[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]




 
                      THE EFFECTIVE REGULATION OF
                          THE OVER-THE-COUNTER
                           DERIVATIVES MARKET

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

                                HEARING

                               BEFORE THE

                    SUBCOMMITTEE ON CAPITAL MARKETS,

                       INSURANCE, AND GOVERNMENT

                         SPONSORED ENTERPRISES

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                               __________

                              JUNE 9, 2009

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 111-41


                  U.S. GOVERNMENT PRINTING OFFICE
48-753                    WASHINGTON : 2009
-----------------------------------------------------------------------
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov  Phone: toll free (866) 512-1800; (202) 512ï¿½091800  
Fax: (202) 512ï¿½092104 Mail: Stop IDCC, Washington, DC 20402ï¿½090001


                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                 BARNEY FRANK, Massachusetts, Chairman

PAUL E. KANJORSKI, Pennsylvania      SPENCER BACHUS, Alabama
MAXINE WATERS, California            MICHAEL N. CASTLE, Delaware
CAROLYN B. MALONEY, New York         PETER T. KING, New York
LUIS V. GUTIERREZ, Illinois          EDWARD R. ROYCE, California
NYDIA M. VELAZQUEZ, New York         FRANK D. LUCAS, Oklahoma
MELVIN L. WATT, North Carolina       RON PAUL, Texas
GARY L. ACKERMAN, New York           DONALD A. MANZULLO, Illinois
BRAD SHERMAN, California             WALTER B. JONES, Jr., North 
GREGORY W. MEEKS, New York               Carolina
DENNIS MOORE, Kansas                 JUDY BIGGERT, Illinois
MICHAEL E. CAPUANO, Massachusetts    GARY G. MILLER, California
RUBEN HINOJOSA, Texas                SHELLEY MOORE CAPITO, West 
WM. LACY CLAY, Missouri                  Virginia
CAROLYN McCARTHY, New York           JEB HENSARLING, Texas
JOE BACA, California                 SCOTT GARRETT, New Jersey
STEPHEN F. LYNCH, Massachusetts      J. GRESHAM BARRETT, South Carolina
BRAD MILLER, North Carolina          JIM GERLACH, Pennsylvania
DAVID SCOTT, Georgia                 RANDY NEUGEBAUER, Texas
AL GREEN, Texas                      TOM PRICE, Georgia
EMANUEL CLEAVER, Missouri            PATRICK T. McHENRY, North Carolina
MELISSA L. BEAN, Illinois            JOHN CAMPBELL, California
GWEN MOORE, Wisconsin                ADAM PUTNAM, Florida
PAUL W. HODES, New Hampshire         MICHELE BACHMANN, Minnesota
KEITH ELLISON, Minnesota             KENNY MARCHANT, Texas
RON KLEIN, Florida                   THADDEUS G. McCOTTER, Michigan
CHARLES A. WILSON, Ohio              KEVIN McCARTHY, California
ED PERLMUTTER, Colorado              BILL POSEY, Florida
JOE DONNELLY, Indiana                LYNN JENKINS, Kansas
BILL FOSTER, Illinois                CHRISTOPHER LEE, New York
ANDRE CARSON, Indiana                ERIK PAULSEN, Minnesota
JACKIE SPEIER, California            LEONARD LANCE, New Jersey
TRAVIS CHILDERS, Mississippi
WALT MINNICK, Idaho
JOHN ADLER, New Jersey
MARY JO KILROY, Ohio
STEVE DRIEHAUS, Ohio
SUZANNE KOSMAS, Florida
ALAN GRAYSON, Florida
JIM HIMES, Connecticut
GARY PETERS, Michigan
DAN MAFFEI, New York

        Jeanne M. Roslanowick, Staff Director and Chief Counsel
 Subcommittee on Capital Markets, Insurance, and Government Sponsored 
                              Enterprises

               PAUL E. KANJORSKI, Pennsylvania, Chairman

GARY L. ACKERMAN, New York           SCOTT GARRETT, New Jersey
BRAD SHERMAN, California             TOM PRICE, Georgia
MICHAEL E. CAPUANO, Massachusetts    MICHAEL N. CASTLE, Delaware
RUBEN HINOJOSA, Texas                PETER T. KING, New York
CAROLYN McCARTHY, New York           FRANK D. LUCAS, Oklahoma
JOE BACA, California                 DONALD A. MANZULLO, Illinois
STEPHEN F. LYNCH, Massachusetts      EDWARD R. ROYCE, California
BRAD MILLER, North Carolina          JUDY BIGGERT, Illinois
DAVID SCOTT, Georgia                 SHELLEY MOORE CAPITO, West 
NYDIA M. VELAZQUEZ, New York             Virginia
CAROLYN B. MALONEY, New York         JEB HENSARLING, Texas
MELISSA L. BEAN, Illinois            ADAM PUTNAM, Florida
GWEN MOORE, Wisconsin                J. GRESHAM BARRETT, South Carolina
PAUL W. HODES, New Hampshire         JIM GERLACH, Pennsylvania
RON KLEIN, Florida                   JOHN CAMPBELL, California
ED PERLMUTTER, Colorado              MICHELE BACHMANN, Minnesota
JOE DONNELLY, Indiana                THADDEUS G. McCOTTER, Michigan
ANDRE CARSON, Indiana                RANDY NEUGEBAUER, Texas
JACKIE SPEIER, California            KEVIN McCARTHY, California
TRAVIS CHILDERS, Mississippi         BILL POSEY, Florida
CHARLES A. WILSON, Ohio              LYNN JENKINS, Kansas
BILL FOSTER, Illinois
WALT MINNICK, Idaho
JOHN ADLER, New Jersey
MARY JO KILROY, Ohio
SUZANNE KOSMAS, Florida
ALAN GRAYSON, Florida
JIM HIMES, Connecticut
GARY PETERS, Michigan


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    June 9, 2009.................................................     1
Appendix:
    June 9, 2009.................................................    75

                               WITNESSES
                         Tuesday, June 9, 2009

Callahan, Thomas F., Chief Executive Officer, NYSE Euronext......    52
Duffy, Terrence A., Executive Chairman, CME Group, Inc...........    54
Edmonds, Christopher, Chief Executive Officer, International 
  Derivatives Clearing Group, LLC................................    56
Ferreri, Christopher, Managing Director, ICAP....................    21
Fewer, Donald P., Chief Executive Officer, Standard Credit Group.    13
Johnson, Christian A., Professor, University of Utah School of 
  Law............................................................    23
Murphy, Timothy J., Foreign Currency Risk Manager, 3M............    17
Pickel, Robert, Chief Executive Officer, International Swaps and 
  Derivatives Association (ISDA).................................    15
Sprecher, Jeffrey S., Chief Executive Officer, 
  IntercontinentalExchange, Inc..................................    57
Thompson, Don, Managing Director and Associate General Counsel, 
  JPMorgan Chase & Co............................................    18
Thompson, Larry E., Managing Director and General Counsel, The 
  Depository Trust & Clearing Corporation (DTCC).................    59

                                APPENDIX

Prepared statements:
    Kanjorski, Hon. Paul E.......................................    76
    Garrett, Hon. Scott..........................................    78
    Callahan, Thomas F...........................................    81
    Culp, Christopher L..........................................    86
    Duffy, Terrence A............................................   132
    Edmonds, Christopher.........................................   139
    Ferreri, Christopher.........................................   147
    Fewer, Donald P..............................................   156
    Johnson, Christian A.........................................   161
    Murphy, Timothy J............................................   171
    Pickel, Robert...............................................   176
    Sprecher, Jeffrey S..........................................   182
    Thompson, Don................................................   189
    Thompson, Larry E............................................   195

              Additional Material Submitted for the Record

Adler, Hon. John:
    Written responses to questions submitted to Don Thompson.....   202


                      THE EFFECTIVE REGULATION OF
                          THE OVER-THE-COUNTER
                           DERIVATIVES MARKET

                              ----------                              


                         Tuesday, June 9, 2009

             U.S. House of Representatives,
                   Subcommittee on Capital Markets,
                          Insurance, and Government
                             Sponsored Enterprises,
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to notice, at 10:40 a.m., in 
room 2128, Rayburn House Office Building, Hon. Paul E. 
Kanjorski [chairman of the subcommittee] presiding.
    Members present: Representatives Kanjorski, Ackerman, 
Sherman, Baca, Lynch, Miller of North Carolina, Scott, Maloney, 
Bean, Klein, Perlmutter, Donnelly, Carson, Speier, Foster, 
Minnick, Adler, Kosmas, Himes; Garrett, Price, Castle, Lucas, 
Manzullo, Royce, Biggert, Hensarling, Bachmann, Neugebauer, 
McCarthy of California and Jenkins.
    Ex officio present: Representative Bachus.
    Also present: Representatives Waters, McMahon, and Lance.
    Chairman Kanjorski. This hearing of the Subcommittee on 
Capital Markets, Insurance, and Government Sponsored 
Enterprises will come to order. Pursuant to committee rules, 
each side will have 15 minutes for opening statements. Without 
objection, all members' opening statements will be made a part 
of the record.
    I want to recognize and welcome Ms. Waters, a member of the 
full committee, participating in today's subcommittee hearing. 
And I ask unanimous consent that Mr. McMahon be allowed to 
participate in today's hearing. Without objection, it is so 
ordered.
    Today, we meet to consider another area of our capital 
markets woefully lacking in effective regulatory oversight, 
over-the-counter derivatives. Within less than 3 decades, over-
the-counter derivatives have become a staggering $500 trillion 
market in notional value. This market also has the potential to 
cause considerable harm. Last year, AIG infamously came 
crashing down because its lightly-regulated Financial Products 
Unit engaged in credit default swaps in the over-the-counter 
markets without holding sufficient capital to hedge the risks.
    Since at least 1994, I have advocated for increased 
regulation of our derivatives markets. That year, I helped 
introduce the Derivatives Safety and Soundness Supervision Act, 
which sought to enhance the supervision of derivatives 
activities of financial institutions.
    In the years since then, I have backed other bills aimed at 
improving transparency in, and enhancing the oversight of, our 
derivative markets. While it has taken than I would have liked, 
I am pleased that we are now finally beginning to approach a 
consensus on these matters. The ongoing financial crisis has 
made it apparent to nearly everyone that we must move the over-
the-counter derivatives market from one that takes place under 
the table to one that happens out in the open. In short, the 
time for common-sense regulation of this vast industry has 
arrived.
    In a letter to Congress last month, the Treasury Secretary 
outlined his regulatory proposals for increasing transparency 
and efficiency in the derivatives markets, reducing risks in 
the overall financial system and preventing market 
manipulation. I look forward to seeing the Administration's 
legislative language, fleshing out its general principles in 
the very near future.
    While the Agriculture Committee is showing considerable 
interest, it is also important that our panel educate itself 
and act on these matters. The Administration's outline 
recognizes this reality. Together, I believe that both 
committees can take action to implement the broad concepts 
contained in the Treasury Secretary's plan. Moreover, we ought 
to move swiftly, yet deliberatively, on these matters in order 
to improve flagging investor confidence.
    As we move forward, we should remember that derivatives 
contracts are highly varied. Importantly, certain derivatives 
take the form of customized contracts that non-financial 
businesses employ to manage risks. By most estimates, more than 
90 percent of Fortune 500 companies use over-the-counter, as do 
thousands of smaller businesses. Clearly, some of these 
customized contracts cannot easily fit within a mandatory 
clearing or exchange trading regime. We therefore must find a 
delicate balance. Subjecting all contracts to mandatory 
exchange trading may cast too wide a net. Yet the clearing of 
most products, not all, through a central clearing entity seems 
appropriate and should not impose an undue burden on the 
affected parties.
    However, carving out too many exemptions as we tackle 
regulatory reform could create widespread economic harm in the 
long term. At the same time, we cannot avoid the realization 
that products with unique features may require different 
treatment under whatever regulatory structure becomes adopted.
    At this point, I believe that the standardization of 
contracts where possible will produce smoother clearing and 
clearing both opens a window through which regulators and 
market participants can keep a closer eye on the dark corner of 
the market and reduces the risks posed through the contracts 
collectively.
    The debate about the extent to which clearing becomes 
required is of particular importance today. Even where clearing 
of contracts proves unfeasible, transparency can exist. By 
mandating the collection of relevant data in a repository, we 
can help to ensure that regulators maintain access to useful 
trading information and perhaps detect warning signs of 
systemically risky transactions.
    Electronic trading also increases transparency. Further, 
electronic execution streamlines trading, minimizes mistakes, 
and enhances monitoring of the over-the-counter derivatives 
markets.
    In sum, we have assembled a number of parties interested 
in, and affected by, the actions Congress will take in the 
months ahead. As we consider legislation to regulate in this 
field, their testimony can help guide us toward achieving the 
appropriate balance as we impose a sense of order in what until 
now has truly been the wild west of the financial services 
world.
    I would like to recognize the ranking member, Mr. Garrett, 
for 4 minutes for his opening statement. Mr. Garrett?
    Mr. Garrett. Thank you, Mr. Chairman. Good morning to all 
the witnesses. Today's hearing is called, ``The Effective 
Regulation of the Over-the-Counter Derivatives Market.'' I 
think it is important to keep in mind that it is not called, 
``The Most Politically Correct Sounding Regulation of 
Derivatives,'' nor is it called, ``Let's Regulate the Heck Out 
of the Derivatives Market Because They Have Been Demonized and 
Let's Ignore All the Positive Contributions They Make to Our 
Capital Markets Under Proper Management.''
    Unfortunately, with some of the regulatory proposals that 
have come forward in this area, you might think that is the 
approach that is going to be taken.
    Here are the facts: 94 percent of the 500 largest global 
companies use derivatives to manage risks. Congress therefore 
needs to tread carefully as it looks at regulatory options for 
these markets. Overly-regulated or improper regulations that 
might sound good politically could have major unintended 
negative consequences, not just for our financial markets but 
for our broader economy as well.
    Rather than reducing risk, poor regulatory reform could 
actually exacerbate it, so before we go any further, it is 
important to remember that derivatives did not cause our 
financial difficulties. In fact, they should be seen more as 
symptoms of the underlying crisis, rather than a reason for it.
    So while our overall financial service regulatory structure 
can be improved, it is important to preserve and protect the 
important benefits that they provide. Derivatives products 
provide firms with the ability to minimize risks. This 
obviously benefits individual firms but also benefits the 
broader market as well.
    For example, as Members of Congress consider reform 
proposals, we must not be overwhelmed by the fact that one high 
profile financial institution, AIG, made a bad investment 
decision. We must also keep in mind that this occurred while 
AIG was under the supervision of its regulator, the Office of 
Thrift Supervision, and was part of broader regulations as 
well. So greater expertise then in some cases is clearly 
required at the functional regulator level for the derivative 
dealers, but AIG was, as you know, a regulated entity. And the 
AIG case is a reminder that regulatory failure contributed to 
our financial crisis as much as anything else did.
    Furthermore, the vast majority of exposures in the CDS 
market, for instance, is contained within the already overly-
regulated banking sector. Arguably, everything is in place 
already for regulators to appropriately regulate the bulk of 
this market and it is dominated by a small number of dealers. 
Regulators then already have oversight responsibilities to 
ensure firms are taking appropriate risks and to set proper 
capital levels. So the power is there; regulators just need to 
do their job.
    Now, when there have been credit events, and there have 
been a number of them, with the Lehman failure being the most 
significant, in each case, the event has been handled in a very 
orderly fashion by the existing infrastructure. Now, as I look 
at some of the particular regulatory ideas that have been put 
forward, I am persuaded that essential counterparties and a 
clearinghouse hold promise, but I am hesitant to say that as 
far as they go, that they should be mandatory for all 
standardized products.
    The private sector has made significant progress in a 
relatively short period of time toward providing multiple 
clearinghouses for various derivative products, and I think we 
should look at this further. Inappropriate mandating of central 
clearinghouses will limit that ability to go further and manage 
risks.
    Another area I would like to look at is the proposal of the 
so-called ``naked'' swaps. It is concerning to me. It is 
important that legislators understand that significant negative 
consequences will arise if such a proposal is actually enacted. 
So the participants and infrastructure provided in the OTC 
markets have accomplished much in recent years to provide 
stability from the ISDA master agreement, to the recent so-
called ``big bang protocol,'' to ongoing efforts to provide a 
more robust infrastructure for these products.
    So, in conclusion, I look forward to continued progress 
being made in regards to greater coordination between the sell 
side and the buy side participants as private sector efforts 
progress to increase efficiency and transparency and reduce the 
risk in the OTC derivative business.
    And, finally, as Congress pushes forward with further 
regulation in these markets, we need to guard against 
unnecessary, overly burdensome regulations that might cause the 
markets to move elsewhere, overseas, or would hinder or 
prohibit firms from providing themselves with superior risk 
management techniques that are so widely employed today and 
that could be enhanced by future innovation.
    Thank you, Mr. Chairman.
    Chairman Kanjorski. Thank you, Ranking Member Garrett. We 
now have 3 minutes for the gentleman from New York, Mr. 
Ackerman.
    Mr. Ackerman. Thank you, Mr. Chairman. Today's hearing is 
meant to focus on proposals for regulating over-the-counter 
derivative products, such as credit default swaps, but in this 
economy, with this market, and with our current fractured 
regulatory regime, we would be naive to consider proposals for 
regulating and clearing OTC products without also establishing 
a regulator to protect our markets against systemic risks.
    During previous hearings held by both this subcommittee and 
the full Financial Services Committee, several of our witnesses 
and a number of our colleagues remarked that systemic risk is a 
lot like pornography in that while difficult to define, you 
know it when you see it. In my view of the two, systemic risk 
is actually the more difficult to identify. At least with 
pornography, you have a general idea of what it is you are 
looking for. I do not know what that means; somebody wrote that 
for me.
    [laughter]
    Mr. Ackerman. If we could step into our time machines and 
go back in time before the near collapse of AIG, I have little 
doubt that we would have near unanimous support for regulating 
credit default swaps. But of course we cannot go back in time, 
we cannot stop AIG from overextending itself, and the next 
crisis will not stem from AIG's credit default swap portfolio.
    Our financial regulatory structure is like a tattered quilt 
made up of dozen of patches, each representing a State and 
Federal supervisor, agency, some patches overlapping, and we 
now know some areas completely bare. Preventing the next crisis 
will require more than simply sewing yet another patch onto the 
quilt.
    Regardless of how meritorious the proposals to regulate and 
clear out these derivatives may be, we need a regulator with 
the ability to see the complete picture, not just the OTC 
derivatives market, not just the exchanges, not just the 
banking system, but all of it. We need a regulator who has the 
ability to see trends in the OTC derivative markets that 
independently might not be worrisome but when paired with 
information pertaining to the reserves of our banks could be 
cause for concern. And we need the regulator to have the 
ability to act appropriately and expeditiously to address 
systemic risk. And so in my view merely granting the SEC or the 
CFDC the authority to regulate and to clear out these products 
is near-sighted and inadequate. If we are to learn from this 
financial crisis, any legislation that seeks to regulate OTC 
products must be paired with a systemic risk regulator.
    I thank you and I yield back the balance of my time.
    Chairman Kanjorski. Thank you very much, Mr. Ackerman. We 
will now hear from the ranking member of the full committee, 
Mr. Spencer Bachus, for 3 minutes.
    Mr. Bachus. Thank you, Mr. Chairman. Mr. Chairman, I would 
like to associate myself with the remarks by the subcommittee 
Chair. Derivatives do help companies manage risk, and I think 
they are a very valuable thing. Of course, the derivative 
market is valued notionally at $684 trillion, which is a 
tremendous amount. And the rapid growth of this market, coupled 
with the potential for widespread credit defaults and 
operational problems in the over-the-counter market have led 
many to conclude that derivatives pose a substantial systemic 
risks. Therefore, the Treasury released a comprehensive 
framework for over-the-counter derivatives. In that, they call 
for financial derivatives suitable for clearing by a federally 
regulated central counterparty to be placed on registered 
exchanges.
    I personally believe that most derivatives, if they are not 
too highly customized, should be placed in a clearinghouse 
situation. It helps you identify risk and define risk. And I 
think from talking to most financial institutions, they know 
what their risk is between two parties but they sometimes do 
not know what the party they are dealing with, what their risk 
with a third party is, and I think that is one of the values of 
a clearinghouse. You not only have to know what your exposure 
to each other is, but sometimes what the exposure they have to 
a third party.
    The idea I think the Treasury has proposed is really an 
over-simplification of the use of an exchange and 
simultaneously may give unsophisticated retail investors a 
false comfort that their products are now safe for purchase 
because they have somehow been approved for exchange trading by 
a government agency.
    Furthermore, in testimony before the committee in March, 
the GAO pointed out that some credit default swaps may be too 
complex or they would be highly tailored even for a clearing, 
and therefore placing them on an exchange to me would be almost 
impossible. And it is in those highly complex derivatives that 
we are going to particularly have a problem.
    As we move forward with regulatory reform proposals, we 
should make every effort to strike the right balance between 
protecting investors and preserving innovation. I think that is 
where Mr. Garrett and I really agree, that there are already 
private sector initiatives well underway to clear a 
standardized derivative contract. A part of that is a response 
to what we have seen in the last year or two. Some of what we 
have seen I do not think will take place again because the 
parties are demanding that. And I think that these are efforts 
to remind us that market-based solutions are capable of 
generating the information that investors and companies need to 
make informed decisions. The last thing Congress should do is 
prevent new entrance into the derivatives clearing marketplace.
    In closing, Mr. Chairman, any ban on over-the-counter 
derivatives would likely harm responsible and well-managed U.S. 
corporations that use derivatives to hedge against business 
risks. Restrictions on credit default swap contracts will also 
limit the ability of investors to appropriately calculate risks 
as it has become apparent that CDS spreads have become a more 
accurate reflection of credit risk than even credit ratings. 
And that is one thing that we have learned in all this is that 
credit rating agencies were way behind what we were seeing on 
some of the credit spreads themselves.
    I appreciate our witnesses testifying. I have some of your 
testimony and I look forward to, over the next few days, 
reading the rest of it if I do not hear it. Thank you.
    Chairman Kanjorski. Thank you very much, Mr. Bachus. And 
now we will hear from the gentleman from Georgia, Mr. Scott, 
for 2 minutes.
    Mr. Scott. Thank you very much, Mr. Chairman. I want to 
thank you and Ranking Member Garrett for holding this hearing. 
As over-the-counter derivatives have been cause for concern 
with AIG's near collapse, caused in large part by its portfolio 
of credit default swaps, the American taxpayer now owns most of 
this company as AIG has access now to nearly $200 billion in 
taxpayer support.
    I also understand the frustrations with my constituents, 
and the constituents of every one of us on this committee and 
in Congress, that our constituents are feeling as their money 
continues to go towards propping up Wall Street firms, all the 
while they are simply trying to stay afloat with unemployment 
numbers rising and people continuing to lose their homes.
    However, today, I am interested to hear what the witnesses 
have to say about the varying regulatory proposals to reign in 
these financial services products. I am looking forward to 
hearing their thoughts on proposals for mandatory clearing of 
all standardized over-the-counter contracts and reporting of 
trades from non-standardized contracts to a qualified trade 
information repository.
    Furthermore, as a member of both the Financial Services 
Committee and the Agriculture Committee, I am interested to 
hear the opinions on legislation that would end the exemptions 
for swaps adopted in the Commodities Futures Modernization Act 
and assert new authority over the over-the-counter derivatives. 
And I would also like to hear their opinions and thoughts on 
the bill we passed in this committee in February, which would 
requiring clearing for all over-the-counter derivatives.
    Our economy continues to be extremely turbulent as 
weakening trends envelops us and the experts predict that the 
downturn might not end any time soon, or at least not until the 
end of next year. So the bottom line with this hearing is we 
must seriously discuss strengthening regulations, specifically 
over these over-the-counter derivatives, but I would put in 
there strengthening them but with flexibility so that this 
system can work with greater transparency and effectiveness.
    We must address concerns regarding current regulatory 
practices and how to further restructure them in a way that 
will provide for real reform.
    And, Mr. Chairman, while I have this opportunity, I would 
also like to welcome from Atlanta, Georgia, Mr. Jeffrey 
Sprecher, who is from my area in Atlanta, Georgia, as well as 
Mr. Price's area. He is the chief executive officer of 
IntercontinentalExchange, which we refer to as ICE, from 
Atlanta, Georgia.
    Thank you, Mr. Chairman. I look forward to the testimony 
from our distinguished witnesses.
    Chairman Kanjorski. Thank you, Mr. Scott. Now, we will hear 
from the second gentleman from Georgia, Mr. Price, for 1 
minute.
    Mr. Price. Thank you, Mr. Chairman, I appreciate it. In a 
free market, over-the-counter derivatives provide an essential 
function by allowing companies to customize the way that they 
address their risks. Many companies have successfully used OTC 
products to help their consumers save money and to create jobs, 
including 3M, which is testifying today, as an end user of 
derivatives.
    A market-based economy allows institutions to succeed and 
to fail. And they fail for a number of reasons: The business 
takes on too much risk; it may be under bad management; or it 
may have an ineffective business model. Despite the fact that 
credit default swaps have come under fire lately because of 
AIG's remarkable over-exposure, when they are used 
appropriately, they can be a very effective risk management 
tool. Thus, we need to be extremely cautious and careful as we 
decide how to appropriately regulate derivatives.
    In fact, the market has already begun addressing some of 
the concerns that credit default swaps and OTC derivatives 
posed. So I look forward to hearing from the witnesses about 
what they are doing to make OTC and CDS trades more 
transparent.
    In the end, however, regulation must not be a one-size-
fits-all system. Such a system stifles innovation, raises 
prices for consumers, punishes entrepreneurs, and destroys 
jobs.
    Thank you, Mr. Chairman.
    Chairman Kanjorski. Thank you, Mr. Price. Now, the 
gentleman from New Jersey, Mr. Adler, for 3 minutes.
    Mr. Adler. Thank you, Chairman Kanjorski. I want to commend 
you and Ranking Member Garrett for holding this hearing today 
on this important but very, very complicated issue.
    Most people can agree, including the majority of industry 
participants, that over-the-counter, OTC, derivatives need to 
be safer. However, Congress must be clear that the credit 
default swaps that damaged AIG's balance sheet made up just a 
fraction of all OTC derivatives. Thousands of American 
municipalities, companies, and financial institutions rely on 
OTC derivatives to manage risks. Interest rate and equity 
derivatives allow entities to hedge against unexpected losses. 
It is my hope that our committee strikes the right balance 
between creating a safer process of overseeing derivatives 
while maintaining the flexibility within the marketplace so 
private and public entities have the ability to manage their 
interests.
    Standardized derivatives should be required to go through 
centralized clearing counterparties, but we should not create a 
process where all derivatives are processed through one CCP 
because it may actually increase the risk of bottle-necking the 
system.
    I hope to hear from our panelists today on how we can best 
arrive at a definition of derivatives that allows for smarter 
and more effective regulation while not enforcing a blanket, 
one-size-fits-all set of regulations. A standardization of 
derivatives cannot include all financial contracts because many 
are individually negotiated and offer parties the opportunity 
to balance specific risks in a way many other traded products 
do not.
    Clearly, Congress must prevent future activities from 
endangering our financial system, similar to what we witnessed 
with AIG, Bear Stearns, and Lehman Brothers last year. We have 
to implement safeguards to bring greater transparency not only 
to the public but also for our regulators. Marketplace 
participants have already started the process of moving towards 
greater transparency by creating and utilizing large electronic 
repositories.
    Today's hearing will provide my colleagues and me with more 
information on the aggregate data that should be available to 
interested parties.
    Finally, Mr. Chairman, today our committee should discuss 
the layered jurisdictional issues preventing the efficient and 
effective regulation of OTC derivatives.
    Thank you again for the time. I yield back.
    Chairman Kanjorski. Thank you, Mr. Adler. And now we will 
hear from the gentleman from Oklahoma, Mr. Lucas, for 1 minute.
    Mr. Lucas. Thank you, Mr. Chairman, and Ranking Member 
Garrett, for holding today's hearing. Serving on this 
committee, as well as being the current ranking member on the 
House Agriculture Committee, I have had the opportunity to 
examine the various issues surrounding the role derivatives 
have played in the current financial crisis and have worked to 
respond to the need for more effective regulation. While better 
transparency and disclosure are needed within the industry, we 
must make sure that we create responsible legislation that does 
not impede appropriate legislation and risk management within 
the marketplace.
    Additionally, I believe we must work to ensure that the 
CFTC plays a leading role in appropriately regulating the 
derivatives and commodities market. The House Agriculture 
Committee recently reported a comprehensive bill aimed at 
addressing these regulatory concerns. I am prepared to use that 
experience to influence the discussion and the actions of this 
committee. I look forward to striking the proper balance as we 
craft the legislation that gives us that regulatory balance we 
need.
    I yield back, Mr. Chairman.
    Chairman Kanjorski. Thank you very much, Mr. Lucas. Now, we 
will hear from the gentleman from Massachusetts, Mr. Lynch, for 
1 minute.
    Mr. Lynch. Thank you, Mr. Chairman, and thank you for 
having this hearing. I appreciate the witnesses coming forward.
    I get the sense I am in the minority, just from hearing the 
testimony on this side of the table. I do think that 
derivatives had a lot to do with the impact and the scope of 
the economic downturn that we are currently experiencing. And 
while I think our job should be regulating this industry, I 
just want to point out that if we are trying to set up a 
regulatory framework to contain some of the damage that has 
been caused, and nobody has mentioned that in their testimony, 
I think we need to give the tools to our regulators to do just 
that.
    And by allowing part or a significant part of the 
derivatives market to just go off unregulated, we have seen 
from our experience that is where the money goes. It goes to 
the unregulated portions of the market, the opaque areas of the 
market.
    We are setting ourselves up to fail. We are not going to 
regulate this, I get the sense of it right now, but we will be 
back here someday. It is just very unfortunate that we are not 
taking advantage of the, I think, desire in the financial world 
to really get at this. I think we are making a mistake on the 
part of the taxpayers and investors. I think we are making a 
terrible mistake here, Mr. Chairman, in taking a very soft 
approach.
    I get the sense of who is winning this fight, and I do not 
think it is the American taxpayer.
    I yield back.
    Chairman Kanjorski. Thank you very much, Mr. Lynch. And now 
we will hear from the gentleman from California, Mr. Royce, for 
1 minute.
    Mr. Royce. Thank you, Mr. Chairman. Certainly there appears 
to be a market consensus forming that highly standardized 
contracts can and should be sent through a central 
counterparty. However, I think it is worth noting that a 
portion of the derivatives market is highly customized and 
tailored to a specific institution, covering a specific risk.
    Over time, with calls for greater transparency, market 
participants will be best equipped to determine which 
instruments should be cleared and which should be traded on an 
exchange. If Congress missteps, we run the risk of driving this 
market overseas and limiting the ability of companies to manage 
risks associated with their business practices.
    In the case of AIG, it appears the failure came from a 
break down in counterparty due diligence, not simply the firm's 
usage of derivatives. Market participants so reliant upon AIG's 
triple A credit rating failed to see the extent to which AIG 
was overleveraged and their vast exposure to an eroding U.S. 
housing market. Deciphering this leverage in an opaque market 
is key. Information warehousing of the non-cleared customized 
trades for transparency would logically help in those cases 
that could not be handled by a central clearinghouse.
    Thank you again, Mr. Chairman.
    Chairman Kanjorski. Thank you very much, Mr. Royce. And now 
we will hear from the gentlemen from California, Mr. Sherman, 
for 2 minutes.
    Mr. Sherman. Thank you. One of the arguments always made 
against regulation is, ``Let the buyer beware.'' The credit 
agencies were here saying, ``Don't regulate us, just don't rely 
on our rating.'' Now, we are told well, the counterparties 
should protect themselves. The fact is at best, these 
derivatives are insurance. At worst, they are a bet at the 
casino. Either way, we do not let you sell fire insurance on my 
house without setting up reserves. And that insurance policy on 
my house is basically for the benefit of my bank, you do not 
want to know how little equity I have in the house.
    Yet, you can go to a bank and say we will protect you not 
from Brad's house burning down, but from the house declining in 
value, and Sherman defaulting on the loan, and it is not 
insurance, it is customized. Or you can sell that as a casino 
bet and go to somebody who does not hold my mortgage and sell 
them an insurance policy against me not paying my mortgage. 
Either way, there ought to be reserves. Anything else means you 
can sell an unlimited quantity and ultimately we are told, 
``Well, this is just a private market decision.'' Tell that to 
the taxpayers who have bailed out AIG.
    And if this business goes overseas, there will always be an 
unregulated casino where you go and you put your money down on 
number 24 and you win and the bank does not pay off. Fine, let 
that casino be offshore. Let some other government have to bail 
out the next AIG. Let us not be told that the present system is 
fine so long as the taxpayers write the check.
    I yield back.
    Chairman Kanjorski. Thank you very much, Mr. Sherman. And 
now we will hear from the gentlelady from Illinois, Mrs. 
Biggert, for 1 minute.
    Mrs. Biggert. Thank you, Mr. Chairman. To justify a curfew, 
some parents stated to their teenagers, ``Nothing good ever 
happens after midnight.'' I would argue that a similar adage 
holds true when it comes to elements of the derivative market. 
This is especially true of those riskier trades of credit 
default swaps and over-the-counter derivatives that were 
conducted in a kind of darkness and contributed to the collapse 
of major financial services companies and contributed to our 
current financial crisis.
    I look forward to hearing suggestions regarding the 
increased capital rate requirements, centralized clearing and 
price discovery as part of the discussions of how to better 
manage risks within the market place. This could only lead to 
more robust competition, restored investor confidence, and 
healthier markets.
    At the same time, I think Congress must aim first to do no 
harm. While legislating, we must be careful not to sacrifice 
market efficiency and liquidity in the name of more transparent 
markets or to simply meet a goal of reducing omissions. The 
Waxman-Markey bill gives financial regulatory authority to the 
wrong regulator, over-restricts trading, and imposes a new 
futures transaction tax. A new tax adds to the cost of future 
transactions, which threaten the vitality of U.S. futures 
markets, especially those in Chicago and all who depend on 
them.
    We must strike the right balance. And with that, I look 
forward to hearing from our witnesses, especially my 
constituent, Mr. Duffy, who is the executive chairman of the 
CME Group.
    I yield back.
    Chairman Kanjorski. Thank you, Mrs. Biggert. The gentleman 
from Texas, Mr. Hensarling, for 1 minute.
    Mr. Hensarling. Thank you, Mr. Chairman. I appreciate the 
title of the hearing, dealing with ``effective regulation'' 
because I think there is a very big difference between 
effective and ineffective.
    Effective regulation helps make markets more competitive 
and transparent, empowers consumers with effective disclosure 
to make rational decisions, effectively polices markets for 
fraud, and reduces systemic risk. Ineffective regulation though 
can hamper competition, create moral hazards, stifle 
innovation, and diminish the role of personal responsibility 
within our economy.
    Now, with respect to more regulation of the OTC derivatives 
market, I come into this hearing with an open mind but not an 
empty mind. I remember that regulators and legislators do not 
always get it right, witness Fannie Mae and Freddie Mac; 
witness the credit rating agency oligopoly, and let us also 
remember that the former director of OTS said they had the 
tools to prevent AIG's position in the CDS and simply did not 
exercise it.
    Now, perhaps we should look to more enlightened risk 
assessment for tools for regulators, appropriate capital 
standards and with respect to our OTC derivatives and current 
economic turmoil, let's be careful we do not confuse the cause 
with the symptoms.
    With that, Mr. Chairman, I yield back the balance of my 
time.
    Chairman Kanjorski. Thank you very much, Mr. Hensarling. 
And now we will hear from the gentlelady from Minnesota, Mrs. 
Bachmann, for 1 minute.
    Mrs. Bachmann. Thank you, Mr. Chairman and Mr. Garrett, for 
holding this important meeting today. I am also pleased that 
the committee has invited Mr. Timothy Murphy to speak before us 
today. He is the foreign currency risk manager for 3M 
Corporation to testify about 3M's use of these financial 
products. Headquartered in St. Paul, Minnesota, it is a 
hometown company we have been proud of for years. They provide 
34,000 people with jobs, and more than 60 percent of the 
manufacturing operations are located here inside the United 
States.
    With over 20 years experience in the over-the-counter 
derivative market, Tim presently manages 3M's currency and 
commodity risk programs, as well as the share re-purchase 
program. He is personally responsible for the management and 
execution of the company's foreign exchange hedging policy, 
including identifying the appropriate exposure estimates to be 
used as the basis of foreign exchange hedging activity and 
balance sheet hedging.
    Prior to joining 3M, he worked at U.S. Bank for more than 
10 years managing their foreign currency and trading relation 
with corporate mutual fund and banking clients.
    As our committee considers the future of over-the-counter 
derivatives, we must remember that many United States companies 
responsibly utilize these financial products to manage their 
risks and limit damage to their balance sheets. We need to ask 
the question of those before us today: How will jobs be 
impacted by the measures that are before us today? These are 
America's job creators. Congress should be careful not to 
overreach and infringe on their ability to hedge risks 
responsibly.
    I look forward to today's important discussion. I yield 
back, Mr. Chairman.
    Chairman Kanjorski. Thank you very much, Mrs. Bachmann. And 
now we will hear from the gentleman from Texas, Mr. Neugebauer, 
for 1 minute.
    Mr. Neugebauer. Thank you, Mr. Chairman. One of the things 
that we have sat here for several months talking about is the 
state of the economy, and I think if we went around this room 
today and asked everybody what they thought caused where we 
are, we would get many different answers, which is one of the 
reasons I have been very concerned about the road that we are 
going down. I do not know that we have adequately analyzed 
where in the system that we had the breakdowns. Instead, I 
think we have embarked on a road to throw a restrictive 
regulatory blanket over the entire financial markets. And what 
I think we may end up doing is in many cases, some of the 
people that we are ``trying to protect or to help,'' there may 
be unintended consequences for this very restrictive regulatory 
blanket that we are trying to throw over the financial markets.
    Derivatives and swaps are important tools, not only for 
discovering risk in many cases, but also for managing risk. We 
need to make sure that we do not destroy those tools simply 
because some do not understand it or some believe that possibly 
they could have been a cause of the financial breakdown. We do 
not know that is in fact the case. What we do know is many 
firms were able to manage their risk through this process by 
having some of these products actually in place.
    And so I look forward to the testimony that we are going to 
hear today, but I also caution my fellow committee members that 
let's go down this road with thoughtful debate and discussion 
and make sure that we get it right because this is a very 
important issue to our country.
    With that, I yield back.
    Chairman Kanjorski. Thank you, Mr. Neugebauer. And now we 
have for 1 minute, the gentlelady from Kansas, Ms. Jenkins.
    Ms. Jenkins. Thank you, Mr. Chairman. This committee is 
being asked to consider massive regulatory reform in the 
financial markets. I hope that any legislation we consider will 
strike a balance between protecting the financial system and 
ensuring open and free markets.
    I have concerns with proposals like the one that is the 
focus of today's hearing. I am eager to learn more during this 
hearing about all of these issues, and I am concerned about new 
entry participation barriers in the over-the-counter markets 
being discussed, such as capital requirements and the effects 
that they may have on competition.
    If this body is to create new regulations in the OTC 
markets to decrease the possibility of systemic risk and 
increase transparency, Congress must ensure robust competition 
and protect the ability of American businesses to use these 
markets to manage their energy, currency and other risks.
    As we take steps to emerge from the current recession and 
get our economy back on track, I, too, urge my colleagues to 
proceed with caution.
    I yield back. Thank you.
    Chairman Kanjorski. Thank you very much, Ms. Jenkins. Now, 
we will have the first panel. I want to thank you for appearing 
before the subcommittee today, and without objection, your 
written statements will be made a part of the record. You will 
each be recognized for a 5-minute summary of your testimony.
    First, we have Mr. Donald Fewer, chief executive officer of 
Standard Credit Group. Mr. Fewer?

