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




 
                     REFORM OF THE OVER-THE-COUNTER
                    DERIVATIVE MARKET: LIMITING RISK
                         AND ENSURING FAIRNESS

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

                                HEARING

                               BEFORE THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                               __________

                            OCTOBER 7, 2009

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 111-85



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                 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


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    October 7, 2009..............................................     1
Appendix:
    October 7, 2009..............................................    77

                               WITNESSES
                       Wednesday, October 7, 2009

Ferreri, Christopher, Managing Director, ICAP, on behalf of the 
  Wholesale Markets Brokers Association..........................    55
Gensler, Hon. Gary, Chairman, Commodity Futures Trading 
  Commission.....................................................     8
Hall, David, Chief Operating Officer, Chatham Financial Corp.....    48
Hill, James J., Managing Director, Morgan Stanley, on behalf of 
  the Securities Industry and Financial Markets Association 
  (SIFMA)........................................................    50
Hixson, Jon, Director, Federal Government Relations, Cargill, 
  Inc............................................................    43
Holmes, Steven A., Director of Treasury Operations, Deere & 
  Company........................................................    54
Hu, Henry, Director, Division of Risk, Strategy, and Financial 
  Innovation, U.S. Securities and Exchange Commission............    10
Johnson, Rob, Director of Economic Policy for the Roosevelt 
  Institute in New York, on behalf of Americans for Financial 
  Reform.........................................................    57
Kaswell, Stuart J., Executive Vice President & Managing Director, 
  General Counsel, Managed Funds Association (MFA)...............    52
Sleyster, Scott, CFA, Chief Investment Officer, Domestic, 
  Prudential Financial, on behalf of the American Council of Life 
  Insurers (ACLI)................................................    47
Stulz, Rene M., Everett D. Reese Chair of Banking and Monetary 
  Economics, Fisher College of Business, The Ohio State 
  University.....................................................    45

                                APPENDIX

Prepared statements:
    Garrett, Hon. Scott..........................................    78
    Ferreri, Christopher.........................................    79
    Gensler, Hon. Gary...........................................   106
    Hall, David..................................................   120
    Hill, James J................................................   124
    Hixson, Jon..................................................   135
    Holmes, Steven A.............................................   140
    Hu, Henry....................................................   147
    Kaswell, Stuart J............................................   157
    Sleyster, Scott..............................................   168
    Stulz, Rene M................................................   175

              Additional Material Submitted for the Record

Himes, Hon. Jim:
    Written statement of Larry E. Thompson, General Counsel, The 
      Depository Trust & Clearing Corporation....................   193
Manzullo, Hon. Donald:
    Written statement of John Hollyer, Principal and Head of Risk 
      Management and Strategy Analysis, Vanguard.................   203
    Written statement of the International Swaps and Derivatives 
      Association................................................   208
Moore, Hon. Dennis:
    Written statement of the electric power and natural gas 
      industries.................................................   210
Watt, Hon. Melvin:
    Written statement of Shawn A. Dorsch, Founder, Blackbird 
      Holdings, Inc..............................................   213


                     REFORM OF THE OVER-THE-COUNTER
                    DERIVATIVE MARKET: LIMITING RISK
                         AND ENSURING FAIRNESS

                              ----------                              


                       Wednesday, October 7, 2009

             U.S. House of Representatives,
                   Committee on Financial Services,
                                                   Washington, D.C.
    The committee met, pursuant to notice, at 10 a.m., in room 
2128, Rayburn House Office Building, Hon. Barney Frank 
[chairman of the committee] presiding.
    Members present: Representatives Frank, Kanjorski, Waters, 
Watt, Sherman, Meeks, Moore of Kansas, Clay, McCarthy, Baca, 
Lynch, Miller of North Carolina, Scott, Green, Cleaver, Bean, 
Ellison, Klein, Perlmutter, Donnelly, Foster, Carson, Minnick, 
Adler, Himes, Maffei; Bachus, Castle, Royce, Lucas, Manzullo, 
Biggert, Capito, Hensarling, Garrett, Price, Campbell, Putnam, 
Marchant, Jenkins, Lee, Paulsen, and Lance.
    Also present: Representatives Murphy and McMahon.
    The Chairman. The hearing will come to order.
    The subject today is derivatives. I want to talk a little 
bit about the process and then about the substance.
    We are dealing with a set of issues that first came to 
light when Secretary Paulson set forward an agenda for 
regulation in April of 2008. Our attention was diverted for a 
while by an economic crisis. It was early this year when we 
felt that things had stabilized enough in the general economy 
in the credit area for us to take this up, and we have been 
working on it. It is very much a work in progress.
    Some people have said that we are rushing it. First, we 
have been studying this, many of us, since April of 2008. It 
has been on everybody's radar screen. Second--I am sorry, but 
my clock hasn't started. I apologize, but I meant it in a way 
that it should come out of my time, so I will cut myself off 30 
seconds early.
    Yes, these things need to be studied. It is also the case 
though that some issues are not going to be joined until there 
are pieces of paper out there and people react to them. We have 
before us a discussion draft, which will and I believe should 
undergo significant change, but you have to start somewhere.
    This bill will not, on the best timetable, be signed by the 
President until December. I hope we can. We certainly will meet 
a timetable of getting legislation to the Floor in November. 
And it is a process, as I said, in which we will be putting 
things forward. It is a process in which a large number of 
Members participate.
    On the specific bill today, I agree with some of the 
criticisms that have been made. And again, I want to make it 
clear this was a discussion draft. Here is the goal, and we 
welcome participation in reaching it. It does seem to many of 
us that there is a distinction between derivatives as ends and 
derivatives as means.
    When we first began to talk about this, I expressed some 
views, for example, about prohibiting naked credit default 
swaps. I did not expect people in the business of selling 
these, people in the financial industry, to be happy with that. 
They weren't. As I said, we didn't expect them to be. We didn't 
care whether they were or weren't.
    What we began to hear were objections to some of this from 
those people for whom derivatives are not an end for making 
money as they are for the financial institutions, but a means 
so that they can go about their business of producing goods and 
services with some stability, with some reasonable expectation 
about cost. Derivatives are a very legitimate way for producers 
of end products, goods or services, to reduce volatility, which 
is very important for them to be able to make the calculations 
they make.
    Our job is to find a way to preserve that legitimate 
function while diminishing the excessive volatility that comes 
from people who are doing it to speculate, from diminishing the 
risk that comes when people get overextended in doing it. And 
it has been a process that is still in place.
    I notice, for instance, that Mr. Hu said that the 
discussion draft could unintentionally preserve existing 
regulatory gaps. He is quite right that it is unintentional. We 
will look for this expertise to deal with it.
    Chairman Gensler told me yesterday that he thought that in 
the bill, it created a presumption against having things go 
essentially cleared, and that is exactly the opposite of our 
intention.
    I want to say at this point that the staff of the Financial 
Services Committee has, in my judgment, given America this year 
the best value for its money that it has ever gotten. These are 
very intelligent dedicated people who work very hard, who put 
up with a lot from a lot of people, me sometimes included, and 
all of whom could be making a lot more money doing similar work 
under less stressful conditions elsewhere.
    I have been urging them to get these drafts out so they can 
be discussed. If I thought we were going to get it right the 
first time, every time, then I guess we wouldn't need hearings, 
and we wouldn't need markups; we would just take them all up on 
the Floor.
    And I acknowledge, and let me just say to my friends in the 
regulatory area, yes, I acknowledge there are some areas here 
where there are gaps that shouldn't have been there. There is 
this, and there may be a distinction here--I do believe that 
there is a need to distinguish between legitimate end-users and 
people who are there because this is a profit incentive for 
them.
    Now, having said that, it is clear we can't expect 
financial institutions to be available to help the end-users as 
a charity. They need to make a profit or they will not be 
available to provide that liquidity, which is important. But 
that is the line we want to draw.
    I have read this over, and I think we have in the first 
cut--well, this is the second cut because we put something out. 
I backed off some of the things, listening to the end-users. I 
think there is some room now to tighten up some of what we are 
doing. It is our intention to have a push in favor of clearing 
but a recognition that it won't always be possible. We picked 
up some things, like to the extent that this collateralization 
will not have to be cash.
    The last point I would make is this: If we were starting 
from scratch, we would only have one person here. There would 
be an SEC/FTC; there wouldn't be an SEC and a CFTC. But we are 
not starting from scratch. Trying to merge these two would 
divert attention. What is important is that we work together, 
both legislatively and going forward, to harmonize their work, 
and that is going to be our goal.
    And next, I recognize the gentleman from Alabama for 4 
minutes.
    Mr. Bachus. I thank the chairman.
    And we do have two gentlemen here with us, so I am not 
seeing double. I thank the chairman for convening the hearing.
    And as the chairman said, derivatives are an essential tool 
used by countless American companies to help them manage risk 
associated with doing business both at home and abroad. 
Derivatives allow companies to hedge against risk, deploy 
capital effectively, lower costs, and offer protection against 
fluctuating prices.
    There is nothing inherently wrong with derivatives. It is 
when they are abused. Congress must take steps to ensure 
increased transparency and enhance oversight of the derivatives 
market.
    However, any new regulation should not hamper the ability 
of businesses to control costs, manage risk, compete in the 
global marketplace, and create jobs.
    Last Friday, the chairman released draft derivatives 
legislation which represents a significant improvement over the 
proposal that the Obama Administration submitted to Congress in 
August. I commend him for that.
    The chairman's draft wisely omits provisions from the 
Administration's proposal which would have severely restricted 
access to the derivatives marketplace and had the effect of 
magnifying rather than mitigating systemic risk.
    However, while the chairman should be commented for 
addressing several of the serious flaws in the Administration's 
approach, there are a number of issues, I think, that still 
require careful attention.
    For example, the chairman's draft would still require that 
some over-the-counter products be shifted onto venues like 
clearinghouses and exchanges. I think he has acknowledged today 
that may not always be possible.
    The bill also calls on the regulators to classify some 
actors in the derivatives marketplace as major swap 
participants. This vague classification could force thousands 
of companies to divert millions of dollars of capital away from 
business investment for use as cash collateral. It seems 
counterintuitive during a recession, with unemployment 
approaching 10 percent, to leave companies exposed to greater 
risk, raise their cost to capital, and make economic recovery 
more difficult to achieve.
    Another potentially troublesome provision of the discussion 
draft, and the chairman discussed this, was prohibiting certain 
swap transactions. Restriction on credit default swap contracts 
limits the ability of investors to appropriately calculate risk 
as it has become apparent that CDS spreads are often a more 
accurate reflection of credit risk than credit ratings. There 
is nothing inherently wrong with credit default swaps. And even 
in the last year I think that has been confirmed. It is when 
they are abused, as in the case of subprime mortgage 
securities, which were improperly rated and underwritten, that 
problems arise. It was the subprime loans that made up the 
securitizations, not the credit default swaps themselves, that 
caused the problem.
    Mr. Chairman, as we move forward with regulatory reform, we 
should make every effort to strike the right balance between 
maintaining market stability and preserving useful innovations 
in the U.S. financial services industry. While the government 
certainly has a role in policing the derivative marketplace, it 
must be noted that there are private sector initiatives already 
under way to clear standardized derivative contracts and 
establish trade repositories that will furnish the information 
regulators and investors need to make informed judgments about 
potential systemic risk and counterparty exposures. Legislation 
in this area should seek to facilitate and, where appropriate, 
codify these market-based solutions while not subjecting U.S. 
companies that operate far from Wall Street to damaging new 
regulatory burden.
    I thank the chairman, and I welcome our two witnesses.
    The Chairman. The gentleman from North Carolina for 2 
minutes.
    Mr. Watt. Thank you, Mr. Chairman.
    And let me try to do two things in the 2 minutes I have. 
Number one is to applaud the Chair for this whole process that 
he is going through, because as he indicated, you can go down a 
road, and then you have to reevaluate, which is what the 
hearings do, and then you have to redraft. So I just think the 
process that we have been following is an entirely appropriate 
and thoughtful and meaningful process to get to the right 
balance.
    Number two, it is probably appropriate that I come after 
the ranking member here because I actually have some strong 
feelings on an issue that probably counter the ranking member's 
position, and I think that the most recent draft may have 
tilted us in a direction that is more contrary to what we are 
trying to achieve. And I specifically refer to the language on 
pages 27 and 28 of the chairman's most recent draft, discussion 
draft, where I think we have perhaps created a loophole that is 
way, way, way too big for major swap dealers and people who are 
engaged in major swap participants.
    So I think we need to look carefully at that language in 
particular, and I will be, as I go through this bill, am trying 
to do that in a responsible way, but remembering that our 
objective here was to create real transparency in this market, 
and we need to stay focused on doing that.
    The Chairman. The gentleman from Oklahoma. I am going to go 
to the gentleman from Oklahoma and the gentlewoman from 
Illinois, so we have equal amounts of time.
    The gentleman from Oklahoma for 1\1/2\ minutes.
    Mr. Lucas. Thank you, Mr. Chairman.
    Thank you for holding this hearing. I think the discussion 
draft the committee has before it today is an interesting next 
step in our review of the overall counterderivatives market. 
Since the Administration's proposal on this issue was published 
on August 11th, the end-user community has been constantly 
knocking on my door. As ranking member of the House Agriculture 
Committee, I listened to the testimony of the end-user 
community, the exchanges and the traders, when they appeared in 
front of that committee on September 17th. The common theme to 
the testimony was that the Administration's proposal 
overreached and would treat many bona fide hedgers as 
systematically risky financial institutions.
    Are there problems in the derivatives markets? Yes. What we 
cannot do is overreach or overregulate. If we do, the impact 
will be felt far beyond Wall Street and reach Main Street. It 
will cost jobs, economic development, and ultimately increase 
the prices consumers pay for energy, food, and manufactured 
goods.
    I am anxious to hear from our second panel today if this 
draft allows effective legitimate domestic risk management 
better than the Administration's proposal. And I am equally 
anxious to hear if our regulators still want to regulate 
everybody to avoid regulatory arbitrage or if they recognize 
the concerns that we shared when they appeared in front of the 
House Agriculture Committee that their approach will make risk 
management too expensive and increase prices and volatility.
    Mr. Chairman, we need to improve the safety and soundness 
of our financial regulation, but we cannot do it at the expense 
of economic development, increased prices, and job losses.
    Thank you, Mr. Chairman.
    The Chairman. The gentlewoman from Illinois for 1\1/2\ 
minutes.
    Mrs. Biggert. Thank you, Mr. Chairman.
    I think that the new draft has some troubling things in it. 
In its current form, I am afraid there is still a one-size-
fits-all approach to regulating derivatives and a ``Big 
Brother'' regulatory model that may stifle innovation, 
unnecessarily tie up capital, and see owners standards on 
businesses, exchanges, and clearinghouses.
    The bill doesn't seem like the right answer to reforming 
the OTC marketplace at a time when our feeble economy is trying 
to regain steam and at a time when we need businesses to use 
capital to invest in their businesses to grow and create jobs 
for Americans.
    We all know that there were abuses in the OTC markets. They 
must be addressed. But to my knowledge, when the entire 
financial system was on the verge of collapse last fall, the 
futures markets pulled through. This bill doesn't seem to, in a 
targeted approach, address those abuses, but rather considers 
all parties, anti-users as well as end-users as well as 
exchanges risky and treat them as such. Non-risky market 
participants may now unnecessarily have increased capital 
requirements, mandatory central clearing margin requirements, 
and product approval by bureaucrats in Washington.
    This doesn't seem like the right answer to managing risk 
and addressing abuses in the marketplace. We need robust 
competition, restored investor confidence, and healthier 
markets.
    I yield back.
    The Chairman. The gentleman from New York, Mr. McMahon.
    I would ask unanimous consent that Mr. McMahon be allowed 
to ask questions out of our 10 minutes.
    Is there any objection? I hear none. I thank the Minority 
for accommodating Mr. McMahon. Let me just say, while he is not 
a member of this committee because by the time he came to 
Congress, there was no room, and I must say, not to take away 
from anybody's time, I am glad that the Speaker finally 
recognized that there is some limit to the size of this 
committee. I think that she thought that we were infinite.
    So I regret Mr. McMahon not being able to join us, but I 
had to accept the principle.
    But Mr. McMahon is someone whose district is heavily 
involved in this, has some expertise, and that is why I asked 
that he be able to ask some questions.
    And I thank our colleagues on all sides for allowing it.
    The gentleman is recognized for 3 minutes.
    Mr. McMahon. Thank you, Chairman Frank, and Ranking Member 
Bachus, and all the members of the committee for allowing me to 
join you today at this very important hearing.
    I would also like to especially thank Chairman Frank and 
his dedicated staff for putting together this balanced 
discussion draft as an excellent starting point for our 
deliberations in working with my legislative director Jeff 
Siegel, who has done an outstanding job as well.
    I know I can speak for many of my colleagues and the new 
Democrats when I say that we look forward to working with you 
constructively to improve this draft in the days ahead.
    Although the regulation of derivatives is complex, this 
issue is extremely important to the proper functioning of our 
capital markets and to almost every business in America, and we 
need to get this right. We all know the effect of derivatives 
and what role they played in particular with the credit default 
swaps in the collapse of AIG and the broader credit crisis. 
Derivatives amplified the effects of the subprime mortgage 
crisis and the overleveraging of our economy.
    There is no doubt that we need much greater transparency 
and regulation of our derivative markets to be sure that we do 
not have to face another AIG-type collapse or spend billions of 
dollars bailing out companies for taking imprudent risks. But 
we must be sure that any new regulation is smart and rational 
regulation. We need to target any new rules to directly address 
the potential for systemic risk without needless imposing of 
regulations that could have unintended effects.
    Because derivatives are financial instruments that help all 
of us, they help keep our energy costs low and stable. They 
help insurance companies keep premiums low. They help companies 
complete construction projects on time and under budget. And 
despite the negative press and lack of understanding of the 
derivatives market, for the most part, the derivatives market 
works. We cannot throw the baby out with the bath water.
    We must work to protect the end-users, good American 
businesses that are just trying to manage their cash flows and 
hedge against uncertain risks beyond their control in a cost-
effective manner. We should work to require standardized trades 
between entities that pose systemic risk, swap dealers, and 
major swap participants to clear their trades. For products 
that are more unique, those should continue to be traded in the 
OTC markets but with higher margin and capital requirements for 
the big players.
    At the same time, we must increase transparency and 
disclosure requirements and grant regulators the authority to 
monitor these important markets for any sign of stress or 
overexposure. Our derivative markets need more regulation, but 
we also must be sure not to needlessly tie up capital or 
increase the cost of credit in ways that stifle economic growth 
or risk sending our financial services industry overseas, 
particularly important to the 80,000 people from my district in 
Staten Island and Brooklyn, New York, who work every day in the 
financial services industry.
    In this age of instant global capital flows, if the 
regulations are not carefully written, any poorly conceived 
rule here in Washington could have a dramatic impact on our 
economy.
    Mr. Chairman, I yield back the remainder of my time, and I 
again thank you for the honor of being here today.
    The Chairman. I thank the gentleman.
    He yielded minus 4 seconds.
    The gentleman from Texas is recognized for 1\1/2\ minutes.
    Mr. Hensarling. Thank you, Mr. Chairman.
    As I look at all the root causes of our economic turmoil, I 
haven't quite convinced myself that the derivatives market is 
among them.
    We all certainly know what happened to AIG's Financial 
Products Unit with the credit default swaps. I am sure not sure 
that wasn't a symptom as opposed to a cause.
    Now, clearly, their behavior in retrospect was reckless, 
and I for one do not agree that the taxpayer should have been 
asked to pick up the tab.
    Be that as it may, it is important to know as we go forward 
what the history is, and the history is that the relevant 
regulator did not lack regulatory authority. They may have 
lacked regulatory expertise, but they did not lack regulatory 
authority.
    Now, as we look at the new draft of the derivatives bill, I 
would like to commend the chairman for significantly improving 
the Administration's bill. It is only 10:20 in the morning, and 
I find myself in the unusual position of having agreed with my 
chairman 3 times now, and the day is early. It probably won't 
happen again any time soon.
    But, nonetheless, I think that it is important that all of 
us realize that ultimately derivatives have a very important 
function in our market. Many of us have received correspondence 
from the Coalition for Derivatives End-Users. I would like to 
quote from that letter, which includes 170 of the largest job 
creators in America, ``Business end-users rely on OTC 
derivatives to manage risk, including currency exchange, 
interest rates and commodity prices by insulating companies 
from risk; customize OTC derivatives; provide businesses with 
access to lower capital, enabling them to grow, make new 
investments and retain and create new jobs.'' We should be 
very, very loathe to ruin that.
    Thank you. I yield back.
    The Chairman. The gentleman's time has expired.
    And indeed, I would recommend that the gentleman take the 
rest of the day off.
    The gentleman from New Jersey is recognized for 1\1/2\ 
minutes.
    Mr. Garrett. I thank the Chair.
    When viewed in the context of the proposal that the 
Administration previously put forward, the chairman's 
discussion draft is basically an improvement in many respects.
    But when we review it in the broader context of exactly 
what problems we are trying to solve with several new layers of 
cumbersome bureaucracy over a huge part of the economy that has 
nothing to do with our financial troubles, the bill really does 
look less attractive.
    The bill sets up a dual regulatory regime with the CFTC and 
the SEC, two agencies that, quite frankly, have a poor record 
of working together. Not only that, we are essentially setting 
that up to be prudential regulators, something that they are 
not equipped to do and which the SEC has already failed at, 
over non-financial companies that really don't need this 
prudential regulation.
    So, to me, that is a fundamental flaw with a basic 
structure of the bill. Rather than certainty, there is a clumsy 
sort of multi-regulator approach to the derivative market that 
will breed widespread uncertainty, uncertainty that will reduce 
credit availability, hamper risk management, and cost jobs in 
the broader economy.
    And while end-users may think that the direction that the 
bill has headed from is better, this legislation will still set 
up a regime with the authority to propose mandatory 
requirements and capital that could have negative consequences 
on them in the end. There is also a mandatory clearing 
component that I fear could rush cooperative buy-side and sell-
side and regulatory effects to responsibly address the central 
clearing issue and could increase rather than decrease the 
potential for systemic risk in the process.
    I have other concerns as well, and I hope that this 
committee and the second panel as well can explore it further.
    Thank you. I yield back.
    The Chairman. We will now begin with our witnesses.
    We have the Chair of the Commodities Futures Trading 
Commission. And let me acknowledge, particularly in the 
presence of the ranking member of that committee, that the 
primary jurisdiction over this agency is in the Agriculture 
Committee.
    And I want to say I am very pleased because I think 
jurisdictional disputes are Congress at its worst. Egos and 
pettiness come out. We have worked very closely with the 
Agriculture Committee, that was in complete agreement, and I 
thank the gentleman for acknowledging that. We even had an 
unusual joint hearing on the subject. And we will continue to 
work with the Agriculture Committee because cooperation between 
our two committees, as between these two agencies, is essential 
if we are going to get this job done.
    Chairman Gensler.

