[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]


 
  HEARING TO REVIEW IMPLEMENTATION OF TITLE VII OF THE DODD-FRANK WALL
               STREET REFORM AND CONSUMER PROTECTION ACT

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

                                HEARINGS

                               BEFORE THE

                        COMMITTEE ON AGRICULTURE

                                AND THE

                            SUBCOMMITTEE ON
                        GENERAL FARM COMMODITIES
                          AND RISK MANAGEMENT

                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                               __________

                         FEBRUARY 10, 15, 2011

                               __________

                            Serial No. 112-1


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



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                        COMMITTEE ON AGRICULTURE

                   FRANK D. LUCAS, Oklahoma, Chairman

BOB GOODLATTE, Virginia,             COLLIN C. PETERSON, Minnesota, 
    Vice Chairman                    Ranking Minority Member
TIMOTHY V. JOHNSON, Illinois         TIM HOLDEN, Pennsylvania
STEVE KING, Iowa                     MIKE McINTYRE, North Carolina
RANDY NEUGEBAUER, Texas              LEONARD L. BOSWELL, Iowa
K. MICHAEL CONAWAY, Texas            JOE BACA, California
JEFF FORTENBERRY, Nebraska           DENNIS A. CARDOZA, California
JEAN SCHMIDT, Ohio                   DAVID SCOTT, Georgia
GLENN THOMPSON, Pennsylvania         HENRY CUELLAR, Texas
THOMAS J. ROONEY, Florida            JIM COSTA, California
MARLIN A. STUTZMAN, Indiana          TIMOTHY J. WALZ, Minnesota
BOB GIBBS, Ohio                      KURT SCHRADER, Oregon
AUSTIN SCOTT, Georgia                LARRY KISSELL, North Carolina
STEPHEN LEE FINCHER, Tennessee       WILLIAM L. OWENS, New York
SCOTT R. TIPTON, Colorado            CHELLIE PINGREE, Maine
STEVE SOUTHERLAND II, Florida        JOE COURTNEY, Connecticut
ERIC A. ``RICK'' CRAWFORD, Arkansas  PETER WELCH, Vermont
MARTHA ROBY, Alabama                 MARCIA L. FUDGE, Ohio
TIM HUELSKAMP, Kansas                GREGORIO KILILI CAMACHO SABLAN, 
SCOTT DesJARLAIS, Tennessee          Northern Mariana Islands
RENEE L. ELLMERS, North Carolina     TERRI A. SEWELL, Alabama
CHRISTOPHER P. GIBSON, New York      JAMES P. McGOVERN, Massachusetts
RANDY HULTGREN, Illinois
VICKY HARTZLER, Missouri
ROBERT T. SCHILLING, Illinois
REID J. RIBBLE, Wisconsin

                                 ______

                           Professional Staff

                      Nicole Scott, Staff Director

                     Kevin J. Kramp, Chief Counsel

                 Tamara Hinton, Communications Director

                Robert L. Larew, Minority Staff Director

                                 ______

      Subcommittee on General Farm Commodities and Risk Management

                  K. MICHAEL CONAWAY, Texas, Chairman

STEVE KING, Iowa                     LEONARD L. BOSWELL, Iowa, Ranking 
RANDY NEUGEBAUER, Texas              Minority Member
JEAN SCHMIDT, Ohio                   MIKE McINTYRE, North Carolina
BOB GIBBS, Ohio                      TIMOTHY J. WALZ, Minnesota
AUSTIN SCOTT, Georgia                LARRY KISSELL, North Carolina
ERIC A. ``RICK'' CRAWFORD, Arkansas  JAMES P. McGOVERN, Massachusetts
MARTHA ROBY, Alabama                 DENNIS A. CARDOZA, California
TIM HUELSKAMP, Kansas                DAVID SCOTT, Georgia
RENEE L. ELLMERS, North Carolina     JOE COURTNEY, Connecticut
CHRISTOPHER P. GIBSON, New York      PETER WELCH, Vermont
RANDY HULTGREN, Illinois             TERRI A. SEWELL, Alabama
VICKY HARTZLER, Missouri
ROBERT T. SCHILLING, Illinois

               Matt Schertz, Subcommittee Staff Director

                                  (ii)


                             C O N T E N T S

                              ----------                              
                                                                   Page

              Full Committee, Thursday, February 10, 2011

Lucas, Hon. Frank D., a Representative in Congress from Oklahoma, 
  opening statement..............................................     1
    Prepared statement...........................................     2
Peterson, Hon. Collin C., a Representative in Congress from 
  Minnesota, opening statement...................................     3
    Prepared statement...........................................     4
Tipton, Hon. Scott R., a Representative in Congress from 
  Colorado, prepared statement...................................
    Prepared statement...........................................     5

                               Witnesses

Gensler, Hon. Gary, Chairman, Commodity Futures Trading 
  Commission, Washington, D.C....................................     6
    Prepared statement...........................................     7
    Submitted questions..........................................    95
Gallagher, Edward W., President, Dairy Risk Management Services, 
  Dairy Farmers of America; Vice President, Risk Management, 
  Dairylea Cooperative, Washington, D.C.; on behalf of National 
  Council of Farmer Cooperatives.................................    37
    Prepared statement...........................................    39
Duffy, Terrance A., Executive Chairman, CME Group, Inc., Chicago, 
  IL.............................................................    42
    Prepared statement...........................................    44
Pickel, Robert G., Executive Vice Chairman, International Swaps 
  and Derivatives Association, Inc., New York, NY................    54
    Prepared statement...........................................    55
Morrison, Scott C., Senior Vice President and CFO, Ball 
  Corporation; Chairman, National Association of Corporate 
  Treasurers, Broomfield, CO; on behalf of Coalition for 
  Derivatives End-Users..........................................    71
    Prepared statement...........................................    73
Olesky, Lee, Chief Executive Officer, Tradeweb, New York, NY.....    75
    Prepared statement...........................................    76

Subcommittee on General Farm Commodities and Risk Management, Tuesday, 
                           February 15, 2011

Boswell, Hon. Leonard L., a Representative in Congress from Iowa, 
  opening statement..............................................    99
    Prepared statement...........................................   100
Conaway, Hon. K. Michael, a Representative in Congress from 
  Texas, opening statement.......................................    97
    Submitted letters on behalf of:
        Donald, Bill, President, National Cattlemen's Beef 
          Association............................................   196
        National Corn Growers Association and Natural Gas Supply 
          Association............................................   196
    Submitted statement on behalf of:
        English, Hon. Glenn, CEO, National Rural Electric 
          Cooperatives Association...............................   193
Boswell, Hon. Leonard L., a Representative in Congress from Iowa, 
  opening statement..............................................    97

                               Witnesses

Bernardo, Shawn, Senior Managing Director, Americas Head of 
  Electronic Broking, Tullett Prebon; Vice Chairman Wholesale 
  Markets Brokers Association, Americas, Jersey City, NJ.........   101
    Prepared statement...........................................   102
Bullard, Jr., William T., Chief Executive Officer, R-CALF USA, 
  Billings, MT...................................................   132
    Prepared statement...........................................   134
Kaswell, Stuart J., Executive Vice President, Managing Director, 
  and General Counsel, Managed Funds Association, Washington, 
  D.C............................................................   147
    Prepared statement...........................................   148
Damgard, John M., President, Futures Industry Association, 
  Washington, D.C................................................   153
    Prepared statement...........................................   156
    Submitted questions..........................................   199
McMahon, Jr., Richard F., Vice President of Energy Supply and 
  Finance, Edison Electric Institute, Washington, D.C.; on behalf 
  of American Public Power Association; Electric Power Supply 
  Association....................................................   161
    Prepared statement...........................................   163
Sanevich, Bella L.F., General Counsel, NISA Investment Advisors, 
  L.L.C., St. Louis, MO; on behalf of American Benefits Council; 
  Committee on Investment of Employee Benefit Assets.............   169
    Prepared statement...........................................   170


  HEARING TO REVIEW IMPLEMENTATION OF TITLE VII OF THE DODD-FRANK WALL
               STREET REFORM AND CONSUMER PROTECTION ACT

                              ----------                              


                      THURSDAY, FEBRUARY 10, 2011

                          House of Representatives,
                                  Committee on Agriculture,
                                                   Washington, D.C.
    The Committee met, pursuant to call, at 10:10 a.m., in Room 
1300 of the Longworth House Office Building, Hon. Frank D. 
Lucas [Chairman of the Committee] presiding.
    Members present: Representatives Lucas, Johnson, Conaway, 
Fortenberry, Stutzman, Austin Scott of Georgia, Fincher, 
Crawford, Huelskamp, Gibson, Hultgren, Hartzler, Schilling, 
Peterson, Holden, Boswell, David Scott of Georgia, Costa, 
Kissell, Welch, and McGovern.
    Staff present: John Goldberg, John Konya, Kevin J. Kramp, 
Joshua Mathis, Ryan McKee, Debbie Smith, Pelham Straughn, Liz 
Friedlander, Clark Ogilvie, and Jamie W. Mitchell.

 OPENING STATEMENT OF HON. FRANK D. LUCAS, A REPRESENTATIVE IN 
                     CONGRESS FROM OKLAHOMA

    The Chairman. This hearing of the Committee on Agriculture 
to review the implementation of Title VII of the Dodd-Frank 
Wall Street Reform and Consumer Protection Act will come to 
order. With that, today this Committee begins what will be a 
long series of hearings to review the implementation of the 
derivatives provisions included in the Dodd-Frank Wall Street 
Reform Act.
    This Committee first considered legislation to reform the 
derivatives legislation. The Ranking Member and I worked hard 
to reach bipartisan consensus around the legislation we 
believed would bring needed reforms to the derivatives markets, 
also maintaining robust and liquid markets to allow farmers, 
ranchers, and commercial end-users to manage risk and discover 
market-driven prices. While it was not ultimately the 
legislation that became law, I believe the same principles 
should be applied as we exercise our oversight responsibilities 
on implementation of Dodd-Frank.
    The complexity of Title VII shouldn't be underestimated, 
but neither should the far-reaching impact it will have on our 
economy. Title VII isn't just about financial firms; it has the 
potential to impact every segment of our economy, from farmers 
and ranchers to manufacturers, energy companies, to healthcare 
and technology. That is why we must ensure that we get it 
right. As we work to revive the economy and create new jobs, we 
simply cannot afford sweeping new regulations that are poorly 
vetted that impose substantial costs that outweigh the benefits 
for our financial system and our economy, or that are crafted 
in the interest of speed rather than sound policy.
    In addition, I am concerned that the regulators may be 
considering rules at odds with the statute, or with 
Congressional intent. Although it may not have been perfect, 
Congress included an exemption in Dodd-Frank for end-users from 
the margin, clearing and exchange trading requirements. Yet, 
there are growing concerns among end-users that they may be 
subject to margin requirements for their over-the-counter 
trades, an outcome that is clearly inconsistent with 
Congressional intent. A margin requirement imposed upon end-
users would subject them to significant cash burdens, cash that 
might otherwise be used to put to work in the economy. And at 
the same time, such a requirement would create a significant 
disincentive to responsible risk-managing practices that 
provide price stability and certainty, and allow companies to 
remain focused on their core businesses.
    Today and through the coming months, we will focus our 
oversight on the following important areas: to ensure that in 
meeting regulatory objectives, there are not undue or misguided 
regulations that will impede well-functioning markets, economic 
growth and the global competitiveness of U.S. firms; to ensure 
the process by which the CFTC and other Federal financial 
regulators implement the rules is fair, transparent, rationally 
sequenced to support public comment, and in line with 
meaningful and deliberate cost-benefit analysis; to ensure new 
rules are consistent with the statutory language and 
Congressional intent of Dodd-Frank, particularly with regard to 
the end-users exemptions; and as a part of this review, we will 
examine the feasibility of the statutory time tables and any 
other provisions of Dodd-Frank that may be impediments to 
meeting these objectives.
    [The prepared statement of Mr. Lucas follows:]

Prepared Statement of Hon. Frank D. Lucas, a Representative in Congress 
                             from Oklahoma
    Today, this Committee begins what will be a long series of hearings 
to review the implementation of the derivatives provisions included in 
the Dodd-Frank Wall Street Reform Act.
    When this Committee first considered legislation to reform 
derivatives regulation, the Ranking Member and I worked hard to reach 
bipartisan consensus around legislation we believed would bring needed 
reforms to the derivatives markets, while also maintaining robust and 
liquid markets to allow farmers, ranchers and commercial end-users to 
manage risk and discover market driven prices. While it was not 
ultimately the legislation that became law, I believe the same 
principles should be applied as we exercise our oversight 
responsibilities over implementation of Dodd-Frank.
    The complexity of Title VII shouldn't be underestimated, but 
neither should the far-reaching impact it will have on our economy. 
Title VII isn't just about financial firms--it has the potential to 
impact every segment of our economy, from farmers and ranchers, to 
manufacturers and energy companies, to health care and technology.
    And that is why we must ensure we get it right. As we work to 
revive the economy and create new jobs, we simply can't afford sweeping 
new regulations that are poorly vetted, that impose substantial costs 
that outweigh the benefits for our financial system and our economy, or 
that are crafted in the interest of speed--rather than in sound policy.
    In addition, I am concerned that the regulators may be considering 
rules at odds with the statute or with Congressional intent. Although 
it may not have been perfect, Congress included an exemption in Dodd-
Frank for end-users from the margin, clearing and exchange trading 
requirements. Yet, there are growing concerns among end-users that they 
may be subject to margin requirements for their over-the-counter 
trades--an outcome that is clearly inconsistent with Congressional 
intent. A margin requirement imposed upon end-users would subject them 
to significant cash burdens, cash that would otherwise be put to work 
in the economy. At the same time, such a requirement will create a 
significant disincentive to responsible risk management practices that 
provide price certainty and stability, and allow companies to remain 
focused on their core businesses.
    Today, and through the coming months, we will focus our oversight 
in the following important areas:

   To ensure that in meeting regulatory objectives, there are 
        not undue or misguided regulations that will impede well-
        functioning markets, economic growth and the global 
        competitiveness of U.S. firms;

   To ensure the process by which the CFTC and other Federal 
        financial regulators implement the rules is fair, transparent, 
        rationally sequenced to support public comment, and in line 
        with meaningful and deliberate cost-benefit analysis; and

   To ensure new rules are consistent with the statutory 
        language and Congressional intent of Dodd-Frank, particularly 
        with regard to the end-user exemption.

    And, as part of this review, we will examine the feasibility of the 
statutory timetables, and any other provisions of Dodd-Frank, that may 
be impediments to meeting these objectives.
    I look forward to hearing from our witnesses today.

    The Chairman. I very much look forward to our witness's 
testimony today, and with that, I turn to the Ranking Member 
for his opening statement.

OPENING STATEMENT OF HON. COLLIN C. PETERSON, A REPRESENTATIVE 
                   IN CONGRESS FROM MINNESOTA

    Mr. Peterson. Good morning, and thank you, Mr. Chairman, 
for holding today's hearing. I welcome Chairman Gensler back to 
the Committee, we appreciate you being with us.
    Today we are discussing the implementation of Title VII of 
the Dodd-Frank Wall Street Reform and Consumer Protection Act. 
It is important that Dodd-Frank is the topic of the Committee's 
first oversight hearing of the new Congress, and I anticipate 
that there will be several more. It is also important that we 
get this right, and that the CFTC remain on track to implement 
the law in a responsible manner and as Congress intended.
    Derivatives played a key role in the collapse of our 
financial markets. We had over $600 trillion over-the-counter 
derivatives market with no oversight, no transparency, no 
regulation. As a consequence of this and many other factors, 
the American taxpayer ended up having to bail out large 
financial institutions, like AIG, when the financial system 
fell apart.
    Even before the financial crisis, nearly 3 years ago this 
Committee was looking into these markets, and we tried to 
address some of these issues in early 2009. Many of the 
provisions this Committee adopted with bipartisan support were 
ultimately included in the Dodd-Frank Act. Mandatory clearing 
of the over-the-counter swaps and requiring major swap 
participants and swap dealers to back up their deals with 
additional capital should help ensure that taxpayer dollars 
will not be needed to rescue these large financial firms again, 
and hopefully bring greater stability to the swaps marketplace.
    The Committee focused closely on ensuring that under these 
new rules, end-users could continue using derivatives to hedge 
risks associated with their underlying business, whether it is 
energy exploration, manufacturing, commercial activities, 
agriculture. End-users did not cause this financial crisis, and 
frankly, they were the victim of it.
    We worked to see that mandatory clearing, mandatory 
training, new capital margin requirements, and other 
obligations fell upon the financial players responsible for 
this crisis, and not upon the commercial end-users. Proper 
oversight by this Committee will ensure that our efforts are 
implemented by the regulators.
    The provisions of Dodd-Frank will also increase 
transparency to better arm end-users with negotiating with the 
big banks. Commercial end-users generally get the worst end of 
any swap deal because they simply do not have the same level of 
information on swap prices and terms as do their dealer 
counterparties. By requiring the big dealers to report and 
clear more of their swaps and move into more transparent 
marketplaces, commercial end-users will be able to get a better 
picture of the swaps market and be better armed in the 
negotiations with these dealers.
    Unfortunately, there is still a lot of confusion and 
misinformation out there with regard to commercial end-users. I 
don't know exactly who is ginning this all up, but you know, at 
the end of the day, my opinion is if we bring transparency to 
this market, these end-users are going to get a better deal 
than they are getting now. This is actually going to cost them 
less money in the long run than they are paying now.
    So we are looking forward to working with you, Mr. 
Chairman, and being involved in this process and working with 
the CFTC and Chairman Gensler to make sure that we get this 
right and we don't have another financial boondoggle like we 
had here a couple years ago.
    Thank you.
    [The prepared statement of Mr. Peterson follows:]

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

    Good morning. Thank you Chairman Lucas for holding today's hearing 
and welcome, Chairman Gensler, to the Committee. Today we are 
discussing the implementation of Title VII of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act.
    It is appropriate that Dodd-Frank is the topic of the Committee's 
first oversight hearing of the new Congress, and I would anticipate 
there will be several more. It is important that we get this right and 
that the CFTC remain on track to implement the law in a responsible 
manner and as Congress intended.
    Derivatives played a key role in the collapse of our financial 
markets. We had an over $600 trillion OTC derivatives market with no 
oversight, no transparency, and with no regulation. As a consequence of 
this and many other factors, the American taxpayer ended up having to 
bail out large financial institutions like AIG when the financial 
system fell apart.
    Even before the financial crisis, nearly 3 years ago, this 
Committee was looking into these markets and we tried to address some 
of these issues in early 2009. Many of the provisions this Committee 
adopted with bipartisan support were ultimately included in the Dodd-
Frank Act.
    Mandatory clearing of over-the-counter swaps and requiring major 
swap participants and swap dealers to back up their swap deals with 
additional capital should help ensure that taxpayer dollars will not be 
needed to rescue these large financial firms again and bring greater 
stability to the swaps marketplace.
    The Committee focused closely on ensuring that under these new 
rules end-users could continue using derivatives to hedge the risks 
associated with their underlying business, whether it is energy 
exploration, manufacturing or other commercial activities. End-users 
did not cause the financial crisis; they were the victims of it.
    We worked to see that mandatory clearing, mandatory trading, new 
capital and margin requirements, and other obligations fell upon the 
financial players responsible for the crisis and not upon commercial 
end-users. Proper oversight by this Committee will ensure that our 
efforts are implemented by the regulators.
    The provisions of Dodd-Frank will also increase transparency to 
better arm end-users when negotiating with the big banks. Commercial 
end-users generally get the worse end of any swap deal because they 
simply do not have the same level of information on swap prices and 
terms as do their dealer counterparties. By requiring the big dealers 
to report and clear more of their swaps and move into more transparent 
marketplaces, commercial end-users will be able to get a better picture 
of the swaps market and be better armed in their negotiations with 
these dealers.
    Unfortunately, there is still a lot of confusion and misinformation 
out there with regard to commercial end-users. I hope this hearing 
gives us an opportunity to clear some of that up. Because if 
implemented properly, the derivative title of Dodd-Frank could prove to 
be a major benefit to commercial end-users.
    Again, I thank the Chairman for holding today's hearing and look 
forward to hearing from our witnesses.

    The Chairman. That is absolutely correct, Ranking Member, 
and as our witness is preparing to offer his opening comments, 
do you have any inquiries you would like to make of the under 
classmen?
    Mr. Peterson. No, I will----
    The Chairman. Save that for later? Fair enough.
    The chair would request that other Members submit their 
opening statements for the record so the witnesses might begin 
their testimony to ensure there is ample time.
    [The prepared statement of Mr. Tipton follows:]

    Prepared Statement of Hon. Scott R. Tipton, a Representative in 
                         Congress from Colorado

    Thank you, Chairman Lucas, for convening today's hearing, and thank 
you to all of you here today. It is an honor to serve on this 
committee, and I welcome today's discussion of derivatives. I also want 
to give a special welcome to Mr. Scott Morrison, Senior Vice President 
and Chief Financial Officer of Ball Corporation, which is headquartered 
in Broomfield, Colorado. Mr. Morrison is on our panel today to share 
his concerns about the rulemaking.
    As a small business owner, I understand the risks inherent in doing 
business, and I recognize the role derivatives play in helping farmers, 
manufacturers and other end-users manage risks. Agriculture is an 
important part of Colorado's economy, and we have many farmers who use 
derivatives to hedge against price swings in the crops they produce and 
in the fertilizer, fuel, and other supplies they rely on. We also have 
manufacturing companies like Ball Corporation who use derivatives as a 
prudent risk-management tool.
    It is important to reduce systemic risk and improve market 
transparency. There are important provisions within Dodd-Frank for 
which the CFTC is currently drafting rules. As the rulemaking process 
progresses however, we must be watchful that the regulations being 
implemented do not unduly hamper private investment. End users like 
farmers and manufacturers did not cause the financial crisis, and that 
is why they were given an exemption within Title VII. Forcing them to 
comply with onerous rules will not help us achieve market transparency 
and risk reduction.
    I have particular concerns about the margin requirement, and how 
this one regulation, if applied to end users, could tie up capital, 
hinder job creation, and further stall economic recovery while not 
doing anything to prevent another financial crisis. As a Member of the 
Small Business Committee, one of my priorities is regulatory reform; I 
oppose excessive government regulation that unduly impedes private 
sector job creation.
    We have not yet seen rules from the CFTC concerning this capital 
and margin issue, but we must be watchful that the CFTC promulgates 
rules in line with the intent of the Dodd-Frank legislation. I have 
here a letter from Chairman Dodd and Chairman Lincoln and a colloquy 
from Chairman Frank and Chairman Peterson, and they could not have been 
clearer in expressing their intent that capital and margin requirements 
should not apply to end users of derivatives. I hope that CFTC 
regulators are mindful of this, and they do not attempt to go beyond 
the scope of their authority and place capital requirements on end 
users that force them out of the derivatives market.
    Thank you again, Mr. Chairman, for holding today's hearing. Today's 
discussion is important, and it is something we must continue as the 
rulemaking process moves forward. We will likely request further 
information from Mr. Gensler and the CFTC, and we will continue to 
exercise oversight over the rulemaking.

    We would like to welcome our first panel to the table, the 
Honorable Gary Gensler, Chairman of the Commodity Futures 
Trading Commission, Washington, D.C. Mr. Gensler, Chairman, 
please begin when you are ready.

           STATEMENT OF HON. GARY GENSLER, CHAIRMAN,
             COMMODITY FUTURES TRADING COMMISSION,
                        WASHINGTON, D.C.

    Mr. Gensler. Chairman Lucas, Ranking Member Peterson, 
Members of this Committee, I thank you for inviting me here 
today to this hearing, as I understand it, your first oversight 
hearing, so it is quite an honor to be here in front of this 
new chair and this new Congress.
    I am pleased to testify on behalf of the Commodity Futures 
Trading Commission. I also want to thank each of my fellow 
Commissioners for their hard work, their thoroughness, and 
commitment on implementing the legislation that was passed last 
year.
    Markets work best when they are transparent, open, and 
competitive. The American public has benefited from these 
attributes in the futures market that you help oversee through 
overseeing us, and the securities markets, those markets that 
were regulated after the great regulatory reforms after an 
earlier crisis in the 1930s. Congress directed the CFTC and the 
SEC after this generation's crisis to try to bring similar 
features to what is called the swaps market, or over-the-
counter derivatives market. The reforms that Congress enacted 
last summer will bring transparency and better pricing for 
corporations throughout America that use derivatives to hedge 
their risk. This is a significant change in the marketplace. 
Currently when a corporation or other end-users want to hedge a 
risk through the use of a swap, they don't benefit from a 
centralized marketplace as they might in a futures marketplace, 
and have that pricing in a transparent exchange or trading 
platform. So bringing transparency to these markets will 
improve information for end-users and other entities, provide 
greater competition in the marketplace, and yes, greater 
liquidity. Such transparency is also critical to lowering risk 
for the clearinghouses and risk in the large financial 
institutions that unfortunately 2 years ago the taxpayers stood 
behind.
    The CFTC is engaged in an open consultative process to 
complete implementation of Dodd-Frank. We are grateful for the 
public's input on the CFTC's rulemakings. In the summer, we 
identified 30 topic areas from the bill itself where rulemaking 
would be necessary. So far, we have proposed rules in 26 of 
those 30 areas. We have done so using significant input from 
the public prior to our proposing of rules, and during the 
official public comment periods. Importantly, commenters inform 
the Commission's consideration of costs and benefits associated 
with the rules. We also have coordinated closely with other 
domestic regulators and international counterparts. As part of 
seeking public comment on each of these individual rules, we 
have asked a question related to the timing of implementation, 
and we do have latitude, and I thank you for the latitude about 
implementation dates. We have asked the public, looking at the 
entire set of rules, the entire mosaic of rules, to please 
inform the Commission as to what requirements can be met sooner 
and which ones will take a bit more time, given the cumulative 
effect of the rules and the potential costs of those rules.
    One of the areas where we have yet to propose rules is in 
capital and margin, where we are working very closely in 
coordination with the banking regulators and the SEC. As it 
relates to margin, Congress recognized the different levels of 
risk posed by transactions between financial entities, a bank 
and an insurance company or hedge fund, and those involving 
non-financial end-users. This is reflected in the non-financial 
end-user exception to clearing. Transactions involving non-
financial entities do not present the same risk to the 
financial system as those between two financial entities.
    Why is this? In our opinion, and I think what is probably 
behind what Congress did, the risk of crisis spreading through 
the financial system is far greater the more interconnected 
financial companies are with other financial companies. This 
interconnectedness among financial entities can spread during a 
crisis--and then create economic harm to the public.
    So consistent with what the Congress did with regard to 
clearing, the proposed rules, as we move forward at the CFTC, I 
believe margin requirements should only focus on transactions 
between the financial entities. Thus, we would not have or 
involve the non-financial end-users, consistent with what this 
Congress did.
    Before I close, I will just briefly address one thing on 
resources. The futures marketplace that we oversee right now is 
$40 trillion in size. The swaps marketplace here in the U.S. 
that we are asked to oversee is about $300 trillion, half of 
what Chairman Lucas talked about. So thus, about seven times 
the size of the futures marketplace that we oversee, and it is 
far more complex. The CFTC's current funding is far less than 
what we would require to fulfill the mandate to oversee the 
swaps market that is seven times the size.
    We look forward to working with this Congress on securing 
the adequate resources. I thank you and I look forward to 
questions.
    [The prepared statement of Mr. Gensler follows:]

 Prepared Statement of Hon. Gary Gensler, Chairman, Commodity Futures 
                  Trading Commission, Washington, D.C.

    Good morning, Chairman Lucas, Ranking Member Peterson and Members 
of the Committee. I thank you for inviting me to today's hearing on 
implementing the Wall Street Reform and Consumer Protection Act. I am 
pleased to testify on behalf of the Commodity Futures Trading 
Commission (CFTC). I also thank my fellow Commissioners for their hard 
work and commitment on implementing the legislation.
    Before I move into the testimony, I want to congratulate Chairman 
Lucas on becoming Chairman of this Committee that is so critical to 
both the economy and American agriculture. I also want to thank 
Chairman Lucas, Ranking Member Peterson and this Committee for leading 
the effort to bring regulatory reform to the over-the-counter 
derivatives--or ``swaps''--markets. This Committee passed the first 
bill during the last Congress--the bipartisan H.R. 977--that included 
comprehensive reform of derivatives. The joint framework for 
derivatives legislation that was released later by this Committee's 
leadership also helped frame the debate on how to best protect the 
American public through regulatory reform of swaps. H.R. 977 and the 
joint framework formed the basis of the derivatives title of the Wall 
Street Reform and Consumer Protection Act.
The Wall Street Reform and Consumer Protection Act
    On July 21, 2010, President Obama signed the Wall Street Reform and 
Consumer Protection Act (the Act). Title VII of the Act, entitled ``The 
Wall Street Transparency and Accountability Act,'' amended the 
Commodity Exchange Act (CEA) to establish a comprehensive new 
regulatory framework for swaps and security-based swaps. The 
legislation was enacted to reduce risk, increase transparency and 
promote market integrity within the financial system by, among other 
things:

    1. Providing for the registration and comprehensive regulation of 
        swap dealers and major swap participants;

    2. Imposing clearing and trade execution requirements on 
        standardized derivatives products;

    3. Creating robust record-keeping and real-time reporting regimes; 
        and

    4. Enhancing the Commission's rulemaking and enforcement 
        authorities with respect to, among others, all registered 
        entities and intermediaries subject to the Commission's 
        oversight.

    The reforms mandated by Congress will reduce systemic risk to our 
financial system and bring sunshine and competition to the swaps 
markets. Markets work best when they are transparent, open and 
competitive. The American public has benefited from these attributes in 
the futures and securities markets since the great regulatory reforms 
of the 1930s. The reforms of Title VII will bring similar features to 
the swaps markets. Lowering risk and improving transparency will make 
the swaps markets safer and improve pricing for end-users.
Implementing the Wall Street Reform and Consumer Protection Act
    The Wall Street Reform and Consumer Protection Act is very 
detailed, addressing all of the key policy issues regarding regulation 
of the swaps marketplace. To implement these regulations, the Act 
requires the CFTC and Securities and Exchange Commission (SEC), working 
with our fellow regulators, to write rules generally within 360 days. 
At the CFTC, we initially organized our effort around 30 teams who have 
been actively at work. We have recently added another team. We had our 
first meeting with the 30 team leads the day before the President 
signed the law.
    The CFTC is working deliberatively and efficiently to promulgate 
rules required by Congress. The talented and dedicated staff of the 
CFTC has stepped up to the challenge and has recommended thoughtful 
rules--with a great deal of input from each of the five Commissioners--
that would implement the Act. Thus far, the CFTC has approved 39 
notices of proposed rulemaking, two interim final rules, four advanced 
notices of proposed rulemaking and one final rule.
    The CFTC's process to implement the rulemakings required by the Act 
includes enhancements over the agency's prior practices in five 
important areas. Our goal was to provide the public with additional 
opportunities to inform the Commission on rulemakings, even before 
official public comment periods. I will expand on each of these five 
points in my testimony.

    1. We began soliciting views from the public immediately after the 
        Act was signed and prior to approving proposed rulemakings. 
        This allowed the agency to receive input before the pens hit 
        the paper.

    2. We hosted a series of public, staff-led roundtables to hear 
        ideas from the public prior to considering proposed 
        rulemakings.

    3. We engaged in significant outreach with other regulators--both 
        foreign and domestic--to seek input on each rulemaking.

    4. Information on both staff's and Commissioners' meetings with 
        members of the public to hear their views on rulemakings has 
        been made publicly available at cftc.gov.

    5. The Commission held public meetings to consider proposed 
        rulemakings. The meetings were webcast so that the Commission's 
        deliberations were available to the public. Archive webcasts 
        are available on our website as well.

    Two principles are guiding us throughout the rule-writing process. 
First is the statute itself. We intend to comply fully with the 
statute's provisions and Congressional intent to lower risk and bring 
transparency to these markets.
    Second, we are consulting heavily with both other regulators and 
the broader public. We are working very closely with the SEC, the 
Federal Reserve, the Federal Deposit Insurance Corporation, the Office 
of the Comptroller of the Currency and other prudential regulators, 
which includes sharing many of our memos, term sheets and draft work 
product. CFTC staff has had 376 meetings with other regulators on 
implementation of the Act.
    Specifically, our rule-writing teams are working with the Federal 
Reserve in several critical areas: swap dealer regulation, 
clearinghouse regulation and swap data repositories, though we are 
consulting with them on a number of other areas as well. With the SEC, 
we are working on the entire range of rule-writing, including those 
previously mentioned as well as trading requirements, real time 
reporting and key definitions. So far, we have proposed two joint rules 
with the SEC as required by Congress.
    In addition to working with our American counterparts, we have 
reached out to and are actively consulting with international 
regulators to harmonize our approach to swaps oversight. As we are with 
domestic regulators, we are sharing many of our memos, term sheets and 
draft work product with international regulators as well. Our 
discussions have focused on clearing and trading requirements, 
clearinghouses more generally and swaps data reporting issues, among 
many other topics.
    We also are soliciting broad public input into the rules. On July 
21st, we listed the 30 rule-writing teams and set up mailboxes for the 
public to comment directly. We determined it would be best to engage 
the public as broadly as possible even before publishing proposed 
rules. We have received 2,851 submissions from the public through the 
e-mail in-boxes as well as 1,111 official comments in response to 
notices of proposed rulemaking.
    We also have organized nine roundtables to hear specifically on 
particular subjects. We have coordinated the majority of our 
roundtables with the SEC. These meetings have allowed us to hear 
directly from investors, market participants, end-users, academics, 
exchanges and clearinghouses on key topics including governance and 
conflicts of interest, real time reporting, swap data record-keeping 
and swap execution facilities, among others. The roundtables have been 
open to the public, and we have established call-in numbers for each of 
them so that anyone can listen in.
    Additionally, many individuals have asked for meetings with either 
our staff or Commissioners to discuss swaps regulation. To date, we 
have had more than 500 such meetings. We are now posting on our website 
a list of all of the meetings CFTC staff, my fellow Commissioners and I 
have with outside organizations, as well as the participants, issues 
discussed and all materials given to us.
    We began publishing proposed rulemakings at our first public 
meeting to implement the Act on October 1, 2010. We have sequenced our 
proposed rulemakings over 11 public meetings thus far. Our next meeting 
is scheduled for February 24.
    Public meetings have allowed us to discuss proposed rules in the 
open. For the vast majority of proposed rulemakings, we have solicited 
public comments for a period of 60 days. On a few occasions, the public 
comment period lasted 30 days. As part of seeking public comment on 
each of the individual rules, we also have asked a question within many 
of the proposed rulemakings relating to the timing for the 
implementation of various requirements under these rules. In looking 
across the entire set of rules and taking into consideration the costs 
of cumulative regulations, public comments will help inform the 
Commission as to what requirements can be met sooner and which ones 
will take a bit more time.
    We have thus far proposed rulemakings in 26 of the 30 areas 
established last July. We still must propose rules on capital and 
margin requirements, product definitions (jointly with the SEC) and the 
Volcker Rule. We also are considering comments received in response to 
advanced notices of proposed rulemaking with regard to disruptive 
trading practices and segregation of funds for cleared swaps.
    A number of months ago we also set up a 31st rulemaking team tasked 
with developing conforming rules to update the CFTC's existing 
regulations to take into account the provisions of the Act. This is 
consistent with one of the requirements included in the recent 
Executive Order issued by the President, entitled ``Improving 
Regulation and Regulatory Review.''
    In reviewing the Executive Order more broadly, the CFTC's practices 
are consistent with the Executive Order's principles. The CFTC has a 
robust process to involve and ensure public participation in the 
rulemaking process. The CFTC also consults broadly with other 
regulators to coordinate, harmonize and simplify regulations. We work 
to identify and consider regulatory approaches that reduce burdens and 
maintain flexibility and freedom of choice for the public. Further, the 
CFTC routinely seeks public comment on technical information and data 
considered during the regulatory process. Last, the CFTC conducts cost-
benefit analyses in its rulemakings as prescribed by Congress in Sec. 
15(a) of the CEA rather than as prescribed in Section 1 of the 
Executive Order. The statute includes particularized factors to inform 
cost-benefit analyses that are specific to the markets regulated by the 
CFTC. Thus, we will continue to fulfill the CEA's statutory 
requirements. Even though the statute dictates different cost-benefit 
analysis methodology, the CFTC's practices are consistent with the 
executive order's principles.
    In addition to considering conforming amendments to update the 
CFTC's existing regulations, we also will examine the remainder of our 
rule book consistent with the executive order's principles to review 
existing significant regulations. We intend to develop and make public 
a preliminary plan for the periodic review of significant regulations 
within the 120 day timeframe outlined in the Executive Order.
End-User Margin
    One of the rules that the CFTC will consider pertains to capital 
and margin requirements. As it relates to margin, the Act states that, 
``to offset the greater risk to the swap dealer . . . and the financial 
system from the use of swaps that are not cleared,'' regulators shall 
``help ensure the safety and soundness of the swap dealer'' and set 
margin requirements that are ``appropriate for the risk associated with 
the non-cleared swaps.''
    Congress recognized the different levels of risk posed by 
transactions between financial entities and those that involve non-
financial entities, as reflected in the non-financial end-user 
exception to clearing. Transactions involving non-financial entities do 
not present the same risk to the financial system as those solely 
between financial entities. The risk of a crisis spreading throughout 
the financial system is greater the more interconnected financial 
companies are to each other. Interconnectedness among financial 
entities allows one entity's failure to cause uncertainty and possible 
runs on the funding of other financial entities, which can spread risk 
and economic harm throughout the economy. Consistent with this, 
proposed rules on margin requirements should focus only on transactions 
between financial entities rather than those transactions that involve 
non-financial end-users.
Conclusion
    Before I close, I will briefly address the resource needs of the 
CFTC. The futures marketplace that the CFTC currently oversees is 
approximately $40 trillion in notional amount. The swaps market that 
the Act tasks the CFTC with regulating has a notional amount roughly 
seven times the size of that of the futures market and is significantly 
more complex. Based upon figures compiled by the Office of the 
Comptroller of the Currency, the largest 25 bank holding companies 
currently have $277 trillion notional amount of swaps.
    The CFTC's current funding is far less than what is required to 
properly fulfill our significantly expanded mission. Though we have an 
excellent, hardworking and talented staff, we just this past year got 
back to the staff levels that we had in the 1990s. To take on the 
challenges of our expanded mission, we will need significantly more 
staff resources and--very importantly--significantly more resources for 
technology. Technology is critical so that we can be as efficient as an 
agency as possible in overseeing these vast markets.
    The CFTC currently is operating under a continuing resolution that 
provides funding at an annualized level of $169 million. The President 
requested $261 million for the CFTC in his proposed Fiscal Year (FY) 
2011 budget. This included $216 million and 745 full-time employees for 
pre-reform authorities and $45 million to provide half of the staff 
estimated at that time needed to implement the Act. The President is 
scheduled to release his FY 2012 budget request soon.
    Given the resource needs of the CFTC, we are working very closely 
with self regulatory organizations, including the National Futures 
Association, to determine what duties and roles they can take on in the 
swaps markets. Nevertheless, the CFTC has the ultimate statutory 
authority and responsibility for overseeing these markets. Therefore, 
it is essential that the CFTC have additional resources to reduce risk 
and promote transparency in the swaps markets.
    Thank you, and I'd be happy to take questions.

    The Chairman. Thank you, Chairman. I will begin the 
questioning.
    We are hearing from companies across the country that the 
rulemaking process that CFTC may very well just simply be 
moving too quickly, and that the sequence of the rules is 
precluding them from commenting in a meaningful way. You have 
to figure out the chain of flow before you can offer comments. 
The proposed rules reflect what some are concerned might be 
rushed policies that potentially jeopardize the viability of 
the derivatives market, which ultimately would be to the 
impediment of the economy.
    You have acknowledged, Chairman, that it may be necessary 
to phase in compliance with the new rules, and we certainly 
commend you for those efforts and comments. But Chairman, the 
concerns about the rulemaking process are shared by market 
participants, not in any one particular part of the economy, 
but in a broad cross section. Despite statutory directives, 
CFTC and the SEC are not only moving in different directions, 
but the rules you are proposing on critical issues are 
inconsistent, including real-time reporting, the swap execution 
facility rules, the ownership and governance rules. In 
addition, you will need to build consensus, I would think, 
among your Commissioners, in line with the bipartisan tradition 
of this Committee, I strongly urge you to work to minimize 
those divided votes among your Commissioners and build 
consensus.
    So I guess that said, Mr. Gensler, does the Commission need 
more time to vet the rules, to collect the data, to build a 
consensus, to do all the things that are important so that we 
can minimize the adversarial consequences to the--adverse 
consequences to the market and our economy? Do you need more 
time, Chairman?
    Mr. Gensler. I think that the Congress laid out this 1 year 
timeframe, and that the Commission--I commend all of my fellow 
Commissioners and the excellent staff at the CFTC has reached 
out to the public. I commend the public. There has been 
enormous input. We have had well over 500 meetings with the 
public. I think we have had thousands of comments.
    We do, right now, have a natural pause. Though we have a 
couple of rules still--important rules to propose, we are where 
the public can now start to see the entire rule set, and in 
fact, one of the rules that has been raised is the entity 
definition rule whose closing period is in a couple of weeks, 
February 22. I would certainly encourage everybody in the 
public, if you have a comment on any of the rules that are out 
there, because there is this interplay that the Chairman talks 
about between the rules. Please submit it. Let us know in this 
period of time, and we will make sure that our Commissioners 
and the staff know all the comments and all the rules, even if 
a comment period is closed. We do have the discretion to 
continue to consider that, look at the whole mosaic.
    I don't envision us taking up final rules, really, until 
this spring, so there is a natural pause right now where we can 
hear from the public, hear from Congress, and consider this in 
the whole mosaic as we move forward. We are human. Some of 
these rules will be put in place after July. There is no doubt 
that some will be after July, but I think that we did have a 
significant crisis 2 years ago, and we are trying to address 
that crisis, and also lower regulatory uncertainty by finishing 
these rules.
    The Chairman. Chairman, we are very sensitive to the 
effects on the economy of these decisions. Can you assert that 
under the current statutory timeframes that the cost-benefit 
analysis that the CFTC has performed are related to each rule, 
and the rules imposed in a comprehensive fashion? Can you 
assert to me that they would stand up to an independent 
evaluation?
    Mr. Gensler. Well, we have actually direction from Congress 
in statute on how to comply with cost-benefit analyses. This 
agency, with this Committee's direction 11 years ago, has 
something called Section 15(a) of our statute that says how to 
do it, and to take into consideration many of the factors you 
talked about.
    So yes, Mr. Chairman, we--and all of our rules comply with 
the very directed, specific, cost-benefit analysis that 
Congress has laid out for us to consider factors like lowering 
risk, promoting price discovery, and the integrity of markets. 
By their nature, they are very important factors for this 
market.
    The Chairman. Can you commit to this Committee, Chairman, 
that without an extension of the statutory deadline, these 
rules will not impose undue costs on end-users or cause the 
distortion to the market by adversely impacting liquidity?
    Mr. Gensler. We are very sensitive to end-users. End-
users--the corporations, tens of thousands of them, 
municipalities, hospitals, small real estate developers, need 
these products to hedge their risk, and that is absolutely 
critical. That is why Congress left that--you can do customized 
bilateral swaps that are not going to be in the clearinghouses. 
I believe we are going to address the margin issue forthwith in 
March, very directly.
    So yes, sir, I believe that end-users will benefit, 
actually, from greater liquidity because there will be greater 
transparency in the marketplaces, but at the same time, not be 
brought into clearing or margining.
    The Chairman. Thank you, Mr. Chairman. My time has expired 
and I turn to the Ranking Member for his questions.
    Mr. Peterson. Thank you, Mr. Chairman.
    You know, one of the reasons we gave the CFTC the latitude 
here, we were looking at doing this ourselves. The more I dug 
into it, the more I realized it was pretty complicated stuff 
and we were probably going to screw it up. I think they are 
working through this and I believe that they are sensitive to 
this.
    I guess the question I have, it seems to me that these end-
users are actually going to have--lower their costs. If you get 
this information available, they are going to be able to go to 
more than one swap dealer and basically play them off against 
each other and get a better deal, right?
    Mr. Gensler. I think that they will have greater 
transparency, even if they don't have to come into the clearing 
or trading. In essence, they get the benefit because all their 
financial firms' transactions have to be in the clearing, so 
they get to see that pricing.
    Mr. Peterson. Do these end--have you looked into this? Do 
these end-users now do business with more than one entity, or 
are they basically always doing their swaps with one bank? You 
know, is there a way for them to actually go out to five banks 
and get the best deal? I mean, how does that work?
    Mr. Gensler. Congressman, they can----
    Mr. Peterson. I mean, there is no information----
    Mr. Gensler. Many end-users spend a significant amount of 
time in their treasury function, working with multiple banks, 
three to five, six. Sometimes they do put them in competition. 
But what a central exchange does is put them more naturally in 
competition, and they get the benefit of seeing that price.
    Mr. Peterson. I understand that, but I guess the stuff that 
can't be cleared or that is not enough for a clearinghouse. So 
we are going to make that information available and you are 
going to try to get that more out there in real time.
    So these customized trades, right now there is no 
information, nobody knows what is going on. So it almost seems 
like, with those kinds of things they are probably just dealing 
with, it is one bank in the dark in terms of what the pricing 
is.
    Mr. Gensler. You are absolutely right. The more customized, 
the more particular usually it is one bank. That still would be 
allowed, but you could also have the benefit of seeing where 
the standard transactions were priced, and you would say, ``Ah-
ha, it is over here, it is priced this way, I can get a better-
informed negotiation.''
    Mr. Peterson. Well, I personally think that what this fight 
is about is that this is actually going to reduce the spreads 
and reduce the profits of these Wall Street guys, and that is 
what is stirring all this up. That is what I think, but what do 
I know? I am just a dirt farmer from Minnesota.
    One of the other issues, there is this story about these 
banking elite getting together and trying to corner this market 
and keep this under control. We gave you guys some authority to 
try and go in there and try to put some rules on in terms of--
so that can't happen, so that we have--so we don't have the big 
Wall Street guys controlling these clearinghouses, which I 
think they have been trying to do. So where is that all in the 
process?
    Mr. Gensler. I think Congress recognized markets work best 
when not only are they transparent, but open and competitive, 
and you included that the clearinghouses have to have what is 
called open access, and the trading platforms have to have 
something called impartial access. So our proposed rules--and 
we look forward to the public comment on it--say on both of 
those that they really do have to be open. The clearinghouse's 
membership have to be far more open than currently exists. The 
clearinghouses have to manage their risk, but they can scale 
that risk. A smaller member would only have smaller 
participation, and then a bigger member, bigger participation.
    Mr. Peterson. Well, I heard some discussion that apparently 
some of the big financials have been resisting getting involved 
in some of these clearing entities because they--apparently 
because they can't control it or something. Is that--have you 
looked into that, or--I mean, has there been a reluctance to 
join some of the clearing folks that have been--that clearly 
know what they are doing and they have been operating and it is 
working, but because they can't--apparently because they can't 
control it, I guess.
    Mr. Gensler. Historically I think there is some truth to 
that. Clearinghouses, though, under the new Dodd-Frank would be 
far more open, because that is what Congress directed. There 
would be more competition amongst the dealers, and the public 
would benefit, I think from that competition, while we still 
will have the risk reduction of clearinghouses.
    Mr. Peterson. That is probably not going to happen until 
you actually get these rules in place that force this to 
happen, right?
    Mr. Gensler. I think that some of it will happen beforehand 
because they will see what is coming, and we will get very good 
comments and we will change some of the rules based on those 
comments, but openness and competitiveness was at the core of 
what Congress asked us to do in these rules.
    Mr. Peterson. Thank you. Thank you, Mr. Chairman.
    The Chairman. The gentleman's time has expired. We turn to 
the gentleman from Illinois, Mr. Johnson.
    Mr. Johnson. Thank you, Mr. Chairman.
    Let me address my comments or I guess my questions, Mr. 
Gensler, specifically to your--to the definition of a swap 
dealer under the Act.
    According to the rules that you promulgated in December, 
and be as specific as you can with this, how many entities do 
you think will be required to register as swap dealers under 
those rules, specifically? I know you can't tell me or I assume 
you can't tell me exactly, but as best you can.
    Mr. Gensler. That is an excellent question. We have 
estimated about 200. We looked at the ISDA website. They have 
over 800 members, and approximately--well, there are some that 
are called primary members----
    Mr. Johnson. So you are saying about 200?
    Mr. Gensler. About 200.
    Mr. Johnson. Okay.
    Mr. Gensler. Some of those I would say would be multiple 
dealers. Some of the big dealers have said they were going to 
register four or five or six legal entities, so that 200 
actually is fewer companies.
    Mr. Johnson. Do you recall--I am assuming you recall in 
February of 2009 at your confirmation hearing where you 
addressed that issue?
    Mr. Gensler. You could help remind me.
    Mr. Johnson. Yes, let me help remind you. Do you recall at 
your testimony before the Senate Banking Committee that you 
estimated between 15 and 20 entities would qualify for 
virtually the entire regulatory scheme? Do you recall that 
comment and that answer?
    Mr. Gensler. And that----
    Mr. Johnson. I am just asking you if you recall that. You 
do? You recall having given that response?
    Mr. Gensler. You have helped me recall that.
    Mr. Johnson. Okay. I guess what I am asking you is there is 
a pretty significant difference between 15 and 20 and 200. I am 
just wondering whether your viewpoint has changed in the last 
several years, or whether that is an evolutionary process as 
well.
    Mr. Gensler. Most of those 15 have told us they will 
register multiple legal entities. Some have said they were 
going to register six or seven, some have said four or five. So 
without naming the largest banks, but most of the largest banks 
have said they have several legal entities. So that----
    Mr. Johnson. Okay. I am assuming the answer is your 
viewpoint has changed.
    In terms of the de minimis exception, the definition under 
the Act, can you tell this Committee now specifically companies 
that would qualify for that exemption?
    Mr. Gensler. I don't----
    Mr. Johnson. I assume you are aware specifically explicitly 
included a de minimis exception under the definition of swap 
dealers. My question is, what entities exist now that you 
believe qualify for that exception?
    Mr. Gensler. Well, I think that many companies will not be 
swap dealers. Tens of thousands of companies will not be swap 
dealers because they are end-users. The de minimis exemption is 
also likely to include certain small banks, certain companies 
that from time-to-time might offer risk management services to 
others, but as a small number----
    Mr. Johnson. Can you give the Committee the names--
specifically the names of companies who qualify for that 
exemption?
    Mr. Gensler. I do not have names. They would come in and 
talk to us, and we are looking forward to the public comment to 
see whether we need to adjust that de minimis number, as well.
    Mr. Johnson. In terms of cooperatives, and I guess I am 
addressing my comments not only to the dairy co-ops that will 
have the opportunity to testify here--or at least on their 
behalf later, but also rural electric co-ops which play a huge 
role in many of our districts.
    What do you think--what is your viewpoint about the 
impact--let me rephrase that. Do you believe that those 
cooperatives, the dairy co-ops, let us even take the rural 
electric co-ops, will have to register as swap dealers, or do 
you think they will be exempt?
    Mr. Gensler. Let me take them one at a time. I am not 
familiar with any rural electric cooperative that has--and we 
have talked to them, has raised this issue, but we are looking 
forward to their public comment. I don't want to preclude--they 
might somehow raise a comment. On the dairy cooperatives, we 
have had a lot of very good dialogue, and I think it is wrapped 
into something, if I might say, related to how they do their 
business. Most of what they do, as I understand it, actually 
are not swaps, they are forwards. If there is an intent to 
deliver dairy product or cattle product or grain wheats, it is 
actually exempted. We are going to take--and I know that 
Congressman Peterson had a colloquy----
    Mr. Johnson. My time is coming to a close. I am not trying 
to cut you off, but I would like to get a specific answer, as 
best you can, as to whether you believe those cooperatives are 
going to be----
    Mr. Gensler. As best I can, I think most of what they do 
aren't even swaps, that they are forwards or forwards with 
embedded options. But again, we look forward to their comments. 
We are working very closely with the dairy cooperatives.
    Mr. Johnson. And I guess my concluding question in those 
cooperatives--because my time is coming to a close--what do you 
believe--I do--whether you believe that there will be a 
specific impact on the members of those cooperatives who are 
also obviously the farmers and otherwise, if they are subjected 
to regulation of this Act. I am assuming you think there will 
be an impact?
    Mr. Gensler. I think that they will benefit from the 
transparency from the marketplace, and we have put out a 
proposed rule that ag swaps should be treated similarly and 
they get the benefit of that, of other swaps.
    Mr. Johnson. Thank you for your comments.
    The Chairman. The gentleman's time has expired. We now turn 
to the gentleman from Pennsylvania for his 5 minutes.
    Mr. Holden. Thank you, Mr. Chairman.
    Chairman Gensler, I believe you tried to reference a 
colloquy that I think then-Chairman Peterson and I had on the 
floor during a debate where we talked about Farm Credit 
institutions and credit unions and small banks and thrifts 
being exempt because they did not cause the problem and they 
should not be subject to regulations. Is that what you were 
just attempting to say to Mr. Johnson?
    Mr. Gensler. It may have been part of that colloquy. I was 
referencing a forwards exemption colloquy, so it may have been 
part of that colloquy.
    Mr. Holden. Yes, because that was the intention of the 
legislation, that these institutions that did not cause the 
problem not be subject to it. And some of these institutions do 
have assets greater than $10 billion, particularly the big Farm 
Credit System. Are you considering exemptions there?
    Mr. Gensler. We have asked the public for comment in--I 
think it was in December--if I recall, to help us with regard 
to this. Congress gave us the authority under the clearing 
exemption to extend that to certain--I think the words in the 
statute was small banks, farm credit, and--I'm sorry, there was 
a third category--credit unions.
    Mr. Holden. Right, thank you.
    The Commission's proposed rule requires such reporting as 
soon as technologically possible and for lock trades a 
reporting delay of 15 minutes is permitted. From your 
discussions within the industry, what is technologically 
possible with regard to real-time reporting?
    Mr. Gensler. If it is traded on a platform, if it is traded 
on an exchange, as soon as technologically practical is within 
seconds. If it is bilateral, we recognize that in some 
circumstances that might take some time. But these are for the 
smaller transactions. The bigger trades, what are called 
blocks, there would be a delay and that is what Congress has 
asked us to do, and we have asked a lot of questions of the 
public about that delay.
    Mr. Holden. I had a public utility in to see me yesterday 
about this issue, and they thought 15 minutes was not 
reasonable. We had a meeting yesterday with Ranking Member 
Peterson and we seem to think--what is your opinion on what--if 
you had up to 24 hours as opposed to 15 minutes? What is the 
difference?
    Mr. Gensler. Well, I think then the market loses 
transparency. The market greatly benefits from real-time 
reporting. Now, in terms of that utility, that utility would 
not have to do a transaction on an exchange because they have 
an exemption from Congress to be out of it. So on the bilateral 
transactions, we have not suggested the 15 minutes. We have 
actually asked a whole series of questions as to what would be 
appropriate, and we put it in three categories. On an exchange, 
it is as soon as technologically practical, if it is small. If 
it is a block and it is on an exchange, it is a 15 minute 
delay, and the third category are these bilaterals where we 
just ask, frankly, a lot of questions.
    Mr. Holden. Thank you. Thank you, Mr. Chairman.
    The Chairman. The gentleman yields back his time. The chair 
now recognizes the gentleman from Texas, Mr. Conaway, for 5 
minutes.
    Mr. Conaway. Thank you, Mr. Chairman. Mr. Chairman, thank 
you, very good to be here.
    I am going to play off the Chairman's question in reference 
to cost-benefit analysis. The President sent out a letter a 
couple of weeks ago that directed Executive Branch agencies, 
which you didn't necessarily come under, that had a sentence in 
it that required cost-benefit analysis in the quantitative and 
qualitative natures must be considered. But in your testimony, 
you said that you are in principle going to put your agency 
under his letter, but then page seven and eight you say 
specifically that you are not going to use the definition in 
his paragraph, but instead, are going to fall back under 15(a).
    Reading both of those, some of the same words are used. 
Some would say there is really no distinction between the two. 
You apparently have made a distinction between the requirement 
under the President's letter to consider the qualitative and 
quantitative amounts for the cost-benefits. Why the distinction 
with pulling yourself out of that one sentence?
    Mr. Gensler. An excellent question, because Congress 
actually has prescribed a very detailed way that we do this 
under what is called 15(a), and it includes considering the 
price discovery market, lowering risk, the integrity of 
markets, and so we feel that we have a prescribed way and that 
we have to follow Congress. I think it is consistent. We have 
also asked the public in each of our rules, please comment on 
the cost-benefit analysis, share anything quantitative with us 
so we can be better informed as we move to final rule.
    So we do want to hear from the public on any quantitative 
means, but we need to follow Congress----
    Mr. Conaway. So you are thinking 15(a) is a stricter or 
more informative way to look at the cost-benefit analysis than 
what the President used in his letter?
    Mr. Gensler. Well, I don't want to comment on the 
President, but it is more informed because Congress tells us 
what we have to do, so we do feel we have to follow Congress, 
with all respect to his Executive Order.
    Mr. Conaway. Yes, it looked like his Order was better.
    Playing off of Mr. Johnson's question, if you do pick up 
commercial firms, energy companies and others in your 
definition of swap dealers, will you regulate their entire 
business? How will you distinguish--will they have to set up 
separate subsidiaries to run this through so that you don't 
reach into their non-swap dealer positions that----
    Mr. Gensler. It would only be on the legal entity. Some of 
the largest integrated oil companies also have a risk 
management business and it is in a separate legal entity, and 
we are working with them very closely. We are being informed by 
them even before we write the capital rules as to how they 
should apply, for instance, capital rules, but it would only be 
to the legal entity, or Congress gave us some authority to do 
it on the activities. So we can----
    Mr. Conaway. But your testimony to us is you have no 
intention of going after ExxonMobil's non----
    Mr. Gensler. No, no, no.
    Mr. Conaway. Whether they set up a separate entity and/or 
they just conducted it under the mother ship.
    Mr. Gensler. No, it would just be the legal entity that 
registered.
    Mr. Conaway. Pushing the OTC markets into an exchange-like 
environment where we have problems with the exchange-like 
environment, a phrase that is new to me, but maybe you guys are 
all--high frequency algorhythmic trading, which may have caused 
a flash crash, a new phrase. How is--how will you protect these 
new entities or this new exchange-like environment from, as we 
said earlier, new products and/or these existing kinds of 
massive consumer-driven trades that with your transparency and 
instant reporting allow folks to get ahead, whatever, take 
advantage of positions as these folks have?
    Mr. Gensler. At the risk of giving a shout-out to the CME 
over here, I know Terry is here, but the futures exchanges have 
very solid risk management practices--they are called 
safeguards--before you can enter a trade. So what we did in our 
execution platform, the SEF proposal, is we said to the public, 
please tell us which risk safeguard should be as a minimum 
involved here.
    What at a minimum should be there for this very reason? 
Also, Scott O'Malia, who heads our technology advisory 
committee, has asked that committee for a full report on what 
we can do in this way as well.
    Mr. Conaway. Thank you. One final comment. I am hopeful 
that, given the extensive input you are getting from users and 
everybody involved in your testimony and what you are actually 
doing, that there will be, between the proposed rules and the 
final rules, clear evidence that you did listen and that you 
did consider what folks had to say to you as opposed to just, 
here are the proposed rules. We received this massive 
information that is just too much to deal with. Here is the 
final rule.
    Mr. Gensler. We are absolutely listening and the five 
Commissioners--the back and forth is working. Not every comment 
will we agree with, but many of them are really helpful. They 
are all helpful, many of them we agree with.
    Mr. Conaway. Very politic of you.
    The Chairman. The gentleman's time has expired. I now 
recognize the gentleman from Iowa, Mr. Boswell, for 5 minutes.
    Mr. Boswell. Thank you, Mr. Chairman, and thank you, Mr. 
Gensler, for your good work. I have been pretty impressed over 
the last couple years, and I think you have a good crew and you 
are working very hard and very diligently. I appreciate it.
    I would associate myself with Mr. Conaway and, in fact, 
everyone who has spoken. I think we sincerely--and what they 
have said and what you said, we want transparency. Transparency 
kind of reveals all, and I would be interested what comment you 
might make--further comment. What is the resistance to 
transparency? I think I kind of know what it is, but I would 
like to hear what your thoughts are on it. What is the 
resistance, you know? Out in the rest of the world we would 
probably say they must have something to hide.
    Mr. Gensler. Well, information does sometimes lead to 
profits. If one has a profit motive--and absolutely, I honor 
this. I was on Wall Street for 18 years. Information is part of 
fulfilling your role to customers, but it is also a way to make 
profit.
    So I think Congress adjusted the information advantage a 
little bit more towards the end-user and the public, and a 
little bit away from the financial community. Not dramatically, 
but that little change has some resistance. Some also say it 
lowers liquidity. I don't necessarily concur with that. I think 
the transparency increases liquidity, as long as you have an 
appropriate exception for the large block trades. I think 
Congress asked us to do that, and we are looking forward to the 
public comment on whether or not we got the block trading 
exception correct.
    Mr. Boswell. Well, I think you are right on and I 
appreciate that, so I compliment your work. Keep it up.
    With that, since I am agreeing with what you said, Mr. 
Chairman and Ranking Member, I am going to yield back.
    The Chairman. The gentleman yields back his time. I now 
recognize the gentleman from Georgia, Mr. Scott, for 5 minutes.
    Mr. Austin Scott of Georgia. Thank you, Mr. Chairman.
    Chairman Gensler, did I understand your correctly to say 
that you don't have the budget currently to implement the rules 
and regulations that you are mandated to implement under Dodd-
Frank?
    Mr. Gensler. You heard me correct. We don't have the budget 
or resources to oversee. We can complete the rule-writing 
through this summer and early fall. We are human. Some of these 
will slip, but we only have about 680 people. We estimate that 
we probably need upwards to 400 more people. The markets are 
seven times larger and far more complex than the markets we 
currently oversee, and we think we need also to probably double 
our technology budget over some time.
    This is a challenge because our great nation has too much 
debt, and I appreciate this is not an easy ask that we might be 
asking this Congress to think about.
    Mr. Austin Scott of Georgia. Yes, sir, and it is one that 
might not happen. I would appreciate it if you would submit to 
the Committee an analysis of your anticipated budget and what 
positions those people would be hired into and what their roles 
would be.
    Mr. Gensler. We look forward to doing that, actually, I 
think next Monday or Tuesday. When the President reveals his 
overall budget, we also will send to this Committee, as we do 
annually, a full detail of that.
    Mr. Austin Scott of Georgia. Okay. Did I understand when 
you talked about the number of entities that when you were 
confirmed, you said it would be 15 to 20, now you are saying--I 
heard as many as 200 and then I heard well, some of the 
entities would do--so maybe seven times 20 is 140, but are we 
150, are we 200? I mean, how many different entities are we 
going to be----
    Mr. Gensler. We made an estimate for budgeting purposes, 
and we have looked closely at the International Swap and 
Derivative Association membership list. We have also looked at 
who has come in and knocked on our door, but you are absolutely 
right. Those 15 or 20 many have anywhere from four to seven 
each. Then we looked at the smaller entities that might only 
have one or two.
    Part of what happened is Congress included a provision that 
was associated with Chairman Lincoln at the time that said that 
some of the things had to be moved out of the bank into an 
affiliate, so that push-out provision sort of multiplied the 
number of potential dealers.
    Mr. Austin Scott of Georgia. If I may, Mr. Chairman?
    I guess, Chairman Gensler, one of the things I am having a 
difficult time with in the math there is how many employees you 
expect to have per entity that you are going to be regulating? 
I mean, if you do that math, in simple terms, what are you 
talking, six, eight, ten employees per entity that you are 
going to regulate?
    Mr. Gensler. Well actually, I wish it were that simple, but 
we currently only have the staff that we roughly had in the 
1990s to oversee the futures marketplace, so we oversee many 
other entities that are not swap dealers. They are called 
futures commission merchants and clearinghouses and the like. 
We were 620 people in 1992, we are 680 people now. With 
Congress's help we sort of got back to where we were to cover 
the futures market, but not for the swaps marketplace, these 
upward of 400 people would be to oversee potentially 300 to 400 
entities. We are going to work very closely with something 
called the National Futures Association and see how much we can 
delegate to them. The National Futures Association and Dan 
Roth, they are ready and willing to help out and take on many 
of these things, but we probably can't and shouldn't move 
everything to them.
    Mr. Austin Scott of Georgia. But again, you acknowledge 
that you don't have the budget necessary to handle the 
implementation of the rules?
    Mr. Gensler. That is a yes.
    Mr. Austin Scott of Georgia. And how does a bill get passed 
without--that mandates an increase in spending that doesn't 
have the spending tied to it?
    Mr. Gensler. Well, partly because there are different 
committees of authorization and appropriation--and we are on an 
annual budget cycle. Also, we are one of the few financial 
regulators that is not self-funded. I am not asking for that. I 
am just noting it. So many of the other financial entities 
are--have self-funding. The SEC and CFTC work with Congress and 
I look forward to this continuing dialogue on this.
    Mr. Austin Scott of Georgia. Thank you, Mr. Chairman. I 
yield the remainder of my time.
    The Chairman. The gentleman's time has expired, and it is a 
good thing the Chairman is not asking, because he is not 
getting that.
    I now recognize the gentleman from Georgia, Mr. Scott, for 
5 minutes.
    Mr. David Scott of Georgia. Thank you, Mr. Chairman.
    First of all, Mr. Gensler, let me ask you. I have heard 
from a few of our market participants that the CFTC's proposed 
rule on margin segregation is highly problematic, and perhaps 
unnecessary. According to them, the proposal could potentially 
raise the cost of clearing with only small risk management 
benefits, and since we are not requiring the same customer 
protection in future clearinghouses which have never failed, I 
question the need for the change, given the fact that swaps and 
futures should be regulated in an equivalent manner.
    So my question to you is this. If what these folks are 
saying is true, then can you explain why CFTC is exploring this 
issue when, number one, it is not required to do so by the 
Dodd-Frank legislation, and number two, it could be very 
expensive for market participants, and number three, it is 
directed towards a problem that does not even seem to exist.
    Mr. Gensler. The question that Congressman Scott asks 
relates to what we put out, an advance notice of proposed 
rulemaking, not a proposal, but it is a way to gather input on 
the question of segregating customer funds at the 
clearinghouses. Congress says that funds should not be 
commingled, except for convenience. That is roughly how it is 
worded. In the futures industry, customer funds have been 
commingled for convenience.
    Many of the buy-side, meaning big pension funds and asset 
managers, asked us to explore segregated accounts. So rather 
than making a proposal, we actually just ask a series of 
questions. That comment period recently closed. We are 
reviewing--and you are right, Congressman, many people said to 
go to full segregation might raise costs, and so the 
Commissioners and the staff are reviewing those comments even 
before we make the proposal. It has been very beneficial.
    There are some differing views. Some, I will say, on the 
pension side and asset management side would like to continue 
to have segregated accounts. Many in the clearing community and 
others raised the cost factors, and we are going to sort this 
through even before we make a proposal.
    Mr. David Scott of Georgia. Well, that is very good because 
I think that you should, and especially since it is not 
required by the Dodd-Frank legislation. If some of these folks 
are saying that it is very, very expensive, I think--and my 
suggestion is you really look at it with a very jaundiced eye 
here. I appreciate that.
    Let me ask you another question. I want to go back to 
something Mr. Johnson had brought up into this whole issue of 
the carve-out, the de minimis carve-out. Can you tell me 
specifically how the CFTC came up with the proposed notional 
value dollar amount, one, and the yearly swap limit?
    Mr. Gensler. In working with the Securities and Exchange 
Commission--this was a joint role--we had to start somewhere. 
What is the meaning of the word de minimis, and to remember, 
all end-users are out. It is just if you do some risk 
management services, if you offer yourself as a dealer, when is 
it de minimis? So I think we proposed a $100 million notional 
amount. I apologize; I can't remember the exact statistics on 
the number of counterparties. We are looking forward to public 
comment on that, but we are trying to follow Congressional 
intent. End-users are out, but what does this word de minimis 
mean and working with the SEC and hearing in many of these pre-
meetings what some people do, we have made a proposal.
    Mr. David Scott of Georgia. Yes. Can you tell me what kind 
of firm that the CFTC had in mind when crafting this carve-out, 
and does such a firm even exist?
    Mr. Gensler. It was a firm that, in essence, did not have 
end-users behind them of any magnitude. So if you are holding 
yourself out to end-users and making markets, then it is 
possible that you are actually a swap dealer. If, in fact, you 
just have five or ten counterparties, it is far more likely you 
are an end-user.
    So it was trying to relate that somebody that just has five 
or ten counterparties, that is not a swap dealer. That doesn't 
have----
    Mr. David Scott of Georgia. And are you willing to revise 
this carve-out to make it meaningful to non-systematically 
risky commercial companies that offer swaps, so that they can 
conduct their business without being caught up in the same net 
as the large banks?
    Mr. Gensler. Well, we look forward to the public comment on 
all of these, so revisions, as I said to Congressman Conaway, 
there are going to be numerous revisions. I just don't know in 
this de minimis area how it will be revised. There are some 
non-bank swap dealers, a few of the very largest integrated oil 
companies have come in and we are talking to them and working 
with them, who actually provide risk management services 
downstream to hundreds of end-users. I think it was Congress's 
intent that there will be some non-banks. In essence, AIG was a 
non-bank swap dealer. But we take very serious that there is a 
de minimis exemption, and we look forward to the public's 
comment on it.
    Mr. David Scott of Georgia. Thank you very much, and thank 
you, Mr. Chairman.
    The Chairman. The gentleman's time has expired. I now 
recognize the gentleman from Tennessee, Mr. Fincher, for 5 
minutes.
    Mr. Fincher. Thank you, Mr. Chairman. Thank you for your 
time today.
    A couple of questions, just quick. Have you assessed the 
impact of derivatives business moving to the foreign markets?
    Mr. Gensler. We are working very closely with the foreign 
regulators to ensure, as best we can, with different cultures 
and different political systems that we have consistent 
regulatory treatment. I am optimistic. Certainly in the 
clearing world, the end-user exemption, the data repositories, 
the dealer world, Europeans and we are quite aligned. They are 
still probably time-wise behind us. They are not moving as 
quickly, but I think this spring and summer they will probably 
take it up in their European Parliament, so we are working very 
closely to ensure, as best we can, consistency.
    We have done one other thing, if I might say. We actually 
have shared a lot of our internal work paper, our memos and 
everything in the fall with the Europeans and in some instances 
in Japan and Asia, the actual documents to get their feedback 
so we could be as aligned as possible, again, given they 
haven't passed their law yet.
    Mr. Fincher. The second question--and I will echo what Mr. 
Boswell said a few minutes ago about transparency being the key 
here. We can see what is happening. Which regions of the 
country may be affected the most?
    Mr. Gensler. Well unfortunately, every region of the 
country had to put up $180 billion into AIG, so I think 
transparency lowers the risk of these toxic assets for every 
region of the country. And I think every region of the country 
uses these derivatives. There are $300 trillion, which if you--
just the arithmetic is $20 of swaps for every dollar in the 
economy. It could be when somebody drives up to a gas station 
in Wichita or Frederick, Maryland, or anywhere that that gas 
tank somewhere somebody has hedged behind it. So greater 
transparency and lower risk will benefit the economy at large.
    Mr. Fincher. Thank you. Thank you, Mr. Chairman.
    The Chairman. The gentleman's time has expired. I now 
recognize the gentlelady from Ohio, Ms. Fudge, for 5 minutes. 
Okay. I now recognize the gentlelady from Alabama, Ms. Sewell. 
I now recognize Mr. McGovern for 5 minutes.
    Mr. McGovern. All the questions I was going to ask have 
already been asked, but I appreciate very much your being here, 
your testimony, and look forward to working with you. I am 
particularly concerned about the issue of making sure you have 
adequate funding to be able to carry out your enormous task 
here. I just want to say thank you for your great work.
    Mr. Gensler. I thank you. It is good to see you again.
    Mr. McGovern. Nice to see you again.
    The Chairman. The chair now recognizes the gentlelady from 
Missouri, Mrs. Hartzler.
    Ms. Hartzler. Thank you, Mr. Chairman.
    I have had a lot of interesting discussions over the last 
few weeks with people in my district, people in my area, and I 
represent a large agriculture area. I have visited with people 
from the Kansas City Board of Trade last weekend. I visited 
with the utilities in my district, and I can tell you the 
common thread among all of them is that your staff is going far 
beyond the--what the bill's original intent is. It is a huge 
amount of regulations. It is going to be very onerous on 
businesses and on the way things are supposed to be conducted. 
I understand you have over 31 teams of people writing these 
rules, and yet the people that are going to be impacted by them 
don't have teams, and they have one, two, three individuals 
that are trying to wade through. The proposals that you have 
put forth for these rules are 45 pages long, 26 pages long, 60 
pages long. Here is a specific comment that was made by the 
President of the Kansas City Board of Trade in a letter, and I 
would like for you to, just in general, respond to it. It says 
``As you might suspect, we have been suffering through the 
myriad of regulations pouring out of the CFTC's result of the 
financial regulatory reform legislation. We are concerned and 
disappointed that the CFTC is using the Dodd-Frank legislation 
to not only implement a regulatory regime for previously 
unregulated OTC trading, but as an opportunity to propose 
unnecessary and extremely prescriptive regulations on already 
regulated derivative markets. The regulated markets were not 
the cause of the 2008 financial crisis. In fact, these 
regulated markets operated exemplary under regulatory 
initiatives required to implement under extreme market 
volatility and pressures. We are left wondering why, with all 
the regulatory initiatives required to implement the provisions 
of Dodd-Frank, does the CFTC find it necessary to impose 
prescriptive regulations on an already well-functioning 
regulated marketplace?'' That is just one of the comments that 
I have heard. I would like for you to respond.
    Mr. Gensler. I thank you. Two thoughts. One is really, we 
encourage the public, if you have a comment on any of the 
rules, even if a comment period has closed, we have discretion, 
the staff and the Commissioners, to still consider that. I note 
that one of the rules that people most focus on is this 
definition of swap dealer. That comment period closes in a 
couple weeks, February 22, to be more precise. I would hope 
that the public, if you have, looking at the whole mosaic, want 
to comment, comment. We will get it to the right staff, we will 
get it to all the Commissioners. We have that discretion.
    The second thought I just wanted to share with you because 
it comes from the really fine people at the Kansas City Board 
of Trade. One of the reasons we have taken up rules with regard 
to clearinghouses and what is called designated contract 
markets of futures exchange as the Kansas City Board is, is 
because now they can also offer swaps. Congress said that a 
clearinghouse, if they wanted to at the Kansas City Board or 
their exchange, could offer swaps.
    So the product can also be there. I haven't personally read 
his letter. Now I will make sure to read it closely. The 
futures marketplace has been a strong, vibrant, transparent 
marketplace, and largely we want to make sure the swaps 
marketplace learns from that and is similar to the futures 
marketplace.
    Ms. Hartzler. Yes. I would just hope that the CFTC doesn't 
use--only abides by the parameters in the legislation, and we 
can discuss what has been passed. I would like to repeal a lot 
of it, but that is currently on the books and don't overstep 
what is there to try to reach out further. We need less 
regulations overall, I believe.
    Mr. Gensler. Let me assure you, I share your view. July 20, 
the day before the President signed a bill, we got the 30 team 
leads together and I said we shouldn't over-read this statute 
nor under-read this statute. We should just do what the statute 
tells us to do. It is a very historic piece of legislation. 
That is what we are doing and hopefully with public comment, we 
will keep being reminded of that.
    Ms. Hartzler. Thank you. Transparency, yes, is important, 
but it is more important or just as important that in our 
economy, we don't hurt businesses that are currently working 
for jobs and for our overall country. Thank you.
    Mr. Gensler. Thank you.
    The Chairman. The gentlelady's time has expired. We now 
turn to the gentlelady from Maine. We now turn to the gentleman 
from North Carolina for his 5 minutes.
    Mr. Kissell. Thank you, Mr. Chairman. Mr. Gensler, thank 
you for being here today.
    We have heard a lot of comments about public comments, and 
not trying to speculate or to foresee where the comments might 
be going, but just curious, what do you feel is the area the 
public is most concerned about, has commented about, maybe 
misunderstands, maybe just--you know, what is the feel for what 
the public is saying so far?
    Mr. Gensler. That is an excellent question. We have had 
about 2,800 comments before we made the proposals, 500 
meetings, and 1,100 comments after the proposal so far. It is a 
little hard to bring it all together. Usually comments are 
about something that affects them. That is a natural thing. 
End-users, which we have had a lot of debate and discussion 
about, want to ensure that the margining doesn't cover them. I 
think hopefully we have addressed that in these prepared 
remarks that we don't see extending margin to these non-
financial end-users, at least at the CFTC.
    There have been a lot of end-users that wanted to make sure 
they weren't caught up in the major swap participant 
definition. That seems to have calmed down greatly once we put 
the proposal out, because we really made those numbers very 
large and systemic. There are still, as people have talked back 
and forth, end-users who don't want to be caught up in this 
swap dealer definition.
    So I am giving you some sense of it. If you move over into 
the Wall Street community, the Wall Street community is largely 
about timing of implementation, that they need to get the 
resources to do it, and so forth. There is a back and forth 
about transparency. Transparency tends to help the end-users. 
It probably shifts some of the advantages away from the 
financial community, modestly.
    So there is a lot of back and forth about transparency with 
the financial community.
    But I am trying to summarize. I guess that would be about 
4,000 comments and 500 meetings. It is not fair to any one 
commenter to try to summarize all of that.
    Mr. Kissell. Thank you, sir, and I yield back, Mr. 
Chairman.
    The Chairman. The gentleman yields back. The gentleman from 
Kansas is now recognized for 5 minutes.
    Mr. Huelskamp. Thank you, Mr. Chairman. I appreciate the 
opportunity to ask a couple questions here. I just want to 
follow up on a few of the earlier questions, if I may.
    Mr. Chairman, you did note--made some comment, I guess, if 
one does have a profit motive--I think it was a reference to 
those that would qualify. Are there folks in this marketplace 
that do not have a profit motive?
    Mr. Gensler. There are many nonprofit entities that use 
derivatives and should be allowed to use derivatives, 
hospitals, municipalities and so forth.
    Mr. Huelskamp. I was presuming when you said they didn't 
have a profit motive that somehow they weren't trying to 
protect a risk or had a financial interest, but they certainly 
all have a financial interest, correct?
    Mr. Gensler. Oh, I think that is correct. I think it is 
hedging a financial interest, hedging a commodity, wheat or 
corn. There can be speculators, who are certainly a very 
important part of the markets as well.
    Mr. Huelskamp. And which portions of the markets would the 
speculators versus the end-users that are hedgers?
    Mr. Gensler. Well, the way that Congress laid out the end-
user provision, if it is not a financial company, so not a bank 
or insurance company, and it was hedging a commercial risk, it 
is out of clearing and we believe out of margin. We put a 
proposal out that said you could be hedging any input, any 
service, you could be hedging a factory, a loan, any commodity. 
We look forward to the public comment, but we tried to be very 
expansive and exhaustive in terms of defining that hedging out 
widely. Again, we will get the public comment to see if we 
missed something, but we tried to be pretty expansive on that.
    Mr. Huelskamp. Thank you, and I appreciate that.
    It is my understanding as well that you do have the 
authority to exempt small banks and small Farm Credit System 
institutions and credit unions from the clearing requirement. I 
just want to know for certain, do you intend to exempt these 
entities?
    Mr. Gensler. We look forward to hearing from the public. We 
have not as a Commission made any determination, other than 
Congress gave us the authority to exempt and we have asked 
questions from the public as to how we should address that 
authority.
    Mr. Huelskamp. Any information or any discussions 
internally? I mean, do you--can you give a sense whether you 
plan on using that authority, or you are just going to wait 
until July and let us all know then?
    Mr. Gensler. No, I think our comment period will close 
earlier, and if we were to use it, we would have to propose an 
exemption, but I don't want to get ahead of the staff and my 
fellow Commissioners. I think we need to really take in what 
people have said. This is with regard to the clearing 
exception.
    Mr. Huelskamp. Do you--so you believe you could wait until 
July 1 to let folks know whether they are exempted or not, or 
will you let them know before that time period? Any thoughts on 
that?
    Mr. Gensler. Well, again, we have an active schedule to 
review the comments, to take those up. If we were to exempt, we 
would be making a proposal well in advance. I mean, that is 
part of our spring agenda is to take up the clearing 
requirements.
    Mr. Huelskamp. So do you expect these small entities to 
comment on all the proposed rules and tell if and when they 
find out they are exempt?
    Mr. Gensler. Well, the small entities to which you are 
referring by and large are not swap dealers. There may be one 
or two exceptions that--I can't speak for thousands. There are 
7,000 or 8,000 small banks in this country. I doubt many of 
them are swap dealers.
    So this is just about the clearing requirement, and we are 
getting comments in about this authority to possibly exempt, 
whether it be the Farm Credit, the credit unions, or the banks.
    We are also working with the regulators. We worked very 
closely with Debbie Mantz and her people, and of course, the 
folks at the Farm Credit Administration and the banking 
regulators.
    Mr. Huelskamp. Do you believe these small financial 
institutions pose a threat to the stability of your system?
    Mr. Gensler. I think the threat is the other way. Clearing 
lowers risk to the whole economy, and I would hate to come to 
the day when a Secretary of the Treasury says I can't let a big 
bank fail because they are so interconnected to the Farm Credit 
System. The risk is the other way in that some 10, 20 years 
from now a Secretary of the Treasury says I can't let them fail 
because they will bring down the Farm Credit System. That is 
the problem.
    Mr. Huelskamp. So in your opinion, they do not pose a risk? 
It is the risk the other way?
    Mr. Gensler. Yes, but then it is this interconnectedness 
that is the risk.
    Mr. Huelskamp. Thank you, Mr. Chairman.
    The Chairman. The chair now turns to the gentleman from 
Vermont for 5 minutes.
    Mr. Welch. Thank you very much, Mr. Chairman.
    Mr. Gensler, as I understand it, there are two goals here. 
One is to make certain that the hedging a benefit is absolutely 
available at the least possible costs and the least possible 
threat to the overall financial condition of the economy to 
end-users. Is that correct?
    Mr. Gensler. I believe that is a key goal in transparency 
and competition helps avail to that goal.
    Mr. Welch. Right, and those are--transparency and 
competition are seen as tools to help provide benefit--economic 
benefit to the end-user, correct?
    Mr. Gensler. Correct.
    Mr. Welch. Then ultimately the American public.
    Mr. Gensler. Right.
    Mr. Welch. And there is--if you have end-users, they also 
rely on some financial institutions in order to carry out the 
trades that provide them with the hedging protection. Is that 
more or less what the relationship is?
    Mr. Gensler. That has been historically correct, but there 
are also on-exchange transactions. Even in the futures market 
it is relying on the marketplace. It could be a speculator on 
the other side or another hedger on the other side anonymously 
on the other side through centralized markets, which work very 
well, and in fact, often have more transparency.
    Mr. Welch. All right. So if you are an end-user, an airline 
or a farm operation, your interest, presumably, is in getting 
the best price for the product you are buying to hedge, 
correct?
    Mr. Gensler. And also to get something that fits your 
hedging needs is very important.
    Mr. Welch. Is there any reason why transparency in 
immediate or reporting that is as soon as technologically 
possible as to the transaction would be an impediment to a 
hedger from getting what they need?
    Mr. Gensler. I believe as long as we follow Congress's 
mandate that the blocks are delayed and second, that we protect 
that the confidentiality of the parties, that it is not an 
impediment, but we still need to make sure that we protect the 
confidentiality of the parties, of course.
    Mr. Welch. All right. So some of the financial 
institutions, I understand, have raised questions about this, 
and I am wondering if you could just state what you understand 
to be their arguments?
    Mr. Gensler. Their argument is that it could take time to 
hedge their product. If it is a block trade they would have a 
time to hedge their product. Certainly if it is on an exchange, 
one would hope that they have enough liquidity.
    The second argument they would say is that somehow we are 
diminishing liquidity. I don't actually think the economic 
study shows that. I think transparency enhances liquidity, not 
diminishes liquidity, but they would take the other side of 
that, and I respect that we might have a difference on that.
    Mr. Welch. And just, if you could, try to explain to us 
what they claim is the rationale for that argument.
    Mr. Gensler. They might say that they themselves would take 
on less risk. This is a marketplace that is very large, $300 
trillion. If I could just do a little arithmetic, one percent 
of one percent is $30 billion, so if transparency brings just a 
little better pricing, one percent of one percent, which is 
called a basis point on Wall Street, is $30 billion. So you 
could see what is--there is a lot at stake here, and end-users 
can't always see these little basis points, but they add up 
like the grains of sand in the financial sector.
    Mr. Welch. When the NASDAQ market went to a more 
transparent system and there was more transparency in immediate 
reporting between the bid and the ask price, were some of the 
arguments that were made in opposition to making that change 
similar to what you are hearing now?
    Mr. Gensler. I don't want to say they are identical, but 
they are often similar.
    Mr. Welch. And has it played out with the changes that were 
made in NASDAQ that did increase transparency and timeliness of 
reporting, has that proven to be an impediment to the financial 
firms?
    Mr. Gensler. As I understand it, it has increased 
competition and increased liquidity in the marketplace. It also 
narrowed what is called the spreads or bid offer spreads in the 
marketplace.
    Mr. Welch. Okay, thank you. I yield back, Mr. Chairman.
    The Chairman. The gentleman yields back his time. I now 
turn to the gentleman from Illinois, Mr. Hultgren, for his 5 
minutes.
    Mr. Hultgren. Thank you, Chairman Lucas. Thank you, 
Chairman Gensler.
    Under Title VII, Congress took an appropriate step and 
provided an exemption from the major swap participant 
definition for pension funds. While the protected pension--this 
protected them from inappropriate regulations as MSPs, pension 
funds are included under the definition of financial entities. 
I am concerned about the substantial cost this will impose on 
pension funds, especially from Illinois and see the significant 
strain that our state and other states are feeling, and I am 
very concerned about the unfunded obligation that we are facing 
there.
    Chairman Gensler, my question is can you commit to this 
Committee that in the rules that will impact pension funds and 
their trading relationships, the CFTC will take every 
precaution not to impose significant and additional new costs 
on pension funds?
    Mr. Gensler. Well, I think that we are--when we look at all 
the rules, if I can expand a bit, past pension funds, we take 
seriously the guidance from this Congress about cost-benefit 
analysis. Pension funds, I don't believe that there is a 
pension fund that has come in after we proposed the rules that 
say that they are going to be a major swap participant, so I am 
not aware there are any. But please, I look forward to 
continuing a dialogue if you know of some. We want to know what 
we need to do there in the major swap participant area, but 
more broadly, I think your question is to ensure that pension 
funds get the benefit of the transparency in these markets. 
Pension funds, some of them were the ones that asked us to look 
at that earlier issue that Congressman Scott asked about. So, 
we are working and listening to a lot of pension funds who want 
transparency and issues resolved for their benefit in this 
marketplace.
    Mr. Hultgren. So pretty much to answer the question, you 
don't see any additional cost that you would expect from the 
rulemaking--from the decisions that you will be making that 
will impact pension funds?
    Mr. Gensler. Well, I think that pension funds are going to 
benefit from the additional transparency, the safeguards in 
clearing, the safeguards in segregation of their funds. I don't 
know if we will come out with individual or commingled or funds 
some other issue.
    I don't know of any pension fund that will be a dealer or a 
major swap participant. Again, if there is one, I am sure my 
saying this they will find us. They all seem to find us.
    Mr. Hultgren. One quick question here as my time is winding 
down.
    Competitiveness is very important for us, especially in the 
world stage here. How does the CFTC ascertain whether its rules 
will cause U.S. firms or swap transactions to move overseas, 
and if you have made any determination there, what are you 
doing to make sure that we keep firms here?
    Mr. Gensler. Congress included in statute a provision to 
cover transactions that have a direct and substantial effect in 
the U.S., 722(d). I know it well because I have read it so many 
times. Most of the international banks have been in and say 
they will register swap dealers because they are doing business 
with U.S. end-users. So, all these major banks say they will 
register. We still have a lot to sort through on this, and it 
is going to be very helpful to hear from the financial 
community that we are covering the trades that have that 722(d) 
effect. It affects the U.S. markets and the U.S. end-users and 
so forth.
    We are also working with the international regulators to 
ensure the best they can that they adopt similar rules. We have 
a very close partnership with the European community, and with 
the folks in London. Japan moved ahead of us. They adopted 
their rules last year. But we are working together very 
closely. I think I am going to be back in Europe again in 
March, and the European Parliament is taking up their 
legislation.
    Mr. Hultgren. So you do recognize that the rules that you 
make could affect whether firms decide to remain here in 
America or move overseas, and that will be part of your 
calculation or part of your planning? Is that right?
    Mr. Gensler. It is absolutely part, but we are, as mandated 
by Congress to ensure that we cover those transactions that are 
happening with U.S. entities or other direct and substantial 
affect here. So regardless, even if it is an overseas entity 
dealing with a U.S. counterparty, that overseas swap dealer is 
likely covered under the Act and will be registering. Most of 
them have come in and say they anticipate registering to deal 
with U.S. counterparties.
    Mr. Hultgren. Thank you, Mr. Chairman.
    The Chairman. The gentleman's time is now expired. We turn 
to the gentleman from California to be recognized for 5 
minutes.
    Mr. Costa. Thank you very much, Mr. Chairman.
    Just to kind of continue to pursue that line of 
questioning. You said the Japanese in the process of 
implementing their regulations and the Europeans--I do some 
work with the European Parliament, I know, are under their 
deliberation. There has been a lot of speculation, I know, 2 
years ago when we talked about the whole notion of 
clearinghouses and whether or not there would be a competitive 
advantage or disadvantage on either continent, based upon the 
new set of rules we were establishing. The question is 
speculative, but could one not determine or think that based 
upon what is going in Japan, and now what is going on in 
Europe, that there is not going to be some sort of a sense in 
which there is a similarity in terms of the way ultimately this 
gets worked out so that--I mean, or do you think that when you 
meet and confer with your counterparts in Europe, that they are 
trying to seek a competitive advantage or disadvantage that 
would allow those to register in one continent versus the 
other?
    Mr. Gensler. Excellent question. As it relates to clearing, 
I think we are very much in line. There is an international 
forum called IOSCA that works on these international standards 
for clearing and elsewhere. We currently have registered 15 
clearinghouses. We think that will grow to 20 or 21, maybe 
there will be some others. Some of those are overseas. For 
instance, the largest interest rate swap clearinghouse we have 
today is in London. It has been registered with us since 2001. 
It has $240 trillion of interest rate swaps.
    Mr. Costa. I think we met with them.
    Mr. Gensler. So we already have that, and so even if it is 
over in Europe or in Japan and wants to do business here in the 
U.S., we will register it. We will then work on a Memorandum of 
Understanding with that foreign regulator so we can leverage 
off their expertise. We are resource constrained anyway, but we 
work and we have these Memoranda of Understanding with the 
Europeans, with Canada, and a number of other places.
    Mr. Costa. As this process continues, I think we will want 
to revisit that. It should be very interesting to see how it 
settles.
    Mr. Gensler. I think you are absolutely right, and I think 
that there will be some attempts for regulatory arbitrage. I 
don't think it will be in the clearing space, but I am not 
naive. It could be.
    Mr. Costa. Getting back to the--and I believe the Chairman 
touched on it in his opening comments, obviously this is a 
complex law that you are in the process of doing your 
rulemaking and your implementation. We talked about the 
timeline for public input, and then following there your 
process. Are you going to come out with some actual timelines 
for us in the near future that you can present to the Committee 
as to how this will roll out over the course of this year and 
when the rules will actually be published in the Federal 
Register, and where will you go from there?
    Mr. Gensler. We are going to take this pause period, 
February and March as I call it a pause to look at the whole 
mosaic. We probably--I hope that we will have some further 
roundtables to hear from the public about the implementation 
phase and what can be done early, what can be done later in 
terms of implementation. And as we firm that up, I think we 
would be sharing it.
    The other piece----
    Mr. Costa. But I mean after the public input is complete, 
then, I mean, you are going to need time to them formulate----
    Mr. Gensler. That is right.
    Mr. Costa.--the rules and--I mean, do you see this all 
being concluded by the end of this year?
    Mr. Gensler. I think so. Congress has actually asked us to 
do it by July, and we are human, so some of it will certainly 
be after July. But I would envision it starting this spring and 
summer we will be taking up the final rules. We will be 
publishing. Some of them will be the easier, maybe less 
controversial ones early.
    Mr. Costa. Two quick questions here before my time is 
expired. What percent of the swap markets do you believe are 
between the non-financial end-users and financial entities, and 
does the size of the swap markets allow exemption to safely 
exist?
    Mr. Gensler. Based on Bank for International Settlements 
data, it is somewhere in the order of nine or ten percent of 
notional amount is between non-financial entities or the end-
user exception. I believe Congress addresses----
    Mr. Costa. Quickly, before my last question. Foreign 
currency swaps, will they be regulated under the swaps under 
the law by the Secretary of the Treasury? Have you spoken with 
the Secretary of the Treasury?
    Mr. Gensler. I think you would have to ask the Secretary of 
the Treasury what he is going to do on that, with all respect. 
Congress gave him the authority and he and I have spoken about 
it, but it is certainly the Secretary of the Treasury's 
determination to make and to share with Congress.
    Mr. Costa. Do you expect a decision for him to make--when 
do you expect a decision for him to make? Do you----
    Mr. Gensler. I don't know. Certainly I would be glad to 
direct your question to the Treasury and ask them to comment to 
you. I don't know if they have made that public.
    Mr. Costa. Thank you, Mr. Chairman. My time has expired.
    The Chairman. The gentleman's time has expired. The chair 
now turns to the gentleman from New York, Mr. Gibson, for 5 
minutes.
    Mr. Gibson. Thanks very much, Mr. Chairman, and I want to 
apologize to our witness. I have multiple hearings that I am 
taking care of today. I did confer with my aide before I got 
back in, and it has been a very comprehensive hearing, and you 
have answered nearly all of the questions that I had.
    Really, just a simple one remains. How big do you assess 
the over-the-counter market is, in terms of dollars and 
participants?
    Mr. Gensler. The market worldwide is about $600 trillion 
notional, about a little less than half of that is here, but 
let us call it $300 trillion. The 25 largest bank holding 
companies have about $277 trillion, as of the most recent data 
from the Comptroller of the Currency. Participants, thousands 
of participants are in it because they use it as a hedging, all 
these we have been calling end-users use it to hedge, but I 
can't tell you how many. It is probably over 10,000 that 
actually use it.
    Mr. Gibson. And so given that, it is certainly a daunting 
challenge. Do you feel that the pace of which you are going to 
unfold these regulations can be absorbed by this market?
    Mr. Gensler. I think that through the extensive work that 
Congress did in its oversight and putting together the Act and 
the extensive work the Securities and Exchange Commission and 
CFTC are doing, the major market participants who will be 
either swap dealers or clearinghouses and so forth have been 
very seriously engaged. The end-users, by and large, are 
exempted from clearing, trading, and I believe should be from 
the margining.
    So I would say yes, in terms of these large clearinghouses 
and financial entities. They are very engaged. I think as it 
relates to the CFTC, I think this schedule that Congress has 
laid out is doable. We are human. Some of it will slip, and I 
believe we are committed to looking at our whole rule book as 
the President put in the Executive Order. We are going to look 
at the rest of our rule book and see if that needs to be 
updated as well. We are going to publish some plan to do that 
in the next 120 days or 120 days from when he made his 
Executive Order.
    Mr. Gibson. Okay, I appreciate the responses. I am somewhat 
concerned, but I have noted what you said and I look forward to 
working with you as we go forward.
    Mr. Gensler. I look forward to working with you directly as 
well.
    Mr. Gibson. I yield back.
    The Chairman. The gentleman yields back the balance of his 
time. The chair recognizes the gentleman from Illinois, Mr. 
Schilling, for 5 minutes.
    Mr. Schilling. Thank you, Mr. Chairman. Thank you, Mr. 
Gensler.
    A lot of my questions have already been answered. I am just 
a small business owner from Illinois and you know, one of the 
things that I have noticed that really kind of got me to run 
for an office for the first time in my entire life is that a 
lot of times our government tends to see something and then 
overreact to it, and move too rapidly. You know, growing up as 
a kid and through most of my adult life, we didn't--businesses 
could be over-taxed, over-regulated, and there wasn't really 
much they could do. I guess one of my big concerns is that what 
is going to happen is we are going to rush this through. We 
have talked several times about how important this is, and I 
think we are moving very fast with it. I know you are under 
time constraints, but you know, my concern is we are going to 
have companies like CME and others that are going to say, 
``Hey, you know what, we are going to move out of the 
country,'' and we are going lose more jobs here in the United 
States, which is one of the reasons why I showed up here.
    You know, that is thing. I am just hoping that when we move 
along--you know, as a business owner, I look at the long-term 
effects of every decision that I make because it makes me 
successful or not. I think that is the--what has been--the 
burden that has been laid upon your shoulders. I know that is a 
big burden, but you know, American families, the people that 
are raising their kids and buying houses and things like that, 
that when we do make decisions that we make sure we give a 
thorough thought.
    But I mean, all of my questions have been answered. That 
was just kind of my comment to you, sir.
    Mr. Gensler. I thank you. Since we just met, what is the 
business that you are in?
    Mr. Schilling. St. Giuseppe's Pizza. It is an Italian 
restaurant.
    Mr. Gensler. Terrific. We take this very seriously. The 
American public doesn't connect necessarily day-to-day with 
derivatives, but they stand behind even that pizza that you 
sold. Somewhere in that supply chain, someone was using 
derivatives to hedge a product along the way. It may have been 
the wheat that went, ultimately, into that pizza. But also, the 
crisis was very real in 2008, and that $180 billion went into 
AIG, which was an ineffectively regulated non-bank in the 
derivatives marketplace, which you know, is $600 for every one 
of your constituents, if you just do the arithmetic.
    So I think that is what we are trying to do and what 
Congress really did, and we have to comply with that statute to 
lower the risk, make sure that end-users aren't caught up into 
it inadvertently, but that the dealer community is regulated, 
the clearinghouses lower risk, and then all the end-users get 
the benefit of the transparency.
    Mr. Schilling. All right, very good. I thank you for your 
time. I yield back.
    The Chairman. The gentleman yields back. The chair now 
recognizes the gentleman from Nebraska for 5 minutes.
    Mr. Fortenberry. Thank you, Mr. Chairman. I appreciate the 
time.
    I would like to step away from the immediate discussion and 
talk about some broader perspectives. If we understand the very 
fundamental purpose of these markets to be to mitigate risk and 
to inform price discovery, we traditionally had--and perhaps 
you can answer this if I am not correct--80 percent of the 
market traditional hedgers versus 20 percent speculators, or 
maybe 70/30. It is my understanding that some of those 
proportions are now inverted. If you look at where we are today 
in terms of our own economic situation, you can trace the 
beginnings of this back to the run-up in commodity speculation 
in oil prices, which then began to create some problems in the 
economy, create layoffs, which then exposed the housing bubble 
due to liberalized credit, which had all the various 
manifestations after that of problematic, bizarre, and 
financial instruments on Wall Street, and here we sit after a 
couple years of the Treasury Secretary coming to us and saying 
you must do this and bail out all these firms in order to 
prevent economic Armageddon.
    The point being is the very markets designed to mitigate 
risk, had they created risk?
    Mr. Gensler. I think in the case of this swaps market or 
what is called over-the-counter derivatives, you are correct, 
that they did help many entities mitigate risk, but they also 
concentrated risk. That the crisis was for many reasons, the 
housing bubble as you talked about and other reasons, but part 
of it was the derivatives marketplace, particularly this 
product called credit default swaps. I think it also helped 
concentrate risks. Rather than mitigating and spreading risk, 
it concentrated risk so that in the height of the crisis the 
Administration at that time felt it needed to come to Congress, 
and as you know, extend bailouts to these large financial 
entities, AIG and others. We shouldn't put the American public 
at that risk. There should be a freedom to fail, that these 
firms can fail and not be so interconnected through their 
derivatives contracts with the rest of the financial entities.
    Mr. Fortenberry. I had a local Chamber of Commerce group 
come to see me a year or so back, including a number of small 
bankers, and I asked any of them if they had ever used or heard 
of a synthetic collateralized debt obligation, and they just 
stared at me with blank stares.
    Mr. Gensler. I am guessing----
    Mr. Fortenberry. Thank you for not knowing exactly what 
that means. Again, when you have institutions that are 
disconnected from an understanding of the underlying asset 
value and a machine out there that pops up the bad information 
in terms of ratings and insurers that are, again, not 
understanding that underlying asset value in those portfolios 
and raking in commissions, and no check mechanisms on that.
    That was the manifestation of the full extent of the 
problem due to liberalized credit that was out there, but also 
a lack of mechanisms that prevented, as you say, the 
concentration of risk and oversight mechanisms that would have 
stopped this type of development.
    But let us go back to that earlier point. Do we have now a 
disproportionate number of hedgers versus speculators, and is 
that a related problem to these markets becoming investment 
markets versus markets designed to mitigate risk?
    Mr. Gensler. This is an age old debate, the role of 
speculators and hedgers in markets. Our markets----
    Mr. Fortenberry. But it is traditionally--we are in a 
different period now where the proportion of speculators is 
much, much higher, if my understanding is correct, than 
traditional hedgers.
    Mr. Gensler. In some markets that is certainly the case. 
Speculators and hedgers both have a role in markets. Agencies 
such as ours and SEC work hard to protect against fraud and 
manipulation. Congress has also asked our agency to use 
something called position limits to protect against the burdens 
of what is called excessive speculation, and we have done that 
over the decades in certain physical commodity markets.
    Mr. Fortenberry. Do you see any parallel between the run up 
and commodity speculation at the moment and what happened in 
2008?
    Mr. Gensler. Well, I think that the American public, which 
you are correct, is observing this run up and the costs they 
see in the gas tank and so forth are very real. We put out 
proposals on position limits to use the authority that this 
body--and in fact, this Committee was probably the first 
Committee that asked us to do that back in 2008 if I remember. 
Congressman Peterson will probably remind me, and Chairman 
Lucas.
    So we are looking forward to the public comment on that 
related to the energy market. It will get a lot of comment. We 
got 8,200 comments on the proposal we put out a year ago.
    Mr. Fortenberry. Well, I look forward to hearing the 
results of that.
    Mr. Gensler. Thank you.
    Mr. Fortenberry. Thank you.
    The Chairman. The gentleman's time has expired. The 
gentleman from Arkansas is recognized for 5 minutes.
    Mr. Crawford. Thank you, Mr. Chairman, and thank you, Mr. 
Gensler, for being here. I apologize for my tardiness. I also 
had another hearing to attend.
    You just alluded to one of the questions I was going to 
ask, and that was the empirical data. In your opinion, the 
diverse fluctuation in the commodity prices, is that due to 
spec trading or is that due to fundamental market activity? And 
based on--is your opinion going to be based on some empirical 
data you can cite?
    Mr. Gensler. Speculators and hedgers each meet in a 
marketplace and both have roles in the marketplaces. We as an 
agency have been asked by Congress to ensure that the markets 
have integrity, free of fraud, manipulation. We do not regulate 
prices or the level of prices, or volatility itself, but we 
have to ensure that the markets have integrity. Part of that is 
this position limit regime to ensure that--and over the decades 
we have used it in the agricultural commodities, and at times 
with the exchanges worked together to do it in the energy 
markets to ensure that they are not so concentrated, that there 
are only a handful of actors, rather than a diversity of actors 
within a marketplace so that price function, that price 
discovery function has a diversity of folks in there. That is 
what is underlying our approach with regard to this 
marketplace.
    I know it didn't directly answer your question, but it gave 
you sort of a concept as to how we have done it.
    Mr. Crawford. It did. It kind of leads me to my next 
question.
    Over the last several years, the open outcry price 
discovery mechanism has been, particularly for agricultural 
end-users, farmers that were hedging, that has been pretty 
critical to real price discovery in the marketplace for them. 
As you said, hedgers and spec traders meet. What role do you 
think e-trading has played in a broad sense to possibly 
exacerbate the problem?
    Mr. Gensler. Well, it has been a very significant change 
over the last 10 years. Nearly 90 percent of the futures 
market--again, Terry could tell you a better number. I think it 
is 88 percent maybe of the markets now are electronic. That 
doesn't mean high frequency, just electronic. I think that 
technology will continue in that direction, and so we have to 
have the tools and the exchanges have to have the tools to be 
able to monitor that electronic trading, that there are 
appropriate safeguards before somebody enters a trade, and 
appropriate pauses if the markets get so unbalanced. Like on 
May 6, there was actually a pause in the trading that I think 
was at a critical time. We have asked the public a lot of 
questions to make sure that that reality--and it is a reality 
that we are in electronic markets now--still works for the 
benefit of the investing and hedging public.
    Mr. Crawford. Does the 24/7 model global marketplace, does 
that play into this volatility? Does it increase volatility 
because we are used to seeing the pit close, and that was your 
closing price? Now with e-trading and 24/7, has that sort of 
created more of a volatility issue?
    Mr. Gensler. Well, I think it has extended it across a 24 
hour timeframe, and that there are more news events that can 
move a market overnight, certainly in the currency and 
financial markets, and in the oil markets, which is very 
global--energy markets are very global. For some of the 
agricultural markets, their real liquidity is during the period 
of time that it is open in the futures market.
    Mr. Crawford. Thank you, Mr. Chairman. I yield back.
    The Chairman. The gentleman's time has expired. The time 
the Member has is expired.
    With the Ranking Member's indulgence, I would like to ask 
the Chairman of the Commission a couple more questions before 
we release him.
    You know, Mr. Chairman, I have been very sensitive, as a 
number of my colleagues have, as we discuss the margin 
questions and potential impact for end-users. Do you believe 
that you have the authority to impose a margin requirement on 
both parties in transactions involving end-users? Do you 
believe you have the authority?
    Mr. Gensler. I believe we have the authority not to, and 
that is what we plan to do if I move forward. Only we ever see 
the non-banks, so we need to address that. I think that is 
consistent with what Congress did in the clearing area.
    The Chairman. So if you believe--and I am not putting words 
in your mouth--that you don't have the authority? Is that the 
way I should interpret that?
    Mr. Gensler. No, I said I believe we have the authority not 
to impose it, and that is what certainly my recommendation to 
the staff is and the Commission, moving forward.
    The Chairman. That is an interesting answer. Well, in the 
rule it will finally come together, will it leave open the 
possibility for dealers to require end-users to post margin?
    Mr. Gensler. We haven't written it, but I believe the 
dealers today have that. It is a matter of individual 
negotiation, and many dealers extend credit, because that is 
really what it means when you don't post margin is extending 
credit. Many dealers extend credit to end-users, but often--
dealers often require margin to be posted after you hit a 
certain trigger. And that would still be allowed. Dealers would 
have the same authorities they would have today to do that by 
individual negotiation, depending upon end-user's balance 
sheet, if an end-user might have assets that are good enough, 
then the dealer can make that determination.
    The Chairman. Let me think this through one more time.
    So you believe you have the authority not to impose. I 
guess that means you have the authority to make a decision, so 
you could, but the rule would indeed leave the possibility in 
certain circumstances for dealers to require--so is the 
outcome--would it still be that end-users, in order--
potentially the outcome would be for end-users, in order to 
engage in these transactions, would either face a margin 
requirement from the dealer or increased costs associated with 
the margin requirement imposed by their dealer?
    Mr. Gensler. No, I don't think so. I think it would be 
exactly where it is right now. Dealers today entering into 
transactions with non-financial entities and individually 
negotiate those arrangements, as they might negotiate a line of 
credit or negotiate any arrangement. It would have to be 
documented. We are proposing that they have documentation. That 
helps lower risk. But it would be up to the--at least where I 
am. I can't speak for all the other fellow regulators. That 
would still be up to that individually negotiated arrangement 
between the dealer and the end-user, as it is today.
    The Chairman. Thinking back, Chairman, to a letter at some 
point in the process from Senator Dodd and Senator Lincoln to 
myself and the Ranking Member, which tried to clarify 
legislative intent, I believe the letter explicitly said the 
legislation does not authorize regulators to impose on the 
marginal end-users. I guess I just simply note, sir, that it 
sounds like as your friends on the authorizing committee, we 
are going to be watching and working very closely with you in 
the coming days.
    Mr. Gensler. I look forward to that. I think that that 
would help us.
    The Chairman. We will have a lot of fun, Mr. Chairman.
    With that, thank you for your time. You are excused.
    Mr. Gensler. Thank you, and for all the very excellent 
questions.
    The Chairman. And while the Chairman is stepping away from 
the table, we will prepare for our next panel.
    As our second panel is coming to the table and preparing 
for the testimony, I would like to welcome them and introduce 
them.
    First is Edward Gallagher, President, Dairy Risk Management 
Services, Dairy Farmers of America, and Vice President, Risk 
Management, the Dairylea Cooperative, on behalf of the National 
Council of Farmer Cooperatives in Syracuse, New York. Also 
joining him at the table will be Mr. Terrence Duffy, Executive 
Chairman, CME Group Incorporated, Chicago, Illinois. Mr. Robert 
Pickel, Executive Vice Chairman at the International Swaps and 
Derivatives Association, Incorporated, New York City. Mr. Scott 
Morrison, Senior Vice President and CFO, Ball Corporation, on 
behalf of the Coalition for Derivatives End-Users from 
Bloomfield, Colorado, and Lee Olesky, Chief Executive Officer 
of Tradeweb, New York, New York.
    And with that, Mr. Gallagher, whenever you are prepared, 
you may begin.

