[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]


 
    HEARING TO REVIEW REAUTHORIZATION OF THE COMMODITY EXCHANGE ACT

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

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
              GENERAL FARM COMMODITIES AND RISK MANAGEMENT

                                 OF THE

                        COMMITTEE ON AGRICULTURE
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED TENTH CONGRESS

                             FIRST SESSION

                               __________

                     WEDNESDAY, SEPTEMBER 26, 2007

                               __________

                           Serial No. 110-27


          Printed for the use of the Committee on Agriculture
                         agriculture.house.gov



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                        COMMITTEE ON AGRICULTURE

                COLLIN C. PETERSON, Minnesota, Chairman

TIM HOLDEN, Pennsylvania,            BOB GOODLATTE, Virginia, Ranking 
    Vice Chairman                    Minority Member
MIKE McINTYRE, North Carolina        TERRY EVERETT, Alabama
BOB ETHERIDGE, North Carolina        FRANK D. LUCAS, Oklahoma
LEONARD L. BOSWELL, Iowa             JERRY MORAN, Kansas
JOE BACA, California                 ROBIN HAYES, North Carolina
DENNIS A. CARDOZA, California        TIMOTHY V. JOHNSON, Illinois
DAVID SCOTT, Georgia                 SAM GRAVES, Missouri
JIM MARSHALL, Georgia                JO BONNER, Alabama
STEPHANIE HERSETH SANDLIN, South     MIKE ROGERS, Alabama
Dakota                               STEVE KING, Iowa
HENRY CUELLAR, Texas                 MARILYN N. MUSGRAVE, Colorado
JIM COSTA, California                RANDY NEUGEBAUER, Texas
JOHN T. SALAZAR, Colorado            CHARLES W. BOUSTANY, Jr., 
BRAD ELLSWORTH, Indiana              Louisiana
NANCY E. BOYDA, Kansas               JOHN R. ``RANDY'' KUHL, Jr., New 
ZACHARY T. SPACE, Ohio               York
TIMOTHY J. WALZ, Minnesota           VIRGINIA FOXX, North Carolina
KIRSTEN E. GILLIBRAND, New York      K. MICHAEL CONAWAY, Texas
STEVE KAGEN, Wisconsin               JEFF FORTENBERRY, Nebraska
EARL POMEROY, North Dakota           JEAN SCHMIDT, Ohio
LINCOLN DAVIS, Tennessee             ADRIAN SMITH, Nebraska
JOHN BARROW, Georgia                 KEVIN McCARTHY, California
NICK LAMPSON, Texas                  TIM WALBERG, Michigan
JOE DONNELLY, Indiana
TIM MAHONEY, Florida

                                 ______

                           Professional Staff

                    Robert L. Larew, Chief of Staff

                     Andrew W. Baker, Chief Counsel

                 April Slayton, Communications Director

           William E. O'Conner, Jr., Minority Staff Director

                                 ______

      Subcommittee on General Farm Commodities and Risk Management

                BOB ETHERIDGE, North Carolina, Chairman

DAVID SCOTT, Georgia                 JERRY MORAN, Kansas, Ranking 
JIM MARSHALL, Georgia                Minority Member
JOHN T. SALAZAR, Colorado            TIMOTHY V. JOHNSON, Illinois
NANCY E. BOYDA, Kansas               SAM GRAVES, Missouri
STEPHANIE HERSETH SANDLIN, South     CHARLES W. BOUSTANY, Jr., 
Dakota                               Louisiana
BRAD ELLSWORTH, Indiana              K. MICHAEL CONAWAY, Texas
ZACHARY T. SPACE, Ohio               FRANK D. LUCAS, Oklahoma
TIMOTHY J. WALZ, Minnesota           RANDY NEUGEBAUER, Texas
EARL POMEROY, North Dakota           KEVIN McCARTHY, California

               Clark Ogilvie, Subcommittee Staff Director

                                  (ii)
                             C O N T E N T S

                              ----------                              
                                                                   Page
Etheridge, Hon. Bob, a Representative in Congress from North 
  Carolina, opening statement....................................     1
Goodlatte, Hon. Bob, a Representative in Congress from Virginia, 
  opening statment...............................................    15
    Prepared statement...........................................     4
Graves, Hon. Sam, a Representative in Congress from Missouri, 
  prepared statement.............................................     4
Moran, Hon. Jerry, a Representative in Congress from Kansas, 
  opening statement..............................................     2
    Prepared statement...........................................     3
Peterson, Hon. Collin C., a Representative in Congress from 
  Minnesota, prepared statement..................................     3
Salazar, Hon. John T., a Representative in Congress from 
  Colorado, prepared statement...................................     5

                               Witnesses

Duffy, Terrence A., Executive Chairman, Chicago Mercantile 
  Exchange Group, Inc., Chicago, IL..............................     5
    Prepared statement...........................................     8
Newsome, Ph.D., James E., President, CEO, and Member, Board of 
  Directors, New York Mercantile Exchange, Inc., New York, NY....    15
    Prepared statement...........................................    17
Carlson, Layne G., Corporate Secretary and Treasurer, Minneapolis 
  Grain Exchange, Minneapolis, MN................................    24
    Prepared statement...........................................    25
Sprecher, Jeffrey C., Founder, Chairman, and CEO, 
  IntercontinentalExchange, Inc., Atlanta, GA....................    27
    Prepared statement...........................................    29
Walsh, Ph.D., Michael J., Executive Vice President, Chicago 
  Climate Exchange, Chicago, IL..................................    32
    Prepared statement...........................................    34
Roth, Daniel J., President and CEO, National Futures Association, 
  Chicago, IL....................................................    49
    Prepared statement...........................................    50
Zerzan, Gregory P.J., Counsel and Head, Global Public Policy, 
  International Swaps and Derivatives Association, Washington, 
  D.C.; on behalf of Securities Industry and Financial Markets 
  Association....................................................    53
    Prepared statement...........................................    55
Damgard, John M., President, Futures Industry Association, 
  Washington, D.C................................................    59
    Prepared statement...........................................    61
Becks, Theresa D., Member, Managed Funds Association; President 
  and CEO, Campbell and Company, Inc., Towson, MD................    67
    Prepared statement...........................................    69
Brodsky, William J., Chairman and CEO, Chicago Board Options 
  Exchange, Chicago, IL; on behalf of U.S. Options Exchange 
  Coalition......................................................    72
    Prepared statement...........................................    75

                          Submitted Statements

Lukken, Walter L., Acting Chairman, U.S. Commodity Futures 
  Trading Commission, Washington, D.C., letter and response to 
  questions......................................................    89
Newsome, Ph.D., James E., President, CEO, and Member, Board of 
  Directors, New York Mercantile Exchange, Inc., New York, NY, 
  response to questions..........................................   101
Niv, Drew, President and CEO, Forex Capital Markets LLC, New 
  York, NY, prepared statement...................................    85


    HEARING TO REVIEW REAUTHORIZATION OF THE COMMODITY EXCHANGE ACT

                              ----------                              


                     WEDNESDAY, SEPTEMBER 26, 2007

                  House of Representatives,
 Subcommittee on General Farm Commodities and Risk 
                                        Management,
                                  Committee on Agriculture,
                                                   Washington, D.C.
    The Subcommittee met, pursuant to call, at 10 a.m., in Room 
1300 of the Longworth House Office Building, Hon. Bob Etheridge 
[Chairman of the Subcommittee] presiding.
    Members present: Representatives Etheridge, Marshall, 
Boyda, Peterson [ex officio], Moran, Conaway and Goodlatte [ex 
officio].
    Staff present: Andy Baker, Adam Durand, Alejandra Gonzalez-
Arias, Scott Kuschmider, Clark Ogilvie, John Riley, Sharon 
Rusnak, Kristin Sosanie, Bryan Dierlam, Kevin Kramp, and Jamie 
Weyer.

 OPENING STATEMENT OF HON. BOB ETHERIDGE, A REPRESENTATIVE IN 
                  CONGRESS FROM NORTH CAROLINA

    Mr. Etheridge. This hearing of the Subcommittee on General 
Farm Commodities and Risk Management to review the 
reauthorization of the Commodity Exchange Act will come to 
order. To begin with, I ask unanimous consent that Mr. Barrow 
may sit with the Committee, without objection.
    Most Americans by now know that Congress needs to pass a 
new farm bill this year. Fewer Americans probably know that we 
also need to reauthorize the Commodity Futures Trading 
Commission. The futures industry impacts our lives every single 
day. Derivatives trading provides customers with fora for price 
discovery and price hedging for a wide variety of commodities 
and financial instruments. As the oversight agency for 
derivatives, the CFTC keeps watch over a trillion dollar 
industry that affects almost everything, from the price of 
corn, wheat and soybeans that goes into our food products, to 
the interest you pay on mortgages. It is the CFTC's mission to 
foster the economic utility of the futures markets by 
encouraging their competitiveness and effectiveness, ensuring 
their integrity and protecting market participation against 
manipulation, abusive trading practices and fraud.
    In 2000, Congress took a bold step in dramatically changing 
how the CFTC oversees derivatives markets by moving from a 
regulatory regime to a principles-based structure. We removed 
the shackles that restrained an industry and we have seen the 
good results of Congress's work. Now, here we are, almost 7 
years removed from that point and people are asking questions, 
whether the regulatory regime we created in 2000 is appropriate 
for every commodity, whether we should increase the Commodity 
Futures Trading Commission's authority in some areas. 
Therefore, as this Subcommittee moves forward with 
reauthorization, it is an appropriate time for us to review 
what Congress accomplished with the Commodity Futures 
Modernization Act of 2000 and the CFTC's oversight of these 
markets.
    Today we will hear from a variety of participants in the 
futures industry. I hope my colleagues will find this hearing 
informative. I know I am looking forward to hearing today's 
testimony from our witnesses. One of the messages we will hear 
from most of the witnesses today concerns enforcement actions 
taken by the CFTC and the Federal Energy Regulatory Commission. 
There is a growing fear that recent FERC action may be 
encroaching upon the CFTC's exclusive jurisdiction over the 
futures markets. The CFTC and FERC have a good working 
relationship and they have been working cooperatively since 
enactment of the Energy Policy Act of 2005. However, when 
Congress passed the Energy Policy Act, nowhere did it repeal or 
limit the Commodity Exchange Act's explicit grant to the CFTC 
of exclusive jurisdiction over the futures market.
    I do not know why the FERC chose to take an enforcement 
action, which has called its own authority into question. I do 
not know that it was Congress's intent that the CFTC should 
have exclusive jurisdiction over futures markets. For the CFTC 
to fail to assert its exclusive jurisdiction, when appropriate, 
would equal a failure to uphold the will of Congress. But we 
will have more opportunity to discuss this with our witnesses. 
I want to welcome each of you here today and thank you for 
testifying.
    With that, I now turn to the gentleman from Kansas, my good 
friend, Mr. Moran, for his opening statement.

  OPENING STATEMENT OF HON. JERRY MORAN, A REPRESENTATIVE IN 
                      CONGRESS FROM KANSAS

    Mr. Moran. Mr. Chairman, thank you very much. We gather 
here today to determine information about the commodities 
futures markets of the United States in preparation for 
reauthorization of the Commodity Exchange Act. As I said 
earlier, the family has gathered once again. Perhaps this time 
we can have an end result with a bill that becomes law. We do 
have a diverse group of witnesses with us today from different 
sectors within the industry and I pledge that I will pay close 
attention to what these individuals have to say.
    Since the passage of the Commodity Futures Modernization 
Act of 2000, this industry has experienced record growth. 
Growth in the commodities future industry has provided new ways 
for businesses to manage risk and has substantially benefited 
the U.S. economy. With growth, however, comes new challenges. 
Recently, the natural gas derivatives market has become the 
center of public attention and in July, this Subcommittee held 
a hearing on natural gas markets. As I stated then, it is the 
duty of the Subcommittee to examine how markets, like exempt 
commercial markets, have evolved and decide whether regulatory 
changes should be made. In doing so, the Subcommittee should be 
adequately informed and only proceed in a deliberative manner.
    As I have said in the past, we should be cautious in making 
sweeping changes to a system that has brought new investment 
and growth to the U.S. economy. Any changes to the Commodity 
Futures Modernization Act by this Subcommittee must take into 
account any possible adverse effects new regulatory burdens on 
the market would have. We should be wary of actions that might 
stifle market growth, drive markets overseas or discourage 
entrepreneurs from developing new and legitimate markets.
    I thank the witnesses for their testimony today and I thank 
Chairman Etheridge for holding this hearing. I look forward to 
working with you, Mr. Etheridge, to see that we reauthorize the 
Commodity Exchange Act in a conscious, yet expeditious manner. 
Thank you, Mr. Chairman.
    [The prepared statement of Mr. Moran follows:]

 Prepared Statement of Hon. Jerry Moran, a Representative in Congress 
                              From Kansas

    Thank you, Mr. Chairman. We are here today to gather information on 
the commodity futures markets in the United States in preparation for 
the reauthorization of the Commodity Exchange Act. To that end we have 
before us a diverse group of witnesses from many different sectors of 
the industry. Each witness is an important player in the commodity 
futures industry and it is incumbent upon this Subcommittee to listen 
closely to what these individuals have to say. In the end, it is they 
who will have to contend with any new regulations that we create during 
reauthorization.
    Since passage of the Commodity Futures Modernization Act in 2000, 
this industry has experienced record growth. Growth in the commodity 
futures industry has provided new ways for businesses to manage risk 
and has substantially benefited the U.S. economy. With growth, however, 
come new challenges. Recently, the natural gas derivatives market has 
become the center of public attention and on July 12, 2007, this 
Subcommittee held a hearing on the natural gas markets.
    As I stated then, it is the duty of this Subcommittee to examine 
how markets, like exempt commercial markets (ECMs), have evolved and 
decide whether a regulatory change should be made. In doing so the 
Subcommittee should be adequately informed and only proceed in a 
deliberate manner. As I have said in the past, we should be cautious in 
making sweeping changes to a system that has brought new investment and 
growth to the U.S. economy. Any changes to the Commodity Futures 
Exchange Act by this Subcommittee must take into account any possible 
adverse effects new regulatory burden will have on the market. We 
should be wary of actions that might stifle market growth, drive 
markets overseas, or discourage entrepreneurs from developing new and 
legitimate markets.
    I want to thank all the witnesses for your testimony today. I also 
want to thank Chairman Etheridge for holding this hearing. I hope we 
can work to together to reauthorize the Commodity Exchange Act in a 
conscious, yet expeditious manner.

    Mr. Etheridge. I thank the gentleman and appreciate his 
comments. The chair would request that other Members submit 
their opening statements for the record so that the witnesses 
may begin their testimony and we ensure that there is ample 
time for questions.
    [The prepared statements of Messrs. Peterson, Goodlatte, 
Graves, and Salazar follow:]

  Prepared Statement of Hon. Collin C. Peterson, a Representative in 
                        Congress From Minnesota

    Thank you, Chairman Etheridge, for calling this hearing today, and 
for all the important work you have done on this issue in preparation 
of reauthorizing the Commodity Exchange Act.
    We have spent the better part of the year preparing and passing a 
farm bill here in the House, but today we renew examination of another 
area of interest in this Committee that affects every producer and 
consumer in America: the derivatives markets. Everyone who pays a 
grocery bill or gas bill, or who applies for a loan or has a mortgage, 
is affected by these markets.
    Congress last reauthorized the Commodity Exchange Act in 2000, 
making what at that time were the most significant changes in the law 
since the Commodity Futures Trading Commission was created in 1974. 
When the CFTC was established, the majority of futures trading took 
place in the agricultural sector. Even today, most people probably 
associate futures trading with people in pits in Chicago or New York, 
loudly haggling over contracts for orange juice or porkbellies. The 
reality is that derivatives have become increasingly varied over time 
and today encompass a wide selection of highly complex financial 
products and indicators like bonds, currencies, interest rates and 
stock indexes.
    Congress allowed for various levels of regulation of futures 
contracts in the 2000 reauthorization, in part to handle the demand for 
these products. Both the CFTC-regulated exchanges and the over-the-
counter exchanges have experienced strong annual growth in trading 
volumes since then, along with the proliferation of new trading 
products and participation of more investors of all classes than ever 
before.
    Every farmer, producer, processor and consumer benefits from open, 
transparent derivatives markets. Consequently, every one of us pays the 
price if these markets are manipulated or distorted. Because futures 
prices are used as points of reference for many physical transactions, 
manipulation in the futures markets can have a significant effect on 
what consumers pay and what farmers and producers receive. That makes 
the activities of the derivatives markets very much in the public 
interest.
    It is my hope that today's hearing will give us a good 
understanding of what needs to be done in this reauthorization given 
the changes in derivatives markets since the last reauthorization was 
passed.
    I welcome today's witnesses and I yield back my time.
                                 ______
                                 
Prepared Statement of Hon. Bob Goodlatte, a Representative in Congress 
                             From Virginia

    Thank you Mr. Chairman, and thank you for holding this hearing. I 
believe it is essential to reauthorize the Commodity Futures Trading 
Commission, which was last reauthorized by the Commodity Futures 
Modernization Act (CFMA) and expired in 2005.
    The CFMA has been lauded by many as the most significant amendments 
to the Commodity Exchange Act since the CFTC was created in 1974. The 
CFMA provided for the creation of unregulated futures exchanges, where 
all trading involved sophisticated or professional investors. Both the 
exchanges and the OTC markets have experienced strong growth in trading 
volumes since 2000. More recently both have experienced increased 
volatility. I am anxious to hear what our witnesses think causes this 
volatility and if it, in anyway, degrades the price discovery function 
of the futures markets.
    I've watched the CFTC's response to the market volatility and I 
have been impressed with its efforts and achievements. That does not 
mean that all should be left as is. I think the CFTC takes very 
seriously its primary responsibility as the exclusive regulator of the 
futures markets. I know the Commission would like and believe it needs 
more resources. I am interested to learn that the Commission now also 
believes it needs more enforcement tools. What government agency or 
regulator doesn't?
    I am more interested to learn what the regulated community 
believes. Has the CFTC done an effective job of regulating the futures 
markets? Does it need more enforcement tools or oversight capability? 
Does it need more regulatory authority? Is it under-funded?
    These are all questions that need to be answered before we can 
craft the next reauthorization effort. The witnesses that are assembled 
today will be able to provide this Committee with that insight. I doubt 
we need to craft changes as significant as those in 2000, but I know we 
need to adequately address the concerns of our witnesses today.
    Thank you Mr. Chairman.
                                 ______
                                 
  Prepared Statement of Hon. Sam Graves, a Representative in Congress 
                             From Missouri

    I want to thank the Chairman and Ranking Member for having this 
hearing today. I appreciate the opportunity to submit remarks to the 
record.
    As most of my colleagues on this panel know, the reauthorization of 
the Commodity Exchange Act is very important to me and my constituents. 
It is my full intention to work with all parties involved to reach a 
deal that is amicable to everyone and I am hopeful that we can 
reauthorizes this program with everyone's support.
    We can all agree that the quicker we reauthorize the Commodity 
Exchange Act the sooner everyone can get back to business, and I think 
that is in the best interest of everyone here today.
    I look forward to listening to the panelists today and moving 
forward with this reauthorization.
                                 ______
                                 
    Prepared Statement of Hon. John T. Salazar, a Representative in 
                         Congress From Colorado

    Good morning. I first want to thank Chairman Etheridge and Ranking 
Member Moran for holding this important hearing today.
    As relieved as I am for completing our portion of the 2007 Farm 
Bill, I know there is still work to be done.
    With that said, I want to thank all of the witnesses for coming in 
today to discuss such a vital issue for farmers today.
    I can only imagine how busy all of you have been with the record 
harvests taking place.
    Over the last few weeks Colorado has had a record wheat harvest and 
corn is soon to come.
    As you know, this Act has been around for over 70 years with just a 
few changes taking place since the original Act in 1936.
    I want to reiterate something I stated many times during the farm 
bill hearings.
    Our average age of U.S. farmers is 55 years old, and I blame it on 
one reason--there is not enough profitability in agriculture.
    I think the 2007 Farm Bill has been written to benefit the producer 
and not the consumer like many farm bills in the past.
    As we move forward reviewing the Commodity Exchange Act, I want to 
make sure we do what we can do take care of our farmers.
    Thanks again to the leadership of the Committee for their hard work 
and I look forward to hearing the testimony.

    Mr. Etheridge. I would like to begin to welcome each of you 
panelists to the table this morning. Thank you for coming and 
being with us.
    Our first witness is Mr. Duffy, who is the Executive 
Chairman of the Chicago Mercantile Exchange Group in Chicago; 
second witness is Dr. Newsome, President and CEO of the New 
York Mercantile Exchange in New York; Mr. Carlson, who is the 
Corporate Secretary and Treasurer of Minneapolis Grain Exchange 
in Minneapolis, Minnesota; Mr. Sprecher, who is Chairman and 
CEO of the IntercontinentalExchange in Atlanta, Georgia; and 
Dr. Walsh, who is Executive Vice President, Chicago Climate 
Exchange in Chicago, Illinois.
    Mr. Duffy, please begin when you are ready. I would ask if 
you would, please, to the extent possible, to summarize your 
statements in 5 minutes and your total statement will be 
included in the record. Thank you. If you will please begin.

  STATEMENT OF TERRENCE A. DUFFY, EXECUTIVE CHAIRMAN, CHICAGO 
          MERCANTILE EXCHANGE GROUP, INC., CHICAGO, IL

    Mr. Duffy. Thank you, Mr. Chairman. I am Terry Duffy. I am 
the Executive Chairman of the Chicago Mercantile Exchange 
Group. I want to thank you, Chairman Etheridge, and Members of 
the Subcommittee for this opportunity to appear here today to 
present our views on some of the issues facing Congress as it 
continues the reauthorization process. CME Group was formed by 
the merger of Chicago Mercantile Exchange Holdings and Chicago 
Board of Trade Holdings. CME Group is the parent of CMS and the 
Board of Trade. CME Group also owns Swapstream Operating 
Services Limited, an OTC trading facility, and owns an interest 
in FXMarketspace Limited, an FX trading platform. We serve the 
global risk management needs of our customers and those who 
rely on price discovery formed by our competitive markets.
    We offer a comprehensive selection of benchmark products, 
including most major asset classes, including futures and 
options based on interest rates, equity indexes, foreign 
exchange, agricultural commodities, energy and alternative 
investment products, such as weather and real estate. I 
submitted my full testimony for the record and will summarize 
our major points here first.
    The CFTC's implementation of the CFMA: The CFTC's 
administration of the Commodity Futures Modernization Act of 
2000 has been a tremendously positive force for the derivatives 
industry. We think that the success of the U.S. derivatives 
industry under the regulatory regime created by the CFMA 
provides a compelling example for the securities industry. The 
reduction of barriers to new and cross-border entry into the 
global futures and options industry has spurred growth and 
innovation. U.S. investors can directly trade foreign futures 
and options contracts from the United States. Also, European 
and Asian investors can directly trade products listed by CME 
Group and other U.S. futures and options exchanges from abroad.
    U.S. capital markets have not had the same advantage. The 
overly prescriptive regulation imposed on U.S. securities 
exchanges and issuers is blamed, in part, for the success of 
foreign securities exchanges and the gravitation of major IPOs 
to offshore markets. The problems with the securities 
regulation have been cited to revive a call for merging the 
CFTC and the SEC. The inadequacies of security markets 
regulation need to be resolved by reform of that regulatory 
regime. It cannot be resolved by subjecting derivative markets 
to a system that is not credible in a global economy. Minor 
jurisdictional disputes have no bearing on effective regulation 
of derivatives or securities. Moreover, the CFTC has done its 
best to find a solution that permits questioned products to 
trade under both regimes and permits the marketplace to choose.
    Second, CME's recommendation for reauthorization: We 
enthusiastically applaud the success of the CFMA and urge the 
CFTC be reauthorized. The U.S. futures industry kept its place 
as a world leader and innovator because CFMA adopted a 
principles-based regulatory regime and the CFTC fostered the 
concept. Reauthorization offers a valuable opportunity to fine 
tune CFMA based on experienced gained since 2000. CME offers 
two recommendations.
    Off-exchange retail FX futures trading: The fact that the 
CFTC and NFA are compelled to devote a large share of their 
resources to protecting retail customers from widespread fraud 
in OTC FX markets is evidence that a serious problem exists. We 
have lost track of the number of CFTC and NFA enforcement 
actions since we first urged elimination of the exemption that 
permitted off-exchange trading of retail foreign exchange 
contracts. As expected, there have been hundreds of enforcement 
actions, hundreds of millions of dollars in fraudulent losses 
to small traders and each day brings new examples.
    At a minimum, we need an amendment that will clarify the 
retail FX system that do not regularly settle contracts by 
delivery are subject to CFTC registration requirements; that 
is, unless they are operated by banks or other financial 
institutions. Further, it should be specified that such systems 
may only be operated by Designated Contract Markets or well-
capitalized and fully regulated futures commodity merchants. In 
addition, all intermediaries who serve the same function as 
commodity pool operators, commodity trading advisors and 
introducing brokers, should register as such and be subject to 
comparable regulation.
    Exempt commodity markets: Section 5(b) of the Commodity 
Exchange Act charges the Commission with the duty to oversee 
the system of effective self-regulation of trading facilities, 
clearing systems, market participants and market professionals. 
It is the Commission's responsibility to deter and prevent 
price manipulation or any other disruptions to market 
integrity, to ensure the financial integrity of all 
transactions subject to this chapter and the avoidance of 
systemic risk and to protect all market participants from 
fraudulent or other abusive sales practices. These purposes, in 
the statutory exemption for commercial markets found in Section 
2(h)(3) are in conflict.
    The key purpose mandated by Congress in Section 5(b) is 
jeopardized if trading facilities for contracts in exempt 
commodities are permitted to coexist with regulated futures 
exchanges that list those same commodities. Exempt commercial 
markets do not have any system to effectively self-regulate 
their facilities or their market participants. Their contracts 
are traded based on the price of commodities that have limited 
supplies and that have often been the subject of manipulative 
activity and disruptive market behavior.
    There is no mechanism in place to deter or prevent price 
manipulation or any other disruptions to market integrity. The 
Commission cannot track the buildup of dominant positions. At 
best, the Commission has the power to punish such conduct only 
after the fact. We find this to be a serious problem that is at 
odds with Congress's intent behind CFMA. If left unaddressed, 
the situation jeopardizes the public's confidence and the 
CFTC's ability to do its job.
    The Section 2(h)(3) exemption for unregulated commercial 
markets should be eliminated. You can't fix the problem by 
merely changing reporting requirements. In order to secure 
accurate reports, a market needs an effective surveillance and 
compliance system. This requires that an effective system of 
self-regulation must be put in place. The logical conclusion is 
that you must implement at least the core principles required 
of derivative transaction execution facilities to get a useful 
result.
    Before I conclude, I want to make mention of the periodic 
attempts to impose transaction tax on exchange traded futures 
contracts. That effort is utterly misguided. First, the tax 
will fall on liquidity providers who will simply be driven 
offshore to untaxed exchanges. Second, the regulated exchanges 
already pay for the Commission's direct oversight and their 
customers pay a fee to the National Futures Association for the 
services it performs, many of which have been off-loaded from 
the CFTC.
    Finally, the CFTC's expenses and need for additional staff 
are attributed to off-exchange frauds and manipulations, not 
self-regulated trading. To close, CME Group, its members and 
their customers and the Nation's market-based economy have 
prospered under CFMA. The CFTC deserves commendation and should 
be reauthorized. The principles of CFMA should be reaffirmed. 
Mr. Chairman, I thank you very much for your time this morning.
    [The prepared statement of Mr. Duffy follows:]

 Prepared Statement of Terrence A. Duffy, Executive Chairman, Chicago 
              Mercantile Exchange Group, Inc., Chicago, IL

    I am Terrence Duffy, Executive Chairman of Chicago Mercantile 
Exchange Group, Inc., (``CME Group'' or ``CME''). Thank you Chairman 
Etheridge and Members of the Subcommittee for this opportunity to 
appear here today to present our views on some of the issues facing 
Congress as it continues the reauthorization process. CME Group was 
formed by the merger this year of Chicago Mercantile Exchange Holdings 
Inc. and CBOT Holdings Inc. CME Group is the parent of CME Inc. and The 
Board of Trade of the City of Chicago Inc. (the ``CME Group 
Exchanges''). CME Group also owns Swapstream Operating Services 
Limited, an OTC trading facility, and owns an interest in FXMarketspace 
Limited, an FX trading platform that is authorized and regulated by the 
Financial Services Authority. The CME Group Exchanges serve the global 
risk management needs of our customers and those who rely on the price 
discovery provided by the competitive markets maintained by the 
Exchanges. The CME Group Exchanges offer a comprehensive selection of 
benchmark products in most major asset classes, including futures and 
options based on interest rates, equity indexes, foreign exchange, 
agricultural commodities, energy, and alternative investment products 
such as weather and real estate. Additionally, we offer order routing, 
execution and clearing services to other exchanges by means of our 
Globex electronic trading platform and our clearing house. CME Group 
is traded on the New York Stock Exchange and NASDAQ under the symbol 
``CME.''

I. The CFTC'S Implementation of CFMA
    I am pleased to give our view of the achievements of the Commodity 
Futures Trading Commission and the successes of our industry made 
possible by the Commodity Futures Modernization Act of 2000 (``CFMA''). 
The CME Group commends Congress, and the agriculture committees, for 
the foresight in 2000 to enact a principles-based regulatory regime for 
our industry.
    The success of the derivatives industry sharply contrasts with 
developments in U.S. capital markets. Foreign exchanges have been 
attracting new listings to the apparent detriment of U.S. markets--
thereby focusing negative attention on the U.S. regulatory system for 
securities exchanges and issuers. There is concern that U.S. security 
markets have been hamstrung in meeting international competition by 
overly-prescriptive regulation. A strong case has been made that 
innovation is slowed and U.S. markets cannot attain a first mover 
advantage because of the lag between idea and implementation imposed by 
the regulatory regime.
    We think that the marked success of the U.S. derivatives industry 
under the regulatory regime created by the CFMA provides a compelling 
example for the securities industry. In our view, reducing or limiting 
barriers to entry in the global futures and options industry has 
strongly contributed to business growth. For example, the compounded 
annual growth rate of the global futures and options industry from 2000 
through 2006 was 28% compared to only 4% for equity securities markets. 
This is due, at least in part, to the fact that U.S. investors can 
directly and electronically trade foreign futures and options contracts 
from the U.S. Correspondingly, European and Asian investors can 
directly and electronically trade products listed by CME and other U.S. 
futures and options exchanges. Moreover, foreign boards of trade can 
efficiently offer U.S. customers access to products also traded on U.S. 
exchanges, thereby increasing global competition in these markets. In 
contrast, under current SEC rules, U.S. investors cannot directly and 
electronically trade foreign equity securities of foreign issuers that 
do not comply with SEC disclosure standards or U.S. GAAP accounting 
standards. The CFTC has wisely promoted global growth and competition 
while recognizing that comparability in regulatory standards is 
superior to insisting upon additional, but not necessarily better, 
regulatory requirements.
    Despite this record, we are concerned that most discussions of 
regulatory shortcomings in the U.S. lump derivative and security 
markets together and treat the regulatory problem as if it were caused 
by separate regulation of those two sectors. We have not discovered a 
single, considered explanation of why separate regulation of futures 
and securities has adversely impacted securities markets.
    The U.S. futures industry kept its place as a world leader and 
innovator because CFMA adopted a principles-based regulatory regime and 
the Commission embraced and fostered the concept. CFMA set the stage 
for innovation and international expansion of U.S. futures markets.
    Some observers argue that the occasional jurisdictional ``overlap'' 
between the CFTC and SEC with respect to some innovative new products 
demonstrates a dysfunctional system that must be changed. Those 
``border disputes'' certainly exist and are unfortunate, but they have 
no bearing on the effective and efficient regulation of the great mass 
of futures products that lie solely within CFTC's jurisdictional 
purview. The proper resolution is the course that the CFTC pioneered, 
i.e., finding a solution that permits the new products to trade under 
both regimes and permitting the ``market'' to choose.
    The continuing call for merging the CFTC and the SEC is sometimes 
justified as a means to resolve these minor conflicts. Such a merger 
has no value for futures markets which already enjoy principal-based 
regulation. There is no benefit to the customers, since the most likely 
outcome will be the elimination of the better regulatory system. The 
inadequacies of securities market regulation cited by critics need to 
be resolved by reform of that regulatory regime, not by subjecting 
derivative markets to a system that is not credible in a global 
economy.
    Perhaps it is premature to comment, but there appears to be a 
serious jurisdictional conflict between the CFTC and the Federal Energy 
Regulatory Commission (``FERC''), arising out of FERC's prosecution of 
Amaranth in connection with its trading of natural gas on NYMEX, a 
designated contract market subject to the exclusive jurisdiction of the 
CFTC. Section 2(a)(1)(A) of the CEA provides: ``The Commission shall 
have exclusive jurisdiction, except to the extent otherwise provided in 
subparagraphs (C) and (D) of this paragraph and subsections (c) through 
(i) of this section, with respect to accounts, agreements . . . and 
transactions involving contracts of sale of a commodity for future 
delivery, traded or executed on a contract market designated or 
derivatives transaction execution facility registered pursuant to 
section 7 or 7a of this title or any other board of trade, exchange, or 
market . . . .'' The CFTC investigated Amaranth's conduct and charged it 
with an attempted manipulation under the CEA. FERC investigated the 
same conduct and charged Amaranth with manipulative conduct under the 
different standard applicable in its statute. FERC is taking the 
position that it has jurisdiction over conduct on a futures exchange if 
that conduct impacts cash markets under its jurisdiction. In effect, 
FERC reads the CFTC's exclusive jurisdiction out of existence. The 
prosecution of the same conduct by separate Federal agencies under 
differing standards creates exactly the sort of conflict that Congress 
sought to avoid by limiting the reach of FERC jurisdiction.

II. CME's Recommendations for Reauthorization
    We urge that the CFTC be reauthorized. Generally we agree that CFMA 
has been a resounding success, but we also believe that reauthorization 
offers a valuable opportunity to fine tune that statute based on 
industry experience gained in the 7 years since the CFMA's enactment. 
In that regard, CME offers three recommendations for consideration. We 
also wish to comment on the recurring efforts to impose a transaction 
tax on exchange traded futures to fund the Commission.
Off-Exchange Retail FX Futures Trading
    The first area in need of fine tuning involves retail, off-exchange 
trading of foreign exchange derivatives. We have lost track of the 
number of CFTC and NFA enforcement actions since we first urged 
elimination of the exemption that permitted off-exchange trading of 
retail foreign exchange contracts. As we predicted, there have been 
hundreds of enforcement actions, hundreds of millions in fraudulent 
losses to small traders, and each day brings new cases and more losses. 
The confluence of the massive continuing frauds committed against 
retail customers by fly-by-night foreign exchange dealers, and the 
unfortunate decision of the 7th Circuit Court of Appeals in CFTC v. 
Zelener, compel this industry to reexamine the public policy 
implications of how the CFMA addresses off-exchange retail foreign 
exchange futures and the threshold definition of what transactions 
should be subject to CFTC jurisdiction.
    The fact that the CFTC and NFA are compelled to devote such 
substantial resources to protecting retail customers from widespread 
fraud in the off-exchange FX market is evidence enough that a serious 
problem exists with the CFMA that cries out for reform. In the 
aftermath of the Zelener decision, FX dealers can structure a margined 
currency contract for speculative use by retail customers and assert 
that is beyond the reach of the CFTC's jurisdiction. I don't believe 
that there is a single person in this room who would not agree that 
such contracts are futures contracts that deserve the protection of the 
CFTC. Under the Zelener case, it does not matter what the dealer 
actually does or what the customer actually expects--a single sentence 
in the small print of the customer agreement denies the CFTC 
jurisdiction. The sharp operators and bucket shops have already figured 
out that the rationale of the Zelener opinion can apply to commodities 
other than FX. If we only fix the FX problem, those operators will 
simply transfer their scams to orange juice, gold and heating oil. The 
CFTC's jurisdiction and its retail consumer protections will be reduced 
to irrelevance.
    At a minimum, we need an amendment that will clarify that retail FX 
derivative trading systems that do not regularly settle contracts by 
delivery are subject to CFTC registration requirements, unless operated 
by banks or other financial institutions. To the extent that such 
systems are regulated by the CFTC, they should only be operated by 
designated contract markets or well capitalized and fully regulated 
FCMs. All intermediaries who serve the same function as CPOs, CTAs and 
IBs and who deal with retail customers of off-exchange FX trading 
systems, regardless of the identity of the operator or the platform, 
must be required to register in the appropriate capacity and be subject 
to comparable regulation.

Exempt Commodity Markets
    Our perspective is based on ``first principles,'' which means we 
look to the findings and purposes adopted by Congress to guide the 
Commission's exercise of its jurisdiction. Section 5(b) of the 
Commodity Exchange Act charged the Commission with a duty to oversee 
``a system of effective self-regulation of trading facilities, clearing 
systems, market participants and market professionals'' and to ``to 
deter and prevent price manipulation or any other disruptions to market 
integrity; to ensure the financial integrity of all transactions 
subject to this chapter and the avoidance of systemic risk; to protect 
all market participants from fraudulent or other abusive sales 
practices.''
    There is a growing conflict between these ``purposes'' and the 
statutory exemption for Commercial Markets found in Section 2(h)(3), 
which is the basis for the Exempt Commercial Market (``ECM'') category. 
It is clear that all of the key purposes mandated by Congress in 
Section 5(b) are jeopardized if trading facilities for contracts in 
exempt commodities are permitted to coexist with regulated futures 
exchanges that list those same commodities. The Exempt Commercial 
Markets authorized by Section 2(h)(3), do not have any system of 
``effective self regulation'' of their facilities or of their market 
participants. Their contracts are traded based on the prices of 
commodities that have limited supplies and that have often been the 
subject of manipulative activity and disruptive market behavior. There 
is no mechanism in place ``to deter and prevent price manipulation or 
any other disruptions to market integrity.'' The Commission cannot 
track the build-up of dominant positions. The ECM has no real power 
over its users. At best, the Commission has power to punish such 
conduct after the fact. We find this to be a serious problem, as 
explained in detail below, that is at odds with Congress's intent 
behind the CFMA and which, if left unaddressed, is likely to jeopardize 
the public's confidence in the CFTC's ability to do its job.

    A. Trading standardized, cash settled, fungible commodity contracts 
        on a multilateral execution facility is indistinguishable from 
        futures trading.