 STATEMENT OF THE HONORABLE GARY GENSLER, CHAIRMAN, COMMODITY 
                   FUTURES TRADING COMMISSION

    Mr. Gensler. Thank you, Chairman Frank, Ranking Member 
Bachus, and members of the committee.
    I am pleased to testify today regarding OTC derivatives 
reform and the discussion draft. I also want to commend your 
staff, Mr. Chairman--David, Peter, Jeanne, Lawranne and others 
who have worked tirelessly on this, and I agree with that.
    AIG demonstrates the need for comprehensive regulatory 
reform. Every single taxpayer in this room, every member of 
this committee put money into that failed institution. Nearly 
$414 million per each of your congressional districts went into 
AIG.
    Now, I would like to address much-needed regulatory reform 
in the context of two principle goals: lowering risk for the 
American public; and promoting transparency of the markets.
    At the conclusion of last month's G-20 summit, President 
Obama and other heads of state made these two goals, lowering 
risk and promoting transparency, key. And I am just going to 
quote from that statement: ``All standardized OTC derivatives--
this is President Obama and 20 heads of state--all standardized 
OTC derivatives contracts should be traded on exchanges or 
electronic trading platforms where appropriate and cleared 
through central counterparties by end 2012 at the latest.''
    It is I think our challenge now, our challenge as an 
Administration and regulators and hopefully working with 
Congress, to achieve this goal. We need to lower risk in the 
system for the American public. That is going to require 
capital standards explicitly set for the large financial 
institutions. They already have capital, but we should be 
explicit about it: margins, so that we lower the risk with the 
counterparties; business conduct standards to make sure that 
boring stuff in the back office works; and, yes, importantly, 
centralized clearing on those products that can be cleared, 
still accommodating customized products, but central clearing 
is key.
    Transparency is the second key principle. And as we discuss 
proposals of OTC derivatives, I believe it is inherent that we 
get this right. But, first, strict recordkeeping and reporting 
requirements should be established and vigorously enforced. 
Second, that all noncleared transactions should be reported to 
a trade repository. Third, that the data on transaction should 
be available and aggregated for the public so the public can 
address an information deficit they have on these markets. But 
fourth, very critically, that standardized part of the market, 
those products that can be brought to an exchange or trading 
venue be moved onto these facilities so we have the same 
benefit that we have in the securities and futures markets of 
transparency. Every economist that looks at transparency, it 
benefits markets.
    I will just now briefly turn to six quick issues raised by 
the discussion draft. First, the discussion draft shifts the 
Administration's proposals presumption that all standardized 
derivatives be cleared to one where product will be cleared 
only if required by a market regulator and then puts the burden 
on the regulators to possibly do this contract-by-contract.
    Second, end-users' transactions should be brought to the 
central clearinghouse to lower risk. End-users should be 
allowed to enter into individualized credit arrangements with 
their financial institutions, but the Administration's proposal 
would still get the benefit of central clearing, again, only on 
the part of the transactions that can be cleared, not the 
customized transactions. We think if there is an end-user 
exception that Congress believes they need to endorse that it 
be very narrowly defined, as the chairman said, to address non-
financial entities that use swaps to hedge actual commercial 
risk as contrasted to financial entities.
    Third, the discussion draft widens an exception for major 
swap participants. It was the goal of the Administration bill 
to cover major swap participants. We are concerned that it may 
be an unintended consequence that swaps entered into for risk 
management purposes would not be covered and as thus the major 
swap participant category would be so narrowed inadvertently.
    Fourth, the discussion draft makes trading on regulated 
exchanges or regulated trading platforms available but not 
required. And as I said, I think that transparency is critical 
to the markets and for all of the end-users that have concerns 
elsewhere in the bill, this actually benefits end-users to have 
the transparency in pricing. I don't know why we would 
accommodate it, and it is natural that Wall Street might have a 
different view of this, but we are trying to recommend things 
that benefit Main Street and end-users who use these products.
    Fifth, U.S. regulators must work with international 
regulators to protect the American public. We just look forward 
to working with the committee to make sure that any efforts to 
accommodate foreign regulatory standards do not inadvertently 
permit market participants to shop for lax foreign regulators.
    And then, lastly, the discussion draft could inadvertently 
enable standardized agricultural swaps to be traded bilaterally 
off exchange. It does not impose the protections that we 
believe are necessary for the market.
    In addition to these points, we look forward to working 
with you in the next several days on other technical thoughts. 
We look forward to working with the SEC as well. Next week, we 
are going to be reporting on the request the President made 
that we look to harmonize our rules, and we look forward to 
making that available to this committee and Congress to help in 
these efforts.
    Thank you.
    [The prepared statement of Chairman Gensler can be found on 
page 106 of the appendix.]
    The Chairman. Thank you.
    Mr. Hu is the Director of the SEC's new Division of Risk, 
Strategy, and Financial Innovation.
    Mr. Hu?

 STATEMENT OF HENRY HU, DIRECTOR, DIVISION OF RISK, STRATEGY, 
    AND FINANCIAL INNOVATION, U.S. SECURITIES AND EXCHANGE 
                           COMMISSION