    STATEMENT OF EDWARD W. GALLAGHER, PRESIDENT, DAIRY RISK 
             MANAGEMENT SERVICES, DAIRY FARMERS OF
AMERICA; VICE PRESIDENT, RISK MANAGEMENT, DAIRYLEA COOPERATIVE, 
   WASHINGTON, D.C.; ON BEHALF OF NATIONAL COUNCIL OF FARMER 
                          COOPERATIVES

    Mr. Gallagher. I am sorry. Implementation of the Dodd-Frank 
Act--I appreciate the opportunity to discuss the role of the 
over-the-counter derivatives market and helping farmers and 
farmer-owned cooperatives manage commodity price risks.
    As I was introduced, I am Edward Gallagher. I am the 
President of Dairy Risk Management Services at DFA, and Vice 
President, Dairylea. I am here representing both DFA, Dairylea, 
and the National Council of Farmer Cooperatives.
    Farmer cooperatives, businesses owned, governed, and 
controlled by farmers, ranchers, and growers are an important 
part of the success of American agriculture, and provide a 
comprehensive array of services for their members. Providing 
risk management tools is among those services. These tools help 
to mitigate commercial risk in the production, processing, and 
selling of a large portion of this country's food supply.
    We ask that the implementation of the Dodd-Frank law 
enhance opportunities for farmers and their cooperatives. It is 
imperative that we continue to mitigate these market risks, and 
it is imperative that we forebear regulatory changes that 
reduce program offerings and increase the very risks that the 
law was intended to address.
    A cooperative can aggregate its own members' small volume 
hedges or forward contracts, and offset that risk with a 
futures contract or by entering into a customized hedge via the 
swap market. More and more producers are depending on their 
cooperatives to provide them with these tools to manage this 
risk, and assist them in locking in margins or creating 
insurance-like margin safety nets. Please refer to my written 
statement for some examples of these.
    Dairylea, DFA, and the National Council support elements of 
the Dodd-Frank Act bringing more transparency and oversight to 
the OTC derivatives markets. Our overall objective in the 
implementation of the Act is to preserve the ability of 
cooperatives to manage commercial risk and support the growing 
demand from our member-owners for products to help them 
mitigate the growing volatility in commodity markets.
    We have had a number of opportunities to express our 
concerns to the CFTC, and they have been accessible and engaged 
and open in our issues, and I appreciate the comment that I 
heard from Chairman Gensler this morning.
    At this juncture, our largest concerns are in the 
uncertainty around the definitions in capital margin rules. 
While the CFTC continues to propose regulations for swaps and 
swap dealers, it is, although perhaps made a little bit more 
clear today what transactions and who will be subject to those 
additional regulations.
    Further, some activities of cooperatives would appear to be 
captured under the swap dealer definition contained in CFTC's 
initial draft regulations. We believe that by applying the 
interpretive approach for identifying whether a person is a 
swap dealer as outlined in the proposed rules, CFTC would 
likely capture a number of entities that were never intended to 
be regulated as swap dealers, including farmer-owned 
cooperatives.
    If farmer cooperatives were to be regulated as dealers, 
increased requirements for posting capital and margin and 
perhaps complying with reporting, record-keeping, and other 
regulatory requirements, could make providing those services 
uneconomical to our members. Such action would result in the 
unintended consequence of increasing the very risk that the law 
intends to mitigate. We do not believe that this was Congress's 
intention, and would urge the Committee, as you have today, to 
reiterate that with the CFTC. Thank you for doing that.
    It is also our understanding that there will be no 
requirements for imposing margins on end-users who are hedging 
or mitigating commercial risk. We trust that will be the case 
when the regulations are put in place. However, we would be 
concerned over excessive margin requirements on dealers and 
major swap participants on transactions entered into with end-
users who are hedging. We fear an increased cost structure 
associated with our hedging operations due to higher 
transaction costs would ultimately discourage prudent hedging 
practices all the way back to the farm.
    Last, it is vitally important to the economic viability of 
producers to continue to utilize forward contracting 
transactions with their cooperatives as a means of mitigating 
their commercial business risk. These forward contracts create 
cash price delivery contracts, allowing producers to mitigate 
risk and have more certainty over future price input, costs, 
and margins. We ask that the definitions acknowledge that 
forward contracts, including those using imbedded price 
options, continue to be excluded from CFTC swap regulations.
    Thank you again for the opportunity to testify today before 
the Committee, and thank you for your leadership and interest 
in the implementation of the Dodd-Frank Act. We look forward to 
working with you and the CFTC on this endeavor, and others that 
may arise that impact the well-being of America's farmers and 
the agricultural cooperatives they own and govern.
    Thank you.
    [The prepared statement of Mr. Gallagher follows:]

    Prepared Statement of Edward W. Gallagher, President, Dairy Risk
  Management Services, Dairy Farmers of America; Vice President, Risk 
    Management, Dairylea Cooperative, Washington, D.C.; on Behalf of
                National Council of Farmer Cooperatives

    Chairman Lucas, Ranking Member Peterson, and Members of the 
Committee, thank you for the opportunity today to discuss the role of 
the over-the-counter (OTC) derivatives' market in helping farmers and 
farmer-owned cooperatives manage commodity price risks, and some of the 
key issues we see in implementation of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act.
    I am Edward Gallagher, President of Dairy Risk Management Services, 
a division of Dairy Farmers of America (DFA), and Vice President of 
Economics and Risk Management at Dairylea Cooperative. Together, those 
two cooperatives represent more than 17,000 dairy farmer members in 48 
states.
    I also serve on the National Council of Farmer Cooperatives' (NCFC) 
Commodity Futures Trading Commission (CFTC) working group, which was 
formed to provide technical assistance to NCFC on commodity markets, 
including implementation of Title VII of the Dodd-Frank Act. On behalf 
of the DFA-Dairylea dairy farmer-owners, and more broadly the more than 
two million farmers and ranchers who belong to farmer cooperatives, I 
appreciate the Committee for holding this hearing on the key issues of 
implementing the Dodd-Frank Act.
    Farmer cooperatives--businesses owned and controlled by farmers, 
ranchers, and growers--are an important part of the success of American 
agriculture, and provide a comprehensive array of services for their 
members. These diverse organizations handle, process and market 
virtually every type of agricultural commodity produced. They also 
provide farmers with access to infrastructure necessary to manufacture, 
distribute and sell a variety of farm inputs.
    In all cases farmers are empowered, as elected board members, to 
make decisions affecting the current and future activities of their 
cooperative. Earnings derived from these activities are returned by 
cooperatives to their farmer-members on a patronage basis thereby 
enhancing their overall farm income.
    America's farmer cooperatives also generate benefits that 
strengthen our national economy. They provide jobs to nearly 250,000 
Americans with a combined payroll over $8 billion. Many of these jobs 
are in rural areas where employment opportunities are often limited.
Cooperatives' Use of the OTC Market
    As processors and handlers of commodities and suppliers of farm 
inputs, farmer cooperatives are commercial end-users of the futures 
exchanges as well as the OTC derivatives markets. We are considered 
end-users because we own, produce, manufacture, process and/or 
merchandise agricultural commodities. Often times, the end-user status 
is based on our operations being the aggregators of our individual 
farmer-owners risks--either the risks directly associated with 
operating their individual farm business or the risks associated with 
operating the multi-farm aggregated risk of manufacturing or processing 
plant operations.
    Due to market volatility in recent years, cooperatives are 
increasingly using OTC products to better manage exposure by 
customizing their hedges. This practice increases the effectiveness of 
risk mitigation and reduces costs to the cooperatives and their farmer 
members.
    In addition, OTC derivatives offer cooperatives the ability to 
provide customized products to producers to help them better manage 
their risk and returns. A cooperative can aggregate its owner-members' 
small volume hedges or forward contracts and offset that risk with a 
futures contract or by entering into another customized hedge via the 
swap markets. More and more producers are depending on their 
cooperatives to provide them with these tools to manage price risk and 
to assist them in locking in margins or creating insurance-like margin 
safety nets.
    Some examples include:

   Local grain cooperatives offer farmers a minimum price for 
        future delivery of a specific volume of grain. The local 
        elevator then offsets that risk by entering into a customized 
        hedge with a cooperative in a regional or federated system.

   Cooperatives offer livestock producers customized contracts 
        at non-exchange traded weights to better match the 
        corresponding number of head they have, while also reducing 
        producers' financial exposure to daily margin calls. The 
        cooperative offsets its risk of those contracts by entering 
        into a corresponding hedge with another counterparty.

   Customized solutions are developed by the cooperative to 
        assist individual farmers with their fuel hedging needs as 
        individual farmers do not have the fuel demands necessary to 
        consume a standard 42,000 gallon monthly NYMEX contract.

   A cooperative aggregates its members' small volume hedges or 
        forward contracts and transfers that risk to a swap partner. A 
        swap dealer or other commercial counterparty would otherwise 
        not have the interest in servicing such small entities.

    While my colleagues at grain, farm supply, and livestock 
cooperatives could provide greater details on how the above programs 
work for those sectors, they are all similar in concept and purpose to 
the risk management programs we provide to our Dairylea-DFA producers. 
We enter into OTC derivatives to hedge the price risk of the 
commodities we supply, process or handle.
    Our member-owners include small farms (such as a 50 cow member-
owner in Pennsylvania), mid-size farms (such as a 350 cow member-owner 
in Wisconsin) and larger farms with 1,000 or more cows. This diversity 
in member-owners requires us to offer a broad range of tools to meet 
their risk management needs, including services to help members 
mitigate the commercial risk associated with the high volatility in 
milk and input prices.
    We offer our members a forward contracting program as a primary 
means of mitigating commercial risk. As one alternative under the 
forward contracting program, we offer our member-owners a fixed price 
for their milk and a hedge on their feed purchases. These risk 
mitigation tools are critical for our farmers. Many producers are not 
able to use the futures markets to hedge input risk because of the 
larger volumes underlying the relevant futures contracts. Furthermore, 
corn and soybean contracts do not trade on a monthly basis--while most 
of our members purchase livestock feed on a monthly basis. However, 
through our forward contracting program, we can offer a more customized 
solution for our member-owners. Yet, we can only provide this service 
to our member-owners because of our ability to enter into swaps for 
customizable volumes and time periods different from the applicable 
futures contract.
Implementation of the Dodd-Frank Act
    Dairylea-DFA and NCFC support elements of the Dodd-Frank Act that 
bring more transparency and oversight to the OTC derivatives markets. 
We also recognize the complexity involved in crafting the implementing 
rules. We have had a number of opportunities to express our concerns to 
the CFTC and they have been accessible and engaged on our issues. We 
thank them for being open to NCFC members and staff in gaining a better 
understanding of how cooperatives are using the OTC market. In fact, 
several CFTC Commissioners recognized this at their public meeting on 
January 20th.
    However, the current ``definitions'' proposed rule appears to be 
headed down a path that would sweep farmer cooperatives into 
regulations intended for swap dealers and would increase costs and 
inhibit our ability to provide risk management tools to producers.
    We do not believe this was Congress's intention and would urge this 
Committee to reiterate that with the CFTC. Furthermore, we do not 
believe that any Member of this Committee would want any action taken 
that would reduce the price and risk management options available to 
our producer-members, especially during these highly volatile economic 
times. Yet on its current path, that may well be the consequence of the 
rulemaking process unless the Committee makes known its desires 
otherwise.
    Our overall objective in the implementation of the Act is to 
preserve the ability of cooperatives to use the OTC market to manage 
commercial risks, and at the same time support the growing demand from 
our member-owners for hedging products to help them mitigate the 
growing volatility in commodity prices.
    At this juncture, our largest concerns are in the uncertainty 
around the ``definitions'' and ``capital and margin'' rules. While the 
CFTC continues to propose regulations for swaps and swap dealers, it is 
unclear to us what transactions, and who, will be subjected to those 
additional regulations.
    Further, the above examples are activities that would appear to be 
captured under the ``swap dealer'' definition contained in CFTC's 
initial draft regulations. We believe that by applying the 
``interpretive approach for identifying whether a person is a swap 
dealer'' as outlined in the proposed rule, CFTC would likely capture a 
number of entities that were never intended to be regulated as swap 
dealers, including farmer cooperatives. This is because cooperatives 
engage in activities that look very similar to those of a dealer when 
they enter into swaps with farmers, local elevators, and customers as 
they provide risk mitigation services and products throughout the 
agriculture and energy sector.
    If farmer cooperatives were to be regulated as dealers, increased 
requirements for posting capital and margin, complying with reporting, 
record keeping and other regulatory requirements intended for large 
systemically important institutions could make providing those services 
uneconomical to our members. Such action would result in the unintended 
consequence of increasing the very risk the law intends to mitigate.
    It is also our understanding that there will be no requirements for 
imposing margin on end-users who are hedging or mitigating commercial 
risk--we trust that will be the case when the regulations are put in 
place. However, we would be concerned over excessive margin 
requirements on dealers and major swap participants on transactions 
entered into with end-users who are hedging. We fear an increased cost 
structure associated with our hedging operations due to higher 
transaction costs would ultimately be passed on in the form of higher 
prices for inputs to our farmer-owners while discouraging prudent 
hedging practices.
    Last, it is vitally important to the economic viability of our 
members to continue to utilize forward contracting transactions with 
their cooperatives as a means of mitigating their commercial business 
risk. These forward contracts create cash-price delivery contracts 
allowing our members mitigate risk and have more certainty over future 
price, input costs and margins. We ask that the definitions acknowledge 
that forward contracts, including those using embedded price options--
allowing for such forward contracts as a minimum milk price that gets 
adjusted upwards if feed prices rise, but the minimum milk price does 
not change if feed prices fall--continue to be excluded from CFTC swap 
regulation.
    In closing, NCFC seeks the following:

   Treat agricultural cooperatives as end-users since they 
        aggregate the commercial risk of individual farmer-members and 
        are treated as such by the CFTC, currently;

   Exclude agricultural cooperatives from the definition of a 
        swap dealer; and

   Exempt agricultural cooperatives from mandatory clearing or 
        margining but allow them to perform either at their discretion.

    Thank you again for the opportunity to testify today before the 
Committee. And thank you for your leadership and interest in the 
implementation of the Dodd-Frank Act. We appreciate your role in 
ensuring that farmer cooperatives will continue to be able to 
effectively hedge commercial risk and support the viability of their 
members' farms and cooperatively-owned facilities.
    Recently, the CFTC wrote: ``Permitting agricultural swaps to trade 
under the same terms and conditions as other swaps should provide 
greater certainty and stability to existent and emerging markets so 
that financial innovation and market development can proceed in and 
effective and competitive manner.'' \1\ We whole-heartedly agree with 
the CFTC. As it relates to agricultural cooperatives, who are the 
primary source of hedging innovation for farmers, we trust the rules 
permitting these actions will not stifle the very innovation it is 
trying to create--or worse yet reduce our ability to help producers 
manage their ever increasing commercial risks.
---------------------------------------------------------------------------
    \1\ Federal Register, Vol. 76, No. 23, Thursday, February 3, 2011, 
page 6103.
---------------------------------------------------------------------------
    Thank you.

    The Chairman. The gentleman's time has expired. The chair 
now recognizes Mr. Duffy for 5 minutes.

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

    Mr. Duffy. Chairman Lucas, Ranking Member Peterson, Members 
of the Committee, thank you for the opportunity to testify on 
the CFTC's rulemaking to implement the Dodd-Frank Wall Street 
Reform and Consumer Protection Act. I am Terry Duffy, Executive 
Chairman of CME Group, which includes our clearinghouse and our 
four exchanges, the CME, the CBOT, NYMEX, and COMEX.
    In 2000, Congress leveled the playing field with our 
foreign competitors and permitted us to prosper as an engine of 
economic growth in Chicago, New York, and the nation as a 
whole. I have had the opportunity on numerous occasions to 
testify in front of this Committee. I am sorry to report today 
that however, the CFTC's Dodd-Frank rulemaking threatens that 
prosperity and the growth of our markets.
    In 2008, the financial crisis focused well-warranted 
attention on the lack of regulation on OTC financial markets. 
The industry learned a number of important lessons, and 
Congress crafted legislation that we hope reduces the risk that 
there could be a repeat performance of that near disaster. It 
is important to note that regulated futures and markets and 
futures clearinghouses operated flawlessly during and after the 
crisis. Futures markets performed all of their essential 
functions without interruption, and despite failures of 
significant financial firms, our clearinghouse experienced no 
default. Significantly, no customer on the futures side lost 
their collateral or were unable to transfer positions 
immediately and continue to manage risk.
    We support the goals of the Dodd-Frank Act, to reduce 
systemic risk to central clearing and exchange trading of 
derivatives, to increase data transparency and price discovery, 
and to prevent fraud and market manipulation. However, with 
respect to futures exchanges and clearinghouses, the CFTC has 
devoted significant resources to regulations. They impose 
unwarranted costs and stifle innovation, and many are 
inconsistent or not required by Dodd-Frank. Several 
Commissioners have counseled caution on the rulemaking front in 
recognition of budgetary constraints. A less welcome response 
has been the suggestion that the CFTC's budget limitations will 
mean delayed approval for applications and findings necessary 
to operate in compliance with Dodd-Frank. Such delay would, 
among other things, stifle innovation, job creation, and 
economic growth in our industry. We do not object to the CFTC 
receiving an appropriate budget; however, we do object to the 
CFTC wasting scarce resources to impose uncalled for 
regulations and duplicating the oversight of self-regulatory 
organizations subject to its jurisdiction.
    Furthermore, they may impose burdens on the industry that 
require increased CFTC staff and expenditures that could never 
have been justified if an adequate cost-benefit analysis had 
been performed.
    Some of the CFTC's objectionable rule proposals might be 
explained by the rush to push proposals out the door before 
they are ready in order to permit the CFTC to adopt final rules 
in time to meet statutory deadlines; however, the consistent 
theme of the CFTC's rulemaking has been to expand its authority 
by changing its role from an oversight agency whose purpose has 
been to assure compliance with sound principles, to a front-
line decision maker that imposes its business judgments on 
every operational aspect of derivatives trading and clearing.
    This role reversal would require doubling of the 
Commission's staff and budget. It will also impose astronomical 
costs on the industry and the end-users of derivatives. Sadly, 
there is no evidence that any of this is necessary or even 
likely to be useful.
    Some Members of the Commission clearly recognize these 
issues. They have been forthright in suggesting that the CFTC 
deliberate further to ensure that the public interest, rather 
than haste in meeting deadlines, temperates an ambitious 
agenda. Others do not. Dodd-Frank was not an invitation to pile 
irrational regulatory burdens on exchanges, clearinghouses, and 
other participants. While the Commission was granted 
discretion, it was directed to make fact-based determinations, 
grounded in evidence and sound economic theory, that 
regulations are necessary, cost effective, and will accomplish 
the overall purpose. Unfortunately, the Commission's extensive 
obligations under Dodd-Frank are making it all but impossible 
for the Commission's staff to document the need for many of the 
agency's rulemaking. Instead, the Commission has either ignored 
its obligations to justify its proposed rules, or simply 
ignored clear direction that such justification is necessary.
    For example, Congress preserved and expanded a scheme of 
principle-based regulation by expanding the list of core 
principles, and granting self-regulatory organizations 
reasonable discretion in establishing the manner in which the 
self-regulatory organization complies with the core principles. 
The Commission asked for, and Congress gave it power, to adopt 
rules respecting core principles, but Congress did not direct 
the agency to put an end to principals based regulation. Yet 
the Commission, immediately and for no apparent reason, 
proposed comprehensive regulations to convert all of the core 
principles into a prescriptive rules-based regulatory system. 
This is the ultimate solution in search of a problem. It adds 
unnecessary bureaucratic red tape to a well-functioning system, 
while at the same time the President and the Congress have 
called for an end to such overreaching.
    My written testimony includes numerous additional examples 
of misdirected or improper rulemaking. This Congress can 
mitigate some of the problems that have plagued the CFTC 
rulemaking process. It can do this by extending the rulemaking 
schedule so that professionals, including exchanges, 
clearinghouses, dealers, market makers, and end-users can have 
their views heard. This would give the CFTC a realistic 
opportunity to assess those views and measure the real cost 
imposed by its new regulations. Otherwise, the unintended 
adverse consequences of these ambiguities and the rush to 
regulation will stifle effective exchange innovation. It will 
also block the most important growth pass in our industry, 
including clearing of the OTC transactions. This is 
inconsistent with the Dodd-Frank's goal of increasing 
transparency and limiting risks by moving more derivatives 
transactions onto clearinghouses.
    I look forward to answering the questions of the Committee. 
Thank you.
    [The prepared statement of Mr. Duffy follows:]

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

    Chairman Lucas, Ranking Member Peterson, Members of the Committee, 
thank you for the opportunity to testify respecting implementation of 
Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection 
Act (P.L. 111-203, July 21, 2010) (``DFA''). I am Terry Duffy, 
Executive Chairman of CME Group, which is the world's largest and most 
diverse derivatives marketplace. CME Group includes four separate 
exchanges--Chicago Mercantile Exchange Inc. (``CME''), the Board of 
Trade of the City of Chicago, Inc. (``CBOT''), the New York Mercantile 
Exchange, Inc. (``NYMEX'') and the Commodity Exchange, Inc. (``COMEX'') 
(together ``CME Group Exchanges''). The CME Group Exchanges offer the 
widest range of benchmark products available across all major asset 
classes, including futures and options based on interest rates, equity 
indexes, foreign exchange, energy, metals, agricultural commodities, 
and alternative investment products. CME also includes CME Clearing, a 
derivatives clearing organization and one of the largest central 
counterparty clearing services in the world; it provides clearing and 
settlement services for exchange-traded contracts, as well as for over-
the-counter (``OTC'') derivatives transactions through CME Clearing and 
CME ClearPort'.
    The CME Group Exchanges serve the hedging, risk management and 
trading needs of our global customer base by facilitating transactions 
through the CME Globex' electronic trading platform, our 
open outcry trading facilities in New York and Chicago, as well as 
through privately negotiated transactions. In addition, CME Group 
distributes real-time pricing and volume data through a global 
distribution network of approximately 500 directly connected vendor 
firms serving approximately 400,000 price display subscribers and 
hundreds of thousands of additional order entry system users. CME`s 
proven high reliability, high availability platform coupled with robust 
administrative systems represent vast expertise and performance in 
managing market center data offerings.
    The financial crisis focused well-warranted attention on the lack 
of regulation of OTC financial markets. We learned a number of 
important lessons and Congress crafted legislation that, we hope, 
reduces the likelihood of a repetition of that near disaster. However, 
it is important to emphasize that regulated futures markets and futures 
clearing houses operated flawlessly. Futures markets performed all of 
their essential functions without interruption and, despite failures of 
significant financial firms, our clearing house experienced no default 
and no customers on the futures side lost their collateral or were 
unable to immediately transfer positions and continue managing risk.
    We support the overarching goals of DFA to reduce systemic risk 
through central clearing and exchange trading of derivatives, to 
increase data transparency and price discovery, and to prevent fraud 
and market manipulation. Unfortunately, DFA left many important issues 
to be resolved by regulators with little or ambiguous direction and set 
unnecessarily tight deadlines on rulemakings by the agencies charged 
with implementation of the Act. In response to the urgent schedule 
imposed by DFA, the Commodity Futures Trading Commission (``CFTC'' or 
``Commission'') has proposed hundreds of pages of new or expanded 
regulations.
    In our view, many of the proposals are inconsistent with DFA, not 
required by DFA, and/or impose burdens on the industry that require an 
increase in CFTC staff and expenditures that could never be justified 
if an adequate cost-benefit analysis had been performed. In the view of 
many experienced derivative industry professionals, the CFTC has been 
selectively reading DFA to implement a policy that is likely to defeat 
the real goals of DFA.
    We realize that the Commission is under immense pressure to 
complete many rulemakings within a very short time period. Put simply, 
DFA set forth an unrealistic rulemaking schedule. And even more 
problematically, many of the rulemakings required by DFA are 
interrelated. That is, DFA requires many intertwined rulemakings with 
varying deadlines. Entities such as CME often cannot fully anticipate 
the meaning of a proposed rule when that proposed rule is reliant on 
another rule that is not yet in its final form. As a result, interested 
parties are unable to comment on the proposed rules in a meaningful 
way, because they cannot know the full effect of the proposed rules.
    This Congress can mitigate some of the problems that have plagued 
the CFTC rulemaking process by extending the rulemaking schedule so 
that professionals, including exchanges, clearing houses, dealers, 
market makers, and end-users can have their views heard and so that the 
CFTC will have a realistic opportunity to assess those views and 
measure the real costs imposed by its new regulations. Otherwise, the 
unintended adverse consequences of those ambiguities and the rush to 
regulation will impair effective exchange innovation and stifle the 
most important growth paths in our industry, including the clearing of 
OTC transactions. Indeed, the threat of such policies has already 
driven major customers to move business off U.S. markets.
    Several Commissioners clearly recognize this issue and have been 
forthright in suggesting that the CFTC temper its ambitions. For 
example, in her recent statement opposing proposed rules in the area of 
position limits, Commissioner Sommers expressed concern regarding the 
lack of analysis performed before proposal of the rules. She 
specifically noted that she was troubled by the lack of analysis of 
swap markets and of whether the proposal would ``cause price discovery 
in the commodity to shift to trading on foreign boards of trade,'' and 
that ``driving business overseas remains a long standing concern.'' 
Further, Commissioner Sommers noted that, in any case, the Commission 
did not have the capacity to enforce the proposed rule.\1\ Commissioner 
Dunn has echoed our concerns regarding the lack of CFTC funding and the 
potential detrimental effects of a prescriptive, rather than 
principles-based, regime upon the markets. More specifically, he 
expressed concern that if the CFTC`s ``budget woes continue, [his] fear 
is that the CFTC may simply become a restrictive regulator. In essence, 
[it] will need to say `No' a lot more . . . No to anything [it does] 
not believe in good faith that [it has] the resources to manage'' and 
that ``such a restrictive regime may be detrimental to innovation and 
competition.'' \2\ Commissioner O'Malia has likewise expressed concern 
regarding the effect of proposed regulations on the markets. More 
specifically, the Commissioner has expressed concern that new 
regulation could make it ``too costly to clear.'' He noted that there 
are several ``changes to [the] existing rules that will contribute to 
increased costs.'' Such cost increases have the effect of ``reducing 
the incentive of futures commission merchants to appropriately identify 
and manage customer risk. In the spirit of the Executive Order, we must 
ask ourselves: Are we creating an environment that makes it too costly 
to clear and puts risk management out of reach.'' \3\
---------------------------------------------------------------------------
    \1\ In full, Commissioner Sommers stated: ``I oppose the proposal 
before us today because I believe it is flawed in a number of respects. 
First, I believe we should conduct a complete analysis of the swap 
market data before we determine the appropriate formula to propose. We 
have not done that. Second, without data on swap market positions, the 
spot month limits we are proposing are not enforceable. I think it is 
bad policy to propose regulations that the agency does not have the 
capacity to enforce. Third, in Section 4a(a)(1) of the Commodity 
Exchange Act, Congress specifically authorized the Commission to 
consider different limits on different groups or classes of traders. 
This language was added in Section 737 of Dodd-Frank. The proposal 
before us today does not analyze, or in any way consider, whether 
different limits are appropriate for different groups or classes of 
traders. Finally, Section 737 of Dodd-Frank states that the Commission 
shall strive to ensure that position limits will not cause price 
discovery in the commodity to shift to trading on foreign boards of 
trade. This proposal does not contain any analysis of how the proposal 
attempts to accomplish this goal. In fact, the proposal does not even 
mention this goal. Driving business overseas is a long standing concern 
of mine, and that concern remains unaddressed.''
    Commissioner Jill E. Sommers, Opening Statement, Open Meeting on 
the Ninth Series of Proposed Rulemakings under the Dodd-Frank Act, 
(January 13, 2011) http://www.cftc.gov/PressRoom/SpeechesTestimony/
sommersstatement011311.html.
    \2\ Commissioner Dunn stated: ``Lastly, I would like to speak 
briefly about the budget crisis the CFTC is facing. The CFTC is 
currently operating on a continuing resolution with funds insufficient 
to implement and enforce the Dodd-Frank Act. My fear at the beginning 
of this process was that due to our lack of funds the CFTC would be 
forced to move from a principles based regulatory regime to a more 
prescriptive regime. If our budget woes continue, my fear is that the 
CFTC may simply become a restrictive regulator. In essence, we will 
need to say `No' a lot more. No to new products. No to new 
applications. No to anything we do not believe in good faith that we 
have the resources to manage. Such a restrictive regime may be 
detrimental to innovation and competition, but it would allow us to 
fulfill our duties under the law, with the resources we have 
available.''
    Commissioner Michael V. Dunn, Opening Statement, Public Meeting on 
Proposed Rules Under Dodd-Frank Act (January 13, 2011) http://
www.cftc.gov/PressRoom/SpeechesTestimony/dunnstatement011311.html.
    \3\ In Facing the Consequences: ``Too Costly to Clear,'' 
Commissioner O'Malia stated: ``I have serious concerns about the cost 
of clearing. I believe everyone recognizes that the Dodd-Frank Act 
mandates the clearing of swaps, and that as a result, we are 
concentrating market risk in clearinghouses to mitigate risk in other 
parts of the financial system. I said this back in October, and 
unfortunately, I have not been proven wrong yet. Our challenge in 
implementing these new clearing rules is in not making it `too costly 
to clear.' Regardless of what the new market structures ultimately look 
like, hedging commercial risk and operating in general will become more 
expensive as costs increase across the board, from trading and 
clearing, to compliance and reporting.''
    ``In the short time I have been involved in this rulemaking 
process, I have seen a distinct but consistent pattern. There seems to 
be a strong correlation between risk reduction and cash. Any time the 
clearing rulemaking team discusses increasing risk reduction, it is 
followed by a conversation regarding the cost of compliance and how 
much more cash is required.''
    ``For example, there are several changes to our existing rules that 
will contribute to increased costs, including more stringent standards 
for those clearinghouses deemed to be systemically significant. The 
Commission staff has also recommended establishing a new margining 
regime for the swaps market that is different from the futures market 
model because it requires individual segregation of customer 
collateral. I am told this will increase costs to the customer and 
create moral hazard by reducing the incentive of futures commission 
merchants to appropriately identify and manage customer risk. In the 
spirit of the Executive Order, we must ask ourselves: Are we creating 
an environment that makes it too costly to clear and puts risk 
management out of reach.''
    Commissioner Scott D. O'Malia, Derivatives Reform: Preparing for 
Change, Title VII of the Dodd-Frank Act: 732 Pages and Counting, 
Keynote Address (January 25, 2011) http://www.cftc.gov/PressRoom/
SpeechesTestimony/opaomalia-3.html.
---------------------------------------------------------------------------
    We are concerned that many of the Commission's rulemakings to date 
would unnecessarily convert the regulatory system for the futures 
markets from the highly successful principles-based regime that has 
permitted U.S. Futures markets to prosper as an engine of economic 
growth for this nation, to a restrictive, prescription-based regime 
that will stifle growth and innovation. We are also concerned that many 
of the Commission's proposed rulemakings go beyond the specific 
mandates of DFA, and do not comply with the Administrative Procedure 
Act's requirements that rulemakings be legitimately grounded in 
evidence and strong economic theory. I will now address, in turn, 
several proposed rules issued by the Commission that illustrate these 
problems.
1. Proposed Rulemaking on Position Limits \4\
---------------------------------------------------------------------------
    \4\ 76 Fed. Reg. 4752 (proposed Jan. 26, 2011) (to be codified at 
17 CFR pts. 1, 150-51).
---------------------------------------------------------------------------
    One example of this is the Commission's proposal to impose broad, 
fixed position limits for all physically delivered commodities. The 
Commission's proposed position limit regulations ignore the clear 
Congressional directives, which DFA added to section 4a of the 
Commodity Exchange Act, to set position limits ``as the Commission 
finds are necessary to diminish, eliminate, or prevent'' ``sudden or 
unreasonable fluctuations or unwarranted changes in the price of'' a 
commodity.\5\ Without any basis to make this finding, the Commission 
instead justified its position limit proposal as follows:
---------------------------------------------------------------------------
    \5\ My December 15, 2010, testimony before the Subcommittee on 
General Farm Commodities and Risk Management of the House Committee on 
Agriculture includes a more complete legal analysis of the DFA 
requirements.

        The Commission is not required to find that an undue burden on 
        interstate commerce resulting from excessive speculation exists 
        or is likely to occur in the future in order to impose position 
        limits. Nor is the Commission required to make an affirmative 
        finding that position limits are necessary to prevent sudden or 
        unreasonable fluctuations or unwarranted changes in prices or 
        otherwise necessary for market protection. Rather, the 
        Commission may impose position limits prophylactically, based 
        on its reasonable judgment that such limits are necessary for 
        the purpose of ``diminishing, eliminating, or preventing'' such 
        burdens on interstate commerce that the Congress has found 
        result from excessive speculation. 76 Federal Register 4752 at 
---------------------------------------------------------------------------
        4754 (January 26, 2011), Position Limits for Derivatives.

    At the December 15, 2010, hearing of the General Farm Commodities 
and Risk Management Subcommittee of the House Agriculture Committee on 
the subject of the implementation of DFA's provisions respecting 
position limits, there was strong bipartisan agreement among the 
Subcommittee Members with the sentiments expressed by Representative 
Moran:

        Despite what some believe is a mandate for the Commission to 
        set position limits within a definite period of time, the Dodd-
        Frank legislation actually qualifies CFTC's position-limit 
        authority. Section 737 of the Dodd-Frank Act amends the 
        Commodity Exchange Act so that Section 4A-A2A states, ``The 
        Commission shall, by rule, establish limits on the amount of 
        positions as appropriate.'' The Act then states, ``In 
        subparagraph B, for exempt commodities, the limit required 
        under subparagraph A shall be established within 180 days after 
        the date of enactment of this paragraph.'' When subparagraphs A 
        and B are read in conjunction, the Act states that when 
        position limits are required under subparagraph A, the 
        Commission shall set the limits within 180 days under paragraph 
        B. Subparagraph A says the position-limit rule should be only 
        prescribed when appropriate.

        Therefore, the 180 day timetable is only triggered if position 
        limits are appropriate. In regard to the word ``appropriate,'' 
        the Commission has three distinct problems. First, the 
        Commission has never made an affirmative finding that position 
        limits are appropriate to curtail excessive speculation. In 
        fact, to date, the only reports issued by the commission or its 
        staff failed to identify a connection between market trends and 
        excessive speculation. This is not to say that there is no 
        connection, but it does say the commission does not have enough 
        information to draw an affirmative conclusion.

    ``The second and third issues relating to the appropriateness of 
position limits are regulated to adequacy of information about OTC 
markets. On December 8, 2010, the commission published a proposed rule 
on swap data record-keeping and reporting requirements. This proposed 
rule is open to comment until February 7, 2011, and the rule is not 
expected to be final and effective until summer at the earliest. 
Furthermore, the commission has yet to issue a proposed rulemaking 
about swap data repositories. Until a swap data repository is set up 
and running, it is difficult to see how it would be appropriate for the 
commission to set position limits.'' CME group is not opposed to 
position limits and other means to prevent market congestion; we employ 
limits in most of our physically delivered contracts.
    However, we use limits and accountability levels, as contemplated 
by the Congressionally-approved Core Principles for Designated Contract 
Markets (``DCMs''), to mitigate potential congestion during delivery 
periods and to help us identify and respond in advance of any threat to 
manipulate our markets. CME Group believes that the core purpose that 
should govern Federal and exchange-set position limits, to the extent 
such limits are necessary and appropriate, should be to reduce the 
threat of price manipulation and other disruptions to the integrity of 
prices. We agree that such activity destroys public confidence in the 
integrity of our markets and harms the acknowledged public interest in 
legitimate price discovery and we have the greatest incentive and best 
information to prevent such misconduct.
    We don't want to lose sight of the real economic cost of imposing 
position limits that are unwarranted. For the last 150 years, modern 
day futures markets have served as the most efficient and transparent 
means to discover prices and manage exposure to price fluctuations. 
Regulated futures exchanges operate centralized, transparent markets to 
facilitate price discovery by permitting the best informed and most 
interested parties to express their opinions by buying and selling for 
future delivery. Such markets are a vital part of a smooth functioning 
economy. Futures exchanges allow producers, processors and agribusiness 
to transfer and reduce risks through bona fide hedging and risk 
management strategies. This risk transfer means producers can plant 
more crops. Commercial participants can ship more goods. Risk transfer 
only works because speculators are prepared to provide liquidity and to 
accept the price risk that others do not. Futures exchanges and 
speculators have been a force to reduce price volatility and mitigate 
risk. Overly inclusive position limits adversely impact legitimate 
trading and impair the ability of producers to hedge. Worse, the drive 
certain classes of speculators into physical markets and distort the 
physical supply chain and prices.
2. Proposed Rulemaking on Mandatory Swaps Clearing Review Process \6\
---------------------------------------------------------------------------
    \6\ 75 Fed. Reg. 667277 (proposed Nov. 2, 2010) (to be codified at 
17 CFR pts. 1, 150, 151).
---------------------------------------------------------------------------
    Another example of a rule proposal that raises concerns and could 
produce consequences counter to the fundamental purposes of DFA is the 
Commission's proposed rule relating to the process for review of swaps 
for mandatory clearing. The proposed regulation treats an application 
by a derivatives clearing organization (``DCO'') to list a particular 
swap for clearing as obliging that DCO to perform due diligence and 
analysis for the Commission respecting a broad swath of swaps, as to 
which the DCO has no information and no interest in clearing. In 
effect, a DCO that wishes to list a new swap would be saddled with the 
obligation to collect and analyze massive amounts of information to 
enable the Commission to determine whether the swap that is the subject 
of the application and any other swap that is within the same ``group, 
category, type, or class'' should be subject to the mandatory clearing 
requirement.
    This proposed regulation is one among several proposals that impose 
costs and obligations whose effect and impact are contrary to the 
purposes of Title VII of DFA. The costs in terms of time and effort to 
secure and present the information required by the proposed regulation 
would be a massive disincentive to DCOs to voluntarily undertake to 
clear a ``new'' swap. The Commission lacks authority to transfer the 
obligations that the statute imposes on it to a DCO. The proposed 
regulation eliminates the possibility of a simple, speedy decision on 
whether a particular swap transaction can be cleared--a decision that 
the DFA surely intended should be made quickly in the interests of 
customers who seek the benefits of clearing--and forces a DCO to 
participate in an unwieldy, unstructured and endless process to 
determine whether mandatory clearing is required. Regulation section 
39.5(b)(5) starkly illustrates this outcome. Every simple request to 
clear a swap is converted into a marathon that is likely to kill the 
runner before Athens is in sight. No application is deemed complete 
until all of the information that the Commission needs to make the 
mandatory clearing decision has been received. The Commission is the 
sole judge of completion and the only test is its unfettered 
discretion. Only then does the 90 day period begin to run. This turns 
DFA on its head.
3. Conversion from Principles-Based to Rules-Based Regulation \7\
---------------------------------------------------------------------------
    \7\ See, 75 Fed. Reg. 80747 (proposed Dec. 22, 2010) (to be 
codified at 17 CFR pts. 1, 16, 38).
---------------------------------------------------------------------------
    Some of the CFTC's rule proposals are explained by the ambiguities 
created during the rush to push DFA to a final vote. For example, 
Congress preserved and expanded the scheme of principles-based 
regulation by expanding the list of core principles and granting self 
regulatory organizations ``reasonable discretion in establishing the 
manner in which the [self regulatory organization] complies with the 
core principles.'' Congress granted the Commission the authority to 
adopt rules respecting core principles, but did not direct it to 
eliminate principles-based regulation.
    The agency's prescriptive regulatory approach would convert its 
role from an oversight agency, whose role is to assure compliance with 
sound principles, to a front line decision maker that imposes its 
business judgments on every operational aspect of derivatives trading 
and clearing. This role reversal will require doubling of the 
Commission's staff and budget and impose astronomical costs on the 
industry and the end-users of derivatives. Yet there is no evidence 
that this interpretation of Congressional intent behind DFA is 
necessary or will be beneficial to the public or to the functioning of 
the markets. This approach will also unnecessarily deplete the agency's 
limited resources. In keeping with the President's Executive Order to 
reduce unnecessary regulatory cost, the CFTC should be required to 
reconsider each of its proposals with an eye toward performing those 
functions that are clearly mandated by DFA.
    Prior to DFA, the Commodity Exchange Act (``CEA''), as amended by 
the Commodity Futures Modernization Act of 2000 (``CFMA''), prohibited 
the CFTC from mandating exclusive means of compliance with the Core 
Principles applicable to regulated entities. See CEA 5c(a)(2). The CFTC 
set forth ``[g]uidance on, and Acceptable Practices in, Compliance with 
Core Principles,'' but these statements operated only as guidance or as 
a safe harbor for compliance--not as requirements.
    Changes to the CEA made by DFA gave the Commission discretion to, 
where necessary, step back from this principles-based regime. That is, 
they changed the language of the CEA to state that boards of trade 
``shall have reasonable discretion in establishing the manner in which 
they comply with the core principles, unless otherwise determined by 
the Commission by rule or regulation.'' See, e.g., DFA  735(b), 
amending Section 5(d)(1)(B) of the CEA. To begin, this language assumes 
that the principles-based regime will remain in effect and that, as 
such, regulated entities will have reasonable discretion as to the 
manner with which they comply with the Core Principles except in 
limited circumstances in which more specific rules addressing 
compliance with a core principle are necessary. The Commission has used 
this change in language, however, to propose specific requirements for 
multiple Core Principles--almost all Core Principles in the case of 
DCMs--and effectively eviscerate the principle-based regime that has 
fostered success in CFTC-regulated entities for the past decade.
    The principles-based regime of the CFMA has facilitated tremendous 
innovation and allowed U.S. exchanges to compete effectively on a 
global playing field. Principles-based regulation of futures exchanges 
and clearing houses permitted U.S. exchanges to regain their 
competitive position in the global market. U.S. futures exchanges are 
able to keep pace with rapidly changing technology and market needs by 
introducing new products, new processes and new methods by certifying 
compliance with the CEA and thereby avoiding stifling regulatory 
review. Indeed, U.S. futures exchanges have operated more efficiently, 
more economically and with fewer complaints under this system than at 
any time in their history.
(a) Proposed Rulemaking under Core Principle 9 for DCMs
    One example of the Commission's unnecessary and problematic 
departure from the principles-based regime is its proposed rule under 
Core Principle 9 for DCMs--Execution of Transactions, which states that 
a DCM ``shall provide a competitive, open and efficient market and 
mechanism for executing transactions that protects the price discovery 
process of trading in the centralized market'' but that ``the rules of 
a board of trade may authorize . . . (i) transfer trades or office 
trades; (ii) an exchange of (I) futures in connection with a cash 
commodity transaction; (II) futures for cash commodities; or (III) 
futures for swaps; or (iii) a futures commission merchant, acting as 
principle or agent, to enter into or confirm the execution of a 
contract for the purchase or sale of a commodity for future delivery if 
that contract is reported, recorded, or cleared in accordance with the 
rules of the contract market or [DCO].''
    Proposed rule 38.502(a) would require that 85% or greater of the 
total volume of any contract listed on a DCM be traded on the DCM's 
centralized market, as calculated over a 12 month period. The 
Commission asserts that this is necessary because ``the price discovery 
function of trading in the centralized market'' must be protected. 75 
Fed. Reg. at 80588. However, Congress gave no indication in DFA that it 
considered setting an arbitrary limit as an appropriate means to 
regulate under the Core Principles. Indeed, in other portions of DFA, 
where Congress thought that a numerical limit could be necessary, it 
stated so. For example, in Section 726 addressing rulemaking on 
Conflicts of Interest, Congress specifically stated that rules ``may 
include numerical limits on the control of, or the voting rights'' of 
certain specified entities in DCOs, DCMs or Swap Execution Facilities 
(``SEFs'').
    Congress did not sanction arbitrary proscriptions by the 
Commission, and the 85% exchange trading requirement is completely 
arbitrary. That is, the Commission justifies the requirement only with 
its observations as to percentages of various contracts traded on 
various exchanges--it provides no support for a position that the 85% 
requirement provides or is necessary to provide a ``competitive, open, 
and efficient market and mechanism for executing transactions that 
protects the price discovery process of trading in the centralized 
market of the board of trade,'' as is required under Core Principle 9. 
Further, Core Principle 9, as noted above, expressly permits DCMs to 
authorize off-exchange transactions including for exchanges to related 
positions pursuant to their rules.
    The Commission does not assert in its proposal that the 85% 
exchange trading requirement has any regulatory benefit for either it 
or market participants. Indeed, there is no such benefit. The 
Commission does not receive any additional information regarding the 
market through the proposed 85% requirement. That is, if an instrument 
is not traded on an exchange, it will in many cases simply be traded on 
an SEF or in the OTC market as a swap. Following DFA, the swap and OTC 
markets, like the futures market, is regulated by the Commission. Thus, 
the Commission will receive the same information for use in regulation 
regardless of whether the instrument is traded in the centralized 
market or not.
    Moreover, imposition of the proposed 85% exchange trading 
requirement will have extremely negative effects on the industry. The 
85% requirement would significantly deter the development of new 
products by exchanges like CME. This is because new products generally 
initially gain trading momentum in off-exchange transactions. Indeed, 
it takes years for new products to reach the 85% exchange trading 
requirement proposed by the Commission. For example, one now popular 
and very liquid foreign exchange product developed and offered by CME 
would not have met the 85% requirement for 4 years after it was 
initially offered. The product's on-exchange trading continued to 
increase over 10 years, and it now trades only 2% off-exchange. Under 
the proposed rule, CME would have had to delist this product.\8\
---------------------------------------------------------------------------
    \8\ More specifically, the product traded 32% off-exchange when it 
was first offered in 2000, 31% off-exchange in 2001, 25% in 2002, 20% 
in 2003, finally within the 85% requirement at 13% off-exchange in 
2004, 10% in 2005, 7% in 2006, 5% in 2007, 3% in 2008, and 2% in 2009 
and 2010.
---------------------------------------------------------------------------
    Imposition of an 85% exchange trading requirement would also have 
adverse effects on market participants. If instruments that are most 
often traded off-exchange are forced onto the centralized market, 
customers will lose cross-margin efficiencies that they currently enjoy 
and will be forced to post additional cash or assets as margin. For 
example, customers who currently hold open positions on CME 
Clearport' will be required to post a total of approximately 
$3.9 billion in margin (at the clearing firm level, across all clearing 
firms).
(b) Proposed Comparable Fee Structures Under Core Principle 2 for DCMs
    In the case of certain proposed fee restrictions to be placed on 
DCMs, the Commission not only retreats needlessly from principles-based 
regulation but also greatly exceeds its authority under DFA. DCM Core 
Principle 2, which appears in DFA Section 735, states, in part, that a 
DCM ``shall establish, monitor, and enforce compliance with rules of 
the contract market including . . . access requirements.'' Under this 
Core Principle, the Commission has proposed rule 38.151, which states 
that a DCM ``must provide its members, market participants and 
independent software vendors with impartial access to its market and 
services including . . . comparable fee structures for members, market 
participants and independent software vendors receiving equal access 
to, or services from, the [DCM].''
    The CFTC's attempt to regulate DCM member, market participant and 
independent software vendor fees is unsupportable. The CFTC is 
expressly authorized by statute to charge reasonable fees to recoup the 
costs of services it provides. 7 U.S.C. 16a(c). The Commission may not 
bootstrap that authority to set or limit the fees charged by DCMs or to 
impose an industry-wide fee cap that has the effect of a tax. See 
Federal Power Commission v. New England Power Co., 415 U.S. 345, 349 
(1974) (``[W]hole industries are not in the category of those who may 
be assessed [regulatory service fees], the thrust of the Act reaching 
only specific charges for specific services to specific individuals or 
companies.''). In any event, the CFTC's overreaching is not supported 
by DFA. Nowhere in the CEA is the CFTC authorized to set or limit fees 
a DCM may charge. To the extent the CFTC believes its authority to 
oversee impartial access to trading platforms may provide a basis for 
its assertion of authority, that attempt to read new and significant 
powers into the CEA should be rejected.
3. Provisions Common to Registered Entities \9\
---------------------------------------------------------------------------
    \9\ 75 Fed. Reg. 67282 (proposed Nov. 2, 2010) (to be codified at 
17 CFR pt. 40).
---------------------------------------------------------------------------
    The CFMA streamlined the procedures for listing new products and 
amending rules that did not impact the economic interests of persons 
holding open contracts. These changes recognized that the previous 
system required massive, worthless paper pushing efforts by exchanges 
and by the CFTC's staff. It slowed innovation and offered no 
demonstrable public benefit. Our ability to compete on a global scale, 
which had been progressively eroded by the disparity between the U.S. 
process and the rules under which foreign competitors operated, was 
restored.
    Under current rules, before a product is self-certified or a new 
rule or rule amendment is proposed, DCMs and DCOs conduct a due 
diligence review to support their conclusion that the product or rule 
complies with the Act and Core Principles. The point of the self-
certification process that Congress retained in DFA is that registered 
entities that list new products have a self-interest in making sure 
that the new products meet applicable legal standards. Breach of this 
certification requirement potentially subjects the DCM or DCO to 
regulatory liability. In addition, in some circumstances, a DCM or DCO 
may be subject to litigation or other commercial remedies for listing a 
new product, and the avoidance of these costs and burdens is sufficient 
incentive for DCMs and DCOs to remain compliant with the Act.
    Nothing in the last decade of self-certification suggests that this 
concept is flawed or that registered entities have employed this power 
recklessly or abusively. During 2010, CME launched 438 new products and 
submitted 342 rules or rule amendments to the Commission. There was no 
legitimate complaint respecting the self-certification process during 
this time. Put simply, the existing process has worked, and there is no 
reason for the Commission to impose additional burdens, which are not 
required by DFA, to impair that process.
    Section 745 of DFA merely states, in relevant part, that ``a 
registered entity may elect to list for trading or accept for clearing 
any new contract, or other instrument, or may elect to approve or 
implement any new rule or rule amendment, by providing to the 
Commission a written certification that the new contract or instrument 
or clearing of the new contract or instrument, new rule, or rule 
amendment complies with this Act (including regulations under this 
Act).'' To be sure, DFA in no way directs the Commission to require the 
submission of all documents supporting such a certification nor to 
require a review of the legal implications of the product or rule with 
regard to laws other than DFA. Essentially, it requires exactly what 
was required prior to the passage of DFA--a certification that the 
product, rule or rule amendment complies with the CEA. Nonetheless, the 
Commission has taken it upon itself to impose these additional and 
burdensome submission requirements upon registered entities.
    The new requirements are likely to significantly impair the speed 
and value of innovation by U.S. exchanges and clearing houses, which 
will be required to watch their innovations brought to market by 
foreign competitors while the U.S. agency checks boxes to insure that 
filings are complete. Moreover, given the volume of filings required by 
the notice of proposed rulemaking, the Commission will require 
significant increases in staffing and other resources. The Commission's 
resources should be better aligned with the implementation of the goals 
of DFA rather than ``correcting'' a well-functioning and efficient 
process.
    The proposed rules greatly and unnecessarily increase the 
documentation burden associated with this submission process, and it 
seems inevitable that they will greatly slow the process of new rule 
and product introduction. First, a registered entity must submit ``all 
documentation'' relied upon to determine whether a new product, rule or 
rule amendment complies with applicable Core Principles. This 
requirement is, to begin with, vague, and thus is likely to result in 
the submission of unnecessary and non-useful information. More 
importantly, this requirement imposes an additional burden on both 
registered entities, which must compile and produce all such 
documentation, and the Commission, which must review it. The benefits, 
if any, to be gathered by this requirement are significantly outweighed 
by the costs imposed both on the marketplace and the Commission.
    Second, the proposed rules require registered entities to examine 
potential legal issues associated with the listing of products and 
include representations related to these issues in their submissions. 
Specifically, a registered entity must provide a certification that it 
has undertaken a due diligence review of the legal conditions, 
including conditions that relate to contractual and intellectual 
property rights. The imposition of such a legal due diligence standard 
is clearly outside the scope of DFA and is unnecessarily vague and 
impractical, if not impossible, to comply with in any meaningful 
manner. An entity, such as CME, involved in product creation and design 
is always cognizant of material intellectual property issues that might 
arise. This amorphous and potentially vast legal diligence requirement 
could require that registered entities expand what could reasonably be 
considered to be a material or colorable intellectual property analysis 
and undertake extensive intellectual property analysis, including 
patent, copyright and trademark searches in order to satisfy the 
regulatory mandates. This would greatly increase the cost and timing of 
listing products without providing any true corresponding benefit to 
the marketplace. Indeed, the Commission itself admits in its NOPR that 
these proposed rules will increase the overall information collection 
burden on registered entities by approximately 8,300 hours per year. 75 
Fed. Reg. at 67290.
    Further, these rules steer the Commission closer to the product and 
rule approval process currently employed by the SEC, about which those 
regulated by the SEC complained at the CFTC-SEC harmonization hearings. 
Indeed, William J. Brodsky of the Chicago Board of Options Exchange 
testified that the SEC's approval process ``inhibits innovation in the 
securities markets'' and urged the adoption of the CFTC`s certification 
process.
4. Requirements for Derivatives Clearing Organizations, Designated 
        Contract Markets, and Swap Execution Facilities Regarding 
        Mitigation of Conflicts of Interest \10\
---------------------------------------------------------------------------
    \10\ 75 Fed. Reg. 63732 (proposed October 18, 2010) (to be codified 
at 17 CFR pts. 1, 37, 38, 39, 40).
---------------------------------------------------------------------------
    The Commission's proposed rules regarding the mitigation of 
conflicts of interest in DCOs, DCMs and SEFs (``Regulated Entities'') 
also exceed its rulemaking authority under DFA and impose constraints 
on governance that are unrelated to the purposes of DFA or the CEA. The 
Commission purports to act pursuant to Section 726 of DFA but ignores 
the clear boundaries of its authority under that section, which it 
cites to justify taking control of every aspect of the governance of 
those Regulated Entities. Section 726 conditions the Commission's right 
to adopt rules mitigating conflicts of interest to circumstances where 
the Commission has made a finding that the rule is ``necessary and 
appropriate'' to ``improve the governance of, or to mitigate systemic 
risk, promote competition, or mitigate conflicts of interest in 
connection with a swap dealer or major swap participant's conduct of 
business with, a [Regulated Entity] that clears or posts swaps or makes 
swaps available for trading and in which such swap dealer or major swap 
participant has a material debt or equity investment.'' (emphasis 
added) The ``necessary and appropriate'' requirement constrains the 
Commission to enact rules that are no more intrusive than necessary to 
fulfill the stated Congressional intent--in other words, the 
regulations must be narrowly-tailored to minimize their burden on the 
industry. The Commission failed to make the required determination that 
the proposed regulations were ``necessary and proper'' and, 
unsurprisingly, the proposed rules are not narrowly-tailored but rather 
overbroad, outside of the authority granted to it by DFA and 
extraordinarily burdensome.
    The Commission proposed governance rules and ownership limitations 
that affect all Regulated Entities, including those in which no swap 
dealer has a material debt or equity investment and those that do not 
even trade or clear swaps. Moreover, the governance rules proposed have 
nothing to do with conflicts of interest, as that term is understood in 
the context of corporate governance. Instead, the Commission has 
created a concept of ``structural conflicts,'' which has no recognized 
meaning outside of the Commission's own declarations and is unrelated 
to ``conflict of interest'' as used in the CEA. The Commission proposed 
rules to regulate the ownership of voting interests in Regulated 
Entities by any member of those Regulated Entities, including members 
whose interests are unrelated or even contrary to the interests of the 
defined ``enumerated entities.'' In addition, the Commission is 
attempting to impose membership condition requirements for a broad 
range of committees that are unrelated to the decision making to which 
Section 726 was directed.
    The Commission's proposed rules are most notably overbroad and 
burdensome in that they address not only ownership issues but the 
internal structure of public corporations governed by state law and 
listing requirements of SEC regulated national securities exchanges. 
More specifically, the proposed regulations set requirements for the 
composition of corporate boards, require Regulated Entities to have 
certain internal committees of specified compositions and even propose 
a new definition for a ``public director.'' Such rules in no way relate 
to the conflict of interest Congress sought to address through Section 
726. Moreover, these proposed rules improperly intrude into an area of 
traditional state sovereignty. It is well-established that matters of 
internal corporate governance are regulated by the states, specifically 
the state of incorporation. Regulators may not enact rules that intrude 
into traditional areas of state sovereignty unless Federal law compels 
such an intrusion. Here, Section 726 provides no such authorization.
    Perhaps most importantly, the proposed structural governance 
requirements cannot be ``necessary and appropriate,'' as required by 
DFA, because applicable state law renders them completely unnecessary. 
State law imposes fiduciary duties on directors of corporations that 
mandate that they act in the best interests of the corporation and its 
shareholders--not in their own best interests or the best interests of 
other entities with whom they may have a relationship. As such, 
regardless of how a board or committee is composed, the members must 
act in the best interest of the exchange or clearinghouse. The 
Commission's concerns--that members, enumerated entities, or other 
individuals not meeting its definition of ``public director'' will act 
in their own interests--and its proposed structural requirements are 
wholly unnecessary and impose additional costs on the industry--not to 
mention additional enforcement costs--completely needlessly.
5. Prohibition on Market Manipulation \11\
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    \11\ 75 Fed. Reg. 67657-62 (proposed Nov. 3, 2010) (to be codified 
at 17 CFR pt. 180).
---------------------------------------------------------------------------
    The Commission's proposed rules on Market Manipulation, although 
not representing as clear an overstepping of its boundaries under DFA, 
are also problematic because they are extremely vague. The Commission 
has proposed two rules related to market manipulation: Rule 180.1, 
modeled after SEC Rule 10b-5 and intended as a broad, catch-all 
provision for fraudulent conduct; and Rule 180.2, which mirrors new CEA 
Section 6(c)(3) and is aimed at prohibiting price manipulation. See 75 
Fed. Reg. at 67658. Clearly, there is a shared interest among market 
participants, exchanges and regulators in having market and regulatory 
infrastructures that promote fair, transparent and efficient markets 
and that mitigate exposure to risks that threaten the integrity and 
stability of the market. In that context, however, market participants 
also desire clarity with respect to the rules and fairness and 
consistency with regard to their enforcement.
    As to its proposed rule 180.1, the Commission relies on SEC 
precedent to provide further clarity with respect to its interpretation 
and notes that it intends to implement the rule to reflect its 
``distinct regulatory mission.'' However, the Commission fails to 
explain how the rule and precedent will be adapted to reflect the 
differences between futures and securities markets. See 75 Fed. Reg. at 
67658-60. For example, the Commission does not provide clarity as to if 
and to what extent it intends to apply insider trading precedent to 
futures markets. Making this concept applicable to futures markets 
would fundamentally change the nature of the market, not to mention all 
but halting participation by hedgers, yet the Commission does not even 
address this issue. Rule 180.1 is further unclear as to what standard 
of scienter the Commission intends to adopt for liability under the 
rule. Rule 180.2 is comparably vague, providing, for example, no 
guidance as to what sort of behavior is ``intended to interfere with 
the legitimate forces of supply and demand'' and how the Commission 
intends to determine whether a price has been affected by illegitimate 
factors.
    These proposed rules, like many others, have clearly been proposed 
in haste and fail to provide market participants with sufficient notice 
of whether contemplated trading practices run afoul of them. Indeed, 
the proposed rules are so unclear as to be subject to constitutional 
challenge. That is, due process precludes the government from 
penalizing a private party for violating a rule without first providing 
adequate notice that conduct is forbidden by the rule. In the area of 
market manipulation especially, impermissible conduct must be clearly 
defined lest the rules chill legitimate market participation and 
undermine the hedging and price discovery functions of the market by 
threatening sanctions for what otherwise would be considered completely 
legal activity. That is, if market participants do not know the rules 
of the road in advance and lack confidence that the disciplinary regime 
will operate fairly and rationally, market participation will be 
chilled because there is a significant risk that legitimate trading 
practices will be arbitrarily construed, post hoc, as unlawful.
6. Anti-disruptive Practices Authority Contained in DFA \12\
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    \12\ 75 Fed. Reg. 67301 (proposed November 2, 2010) (to be codified 
at 17 CFR pt. 1).
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    Rules regarding Disruptive Trade Practices (DFA Section 747) run 
the risk of being similarly vague and resulting in chilling of market 
participation. At this juncture, the Commission has issued only an 
Advance notice of proposed rulemaking (``ANPR'') on this issue, and the 
ANPR demonstrates the Commission's understanding that it must provide 
clarity beyond that provided by DFA. Still, it is worthy of note that 
Section 747 of DFA, which authorizes the Commission to promulgate 
additional rules if they are reasonably necessary to prohibit trading 
practices that are ``disruptive of fair and equitable trading,'' is 
exceedingly vague as written and does not provide market participants 
with adequate notice as to whether contemplated conduct is forbidden. 
Hasty rulemaking resulting in vague rules in the area of disruptive 
trade practices will have the same effect as such rulemaking in the 
area of market manipulation--participation in the market and the 
hedging and price discovery functions of the market will be chilled due 
to uncertainty among participants as to whether their contemplated 
conduct is acceptable.
    The above are merely a few examples of instances in which CME 
believes the Commission has proposed rules inconsistent with DFA or 
that impose unjustified costs and burdens on both the industry and the 
Commission. We ask this Congress to extend the rulemaking schedule 
under DFA to allow time for industry professionals of various 
viewpoints to fully express their views and concerns to the Commission 
and for the Commission to have a realistic opportunity to assess and 
respond to those views and to realistically assess the costs and 
burdens imposed by the new regulations. We urge the Congress to ensure 
that implementation of DFA is consistent with the Congressional 
directives in the Act and does not unnecessarily harm hedging and risk 
transfer markets that U.S. companies depend upon to reduce business 
risks and increase economic growth.

    The Chairman. Mr. Pickel, 5 minutes.

         STATEMENT OF ROBERT G. PICKEL, EXECUTIVE VICE
         CHAIRMAN, INTERNATIONAL SWAPS AND DERIVATIVES
                ASSOCIATION, INC., NEW YORK, NY

    Mr. Pickel. Mr. Chairman, Ranking Member Peterson, and 
Members of the Committee, thank you for the opportunity to 
testify once again today before this Committee, this time 
regarding implementation of Title VII of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act.
    Like all of you here today, ISDA is very supportive of 
efforts to build a more robust and effective financial 
regulatory framework. We fully share the goal of U.S. 
policymakers and policymakers around the world to enhance the 
safety and soundness of our financial markets. ISDA has taken 
numerous steps over the years to make OTC markets safe and 
efficient, and has a strong incentive to see the Dodd-Frank Act 
implemented effectively. We are actively at work in key areas, 
such as reducing counterparty risk and increasing transparency, 
that support these goals.
    We are, however, concerned at the volume of, and the 
compressed timeframe for, finalizing the rules required under 
the Act that may work against the law's essential purpose, 
impede the availability of hedging tools that U.S. companies 
need to manage their risks, and adversely impact the 
competitiveness of U.S.-based derivatives markets.
    The timelines contained in the Dodd-Frank Act require the 
CFTC and the SEC to move at a speed that we believe will make 
it difficult to establish a sound regulatory environment. Thus, 
we strongly support a phased in implementation of any new 
regulatory requirements to protect against unintended 
consequences.
    In light of the already difficult timelines, we are also 
concerned that some of the proposed regulations go beyond the 
statutory requirements of the Dodd-Frank Act, pulling resources 
away from implementation of regulations focused on safety and 
soundness and creating new rules that will adversely affect the 
existing swaps market with little apparent benefit.
    We also urge the agencies and this Committee as the 
rulemaking process moves forward, to take the time to consider 
the aggregate effect of the totality of the regulations.
    As I listened to the first--Chairman Gensler on the first 
panel, there were several questions about the size of this 
market, the size of this business. We often use this notion of 
notional amount, which is $600 trillion globally, roughly $300 
trillion here in the United States. What I think is also 
important to focus on is despite that size, trading in the OTC 
markets is relatively limited in terms of number of contracts. 
Roughly 5,500 interest rate swaps contracts are executed each 
day in over 20 currencies around the globe. This compares to 
the approximately 300,000 tickets per day that are executed in 
the U.S. Government and Euro dollar futures contracts on the 
CME. Daily OTC interest rate swap volume is two percent of the 
corresponding CME Group futures contracts. The daily volume of 
trades executed in U.S. dollars is less than one percent of the 
corresponding futures contracts. If we look at the more 
standardized trades, those trades that will likely go into a 
clearing environment and perhaps traded on a swap execution 
facility, there are approximately 2,000 standardized interest 
rate swaps executed on an average day. The largest maturity for 
10 year U.S. dollar swaps trade about 200 times a day, or once 
every 4 minutes, quite different from the frequency of trading 
of a contract that you would see on the CME. I think it is 
important, as we look at issues of implementation, as we look 
at issues of block trading and transparency, that we keep in 
mind the number of contracts that are traded each day in the 
OTC markets around the world.
    As the Committee moves forward, I urge you to consider 
three important factors as it considers the rules that are 
being implemented at the CFTC. ISDA strongly believes that 
preserving market liquidity is a critical consideration in the 
promulgation of new regulatory requirements. Liquidity is the 
lifeblood of the financial system. It is universally recognized 
as a key element of an efficient marketplace, and necessary for 
financial markets to remain viable. We would recommend, then, 
that when considering aspects of the Dodd-Frank Act that could 
impact liquidity, such as appropriate exceptions to real-time 
reporting for block trades, that the Commission engage in 
robust market and impact analyses of these proposals prior to 
finalizing their rules.
    Although adverse effects on liquidity can be avoided or 
mitigated in the implementation process, increased costs 
related to new regulations are often unavoidable. It is 
imperative that the Commission recognize the need to accurately 
assess all costs, both explicit and implicit, and mitigate 
these costs to the maximum extent possible. These costs can be 
alleviated by leveraging existing industry processes and 
practices, and by ensuring that new regulations do not go 
beyond the mandates set by the Dodd-Frank Act.
    Last, I would urge the Committee to consider--and as 
certainly indicated in numerous remarks today--that as the 
Commissions proceed, they should consider the competitiveness 
of the U.S. financial markets and U.S. financial firms when 
setting these new requirements. Over 90 percent of the largest 
U.S. companies use OTC derivatives to manage their business and 
financial risks. We are concerned that overly restrictive 
requirements, coupled with increased and unnecessary costs, may 
result in transfers of business and eventually jobs overseas.
    In conclusion, we appreciate the enormous task that has 
been set out for the CFTC and the SEC in promulgating the 
number of Dodd-Frank Act rulemakings, and we appreciate the 
transparency that they have provided in this process. We 
recommend, however, that the Commissions assure that their 
rulemaking processes allow for an iterative process between 
their staff and industry commentators, a complete assessment, 
an analysis of proposed rules potential impact on markets, 
firms, and the U.S. swaps and derivatives markets, and an 
orderly transition to this new regulatory regime.
    Thank you, and I look forward to your questions.
    [The prepared statement of Mr. Pickel follows:]

   Prepared Statement of Robert G. Pickel, Executive Vice Chairman, 
  International Swaps and Derivatives Association, Inc., New York, NY

    Chairman Lucas, Ranking Member Peterson and Members of the 
Committee:

    Thank you for the opportunity to testify today regarding 
implementation of Title VII of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act. Like all of you here today, ISDA is very 
supportive of efforts to build a more robust and effective financial 
regulatory framework. We fully share the goal of policymakers in the 
U.S. and around the world to enhance the safety and soundness of our 
financial markets. As you will hear, we are actively at work in key 
areas--such as reducing counterparty risk and increasing transparency--
that support these goals. We are, however. concerned that the volume of 
and the compressed timeframe for finalizing the rules required under 
the Act may work against the law's essential purpose, impede the 
availability of hedging tools that U.S. companies need to manage their 
risks and adversely impact the competitiveness of the U.S.-based 
derivatives markets. We also are concerned that some of the proposed 
regulations go beyond the statutory requirements of the Dodd-Frank Act 
and will create new rules with that will adversely affect the existing 
swaps markets with little apparent benefit.

Introduction
    The International Swaps and Derivatives Association, or ISDA, was 
chartered in 1985 and has over 800 member institutions from 54 
countries on six continents. Our members include most of the world's 
major institutions that deal in privately negotiated derivatives, as 
well as many of the businesses, governmental entities and other end-
users that rely on over-the-counter derivatives to manage efficiently 
the financial market risks inherent in their core economic activities.
    ISDA's focus is primarily on making the OTC derivatives markets 
safe and efficient. Over its 25 year history, ISDA has pioneered 
efforts to identify and reduce the sources of risk in the derivatives 
and risk management business through documentation that is the 
recognized standard throughout the global market, legal opinions that 
facilitate enforceability of agreements, the development of sound risk 
management practices, and advancing the understanding and treatment of 
derivatives and risk management from public policy and regulatory 
capital perspectives.
    In the years leading up to and since the passage of the Dodd-Frank 
Act, ISDA, the major dealers, buy-side institutions and other industry 
associations have worked collaboratively to deliver structural 
improvements to the global over-the-counter (OTC) derivatives markets. 
These actions were undertaken as part of an ongoing dialogue with and 
commitments to global supervisors, including the Federal Reserve Bank 
of New York, the Securities and Exchange Commission (SEC), the 
Commodity Futures Trading Commission (CFTC), the Office of the 
Comptroller of the Currency and the Office of Thrift Supervision.
    Through this process, the industry has made and continues to make 
substantial progress in three key areas: reducing counterparty risk; 
increasing transparency and enhancing the operational infrastructure of 
the swaps and derivatives business.
    As to the reduction in counterparty risk, the industry is making 
significant progress through both clearing and portfolio compression. 
Today, about $248 trillion of interest rate swaps, representing more 
than 40 percent of the market, is centrally cleared.\1\ Another $106 
trillion of interest rate swaps has been eliminated due to portfolio 
compression.\2\ In the credit default swaps markets, more than $15 
trillion has been centrally cleared.\3\ Portfolio compression has 
eliminated more than $70 trillion of CDS.\4\ In fact, by virtue of the 
combination of central clearing and portfolio compression, the size of 
the CDS market has been reduced by 75 percent in the past several 
years. We believe the volume of cleared swaps could double in the next 
2 to 3 years.
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    \1\ http://www.lchclearnet.com/swaps/
swapclear_for_clearing_members/.
    \2\ http://www.trioptima.com/services/triReduce.html.
    \3\ http://ir.theice.com/releasedetail.cfm?ReleaseID=545362.
    \4\ http://www.trioptima.com/services/triReduce/triReduce-
credit.html.
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    As for our goal of increasing transparency, it is important to keep 
in mind that a distinction should be made between regulatory 
transparency and market transparency. Regulatory transparency means 
that regulators should have access to trade information on a timely 
basis in order to monitor market risk. ISDA fully supports this goal. 
The Association has helped establish trade repositories that provide 
global regulators with significant visibility into firm and 
counterparty risk exposures. This means that the uncertainties that 
occurred in the recent financial crisis regarding risk exposures of 
Lehman Brothers simply could not happen again.
    Another aspect of transparency is market transparency, or price 
visibility for market participants. Recent ISDA surveys and tests 
demonstrate that users of most derivatives have tremendous pricing 
transparency and extremely competitive pricing. To obtain competitive 
pricing, the large majority of users receive price quotations from 
multiple dealers. Their concern is that these products remain available 
and affordable. A recent blind test of interest rate swap pricing for 
three American investment firms found tremendous price competition in 
both the dollar and Euro markets. When measured against a benchmark 
screen, these firms were able to obtain firm pricing on nearly $2 
billion of swaps at a spread of 0.001% over the middle of the bid-offer 
on the screen. These swaps were for maturities from 2 to thirty years 
and for sizes up to $250 million.\5\
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    \5\ http://isda.org/media/pdf/ISDATestReport.pdf.
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    While the evidence indicates there is a significant level of price 
transparency in the OTC derivatives markets, the industry is actively 
exploring ways to improve further improve upon this and ISDA has 
sponsored research to this effect. We believe it is important that any 
efforts to build greater market transparency be done after careful 
analysis and evaluation of its benefits, its impact on liquidity and on 
the ability of end-users to use derivatives to manage their risks.
    As to the operational infrastructure of the OTC derivatives 
business, over the past several years, the industry has made 
significant improvements in reducing backlogs, and improving and 
automating middle- and back-office processes.
    Our commitment in these areas has been detailed in a series of 
letters, beginning in September 2005, to the group of global 
supervisors referenced above, the latest of which, dated March 1, 2010, 
is attached to this testimony.\6\ These actions by ISDA, the major 
dealers, buy-side institutions and other industry associations have 
improved the way OTC derivatives are traded, processed and cleared and 
reflect significant investment of resources and capital. They are a 
powerful indication of the commitment the industry has made to improve 
the market infrastructure as a means to achieving the shared policy 
goals of reducing systemic risk and increasing transparency. The 
industry recently met again with global supervisors and is in 
discussions about an additional commitment letter that will provide a 
roadmap to achieving compliance with regulatory requirements both in 
the United States and elsewhere.
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    \6\ http://www.newyorkfed.org/newsevents/news/markets/2010/
100301_letter.pdf.
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Dodd-Frank Rulemaking Process
    The Dodd-Frank Act is a wide-ranging and comprehensive piece of 
legislation. As a result, all of the Federal financial regulatory 
agencies have been faced with an unprecedented level of obligated 
rulemaking. The CFTC and SEC, in particular, have an especially 
challenging task as they attempt to create a new regulatory regime for 
the OTC derivatives markets. Since the passage of the Dodd-Frank Act 
last July, ISDA has continued to work closely with various U.S. 
regulators with the goal of helping them develop rules that achieve the 
goals of the Act, while mitigating against any undesirable, unintended 
adverse consequences.
    It is vital that this new regulatory regime create a framework that 
increases transparency and mitigates systemic risk, while preserving 
the ability of derivatives users to hedge and manage risk in a prudent 
and cost-effective manner. As the regulators attempt to strike this 
very difficult balance, we have several recommendations that we believe 
may be helpful regarding the rulemaking process that take into 
consideration key issues regarding the market's structure and 
liquidity, the costs and availability of derivatives and hedging for 
end-users, and the continued competitiveness of the U.S. firms in the 
global swaps and derivatives markets.