STATEMENT OF DONALD P. FEWER, CHIEF EXECUTIVE OFFICER, STANDARD 
                          CREDIT GROUP

    Mr. Fewer. Chairman Kanjorski, Ranking Member Garrett, and 
members of the subcommittee, my name is Donald Fewer. I would 
like to thank the subcommittee for the opportunity to share my 
views on the regulation of the over-the-counter derivatives 
market and address the areas of interest outlined by the 
subcommittee. I have also submitted a larger statement for the 
record.
    Analysis of the credit crisis points to the need for 
enhanced regulation of the OTC market. Results from such 
analysis point to multiple, and sometimes conflicting, causes 
of the crisis and the role played by the OTC derivatives 
market. We suggest creating a cohesive regulatory regime with a 
systemic risk regulator that has the authority and 
accountability to regulate financial institutions that are 
determined to be systemically important.
    Regulation need not reshape the market or alter its 
underlying functionality. The U.S. share of global financial 
markets is rapidly falling and oversight consolidation should 
not create a regulatory environment that prohibits capital 
market formation, increases transaction costs, and pushes 
market innovation and development to foreign markets.
    The use of CCPs by all market participants, including end 
users, should be encouraged by providing open and fair access 
to key infrastructure components, including central clearing 
facilities, private broker trading venues, and derivative 
contract repositories. Central clearing will reduce systemic 
risk by providing multilateral netting and actively managing 
daily collateral requirements. Mandated clearing of the most 
standardized and liquid product segments is congruent with 
efficient global trade flow.
    Given the size, history and global scope of the OTC 
derivatives market, migration toward exchange execution has 
been, and will be, minimal apart from mandatory legislative 
action. OTC derivative markets will use well-recognized 
protocols of size, price, payment and maturity dates. Because 
of these internationally-recognized protocols, OTC dealers 
globally are able to efficiently customize and best execute at 
least cost trillions of dollars of customer orders within 
generally acceptable terms to the market. There is a class of 
OTC product that is extremely conducive to exchange execution 
and can warrant exchange listing.
    The over-the-counter market has a well-established system 
of price discovery and pre-trade market transparency that 
includes markets such as U.S. Treasuries, U.S. repo, and EM 
sovereign debt. OTC markets have been enhanced by higher 
utilization of electronic platform execution. The unique nature 
of the OTC markets' price discovery process is essential to the 
development of orderly trade flow and liquidity, particularly 
in fixed income credit markets. We are in a period of abundance 
of mispriced securities where professional market information 
and execution is required.
    OTC derivatives and underlying cash markets use an 
exhaustive price discovery service that can only be realized in 
the OTC market via execution platforms that integrate cash and 
derivative markets.
    Post-trade transparency for all OTC derivative transactions 
can be properly serviced by CCPs and central trade repositories 
that aggregate trading volumes and positions, as well as 
specific counterparty information. These institutions can be 
structured to maintain books and records and provide access to 
regulatory authorities on trade-specific data.
    I would not endorse OTC trade reporting to the level that 
is currently disclosed by trace. There is ample evidence in the 
secondary OTC corporate bond market that the trace system has 
caused dealers to be less inclined to hold inventory and to 
make capital to support secondary markets.
    Successful utilization of electronic trade execution 
platforms is evident in markets such as U.S. Government bonds 
and U.S. Government repo. I would caution against the mandated 
electronic execution of OTC cash-in derivative products by 
regulatory action. Effective implementation of such platforms 
should be the result of a clear demand made by market makers 
and a willingness by dealers to provide liquidity 
electronically. Our experience in North America is that the 
dealer community has refrained from electronic execution due to 
the risk of being held to prices during volatile market 
conditions.
    I would strongly endorse the hybrid use of electronic 
platforms where market participants utilize the services of 
voice brokers in conjunction with screen trading technology.
    Mr. Chairman, Mr. Ranking Member, and members of the 
subcommittee, I appreciate the opportunity to provide this 
testimony. I am available to answer any questions you may have.
    [The prepared statement of Mr. Fewer can be found on page 
156 of the appendix.]
    Chairman Kanjorski. Thank you, Mr. Fewer.
    Next, we will have Mr. Robert Pickel, chief executive 
officer, International Swaps and Derivatives Association, 
Incorporated. Mr. Pickel?

     STATEMENT OF ROBERT PICKEL, CHIEF EXECUTIVE OFFICER, 
  INTERNATIONAL SWAPS AND DERIVATIVES ASSOCIATION, INC. (ISDA)

    Mr. Pickel. Thank you, Mr. Chairman, Ranking Member 
Garrett, and members of the subcommittee. Thank you very much 
for inviting ISDA to testify today. We are grateful for the 
opportunity to discuss public policy issues regarding the 
privately negotiated or OTC derivatives business. Our business 
provides essential risk management and risk reduction tools for 
many users. Additionally, it is an important source of 
employment, value creation, and innovation for our financial 
system. It is one that employs tens of thousands of individuals 
in the United States and benefits thousands of American 
companies across a broad range of industries.
    In my remarks today, I would briefly like to underscore 
ISDA's and the industry's strong commitment to identifying and 
reducing risk in the privately negotiated derivatives business. 
We believe that OTC derivatives offer significant value to 
customers who use them, to the dealers who provide them, and to 
the financial system in general by enabling the transfer of 
risk between counterparties. OTC derivatives exist to serve the 
risk management and investment needs of end users. These end 
users form the backbone of our economy. They include over 90 
percent of the Fortune 500 companies, 50 percent of mid-size 
companies, and thousands of other smaller American companies.
    We recognize, however, that the industry today faces 
significant challenges, and we are urgently moving forward with 
new solutions. We have delivered and are delivering on a series 
of reforms in order to promote greater standardization and 
resilience in the derivatives markets. These developments have 
been closely overseen and encouraged by regulators who 
recognize that optimal solutions to market issues are 
effectively achieved through the participation of market 
participants.
    As ISDA and the industry work to reduce risk, we believe 
that it is essential to preserve flexibility, to tailor 
solutions to meet the needs of customers. Efforts to mandate 
that privately negotiated derivatives trade only on an exchange 
would effectively stop any such business from being conducted. 
Requiring exchange trading of all derivatives would harm the 
ability of American companies to manage their individual, 
unique financial risks and ultimately harm the economy.
    Mr. Chairman, let me assure you that ISDA and our members 
clearly understand the need to act quickly and decisively to 
implement the important measures that I will describe in the 
next few minutes.
    Last month, Treasury Secretary Geithner announced a 
comprehensive regulatory reform proposal for the OTC 
derivatives market. The proposal is an important step toward 
much needed reform of financial industry regulations. ISDA and 
the industry welcomed in particular the recognition of industry 
measures to safeguard smooth functioning of our markets and the 
emphasis on the continuing need for the ability to customize 
derivatives for the specific needs of users of derivatives.
    The Treasury plan proposes to require that all derivatives 
dealers and other systemically important firms be subject to 
prudential supervision and regulation. ISDA supports the 
appropriate regulation of financial and other institutions that 
have such a large presence in the financial system that their 
failure could cause systemic concerns.
    Most of the other issues raised in the Treasury proposal 
and the questions you have asked of the panelists today were 
addressed in a letter that ISDA and industry participants 
delivered to the Federal Reserve Bank of New York earlier this 
month. As you may know, a Fed-industry dialogue was initiated 
under Secretary Geithner's stewardship of the New York Fed 
nearly 4 years ago. This dialogue has led to substantial and 
ongoing improvements in the key areas of the OTC derivatives 
infrastructure, increased standardization of trading terms, 
improvements in the trade settlement process, greater clarity 
in the settlement of defaults, significant positive momentum 
toward central counterparty clearing, enhanced transparency, 
and a more open industry governance structure.
    In our letter to the New York Fed this month, ISDA and the 
industry expressed our firm commitment to strengthen the 
resilience and robustness of the OTC derivatives market. As we 
stated, we are determined to implement changes to risk 
management, processing, and transparency that will 
significantly transform the risk profile of these important 
financial markets. We outlined a number of steps towards that 
end, specifically in the areas of information transparency and 
central counterparty clearing.
    ISDA and the OTC derivatives industry are committed to 
engaging with supervisors globally to expand upon the 
substantial improvements that have been made in our business 
since 2005. We know that further action is required, and we 
pledge our support in these efforts. It is our belief that much 
additional progress can be made within a relatively short 
period of time. Our clearing and transparency initiatives, for 
example, are well underway with specific commitments aired 
publicly and provided to policymakers.
    As we move forward, we believe the effectiveness of future 
policy efforts will be driven by how well they answer a few 
fundamental questions. First, do they recognize that OTC 
derivatives play an important role in the U.S. economy? Second, 
do the policy efforts enable firms of all types to improve how 
they manage risk? Third, are the policy efforts based on a 
complete understanding of how the OTC derivatives markets 
function and their true role in the financial crisis? And, 
fourth, do the policy efforts ensure the availability and 
affordability of these essential risk management tools?
    Mr. Chairman and committee members, the OTC derivatives 
industry is an important part of the financial services 
business in this country and the services we provide help 
companies of all shapes and sizes. Let me assure you that we in 
the derivatives industry do recognize the challenges that we 
face as we seek to enact a comprehensive and prudent system of 
regulatory reform.
    As I have indicated, we are fully committed to working with 
legislators, this committee, and supervisors to address the key 
issues ahead.
    Thank you for your time, and I look forward to your 
questions.
    [The prepared statement of Mr. Pickel can be found on page 
176 of the appendix.]
    Chairman Kanjorski. Thank you very much, Mr. Pickel.
    And now we will hear from Mr. Timothy J. Murphy, foreign 
currency risk manager, 3M. Mr. Murphy?

STATEMENT OF TIMOTHY J. MURPHY, FOREIGN CURRENCY RISK MANAGER, 
                               3M

    Mr. Murphy. Chairman Kanjorski, Ranking Member Garrett, and 
members of the subcommittee, thank you for inviting 3M to speak 
today on the importance of the over-the-counter derivatives 
market. Representative Bachmann, thank you for your kind 
introduction, as well as your kind words about 3M Company.
    As you know, my name is Timothy Murphy, and I am the 
foreign currency risk manager for 3M Company. As you now know, 
3M is a U.S.-based employer headquartered in Minnesota. We are 
home to such well-known brands as Scotch, Post-It, Nexcare, 
Filtrete, Command, and Thinsulate. 3M has over 34,000 employees 
in the United States and operations in 27 States where over 60 
percent of 3M's worldwide R&D and where 60 percent of our 
manufacturing occurs.
    While our U.S. presence is strong, being able to compete 
successfully in the global marketplace is critical. In 2008, 64 
percent of our sales or over $16 billion were outside the 
United States. And this number is expected to grow to over 70 
percent by 2010.
    It is because of the global success of our brands that we 
need to manage foreign currency risks via the OTC markets. 
Likewise, our desire to officially manage our raw material and 
financing costs gives rise to our use of OTC commodity and 
interest rate tools.
    I want to stress that 3M, like the majority of corporate 
end users, does not speculate with derivatives. All of our 
hedge transactions are carefully matched with underlying risks 
from the operation of our businesses.
    I am here today to share 3M's perspective on proposals to 
establish a regulatory framework for OTC derivatives. While 3M 
supports the objectives outlined in Treasury Secretary 
Geithner's recent proposal, as well as many of the ideas put 
forward by Members in the House and the Senate, we have strong 
concerns about the potential impact on OTC derivatives and 3M's 
ability to continue to use them to protect our operations from 
the risk of currency, commodity, and interest rate volatility.
    3M agrees that the recent economic crisis has exposed some 
areas in our financial regulatory system that should be 
addressed. However, not all OTC derivatives have put the 
financial system at risk, and they should not all be treated 
the same. The OTC foreign exchange commodity and interest rate 
markets have operated largely uninterrupted throughout the 
economy's financial difficulties. We urge policymakers to focus 
on the areas of highest concern.
    3M understands and respects the need for reporting and 
recordkeeping. Publicly-held companies are currently required 
by the SEC and FASB to make significant disclosures about our 
use of derivative instruments and hedging activities, including 
disclosures in our 10-Ks and 10-Qs. We would like to work with 
policymakers on ways to efficiently collect information into a 
trade repository to further enhance transparency.
    3M opposes a mandate to move all derivatives into a 
clearing or exchange environment. One key characteristic of OTC 
derivatives for commercial users is the ability to customize 
the instrument to meet a company's specific risk management 
needs. Provisions that would require the clearing of OTC 
derivatives would lead to standardization, thus impeding a 
company's ability to comply with hedge accounting requirements 
for financial reporting, thereby exposing reported corporate 
financial results to unwarranted volatility and distracting 
from our operating results.
    While we are mindful of the reduction in credit risk 
inherent in a clearing or exchange environment, robust initial 
and variation margin requirements would create substantial 
incremental liquidity and administrative burden for commercial 
users, resulting in higher financing and operational cost.
    Scarce capital currently deployed in growth opportunities 
would need to be maintained as margin, which could result in 
slower job creation, lower capital expenditures, less R&D, and/
or higher cost to consumers. The hedging of business risks 
could well be discouraged.
    3M thanks the committee for studying the critical details 
related to financial system reforms and for considering our 
perspective in this important debate.
    Again, 3M respectfully urges the committee to preserve 
commercial users' ability to continue using OTC derivative 
products to manage various aspects of corporate risk while 
addressing concerns about stability of the financial system.
    3M looks forward to working with the committee as you craft 
this important legislation.
    Thank you.
    [The prepared statement of Mr. Murphy can be found on page 
171 of the appendix.]
    Chairman Kanjorski. Thank you very much, Mr. Murphy.
    And next we will hear from Mr. Don Thompson, managing 
director and associate general counsel of JPMorgan Chase & Co. 
Mr. Thompson?