    Bilateral swaps, including swaps respecting energy, metals and 
other non-agricultural products, as defined at section 2(g) of the CEA, 
were excluded from the exchange trading requirement of the CEA because 
they had developed into an important product and a formal confirmation 
of their excluded status was desirable. The Commission's Policy 
Statement Concerning Swap Transactions, 54 Fed. Reg. 30,694 (July 21, 
1989) was the first step in the direction of excluding financial 
product swaps. The Futures Trading Practices Act of 1992, P.L. No. 102-
546, 106 Stat. 3590, amended the CEA and clarified the Commission's 
authority to exempt certain transactions from the exchange trading 
requirement. The Commission adopted such regulations in 1992, e.g., 17 
C.F.R. 35. An excluded bilateral swap must be ``subject to individual 
negotiation by the parties and not executed on a trading facility.'' 
\1\
---------------------------------------------------------------------------
    \1\ (g) Excluded swap transactions

      No provision of this chapter (other than section 7a (to the 
extent provided in section 7a(g)
  of this title), 7a-1, 7a-3, or 16(e)(2) of this title) shall apply to 
or govern any agreement,
  contract, or transaction in a commodity other than an agricultural 
commodity if the agree-
  ment, contract, or transaction is--

        (1) entered into only between persons that are eligible 
contract participants at the time
    they enter into the agreement, contract, or transaction;
        (2) subject to individual negotiation by the parties; and
        (3) not executed or traded on a trading facility.

    CEA Section 2(d)(2) excluded electronically traded contracts based 
on certain financial measures that were deemed unlikely to be subject 
to manipulative activity (an ``excluded commodity'') if the contract is 
entered into on a principal-to-principal basis between eligible 
contract participants. This exclusion is based on the recommendations 
of the President's Working Group (``PWG''). The PWG carefully limited 
its recommendation for an excluded electronic trading platform to a 
class of commodities that did not include the types of commodities 
---------------------------------------------------------------------------
traded on an ECM:

    ``Accordingly, the Working Group unanimously recommends that 
        Congress amend the CEA to clarify that entering into or trading 
        excluded swap agreements (i.e., agreements between eligible 
        swap participants that do not involve non-financial commodities 
        with finite supplies) through electronic trading systems with 
        certain characteristics does not affect the status of the 
        agreements traded through the system and does not provide a 
        basis for regulation of the system. Over-the-Counter 
        Derivatives Markets and the Commodity Exchange Act, Report of 
        The President's Working Group on Financial Markets, at 18-19 
        (November 1999) (emphasis supplied)

    CME supported and continues to support those portions of the CFMA 
that exclude bilateral swaps in financial commodities. We also support 
the electronic trading of financial derivatives on Exempt Boards of 
Trade as provided in CFMA. But, the contracts traded on ECMs are not 
such bilateral swaps. They are standardized derivatives whose terms are 
set by the operator of the trading platform. Identical contracts become 
fungible if the platform provides central counterparty clearing. 
Consequently a buyer can offset his position by selling an equal and 
opposite contract. The price of the transaction is set at the time of 
the transaction but delivery is deferred. We do not consider these to 
be forward cash contracts because they are not regularly settled by the 
delivery of a specific cash instrument; rather they are cash settled 
like many financial futures contracts.
    The only significant differences between traditional DCMs and ECMs 
is the ``eligible contract participant'' (``ECP'') qualification of the 
ECM's customers and the requirement that ECM customers execute 
transactions without a broker or other intermediary. However, it is 
only those traders that are large enough to satisfy the ECP 
requirements who are likely to be involved in manipulative activity. Of 
course, CME Group Exchange customers can also directly enter their 
orders into the GLOBEX trading system and most customers do qualify as 
eligible contract participants. That difference may justify a different 
set of customer protection rules for ECMs, but it does not justify the 
lack of a self-regulatory system, large trader reporting or information 
sharing with other exchanges.

    B. Coexisting regulated and unregulated markets for economically 
        equivalent commodity contracts impair information flows 
        necessary to prevent misconduct.

    Large trader reports are the key element of Commission and self-
regulatory organization surveillance programs to prevent disruptive 
market activities. ECMs do not require large trader reports and do not 
participate in the Intermarket Surveillance Group, which shares 
information across exchanges. There is no logical basis for this 
distinction. If the prevention of disruptive market behavior is to 
remain a goal of derivatives regulation, information collection and 
sharing is essential.
    The intensity of concern respecting this lack of information 
depends on the likelihood of manipulation or other market disruptions 
that may be caused by trading particular underlying products, i.e. 
excluded versus exempted commodities. Again, the 1999 PWG report is 
instructive. The PWG's recommendations for eliminating the exchange 
trading requirement and easing regulatory burdens on electronic trading 
facilities, which host transactions involving derivatives based on 
excluded commodities, were premised on its considered judgment 
respecting the risks of manipulative and market distorting activity in 
the excluded commodities:

    ``Where regulation exists, it should serve valid public policy 
        goals. The justifications generally cited for regulation of the 
        futures markets include the goals of protecting retail 
        customers from unfair practices, protecting the price discovery 
        function, and guarding against manipulation. With similar 
        policy goals in mind, the Working Group has recommended 
        limiting the proposed exclusion for swap agreements to eligible 
        swap participants trading for their own account . . . . It has 
        also recommended limiting proposed exclusions to markets that 
        are not readily susceptible to manipulation and that do not 
        currently serve a significant price discovery function.'' Over-
        the-Counter Derivatives Markets and the Commodity Exchange Act, 
        Report of The President's Working Group on Financial Markets, 
        at 22 (November 1999) (emphasis supplied)

    The PWG made it abundantly clear that trading facilities for energy 
and metals products should not be exempted:

    ``Due to the characteristics of markets for non-financial 
        commodities with finite supplies, however, the Working Group is 
        unanimously recommending that the exclusion not be extended to 
        agreements involving such commodities. For example, in the case 
        of agricultural commodities, production is seasonal and 
        volatile, and the underlying commodity is perishable, factors 
        that make the markets for these products susceptible to supply 
        and pricing distortions and to manipulation. There have also 
        been several well-known efforts to manipulate the prices of 
        certain metals by attempting to corner the cash or futures 
        markets. Moreover, the cash market for many non-financial 
        commodities is dependent on the futures market for price 
        discovery.'' Id. at 16 (emphasis supplied)

    The testimony adduced at the recent Congressional hearings on the 
Amaranth episode and energy trading issues confirms the validity of the 
PWG's concerns about an exclusion for energy trading facilities.

    C. The Remedy: The Section 2(h)(3) exemption for unregulated 
        commercial markets should be eliminated.

    Potential disruption of regulated markets and the cash market for 
certain exempted commodities justifies an increase in the flow of 
current information from organized OTC markets to the Commission. One 
seemingly simple solution is to change reporting requirements. Our 
experience suggests that this will be a failure. In order to provide 
accurate reports, a market needs an effective surveillance and 
compliance system. This implies that an effective system of self 
regulation must be put in place. The logical conclusion is you must 
implement at least the core principles required of a Designated 
Transaction Execution Facility (``DTEF'') to get a useful result.
    The 2(h)(3) special exemption for commercial markets trading 
commodity futures contracts based on energy, metals and other non-
enumerated commodities is directly contrary to the recommendations of 
the President's Working Group on which CFMA was based. The PWG 
expressly found that an exemption for exchange-like trading of 
derivatives based on underlying commodities that were not immune from 
manipulation was not appropriate. The legislative history of the CFMA 
provides no explanation for why Congress deviated from the PWG 
recommendations.
    If Congress needs any further justification for taking action to 
reverse this hole in the CEA's regulatory safety net, Intercontinental 
Exchange's Jeffrey Sprecher's recent testimony before Congress 
adequately confirms that there is ample need for it now. He conceded 
that it is essential to the performance of the CFTC's oversight 
function that there be enhancements ``to the quality and quantity of 
information currently available to the CFTC and, in particular, its 
ability to integrate data from ICE and NYMEX.'' \2\ Additionally, our 
sense is that the CFTC devotes an outsized proportion of its human and 
financial resources to trying to stay abreast of problems in the ECM 
market and dealing with other off-exchange trading. Eliminating the 
2(h)(3) category would produce significant efficiencies of 
administration and more effective regulatory oversight without any 
adverse implications for innovation, competition or market flexibility. 
Any trading facility that is now successfully operating as an ECM can 
easily and inexpensively convert to a DTEF or DCM. Beyond the market 
protections reflected in a DTEF's core principles, a DTEF has an 
affirmative obligation to deter market abuses and to implement systems 
and procedures to comply with that obligation.\3\ The Commission has 
oversight powers to insure that the obligation is met. The existing 
DTEF regulatory scheme would appear to provide an effective remedy to 
the problems identified with ECMs without the need to invent something 
new.
---------------------------------------------------------------------------
    \2\ Testimony of Jeffrey C. Sprecher, Chairman and Chief Executive 
Officer, IntercontinentalExchange, Inc., Before the House Agriculture 
Subcommittee on General Farm Commodities and Risk Management Committee 
on Agriculture, page eight (July 12, 2007).
    \3\ CEA Section 5a(c)(2) provides as follows:

      Deterrence of abuses.--

        The board of trade shall establish and enforce trading and 
participation rules that will
    deter abuses and has the capacity to detect, investigate, and 
enforce those rules,
    including means to--

          (A) obtain information necessary to perform the functions 
required under this section;
      or
          (B) use technological means to--

            (i) provide market participants with impartial access to 
the market; and
            (ii) capture information that may be used in establishing 
whether rule violations have
        occurred.

    The Commission's published list of ECMs confirms our belief that 
there appears to be no barrier for ECMs to convert to DTEFs or DCMs. 
There are numerous providers to whom any servicing needs, such as 
clearing and/or compliance, can be outsourced efficiently. The 
significant entrants, such as ICE, ChemConnect, Inc., Chicago Climate 
Exchange, Inc., and TradeSpark have affiliates that are already 
regulated by the Commission and can provide such services in house. 
HoustonStreet seems to be a marketplace for physical crude oil and 
other refined products that makes certain NYMEX ClearPort products 
available in a linkage arrangement. NetThruPut Inc. appears to be a 
cash crude oil trading system. It is unclear, from its websites, what 
ICAP is actually doing as an ECM. Some, such as Optionable, Inc. and 
Commodities Derivative Exchange, Inc., are out of business. Others 
appear to be trading agricultural commodities like pulp and salmon, 
which, not being exempt commodities, are not within the purview of 
ECMs.

Security Futures Products
    In my Congressional testimony of June of 2003, I characterized 
single stock futures as ``the CFMA's unfulfilled promise''. I am sad to 
say what was true then remains so even today. As evidenced by the 
success and acceptance of the contract in European markets, single 
stock futures can be a great product with enormous benefits to market 
users. The regulatory system that has slowly evolved between CFTC and 
SEC has yet to address various key issues and several of the 
regulations that have been produced thus far are overly burdensome and 
inflexible, frustrating development of products that would be both 
useful and desirable to market participants.
    It is time to let futures exchanges trade the product as a pure 
futures contract and to let securities exchanges trade it as a 
securities product. Let the relevant exchanges deal solely with their 
respective regulator, the CFTC or the SEC, which is what I believe the 
Congress intended in 2000 in authorizing single stock futures. We want 
competitive forces to determine the outcome--not government. Fulfilling 
that promise made in 2000 will advance the customers' interest 
substantially. We would encourage the Subcommittee to use its oversight 
jurisdiction to insist that the respective regulatory agencies 
eliminate undue regulatory impediments that have been erected to 
frustrate the introduction of security futures products.\4\
---------------------------------------------------------------------------
    \4\ In their letter to Congressional leaders dated November 3, 
2005, the PWG principals stated inter alia that: ``In addition to 
retail foreign currency fraud issues, the PWG members have discussed 
the complex issues related to . . . the implementation of risk-based 
portfolio margining systems for security futures products and security 
options . . . As part of these discussions, the PWG is committed to 
resolving the portfolio margining system and narrow-based index issues 
within the time frames set forth below:

      With regard to portfolio margining, the SEC has committed to 
approving self regulatory or-
  ganization (SRO) rules that permit the use of risk-based portfolio 
margining methodology to
  determine margin requirements for portfolios that include security 
futures products and for
  security options by June 30, 2006. In the event that the SEC does not 
approve such SRO
  rules, the SEC will promulgate rules to permit risk-based portfolio 
margining for security op-
  tions by September 30, 2006, and the SEC and CFTC will do so jointly 
for security futures
  products by the same date.''
---------------------------------------------------------------------------
Transaction Tax
    The periodic attempts to impose a transaction tax on exchange 
traded futures contracts are misguided. First, the tax will fall on 
liquidity providers who will simply be driven off shore to untaxed 
exchanges. Second, the regulated exchanges already pay for the 
Commission's direct oversight and their customers pay a fee to the 
National Futures Association for the services it performs, many of 
which have been offloaded from the CFTC. Finally, the CFTC's expenses 
and need for additional staff is attributable to off-exchange frauds 
and manipulations, not self-regulated exchange trading.
    Each year we are faced with a proposal to fund the Commodity 
Futures Trading Commission's budget with a ``transaction tax'' levied 
on U.S. futures exchange trading. This tax will: (1) impair liquidity 
of U.S. futures markets; (2) change the competitive balance in favor of 
foreign and OTC markets; (3) unfairly burden U.S. futures exchanges 
with the costs of policing OTC fraud; (4) hurt the local economies in 
the cities and states where futures exchanges create great employment 
opportunities; (5) lessen the value of the information provided to 
farmers and the financial services industry by means of the price 
discovery that takes place in liquid, transparent futures markets; (6) 
adversely impact the cost of financing the national debt; and, 
ironically, (7) fail to increase the taxes actually collected. 
Fortunately, with the Agriculture Committee's leadership, Congress has 
consistently rejected this ill-conceived tax proposal.\5\ A transaction 
tax is ill-conceived and counter-productive and should be rejected for 
all of the reasons listed, as explained in more detail below:
---------------------------------------------------------------------------
    \5\ In its March 1, 2007 budget recommendation letter, the bi-
partisan leadership of the House Agriculture Committee stated: ``The 
Administration has also proposed the enactment of new user fees to be 
charged by a number of different agencies under the jurisdiction of the 
Committee on Agriculture. Some of these fees have been proposed before, 
and it has been the consistent judgment of our Committee that the 
widespread benefits of the activities involved justify the use of the 
general treasury.''
---------------------------------------------------------------------------
    1. Adversely Impacting Liquidity: We estimate that the transaction 
tax will add significantly to the execution costs of the significant 
liquidity providers on U.S. futures exchanges. These market makers 
whose constant participation and rapid turn-over is the major source of 
market liquidity operate on razor thin margins. Every market maker 
would pay an additional tax on top of his existing Federal, state and 
local taxes. A transaction tax to fund the CFTC imposes millions per 
year in tax on market makers in addition to the tax they already pay on 
any profits they achieve. The transaction tax is imposed whether or not 
they actually profit. Many of these market makers are at the margin of 
profitability. This significant tax will expose them to the choice of 
continuing at a profit level unjustified by the risks assumed or 
exiting the business. The exit of liquidity providers means decreased 
efficiency of the futures markets, more volatility and less facility 
for other market participants to make effective use of futures markets. 
We are also concerned that the discipline exerted on the agency's 
budget by the appropriations process will evaporate under a regime 
where the costs are allocated to certain market users.
    2. Upsetting the Competitive Balance: The transaction tax only 
applies to domestic futures exchange trading: competing over-the-
counter markets, including the ECMs that are discussed above, and 
foreign futures exchanges are not covered. This feature grants those 
venues substantial, unearned competitive advantages over U.S. regulated 
futures exchanges. Users of U.S. futures markets can and do readily 
shift their business off-exchange or overseas if U.S. futures markets 
are too costly. In this era of electronic trading, market participants 
can transfer their business to trading platforms that offer the most 
competitive transactional pricing. It is as easy for an exchange to 
claim a foreign venue and avoid costly U.S. regulation or taxes. This 
is not a remote possibility, it is happening now in connection with the 
major competitive battle between a U.S. and U.K. energy futures market.
    3. Taxing the Wrong Parties: Futures exchanges already pay for 
direct supervision by the CFTC. Customers trading on U.S. futures 
exchanges pay a fee to cover the regulation of intermediaries provided 
by the National Futures Association, which has taken over many of the 
responsibilities of the CFTC. A significant and increasing amount of 
CFTC's enforcement and surveillance budget is dedicated to detecting 
and prosecuting fraud in OTC trading (for example, OTC currency and 
energy trading), yet this transaction tax proposal would have exchange 
traders foot the bill for CFTC's OTC-related surveillance and 
enforcement activities. So too, trading done through foreign exchange 
affiliates of U.S.-based OTC entities would similarly escape the ambit 
of the transaction tax even while CFTC would be dedicating its staff 
resources to surveillance and enforcement activities related to those 
markets.
    4. Hurting Local Economies: Harming the U.S. futures industry will 
affect both the U.S. and local economies. In Chicago, the exchange 
industry provides more than 100,000 direct and indirect jobs; more than 
$48 billion are on overnight deposit in Chicago and New York banks as a 
result of the exchanges. The exchanges and those who depend on them for 
their livelihoods are the source of millions of dollars in Federal, 
state and local tax revenues. New York benefits just as directly from 
its three futures exchanges, with billions contributed to NYC's economy 
and hundreds of millions in Federal state and local taxes.
    5. Impairing Price Discovery: Futures markets provide significant 
benefits to market users and to persons seeking good information on 
future pricing in order to guide their decision making on investment, 
planting, herd management, etc. The deeper and more liquid the market, 
the better the price discovery and information provided. Any impairment 
of liquidity lessens the value of the information and the functioning 
of our market based economy.
    6. Increasing the Cost of Financing the National Debt: The value to 
the Federal Government of liquid, efficient domestic futures markets 
far exceeds the revenue that might be generated by the transaction tax. 
Liquid futures markets save the Treasury and taxpayers millions of 
dollars by allowing government securities dealers effectively to hedge 
their risks and to bid more aggressively at auctions for Treasury 
securities. The savings to the Treasury in interest rate payments are 
worth far more than the $127 million the transaction tax is expected to 
raise. If a government-imposed transaction tax diminishes liquidity in 
futures markets, thereby increasing government borrowing costs by even 
one basis point, that tax would increase the Federal deficit by at 
least $474,543,158.71 million per year.
    7. Securing No Real Gain in Revenues: In every instance when a 
government imposed a transaction tax on futures trading, the loss of 
business to foreign exchanges forced a reversal. In some cases it came 
too late and the industry was lost. If the proposed transaction tax 
forces the U.S. futures business overseas or to untaxed substitute 
markets, the anticipated revenue will be an illusion. Diminished 
futures industry business and employment will also result in reduced 
corporate and personal income taxes in this country. Not only will the 
proposed transaction tax fail to produce enough ongoing revenue to fund 
the CFTC, but it will reduce government revenues generally.

V. Conclusion
    The CME, its members and their customers, and the nation's market 
based economy have prospered under the CFMA. The CFTC should be 
reauthorized and the principles of CFMA should be reaffirmed. The CME 
looks forward to engaging significantly in the reauthorization process 
and to achieving legislation that maintains the significant successes 
of the CFMA while making discreet corrections designed to materially 
improves the utility, efficiency, competitiveness and fairness of our 
futures markets for our customers and all market participants.

    Mr. Etheridge. Thank you, Mr. Duffy. And if the other 
Members would suspend for just a minute. We have been joined by 
the Ranking Member of the full Committee, if he has comments 
for an opening statement.
    Mr. Goodlatte. Thank you, Mr. Chairman.
    Mr. Etheridge. We would gladly recognize you this morning.

 OPENING STATEMENT OF HON. BOB GOODLATTE, A REPRESENTATIVE IN 
                     CONGRESS FROM VIRGINIA

    Mr. Goodlatte. The only thing I will say is that I very 
much appreciate your holding this hearing, that we have been 
long working on the effort to reauthorize this important 
legislation, so I am pleased to be here to hear the testimony 
of the witnesses and have them help us find a way forward. I 
welcome all members of this panel.
    Mr. Etheridge. Thank you, sir. Dr. Newsome.

   STATEMENT OF JAMES E. NEWSOME, Ph.D., PRESIDENT, CEO, AND 
              MEMBER, BOARD OF DIRECTORS, NEW YORK
            MERCANTILE EXCHANGE, INC., NEW YORK, NY

    Dr. Newsome. Thank you, Mr. Chairman. Mr. Chairman, Mr. 
Moran, Members of the Committee, as President and CEO of the 
New York Mercantile Exchange, I appreciate the opportunity and 
the invitation to share our views today. The CFMA has provided 
critically needed legal certainly and modernization to U.S. 
futures and derivatives markets. The CFMA also provides a well-
considered oversight framework for futures markets that has 
enhanced the abilities of NYMEX and the other regulated 
exchanges to operate in a rapidly changing business 
environment.
    The CFMA shifted away from a ``one-size-fits-all'' 
prescriptive approach to a more flexible approach that included 
the use of core principles for DCMs or Designated Contract 
Markets. In today's competitive global environment, this shift 
is more important now than ever before. In addition, the CFMA 
strengthened the CFTC's role as an oversight regulator. The 
CFMA's flexible regulatory framework provides benefits to the 
marketplace while continuing to ensure confidence in the 
integrity of futures markets.
    However, with an ever evolving marketplace, some markets 
differ dramatically now than just 7 years ago, causing the need 
for this Committee's reevaluation of certain aspects of the 
CFMA. The CFMA established an unregulated market category, the 
exempt commercial market, and due to evolution of some markets, 
non-regulation of certain ECM markets can no longer be 
justified. Over the last several months, the role of ECMs has 
received a great deal of scrutiny in Congress and elsewhere. 
Prior to and during this period, NYMEX has observed and voiced 
a broad and growing consensus that certain products traded on 
ECMs and DCMs are tightly linked and effectively comprise one 
broader market.
    Consequently, NYMEX, along with others, have concluded that 
there is a need for appropriate statutory change to provide 
effective regulatory oversight of markets that are of critical 
importance to U.S. consumers and to the overall economy. The 
debate over the changes in the marketplace is now largely 
settled. The real question becomes the appropriate statutory 
response. Mr. Chairman, today's timely hearings provides an 
opportunity for the Congress, the CFTC and the industry to 
begin to work together constructively on developing a solution.
    It has become apparent to me that the structural issues 
raised by changes in the marketplace cannot be addressed 
effectively at the level of individual exchanges. NYMEX 
believes that a targeted approach that directly addresses the 
specific issues raised by these industry changes would be the 
most effective policy response and would provide the greatest 
assurance of limiting the unintended consequences of broader 
changes.
    NYMEX believes that a heightened level of CFTC oversight 
should be mandated for certain products listed on ECMs whose 
products are directly linked to regulated markets. However, 
NYMEX does not believe that the case has been made for 
extending such heightened regulation to other products listed 
on such an ECM to other ECMs that have not triggered these 
policy interest and concerns or the traditional bilateral OTC 
marketplace.
    Specifically, for those products trading on ECMs that have 
triggered public policy interest and concerns, NYMEX believes 
that the CEA should be amended to mandate routine large trader 
reporting and position accountability requirements for 
financially settled ECM contracts that are highly linked and 
functionally equivalent to regulated DCM contracts. Such ECMs 
must also be assigned self-regulatory responsibilities to 
police their own markets and to submit applicable rule changes 
to the CFTC.
    Finally, over 30 years ago, Congress very wisely gave the 
CFTC exclusive statutory authority over the regulation of 
futures transactions. This exclusive authority has been 
reaffirmed by Congress in every subsequent reauthorization of 
the CEA. It has also established case law in the Federal 
courts. NYMEX believes strongly that the CFTC currently has and 
should continue to have exclusive authority and jurisdiction 
over futures transactions and futures markets. To vary from 
this prudent regulatory structure would create confusion, 
inconsistency and uncertainty, ultimately harming the vitality 
and effectiveness of derivatives markets, as well as the 
broader economy relying upon such markets for both price 
discovery and the hedging of risk. Thank you, Mr. Chairman.
    [The prepared statement of Dr. Newsome follows:]

  Prepared Statement of James E. Newsome, Ph.D., President, CEO, and 
  Member, Board of Directors, New York Mercantile Exchange, Inc., New 
                                York, NY

    Mr. Chairman and Members of the Committee, my name is Jim Newsome 
and I am the President and Chief Executive Officer of the New York 
Mercantile Exchange, Inc. (NYMEX or Exchange). NYMEX is the world's 
largest forum for trading and clearing physical-commodity based futures 
contracts, including energy and metals products, and has been in the 
business for more than 135 years. NYMEX is a federally chartered 
marketplace, fully regulated by the Commodity Futures Trading 
Commission (CFTC) both as a ``derivatives clearing organization'' (DCO) 
and as a ``designated contract market'' (DCM).
    These categories of regulated entities were established by the 
Commodity Futures Modernization Act of 2000 (CFMA), which amended the 
Commodity Exchange Act (CEA or the Act). The CFMA provided greater 
legal certainty for over-the-counter (OTC) derivatives transactions and 
established a number of other new statutory categories for trading 
facilities. On behalf of the Exchange, its Board of Directors and 
shareholders, I want to express our appreciation to the Committee for 
holding today's hearing on the reauthorization of the CFTC.

Overview
     The CFMA is a landmark piece of Federal legislation that has 
provided critically needed legal certainty and regulatory streamlining 
and modernization to U.S. futures and derivatives markets. The CFMA 
provides a well-considered oversight framework for futures markets that 
has enhanced the abilities of NYMEX and the other regulated exchanges 
to operate in a rapidly changing business environment. The CFMA's 
flexible regulatory framework also provides competitive benefits to the 
marketplace while continuing to ensure confidence in the integrity of 
our markets. The Exchange further believes that the tiered statutory 
structure for trading facilities has been effective in many respects.
    However, with an ever-evolving market place, today's markets differ 
dramatically from only 7 years ago, causing the need for this 
Committee's reevaluation of certain aspects of the CFMA. The CFMA 
established an unregulated market category, the exempt commercial 
market (ECM), and due to the changes in the market place, non-
regulation of certain ECMs can no longer be justified.
    Over the last several months, the role of ECMs has received a great 
deal of scrutiny in Congress and elsewhere. During this period, NYMEX 
has observed a broad and growing consensus that certain products traded 
on ECMs and DCMs are tightly linked and effectively comprise one 
broader market. Consequently, NYMEX, along with some legislators and 
regulators, have concluded that there is a need for appropriate 
statutory change to provide effective regulatory oversight of markets 
that are of critical importance to U.S. consumers and to the overall 
economy. The debate over the changes in the marketplace is now largely 
settled. The real question becomes the appropriate statutory response. 
Today's timely hearing provides an opportunity for Congress, the CFTC 
and the industry to begin to work together constructively on developing 
a solution.
    Finally, over thirty years ago, Congress unambiguously gave the 
CFTC exclusive statutory authority over the regulation of futures 
transactions. This exclusive authority has been continually reaffirmed 
by Congress in every subsequent reauthorization of the CEA and is also 
established case law in the Federal courts. NYMEX believes strongly 
that the CFTC currently has and should continue to have exclusive 
authority and jurisdiction over futures transactions and markets. To 
vary from this prudent regulatory structure would only create 
confusion, inconsistency and uncertainty, ultimately harming the 
vitality and effectiveness of derivatives markets as well as the 
broader economy relying upon such markets for price discovery and 
hedging of risk.

    I. The CFMA, by all indicators, is providing a reasonable, 
        workable, and effective oversight regime for the regulated 
        exchanges.

    The CFMA provides a well-considered, flexible regulatory framework 
that has enhanced the abilities of NYMEX and the other regulated 
exchanges to operate in a rapidly changing business environment and 
that has provided competitive benefits to the marketplace while 
continuing to ensure confidence in the integrity of our markets.
    Prior to the CFMA, the CFTC operated under a ``one-size-fits-all'' 
regulatory approach. Regulatory inequities imposed severe and 
unreasonable constraints on the abilities of domestic exchanges to 
compete with foreign exchanges operating in the U.S. and abroad and 
with unregulated over-the-counter markets. In particular, prior 
approval requirements for rule and contract changes, especially where 
few or no substantive regulatory concerns were present, further 
exacerbated an uneven playing field and disadvantaged U.S. regulated 
markets.
    The CFMA shifted away from a ``one-size-fits-all'' prescriptive 
approach to futures exchange regulation to a more flexible approach 
that included the use of ``Core Principles'' for DCMs. In addition, the 
CFMA confirmed the CFTC's role as an oversight agency (rather than a 
``command and control'' agency that must issue affirmative approval 
before any new innovations could be introduced to the market). Congress 
largely replaced extremely detailed, prescriptive regulation with more 
broadly structured ``Core Principles'' for regulated markets. Under the 
Core Principles approach, Congress sets broad performance standards 
that must be met by the regulated entity, while enabling the entity to 
have flexibility with regard to how it complies with these standards. 
Thus, the CFMA made clear that regulated DCMs shall have reasonable 
discretion as to the manner in which they comply with the applicable 
Core Principles set forth in regulation.
    As a result of the flexible Core Principles approach to regulation, 
the Exchange can respond rapidly to changing markets by introducing new 
risk management products, which benefit a broad spectrum of market 
participants. Market participants have also benefited from recent 
increased volume levels at all exchanges, which further emphasizes the 
exchanges' need to be able to respond quickly to market participants' 
risk management needs. As a result of Congress' foresight and 
innovation, such improvements can be implemented, subject to CFTC 
review and oversight, without protracted approval processes. CFTC staff 
periodically undertakes reviews to assess the adequacy of self-
regulatory programs and NYMEX has consistently been deemed to have 
maintained adequate regulatory programs in compliance with its 
obligations as a self-regulatory organization (SRO) under the CEA.
    The CFMA also created several new market tiers. The tiered 
structure was intended to impose a degree of regulation necessary to 
the market place based on the product traded and the market 
participants. Thus, at the highest tier of regulation, the DCM 
category, 18 core principles apply on an ongoing basis and the market 
is open to all products and all market participants and trades are or 
can be intermediated.
    The derivatives transaction execution facility (DTEF) is at the 
second tier of regulation and is subject to nine core principles. The 
market generally can trade products that are highly unlikely to be 
susceptible to manipulation, and it is not open to all market 
participants. Under one version of the DTEF, market participants must 
be eligible contract participants or trade through a registered FCM 
with net capital of at least $20,000,000. Under the other version of 
DTEF, participants are limited to eligible commercial entities. The 
DTEF category to date has not been utilized by the derivatives 
industry.
    The third market tier, for exempt markets, includes ECMs and Exempt 
Boards of Trade (EBOT). EBOTs generally are limited to excluded 
commodities and are unregulated. The ECM tier is open only to eligible 
commercial entities, trades products other than financial derivatives 
and agricultural commodities and also, as a facility, is completely 
unregulated. Transactions on the ECM are subject only to the CFTC's 
antifraud and anti-manipulation authority. To date, 20 entities have 
filed notification with the CFTC of their intention to operate as an 
ECM, and approximately six companies have filed notification of their 
intention to operate as an EBOT.

    II. The current statutory structure no longer works for certain 
        markets operating as ECMs.

    The CFMA was enacted following the issuance of a report by the 
President's Working Group on Financial Markets (PWG) that was 
undertaken at the direction of Congress to examine OTC derivatives 
markets and to provide legislative recommendations to Congress. The PWG 
Report, entitled ``Over-the-Counter Derivatives Markets and the 
Commodity Exchange Act,'' was issued in 1999 and focused primarily on 
swaps and other OTC derivatives transactions executed between eligible 
participants. Among other things, the PWG Report recommended exclusion 
from the CEA for swap transactions in financial products between 
eligible swap participants. Yet, the PWG Report explicitly noted that 
``[t]he exclusion should not extend to any swap agreement that involved 
a non-financial commodity with a finite supply.'' (Report of the PWG, 
``Over-the-Counter Derivatives Markets and the Commodity Exchange Act'' 
(November 1999) at p. 17.). However, in a footnote, the PWG stated that 
``[t]he CFTC would retain its current exemptive authority for swap 
agreements that involve a non-financial commodity with a finite 
supply.'' (Id.).
    The CFMA added new section 2(h) to the CEA, which exempted energy 
commodities from CFTC regulation and allowed the trading of energy 
swaps on an electronic trading platform. Section 2(h) was intended to 
provide legal certainty to energy swaps traded on or off a trading 
facility by clarifying that bilateral contracts, agreements or 
transactions in exempt commodities between eligible commercial entities 
were not subject to CFTC regulation, even if the contracts were 
cleared, but remained subject to the CFTC's anti fraud and anti 
manipulation provisions. The CFTC implemented Section 2(h)(3) in Part 
36 of its regulations by creating the category of markets known as 
ECMs. While transactions executed on an ECM generally are subject to 
anti-fraud and anti-manipulation authority, the ECM itself is 
essentially exempt from all substantive CFTC regulation and oversight. 
In addition, the ECM by statute has no affirmative requirements to 
engage in any self-regulatory activities to monitor its markets or 
otherwise seek to prevent any manner of market abuses.
    The ECM category was designed for commercial market participants 
who were in the business of making and taking delivery of the physical 
product, and who would be limited to engaging in principal-to-principal 
trading with each other. The exemption from effective CFTC oversight 
and regulation of the ECM trading facility built on the CFTC's existing 
1993 Energy Exemption for OTC bilateral energy swaps between commercial 
entities. There was a view at the time that there was not a public 
policy need to protect large commercial participants from transactions 
with other large and similarly situated commercial entities. However, 
the large-scale exemption of ECMs from effective CFTC oversight did not 
contemplate that the trading activities of commercial players on such 
trading facilities eventually would have spill-over or ripple effects 
on the broader regulated energy markets and ultimately affect 
consumers.
    A series of profound changes have occurred in various OTC markets 
since the passage of the CFMA, including technological advances in 
trading, such that NYMEX, the regulated DCM, and the 
IntercontinentalExchange (ICE), an unregulated ECM, have become highly 
linked trading venues. As a result of this phenomenon, which could not 
have been reasonably predicted only a few short years ago, the current 
statutory structure no longer works for certain markets now operating 
as ECMs.
    Specifically, the regulatory disparity between the NYMEX and the 
ICE, which are functionally equivalent, has created serious challenges 
for the CFTC and for NYMEX in its capacity as a self-regulatory 
organization. NYMEX also has concluded that ECMs, such as ICE, which 
function more like a traditional exchange and which are linked to an 
established exchange, should be subject to regulation of the CFTC for 
certain products in the form of large trader reporting, position 
limits/accountability levels and self-regulatory responsibilities.
    In addition, the continuing exchange-like aggregation and 
mutualization of risk at the clearinghouse level from trading on active 
ECMs, such as ICE, where large positions are not monitored, raise 
concerns about spill-over or ripple implications for other clearing 
members and for various clearing organizations that share common 
clearing members. Consequently, legislative change is necessary to 
address the real public interest concerns created by the current 
structure of the OTC electronically-traded natural gas market and the 
potential for systemic financial risk from a market crisis involving 
significant activity occurring on the unregulated trading venue.
    Subsequent to the passage of the CFMA in late 2000, derivatives 
markets, especially natural gas derivatives markets, evolved in just a 
few short years to an extent and at a rate that would have been very 
difficult to predict in 2000. For example, when the CFTC was in the 
midst of proposing and finalizing implementing regulations and 
interpretations for the CFMA in 2001, even shortly following the wake 
of the Enron meltdown in late 2001, the natural gas market continued to 
be largely focused upon open outcry trading executed on the regulated 
NYMEX trading venue. At that time, NYMEX offered electronic trading on 
an ``after-hours'' basis, which contributed to only approximately 7-10% 
of overall trading volume at the Exchange. Electronic trading (of 
standardized products based upon NYMEX's natural gas contracts) was at 
best a modest proportion of the overall market. Moreover, it was more 
than 6 months following the Enron meltdown before the industry began to 
offer clearing services for OTC natural gas transactions.
    However, in determining to compete with NYMEX, ICE, which as 
previously noted operates as an ECM, not only copied all of the 
relevant product terms of NYMEX's core or flagship natural gas futures 
contract, but also misappropriated the NYMEX settlement price for daily 
and final settlement of its own contracts. As things stand today, 
natural gas market participants have the assurance that they can 
receive the benefits of obtaining NYMEX's settlement price, which is 
now the established industry pricing benchmark, by engaging in trading 
either on the regulated NYMEX or on the unregulated ICE.
    For some period of time following the launch of ICE as a market, 
ICE was the only trading platform that offered active electronic 
trading during daytime trading hours. In September of 2006, NYMEX began 
providing ``side-by-side'' trading of its products--listing products 
for trading simultaneously on the trading floor and on the electronic 
screen. Since that time, there has been active daytime electronic 
trading of natural gas on both NYMEX and ICE. The share of electronic 
trading at NYMEX as a percentage of overall transaction volume has 
shifted dramatically to the extent that electronic trading now accounts 
for 80-85% of overall trading volume at the Exchange.
    The existence of daytime electronic trading on both NYMEX and ICE 
has fueled the growth of arbitrage trading between the two markets. 
Thus, for example, a number of market participants that specialize in 
arbitrage activity have established computer programs that 
automatically trade the spread between the two markets and that 
transmit orders to one market when there is an apparent price imbalance 
with the other market. As a result, there is now a relatively 
consistent and tight spread in the prices of the competing natural gas 
products. Hence, the two competing trading venues are now tightly 
linked and highly interactive and in essence are simply two components 
of a broader derivatives market. As the CFTC itself acknowledged in its 
recent proposed rule-making, there is now ``a close relationship among 
transactions conducted on reporting markets and non-reporting 
transactions.'' (72 Fed. Reg. 34,413, at 34,414 (2007) (proposed June 
22, 2007.)
    Because ICE price data are available only to its market 
participants, NYMEX does not have the means to establish conclusively 
the extent to which trading of ICE natural gas swaps contributes to, 
influences or affects the price of the related natural gas contracts on 
NYMEX. However, a recent CFTC staff study provided confirmation that 
price discovery is occurring on both the ICE and the NYMEX trading 
venues. It is also clear that, as a consequence of the extensive 
arbitrage activity between the two platforms and ICE's use of NYMEX's 
settlement price, as well as other factors, the two natural gas trading 
venues are now tightly linked and highly interactive. These two trading 
venues serve the same economic functions and are now functionally 
equivalent.
    NYMEX staff has been advised that, during most of the trading cycle 
of a listed futures contract month, there is a range of perhaps only 
five to twelve ticks separating the competing NYMEX and ICE products. 
(The NYMEX NG contract has a minimum price fluctuation or trading tick 
of $.001, or .01 cents per mmBtu.) NYMEX staff has also been advised by 
market participants who trade on both markets that a rise (fall) in 
price on one trading venue will be followed almost immediately by a 
rise (fall) in price on the other trading venue, whether the change in 
price be initiated on either NYMEX or ICE. These observations of real-
world market activity along with the recent CFTC staff study support 
the conclusion that trading of ICE natural gas swaps do in fact 
contribute to, influence and affect the price of the related natural 
gas contracts on NYMEX. No one could have predicted in 2000, when the 
exemption was crafted for energy swaps, how this market would evolve.
    The ICE market now holds a significant market share of natural gas 
trading, and a number of observers have suggested that most of the 
natural gas trading in the ICE Henry Hub swap is subsequently cleared 
by the London Clearing House, the clearing organization contracted by 
ICE to provide clearing services. Thus, there is now a concentration of 
market activity and positions occurring on the ICE market, as well as 
the exchange-like concentration and mutualization of financial risk at 
the clearing house level from that activity.
    As previously noted, at the time that the CFMA was being formulated 
in Congress, the presumption was that larger, sophisticated market 
participants did not need a regulatory agency to protect them from 
trading with each other. Also, there were no perceived concerns at that 
time about potential impact on the public interest implicated by 
trading on ECMs. Yet, what has become clear in the last several years 
is that the changing nature and role of ECM venues, such as ICE, do now 
trigger public interest concerns in several ways, including with 
respect to the multiple impacts on other trading venues that are 
regulated, as well as through the exchange-like aggregation of 
financial risk.
    The CFMA, however, did contemplate the possibility of ECMs becoming 
price discovery markets and, accordingly gave the CFTC authority to 
make the determination that an ECM performed a significant price 
discovery function and to require the dissemination of prices, trading 
volume and other trading data. This authority has never been exercised 
despite the tremendous growth in the volume of trading in the natural 
gas contract on ICE and the clear linkage between that market and the 
NYMEX. In recent public statements at both the staff and the Commission 
level, there have been indications from the CFTC that the price 
discovery criteria initially established by CFTC rules in 2004 may have 
become outdated. Consequently, CFTC staff is now reviewing those 
standards and considering whether to replace them with newer criteria 
that more appropriately capture the current marketplace reality.
    NYMEX does not have any ongoing formal relationship with ICE. In 
particular, as ICE and NYMEX are in competition with each other, there 
are currently no arrangements in place, such as information-sharing, to 
address market integrity issues. NYMEX as a DCM does have affirmative 
self-regulatory obligations; ICE as an ECM has no such duties. Yet, 
from a markets perspective, the ICE and NYMEX trading venues for 
natural gas are tightly linked and highly interactive; trading activity 
and price movement on one venue can quickly affect and influence price 
movement on the other venue.
    As one case example of concerns created for NYMEX as a DCM because 
of the differences in the level of regulation, NYMEX staff was aware of 
and monitored all open positions that Amaranth maintained in NYMEX 
trading venues, including the physically delivered NG natural gas 
futures contract. NYMEX conducted regular reviews of Amaranth's open 
positions in excess of position accountability levels prescribed by 
NYMEX rule. NYMEX staff members directed Amaranth in early August 2006 
to reduce its open positions in the first two nearby contract months 
based upon what they believed to be a significant concentration in 
NYMEX markets in Natural Gas (relying upon an NG ``futures only'' 
approach). NYMEX believes that such a directive was prudent and also 
was effective with respect to reducing positions carried on our 
platform.
    As noted, NYMEX maintains no information sharing agreement of any 
kind with ICE; the Exchange also observes that, during the period in 
question, the CFTC was not receiving any regular information from ICE 
as to positions on its platform. Thus, a shift of positions by Amaranth 
from NYMEX to ICE was undetectable at that time both by NYMEX and the 
CFTC. NYMEX believes that the outdated provisions of the CEA concerning 
ECMs do raise concerns not only for DCMS and for regulators but also 
for market participants and indeed for the general public as a whole.
    While the dissemination of market data from ICE would be useful, 
the CFTC's existing statutory authority does not go far enough in order 
to address the significant regulatory problems identified by the 
Amaranth case. Thus, a legislative change is required to give the CFTC 
a certain level of authority over these markets as needed to address 
the identified public interest concerns.
    It has become apparent to NYMEX that the broad structural issues 
raised by changes in the marketplace cannot be addressed effectively at 
the level of individual exchanges. For example, earlier this year, in 
an effort to cooperate with the Federal Energy Regulatory Commission 
(FERC) and following consultation with CFTC staff, NYMEX issued a 
compliance advisory in the form of a policy statement related to 
exemptions from position limits in NYMEX Natural Gas (NG) futures 
contracts. NYMEX adopted this new policy on an interim basis in a good 
faith effort to carry out its self-regulatory responsibilities and to 
address on an individual exchange level the market reality demonstrated 
by Amaranth's trading on both regulated and unregulated markets.
    However, this experience has had an adverse impact on NYMEX's 
trading venues and is seemingly creating the result of shifting trading 
volume (during the critically important NG closing range period at 
NYMEX on the final day of trading) from our regulated trading venue to 
unregulated trading venues. Specifically, the new interim policy 
implemented by NYMEX on a good-faith basis has: (1) reduced volume on 
NYMEX during the critical 30 minute closing range period; (2) 
presumably shifted volume from the regulated to the unregulated trading 
venues; and (3) failed to solve the structural imbalances brought to 
light by Amaranth's trading. In addition, this policy could create new 
problems by diminishing the vitality of the natural gas industry's 
pricing benchmark. Consequently, NYMEX now believes strongly that 
legislative change is both necessary and appropriate.
    NYMEX believes that a targeted approach that directly addresses the 
specific issues raised by these industry changes would be the most 
effective policy response and would provide the greatest assurance of 
limiting the unintended consequences of more sweeping or draconian 
changes. Thus, NYMEX believes that a heightened level of CFTC 
regulation and oversight should be mandated for certain products listed 
on a particular ECM triggering the public policy concerns noted above. 
NYMEX does not believe that the case has been made for extending such 
heightened regulation to other products listed on such an ECM, to other 
ECMs that have not triggered these policy interests and concerns, or to 
the traditional bilateral OTC market.
    In particular, for those products trading on ECMs that have 
triggered public policy interests and concerns, NYMEX believes that the 
CEA should be amended to require routine mandated large trader 
reporting and position accountability requirements for financially 
settled ECM contracts that are highly linked to and functionally 
equivalent with regulated DCM contracts. Such ECMs also must be 
assigned self-regulatory organization duties to police their own 
markets and to submit applicable rule changes to the CFTC in a manner 
similar to other regulated entities; the CFTC also should have clear 
authority to address any failures by the ECM to comply with such 
requirements. NYMEX believes strongly that such statutory changes are 
necessary and appropriate and would not negatively impact the core 
price discovery and hedging functions provided by derivatives markets.
    At present, the greatest attention has been focused upon energy 
products listed by ECMs. NYMEX does not believe it would be appropriate 
to exclude products by category from heightened regulation, as markets 
may evolve for other products, such as metals, biofuel or weather 
derivatives, in a manner similar to the evolution of energy markets.
    The targeted approach that NYMEX recommends should not unduly 
affect the ability of ECMs to be sources of innovation, including with 
respect to the adoption of new trading technologies. This targeted 
approach may result in an ECM needing to distinguish on its electronic 
trading system those products that are subject to CFTC oversight from 
those products that remain exempt from CFTC regulation. However, more 
generally, NYMEX's recommended approach would not appear to require 
whole-sale changes in an ECM's business model.
    It has been suggested that any manner of regulation of an ECM would 
lead immediately to the shift of trading elsewhere, either to the 
traditional bilateral OTC market or to less-regulated foreign boards of 
trade. NYMEX believes that this prospect is improbable for several 
reasons: (1) market participants will continue to be attracted to 
markets that offer pools of liquidity for trading in their products; 
(2) market participants appear to have a preference for the speed and 
efficiency of electronic trading as compared to the traditional phone 
bilateral market; and (3) electronic trading systems facilitate the 
clearing of traded products, which also seems to be the growing 
preference for OTC participants in a variety of products. Consequently, 
NYMEX believes that the hypothetical prospect of a worst-case scenario 
should not be misused to dissuade Congress or the CFTC from undertaking 
carefully considered and targeted solutions that can effectively fix 
the current shortcomings of the existing statutory structure.