The Process
    We applaud the efforts of the CFTC and SEC to create an open and 
transparent rulemaking process. The Commissions have diligently posted 
and reported all meetings with stakeholders and have held a series of 
public roundtables to consider a number of issues related to Dodd-Frank 
Act rulemakings. ISDA has taken part in this transparent rulemaking 
process and has filed approximately 30 formal comment letters. In 
addition, ISDA has had a number of discussions with the Chairpersons 
and Commissioners of the CFTC and SEC and the Staffs of both 
Commissions, and has participated in a number of public roundtables.
    Of course, in addition to transparency, a key to the promulgation 
of effective and meaningful rulemaking is to allow for, in essence, an 
iterative process between the Commissions and commentators. We are 
concerned that the volume of proposed rulemakings and the Commissions' 
compressed statutory time frame for promulgating their new rules may 
impair such a process, and hamper the ability of commentators to 
provide thoughtful and comprehensive comments and of agency staff to 
digest and assess the comments that are submitted. Toward that end, 
ISDA and a number of trade associations jointly wrote to the 
Commissions to urge them to use their discretion to propose, adopt and 
implement rules in an appropriate sequence and timeframe.\7\
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    \7\ http://www.isda.org/speeches/pdf/Comment-Letter-on-Regulatory-
Process-and-Phase-In.pdf.
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    Some of the proposed rules, for example, contain or are based on 
standards or numbers that will be hardwired into the regulatory 
framework. This includes the requirement that trades below $250 million 
in notional principal be subject to real-time reporting requirements, a 
level that does not take into account the structure of the derivatives 
market. This proposed rule could disrupt risk transfer by American 
companies and impede the capital formation process that is essential to 
economic growth.
    We also are concerned that some of the proposed regulations go 
beyond the statutory requirements of the Dodd-Frank Act and will create 
new obligations or set new standards that will fundamentally and 
negatively affect the existing swaps markets with little apparent 
benefit. For example, the CFTC's proposes to require that swaps 
execution facilities (SEFs) must have access to quotes from five 
dealers. There is to our knowledge no objective evidence that supports 
this decision or that indicates why five is the optimal number of 
dealers on a SEF. The law itself only specifies that such quotes be 
sent to multiple dealers.
    Finally, we are encouraged that the agencies appear to recognize 
the need to phase-in the requirements of the Dodd-Frank Act and stress 
that the transition to this new regulatory regime occur incrementally 
in a way that ensures the continued viability of the market and that 
also protects overall liquidity.

Liquidity
    As noted, ISDA strongly believes that consideration of the effects 
of any rule on market liquidity is critical in connection with the 
promulgation of new regulatory requirements. Liquidity is the lifeblood 
of the financial system; it is universally recognized as a key element 
of an efficient marketplace and necessary for financial markets to 
remain viable. A market's liquidity is a function of its structure. For 
example, despite its size, trading in the OTC derivatives markets is 
quite limited. Roughly 5,500 interest rate swap contracts are executed 
each day in over 20 currencies. This compares to the approximately 
300,000 tickets per day in the U.S. Government and Eurodollar futures 
contracts traded at the CME Group. Daily OTC interest rate swap volume 
is two percent of the corresponding CME Group futures contracts. The 
daily volume of trades executed in U.S. dollars is less than one 
percent of the corresponding futures markets.\8\
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    \8\ http://www.trioptima.com/repository.html.
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    Congress recognized the importance of liquidity throughout the 
Dodd-Frank Act. For example, when setting real-time reporting 
requirements, the CFTC and SEC are required to consider the effects on 
liquidity when setting block trading exemptions. This is important 
considering that the average size of a 10 year U.S. dollar interest 
rate swap was $75 million during 2010, whereas comparable transactions 
in futures and securities markets are substantially smaller ($2 million 
for 10 year U.S. Treasury Notes futures and $3 million for U.S. 
corporate bonds, respectively.) \9\ ISDA believes that block trade 
thresholds should be set so that liquidity is not impaired, in order to 
ensure that these vital markets enable cost-effective risk-hedging, so 
vital to the preservation of economic stability. In addition, we do not 
believe that there is a ``one size fits all'' solution; rules should be 
tailored to products and markets. Rules for relatively less liquid 
products should be different from rules for more liquid products. 
Uniform rules that do not take into account the structure of the 
derivatives market will discourage the transfer of risks by U.S. 
companies, particularly during times of market stress. Firms will be 
extremely wary of offering firm quotes if they can not effectively 
hedge the risks they are taking on because of post-trade transparency 
rules.
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    \9\ http://www.isda.org/c_and_a/pdf/EquitiesTransparency-Study.pdf.
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    The Commissions also are required to consider liquidity when 
determining which instruments should be subject to new clearing 
requirements. ISDA believes it is imperative that any new requirements 
do not impair existing liquidity. Failure to consider such impacts will 
hurt the fairness, stability and efficiency of the overall market and, 
in many instances, make it more difficult, or even impossible, to hedge 
or mitigate risk in an efficient and cost-effective way. We recommend 
that when considering aspects of the Dodd-Frank Act that could impact 
liquidity, such as appropriate exceptions to real-time reporting 
requirements for ``block'' trades, that the Commissions engage in 
robust market and impact analyses of these proposals prior to 
finalizing their rules. ISDA has conducted research on the structure of 
the interest rate, credit default and equity swaps markets and has 
sponsored a test on interest rate swaps pricing that is publicly 
available for review.
    Another concern regarding the impact of the Dodd-Frank Act on the 
liquidity of the derivatives markets and the ability of end-users to 
hedge their risks relates to the foreign exchange (FX) market. Under 
the law, the Treasury Department has the ability to exempt FX swaps and 
forwards from the definition and related regulation of swaps under the 
law. The FX market is large, liquid, a vital part of the commercial 
banking market and essential to economic activity. Classification of FX 
swaps and forwards as swaps would subject many FX transactions to 
clearing and execution requirements and would have significant adverse 
effects on the market for these transactions. For these reasons, ISDA 
urges the Treasury Department to use the exemptive authority that the 
Dodd-Frank Act provides to it.

Costs
    Although adverse effects on liquidity can be avoided or mitigated 
in the implementation process, increased costs related to new 
regulations are often unavoidable. These costs are even higher when 
creating a new regulatory regime from whole cloth as is the case with 
the swaps markets; as a result, it is imperative that the Commission 
recognize the need to accurately assess all costs (both explicit and 
implicit) and mitigate these costs to the maximum extent possible. 
These costs can be alleviated by leveraging existing industry processes 
and practices and by ensuring that new regulations do not go beyond the 
mandate set by the Dodd-Frank Act.

U.S. Competitiveness
    Perhaps most importantly, the implementing Commissions should 
consider the competitiveness of the U.S. financial markets and U.S. 
financial firms when setting new requirements. Over 90 percent of the 
largest U.S. companies use OTC derivatives to manage their business and 
financial risks. A broader survey of the top 2,200 American companies 
found that 65 percent use derivatives.\10\
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    \10\ http://papers.ssrn.com/sol3/papers.cfm?abstract_id=962942.
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    We are concerned that overly restrictive requirements, coupled with 
increased and unnecessary costs, may result in transfers of businesses 
and, eventually, jobs overseas. Although the U.S. remains the most 
dynamic, innovative marketplace in the world, we note that transaction 
volume in London already exceeds that in New York. We also note that 
the five largest U.S.-based dealers reported a notional amount 
outstanding equal to only 37 percent of the total notional amount for 
interest rate, credit, and equity derivatives.\11\ We strongly 
recommend that the CFTC and SEC engage in thorough market analyses 
before promulgating new requirements, to ensure that such requirements 
are not unduly burdensome or likely to create incentives to do business 
outside the U.S.
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    \11\ http://www.isda.org/media/press/2010/press102510.html.
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          * * * * *
    In conclusion, we applaud the efforts of the CFTC and SEC to 
promulgate the massive number of Dodd-Frank Act rulemakings and 
appreciate the transparency they have attempted to provide. We 
recommend, however, that the Commissions assure that their rulemaking 
processes allow for an iterative process between their staff and 
industry commentators, a complete assessment; an analysis of proposed 
rules' potential impacts on markets, firms and the U.S. swaps and 
derivatives markets; and an orderly transition to this new regulatory 
regime.
                               Attachment
March 1, 2010

Identical versions of this letter have been addressed directly to the 
heads of the primary supervisory agency of each of the regulated 
signatories.

Hon. William C. Dudley,
President,
Federal Reserve Bank of New York,
New York, NY.

    Dear Mr. Dudley,

    The undersigned dealers (each, a G14 Member) and buy-side 
institutions continue to work collaboratively to deliver structural 
improvements to the global over-the-counter derivatives markets (OTC 
Derivatives Markets).\1\ This effort is undertaken as part of our 
ongoing partnership with Supervisors, government departments, trade 
associations, industry utilities and private vendors. The purpose of 
this letter is to set forth goals and commitments the fulfillment of 
which will continue to move the market to the standards of resilience 
and robustness envisaged by bodies such as the G20.\2\
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    \1\ The commitments or undertakings described throughout this 
letter are subject to the applicable fiduciary responsibilities of 
signatory firms, including any and all client-specific duties, 
obligations and instructions.
    \2\ Pursuant to this, we strongly support many of the goals and 
aspirations set out in relevant white papers and consultation documents 
published by, inter alia, the European Commission, the FRBNY and the UK 
Treasury/FSA.
---------------------------------------------------------------------------
    The industry recognizes the significant work that lies ahead, and 
re-affirms its commitment to aggressively pursue improvements along 
five overarching themes:

   In order to increase transparency and better understand 
        transparency needs in the OTC Derivatives Market, the 
        signatories will: (a) continue to advance the development of 
        global data repositories; (b) provide relevant Supervisors 
        with: (i) an inventory of existing forms of transparency in OTC 
        Derivatives Markets by product and asset class; (ii) a study 
        which describes and evaluates the spectrum of methods that can 
        be used to increase transparency, analyzes the benefits and 
        costs and attempts to identify to whom such benefits and costs 
        accrue and (iii) relevant transaction data to support the 
        Supervisors' own analysis.

   In order to deliver robust, efficient and accessible central 
        clearing to the OTC Derivatives Markets, the signatories make a 
        strong commitment to increase: (a) the range of products 
        eligible for clearing and (b) the proportion of open interest 
        in the products that are cleared. In support of this 
        commitment, where appropriate, the signatories will work 
        towards the inclusion of users, either through direct access or 
        through indirect client access, including extension of 
        segregation and portability. In order to better reflect the 
        composition of the credit default swap (CDS) market, the 
        signatories who are participants on the ISDA Credit Derivatives 
        Determinations Committees (each, a DC) will propose a framework 
        to involve CDS central counterparties (each, a CCP) in the DC 
        process.

   Drive a high level of product, processing and legal 
        standardization in each asset class with a goal of securing 
        operational efficiency, mitigating operational risk and 
        increasing the netting and clearing potential for appropriate 
        products (recognizing that standardization is only one of a 
        number of criteria for clearing eligibility). Accordingly, 
        workstreams have been established to analyze existing, and 
        where appropriate, potential opportunities for further 
        standardization by asset class and by product.

   Continue to work to enhance bilateral collateralization 
        arrangements to ensure robust risk management, including strong 
        legal and market practices and operational frameworks. In 
        particular, continue the work on resolution procedures for 
        variation margin disputes arising out of bilateral derivatives 
        transactions, and on publication and adoption of best practices 
        among the G14 Members and other signatories. Additionally, 
        continue the consideration of the risks, mitigants and 
        enhancements associated with initial margin.

   Build on improvements in operational performance, with a 
        focus on driving `electronification', straight-through-
        processing, and trade date matching, affirmation and 
        processing.

    Having recognized the need to act expeditiously to implement a 
robust and resilient framework for OTC derivatives risk management and 
market structure, and acknowledging the importance of OTC Derivatives 
Markets, we have laid out goals with specific targets to the 
Supervisors in five previous joint industry commitment letters. Since 
the June 2, 2009 letter, we have completed the following steps:

   Implementation of the industry governance model put forward 
        by ISDA in 2009.

   Further standardization of Credit Derivatives.

   The successful launch of CDS clearing in Europe.

   Initial extension of clearing services to buy-side firms.

   Substantial progress in the implementation of global data 
        repositories.

   Delivery of proposals for improvements to the OTC bilateral 
        collateral processes.

   Continued improvement in industry infrastructure.

    These commitment letters represent not only a powerful statement of 
intent but also evidence of positive action from the industry, and also 
reflect significant investment of resources and capital.
    Contained in the attached Annexes are a series of further 
commitments which reflect these common themes, and which will support 
continued progress towards our shared goals of a resilient and robust 
OTC Derivatives Markets infrastructure. We believe that fulfillment of 
these commitments will deliver structural improvements to the OTC 
Derivatives Markets and will thus enable them to continue to perform 
their crucial function of risk management, while, where appropriate, 
retaining flexibility in terms of products and execution in a 
systemically sound construct.
    We look forward to our continued collaboration and strong dialogue 
with the Supervisors and legislators as we drive forward with these 
fundamental industry initiatives.

    From the Managements of:

AllianceBernstein;
Bank of America-Merrill Lynch;
Barclays Capital;
BlackRock, Inc.;
BlueMountain Capital Management LLC;
BNP Paribas;
Citadel Investment Group, L.L.C.;
Citi;
Credit Suisse;
Deutsche Bank AG;
D.E. Shaw & Co., L.P.;
DW Investment Management LP;
Goldman Sachs & Co.;
Goldman Sachs Asset Management, L.P.;
HSBC Group;
International Swaps and Derivatives Association, Inc.;
J.P.Morgan;
Managed Funds Association;
Morgan Stanley;
Pacific Investment Management Company, LLC;
The Royal Bank of Scotland Group;
Asset Management Group of the Securities Industry and Financial Markets 
Association;
Socite Generale;
UBS AG;
Wachovia Bank, N.A.;
Wellington Management Company, LLP.

    Identical versions of this letter have been addressed directly to 
the heads of the primary supervisory agency (each, a Supervisor) of 
each of the regulated signatories, including:

Board of Governors of the Federal Reserve System;
Connecticut State Banking Department;
Federal Deposit Insurance Corporation;
Federal Reserve Bank of New York;
Federal Reserve Bank of Richmond;
French Secretariat General de la Commission Bancaire;
German Federal Financial Supervisory Authority;
Japan Financial Services Agency;
New York State Banking Department;
Office of the Comptroller of the Currency;
Securities and Exchange Commission;
Swiss Financial Market Supervisory Authority;
United Kingdom Financial Services Authority.

CC:

Commodity Futures Trading Commission;
European Commission;
European Central Bank.

                      ANNEX A--RECENT ACHIEVEMENTS

    1. The implementation of a revised and formal ISDA Governance 
        framework, with increased participation of the buy-side in the 
        strategic agenda, policy formation and decision-making process. 
        The newly created ISDA Industry Governance Committee (IIGC), 
        under the auspices of the ISDA Board, provides governance and 
        strategic direction for the product level steering and working 
        groups, and acts as a focal point for the Supervisors and 
        legislators to engage effectively with the industry.

    2. Significant progress on product standardization for Credit 
        Derivatives, including, the completion of the 2009 ISDA Credit 
        Derivatives Determinations Committees, Auction Settlement and 
        Restructuring CDS Protocol (often referred to as the ``Small 
        Bang''), which allowed existing Credit Derivative contracts to 
        be modified to provide for Auction Settlement for Restructuring 
        Credit Events.

    3. The successful completion of the auction settlement process for 
        Credit Derivatives that included the Modified Modified 
        Restructuring Credit Event after the Thomson Restructuring.

    4. The successful application of the DC External Review procedure 
        for the Cemex S.A.B. de C.V. Restructuring Credit Event.

    5. Meeting or exceeding clearing targets set in respect of dealer-
        to-dealer new and historic volume for clearing Eligible Trades 
        \3\ in Interest Rate and Credit Derivative products. In excess 
        of 90% of new dealer-to-dealer volume in Eligible Trades of 
        Interest Rate Derivative products, and total dealer-to-dealer 
        volume in Eligible Trades of Credit Derivative products is now 
        cleared through CCPs.
---------------------------------------------------------------------------
    \3\ ``Eligible Trade'' is defined in our prior commitment letter 
dated September 8, 2009.

    6. Twenty-six of the largest Interest Rates Derivative market 
        makers are currently utilizing the LCH.Clearnet Ltd. SwapClear 
        (LCH) service to clear Interest Rate Derivatives. Six new 
        dealers joined the service in 2009 as direct clearing members 
        and twelve eligible dealers are expected to join in 2010. The 
        service was extended to support clearing of Overnight Index 
        Swaps (OIS) in July 2009. By the end of 2009, the platform had 
        $215 trillion notional and 1.57 million sides outstanding on 
---------------------------------------------------------------------------
        the system.

    7. The successful launch of CDS clearing in Europe and the recent 
        launch of Single Name clearing in Europe and North America.

    8. The initial extension of clearing services to the buy-side, with 
        the launch of initial client access to the clearing of Credit 
        Derivatives (ICE Trust on December 14, 2009 and CME on December 
        15, 2009) and Interest Rate Derivatives (LCH on December 17, 
        2009).

    9. Significant progress in the implementation of global data 
        repositories, with the successful launch of coverage for Credit 
        Derivative and Interest Rate Derivative products. In addition, 
        the selection process for the global data repository for Equity 
        Derivative products has concluded, with launch anticipated on 
        schedule on July 31, 2010.

    10. Delivery of proposals for improvements to the OTC collateral 
        process, through Dispute Resolution Procedures that would 
        employ, inter alia, portfolio reconciliation, along with formal 
        dispute resolution for intractable disputes.

    11. Publication in 2009 of the Roadmap for Collateral Management, 
        which is a forward-looking blueprint for evolving 
        collateralization into a more efficient and effective 
        counterparty credit risk reduction technique. Market 
        participants have implemented several commitments outlined by 
        the Roadmap to date; for example, a regime of daily portfolio 
        reconciliations for collateralized portfolios, allowing firms 
        to identify mismatches and achieve more complete 
        collateralization of risk, and publication of an open standard 
        to facilitate future electronic messaging of margin calls and 
        automation of collateral processes.

    12. Continued improvement in industry infrastructure, as measured 
        by further reduction, and in some cases elimination, of 
        unsigned transaction confirmation backlogs, and continued 
        improvement in operating performance metrics.

                         ANNEX B--TRANSPARENCY

    (1) Transparency Study

                  With respect to the Credit Derivatives, Interest Rate 
                Derivatives and Equity Derivatives Markets, the 
                signatories will deliver to the Supervisors:

                           an inventory of existing forms of 
                        transparency in OTC Derivative 
                            Markets by product and asset class (1st 
                        Deliverable);

                           a study which (a) describes the 
                        spectrum of methods that can be
                            used to increase transparency, (b) analyzes 
                        the benefits and costs
                            by product and asset class and (c) attempts 
                        to identify to whom the
                            benefits accrue and to whom the costs 
                        accrue (2nd Deliverable);
                            and

                           relevant transaction data that can 
                        be used by the Supervisors to
                            conduct analysis on post trade transparency 
                        (3rd Deliverable).

                  The target dates with respect to Credit Derivatives, 
                Interest Rate Derivatives and Equity Derivatives are:

------------------------------------------------------------------------
                    1st Deliverable    2nd Deliverable   3rd Deliverable
------------------------------------------------------------------------
Credit             March 31, 2010     June 30, 2010     July 31, 2010
 Derivatives
Interest Rate      March 31, 2010     August 31, 2010   September 30,
 Derivatives                                             2010
Equity             March 31, 2010     August 31, 2010   September 30,
 Derivatives                                             2010
------------------------------------------------------------------------

                  We commit to provide to the Supervisors, by March 31, 
                2010, a plan and timeline, including concrete 
                milestones and target dates, for accomplishing the 3rd 
                Deliverable.
                  Each of the Commodities and Foreign Exchange market 
                participants will separately continue their dialogue 
                relating to market transparency issues with the 
                relevant regulators.

    (2) Global Data Repositories

      (a) Equity Derivatives

                  We re-affirm our commitment made in the June 2, 2009 
                letter to Supervisors to implement a centralized 
                reporting infrastructure for all OTC Equity Derivatives 
                by July 31, 2010, with launch currently anticipated on 
                schedule. We will work with the Supervisors to 
                implement a reporting process that is both practical 
                and meets regulatory expectations in regard to the 
                agreed information held in the Equity Derivatives 
                Reporting Repository.

      (b) Interest Rate Derivatives

                  The global Interest Rate Reporting Repository (IRRR) 
                was launched on December 31, 2009, and the G14 Members 
                are now providing monthly reporting from this global 
                data repository on outstanding non-cleared trades to 
                primary regulators. Since initial launch, enhancements 
                have been made to normalize submissions between 
                dealers,\4\ and we will continue to work with 
                regulators and the legal community to expand and 
                enhance this reporting process. Our efforts will 
                include the following:
---------------------------------------------------------------------------
    \4\ Since inception of the IRRR, G14 Members have been working with 
the service provider to ensure that the data aggregation process is as 
thorough as possible and does not double count trades where G14 Members 
face each other.

                           Include cleared trades in the 
---------------------------------------------------------------------------
                        submission scope by March 15, 2010.

                           Expand regulators' reporting to 
                        include participant type (G14/CCP/
                            Non-G14) by April 15, 2010.

                           Provide public access to aggregate 
                        industry notional and trade
                            count data on a monthly basis, in order to 
                        provide greater position
                            transparency by April 30, 2010.

                           Increase submission and reporting 
                        frequency to weekly beginning
                            September 30, 2010.

                       ANNEX C--CENTRAL CLEARING

    (1) Targets

      (a) Submission Targets \5\ \6\
---------------------------------------------------------------------------
    \5\ ``Eligible Trade'' is defined in our prior commitment letter 
dated September 8, 2009.
    \6\ An example of why a dealer would want to exclude an Eligible 
Trade from clearing for counterparty risk management purposes would be 
where such dealer faces a counterparty bilaterally on two trades which 
offset each other from a net exposure perspective but where only one 
trade is an Eligible Trade. Moving the Eligible Trade to a CCP could 
immediately create a large uncollateralized payable from the 
counterparty to the dealer with respect to the uncleared (ineligible) 
trade, thereby increasing counterparty risk. In addition, even where 
the counterparty posted collateral with respect to such payable within 
the prescribed timeframe, the lack of the offsetting trade facing the 
counterparty would increase the dealer's jump to default risk with 
respect to such counterparty. This problem is magnified considerably 
where the analysis above is applied on a multi billion dollar OTC 
derivatives portfolio. With respect to accounting, regulatory capital 
and balance sheet issues, an example of why a dealer would want to 
exclude an Eligible Trade from clearing would be where the dealer is 
hedging an outstanding loan position with the Eligible Trade. The 
automatic compression that results from trades placed in clearing could 
effectively ``remove'' the matched offsetting CDS hedge from the 
dealer's book. Since the outstanding loan is no longer ``paired'' with 
an identifiable hedge (notwithstanding that the dealer's risk position 
has not changed), the hedge accounting treatment of the loan could be 
impacted and the dealer could incur increased regulatory capital 
charges and detrimental balance sheet treatment.

---------------------------------------------------------------------------
                        (i) Credit Derivatives

                                  On September 8, 2009, each G14 Member 
                                (individually) committed to submitting 
                                95% of new Eligible Trades (calculated 
                                on the basis of previously agreed 
                                methodology) for clearing. We reaffirm 
                                this commitment. Each G14 Member will 
                                work with its primary regulator to 
                                assess its performance against this 
                                target by March 31, 2010. The G14 
                                Members have agreed with the 
                                Supervisors to re-evaluate by June 30, 
                                2010, the appropriate target percentage 
                                and definition of Eligible Trades to 
                                better reflect the need to preserve 
                                certain bilateral trades for 
                                counterparty risk management, 
                                accounting, regulatory capital, balance 
                                sheet and customer reasons.

                        (ii) Interest Rate Derivatives

                                  On September 8, 2009 each G14 Member 
                                (individually) committed to submitting 
                                90% of new Eligible Trades (calculated 
                                on a notional basis) for clearing. The 
                                G14 Members now commit to extend this 
                                target so that, each G14 Member 
                                (individually) commits to submitting 
                                92% of new Eligible Trades (calculated 
                                on a notional basis) for clearing by 
                                June 30, 2010.

      (b) Clearing Targets

                        (i) Credit Derivatives

                                  On September 8, 2009, the G14 Members 
                                (collectively) committed to clearing 
                                80% of new and historical Eligible 
                                Trades (calculated on the basis of 
                                previously agreed methodology). The G14 
                                Members (collectively) increase their 
                                commitment to clearing from 80% of new 
                                and historical Eligible Trades 
                                (calculated on the basis of previously 
                                agreed methodology) to 85%.

                        (ii) Interest Rate Derivatives

                                  On September 8, 2009 the G14 Members 
                                (collectively) committed to clearing 
                                70% of new Eligible Trades (calculated 
                                on weighted average notional basis). 
                                The G14 Members (collectively) increase 
                                their commitment to clearing from 70% 
                                of new Eligible Trades (calculated on 
                                weighted average notional basis) to 90% 
                                by June 30, 2010.
                                  On September 8, 2009 the G14 Members 
                                (collectively) committed to clearing 
                                60% of historical Eligible Trades 
                                (calculated on a weighted average 
                                notional basis). The G14 Members 
                                (collectively) increase their 
                                commitment to clearing from 60% of 
                                historical Eligible Trades (calculated 
                                on weighted average notional basis) to 
                                75% by June 30, 2010.

    (2) Expansion of Products Eligible for Clearing

                  The signatories to this letter commit to continue to 
                provide considerable risk, legal and operational 
                resources and to actively engage with CCPs, regulators 
                and Supervisors globally to broaden the set of OTC 
                Derivatives eligible for clearing, taking into account 
                risk, liquidity, default management and other 
                processes.
                  Significant issues will need to be analyzed and 
                addressed by CCPs, regulators and market participants 
                in order to begin clearing additional products. The 
                analysis must address risk, legal and operational 
                issues as well as the constraints associated with 
                liquidity, volumes, standardization and fungibility. 
                The process is different at each CCP, but generally 
                requires consultation by a CCP with one or more working 
                groups, a recommendation from a CCP's risk manager, 
                approval by the CCP's risk committee and consultation 
                with or approval by the CCP's primary regulator.

      (a) Credit Derivatives

                          To assist in this analysis, the signatories 
                        have asked the Depository Trust & Clearing 
                        Corporation (DTCC) to perform an analysis of 
                        all CDS trades in the Warehouse Trust \7\ which 
                        are on products not yet eligible for clearing. 
                        DTCC expects to deliver the completed analysis 
                        by April 15, 2010.
---------------------------------------------------------------------------
    \7\ DTCC is in the process of transferring the operations of the 
Trade Information Warehouse for CDS to a recently organized subsidiary, 
The Warehouse Trust Company LLC (Warehouse Trust).
---------------------------------------------------------------------------
                          We will prioritize outstanding index 
                        transactions not already eligible and single 
                        name components of the indices. To that end, 
                        (i) the G14 Members have delivered to each 
                        relevant CCP (and commit to deliver on a 
                        monthly basis) a list of recommended launch 
                        targets for new products in order of priority, 
                        and (ii) the end-user signatories have 
                        delivered (and commit to deliver on a monthly 
                        basis) a substantially similar document to each 
                        relevant CCP. The signatories will encourage 
                        each relevant CCP to provide these lists 
                        together with their perspectives to the 
                        relevant Supervisors.

      (b) Interest Rate Derivatives

                          We will work with CCPs to prioritize zero 
                        coupon swaps, single currency basis swaps and 
                        additional swap features utilized by end-users 
                        this year, including extending the maximum 
                        tenors that can be cleared. Further analysis is 
                        required to assist CCPs in prioritizing the 
                        next phase of product expansion but we are 
                        considering including Forward Rate Agreements, 
                        cross-currency swaps, caps, floors, European 
                        swaptions and inflation swaps. We commit to 
                        developing a plan for the next phase of product 
                        expansion before the end of 2010.

    (3) Customer Access to Derivatives Clearing

                  Remaining impediments to the expansion of buy-side 
                access to clearing include legal and regulatory, risk 
                management, and operational issues. Pursuant to our 
                prior commitments, the signatories commit to work 
                together with each relevant CCP \8\ to resolve these 
                remaining impediments to the expansion of buy-side 
                access to clearing and to collectively agree the 
                timeframes for the resolution of each such impediment. 
                The process and priorities for each asset class will be 
                targeted to achieve the following goals:
---------------------------------------------------------------------------
    \8\ As per the June 2, 2009 commitment letter, a CCP that has (a) 
broad buy-side and dealer support and (b) a commitment to develop 
viable direct and indirect buy-side clearing models.

                           resolution of all risk, margin, 
                        default management, legal and regu-
                            latory issues as required to meet the 
                        product roll-out schedules es-
                            tablished with each CCP, without volume or 
---------------------------------------------------------------------------
                        open interest caps;

                           reasonable automated operational 
                        access, and completion of end-to-
                            end testing, for qualifying clearing 
                        members and their buy-side
                            customers to meet the product roll-out 
                        schedules established with
                            each CCP; and

                           reasonable access to facilities to 
                        allow backloading of trades in eli-
                            gible products.

                  Upon the achievement of the above goals, the 
                signatories will make reasonable efforts to work 
                towards increasing utilization of client clearing 
                services. We understand that the Supervisors will 
                closely monitor the industry's progress against the 
                goals above and that if in their monitoring, the 
                Supervisors determine that progress in meeting those 
                goals is unsatisfactory, they will work with industry 
                participants and CCPs to establish concrete methods to 
                ensure that a meaningful amount of open interest in 
                buy-side transactions will be centrally cleared.
                  To the extent that any impediment requires regulatory 
                action and/or legislative change, the signatories 
                commit to proactively inform the relevant regulatory or 
                legislative bodies.

      (a) Credit Derivatives

                          Pursuant to our prior commitment, customer 
                        access to CDS clearing was initiated on 
                        December 14, 2009. While this launch represents 
                        a significant milestone, it is preliminary and 
                        requires further substantial work in order to 
                        effectively implement the prior commitment.
                          To that end, (i) the G14 Members have 
                        delivered to each relevant CCP (and commit to 
                        deliver on a bi-weekly basis) a current list of 
                        open items categorized by importance and 
                        priority, the suggested action plan, 
                        responsible parties and target date for 
                        completion of all critical items and the 
                        current targets for launching new products as 
                        referenced above, and (ii) the end-user 
                        signatories have delivered (and commit to 
                        deliver on a monthly basis) a substantially 
                        similar document to each relevant CCP. The 
                        signatories will encourage each relevant CCP to 
                        provide these lists together with their 
                        perspectives to the relevant Supervisors 
                        expeditiously. In addition, the signatories 
                        commit to work with each relevant CCP to arrive 
                        at a unified list of open items and to 
                        encourage each relevant CCP to provide such 
                        lists to the Supervisors on an ongoing basis.

      (b) Interest Rate Derivatives

                          Customer access to Interest Rate Derivatives 
                        clearing was initiated in the LCH service on 
                        December 17, 2009. This launch represents a 
                        significant milestone in extending clearing 
                        services to clients. Clients access the LCH CCP 
                        through the existing direct clearing members, 
                        and the eligible product set is aligned with 
                        those products that can currently be cleared 
                        through the existing inter-dealer service.
                          The signatories recognize the Supervisors' 
                        policy goal of making available to the buy-side 
                        the benefits of client clearing for Interest 
                        Rate Derivatives. The signatories commit to 
                        work together to make available to the industry 
                        an effective client clearing framework.
                          We commit to creating working groups for 
                        relevant CCPs (where they do not exist already) 
                        by March 31, 2010, encompassing key buy-side, 
                        sell-side and CCP representation. These CCP 
                        working groups will meet at least monthly and 
                        focus on identifying and resolving the barriers 
                        to clearing to the extent possible and will 
                        report progress back to Supervisors on an 
                        ongoing basis.

    (4) CCP Involvement in ISDA Credit Derivatives Determinations 
        Committees

                  Interim Regulatory Guidance on CCP Governance and 
                Market Protocols issued by the CPSSIOSCO RCCP Working 
                Group on December 15, 2009, states that CCPs' interests 
                should be represented on the DCs as they participate in 
                the Credit Derivatives Market by providing clearing 
                services and are expected to adhere to market 
                protocols. The signatories who are members of the 
                various DCs agree to put forth by April 30, 2010 a 
                specific proposed framework \9\ to implement observer 
                status for CCPs and will urge the various DCs to act 
                promptly thereon. The signatories commit, from time to 
                time upon the request of the CCPs, to ask the DCs, in 
                consultation with Supervisors, to re-evaluate the CCPs' 
                observer status to determine the appropriate membership 
                role of CCPs.
---------------------------------------------------------------------------
    \9\ Inclusion of CCPs active in credit default swap clearing as 
observers on various DCs will require amendments to the Credit 
Derivatives Determinations Committee Rules. Amendments of this type 
require a supermajority (80%) vote as well as a 7 day public 
consultation period. The signatories who are on the various DCs will 
consult with the regulators on preparation of this framework.
---------------------------------------------------------------------------
                        ANNEX D--STANDARDIZATION

    (1) Credit, Interest Rate and Equity Derivatives

                  We commit to drive a high level of product, 
                processing and legal standardization in each asset 
                class with a goal of securing operational efficiency, 
                mitigating operational risk and increasing the netting 
                and clearing potential for appropriate products 
                (recognizing that standardization is only one of a 
                number of criteria for clearing eligibility). 
                Accordingly, workstreams have been established to 
                analyze existing, and where appropriate, potential 
                opportunities for further standardization, and a 
                standardization matrix will be completed in partnership 
                with the Supervisors.

    (2) Equity Derivatives

                  A very significant portion of the Equity Derivatives 
                market is highly standardized and is already traded on-
                exchange and settled through a clearing house. The OTC 
                portion of the Equity Derivatives Market consists of a 
                number of different products at varying levels of 
                standardization, complexity, and customization. 
                Documentation standardization improvements will 
                therefore vary by product and region.
                  We re-affirm our commitment to review, update and 
                expand the 2002 Equity Definitions by December 31, 2010 
                in accordance with the Equity Documentation framework 
                document published on January 30, 2009.
                  The project is multifaceted and includes:

                           consolidation, review and updating 
                        of the 2002 Equity Definitions
                            and subsequent master confirmation 
                        agreement (MCA) publica-
                            tions;

                           expansion of existing 2002 Equity 
                        Definitions coverage to include
                            a wider set of product types, pay offs and 
                        underliers; and

                           introduction of a menu approach to 
                        facilitate standardization of
                            contractual terms and product flexibility.

                  During the 2011 implementation of the 2010 Equity 
                Definitions, the signatories commit to using the range 
                of menu items as published in the 2010 Equity 
                Definitions to create matrices and MCAs for products 
                agreed by the industry.
                  We commit to providing verbal updates to the 
                Supervisors on 2010 Equity Definitions progress on a 6 
                weekly basis commencing March 31, 2010.
                  Alongside the 2010 Equity Definitions, we commit to 
                complete the following MCA projects by April 30, 2010:

                           European Interdealer Index Swap 
                        Annex (Annex EFIS);

                           EMEA EM Options Annex (Interdealer); 
                        and

                           European Interdealer Fair Value Swap 
                        Annex (Annex FVSS).

                  We will continue to monitor non-electronically 
                eligible volume in order to identify product 
                eligibility for documentation standardization, 
                according to our previously committed 2% threshold. We 
                will use this information to ensure that the products 
                identified have appropriate coverage in the 2010 Equity 
                Definitions so delivery of new MCAs can be prioritized 
                after the 2010 Equity Definitions are published.
                  Furthermore, we commit, upon request from a relevant 
                counterparty (dealer or buy-side), to review existing 
                MCAs with the counterparty in order to determine if 
                with respect to an existing MCA there exists a 
                preference to have the relevant ISDA published MCA 
                govern all relevant new transactions executed after an 
                agreed future date in lieu of such existing MCA. If 
                such preference exists, the parties commit to negotiate 
                in good faith a new MCA utilizing the ISDA published 
                MCA with such modifications as the parties may agree in 
                good faith and will mutually agree whether to migrate 
                existing transactions under the new MCA or to leave 
                existing transactions under previously agreed MCAs 
                until termination or maturity.

                          ANNEX E--COLLATERAL

    In this letter we set out new goals in the areas of Portfolio 
Reconciliations and Dispute Resolution. We also commit to update the 
Roadmap for Collateral Management. In particular, addressing one of the 
top concerns of the Supervisors, we re-affirm our intention to develop 
an enhanced industry framework for resolving disputed margin calls. The 
industry has made good progress in developing and testing the initial 
Dispute Resolution Procedure (DRP). In addition to the DRP, which 
focuses on the resolution of disputes after they have occurred, market 
participants recognize that disputes must also be tackled by prevention 
and increased escalation to regulators. The new commitments below 
reflect a multi-pronged strategy to address margin disputes, including 
measures designed to prevent, detect, resolve and report them to 
regulators.
    The signatories are pleased to make the following new commitments:

    (1) Collateral Roadmap

                  We commit to update the Roadmap for Collateral 
                Management by April 15, 2010 based on the 
                recommendations from the Independent Amount white paper 
                (March 1, 2010) and the Market Review of 
                Collateralization (March 1, 2010). Because of the wide-
                ranging nature of those recommendations, we will seek 
                engagement from dealers, end-users, custodians, 
                regulators and legislators as appropriate in order to 
                determine the best path towards implementation.

    (2) Portfolio Reconciliation

                  The commitments already made by the industry with 
                respect to Portfolio Reconciliation have proven 
                effective at reducing the incidence and size of margin 
                disputes.\10\ In addition, ISDA has published a 
                Feasibility Study for Extending Collateralized 
                Portfolio Reconciliations (December 2009) and the 
                follow-on Implementation Plan for Wider Market Roll-out 
                (February 2010).\11\ Consistent with those recent 
                publications, we commit that:
---------------------------------------------------------------------------
    \10\ This is illustrated by the dispute reporting provided in 
private by firms to their regulators showing dispute levels 
significantly reduced from a year ago.
    \11\ These documents embody a response to recommendation V-10 of 
``Containing Systemic Risk: The Road to Reform'' (CRMPG III, August 
2008).

                          (a) The signatories will undertake 
                        reconciliation (bilateral where possible and 
                        otherwise unilateral) \12\ of collateralized 
                        portfolios with any OTC counterparty comprising 
                        more than 1,000 trades at least monthly by June 
                        30, 2010.
---------------------------------------------------------------------------
    \12\ The majority of smaller portfolios are between G14 Members and 
end-users, not all of whom are equipped to perform bilateral portfolio 
reconciliation (where both parties work together using a central 
reconciliation service to resolve trade level differences). Therefore, 
although bilateral reconciliation is preferred, as a fallback this 
commitment is based on a unilateral reconciliation performed by the 
dealer. In order to promote the extension of portfolio reconciliation 
discipline more deeply into the wider market, the only practical 
solution is for dealers to perform the reconciliation for both parties 
where necessary. In order for a dealer to perform a unilateral 
reconciliation, a dealer's counterparty needs to provide a data file 
representing such counterparty's view of the portfolio in a 
reconcilable and standard format. ISDA has published Collateralized 
Portfolio Reconciliation Best Practices and data Minimum Market 
Standards to guide the market in this respect. Dealers will use 
commercially reasonable efforts to gain the cooperation of their 
counterparts in obtaining these files. The degree to which these 
requests are satisfied will be made transparent in the expanded 
portfolio reconciliation reporting provided to regulators, and after a 
period of several months industry participants and regulators should 
review cooperation levels.

                          (b) Signatory firms will expand the current 
                        monthly Portfolio Reconciliation reports 
                        submitted to the Supervisors to reflect the 
---------------------------------------------------------------------------
                        above commitment by July 31, 2010.

    (3) Dispute Resolution

                  Market experience has shown that although disputed 
                margin calls may need to be addressed by formal methods 
                of dispute resolution in some rare circumstances, a 
                larger proportion of dispute events can be addressed by 
                prevention and escalation to regulators. Therefore we 
                make the commitments below which reflect the three 
                distinct ways in which the risks of disputed margin 
                calls must be addressed:

      (a) Preventing Disputes From Arising

                          As described above under ``Portfolio 
                        Reconciliation''.

      (b) Detecting Disputes Early and Resolving Them Definitively

                          The DRP continues to undergo the process of 
                        testing and further refinement commenced in Q4 
                        2009. We commit to provide regular updates for 
                        each phase of the DRP evolution with the 
                        intention to complete this process by September 
                        30, 2010.

      (c) Reporting Disputed Collateral and Exposure Amounts

                          We commit to develop consistent reporting 
                        that provides the Supervisors with the ability 
                        to assess the top margin disputes that 
                        potentially pose significant risk by May 31, 
                        2010. We will provide a pro forma template for 
                        such reporting to the Supervisors by April 15, 
                        2010 to seek their input on content and 
                        presentation.\13\
---------------------------------------------------------------------------
    \13\ Industry practitioners will work with regulators over coming 
weeks to establish the appropriate reporting criteria and thresholds. 
The intention is to identify margin disputes of significance. Included 
in this consideration for materiality are likely to be dispute scale 
(disputes exceeding an established amount) and dispute persistence 
(disputes aged over an established number of days).
---------------------------------------------------------------------------
                ANNEX F--OPERATIONAL EFFICIENCY TARGETS

    (1) Credit Derivatives

      (a) Central Settlement

                          The Credit Derivatives market has benefitted 
                        from the increased usage of central 
                        settlement,\14\ and industry participants 
                        remain committed to settlement automation. The 
                        quality of the existing bilateral settlement 
                        mechanisms, coupled with the likely increased 
                        penetration of clearing into the Credit 
                        Derivatives market, limits the benefits 
                        associated with any additional central 
                        settlement service beyond the existing use of 
                        CLS. As a consequence, the industry's resources 
                        will focus on the resolution of the other 
                        commitments identified within this letter.
---------------------------------------------------------------------------
    \14\ 79% of all CDS trades in the Warehouse Trust were centrally 
settled for the December 2009 quarterly roll Electronic Confirmation 
Targets Submission.

---------------------------------------------------------------------------
      (b) Submission Timeliness/Matching

                          MarkitSERV remains the primary service 
                        provider within the Credit Derivatives realm, 
                        with more than 99% of electronically confirmed 
                        trades being processed on MarkitSERV and 
                        greater than 90% of these trades confirmed 
                        electronically on trade date. We reiterate our 
                        commitment to achieving T+0 submission and 
                        matching.
                          Given the significant architectural changes 
                        to the Credit Derivatives infrastructure in 
                        support of our efforts to achieve (i) 
                        interoperability with clearing solutions and 
                        (ii) trade date matching through improvements 
                        to the novation consent process and associated 
                        technology enhancements, we commit to an 
                        ongoing periodic review of existing commitments 
                        for both T+0 submission (currently 90%) and T+2 
                        matching (currently 94%), for electronically 
                        eligible transactions, with the Supervisors.

    (2) Equity Derivatives

      (a) Electronic Eligibility

                          We re-affirm our commitment to set blended 
                        targets for electronically eligible OTC Equity 
                        Derivative transactions. For purposes of 
                        measuring targets, confirmations that are 
                        deemed eligible for inclusion (Electronically 
                        Eligible Confirmations) will include:

                        (i) confirmations for products (Electronically 
                        Eligible Products) that;

                                (A) have an ISDA published MCA 
                                (irrespective of whether such 
                                ISDApublished form or pre-existing 
                                bilateral form is used),\15\ and
---------------------------------------------------------------------------
    \15\ Products which do not have an ISDA published MCA will not be 
included in this target irrespective of whether a bilateral MCA exists.

                                (B) can be matched on an electronic 
---------------------------------------------------------------------------
                                platform; and

                        (ii) confirmations of Confirmable Lifecycle 
                        Events \16\ for transactions which were 
                        executed on an electronic platform under 
                        existing bilateral MCAs but for which an ISDA 
                        MCA is subsequently published and which are 
                        currently confirmable on an electronic platform 
                        will be deemed Electronically Eligible 
                        Confirmations as of the date that the relevant 
                        product becomes an Electronically Eligible 
                        Product. Confirmations of Confirmable Lifecycle 
                        Events for transactions that were originally 
                        confirmed on paper will not be deemed 
                        Electronically Eligible Confirmations.
---------------------------------------------------------------------------
    \16\ Confirmable Lifecycle Events will be identified in the 
Electronic Eligibility Matrix.

---------------------------------------------------------------------------
      (b) Electronic Confirmation Targets

                          We commit to processing, by June 30, 2010, 
                        75% of Electronically Eligible Confirmations on 
                        an electronic platform. We further commit to 
                        increasing this target to 80% by September 30, 
                        2010.
                          Furthermore, we commit to publishing an 
                        Electronic Eligibility Matrix \17\ of 
                        Electronically Eligible Products and 
                        Confirmable Lifecycle Events by March 1, 2010 
                        and will publish an updated version of this 
                        matrix on a quarterly basis.\18\
---------------------------------------------------------------------------
    \17\ The matrix will be published on the ISDA website on March 1, 
2010 and on a quarterly basis thereafter.
    \18\ New products will be deemed Electronically Eligible Products 
90 days following the date on which both an ISDA MCA has been published 
and such product is supported by an electronic platform.

---------------------------------------------------------------------------
      (c) Submission Timeliness/Matching

                          We commit to the following targets:

                                   By June 30, 2010, 95% T+1 
                                submission and 95% T+3 matching
                                    of global options and variance 
                                swaps between G14 Members
                                    for Electronically Eligible 
                                Confirmations processed on an elec-
                                    tronic platform.

                                   By June 30, 2010, 70% T+1 
                                submission and 75% T+5 matching
                                    of Discrete total return swaps \19\ 
                                between G14 Members for
                                    Electronically Eligible 
                                Confirmations processed on an elec-
                                    tronic platform.
---------------------------------------------------------------------------
    \19\ As defined in the December 10, 2008 EFS Roadmap.

                                   By September 30, 2010, 90% 
                                T+1 submission and 90% T+5
                                    matching for G14 Members versus all 
                                counterparties for Elec-
                                    tronically Eligible Confirmations 
                                processed on an electronic
---------------------------------------------------------------------------
                                    platform.

      (d) Confirmation Backlog Reduction

                          By June 30, 2010, we commit that outstanding 
                        confirmations aged more than 30 calendar days 
                        are not to exceed 1 business day of trading 
                        volume based on average daily volume in the 
                        prior 3 months.

      (e) Cash Flow Matching

                          We commit to publishing a cash flow matching 
                        implementation plan to the Supervisors by March 
                        31, 2010 with a further commitment to deliver 
                        cash flow matching functionality by December 
                        31, 2010.

    (3) Interest Rate Derivatives

      (a) Central Settlement

                          The increased penetration of central clearing 
                        into the Interest Rate Derivatives market in 
                        2010 will significantly reduce the volume and 
                        size of bilateral settlements between market 
                        participants. This reduction in bilateral 
                        activity will take place against a backdrop of 
                        strong existing risk management practices where 
                        only 0.59% of gross settlements have post-value 
                        date discrepancy \20\ and 0.1% of these issues 
                        persist 30 days after settlement date. As a 
                        consequence, the industry's resources will be 
                        focused on the delivery of the other 
                        commitments identified in this letter. We will 
                        continue to monitor the incidence of post value 
                        date issues of gross settlements over time to 
                        ensure no risk mitigating initiatives are 
                        required.
---------------------------------------------------------------------------
    \20\ A post-value date discrepancy may be defined as any mismatch 
in settlement amounts or value-date or a failure to settle funds on the 
date expected. Such discrepancies are typically investigated and 
resolved by operational control groups within the respective 
organizations.

---------------------------------------------------------------------------
      (b) Rates Allocation Commitment

                          MarkitSERV will deliver electronic allocation 
                        delivery functionality consistent with the 
                        requirements gathered at the Allocation 
                        Industry Working Group meetings. We will 
                        provide the Supervisors with a plan by March 
                        31, 2010 to achieve this.
                          The scope of the project will include the 
                        ability for buy-side users to electronically 
                        submit allocations to dealers in either a 
                        single step, where allocations plus 
                        confirmation occur, or a two-step process, 
                        where electronic allocation delivery is 
                        distinct from confirmation. Further planned 
                        functionality caters to additional workflows 
                        where buy-side clients submit allocations 
                        directly on pending trades or where the system 
                        matches grouped allocations to dealer block 
                        trades. Confirmation of Independent Amount 
                        percentage at an allocation level will be in 
                        scope.

      (c) Electronic Confirmation Targets

                          We commit to the following electronic 
                        confirmation targets:

                                   By June 30, 2010, 93% of 
                                electronically eligible confirmable
                                    events with G14 Members will be 
                                processed on electronic plat-
                                    forms, with a further commitment to 
                                achieve 95% by December
                                    31, 2010; and

                                   By June 30, 2010, 60% of 
                                electronically eligible confirmable
                                    events with all other participants 
                                will be processed on elec-
                                    tronic platforms with a further 
                                commitment to provide a plan
                                    for the implementation of a more 
                                streamlined process for low
                                    volume clients also by June 30, 
                                2010.\21\
---------------------------------------------------------------------------
    \21\ The Rates Implementation Group is performing analysis on the 
non-G14 Member volume to understand the material impact of those 
customers executing four or fewer electronically eligible trades per 
month.

---------------------------------------------------------------------------
      (d) Submission Timeliness/Matching

                          The launch of MarkitSERV's interoperable 
                        confirmation service enables market 
                        participants to use DTCC Deriv/SERV or 
                        Markitwire, regardless of what service their 
                        counterparty uses. Interoperability eliminates 
                        the requirement to process confirmations 
                        independently on Markitwire or DTCC/DerivSERV 
                        and we believe the process should be subject to 
                        new performance targets. With 87% of 
                        electronically confirmed trades being processed 
                        on Markitwire and greater than 98% of these 
                        trades confirmed on trade date, we commit to 
                        the following targets upon adoption of 
                        MarkitSERV interoperability, with a commitment 
                        to review and re-evaluate these targets with 
                        Supervisors on a quarterly basis to get to a 
                        steady state and progress toward T+0 submission 
                        and matching:

                                   Submit 90% of electronic 
                                confirmations no later than T+0 busi-
                                    ness days by September 30, 2010.

                                   Match 97% of electronic 
                                confirmations no later than T+2 busi-
                                    ness days by September 30, 2010.

      (e) Confirmation Backlog Reduction

                          By April 30, 2010: We commit that electronic 
                        and paper outstanding confirmations aged more 
                        than 30 calendar days are not to exceed 0.20 
                        business day of trading volume based on the 
                        prior 3 months rolling volume and we commit to 
                        continue reporting these targets on a monthly 
                        basis. We commit to review and re-evaluate this 
                        target with Supervisors on a quarterly basis to 
                        get to a steady state and progress towards T+0 
                        matching.

    The Chairman. Thank you, Mr. Pickel. Mr. Morrison for 5 
minutes.

          STATEMENT OF SCOTT C. MORRISON, SENIOR VICE
         PRESIDENT AND CFO, BALL CORPORATION; CHAIRMAN,
 NATIONAL ASSOCIATION OF CORPORATE TREASURERS, BROOMFIELD, CO; 
                 ON BEHALF OF THE COALITION FOR
                     DERIVATIVES END-USERS

    Mr. Morrison. Thank you, Mr. Chairman, Ranking Member 
Peterson, and the Committee. My name is Scott Morrison. I am 
Senior Vice President and Chief Financial Officer of Ball 
Corporation, and Chairman of the National Association of 
Corporate Treasurers. Collectively, we are also members of the 
Coalition for Derivatives End-Users. The Coalition represents 
thousands of companies across the U.S. that employ derivatives 
to manage risks. It is a privilege to speak with you today.
    Ball Corporation is based in Colorado, and we operate over 
30 manufacturing locations in the U.S. We operate in nearly 70 
percent of the states represented by the Agriculture Committee 
that I have the honor of addressing today. We are a 131 year-
old publicly traded company with deep roots in supplying 
packaging to the food, beverage, and consumer product 
industries in the U.S. Approximately 65 percent of our 14,500 
employees work in the United States. We support the efforts of 
this Committee to reduce systemic risk and increase 
transparency in the over-the-counter derivatives markets.
    While I agree that the reckless and over-leveraged use of 
derivatives by systemically significant institutions can have 
dire consequences, the prudent use of derivatives by end-users 
like us should not be put into the same category. For end-users 
like ourselves, OTC derivatives provide a critical risk 
management tool to reduce commercial risk and volatility in our 
normal business operations, allowing us to create sustainable 
and prosperous businesses. I am here today to share with you 
our perspective on a couple of these matters.
    Our use of derivatives is driven by the desire to reduce 
commercial risk associated with our business. Ball's largest 
business, beverage can manufacturing, involves buying over $3 
billion of aluminum coils per year, converting those coils into 
cans, and selling them to large beverage and food companies. We 
are able to use OTC swaps to exactly match the prices and 
timing of when we buy coils of aluminum to when we sell the 
completed cans. This risk management technique allows us to 
prudently manage our costs and reduce volatility of price 
changes during the manufacturing process and over multi-year 
sales agreements. We have used this risk management process for 
over 15 years with no adverse consequences.
    We believe a broad end-user exemption is a critical feature 
of derivatives legislation. During the regulatory process, we 
have sought to ensure that the exemption provided for by 
Congress would not be unduly narrowed. In particular, we have 
urged regulators to give thoughtful consideration to key 
definitions to ensure that end-users like us are not regulated 
as if we dealt in speculative swaps.
    The second area I would like to address is that of margin 
to be posted on future or even previously entered into 
contracts. Such a requirement would be particularly troublesome 
to end-users like Ball. A requirement for end-users to post 
margin would have a serious impact on our ability to invest in 
and grow our business. For example, Ball is currently investing 
significant amounts of capital in plant expansions in Texas, 
Indiana, California, and Colorado, totaling well in excess of 
$150 million, and adding several hundred jobs when complete. 
Tying up capital for initial and variation margin could put 
those types of projects at risk at a time when our economy can 
ill afford it. The impact of posting initial margin for us can 
easily exceed $100 million, while the change in value on our 
trades over time could easily surpass $300 million. Diverting 
more than $400 million of working capital into margin accounts 
would have a direct and adverse impact on our ability to grow 
our business and create and maintain jobs.
    In short, margin requirements will cost the communities in 
which we are located literally hundreds of good new jobs.
    Additionally, because of the importance of this market to 
main street businesses like Ball, we believe it is critical to 
get the regulation right. The current rulemaking timeline is 
aggressive, and may force regulators to prioritize speed over 
quality. We would urge Congress to provide regulators with more 
time for rulemaking and for regulators to allow market 
participants sufficient time for implementation. This is 
critical to ensure that the market participants have ample 
opportunity to provide useful feedback and ensuring this 
important market continues to function with minimal disruption.
    As regulators go about the important work of finalizing the 
rules that address the lessons learned from the financial 
crisis, it is of the utmost importance that they do so in a 
manner that does not break those things that function well. 
Though it may be tempting to view all derivatives ask risky 
financial products that were central to the credit crisis, we 
must remember that these are important tools upon which 
thousands of companies like ours depend to manage risks in the 
economy.
    Thank you for your time.
    [The prepared statement of Mr. Morrison follows:]

Prepared Statement of Scott C. Morrison, Senior Vice President and CFO, 
     Ball Corporation; Chairman, National Association of Corporate
Treasurers, Broomfield, CO; on Behalf of Coalition for Derivatives End-
                                 Users

    Good afternoon, my name is Scott Morrison. I am Senior Vice 
President and Chief Financial Officer of Ball Corporation and Chairman 
of the National Association of Corporate Treasurers (``NACT''), an 
organization of Treasury professionals of several hundred of the 
largest public and private companies in this country. Collectively, we 
are also a member of the Coalition for Derivatives End-Users 
(``Coalition''). The Coalition represents thousands of companies across 
the United States that employ derivatives to manage risks they face in 
connection with their day-to-day businesses. It is a privilege to have 
the opportunity to speak with you today on behalf of both our company, 
and the NACT about the new derivatives legislation. Ball Corporation is 
based in Colorado and we operate over 30 manufacturing locations in the 
U.S. We operate in nearly 70% of the states represented by the 
Agriculture Committee I am addressing today. We also operate another 25 
locations around the world. We are a 131 year old publicly traded 
company with deep roots in supplying packaging to the food, beverage 
and consumer product industries in the U.S.; our customers include 
Coca-Cola, Pepsi, Miller Coors and Anheuser Busch InBev along with 
ConAgra Foods, Abbott Labs and numerous family-owned beverage fillers 
and food packers. Approximately 75% of our 14,500 employees reside in 
the United States.
    We understand and support the efforts of this Committee to reduce 
systemic risk throughout the financial system to avoid the issues that 
contributed to the financial turmoil that boiled over in 2008 and also 
we applaud your efforts to increase transparency in the over-the-
counter (``OTC'') derivatives markets. While I would agree that the 
reckless and over-leveraged use of derivatives by systemically 
significant institutions can have dire consequences, the prudent use of 
derivatives by manufacturers such as ourselves and the vast majority of 
end-users like us should not be put into the same category. For end-
users like ourselves the prudent use of derivatives provides us a 
critical risk management tool to reduce commercial risk and volatility 
in our normal business operations allowing us to create sustainable and 
prosperous businesses. I am here today to share with you our 
perspective on these matters and want to specifically address three 
areas of the legislation: an appropriate end-user exemption; margin 
requirements; and the need to avoid overly complex clearing and 
reporting. I would like to take a minute to address each in greater 
detail.
    Our use of derivatives is driven by the desire to reduce commercial 
risk associated with our business. Ball's largest business (beverage 
can manufacturing) involves buying over $3 billion of aluminum coils 
per year, converting those coils into cans and selling them to large 
beverage and food companies mentioned earlier. As aluminum is an 
actively traded commodity, we are able to use OTC swaps to exactly 
match the prices and timing of when we buy coils of aluminum to when we 
sell the completed cans. This risk management technique allows us to 
prudently manage our costs and reduce volatility of price changes 
during the manufacturing process as well as over the life of multi-year 
contracts. We have used this risk management process for over 15 years 
with no adverse consequences. We clearly are not a trading operation. 
Our policies state that speculation is forbidden--a policy consistently 
applied by end-users generally. While our use of derivatives can be 
substantial, our hedges are executed to reduce commercial risk. Not 
executing the swaps would create more volatility in our business 
outcomes. We believe a broad end-user exemption is a critical feature 
of derivatives legislation. During the regulatory process, we have 
sought to ensure that the exemption provided for by Congress would not 
be unduly narrowed. In particular, we have urged regulators to give 
thoughtful consideration to key definitions, including major swap 
participant and swap dealer, to ensure that manufacturers and other 
end-users like us are not regulated as if we dealt in speculative 
swaps.
    The second area I would like to address is that of margin to be 
posted on future or even previously entered into contracts; this 
requirement would be particularly troublesome to end-users like Ball 
Corporation. Retroactive application of a margin requirement would 
upset the reasonable expectations we had when entering into existing 
risk management contracts. These expectations are negotiated 
extensively in ISDA agreements that we have with our financial 
counterparties. Those arrangements have already included a credit cost 
that we have paid, so retroactive application of margin requirements 
would essentially double our costs. A requirement for end-users like 
Ball Corporation to post margin to its counterparties would have a 
serious impact on our ability to invest in and grow our business. For 
example, Ball Corporation is currently investing significant amounts of 
capital in plant expansions we are currently executing in Texas, 
Indiana, California and Colorado. Those expansions alone are 
investments totaling well in excess of $150 million and will add 
several hundred jobs when complete. Tying up capital for initial and 
variation margin could put those types of projects at risk at a time 
when our economy can ill afford it. The impact of posting initial 
margin for us can easily exceed $100 million, while the change in value 
on our trades over time could easily surpass $300 million in required 
capital that would be removed from productive economic use. Notably, 
diverting more than $400M of working capital into margin accounts would 
have a direct and adverse impact on our ability to grow our business 
and create and maintain jobs. In short, margin requirements will cost 
the communities in which we are located literally hundreds of good, new 
jobs.
    The third area to focus on is avoiding the creation of rigid and 
expensive trading requirements that could cause the unintended 
consequence of companies either retaining more risk or to seek risk 
management alternatives overseas. We are not a ``trading house'' our 
activity in derivatives is not daily or even weekly. In addition, by 
utilizing over-the-counter swaps we are able to customize our hedges to 
perfectly match the underlying exposure. If we were required to use 
only standardized or exchange traded hedge products we would not create 
the risk offset we currently achieve today and this would result in 
both accounting and real economic volatility. Though end-users are not 
directly subject to such requirements, excessive capital requirements 
imposed on our financial counterparties could significantly increase 
our costs. Though these capital requirements should be appropriate for 
the risk of the product, they should not be increased in such a manner 
so as to deter prudent use of uncleared over-the-counter derivatives by 
end-users. The end result and unintended consequence of margin 
requirements applied to end-users or excessive capital requirements 
applied to our financial counterparties could be to reduce the risk 
management activity of end-users, a result which would actually 
increase systemic risk or even push transactions offshore. Neither of 
these would be favorable to our economy.
    Additionally, because of the importance of this market to main 
street businesses like Ball Corporation, we believe it is critical to 
get the regulation right. The current rulemaking timeline is 
aggressive, and may force regulators to prioritize speed over quality. 
Doing so could hurt companies' ability to manage their risks. We would 
urge Congress to provide regulators with more time for rulemaking, and 
for regulators to allow market participants sufficient time for 
implementation. This is critical to ensuring that market participants 
have ample opportunity to provide useful feedback, and to ensuring this 
important market continues to function with minimal disruption. 
Chairman Gensler has reached out to businesses for input on a realistic 
implementation timeline. That is a positive step and one that we 
appreciate greatly. However, developing a workable implementation 
timeline still would not fix the problem of too many rules being 
promulgated over too little time. The statutory effective date must be 
extended for end-users to be able to participate meaningfully in the 
regulatory development process.
    As regulators go about the important work of finalizing the rules 
that address the lessons learned of the financial crisis, it is of the 
utmost importance that they do so in a manner that does not break those 
things that functioned well. I am confident that the way in which these 
products are utilized by our company, and end-users generally, provides 
important benefits to the economy, including reduced volatility and 
greater stability to a significant sector of the economy. Though it may 
be tempting to view all derivatives as risky financial products that 
were central to the credit crisis, we must remember that these are 
important tools upon which thousands of companies depend to managing 
risks in the real economy. Thank you for your time and I am happy to 
answer any questions that you have.

    The Chairman. Thank you, Mr. Morrison. Mr. Olesky? Did I 
butcher your name?
    Mr. Olesky. Olesky.
    The Chairman. Olesky, sorry about that.

STATEMENT OF LEE OLESKY, CHIEF EXECUTIVE OFFICER, TRADEWEB, NEW 
                            YORK, NY

    Mr. Olesky. Thank you, Mr. Chairman, Ranking Member 
Peterson, and Members of the Committee. Good afternoon. Thank 
you for inviting me to participate in this hearing. My name is 
Lee Olesky. I am Chief Executive Officer of Tradeweb, and I 
appreciate the opportunity to testify today about the 
implementation of Title VII of the Dodd-Frank Act.
    For the last 12 years, Tradeweb has been on the forefront 
of creating electronic trading solutions for the bond markets. 
Before platforms like Tradeweb were established, institutional 
clients picked up the phone and spoke to one or more dealers in 
order to buy or sell U.S. Treasury government bonds. In 1998, 
Tradeweb established an electronic marketplace for U.S. 
Treasury securities and transformed a phone-based opaque 
government bond market into a more transparent and efficient 
market.
    As a result of this evolution, institutional clients such 
as asset managers and pension funds now have access to 
regulated trading systems that provide greater price 
transparency and more efficient execution, which has the added 
benefit of reducing operational risk, the very goals of Title 
VII of Dodd-Frank.
    Several years ago, Tradeweb expanded into derivatives and 
began offering an execution facility for interest rate and 
credit derivatives. So when Congress passed Dodd-Frank and 
created a new type of registered trade execution venue, a swap 
execution facility, or SEF, Tradeweb was extremely well-
positioned to become a SEF and meet the stated policy 
objectives for SEFs to improve price transparency, and promote 
the trading of swaps on regulated electronic markets.
    Whether it is for government bonds or any other instrument 
traded on the 20 markets we operate around the world, our focus 
has always been on using technology to create products and 
services for our clients. This has resulted in more transparent 
and efficient bond markets globally.
    What we have learned in the last 12 years is how important 
it is to evolve our technology based on our client's current 
and future needs. Thus, while Tradeweb is supportive of the 
goals of the Act, Congress and the regulators should understand 
and give due consideration to the needs of the market 
participants. We believe the key for achieving the policy 
objectives for SEFs, which is greater transparency and 
promoting the trading of swaps on regulated markets, is to 
provide for flexibility in the way that market participants can 
trade swaps on those regulated markets.
    By ensuring that the rules retain sufficient flexibility 
for market participants, clients can trade in a manner that 
suits their trading strategies and risk profiles. Some 
institutions will want to transact on live prices, some will 
want to use a disclosed request for quote model, known as an 
RFQ, others will still want to transact through an anonymous 
order book, which is similar to an exchange. We believe 
regulators should not mandate that clients pick one model to 
trade on. They must be flexible to achieve the goals of the Act 
without materially disrupting the market. Creating arbitrary or 
artificially prescriptive limitations on the manner in which 
market participants interact and trade could result in 
liquidity drying up, and add increased costs to trade swaps. 
This could move participants away from executing in the swap 
markets, which we know is not the goal of Title VII, Congress, 
or the regulators.
    Along the same lines, overly prescriptive ownership limits 
or governance requirements for SEFs or DCMs will impact the 
ability to attract investment capital in new or existing 
platforms. A careful balance needs to be reached between 
mitigating conflicts and encouraging private enterprise, which 
will encourage investment and innovation. For example, it would 
have been very difficult for Tradeweb to have raised its seed 
capital in future investments if investors were told that more 
than half of our Board would be made up of independent 
directors with no ties to the company.
    In conclusion, we are supportive of the goals to reform the 
derivatives markets, and indeed, we provide the very solutions 
the regulations seek to achieve, but we are concerned the 
Commissions may overreach in their interpretation and 
implementation of Dodd-Frank, and in doing so, create 
unintended consequences for market participants and the 
marketplace as a whole.
    We hope that our experience in the electronic markets can 
be helpful and instructive as Congress and the regulators take 
on the great challenge of implementing Title VII of Dodd-Frank. 
Thank you.
    [The prepared statement of Mr. Olesky follows:]

 Prepared Statement of Lee Olesky, Chief Executive Officer, Tradeweb, 
                              New York, NY

    Tradeweb Markets LLC (``Tradeweb'') appreciates the opportunity to 
provide testimony to the House Agriculture Committee with respect to 
swap execution facilities (``SEFs'') and the impact of the 
implementation of Title VII of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act (the ``Dodd-Frank Act'') under the proposed 
regulations from the Commodity Futures Trading Commission (``CFTC'') 
and U.S. Securities and Exchange Commission (``SEC'', together with the 
CFTC, the ``Commissions'').

I. Background on Tradeweb
    Tradeweb is a leading global provider of electronic trading 
platforms and related data services for the OTC fixed income and 
derivatives marketplaces. Tradeweb operates three separate electronic 
trading platforms: (i) a global electronic multi-dealer to 
institutional customer platform through which institutional investors 
access market information, request bids and offers, and effect 
transactions with, dealers that are active market makers in fixed 
income securities and derivatives, (ii) an inter-dealer platform, 
called Dealerweb, for U.S. Government bonds and mortgage securities, 
and (iii) a platform for retail-sized fixed income securities.\1\
---------------------------------------------------------------------------
    \1\ Tradeweb operates the dealer-to-customer and odd-lot platforms 
through its registered broker-dealer, Tradeweb LLC, which is also 
registered as an alternative trading system (``ATS'') under Regulation 
ATS promulgated by the SEC under the Securities Exchange Act of 1934. 
Tradeweb operates its inter-dealer platform through its subsidiary, 
Hilliard Farber & Co., Inc., which is also a registered broker-dealer 
and operates Dealerweb as an ATS. In Europe, Tradeweb offers its 
institutional dealer-to-customer platform through Tradeweb Europe 
Limited, which is authorized and regulated by the UK Financial Services 
Authority as an investment firm with permission to operate as a 
Multilateral Trading Facility. In addition, Tradeweb Europe Limited has 
registered branch offices in Hong Kong, Singapore and Japan and holds 
an exemption from registration in Australia.
---------------------------------------------------------------------------
    Founded as a multi-dealer online marketplace for U.S. Treasury 
securities in 1998, Tradeweb has been a pioneer in providing market 
data, electronic trading and trade processing in OTC marketplaces for 
over 10 years, and has offered electronic trading in OTC derivatives on 
its institutional dealer-to-customer platform since 2005. Active in 20 
global fixed income, money market and derivatives markets, with an 
average daily trading volume of more than $250 billion, Tradeweb's 
leading institutional dealer-to-customer platform enables 2,000 
institutional buy-side clients to access liquidity from more than 40 
sell-side liquidity providers by putting the liquidity providers in 
real-time competition for client business in a fully-disclosed auction 
process. These buy-side clients comprise the majority of the world's 
leading asset managers, pension funds, and insurance companies, as well 
as most of the major central banks.
    Since the launch of interest rate swap (``IRS'') trading in 2005, 
the notional amount of interest rate derivatives traded on Tradeweb has 
exceeded $5 trillion from more than 65,000 trades. Tradeweb has spent 
the last 5 years building on its derivatives functionality to enhance 
real-time execution, provide greater price transparency and reduce 
operational risk. Today, the Tradeweb system provides its institutional 
clients with the ability to (i) view live, real-time IRS (in six 
currencies, including U.S., Euro, Sterling, Yen), and Credit Default 
Swap Indices (CDX and iTraxx) prices from swap dealers throughout the 
day; (ii) participate in live, competitive auctions with multiple 
dealers at the same time, and execute an array of trade types (e.g., 
outrights, spread trades, or rates switches); and (iii) automate their 
entire workflow with integration to Tradeweb so that trades can be 
processed in real-time from Tradeweb to customers' middle and back 
offices, to third-party affirmation services like Markitwire and DTCC 
Deriv/SERV, and to all the major derivatives clearing organizations. 
Indeed, in November 2010, Tradeweb served as the execution facility for 
the first fully electronic dealer-to-customer interest rate swap trade 
to be cleared in the U.S. Tradeweb's existing technology maintains a 
permanent audit trail of the millisecond-by-millisecond details of each 
trade negotiation and all completed transactions, and allows parties 
(and will allow SDRs) to receive trade details and access post-trade 
affirmation and clearing venues.
    With such tools and functionality in place, Tradeweb is providing 
the OTC marketplace with a front-end swap execution facility. Moreover, 
given that it has the benefit of offering electronic trading solutions 
to the buy-side and sell-side, Tradeweb believes that it can provide 
the Commissions with a unique and valuable perspective on the proposed 
rules.
    As additional background, Tradeweb was established in 1998 with 
financial backing from four global banks that were active in, and 
interested in expanding and fostering innovation in, fixed income (U.S. 
Government bond) trading. After 6 years of growth and expansion into 15 
markets globally, in 2004, Tradeweb's bank-owners (which had grown from 
four to eight over that time) sold Tradeweb to The Thomson Corporation, 
which wholly-owned it until January 2008. Although the original bank-
owners continued to be a resource for Tradeweb from 2004 to 2008, The 
Thomson Corporation recognized that bank ownership was an important 
catalyst of Tradeweb's development and sold through a series of 
transactions a strategic interest in Tradeweb to a consortium comprised 
of ten global bank owners. Today, Tradeweb is majority owned by Thomson 
Reuters Corporation (successor to The Thomson Corporation) and minority 
stakes are held by the bank consortium and Tradeweb management. 
Accordingly, Tradeweb was launched by market participants and has 
benefitted from their investment of capital, market expertise and 
efforts to develop and foster more transparent and efficient markets. 
With the support of its ownership and its board comprised of market and 
non-market participants, Tradeweb has, since its inception, brought 
transparency and efficiency to the OTC fixed income and derivatives 
marketplace.

II. Summary
    With the goal of increasing transparency and efficiency, and 
reducing systemic risk, in the derivatives markets, Congress passed 
Title VII of the Dodd-Frank Act, and in doing so, created a new type of 
registered entity--known as a swap execution facility or ``SEF.'' 
Congress expressly created SEFs to promote the trading of swaps on 
regulated markets, and provide a broader level of price transparency 
for end-users of swaps. While the definition of a SEF has been the 
subject of much debate and speculation, the plain language of the Dodd-
Frank Act requires the Commissions to recognize the distinction between 
SEF's on the one hand and designated contract markets (``DCMs'') or 
exchanges on the other. There was a recognition by Congress that 
alternatives to traditional DCMs and exchanges were necessary, 
particularly in light of the current working market structure and 
manner in which OTC derivatives trade. We applaud the direction of the 
regulation, but want to ensure that the Commissions adopt rules that 
are clear and allow for flexibility in the manner of execution for 
market participants.\2\ This will give the end-users choices, 
confidence and liquidity, and will do so in a regulated framework that 
promotes the trading of swaps, in an efficient and transparent manner 
on regulated markets.
---------------------------------------------------------------------------
    \2\ The term `swap execution facility' has been defined in the 
Dodd-Frank Act as a trading system or platform in which multiple 
participants have the ability to execute or trade swaps by accepting 
bids and offers made by multiple participants in the facility or 
system, through any means of interstate commerce, including any trading 
facility, that--(A) facilitates the execution of swaps between persons; 
and (B) is not a designated contract market. The Dodd-Frank Act amends 
Section 1a of the Commodities Exchange Act with a new paragraph (50, 
and Section 761(a)(6) of the Dodd-Frank Act amends Section 3(a) of the 
Securities Exchange Act of 1934 by adding a new paragraph (77) 
(defining a ``security-based swap execution facility''). We refer to 
both as a SEF in this submission.
---------------------------------------------------------------------------
    Since 1998, Tradeweb has been operating a regulated marketplace for 
the OTC fixed income marketplace and has played an important role in 
providing greater transparency and improving the efficiency of the 
trading of fixed income securities and derivatives. Indeed, Tradeweb 
has been at the forefront of creating electronic trading solutions 
which support price transparency and reduce systemic risk, the 
hallmarks of Title VII of the Dodd-Frank Act. Accordingly, Tradeweb is 
supportive of the Act and its stated goals, and while our existing 
electronic trading capabilities will allow us to readily adapt to the 
trading, clearing and reporting rules ultimately promulgated by the 
CFTC and SEC, it is important for this Committee, Congress as a whole 
and the regulators to understand and give due consideration to the 
needs of market participants. The aim must be to achieve the goals of 
the Act without materially disrupting the market and the liquidity it 
provides to end-users who use derivatives to manage their varying risk 
profiles. Market participants need confidence to participate in these 
markets and if careful consideration is not given to what the rules say 
and how they will ultimately be implemented, we fear that this 
confidence could be materially shaken.
    To that end, the rules relating to Title VII must be flexible 
enough so as not to deter the trading of swaps on regulated platforms. 
By ensuring that the rules retain sufficient flexibility to allow end-
users to elect where and how they transact business, it provides for 
the most competitive execution of trades. The Act clearly recognizes 
the existence and importance of electronic platforms in achieving these 
objectives, and we believe regulation should foster the benefits these 
venues provide, rather than inhibit them. Accordingly, the rules should 
not limit the choices of trading protocols available for end-users to 
efficiently and effectively manage their risks.
    For example, if the rules regarding how market participants must 
interact with each other from a trading perspective and accessing 
liquidity are arbitrary and artificially prescriptive, and thus not 
flexible enough to accommodate the varying methods of execution, market 
participants simply will not participate and will seek alternative, 
less efficient markets to manage their risk. We certainly do not 
believe that is the ultimate goal of Title VII.
    Similarly, arbitrary or artificially prescriptive ownership limits 
or governance requirements will deter investment of capital in new or 
existing platforms. A careful balance needs to be reached between 
safeguarding the system and encouraging private enterprise, which will 
allow end-users access to choose among robust trading venues and 
clearing organizations. To be clear, we favor having an independent 
voice on the Board of registered entities, but the rules should not go 
so far as to make that the predominant voice--one that creates a 
conflict of interest on the opposite extreme.
    It is important in this regard, and for other reasons, that there 
is a consistent approach between regulators, both in the U.S. and 
globally, as overly rigid regulation in one jurisdiction will 
materially impact how other regulators promulgate rules in an effort to 
maintain a harmonized approach to overseeing the derivatives markets. 
The potential result is a movement of the market outside the U.S., and 
that would likewise be an unfortunate unintended consequence.
    Accordingly, we believe it is important that the implementation of 
the new regulations be conducted in a flexible manner. An overly hasty 
or ill thought-out timetable for implementation could directly impact 
the health of the derivatives markets by disenfranchising the inter-
connected members of this complex ecosystem. In short, implementing 
these regulations in one ``big bang'' is unrealistic and as such, we 
favor a phased-in approach.
    Tradeweb is supportive of the goals to reform the derivatives 
markets and indeed we provide the very solutions the regulation seeks 
to achieve, but we are concerned that the Commissions may overreach in 
their interpretation and implementation of Dodd-Frank, and in doing so 
create unintended consequences for end-users and the marketplace as a 
whole.

III. Background on the OTC Rates and Credit Derivatives Marketplace
    There are generally two institutional marketplaces for over-the-
counter (OTC) credit and rates derivatives: the dealer-to-customer 
market (institutional) and the interdealer market (wholesale). In the 
institutional market, certain dealers act as market makers and buy and 
sell derivatives with their institutional customers (e.g., asset 
managers, corporations, pension funds, etc.) on a fully-disclosed and 
principal basis. In the institutional market, the provision of 
liquidity is essential for corporations, municipalities and government 
organizations (i.e., end-users), which have numerous different asset 
and liability profiles to manage. The need for customized risk 
management solutions has led to a market that relies on flexibility--so 
end-users can adequately hedge interest rate exposure--and liquidity 
providers, who have the ability to absorb the varied risk profiles of 
end-users by trading standard and customized derivatives. These market 
makers then often look to the wholesale market--the market wherein 
dealers trade derivatives with one another--to obtain liquidity or 
offset risk as a result of transactions effected in the institutional 
market or simply to hedge the risk in their portfolios.
    In the wholesale or inter-dealer market, brokers (``IDBs'') act as 
intermediaries working to facilitate transactions between dealers. 
There is no centralized exchange (i.e., derivatives are traded over-
the-counter), and as a result, dealers look to IDBs to obtain 
information and liquidity while at the same time preserving anonymity 
in their trades. Currently, in the United States, these trades are 
primarily accomplished bilaterally through voice brokering. By 
providing a service through which the largest and most active dealers 
can trade anonymously, IDBs prevent other dealers from discerning a 
particular dealer's trading strategies, which in turn (i) reduces the 
costs associated with the market knowing a particular dealer is looking 
to buy or sell a certain quantity of derivatives, (ii) allows the 
dealer to buy or sell derivatives in varying sizes, providing stability 
to the marketplace, and (iii) enhances liquidity in the marketplace.
    Both the wholesale and institutional derivatives markets trade 
primarily through bilateral voice trading, with less than 5% of the 
institutional business trading electronically. In these markets, trades 
are often booked manually into back office systems and trades are 
confirmed manually (by fax or other writing), and some (but not all) 
derivatives trades are cleared.
    With the implementation of the Dodd-Frank Act, we expect that most 
of the interest rate and credit derivatives markets will be subject to 
mandatory clearing, and therefore be traded on a regulated swap market. 
Accordingly, with increased electronic trading, the credit and rates 
derivatives markets will be much more transparent (with increased pre-
trade price transparency) and efficient, and systemic risk will be 
greatly reduced as the regulated swaps markets will have direct links 
to designated clearing organizations (``DCOs'') and swap data 
repositories (``SDRs'').
    In light of the foregoing and with the forthcoming business conduct 
standards, we believe the trading mandate was not intended to be and 
does not need to be artificially and arbitrarily prescriptive to 
achieve the goals of the Dodd-Frank Act. Indeed, to do so, would 
undermine these goals. For example, by mandating a minimum of five 
liquidity providers from which a market participant can seek prices 
would likely reduce liquidity and effectively reduce the ability for 
end-users to adequately manage their risk. In short, regulated swap 
market trading (without regard to trading model but with the 
appropriate transparency and regulatory oversight) and clearing is what 
will accomplish the policy goals without hurting liquidity and 
disrupting the market. It is critical that the Commissions do not 
propose rules that artificially and unnecessarily hurt the market and 
undermine the goals of the Dodd-Frank Act.

IV. Key Considerations for SEF Rulemaking
SEFs
    As noted above, it is imperative that the Commissions adopt rules 
that are clear and allow for flexibility in the manner of execution for 
market participants. This will give the market choices, confidence and 
liquidity, and will do so in a regulated framework that promotes the 
trading of swaps, in an efficient and transparent manner.
    Consistent with the goals of the Dodd-Frank Act, for institutional 
users, a SEF should (i) provide pre-trade price transparency through 
any appropriate mechanism that allows for screen-based quotes that 
provide an adequate snapshot of the market (e.g., through streaming 
prices for standardized transactions and competitive real time quotes 
for larger or more customized transactions), (ii) incorporate a 
facility through which multiple participants can trade with each other 
(i.e., must have competition among liquidity providers), (iii) have 
objective standards for participation that maintain the structure of 
liquidity providers (like swap dealers) providing liquidity to 
liquidity takers (institutional buy-side clients), (iv) have the 
ability to adhere to the core principles that are determined to be 
applicable to SEFs, (v) provide access to a broad range of participants 
in the OTC derivatives market, allowing such participants to have 
access to trades with a broad range of dealers and a broad range of 
DCOs; (vi) allow for equal and fair access to all the DCOs and allow 
market participants the choice of DCO on a per trade basis, and (vii) 
have direct connectivity to all the SDRs.
    In order to register and operate as a SEF, the ``trading system or 
platform'' must comply with the enumerated Core Principles in the Dodd-
Frank Act applicable to SEFs. Regulators have the authority to 
determine the manner in which a SEF complies with the statutory core 
principles, and there is discretion for the Commissions to retain 
distinct regulatory characteristics for SEFs versus DCMs. It is 
critically important for the Commissions to apply the principles with 
flexibility given the market structure in which swaps are traded. 
Accordingly, regulators should interpret core principles in a way in 
which SEF's can actually comply with them. While many of the SEF Core 
Principles are broad, principle-based concepts--which make sense given 
the potential for different types of SEFs and trading models--some of 
the Core Principles are potentially problematic for SEFs that do not 
operate a central limit order book or clearing.\3\
---------------------------------------------------------------------------
    \3\ For example, the Position Limits or Accountability Core 
Principle continues to be a big issue in terms of a SEF's ability to 
know and react to the parties' positions (i.e., each SEF will need a 
full market view to have the appropriate transparency to monitor this 
issue). This would require cooperation among all the venues (SEFs, DCMs 
and DCOs), including position information sharing agreements, so that 
if a position was exceeded, the SEF could block any execution. This 
might work in a futures exchange environment where contracts are 
particular to the exchange; this will be significantly problematic 
where multiple venues (SEFs and/or DCMs) will trade the same products.
---------------------------------------------------------------------------
Ownership and Governance
    As noted above, Tradeweb was launched by market participants, and 
has benefitted from their investment of capital, market expertise, and 
efforts to foster the development of more transparent and efficient 
markets. With the help of its board, comprised of market and non-market 
participants, Tradeweb has since its inception brought transparency and 
efficiency to the fixed income and derivatives marketplace.
    The success story of Tradeweb may not have been possible if overly 
prescriptive governance and ownership limits had been imposed at the 
time. It was highly unlikely that under those circumstances, any of the 
banks would have made an investment. Moreover, beyond the initial seed 
capital, the banks' participation also allowed Tradeweb to continue to 
invest in its infrastructure and evolve with the market--thus building 
the robust and scalable architecture that has allowed it to expand to 
20 markets, technologically survive 9/11 (Tradeweb's U.S. office was in 
the North Tower of the World Trade Center), and develop connectivity 
with over 2000 institutions globally. Under the proposed rules of the 
CFTC and the SEC, ownership and independent director limits will be 
imposed on the different registered entities that will provide the 
technological infrastructure to the swaps market--from trading to 
clearing. Tradeweb believes that independent directors are a very good 
idea, in terms of bringing an independent perspective to the governing 
board, but their duties must be consistent with other board members. 
However, artificial caps on ownership or excessive requirements for 
independent directors on the board (such as 51% of the voting power) go 
too far. As a practical matter, ownership limits will impair registered 
entities such trading platforms and clearing organizations from raising 
capital, and overly restrictive director requirements will likewise 
hurt investment because investors will lack a sufficient say in how 
their investment will be governed. Moreover, Dodd-Frank provides other, 
more direct, ways in which to mitigate conflicts of interest, and 
employing each of these tools in a reasonable fashion will, in the 
aggregate, address the potential conflicts of interest without 
negatively impacting investment of capital and innovation in the 
marketplace.
    Finally, in terms of oversight, Tradeweb asks that the Committee 
consider the substantial expense and burden that regulatory oversight 
departments can create on entities. Tradeweb ironically may be the 
beneficiary of stricter rules, because it would deter new entrants into 
the marketplace, but this would not be best for competition, and the 
end-user would suffer. Additionally, if costs mount for SEFs, these 
will inevitably be passed on to the end-user. Along with other costs 
resulting from the Dodd-Frank Act, such as central clearing, the result 
could be that derivatives themselves become less attractive vehicles 
for managing risk.
    For these reasons, we urge legislators and regulators to consider a 
more reasoned approach to mitigating conflicts of interest.

Implementation
    Because of its technological experience and expertise, Tradeweb 
will be in a position to implement whatever trading rules are imposed 
by the CFTC and SEC for SEFs shortly after registration. However, as we 
note above, the implementation of Title VII of the Dodd-Frank Act will 
require cooperation between regulators (both domestically and abroad) 
in their rulemaking and implementation plan, as well as the cooperation 
and investment of market participants. It is critical therefore that in 
the first instance, the rulemaking is flexible but clear, and that each 
facet is implementation is thought through--because a lack of 
confidence in implementation will result in a lack of confidence in the 
marketplace, the result of which would be a marketplace which would not 
best serve the interests of the end-user.
          * * * * *
    In sum, while we are supportive of the goals of the Dodd-Frank Act 
and believe increased regulatory oversight is good for the derivatives 
market, we want to emphasize that flexibility in trading models for 
execution platforms are critically important to maintain market 
structure so end-users can manage their risks in a flexible manner. If 
you have any questions concerning our comments, please feel free to 
contact us. We welcome the opportunity to discuss these issues further 
with the Committee and their members.