  STATEMENT OF DON THOMPSON, MANAGING DIRECTOR AND ASSOCIATE 
             GENERAL COUNSEL, JPMORGAN CHASE & CO.

    Mr. Don Thompson. Mr. Chairman, Ranking Member Garrett, and 
members of the committee, my name is Don Thompson, and I am a 
managing director and associate general counsel at JPMorgan 
Chase & Co. Thank you for inviting me to testify at today's 
hearing.
    For the past 30 years, American companies have used OTC 
derivatives to manage interest rate currency and commodity 
risk. Increasingly, many companies incur risks outside their 
core operations that if left unmanaged would negatively affect 
their financial performance and possibly even their viability.
    In response to marketplace demand, risk management 
products, such as futures contracts and OTC derivatives, were 
developed to enable companies to manage risks. OTC derivatives 
have become a vital part of our economy. According to the most 
recent data, over 90 percent of the largest American companies 
and over 50 percent of mid-size companies use OTC products to 
hedge risk.
    JPMorgan's role in the OTC derivatives market is to act as 
a financial intermediary. In much the same way that financial 
institutions act as a go-between with investors seeking return 
and borrowers seeking capital, we work with companies looking 
to manage their risks and entities looking to take on those 
risks.
    A number of mainstream American companies have expressed 
great concern about the unintended consequences of recent 
policy proposals, particularly at a time when our economy 
remains fragile. In our view, the effect of forcing such 
companies to face an exchange or a clearinghouse will limit 
their ability to manage the risk they incur in operating their 
businesses and have negative financial consequences for them 
because of increased collateral posting. These unintended 
consequences have the potential to harm economic recovery.
    Let me first touch on some of the benefits of OTC 
derivatives. Companies today demand customized solutions for 
risk management and the OTC market provides them. Keep in mind 
that customization does not necessarily mean complexity. 
Rather, it means the ability to hand tailor every aspect of a 
risk management product to the company's needs to ensure that 
the company is able to offset its risks exactly.
    For example, a typical OTC derivative transaction might 
involve a company that is borrowing at a floating interest 
rate. To protect itself against the risk that interest rates 
will rise, the company would enter into an interest rate swap. 
These transactions generally enable the company to pay an 
amount tied to a fixed interest rate and the dealer 
counterparty will pay an amount tied to the floating rate of 
the loan. This protects the company against rising interest 
rates and allows them to focus on their core operations. In 
addition, the company is often able to qualify for hedge 
accounting and thus avoid seeing volatility in its financial 
reporting that would obscure the true value of its business.
    OTC derivatives are used in a similar manner by a wide 
variety of companies seeking to manage volatile commodity 
prices, foreign exchange rates, and other market exposures.
    In addition to customization, the other main benefit of OTC 
derivatives is flexibility with respect to the collateral that 
supports a derivative transaction. In the interest rate swap 
example I went through before, the dealer counterparty may ask 
the company to provide credit support to mitigate the credit 
risk that it faces in entering into the transaction. Most 
often, that credit support comes in the same form as the 
collateral provided for in the extensions of credits by that 
dealer counterparty to the customer. Thus, if the loan is 
agreement is secured by property, equipment or accounts 
receivable, that same high-quality collateral would be used to 
secure the interest rate swap. As a result, the company does 
not have to incur additional costs in obtaining and 
administering collateral for the interest rate swap.
    It is important to note that although derivatives are 
currently offered on U.S. exchanges, few companies use these 
exchange traded contracts for two main reasons: First, 
exchange-traded products are by necessity highly standardized 
and not customized. As a result, companies are unable to match 
the products that are offered on exchanges to their unique 
portfolio of risks.
    Second, clearinghouse collateral requirements are by design 
onerous and inflexible. Clearinghouses require that 
participants pledge only highly liquid collateral, such as cash 
or short-term government securities to support their positions. 
However, companies need their most liquid assets for their 
working capital and investment purposes. Thus, in the example I 
gave, if the company had actually hit its hedge on an exchange, 
it would have had to post cash or readily marketable collateral 
up front and twice daily thereafter.
    By transacting in the OTC market, the company is able to 
use the same collateral that it has already pledged to secure 
its loan with no additional liquidity demands or administrative 
burdens. This collateral is high quality, given that it is the 
basis for the extension of credit in the loan but posting it 
does not affect the company's operations or liquidity.
    The flexibility to use various forms of credit support 
significantly benefits companies because without it, many 
companies will choose not to hedge risks because they cannot 
afford to do so.
    While we believe that exchanges play a valuable role in 
risk management, not all companies can or want to trade on 
exchange. Currently, companies have the choice of entering into 
hedging transactions on exchange or in the OTC markets, and we 
believe that companies should be allowed to have the choice to 
continue to use those competing products.
    The discussion of the benefits of OTC derivatives is not to 
deny that there have been problems with their use and it is 
essential that policymakers carefully examine the causes of the 
financial crisis to ensure that it does not repeat it.
    We have noted recent press reports indicating that banks 
are engaged in the concerted effort to avoid regulation. This 
is absolutely not true. For the past 4 years, major derivatives 
dealers, working in conjunction with regulators, have been 
engaged in an extensive effort to improve practices and 
controls in the OTC derivatives market. The letter referred to 
is just the latest quarterly submission outlining our efforts 
to enhance market practices, and we are committed to reforming 
the regulatory system and increasing confidence in the markets.
    To that end, we propose the following, which is consistent 
with the Administration's position, and CFDC Chairman Gensler's 
recent remarks on the issue: First, financial regulation should 
be considered on the basis of function, not form; second, a 
systemic risk regulator should oversee all systemically 
significant financial institutions and their activities; third, 
standardized OTC derivative transactions between major market 
participants should be cleared through regulated 
clearinghouses; and, finally, enhanced reporting requirements 
should apply to all OTC derivatives transactions, whether 
cleared or not.
    JPMorgan is committed to working with Congress, regulators, 
and other industry participants to ensure that an appropriate 
regulatory framework for OTC derivatives is implemented.
    I appreciate the opportunity to testify and look forward to 
taking your questions.
    [The prepared statement of Mr. Don Thompson can be found on 
page 189 of the appendix.]
    Chairman Kanjorski. Thank you very much, Mr. Thompson.
    And next, we will have Mr. Christopher Ferreri, managing 
director of ICAP. Mr. Ferreri?

   STATEMENT OF CHRISTOPHER FERRERI, MANAGING DIRECTOR, ICAP

    Mr. Ferreri. Thank you, Chairman Kanjorski, Ranking Member 
Garrett, and members of the subcommittee for allowing me the 
opportunity to participate in today's hearing. I am Chris 
Ferreri, and I work for a company called ICAP. We are the 
world's largest inter-dealer broker, employing more than 4,000 
personnel worldwide, including New York, New Jersey, and the 
other major financial centers. Using a combination of voice and 
electronic services, our function is to match buyers and 
sellers, specifically banks and other large financial 
institutions, operating in the wholesale financial markets.
    On their behalf, we execute thousands of trades daily and a 
broad array of financial products, including U.S. Treasury 
securities, foreign exchange, commodities, and other financial 
derivatives.
    Products and trades in the OTC markets are simply products 
that do not trade exclusively on registered exchanges. It 
should be noted that included in these products are U.S. 
Treasury securities and foreign exchange, by volume of trade, 
the world's two largest financial products.
    It should also be emphasized that for the most part 
institutional participants in these markets are currently 
subject to regulation by government authorities, specifically 
in the United States, the Fed, the SEC, and FINRA.
    During my testimony, I would like to emphasize the 
following three points: First, ICAP supports greater oversight 
of major participants in OTC markets, in particular to ensure 
the integrity of their capital base. We also support additional 
transparency through the increased use of electronic trading 
platforms and post-trade reporting facilities already available 
through companies like ICAP and others.
    Second, some have suggested that the solution to greater 
oversight with regard to the over-the-counter market should be 
to force much of the present activity on to existing exchanges. 
We do not believe this is necessary or indeed that it would 
accomplish its intended goal. Rather, we believe that better 
use of facilities that already exist, such as the electronic 
trading platforms, direct and immediate access to 
clearinghouses, and post-trade reporting and processing will 
lead to greater price transparency, more efficient markets, and 
additionally facilitate the oversight function of the 
regulatory authorities.
    Third, these products have increased in number and size so 
dramatically because virtually every major financial and 
corporate institution in the world needs and uses them to raise 
capital, to protect portfolio positions, and to mitigate risk. 
Whatever regulatory decisions are made, we must make every 
effort that they do not impair access to capital or the ability 
to hedge risk for private and public institutions alike.
    The subcommittee did give us seven points to touch on. I 
will address as many as I can in the time allotted.
    On the view for OTC regulation: ICAP favors changes to the 
regulatory framework supporting fairness and transparency. 
Inter-dealer brokers like ICAP are regulated by both the 
national regulators in each relevant market and by their 
overall lead regulator. There are many forms of regulation 
already in place that apply to the OTC cash and derivatives 
markets, in cases where the markets themselves may not be 
regulated but participants can be.
    How clearing will affect the OTC markets: Roughly 60 
percent of the OTC markets we operate are cleared. We would 
expect that increased clearing can lead to increased liquidity 
in the OTC markets.
    The pros and cons of exchange trading: We must first 
underscore the distinctions between exchange trading and 
clearing. ICAP operates fully electronic marketplaces for many 
products and none of them are single silos of exchange trading 
and clearing but are traded electronically and cleared 
centrally. This one-size-fits-all approach is completely 
standardized, non-fungible contracts means that corporations, 
mortgage providers, bond issuers and others are unable to 
accurately hedge their risk exposures. It is for this reason 
that the OTC markets are both larger in scale and broader in 
scope than the exchange markets.
    The potential benefits of electronic trading: Electronic 
trading could provide more efficient price discovery; simplify 
trade capture; materially reduce operational risk; improve 
trading supervision; increase audit ability; and create 
processing capacity in the OTC markets. In addition, multiple 
trading venues increase competition, keep costs down, and 
provide security from failure of individual platforms. 
Migrating liquidity is difficult. The turnkey development of a 
completely new market infrastructure is unnecessary and will 
require significant implementation time and incur a high level 
of risk. Rather than rushing to develop new infrastructure, 
better and more extensive use should be made of the tremendous 
capabilities of the existing OTC market infrastructure.
    In summary, it should be clear that the over-the-counter 
market is not unregulated or even less regulated. Our 
electronic trading platforms are global, connect to thousands 
of customers in dozens of countries, as well as the world's 
largest clearance and settlement systems.
    ICAP welcomes the coming reform, and we feel our goals of 
promoting competition, electronic trading, and clearing helps 
both our customers and ICAP.
    The OTC market has already invested significantly in 
developing this infrastructure for price discovery, trade 
execution and post-trade automated processing which contributes 
hugely to reducing risks, but it needs to be further developed 
and better leveraged for the benefit of all.
    Once again, I think the committee for allowing me to speak 
on this topic, and I look forward to working with the committee 
on building a bridge for a better marketplace.
    Thank you.
    [The prepared statement of Mr. Ferreri can be found on page 
147 of the appendix.]
    Chairman Kanjorski. Thank you very much, Mr. Ferreri.
    And, finally, we have Mr. Christian Johnson, professor, 
University of Utah School of Law. Mr. Johnson?