    III. The CFTC has exclusive jurisdiction over futures transactions 
        and markets.

    Since the original passage of the CEA, the CFTC has had clear and 
unambiguous exclusive authority over futures transactions and markets. 
When the CEA was first enacted, Congress provided that the CFTC have 
``exclusive jurisdiction. . . . with respect to accounts, agreements 
and transactions involving contracts of sale of a commodity for future 
delivery.'' 7 U.S.C.  2(a)(1)(A) (emphasis added.) Moreover, the 
legislative history is quite clear as to Congress' legislative intent: 
``(a) the Commission's jurisdiction over futures markets or other 
exchanges is exclusive and includes the regulation of commodity 
accounts, commodity trading agreements, and commodity options; (b) the 
Commission's jurisdiction, where applicable, supersedes state as well 
as Federal agencies. . . .'' Sen. Rep. No. 93-1131, 93rd Cong., 2d 
Sess., (1974) U.S.C.A.N. p. 48. In particular, Congress expressly made 
clear that the CFTC's jurisdiction over futures transactions and 
markets was to ``avoid unnecessary, overlapping and duplicative 
regulation.'' 120 Cong. Rec. H34, 736 (Oct. 9, 1974).
    The Federal courts have consistently upheld and affirmed this 
exclusive jurisdiction. Thus, for example, the U.S. Seventh Circuit 
Court of Appeals observed that the purpose of the CEA was to place the 
futures markets ``under a uniform set of regulations.'' Am. Agric. 
Movement, Inc. v. Board of Trade of the City of Chicago, 977 F. 2d 
1147, 1155-57 (7th Cir. 1992).
    The Energy Policy Act of 2005 (EPAct) provided the FERC for the 
first time with enforcement powers in the form of anti-manipulation 
authority over transactions in connection with its jurisdictional 
entities. In addition, the EPAct directed that FERC establish a 
memorandum of understanding with the CFTC to work together 
cooperatively and to share information. It is interesting to note that, 
in that memorandum of understanding, the FERC specifically acknowledged 
that the CFTC: ``has exclusive jurisdiction with respect to accounts, 
agreements, and transactions involving contracts of sale of a commodity 
for future delivery. . . .'' (emphasis added.)
    More recently, FERC appears to have interpreted its new found 
authority expansively in a manner that encroaches upon the CFTC's 
exclusive authority over transactions executed on futures exchanges. 
FERC argues that its jurisdiction includes authority over futures 
contracts that serve as a price reference for cash transactions which 
are entered into by its jurisdictional entities. The effect of this 
broad construction (of the language in EPAct granting FERC anti-
manipulation authority over cash market transactions) is the 
elimination of the CFTC's exclusive jurisdiction over futures market 
transactions. Thus, the latest FERC position is clearly inconsistent 
with the plain meaning of the CEA's exclusivity provisions. It is also 
inconsistent with the general understanding of the terms of the 
memorandum of understanding that FERC negotiated and ultimately 
executed with the CFTC.
    NYMEX believes strongly that Congress was correct when it 
established the CEA's statutory framework to provide for uniform 
regulation of futures transactions and markets. The Exchange also 
believes that it is clear that the CFTC currently has and should 
continue to have exclusive authority and jurisdiction over futures 
transactions and markets. This is imperative to avoid duplicative and 
conflicting regulation. To vary from this prudent regulatory structure 
would only create confusion, inconsistency and uncertainty, ultimately 
harming the vitality and effectiveness of derivatives markets as well 
as the broader economy relying upon such markets for price discovery 
and hedging of risk.

Conclusion
    The CFMA is a landmark piece of Federal legislation that has 
provided critically needed legal certainty and regulatory streamlining 
and modernization to U.S. futures and derivatives markets. The CFMA 
provides a well-considered oversight framework for futures markets that 
has enhanced the abilities of NYMEX and the other regulated exchanges 
to operate in a rapidly changing business environment. The Exchange 
further believes that the tiered statutory structure for trading 
facilities has been effective in many respects. However, a series of 
profound changes have occurred in various OTC markets since the passage 
of the CFMA, including technological advances in trading, such that the 
regulated DCM, NYMEX, and the unregulated ECM, 
IntercontinentalExchange, have become highly linked trading venues. As 
a result of this phenomenon, which could not have been reasonably 
predicted only a few short years ago, the current statutory structure 
no longer works for certain markets now operating as ECMs.
    Specifically, the regulatory disparity between the NYMEX and 
certain ECMs, particularly the ICE, which are functionally equivalent, 
has created serious challenges for the CFTC and for NYMEX in its 
capacity as an SRO. NYMEX has also concluded that ECMs such as ICE, 
which function more like a traditional exchange and which are linked to 
an established exchange, should be subject to regulation of the CFTC 
for certain products in the form of large trader reporting, position 
limits/accountability levels and self-regulatory responsibilities. In 
addition, the continuing exchange-like aggregation and mutualization of 
risk at the clearinghouse level from trading on active ECMs such as 
ICE, where large positions are not monitored, raise concerns about 
spill-over or ripple implications for other clearing members and for 
various clearing organizations that share common clearing members. 
Consequently, legislative change is necessary to address the real 
public interest concerns created by the current structure of the OTC 
electronic trading market and the potential for systemic financial risk 
from a market crisis involving significant activity occurring on the 
unregulated trading venue.
    Finally, over thirty years ago, Congress unambiguously gave the 
CFTC exclusive statutory authority over the regulation of futures 
transactions. This exclusive authority has been reaffirmed by Congress 
in every subsequent reauthorization of the CEA and is also established 
case law in the Federal courts. NYMEX believes strongly that the CFTC 
currently has and should continue to have exclusive authority and 
jurisdiction over futures transactions and markets. To vary from this 
prudent structure would only create confusion, inconsistency and 
uncertainty, ultimately harming the vitality and effectiveness of 
derivatives markets as well as the broader economy relying upon such 
markets for price discovery and hedging of risk.
    I thank you for the opportunity to share the viewpoint of the New 
York Mercantile Exchange with you today. I will be happy to answer any 
questions that any Members of the Committee may have.

    Mr. Etheridge. Thank you, sir. Mr. Carlson.

    STATEMENT OF LAYNE G. CARLSON, CORPORATE SECRETARY AND 
             TREASURER, MINNEAPOLIS GRAIN EXCHANGE,
                        MINNEAPOLIS, MN

    Mr. Carlson. Good morning. My name is Layne Carlson and I 
am an officer of the Minneapolis Grain Exchange. It is a great 
pleasure to be here before the Subcommittee and speak on 
matters important to us. The Minneapolis Grain Exchange is both 
a Designated Contract Market for trading futures and a 
Derivatives Clearing Organization, which means we clear all 
trades executed on our market and assume all counterparty risk 
that the buyers and sellers will make payment for the contracts 
traded. As a Designated Contract Market and a Derivatives 
Clearing Organization, the MGEX is subject to CFTC oversight of 
our trading markets and our clearing operations.
    The Grain Exchange was first established in 1881 and is the 
only futures and options market for hard red spring wheat and 
five index contracts based on wheat, corn and soybeans. 
Clearly, our current focus on agricultural based contracts and 
being located in the Midwest these past 126 years, we are part 
of that bread basket of America. However, traders from around 
the world now trade our contracts and that trend is expected to 
continue. Trade volume and open interest records are becoming 
routine at the Grain Exchange. In short, the Grain Exchange 
provides a demonstrated and valuable service to the public for 
price discovery and risk control that goes beyond just 
agriculture, merchandising and food product sectors.
    While the Grain Exchange is not the size of the better 
known contract markets in Chicago and New York, we can be and 
are affected by global events, domestic and international 
policies, Federal laws and CFTC rules and regulations. Events 
and rules that may affect large markets nominally may be 
significant to the MGEX, our clearing members, our market 
participants and our membership. Consequently, what is put into 
or left out of the bill reauthorizing the CFTC can be positive 
or detrimental to us as a viable market.
    One item that is debated from time to time is folding the 
CFTC into the Securities and Exchange Commission. From the 
viewpoint of the Grain Exchange, we believe that would be 
detrimental. While the CFTC and the SEC share some common 
goals, such as protecting the marketplace from fraud, we also 
have unique and competing purposes. No more so was this in 
evidence than the recent events surround Sentinel Management 
Group. Sentinel was a specialized firm investing funds on 
behalf of other firms, many of whom were small clearing members 
at the Grain Exchange. When Sentinel froze the release of 
customer funds, it put a severe strain on them and had the 
potential to materially affect the operations of the Grain 
Exchange.
    The CFTC recognized the risk to the futures industry and 
worked with the exchanges and the clearinghouse on behalf of 
the FCMs to get some of those funds released so that certain 
FCMs could remain a going concern. The SEC, on the other hand, 
initially tried to prevent the release of the funds. The point 
being, a Federal regulator that is more closely attuned to the 
needs of those it is regulating is preferable to a regulator 
that is monitoring multiple industries.
    As mentioned earlier, the MGEX is not the size of our 
larger contract markets. As such, when laws and rules focus on 
addressing issues deemed important to them or the futures 
industry it can have a material and unintended spillover effect 
to the Grain Exchange. In other words, in this instance, a one-
size-fits-all approach regulatory law may not--may be easier to 
draft and implement, but it often creates unnecessary cost for 
the Grain Exchange, which is forced to address compliance 
issues not present in our size market. A perfect example was 
the perceived conflict of interest within large for-profit 
entities. At no time did those allegations of problems within 
the governance or regulatory structure extend to mutual or not-
for-profit entities, such as the Grain Exchange.
    Nonetheless, the Grain Exchange was required to meet new 
regulations mandating a minimum percentage of narrowly defined 
public directors be placed on our Board and even the 
establishment of a regulatory oversight committee. The 
regulatory oversight committee has a requirement of at least 
three public directors, which is puzzling to the Grain 
Exchange, since we only have three staff members in our 
regulatory department. Further, finding qualified individuals 
to serve in that capacity is not easy and it is going to likely 
require funding. In short the MGEX gets penalized for something 
perceived happening elsewhere in the industry.
    An annual budget topic that won't go away is the 
transaction fee for commodities trades that are executed. While 
a source of revenue for the government, it is essentially 
another layer of taxation on the futures industry. The industry 
in which we operate is extremely price competitive and 
worldwide the focus, again, is on reducing costs and fees to be 
competitive. The MGEX is no different. We have to look at our 
trading costs, as well. A Federal transaction fee can only 
hinder our ability to be competitive on cost. Further, the 
regulatory burden should not be placed just on market 
participants since all taxpayers benefit from that.
    The MGEX is very supportive and thankful for the regulatory 
changes Congress was able to initiate by passing the CFMA of 
2000. We view the Act as a welcome potential to reduce the 
regulatory burden experienced by traditional and domestic 
markets, compared to foreign. The MGEX believes there has been 
an improvement in the area and we would like to thank the CFTC, 
as well, for moving from a very prescriptive regulatory policy 
to a more flexible approach with the introduction of core 
principles. In short, we support the reauthorization of the 
CFTC.
    The MGEX again thanks the Subcommittee for this opportunity 
to express our views.
    [The prepared statement of Mr. Carlson follows:]

    Prepared Statement of Layne G. Carlson, Corporate Secretary and 
         Treasurer, Minneapolis Grain Exchange, Minneapolis, MN

    Good morning, my name is Layne G. Carlson and I am an officer of 
the Minneapolis Grain Exchange (MGEX). It is a great pleasure to be 
here before the Subcommittee on General Farm Commodities and Risk 
Management, and speak on matters important to us.
    The Minneapolis Grain Exchange is both a Designated Contract Market 
(DCM) for trading futures and a Derivatives Clearing Organization (DCO) 
which means we clear all trades executed on our market and assume the 
counterparty risk that the buyers and sellers will make payment for the 
contracts traded. As a DCM and DCO, the MGEX is subject to CFTC 
oversight of our trading markets and clearing operations.
    The Minneapolis Grain Exchange was first established in 1881, and 
is the only futures and options market for Hard Red Spring Wheat, and 
five Index contracts based on wheat, corn and soybeans. Clearly, our 
current focus is on agriculture based contracts. Being located in the 
Midwest these past 126 years, we are part of the bread basket of 
America. However, traders from around the world trade our contracts and 
that trend is expected to continue. Trade volume and open interest 
records are becoming routine at the MGEX. In short, the MGEX provides a 
demonstrated and valuable service to the public for price discovery and 
risk control that goes beyond just the agriculture, merchandising, and 
food product sectors.
    While the MGEX is not the size of the better known contract markets 
in Chicago and New York, we can be and are affected by global events, 
domestic and international policies, Federal laws, and CFTC rules and 
regulations. Events and rules that may affect large markets nominally 
may be significant to the MGEX, our clearing members, market 
participants and membership. Consequently, what is put into or left out 
of any bill reauthorizing the CFTC can be positive or detrimental to 
the MGEX' future as a viable market.
    One item that is debated from time to time, is folding the CFTC 
into the Securities and Exchange Commission (SEC). From the viewpoint 
of the MGEX, we believe that would be detrimental. While the CFTC and 
SEC share some common goals, such as protecting the marketplace from 
fraud, each also have unique and competing purposes. No more so was 
this in evidence than with the recent events surrounding Sentinel 
Management Group, Inc. (Sentinel). Sentinel was a specialized firm 
investing funds on behalf of other firms, many of whom were small 
clearing members investing customer funds. Some of these firms were 
clearing members and futures commission merchants (FCMs) at the MGEX. 
When Sentinel froze the release of customer funds, it put a severe 
strain on them and had the potential to materially affect the MGEX. The 
CFTC recognized the risks to the futures industry and worked with the 
exchanges and clearing houses on behalf of FCMs to get some of the 
funds released so that certain FCMs could remain a going concern. The 
SEC, on the other hand, initially tried to prevent the release of the 
funds. The point being, a Federal regulator that is more closely 
attuned to the needs of those it is regulating is preferable to a 
regulator that is monitoring multiple industries.
    As mentioned earlier, the MGEX is not the size of the larger 
contract markets. As such, when laws and rules focus on addressing 
issues deemed important to them or the futures industry, it can have a 
material and unintended spillover effect to the MGEX. In other words, a 
one-size-fits-all approach to regulatory laws and rules may be easier 
to draft and implement, but it often creates unnecessary costs for the 
MGEX which is forced to address compliance issues not present in our 
size market. A perfect example was the perceived conflicts of interest 
within the large for profit entities. At no time did the allegations of 
problems within the governance or regulatory structures extend to the 
mutual or not for profit entities such as the MGEX. Nonetheless, the 
MGEX was required to meet the new regulations mandating a minimum 
percentage of narrowly defined public directors be placed on our board 
and the establishment of a Regulatory Oversight Committee (ROC). The 
CFTC requirement that the MGEX create a ROC consisting of at least 
three public directors to monitor the MGEX regulatory department 
consisting of three staff employees is entirely puzzling. Further, 
finding qualified individuals to serve in that capacity is not easy and 
will likely require funding. In short, the MGEX gets penalized for 
something perceived happening elsewhere in the industry.
    An annual budget topic that won't go away is the transaction fee 
for each commodities trade executed. While a source of revenue for the 
government, it essentially is another layer of taxation to the futures 
industry. The industry in which we operate is extremely price 
competitive. Worldwide, the focus is on reducing costs and fees to 
remain competitive. The MGEX is no different; we have to look at our 
trading and clearing costs as well. A Federal transaction fee can only 
hinder the ability to be competitive on cost. Further, the regulatory 
burden should not be placed on just market participants since all 
taxpayers benefit from government oversight.
    The MGEX was supportive of and thankful for the regulatory changes 
Congress was able to initiate by passing the Commodity Futures 
Modernization Act of 2000. The MGEX viewed the Act as a welcome 
potential to reduce the regulatory burden experienced by traditional 
domestic contract markets compared to foreign markets. The MGEX 
believes there has been an improvement in that area. The MGEX expresses 
its thanks to the CFTC as well for moving from a very prescriptive 
regulatory policy to a more flexible approach with the introduction of 
core principles. However, the MGEX would like to see Congress' original 
intention for a flexible regulatory environment extended further to 
specifically account for small contract markets or not for profit 
entities. The MGEX looks forward to working with CFTC Acting Chairman 
Lukken and the other Commissioners in applying that flexibility.
    The Act also opened up the domestic market to non-traditional 
trading markets such as DTEFs and ECMs. These new markets were, for the 
most part, excluded or exempt from much of the regulatory burdens still 
imposed on the traditional contract markets such as the MGEX. While the 
new markets provide many beneficial trading products, the traditional 
small markets remain under a regulatory oversight that even with the 
changes noted earlier has not moved far enough from its pre-Act days to 
account for small contract markets. The MGEX is simply looking for that 
level playing field so that we can compete in areas such as new trade 
products.
    The MGEX again thanks the Subcommittee for this opportunity to 
express our views. That concludes my testimony.

    Mr. Etheridge. Thank you, sir. Mr. Sprecher.

           STATEMENT OF JEFFREY C. SPRECHER, FOUNDER,
       CHAIRMAN, AND CEO, IntercontinentalExchange, INC.,
                          ATLANTA, GA

    Mr. Sprecher. Mr. Chairman and Members, my name is Jeff 
Sprecher. I am the Chairman and Chief Executive Officer of 
IntercontinentalExchange, which is also known in the industry 
as ICE. We very much appreciate the opportunity to appear 
before you today to discuss our views on the reauthorization. 
ICE was established in the year 2000 as an over-the-counter 
energy market and since that time, ICE has grown significantly 
through both innovation and acquisition. It is now a 
diversified global marketplace in futures and over-the-counter 
derivatives across a variety of product classes, including 
agriculture and energy commodities, foreign exchange and equity 
indices.
    Headquartered in Atlanta, ICE now has offices in New York, 
Chicago, Houston, London, Singapore, Winnipeg and Calgary. ICE 
hosts three separate markets on our electronic platform. First, 
there is ICE's over-the-counter energy market, which operates 
under the CEA as an exempt commercial market. Second is a 
British subsidiary, ICE Futures Europe, which was formerly 
known at the International Petroleum Exchange of London, and 
that is regulated by the UKFSA. Third is an American 
subsidiary, ICE Futures U.S., which was formerly known as the 
New York Board of Trade, which is a Designated Contract Market 
under the CEA. ICE recently also acquired the Winnipeg 
Commodity Exchange, a regulated futures exchange in Canada, 
which will also be migrated to the ICE electronic platform 
shortly.
    ICE Futures U.S. offers both traditional open-outcry 
trading, as well as electronic trading in futures and options 
on soft commodities like coffee, sugar and cotton, and 
financial indices and currencies. ICE Futures U.S. is 
headquartered in New York City. Adding electronic trading to 
these markets, beginning just this past February, gave market 
users greater flexibility in trade execution with availability 
via the Internet or dedicated lines anywhere in the world. As a 
result, ICE Futures U.S. became more competitive in the global 
marketplace, as evidenced by a rapid increase in trading volume 
in excess of 35 percent. ICE also acquired a U.S. clearinghouse 
which is now called ICE Clear U.S. and it continues to be 
operated as a registered Derivatives Clearing Organization 
under the CEA.
    As the Subcommittee considers the reauthorization of the 
CEA, we urge you to maintain the principles-based regulatory 
structure and flexibility that is embodied in the landmark 
Commodity Futures Modernization Act of 2000. In particular, the 
tiered system of regulation provides regulatory certainty and 
has placed the United States in a better position to attract 
business and maintain its competitive position in a global 
marketplace. ICE and it market participants, including energy 
producers, distributors and users have benefited significantly 
from regulatory flexibility that is embodied in the CFMA 
through the ECM structure established under Section 2(h)(3) of 
the Act.
    At the time of ICE's formation, commercial hedgers had only 
two options if they wished to hedge energy price risk. They 
could seek to hedge their risks through one of a limited number 
of futures contracts that were traded on a regulated exchange, 
such as NYMEX, which offered liquidity, however, the terms of 
which were often an imperfect match for the hedging needs of 
commercial users. Or they could work with an investment bank or 
so-called voice broker, to negotiate a bilateral swap contract 
to address their specific hedging needs in a more tailored 
fashion. The bilateral swap markets were less than transparent 
and the commercial hedger often had little sense of where the 
true market was and whether it was being charged a fair price 
by the dealer or the voice broker.
    I formed ICE to bridge the gap between the existing futures 
market and voice brokered swaps market. Fundamentally, ICE's 
over-the-counter functionality serves as an electronic voice 
broker, offering its services to institutional and commercial 
entities that participate in the over-the-counter markets, but 
allowing them to trade in a more transparent and much more 
cost-effective manner. ICE offers some bilateral swaps that are 
financially settled based on a futures contract price. We also 
offer a large number of customized swaps that are tailored to 
delivery locations of users around the country, and thus, are 
better able to meet the specific hedging needs of the end-user.
    Importantly, we offer all of these contracts through a 
transparent electronic marketplace that does not discriminate 
between market users, including the small utility, who gets the 
same treatment as a large investment bank. Furthermore, viewers 
and users can see the entire bid/offer stack, giving them 
access to the depth of market and the liquidity in the market. 
These tangible benefits from ICE's commercial markets include 
more efficient hedging of price risk, greater transparency in 
all parts of the market, not just the benchmark futures hubs, 
and vastly improved liquidity through the introduction of more 
market participants.
    These benefits were brought about by ICE's innovative 
business model, its product offerings and other changes to 
markets that were stimulated by our competitive challenge. As 
markets have grown and developed since the passage of the CFMA, 
so have new regulatory challenges. ICE advocates a targeted 
approach to any reform of the CEA, recognizing unique 
characteristics of many customized markets that have evolved 
and the importance of continuing to encourage market 
innovation.
    In this regard, some level of additional reporting and a 
system of position accountability may be appropriate for 
certain ECM contracts, specifically, those that settle on 
futures market contract prices and that are the true equivalent 
of regulated futures. However, most of the energy swap 
contracts traded on ICE are niche products that are over-the-
counter markets, that are illiquid and they are not amenable to 
the application of such requirements. ICE therefore urges the 
Subcommittee to stay within the current regulatory framework 
and allow the CFTC to make adjustments that may be appropriate 
for particular products.
    Mr. Chairman, my complete statement has been submitted for 
the record and I look forward to answering your questions.
    [The prepared statement of Mr. Sprecher follows:]

Prepared Statement of Jeffrey C. Sprecher, Founder, Chairman, and CEO, 
              IntercontinentalExchange, Inc., Atlanta, GA

    Mr. Chairman, I am Jeff Sprecher, Chairman and Chief Executive 
Officer of IntercontinentalExchange, Inc., or ``ICE.'' We very much 
appreciate the opportunity to appear before you today to discuss our 
views on the reauthorization of the Commodity Exchange Act (the ``Act'' 
or ``CEA'').
    ICE was established in 2000 as an over-the-counter (OTC) market. 
Since that time, ICE has grown significantly, both through its own 
market growth fostered by ICE's product, technology and trading 
innovations, as well as by acquisition of other markets to broaden its 
product offerings.
    Today, ICE operates a leading global marketplace in futures and OTC 
derivatives across a variety of product classes, including agricultural 
and energy commodities, foreign exchange and equity indexes. Commercial 
hedgers use our products to manage risk and investors provide necessary 
liquidity to the markets. Headquartered in Atlanta, ICE has offices in 
New York, Chicago, Houston, London, Singapore, and Calgary.
    ICE hosts three separate markets on our electronic trading 
platform--ICE's OTC energy market, which operates under the CEA as an 
``exempt commercial market,'' or ECM, and two subsidiaries: ICE Futures 
Europe, formerly known as the ``International Petroleum Exchange,'' 
which is regulated by the UK Futures and Securities Authority and ICE 
Futures U.S., formerly known as ``The Board of Trade of the City of New 
York (NYBOT),'' which is a regulated Designated Contract Market (DCM) 
under the CEA.
    ICE Futures U.S. offers traditional open-outcry trading in futures 
and options on soft commodities (coffee, sugar, cocoa, cotton, and 
orange juice), financial indexes and currencies through trading floors 
located in New York City and in Dublin, Ireland. In February 2007, ICE 
Futures U.S. started trading its core agricultural futures on the ICE 
electronic platform, side-by-side with open outcry and we are in the 
process of introducing electronic trading of futures and options in our 
equity index and foreign currency products. Adding the electronic 
platform gave market users greater flexibility in trade execution, with 
availability via Internet or dedicated lines anywhere in the world. As 
a result, ICE Futures U.S. became more competitive in the global 
marketplace, as evidenced by a 36% increase in volume in soft commodity 
futures during the first 6 months following initiation of electronic 
trading, compared to the same 6 month period in 2006.
    ICE also acquired NYBOT's clearinghouse, which is now called ``ICE 
Clear U.S.'' and continues to be operated as a registered Derivatives 
Clearing Organization (DCO) under the CEA. Currently, it only clears 
trades transacted on ICE Futures U.S.. ICE's other contracts are 
cleared through LCH.Clearnet Ltd. in the United Kingdom, but plans are 
underway to transition ICE's other contracts to our own, newly-formed 
UK clearinghouse.
    As the Subcommittee considers reauthorization of the CEA, we urge 
you to maintain the principles-based regulatory structure and 
flexibility embodied in the landmark Commodity Futures Modernization 
Act of 2000 (CFMA). In particular, the tiered system of regulation 
provides regulatory certainty and has placed the United States in a 
better position to attract business and maintain competitiveness in the 
global marketplace. U.S. futures and derivatives markets flourished, 
while new technologies and products tailored to meet the changing needs 
of commercial customers and investors were given the opportunity to 
develop.
    ICE and its market participants, including energy producers, 
distributors and users, benefited significantly from the regulatory 
flexibility embodied in the CFMA through the ECM structure established 
under section 2(h)(3) of the Act. It allowed the development of a 
transparent electronic trading system for commercial and professional 
market users, allowing them to hedge risk in a more efficient and 
effective manner.
    As these markets have grown and developed since passage of the 
CFMA, new regulatory challenges have emerged. ICE advocates a targeted 
approach to any reform of the CEA. Such an approach recognizes the 
unique characteristics of the many customized markets that have evolved 
and the importance of continuing to encourage market innovation.
    In this regard, some level of additional reporting and a system of 
position accountability may be appropriate for certain ECM contracts--
specifically, those that settle on a futures market contract price and 
that are the true economic equivalent of a contract actively traded on 
a regulated futures market. However, most of the energy swap contracts 
traded on ICE are niche OTC products that are not amenable to the 
application of such requirements. ICE therefore urges the Subcommittee 
to stay within the current regulatory framework and to allow the CFTC 
to make adjustments that may be appropriate for a few particular 
products.

Background and History
    At the time of CFMA's passage and ICE's formation, commercial 
hedgers had two primary options if they wished to hedge energy price 
risk--they could seek to hedge their risk through one of the limited 
number of futures contracts traded on an exchange, such as NYMEX, or 
they could work with an investment bank or so-called ``voice broker'' 
to negotiate a bilateral swap contract to address their hedging needs 
in a more tailored fashion. Each of these markets had its benefits and 
drawbacks.
    Futures exchanges such as NYMEX offered a limited number of highly 
liquid benchmark contracts. While these pricing benchmarks offered deep 
liquidity (and hence a better view of true market price at a given 
location), they usually did not address the precise hedging needs of 
the commercial user due to the limited number of contracts traded and 
the limited number of delivery points of those contracts. For example, 
a NYMEX Henry Hub natural gas futures contract is tied to the price of 
natural gas delivered at the Henry Hub in Tailgate, Louisiana. While 
relevant, the price of natural gas at the Henry Hub does not define the 
price of natural gas at all locations around the country for a large 
number of reasons, ranging from the influence of transportation and 
storage costs to local supply and demand dynamics. For this reason, 
futures contracts did not provide a complete hedge of the commercial 
user's ultimate price risk. In addition, a physically delivered futures 
contract had the added problem that if held to expiration (the time 
through which a commercial user might need to hedge price risk), the 
holder of the contract could be forced to make or take delivery of the 
underlying commodity.
    Furthermore, NYMEX was, until the introduction of meaningful 
competition by ICE, overwhelmingly an open outcry trading market. The 
hedger or customer wishing to execute business would call its broker 
and typically be quoted a wide ``bid/ask spread''. Customers often did 
not even get executed in the quoted range due to the time delay 
inherent in the process and the absence of firm, executable prices 
resulted in customers paying more to hedge their price risk--making 
their businesses more expensive to operate, with costs ultimately 
either being born by the business itself (resulting in lower operating 
margins) or by its customers (higher prices being charged to 
customers). Finally, open outcry gave floor traders who were trading 
for their own account an important time and information advantage in 
the market.
    Alternatively, if the hedger sought to hedge its price risk through 
use of a bilateral swap contract executed with a dealer (such as an 
investment bank) or through the services of a voice broker, the hedger 
faced a number of different trade-offs. On the one hand, the hedger 
could better tailor the product to its specific hedging needs, for 
example, by entering into a swap contract that was tied to a delivery 
point closer to where the commodity would be used. On the other hand, 
bilateral swap markets tended to be opaque and the commercial hedger 
often had little sense of where the true market was and whether it was 
being charged a fair premium by the dealer or voice broker for shifting 
the risk in question. Finally, there was no guarantee of fairness in 
pricing--different fees and better terms could be charged to different 
customers--meaning the small commercial player with limited hedging 
needs might not be offered the same opportunity as another market 
participant that transacted a significant volume of business with the 
investment bank or voice broker. As a result, spreads might be even 
wider than in the futures market.
    I formed ICE to bridge the gap between the existing futures market 
and the voice brokered swaps market. In addition to offering bilateral 
swaps tied to individual futures contracts (swaps that were financially 
settled and could be held to contract expiry), ICE also offered a large 
number of tailored swap contracts that, like those being offered in the 
broader OTC swaps market, were better tailored to the delivery 
locations of users around the country and thus better tailored to the 
specific hedging needs of the end user. Importantly, ICE offered all of 
these contracts through a transparent electronic marketplace offering 
firm, executable prices and employing a strict best bid/best offer 
trading protocol that did not discriminate between market users (the 
smallest utility would get the same treatment as the largest investment 
bank). Furthermore, ICE offered users a view into the ``bid/offer'' 
stack so that market participants could for the first time assess the 
depth of liquidity in a market.
    In summary, ICE provided market participants a compelling 
alternative to the hedging opportunities then being offered by the 
futures market or by the voice-brokered swaps market. Fundamentally, 
however, ICE served as an ``electronic voice broker,'' offering its 
services to the same institutional and commercial entities 
participating in the OTC market, but allowing them to trade in a more 
efficient and cost effective manner.
    Responding to the needs presented by the downturn in the merchant 
energy markets in 2002, ICE continued to innovate through its 
subsequent introduction of ``cleared'' OTC swap contracts. Following 
its acquisition of ICE Futures Europe (formerly the International 
Petroleum Exchange), ICE for the first time had the infrastructure to 
offer the option of credit intermediation in a swap contract to better 
provide liquidity to the marketplace. The elimination of bilateral 
counterparty credit risk was an important innovation facilitated by the 
CFMA, which allowing contracts to be cleared through third party 
clearing arrangements such as the one ICE entered by ICE with a third 
party clearing house.

Benefits to the Marketplace
    Ultimately, the tangible benefits to the marketplace included more 
efficient hedging of energy price risk (tighter markets), greater price 
transparency in all parts of the marketplace (not just at benchmark 
hubs tied to futures contracts), and vastly improved liquidity through 
the introduction of more participants (and thus greater price 
competition) in the markets. These benefits have not been limited to 
those brought about directly by ICE's business and its product 
offerings, but include those resulting from changes to the business 
models and product offerings of other market participants that 
responded to the competitive challenge presented by ICE's business. It 
is ultimately for others to determine cause and effect, but one cannot 
ignore the question of whether and how quickly other parts of the 
market, in some cases dominated by member interests, would have adopted 
electronic trading and pursued product innovation in the absence of the 
competition presented by ICE's markets.