    The Chairman. Thank you, Mr. Olesky. I appreciate that. We 
will now go to questions from the Committee, and I will yield 
my time to Mr. Hultgren at the front, who was way down on the 
list the first time around. Mr. Hultgren for 5 minutes.
    Mr. Hultgren. Thank you. It pays to stick around. Thank you 
very much. I appreciate all of you being here. I really 
appreciate your very extensive testimony today, but also the 
testimony that you have given to us to work with.
    I hear some very common themes through your testimony of 
real concern of overreach from Dodd-Frank, and impact on all of 
our economy, albeit specifically the work that you are doing.
    So I have quick questions I would like to ask for each of 
you in my time available, so I would ask if you can respond 
quickly, that would be terrific.
    First for Mr. Gallagher, what will be the impact of 
procedures if they can no longer--excuse me, of producers if 
they can no longer access their customized hedges through the 
co-op?
    Mr. Gallagher. The opportunity for them to mitigate their 
risk will likely be diminished. For the most part, large swap 
dealers generally do not have an interest in dealing with 
individual farms because of their lack of understanding about 
the financials on the farms, and the small net worth that they 
may have, and so they are--our member's opportunities are 
through aggregate and through cooperative DFA or Dairylea or 
other national council members, in order to access the swap 
markets on their behalf.
    Mr. Hultgren. Thank you. Mr. Duffy, what is your view on 
the concerns we have heard today regarding the special speed 
and sequence with which the CFTC is issuing rules, and to be 
able to maybe provide some specific examples of how that speed 
of rules is affecting the Chicago Mercantile Exchange and 
others?
    Mr. Duffy. Yes, I think the speed of rules, as I said in my 
testimony, concerns us for a lot of different reasons. One, 
because they are going more from a principles-based regime 
looking to go into more of a rules-based regime, and they are 
also coming out with--we have a big legal team at the CME 
Group, and we have external legal folks. They are having a very 
hard time keeping up with it, so we are concerned how in the 
world can the rest of the Commissioners actually have an 
opportunity to look at this information and analyze it and make 
good decisions. So, we are overwhelmed on our side. We don't 
know how we are going to get good responses into the CFTC so 
they can make a good analysis of the public comments, going 
forward.
    So that is one of the big things that concerns us.
    Mr. Hultgren. Mr. Pickel, in your testimony you expressed 
concerns regarding the proposed metric for determining block 
trades. How does the CFTC proposal fall short in this regard, 
and how would you propose that we could revise that?
    Mr. Pickel. I think our principle focus--and we did a study 
which we filed as part of our comment letter that looked at 
experiences in other markets with transparency and block 
trades, and we just--we feel that the thresholds that they are 
talking about are far too high. Keep in mind that as much as 
those requirements are there for dealers, they are also there 
for end-users. We have heard from a lot of larger asset 
management firms who will do a large trade with their dealer 
and put the burden effectively on the dealer to parcel that out 
into the marketplace. If that trade, large as it may be, is 
still below the block trading thresholds, then the dealer may 
be reluctant to take on that burden because as soon as that 
trade is done with the asset manager, that will need to be 
disclosed to the marketplace.
    So we are focusing very much on those thresholds, trying to 
get the information, and then urging the Commission to in 
turn--both Commissions, actually, because they both have rules 
regarding block trading--but both Commissions to do studies to 
analyze the effects on liquidity. Because once you have dealers 
pulling back, you have a much less liquid market and 
effectively, you have put the burden on the asset manager in 
that circumstance to do smaller trades, which may be not as 
efficient for them.
    Mr. Hultgren. Thank you. Mr. Morrison, if I could ask you a 
quick question. How would you respond to the claim that 
clearing and exchange trading is in the best interest of end-
users because it prevents dealers from charging them high 
prices to engage in OTC transactions, especially reflective 
from Chairman Gensler's remarks today?
    Mr. Morrison. We feel that we have good transparency today 
in terms of the markets and in terms of the prices. There are 
numerous information services, whether it is Bloomberg or 
Reuters or bank trading systems or direct links to the LME 
which we trade on, and so we are not concerned. We use multiple 
counterparties, and so we think we have sufficient transparency 
today in terms of the prices and credit spreads and things that 
we are paying.
    Mr. Hultgren. Thanks. Just to wrap up, Mr. Olesky, as you 
know, the SEC and CFTC proposals for SEFs have significant 
differences. How would this lack of harmonization impact SEFs 
and their customers?
    Mr. Olesky. Well, as much as possible we like to see 
consistency, but I don't think the differences are the issue. I 
think the key is, again, how we phase in these rules, how 
flexible they are, and how much they take into consideration 
the market participation and the impact it is going to have on 
the market as a whole.
    Mr. Hultgren. Well thank you all very much. I really do 
appreciate you being here today. I appreciate your testimony. 
We are going to need your help, going forward, as we work 
though this, so it really does mean a lot to me and the rest of 
my colleagues that you are here.
    Thank you, Mr. Chairman.
    The Chairman. The gentleman yields back. Mr. Peterson for 5 
minutes.
    Mr. Peterson. Thank you, Mr. Chairman. Mr. Duffy, your 
clearinghouse, you launched clearing for interest rate swaps 
and credit swaps, apparently, but you are not showing much 
volume, I guess, at the moment. Is that correct?
    Mr. Duffy. That is correct.
    Mr. Peterson. And do you believe that the big dealers of 
these swaps are resisting clearing in general, or your 
clearinghouse in particular?
    Mr. Duffy. I think, personally, the large dealer community 
is waiting for some of these rules to be written to see exactly 
where they are going to be at. They know that they have 
alternatives in clearing swaps, whether it be at CME Group, ICE 
Trust, LCH, or whoever else decides they are going to open up a 
swaps clearing entity. So I think they know they have the 
ability to ramp up very quickly from a technology standpoint to 
have the pipes go to these clearinghouses, so I think they are 
actually waiting as long as possible to see where the rules 
come out.
    We have been dealing with--we have about 925 million 
cleared interest rate swaps to date, and we started the 
initiative back in December, so for the most part, it is a 
situation to your point, sir.
    Mr. Peterson. How much do you think this reporting here 
that they are getting together, these big guys and this secret 
cabal in New York has to do with this?
    Mr. Duffy. If you are asking me, I don't think it has 
anything to do with it. I don't think there is a cabal at all 
amongst the dealers in this.
    Mr. Peterson. They are not trying to keep control of this 
for themselves?
    Mr. Duffy. No, I think what the dealers are looking at, 
they have the most to lose because they are the largest influx 
of cash entities, clearing entities, so when you have a smaller 
participant come in with a large transaction, he could take 
down somebody who put up all the money, so I think that they 
are a little concerned that that wouldn't be an appropriate 
thing to have happen. I agree with what Chairman Gensler said 
earlier about that they should put up small capital, they 
should be able to do small transactions. You know, I am sure 
the banks are trying to work with some of these other clients 
to figure out how that waterfall system would work. But their 
main concern is, and I don't blame them, is that they would 
have a transaction coming into that clearing entity that they 
have put all the money up for that is not well capitalized that 
has a tremendous amount of risk associated with it.
    Mr. Peterson. All right. Mr. Gallagher and Mr. Morrison, do 
your--do you, when you are doing these over-the-counter swaps 
that are not standardized, I assume you do some of that----
    Mr. Gallagher. Yes.
    Mr. Peterson. How does it work? Do you have six of these 
big banks that you go and give this out, or is there just one 
entity that you normally do business with, or how does that 
work?
    Mr. Gallagher. I can comment on how DFA operates. We have a 
number of entities, I believe only two of them may be banks, 
but a number of entities who we have ISDA agreements with that 
we can do swap transactions with, and we will contact them 
looking to see which one we can get the best pricing at.
    Mr. Peterson. So you lay out the terms of the swap and you 
send it to these folks, and you take the best----
    Mr. Gallagher. If we have enough time to do that, we do. 
Some of what we do, for instance, one of the swap transactions 
we may do would be for a Class IV price, and there is a futures 
contract on the Class IV price, but the volume is very limited 
and sometimes it is easier for us to get that trade done on 
behalf of a member by writing a swap with an entity, and so 
there may be one or two or three entities we know that would 
consider that, and so we would contact them and see what their 
pricing is. In some cases, we go there just because we can't 
get the volume done on the futures exchange.
    Mr. Peterson. And are you in the school that doesn't think 
that the transparency that they are trying to get going here is 
going to actually give you more information so you are going to 
be able to get better deals?
    Mr. Gallagher. We think transparency will always lead to 
better information. The degree of the value of that I am 
uncertain with yet because I am not sure what types of things 
will be posted for public information.
    Mr. Peterson. It depends on how it is set up?
    Mr. Gallagher. That is right. If it is limited to what is 
currently the Commitment of Traders Report, I am not sure there 
would be much additional value.
    Mr. Peterson. Mr. Morrison, is it a similar situation?
    Mr. Morrison. Similar in that we use multiple information 
sources where we can see live prices, and then we have 
approximately ten different counterparties that we can use. So 
we know exactly what kind of credit spread we are paying, and 
so we think we have sufficient transparency today.
    Mr. Peterson. That is for your company?
    Mr. Morrison. That is for our company.
    Mr. Peterson. But there is probably other companies out 
there that don't have the information, from what I can tell. I 
am not, you know----
    Mr. Morrison. Perhaps very small companies that don't do a 
lot of this, that could be the case.
    Mr. Peterson. But wouldn't you agree, as Mr. Gallagher 
said, that the more information that is out there, the better 
prices you are going to get? You know, if you believe in the 
free market and----
    Mr. Morrison. I am worried about the unintended consequence 
of some of the transparency. Having to report trades real-time 
and the--I believe that will reduce liquidity in certain 
markets, especially longer dated markets. So I think that will 
actually drive costs up.
    Mr. Peterson. Well, I am not sure we would know it until we 
actually tried it, but if I might, Mr. Chairman, I just 
wanted--what--I forgot what I was going to ask now, so maybe it 
will have to wait until later. Thank you.
    The Chairman. The gentleman yields back. Mr. Johnson, 5 
minutes.
    Mr. Johnson. Mr. Duffy, if I could ask you, I think it is 
apparent that these regulations and the compliance process with 
Dodd-Frank is going to be very costly. I think it is also at 
least apparent to me that the volume that you are to be 
expected to address of new swaps under this Act is going to be 
gigantic. I also think it is apparent, without trying to 
prejudice your answer, that this is going to have an effect--
large or maybe less than large--on the competitiveness of U.S. 
financial markets with European and otherwise.
    Can you just address some of those issues in particular as 
to how it is going to impact you, because I think it is also 
obvious that virtually every district in the country, and 
certainly ours, is going to be dramatically impacted by 
regulations that affect you that in turn affect us. So I am 
just concerned about what this is going to do to us in a 
competitive structure, and also what it is going to do in terms 
of costs of compliance that inevitably are going to have to be 
passed along to somewhere else.
    Mr. Duffy. I think the latter part of your question is the 
more important and relevant one, sir, and that is the costs 
associated with it, because what--some of the things we are 
seeing coming out of the rulemaking process under the agency is 
basically duplicating what an SRO or a self-regulatory 
organization already does today. CME Group already does these 
things today, so what it appears to us what the agency is doing 
is just creating a duplicate process which is adding tax and 
burden--adding the burden to the taxpayers to fund that 
particular entity when we can do it. They already have the 
ability, sir. If we are not acting appropriately, they can come 
in and obviously have the oversight of our business. But at the 
same time, we have what is called a principles-based regime 
which was put into place in 2000 by this Congress under the 
Commodity Futures Modernization Act so we can grow and prosper 
throughout the world. That is being taken away and it is being 
done with prescriptive rules that were not to be put in place 
for the futures exchanges.
    So yes, I am very concerned about the competitiveness of 
U.S. entities as we go forward.
    Mr. Johnson. In terms of the process that--the process by 
which the CFTC issues rules, do you think that they are 
sequentially and in a timely manner issuing rules or do you 
think there are problems? And if so, could you maybe give us a 
few examples of where you see issues that have arisen?
    Mr. Duffy. You know, I think what we are going to try to 
do--and I talked to the Chairman the other day. He called and 
asked me something very similar to that, and I think on a 
sequential basis as the rules come out, we want to put a very 
thoughtful process into place and give him our best opinion, 
and I didn't want to do that in that conversation with him, so 
to answer your question, Congressman Johnson, we are actually 
formulating all that data now for a meeting with the agency 
next week about the implementation and the timing of those 
rules, how they should come out.
    Mr. Johnson. As you probably know, Mr. Duffy, today and 
tomorrow the full House is addressing issues of what some 
people see as regulatory excesses. I don't necessarily expect 
or want you to engage in that debate, but I am assuming that 
CME has been either victimized by or at least affected by 
regulatory excesses, perhaps in excess, so to speak, of what 
the Congress ever intended. Do you think it is----
    Mr. Duffy. That is an excellent summary, sir. When you have 
a history--and I heard Mr. Morrison talk about they have been a 
publicly traded company for 139 years. We have been around for 
156 years. We have never had a customer lose a penny due to one 
of our clearing member defaults. I think that is a pretty 
stellar record, and something that we cherish very much. We 
weren't the cause of the 2008 crisis, yet we seem to be the 
bright shiny object in the room, so let us try to implement a 
bunch of new rules on futures houses and clearinghouses 
associated with them. It doesn't make a bit of sense to me. 
They should be focusing on what put us into this situation, not 
what has helped preserve the stability of the financial 
markets.
    Mr. Johnson. Speaking only for myself, but I believe this 
probably would reflect the viewpoint of some other Members of 
this Committee and Congress generally, I would welcome hearing 
from you and your colleagues in the panel and related entities 
about what we can do as a Congress to be able to address some 
of those issues that you face along the way, because I believe 
the current law as it is being implemented is going far too 
far, if you will, and that we really need your help in being 
able to address the practical effects of these things and how 
we can work with you to make the world better for all of us, so 
to speak.
    Mr. Duffy. If I may just give two quick examples, Mr. 
Chairman, if you will allow me to?
    The Chairman. Absolutely.
    Mr. Duffy. You know, to that point, sir, we have new 
contracts that we put up every day, and some are successful. 
Most are not. We have to put these up in a way that makes sense 
for the end-users of our product line, so a lot of times we 
will put them up as an OTC contract because they trade very, 
very little, and if they ever get a higher volume then we 
migrate them onto our central limit order book, and that is the 
way we do it.
    The CFTC is now saying if you don't have that liquidity, or 
85 percent of that liquidity traded on your central limit order 
book, that product needs to go away. Well, I have contracts 
that have listed for 5 years with no volume, but all of a 
sudden, they trade one million contracts. Why? Because the 
world changes. Maybe our timing was a little off. So that is 
one example.
    Another example is they want to have the ability to decide 
who is on my nominating committee, because they think they have 
a better--what is in the best interest of my shareholders about 
what is the composition of that. These are things that are way 
overreaching from a regulator into our business and into other 
businesses.
    So I look forward to the opportunity to work with you and 
other Members, sir.
    Mr. Johnson. Thanks so much for your help.
    The Chairman. The gentleman yields back. Mr. Boswell for 5 
minutes.
    Mr. Boswell. Thank you, Mr. Chairman. I appreciate everyone 
being with us today and I think this is good. Early on, I think 
we discussed, if you didn't cause the problem, why are you in 
so much oversight? But again, we are trying to protect the 
public so I appreciate you being here.
    I think I will start with Mr. Morrison and Mr. Gallagher. 
You heard in Chairman Gensler's testimony a statement of 
transactions involving non-financial entities do not present 
the same risk to the financial system, as those solely between 
financial entities. Therefore, proposed rules on margin 
requirements should focus only on transactions between 
financial entities rather than those transactions that involve 
non-financial end-users. Does this statement address your 
concerns about margin requirements for swap dealers and major 
swap participants for their transactions with your members?
    Mr. Gallagher. I believe it can. I would like to read what 
comes out. Right now, we have a concern on margins because that 
is part of--we have to margin, we have to utilize working 
capital. Others have testified how if you have to--if you don't 
have to use your working capital now to margin some of your 
swaps and you do later on, that you are taking that working 
capital away from doing other things in your business that, in 
our specific part of the economy, is going eventually come back 
to providing less opportunity for farmers. So I would like to 
be able to see what they are writing, because sometimes I think 
they may think that they are excluding us, but the way they 
write things maybe captures us, so I would like to see it in 
writing before I----
    Mr. Boswell. I think your point is valid. Long-time 
Chairman of the local board, I appreciate that working capital 
concern and it depends on time of year and a number of things.
    Mr. Morrison. I have a similar concern. If end-users are 
exempt from posting margin, what I would be concerned with is 
if we conduct a trade with a bank, for instance, and that bank 
then offsets that exposure with another bank, does that require 
margin somewhere in the system? And my concern is that if there 
is margin required somewhere in the system on that trade, it is 
going to come back to me in higher costs.
    Mr. Boswell. Okay, let us move along. Mr. Gallagher, in 
your testimony you expressed concern that the CFTC may impose 
over-excessive margin requirements. Is that part of what you 
are referring to?
    Mr. Gallagher. Yes, certainly. One of the things right now 
is we aggregate the risk of our member-owners, and then we go 
into the market as the swap entity. Depending on how they 
define what a swap dealer is, we could easily fall into that, 
just the notion that we act like one----
    Mr. Boswell. Do you think Mr. Gensler kind of set that 
aside for you in his statement, or are you still concerned?
    Mr. Gallagher. I am still concerned about how we will be 
viewed as we call up different entities saying we have some 
risk on something like buttermilk powder, where there is no 
market for--no futures market for, we call up different 
entities. Are we going to be considered a swap dealer because 
we are calling up different entities, and then are we going to 
be a swap dealer because we have to do this more than 20 times 
a year, and we--to mitigate our risk, we are doing it with ten 
different entities? I would hope that wouldn't qualify us as a 
swap dealer.
    Mr. Boswell. Well, I think we can monitor that and see how 
that gets defined.
    Thank you. I yield back.
    The Chairman. The gentleman yields back. Mr. Stutzman, 5 
minutes.
    Mr. Stutzman. Thank you, Mr. Chairman, and I appreciate you 
all coming in here today. I apologize that I wasn't here for 
most of the testimony. I have had a budget committee meeting 
going on simultaneously, so--but I have been trying to read 
through some of your testimony. Coming from northeast Indiana 
and an agricultural community, a manufacturing community, of 
course Ball being in Indiana, we are very familiar with you all 
and appreciate the business that you do there.
    I guess what I want to start out with, the testimony that 
Mr. Gallagher gave. Being in small town America, we are very 
familiar with co-ops. I guess my initial question is what 
distinguishes a co-op and the services they provide to their 
members from a swap dealer?
    Mr. Gallagher. Cooperatives have a governance structure, 
much like the House of Representatives, where they have farmers 
that are elected to boards. Boards govern the management of the 
organization, and any earnings that may accumulate at the 
business end eventually come back to the member-owners. So 
there is a significant difference between what agricultural 
cooperatives do and how they are managed, and how they pass 
back earnings is probably different than any other business 
entity.
    Mr. Stutzman. I grew up on a dairy, and thankfully my dad 
had decided not to continue on as us boys got older and just 
focused mostly on grain, but what would the impact on producers 
be if co-ops or if they can no longer access their customized 
hedges through the co-op?
    Mr. Gallagher. Okay. One of the things that we are doing 
right now is that because of the extraordinary explosion in 
grain prices, feed is the single biggest input cost on a dairy 
farm. So we are customizing our forward contracts so that they 
can not only manage a milk price, but they can manage that feed 
price, all in context as a milk price. In order for us to do 
that, we have to go to the swap market to lay that risk off, 
because typically we have farmers that--they don't utilize 
5,000 bushels of feed in a month, or they may need that 
contract to carry out every single month, and the futures 
market doesn't trade feed every single month. So they need our 
help customizing that for them so that we can then lay that 
risk off for them on a swap basis in the swap market. And if 
something happens where we are prevented--if we get regulated 
as a swap dealer, I am not sure we would continue offering that 
particular program, and then I am afraid that because of the 
size of the farms and their ability to get working capital on 
the farm, that they come to us because they don't have the 
working capital to have their own futures account. We provide 
that working capital for them through our forward contracting 
process. I am concerned that they will not have the ability to 
manage that significant input price risk if they are taking on 
right now--and that will reduce their profitability in the long 
term.
    Mr. Stutzman. And I am not, I guess, aware of any problems 
before Dodd-Frank in particular. Do you know of any problems 
that were, I guess, maybe publicized? I am a freshman here in 
Congress, so I mean, you know--I guess kind of how did you get 
brought into this? What is kind of the history of--behind Dodd-
Frank and you all and why you are kind of pulled into this 
situation?
    Mr. Gallagher. Okay. We have had--forward contracts have 
been excluded and we want them to continue to be excluded. 
There have been certain information in some of the stuff coming 
out of the CFTC rulemaking that suggests maybe they are going 
to regulate options that are imbedded in--price options that 
are imbedded in forward contracts. That would be a travesty for 
agriculture if that happened.
    We then are concerned because we have been building these 
swap books to help our members mitigate their risks. My 
colleagues in some of the other organizations use swaps far 
more than my organization does, and for some of the things that 
they are doing, if something happens where they get regulated 
as--we get regulated as swap dealers and we have to margin, we 
are not sure we are going to have the working capital to be 
able to provide the same benefits that we have been providing 
in the past. So we are concerned that this--as this rolls out, 
it rolls out the right way and that right now, it seems like at 
least the stuff we have read today, that the mesh on that net 
is pretty tight, and it is capturing a lot of fish that 
probably don't need to be captured. So we need a little bit of 
a wider mesh to capture the big fish and not harm the small 
fish.
    Mr. Stutzman. Can you quick just answer, how is this going 
to affect a smaller dairy, which I have more smaller dairies, 
even though we have large dairies in Indiana as well?
    Mr. Gallagher. We wouldn't be able to--we would likely not 
be able to help them hedge their feed.
    The Chairman. The gentleman yields back. Mr. Welch for 5 
minutes.
    Mr. Welch. Thank you, Mr. Chairman. I will follow up on 
some of the questions Mr. Stutzman was asking. Vermont is a 
dairy state, so we have some of the challenges that you were 
just asking about and answering.
    The goal here is to try to get the regulation right. 
Something bad happened as you indicated, Mr. Duffy, but we are 
getting it right means that we don't blame the folks who were 
doing it right in the first place. So I am just going to ask a 
couple of questions.
    Let me start with you, Mr. Olesky. The AIG problem was 
brutal, and it ended up costing every taxpayer about $600. As I 
understand it, it was their overexposure in the derivatives 
market that led to their downfall and the taxpayer rescue. What 
were the specific failures that led to that default?
    Mr. Olesky. I am not sure of all the specifics with respect 
to AIG. I do think, though, that the regulation and the 
legislation that has been--the legislation has passed and the 
regulation has been proposed, is going to bring an awful lot of 
transparency into the marketplace. We wholly support that. In 
addition to transparency, we think it is going to lead to more 
electronic trading, risk reduction, certainly systemic risk 
reduction through using central counterparties, and a lot more 
information in the hands of regulators on a real-time basis.
    Mr. Welch. All right, so let me just interrupt. This is 
helpful. I mean, I have a lot of community bankers who are very 
upset about some of the regulatory impacts of Dodd-Frank, and 
they were not the ones that caused the problem, but they 
acknowledged that a problem is there and has to be corrected. 
So that is what I think is a mutual goal here, to try to get it 
right.
    Mr. Duffy, you were describing your situation, and you have 
this incredible record of 156 years without losing anybody a 
nickel. That is pretty--how do we invest, by the way. But what 
are the specifics that did need to be attended to that we saw 
in AIG that Mr. Olesky was speaking about?
    Mr. Duffy. Well first of all, you can lose money, we don't 
lose money because of our risk management.
    Mr. Welch. Right, I got that.
    Mr. Duffy. So we have a stellar record of risk management 
to make sure that you don't lose your money.
    You know, I have testified in front of this Committee over 
the last couple years, and maybe against our own book when I 
said that I didn't think clearing should be mandatory. I 
thought that clearing should be an incentive to be done, so the 
end-users, if they want to use it, they should have a capital 
charge of X if they don't clear and Y if they do clear. So that 
is what my whole stance has been all along. You know I was the 
one that appeared to be the winner in this, because we already 
had the largest clearinghouse in the United States and we would 
get all this supposed business. I didn't see it that way 
because I can see it as business either not getting done, or 
being forced overseas. So we have never subscribed to this 
mandatory law of clearing, and I still am not going to 
subscribe to it, even though it is law today, so we will 
comply.
    As far as AIG goes, sir, in all due respect it is no 
different than an options trader who is selling premium because 
when you sell premium on an options transaction, you receive 
the cash and your exposure gets bigger and bigger and you have 
nothing to back it up with.
    Mr. Welch. All right, but there was a total lack of 
regulation. They didn't have any margin requirements, and it 
led to outsize risk taking.
    Mr. Duffy. There was no margin. There was capital and they 
were--you know, what is capital? So they were adding up 
everything in a room and calling it capital and putting a value 
on it, and that is the way they were backing up the positions 
with a balance sheet.
    Mr. Welch. Right, and they nearly blew up the financial 
system.
    Mr. Duffy. I am well aware what happened.
    Mr. Welch. Right, so what steps would we need to take in 
order to protect, in effect, not just the taxpayers who ended 
up having to bail them out, but a lot of main street businesses 
that needed stability in the credit markets?
    Mr. Pickel. If I----
    Mr. Welch. Mr. Pickel, go ahead.
    Mr. Pickel. If I might jump in there, I think that--first 
of all, that AIG utilized derivatives to take exposure to real 
estate. That is what they did with their derivatives. They also 
used secured lending to take that exposure. So ultimately, that 
was the driver there.
    I think, though, that let us look at what is in the law and 
let us look at what is, going forward, to deal with the AIG 
situation. This major swap participant definition is a critical 
piece of that, and when it was first proposed, it was proposed 
as that to catch the next AIG. And so I think that is why 
people are very concerned about where that definition goes 
because if it is drawn narrowly to catch whatever that next AIG 
might be, everybody is in agreement. Let us do that. And I 
think that Chairman Gensler today gave an indication that they 
would expect a fairly small number of entities to fall into 
that definition. So that is very helpful, but if it were 
defined more broadly, I think it would go beyond the intended 
purpose.
    The other thing is a couple things regarding AIG. First of 
all, with these data repositories which were in existence 
before Dodd-Frank, but obviously given greater relevance in 
Dodd-Frank, there is more information to the regulators about 
the exposures that are building up in the system, particularly 
in the credit default swap world. That is the most mature of 
these data repositories to date. So that information will be 
available to regulators around the world.
    There is also--because of the major swap participants, 
there is greater regulation of that entity. AIG was overseen by 
the Office of Thrift Supervision, but you know, obviously not 
every effectively and so that was one of the reasons that they 
had the problems that they did.
    There would also be greater use of collateral. Collateral 
was used by AIG, but its policies were such that it aggravated 
the situation in a sense, because it was not used from day one, 
it was only used when AIG was downgraded, which led to kind of 
cliff effects and liquidity effects for AIG.
    The other thing, just to mention, is the trades that they 
did there were very customized. They are not going to lend 
themselves to clearing via the CME platform, any of the other 
platforms that exist for clearing credit default swaps. It is 
more customized and therefore needs greater scrutiny by the 
regulator.
    Mr. Welch. Okay, thank you. I see my time has expired and I 
yield back. Thank you, Mr. Chairman.
    The Chairman. Thank you. Just a couple of questions to 
finish off with.
    Let me pose a question that I asked to Mr. Gensler with 
respect to these high frequency algorhythmic trading systems 
that are in exchange environments today. Will someone have an 
opportunity to do that in the exchanges that are being 
contemplated with respect to these derivatives? Anybody on the 
panel want to answer?
    Mr. Duffy. Well, the question being will the new products 
that are listed for trade, OTC products listed for trade, will 
the high frequency or algorhythmic trader have access to them, 
is that the question?
    The Chairman. Yes, I mean will we create a new arena for 
that technique to be used by pushing all these derivatives on 
an exchange----
    Mr. Duffy. I think we have to wait for the CFTC to come out 
with a definition of what a SEF is and who qualifies for a SEF, 
which is a swaps execution facility, which these products will 
be traded on. So, if the banks get to have their own SEF, I may 
not have access to it as a high frequency trader, because I may 
not meet their qualifications to trade on their SEF. I guess it 
is yet to be completely determined what a SEF is going to look 
like.
    The Chairman. Yes, but you have to push your side of the 
trade 15 seconds before you execute, doesn't that open up a 
window of opportunity for computer-driven mischief?
    Mr. Duffy. I don't believe so, no.
    Mr. Pickel. Mr. Chairman, I think that it really is a 
question--and I know Mr. Olesky will comment as well, he is 
ready to push the button. It really is a question of how these 
SEFs develop. I mentioned in my remarks at the opening that the 
number of trades done--and we are talking about standardized 
trades--2,000 standardized trades currently done around the 
world in the most liquid products, U.S. dollar swaps, 10 year 
swaps, maybe 400 over the course of a day around the world. So 
we are not at that kind of volume that would lend itself to 
that. Now if SEFs are successful and there are more 
transactions being done on those platforms, perhaps down the 
road, but that is certainly something I think we will have some 
time to see how it develops, although the definitions are 
certainly critical.
    The Chairman. Sure.
    Mr. Olesky. I would just add that this is a key point for 
us. We think it is incredibly important for market participants 
that the rules allow for sufficient flexibility to give the 
participants what they need. So if you are an end-user, if you 
are an asset manager, you need to be able to access liquidity 
in a way where it is not going to be impeded, where you can go 
and get your business done without interference. And that has 
been core to our position is that there should be real 
flexibility in the rules so that you have a variety of 
different places to execute these businesses on regulated 
markets, such as SEFs. But it is that flexibility that is key.
    The Chairman. Thank you. The cost estimates a year ago when 
Dodd-Frank was being kicked around versus the cost estimates 
today are dramatically different. In terms of your compliance, 
the CFTC's side, have you guys been able to make any kind of an 
analysis at this early stage as to where those increased costs 
are going to wind up versus the shrinking and spreads from the 
transparency that may occur? Who is going to--if we are just 
going to create more costs for no benefit, we ought to address 
that, obviously.
    Mr. Pickel. I think that that is yet to be determined. We 
have not done a thorough study. We did, at the time that the 
bill was passed, point out that because of the lack of clarity 
on the application of the margin requirements to end-users, 
potentially it could have under various assumptions and 
scenarios, cost end-users as much as $1 trillion. Now 
obviously, that is very----
    The Chairman. Subjective.
    Mr. Pickel.--different--well, it is based on some numbers 
and makes a certain amount of assumptions. We can share that 
with the Committee. But I think it is very important and 
noteworthy that the indication from Chairman Gensler today is 
that that will not be a requirement, so that is very helpful.
    The Chairman. Right. Mr. Gallagher, what are the--I am 
sorry, go ahead.
    Mr. Olesky. I was just going to--one quick point is that 
frankly the longer there is a lack of clarity and the longer 
the whole process goes on, the more expensive it is. So I can 
just say for our business it is a complex situation. We are 
building technology to try to be responsive, but all of us in 
the marketplace I think suffer from the uncertainty, and the 
longer it goes on, the more challenging it is and the more 
expensive it ends up being.
    The Chairman. All right, thank you for that.
    Mr. Gallagher, one of the center points for Dodd-Frank was 
to be able to identify systemic risk or systemic risk players 
in the market. Can you--would your co-op, in your mind, ever 
remotely be a systemic risk as a swap dealer, if you wind up 
being tagged with that definition? Can you create the kind of 
volume for your membership that would be a systemic risk as we 
understand that happening?
    Mr. Gallagher. I can't see DFA or Dairylea or for that 
matter, and probably any of the members of the national 
council, having enough volume to create systemic risk that we 
could cause any type of damage to the U.S. economy. I can't 
envision that right now.
    The Chairman. All right. Thank you, gentlemen, I appreciate 
it, Mr. Duffy, one last thing.
    Mr. Duffy. Just one comment on the cost side of this. A 
rush to judgment, I understand, can be even a bigger cost in my 
opinion than getting some clarity on this. I appreciate what 
the gentleman said about it is costing us--so we don't 
understand that, but if we don't get this right, I assure you 
the cost will be the least of our problems. If you looked at 
some of the announcements that happened yesterday between some 
of the major exchanges in Germany and coming into the U.S. to 
do a deal with the New York Stock Exchange, this is what I have 
been talking about for years with this Committee, about how 
business is going to go overseas, and this is another way they 
can do it, do it by mergers and acquisitions.
    So by getting these rules right, it is just as important as 
the cost burden today. Let us get the rules right so--to my 
testimony I would hope that this Committee would remind the 
CFTC that this is a very important rulemaking process.
    The Chairman. Well thank you. We are constantly--we will 
have another hearing next week. Just one word, in a 
conversation that the Ranking Member and I had with Mr. Gensler 
ahead of the meeting, he assured us that he had all the 
flexibility he needed for a common sense implementation phase. 
In other words, he has legal restrictions on creating the 
rules, but yet he has all the flexibility he needs to implement 
this in a way that makes sense. So be thinking about that 
statement that he made in y'all's analysis--he obviously has 
legal counsel that gets paid--you know, feeds his family making 
those judgments, but it would be helpful next week if you 
thought about--due to the fact they have--the law is in effect 
and the rules are going to be in place. You guys have to comply 
with them whether they get the rules right or not, and so you 
have the cost of doing business as a risk. You may or may not 
be able to lay off some swap market with another regulator that 
you have to comply with the law during this timeframe.
    So again, thank you all for coming. I appreciate your time, 
and with no other comments, we are adjourned.
    [Whereupon, at 1:00 p.m., the Committee was adjourned.]
    [Material submitted for inclusion in the record follows:]

                          Submitted Questions
Response from Hon. Gary Gensler, Chairman, Commodity Futures Trading 
        Commission *
---------------------------------------------------------------------------
    * There was no response from the witness by the time this hearing 
went to press.
---------------------------------------------------------------------------
Questions Submitted by Hon. K. Michael Conaway, a Representative in 
        Congress from Texas

Major Swap Participant
    Question 1. I believe that various companies are interested in 
understanding whether the Commission believes the hedging of financial 
or balance sheet risks are included in the definition of commercial 
risk. In particular, would the definition allow for the hedging of debt 
or duration mismatches? Are there particular hedging strategies that 
the Commission believed should be excluded?
    Question 2. Although the Commission proposed to subtract collateral 
when assessing whether a person has substantial position, the 
Commission also requested comment on whether collateral should indeed 
be excluded. It has been suggested to me that companies believe that 
posting collateral fundamentally reduces or eliminates a risk position. 
Do you affirm that it is appropriate for the Commission to have 
subtracted collateral?

Swap Dealer
    Question 3. As you may know, some end users, including non-
financial end users, centralize certain treasury functions, including 
hedging operations, out of one or more entities that execute trades 
with the dealer banks and then document an off-setting transaction with 
the affiliate entity or entities, under the same parent company, that 
require the hedge. I have been made aware that these end users have 
several concerns over whether these trades could subject them to a 
variety of new regulatory burdens, including the following:

    (1) The market-facing entity could be considered to be a swap 
        dealer;

    (2) The market-facing and inter-affiliate transactions could be 
        counted toward the major swap participant thresholds;

    (3) The inter-affiliate transactions could be subject to the 
        clearing and trading requirements; and

    (4) The inter-affiliate transactions could be subject to the 
        reporting requirements.

    Can you please comment on whether these inter-affiliate 
transactions will be treated the same as the market-facing 
transactions?

Swap Dealer
    Question 4. Do you intend to apply margin requirements to non-
cleared swaps that market participants have negotiated and entered into 
before Title VII becomes effective?
    Question 5. Is it the Commission's intent that margin requirements 
should apply to firms that are neither swap dealers nor major swap 
participants?
    Question 6. Do you believe that the Dodd-Lincoln letter and 
subsequent Frank-Peterson colloquy make clear Congress' intent with 
respect to whether margin should be imposed on end-users?


  HEARING TO REVIEW IMPLEMENTATION OF TITLE VII OF THE DODD-FRANK WALL
               STREET REFORM AND CONSUMER PROTECTION ACT

                              ----------                              


                       TUESDAY, FEBRUARY 15, 2011

                  House of Representatives,
 Subcommittee on General Farm Commodities and Risk 
                                        Management,
                                  Committee on Agriculture,
                                                   Washington, D.C.
    The Subcommittee met, pursuant to call, at 1:00 p.m., in 
Room 1300, Longworth House Office Building, Hon. K. Michael 
Conaway [Chairman of the Subcommittee] presiding.
    Members present: Representatives Conaway, Neugebauer, 
Schmidt, Gibbs, Huelskamp, Ellmers, Hultgren, Schilling, 
Boswell, Kissell, McGovern, David Scott of Georgia, Courtney, 
Welch, and Sewell.
    Staff present: Tamara Hinton, John Konya, Kevin J. Kramp, 
Ryan McKee, Debbie Smith, Clark Ogilvie, and Jamie W. Mitchell.

OPENING STATEMENT OF HON. K. MICHAEL CONAWAY, A REPRESENTATIVE 
                     IN CONGRESS FROM TEXAS

    The Chairman. Good afternoon. We will start the hearing.
    Just for the witnesses' knowledge, we have votes called at 
approximately 1:20, but we will go through our opening 
statements and we will start with yours and then go vote. And 
then if you could please stay and wait, we will come back and 
resume the hearing as soon as we get clear of the votes.
    With that, good afternoon. Welcome to the first hearing of 
the Subcommittee on General Farm Commodities and Risk 
Management for the 112th Congress. I am honored to hold the 
gavel and look forward to a productive Congress.
    We are here today to continue examination of the impact of 
the multitude of new rules proposed by the Commodity Futures 
Trading Commission pursuant to the enactment of the Dodd-Frank 
Wall Street Reform and Consumer Protection Act.
    We have several new Members to the Subcommittee, and I am 
looking forward to their full participation.
    Dodd-Frank requires the promulgation of a extraordinary 
number of new regulations governing our financial markets, and 
much of that overhaul has fallen on the shoulders of leadership 
and staff of the CFTC to implement.
    To say that Congress has set high expectations for the CFTC 
is an understatement. For the Commission it means a dramatic 
expansion of authority and discretion over the markets under 
its control.
    Last week we focused on the process the Commission 
undertook and what data they utilized in drafting their 
proposals. Our work today, while similar, is focused on what 
these new rules mean to market participants.
    By the end of this hearing, I hope to have a better 
understanding of how much compliance will cost, what business 
practices will have to be altered, and how much the new 
regulatory burdens will impact economic growth. As discussed 
here last week, many Members of this Committee, including 
myself, remain worried about the burdens of these new rules on 
businesses and individuals alike.
    Chairman Lucas and I have repeatedly requested Chairman 
Gensler voluntarily to submit to the Committee the principles 
established in the President's recent Executive Order on 
approving regulation and regulatory review, which include 
comprehensive cost-benefit analysis and the use of both 
quantitative and qualitative data in rulemaking.
    For the time being, the Chairman has refused to fully 
embrace the President's call, citing a conflict with the law.
    Having examined his claims, I am uncertain how existing law 
precludes them from full compliance, but I will continue to 
request that the Commission adhere to the President's Executive 
Order in full rather than just in principle.
    I believe the law of unintended consequences is the 
hallmark of hastily considered rules and ill-conceived 
regulation. There is significant concern that the CFTC's 
process for implementing Dodd-Frank has been just that: Rules 
have been proposed in an irrational sequence; industry groups 
have complained that the CFTC has underestimated certain 
compliance costs by a factor of two or three and as much as 63 
for some; and the commissioners appear to be stretching the 
regulatory mandates far beyond the intent of Congress.
    I am pleased to welcome a broad spectrum of market 
participants this afternoon to share with us how they view the 
pending regulations and what their suggestions are for 
improving the process and the output of the CFTC rulemaking. 
Also with our witnesses today, Glenn English has submitted 
testimony to the Committee on behalf of the National Rural 
Electric Cooperative Association.
    I ask unanimous consent to insert that into the record.
    [The document referred to is located on p. 193.]
    The Chairman. For my own part, I have supported the CFTC's 
collaborative regulatory process. For over 30 years, the 
consultative light-handed principles-based approach to 
regulating the commodities and derivatives markets have served 
our nation well. In that time, new markets and new financial 
products have flourished, creating innovative ways for 
participants to plan for the future.
    Without question, these financial instruments have been a 
blessing to agriculture producers and manufacturers and many 
others. It is these business and investment strategies, those 
that were once novel but are today routine that this Committee 
must protect as we oversee the implementation of Dodd-Frank.
    In the last 10 years, our financial markets have grown more 
complex and participants in the market have grown more savvy. 
New financial instruments have unlocked capital and reduced 
risks for millions of investors. These innovations cannot be 
rolled back. Eliminating or restricting them will serve only to 
increase the relative costs of doing business in the United 
States. It is incumbent on this Committee to ensure that the 
rules proposed by the CFTC are not overly burdensome and do not 
choke off legitimate financial instruments with onerous rules 
or heavy compliance costs.
    I look forward to this opportunity to hear from our 
panelists today as we discuss the many rules proposed by the 
CFTC over the past year. I hope they can each share with us 
where the Commission did it right and where our panelists think 
the commissioners need to go back and rewrite their proposals.
    Thank you each for being here today, and I look forward to 
an informative and productive hearing.
    With that, I ask the Ranking Member for his comments.

OPENING STATEMENT OF HON. LEONARD L. BOSWELL, A REPRESENTATIVE 
                     IN CONGRESS FROM IOWA

    Mr. Boswell. Thank you, and I have no quarrel with what you 
said. I could stop there, but I am going to make a couple of 
remarks.
    First off, I appreciate and congratulate you for having the 
chairmanship of this Committee, and I look forward to us 
continuing our work together, and I am confident we will.
    Just to reflect a little bit. You know, when we went 
through this debacle, if you will, we handled this bipartisanly 
with our bosses, our chairs and us together, we recognized it 
was a SEC challenge, not CFTC. And we think we somewhat brought 
that to daylight, and we are glad we were able to do that.
    But the goal of the legislation was and is to give 
transparency to the over-the-counter derivatives market and, at 
the same time, not to hinder the ability of folks like 
yourselves and those out there that I have said over and over 
and over that if I have a bias, it is towards that producer out 
there. And I guess I will confess that is still where it is. 
You have to be able to use the tools because it is so capital 
intensive. There is so much risk involved. So they have to have 
the tools. So I want us to do that. And I think that is our 
goal.
    And to meet the ends that are set forth in the Dodd-Frank 
legislation, the Title VII goals of transparency, we must--I 
think we have to have transparency. And I have said before I 
came into this environment and never intended to do it--maybe 
you have had it on your wish list; it wasn't on mine--but you 
know don't be afraid to put daylight on it, transparency. And 
if you are doing it right, keep doing it right. If you are not 
doing it right, then be courageous and make the adjustments.
    So I think we went through their process, and I think there 
is still some stuff right, I would guess, from the field, if 
you will. We are going to find some things that probably could 
be more right or not good. But your suggestions, your positive 
workable attainable suggestions that we can deal with is very 
important to what we want to do here.
    So I welcome the Committee and the witnesses and take us to 
school and just be straight with us. And I think you will. Just 
be straight with us. What do you really need to be transparent, 
and you know, you have to be competitive I understand that. But 
if we don't have anything to hide, then let us just get right 
out there and grow this country and grow those markets and do 
what we need to do. And actually, the CFTC has been pretty 
successful overall. And we need to remember that, too.
    So, with that, I yield back and look forward to what is 
next.
    [The prepared statement of Mr. Boswell follows:]

  Prepared Statement of Hon. Leonard L. Boswell, a Representative in 
                           Congress from Iowa

    I would like to thank everyone for joining us here today as we 
review the state of the implementation provisions of the Dodd-Frank 
Wall Street Reform and Consumer Protection Act. I would especially like 
to thank our witnesses today as this Committee looks forward to hearing 
your valuable insight.
    The goal of this legislation is to bring greater transparency to 
Wall Street and the over-the-counter derivatives markets. In doing so, 
we must ensure that we provide necessary oversight of these markets 
without hindering legitimate consumers from operating within them.
    In regulating over-the-counter derivatives, Congress made certain 
exceptions for end-users who utilize swaps to hedge risk and keep their 
businesses stable. I believe it is imperative that the regulations 
implemented reflect the true intent of Congress. Our goal should not 
punish the end-users who, like consumers, were victims in the financial 
crisis. Our efforts instead should focus on preventing the markets from 
being manipulated by a few players, and making sure that never again 
are American taxpayers left with the bill.
    To truly meet the ends set forth in the Dodd-Frank legislation and 
title seven's goals of transparency and competition, we must have 
transparency in our regulatory process and ensure that the rules and 
definitions fit the needs of the markets and stakeholders, and the aims 
of this legislation.
    I think all of us on this Subcommittee would agree that the CFTC 
and SEC must take the time to get this right. However, these 
commissions must also move quickly to ensure that individuals who use 
these markets for bona fide hedging purposes can have confidence that 
these markets are fair markets. Confidence in these markets is 
critical.
    I look forward to hearing from the witnesses today, and gathering 
insight and expertise on this issue from a variety of industries. I am 
committed to working with you and the Commissions to ensure the 
regulations being crafted regulate this market with efficiency and 
transparency without hindering its practical uses. Your thoughts and 
submitted comments on this matter are appreciated. Thank you.

    The Chairman. Thank you, Ranking Member.
    I, too, look forward to working with you on this Committee.
    I would ask unanimous consent to insert a letter from the 
National Cattleman's Beef Association, and National Corn 
Growers Association, and Natural Gas Supply Association into 
the record.
    [The documents referred to are located on p. 196.]
    The Chairman. With that, we now go to our witnesses.
    And our first is Shawn Bernardo, Managing Director of 
Americas Head of Electronic Broking, Tullett Prebon, and Vice 
Chairman, Wholesale Markets Brokers Association, Americas, 
Jersey City, New Jersey.
    Mr. Bernardo.

 STATEMENT OF SHAWN BERNARDO, MANAGING DIRECTOR, AMERICAS HEAD 
OF ELECTRONIC BROKING, TULLETT PREBON; VICE CHAIRMAN, WHOLESALE 
    MARKETS' BROKERS ASSOCIATION, AMERICAS, JERSEY CITY, NJ

    Mr. Bernardo. Chairman Conaway, Ranking Member Boswell, and 
Members of the Subcommittee. Thank you for providing me this 
opportunity to participate in today's hearing.
    My name is Shawn Bernardo. I am a Managing Director and a 
member of the Americas Executive Committee for Tullett Prebon, 
the leading global interdealer broker of over-the-counter 
financial products.
    I am also the Vice Chairman of the Wholesale Markets 
Brokers Association, Americas, an independent industry body 
whose membership includes the largest North American inter-
dealer brokers.
    Tullett Prebon's acts as intermediary in the wholesale 
financial markets where we execute trades on behalf of our 
customers. Our business covers a wide variety of products 
including U.S. Treasuries, interest rate derivatives, energy 
and credit, and offers voice, hybrid, and electronic broking 
solutions for these products.
    I am here today as a practitioner in the formation of 
liquidity, transparency, and execution in over-the-counter 
markets. I began my career in the inter-dealer broker industry 
in 1996 as a U.S. Treasuries broker. At that time, the U.S. 
Treasury market was brokered predominantly in an open outcry 
pit where trades were executed by voice commands.
    Today, the secondary market in U.S. Treasuries is an 
exclusively over-the-counter market but has evolved to include 
both electronic and voice trading and stands as an example as 
one of most liquid and efficient markets in the world.
    My experience as a broker allowed me to help create 
electronic broking systems for U.S. Treasuries and CDS Index 
products. And I have spent the vast majority of the past 15 
years building various electronic and hybrid broking platforms 
to promote more efficient markets.
    Title VII of the Dodd-Frank Act seeks to reengineer the 
U.S. swaps market on two key pillars: central counterparty 
clearing and mandatory execution of clearable trades through 
registered intermediaries, such as swap execution facilities, 
or SEFs. Wholesale brokers are today's essential marketplaces 
in the global swaps market and, as such, are the prototype of 
these new entities being called SEFs.
    We are experts in forcing liquidity and transparency in 
global swaps markets by utilizing trade execution methodologies 
that feature a hybrid blend of knowledgeable and qualified 
brokers as well as sophisticated electronic technology.
    Tullett and the WMBA support Dodd-Frank's attempts to 
ensure regulatory transparency and compliance but are concerned 
that the regulatory agencies may interpret these goals in such 
a way that hinders the creation of liquidity for market 
participants.
    Such a result will impose increased costs, particularly for 
end-users, or potentially render OTC derivatives markets 
ineffective for the purpose of hedging commercial risks.
    In considering appropriate regulations, it is important to 
remember that liquidity in today's swaps markets is 
fundamentally different than liquidity in futures and equities 
markets. While some swaps are standardized, the general deal 
flow for swaps is not continuous. Wholesale brokers' varied 
execution methodologies are specifically tailored to the unique 
liquidity characteristics of particular swaps markets. This is 
why Congress permits SEFs to execute trades through any means 
of interstate commerce.
    From the perspective of the inter-dealer broker community, 
it is critical that the regulators gain a thorough 
understanding of the many modes of execution currently deployed 
by wholesale brokers and then accommodate those methods and 
practices in their SEF rulemaking.
    While the Commissions and staffs of the relevant agencies 
have worked extremely hard and have been attempting to better 
understand these markets, because of the tight time frames 
mandated by the Dodd-Frank Act, regulators at the SEC and CFTC 
have not had sufficient time and/or opportunity to properly 
study and understand the unique nature of the markets they are 
now endeavoring to write rules on and regulate.
    As a result, too many of the SEC's and CFTC's proposed 
rules are derived directly from rules governing the equities 
and futures markets and are ill-suited for the fundamentally 
different liquidity characteristics of the swaps markets. I 
would suggest that there are four critical elements regulators 
need to get right.
    First, SEFs must be able to use the multiple modes of trade 
execution successfully used today to execute swap transactions. 
Second, the goal of pre-trade transparency must be realized 
through means that do not destroy market liquidity from market 
participants and end-users. Third, the final rules for 
derivatives clearing organizations must comply with the 
nondiscriminatory access provision of the Dodd-Frank Act. And 
finally, regulators need to carefully structure a public trade 
reporting regime that takes into account the unique challenges 
of fostering liquidity in a diverse range of swaps markets.
    I thank you for your time and look forward to answering any 
questions you may have.
    [The prepared statement of Mr. Bernardo follows:]

    Prepared Statement of Shawn Bernardo, Senior Managing Director,
  Americas Head of Electronic Broking, Tullett Prebon; Vice Chairman, 
    Wholesale Markets Brokers Association, Americas, Jersey City, NJ

    Chairman Conaway, Ranking Member Boswell and Members of the 
Subcommittee, thank you for providing this opportunity to participate 
in today's hearing.
    My name is Shawn Bernardo. I am a Senior Managing Director and a 
member of the Americas executive committee for Tullett Prebon, a 
leading global inter-dealer broker of over-the-counter financial 
products.\1\ I am also the Vice Chairman of the Wholesale Markets 
Brokers Association, Americas (the ``WMBAA''), an independent industry 
body whose membership includes the largest North American inter-dealer 
brokers.\2\
---------------------------------------------------------------------------
    \1\ Tullett Prebon (LSE: TLPR) (www.tullettprebon.com) is one of 
the world's largest inter-dealer brokers and operates as an 
intermediary in wholesale financial markets facilitating the trading 
activities of its clients, in particular commercial and investment 
banks. The business now covers seven major product groups: Rates, 
Volatility, Treasury, Non Banking, Energy and Commodities, Credit and 
Equities. Tullett Prebon Electronic Broking offers electronic solutions 
for these products. In addition to its brokerage services, Tullett 
Prebon offers a variety of market information services through its IDB 
Market Data division, Tullett Prebon Information. Tullett Prebon has 
its principal offices in London, New Jersey, Hong Kong, Singapore and 
Tokyo, with other offices, joint ventures and affiliates in Bahrain, 
Bangkok, Frankfurt, Houston (Texas), Jakarta, Luxembourg, Manila, 
Mumbai, New York, Paris, Seoul, Shanghai, Sydney, Toronto, Warsaw and 
Zurich.
    \2\ The WMBAA is an independent industry body representing the 
largest inter-dealer brokers (``IDBs'') operating in the North American 
wholesale markets across a broad range of financial products. The WMBAA 
and its member firms have developed a set of Principles for Enhancing 
the Safety and Soundness of the Wholesale, Over-The-Counter Markets. 
Using these Principles as a guide, the WMBAA seeks to work with 
Congress, regulators, and key public policymakers on future regulation 
and oversight of institutional markets and their participants. By 
working with regulators to make wholesale markets more efficient, 
robust and transparent, the WMBAA sees a major opportunity to assist in 
the monitoring and consequent reduction of systemic risk in the 
country's capital markets. The five founding members of the WMBAA are 
BGC Partners; GFI Group; ICAP; Tradition and Tullett-Prebon. More about 
the WMBAA can be found at: www.WMBAA.org.
---------------------------------------------------------------------------
    Tullett Prebon's business covers treasury products, fixed income, 
interest rate derivatives, equities, and energy products, and offers 
voice, hybrid, and electronic broking solutions for these products. 
Tullett also offers a variety of market information services through 
its inter-dealer broker market data division, Tullett Prebon 
Information.
    I began my career in the inter-dealer broker industry in 1996 as a 
U.S. Treasuries broker. As you may know, the secondary market in U.S. 
Treasuries traded exclusively over-the-counter, both electronically and 
via voice, and stands as an example of one of the most liquid and 
efficient markets in the world. My experience as a broker allowed me to 
help create electronic brokering systems for U.S. Treasuries and CDS 
Index products and I have spent the vast majority of the past 15 years 
building various electronic and hybrid brokering platforms to promote 
more efficient markets in Fixed Income, Energy, Credit, FX Options and 
Interest Rates.
    I welcome this opportunity to discuss with you implementation of 
the Dodd-Frank Wall Street Reform and Consumer Protection Act (``Dodd-
Frank'' or ``DFA'') from the perspective of the primary intermediaries 
of over-the-counter swaps operating today here in the United States and 
across the globe.
    In my written testimony, I plan to cover the following points:

   Wholesale brokers are today's central marketplaces in the 
        global swaps markets and, as such, are the prototype of swap 
        execution facilities or ``SEFs.''

   Wholesale brokers are experts in fostering liquidity and 
        transparency in global swaps markets by utilizing trade 
        execution methodologies that feature a hybrid blend of 
        knowledgeable and qualified brokers as well as sophisticated 
        electronic technology.

   Liquidity in today's swaps markets is fundamentally 
        different than liquidity in futures and equities markets and 
        the unique characteristics of this liquidity are what naturally 
        determine the optimal mode of market transparency and trade 
        execution.

   Wholesale brokers' methodologies for price dissemination and 
        trade execution are specifically tailored to the unique 
        liquidity characteristics of particular swaps markets.

   It is critical that regulators gain a thorough understanding 
        of the many modes of swaps trade execution currently deployed 
        by wholesale brokers and how these methods accommodate the 
        variety of markets in which we operate. In the extremely tight 
        time frames mandated by the DFA, regulators at the Securities 
        and Exchange Commission (``SEC'') and the Commodity Futures 
        Trading Commission (``CFTC'') have not had sufficient 
        opportunity to properly study and understand the unique nature 
        of the markets they are now endeavoring to write rules on and 
        regulate.

   As a result, too many of the SEC's and CFTC's Title VII 
        proposals seem to rely heavily on rules governing the equities 
        and futures markets and are ill-suited for the fundamentally 
        different liquidity characteristics of today's swaps markets.

   Three critical elements that regulators need to get right 
        under Title VII are:

     SEFs must not be restricted from deploying the many 
            varied and beneficial trade execution methodologies and 
            technologies successfully used today to execute swaps 
            transactions;

     The ``goal'' of pre-trade transparency must be 
            realized through means that do not destroy market liquidity 
            for market participants and end-users; and

     Regulators need to carefully structure a public trade 
            reporting regime that is not ``one size fits all'', but 
            rather takes into account the unique challenges of 
            fostering liquidity in the diverse range of swaps markets.

   As the WMBAA has proposed in formal comment letters with the 
        SEC and CFTC,\3\ a block trade standards advisory board (the 
        ``Swaps Standards Advisory Board'') should be established and 
        made up of recognized experts and representatives of registered 
        SDRs and SEFs to make recommendations to the SEC and CFTC for 
        appropriate block trade thresholds for swaps and security-based 
        swaps.
---------------------------------------------------------------------------
    \3\ See Comment Letter from WMBAA (January 18, 2011) (``1/18/11 
WMBAA Letter'').

   Congress can assist with technical corrections to Dodd-Frank 
        and, crucially, by providing regulators with adequate time and 
        resources to thoroughly understand the challenges and current 
---------------------------------------------------------------------------
        solutions to garnering trading liquidity in the swaps markets.

   Taking adequate time to get the Title VII regulations right 
        will expedite the implementation of the worthy goals of Dodd-
        Frank: central counterparty clearing and effective trade 
        execution by regulated intermediaries in order to provide end-
        users with more competitive pricing, increased transparency and 
        deeper trading liquidity for their risk management needs.

Background on Tullett Prebon and Wholesale Brokers
    My firm, Tullett Prebon, has a presence in over 20 countries and 
employs over 2,400 people. In the United States, we have operations in 
New York, New Jersey, Alabama, and Texas, employing nearly 500 brokers 
and 700 total employees at these locations. Tullett Prebon's history 
stretches back to 1868 in England as one of the first money brokers in 
the City of London and, though we have grown through various mergers 
over the years, we have maintained a proud tradition of brokering on 
behalf of our clients and providing transparency and liquidity in the 
over-the-counter markets through world-class expertise and service.
    We provide a marketplace for a relatively small number of 
sophisticated institutional buyers and sellers of OTC financial 
products where their trading needs can be matched with other 
sophisticated counterparties having reciprocal interests in a 
transparent, yet anonymous, environment. To persons unfamiliar with our 
business, I often describe interdealer brokers as something of a 
virtual trading floor where large financial institutions buy and sell 
financial products that are not suited to and, therefore, rarely trade 
on an exchange.
    As we sit here today, interdealer brokers are facilitating the 
execution of hundreds of thousands of OTC trades corresponding to an 
average of $5 trillion in notional size across the range of foreign 
exchange, interest rate, Treasury, credit, equity and commodity asset 
classes in both cash and derivative instruments. We are wholesale 
brokers (sometimes called ``inter-dealer'' brokers). WMBAA member firms 
account for over 90% of intermediated swaps transactions taking place 
around the world today. Our industry does not serve household or retail 
customers. Rather, we operate at the center of the global wholesale 
financial markets by aggregating and disseminating prices, providing 
price transparency and fostering trading liquidity for financial 
institutions around the world. The roots of our industry go back over a 
century in the world's major financial centers. Our activities in most 
of the markets we serve today are highly regulated.
    Wholesale brokers provide highly specialized trade execution 
services, combining teams of traditional ``voice'' brokers with 
sophisticated electronic trading and matching systems. As in virtually 
every sector of the financial services industry in existence over the 
past 50 years, wholesale brokers and their dealer clients began 
connecting with their customers by telephone. As technologies advanced 
and markets grew larger, more efficient, more diverse and global, these 
systems have advanced to meet the changing needs of the market. Today, 
we refer to this integration of voice brokers with electronic brokerage 
systems as ``hybrid brokerage''. Wholesale brokers, while providing 
liquidity for markets and creating an open and transparent environment 
for trade execution for their market participants, do not operate as 
single silo and monopolistic ``exchanges.'' Instead, we operate as 
competing execution venues, where wholesale brokers vie with each other 
to win their customers' business through better price, provision of 
superior market information and analysis, deeper liquidity and better 
service. Our customers include large national and money center banks 
and investment banks, major industrial firms, integrated energy and 
major oil companies and utilities.
    Increasingly, the efficiencies of the market have inevitably led to 
a demand for better trading technology. To that end, we develop and 
deploy sophisticated trade execution and support technology that is 
tailored to the unique qualities of each specific market. For example, 
Tullett Prebon's customers in certain of our more complex, less 
commoditized markets may choose among utilizing our 
tpCreditdealTM, tpEnergytradeTM, 
tpMatchTM or TradeBlade' electronic brokerage 
platforms to trade a range of fixed income derivatives, interest rate 
derivatives, foreign exchange options, repurchase agreements and energy 
derivatives entirely on screen or they can execute the same transaction 
through instant messaging devices or over the telephone with qualified 
Tullett Prebon brokers supported by sophisticated electronic 
technology. It is important to note that the migration of certain 
products to electronic execution was not and has never been because of 
regulatory or legal mandate but simply part of the natural evolution 
and development of greater market efficiencies in particular markets.
    The electronic platforms mentioned above serve our customers needs 
in various ways. Some of the platforms are hybrid where the customer 
has the choice of speaking with a broker to bid, offer or execute or 
the customer can execute directly on the screen. While other platforms 
are fully electronic and there is no broker intervention, the customers 
bid, offer and execute on their own behalf. These systems have evolved 
over time to meet the demands of the markets and need of the customers. 
At no time in my experience on Wall Street has there been a regulatory 
or legal mandate that helped these markets evolve. There are times when 
we have attempted to migrate markets onto an electronic system 
prematurely and were unsuccessful because the market was not ready.
    The critical point is that competition in the marketplace for 
transaction services has led interdealer brokers to develop highly 
sophisticated transaction services and technologies that are well 
tailored to the unique trading characteristics of the broad range of 
swaps and other financial instruments that trade in the over-the-
counter markets today. Unlike futures exchanges, we enjoy no execution 
monopoly over the products traded by our customers. Therefore, our 
success depends on making each of our trading methods and systems right 
for each particular market we serve. From our decades of competing for 
the business of the worlds' largest financial institutions, we can 
confirm that there is no ``one size fits all'' method of executing 
swaps transactions.

Fostering Liquidity in Swaps Markets
    The essential role of a wholesale broker is to enhance trading 
liquidity. In essence, liquidity is the degree to which a financial 
instrument is easy to buy or sell quickly with minimal price 
disturbance. The liquidity of a market for a particular financial 
product or instrument depends on several factors, including the 
parameters of the particular instrument such as tenor and duration of a 
swap, the degree of standardization of instrument terms, the number of 
market participants and facilitators of liquidity, and the volume of 
trading activity. Liquid markets are characterized by substantial price 
competition, efficient execution and high trading volume.
    While the relationship between exchange-traded and OTC markets 
generally has been complimentary, each market provides unique services 
to different trading constituencies for products with distinctive 
characteristics and liquidity needs. As a result, the nature of trading 
liquidity in the exchange-traded and OTC markets is often materially 
different. It is critically important that regulators recognize the 
difference.
    Highly liquid markets exist for both commoditized, exchange-traded 
products, and the more standardized OTC instruments, such as U.S. 
Treasury securities, equities and certain commodity derivatives. 
Exchange-traded markets provide a trading venue for the most 
commoditized instruments that are based on standard characteristics and 
single key measures or parameters. Exchange-traded markets with central 
counterparty clearing rely on relatively active order submission by 
buyers and sellers and generally high transaction flow. Exchange-traded 
markets, however, offer no guarantee of trading liquidity as evidenced 
by the high percentage of new exchange-listed products that regularly 
fail to enjoy active trading. Nevertheless, for those products that do 
become liquid, exchange marketplaces allow a broad range of trading 
customers (including retail customers) meeting relatively modest margin 
requirements to transact highly standardized contracts in relatively 
small amounts. As a result of the high number of market participants 
and the relatively small number of standardized instruments traded and 
the credit of a central counterparty clearer, liquidity in exchange-
traded markets is relatively continuous in character.
    In stark contrast, most swaps markets and other less commoditized 
cash markets feature a far broader offering of less-standardized 
products and larger-sized orders that are traded by far fewer 
counterparties, almost all of which are institutional and not retail. 
Trading in these markets is characterized by sporadic or non-continuous 
liquidity. To offer one simple example, of the over 4,500 corporate 
reference entities in the credit default swaps market, 80% trade less 
than five contracts per day.\4\ Such thin liquidity can often be 
episodic, with liquidity peaks and troughs that are often related to 
key events such as unemployment reports, meetings of the Federal 
Reserve and tied to external market economic and geopolitical 
conditions (e.g., many credit and interest rate products).
---------------------------------------------------------------------------
    \4\ ISDA & SIFMA, ``Block Trade Reporting for Over-the-Counter 
Derivatives Markets,'' January 18, 2011, (``ISDA/SIFMA Block Trade 
Study''). Available at http://www.isda.org/speeches/pdf/Block-Trade-
Reporting.pdf.
---------------------------------------------------------------------------
General Comparison of OTC Swaps Markets to Listed Futures Markets \5\
---------------------------------------------------------------------------
    \5\ See ISDA/SIFMA Block Trade Study.
    \6\ Inclusive of all tenors, strikes and duration.

------------------------------------------------------------------------
       Characteristic              OTC Swaps           Listed Futures
------------------------------------------------------------------------
Trading Counterparties        10s-100s (no         100,000s (incl.
                               retail)              retail)
Daily Trading Volume          1,000s               100,000s
Tradable Instruments          100,000s 6           1,000s
Trade Size                    Very large           Small
------------------------------------------------------------------------

    Drawing a simple comparison, the futures and equities exchange 
markets generally handle on any given day hundreds of thousands of 
transactions by tens of thousands of participants (many retail), 
trading hundreds of instruments in small sizes. In complete contrast, 
the swaps markets provide the opportunity to trade tens of thousands of 
instruments that are almost infinitely variable. Yet, on any given day, 
just dozens of large institutional counterparties trade only a few 
thousand transactions in very large notional amounts.
    The effect of these very different trading characteristics results 
in fairly continuous liquidity in futures and equities compared with 
limited or episodic liquidity in swaps. There is richness in those 
differences, because taken together, this market structure has created 
appropriate venues for trade execution for a wide variety of financial 
products and a wide variety of market participants. But the difference 
is fundamental and a thorough understanding of it must be at the heart 
of any effective rule making under Title VII of DFA. The distinct 
nature of swaps liquidity has been the subject of several studies and 
comment letters presented to the CFTC and the SEC.\7\
---------------------------------------------------------------------------
    \7\ ISDA/SIFMA Block Trade Study; Comment Letter of JPMorgan 
(January 12, 2011) (``JP Morgan Letter'').
---------------------------------------------------------------------------
    It is because of the limited liquidity in most of the swaps markets 
that they have evolved into ``dealer'' marketplaces for institutional 
market participants. That is, corporate end-users of swaps and other 
``buy side'' traders recognize the risk that, at any given time, a 
particular swaps marketplace will not have sufficient liquidity to 
satisfy their need to acquire or dispose of swaps positions. As a 
result, these counterparties may chose to turn to well capitalized 
sell-side dealers that are willing to take on the ``liquidity risk'' 
for a fee. These dealers have access to secondary trading of their 
swaps exposure through the marketplaces operated by wholesale and 
inter-dealer brokers. These wholesale marketplaces allow dealers to 
hedge the market risk of their swaps inventory by trading with other 
primary dealers and large, sophisticated market participants. Without 
access to wholesale markets, the risk inherent in holding swaps 
inventory would cause dealers to have to charge much higher prices to 
their buy side customers for taking on their liquidity risk, assuming 
they remain willing to do so.

Dodd-Frank Impact on Swaps Market Structure: Clearing and Competing 
        Execution
    Title VII of Dodd-Frank was an earnest and commendable effort by 
Congress to reform certain aspects of the OTC swaps market. The DFA's 
core provisions concerning swaps are: one, replacing bilateral trading 
where feasible with central counterparty clearing, and two, requiring 
that cleared swaps transactions between swaps dealers and major swaps 
participants be intermediated by qualified and regulated trading 
facilities, including those operating under the definition of ``Swap 
Execution Facilities (SEFs)'' through which ``multiple participants 
have the ability to execute or trade swaps by accepting bids and offers 
made by multiple participants in the facility or system, through any 
means of interstate commerce . . .'' \8\ These two operative provisions 
seek to limit the current market structure where swaps and the 
underlying counterparty risk may be traded directly between 
counterparties without the use of trading intermediaries or clearing, 
and to replace it for most transactions with a market structure in 
which a central clearing facility acts as the single counterparty to 
each market participant (i.e., buyer to each seller and seller to each 
buyer) and where those cleared transactions must be traded through SEFs 
and other intermediaries and not directly between the counterparties.
---------------------------------------------------------------------------
    \8\ See Commodity Exchange Act (``CEA'') Section 1a(50).
---------------------------------------------------------------------------
    In enacting these structural changes, DFA wisely rejected the anti-
competitive, single silo, exchange model of the futures industry, in 
which clearing and execution are intertwined thereby giving the 
exchange an effective execution monopoly over the products that it 
clears.\9\ Rather, by requiring central clearing counterparties to 
provide non-discriminatory access to unaffiliated execution facilities, 
DFA promotes a market structure in which competing SEFs and exchanges 
will vigorously compete with each other to provide better services at 
lower cost in order to win the execution business of sophisticated 
market participants. In this regard, DFA preserves the best competitive 
element in the existing swaps landscape: competing wholesale brokers.
---------------------------------------------------------------------------
    \9\ As the Justice Department observed in a 2008 comment letter to 
the Treasury Department, where a central counterparty clearing facility 
is affiliated with an execution exchange (such as in the case of U.S. 
futures), vertical integration has hindered competition in execution 
platforms that would otherwise have been expected to: result in greater 
innovation in exchange systems, lower trading fees, reduced ticket size 
and tighter spreads, leading to increased trading volume and benefits 
to investors. As noted by the Justice Department, ``the control 
exercised by futures exchanges over clearing services . . . has made it 
difficult for exchanges to enter and compete.'' In contrast to futures 
exchanges, equity and options exchanges do not control open interest, 
fungibility, or margin offsets in the clearing process. The absence of 
vertical integration has facilitated head-to-head competition between 
exchanges for equities and options, resulting in low execution fees, 
narrow spreads and high trading volume. See Comments of the Department 
of Justice before the Department of the Treasury Review of the 
Regulatory Structure Associated With Financial Institutions, January 
31, 2008. Available at http://www.justice.gov/atr/public/comments/
229911.htm.
---------------------------------------------------------------------------
    Tullett Prebon and the WMBAA members heartily support Dodd-Frank's 
twin requirements of clearing and intermediation. Their advocacy of 
swaps intermediation is fundamental to their business success in 
fostering liquidity, providing price transparency, developing and 
deploying sophisticated trading technology tools and systems and 
operating efficient marketplaces in global markets for swaps and other 
financial products.

Wholesale Brokers Will Serve as Responsible SEFs
    As noted, interdealer brokers actively deploy a range of execution 
services, technologies and other ``means of interstate commerce'' to 
display prices to ``multiple participants'' to connect them with other 
``multiple participants'' in billions of dollars of daily swaps trades. 
As such, wholesale brokers are the true prototype for prospective 
independent and competitive SEFs under DFA.
    More importantly, Tullett Prebon and other members of the WMBAA 
look forward to performing our designated roles as SEFs under DFA. The 
wholesale brokerage industry is working hard and collaboratively with 
the two Commissions to inform and comment on proposed rules to 
implement DFA. The WMBAA has submitted several comment letters \10\ 
(copies attached) and expects to provide further written comments to 
the CFTC and SEC. The WMBAA has also hosted the first conference, 
SEFCON 1 \11\, dedicated specifically to SEFs. Further, the WMBAA has 
conducted numerous meetings with Commissioners and staffs. We and the 
wholesale brokerage industry are determined to play a constructive role 
in helping the SEC and the CFTC to get the new regulations under Title 
VII of DFA right.
---------------------------------------------------------------------------
    \10\ See Comment Letter from WMBAA (November 19, 2010) (``11/19/10 
WMBAA Letter''); Comment Letter from WMBAA (November 30, 2010) (``11/
30/2010 WMBAA Letter''); 1/18/11 WMBAA Letter; Comment Letter from 
WMBAA (February 7, 2011) (``2/7/11 WMBAA Letter'').
    \11\ SEFCON 1 was held in Washington, D.C. on October 4, 2010. The 
keynote address was given by CFTC Commissioner Gary Gensler.
---------------------------------------------------------------------------
Three Critical Elements To Get Right
    There are many things to get right under DFA. Given that DFA 
requires all clearable trades to be transacted through an intermediary 
(either an exchange or a Swap Execution Facility), three critical 
elements are:

    1. Permitted Modes of Swaps Execution.

    2. Pre-Trade Price Discovery & Transparency for Market 
        Participants.

    3. Post-Trade Price Transparency & Reporting.

1. Permitted Modes of Execution
    As stated, DFA defines SEFs as utilizing ``any means of interstate 
commerce'' to match swaps counterparties. This is an appropriate 
allowance by Congress as the optimal means of interaction in particular 
swaps markets varies across the swaps landscape. Congress recognized 
that it was best left to the marketplace to determine the best modes of 
execution for various swaps and, thereby, foster technological 
innovation and development. Congress specifically did not choose to 
impose a Federally mandated ``one-size-fits-all'' transaction 
methodology on the regulated swaps market.
    As the swaps market has developed, it has naturally taken on 
different trading, liquidity and counterparty characteristics for its 
many separate markets. For example, in more liquid swaps markets with 
more institutional participants, such as certain U.S. Treasury, foreign 
exchange and energy products, wholesale brokers operate fully 
interactive electronic trading platforms, where counterparties can view 
prices and act directly through a trading screen and also conduct a 
range of pre- and post-trade activities like on-line price analysis and 
trade confirmation. These electronic capabilities reduce the need for 
actual voice-to-voice participant interaction for certain functions, 
such as negotiation of specific terms, and allow human brokers to focus 
on providing market intelligence and assistance in the execution 
process. And yet, even with such technical capabilities, the blend of 
electronic and voice assisted trading methods still varies for 
different contracts within the same asset class.
    In markets for less commoditized products where liquidity is not 
continuous, Tullett Prebon and its competitors provide a range of 
liquidity fostering methodologies and technologies. These include 
hybrid modes of: (a) broker work up methods of broadcasting completed 
trades and attracting others to ``join the trade'' and (b) auction-
based methods, such as matching and fixing sessions. In other swaps 
markets, brokers conduct operations that are similar to traditional 
``open outcry'' trading pits where qualified brokers communicate bids 
and offers to counterparties in real time through a combination of 
electronic display screens and hundreds of installed, always-open phone 
lines, as well as through other e-mail and instant messaging 
technologies. In every case, the technology and methodology used is 
well calibrated to disseminate customer bids and offers to the widest 
extent and foster the greatest degree of liquidity for the particular 
market.
    The WMBAA has been active in seeking to educate U.S. regulators 
about the multiple modes of execution utilized in the swaps markets 
today. We have given technology demonstrations to regulators in their 
offices and hosted tours of our New York brokerage operations to CFTC 
Commissioners O'Malia and Chilton. We are in the process of trying to 
schedule these educational tours for other CFTC and SEC Commissioners 
and staff who are actually writing the rules, the majority of whom have 
never seen an actual swaps trade transacted. We understand that budget 
constraints currently facing these agencies may be a hindrance for 
additional tours and demonstrations. Yet, we believe it is critical 
that the CFTC and SEC completely understand these markets and 
familiarize themselves with the many modes of execution currently 
deployed in the marketplace to accommodate the varying characteristics 
of different swaps markets before finalizing the rules governing trade 
execution.
    CFTC Commissioner Bart Chilton had this to say about a recent visit 
he made to one of the WMBAA member's New York brokerage floor, ``I was 
surprised by what I didn't know . . . Well, these are big, dynamic 
operations, not just a couple of guys in a back room with a phone. I 
don't think we have a full appreciation of the OTC markets yet.'' \12\
---------------------------------------------------------------------------
    \12\ Energy Metro DESK, February 7, 2011. p. 6. (``Chilton Desk 
Interview''). The article further states, ``Chilton says his trip . . . 
changed his opinion about SEFs and OTC transparency in general. He says 
the hybrid broker model (voice and screens) for example, which actually 
is the rule and not the exception around the market, was news to him.''
---------------------------------------------------------------------------
    It is vitally important that SEF rules promulgated by the CFTC and 
SEC encompass the many varied and beneficial trading methodologies that 
are used today to execute swaps in these very competitive swap markets. 
Under Dodd-Frank, Congress wisely permitted SEFs to utilize ``any means 
of interstate commerce'' to transact swaps. Congress recognized that 
restricting methods of execution of swaps instruments with non-
continuous liquidity could do substantial harm to the orderly operation 
of U.S. swaps markets overall, to the detriment of those market 
participants who need to manage risk. There is no basis in Dodd-Frank 
for regulations designed to restrict or promote any one component or 
other of the hybrid means of swaps execution utilized by wholesale 
brokers and SEFs. Moreover, we believe it would be detrimental to 
liquidity in the swaps markets for the CFTC or SEC to mandate unduly 
restrictive or prescriptive transaction methodologies. Similarly, we 
believe it would be harmful to liquidity for the CFTC or SEC to mandate 
swaps trading methodologies taken from the highly commoditized equities 
or futures markets that are inappropriate and ill suited for the 
multiple and varied U.S. swaps markets. We are highly concerned about 
seemingly artificial and arbitrary divisions between electronic and 
human-assisted modes of swaps execution that would be imposed under the 
CFTC's SEF proposals.
    The WMBAA is currently drafting comment letters on the CFTC and SEC 
SEF proposals. We will be happy to provide this Committee copies as 
soon as those letters are filed. At this stage we are concerned that 
the rules have not provided enough flexibility or sufficient guidance 
to ensure that all modes of trade execution utilizing ``any means of 
interstate commerce'' will be embraced, a very clear directive of the 
DFA. We believed this is rooted in a lack of sufficient exposure and 
understanding as to how trades are currently executed in the wholesale 
markets in a way that employs a wide array of technology to provide a 
vibrant and transparent market for ``multiple participants [to] have 
the ability to execute or trade swaps by accepting bids and offers made 
by multiple participants in the facility or system.''
    It is worth noting that European regulators do not appear to be 
considering rules with similarly proscriptive limits on trade execution 
methodology. We are not aware of any significant regulatory efforts in 
Europe to mandate electronic execution of cleared swaps by 
institutional market participants. In a world of competing regulatory 
regimes, business naturally flows to the market place that has the best 
regulations--not necessarily the most lenient, but certainly the ones 
that have the optimal balance of liquidity, execution flexibility and 
participant protections. In a market without retail participants, we 
question what useful protections are afforded to large institutions 
(required to transact swaps on SEFs) by proposed U.S. regulations that 
would limit the methods by which market participants may execute their 
orders. Rather, U.S. regulations need to be in harmony with regulations 
from foreign jurisdictions to avoid driving trading liquidity away from 
U.S. markets towards markets offering greater flexibility in modes of 
trade execution.

2. Pre-Trade Price Transparency
    The SEF provisions in Dodd-Frank contain a rule of construction for 
their operation: ``to promote pre-trade price transparency in the swaps 
market.'' \13\ Not surprisingly, interdealer brokers operate in 
furtherance of that goal. Our business model is driven by revenues from 
commissions paid on transactions. Our goal is to complete more 
transactions with more customers. Therefore, it is in each of our 
firm's economic interest to naturally and consistently disseminate 
trade bids and offers to the widest practical range of customers with 
the express purpose of price discovery and the matching of buyers and 
sellers. We employ a number of means of pre-trade transparency from 
software pricing analytics to electronic and voice price dissemination 
to electronic price work up technology. There is no reason we should be 
required to or would wish to curtail these transparency techniques upon 
qualification as SEFs. We endorse and currently promote the goal of 
pre-trade price transparency by providing market information by voice 
and electronic means to multiple market participants to create greater 
trading liquidity, the natural activity of intermediaries.
---------------------------------------------------------------------------
    \13\ See CEA Section 5h(e).
---------------------------------------------------------------------------
    We are concerned, however, that this pre-trade price transparency 
rule of construction not be used as the basis for the imposition of 
artificial and, somewhat, experimental restrictions on market activity. 
For example, the CFTC's SEF proposals require ``a minimum pause of 15 
seconds between entry of two potentially matching customer-broker swap 
orders or two potentially matching customer-customer orders'' \14\ 
(Referred to below as the ``15 Second Rule''). We are concerned that 
this provision could have a potentially devastating impact on liquidity 
in most swaps markets and we intend to address it in formal comments to 
the CFTC.
---------------------------------------------------------------------------
    \14\ Core Principles and Other Requirements for Swap Execution 
Facilities, 76 FR 1214 (January 7, 2011).
---------------------------------------------------------------------------
    As noted earlier, buy-side customers often look to swaps dealers to 
undertake the liquidity risk of trading in swaps for which there is 
non-continuous liquidity. Under DFA, the dealer would take on that risk 
by placing both the customer's sale order and the dealer's buy order 
into a SEF for execution. One adverse impact of the proposed 15 Second 
Rule may be that the dealer will not know until the expiration of 15 
seconds whether it will have completed both sides of the trade or 
whether another market participant will have taken one side. Therefore, 
at the time of receiving the customer order the dealer has no way of 
knowing whether it will ultimately serve as its customer's principal 
counterparty or merely as its executing agent. The result will be 
greater uncertainly for the dealer in the use of its capital and, 
possibly, the reduction of dealer activities leading, in turn, to 
diminished liquidity in and competitiveness of U.S. markets with 
detrimental results for buy-side customers and end-users.
    As a general matter, we note the conflict between, on the one hand, 
a rule of construction to promote pre-trade price transparency and, on 
the other hand, the express mandate under Dodd-Frank to allow delayed 
reporting of trade information for block trades because of the impact 
disclosure would have on liquidity in the market. In the first case, 
there are no operative provisions for pre-trade price transparency in 
Dodd-Frank that correspond to the non-binding rule of construction. In 
the second case, DFA specifically requires delayed reporting of block 
trades to preserve market liquidity and counterparty anonymity. We 
believe the specific DFA requirement for delayed block trade reporting 
takes precedence in implementation over the non-binding rule of 
construction to promote pre-trade transparency. We believe the 
Commissions should place great emphasis on complying with the operative 
requirements \15\ of Dodd-Frank regarding block trading, ensuring 
liquidity of markets and preserving anonymity of parties to a trade as 
they relate to public reporting of trade information and ensuring that 
those requirements are not conflicted in the arbitrary pursuit of a 
``goal'' of pre-trade transparency. We do not believe that the goal of 
pre-trade transparency justifies imposing on SEF's experimental trade 
execution mechanisms that are ill-suited for the unique characteristics 
of the swaps markets.
---------------------------------------------------------------------------
    \15\ Section 727 of the Dodd-Frank Act; Section 763(i) of the Dodd-
Frank Act.
---------------------------------------------------------------------------
3. Post-Trade Price Reporting & Transparency
    It is certainly true that the right measure of pre and post trade 
transparency can benefit market liquidity. Yet, it is also true that 
absolute transparency can harm liquidity. The objective must be to 
strike the right balance. The impact on market liquidity of the CFTC 
and SEC's proposals on swaps trade reporting and transparency depend on 
finding the right balance in the final rules governing large block 
trading. If the rules do not properly define block trade size and 
thresholds in the context of the unique characteristics of various 
swaps markets, then the trade reporting of blocks could negatively 
impact market liquidity, disturbing businesses' ability to hedge 
commercial risk, to appropriately plan for the future and, ultimately, 
stifle economic growth and job creation.
    Brokers have long recognized that in the less liquid swaps markets 
where a smaller number of primary dealers and market makers cross 
larger size transactions, the disclosure of the intention of a major 
institution to buy or sell could disrupt the market and lead to poor 
pricing. If a provider of liquidity to the market perceives greater 
danger in supplying liquidity, it will step away from providing tight 
spreads and leave those reliant on that liquidity with poorer hedging 
opportunities. From a market structure standpoint, liquidity ``takers'' 
benefit from liquidity providers acting in a competitive environment. 
The liquidity providers compete with each other, often deriving 
reasonably small profits per trade from a large volume of transactions. 
By relying on their ability to warehouse trades and post capital to 
make markets and using their distribution and professional know-how to 
offer competitive prices to their customer base, dealers and market 
makers provide liquidity essential to the execution of hedging and 
other risk management strategies.
    By imposing a regulatory regime where the market is quickly alerted 
whenever providers of liquidity take on risk, it becomes difficult for 
the risk takers to offset such risk without significant loss. The 
effect is greater risk, higher costs and, ultimately, less liquidity. 
Disseminating the precise notional amount of a particular large 
transaction could jeopardize the anonymity of the counterparties to 
such trades, making counterparties less willing to engage in 
transactions of size. Similarly, the effect of having no delay, or only 
a short dissemination delay, for a block trade report that includes the 
full notional size will discourage market makers from committing 
capital and providing liquidity to the broader market. For these 
reasons, having either no delay or a short dissemination delay will 
actually erode price discovery and the level of price efficiency in the 
market. We note and echo the concerns expressed by the Coalition for 
Derivatives End-Users that, ``An across-the-board 15 minute time delay 
that does not account for the instrument type and market conditions is 
too simplistic to be effective for the derivatives market.'' \16\
---------------------------------------------------------------------------
    \16\ Comment Letter from Coalition for Derivatives End-Users 
(February 7, 2011) (``2/7/11 Coalition Letter'').
---------------------------------------------------------------------------
    There are historical examples of markets that have sought to 
achieve full post-trade transparency without adequate block trade 
exemptions. The results were not positive. In 1986, the London Stock 
Exchange (``LSE'') enacted post trade reporting rules designed for 
total transparency with no exceptions for block sizes. What ensued was 
a sharp drop in trading liquidity as market makers withdrew from the 
market due to increased trading risk.\17\ The LSE thereafter engaged in 
a series of amendments to make its block trade rules more flexible and 
detailed over time.
---------------------------------------------------------------------------
    \17\ ISDA/SIFMA Block Trade Study, p. 8.
---------------------------------------------------------------------------
    Achieving the right balance in block trade rules for swaps markets 
requires recognition that the thresholds and reporting delay must be 
different by asset class and instrument and need to be tailored with 
the greatest of precision. A ``one-size-fits-all'' approach will not 
work. The elements of trade size, delay period and disclosed 
information set should be individually established based upon the 
unique liquidity requirements of particular instruments and markets. It 
is vitally important that block trade thresholds and reporting periods 
be matched properly to the markets to which they apply; otherwise, the 
markets will adversely adapt to arbitrary rules leading to all manner 
of dislocation and misuse.
    It is worth noting that the trade reporting regime that is often 
cited positively as a model for swaps trade reporting is the TRACE 
system for U.S. corporate bonds. That system was phased in over 3 
years. We believe that markets as complex as the swaps markets require 
at least as long a phase-in period to be cautious and make sure the 
formulas and mechanisms work properly. Furthermore, as with TRACE, 
during the phase-in period, there should be appropriate study of the 
effects on market liquidity, as required by the statute.
    We also note that because of the fundamental differences in 
liquidity in the swaps markets from those in the futures and equities 
markets, those markets provide inadequate and inappropriate models for 
the swaps markets for block trade calculations of size, content and 
time delay. As a result of the unique non-continuous nature of 
liquidity in certain swaps markets (with fewer participants), we 
believe that the CFTC and SEC need to carefully structure a public 
trade reporting regime that is not ``one size fits all'', but rather 
takes into account the unique challenges of fostering liquidity in the 
diverse range of swaps markets, provides for the transacting of larger 
transactions without unnecessary regulatory burdens, and does not 
materially reduce market liquidity.
    The WMBAA has proposed \18\ the formation of a block trade 
standards advisory board (the ``Swaps Standards Advisory Board'') made 
up of recognized experts and representatives of registered SDRs and 
SEFs to make recommendations to the Commissions for appropriate block 
trade thresholds for swaps and security based swaps. (Copy attached.) 
The WMBAA cites the role of existing CFTC advisory committees, such as 
the in Agricultural Advisory Committee, Global Markets Advisory 
Committee, Energy and Environmental Markets Advisory Committee, and the 
Technology Advisory Committee, which serve to receive market 
participant input and recommendations related to regulatory and market 
issues. While the Commission is authorized under Dodd-Frank to 
establish block trade standards on its own, we believe that a Swaps 
Standards Advisory Board, similar to the above-referenced advisory 
committees, could provide the Commission with meaningful statistics and 
metrics from a broad range of contract markets, SDRs and SEFs to be 
considered in any ongoing rulemakings in this area.
---------------------------------------------------------------------------
    \18\ 1/18/11 WMBAA Letter.
---------------------------------------------------------------------------
    A Swaps Standards Advisory Board would work with the Commissions to 
establish and maintain written policies and procedures for calculating 
and publicizing block trade thresholds for all swaps reported to the 
registered SDR in accordance with the criteria and formula for 
determining block size specified by the Commissions. The Swaps 
Standards Advisory Board would also undertake the market studies and 
research at industry expense that is necessary to help establish such 
standards. This arrangement would permit SEFs, as the entities most 
closely related to block trade execution, to provide essential input 
into the Commission's block trade determinations and work with 
registered SDRs to distribute the resulting threshold levels to SEFs. 
Further, the proposed regulatory structure would reduce the burden on 
SDRs, remove the possibility of miscommunication between SDRs and SEFs, 
and ensure that SEFs do not rely upon dated or incorrect block trade 
thresholds in their trade execution activities.

