Washington, DC.
    The committee met, pursuant to notice, at 10:08 a.m., in 
room SR-328A, Russell Senate Office Building, Hon. Saxby 
Chambliss, chairman of the committee, presiding.
    Present or submitting a statement: Senators Chambliss and 
Salazar.

  STATEMENT OF SAXBY CHAMBLISS, A U.S. SENATOR FROM GEORGIA, 
              CHAIRMAN, COMMITTEE ON AGRICULTURE, 
                    NUTRITION, AND FORESTRY

    The Chairman. This hearing will come to order, and good 
morning.
    We are here today to discuss the reauthorization of the 
Commodity Futures Trading Commission, which is set to expire in 
September of this year. CFTC is charged with the responsibility 
of overseeing the trading of commodities futures contracts, and 
the Commodity Exchange Act is the basic law that empowers CFTC 
to carry out this responsibility.
    As part of the last CFTC reauthorization in 2000 Congress 
passed the Commodity Futures Modernization Act, making some 
substantial changes in the Commodities Exchange Act. The CFMA 
provided legal certainty for the over-the-counter swaps market 
and also streamlined the regulatory process for exchange, 
traded futures markets.
    As we proceed into this reauthorization of the CFTC, the 
committee is hoping to learn not only how people view the 
changes made in 2000, but also what changes, if any, need to be 
made in future legislation.
    This is the second hearing held by the committee on the 
subject of CFTC reauthorization, and I thank all the witnesses 
for appearing today to discuss this very important topic. We 
have already heard from the acting chairman of the CFTC as well 
as a group of people representing U.S. futures exchanges and 
the futures industry.
    Today I would like to welcome representatives from the 
over-the-counter markets and others from across the industry. 
The committee looks forward to hearing your views on this 
reauthorization process. We have with us today Mr. Jeffrey 
Sprecher, the CEO of InterContinentalExchange in Atlanta, 
Georgia; Mr. Robert Pickel, Executive Director and CEO of the 
International Swaps and Derivatives Association from New York; 
and Mr. Oliver Ireland, Partner with Morrison & Foerster here 
in Washington, DC, on behalf of Huntsman Chemical, a member of 
the Industrial Energy Consumers of America.
    This will be our first panel, and gentlemen, we welcome you 
this morning. We have a number of other hearings that are 
ongoing this morning, including a very important hearing that 
affects this committee and that is the markup on the budget for 
fiscal year 2006, so we have a number of members who are absent 
as a result of that hearing and others.
    I am advised that Senator Harkin will be running a little 
late getting here, but he will be here shortly. We are going to 
go ahead and proceed with opening statements from this first 
panel. Mr. Sprecher, we will start with you, then Mr. Pickel 
and then Mr. Ireland. We welcome you again. Thank you for being 
here. We look forward to your comments.
    Mr. Sprecher.

          STATEMENT OF JEFFREY C. SPRECHER, CHAIRMAN 
AND CHIEF EXECUTIVE OFFICER, INTERCONTINENTALEXCHANGE, ATLANTA, 
                            GEORGIA

    Mr. Sprecher. Thank you, Mr. Chairman.
    My name is Jeff Sprecher, and I am the founder, the Chief 
Executive Officer and the Chairman of InterContinentalExchange, 
which in our industry is also known as ICE. ICE operates the 
leading global electronic over-the-counter marketplace for 
trading energy commodities and derivative contracts that are 
based on energy commodities. Energy commodities that are traded 
on our platform include oil, natural gas and power. ICE also 
operates an energy commodities futures exchange through a 
wholly owned London-based subsidiary called the International 
Petroleum Exchange of London, which is also known in the 
industry as the IPE.
    I would like to thank the committee for its effective and 
farsighted work in developing and adopting the CFMA. The CFMA 
has been critical to my company's success for three reasons. 
First, the CFMA provided legal certainty for OTC derivative 
contracts. Second, the CFMA created a new category of trading 
facility called the exempt commercial market. This committee 
recognized that electronic marketplaces whose participants are 
limited to eligible commercial entities, or ECMs, trading on a 
principal-to-principal basis do not require the same level of 
Federal oversight as futures exchanges that are accessed by the 
retail public. The CFMA also permitted the clearing of OTC 
transactions. Today ICE provides clearing for a variety of its 
OTC contracts, reducing unwanted credit exposure and increasing 
market liquidity.
    As you mentioned, we are headquartered in Atlanta, Georgia 
and we operate a many-to-many electronic platform that allows 
buyers and sellers of physical commodities and derivative 
contracts to view and act on each other's bids and offers. ICE, 
unlike Enron with its EnronOnline, is not a party to any of the 
transactions on our platform. ICE's electronic platform is 
designed to enhance the transparency, the speed and the quality 
of trade execution. In addition our platform offers a 
comprehensive suite of trading-related services including OTC 
electronic trade confirmation, access to clearing services and 
the publication and dissemination of market data and 
information.
    As I stated earlier, ICE operates as an ECM under the 
jurisdiction of the CFTC. As an ECM ICE is required to comply 
with access, with reporting and recordkeeping requirements. ICE 
has worked closely with the CFTC since our inception and we 
look forward to continuing a cooperative relationship. We also 
look forward to working with this committee as it considers the 
many issues facing the CFTC during its reauthorization.
    With respect to issues affecting ECMs in particular, ICE is 
of the view that the CFMA and the rules adopted by the CFTC 
provide for an effective framework for oversight of commercial 
marketplaces. There is no need to amend the Commodity Exchange 
Act in this area. The CFTC has promoted open, freely accessible 
and transparent markets including permitting the creation of 
ECMs. I believe that restricting trading activity through 
additional regulation would only adversely affect the market 
liquidity and price transparency and would not reduce price 
volatility that we have been seeing recently in energy.
    On behalf of ICE I would again like to thank the committee 
for its excellent work in enacting the CFMA. It's been a clear 
benefit to my company, and I would submit, to the producers and 
the users of energy commodities around the world.
    ICE looks forward to working with the committee during the 
reauthorization process, and at the appropriate time I will be 
happy to take your questions. Thank you.
    [The prepared statement of Mr. Sprecher can be found the 
appendix on page 188.]
    The Chairman. Great. Thank you.
    Mr. Pickel.

  STATEMENT OF ROBERT G. PICKEL, EXECUTIVE DIRECTOR AND CHIEF 
    EXECUTIVE OFFICER, INTERNATIONAL SWAPS AND DERIVATIVES 
             ASSOCIATION, INC., NEW YORK, NEW YORK