One Size of Regulation Does Not Fit All Markets or Contracts
    As these markets have grown and developed, new regulatory 
challenges have emerged, requiring a thorough and careful review by 
Congress and the CFTC during the CEA reauthorization process. As we 
have stated previously before this Subcommittee, ICE advocates a 
targeted approach to any reform of the CEA. This approach recognizes 
the unique characteristics of the many customized markets that have 
evolved under the CFMA. Unfortunately, some in Congress are suggesting 
a uniform approach to regulating these markets. This would be a great 
mistake.
    The problem with ``one-size-fits-all'' regulation can best be 
illustrated by contrasting the historic nature of futures markets 
(limited number of actively traded benchmark contracts, all 
transactions executed through a broker who can trade for its own 
account or that of a retail customer) with the ECM OTC swaps markets 
(large number of niche products, many illiquid and thinly traded, 
principals only trading). Recognizing the importance of futures pricing 
benchmarks to the general public (a DCM is obligated to publish its 
prices to be used by the broader market), and in recognition of the 
potential for conflicts of interest due to members trading for their 
own accounts alongside business transacted on behalf of customers, some 
of whom were retail customers, DCM core principles were developed to 
facilitate regulation of the markets by the DCM, which acted as a self 
regulatory organization. The typical high level of liquidity in 
benchmark contracts make application of core principles such as market 
monitoring and position accountability and limits feasible and 
appropriate.
    Suggesting that these same DCM core principles, which were 
developed with the futures exchange model in mind, should apply to all 
OTC swap contracts traded on an ECM market is attempting to fit the 
proverbial square peg in a round hole. While some level of additional 
reporting and a system of position accountability may be appropriate 
for certain contracts--specifically, those that settle on a futures 
market contract price and that are the true economic equivalent of a 
contract actively traded on a regulated futures market--most of the 
energy swap contracts traded on ICE are niche OTC products that trade 
in illiquid markets that are not amenable to the application of DCM 
core principles. For example, how would an ECM actively monitor an 
illiquid swaps market in an attempt to ``prevent manipulation'' where 
price changes can be abrupt due to the limited liquidity in the market? 
How would an ECM swaps market administer accountability limits in a 
market that has only a handful of market participants? Should the ECM 
question when a single market participant holds 50% of the liquidity in 
an illiquid market when the market participant is one of the few 
providers of liquidity in the market?
    It is important to analyze these questions not in isolation, but in 
the context of market participants having alternatives such as OTC 
voice brokers through which they can conduct their business. 
Importantly, such OTC voice brokers can even offer their customers the 
benefits of clearing through use of block clearing facilities offered 
by NYMEX (and also by ICE). Faced with constant inquiries or regular 
reporting by the ECM related to legitimate market activity, and facing 
no such monitoring when it transacts through a voice broker, market 
participants might choose to conduct their business elsewhere. It is 
for these and other reasons that Congress and the Commission have 
developed the carefully calibrated two-tier regulatory structure 
applicable to DCMs and ECMs. We believe that the judgments made by 
Congress and the Commission thus far have been prudent and should 
generally be maintained.

Conclusion
    ICE has always been and continues to be a strong proponent of open 
and competitive markets in energy commodities and other derivatives, 
and of appropriate regulatory oversight of those markets. As an 
operator of global futures and OTC markets, and as a publicly-held 
company, ICE understands the importance of ensuring the utmost 
confidence in its markets. To that end, we have continuously worked 
with the CFTC and other regulatory agencies in the U.S. and abroad in 
order to ensure that they have access to all relevant information 
available to ICE regarding trading activity on our markets. We have 
also worked closely with Congress to address the regulatory challenges 
presented by emerging markets and will continue to work cooperatively 
for solutions that promote the best marketplace possible.
    However, in prescribing regulation, it is important to consider the 
fundamental nature of the market in question and avoid engaging in a 
superficial, ``one-size-fits-all'' analysis that would unduly burden 
the efficient operation of markets and potentially stifle innovation. 
In short, the level of regulation should fit the market in question 
both in terms of the users who can access the market as well as the 
amenability of the market to active monitoring and the prevention of 
manipulative activity.
    The goal of regulation fitting the characteristics of the market in 
question has been ably achieved under the principles-based regulation 
embodied in the CFMA, and calls to apply DCM core principles to 
illiquid markets, to replace the ECM category of marketplace with a 
more regimented level of oversight, or to eliminate the ECM category 
entirely, are misguided and counterproductive. The CFMA has allowed for 
greater competition and heightened transparency and provided the CFTC 
with a deeper view of the OTC markets than they would have otherwise 
had.
    Mr. Chairman, thank you for the opportunity to share our views with 
you on reauthorization of the CEA. We look forward to continuing to 
work with the Subcommittee and your staff as you address this critical 
reauthorization. I would be happy to answer any questions you may have.

    Mr. Etheridge. Thank you, sir. Dr. Walsh.

STATEMENT OF MICHAEL J. WALSH, Ph.D., EXECUTIVE VICE PRESIDENT, 
             CHICAGO CLIMATE EXCHANGE, CHICAGO, IL

    Dr. Walsh. Good morning, Mr. Chairman and Committee 
Members. Thank you for the chance to be here. I am a last 
minute substitute for Dr. Richard Sander, who, under doctor's 
orders was told to stay in bed for a day or two and I 
appreciate the opportunity to brief you. The Chicago Climate 
Exchange is a real life example how the vision that under-lied 
the establishment of the Exempt Commercial Market structure has 
led to significant economic and social benefits for American 
businesses and farmers and foresters, because we were able to 
build an exchange rapidly and in an environment that fostered 
innovation and led to these benefits.
    The Chicago Climate Exchange operates a voluntary but 
legally binding greenhouse gas emission reduction and trading 
program. As you know, there is no such regulatory requirement 
for management of greenhouse gases in North America at this 
time, but many American businesses and businesses throughout 
the Western Hemisphere wanted to prepare and build their 
abilities to operate under market-based carbon constraints they 
are facing internationally. And more importantly, the Chicago 
Climate Exchange wanted to demonstrate firmly how U.S. farmers 
and foresters can be a core part of the solution set in market-
based mechanisms to reduce greenhouse gas emissions and global 
warming.
    The Commodity Futures Modernization Act and its Exempt 
Commercial Market structure were critical in facilitating the 
implementation of Chicago Climate Exchange. It fostered 
innovation, speed to market and allowed us to be competitive on 
a global basis, as I will briefly explain in a moment. Chicago 
Climate Exchange also made the very important decision to 
develop a self-regulatory structure. We did this by 
establishing a detailed rule book for the cap-and-trade 
mechanism that governed the environmental aspects of the 
program, providing a transparent market, and by contracting 
with the NASD, now known as the Financial Industry Regulatory 
Authority, or FINRA, to provide regulatory services.
    Now, this is a market mechanism for environmental 
improvement that is modeled on the law that the U.S. Congress 
passed in 1990, establishing a sulfur dioxide reduction cap and 
trade program. The members of the Exchange execute a legally 
binding contract to annually reduce their greenhouse gas 
emissions, have them independently audited--and every member of 
the Exchange has its emissions independently audited. All of 
the mitigation projects, such as agricultural soils, methane 
capture, reforestation, such as Senator Lucas' farm, are 
subject to independent verification by qualified experts.
    So in achieving the annual emission reduction goals, there 
are options, there is flexibility. The members can either 
internally reduce their emissions or they can partner with 
other members of the Exchange, such as those industrial or 
governmental enterprises that beat the emission reduction goal 
and they can make a trade so they can combine to achieve the 
goals, or they can partner with the U.S. farmers and foresters 
who do qualified and verified mitigation practices on farms, 
livestock operations and forests. It has become a significant 
enterprise and there is lots of learning going on, lots of 
business opportunity being developed.
    The members of the Exchange, almost 350 members now, 
include agricultural businesses such Cargill and Smithfield 
Foods, Ford Motor Company, Temple Inland, Waste Management, 
Dupont, Bayer, universities, Bank of America. We have got a 
couple of states, several cities, even the United States House 
of Representatives has decided that it wants to, in part, 
address its greenhouse gas mitigation through participation in 
the Exchange. We are very happy to see engagement and 
participation around the world. It is critical to engage our 
partners in building these solutions wherever we can, including 
China and India.
    Now, it turns out that the members of the Exchange have 
found amazing internal efficiencies, business opportunities in 
developing new renewable energy and energy management systems, 
and they have a price of carbon to work towards and to manage 
towards. Many of the members joined the Exchange for lots of 
reasons, to better manage their emissions and energy 
consumption, but we would not have been able to establish this 
mechanism, this organized rules-based self-regulatory structure 
without the ECM structure, without the rule that facilitates 
and fosters innovation.
    Let me spend a short moment--I would love to spend a lot 
more time on this, my favorite topic, of how farmers and 
foresters are finding new income opportunities around the 
country in providing a global environmental service. The Iowa 
Farm Bureau, the North Dakota Farmers Union, farmers and 
foresters throughout the country are doing greenhouse gas 
mitigation services and being paid for it, right now. We would 
not be here if we were not able to expeditiously build the 
start-up mechanism and get it going. I should note that the 
Chicago Climate Exchange has been able to implement, in the 
field, some of these agricultural and forestry practices and 
verify those under a grant from the USDA, full disclosure.
    So we are demonstrating, on a daily basis, a globally 
significant piece of progress for environmental improvement and 
a cost-efficient rules-based structure. Had we faced a 
significantly higher cost structure due to institutional 
regulatory requirements, we would not have been able to get off 
the ground. It is as simple as that. We do think that having a 
self-regulatory service, having transparent rules-based 
markets, is absolutely critical to making sure that the 
environmental commodity is being exchanged in an area of 
integrity, but we are seeing, right now, that U.S. businesses, 
governments, educational institutions, farmers and foresters 
are enjoying benefits from the ability to quickly implement an 
innovative new structure.
    We would not have been able to realize the significant 
progress, demonstrating how to do this on the ground, 
demonstrating the full role that farmers and foresters should 
be able to participate in a market-based solution had we not 
been able to operate quickly and under the low-cost structure 
that the Exempt Commercial Market structure provided. We think 
it is an important opportunity to foster innovation. We have 
exported some of our skills sets internationally and now 
globally and we think this is a very critical innovation 
fostering element of the CFMA and we look forward to the open 
discussion. Thank you, Mr. Chairman.
    [The prepared statement of Dr. Walsh follows:]

     Prepared Statement of Michael J. Walsh, Ph.D., Executive Vice 
            President, Chicago Climate Exchange, Chicago, IL

    Chairman Etheridge, Congressman Moran and Members of the 
Subcommittee. I want to thank you for your invitation to be with you 
today. In the context of the discussions regarding Section 2(h)3 of the 
Commodity Exchange Act, I would like to share with the Subcommittee the 
experience of developing, launching and implementing the Chicago 
Climate Exchange (``CCX''), which is a cap-and-trade system that has 
been trading emissions allowances derived from real emissions 
reductions and offset projects in the United States since 2003, and the 
context in which it was created.
    As you know, the United States does not require emissions 
reductions of greenhouse gases and therefore most elements of the U.S. 
economy have not been able to access what has become known as the 
``carbon market.'' However, the successful innovation, design and 
operation of CCX has enabled key members of the U.S. economy, including 
the agriculture sector, to realize the significant economic, financial, 
social and operational benefits associated with the reduction of 
greenhouse gas emissions and emissions trading, which was pioneered in 
the United States as part of the Clean Air Act.
    The Commodity Futures Modernization Act (``CFMA'') and the 
implementation of the Exempt Commercial Market (``ECM'') status were 
critical to facilitating the creation of the Chicago Climate Exchange. 
The intentions of the CFMA in terms of enabling legislation to foster 
innovation, ``speed to market'' and to enhance the competitiveness of 
U.S. commodities markets were fundamental in the development of CCX. At 
the same time, CCX's decision to develop a self-regulatory structure 
was fundamental in ensuring the credibility and integrity of this 
nascent market. CCX did this by developing a rulebook for its cap-and-
trade system, providing a transparent market and by contracting with 
the NASD, now FINRA, to provide regulatory services to CCX.
    CCX is a financial institution that exists to advance economic, 
environmental and social goals. We are the world's first, and North 
America's only, voluntary but legally binding rules-based greenhouse 
gas emission reduction and trading program, as well as the only global 
emissions trading system handling all six greenhouse gases with a 
multi-sector emissions reduction requirement. Designed in 1999 and 2000 
as a pilot project based in the Midwest, CCX began trading in 2003, and 
its membership has grown to almost 350 diverse entities including some 
of the most significant names in the American economy.
    Emissions of CCX Members represent 14% of stationary emission 
sources in the United States. CCX members execute legally binding 
commitments to meet annual emission reduction goals of 4% below 
baseline for 2006 and 6% below by 2010, at a minimum. Members who 
exceed their reduction commitments may sell allowances; those who do 
not make the required cuts must buy allowances to come into compliance. 
CCX Rules require that all emission baselines, annual reduction 
commitments and offset projects are subject to a standardized third 
party verification by FINRA. As an ECM, screen trading is principal-to-
principal trading. FINRA conducts market surveillance to monitor 
trading activity on the CCX trading platform for market manipulation 
and fraud.
    CCX Membership includes representatives from a diverse array of 
economic sectors, both domestically and abroad, including nearly every 
state represented on this Committee. Among these sectors, CCX 
membership includes agricultural entities (Cargill and Smithfield 
Foods), automotive (Ford Motor Co.), utilities (American Electric Power 
and American Municipal Power), chemicals (DuPont, Bayer and Dow 
Corning), forestry (International Paper and MeadWestvaco), academic 
institutions (Michigan State, Iowa, Minnesota and Oklahoma) and 
financial institutions (Bank of America), and public sector entities 
such as the States of New Mexico and Illinois, seven municipalities and 
three counties (King County, County of Sacramento and Miami-Dade 
County). Approximately 25 million people live and work in the cities, 
counties and states which are members of CCX and another 2 million are 
employed by its corporate members. In addition, I am proud to note that 
the U.S. House of Representatives itself is in the process of becoming 
an Exchange Participant on the Chicago Climate Exchange as part of its 
efforts to address the greenhouse gases derived from operating this 
building and its offices.
    CCX international membership includes a city and a utility in 
Australia (Melbourne and AGL), and eight companies in South America 
which have taken on a legally-binding commitment to reduce their 
emissions even though they are not yet required to do so. We have also 
engaged the interest of both Chinese and Indian policy leaders on the 
issue of market-based initiatives to address environmental concerns. We 
have approved and registered offset projects from both China and India, 
as well as Costa Rica and Brazil.
    Members report that the baselines, audits and annual commitments 
represent concrete goals that help them focus on internal efficiencies 
and attendant financial opportunities. They reduced their emissions 
through increased energy efficiency, expanded use of renewable fuels, 
and realized low-cost reductions in non-CO2 greenhouse gases 
through use of direct abatement equipment. Many members have exceeded 
their reduction targets. As an important aside, another benefit of the 
price discovery mechanism provided by an organized market is the 
ability to spur innovations. Now that the price of carbon is more 
transparent, entrepreneurs in areas related to clean energy have been 
able to raise capital from both fixed income and equity investors after 
factoring in CCX prices in their business plans.
    Members join CCX for various reasons, but all for at least these 
reasons: to better master their emissions data and to gain early 
adopter benefits with price discovery for carbon and all aspects of 
risk mitigation, including financial, operational, and reputational. To 
date, CCX Members as a group have reduced their emissions by almost 11% 
beyond their annual commitments, representing 90 million tons of 
reduction of CO2 in the first three compliance years. These 
activities have placed CCX members in the United States at the 
forefront of a major economic opportunity. Had CCX not been able to 
form as an ECM, these benefits would have been lost, along with the 
vital time needed to build our infrastructure in order to address these 
important environmental and economic challenges.
    In addition, the CCX Offsets Program is proving successful at 
rewarding emissions mitigation through sustainable farming and 
forestry, while also providing a new income source for U.S. 
agriculture. Entities such as the Iowa Farm Bureau and the National 
Farmers Union are leading the way in building the infrastructure for 
the agricultural offsets program. To date, projects representing more 
than 2 million acres of conservation tillage and grassland in multiple 
U.S. States have been registered, verified and sold through the 
Exchange. In 2005 and 2006, over 1.2 million acres in the U.S. have 
been enrolled, with producers earning over $3 million from the sale of 
CCX Carbon Financial Instrument contracts. The same growth was 
experienced in the tonnage enrolled under the agricultural methane 
program, which went from 24,100 tons to 207,200 tons during the same 
period. These offsets provide a least-cost avenue for society to reduce 
greenhouse gas emissions in addition to enhancing farm profitability 
and income diversification.
    American agricultural producers are taking a leadership role in 
promoting long term sustainability of U.S. agricultural soils through 
the CCX. The CCX Offsets Committee has recently approved protocols for 
rangeland management soil carbon offsets projects, which will soon be 
registered in the Exchange. A Member of this Congress, Senator Richard 
Lugar, has registered reforestation credits from trees planted at his 
Indiana family farm, which is helping set the example for many other 
farmers. CCX is also pleased to inform the Committee that it is 
received a grant supported by the U.S. Department of Agriculture to 
further the goals and objectives of the CCX agricultural offset 
program. Expansion of this program can help minimize the need for 
additional subsidies, lower the tax burden required to finance them 
while encouraging behavioral change and innovative practices. It is 
also important to note that the potential for offsets coming from coal 
mine/coal bed methane is substantial, and protocols have been approved 
and projects will soon be registered.
    CCX has also created a futures exchange for trading futures 
contracts based on U.S. SO2 and NOX emission 
allowances--the Chicago Climate Futures Exchange--which is a designated 
contract market regulated by the Commodity Futures Trading Commission; 
and the European Climate Exchange, the leading marketplace for carbon 
emissions in Europe, regulated by the United Kingdom's Financial 
Services Authority. In a note of irony, we have American ingenuity and 
financial know-how being exported to Europe. Jobs are being created and 
an entire new field of specialization is being developed in both the 
U.S. and around the world. These financial institutions advance social 
objectives and economically efficient environmental protection by 
providing rules-based markets with low transaction costs and 
transparent prices.
    The effectiveness of a cap-and-trade system with the above design 
features is now being demonstrated every day by CCX members across the 
globe. The environmental and economic benefits being generated are of 
national and global significance. The innovative approach taken by CCX 
benefited greatly from its ability to establish and function as an 
Exempt Commercial Market. The costs of establishing an exchange such as 
ours from an institutional and regulatory standpoint would have been 
prohibitive had we not had this opportunity. At the same time, the 
importance of the regulatory services provided by FINRA in the case of 
CCX is critical. In a cap-and-trade system the ability to ascertain the 
quality of the commodity being traded is fundamental for market 
participants and the integrity of the program.
    As you can see from our experience, CCX's objective is to provide a 
social benefit through the reduction of greenhouse gases in the 
atmosphere. For that to have happened, proper measurement, monitoring 
and verification were necessary and, in our case, has enabled thousands 
of U.S. farmers and foresters to provide an environmental service in a 
credible and transparent way. We are happy to announce that the world's 
largest market in terms of emissions under management now operates out 
of Chicago, and its birth and ability to stay competitive have 
benefited tremendously from the provisions of the CFMA and the Exempt 
Commercial Market category.
    We hope that our experience in CCX can help inform this important 
discussion. Thank you again for your interest.

    Mr. Etheridge. Thank you, Dr. Walsh. Just so that everyone 
will know, it looks like we are going to have a vote call 
somewhere between maybe 11:20 and 11:45, so probably within the 
next hour. And we will ask each Member, to the extent possible, 
to constrain yourself to the 5 minutes that will be allocated. 
The chair will now recognize himself for 5 minutes and I will 
try to restrain myself within the 5 minute time limit.
    Dr. Newsome and Mr. Sprecher, both of you appear to be 
circling around the same idea that some heightened oversight 
might be necessary for certain products listed on the ECM. You 
may differ on the amount and scope of oversight and regulation, 
you may differ on whether a change in law is necessary to 
achieve greater oversight, but in principle, you don't seem to 
be quite that far apart. My question is what is the trigger?
    If Congress is to act in this area, we could write a change 
application just to the contract or the commodity in question, 
but this would fail to address the next problem that might come 
along. We could give the CFTC some broader authority, but that 
might just stifle the innovation. What, in the EMC, should 
trigger greater oversight? Both of you have touched upon it, to 
some extent, so please expand upon your own comments on each 
other's ideas of what should trigger oversight of the EMC 
traded contract. Whichever wants to begin first.
    Dr. Newsome. Thank you, Mr. Chairman. I think we have got a 
real live example to use and we don't just have to talk in 
theory about what an appropriate trigger might be, and that 
goes back to the situation with Amaranth and the collapse. This 
Subcommittee held a hearing about that earlier in the summer, 
and we talked through it in detail. But I think, in looking 
back at that situation, there are a couple of things that 
strike us in terms of the linkage of the ECM contract and 
natural gas directly to the regulated futures contract. The 
fact that the ECM natural gas contract served as an effective 
substitute for the exchange contract and even based upon the 
CFTC staff comments last week that, in fact, that contract 
served a price discovery role on a certain percentage of the 
days that the trading community used it.
    So we think those are the key components that can be used 
as a trigger to create more effective oversight from the CFTC 
in terms of submission of the large trader reports, position 
accountability and the self-regulatory oversight functions. We 
have talked about that contract specifically, but we also 
believe that other contracts may develop in the same manner as 
natural gas and that the CFTC should have flexibility to 
continue to evaluate other contracts and if other contracts, in 
fact, meet those same triggers that natural gas has met, then 
that oversight would be accepted, as well.
    Mr. Etheridge. Thank you, sir. Mr. Sprecher, anything you 
want to add to that?
    Mr. Sprecher. No, I think he framed the question, actually, 
quite eloquently, which is we are definitely in broad agreement 
and there are some nuance differences Dr. Newsome and I have. 
Generally speaking, when a contract that is less regulated or 
unregulated becomes the functional equivalent of a regulated 
contract, it only makes sense that we should close that gap. I 
mean, we shouldn't create a regulatory arbitrage opportunity 
within our country.
    So the question is how do we do that? I am cognizant that 
the CFTC has testified here, that they believe they have what 
they need to handle that and but also, I believe it was at the 
last hearing on natural gas that Acting Chairman Lukken said he 
may be at the outer limits of his view on that and so to the 
extent that the CFTC needs to define that outer limit, needs to 
push the outer limit a little further, we would certainly 
support some modification. But generally speaking, I believe 
that they have the authority and we continue, at ICE, to work 
with the CFTC to provide more information, more systems, more 
visibility to help them bridge that gap between ICE and NYMEX.
    Mr. Etheridge. Thank you. Let me quickly try to get one 
other. Mr. Duffy, Dr. Newsome, in each of your written 
statements, you mention the jurisdictional conflict between 
FERC and CFTC. Both of you fear FERC's potential encroachment 
upon the CFTC's exclusive jurisdiction over futures markets. 
Can either of you give the Subcommittee some practical, real 
world implications of what could happen to your exchanges and 
the people who use them if FERC's action does constitute an 
encroachment in the CFTC's jurisdiction, because some might 
say, as a question, why shouldn't we have another cop on the 
beat and what can you tell them?
    Dr. Newsome. Mr. Chairman, we view this as a very serious 
issue and one that could go to the core of tearing down the 
very structure of the Commodity Exchange Act and the 
jurisdiction of the CFTC. I think FERC is but the example that 
is in front of us today. If that is allowed to happen, then you 
are looking at USDA coming in on other contracts, the Treasury 
on financial contracts and I think the exclusive jurisdiction 
of the CFTC is what sets us apart from other jurisdictions from 
around the globe that have allowed the growth and effectiveness 
of our markets.
    We have a specific example regarding FERC and the CFTC with 
FERC coming in, requesting--probably requesting is not quite 
strong enough, but almost demanding that we make changes to 
certain settlements that the CFTC had long approved and was 
comfortable with and as the Exchange, we are caught in the 
middle between the views of two Federal regulatory agencies and 
that is not useful to our market.
    Mr. Etheridge. Thank you.
    Mr. Duffy. You know, Mr. Chairman, it would be--I am not 
even going to try to add to that because I think Dr. Newsome 
summed it up quite well on all products.
    Mr. Etheridge. Thank you, sir. Before we move to my good 
friend, Mr. Moran, we have been joined by the Chairman of the 
full Committee, Mr. Peterson. With that, I will move to Mr. 
Moran and recognize him for 5 minutes.
    Mr. Moran. Mr. Chairman, thank you very much. I am anxious 
for the day in which the gentleman from Virginia's portrait is 
hanging in this room. My failure to attend the reception last 
night is--perhaps you didn't even notice I wasn't there, but 
now that----
    Mr. Etheridge. Now that you have since raised the issue, it 
is a serious issue.
    Mr. Moran. And as a result of feeling badly about my 
absence, I would yield my time to the gentleman from Virginia.
    Mr. Goodlatte. Well, the cat is out of the bag now. I thank 
the gentleman. That day is well nigh and I thank him for his 
gracious--I want to join the Chairman in expressing my concern 
about the question of the exclusive jurisdiction of the CFTC 
over futures contracts. I have had many discussions with a 
number of you over time about this issue and the various 
ramifications of it, but I just want to be on the record as 
saying that I think that if that jurisdiction were to somehow 
be narrowed, the consequences for your industry and playing in 
a different arena, if you will, would be significant in the 
conflict between these two different Federal regulatory 
agencies. It is not going to be well for the openness and 
transparency of these markets that I think the CFTC has done a 
generally good job of protecting.
    Let me ask you, in following up on that, if you might just 
comment on some of the operations of the CFTC. Do you think it 
is adequately funded? I will start with Mr. Duffy.
    Mr. Duffy. Well, I think the funding would be a budget of 
around $87 million to $93 million over the last couple years 
and they were asking for $120 million annually. One of the 
things that I said in my testimony, a big part of the CFTC's 
budget goes to chasing off-exchange unregulated platforms and 
there are hundreds of millions of dollars being lost by people 
that are soliciting retail people to trade foreign exchange 
products, promising them great returns that are just literally 
impossible and we all know it, so the CFTC is chasing these 
folks. Unfortunately, the way the statute reads, they are 
chasing them after the crime has been committed, so that is 
very difficult.
    So that is another reason why we need a fix for this retail 
FX platform, so again, we are very supportive of the Commission 
getting all the resources it needs. I think I echo your 
comments, Congressman, that you know, we need to have this 
single regulator. We do compete globally and for us to have 
multiple regulators in the U.S., it would cripple us in a 
global marketplace and again, that is where we do compete. We 
don't compete so much centrically, we compete globally and 
again, that is another thing I cited in my testimony that is a 
problem with the securities industry and why I think that it 
has been crippled, and IPOs are going to foreign lands versus 
staying here in the U.S., so that would be my view on the 
funding of the CFTC.
    Mr. Goodlatte. Dr. Newsome.
    Dr. Newsome. Mr. Goodlatte, I admit up front that I may be 
somewhat biased as a former Chairman of that agency in my 
response, but I do believe that the CFTC is under-funded. They 
have got the lowest level of staff in over 20 years at a time 
when they are regulating more markets, more contracts. We all 
know and are aware of the explosion in growth of this business, 
so I think I would agree with my friend, Mr. Duffy, that we are 
asking them to do something in a much larger space that has 
become very, very difficult for them to do. In addition to 
increasing the funding and staff size, I also think we should 
increase the penalties in which they have the authority to 
place upon these wrongdoers that Mr. Duffy mentioned. I think 
if we increase the penalties as we were all in agreement in 
reauthorization hearings last year, that, too, would help with 
some of the jurisdictional issues and penalties that other 
agencies have.
    Mr. Goodlatte. Let me ask, has it been your experience that 
the Presidential Working Group responds quickly to matters put 
before it?
    Dr. Newsome. In my experience, yes. The PWG has responded 
very quickly, particularly in issues not only that are 
significant to the industry, but the Congress is attempting to 
address, as well.
    Mr. Goodlatte. Mr. Carlson, do you have a view on that?
    Mr. Carlson. We very much have kept up with the 
Presidential Working Group and we appreciate the work that they 
have done. Stepping back to the budget size of the CFTC, we 
believe, from a small exchange standpoint, we have been 
adequately regulated, so the effect that we see on their budget 
is nominal, in some respects, but we also notice that they are 
also chasing off-exchange regulatory matters.
    Mr. Goodlatte. Thank you. And Mr. Duffy, you commented 
about our ability to remain competitive in the international 
marketplace and I wonder if you could compare our regulatory 
regime with that of the Europeans?
    Mr. Duffy. Well, I mean, Jim might be better suited for 
this question, since he was a big part of the regulatory regime 
as it was being harmonized throughout the country, especially 
in Europe, when he was Chairman of the CFTC, but right now, it 
appears that we are on much more of a level playing field, 
especially dealing with the European countries, by having our 
products in there. The CME Group now is in 83 countries 
throughout the world with our product and we are executing 
business globally, so as far as the regulatory regime goes, I 
mean, I think it suits us quite well right now.
    Mr. Goodlatte. Thank you. And that was a handoff to Dr. 
Newsome, so----
    Dr. Newsome. I think we have made a lot of progress in 
leveling the playing field globally. Still, there are some 
differences that exist. If you look at the Financial Services 
Authority in the UK recognized as a comparable regulator to the 
CFTC within the derivatives space, but I think there are some 
real differences, as well. They have roughly 20 to 30 people 
that are dedicated solely to the derivatives space, where the 
CFTC has over 400. If you look at the number of enforcement 
cases that have been brought by the CFTC, which I think their 
record is very, very good and aggressive in policing 
wrongdoing, much, much fewer cases are brought within the 
European community.
    Mr. Goodlatte. Thank you. Mr. Chairman, I know my time has 
expired. I wonder if I might direct one question to Dr. Walsh, 
because I am interested in this new area.
    Mr. Etheridge. Proceed.
    Mr. Goodlatte. Can you tell us a little bit about how you 
determine what various agricultural activities are--is there a 
schedule, for example, in terms of evaluating that for carbon 
sequestration?
    Dr. Walsh. Yes, Congressman. We have got a variety of tools 
that have been developed with, really, some of the top experts 
in the world on these issues from Kansas State University, 
Virginia Tech, Ohio State and so on. We have established a 
schedule of standardized crediting for certain conservation 
tillage practices when done on a continuous basis, depending on 
the part of the country that you are located in, which is the 
function of crop growth, soil types and so forth in the area of 
methane capture.
    There are standard measurement methodologies that have been 
developed, a little bit of trial and error there, but an 
important mitigation and clean energy source in the area of 
rangeland management, we are currently piloting some field 
tests to confirm our ability to quantify acreage and apply the 
standard factors on a per acre, per year crediting basis. And 
in the space of forestation, we use some of the direct 
measurement and standardized lookup tables that have been 
established by the Forest Service.
    Mr. Goodlatte. I recognize that we don't have these 
requirements to reduce greenhouse gases in the U.S. at this 
time. In light of that, in light of what is going on elsewhere 
in the world, what is your volume of business and who are your 
competitors?
    Dr. Walsh. Well, Congressman, we operate three separate 
exchanges. One is an Exempt Commercial Market, which, of 
course, involves screen trading on a principle-to-principle 
basis and the trading in that market, spot market trading, is 
monitored for market manipulation and fraud by FNRA. The 
volumes in our North America based market are approximately \1/
100\ of the volumes in our European market we established and 
we sort of exported an American financial know-how and 
established the European Climate Exchange. We are transacting 
in the range of about $100 million a day at our London 
operation. We transact a half a million to a million dollars a 
day in our U.S. operation.
    Mr. Goodlatte. Okay. Thank you very much, Mr. Chairman.
    Mr. Etheridge. Thank you, sir. The gentlelady from Kansas, 
Mrs. Boyda.
    Mrs. Boyda. Thank you, Mr. Chairman. Dr. Walsh, I would 
just like to say thank you for what you are doing and the work 
that is going on in Kansas. It is growing. I think we are 
looking at what is going on around some of our neighboring 
states and so there is growing appreciation of what you have 
been trying to do.
    Mr. Duffy, if I could--I am new to this. I am one of the 
new kids in Congress and your initial testimony kind of did 
this. You seem to be concerned about something and I am not 
quite sure and if you could just step back and help me 
understand what your concern was and as it went down the line. 
I just couldn't figure out where that concern, as such, was 
coming from.
    Mr. Duffy. The concern is a couple different things, 
Congresswoman, and the first was on the elimination of 2(h)(3). 
They have had a bit of a debate about it here.
    Mrs. Boyda. Help me with what 2(h)(3) is.
    Mr. Duffy. 2(h)(3) is the exempt commodity code of the 2000 
Act and it gives people an opportunity to trade principle-to-
principle with exempt products, so basically, not being 
regulated and our concern is that some of these products are 
being competitively traded on an exchange. And Dr. Newsome 
could talk to this more because he lists these contracts at the 
NYMEX. We do process them at the CME, because we are their 
electronic provider for all NYMEX's products, so we are trading 
these on a regulated platform and they are competed with an 
unregulated platform, so there are position limits that the 
CFTC has on a regulated exchange, where on an unregulated 
platform, they don't have these limits, so there can be 
manipulation in products.
    That concerns us. There is reputational harm if there is 
manipulation in energy or any other product that harms the 
entire industry. So even thought the CME doesn't list, as its 
core products, energy, we do it for the NYMEX. It is still 
reputational risk to the industry and that concerns us, so 
again, that is why we believe 2(h)(3) should be eliminated, 
because there are competing products being traded on regulated 
platforms that are identical. Second, on our----
    Mrs. Boyda. And again, who would that impact the most here? 
If it was eliminated?
    Mr. Duffy. I don't know if it would impact anybody, because 
we have, in my testimony, said that we believe that there is a 
DTEF solution, which is a Derivatives Transaction Execution 
Facility, and this has standards that they would have to adhere 
to, nine core standards which are fairly benign standards, 
including daily publication of trading information, fitness 
standards, conflicts of interest, recordkeeping and antitrust 
consideration, so most exchanges today, the 
IntercontinentalExchange operates a futures exchange. They 
already have an SRO.
    The Climate Exchange has a futures exchange, as Dr. Walsh 
has cited, so they already fit under this. We don't believe 
that innovation would be harmed any way. We, at the CME Group, 
have been around for 150 years as a regulated institution and 
we have been able to innovate through that entire time without 
any problems, so we don't see where there has been any 
arguments being made that innovation would be stymied, for lack 
of a better term, so again, we don't see how this impacts 
anybody if it was to go into a DTEF.
    Mrs. Boyda. Is there agreement or disagreement?
    Dr. Newsome. From the New York Mercantile Exchange, of 
course, we operate as a regulated marketplace, just as our 
colleagues in Chicago. I think the most important concept is 
the fact that we are in complete agreement with our friends in 
Chicago that something needs to be done. We are taking a 
slightly different approach on how you address that.
    The CME Group is recommending to repeal the 2(h)(3) and I 
think it makes some valid arguments. Our approach has been 
based upon the situation with Amaranth, to take a more targeted 
approach and address specifically the contracts that are linked 
to an exchange contract, that serve as an effective substitute, 
while maintaining the structure of the CFMA as it has been 
since 2000.
    Mr. Sprecher. We operate both, as Chairman Duffy mentioned, 
we operate both regulated futures exchanges and Exempt 
Commercial Markets. I started ICE as the founder, as an Exempt 
Commercial Market. In other words, I was able to just find two 
people that were willing to trade with each other across a 
relatively crude network and from that, build a company. The 
same thing has happened with Dr. Sander, who started the 
Chicago Climate Exchange, which we operate for him under an 
outsourcing relationship, did the same thing.
    So the innovation that we are talking about is the ability 
of entrepreneurs to come in and create new market structures at 
low cost and to start a self-regulated futures exchange from 
scratch would be a daunting task. I am not sure it can really 
be done. And certainly, I couldn't have done it, I will say 
that. So where Dr. Newsome and Chairman Duffy and I do agree is 
that at times, if a contract becomes the functional equivalent 
of a future and has a different regulatory regime, we should 
take away that regulatory arbitrage.
    Nobody is looking to, nobody that I have heard on this 
panel is looking to take regulated futures into an unregulated 
environment. That, I don't think, is actually helpful for a 
market, but to allow entrepreneurs to start new markets at low 
barriers to entry, which they can do in every other country, I 
would remind you, I don't think we should preclude that in this 
country.
    Mrs. Boyda. All right. Thank you very much. Yes?
    Dr. Walsh. Congresswoman, first thank you for your kind 
remarks. We are working hard to grow opportunities in Kansas, 
in these emerging markets. I would note that it is not just the 
cost of activating the exchange that would become prohibitive 
if the designated contract market rules were applied to a lot 
of these innovative upstarts, not just CCX, but others that are 
emerging with some promising new opportunities for American 
businesses, but the cost of participation. Many of the members 
of Chicago Climate Exchange, take the City of Melbourne, 
Australia, the University of Minnesota, other governments and 
small businesses, are not necessarily involved in the Chicago 
Climate Exchange because they are eager to do so much trading.
    They want to learn how to manage their energy and emissions 
flow, they want to understand the policy implications. They 
want to prepare for a carbon constrained future. So if we put 
up the sorts of hurdles that the entities would have to face 
under a DCM and under a futures market regulatory structure, we 
might not only kill off the sort of the potential golden goose 
of the exchange itself, but kill off the possibility for lots 
of businesses and farmers and foresters to learn how to work in 
these markets. So it is the exchange and the participation that 
would become more difficult and costly if we ditch this really 
innovative provision to foster new market mechanisms.
    Mr. Etheridge. Thank you very much. Thank you very much. 
The gentleman from Texas is recognized for 5 minutes. Just so 
you know, a vote has been called. This will probably be the 
last question we are able to get in before we have to take a 
break. Probably we will be gone anywhere from 15 to 20 minutes 
and then we will come back and continue. It is two votes.
    Mr. Conaway. Thank you, Mr. Chairman. Dr. Walsh, a couple 
of things. What are those hurdles that you say this would put 
in place that would prevent participants like Melbourne, 
Australia? Give us a sense of what that hurdle is.
    Dr. Walsh. Well, anybody who wants to trade in a futures 
market has a significant set of procedures to go through to 
demonstrate wherewithal, to demonstrate understanding and 
familiarity and these are steps that are absolutely appropriate 
for the large, economically important commodity futures and 
financial futures markets, but is this at all necessary? And I 
think the wisdom of the Congress, in establishing the Exempt 
Commercial Market structure, said no, that is not necessary, a 
costly regulatory and reporting set of procedures for these new 
upstart markets that are indeed, not even a futures market, in 
our case. This is a spot market.
    Mr. Conaway. Did I hear you say the participant does not 
need to demonstrate knowledge and understanding of what he or 
she might be doing? Does Orange County, California, come to 
mind?
    Dr. Walsh. Well, in the case of financial derivatives and 
large----
    Mr. Conaway. We were talking about your--but it is odd that 
you would say you don't want informed participants.
    Dr. Walsh. Oh, no, sir. That is not at all what we are 
saying. We absolutely have an extensive preparation and 
briefing before the members of the Exchange execute the 
contract to commit to the terms of the Exchange. We facilitate 
their participation and reporting and annual compliance and it 
is really a facilitative audit, in fact, to help them get their 
numbers and data in order. But many of the members of the 
Exchange choose not to, because they don't need to, participate 
in the trading part.
    Mr. Conaway. Okay.
    Dr. Walsh. And they have that as an option. And to say you 
are going to be trading some sophisticated, high-value 
commodity, your financial instruments--is not the correct 
assessment in this particular case.
    Mr. Conaway. Okay. How do you settle arguments between your 
participants?
    Dr. Walsh. We generally don't have many arguments. We have 
an overnight payment and delivery process. Nobody has failed on 
the payment and delivery terms and we do have a committee 
structure that is the governance process. Members of the 
Exchange participate in a self-regulatory structure, sir.
    Mr. Conaway. And on your disclosure sheet, you got 
contracts of some sort with USDA? What are those contracts?
    Dr. Walsh. I am sorry, sir?.
    Mr. Conaway. On your disclosure page you have contracts 
with the USDA.
    Dr. Walsh. Oh, yes, sir. The USDA has provided, through 
NRCS, first, a small grant and then a little bit bigger one, to 
help us to engage expert verifiers to do field inspections, in 
particular, on conservation tillage plots, on grass planting 
plots and now on rangeland management fields. It is a fairly 
expensive initial cost and we are trying to build up the 
capacities, bringing in folks like SES, out of Lenexa, Kansas, 
bringing in forestry and farm experts to do in-field 
inspections, so we have integrity underlying the product.
    Mr. Conaway. Why would the participants not pay for that?
    Dr. Walsh. Well, I think we are going to move to that sort 
of model, but my sense is the good folks at USDA thought that 
this was a public benefit to test out these ideas and to form 
and revise the protocols and to get that talent base built up. 
We do envision a self-funding model in the not-too-distant 
future.
    Mr. Conaway. Okay. Thank you, Mr. Chairman, I yield back.
    Mr. Etheridge. I thank the gentleman. The gentleman from 
Georgia, Mr. Marshall, for 5 minutes.
    Mr. Marshall. Thank you, Mr. Chairman. I guess I am pleased 
to see the sensitivity of our staff in putting Mr. Carlson 
between Mr. Sprecher and Dr. Newsome and Mr. Duffy. We 
appreciate the service that you are providing us, sir.
    Just real briefly, Mr. Sprecher, following up on Mrs. 
Boyda's question. How do we keep the baby and toss the 
bathwater with regard to this exempt market issue, the 2(h)(3) 
issue? Real briefly.
    Mr. Sprecher. Sure. I think the CFTC is, itself, trying to 
do that, but if Congress wants to play a role, I think it can 
help codify some of the things that they are doing, which is 
continued reporting. The area where I think there is some 
vagary that could use some direction from Congress is that if a 
problem is seen, what action should be taken and who should 
take. For example, should ICE become a self-regulated type 
organization where it can direct market participants or should 
the CFTC, itself, direct market participants? We have told the 
CFTC we are happy to play either role.
    Mr. Marshall. In trying to figure out what direction we 
should take, perhaps we should take some guidance from the 
CFTC. If the CFTC feels that it is able to deal with the 
worries about inappropriate manipulation, et cetera, with the 
tools that it has at the moment, then perhaps the CFTC might 
tell us that it doesn't need additional legislation from 
Congress. Contrariwise, if it doesn't, would that be where we 
should seek our guidance?
    Mr. Sprecher. I hesitate in telling somebody like you what 
to do, but I do think that the----
    Mr. Marshall. I need lots of advice on this issue.
    Mr. Sprecher. I do think, as some of my colleagues have 
pointed out, there is a general awareness, in our industry, in 
Congress and the CFTC, a potential for problems that need to be 
corrected and I am cognizant of the fact that the acting 
Chairman said he is at the outer limits of what he can do, so I 
suspect that is a signal to Congress that he could potentially 
use some help.
    Mr. Marshall. CFTC funding, I think everybody agrees that 
it is a challenge, simply to keep the kind of good folks 
working for the CFTC that we really need to have. In order for 
them to be competent, to appropriately regulate, we have got to 
increase their salaries substantially and if the budget doesn't 
grow substantially in order to do that, then the staffing has 
to diminish dramatically and when you diminish the staffing, 
you have a quantity problem. It is just simply not enough 
people.
    And a number of people have suggested that the industry 
should be bearing the cost of this. It is the way the SEC 
works. Just brief comments about that. I want to talk about 
energy and Graves-Barrow here if we have an opportunity, so 
very brief comments about where should the funding come from? 
It seems to me to be a fairly minor expense compared to the 
size of the industry and that the industry ought to step up and 
offer to carry some of this cost. And I guess this is 
principally directed to the exchanges.
    Mr. Duffy. Yes. If I may, Mr. Chairman, answer that 
question?
    Mr. Marshall. I appreciate the promotion, thank you.
    Mr. Duffy. No. Congressman, thank you. We have a big 
difference in this because the budget for the CFTC, as I have 
outlined in my testimony, a lot of budgetary needs go to 
trading or chasing off-exchange, unregulated activity and that 
is a big concern for us, that the regulated exchanges should 
bear that cost. Also----
    Mr. Marshall. Can I interrupt?
    Mr. Duffy. Yes, sir.
    Mr. Marshall. So if we--I suspect your view is that somehow 
we ought to make some adjustments legislatively that limits the 
extent to which this kind of thing can go on off-exchange, 
which means it would come on to exchange, so at that point, you 
would be willing to carry all the costs?
    Mr. Duffy. Well, again, that is not--what we are saying is 
when there are hundreds of millions of dollars being lost and 
fines being levied after the horse has been out of the barn, it 
is a little difficult to collect those fees because the people 
are gone. Again, our people do pay a fee to the National 
Futures Association for regulation, which a lot of that CFTC 
regulation has been off-loaded to the NFA, so we already do 
participate, our clients do, in paying for regulation to the 
agency.
    Second, we are talking about an industry that has got half 
a million in commodity accounts in the U.S. versus several 
millions of contracts of equities and we have only a handful of 
people providing deep pools of liquidity that benefit multiple 
constituencies, that that would not happen if they had to pay a 
user fee on top of that. We are talking about a fee or a tax 
before they even made or lost a profit on each and every one of 
their transactions and these folks can go overseas quite 
quickly.
    Mr. Marshall. I apologize for interrupting. My time is 
about to expire. We have votes coming up. It would be very 
helpful to us, for all of you, and I am sure you will be doing 
so, but if you could comment in writing about the proposed 
Graves-Barrow legislation and assuming that there is a problem 
here, what sort of solution is appropriate, in your views. 
Thank you, Mr. Chairman.
    Mr. Etheridge. I thank the gentleman and if you would 
submit that in writing, it would be helpful. We will stand in 
recess probably for about 15 minutes, soon as we get these two 
votes. We are in the last 3 or 4 minutes of one vote and we 
have one 5 minute vote and then we will back. Thank you.
    [Recess]
    Mr. Etheridge. We thank you very much for waiting on us. I 
recognize the gentleman from Kansas for 5 minutes.
    Mr. Moran. Mr. Chairman, thank you very much. A number of 
our colleagues on this Committee have zeroed in on issues 
related to the regulation of ECMs and on the testimony of Mr. 
Sprecher, he indicates that most energy swap contracts traded 
on ICE are niche OTC products that are not amenable to the 
application of such requirements, urges the Subcommittee to 
stay within the current regulatory framework and allow CFTC to 
make adjustments that may be appropriate for a few particular 
products. Is the division between you and your colleagues, to 
whatever side of the room that is, is this the issue about the 
few regulated products, is that the distinction that we are 
having a discussion about?
    Mr. Sprecher. Well, I think Dr. Newsome and I could 
actually probably even agree on what the products are and I 
think the industry, generally, the energy industry would 
generally support us in our views, given all the conversations 
we have had. I think what we are talking about now are okay, 
having figured out the specific products should have more, let 
us call it, oversight, what form and how should----
    Mr. Moran. It is not the products. It is the level of 
regulation, the level of oversight?
    Mr. Sprecher. Correct. And its nuance diversions of that, 
not whether or not it should exist at all.
    Mr. Moran. Mr. Carlson, the CFTC made some changes in their 
rules and regulations in regard to outside directors, I would 
guess, 6 months ago. Are you able to easily comply with those 
new rules and regulations? And do you have a sense, that with a 
new Chairman of the CFTC, there is flexibility there in meeting 
the criteria that was established for outside directors?
    Mr. Carlson. Well, we are complying with the Safe Harbor 
provisions under the core principles that they provided us. We 
are not necessarily in favor of it coming from the top down, 
forcing us to make these changes, but I think we are trying to 
put the best face on it as possible and use this as an 
opportunity for us to try to make some changes that we wanted 
to make internally. So in some respects, we are not necessarily 
that opposed to what happened, but we did not like the fact 
that it was coming down, forcing us to make those changes, as 
opposed to us moving on our own.
    Mr. Moran. So you would have no suggestions to this 
Subcommittee in regard to legislative changes as we discuss 
reauthorization about those rules?
    Mr. Carlson. Well, what we have proposed, as I put in my 
testimony, was the fact that there are little nuances here and 
there, and one particular one that kind of bothers is, as a 
small exchange, is that there is a regulatory oversight 
Committee consisting of these three public directors and that 
is under the Safe Harbor provision. It seems silly, in our 
respect, to have to have that because we don't have some of the 
underlying problems that were perceived at the other exchanges 
from a regulatory side. And we only have three staff 
individuals that will be supervised under the three public 
directors, so again, it is a little bit top-heavy, to say the 
least.
    Mr. Moran. Do you have any sense that the CFTC, with new 
leadership, new Commissioners, has a different approach to this 
topic?
    Mr. Carlson. I think we are very pleased with Acting 
Chairman Lukken and we are in contact with them and we are 
hoping there may be some changes yet to come, prior to----
    Mr. Moran. From my perspective, that would be a good thing 
and much less cumbersome and more timely than what this 
Committee might be able to do, based upon our history with 
reauthorization.
    Mr. Carlson. I agree. Thank you.
    Mr. Moran. Thank you. Let me ask one other question, just a 
broader question is that much of the testimony has been about 
examples of things that have occurred in the markets that 
perhaps suggest the need for additional regulation. We look, 
retrospectively, back and make suggestions for what we ought to 
do with reauthorization. Do any of you see future trends in the 
futures industry that we need to be made aware of so that we 
are legislating proactively, as compared to responding to 
issues that have arisen in the past that perhaps need our 
attention now? Anything out there in the industry that we ought 
to be aware of?
    Dr. Newsome. Congressman, I think the issue that we are 
talking about with regard to ECMs and triggers for more 
regulation certainly could be a trend. Right now, it is 
contained to one marketplace and we are trying to address it 
specifically. I think if Congress takes the targeted approach 
that we recommended, I agree with Mr. Sprecher, that we have 
the exact idea of what product would, at least initially, be 
encompassed.
    I think one area that I would slightly disagree with Mr. 
Sprecher on is the authority that the CFTC currently has. The 
CFTC currently has special call authority to collect 
information. That information is collected after the fact and 
we are looking at a preventative solution here with regard to 
these recommendations, so I think the mandated large trader 
reports needs to be one of the components. Second, with regard 
to position accountability or the self-regulatory organization, 
the CFTC does not have the authority to oppose those 
requirements on EMCs today.
    Mr. Moran. Dr. Newsome, thank you. I am pleased to have 
asked an open-ended question to give you the opportunity to 
answer the question that you would like to answer. Mr. 
Chairman, thank you for the time and my time is expired.
    Mr. Etheridge. I thank my friend for his comments and I 
would say, before we dismiss this panel, there may be 
additional questions by Members to you and we would ask that 
you respond to those as quickly as possible for the Committee. 
And with that, if the gentleman from Kansas has a closing 
comment?
    Mr. Moran. Mr. Chairman, no. I would like to proceed with 
the next panel. I appreciate the testimony we have heard today 
and again, hope that we have some results from these continual 
discussions about reauthorization.
    Mr. Etheridge. I thank the gentleman. Let me thank each of 
our panelists. You have been most helpful this morning in your 
comments and I can assure you that we will be in touch with 
you, other Members may, for information as we move forward with 
this reauthorization. Thank you very much and we will now 
welcome the second panel.
    Let me welcome our second panel to the table and thank you 
for coming. First is Mr. Roth, who is President and CEO of 
National Futures Association in Chicago. Second is Mr. Zerzan, 
Counsel and Head of Global Public Policy, International Swaps 
and Derivatives Association on behalf of ISDA and the 
Securities Industry and Financial Markets Association here in 
D.C.; Mr. Damgard, President of Futures Industry Association 
here in D.C.; Ms. Becks, President and CEO of Campbell & 
Campbell, Incorporated, on behalf of the Managed Funds 
Association in Baltimore; and Mr. Brodsky, Chairman and CEO of 
Chicago Board Options Exchange on behalf of the U.S. Options 
Exchange Coalition out of Chicago.
    Let me thank each of you and Mr. Roth, if you would, begin 
when you are ready and I would ask all the witnesses, if you 
would, try to limit your time to 5 minutes. It looks like we 
could have another vote somewhere around noon or shortly 
thereafter, which hopefully will give us time to get most of 
our stuff in if we move and we aren't joined by others, we may 
get it all in. So Mr. Roth, we will begin with you, please, 
sir.