Areas Where Congress Can Help
    In this testimony, I have called on the CFTC and SEC to better 
understand the distinct nature of the swaps markets and not align their 
rulemaking with familiar and inappropriate models of the futures and 
equities markets simply because they do not have the time necessary to 
understand the unique nature of how the swaps market works due to the 
arbitrary time constraints set forth in the DFA. I have criticized a 
specific rule proposal (the 15 Second Rule) and arbitrary limits on 
SEFs' use of ``any means of interstate commerce'' to transact customer 
orders.
    I commend the two Commissions (SEC and CFTC) and their staffs for 
their evident good faith and determination. They are working very hard 
to get this right. I and many colleagues in the wholesale brokerage 
industry are optimistic that, given enough time, we can work with the 
regulators to fine tune rules regarding modes of intermediation, 
transparency and non-discrimination towards SEFs. That said, there are 
two areas where Congress can help.
    Time Frames: In proscribing specific rule promulgation dates, DFA 
did not give regulators enough time to complete an orderly 
transformation of the multi-trillion Dollar U.S. swaps market to a 
cleared and intermediated structure. The mandated time frames are just 
too tight to get the details right. CFTC Commissioner Scott O'Malia has 
called them ``unrealistic.'' \19\ They are indeed unrealistic and put 
an unreasonable burden on the staff of the regulatory commissions to 
sufficiently familiarize themselves with the workings of the OTC swaps 
markets. Yet, such familiarity and, indeed, expertise, is absolutely 
necessary since heretofore neither agency had direct regulatory 
authority or involvement with these markets. Without the time or the 
resources to understand these markets, each agency will have the 
natural tendency to fall back on the familiarity of the markets they 
already regulate. The CFTC's proposals rely heavily on the futures 
exchange market model and the SEC's rules more prone to a securities 
market model. Not only is the swap market and its diverse elements 
unique, but it is critically important that there be consistency 
between the two agencies. More time and resources would surely give 
both agencies a better chance to first, do no harm and second, reach 
the right outcome.
---------------------------------------------------------------------------
    \19\ Keynote Address by Commissioner Scott D. O'Malia at Tabb Forum 
Conference (January 25, 2011).
---------------------------------------------------------------------------
    Several days after viewing a WMBAA member's New York brokerage 
operations, CFTC Commissioner Bart Chilton put it thus in a speech: ``. 
. . We are also working, in the crafting of SEF rules, to ensure that 
we do not mess up platforms that are currently working well. This is a 
delicate balancing act, and we need to hear from market participants 
that have the expertise and interest in this area to make sure we get 
it right.'' \20\ Commissioner Chilton is exactly correct that in 
crafting SEF rules, regulators must better understand platforms that 
are currently working well so as not to mess them up.
---------------------------------------------------------------------------
    \20\ Speech of Commissioner Bart Chilton to the American Public Gas 
Association Winter Conference, Fort Myers, Florida, (February 1, 2011).
---------------------------------------------------------------------------
    What is needed is for Congress to give regulators the necessary 
time to understand more precisely those swaps platforms that are 
currently working well and discourage them from ``ready, fire, aim'' 
approach to the regulation. Commissioners like Bart Chilton and 
responsible regulators must have the opportunity to better consider how 
existing intermediaries function, how they deploy technology, how they 
promote price transparency and how they use many means of execution to 
connect multiple to multiple market participants. From an understanding 
of the effectiveness of these systems for the markets they serve, 
regulators may gain comfort to more fully endorse working execution 
models rather than having to impose artificial models or those from 
distinct markets. Market research and further studies may be required 
to provide the thorough knowledge necessary to craft workable, 
effective and appropriate rules and regulations, and this will take 
time.
    If regulators are given sufficient time and, frankly, resources to 
craft SEF rules that are well tailored to the existing trading methods 
in the swaps markets, a benefit may be a shorter and more effective 
implementation period by the swaps industry. Rushing the rules will 
make implementation slower, harder and more costly. Taking the time to 
make the rules reflect the way the swaps markets actually work will 
speed implementation and save money. As the adage goes, ``Measure 
twice, cut once.''
    Industry Efforts: Second, DFA failed to dot a few `i's and cross a 
few `t's. For example, Dodd-Frank sets up a framework of competing SEFs 
and DCMs, yet in its core principles requires that each SEF monitor and 
enforce counterparty position limits and manipulative trading 
practices.\21\ The requirement presumes that each SEF has sufficient 
market and customer knowledge to comply. However, as competing 
execution facilities, SEFs will rarely handle or be aware of a 
counterparty's entire trading activity, which will be directed most 
likely to numerous SEFs depending on best execution, price and 
liquidity. Because SEFs are not structured as Designated Clearing 
Organizations or Swap Data Repositories, they will have no way of 
knowing the aggregate position limits or composite trading strategies 
of their customers and will fail to comply with the respective Core 
Principles.
---------------------------------------------------------------------------
    \21\ CEA Section 5h(f)(6); See Section 733 of the Dodd-Frank Act.
---------------------------------------------------------------------------
    Another practical impossibility is presented by Core Principle 4 
which requires SEFs to monitor trading and trade processing.\22\ This 
requirement provides that when a swap is settled by reference to the 
price of an instrument traded in another venue the SEF must also 
monitor trading in the market to which the swap is referenced. In other 
words, a SEF that executes a trade of a credit default swap on a Ford 
Motor Company bond must also monitor trading in Ford Motor Company 
bonds. Yet, while SEFs certainly have the ability to monitor trades 
that they execute, they are not in a position to independently and 
effectively monitor positions and trading that takes place in other 
markets.
---------------------------------------------------------------------------
    \22\ CEA Section 5h(f)(4); See Section 733 of the Dodd-Frank Act.
---------------------------------------------------------------------------
    As the CFTC states on their website \23\ regarding their trade 
surveillance program, only it can ``consolidate data from multiple 
exchanges and foreign regulators to create a seamless, fully-surveilled 
marketplace'' due to the Commission's unique space in the regulatory 
arena. The surveillance ``requires access to multiple streams of 
proprietary information from competing exchanges, and as such, can only 
be performed by the Commission or other national regulators''. The CFTC 
correctly states that the surveillance ``can not be filled by foreign 
and domestic exchanges offering related competing products'', and there 
is no reason to believe a SEF would be better situated. And yet, unless 
each SEF fills this sort of surveillance function, it will be in 
violation of SEF core principles.
---------------------------------------------------------------------------
    \23\ CFTC Market Surveillance Program. Available at http://
www.cftc.gov/IndustryOversight/MarketSurveillance/
CFTCMarketSurveillanceProgram/tradepracticesurveillance.html.
---------------------------------------------------------------------------
    A further issue is that SEFs ideally should be able to delegate 
relevant functions to a self-regulatory organization (``SRO''). 
Unfortunately DFA does not expressly contemplate such delegation as, 
for example, the CEA permits for other types of registered 
entities.\24\ Further, it is not clear that even if permitted, SEFs 
would voluntarily delegate responsibilities to the existing SROs.
---------------------------------------------------------------------------
    \24\ See 7 U.S.C.  7a-2(b).
---------------------------------------------------------------------------
    What is clear is that the proposed SEF rules create a host of new 
obligations for SEFs, as well as for the CFTC and the SEC. It also 
appears that the SEC and CFTC lack the resources necessary to implement 
and enforce the new rules. And if projections of 50-100 SEFs are 
correct, a new regulatory structure to facilitate compliance by SEFs 
with the applicable laws and regulations will need to be developed.
    To address some of these issues, the WMBAA proposes the 
establishment of a common regulatory organization (CRO) \25\ that will 
facilitate compliance with the core principles by each of its members 
as well as for any other SEF that agrees to follow its rules. The CRO 
would not itself have any direct regulatory responsibilities, but it 
would, by way of contractual obligations, assist its members by 
addressing compliance issues that are common to all SEFs. This solution 
would be industry and not taxpayer financed. However, this solution is 
not expressly authorized by DFA and would benefit from a Congressional 
mandate to confirm its utility.
---------------------------------------------------------------------------
    \25\ Distinguished from an SRO to avoid confusion with the legal 
and regulatory implications of an SRO.
---------------------------------------------------------------------------
Conclusion
    Dodd-Frank seeks to reengineer the U.S. swaps market on two key 
pillars: central counterparty clearing and mandatory intermediation of 
clearable trades through registered intermediaries such as SEFs. 
Wholesale brokers are today's central marketplaces in the global swaps 
markets and, as such, are the prototype of swap execution facilities.
    Liquidity in today's swaps markets is fundamentally different than 
liquidity in futures and equities markets and naturally determines the 
optimal mode of market transparency and trade execution. Wholesale 
brokers are experts in fostering liquidity in non-commoditized 
instruments by utilizing methodologies for price dissemination and 
trade execution that feature a hybrid blend of knowledgeable qualified 
voice brokers and sophisticated electronic technology. Wholesale 
brokers' varied execution methodologies are specifically tailored to 
the unique liquidity characteristics of particular swaps markets.
    It is critical that regulators gain a thorough understanding of the 
many modes of swaps trade execution currently deployed by wholesale 
brokers and accommodate those methods and practices in their SEF 
rulemaking. Too many of the SEC's and CFTC's Title VII proposals are 
based off of rules governing the equities and futures markets and are 
ill-suited for the fundamentally different liquidity characteristics of 
today's swaps markets.
    Regulators are undoubtedly working hard to put in place appropriate 
rules under Title VII. They have their work cut out for them and there 
are at least three critical elements for success:

    1. SEFs must not be restricted from deploying the many varied and 
        beneficial trade price dissemination and trade execution 
        methodologies and technologies successfully used today to 
        execute swaps.

    2. The ``goal'' of pre-trade transparency must be realized through 
        means that do not destroy market liquidity for market 
        participants and end-users.

    3. Regulators need to carefully structure a public trade reporting 
        regime that is not ``one size fits all'', but rather takes into 
        account the unique challenges of fostering liquidity in the 
        diverse range of swaps markets.

    Congress can assist with technical corrections to Dodd-Frank and, 
crucially, by providing regulators with adequate time and resources to 
thoroughly understand the challenges and current solutions to garnering 
trading liquidity in the swaps markets. Rushing the rule making process 
and getting things wrong will negatively impact market liquidity in the 
U.S. swaps markets, disturbing businesses' ability to hedge commercial 
risk, to appropriately plan for the future and, ultimately, stifle 
economic growth and job creation.
    Taking adequate time to get the Title VII regulations right will 
expedite the implementation of the worthy goals of Dodd-Frank: central 
counterparty clearing and effective trade execution by regulated 
intermediaries in order to provide end-users with more competitive 
pricing, increased transparency and deeper trading liquidity for their 
risk management needs. With Congress' help, and the input and support 
of the swaps industry, regulators can continue their dedicated efforts 
at well crafted rule making. If we are successful, our U.S. financial 
system, including the U.S. swaps markets, can once again be the well 
ordered marketplace where the world comes to trade.
    Thank you for your consideration. I look forward to answering any 
questions that you may have.

                              Attachments

November 19, 2010

Hon. Gary Gensler,
Chairman,
Commodity Futures Trading Commission,
Washington, D.C.

Hon. Mary Schapiro,
Chairman,
Securities and Exchange Commission,
Washington, D.C.

    Dear Chairmen Gensler and Schapiro,

    The Wholesale Markets Brokers Association, Americas (``WMBAA'' or 
``Association'') appreciates the opportunity to submit to the U.S. 
Commodity Futures Trading Commission (``CFTC'') and the U.S. Securities 
and Exchange Commission (``SEC'' and, collectively with the CFTC, the 
``Commissions'') general comments for your consideration. We appreciate 
the great efforts of both Commissions to implement regulations under 
Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection 
Act (``Dodd-Frank Act'') and are supportive of steps taken to ensure 
stability in over-the-counter (``OTC'') derivatives markets.
    As you and your fellow Commissioners discuss staff proposals for 
rules governing swap execution facilities and security-based swap 
execution facilities (``SEFs'') and other related issues, the WMBAA 
offers the following comments for your consideration.

Pre-trade Transparency
    The SEF provisions in the Dodd-Frank Act contain a rule of 
construction that the goal is, in part, ``to promote pre-trade 
transparency in the swaps market.'' Currently, the WMBAA member firms 
each operate trading facilities that thrive as competitive sources of 
liquidity because each facility naturally and consistently disseminates 
market information to all its participants, with the express purpose of 
matching buyers and sellers. As these fundamental principles are 
applied to the establishment of SEFs, which themselves permit multiple 
participants to accept bids and offers made by multiple participants in 
the facility, the notion of intermediaries providing market information 
to participants in an effort to create liquidity is one that the WMBAA 
recognizes as essential to the vitality of OTC derivatives markets.
    WMBAA members are supportive of providing information to their 
participants through multiple modes of communication, depending on the 
depth of liquidity and trading frequency of the asset class, to ensure 
access to competitive pricing for counterparties. Further, the WMBAA 
recognizes the required compliance with core principles that include a 
mandate to (i) establish and comply with trading procedures for 
entering and executing large notional swap or security-based swap 
transactions (block trades) traded on the facility and (ii) comply with 
the Commission-established time delay for reporting block trades. In 
addition, the provisions in the Dodd-Frank Act related to the public 
reporting of swap and security-based swap transaction data require 
that, with respect to the providing for the public availability of 
transaction and pricing data, rules promulgated by each Commission must 
protect the identity of counterparties and take into account whether 
public disclosure will materially reduce market liquidity. The WMBAA 
believes that the Commissions should work carefully to ensure that any 
reporting regime, whether for pre- or post-trade information, 
adequately protects these interests and does not jeopardize OTC 
derivatives as an effective source of liquidity.
    The WMBAA urges the Commissions to consider the difficulties 
associated with complying with pre-trade price transparency 
requirements, on the one hand, and delayed reporting of trade 
information for those transactions that qualify as block trades. The 
publication of pre-trade price information does not comport with the 
notion that, in certain instances, trade information should be reported 
on a delayed basis to protect trade information and counterparty 
anonymity. In addition, in reviewing the organization of the Dodd-Frank 
Act, the WMBAA respectfully submits that the block trade reporting 
delay, an obligation specifically enumerated in the Dodd-Frank Act, 
takes precedence in implementation when compared with the rule of 
construction provision which indicates that a goal of the legislation 
is to merely promote pre-trade transparency. For that reason, the WMBAA 
believes the Commissions should place great emphasis on complying with 
the ``requirements'' of Sections 727 and 763(i) with regard to block 
trading, ensuring liquidity of markets and preserving anonymity of 
parties to a trade as they relate to public reporting of trade 
information and ensuring that those requirements are not conflicted in 
the pursuit of a ``goal'' of pre-trade transparency as described in a 
rule of construction in the Dodd-Frank Act.

Multiple Modes of Execution
    A SEF, by definition, may facilitate the trading or execution of 
swaps and security-based swaps ``through any means of interstate 
commerce.'' The WMBAA strongly supports the use of electronic, voice 
and hybrid trading methods to bring parties together and foster a 
competitive OTC derivatives market. This flexibility allows U.S. 
markets to stay competitive, and provides greater options in servicing 
the needs of market participants. The WMBAA embraces technological 
advances that provide future advances in communication methods, 
furthering transparency and liquidity to as many market participants as 
is warranted.
    The availability of multiple modes of execution widens the scope of 
products which can be traded more frequently, broadening the base of 
buyers and sellers participating in even deeper markets. This increased 
trading activity results in higher trade volumes and more standardized 
transactions, which will ultimately bring more clearable trades, and 
thus accomplishing one of the primary objectives of the Dodd-Frank Act.

Nondiscriminatory Access to Clearing
    As competitive swap execution facilities, the WMBAA members firmly 
believe that the nondiscriminatory access to central clearinghouses 
provided by the Dodd-Frank Act is necessary to the foundation of 
competitive, liquid markets that provide affordable access to OTC 
derivatives products. Any restrictions imposed on market participants' 
access to clearing will result in disparate levels of transparency and 
preclude certain derivatives counterparties from the benefits of 
efficient markets.

Public Reporting of Transaction Data; Treatment of Block Trades
    As previously discussed, both Commissions are authorized to write 
rules to facilitate block trades. In general, the WMBAA is supportive 
of trade reporting for all trades as soon as technologically 
practicable. The Association believes that all trade reporting, 
regardless of size, should be reported to the swap data repositories.
    As interdealer brokers involved in the formulation and execution of 
large derivatives transactions between swap and security-based swap 
dealers, the distinction between block and non-block trades is vital to 
ensure OTC derivatives markets can continue to provide liquidity to and 
be a source for risk mitigation for businesses. Further, the CFTC and 
SEC need to carefully structure a clearing and reporting regime for 
block trades that protects counterparties' identities and provides for 
the transacting of larger transactions without unnecessary regulatory 
burdens.
    While the WMBAA believes that each asset class has a threshold 
amount that could be calculated and used to distinguish between typical 
and block trades, its primary concern is that the block trade exception 
be set at such a level that trading may continue without impacting 
market participants' ability to exit or hedge their trades. In 
addition, while the appropriate threshold amount will differ by asset 
class, the notion of a block trade involves more than merely the size 
of a transaction. A block trade is frequently assembled through a 
series of actions. The WMBAA believes it is appropriate to provide 
regulators with necessary market information for oversight purposes, 
but the public dissemination of incremental activity that would 
otherwise constitute a block trade could jeopardize identification of 
counterparties and materially reduce market liquidity, which does not 
comport with the reporting goals enumerated in the Dodd-Frank Act.
    Finally, the WMBAA is committed to any regulatory regime 
promulgated with electronic trade reporting requirements. As the 
WMBAA's member firms have historically demonstrated through successful 
Trade Reporting and Compliance Engine (``TRACE'') reporting, these 
firms have the capabilities to comply with any requirement for 
reporting swap and security-based swap transaction data as soon as 
technologically practicable. Further, WMBAA members are willing to 
report this information to any entity designated by each Commission, 
including a swap/security-based swap data repository or the Commission 
itself.

SEF Rule Enforcement
    In order to ensure that SEFs establish and enforce consistent rules 
with each other, it has been suggested that a self-regulatory 
organization (``SRO'') would be established (or contracted with) to 
ensure uniformity in investigations and enforcement. The WMBAA supports 
ensuring that competitive SEFs are equal in enforcing trading rules, 
but believes that any SRO must demonstrate adequate independence in its 
organization and enforcement of rules in order to carry out this 
important function. Furthermore, the WMBAA believes that while the 
regulatory compliance responsibility cannot be shifted from a SEF to a 
separate SRO, SEFs should be permitted to contract with an SRO to 
provide regulatory services to help ensure consistent application of 
rules under Core Principle number two.

Impartial Access
    The SEF core principles in the Dodd-Frank Act require SEFs to 
``establish and enforce trading, trade processing, and participation 
rules that will deter abuses and have the capacity to detect, 
investigate, and enforce those rules,'' including means ``to provide 
market participants with impartial access to the market [emphasis 
added].'' The WMBAA member firms fully expect that, under the Dodd-
Frank Act, each facility's participants should and will have impartial 
access to the facility.
    However, any expansion of the impartial access requirement beyond 
market participants should be considered to be outside of the text of 
the Dodd-Frank Act. Requiring that each SEF provide impartial access to 
other SEFs, which are intermediaries and not market participants, would 
have a stifling effect on competition, to the ultimate detriment of SEF 
participants. Because these trading platforms compete to offer superior 
service, technology, liquidity and commission prices to each other, 
allowing SEFs knowledge of each other's price quotes would allow 
facilities with lower quality services to exploit this information for 
their gain and potentially cause a ``race to the bottom.'' The end 
result would be that SEFs would only match the lowest common 
denominator with respect to facility characteristics, to the detriment 
of market participants who currently benefit from the fruits of a 
competitive marketplace. Rules implementing the SEF core principles 
should foster the environment of competitive, aggressive facilities to 
ensure affordable access to and readily-available liquidity for various 
asset classes. The WMBAA agrees that SEFs should provide ``impartial 
access'' to market participants, but not to competing SEFs.
    We would like to thank both of you, your fellow Commissioners, and 
the staffs at the Commissions for being so willing to consider our 
opinions and for conducting an open and transparent rulemaking process. 
We appreciate the opportunity to share our opinions with you and are 
available to discuss with you and your staffs at any time.
            Sincerely,

            
            

Hon. Michael Dunn, Commissioner, CFTC;
Hon. Jill Sommers, Commissioner, CFTC;
Hon. Bart Chilton, Commissioner, CFTC;
Hon. Scott O'Malia, Commissioner, CFTC;

Hon. Kathleen Casey, Commissioner, SEC;
Hon. Elisse Walter, Commissioner, SEC;
Hon. Luis Aguilar, Commissioner, SEC;
Hon. Troy Paredes, Commissioner, SEC.
                                 ______
                                 
November 30, 2010

Hon. Gary Gensler,
Chairman,
Commodity Futures Trading Commission,
Washington, D.C.

Hon. Mary Schapiro,
Chairman,
Securities and Exchange Commission,
Washington, D.C.

Re: Self-Regulation and Swap Execution Facilities

    Dear Chairman Gensler and Chairman Schapiro:

    As you know, on July 29, 2010, the Wholesale Markets Brokers' 
Association Americas \1\ (``WMBAA'') submitted to the Commodity Futures 
Trading Commission (``CFTC'') and the Securities and Exchange 
Commission (``SEC'') a Discussion Draft of Model Core Principles for 
Swap Execution Facilities (``SEFs''). Since then the SEC and CFTC have 
begun an ambitious process to write the rules to regulate the swaps 
marketplace, including rules necessary to regulate swap execution 
facilities and security based swap execution facilities (collectively 
referred to herein as ``SEFs.'')
---------------------------------------------------------------------------
    \1\ The Wholesale Markets Brokers' Association Americas (WMBA 
Americas) is an independent industry body representing the largest 
inter-dealer brokers (``IDBs'') operating in the North American 
wholesale markets across a broad range of financial products. The WMBA 
and its member firms have developed a set of Principles for Enhancing 
the Safety and Soundness of the Wholesale, Over-The-Counter Markets. 
Using these Principles as a guide, the Association seeks to work with 
Congress, regulators, and key public policymakers on future regulation 
and oversight of over-the-counter (OTC) markets and their participants. 
By working with regulators to make OTC markets more efficient, robust 
and transparent, the Association sees a major opportunity to assist in 
the monitoring and consequent reduction of systemic risk in the 
country's capital markets.
---------------------------------------------------------------------------
    The Dodd-Frank Act (``DFA'') establishes a series of core 
principles for SEFs that are in many cases the same or substantially 
the same as the core principles for designated contract markets. These 
include requirements to (i) establish, investigate and enforce rules, 
and (ii) monitor trading and obtain information necessary to prevent 
manipulation. Such requirements are typical for exchanges and self-
regulatory organizations.
    However, many of the entities that will seek to become registered 
as SEFs, including the WMBAA's members, are not exchanges. They operate 
today as futures commission merchants (``FCMs''), broker-dealers and, 
where applicable, as alternative trading systems (``ATS''). These 
entities are required to join and follow the rules of one or more self-
regulatory organizations, such as FINRA or the NFA, which together with 
the SEC and the CFTC, perform many of the regulatory functions assigned 
by DFA to SEFs. In fact, the regulatory status of a SEF seems to most 
closely resemble that of an ATS, which is defined as any organization, 
association, person, group of persons, or system that brings together 
purchasers and sellers of securities, but that does not (i) set rules 
governing the conduct of subscribers other than the conduct of such 
subscribers' trading on the alternative trading system; or (ii) 
discipline subscribers other than by exclusion from trading.\2\
---------------------------------------------------------------------------
    \2\ See 17 CFR  242.300(a)
---------------------------------------------------------------------------
    Ideally SEFs would be able to delegate relevant functions to an 
exchange or an SRO. Unfortunately DFA does not expressly contemplate 
such delegation as, for example, the Commodity Exchange Act permits for 
other types of registered entities.\3\ Further, it is not clear that 
even if permitted, SEFs would voluntarily delegate responsibilities to 
the existing SROs.\4\
---------------------------------------------------------------------------
    \3\ See 7 U.S.C.  7a-2(b).
    \4\ It is possible that SRO membership could indirectly be required 
if CFTC and SEC regulations were to require that SEFs also register as 
FCMs and broker-dealers. Such regulations, however, would have 
unintended consequences. First, it would create a conflicting web of 
overlapping responsibilities as SEFs reconcile their obligations under 
DFA with their obligations as members of the respective SROs. In 
addition, mandatory broker-dealer or FCM registration for SEFs would 
likely cause prospective SEFs to file new broker-dealer and FCM 
applications rather than use existing registered entities that would 
become subject to SEF regulations on ownership and conflicts of 
interest. If projections of 50-100 SEF applications are correct, and 
each SEF also files for registration as an FCM or broker-dealer, the 
result could cause as many as 200-400 regulatory applications 
associated with SEFs.
---------------------------------------------------------------------------
    However, it is clear that the new rules will create a host of new 
obligations for swap execution facilities, as well as for the CFTC and 
the SEC. It is also becoming clear that the SEC and CFTC lack the 
resources necessary to implement and enforce the new rules. And if 
projections of 50-100 SEFs are correct, it will become clear that a new 
regulatory structure to facilitate compliance by SEFs with the 
applicable laws and regulations will need to be developed.
    To address these issues, members of the WMBAA and possibly others 
propose to establish a common regulatory organization (``CRO'') \5\ 
that will facilitate compliance with the core principles by each of its 
members as well as for any other SEF that agrees to follow its rules. 
The CRO would not itself have any direct regulatory responsibilities, 
but it would, by way of contractual obligations, assist its members by 
addressing compliance issues that are common to all SEFs, including the 
following:
---------------------------------------------------------------------------
    \5\ Distinguished from an SRO to avoid confusion with the legal and 
regulatory implications of an SRO.

    1. establishing and maintaining model provisions for each SEF's 
        rule book that would be adopted by each of its SEF members with 
        regard to core principles on investigations, enforcement 
---------------------------------------------------------------------------
        authority, trade monitoring and obtaining information.

    2. on behalf of its members, enter into one or more regulatory 
        services agreements with existing SROs pursuant to which the 
        CRO will have the capacity to detect, investigate, and enforce 
        those rules for its members. These services would including:

      a. monitoring trading to prevent manipulation.

      b. enforcing position limitations.

      c. investigating possible violations of SEF, CFTC, SEC rules, or 
            other applicable laws.

      d. establishing a code of procedure for administering discipline 
            for rule violations and conducting hearings when necessary 
            to determine if a violation may have occurred.

    3. on behalf of its members, establish and enforce rules that will 
        allow the facility to obtain any necessary information from 
        other SEFs, other market participants and other markets to 
        perform any of the functions required by the core principles.

    4. Review associated persons of each SEF to ensure that that are 
        not statutorily disqualified to be associated with a SEF.

    Membership in the CRO would initially be open to any entity that 
intended to register as a SEF. Membership in this CRO would be 
voluntary, but members would be contractually bound to abide by the 
rules. Upon implementation of the CFTC and SEC rules, membership would 
become open to any entity that agreed to adopt the CRO's rules that was 
either registered with the SEC or CFTC as a SEF, or intended to file 
for registration with the SEC or CFTC to become a SEF.
    The benefits to creating a CRO are several. First, it creates a 
platform to ensure that certain key rules for SEFs are written fairly 
and establish a uniform standard of conduct. This in turn would also 
make it easier and more efficient for the SEC and CFTC to review 
potential SEF applications in accordance with the above mentioned core 
principles as any SEF that was a member of the CRO would agree to 
implement the model provisions for their rule books, and would agree to 
utilize the services offered by the CRO to aid with satisfying many of 
their obligations under the core principles. Moreover, by acting as an 
intermediary for compliance by its members, the CRO would simplify the 
CFTC's and SEC's oversight responsibilities for SEFs.
    Such a scheme would appear to be permissible under DFA, which 
provides SEFs with ``reasonable discretion'' in establishing the manner 
in which they comply with the core principles.\6\ Further, as a 
voluntary organization, the CRO would not necessarily need legislative 
or rule making authority to proceed. However the ambiguity caused by 
the lack of an express Congressional mandate suggests that some degree 
of authorization in the rulemaking process for a CRO would be desirable
---------------------------------------------------------------------------
    \6\ See 7 U.S.C.  7b-3(f)(1)(B).
---------------------------------------------------------------------------
    Otherwise the CRO could presumably be organized today with a 
mandate from its originating members to provide services in accordance 
with the core principles that could be implemented as soon as its 
members agree, and not necessarily wait for the implementation of the 
DFA (although any rules adopted may have to be revised to be consistent 
with the CFTC and SEC rules). It would start by drafting rules, 
identifying the resources, systems and agreements necessary to become 
operational and conducting preliminary discussions with NFA, FINRA or 
others to provide regulatory services where appropriate.
    The result would be an entity that could help address the operating 
issues created for SEFs by the DFA, and through the establishment of 
uniform standards for its members, make their investigation, 
surveillance and enforcement efforts more effective. It might also 
allow the SEC and CFTC to perform their oversight duties with respect 
to SEFs in a more efficient manner.
            Sincerely,

            
            
                                 ______
                                 
January 18, 2011

Elizabeth Murphy,
Secretary,
Securities and Exchange Commission,
Washington, D.C.

Re: Regulation SBSR--Reporting and Dissemination of Security-Based Swap 
Information (File Number S7-34-10)

    Dear Ms. Murphy:

    The Wholesale Market Brokers' Association, Americas (``WMBAA'' or 
``Association'') \1\ appreciates the opportunity to provide comments to 
the Securities and Exchange Commission (``SEC'' or ``Commission'') on 
the proposed Regulation SBSR--Reporting and Dissemination of Security-
Based Swap Information (``Regulation SBSR'') under the Securities 
Exchange Act of 1934 (``Exchange Act'').\2\
---------------------------------------------------------------------------
    \1\ The WMBAA is an independent industry body representing the 
largest inter-dealer brokers (``IDBs'') operating in the North American 
wholesale markets across a broad range of financial products. The WMBAA 
and its member firms have developed a set of Principles for Enhancing 
the Safety and Soundness of the Wholesale, Over-The-Counter Markets. 
Using these Principles as a guide, the WMBAA seeks to work with 
Congress, regulators, and key public policymakers on future regulation 
and oversight of over-the-counter (``OTC'') markets and their 
participants. By working with regulators to make OTC markets more 
efficient, robust and transparent, the WMBAA sees a major opportunity 
to assist in the monitoring and consequent reduction of systemic risk 
in the country's capital markets.
    \2\ See Regulation SBSR--Reporting and Dissemination of Security-
Based Swap Information, 75 Fed. Reg. 75208 (December 2, 2010).
---------------------------------------------------------------------------
Summary of Response
    As the Commission contemplates an appropriate regulatory regime for 
reporting and dissemination of security-based swap (``SBS'') 
information, the WMBAA believes it is incumbent upon the Commission to 
follow the direction given in section 13(m)(1)(E) of the Exchange Act, 
which requires that the Commission's rule providing for the public 
availability of SBS transaction and pricing data contain provisions 
that take into account whether public disclosure will materially reduce 
market liquidity. The WMBAA, as an association representing the largest 
inter-dealer brokers in OTC markets, believes that the impact of these 
rules on market liquidity is highly dependent on how the policy 
governing large block trading is finalized. If the policy governing 
block trades does not properly define such a trade, the WMBAA remains 
very concerned that possible rules related to the calculation of a 
block trade threshold and trade reporting could negatively impact 
market liquidity, disturbing businesses' ability to hedge commercial 
risk, to appropriately plan for the future and, ultimately, stifle 
economic growth and job creation.
    The WMBAA is pleased to offer its comments related to: (i) 
appropriate methods to calculate block trade thresholds; (ii) 
appropriate entities to calculate and publish block trade thresholds; 
(iii) post-trade dissemination of block trades; and (iv) the 
publication of market data by market participants.

Discussion of Proposed Regulation SBSR
    As interdealer brokers involved in the formulation and execution of 
large derivatives transactions between swap and security-based swap 
dealers, the distinction between block and non-block trades is vital to 
ensure OTC derivatives markets can continue to provide liquidity to and 
be a source for risk mitigation for end-users.
    It is important that the Commission recognize that OTC derivatives 
markets are different than financial markets that have significant 
retail participation.\3\ While the relationship between exchange-traded 
and OTC markets generally has been complimentary, as each market 
typically provides unique services to different trading constituencies 
for products with distinctive characteristics and liquidity needs, the 
nature of trading liquidity in the exchange-traded and OTC markets is 
fairly different. Liquidity is the degree to which a financial 
instrument is easy to buy or sell quickly with minimal price 
disturbance. The liquidity of a market for a particular financial 
product or instrument depends on several factors, including: the number 
of market participants and facilitators of liquidity, the degree of 
standardization of instrument terms, and the volume of trading 
activity.
---------------------------------------------------------------------------
    \3\ See, e.g., Comments from Yuhno Song, Merrill Lynch, (``I think 
one of the distinctions we have is a market that may be more smaller in 
retail based versus a market that is with far small number of 
participant and that's institutional based.'') Public Roundtable to 
Discuss Swap Data, Swap Data Repositories, and Real Time Reporting, 
September 14, 2010 (``Roundtable Transcript'') at 332-333. Available 
at: http://www.cftc.gov/ucm/groups/public/@swaps/documents/file/
derivative18sub091410.pdf.
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    Highly liquid markets exist for both commoditized, exchange-traded 
products, and more standardized OTC instruments, such as the market for 
U.S. treasury securities, equities and certain commodity derivatives. 
Exchange-traded markets provide a trading venue for fairly simple and 
commoditized instruments that are based on standard characteristics and 
single key measures or parameters. Exchange-traded markets rely on 
relatively active order submission by buyers and sellers and generally 
high transaction flow. These markets allow a broad base of trading 
customers meeting relatively modest margin requirements to transact 
standardized contracts in a relatively liquid market. As a result of 
the high number of market participants and the relatively small number 
of standardized instruments traded, liquidity in exchange-traded 
markets is relatively continuous in character.
    In comparison, many swaps markets feature a broader array of less-
commoditized products and larger-sized orders that are traded by fewer 
counterparties. Trading in these markets is characterized by variable 
or non-continuous liquidity. Such liquidity can be said to be episodic, 
with liquidity peaks and troughs that are seasonal (certain energy 
products) or more volatile and tied to external market conditions 
(certain credit products).
    As a result of the episodic nature of liquidity in certain swaps 
markets with fewer participants, we believe that the CFTC and SEC need 
to carefully structure a clearing and reporting regime for block trades 
that is not a ``one size fits all'' approach, but rather takes into 
account the unique challenges of fostering liquidity in the broad range 
of swaps markets, provides for the transacting of larger transactions 
without unnecessary regulatory burdens, and does not materially reduce 
market liquidity.

Formulation of Block Trade Threshold
    While the WMBAA believes that each asset class and each swaps 
instrument has a threshold amount that could be calculated and used to 
distinguish between typical and block trades, its primary concern is 
that the block trade exceptions be individually set for the unique 
liquidity requirements of the broad range of swaps instruments so that 
the process of completing a block trade is appropriately defined and 
trading may continue without adversely impacting market participants' 
ability to place, exit or hedge their trades.
    With respect to block trade thresholds, while the appropriate 
threshold amount will differ by asset class and instrument, the notion 
of a block trade involves more than merely the size of a transaction. 
The WMBAA member firms have witnessed an evolution in interdealer 
markets with the development of a process referred to as ``work-up.'' 
In this model, once a price is agreed for trading, the resultant trade 
is reported to market participants and they are offered the opportunity 
to join the trade and increase liquidity. Work-up enables traders to 
assess the markets in real-time and make real-time decisions on trading 
activity, without the fear of moving the market one way or another. It 
is vital that any block trade calculation recognize the role work-up 
plays in forming liquidity. This is done to allow the market to find 
the appropriate pricing levels to optimally complete the transaction 
without prematurely causing the market impact of a large block.
    The WMBAA believes it is appropriate to provide regulators with 
necessary market information for oversight purposes, but the public 
dissemination of incremental activity that would otherwise constitute a 
block trade could jeopardize identification of counterparties and 
materially reduce market liquidity, which does not comport with the 
reporting goals enumerated in the Dodd-Frank Wall Street Reform and 
Consumer Protection Act.\4\
---------------------------------------------------------------------------
    \4\ Pub. L. No. 111-203, H.R. 4173.
---------------------------------------------------------------------------
    Congress recognized the importance of tailored block trade 
thresholds specific to an asset class and instrument.\5\ The WMBAA 
advocates, as an example, a tiered solution for SBS classification and 
reporting. The first tier would include all ``social'' size trades, 
which must be reported immediately to market participants. The second 
tier would include trades that are a certain multiple of the ``social'' 
size, dependent on the maturity, underlying credit, and frequency of 
recent transactions in the specific instrument. Each of these 
transactions would be reported to a security-based swap data repository 
(``SDR'') within 15 minutes of trade execution. This, the WMBAA 
believes, would be acceptable to the market participants in as much as 
it would be less disruptive to their ability to place, hedge or exit 
positions. Finally, the WMBAA would suggest a third tier for trades 
greater than twice the amount of the block trade threshold, reported 
with an indication that an extremely large block trade was executed.
---------------------------------------------------------------------------
    \5\ Statement of Senator Blanche Lincoln (``The committee expects 
the regulators to distinguish between different types of swaps based on 
the commodity involved, size of the market, term of the contract and 
liquidity in that contract and related contracts, i.e.,, for instance 
the size/dollar amount of what constitutes a block trade in 10 year 
interest rate swap, 2 year dollar/euro swap, 5 year CDS, 3 year gold 
swap, or a 1 year unleaded gasoline swap are all going to be 
different.''). Senate Congressional Record S. 5921, July 15, 2010.
---------------------------------------------------------------------------
    Such a reporting regime would ensure market participants retain a 
level of transparency acceptable to successful trading. It is important 
to distinguish between public reporting to market participants and 
regulatory reporting through the SDR, which would be privy to complete 
trade information. By identifying an appropriate social size, the 
Commission would encourage additional market participants to post 
prices and provide liquidity on electronic platforms. This, in turn, 
would support the Commission's objective of increasing the number of 
market makers and bringing greater transparency into the swaps markets.

Block Trade Calculation and Publication
    Proposed Regulation SBSR contemplates that a registered SDR would 
be responsible for establishing and maintaining written policies and 
procedures for calculating and publicizing block trade thresholds for 
all security-based swap instruments reported to the registered SDR in 
accordance with the criteria and formula for determining block size as 
specified by the Commission.\6\ Under this framework, the Commission 
would specify the criteria and formula for determining block size based 
on the limited information provided to it consisting of SBS transaction 
data reported to an SDR for completed SBSs. Such information only 
provides a partial picture of the liquidity challenges of a particular 
SBS marketplace. There is other information, such as the size and 
quantity of bids and offers that do not result in completed 
transactions, that is available to security-based swap execution 
facilities (``SB SEFs'') as neutral intermediaries in the market.
---------------------------------------------------------------------------
    \6\ See 75 Fed. Reg. at 75287.
---------------------------------------------------------------------------
    The WMBAA believes that it is necessary to consider this more 
complete scope of information in calculating block trade thresholds 
that are truly appropriate for security-based swap markets. The WMBAA 
therefore proposes the formation of a block trade standards setting 
board (the ``Security-Based Swaps Standards Board'') made up of 
recognized experts and representatives of registered SDRs and SB SEFs 
to make recommendations to the Commission for appropriate block trade 
thresholds for SBSs.
    The Security-Based Swaps Standards Board would work with the 
Commission to establish and maintain written policies and procedures 
for calculating and publicizing block trade thresholds for all SBSs 
reported to the registered SDR in accordance with the criteria and 
formula for determining block size as specified by the Commission. The 
Security-Based Swaps Standards Board would also undertake market 
studies and research at its expense as is necessary to establish such 
standards. This arrangement would permit SB SEFs, as the entities most 
closely related to block trade execution, to provide essential input 
into the Commission's block trade determinations and work with 
registered SDRs to distribute the resulting threshold levels to SB 
SEFs. Further, the proposed regulatory structure would reduce the 
burden on SDRs, remove the possibility of miscommunication between SDRs 
and SB SEFs, and ensure that SB SEFs do not rely upon dated or 
incorrect block trade thresholds in their trade execution activities.
    Further, if there is more than one registered SDR for an asset 
class, it may prove difficult for the Commission to ensure that all 
registered SDRs calculate the same block trade thresholds for the same 
SBS instruments. In comparison, one common regulatory organization 
responsible for facilitating SB SEF compliance with core principles 
will be uniquely situated to prevent the problem posed by multiple 
SDRs, which becomes further exacerbated if there are multiple 
registered SDRs in the same asset class each with individual market 
data feeds that need to be aggregated to calculate block trade 
thresholds.
    The determination whether an SBS transaction is a block trade 
should reflect a risk-weighted basis, calculated on an instrument-by-
instrument basis. This threshold should be updated at an appropriate 
time interval, taking into account the unique liquidity characteristics 
and challenges of the market in which the instrument trades. Any 
formulaic approach to computing the thresholds from trade size or other 
population parameters should reflect the number of participants in the 
market, the frequency of trading activity (daily, weekly and monthly) 
and the average trade sizes and terms of the transactions.
    The established block trade threshold could be subject to gaming, 
particularly if the market perceives the threshold to be arbitrarily 
determined. However, if the block threshold accurately captures the 
risk and liquidity parameters related to trading activity, then gaming 
would be ineffective, and less likely to occur.
    With respect to inter-affiliate transactions or trades resulting 
from portfolio compression, the WMBAA believes that if the block 
thresholds are appropriately calculated, market participation will 
increase, resulting in additional transparency and markets that better 
serve the public interest. If the block trade levels allow market 
makers time to appropriately hedge the risk that they've committed 
capital to, then they will be better able to continue to provide 
liquidity.

Reporting of Block Trades
    The Commission remarks in the preamble to proposed Regulation SBSR 
that because the registered SDR, and not the reporting party, would 
have the responsibility to determine whether a transaction qualifies as 
a block trade, the reporting party would be required to report an SBS 
to a registered SDR or the Commission pursuant to the time frames set 
forth in Rules 901(c) and (d), regardless of whether the reporting 
party believes the transaction qualifies for block trade treatment. 
Proposed Regulation SBSR does not include a delay in reporting block 
trades to a registered SDR.\7\
---------------------------------------------------------------------------
    \7\ See id. at 75233.
---------------------------------------------------------------------------
    As noted in a previous letter, the WMBAA is supportive of trade 
reporting for all trades as soon as technologically practicable. The 
Association believes that all trade reporting, regardless of size, 
should be reported to the SDR. The WMBAA members each possess the 
technological capabilities to provide regulators with real-time 
electronic trade information for transactions executed in multiple 
financial markets.\8\
---------------------------------------------------------------------------
    \8\ See, e.g., Comments from Shawn Bernardo, Tullett Prebon 
Americas Corp., representing Wholesale Markets Brokers Association, 
(``All of the brokers have the capability to report trades to the 
regulators in a timely fashion . . . as far as TRACE is concerned, we 
have a track record of reporting those trades efficiently, and we have 
the systems in place to do that, along with the various means . . . we 
can do that voice, we can do it electronically, we can do it as hybrid 
as far as the execution, but we send those trades electronically to 
them in a timely fashion.'') Roundtable Transcript at 227-228.
---------------------------------------------------------------------------
    While the WMBAA believes that posting the full details of SB SEF-
executed transactions to market participants should be at the core of 
the SB SEF obligations, the reporting obligations of the SB SEF should 
reflect the information that the SB SEF possessed at the time of the 
transaction. The SB SEF should not have the primary reporting 
obligations. The SB SEF would likely not be privy to all of the terms 
required to be reported in accordance with proposed Regulation SBSR, 
such as, but not limited to: (i) contingencies of the payment streams 
of each counterparty to the other; (ii) the title of any master 
agreement or other agreement governing the transaction; (iii) data 
elements necessary to calculate the market value of the transaction; 
and (iv) other details not typically provided to the SB SEF by the 
customer, such as the actual desk on whose behalf the transaction is 
entered. Moreover, and quite critical, an SB SEF would not be in a 
position or necessarily have the capabilities to report life cycle 
event information. Indeed, even if an SB SEF were required to report 
the transaction details as the proposed regulation requires, something 
we do not think advisable, it would likely take at least 30 minutes to 
gather and confirm the accuracy of that information.
    Additionally, the post trade reporting requirements may have an 
adverse effect on liquidity, particularly with respect to larger 
transactions since the reporting of larger transactions will likely 
have the effect of causing participants to refrain from entering the 
market which those participants might not otherwise have done, 
adversely impacting the ability of the parties to the large transaction 
to mitigate the risks of that transaction by entering into separate, 
offsetting transactions. This could effect a party's ability to hedge 
its risks and mitigate the exposure of that legitimate hedge will be 
diminished, resulting in fewer transactions of that nature and 
potentially widening spreads, which in turn will increase end-user 
costs.
    Nevertheless, the WMBAA believes that trading counterparties with 
reporting obligations should be able to contract with a SB SEF to 
handle the reporting process without transferring their reporting 
obligations. This will put smaller counterparties with limited trading 
reporting technology in a less disadvantaged trading position to larger 
trading counterparties.

Dissemination of Block Trade Information
    Under proposed Regulation SBSR, a registered SDR must publicly 
disseminate a transaction report of an SBS that constitutes a block 
trade immediately upon receipt of information about the block trade 
from the reporting party. Under proposed Regulation SBSR, the market 
participants will learn the price, but not the size, of an SBS block 
trade in real-time. The transaction report must contain all of the 
information required under the real-time reporting rules, including the 
transaction ID and an indicator that the report represents a block 
trade. The SDR is required to publicly disseminate a complete 
transaction report for a block trade (including the transaction ID and 
the full notional size) as follows:

   If the SBS was executed on or after 05:00 Coordinated 
        Universal Time (``UTC'') and before 23:00 UTC of the same day 
        (which corresponds to 12:00 midnight and 6:00 p.m. EST), the 
        transaction report (including the transaction ID and the full 
        notional size) will be disseminated at 07:00 UTC of the 
        following day (which corresponds to 2:00 a.m. EST of the 
        following day).

   If the SBS was executed on or after 23:00 UTC and up to 
        05:00 UTC of the following day (which corresponds to 6:00 p.m. 
        until midnight EST), the transaction report (including the 
        transaction ID and the full notional size) will be disseminated 
        at 13:00 UTC of that following day (which corresponds to 8:00 
        a.m. EST of the following day).

    All block trades will have at least an 8 hour delay before the full 
notional size will be disseminated. The established cut-off time will 
be 23:00 UTC, which corresponds to 6:00 p.m. EST. Block trades executed 
on or after 05:00 UTC (which corresponds to midnight EST) and up to 
23:00 UTC (6:00 p.m. EST) will have to have their full notional size 
disseminated by 07:00 UTC, which corresponds to 2:00 a.m. EST. Under 
the proposed approach, block trades executed during a period that runs 
roughly from the close of the U.S. business day to midnight EST will 
have their full sizes disseminated by a registered SDR at a time that 
corresponds to the opening of business on the next U.S. day. If a 
registered SDR is in normal closing hours or special closing hours at a 
time when it will be required to disseminate information about a block 
trade pursuant to this section, the registered SDR must disseminate 
that information immediately upon re-opening.
    The WMBAA would suggest that disseminating the specific notional 
amount of a block could jeopardize the anonymity of the counterparties 
to such trades, making counterparties less willing to engage in 
transactions of size. Further, the effect of having no delay, or only a 
short dissemination delay, for a block trade report that includes the 
full notional size will discourage market makers from committing 
capital and providing liquidity to the broader market. From a market 
perspective, there is little gain from disseminating full notional size 
information. Consistent with the experiences from the implementation of 
the Financial Industry Regulatory Authority's Transaction Reporting and 
Compliance Engine (``TRACE''), which provides regulators with full 
trade information and publicly disseminates trades within a size range, 
the WMBAA believes the Commission should implement a public reporting 
methodology. This benefits market participants without exposing a 
trade's notional size, which protects counterparty anonymity, and 
preserves liquidity and price competition in the market.\9\
---------------------------------------------------------------------------
    \9\ See 75 Fed. Reg. at 75232, fn. 108. (``If the par value of the 
trade exceeds $5 million (in the case of investment grade bonds) or $1 
million (in the case of non-investment-grade bonds) the quantity 
disseminated by TRACE will be either ``5 million+'' or ``1 million+''. 
At no time will TRACE subsequently disseminate the full size of the 
trade. See TRACE User Guide, version 2.4 (last update March 31, 2010), 
at 50.'')
---------------------------------------------------------------------------
    Additionally, market participants will be wary of committing to 
larger sized transactions knowing the rapidity in which other 
participants will gain knowledge of these trades, leading to less 
liquidity for the dealer market, and ultimately for end-user 
participants. The WMBAA also believes that the public dissemination of 
block trades, as proposed, will allow some market participants to infer 
the identity of the parties to the transaction and materially reduce 
market liquidity.
    If a liquidity provider perceives greater danger in supplying 
liquidity, it will step away from providing tight spreads and leave 
those reliant on market maker liquidity with poorer hedging 
opportunities. From a market structure standpoint, liquidity ``takers'' 
benefit from liquidity providers acting in a competitive environment. 
The liquidity providers compete with each other, often deriving very 
small profits per trade from a large volume of transactions. By relying 
on their ability to warehouse trades and post capital to make markets 
and using their distribution and professional know-how to offer 
competitive prices to their customer base, market makers provide 
liquidity essential to fulfill the need of hedgers. For these reasons, 
having either no delay or a short dissemination delay will actually 
erode price discovery and the level of price efficiency in the market.

Publication of Market Data
    Proposed Regulation SBSR contemplates that no person other than a 
registered SDR can make available to one or more persons (other than a 
counterparty) transaction information relating to an SBS before the 
earlier of 15 minutes after the time of execution of the security-based 
swap, or the time that a registered SDR publicly disseminates a report 
of that security-based swap.\10\ The preamble indicates that other 
private sources of market data reflecting subsets of the security-based 
swaps market could arise. The Commission remarks in the preamble to 
proposed Regulation SBSR that SB SEFs would have information about SBSs 
executed on its systems and could find that commercial opportunities 
exist to sell such information.\11\ In a related release, the 
Commission's proposed regulation concerning Security-Based Swap Data 
Repository Registration, Duties, and Core Principles does not 
specifically address commercial use of SBS data.\12\ However, under 
proposed 17 CFR  240.13n-4(c)(3)(iii) the third core principle--rules 
and procedures for minimizing and resolving conflicts of interest--
requires an SDR to establish, maintain and enforce policies and 
procedures regarding the SDR's non-commercial and/or commercial use of 
SBS data.\13\ In connection with the preamble discussion of this 
requirement, the SEC makes several requests for comment on an SDR's 
commercial use of data.\14\
---------------------------------------------------------------------------
    \10\ See 75 Fed. Reg. at 75286.
    \11\ See id. at 75242, fn. 153.
    \12\ See Security-Based Swap Data Repository Registration, Duties, 
and Core Principles, 75 Fed. Reg. 77306 (December 10, 2010).
    \13\ See id. at 77369.
    \14\ See id. at 77325-26.
---------------------------------------------------------------------------
    The WMBAA member firms will report the required SBS transaction 
information to a registered SDR in the mandated time frame as set forth 
in Commission regulations. However, the provisions of such information 
to SDRs should be for the specific and limited purpose of the SDR 
fulfilling specific regulatory requirements (reporting data to 
regulators for regulatory oversight and enforcement, public reporting 
of trade information as specifically prescribed by the Commission). 
Reporting such data to an SDR by a reporting entity (e.g., an SB SEF or 
any other party reporting the transaction information) should not 
relinquish ownership of such data by the SB SEF or other reporting 
entity and would also not inhibit its right to use the data for other 
purposes. Consistent with reporting practices in other markets, the 
reporting of SBS transaction information to a registered SDR should not 
bestow the SDR with the authority to use the SBS transaction data for 
any purpose other than those explicitly enumerated in the Commission's 
regulations.
    The WMBAA is concerned that proposed rules inhibit an SB SEF's 
ability to continue to have ownership and control over its data and the 
ability to sell that data to the marketplace. The WMBAA would suggest 
that Section 242.902(d) of proposed Regulation SBSR be revised in such 
a way that an SDR would accept and maintain SBS transaction data for 
use by regulators, but the SBS counterparties and SB SEFs continue to 
have the ability to market and commercialize their own proprietary 
data. This could be achieved, in part, by requiring SDRs to include 
such a provision in its required policies and procedures regarding the 
SDR's non-commercial and/or commercial use of SBS data required to be 
established, maintained and enforced by the Commission's proposed SDR 
rules. Ultimately, the WMBAA urges the Commission to take caution in 
implementing a regulation that could be inconsistent with existing 
models in equity and futures markets and might prevent entities with 
the necessary technological capabilities from capturing, publishing, 
and monetizing data for purposes outside of regulatory oversight.

Conclusion
    The WMBAA thanks the Commission for the opportunity to comment on 
the proposed Regulation SBSR. Please feel free to contact the 
undersigned with any questions you may have on our comments.
            Sincerely,
            
            
                                 ______
                                 
February 7, 2011

David A. Stawick,
Secretary,
Commodity Futures Trading Commission,
Washington, D.C.

Re: Real-Time Public Reporting of Swap Transaction Data (RIN 3038-AD08)

    Dear Mr. Stawick:

    The Wholesale Market Brokers' Association, Americas (``WMBAA'' or 
``Association'') \1\ appreciates the opportunity to provide comments to 
the Commodity Futures Trading Commission (``CFTC'' or ``Commission'') 
on the proposed rules related to the real-time public reporting of swap 
transaction data (``Proposed Rules'') \2\ under the Commodity Exchange 
Act (``CEA'').
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    \1\ The WMBAA is an independent industry body representing the 
largest inter-dealer brokers (``IDBs'') operating in the North American 
wholesale markets across a broad range of financial products. The WMBAA 
and its member firms have developed a set of Principles for Enhancing 
the Safety and Soundness of the Wholesale, Over-The-Counter Markets. 
Using these Principles as a guide, the WMBAA seeks to work with 
Congress, regulators, and key public policymakers on future regulation 
and oversight of over-the-counter (``OTC'') markets and their 
participants. By working with regulators to make OTC markets more 
efficient, robust and transparent, the WMBAA sees a major opportunity 
to assist in the monitoring and consequent reduction of systemic risk 
in the country's capital markets.
    \2\ See Real-Time Public Reporting of Swap Transaction Data, 75 
Fed. Reg. 76140 (December 7, 2010).
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Summary of Response
    As the Commission contemplates an appropriate regulatory regime for 
reporting and dissemination of swap information, the WMBAA believes it 
is incumbent upon the Commission to follow the direction given in 
Section 2(a)(13)(E) of the CEA, which requires that the Commission's 
rule providing for the public availability of swap transaction and 
pricing data contain provisions that take into account whether public 
disclosure will materially reduce market liquidity. The WMBAA, as an 
association representing the largest inter-dealer brokers in OTC 
markets, believes that the impact of these rules on market liquidity is 
highly dependent on how the policy governing large block trading is 
finalized. If the policy governing block trades does not properly 
define such a trade, the WMBAA remains very concerned that possible 
rules related to the calculation of a block trade threshold and trade 
reporting could negatively impact market liquidity, disturbing 
businesses' ability to hedge commercial risk, to appropriately plan for 
the future and, ultimately, unnecessarily inhibit economic growth and 
competitiveness.
    The WMBAA is pleased to offer its comments related to: (i) the 
importance of a harmonized regulatory regime for execution facilities; 
(ii) methods to calculate block trade thresholds; (iii) appropriate 
entities to calculate and publish block trade thresholds; and (iv) time 
delays for post-trade dissemination of block trade information.

Importance of Harmonized Regulatory Regime
    Several differences exist between the SEC's Proposed Regulation 
SBSR--Reporting and Dissemination of Security-Based Swap 
Information,\3\ and the CFTC's Proposed Rule. While the WMBAA does not 
strongly support one Commission's proposed approach in its entirety 
over the other, as entities likely to register as swap execution 
facilities (``SEFs'') with the CFTC and security-based SEFs with the 
SEC, respectively, it is important that the framework for block trade 
calculation, reporting, and dissemination are consistent between the 
two agencies and do not unreasonably burden market participants with 
duplicative compliance requirements. The WMBAA does, however, believe 
that the framework ultimately adopted should provide sufficient 
discretion for market participants. In this regard, the WMBAA believes 
the CFTC's Proposed Rules are more prescriptive when compared with the 
SEC's proposed rules.
---------------------------------------------------------------------------
    \3\ See Regulation SBSR--Reporting and Dissemination of Security-
Based Swap Information, 75 Fed. Reg. 75208 (December 2, 2010).
---------------------------------------------------------------------------
    The WMBAA encourages the use of block trade calculation provisions 
that provide deference to the SEF in determining what constitutes a 
block trade, which is most explicitly suggested in the SEC's proposed 
rules for security-based SEFs.\4\ The SEC's proposed rules define the 
term block trade in a way that gives each security-based SEF the 
authority to set the criteria and formula for determining what 
constitutes a block trade, as long as such criteria and formula comply 
with the core principles relating to security-based SEFs (until the SEC 
sets the requisite criteria).\5\ This approach allows the necessary 
time and flexibility for the markets to establish the appropriate 
criteria and formula based on actual trading on security-based SEFs in 
each security-based swap category and should be considered by the 
Commission for its corresponding rules.
---------------------------------------------------------------------------
    \4\ See Registration and Regulation of Security-Based Swap 
Execution Facilities, Release No. 34-63825, File No. S7-06-11. 
Available at http://www.sec.gov/rules/proposed/2011/34-63825.pdf.
    \5\ See id. at 390. (``The term block trade has the same meaning as 
 242.900 (published at 75 FR 75208, Dec. 2, 2010), provided however 
that until the Commission sets the criteria and formula for determining 
what constitutes a block trade under  242.907(b), a security-based 
swap execution facility may set its own criteria and formula for 
determining what constitutes a block trade as long as such criteria and 
formula comply with the Core Principles relating to security-based swap 
execution facilities in section 3D of the Act (15 U.S.C. 78c-4) and the 
rules and regulations thereunder.'').
---------------------------------------------------------------------------
Discussion of Proposed Rules
    As interdealer brokers involved in the formulation and execution of 
large derivatives transactions between swap dealers and major swap 
participants, the distinction between block and non-block trades is 
vital to ensure OTC derivatives markets can continue to provide 
liquidity to and be a source for risk mitigation for end-users.
    It is important that the Commission recognize that OTC derivatives 
markets are different than financial markets that have significant 
retail participation.\6\ While the relationship between exchange-traded 
and OTC markets generally has been complimentary, as each market 
typically provides unique services to different trading constituencies 
for products with distinctive characteristics and liquidity needs, the 
nature of trading liquidity in the exchange-traded and OTC markets is 
often materially different. Liquidity is the degree to which a 
financial instrument is easy to buy or sell quickly with minimal price 
disturbance. The liquidity of a market for a particular financial 
product or instrument depends on several factors, including the 
parameters of the particular instrument, including tenor and duration, 
the number of market participants and facilitators of liquidity, the 
degree of standardization of instrument terms, and the volume of 
trading activity.
---------------------------------------------------------------------------
    \4\ See, e.g., Comments from Yuhno Song, Merrill Lynch, (``I think 
one of the distinctions we have is a market that may be more smaller in 
retail based versus a market that is with far small number of 
participant and that's institutional based.'') Public Roundtable to 
Discuss Swap Data, Swap Data Repositories, and Real Time Reporting, 
September 14, 2010 (``Roundtable Transcript'') at 332-333. Available 
at: http://www.cftc.gov/ucm/groups/public/@swaps/documents/file/
derivative18sub091410.pdf.
---------------------------------------------------------------------------
    Highly liquid markets exist for both commoditized, exchange-traded 
products, and the more standardized OTC instruments, such as the market 
for U.S. Treasury securities, equities, and certain commodity 
derivatives. Exchange-traded markets provide a trading venue for fairly 
simple and commoditized instruments that are based on standard 
characteristics and single key measures or parameters. Exchange-traded 
markets rely on relatively active order submission by buyers and 
sellers and generally high transaction flow. These markets allow a 
broad base of trading customers meeting relatively modest margin 
requirements to transact standardized contracts in a relatively liquid 
market. As a result of the high number of market participants and the 
relatively small number of standardized instruments traded, liquidity 
in exchange-traded markets is relatively continuous in character.
    In comparison, many swaps markets feature a broader array of less-
commoditized products and larger-sized orders that are traded by fewer 
counterparties, almost all of which are institutional and not retail. 
Trading in these markets is characterized by variable or non-continuous 
liquidity. Such liquidity can be episodic, with liquidity peaks and 
troughs that can be seasonal (e.g., certain energy products) or more 
volatile and tied to external market and economic conditions (e.g., 
many credit, energy, and interest rate products).
    As a result of the episodic nature of liquidity in certain swaps 
markets combined with the presence of fewer participants, the WMBAA 
believes that the CFTC and SEC need to carefully structure a clearing 
and reporting regime for block trades that is not a ``one size fits 
all'' approach, but rather takes into account the unique challenges of 
fostering liquidity in the broad range of swaps markets. Such a regime 
would provide an approach that permits the execution of larger 
transactions without unnecessary regulatory burdens, and does not 
materially reduce market liquidity.

Formulation of Block Trade Threshold
    Section 43.5(g) of the Proposed Rules describes the procedure and 
calculations that a registered swap data repository (``SDR'') must 
follow in determining the appropriate minimum block size. Specifically, 
the Proposed Rules would require a registered SDR to set the 
appropriate minimum block size at the greater resulting number of each 
of the ``distribution test'' and ``multiple test.'' \7\
---------------------------------------------------------------------------
    \7\ See 75 Fed. Reg. at 76161.
---------------------------------------------------------------------------
Distribution Test
    The distribution test would apply the ``minimum threshold'' to the 
``distribution of the notional or principal transaction amounts'' and 
would require a registered SDR to create a distribution curve to see 
where the most and least liquidity exists, based on the notional or 
principal transaction amounts for all swaps within a category of swap 
instrument. Under this proposed approach, a registered SDR must first 
determine the distribution of the rounded notional or principal 
transaction amounts of swaps and then apply the minimum threshold to 
such distribution. The Proposed Rules describe the ``minimum 
threshold'' as a notional or principal amount that is greater than 95% 
of transaction sizes in a swap instrument or category during the period 
of time represented by the distribution of the notional or principal 
transaction amounts.

Multiple Test
    The multiple test would require a registered SDR to multiply the 
``block multiple'' by the ``social size'' to determine the appropriate 
block threshold for each swap instrument. The Commission recognizes 
that the social size for a swap varies by asset class, tenor, and 
delivery points. Once the appropriate social size is determined, the 
registered SDR must then apply the block multiplier, currently proposed 
to be five. The resulting product would be the number that the 
registered SDR compares to the resulting number from the distribution 
test, the greater of which would be the appropriate minimum block size 
for such swap instrument.\8\
---------------------------------------------------------------------------
    \8\ See id. at 76162.
---------------------------------------------------------------------------
    While the WMBAA believes that each asset class and each swaps 
instrument has a threshold amount that could be calculated and used to 
distinguish between typical and block trades, its primary concern is 
that the block trade exceptions be individually set for the unique 
liquidity requirements of the broad range of swaps instruments. 
Appropriate threshold levels will ensure that the process of completing 
a block trade is appropriately defined and trading may continue without 
adversely impacting market participants' ability to place, exit, or 
hedge their trades. As other industry participants have noted, academic 
studies on the impact of transparency rules in major markets have found 
evidence of an adverse impact of transparency in a range of markets.\9\ 
The WMBAA urges the Commission to implement a flexible, appropriate 
regime that will provide increased transparency without impairing the 
liquidity currently found in OTC derivatives markets.
---------------------------------------------------------------------------
    \9\ See International Swaps & Derivatives Association and the 
Securities Industry and Financial Markets Association, ``Block Trade 
Reporting for Over-the-Counter Derivatives Markets,'' January 18, 2011 
(Citing Canadian stock markets, London Stock Exchange, and future 
exchanges). Available at: http://www.isda.org/speeches/pdf/Block-Trade-
Reporting.pdf.
---------------------------------------------------------------------------
    With respect to block trade thresholds, while the appropriate 
threshold amount will differ by asset class and instrument, the notion 
of a block trade involves more than merely the size of a transaction. 
WMBAA member firms have witnessed an evolution in interdealer markets 
with the development of a process referred to as ``work-up.'' In this 
model, once a price is agreed for trading, the resultant trade is 
reported to market participants and they are offered the opportunity 
for a brief, pre-set period of time to ``join the trade'' by placing a 
firm bid or offer that is characterized by only two variables (the 
quantify and whether the order is a ``buy'' or ``sell'' order). This 
results in an increase in liquidity at the most recently established 
market price. Work-up enables traders to assess the markets in real-
time and make real-time decisions on trading activity, without the fear 
of moving the market one way or another. It is vital that any block 
trade calculation recognize the role work-up plays in forming 
liquidity. This is done to allow the market to find the appropriate 
pricing levels to optimally complete the transaction without 
prematurely causing the market impact of a large block trade. During 
the ``work up'' or ``join the trade'' period, all market participants 
have knowledge that a trade is taking place and are welcome to 
participate in this transparent process. However, as the initiating 
trade and other trades that take place are not fully complete until the 
end of the work-up period, and may result in both block and non-block 
trades, the reporting of the amounts executed during this process 
should not be done until the short work-up period expires.
    The WMBAA believes it is appropriate to provide regulators with 
necessary market information for oversight purposes, but the public 
dissemination of incremental activity that would otherwise constitute a 
block trade could jeopardize identification of counterparties and 
materially reduce market liquidity, which does not comport with the 
reporting goals \10\ enumerated in the Dodd-Frank Wall Street Reform 
and Consumer Protection Act (``Dodd-Frank Act'').\11\
---------------------------------------------------------------------------
    \10\ CEA Section 2(a)(13)(E) (``With respect to the rule providing 
for the public availability of transaction and pricing data for swaps . 
. . , the rule promulgated by the Commission shall contain provisions . 
. . (iv) that take into account whether the public disclosure will 
materially reduce market liquidity.'').
    \11\ Pub. L. No. 111-203, H.R. 4173.
---------------------------------------------------------------------------
    Congress recognized the importance of tailored block trade 
thresholds specific to an asset class and instrument.\12\ The WMBAA 
advocates, as an example, a tiered solution for swap classification and 
reporting. The first tier would include all ``social'' size trades, 
which must be reported immediately to market participants. The second 
tier would include trades that are a certain multiple of the ``social'' 
size, dependent on the maturity, underlying credit, and frequency of 
recent transactions in the specific instrument. Each of these 
transactions would be reported to a registered SDR within an 
appropriate time after trade execution. This, the WMBAA believes, would 
be acceptable to market participants because it would be less 
disruptive to their ability to place, hedge or exit positions. Finally, 
the WMBAA would suggest a third tier for trades greater than twice the 
amount of the block trade threshold, reported with an indication that 
an extremely large block trade was executed.
---------------------------------------------------------------------------
    \12\ Statement of Senator Blanche Lincoln (``The committee expects 
the regulators to distinguish between different types of swaps based on 
the commodity involved, size of the market, term of the contract and 
liquidity in that contract and related contracts, i.e., for instance 
the size/dollar amount of what constitutes a block trade in 10 year 
interest rate swap, 2 year dollar/euro swap, 5 year CDS, 3 year gold 
swap, or a 1 year unleaded gasoline swap are all going to be 
different.''). Senate Congressional Record S. 5921, July 15, 2010.
---------------------------------------------------------------------------
    Such a reporting regime would ensure market participants retain a 
level of transparency acceptable to successful trading. It is important 
to distinguish between public reporting to market participants and 
regulatory reporting through the SDR, which would be privy to complete 
trade information. By identifying an appropriate social size, the 
Commission would encourage additional market participants to post 
prices and provide liquidity on electronic platforms. This, in turn, 
would support the Commission's objective of increasing the number of 
market makers and bringing greater transparency into the swaps markets.

Block Trade Calculation and Publication
    Section 43.5(g) of the Proposed Rules would require registered SDRs 
to calculate the appropriate minimum block size for swaps for which 
such registered SDR receives data in accordance with Section 
2(a)(13)(G) of the CEA. The appropriate minimum block sizes for each 
swap instrument must be the greater of the resulting number derived 
from the ``distribution test'' and the ``multiple test.'' If there is 
only one registered SDR for a particular asset class, that registered 
SDR will have to calculate the appropriate minimum block size. In the 
event that there are multiple registered SDRs for an asset class, and 
therefore multiple registered SDRs will accept swaps for a particular 
category of swap instrument, the Commission will prescribe how the 
appropriate minimum block size should be calculated in a way that 
accounts for all of the relevant data.\13\
---------------------------------------------------------------------------
    \13\ See 75 Fed. Reg. at 76160.
---------------------------------------------------------------------------
    Proposed Section 43.5(h) provides that after an ``appropriate 
minimum block size'' is established by either a registered SDR or by a 
Commission-prescribed method, a swap market must set the ``minimum 
block trade size'' for those swaps that it lists and wishes to allow 
block trading, by referring to the appropriate minimum block size 
(equal to or greater than the SDR threshold) that is posted on a 
registered SDR's Internet website (along with the precise methodology 
and complete data set used by the SDR for calculating each swap) for 
the swap instrument category for such swap.

Swaps Standards Advisory Committee
    The WMBAA believes that it is necessary to consider this more 
complete scope of information in calculating block trade thresholds 
that are truly appropriate for swap markets. The WMBAA therefore 
proposes the formation of a block trade standards setting advisory 
committee (the ``Swaps Standards Advisory Committee'') made up of 
recognized experts and representatives of registered SDRs and SEFs to 
make recommendations to the Commission for appropriate block trade 
thresholds for swaps.
    The WMBAA recommends that the Commission consider the role of 
existing advisory committees, such as the Agricultural Advisory 
Committee, Global Markets Advisory Committee, Energy and Environmental 
Markets Advisory Committee, and the Technology Advisory Committee, as a 
model for receiving market participant input and recommendations 
related to regulatory and market issues concerning block trades on 
swaps. Recent Commission rulemakings in agricultural commodities \14\ 
and co-location \15\ have benefitted greatly from industry input on 
these advisory committees. While the Commission is authorized under the 
Dodd-Frank Act to establish block trade standards on its own, and 
possesses the requisite knowledge and experience in futures markets, 
the WMBAA believes that a Swaps Standards Advisory Committee, similar 
to the above-referenced advisory committees, could provide the 
Commission with meaningful statistics and metrics from a broad range of 
contract markets, SDRs and SEFs to be considered in any ongoing 
rulemakings in this area.
---------------------------------------------------------------------------
    \14\ See Agriculture Commodity Definition, 75 Fed. Reg. 65586 
(October 26, 2010).
    \15\ See Co-Location/Proximity Hosting Services, 75 Fed. Reg. 33198 
(June 11, 2010).
---------------------------------------------------------------------------
    The Swaps Standards Advisory Committee would work with the 
Commission to establish and maintain written policies and procedures 
for calculating and publicizing block trade thresholds for all swaps 
reported to the registered SDR in accordance with the criteria and 
formula for determining block size as specified by the Commission. The 
Swaps Standards Advisory Committee would also undertake market studies 
and research at its expense as is necessary to establish such 
standards. This arrangement would permit SEFs, as the entities most 
closely related to block trade execution, to provide essential input 
into the Commission's block trade determinations and work with 
registered SDRs to distribute the resulting threshold levels to SEFs. 
Further, the proposed regulatory structure would reduce the burden on 
SDRs, remove the possibility of miscommunication between SDRs and SEFs, 
and ensure that SEFs do not rely upon dated or incorrect block trade 
thresholds in their trade execution activities.
    The WMBAA supports the notion that the Commission should require 
registered SDRs to self-certify determinations of the appropriate 
minimum block size for swap instruments. SDRs should be subject to 
certification by the Commission (or the Swaps Standards Advisory 
Committee) and be required to display on their website the precise 
calculation of every block size (including the complete data set used 
for the calculation).
    The WMBAA also believes it is important for the Commission to 
recognize the potential for abuse of the block trade calculation by an 
SDR that operates an affiliated SEF or designated contract market. The 
WMBAA believes that the Commission must authorize a Swaps Standards 
Advisory Committee to insure that the block facility serves the public 
interest and is not abused to serve one or more narrow commercial 
interests.
    Further, as the Commission recognizes, if there is more than one 
registered SDR for an asset class, it may prove difficult for the 
Commission to ensure that all registered SDRs calculate the same block 
trade thresholds for the same swap instruments. In comparison, one 
common regulatory organization responsible for facilitating SEF 
compliance with core principles will be uniquely situated to prevent 
the problem posed by multiple SDRs, which becomes further exacerbated 
if there are multiple registered SDRs in the same asset class, each 
with individual market data feeds that need to be aggregated to 
calculate block trade thresholds.
    The determination of whether a swap transaction is a block trade 
should reflect a risk-weighted analysis, calculated on an instrument-
by-instrument basis. This threshold should be updated at an appropriate 
time interval, taking into account the unique liquidity characteristics 
and challenges of the market in which the instrument trades. Any 
formulaic approach to computing the thresholds from trade size or other 
population parameters should reflect the number of participants in the 
market, the frequency of trading activity (daily, weekly, and monthly), 
and the average trade sizes and terms of the transactions.
    The established block trade threshold could be subject to gaming, 
particularly if the market perceives the threshold to be arbitrarily 
determined. However, if the block threshold accurately captures the 
risk and liquidity parameters related to trading activity, then gaming 
would be ineffective and less likely to occur.
    With respect to inter-affiliate transactions or trades resulting 
from portfolio compression, the WMBAA believes that if the block 
thresholds are appropriately calculated, market participation will 
increase, resulting in additional transparency and markets that better 
serve the public interest. The allocation or compression of trades that 
have already occurred are not open market transactions, and it would be 
misleading if they were reported as open market transactions, giving 
the illusion of more liquidity than exists. These transactions should 
be reported as compression trades or allocations, so as not to be taken 
into account in any type of market liquidity or block trading 
equations.

Reporting of Block Trades
    The Proposed Rules provide that a reporting party for any block 
trade must report the block trade transaction and pricing data pursuant 
to the rules of the swap market that makes that swap available for 
trading. Such reporting must occur as soon as technologically 
practicable after execution of the block trade and pursuant to the 
rules of the swap market. The Proposed Rules define the term ``as soon 
as technologically practicable'' to mean as soon as possible, taking 
into consideration the prevalence of technology, implementation, and 
use of technology by comparable market participants. The Commission 
recognizes that what is ``technologically practicable'' for one party 
to a swap may not be the same as what is ``technologically 
practicable'' for another party to a swap. The swap market that accepts 
the block trade must immediately send the block trade transaction and 
pricing data to a real-time disseminator, which must not publicly 
disseminate the swap transaction and pricing data before the expiration 
of the time delay described in Proposed Section 43.5(k).
    As noted in previous letters, the WMBAA is supportive of trade 
reporting for all trades as soon as technologically practicable. The 
Association believes that all trade reporting, regardless of size, 
should be reported to the SDR. The WMBAA members each possess the 
technological capabilities to provide regulators with real-time 
electronic trade information for transactions executed in multiple 
financial markets.\16\
---------------------------------------------------------------------------
    \16\ See, e.g., Comments from Shawn Bernardo, Tullett Prebon 
Americas Corp., representing Wholesale Markets Brokers Association, 
(``All of the brokers have the capability to report trades to the 
regulators in a timely fashion . . . as far as TRACE is concerned, we 
have a track record of reporting those trades efficiently, and we have 
the systems in place to do that, along with the various means . . . we 
can do that voice, we can do it electronically, we can do it as hybrid 
as far as the execution, but we send those trades electronically to 
them in a timely fashion.'') Roundtable Transcript at 227-228.
---------------------------------------------------------------------------
    While the WMBAA believes that posting the full details of SEF-
executed transactions to market participants should be at the core of 
the SEF obligations, the reporting obligations of the SEF should 
reflect the information that the SEF possessed at the time of the 
transaction. The SEF should not have the primary reporting obligations. 
The SEF may not necessarily be privy to all of the terms required to be 
reported in accordance with the Proposed Rules, such as, but not 
limited to: (i) contingencies of the payment streams of each 
counterparty to the other; (ii) the title of any master agreement or 
other agreement governing the transaction; (iii) data elements 
necessary to calculate the market value of the transaction; and (iv) 
other details not typically provided to the SEF by the customer, such 
as the actual desk on whose behalf the transaction is entered. 
Moreover, and quite critical, a SEF would not be in a position or 
necessarily have the capabilities to report lifecycle event 
information. Indeed, even if a SEF were required to report the 
transaction details as the Proposed Rules require, something the 
Association does not think is advisable, it would likely take at least 
30 minutes to gather and confirm the accuracy of that information.
    Additionally, requiring the post trade reporting requirements to be 
``as soon as technologically practicable'' may have a negative effect 
on liquidity, particularly with respect to larger transactions.
    The reporting of larger transactions will likely cause participants 
to refrain from entering the market in situations where they might 
otherwise have entered, which will adversely impact the ability of the 
parties to the large transaction to mitigate the risks of that 
transaction by entering into separate, offsetting transactions. This 
could affect a party's ability to hedge its risks, and the exposure of 
that legitimate hedge will be diminished, resulting in fewer 
transactions and potentially widening spreads, which in turn will 
increase end-user costs.
    Nevertheless, the WMBAA believes that trading counterparties with 
reporting obligations should be able to contract with a SEF to handle 
the reporting process without transferring their reporting obligations. 
This will put smaller counterparties with limited trade reporting 
technology in a less disadvantaged trading position to larger trading 
counterparties.

Real-Time Public Reporting of Block Trade Information
Time Delay
    Section 43.5(k) of the Proposed Rules provides that the time delay 
for block trades must be no later than 15 minutes after the time of 
execution (the time that that a swap market receives the swap 
transaction and pricing data from a reporting party). After the 15 
minute time delay has expired, the registered SDR or the swap market 
(through a third-party service provider) must immediately disseminate 
the swap transaction and pricing data to the public. By comparison, the 
SEC's proposed Regulation SBSR requires the immediate dissemination of 
most of the block trade data, with delayed dissemination for the 
trade's notional size and the transaction ID at a designated delayed 
time.
    Based on the experiences related to the implementation of the 
Financial Industry Regulatory Authority's Transaction Reporting and 
Compliance Engine (``TRACE''), the WMBAA advocates a gradual 
implementation of the 15 minute delayed reporting requirement. When the 
TRACE reporting system was first introduced in 2002, there was a 75 
minute delay for block trades. This time delay was reduced to 45 
minutes the next year, and then reduced to current standard of 15 
minutes in 2005. For the same reasons that the TRACE system required a 
delayed implementation period, the WMBAA would recommend the CFTC 
consider a similar phased-in approach to this requirement.
    Further, the WMBAA would suggest that the CFTC consider fashioning 
a more flexible time delay regime that takes into account the block 
trade's asset class, the type of swap instruments, and the actual trade 
size. The time delay should not be an arbitrary period of time, but 
rather should reflect the period of time reasonably needed to hedge the 
block trade position without distorting the market. Each asset class 
will have varying regular trade frequency and block size thresholds. 
Accordingly, if implemented, the Commission may find that 15 minutes is 
too long of a time delay for markets which trade actively, and too 
short of a time delay for markets with see infrequent trading. To this 
end, an approach that factors in the relative size of a transaction 
compared to average trading volume and transaction activity for that 
specific asset class might be more appropriate to achieve the stated 
goals for the time delayed reporting provisions.

Information Publicly Reported
    Section 43.5(l) of the Proposed Rules provides that all information 
in the data fields described in Section 43.4 and Appendix A to the 
Proposed Rules must be disseminated to the public for block trades and 
large notional swaps. The Proposed Rules list 23 data fields, which 
include date stamp, time stamp, whether the trade is cleared or 
uncleared, an indication of a block trade, the execution venue, the 
asset class, contract type, underlying asset, price notation, the 
unique product identifier, and the notional currency.
    The WMBAA suggests that disseminating the specific notional amount 
of a block trade could jeopardize the anonymity of the counterparties 
to such trades, making counterparties less willing to engage in 
transactions of size. Further, the effect of having no delay, or only a 
short dissemination delay, for a block trade report that includes the 
full notional size will discourage market makers from committing 
capital and providing liquidity to the broader market. From a market 
perspective, there is little gained from disseminating full notional 
size information. Consistent with the experiences from the 
implementation of TRACE, which provides regulators with full trade 
information and publicly disseminates trades within a size range, the 
WMBAA believes the Commission should implement a similar public 
reporting methodology. This benefits market participants without 
exposing a trade's notional size, which protects counterparty 
anonymity, and preserves liquidity and price competition in the 
market.\17\ The Swaps Standards Advisory Committee would formulate and 
recommend to the Commission methodology for determining appropriate 
transaction information to be reported to the public. For example, the 
Swaps Standards Advisory Committee could recommend that amounts under 
block size were reported as soon as practicable while blocks were 
reported only as ``block size+'' after the appropriate delay for that 
particular instrument. As with block size itself, the amount reported 
to the public would be based on the observed number of bids and offers 
in a given instrument, the number of market participants, the amount of 
retail participation (if any), and the volume of trades executed.
---------------------------------------------------------------------------
    \17\ See 75 Fed. Reg. at 76161. (``The Commission also considered 
the standards used by TRACE in setting its minimum threshold for block 
trades. In that regard, for trades with a par value exceeding $5 
million for investment grade bonds or $1 million for non-investment 
grade bonds (e.g., high-yield and unrated debt), TRACE publicly 
disseminates the quantity as ``5MM+'' and ``1MM+'', respectively.'')
---------------------------------------------------------------------------
    Additionally, market participants will be wary of committing to 
larger sized transactions after knowing the rapidity in which other 
participants will gain knowledge of these trades, leading to less 
liquidity for the dealer market, and ultimately for end-user 
participants. The WMBAA also believes that the public dissemination of 
block trades, as proposed, will allow some market participants to infer 
the identity of the parties to the transaction and materially reduce 
market liquidity.
    If a liquidity provider perceives greater danger in supplying 
liquidity, it will step away from providing tight spreads and leave 
those reliant on market maker liquidity with poorer hedging 
opportunities. From a market structure standpoint, liquidity ``takers'' 
benefit from liquidity providers acting in a competitive environment. 
The liquidity providers compete with each other, often deriving very 
small profits per trade from a large volume of transactions. By relying 
on their ability to warehouse trades and post capital to make markets 
and using their distribution and professional know-how to offer 
competitive prices to their customer base, market makers provide 
liquidity essential to fulfill the need of hedgers. For these reasons, 
having either no delay or a short dissemination delay will actually 
erode price discovery and the level of price efficiency in the market.

Conclusion
    The WMBAA thanks the Commission for the opportunity to comment on 
the Proposed Rule. Please feel free to contact the undersigned with any 
questions you may have on our comments.
            Sincerely,

            
            

    The Chairman. Thank you, Mr. Bernardo.
    I appreciate that.
    We now go to Bill Bullard, Chief Executive Officer of R-
CALF, Billings, Montana.
    Mr. Bullard.

STATEMENT OF WILLIAM T. BULLARD, Jr., CHIEF EXECUTIVE OFFICER, 
                    R-CALF USA, BILLINGS, MT

    Mr. Bullard. Thank you, Chairman Conaway, Ranking Member 
Boswell, and Members of the Subcommittee, for this opportunity 
to testify on the Dodd-Frank Wall Street Reform and Consumer 
Protect Act that I will refer to as the Wall Street Reform Act.
    R-CALF USA, of which I am the CEO, my name is Bill Bullard, 
is a national nonprofit cattle association representing the 
interest of farmers and ranchers who raise and sell live 
cattle. Unlike our counterpart, the National Cattlemen's Beef 
Association, that has meat packers seated on their governing 
board and tries to represent the entire beef supply chain, R-
CALF USA does not represent packers. We exclusively represent 
the interests of the actual farmers and ranchers that are 
raising and selling cattle.
    R-CALF is the largest organization in the United States 
representing cattle producers, again exclusively regarding the 
economic interests of the actual cattle farmers and ranchers of 
this country.
    It is critically important for this Subcommittee to 
understand that there is a clear demarcation point between the 
live cattle industry and the beef production industry, the beef 
packing industry. And that demarcation point is so profound 
that often there is an inverse relationship between the 
economic prosperity in the cattle industry and the economic 
price prosperity in the beef processing industry.
    That competition between the live cattle industry and the 
beef industry over the price of cattle is fierce, or so it 
should be in a free market system. But today it isn't, and that 
is because a handful of concentrated packers have all but 
captured the marketplace for live cattle. And that is why we 
are here today, to discuss the necessity of implementing the 
significant regulatory reforms under the Wall Street Reform Act 
to restore robust, if not fierce, competition in the cattle 
market that is today largely controlled by the four dominant 
packers.
    As a result of the meet packers' control, we have seen that 
our cattle industry is in a severe state of crisis. And for the 
benefit of this Subcommittee, we looked at the 16 states that 
are represented by the 24 Members of this Subcommittee and 
realized that over the past 10 years, where data are available, 
the 16 states have lost 49,850 cattle producers. During that 10 
year period, the size of the beef cow herd in those 16 states 
has been reduced by 1.3 million head, and the production of 
cattle and calves in those states has been reduced by 935 
million pounds.
    Nationally, this same fate is being suffered by cattle 
producers all across the country.
    This unprecedented long-term contraction of our industry is 
occurring even while domestic consumption of beef has actually 
increased and reached a 40 year high in 2007 and 2008. A 
shrinking industry that is unable to keep pace with growth and 
domestic consumption is an industry with a severe problem, a 
problem that can be addressed with the Wall Street Reform Act.
    Today I want to provide evidence showing that the dominant 
beef packers are engaging in practices that are destroying the 
price discovery and the risk-management function of the cattle 
futures markets, practices that the Wall Street Reform Act can 
address.
    In February of 2006, four of the largest meat packers 
engaged in a coordinated action of withdrawing from the cash 
market for an unprecedented 2 week period. Industry analysts at 
the time said the packers did this to gain control over cattle 
prices, which they did. Cash prices fell $3 a hundredweight 
during their boycott, and live cattle futures markets fell to 
multi-month lows during the period.
    The effect of this coordinated action was to destroy 
completely the price discovery function and the risk-management 
function of the cattle futures market. And this caused direct 
financial harm to cattle producers that were selling cattle all 
across the country. In 2008, we testified before Congress and 
said if this type of attack isn't--attack on our marketplace is 
not addressed immediately by Congress, we would witness this--
experience this type of a problem again in the near future. And 
we didn't have to wait long before our prediction materialized.
    On the last trading day in October 2009, the cattle futures 
market fell to $81.65 a hundredweight. There were no underlying 
market forces that would warrant this break in the market. 
Suggesting that a dominant market participant had shorted the 
market, the cash price at the time was $87.50, and we viewed 
this as the worst convergence in a long time in the cattle 
futures market.
    On February 7, the CFTC ordered a trader Newedge to pay a 
penalty of over $220,000 for activities, unlawful activities 
that occurred in October 2009. The CFTC found that in October, 
Newedge exceeded the contract speculative limit for trading 
cattle over 4,000 contracts, which contracts it had purchased 
from JBS, the world's largest packer, and then Newedge then 
sold JBS an over-the-counter swap in live cattle. The CFTC took 
this action in part under the--pursuant to the Wall Street 
Reform Act.
    Ladies and gentlemen, we believe firmly that we must 
immediately implement the Wall Street Reform Act, support the 
CFTC's rulemaking process, fund it completely in order to 
ensure that we restore for independent cattle producers across 
this country an open robust marketplace that is functional in 
terms of discovery price and the marketplace that provides them 
with a risk-management tool.
    Thank you.
    [The prepared statement of Mr. Bullard follows:]

Prepared Statement of William T. Bullard, Jr., Chief Executive Officer,
                        R-CALF USA, Billings, MT

    Good afternoon, Chairman Conaway, Ranking Member Boswell, and 
Members of the Subcommittee. I am Bill Bullard and I thank you for the 
opportunity to provide testimony regarding the Subcommittee's review of 
the implementation of title VII of the Dodd-Frank Wall Street Reform 
and Consumer Protection Act (``Wall Street Reform Act'').
    I am here today representing the cattle-producing members of R-CALF 
USA, the Ranchers-Cattlemen Action Legal Fund, United Stockgrowers of 
America. R-CALF USA is a membership-based, national, nonprofit trade 
association that represents United States farmers and ranchers who 
raise and sell live cattle. We have thousands of members located in 46 
states and our membership consists of seed stock producers (breeders), 
cow/calf producers, backgrounders, stockers and feeders. The 
demographics of our membership are reflective of the demographics of 
the entire U.S. cattle industry, with membership ranging from the 
largest of cow/calf producers and large feeders to the smallest of cow/
calf producers and smaller, farmer-feeders. Our organization's mission 
is to ensure the continued profitability and viability for all 
independent U.S. cattle producers.
    R-CALF USA does not represent the entire U.S. beef supply chain. 
Rather, R-CALF USA exclusively represents the live cattle segment of 
the beef supply chain, meaning it represents the farmers and ranchers 
located across the U.S. who breed, birth, and raise live cattle for 
breeding purposes and beef production. These live cattle are 
subsequently marketed to beef packers that transform live cattle into 
the commodity beef, which beef is then further processed and/or 
marketed to other entities within the beef commodity industry (e.g., 
beef processors, beef wholesalers and distributors, and beef 
retailers).
    It is critically important that the Subcommittee recognize that the 
live cattle industry is a distinct industry segment within the U.S. 
beef supply chain and that a clear demarcation point exists between the 
live cattle industry and the beef commodity industry--a demarcation 
point so profound that often there is an inverse relationship between 
economic prosperity in the live cattle industry and economic prosperity 
in the beef commodity industry.\1\
---------------------------------------------------------------------------
    \1\ See, e.g., Sparks Companies Inc., ``Potential Impacts of the 
Proposed Ban on Packer Ownership and Feeding of Livestock,'' A Special 
Study, (March 18, 2002) at 24 (``Vertical integration [of the live 
cattle industry and the beef commodity industry] often attracts 
investors because of the negative correlation between profit margins at 
the packing stage [beef commodity stage] and the feeding stage [live 
cattle stage].'').
---------------------------------------------------------------------------
I. Introduction
    The United States cattle industry is in prolonged state of severe 
crisis. For the benefit of the Subcommittee, in just the most recent 10 
year periods where data are available, the 16 states represented by 
this Subcommittee's 24 members collectively lost 49,850 beef cattle 
businesses from their respective rural economies (1988-2007),\2\ 
representing a rate-of-loss of nearly 5,000 beef cattle business 
operations per year. In addition, the combined size of the U.S. beef 
cow herd in those 16 states declined during the most recent 10 year 
period (2002-2011) by over 1.3 million cows.\3\ And, the volume of 
production of cattle and calves in those 16 states declined during this 
period (2000-2009) by over 935 million pounds.\4\
---------------------------------------------------------------------------
    \2\ See Cattle and Calves: Number of Operations by State and United 
States, 1997-1998, Cattle, U.S. Department of Agriculture, Agricultural 
Statistics Board, National Agricultural Statistics Service, January 
1999, at 12; see also Farms, Land in Farms, and Livestock Operations 
2008 Summary, U.S. Department of Agriculture, Agricultural Statistics 
Board, National Agricultural Statistics Service, February 2009, at 18.
    \3\ See Cattle and Calves: Number by Class, State, and the United 
States, January 1, 2002-2003, Cattle, U.S. Department of Agriculture, 
Agricultural Statistics Board, National Agricultural Statistics 
Service, January 2003, at 5; see also Cattle Inventory by Class--States 
and United States: January 1, 2010 and 2011, Cattle, U.S. Department of 
Agriculture, Agricultural Statistics Board, National Agricultural 
Statistics Service, January 2003, at 6.
    \4\ See Cattle and Calves: Production and Income by State and the 
United States, Revised 2000, Meat Animals Production, Disposition, and 
Income 2001 Summary, U.S. Department of Agriculture, Agricultural 
Statistics Board, National Agricultural Statistics Service, April 2002, 
at 4: see also Cattle and Calves: Production and Income by State and 
the United States, 2009, Meat Animals Production, Disposition, and 
Income 2009 Summary, U.S. Department of Agriculture, Agricultural 
Statistics Board, National Agricultural Statistics Service, April 2010, 
at 7.
---------------------------------------------------------------------------
    Data clearly show that the geographic segment of the U.S. cattle 
industry represented by the 16 states represent by the Members of this 
Subcommittee is declining rapidly in terms of the number of beef cattle 
operations, the size of the beef cow herd, and the volume of cattle and 
calf production. Nationally, the number of U.S. cattle operations has 
declined 40 percent since 1980,\5\ the size of the U.S. cattle herd is 
now the smallest since 1958,\6\ and the production of U.S. beef has 
declined since 2000.\7\
---------------------------------------------------------------------------
    \5\ The size of the U.S. cattle industry, as measured by the number 
of cattle operations in the U.S., declined from 1.6 million in 1980 to 
983,000 in 2005 and further declined to 967,400 in 2007. See Fed. Reg. 
Vol. 72, No. 152, Wednesday, August 8, 2007, at 44681, col. 2.
    \6\ See Cattle, U.S. Department of Agriculture, National 
Agricultural Statistics Service, January 28, 2011.
    \7\ See Beef: Supply and disappearance (carcass weight, million 
pounds) and per capita disappearance (pounds), Livestock, Dairy, and 
Poultry Outlook: Tables, U.S. Department of Agriculture, Economic 
Research Service (Total production declined from 26.89 billion pounds 
in 2000 to 26.07 billion pounds in 2009), available at http://
www.ers.usda.gov/publications/ldp/LDPTables.htm. 
---------------------------------------------------------------------------
    These factors indicate an industry in severe crisis, particularly 
when one considers that this ongoing, rapid contraction was rapidly 
occurring even while domestic consumption of beef, as measured by its 
disappearance from the market, was increasing significantly and reached 
40 year highs in both 2007 and 2008,\8\ before beginning a decline due 
to the United States' recent economic downturn. Even though per capita 
beef consumption decreased over the past few decades, the considerable 
growth in U.S. population fostered a long-term increase in total 
domestic beef consumption that the U.S. cattle industry has been unable 
to satisfy.
---------------------------------------------------------------------------
    \8\ See id. (Total disappearance (i.e., consumption) of beef 
increased to a over 28 billion pounds in both 2007 and 2008, which are 
record-setting highs since USDA began reporting disappearances in 
1970).
---------------------------------------------------------------------------
    A shrinking industry unable to keep pace with domestic consumption 
is, undeniably, an industry in serious trouble--the kind of serious 
trouble that warrants sweeping remedial reforms such as those Congress 
passed in the Wall Street Reform Act.
    A principal factor driving the rapid contraction of the U.S. cattle 
industry is a dysfunctional cattle market that lacks robust competition 
and adequate transparency, which results in a marketplace that is 
subject to manipulation and distortion.