  STATEMENT OF CHRISTIAN A. JOHNSON, PROFESSOR, UNIVERSITY OF 
                       UTAH SCHOOL OF LAW

    Mr. Johnson. Thank you, Mr. Chairman, Ranking Member 
Garrett, and subcommittee members. As an academic, I thought I 
might take a moment to step back and try and provide some 
historical context as to why the over-the-counter derivative 
markets look like they do.
    The first OTC derivative that was publicly announced I 
believe was a cross-currency swap between IBM and the World 
Bank back in 1981. And there was probably activity before that 
but at the time there was tremendous legal uncertainty as to 
whether it was even legal to do over-the-counter derivatives. 
The biggest concern at the time was whether or not these over-
the-counter derivatives were what we call illegal off-exchange 
future transactions and thus subject to CFTC regulation and 
could conceivably be held to be void by the courts.
    And what began then for a period of about 7 or 8 years, was 
a tremendous perhaps we call it turf war going on between the 
CFTC's thoughts on asserting jurisdiction over this growing 
market and the large dealers pushing back, oftentimes with the 
help of regulators, to keep this as an unregulated and 
customized market.
    In 1989, the CFTC officially agreed to not exercise 
jurisdiction over the over-the-counter derivative market 
provided that the transactions were not standardized and 
provided that they were not cleared or did not enjoy exchange 
offset. And so essentially what happened is because of this 
legal uncertainty, the goal of the OTC market was to look as 
little as possible like exchange traded derivative 
transactions.
    In 1993, Congress gave the CFTC authority again to not 
regulate over-the-counter derivative transactions, provided 
that the transactions were not standardized. And so in the 
initial history of the over-the-counter derivative market, you 
have tremendous pressure to drive the over-the-counter activity 
away from what we appear to be trying to do today, to try to 
get them back to being more standardized and put back on to 
exchanges and traded in a way that might minimize the risks 
that we all have been talking about.
    So the problem we have now is we have a global industry 
that was initially driven by the efforts not to look like 
standardized transactions that could be cleared and traded over 
exchanges. And so you have a global market that has designed 
products, created infrastructure and to do all the things that 
we do not want them to do right now. And now we are trying to 
force them back into the model where they are standardized, 
where they are cleared and enjoy some of those different 
benefits.
    The reason I bring this up is, one, again, because a lot of 
this situation we are in was caused because of I guess what you 
would call regulatory competition over who is going to take 
control over this particular market, and the problem we have is 
we have a very mature and developed market that does not 
operate in the way that we want it to at this particular 
moment. And it will probably take time and nudges from 
regulators and from Congress to start doing the kinds of things 
that we have been talking about today.
    When you look at Secretary Geithner's May 13th letter where 
he talked about what we should be doing to regulate over-the-
counter derivatives, his last paragraph is almost a throw away 
paragraph, and one of his last lines in the letter is, ``We 
would like to promote the implementation of complementary 
measures in other jurisdictions.'' And essentially what he is 
saying is that if we try and regulate here without getting 
similar regulation in Europe and Asia, that we run the risk 
that we are going to drive this market offshore. I am not 
trying to trivialize this point, but if you look at the OTC 
market, it is a bit like a big round children's squishy ball. 
And when you grab it and you try and conform it, it pops out in 
funny directions.
    And, again, I am not trying to trivialize what we are 
talking about, but this is a truly global industry that will 
move quickly and easily from jurisdiction to jurisdiction, 
wherever it is easiest to trade and where we have the least 
regulation. The concern of course is that we do not do this, 
and that we are able to preserve the dominance that our 
institutions have developed and maintain some control here in 
the United States.
    Thank you very much for your time.
    [The prepared statement of Professor Johnson can be found 
on page 161 of the appendix.]
    Chairman Kanjorski. Thank you very much, Professor. Now, we 
will see if we have any questions from our colleagues, and I 
will start off. First, let me ask a very obvious question, is 
there anyone of the six of you on the panel who feels that 
there is no corrective action that is necessary to be taken by 
the Congress in regards to derivatives?
    [no response]
    Chairman Kanjorski. So I guess we have uniform agreement 
that there are at least some or many fixes that should be made 
in the field of derivatives to improve the situation as they 
presently exist. Is that correct?
    Mr. Pickel. Yes, Mr. Chairman, I think that is correct. As 
I mentioned in my testimony, I focus on the efforts that have 
taken place over the last several years. In very close dialogue 
between regulators and the industry to identify some of these 
things, some of these issues. There are other parts of the 
proposal from Secretary Geithner, particularly on systemic risk 
and how you address that issue, that really cannot be addressed 
in that private/public dialogue. It really needs to be 
addressed by Congress.
    Chairman Kanjorski. One of the issues that the professor 
brought up in terms of after the recession is over and after 
the recovery is had, the next natural pressure will be shopping 
for forums for the derivative industry and will be back in the 
competition. Is New York, is Chicago, is London or is Peking 
going to be the capital where the industry goes? And it perhaps 
will be a race to the bottom of the least regulated area in the 
world. What could we do to create a position in the American 
market at least that would deny either getting the contract 
satisfied by assets held in the United States or some other 
means so that we would not change the forum of where these 
actions are taking place? In other words, can we in American 
law say any action taken in the derivative market in a foreign 
country that does not have an equal regulatory regime as the 
United States will not be actionable in the United States? 
Would that tend to be detrimental to their being trading abroad 
or in a different forum than they are now?
    Mr. Don Thompson. Mr. Chairman, I would like to take that 
question. First of all, I disagree with the premise that 
derivatives dealers will automatically be looking for 
jurisdictions to operate in which present the loosest 
regulation. It has become abundantly clear to us that even if 
our own house is in order, if our neighbors' houses are not in 
order, that presents problems to us as an industry. So I would 
be careful about accepting the premise of my co-panelists as 
being fact for all derivative dealers.
    Secondly, I do think one of the key unintended consequences 
that need to be avoided, and you used the word I believe 
``actionable'' in your question, is creation of legal 
uncertainty about whether contracts are enforceable. These 
contracts are market sensitive instruments, which vary in value 
based upon the underlying market factors on which they are 
based. And I would urge Congress to avoid any formulation which 
calls into question the legality of existing contracts based 
upon any of a number of criteria which I think has the 
potential to be significantly de-stabilizing.
    Chairman Kanjorski. So rather than provide for 
actionableness as the qualifying factor, do you think that by 
treaty or international agreement, we could stabilize a world 
market recognizing standardized conditions?
    Mr. Don Thompson. I think it would be much more effective 
and important for American policymakers to make sure that 
whatever steps we enact here in the United States are broadly 
consistent with the regulatory regime overseas as well to avoid 
any regulatory forum shopping of the nature you mentioned 
before.
    Chairman Kanjorski. What portion of nations would have to 
be participants in that type of standardization, of a treaty or 
otherwise, to accomplish the end, do we have to get 75 or 80 
percent of the countries, certainly not all, because we cannot 
get all of them?
    Mr. Don Thompson. No, I would imagine it would be, Mr. 
Johnson is right, this is a global business. It is a global 
business which is concentrated in regional hubs, New York, 
Chicago, London, Paris, and a number of Asian jurisdictions are 
the principal ones. I would not limit it to those, and I cannot 
give you a precise number. I think your instinct that you would 
not have to achieve unanimity in the international community 
but some reasonable number of major jurisdictions having the 
same regulatory framework is probably the right one.
    Mr. Pickel. Mr. Chairman, I might also add that there are 
existing international groups that I am sure you are well aware 
of, like IOSCO, the securities commissioners, there is the 
Basel Committee, which is very important on the bank capital 
front and also the newly formed Financial Stability Board, 
formerly the Financial Stability Forum, which provide 
frameworks for regulators across the major jurisdictions to 
coordinate. And also ISDA is actively involved in meeting with 
regulators around the world, getting the word out about for 
instance these commitments made to the New York Fed in the 
letter last week. I was just on a phone call with the 
Australian regulators last week, we had our meeting, our large 
annual meeting for members in Beijing in April, and we were 
addressed by senior regulators from the Chinese community.
    Chairman Kanjorski. Thank you very much. I see my time has 
expired. Mr. Garrett, you are recognized for 5 minutes.
    Mr. Garrett. I thank the chairman. I thank the panel. To 
Mr. Thompson or anyone on the panel, following the chairman's 
comment, which was sort of going to the direction that if we do 
certain things in this country, we might push the industry 
offshore and your suggestion, and others may concur, that it 
may not be an issue of a race to the bottom. Maybe the flip 
side of that question is, is there something that we would 
actually do that would actually attract them back here to this 
market, and not just by having a proverbial wild west, as some 
would say, approach to it?
    Mr. Don Thompson. Yes, I think that if correctly done, this 
has the potential to make the United States a pillar of 
financial responsibility in the sense that regulation 
intelligently applied will reduce systemic risk and increase 
transparency. And if it is done in an intelligent fashion where 
it does not by virtue of unintended consequences restrict the 
ability of end-users, mainstream American companies and the 
like, to continue to access custom risk management solutions 
from the OTC derivatives market, I think it has the potential 
to make the United States a pillar of responsible financial 
regulation and perhaps enhance the image of this country 
internationally.
    Mr. Pickel. I would also reference back to this whole 
discussion about legal certainty. The Act passed by Congress, 
the Commodity Futures Modernization Act in 2000, provided that 
legal certainty and Secretary Geithner's letter makes it very 
clear, and you have heard from the panelists today, that we 
should not tinker with that legal certainty. In that situation, 
if the wrong decision had been made, the business would have 
almost by necessity had to move elsewhere.
    Here we are talking about aspects of regulation, it may on 
the margin increase the cost, it may in some cases decrease the 
costs. That will be a calculation in the decision as to where a 
transaction might be traded or booked, but we are not talking 
about undermining the fundamental enforceability.
    Mr. Garrett. And following along that line, along the 
adding the cost, and maybe Mr. Murphy or others want to chime 
in on this, a couple of thoughts come to mind. One of the 
proposals that are out there is in regard to clearinghouses, 
right? And one of the ideas is you have one central 
clearinghouse and another is you have multiple clearinghouses. 
And one aspect of that is to force the mandatory use of the 
clearinghouse. So could we do more harm than good if we said--
the first question would be is that we have a mandatory use, 
basically standardize the marketplace, would that attract or 
distract?
    And along that line, we had a gentleman speak to us the 
other night, and he made this point, which very quickly, he 
said that it is almost counterintuitive that if you allow for 
the option on the clearinghouses, that in fact in order to gain 
the liquidity, like Mr. Murphy and other industries would want 
in the marketplace, you actually would be driven naturally to 
that clearinghouse because that is where you are going to find 
the liquidity as opposed to outside of such a clearinghouse 
mechanism? Is that argument correct and answer the first 
question as well?
    Mr. Murphy. Well, let me if I can just back up on this 
international U.S. issue.
    Mr. Garrett. Okay.
    Mr. Murphy. From a business perspective, my concern--it is 
not this so-called ``race to the bottom,'' my concern is as a 
global company, 3M has competitors all over the world, Germany, 
Korea, wherever the case may be, so it is not a concern about 
business leaving the United States, my concern is if I have a 
competitor in Germany and he can call up his or her banker in 
Geneva and deal in the OTC market on a more or less unfettered 
basis, and we have to deal with a different, more stringent 
regime here in the United States, now we are at a competitive 
disadvantage in terms of our ability to manage risk.
    Mr. Garrett. Right, so if you have a mandatory 
clearinghouse arrangement where you are required to have a cash 
or collateral backstop to that over here, that may create 
problems actually both over there and over here with that 
market.
    Mr. Murphy. Yes, there are really two issues with the 
mandatory clearing. Issue one, you may notice this large book 
that I have brought today with lots of 3M products inside of 
it, this is FAS 133. This is the Financial Accounting Standards 
Board's Ruling 133, which governs the accounting treatment for 
derivatives for corporations. As you might imagine, not a lot 
of pictures in here, not really very light reading. It is a 
very difficult standard, very stringent. It is getting harder 
to meet these requirements and not getting easier over time.
    The problem with a clearing or exchange environment is that 
by their nature, products must become more standardized to work 
on those environments. And when you have a specific business 
risk, you need to, per the standard, hedge it with a specific 
hedge that matches up very precisely with that risk. And so if 
you move to a clearing environment, which is standardized by 
nature, you end up with a mismatch. You cannot precisely manage 
the risk. And so what happens is as a corporation, you lose 
hedge accounting treatment, which means the mark-to-market on 
those hedges hit your P&L, your income statement every quarter. 
And that is definitely something as a corporation you do not 
want to have happen. And so what that would lead to frankly in 
my opinion is companies will probably do less hedging frankly. 
So that is sort of issue one is being able to meet this.
    The second issue is just a cost issue. We have done some 
studies, some of my colleagues and I, over the last month to 
say over the last 3 years, what would it cost 3M if we were in 
a mandatory clearing environment. And without looking at the 
administrative burden, without looking at any trading fees 
even, although the trading fees are probably not a huge number, 
the margin required on average for 3M over the last 3 years 
would have been $100 million. At its high point in 2007, it 
would have been as much as $200 million. So that is $100 to 
$200 million of our balance sheet which we would have to move 
into this clearinghouse account to essentially just sit idle.
    Now, 3M is a highly rated corporation--
    Mr. Sherman. [presiding] Mr. Murphy, the time has expired.
    Mr. Murphy. Sorry.
    Mr. Garrett. Thank you, Mr. Murphy.
    Mr. Sherman. I now recognize myself for 5 minutes. AIG was 
under the control of a ravenous and reckless management, a 
greed management, I am not saying there are not similar 
managements in control of other corporations. But in spite of 
that management, the regulated insurance companies did just 
fine because the regulation was the counterbalance to the 
ravenous, reckless and greedy nature of the management. The 
unregulated portion failed. And no one was hurt much except the 
taxpayer and the economy. The officers and directors seem to be 
doing just fine. And, more importantly perhaps, the 
counterparties have been insured to the last penny. What 
concerns me is that everyone in this room is just focused on 
how is it working for corporate America and not what is 
happened to the economy and the country and what risks have 
been taken by the taxpayer.
    Now, is there anyone on this panel who can say that your 
organization came to Congress a couple of years ago and said, 
``My God, you have to stop what is going on in our industry. It 
threatens the world economy. AIG has gone crazy. Other 
companies have gone crazy.'' Is there anyone here who wishes to 
say that being on the front line, they looked, they saw, and 
they warned?
    [no response]
    Mr. Sherman. We are told that we could, through legal 
action, make it so that the next AIG was a foreign company. We 
are told that this is really an international business, which 
begs the question why is it that the United States had to bail 
out AIG and the foreign counterparties of AIG? And perhaps if 
bailing out is one of the responsibilities of the host 
government, would not we want to drive this industry overseas?
    Mr. Pickel, is AIG a member of your organization?
    Mr. Pickel. Yes, AIG is a member of our organization.
    Mr. Sherman. When you saw them taking risks that could 
bring down the economy and force them to squeeze taxpayers for 
over $100 billion, did you demand that they take corrective 
action or kick them out of the organization?
    Mr. Pickel. The nature of our organization is a member 
organization, we do not perform a self-regulatory function, so 
we do not enforce--
    Mr. Sherman. So if the devil wants to join your 
organization, the only question is, does his dues check clear?
    Mr. Pickel. We have an extensive membership, including AIG, 
across the world, yes.
    Mr. Sherman. But if the devil wants to join the 
organization, the question is, does the dues check clear?
    Mr. Pickel. We are involved in education and awareness.
    Mr. Sherman. I am sure you do wonderful work. Now, I am 
told here we are losing the capacity to get the cheapest 
insurance most customized. Why can't I buy a customized fire 
insurance policy for my house from an unregulated Cayman 
Islands insurance company? The answer is we have decided that 
we want secure insurance companies. We do not want to have to 
be bailing them out. And we want the consumer to be paid.
    Mr. Murphy, I assume that 3M has insurance, buyer and 
casualty and liability insurance. Do you buy any of that from 
unregulated companies with no known reserves?
    Mr. Murphy. I will be honest with you, I am not in the 
insurance area at 3M. We do purchase insurance for our 
facilities, but I cannot really give any more details than 
that.
    Mr. Sherman. I have a number of other questions I will ask 
for the record. I see my time is nearly expired. I now 
recognize the distinguished ranking member of the full 
committee, Mr. Bachus.
    Mr. Bachus. Thank you, Congressman Sherman. I guess if the 
devil wanted to run for Congress, we could not prevent that 
either.
    [laughter]
    Mr. Sherman. But we would kick him out, wouldn't we?
    Mr. Bachus. I am not sure we would.
    [laughter]
    Mr. Sherman. We would kick him out of the Democratic 
Caucus. I yield back.
    Mr. Bachus. I am not sure you would.
    [laughter]
    Mr. Bachus. What lessons has the financial services 
industry learned from the Lehman Brothers' bankruptcy and from 
the near collapse of AIG, any of you?
    Mr. Pickel. Let me comment briefly on AIG. They, through 
their credit default swaps, were taking exposure to subprime 
debt, the collateralized debt obligations, certain tranches of 
those obligations, so they had an appetite for subprime 
exposure. In fact, through their regulated insurance companies, 
as Mr. Polakoff testified in the Senate Banking Committee in 
March, they were also taking on exposure to subprime past the 
time that the financial products company stopped taking on 
exposure, well into 2006 and even 2007. So that was the 
appetite that they had.
    They also looked at risk in a very narrow way. The head of 
FP, the Financial Products Division, was quoted as saying he 
could not imagine ever losing a dollar on these trades. And he 
was looking at that really only in respect to payouts on the 
transactions. He was not really looking at the mark-to-market 
exposure, which ultimately is what undermined AIG.
    They also traded on their triple A, which other 
institutions--in fact some of the institutions who have been 
the source of the greatest problems, Fannie and Freddie, some 
of the monolines, have traded on their triple A, resisted the 
providing of collateral, and even worse, agreed in certain 
circumstances to provide collateral on downgrades. And, 
frankly, ever since the Group of 30 Report published in 1993, 
it has been very clear that downgrade provisions, where you 
provide collateral on downgrades, are to be dealt with very 
cautiously because of the liquidity problems they can cause. In 
fact, the banking regulators discourage them, they do not 
prevent them but they do discourage the use of those types of 
provisions. So those are our observations on the AIG situation, 
and I think is very important as we look forward in reform.
    Mr. Bachus. Okay, thank you.
    Mr. Don Thompson. Congressman, you mentioned Lehman 
Brothers as well, and I think it is important to realize that 
there were other entities besides AIG who have been part of the 
financial crisis that we are in and to recognize that not all 
of the financial difficulties which we have experienced have 
been a result of OTC derivatives. If you look at Lehman 
Brothers and you look at Bear Stearns, for example, you see the 
classic banking error being made again and again, which 
hopefully we will learn from, which is buying very long-dated 
assets that are somewhat illiquid, and funding them with 
overnight money in the wholesale money markets, which can go 
away at the drop of a hat.
    And I think that if you look at exactly what happened to 
Bear and Lehman, that was the paradigm. Although they were both 
major OTC derivatives dealers, their OTC derivatives operations 
were mere footnotes in the story of Lehman and Bear. It was 
really compiling a large volume of 30 year mortgage-related 
assets and funding them overnight in the repo market that did 
those firms in.
    Mr. Pickel. I might also just add on the Lehman Brothers, 
it is a very effective example of a clearinghouse existing 
together with the bilateral. The clearinghouse existed for 
interest rate swap trades, and they settled out their trades 
very efficiently. And parties on the bilateral, as the master 
agreement relationship, moved to terminate and close out on a 
fairly reasonable time frame and crystallize those exposures.
    Mr. Bachus. Okay, thank you. Mr. Johnson?
    Mr. Johnson. I think one last thing is that intellectually 
we always knew that a big dealer like a Lehman or Bear Stearns 
could go insolvent but given the amount of trading that was 
going on with those institutions, I am not sure that we 
expected it actually to happen and that it was sort of one of 
those 100-year events. And I think the reality has woken up a 
lot of people that how any counterparty can have these kinds of 
trouble.
    Mr. Bachus. Thank you. Thinking about how AIG never 
imagined that these things could go down, I guess a lot of 
homeowners, a lot of people who bought commercial property and 
houses sort of assumed the same thing, obviously to their 
detriment. But I appreciate those responses, and I think they 
are very insightful.
    Dr. Johnson, you mentioned the turf battle here in Congress 
some time between CFTC and the SEC. Now, the Commodities 
Exchange Act actually excludes credit default swaps from 
jurisdiction of--well, they are excluded from the coverage of 
the Commodities Exchange Act, so the CFTC draws its 
jurisdiction from that Act. So if we were to give some function 
on credit default swaps, which are really meant to insure 
against default by a publicly-traded company I guess or a group 
of publicly-traded companies defaulting on their debt, if the 
CFTC was given that authority, would we have to amend the Act 
or would they have jurisdiction?
    Mr. Johnson. Clearly, there is going to have to be a lot of 
regulatory changes to do what we are trying to do based on the 
current structure that we have, and that becomes the real 
question as to who we are going to give this regulatory 
authority to. And that has been the battle since the early 
1980's as to who gets to regulate this particular industry.
    Mr. Bachus. Yes, and I am not advocating regulation.
    Mr. Sherman. I thank the gentleman. I recognize the 
gentleman from Massachusetts.
    Mr. Lynch. Thank you, Mr. Chairman. At the outset, I would 
just like to say if we cannot fix this system, given the 
experience we have had with this, if we cannot fix it and allow 
all investors and institutions to I think readily rely on a 
derivatives system, it is probably better that it go overseas 
rather than put the stamp of this country and the full faith 
and credit of this Nation behind such a system if we do not 
think it is really sound. Now, I have heard that argument 
before from other firms within the financial services industry 
that if we regulate this industry, it will go overseas. Well, 
there are probably some folks over in London who sort of wish 
that type of dynamic had not been created.
    Now, a couple of observations that I want to make. Dimitris 
Chorafas wrote that, ``Compared to horse-and-buggy classical 
bonds and equities, complex derivatives are supersonic 
engines.'' And I just want to bring to mind the power of 
derivatives. I will readily admit there is some advantage to be 
had from their use, but I am very concerned about the idea that 
there would be customized derivatives outside of a regulatory 
system because I think there is a certain attraction to firms, 
such as 3M and others, to have a derivative customized to their 
very specific situation. I understand the attraction of that. I 
also understand that where AIG and some others got into some 
tough situations in terms of the derivatives they were holding 
is that they were not fungible. They were so uniquely crafted 
that no one could determine what the value of those derivatives 
were and there were just no buyers on the market, so it seized 
up. So there were advantages but it also created problems.
    Let me ask you this question: If we allow a customized 
derivative industry to operate outside of--just over-the-
counter, without anybody knowing the details and the dynamic of 
those customized derivatives, and frankly stability has always 
been gained at some cost to innovation. That is just the way it 
operates. But if we are going to allow that to happen in this 
opaque and complex system, customized derivatives to be traded 
over-the-counter, how do the regulators protect the American 
system here, our financial system, if we do not know what is 
going on out there, the only limit is the creativity of some of 
those folks over at MIT, some of whom live in my district, how 
do we allow that to operate when all the good that your 
industry might do, you also have the ability to destroy the 
economy and bring the economy down, how do we balance that?
    Mr. Don Thompson. Well, I would like to address that. I 
think that the framework that we have been working on with the 
Fed and the other regulators provides a paradigm here where you 
have clear transactions between major dealers that are 
standardized being given up to a clearinghouse. And then with 
respect to transactions that are not cleared, you have central 
trade repositories, which contain all of the trade information 
of those non-cleared transactions, whether they be not cleared 
because of their degree of customization or because of the 
counterparties to the transaction, which are accessible to 
regulators in whatever form and as frequently as they want it.
    Mr. Lynch. Okay, I understand that part so far, but let's 
go back to my point was if in the derivatives, you get a 
substantial number of derivatives that we call it, ``the too 
many people on one side of the boat phenomena,'' like we had 
with AIG and a lot of others where unbeknownst to us everybody 
had loaded up on the same positions, those positions went bad, 
everybody tried to liquidate at the same time and because we 
did not know what the counterparty risk was there, we could not 
do anything about it, and so the boat sank. How do we get at 
that when we have an opaque system of customized derivatives, 
how do we get at that problem?
    Mr. Don Thompson. Well, I do not believe you would have an 
opaque system of customized derivatives because all of the 
customized derivative trade level information would be in the 
trade repository and would be available to the systemic 
regulator on a more or less real-time basis. So to use your 
analogy, the systemic risk regulator sees who is going over to 
one side of the boat and is able to take preemptive action 
before everybody moves over to one side of the boat or before 
one major market participant, like an AIG, gets way over to the 
one side of the boat.
    Mr. Lynch. I appreciate your attempt there but having 
looked at these derivatives and how complex they are, and if 
they are all carved out individually, customized to these firms 
and their situations, I do not think there is any systemic 
regulator who is going to be able to make that determination 
based on the instrument itself. These are very, very complex, 
it is mind-numbing how complex these things are, and I just do 
not think that is a realistic expectation.
    I think I have exhausted my time, Mr. Chairman. I 
appreciate your attempt to address that, and I appreciate the 
attendance of all the witnesses. Thank you.
    Mr. Sherman. I will ask you for the record to comment 
whether instead of just making this available to the regulator, 
every word should be put on the Web site of every one of these 
that are in the depository, but I have no time because I yield 
to the gentlelady from Illinois.
    Mrs. Biggert. Thank you, Mr. Chairman. My question is 
directed to all of you or whomever wants to answer. There has 
been much discussion or warning rather against a one-size-fits-
all approach. So my question is, should we have three buckets 
of OTC products? For example, number one would be standardized 
OTC products potentially traded on an exchange; number two 
would be OTC products run through a clearinghouse or central 
counterparty; and number three would be customized OTC products 
that remain privately traded but are reported to a warehouse. 
So how would these be defined, how would you define these? And 
then second, should a trigger mechanism be established so that 
all OTC products clearly fall into one of these three buckets?
    Mr. Pickel. If I could just comment, I think that is a very 
good division of how this market will evolve and is already in 
the process of evolving. You would have an exchange traded, or 
perhaps an electronically traded element, that would allow the 
highly standardized trades to be traded that way. You would 
have this category of cleared trades and then you would have 
the customized trades.
    I think the question of where a product is in the 
standardization process is largely a function of how actively 
traded and how liquid the underlying market is because keep in 
mind a clearinghouse will need to at least daily, and sometimes 
twice daily, mark those positions to market and call for 
margin, and so it needs to have a liquid market for that 
project. An exchange needs an even higher degree of liquidity, 
market makers who are active in the exchange, ready to do a 
transaction at any time during the trading day. So that 
liquidity I think largely drives where the dividing line would 
be, but that is not an easy determination to make.
    Mrs. Biggert. And then what about the customized OTC 
products that would be privately traded, there would be no 
control over them except reported to the warehouse?
    Mr. Pickel. Well, there would be the reporting to the 
warehouse. There would be most of the dealers who are engaged 
in these transactions and would continue to be regulated, 
primarily by the banking regulators. And then for those 
entities that would fall into this category of taking on 
significant exposure to counterparties, the systemically 
important entities, you would have the systemic risk regulator 
overseeing their activities.
    Mrs. Biggert. Could you suggest a trigger mechanism that 
would help to ensure that they fall into one of these buckets?
    Mr. Pickel. Well, I think that is the important issue, and 
we are actively engaged in conversations with the 
Administration about how we would go about identifying what is 
sufficiently standardized to move to a cleared environment and 
then furthermore to an exchanged trade or an electronically 
traded environment. I think that is something that the 
Administration is wrestling with currently.
    Mrs. Biggert. Would anyone else like to--Mr. Thompson?
    Mr. Don Thompson. Yes, I would like to add that in addition 
to the measures that Bob mentioned about the customized bucket 
of OTC derivatives, we are broadly supportive of the steps that 
Chairman Gensler outlined in his recent testimony in terms of 
codes of business practices, increased capital requirements, 
strengthened anti-fraud and market manipulation, and trade 
reporting. So I do not think it is fair to say you would be 
relying entirely on the trade repositories as the only measure. 
I think there are a host of other measures that Chairman 
Gensler has thoughtfully outlined and that are broadly 
consistent with the Administration's proposal as well.
    Mrs. Biggert. Okay, thank you. Another question is would 
any of you care to describe any issues that you may have with 
the Waxman-Markey bill and how do you feel about a new 
transaction fee or tax? No interest in that?
    Mr. Pickel. Well, we have weighed in, we have worked with 
other organizations that are members to oppose those 
provisions. And I think that imposing a tax, just as has been 
debated over the years about imposing a tax on futures trading, 
I think harms the efficiencies of these markets.
    Mrs. Biggert. Okay. No one else? Well, then if it has been 
a concern that some of the OTC derivative products are not safe 
for retail investors, should we simply restrict participation 
in these markets? We heard long ago that these were not for the 
people who were in pensions or whatever but for those who had 
the ability to take a loss on a large amount of money and 
somehow it seemed to have slipped from that. Is there any 
concern that we would go back to that?
    Mr. Don Thompson. Well, I think it is fair to say the over-
the-counter derivatives market is already an institutional 
market. The eligible contract participant requirement in the 
Commodity Exchange Act restricts it from retail investors. Now, 
I guess one can quibble about whether that has been set high 
enough, low enough or whatever, but it is not, and has never 
been, a retail market, unlike the exchange traded markets.
    Mrs. Biggert. Okay, thank you. I yield back.
    Chairman Kanjorski. The gentleman from North Carolina, Mr. 
Miller?
    Mr. Miller of North Carolina. Thank you, Mr. Chairman. You 
all have spoken of derivatives as being a risk management tool 
but it appears that there is a great deal more in derivative 
contracts than there is risk to manage. Mr. Kanjorski estimated 
or repeated the estimate of $500 trillion in outstanding 
contracts. Mr. Bachus said $684, which is the number I have 
heard more often, trillion. Our GDP is about $14 trillion, so 
that it is a big number. I know it is not a real number, it is 
a notional value, it is both sides of the transaction, on and 
on, but it is still a big number. Do you have a sense of what 
percentage of the outstanding contracts actually have one of 
the parties to the contract with an interest in the underlying 
asset? I was hoping for a short answer, not an essay on that.
    Mr. Pickel. We do not have a statistic on that 
specifically. In the credit default swap space, there is 
discussion about whether 10 or 12 percent or something like 
that would have that underlying interest.
    Mr. Miller of North Carolina. That is a small number, okay. 
There have been a lot of criticisms of naked derivatives, that 
it creates tremendous uncertainty about what the real economic 
consequences are for an event that would appear to be not that 
consequential. It creates an interconnectedness, it means that 
a great many institutions are too interconnected to fail. And 
some have even said that it means that there are a great many 
economic players who stand to profit from what appears to be an 
economic loss and have a power to make it happen.
    There was an article in the Financial Times about 6 weeks 
ago about a bank in Kazakhstan. I am sure you know about it. 
Times have been tough economically in the former Soviet space 
and the Kazakhstan government took over the bank. Morgan 
Stanley had debt. That bank owed Morgan Stanley debt, Morgan 
Stanley could call the debt due if there is a change of 
ownership. Morgan Stanley said initially, ``No, no, go ahead, 
just keep making the payments,'' and then they changed their 
mind and said, ``No, come to think of it, we want you to pay it 
all,'' which they could not. And shortly after that, or about 
the same time, they filed with the International Swaps and 
Derivatives Association to start the formal proceedings to 
settle credit default swap contracts with that bank, and the 
suggestion, the Financial Times' suggestion was that they 
actually made more money on their credit default swap positions 
than they would if they got paid by the bank. Is that concern a 
valid one? Is that something we should worry about?
    William Buiter, a prominent economist, despite my 
difficulty in pronouncing his name, has called for derivatives 
to become instruments of insurance risk management rather than 
instruments for placing bets, for gambling. What is the social 
value in allowing derivative positions when neither party of 
the contract has any interest in the underlying contract? There 
are obviously a lot of downsides to that, what is the 
advantage?
    Mr. Pickel. Well, let me--there are a number of things to 
focus on there. One is this Kazakhstan situation where we as an 
organization and our member firms have been very sensitive to 
the issue of making sure that there is a Chinese wall, there is 
a division between the lending operation of a bank and the 
trading or CDS trading side of the bank. We have published a 
number of guidelines and rules. People follow those very 
closely. I think Mr. Thompson could elaborate on how that is 
addressed at JPMorgan, I am sure. So that is in place.
    Furthermore, yes, Morgan Stanley did present the question 
to our determinations committee at ISDA but that is a committee 
of 15 firms represented, and they all agreed that what happened 
there was a credit event. So there was unanimous support in the 
marketplace.
    Mr. Miller of North Carolina. But more fundamentally, why 
should there not be something resembling an insurable interest? 
Why should 200 people be able to buy insurance on someone who 
turns up the victim of foul play? Why should there not be a 
requirement of an interest in the underlying asset? If there is 
not, how is it risk management?
    Mr. Pickel. Well, primarily because if you want to be able 
to have a product there for those who do need to hedge a risk, 
it is important to have a market there where people are willing 
to take a view on whether the pricing of that is cheap or 
expensive, so providing that liquidity.
    Furthermore, you have the traditional bond or loan holder, 
but you have other individuals, including the dealers who sell 
the protection to those people who hold the bonds and loans who 
will also need to manage that risk. So it is a complicated 
issue of many different types of risks even though the 
underlying bond and loan may be only held by 10 or 15 percent 
of the users.
    Mr. Miller of North Carolina. I probably do not have enough 
time to ask another question, so I yield back.
    Chairman Kanjorski. Ask your question.
    Mr. Miller of North Carolina. Well, Mr. Murphy, you 
mentioned or you held up the FAS rule on how derivatives are 
treated in accounting. Insurance or re-insurance, we do not 
have much control over re-insurance companies. It is an 
international market, much of it is through the markets at 
Lloyd's but American insurers only get safety and soundness--
credit from their safety and soundness regulator, State 
insurance commissioners, if the parties with which they have 
re-insurance meet certain criteria. Why should there not be a 
similar requirement or is there a similar requirement for 
safety--how are derivative contracts treated for safety and 
soundness purposes by financial institutions?
    Mr. Murphy. I am not sure I have an answer for that. I 
think maybe Mr. Thompson might be better qualified.
    Mr. Don Thompson. Well, you used the--
    Mr. Miller of North Carolina. Obviously, it is both an 
asset and a liability, how is it treated on the books, how is 
it treated by safety and soundness regulators?
    Mr. Don Thompson. So, how are our derivatives activities 
accounted for?
    Mr. Miller of North Carolina. Right, how are they treated 
for safety and soundness regulation?
    Mr. Don Thompson. Okay, well, from an accounting 
perspective, we operate under a different regime than 3M has 
opted into with respect to its derivatives hedging activities. 
We as a dealer are subject to mark-to-market accounting with 
respect to our overall portfolio derivatives transactions. So 
everyday at the end of the day we total up all the gains, total 
up all of the losses, and those unrealized gains and losses, as 
they are called, are listed as assets or liabilities 
respectively on our balance sheet.
    Mr. Miller of North Carolina. In any of that, do you take 
into account whether the counterparties can actually pay?
    Mr. Don Thompson. Yes, and in fact under so-called fair 
value accounting, there is something applied called a CVA, it 
is a credit valuation adjustment, such that if we, for 
instance, and 3M being the kind of credit that it is a bad 
example but I will use them anyway, if we have 3M as a 
counterparty and they owe us let's say $100 million across 10 
different derivatives contracts and 3M's credit rating declines 
or actually we have keyed off their credit default spreads, if 
their credit default spreads indicate that they are a riskier 
credit, in effect we haircut the $100 million that 3M owes us, 
and we will claim it as an asset for let's say $95 million 
instead of $100 million, applying a credit valuation adjustment 
of $5 million to reflect the riskiness of the asset that we 
hold with respect to which 3M is obligated.
    Mr. Miller of North Carolina. I really have exceeded my 
time. Mr. Chairman, thank you for your indulgence.
    Chairman Kanjorski. Thank you very much. And now the 
gentleman from Georgia, Mr. Price, for 5 minutes? Okay, you 
want to subvert the rules on the Republican side and honor--
okay, very good, we will recognize Mr. Hensarling for 5 
minutes.
    Mr. Hensarling. Thank you, Mr. Chairman. Some of this may 
be a little bit of old ground, but I want to put a finer point 
on it. A Reuters article came across my desk a couple of weeks 
ago and it has this take away, I will quote from it, it is a 
May 14th article, ``The Obama Administration's plans to move 
derivatives trading to exchanges could end up hurting companies 
that use the products because accounting rules often make 
customized off-exchange products a better choice for 
corporations. In the end, the Administration will have to limit 
the scope of the reforms it is looking for, press for new 
accounting rules for derivatives or risk killing the market for 
corporate derivatives, experts said,'' whomever those experts 
may be. I have a panel of experts before me now.
    Mr. Murphy, you have commented somewhat on this but could 
you put a fine point, is changing FAS 133 one of the potential 
answers to this dilemma? And I think you mentioned that already 
it is being somewhat moderated, if that is the proper term?
    Mr. Murphy. Well, it is definitely not getting easier. This 
is a slope that I probably do not want to go down, but clearly 
if we move to an exchange or clearing environment, companies 
would have to re-examine whether they can continue to hedge 
under these regulations. So if you said that they were going to 
be relaxed somehow, could that possibly give kind of more 
running room to continue to hedge risk? I would say, yes, that 
is a possibility, but this is a big complicated document, and I 
think changing it would probably not be a slam dunk either, but 
it is a possibility.
    Mr. Hensarling. Anybody else? Mr. Thompson?
    Mr. Don Thompson. Yes, I would like to address the question 
and maybe go through the accounting in a little more detail to 
make sure everybody understands it. Under the current 
accounting framework, the general rule for derivatives is they 
need to be mark-to-market. That applies to everybody, including 
3M. And the rationale there is clear, their value changes day-
to-day, your financial statements should reflect the value of 
your assets and liabilities, so to the extent that those assets 
and liabilities change day to day, that should be reflected in 
your financial statement.
    Hedge accounting reflects a very narrow exception to that 
and it generally goes like this: When you have a specific 
liability or a specific risk, and you have a derivative so 
closely associated with that liability, that they are 
essentially part and parcel of each other, and a gain in one 
will exactly offset a loss in the other, you can ignore both 
marking the liability and the hedge to market and ignore 
fluctuations in the derivatives value.
    To the extent that you relax FAS 133 and require a looser 
fit between the hedge and the risk that the hedge is hedging, 
you then do--you have a problem with respect to fair value 
accounting generally because you will allow people to avoid 
fair value accounting for things that are not a perfect hedge 
but only an approximate hedge.
    Mr. Hensarling. Let's talk about AIG for a moment since AIG 
really put credit default swaps on the public's radar screen. I 
would think in any prudent system of risk management, that 
public policy would want to encourage the proper use of credit 
default swaps and their risk management. Clearly, in 
retrospect, AIG took oversized bets that ultimately someone 
decided the taxpayer must be compelled to bail out, and I 
assure you it was not me. But the acting Director of OTS, under 