   STATEMENT OF DANIEL J. ROTH, PRESIDENT AND CEO, NATIONAL 
                FUTURES ASSOCIATION, CHICAGO, IL

    Mr. Roth. Thank you, Mr. Chairman. My name is Dan Roth and 
I am the President of National Futures Association, which is 
the industry-wide self-regulatory body for the futures 
industry. The first panel this morning touched on a number of 
really crucial issues, whether it is 2(h)(3) or the CFTC's 
exclusive jurisdiction. Those are all important issues and we 
are glad that they are being debated here.
    If I could this morning, though, I just wanted to remind 
the Committee that we have some unfinished business related to 
customer protection issues in the off-exchange retail forex 
space. I testified in both 2003 and 2005 that I felt that 
certain provisions of the CFMA, along with subsequent case law, 
had created situations where unsophisticated retail customers 
were particularly vulnerable in the off-exchange forex area. If 
I could, I would like to take a couple of minutes and describe 
the context of those issues, describe in greater detail some of 
the problems we have seen and some possible solutions.
    First of all, when I testified in 2003, I told the 
Committee that the forex dealer/members of NFA at that time 
held about $170 million in customer funds. Today, 4 years 
later, that number has grown to over $1 billion in customer 
funds. So that is pretty dramatic growth and it has been 
accompanied by some pretty dramatic problems. Our forex dealer/
members at NFA constitute less than 1 percent of our overall 
membership, but those members account for over 20 percent of 
the customer complaints that are filed in our arbitration 
program; they account for 50 percent of NFA's enforcement 
docket; they account for 50 percent of the emergency actions 
that we have had to take this year.
    I think there are a number of provisions in the Act that 
have contributed to those problems and I would like to discuss 
them briefly, if I could. If you look at the firms that have 
created most of the problems, they share a couple of traits. 
First of all, most of these firms, although registered as FCMs, 
aren't really FCMs, at all, at least, not as the way that term 
in defined in Section 1(a)(20) of the Act. These firms don't do 
any exchange traded futures business, at all. They get 
registered as FCMs for the sole purpose of qualifying, under 
the Act, to do off-exchange retail forex. So in that sense, 
they are not really FCMs, at all.
    The second trait that these firms often share, not always, 
but very often, is that they tend to be thinly capitalized, 
which is of particular concern because frankly, the risks that 
operating a dealer market include are substantially different 
than the risks involved in a traditional FCM business, where 
you are acting as an agent for your customer. And second, there 
is no clearing organization standing behind these off-exchange 
products, so that the forex dealer is really the sole source to 
ensure the fulfillment of financial obligations to customers.
    So for those two reasons, I think that there needs to be a 
substantially higher capital requirement for forex dealers than 
for traditional FCMs. So really with respect to those two 
problems, I think we would urge Congress to limit the FCMs that 
can act as counterparties to retail forex transactions to those 
FCMs that are real FCMs, that are actively engaged in the 
activities described in Section 1(a)(20) of the Act and to 
those firms that have at least $20 million in capital.
    The next problem I just wanted to discuss is one that this 
Committee dealt with in H.R. 4473 and I applaud you for doing 
that, and it is the solicitor issue, what we have referred to 
as the solicitor issue. The CFMA provides that if a 
counterparty to the retail forex transaction is an FCM, then 
that whole transaction is outside the regulatory authority of 
the Act, which means that the person soliciting the customers, 
the person actually working the phones and selling the product 
to the retail customers, is not required to be registered, not 
required to be regulated at all and H.R. 4473 addressed that 
issue and that is good.
    What I am telling you is that in the last couple of years 
we have seen a slight variation on that theme where now we have 
firms that become active as the equivalent of commodity pool 
operators or commodity trading advisers, but again, they limit 
themselves to off-exchange retail forex transactions with the 
result that those pool operators and trading advisers aren't 
required to be registered. They are not regulated and those 
customers don't receive the same regulatory protections as 
regular CPO/CTA customers. I think the H.R. 4473 approach on 
the solicitor just needs to be modified slightly to capture the 
CPO/CTA elements, as well.
    And finally, Mr. Chairman, let me just conclude by just 
mentioning again, briefly, the Zelener case. As I mentioned 
before in my testimony, in our view, the problem with the 
Zelener case is that it gives the scammers a blueprint, 
directions on how to write their contracts to avoid CFTC 
jurisdiction. In that sense, the problem with Zelener, it is 
not a forex problem, per se, it is a problem with unregulated 
retail futures markets. That is why we supported, last time, a 
broad Zelener fix rather than the narrow fix that was in H.R. 
4473. We continue to think that the broad fix is the better 
fix, but in light of all the problems we have had, we also 
believe that a fix now is infinitely better than a fix later. 
And we continue to support a broader fix, but what we urge most 
is a prompt resolution of these issues and prompt 
reauthorization of the CFTC and we will support any sort of 
proceeding or any sort of proposal that helps us achieve those 
ends.
    So Mr. Chairman, thank you very much and I would be happy 
to answer any questions.
    [The prepared statement of Mr. Roth follows:]

   Prepared Statement of Daniel J. Roth, President and CEO, National 
                    Futures Association, Chicago, IL

    My name is Daniel Roth, and I am President and Chief Executive 
Officer of National Futures Association. Thank you Chairman Etheridge 
and Members of the Subcommittee for this opportunity to appear here 
today to present our views on some of the issues facing Congress as it 
continues the reauthorization process. NFA is the industry-wide self-
regulatory organization for the U.S. futures industry. As a regulator, 
NFA is first and foremost a customer protection organization.
    I testified before this Subcommittee in 2003 and in 2005 about off-
exchange forex futures that were being sold to retail customers. I 
stated then and believe now that certain provisions of the Commodity 
Futures Modernization Act of 2000 and subsequent case law had the 
unintended consequence of making unsophisticated, retail customers the 
prey of fly-by-night operators. Let me put these issues in some overall 
context, describe in detail the problems we have seen in the statute 
and share with you some proposed solutions.
    In the CFMA Congress attempted to resolve the so-called Treasury 
Amendment issue once and for all by clarifying that the CFTC does, in 
fact, have jurisdiction to protect retail customers investing in 
foreign currency futures. The basic thrust of the CFMA in this area was 
that foreign currency futures with retail customers were covered by the 
Commodity Exchange Act (``Act'') unless the counterparty was an 
``otherwise regulated entity,'' such as a bank, a broker-dealer or an 
FCM. When I testified here in 2003, I told you that NFA Member FCMs 
held $170 million in retail customer funds trading off-exchange forex. 
Four years later, that number is now over $1 billion. With this 
dramatic growth there have been some pretty dramatic problems.
    Members acting as counterparties to retail forex transactions 
account for less that 1% of NFA's membership. Unfortunately, they also 
account for over 20% of the customer complaints filed with our 
arbitration program, over 50% of NFA's current enforcement docket and 
over 50% of the emergency enforcement actions NFA has taken over the 
last year.
    There a number of problems in the current statute that have 
contributed to these problems. If you look at the firms that have 
caused virtually all of the customer protection problems in retail 
forex, they share a couple of traits. First of all, they are not really 
FCMs at all. Congress intended to allow FCMs, along with banks, broker-
dealers and insurance companies, to act as counterparties to retail 
forex transactions because they are all ``otherwise regulated 
entities.'' The wording of the statute, though, opened the door for 
firms that are not really FCMs to take advantage of the FCM exemption. 
Firms became registered as FCMs that are FCMs in name only--they do no 
exchange-traded futures. They are registered as FCMs solely to qualify 
to do retail forex business. To make matters worse, due to a further 
anomaly in the statute, the Act currently does not provide the CFTC 
with any rulemaking authority over these firms at all. Clearly, 
Congress did not intend to allow firms that are FCMs in name only to 
act as counterparties to retail forex futures. Congress should fix this 
problem by limiting the FCMs that can act as counterparties to those 
that are primarily and substantially engaged in the activities 
described in Section 1(a)(20) of the Act.
    The second trait that marks the problem firms in retail forex is 
that most, though not all, have been thinly capitalized. Congress long 
ago recognized that acting as a dealer involves greater risk than 
acting as an agent in futures trading, the way a traditional FCM does. 
That is why Congress in 1978 imposed a $5 million net worth requirement 
for firms granting dealer options and why the CFTC created a $2.5 
million capital requirement for leverage transaction merchants in 1984. 
Congress should amend Section 2(c) of the Act to require FCMs acting as 
counterparties to retail forex transactions to maintain minimum capital 
of at least $20 million. NFA has raised the capital requirements for 
forex dealers several times but this congressional action could ensure 
that firms can meet their obligations to their customers and have a 
significant financial stake in their business.
    NFA is strongly supportive of both of these solutions to the 
customer protection problems we have experienced with retail forex. We 
are also strongly supportive of giving the CFTC rulemaking authority 
over FCM only firms (i.e. those that are not otherwise enumerated in 
Section 2(c) of the Act to act as retail forex counterparties). It is 
simply paradoxical to call these FCMs ``otherwise regulated'' when, 
other than anti-fraud jurisdiction, there is no Federal regulatory 
oversight of these firms' activities.
    There's one more forex problem I should mention that poses 
significant customer protection issues based upon the wording of the 
CFMA. Specifically, the wording of the statute currently only requires 
the counterparty to these transactions to be an otherwise regulated 
entity. This creates the possibility that an FCM, for example, might be 
the counterparty but the firm that actually does the telemarketing for 
these products is completely unregistered and unregulated. There are 
literally hundreds of these unregulated firms selling off-exchange 
forex transactions to retail customers and in some instances the people 
making the sales pitches have been barred from the futures industry for 
sales practice fraud. I do not think that's what Congress intended at 
all, and H.R. 4473 passed by the House in 2005 contained an amendment 
to Section 2(c) of the Act to make clear that not only the 
counterparties but also the persons actually selling these products to 
retail customers must be registered with the CFTC and subject to its 
jurisdiction. We, of course, support this amendment.
    In the last few years we have also seen a growing number of firms 
acting as trading advisors and pool operators that trade exclusively 
off-exchange forex. Under the current statute, these firms are not 
required to be registered and their customers do not receive the same 
regulatory protections as customers of CPOs and CTAs that trade on-
exchange. Some of these unregistered firms tout outlandish performance 
claims that cannot be substantiated. We believe that H.R. 4473's 
amendment should be extended to require those persons that manage 
accounts or pooled investment vehicles on behalf of retail customers to 
register and be subject to the CFTC's jurisdiction.
    The last issue I wanted to discuss brings us back to the Zelener 
case. As you may recall, in the Zelener case the CFTC attempted to 
close down a boiler room selling off-exchange forex trades to retail 
customers. The District Court found that retail customers had, in fact, 
been defrauded but that the CFTC had no jurisdiction because the 
contracts at issue were not futures. The Seventh Circuit affirmed that 
decision. The ``rolling spot'' contracts in Zelener were marketed to 
retail customers for purposes of speculation; they were sold on margin; 
they were routinely rolled over and over and held for long periods of 
time; and they were regularly offset so that delivery rarely, if ever, 
occurred. In Zelener, though, the Seventh Circuit based its decision 
that these were not futures contracts exclusively on the terms of the 
written contract itself. Because the written contract in Zelener did 
not include a guaranteed right of offset, the Seventh Circuit ruled 
that the contracts at issue were not futures.
    For a short period of time, Zelener was just a single case 
addressing this issue. However, time has proven that the CFTC cannot 
litigate itself out of the Zelener problem. Since 2004, various Courts 
have continued to follow the Seventh Circuit's approach in Zelener 
causing the CFTC to lose enforcement cases relating to forex fraud. 
Therefore, Zelener allows completely unregulated firms and individuals 
through clever draftsmanship to sell to retail customers contracts that 
look like futures and act like futures outside the CFTC's jurisdiction. 
The bottom line is that these Court decisions make it much harder for 
the Commission to prove that contracts sold to retail customers to 
speculate in commodity prices are futures, makes it easier for the 
unscrupulous to avoid CFTC regulation and creates a real, live customer 
protection issue. Unsophisticated retail customers are being victimized 
by high-pressured sales pitches for foreign currency futures look-alike 
products. These retail customers are the ones who most need regulatory 
protection, and that protection should not be stripped from them 
because a clever lawyer finds a loophole in the law.
    NFA recognizes that H.R. 4473 addressed the Zelener problem with 
regard to retail forex. NFA applauds those efforts in addressing the 
current scam of choice--forex--among fraudsters and believes that any 
future reauthorization legislation should at the very least incorporate 
H.R. 4473's approach to this issue. However, NFA remains concerned that 
the rationale of the Zelener decision and its progeny is not limited to 
foreign currency products. Similar contracts for unleaded gas, heating 
oil, agricultural products or virtually any other commodity could be 
sold to the public in an unregulated environment.
    NFA and the exchanges have developed a fix to Zelener that goes 
beyond forex and does not have unintended consequences. Our approach 
codifies the approach the Ninth Circuit took in CFTC v. Co Petro--which 
was the accepted and workable state of the law until Zelener--without 
changing the jurisdictional exemptions in Section 2(c) of the Act. In 
particular, our approach would create a statutory presumption that 
leveraged or margined transactions offered to retail customers are 
futures contracts if the retail customer does not have a commercial use 
for the commodity or the ability to make or take delivery. This 
presumption is flexible and could be overcome by showing that the 
transactions were not primarily marketed to retail customers or were 
not marketed to those customers as a way to speculate on price 
movements in the underlying commodity.
    This statutory presumption would not affect either the interbank 
currency market or already regulated instruments like securities and 
banking products. It would, however, ensure that scammers cannot tailor 
their written agreements to sell leveraged commodity products to retail 
customers for speculative purposes in a completely unregulated 
environment. Moreover, it protects retail customers by giving the CFTC 
the power to shut down unregulated boiler rooms and freeze their funds.
    While NFA continues to believe that the solution to Zelener should 
go beyond forex, we recognize that H.R. 4473's narrow Zelener fix would 
be a marked improvement over the current state of the law. If Congress 
adopts only a narrow Zelener fix and boiler rooms move to other 
commodities using Zelener-type contracts, then Congress must be willing 
to re-open the Act before the next reauthorization to consider 
resolving this issue completely.
    In closing, let me state that NFA believes the industry and the 
public have benefited greatly from the enlightened regulatory approach 
that Congress adopted in the CFMA and from the CFTC's role in 
implementing the Act. We look forward to working with this 
Subcommittee, other Congressional committees, the CFTC, and the 
industry to address the important customer protection issues outlined 
above.

    Mr. Etheridge. Thank you, Mr. Roth. Mr. Zerzan.

  STATEMENT OF GREGORY P.J. ZERZAN, COUNSEL AND HEAD, GLOBAL 
             PUBLIC POLICY, INTERNATIONAL SWAPS AND
    DERIVATIVES ASSOCIATION, WASHINGTON, D.C.; ON BEHALF OF 
           SECURITIES INDUSTRY AND FINANCIAL MARKETS
                          ASSOCIATION

    Mr. Zerzan. Thank you, Mr. Chairman and Ranking Member, for 
inviting ISDA and SIFMA to testify today. Collectively, ISDA 
and SIFMA represent over a thousand entities that participate 
in both the on-exchange and over-the-counter markets. These 
entities range from financial services companies to 
manufacturers to insurance companies to parties that 
participate both as market makers as well as end-users of these 
products.
    At a time when commentators are increasingly calling for 
the adoption of a principles-based approach to financial 
services regulation, it is important to remember that this 
Committee got there first and the adoption of the Commodity 
Futures Modernization Act of 2000 represented a momentous 
achievement in terms of financial services legislation. The 
financial service industry, as a whole is tremendously 
important to our economy. It is the third largest contributor 
to GDP and one in every 19 jobs in this country is in the 
financial services sector.
    The Commodity Futures Modernization Act has allowed both 
on-exchange and over-the-counter derivatives business to 
explode in the United States and it is the leadership of this 
Committee which played a leading role in ensuring that that 
would happen. Nevertheless, in the time since the passage of 
the CFMA, the rest of the world has caught up to the fact that 
the financial services sector is a tremendous generator of 
economic growth. As several reports this year have already 
noted, the United States leadership, as the premiere center for 
financial services, is increasingly under assault.
    The world's largest derivatives exchange, the Chicago 
Mercantile Exchange, is in the United States, but it is 
followed closely by two European-based entities. In the over-
the-counter markets, United States leadership has actually 
succumbed to that of the UK: 43 percent of the over-the-counter 
derivatives business is done in the United Kingdom, compared to 
24 percent in the United States.
    So what we have seen is an issue arise around the question 
of what can the United States do to increase its 
competitiveness in this area. The prudent leadership of the 
Commodity Futures Trading Commission ensures that the U.S. 
remains a very attractive market for over-the-counter 
derivatives, but regulatory uncertainty has been cited as a 
reason why some market participants choose to go overseas. In 
that vein, with the recent actions of the Federal Energy 
Regulatory Commission, we see some of the uncertainty that 
market participants are wary of. With respect to 
reauthorization, then, ISDA and SIFMA have the following 
recommendations.
    First, we think Congress should provide CFTC with the 
resources necessary to meet its staffing and IT procurement 
needs. Second, the Congress should consult with the President's 
Working Group to determine if a definable market problem in 
need of a legislative solution exists. To the extent that the 
President's Working Group and Congress are able to identify a 
problem, then any such solution should be narrowly tailored to 
address that problem in a way that imposes the least cost on 
market participants. Last, we would urge that Congress reaffirm 
the exclusive jurisdiction of the Commodity Futures Trading 
Commission with respect to transactions on a registered 
exchange involving energy commodity derivatives.
    We thank the Committee for its continued leadership and we 
are happy to answer any questions.
    [The prepared statement of Mr. Zerzan follows:]

  Prepared Statement of Gregory P.J. Zerzan, Counsel and Head, Global
    Public Policy, International Swaps and Derivatives Association,
   Washington, D.C.; on Behalf of Securities Industry and Financial 
                                Markets
                              Association



    Etheridge. Thank you. Mr. Damgard.STATEMENT OF JOHN M. DAMGARD, 
       PRESIDENT, FUTURES INDUSTRY ASSOCIATION, WASHINGTON, D.C.

    Mr. Damgard. Chairman Etheridge, Ranking Member Moran and Members 
of the Subcommittee, I am John Damgard, President of the Futures 
Industry Association and thank you very much for the opportunity to 
appear today.
    FIA has three general points to make. Number one, we endorse CFTC 
reauthorization. We support CFTC exclusive jurisdiction and we oppose 
any major changes to the CFMA. FIA believes that the CFTC is an 
excellent agency that fulfills its statutory mission in an efficient 
and effective manner. CFTC's past and present leadership is to be 
commended for this record. The CFTC does, indeed, deserve to be 
reauthorized. Recently, a controversy has arisen concerning the scope 
of the Commission's exclusive jurisdiction. There should be no 
controversy. In 1974, the House Ag Committee created both the CFTC and 
its exclusive jurisdiction to make sure that only an expert, 
specialized agency would regulate futures trading.
    Congress knew that exposing futures exchanges, intermediaries and 
market participants to duplicative or conflicting regulation from other 
agencies with no expertise in futures markets would be a recipe for 
disaster. That is why Congress has made crystal clear that the CFTC's 
exclusive jurisdiction, where applicable, supersedes that of any other 
agency. As the courts have held, that means no other agency, whether it 
is the SEC, the FERC, the USDA or the states may police the futures 
markets. Any other result would threaten the competitiveness of U.S. 
futures markets.
    This Subcommittee was the birthplace of the CFMA. That landmark 
legislation has allowed our markets to prosper and grow and even though 
FIA does not believe its full competitive promise has been realized, we 
would oppose major changes to the CFMA's framework. There are four 
specific substantive areas we expect the Subcommittee will consider in 
it deliberation and let me offer our views.
    SRO reform: FIA supports the important role the exchanges, clearing 
organizations and NFA perform as self-regulatory organizations. Their 
expert market knowledge and close proximity to the trading markets is 
vital to its effective oversight. However, as exchanges are moved 
successfully into the for-profit world, their public interest duties 
have come into conflict with their private interests. That has affected 
public confidence in self-regulation. To address this concern, the CFTC 
has proposed a series of best practice reforms for SROs, including a 
Safe Harbor for an exchange when 35 percent of its Board of Directors 
are independent public directors. The CFTC has proposed some modest 
revisions to its new guidelines. FIA strongly supports these SRO 
reforms and urges the Commission to implement them as soon as possible.
    Competition: Promoting fair competition was a goal of the CFMA. 
Although it has led to the creation of more new exchanges, it has not 
stimulated the kind of direct product competition that the CFMA 
envisioned and this is very disappointing. Competition leads to reduced 
costs, higher volumes, narrower spreads and greater innovation. 
Competition also is the best system for serving the interests of our 
customers. Exempt commercial markets, ECMs, in the energy space have 
been the one area of direct product competition under CFMA. ECM trades 
are principle-to-principle, not brokered, and my member firms are 
largely brokers, so you might expect me to oppose ECMs. We do not. We 
support them because ECMs serve as incubators for the successful 
training platforms of tomorrow. If you cut out ECMs, you cut out the 
competitive, innovative heart of the CFMA. With the merger of the 
Chicago Merc and the Board of Trade, some might argue that futures 
exchanges have become more concentrated than competitive and if this 
true, it is unfortunate because real competition leads to better 
service, lower fees for the customers.
    Recently we have seen clearing fees reduced for some financial 
markets, but not on U.S. futures exchanges. With the explosive growth 
in futures trading volume, my members have asked me why they have not 
enjoyed similar clearing fees reductions and I do not have a good 
answer. I do know that competition and market structures are critical 
issues for customer service. Unless competitive forces materialize in 
our markets, FIA believes the CFTC should study the state of 
competition in our industry to make sure that we have the best market 
structure in place for serving our customers.
    Energy: Everyone agrees that the price of energy is a critical 
element of our national economy. As a result of CFMA, our energy 
markets have experienced considerable innovation and increased 
competition without compromising the public interest. There is no 
regulatory gap for futures manipulation. The Commission uses a wealth 
of market surveillance techniques and an arsenal of enforcement weapons 
in its pursuit of what Chairman Lukken has labeled the agency's zero 
tolerance for price manipulation. FIA agrees with this emphasis. Price 
manipulation should be prevented whenever possible and never tolerated.
    Some have questioned how well existing anti-manipulation defenses 
work when more than one energy market exists. Multiple trading 
facilities, like NYMEX and ICE only enhance the need for strong CFTC 
oversight. When two markets are competing directly, the CFTC's market 
surveillance staff must have ready access to all relevant large trader 
reporting. At the same time, FIA believes price manipulation is of 
little concern in one-off, non-standardized transactions between two 
eligible contract participants where the price affects the individual 
transaction, not a wider market. Those transactions should remain 
outside the CFTC's price manipulation authority.
    Retail FX: FIA continues to support the legislation offered by the 
President's Working Group in 2005 to enhance the CFTC's power over 
retail FX transactions. This targeted, focused approach makes sense and 
should help the Commission to combat the boiler rooms and bucket shops 
that abuse customers.
    And in conclusion, our last part is a familiar one and a critical 
one. FIA opposes the funding of the CFTC through a transaction tax. All 
taxpayers benefit from CFTC market oversight, therefore all taxpayers 
should pay for it. If the CFTC needs additional resources, and we 
believe they do, the Administration should request and Congress should 
appropriate the necessary funds, but a transaction tax would hit 
hardest those traders that provide essential market liquidity. It is 
therefore a bad idea whose time should never come.
    Thank you for holding this hearing and I am happy to answer any 
questions.
    [The prepared statement of Mr. Damgard follows:]

  Prepared Statement of John M. Damgard, President, Futures Industry 
                     Association, Washington, D.C.

    Chairman Etheridge, Ranking Member Moran, Members of the 
Subcommittee, I am John Damgard, president of the Futures Industry 
Association (FIA). On behalf of FIA, I want to thank you for the 
opportunity to appear before you today. FIA is a principal spokesman 
for the commodity futures and options industry. Our regular membership 
is comprised of 35 of the largest futures commission merchants (FCMs) 
in the United States. Among our associate members are representatives 
from virtually all other segments of the futures industry, both 
national and international. Reflecting the scope and diversity of its 
membership, FIA estimates that its members serve as brokers for more 
than ninety percent of all customer transactions executed on United 
States contract markets.
    As these statistics indicate, the clearing firms are the backbone 
of FIA's membership. Not surprisingly, the clearing firms are also the 
backbone of the futures industry. These firms underwrite the financial 
performance of their customers and provide the billions of dollars in 
capital that makes the U.S. futures clearing system widely respected as 
the world-wide hallmark of financial integrity. The U.S. futures 
exchanges are remarkably successful and profitable enterprises, as the 
price of their stock reflects. The futures clearing firms are a big 
part of that success story, a part often overlooked and sometimes 
underappreciated.
    In 2000, Congress passed and President Clinton signed into law the 
Commodity Futures Modernization Act (CFMA). With the goal of promoting 
``responsible innovation and fair competition among boards of trade, 
other markets and market participants,'' the CFMA amended the Commodity 
Exchange Act to:

   Authorize the Commission to develop a regulatory program for 
        markets that would be ``tailored to match the degree and manner 
        of regulation to the varying nature of the products traded 
        thereon, and to the sophistication of the customer;''

   Remove the 20 year prohibition on futures on individual 
        securities and narrow-based securities index contracts and, in 
        another radical departure, provide for the joint regulation of 
        these products by the Commission and the Securities and 
        Exchange Commission; and

   Assure legal certainty for over-the-counter derivatives.