    Mr. Pickel. Mr. Chairman and members of the committee, I 
appreciate your invitation to testify today on behalf of ISDA. 
ISDA has appeared frequently before the committee in prior 
years and we welcome the opportunity to be with you today as 
you continue your important hearings with respect to 
legislation to reauthorize the Commodity Futures Trading 
Commission.
    ISDA is an international organization, and its more than 
600 members include the world's leading dealers in swaps and 
other off-exchanged derivative transactions commonly referred 
to as OTC derivatives. ISDA's membership also includes many of 
the businesses, financial institutions, governmental entities 
and other end users that rely on OTC derivatives to manage risk 
inherent in their core economic activities effectively and 
efficiently. I am also happy to say that my two fellow 
panelists, their firms are also members of our organization.
    The Commodity Futures Modernization Act was adopted by 
Congress with broad bipartisan support after careful 
consideration over several years by four congressional 
committees and with the support of the President's working 
group. The CFMA extended much needed regulatory relief for the 
futures exchanges, provided legal certainty and regulatory 
clarify for OTC derivatives, and removed the ban on the trading 
of single stock futures.
    ISDA's principal interest in the CFMA was and remains with 
those provisions intended to provide legal certainty for OTC 
derivatives. The phrase ``legal certainty'' means simply that 
the parties to an OTC derivatives transaction must be certain 
that their contracts will be enforceable in accordance with 
their terms. The CFMA framework for providing legal certainty 
is based on a longstanding consensus among Congress, the CFTC 
and others that OTC derivative transactions are not 
appropriately regulated as futures under the CEA.
    The legal certainty provisions of the CFMA were intended by 
Congress to reduce a systemic risk and promote financial 
innovation. Our experience since 2000 confirms that both of 
these objectives have been achieved. The use of OTC derivatives 
for risk management purposes has continue to grow both in 
periods of economic downturn and uncertainty and in times of 
economic expansion.
    The reductions in systemic risk resulting from enactment of 
the legal certainty provisions of the CFMA have not come at the 
expense of financial innovation. New types of OTC derivatives 
have gained increased market acceptance since enactment of the 
CFMA. For example, the significant growth in credit default 
swaps to manage credit risk in times of volatility and 
uncertainty has been greatly enhanced by the legal certainty 
provisions of the CFMA. Similarly, the legal certainty 
provisions have encouraged dealers to develop and businesses to 
use an increasing range of new kinds of OTC derivatives such as 
weather derivatives to manage additional types of risk. 
Finally, the CFMA removed the regulatory barriers to clearing 
of OTC derivatives, and while collateralized transactions 
remain more prevalent, the emergence of alternative clearing 
proposals attests to the positive effects of the CFMA on 
financial innovation.
    For these reasons ISDA shares the view expressed by Acting 
CFTC Chair Sharon Brown-Hruska that the CFMA functions 
extremely well. In our view this is attributable to the care 
with which Congress constructed the legislation, to the even-
handed manner in which the CFTC has interpreted and 
administered the CFMA in accordance with congressional intent, 
and to the CFTC's vigorous enforcement program following the 
collapse of Enron and the California energy situation.
    ISDA believes that the experience that its members and 
others have had under the CFMA demonstrates that there is no 
fundamental need for Congress to make substantive changes to 
those portions of the legislation governing OTC derivatives. 
ISDA is of course aware that others have advocated substantive 
changes to the legislation, including changes with respect to 
OTC derivatives. In our view, however, the case for such 
changes simply has not been made.
    We understand that you and your colleagues will want to 
have the benefit of a full range of views concerning the CFMA. 
We think this is highly desirable and welcome the opportunity 
to participate constructively in the debate and discussion of 
possible changes. We do, however, urge you and your colleagues 
to proceed cautiously in reopening the CFMA. The legislation, 
although carefully crafted, is complex and the potential for 
unintended and undesirable consequences from selective changes 
is great.
    We also urge you and your colleagues to ensure that your 
committee asserts fully its right and responsibility to review 
and approve any substantive changes to the CEA. Our experience 
in recent years has confirmed that the use of freestanding 
amendments offered to separate legislation without your 
committee's review, scrutiny and public comment is an 
undesirable method of considering changes to legislation as 
complex and important as the CEA.
    Let me conclude, Mr. Chairman, with three observations. 
First, by providing legal certainty and regulatory clarity for 
OTC derivatives in a manner consistent with the longstanding 
policies and the CFTC, the CFMA materially reduced systemic 
risk and encouraged financial innovation. Second, the 
regulatory relief provided to the futures exchanges has 
likewise provided substantial benefits to the capital markets. 
Together these two factors confirm that the policy judgments 
made in 2000 were sound then and remain so today.
    Finally, ISDA remains available and is looking forward to 
working cooperatively and constructively with your committee, 
and we look forward to the opportunity to do so in the coming 
months.
    I look forward to any questions you may have. Thank you.
    [The prepared statement of Mr. Pickel can be found in the 
appendix on page 199.]
    The Chairman. Thank you very much.
    Mr. Ireland.

 STATEMENT OF OLIVER I. IRELAND, PARTNER, MORRISON & FOERSTER, 
               LLP, WASHINGTON, DC, ON BEHALF OF 
          HUNTSMAN CORPORATION AND INDUSTRIAL ENERGY 
                      CONSUMERS OF AMERICA