    Mr. Hu. Thank you, Mr. Chairman.
    Chairman Frank, Ranking Member Bachus, and members of the 
committee, thank you for the opportunity to testify on behalf 
of the Securities and Exchange Commission concerning the Over-
the-Counter Derivatives Markets Act of 2009 proposed in August 
by the Treasury Department, and the discussion draft recently 
circulated by the chairman.
    I am especially pleased to appear with CFTC Chairman Gary 
Gensler, with whom the SEC has worked closely over the last 
several months on a variety of issues. Both of our Commissions 
are eager to address these issues and ensure that remaining 
differences are justified by meaningful distinctions between 
markets and products.
    As you know, the recent financial crisis revealed serious 
weaknesses in the U.S. financial regulation, including gaps in 
the regulatory structure. Both the SEC and the CFTC are fully 
committed to filling gaps and shoring-up the regulatory system.
    One significant gap is the lack of regulation of OTC 
derivatives, which were largely excluded from the regulatory 
framework in 2000 by the Commodity Futures Modernization Act.
    OTC derivatives present a number of risks. They can 
facilitate significant leverage, enable concentrations of risk, 
and behave unexpectedly in times of crisis. And while some 
derivatives can reduce certain risks, they can also cause 
others.
    Importantly, these risks are heightened by the lack of 
regulatory oversight of dealers and other market participants--
a combination that can lead to insufficient capital, inadequate 
risk management standards, and associated failures cascading 
through the global financial system.
    Lastly, the largely unregulated derivatives market can also 
undermine the regulated securities and futures markets by 
luring participants to a less-regulated alternative.
    The discussion draft is an important step forward in 
improving transparency and establishing the necessary 
regulatory framework. While it would go a long way towards 
improving the regulation of OTC derivatives, I believe it 
should be strengthened in several ways.
    First, to minimize regulation arbitrage, swaps should be 
regulated like their underlying references. Market participants 
often view derivatives and the underlying assets they reference 
as substitutes. Whether the participation is direct or 
indirect, the same or similar economic effects can often be 
achieved.
    As a result, even subtle differences in the regulation of 
economic substitutes can lead to gaming advantages for any one 
participant. But that participant's regulatory arbitrage 
activity, and a general migration to the less-regulated 
derivatives markets, can undermine the interest of other 
participants, as well as everyone's interest in minimizing 
fraud and systemic risk. The easiest way to achieve this goal 
is to move over the existing securities regime to securities-
related swaps. If Congress decides to retain the bill's 
existing rulemaking framework, it should include these swaps 
within the definition of securities within the Federal 
securities laws. This will ensure that existing protections and 
authority can automatically flow through to these products. 
Exemptions could be provided where needed. I believe it is 
better to start from an existing framework for substantially 
similar products than to start from scratch not knowing what 
might be missed in some cross reference, not knowing what 
future financial innovation may bring.
    Second, it is essential that the legislation address anti-
fraud authority matters and provide the tools needed to 
appropriately enforce anti-fraud authority. The discussion 
draft seeks to retain certain existing anti-fraud authority 
over, for instance, certain broad-based swaps, but may have 
inadvertently weakened that authority over certain other 
related swaps.
    The SEC should also have the tools needed to effectively 
exercise the anti-fraud authority. The discussion draft 
recognizes the importance of inspections and examinations of 
swap dealers and major participants to the SEC. We recommend 
that this authority be extended to central counterparties and 
swap repositories, so that regulators can have quick access to 
comprehensive data.
    Third, the discussion draft should clarify that the 
definition of ``securities-based swap'' includes not only 
single and narrow-based credit default swaps but broad-based 
credit default swaps where payment is triggered by a single 
security or small group of securities.
    Fourth, the legislation should narrow the ``risk 
management'' exclusion for major swap participants. Regulation 
of major swap participants and dealers is a vital part of the 
OTC regulatory regime. We do understand that there may be 
entities that use swaps that should not fall into this new 
framework. The discussion draft, however, effectively provides 
an exclusion for major participants who hold positions, ``for 
risk management purposes.'' The term ``risk management'' is 
ambiguous and could cause a large number of important entities 
to fall outside this new regime.
    Finally, the legislation should direct regulators to adopt 
stronger business conduct rules to protect less sophisticated 
investors and end-users.
    In closing, this proposal makes significant strides towards 
addressing current problems in the OTC derivatives marketplace. 
I look forward to continuing to work with this committee, the 
Congress, the Treasury, and the CFTC to enact strong 
legislation in this area.
    Thank you for the opportunity to testify here today. I look 
forward to answering your questions.
    [The prepared statement of Mr. Hu can be found on page 147 
of the appendix.]
    The Chairman. Thank you.
    As I said, I think we appreciate and we are in agreement 
with much of what you say. There will be some disagreements. 
Let me start off with two points, though.
    Some of the points you make, Mr. Gensler and also Mr. Hu, 
you have to take them to the Agriculture Committee. For 
example, your proposal--your objection to the swaps between 
agriculture entities, it would be an intrusion on the 
jurisdiction of the Agriculture Committee, and we will be 
working on this together. We will be submitting our bill, and 
they will be offering some amendments. Where you were talking 
about a swap between agriculture entities, you have to take it 
to them.
    I have said that I think there is a presumption that we 
have jurisdiction over things that aren't edible, but they are 
certainly clearly in charge of the edible, not just that, but I 
guess tangible is a better way of putting it.
    So, secondly, Mr. Hu, I will say that some of your points 
similarly are jurisdictional issues between yourself and the 
CFTC. And that means between us and the Agriculture Committee. 
There are some substantive issues where I very much agree and a 
couple where I don't agree, but I do want to say, as I go 
through your points, some of them will have to go to the 
Agriculture Committee.
    For example, Mr. Gensler, your fourth point where you say 
the discussion draft makes trading on regulated exchanges or 
regulated trading available to swap dealers but not required. 
And then, again, that is covered in your sixth point, 
agriculture swaps. Let me put it this way, for agriculture 
swaps, you need to deal with the Agriculture Committee.
    On your fourth point, to the extent that we are dealing 
with swaps that are not agriculture, we would be inclined to 
agree with you. So points four and six, you will have to split 
those.
    Let me just go through a couple of the other points you 
make. On the question of clearing, no, we did not mean to have 
a presumption against clearing. I do think it is appropriate to 
have the presumption in favor of clearing, understanding when 
it doesn't happen, so we will work with you on that. And you 
should, I believe, have the authority to deal with a broad 
class of swaps, even under that presumption. And again, the two 
of you together. I assume this is one.
    Mr. Hu. We are good friends.
    The Chairman. That one point appears in both of your 
statements, so on that one, we are there.
    On the clearing requirements for end-users, you say you 
recommend that they all go to a clearinghouse. I don't think 
you are going to see that happen because of the response that 
many will have to the end-users. But at the bottom of the page, 
you say, ``To the extent that Congress decides not to follow 
this approach, any clearing exceptions for end-users should be 
very narrowly defined to only include non-financial entities 
that use swaps incidental to their business to hedge actual 
commercial risk.'' That is the essence of what we are trying to 
do. We will work with you to do this.
    But I do have one question. Obviously, when you mention 
insurance, people think of AIG, which was a major problem here. 
But is it possible to make a distinction between insurance qua 
insurance, and insurance companies that make so much money they 
won't get themselves in trouble? That is, we generally agree 
with this financial non-financial. But there is a definitional 
question about insurance. People who are in the business of 
selling insurance to policyholders, how would you classify them 
in this? Obviously, if an insurance company is engaging in non-
insurance-related transactions like AIG, they should not be 
exempted. But what about an insurance company that is selling 
life insurance or automobile insurance?
    Mr. Gensler. We would believe that insurance companies 
should be under, just like other financial firms and bring 
their standard product, not the customized product, but to the 
benefit of the clearinghouse.
    The Chairman. We will be working on that one, because there 
is I think some question that was there. And then both of you, 
I guess, had this issue. You worry that our exemption for risk 
management, that could be a huge loophole. I agree that it 
could be a loophole, and people want to make it one. I would 
hope you would work with us so that we could define risk 
management better, both substantively and procedurally. That 
is, we would define risk management, and you would be the 
primary deciders of that. And the fact that someone was doing 
something that met GAAP, we wouldn't be interfering with GAAP, 
but that would not be dispositive of the issue. They couldn't 
say, well, this is risk management according to GAAP, 
therefore, you guys mind your own business. Work with us on 
that, because, again, there is more common agreement here on 
the goal, and we would be able to deal with this.
    Finally, let me say, Mr. Gensler, you say market 
participants should only be exempt from American regulation 
where there has been a determination by U.S. regulators that 
the foreign regulatory scheme is comprehensible and comparable. 
Agreed, we will do that. So, as I said, I think we will 
probably still do more for end-users in terms of exemptions 
than you would like. But in almost every other case, we are in 
agreement, saving those where you are going to have to take it 
to the Agriculture people.
    Mr. Gensler. I thank the chairman for that quick review. If 
I could just comment on two of the points.
    On exchange trading, I take it that maybe we are closer 
together that we should mandate the benefits of either exchange 
or these execution facilities. Accommodating some transactions 
that are illiquid and too large can come to a mandate.
    The Chairman. Mandate is too strong a word. You talked 
about a presumption. There would be a presumption that they 
would be there, and you would have the ability to decide that. 
I don't know how you mandate them all, and then you say you 
can't mandate everything except for a few.
    Mr. Gensler. But to require those products that are able to 
be cleared--
    The Chairman. Yes, so burden of proof should be on those to 
show you that they can't be.
    Mr. Gensler. That those would not only have the benefit of 
clearing but also exchange trading or trading venues.
    The Chairman. Right.
    Mr. Hu?
    Mr. Hu. Chairman Frank, I truly welcome your remarks about 
the risk management exclusion.
    The Chairman. It is always nice to feel welcome, Mr. Hu.
    Mr. Hu. A Texas-size welcome. I really welcome it because--
    The Chairman. Okay. Since you agree, I can't take time to 
do that. Do you have any--
    Mr. Hu. Yes. In terms of the exclusion, we are calling for 
objective, narrow, and verifiable notions of ``risk 
management.''
    The Chairman. All right. We will deal with that. I am 
taking other people's time, and I can't do that. We have a 
conceptual agreement. We will work with you.
    The gentleman from New Jersey.
    Mr. Garrett. I thank the chairman.
    And I thank the members of the panel. The first question, I 
guess, is for both of you. On page 165 of the draft, it states 
that margin requirements for swaps set by the SEC and the CFTC 
for end-users shall provide for non-cash collateral, non-cash 
assets as collateral. The way I read this is it doesn't mean 
that they always have to do so, but they have some flexibility 
in there. Is that the way you read it? And if so, then how will 
you actually implement the use of those assets? And if not, do 
you have broader authority than that under this direct 
proposal?
    Mr. Gensler. We believe that in working with the committee, 
we can get this right, but that end-users should be able to 
enter into individual credit arrangements with the swap houses 
and the financial entities, and that would be allowed non-cash 
collateral in that regard. But that which could be cleared 
could still be brought to the clearinghouse and benefit from 
that lower risk.
    Mr. Hu. In terms of how we interpret this provision, as we 
understand it, this provision applies to dealers accepting non-
cash collateral. And in terms of non-cash collateral, it could 
be things like Treasury bills. Highly liquid matters could fall 
under that rubric. The provision does not, we understand, apply 
to clearinghouses. In terms of clearinghouses, we are hoping 
that, in fact, the requirement in terms of collateral would be 
involving a tighter rein by regulators.
    Mr. Garrett. Through the clearinghouse, then, what is the 
tighter range--what would potentially the clearinghouses be 
required to provide if not those assets? Would they require 
cash assets, cash?
    Mr. Hu. Well, we allow things like--
    Mr. Garrett. But could they--under the authority, could the 
circumstances be that it is not going to be non-cash assets, 
but they could actually have to require cash?
    Mr. Hu. In terms of our existing clearinghouses that the 
SEC regulates, we do allow things like money market funds and 
other kinds of liquid, high-quality assets.
    Mr. Garrett. And if those are required, could that not 
cause a deleterious effect upon the end-users at the end of the 
day? I know the end-users at this point feel, hey, we have been 
sort of carved out, and we are happy about this, but if the 
clearinghouse arrangement is not done in that particular 
manner, the authority is broad enough to actually require, that 
they may not be as scot-free in this as they think they may be?
    Mr. Hu. There are two possible ways in which those concerns 
are alleviated. First, the SEC historically has viewed 
clearinghouses as public utilities subject to heavy regulation 
to make sure that there is open access--and that the fees are 
reasonable and the other requirements are reasonable.
    The second way is that we really want to do everything we 
can to ensure the safety and soundness of clearinghouses, a 
central element to minimizing the AIG interconnectedness 
problem.
    Mr. Garrett. So it might take away from this, is that is 
going to be a paramount requirement and concern of you is the 
systemic risk aspect of the clearinghouses and their soundness 
of that, and so that will be--that would trump necessarily, 
under certain circumstances, potentially over the end-users 
situation.
    I only have a little bit of time. You also, Mr. Hu, spoke 
to the issue of trading swaps--I will use layman's terms--
trading swaps, basically, and implementation of the rules with 
the same manner and such as derivatives, right, in your opening 
statement.
    Mr. Hu. To have securities-related swaps being treated like 
securities would help simplify matters.
    Mr. Garrett. Does it simplify matters? In actuality, how 
does that actually play out in real life? Because under the 
rules that you would have to apply to them, can they basically 
implement them and carry them out in the same timely manner 
that you would necessarily do it with the swaps?
    Mr. Hu. Well, in terms of that issue, right now there is a 
distinction, for instance, between broad-based security-based 
swaps and narrowly-based security swaps. Broad-based security 
swaps basically fall under the jurisdiction of the CFTC, while 
security-based swaps and narrow-based security swaps fall under 
the jurisdiction of the SEC.
    We feel that because of the arbitrage possibilities from 
using two broad-based security-based swaps to get targeted 
exposure to a single company or a narrow group of companies, 
that it allows for easy gaming. By simplifying things to treat, 
for instance, all security-based swaps as securities and 
falling within the parameters of the Federal securities laws 
simplifies matters, reduces the possibility of gaming of gaps, 
and facilities more efficient responses.
    Mr. Gensler. We think that the Administration proposal and 
the discussion draft got this right, and it kept in line the 
27-year arrangement where broad-based indices and futures and 
derivatives on them are regulated by one. And the market 
regulator and the narrow-based are by the SEC. Of course, the 
chairman noted, we are two agencies, so there are boundaries.
    Mr. Hu. May I quickly respond to that?
    The Chairman. No. There is an interagency here. We will 
have to move on. I will have to tell the SEC, you are up 
against a pretty high hill if you have the Administration and 
the Agriculture Committee on one side.
    Mr. Garrett. And that is the uncertainty that I guess we 
are questioning.
    The Chairman. But it is certainly our responsibility to 
resolve it. The gentleman brought up an important issue.
    The gentleman from Pennsylvania.
    Mr. Kanjorski. Thank you, Mr. Chairman.
    First of all, allow me to congratulate Mr. Gensler and the 
SEC. You are certainly a lot closer than you were 2 months ago 
when we had our opening discussions as to what to do. I do have 
a question, and I guess the last question by Mr. Garrett really 
triggers it. What unresolved problems in the jurisdiction 
between the two agencies have not yet been resolved, and when 
will it be resolved?
    Mr. Gensler. We intend next week to report to the President 
and the Congress on a report of the gaps in our oversight. And 
in that, we will be having a series of recommendations, some 
related to enforcement matters, some related to product review, 
cross margining. It looks across the whole gamut of issues 
between our two regulatory approaches and makes 
recommendations, where appropriate, to Congress; some 
recommendations for ourselves in rule writing.
    Mr. Hu. On September 2nd and 3rd, the SEC and the CFTC held 
historic joint meetings to seek input from the public on the 
harmonization of regulation and futures. It was very 
successful, and there have been ongoing discussions on a wide 
range of matters, and the talks have been going very well.
    Mr. Kanjorski. Very good. All in all, looking at the 
discussion draft do you see anything so fundamentally offensive 
that you would not be supportive of its enactment into law?
    Mr. Gensler. Congressman Kanjorski, we look forward to 
working with this committee and Congress to enhance this 
important step. But as I highlighted, we do believe that the 
American public needs to benefit from the full transparency 
that comes from getting the standard part of this market onto 
trading platforms and exchanges. We do want to narrow this 
exception for major swap participants and in the presumptions 
that we talked about in the other areas in the testimony. We 
think those are important so that we cover this entire 
marketplace.
    Mr. Hu. We do think it is important in terms of the 
securities framework that it basically apply to substitutes, to 
economic substitutes. Otherwise the dangers of arbitrage and 
gaps occurring are too serious.
    Mr. Kanjorski. Very good.
    Mr. Chairman, I have had an opportunity to ask a lot of 
questions in the past. Let me yield back to the Chair so other 
members may have an opportunity.
    The Chairman. I thank the gentleman.
    And I apologize, I should have gone directly--I wasn't 
looking at my list--to the gentleman from Oklahoma who serves 
on this committee and is also the ranking member of the 
Agriculture Committee, and so he has been an important part of 
our trying with the gentleman from Georgia, Mr. Scott, and some 
others, Mr. Minnick, to try to make sure that our two 
committees are at least abreast of what each are doing.
    The gentleman from Oklahoma.
    Mr. Lucas. Thank you, Mr. Chairman, and I appreciate your 
observations, and I think we have very good working 
relationship, the House Agriculture Committee having passed an 
earlier attempt at this reform concept this year, and now 
Chairman Peterson indicates that we may well be addressing 
another series of hearings and potentially markups to have a 
companion bill.
    So, let me direct my first question to the Securities and 
Exchange Commission. SEC has had anti-fraud and anti-
manipulation jurisdiction over credit derivative markets since 
2000. Could you list for us, please, how many cases the SEC has 
brought and in what years those cases were initiated?
    Mr. Hu. There is one very important case going on right now 
that involves using credit derivatives for insider trading 
purposes--involving people who learned about certain 
restructuring events at a company and whom the SEC believes 
used credit default swaps as a way of betting on that 
particular transaction.
    One of the great things about this bill, relating to your 
question, is in terms of being able to bring more cases by 
being able to look more carefully at the transactions going on. 
There is a drastic increase in transparency flowing from the 
clearinghouses and the swap repositories. With this greater 
transparency, it would help us ensure a greater ability to 
detect market manipulation.
    Mr. Lucas. So, in the last 8 years, we have had how many 
cases brought?
    Mr. Hu. Congressman, I am afraid--
    Mr. Lucas. That you are aware of.
    Mr. Hu. Congressman, I am afraid I have been at the SEC all 
of 4 weeks, and I will have to get back to you and find out 
about the other cases.
    Mr. Lucas. Since we are talking about, in many cases, some 
substantial increase in enforcement authority, I think it would 
be fascinating to know how many have been brought under 
existing rules in a very complicated time, so I look forward to 
that, very much, to that response.
    Now, I address this to both of you. Looking at the way this 
draft proposal is crafted, tell me what kind of resource 
increases, both personnel and dollars, would you expect from an 
administrative perspective you will have to have to implement 
the language, assuming we ultimately come up with a bill very 
similar to this draft.
    Mr. Gensler. Congressman, it is good to see you in both 
committees. We will look forward to working with Congress, the 
appropriators on additional resources as I believe we will need 
that. We have not scaled it yet, but it is clear to us that we 
will need additional resources. And all I can commit to you is 
to work with this committee and the appropriators and the 
Agriculture Committee as the scope of this comes together over 
the next month or 6 weeks.
    Mr. Hu. There will be a material increase in resources that 
will be needed. Indeed, we at the SEC realize the need for 
expertise--real-world Wall Street expertise in terms of areas 
like credit derivatives and the like. And I personally have 
been involved in terms of recruitment efforts in that respect. 
And so with a wider jurisdiction over this previously 
unregulated market, there will be a corresponding increase in 
resources needed.
    Mr. Lucas. Just as the CFTC's primary focus are these 
issues all the time, I appreciate that greatly. I also realize 
that the Securities and Exchange Commission has a wide variety 
of responsibilities. Over the course of the last so many years, 
how many people have been committed at the SEC to doing this 
kind of work already within existing jurisdictions?
    Mr. Hu. In terms of specific numbers of people, I am afraid 
I will have to get back to you. I could tell you that in terms 
of these derivatives-related activities, they cut across 
Divisions. For instance, the Division of Trading and Markets 
has been very concerned in terms of certain derivatives issues 
and the Division of Enforcement in terms of insider trading. 
The Division of Investment Management has been concerned with 
mutual funds investing in derivatives and the like--we are 
seriously concerned about that issue and have asked an ABA 
subcommittee to look at those kinds of issues.
    The creation of this new Division is in part a reflection 
of the need to adopt a more integrated approach to thinking 
about the benefits and the costs associated with the 
derivatives revolution.
    Mr. Lucas. The reason I ask those questions, of course, is 
it appears that we will have another opportunity to visit about 
this in the Agriculture Committee in a few days, perhaps a few 
weeks. So preparing information in regards to both, I look 
forward--because after all, we are not just talking about 
expanding authority for both agencies and compelling you to 
work together; we are also reviewing how efficiently you have 
used the resources and the responsibilities you have already 
had. That is a key, I think, measure that needs to be taken.
    With that, thank you, Mr. Chairman. I yield back.
    The Chairman. The gentlewoman from California.
    Ms. Waters. Thank you very much, Mr. Chairman.
    Mr. Hu, I want you to help me understand something about 
credit default swaps. From everything that I have learned, I 
came to the conclusion that they should be banned. So I am very 
pleased that the chairman has included language which would 
allow the CFTC and the SEC to ban abusive swaps, including 
credit default swaps. However, I am concerned with the problem 
of what I have come to know and I understand of empty 
creditors. And let me read an article to you that was recently 
in Financial Times. There have been a lot of articles on this.
    ``The relationship between Goldman Sachs and ailing 
commercial lender CIT provides further evidence of the dangers 
of the credit default swap market. Credit default swaps have 
become an increasingly contentious issue in debt restructuring, 
such as one that CIT is now trying to complete. Many creditors 
who hold such insurance make more if a company files for 
Chapter 11 bankruptcy protection than they make on their debt 
if the company succeeds in restructuring its debt outside of 
bankruptcy. In the case of CIT, the market has bought more 
insurance than the company's $30 billion in debt. These holders 
include Goldman Sachs, which purchased such a credit protection 
to hedge against a June 2008 rescue financing of up to $3 
billion to CIT, Goldman said. Goldman also held other CIT debt, 
although the company declined to comment on these other 
exposures.''
    Now, we bailed out Goldman, and we bailed out AIG. We 
bailed out AIG to the tune of $100 billion, I believe. We--and 
it appears that they ended up paying Goldman about--I think 
about $13 billion. Now we see the CIT situation. How will the 
Commission be able to use this new authority to prevent empty 
creditors or lenders who are net short their own clients? Would 
the Commission need any additional statutory authority to 
address this problem, or does this bill provide you with enough 
tools to prevent empty creditors from triggering defaults and 
bankruptcies?
    Mr. Hu. In the interest of full disclosure, I am afraid I 
am the one who came up with the term ``empty creditors.'' In 
particular, the Goldman situation--CIT situation you referred 
to might be of the ``empty creditor with a negative economic 
interest'' variety. This variety poses particularly difficult 
issues relating directly to your broader question in terms of 
this anti-abuse provision.
    This anti-abuse provision appears for the first time in 
this bill in this discussion draft. The SEC is right now just 
starting to analyze this particular provision. And your 
particular example of the Goldman Sachs/CIT situation 
illustrates some of the questions we are thinking about and we 
are working our way through.
    For instance, this anti-abuse provision talks about 
watching out for products that destabilize the system or an 
individual market participant and possibly banning them. What 
if it turns out that something--a particular kind of swap--is 
beneficial to the system in the sense of allowing banks, for 
instance, to hedge against risks or financial institutions to 
make loans and so forth, and yet perhaps be harmful to a 
particular market participant? The bill's provision doesn't 
answer that. It also raises issues--difficult issues that we 
are starting to analyze--as to what extent should some of the 
benefits flowing from a particular product be balanced against 
the potentially destabilizing effects of the products?
    Naturally, these issues raise profound questions that we 
are starting to look at, and we will be engaging in many 
consultations with other concerned regulatory agencies. But you 
raise a very, very good issue, Congresswoman Waters.
    Ms. Waters. I yield back. Thank you very much.
    Mr. Watt. [presiding] The gentleman from Texas, Mr. 
Hensarling.
    Mr. Hensarling. Thank you, Mr. Chairman.
    I have no doubt that our derivatives market can be 
improved, made more competitive, made more transparent. But I 
usually ask myself a threshold question when proposals are put 
on the table, and that is, is the cure worse than the illness?
    I don't think we would be here today but for AIG. Again, I 
haven't convinced myself they weren't a symptom as opposed to a 
cause. But if you believe they are a cause, just to ensure what 
we are trying to protect against, are you gentlemen aware, were 
there other abuses in the derivatives market or other major 
economic players besides AIG that bring us here today?
    Mr. Gensler. Absolutely, Congressman. Derivatives are an 
unregulated marketplace, and we believe that the dealers, 
whether it was the affiliates of Lehman Brothers, the 
affiliates of Bear Stearns, or even the affiliates of the 
institutions that made it through last year with the support of 
the government--taxpayers supported a lot of institutions last 
year--many institutions used derivatives, significantly 
leveraged up their exposures to risk, and it did it in a 
nontransparent way. So what we are here about discussing is how 
do we lower risk to the American public, not just in AIG's 
case, but lower risk to the American public and also address 
information deficits? The public knows--
    Mr. Hensarling. I am sorry. Specifically, which companies 
do you view as abusing derivatives; and it was a derivative, or 
was it a problem with the underlying asset being residential 
real estate?
    Mr. Gensler. Derivatives allow for risks to be managed, 
managed well. But also in the aggregate, particularly in the 
books of many financial institutions, it also allows risks to 
be accumulated and large leveraged to--
    Mr. Hensarling. I understand that, but can you name 
specific companies?
    Mr. Gensler. I believe that in--many financial institutions 
have used derivatives to take on significantly extra risk, and 
so we are saying we need to bring this into the capital regime 
as a cushion, whether it is any of the remaining 15 large--
    Mr. Hensarling. Let me try asking a slightly different 
variation of the question. Are you aware, then, of any other 
major economic institution in the economy besides AIG that 
wrote credit default swaps without posting collateral to their 
counterparties?
    Mr. Gensler. Yes.
    Mr. Hensarling. Who?
    Mr. Gensler. We could go straight down the list of the 
large financial institutions, many of them that still exist 
today, and recall that of the first $90 billion that went into 
AIG, $60 billion went overseas to overseas institutions. It 
gives you a sense of how interconnected we are. The other $30 
billion went to many of the other financial--
    Mr. Hensarling. I understand that. That is the reason why 
many of us opposed that in the first place.
    We have had the head of OTS previously testify before this 
committee, that is the prudential regulator. They had the 
authority to rein in AIG's Financial Products Division with 
their credit default swaps. They simply missed it. They didn't 
lack the regulatory authority. Do either of you disagree with 
that testimony, which, by the way, was under oath?
    Mr. Hu. Congressman, to this question you just asked as 
well as the previous question, one of the key aspects of AIG, 
and, in a sense, of the involvement of other financial 
institutions and credit default swaps, is the whole issue of 
interconnectedness. When markets panic, they sometimes can 
freeze up. And part of what caused the financial problem and 
caused the intervention with respect to AIG subsequent to 
Lehman was the notion that this interconnectedness was 
spreading, that people were suddenly refusing to deal with each 
other and so forth. By having these clearinghouse arrangements 
so that in effect people don't really have to depend on--
    Mr. Hensarling. Forgive me for interrupting. I see my time 
is about to run out. With respect to interconnectedness, is it 
not possible that some type of mandatory clearing, is that not 
making us more interconnected? Is that not somehow centralizing 
the risk in one particular location? And if interconnectedness 