    The CFMA signaled a dramatic, new approach to the regulation of the 
derivatives markets and, as such, placed enormous demands on the 
Commission and its staff as they developed the regulations necessary to 
implement its myriad provisions. The CFTC has done, and continues to 
do, an admirable job administering the provisions of the CFMA and the 
Commodity Exchange Act as a whole, adapting its regulatory authority to 
the dynamics of an ever-changing and ever-challenging market place.
    FIA wholeheartedly endorses the reauthorization of the CFTC. While 
FIA and the CFTC do not see eye to eye on every issue, we believe the 
CFTC is an excellent Federal agency that discharges its statutory 
obligations in an efficient and effective manner. The CFTC's past and 
present leadership is to be commended for this record. The CFTC 
deserves to be reauthorized.
    Recently, a controversy has arisen concerning the scope of the 
Commission's exclusive jurisdiction. There should be no controversy. 
Exclusive jurisdiction was created in the House Agriculture Committee 
in 1974 to make sure that only the CFTC would regulate futures trading 
activity and conduct by futures exchanges, futures professionals and 
futures market participants. Congress made crystal clear in 1974 that 
the CFTC's jurisdiction, where applicable, supersedes the authority of 
other Federal agencies.
    Congress actually anticipated the seeds of the current controversy 
when it enacted exclusive jurisdiction. The Federal Energy Regulatory 
Commission claims its cash transaction anti-manipulation authority 
allows it to police the futures markets themselves because futures 
prices are used in entering into cash transactions. But Congress knew 
that one purpose of futures trading is to provide pricing information 
that non-futures market participants can rely upon in their commercial 
dealings. To this day, futures price dissemination is one of the 
Congressionally-recognized public interests served by futures markets. 
7 U.S.C.  5(a). Given that economic reality, Congress knew that if 
cash market regulators, like FERC, could stretch their policing arm 
into the futures markets, futures exchanges, professionals and market 
participants would be subjected to regulation from multiple Federal 
regulators, including the Securities and Exchange Commission, Bureau of 
Mines, the Department of Agriculture, the Department of the Treasury, 
the Board of Governors of the Federal Reserve System as well as FERC.
    Congress made a choice. In our view, the right choice. It said CFTC 
jurisdiction over futures was exclusive. The dictionary defines 
exclusive as ``not shared with others.'' Congress adopted CFTC 
exclusive jurisdiction because it wanted the CFTC's jurisdiction not to 
be shared with others in order to prevent U.S. futures markets, 
professionals and market participants from bearing the cost of 
``duplicative or conflicting'' regulation. And it wanted to entrust the 
nationally important economic activity in futures markets to the 
oversight of one expert regulator, the CFTC.
    For over thirty years, CFTC exclusive jurisdiction has achieved 
Congress' objective because courts have uniformly accepted that 
Congress used the word ``exclusive'' so that the CFTC's jurisdiction 
would not be shared with other agencies. For over thirty years, these 
exclusive jurisdiction cases have arisen in two contexts: (1) where a 
Federal or state regulator sought to punish alleged misconduct arising 
out of transactions within the CFTC's jurisdiction or (2) where a 
Federal agency, like the SEC, had approved options or futures products 
under its regulatory regime that were really subject to the CFTC's 
authority.
    The FERC's recent attempt to change the meaning of ``exclusive'' to 
``non-exclusive'' falls into the first category. No court has ever 
accepted the position advanced by FERC. And no court should. Exclusive 
jurisdiction is vitally important to the proper functioning of the 
futures markets. It must be preserved.
    FERC's latest assertion is that there is a regulatory gap in 
policing futures market manipulation. Nothing could be further from the 
truth. The CFTC has comprehensive, time-tested futures price anti-
manipulation authority. It vigorously enforces the law. FERC and the 
CFTC should work together. Each has enormous and important 
responsibilities. By double-teaming futures trading, however, FERC is 
actually diverting resources from those duties. Exclusive means just 
what it says. It was sound policy in 1974 and remains sound policy 
today.
    In terms of specific areas for reform of the existing regulatory 
structure, FIA is considering a few proposed areas of technical 
improvement. Rather than discuss them in detail at this time, FIA would 
prefer to focus on bigger picture issues and continue its dialogue with 
the Commission and others in the futures industry on the areas where 
modest reform would be helpful. Perhaps, in some areas, an 
administrative solution can be found and no statutory amendments will 
be necessary. In light of the Subcommittee's interest in moving a 
reauthorization bill, FIA will expedite this process so that the 
Subcommittee may give timely consideration to any amendments the 
Commission might recommend.
    At this stage of the process, we want to let you know the views of 
our members in four areas: (a) SRO Reform; (b) Competition; (c) Energy; 
and (d) Retail FX Transactions.

SRO Governance and Rule Approvals
    FIA supports the important role that the exchanges, clearing 
organizations and the National Futures Association (NFA) perform as 
self-regulatory organizations (SROs). Given their expert market 
knowledge and close proximity to the trading markets, they provide the 
best vantage point for addressing many of the futures markets' 
oversight functions. However, to be fully effective, there must be an 
increased degree of public confidence in the integrity and objectivity 
of SROs.
    The Commission, to its great credit, has conducted a comprehensive 
study of SROs in the futures industry, resulting in the promulgation 
last February of rules designed to reform SRO governance in many 
respects. FIA strongly supported the CFTC's efforts to get ahead of the 
curve on this issue and devoted considerable time and resources to 
answering the Commission's many inquiries on this subject over the 
years.
    The Commission's newly adopted ``best practices'' are a balanced 
and sensible work product that resulted from its careful study. In the 
context of a Safe Harbor for compliance with applicable core principles 
for Designated Contract Markets, the Commission has identified sound 
and constructive ``best practice'' guidelines for DCM Board 
composition, the development of independent Regulatory Oversight 
Committees and improvements in the DCM disciplinary process. Most 
significantly, the safe harbor would be available to any DCM with a 
Board of Directors comprised of at least 35% public (independent, non-
industry) board members.
    FIA believes the Commission's best practices constitute a major 
step toward addressing the conflicts of interest inherent in for-profit 
self-regulatory bodies. SROs that serve both the public interest and 
private interests necessarily serve masters that at least sometimes 
conflict. Adding public directors to the board of these SROs brings 
balance to the resolution of those conflicts, and avoids the public 
perception that DCMs will sacrifice public interest responsibilities 
for the commercial interests of their shareholder and members.
    The Commission published its final rules in this area in February 
and then proposed clarifying and technical amendments to the ``public 
director'' definition of its safe harbor. FIA strongly encourages the 
Commission to act as soon as possible on its proposed amendments and 
then implement fully its SRO reforms. FIA is confident these measures 
will increase public confidence in the self-regulatory protections 
afforded by DCMs under the CFTC's enlightened oversight.
    The Commission's SRO study and safe harbor do not directly address 
one other area where FIA has expressed concerns--self-certification of 
DCM rules. As the Subcommittee no doubt appreciates, DCM rules impose 
important and sometimes costly mandates on intermediaries and market 
participants alike. Often they can be as important as Commission rules 
which are adopted after full compliance with the Administrative 
Procedure Act with its notice and comment requirements.
    DCMs do not operate under any restrictions even approaching the 
APA. Their rule making procedures are often opaque to market 
participants and the public at large. Yet the CEA now allows SROs, 
primarily DCMs, to self-certify virtually all rule changes and make 
them effective immediately. (The only exception is for changes to terms 
and conditions of agricultural commodity futures contracts with open 
interest.) Commission prior approval of DCM rule changes is limited to 
those situations where a DCM affirmatively requests Commission 
approval.
    FIA generally does not quarrel with the decision to grant DCMs 
self-certification powers. We do have considerable concern, however, 
that in some cases virtually industry-wide trading rules and other 
important mandates, including fee changes, are being imposed on market 
participants and intermediaries, including clearing firms, without any 
Commission prior review and certainly without any form of APA notice 
and public comment. We would urge the Commission, when it is requested, 
or decides, to review any rule submission from any registered entity to 
publish the rule submission for notice and comment under the APA. The 
law is clear that Commission action on registered entity rules is 
agency action under the APA. FIA believes the CFTC must therefore 
follow the APA's requirements when it considers both new registered 
entity rules and changes to existing rules. Adding this level of 
transparency to the Commission's review process will further enhance 
public confidence in our markets.
    In some cases, the power to self-certify a rule change may be 
misread to override other powers and policies under the Act, especially 
when changes are made that affect trading in contracts with 
considerable open interest. Those changes have real financial 
consequences and should be subject to prior Commission approval. For 
years, the Commission has reviewed DCM emergency orders--applied by 
definition to trading in contracts with open interest--for many public 
policy reasons. Allowing the DCM's self-certification powers to 
circumvent these emergency procedures would seem to be counter-
productive. This is another area we wish to discuss with the new 
leadership at the Commission and the DCMs themselves to see if we can 
reach agreement on a workable resolution.

Competition
    Promoting fair competition should be the goal of any sound 
regulatory program. Our strong support for the CFMA in 2000 was based 
in substantial part on our belief that competition, rather than a 
prescriptive regulatory structure that established high barriers to 
entry, would be the best regulator. We fully anticipated that the 
CFMA's regulatory reforms would encourage new entrants to apply for 
designation with the Commission as contract markets or clearing 
organizations. These new SROs would compete among themselves and with 
the existing exchanges for customer business based on products, quality 
of execution and cost.
    The CFMA has sparked innovation and more new exchange applicants. 
But, except in the energy area, the direct product competition the CFMA 
had envisioned has not materialized. This is disappointing. Robust 
competition facilitates the ability of U.S. futures markets to serve 
the public interest. Competition leads to reduced costs, higher 
volumes, narrower spreads and greater innovation. Competition also is 
the best system yet devised for serving the interests of our customers. 
That should be the touchstone of our competitive goals.
    Promoting competition and innovation are the twin reasons FIA urges 
this Subcommittee to reject calls to eliminate the Exempt Commercial 
Market category in Section 2(h) of the CEA. The ECM category has 
stimulated most of the innovation in trading and clearing under the 
CFMA. ECMs are electronic trading markets for principal-to-principal 
trading in non-agricultural, non-financial commodities. While some ECM 
trades are cleared, they are not intermediated (brokered) in the 
traditional sense. My member firms are largely in the intermediation 
business and their bottom line is not necessarily well-served by non-
intermediated trading. Nonetheless, FIA still supports retention of the 
ECM category because it serves as an incubator for the successful 
trading platforms of tomorrow. Entrepreneurs and other challengers of 
established exchanges should be able to choose how they want to begin 
their business and what level of regulation is compatible short term 
and long term with their business objectives. If you cut ECMs out of 
the CFMA, you cut out the competitive, innovative heart of the CFMA.
    With the merger of the Chicago Mercantile Exchange and Chicago 
Board of Trade, some might argue that the futures industry has moved 
more toward concentration than competition. If that is true, FIA 
believes it would be very unfortunate. We know the new CME Group 
believes it faces real competition every day and we trust their 
apparent domination today will not stop them from innovating tomorrow.
    FIA is still hopeful that the CFMA formula of low regulatory 
barriers to entry through principles-based oversight will stimulate new 
trading platforms to compete with the traditional exchanges. 
Technological advances and globalization may inspire competition in 
areas we can't even predict today. After all, in 2000 who would have 
predicted that the ``winner takes all'' natural monopoly model for 
futures trading would be so discredited in the energy area today where 
the New York Mercantile Exchange and IntercontinentalExchange 
leadership match wits daily to try to gain a market advantage. Perhaps 
8 years from now or less, this form of vigorous direct competition will 
expand to other commodity areas beyond energy.
    If not, it may be appropriate to reconsider various market 
structure issues. Other competitive models exist in other financial 
trading markets, like the securities options world, which might have 
elements that could be adapted to the futures markets. For example, I 
have been asked by my members why the Options Clearing Corporation has 
been able to reduce its clearing fees in light of extraordinary trading 
volume, while the futures clearing fees have not experienced a similar 
reduction despite record futures volume. Is this difference because of 
administrative efficiencies, technology, ownership structure, 
governance or some other factor? At this point, I have to admit, I 
don't know the answer.
    What I do know is that competition and market structure are 
critical issues for customer service. We would urge this Subcommittee 
to ask the CFTC to study the state of competition among centralized 
trading platforms and clearing entities for derivatives products with 
an eye toward making sure the existing futures market structure is the 
best for serving our customers.

Energy
    Everyone agrees that the price of energy is a critical element of 
our national economy. For decades, energy futures have served our 
national interest by providing a means for efficiently managing and 
reliably discovering energy prices. The Commission should take pride in 
its effective oversight and stewardship of these markets.
    In recent years, energy markets have experienced considerable 
innovation and increasing competition, largely as a result of the CFMA. 
The CFMA has made it possible for new markets to compete with 
established exchanges. That competition has caused traditional 
exchanges to modernize through electronic trading or at least increase 
their pace of modernization. The CFMA has also encouraged innovative 
thinking by established exchanges and new trading platforms. The result 
is that those trying to manage energy price risks and those willing to 
assume those risks now have more choices than ever before. Indeed, one 
of the most popular recent innovations in energy--the ability to submit 
certain private bilateral energy transactions to regulated clearing 
entities--flowed directly from the CFMA's provisions. The importance of 
this innovation cannot be overstated. Those bilateral, but cleared, 
transactions on the New York Mercantile Exchange's ClearPort facility 
now comprise approximately 20-25% of that exchange's monthly volume.
    In our view, the CFMA has sparked these positive developments 
without compromising the public interest, including the vital interest 
in preventing price manipulation. The Commission continues to deploy a 
wealth of market surveillance techniques and an arsenal of enforcement 
weapons in its pursuit of what Chairman Lukken has labeled the agency's 
zero tolerance of price manipulation. These Commission tools include 
large trader reports, special calls, position limits, price 
manipulation enforcement actions and even sweeping, perhaps 
unprecedented market emergency powers. Clearly, the Commodity Exchange 
Act and the Commission's regulatory apparatus continue to target price 
manipulation as public enemy #1.
    FIA agrees with this emphasis. Price manipulation should be 
prevented whenever possible and never tolerated. The best defense 
against price manipulation is effective CFTC market surveillance based 
on all relevant large trader information. The Commission's recent 
proposal to confirm under its special call authority that large traders 
must maintain books and records for related non-reportable transactions 
is fully consistent with this philosophy. The Commission's proposal 
would even include trades on foreign boards of trade within this 
special call authority so that the Commission could obtain access to 
surveillance data from a large futures trader on both a U.S. exchange 
and a foreign exchange in the same commodity. The Commission's proposal 
illustrates that the agency's existing authority is substantial and 
adaptable to current market needs and conditions.
    Some have questioned how well the existing anti-manipulation 
defenses work when more than one energy derivative market exists. In 
FIA's view, multiple trading facilities, like NYMEX and the 
IntercontinentalExchange today in energy, only enhance the need for 
vigorous CFTC oversight. When two markets are largely competing 
directly, it is most important that CFTC market surveillance have ready 
access to all relevant large trader information.
    If we are to have same commodity competition among trading 
facilities, as the CFMA contemplated and FIA has espoused, then the 
Commission must conduct this kind of multiple market surveillance. This 
is perfectly consistent with the statute. In the CFMA itself, Congress 
signaled that promoting multiple trading platforms in energy 
derivatives did not mean that price manipulation prevention should be 
short-changed. Instead, Congress made clear in the statute that for any 
energy or other ``exempt commodity'' transactions conducted on a ``many 
to many'' trading facility--whether that facility was a DCM, DTEF, or 
ECM--the Commission was empowered to enforce the statute's prohibition 
against price manipulation.
    In contrast, Congress did not extend manipulation protections to 
bilateral, non-trading facility transactions in excluded or exempt 
commodities. FIA agrees with that congressional judgment, embodied in 
sections 2(d) and 2(g) of the CEA. Price manipulation is of little 
concern in one-off, non-standardized transactions between two eligible 
contract participants where the price affects the individual 
transaction, not a wider market. But where the pricing of trades would 
affect the interests of other market participants, or even others that 
base commercial transactions on futures market prices, the CFTC has an 
interest in preventing futures price manipulation. In those 
circumstances, the CFTC must be the cop on the beat.
    The Commission's traditional role as the exclusive regulator of 
futures transactions and markets actually compels this kind of 
comprehensive and vigilant multi-market surveillance approach. Multiple 
markets combined with multiple regulators would be a recipe for 
disaster. The slow growth of single stock futures in the U.S., relative 
to other countries, indicates that shared jurisdiction regimes may at 
least inhibit the development of viable trading markets.
    The Commission has in the past made its preeminence in U.S. futures 
market surveillance known to its sister regulatory agencies overseas. 
If a DCM and a foreign board of trade list for trading essentially the 
same contract, the Commission understandably coordinates its 
surveillance activities with foreign regulators. The Commission's 
experience with the Financial Services Authority and ICE Futures Europe 
illustrates how well this kind of cooperative information sharing 
approach can work in practice. The Commission is to be commended for 
establishing the necessary arrangements without overburdening market 
participants or sacrificing its legitimate surveillance needs.
    FIA recognizes that Congress is not clairvoyant and that market 
conditions change, especially in a world driven by changes in 
technology that come at us faster every day. We know the Commission 
will take whatever steps it determines to be appropriate to update its 
regulatory approaches consistent with its statutory authority. FIA 
understands it is possible that the Commission may decide that it lacks 
some needed authority in some areas and may therefore want to recommend 
to this Subcommittee some changes in those areas. Perhaps, as one major 
ECM has observed in a Congressional hearing, limited changes might be 
called for in the ECM area for some commodities in some circumstances 
where multiple markets exist. But the tests for any of these changes 
should be: are they essential for the performance of the CFTC's market 
surveillance function and are they the least intrusive means for 
achieving the required outcome?
    FIA does not believe that any statutory change should be a basis 
for leveling the so-called competitive playing field in energy or any 
other area. Congress has appropriately allocated regulatory oversight 
in the CEA based on differences in market participants, commodities 
traded, means of trading, intermediation and even impact on cash 
markets. FIA would not support any fundamental change to that 
regulatory alignment.

Retail OTC Foreign Currency Transactions.
    As the Subcommittee will recall, the CFMA amended the so-called 
Treasury Amendment based on a two-fold recommendation of the 
President's Working Group on Financial Markets. First, the CFTC would 
continue to have no jurisdiction over OTC foreign currency futures and 
options transactions effected between eligible contract participants, 
as defined in the Act (large, financially-sophisticated, well-
capitalized, or otherwise regulated market participants). Second, 
retail customers could effect OTC foreign currency futures and options 
transactions only if the customer's counterparty for those transactions 
was among a group of otherwise regulated entities, including banks, 
broker-dealers and futures commission merchants. Although not expressly 
stated in the amendments, OTC futures and options transactions effected 
between retail customers and counterparties that were not among the 
group of otherwise regulated entities would be subject to the exchange-
traded requirements of section 4(a) of the Act and, therefore, illegal. 
In order to enforce that ban, the CFTC would have to prove in court 
that the offending transactions were futures or options.
    It is important to stop here to emphasize that the CFMA provided 
the CFTC with these enforcement powers solely with respect to 
transactions that are futures or options on foreign currency. The 
amendments did not purport to grant the Commission jurisdiction over 
cash and forward contracts. Under the CFMA, the active cash and forward 
markets in foreign currency would continue to fall outside of the 
Commission's jurisdiction. (Historically, of course, cash and forward 
transactions on all commodities have been excluded from the 
Commission's jurisdiction.)
    In the past 7 years, many unregistered and unregulated entities 
have engaged in widespread sales practice and financial fraud in 
connection with off-exchange foreign currency transactions with retail 
customers. Some of these entities have attempted to avoid CFTC 
prosecution by claiming not to be offering futures on foreign currency. 
To the contrary, the agreements between these entities and their 
customers stated that these transactions would be conducted on the spot 
market. Nonetheless, applying a multi-factor approach first blessed by 
the 9th Circuit in CFTC v. Co-Petro Marketing Group, Inc., the 
Commission has taken the position that these transactions are futures 
transactions and, therefore, illegal.
    Some years ago the 7th Circuit's decision in CFTC v. Zelener 
concerning the legal tests for proving that a transaction is a futures 
contract called into question the Commission's jurisdiction. In that 
case, the court rejected the multi-factor futures definitional approach 
and, focusing solely on the terms of the customer agreement, held that 
the so-called ``rolling spot'' contracts offered by the defendants 
were, in fact, spot contracts and not futures contracts. Some claim 
this decision has created enforcement problems for the Commission.
    As FIA told this Subcommittee in 2005, we agree the CFMA's approach 
to granting the Commission enforcement jurisdiction over retail fraud 
in foreign currency (FX) transactions was imperfect. That is why we 
were pleased when the PWG came forwarded with a targeted solution to 
this problem in 2005, and we endorsed the PWG's proposal. While we have 
some technical suggestions for that legislative proposal, FIA continues 
to support the PWG's approach. It would expand the CFTC's enforcement 
powers to apply its antifraud authority to the offer and sale of 
Zelener-like FX contracts. And it would require those that solicit 
customer business in the retail FX area to be registered.
    FIA does not believe that further regulatory authority is needed at 
this time, but we understand that National Futures Association may 
offer some further refinements to shore up the PWG's language in some 
respects. We look forward to reviewing the NFA proposals in the retail 
FX area.

Conclusion
    Our last point is a familiar one and a critical one. Price 
manipulation is public enemy #1 because it affects both market 
participants and the public at large. Price manipulation can have a 
serious ripple effect in our economy and can hurt many innocent 
bystanders. That is why continued CFTC vigilance is so important.
    It is also why Commission regulation benefits not just market 
participants, but just as profoundly non-market participants. For that 
reason, FIA continues to be vehemently opposed to funding the CFTC 
through a transaction tax. In our view, all taxpayers benefit from CFTC 
market oversight. Therefore all taxpayers should pay for it. If the 
CFTC needs additional resources, the Administration should request and 
Congress should appropriate the necessary funds. But imposing an 
arbitrary and egregious tax that would be borne most by those that 
provide the liquidity that allows futures markets to serve so many 
public interests is a bad idea whose time should never come.
    Thank you for holding this hearing and for considering our views. I 
would be happy to answer any questions you might have.

    Mr. Etheridge. Thank you, sir. Ms. Becks.

     STATEMENT OF THERESA D. BECKS, MEMBER, MANAGED FUNDS 
  ASSOCIATION; PRESIDENT AND CEO, CAMPBELL AND COMPANY, INC., 
                           TOWSON, MD

    Ms. Becks. Chairman Etheridge and Members of the 
Subcommittee, thank you for inviting me to testify today. My 
name is Terri Becks. I am appearing today in my capacity as a 
Member of the Managed Funds Association, the MFA, of which I 
recently served on the Board of Directors. I am involved in MFA 
through my role as President and CEO of Campbell and Company, 
Inc. We are one of the oldest and largest futures trading 
advisers in the world.
    A little bit about MFA. It is the primary trade association 
representing professionals who specialize in the management of 
alternative investments. MFA members offer investment products 
that are not generally correlated to the performance of 
traditional stock and bond investments. These alternative 
investments help public investors, as well as more 
sophisticated investors diversify their portfolio. By taking 
speculative positions in alternative markets, these investments 
serve the markets as a whole by adding liquidity and acting as 
shock absorbers.
    MFA members have no competitive agenda. We simply want 
access to efficient, transparent, fair and financially secure 
markets. In that sense, the interests of MFA members have been 
well-served by the excellent work the CFTC and its staff have 
performed for many years. In order to continue to fulfill its 
unique role and important responsibilities, the CFTC must have 
sufficient funding to support a full and competent staff. 
Accordingly, MFA strongly supports reauthorizing the CFTC and 
providing the CFTC with additional resources.
    MFA members' interests have also been very well served by 
the Commodity Futures Modernization Act, landmark legislation 
that was authorized by this Subcommittee. MFA does not see a 
need for major changes to the CFMA. No case has been made to 
turn back the clock by re-regulating Exempt Commercial Markets 
that have served as an incubator for derivatives trading 
innovation. Although where the markets are linked, the CFTC 
should have authority to obtain large trader reports. We do 
agree with that suggested change.
    When creating the CFTC in 1974, Congress entrusted it with 
exclusive jurisdiction over futures markets to ensure that no 
other agency would look over its shoulder and second guess its 
regulatory judgments. If jurisdiction is shared either at the 
Federal or state level, market participants will find 
themselves facing, at worse, conflicting, and at best, 
duplicative government regulations. For this reason, MFA 
encourages the CFTC to assert vigorously its exclusive 
jurisdiction as Congress intended and the courts have 
interpreted. MFA members are acutely aware of the unwarranted 
cost and burden multiple regulators impose.
    One of the best examples of how multiple sources of 
regulation squelch innovation is the public commodity pool 
business. I am very familiar with that, as we sponsor our own 
public funds. Public commodity pools are the best vehicle 
through which retail investors can access the futures markets. 
These pools are managed professionally, allow investors to 
diversify their risks and provide an affordable futures-based 
product with a limited liability structure. Besides the CFTC, 
the SEC, the NFA, FINRA and each of the 50 states all regulate 
commodity pools. Multiple regulators impose a great cost upon 
commodity pools that is often not warranted by a cost benefited 
analysis.
    In addition to that, in all honesty, I find, in dealing 
with all the various regulators, there is a little bit of 
teaching that we have to do with those that are not familiar 
with things like the CFTC is on our specific investment 
vehicles. Another thing, for example, commodity pools are 
subject to the same record maintenance and Sarbanes-Oxley 
reporting requirements as Fortune 500 companies. SOX was not 
designed with passive investment pools in mind and its 
application to commodity pools is unwarranted. MFA recommends 
that public commodity pools be treated like investment 
companies for purposes of SOX under the same applicable 
exemption.
    Another example of over-regulation is FINRA RULE 2810. 
Prior to approving a public offering of commodity pools, FINRA 
calculates the underwriting compensation. It imposes a 10 
percent cap on such compensation. Previously, FINRA exempted 
from this calculation the payment trails for public commodity 
pools. That exemption reflected the additional service an 
associated person would provide to a pool investor due to the 
esoteric nature of commodity pools and market. In 2004 FINRA 
ended the exemption for pool trail commissions. FINRA believed 
that its action would not stop the offering of commodity pools 
to the public.
    However, since its action, we have seen fewer public 
commodity pools offered. As a practical matter, FINRA's actions 
have forced new commodity pools that would have been offered 
publicly to become private or not offered at all. In effect 
FINRA's actions deny public investors access to an attractive 
diversification in their investment alternatives. MFA believes 
that the trail commission experience and the duplicative filing 
requirements illustrate well the dangers of multiple regulators 
and the costs it imposes on market innovation. In your 
deliberations, MFA asks the Subcommittee to take these concerns 
into account and to consider any appropriate measures to help 
revive the public commodity pool business.
    Again, thank you for this opportunity to appear today and I 
would be happy to answer any questions that you have.
    [The prepared statement of Ms. Becks follows:]

     Prepared Statement of Theresa D. Becks, Member, Managed Funds 
 Association; President and CEO, Campbell and Company, Inc., Towson, MD

    Chairman Etheridge and Members of this Subcommittee, thank you for 
inviting me to testify today. My name is Terri Becks. I am appearing 
today in my capacity as a Member of the Managed Funds Association (the 
``MFA''), for which I recently served on the Board of Directors. I am 
involved in MFA through my role as President and CEO of Campbell & 
Company, Inc.--one of the oldest and largest futures trading advisors 
in the world.
About MFA
    MFA is the primary trade association representing professionals who 
specialize in the management of alternative investments, including 
hedge funds, funds of funds and managed futures funds. MFA has over 
1,400 members, including the vast majority of the largest hedge fund 
groups in the world who manage a substantial portion of the over $1.67 
trillion invested in absolute return strategies. Many MFA members are 
registered with the Commodity Futures Trading Commission (the ``CFTC'') 
as commodity trading advisors (``CTAs'') and commodity pool operators 
(``CPOs'').
    MFA has been a vocal advocate for sound and sensible public policy 
in this important sector of the financial world--a sector that provides 
many benefits to the global marketplace. Funds sponsored by MFA members 
offer investors the ability to diversify their portfolios in a 
meaningful way by providing investment products that perform in a 
manner that is not generally correlated to the performance of 
traditional stock and bond investments. 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. These investments also help 
them meet their future funding obligations and other investment 
objectives. MFA 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 remain on the sidelines. Fund trading activity also 
provides markets with price information, which translates into pricing 
efficiencies, and assists in identifying pricing inefficiencies or 
trouble spots in markets. Moreover, these funds utilize state-of-the-
art trading and risk management techniques that foster financial 
innovation and risk sophistication among market participants.
    As major customers of futures exchanges and futures commission 
merchants (``FCMs'') as well as purchasers of other futures industry 
services, many of MFA's members directly benefit from the provisions of 
the Commodity Exchange Act (the ``CEA'' or the ``Act'') and in 
particular, the reforms brought about by the Commodity Futures 
Modernization Act of 2000 (the ``CFMA''). The CFTC's oversight of the 
U.S. futures markets has an important impact on CPOs, CTAs and their 
clients. Furthermore, many aspects of MFA members' business operations 
(such as sales, promotional, registration and operational activities) 
are also subject to regulation by the National Futures Association (the 
``NFA'')--the industry's self-regulatory organization. The CFTC and the 
NFA oversee the business activities of CPOs and CTAs through 
registration, disclosure, anti-fraud, recordkeeping and reporting 
requirements, and periodic audits. Each of the futures exchanges also 
monitors trading activities of MFA members in their respective markets.
    Many of MFA's members are subject to regulation under other Federal 
statutes in addition to the CEA. The public offer and sale of interests 
in commodity funds are subject to the Securities Act of 1933 (the 
``1933 Act''), which requires registration of these interests and 
mandates certain disclosure obligations. Commodity funds are also 
subject to the Securities Exchange Act of 1934, which requires the 
filing of certain publicly-available reports as well as to the 
individual securities laws of each of the 50 states. Many of MFA's 
members are also subject to the anti-money laundering requirements of 
the USA PATRIOT Act of 2001. Unlike investment companies, many MFA 
members are also subject to all of the records maintenance requirements 
of the Sarbanes-Oxley Act of 2002 (``SOX'').
    MFA has a strong interest in the issues you are discussing today. 
MFA members trade on exchange and off exchange. We are neutral in any 
competitive battles that pit traditional exchanges against new trading 
platforms, or multi-lateral systems against bilateral dealer 
operations. Our members simply want access to efficient, transparent, 
fair and financially secure markets. In that sense, the interests of 
MFA members have been well served by the excellent work the CFTC and 
its staff have performed for many years.
    MFA members' interests have also been well served by the CFMA, 
landmark legislation that was authored in this Subcommittee. In that 
statute, Congress adopted a cascading regulatory approach with 
different levels of oversight assigned to trading in different 
categories of commodities, market participants and order execution 
facilities. The CFTC has been masterful in applying these new statutory 
provisions to allow new market forces to compete with traditional 
exchanges in a host of areas, especially in energy. MFA members have 
benefited from these CFMA-inspired innovations. Since the CFMA was 
passed, MFA has worked together with the CFTC on a number of important 
rulemaking projects. We believe the CFTC's efforts at reducing 
unnecessarily burdensome regulations, also a direct result of the CFMA, 
will continue to encourage greater use of futures products in the 
financial marketplace. Accordingly, we are delighted to be here today 
to discuss the importance of the CFTC to our industry and the statutory 
framework under which it operates. MFA strongly supports reauthorizing 
the CFTC.

Importance of the CFTC and the CFMA
    In order to continue effectively fulfilling the CFTC's unique role 
and important responsibilities, the CFTC must have sufficient funding 
to support a full, competent staff. Accordingly, MFA supports the 
CFTC's requests for additional resources.
    MFA does not see a need for major changes to the CFMA. No case has 
been made to turn back the clock by re-regulating new trading 
platforms, known as Exempt Commercial Markets (``ECMs''), that have 
served an incubator function for derivatives trading innovation. MFA 
understands that the CFTC's website has listed 19 ECMs that have been 
created since the CFMA was passed. Those markets operate as principals 
only, electronic trading venues for sophisticated well-capitalized 
market participants. MFA believes it is both appropriate and important 
to cultivate those innovative enterprises.
Exclusive Jurisdiction and the Avoidance of Duplicative Regulation
    When the CFTC was created in 1974, Congress entrusted it with 
exclusive jurisdiction over futures markets to ensure that no other 
agency--whether it be the SEC, USDA or the Bureau of Mines--would look 
over its shoulder and second-guess its regulatory judgments. Congress 
wanted an agency expert in futures markets to determine whether a 
threat of manipulation existed or some other major market disturbance 
caused futures market prices not to reflect accurately the forces of 
supply and demand. In short, Congress wanted the CFTC to be able to 
take appropriate action if it sniffed the possibility of manipulation 
in the air.
    Congress vested extraordinary emergency powers in the CFTC to 
address any such threat, powers the CFTC once called the linchpin of 
the Act. The CFTC has correctly used those powers very sparingly, but 
their existence serves a very important purpose. Exchanges and market 
participants alike know that the CFTC alone is ready to act when in its 
informed, expert judgment, action is warranted. That power can not work 
if it is shared with other regulatory bodies, either at the Federal 
level or the state level; nor can more than one agency police price 
manipulation in futures markets themselves.
    Otherwise exchanges, intermediaries, advisors, funds and other 
market participants will find themselves facing at worst conflicting, 
and at best, duplicative, government regulation, the very ills Congress 
sought to cure with exclusive jurisdiction. Multiple regulators sharing 
concurrent jurisdiction will not strengthen regulation. They will just 
water down regulation at a considerable cost to market participants.
    MFA encourages the CFTC to assert vigorously its exclusive 
jurisdiction as Congress intended and the courts have interpreted.

Public Offerings of Commodity Pools
    One of the best examples of how multiple sources of regulation 
squelch innovation is the public commodity pool business.
    Public commodity pools are the best vehicle through which retail 
investors can access the futures markets because these funds are 
offered through a full risk disclosure regime and provide an affordable 
futures-based product with a limited liability structure. Public 
commodity funds are one of the only alternative investment products 
available to public investors to diversify a traditional stock and bond 
portfolio. Public commodity pools are managed professionally and 
typically offer liquidity monthly--much more frequently than many other 
forms of alternative investments.
    The CFTC, of course, exercises regulatory jurisdiction over 
commodity pools. But its jurisdiction is far from exclusive. Commodity 
pools are also regulated by the SEC, NFA, the Financial Industry 
Regulatory Authority \1\ (the ``FINRA'') as well as state blue sky 
regulators.
---------------------------------------------------------------------------
    \1\ The Financial Industry Regulatory Authority is a self-
regulatory organization created in July 2007 through the consolidation 
of the National Association of Securities Dealers and the member 
regulation, enforcement and arbitration functions of the New York Stock 
Exchange.
---------------------------------------------------------------------------
    MFA believes that multiple sources of regulation have contributed 
directly to severe contraction of the public commodity pool offering 
market. Why? Regulation and over-regulation bear at least some of the 
responsibility. For example, unlike investment companies, commodity 
pools are subject to the same records maintenance and SOX reporting 
requirements as Fortune 500 companies. It is worth noting that public 
commodity pools have been subject to substantively similar oaths, 
recordkeeping and reporting requirements for more than 2 decades prior 
to the enactment of SOX. Unlike these requirements which were tailored 
specifically for public commodity pools, SOX applies broadly to 
operating companies. The unnecessarily complicated and duplicative 
requirements of SOX impose real costs to those that may want to offer 
new public commodity pools as variations exist between the SOX 
requirements and those requirements tailored for public commodity 
pools. MFA supports and encourages the treatment of publicly offered 
commodity pools like investment companies for purposes of SOX, 
providing exemptive relief that would promote competition.
    Moreover, public commodity pools are subject to both registration 
with and regulation by each of the 50 states which are often referred 
to as Blue Sky laws. Blue Sky registration and regulation impose a 
great cost that is often not warranted by a cost-benefit analysis. Blue 
Sky laws from one state sometimes contradict those from another state. 
Certain Blue Sky laws even conflict with Federal regulation. Blue Sky 
compliance therefore is an extra cost imposed on commodity pool 
offerings.
    FINRA RULE 2810 (also commonly referred to as ``Direct 
Participation Programs'' or ``DPP Rule'') is another example. It 
requires that, prior to the public offering of commodity pool 
securities, information must be filed with FINRA's Corporate Financing 
Department, who must then provide a ``no objections'' opinion. Before 
issuing this opinion, FINRA takes into account the proposed terms and 
arrangements of the DPP offering, including the level of underwriting 
compensation which may not exceed 10 percent of the gross proceeds of 
the offering.
    Prior to October 12, 2004, FINRA staff excluded the payment of 
trail commissions for commodity pool direct participation programs from 
the underwriting compensation limits of the DPP Rule if: (a) the member 
was registered as a FCM with the CFTC; (b) the associated person 
receiving the trail commissions passed one of two exams (the National 
Commodity Futures Examination (``Series 3'') or Futures Managed Funds 
Examination (``Series 31'')); and (c) the associated person receiving 
the trail commissions provided ongoing investor relations services to 
its investors. Trail commissions for public commodity pools were not 
included within the underwriting compensation because this money was 
seen as a service fee the investor paid to a qualified associated 
person in exchange for ongoing advice. This policy of excluding public 
commodity pools from the DPP Rule was based on the continuing and 
regular service the associated person would provide to keep the 
investor informed about the status of the investment due to the 
esoteric and complex nature of commodity pools and markets. In addition 
to encouraging associated persons to obtain Series 3 or Series 31 
certification, this treatment provided an incentive for associated 
persons to recommend public commodity pools to investors where 
appropriate as the trail commissions compensated him or her for the 
additional servicing required due in part to the nature of regular and 
frequent redemption opportunities.
    The trail commission is the portion of futures brokerage fee or 
commission charged by the FCM to the pool which is allocated to the 
associated person. FINRA lacks jurisdiction over the level of futures 
brokerage commissions and cannot regulate either the brokerage fee as a 
whole or its internal allocation within the brokerage firm. In any 
event, from the perspective of many public investors, trail commissions 
would not increase their cost. If trail commissions are unavailable, 
the FCM will simply charge the same brokerage commission to the pool, 
without allocating any portion of it to the associated person who sold 
the investment.
    In July 2004, FINRA acted on its belief that notwithstanding the 
limitation of including trail commissions as underwriting compensation, 
firms and registered representatives would continue to offer and 
recommend commodity pool DPPs. FINRA believed revocation of the trail 
commission exemption would benefit investors in commodity pool DPPs by 
limiting compensation to the same amounts that already applied to all 
other DPP investments. Thus, effective October 12, 2004, FINRA began 
including trail commissions in calculating whether the level of 
underwriting compensation exceeds the 10% limitation in the DPP Rule.
    Since FINRA began including trail commissions for commodity pools 
as underwriting compensation, fewer new public commodity pools have 
been offered. It seems clear that--contrary to FINRA's belief--firms 
and registered representatives have drastically reduced offering public 
commodity pools and have fewer public commodity pools to recommend 
where such products meet investors' financial status and investment 
objectives. As a practical matter, FINRA's actions have forced new 
commodity pools that would have been public offerings to become private 
offerings or not be offered at all. Because commodity pools are not 
available to many public investors when offered privately, many public 
investors are denied access to an attractive diversification investment 
alternative. In contrast to more sophisticated investors, the best 
diversification alternative available to these public investors is to 
invest directly in the futures market--a far riskier undertaking than 
public commodity pools. Ironically, public customers also pay full 
brokerage commissions to FCMs for such direct participation in a 
futures trading account, not the lower rates often charged commodity 
funds.
    MFA makes these observations both as a reminder of the perils of 
over-regulation through multiple regulation and to request the 
Subcommittee's consideration of appropriate measures that could be 
taken to revive the public commodity pool business.
    Again, thank you for this opportunity to appear today. I would be 
happy to answer any questions you may have.