    Mr. Ireland. Thank you, Mr. Chairman and members of the 
committee.
    I am a partner in the D.C. office of Morrison & Foerster. I 
previously served as Associate General Counsel to the Board of 
Governors of the Federal Reserve System, and there advised the 
Board on matters relating to derivative transactions. I am here 
on behalf of the Huntsman Corporation, a member of the 
Industrial Energy Consumers of America. I thank you and the 
members of the committee for the opportunity to participate in 
today's hearing on CFTC reauthorization legislation.
    Huntsman is a global leader in the chemical manufacturing 
business. Global manufacturing companies like Huntsman depend 
on the commodities markets for their materials and rely on fair 
pricing in those markets. A key commodity for Huntsman, as well 
as thousands of other domestic businesses and millions of 
farmers and consumers is natural gas.
    While we generally believe that the Commodity Exchange Act 
as amended by the Commodity Futures Modernization Act of 2000 
functions exceptionally well, price volatility in the natural 
gas contracts since mid 2000 suggest that the market for 
natural gas futures may not be operating efficiently, and that 
the regulatory framework for these contracts should be 
reviewed.
    A price of natural gas that is shaped by fundamental forces 
of supply and demand will allocate the supplies of gas within 
the economy most effectively. Facilitating this pricing 
function is one of the key purposes of the Commodity Exchange 
Act. However, if this pricing process breaks down, that 
breakdown can result in inappropriate pricing and inefficient 
allocation of natural gas in the economy.
    We believe that there is evidence that the level of price 
volatility in the futures market for natural gas is impairing, 
rather than promoting, pricing in the natural gas market. Since 
2000 day-to-day price volatility in the natural gas futures 
contract traded on the NYMEX has increased substantially, even 
after taking into account the higher prices for natural gas 
during this period. By some measures price volatility in the 
natural gas contracts traded on the NYMEX has increased by 60 
percent. During the same period commercial trading participants 
on the NYMEX have declined to a relatively small percentage of 
the market participants. We believe that this price volatility 
raises questions as to whether the trading in natural gas may 
be subject to inappropriate practices.
    While the CFTC has responded to a number of unlawful acts 
in the markets for natural gas, we believe that the committee 
should consider four changes to the Commodity Exchange Act to 
augment the authority of the CFTC to address natural gas 
contracts.
    First, we think that the committee should consider 
regulating natural gas under the Commodity Exchange Act under 
the same framework applicable to agricultural commodities.
    Second, we believe that the committee should consider 
requiring the CFTC to review and seek public comment on and 
approve existing and new rules for natural gas contracts based 
on consistency with the core principles established in the 
Commodity Exchange Act. We believe that this process should 
focus particular attention on price fluctuation limits or 
circuit breakers. Circuit breakers can provide time for markets 
to evaluate new information and to act appropriately, therefore 
promoting price discovery. We believe that a circuit breaker 
more on the order of the 8 percent that was in effect prior to 
the year 2000 should be the benchmark and that circuit breakers 
above that level should be scrutinized carefully.
    Third, we believe that the committee should consider giving 
the CFTC backup authority to require large position reporting 
where such reports are not otherwise being made. The CFTC 
should also be authorized to require recordkeeping to help 
police the reporting requirement. We recognize that these 
authorities should be used sparingly, taking into consideration 
the burden that they may impose as well as their utility in 
detecting or deterring inappropriate market practices.
    Finally, we believe that the committee should consider 
giving special authority to the CFTC to address rules for 
settlement in the natural gas futures contracts, allowing for 
cash settlement where market manipulation is suspected, and 
thereby making short squeezes in the futures market more 
difficult.
    Thank you for the opportunity to be here today, and I would 
be happy to address any comments or questions the committee may 
have.
    [The prepared statement of Mr. Ireland can be found in the 
appendix on page 213.]
    The Chairman. Thank you very much. Thanks to all of you.
    Mr. Ireland, I will let you back up a minute and explain to 
my limited brain capacity this circuit breaker. Would you run 
through that one more time? I am not sure I followed you.
    Mr. Ireland. Many markets, including the futures markets, 
have what I refer to as a circuit breaker which when the price 
of trading reaches a certain level at variance with the 
previous trade's close, trading stops either for the day or for 
some period of time. For example, in the natural gas contract 
on the NYMEX up until early the year 2000 if the price moved 15 
cents they stopped trading until the next day. That gives----
    The Chairman. Which is what we refer to as limit up or 
limit down?
    Mr. Ireland. Limit up or limit down, the same thing. 
Similar provisions are in place in the equities market and were 
recommended by the President's working group on financial 
markets following the 1987 stock market break.
    The Chairman. There is no such provision for natural gas is 
what you are saying?
    Mr. Ireland. Well, there is a provision today, but the 
dollar limit is I believe on the NYMEX $3, and that stops 
trading for 5 minutes, and then it resumes, and then it stops 
if it moves another $3. With the prevailing price of natural 
gas of about $6, that $3 trading limit, which restarts again so 
quickly, I do not think imposes any meaningful time for the 
market to catch up with new information.
    The Chairman. Explain to me again what your thought is 
relative to what sort of regulatory measure ought to be 
established to control that.
    Mr. Ireland. We think that the CFTC should review each 
natural gas contract provision or exchange rule applicable to 
natural gas for consistency with the core principles. We 
believe that when the CFTC reviews those rules, as the current 
gas contract does provide for a trading limit greater than the 
pre-early 2000 number, which was about 8 percent, that that 
number ought to receive particular scrutiny and the Commission 
ought to affirmatively find, based on substantial evidence, 
that that number is not going to facilitate manipulation in the 
markets, and that that is consistent with the price discovery 
function of the exchange.
    The Chairman. OK. Mr. Sprecher, we understand that ICE is 
an exempt commercial market under the CEA, and why are you not 
regulated in the same way as NYMEX?
    Mr. Sprecher. Thank you for your question. As an exempt 
commercial market, ICE is limited as to the participants that 
we can allow to use our system, and under the CFMA those 
participants are called ECEs, I believe, exempt commercial 
entities, but they essentially are companies with substantial 
knowledge and a substantial asset base. I believe a company 
must have at least $100 million worth of assets, $10 million in 
net worth, and a substantial business in the industry to 
participate on ICE.
    We are not allowed access--to allow participants to access 
our platform who are retail customers, unknowledgeable or small 
net worth companies, which is allowed in the futures industry, 
and we think the Modernization Act was very well crafted in 
recognizing that the Government does not need the same level of 
scrutiny to two large international oil companies doing 
business with one another as opposed to the broad access 
consumer-base marketplaces that are a part of the futures 
business.
    The Chairman. Let me ask you about the comments of Mr. 
Ireland relative to this circuit breaker issue. You of course 
trade in energy contracts.
    Mr. Sprecher. Yes.
    The Chairman. While you have this exempt status, I am 
certain that there obviously are times when you have 
interaction with CFTC relative to the contracts you utilize. 
Would you comment on his statement relative to this proposed 
control of the volatility, and also how you interact with CFTC 
relative to energy contracts that you have.
    Mr. Sprecher. Sure. I have a number of thoughts. First of 
all with respect to reauthorization, I have the view that the 
CFTC has a lot of tools in its capacity to make sure that 
markets run orderly and to make sure that there is no fraud or 
manipulation, and while I do not have a specific stake in the 
New York Mercantile Exchange, I am aware that exchanges in 
general have anti-fraud, anti-manipulation, and free and 
orderly market responsibilities as part of their charter and 
mandate to the CFTC. I do not know that the reauthorization 
needs to specifically address new language.
    Now that being said, there is no question that natural gas 
has become a preferred fuel in our country because of its 
clean-burning efficiency and wide accessibility, and as such 
the market has become incredibly complicated with many users 
and gas moving around the country. The New York Mercantile 
Exchange trades a single contract that is delivered at the 
Henry hub in Louisiana. On the over-the-counter market, or in 
layman's terms, the non-exchange market, there are over 200 
different delivery points for natural gas, and they are all 
woven together in a complex marketplace, and so while it might 
be beneficial to halt trading in one market to allow an orderly 
process, I think the reality is that there are these other 
markets that would continue to trade unabated, and you run the 
risk of essentially allowing sophisticated market participants 
or these ECEs that trade in the over-the-counter market to 
continue to trade and hedge during high volatility while the 
retail customer and the smaller participant who do not access 
these markets would essentially be trapped by an artificial 
price cap for a moment in time. I am not sure it is ultimately 
a workable solution given the complexity of our markets today.
    The Chairman. Mr. Pickel, do you have a comment relative to 
that issue?
    Mr. Pickel. Not specifically on the recommendations that 
Mr. Ireland made. I would say that you have here represented on 
the panel the range of activity. You have comments regarding an 
actual exchange, the NYMEX. You have the perspective of the ECM 
in ICE. Then you have the perspective that ISDA brings to the 
issues, which is the privately negotiated sector where parties 
will enter into a transaction on a bilateral basis typically 
governed by a contract that we have published and developed 
over the years, and again, under the CFMA those transactions 
are excluded from the CEA in recognition that those 
transactions are typically done between sophisticated parties. 
They negotiate a contract and agree to their own protections in 
that contract, and it is really only those two parties who are 
aware of the terms of that particular contract, as distinct 
from an exchange where that price gets published and is 
available on screens on a running basis, and also information 
regarding the trading on ICE that can also be obtained by those 
people who are participating in that marketplace.
    The Chairman. Would your customers' transactions not have 
an influence on the price of natural gas on NYMEX, for example?
    Mr. Pickel. The transaction itself, no, I do not think 
those would serve that price discovery function. Now, the 
parties may in turn go and look to lay off some of their 
exposure either on the NYMEX or on ICE or some other market 
that might be available, and to the extent that those 
activities trigger concerns from a manipulation standpoint, the 
protections and the authorities that the CFTC has would apply, 
but with respect to those activities, not with respect to the 
bilateral contract.
    The Chairman. Mr. Ireland, is it your thought that 
regulation ought to extend to those private contracts as well?
    Mr. Ireland. My thought is that we ought to treat natural 
gas more as an agricultural commodity, and agricultural 
commodities were excluded from many of the exemptions created 
in the Commodity Exchange Act and the Commodity Futures 
Modernization Act. To a certain extent, yes, we would restore 
some of the CFTC provisions applicable to the natural gas 
contract that do not apply now to over-the-counter 
transactions.
    The Chairman. Before I forget, Mr. Pickel, you mentioned 
weather derivatives. Again, explain that to me if you will. 
Give me your definition again of a weather derivative and what 
we are talking about here.
    Mr. Pickel. It is a transaction typically entered into 
again on a bilateral basis using ISDA documentation, where a 
party may look to hedge his exposure that he might have as a 
result of weather activity, for instance, rainfall is typical, 
heating degree days, there are often contracts done on that. 
This is a growing, this is a newer product, but it allows, for 
instance, an ice cream manufacturer who thinks it is going to 
be--whose profits depend on it being a very hot summer, buying 
some protection in the event that the summer ends up being 
cooler than expected. This allows them through a bilateral 
contract to obtain some financial protection against the 
exposure that it might have to a cooler than normal summer.
    The Chairman. Again, that would be an exempt transaction.
    Mr. Pickel. Again, done pursuant to the requirements of 
typically Section 2(g) of the CFMA. It is between parties that 
satisfy the requirements for eligible contract participants, 
and if it is individually negotiated as described in that 
particular clause, then yes, and I mean weather derivatives in 
particular are very much tailored to the specific needs of the 
parties, so virtually all of those would satisfy the individual 
negotiation requirement there.
    The Chairman. Mr. Sprecher, one issue that keeps arising is 
the situation involving Enron and the collapse of that company 
and the obvious financial effect on not just employees but 
investors. How is ICE different from EnronOnline and what 
protections are in place in your opinion that really will not 
allow another situation involving Enron in the industry to 
occur?
    Mr. Sprecher. First of all, probably the main difference 
between ICE and Enron is that Enron was a party to every buy 
and sell transaction on its EnronOnline, whereas we simply are 
operating a neutral marketplace. We are more like an eBay, 
running the eBay site where buyers and sellers come together, 
and we are not a party to the transactions.
    I am sure of most interest to you in your unique role is 
that my understanding is that Enron received an exemption from 
oversight by the CFTC, and thanks to the foresight I guess of 
the committee in putting in the CFMA, companies like mine are 
actually in this unique category called ECMs where the CFTC 
does have oversight on my company and where we are tasked with 
anti-fraud and anti-manipulation responsibilities and 
accountable to the CFTC.
    The Chairman. Does the CFTC ever come to you and say: We 
are doing some oversight on natural gas; we want to see some of 
your contracts?
    Mr. Sprecher. Yes, actually quite often. It is obvious that 
there was a fair amount of nonsense that went on in the energy 
markets early in this decade, and in trying to build an 
enforcement record and hold people accountable for their 
actions we have become a data repository for transactions that 
were done, and we often provide that information to the CFTC so 
that they can recompile trading. One of the luxuries of 
electronic trading is that it is saved in a data base and the 
CFTC has tasked us with the responsibility to keep those 
records intact and to be able to provide them to them. I would 
also mention to you that we have a similar relationship with 
the Federal Energy Regulatory Committee and work closely with 
them in the same vein.
    The Chairman. Is there any pattern that has developed that 
would indicate that when certain things happen that that 
triggers CFTC coming to you, for example, a spike or increase 
in oil prices, or is there a pattern that dictates when they 
are going to come ask you for those contracts, or they do it 
just at random?
    Mr. Sprecher. It is a bit of actually a two-way street. A 
unique spike price is very often an example of when they would 
come to us, also a specific investigation that may be underway 
against either an unexplainable market activity or an 
individual company or a trader. Similarly, we have adopted with 
the CFTC a mechanism where if we ourselves see something in the 
market that we cannot explain, we report it to the CFTC so that 
they are aware of it, and between us work out some kind of data 
coordination.
    The Chairman. Senator Salazar.