is a critical component of systemic risk, why aren't we 
arguing--
    Mr. Gensler. It actually lowers risk, because right now the 
large swap dealers, there are about 15, maybe generously 20, 
around the globe are also in the banking business, they are in 
the securities business, they are in the insurance business, 
and the leasing business and proprietary trading business, and 
they are central counterparties. AIG was a central 
counterparty, not a regulated clearinghouse.
    What we are trying to do is we are trying to separate out 
of the large financial houses this counterparty function 
regulated. I would daresay if this committee--if somebody came 
here and said, could the large central counterparties today 
that are regulated go into the leasing business, go into the 
banking business, go into the insurance business, you would 
say, no, no, no, we want to keep that separate and make sure 
that function is regulated and has the discipline of a daily 
marking to market, a daily accounting, a daily settling up. It 
is a harsh discipline in a sense, but it works in the futures 
industry, the largest clearinghouse there. It works well. It 
works in the options on securities, which is called the Options 
Clearing Corporation. It works very well, and it is separated 
out from banking securities and so forth, obviously, with great 
benefit.
    Mr. Watt. The gentleman's time has expired. And I recognize 
myself for 5 minutes.
    Mr. Gensler, I am going to zero in on the part of your 
testimony on page 10 that deals with exchange trading. And I 
know that you and the Chair have had an exchange about this 
earlier, but I want to be clear on where this is likely to 
lead. It seems to me that the Administration's draft dealt with 
this, and the discussion draft that has been circulated by the 
chairman now muddies the water. Is that your assessment? That 
seems to be what you are saying on page 10.
    Mr. Gensler. The Administration bill, which I fully 
support, requires that those products that can be cleared also 
have the benefit of either trading platforms, execution 
facilities or exchanges, and that benefits all these end-users 
that we have been talking about earlier on the clearing issue.
    Mr. Watt. And that would be--under the Administration's 
bill, swap dealers and major swap participants would be 
required to do a certain set of things, and then everybody else 
would not be, or would everybody be required to--
    Mr. Gensler. It requires all of the transactions that can 
be cleared and listed to be listed on these facilities. Now, 
some have raised the issue of what if there is not enough 
liquidity and so forth. And what we have recommended here in 
this testimony and look to work with this committee on is that 
through rulemaking the SEC and the CFTC, just as we do in 
futures and securities, would allow for certain block trading 
and certain transactions to happen, but still be less--
    Mr. Watt. But legislation won't accommodate the rulemaking. 
You can't make a rule that is inconsistent with the 
legislation.
    Mr. Gensler. That is right. The discussion draft does not 
allow for this. The discussion draft goes from requiring 
exchange transparency to just making it optional.
    Mr. Watt. Now, the thing that I wasn't clear on when I read 
this was whether this--this appeared to me to be as potentially 
a drafting error as opposed to a conscious decision. I don't 
want to put you in the position of deciding whether that--is 
this something that can be fairly easily corrected?
    Mr. Gensler. Absolutely. My compliments to the dedicated 
staff of this committee. This could very well just be an 
unintended consequence. But we think that, aligned with what 
President Obama and the heads of state laid out, that we should 
move towards the exchange and exchange venue transparency, get 
the benefits of the self-regulatory function, the trade 
affirmation function and all that goes on on these exchange and 
trading venues.
    Mr. Watt. So just changing it back to making it, at least 
for major swap dealers and major swap participants, mandatory, 
is there another category outside swap dealers and major swap 
participants for which it may be--there may be a different 
standard?
    Mr. Gensler. There is a benefit to end-users. If I can 
tease out--the end-user issue on clearing, which is a very real 
issue and we are all grappling together on that about posting 
margin and capital and so forth, is different than on the 
exchange side. It is all about transparency. This truly does 
benefit every small utility company, every small user of 
derivatives to have greater transparency. The only party that 
would naturally be opposed is Wall Street because they right 
now have the information advantage, and that is natural.
    Mr. Watt. Talk to us about some of the advantages of 
greater transparency outside Wall Street. I understand that 
some people on Wall Street would like to have that kind of 
advantage, but what are some of the advantages to greater 
transparency outside?
    Mr. Gensler. The advantages that economists for decades 
have noticed is that end-users then get the benefit of seeing 
that price discovery function. If you are a small hospital in 
any State, and you are thinking about hedging an interest rate 
risk, you can see what happened even a half an hour earlier on 
a standard interest rate hedging transaction.
    Mr. Watt. How does that compare, for example, with the kind 
of transparency that is currently available on a regular 
exchange?
    Mr. Gensler. Well, it would be very close to the 
transparency that you would see on the regulated securities, 
exchanges and regulated trading venues. There is also these 
alternative trading venues in the securities and in the futures 
world.
    Mr. Watt. Thank you.
    My time has expired, and the gentleman Mr.--let me see who 
is next--Mr. Castle, I think, is next.
    Mr. Castle. Thank you, Mr. Chairman.
    I am impressed by the testimony of both of you and the work 
you have done on this, including this committee and the 
Agriculture Committee, which has been referenced. And I just 
want to get confirmation from you. I assume that you are--this 
is a positive question, not a negative question. You are 
working together with respect to the various recommendations 
which you are working on. I don't see a lot of space between 
you, and I would assume that is the case, and you are working 
jointly with this committee and the Agriculture Committee; you 
are not setting one off against the other is my assumption, 
based on what I am hearing.
    Mr. Gensler. I thank you for that, Representative Castle, 
and I believe that would be the case at the staff and 
Commission and Chair levels.
    Mr. Castle. Let me ask you this, Mr. Gensler. You mentioned 
earlier in your testimony the need for explicit capital 
standards. And I am not enough of an expert to perhaps even ask 
the right question, but I am worried about the liquidity in all 
of this. Capital is one thing, but sometimes there is capital 
without liquidity. Is that a factor that is taken into 
consideration, or am I not understanding it correctly in terms 
of the capital versus liquidity needs and trading 
circumstances?
    Mr. Gensler. Liquidity is fundamental to markets and 
fundamental to all the users of these products. Capital is that 
the financial institutions that hold themselves out to the 
public as dealers have sufficient shock absorbers, so to speak, 
in their business.
    One of the key assumptions to regulation is that we were 
regulating the large financial institutions, and I truly 
believe the financial regulatory system failed the American 
public. So that is why we are recommending that it has to be 
more explicit in writing rules about the capital. These large 
financial institutions already were supposed to have capital 
for their derivatives business; not AIG, but the others, so to 
speak. We think that is just more transparent, go through the 
usual Administrative Procedures Act and have real explicit 
rules on the capital on these products.
    Mr. Castle. Thank you.
    Like everybody here, and I think you are addressing these 
issues, I obviously believe we need greater transparency and 
accountability of OTC derivatives, but there are--and we all 
know this--users out there who are concerned that implementing 
these reforms will limit the use of derivatives as a way to 
manage risk because margin capital requirements to participate 
in these deals may be too costly. And I think I am referring 
mostly to entities that use the trade and these various 
derivatives for business, or whatever it may be. So there is 
some legitimate concern about that. Have you addressed--have we 
addressed this in the legislation, and are you taking this into 
consideration as you comment on this?
    Mr. Gensler. We are concerned that we get this right, the 
balance is right, and what we suggested is that the end-users 
be allowed to enter into their own individual credit 
arrangements with the financial institutions so that the 
financial institutions still bring the transactions to central 
clearing. However, if Congress doesn't accept that approach, we 
think that we would want to work with this committee and 
Congress just to make sure it is a very narrow exception for 
end-users that are non-financial institutions that are using 
swaps not--they are incidental to the business, and it is to 
hedge particular commercial risk.
    I should note this is only really a debate about the 
standard or clearable contracts, because all the end-users, 
appropriately the Administration, the CFTC support, should be 
able to enter into tailored or customized products for their 
particular risks.
    Mr. Hu. I should emphasize that one of the key ways we want 
to protect end-users is to make sure that the clearinghouses 
don't overcharge. So what we have done historically in terms of 
ensuring that is to, in fact, refuse to tie a particular 
exchange to a particular clearing service. So the result is 
that we have a single stock or a similar product trading across 
multiple exchanges cleared through one entity, and that has 
really redounded to the benefit of the investors. So this 
public utility model of clearinghouses, we think, is very 
important.
    A second aspect in terms of protecting end-users, I think, 
is that while central clearing and exchange trading are both 
worthy goals, worthy to think about in terms of improving 
transparency and the like, but in terms of making exchange 
trading mandatory, historically in terms of the securities 
laws, we don't require mandatory exchange trading. We have 
alternative trading systems to stock exchanges and the like, 
and study after study have shown they have made things more 
efficient for the investors.
    The Chairman. The gentleman from California.
    Mr. Sherman. Thank you, Mr. Chairman.
    We have had quite a number of regulators sit where you 
gentleman are. Now, every time I hear from regulators, they 
always want to regulate. They never want to abolish the actual 
activity that would eliminate the need for regulation. We have 
a $592 trillion over-the-counter derivatives industry. This 
makes all of Las Vegas seem like a single grain of sand. For 
the most part, as far as I can tell, most of these derivatives 
are just gambling contracts. There is no airline hedging 
against increases in fuel costs. There is just somebody who 
thinks they can make money that day by betting on airline fuel.
    The question--one of the reasons this casino grew so large 
is that those who are betting believed that if the individual 
casino got in trouble, the Federal Government would be there to 
bail them out with regard--there is substantial possibility of 
that. Those who bet at the Lehman Brothers casino were wrong; 
those who bet at the much larger AIG casino turned out to be 
right and haven't lost a penny.
    The question is can the over-the-counter derivatives 
industry work without an implicit possible--because we saw 
sometimes it is there, sometimes it is not--Federal guarantee? 
If, for example, Congress did not adopt section 1204 of the 
Treasury proposal and did not provide a mechanism by which the 
Federal Government could come in with hundreds of billions of 
dollars and bail out one of these casinos, what harm would 
there be to the economic institution and to over-the-counter 
derivatives industry?
    Mr. Gensler. Congressman, if I--I apologize. If you can 
remind me of section 1204?
    Mr. Sherman. Section 1204 is the mechanism by which the 
Executive Branch can lend unlimited amounts of money or make 
unlimited investments in any systemically important--which 
really means top 20--financial institution.
    Mr. Gensler. I thank you.
    We believe that it is really important to separate out this 
central counterparty function from these large financial 
institutions precisely for the reason that you just raised, 
that they are so large that there is this moral hazard issue of 
where is the government, what is the government's role in those 
institutions. So in separating them out, in central 
counterparties that are fully regulated and have to take an 
accounting on a daily basis, have to have collateral posted, 
and it is separated from a lending business, separated from an 
insurance or securities or proprietary trading business, we 
firmly believe that lowers--
    Mr. Sherman. If we separate it out, do you have a system 
that will work without a section 1204, without an implicit 
Federal contingent guarantee?
    Mr. Gensler. I think separated out, the central 
counterparties should be rigorously regulated and have to have 
the posting of that daily collateral.
    Mr. Sherman. Sir, I have a limited amount of time.
    Mr. Gensler. It might be better to avoid the moral hazard.
    The Chairman. The chairman yields--it is the Member's time.
    Mr. Sherman. Will your system work if Congress makes it 
clear that there is no implicit guarantee? Do you need that 
guarantee to make it work?
    Mr. Gensler. On the central counterparties, I don't think 
so, sir.
    Mr. Sherman. So if we were to go with your system and 
prohibit or at least not provide for future Federal bailout, 
the system would still achieve its economic purpose?
    Mr. Gensler. I am referring to just solely the central 
counterparty clearinghouses.
    Mr. Sherman. What about the rest of the over-the-counter 
derivatives industry? Mr. Hu?
    Mr. Hu. The chances of needing this kind of emergency 
backup are so reduced with just fishbowl or a series of 
fishbowls that we are creating, simple activities that we look 
at--
    Mr. Sherman. Mr. Hu, will it work without a code section 
that provides for this admittedly rare Federal bailout 
possibility?
    Mr. Hu. That would call for analysis that we would have to 
do.
    Mr. Sherman. I look forward to your analysis. Thank you.
    The Chairman. The gentleman from New York, Mr. Meeks.
    Mr. Meeks. Thank you, Mr. Chairman. First, I want to 
commend you, Mr. Chairman, for trying to bring far greater 
clarity to many of the definitions of parties, instruments, and 
practices.
    I think the discussion draft brings back the focus to 
systemic risk, which I think is tremendously important. And, 
for example, I think the provision of a clear exemption from 
most of the new requirements for end-users and hedgers who use 
derivatives primarily for operational risk management. Though 
we need to be cautious about this, because we don't want to 
create all these loopholes, it is important, however, for us to 
be reasonable and responsible to require end-users who pose no 
systemic risk and who do the right thing by hedging business 
risks they don't control to be subject to the same capital or 
margin requirements as financial institutions and market makers 
who are, in fact, systemically significant institutions.
    Secondly, I think it was also important that we bring the 
focus back on proper capitalization and margining of trades by 
major players and by putting the responsibility of evaluating 
the appropriate level of capital and margin to a given market 
participant's functional regulator. Again, this brings the 
focus back to systemic risk by addressing issues of leverage 
and safety and soundness.
    And third, that other forms of collateral be held by 
independent third-party custodians, which is critical, I 
believe, in protecting the system from some critical abuses as 
identified in the past year.
    And lastly, how we deal with--and I have been talking about 
this a lot--international transactions, how they will be dealt 
with, and the criteria which--and a process by which certain 
international players may be excluded if they pose a systemic 
risk.
    However, there are still a few things that I think are out 
there that we need to--and I would like to get your opinions on 
this. I think we need more clarity. They include the degree of 
independence and competitiveness of clearinghouses which may be 
subject to natural monopolies, and which may have the power to 
skew the competitive playing field in their favor, particularly 
if they are predominantly owned by dealer banks.
    The other area of concern I think that we need to keep a 
close eye on, and I would like to get your opinion on that, is 
how our new regulations encourage continued innovation and 
competition in this space. Specifically, with new powers given 
to many regulators, particularly the SEC and the CFTC, it would 
be critical, I think, to hold them to a higher standard of 
efficiency and responsiveness. I would like to get your opinion 
on that.
    Mr. Gensler. If I may, we agree with the goal of promoting 
competition on exchanges, on trading venues and on 
clearinghouses. What we have proposed is: the clearinghouses be 
open and accept transactions from any of the exchange venues, 
and I believe that was included in the discussion draft that we 
have some technical things just to make it nondiscriminatory; 
second, that the clearinghouses be open in membership, that 
they allow some of the nonswap dealers in as long as they meet 
the membership requirements of these clearinghouses; and third, 
that the governance be opened, and that governance not just be 
controlled--as you suggest you would want to avoid as well--
controlled by the dealer community, to help promote 
competition.
    Working with this committee, we could also work on rules to 
make sure, as Mr. Hu said, that the clearinghouses couldn't 
just demand such charges for their central clearing because of 
the concerns you say they might naturally end up being single 
entities.
    Mr. Hu. Congressman, you raise excellent questions. The SEC 
has historically emphasized very much the public utility model 
as to clearinghouses so that we actually expect fair 
representation of people who use these clearinghouses so that 
there is active involvement in terms of making sure that the 
fees are not exorbitant, that they don't unfairly burden 
people. And we have set up this model to prevent exchanges from 
controlling clearinghouses. We believe that is an essential 
element as well.
    In terms of innovation, competition, the discussion draft 
Treasury proposal recognized both the benefits of financial 
innovation and some of the costs. And in terms of this balance, 
these are issues that the CFTC and the SEC, together with this 
committee and other committees, will work closely on.
    Mr. Meeks. Thank you.
    The Chairman. The gentleman from California, Mr. Royce.
    Mr. Royce. Thank you, Mr. Chairman.
    It appears that questions surrounding the idea of a central 
counterparty still remain, and one of those is the argument 
that some economists make, and it basically goes like this. 
They say by inserting this third party into the mix, you end up 
concentrating the credit risk, and, of course, you weaken the 
due diligence that would otherwise exist among the 
counterparties. The line of argument they make, and I would 
like to hear your response to this, is that while central 
counterparties do not have market risk, they do have the credit 
risk to their members. So it appears that the central 
counterparty idea presents a tradeoff between the benefits of 
economies of scale and the concentration of credit risk in the 
central counterparty.
    So the way it is portrayed by economists is the central 
counterparty would become systemically significant and thereby 
will be perceived probably as being ``too-big-to-fail.'' And if 
the central counterparties' capital and the additional capital 
it can raise by making capital calls on its members are 
insufficient to cover losses from defaulting members, then who 
will bail out the central counterparty? That becomes sort of 
the moral hazard problem that might result. Who is the lender 
of last resort, especially when you consider a multinational 
central counterparty?
    Do you think there is justification in that concern? Does 
that erode market discipline and due diligence? Do you think 
there is an argument there?
    Mr. Gensler. Congressman, we currently have central 
counterparties that are called Wall Street financial 
institutions. Generally, there are about 15 around the globe. 
There are 5 major ones right now that are 80 to 90 percent of 
these markets. And they are not being regulated to lower risk 
as central counterparties, they are being regulated as banks 
and securities firms.
    So we think we need to separate out that which we can, put 
it into central clearinghouses that are regulated, only the 
product that can be cleared, that has enough liquidity, and 
then you get the benefit of lowering risk, because there is a 
daily accounting, there is a daily settling up where collateral 
is posted, and we truly actually are addressing the same issue 
those economists you referred to are trying to address, but 
trying to lower risk, because right now we have a very highly 
concentrated financial industry, but we are not regulating this 
activity separately.
    Mr. Royce. Yes, Mr. Hu?
    Mr. Hu. I agree with those. In addition, one of the central 
points I want to emphasize is that these big derivatives 
dealers are engaged in a tremendously wide-ranging set of 
activities, everything from merchant banking to insurance to 
all manner of activities, much of which may not be transparent. 
With clearinghouses, in addition to these really tight 
controls, daily controls, you have a tightly limited set of 
activities. So it becomes much easier to make sure that they 
have the right capital and so forth. It is a much simpler 
regulatory task.
    Mr. Royce. Let me ask you the other half of that equation, 
because the other part of the concern with that is the 
weakening of due diligence among the members of a central 
counterparty. If by definition, the central counterparty then 
absorbs the counterparty risk of its members, will this 
structure encourage the outsourcing of due diligence by the 
members of the central counterparty? And I will give you an 
example.
    We saw with the rating agencies the outsourcing of due 
diligence, right, and the outsourcing to institutions that were 
perceived to have superior knowledge. And we saw that was a 
mistake which could result in unintended consequences. Do you 
think that humans could make the same error here in judgment?
    Mr. Gensler. Humans definitely are prone to make similar 
errors, I concur with that. What this replaces it with is 
rather than another judgment on credit risk, it replaces it 
with the discipline of actually doing a daily accounting and a 
daily settling up with margin. So that is the replacement 
rather than just unsecured exposures.
    Mr. Hu. Two differences. One is that in contrast to merely 
doing due diligence in terms of other counterparties--that is, 
that one bank trying to figure out whether another bank is 
reliable, here we have government actually coming in and 
saying, you have to do ``X,'' ``Y,'' and ``Z.'' So it goes 
beyond just the screening, informational element. Very 
important.
    The second issue involves flipping it around. We are 
talking about reducing burdens to end-users and the like, those 
who use these products that are on clearinghouses. Flipping it 
around--if you have assurance that, in fact, the central 
clearinghouses worked, you don't need to spend money 
investigating.
    The Chairman. Thank you.
    The gentleman from Kansas.
    Mr. Moore of Kansas. Thank you, Mr. Chairman.
    Chairman Gensler, I know you are a proponent for mandatory 
exchange trading. There are benefits to exchange trading, but I 
have heard from some end-users, not Wall Street bankers, but a 
number of small businesses and even Kansas farmers who say 
custom derivatives provide a useful tool to hedge risks.
    I am also concerned about mandatory exchange tradings, a 
blunt instrument, when strong incentives can drive derivative 
trading to clearinghouses and exchanges. So at a time when 
credit remains tight and business activities restrained, 
Chairman Gensler, do you have any concern that mandatory 
exchange trading could slow the economic recovery underway?
    Let me ask one more thing, too. Might it have a negative 
impact on end-users that have used derivatives in a responsible 
way?
    Mr. Gensler. I think it is a positive for end-users and a 
positive for this recovering economy, because it brings 
transparency and still allows, exactly as you said, the 
customized product--we are not talking about the customized 
product, but that which is standard in these markets, which, 
depending upon estimates, is between 50 and 80 percent of the 
market, still leaving a very large part of customization. But 
that 50 to 80 percent would be either on exchanges or on 
trading venues--people have different words for that--but 
alternative trading platforms, and then it would be very 
positive for the end-users to get that transparency and 
benefit. Even if it is a few basis points, it is large for the 
economy and for the end-users.
    Mr. Moore of Kansas. Mr. Hu, what are your views on the 
potential effect of mandatory exchange trading, sir?
    Mr. Hu. We differ slightly from Chairman Gensler as to the 
mandatory exchange trading as distinguished from the 
clearinghouse arrangements. We believe that clearinghouse 
arrangements will get you a lot of the transparency and other 
benefits associated with the two.
    And in terms of the burdens on end-users, we believe that 
the enhanced transparency and the standardization of a lot of 
these swaps that the end-users will be relying on may in some 
ways reduce costs, in some circumstances, for end-users.
    Mr. Moore of Kansas. Thank you.
    And, Mr. Hu, something to remember as we consider 
derivatives regulation is that we are not legislating in a 
vacuum, and this is part of a broader regulatory reform 
package. I believe there are some items related to municipal 
swaps that should clearly remain under the jurisdiction of the 
SEC in order to be covered by the increased protections for 
many securities and advisors that are coming out of the SEC and 
other parts of regulatory reform. But what are your thoughts on 
the unique nature of municipal finance that often require their 
contracts to be more customized?
    Mr. Hu. In terms of how municipalities most directly relate 
to this bill and these customized products, I think it has been 
the area of business conduct. And so one of the areas that we 
think may be appropriate would be, in fact, enhancing the 
business conduct requirements with respect to less 
sophisticated participants, some of whom may be municipalities. 
We have real concerns about that. We have seen issues involving 
municipalities and their derivatives activities that concern 
us.
    Mr. Moore of Kansas. Thank you, sir.
    Mr. Chairman, I yield back.
    The Chairman. The gentleman from California, Mr. Baca.
    Mr. Baca. Thank you, Mr. Chairman.
    Mr. Gensler, when you testified before this committee in 
July, I addressed my concerns about the initial transfer of the 
standardized derivatives into the clearinghouse. There was a 
proposal that initially a few clearinghouses will compete to 
carry these products. I was concerned, however, that this may 
create a conflict of interest similar to what we have 
experienced in the credit rating agencies. The discussion draft 
now calls for the Federal regulators to determine whether these 
derivative products are standardized enough to go into the 
clearing mechanism. In your mind, would this change eliminate 
any possibility of conflict to exist, or are more safeguards 
needed?
    Mr. Gensler. Congressman, I concur with you that we need to 
ensure that the clearinghouses, through that conflict, don't 
force things in that ought not be there, and there should be 
strong oversight of that process. Working with this committee, 
though, we look forward to making sure that the presumption 
still is if it can be cleared, it would be in the 
clearinghouse. But I think that we can get this right working 
with your staff.
    Mr. Baca. So this would eliminate some of the conflict of 
interest or not?
    Mr. Gensler. I think that the regulator should have 
oversight with regard to it, but that on a first order, the 
clearinghouses should determine under their risk management 
guidelines which contracts are clearable. Also, we would not 
want the burden to go the other way, that we force something 
into a clearinghouse that they can't properly risk manage.
    Mr. Baca. Mr. Hu?
    Mr. Hu. One thing we appreciate about this discussion draft 
is the ability for the regulators to help determine what should 
be cleared or not. This way, there is greater likelihood that, 
in fact, the particular clearinghouse meets the needs of the 
end-users and other participants. It is a more regulated 
process rather than the automatic--the much more presumptive 
approach of the Treasury bill.
    Mr. Baca. Thank you.
    In continuation, the discussion draft proposes a joint 
rulemaking between the CFTC and the SEC, and, Mr. Hu, in your 
testimony, you expressed concerns over his proposal. Instead of 
referring to Congress to include definitions in the 
legislation, if the SEC and the CFTC officials are supposed to 
be experts in these matters, in regulating the abuse, wouldn't 
it be best interest to agree on definitions rather than 
Congress so this way you don't wash your hands? And can you 
comment on why you think this legislation is a better or more 
effective approach?
    Mr. Hu. I think perhaps an illustration may be helpful in 
terms of answering this question.
    Right now, in terms of the world of security-based swaps, 
those based on broad-based swaps basically fall within the 
Commodity Futures Trading Commission's jurisdiction. The 
narrow-based securities-based swaps fall within the SEC's 
jurisdiction.
    In fact, in the real world, with clever hedge funds and 
others, you can use two different credit default swaps, or two 
different security-based swaps involving broad-based indices, 
to get very targeted exposure.
    So you might have a system where, in effect, one falls 
within securities law and pure securities law considerations 
apply. The other may deal with exactly the same kind of 
concerns and yet be subject to a wider range of perspectives. 
So you may end up with gaps between the two approaches. And 
this is one of the reasons why we think that close economic 
substitutes ought to be treated the same.
    Mr. Baca. Thank you. I yield back the balance of my time.
    The Chairman. The gentleman from Georgia, Mr. Scott.
    Mr. Scott. Thank you, Mr. Chairman. And welcome to the 
committee.
    I first want to thank you, Chairman Frank, for listening to 
some of our concerns earlier on and responding in a very 
positive way with the new draft bill for the increased clearing 
flexibility for end-users and the situation regarding our 
foreign board of trade by linking them to U.S. contracts. I 
still remain somewhat concerned about not overregulating 
foreign boards of trade, and being wary that they could, and it 
might invite retaliation by foreign regulators. I think that is 
something we should keep our eye on. I certainly want to 
commend you for that and also for--I appreciate your concerns 
and your response by exempting end-users of derivatives from 
the clearing capital and margin requirements.
    But my understanding is that the bill still mandates 
capital requirements for non-financial dealers, which could 
very well drive non-bank dealers out of the over-the-counter 
derivative market and end up concentrating a tremendous amount 
of power in the hands of the large banks. So, Mr. Gensler, 
could you comment on that? Are you somewhat concerned about the 
concentration of over-the-counter swap dealer markets, and do 
you believe that we ought to be concerned here in Congress that 
some of the proposals like capital requirements for non-
financial dealers will give large banks, which already control 
90 percent of this market, even more power? Is that a healthy 
thing?
    Mr. Gensler. I share the Congressman's view that there is a 
highly concentrated market here, and probably 5 or 10 years 
from now, it will be even more concentrated. This happens in 
the airline and other industries as well.
    But I do think on the non-bank dealers, people holding 
themselves out in dealing in these, that there is an 
appropriateness to have capital; that we don't want to have 
something outside the system. These are generally in the 
commodity swaps area, the oil and natural gas and commodity 
areas, and many of them have capital. It is not to be 
additional capital, what they currently have, but just to make 
sure they have a minimum amount of capital if they are holding 
themselves out and making markets in these commodity swaps or 
other swaps as a non-bank dealer.
    Mr. Scott. But are you worried that it may drive some of 
them out of the market, thereby lessening transparency?
    Mr. Gensler. Our concern is overall to lower risk in the 
system and enhance transparency, to promote the competition 
that you, too, as well want. But we want to ensure that there 
then wouldn't be some regulatory arbitrage that a non-bank 