oath in this committee, said that his regulatory body had the 
manpower, had the expertise, had the regulatory authority to 
curtail AIG's CDS position, they just missed it. They just made 
a mistake.
    So I guess my question would be this, if we had this 
concept of a clearinghouse in place prior to AIG's meltdown, 
what type of difference might it have made? And as we attempt 
to lessen the risk in the system, and clearly the flip side of 
risk is rate of return, but if all members of the clearinghouse 
are going to be responsible for the risk, does that not 
incentivize some to try to pawn the risk off to the larger 
group and have we not perhaps even created more systemic risk 
and created the next big bailout with such a clearinghouse? 
Anybody who cares to answer, Mr. Pickel seems to be the first 
at the buzzer.
    Mr. Pickel. Right, not playing Jeopardy, are you. No, that 
is certainly a concern with a clearinghouse, and it has been 
identified by regulators as a significant concern, which is why 
having the appropriate regulatory oversight, having 
requirements for capital up front, margin requirements, a 
reserve fund, all those things are critical components. And the 
dealers who have been active in putting these together, whether 
it is the existing clearinghouse in the interest rate swaps 
base or the more recent initiatives in the credit default swaps 
space, have focused on providing just those protections. But it 
is something that requires regular diligence to oversee and 
make sure that that clearinghouse does not in fact increase 
risk.
    Mr. Hensarling. Thank you. I see my time has expired.
    Chairman Kanjorski. The gentleman from Georgia, Mr. Scott, 
is recognized for 5 minutes.
    Mr. Scott. Thank you, Mr. Chairman. It seems to me that the 
issue here is the central clearinghouse, whether or not we 
should mandate it, and there have been some concerns raised 
that if we do that, that it will drive business overseas. Then 
there is also the issue of illiquid and unstandardized 
derivatives. And I would like for you to kind of explain to me 
how having a clearinghouse, as the Secretary of the Treasury, 
Mr. Geithner, has proposed, and which seems to be the drift 
here, would force this business overseas? Is that true first of 
all? And, if so, if you could explain how that would happen?
    And since derivatives are based on a value of something 
else, meaning stocks and so forth, which I think is liquid, 
what is an illiquid and unstandardized? And does that bring a 
greater risk itself?
    Mr. Fewer. Congressman, there is a class of--if we talk 
about credit, there is a class of credit product that is easily 
conducive to exchange listing. They are a family of a composite 
of index products that frankly account for a very significant 
portion of outstanding CDS contracts. And these are very, very 
standardized products, trade in very large size, high trading 
frequencies, an example would be a bespoke basket of credit 
default swaps. Dealers have huge portfolios of credit default 
swaps that they would like to customize and take some very 
difficult to trade names, put them in a basket and try to have 
the market price what actual protection on that bespoke pool. 
That would be a very difficult product to force through a 
central counterparty clearance. However, that does not mean 
that there could not be prudence from a risk-based capital 
standpoint.
    And Basel II has done a lot of work along these lines, but 
also the fact that a central counterparty clearer and a trade 
repository would be able to bring some information regarding 
that trade, not necessarily give the specific trades that would 
expose dealers to having their proprietary positions open to 
the market, but being able to give regulators the appropriate 
information and the ability to assess value of the very, very 
bespoke types of transactions. But that would be an example of 
a bespoke transaction as opposed to an index trade, which is a 
very high volume type, very, very standardized transaction.
    Mr. Pickel. I might add on the clearing point and whether 
that would encourage business to be done overseas, there is an 
initiative, which ISDA is involved in, as are our major 
members, with the European Commission to focus on establishing 
a clearinghouse over in Europe. There could be advantages to 
having a linkage between a U.S. and a European clearinghouse 
for the CDS product. But that is an ongoing discussion, so I do 
not see that--I do not see clearing as such as a driver for 
moving certain business--at least a market-driven reason for 
moving business here or overseas. It may be a regulatory-driven 
decision given the stance of the European Commission on that.
    Mr. Scott. Okay, yes?
    Mr. Don Thompson. I think that the moving business overseas 
argument is not one I am as focused on as the risk that 
companies such as 3M and other end users of derivatives, if 
they are forced into a mandatory clearing for everything or 
exchange trading platform, will simply choose to leave risks 
unhedged. And I think that is frankly the greater risk from a 
public policy perspective in the United States.
    Mr. Scott. Let me ask you, I have a little bit more time 
left, I remember when this whole issue of derivatives came up 
in the great financial mind that we all have great respect for, 
Warren Buffett, referred to them as ``weapons of mass 
destruction.'' Do you all think Warren Buffett was right?
    Mr. Don Thompson. I have read that quote as well, and after 
I read that quote, I continued to go through Mr. Buffett's 
piece where he outlined his firm's derivatives portfolio, 
which, as I recall, was a large portfolio of CDS index 
positions, a recent entrance by his firm into trading single 
name credit default swaps, and I believe a large portfolio of 
puts, long-dated puts on the S&P 500 Equity Indices. So after I 
read the whole piece, which is the case with everything with 
Mr. Buffett, very illuminating, I found it difficult to square 
the beginning characterization of derivatives with the detailed 
disclosure of his firm's active participation in a number of 
OTC derivatives markets.
    Mr. Scott. I see my time has expired. Thank you, Mr. 
Chairman.
    Chairman Kanjorski. The gentleman from Georgia, Mr. Price, 
is recognized for 5 minutes.
    Mr. Price. Thank you, Mr. Chairman. I appreciate that. The 
decisions that we make here are consequential, in fact the 
decision to do nothing is consequential. But my concern 
oftentimes here, and I know that many of my colleagues here, 
whatever we decide, we often do not look at the outcome or the 
consequences of the decision that we make down the line. So, 
Mr. Murphy, if I could ask you a couple of questions as again 
the only end user of CDS's on the panel today. How has 3M 
utilized CDS's to benefit your consumers.
    Mr. Murphy. We do not use CDS products.
    Mr. Price. You do not?
    Mr. Murphy. No.
    Mr. Price. And so in the process of this discussion, do you 
have any thoughts about whether we mandate a clearinghouse in 
this arena or not?
    Mr. Murphy. In the CDS arena?
    Mr. Price. Yes.
    Mr. Murphy. I really do not have an opinion on that.
    Mr. Price. How about any over-the-counter products?
    Mr. Murphy. Other over-the-counter products, absolutely.
    Mr. Price. And how is the use of over-the-counter products 
a benefit to your customers?
    Mr. Murphy. Well, it benefits our customers because it 
allows us to go into markets, particularly overseas, and be 
confident our products competitively and then manage the risk 
of converting those funds back into U.S. dollars. They are 
really pretty simple: we sell goods into Thailand, and we enter 
into a very simple derivative that allows us to sell Thai bhat 
by U.S. dollar at a fixed rate at a date out into the future. 
So we are able to go into those markets and more or less know 
what we are going to get back, being able to bring back to our 
shareholders in the United States in the future.
    Mr. Price. Has 3M changed any of the policies that you have 
regarding OTC products since the financial meltdown last fall?
    Mr. Murphy. No, we have not. We just continue to be mindful 
that we want to spread our business around to various 
counterparties, that we are not doing all of our business with 
one or two banks, so we have a half a dozen institutions that 
we deal with. But I would say we have not made any policy 
changes in the last year.
    Mr. Price. And the market for those products is the same, 
greater, less?
    Mr. Murphy. It is really the same. It has continued to 
function very well all through last fall.
    Mr. Price. I want to pick up on some of the questions that 
my colleagues have asked about driving business overseas. Mr. 
Pickel, if I may, and I apologize for being out earlier, but in 
your testimony you note that, ``Mandating that interest rate 
swaps and credit default swaps being traded on exchanges is 
likely to result in only higher costs and increased risk to 
manufacturers, technology firms, energy producers, utility 
service companies and others, who use OTC derivatives in the 
normal course of their business. It will put American 
businesses at a significant disadvantage to their competitors 
around the world.'' And when you say ``American businesses,'' 
you do not mean the clearinghouses, you mean American 
businesses?
    Mr. Pickel. I mean companies like 3M, Cargill, Boeing, 
others that have exposure either to interest rate fluctuations 
or currency fluctuations.
    Mr. Price. And in that risk to American business, you 
believe that would drive businesses overseas?
    Mr. Pickel. It would, as I think Mr. Murphy has 
highlighted, increase their costs and decrease their 
competitiveness, so that would likely result in less business 
being done by U.S. companies.
    Mr. Price. Do you know what other governments are doing to 
determine their systemic risk in the derivatives market or act 
upon their systemic risk in the derivatives market?
    Mr. Pickel. Well, a lot of discussions are taking place 
over in the European Commission. It is now focused primarily on 
clearing, in establishing a clearinghouse for European credit 
default trades. The Commission is in the process, and we expect 
to see a report out of them in the next week to 2 weeks 
regarding OTC derivatives and how they might approach some of 
the issues. We anticipate it will touch on similar points to 
Secretary Geithner's letter from a couple of weeks ago.
    Mr. Price. Mr. Thompson, I have just a few minutes left. 
You mentioned that if we mandated a clearing companies would 
``leave risks unhedged.'' What is the consequence of that?
    Mr. Don Thompson. The consequence of that is that a company 
which is an exporter and is exposed to fluctuations in currency 
risk may incur losses as a consequence of currency exchange 
rates that it otherwise might not incur if it were enabled to 
hedge them in the manner that it wanted to in the OTC markets.
    Mr. Price. So a decrease in potential business viability?
    Mr. Don Thompson. It is generally being exposed to a risk 
that is not its core business. 3M is a great example. They make 
all these little things in the book and they do a great job, 
and we all use them. Their specialty is not forecasting 
interest rates or forecasting the exchange rate of the U.S. 
dollar versus the Thai bhat. They would prefer to hedge those 
risks away and focus on their core business, which is the 
attitude of many of our corporate clients.
    However, if they have to post liquid securities or cash to 
a clearinghouse or if they have to suffer income statement 
volatility because their hedges have to be on an exchange and 
thus do not qualify for FAS 133 hedge accounting, they face a 
difficult choice: Do I pay the increased cost? Do I suffer the 
increase income statement volatility and go ahead and hedge the 
risk anyway or do I not hedge the risk and hope it works out 
for the best? I am sure some companies will pay the increased 
cost. I am sure some companies will say, ``No, we will leave 
the risk open.'' I think in neither case is that good for 
American business.
    Mr. Price. Thank you, Mr. Chairman.
    Chairman Kanjorski. The gentleman from Connecticut, Mr. 
Donnelly, for 5 minutes? I am sorry, from Indiana. I am always 
putting you in Connecticut.
    Mr. Donnelly. You have me on a vacation, sir. Thank you, 
Mr. Chairman. I guess I would just like to ask following up, we 
heard about the risk to American business, I come from Indiana, 
and I will tell you what the risk to our business has been, it 
was the destruction of the credit markets. And we saw business 
after business fail because of what happened in the credit 
market. So when I think about risk to American business, I 
think about the entrepreneurs in my towns whose credit simply 
dried up on, who were unable to have their business function 
because of what happened in part in the derivatives market. So 
that risk comes in many different directions.
    With naked credit default swaps, in reading your testimony, 
we talk about enabling the transfer of risks between 
counterparties. Now, if we have naked credit default swaps 
where Mr. Thompson is betting on Mr. Pickel's package of 
securities, and someone else is insuring it, what risk are you 
transferring? Is not that just a straight bet? I mean you do 
not even own anything. You are just betting on somebody else's 
judgment. Anybody can comment.
    Mr. Don Thompson. Okay, one thing I think one needs to keep 
in mind in the naked CDS debate is there are a number of 
different market participants who use the products for very 
different purposes. There are hedgers, small banks for example, 
who hedge their loan book or their securities holdings in a 
more traditional fashion. There are also investors, hedge 
funds, asset managers, pension funds and the like, who engage 
in credit derivatives activity as an alternative to other 
investments, either buying bonds or other funded financial 
assets, and they comprise a significant percentage of the over-
the-counter CDS market.
    Mr. Donnelly. But that is speculation, that is not a risk 
transfer. That is totally different.
    Mr. Don Thompson. You can assign it whatever term you would 
like. I prefer to think of it as investing in the hope of 
getting a return. If that equals speculation, so be it.
    Mr. Donnelly. But risk do you have if you do not own the 
underlying assets to start with? You are not putting off the 
risk you have in owning those, you are simply speculating on 
somebody else's judgment is all you are doing.
    Mr. Don Thompson. What that investor is doing is deciding 
to take credit risk in CDS form instead of taking credit risk 
in more traditional form, such as buying the bonds of a 
particular issuer or buying loans of a particular issuer. That 
also happens frequently in the financial markets. What we have 
seen with many investors is they prefer to take risk in CDS 
form because the CDS market provides diversified, lower risk 
forms of credit risks, such as the credit default swap indices, 
which are the most popular product in the over-the-counter CDS 
market.
    Mr. Donnelly. But it is not the risk of them having 
anything underlying that they own? They are making a bet on 
someone else's judgment.
    Mr. Don Thompson. If you think of a typical investor, they 
are typically long on cash and they need to invest that cash in 
an investment. That invest that cash in an investment. That 
investment could be a traditional investment product, such as a 
bond or a loan, or another form of funded financial instrument. 
Alternatively, many investors prefer to transact in the 
derivatives market in a so-called non-funded product whereby 
they get compensated for taking credit risk, often to a broad-
based index of companies, such as the CDX index, which is the 
prominent index which trades in the United States.
    Mr. Donnelly. Why would making those trades more 
transparent result in less competitive conditions for American 
companies, why would transparency harm their ability to manage 
risk instead of being stuck in a drawer at AIG that everybody 
in Indiana eventually has to pay for?
    Mr. Don Thompson. I think that is an excellent question, 
and I think that the first point I would make in response to it 
is we are broadly supportive of increased transparency in the 
OTC markets generally and particularly in the CDS markets. We 
have been working actively with the Fed and other regulators 
for the past 4 years to increase transparency, increase 
centralized clearing of standardized contracts, including many 
of the index products, which I mentioned to you in my earlier 
remarks, it is not at all the case that we are opposed to 
increase transparency in the OTC markets. We do think that one 
needs to be careful when making decisions about market 
structure as a public policy-maker, to consider not just the 
benefits of transparency but it does in certain cases have 
costs as well. And all we ask is that there be a thoughtful 
debate about the relative cost and benefit.
    Mr. Pickel. I would also just add that the risk that AIG 
was taking on through their use of credit default swaps 
represented a very small portion of the overall CDS business 
and what they were doing was taking on exposure again to 
underlying subprime risk. And to the extent that, I think 
somebody said earlier, the CDS were hard to value, the CDS 
value is driven by the value of the underlying position. It was 
the CDOs that they sold protection on that were in fact hard to 
value.
    Mr. Donnelly. You say it is a small portion of it, but that 
is like saying, ``Well, it is a small natural gas pipe but it 
blew up the whole house.'' We are in a position where we have 
business after business that folded and encountered 
extraordinary difficulty because of what happened based on the 
credit market actions that began in New York and in other 
places.
    Mr. Don Thompson. And no one is advocating another AIG. 
And, in fact, a key part of many of the proposals, which we as 
an industry do advocate, is a systemic risk regulator, which is 
professional, well-funded, and has a holistic view of risk 
across the entire risk spectrum. And the reason we advocate 
that is precisely to ensure that another AIG never occurs.
    Mr. Donnelly. Thank you very much. Thank you, Mr. Chairman.
    Chairman Kanjorski. Thank you. The gentleman from Texas, 
Mr. Neugebauer, for 5 minutes.
    Mr. Neugebauer. Thank you, Mr. Chairman. Mr. Murphy, 
besides derivatives, are there other ways that you could hedge 
your current C positions in other ways or is that the sole way 
that is available to you?
    Mr. Murphy. There are some operational things you can do in 
certain countries, for example, where we do not use 
derivatives, where the derivative markets are not developed, 
Latin America for example. You can change payment terms with 
customers, you can take out debt in certain currencies and 
match that against some of your assets in those currencies, but 
typically that takes place in those more Third World type 
markets. In G-20 countries where we have sophisticated 
competitors who have access to capital markets, we have to be 
more nimble, more efficient from a pricing standpoint, and so 
derivatives are clearly the number one way to go.
    Mr. Neugebauer. Okay. Mr. Pickel, when you look at the 
market between what possibly products that could be 
standardized and then those that are a custom, and I think you 
have done a pretty good job earlier of kind of differentiating 
what those definitions are. What today if everything was sorted 
into two stacks, customized and standard, what would the mix 
be?
    Mr. Pickel. It really varies by product type. In the credit 
default swap space, especially with some steps taken earlier 
this year to standardize a couple of other parts of the trading 
terms, there is a high degree of standardization across index 
and single name products. So, again, it is hard to say exactly 
what that number would be but people throw out the number of 80 
to 90 percent but there is still a decent portion that would be 
customized.
    In other product areas, for instance in the interest rate 
swap world where there is--there has been an existing 
clearinghouse in London for close to the past 10 years, they 
clear about a little over 50 percent of inter-dealer trades, so 
not the customer trades and not all dealer trades but a 
significant portion, and there is probably more room there in 
the interest rate swap space to achieve more.
    And then also in energy areas, there is a fair amount of 
clearing through an ICE facility that is used and also the 
NYMEX Clearport Facility. Equity derivatives, there are some 
clearing options available. But it is hard to say exactly what 
that percentage would be.
    Mr. Neugebauer. And one of the things that is being 
discussed is whether there should be one clearing or a multiple 
clearing. And just kind of going down the row there, kind of 
give me your perspective, one or many? Mr. Fewer?
    Mr. Fewer. Most likely it would probably make sense that 
there would be one or two global clearers. The issues in Europe 
I think surrounding what constitutes bankruptcy are probably 
being looked at and properly addressed so that there will be 
much more cohesion with U.S. interpretations, so certainly no 
more than two.
    Mr. Neugebauer. Okay, Mr. Pickel?
    Mr. Pickel. I think inevitably it will be many certainly to 
begin with but over time the market will determine, and I would 
not be surprised if we would move to two or one.
    Mr. Neugebauer. Mr. Murphy?
    Mr. Murphy. I would agree with the many answer, at least up 
front. I worry about from a band width standpoint, the size of 
the market, is there a player out there that is really able to 
take this all on in one big bang?
    Mr. Neugebauer. Mr. Thompson?
    Mr. Don Thompson. I would echo Mr. Murphy's comments about 
the band width restriction. These are incredibly complicated 
and difficult things to set up and get up and running. I also 
think it is worth pointing out that they are by their nature, 
especially if coupled with some form of mandated clearing 
requirement, anti-competitive in that you have no choice. So 
having some alternatives, in the sense of more than one, is 
probably a good thing from that perspective.
    Mr. Ferreri. I think it is going to wind up being no more 
than a handful. I do not see the benefits to a regulator to 
have to look at 30 or 40 or 50 different clearinghouses to try 
to find out what the repositories might be. Having said that 
though, I think the competitive nature of our business and 
having to keep cost down in an effort to handle a high band 
width needs of markets will mandate the need for two or three.
    Mr. Johnson. There is some academic evidence that suggests 
the benefits start going down if you have more than one.
    Mr. Neugebauer. And a follow-up question, what benefits 
start to go down if you have more than one?
    Mr. Johnson. I think it is efficiencies and 
competitiveness. I would be happy to get you a copy of some of 
the articles on that.
    Mr. Neugebauer. I would like to see that. I see my time has 
expired. Thank you, Mr. Chairman.
    Chairman Kanjorski. Thanks, Mr. Neugebauer. The gentleman 
from Illinois, Mr. Foster.
    Mr. Foster. Thank you, Mr. Chairman. Mr. Johnson, on the 
last page of your written testimony, you have a very 
interesting pie chart with the different components of the OTC 
derivatives market. And the most interesting number to me there 
is that credit default swaps are 7 percent, which is 
interesting considering the effect that they have had on our 
economy. But if you start with the big pieces, interest rate 
contracts are 71 percent. And it seems to me that they 
represent a rather small systemic risk and are already exchange 
traded and so on, and that really there is not a lot of action 
that is necessary from our point of view there. Is that 
something you would agree with?
    Mr. Johnson. Well, I think the pricing is more stable, 
although we had some wild gyrations that went on after the 
Lehman failure. I think the more stable and the more 
commodities and--
    Mr. Foster. Are they all standardized?
    Mr. Johnson. No, no, they are quite different from each 
other. I think one thing the market has done though is that the 
pricing of them is very easy to do in terms of everyone is able 
to price them and come up based on how LIBOR moves and come up 
with them.
    Mr. Foster. Similarly, the foreign exchange contracts, the 
transparency of those must be total essentially?
    Mr. Johnson. Well, it is the most liquid and largest 
market--the most liquid market is currency and so you do tend 
to get better pricing, although Mr. Murphy could probably 
explain better.
    Mr. Foster. Yes, so would you also agree that the systemic 
risk probably is not there if that is what we are worried 
about?
    Mr. Johnson. Oddly enough, we have had some terrible crises 
involving foreign currency issues. Back in 1998, we had our 
Indonesian crises, in Hong Kong and other places, where the 
problems keyed off of foreign currency problems. Mexico just 
recently has had tremendous problems with their bets made on 
foreign currency, that has bankrupted several companies there 
tied to the derivative industry and so it comes and goes 
depending on how they are structured.
    Mr. Foster. Are there specific motions that we can make 
that you find attractive to try to stabilize that or prevent 
that sort of mess in the future?
    Mr. Johnson. Well, I think what is interesting is the good 
work that is being done in the credit default swap market as 
the regulators have nudged participants to clean up the area 
and to try and reduce systemic risk. Some of the best 
practices, and it has almost become a model for what we could 
do in other areas as we move forward.
    Mr. Foster. And if I go to the next smaller slice is credit 
default swaps at 7 percent. And a general question, would have 
forcing all of the OTC derivatives on to clearing or an 
exchange have prevented AIG financial products, at least the 
part that was not related to the mortgage lending or their 
securities lending business?
    Mr. Johnson. I think a huge problem with AIG was their 
margin calls that they received as their credit rating slipped.
    Mr. Foster. Would that have been allowed if they had been 
on an exchange, at least of the kind I am familiar with?
    Mr. Johnson. They clearly would have been margined 
differently, and I defer to--
    Mr. Foster. Right, and so at some point the people who 
supervise the margins and the capital accounts here would have 
said, ``Okay, guys, you are trading on the good name of AIG, 
but we want to see the collateral,'' and that is what would 
have stopped them, is that a fair guess as to how the scenario 
would have played out or are there more--do I not understand 
the mechanics of how AIG would have been prevented by putting 
it on the exchange?
    Mr. Johnson. So, Congressman, I think that at the time that 
what AIG was doing was selling default swaps on very complex 
CDOs. If those credit default swaps were then subject to some 
type of margining certainly earlier on, the dealers that were 
buying those credit default swaps, to hedge their own 
portfolios, would have looked at it and said, ``This does not 
make sense. We would not be able to post a margin that the 
exchange would require in order for us to do this 
transaction.'' And margin requirements, particularly in single 
name default swaps, is a complex issue because the default 
probability that the exchange would have to calculate to get 
the margin is something that needs work.
    Mr. Foster. So, again, the thing you would say is to 
actually have margining in collateral posting requirements--
    Mr. Johnson. Well, that is what it--
    Mr. Foster. --to prevent this sort of--that is what is 
actually more important than the transparency of exchanges, the 
transparency I take it was not an issue with AIG?
    Mr. Johnson. The transparency of the over-the-counter 
market, if it is really looked at, is generally healthy and the 
perception that would happen in AIG really reflected the 
transparency of the global over-the-counter market is not--
there is not a direct relationship there. Certainly, if there 
was a central counterparty clearing facility in place when a 
dealer would have went to try to book a trade to hedge his or 
the CDO portfolio, the amount of margin required certainly 
would have--
    Mr. Foster. That would have triggered--
    Mr. Johnson. That would have--
    Mr. Foster. That would have stopped it?
    Mr. Johnson. --at least a question and turn around and say 
something is not right.
    Mr. Foster. In order to preserve that, you need to have 
that sort of margin requirement for both the customized and the 
non-customized things if you intend to use margining as the way 
of preventing future AIG's? Okay, thank you. I yield back.
    Chairman Kanjorski. Thank you very much, Mr. Foster. Now, 
we will hear from the gentlelady from Minnesota, Ms. Bachmann?
    Mrs. Bachmann. Thank you, Mr. Chairman. I had a question 
for Mr. Murphy, and I understand that earlier you had mentioned 
that 3M would see anywhere between $100 million to $200 
million, if that was accurate, should 3M have to post against 
their risk management activity. Is this impact unique to 3M or 
what are you seeing with other countries--other companies 
across the board?
    Mr. Murphy. No, it definitely would not be unique to 3M. As 
we are a large company, those numbers are large probably 
relative to other companies, but it could be a smaller company, 
a mid-size company, a small company that is $50 million in 
sales and imports goods from Germany, they could be in the same 
boat. And, frankly, the smaller company is going to be even 
worse off because they will have fewer resources to credit than 
a 3M would. They may have a single bank and that bank may not--
may have tighter covenants on their loan agreements and so that 
capital is even more valuable or more scarce to a smaller 
entity. So it would be very, very widespread. It would not be 
limited to a large multi-national like 3M.
    Mrs. Bachmann. What about the issue of transparency, we 
hear that a lot and I am wondering, do you see transparency now 
being available on over-the-counter products?
    Mr. Murphy. Well, certainly we have very lengthy 
disclosures that we have to make as a publicly-traded company. 
That is not the same for privately-held firms obviously. But we 
see in foreign exchange, for example, over 50 percent of the 
volume in foreign exchange is done on electronic platforms. We 
are definitely in favor of the idea of potentially the trade 
repository where that information gets delivered on a more real 
time basis. We would like to work with the committee on that 
effort. So we are definitely not opposed to greater 
transparency but I can tell you the market today is certainly 
much more transparent than it was 5 or 10 years ago.
    Mrs. Bachmann. And what would your suggestions be on 
efficiency and transparency, that is where I think the 
committee wants to go with greater efficiency and transparency? 
You had mentioned a little bit of what your concerns were and 
maybe what your ideas were?
    Mr. Murphy. Well, again, I think we certainly would have to 
work with the dealers. I think, again, this trade repository 
idea is the one that we would be most in favor of. We believe 
that the OTC market, as they are structured today, are very 
efficient for corporations, so I am not sure--we certainly do 
not believe that moving to a mandatory clearing or exchange 
environment would improve the efficiency of the market in any 
way.
    Mrs. Bachmann. Mr. Chairman, I do not know if I still have 
time remaining but I would open that question up to anyone on 
the panel, your suggestions for improving efficiency and 
transparency, knowing that is where our body is hoping to go?
    Mr. Ferreri. If I could add just a comment. Many references 
have been made to the foreign exchange market. That 50 percent 
of foreign exchange trading, the spot foreign exchange markets 
happens at ICAP on screens and electronically. The transparency 
issues are price transparency, which is the over-the-counter 
inter-dealer market, wholesale market and the trade 
transparency which falls under the trade repository. So it is a 
twofold transparency issue. I also think it is important, I 
have not heard much about this and the exchange concept but 
delineating between an exchange traded contract and an over-
the-counter traded contract on an electronic mechanism, all 
right, that were not defined as electronic exchanges but these 
are fully transparent and in real time. So there are ways to 
enhance the transparency. They evolve over time. U.S. 
Treasuries, when I started in business a very long time ago, 
were barely onscreen. They were traded over telephones. Today, 
they are fully electronic with real time post-trade processing. 
So it is an evolutionary process. Mechanisms are in place to 
advance that and the ability to advance that frankly is based 
on the liquidity as it grows in the asset.
    Mr. Pickel. I think to the extent that we can encourage 
various ways of trading, various ways of managing counterparty 
credit risk, clearing and a bilateral relationship, all of that 
generates information for the participants in the market. It 
generates information for the regulators and in many cases it 
generates information for the public generally. So I think to 
the extent we can encourage the clearing, the trade repository, 
electronic trading. And, of course, exchange trading exists in 
many product areas, not exactly to mirror the underlying or to 
mirror the OTC product but it provides an effective hedge, 
particularly for dealers who are looking to hedge the exposures 
they take on through their OTC risk. They can lay that off in 
many ways via the exchange trading of products. So the more 
variety we can provide here, I think the better transparency 
overall.
    Mrs. Bachmann. Good. I yield back, Mr. Chairman.
    Chairman Kanjorski. Thank you very much, Mrs. Bachmann. 
Now, we have the gentleman from New York, Mr. McMahon, for 5 
minutes.
    Mr. McMahon. Thank you, Mr. Chairman, and thank you for 
allowing me to participate in this hearing with you today as a 
guest Member.
    I want to first give a shout out to Mr. Ferreri. Chris, it 
is great to see you here, and I am proud to introduce you to my 
colleagues and to the chairman as a constituent and proud son 
from the great borough of Staten Island and New York City. And 
I have said here in my months in Congress, since January, New 
York City is the financial capital of the world, and when I 
tell my colleagues that I represent people from the executive 
level all the way to the back office and support services, 
certainly it is great to have you as an example of the people 
who make this industry run.
    I know that many of my colleagues feel some anger toward 
the financial services industry, but I just would like to 
caution that those who think it would be okay to let part or 
all of this industry move to other countries or not be 
successful would be a bad thing for our Nation, it certainly 
would be a very bad thing for the people whom I represent, more 
than 80,000, just in my district alone, who directly work in 
the industry and many as well. And certainly we look to bail 
out General Motors, but we do not say, ``Let's get rid of the 
automobile industry in this country,'' and I think that is 
something that we have to be mindful about.
    As you know, Chris--Mr. Ferreri, when it comes to the 
practice of trading credit default swaps, the House and the 
Senate have approached this issue in different ways. The House 
bill, which passed the Agriculture Committee, banned credit 
default swaps while the Senate bill did not. Yet, the Senate 
bill also goes a step further requiring exchange trading for 
all over-the-counter derivatives. So there is a blending here, 
and I even heard in the testimony, it may be in confusion, 
credit default swaps is that all derivatives, and I know 
Congressman Foster fleshed this out a little bit, but clearly 
the credit default swaps led to the downfall of AIG, as well as 
the financial instruments upon which they were based. But if 
you could just kind of flesh out a little bit more how much of 
the overall derivative market is credit default swaps and what 
role does it play in the overall industry?
    Mr. Ferreri. Dr. Johnson put together a very good summary 
that it is a small percentage of the overall derivative market. 
Interest rate swaps make up the largest portion of it. Interest 
rate swaps are on screens, a representation of those markets 
are on screens to hundreds of thousands of people worldwide to 
participate in the interest rate swap business. The ability to 
see a bid in an offer, someone willing to take risks, take a 
position on a product on a screen or through the inter-dealer 
market does enhance the information flow, it enhances the 
knowledge that people have to participate in these markets. The 
CDS market for ICAP is very small. For us as a company, it is 
less than 3 or 4 percent of what we do. So it is not this 
embedded CDS bias. I do think frankly that the ability to 
migrate products as they come on to screens, on to electronic 
platforms, is a natural progression toward liquidity. And I 
think as those markets become more standardized and the ability 
to clear them and to margin them, which is not talked about 
very much when we talk about clearing, to effectively margin 
them would make sense.
    Mr. McMahon. So are credit default swaps the problem in all 
that is going on here, and should we focus only on those and 
leave the rest of the derivative market alone and that would 
allow certainly Mr. Murphy, 3M, most of their derivative action 
seems to be with foreign exchange fluctuations? Do you 
understand my question? My fear is we are throwing the baby out 
with the bath water, can we separate the two here?
    Mr. Ferreri. It is effective derivatives regulation, right, 
so this is about the derivative market in general. CDS, CDOs, 
at the core of the AIG problems, and books are being written 
about the AIG failure, but I do think that from a broader 
perspective, the over-the-counter market in derivatives exist 
because there is a strong need and demand. These are not 
products that are built up and no one participates in. These 
are products that have been developed over time, have been 
developed to assist a hedge to a specific need, and as a result 
become a tradeable object. So I think as those tradeable 
objects become more liquid, we can see that the increased 
liquidity, it is an evolutionary process.
    Mr. McMahon. But can we remove anyone, can we remove the 
CDS's out of this equation and leave the derivative markets 
alone and just deal with that one issue or you have to deal 
with it all together?
    Mr. Fewer. Congressman, I would try to look at the CDS 
market from a different viewpoint. The CDS market generally is 
made up of very liquid CDX index product, most of what is 
traded, and single name product. That area of the credit link 
market is very, very conducive to central counterparty 
clearing. These instruments did not cause the problem of AIG. 
The collateralized debt obligations did, everyone knows that. 
It would be a fair comment to say that a proper postmortem of 
AIG, to really understand what the dynamics were between CDS 
and the actual CDOs, however, to parcel out CDS from the rest 
of the derivative world, we should be able to apply the same 
rules right across the board. And over a period of time, CDS 
happens to be in the major headlines but over a period of time, 
I think that the general public will see that whether it is a 
credit index or an equity index or a interest rate swap, these 
products can be very well harnessed and managed within the 
context of proper market protocols.
    Mr. Pickel. I think the critical thing, building on the 
Geithner proposals, is the focus on an entity that builds up 
significant counterparty exposure. That is kind of, if you 
will, the AIG clause of the proposal. That is what AIG did. 
They happened to build that up via selling protection on the 
super senior tranches of these CDOs via credit default swaps. 
It is conceivable, although frankly not that hard to conceive, 
that somebody could build up that position in interest rate 
swaps or equity derivatives or something like that. It is 
possible, and therefore I think if you had the authority for 
someone to be able to identify that and step in and regulate 
that type of build up, then I think you deal with the AIG 
issue, whether that next issue is a CDS issue, an interest rate 
swap issue or some other derivative type issue.
    Mr. McMahon. That entity that would identify that, that is 
a so-called systemic risk regulator?
    Mr. Pickel. Well, that is who would eventually, based on 
the information from these warehouses that would exist for the 
different product areas, that would be the entity that would 
step in and oversee that. I think that entity would also need 
to work very closely with the existing regulators of the banks 
and other institutions because the banks see that flow, they 
see that build up. Even in the situation of AIG, the regulators 
would have been able to see that the banks were taking on 
exposure to AIG.
    Mr. McMahon. My time is up, maybe you can end with this, 
Mr. Thompson, I call it my ``Chicken Little question,'' which 
is did not we have those checks and balances in place already 
and there is the Fed and there are all these other agencies, 
why was not that done in the past and why is the creation of a 
so-called systemic risk regulator would inhibit this from 
happening again when we really should have been inhibited this 
time around?
    Mr. Don Thompson. Fair enough, that is an excellent 
question, and I think when people are talking about the 
systemic risk regulator, the idea is not just another 
regulator. It needs to be a regulator who has market savvy 
across a wide range of financial instruments.
    When we think about the problem here, the problem is risk, 
not the form in which risk is taken. So you can look at AIG and 
say they piled up all of this risk in CDS form, ban CDS, but 
then my response in part would be look at Lehman Brothers and 
Bear Stearns who piled up billions of dollars of risk in the 
form of mortgage-backed securities, which in and of themselves 
are fine and unobjectionable and serve a very valid commercial 
purpose, but the manner in which they finance them on very thin 
margins in the repo market meant that they were able to lever 
up 30 or 40 to one with obvious disastrous consequences. What 
you need is a systemic risk regulator who can look at the whole 
risk spectrum, understands all the products, and ensures 
against a reoccurrence of overleverage and excessive risk-
taking in whatever form.
    Mr. McMahon. Thank you. Thank you, Mr. Chairman.
    Chairman Kanjorski. Thank you very much, Mr. McMahon. We 
want to thank the panel for their participation, but if I may, 
before we close down the first panel, you really heard the 
questions of the committee members on both sides. We are not 
looking at just regulating for the sake of regulating. We are 
looking at what is the best thing to do under the 
circumstances, and I would just point out my observation on 
AIG. The reason why it is such a traumatic failure is that it 
represented a failure of the marketplace. Every person involved 
in those transactions with AIG should have been doing due 
diligence to see whether there were reserves, whether there 
were margins there, whether their counterparties were 
responsible to pay off. It shocks me that engaging in $2.7 
trillion in derivative risk by AIG without any of the great 
companies of the world, calling their attention to AIG, that 
they did not have the support systems or reserves behind the 
products they were guaranteeing says to me the market failed. 
Now, why it failed, I do not know. Did the sellers of those 
risks or the traders of those risks think that they were too-
large-to-fail and exactly what would happen, as did happen, 
that the government would come in and stand as a supporting 
party? And if that is the case, then what we see here is a 
total failure of the marketplace that needs great regulation.
    I do not happen to agree that we need necessarily great 
regulation, but what I capture from the testimony of all six 
witnesses today is that you obviously have greater knowledge 
than the members of the committee. I would like you to help us. 
We have to write some regulations, which we have probably 
identified. We need some requirements for reserves. We need 
requirements for transparency. We need some requirements that 
when we have a systemic risk evaluator, I will not call them a 
regulator, because if are going to have a systemic risk 
regulator, that has to be some super regulator that has 
authority over every transaction of commerce in the world. I do 
not think America wants that, nor an it afford it. And we are 
just putting off until tomorrow another disaster because they 
will not be testing the great institutions, like AIG, they will 
be going and looking at the questionable institutions.
    So, what we really want to get to is an efficient, 
effective way, call it regulation or call it watching, what you 
will, but the use of your knowledge, the members of this panel 
and maybe a few other experts around the country, to sit down 
and argue among yourselves if you will, and send us some of our 
regulations and your suggestions for regulation or oversight so 
that we can have that as we deliberate to right the new 
methodology of doing this. If you fail to do that, I think you 
can clearly see that there are no derivative experts on the 
Financial Services Committee. I have my fellow members here, 
and I think they will agree. So, we will be operating blindly. 
On the other hand, if we can get your suggestions and your 
assistance, we probably could make a major attempt here to get 
this right. That is what I would like to see you help us do.
    So, before I dismiss the panel, is there any reason why any 
of you would not be willing to serve in advisory roles and 
perhaps collaborate among yourselves and perhaps over the next 
several months because that is all we have until we get to 
writing the comprehensive regulation that we are going to have, 
covering this field and many others, particularly in the 
derivative field, I think you have established to me that 
clearly it is a tool of great value. Listening to 3M's 
testimony, I can imagine what it would take to do 70 percent of 
your business worldwide and not have a tool of derivatives to 
guarantee the cost of your product and the value of the 
currency you are dealing in the sales contract of the future.
    So, that being the case, why do not the best minds in the 
country help out the Representatives of the people of the 
country to write the best rules and regulations to allow the 
markets of the country and the world to properly function? If I 
could indulge you on that, I would appreciate it. Is there 
anyone who would not be willing to serve?
    Mr. Don Thompson. I think we would all volunteer for that.
    Chairman Kanjorski. Okay, well, consider yourself imposed 
in the army to solve the derivative problem. And thank you very 
much for your appearance and your testimony today, we certainly 
do appreciate it. Thank you.
    Thank you very much. We will now have our second panel. 
First of all, thank you all for appearing before the committee, 
and without objection, your written statements will be made a 
part of the record. You will each be recognized for a 5-minute 
summary of your testimony.
    First, we have Mr. Thomas Callahan, chief executive 
officer, NYSE Liffe. Mr. Callahan?