  STATEMENT OF HON. KEN SALAZAR, A U.S. SENATOR FROM COLORADO

    Senator Salazar. Thank you very much, Chairman Chambliss, 
and thank you members of the committee for spending some time 
with us here this morning.
    My own view is that CFMA and the CFTC have been working 
well, but this is an opportunity, as you go through the needle 
of reauthorization, to figure out how we might be able to 
improve the law.
    My distinguished colleagues Senator Leahy and Senator 
Feinstein have talked about the need for additional oversight 
of over-the-counter energy markets and many of them have talked 
to me about the need to move forward, and in that direction, 
Senator Feinstein has legislation that would modernize the act 
from her point of view and would give additional authority to 
prevent fraud and manipulation in the energy markets.
    I was wondering whether you might share with me your 
perspectives on Senator Feinstein's legislation and whether or 
not that is a direction that we should be encouraged to head in 
as we review the reauthorization of CFMA?
    Mr. Pickel. Perhaps I will start on that, and obviously we 
have been active in the past 5 years as we have seen Senator 
Feinstein's proposal come up for consideration on the floor of 
the Senate and reacting to that.
    As we have all said, the CFMA was a great advance forward. 
One of the ways it was was recognizing that there really are 
several different ways in which products are transacted and 
entered into so that you have a provision that is very much 
consistent with the longstanding policy of Congress and the 
CFTC, that the types of bilateral contracts that people enter 
into privately negotiate, tailor the terms specifically to 
their needs, and also typically entered into using an ISDA 
contract, are the types of private activity that are not 
subject to and should not be subject to regulation by the CFTC.
    Mr. Ireland mentioned the agricultural commodities which 
were very consciously recognized as being something separate. 
There are a number of provisions in the CFMA that recognize 
that energy may have some different features, and depending on 
the type of activity and the level of interaction between 
parties and their effect on the marketplace, there are 
provisions in there that put in a different layer of 
regulation, if you will, including anti-fraud and anti-
manipulation authority, so those protections are in there. In 
fact, the CFTC since the CFMA was enacted has had a vigorous 
enforcement program in light of the California energy situation 
in light of some of the effects on the energy marketplace, and 
they should be applauded for that activity, and they have 
confirmed that they feel, and they have repeated this several 
times over the last several years, that they have sufficient 
authority to take action against fraud that happened in those 
marketplaces, and I am sure that they will continue to do that 
and protect consumers in the energy area.
    Mr. Sprecher. I guess I would echo Mr. Pickel's thoughts in 
that my company is of the opinion that the CFMA and the 
statutory oversight of the CFTC has the provisions that they 
need to run effective markets. In our dialog with the 
Commission they too have said to us that they believe they have 
all the tools that they need.
    I understand the frustration in the West and am sympathetic 
to it. We as a marketplace want there to be fair and orderly 
markets. My company charges a commission on every trade, so the 
more trades that are done, the more money we make, and the only 
way you can bring more participants into a market is if they 
feel that it is fair and orderly.
    With respect to the specific Feinstein legislation, we 
think that it is a bit redundant from what is already available 
to the CFTC.
    Senator Salazar. Mr. Ireland.
    Mr. Ireland. Senator Salazar, our particular concern is the 
natural gas contract, and more particularly, volatility in the 
natural gas contract. As I understand Senator Feinstein's 
legislation it is substantially broader than that. Like my 
colleagues on the panel we generally think that the CFMA has 
worked well and that the Commodity Exchange Act has worked well 
as amended by the CFMA, and we have a much narrower issue than 
is addressed by the Feinstein bill.
    We also think that there are particular characteristics in 
the gas contract that are different than other energy 
contracts.
    Senator Salazar. I am interested also to find out a little 
bit more about these weather derivatives. My wife is the proud 
owner and operator of a Dairy Queen and----
    [Laughter.]
    Senator Salazar. [continuing] is very acutely aware of what 
happens when you have a cold day and you are trying to sell ice 
cream. I am wondering if you could just tell us a little bit 
more about how weather derivatives do actually work and is it 
an emerging part of what is happening with commodity trading? 
It is a concept that I had not heard about until this morning.
    Mr. Pickel. Perhaps Mr. Sprecher can indicate whether he is 
developing a contract on ICE for weather derivatives. I really 
cited that example in my testimony as indication of innovation. 
New products, new ways of looking at risk, developing new tools 
to help companies manage the risks that they have. The 
traditional OTC derivative had been developed in the interest 
rate world, the FX world. Once that was developed people said, 
well are there not other types of risks we can apply this same 
technology, if you will, to manage risk?
    Weather is one of the next steps. I do not know that people 
would say that it is going to grow into the size of business 
that that interest rate and currency or the credit derivative 
business is, but nevertheless, it is an indication that by 
having the right regulatory framework you encourage innovation, 
people are developing new tools.
    As far as the specifics of the trade, it is really very 
much dependent upon where somebody works or has their Dairy 
Queen or has their factory, where they have their market, what 
the particular historical weather trends are, because it is 
very much--the pricing of it, the level at which you are 
willing to buy or sell protection is very much dependent upon 
what the historical experience is, and fortunately here in the 
United States we have a very deep and rich history of 
collecting rainfall data, temperature data, so it provides a 
very conducive environment for developing that. Other countries 
do not have that same rich history in terms of collecting that 
information, so it is a product that has potential, has 
application, but it is really cited by me more as an example of 
innovation than in terms of the next big thing.
    Senator Salazar. I have to go to a meeting with the 
Secretary of Interior but I wanted to thank the panel for 
participating here with us this morning, and I applaud and 
appreciate the leadership of Chairman Chambliss on this 
important issue and look forward to the reauthorization of 
CFMA.
    Thank you very much.
    The Chairman. Thank you very much, Senator Salazar.
    Mr. Sprecher, the acronym of ICE may be an appropriate 
acronym to initiate these weather contracts.
    [Laughter.]
    The Chairman. I want to be a little bit informal because I 
have been informed that Senator Harkin is now not going to be 
able to make it, and I do not want to have all this expertise 
here and not take full advantage of it. Just before we close, 
if any of the three of you have any comments that you feel need 
to be made relative to any further explanation of anything you 
have said or anything we have not asked about, I want to give 
you an opportunity for that. Does anybody want to make any 
additional comments?
    Mr. Pickel. Mr. Chairman, I might just reemphasize 
something that I mentioned in my testimony. I am sure you are 
well aware of these provisions, principally in the energy bill 
in the past Congress that were amending provisions of the 
Commodity Exchange Act, and it is important for you and for 
your committee to work with the Energy Committee to let them 
know that you have a process this year in reauthorization, you 
are going to be looking at various aspects of the CEA and that 
it is really appropriate for those issues to be considered 
through your committee and not through other processes. I would 
just reemphasize that.
    The Chairman. Thank you. That will be done. When we went 
through the reauthorization back in 2000 I was on the 
subcommittee that Congressman Tom Ewing chaired over on the 
House side, and of course, Tom led the way on our side on that, 
and basically it was two of us that worked on that side. The 
one thing that I walked away from that process with was an 
understanding that this was a highly complex area of the 
financial community that unsophisticated people needed to stay 
away from. I am not just sure how much Government involvement 
ought to be relative to the ability of individuals to enter 
into contracts.
    By the same token I am sensitive to what you said, Mr. 
Ireland, relative to outside transactions having an influence 
on market transactions. I do want to make sure that as we go 
through this process we thoroughly vet that and make sure that 
we give it every due consideration as to whether or not there 
should be some regulation.
    In that vein, let me just close with you by saying, as I am 
going to tell the other panel, as I told the folks on Tuesday, 
we are not asking for any additional comments. We have your 
statements. We know where your positions are. If you want to 
provide any comments, suggestions, recommendations to us in 
writing in addition to what you have done already as a result 
of this hearing and the hearing on Tuesday, please feel free to 
do so.
    We do not have a timeline set. Senator Harkin and I have 
talked about the fact that we are going to complete this 
hearing, analyze the information that we have received, and 
then we will move ahead. I just want to make sure that we let 
everybody who has a stake in this complex issue to feel like 
they have had full opportunity to provide us information.
    Again, thank you all very much for being here. We 
appreciate your testimony and participation.
    We will move to the next panel which will be Mr. Daniel J. 
Roth, President of the National Futures Association of Chicago; 
Mr. John G. Gaine, President, Managed Funds Association here in 
Washington, DC, and Micah S. Green, President of the Bond 
Market Association here in Washington, DC.
    Gentlemen, thank you very much for being here today. We 
appreciate your participation in this process as we move 
forward with reauthorization of CFTC, and we will again go down 
the line, starting with you, Mr. Roth. Thank you, and we look 
forward to your testimony.