could have zero capital and all the banks have to have capital. 
So we do think it is appropriate to have some minimum amount of 
capital if you are holding yourself out to the public as a 
dealer. This is the dealers themselves. And that is generally 
only in, as I said, the energy commodity swaps.
    Mr. Scott. Yes, Mr. Hu?
    Mr. Hu. In terms of your specific point about perhaps 
driving business abroad, one of the things that helps is the 
extensive financial coordination going on right now: the OTC 
Derivatives Regulators Forum, IOSCO--indeed, Chairman Schapiro 
is at an IOSCO meeting in Switzerland today--the Over-the-
Counter Derivative Supervisors Group. And among the reforms 
that have been discussed are things like standardized clearing, 
encouraging trading on exchanges, a lot of the same kinds of 
things that are going on here. So the international 
coordination should help a lot.
    Mr. Scott. Going back to you for a minute, how would the 
CFTC plan to implement and structure capital requirements for 
non-financial dealers so that we do not create a bank-
monopolized over-the-counter derivative market?
    Mr. Gensler. Similar in some regards to what we do 
overseeing futures commissions merchants, we work with other 
prudential regulators to look at their capital regimes. Where 
they are regulated by somebody else, we generally have lower 
regimes at the CFTC than the Federal Reserve or the SEC. I 
would envision it would be very similar to that, and we would 
allow the capital they have in their business--it could be in 
oil and gas reserves, it could be elsewhere--but just at the 
minimum. It doesn't have to be liquid capital.
    Mr. Scott. I yield back. Thank you again, Mr. Chairman, 
for--
    The Chairman. The gentleman from California, Mr. Campbell.
    Mr. Campbell. Thank you, Mr. Chairman. I will apologize in 
advance since I missed part of this hearing. If these questions 
have been asked, or some of this, I will apologize in advance.
    But if we talk about the standardized clearing and so 
forth, and then the custom products, which is what I am hearing 
you call them, either in your opinion or under the discussion 
draft, other than transparency, would there be any limitations 
to the creation of and marketing of customized products, either 
ones that we currently see or ones that haven't yet been 
developed?
    Mr. Gensler. We believe that the legislation should cover 
all of the products, but allow for hedgers to hedge risk, and 
even if they are tailored in particular and customized, so that 
they would be able to innovate, and that is part of our 
important risk management in our economy.
    Mr. Campbell. Mr. Hu?
    Mr. Hu. The financial innovation process is critical not 
only for this country, but the financial services industry and 
the social wellbeing. This bill does not stop that; it controls 
it. It tries to confine it so that the externalities of these 
kind of activities are severely limited.
    Mr. Campbell. Let us get to that, because homogenizing 
derivative products is not an easy thing. Obviously, everyone 
even in the bond market you haven't been able to homogenize and 
make an exchange trade and so forth. How much would fit in this 
standardized? How much homogenization is there going to be? And 
is there, then, incentive for me to create products that do not 
homogenize, because even though there is transparency, there 
can be more margins in something that is outside of this--well, 
not exchange, but outside of this clearing than would be inside 
the clearing?
    Mr. Gensler. Well, I was going to say it depends on the 
market today, but in the rates-based various estimates, close 
to 80 percent of the market is already standard in some regard. 
In the commodity and the credit default space, it is lower, but 
still probably 60 or 70 percent. These is anecdotal evidence of 
that. But we are not trying to homogenize the other 20 to 40 
percent. There is no goal in the Administration proposal or in 
the discussion draft to do that.
    Mr. Hu. The standard process of modern financial innovation 
involves the OTC derivatives market as being the hothouse for 
financial innovation. The weird products basically appear there 
first, the newest products, and they migrate. They get 
standardized. So right now interest rate swaps are highly, 
highly commoditized. Back in the 1980's, hardly so. You 
sometimes still had to argue about documentation. There is a 
process.
    Mr. Campbell. Okay. So you are saying that 60 to 80 percent 
of the market today is naturally homogenized simply by the 
marketplace so that buyers and sellers, people on both sides of 
the hedge, understand what they are getting, they are used to 
it, etc., etc., and that they are naturally homogenized not by 
government action or whatever, and that there is no further 
homogenization--probably not a word--that either would need to 
be done or should be done by government or by you or by 
anybody?
    Mr. Gensler. Not on the economic terms. There is a desire 
to have rulewriting for these two agencies in terms of the 
processing, the netting and the documentation, what I will call 
the back office terms, but not on the economic terms.
    Mr. Hu. The existence of these designated products, 
designated for clearing on these clearinghouses under the draft 
bill, under the discussion draft, makes it very transparent 
what standardized products are out there, and that with this 
kind of transparency, various end-users and others can 
determine, well, gee, do I really need a customized product, or 
will that standardized product get me 99 percent of the way 
there? Should I pay that extra markup that you referred to, 
Congressman?
    Mr. Campbell. Right, right. But if I do want to have that 
customized product, I would be able to do that, and there would 
be some transparency to that, that doesn't currently exist, but 
I am not going to be limited.
    Mr. Gensler. That is correct. You would not be limited, and 
you would benefit by seeing where the standard product, the 
homogenized product, traded 10 or 20 minutes ago when you think 
about the particular risk you want to hedge.
    Mr. Campbell. And the clearinghouses themselves would be 
through how, through what--who operates clearinghouses?
    Mr. Gensler. The clearinghouses would be private entities, 
but regulated by our two agencies and overseen for risk 
management.
    Mr. Campbell. How many of those do we think there would be?
    Mr. Gensler. It is hard to determine. Right now, there are 
five or six that are trying to compete in this space, and 
whether that narrows down to be one here in the North American 
and one in Europe, by product or otherwise. We think it is 
important, though, that we get full access. If it ends up in 
Europe, that is all right, but do we get full access as we 
would think foreign regulators should have full access if it 
ends up in the United States.
    Mr. Hu. Right now, in terms of clearinghouses for credit 
default swaps, there have been three or four or five that 
exist, two or three of which are active.
    Mr. Campbell. Okay. My time has expired. Thank you, Mr. 
Chairman.
    Thank you both.
    The Chairman. By the way, that is a recess, not a vote, So 
we hope to be able to finish soon.
    The gentleman from Texas, Mr. Green. And then we will go 
to--I cannot accommodate non-members, I apologize. But this 
committee is too big, and we can't do it.
    Mr. Green.
    Mr. Green. Thank you, Mr. Chairman.
    I thank the witnesses for appearing. I thank the 
Administration for its guidance and leadership. And I would 
like to repeat some things that have been said, but probably 
say them slightly different.
    It seems to me that what we have is this: We have a stock 
market that is mostly regulated, I think you will agree. We 
have a swap market that is mostly unregulated, and they are at 
the end zones. And then in the middle, we have this twilight 
zone of ``swap stop'' or ``stop swap'' market that is somewhat 
regulated and somewhat unregulated, which is where AIG was in 
this sort of twilight zone of swap market and stock market. Is 
that a fair statement, Mr. Gensler?
    Mr. Gensler. I don't wish to disagree with you, but I 
think--
    Mr. Green. Please do.
    Mr. Gensler. AIG was largely in the ineffectively 
regulated, and the products that they were trading in, the 
products were not regulated at all.
    Mr. Green. So they had more of a swap market unregulated 
than they did the stock market that was regulated?
    Mr. Gensler. That is correct.
    Mr. Green. Mr. Hu?
    Mr. Hu. It is a huge gap that this discussion draft helps 
address. How we get there is a matter that we are all going to 
work together on.
    Mr. Green. Exactly. And what this proposal seeks to do is 
deal with that unregulated swap market to a great extent. And 
in so doing, you have promulgated some rules that we have not 
had heretofore. One would be a proposal to deal with abusive 
and--products that would pose a threat, a systemic threat. And 
in so doing, you can go so far as to declare some products as 
unworthy of being products in the regulated market. Are all of 
these fair statements?
    Mr. Hu. The anti-abuse provision that you refer to is 
something that we are just starting to analyze, but among the 
issues is this.
    Mr. Green. Exactly.
    Now, let me say this: One of the reasons why--there may be 
a multiplicity, but one of the reasons we are so concerned 
about this is because of the systemic risk that developed with 
AIG, and other companies as well, and it is really the systemic 
risk that we are trying to deal with. We, generally speaking, 
wouldn't be in this position, wouldn't be here today, if we had 
not had some systemic risk problems we had to deal with, and 
taxpayer dollars ultimately had to help us maintain the 
financial system. So this is why we are here.
    Now, with reference to products that create a risk that can 
be deemed systemic by virtue of being pervasive and by virtue 
of being so risky that they just don't fit well in a regulated 
market, are there any products at all that you can think of 
that would be so abusive or so systemically risky that you 
would not have them in this market?
    Mr. Hu. In terms of that issue, we have not tried to look 
for particular products that--
    Mr. Green. I understand.
    Let me share this with you: We talked with Chairman 
Bernanke recently and this question was posed to him, and I 
think his response was that he thought that no-doc loans just 
didn't have a place that was one that could be placed in a 
market, but no-doc loans were just not good.
    I am asking you because, if there are no products, no 
products that are so abusive and so systemically risky that we 
would want to--I don't want to say ``outlaw,'' but say that 
this is something we really shouldn't have, is this provision 
going to be effective?
    Mr. Hu. Congresswoman Waters, earlier on, referred to the 
Goldman Sachs ``empty creditor with a negative economic 
interest'' situation.
    Mr. Green. Exactly.
    Mr. Hu. So that--and similarly in terms of Goldman Sachs--
was perhaps an empty creditor as to AIG. So in terms of the 
Goldman Sachs situation Congresswoman Waters was referring to, 
incentives may sometimes be created for creditors not to care 
about what happens to their borrowers.
    Mr. Green. Because my time is going to expire, let me go 
quickly to this.
    A part of the problem also was that many of these 
counterparties outsourcing their risk management to the rating 
agencies, because if it was a triple-A rating, which is what 
AIG had, they relied on that, rather than having their own 
internal risk management.
    Will this deal with that kind of circumstance wherein you 
can outsource your risk management to the rating agency?
    Mr. Gensler. I think it will largely regulate the credit 
default swap area, which is at the heart of what you just said, 
because that outsourcing of ratings was also relying on these 
credit default swaps. So I do believe that the Administration 
proposal and the discussion draft brings that into regulation, 
and this last provision that you talked about would add to it.
    Mr. Green. Thank you, Mr. Chairman. I yield back.
    Mr. Moore of Kansas. [presiding] The Chair next recognizes 
the gentleman from California, Mr. Perlmutter.
    Mr. Perlmutter. Just a comment, and then I want to yield to 
Mr. Murphy from New York.
    The terminology, the nomenclature, how we describe these 
things, changes all the time from swaps to straddles to just 
different things. It is just different methods of calling how 
you hedge, how you risk, how you speculate, how you gamble.
    My goal here, in all of this, is that there not be a risk 
to the system; that you two have enough resources within your 
agencies to make sure that whoever is doing this trading has 
the capital if their bets go south. And really that is all I 
want to know, because I don't want--I am okay with people 
trading and trying to manage their risks and doing whatever, so 
long as it is over here in the corner and can't pull the whole 
system down; that there is clearing on a daily basis or there 
is posting on a daily basis, or so that you know what kind of 
leverage really exists in the market.
    So at any time, if you don't think you have the resources 
to manage this stuff, I would like you to just come to this 
committee ASAP. Otherwise, we are going to spend another $700 
billion like we did last fall, and we can't have that. Just a 
statement.
    Now I want to yield to Mr. Murphy, who does understand all 
of the ins and outs. I am looking at the bigger picture. Now I 
am going to turn it over to him.
    I yield to Mr. Murphy from New York.
    Mr. Murphy. Thank you, Congressman.
    A question to you, Mr. Gensler, trying to understand the 
idea of requiring everything to be exchange traded or through a 
trade execution vehicle. I am not sure I can get my hands 
around this.
    So in the standard market that we are familiar with for 
fixed floating swaps, some company is going to borrow $10 
million and they want to change it from fixed to floating, or 
vice versa, and they do that transaction with a swap dealer. 
They want it to start the day their loan is going to close, so 
it happens to be November 25th, and it is going to last for 10 
years or 10 years and 3 months, so there is still some nuance 
to that.
    What does it mean to put that on an exchange? I am not sure 
I really understand, because there is not going to be a big 
market of 8 other guys who want a 10-year, $10 million fixed 
floating swap on November 28th.
    So what does that mean?
    Mr. Gensler. Right. First, I want to say, Congressman, in 
view of the time, we are here today saying we don't have the 
authority and the resources we need--for the record, to make it 
clear.
    In terms of bringing it on into this central, transparent 
trading platform, we have some examples now. They are called 
exempt commercial markets. An organization called ICE does this 
in the energy space. And many--over 700 contracts are listed in 
oil and natural gas contracts. They are swaps. So it would mean 
they would be listed.
    In your example, a 10-year interest rate swap would be 
listed, and it would be quoted, and there would be some bids in 
office on a regular basis. We would write rules so that if the 
transaction that you just referred to was so illiquid or 
specific that, just like block trading today in the futures 
world and the securities world can be done off-exchange, but 
you would still get the benefit that you see some listed market 
on the standard product, the trade is affirmed through the 
trading platform and then reported. Just as in the futures 
world, it is within 5 minutes when it is an off-exchange or 
block trade. It is a little different over here.
    So we get the benefit of multiplicity and competition of 
trading venues. It is not all on a fully-regulated exchange. We 
get the benefit of some self-regulatory function even on the 
trading venues, trade affirmation, trade reporting; and, where 
possible, you also get some bids and offers on the standard 
product that you can see a picture of the marketplace.
    Mr. Murphy. So you would be reporting the trade even if you 
are not hitting the exact standard. What is the nuance if it is 
a 10-year trade versus a 10-year-and-2-month? Does that put it 
in the customized world, or does that still go through the kind 
of standard? Because everything else is standard and clearable, 
but yet it is not maybe going to hit something that is listed.
    I guess my sense is that is going to be most of the 
transactions, so I am trying to understand that.
    Mr. Gensler. No, actually most of the transactions in the 
interest rate product area are clearable.
    Mr. Murphy. Absolutely. But I think almost none of them 
would be exchange tradable in terms of volume or specificity 
based on what I have always seen in business when we put these 
trades on.
    Mr. Gensler. And I think we are suggesting a change of a 
model, that Wall Street dominates this and keeps it close hold, 
and that small companies or small municipalities can't see a 
picture of that marketplace.
    We say that we allow for that. We allow the current inter-
dealer brokers, who would register as swap execution 
facilities. Others that don't even exist today would compete in 
this area, similar to my example of ICE Atlanta that has over 
700 contracts in the energy market, and we would see real 
competition in this world and transparency for these individual 
products.
    But, again, I think it would be appropriate to write into 
statute that we can write rules for what I would call voice-
brokered transactions off exchange. They still then would be 
brought and affirmed on the platform, reported on the platform. 
There would be some self-regulatory function of those 
platforms, as we have in our two regulatory regimes.
    Mr. Moore of Kansas. The gentleman's time has expired.
    The Chair would next recognize the gentleman from 
Minnesota, Mr. Ellison.
    Mr. Ellison. Well, I am glad we have Congressman Murphy 
here asking you guys, talking mano-a-mano, sort of.
    Let me ask this question. The new draft legislation 
requires dealers to report prices at 5:00 for derivatives not 
traded on an exchange or electronic platform. Do you think this 
requirement goes far enough in terms of promoting price 
transparency in the derivatives market?
    Mr. Gensler. We think that it may be an unintended 
consequence, but there are some exceptions in foreign trading, 
and it leaves it as an optional. But we think we should bring 
some real-time reporting, hopefully maybe not end of day, but 
during the day as well.
    But we think it is the right goal, and we will work with 
committee staff on this.
    Mr. Ellison. Mr. Hu?
    Mr. Hu. Indeed, one of the areas we are looking at is 
regulators getting real-time information so that we can catch 
things very quickly.
    Mr. Ellison. Thank you. How does this approach differ from 
the Administration's bill, which would require all standardized 
derivatives to trade on an exchange or alternative swap 
execution platform?
    Mr. Gensler. In one case, it is required. We are suggesting 
it be required and allow for some rule-writing for this voice-
brokered or upstairs market. And in the discussion draft, it is 
optional. We would like to work with the committee to close 
those differences.
    Mr. Ellison. Do you prefer or have any thoughts on which 
would be better for the public?
    Mr. Gensler. I think it is better for the public to have 
the additional protections of the markets, including the 
trading venues, that it is not always a fully regulated 
exchange. But I believe the Administration proposal brings 
greater transparency and protections to the public.
    Mr. Ellison. Mr. Hu?
    Mr. Hu. We think that clearinghouses could get you many, 
many of the benefits of exchange trading, so our views don't 
quite match up with the CFTC's.
    Mr. Ellison. Thank you.
    The draft bill provides an exemption for entities primarily 
using derivatives for hedging and risk-management purposes. 
However, as you know, Fannie Mae and Freddie Mac are also major 
end-users of derivatives which they use to hedge interest rates 
and other risks.
    Would the draft language potentially exempt Fannie and 
Freddie and their counterparts from submitting standardized 
contracts to central clearing?
    Mr. Gensler. I believe that the discussion draft would 
exempt the Government-Sponsored Enterprises. I think this is 
probably an unintended consequence of the drafting around what 
are called major swap participants.
    Mr. Ellison. Do you think that is something that should be 
addressed?
    Mr. Gensler. We believe it should be addressed, that such 
major swap participants should come under this regulatory 
regime.
    Mr. Ellison. Mr. Hu?
    Mr. Hu. Yes, we believe it is important to have objective, 
somewhat narrower, verifiable standards in terms of what you 
mean, in terms of what you count as hedging in terms of this 
exclusion.
    Mr. Ellison. I have a question to follow that up, but 
before I do, let me ask you this: Chairman Gensler, you have 
indicated that any exemption should be limited to non-financial 
firms. Would that be an artificial distinction, given that some 
firms wear multiple hats?
    Mr. Gensler. It is a very good question. But what we are 
trying to address is a very real issue that end-users have 
raised about hedging their risk and the posting of collateral.
    What we have suggested is that they be part of this. But if 
Congress decides not to have them be part of it, this is an 
alternative we recommend to address the many people in the real 
economy who are concerned about posting margin.
    Mr. Ellison. So what should we do about those firms that do 
have those multiple roles they play?
    Mr. Gensler. I believe that they should be part of this 
regime. I recognize the Congress, in grappling with this very 
real issue of end-users, may adopt some end-user exemption from 
this. That is not our preferred approach or what I am 
recommending, but if the Congress does, we would look forward 
to working with you in trying to get this language narrowed so 
the exemption doesn't swallow the rule.
    Mr. Ellison. This is my last question. Hopefully, we can 
get in under the time.
    In addition to hedging and risk management--both are broad 
and subjective terms that can cover a wide range of 
transactions. Given that hedging and risk management are 
subject to different understandings by different people, 
different interests, should these terms be defined in the 
statute and how would you define them? What proposals would you 
have?
    Mr. Gensler. I think it would be best not to have the risk 
management exception in there at all. We have had years 
grappling with this at the CFTC, and unfortunately, you can 
drive a lot through those words.
    Mr. Moore of Kansas. The gentleman's time has expired.
    We should have done this earlier, but I ask unanimous 
consent for Scott Murphy, a noncommittee member, to 
participate. Without objection.
    Mr. Perlmutter. Objection.
    No, I withdraw my objection.
    The Chairman. Overruled.
    Next, the Chair recognizes the gentleman from Illinois, Mr. 
Foster.
    I will say, we have votes coming up. We will probably just 
have time for one more round of questions here. Then we are 
going to thank and excuse the first panel and the committee 
will be in recess for votes on the Floor, and then we will 
reconvene with the second panel right after votes.
    You are on, sir.
    Mr. Foster. It is my understanding that the major players 
in OTC derivatives reduced even their complex derivatives to 
algorithmic form for jamming into their risk evaluation 
computer programs. So my question is whether there is a 
potential benefit for having industry-wide standards for 
descriptions of even complex OTC derivatives, which would seem 
to address two concerns.
    One is that if this is the format in which the repositories 
received the description of the OTC derivatives, as well as the 
systemic risk regulator, that there might be a chance for the 
systemic risk regulator to have an analogous system where their 
computers would also net out the industry-wide exposure.
    It also might address Representative Murphy's questions 
about what it means to be an exchange for very complex 
derivatives; that what you do is, you have not a listing you 
can read in the newspaper, but you would have a listing of here 
are all the algorithmic definitions of all of these complex 
derivatives and what they have been selling for.
    So I was wondering if you think that is something that is 
happening already in the industry, or is there a useful role 
for government in enforcing that standardization?
    Mr. Gensler. There is a natural tendency towards that 
naturalization of the defined terms. The discussion draft and 
the Administration proposal gives us rule-writing authority to 
set business conduct standards on processing, netting and, I 
broadly call it, back office.
    But I think you are right, Congressman, it can go a little 
further in terms of also how the computers match up so that the 
regulators and the trade repositories and the clearinghouses 
have a consistent format, both domestically and internationally 
is very critical.
    Mr. Foster. Okay. My second question is whether anyone has 
written down a draft, even a draft definition, of what is too 
complex to clear, or maybe a list of things: These are clearly 
too complex to clear, these are clearly clearable, and these 
are the gray area.
    Is there anyone who has just had the courage to write down 
an operational definition?
    Mr. Gensler. I don't know if it has been written down, but 
conceptually it is why we think the clearinghouse should be the 
first place, if they can manage the risk, rather than a 
government agency pushing it upon them. But then the government 
agency should have a role to make sure that they are not so 
biased to take on risk that they shouldn't, or misprice them 
and so forth.
    Generally, it has to have some liquidity to it, that they 
can manage the risk if the counterparty fails and you can get 
out of the trade in a several-day timeframe, not a several-
month timeframe work. That is the conceptual frame.
    Mr. Foster. But no one has even tried to define that?
    Mr. Gensler. No, actually the international regulators 
have, and even we have, received futures clearing, which is a 
derivatives clearing. We have a very real set of standards in 
that regard.
    Mr. Foster. Okay.
    And lastly, do you have any comments on what the European 
Commission did regarding the credit default swaps based on 
European entities and requiring them to be cleared on an 
European clearinghouse? What is the end game on that?
    Mr. Gensler. I was honored to be asked to speak before 400 
people at the European Commission 2 weeks ago at the end of 
their consultation. And I spoke specifically on this and six 
other items and said, I think it would be a mistake to have a 
geographic mandate for clearing; that we should allow the 
clearinghouses, whether they be in Europe, the United States or 
Asia, that the international regulators have full and 
unfettered access, not shortchanged by bank secrecy laws, but 
full and unfettered access to the information you vigorously 
regulated.
    The largest swap clearinghouse right now is in London. That 
works for U.S. regulators, as long as we can regulate it and 
have full access.
    Mr. Foster. And you don't see problems down the line with 
the United States giving up information to any country that 
might want to see every trade that happened?
    Mr. Gensler. No. I think we have to have work with those 
international regulators, the large ones, like the European 
Commission and the FSA in London and so forth. And we have very 
good working understandings with these international 
regulators.
    Mr. Foster. Thank you.
    I yield back.
    Mr. Moore of Kansas. Thank you.
    The Chair will finally recognize the gentleman from 
Connecticut, Mr. Himes.
    Mr. Himes. Thank you, Mr. Chairman.
    I thank you for being here.
    Mr. Moore of Kansas. I will remind folks that as you finish 
here, votes are going to be called and this panel will be 
excused. Thank you very much.
    Mr. Himes. Thank you. I am gratified that there seems to be 
an alignment now around the notion of really clearing 
everything that we can and, hopefully, creating as much of a 
standardized universe as we can. This obviously imposes quite a 
bit of burden as a risk manager upon the clearinghouses, and I 
have a couple of questions and observations related to that.
    First, there is I think a danger associated with the 
fragmentation of clearinghouses, both here in the United States 
and internationally. I would like to ask you about that.
    But I would also like to ask the chairman for unanimous 
consent to submit for the record some testimony by the 
Depository Trust and Clearing Corporation, which is just 
raising the question of whether there should be a central 
depository for this information that would be available to the 
regulators, if there is no objection.
    Mr. Moore of Kansas. Without objection, it is so ordered.
    Mr. Himes. Secondly, I guess just an open question: Are you 
comfortable, gentleman, that you have--we heard your comment on 
resources, but the culture and the intellectual capability 
within your organizations to really peer deep into the 
clearinghouses, to form judgments on how they are doing as risk 
managers?
    Mr. Gensler. First, I want to say it is really good to see 
you as a Congressman, because I should disclose we have worked 
with low-income housing issues at the Enterprise Foundation.
    Mr. Himes. Right, also under the jurisdiction of this 
committee.
    Mr. Gensler. I do think--one the things I found in coming 
to the CFTC is tremendous expertise. It is an agency that 
oversees risk management markets, derivatives markets and 
clearinghouses, multifaceted clearinghouses right now, and has 
tremendous expertise. But it is, unfortunately, sorely 
underresourced.
    For instance, we are only right now able to go into the 
Chicago Mercantile Exchange once every 3 years to check on 
certain rule enforcement, rather than on an annual basis. So it 
is a resource-constrained, but well-educated, well-dedicated 
staff.
    Mr. Hu. We also have wonderful staff, very hardworking. In 
addition, we are hiring new people precisely because we need to 
better understand the new capital markets, these products, the 
need to keep up. I am totally confident that with sufficient 
resources, we are going to be able to make sure--not only make 
sure that these clearinghouses survive, but make damn sure 
these clearinghouses survive.
    Mr. Himes. Thank you.
    Next, one of the concerns I have, and I am sure this is 
broadly shared, is, we do not want to set up a situation where 
there is a clear incentive for people who otherwise might use 
standardized contracts to, in fact, use tailored contracts, 
perhaps to escape some of the oversight or requirements of 
standardized clearing.
    In your review of this legislation and as you think about 
the rulemaking that comes subsequently, are you confident, 
based on what you see here, that we will not be creating an 
incentive to send people into a customized universe?
    Mr. Gensler. I think there is some incentive to do that by 
Wall Street, who might want to have a little less transparency. 
I don't know that end-users would have that, but I do think it 
is there.
    The European Commission and the U.S. regulators have come 
together and think that there should probably be a little 
higher capital standard if things are less liquid, so that sort 
of guards against that, if they are truly less liquid and they 
are not in central clearing.
    Mr. Himes. Thank you.
    Actually, you anticipated my last question, which is the 
international dimension of this, European differences between 
the United States. Again, sort of based on what you see in the 
legislation and as you think about your institutions and your 
recent experience internationally, should we be mindful of the 
risk that there is a flight away from the better 
clearinghouses, perhaps, abroad?
    Mr. Gensler. Absolutely. Capital and risk does not know 
geographic boundaries. It will go globally. I am very 
optimistic, working with the European Commission, that we can 
achieve a coordinated approach. But there are different 
cultures and different political systems.
    I believe they are making their next key announcement on 
this on October 20th, and so we should look at that very 
closely.
    Mr. Himes. Is there a risk that our efforts to see these 
instruments cleared--if the Europeans move more slowly than we 
do, is there a risk that we see, in fact, this clearing 
activity move offshore?
    Mr. Gensler. Right now, there is some clearing offshore, 
but it is regulated. Even this swap clearinghouse I mentioned 
in London is regulated by the CFTC, and then there are some 
exemptive things that the SEC does.
    So I think that we can, through legislation in Congress, be 
able to regulate even if it is offshore. I would rather do it 
jointly with the Europeans. I think we can achieve that. Their 
time scale is probably into next year.
    Mr. Hu. The only thing I would care to add to those 
excellent comments is that we work perhaps especially closely 
with the FSA, and it has been a remarkable relationship. They 
have deep knowledge in this area.
    Mr. Himes. Thank you.
    Mr. Chairman, I yield back the balance of my time.
    Mr. Moore of Kansas. Thank you. I want to thank the members 
of the panel for your testimony here today and for answering 
questions.
    The committee will stand in recess for votes on the Floor, 
and then we will reconvene with the second panel.
    We are in recess.
    [recess]
    Ms. Bean. [presiding] We have the requisite number of 
members, so this hearing will resume.
    We will begin with the testimony from Jon Hixson, director 
of Federal Government Relations, Cargill, Inc.