    Mr. Etheridge. Thank you, ma'am. Mr. Brodsky.

  STATEMENT OF WILLIAM J. BRODSKY, CHAIRMAN AND CEO, CHICAGO 
            BOARD OPTIONS EXCHANGE, CHICAGO, IL; ON
           BEHALF OF U.S. OPTIONS EXCHANGE COALITION

    Mr. Brodsky. Thank you, Chairman Etheridge and Ranking 
Member Moran. I am William J. Brodsky, Chairman and Chief 
Executive Officer of the Chicago Board Options Exchange. Prior 
to my service at the Chicago Board Options Exchange, I was for, 
almost 12 years, CEO of the Chicago Mercantile Exchange, where 
I was obviously involved on the futures side of the business. I 
am also currently Chairman of the International Option Market 
Association, which represents 50 options exchanges around the 
world.
    I appear today, however, on behalf of the CBOE and the five 
other United States securities options markets, which include 
the American Stock Exchange, the Boston Options Exchange, the 
International Securities Exchange, the New York Stock Exchange 
and the Philadelphia Stock Exchange, as well as our 
clearinghouse, the Options Clearing Corporation, and together, 
we comprise the U.S. Options Exchange Coalition.
    And just by way of perspective, the U.S. options industry 
provides an increasingly important role in our economy. Last 
year the exchange listed option business grew at a 35 percent 
rate, which is higher than the stock business, the equity 
business, at 13 percent, and the futures business at 26 
percent. In addition, the volume on all the U.S. options 
exchanges is approximately the same as all the futures 
exchanges, so it keeps in perspective the size of our 
community, as well.
    In brief, we support reauthorization of the CFTC. We 
believe the CFTC has done a very good job. But we also believe 
that it is high time for a macro review of regulation of 
financial derivatives that recognize the overlapping 
jurisdiction in financial derivatives. And I would point out 
the fact that the Treasury is now undertaking a study which 
will include some of these issues.
    In addition, I would like to commend the Committee not only 
on CFMA of several years ago, but also your support 2 years ago 
of the vital issues on portfolio margining that helped spur the 
SEC to act on implementing a broad base portfolio margining 
pilot that unequivocally has made our securities markets more 
competitive. However, there are still many issues that Congress 
can address related to portfolio margining and other important 
topics. As I sit here today, it is clear that despite the best 
intentions of all the parties, the system of separating the 
regulation of futures and securities is broken and needs to be 
fixed.
    This creates regulatory inefficiencies, hampers U.S. 
competitiveness and impedes innovation. No other country in the 
developed derivative markets applies such a system of two 
different government agencies regulating equivalent financial 
products. While a merger of the CFTC and the SEC into a 
combined agency or the creation of a newer agency would address 
these issues, the mechanics and the politics of such a merger 
would be a long time goal. In the meantime, there are concrete 
steps that can be taken now to address the effects of split 
jurisdiction.
    First, Congress could end the current system of split 
Congressional oversight of the two agencies. Having both the 
SEC and the CFTC subject to the jurisdiction of a single 
Congressional Committee would help ensure the consistent 
oversight of financial regulators. Second, when jurisdictional 
disputes do arise between the SEC and the CFTC, there is 
currently no mechanism to resolve them other than a dialogue 
between the two agencies or litigation. Perhaps, if the SEC and 
the CFTC, despite their best intentions, find themselves at an 
impasse, they should seek the input of other members of the 
Presidential Working Group, specifically, the Treasury and the 
Fed, to resolve these issues promptly.
    But even assuming these steps are taken, the current 
regulatory system is impeding U.S. global competitiveness and 
innovation in several ways. Our major areas of concern are the 
following: One is new product approval process and the lack of 
legal certainty and the other is portfolio margining. The 
U.S.'s bifurcated regulatory system presents significant 
hurdles that must be overcome in connection with new product 
approval. When questions arise as to whether a particular new 
product is more properly a security or a future, the result can 
be an interminable delay in bringing that product to market 
while the two agencies try to decide who has the jurisdiction 
over the product.
    Two recent examples are illustrative. The first involves 
options on exchange traded funds that invest and hold gold. In 
June of 2005, the CBOE filed a proposal with the SEC to trade 
options on gold ETFs. The gold ETFs themselves have continued 
to trade as securities on securities exchanges. CBOE's related 
option proposal has not advanced because the SEC and the CFTC 
are still trying to agree, more than 2 years later, on which 
agency should regulate this option product.
    Another example, both the Chicago Mercantile Exchange and 
the CBOE began to trade credit default derivatives this year, 
but not before it took the SEC and the CFTC approximately 9 
months to determine how to allocate the jurisdiction of these 
two products between the two agencies and after a similar 
product began trading overseas. The bifurcated system also 
subjects our clearing agency, the Option Clearing Corp, to the 
jurisdiction of both the SEC and the CFTC every time it 
proposes to clear a new product. This process is time consuming 
and delays product innovation and effectively gives the CFTC a 
veto over the introduction of new securities products.
    There must be a means to ensure that the proposed new 
products that raise jurisdictional issues may be introduced to 
the market more promptly and efficiently. Perhaps other members 
of the Presidential Working Group could broker the 
jurisdictional issue in the case of an impasse. This could also 
be a recognition by the SEC and the CFTC of the circumstances 
such as where the underlying instrument is either a security or 
a future in which jurisdiction should not be a dispute.
    The second example involves portfolio margining. While 
earlier this year the potential availability of portfolio 
margining became greatly expanded, legal impediments to putting 
those futures positions in securities customers' accounts for 
portfolio margining still exist. Two important changes must 
occur in order to permit investors to avail themselves of the 
full potential of portfolio margining. First, Congress needs to 
amend the Securities Investor Protection Act so that futures 
positions in a customer's portfolio margining account are 
protected by SIPA insurance. Without a legislative change to 
SIPA, full evolution to a state-of-the-art portfolio margining 
system for customers may never occur in the U.S.
    Second, the securities industry and the futures industry 
have advocated different approaches to the issue of portfolio 
margining. Under the security industry's ``one pot'' approach, 
all securities and futures positions are maintained in a single 
portfolio margins securities account for the purpose of 
maximizing the utility of margin collateral in the account. 
Under the futures industry ``two pot'' approach, a futures 
account holds the futures position and the securities account 
holds the securities position for purposes of maintaining 
margin collateral. For a host of reasons, the Coalition 
believes that the ``one pot'' approach is the most efficient 
means of portfolio margining.
    To enable customers to use a single securities account for 
portfolio margining purposes, however, the CFTC will have to 
provide exemptive relief under the Commodity Exchange Act, yet 
as another example of the jurisdictional divide between the SEC 
and the CFTC, the two agencies continue to disagree on the most 
appropriate approach to implementing portfolio margining. If 
the agencies are unable to agree on the steps necessary to 
fully implement portfolio margining, as its most efficient 
``one pot'' level outlined above, Congress or the Presidential 
Working Group should step in to help facilitate a full-course 
margining for all securities products and their related 
futures.
    The Coalition and I stand ready to work with the Committee 
and its staff as they consider these important issues. I would 
be happy to answer any questions you may have and I would 
request that my full statement be entered into the record. 
Thank you very much.
    [The prepared statement of Mr. Brodsky follows:]

  Prepared Statement of William J. Brodsky, Chairman and CEO, Chicago 
Board Options Exchange, Chicago, IL; on Behalf of U.S. Options Exchange 
                               Coalition

    Mr. Chairman and Members of the Subcommittee, I am William J. 
Brodsky, Chairman and Chief Executive Officer of the Chicago Board 
Options Exchange (``CBOE''). I appear today on behalf of the CBOE and 
the five other United States options markets: the American Stock 
Exchange, the Boston Options Exchange, the International Securities 
Exchange, NYSE-ARCA, the Philadelphia Stock Exchange, and our 
clearinghouse, The Options Clearing Corporation (``OCC''). Together, we 
comprise the U.S. Options Exchange Coalition (``Coalition''). Our 
markets trade all the exchange-traded security options in the U.S., 
such as options on individual stocks, stock indexes, exchange-traded 
funds, debt securities, securities volatility, and foreign currency. 
These markets provide the major hedging instruments for the U.S. stock 
market.
    Chairman Etheridge, Ranking Member Moran and Members of the 
Subcommittee, I would first like to thank you for allowing the U.S. 
Options Exchange Coalition to provide its views on reauthorization of 
the Commodity Exchange Act (``CEA''). The U.S. options industry 
provides an increasingly important role in our economy. Last year 
exchange-listed options experienced a 35% growth rate, higher than both 
stock (13%) and futures (26%) trading. Additionally, the number of U.S. 
listed options contracts traded in 2006 approached the number of 
contracts traded in all U.S. futures markets combined. Through August 
2007, a record 1.82 billion option contracts changed hands in the U.S. 
options market, a 37.5% increase from the same year-ago period, and 
daily trading volume has averaged 10.8 million contracts up from 7.9 
million contracts at the end of August 2006, with a record 23.7 million 
options contracts being traded on August 16, 2007.
    This unprecedented growth could not have been possible without 
effective Congressional support and oversight of the U.S. commodity 
futures and securities markets and their regulators. In particular, I 
would like to commend this Subcommittee's exemplary work in the 109th 
Congress on reauthorization of the Commodity Exchange Act. While the 
reauthorization process was not completed, your support 2 years ago on 
vital issues such as portfolio margining helped to spur the U.S. 
Securities and Exchange Commission (``SEC'') to act on implementing a 
broad-based portfolio margining pilot program that will unequivocally 
make our securities markets more competitive. However, there are still 
issues Congress can address related to portfolio margining and other 
important topics, which leads me to comment at today's hearing.
    Above all else, let me stress that it is not our intention to 
impede, in any way, the reauthorization of the CEA. Rather, while you 
consider the various issues surrounding reauthorization, we urge you to 
consider our proposals, which we believe will benefit all U.S. 
financial markets and U.S. investors. We believe that actions can be 
taken now that will help to finally resolve issues that have persisted 
for over 30 years.
    Since the enactment in 1974 of amendments to the CEA, which gave 
the CFTC jurisdiction over all futures but also provided that the 
jurisdiction of the SEC was not otherwise superseded or limited, there 
have been conflicts between the two agencies as to their respective 
jurisdiction over novel financial instruments that have elements of 
both securities and futures or commodity contracts. In an attempt to 
resolve those conflicts, the CFTC and SEC agreed, through what became 
known as the Shad-Johnson Accord, to specify which financial 
instruments fell within each agency's jurisdiction. In 1982 and 1983, 
Congress codified the Shad-Johnson Accord through amendments to the CEA 
and the Federal securities laws.\1\ Although that legislation helped to 
provide legal certainty regarding each agency's jurisdiction in certain 
situations, it did not put an end to the jurisdictional disputes 
between the two agencies in all circumstances. Congress took a step 
toward this goal when it enacted the Commodity Futures Modernization 
Act of 2000 (``CFMA'').\2\ The CFMA established a delicate competitive 
balance between security futures (i.e., single stock futures) and 
security options, but the bifurcated system of regulation between all 
other security-based futures and securities still exists today.
---------------------------------------------------------------------------
    \1\ See Futures Trading Act of 1982, P.L. No. 97-444, 96 Stat. 2294 
(1983); Act of Oct. 13, 1982, P.L. No. 97-303, 96 Stat. 1409.
    \2\ P.L. No. 106-554, 114 Stat. 2763 (2000).
---------------------------------------------------------------------------
    Competitive forces and the demutualization of exchanges, among 
other factors, have caused the jurisdictional divide between the SEC 
and CFTC to widen dramatically in recent years. This lack of agreement 
between the two agencies has recently been called a ``jurisdictional 
balkanization'' by current SEC Chairman Christopher Cox. As I sit here 
today, it is clear that, despite the best intentions of all parties 
involved, the bifurcated system of regulating futures and securities is 
broken and needs to be fixed. This disjointed structure adversely 
affects the ability of U.S. exchanges to bring new products to market 
and to compete. Additional measures can and should be taken to 
streamline the regulation of these similar investment products.
    Competitive forces and the demutualization of exchanges, among 
other factors, have caused the jurisdictional divide between the SEC 
and CFTC to widen dramatically in recent years. This lack of agreement 
between the two agencies has recently been called a ``jurisdictional 
balkanization'' by current SEC Chairman Christopher Cox.\3\ As I sit 
here today, it is clear that, despite the best intentions of all 
parties involved, the bifurcated system of regulating futures and 
securities is broken and needs to be fixed. This disjointed structure 
adversely affects the ability of U.S. exchanges to bring new products 
to market and to compete. Additional measures can and should be taken 
to streamline the regulation of these similar investment products.
---------------------------------------------------------------------------
    \3\ See Grant, J., ``Lack of Consensus Dogs US Regulators,'' 
Financial Times (Aug. 26, 2007).
---------------------------------------------------------------------------
    In the view of the U.S. Options Exchange Coalition, competitive 
fairness requires that futures and comparable securities be regulated 
in a consistent manner. That, unfortunately, is not always the case due 
to the differing missions of the SEC and the CFTC. In general, the 
securities laws are designed to protect investors, provide full 
disclosure of corporate and market information, and prevent fraud, 
insider trading and market manipulation. By contrast, the commodities 
laws are designed to facilitate commercial and professional hedging and 
speculation and to oversee the price discovery process. These differing 
goals may come into conflict when applied to a particular situation in 
which both agencies have an interest.
    A prime example of this occurred recently in connection with the 
highly publicized problems surrounding Sentinel Management Group, Inc. 
Sentinel is both an investment adviser registered with the SEC and a 
futures commission merchant registered with the National Futures 
Association. When questions arose as to the disposition of certain 
funds held by Sentinel on behalf of various futures commission 
merchants (``FCMs'') and other clients, the SEC and the CFTC took very 
different positions. While the SEC sought to freeze the proceeds in all 
Sentinel accounts (which it asserted had been improperly commingled) 
for the ultimate benefit of injured investors (including, but not 
limited to, the affected FCMs), the CFTC sought to ensure that the FCMs 
were given access to their (or their customers') funds that had been in 
a segregated account in order to preserve the integrity of the futures 
markets and prevent a potentially broader, market-wide collapse. This 
lack of consensus between the two agencies so exasperated the U.S. 
District Court judge hearing the matter that he was quoted in the 
hearing transcript as saying, ``Why doesn't this agency of the 
government go over and talk to this [other] agency of the government 
and get your act together, for crying out loud?'' \4\
---------------------------------------------------------------------------
    \4\ Id.
---------------------------------------------------------------------------
    The current bifurcated regulatory system, under which futures and 
securities are regulated differently, has led to persistent negative 
consequences for our markets. The disjointed structure creates 
regulatory inefficiencies, hampers competitiveness, and impedes 
innovation. Because of the differing views of the two agencies, 
questions of jurisdiction with respect to new products--that is, is a 
new product a security or a future?--are rarely resolved quickly. Split 
jurisdiction and different governing statutes also lead to legal 
uncertainties, since a novel aspect of a new securities derivative 
product could cause the CFTC to claim that the product has elements of 
a futures contract, and a novel aspect of a new futures product could 
cause the SEC to claim that the product is a security. No other country 
with developed derivative markets applies such a system of two 
different government agencies regulating equivalent financial products.
    While a merger of the CFTC and the SEC, or the creation of one new 
agency that regulates both futures and securities, would address these 
issues, the mechanics of effectuating such a merger or creating a new 
agency make it a long-term goal. In the meantime, there are concrete 
steps that can be taken now to help bridge the sometimes wide divide 
between the two agencies and streamline the regulatory process. The 
Coalition believes that taking these actions will help to even out the 
competitive landscape, both domestically and between U.S. and foreign 
competitors, as well as provide for a more rapid way of resolving 
inter-agency disputes. As it considers the issues surrounding 
reauthorization of the CFTC, the Coalition strongly urges Congress to 
take these recommendations into consideration.
    First, rather than take the laborious step of merging the agencies, 
Congress could more easily end the current system of bifurcated 
congressional oversight of the two agencies. The various committees 
with jurisdiction over the CFTC and the SEC all have legitimate 
interests in, and concerns about, the operation of the U.S. financial 
markets, but sometimes the interests of one Committee may conflict or 
compete with those of another. Having both the SEC and the CFTC subject 
to the jurisdiction of a single congressional oversight Committee would 
go a long way to ensure consistent oversight of financial regulators. A 
single, unified Committee structure not only would decrease the 
likelihood of potentially contradictory direction, but also would 
enable Congress to address issues arising with these financial products 
more quickly and comprehensively.
    Second, when jurisdictional disputes do arise, there is currently 
no mechanism in place to resolve them other than a dialogue between the 
two agencies. This can lead to long delays in the decision-making 
process, which hinders competitiveness to the detriment of investors 
and our markets. This is not intended to imply that, when disputes do 
arise, either agency is not putting forth a good-faith effort to 
resolve them. Instead, each agency earnestly believes that it is 
properly applying its statute when analyzing a particular 
jurisdictional issue. The impasses that frequently arise may be the 
natural result of the differing, and sometimes conflicting, 
philosophies of the securities laws and the commodities laws. In such a 
case, however, a neutral arbiter is needed.
    To help the decision-making process move more rapidly, the 
President's Working Group on Financial Markets (``President's Working 
Group'') could and, we respectfully submit, should take a more 
affirmative role in resolving jurisdictional issues and in brokering 
disputes between the two agencies. The members of the President's 
Working Group, comprised of the Secretary of the Treasury (Chairman), 
the Chairman of the Board of Governors of the Federal Reserve System, 
and the Chairmen of both the SEC and the CFTC, are well-versed in the 
issues presented in such jurisdictional disputes. If the SEC and CFTC, 
despite their best intentions, find themselves at an impasse, they 
could seek input from the other members of the President's Working 
Group to resolve the issues promptly. Prompt resolution of 
jurisdictional disputes is extremely important in order to be able to 
bring new products to market quickly so that the U.S. capital markets 
can maintain their global competitiveness.
    Even assuming that these overarching steps are taken, the current 
regulatory system is failing to foster U.S. competitiveness in stocks, 
futures and security option products in several ways. Our major areas 
of concern today are the new product approval process and lack of legal 
certainty, jurisdictional issues and dual clearing agency regulation, 
and portfolio margining.
    The Coalition believes that steps can, and must, be taken in each 
of these areas, either by Congress or by the affected agency, that will 
improve the regulatory system governing stock, futures, and security 
options and keep our markets competitive in the global arena.

New Products
    The bifurcated regulatory system presents significant hurdles that 
must be overcome in connection with the new product approval process. 
When questions arise as to whether a particular new product is more 
properly a security or a future, the result can be an interminable 
delay in bringing that product to market while the two agencies try to 
decide who has jurisdiction over the product. As a result, a comparable 
product may begin trading overseas, while U.S. agencies are still 
attempting to resolve the jurisdictional issue.
    Two recent examples are illustrative. The first involves options on 
exchange-traded funds (``ETFs'') that invest in and hold gold. These 
ETFs are securities and were approved for listing by the SEC on the New 
York Stock Exchange and the American Stock Exchange in October 2004 and 
January 2005, respectively. Seeking to meet customer demand for an 
option on the gold ETFs, and assuming that an option on SEC-approved 
gold ETFs also would be considered a security, in June 2005, the CBOE 
filed a proposal with the SEC to trade options on gold ETFs. Though the 
gold ETFs have continued to trade as securities on securities 
exchanges, the related option proposal has not moved forward because 
the SEC and CFTC are still trying to agree, more than 2 years later, on 
which agency should regulate the product.\5\
---------------------------------------------------------------------------
    \5\ It should be noted that recently, in connection with a private 
letter ruling, the Internal Revenue Service agreed that gold ETFs were 
securities, and were not simply an ownership interest in the underlying 
metal. See Private Letter Ruling 200732036 (August 10, 2007).
---------------------------------------------------------------------------
    Another problem area has been the introduction of new credit 
derivative products. Both the Chicago Mercantile Exchange and the CBOE 
began to trade credit default products this year, but not before it 
took the SEC and CFTC approximately 9 months to determine how to 
allocate the jurisdiction of these products between the two agencies. 
The compromise reached by the two agencies, however, still did not 
provide legal certainty as to the basis for the allocation. Meanwhile, 
Eurex, a European Exchange, was able to introduce a competitive product 
overseas within weeks of announcing its intention to do so and before 
CBOE and CME could obtain the requisite approvals.
    There must be a means to ensure that proposed new products that 
raise jurisdictional issues may be introduced to the market more 
promptly and efficiently. Possible solutions could include the adoption 
of a time limit related to new product approvals and/or having the 
other members of the President's Working Group broker the 
jurisdictional issue in the case of an impasse after a certain amount 
of time. There also could be a recognition by the two agencies of 
certain circumstances--such as where it is clear that the underlying 
instrument is either a security or a future or a commodity option--in 
which jurisdiction should not be in dispute. For instance, if the SEC 
has already approved a new product as a security, and that security has 
been registered as such with the SEC, an option on that instrument 
should also be presumed to be a security, barring the opposite 
conclusion by the SEC after its review. If this presumption would have 
been applied to options on gold ETFs, those option products likely 
would have been brought to market long ago for the benefit of U.S. 
investors (and others) who had made this ETF a very actively-traded 
product.

Jurisdictional Issues and Dual Clearing Agency Regulation
    The options markets' clearing agency, OCC, clears exchange-traded 
derivative products, and is registered with both the SEC and the CFTC. 
OCC clears securities options, under the jurisdiction of the SEC, 
security futures, jointly regulated by the SEC and CFTC, and futures, 
under the jurisdiction of the CFTC. OCC is the only U.S. clearing 
organization with the ability to clear all of these products within a 
single clearing organization, and this provides the opportunity for 
greatly enhanced efficiency in the clearing process. However, this 
potential efficiency is seriously diminished by the dual regulatory 
structure.
    Because of this dual registration, OCC is subject to the 
jurisdiction of the CFTC, as well as that of the SEC, every time it 
introduces a new securities option product. Although the CFTC operates 
under a self-certification process by which OCC could certify that a 
particular new product does not fall within the jurisdiction of the 
CEA, there are cases where there is genuine ambiguity as to where the 
jurisdictional line lies. In such cases, OCC has felt compelled to ask 
for prior approval of both agencies in order to avoid the risk of 
litigation after trading has begun. While this may be ultimately 
effective in limiting that risk, it can also lead to protracted 
discussions between the two agencies. This process is time consuming 
and can lead to compromises that distort product development by forcing 
product design to be driven by jurisdictional considerations instead of 
economic ones. The lengthy process by which credit default options were 
brought to the market is an example of how this process is broken. And 
if no agreement can be reached at all, the exchanges and OCC are forced 
to either abandon the product--thus effectively allowing the CFTC a 
veto over a product proposed to be traded under the SEC's 
jurisdiction--or to incur the delay and expense of seeking a judicial 
resolution of the dispute.
    While the dual regulation of OCC may be inefficient, it does not 
create the jurisdictional conflicts which are inherent in a dual 
regulatory scheme that attempts to divide highly similar economic 
products between two regulatory agencies under two different statutes. 
If that scheme is perpetuated, then, at the very least, we need a 
single decision-maker who can act as a tie-breaker to bring about 
prompt and inexpensive resolution of any jurisdictional question. The 
courts are not an efficient vehicle for this purpose. As previously 
noted, we believe that the President's Working Group could provide a 
solution.

Portfolio Margining
    Earlier this year, the availability of portfolio margining was 
greatly enhanced for securities customers, including those who trade 
security futures, through expansion of an existing portfolio margin 
pilot program approved by the SEC.\6\ This expanded pilot includes 
equity options, security futures and individual stocks as instruments 
eligible for portfolio margining. The pilot enhances U.S. 
competitiveness by bringing the benefits of risk-based margining 
employed in the futures markets, and in most non-U.S. securities 
markets, to U.S. securities customers. The exchange rules approving 
this pilot also authorized the inclusion of related futures positions 
in securities customer portfolio margining accounts, often referred to 
as cross-margining. The ability to margin all related instruments in 
one account would allow customers to fully realize the risk management 
potential of these instruments in a way that is operationally 
efficient. However, legal impediments to putting those futures 
positions into a securities customer portfolio margining account exist 
and undercut significantly the ability of customers to fully realize 
the capital efficiency benefits of portfolio margining.
---------------------------------------------------------------------------
    \6\ See Exchange Act Release No. 34-54919 (Dec. 12, 2006), 71 FR 
75781 (Dec. 18, 2006); File No. SR-CBOE-2006-14; and Exchange Act 
Release No. 34-54918 (Dec. 12, 2006), 71 FR 75790 (Dec. 18, 2006); File 
No. SR-NYSE-2006-13. The effective date for these rule changes was 
April 2, 2007.
---------------------------------------------------------------------------
    As discussed below, two important changes must occur in order to 
permit investors to avail themselves of the full potential of portfolio 
margining. First, Congress needs to amend the Securities Investor 
Protection Act of 1970's (``SIPA'') current treatment of futures 
positions in a customer portfolio margining account. Second, the CFTC 
must provide exemptive relief from the CEA's requirements regarding 
segregation of customer funds.
    SIPA is the law which governs the activities of the Securities 
Investor Protection Corporation (SIPC). SIPC provides insurance to 
securities customers to protect them from losses caused by the 
insolvency of their broker-dealer. SIPC insurance does not extend to 
futures positions, other than security futures. Under SIPA, claims of 
securities customers take priority over claims of general creditors. 
There is a possibility, under current law, that a portfolio margining 
customer will be treated as a general creditor with respect to the 
proceeds from such customer's futures positions. The possibility of 
uneven treatment substantially lessens the likelihood that customers 
would want to include related futures products in their portfolio 
margining securities accounts, and would disincent those customers from 
taking full advantage of the efficiencies created from hedging related 
positions in a single account. Without a legislative solution, full 
realization of a state-of-the-art portfolio-based margining system for 
customers may never occur in this country. We advocate a targeted 
amendment to SIPA that would extend SIPC insurance to futures positions 
held in a portfolio margining account under a program approved by the 
SEC. A copy of our legislative proposal is attached. We ask the 
Committee's help in addressing this issue.
    Assuming that SIPC insurance coverage is extended to futures 
products held in a customer's securities portfolio margining account, a 
second step is necessary to fully implement portfolio margining. 
Currently, the securities industry and the futures industry are 
advocating differing approaches to the issue of portfolio margining. 
Under the securities industry's ``one pot'' approach, all securities 
and futures positions are maintained in a single portfolio margin 
securities account for purposes of maximizing the utility of margin 
collateral in the account. Under the futures industry's ``two pot'' 
approach, a futures account holds the futures positions and a 
securities account holds the securities positions for purposes of 
maintaining margin collateral. The Coalition believes that the ``one 
pot,'' single account approach is the most efficient means of portfolio 
margining for customers and their brokers.\7\ In order for customers to 
use a single securities account for portfolio margining purposes, 
however, CFTC action is required. Specifically, the CFTC will need to 
exempt futures products held in a securities portfolio margining 
account from the operation of Section 4d(a)(2) of the CEA. This 
provision requires that all funds and property (including securities 
held as collateral) in a customer's futures account must be segregated 
from all other funds and property, although it may be commingled with 
the property of other futures customers. Consequently, it prohibits the 
carrying of futures products and related customer property in a 
portfolio margining account regulated as a securities account and 
commingled with property other than the segregated funds of other 
futures customers. In order to facilitate cross-margining in securities 
accounts under the ``one pot'' approach, the CFTC would therefore need 
to promulgate a rule or issue an order exempting futures products in 
such accounts from the segregation requirements of CEA Section 4d(a)(2) 
to the extent necessary to permit them to be carried in a portfolio 
margin account and segregated pursuant to the SEC's customer protection 
rule. Once SIPC insurance is extended to futures positions held in a 
securities customer portfolio margining account, we intend to seek such 
an exemption from the CFTC.
---------------------------------------------------------------------------
    \7\ The ``two pot'' approach has been used at the clearing level to 
permit hedging between positions in Government securities and 
repurchase agreements in Government securities and various interest 
rate futures or futures on Government securities, but these 
arrangements have been limited to proprietary positions of member firms 
of the clearing agencies, not customer accounts. The ``two pot'' 
approach has never been developed for customer accounts at the firm, as 
opposed to clearing agency, level. The primary reason for this is that 
significant legal and regulatory issues would need to be resolved in 
order to implement a ``two pot'' approach for customers. See Letter 
from William H. Navin, Executive Vice President and General Counsel, 
OCC, to Ms. Nancy M. Morris, Secretary, Securities and Exchange 
Commission, re: Portfolio Margin and Cross-Margin Proposals: SR-NYSE-
2006-13 and SR-CBOE-2006-14, dated May 19, 2006.
---------------------------------------------------------------------------
    Highlighting the jurisdictional divide between the SEC and the 
CFTC, the two agencies continue to disagree on the most appropriate 
approach to implementing portfolio margining. In mid-2006, there were 
plans to establish a working group to help the agencies come to a 
consensus on whether the ``one pot'' or ``two pot'' approach should be 
implemented, but that effort appears to have stalled. Even without the 
input from this proposed industry working group, we strongly believe 
that the ``one pot'' approach is preferable and easier to implement.\8\ 
If the agencies are unable to agree on the steps necessary to fully 
implement portfolio margining at its most efficient ``one pot'' level 
as outlined above, Congress and/or the President's Working Group should 
step in to help facilitate full cross margining to all securities 
products and their related futures.
---------------------------------------------------------------------------
    \8\ We note that, even though it has expressed support for a ``two 
pot'' approach to portfolio margining, the Chicago Mercantile Exchange 
also has acknowledged that ``[t]he one pot approach generally provides 
the most optimal level of economic risk offsets . . . .'' See Letter 
from Craig S. Donohue, President, Chicago Mercantile Exchange, to Mr. 
Jonathan G. Katz, Secretary, U.S. Securities and Exchange Commission, 
re: SR-CBOE-2006-14; SR-NYSE-2006-13; Portfolio Margining and Cross 
Margining, dated May 9, 2006.
---------------------------------------------------------------------------
    Portfolio margining is another area where a lack of action here has 
placed U.S. markets at a competitive disadvantage to other markets that 
do not distinguish between securities and futures products.

Conclusion
    The U.S. Options Exchange Coalition believes that CFTC 
reauthorization provides an opportunity to bring needed change to the 
U.S regulatory landscape in order to promote the competitiveness of 
U.S. financial markets. Until major structural changes are made, 
Congress, the CFTC and the SEC should make targeted, discrete changes 
to the ways in which new products are approved for trading in the 
markets, and provide the means by which customers can fully utilize the 
benefits of portfolio margining. Taking these steps will help our 
markets remain the most competitive in the world.
    The Coalition, and I personally, stand ready to work with the 
Committee and its staff as it considers these important issues.
    Thank you again for the opportunity to testify at this important 
hearing. I would be happy to answer any questions that you may have.



Etheridge. Thank you. And I would say to all the panelists, your full 
statement will be entered into the record and thank you. We have just a 
few minutes and I am going to try to limit my time to less than 5 
minutes. If you will answer very quickly and hopefully, when we 
conclude here, I would say to you, at this point, that we are going to 
request that any other Members who want to submit questions, we will 
    get them and ask you to respond quickly so we can use that testimony.
Mr. Zerzan, you cited FERC's action challenging the CFTC's exclusive 
jurisdiction as an example of why the United Kingdom is beating the 
U.S. in the world of over-the-counter derivatives. However, from some 
of the figures you cite in your written testimony, the UK's lead 
existed long before FERC's action arose. Given the CFMA and its legal 
certainty with OTC swaps and its hands-off approach for most of the OTC 
market, what other explanations can you give for why the U.S. is losing 
derivative business and why you may be ready to blame Sarbanes-Oxley. I 
am interested in more derivative specific regulatory problems and the 
Sarbanes-Oxley is a problem that has a greater impact on the securities 
world. You can give me a quick answer.
    Mr. Zerzan. Yes, Mr. Chairman. I apologize if it appeared that I 
was directly linking FERC to the UK's lead. In fact, that was meant to 
be an example of the uncertainty that is often cited as to why 
businesses will trade in the UK as opposed to the United States. They 
feel there is a more certain regulatory environment in which they know 
what their potential liabilities are.
    Mr. Etheridge. Okay. You don't have a specific answer other than 
that? Okay. Let me move to Mr. Brodsky, much of the futures industry 
fears losing all the benefits of a principle-based regulatory approach 
that the CFMA provides the industry. Should the CFTC be combined with 
the SEC, additionally, there are other concerns about the SEC like 
those illustrated in the recent GAO report that found that the SEC 
enforcement division is too slow to take action on enforcement cases 
with \2/3\ of the investigations pending at the end of last year having 
begun 2 or 3 years earlier. Before we can talk merger, shouldn't 
Congress focus on improving the SEC first?
    Mr. Brodsky. You know, I think that this is a smoke screen to avoid 
an honest discussion about whether the agencies should be combined. If 
a division is inefficient, that is a micro problem. I am talking about 
the macro issue that we have virtually economic equivalent products 
being regulated by two agencies and all my colleagues on the panel 
complain about the concern about duplicative regulation and we suffer 
it right now. And whether I am before this Committee or the House 
Financial Services Committee or the comparable committees in the 
Senate, the issue is there and to pretend that it doesn't exist is not 
being fair to the American financial system. I think that these issues 
on principles-based are valid issues for discussion, but that is part 
of the review that I am urging that the Congress do.
    Mr. Etheridge. Thank you, sir. I yield to the gentleman from 
Kansas.
    Mr. Moran. Mr. Chairman, thank you very much. Much of our 
discussion with the first panel involved ECMs and I wondered if any of 
you would give us your synopsis of the solution to the level of 
regulation, if you believe additional regulation is useful, give us the 
key to what that regulation should be. Mr. Damgard.
    Mr. Damgard. I think the CFTC is working pretty closely with both 
NYMEX and ICE right now and it sounded to me, in their testimony, that 
you had with Mr. Sprecher and Dr. Newsome, very close to a solution. 
And I think, to sum it up, if a product that incubates in an ECM 
becomes the equivalent of a futures contract, then to prevent any kind 
of disparity in the regulatory system, they should still be able to 
have that choice. I mean, one of our points is competition is what is 
lacking in many of the areas of futures with the one exception of 
energy and we know customers are a whole lot better off because we have 
two viable markets at work. One of them is a regulated market and one 
of them is not. But to stamp out ECMs and try to drive everything onto 
an existing exchange simply would serve the purposes of furthering the 
lack of competition.
    Mr. Moran. I have additional questions, but due to the time 
constraints, I will submit them to you in writing and anyone else who 
would like to respond, as Mr. Damgard has, I would appreciate that and 
yield back the balance of my time.
    Mr. Etheridge. The gentleman from Georgia.
    Mr. Marshall. It looks like we are going to be able to get you all 
out of here and you won't have to wait for us to come back from votes. 
Thank you all for being here and for your testimony, most of which I 
missed, but I will read. Mr. Zerzan, I would simply remind you that 
after the last hearing that we had specifically on energy and we 
adjourned to the meeting room back there, you committed to me, and I 
hope you can live up to this commitment, that you would prepare some 
notes of the discussion and circulate those notes so that everybody 
would have an opportunity to comment on your take on what was said and 
argued and the positions that were taken. And it would certainly be 
helpful to the Committee to have that and is it possible for you to go 
ahead and do what we agreed you were going to do?
    Mr. Zerzan. I don't want to get your Chief of Staff in trouble, but 
I actually submitted those----
    Mr. Marshall. Oh, you did. Great. I appreciate that very much. Now, 
have they been circulated or am I supposed to do that?
    Mr. Zerzan. I don't know.
    Mr. Marshall. Okay, they haven't been circulated, so I will 
circulate to the other folks who were in that meeting. Thank you all. 
Thank you, Mr. Chairman.
    Mr. Etheridge. Thank you. Let me thank each of our panelists and I 
have a couple more questions I withheld and I will submit those to you 
and if you would respond to them. Let me thank you. Let me thank the 
Ranking Member. Each of you, for your testimony, for your help with the 
witnesses. And before we adjourn, a little bit of housekeeping business 
here. Under the rules of the Committee, the record of today's hearing 
will remain open for 10 days to receive additional material and 
supplemental written responses from witnesses to any question posed by 
a Member of the panel. This hearing of Subcommittee on General Farm 
Commodities and Risk Management is adjourned. Thank you very much.
    [Whereupon, at 12:17 p.m., the Subcommittee was adjourned.]
    [Material submitted for inclusion in the record follows:]
      
   Prepared Statement of Drew Niv, President and CEO, Forex Capital 
                       Markets LLC, New York, NY

    We thank the Chairman of the Subcommittee on General Farm 
Commodities and Risk Management, Bob Etheridge, the Ranking Member 
Jerry Moran, and the Members of the Subcommittee, for this opportunity 
to submit a statement for the record regarding the important issues 
facing Futures Commission Merchants and the fast growing industry of 
retail foreign exchange trading. My name is Drew Niv. I am the 
President and Chief Executive Officer of Forex Capital Markets LLC 
(FXCM). FXCM is regulated as a Forex Dealer Member by the National 
Futures Association. Forex Dealer Members are U.S. registered Futures 
Commission Merchants that have greater than 35% of revenue from foreign 
exchange.
    In 2001 retail online currency trading was regulated for the first 
time with the passage of the Commodity Futures Modernization Act of 
2000 (``CFMA''). This law required that any non-bank firm making a 
market in FX be registered and licensed by the Commodities Futures 
Trading Commission. This law was a step in the right direction and has 
greatly facilitated the growth of the retail forex market here in the 
United States. Indeed, FXCM was glad to see the CFMA become law and was 
the very first forex broker to be granted a license under its auspices 
in early 2001. Since then we have strongly supported the NFA and CFTC 
in their efforts to resolve many of the problems confronting the 
industry, including the ones that NFA President Dan Roth recently 
brought to the Committee's attention during his testimony on September 
26, 2007.
    However, there are two areas the CFMA did not address that are in 
need of the Congress' immediate attention. The first area is in regard 
to the absence of customer funds' segregation in the FX Industry. The 
second area relates to the continuing problem of unlicensed introducing 
FX brokers in the United States.
    The absence of customer funds protection in the United States is 
currently the most pressing issue the domestic FX industry faces. This 
is because the CFMA did not make any adjustments to the CFTC's 
``segregation rule'' when the law was implemented in 2001. The 
segregation rule stipulates that all client funds deposited for trading 
domestic, on exchange futures or options on futures be kept segregated 
from all company funds and that in the event of bankruptcy the 
customer's funds are legally segregated from creditors and must be 
returned to the clients. Because the segregation rule does not 
explicitly state that customer funds that are used to trade OTC 
derivatives, such as foreign exchange contracts, be segregated in the 
same manner these customers are in effect left completely unprotected. 
This is not the case in the other major financial centers where retail 
forex trading takes place, such as the United Kingdom, Canada and Hong 
Kong. The failure to amend the segregation rule to include CFTC 
registered Forex Dealer Members places customers are at a greater risk 
in the event of bankruptcy while simultaneously leaving the domestic FX 
retail industry at a severe competitive disadvantage to foreign Forex 
Broker Dealers.
    The issue is of the utmost importance to the forex trading 
community and as such I have included a letter that was submitted to 
Chairman Peterson earlier this year that was signed by some of the 
largest firms in the industry in support of customer funds' 
segregation.
    Customers can lose their funds not only when a legitimate firm goes 
bankrupt but when an illegitimate, unlicensed broker encourages naive 
investors into trading high risk futures contracts they know nothing 
about. One of the problems for retail foreign exchange trading has been 
the prevalence of get rich quick scam artists promising riches to 
customers with little knowledge of the market. The CFTC has been 
aggressive in putting such people out of business yet there are still 
thousands of unlicensed firms and individuals who can legally solicit 
customers to trade foreign exchange. Thus this glaring potential for 
fraud remains a constant in the FX market and continues to leave a 
black mark on industry as a whole.
    The best way to prevent this kind of fraud from happening is to 
mandate that anyone who solicits customers to trade FX be licensed with 
the CFTC. The CFTC already requires any non-bank firm that makes a 
market in foreign exchange be registered (unless they are exempt under 
the CFMA.) Yet the failure to hold others soliciting customers to these 
same standards is leading to a great deal of inefficiency in the 
industry. By mandating a licensing regime for anyone involved in the 
business of foreign exchange overnight the industry would be cleaned up 
as the CFTC would have a clear mandate to close down anyone not 
complying with the CFTC's registration requirement. As it is, the CFTC 
only acts after fraud has been committed and by then it is too late for 
customers to ever regain their funds.
    We recommend that the Congress do the following in order to redress 
the problems described earlier.
    (1) Amend the CFTC's ``segregation rule'' to include OTC 
derivatives (such as leveraged foreign exchange contracts) as part of 
the customer funds that cannot be legally co-mingled with company 
funds. Making this legal distinction will ensure that the trading 
public will not have to endure another RefcoFX bankruptcy debacle. 
Furthermore, it will inspire confidence in U.S. markets and make it 
easier for American firms to compete with overseas firms where these 
legal protections are already in place. (Please note: making such a 
legal distinction in no way means that we are advocating that the 
Federal Government should somehow insure the accounts of currency 
traders. The issue is merely about priority in bankruptcy. Right now 
currency traders have no priority in bankruptcy should their broker go 
bankrupt because their funds are not segregated by law. Therefore by 
requiring that brokers segregate customer funds we will give currency 
traders the same priority as do traders in Futures and Equities 
currently have should a futures or equity broker go bankrupt.)
    (2) Mandate that introducing brokers who refer customers to 
registered commission merchants be licensed by the National Futures 
Association and regulated by the Commodities Futures Trading 
Commission. Right now it is illegal to solicit someone to trade stocks 
or exchange traded futures contracts without a license. These same 
standards need to be applied to anyone soliciting retail customers to 
trade foreign exchange. This is the next logical regulatory step as the 
industry works towards greater transparency and increased protection of 
client funds.
    The domestic retail foreign exchange trading industry is one of the 
fastest growing industries in the nation today (five retail FX brokers 
made INC. Magazine's list of the fastest growing companies in America 
in 2006.) As such, it is important that the Congress keep pace with the 
growth of the industry by passing legislation that adequately protects 
the tens of thousands of investors who start trading in this fast 
growing market each year. Taking these actions lays an excellent 
foundation that can lead to the United States taking a position of pre-
eminence in this fast growing industry. Failure to take action will 
lead to the United States losing the battle, not because of inadequate 
technology or because of a lack of effort, but because of a regulatory 
environment deemed backward and unresponsive to the needs of the 
trading public.
    We look forward to working with this Subcommittee, other 
Congressional committees, the CFTC, the NFA, and the industry to 
address the important customer protection issues outlined above.