II. The Cash and Futures Markets in the Cattle Industry Are Prone To 
        Manipulation and Distortion

A. The Live Cattle Production Chain and Its Relation To Markets
    The U.S. cattle industry is unique in that it raises an animal with 
the longest biological cycle of any farmed animal. This is the 
characteristic that created the historical phenomenon known as the 
cattle cycle. According to the U.S. Department of Agriculture 
(``USDA''), the cattle cycle ``arises because biological constraints 
prevent producers from instantly responding to price.'' \9\ It takes 
approximately 15 to 18 months to rear cattle to slaughter weight and 
cattle consume considerable volumes of forage (i.e., from grazing) for 
much of this time. After cattle reach approximately 1 year of age on 
forage, and weigh approximately 800 pounds, they then become adaptable 
to a more concentrated production regime (i.e., they can be finished in 
concentrated feedlots).
---------------------------------------------------------------------------
    \9\ Cattle: Background, Briefing Room, USDA, ERS, updated June 7, 
2007, available at
http://www.ers.usda.gov/Briefing/Cattle/Background.htm.
---------------------------------------------------------------------------
    Because of the long biological cycle and the diminishing forage 
requirements as cattle intended for slaughter grow to maturity, the 
cattle production chain is segmented. Typically, the farmer or rancher 
that maintains a beef-cow herd births new calves each year and those 
calves are raised at their mothers' side on milk and forage for their 
first several months of life. At approximately 6 months of age the 
calves are typically weaned from their mothers and placed in a 
backgrounding lot where they are fed a growing ration of forage and 
grain, or they may be weaned and turned back out on forage such as 
pasture. At approximately 1 year of age and weighing approximately 800 
pounds, the calves will have matured sufficiently to be placed in 
feedlots and fed a fattening grain ration for approximately 4 to 5 
additional months before they become slaughter-ready.
    The approximately 1 year-old cattle that weigh approximately 800 
pounds and are ready to be placed in a feedlot correspond to the 
``Feeder Cattle'' category of the commodity futures market. The feeder 
cattle that are subsequently fed in a feedlot for 4 to 5 months and are 
ready to be sold to the beef packer to be slaughtered correspond to the 
``Live Cattle'' category of the commodity futures market and are 
referred to as fed cattle.
    Due to the segmented production chain in the cattle industry, 
calves are often first sold by those who raised them--the cow/calf 
producer--then sold to those that background them or turn them back to 
pasture--the backgrounder or stocker--who in turn sells them to those 
that feed them to slaughter weight--the feedlot. From the moment a 
newborn calf hits the ground, its value is based on the expected future 
value of that calf when it is mature and ready for slaughter. Thus, the 
value of a calf weaned today at approximately 6 months of age is the 
expected value of that calf when it is sold for slaughter approximately 
1 year into the future. This explains why it is so vitally important to 
the entire cattle industry to ensure that the market for slaughter-
ready cattle--the price discovery market--is robustly competitive and 
transparent. Any manipulation or distortion of the price for cattle 
that are ready for slaughter permeates throughout the entire cattle 
industry and can translate into lower prices for everyone within the 
cattle industry (which includes 753,000 cattle farmers and ranchers 
throughout the United States),\10\ regardless of what segment of the 
production chain they specialize in.
---------------------------------------------------------------------------
    \10\ See Farms, Land in Farms, and Livestock Operations 2009 
Summary, USDA, National Agricultural Statistics Service (hereafter 
``NASS''), Feb. 2010, at 14, available at http://
usda.mannlib.cornell.edu/usda/current/FarmLandIn/FarmLandIn-02-12-
2010.pdf.
---------------------------------------------------------------------------
    The entire cattle industry can thus be visualized as a pyramid as 
depicted below in which the nation's feedlots comprise the top sections 
of the pyramid and the nation's hundreds of thousands of cattle 
producers occupy its base. Importantly, it is the price negotiated at 
the pyramid's apex between the feedlots and the highly concentrated 
beef packers that determines whether the cattle industry as a whole 
remains profitable. Economists have long expressed grave concerns 
regarding the unprecedented concentration in the beef packing industry. 
For example, as early as 2001, Oklahoma State University Economist 
Clement E. Ward described the concentration level in the U.S. 
meatpacking industry as among the highest of any industry in the United 
States, ``and well above levels generally considered to elicit non-
competitive behavior and result in adverse economic performance.''\11\
---------------------------------------------------------------------------
    \11\ A Review of Causes for and Consequences of Economic 
Concentration in the U.S. Meatpacking Industry, Clement E. Ward, 
Current Agriculture Food and Resource Issues, 2001, at 1.



This characteristic severely reduces the pricing power of fed cattle 
sellers who often are relegated to take whatever price is offered by 
the beef packer, regardless of whether it is a legitimate price or a 
    distorted price.\12\ See GIPSA Livestock and Meat Marketing Study, 
January 2007, Volume 3, at 5-4, available at http://
archive.gipsa.usda.gov/psp/issues/livemarketstudy/LMMS_Vol_3.pdf.
---------------------------------------------------------------------------
    The cash market for slaughter-ready or fed cattle is the price 
discovery market for the entire cattle industry. The cattle futures 
market was intended to compliment the price-discovery function of the 
cash market by projecting it out into future months, thus serving as a 
risk-management tool for cattle producers that raise and sell cattle 
intended for slaughter and for beef packers that purchase and slaughter 
the fed cattle for human consumption. Unfortunately, the cash market 
for fed cattle, to which the futures market is intrinsically tied, has 
become too thin to function as an accurate indicator of the fair market 
value of fed cattle.
    The USDA reports that the national-average volume of fed cattle 
sold in the cash market has shrunk from 52 percent in 2005 to 37 
percent in 2010.\13\ The volume of cash cattle in the Texas, Oklahoma, 
and New Mexico marketing region is now down to less than 22 percent 
\14\ and the Colorado region is now down below 20 percent.\15\ With 
such a small volume of cattle actually sold in the cash market today, 
the cash market can no longer function as an accurate price discovery 
market. With an overwhelming number of cattle committed to the beef 
packers outside the cash market at undisclosed prices and terms on any 
given day (which cattle are referred to as the beef packers' captive 
supply), the actual fair market price for fed cattle is difficult, if 
not impossible, to determine. This is why, in addition to supporting 
the ongoing rulemaking by the Commodity Futures Trading Commission 
(``CFTC'') that will increase transparency in the futures market, R-
CALF USA also supports the USDA Grain Inspection, Packers and 
Stockyards Administration (``GIPSA'') rulemaking that will increase 
transparency in the fed cattle market.
---------------------------------------------------------------------------
    \13\ See National Breakdown by Purchase Type, 2005-2010 Fed Cattle 
Summary of Purchase Types, USDA Market News.
    \14\ See Texas-Oklahoma-New Mexico Breakdown of Volume by Purchase 
Type, 2005-2010 Fed Cattle Summary of Purchase Types, USDA Market News.
    \15\ See Colorado Breakdown of Volume by Purchase Type, 2005-2010 
Fed Cattle Summary of Purchase Types, USDA Market News.
---------------------------------------------------------------------------
    In addition to the reduced volume of cattle sold in the cash 
market, the trades that do occur in the cash market are too infrequent 
to function as a viable price discovery tool. Anecdotal evidence from 
numerous cattle feeders indicate that beef packers' exposure to the 
cash market is now so limited that the current bidding practice often 
involves an offer by the beef packer once per week, and oftentimes 
within only about a fifteen minute timeframe. If the beef packers are 
short bought (i.e., they have insufficient cattle numbers even with 
their captive supplies), this fifteen minute window may occur on a 
Thursday, or perhaps even on a Wednesday. However, if the beef packer 
is long-bought (i.e., has more than enough captive supply cattle), the 
fifteen minute marketing opportunity may not occur until late Friday 
afternoon, after the close of the futures markets. This extremely 
narrow window of opportunity to market cattle places cattle feeders at 
a distinct disadvantage as there is insufficient time to make calls to 
other beef packers after an offer is made--it is essentially a take-it 
or leave-it offer that, if refused, means the cattle feeder must 
continue feeding for another week, even if the cattle have already 
reached their optimal weight, in hopes of a more realistic offer the 
next week. This limited and infrequent bid window affords the beef 
packers with tremendous market power that gives them the ability to 
leverage down the price discovery market.

B. Empirical Evidence of Behaviors That Manipulate and Distort the Cash 
        and Futures Market
    Empirical evidence shows that the U.S. cattle market is already 
susceptible to coordinated and/or simultaneous entries and exits from 
the cash market that negatively affect the futures market. In February 
2006, all four major beef packers--Tyson, Cargill, Swift, and 
National--withdrew from the cash cattle market in the Southern Plains 
for an unprecedented period of 2 weeks. On February 13, 2006, market 
analysts reported that no cattle had sold in Kansas or Texas in the 
previous week.\16\ No cash trade occurred on the southern plains 
through Thursday of the next week, marking, as one trade publication 
noted, ``one of the few times in recent memory when the region sold no 
cattle in a non-holiday week.'' \17\ Market analysts noted that ``[n]o 
sales for the second week in a row would be unprecedented in the modern 
history of the market.'' \18\ During the week of February 13 through 
17, there were no significant trades in Kansas, western Oklahoma, and 
Texas for the second week in a row.\19\ Market reports indicated that 
Friday, February 17, 2006, marked 2 full weeks in which there had been 
very light to non-existent trading in the cash market, with many 
feedlots in Kansas, Oklahoma, and Texas reporting no bids at all for 
the past week.\20\ The beef packers made minimal to no purchases on the 
cash market, relying on captive supplies of cattle to keep their plants 
running for 2 weeks and cutting production rather than participating in 
the cash market. The beef packers reduced slaughter rates rather than 
enter the cash market. Cattle slaughter for the week of February 13-17 
was just 526,000 head, down from 585,000 the previous week and 571,000 
at the same time a year earlier.\21\ According to one analyst, the 
decision to cut slaughter volume indicated ``the determination by beef 
packers to regain control of their portion of the beef price 
pipeline.'' \22\ Another trade publication noted that the dramatic drop 
in slaughter was undertaken in part to ``try and get cattle bought 
cheaper.'' \23\ At the end of the second week of the buyers' 
abandonment of the cash market, one market news service reported, ``The 
big question was whether one major [packer] would break ranks and offer 
higher money. That has often occurred in the past, said analysts.'' 
\24\
---------------------------------------------------------------------------
    \16\ ``Packers Finally Seriously Cut Kills,'' Cattle Buyers Weekly 
(Feb. 13, 2006).
    \17\ ``Classic Standoff Continues Through Thursday,'' Cattle Buyers 
Weekly (Feb. 20, 2006).
    \18\ ``Classic Standoff Continues Through Thursday,'' Cattle Buyers 
Weekly (Feb. 20, 2006).
    \19\ Curt Thacker, ``Cash Cattle Quiet 2-20,'' Dow Jones Newswires 
(Feb. 20, 2006).
    \20\ Lester Aldrich, ``Cash Cattle Standoff 2-17,'' Dow Jones 
Newswires (Feb. 17, 2006).
    \21\ Curt Thacker, ``Cash Cattle Quiet 2-20,'' Dow Jones Newswires 
(Feb. 20, 2006).
    \22\ Jim Cote, ``Today's Beef Outlook 2-17,'' Dow Jones Newswires 
(Feb. 17, 2006).
    \23\ ``Classic Standoff Continues Through Thursday,'' Cattle Buyers 
Weekly (Feb. 20, 2006).
    \24\ ``Classic Standoff Continues Through Thursday,'' Cattle Buyers 
Weekly (Feb. 20, 2006).
---------------------------------------------------------------------------
    As a result of the beef packers shunning the cash market, cash 
prices fell for fed cattle, replacement cattle, and in futures markets. 
Sales took place after feedlots in Kansas and the Texas Panhandle 
lowered their prices to $89 per hundredweight, down $3 from the $92 per 
hundredweight price reported in the beginning of February.\25\ The same 
day, February 17, live and feeder cattle futures fell to multi-month 
lows.\26\ Replacement cattle prices also dropped in response to buyer 
reluctance.\27\ In Oklahoma City, prices for feeder cattle dropped as 
much as $4 per hundredweight.\28\
---------------------------------------------------------------------------
    \25\ Curt Thacker, ``Cash Cattle Quiet 2-20,'' Dow Jones Newswires 
(Feb. 20, 2006).
    \26\ Jim Cote, ``Live Cattle ReCap--2/17/2006,'' Dow Jones 
Newswires (Feb. 17, 2006).
    \27\ ``The Markets,'' AgCenter Cattle Report (Feb. 18, 2006), 
available on-line at http://www.agcenter.com/cattlereport.asp.
    \28\ ``The Markets,'' AgCenter Cattle Report (Feb. 18, 2006), 
available on-line at http://www.agcenter.com/cattlereport.asp.
---------------------------------------------------------------------------
    Whether the beef packers' simultaneous boycott of the cash market 
was deliberately coordinated or not, it was a highly unusual event that 
required simultaneous action in order to effectively drive down prices, 
which it did. As market analysts observed, the major question in 
markets during the second week of the buyers' strike was whether or not 
any one of the major beef manufacturers would ``break ranks'' to 
purchase at higher prices than the other beef manufacturers. No buyer 
did so until prices began to fall. In fact, beef packers were willing 
to cut production rather than break ranks and purchase on the cash 
market.
    Abandonment of the cash market in the Southern Plains by all major 
beef manufacturers for 2 weeks in a row resulted in lower prices and 
had an adverse effect on competition. Cattle producers in the Southern 
Plains cash markets during those two weeks were unable to sell their 
product until prices fell to a level that the buyers would finally 
accept. The simultaneous refusal to engage in the market did not just 
have an adverse effect on competition--it effectively precluded 
competition altogether by closing down an important market for sellers. 
The simultaneous boycott of cash markets in the Southern Plains was, 
however, a business decision on the part of the beef packers that did 
not conform to normal business practices and that resulted in a marked 
decline in cattle prices. At the time, market analysts interpreted the 
refusal to participate in the cash market as a strategy to drive down 
prices, and purchases only resumed once prices began to fall.
    The coordinated/simultaneous action in February 2006 was not 
isolated and was soon followed by a second, coordinated/simultaneous 
action. During the week that ended October 13, 2006, three of the 
nation's four largest beef packers--Tyson, Swift, and National--
announced simultaneously that they would all reduce cattle slaughter, 
with some citing, inter alia, high cattle prices and tight cattle 
supplies as the reason for their cutback.\29\ During that week, the 
packers reportedly slaughtered an estimated 10,000 fewer cattle than 
the previous week, but 16,000 more cattle than they did the year 
before.\30\ Fed cattle prices still fell $2 per hundredweight to $3 per 
hundredweight and feeder prices fell $3 per hundredweight to $10 per 
hundredweight.\31\
---------------------------------------------------------------------------
    \29\ See ``National Beef Cuts Hours at Two Kansas Plants (Dodge 
City, Liberal),'' Kansas City Business Journal (October 10, 2006) 
attached as Exhibit 17; ``Update 1--Tyson Foods to Reduce Beef 
Production,'' Reuters (October 10, 2006), attached as Exhibit 18; 
``Swift to Stay with Reduced Production at U.S. Facilities,'' 
Meatpoultry.com (October 10, 2006), attached as Exhibit 19.
    \30\ See ``Livestock Market Briefs, Brownfield Ag Network,'' 
(October 13, 2006), attached as Exhibit 20.
    \31\ See id.
---------------------------------------------------------------------------
    By Friday of the next week, October 20, 2006, the beef packers 
reportedly slaughtered 14,000 more cattle than they did the week before 
and 18,000 more cattle than the year before--indicating they did not 
cut back slaughter like they said they would.\32\ Nevertheless, live 
cattle prices kept falling, with fed cattle prices down another $1 per 
hundredweight to $2 per hundredweight and feeder cattle prices were 
down another $4 per hundredweight to $8 per hundredweight.\33\
---------------------------------------------------------------------------
    \32\ See ``Livestock Market Briefs, Brownfield Ag Network,'' 
(October 20, 2006), attached as Exhibit 21.
    \33\ See id.
---------------------------------------------------------------------------
    The anti-competitive behavior exhibited by the beef packers' 
coordinated/simultaneous market actions caused severe reductions to 
U.S. live cattle prices on at least two occasions in 2006. This 
demonstrates that the exercise of abusive market power is manifest in 
the U.S. cattle industry.
    In testimony to the U.S. Senate Judiciary Subcommittee on 
Antitrust, Competition Policy, and Consumer Rights, R-CALF USA informed 
Congress on May 7, 2008, that the potential for a recurrence of this 
type of anti-competitive behavior that caused the manipulation and 
distortion of both the cash market and the futures market was 
considerable and constitutes an empirically demonstrated risk that 
would likely become more frequent, more intense, as well as extended in 
duration unless Congress took decisive, remedial action.
    R-CALF USA did not have to wait very long before evidence surfaced 
that indicated the beef packers were once again involved in 
manipulating and distorting the cash/futures market relationship. As 
discussed more fully below, R-CALF USA immediately recognized the 
symptoms of the unlawful market manipulation that occurred in the 
cattle futures market in October 2009 and formally notified Federal 
regulatory officials of the disastrous consequences to U.S. livestock 
producers resulting from that manipulation. At that time, R-CALF USA 
witnessed a severe break in the cattle futures market, likely 
indicating that a dominant market participant had shorted the market, 
causing the futures market to fall the limit. However, R-CALF USA had 
no knowledge at that time regarding which dominant market participant 
was involved. Below are actions R-CALF USA initiated in its attempts to 
address this incidence of obvious market manipulation:
    Soon after the close of the October 2009 live cattle futures 
contract month, on Dec. 9, 2009, R-CALF USA Marketing Committee 
Chairman Dennis Thornsberry submitted a formal complaint/affidavit to 
GIPSA in which he stated:

        I have used the Chicago Mercantile Exchange to hedge cattle for 
        the purpose of managing the risk associated with marketing my 
        cattle. However, the problems in the cash cattle market are 
        mirrored in the futures market as it too is subject to undue 
        influence by the dominant corporate packers and feedlots. For 
        example, on the last trading day before the October futures 
        contract expired, some outside force broke the October board, 
        causing it to fall by the full $3.00 limit to $81.65 per cwt. 
        However, the live cattle trade was at $87.50. This was among 
        the worst convergences that I have seen in the futures market 
        for a long time. It is unlikely that the futures market can 
        attract sufficient long positions to add the needed liquidity 
        to the futures market for determining the value of cattle when 
        the market remains vulnerable to those who would exercise 
        speculative short selling to effectively drive down the futures 
        price. Given that this type of volatility cannot be attributed 
        to market fundamentals (but, according to market analysts can 
        be triggered by a $50 million infusion, which is not beyond the 
        means of hedge funds and perhaps the dominant beef packers), 
        small to mid-sized producers would not have the financial 
        wherewithal to cover the margin calls associated with such a 
        volatile market. This, I believe, plays directly into the hands 
        of the large corporations that use the markets daily to gain an 
        advantage over the small to mid-sized producer. And, the 
        volatility in the futures market caused by manipulative 
        practices has rendered it incapable of serving as a risk 
        management tool for the small to mid-sized producer and is 
        contributing to the exodus of these producers from the 
        industry.

    Later, in its formal comments submitted December 31, 2009, to both 
the U.S. Department of Justice (``Justice Department'') and USDA 
regarding the two agencies' joint investigation on Agriculture and 
Antitrust Enforcement Issues in Our 21st Century Economy, R-CALF USA 
provided the same evidence that indicated that the beef packers' 
manipulation of the cash market is mirrored in the futures market where 
they also exercise abusive market power. R-CALF USA stated:

        R-CALF USA is concerned that beef packers are able to 
        significantly influence the commodities futures market, 
        rendering it unsuitable for managing the risks of independent 
        cattle producers. Practices such as shorting the market to 
        drive down both cash and futures prices, particularly on the 
        last trading day of the month before futures contracts expire 
        are a form of market manipulation. The October 2009 futures 
        board, e.g., broke the limit down on the last trading day in 
        October, causing an unprecedented number of live cattle 
        deliveries to occur. Based on information and belief, the 
        manipulative practices by the beef packers in the commodities 
        futures market has created a disinterest among speculators who 
        would otherwise participate in long speculative positions in 
        the market. The lack of speculative long positions in the 
        market may well be depressing the cash and futures market by 
        several dollars per hundredweight and reducing the utility of 
        the commodity futures market as a risk management tool for 
        cattle producers. R-CALF USA urges the Department of Justice 
        and USDA to investigate the beef packers' activities in the 
        commodities futures market.

    Later, on April 26, 2010, R-CALF USA submitted formal comments to 
the CFTC concerning its proposed Federal speculative position limits 
under the Wall Street Reform Act and informed the agency of R-CALF 
USA's concern that dominant beef packers were manipulating the cattle 
futures market to lower the price of live cattle. R-CALF USA provided 
the CFTC with the information that originated in Mr. Thornsberry's 
complaint/affidavit to GIPSA to substantiate R-CALF USA's concern that 
dominant market participants were manipulating the cattle futures 
market:

        Evidence, albeit anecdotal, that the cattle futures market is 
        subject to undue influence by dominant market participants 
        includes market events that occurred in October 2009. On the 
        last trading day before the October 2009 futures contract 
        expired, some outside force broke the October board, causing it 
        to fall by the full $3.00 limit to $81.65 per cwt. However, the 
        live cattle trade was at $87.50, resulting in an unexplained 
        convergence that is suggestive of direct manipulation.

    Just last Monday, on Feb. 7, 2011, the CFTC issued an announcement 
stating it had ordered Chicago-based futures commission merchant 
Newedge USA, LLC (``Newedge'') to pay more than $220,000 for violating 
speculative position limits in live cattle futures trading.\34\ In its 
announcement, the CFTC stated that one of the nation's largest beef 
packers, JBS USA, LLC (``JBS''), was involved in the transaction that 
led to the CFTC's remedial sanction.
---------------------------------------------------------------------------
    \34\ See CFTC Orders Chicago-Based Futures Commission Merchant 
Newedge USA, LLC to Pay More than $220,000 for Violating Speculative 
Position Limits in Live Cattle Futures Trading, U.S. Commodity Futures 
Trading Commission, Release PR5981-11, Feb. 7, 2011, available at 
http://www.cftc.gov/PressRoom/PressReleases/pr5981-11.html.
---------------------------------------------------------------------------
    According to the CFTC order issued in this matter, Newedge 
purchased 4,495 October 2009 live cattle futures contracts on the CME 
from their client JBS, and then Newedge sold JBS an over-the-counter 
swap (OTC) in live cattle on Oct. 9, 2009--a transaction that caused 
Newedge to exceed the 450 contract speculative limit for trading live 
cattle by 4,045 contracts.\35\ The CFTC order further states of the 
transaction: ``On Friday, October 9, 2009, Newedge and JBS, a live 
cattle end-user, agreed that JBS would sell Newedge 4,495 contract long 
October 2009 live cattle futures position. Newedge would hedge the 
purchase with a short position in an underlying swap in live cattle and 
sell JBS a live cattle swap.'' \36\ The CFTC order also stated that 
Newedge earned $80,910 in total profit and commissions on related 
transactions with JBS.\37\
---------------------------------------------------------------------------
    \35\ See CFTC Docket No: 11-07, Order Instituting Proceedings 
Pursuant to Section 6(c) and 6(d) of the Commodity Exchange Act, Making 
Findings and Imposing Remedial Sanctions, U.S. Commodity Futures 
Trading Commission, Feb. 7, 2011, available at http://www.cftc.gov/ucm/
groups/public/@lrenforcementactions/documents/legalpleading/
enfnewedgeorder020711.pdf.
    \36\ Ibid.
    \37\ Ibid.
---------------------------------------------------------------------------
    We applaud the CFTC for taking this enforcement action, which, 
according to the CFTC's order in this matter, was taken pursuant to the 
Commodity Exchange Act, the Food, Conservation, and Energy Act of 2008, 
the new Wall Street Reform Act, and CFTC regulations. The CFTC has 
taken decisive steps to ensure that dominant market participants are 
not exercising abusive market power to manipulate and distort the 
cattle futures market. Though three Federal agencies were informed 
about this incident, to our knowledge only the CFTC took the initiative 
to investigate and enforce this unlawful action. R-CALF USA believes 
the October 2009 live cattle futures market transaction that involved 
both Newedge and JBS, and in which Newedge was known to have engaged in 
unlawful activity, was a significant, contributing cause for the 
manipulation of the cattle futures price and resulting harm to U.S. 
cattle producers. Further, and based on the available information, we 
believe JBS' involvement in this transaction constitutes a direct 
violation of the Packers and Stockyards Act of 1921 (``PSA'') that 
prohibits beef packers from engaging in any course of business or do 
any act for the purpose or with the effect of manipulating or 
controlling prices.\38\ For those reasons, R-CALF USA has formally 
requested GIPSA and the Justice Department to immediately initiate a 
PSA enforcement action against JBS for its role in the debilitating 
cattle futures market transaction that occurred in October 2009.
---------------------------------------------------------------------------
    \38\ See 7 U.S.C.  192(e).
---------------------------------------------------------------------------
III. The Dire Need for Sweeping Futures Market Reform
    R-CALF USA is a member of the Commodity Markets Oversight Coalition 
(``CMOC''), which is an independent, non-partisan and nonprofit 
alliance of groups that represent commodity-dependent industries, 
businesses and end-users, including American consumers, that rely on 
functional, transparent and competitive commodity derivatives markets 
as a hedging and price discovery tool. The CMOC strongly supported 
Congressional reforms to the commodity futures market and is actively 
involved in the CFTC's rulemaking process to fully and expeditiously 
implement the Wall Street Reform Act.
    R-CALF USA is particularly concerned with the practice whereby 
large beef packers, which are legitimate hedgers for a certain volume 
of cattle, enter the commodity futures markets also as speculators with 
the intent and effect of manipulating the futures (and hence the cash 
price) of cattle. These beef packers should not be entitled to the end-
user exception for speculative trades beyond their physical needs for 
slaughter cattle.
    R-CALF USA has urged the CFTC to use its rulemaking authority to 
fully restore the cattle futures market to its original purpose of 
affording U.S. cattle producers a useful risk-management marketing tool 
void of distortion and manipulation by certain speculators and other 
dominant market participants (i.e., beef packers). As previously 
mentioned, United States cattle producers sell their cattle into one of 
the most highly concentrated marketing structures in the U.S. economy. 
Inherent to this high level of market concentration is substantial 
disparity between the economic power of the hundreds of thousands of 
disaggregated U.S. cattle producers (i.e., cattle sellers) and the 
economic power wielded by very few beef packers (i.e., cattle buyers).

A. The Futures Market for Live Cattle Is Fundamentally Broken
    R-CALF USA believes the commodities futures market is fundamentally 
broken and no longer functionally capable of serving as an effective, 
economic risk management tool for U.S. cattle producers. Rather than to 
provide true price discovery, the live cattle futures market has become 
a device that enhances the ability of dominant market participants to 
manage and manipulate both live cattle futures prices and cash cattle 
prices.
    Evidence that the live cattle futures market is no longer 
functionally capable of serving as an effective risk management tool 
for U.S. cattle producers includes data that show the physical hedgers 
share of the long open interest in the feeder cattle futures market and 
the live cattle futures market declined from 52.4 percent and 67.6 
percent, respectively, in 1998 to only 17 percent and 11.7 percent, 
respectively, in 2008.\39\ Such a drastic decline in the physical 
hedgers open interests in just a 10 year period in these commodities 
show either or both that commercial (i.e., bona fide hedgers) interests 
are now avoiding the futures market (which they would not do if the 
market served an economically beneficial function) and/or speculator 
interests have now besieged the markets once dominated by actual 
sellers and buyers of the commodities.
---------------------------------------------------------------------------
    \39\ See The Accidental Hunt Brothers: How Institutional Investors 
Are Driving Up Food and Energy Prices, Michael W. Masters and Adam K. 
White, CFA, Table 10: Commodities Futures Markets--Long Open Interests 
Composition, July 31, 2008, at 34, available at http://
accidentalhuntbrothers.com/wp-content/uploads/2008/09/accidental-hunt-
brothers-080731.pdf.
---------------------------------------------------------------------------
    The consolidation and concentration that already has occurred in 
the beef packing industry is now occurring at a rapid rate in the 
feedlot sector of the U.S. cattle industry, thereby exacerbating the 
ongoing thinning of the numbers of bona fide hedgers participating in 
the cattle futures market. For example, the numbers of U.S. feedlots 
that purchase feeder cattle and sell fed cattle have declined 
drastically in recent years. Today just 58 of the 2,170 feedlots with 
capacities of more than 1,000 head feed approximately seven million of 
the approximately 26 million cattle fed and marketed, representing over 
\1/4\ of all the fed cattle in 2008.\40\ As shown below, the number of 
smaller U.S. feedlots, those with capacities of less than 1,000 head, 
has declined sharply over the past 13 years, with nearly 30,000 
feedlots having exited the industry since 1996.\41\
---------------------------------------------------------------------------
    \40\ See Cattle on Feed, USDA, NASS, Feb. 20, 2009, at 14.
    \41\ See Cattle, Final Estimates, various reports, 1996-2008, USDA, 
National Agricultural Statistics Service (hereafter ``NASS''); see also 
Cattle on Feed, USDA, NASS, Feb. 20, 2009.
---------------------------------------------------------------------------
Decline in Numbers of U.S. Feedlots
1996-2008




    As a result of the worsening economic disparity caused by the 
ongoing consolidation and concentration of the U.S. cattle market, the 
remaining cattle producers, some of whom continue to rely on futures 
markets to offset price risk, are vulnerable to any market distortions 
caused by beef packers that may not only participate in the futures 
market as physical hedgers, but as significant speculators as well. The 
cattle futures market is susceptible to downward price movements--in 
contradiction of supply/demand fundamentals, when, e.g., beef packers, 
who may hold a physical hedging position in the market, also engage in 
substantial speculative short selling of the market. The effect of the 
beef packers' speculative short selling is to lower not only the 
futures market price, but also the cash spot market price, which is 
intrinsically tied to the futures market.
    Another troubling development in the U.S. cattle market is that the 
same concentrated beef packers, who are the dominant purchasers of fed 
cattle, are fast becoming dominant purchasers of feeder cattle through 
their expanded feedlot holdings. Of the nations four largest feedlot 
companies, JBS Five Rivers Ranch Cattle Feeding; Cactus Feeders, Inc.; 
Cargill Cattle Feeders, LLC; and, Friona Industries, LP,\42\ two, 
including the largest, are owned by two of the largest beef packers, 
JBS and Cargill. Thus, the beef packers' ongoing infiltration into the 
cattle feeding industry means that dominant participants in both the 
feeder cattle futures market and the live cattle futures market now 
have an economic interest in lowering both feeder cattle prices and fed 
cattle prices.
---------------------------------------------------------------------------
    \42\ See Recent Acquisitions of U.S. Meat Companies, Congressional 
Research Service, 7-5700, RS22980, March 10, 2009, at 2.
---------------------------------------------------------------------------
    It is R-CALF USA's belief that futures market prices directly and 
significantly influence prices for all classes of cattle, including fed 
cattle, feeder cattle, stocker calves, and breeding stock, regardless 
of whether or not these cattle are included under any futures contract. 
For this reason, it is imperative that the futures market be protected 
from unfair, manipulative, and speculative practices that effectively 
distort the U.S. cattle market.

B. The Cattle Futures Market Must Be Protected From Manipulation by 
        Speculators With a Vested Interest in the Prices for Cattle
    R-CALF USA believes the ongoing distortions to and manipulation of 
the cattle futures markets, particularly those that we believe are 
perpetrated through speculative short selling by one or more dominant 
beef packers and/or other concentrated/dominant traders, can be 
rectified within the CFTC's rulemaking by prohibiting traders holding 
positions pursuant to a bona fide hedge exemption from also trading 
speculatively.\43\ To be effective, this provision would need to apply 
to any subsidiary, affiliate, or other related entity of the bona fide 
hedger, particularly with respect to a dominant beef packer.
---------------------------------------------------------------------------
    \43\ See 75 Fed. Reg. 4159.
---------------------------------------------------------------------------
C. The Cattle Futures Market Must Be Protected From Distortions Caused 
        by Excessive Speculation
    Like other commodity futures markets, the futures market for live 
cattle is highly susceptible to market distortion should excessive 
liquidity be introduced in the form of excessive speculation. The 
remaining participants in the U.S. live cattle industry, whose numbers 
have already been reduced by an alarming 40 percent since 1980,\44\ 
operate on slim margins and are highly vulnerable to even small changes 
in cattle prices.\45\ As a result, cattle producers are particularly 
susceptible to financial failure caused by both market volatility and 
market distortions created by excessive speculation that can swing 
prices low, even for short periods, as they are operating in an 
industry already suffering from a long-run lack of profitability. In 
addition, small to mid-sized cattle producers do not have sufficiently 
deep pockets to cover margin calls associated with market volatility 
caused by excessive speculation, which, we believe, has rendered the 
cattle futures markets incapable of serving as an effective risk 
management tool for the small to mid-sized producer and is contributing 
to the ongoing exodus of these producers from the U.S. cattle industry.
---------------------------------------------------------------------------
    \44\ The size of the U.S. cattle industry, as measured by the 
number of cattle operations in the U.S., declined from 1.6 million in 
1980 to 983,000 in 2005 and further declined to 967,400 in 2007. See 
Fed. Reg. Vol. 72, No. 152, Wednesday, August 8, 2007, at 44681, col. 
2.
    \45\ See A Review of Causes for and Consequences of Economic 
Concentration in the U.S. Meatpacking Industry, Clement E. Ward, 
Current Agriculture Food and Resource Issues, 2001, at 2 (``[E]ven 
seemingly small impacts on a $/cwt. basis may make substantial 
difference to livestock producers and rival meatpacking firms operating 
at the margin of remaining viable or being forced to exit an 
industry.'').
---------------------------------------------------------------------------
    R-CALF USA believes the ongoing distortions to the cattle futures 
market, particularly those we believe are created by excessive 
speculation, can be rectified within the CFTC's rulemaking with a 
provision that would limit speculative positions by index funds and 
other trading entities that have no specific interest in the underlying 
commodity and bear no risk relative to the commodity's production or 
consumption. To achieve the goal of effectively preventing excessive 
speculation, which is known to facilitate abrupt price movements and 
price distortions in other futures markets,\46\ we are inclined to 
agree with the recommendation made by Michael W. Masters:
---------------------------------------------------------------------------
    \46\ See, e.g., 75 Fed. Reg. 4148, col. 3.

        As a general rule of thumb, speculators should never represent 
        more than 50% of open interest, because at that level, they 
        will dominate the price discovery function, due to the 
        aggressiveness and frequency of their trading. The level I 
        recommend is 25%; this will provide sufficient liquidity, while 
        ensuring that physical producers and consumers dominate the 
        price discovery function.\47\
---------------------------------------------------------------------------
    \47\ Testimony of Michael W. Masters, Managing Member/Portfolio 
Manager, Masters Capital Management, LLC, before the Commodities 
Futures Trading Commission, March 25, 2010.
---------------------------------------------------------------------------
D. The Cattle Industry Must Be Protected From Distortions in Feed Grain 
        Prices Caused Also by Excessive Speculation
    Because feed grains are a major component of production costs for 
fed cattle, the price of feed grains is a major consideration by bona 
fide hedgers when formulating expectations for future cattle prices. If 
feed grain prices are expected to rise--thus increasing the cost of 
cattle production--without a corresponding expectation that beef prices 
also will rise, cattle feeders will attempt to offset the expectation 
of higher feed grain prices by purchasing feeder cattle at lower 
prices. The relationship between feed grain prices and cattle-feeder 
profitability has long influenced pricing decisions by bona fide 
hedgers. If, however, feed grain prices are themselves subject to non-
market forces such as excessive speculation, as they were during the 
2008 commodity bubble, the profitability of cattle feeders can be 
immediately affected. And, this lack of profitability, or reduced 
profitability, immediately translates into a perception that feeder 
cattle must be purchased at lower prices to offset the resulting 
increase in production costs. Thus, distortions in futures feed grain 
prices result in distortions to cattle futures prices and must be 
eliminated. R-CALF USA believes that effective speculative position 
limits imposed on all feed grain commodities markets would alleviate 
the transference of market distortions from the feed grains futures 
market to the cattle futures market.

E. The CFTC Should Consider Additional Reforms To Protect the Integrity 
        of the Cattle Futures Market
    R-CALF USA has urged the CFTC to ensure that the cattle futures 
market is always dominated by bona fide hedgers. In addition, it has 
urged the CFTC to strictly curtail the practice of allowing passive 
speculation in the commodities futures market by entities that hold 
large market positions without any interest in the underlying commodity 
and without any risk relative to the commodity's production or 
consumption. R-CALF USA further believes it important that the CFTC 
recognize the two types of excessive speculation that has invaded the 
cattle futures market: (1) the excessive speculation by one or more 
dominant market participants with market shares sufficient to engage in 
market manipulation (this can include dominant beef packers acting 
speculatively as discussed above or any other concentrated/dominant 
speculator), and (2) the excessive speculation by those without any 
vested interest in the underlying commodity and without any risk 
relative to the commodity's production or consumption (including both 
active and passive speculators). Both of these types of excessive 
speculation contribute to market distortions that are harmful to bona 
fide market participants, as well as to consumers who ultimately 
consume products derived from these commodities.
    To achieve an optimal level of liquidity provided by speculators, 
it would be important that the actual speculative position limits for 
one or more concentrated/dominant speculators and the overall actual 
limit of speculation in the cattle futures market be established by 
bona fide hedgers in the futures market and adjusted by them from time-
to-time as conditions may warrant. Further, the CFTC should restore 
daily market price limits to levels that minimize market volatility. 
The previous daily market limit in the cattle futures market of $1.50, 
which could still be adjusted upward following extended periods of 
limit movement, resulted in far less volatility than the current $3.00 
daily market limit. Finally, R-CALF USA seeks reform to the practice of 
allowing cash settlements on futures contracts in lieu of actual 
delivery of the commodity, a practice that effectively lowers the 
cattle futures price on the day of contract expiration.

IV. Like Cattle Producers, Consumers Are Being Harmed by the 
        Dysfunctional Cash and Futures Markets in the U.S. Cattle 
        Industry
    The USDA Economic Research Service (``ERS'') states that the price 
spread data it reports can be used to ``measure the efficiency and 
equity of the food marketing system,'' \48\ and ``increasing price 
spreads can both inflate retail prices and deflate farm price.'' \49\ 
According to ERS, ``[h]igher price spreads translate into lower prices 
for livestock,'' \50\ innovative technologies can reduce price spreads 
and economic efficiency increases when price spreads drop,\51\ and 
``[b]oth consumers and farmers can gain if the food marketing system 
becomes more efficient and price spreads drop.'' \52\ Thus, if U.S. 
cattle markets were functioning properly and the ongoing concentration 
and consolidation of U.S. cattle markets were creating efficient 
economies of scale, then the spread between cattle prices and consumer 
beef prices would be expected to narrow over time. However, this is the 
opposite of what has occurred within the present marketing system. As 
shown below, the price spreads between ranch gate prices (i.e., cattle 
prices) and retail prices (i.e., prices paid by consumers) have been 
steadily increasing over time.
---------------------------------------------------------------------------
    \48\ Beef and Pork Values and Price Spreads Explained, U.S. 
Department of Agriculture, Economic Research Service, at 3.
    \49\ Id. at 2.
    \50\ Id. at 8.
    \51\ Id. at 3.
    \52\ Ibid.
---------------------------------------------------------------------------
Consumers' Retail Beef Prices Compared To Cattle Prices
Jan. 1980-May 2010




    It is clear that both consumers and producers are being harmed by 
the current marketing structure that is creating increased price 
spreads, which means the marketplace is becoming less innovative and 
less inefficient. USDA found in 2004 that ``the total price spreads 
show a weak upward trend when corrected for inflation,'' \53\ and this 
upward trend has only worsened since 2004. The ever-increasing price 
spread between ranch gate prices for cattle and retail prices for beef 
is further evidence of the broken cash and futures markets in the U.S. 
cattle industry where price discovery occurs. R-CALF USA believes this 
market anomaly is caused by the unrestrained exercise of market power 
by dominant industry participants and results in the exploitation of 
both consumers and producers.
---------------------------------------------------------------------------
    \53\ See Beef and Pork Values and Price Spreads Explained, U.S. 
Department of Agriculture, Economic Research Service, at 10.
---------------------------------------------------------------------------
V. Conclusion
    R-CALF USA encourages Congress to continue its efforts to implement 
sweeping changes that will improve market transparency and eliminate 
manipulation and other anti-competitive practices that have caused 
artificial price distortions in the commodities futures market and 
relegated the cattle futures market to an ineffective tool for price 
discovery and risk management for U.S. cattle producers. We urge 
Congress to support CFTC's rulemaking as well as to ensure that the 
agency has sufficient funding to effectively carry out the new 
responsibilities Congress mandated in the Wall Street Reform Act.
    The integrity of the cattle futures market will depend on Congress' 
and CFTC's ability to impart the greatest transparency possible into 
the cattle futures market and on a sincere effort by both Congress and 
the CFTC to address the causes of volatility in the cattle futures 
market that are unrelated to underlying commodity fundamentals. We 
firmly believe that Congress and the CFTC are on the right track for 
restoring the cattle futures market to its original purpose of 
providing buyers and sellers with both a risk management tool that also 
can serve an important price discovery function by reflecting the 
legitimate market signals of supply and demand.
            Respectfully,

            
            

    The Chairman. We will now go to Stuart Kaswell, General 
Counsel, Managed Funds Association, Washington, D.C.
    Mr. Kaswell, 5 minutes.

         STATEMENT OF STUART J. KASWELL, EXECUTIVE VICE
           PRESIDENT, MANAGING DIRECTOR, AND GENERAL
      COUNSEL, MANAGED FUNDS ASSOCIATION, WASHINGTON, D.C.

    Mr. Kaswell. Thank you very much, Chairman Conaway, Ranking 
Member Boswell, Members of the Subcommittee.
    I am Stuart Kaswell. I am the General Counsel of the 
Managed Funds Association, and we appreciate the opportunity to 
provide our views on the implementation of Title VII of the 
Dodd-Frank Wall Street Reform and Consumer Protection Act. MFA 
commends the Subcommittee for its diligent oversight of the new 
OTC derivatives framework.
    MFA is the voice of the global alternative investment 
industry and is the primary advocate for professionals in hedge 
funds, fund to funds, and managed futures funds as well as 
industry service providers. Our members primarily help 
pensions, university endowments and other institutions 
diversify their investments, manage risk, and generate reliable 
returns to meet their obligations to their beneficiaries.
    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 
through increased transparency and systemic risk mitigation. In 
seeking to accomplish these goals, it is important to ensure 
that the implementation of Title VII proceeds in a thoughtful, 
logical fashion that strengthens the derivatives markets and 
does not impair market participants' ability to mitigate risks 
through swaps.
    We support the implementation of a thoughtful regulatory 
framework that will protect the public while fostering 
legitimate economic activity. Therefore, we believe regulators 
should gather data and complete more empirical analysis before 
adopting new rules. We think regulators can accomplish this in 
a quick and efficient manner that properly balances the desire 
to move forward toward central clearing--sorry--to move 
promptly towards central clearing with a need to develop rules 
through a deliberative process.
    We also ask that regulators continue to coordinate to 
ensure consistent implementation and harmonization. MFA 
supports policymakers' efforts to reduce systemic risk by 
requiring central clearing and data gathering about swaps. We 
believe that central clearing will play an essential role in 
reducing systemic, operational and counterparty risk, and will 
enhance market transparency, competition and regulatory 
efficiencies.
    Since the beginning of this important debate, MFA has 
supported central clearing, and we urge regulators to move with 
alacrity to implement it.
    The success of central clearing and data gathering will 
depend on the structured governance and financial soundness of 
derivatives clearing organizations, data repositories, swap 
execution facilities, and designated contract markets. We 
strongly believe that there is a need for those entities to 
have transparent, irrevocable risk models that enable fair and 
open access, incentivize competition and reduce barriers to 
entry.
    We also believe that it is important to have customer 
representation on the governance and risk committees of 
derivatives clearing organizations and for no one group to 
constitute a controlling majority.
    In addition, MFA believes several other Title VII 
provisions can further protect against the risk of future 
systemic events. Among those measures is segregation of 
customer collateral for swaps. We believe that the right to 
elect individual segregation of customer initial margin on 
commercially reasonable terms is essential for effective OTC 
derivatives regulation.
    For non-cleared swaps, we support the CFTC's efforts to 
require segregation of customer collateral using tri-party 
arrangements. While some customers have individually been able 
to negotiate these types of agreements, we believe all 
customers should have the right to this protection, which can 
help avoid the type of systemic event we witnessed with the 
collapse of Lehman Brothers.
    For cleared swaps, MFA supports complete segregation of 
customers' initial margin at both the futures commission 
merchant and the central counterparty levels. We think this 
level of segregation provides the greatest protection of 
customer assets and provides for portability in the event of a 
default.
    We are concerned that the CFTC appears to be moving away 
from complete segregation for customer collateral posted on 
cleared swaps. We encourage policymakers to recommend that the 
CFTC conduct or sponsor an independent comparative cost study 
that thoroughly examines the direct and external costs of 
segregation before adopting any rule.
    Last, the CFTC and SEC recently issued a joint proposed 
rule intended to further clarify which entities meet this major 
swap participant definition, a new category created by the 
legislation. Because entities that become MSPs will be subject 
to significant regulatory obligations, including new capital 
requirements, as well as a number of business conduct and other 
requirements, we would appreciate additional details to support 
the SEC and CFTC's proposal in order to ensure that market 
participants are clear on whether they need to register as an 
MSP.
    MFA appreciates the opportunity to testify before the 
Subcommittee, and I am happy to answer any questions.
    [The prepared statement of Mr. Kaswell follows:]

   Prepared Statement of Stuart J. Kaswell, Executive Vice President,
  Managing Director, and General Counsel, Managed Funds Association, 
                            Washington, D.C.

    Managed Funds Association (``MFA'') is pleased to provide this 
statement in connection with the House Agriculture Subcommittee on 
General Farm Commodities and Risk Management's hearing, ``[t]o review 
implementation of title VII of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act [(the `Dodd-Frank Act')], Part II'' held on 
February 15, 2011. MFA represents the majority of the world's largest 
hedge funds and is the primary advocate for sound business practices 
and industry growth for professionals in hedge funds, funds of funds 
and managed futures funds, as well as industry service providers. MFA's 
members manage a substantial portion of the approximately $1.9 trillion 
invested in absolute return strategies around the world.
    MFA's members are among the most sophisticated institutional 
investors and play an important role in our financial system. They are 
active participants in the commodity, securities and over-the-counter 
(``OTC'') derivatives markets. They provide liquidity and price 
discovery to capital markets, capital to companies seeking to grow or 
improve their businesses, and important investment options to investors 
seeking to increase portfolio returns with less risk, such as pension 
funds trying to meet their future obligations to plan beneficiaries. 
MFA members engage in a variety of investment strategies across many 
different asset classes. The growth and diversification of investment 
funds have strengthened U.S. capital markets and provided investors 
with the means to diversify their investments, thereby reducing overall 
portfolio investment risk. As investors, MFA members help dampen market 
volatility by providing liquidity and pricing efficiency across many 
markets. Each of these functions is critical to the orderly operation 
of our capital markets and our financial system as a whole.
    In addition, MFA members are active participants in the OTC 
derivatives markets, where they use swaps to, among other things, hedge 
risk. For example, an asset manager that has investments denominated in 
foreign currencies may engage in a currency swap to hedge against the 
risk of currency fluctuations and protect its portfolio from such 
related losses. As active participants in the derivatives markets, MFA 
members also play a critical role in enabling commercial and other 
institutional market participants to reduce their commercial or balance 
sheet risk through the use of swaps. For example, corporate end-users 
may purchase a credit default swap from a dealer to protect themselves 
from the default of another corporation, or a pension fund may purchase 
a variance swap from a dealer to protect against stock market 
volatility and to ensure that it can meet its future obligations to 
pensioners. In such scenarios, dealers generally look to balance their 
books by purchasing offsetting protection from market participants who 
may be better positioned to manage such risk, such as hedge funds. 
Dealers would be limited in the amount of protection they could offer 
their customers if there were no market participants willing to 
purchase or sell protection to mitigate a dealer's risk.
    MFA members depend on reliable counterparties and market stability. 
As such, we have a strong interest in promoting the integrity and 
proper functioning of the OTC derivatives markets, and in ensuring that 
new regulations appropriately address counterparty and systemic risk, 
and protect customers' collateral by requiring a clearing organization 
to hold, and a swap dealer to offer to hold, customer funds in 
individually segregated accounts, which are protected in the event of 
bankruptcy. MFA is fully supportive of policymakers' goals to improve 
the functioning of the markets and protect customers by promoting 
central clearing of derivatives, increasing transparency and 
implementing other measures intended to mitigate systemic risk. MFA 
believes that smart regulation will improve efficiency and 
competitiveness in the OTC derivatives markets, reduce counterparty and 
systemic risk, and help regulators identify cases of market 
manipulation or other abuses.
    MFA appreciates the Committee's review of the implementation of 
Title VII of the Dodd-Frank Act. We provide a number of comments, which 
we believe are consistent with the Committee's public policy goals and 
will further enhance the benefits of OTC derivatives regulation. We 
would like to work with the Subcommittee, the CFTC and any other 
interested parties in addressing these issues and are committed in 
working towards regulations that will restore investor confidence, 
stabilize our financial markets, and strengthen our nation's economy.

Protecting the Integrity of the Regulatory Process
    MFA recognizes that the Dodd-Frank Act mandates regulators to 
promulgate a record number of new regulations within 360 days of its 
enactment, and commends regulators for their diligence and dedication 
to implementing a new OTC derivatives regulatory framework. 
Nevertheless, we offer a few recommendations to further encourage the 
Committee, in its oversight role, to ensure and protect the integrity 
of the regulatory process.
    The OTC derivatives markets play an important role in our economy 
because OTC derivatives have become an important tool for market 
participants to mitigate risk. MFA supports a formal OTC derivatives 
regulatory framework as we believe smart regulation will reduce 
systemic and counterparty risk, and enhance market efficiency, 
competition and investor protection. We are concerned however, that at 
times the current regulatory process has been overly focused on 
quantity over quality of regulations.
    In order to establish a regulatory framework that achieves the 
goals of policymakers, it is important to ensure that the 
implementation of Title VII proceeds in a thoughtful, logical fashion 
that strengthens the derivatives markets and does not impair market 
participants' ability to mitigate risk through swaps. In this respect, 
we note, as an example, that it has been a challenge responding to 
proposals on the regulatory requirements of certain entities prior to 
understanding how the specific entities are proposed to be, or will be, 
defined.
    MFA also respectfully urges the Committee to encourage regulators 
to enhance coordination and consistency of their regulations, where 
applicable, and reduce duplicative regulation. The reality of more and 
more market participants diversifying their trading strategies and 
business ventures is that more entities will find that they need to 
register with both the Commodity Futures Trading Commission (``CFTC'') 
and Securities and Exchange Commission (``SEC''). Inconsistent 
regulations will be costly, burdensome and, in some cases, impossible 
for market participants to comply with both regimes. We believe 
regulators should also work together to reduce duplicative regulation. 
This would be a more efficient use of government resources, as well as 
reduce the regulatory costs and burdens on market participants and 
their customers.

Central Clearing and Access To Clearing Significant Entities
    MFA supports policymakers' efforts to reduce systemic risk through 
proliferating central clearing and enhancing transparency. We believe 
that central clearing will play an essential role in reducing systemic, 
operational and counterparty risk. While we expect a bilateral market 
to remain for market participants to customize their business and risk 
management needs, we believe that mandatory clearing and gathering of 
data by swap data repositories (``SDRs''), to the extent practicable, 
are key first steps that will offer increased regulatory and market 
efficiencies, greater market transparency and competition. Therefore, 
it is important to move with alacrity towards central clearing.
    As customers, we recognize that the success of central clearing and 
the gathering of data will depend on the structure, governance and 
financial soundness of derivatives clearing organizations (``DCOs''), 
SDRs, swap execution facilities (``SEFs'') and designated contract 
markets (``DCMs''). Accordingly, we emphasize the need for DCOs, 
wherever applicable, to have transparent and replicable risk models and 
to enable fair and open access in a manner that incentivizes 
competition and reduces barriers to entry. Thus, from a customer 
protection perspective, we believe it is important to have customer 
representation on the governance and risk committees of DCOs because 
given the critical decisions such committees will make (e.g., decisions 
about which classes of swaps the DCO is permitted to clear), they will 
benefit from the perspective of such significant and longstanding 
market participants. We also believe that to completely effectuate fair 
representation and balanced governance, it is critical that the CFTC 
adopt regulations that prohibit any group from constituting a 
controlling majority of DCO boards or risk committees.
    With respect to DCOs, DCMs and SEFs, MFA appreciates that the CFTC 
has proposed rules intended to ensure that these crucial entities are 
governed in a manner that prevents conflicts of interest from 
undermining the CFTC's mission to reduce risk, increase transparency 
and promote market integrity within the financial system. We very much 
appreciate that the proposed rules reflect the CFTC's detailed 
appraisal of market concerns, and we believe the rules are a critical 
step towards mitigating conflicts of interest at DCOs, DCMs and SEFs 
while preserving their competitiveness and ability to provide the best 
possible services to the markets.
    With respect to SDRs, we emphasize that their role as data 
collectors is critical to providing transparency and greater 
information about the financial markets. We believe that the data 
received by SDRs and shared with regulators will form an essential 
component of the regulatory process by providing regulators with the 
information necessary to refine their regulations and to effectively 
oversee the markets and market participants.

Segregation of Customer Collateral
    MFA supports measures aimed at increasing protections for customer 
assets posted as collateral for swaps. Therefore, with respect to 
uncleared swaps, we support the legislation's requirement that swap 
dealers (``SDs'') offer their customers the option to segregate initial 
margin in a custodial account, separate from the assets and other 
property of the SD. Similarly, we support indications from the CFTC 
that they intend to require segregation of customer collateral for 
uncleared swaps be pursuant to custodial agreements where the SD or 
MSP, custodian and customer are all parties (i.e., tri-party 
agreements). It is essential that counterparties have the right to 
elect individual segregation of initial margin for uncleared swaps on 
commercially reasonable terms because it not only protects customer 
property in the event of an SD or MSP default, but also ensures the 
stability and integrity of the OTC derivatives markets.
    While the CFTC's proposed rule for uncleared swaps seems to imply 
that an SD or MSP is required to offer segregation of initial margin to 
its counterparty in the form of a tri-party agreement, policymakers 
should recommend that the CFTC explicitly clarify that use of a tri-
party agreement is required. Many of our largest members have already 
negotiated tri-party agreements with respect to their initial margin 
for uncleared swaps, but we believe all counterparties should have the 
right to these protections, which will help to prevent harm to 
counterparties and the markets.
    However, we recognize that tri-party agreements are only one of 
several arrangements through which counterparties might protect their 
collateral delivered as margin for uncleared swaps. As a result, we 
appreciate that the CFTC has retained the flexibility for 
counterparties to accept a less secure form of segregation. We agree 
that market participants' should have the freedom to use any form of 
negotiated collateral arrangement they so choose.
    For cleared swaps, MFA applauds policymakers' decision in the 
legislation to prohibit futures commission merchants (``FCMs'') from 
treating a customer's margin as its own and from commingling their 
proprietary assets with those of their customers. We agree that 
segregation of assets is a critical component to the effective 
functioning of the mandatory clearing regime and necessary to ensure 
that customer assets are protected in the event of the FCM's 
insolvency. Because we support the protection of customers, we are 
concerned that the CFTC appears to be moving away from requiring the 
use of individual customer segregated accounts for cleared swaps.
    The comment period recently closed on a CFTC advanced notice of 
proposed rulemaking, where the CFTC solicited comment on four potential 
segregation models for collateral posted on cleared swaps. Out of the 
CFTC's four proposed models, we believe that only the full segregation 
model offers strong protections for customer collateral in the event of 
an FCM default and allows for efficient transfer of customer positions 
and collateral in the event of an FCM default.
    MFA recognizes that other market participants have provided the 
CFTC with conflicting views on the expense of the proposed segregation 
models. We believe current cost estimates associated with the use of 
the full physical segregation model may be overstated. To determine 
which proposed model best accomplishes the goals of the legislation and 
the CFTC, we strongly urge policymakers to recommend that the CFTC 
conduct or sponsor an independent, comparative cost study of each 
segregation option before adopting any particular model, and require 
the CFTC to provide market participants sufficient time to evaluate the 
study results and respond. If the study concludes that adopting full 
physical segregation for cleared swaps would not impose inordinate 
costs on customers, we strongly urge adoption of this model in order to 
best protect customer assets and allow for the transfer of customer 
accounts and related assets.

Definition of Major Swap Participant
    The legislation provides a definition for a new category of market 
participant called ``major swap participants'' (``MSPs''). Because 
entities that become MSPs will be subject to significant regulatory 
obligations, including new capital requirements as well as a number of 
business conduct and other requirements, the way in which this 
important term is defined will significantly affect the evolving 
markets for swaps and the conduct of participants in these markets. MFA 
believes that the MSP designation should capture systemically 
important, non-dealer market participants whose swap positions may 
adversely affect market stability. In addition, we strongly support the 
need for enhanced market standards and consistency to prevent anomalous 
and dangerous practices, such as AIG's, and which mitigate the 
excessive build-up of counterparty and systemic risk.
    The legislation gives the CFTC, jointly with the SEC, (together 
with the CFTC, the ``Commissions''), the authority to define certain 
important terms that form part of the MSP definition, such as 
``substantial position'', ``substantial counterparty exposure'' and 
``highly leveraged''. Recently, the CFTC and SEC jointly issued a 
proposed rule providing different tests and threshold levels for these 
terms in order to clarify which entities are MSPs.
    MFA supports the Commissions' general approach to the MSP 
definition and the tests for the different terms. However, we think it 
would be useful for the Commissions first to conduct an informal survey 
to determine which types of market participants will likely meet the 
definition and whether the proposed definitional thresholds are 
appropriate as proposed. We think such a survey can be conducted 
without incurring significant costs or delaying the progression of the 
regulations. In addition, we would appreciate more clarity around the 
tests, such as the effects of over-collateralization or cleared swap 
positions on the calculations, to ensure that there is a bright line 
where market participants have certainty as to whether they need to 
register as an MSP. Lastly, to be effective going forward, the 
Commissions need to ensure that their proposed rules take into account 
reasonable projections about market activity and growth, so that the 
rules capture the intended market participants.

Capital and Margin Requirements
    For market participants that must register as MSPs, the legislation 
requires that the CFTC impose capital and margin requirements on 
entities that are subject to regulation as non-bank SDs or MSPs. We are 
concerned, however, about what capital requirements the CFTC may 
impose.
    Unlike banks, our members do not hold capital, but instead manage 
assets on behalf of their investors, who have the right to redeem them 
subject to the terms of their contractual agreements. Accordingly, 
instead of holding capital, our members post margin to secure their 
obligations to their counterparties and our members are generally 
comfortable with margin requirements consistent with current market 
levels. Moreover, our members posting of margin serves a risk 
mitigation purpose functionally equivalent to the role that capital 
serves for banks (i.e., protecting our counterparties and the financial 
system against our default).
    As a result, requiring our members to hold capital would be 
inconsistent with their business structures and would materially 
increase the cost for them to enter into OTC derivatives contracts. 
Furthermore, imposing capital requirements over and above the margin 
that our members post could have significant, unintended consequences, 
including potentially precluding them from participating in the market 
altogether. Accordingly, given our members' business model, we believe 
that in setting capital requirements for non-bank MSPs, the CFTC should 
count margin posted by such non-bank MSPs towards any capital 
requirements to which they may be subject.

Position Limits
    MFA recognizes that the Dodd-Frank Act expanded the CFTC's 
authority to set position limits, as appropriate, to deter and prevent 
excessive speculation, market manipulation, squeezes and corners. 
Academic and governmental studies and real world examples show that 
policies restricting investor access to derivatives markets impair 
commercial participants' ability to hedge and restrict the use of risk 
management tools. We do not believe position limits have proven to be 
effective at reducing volatility or market manipulation.
    As a general matter, MFA believes that position limits should only 
be imposed for physically-delivered commodities and only where the 
deliverable supply of the commodity is limited and, thus, subject to 
control and manipulation. Even then, regulators need to consider the 
right size for such limits to accommodate a market's unique depth and 
liquidity needs. On the other hand, where there is a nearly 
inexhaustible supply of the underlying commodity, concerns related to 
control and manipulation are largely irrelevant, making position limits 
an unnecessary and costly interference in markets.
    Nevertheless, if the CFTC is determined to impose position limits, 
we believe it is critical for the CFTC to conduct a study on 
commodities markets for purposes of assessing the appropriateness of 
setting position limits, and, if appropriate, the level at which limits 
should be set. Regulation should be based on appropriate findings, and 
the CFTC should have data on the size of the markets before considering 
imposing position limits. We also believe it is critical for any 
position limits regulation to provide market participants with a bona 
fide hedging exemption, consistent with CFTC Regulation 1.3(z), and 
independent account controller exemptions. In this way, position limits 
regulation is less likely to unintentionally reduce market liquidity 
and the ability of market participants to appropriately diversify and 
hedge risk. Accordingly, we recommend that the Subcommittee encourage 
the CFTC to conduct a study of the commodities markets, including the 
size and number of market participants in related or equivalent OTC 
derivatives markets, prior to imposing position limits.

Swap Execution Facilities
    The legislation defines a ``swap execution facility'' (a ``SEF'') 
as ``a trading system or platform in which multiple participants have 
the ability to execute or trade swaps by accepting bids and offers made 
by multiple participants in the facility or system, through any means 
of interstate commerce, including any trading facility, that--(A) 
facilitates the execution of swaps between persons; and (B) is not a 
designated contract market.'' However, we are concerned that the CFTC 
is interpreting the definition too narrowly because its proposed rule 
requires that to qualify as a SEF a company must offer a ``many-to-
many'' quote platform (i.e., a trading platform where a market 
participant must transmit a request for a buy or sell quote to no less 
than five market participants).
    MFA believes that each SEF trading platform needs to be appropriate 
for the product type it will execute, as the characteristics and 
corresponding trading needs vary. In addition, we believe that 
permitting the broadest range of swap trading platforms (subject to the 
requirements under the legislation) would benefit investors, promote 
market-based competition among providers, and enable greater 
transparency over time and across a variety of products. Therefore, we 
would appreciate it if policymakers could provide guidance to the CFTC 
on Congress's intended interpretation of the definition, so that the 
CFTC's final rules will preserve flexibility and opportunity for 
variety and organic development among SEF trading platforms to the 
benefit of all market participants and consistent with the approach in 
other markets.
    MFA is still reviewing and analyzing the CFTC's proposal and we 
would appreciate the opportunity to provide our written comment letter 
to the Committee as an addendum to our testimony once it is complete.

Conclusion
    MFA appreciates the Subcommittee's review of the implementation of 
Title VII of the Dodd-Frank Act. As discussed, MFA believes that OTC 
derivatives regulation has the potential benefits of reducing systemic 
and counterparty risk, and enhancing market efficiency, competition and 
investor protection. We recommend that the Subcommittee encourage the 
CFTC in implementing the Dodd-Frank Act to work with market 
participants to consider and adopt meaningful and cost-effective 
regulations in a logical, thoughtful and timely manner. To the extent 
practicable, regulation of OTC derivatives by the CFTC and SEC should 
be streamlined, consistent, and take into consideration the economic 
fundamentals of the product, as well as the likelihood that an entity 
will need to register with both agencies. We believe that smart 
regulations that parallel market practice will enhance oversight and 
compliance, support the risk management needs of market participants 
and further promote innovation and competition.
    MFA is committed to working with Members and staff of the 
Subcommittee and regulators to restore investor confidence, enhance our 
regulatory system, stabilize our financial markets, and strengthen our 
nation's economy. Thank you for the opportunity to appear before you 
today. I would be happy to answer any questions that you may have.

    The Chairman. Thank you.
    Now the President of the Futures Industry Association in 
Washington, D.C., John Damgard.
    Five minutes, sir

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

    Mr. Damgard. Thank you very much, Chairman Conaway, Ranking 
Member Boswell, ladies and gentlemen of the Committee.
    I am John Damgard, President of the Futures Industry 
Association and am pleased to be here today. Many Members of 
the Subcommittee are new, and I would like to take a minute to 
explain who we are.
    FIA is the principal spokesman for the commodity futures 
and options industry, and our regular membership is comprised 
of approximately 30 of the largest futures commission merchants 
in the United States. And among FIA's associate members are 
representatives from virtually all other segments of the 
industry, both national and international, and we estimate that 
among our members, probably 80 to 85 percent of the public 
customer transactions executed on futures exchanges are done by 
our member firms.
    As the principal clearing members of the U.S. derivatives 
clearing organizations, our members' firms play a critical role 
in the reduction of systemic risk in the our financial system. 
Our member firms commit a substantial amount of our own capital 
to guarantee the futures and options transactions that our 
customers submit for clearing. We take justifiable pride that 
the U.S. futures markets operated extremely well throughout the 
financial crisis. No FCM failed, and no customer lost money as 
a result of the failure of the futures regulatory system.
    And I should say this Committee deserves a lot of credit 
for that. You created the CFTC in this very room some 45 years 
ago, and you have created an agency that has done a tremendous 
job of protecting the public and at the same time nurturing an 
industry that has grown by something like 6,000 or 7,000 
percent, as measured by the volume of trades.
    Today I would like to highlight four major concerns about 
the Dodd-Frank rulemaking process.
    First, some of the proposed rules have gone well beyond the 
intent of Congress. Given the intense pressure that we all face 
in bringing down the level of government spending, it would 
make more sense to focus on the regulatory requirements that 
are mandated by Congress and set aside other initiatives for a 
future date.
    Second, the rules have been published for comment in an 
order and at a pace that makes meaningful analysis and comment 
very difficult, if not impossible. We encourage both Congress 
and the Commodity Futures Trading Commission to take the time 
necessary to fully analyze all of the costs and benefits of the 
proposed rules and allow sufficient time for the 
implementation.
    Third, the cost of complying with Dodd-Frank will 
discourage participation in the markets and force certain firms 
out of business. You have already heard similar concerns from 
many groups that represent the end-users of derivatives. I 
would only add that the potential costs could lead to a loss of 
competition among clearing firms and also liquidity providers.
    Fourth, I encourage Congress to consider the international 
dimensions of rulemaking process. In particular, FIA believes 
that the Commission should use its exemptive authority to avoid 
duplicative and perhaps conflicting regulatory requirements for 
activities that take place outside the United States.
    Let me turn to the rulemaking process.
    Our member firms believe that the CFTC should implement the 
reforms envisioned by Dodd-Frank in a deliberate and measured 
way. We recognize that the CFTC and its staff are working day 
and night to comply with the very tight time frames set out in 
the Act, and we also appreciate that the Commission has 
repeatedly invited affected parties to provide input into the 
rulemaking. And we have responded.
    As of today, we filed comment letters on 17 proposed 
rulemakings with many more to come. We have participated in 
three CFTC roundtables, and we have met with CFTC staff on many 
occasions to discuss matters of particular concern. I regret to 
say, however, that providing meaningful analysis and comment is 
extraordinarily difficult due to the tremendous number of rules 
that have been proposed in such a short period of time.
    To give you one example, the Commission has proposed a 
myriad of rules that taken together would completely overhaul 
the record keeping and reporting requirements for clearing 
member firms. These proposals include the advanced notice of 
proposed rulemaking, core principles, and other requirements 
for designated contract markets, risk management requirements, 
information management requirements, position limits for 
derivatives, core principles, and many other requirements for 
swap execution facilities.
    All of the pending rulemaking and reporting requirements 
must be evaluated collectively, not individually. Otherwise, it 
is impossible to determine whether the pending rules are 
complimentary or conflicting, nor is it possible to calculate 
the financial and operational burdens these proposals will 
impose on the industry and customers.
    FIA also believes that some of the Commission's proposed 
rules go way beyond Congressional intent. And an example is the 
rulemaking on governance and ownership of clearing 
organizations, contract markets, and swap execution facilities. 
Although the House version of the financial reform legislation 
contained provisions that set specific limits, these provisions 
were removed when the legislation reached the conference 
committee. And the Dodd-Frank Act in its final form simply 
authorized the Commission to adopt a rule with respect to 
ownership and governance.
    Furthermore, the Act states that any such rule should be 
adopted only after the Commission first determines that such 
rules are necessary or appropriate to improve the governance, 
mitigate systemic risk, promote competition, or mitigate 
conflicts of interests. Although the Commission has not made 
the required determination, the Commission nonetheless has 
proposed specific rules on governance and ownership that 
effectively would implement the very provisions that were 
removed.
    It has been suggested that the Commission should move 
forward with rules adopting Dodd-Frank Act time frames but set 
selective dates that will afford participants sufficient time 
to come into compliance. Although this is certainly one 
alternative, we believe the better choice is to delay adopting 
final rules until all affected participants have a reasonable 
opportunity to fully analyze and understand the scope of the 
complex and far-reaching regulatory regime that the Commission 
has proposed.
    Furthermore, it is our view that the Commission should be 
encouraged to use its exemptive authority to ensure the market 
participants and transactions taking place outside the United 
States are not subject to duplicative regulations.
    We urge the Subcommittee to take whatever actions it deems 
necessary to encourage the Commission to shift regulatory 
obligations to the NFA, through the NFA and to other self-
regulatory organizations. As discussed above, for example, the 
Commission could delegate to the NFA the responsibility to 
adopt rules for chief compliance officers.
    Thanks again for the opportunity to appear before you 
today. I am happy to answer any questions.
    [The prepared statement of Mr. Damgard follows:]

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

    Chairman Conaway, Ranking Member Boswell, Members of the 
Subcommittee, I am John Damgard, President of the Futures Industry 
Association (FIA). On behalf of FIA, I want to thank you for the 
opportunity to appear before you today.
    As the Subcommittee is aware, the Dodd-Frank Wall Street Reform and 
Consumer Protection Act (Dodd-Frank Act) substantially rewrote the 
Commodity Exchange Act (CEA) to: (i) establish a comprehensive regime 
for swaps, including the mandatory clearing of swaps; (ii) grant 
important new authority to the Commodity Futures Trading Commission 
(Commission); and (iii) impose significant, new obligations on futures 
industry participants, in particular, the futures commission merchants 
(FCMs) that FIA represents.
    Because Congress gave the regulatory agencies, including the 
Commission, broad discretion in adopting rules to implement provisions 
of the Dodd-Frank Act, it is essential that the Committee on 
Agriculture, as the Committee of jurisdiction with respect to matters 
relating to the CEA, monitor carefully the Commission's implementation 
of the Dodd-Frank Act and provide additional guidance when appropriate. 
We, therefore, welcome these hearings and are pleased that Chairman 
Lucas and Chairman Conaway have indicated that they intend to conduct 
regular oversight hearings with respect to the Dodd-Frank Act.
    We have had an opportunity to review the testimony presented by the 
Chicago Mercantile Exchange and the International Swap Dealers 
Association at the full Committee hearing last Thursday and share some 
of the concerns they expressed.

Futures Industry Association: Who We Are
    Since many of the Members of the Subcommittee are new, I would like 
to take a minute to explain who we are. FIA is a principal spokesman 
for the commodity futures and options industry. FIA's regular 
membership is comprised of approximately 30 of the largest futures 
commission merchants in the United States. Among FIA's associate 
members are representatives from virtually all other segments of the 
futures industry, both national and international. Reflecting the scope 
and diversity of its membership, FIA estimates that its members effect 
more than eighty percent of all customer transactions executed on 
United States contract markets.
    As the principal clearing members of the U.S. derivatives clearing 
organizations (DCOs), our member firms play a critical role in the 
reduction of systemic risk in the financial markets. We commit a 
substantial amount of our own capital to guarantee our customers' 
transactions cleared through the DCO and, through contributions to the 
DCO's guarantee fund, guarantee the obligations of other clearing 
members to the DCO, in the unlikely event of a clearing member's 
default. As a result, our member firms, along with the DCOs of which 
they are members, take seriously their responsibility to manage 
carefully the significant financial risks that they assume on a daily 
basis.
    We take justifiable pride that throughout the financial crisis, the 
futures markets operated well; no FCM failed and no customer lost money 
as a result of a failure of the futures regulatory system.
    The FIA Principal Traders Group. This past year, we welcomed the 
FIA Principal Traders Group (FIA PTG) as a new division of FIA. The FIA 
PTG is comprised of firms that trade their own capital in exchange-
traded markets. Members of the FIA PTG engage in automated, manual and 
hybrid methods of trading and are active in a variety of asset classes, 
such as futures, equities, foreign exchange, and fixed income. They are 
a critical source of liquidity in the exchange-traded markets, allowing 
those who use these markets to manage their business risks, to enter 
and exit the markets efficiently.
    Depending on the eventual market structure of the swaps market, 
some of the firms that are members of the FIA PTG may choose to provide 
liquidity to the developing cleared swaps markets. They currently are 
active participants in the over-the-counter markets operated by ICE and 
the New York Mercantile Exchange, both of which may be required to be 
registered as swap execution facilities, and would expect to continue 
trading these products under the Dodd-Frank regulatory regime. These 
firms' willingness and ability to do so, however, will depend on a 
number of factors, including the costs associated with complying with 
requirements applicable to cleared swaps, as well as the absence of 
other barriers to entry to the swaps market.
Implementation of the Dodd-Frank Act: The Rulemaking Process
    The success of the futures model understandably led Congress to 
require a comparable model for the swaps markets. What may have seemed 
like a simple solution in concept to address systemic risk in the 
bilateral swaps market, however, has proved to be tremendously complex 
in implementation. While swaps and futures may serve similar risk 
management purposes, the manner in which they trade and are priced and, 
consequently, the financial risks they pose to DCOs and clearing 
members when cleared, are substantially different.
    As clearing member FCMs will be most directly affected by the 
failure of a customer or other clearing member to meet its financial 
obligations with respect to cleared swaps, our member firms believe it 
is essential that the reforms envisioned by the Dodd-Frank Act be 
implemented in a deliberate, measured way to assure that the risks 
associated with the clearing of swaps are properly identified and 
managed. A ``Big Bang'' approach threatens simply to shift systemic 
risk to DCOs and their clearing members, to the potential detriment of 
both futures market participants and swaps market participants.
    We do not underestimate the challenges facing the Commission, and 
we recognize that the Commission and its staff are working hard to 
comply with the very tight timeframes set out in the Dodd-Frank Act. We 
also appreciate that the Commission has made an effort to solicit the 
views of affected parties.
    In this regard, FIA member firms have committed significant time 
and resources to provide their views and assist the Commission in 
developing the rules to implement this regulatory regime. Our members 
have made available more than 200 professional staff with risk 
management and operational expertise to help FIA in this effort. Member 
firm representatives have participated in three roundtables conducted 
by Commission staff and have met with the staff on other occasions to 
discuss matters of particular concern. Moreover, to date, FIA has filed 
comment letters on 17 rule proposals.
Insufficient Time To Analyze and Comment Meaningfully
    Although FIA has supported several of the Commission's proposals, 
as a general matter, rules have been published for comment in an order 
and at a pace that makes meaningful analysis and comment difficult, if 
not impossible.
    The Commission has published for comment a myriad of proposed 
rulemakings that, collectively, contemplate a complete overhaul of the 
record-keeping and reporting requirements to which FCMs, U.S. exchanges 
and clearing organizations are subject. These proposals include: (i) 
the advance notice of proposed rulemaking regarding the protection of 
cleared swaps customers before and after commodity broker bankruptcies; 
(ii) core principles and other requirements for designated contract 
markets; (iii) risk management requirements for derivatives clearing 
organizations; (iv) information management requirements for derivatives 
clearing organizations; (v) position limits for derivatives; (vi) core 
principles and other requirements for swap execution facilities; and 
(vii) swap data record-keeping and reporting requirements.
    These various rulemakings cannot be considered in isolation. All of 
the pending record-keeping and reporting requirements, and the 
estimated costs and benefits of each, must be analyzed and evaluated 
collectively, not individually. In the absence of such a coordinated 
analysis, it is impossible to determine whether the pending rules are 
complementary or conflicting. Neither is it possible to calculate the 
aggregate financial and operational burdens these various proposals 
will have on the industry.
    The Ownership and Control Rules. Record-keeping and reporting 
requirements have real costs. The Commission's proposed rules requiring 
designated contract markets and other reporting entities to submit 
weekly ownership and control reports (OCR) to the Commission 
demonstrate this point. It is important to note that the OCR rules not 
required under the Dodd-Frank Act and are in addition to the list of 
rules above.
    The pending OCR rules would require each reporting entity to 
provide the Commission detailed information, consisting of 
approximately 28 separate data points, with respect to each account 
reported in its trade register. The proposed data points include 
detailed information on beneficial owners and account controllers, 
account numbers and dates on which account numbers were assigned.
    Because the OCR rules would require FCMs to collect and report a 
substantial amount of information that either is not collected in the 
manner the Commission may anticipate or is not collected at all, the 
proposed rules would require a complete redesign of the procedures, 
processes and systems pursuant to which FCMs create and maintain 
records with respect to their customers and customer transactions. To 
obtain and maintain the required information, an FCM would be required 
to: (i) re-negotiate all active customer agreements to require 
customers to provide and routinely update the necessary data points; 
(ii) build systems to enter the data; (iii) manually enter the data for 
each active account; (iv) put in place resources and processes to 
maintain the data; (v) provide it to the reporting entity on a weekly 
basis; and (vi) monitor changes daily in order to update the database.
    To prepare our comment letter on the proposed OCR rules, FIA formed 
an OCR Working Group, comprised of individuals with significant 
experience in operations from (i) 16 FCMs, both large and small, with 
both retail and institutional customers, (ii) the several U.S. 
exchanges, (iii) the principal back office service providers, and (iv) 
other experts to analyze their potential impact.
    FIA received cost estimates for building and maintaining an OCR 
database from 12 FIA member firms, both large and small. These firms 
carry more than 500,000 customer accounts and hold in excess of $83.8 
billion of customer funds, or approximately 62 percent of customers' 
segregated funds (as of July 31, 2010, according to monthly financial 
reports filed with the Commission). We found that the median firm would 
face total costs of roughly $18.8 million per firm, including 
implementation costs of roughly $13.4 million, and ongoing costs of 
$2.6 million annually. These costs, combined with the unwarranted 
structural change in the conduct of business among U.S. futures markets 
participants the proposed rules would require, could force a number of 
FCMs to withdraw from the business and the barrier to entry for 
potential new registrants will be raised.
    In its comment letter, FIA presented an alternative OCR proposal 
which we believe would achieve the essential regulatory purposes of the 
Commission's proposed rules. The cost of the alternative OCR was 
considerably less than the estimated cost of implementing the OCR 
rules, but they are substantial nonetheless. We must emphasize that 
this alternative was not developed within the 60 day comment period 
originally proposed by the Commission. It took several months of 
detailed analysis by industry representatives who otherwise perform 
critical operational and risk management responsibilities in their 
firms.

Rules Go Beyond Congressional Intent
    The Commission has also proposed rules (or published an advance 
notice of proposed rulemaking) that we believe go well beyond 
Congressional intent in the Dodd-Frank Act. In doing so, the Commission 
has moved away from the principles-based regulation, which has 
facilitated growth and innovation in the exchange-traded markets over 
the past decade, and has proposed a far more prescriptive regulatory 
regime.
    Conflicts of Interest. The rules regarding conflicts of interest 
for FCMs, swap dealers and major swap participants provide one example 
where we believe the Commission has gone beyond the requirements of the 
Dodd-Frank Act. Among other things, these provisions, found in 4s(j)(5) 
and 4d(c) of the CEA, require firms to establish informational barriers 
among the different business units within the firm to assure that the 
research and analysis unit and the unit responsible for clearing are 
not subject to pressure from the swap dealer unit that might bias their 
judgment or supervision.
    The Commission's proposed rules go far beyond the principles 
established in these provisions of the CEA and require absolute bans on 
communications in many instances. They would prohibit any employee of a 
swap dealer or major swap participant business unit from participating 
in any way with the provision of clearing services and related 
activities by the FCM. The rules would restrict routine contacts 
between trading and clearing personnel, which we believe would work to 
the detriment of customers, and call into question other forms of 
completely benign and beneficial conduct. Moreover, these proposed 
rules could impair a firm's ability to follow established risk 
management best practices. We believe the Commission needs to revise or 
even reissue these rules for comment.
    Governance and Ownership. Proposed rules on governance and 
ownership of clearing organizations, contract markets and swap 
execution facilities is another example of the Commission's decision to 
propose rules that go beyond the Dodd-Frank Act and, in this case, 
would impose restrictions that Congress specifically rejected. Although 
the House version of the financial reform legislation contained 
provisions that set specific ownership limits for these entities, they 
were rejected in the Dodd-Frank Act, which simply authorizes the 
Commission to adopt rules with respect to ownership and governance, but 
only after completing a review, and only if it first determines ``that 
such rules are necessary or appropriate to improve the governance of, 
or to mitigate systemic risk, promote competition, or mitigate 
conflicts of interest.'' Although the Commission conducted no review 
and did not make the required determination, the Commission nonetheless 
proposed rules that would effectively implement provisions that were 
removed by the Conference Committee.
    Chief Compliance Officer. The proposed rules relating to chief 
compliance officers provide another. The Dodd-Frank Act sets out 
specific responsibilities that chief compliance officers of swap 
dealers and major swap participants must meet, but simply requires 
chief compliance officers of FCMs to ``perform such duties and 
responsibilities as shall be set forth in regulations to be adopted by 
the Commission or rules to be adopted by a futures association.''
    Notwithstanding these differences, the Commission elected to 
propose that FCMs be subject to the same rules as swap dealers and 
major swap participants. Although there may be advantages in creating 
uniform rules for entities under its jurisdiction, we are concerned 
that, in so doing, the Commission has ignored the model for compliance 
that FCMs have long followed.
    In a detailed comment letter that FIA filed jointly with the 
Securities Industry and Financial Markets Association, we explained 
that the proposed rules would establish a compliance framework that is 
significantly different from that currently in place in the financial 
services industry under the regulations promulgated by other Federal 
regulators, including the Securities and Exchange Commission (SEC) and 
the several banking regulators, as well as the compliance model adopted 
by the Commission itself as recently as September 2010.
    Among other things, the proposed rules would fundamentally change 
the role of chief compliance officers by requiring them to perform 
supervisory duties. Traditionally, the chief compliance officer acts as 
an independent advisor to the firm's business-line supervisors, who 
have the authority to supervise the firm's business activities and are 
ultimately responsible for the firm's compliance with applicable law. 
By eliminating the separation between supervision and compliance, the 
proposed rules would eliminate the independence necessary to perform 
the chief compliance officer function effectively and would undermine 
the long-standing regulatory principle that the supervisory 
responsibility in the firm rests with the business managers, not the 
chief compliance officer.
    Particularly troublesome is the Commission's statement that chief 
compliance officers may be subject to criminal liability as a result of 
carrying out their duties, although there is no indication that 
Congress intended that chief compliance officers would be subject to 
criminal liability under the applicable sections of the Dodd-Frank Act. 
Criminal liability is not specifically a part of the existing financial 
services compliance model, and potential criminal liability will make 
it much more difficult, if not impossible, for firms to hire competent 
employees who will be willing to serve as chief compliance officers. 
Moreover, imposition of criminal liability on chief compliance officers 
would create a duplicative, inconsistent, burdensome and unpredictable 
regulatory environment in many registrants that are subject to and have 
implemented the existing financial services compliance model.
    In lieu of these proposed rules, we believe the Commission should 
exercise the authority that Congress specifically provided in the Dodd-
Frank Act and delegate to the National Futures Association (NFA) the 
responsibility to adopt rules for chief compliance officers. NFA has 
considerable experience in this area and such delegation would be 
consistent with the policy followed by the SEC, which has delegated 
this responsibility to FINRA.

The Potential Costs Are Not Well-Understood
    The Commission has acknowledged that its proposed rules will 
increase the costs of effecting transactions in swaps, but believes 
that the benefits outweigh any additional costs that may be imposed on 
customers. We believe the Commission may well have underestimated 
certain costs. Again, however, we simply have not had the time, and in 
certain cases lack the information necessary, to make a meaningful 
analysis in the time provided.
    Moreover, these additional costs will not be imposed solely on swap 
participants. They are certain to affect participants in the exchange-
traded markets as well. In this regard, we are concerned by Chairman 
Gensler's announcement in his testimony last week that the Commission 
has established a rulemaking team to develop ``conforming rules'' to 
update the Commission's existing rules to take into account the 
provisions of the CEA. To the extent this rulemaking team recommends 
imposing the proposed rules for swaps on the exchange market, costs are 
certain to rise. As a result, as discussed earlier, a number of FCMs 
could be compelled to withdraw from registration and the barrier to 
entry for potential new registrants will be raised which will 
negatively affect competition. In any event, FCMs will have little 
choice but to pass these costs on to their customers.

Essential Decisions Have Been Deferred
    As important, the Commission has not yet made decisions on critical 
issues that will determine the Commission's view of the full scope of 
its jurisdiction. The basic definitions of a ``swap dealer'', ``major 
swap participant'' and ``swap'' have not been adopted. Similarly, rules 
relating to capital and margin requirements have not been proposed. As 
a result, many swap market participants may not be aware, or may be 
uncertain, whether they will be required to be registered with the 
Commission in some capacity or otherwise be affected by the proposed 
rules. Therefore, they may not have had an opportunity to, or reason to 
believe that they should, comment on the proposed rules.
    The Commission has also offered no guidance on the extent to which 
it may seek to assert its jurisdiction over entities located, or 
transactions that take place, outside of the United States, but which 
touch the U.S. in some way. Because swaps have not previously been 
entered into on organized exchanges or other trading facilities, the 
swaps market is truly international in scope. For example, the U.K. 
branch of a U.S. bank and a French bank may enter into an interest rate 
swap, which is governed by New York law.
    The Dodd-Frank Act provides that its provisions should not apply to 
activities that take place outside of the United States, unless those 
activities have a ``direct and significant connection with activities 
in, or effect on, commerce of the United States.'' Further, the 
Commission is authorized to exempt from regulation foreign derivatives 
clearing organizations and swap execution facilities that are subject 
to comparable, comprehensive supervision and regulation in their home 
country. As the Members of the Subcommittee may be aware, the European 
Union (EU) is developing a comprehensive regulatory regime for swaps, 
including clearing through EU clearing organizations. The Commission 
should be encouraged to use its exemptive authority to assure that 
transactions and participants that do not have a ``direct and 
significant connection with activities in, or effect on, commerce of 
the United States'' are not subject to duplicative, and perhaps 
conflicting, regulatory requirements.
    The Commission has a successful model for the regulation of 
international transactions that could serve as an starting point for 
exempting participants and transactions from its jurisdiction. Under 
the Commission's Part 30 rules, governing the offer and sale of futures 
and options traded on foreign exchanges, the Commission has granted 
exemptions from registration to non-U.S. firms that deal with U.S. 
customers and that the Commission determines are subject to comparable 
regulation in their home country. On the same basis, the Commission has 
also authorized certain foreign boards of trade to permit direct access 
from the U.S. In each case, the exemption is made subject to 
appropriate information sharing agreements and all affected 
participants must consent to the jurisdiction of the Commission and 
Department of Justice to be certain that the Commission and the 
Department of Justice are able to obtain information when necessary.

Delay in Adopting Final Rules
    It has been suggested that the Commission should move forward with 
adopting final rules within the Dodd-Frank Act timeframes, but set 
effective dates that will afford participants sufficient time to come 
into compliance. Although this is certainly one alternative, we believe 
the better choice is to delay adopting final rules until all affected 
participants have a reasonable opportunity to analyze fully and 
understand the scope of the regulatory regime the Commission has 
proposed.