       STATEMENT OF DANIEL J. ROTH, PRESIDENT AND CHIEF 
   EXECUTIVE OFFICER, NATIONAL FUTURES ASSOCIATION, CHICAGO, 
                            ILLINOIS

    Mr. Roth. Thank you, Mr. Chairman.
    National Futures Association is the industry-wide self-
regulatory body for the futures industry, and I know that the 
process of self-regulation has come under a fair amount of 
criticism over the last couple of years, and the problems that 
have been encountered over in the securities industry have been 
very well publicized.
    What has not been very well publicized is the success that 
self-regulation has had in the futures industry, and what I 
would point out to you is that since 1982, which is when NFA 
began operation, since the date that NFA began operation----
    The Chairman. What was that, 1982?
    Mr. Roth. 1982. Since that time volume on U.S. futures 
exchanges has increased by over 1,200 percent. During that same 
period of time customer complaints have actually dropped by 74 
percent, and that is a fairly significant and dramatic 
achievement, and it is an achievement that was not an accident. 
It was the result of a lot of hard work. It was the result of a 
very close working partnership between the CFTC and NFA to 
close down the boiler rooms and the bucket shops that generated 
so many of those complaints.
    Today though I am concerned that all the progress that we 
made in shutting down those types of firms, all that progress 
may be in jeopardy, and it may be in jeopardy because the CFMA, 
for all of its success, failed to achieve one of its customer 
protection objectives. In the CFMA Congress tried to clarify 
once and for all the CFTC's authority to protect retail 
customers that were investing in foreign currency futures. As 
we sit here today, the Commission's authority to protect retain 
customers may be more uncertain now than it was then, and the 
main problem is the Zelener decision from the 7th Circuit that 
you have heard about and that we talked about at some length in 
the last hearing. That decision, in my view, really did three 
things.
    No. 1, it made it a lot harder for the Commission to prove 
that these leveraged contracts marketed to retail customers to 
speculate in commodity prices made it much harder to prove that 
those contracts are in fact futures. No. 2, the decision made 
it much easier for the unscrupulous, for the fraud guys to set 
up their operations in such a way that they can place 
themselves beyond the reach of the CFTC. No. 3, by doing those 
two things, that decision, in my view, created an honest to God 
real live customer protection issue.
    To make matters worse, the committee should be aware that 
this is not a foreign currency problem, per se. There was 
nothing in that Zelener decision that limited its rationale to 
that particular product, to foreign currency products. The 
scammers that are setting up boiler rooms to sell foreign 
currency products under the Zelener decision could just as 
easily sell heating oil products, unleaded gas, natural gas, ag 
products, metal products, anything.
    In the view of National Futures Association, this decision 
has created a real customer protection issue, and we feel that 
it is an issue that Congress has really got to tackle head on.
    In all the discussions I have heard four different reasons 
why Congress should not reopen the Act, why Congress should not 
address this issue, and frankly, I do not find any of them 
particularly persuasive.
    No. 1. I have heard some argue that there is no need to 
clarify the CFTC's authority to protect retail customers 
because the State regulators have all the authority necessary 
to go after these firms. I have spent over 20 years working 
with State regulators, and I can tell you firsthand that I know 
that they are dedicated and they are committed and they are 
intelligent and they are overwhelmed. If anybody thinks that 
the State regulators have both the resources and the expertise 
to protect retail customers from these futures look-alike 
scams, well, they are just dreaming.
    No. 2. I have heard people say that there is no need for 
Congress to act here because the CFTC may be able to litigate 
its way out of the Zelener problem, that the CFTC can just 
bring different types of cases with different types of 
evidence, and deal with the problem that way.
    Mr. Chairman, I have explained in my written testimony why 
that is nowhere near as easy as it sounds, and that really to 
try to rely on litigating our way out of the Zelener problem 
places an awful lot of chips on a bet that is no sure thing.
    No. 3. I have heard that it is just premature. You know, 
the Zelener decision was handed down by the 7th Circuit last 
August. The CFMA itself is relatively new and it is just 
premature to be doing anything at this point and we should wait 
and let events unfurl. Well, realistically, if we talk about 
waiting, or waiting till the next reauthorization, and we all 
know that an awful lot of people can get hurt in 5 years, and I 
just do not think that that is an acceptable approach.
    The final thing that I have heard, Mr. Chairman, is that if 
Congress does act in this area, whatever we do should be 
limited to deal with just Forex products and not go beyond 
foreign currency products. Well, as I explained earlier, I do 
not think the problem is limited to foreign currency products, 
and I do not think the solution can be limited to foreign 
currency products either.
    I recognize very well that there are very legitimate 
concerns about a legislative fix to this problem. I know that 
all of us are fearful of unintended consequences, and my goal 
here is to restore the CFTC's jurisdiction, not to expand the 
CFTC's jurisdiction, and my goal here is to protect retail 
customers and not to in any way interfere with institutional 
business. I know there is always a threat of unintended 
consequences, but all that means is that it is a hard problem 
to solve, and just because it is hard does not mean it cannot 
be done.
    We feel that legislative action here is mandatory. We have 
to come up with the right solution, and NFA is very much 
dedicated to working with this committee, to working with the 
industry, to working with the Commission, and to work with 
anybody else that can help us find a solution that is 
practical, that is politically acceptable, and that actually 
achieves the goal of customer protection.
    Thank you, Mr. Chairman.
    [The prepared statement of Mr. Roth can be found in the 
appendix on page 218.]
    The Chairman. Thank you.
    Mr. Gaine.