                               Attachment



Washington, D.C.

Questions From Hon. Bob Etheridge, a Representative in Congress From 
        North Carolina
    Question 1. Regarding the President's Working Group (PWG) suggested 
language to correct the ruling in the Zelener case, has the current 
Commission taken another look at the language to determine its 
adequacy. If not, do each of the current Commissioners believe the 
proposal is adequate or does any of them believe it should be modified 
in some way; and, if so, how?
    Answer. The Commission believes it is necessary to resolve the 
Zelener issue. The current Commission has not revisited this issue 
since 2005, when the House approved the PWG proposed Zelener language. 
The Commission as a whole has never opined on the proposed PWG 
language. As I testified at the September hearing, I believe it is 
critical to resolve the Zelener issue and that the PWG language is an 
appropriate solution. At least two Commissioners now believe that a 
broader fix would be appropriate.

    Question 2. As you know, Senator Levin has introduced legislation 
to amend the CEA with regard to regulation of exempt commercial markets 
(ECMs) that trade energy-based derivatives. I want to hear a comparison 
between that bill and your recommendations. Please provide a detailed 
side-by-side comparison.
    Answer. Senator Levin's bill (S. 2058) and the Commission's 
recommendations are directed to the same goal, though there are several 
differences in approach. For example, the triggers in Senator Levin's 
bill and the Commission's recommendations are generally similar--each 
looks to whether a significant price discovery function is being 
performed. But the Commission's approach keeps the CEA Section 2(h) 
framework for ECMs in place, with targeted add-on provisions for 
significant price discovery contracts in exempt commodities. Senator 
Levin's bill, by contrast, would establish a new category of registered 
trading platform for facilities trading price-discovery energy 
commodity contracts, which would be separate and apart from the ECM 
trading platform for other exempt commodities.
    The consequences that result from a finding of a significant price 
discovery function also differ. Under Senator Levin's bill, trading 
facilities that meet the price discovery test would be subject to 17 
Core Principles. By contrast, the Commission's recommendations focus on 
four key authorities: (1) large trader position reporting; (2) position 
limits and/or accountability levels; (3) self-regulatory oversight; and 
(4) emergency authority. This measured approach will preserve the role 
of ECMs as incubators for start-up markets and concepts, which several 
witnesses at our recent hearing said spurs competition and innovation.
    Finally, Senator Levin's bill calls for recordkeeping and reporting 
obligations with respect to U.S. screen-based trading in energy 
contracts listed on foreign boards of trade. The Commission has not 
made any similar recommendations, which are problematic in today's 
global marketplace. They also are unnecessary given the effectiveness 
of the Commission's recently-adopted Policy Statement regarding screen-
based trading in contracts listed on foreign boards of trade.
    Although these differences in approach make a precise side-by-side 
analysis difficult, a chart comparing Senator Levin's bill and the 
Commission's recommendations in general terms is attached.

    Question 3. Under CFTC Rule 36.3, exempt commercial markets must 
provide price, quantity, and other data on contracts that average five 
or more trades a day over the most recent quarter for which they are 
relying on the Commodity Exchange Act's exemption for these markets. 
The GAO report cites CFTC officials who say the agency does not 
actively check to determine whether that five or more trades a day 
threshold is being met on those exchanges that are relying on the CEA 
exemption but not providing information to the CFTC. Why isn't the CFTC 
conducting more checking to see if contracts on those markets are 
meeting the five a day threshold? Does an ECM have a responsibility in 
this area? What are the consequences, if any, to an ECM that fails to 
notify the CFTC that a contract has crossed the threshold?
    Answer. GAO is correct. The Commission does not have a regular rule 
enforcement review program in place to check ECMs for compliance with 
the five-trade per day reporting requirement. However, there are 
safeguards in place to ensure ECM compliance with this provision. 
First, Regulation 36.3(b)(1)(ii) itself places an affirmative 
obligation on ECMs to notify the Commission when they have a contract 
that exceeds the threshold. Second, Regulation 36.3(c)(4) requires each 
ECM to file an annual certification with the Commission that it is 
continuing to operate within the conditions of its exemption from 
having to register as a designated contract market (DCM). The terms of 
the Commission's ECM annual certification form make clear that these 
conditions include apprising the Commission of those contracts that 
meet the five-trade per day threshold.
    Finally, the consequences of failing to properly notify the 
Commission of a triggering of the reporting requirement are extreme--
there is a strong incentive for ECMs to honor this provision. ECMs that 
fail to apprise the Commission that they have triggered the reporting 
requirement run the risk of losing their exemption from DCM 
registration and expose themselves to a Commission enforcement action 
for operating an unregistered exchange pursuant to Section 4(a) of the 
CEA, for failing to comply with the reporting requirement of Regulation 
36.3(b)(1)(ii), and, likely, for making a false statement in a filing 
required under the Commission's regulations pursuant to CEA Section 
9(a)(3).

    Question 4. Assuming the PWG Zelener language became law, what 
specific sections of the Commodity Exchange Act--if any--would prevent 
someone from using the same Zelener-type contract but for natural gas, 
corn, wheat, or another commodity besides forex?
    Answer. The Commodity Futures Modernization Act of 2000 (CFMA) 
authorized off-exchange trading by retail customers only in foreign 
currency futures and options. It did not change the law for commodities 
other than foreign currencies. Thus, off-exchange futures trading 
activity involving retail customers in any other commodity (such as 
natural gas, metals, corn, or wheat) remains illegal under CEA Section 
4(a), which prohibits off-exchange trading in futures.
    Thus far, we have not seen the Zelener contract form, which the 7th 
Circuit held to be a spot contract, utilized for commodities beyond 
foreign currency. Further, the best means to address the Zelener 
issue--striking the necessary balance between cracking down on 
fraudsters while not interfering with legitimate businesses--may vary 
depending on the commodity involved. Accordingly, I believe that it is 
best to address the problem that is presently before us and that has 
been before us for the past several years--foreign currency.

    Question 5. The CFTC Reauthorization bill from last Congress would 
have required introducing brokers to register with the National Futures 
Association (NFA). In his testimony last month, Mr. Roth, President of 
the NFA proposed to expand this to include commodity trading advisors 
(CTAs) and commodity pool operators (CPOs). Can you talk about whether 
CTAs and CPOs current are registered with any regulatory body and 
whether the Commission thinks we need to require their registration 
with the NFA?
    Answer. The CFMA specified certain categories of entities that may 
act as counterparties to customers for off-exchange retail forex 
transactions. However, the CFMA was silent with respect to 
intermediaries for such transactions and provided that most of the CEA 
does not apply to such transactions. Thus, entities that act in a 
manner similar to that of introducing brokers, CPOs or CTAs with 
respect to these forex transactions are not required to register, as 
would be the case if they were intermediating exchange-traded 
transactions. The registration requirement in the proposed forex 
amendments submitted by the PWG and included in the Reauthorization 
bill passed by the House of Representatives in December 2005 was not 
limited to introducing brokers. It would require registration of any 
person who participates in the solicitation or recommendation of off-
exchange retail forex transactions.

    Question 6. Please provide the Subcommittee with a record of total 
dollar amount of fines levied by the Commission for each year starting 
with 2000. Please do likewise for the total dollar amount of fines 
actually collected.
    Answer.

                  Civil Monetary Penalties FY 2000-2008
------------------------------------------------------------------------
       Fiscal Year           Penalties Imposed      Penalties Collected
------------------------------------------------------------------------
             2000              $179,811,562              $3,299,362
             2001               $16,876,335              $3,170,252
           2002 1                $9,942,382              $5,922,387
             2003              $110,264,932             $87,699,077
             2004              $302,049,939            $122,468,925
           2005 2               $76,672,758             $34,237,409
             2006              $192,921,794             $12,321,530
             2007              $327,378,507             $11,897,033
           2008 3              $126,045,682                  $4,835
------------------------------------------------------------------------
1 Includes $30,005 for civil monetary penalties imposed in prior years.
2 Includes $617,409 for civil monetary penalties imposed in prior years.
3 Through October 2007. Pending $125,000,000 BP Settlement Collection.

    The discrepancy between the amount of civil penalties imposed and 
the amount collected is accounted for by the following factors: (1) 
when courts order the defendants to pay both restitution to victims and 
a civil monetary penalty to the Commission, established Commission 
policy directs available funds to satisfy customer restitution 
obligations first; (2) in fraud actions, it is not uncommon that the 
proceeds of the fraud have been dissipated and/or that the penalty far 
exceeds the defendants' represented financial ability to pay; (3) 
penalties assessed in default proceedings against respondents who are 
no longer in business and who cannot be located or are incarcerated; 
(4) penalties imposed in 1 year may not become due and payable until 
the next year; (5) a penalty may be stayed by appeal; (6) some 
penalties call for installment payments that may span more than 1 year; 
(7) penalties have been referred to the Attorney General for 
collection; and (8) collection still in process internally.

    Question 7. If the Commission were allowed to keep 10% of the fines 
its actually collects to fund IT upgrades, modernization, and 
improvements, would that make a significant difference in improving the 
CFTC's IT infrastructure--assuming there are no corresponding 
reductions on the appropriations side?
    Answer. Assuming there were no corresponding reductions on the 
appropriations side, any funds from penalties collected would improve 
our fiscal situation. In fiscal year 2006, we collected over $12 
million in penalties, which (assuming the Commission retained 10%) 
would translate roughly into $1.2 million. This amount would not fully 
fund our IT requirements, but would provide much needed fiscal relief.

Questions From Hon. Bob Goodlatte, a Representative in Congress From 
        Virginia
    Question 1. The CFTC report recommends that if an Exempt Commercial 
Market (ECM) has a significant price discovery function it should have 
position limits imposed on it. Would the policy on position limits on 
ECMs be similar to the policy on Designated Contract Markets (DCM) with 
limits on speculative trades, reduced limits near expiration and review 
or exemptions of positions held in excess of the limits for legitimate 
hedges? Would the imposition of position limits on ECMs stifle in any 
way the creativity offered by ECMs?
    Answer. We anticipate that ECMs would be subject to the same type 
of accountability-level/position-limit regime that is currently 
required of DCMs under DCM Core Principle 5, including the availability 
of hedge exemptions and spot-month position limits where appropriate. 
Accordingly, ECM contracts that became subject to such an 
accountability-level/position-limit regime would be treated in a 
similar manner to comparable DCM contracts under DCM Core Principle 5.
    As with any regulatory restriction, there is a possibility that 
position limits may impact ECM operations. However, the Commission's 
recommendation that an accountability-level/position-limit regime be 
imposed on ECM contracts that perform a significant price discovery 
function is a very discrete measure. This high standard has been 
carefully chosen to ensure that there are minimum safeguards in place 
to prevent the manipulation of contracts that could have a very real 
impact on the prices of commodities in interstate commerce--a goal that 
underpins the CEA and the statutory mandate of the CFTC.

    Question 2. If a contract trading on an ECM is deemed to provide a 
significant price discovery function, by what mechanism would the 
authority you are requesting be effectuated?
    Answer. We would anticipate that any amendments to the CEA that 
require additional obligations of ECMs when they list contracts that 
become significant sources of price discovery would themselves include 
rulemaking authority for the Commission to establish standards and 
procedures for making such determinations and for effectuating the 
authorities that result from such a determination. These rules also 
would set forth the specific procedures and guidelines that the 
Commission would follow in making such determinations. The Commission 
in establishing such standards and procedures would attempt to ensure 
that they had a high degree of objectivity, thus minimizing any legal 
uncertainty for ECM operations.

    Question 3. Additionally, who would make the determination that a 
contract trading on an ECM is serving a significant price discovery 
function? Over what time frame would you see the determination being 
made that a contract trading on an ECM is serving a significant price 
discovery function and that the additional authority needs to be 
implemented on this contract?
    Answer. We would anticipate that the Commission would be given the 
authority to make determinations as to whether ECM contracts are 
serving a price discovery function. We also anticipate that any price-
discovery determination would be based upon a contract's behavior over 
some reasonable length of time, as the Commission would want to avoid a 
situation where contracts are moving in and out of price-discovery 
status.

    Question 4. Last year the Commission testified that the changes 
proposed in Title 2 of HR 4473 (the CFTC reauthorization bill in the 
109th) specific to natural gas price transparency were not necessary. 
Has the Commission changed its position?
    Answer. We appreciated the bipartisan efforts of this Committee 
during the 109th Congress to address consumer concerns over volatility 
in the natural gas markets. The measures recommended in the 
Commission's ECM Report strike an appropriate balance in the regulatory 
approach to these issues. As indicated in the Report, we do not see a 
need to impose added regulatory requirements on over-the-counter (OTC) 
bilateral energy contracts. A targeted approach to ECM significant 
price discovery contracts will best address the regulatory concerns 
that have been raised while still allowing ECMs to serve as a venue for 
start-ups where innovative trading ideas can incubate and be tested.

    Question 5. What type of self-regulatory structure does ICE 
currently have?
    Answer. Currently, ICE, as an ECM, is not required by the CEA to 
have any oversight structures commonly associated with a self-
regulatory organization such as a DCM.

    Question 6. If an ECM and the CFTC were provided with emergency 
authority over a contract what could either do if fraud or manipulation 
were suspected or detected?
    Answer. Historically, the futures exchanges and the Commission have 
possessed broad authority under the CEA to address market emergencies. 
Under Section 8a(9) of the CEA, in an emergency, the Commission can 
require an exchange ``to take such action as in the Commission's 
judgment is necessary to maintain or restore orderly trading'' in a 
contract. This broad authority would permit the Commission to impose 
trading limits, or even require liquidation, to restore orderly trading 
conditions in the marketplace. Similarly, Core Principle 6 of the CEA 
requires that DCMs adopt rules to provide for the exercise of emergency 
authority, in consultation or cooperation with the Commission, 
including the authority to liquidate positions and suspend trading 
where necessary and appropriate. Having these emergency authorities 
available often enables Commission and exchange staff to work with 
market participants to prevent emergency situations from arising in the 
first instance. We would anticipate that these same authorities would 
apply to significant price discovery contracts traded on ECMs.

    Question 7. I, too, think the penalties under  9 should be 
increased to reflect the severity of the crime. Instead of limiting 
penalties to $1 million, why not make the sanction a factor of the 
illegally obtained profit? Perhaps we should allow for treble damages 
(Three times the amount of damage a judge/jury found the defendant to 
cause) like antitrust law calls for.
    Answer. In addition to CEA Section 9, Sections 6(c) and 6c of the 
CEA currently provide for penalty authority of ``not more than the 
higher of $100,000 [adjusted to $130,000 to account for inflation] or 
triple the monetary gain,'' whichever is higher. Accordingly, the CEA 
already contemplates the possibility of penalties based on illegally 
obtained profits, including treble damages.

    Question 8. You have testified, stated in press accounts, and told 
me in conversation that CFTC staffing levels have hit an all time low. 
In the 2000 modernization effort we authorized pay parity for the CFTC. 
How has this affected your staffing levels?
    Answer. Exempting the CFTC from Title V and authorizing pay parity 
with the FIRREA agencies has been crucial to recruiting and retaining 
professionals needed to oversee the complex futures markets. The 
Commission has implemented pay parity with funds appropriated by 
Congress. Since authorization, the Commission has, when necessary, 
sought funds to ensure that our pay structure and pay ranges are in 
line with the FIRREA agencies--and we are satisfied that they are.
    However, presently at the Commission, staffing levels are at an 
all-time historic low, and employee turnover has returned to the 
double-digit levels we had experienced prior to exemption from Title V. 
In the last 2 years, the Commission has lost over 100 employees, most 
of which were retirements of senior professionals. We need to improve 
in our ability to recruit, promote, retain, and reward good performers 
within the existing pay structure--and additional funds have been 
requested in FY 2009 for this effort.

    Question 9. If the Commission does not receive an increase in its 
appropriation, can the Commission augment its budget by imposing/
increasing registration fees or assessments on trades?
    Answer. The Commission has the authority to collect a number of 
fees related to our regulatory functions, such as contract market rule 
enforcement reviews and contract market designations. We have not 
interpreted this authority to extend to assessments on trades. The fees 
that we currently are authorized to collect are deposited in the 
General Fund of the U.S. Treasury.

    Question 10. What happens to the money collected through the 
Commission's enforcement activity?
    Answer. Funds collected from civil monetary penalties in CFTC 
enforcement actions are deposited in the General Fund of the U.S. 
Treasury. Funds collected from orders of restitution and disgorgement 
are distributed to injured victims.

    Question 11. Last month this Subcommittee received testimony that 
securities and futures should be regulated in a consistent manner. Do 
you care to comment?
    Answer. We support the notion of regulating securities and futures 
in a consistent manner wherever possible, and over the past several 
years the Commission has taken several steps to align our requirements 
with those of the SEC where that makes sense.
    But it must be remembered that these are different markets--the SEC 
regulates markets whose primary function is capital formation, whereas 
the CFTC regulates markets whose primary functions are price discovery 
and risk management. Sometimes, the different functions of the markets, 
and the correspondingly different statutory mandates of the SEC and 
CFTC under the securities laws and the CEA, require different 
approaches by the two agencies.
    For example, in the securities world, there are extensive 
disclosures required by the issuers of securities, i.e., public 
companies. In the futures markets, there are no ``issuers.'' The 
mandated disclosures to retail futures customers thus focus upon the 
risks common to all futures trading.

    Question 12. GAO testified that the Commission should more 
accurately report trading data for commercial versus non-commercial 
trades. The GAO highlights instances where commercial entities may 
actually place speculative trades but these trades are reported as 
commercial because the entity is a routine commercial trader. As a 
practical matter, can this be done given that entities are organized in 
any number of business units, they place trades in a variety of ways, 
and often establish proprietary methods for managing their company's 
risk? This would make standardizing the reporting in the manner 
recommended by GAO very difficult. What kind of problems can this 
detailed reporting create? What would happen if you reported with this 
type of specificity?
    Answer. Using current reporting methodology, this detailed breakout 
of speculative positions held by commercials is not possible. To 
accomplish this, it would probably be necessary to either (1) have 
every commercial firm set up a separate reporting account for 
speculative trading; or (2) report its positions directly to the CFTC 
(as opposed to the current large trader reporting system, where futures 
commission merchants report customer positions to the CFTC). Either of 
these changes would entail additional costs to traders. Yet, it is not 
clear that such a change would substantially improve the commitments of 
traders (COT) data, as we are not aware that there is a substantial 
amount of speculative trading by commercials.
    The main issue that the CFTC has faced with COT reporting is that 
commercial swap dealers hedge OTC activity (including OTC commodity-
index related activity) in futures markets. While this trading is 
hedging (i.e., it is to offset price risk), it is different than 
traditional hedging of underlying physical business.

    Question 13. Given the global growth of risk management and the 
futures industry, what is the CFTC doing with international regulatory 
bodies to coordinate efforts to prevent fraud and manipulation across 
the globe?
    Answer. The CFTC has a robust and long-standing international 
presence. We are an active member of the International Organization of 
Securities Commissions (IOSCO), which is a standard-setting body for 
securities and futures regulators. IOSCO coordinates regulators around 
the world to promote high standards of regulation, including 
surveillance and enforcement standards. Additionally, the CFTC has 
numerous enforcement arrangements to share information with our 
overseas counterparts and coordinate our enforcement actions as much as 
possible. In addition to the CFTC's 24 bilateral enforcement 
information sharing arrangements with foreign regulatory authorities, 
the CFTC also is a signatory to the IOSCO Multilateral Memorandum of 
Understanding that provides for the sharing of bank, brokerage, and 
client identification records among the international regulators. Most 
recently, the CFTC signed an MOU with the UK Financial Services 
Authority (FSA) in 2006 to share information on an on-going basis to 
help detect potential market abuses where contracts are linked by 
settlement provisions. Finally, this past October, the CFTC Division of 
Enforcement convened an international enforcement meeting with 
commodity regulators including participants from Europe, Asia, and 
South America. The meeting was focused on detecting and enforcing 
against anti-manipulative conduct, with the goal of enhancing the 
ability of the CFTC and its fellow regulators to detect and deter 
misconduct affecting commodity prices.

    Question 14. GAO has recommended the CFTC develop ``meaningful 
outcome-based measures'' to determine the agency's effectiveness. What 
type of improved measures have you explored? Has GAO provided you 
detailed suggestions on what ``meaningful outcome-based measures'' 
would be appropriate for an agency like the CFTC?
    Answer. GAO's conclusions were derived primarily from the OMB PART 
review, which recognized that the effectiveness of an enforcement 
program is not easily measured. GAO suggested that ``there are a number 
of . . . ways to evaluate program effectiveness, such as using expert 
panel reviews, customer service surveys, and process and outcome 
evaluations.'' The Commission has requested funding in the OMB FY09 
budget in order to explore alternate means to evaluate the 
effectiveness of the program.

Question From Hon. Nancy E. Boyda, a Representative in Congress From 
        Kansas
    Question. In our hearing in late September, Mr. Damgard, President 
of the Futures Industry Association, in his written testimony asked 
this Subcommittee and the CFTC to study the state of competition among 
centralized trading platforms and clearing entities for derivatives 
products with an eye toward making sure the existing futures market 
structure is the best for serving our customers. Does the Commission 
have any plans to look into this matter?
    Answer. Section 5b(c)(2)(N) of the CEA requires each derivatives 
clearing organization (DCO), unless appropriate to achieve the purposes 
of the CEA, to avoid (1) adopting any rule or taking any action that 
results in an unreasonable restraint of trade, or (2) imposing any 
material anti-competitive burden on trading. On an ongoing basis, the 
Commission reviews DCO rules and other actions for compliance with this 
provision. The Commission notes that this provision directs that 
competitive concerns be weighed in light of the other purposes of the 
CEA, such as maintaining the financial integrity of the markets. To 
date, the Commission has not identified an instance where a DCO has 
violated this provision. The Commission will continue to monitor DCO 
activity in this area.

                                                   Attachment
----------------------------------------------------------------------------------------------------------------
                                                                       CFTC Proposal significant price discovery
      Senator Levin's ``Close the Enron Loophole Act'' S. 2058                     contracts on ECMs
----------------------------------------------------------------------------------------------------------------
I. Energy Trading Facilities                                          Analogous Provisions in CFTC Proposal
                                                                       Applicable to Significant Price Discovery
                                                                       Contracts on ECMs.
  Section 2(a) of S. 2058 amends Section 1a of the CEA                Section 1 of the CFTC proposal amends
                                                                       Section 1a of the CEA.
    A. Adds definition of ``energy commodity'' as commodity           A. Adds definition of ``significant price
      1. used as source of energy such as crude oil, gasoline,         discovery contract'' as agreement,
    natural gas, and electricity, and                                  contract, or transaction subject to
                                                                       proposed CEA Section 2(h)(7).
      2. results from burning of fossil fuel
    B. Adds definition of ``energy trading facility''                 Not applicable to CFTC proposal.
      1. not a designated contract market (``DCM'')
      2. facilitates the execution or trading of agreements,
       contracts, or transactions in an energy commodity AND
        a. facilitates the clearance and settlement of agreements,    Not applicable to CFTC proposal.
         contracts, or transactions in an energy commodity; or
        b. the Commission determines performs a significant price     CFTC to determine whether contract
         discovery function for energy commodities listed on a         performs a significant price discovery
         trading facility or in the cash market. Factors for the       function. Proposed CEA Section 2(h)(7)(A)-
         CFTC to consider:                                             (B).
          (1) extent to which price of an agreement, contract, or     Similar provision in CFTC proposal.
           transaction is derived from or linked to the price of a     Proposed CEA Section 2(h)(7)(B)(i)(I).
           futures contract traded on a DCM
          (2) extent to which cash market transactions are directly   Similar provision in CFTC proposal.
           based on the prices in the same energy commodity traded     Proposed CEA Section 2(h)(7)(B)(ii).
           on the energy trading facility
          (3) the volume of contracts traded on the trading facility  Similar provision in CFTC proposal.
                                                                       Proposed Section 2(h)(7)(B)(iii).
          (4) extent to which data is published after completion of   Similar provision in CFTC proposal.
           transactions                                                Proposed CEA Section 2(h)(7)(B)(ii).
          (5) extent to which arbitrage market exists between the     Similar provision in CFTC proposal.
           trading facility and the DCM                                Proposed CEA Section 2(h)(7)(B)(i)(II).
          (6) other factors Commission deems appropriate              Similar provision in CFTC proposal.
                                                                       Proposed CEA Section 2(h)(7)(B)(iv).
----------------------------------------------------------------------------------------------------------------
II. Section 2(b). Oversight of Energy Trading Facilities              Analogous Provisions in CFTC Proposal.
  A. Section 2(b)(1) of S. 2058 amends CEA Section 2(h)(3) to         Not applicable to CFTC proposal.
   exclude
    ``energy trading facility'' from qualifying as an exempt
     commercial market in order to make clear that those facilities
     must comply with new CEA Section 2(j)
  B. Section 2(b)(2) of S. 2058 adds a new Section 2(h)(7) to the     Not applicable to CFTC proposal.
   CEA. This
    new section provides that notwithstanding any other provision of
     CEA, an energy trading facility and persons trading on an
     energy trading facility are subject to the new CEA Section 2(j)
----------------------------------------------------------------------------------------------------------------
III. Section 2(c). Criteria for Trading Facility Registration         Analogous Standards for Significant Price
                                                                       Discovery Contracts.
      1. New Section 2(j)(4)(A) requires a trading facility to have   Adds proposed CEA Section 2(h)(7)(C)(ii)
       the capacity to prevent price manipulation, excessive           Core Principle applicable to significant
       speculation, price distortion, and disruption of the delivery   price discovery contracts--ECM must have
       or cash-settlement process                                      market surveillance, compliance, and
                                                                       disciplinary practices and procedures.
      2. New Section 2(j)(4)(B) requires a trading facility to        Adds proposed CEA Section 2(h)(7)(C)(ii)
       monitor trading to prevent price manipulation, excessive        Core Principle applicable to significant
       speculation, price distortion, and disruption of delivery or    price discovery contracts--monitoring of
       cash-settlement prices                                          trading to prevent market manipulation,
                                                                       price distortion, and disruptions of the
                                                                       delivery or cash-settlement process.
      3. New Section 2(j)(4)(C) requires a trading facility to list   Adds proposed CEA Section 2(h)(7)(C)(i)
       contracts not susceptible to manipulation                       Core Principle applicable to significant
                                                                       price discovery contracts--not readily
                                                                       susceptible to manipulation.
      4. New Section 2(j)(4)(D) requires a trading facility that      Not applicable to CFTC proposal.
       facilitates clearance and settlement by a derivatives
       clearing organization (``DCO'') must establish and enforce
       rules requiring financial integrity of contracts
      5. New Section 2(j)(4)(E) requires a trading facility to        Adds proposed CEA Section 2(h)(7)(C)(iii)
       establish and enforce rules for obtaining information           Core Principle--ability to obtain
                                                                       information.
      6. New Section 2(j)(4)(F) requires a trading facility to adopt  Adds proposed CEA Section 2(h)(7)(C)(iv)
       position limits or accountability levels to reduce threat of    Core Principle--position limitations or
       price manipulation, excessive speculation, price distortion     accountability.
       or delivery or cash-settlement process
      7. New Section 2(j)(4)(G) requires a trading facility to adopt  Adds proposed CEA Section 2(h)(7)(C)(v)
       rules for emergency authority including to (i) liquidate open   Core Principle--emergency authority,
       positions; (ii) suspend or curtail trading; and (iii) require   including authority to (i) liquidate open
       market participants to meet special margin requirements         positions, and (ii) suspend or curtail
                                                                       trading in contract.
      8. New Section 2(j)(4)(H) requires a trading facility to        Adds proposed CEA Section 2(h)(7)(C)(vi)
       arrange for daily publication of trading information            Core Principle--daily publication of
                                                                       trading information.
      9. New Section 2(j)(4)(I) requires a trading facility to        Adds proposed CEA Section 2(H)(7)(C)(vii)
       establish and enforce rules to deter abuse                      Core Principle--compliance with rules.
      10. New Section 2(j)(4)(J) requires a trading facility to       Not applicable to CFTC proposal.
       establish rules for recording and safe storage of trading
       information
      11. New Section 2(j)(4)(K) requires a trading facility to       Not applicable to CFTC proposal.
       establish rules about trading procedures for entering and
       executing orders
      12. New Section 2(j)(4)(L) requires a trading facility to       Adds proposed CEA Section 2(h)(7)(C)(vii)
       insure compliance with the rules                                Core Principle--compliance with rules.
      13. New Section 2(j)(4)(M) requires a trading facility to       Not applicable to CFTC proposal.
       disclose to the public and the Commission information about
       contract terms, trading conventions, financial integrity
       protections, etc.
      14. New Section 2(j)(4)(N) requires a trading facility to       Not applicable to CFTC proposal.
       establish fitness standards for directors and members of
       disciplinary committees
      15. New Section 2(j)(4)(O) requires a trading facility to       Not applicable to CFTC proposal.
       establish rules governing conflicts of interest in the
       decision making process
      16. New Section 2(j)(4)(P) requires a trading facility to       Not applicable to CFTC proposal.
       maintain all business records for 5 years
      17. New Section 2(j)(4)(Q) requires a trading facility to       Not applicable to CFTC proposal.
       avoid adopting rules that create an unreasonable restraint of
       trade or impose anti-competitive burdens on trading on the
       facility
  B. Criteria for Energy Trading Facilities--new section 2(j)(5)      Core Principles apply to ECMs trading
   provides that an energy trading facility must continue to comply    significant price discovery contracts on
   with all of the criteria in section 2(j)(4) to continue             an ongoing basis. Violations of the
   operation, and that violation of any criteria shall constitute a    provisions of proposed CEA Section
   violation of the CEA.                                               2(h)(7) constitute violations of the CEA.
  C. Position Limits and Accountability--new section 2(j)(6) directs  Adds proposed CEA Section 2(h)(7)(C)(iv)
   the Commission                                                      Core Principle--position limitations or
     1. to ensure that the position limits and accountability levels   accountability. Also, amends CEA Sections
      that are established for energy trading facilities are on a      4g and 4i regarding recordkeeping and
      parity with the position limits and accountability levels        large trader reporting, and Section 8a
      established for similar contracts traded on a DCM and applied    regarding emergency authority, for
      in a functionally equivalent manner,                             significant price discovery contracts.
      2. to take action as necessary to reduce potential threat of
       price manipulation, excessive speculation, price distortion
       or disruption of delivery or cash-settlement process, and
      3. to obtain information from a trader regarding the trader's
       exchange and off-exchange positions.
  D. Criteria for Commission Determination--new section 2(j)(6)(D)    Not applicable to CFTC proposal.
   specifies criteria the Commission or exchange may consider when
   determining whether to require a trader to limit, reduce, or
   liquidate a position including:
      1. person's open interest relative to the total open interest
      2. daily volume of contract
      3. person's overall position in related contracts, including
       options, and the overall open interest or liquidity in the
       related contracts and options
      4. potential for positions to cause or allow price
       manipulation, excessive speculation, price distortion, or
       disruption of delivery or cash-settlement process
      5. person's compliance record
      6. any justification provided by person for such position, and
      7. other factors as deemed appropriate by Commission
  E. Information for Price Discovery Determination--Section 2(d)      Conforming amendment (d) amends Section
   amends other provisions of the CEA to enable the Commission to      2(h)(5) to extend CFTC's special call
   obtain information from an electronic trading facility or a         authority for ECMs to obtaining
   derivatives transaction execution facility to evaluate whether      information to make a significant price
   the energy trading facility performs a price discovery function     discovery determination. Also,
                                                                       significant price discovery determination
                                                                       process subject to CFTC rulemaking
                                                                       authority under proposed CEA Section
                                                                       2(h)(7)(A).
----------------------------------------------------------------------------------------------------------------
IV. Section 3. Reporting of Energy Trades                             Analogous Provisions in CFTC Proposal.
  A. Section 3 of S. 2058 adds a new CEA section 2(K) which requires  Not applicable CFTC proposal.
   U.S. persons who trade certain energy contracts on a foreign
   board of trade (``FBOT'') to keep records and to report large
   trades.
----------------------------------------------------------------------------------------------------------------
V. Antifraud Authority                                                Analogous Provisions in CFTC Proposal.
  A. Section 4 of S. 2058 amends Section 4b of the CEA to clarify     Outside scope of proposal regarding
   the CFTC's authority to bring fraud actions in off-exchange         significant price discovery contracts
   principal-to-principal futures transactions.                        trading on ECMs; CFTC supports including
                                                                       this provision as part of CFTC
                                                                       reauthorization.
----------------------------------------------------------------------------------------------------------------
VI. Commission Rulemaking                                             Analogous Provisions in CFTC Proposal.
  A. Section 5 of S. 2058 requires the CFTC to issue proposed rules   Adds proposed CEA Section 2(h)(7)(A)
   within 180 days regarding requirements for an application for       requiring CFTC rulemaking to implement
   registration for an energy trading facility. CFTC must finalize     the provisions of this legislation.
   rule within 270 days.
----------------------------------------------------------------------------------------------------------------
VII. Conforming Amendments                                            Analogous Provisions in CFTC Proposal.
  A. Section 2 of S. 2058 includes various CEA conforming amendments  Adds conforming amendments to :
   to provide a comparable degree of CFTC authority over operations     CEA Sections (2)(a)(1)(A)--exclusive
   of registered energy trading facilities as exists with respect to     jurisdiction over significant price dis-
   DCMs.
                                                                        covery contracts on ECMs;
                                                                        CEA Section 2(h)(4)(D)--remove existing
                                                                         significant price discovery function
                                                                        provision applicable to ECMs in light of
                                                                      new Core Principle in CEA
                                                                        Section 2(h)(7)(C)(vi) requiring daily
                                                                      publication of certain trading informa-
                                                                        tion;
                                                                        CEA Section 5c--issuance of CFTC
                                                                         interpretations regarding compliance
                                                                         with
                                                                        Core Principles, delegation of functions
                                                                      under Core Principles, violations of
                                                                        Core Principles;
                                                                        CEA Section 8a--authority to alter or
                                                                         supplement rules of the trading
                                                                         facility
                                                                        and to share information with the
                                                                      trading facility.
----------------------------------------------------------------------------------------------------------------

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