     STATEMENT OF JON HIXSON, DIRECTOR, FEDERAL GOVERNMENT 
                    RELATIONS, CARGILL, INC.

    Mr. Hixson. Thank you. My name is Jon Hixson, and I am 
director of Federal Government relations at Cargill. I want to 
thank you for the opportunity to testify today.
    Cargill is an international provider of food, agricultural, 
and risk-management products and services. As a merchandiser 
and processor of commodities, Cargill is an extensive end-user 
of derivatives on both regulated exchanges and in the OTC 
markets.
    Cargill's activity in offering risk-management products and 
services to commercial customers and producers in the 
agriculture and energy markets can be highlighted with the 
following OTC examples: We offer customized hedges to help 
bakeries manage price volatility of their flour so that their 
retail prices for baked goods can be as stable as possible for 
consumers and grocery stores; we issue critical hedges to help 
regional New England heating oil distributors manage price 
spikes and volatility on their purchases so that they can offer 
families stable prices throughout the winter season; and we 
offer customized hedges to help a restaurant chain maintain 
stable prices on their chicken so the company can offer 
consistent prices and value for their retail customers when 
selling chicken sandwiches.
    Chairman Frank's discussion draft is a positive step in 
addressing comprehensive market reforms of the OTC market. 
While we have some areas of concern, there are many well-
supported elements included in this proposal.
    The discussion draft would improve transparency with dealer 
registration and audit trails, the proposal would create a 
regulated trade data repository and has a stronger focus on 
reducing systemic risk and more rigorous requirements for 
inter-dealer transactions.
    The bill also provides flexibility for end-users and 
traditional hedgers utilizing OTC risk-management products and 
clearly establishes regulatory authority to ban any swap deemed 
abusive. Cargill supports these provisions and appreciates the 
work of the chairman and other members of the committee in 
developing this discussion draft.
    The draft bill represents a significant improvement over 
many other proposals that, in our view, would overly restrict 
the use of OTC markets for hedging purposes.
    Our main concerns with the discussion draft relate to two 
areas of the legislation: first, the application of capital and 
margin requirements. The discussion draft gives regulators 
discretion in whether to impose margining requirements in 
traditional hedging and risk-management transactions. We 
appreciate this flexibility. However, we are concerned that, 
given recent regulatory statements and testimony, the 
imposition of mandatory margining for hedging transactions 
would still likely occur. This will make it very difficult, if 
not unlikely, that firms would be able to affordably and 
efficiently hedge their flour, heating oil, and chicken risks 
as described earlier.
    To ensure congressional intent, the legislation could 
include a list of factors and in a similar style as the 
provisions within the discussion draft that provide greater 
guidance on the clearing requirement. In addition, capital 
requirements should clearly recognize and reflect the risk-
management processes utilized by dealers.
    When Cargill offers tailored risk-management products to 
our customers like the bakery hedge, we offset a substantial 
amount of that risk by taking positions on a regulated, 
centrally cleared exchange, margined for daily mark-to-market 
exposure. We also use margin agreements with most of our 
customers.
    These steps greatly reduce overall risks in the hedging 
transaction. Regulators should consider such prudent risk-
management actions as they analyze and develop appropriate 
capital requirements to ensure that the charges are based on 
actual risk of loss.
    Regulators are also given much discretion in setting margin 
and capital requirements for non-bank dealers. The provisions 
often call for requirements as strict or stricter than those a 
prudential regulator would establish for a systemically 
significant financial institution.
    While we are very sensitive to the role played by a non-
banking firm in last year's financial crisis, there should be 
some recognition that the bakery hedge, for example, did not 
cause systemic risks for the financial system. Excessive 
requirements on our segment will likely only result in less 
competition among dealers within the OTC segment.
    Surrogation of assets is our second area of concern. We are 
sympathetic to those who lost initial margin money last year 
and would like to work with others, including members of this 
committee, to address this issue. However, restrictions around 
variation margining will have the unintended consequence of 
curtailing sound business practices that would otherwise 
minimize the risks of a hedging transaction.
    We appreciate the opportunity to testify before the 
committee to offer examples of our use of OTC products in risk 
management and to highlight our areas of support and concern 
within the discussion draft.
    We look forward to working together as this legislation 
continues to develop.
    [The prepared statement of Mr. Hixson can be found on page 
135 of the appendix.]
    Ms. Bean. Thank you for your testimony.
    We are going to proceed to the next witness, Professor Rene 
Stulz, chair of banking and monetary economics at the Fisher 
College of Business at Ohio State University.

 STATEMENT OF RENE M. STULZ, EVERETT D. REESE CHAIR OF BANKING 
 AND MONETARY ECONOMICS, FISHER COLLEGE OF BUSINESS, THE OHIO 
                        STATE UNIVERSITY

    Mr. Stulz. Madam Chairwoman, Ranking Member Bachus, and 
members of the committee, I thank you for providing me this 
opportunity to discuss with you draft legislation concerning 
the over-the-counter derivatives market. I am testifying in my 
individual capacity as an economic expert in risk management 
and derivatives. I would like my whole written testimony to be 
incorporated in the record.
    In the time allocated to me, I want to focus on two points 
from that written testimony. First, the legislation should not 
erect obstacles to trading customized on illiquid derivatives 
in a way that would make it hard for firms to manage risk. 
Second, requiring clearing for some derivatives products could 
increase systemic risk, and it is important for the legislation 
to make sure that does not happen and that, instead, clearing 
be properly implemented to make the financial system safer.
    Let me start with an example of how the use of derivatives 
can create jobs. Consider a firm in Ohio that exports machinery 
and considers bidding on a contract to export to Italy where it 
will be paid in euros. The moment the exporter makes a bid in 
euros, it takes on currency risk. The euro would depreciate 
between the time that it is made and a decision is rendered in 
such a way that all the profits of the exporter are lost. 
Because of this possibility, the exporter may decide not to bid 
because the currency risk is too large. With currency options, 
the exporter could hedge against a possible depreciation of the 
euro and lock in the profit margin after hedging costs. Hence, 
because of derivatives, the exporter could decide that it can 
bid on the contract, in which case jobs would be created as a 
contract is awarded.
    In my example, the exporter would have to use the over-the-
counter market to obtain the best hedge. The reason is 
straightforward: The contract would have to be tailored to the 
size of the bid and reference a date that a decision is made in 
order to be effective.
    Often customized and infrequently traded derivatives are 
the most useful derivatives to resolve specific risk-management 
problems for non-financial firms. Such derivatives can only be 
sold on the over-the-counter market, and clearing of such 
derivatives, if feasible at all, is uneconomical. It is 
important that the proposed legislation does not make it more 
difficult and expensive for end-users to obtain customized 
derivatives by imposing reporting, margin, disclosure, and 
business conduct requirements that make it unprofitable for 
financial institutions to sell such derivatives.
    An important concern from this perspective is the ability 
of regulators in the draft to impose margins on derivatives 
that are not cleared. With new or customized products, such a 
requirement is impractical and could essentially correspond to 
our regulatory preapproval process.
    Clearinghouses assume counterparty risk. As long as 
clearinghouses are well-capitalized and manage risks well, 
there is no material counterparty risk with clearinghouses. 
However, clearing is not a panacea. Failure of a clearinghouse 
could have a much more dramatic impact on the financial system 
than failure of a derivatives dealer. It is therefore critical 
that clearinghouses be properly capitalized and that margins be 
sufficient to ensure a low probability of loss in the event of 
default.
    The proposed legislation requires margins that cover risks 
in the ordinary course of business and requires the 
clearinghouse to hold capital that would cover the losses 
resulting from the failure of its largest participant. Neither 
requirement seems sufficient. The span margining system, which 
I understand to be industry best practice, is set up so that 
margins cover stress losses. This requirement should apply to 
over-the-counter clearinghouses generally. Further, the capital 
requirement should be such that a clearinghouse should still be 
able to operate properly if its largest member defaults. The 
capital requirement in the proposed draft does not appear 
sufficient for that purpose because such a default is likely to 
be correlated with other losses.
    Academic research has shown that clearing could increase 
systemic risk if there are too many clearinghouses. It is 
therefore important that legislation does not lead to a 
plethora of clearinghouses. With few clearinghouses, the 
collapse of any clearinghouse would have a substantial impact 
on the financial system. Therefore, with few clearinghouses, 
the risk management capabilities of each clearinghouse becomes 
critical to the stability of the financial system.
    Further is that with few clearinghouses, these 
clearinghouses will have some monopoly power, and they could 
abuse that power. It would be beneficial for the legislation to 
address explicitly the situation where a clearinghouse becomes 
a monopolist in clearing trades of a given type of derivative.
    Finally, there has to be clarity for market participants as 
to when regulators are going to be able to require that a type 
of derivative be cleared. To make such a requirement regulators 
should be asked to show conclusively that the systemic risk 
benefits of requiring clearing exceeds the cost associated with 
it.
    Thank you.
    [The prepared statement of Mr. Stulz can be found on page 
175 of the appendix.]
    Ms. Bean. Thank you for your testimony.
    And we are now going to go to Scott Sleyster, CFA, chief 
investment officer, domestic, for Prudential Financial.