     STATEMENT OF JOHN G. GAINE, PRESIDENT, MANAGED FUNDS 
                  ASSOCIATION, WASHINGTON, DC

    Mr. Gaine. Chairman Chambliss and members of the committee, 
my name is Jack Gaine. I am President of Managed Funds 
Association, and I thank you for the opportunity to share our 
views with you today about the CFTC's reauthorization.
    I will be very brief in my oral comments but would ask that 
my written statement be included in the record.
    We commend the committee for this timely hearing and we 
commend the CFTC for their steady, sensible hand in 
implementing the CFMA over the last 4 years. We are not 
advocating any statutory change at this time, but I will put a 
footnote on that and say that with regard to Mr. Roth's concern 
about a gap in the anti-fraud provisions, we certainly are, as 
NFA is willing to, willing to work with him, the committee, et 
cetera, to close any real gaps that exist in order to provide 
full public protection against fraudulent activities.
    MFA is the primary trade association representing 
professionals who specialize in the alternative investment 
industry which consists of funds of funds, futures funds and 
hedge funds. We have over 850 members including representatives 
of 35 of the 50 largest hedge fund groups in the world. Our 
members, many of whom represent firms that are registered with 
the CFTC as commodity trading advisers and commodity pool 
operators, manage a substantial portion of the over one 
trillion dollars invested in alternative investment products 
globally. We are major users of the futures markets and many of 
us are regulated by the National Futures Association as well.
    Since the last reauthorization we have worked extensively 
with the CFTC on a number of important rule-making projects as 
well as private sector initiatives which I have detailed in my 
written statement.
    We are different from most of the witnesses who will appear 
before you because we are the user of a lot of the facilities 
and the services that are provided by the exchanges and other 
witnesses. Increased interest in and use of alternative 
investments is a direct result of the growing demand from 
institutional and other sophisticated investors, for investment 
vehicles that deliver true diversification and help them meet 
their future funding obligations and other investment 
objectives.
    Our members' funds perform a number of important roles in 
the global marketplace, including contributing to a decrease in 
overall market volatility, acting as shock absorbers and 
liquidity providers by standing ready to take positions in 
volatile markets when other investors choose to remain on the 
sidelines. Moreover, our funds utilize state-of-the-art trading 
and risk management techniques that foster financial innovation 
and risk sophistication among market participants.
    Let me turn briefly to just two or three specific issues. 
Hedge funds' effect on the energy markets, and I will put a 
footnote to this as well, that at Tuesday's hearing, President 
Newsome released a study that the NYMEX had done on the role of 
hedge funds in natural gas and crude oil futures. I have read 
the report. It is very comprehensive and it has a lot of data 
and makes a very strong case that there is no adverse effect on 
the energy markets by virtue of hedge fund activities.
    Energy markets enjoy all of the described benefits provided 
by the alternative investment industry. Recently, there has 
been increased discussion about hedge funds' impact on energy. 
Some participants have argued that price swings and volatility 
are a result of the impact of speculative futures trading by 
hedge funds.
    Recently both the CFTC, and the Federal Energy Regulatory 
Commission concluded that hedge funds really were not the cause 
of the volatility. We also believe that the CFTC is doing an 
excellent job in overseeing the energy trading market. They 
have assessed penalties of approximately $300 million in recent 
years. The industry, including MFA members who trade in these 
markets, benefit from appropriate regulatory actions since 
these actions promote fair and efficient pricing in the 
marketplace.
    We are comfortable that the CFTC, the FERC and the New York 
Mercantile Exchange each have correctly recognized that hedge 
funds are not dominating energy trading, and that the current 
system in place is adequate to provide public protection.
    We would ask this committee, in its oversight function, to 
urge the SEC and CFTC to work cooperatively to avoid 
duplicative regulation. I have gone into more detail in my 
written testimony. We would ask also that the committee, in its 
oversight function, urge the CFTC to act on the petitions of 
the various exchanges--Chicago, Minneapolis and Kansas City--to 
liberalize or relax the speculative position limits on a number 
of agricultural contracts.
    In conclusion we think the CFMA was a masterful piece of 
work. We think the implementation has been excellent. We stand 
ready to assist the committee, answer any questions and work 
with Mr. Roth, because he seemed to include the world in the 
people he is willing to work with, in solving any of his 
problems.
    Thank you, Mr. Chairman.
    [The prepared statement of Mr. Gaine can be found in the 
appendix on page 224.]
    The Chairman. Thank you very much, Mr. Gaine.
    Mr. Green.