STATEMENT OF THOMAS F. CALLAHAN, CHIEF EXECUTIVE OFFICER, NYSE 
                            EURONEXT

    Mr. Callahan. Chairman Kanjorski and members of the 
subcommittee, my name is Tom Callahan. I am an executive vice 
president head of U.S. futures for NYSE Euronext.
    NYSE Euronext operates one of the world's largest and most 
liquid exchange groups, bringing together seven cash equity 
exchanges and seven derivatives exchanges in six countries.
    In addition, in late May of this year, we received approval 
and principal from the UK's FSA to launch NYSE Liffe Clearing 
and will shortly begin providing derivative clearing services 
for our London derivatives market. We also provide technology 
to more than a dozen cash and derivatives exchanges throughout 
the world. NYSE's geographic and product diversity informs our 
views on the principal issue we are discussing with you hear 
today.
    I am pleased to appear on behalf of NYSE Euronext and its 
affiliated exchanges as the subcommittee considers the possible 
amendments to the various Federal laws that affect over-the-
counter derivative transactions. NYSE Euronext has always been 
an advocate for fair, open, and transparent markets. 
Accordingly, our global exchange group has a strong interest in 
the appropriate regulation of OTC derivatives. A large number 
of our over 4,000 listed companies use OTC derivatives as 
fundamental hedging tools to manage the various risks incurred 
in connection with the conduct of their business. It is 
essential that these companies have confidence in both the 
integrity of the transactions they enter into and in the 
ability of their counterparties to perform their financial 
obligations. An appropriate and sensible regulatory regime for 
OTC derivatives is a necessary element in restoring and 
retaining this confidence.
    While it is essential that OTC derivatives be subject to 
greater regulatory oversight, it is also important that the 
regulatory regime not impose unnecessary requirements that 
greatly diminishes their value, or worse yet, drives these 
vital markets to opaque offshore jurisdictions.
    It is for this reason that we strongly support the proposed 
framework for the regulation of OTC derivatives that Treasury 
Secretary Geithner set out in his May 13th letter to the 
congressional leadership, which takes into consideration the 
differences amongst OTC derivative products and the legitimate 
needs of market participants that use these products to manage 
their business risks. In particular, we agree that to the 
extent OTC derivatives are standardized, they should be traded 
on a regulated exchange or a comparably regulated electronic 
trading system and cleared through a central counterparty. The 
clearing of OTC derivatives will reduce systemic and 
operational risks, increase market transparency, and create 
market surveillance databases from which regulatory authorities 
can audit for potentially fraudulent or manipulative activity.
    To the extent a limited class of OTC derivatives are 
sufficiently customized and therefore cannot be executed 
through an exchange or electronic trading system or cleared 
through a central counterparty, such transactions should be 
subject to public reporting via a tape mechanism, as well as 
record keeping requirements to a regulated trade repository. 
Importantly any trade that falls outside of the regulated 
exchange and central clearing infrastructure should be subject 
to robust risk-based capital regimes that appropriately reflect 
the risk to all counterparties in these transactions.
    A number of different bills have been discussed in Congress 
to address the identified deficiencies of the OTC derivatives 
market, some of which appear to be designed to force certain 
prescriptive solutions on the market. Some of these proposals 
include requiring that all OTC derivatives, standardized and 
non-standardized, be traded on an exchange in a central order 
book or requiring that all OTC derivatives be cleared through a 
CFTC-registered clearing organization regardless of the 
liquidity of the underlying instrument or prohibiting certain 
participants from acting in certain markets.
    As it undertakes the task of developing a regulatory regime 
for OTC derivatives, we encourage the subcommittee to strike a 
balance similar to that suggested in Secretary Geithner's 
letter. NYSE Euronext believes it would be unhelpful to impose 
inflexible solutions that would mandate specific market 
structures in either execution or clearing. This could prove 
disruptive to markets, introduce unacceptable risks into 
central counterparties, and could have the unintended effect of 
designating winners and losers amongst exchanges and clearing 
organizations and thereby decreasing needed competition.
    Consistent with Secretary Geithner's proposed framework, we 
believe it would be appropriate for Congress to provide this 
newly regulated market and the authorities that will oversee it 
sufficient flexibility to evolve and adjust over time. We 
believe that the most efficient way to determine optimal market 
structure for the wide variety of OTC derivative products is to 
let market users and regulators decide as market conditions 
dictate.
    On behalf of NYSE Euronext, I want to thank the 
subcommittee for the opportunity to appear before you today. We 
look forward to working with you to implement an effective 
regulatory regime for OTC derivatives.
    Thank you.
    [The prepared statement of Mr. Callahan can be found on 
page 81 of the appendix.]
    Chairman Kanjorski. Thank you very much, Mr. Callahan.
    And now we will hear from Terrence A. Duffy, executive 
chairman, CME Group, Incorporated. Mr. Duffy?

STATEMENT OF TERRENCE A. DUFFY, EXECUTIVE CHAIRMAN, CME GROUP, 
                              INC.

    Mr. Duffy. Thank you, Chairman Kanjorski, for this 
opportunity to present our views on effective regulation of the 
OTC derivatives market.
    Treasury Secretary Geithner's May 9, 2009, letter to 
Senator Harry Reid outlined the Administration's plan for 
regulatory reform of the financial services sector. His plan 
proposed increased regulation of credit default swaps and other 
OTC derivatives.
    This committee posed seven questions for our consideration 
this morning. We agree with many of Secretary Geithner's 
proposals. For example, we support position reporting for OTC 
derivatives and agree that enhanced price transparency across 
the entire market is essential to quantify and control risk. We 
believe, however, that the measure chosen to achieve these ends 
should be fine-tuned to avoid adverse consequences for U.S. 
markets.
    We are concerned that legislation mandating the clearing of 
all OTC transactions could well induce certain market 
participants to transfer this business offshore, resulting in 
significant loss of U.S. futures business.
    By reducing liquidity on U.S. exchanges, this would 
undermine the Congress' attempt to establish greater 
transparency, price discovery, and risk management of U.S. 
markets.
    We applaud the Administration's efforts to enhance 
transparency, stability, integrity, efficiency, and fairness in 
all markets, but we believe that with slight modifications to 
the proposal outlined by Secretary Geithner, and the inclusion 
of a few additional measures would complement the 
Administration's efforts.
    We have responded to your specific questions at length in 
our written testimony. Let me offer a brief summary of our 
responses:
    First, we agree with the informed consensus that the 
financial crisis was attributable in part to the lack of 
regulation in the over-the-counter market, which was not 
subject to appropriate disclosure and risk management 
techniques.
    Second, clearing should be offered to the OTC market in a 
form that makes a compelling alternative to the current model. 
Central counterparty clearing offers a well-tested method to 
monitor and collateralize risk on a current basis, reducing 
systemic risk and enhancing fairness for all participants.
    Third, we are not in favor of government-mandated clearing 
even though we are strong proponents of the benefits of central 
counterparty clearing. Central counterparty clearing serves as 
an effective means to collect and provide timely information to 
regulators. It also reduces systemic risk imposed on the 
financial system by unregulated, bilateral OTC transactions.
    Nevertheless, rather than compel clearing of all OTC 
transactions, we believe appropriate incentives should be put 
in place. The incentives could be in the form of reporting and 
capital charges for uncleared OTC positions and reduce capital 
charges for cleared OTC positions. We believe they would 
contribute both to the transparency and the reduction of 
systemic risks.
    Fourth, obviously, we are strong proponents of the benefits 
of exchange trading of derivatives, but we are also realists on 
the issue of whether exchanges can generate sufficient 
liquidity to make exchange trading efficient and economical for 
our customers. We are concerned that government-mandated 
exchange trading will be a massive waste of resources and 
capital.
    Fifth, in our view, electronic trading offers many 
benefits. It levels the playing field. It enhances price 
transparency and liquidity. It speeds execution and strengthens 
processing and eliminates any classes of errors of unmatched 
trades. Overall, it is an enormous benefit to the market and to 
our customers. Electronic trading when coupled with our 
intelligent audit and compliance programs allows us to better 
monitor our markets for fraud and manipulation. It also gives 
us the tools to effectively prosecute anyone foolish enough to 
engage in misconduct in a forum with a perfect audit trail and 
a highly skilled enforcement staff.
    Sixth, we believe that there is an appropriate balance 
between price discovery and liquidity that is effectively 
controlled by the current procedures to police excessive 
speculation. Regulated future markets and the CFTC have the 
means and the will to limit speculation that distorts prices or 
the movement of commodities in interstate commerce.
    Seventh, we operate trading systems in a clearinghouse in 
which every bid and offer, as well as every completed 
transaction, is instantaneously documented. In addition, those 
records are preserved for an extended period of time.
    We hope that our views on regulating the OTC market will be 
given significant weight based on our record and experience, 
and I look forward to answering your questions. Thank you, sir.
    [The prepared statement of Mr. Duffy can be found on page 
132 of the appendix.]
    Chairman Kanjorski. Thank you very much, Mr. Duffy.
    And next we will have Mr. Christopher Edmonds, chief 
executive officer, International Derivatives Clearing Group. 
Mr. Edmonds?

  STATEMENT OF CHRISTOPHER EDMONDS, CHIEF EXECUTIVE OFFICER, 
         INTERNATIONAL DERIVATIVES CLEARING GROUP, LLC

    Mr. Edmonds. Good afternoon, Chairman Kanjorski, and 
members of the subcommittee. I appreciate the opportunity to 
testify today on behalf of the International Derivatives 
Clearing Group. IDCG is an independently managed, majority-
owned subsidiary of the NASDAQ OMX Group. IDCG is a CFDC-
regulated clearinghouse, offering interest rate futures 
contracts, which are economically equivalent to the over-the-
counter interest rate swap contracts prevalent today.
    The effective regulation of the over-the-counter 
derivatives market is essential to the recovery of our 
financial markets. And this is a very complicated area that is 
easy to get lost in. Let me summarize by emphasizing four 
points that go to the heart of the debate:
    First, central clearing dramatically reduces systemic risk. 
Second, if we do not make fundamental changes in the structure 
of these markets, we will not only tragically miss an 
opportunity that may never come again, but we will also run the 
risk of repeating the same mistakes. Half measures will not 
work. Specifically, access to central clearing should be open 
and conflict free. Third, the cost of the current system should 
not be understated. The cost of all counterparties posting 
accurate, risk-based margins pales in comparison to the costs 
we are incurring today for our flawed system. Finally, the 
benefits of central clearing, if done correctly, do open access 
and maximum transparency will benefit all users of these 
instruments and allow these financial instruments to play the 
role they were designed to play, the efficient management of 
risk, and the facilitation of market liquidity.
    While there is debate around the use of central 
counterparties, it is important to recognize not all central 
counterparties are the same. Ultimately, market competition 
will determine the commercial winners, but I encourage members 
of this subcommittee to stay focused on one simple point: All 
participants must play by exactly the same rules. This in turn 
increases the number of participants, which reduces systemic 
risk. Central clearing gathers strength from greater 
transparency and more competition. This is in contrast to the 
current bilateral world where all parties are only as strong as 
the weakest link in the chain.
    There has been much fanfare over the handling of the Lehman 
default. While it is true some counterparties were part of a 
system that provided protection, this system was far more of a 
club than a systemic solution. The Federal Home Loan Bank 
system in Jefferson County, Alabama, and the New York Giants 
stadium are examples of end users who suffered losses in the 
hundreds of millions of dollars. The current system simply 
failed the most critical component of user, the end user.
    These are real world examples of why new regulation needs 
to focus on all eligible market participants. This is the 
foundation of the all to all concept. As some have continued to 
confuse the true cost of clearing services, IDCG began to offer 
what we call ``shadow clearing.'' This is a way users can 
quantify the actual cost of moving existing portfolios into our 
central counterparty environment. We now have over $250 billion 
in shadow clearing.
    Our data has shown significant concentration risk in the 
interest rate swap world. In fact, two of the largest four 
participants were required to raise significant capital as a 
result of the recently completed stress test. Just last week, 
before this same subcommittee, Federal Housing Finance Agency 
Director James Lockhart acknowledged a concentration of 
counterparties during the past year, along with the 
deterioration in the quality of some institutions has resulted 
in Fannie Mae, Freddie Mac and the Federal Home Loan Banks 
consolidating their derivatives activities among fewer 
counterparties. We must reverse this trend or we will continue 
to foster the development of institutions too-large-to-fail.
    IDCG provides a private industry response to the current 
financial crisis and our mission has never been more relevant 
than in today's difficult economic environment. Today's 
financial system is not equal. The rules of engagement are not 
transparent, and there are significant barriers to innovation 
unless the work of this committee, Congress, the 
Administration, and all of the participants in the debate 
yields a system that protects all eligible market participants 
in a manner consistent with the largest participants, the 
system will fail again.
    Mr. Chairman, thank you for the opportunity to appear as a 
witness today, and I am happy to answer any questions.
    [The prepared statement of Mr. Edmonds can be found on page 
139 of the appendix.]
    Chairman Kanjorski. Thank you very much, Mr. Edmonds.
    And next we have Mr. Jeffrey Sprecher, chief executive 
officer, IntercontinentalExchange, Incorporated. Mr. Sprecher?