  STATEMENT OF SCOTT SLEYSTER, CFA, CHIEF INVESTMENT OFFICER, 
   DOMESTIC, PRUDENTIAL FINANCIAL, ON BEHALF OF THE AMERICAN 
                COUNCIL OF LIFE INSURERS (ACLI)

    Mr. Sleyster. Thank you. Members of the committee, my name 
is Scott Sleyster. I am the chief investment officer of 
Prudential Financial's U.S. operations, and I appear here today 
as a representative of the American Council of Life Insurers, 
also known as the ACLI. The ACLI is a national trade 
association of 340 member companies who serve as the leading 
providers of financial security and retirement products for 
both the individual and group insurance markets. Prudential 
Financial is a financial services leader, providing compelling 
asset growth and protection solutions for the ever-increasing 
retirement needs of individuals in businesses in the United 
States and abroad.
    I would like to thank the committee for its invitation to 
appear today and to present the ACLI's view on the new 
discussion draft of the Over-the-Counter Derivatives Markets 
Act of 2009. In my capacity as Prudential's CIO, I am 
responsible for asset liability management, a critical function 
at all life insurance companies.
    The business of selling life insurance policies and 
annuities contracts requires us to match our asset portfolios 
with those of our liabilities so that we have the future cash 
flows necessary to meet the long-term financial promises that 
we make to our policyholders. The protections we provide often 
cover an extensive time horizon that does not correspond neatly 
to available investments. OTC derivatives allow us to 
effectively tailor the payment streams of our assets to match 
those of our expected liabilities.
    Customized derivatives in particular help to stabilize 
prices and mitigate risk within our industry's annuity 
business. For example, Prudential and other life insurers offer 
annuity products with custom guarantees that protect against 
downside risks of the underlying equity exposures of our 
clients. Our ability to provide principal guarantees, which are 
often accompanied with minimum retirement income guarantees, 
collectively protected retirees and consumers from an estimated 
$230 billion in losses during the most recent equity market 
collapse.
    Given the critical role that OTC derivatives play in the 
life insurance industry's asset liability management, the ACLI 
would like to offer the following six observations regarding 
the discussion draft released last week.
    First, we applaud the discussion draft's call for 
comprehensive Federal regulation of over-the-counter derivative 
markets. The proper operation of these markets and continued 
availability of OTC products remains a top priority to ACLI 
members. We remain concerned, however, that the draft's current 
definition of ``swaps'' and ``security-based swaps'' could be 
misunderstood to include certain insurance products such as 
annuities with optionlike features, which we feel should be 
explicitly excluded.
    Second, we appreciate that the draft does not establish a 
hard distinction between so-called standardized and customized 
OTC derivatives. We agree that it makes sense for responsible 
agencies to develop rules governing which derivatives should be 
centrally clear and those that should remain OTC.
    Third, we thank the committee for the significant 
improvement in the draft's new definitions of ``major swap 
participant'' and ``major securities-based swap participant,'' 
which now exclude end-users employing OTC derivatives for 
nonspeculative reasons, such as hedging and risk management. 
State-regulated life insurers are required to limit our use of 
derivatives to nonspeculative activity, providing us comfort 
that we would fall outside of both definitions. This is in 
sharp contrast to AIG, whose Financial Products Division was an 
OTC derivative dealer functioning outside the limitations of a 
State-regulated insurance company.
    Fourth, we strongly agree with the draft's proposal that 
non-cash assets should be acceptable collateral for derivatives 
transactions. As the largest class of investors of debt of U.S. 
corporations, insurers frequently use corporate securities as 
collateral subject to appropriate haircuts. The provision of 
the draft may need further refinement if the intent is to be 
fully realized, and we would welcome the opportunity to work 
with the committee on this matter.
    Fifth, we do remain concerned that the draft bill adopts 
Treasury's recommendation that the CFTC and the SEC be stripped 
of their customary authority. Given the complexity of this 
legislation, coupled with the dynamic aspects of the insurance 
and derivatives markets, we believe that businesses and 
consumers will be best served if the CFTC and the SEC have the 
flexibility to deal with matters as they emerge in real time.
    Finally, the ACLI endorses proposals to bring greater 
transparency to the OTC derivatives markets through trade 
reporting and centralized clearing of standardized products. 
Likewise, we support efforts to regulate derivatives dealers to 
ensure sound and efficient markets prevail.
    We thank the committee for this opportunity to share our 
perspective, and I look forward to answering any questions you 
may have.
    [The prepared statement of Mr. Sleyster can be found on 
page 168 of the appendix.]
    Ms. Bean. Thank you very much.
    And now Mr. David Hall, chief operating officer of Chatham 
Financial Corp.

   STATEMENT OF DAVID HALL, CHIEF OPERATING OFFICER, CHATHAM 
                        FINANCIAL CORP.

    Mr. Hall. Good afternoon. It is an honor and a 
responsibility to participate in this hearing today. Thank you 
for inviting me to testify regarding the regulation of over-
the-counter derivatives.
    To begin, it may be helpful to know the role of my firm in 
the OTC derivatives market. Chatham Financial is the largest 
independent advisor and service provider to businesses who use 
derivatives to reduce their interest rate and foreign currency 
risk. A global firm based in Pennsylvania, Chatham has over 
1,000 end-user clients in 45 States, ranging from Fortune 100 
companies to very small businesses. Chatham is employee-owned 
and independent. We do not accept compensation from dealer 
banks. We help our clients hedge risks, not speculate, and we 
do not advise on credit default swaps.
    Given the events in the financial markets in recent years, 
we applaud the Administration and Congress for considering 
appropriate changes to our financial regulatory system, 
including the area of derivatives. We believe we should all 
work to reduce the risk to our financial system should one of 
our largest banks, insurance companies, hedge funds or any 
other of our largest financial institutions fail. While prudent 
policy changes are needed to address the problems that gave 
rise to AIG's failure in credit default swaps and in other 
areas, policymakers need to be careful to ensure that such 
policies do not harm the many areas of the OTC market that are 
functioning well.
    OTC derivatives are very important tools for businesses to 
efficiently and effectively reduce risk. In fact, 94 percent of 
the 500 largest global companies and thousands of small 
businesses use derivatives to manage their business risks.
    The main issue at hand is reducing systemic risk. The 
business end-users who use derivatives to hedge do not create 
systemic risk; rather they use derivatives to reduce their 
business risks, which in turn reduces systemic risk. Therefore, 
especially since business end-users only make up 10 to 15 
percent of the overall OTC market, we believe derivatives 
regulation should be directed at trading activity between 
systemically significant institutions.
    We are very pleased that Chairman Frank and his staff, 
Members, and others have developed this draft legislation which 
recognizes and differentiates business end-users from large 
financial institutions. Specifically, this draft focuses 
central clearing requirements on large market participants 
rather than on business end-users. Additionally, it precludes 
those who would use derivatives to prudently manage risk from 
being subject to high regulatory thresholds under the 
definition of major swap participants.
    We are grateful for the opportunity to offer our 
suggestions for how the draft bill can be improved following 
our five recommendations for improvement. Number one, margin. 
Any requirement for business end-users to cash collateralize 
hedging transactions would create an extraordinary and 
unnecessary drain on working capital. This draft appropriately 
recognizes this cash burden by excluding end-users from the 
clearing requirement. Similarly, we believe this draft should 
also recognize this cash burden by excluding end-users from any 
margin requirement.
    For trades with business end-users, we believe credit terms 
should be negotiated by the two parties. To illustrate this 
point a bank may choose to make a loan without collateral if 
the business is creditworthy; therefore, it is reasonable that 
a derivative should be allowed to be offered to a business end-
user without margin if the business end-user is creditworthy.
    Number two, capital charges. This draft calls for higher 
capital charges for noncleared derivatives. We believe this 
draft should be clarified so that regulators are instructed to 
set capital charges based on historical predicted loss, not as 
a penalty to discourage the use of OTC derivatives.
    Three, systemic significance. This draft bill recognizes 
that systemically significant institutions should be subject to 
higher standards than those that cannot impose systemic risk. 
However, as currently written, it is possible that 
nonsystemically significant firms could be subject to the same 
regulatory burden that applies to large financial institutions. 
For example, community banks that utilize OTC derivatives to 
hedge their balance sheet risk and offer risk management 
products to their borrowers could be deemed swap dealers and be 
subject to the same reporting, clearing, and margining 
requirements. Removing the burden for smaller, nonsystemically 
significant swap dealers will encourage competition and reduce 
prices for business end-users.
    Number four, a major swap participant is largely defined by 
having a substantial net position, a term to be defined by 
regulators. We believe this term should either be defined by 
legislation, or, if it is not, we would like to see the intent 
be clear that this definition should target systemically 
significant institutions.
    Number five, exemptive relief. As we make these historic 
changes to regulate the OTC derivatives market, we cannot now 
foresee many of the consequences resulting from this 
regulation; therefore, we should grant regulators the authority 
to provide exemptive relief where they deem necessary.
    To conclude, even though we have identified several areas 
for proposed improvements, we want to be clear that we believe 
this draft is the most thoughtful proposal for regulation of 
the OTC derivatives market to date. Thank you for the 
opportunity to testify today.
    [The prepared statement of Mr. Hall can be found on page 
120 of the appendix.]
    Ms. Bean. Thank you for your testimony.
    And we are now going to go to Mr. James Hill, managing 
director of Morgan Stanley, on behalf of SIFMA.

STATEMENT OF JAMES J. HILL, MANAGING DIRECTOR, MORGAN STANLEY, 
  ON BEHALF OF THE SECURITIES INDUSTRY AND FINANCIAL MARKETS 
                      ASSOCIATION (SIFMA)

    Mr. Hill. Thank you. My name is James Hill. I am a managing 
director at Morgan Stanley, and I am appearing today on behalf 
of the securities association known as SIFMA. We appreciate 
your invitation to testify.
    There is much in the committee discussion draft that SIFMA 
and its members support, and we believe that it includes many 
significant improvements over the Administration's proposal 
relating to over-the-counter derivatives. We appreciate the 
thoughtful consideration that you and your committee 
colleagues, as well as your staff, have given to comments that 
industry participants have provided, in particular those of 
corporate end-users.
    I would like to express SIFMA's support for legislative 
proposals to ensure that systemically significant market 
participants are subject to comprehensive regulatory oversight. 
It was lack of meaningful regulation of AIG's derivatives 
affiliate that allowed poor business practices to lead to a 
situation in which the Federal Government had to invest tens of 
billions of dollars in order to avert what would have been a 
systemically significant business failure. The discussion draft 
would address this regulatory shortcoming by creating a 
legislative and regulatory framework that ensures such a lapse 
would not likely occur again.
    We also support measures that would improve regulatory 
transparency and thereby facilitate oversight of the 
derivatives markets and the activities of individual market 
participants. The discussion draft accomplishes this by 
requiring that swaps be submitted to a derivatives clearing 
organization or reporting to a swap repository.
    We do, however, have concerns about some of the particular 
provisions in the discussion draft. I will briefly describe 
several.
    Although the discussion draft generally excludes corporate 
end-users from the provisions that would require exchange 
trading or clearing of swap transactions, they would be covered 
by other provisions. For example, the discussion draft would 
authorize regulators to impose margin requirements on swaps in 
which one of the counterparties is a corporate end-user. We do 
not believe that counterparty credit exposure created through a 
swap transaction should be required to be collateralized when 
lending arrangements between the parties can be made on an 
unsecured basis. We believe the decision to require margin and 
the details of how it is handled should be left to an 
individual negotiation between the dealer and its end-user 
client.
    The provisions of the discussion draft regarding security-
based swaps are another area of concern. The draft gives the 
SEC jurisdiction over these swaps in part by amending the 
Securities Act of 1933 to include them in the definition of 
``security.'' This approach is expedient, but likely would have 
unintended consequences that would be difficult and time-
consuming to resolve. This is because many of the concepts and 
requirements under Federal and State securities laws do not 
readily apply to securities-based swaps.
    A better approach to providing for SEC oversight and 
regulation of securities-based swaps would be to give the SEC 
broad authority to adopt regulations that are consistent with 
the regulatory framework for other swaps. This would enable the 
SEC to address unforeseen issues without contorting the 
existing Federal securities laws and regulations to accommodate 
instruments for which they were not designed.
    Finally, we have practical concerns about constraints on 
the SEC and the CFTC's exemptive authority and the Act's short 
implementation period. The legislation could well have 
unintended consequences, some of which may be adverse to the 
market and individual market participants. Rather than having 
to pass new legislation to address such consequences each time 
they arise, we believe it would be more practical to grant the 
CFTC and the SEC authority to create exemptions that are 
consistent with the purposes and intentions of the act.
    With respect to implementation, we note the Act's 
provisions generally would become effective 180 days after 
enactment. We don't believe this would give derivatives dealers 
and other market participants, as well as corporate end-users, 
sufficient time to comply with the Act's complex and far-
reaching provisions. We believe the effective date should be no 
less than 1 year after the date of enactment.
    In conclusion, I would like to emphasize that SIFMA and its 
members support legislation to address the weaknesses in the 
current regulatory framework for derivatives. The events of the 
past year have made clear that improvements are needed. 
However, the use of derivatives have become an integral part of 
our economy because they enable corporate end-users to 
effectively manage risk. As such, it is important that 
legislation intended to improve derivatives regulation and 
reduce systemic risk do not unnecessarily impair the usefulness 
of derivatives as an important risk management tool.
    Thank you.
    [The prepared statement of Mr. Hill can be found on page 
124 of the appendix.]
    Ms. Bean. Thank you very much.
    We move to Mr. Stuart Kaswell, executive vice president and 
managing director, general counsel, of the Managed Funds 
Association.

  STATEMENT OF STUART J. KASWELL, EXECUTIVE VICE PRESIDENT & 
 MANAGING DIRECTOR, GENERAL COUNSEL, MANAGED FUNDS ASSOCIATION 
                             (MFA)

    Mr. Kaswell. Thank you, Madam Chairwoman, Ranking Member 
Bachus, and members of the committee. My name is Stuart 
Kaswell, and I am the executive vice president and general 
counsel of Managed Funds Association. MFA is the voice of the 
global alternative investment industry and is the primary 
advocate for sound business practices and industry growth for 
professionals in hedge funds, funds of funds and industry 
service providers. Our members provide liquidity and price 
discovery to markets, capital to allow companies to grow or 
improve their businesses, and sophisticated risk management to 
investors such as pensions to allow those pensions to meet 
their obligations to their beneficiaries.
    MFA appreciates the opportunity to provide its views on the 
Over-the-Counter Derivatives Markets Act of 2009. MFA's members 
are active participants in the OTC derivatives markets. As 
such, we have a strong interest in promoting the integrity and 
proper functioning of these markets and ensuring that there is 
no repetition of systemic events, like the collapse of AIG, 
which required Congress to use taxpayer funds to stabilize 
markets. Similarly, we wish to prevent another Lehman Brothers-
like failure where a large portion of the money lost or tied up 
in bankruptcy belongs to Lehman customers, including swap 
customers who posted collateral on OTC swap positions. Both of 
these events raise significant counterparty and systemic risk 
concerns for our members and are why MFA is fully supportive of 
the goals of the committee's discussion draft.
    MFA appreciates and commends the committee on the DMA. We 
believe it takes an important step in the right direction and 
addresses outstanding concerns with respect to the OTC 
derivatives markets. Particularly, we support: one, reducing 
systemic risk through the use of central clearinghouses; two, 
reducing counterparty risk by segregating customer collateral; 
and three, clarifying the definition of a major swap 
participant.
    We would like to offer a few recommendations with respect 
to these three items. First, we believe that cleared OTC 
derivatives play an essential role in reducing systemic risk. 
It does so by reducing the interconnectedness that results from 
too much credit exposure flowing through a limited number of 
dealers. Clearing also increases regulatory transparency and 
market efficiency with respect to cleared products. Because of 
the benefits of central clearing, we would like to see the DMA 
go further in promoting the use of clearing organizations by 
dealers to clear standardized products through capital 
incentives. The DMA does create capital incentives to clear 
swaps, but we believe it should ensure that dealers actually 
use central clearing. We also suggest that end-users that post 
cash collateral should have access to central clearing either 
through direct participation in the clearing organization or 
through a swap dealer.
    Second, we believe that the DMA takes a number of important 
steps to address counterparty and systemic risk by first 
expressly requiring the segregation of collateral on cleared 
trades, and second by requiring that dealers offer customers 
the option to segregate collateral for customized contracts. 
Requiring a clearing organization to segregate customer 
collateral will protect customer assets and make it possible to 
transfer swaps out of a failing dealer and into a stable 
dealer, which should diminish financial contagion in a crisis.
    With respect to customized swaps, MFA members, as end-
users, post collateral with swap dealers as a safeguard for the 
dealer against customer failure. Currently, dealers are free to 
use this collateral as their own property. In the event of a 
dealer default, such as Lehman, customers are at risk of losing 
their collateral because it is not segregated from the dealer's 
proprietary assets.
    We believe the DMA goes a long way in protecting customers 
by requiring dealers to make segregation of collateral 
available to their customers; however, we are concerned that 
Congress' intent in protecting end-users from a dealer failure 
may not be realized unless Congress makes corresponding changes 
to the bankruptcy laws, including those applicable to banks 
that act as swap dealers.
    Third, we understand that the major swap participant 
category is meant to prevent a repetition of the AIG meltdown--
entities with a substantial net position. We recommend that the 
committee provide clarity to the term ``substantial net 
position.'' The DMA should direct the SEC and the CFTC, in 
defining the term, to consider the following factors: One, the 
relative net position of swap dealers, for example, a 
substantial net position should be measured with respect to the 
net position of swap dealers; two, a participant's average net 
position over a relative period, such as a year; three, whether 
a participant's counterparties have a substantial unsecured 
credit exposure to such participant from outstanding swaps; 
four, whether the participant holds assets belonging to retail 
customers; and five, whether the participant is an existing 
registrant with either the SEC or the CFTC. These steps could 
help prevent a repetition of future failures like those 
witnessed at AIG and Lehman.
    My written statement provides additional recommendations 
for the ways we believe the committee draft could be 
strengthened consistent with its important objectives. For 
example, we suggest changes to the portions of the DMA that 
address position limits and reporting.
    Thank you for the opportunity to testify. I would be happy 
to answer questions.
    [The prepared statement of Mr. Kaswell can be found on page 
157 of the appendix.]
    Ms. Bean. Thank you for your testimony.
    We are now going to move to Mr. Steven Holmes, director of 
treasury operations, Deere & Company.

STATEMENT OF STEVEN A. HOLMES, DIRECTOR OF TREASURY OPERATIONS, 
                        DEERE & COMPANY

    Mr. Holmes. Madam Chairwoman, Ranking Member Bachus, and 
members of the committee, my name is Steven Holmes, and I am 
the director of treasury operations for Deere & Company, also 
known as John Deere. Thank you for inviting me today to testify 
at this hearing on reform of the over-the-counter derivatives 
market. I am here today in my capacity as an executive of Deere 
& Company. My testimony reflects the views of Deere and the 
views of the Business Roundtable, of which we are a member, and 
which represents leading companies with more than $5 trillion 
in revenues and more than 10 million employees.
    Deere is a major U.S. company with significant overseas 
sales. We raise capital, manufacture products, and sell in the 
United States and in foreign markets. These international 
activities subject us to economic risk. To manage these risks, 
we use derivatives. We do not use them as speculative 
investments, but instead to convert transactions that carry 
inherent risk into ones that produce predictable cash flows. 
This enables us to offer competitively priced products and 
financing to our customers.
    Let me give you an example of how we use foreign exchange 
derivatives to manage currency risk. Australian farmers are 
important producers of agricultural commodities. Deere has 
sales and credit operations in Australia, but no manufacturing. 
The products we sell there are manufactured mostly in the 
United States and Europe. Australian farmers place orders for 
equipment well in advance of the use season to ensure they will 
be ready for the spring planting or fall harvest. There is a 
significant lead time to manufacture a tractor to the farmer's 
specifications and ship it to Australia. Since our sales are in 
Australian dollars and our manufacturing costs are in U.S. 
dollars and euros, we are exposed to exchange rate risk. 
Without hedging this exposure with derivatives, we would not be 
able to offer a reasonable fixed price to the Australian 
farmer, and we would lose sales.
    Let me provide one more example, this time of how we use 
interest rate swaps. We provide financing for our customers on 
a significant percentage of our sales. We offer both fixed- and 
variable-rate financing to meet the various long- and short-
term needs of our customers. Derivatives enable us to match the 
interest rate characteristics of the funding available in the 
capital markets with our customers' requirements. This was 
especially critical during the credit crisis as capital was 
scarce. John Deere's volume of new loans increased during the 
credit crisis as we stepped in to replace other financial 
institutions that curtailed lending. We were able to issue 
long-term, fixed-rate debt and use interest rate swaps to match 
the shorter-term fixed and floating loans our customers 
required.
    Many investment-grade companies like Deere have debt 
covenants that prohibit the posting of collateral for 
derivatives. If existing derivative contracts are not permitted 
a grandfather exemption from the clearing and collateral 
requirements of the regulations, we will have to terminate 
these transactions at significant cost.
    Your bill takes key steps that accommodate the needs of 
derivative end-users like Deere. For example, your bill 
recognizes that many companies use derivatives for prudent risk 
management purposes. Your bill does not rely on clearinghouses 
to determine which transactions are accepted from central 
clearing. And your bill does not prohibit the use of non-cash 
assets to satisfy margin requirements.
    At the same time, we have concerns about the derivatives 
legislation that the committee plans to consider next week. I 
would offer the following three observations. First, we are 
concerned that regulators will be ceded too much authority to 
determine which companies are subject to higher regulatory 
thresholds and higher margin requirements.
    Second, we are concerned about the capital requirements for 
noncentrally cleared transactions. We believe that capital 
charges should be levied solely based on risk of loss and not 
as a means of forcing companies to centrally clear 
transactions.
    And finally, while your bill does not rely on a hedge 
accounting definition to determine which end-users are major 
market participants, we are concerned by the bill's open-ended 
definition of ``substantial net position,'' which creates 
uncertainty and again gives the regulators too much authority 
to determine which end-users are covered.
    Deere & Company is committed to working with this 
committee, the Administration, and other congressional bodies 
to enact thoughtful derivatives regulation that facilitates, 
not hinders, well-functioning capital markets. At the same 
time, the regulation should not be a disincentive to companies 
to enter into prudent hedging transactions.
    Thank you, and I am happy to respond to any questions you 
might have.
    [The prepared statement of Mr. Holmes can be found on page 
140 of the appendix.]
    Ms. Bean. Thank you for your testimony.
    And now, we will hear from Christopher Ferreri, managing 
director of ICAP, on behalf of the Wholesale Markets Brokers 
Association.

 STATEMENT OF CHRISTOPHER FERRERI, MANAGING DIRECTOR, ICAP, ON 
      BEHALF OF THE WHOLESALE MARKETS BROKERS ASSOCIATION

    Mr. Ferreri. Madam Chairwoman, members of the committee, 
thank you for inviting me to testify today on the reform of the 
over-the-counter derivatives market. My name is Chris Ferreri, 
and I am testifying today in my capacity as chairman of the 
Wholesale Markets Brokers Association, Americas, an independent 
industry body representing the largest wholesale and 
interdealer brokers operating in the North American markets 
across a broad range of financial products. I am also managing 
director at ICAP, one of the founding member firms of the WMBA.
    Interdealer brokers serve as intermediaries for broker-
dealers and other financial institutions that facilitate access 
to a full range of OTC and exchange-traded products and their 
associated derivatives forms. For relevant markets interdealer 
brokers are registered broker-dealers and are regulated by 
numerous agencies, including the SEC, the Federal Reserve, and 
the CFTC. It is estimated that each day, IDBs handle on average 
2 million OTC trades globally, corresponding to about $5 
trillion in notional amounts across the range of FX securities, 
interest rate, credit, equity and commodity asset classes in 
both cash and derivative form.
    Mr. Chairman, the WMBA is supportive of the efforts to more 
effectively oversee the OTC markets for derivative financial 
products. We believe that our current practices will integrate 
smoothly with many of the requirements in the discussion draft 
as well as the Treasury Department's proposal. We support the 
efforts taken thus far by the Administration and Congress to 
broaden the roles of the CFTC and the SEC in increasing the 
safety and soundness of the OTC markets.
    Today, we would like to focus on two particular issues: the 
characteristics and responsibilities of the swap execution 
facilities; and the protection of open, neutral, and 
nondiscriminatory access to central clearing.
    It is clear that the interdealer brokers would currently 
fulfill many of the criteria of the swap execution facilities 
described under the draft legislation or the alternative swap 
execution facilities under the Treasury Department's proposal. 
Much of what is contemplated for these facilities is already 
well within the capabilities of our member firms. Our 
technology-based reporting systems can provide the relevant 
regulators with real-time trading information.
    The WMBA is concerned with the requirement that swap 
execution facilities must undertake certain SRO enforcement-
type responsibilities, including discretionary supervision and 
approval of particular swap contracts as suitable for trading 
and the general oversight of the trading activities of our 
customers. This is not to diminish the capabilities we 
currently possess to monitor for suspicious or manipulative 
trading activity and to report such activity to regulators. 
This is consistent with our concerns about the requirements set 
forth in the Treasury Department's proposed legislation for 
alternative swap execution facilities to adopt position 
limitations or position accountability for our customers. We 
therefore appreciate the committee not including such a 
provision in the chairman's discussion draft, recognizing that 
each WMBA member firm can only monitor the activities taking 
place within its own execution facility.
    Multiple and competitive execution platforms have 
demonstrated their ability to create efficient, liquid and 
innovative markets. Yet with the expansion and requirement of 
central clearing, there is serious risk that central 
clearinghouses will create, modify, and ultimately favor their 
own execution facilities over competing execution facilities by 
access fees, access technologies or cross-subsidization of 
execution and clearing fees. The WMBA would respectfully ask 
that you consider whether this is sufficient to promote and 
protect competition among execution platforms.
    As the Justice Department observed in a 2008 comment letter 
to the Treasury Department, a vertically integrated derivatives 
market, where a central counterparty providing clearing 
services also provides trade execution services, will limit 
competition, increase costs, and ultimately hurt end-users and 
larger market participants. One only needs to look at the 
securities and options markets compared to the futures markets.
    The WMBA is encouraged that this is consistent with CFTC 
Chairman Gary Gensler, who remarked at a House Agriculture 
Committee several weeks ago that, ``A clearinghouse should not 
be vertically integrated in such a way with an exchange or 
trading platform so that the only product they accept is from 
that exchange or trading platform.''
    Frankly, if the clearing entity also provides execution 
services, there is not only an opportunity, but also an 
incentive for them to structure their services to squeeze out 
competition. The WMBA would ask that the legislation include 
language to protect against such behavior.
    In closing, Madam Chairwoman, we congratulate you on your 
work on the discussion draft and the Treasury Department's 
proposed legislation. The WMBA looks forward to working with 
you to achieve these goals. Thank you for the invitation to 
participate in today's hearing.
    [The prepared statement of Mr. Ferreri can be found on page 
79 of the appendix.]
    Ms. Bean. Thank you for your testimony.
    And our final witness is Rob Johnson, director of economic 
policy for the Roosevelt Institute in New York, on behalf of 
Americans for Financial Reform.