Responsibilities Should Be Delegated to the National Futures 
        Association
    In closing, I want to note that we were pleased that Chairman 
Gensler has indicated that he intends to rely more heavily on the 
National Futures Association. Self-regulation has worked extremely well 
in the futures markets, and we see no reason why the success of these 
programs cannot be transferred to the swaps markets.
    When Congress amended the CEA in 1974 to establish the Commission, 
it included a provision for an industry-wide self-regulatory 
organization such as NFA. Since NFA began operations in 1982, Congress 
has demonstrated its confidence in NFA by amending the CEA three times 
to provide it with additional responsibilities.
    As a self-regulatory organization, NFA is subject to the ongoing 
oversight of the Commission. Our experience is that NFA and the 
Commission have a very close and cooperative working relationship. The 
Subcommittee can be confident, therefore, that NFA will use its broad 
authority to achieve the regulatory goals that Congress sought in 
enacting the Dodd-Frank Act. Importantly, NFA is funded entirely by 
futures market participants, thereby relieving additional strain on the 
Federal budget.
    We urge the Subcommittee to take whatever action it deems 
appropriate to encourage the Commission shift many of the regulatory 
obligations that it has assumed for itself under the proposed rules to 
NFA and, through NFA, to the other industry self-regulatory 
organizations. As discussed above, for example, the Commission could 
delegate to NFA the responsibility to adopt rules for chief compliance 
officers.
    Thank you again for the opportunity to appear before you today. I 
would be happy to answer any questions you may have.

    The Chairman. Thank you, Mr. Damgard.
    Votes have been called. If we could go through Mr. 
McMahon's testimony, and then we will recess real quickly, go 
vote and come back.
    Ms. Sanevich, we will come back to visit with you about 
your testimony.
    Mr. McMahon.

STATEMENT OF RICHARD F. McMAHON, Jr., VICE PRESIDENT OF ENERGY 
              SUPPLY AND FINANCE, EDISON ELECTRIC
INSTITUTE, WASHINGTON, D.C.; ON BEHALF OF AMERICAN PUBLIC POWER 
         ASSOCIATION; ELECTRIC POWER SUPPLY ASSOCIATION

    Mr. McMahon. Chairman Conaway, Ranking Member Boswell, and 
Members of the Subcommittee. Thank you for the opportunity to 
discuss the role of over-the-counter derivatives markets in 
helping energy companies insulate our customers from the 
volatility of commodity price risk as well as some of the key 
implementation issues of the Dodd-Frank Act.
    I am Richard McMahon, Vice President of Energy Supply and 
Finance for the Edison Electric Institute. I am testifying 
today on behalf of EEI, APPA and EPSA. Together our members 
serve most of our nation's electric consumers. The goal of our 
members is to provide our customers with reliable electric 
service at affordable and stable rates. Therefore, it is 
essential to manage the significant price volatility inherent 
in wholesale commodity markets for natural gas and electricity.
    The derivatives market is an extremely effective tool in 
insulating our customers from this price volatility. Utility 
and energy companies are financially stable and highly credit 
worthy. As a result, utilities and their customers get a 
significant cost-benefit from little or no collateral 
requirements for their OTC derivative swaps from exchanges, and 
clearinghouses, on the other hand, are generally blind to the 
financial help of our participants and demand cash margin 
requirements from us.
    We support the goals of Dodd-Frank to bring greater 
transparency and oversight to the derivatives markets and to 
address the systemic risk to the economy. However, a margin 
requirement on all utility OTC swaps would have an average 
annual cash flow impact of between $250 million and $400 
million per company.
    If our members are forced to post margin on all of their 
OTC transactions, we will have three equally undesirable 
choices: One, redirect dollars from our core infrastructure 
capital spending programs to margin accounts at clearinghouses; 
or borrow the money to post in margin accounts and pass the 
costs of borrowing through to our customers in rates; or 
curtail our derivatives hedging programs and pass the commodity 
price volatility in natural gas and electric power through to 
our customers.
    We were pleased to hear CFTC Chairman Gary Gensler testify 
last week that proposed rules on margins shall focus on 
transactions between financial entities rather than those 
transactions involving non-financial end-users. It is essential 
that this approach be fully implemented. It was the clear 
intent of Congress, as confirmed in the letter drafted by 
Senators Dodd and Lincoln as part of the conference, to fully 
exempt end-users from margin and burdensome CFTC compliance 
obligations.
    The Dodd-Frank Act left many important issues to be 
resolved by regulators and set impractical, tight deadlines on 
rulemakings. To further complicate matters, many of the complex 
issues raised by scores of rulemakings are interrelated. As a 
result, interested parties are unable to comment on the 
proposed rules in a meaningful way because they cannot know the 
full effect of the complete universe of the proposed rules.
    For instance, the CFTC has not yet issued proposed rules on 
the definition of a swap. This definition is critical to many 
of the current rulemakings of Dodd-Frank and could 
significantly expand the reach and impact of these regulations.
    In the end-user clearing exemption provision of Dodd-Frank, 
Congress gave our members the flexibility to elect, not to 
clear, swaps that they use to hedge commercial risk. The CFTC's 
proposed rulemaking implementing this provision would require 
an end-user to report roughly a dozen items of information to 
CFTC every time it elects to rely on the end-user clearing 
exemption for a swap. The CFTC does not need such 
representations from end-users about every one of their non-
cleared swaps to prevent abuse of the end-user clearing 
exemption. End-users understand that knowingly providing the 
CFTC with inaccurate information is a very serious violation of 
the Commodity Exchange Act.
    We request that the Subcommittee emphasize to CFTC that it 
can implement the end-user clearing exemption consistent with 
Congress' intent, by streamlining their proposed requirements 
in the following ways: By requiring end-users to represent once 
that they will only rely on the end-user exemption for swaps 
that hedge commercial risks; and by informing the Commission 
once how they generally meet their financial obligations 
associated with entering into non-cleared swaps, of course 
coupled with an obligation to provide notice of any material 
change; and in the case of publicly traded companies, by 
maintaining a record showing that an appropriate committee of 
the board of directors has reviewed and approved their overall 
decision not to clear.
    We also have serious concerns about the CFTC's plans to 
define swap dealer. The CFTC's proposed rule includes very 
extensive language, expansive language about the types of 
activity that CFTC views as dealing. At the same time, the 
Commission has proposed to implement the ``not as part of the 
regular business'' and de minimis exceptions in a very 
restrictive manner. The result could be that commercial end-
users are inappropriately miscast as swaps dealers.
    We appreciate your role in helping to ensure that energy 
end-users can continue to use OTC derivatives to help to 
protect and insulate our nation's consumers from volatile 
wholesale gas and wholesale power commodity prices in a cost-
effective way.
    I am happy to answer any questions you may have.
    [The prepared statement of Mr. McMahon follows:]

Prepared Statement of Richard F. McMahon, Jr., Vice President of Energy 
  Supply and Finance, Edison Electric Institute, Washington, D.C.; on
   Behalf of American Public Power Association; Electric Power Supply
                              Association

    Chairman Conaway and Members of the Subcommittee, thank you for 
this opportunity to discuss the role of over-the-counter (OTC) 
derivatives markets in helping utilities and energy companies insulate 
our customers from the volatility of commodity price risk, as well as 
some of the key issues we see in the implementation of the Dodd-Frank 
Wall Street Reform and Consumer Protection Act (Dodd-Frank).
    I am Richard McMahon, Vice President of Energy Supply and Finance 
for the Edison Electric Institute (EEI). EEI is the trade association 
of U.S. shareholder-owned electric utilities, with international 
affiliates and industry associates worldwide. EEI's U.S. members serve 
95 percent of the ultimate electricity customers in the shareholder-
owned segment of the industry, and represent approximately 70 percent 
of the total U.S. electric power industry.
    I also am testifying on behalf of the American Public Power 
Association (APPA) and the Electric Power Supply Association (EPSA). 
APPA represents the nation's more than 2,000 community-owned electric 
utilities. EPSA is the national trade association representing 
competitive power suppliers, including generators and power marketers.

Utilities and Energy Companies Hedge Risk
    Wholesale natural gas and electric power are, and have been 
historically, two of the most volatile commodity groups. Our members 
use natural gas extensively as a fuel to generate electric power, as 
well as distribute natural gas to consumers in their homes. 
Additionally, utilities purchase wholesale electricity from generators 
and marketers to meet consumer demand.
    The goal of our members is to provide their customers with reliable 
service at affordable and stable rates. Therefore, it is essential to 
manage the price volatility inherent in wholesale commodity markets for 
natural gas and electric power. Our members purchase fuel and sell 
power at thousands of delivery points throughout the U.S. They need the 
ability to use OTC swaps because existing futures contracts cover 
limited natural gas and electricity delivery points. The derivatives 
market has proven to be an extremely effective tool in insulating our 
customers from this risk and price volatility. Utilities and energy 
companies use both exchange traded and cleared and OTC swaps for 
natural gas and electric power to hedge commercial risk. About \1/2\ of 
our gas swaps and about \1/3\ of our power swaps are traded on-
exchanges.

Why the Margin Issue is Critically Important
    Utilities and energy companies are financially stable and highly 
creditworthy. On average EEI's members are rated BBB. As a result, 
utilities and their customers get a significant cost-benefit from low 
or no collateral requirements for their OTC derivatives transactions. 
In some cases, our members provide a letter for credit or a lien on 
assets as collateral to support their obligations on swaps. Exchanges 
and clearinghouses are generally blind to the financial health of their 
participants and demand cash margin deposits, both initial and 
variation margin.
    Our industry is in the midst of a major capital spending program to 
enhance the electric grid, make our generation fleet cleaner and bring 
new technologies to our customers. Last year, shareholder-owned 
electric utilities' capital expenditures (CAPEX) were $83 billion, and 
we expect this pace of capital investment to continue throughout the 
decade. The capital investments of all of our members are contributing 
to our nation's economic recovery and job growth.
    A margin requirement on all utility OTC swaps would have an average 
annual cash flow impact of between $250 million-$400 million per 
company. This ``dead capital'' tied up in margin accounts at 
clearinghouses would need to be funded by our customers.
    If our members are forced to post margin on all of our OTC 
transactions, we have three equally undesirable choices:

   Re-direct dollars from our core infrastructure capital 
        spending programs to margin accounts at clearinghouses;

   Borrow the money to post in margin accounts and pass that 
        cost through to our customers in rates; or

   Curtail our derivatives hedging programs and pass the 
        commodity price volatility in gas and electric power through to 
        our customers.

    Because of these undesirable consequences, the National Association 
of Regulatory Utility Commissioners (NARUC) passed a resolution in 
support of the industry's goal of maintaining our ability to use OTC 
derivatives without cash margining requirements (see attached).
    We were very pleased to hear Commodity Futures Trading Commission 
(CFTC) Chairman Gensler's testimony last week before the full House 
Agriculture Committee in which he stated, ``Proposed rules on margin 
shall focus on transactions between financial entities rather than 
those transactions that involve non-financial end-users.'' It is 
essential that this now unambiguous direction from the CFTC Chairman be 
carried through fully in implementation of the Dodd-Frank Act. We 
believe this was the clear intent of the Congress, and it was confirmed 
in the Dodd-Lincoln letter, which was drafted as part of the conference 
committee to fully clarify the intent of the Congress to fully exempt 
end-users from margining and burdensome CFTC compliance obligations. 
(see attached)

Need for a Proper Sequencing and Implementation Timetable
    We support the overarching goals of the Dodd-Frank Act to bring 
greater transparency and oversight to derivatives markets and to 
address systemic risk to the economy. Additionally, we compliment the 
CFTC Chairman, Commissioners and staff for their hard work and openness 
in seeking input from different market participants during the 
implementation process.
    However, the Dodd-Frank Act left many important issues to be 
resolved by regulators and set impractical, tight deadlines on 
rulemakings by the agencies charged with implementation. To further 
complicate matters, many of the complex issues raised by scores of 
rulemakings are interrelated. As a result, interested parties are 
unable to comment on the proposed rules in a meaningful way, because 
they cannot know the full effect of the complete universe of proposed 
rules. For example, it is difficult to comment on the proposed swap 
dealer definition, position limits, and record-keeping and reporting 
rules for swaps before the proposed definition of a swap has been 
issued.

Concerns Regarding Implementation Burdens on End-Users
    In a provision of the Dodd-Frank Act known as the ``end-user 
clearing exception,'' Congress gave our members and other end-users of 
swaps the flexibility to elect not to clear swaps that they use to 
hedge commercial risk.
    The CFTC's proposed rule implementing this provision would require 
an end-user to report roughly a dozen items of information to the CFTC 
every time it elects to rely on the end-user clearing exception for a 
swap. The required information for each swap includes representations 
that:

   it is a non-financial entity,

   the swap is hedging commercial risk,

   it has certain credit arrangements in place, and

   in the case of publicly-traded companies like most of our 
        members, that an appropriate committee of the board of 
        directors (or equivalent body) has reviewed and approved its 
        decision not to clear.

    The CFTC does not need such representations from our members and 
other end-users about every one of their non-cleared swaps to prevent 
abuse of the end-user clearing exception. Our members and other end-
users understand that knowingly providing the CFTC with inaccurate 
information is a very serious violation of the Commodity Exchange Act 
(CEA). That is more than sufficient incentive for end-users to rely on 
the end-user clearing exception only when they are authorized to do so.
    We request that the Subcommittee emphasize to the CFTC that it can 
implement the end-user clearing exception, consistent with Congress's 
intent, by requiring end-users to:

   represent once that they will only rely on the end-user 
        clearing exception for swaps that hedge commercial risk;

   inform the Commission once how they generally meet their 
        financial obligations associated with entering into non-cleared 
        swaps (coupled with an obligation to provide notice of material 
        changes); and

   in the case of publicly-traded companies, maintain a record 
        that shows that an appropriate committee of the board of 
        directors (or equivalent body) has reviewed and approved their 
        decision not to clear.

    In addition to our concerns about the CFTC's proposed 
implementation of the end-user clearing exception, we have serious 
concerns about how the CFTC plans to define ``swap dealer.'' The CFTC's 
proposed rule includes very expansive language about the types of 
activity--including ``accommodating'' the demand of third parties for 
swaps--that the CFTC views as dealing activity. At the same time, the 
Commission has proposed to implement the ``not as part of a regular 
business'' and ``de minimis'' exceptions to the definition of ``swap 
dealer'' in a very restrictive manner. The result could be that 
commercial end-users are inappropriately miscast as swap dealers. If 
our members, which primarily engage in hedging activities, are caught 
within the definition of ``swap dealer,'' not only will they face the 
costs of margin requirements, but they also will be subject to 
additional capital and collateral requirements (not yet defined by the 
CFTC), cost of IT systems for additional reporting, and other costly 
requirements not appropriate for end-users.
    The CEA, prior to the passage of the Dodd-Frank Act, excluded 
physical forward transactions from the CFTC's jurisdiction over futures 
contracts. The definition of swap in the Dodd-Frank Act includes 
options on physical commodities, but excludes ``any sale of a non-
financial commodity . . . so long as the transaction is intended to be 
settled.'' The CFTC has issued proposed rules on swap position 
reporting and on agricultural swaps which indicate that the CFTC 
intends to regulate options on physical commodities as swaps or 
``swaptions.'' The end-user community is concerned about the CFTC's 
proposal because many contracts for the delivery of power in the 
electric industry, such as capacity and requirements contracts, include 
price, volume or other optionality. Including these end-user to end-
user contracts in the definition of swap would greatly expand the scope 
of the CFTC's regulation over the electric utility industry and 
potentially would subject end-users to a number of burdensome 
regulatory requirements. We urge Congress to restrain CFTC's regulatory 
authority in this critical area of our business.
Conclusion
    Thank you for your leadership and interest in implementation of the 
Dodd-Frank Act. We appreciate your role in helping to ensure that 
utilities and energy companies can continue to be able to use OTC 
derivatives to cost-effectively help protect our nation's consumers 
from volatile wholesale natural gas and power commodity prices.

                              Attachments

National Association of Regulatory Utility Commissioners
Resolution on Financial Reform Legislation Affecting Over-the-Counter 
        Risk Management Products and Its Impacts on Consumers
    Whereas, There is a diverse group of end-users, consisting of 
electric and natural gas utilities, suppliers, customers, and other 
commercial entities who rely on over-the-counter (``OTC'') derivative 
products and markets to manage electricity and natural gas price risks 
for legitimate business purposes, thereby helping to keep rates stable 
and affordable for retail consumers; and

    Whereas, The United States Congress is considering financial reform 
legislation with the goal of ensuring that gaps in regulation, 
oversight of markets and systemic risk do not lead to economic 
instability; and

    Whereas, Previous NARUC resolutions support Federal legislative and 
regulatory actions that fully accommodate legitimate hedging activities 
by electric and natural gas utilities; and

    Whereas, The proposed legislation would, among other things, 
provide the Commodity Futures Trading Commission (CFTC) with oversight 
of OTC risk management products, including mandatory centralized 
clearing and exchange trading of all OTC products; and

    Whereas, Mandatory centralized clearing of all OTC contracts will 
increase expenses associated with hedging activity, and ultimately end-
user prices, due to increased margin requirements; and

    Whereas, A report by the Joint Association of Energy End-Users 
stated that the effect of margin requirements resulting from mandatory 
clearing for electric utilities would have the unintended effect of 
reducing or eliminating legitimate hedging practices and could 
jeopardize or reduce investments in Smart Grid technology; and for 
natural gas utilities and production companies could reduce capital 
devoted to infrastructure and natural gas exploration; and

    Whereas, The laudable goals of reform that ensure market 
transparency and adequate regulatory oversight can be accomplished by 
means other than mandatory clearing of OTC risk management contracts 
and the anticipated extra expense. For example, a requirement that 
natural gas and electric market participants engaging in legitimate 
hedging report all OTC derivative transactions to a centralized data 
repository, like the CFTC, provides sufficient market transparency 
without the costs associated with mandatory clearing; and

    Whereas, Proposed reforms would cause regulatory uncertainty with 
regard to the oversight of Regional Transmission Organizations (RTOs) 
and Independent System Operators (ISOs), where such uncertainty and/or 
overlapping jurisdiction can lead to negative impacts on liquidity, 
market confidence and reliability; and

    Whereas, The Federal Energy Regulatory Commission (FERC), and the 
Public Utility Commission of Texas (PUCT) for Texas/ERCOT, as the 
regulators with the necessary expertise and statutory mandates to 
oversee electricity and natural gas markets to protect the public 
interest and consumers, should not be preempted by the financial reform 
legislation from being able to continue exercising their authority to 
ensure reliable, just and reasonable service and protect consumers; and

    Whereas, Energy markets currently regulated by FERC or the PUCT 
(for Texas/ERCOT) under accepted tariffs or rate schedules should 
continue to be subject to FERC's and the PUCT's (for Texas/ERCOT) 
exclusive Federal jurisdiction, including jurisdiction over physical 
and financial transmission rights, and market oversight; and should 
themselves not be subject to CFTC jurisdiction as a clearinghouse due 
to the financial and other settlement services they provide those 
transacting in regional electricity markets; now, therefore be it

    Resolved, That the Board of Directors of the National Association 
of Regulatory Utility Commissioners, convened at its 2010 Winter 
Committee Meetings in Washington, D.C., supports passage of financial 
reform legislation ensuring that electric and natural gas market 
participants continue to have access to OTC risk management products as 
tools in their legitimate hedging practices to provide more predictable 
and less volatile energy costs to consumers; and be it further 

    Resolved, That new financial legislation being considered by 
Congress should weigh the costs of potential end-user utility rate 
increases versus the benefits of new standards for the clearing of OTC 
risk management contracts used by natural gas and electric utilities 
for legitimate hedging purposes; and be it further

    Resolved, That any Federal legislation addressing OTC risk 
management products should provide for an exemption from mandatory 
clearing requirements for legitimate hedging activity in natural gas 
and electricity markets; and be it further 

    Resolved, That any exemption to the mandatory clearing requirement 
for OTC derivatives be narrowly tailored as to not allow excessive 
speculation in natural gas and electricity markets; and be it further 

    Resolved, That the FERC, and the PUCT for Texas/ERCOT, charged with 
the statutory obligation to protect the public interest and consumers, 
should continue to be the exclusive Federal regulators with authority 
to oversee any agreement, contract, transaction, product, market 
mechanism or service offered or provided pursuant to a tariff or rate 
schedule filed and accepted by the FERC, or the PUCT for Texas/ERCOT; 
and be it further

    Resolved, That NARUC authorizes and directs the staff and General 
Counsel to promote with the Congress, the Commodity Futures Trading 
Commission and other policymakers at the Federal level, policies 
consistent with this statement.

        Sponsored by the Committee on Gas, Consumer Affairs, and 
        Electricity Adopted by the NARUC Board of Directors February 
        17, 2010.
                                 ______
                                 
June 30, 2010

Hon. Barney Frank,
Chairman,
House Committee on Financial Services,
Washington, D.C.

Hon. Collin C. Peterson,
Chairman,
House Committee on Agriculture,
Washington, D.C.

    Dear Chairmen Frank and Peterson:

    Whether swaps are used by an airline hedging its fuel costs or a 
global manufacturing company hedging interest rate risk, derivatives 
are an important tool businesses use to manage costs and market 
volatility. This legislation will preserve that tool. Regulators, 
namely the Commodity Futures Trading Commission (CFTC), the Securities 
and Exchange Commission (SEC), and the prudential regulators, must not 
make hedging so costly it becomes prohibitively expensive for end-users 
to manage their risk. This letter seeks to provide some additional 
background on legislative intent on some, but not all, of the various 
sections of Title VII of H.R. 4173, the Dodd-Frank Act.
    The legislation does not authorize the regulators to impose margin 
on end-users, those exempt entities that use swaps to hedge or mitigate 
commercial risk. If regulators raise the costs of end-user 
transactions, they may create more risk. It is imperative that the 
regulators do not unnecessarily divert working capital from our economy 
into margin accounts, in a way that would discourage hedging by end-
users or impair economic growth.
    Again, Congress clearly stated in this bill that the margin and 
capital requirements are not to be imposed on end-users, nor can the 
regulators require clearing for end-user trades. Regulators are charged 
with establishing rules for the capital requirements, as well as the 
margin requirements for all uncleared trades, but rules may not be set 
in a way that requires the imposition of margin requirements on the 
end-user side of a lawful transaction. In cases where a Swap Dealer 
enters into an uncleared swap with an end-user, margin on the dealer 
side of the transaction should reflect the counterparty risk of the 
transaction. Congress strongly encourages regulators to establish 
margin requirements for such swaps or security-based swaps in a manner 
that is consistent with the Congressional intent to protect end-users 
from burdensome costs.
    In harmonizing the different approaches taken by the House and 
Senate in their respective derivatives titles, a number of provisions 
were deleted by the Conference Committee to avoid redundancy and to 
streamline the regulatory framework. However, a consistent 
Congressional directive throughout all drafts of this legislation, and 
in Congressional debate, has been to protect end-users from burdensome 
costs associated with margin requirements and mandatory clearing. 
Accordingly, changes made in Conference to the section of the bill 
regulating capital and margin requirements for Swap Dealers and Major 
Swap Participants should not be construed as changing this important 
Congressional interest in protecting end-users. In fact, the House 
offer amending the capital and margin provisions of Sections 731 and 
764 expressly stated that the strike to the base text was made ``to 
eliminate redundancy.'' Capital and margin standards should be set to 
mitigate risk in our financial system, not punish those who are trying 
to hedge their own commercial risk.
    Congress recognized that the individualized credit arrangements 
worked out between counterparties in a bilateral transaction can be 
important components of business risk management. That is why Congress 
specifically mandates that regulators permit the use of non-cash 
collateral for counterparty arrangements with Swap Dealers and Major 
Swap Participants to permit flexibility. Mitigating risk is one of the 
most important reasons for passing this legislation.
    Congress determined that clearing is at the heart of reform--
bringing transactions and counterparties into a robust, conservative 
and transparent risk management framework. Congress also acknowledged 
that clearing may not be suitable for every transaction or every 
counterparty. End-users who hedge their risks may find it challenging 
to use a standard derivative contracts to exactly match up their risks 
with counterparties willing to purchase their specific exposures. 
Standardized derivative contracts may not be suitable for every 
transaction. Congress recognized that imposing the clearing and 
exchange trading requirement on commercial end-users could raise 
transaction costs where there is a substantial public interest in 
keeping such costs low (i.e., to provide consumers with stable, low 
prices, promote investment, and create jobs.)
    Congress recognized this concern and created a robust end-user 
clearing exemption for those entities that are using the swaps market 
to hedge or mitigate commercial risk. These entities could be anything 
ranging from car companies to airlines or energy companies who produce 
and distribute power to farm machinery manufacturers. They also include 
captive finance affiliates, financials that are hedging in support of 
manufacturing or other commercial companies. The end-user exemption 
also may apply to our smaller financial entities--credit unions, 
community banks, and Farm Credit institutions. These entities did not 
get us into this crisis and should not be punished for Wall Street's 
excesses. They help to finance jobs and provide lending for communities 
all across this nation. That is why Congress provided regulators the 
authority to exempt these institutions.
    This is also why we narrowed the scope of the Swap Dealer and Major 
Swap Participant definitions. We should not inadvertently pull in 
entities that are appropriately managing their risk. In implementing 
the Swap Dealer and Major Swap Participant provisions, Congress expects 
the regulators to maintain through rulemaking that the definition of 
Major Swap Participant does not capture companies simply because they 
use swaps to hedge risk in their ordinary course of business. Congress 
does not intend to regulate end-users as Major Swap Participants or 
Swap Dealers just because they use swaps to hedge or manage the 
commercial risks associated with their business. For example, the Major 
Swap Participant and Swap Dealer definitions are not intended to 
include an electric or gas utility that purchases commodities that are 
used either as a source of fuel to produce electricity or to supply gas 
to retail customers and that uses swaps to hedge or manage the 
commercial risks associated with its business. Congress incorporated a 
de minimis exception to the Swap Dealer definition to ensure that 
smaller institutions that are responsibly managing their commercial 
risk are not inadvertently pulled into additional regulation.
    Just as Congress has heard the end-user community, regulators must 
carefully take into consideration the impact of regulation and capital 
and margin on these entities.
    It is also imperative that regulators do not assume that all over-
the-counter transactions share the same risk profile. While uncleared 
swaps should be looked at closely, regulators must carefully analyze 
the risk associated with cleared and uncleared swaps and apply that 
analysis when setting capital standards for Swap Dealers and Major Swap 
Participants. As regulators set capital and margin standards on Swap 
Dealers or Major Swap Participants, they must set the appropriate 
standards relative to the risks associated with trading. Regulators 
must carefully consider the potential burdens that Swap Dealers and 
Major Swap Participants may impose on end-user counterparties--
especially if those requirements will discourage the use of swaps by 
end-users or harm economic growth. Regulators should seek to impose 
margins to the extent they are necessary to ensure the safety and 
soundness of the Swap Dealers and Major Swap Participants.
    Congress determined that end-users must be empowered in their 
counterparty relationships, especially relationships with swap dealers. 
This is why Congress explicitly gave to end-users the option to clear 
swaps contracts, the option to choose their clearinghouse or clearing 
agency, and the option to segregate margin with an independent third 
party custodian.
    In implementing the derivatives title, Congress encourages the CFTC 
to clarify through rulemaking that the exclusion from the definition of 
swap for ``any sale of a non-financial commodity or security for 
deferred shipment or delivery, so long as the transaction is intended 
to be physically settled'' is intended to be consistent with the 
forward contract exclusion that is currently in the Commodity Exchange 
Act and the CFTC's established policy and orders on this subject, 
including situations where commercial parties agree to ``book-out'' 
their physical delivery obligations under a forward contract.
    Congress recognized that the capital and margin requirements in 
this bill could have an impact on swaps contracts currently in 
existence. For this reason, we provided legal certainty to those 
contracts currently in existence, providing that no contract could be 
terminated, renegotiated, modified, amended, or supplemented (unless 
otherwise specified in the contract) based on the implementation of any 
requirement in this Act, including requirements on Swap Dealers and 
Major Swap Participants. It is imperative that we provide certainty to 
these existing contracts for the sake of our economy and financial 
system.
    Regulators must carefully follow Congressional intent in 
implementing this bill. While Congress may not have the expertise to 
set specific standards, we have laid out our criteria and guidelines 
for implementing reform. It is imperative that these standards are not 
punitive to the end-users, that we encourage the management of 
commercial risk, and that we build a strong but responsive framework 
for regulating the derivatives market.
            Sincerely,

            
            
Christopher Dodd,Chairman,
Senate Committee on Banking, Housing, and Urban Affairs;



Blanche L. Lincoln,Chairman,
Senate Committee on Agriculture, Nutrition, and Forestry.

    The Chairman. Thank you.
    We will stand in recess. In the good old days, we could 
count on 30 minutes for that first vote, but we have a new 
sheriff in town. So we will be right back.
    So thank you.
    [Recess.]
    The Chairman. The Committee will come back into session, 
and we will now hear from Ms. Sanevich, 5 minutes please.

    STATEMENT OF BELLA L.F. SANEVICH, GENERAL COUNSEL, NISA 
         INVESTMENT ADVISORS, L.L.C., ST. LOUIS, MO; ON
BEHALF OF AMERICAN BENEFITS COUNCIL; COMMITTEE ON INVESTMENT OF 
                    EMPLOYEE BENEFIT ASSETS

    Ms. Sanevich. Good afternoon and thank you and welcome 
back.
    My name is Bella Sanevich, and I am the General Counsel of 
NISA Investment Advisors. NISA is an investment advisor with 
over $60 billion under management for over 100 clients, the 
majority of which are private and public retirement plans.
    I am testifying today on behalf of the American Benefits 
Council and the Committee on Investment of Employee Benefit 
Assets, which are two of the leading employee benefit trade 
associations in the country. Together, their members provide 
benefits directly or indirectly to over 100 million 
participants. We very much appreciate the opportunity to 
address the swap-related issues raised by Dodd-Frank for 
private retirement plans governed by ERISA, and we applaud the 
Subcommittee for holding a hearing on this critical set of 
issues.
    We believe that the CFTC and the SEC have been working hard 
to provide guidance in this area. Nevertheless, there is one 
issue that is dwarfing all others--timing. The agencies are 
attempting to perform a complete restructuring of a nearly $600 
trillion market with rules developed over only a few months. It 
is simply not possible to do that in a way that takes into 
account all relevant factors. It is inevitable that the rules 
will have unintended and unforeseen consequences that could 
adversely impact the retirement security of millions of 
Americans, and cost our country billions of dollars and 
countless jobs.
    ERISA pension plans use swaps to manage the risk resulting 
from the volatility inherent in the present value of a pension 
plan's liability, as well as to manage regulatory plan funding 
obligations. If swaps were to become materially less available 
by reason of rules developed too quickly, funding volatility 
and cost would increase substantially, putting Americans' 
retirement assets at greater risk and forcing companies to 
reserve billions of additional dollars to satisfy possible 
funding obligations. Those greater reserves would have an 
enormous effect on the working capital that would be available 
to companies to create new jobs and for other business 
activities that promote economic growth. The greater funding 
volatility could also undermine the security of participant 
benefits.
    Accordingly, we strongly urge you to adopt legislation that 
would provide that each provision of Title VII shall become 
effective as of the later of January 1, 2013, or 12 months 
after the publication of final regulations implementing such 
provision.
    I also want to describe three critical problems in the 
proposed regulations as they relate to pension plans.
    The first issue involves the business conduct standards. 
Although several aspects of the business conduct standards are 
problematic, one of the biggest problems is that the proposed 
CFTC rules, when combined with those recently proposed by the 
DOL relating to fiduciaries, will either cause an illegality to 
occur, which is a prohibited transaction in ERISA language, or 
will prevent an ERISA plan from entering into a swap 
transaction altogether. The two sets of results are 
irreconcilable in their current form.
    The next issue involves required clearing of swaps by 
pension plans. Business end-users, such as operating companies, 
have the right to decide whether to clear a swap, this is the 
end-user exemption, but not the plan sponsored by those 
companies. To our knowledge, there is no substantive reason for 
this distinction. In fact, like operating companies, pension 
plans have an inherent risk to hedge which is interest rate 
risk. Plans need the flexibility to structure their swaps in a 
manner to protect and best serve their beneficiaries. Requiring 
clearing may hamper that flexibility.
    The last issue relates to real-time reporting. Although the 
purpose of real-time reporting is to enhance price transparency 
with the ultimate goal of reducing prices, we believe the 
current proposed rules would likely have exactly the opposite 
effect. In fact, we believe that if the CFTC rules were 
finalized in their current form, swap transaction costs would 
increase dramatically.
    In conclusion, the CFTC, the SEC, and the swaps community 
have an enormous challenge in working together to implement a 
complete restructuring of a nearly $600 trillion market. If we 
are forced to do this too quickly, it is inevitable that there 
will be negative unintended consequences, costing billions of 
dollars in the aggregate.
    We urge Congress to modify the effective date of Dodd-Frank 
to let the process proceed in an orderly and careful manner, 
extend the end-user exemption to plans, and address any 
problems under the regulations, such as the proposed business 
conduct rules which would effectively ban all swaps with plans.
    Thank you for the opportunity to present our views, and I 
would be happy to take any questions you may have.
    [The prepared statement of Ms. Sanevich follows:]

    Prepared Statement of Bella L.F. Sanevich, General Counsel, NISA
   Investment Advisors, L.L.C., St. Louis, MO; on Behalf of American 
  Benefits Council; Committee on Investment of Employee Benefit Assets

    My name is Bella Sanevich and I am the General Counsel of NISA 
Investment Advisors, L.L.C. NISA is an investment advisor with over $60 
billion under management for over 100 clients, including private and 
public retirement plans. I am testifying today on behalf of the 
American Benefits Council, with respect to which NISA is a member, and 
the Committee on Investment of Employee Benefit Assets.
    The Council is a public policy organization representing 
principally Fortune 500 companies and other organizations that assist 
employers of all sizes in providing benefits to employees. 
Collectively, the Council's members either sponsor directly or provide 
services to retirement and health plans that cover more than 100 
million Americans.
    CIEBA represents more than 100 of the country's largest corporate 
sponsored pension funds. Its members manage more than $1 trillion of 
defined benefit and defined contribution plan assets, on behalf of 15 
million plan participants and beneficiaries. CIEBA members are the 
senior corporate financial officers who individually manage and 
administer ERISA-governed corporate retirement plan assets.
    We very much appreciate the opportunity to address the swap-related 
issues raised by Dodd-Frank for private retirement plans governed by 
the Employee Retirement Income Security Act of 1974 (``ERISA''). And we 
applaud the Subcommittee for holding a hearing on this critical set of 
issues.
    We believe that the agencies--the Commodity Futures Trading 
Commission (``CFTC''), which has jurisdiction over the types of swaps 
most important to plans, and the Securities and Exchange Commission 
(``SEC'')--have been working extremely hard to provide needed guidance. 
Also, both agencies have been very open to input on the swap issues 
from the plan community. We very much appreciate the open and frank 
dialogue we have had with the agencies to date.
Timing
    Implementing Dodd-Frank is an enormous undertaking. With respect to 
the derivatives title of Dodd-Frank, there is one issue, however, that 
is dwarfing all others: timing. The agencies are attempting to perform 
a complete restructuring of a nearly $600 trillion market with rules 
developed over a few months. It simply is not possible to do that in a 
way that takes into account all relevant factors. It is inevitable that 
the rules will have unintended and unforeseen consequences that could 
adversely impact the retirement security of millions of Americans, and 
cost our country billions of dollars and countless jobs.
    In the pension area alone, almost no one can keep up with the 
breathtaking speed at which regulations are being proposed and will 
soon be finalized. The pension community barely digests one significant 
proposed regulation when another significant proposed regulation is 
issued. More importantly, subsequent proposed regulations can affect 
the application of prior proposed regulations, making the comment 
process very challenging at best and ineffective at worst. Also, the 
pension community finds itself having to comment on everything, even 
regulations that it hopes will not apply to ERISA plans, because of the 
uncertainty regarding whether the regulations may apply.
    As noted, the regulators are rushing to meet statutory deadlines. 
Those statutory deadlines were aggressive at the time they were 
adopted. In retrospect, given the enormity of the market, such 
deadlines now appear dangerous for pension plans because, in an attempt 
to meet those deadlines, regulators have proposed regulations which 
could ultimately threaten pension plan participants' retirement 
security.
    As noted the CFTC and the SEC have opened their doors to ERISA 
pension plans and we have seen our comments very helpfully taken into 
account by these agencies in a number of proposed rules. But these 
agencies are under extreme time constraints. And pension trade groups 
are very concerned that such time constraints could result in 
regulations being adopted that inadvertently harm pension plans.
    Effects of staying on the current course. To stay on the current 
course is to invite, if not ensure, a train wreck. In the pension area, 
inadvertent adverse developments with respect to the use of swaps would 
have devastating effects.
    ERISA pension plans use swaps to manage the risk resulting from the 
volatility inherent in determining the present value of a pension 
plan's liability, as well as to manage plan funding obligations imposed 
on companies maintaining defined benefit plans. If swaps were to become 
materially less available or become significantly more costly to 
pension plans, funding volatility and cost could increase 
substantially, putting Americans' retirement assets at greater risk and 
forcing companies in the aggregate to reserve billions of additional 
dollars to satisfy possible funding obligations, most of which may 
never need to be contributed to the plan because the risks being 
reserved against may not materialize. Those greater reserves would have 
an enormous effect on the working capital that would be available to 
companies to create new jobs and for other business activities that 
promote economic growth. The greater funding volatility could also 
undermine the security of participants' benefits.
    Let me explain this volatility issue further. In a defined benefit 
pension plan, a retiree is promised payments in the future. The 
obligations of a pension plan include a wide range of payments, from 
payments occurring presently to payments to be made more than 50 years 
from now. The present value of those payments varies considerably with 
interest rates. If interest rates fall, the present value of 
liabilities grows. So if interest rates drop quickly, the present value 
of liabilities can grow quickly, creating additional risk for 
participants and huge economic burdens for the company sponsoring the 
plan. Swaps are used to address this risk, as illustrated in a very 
simplified example below.
    Assume that a plan has $15 billion of assets and $15 billion of 
liabilities so that the plan is 100% funded and there is thus no 
shortfall to fund. Assume that interest rates fall by one percentage 
point. That alone would increase liabilities substantially. Based on a 
real-life example of a plan whose interest rate sensitivity is somewhat 
higher than average, we assume a 13% increase in plan liabilities to 
$16.95 billion. Based on a realistic example, we assume that assets 
increase to $15.49 billion. Thus, the decline in interest rates has 
created a $1.46 billion shortfall. Under the general pension funding 
rules, shortfalls must be amortized over 7 years, so that the plan 
sponsor in this example would suddenly owe annual contributions to the 
plan of approximately $248 million, starting with the current year. A 
sudden annual increase in cash outlays of $248 million can obviously 
present enormous business challenges as well as increased risks for 
participants.
    Swaps are a very important hedging tool for plan sponsors. Hedging 
interest rate risk with swaps effectively would avoid this result by 
creating an asset--the swap--that would rise in value by the same $1.46 
billion if interest rates fall by one percentage point. Thus, by using 
swaps, plan sponsors are able to avoid the risk of sudden increases in 
cash obligations of hundreds of millions of dollars. If, on the other 
hand, plans' ability to hedge effectively with swaps is curtailed by 
the new rules, funding obligations will become more volatile, as 
illustrated above. This will, in turn, increase risk for participants 
and force many employers to reserve large amounts of cash to cover 
possible funding obligations, thus diverting cash from critical job 
retention, business growth projects, and future pension benefits.
    Without swaps, some companies would attempt to manage pension plan 
risk in other ways, such as through the increased use of bonds with 
related decreases in returns. One company recently estimated that its 
expected decrease in return that would result from the increased use of 
bonds would be approximately $100 million. And this pain will be felt 
acutely by individuals. Companies that lose $100 million per year may 
well need to cut jobs and certainly will have to think about reducing 
pension benefits.
    We also note that the bond market is far too small to replace swaps 
entirely as a means for plans to hedge their risks. There are not 
nearly enough bonds available, especially in the long durations that 
plans need. Furthermore, a flood of demand for bonds would drive yields 
down, increasing the present value of plan liabilities dramatically. In 
short, a shift from swaps to bonds would be costly, insufficient, and 
potentially harmful for plans.
    What is needed. We believe:

   The agencies need more time to develop proposed rules. They 
        also need to sequence the rule proposals in a logical 
        progression.

   The retirement plan community needs more time to review 
        those proposed rules and to provide comments to the agencies. 
        Given the volume of rules being proposed in such a compressed 
        time period, we propose that the Commission give much more than 
        60 days to comment.

   The agencies need more time to consider the comments and 
        provide final rules.

   The retirement plan community needs more time to prepare to 
        comply with an entirely new system.

    Accordingly, we strongly urge you to adopt legislation that would 
provide that each provision of Title VII shall become effective as of 
the later of (a) January 1, 2013 or (b) 12 months after the publication 
of final regulations implementing such provision.
Issues
    It is important for two reasons to share with you some specific 
issues arising under Title VII for plans. First, those issues will 
strikingly illustrate the need for more time and the potential adverse 
consequences of forcing the process to move too quickly. Second, if 
additional time is not provided or if the agencies do not modify their 
rules, it may be important for Congress to step in to prevent 
potentially devastating results.
    Business conduct standards. Under the business conduct rules, a 
swap dealer entering into a swap with a plan is required to provide 
counsel and assistance to the plan. The underlying rationale of these 
rules was that swap dealers are more knowledgeable than plans and are 
likely to take advantage of plans unless compelled to help them. By 
definition, this rationale has no application to ERISA plans. By law, 
ERISA plans are prohibited from entering into swaps unless they have an 
advisor with an expertise in swaps. Accordingly, ERISA plans do not 
have any need for any assistance or counsel from dealers. And ERISA 
plans have no interest in counsel from their opposing party. So at 
best, the rules have no effect. Unfortunately, the rules as proposed by 
the CFTC would actually have devastating effects. Here are just two 
examples, although there are other issues with respect to these 
proposed rules.

   Requiring actions that would make swaps impossible. The 
        counsel that a swap dealer is required to provide to a plan 
        under the CFTC's proposed rules would make the swap dealer a 
        plan fiduciary under regulations recently proposed by the 
        Department of Labor (the ``DOL''). Pursuant to the DOL's 
        prohibited transaction rules, a fiduciary to a plan cannot 
        enter into a transaction with the plan. So, if the swap dealer 
        is a plan fiduciary, then either no swap transaction can be 
        entered into or the swap is an illegal prohibited transaction 
        under the rules applicable to plans. Thus, the business conduct 
        rules would require a swap dealer to perform an illegal action 
        or refrain from entering into a swap with a plan. The only way 
        to avoid violating the law is for all swaps with plans to 
        cease, with the adverse results described above.

    The above characterization is not just our view. To our knowledge, 
        it is the universal business community perspective, and 
        informal conversations with agencies indicate that they also 
        recognize this problem.

    Congress clearly never intended to indirectly prohibit plans from 
        utilizing swaps. The CFTC must not propose conduct standards 
        that require a swap dealer to do the impossible--act in the 
        best interests of both itself and its counterparty. Even more 
        importantly, the CFTC and the DOL must jointly announce that 
        the business conduct rules will not be interpreted in a manner 
        that will require the swap dealer to perform an illegal act 
        under ERISA when trading with an ERISA plan in order to comply 
        with a CFTC rule under the Commodity Exchange Act. If the 
        agencies do not do this--and because of the time constraints 
        and the difficulties of inter-agency coordination it is very 
        possible that they will not--Congress needs to step in.

   Dealers' right to veto plan advisors. Under the proposed 
        CFTC rules, swap dealers are required to carefully review the 
        qualifications of a plan's advisor and would have the ability 
        to veto any advisor advising a plan with respect to a swap. We 
        are not suggesting that a dealer would use this power, but the 
        fear of that result would have an enormous effect on advisors' 
        willingness to zealously represent plans' interests against a 
        dealer. Moreover, the specter of liability for not vetoing an 
        advisor that subsequently makes an error may have an adverse 
        impact on the dealers' willingness to enter into swaps with 
        plans; this may result in the dealers demanding additional 
        concessions from the plans or their advisors, or may cause the 
        dealers to cease entering into swaps with plans. In all of the 
        above cases, the effect on plans' negotiations with dealers 
        would be extremely adverse. This, too, was never intended by 
        Congress.

    As stated above, placing the responsibility on the dealers to veto 
        advisors is not a service that would benefit plans. ERISA has a 
        long history of requiring plan fiduciaries to be held to the 
        highest fiduciary standard--that of a prudent expert. 
        Therefore, not only are investment advisors held to this 
        standard, but the plan sponsors choosing the advisors are held 
        to the same strict standard. It is hard to see how a 
        counterparty whose interests are adverse to a plan's interests 
        can do a better job of choosing advisors. Consistent with the 
        statute, a dealer should be deemed to meet the business conduct 
        standards relating to dealers acting as counterparties if a 
        plan represents that it is being advised by an ERISA fiduciary.

    Required clearing. Business end-users, such as operating companies, 
have the right to decide whether to clear a swap (i.e., the ``end-user 
exemption''). Oddly, the plans sponsored by such companies do not have 
that right. Although plans have an ``end-user exemption'' with respect 
to major swap participant status, they are not eligible for the end-
user exemption from the clearing requirement. To our knowledge, there 
is no substantive reason for this distinction; in fact, like operating 
companies, plans have an inherent risk to hedge--interest rate risk. 
Moreover, plans are required by law to be diversified, prudent, and 
focused exclusively on participants' interests. Fiduciaries, acting 
pursuant to the highest standard of conduct under the law, should have 
the right to decide whether to clear a swap. In this regard, here are 
two examples of very troubling aspects of applying the clearing 
requirement to plans:

   Anti-avoidance and potential loss of customized terms. Each 
        plan has different risks, based on the unique demographics of 
        its plan participants and its unique investment strategy. 
        Accordingly, plans have a great need to customize the terms of 
        their swaps to seek to most effectively hedge their unique 
        risks; because of the customized terms, plans' swaps may not be 
        generally clearable. An issue arises because Dodd-Frank 
        contains a section directing the CFTC to prescribe rules 
        precluding evasion of the clearing requirement. The problem is 
        that there is no clarity as to how this requirement will be 
        interpreted and applied, and this may cause plans and their 
        advisors to forego customized swaps that they think are in the 
        best interests of the plan and its participants, in order to 
        avoid inadvertently violating Dodd-Frank. It is critical that 
        plans not be forced to give up those customized terms. Plans 
        should be free to retain their customized terms and to use the 
        over-the-counter market if the customized terms render a swap 
        unclearable, without fear of violating the law.

   Fellow customer risk. Unless the CFTC allows segregation of 
        collateral, the collateral posted by a pension plan would be 
        aggregated with the collateral posted by other users of the 
        clearing platform and thus could be subject to risks posed by 
        other far less secure swap market participants. For example, in 
        a clearing context, collateral posted by a plan could be used 
        to address defaults by a very risky hedge fund that uses the 
        same clearing platform. Prior to Dodd-Frank, plans were not 
        exposed to the risk of other far riskier entities. It would be 
        strange and ironic if Dodd-Frank were to force plans to assume 
        far greater risk.

    We ask Congress to step in and extend the end-user exemption from 
        clearing to plans.

    Real-time reporting. The CFTC has issued rules regarding the real-
time public reporting of swaps. The purpose of such reporting is to 
enhance price transparency, with the ultimate goal of reducing prices. 
But the CFTC issued rules that we believe would likely have exactly the 
opposite effect. In fact, we believe that if the CFTC rules were 
finalized in their current form, swap transaction costs would increase 
dramatically, perhaps by as much as 100% in some cases.
    The problem is that if the terms of a swap are immediately known to 
the market, the dealer assuming the risk with respect to the swap will 
have far more difficulty in offsetting that risk in a subsequent 
transaction. Knowing that the dealer has to offset a specific risk, the 
rest of the market has a large negotiating and informational advantage 
over the dealer and can charge the dealer much more to offset its risk. 
The dealer thus has to charge much more for the original swap.
    This is a problem that can be easily solved with data regarding how 
much time dealers need to offset risk with respect to different types 
of swaps. Any effort to act before sufficient data are collected and 
analyzed is likely to result in exactly the wrong result--cost 
increases.
    Plan swap terms should not be altered without plan consent. It is 
essential that the CFTC and SEC adopt clear rules under which no party 
involved in the reporting or clearing process has the power to modify 
the terms of any swap. For example, today, it is not uncommon for a 
swap data repository or an electronic confirmation service provider to 
require, as a condition of using their service, the unilateral right to 
modify swap terms by ``deeming'' a user to have agreed to such terms if 
they use the system after notice. Today, plans can simply elect not to 
use those services. But after Dodd-Frank becomes effective, plans will 
be required by law to report swaps. If the swap data repository 
receiving such reports or an entity providing services with respect to 
such repository has the right to modify plan terms, the repository or 
entity would effectively have government-type power to control swap 
terms. This would be shocking and certainly not what Congress had 
intended.
          * * * * *
    In conclusion, the CFTC, the SEC, and the swaps community have an 
enormous challenge in working together to implement a complete 
restructuring of a nearly $600 trillion market. This cannot, and should 
not, be done in a few months. If we are forced to do this too quickly, 
it is inevitable that there will be negative unintended consequences, 
costing billions of dollars in the aggregate. With respect to the plan 
area alone, retirement benefits would be subject to greater risk and 
huge numbers of jobs and billions of dollars of participants' benefits 
could be adversely affected. We urge Congress to (1) modify the 
effective date of Dodd-Frank to let the process proceed in an orderly 
and careful manner, (2) extend the end-user exemption from clearing to 
plans, and (3) address any problems under the regulations, such as the 
fact that the proposed business conduct rules would effectively ban all 
swaps with plans.
    Thank you for the opportunity to present our views. I would be 
happy to take any questions that you may have.

    The Chairman. All right. Thank you, Ms. Sanevich.
    I thank all the witnesses for being here today.
    I was in a meeting with a fellow who runs the NSA named 
Keith Alexander who said, nothing is impossible for those who 
don't have to do it. And it seems like we have asked Gary 
Gensler and his team to do the impossible. Because, quite 
frankly, Congress didn't have to do it. And whether the 360 
days to get all of this done made sense--it certainly made 
sense to those who supported this work last year. But in the 
current mix of things that are going on and all of the things 
that you talked about, the 360 does not make as much sense as 
it does to now.
    We will go on the 5 minute clock.
    I would like all of the witnesses to address these 
questions. If we don't have a chance to get to everybody, we 
will do a second round after we have gone through everybody. So 
I will just take my 5 minutes along with everyone else.
    In terms of--help us understand the body of rules that are 
out there. Mr. Gensler said last week that he would have most 
of it done soon, and it would be in a quieter pause while they 
assimilated everything they have done.
    If you were Mr. Gensler, in what order would you roll out 
the next round of either final rules or proposed rules or 
whatever in terms of a pecking order that he would--that you 
would roll those out in, and give me something a little 
clearer.
    Ms. Sanevich, you mentioned compliance costs would go way 
up, dramatic was your word. If you could quantify those a 
little better.
    Mr. McMahon, you talked about hundreds of millions of 
dollars in terms of margin and those kind of things, but help 
us understand from a qualitative standpoint how much we are 
actually talking about in terms of compliance costs.
    So I will throw it open to anyone who wants to start off, 
and we will come back after we have had the other speakers.
    Mr. Damgard. I am happy to start off.
    He has really got it backwards. We would like to know what 
a definition of a swap is going to look like. We would like to 
know who qualifies as a significant swap participant. We would 
like to know what a SEF is. Until we have definitions of those 
kinds of organizations or those definitions, there are bodies 
of people out there that have no idea whether they are going to 
be affected. And if they find out after the fact it is going to 
be too late for them to comment.
    Now I know that they are working real hard at the CFTC. I 
will say my organization is totally exhausted. We face four or 
five rulemakings a year historically from the CFTC, and there 
are 30 pending right now. We simply are unable to do an 
adequate job of making sure that what we are able to send to 
the CFTC, which has historically been very helpful, is even 
being properly considered.
    I mean, I remember when the CFTC was created in this room. 
It was created as an oversight regulator. And the exchanges 
have very, very deep rule books; and they have an awful lot of 
self-interest in making sure that their exchanges are seen as 
good organizations. They don't want manipulation in their 
markets, because people wouldn't use them.
    We have a very good self-regulator called the National 
Futures Association, which was also created by you guys; and 
they have done an excellent job and a very efficient job.
    My view is Mr. Gensler wants to change all that from being 
an oversight regulator and go back to this prescriptive rules 
and regulation where everybody is going to have to come to the 
CFTC and ask his permission once he finalizes all these rules. 
He certainly has enough economists over there to write these 
rules and finalize them. Where he is going to ask for more 
money is implementation and enforcement.
    And my concern--and he has essentially made this threat 
recently--he said, well, once I have all these regulations in 
place, then if I don't have the revenues and I don't have the 
resources in which to decide whether I am going to allow you to 
register as a SEF, then get in line. It could take a long, long 
time. So you people ought to be out there helping us get the 
additional resources.
    Well, whether I would like to do that or not is irrelevant. 
It isn't going to happen. And I would like to see Congress 
maybe go back to what we did initially; and that was, when we 
created the CFTC, there were an awful lot of people that were 
already in the business and that they didn't instantly have all 
the resources at the CFTC to make all these approvals.
    Truthfully, the year 2000 and that reauthorization was 
extremely helpful to the industry; and we have seen the 
industry grow dramatically because of that.
    Now, it is true that--and I represent the listed markets. I 
represent exchange-traded futures. And other people can make 
excuses for the swaps market, but, truthfully, energy swaps, 
interest rate swaps, currency swaps, all those work perfectly. 
It is only when we get into the debt instruments and the CDSs, 
I mean, it just seems like our whole industry is paying an 
awful price for AIG.
    And I see my time is almost up.
    The Chairman. Ms. Sanevich.
    Ms. Sanevich. I agree that the definition of who is covered 
by what and who--so what is a swap, who falls under an MSP, who 
is an end-user, what is required under those things have to be 
sequentially addressed so that then people can process and 
think through how the various other rules that are being 
promulgated for all these entities will apply to that 
particular entity.
    And very importantly from the pension plans perspective is 
that we have very similar sequencing issues and concerns. But, 
on top of that, we have the Department of Labor coming out and 
working with rules that will effectively shut down the use of 
pension plan swaps completely. And so at a very high level for 
pension plans, unless these things are coordinated and resolved 
adequately, the rest of it might be moot from a pension plan's 
perspective because they won't be able to use these 
instruments.
    The Chairman. Thank you. We will come back on the other 
witnesses after everybody has had a chance.
    Mr. Boswell, 5 minutes.
    Mr. Boswell. Thank you, Mr. Chairman.
    I know that some of the Members have meetings, so I am 
going to yield to them to go down your list. Because I am going 
to stay until it is over, and I will have another opportunity.
    The Chairman. The gentleman from North Carolina, Mr. 
Kissell.
    Mr. Kissell. Thank you, Mr. Chairman. I thank everybody for 
being with us here today and your patience with us during 
voting and your testimony before us.
    This whole idea of the derivatives was the first hearing I 
came into--this is my second term in Congress--my first year I 
came in here was on derivatives. And it was a back-and-forth 
testimony at the time between those who felt we needed to do 
something and those who said, well, no one lost any money and 
everything is fine.
    Mr. Damgard, you mentioned a second ago the industry is 
paying a high price for AIG, and I felt that more than just the 
industry paid for AIG, is gas prices went up to $4 a gallon, 
and all the things that we associated with, while people may 
not have lost money, per se, that were in the swaps, I felt 
that we as a nation paid a pretty high price for some of the 
pricing and so forth and so on. And, as Mr. Boswell said 
earlier, shining a little bit of light in here, it doesn't seem 
like that is an issue.
    So I am curious about when you said the industry paid a 
price for AIG, how would you separate the industry from AIG? 
And if you could elaborate on that briefly for me, please.
    Mr. Damgard. AIG is now one of my member organizations, but 
I would say it is awful easy to shoot the messenger. Markets 
have worked extremely well. And when gas prices go up, 
truthfully, it is not the fault of the market. There are people 
in the market that are buying and selling, and, yes, there are 
passive longs, but the energy market, frankly, is hardly a free 
market when you have OPEC controlling a large percentage of the 
volume.
    So when I say AIG is causing us a lot of agony, because we 
weren't directly involved in any of the difficulties in the 
market, and I am very proud of the fact that futures markets 
all over the world worked very, very smoothly through all of 
that stress. And the CFTC is now given this huge new mandate to 
regulate the OTC world or the swaps world, and an awful lot of 
that is, unfortunately, carrying over into the futures market. 
We would like to say futures markets have worked extremely 
well.
    There is nothing in Dodd-Frank that says you have to go out 
and totally rewrite the rule book on an industry that worked 
perfectly well, and this is basically what is happening. And 
some of it is inevitable. If you are going to do something in 
the swaps area, it is almost impossible to necessarily 
differentiate those kinds of things from the futures market.
    Just in collecting data, and I won't bore you with it, but 
in my----
    Mr. Kissell. If I could interrupt you, and I apologize, but 
I have a couple other questions I want to get to.
    Mr. McMahon, you had talked about the concerns for the end-
user; and if I heard you correctly, you said, yes, they are 
saying they are going to exempt the end-user. Are you satisfied 
that they are and that is what they say they are going to do? 
Or do you still have concerns there?
    Mr. McMahon. Well, our concerns I think are two-fold.
    One, as I mentioned in my statement, we want to make sure 
that we are fully exempt from the margining requirements, that 
commercial end-users are exempt, and also because of the $250 
to $400 million per company impact of that on our companies. I 
will say our companies use exchange-traded products as well as 
over-the-counter products. So it is not that we don't use them. 
It is just that when they are appropriate we do.
    The other aspect of it, again, is the fact that the 
compliance cost associated with it, it looks to us as if the 
CFTC is taking more of a transactional approach to the end-user 
exemption so that instead of making a declaration that we use 
these products to hedge commercial risk and that being the end 
of it, in addition to the reporting that would come along with 
it, it appears that it looks as if we are going to have to make 
a transaction by transaction disclosure so that the compliance 
burden would be, we feel, pretty heavy in that sort of 
approach. And we haven't computed the cost of that, but we 
believe it would be pretty burdensome to do that. So I think 
that is a real concern.
    And, again, we are not quite sure, because the definition 
of a swap hasn't been promulgated, how many of our transactions 
would be affected, because utilities are subject to weather and 
things like that, and that causes us to build in a lot of 
optionality into our agreements for fuel and things like that. 
So we are concerned that things that we would normally consider 
to be derivatives or swaps, if the definition is very broad, 
could be encompassed in this; and, of course, that would change 
potentially the end-user status if they are using a lot of 
these products that we normally wouldn't consider to be swaps.
    Mr. Kissell. Thank you, sir.
    Thank you, Mr. Chairman.
    The Chairman. Sure. I thank the gentleman.
    And the gentlelady from Alabama, Terri Sewell, quite the 
comedienne from the other night. I was in the audience. I heard 
that activity. You are recognized for 5 minutes.
    Ms. Sewell. Thank you, Mr. Chairman.
    To our panelists, thank you so much for coming in and 
enlightening us on this topic.
    My question, everyone on the panel seemed to say that the 
lawmaking should not go into effect in July, that it is too 
onerous, that there is just not enough time. So my question 
really is--and this is to anyone who wants to answer it--are 
you saying that the market should go unregulated, that somehow 
we shouldn't put regulations on swaps and on these derivatives?
    And if you are not saying that, then when is the timeline? 
Give me a timeline that would be acceptable to the marketplace.
    Mr. Bullard. Congresswoman, we believe that these 
regulations should be implemented as swiftly as possible. We 
have already identified dysfunctionality within the futures 
market. We need to restore that market as quickly as possible 
so it is a used and useful tool to discover price in tandem 
with the cash market, which is also a price discovery market in 
our industry, as well as to provide producers a legitimate and 
genuine risk management tool that is unavailable when the 
market is prone to manipulation and distortion, as we 
witnessed.
    Mr. Kaswell. If I may, we would not say don't do anything. 
We are not trying to deliver that message. I think we are 
trying to say we respectfully think it should be done 
selectively. And we think that moving forward on things like 
central clearing, that is very important to us, segregation of 
collateral, that is very important to us. But, in other cases, 
it is a matter of sequencing; and I think this is where it gets 
back to the Chairman's question.
    We also would like to know what a major swap participant is 
before we know what those responsibilities entail. It is 
similar to comments made about the definition of a swap, and 
the sequencing and the clarity to know where we stand so then 
we will understand, if you are in this category, what does that 
mean.
    There are also some things that the CFTC is proposing that 
we are troubled about, which is they are proposing to take away 
one of the exemptions for CPOs, commodity pool operators, which 
will in effect require those organizations to be duly regulated 
by the SEC and the CFTC with potentially conflicting 
regulations. We don't think that is an effective use of 
regulatory resources at a time when we understand the pressures 
that everyone is under.
    Thank you.
    Mr. Damgard. And I am not here to apologize for the OTC 
world, but I do think they make a good case. Ag swaps worked 
just fine. People trusted their counterparties, and for the 
most part so did interest rate swaps and the others.
    One example is the energy market. We have a very fine 
energy market in New York, and that is called--belongs to the 
CME. It is the WTI. It is called the West Texas Intermediate. 
That is the benchmark trade.
    Now the oil is not coming from west Texas, with all due 
respect. The oil is coming from the Middle East. We are losing 
that market share. We are losing it every day to the Brent. 
Because, to the extent that there are going to be position 
limits in the energy market, any dealer that has customers all 
over the world may run the risk of exceeding what that position 
limit may be at any given moment.
    Someone mentioned that somebody just got fined the other 
day, and it was not an intentional--but firms will go to a 
market where they don't run that risk, and the Brent market is 
an extremely good market. It is called the International 
Petroleum Exchange. So we are not only losing market share to 
foreign markets, we may lose those markets altogether, and the 
Brent will soon be the benchmark that people will trade.
    And I just hate to see the United States lose a business, 
lose an industry, for the wrong reasons. If we are being out-
competed, that is one thing. But if we go overboard and we see 
the pendulum swing way over to one side, then it is going to be 
very damaging to business in the United States.
    Mr. Bernardo. Just to add to that, I think that the 
regulatory transparency should be and could be done quickly, 
but the regulators need to understand the markets that they are 
regulating.
    Ms. Sanevich. This is a very diverse market. You can see by 
the different entities represented here. And at least from our 
perspective, we are very concerned about unintended--no one 
meant for a bad consequence to happen, but because everything 
has to be promulgated so quickly not only is it hard for the 
regulators to think through a very complicated market but for 
those who are directly impacted to actually digest and respond 
and to raise issues. These are very complex issues that are 
very interrelated. And that is the angst in our case. There is 
different regulatory agencies now that are in direct conflict.
    The Chairman. Thank you.
    Now, Mr. Welch, you are up next for 5 minutes.
    Mr. Welch. Thank you very much, Mr. Chairman.
    As I listened to your testimony and read your testimony, 
the conflict that seems to be the problem inherent in this is 
that, on the one hand, you have the physical hedgers, the ones 
buying the product; and the statistics that you gave, Mr. 
Bullard, that the futures markets declined from 52 percent and 
67 percent respectively for the futures market and in the live 
cattle market in 1998 to 17 percent and 11.7 percent shows that 
the participation rate by the physical hedgers has obviously 
declined.
    On the other hand, Mr. Damgard, what you are concerned 
about, and rightly so, is that if there are rules and 
regulations that interfere with the work that you are doing for 
the overall market, then we will lose a good industry.
    But what may be good for one end of the futures market, 
which is essentially the financial transactions, some people 
would use the term speculation which plays a role in liquidity, 
the interests of that segment of the market really do seem to 
be in some conflict with the small feedlot operators who needed 
this market for a very simple, straightforward hedging 
position.
    And I don't know how we thread that needle. That to me is 
the question. Because I think we have to have a futures market 
that protects the folks that Mr. Bullard works for and 
obviously wants the jobs that your activity represents. And I 
am just going to ask each of you to tell me what your 
recommendations are about how to resolve that conflict so we 
don't hammer the cattle and feedlot dealers and destroy jobs 
that might go overseas.
    I will start are with you, Mr. Bullard.
    Mr. Bullard. Congressman, the futures commodity market is a 
market that supports an entire underlying industry with those 
who are, as you indicated, physical hedgers. And what has 
transpired as a result of the excessive speculation by the 
index funds and the hedge funds that have entered these markets 
is that the market has become less and less capable of 
discovering the fair market value. As a result, we no longer 
have a market that is actually providing the price discovery 
function that it should be that would normally occur if you had 
the majority of physical hedgers in the market.
    And our concern also is with the industry itself, the 
industry that has become so dominated by just four large 
packers that now control over 80 percent of all the fed steer 
and heifer slaughter. You have on one side of that physical 
market essentially four participants and all the rest are the 
independent feeders who are trying to sell to them. That market 
has to be protected, and we have already seen that we have 
severe problems in the market. So that is why we support 
strongly reductions on the number of speculators that are 
involved in the market.
    And we also believe that it is improper for a packer who 
may be a physical hedger to step out of the role of a physical 
hedger and suddenly become a speculator in order to try to 
manage the direction of the market, and we believe that that 
has been ongoing for a number of years.
    Mr. Welch. Thank you.
    Mr. Damgard, I will ask you to basically try to, for me, 
let me understand how we could accomplish what you want without 
destroying what Mr. Bullard represents, or is it impossible?
    Mr. Damgard. In defense of the futures markets, let me just 
say that these markets have grown just exponentially. And I 
would agree that the CFTC has done an excellent job of--I mean, 
you don't hear about the Hunt brothers anymore. If there is 
manipulation in the market, you pay a very, very dear price. So 
if somebody is manipulating the market, I believe the CFTC is 
the right place to determine whether that manipulation has 
taken place, and to the extent that it does take place people--
--
    Mr. Welch. Let me just address that. Because I don't think 
that Mr. Bullard is talking about manipulation so much as if 
the market has gone from essentially something that serves 
physical hedgers to one that serves financial players, it works 
differently; and that is I think the dilemma that we are in.
    Mr. Damgard. I am a corn grower and soybean grower in 
central Illinois. I use the markets all the time. I decided 
that at $4.50 that was a pretty good price. That covered my 
cost and gave me a profit. So I sold a lot of corn at $4.50. 
Today, it is $7.
    Now the real problem for the cattle feeders, in my 
judgment, is you can't feed animals $7 corn and make any money. 
So what is happening is you see the herds declining, fewer 
animals; the price of the animal is more expensive; you are 
going to pay a whole lot more for a steak; and my ability to 
grow corn next year and sell it at a good price is going to be 
limited by the lack of demand from the cattle industry.
    Now, we can get into ethanol, but we can also get into the 
fact that China is a huge buyer of U.S. agricultural products. 
Most of the corn that I grow today in central Illinois that 
used to go down the river gets on a train and goes out to 
Portland, Oregon. Because the bottoms are in short demand, and 
it is shorter to go from Portland to Beijing or wherever.
    My own view is that there may be markets that get so thin 
that they are no longer useful for the people using those 
markets. And if that is the case, it is the exchange's problem. 
I think the exchange went to great lengths to try to change the 
terms of the cotton contract last year because a lot of people 
were concerned that the cotton market wasn't working properly. 
But to blame the whole thing on the lack of regulation is a 
terrible mistake. We don't want that.
    Mr. Welch. My time is up, but I thank you for your answer.
    Thank you, Mr. Chairman.
    The Chairman. Thank you.
    Mr. Scott from Georgia, 5 minutes.
    Mr. David Scott of Georgia. Thank you, Mr. Chairman.
    Mr. Kaswell, both last week at the full Committee's 
hearing, and then this morning at Financial Services, I 
questioned Chairman Gensler regarding the CFTC's advance notice 
of proposed rulemaking on margin segregation. And I would kind 
of like to explore that with you but particularly on the cost 
versus benefits of regulation and how it relates to this issue.
    I have heard from dealers, I have heard from some 
clearinghouses that margin segregation could dramatically 
increase costs for everyone involved and will produce only 
marginal gains in risk protection. Listening to you, you seem 
to dispute my position and assertion. Is that correct?
    Mr. Kaswell. I disagree with that position. I hate to 
disagree with you, sir.
    Mr. David Scott of Georgia. Let me ask you this. Have your 
members been able to quantify what their additional costs may 
be and how much additional risk mitigation they may receive 
from a margin segregation regulatory requirement?
    Mr. Kaswell. I think we don't know the cost, but I don't 
think anyone knows the cost, and I think that is part of the 
concern that we have.
    The statute has a preference for segregation of collateral 
for cleared swaps, complete segregation. We think that reduces 
systemic risk and provides the greatest stability for the 
trading system and for the public at large. We know there will 
be costs in building these clearing systems.
    What I think is the fair question is not that it will be 
expensive but what will be the marginal cost of providing that 
additional level of protection?
    And we think that before we say we can't afford it, even 
though it would prevent repetitions of problems like Lehman 
Brothers, we think that we should have a better sense of what 
those costs are. And once we know that, then I think we will be 
in a better position to say, yes, we actually think this is not 
going to be too bad and we can get those benefits, or them to 
say maybe it is too expensive. But I think those who argue that 
we don't need the protection and notwithstanding that the 
statute expresses a preference for it, admittedly with 
exceptions, that we should look to fully explore it before we 
discard that option.
    Mr. David Scott of Georgia. It is true that the Dodd-Frank 
Act doesn't even require the CFTC to explore this issue.
    Mr. Kaswell. Well, I don't think it directs a rulemaking on 
it, but it does require in the provision for section 724 that 
it says, for cleared swaps, segregation is required. And it 
says commingling is prohibited. And then it goes on to create 
some exceptions so that we can have the range of possibilities 
that the CFTC has proposed. And so I am not saying that the 
statute forecloses a discussion on this, but we think it 
expresses a preference for full segregation.
    One of the issues that you face is that if I am a customer 
in an FCM and I have no ability to know who the other customers 
are at that FCM, I can't do due diligence. If my good friend 
John Damgard is another customer, I can't know--I mean, I know 
he is a great guy. You are good for it. But there is no way I 
can do due diligence on that. And if his failure could 
jeopardize that FCM, which could then jeopardize the system, my 
position as a solvent participant could be harmed and my 
ability to move my collateral from one FCM to another, or from 
one clearing entity to another would be compromised and we 
could be in the soup that we saw with Lehman in Europe.
    Mr. David Scott of Georgia. Just to clear up, given that we 
don't require this margin segregation for futures 
clearinghouses, I would be interested to know why. The question 
is, why do you think they are looking into this? Did someone 
come to the CFTC to request this? What was the origination for 
this? I am just simply--it wasn't required in the law. It is 
clear that there have been complaints about the expensiveness 
and the cost and minimal benefits.
    Mr. Kaswell. I think you would have to ask the CFTC, but I 
do know the CFTC has proposed at least four options in the 
notice. The one that we think makes the most sense is the 
first, which is the complete segregation of collateral, but 
they have they laid out various other alternatives.
    Mr. David Scott of Georgia. And is it not true that perhaps 
they have undertaken their own investigation to determine 
whether or not this is a rule they will pursue?
    Mr. Kaswell. Well, I believe there is a notice of proposed 
rulemaking, but I really think these questions are better 
directed at the CFTC.
    Mr. David Scott of Georgia. You do not believe that 
future--just one little bit here--God bless you. I thank you so 
much.
    The Chairman. You are the only guy to do it so far.
    Mr. David Scott of Georgia. You are a good man.
    Shouldn't futures clearinghouses and derivative 
clearinghouses be treated the same? And, in general, are your 
members supportive of this effort of the CFTC and are they all 
of one mind to do, or do some of them feel that this is not 
necessary?
    Mr. Kaswell. We are strongly in support of the idea of 
segregation of collateral at the FCM and the clearinghouse 
level. We think that is the optimal answer.
    We understand there are questions and there should be 
thoughtful inquiry into that. But, again, we think that, before 
rejecting that which we see is the best alternative, we think 
we should conclude that the marginal cost is too high and not 
worth it. And we don't think anybody has made that case, and 
so, therefore, we think we should pick the best option because 
it provides the greatest amount of protection for the system 
and will allow us to avoid problems that have occurred in the 
past.
    Mr. David Scott of Georgia. Thank you very much, Mr. 
Chairman, for your kindness and generosity.
    The Chairman. The gentleman yields back.
    Mr. Hultgren from Illinois, 5 minutes.
    Mr. Hultgren. Thank you, Mr. Chairman; and thank you all 
for being here. Thank you for your testimony. Sorry for the 
busy day we have going here, but I really appreciate your being 
here on some very important issues that we are going to be 
facing, going forward.
    I do have a couple of questions to Ms. Sanevich.
    First, from your testimony, from the written testimony, you 
made a point under the proposed CFTC rule swap dealers will be 
required to provide counsel to pension plans that would then 
make them fiduciaries under the DOL rules. Also, under DOL 
rules, fiduciaries cannot trade with pension plans so that CFTC 
results would essentially shut pension plans out of the market 
altogether. Am I misreading that?
    Ms. Sanevich. Combined with the DOL rules, that is 
absolutely correct. Pension plans will not be able to engage in 
swaps if the two rules are promulgated as proposed currently.
    Mr. Hultgren. Is that your sense? Is that the direction it 
is going? Have you heard anything different on that?
    Ms. Sanevich. The CFTC has been very open to hearing our 
issues and concerns. It is hard for me to tell where this might 
be going. But I can tell you that, without very clear 
statements jointly from both agencies, that the two rules do 
not conflict in a manner that people tend to read them. It will 
cause enormous disruptions and will shut pension plans out of 
the swaps market in the future.
    Mr. Hultgren. I think you started to address this already, 
but will your counterparties be subject to new liability under 
Dodd-Frank? And what impact may this have in your ability to 
engage in the swap markets?
    Ms. Sanevich. Yes, certainly dealers, as was intended in 
part, will be subject to additional responsibilities; and we 
are certainly not saying, don't do that. The problem is that a 
lot of the responsibilities that are contemplated are in direct 
conflict with how pension plans invest. They already have 
fiduciaries at many levels acting as prudent experts for the 
investment in pension plans, so imposing this duty on dealers 
is not only kind of irrelevant because the pension plans 
already have lots of layers of prudent experts, but is quite 
problematic and potentially will shut pension plans out of the 
market. So, yes.
    Mr. Hultgren. I wonder if you could just briefly describe 
the real-time reporting rules. They were intended to enhance 
price transparency and also to reduce costs, but I wonder if 
you can explain how they might have exactly the opposite 
impact.
    Ms. Sanevich. Sure. And in this case it is really a 
question of very much lack of information in connection with a 
proposed rule. So our concern is that real-time reporting to 
everyone in the market, for every trade, will increase 
transaction costs for everyone. The dealers will pass them on 
ultimately to the other side of the trade and the concern is 
that these transaction costs will be material. They may differ 
from different kinds of swaps, but they will increase 
transaction costs.
    And what we have suggested is the agencies should collect 
the data for a year--there is certainly no problem with them 
receiving the data--analyze it, and then promulgate rules that 
will not disrupt the markets and will not have the perverse 
effect of increasing transaction costs when the whole intent is 
to decrease the costs.
    Mr. Hultgren. It seems so oftentimes here where intended 
results arrive at unintended consequences.
    Ms. Sanevich. That is the concern here, is that these 
unintended consequences--these are some of the ones we happen 
to have thought of; and lots of very busy, smart people are 
thinking about these things, including the CFTC and the SEC. 
But this is such a vast undertaking that there may be many 
negative unintended consequences that we just can't foresee.
    Mr. Hultgren. One last question, pension plans, from your 
perspective, how would you encourage them to protect themselves 
from risks posed by their counterparties.
    Ms. Sanevich. Well, pension plans right now, because their 
investment advisors are subject to the highest fiduciary 
standards, they already do that now. Most pension plans 
certainly are client based, and others we know have lots of 
termination events. If a counterparty's credit rating declines, 
they require daily posting of collateral. Many require 
segregation of their collateral so that it is kept by an 
independent third party.
    And so many plans use any of these tools in combination 
currently so that, in fact, when Lehman did go under, at least 
from our experience, to the extent plans lost anything, it was 
.001 percent of the plan or two or three percentage points of a 
trade, really insignificant amounts. Because plans already have 
a lot of these protections embedded in their documents.
    Mr. Hultgren. Mr. Chairman, I see my time is up. Can I ask 
one more quick question? Would that be all right?
    The Chairman. In fairness to Mr. Scott, yes.
    Mr. Hultgren. Following up on that, basically, to what 
degree during the financial crisis did pension plans suffer 
losses due to swap activities? Just briefly.
    Ms. Sanevich. Yes, the losses that we tend to think because 
of the financial crisis was losses from a Lehman or an AIG 
going down. And as I mentioned, at least in our experience and 
from those of others that we have informally talked to, they 
were really miniscule percentages on a trade and as a 
percentage of a plan, really nothing, .001, or whatnot percent.
    Mr. Hultgren. Well, thank you so much.
    Thank you, Mr. Chairman.
    And I do want to thank you all of you for your part. We 
need your help and involvement as we work through this, the 
implications of what was passed last year. So thank you very, 
very much.
    Thank you, Mr. Chairman.
    The Chairman. The gentleman yields back.
    The gentleman from Massachusetts, Mr. McGovern.
    Mr. McGovern. I want to thank the Chairman.
    I should preface my remarks by saying I am new here on the 
Agriculture Committee. I have the very last seat in the front 
row when the full Committee is here. And I apologize for 
missing most of your testimony. I was handling the rule on the 
continuing resolution. But from the give and take, I just have 
a couple of questions for clarification.
    I get the fact that there are a lot of concerns about how 
we are proceeding here and what is going on in the CFTC and 
that you want to make sure that they don't overreach. On the 
other hand, it seems most people agree that doing something is 
not necessarily a bad thing, but we have to figure out what 
that right thing to do is.
    I am on the Rules Committee, so I am anticipating whatever 
might come before the Rules Committee. One of our colleagues, 
Michele Bachmann, introduced a bill to totally repeal Dodd-
Frank. And I would just like to see a show of hands here. How 
many people support the outright repeal?
    Mr. Damgard. We can think of parts of it that we would like 
to get rid of.
    Mr. McGovern. But nobody here is advocating an outright 
repeal.
    Now I just came from the floor. We are dealing with a 
continuing resolution. I heard a number of concerns about 
making sure that everyone's comments are properly assessed, 
that the data that needs to be gathered is properly analyzed. 
They want to analyze the reported swap data that will take more 
infrastructure and technology is going be necessary. And we 
were warned that the Commission is estimated to run out of data 
storage by October of this year.
    The continuing resolution that we are dealing with on the 
House floor right now would reduce the Commission's budget to 
Fiscal Year 2008 levels. Now when the Chairman was here last 
week, he talked about the need that they need to expand their 
staff and their technology in order to do this right, to get it 
right. And I think, Mr. Damgard, I was hearing you say that 
they were trying to get you guys to come on board and advocate 
for an appropriate budget, which seems to me, no matter whether 
you have concerns about some of the things that are going on or 
not, would be the right thing to do.
    What I am worried about is, are decisions being made 
without the proper analysis? I am worried about when things get 
put into place a review of applications taking a long time 
because there is not the proper staff.
    I would think, no matter what your concerns on this, that 
you would be a little bit concerned about what we are doing on 
the floor today.
    Any response you have I would appreciate listening to.
    Mr. Damgard. As I pointed out earlier, I am a big believer 
in self-regulation; and I think self-regulation has worked 
extremely well in the futures markets. The question that the 
Congressman asked, how much money did pension funds lose as a 
result of Dodd-Frank? Futures customers didn't lose anything 
because of the segregation of the funds. Even Lehman Brothers 
customers, when Lehman went down, those customers got their 
money back.
    Mr. McGovern. That is not my question. My question is 
whether or not, given the fact that none of you are on record 
as calling for the outright repeal of Dodd-Frank, which means 
that the CFTC has a lot of work to do, I was asking about 
whether you agreed with the fact that they need to have 
additional resources to be able to better do their job.
    Mr. Damgard. And what I said was I think the NFA can 
relieve an enormous amount of their burden without them needing 
a lot more money.
    Mr. McGovern. So the answer to that is no?
    Mr. Damgard. It is not no----
    Mr. McGovern. I am looking for kind of straight answers 
here. Because, again, we are dealing with a cut today going 
down to Fiscal Year 2008 levels. I am wondering whether that is 
a good idea from your perspective or whether or not you think 
there are additional resources, cutting back would be a bad 
idea.
    Mr. Damgard. You mean I should decide whether or not we 
should go to 2008 levels or what is in the President's budget? 
I would say somewhere in the middle.
    Mr. McGovern. Well, whatever. Today, we are going back to 
Fiscal Year 2008 levels. I am wondering whether you think that 
is a good idea or not. That means less resources.
    Mr. Damgard. I am not qualified to say that the CFTC is 
expending all their finances and resources, so I am not 
qualified to answer the question.
    Mr. McGovern. I am making a suggestion that if, in fact, we 
want to get this right, it is going to require the proper 
analysis, which means that I do think they are going to need 
more resources to be able to do that.
    Mr. Damgard. If the CFTC decides to take it all upon 
themselves and not delegate to the NFA, it is clearly going to 
take more resources.
    Mr. McGovern. Thank you, Mr. Chairman.
    The Chairman. The gentleman yields back. Thank you.
    Mrs. Ellmers from North Carolina 5 minutes.
    Mrs. Ellmers. Yes. Thank you. Thank you, Mr. Chairman.
    For Mr. McMahon, how would you respond to claims that 
clearing and exchange trading is in the best interest of the 
end-users, because it prevents swap dealers from charging 
higher prices to engage in OTC transactions?
    Mr. McMahon. As I mentioned a little bit earlier, we do use 
exchange and clear transactions on the gas side for about half 
of our transactions and about a third of our power 
transactions, and where it is possible it does make sense in 
some of our transactions. But in a lot of cases, because of the 
customized nature, particularly on the power side, and the fact 
that we are very creditworthy entities and we have a benefit 
because of that creditworthiness of not having to post margin 
and tie up that capital in such a way, it benefits our 
customers not to have to clear those transactions, and we don't 
get any real net risk reduction in the overall transaction 
because of not having to post margin.
    So forced margining and forced clearing would have a huge 
negative impact on our industry and result in us having to tie 
up a lot of capital that we are using right now to enhance the 
grid to deploy cleaner technologies and do those things and put 
it into margin accounts, and we just do not see any benefit at 
all coming back to our customers. And a lot of our OTC swaps 
are done with long-standing relationships with people we have 
been trading with for a long time, so we don't really see any 
benefit to our customers for those swaps.
    Mrs. Ellmers. Thank you. So, in the end, basically, this is 
going to be more costly, more cumbersome for your particular 
customers?
    Mr. McMahon. Yes. Any requirement along those lines would 
be. And, as I said, when it makes sense and the standardized 
swaps meet our needs, we use them. But for the ones that we 
don't, we just don't have that option.
    Mrs. Ellmers. And from a business standpoint, would you say 
that this then is going to be an increase in costs to you to do 
these transactions?
    Mr. McMahon. Yes. I think that it comes down to if we are 
required to clear these transactions--and some of them are so 
customized that they probably couldn't be cleared. But if you 
assume that they could be cleared, it would be a significant 
increase in costs to our companies; and, ultimately, that cost 
would either need to be borne by our customers or else we would 
need to probably do less hedging and pass that volatility to 
our customers, neither of which is a good option.
    Mrs. Ellmers. Thank you very much.
    I yield back the remainder of my time.
    The Chairman. The gentlelady yields back.
    The Ranking Member, Mr. Boswell, for 5 minutes.
    Mr. Boswell. Thank you.
    Interesting discussion. I thank you for being here again.
    Mr. Bullard, you talked quite a bit about the discovery 
process. Is it working? In the sense--and, Mr. Chairman, you 
join in if you want to, because we had some interesting side 
discussion here. But I have producers out there that have a 
couple, three feedlots of cattle and they want to sell them and 
they don't really know what the price is, at least up to date. 
I suggest if they went to the auction the day before they might 
know that. But I don't think that is good enough in today's 
deal. So I just wanted you to talk about that a little bit.
    Mr. Bullard. Price discovery in the cattle market is 
extremely difficult, and it is because there are so many 
various options with which to sell cattle. You have formula 
contracts, forward contracts. You have premiums. You have 
discounts. You have premiums for certain breeds. You have 
transportation premiums that are factored in.
    And you have a cash market that has become so thin in the 
cattle industry where, in 2005, we had 52 percent of the volume 
of cattle were sold on the cash market. By 2010, that volume 
had shrunk to about 37 percent. In some markets like in 
Colorado, we are down below 20 percent.
    So you now have a minority of the cattle that are sold in 
the cash market where the price discovery occurs; and then all 
of the other cattle, whether it be on a forward contract, a 
marketing agreement, the base price is all tied to that thin 
cash market that hasn't discovered the true market value of 
cattle.
    The same is occurring in the futures market where you are 
now dominated not by the physical hedgers in the market but 
rather by speculators.
    So we are having an extremely difficult time to ascertain 
what is the fair market value of cattle at any given point in 
time because of the complex nature of the industry and the 
thinning of the markets that have historically been used for 
price discovery.
    Mr. Boswell. It brings to what you just said much better 
than I could have. That is my point. You made my point. It 
seems like we are just running as fast as we can go on the 
cattle side to see if we can get vertical integration to the 
point we don't have a cash market.
    Mr. Bullard. We have already seen that, Congressman, in the 
hog industry. The hog industry has essentially lost its cash 
market. And we saw a reduction in the number of hog producers 
fall over about 90 percent. We had 667,000 independent hog 
producers in the United States back in 1980. We now have about 
67,000. We eliminated 90 percent of the producers. That means 
that the rural communities that were supported by these hog 
producers are now no longer receiving the economic vitality 
that these producers brought, and that is why we are seeing a 
hollowing out in rural communities all across the U.S.
    Mr. Boswell. Well, it has a lot to do with it. And one of 
the things we have heard here in this room over and over with 
the rural development, and as I see this happening where I come 
from and some of the other places I have traveled, I think you 
are hitting a very salient point. And I don't know what we can 
do about it.
    Maybe somebody else would have some idea at the table 
there. But is this a concern or is this just something for a 
few of us? Is it a concern for others? Anybody?
    Mr. Damgard. I was in the hog business in Illinois, and we 
had a marketing problem when they closed down Joliet. All the 
hogs were being sent down to North Carolina. So I just got out 
of the hog business and went straight to grain. Turns out it 
was pretty good idea.
    Mr. Bullard. Congressman, I would like to add, too, and 
that is exactly what is happening in the cattle industry. We 
can't let the cattle industry, which is the single largest 
segment of American agriculture, go the way of the hog 
industry. Illinois used to be one of the top hog-producing 
states in the nation. Back in 1980, it was among the top three 
states. And then the meat packers, having vertically controlled 
the industry, decided to uproot from the Midwest and move to 
North Carolina. Illinois got booted out of the status of having 
among the largest hog-producing states of the United States. 
And this is the result of lack of competition and anti-
competitive practices that are occurring as a result of the 
dominance by the meat packers who are essentially unrestrained, 
unrestrained in the futures market and unrestrained in the cash 
market.
    Mr. Boswell. Well, you are making a point that I am 
concerned about.
    I don't know, Mr. Chairman, is there something that we can 
look at further down the road or whatever? But it seems like it 
is happening, and I have been worried over this now for a 
number of years, and it seems like the pace is keeping up. And 
I have seen that happen to the hog market, and we have heard 
some testimony just here now. And it seems like we are at a 
fast pace of it happening to the cattle market. So I guess we 
can talk some more on that. But I am concerned.
    My time is up. I yield back.
    The Chairman. Thank you, Mr. Boswell.
    And I am not sure if you can blame it all on--things 
change. At some point in time, somebody built the latest, 
greatest, best buggy whip manufacturing facility known to man, 
and times change. I don't know how much a differential that is.
    But back to the broader point, from a sequencing 
standpoint, if the CFTC does, in fact, roll out a swaps 
definition rule, which surely they have to do, and your 
comments from the folks about if they did the definitions first 
and rolled those out so that you then knew for sure you were 
either a major swap participant or the transactions you were 
doing were swaps or whatever, how much time would you need to 
turn around your comments back to the CFTC to absorb what the 
new definitions are and then look at what the regulatory 
umbrella looks like once we understand what the definitions 
are? Is there a time step you can help us understand?
    Mr. Damgard. I would say historically when rules are rolled 
out, we have taken an awful lot of time to implement them to 
make sure that it wasn't disruptive to the market.
    And there is no set time table, depending on how 
complicated that rule might be. But I think discretion is the 
important thing to consider here. I mean, we really need to 
take our time and get it right. I have heard Mrs. Shapiro say 
that. I have heard Gary Gensler say that. And rushing these 
things through to meet these arbitrary deadlines, which are 
unreasonable, is not the way to go.
    The Chairman. Other comments?
    Mr. Kaswell. I think there are some things that we feel 
need to move more quickly than others, and I think I have 
mentioned that. But the sequencing on these definitions that 
you have addressed, Mr. Chairman, I think those are of great 
concern, and I think that would make the process move much more 
logically so that we come out to a set of rules that we all 
feel we can work with and play by.
    The Chairman. Last week we had the Chairman in. He said he 
had all of the authority he needs. While he has a statutory 
limit of 360 days to get the rules finalized, he has extensive 
authority to pace the rollout and/or the implementation over a 
much longer period of time.
    Do you all think he has that authority to do that 
implementation issue over a more reasonable approach than he 
has in terms of developing the rules themselves?
    Mr. Damgard. There are issues of whether he has the 
authority to do a number of things.
    For instance, position limits, in the legislation, he has 
the authority to put in position limits subject to the CFTC 
making a determination that somehow position limits were part 
of the problem. And they made no such effort to do that.
    So my sense is that the last thing we want to do is attract 
a lot of lawsuits that would tie things up for much, much 
longer. I mean, Mr. Kaswell, mentioned the fact that for 70 
years, segregation has been segregating the customer's money 
from the firm's money. And it worked very well. It has worked 
well for 70 years. To go a step beyond that may or may not be 
allowed without some sort of change either in the bankruptcy 
law or the Commodity Exchange Act and lawyers are going to 
argue about that one way or the other.
    I would hate to see this being stalled 2 or 3 years while 
we wait for a legislative solution. And as a result, I think 
that the industry is looking for more time to figure out what 
these costs are going to mean, whether or not there are 
unintended consequences that we should worry about.
    But yes, there will be legal challenges to some of these 
things based on what some of the lawyers have said to me.
    Mr. Kaswell. I think on full segregation, I think there is 
pretty good clarity, with all due respect. But I think that--
but again, on some of the definitions, the sequencing is very 
important.
    The Chairman. All right. Comments from others?
    Ms. Sanevich. Well, I have two quick points to make.
    It is really that certainly there will need to be some time 
after the rules are finalized to give everyone time to put 
processes in place to implement. I mean, there are lots of 
different aspects to it. But even in thinking through the rules 
as to who comments on what, I mean, that is an important 
sequencing aspect as well. No one knows what a swap may be or 
an MSP or, in our case, what the DOL is going to do. And so it 
is very hard to seek to wrap your head around everything that 
may or may not apply because you are not quite sure how it will 
affect you.
    And importantly from the pension plans perspective, both as 
it relates to the DOL issue and others, uncertainty in the 
market as to whether we may be covered by this or not covered 
by that, or whether we are going to get hit with an anti-
avoidance issue because our swaps are not--are customized and 
maybe they should have been cleared, those are huge issues. And 
any uncertainty in the market will significantly hamper a 
pension plan's ability and maybe others as well to engage in 
these kinds of instruments.
    The Chairman. All right.
    Mr. Bullard. Mr. Chairman?
    The Chairman. Yes.
    Mr. Bullard. From our perspective, we think the most 
important thing here is to bring transparency to the opaque 
markets, like the swaps and the over-the-counter trades. And so 
we think the priority for Mr. Gensler should be to implement 
those as quickly as possible, because it is one thing for an 
industry to change because of competitive forces; it is quite 
another for another industry to be fashioned because of the 
anti-competitive conduct that is occurring in the market and we 
don't know about it.
    So we need transparency so the regulators can see with 
certainty what involvement the dominant participants are having 
in marketplaces that are as important to the cattle industry as 
is the cattle futures market.
    The Chairman. Thank you.
    Any Members have other questions?
    Anybody else?
    Well, I want to thank the panel.
    One of the things that was said to Chairman Gensler last 
week was he put on the record the extensive work he and his 
team have done to reach out to you and your colleagues and any 
interested party in the deal, all of the participants, and the 
feedback he has gotten, the thousands of this and the hundreds 
of those and these kinds of things.
    And what I asked him to do was--we have to propose rules. 
You have had all of this public help. I am hopeful that they 
will be able to look at the final rules and see meaningful 
improvements from the proposed rule to the final rule and that 
the funnel that is getting created by the tyranny of time by 
the hard date in the legislation doesn't in fact create some 
sort of a de facto fallback to the proposed rule because they 
run out of time and they just kind of roll that back.
    So any insight that you can help us with that to see where 
we all listen but whether or not you change what you were going 
to do based on what I said is the bigger point.
    So anybody else have a comment before we adjourn.
    Okay. This is our first Subcommittee hearing. So we are a 
little disjointed.
    Under the rules of the Committee, the record for today's 
hearing will remain open for 10 calendar days to receive 
additional material and supplementary written responses from 
the witnesses to any questions posed by a Member.
    This hearing on the Subcommittee on General Farm 
Commodities and Risk Management is adjourned.
    Thank you.
    [Whereupon, at 3:28 p.m., the Subcommittee was adjourned.]
    [Material submitted for inclusion in the record follows:]

  Submitted Statement by Hon. K. Michael Conaway, a Representative in
  Congress from Texas; on Behalf of Hon. Glenn English, CEO, National 
                Rural Electric Cooperatives Association

    Mr. Chairman, Ranking Member Boswell, and Members of the 
Subcommittee. Thank you for holding this hearing to address the role of 
over-the-counter (OTC) derivatives in helping electric cooperatives 
keep electric rates affordable for our consumer-members.
    The National Rural Electric Cooperative Association (NRECA) is the 
not-for-profit, national service organization representing over 900 
not-for-profit, member-owned, rural electric cooperative systems, which 
serve 42 million customers in 47 states. NRECA estimates that 
cooperatives own and maintain 2.5 million miles or 42 percent of the 
nation's electric distribution lines covering \3/4\ of the nation's 
landmass. Cooperatives serve approximately 18 million businesses, 
homes, farms, schools and other establishments in 2,500 of the nation's 
3,141 counties. Our member cooperatives serve nearly 1.5 million member 
owners in Congressional Districts represented on this Subcommittee.
    Cooperatives still average just seven customers per mile of 
electrical distribution line, by far the lowest density in the 
industry. These low population densities, the challenge of traversing 
vast, remote stretches of often rugged topography, and the increasing 
volatility in the electric marketplace pose a daily challenge to our 
mission: to provide a stable, reliable supply of affordable power to 
our members--including constituents of many members of the Committee. 
That challenge is critical when you consider that the average household 
income in the service territories of our member co-ops lags the 
national average income by over 14%.
    Mr. Chairman, the issue of derivatives and how they should be 
regulated is something with which I have a bit of personal history 
going back twenty years in this very Subcommittee. Accordingly, I am 
grateful for your leadership, in pursuing the reforms necessary to 
increase transparency and prevent manipulation in this marketplace.
    From the viewpoint of the rural electric cooperatives, the over-
the-counter or ``OTC'' derivatives market can be boiled down to a 
single, simple concern that I know you have heard me articulate before: 
affordability.
    NRECA's electric cooperative members, primarily generation and 
transmission members, need predictability in the price for power, fuel, 
transmission, financing, and other supply resources if they are to 
provide stable, affordable rates to their members. As not-for-profit 
entities, we are not in the business of making money. Rural electric 
cooperatives use derivatives to keep costs down by reducing the risks 
associated with those inputs. It is important to understand that 
electric co-ops are engaged in activities that are pure hedging, or 
risk management. We DO NOT use derivatives for speculation or other 
non-hedging purposes. We are in a difficult situation, but OTC 
derivatives are an important tool for managing risk on behalf of our 
members.
    Most of our hedges are bilateral trades on the OTC market. Many of 
these trades are made through a risk management provider called the 
Alliance for Cooperative Energy Services Power Marketing or ACES Power 
Marketing, which was founded a decade ago by many of the electric co-
ops that still own this business today. Through diligent credit risk-
management practices, ACES and our members make sure that the 
counterparty taking the other side of a hedge is financially strong and 
secure.
    Even though the financial stakes are serious for us, rural electric 
co-ops are not big participants in the derivatives markets. This market 
is estimated at $600 trillion dollars. Our members have a miniscule 
fraction of that sum at stake and are simply looking for an affordable 
way to manage risk and price volatility for our consumers. Because many 
of our co-op members are so small, and because energy markets are so 
volatile, legislative or regulatory changes that would dramatically 
increase the cost of hedging or prevent us from hedging all-together 
would impose a real burden. If this burden is unaffordable, then these 
price risks will be left unhedged and will be passed on to the 
consumer, where they are unmanageable.
    Electric cooperatives are owned by their consumers. Those consumers 
expect us, on their behalf, to protect them against volatility in the 
energy markets that can jeopardize their small businesses and adversely 
impact their family budgets. The families and small businesses we serve 
do not have a professional energy manager. Electric co-ops perform that 
role for them and should be able to do so in an affordable way.
    Our concerns with implementation of the Dodd-Frank Act are as 
follows:

The Definition of ``Swap''
    The most important term in the Dodd-Frank Act--because it defines 
the scope of the CFTC's regulatory authority--is ``swap.'' 
Unfortunately, however, after over 40 ``swap'' rulemakings to date, the 
CFTC has not yet explained what transactions it believes constitute 
swaps. NRECA is concerned that if the CFTC defines that term too 
broadly, it could bring under the CFTC's jurisdiction numerous 
transactions that cooperatives and others in the energy industry have 
long used to manage electric grid reliability and to provide long-term 
price certainty for electric consumers. It is our belief that the CFTC 
must acknowledge in its rules that a ``swap'' does not include physical 
forward commodity contracts, ``commercial'' options that settle 
physically, or physical commodity contracts that contain option 
provisions, including full requirement contracts that even the smallest 
cooperatives use to hedge their needs for physical power and natural 
gas. Further, CFTC should acknowledge that a ``swap'' excludes long-
term power supply and generation capacity contracts, reserve sharing 
agreements, transmission contracts, emissions contracts or other 
transactions that are subject to FERC, EPA, or state energy or 
environmental regulation.
    These instruments are non-financial contracts between non-financial 
entities that have never been considered ``derivatives'' or employed 
for speculative purposes. They protect the reliability of the grid by 
ensuring that adequate generation resources will be available to meet 
the needs of consumers and do not impose any systemic risk to the 
financial system. Yet, if they were to be regulated by the CFTC as 
``swaps,'' it could impose enormous new costs on electric consumers and 
could undermine reliability of electric service if the costs forced 
utilities to abandon these long-term arrangements.
    In the Dodd-Frank Act, Congress excluded from the definition of 
``swap'' the ``sale of a non-financial commodity . . . so long as the 
transaction is intended to be physically settled.'' NRECA asks Congress 
to insist that the CFTC read this language as it was intended to 
exclude from its regulation these kinds of contracts utilities use to 
meet the needs of consumers.
Margin and Clearing Requirements
    In general, co-ops are capital constrained. We and our members 
would prefer that cash remain in our members' pockets rather than 
sitting idle in large capital reserve accounts. At the same time, we 
have significant capital demands, such as building new generation and 
transmission infrastructure to meet load growth, installing equipment 
to comply with clean air standards, and maintaining fuel supply 
inventories. Maintaining 42% of the nation's electrical distribution 
lines requires considerable and continuous investment.
    Congress respected those constraints in Dodd-Frank by establishing 
an ``end-user exemption'' that exempted those entities--like 
cooperatives--that use swaps solely to hedge commercial risk 
obligations, may choose to forgo the requirements to trade their swaps 
on regulated exchanges or to pay ``margin'' (collateral) on those 
swaps. If properly implemented by regulation, that exemption would 
leave millions of dollars in electric consumers' pockets that might 
otherwise sit in margin accounts or be paid in fees to financial 
institutions.
    I want to remind you that we are NOT looking to hedge in an 
unregulated market. NRECA DOES want swaps markets to be transparent and 
free of manipulation.
    The problem is that requiring cooperatives' hedges to be centrally 
cleared or subjected to margin requirements contracts would be 
unaffordable for most co-ops and would provide no value to the markets 
or to the nation. That is because our hedging transactions do not 
impose any of the systemic risk Dodd-Frank was intended to address, yet 
any ``initial margin'' or the ``working'' or ``variance'' margin 
requirements on our transactions under broad CFTC rules could force our 
members to post hundreds-of-millions of dollars in idle collateral that 
our consumers cannot afford to provide.
    If the CFTC implements Dodd-Frank's end-user exemption too 
narrowly, the resulting clearing and margining requirements could force 
cooperatives to postpone or cancel needed investment in our 
infrastructure, borrow to fund margin costs, abandon hedging, or 
dramatically raise rates to consumers to raise the capital. Of course, 
whatever choice co-ops made would lead to the same result: increased 
electric rates for cooperative members.