  STATEMENT OF JEFFREY S. SPRECHER, CHIEF EXECUTIVE OFFICER, 
                 INTERCONTINENTALEXCHANGE, INC.

    Mr. Sprecher. Chairman Kanjorski, Ranking Member Garrett, 
and members of the subcommittee, my name is Jeff Sprecher, and 
I am the chairman and chief executive officer of 
IntercontinentalExchange, which is also known by our New York 
Stock Exchange ticker symbol as ICE.
    I very much appreciate the opportunity to appear before you 
today to testify on the over-the-counter derivatives 
regulation. And, Congressman Scott, thank you for your kind 
introduction earlier today.
    In the mid-1990's, I was a power plant developer in 
California, and I witnessed the State's challenge in launching 
a market for electricity. Problems arose from a complex market 
design and partial deregulation, and I was convinced that there 
was a more efficient and transparent way to manage risks in the 
wholesale markets for electric power and natural gas. 
Therefore, in 1997, I purchased a small energy trading platform 
that was located in Atlanta, and I formed ICE. The ICE over-
the-counter platform was designed to bridge a void that existed 
between a bilateral, voice-brokered over-the-counter market, 
which were opaque, and open up futures exchanges, which were 
inaccessible or they lacked products that were needed to hedge 
power markets.
    ICE has grown substantially over the past decade, and we 
now own three regulated futures exchanges and five regulated 
clearinghouses. Yet, we still continue to offer the over-the-
counter processing along with futures markets.
    In discussing the need for the over-the-counter regulation, 
it is important to understand the size of the over-the-counter 
derivatives market and their importance to the health of the 
U.S. economy.
    In this current credit crisis, derivatives have been 
commonly described as complex, financially engineered products 
transacted between large banks. However, in reality, an over-
the-counter derivative can encompass anything from a promise of 
delivery in the future between a farmer and his grain elevator, 
to a uniquely structured instrument, like an exotic option, and 
much of the Nation's risk management occurs in between these 
two extremes.
    Derivatives are not confined to large corporations. Small 
utilities, farmers, manufacturing companies and municipalities 
all use derivatives to hedge their risks. Providing clearing, 
electronic execution and trade processing are core to ICE's 
business model. As such, my company would clearly stand to 
benefit from legislation that required all derivatives to be 
traded and cleared on an exchange.
    However, forcing all OTC derivatives onto an exchange would 
likely have many negative and unintended consequences for our 
markets as a whole. In derivative markets, clearing and 
exchange trading are separate concepts. At its core, exchange 
trading is a service that offers order matching to market 
participants. Listing a contract on an exchange does not 
necessarily mean it will have better price discovery. Exchange 
trading works for highly liquid products, such as the Russell 
2000 or standardized commodity contracts that appeal to a whole 
host of a broad set of market participants.
    However, for many other markets, exchange trading is not 
the best solution as the market may be illiquid, with very wide 
bid offer spreads, leading to poor or misleading price signals. 
Nonetheless, these illiquid products can still offer value to 
hedgers and thus they have a place in the over-the-counter 
deliberative market.
    Turning to clearing, this technique gracefully reduces 
counterparty and systemic risk in markets where you have 
standardized contracts. However, forcing unstandardized 
contracts into a clearinghouse could actually increase market 
risk. Where the market depth is poor or the cost of contracts 
are not accurate for price discovery, it is essential that the 
clearinghouse be operated so that it can see truly discovered 
value. So while ICE certainly supports clearing as much 
standardized product as is possible, there will always be 
products which are either non-standard nor sufficiently liquid 
for clearing to be practical, economic or even necessary. Firms 
dealing in these derivatives should nonetheless have to report 
them to regulators so that regulators have a clear and a total 
view of the market.
    ICE has been a proponent of appropriate regulatory 
oversights of markets and as an operator of global futures and 
over-the-counter markets, we know the importance of ensuring 
the utmost confidence, which regulatory oversight contributes 
to.
    To that end, we have continuously worked with regulatory 
bodies in the United States and abroad to ensure that they have 
access to relevant information that is available from ICE 
regarding trading activity in our markets.
    We have also worked closely with Congress and regulators to 
address the evolving oversight challenges that are presented by 
complex derivatives. We continue to work cooperatively to seek 
solutions that promote the best marketplace possible.
    Mr. Chairman, thank you for the opportunity to share our 
views with you, and I will be happy to answer any questions 
that you may have.
    [The prepared statement of Mr. Sprecher can be found on 
page 182 of the appendix.]
    Chairman Kanjorski. Thank you, Mr. Sprecher.
    We will now and lastly hear from Mr. Larry Thompson, 
managing director and general counsel, Depository Trust and 
Clearing Corporation. Mr. Thompson?

 STATEMENT OF LARRY E. THOMPSON, MANAGING DIRECTOR AND GENERAL 
  COUNSEL, THE DEPOSITORY TRUST & CLEARING CORPORATION (DTCC)

    Mr. Larry Thompson. Thank you, Chairman Kanjorski, and 
members of the subcommittee. I am Larry Thompson, general 
counsel for the Depository Trust and Clearing Corporation, 
better known as DTCC.
    DTCC brings an unique perspective to your discussion as a 
primary infrastructure organization serving the U.S. capital 
markets with a 36-year history of bringing safety, soundness, 
risk mitigation, and transparency to our financial markets. 
Last year, DTCC cleared and settled in U.S. dollars $1.88 
quadrillion in securities transactions across all multiple 
asset classes. That is the equivalent of turning over the U.S. 
GDP every 3 days.
    As an example of DTCC's contribution to safety and 
soundness, following the Lehman bankruptcy last year, DTCC 
played a significant role in unwinding over $500 billion in 
open trading positions from trades in equities, muni bonds, 
mortgage-backed and U.S. Government securities without any loss 
to DTCC, any of its members or to the industry and obviously to 
the U.S. taxpayer.
    Today, I would like to share some insights gained from the 
financial crisis of the past year and emphasize one fundamental 
policy point: Fragmentation of data in the financial industry 
can impede the ability of regulators to protect investors and 
the integrity of the financial services system as a whole. 
These core policy goals are advanced when information on trades 
are held on a centralized basis.
    We believe maintaining a single trade repository for OTC 
derivatives contracts is an essential element of the safety and 
soundness for two primary reasons: First, it helps assist 
regulators in assessing systemic risk, thereby protecting 
consumers and financial markets. Second, as a practical matter, 
it provides the ability from a central vantage point to 
identify the obligations of trading parties, which can speed 
the resolution of these positions in the event of a firm 
failure. However, there is no absolute assurance a single trade 
repository for OTC derivatives will be retained unless that 
public policy objective is expressed in law.
    While DTCC supports the role of central counterparties, 
CCP's, in OTC derivatives trading to support trade guarantees, 
CCP's do not obviate the need to retain the full details on the 
underlying trading positions in a central trade repository to 
support regulatory oversight and transparency in the market.
    DTCC's primary mission is to protect and mitigate risks for 
its members and to safeguard the integrity of the U.S. 
financial system. We launched the trade information warehouse 
in November 2006 to provide an automated repository to house 
all credit default swaps contracts. And, during 2007, working 
with the industry, we updated the warehouse with information on 
$2.2 million outstanding credit default swaps contracts. And 
our DTCC deriv/serv matching engine is now supplying to the 
warehouse more than 41,000 trade sides daily. Today, our trade 
information warehouse is the only comprehensive repository of 
OTC derivatives activity in the world.
    Since last year, DTCC has seamlessly processed, or is 
processing through the warehouse, numerous credit events, 
including Lehman, Washington Mutual, as well as the 
conservatorships involving Fannie Mae and Freddie Mac.
    DTCC supports the public policy goals articulated in 
Secretary Geithner's letter to the House and Senate leadership 
on a need to promote transparency in the OTC marketplace. 
However, we are concerned that regulatory calls to require the 
use of CCP solutions for standardized derivatives transactions 
could mislead some to think that this step alone would be 
sufficient to provide a complete cure for the problem.
    Our trade information warehouse connects and services 1,400 
market participants, providing a central operation 
infrastructure, covering 95 percent of all current credit 
derivatives trades. This trade repository is designed to be, 
and we recommend, that it be mandated to extend and include 
other OTC derivatives classes. A regulator charged with 
overseeing the financial markets from a systemic risk 
perspective needs a comprehensive view of where the risks and 
exposures lay to provide an advance warning to any problems 
that could jeopardize the stability of the system. Should there 
be a firm failure, knowing the underlying position of multiple 
transactions in a timely manner will be significant in 
providing transparency to regulators and in protecting 
confidence in the market itself. Therefore, we believe the role 
of having a central repository should be reinforced as a matter 
of public policy by Congress.
    We appreciate your time today, and I would be happy to 
respond to your questions.
    [The prepared statement of Mr. Larry Thompson can be found 
on page 195 of the appendix.]
    Chairman Kanjorski. Well, thank you very much, gentlemen. 
As you can see, this is one of the most exciting issues to come 
before the Congress and that is why the exceptional turnout. 
Maybe that is the reason why we have not had the legislation 
move along a lot faster.
    [laughter]
    Chairman Kanjorski. But I have just a few questions myself 
before I recognize my ranking member. Mr. Sprecher, you talked 
about the clearinghouse operation, I was interested, your 
exchanges, are they for-profit owned or are they not-for-
profit?
    Mr. Sprecher. They are for-profit, and we are a New York 
Stock Exchange public company.
    Chairman Kanjorski. And who is your regulator, the actual 
exchanges?
    Mr. Sprecher. Well, we have three regulated futures 
exchanges, so one is regulated here in the United States by the 
CFTC, one is regulated in Canada by a provincial regulator and 
one is regulated in Europe by the London FSA. We have five 
regulated clearinghouses, two are regulated in the United 
States by the CFTC, one that is handling credit default swaps 
is regulated in the United States by the New York Fed as a 
trust bank. One is regulated by a provincial regulator in 
Canada and one is regulated by the Financial Services Authority 
in the UK. So that is the world I live in.
    Chairman Kanjorski. I myself had some doubts about whether 
or not we should have had some of the major exchanges change 
from not-for-profit exchanges to for-profit. I anticipate there 
is a great temptation out there to use exchanges for various 
and sundry purposes that could constitute a scandal. That has 
not happened yet, but I am not certain it will not happen some 
time in the future. What provisions have you taken to make sure 
that will not happen on your three exchanges?
    Mr. Sprecher. You have an interesting thought about this 
because one of the things that has happened in the world as we 
went from mutualized organizations that were memberships to 
public companies, which many of us represent, and when that 
happens, you sometimes disconnect from the interest of your 
members because they no longer are your bosses. And so all of 
us that run exchanges have a delicate balance, which is trying 
to be--act as a neutral counterparty and meet the needs of our 
members but still be beholden to stockholders and regulators. 
And so far I think it has worked quite well and it has created 
a lot of value within the exchange community but nonetheless it 
is incumbent on managers like myself to continue to poll the 
market and make sure we are serving the needs of the ultimate 
end user.
    Chairman Kanjorski. You said you traded on the New York 
Stock Exchange. Does that mean that I could buy a controlling 
interest in any of your exchanges by purchasing stock on the 
exchange?
    Mr. Sprecher. Technically, yes.
    Chairman Kanjorski. So that if I wanted to invade the 
United States rather than doing it militarily, I could do it 
economically by taking control of your exchanges and then just 
closing them?
    Mr. Sprecher. You would have to get through Senator Schumer 
but otherwise, yes.
    Chairman Kanjorski. Charlie is a good man but he is not 
everywhere.
    Mr. Duffy. Mr. Chairman?
    Chairman Kanjorski. Yes?
    Mr. Duffy. The CME Group is the largest publicly-traded 
exchange in the world today, and you cannot just come in here 
and take over a U.S. exchange. We have what is called a 
``poison pill,'' so anything over 15 percent ownership, you 
would be technically diluted down in value, so there is no way 
you could come in here and just buy a U.S. exchange that is 
listed. We are also a public company.
    Chairman Kanjorski. So you do not think there is any way we 
could construct hidden trusts or other organizations that if I 
were representing the oil interests of the world, that I could 
come in and take control of your exchange?
    Mr. Duffy. No, I do not.
    Chairman Kanjorski. You are a real optimist. I think that 
someone could, by convoluted methodologies of using trusts, 
etc., you could do it in a successful way and never be detected 
unless you were to open up all the trust operations in the 
country, which obviously we do not do. I am not sure why we do 
not do it, maybe we need a clearinghouse for trusts to find out 
who really owns things. Anyway, that is another issue for 
another day.
    Obviously, you all agree that there is a role for Congress 
to play in the derivative market. I am curious, I asked a 
question of the prior panel, is there any of you who feel 
absolutely that operations are occurring in such a way in the 
derivative area that there is no role or need for Congress to 
take action or for the government to provide for regulation? Is 
there anyone who feels we are moving on the course and should 
stay there as the present law constitutes us to do?
    Mr. Duffy. I will just say, sir, we have been on the record 
since the Modernization Act of 2000, that the loophole of 
2(h)(3) should be eliminated, that there was going to be a 
problem with product. So here in the last panel, they asked, 
did anybody foresee this coming or if they would admit it. We 
are on record as saying we saw this coming and there was going 
to be problems with these unregulated markets. So, I think 
government has a role in these marketplaces, there is an 
integrity to them but at the same time, we are not talking 
about huge regulation for the over-the-counter market, we are 
talking about a few different things.
    Chairman Kanjorski. But you definitely see a need for us to 
act now in some regulatory capacity, is that correct?
    Mr. Duffy. I do.
    Mr. Edmonds. I would just add to that I do not believe that 
you can continue the evolution that the market demands at the 
moment as these instruments continue to be developed and risk 
management tools continue to be used over time without an 
effective involvement from organizations and committees like 
this one. It will not reach the point of confidence the market 
can accept without involvement from the government.
    Chairman Kanjorski. Why did the market fail, and this is 
open to any one of you who want to take it on, in terms of AIG 
for instance? Obviously, their counterparties positions were 
way outside their capacity to perform because they lacked the 
reserves to do that. Why did not the parties that were dealing 
with them see that and have the market in itself react or did 
they not know what their counterparty positions were and 
therefore the limitations they had or were they planning on the 
fact that there would be a too-large-to-fail resolve and that 
in fact the government was going to stand in their position, so 
there was not any risk in finding out their due diligence, 
pursuing due diligence as to their capacity to perform?
    Mr. Duffy. I will just say that I think that they had a 
huge bet that the housing market would never go down. I do not 
think they ever believed that that asset would go down, and 
they could leverage it as many times over as they want. And 
they were undercapitalized to write all these contracts. And 
when the market turned, you talk about an illiquid market, the 
housing market might be the most illiquid market in the world, 
so there is no one to take over the exposures.
    Chairman Kanjorski. But you said you saw the risk?
    Mr. Duffy. Pardon me?
    Chairman Kanjorski. You said you saw the risk.
    Mr. Duffy. We talked about the elimination of 2(h)(3), 
which includes credit default swaps, which was eliminated from 
the exchange. We said that they should be regulated back in 
2000, and we said that in 2002 and in 2004 and as little as a 
year ago. That is what I was referring to.
    Chairman Kanjorski. But you did not see the failure coming?
    Mr. Duffy. I did not know what the leverage balance sheet 
of AIG was, sir, no.
    Chairman Kanjorski. Well, that would have been interesting 
if we had had a clearinghouse operation going, like Mr. 
Thompson is saying, everybody in the world could have examined 
to see what their exposure was, is not that correct? And would 
that have afforded the opportunity for the market itself to do 
the corrective action and not accept them as a counterparty?
    Mr. Edmonds. Well, it certainly would have highlighted the 
issue much earlier, so the default you dealt with or we 
continue to deal with in the fallout from the AIG default still 
a fairly--well, obviously, a very significant size. Well, had 
you had those mechanisms in place early on, you would have been 
able to detect that before it spiraled to that level. I am not 
going to say there would not have been a default because there 
was certainly behavior there that you had to deal with but the 
size of the default may have been mitigated far before it got 
to $170 billion of taxpayer money.
    Mr. Larry Thompson. I think, Mr. Chairman, in fairness--
    Chairman Kanjorski. Yes?
    Mr. Larry Thompson. I do not think anybody has actually 
done a real study on the causes of the AIG failure. It could 
have been due to a number of reasons. One, it could be that the 
counterparties did not know what their full exposure was, they 
are relying totally on the fact that it was a triple A rated 
company and therefore did not think that they needed to take 
the same margin requirements. Some of them we know did hedge 
some of their positions though with AIG. We also know now that 
the particular regulator, who did regulate that particular 
section of AIG, perhaps did not go in and do the right kind of 
examinations. So I think what you had called for earlier in the 
first panel, which is really an examination of AIG to see what 
occurred, should occur before we begin to speculate as to what 
went wrong there.
    Obviously, we believe that having all of those contracts in 
one central location where regulators could have gone in, could 
have looked at what the positions were, would have been 
something that would have been something that would have been 
very good from a regulatory standpoint. Thank you.
    Chairman Kanjorski. I appreciate that, Mr. Thompson, but is 
it possible that we should recognize that perhaps the capacity 
of government regulators because of salary and other 
limitations in the field are really not adequate to make the 
type of analysis and regulatory positions that occur in 
industry because of the lopsided effect of salary and 
competency and size?
    Mr. Larry Thompson. You hit upon a very excellent point, 
which is that one of the things that we have to do as part of 
reviewing the whole issue of what regulatory reform means, does 
it mean looking at whether the regulators have the right skill 
sets? Do they have the right band width to regulate the 
industries that they should be looking at? Is the pay 
comparable to retain seasoned veterans to look at those 
particular issues? I think all of those are very good things 
that should be approached and looked at by this Congress.
    Chairman Kanjorski. Well, I just want to bring as a matter 
of fact that point up, in the Federal Home Loan Bank system, 
Senator Graham had been successful several years ago before he 
left the Senate of restricting the salaries and, of course, I 
have been very active with the Federal Home Loan Bank system 
because it fascinates me in a way, how it is a cooperative 
working with the private sector. And they came to me and said, 
``Well, what we have decided is we would like to specialize,'' 
that is when we had appointments by the President of the 
members of the board, and they wanted to make a requirement 
that each board have at least one specialist in derivatives 
because they found it very difficult dealing with derivatives. 
And so the question that was posed in my office in a debate at 
that time was how difficult it would be to define 12 
specialists who were willing to work for $19,000 a year, which 
was the limitation of salary on a director to the Federal Home 
Loan Bank Board.
    Now, maybe some people who would be watching this hearing 
would say, ``Well, why not?'' But you and I know that 
specialists in the derivative field generally talk about 
starting salaries in excess of seven figures, going on up. And 
our problem is we have no way in government to match that type 
of salary, so how do we go about attracting the type of 
mathematical talent that is necessary to protect the hedging 
that occurs in these transactions?
    Mr. Larry Thompson. Well, one way may be to use academia. 
The one thing that obviously academia would be able to do, 
professors love to get information and study it, to write their 
papers and to publish things. So, as a resource, and it is just 
a suggestion, there may be a way of getting resources through 
other neutral sources, even though they have an interest in 
publishing the information they gather as opposed to making it 
a government resource if it were the work of a government 
salaried employee. It is just a suggestion.
    Chairman Kanjorski. I have exceeded my time, and I have 
been lenient with myself because considering we have a such a 
huge number of members here, I thought maybe we could by 
unanimous consent extend our questioning to 10 minutes each. Is 
there any objection to that? There being none, let me move and 
recognize Mr. Garrett for 10 minutes.
    Mr. Garrett. Well, I may just use a portion of that.
    Chairman Kanjorski. That is okay, you can hand it back. You 
can give it as a present.
    Mr. Garrett. I will yield to my colleague here. Thank you, 
gentlemen, for your testimony. I am taking a page or a comment 
out of the chairman's comment, and may be playing off comments 
of Mr. Edmonds as well, the idea of trying to find regulators 
to be able to do some of these things. Now, just the other day, 
I had lunch with a gentleman who is a CEO of a smaller 
international company, an international company but a small 
one, not one of the big guys, and when we got into the aspects 
of the regulators coming in, he said, ``Do you know how 
complicated it is within my own business for me to know exactly 
what is going on in my company and with my auditing departments 
and with my financial units in my company to have a clear 
picture or a snapshot, if you will, at any one point in time of 
how my company is doing?'' He said when you talk about the 
regulators, regardless of how well we pay them, when they come 
in and try to take a look at it, we may be going down the wrong 
proverbial road if we ever really want to think that we can 
solve some of these problems by bringing some people in on a 
short-term basis to examine the books proverbially and get a 
good snapshot out of it.
    I know the chairman asked, I think it was the last panel, 
did any of you see this all coming and come back and tell us 
beforehand, and everybody sat mute, although I am sure some of 
them probably had some premonitions but just did not act on it. 
That same question could always be asked by that panel, and we 
have to be careful what we ask them because if they ever ask us 
that question, did we ever see any of this coming, and if we 
did, how come we did not say anything? Congress did not see a 
lot of it coming, otherwise the chairman and I would have 
stopped it. Some of it we did, some of it we did not, obviously 
with the GSEs.
    But just on that last note, I guess, Mr. Edmonds, you were 
saying with regard to we cannot get to where we all need to be 
or where you would like to be unless Congress steps and does 
some of this, you probably have a little more rosy view of the 
good works that Congress can do in some of these areas in light 
of our past track record of not providing the appropriate, this 
is what you are talking about, not providing the appropriate 
regulation in the past in some of these areas. Hopefully, that 
we will be able to do so in the future. Do you want to comment 
on that?
    Mr. Edmonds. The issue at the end of the day that what 
Congress wants, I believe the answer to the question you 
fundamentally were asking the industry is what is something 
worth, whether you are talking about the salary of the 
regulator that is going to be there, but what is the value that 
you are going to receive for that? If we looked at the question 
of clearing across all of a number different products and asset 
classes at the end of today, there is some standard or accepted 
curve of what the value of an instrument is. We come to expect 
that as just it is going to be there as a constant. It is only 
when it is no longer a constant that we have a major issue in 
this predicament. And what we experienced over the last year is 
we lost a constant. It was not a defined measure of value that 
the consensus of the market agreed upon. We spent a lot of time 
debating and a lot of time discussing data processes and how 
that process of determining what something is valued at impacts 
the marketplace.
    So when you have the right folks in the right positions at 
the regulators, paid the right amount, and the values received 
or whether or not it is subcommittees like this and others 
within the government itself producing that function, we all 
have to agree at some point in time that fair value is worth 
``X,'' and when we lose that, we typically lose our way. I do 
believe, and my comment earlier was this is a point in time 
where I believe history says bodies as this one will step up 
and attempt to correct the show.
    If you look at the energy markets in the earlier part of 
this decade, which is where my career began, you had people 
take advantage of that in the fall of Enron and the energy 
emergent sectors, and there were certain rules put into place 
that both Mr. Duffy and Mr. Sprecher have great businesses from 
today, and this is another point in time where I believe we 
have to stand up and do that for other asset classes. And I 
believe those are the questions you are asking the previous 
panel and the one that we sit before you today of where does it 
start and how far can we go without going too far.
    Mr. Garrett. Well, one of the proposals that's out there 
from CFTC Chairman Gensler was that he said in his proposal, 
``We need to protect the public from improper marketing 
practices.'' And I guess the one question that follows from 
that is that endemic in the system right now, we are talking 
about sophisticated firms that are out there, is improper 
marketing practices--you mentioned energy but is that something 
that is widespread in the industry. And if you put in mandates 
and what have you, a second part, and anybody can answer this, 
if you put in mandates to beyond exchanges and clearinghouses, 
is there a potential, and maybe not, maybe I am just not seeing 
this, exposing the average investor then to a higher risk at 
the end of the day?
    Mr. Edmonds. Well, I will start in response to that. Our 
solution and others that are represented up here, have a 
certain mechanism that is not going to go down to the retail 
investor. They are eligible commercial participants. But even 
with that, and that defines some level of sophistication of the 
user of these instruments. But even with that definition there, 
the rules of the game are not the same for all the different 
participants. And depending upon where you are or how you 
behave, in the previous panel, Mr. Murphy from 3M spent a lot 
of time talking about his business as a corporate, and they 
have a very defined function in how that works. But in the 
world I live in, interest rate swaps, that type of business 
only represents sub-10 percent of the marketplace. So the other 
90 percent are not playing by the same rules. And I believe if 
you are going to get to that point of fair value, at some point 
in time you are going to have to have consensus on what the 
baseline is.
    Mr. Garrett. Thank you. Any other comments on that?
    Mr. Duffy. Well, what I think Mr. Gensler was referring to 
was some of the marketing practices that have gone on 
historically that have targeted some of the uninformed people 
who may be in a retirement area, such as California, Florida, 
and others, trying to target them to solicit them to trade 
foreign exchange product, promising them 60 percent gains in 60 
days. And the problem, what happened with the CFTC, most of 
their budget, I think it was roughly 70 percent was the number, 
was going to police off exchange fraudulent activity. And I 
think that is what Mr. Gensler is referring to, that it has to 
stop. I mean they have to either police it or they are not 
going to police it but that is a big part of what their budget 
was going towards.
    Mr. Garrett. Can you stop that just by bringing it all on 
then?
    Mr. Duffy. Well, I think there are other issues that they 
have to deal with. A lot of this going over the Web, a lot of 
this is going over cold calls. How do they get these people? 
They show up at a bucket shop and the bucket shop has four kids 
who never had a job before in their lives, but yet they are the 
four principals of the firm. So the real guy that is taking the 
money is already to the next city or the next village. It is 
very difficult to police.
    Mr. Garrett. Right, and just one little question, Mr. 
Thompson, and if anybody else wants to. You were speaking when 
I came in, and I was watching you folks in the back room by the 
way, with regard to the repository facilities, how is this all 
envisioned as far as, I hate this word, but the granular aspect 
of it and the aggregation aspect of it, how much information is 
actually out there on the individual company and trade versus 
the aggregate aspect of it?
    Mr. Larry Thompson. We publish at the moment, once a week, 
1,000 names, information on an aggregate basis in all of the 
indices. We do that on a public Web site that everyone has 
access to. We obviously give more granular information to 
regulators that would include position information by who is 
doing the trades. We also put trading information on an 
aggregate basis on our Web site, but we do give to regulators, 
including the Fed, the ECB, the FSA, very granular detail 
information as to what the positions are when they request it.
    Mr. Garrett. Okay, great, I appreciate the information. 
Thanks a lot, gentlemen.
    Chairman Kanjorski. The Chair recognizes Mr. Scott.
    Mr. Scott. Thank you, Mr. Chairman. I might say that this 
is absolutely stunning in its scope of complexity and challenge 
but as we try to grasp or get our hands around this, to try to 
figure how we regulate it, I think it would be very helpful, 
Mr. Sprecher, if you might share with us the description of the 
day-to-day Federal regulation of your clearinghouse and whether 
or not you can come to the conclusion that the Federal 
regulation that you are currently under. And in your opening 
statement and your response to the chairman, you reiterated 
several layers of Federal regulation. It might be well for you 
to kind of give us kind of an overview as to how effective if, 
in your opinion, this regulation has been?
    Mr. Sprecher. Certainly. Well, we launched a credit default 
swap clearinghouse about 90 days ago and so far have done 
almost a trillion dollars worth of clearing in that market. And 
that particular clearinghouse is regulated by the New York Fed. 
First of all, we had a hard time--we wanted to be regulated and 
we had a hard time figuring out who should regulate us, there 
were some regulatory gaps in credit default swaps that I am 
sure many of you are aware of, and it did not look like it fell 
under the CFTC and it did not look like a security that fell 
under the SEC. And ultimately in discussions with the Fed, it 
seemed appropriate to be under their jurisdiction, so we set up 
under the Fed, it is our first opportunity of working with the 
Fed. I am frankly very impressed with the quality of people 
that the Fed has. They are an amazing organization. They have a 
deep understanding of derivatives, and they are a very hands-on 
regulator. In fact today, they are doing I think their second 
audit of our clearinghouse, and we are only 90 days old, and I 
think that audit goes all week long.
    But there are some regulatory voids that I think Secretary 
Geithner was trying to point out in his letter, things about 
how the FDIC would get involved in a wind up, for example, of a 
bank versus a clearinghouse, whether we would wind up the 
affairs or whether the Fed would be involved, so that there are 
some jurisdictional issues that we are trying to work out 
between agencies on a collaborative basis but ultimately I 
think Congress may have to step in and help dictate some of 
these.
    Mr. Scott. Let me pursue just a moment if I may, I am 
reading your statement and just to clarify, you state that, 
``Clearing all over-the-counter derivatives and the trading of 
over-the-counter derivatives on a transparent electronic 
platform may provide additional risk management and potentially 
additional price transparency. However, forcing all over-the-
counter derivatives to be cleared and traded on the exchange 
would likely have many unintended consequences.'' Can you give 
us a little clarity there? It seems as if you are saying on the 
one hand that it is good but on the other hand there are some 
bad things that will happen?
    Mr. Sprecher. Yes, this is the dilemma that we are all in 
here, which is we all--all of us here believe in open, 
transparent, predictable markets but you all trying to regulate 
everybody into one of those could have unintended consequences. 
One unintended consequence, for example, may be what a number 
of us have heard you talk about today, which is the flight of 
some of this business overseas. We have 12 members of our 
credit default swap clearinghouse. They are the largest holders 
of credit default swaps in the world, probably could hold at 
least 80 percent of the open positions in credit default swaps. 
Of the 12 members, only four of them are U.S. companies. The 
other members have come here because they ultimately believe 
that we need to do clearing. They ultimately believe that it 
will be better for the marketplace but was the case where 
through some regulatory prodding and cooperation with industry 
and the aftermath of this terrible credit crisis, there is some 
voluntary work. But I do not know that we can always depend 
that foreign companies will cooperate with U.S. regulation.
    Mr. Scott. Mr. Duffy, I think you raised that point, and I 
asked that question earlier to the other panel because we 
really want to be I think very careful and judicious at what we 
do here. All of this is sort of new territory for us. Can you 
give us your rationale for your fears, you were pretty strong 
in your statements that we would lose business overseas. Would 
it be on overseas exchanges, would it be offshore accounts? Can 
you tell us exactly how we would lose overseas?
    Mr. Duffy. Well, I think Mr. Sprecher said it correctly, 
you have to look at a lot of these dealers, there are 12 large 
ones in the United States, of which they have operations 
throughout the world, and they can pass their book from one 
place to another so the book truly just travels along through 
the time zones. And that is a concern because they cannot 
operate outside the United States. Our concern with that aspect 
is if you take that market off of the United States, that hurts 
the regulated U.S. futures exchanges because we are really the 
price discovery mechanism for a lot of the look-alike's that 
trade over-the-counter, so that is the price that they are 
looking to use for their risk management needs. So if we have 
less liquidity in the over-the-counter trading on our exchange, 
it is going to hurt the whole food chain. So it is a concern.
    So when we look at--I will go back to maybe your other 
question about why we cannot take some of these trades in our 
clearinghouse, they are so customized in nature where a dealer 
may be out looking for the other side of a trade for not 6 
milliseconds, like we trade at the CME Group, he may be out and 
be looking for 6 hours for the other side of his one particular 
trade for his one particular client. That is why it is very 
difficult. So we cannot bring those into our clearinghouse and 
assume the risk associated with those transactions at CME Group 
because we just do not have all the information we have on a 
standardized futures contract. But I guess that is a long way 
of saying is we are concerned about the liquidity, which is the 
direct result that the futures exchanges get from the over-the-
counter market.
    The last panel made a statement, they said that the OTC 
market is roughly several times larger than a regulated 
exchange model. It is 5 times larger. It is much larger than a 
regulated exchange model, so they work together. And the 
pricing comes from the exchange model.
    Mr. Scott. All right, so you say moving forward, we need to 
separate the requirement if we mandate the clearinghouse and 
separate illiquid and unstandardized derivative contracts from 
liquid?
    Mr. Duffy. Yes, we do not believe that Congress should 
mandate it, we think they should use capital incentives for 
clearing and that is the way we approach this. We do not think 
a mandate is a good thing.
    Mr. Scott. Well, if we did that, would we not be having 
some sort of loophole that could allow a repeat of what AIG and 
what Enron--
    Mr. Duffy. Well, I think you could have other reporting 
requirements that are not being put forth today for some of 
these transactions that would bring greater transparency to the 
regulator, whether it be the SEC, CFTC or the systemic risk 
regulator.
    Mr. Scott. All right. Thank you, Mr. Chairman.
    Chairman Kanjorski. The gentleman from Illinois, Mr. 
Manzullo?
    Mr. Manzullo. Thank you, Mr. Chairman. Let me ask a very 
basic question. I believe that we would not be in this crisis 
that we are today if the subprime market had not gone sour and 
thus tainted the basis of the investments, which grew, the 
investments grow obviously exponentially through derivatives. 
Does that statement make sense or am I missing something on it?
    Mr. Sprecher. I believe it does. We develop in the world an 
unbelievable distribution system for syndicating risks with the 
idea that people holding small amounts of risks, widely 
dispersed, is good risk management, but then we pump poison 
through that system and just kept pumping it and pumping and 
pumping it.
    Mr. Manzullo. Because the underlying investment was 
destined to go bad.
    Mr. Sprecher. Correct.
    Mr. Manzullo. You just cannot sell homes to people who 
cannot afford to make the first installment. In fact, the 
attorney general 2 years ago in Illinois, came out with her 
report on mortgages and she thought that the reason for the 
foreclosures were that people were not prepared to pay the 
increased rate on the variable rate mortgages when they begin 
to reset and then she shockingly found out that some people 
could not even make the first and second mortgage payments on 
the original mortgage. And the reason I ask that question is 
that what you gentleman do is to provide more liquidity in the 
market for good loans. That is really what you are doing, would 
that be correct?
    Mr. Edmonds. I think that it may be more accurate to say 
that what each of us respectively represent are mechanisms that 
provide better transparency, whether it be through clearing or 
through execution services, and that transparency results in an 
increased confidence. So the increased confidence you have in 
the next product that is highly correlated back at this 
standard thing that trades on an exchange or is cleared in a 
clearinghouse is enough for people to take that additional 
risk. And I think what Mr. Sprecher was trying--
    Mr. Manzullo. Because of confidence?
    Mr. Edmonds. Because that increased confidence exists but 
then what you have to begin to question is the correlation 
method between what everyone understands and accepts as 
something of value and this thing over here that is not 
something of value, that you do not know until it is too late.
    Mr. Manzullo. So the emphasis upon more regulation on the 
derivatives really has its genesis in the fact that the 
original investments themselves went sour, would that be 
correct?
    Mr. Larry Thompson. I think that is correct, that when you 
have an underlying instrument, such as the subprime that went 
south, that causes pressure all along. The one thing that the 
U.S. markets have done is has brought capital here to the 
United States, which has made us the broadest capital markets 
and one of the reasons why so many foreign companies want to 
come here and invest in Mr. Sprecher's company and be involved 
in it is because the U.S. capital markets have, one, been 
transparent; two, have been very liquid, and now what the worry 
is that has the regulation stayed in tune with what the 
instruments are all about and can they in fact continue to 
provide the same kind of transparency? I think they can. I 
think that the market participants have already started working 
in that regard. We, for instance, work very cooperatively with 
all of the members who are sitting here. We were instrumental 
in helping Mr. Sprecher's company set up their CCP because they 
pull the trades on a credit default swaps directly from the 
Depository Trust and Clearing Corporation.
    Mr. Manzullo. The follow-up question would be based upon 
our discussion, do you believe that any derivative product that 
can clear through a clearinghouse can also trade on an 
exchange?
    Mr. Larry Thompson. I think there is some confusion between 
clearing and what exchange traded means.
    Mr. Manzullo. Please?
    Mr. Larry Thompson. I think what we do at DTCC is clearing. 
We match the size of the trades. We actually net the 
transactions. We decide through our automated systems what the 
calculations are. We actually send those payments to CLS Bank 
to be settled. That is clearing. Trading is what takes place on 
an exchange when two sides who want to in fact do a trade 
decide to put it through. Clearing is all of the post-trade 
activity and making certain--
    Mr. Manzullo. Selling of accounts?
    Mr. Larry Thompson. Making certain the buyer got what he 
was supposed to get and the seller is getting the funds that he 
thought he or she should be getting. That is really part of the 
clearance system. And I think there has been a little confusion 
in today's discussion, both in the first panel and to some 
extent perhaps here, as to what clearance and settlement has 
meant here in the United States.
    Mr. Edmonds. I would add just a little bit to Mr. 
Thompson's comments that when we talk about clearing, the next 
component of the clearing is whether or not you provide credit 
mitigation. Mr. Thompson is incredibly correct in the fact that 
there are certain processes that you can use to clear 
information, in some contexts are you also removing that credit 
exposure between the counterparties. But to your earlier 
question, I think it is incredibly important that until you 
figure out how to clear it, it is very difficult to move to how 
can you trade it on an exchange. And there are plenty of asset 
classes that we have not yet put into an essentially cleared 
model.
    Mr. Duffy. Congressman, it is important to have liquidity 
to get price information so you can do risk management and 
clearing. That normally comes from trading and then it goes 
into the clearinghouse once the price has been established, and 
then the risk management process goes on until that position is 
liquidated.
    I think that you can do some clearing without trading the 
product, but you need to have some relevant information from 
some of the providers that are out there today that are giving 
you price information as relates to this. There are margin 
requirements. There are twice daily mark-to-market requirements 
associated with clearing, so there are some things that are not 
a custom to the OTC world today that will burden additional 
costs but will also protect the taxpayer from additional 
liabilities like they had in the last several months.
    Mr. Manzullo. Thank you.
    Mr. Duffy. Thank you, sir.
    Chairman Kanjorski. Thank you, Mr. Manzullo. We could go 
on, but I know that on the Republican side of the aisle, they 
have a commitment for a 3:00 meeting, is that correct? So 
rather than holding our members here, we will wind this up. I 
just want to thank you first of all for appearing. Two, I asked 
the question of the first panel, would you all be willing to 
participate in giving us your best thoughts as to what we can 
do eventually to do fair and effective regulation without 
smothering the derivative industry but on the other hand to 
avoid a reoccurrence of what has happened over the last several 
years. Is there anybody here who would not be willing to 
participate in the future in sort of an advisory role to 
accomplish that?
    Mr. Duffy. I applaud you for doing it, sir. I think it 
makes a tremendous amount of sense.
    Chairman Kanjorski. Well, we appreciate that. You can be of 
great assistance. And not only that, when mistakes are made in 
the future as a result of our legislation, we can point to the 
expert advisors and say that you all made the mistake.
    [laughter]
    Chairman Kanjorski. No, we would appreciate it. I certainly 
invite it. There is nobody on the committee who has the 
expertise of the panels that we reviewed today, and if we can 
get your assistance in that, that will be extremely helpful 
over these next several months because that is the period of 
time in which some piece of legislation will occur.
    And I may caution also to take advantage of reviewing the 
drafts of that legislation as it starts to circulate and do not 
hesitate using that thing called a telephone and call any 
member of the committee or myself and let us know what a 
dastardly thing we are doing by even considering one part of 
the piece of legislation. I am not guaranteeing that we will 
respond positively to your critiques, but we would like to hear 
your critiques on all those issues.
    Mr. Manzullo. Would the chairman yield for a second?
    Chairman Kanjorski. Sure, I will.
    Mr. Manzullo. I was just in Switzerland and met with the 
folks from FINRA. It took them 10 years, a 10-year study, in 
order to come up with their new regulatory body of all 
instruments of all categories of investments that might in 
their opinion come up with a systemic risk. And the first 
statement that came out of the mouth of the person with whom I 
spoke, he said, ``Congressman,'' he said, ``Whatever system of 
regulation that you come up with, you must give companies the 
ability to fail.'' He said, ``If you do not do that, you will 
not have an investment system in your country.''
    And I want to commend you for the caution that I know that 
you are taking and also Chairman Frank for moving deliberately 
but very slowly into an area like this.
    Chairman Kanjorski. Well, we thank you. Of course, we are 
much swifter than this place.
    Mr. Scott. Mr. Chairman, could you yield for one second, 
please?
    Chairman Kanjorski. Yes.
    Mr. Scott. I would also like to just insert a word of 
caution. I want to certainly make the record reflect that I am 
very concerned about two major areas as we move forward because 
I think that we have received some good information from both 
of these panels that we want to make sure that we get our arms 
around, and that is the impact this has on foreign business 
going overseas. I think you made a good point that we need to 
be careful as we move forward on that. And the non-standardized 
derivatives as well, that we might have to do what Mr. Geithner 
suggested but to separate those two levels.
    Chairman Kanjorski. I appreciate that. Let me just add to 
the record because, Mr. Thompson, you made a statement, and I 
wanted to ask you the question, you said 95 percent, was that 
in volume or dollar value?
    Mr. Larry Thompson. That is in volume at this point. That 
is what our belief is in CDS, in credit default swaps that we 
are talking about.
    Chairman Kanjorski. Okay, they are equal, the dollar value 
and the volume?
    Mr. Larry Thompson. It is approximately but it is based on 
what the dealers have told us of what they are doing at this 
point.
    Chairman Kanjorski. Okay, very good. Thank you.
    Mr. Duffy. Mr. Chairman, if I just may for the record, Mr. 
Scott, I am sorry earlier when you asked about the difference 
between standard and customized products, my comment was that 
we are not supporting mandatory clearing of either one. I am a 
supporter of standardized OTC contracts being cleared through a 
regulated exchange, just so I was clear on that point, sir. I 
apologize if I was confusing earlier.
    Chairman Kanjorski. Well, very good. Again, I want to thank 
you very much for your testimony, gentlemen. And we will put 
you on our advisory committee and ask for anything that you can 
give.
    Mr. Duffy. Thank you, sir.
    Chairman Kanjorski. The Chair notes that some members may 
have additional questions for this panel which they may wish to 
submit in writing. Without objection, the hearing record will 
remain open for 30 days for members to submit written questions 
to these witnesses and to place their responses in the record.
    The panel is thereby dismissed and this hearing is 
adjourned.
    [Whereupon, at 2:50 p.m., the hearing was adjourned.]