    STATEMENT OF MICAH S. GREEN, PRESIDENT, THE BOND MARKET 
                  ASSOCIATION, WASHINGTON, DC

    Mr. Green. Good morning, Mr. Chairman. Thank you very much 
for allowing the Bond Market Association to participate in this 
hearing on the reauthorization of the CEA and in particular the 
changes made in 2000 under the CFMA, a law which, by the way, 
we believe was an outstanding achievement of the Congress.
    Through our offices in New York, Washington, and London, 
the Association represents the $44 trillion global bond 
markets. Our members include all major dealers in Federal 
agency bonds, as well as the securitization market, corporate 
and municipal securities, in addition to all of the primary 
dealers of U.S. Treasury securities as recognized by the 
Federal Reserve Bank of New York. Our members are also active 
in the markets for over-the-counter financial products and 
contracts involving forward payments or deliveries relating to 
a variety of fixed income securities, interest rates and credit 
products.
    The Bond Market Association participated actively in the 
debate that led to the enactment of the CFMA. At that time we 
advocated changes to the CEA that were viewed as critical to 
vibrant markets in OTC securities, derivatives and foreign 
exchange. The CFMA has proved to be extremely successful in 
that regard because it clarified the exclusion from the CEA and 
the jurisdiction of the CFTC of OTC derivatives, swaps and 
foreign exchange transactions. The much-needed legal certainty 
the Treasury amendment in the CEA continues to bring these 
important sectors of the capital markets, enables markets for 
U.S. Treasury securities in particular, which allows the 
Government to borrow at a lower cost and save U.S. taxpayers 
real money.
    I want to congratulate this committee and your counterparts 
in the House, as well as past and current leadership and 
members of the CFTC for your foresight in enacting the CFMA 
nearly 5 years ago. You clearly anticipated the expansion of 
the markets around the globe and the need to facilitate liquid 
and efficient markets wherever they may exist, and to 
particularly ensure that U.S. markets are not at a 
disadvantage. You clearly sensed that prescriptive rules and 
regulations in an economy that require nimbleness and 
flexibility would make it more difficult for markets to adjust 
to changing conditions, and that sound principles-based rules 
ensured that markets function smoothly even in times of stress.
    Finally, you clearly foresaw the development of 
sophisticated risk management techniques that permit 
institutional market participants to manage risk in an 
increasingly precise manner. Market participants can retain the 
risk they wish to retain, and for a fee transfer those risks 
they do not wish to retain to other market participants. These 
improvements in risk management facilitated by the OTC 
derivatives market have helped the U.S. and global economies 
weather recessions and interest rate volatility. In other 
words, the leadership you provided nearly 5 years ago when you 
were in the House and now in the Senate, was really quite 
extraordinary and has provided tangible benefits to the 
economy.
    The Bond Market Association set out three fundamental 
policy goals during the last reauthorization process. We called 
for maintaining the OTC markets as a viable alternative to 
traditional organized exchanges, preserving the enforceability 
of contracts freely negotiated between market participants, and 
avoiding duplicative regulation.
    I am happy to report for the benefit of the broader 
national and global economies the CFMA did in fact meet those 
goals. Clarifying the exclusions for commodities and swaps from 
the CFTC's jurisdiction and assuring contract enforceability as 
the CFMA does, have brought the OTC derivatives market the 
legal certainty it needed to thrive.
    In closing, Mr. Chairman, I would like to reiterate our 
support for the CFMA. The law strikes a delicate balance 
between regulating a rapidly changing market and encouraging 
innovation and diversity. Prior to the CFMA, the OTC 
derivatives market was restrained by legal uncertainty. Again, 
thanks to the foresight of the Congress and particularly this 
committee, this market is now thriving and helping to save 
taxpayers money by lowering the cost of borrowing for the 
Federal Government. Improved risk management and lower capital 
costs also help to stimulate the broader economy.
    In the context of the reauthorization process, the 
Association strongly urges this committee and Congress not to 
alter any of the fundamental elements of the CFMA that 
encourage and orderly and innovative OTC derivatives market.
    Thank you very much for the opportunity to testify.
    [The prepared statement of Mr. Green can be found in the 
appendix on page 231.]
    The Chairman. Thank you very much, Mr. Green. In your 
written testimony you mention a 2002 observation by Federal 
Reserve Board Chairman Alan Greenspan, that complex financial 
instruments developed to manage risk have made the global 
economy, and a I quote, ``a far more flexible, efficient and 
resilient financial system that existed just a quarter-century 
ago.''
    Would you elaborate on that a little bit, and what is the 
role of the over-the-counter derivatives such as swaps in this 
development?
    Mr. Green. If you think about risks in the marketplace you 
have interest rate risks and the movement of the markets, and 
you have credit risk, if you have credit exposure. As Mr. 
Pickel described earlier, you can now look at other risks that 
are out there, catastrophic events. You can look at weather-
related issues, virtually--any risk that right now is 
manageable that many years ago was not manageable--and in an 
economy where you cannot necessarily predict what is going to 
happen as it relates to interest rates, as it relates to credit 
quality, as it relates to weather and other potentially 
uncontrollable events. The ability to manage that risk allows 
you to absorb changes in a much more measured and much more 
organized way. In fact, there was a time about a summer and a 
half ago, interest rates spiked up tremendously at a time when 
interest rates were at record lows. In previous years when that 
happened in 1998 or 1994 you would have seen a particular 
catastrophic event in the marketplace, and I am not saying for 
a second that there will not be future catastrophic events in 
marketplaces, but it is instructive to see that that happened 
post-CFMA, and you saw the marketplace absorb it.
    Now, obviously, when there are losses in the market, the 
losses find themselves somewhere, but they are less 
concentrated now because people have been able to use the 
financial products, again, that the CFMA has allowed for 
privately negotiated and very specialized and precise contracts 
to allow for that very knowledgeable management of that risk 
and absorb the changes in the economy.
    The Chairman. Did that flexibility exist prior to the 
Modernization Act in 2002?
    Mr. Green. Not to the degree it does now. There was 
uncertainty, and every bit of uncertainty, no matter how minute 
it is, carries with it a cost and a burden to the free flow of 
the economy. There is no question that the CFMA has contributed 
greatly to dealing with that legal uncertainty.
    The Chairman. Who is the beneficiary of that flexibility? 
Is it more the market or the customer?
    Mr. Green. Everyone. The fact is that when the marketplace 
can absorb sudden changes in interest rates or credit quality 
or virtually any other thing, everyone--and frankly not just in 
the United States but around the globe--benefits and it allows 
for the absorption factor. It is like driving a car without 
shock absorbers. You need those shock absorbers, and that is 
all about risk management, and certainly the parties involved 
in the transactions benefit from that, but the customers of 
those people and the beneficiaries of the products and the 
economy generally benefits.
    The Chairman. What if any effect would the Feinstein 
legislation, in your opinion, have on that flexibility?
    Mr. Green. Well, I share the views that were expressed by 
the prior panel. We believe that the CFTC has the authority, 
and they have exercised that authority, to their credit. What 
we worry about is imprecision and building of more uncertainty, 
and that is why we join in calling that this committee 
particularly, with its expertise in the CEA and the CFMA, needs 
to make sure that it carries out its will in this process as 
opposed to writing this sort of legislation on the floor, 
because it is a very delicate piece of legislation. You 
remember from the House how really masterfully, you all put it 
together in a way that made sense for the market and the market 
participants, and if any changes were to lead to uncertainty, 
you would basically be turning back the hands of time. We are 
worried that the Feinstein amendment, No. 1, is not needed; No. 
2 was overly broad, leading to more uncertainty. We would join 
certainly with Mr. Pickel, and the Bond Market Association has 
worked very closely with ISDA on that issue in opposing such an 
amendment.
    The Chairman. Before I leave that particular issue, let me 
ask Mr. Gaine and Mr. Roth for your reaction to the Feinstein 
proposal.
    Mr. Gaine. I really would only echo Mr. Green and the 
earlier panelists and my own testimony here, that the existing 
statutory and regulatory framework that is in place has been 
shown to be adequate to address the issues.
    I do feel Mr. Ireland's pain. We all would like lower 
energy prices, but the volatile supply and demand domestically 
and internationally, factors that are at play now, 
unfortunately do not give us that luxury. Having markets that 
can adapt nimbly and quickly, are very important, and the cause 
of any volatility, are the fundamental supply and demand 
factors.