 STATEMENT OF ROB JOHNSON, DIRECTOR OF ECONOMIC POLICY FOR THE 
  ROOSEVELT INSTITUTE IN NEW YORK, ON BEHALF OF AMERICANS FOR 
                        FINANCIAL REFORM

    Mr. Johnson. Thank you, Congresswoman Bean, Chairman Frank, 
Ranking Member Bachus, and other members of the committee for 
including me here in your proceedings regarding derivatives 
reform.
    First off, when I worked in the Senate Banking Committee 
years ago, the derivatives regulation was solely the province 
of the Agriculture Committee. But I believe in the current 
circumstance where derivatives regulation is really the 
centerpiece of financial reform, and that is because of the 
current market structure, I want to applaud you for undertaking 
this endeavor, because I believe in the challenge that you face 
following the crisis, this is the essential ingredient to 
restoring confidence in our financial system.
    The upshot is that we have roughly five large financial 
intermediaries: Goldman Sachs; Morgan Stanley; Citibank; 
JPMorgan Chase; and Bank of America. About 95 percent of the 
derivatives activity undertaken by the largest 25 bank holding 
companies, according to the Comptroller of the Currency, takes 
place within the walls of those five firms, who are very likely 
to be categorized as Category 1 or ``too-big-to-fail'' firms. 
Ninety percent of their activities, according to the OCC, are 
OTC derivatives. Bloomberg and others have estimated that this 
year, those 5 firms will make roughly $35 billion in the OTC 
derivatives market.
    The reason I feel this is the centerpiece of reform is the 
``too-big-to-fail'' policy is eminently intertwined with 
derivatives reform. The American public is quite demoralized by 
what we might call the induced forbearance of the bailouts that 
we experienced last fall. And I know one other dimension that 
the financial committees are working on has to do with 
resolution powers so that financial services holding companies, 
insurance companies, and others can, in fact, undergo prompt 
corrective action, as the FDIC could do with a bank now. But in 
a world where the opaque and deeply intertwined and entangled 
derivative exposures are present, it is very, very difficult 
for me to imagine someone like Secretary Geithner or Lawrence 
Summers considering anything other than forbearance when these 
entanglements are present, because it is unknown; it is like 
sailing in the fog. You could really hit the rocks if you 
decide to resolve these institutions, yet the discipline of 
market capitalism requires that insolvent institutions be 
restructured and resolved not just in the financial sector, but 
across the entire spectrum.
    The concern that I have is also that markets understand 
when things are too difficult to fail and unwind, and creditors 
of those firms, the people who hold the bonds, will actually 
diminish the amount they charge when they know that the firm 
can't go bankrupt; the so-called default risk will be 
diminished. What that does is it creates a very nasty feedback, 
because these large firms get a funding cost advantage, and 
they can drive competitors out of the market and increase their 
market share by virtue of being too complex and entangled to be 
able to bankrupt. And I think that is very distorting for our 
capital markets.
    One goal, therefore, of policy, and as we come back to your 
particular work on derivatives, is to figure out ways to 
contribute to ending this ``too-difficult-to-fail-or-unwind'' 
regime. When we look back at the market crisis, two things 
really occurred that I thought were quite prominent. One was 
what you might call discontinuous pricing. When you had opaque 
or complex instruments that were not readily traded, and margin 
or capital and pricing were not readily measured, it set up the 
system for violent discontinuities in price. People talk about 
many things that were carried on the books, particularly 
collateralized debt obligations, being in the neighborhood of 
100 cents on the dollar and then instantly 20 cents on the 
dollar. What this tends to do when it is opaque and when many 
large institutions are intertwined is it makes them afraid of 
each other, it makes them very, very anxious, and that 
compounds the fear and the breakdown of the capital markets.
    Ms. Bean. I am going to have to ask you to wrap up, because 
we are running out of time.
    Mr. Johnson. So when I hear the testimony today that are 
largely two financial institutions and end-users, I believe 
that I represent a third group that comes to the table, which 
is the taxpayers, the working people of the United States. And 
while I expect if you put a proper structure in place in the 
derivatives markets, it will impose burden or cost at the 
margin, because we have had too much incentive for private 
risk-taking relative to public risk-taking--
    Ms. Bean. I do need a final comment.
    Mr. Johnson. What I will do, I was just called to this 
hearing last night, so I will provide detailed comments on your 
bill and a statement for the record that will finish my 
comments. Thank you for including me.
    Ms. Bean. All right. Thank you for your testimony.
    I will recognize myself for 5 minutes to begin questions.
    First, I would like to thank Chairman Frank for working 
with myself, and with the gentleman from New York, Mr. McMahon, 
permitting the new Democrats on the task force who have been 
studying derivatives and initiated a number of the ideas that 
were ultimately incorporated into the draft bill that we are 
discussing today.
    My first question for Professor Stulz would be with the 
emphasis towards mandatory clearing, what is your expectation 
that the clearinghouses can handle the additional capacity?
    Mr. Stulz. My expectation is that with proper regulation of 
the clearinghouses, they should be able to handle the capacity. 
The worry is that it will be an operational challenge for them, 
and that the regulatory authorities will have to be monitoring 
their ability to do so very carefully. I am not sure that the 
current draft gives them enough power to do so, and I think it 
will be helpful for them to have those powers.
    Ms. Bean. Thank you.
    I also have a question for Mr. Kaswell. A company stock 
price can be responsive to changes in CDS spreads for their 
company. There have been allegations that some market 
participants bought CDS credit protection, and at the same time 
took large short positions of the same referenced company stock 
with the intent of increasing the cost of credit to and credit 
risk of the company, ultimately causing the stock to fall 
significantly. Congress is exploring how to root out that type 
of manipulative and predatory behavior.
    Is it workable to ban short sales of a company stock when 
one is simultaneously purchasing CDS on the same referenced 
entity, or do you have some better ideas about deterring 
predatory or manipulative practices?
    Mr. Kaswell. Thank you for that question. I think that it 
is important to think about the CDS market in conjunction with 
bankruptcy.
    As far as anybody has been able to show, we think that when 
companies have failed, they failed on the merits; that 
companies went out of business because their fundamental 
business model was not working in the economy, and therefore we 
think that to suggest that the CDS somehow was related to that, 
I don't think that there is evidence to demonstrate that.
    We think that CDS performs important functions in the 
economy. It helps provide an indication as to the value of the 
company. The price of CDS, I think, is a better indication than 
rating agencies, for example. It provides liquidity to market 
participants, and it also helps with the ability to hedge. And 
so we think that the benefits of CDS are important, and we 
don't see evidence that the bankruptcy scenario that you have 
described actually can occur.
    Ms. Bean. Also for Mr. Kaswell, does the draft legislation 
provide an effective medium to resolve the differences between 
the SEC and the CFTC?
    Mr. Kaswell. I think it is a good start. I think that there 
has always been a tension between these two agencies. We 
operate in multiple markets. A product may fall on one side or 
the other legally, but as an economic matter, these products 
are often traded together with different trading strategies. So 
I think it is critical that if there is a joint regulatory 
responsibility, that there be joint rulemaking, joint 
interpretation. I think in some instances, interpretation can 
be as critical as the rulemaking itself, and I know that it can 
be a cumbersome process, but we think that the bill is a step 
in the right direction.
    Ms. Bean. I had a question for Mr. Hall. Do you think 
corporate end-users contributed to systemic risk in the economy 
at all?
    Mr. Hall. I think my simple answer to that is no. Business 
end-users use derivatives to manage risk. They reduce their 
business risks, which reduces the likelihood that they will 
fail. And to the extent that any failure of a business would 
contribute to systemic risk, on a small scale, a business 
failing is tragic for that business and maybe for its 
customers, but it does not create systemic risk.
    Ms. Bean. Mr. Holmes, would you concur?
    Mr. Holmes. Yes, I would concur. In the cases where 
companies are using derivatives to hedge when the derivative 
reaches maturity, there is an offset in cash flow. For a 
liability position, we have a cash flow coming in to settle 
that position.
    Actually, what could be a problem is if the company has to 
come up with cash in advance of the termination date, which 
would happen if collateral was required to be posted, and that 
can create a liquidity event for firms that aren't able to 
access the capital markets and raise the margin.
    Ms. Bean. Thank you. My time has expired, so I will 
recognize Mr. Bachus.
    Mr. Bachus. Thank you.
    I received testimony from all of the witnesses except, Mr. 
Johnson, I didn't receive yours. You worked in the Senate prior 
to--
    Mr. Johnson. I worked for Senator Pete Domenici of the 
Senate Budget Committee when they were in the Majority until 
1986. And then I worked with Senator William Proxmire when he 
was in the Majority in 1987 and 1988 on the Senate Banking 
Committee.
    Mr. Bachus. Now, you testified at the request of the White 
House; are you aware of that?
    Mr. Johnson. No, I am not. All I am aware of is that the 
committee members called me last night at 6:00 and asked me if 
I could join this panel today. So I am not aware of what the 
inspiration was.
    Mr. Bachus. The White House requested you testify, which is 
fine. I didn't know if you had--have you looked at the White 
House proposal as opposed to the chairman's draft?
    Mr. Johnson. Yes, I have looked at the White House proposal 
in great detail. I have only looked at Chairman Frank's 
proposal in a cursory manner this morning.
    Mr. Bachus. The White House proposal, there has been a lot 
of testimony from these witnesses that the White House proposal 
as it was offered would have actually made things a lot worse, 
I think is maybe a characterization I would use from some of 
the witnesses, not all. Do you agree?
    Mr. Johnson. No I don't. Well, let me say I do and I don't. 
If forced to choose between the current discussion draft and 
the White House proposal, I would still prefer the White House 
proposal, but I can understand why the gentlemen on this panel 
with me who are describing primarily the impact on them rather 
than the overall impact on the market system--
    Mr. Bachus. Well, Cargill, Deere, manufacturers, all sorts 
of companies in transportation, it would increase their cost. 
You understand that?
    Mr. Johnson. I do understand that, and I believe that is 
accurate; it would increase the cost.
    Mr. Bachus. That being accurate, if it increased it 
substantially, they would either have to lay employees off, or 
charge more for their products or take actions like that, 
right?
    Mr. Johnson. Yes. But I think that has to be put into 
balance with the costs that we have incurred because we have 
had a malfunctioning capital market.
    Mr. Bachus. Also, it would also reduce profits, which would 
reduce government revenues, which would put us further behind. 
So there are some real downsides to the proposal. But you are 
saying there is an upside, too. And the upside is that, what, 
we would avoid an AIG?
    Mr. Johnson. I believe by creating more discipline in the 
derivatives market in terms of pricing and margining, we would 
improve confidence, diminish volatility in many of those 
markets as well as other market segments, and we would also 
bail out fewer banks.
    Mr. Bachus. We didn't really have any problem with 
commodity derivatives. What we had problems with was basically 
the subprime market, that it was junk, and they put junk in 
derivatives, and if you put junk in, then the derivative is 
junk. And so if you regulate, if you put rules which the 
Congress has on subprime loans, and you--we have regulations on 
underwriting, and we had unregulated subprime lenders, but if 
we regulate those, and we try to have some credit-rating 
reform, and we have had subprime lending reform, that wouldn't 
be repeated hopefully, would it?
    Mr. Johnson. I would agree with you that those reforms 
would be helpful and meaningful and that they were the 
triggering episode, but I believe that the opacity of the large 
intertwined markets which included a lot of derivative 
exposures added to the fear and the depth and the severity of 
the downturn. Another trigger could cause that.
    Mr. Bachus. Thank you. I appreciate that.
    Mr. Hixson and Mr. Holmes, would you tell me if this bill 
passed as the President constituted and maybe as if it passed 
as proposed by the White House, what would be the effect on 
Deere and Cargill as far as your costs? And I am sure that--
what is your best estimate?
    Mr. Holmes. It would be fairly material. It would affect us 
in a couple of ways. Our credit operations has the largest 
share of our derivatives outstanding, roughly $18 billion of 
derivatives, which sounds like a large number, but in the 
context of the loans we make to customers in excess of $20 
billion, it is reasonable. Many of those derivatives we would 
not be able to execute under the proposal, and that means our 
cost of funding would go up substantially, and we would have to 
increase those loan rates to customers, and there would be 
probably loss of revenues, loss of sales in that situation.
    Mr. Bachus. So either cost to farmers and those who bought 
industrial equipment more, or it would--their costs are borne--
    Mr. Holmes. The cost of acquiring equipment, the cost of 
financing it would increase and it would also make us less 
competitive in the international markets.
    Mr. Bachus. Thank you. Mr. Hixson?
    Mr. Hixson. For us, we have estimated it would cost 
approximately about a billion dollars depending upon market 
conditions, an additional amount of money we would have to 
borrow. For some local context, one of our largest 
investments--we have two members from Kansas City sitting here. 
We built a brand new oil facility, our largest in the United 
States, in Kansas City. So for us we would have to choose 
whether you put that money in margin or do you continue and 
build that plant. That is the type of thing we have to decide.
    Mr. Bachus. It would certainly impact the number of 
employees you have. Thank you.
    Mr. Moore of Kansas. Thank you. The gentleman from 
California, Mr. Sherman, is recognized.
    Mr. Sherman. Thank you. The over-the-counter derivatives 
market is a $592 trillion casino. By comparison, Las Vegas is 
just a grain of sand. And it worked pretty well up until last 
year in large part because everybody at the casino thought that 
if the casino went under, the Federal Government would be there 
to bail them out. Those who played at the AIG casino were 
right. Those who played at the Lehman Brothers casino turned 
out to be wrong, they were surprised, the whole world was 
surprised, and we had people running for the exits when they 
discovered that the implicit Federal guarantee wasn't 
absolutely there. So the question going forward is whether we 
want to recreate a system that works only with some sort of 
implicit Federal guarantee. Now, if you look at the Treasury 
draft, it provides for unlimited, permanent TARP and when the 
Secretary of the Treasury was here, I asked him whether he was 
willing to limit that power to merely $1 trillion and he said 
no.
    So the question we have is, not does this system help 
business, but is it worth multitrillion dollars of risk to the 
taxpayer to keep it going or alternatively, is there a way to 
design it that would allow it to work without any kind of 
implicit Federal guarantee? Mr. Holmes, you have used 
derivatives. Could you make it work if it was clear that your 
counterparties did not have an implicit Federal guarantee, that 
the taxpayers were not part of the system?
    Mr. Holmes. I believe so. You have to understand the 
counterparties that you are dealing with. We deal with the 
large commercial and investment banks that we have had 
relationships with for on average 30 years. Some of those 
relationships go back 100 years. Having said that, we still 
have credit limits that we place on our exposures with those 
counterparties. And when we approach those limits, we curtail 
our activity. Certainly during the credit crisis we were 
concerned about some of those counterparties, but the failure 
of any one of them would not have been a major financial 
problem.
    Mr. Sherman. So if we don't adopt proposed Section 1204 
providing the Treasury with that unlimited bailout authority, 
you will still be okay? Mr. Johnson, you are the only person 
here representing a public interest entity. Do over-the-counter 
derivatives do this economy so much good that in order keep 
them going, the taxpayer should give to the Executive Branch 
unlimited bailout authority to bear whatever risk future 
Administrations decide is necessary under whatever exigencies 
occur in the future?
    Mr. Johnson. The answer to your question is no.
    Mr. Sherman. Okay. I would point out, I believe, you are 
here at the request of the Administration and you are helping 
me illustrate how that one section of the Administration's 
proposal is not helpful.
    Mr. Johnson. Let me say that I was unaware that I was here 
at the request of the Administration.
    Mr. Sherman. I know. Yes. And I should make a further 
comment based on the ranking member's comments. His comments 
seem to be on the order of, well, the old system was working 
just fine except for subprime. I would point out it was working 
fine because it had an implicit Federal guarantee and the 
market was shocked when Lehman Brothers was outside of what 
people thought was that umbrella. So it is hard to say the old 
system was working fine when it only worked with an implicit 
Federal guarantee that I think most of our colleagues on the 
other side of the aisle voted against. Mr. Hill, can Morgan 
Stanley do just fine without a code section that allows the 
Administration to bail you out without consulting Congress in 
the future?
    Mr. Hill. Thanks for the question. I respectfully disagree 
with the characterization of the market as a giant casino, 
though. I would like to say that a healthy and robust financial 
market--
    Mr. Sherman. Let me interrupt. Do we have any proof that a 
majority of the debts or derivatives placed were placed by 
people who had real business reasons as opposed to just folks 
who thought they could make money because they could guess 
which way the price of orange juice was going to go?
    Mr. Hill. The foundation of any financial market is both 
hedgers and speculators. That has been the case for over 200 
years with the advent of the futures markets, as well--
    Mr. Sherman. Do we know how many of each we have?
    Mr. Hill. I, off the top of my head, cannot tell you what 
percentage of the market is comprised of hedgers versus 
speculators but I assure you there are both.
    Mr. Sherman. In Las Vegas, it is 100 percent speculators. 
And derivatives seems to be close. I yield back.
    Mr. Moore of Kansas. Thank you. The gentleman from 
Illinois, Mr. Manzullo, is recognized.
    Mr. Manzullo. Thank you. Let me ask probably the most 
simple question. I ask the same question just as Mr. Sherman 
asks the same question every time we have somebody talking 
about these instruments. If the subprime market had not gone 
sour, would there have been any problems with the derivative 
markets? I know you are all anxious to jump into that one.
    Mr. Sleyster. I would just pass along the experience that 
within the life insurance industry, we are restricted in the 
use of derivatives to two things: We can either replicate an 
asset that we could have otherwise bought, which is restricted 
in and of itself; or we can use it for hedging purposes. And I 
think we would say that our experience as people who use these 
for risk management and hedging tools was that even through 
this extraordinarily difficult cycle, derivatives served us 
very well and, in fact, served as significant risk mitigants so 
that we could stand behind the promises that we made while we 
have significant counterparty exposure risk that we have to 
manage.
    As Mr. Holmes noted, we think about the credit exposure, 
the potential credit exposure that we can have with 
counterparties and we, in fact, post collateral and limit the 
amount of business that we do. So I think we would say it 
actually worked quite well for this cycle for most of the end-
users, and certainly for the life of insurance companies.
    Mr. Manzullo. Mr. Holmes, and then Mr. Johnson. Go ahead.
    Mr. Holmes. Yes. Certainly our major concern through the 
credit crisis was the health of our counterparties. And it 
certainly didn't appear that any of the interest rate swaps in 
which end-users were participants or foreign exchange 
transactions were the things that created financial 
difficulties for our counterparties. It was the subprime 
market, as you indicated.
    Mr. Manzullo. Mr. Johnson?
    Mr. Johnson. I believe that the subprime market was the 
catalyst, the trigger in this episode and the opacity that was 
associated with the collateralized debt obligations. The funny 
ratings from the rating agencies played a very large role. But 
I do not think that is the exclusive source of opacity in this 
very large scale derivatives markets. Nor, by the way, do I 
think that derivatives are--I think they play a meaningful 
role, but they have to be structured so that as the gentleman 
speaking before me said, counterparties can assess each other 
and not become afraid and not withdraw credit in times of 
crisis or shock that emanates from any source, domestic or 
foreign.
    Mr. Manzullo. Okay.
    Mr. Ferreri. Could I add some insight to that, please? As 
an inter-dealer broker, when we hear stories from end-users, 
our customers are not end-users as the dealers that they deal 
with. The interest rate swap market, even during the crisis, 
the height of the crisis, operated very effectively and very 
efficiently. The foreign exchange market that our members 
operate, operated very effectively and very efficiently. The 
London Clearing House, in a report to the European Commission, 
made a case that after Lehman failed, $9 trillion in interest 
rate swaps with Lehman as a counterparty were in the Clearing 
House, more than 60,000 trades. Those trades settled through 
the Clearing House without a single dollar lost of member 
funds. So although there may be underlying problems in a 
certain aspect or a certain area, the breadth of the 
marketplace and the ability for the dealers to participate as 
market makers instinctively for the inter-dealer market was 
certainly proven to be strong.
    Mr. Manzullo. Mr. Hill?
    Mr. Hill. Yes. I would agree with what has been said. I 
think the key thing here is that with respect to all the 
markets we have been talking about, interest rates, currencies, 
and the corporate credit default swap market, the underlying 
instrument on which the derivative was based was a relatively 
liquid and transparent market. For example, with respect to the 
corporate CDS market, the underlying corporate credits were 
typically 34 reporting companies. So people who are transacting 
in the corporate credit default swaps understood the risks they 
were taking because the underlying credits were reporting 
companies that had financials, had to file periodic reports as 
their material events changed, and therefore the corporate 
credit default swap market actually performed very, very well 
during the financial crisis. In fact, it was far more liquid 
and far more transparent than the bond market. The problem with 
the subprime credit default swap market was not with the credit 
default swap itself, but how the underlying instrument that 
people were basing their derivatives on--
    Mr. Manzullo. Was crap.
    Mr. Hill. Was misunderstood. Not only was it that--
    Mr. Manzullo. It was.
    Mr. Hill. It was misunderstood. People assumed that 
borrowers disclosed their incomes correctly, people assumed 
lenders checked, people assumed the real estate appraisals were 
done accurately. And it turned out that a lot of those things 
weren't the case. So I have always felt the focus should be 
less so on the derivative and more so on what is the derivative 
on and is that market performing correctly. And I think in this 
case of the subprime, it clearly wasn't. In the case of the 
corporate bond market and the corporate CDS market, it 
certainly was.
    Mr. Manzullo. Thank you.
    Mr. Moore of Kansas. I have been asked by Chairman Frank to 
clarify for the record that the White House did not invite any 
witnesses. All the invitations came from the chairman. I have 
just been asked to state that for the record and I have done 
it. Thank you, Mr. Manzullo. And next, the gentleman from New 
York, Mr. Meeks, is recognized for questions.
    Mr. Meeks. Thank you. And I yield to Mr. Watt.
    Mr. Watt. I thank the gentleman for yielding just long 
enough for me to apologize to the members of the panel for 
having to run out and not being here to ask questions. That is 
probably a blessing to you. But also second, to ask unanimous 
consent to submit for the record a statement of Shawn Dorsch, 
who is my constituent and the founder of Blackbird Holdings, 
Inc., on the subject matter of today.
    Mr. Moore of Kansas. Without objection, it is so ordered.
    Mr. Watt. I yield back to the gentleman and I thank him 
profusely.
    Mr. Meeks. Thank you. One of the issues that I have been 
very focused on is what is taking place right now with the 
money that is still caught up in the U.K. with Lehman Brothers. 
And a lot of foundations and institutions and you are talking 
about money that is really caught up there. So I was wondering 
in looking at the draft--but I guess I will address this to Mr. 
Kaswell--that if the key pillars of the discussion draft had 
been in place at the time of the Lehman's bankruptcy, how would 
things have--would things be the same? Would they have evolved 
differently? And particularly, I am interested in the two key 
pillars of the independent third-party custodians and the 
central clearing of trades by major-market participants. Would 
it have made a difference?
    Mr. Kaswell. Thank you for your question, Congressman. I 
want to commend you for your leadership on this issue. The 
Lehman situation in the United States and the United Kingdom 
has been an unmitigated mess. And by focusing attention on it, 
shining a bright light on it, we think you are helping to 
resolve these issues. For my constituency, we are investors and 
we represent other investors, pension funds, college endowments 
and so on. And their money is tied up in Lehman, LBIE as they 
call it in the U.K., and also in LBI in the United States.
    And the most recent effort to resolve it did not work out. 
I understand there is going to be another effort starting 
tomorrow perhaps. But this is our investors' money that is 
sitting there. So again, we appreciate the efforts you have 
made in that regard. The bill would go a long way toward 
addressing some of the concerns because of its protection of 
collateral by segregating it off into a central clearing 
facility, in some cases, if it is a centrally cleared 
derivative, or in the case of an OTC product, providing 
customers with the option of having it segregated.
    So putting collateral and margin aside in a segregated 
account would have made a substantial difference in LBIE. And 
so that is one thing that we think is important. The Lehman 
administration, I think, is another issue. There are different 
approaches to that, and I think we could talk about that more 
at another time. Another issue I think is important is 
portability, the ability to move assets from a failing clearing 
member, if there were such clearing member, to another clearing 
member and to move those positions over quickly and 
efficiently. This would make a tremendous difference in 
avoiding the kind of nightmare we have had with LBIE. So thank 
you for the question.
    Mr. Meeks. Thank you. Let me jump now to Mr. Hall. The bill 
provides an exemption for swaps that did not involve dealers or 
so-called major swap participants, likely excluding anyone that 
uses swaps for hedging operational risks. This may mean that it 
is primarily contracted between dealers or between a dealer and 
fund managers that have to be cleared. Could you comment, if 
you will, on the amount of outstanding trade that this likely 
represents and whether this level of clearing will be enough to 
make a meaningful reduction in the level of systemic risk 
associated with the derivatives.
    Mr. Hall. Sure. I would be happy to. Approximately 
somewhere between probably 85 and 90 percent of transactions 
are between major-market participants. So as this draft allows 
and can require, is that those transactions would need to be, 
first of all, cleared if the regulator requires that they would 
be cleared; and then second of all, it allows the regulators to 
set margin requirements. So that would address the vast 
majority of the--that would address the systemic risk in the 
system. And we have some concerns with the definitions and the 
definition of major swap participants. The language around 
substantial net position is undefined.
    We are actually concerned that threshold could be set too 
low so that it could require normal businesses who are using 
derivatives for risk management purposes, maybe they have other 
transactions that wouldn't qualify, they could get caught up in 
that definition. But to answer your question specifically, this 
language would catch the largest counterparties. In the 
previous panel--I should point out in the previous panel, it 
was pointed out that Government-Sponsored Enterprises such as 
Fannie Mae or Freddie Mac that are doing transactions that 
might broadly fall under the range of risk management may avoid 
being captured by this language. So we think there is still 
some work to be done on these paragraphs, but I think it is 
definitely moving in the right direction.
    Mr. Meeks. I am out of time already?
    Mr. Moore of Kansas. Yes, you are. The Chair recognizes Mr. 
Manzullo for a unanimous consent request.
    Mr. Manzullo. Thank you, Chairman. I ask unanimous consent 
that the statement of John Hollyer, principal and head risk 
management of strategy analysis at Vanguard, be made a part of 
the record.
    Mr. Moore of Kansas. Without objection, the statement will 
be made a part of the record.
    And I recognize myself for a unanimous consent request, a 
statement on proposed reform of over-the-counter derivatives 
markets from the electric power and natural gas industries. 
Without objection, this will also be made a part of the record. 
Next, the Chair recognizes Mr. Garrett from New Jersey.
    Mr. Garrett. Thank you. And I thank the panel. In the last 
comment--we have heard before actually that this is a step in 
the right direction. We have heard a lot of people say that. 
The Administration had their plan here. The chairman has come 
out with his plan here, which is a step in the right direction. 
I guess as I hear that, I often think that had you all the 
opportunity to push that proverbial reset button on this 
debate--and we haven't passed legislation yet and we haven't 
had a markup yet--is the legislation or even the draft 
legislation that we have really the type of legislation that 
you think we need in order to address the problems that we need 
to have addressed here? I will open that to anyone who wants 
to. In other words, if you had your druthers, would this be the 
legislation even with the definitional changes and what have 
you that you have here if we do all those? Is this the 
legislation that you hope to have in place come January of next 
year to regulate the industry?
    Mr. Hall. I will take a crack at it, if that is okay. I 
think the way we view this is we have been reviewing the issue 
and reviewing the situation. And we have been thinking about 
this ever since AIG, certainly as many of you have. The key 
issue in our minds is systemic risk. The way to address 
systemic risk is to identify who are the systemically 
significant institutions, require that when the systemically 
significant institutions trade with one another, they fully 
collateralize their trades. They can fully collateralize their 
trades either through collateral arrangements or clearing or 
exchanges. So that would take care of the systemic risk issue. 
Now to the question of transparency. And if the regulators need 
access to information, certainly let us give regulators the 
access to information.
    One of the provisions in this bill talks about central data 
repositories where trades can be reported. We think that is a 
very sound idea. So those two elements should be the key 
elements, the core elements. Then there should be a question of 
anything added to that, I think, should be examined for both of 
it costs and benefits.
    Mr. Garrett. I appreciate that. And I take it as 
significant when I said does anybody think this is what you 
want to have in the market and note there was no waving of 
hands saying, this is it. So I will ask Mr. Hixson. When you 
look at your company and industry, basically what you have is a 
Byzantine system of regulation that this draft is coming up 
with to address mainly just non-financial derivative dealers 
such as yourselves who don't have a prudential regulator out 
there already. So we are creating this massive regulation just 
to address this one little area basically. It goes with the 
other carve-outs that have now come in for the end-users and 
what have you. Couldn't we have done this in some other ways? 
And you addressed--Mr. Hall addressed some of it by dealing 
with the repository. And I guess even before that--here is a 
seminal question. Are you so systemically important and risky 
that we would have the same problems that we have dealt with 
over the last 9 months if we didn't do this, and you had a 
problem in your company?
    Mr. Hixson. I think as the first panel kind of mentioned 
and certainly in the statistics on the notion of outstanding 
derivatives, we are tiny. So I don't think--
    Mr. Garrett. Hoping to grow bigger, but still tiny.
    Mr. Hixson. Certainly a very small player. I would not 
think there is any systemic risk in what we do. And 
particularly given the nature of our transactions, we are 
providing hedges for our customers. So in essence they already 
have the risk on their books. They need to buy flour to run 
their operations, they are going to be selling the heating oil 
in the examples I used. So we are just trying to help them 
provide a product to manage that risk. So, no, we are not 
particularly viewed as systemic in nature. And we have a 
regulator. We certainly report all of our large trading 
positions that we do, both over-the-counter and on the exchange 
to the CFTC currently. That system exists for any large data 
amounts of transactions, we do provide that already.
    Mr. Garrett. It seems to me as we begin to get into this--
maybe I am wrong--that you can deal with the transparency 
issues that I came in here to hear you talk about by the 
repository, you can deal with the other aspect that is in this 
draft that Chairman Frank has put in and that is dealing with 
the Lehman situation regarding the segregation of funds and 
what all brought us to that situation. We already know what is 
going on in the marketplace right now is that we are moving to 
this clearinghouse arrangement. We don't have to get into all 
the definitional problems I think Mr. Hall was raising by this 
Byzantine structure doing it because we are already moving in 
the right direction.
    So if you did just a couple of those things, you seem like 
you would address a major portion of the problem. We will not, 
even if we pass this bill, or I think even if we pass the 
Administration's bill--correct me if I am wrong on this--deal 
with what got us here by some argument with the AIG situation 
because--will the AIG type of instruments be covered and be 
forced to be cleared through a clearinghouse? No, right? 
Because they are--Mr. Hall?
    Mr. Hall. If I could. This bill does require that if you 
are deemed a major swap participant or if you are a swap 
dealer, then regulators can compel you to trade--do certain 
trades on exchange or clear and for other trades post margin.
    Mr. Garrett. But it wouldn't require for those types to 
actually go through it because they would be the unique type of 
product that wouldn't go through it, correct?
    Mr. Moore of Kansas. The gentleman's time has expired.
    Mr. Garrett. You can do a quick nod.
    Mr. Hall. If it is a unique product, they still could 
require margins.
    Mr. Garrett. Margins only. Thanks.
    Mr. Moore of Kansas. The Chair next recognizes the 
gentleman from Missouri, Mr. Cleaver.
    Mr. Cleaver. Thank you, Mr. Chairman. How many of your 
associations or agencies are related to other associations or 
agencies at the table? How many of you are connected in any 
way?
    Mr. Kaswell. I am not sure I understand the question. I 
represent the Managed Funds Association, which is the trade 
group.
    Mr. Cleaver. Yes, I understand. And so what trade groups 
that you represent are also connected with any of the other 
associations or groups that are represented at the table?
    Mr. Kaswell. I don't believe we are connected.
    Mr. Cleaver. None of you are related in any way, not 
connected in any way? The people you represent are not--don't 
have any relationship at all?
    Mr. Hall. An affiliate of Prudential is one of our clients, 
but that is the only connection I have.
    Mr. Kaswell. There may be cross membership.
    Mr. Ferreri. I was just going to add that. My company, 
ICAP, is a member of the WMBA and also a member of SIFMA.
    Mr. Cleaver. So if we really took a little time, we could 
probably come to the realization that most--there is some kind 
of connection with those companies you represent and others 
represented at the table? Am I right about it? We just took a 
little short period--we haven't taken lot of time. We have 
already seen that there are some crossovers.
    Mr. Kaswell. Right. But there are different perspectives. 
We are--
    Mr. Cleaver. I understand. That is not where I am going. I 
wanted to just see what the relationships would be.
    Mr. Holmes. Certainly as an end-user, I am not aware of any 
direct relationships I have with these other associations, yes.
    Mr. Cleaver. No. That is not what--I am not saying you have 
a relationship with them. I am saying that in the industry that 
you represent, some of those members would have relationships 
with the members of the agencies represented at the table. Is 
that clearer?
    Mr. Kaswell. Yes.
    Mr. Johnson. In my case, there are no cross affiliations.
    Mr. Cleaver. Yes. You are segregated. Earlier today, Mr. 
Gary Gensler, the Chairman of the Commodities Futures Trading 
Commission was here. He actually delivered a speech last month. 
And in his speech, he said that he believed that institutions 
are becoming ``too-interconnected-to-fail'' and not ``too-big-
to-fail,'' that the real problem is that we are developing a 
pyramid financial system in this country and so everybody is 
connected and so if one block falls it could conceivably knock 
down all the other blocks because of their connectivity. None 
of you agree with that, do you?
    Mr. Sleyster. If I could. As representing insurance 
companies, we believe very strongly in diversification and we 
believe in posting collateral and the kinds of things that can 
protect you from concentrations. But clearly as the world gets 
smaller, as financial institutions, for example, merge--if you 
had holdings in two of those bonds and there is a merger, then 
suddenly your exposure to a single firm has gotten much larger 
and you have to work those down.
    So I think certainly we are concerned about concentration 
and about using things like CDS and derivatives and OTC 
contracts quite frankly to help us mitigate and spread out that 
risk when those kind of events occur. But certainly they are 
real risks and real concerns.
    Mr. Cleaver. Yes, I appreciate that. You and I are on the 
same wavelength. That is a concern. When he expressed that, I 
have frankly thought a great deal about that and wonder whether 
or not the ``too-big-to-fail'' is really something we are 
concentrating on. And that even if we conclude that we have 
come up with a solution to that, we still have a problem 
because of this interconnectedness. And I think my time is 
running out just as I was--all right. Thank you, Mr. Chairman.
    Mr. Moore of Kansas. The Chair next recognizes himself for 
a question. As we consider where to draw the line of 
jurisdiction between the SEC and the CFTC, I think Chairman 
Frank has a very interesting perspective. If you can eat it, it 
should remain the CFTC and the Agriculture Committee that has 
jurisdiction; but if it is a financial matter, it should remain 
with the SEC. In the grey areas like interest rate swaps and 
currencies I would like to hear from the entire panel whether 
the SEC or the CFTC should have jurisdiction of these items. 
Are interest rate swaps and currencies a financial matter that 
should be under the SEC's jurisdiction? I will start with my 
fellow Kansan, Mr. Hixson, and just go down the line if we 
could, please.
    Mr. Hixson. We have really not waded into the 
jurisdictional dynamic if you will. We have really tried to 
focus on the use of the instrument and if you are a hedger and 
focus on kind of exemptive language and clarifying that 
segment. So I don't know that we really have a lot to offer on 
the dynamics of the various agencies.
    Mr. Moore of Kansas. Very good. Professor?
    Mr. Stulz. I don't have much to offer on this. I was 
concerned this morning about the lack of selectivity of the 
CFTC to end-users. I am much more concerned about focusing on 
exchanges and that would be a concern to me.
    Mr. Moore of Kansas. Very good. Next, sir, Mr. Sleyster?
    Mr. Sleyster. The ACLI did not express a view on that, but 
I would reiterate our concern that we would like those agencies 
to have the ability to deal with issues as they emerge on a 
real-time basis.
    Mr. Moore of Kansas. Very good. Mr. Hall, sir?
    Mr. Hall. We don't have experience with either agency. So 
this will need new--I think our concern is that the testimony 
this morning, they clearly want to move towards clearing and 
exchanges. So to the extent they have latitude, we are 
concerned at the implications of our clients.
    Mr. Moore of Kansas. Thank you, sir. Mr. Hill?
    Mr. Hill. The system is agnostic under this jurisdiction. 
But I will point out that there are some unusual aspects of the 
way the current split is set up. So, for example, in the case 
of corporate credit default swaps, where if you do a single 
name corporate credit default swap, it would be with one 
agency. But if you did a corporate credit default swap of 25 
names which is effectively just 25 of those single names 
combined, it is a different agency and that seems like an odd 
result to me.
    Mr. Moore of Kansas. Thank you. Mr. Kaswell?
    Mr. Kaswell. We don't have a formal position on the issue. 
We think it is a decision for the Congress.
    Mr. Moore of Kansas. Right. Mr. Holmes, sir?
    Mr. Holmes. We have not done any exchange traded 
transactions that would give us experience with either 
organization, so we don't have an opinion at this time.
    Mr. Moore of Kansas. Mr. Ferreri?
    Mr. Ferreri. As an operator of a marketplace, we are 
regulated by both the SEC and the CFTC. What we would hope 
would happen--the company I represent, ICAP, is a London-based 
company that operates under a single regulator. We operate 
regulated derivatives platforms. I think if there is enough 
harmonization between the trading transparency rules, between 
the two commissions, it would go a long way to making this an 
easier goal to achieve.
    Mr. Moore of Kansas. Thank you, sir. Finally, Mr. Johnson?
    Mr. Johnson. I tend to concur with Mr. Ferreri, that making 
things easier and more harmonized would help market 
participants. In this particular year, I have had very good 
experience with Mr. Gensler's work. So as one particular 
chairman at one particular time, I think he is making a great 
deal of progress. I have less familiarity with the SEC.
    Mr. Moore of Kansas. My thanks to the panel. I yield back 
the balance of my time. Next, the Chair recognizes Mr. Adler of 
New Jersey.
    Mr. Adler. Thank you, Mr. Chairman. Gentlemen, thank you 
for your patience this afternoon. I was struck by a line of 
questioning by Mr. Garrett, my colleague from New Jersey, a few 
moments ago, who I think was trying to bait you into 
criticizing this legislation. My sense sitting by the previous 
sponsor of a similar bill, Mr. McMahon, is this particular 
piece of legislation recognizes the good aspects of 
derivatives, is trying to avoid some of the systemic risk 
problems, offers an opportunity for greater transparency and 
relieving some of the opacity which was, I think, hurting but 
maintains the prudent risk management tools that all of you 
need and particularly the end-users here--I heard from Mr. 
Holmes and Mr. Hixson in particular talking about how this is a 
positive thing to preserve the good aspects of derivatives.
    So I guess I would like to have the flip side of Mr. 
Garrett's question to you. If you could briefly tell me that 
this is good legislation that I should support, that by and 
large will preserve the good aspects of risk management for 
end-users, but also protect the American people from some of 
the disasters we heard about, even from your own testimony 
about AIG. And I welcome any of you jumping in on that one.
    Mr. Ferreri. I would love to take the first shot at it. 
These are comprehensive bits of legislation. There are a lot of 
components, to them. I will speak to the components that my 
association would focus on, those being central clearing and 
transparency. We have the ability today in real-time to send 
trades between major financial institutions and the OTC 
derivatives market to a central repository in real-time. The 
U.S. Treasury market is an over-the-counter centrally cleared 
market. Trades are novated in milliseconds between 
counterparties hundreds of thousands of times a day. There are 
components of the bill that strengthen that on the derivatives 
side. Our association is fully supportive of those aspects of 
the bill. With regard to central clearing and the risk that 
mitigate, again centrally cleared products with a 
nondiscriminatory access to the clearinghouse gives us an 
opportunity to get these transactions done, get them into a 
clearinghouse and move onto the next trade. There are 
components that our association supports of the bill.
    Mr. Adler. And before you go, I also heard testimony or 
read testimony about your legitimate ongoing concerns about 
capital requirements and margin requirements and the 
segregation of assets for collateral. So you can reiterate 
that, but I at least have heard that clearly. But I would 
welcome other gentlemen speaking.
    Mr. Holmes. Well, I would like to comment on one really 
positive aspect, I think, of the regulation and that is the 
reporting and information gathering. There is quite a bit of 
information about derivatives that are disclosed by 
corporations today in the aggregate, but not at the transaction 
level. That information will be very useful in determining 
whether companies are truly hedging underlying risks or 
speculating. So I think that is very helpful. The margining and 
collateral requirements being a real concern for our particular 
firm.
    Mr. Adler. Understood. Mr. Johnson, you were patient.
    Mr. Johnson. What I feel is that you are faced with a 
tension between wanting to standardize, harmonize, make things 
more transparent on the one hand and preserve the capacity for 
customization for end-users on the other. I think this is a 
real entrant into the dialogue, along with the Administration's 
bill and some of the work that Gary Gensler has done. But I 
think at this point, the danger of this particular draft after 
my first reading within the last 18 hours, is that some of the 
definitions of nonmajor market participants and so forth could 
end up spilling over to create unintended what you might call 
laxity or benefit for some of the major ``too-big-to-fail'' 
financial institutions. And I would urge the committee--and I 
will put a written submission in on how to tighten that 
language.
    Mr. Adler. I would desperately urge you to do that, because 
we are going to be doing something on this measure very, very 
soon. So your written comments would be very helpful. I know 
Mr. Hall would like to comment that we want to make sure that 
we preserve the customized nature of derivatives as much as 
possible.
    Mr. Hall. I think the question is, what is good about this 
bill and what do we like. I think you addressed some of the 
concerns, the margin and the capital. There is a couple of 
other kind of more definitional concerns that we had in our 
testimony. But I want to emphasize that we believe that this 
bill is the most thoughtful bill to date. And I think it has a 
lot of hope of trying to balance the needs for end-users with 
addressing the systemic risk issue.
    Mr. Adler. Since I am sitting next to a previous sponsor of 
a derivatives bill, I think the previous bill was also very 
thoughtful.
    Mr. Sleyster. If I could. One observation with sympathy to 
sort of the expressed view, we felt like derivatives actually 
worked very well as a risk-management tool through the cycle. 
And when we reported to our own board about experiences of the 
cycle, that was actually one of the items we noted that worked 
well. The reason we think it worked well for the life insurance 
industry is that we already have a restricted use from our own 
State regulators that we can only use derivatives for hedging a 
replication. And so one of the observations I think I would 
make is that we don't think it is necessarily--we don't see why 
we would need to be regulated by the CFTC or the SEC on that. 
Thank you.
    Mr. Adler. Thank you, Mr. Chairman.
    Mr. Moore of Kansas. Thank you. I would ask unanimous 
consent that Mr. McMahon--who is not a member of this 
committee--be permitted to ask questions. Mr. McMahon, you are 
recognized sir.
    Mr. McMahon. Thank you, Mr. Chairman, and to the ranking 
member and also to Mr. Adler for not objecting to allowing me 
to ask a few questions. I appreciate that very much. And also 
for the shout-out on the many portions of our bill which are 
part of the chairman's draft for discussion. We are very 
pleased about that. And we thank you for your great efforts in 
that regard as well.
    Again, with the new Democrats, this for us is a very 
important issue and it is--all politics is local. So for me 
back home, as I mentioned this morning, so many people from my 
district work on Wall Street and for the City of New York. It 
is just an integral part of the City's budget. It is about 
policemen on the street, firefighters in the fire houses, 
teachers in the schools. And one of the things that we have 
tried to--have had to make clear with the meltdown at Lehman 
and AIG is when it comes to derivatives, is that--and you have 
done that very well, many of you today, that this is not just 
about speculation and people sitting around in a conference 
room or on a trading floor somewhere on a computer on a trading 
platform. This is a very important part of America's economy 
because we are able to produce fuels or things from grain or 
tractors that go around the world. And that is very important. 
We are glad you are here. I would ask you--especially Mr. 
Hixson and Mr. Holmes but the others as well because I heard 
what you said to Mr. Adler, that we are in a pretty good place 
in a lot of the parts of the bill. But as end-users--and we 
need you to continue this dialogue so that people understand it 
is about the end-users, what that means to the American 
economy, not just for those who are using credit default swaps 
to speculate. As end-users, could you give us your 
perspectives? I know you talked a little bit about how the 
Administration's proposal requiring the end-users to clear and 
the post-margin obligations would specifically impact your 
business. If you would maybe start, Mr. Holmes. Tell me about 
the farmer in Australia and what would happen then if you had 
to then--if your credit was tighter and what that would mean to 
your business. And I know you just touched on this, but we have 
been in and out during the day. So if you could just for the 
record.
    Mr. Holmes. Well, if we weren't carved out as a nonmajor 
swap participant and we had to clear all of our transactions 
and post initial and variation margin or collateral, we would 
have to curtail significantly our hedging activities because--
in my testimony, I indicated that our credit operation, which 
executes the majority of our derivatives, is prohibited from 
posting collateral under its indentures. And that prohibition 
will last as long as the debt is outstanding for up to 10 
years.
    So we would have to curtail our hedging activity and that 
would increase the volatility that we experience and ultimately 
the price of our goods that we sell internationally, as well as 
the cost of our financing for our customers both domestically 
and internationally.
    Mr. McMahon. So the derivatives, the ability to hedge your 
risk is sort an oil in your tractor, so to speak, that allows 
it to run of your company, allows it--we are always looking for 
metaphors that we hope some reporter will write down. But it is 
your ability to function, to allow the goods and services to 
flow worldwide ultimately, right?
    Mr. Holmes. Absolutely. It helps us to smooth out our cash 
flows, which enables us to invest on a consistent basis. And 
that is a really important aspect.
    Mr. McMahon. And there are some who think that you could--
instead of using derivatives, you could do that by getting 
credit from a bank to--in lieu of--or at least post a margin by 
getting credit from a bank. What would that mean to your 
business?
    Mr. Holmes. Well--
    Mr. McMahon. Could you get that credit in today's market? 
And what would it mean?
    Mr. Holmes. Certainly, credit availability and cost has 
changed since the credit crisis. So it would be very costly. We 
would have to raise hundreds of millions of dollars and keep 
cash on our balance sheet to meet margin requirements that 
instead could be productively employed in building factories 
and employing people.
    Mr. McMahon. Thank you. Mr. Hixson?
    Mr. Hixson. I appreciate the chance to discuss this. In a 
local kind of example, maybe in your background or at least for 
your upstate brethren in their backyards. One, we have a large 
export grain facility in Albany, New York where we ship wheat 
out. Certainly when we ship wheat to Egypt out of there, we 
would want to hedge the currency risk and the cost of doing 
that could be dramatically higher. And I think at times, we 
forget there are consumer benefits as well, particularly for 
the type of program I described in our kind of a distributor 
product for where we do a hedge for a heating oil.
    Well, if you figure a small job where I may sell $1 million 
worth of heating oil in the northeast, the initial margin on 
that contract would typically be somewhere around 10 percent or 
so. So you have to post $100,000 of margin if you are that 
little guy out there doing this and you have the margin all the 
way through there. That would be expensive for that small 
business.
    Mr. McMahon. Thank you very much. And thank you for your 
patience today. And just a shout-out to Mr. Ferreri who is a 
constituent of mine from Staten Island. Thank you, Mr. 
Chairman, for your indulgence and allowing me to be here today.
    Mr. Moore of Kansas. Thank you sir. And the Chair at this 
time recognizes Mr. Manzullo for a unanimous consent request.
    Mr. Manzullo. I ask unanimous consent that a statement from 
the International Swaps and Derivatives Association be made a 
part of the record.
    Mr. Moore of Kansas. Without objection, it will be received 
in the record. And I would like to thank each of the panelists 
for appearing here today and giving us your testimony, the 
benefit of your expertise and information on this subject that 
we are discussing here. 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. Again, thanks to our panelists. And at this time, 
this hearing is adjourned.
    [Whereupon, at 3:54 p.m., the hearing was adjourned.]


                            A P P E N D I X



                            October 7, 2009


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