                            A P P E N D I X



                              June 9, 2009


[GRAPHIC] [TIFF OMITTED] T2397.001

[GRAPHIC] [TIFF OMITTED] T2397.002

[GRAPHIC] [TIFF OMITTED] T2397.003

[GRAPHIC] [TIFF OMITTED] T2397.004

[GRAPHIC] [TIFF OMITTED] T2397.005

[GRAPHIC] [TIFF OMITTED] T2397.006

[GRAPHIC] [TIFF OMITTED] T2397.007

[GRAPHIC] [TIFF OMITTED] T2397.008

[GRAPHIC] [TIFF OMITTED] T2397.009

[GRAPHIC] [TIFF OMITTED] T2397.010

[GRAPHIC] [TIFF OMITTED] T2397.011

[GRAPHIC] [TIFF OMITTED] T2397.012

[GRAPHIC] [TIFF OMITTED] T2397.013

[GRAPHIC] [TIFF OMITTED] T2397.014

[GRAPHIC] [TIFF OMITTED] T2397.015

[GRAPHIC] [TIFF OMITTED] T2397.016

[GRAPHIC] [TIFF OMITTED] T2397.017

[GRAPHIC] [TIFF OMITTED] T2397.018

[GRAPHIC] [TIFF OMITTED] T2397.019

[GRAPHIC] [TIFF OMITTED] T2397.020

[GRAPHIC] [TIFF OMITTED] T2397.021

[GRAPHIC] [TIFF OMITTED] T2397.022

[GRAPHIC] [TIFF OMITTED] T2397.023

[GRAPHIC] [TIFF OMITTED] T2397.024

[GRAPHIC] [TIFF OMITTED] T2397.025

[GRAPHIC] [TIFF OMITTED] T2397.026

[GRAPHIC] [TIFF OMITTED] T2397.027

[GRAPHIC] [TIFF OMITTED] T2397.028

[GRAPHIC] [TIFF OMITTED] T2397.029

[GRAPHIC] [TIFF OMITTED] T2397.030

[GRAPHIC] [TIFF OMITTED] T2397.031

[GRAPHIC] [TIFF OMITTED] T2397.032

[GRAPHIC] [TIFF OMITTED] T2397.033

[GRAPHIC] [TIFF OMITTED] T2397.034

[GRAPHIC] [TIFF OMITTED] T2397.035

[GRAPHIC] [TIFF OMITTED] T2397.036

[GRAPHIC] [TIFF OMITTED] T2397.037

[GRAPHIC] [TIFF OMITTED] T2397.038

[GRAPHIC] [TIFF OMITTED] T2397.039

[GRAPHIC] [TIFF OMITTED] T2397.040

[GRAPHIC] [TIFF OMITTED] T2397.041

[GRAPHIC] [TIFF OMITTED] T2397.042

[GRAPHIC] [TIFF OMITTED] T2397.043

[GRAPHIC] [TIFF OMITTED] T2397.044

[GRAPHIC] [TIFF OMITTED] T2397.045

[GRAPHIC] [TIFF OMITTED] T2397.046

[GRAPHIC] [TIFF OMITTED] T2397.047

[GRAPHIC] [TIFF OMITTED] T2397.048

[GRAPHIC] [TIFF OMITTED] T2397.049

[GRAPHIC] [TIFF OMITTED] T2397.050

[GRAPHIC] [TIFF OMITTED] T2397.051

[GRAPHIC] [TIFF OMITTED] T2397.052

[GRAPHIC] [TIFF OMITTED] T2397.053

[GRAPHIC] [TIFF OMITTED] T2397.054

[GRAPHIC] [TIFF OMITTED] T2397.055

[GRAPHIC] [TIFF OMITTED] T2397.056

[GRAPHIC] [TIFF OMITTED] T2397.057

[GRAPHIC] [TIFF OMITTED] T2397.058

[GRAPHIC] [TIFF OMITTED] T2397.059

[GRAPHIC] [TIFF OMITTED] T2397.060

[GRAPHIC] [TIFF OMITTED] T2397.061

[GRAPHIC] [TIFF OMITTED] T2397.062

[GRAPHIC] [TIFF OMITTED] T2397.063

[GRAPHIC] [TIFF OMITTED] T2397.064

[GRAPHIC] [TIFF OMITTED] T2397.065

[GRAPHIC] [TIFF OMITTED] T2397.066

[GRAPHIC] [TIFF OMITTED] T2397.067

[GRAPHIC] [TIFF OMITTED] T2397.068

[GRAPHIC] [TIFF OMITTED] T2397.069

[GRAPHIC] [TIFF OMITTED] T2397.070

[GRAPHIC] [TIFF OMITTED] T2397.071

[GRAPHIC] [TIFF OMITTED] T2397.072

[GRAPHIC] [TIFF OMITTED] T2397.073

[GRAPHIC] [TIFF OMITTED] T2397.074

[GRAPHIC] [TIFF OMITTED] T2397.075

[GRAPHIC] [TIFF OMITTED] T2397.076

[GRAPHIC] [TIFF OMITTED] T2397.077

[GRAPHIC] [TIFF OMITTED] T2397.078

[GRAPHIC] [TIFF OMITTED] T2397.079

[GRAPHIC] [TIFF OMITTED] T2397.080

[GRAPHIC] [TIFF OMITTED] T2397.081

[GRAPHIC] [TIFF OMITTED] T2397.082

[GRAPHIC] [TIFF OMITTED] T2397.083

[GRAPHIC] [TIFF OMITTED] T2397.084

[GRAPHIC] [TIFF OMITTED] T2397.085

[GRAPHIC] [TIFF OMITTED] T2397.086

[GRAPHIC] [TIFF OMITTED] T2397.087

[GRAPHIC] [TIFF OMITTED] T2397.088

[GRAPHIC] [TIFF OMITTED] T2397.089

[GRAPHIC] [TIFF OMITTED] T2397.090

[GRAPHIC] [TIFF OMITTED] T2397.091

[GRAPHIC] [TIFF OMITTED] T2397.092

[GRAPHIC] [TIFF OMITTED] T2397.093

[GRAPHIC] [TIFF OMITTED] T2397.094

[GRAPHIC] [TIFF OMITTED] T2397.095

[GRAPHIC] [TIFF OMITTED] T2397.096

[GRAPHIC] [TIFF OMITTED] T2397.097

[GRAPHIC] [TIFF OMITTED] T2397.098

[GRAPHIC] [TIFF OMITTED] T2397.099

[GRAPHIC] [TIFF OMITTED] T2397.100

[GRAPHIC] [TIFF OMITTED] T2397.101

[GRAPHIC] [TIFF OMITTED] T2397.102

[GRAPHIC] [TIFF OMITTED] T2397.103

[GRAPHIC] [TIFF OMITTED] T2397.104

[GRAPHIC] [TIFF OMITTED] T2397.105

[GRAPHIC] [TIFF OMITTED] T2397.106

[GRAPHIC] [TIFF OMITTED] T2397.107

[GRAPHIC] [TIFF OMITTED] T2397.108

[GRAPHIC] [TIFF OMITTED] T2397.109

[GRAPHIC] [TIFF OMITTED] T2397.110

[GRAPHIC] [TIFF OMITTED] T2397.111

[GRAPHIC] [TIFF OMITTED] T2397.112

[GRAPHIC] [TIFF OMITTED] T2397.113

[GRAPHIC] [TIFF OMITTED] T2397.114

[GRAPHIC] [TIFF OMITTED] T2397.115

[GRAPHIC] [TIFF OMITTED] T2397.116

[GRAPHIC] [TIFF OMITTED] T2397.117

[GRAPHIC] [TIFF OMITTED] T2397.118

[GRAPHIC] [TIFF OMITTED] T2397.119

[GRAPHIC] [TIFF OMITTED] T2397.120

[GRAPHIC] [TIFF OMITTED] T2397.121

[GRAPHIC] [TIFF OMITTED] T2397.122

[GRAPHIC] [TIFF OMITTED] T2397.123

[GRAPHIC] [TIFF OMITTED] T2397.124

[GRAPHIC] [TIFF OMITTED] T2397.125

[GRAPHIC] [TIFF OMITTED] T2397.126

[GRAPHIC] [TIFF OMITTED] T2397.127

[GRAPHIC] [TIFF OMITTED] T2397.128