    The Chairman. Mr. Roth.
    Mr. Roth. Mr. Chairman, I would just point out that from a 
regulatory point of view, every time you run into an issue what 
you are really trying to do is the most efficient to deal with 
any regulatory issue is to provide the least degree of 
regulation that you need to do to accomplish the results and 
generally let the markets work out the rest.
    We always, in any issue that we encounter, try to figure 
out what is the least burdensome method to achieve the desired 
result. That is always what you are striving to do because that 
is what avoids the unintended consequences that I was referring 
to earlier. Without getting specific as to the Feinstein 
amendment, all the comments from the other panelists are really 
attuned to that same basic philosophy to make sure that the 
regulations that you do impose are sufficient to achieve the 
desired objective without being too burdensome and having those 
unintended consequences. Everything that Mr. Pickel and Mr. 
Green and Mr. Gaine have said, are certainly things that 
philosophically NFA would agree with.
    The Chairman. Mr. Roth, you talked about the amount of 
increase in contracts since 1982, and the correlating decrease 
in complaints. I notice in your testimony, I believe, you had, 
what, 93 complaints in the last year, which does seem like a 
fairly minimal number. What kind of increase have you seen 
since the CFMA relative to the increase in contracts and 
decrease in complaints?
    Mr. Roth. Let me just put in context the statistic that you 
cited from my testimony. One of the points we make in our 
written testimony was that Congress may want to reconsider 
whether it should continue to require the CFTC to operate a 
reparations program, which is a dispute resolution program for 
customers, and it is a program that has been in place for a 
very long time, since back in the 1970's. What we pointed out 
was that back when the program was instituted the world was a 
much different place. For one thing the boiler rooms were 
really a problem of much greater scope than they are right now, 
generating a lot more customer complaints than we have now. No. 
2, NFA had not even begun operations yet, and our arbitration 
program that we offer customers had not been in place yet.
    What we point out in our testimony was that back in 1982 
when NFA began operations the CFTC used to get a thousand 
complaints a year in the reparations program, and last year 
they had 93.
    Our point is that we think maybe that is a program that was 
valuable at its time but maybe has outlived its usefulness and 
maybe the Commission could redeploy its resources elsewhere, 
and maybe it is time to get rid of the reparations program. 
That is the specific point about this statistic.
    With respect to the CFMA and its impact on customer 
complaints, I can tell you that for the most part we have been 
able to keep the level of customer complaints at near record 
level lows. What is of concern to me is that with respect to, 
again, retail Forex problems, completely apart from the Zelener 
decision. You know, we have members that are Forex dealer 
members of NFA that we regulate and we have about 27 members 
that are active in that area right now, and though few in 
number, those retail Forex accounted for about over 20 percent 
of the customer complaints we received in arbitration last year 
at NFA. That even apart from Zelener there have been regulatory 
problems with respect to retail Forex. It is a disproportionate 
share of our customer complaint docket and it is something that 
we are going to continue to work on and struggle with.
    Where we have the authority to act, at least we can act. 
The Zelener problem creates issues where neither the CFTC nor 
NFA would really have the authority to regulate that activity.
    The Chairman. I want to make sure you have answered my next 
follow-on thought process, and that is I hear what you are 
saying when you say that the Zelener decision has brought on 
some problems, some of those unintended consequences almost 
that we did not anticipate with the legislation. I noted your 
suggestions and comments relative to the reasons why, and your 
response is too there should be no changes in the Act. By the 
same token what I am hearing from you is that you like the idea 
of self-regulation, that you do not want any more Government 
involvement than you have to have. The same token you want to 
make sure that you have the ability I guess to put some teeth 
into the self-regulatory process that maybe you do not have 
now. By the same token you are saying that you have had a 
tremendous increase in the volume of contracts and a collateral 
declining decrease in the number of complaints.
    I am just wondering why we really ought to think about 
making changes when that scenario is in place.
    Mr. Roth. Mr. Chairman, the reason we have to make a change 
is that the reason that we have been able to achieve a dramatic 
drop in customer complaints is that there was a regulatory 
presence and a strong regulatory presence where these types of 
products were being marketed to retain customers. That is how 
we got to where we are. The problem with the Zelener decision 
is that it creates the exact opposite environment, where that 
marketing activity can go on with retail customers in a 
completely unregulated environment. The format, the way we got 
to where we are is by having a regulatory presence with respect 
to the protection of retail customers. The Zelener decision 
threatens to undo that and that is why I am concerned about it.
    The Chairman. Mr. Gaine, you heard the previous panel talk 
a lot about the energy market and in particular the natural gas 
market. Can you explain how hedge funds increase liquidity with 
respect to the energy market and how this benefits the market?
    Mr. Gaine. Yes. This was probably discussed in some detail. 
First, I am just a lawyer, not an economist. Maybe that is a 
plus. It is discussed in some detail in the NYMEX study that I 
referenced that was released several days ago. In their 
analysis they did a study of trading activity over certain 
periods of time, and actually found that hedge fund activity 
decreased the volatility, and they did it by using mathematics 
and looking at the trading records over a considerable period 
of time, both in natural gas and crude oil futures. The 
increase in liquidity would as a general proposition serve to 
be neutral or favorable toward reducing volatility, and we 
certainly do provide that to these markets.
    As I said, hedge funds have to come in to the market and 
have to get out of the market. They are not going to stand for 
delivery. They do not take a position in crude oil and then put 
it in the tanker and put it offshore. They are going to 
liquidate that, so they are going to be both a buyer and seller 
in most instances. As I say, they are expanding the pool, the 
liquidity pool. That coupled with the findings of the study 
that I referred to make a fairly firm case that they are a plus 
to the pricing discovery and other functions of the futures 
markets.
    The Chairman. Gentlemen, again, we have had a vote that was 
just called, so we are going to have to conclude anyway. We do 
have a few minutes, and I want to give you the same opportunity 
that I gave the last panel. We are in a little more of an 
informal situation here. If anybody has any additional comments 
you want to make relative to anything you said or any other 
issue that has been brought up, I want to make sure that we get 
all of the input from you we can. I will give each of the three 
of you that opportunity if you would like to.
    Mr. Gaine. Mr. Chairman, if I might just say I would like 
to associate particularly with Mr. Green's comments about the 
pocket of expertise that resides in 328 Russell with respect to 
many of these issues, and it is a problem on this side, but 
even a greater problem in the other body. It is very important 
that any crafting or any considerations of changes to these 
highly complex issues be really managed by those who are in the 
know, which is this committee and its members and its staff.
    The Chairman. I appreciate that compliment, particularly as 
a recovering lawyer myself, Mr. Gaine.
    [Laughter.]
    The Chairman. As we move through this, it is a very 
complicated issue, as all of you have explained and as we know. 
We would appreciate a continuing dialog with you because that 
is the way the best legislation is ultimately produced.
    While we have your written testimony, while we have your 
comments today, if there is any other written suggestions or 
comments, not just on what may have been said over the last 
couple of days, but there are going to be other developments. 
We do not know where the Zelener decision is going, Mr. Roth. I 
agree with you that may present a whole new factual set of 
circumstances to us that may evolve even further between now 
and the time legislation is crafted.
    We would appreciate your input and appreciate your comments 
and your continuing dialog with staff and with our offices 
also.
    Thank you very much for being here. We are going to leave 
the record open for 5 days. I feel certain that Mr. Harkin 
probably will have some questions to ask one or both panels. We 
would ask that you get those responses to us as soon as 
possible.
    There are many groups that have an interest in the 
reauthorization process, and without objection written 
testimony submitted today may be included in the record.
    Thank you very much for being here and for your 
participation. This hearing is concluded.
      
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                            A P P E N D I X

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                   DOCUMENTS SUBMITTED FOR THE RECORD

                             March 10, 2005



      
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