Reporting Requirements
    Mr. Chairman, the Dodd-Frank Act quite properly requires the CFTC 
to require reporting of those swaps traded on regulated exchanges. That 
information is critical to providing transparency to those markets. 
Unfortunately, the CFTC is proposing to move far beyond the reporting 
requirements in the Act to also require utilities to report a 
significant volume of information for those end-user transactions that 
Congress exempted from Dodd-Frank's central clearing requirements. In 
our energy markets, many utility-to-utility transactions are entered 
into between two end-users, and there are no swap dealers or major swap 
participants to bear the reporting burdens that these types of dealer 
entities are accustomed to.
    I encourage the Subcommittee to urge the CFTC to reduce this 
reporting process burden, as provided for in the law. We are requesting 
that the CFTC adopt a ``CFTC-lite'' form of regulation for non-
financial entities like the cooperatives. The CFTC should let us 
register, keep records and report in a less burdensome and less 
frequent way--not as if we were swap dealers or hedge funds. For 
example, it should be sufficient to require end-users to make a single 
representation that they will rely on the end-user exemption 
exclusively to hedge commercial risk, and once they have made that 
representation, they should not have to report those transactions any 
more frequently than is now required by the Federal Energy Regulatory 
Commission.
    As explained above, these transactions represent a miniscule 
fraction of the swap market and pose no systemic risk to that market, 
making more frequent reporting unnecessarily expensive.

Exemptions for FERC-Regulated and 201(f) Transactions
    Congress recognized in the Dodd-Frank Act that elimination of the 
Commodity Exchange Act's exemption for energy transactions could lead 
to duplicative and potentially conflicting regulation of transactions 
now subject to FERC regulation and could lead to unnecessary and 
expensive regulation of transactions between non-public utilities. 
Accordingly, it directed the CFTC to exempt those transactions from its 
regulation if it found such an exemption to be in the public interest.
    No entity has yet sought such an exemption because the rules from 
which they would be seeking exemption have not yet been written. 
Because the industry does not yet know what the CFTC will consider to 
be a ``swap'' or whether utility hedging efforts will be exempted from 
central clearing and margining requirements as end-user transactions, 
it does not yet know how critical it will be to pursue these additional 
avenues for relief. We certainly hope that the CFTC will choose to 
write its rules in a manner that minimizes potential conflicts with 
FERC regulation and that minimizes potential costs for transactions 
between cooperatives or municipal utilities.
    Nevertheless, should it become necessary to pursue additional 
exemptions, NRECA hopes that the CFTC will recognize that Congress 
intended in Dodd-Frank to address systemic risk in financial markets 
without disrupting existing markets for electricity, and that the CFTC 
will entertain the industry's applications for further exemptions if 
and or when they are submitted.

Treatment of Cooperative Lenders
    Rural electric cooperatives banded together four decades ago to 
form their own financing cooperative to provide private financing to 
supplement the loan programs of the US Department of Agriculture's 
Rural Utilities Service. Today, this nonprofit cooperative association, 
the National Rural Utilities Cooperative Finance Corporation (CFC), 
provides electric cooperatives with private financing for facilities to 
deliver electricity to residents of rural America, and to keep rates 
affordable. In this context, CFC, which is owned and controlled by 
electric cooperatives, uses OTC derivatives to mitigate interest rate 
risks, and tailor loans to meet electric cooperative needs. CFC does 
not enter into derivative transactions for speculative purposes, nor is 
it a broker dealer. CFC only enters into derivatives necessary to hedge 
the risks associated with lending to electric cooperatives. If CFC is 
unnecessarily swept up in onerous new margining and clearing 
requirements, electric cooperatives will likely have to pay higher 
rates and fees on their loans, and those costs will ultimately be 
passed on to rural consumers.
    We ask that CFC's unique nature as a nonprofit cooperative 
association owned and controlled by America's consumer-owned electric 
cooperatives be appropriately recognized. Electric cooperatives should 
not be burdened with additional costs that would result by subjecting 
their financing cooperative, CFC, to margining and clearing 
requirements.

Conclusion
    Mr. Chairman, at the end of the day, we are looking for a 
legitimate, transparent, predictable, and affordable device with which 
to hedge risk and volatility for our members. If we are to do that, the 
CFTC must define ``swap'' narrowly to exclude those pure hedging 
transactions the industry uses to preserve reliability and manage long-
term power supply costs; must give meaning to Dodd-Frank's end-user 
exemption; must limit unnecessary reporting costs for end-users; and 
must limit duplicative and unnecessary regulation of cooperatives and 
other electric utilities.
    Rural electric cooperatives are not financial entities, and 
therefore should not be overburdened by new regulation or associated 
costs as if we were financial entities. We believe the CFTC should 
preserve access to swap markets for non-financial entities like the co-
ops who simply want to hedge commercial risks to provide affordable 
power to its consumers.
     I thank you for your leadership on this important issue. I know 
that you and your committee are working hard to ensure these markets 
function effectively. The rural electric co-ops hope that at the end of 
the day, there is an affordable way for the little guy to effectively 
manage risk.
    Thank you.
                                 ______
                                 
   Submitted Letter by Hon. K. Michael Conaway, a Representative in 
  Congress from Texas; on Behalf of Bill Donald, President, National 
                      Cattlemen's Beef Association
February 15, 2011

Hon. K. Michael Conaway,
Chairman,
Subcommittee on General Farm Commodities and Risk Management, House 
Committee on Agriculture,
Washington, D.C.

    Dear Chairman Conaway:

    As you prepare for today's Subcommittee hearing to review 
implementation of title VII of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act, I wanted to give you some perspective from the 
cattle industry. Futures markets originated with agricultural 
commodities as a way to establish value. For more than 100 years, these 
markets have provided a mechanism to discover value, and more 
importantly, have provided a tool to help cattle producers manage the 
inherent risk that comes with marketing cattle.
    As the Subcommittee looks at the Act, it is important to ensure 
that implementation of the Act's provisions are done in a thorough and 
methodical fashion. Rushing to implement this Act could result in 
unintended consequences that could actually harm or hinder the 
marketplace. Cattle producers are already being harmed by the 
unintended consequences of other regulatory actions such as dust 
enforcement by the Environmental Protection Agency (EPA) and the 
proposed Grain Inspection Packers and Stockyards Administration's 
(GIPSA) marketing rule. We cannot afford to let another rulemaking 
further hamper our ability to stay in business.
    Commodity markets work and have provided risk management tools 
benefiting U.S. producers. The commodity markets have not forced 
producers out of our industry. On the contrary, their risk management 
products have provided non-government program safety nets that have 
protected producers. Transparency and regulation of the market is 
needed, but not to the extent that it actually hampers trade and 
distorts the most efficient means of price discovery in agricultural 
markets.
    We ask you to thoroughly review the regulatory actions taken by the 
Obama Administration to implement this Act in order to maintain our 
ability to use the commodity markets as a beneficial tool in managing 
ever increasing risks in agricultural marketing.
            Sincerely,

            
            
                                 ______
                                 
   Submitted Letter by Hon. K. Michael Conaway, a Representative in 
Congress from Texas; on Behalf of National Corn Growers Association and 
                     Natural Gas Supply Association
February 9, 2011

Hon. Frank D. Lucas,
Chairman,
House Committee on Agriculture,
Washington, D.C.;

Hon. Collin C. Peterson,
Ranking Minority Member,
House Committee on Agriculture
Washington, D.C.

Subject: Dodd-Frank Wall Street Reform and Consumer Protection Act, 
Implementation of Swap Dealer Definition

    Dear Chairman Lucas and Ranking Member Peterson:

    The Commodity Futures Trading Commission's (CFTC) implementation of 
title VII of the Dodd-Frank Wall Street Reform and Consumer Protection 
Act of 2010 (Dodd-Frank Act) is critical to maintaining the economic 
protections provided by the Dodd-Frank Act to end-users.
    The National Corn Growers Association (NCGA) and the Natural Gas 
Supply Association (NGSA) were active participants in the shaping of 
the Act during its passage and are taking an active role in the Act's 
successful implementation through participation in the CFTC's 
rulemaking process.
    Financial reform must not come at the expense of America's energy 
and commodity producers, consumers, and ultimately, the entire U.S. 
economy. Absent careful CFTC implementation of the swap dealer 
definition, the practical effect of the Dodd-Frank Act could be 
mandatory clearing for many commercial end users. Imposing a clearing 
requirement on commercial end-users does not further the goal of 
ensuring financial system integrity, and instead, centralizes risk that 
would have otherwise been diversified, increasing systemic risk and 
unnecessarily removing productive capital from the economy.
    Mandatory clearing of derivatives transactions will drain the 
economy of more than $650 billion * in capital. Keeping U.S. industry's 
capital at work in a recovering economy through the sound 
implementation of the end user protections in the Dodd-Frank Act will 
help create jobs, energy and products for U.S. consumers without 
compromising the integrity of the U.S. financial system.
---------------------------------------------------------------------------
    * Estimate based on the U.S. portion of global credit exposure that 
is not already collateralized. Data sources include the Bank for 
International Settlements, Monetary and Economic Department OTC 
Derivatives Market Activity Report, ``Cross-border derivatives 
exposures: how global are derivatives markets?'' by Sally Davies of the 
Division of International Finance, Board of Governors of the Federal 
Reserve System, and Country Exposure Report that shows U.S. banks' 
exposure from derivatives. For the detailed calculation methodology, 
please contact the Natural Gas Supply Association at [Redacted].
---------------------------------------------------------------------------
    A primary purpose of CFTC regulation of the ``over-the-counter'' 
(OTC) markets is to protect consumers from systemic risk. The CFTC's 
definition of Swap Dealer should balance the goals of protecting 
consumers from systemic risk and ensuring no unnecessary harm to the 
economy. Thus, the CFTC must carefully scope the definition of Swap 
Dealer because an unnecessarily broad definition will sweep in end-
users, limiting one of the key protections for the economy incorporated 
into the Dodd-Frank Act.
    In November 2010, NCGA and NGSA offered the following pre-proposal 
comments to the CFTC, outlining what we believe is a workable solution 
to the implementation of the swap dealer definition. NCGA and NGSA 
intend to provide further comments to the CFTC on this issue later this 
month but believe that the approach to the definition of Swap Dealer 
might be also be helpful in your review of the implementation of Title 
VII of the Dodd-Frank Act later this week.
    Trading in Swaps Should Not Make a Company a Swap Dealer. The CFTC 
should implement the Swap Dealer definition by ensuring that both the 
law's general exception and the de minimis exception are properly 
applied. The general exception applies to entities entering into swaps 
for their own account (e.g., traders). The de minimis exception allows 
for the exclusion from a Swap Dealer designation of entities that 
engage in a de minimis quantity of swap transactions ``with or on 
behalf of'' their customers. These two exceptions are essential because 
they allow entities that use swaps to hedge or mitigate commercial 
risks, such as those risks that stem from the production of energy and 
agricultural commodities, to avoid being designated as Swap Dealers, a 
designation that would preclude eligibility for the end-user clearing 
exception. Entities designated as Swap Dealers would be required to 
transact their swaps on an exchange or to clear such transactions, 
subjecting them to costly margin and clearing expenses and draining the 
economy of billions of working capital dollars.
    The CFTC Should Use the Concept of ``Intermediation'' to Define 
Swap Dealer. To achieve Congressional goals, the CFTC should use a two-
step process based on the Securities Exchange Act and the concept of 
intermediation (transacting to satisfy a customer order or, simply put, 
acting on behalf of a customer) to first implement the general 
exception and then implement the de minimis exception in the Swap 
Dealer definition. The Securities and Exchange Commission (SEC) 
precedent  on the designation of a dealer provides a comprehensive way 
to distinguish trading from dealing. Central to the SEC case law that 
distinguishes ``dealing'' from ``trading'' is the concept of 
intermediation. To implement the two exceptions, the CFTC should use 
the concept of intermediation as the basis for filtering dealers from 
traders, many of whom use swaps to hedge business risk. This approach 
will ensure that financial entities engaging in swaps with or on behalf 
of customers remain in the regulatory purview of the CFTC without 
diminishing the integrity of the end-user clearing exception.
---------------------------------------------------------------------------
     Vol. 15, Broker-Dealer Regulation, David A. Lipton, Section 1:6 
at 1-42. 11, n. 4.
---------------------------------------------------------------------------
    Step one: Use the SEC model for distinguishing between ``dealers'' 
and ``traders'' to implement the general exception. Built into the Swap 
Dealer definition is a general exception excluding ``persons that enter 
into swaps for that person's own account, either individually or in a 
fiduciary capacity, but not as a part of a regular business''--from 
designation as a Swap Dealer. Put another way, the general exclusion 
establishes that only an entity trading swaps that are not for its own 
account (e.g., done in an intermediary capacity) is a Swap Dealer. In 
securities markets, the SEC and the courts have identified a number of 
characteristics for dealing activity. While the securities market 
activities do not translate precisely to the commodity swaps market, 
the concept of ``intermediation'' does translate. (See inset below.) 
The concept of intermediation can be used to implement the general 
exception as the starting point for sorting dealers from traders so 
that the integrity of the economic protection provided by the general 
exclusion can be maintained.
    Step two: Implement the de minimis exclusion by considering the 
level of ``dealing'' transactions relative to total swap transaction 
activities. An entity would not qualify for the general exception if it 
both trades and deals. While not universal, many commercial entities 
with

------------------------------------------------------------------------

-------------------------------------------------------------------------
    Securities Market Intermediation Concept Translates to Commodity
 Swaps Market Swap Dealer Characteristics

     performing an intermediary role in swaps
      markets by engaging in swap transactions
      with customers;

     remaining essentially neutral to price move-
      ments with respect to the swap and under-
      lying commodity;

     quoting a two-sided market for swaps and
      standing ready to take the opposite side of
      customer orders; and

     providing financially-related, ancillary dealer
      activities (e.g., advising on investments).
------------------------------------------------------------------------

astute trading capabilities also enter into transactions with their 
traditional customers that may ultimately resemble dealing. Often this 
``dealing'' is the result of the customer's interest in transacting 
financial hedges with a counterparty that has physical assets and a 
history in bringing physical product to market. This is where the de 
minimis exception plays a critical role. For entities that trade swaps 
and engage in this limited form of dealing, the CFTC should design the 
de minimis exception so that the level of dealing (defined by using the 
concept of intermediation as reflected in the SEC regulations) is 
compared to their total swap transactions (e.g., trading and dealing). 
If the level of dealing relative to the total is small, in other words, 
if the entity primarily trades swaps, the de minimis exception is 
satisfied.
    The right Swap Dealer approach works for consumers and the economy. 
Using the concept of intermediation to implement the general and de 
minimis exceptions will allow the CFTC to sort true swap dealers from 
those entities that trade swaps to hedge commercial business risk. This 
approach is consistent with existing case law and the Congressional 
goal of avoiding unnecessary harm to the economy. Finally, the solution 
provides the CFTC with a practical and valid way to regulate Swap 
Dealers that buy and sell swaps to satisfy customer orders, without the 
harm to the economy that would result from avoidable and unnecessary 
increases in business risk management costs. Appropriate implementation 
of the Swap Dealer definition is essential to maintaining the integrity 
of the end-user protection provisions that were central to the passage 
of the Dodd-Frank Act.
    Founded in 1957, NCGA is the largest trade organization in the 
United States representing 35,000 dues-paying corn farmers nationwide 
and the interests of more than 300,000 growers who contribute through 
corn checkoff programs in their states. NCGA and its 48 affiliated 
state associations and checkoff organizations work together to create 
and increase opportunities for their members and their industry. 
Established in 1965, NGSA represents integrated and independent 
companies that produce and market approximately 40 percent of the 
natural gas consumed in the United States.
    Please do not hesitate to contact Sam Willett, Senior Director of 
Public Policy for NCGA at [Redacted] or Jenny Fordham, Vice President, 
Markets for NGSA at [Redacted], if we can provide any additional 
information. Thank you for your review of the implementation of title 
VII of the Dodd-Frank Act.
            Sincerely,

National Corn Growers Association;
Natural Gas Supply Association.
                                 ______
                                 
                          Submitted Questions

Questions Submitted by Hon. Collin C. Peterson, a Representative in 
        Congress from Minnesota
Response from John M. Damgard, President, Futures Industry Association
    Question 1. CFTC Commissioner Dunn, in various public comments, 
appears to be making the argument that the CFTC's budgetary uncertainly 
could lead the agency to put forth a rules-based regulatory regime as 
opposed to a principles-base regime. Do any of you agree with his 
comments?
    Answer. We respectfully disagree with Commissioner Dunn. With the 
enactment of the Commodity Futures Modernization Act of 2000 (CFMA), 
which replaced the overly prescriptive regulatory structure that 
previously had so restricted the conduct of designated contract markets 
(DCMs) and derivatives clearing organizations (DCOs) with the core 
principles, Congress confirmed that the CFTC's appropriate role is as 
an oversight agency, with direct supervisory responsibility exercised 
by the several self-regulatory organizations, NFA and the DCMs.
    The CFMA facilitated a period of unprecedented growth and 
innovation in the futures industry, without requiring any significant 
increase in CFTC staff. A rules-based regulatory regime, on the other 
hand will require additional staff, as staff would be required to 
review and approve virtually all DCM and DCO proposed rules to assure 
that they fall within the four corners of the CFTC-prescribed rules. A 
rules-based regulatory regime will also stifle innovation, which is 
essential to promote competition in the market for cleared swaps, which 
is in its initial stages. The CFTC's proposed rules are already highly 
prescriptive and are based primarily on current market practices. DCMs 
and DCOs will not be able to respond to changes in the international 
market in a timely manner in a rules-based regulatory regime.

    Question 2. Your testimony states that FIA has presented an 
alternative ownership and control rule which would achieve the same 
purposes as the CFTC's proposed rules at less cost. Can you explain 
your proposal in more detail and tell us your estimate of the cost 
differences?
    Answer. A copy of our comment letter on the CFTC's proposal, which 
describes our alternative in detail, is attached for your review. As 
explained in the appendix to the letter, we estimate that, compared 
with the CFTC's proposal, the FIA alternative would result in an 
average first-year cost savings of approximately $18.8 million. As 
described in the charts at the end of the appendix, the first year 
costs of the CFTC's proposal is four times greater than the median 
costs incurred by FCMs under the FIA alternative.
    We recently met with the CFTC staff on this proposal and responded 
to questions they had.

    Question 3. Your testimony mentions the CFTC should delegate some 
responsibilities to the National Futures Association, a self-regulatory 
organization that already performs several oversight functions for the 
CFTC. What responsibilities do you believe should be delegated to the 
NFA and which ones should the CFTC retain?
    Answer. As described above, we believe the CFTC should be an 
oversight agency, with primary responsibility for supervising CFTC 
registrants vested in NFA and the exchanges. Chairman Gensler has 
already announced that NFA will process registration applications for 
swap dealers and major swap participants. Since NFA currently processes 
all other CFTC registration applications, this is not only appropriate, 
but necessary. It is not clear that the CFTC has the necessary 
infrastructure any longer to process applications.
    Primary responsibility for the oversight of FCMs and other 
intermediaries is currently allocated among NFA and the exchanges in 
accordance with the Joint Audit Plan. There is no reason why these SROs 
could not perform the same activities with respect to swap dealers. Our 
understanding, however, is that the CFTC has only recently begun to 
talk with NFA about the role NFA can play in implementing the 
regulatory program for swaps.
    NFA should also be responsible for developing and enforcing rules 
regarding the obligations of chief compliance officers of registrants 
and, more generally, business conduct rules governing swap dealers, 
major swap participants and other CFTC registrants. As we noted in our 
comment letter, FINRA has this responsibility on the securities side, 
and the CFTC proposal conflicts in several significant ways with the 
FINRA rules. Since most FCMs are also registered with the SEC as 
broker-dealers and are FINRA members (and we expect that most swap 
dealers will also be security-based swap dealers), it is critical that 
these firms not be subject to conflicting business conduct and other 
rules.
    SROs also have enforcement authority and should have primary 
responsibility for taking enforcement action against members that 
violate SRO rules. These rules also require their members to comply 
with applicable provisions of the Commodity Exchange Act and CFTC 
regulations. Of course, the CFTC also has an important role to play in 
enforcing the CEA. However, the CFTC has recently begun to take over 
enforcement investigations which had been initiated against market 
participants by an exchange and which could properly have been resolved 
there. This results in a duplication of effort and an unnecessary 
demand on CFTC enforcement staff resources. (It may also significantly 
increase costs on respondents.)

    Question 4. In mentioning that the CFTC should delegate some 
responsibilities to the National Futures Association, you state that 
the NFA is funded entirely by its participants. Given that the CFTC is 
not funded directly by the participants in the markets it oversees, but 
by taxpayers, wouldn't direct NFA oversight place a greater cost on the 
industry than direct CFTC oversight?
    Answer. The industry does not object to paying fees to support the 
regulatory activities of NFA, because the industry believes it is 
appropriate to share the cost of assuring market integrity. The current 
regulatory regime strikes the appropriate balance, with the industry 
assuming responsibility for direct supervision of market participants, 
and taxpayers assuming responsibility for oversight of NFA, DCMs and 
DCOs.
                               attachment
By Electronic Mail Revised

December 23, 2010

David A. Stawick,
Secretary,
Commodity Futures Trading Commission,
Washington, D.C.

Re: Account Ownership and Control Report, 75 Fed. Reg. 41775 (July 19, 
2010)

    Dear Mr. Stawick:

    This letter supplements and replaces the October 7, 2010 letter 
that the Futures Industry Association (``FIA'')\1\ filed in response to 
the Commodity Futures Trading Commission's (``Commission's'') request 
for comment on its proposed rules requiring designated contract markets 
and other ``reporting entities,'' as defined in the proposed rules,\2\ 
to submit certain ownership and control reports (``OCR'') to the 
Commission weekly (``OCR Rules''). The OCR Rules would require each 
reporting entity to provide the Commission detailed information, 
consisting of approximately 28 separate data points, with respect to 
each account reported in its trade register. ``The OCR will necessitate 
each reporting entity to collate and correlate these and other data 
points into a single record for trading accounts active on its trading 
facility, and to transmit such record to the Commission for regulatory 
purposes.'' \3\
---------------------------------------------------------------------------
    \1\ FIA is a principal spokesman for the commodity futures and 
options industry. FIA's regular membership is comprised of 
approximately 30 of the largest futures commission merchants (``FCMs'') 
in the United States. Among FIA's associate members are representatives 
from virtually all other segments of the futures industry, both 
national and international. Reflecting the scope and diversity of its 
membership, FIA estimates that its members effect more than eighty 
percent of all customer transactions executed on United States contract 
markets.
    \2\ A ``reporting entity'' is defined as ``any registered entity 
required to provide the Commission with trade data on a regular basis, 
where such data is used for the Commission's trade practice or market 
surveillance programs.'' Reporting entities include, but are not 
limited to, designated contract markets and exempt commercial markets 
with significant price discovery contracts. Proposed Commission Rule 
16.03(a). In addition, the Commission anticipates that it would also 
collect ownership and control information from swap execution 
facilities and foreign boards of trade operating in the U.S. pursuant 
to staff direct access no-action letters, provided such letters are 
conditioned on the regular reporting of trade data to the Commission. 
FIA is concerned that efforts to extend the OCR Rules to foreign boards 
of trade may conflict with the laws and regulations of the jurisdiction 
of that board of trade. Significantly, the definition does not 
contemplate that FCMs would be designated as ``reporting entities.''
    \3\ 75 Fed. Reg. 41775, 41776, fn. 1 (July 19, 2010).
---------------------------------------------------------------------------
    As the Commission further explains in the Federal Register release 
accompanying the proposed OCR Rules:

        The OCR will serve as an ownership, control, and relationship 
        directory for every trading account number reported to the 
        Commission through reporting entities' trade registers. The 
        data points proposed for the OCR have been specifically 
        selected to achieve four Commission objectives. These include: 
        (1) identifying all accounts that are under common ownership or 
        control at a single reporting entity; (2) identifying all 
        accounts that are under common ownership or control at multiple 
        reporting entities; (3) identifying all trading accounts whose 
        owners or controllers are also included in the Commission's 
        large trader reporting program (including Forms 40 and 102); 
        and (4) identifying the entities to which the Commission should 
        have recourse if additional information is required, including 
        the trading account's executing firm and clearing firm, and the 
        name(s) of the firm(s) providing OCR information for the 
        trading account.\4\
---------------------------------------------------------------------------
    \4\ 75 Fed. Reg. 41775, 41783 (July 19, 2010).

    Broadly, the Commission asserts that the information collected 
will: (i) enhance market transparency; (ii) increase the Commission's 
trade practice and market surveillance capabilities; (iii) leverage 
existing market surveillance systems and data; and (iv) facilitate the 
Commission's enforcement and research programs.
    Although reporting entities would be responsible for submitting the 
OCR, the Commission acknowledges that these entities do not currently 
collect a significant amount of this information. The ``root sources'' 
for much of the information required rests instead with others. As 
discussed below, clearing member FCMs will be the primary source of 
this information. They, in turn, will be required to rely on their 
customers to provide, and keep current, the required information.\5\
---------------------------------------------------------------------------
    \5\ In the Federal Register release accompanying the OCR Rules, the 
Commission implies that it would expect a reporting entity to prohibit 
members from trading on or through the entity, unless the member 
complies with any applicable reporting requirements the reporting 
entity may impose: ``Successful implementation of the OCR will require 
reporting entities to offer their services only on the condition that 
ownership and control information be provided upon request by the 
relevant party in possession of such information.'' Id. at 41785. 
Presumably, member FCMs, in turn, would be prohibited from carrying 
accounts on behalf of customers that fail to provide, and keep current, 
the information required with respect to each account. As discussed 
below, FCMs must rely almost entirely on customers to provide and keep 
current, information with respect to data such as: (i) beneficial 
owners; (ii) account controllers; (iii) dates of birth; (iv) primary 
residence addresses; and (v) date accounts are assigned to current 
controllers. Although FCMs can advise customers of the information 
required and contract with their customers to provide such information, 
FCMs cannot be placed in the position of being guarantors of the 
information that their customers provide, or fail to provide.
---------------------------------------------------------------------------
    In our October 7, 2010 letter, we advised the Commission that, to 
assure that both the feasibility of the proposed OCR Rules and their 
potential impact on the industry were properly assessed, FIA had formed 
an OCR Working Group, comprised of individuals with significant 
experience in operations from (i) 16 FCMs, both large and small, with 
both retail and institutional customers, (ii) the several U.S. 
exchanges, (iii) the principal back office service providers, and (iv) 
other experts.\6\ The group carefully analyzed each of the data points 
to be collected under the OCR Rules and identified: (1) the required 
data that is currently collected; (3) the required data that is not 
collected; and (3) the required data that would be difficult, if not 
impossible, to collect. The group then estimated the cost of 
implementing and maintaining the proposed database.
---------------------------------------------------------------------------
    \6\ Several members of the group participated in the Commission's 
September 16, 2010 roundtable on the proposed OCR Rules.
---------------------------------------------------------------------------
    After fully analyzing the Commission's proposal, the OCR Working 
Group concluded that the financial and operations burdens imposed by 
the OCR Rules would be overwhelming. In addition, the OCR Rules would 
force an unwarranted structural change in the conduct of business among 
U.S. futures markets participants, especially among clearing member and 
nonclearing member FCMs, foreign brokers, and their respective 
customers. In particular, the proposed requirement that clearing member 
FCMs know and report to the relevant clearing organization the identity 
of each customer that comprises an omnibus account and their respective 
positions will disrupt, if not destroy, the regulatory and operational 
synergies among market participants that have developed over decades 
and are essential to the efficient operation of the markets.
    Equally important, the OCR Rules would impose on such FCMs 
substantial increased regulatory and concomitant financial obligations. 
As a result, a number of FCMs could be compelled to withdraw from 
registration and the barrier to entry for potential new registrants 
will be raised. In addition, a significant number of foreign customers 
will effectively be denied access to U.S. markets.
    Consequently, we advised the Commission that we cannot support the 
adoption of the OCR Rules as currently proposed. We further advised the 
Commission, however, that the OCR Working Group was working on an OCR 
alternative that we would submit to the Commission for its review.
    Since the proposed OCR Rules were published in July, and since we 
undertook to submit an OCR alternative, the regulatory landscape has 
shifted dramatically. The Commission has published (or shortly will 
publish) for comment a myriad of proposed rulemakings that, 
collectively, contemplate a complete overhaul of the recordkeeping and 
reporting requirements to which FCMs, U.S. exchanges and clearing 
organizations are subject. These proposals include: (i) the advance 
notice of proposed rulemaking regarding the protection of cleared swaps 
customers before and after commodity broker bankruptcies; (ii) core 
principles and other requirements for designated contract markets; 
(iii) risk management requirements for derivatives clearing 
organizations; (iv) information management requirements for derivatives 
clearing organizations; (v) position limits for derivatives; (vi) core 
principles and other requirements for swap execution facilities; and 
(vii) swap data recordkeeping and reporting requirements.
    We respectfully submit that these various rulemakings cannot be 
considered in isolation. All of the pending recordkeeping and reporting 
requirements, and the estimated costs and benefits of each, must be 
analyzed and evaluated collectively, not individually. In the absence 
of such a coordinated analysis, it is impossible to determine whether 
the pending rules, including the OCR Rules and alternative set out 
herein, are complementary or conflicting. Neither is it possible to 
calculate the aggregate financial and operational burdens these various 
proposals will have on the industry.\7\
---------------------------------------------------------------------------
    \7\ Among other burdens, these various proposal, if promulgated, 
are likely to severely strain the resources of FCMs' information 
technology staffs as well as the staffs of the principal back-office 
software vendors.
---------------------------------------------------------------------------
    In order to assure an efficient and competitive futures industry, 
it is essential that the financial and operational burdens imposed by a 
revised recordkeeping and reporting system are necessary and 
proportionate to benefits realized. In this regard, therefore, we are 
prepared to expand both the charter and the composition of the OCR 
Working Group to undertake the necessary analysis. We encourage the 
participation of the Commission staff in any manner the Commission 
deems appropriate.
    In light of the foregoing, the OCR alternative included herein at 
Appendix A and Appendix B should not be viewed as an industry-approved 
alternative, but solely as a basis for further discussions among the 
Commission, the futures industry and other interested parties. 
Consistent with the Commission's request, the estimated costs of 
implementing this OCR alternative are also set out in Appendix A. 
Although these costs are significantly less than the estimated costs of 
implementing the OCR Rules, they are substantial nonetheless (even 
without taking into account the other rule proposals summarized above) 
and emphasize the importance of analyzing the Commission's proposed 
recordkeeping and reporting requirements as integrated parts of a 
single unit rather than distinct requirements.
    For the convenience of the Commission, set out below, with certain 
non-substantive revisions, is the body of our October 7, 2010 letter on 
the OCR Rules.
The OCR Rules Would Impose Substantial Costs on FCMs
    Because the OCR Rules would require FCMs to collect and report a 
substantial amount of information that either is not collected in the 
manner the Commission may anticipate or is not collected at all, the 
proposed rules would require a complete redesign of the procedures, 
processes and systems pursuant to which FCMs create and maintain 
records with respect to their customers and customer transactions. Such 
redesign would take far longer and be far more expensive than the 
Commission suggested in the Federal Register release accompanying the 
proposed rules.
    In this latter regard, we respectfully submit that the Commission 
erred in basing its cost analysis under the Paperwork Reduction Act 
only on anticipated costs to be incurred by registered entities.\8\ 
FCMs are the root source of approximately \1/2\ of the data points the 
Commission is proposing to collect. The cost to FCMs of building an OCR 
database, collecting the required information and transmitting it to 
the relevant exchange will be substantially greater than the 
Commission's estimate of the costs that will be incurred by the 
exchanges alone. Such costs will be particularly burdensome on smaller 
FCMs, which frequently carry a proportionately higher number of 
accounts, comprised of non-institutional hedgers and individual 
traders.\9\
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    \8\ We take no view on the analysis presented in the Federal 
Register release of the costs to be incurred by exchanges. We 
anticipate that the designated contract markets will submit comments in 
this regard.
    \9\ Implementation of the OCR Rules would also place smaller 
exchanges and potential new exchange entrants at a significant 
disadvantage.
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    We are concerned that the cost of opening and maintaining these 
smaller accounts in compliance with the OCR Rules may result in certain 
FCMs withdrawing from registration, raising the bar to entry, and 
denying certain customers, including certain non-institutional hedgers, 
access to the futures markets. To obtain and maintain the required 
information, an FCM would be required to: (i) re-negotiate all active 
customer agreements to require customers to provide and routinely 
update the necessary data points; (ii) build systems to enter the data; 
(iii) manually enter the data for each active account; (iv) put in 
place resources and processes to maintain the data; (v) provide it to 
the reporting entity on a weekly basis; and (vi) monitor changes daily 
in order to update the database.
    FIA received cost estimates for building and maintaining an OCR 
database from 12 FIA member firms. The cost analysis included:

   operational costs, such as notifying beneficial owners and 
        account controllers, collecting and recording data;

   technology costs of building databases, developing user 
        interfaces, storing additional data, and developing a 
        transmission mechanism; and

   legal costs of client notification, and re-executing client 
        agreements.

    These cost estimates do not include rebuilding systems/processes to 
manage account numbers, including vendor costs, which will be passed on 
to each FCM. They also do not include the cost of tracking beneficial 
owner and account controller information through the omnibus chain.
    Our sample of 12 firms represents approximately 16 percent of the 
approximately 70 FCMs that execute and clear customer accounts. These 
firms handle in excess of $83.8 billion of customer funds, or 
approximately 62 percent of customers' segregated funds (as of July 31, 
2010, according to monthly financial reports filed with the 
Commission). We found that the median firm would face total costs of 
roughly $18.8 million per firm, including implementation costs of 
roughly $13.4 million, and ongoing costs of $2.6 million annually. On a 
per account basis, the median cost would be $623 per account.\10\
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    \10\ We understand that the Commission requested that cost data be 
presented with respect to specific firms and not on an aggregate basis. 
However, because this cost data constitutes confidential business 
information, the firms that provided the data have not been identified 
by name.

                                    FCMs' CFTC Proposed Rule Cost Estimates 1
----------------------------------------------------------------------------------------------------------------
                                                                            Total Start-up and      First-Year
                     Affected            Start-up             Ongoing       Ongoing/First-Year       Costs Per
                     Accounts                                                      Costs              Account
----------------------------------------------------------------------------------------------------------------
       Firm A            90,000             $49,280,000      $6,768,844             $56,048,844            $623
       Firm B            75,300             $13,395,600      $2,625,500             $16,021,100            $213
       Firm C            50,000             $28,000,000      $3,000,000             $31,000,000            $620
     Firm D 2            39,979                     N/A             N/A             $18,208,863            $455
       Firm E            34,700             $22,000,000      $3,750,000             $25,750,000            $742
     Firm F 3            30,000         $10,000-$35,000        $540,000       $560,000-$575,000             N/A
       Firm G            19,473                     N/A             N/A             $50,000,000          $2,568
       Firm H            14,000                     N/A             N/A             $21,525,000          $1,538
       Firm I               250                $50,000+       $150,000+               $200,000+           $800+
     Firm J *           130,000   $2,000,000-$2,500,000        $200,000   $2,200,000-$2,700,000             $19
     Firm K *            40,000              $2,900,000        $280,000              $3,180,000             $80
        Firm L *            550              $3,600,000      $1,150,000              $4,750,000          $8,636
----------------------------------------------------------------------------------------------------------------
Notes:

1 The 12 firms in the sample handle in excess of $83.8 billion, or almost 62% of customers' segregated funds (as
  of July 31, 2010, according to monthly financial reports filed with the CFTC).
2 Total cost estimate is based on estimate for affected accounts and average cost per account.
3 Firm's estimates exclude IT costs.
* Firm did not provide cost estimates for the Industry Solution.

Cost Analysis
FCMs' CFTC Proposed Rule Cost Estimates




    Based on the foregoing, we submit that the cost of building and 
maintaining a database to comply with the OCR Rules is overly 
burdensome for FCMs and some reporting entities. This is particularly 
true, since FIA found that the size of the FCM had little to do with 
the projected costs. As noted earlier, smaller FCMs may have a large 
number of retail accounts, i.e., non-institutional hedgers and 
individual traders. Taking into consideration today's extremely low 
commission rates, it could take years for firms to recoup the cost of 
OCR implementation and maintenance. Most firms will certainly elect to 
pass on those costs to end-users. FCMs may avoid smaller accounts 
altogether, since the commissions earned would be far less than the 
cost of establishing and maintaining the account.
    In addition, although the costs for a reporting entity may not seem 
significant for the larger, well-established exchanges, they are 
significant for the smaller exchanges and other entities such as swap 
execution facilities that the Commission has indicated may be required 
to be reporting entities. At a time when legislators and regulators are 
trying to encourage transparent execution venues and centralized 
clearing, the scope of the OCR seems counterproductive.
The Commission and the Industry Must Work Together
    Notwithstanding the foregoing, and as noted earlier, FIA supports 
the Commission's goals. We are committed to working with the Commission 
and the other futures market participants to develop a meaningful 
alternative to the proposed OCR Rules. To this end, FIA is submitting 
herein for the Commission's review an alternative proposal that has 
been developed by FIA's OCR Working Group.\11\
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    \11\ As discussed above, the OCR Working Group that FIA formed 
includes (i) 16 FCMs, both large and small, representing retail and 
institutional customers, (ii) exchanges, (iii) back office service 
providers and (iv) other experts.
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    The alternative seeks to maximize the use of existing data; 
automate and enhance the current, largely manual, large trader 
reporting system; \12\ provide the Commission with an efficient means 
of monitoring trading behavior based on volume thresholds; and linking 
ownership data to the trade registers. The large trader reporting 
system already provides the Commission the ability to aggregate certain 
customer activities across clearing firms. In addition to automating 
the large trader system, the OCR Working Group's alternative would 
enhance this system, in part, by extending reporting requirements to 
traders that engage in a certain volume of transactions without regard 
to their open positions. As under the proposed rules, the Commission 
would remain responsible for linking accounts across exchanges and 
FCMs.
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    \12\ Currently, once an account becomes reportable, the carrying 
FCM assigns it a ``special account number'' and submits ownership and 
control data to the Commission and the exchanges on Commission Form 
102. This form is submitted by facsimile or e-mail, and the Commission 
staff then enters the information into its systems. (We understand that 
some exchanges, but not all, enter this information into an exchange 
database.) At the request of the Commission, a customer may be required 
to file a separate report effectively confirming and supplementing the 
information provided on the Form 102. This Statement of Reporting 
Trader, Commission Form 40, is also filed with the Commission by 
facsimile or e-mail. The carrying FCM frequently does not receive a 
copy of the Form 40.
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    The OCR alternative would achieve the essential regulatory purposes 
underlying the proposed OCR Rules, while reducing the regulatory, 
operational and financial costs that would be imposed by the OCR 
Rules.\13\ Importantly, these costs would be distributed more fairly 
across the industry, thereby easing the potentially adverse competitive 
impact of the OCR Rules.
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    \13\ To the extent the OCR Working Group alternative would not 
provide the Commission the full scope of information contemplated under 
the proposed OCR Rules, the Commission would be able to use its special 
call authority to obtain such information.
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    The alternative represents our best collective efforts to date. 
However, we must emphasize here, as we did at the staff roundtable on 
September 16, the importance of Commission participation in this 
project. We submit that nothing is gained by the Commission and the 
industry working on parallel yet separate tracks. Without the active 
participation of Commission staff, the industry runs the considerable 
risk of expending substantial time and resources developing an 
alternative that the Commission will ultimately conclude does not 
achieve its goals. FIA, therefore, encourages the Commission to 
authorize the staff to meet with industry representatives (and other 
participants as the Commission may select) to develop a mutually 
acceptable alternative to the OCR Rules or, at the very least, to 
provide necessary feedback to the industry's initiative.\14\
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    \14\ FIA has no objection to opening these meetings to the public, 
if the Commission were to determine that it would be necessary or 
appropriate to do so.
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Proposed Data Points
    The balance of this letter will first discuss each of the data 
points that the proposed OCR Rules would require FCMs and reporting 
entities to collect and maintain. We will describe (i) the data that is 
currently collected, (ii) the data that is not currently collected, and 
(iii) the data that the OCR Working Group has concluded would be 
difficult, if not impossible, to collect.\15\ We conclude with a 
discussion of the tremendous structural changes the OCR Rules would 
impose.
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    \15\ The information with respect to the proposed data points is 
based in substantial part on information that was provided to FIA by 13 
of its member FCMs. In the aggregate, these FCMs carry approximately 
530,000 accounts. As noted earlier, the number of accounts carried by 
an FCM is not necessarily proportional to the FCM's size, i.e., its 
adjusted net capital. Several smaller FCMs carry significantly more 
accounts on behalf of noninstitutional hedgers and individual traders.
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    In general. Because FCMs, not reporting entities, establish and 
maintain the customer relationship, much of the information that would 
be required to be collected and reported under the OCR Rules would be 
collected in the first instance by FCMs. Of the approximately 28 data 
points listed in OCR Rules, FCMs are the root source for 10-12.
    Exhibit A, set out on the following page, identifies the data 
points that the Commission is proposing to be collected and reported in 
the OCR for which FCMs would be the root source. The exhibit identifies 
the data points that currently: (i) are captured electronically; (ii) 
are captured in hard copy; and (iii) are not captured at all. To the 
extent these data points are currently captured, they reside in a 
variety of systems and formats. Importantly, no system consolidates 
this information in a single location, where it can be easily reported 
to an exchange. Rather, FCMs use mapping tables and a variety of 
reconciliation tools to manage the accounts they carry or for which 
they act as an executing broker.
    In order to collect the information as proposed in the OCR Rules, 
therefore, an FCM would have to overhaul completely its existing 
procedures, processes and systems. As noted earlier, an FCM would be 
required to: (i) re-negotiate all active client agreements to require a 
customer to provide and routinely update the necessary data points; 
(ii) build systems to enter the data; (iii) manually enter the data for 
each active account; (iv) put in place resources and processes to 
maintain the data; (v) provide it to the reporting entity on a weekly 
basis; and (vi) monitor changes daily in order to update the database.

Exhibit A
Proposed OCR Data Elements



    Account numbers. Account numbers are the key to identifying trading 
activity but present significant challenges in tying account ownership 
and control information to the trade register, as proposed in the OCR 
Rules. Account numbers assigned by FCMs when the account is opened are 
not standardized across the industry. The field that carries account 
numbers varies from system to system, firm to firm and exchange to 
exchange. Some fields allow six characters; others allow nine 
characters. Some justify left; others justify right. Some recognize 
spaces; others do not.
    In addition, a customer may have multiple account numbers, 
representing various trading strategies, funds, or traders. For 
example, FIA understands that one major fund manager has 1,500 account 
numbers at a single FCM. Further, certain customers may have their own 
account numbers, which they provide to their carrying FCM. The FCM 
assigns an account number that follows the FCM's account number 
conventions, which it then maps to the customer provided account 
number.
    Critically, the account numbers reflected in the trade register 
will not always match the account numbers assigned by the carrying FCM. 
Among other reasons, these differences arise from the use of: (i) give-
up transactions; (ii) short codes; and (iii) average pricing. Give-up 
transactions and average price transactions, for example, are often 
allocated to suspense accounts using short codes, pending completion of 
the trade and allocation among the receiving customers and carrying 
FCMs.\16\ FCMs use mapping tables and reconciliation tools extensively 
to manage account numbers.
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    \16\ The use of short codes is consistent with Commission Rule 
1.35(a-1), which does not require that an FCM record the customer's 
account number when submitting an order for execution. The rule simply 
requires that the order include an account identification.
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    In many cases, of course, the ownership information can be tied to 
the trade register through the account number (Diagram 1). ``Trade 
Order Routing Flow'' shows at a high level how orders are initiated 
from a customer or trader, either directly or through an executing 
broker, and are processed through the various systems in the trade 
management chain of systems. An account identifier is used by the 
executing firm and clearing firm to identify the customer account 
associated with the individual trades/positions. The account identifier 
is entered into trade management systems by the customer or traders 
(directly), or by the executing broker trading on behalf of the 
customer. The account identifier is captured in trade management 
interfaces, passed through to the exchange trading platforms and is 
stored in the exchange/clearinghouse clearing systems. These same 
account identifiers are reported to regulatory agencies through trade 
register files.



    There are several instances, however, when the account identifiers 
recorded on the trade register do not reflect the actual customer or 
traders (Diagrams 2-4). In these instances, the account identifiers on 
the trade register cannot be used to identify trade account ownership.
    In Diagram 2, Client A places an order with the executing broker. 
The executing broker enters the order using account identifier 
``12345,'' which represents the company making the trade and not the 
individual executing the trade. The order is given up to the clearing 
broker, which assigns the account identifier ``ABCDE,'' which is a 
short code that allows the clearing broker to tie the trade back to the 
individual trader at Client A. The clearing broker converts the short 
code to the Client A settlement account identifier in its internal 
system. The trade register contains the short codes used by both the 
executing and clearing brokers, but not the client's settlement account 
number (123-ABCDE).




    Diagram 3 describes how the use of ``short codes'' adversely 
impacts the ability of the trade register to identify account 
ownership. In this diagram, the customer/trader executes a trade using 
the short code ``ABCDE''. The executing broker also executes a trade 
for a client using the short code ``UVXYZ.'' The clearing broker 
receives both the client executed trade (ABCDE) and the broker-executed 
trade (UVXYZ) for Client A. The clearing broker then converts both 
short codes to Client A's settlement account 123-ABCDE. As in the 
previous example, the trade register does not contain Client A's 
settlement account identifier.




    Diagram 4 shows processing for average priced transactions executed 
by one firm and given-up to the carrying FCM. Average priced trades 
represent transactions traded as a group with an average price applied 
to them. In many cases, they are given up using an account identifier 
for the average priced group. In the diagram, an average priced trade 
for account ``APS12'' is executed. The trade is then given up to the 
clearing broker using the clearing broker's short code 123-APS12. The 
clearing broker subsequently allocates the trades into Client A's 
settlement account 123-ABCDE, which is not represented on the executing 
firm's records or on the trade register.




    Ultimate beneficial owners. An FCM currently collects only limited 
information on certain ultimate beneficial owners of an account. This 
information is obtained only when the account is opened and is 
generally not updated. For example, when an account is opened for a 
managed fund (e.g., a commodity pool), the FCM generally will ask the 
fund manager for the identity of any investor that holds more than a 10 
percent interest in the fund. The FCM employs its customer 
identification program to verify the identity of these investors. 
However, FCMs have no means to independently verify the fund's 
beneficial owners and rely completely on the fund manager to identify 
these investors.
    Moreover, investors may increase or decrease their investment 
throughout the life of the fund (or may withdraw entirely), and new 
investors will be accepted on a regular basis. FCMs generally do not 
receive information with respect to changes in the composition of the 
investors in a fund once an account is opened. Although FCMs will ask 
for a copy of the fund's annual report, this report does not reflect 
changes in the composition of investors.
    When a corporate account is opened, FCMs will obtain information on 
the parent company, if any, and on the individual or entity that 
controls the trading in the account. However, once the account is 
opened, FCMs generally do not monitor the customer for changes in its 
organizational structure and relies on the customer to inform the FCM 
of any changes. As a practical matter, FCMs do not receive updates to 
this information on a regular basis.
    Owner's Name. While an individual account owner's name is certainly 
kept within a firm's books and records, it can be difficult to compare 
names across systems. One firm may enter a customer name in full while 
another may use a version of the customer name. For example, the name 
for John Smith could be entered in an FCM's records as follows: (i) 
John Smith; (ii) John R. Smith; (iii) John Ronald Smith; (iv) John R 
Smith; (v) J R Smith; or (vi) J. R. Smith. Each variation of this name 
refers to the same individual account owner. However, because of manner 
in which names are stored electronically, electronic systems cannot 
detect that each of the six names refers to the same account owner.
    The same is true for accounts that are owned by entities. For 
example, when setting up a database for give-up agreements, FIA found 
52 versions of the name ABN Amro.
    Date of birth. An FCM generally does not record the date of birth 
of a customer or account controller that is an individual. An FCM may 
be required to confirm the age/date of birth of the customer for 
purposes of NFA Compliance Rule 2-30 \17\ or compliance with anti-money 
laundering rules, but neither rule requires an FCM to capture that 
information in its systems. Therefore, an individual's date of birth 
generally is not stored electronically. When it exists in the records 
maintained by the FCM, it is stored in the form of a paper copy of a 
driver's license or passport.\18\
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    \17\ NFA Compliance Rule 2-30, Customer Information and Risk 
Disclosure, requires NFA member firms to obtain certain information 
about its customers who are individuals, including the customer's 
approximate age. The rule does not require member firms to pierce 
through a customer that is an entity and collect information regarding 
the beneficial owners of the customer. Further, a customer may decline 
to provide certain information.
    Effective January 3, 2011, NFA Compliance Rule 2-30, has been 
amended to provide, in relevant part: ``For an active customer who is 
an individual, the FCM Member carrying the customer account shall 
contact the customer, at least annually, to verify that the information 
obtained from that customer under Section (c) of this Rule [i.e., name, 
address, occupation, estimated income and net worth, approximate age, 
and previous investment experience] remains materially accurate, and 
provide the customer with an opportunity to correct and complete the 
information.''
    \18\ FIA further understands that it is considered a violation of 
privacy to ask for date of birth in certain countries, including 
Germany and Canada. We understand that privacy laws in foreign 
jurisdictions generally may prevent the routine disclosure of other 
proposed data points relating to individuals.
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    Primary residence. An FCM may collect the residential address of 
its individual customers. However, in some cases this information is 
subject to data privacy laws. Further, residential address information 
is not routinely updated, particularly when customer statements are 
delivered electronically). Moreover, if the beneficial owner 
participates in a fund or is part of an omnibus account, FCMs would not 
have the individual's primary residence address. In any event, primary 
address information is entered in a free form field in the FCM's system 
and is not standardized. Therefore, to the extent this information is 
collected to meet the OCR Rules, it would have to be re-entered in a 
standardized format.
    NFA identification number. Not all entities or individuals are 
registered with the Commission and members of NFA. Subject to NFA Bylaw 
1101, FCMs generally do not request or record this information. If the 
Commission were to insist on this data point, an FCM would be required 
to separately confirm with NFA whether each account owner, beneficial 
owner or account controller had an NFA identification number (or 
whether the number provided was accurate).
    Account controllers (who must be natural persons). Our comments 
with respect to the difficulty in obtaining and maintaining records 
with respect to name, address, date of birth and NFA identification 
number of account owners (and beneficial owners) of accounts apply 
equally to account controllers. More important, the broad definition of 
an account controller is troubling. The OCR Rules define an account 
controller as ``a natural person, or a group of natural persons, with 
the legal authority to exercise discretion over trading decisions by a 
trading account, with the authority to determine the trading strategy 
of an automated trading system, or responsible for the supervision of 
any automated system or strategy.'' \19\
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    \19\ The authority to exercise discretion is sufficient, regardless 
of whether such authority is actually exercised. Proposed Rule 
16.03(c).
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    This definition cuts too broad a swath and would require 
information on individuals that never actually exercise trading 
authority over an account but, because of their position with the 
customer, as a owner or officer, would be deemed to have this 
authority.\20\ FCMs do not collect information on officers or employees 
of a customer who place orders for the customer's account.\21\
---------------------------------------------------------------------------
    \20\ Although certain exchanges have adopted programs that require 
customers afforded direct access to the exchange trading platform be 
identified to the exchange (e.g., CME Tag 50), the individual 
responsible for data input may not be the account controller. 
Correspondingly, account controllers are not always identified through 
such programs.
    \21\ At one point, FCMs collected this information but stopped this 
practice many years ago after finding that a customer's authorized 
traders changed frequently, but customers advised FCMs of such changes 
infrequently, if at all. As a result, FCMs were placed in the untenable 
position of either refusing to accept an order from an individual that 
was not on the approved traders list, potentially adversely affecting 
the customer's trading strategy, or accepting a trade from an 
individual with apparent authority, potentially exposing the FCM to 
liability for accepting an order from an unauthorized individual. FCMs 
generally concluded that the responsibility for maintaining control of 
an account belonged to the customer, not the FCM.
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    FIA believes the definition of an account controller should be 
consistent with the Commission's definition of control as set out in 
Commission Rule 1.3(j) and generally applied at exchanges. That is, 
unless a customer specifically provides discretionary trading authority 
to a third party that is either registered with the Commission as a 
commodity trading advisor or is excluded or exempt from registration, 
the account controller should be deemed to be the owner of the account.
    Date account is assigned to the current controller. This 
information is not captured by FCMs. The cost of capturing this 
information would outweigh the regulatory benefit.
    Designation of the manner in which the trade is executed. FCMs do 
not currently capture information with respect to whether a trade is 
executed by a natural person, automated trading system or both. We 
believe any effort to do so would be difficult at best. Many account 
controllers, as broadly defined in the OCR Rules, input orders in a 
variety of ways for a variety of reasons. Simply because an account 
controller generally executes trades through an automated trading 
system does not mean that certain trades will not be executed manually.
    Special account number. Special account numbers associated with an 
account are generally assigned by an FCM's compliance or operations 
department. The number is not included with the customer information 
that is submitted with a trade and, therefore, is not included on the 
trade register. Rather, the special account number is added to the 
position file at the end of the day.
    Date the account becomes reportable. FCMs currently do not record 
when an account becomes reportable, since this information appears to 
be of limited regulatory value.\22\
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    \22\ Since the alternative described below will effectively 
automate the Form 102, information with respect to all reportable 
accounts will be provided to the Commission weekly.
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    Omnibus accounts. Although FCM systems identify accounts as omnibus 
accounts, the name of the account may be different at each carrying 
FCM, making it difficult to compare names across systems.
    Name of the executing firm and its unique identifier reported in 
the reporting entity's trade register. This information is not included 
in the trade register. A customer may use a variety of executing 
brokers and the carrying firm does not record this information at the 
account level.
    Name of the clearing firm for the trading account and its unique 
identifier reported in the reporting entity's trade register. This 
information is contained in the trade register and carried at the 
account level.
    Name of root data source. Providing the reporting entity with 
information with respect to the trading account. This point needs 
additional clarification. The root data source is typically the 
beneficial owner or account controller. The FCM, however, would provide 
the data to the reporting entity. This data point appears to be 
unnecessary and would add complexity to the OCR database.
    Reporting entity. Name of the reporting entity would be added when 
submitted to the Commission.
    OCR transmission date. The OCR transmission date would be added 
automatically upon transmission of the data to the Commission.

The OCR Rules Would Force a Structural Change in the Conduct of 
        Business
    As we noted at the outset of this letter, implementation of the OCR 
Rules would force an unwarranted structural change in the conduct of 
business among U.S. futures markets participants, especially among 
clearing member and non-clearing FCMs, foreign brokers, and their 
respective customers. Because the proposed rules would require clearing 
member FCMs to know and report to the relevant clearing organization 
the identity of each customer that comprises an omnibus account and 
their respective positions, the ability to maintain omnibus accounts 
would be significantly impaired, if not eliminated.
    Omnibus accounts, which are treated as the account of a single 
customer for all purposes on the books and records of the carrying FCM 
or clearing organization, have been an integral part of the futures 
markets since well before the Commission was created in 1974. Foreign 
brokers and FCMs that are not members of a particular clearing 
organization maintain omnibus accounts with clearing members; clearing 
member FCMs, in turn, maintain omnibus accounts with the relevant 
clearing organization.
    Omnibus accounts serve both a practical and regulatory purpose. 
FCMs, whether clearing members or non-clearing members of a particular 
clearing organization, compete for customers.\23\ Non-clearing FCMs, 
therefore, do not want to disclose the names of their customers to the 
FCM that clears their customers' accounts. The same practical 
considerations lead foreign brokers to open customer omnibus accounts 
with the FCMs that clear their customers' positions.\24\
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    \23\ An FCM may choose to become, or elect not to become, a member 
of a particular clearing organization for a number of reasons. For 
example, the cost of becoming a member of a clearing organization may 
be too high or the volume of business that the FCM would clear through 
the clearing organization may not justify the operational and financial 
costs.
    \24\ The Commission's recognition of the essential purpose of 
omnibus accounts was described in a 1984 exchange of correspondence 
between the Commission's Division of Trading and Markets (now the 
Division of Clearing and Intermediary Oversight) and the Federal 
Deposit Insurance Corporation (``FDIC''), in which the FDIC confirmed 
that, provided that the books and records of bank and the relevant FCMs 
properly indicate that the funds in the account are being held in a 
custodial capacity, FDIC insurance would be afforded each ultimate 
customer's interest in an omnibus account in which the transactions of 
two or more persons are carried by a carrying FCM in the name of an 
originating FCM. Interpretative Letter No. 84-14, [1984-1986 Transfer 
Binder] Comm. Fut. L. Rep.  22,311.
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    For their part, clearing member FCMs may not want to incur the 
operational expense of maintaining an extensive branch office network. 
They rely instead on non-clearing FCMs that are often physically closer 
to their customers and, as result, are better able to serve them and 
evaluate more fully any credit risk they may pose.\25\ In these 
circumstances, the non-clearing FCM is the clearing member FCM's 
customer, and the clearing member FCM will conduct due diligence on the 
non-clearing FCM to be certain that it understands the nature of the 
business in which the non-clearing FCM is engaged, the types of 
customers that non-clearing FCM serves and the non-clearing FCM's risk 
management practices. Because non-clearing FCMs stand between their 
customers and the clearing member FCM, the clearing member FCM has to 
consider only the credit of the non-clearing FCM.
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    \25\ For these same reasons, a customer may prefer to deal with a 
non-clearing FCM that is able to provide more personal service and make 
an informed judgment concerning the credit risk the customer may pose. 
Alternatively, an institutional customer holding positions cleared 
through a smaller clearing organization may prefer to have its trades 
carried by a non-clearing FCM that has substantially greater capital 
than a clearing member FCM of that clearing organization.
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    From a regulatory perspective, omnibus accounts facilitate the 
conduct of business by a clearing member FCM, in particular, in 
connection with customers located outside of the U.S. A clearing member 
FCM's ability to carry an omnibus account of a foreign broker allows 
the FCM to carry the accounts of foreign customers without having to be 
registered in the home jurisdiction of each customer.
    The Commission historically has taken the position that a firm 
acting in the capacity as an FCM is required to be registered as such 
if either the firm is located in the U.S. or the firm's customers are 
located in the U.S. Under the Commission's Part 30 rules, the only 
exception to this requirement the Commission has made is with respect 
to foreign firms that carry a customer omnibus account on behalf of a 
U.S.-registered FCM.\26\
---------------------------------------------------------------------------
    \26\ Commission Rule 30.4(a).
---------------------------------------------------------------------------
    Foreign jurisdictions generally take the same position. That is, a 
U.S. FCM would be prohibited from soliciting or accepting orders 
directly from a foreign person for execution on a U.S. contract market, 
unless the FCM were properly registered in the foreign person's home 
jurisdiction. A U.S. FCM, however, may carry the customer omnibus 
account of a foreign broker without being so registered.
    More generally, because the omnibus account is treated as a single 
customer, a clearing member FCM's rights and responsibilities under the 
Act and Commission rules are solely with respect to the omnibus 
account. The clearing member FCM has no obligation to pierce through 
the omnibus account to know the identity of each of the customers that 
comprise the omnibus account.
    Thus, the omnibus account is treated as a single account for 
purposes of compliance with: (i) the provisions of section 4d(a)(2) of 
the Act and Commission Rules 1.20-1.30, including the investment of 
customer funds under Rule 1.25; (ii) the early warning requirements 
under Rule 1.12(f)(3); (iii) the provisions of Rule 1.33 regarding 
confirmations and monthly statements; (iv) the provisions of Rule 1.35 
regarding records of futures and options on futures transactions; (v) 
the provisions of Rule 1.36 regarding records of securities and 
property received from customers; (vi) the provisions of Rule 1.37 
regarding the name, address and occupation of customers; (viii) the 
large trader reporting requirements of Part 17; and (ix) the provisions 
of Rule 166.3, which require an FCM to supervise diligently the 
handling of all commodity interest accounts carried, operated, advised 
or introduced by the FCM and all other activities relating to its 
business as a Commission registrant. Significantly, the omnibus account 
also is treated as a single account for purposes of compliance with the 
PATRIOT Act, including an FCM's anti-money laundering and suspicious 
activity reporting requirements.
    If the Commission were to require clearing member FCMs to know and 
report to the relevant clearing organization the identity of each 
customer that comprises an omnibus account and their respective 
positions, the carefully crafted provisions of law and rules that have 
governed the conduct of omnibus accounts for decades would be 
destroyed. We do not believe--and more importantly, do not believe that 
the Commission has ever taken the position--that an FCM can know the 
identity of customers in an omnibus account, as well as the positions 
that are attributable to such customers, with incurring the concomitant 
obligations of treating those customers as customers of the FCM for all 
purposes.
    In the absence of a Commission rule to the contrary,\27\ which 
would specifically relieve a clearing member FCM of such obligations, 
once the FCM knows the identity of such customers, the FCM would have 
to assume that it would have the obligation with respect to each such 
customer, individually: (i) under Rule 166.3, to supervise the handling 
of each customer's accounts; (ii) under section 4d(a)(2) of the Act and 
Commission Rules 1.20-1.30, to segregate each customer's funds; (iii) 
under Rule 1.33, to provide each such customer with a confirmation of 
each trade and a monthly statement; (iv) under Rule 1.35, to make a 
record of each customer's transactions; (v) under Rule 1.36, make a 
record of the securities and property received from each customer; (vi) 
under Rule 1.37, record the name , address and occupation of each 
customer; and (vii) under Part 17, file a large trader report with 
respect to each customer.
---------------------------------------------------------------------------
    \27\ The Treasury would also have to grant relief from the 
applicable PATRIOT Act requirements.
---------------------------------------------------------------------------
    The clearing member FCM would have no choice but to restructure 
completely the way in which it conducts business. It would be required 
to make each customer within the omnibus account a direct customer, 
thereby negating any need or reason for maintaining a relationship with 
the nonclearing member FCM. The result would be a further contraction 
of the number of FCMs able to compete for customer business. Further, 
without the intermediation of a non-clearing member FCM willing to 
assume the credit risk of customers not known to the clearing member 
FCM, those customers would probably not be able to maintain a trading 
account.
    The abolition of omnibus accounts could have potentially serious 
effects as well on smaller exchanges and their affiliated clearing 
organizations. As noted earlier, an institutional customer holding 
positions cleared through a smaller clearing organization may prefer to 
have its trades carried by a non-clearing member FCM that has 
substantially greater capital than a clearing member FCM of that 
clearing organization. If the institutional customer is required to 
open an account directly with the smaller clearing member FCM, it may 
simply decline to trade on that smaller exchange.
    Perhaps most severe could be the potential impact on the ability of 
foreign customers to trade on U.S. markets. If U.S. FCMs were required 
to be registered in the home country of each foreign customer whose 
account it carried, the FCM would be subject to potentially conflicting 
regulatory requirements. Even if the conflicting regulatory 
requirements could be managed, the operational and financial burdens 
would be such that only the most highly capitalized FCMs could even 
contemplate conducting business on behalf of foreign customers. The 
more likely result would be that foreign customers would be effectively 
shut out of the U.S. markets.

Unique Account Identifier
    The Commission has invited comment on how the futures industry 
could develop and maintain a system to assign unique account 
identification numbers (``UAIN'') to all account owners and account 
controllers. We do not believe such a project is feasible. On the 
surface, assigning each customer a unique identifier that would be used 
by all firms and exchanges would appear to solve many of the issues 
with creating an OCR database. However, UAINs would require a massive 
change in all systems in the trading cycle. Every system in the 
industry would have to be modified, including all front-end systems, 
customer order entry systems, middleware and back-end systems, as well 
as exchange trading and clearing systems. We have not computed this 
cost. The addition of a UAIN also adds data/risk to the clearing 
systems which are already facing capacity issues.

Conclusion
    For all of the above reasons, FIA regrets that we cannot support 
the OCR Rules as proposed. We nonetheless appreciate the deliberative 
manner in which the Commission has approached this project, and we look 
forward to having the opportunity to work with the Commission and staff 
in developing an OCR database and reporting system that will achieve 
the Commission's goals in an effective and efficient manner. In the 
meantime, if the Commission has any questions concerning the matters 
discussed in this letter, please contact Barbara Wierzynski, FIA's 
Executive Vice President and General Counsel.
            Sincerely,

            
            
President.

Honorable Gary Gensler, Chairman;
Honorable Michael Dunn, Commissioner;
Honorable Jill E. Sommers, Commissioner;
Honorable Bart Chilton, Commissioner;
Honorable Scott O'Malia, Commissioner;

Division of Market Oversight:

  Richard Shilts, Acting Director;
  Rachel Berdansky, Deputy Director;
  Sebastian Pujol Schott, Associate Deputy Director;
  Cody J. Alvarez, Attorney Advisor.

                               APPENDIX A

Ownership and Control Reports Proposed OCR Alternative
    The Futures Industry Association (``FIA'') hereby submits for the 
Commission's review the following OCR alternative, in lieu of the 
ownership and control reporting requirements that the Commission has 
proposed to impose on ``reporting entities.'' 75 Fed. Reg. 41775 (July 
19, 2010) The OCR alternative was developed by the OCR Working Group, 
which was formed by FIA and is comprised of a broad cross-section of 
the futures industry. Its members include representatives from (i) 16 
FCMs, both large and small, serving retail and institutional customers, 
(ii) the several U.S. exchanges, (iii) back office service providers, 
and (iv) other experts. By no means perfect, the OCR alternative 
nonetheless presents a more cost effective and practical mean to create 
an OCR database, which is user-friendly and familiar to the Commission 
staff and investigators. It should not be viewed as an industry-
approved alternative, but solely as a basis for further discussions 
among the Commission, the futures industry and other interested 
parties.
    Based on the Commission's large trader reporting system, the OCR 
alternative may be implemented more effectively across multiple 
exchanges. The alternative integrates the existing trade register data 
generated by the exchanges with the fundamental OCR data collected by 
FCMs, thereby allowing the Commission to access the data more quickly 
and aggregate account-level information across multiple exchanges. 
Although the OCR alternative would require clearing-member FCMs to make 
significant changes in the collection, storage and transmission of 
customer and trade-related data, the alternative would be less costly 
and could be implemented more quickly. As important, the alternative 
would achieve the essential regulatory purposes underlying the proposed 
OCR Rules, as outlined in the Federal Register release accompanying the 
proposed rules.
    Specifically, the OCR alternative would: (i) help integrate data 
found in the Integrated Surveillance System and the Trade Surveillance 
System by linking individual transactions reported on exchange trade 
registers with aggregate positions reported in large trader data; (ii) 
identify small and medium-sized traders whose open interest does not 
reach reportable levels, but whose intra-day trading may aversely 
affect markets during concentrated periods of intra-day trading; (iii) 
reduce the time-consuming process of requesting and awaiting 
information from outside the Commission to identify the entity 
associated with the account number and aggregate all identified 
entities that relate to a common owner; (iv) link traders' intra-day 
transactions with their end-of-day positions; (v) calculate how 
different categories of traders contribute to market-wide open 
interest; and (vi) categorize market participants based on their actual 
trading behavior on a contract-by-contract basis, rather than on how 
they self-report to the Commission (e.g., registration type or 
marketing/merchandising activity on Commission Form 40).
    At a high level, the alternative proposes that clearing firms will 
provide a weekly OCR file to exchanges and the Commission that will 
facilitate the linking of trading activity to owners and controllers 
across firms and exchanges. This file would be provided for each 
trading account exceeding an agreed upon volume threshold. Much of the 
data currently collected on Form 102 would be included in the OCR file, 
thereby automating the Form 102 process.
    In developing this proposal, the OCR Working Group was guided by 
the principle that, to the extent practicable, the alternative should:

   extract certain data from existing systems to create and 
        maintain an OCR file;

   rely on data currently available in existing systems;

   minimize new data recording requirements; \28\
---------------------------------------------------------------------------
    \28\ The new data required to be collected would be limited to the 
short codes employed in exchange trade registers and customer e-mail 
addresses.

   confine collection of the data to the clearing-member FCM; 
---------------------------------------------------------------------------
        and

   use volume thresholds to determine the accounts that should 
        be subject to OCR.

    The OCR alternative contains the following assumptions:

   The definition of ``control'' would be limited to that which 
        is currently used for purposes of the large trader reporting 
        system (i.e., a person other than the account owner will be 
        deemed to ``control'' an account only if the person is a third 
        party with discretionary authority to trade the account; the 
        account owner's employees will not be deemed to ``control'' the 
        owner's account).

   Non-disclosed omnibus accounts would report the name of the 
        omnibus account only; disclosure of all accounts within the 
        omnibus will not be required.

   OCR data would be captured for end-of-day cleared accounts 
        at the carrying broker level.\29\
---------------------------------------------------------------------------
    \29\ Executing brokers do not usually have, and should not be 
required to provide, account ownership and control information.

   The Commission will acquire additional information required 
        for OCR that is not currently captured or stored by clearing 
        member FCMs directly from account owners/controllers (i.e., 
---------------------------------------------------------------------------
        through Form 40 reporting).

   The OCR Working Group would work with the Commission to 
        determine an appropriate volume threshold. For purposes of 
        estimating costs, however, the OCR Working Group limited the 
        number of accounts that would be reported to accounts that 
        traded more than 250 contracts weekly.\30\
---------------------------------------------------------------------------
    \30\ The OCR Working Group also discussed pegging the volume 
threshold to current large trader position reporting levels.
---------------------------------------------------------------------------
Account Ownership Data
    As indicated above, the alternative would leverage and automate the 
Form 102, which FCMs file with the Commission whenever a customer 
exceeds the large trader reporting thresholds.\31\ Form 102 would be 
updated to reflect the current trading environment, in particular, 
significant intraday trading activity, and collect information with 
respect to accounts that exceed either position or volume thresholds.
---------------------------------------------------------------------------
    \31\ The Form 102 provides essential information about the account: 
(1) type of account, e.g,, house, customer omnibus, corporation, 
limited liability company, individual: (2) name of account owner; (3) 
address; (4) registration category, if any; (5) commodities hedged, if 
any; and (6) identity of account controller, if any. Certain 
information currently collected on the Form 102 would not be collected 
under the OCR alternative.
---------------------------------------------------------------------------
    Although Form 40 provides more detail regarding account owners and 
account controllers, if any, this form is completed by customers and, 
in most cases, is forwarded directly to the Commission. FCMs generally 
do not receive a copy of the Form 40 and, in any event, do not record 
the information electronically. We appreciate that the Commission may 
want to amend the Form 40 to enhance the information that the 
Commission receives. However, the OCR alternative does not contemplate 
any change in the current procedures regarding the Form 40.

The OCR Alternative
    The OCR alternative would require each FCM to develop and maintain 
an electronic reporting system containing the following fields of 
information. Appendix B hereto summarizes the data to be collected and 
identifies whether the information currently resides in FCM back-office 
systems or the Form 102.
    Trading Account Number. Account numbers are the key to linking 
account ownership and control information to the information contained 
in the exchange trade registers. The OCR alternative overcomes the 
problems described earlier in our comment letter by providing the means 
to relate the trading account and short codes to the ownership and 
control information.
    Special Account/Reportable Account Number. This field contains the 
large trader reportable position account number that the FCM assigns, 
if applicable.
    Short Code. Exchange trade registers contain the account numbers 
submitted by both executing and carrying firms for each transaction 
executed on the relevant exchange. Although these account numbers can 
be used to identify account owners, as explained earlier, the account 
number in the trade register is often a ``short code'', or proxy 
number, that does not tie directly to the account owner. FCMs maintain 
internal mappings for these account schemes, but these ``short codes'' 
are not always in the firm's account reference file. Middleware systems 
are used to translate short codes to actual account numbers for firms' 
internal books; these translation rules can be leveraged to create 
mapping tables for matching trades to the OCR. The alternative would 
require firms to include the short code mappings in the back-office 
identification of the account ownership and control information.
    Owner Name. This field will include owner first name and last name, 
and middle name as available, if the owner is a natural person.
    Owner Organization. This field would include the name of the 
entity, if the owner is not a natural person.
    Owner Address. Multiple address fields would include the street 
address, city, ZIP Code and country for the account owner.
    Owner E-mail Address. This field would include the e-mail address 
of the owner, if a natural person. E-mail addresses hold promise as a 
unique identifier for customer accounts. However, implementation and 
maintenance would have operational challenges as well as financial 
costs. At present, some FCMs have no robust process for collecting and 
maintaining customers' e-mail addresses and would need to upload (and 
update) e-mail addresses manually. Therefore, the customer's e-mail 
address initially would be a non-mandatory data field.
    Controller Name. This field would include the first and last name 
of the controller, if the controller is a natural person.
    Controller Organization. This field would include the name of the 
business or organization that controls the account if the controller is 
not a natural person.
    Controller Address. Multiple address fields would include the 
street address, city, ZIP Code and country for account controller.
    Controller E-mail Address. This field would include the e-mail 
address of the account controller.
    Controller Type. This field would indicate whether the customer 
represents a fund or a CTA/CPO.
    FCM Identification Number. This field would includes the number 
assigned to the clearing FCM by the Commission.
    Omnibus Flag. This field would indicate whether the account is an 
omnibus account.
    Trading Account Effective Date. This field would include the date 
on which the account was established in the clearing FCM's back office 
accounting system.

OCR Construction Work Effort
    Although the alternative would use data that is currently stored in 
existing systems, those systems would be required to be modified to 
extract, report, and transmit OCR-related information. In addition, it 
would be necessary to build certain databases to support the OCR.
    Firms would be required to supply information to build the OCR 
file. Firms would need to:

   modify systems to build an OCR file for daily or weekly 
        submission to the Commission;

   create processes to identify trading accounts that exceed 
        volume thresholds;

   acquire ownership and control information for the initial 
        construction of the OCR file; and

   create operational processes to maintain the OCR file on an 
        ongoing basis.

Cost Analysis of OCR Alternative
    The OCR Working Group estimates that, compared with the 
Commission's proposal, the OCR alternative would result in an average 
first-year cost saving of approximately $18.8 million. As described in 
the charts at the end of this Appendix, the first year costs of the 
Commission proposal is four times greater than the median costs 
incurred by FCM's under the alternative.
    The first-year cost estimates were collected from a sample of 12 
FCMs.\32\ Three of the FCMs that responded to this survey were not 
among the 12 firms that provided estimates of the costs of implementing 
the Commission's proposed OCR Rules and the assumptions underlying one 
firm's estimates were inconsistent with the assumptions of the 
remaining nine FCMs. For comparison purposes, therefore, we used only 
the estimates provided by the eight FCMs that responded to both surveys 
applying comparable assumptions. The cost of building an OCR file 
containing the data elements identified above and in Appendix B ranges 
from $400,000 to $14,500,000, with the average estimated cost per firm 
being $4,647,292. The estimated ongoing costs associated with operating 
and maintaining the OCR data files ranges from $125,000 to $7,000,000 
on an annual basis, averaging $1,337,292 per firm.
---------------------------------------------------------------------------
    \32\ According to the FCM Financial Data reported on the Commission 
website, as of July 31, 2010, the 12 firms surveyed held segregated 
customer funds in excess of $96.4 billion, approximately 71 percent of 
all customer funds.
---------------------------------------------------------------------------
    Each FCM's estimated costs would depend on the number of accounts 
for which the OCR data must be collected, with larger firms facing 
greater costs but also realizing economies of scale in implementation. 
Small FCMs that carry fewer than 250 accounts and would rely 
exclusively on vendors to implement the alternative may not realize 
economies of scale.
    Although the total costs small FCMs would incur appear reasonable, 
their first-year cost per account would be significantly greater than 
the FCMs that are able to rely to a lesser extent on vendors for 
developing the OCR. The average estimated first year cost for smaller 
FCMs is $1,850 per account, while the average cost for other firms 
would be $205 per account.\33\ However, it is important to note that 
these estimates are not firm quotes on cost by the vendors, and the 
actual cost would depend on the size of the business, optional modules 
utilized, number of connectors from either vendor or third party back/
middle office systems and whether or not the service is hosted by the 
vendor or deployed in-house at each firm.
---------------------------------------------------------------------------
    \33\ While this amount is high, the estimated cost per account 
under the Commission's proposal was also on an order of magnitude 
greater than most other FCMs. These FCMs are largely dependent on the 
vendors and have used cost estimates provided by the vendors to 
formulate their estimates.
---------------------------------------------------------------------------
    Most FCMs found that adopting a volume threshold of 250 contracts 
per week would decrease significantly the costs of implementing the 
alternative, by reducing the amount of data required to be processed 
and the associated cost of transmitting large amounts of data to the 
exchanges and the Commission. The average estimated cost of populating 
the OCR database using a volume threshold of 250 contracts per week is 
$1,783,750. In contrast, the estimated total cost for initially 
populating the OCR file based on a volume threshold that includes all 
accounts (referred to in our survey as option 1) is $2,134,375.
    Some FCMs suggested that a volume threshold could increase the cost 
of implementing the alternative initially. This is because processes 
would have to be developed to identify when customers exceed the 
threshold and logic code would have to be developed to pull the OCR 
data for transmission to the Commission. Regardless of the impact on 
the cost burden placed on the FCMs, however, a volume threshold would 
introduce efficiencies in processing and transmission, and will help 
avoid data overload for both the FCMs and the Commission.
    As we found with the Commission's OCR proposal, the effort to 
automate the processes and develop the database would be challenging. 
However, most firms felt that the alternative would be a much more 
robust process and could be implemented within the 18 month timeframe 
envisioned by the Commission.
    The end result of the developing the alternative system could 
ultimately save the firms (and the Commission) significant time and 
money by automating the current manual process for filing out and 
submitting Form 102 information. Implicit in the Working Group proposal 
and the related cost estimates is the assumption that the weekly OCR 
change files would replace the manual process of submitting Form 102 by 
hard copy. As we previously noted, these forms currently are updated as 
requested by the Commission, generally, annually or upon request. With 
OCR automation, FCMs would be providing weekly feeds that would include 
updated information on each account meeting the threshold (e.g., 
changes in the customer's address and e-mail address, as well as 
changes in the identity of the account controller).
    Once implemented, the average cost savings associated with 
automating the Form 102 was estimated to be $33,300 per firm on an 
annual basis. This efficiency would also be realized by the Commission 
because of the decreased reliance on data entry, manual processing, 
recordkeeping, and document management in the current system of 
collecting and storing manual Forms 102.

Conclusion
    For all of the above reasons, the OCR alternative described herein 
would achieve the essential regulatory purposes underlying the proposed 
OCR Rules and forms a basis for further discussion on the proper 
structure of an OCR report. As noted earlier, however, these 
discussions cannot take place in a vacuum. All of the pending 
recordkeeping and reporting requirements, and the estimated costs and 
benefits of each, must be analyzed and evaluated collectively, not 
individually. The OCR Working Group is anxious to work with the 
Commission and staff in developing and implementing an effective and 
efficient recordkeeping and reporting program.

                                    FCMs' Industry Solution Cost Estimates 1
----------------------------------------------------------------------------------------------------------------
                                                                                  Total Start-up
                     Affected                                                      and Ongoing/     First-Year
                     Accounts            Start-up                 Ongoing           First-Year       Costs Per
                                                                                       Costs          Account
----------------------------------------------------------------------------------------------------------------
       Firm A            90,000              $7,500,000              $7,000,000     $14,500,000            $161
       Firm B            75,300              $8,370,000                $225,000      $8,595,000            $114
       Firm C            50,000              $2,935,000              $3,000,000      $5,935,000            $119
       Firm D            39,979                $135,000                $600,000        $735,000             $18
       Firm E            34,700              $2,000,000                $500,000      $2,500,000             $72
       Firm F            30,000              $3,950,000   $1,080,000-$1,095,000      $5,037,500            $168
       Firm G            19,473              $5,135,000              $2,550,000      $7,685,000            $395
       Firm H            14,000              $5,050,000                $125,000      $5,175,000            $370
       Firm I               250                $100,000                $300,000        $400,000          $1,600
     Firm M *            10,000   $3,500,000-$4,000,000                $500,000      $4,250,000            $425
     Firm N *               N/A       $650,000-$850,000        $50,000-$150,000        $850,000             N/A
     Firm O *                50                 $45,000                 $60,000        $105,000          $2,100
----------------------------------------------------------------------------------------------------------------
Notes:

1 The 12 firms in the sample handle in excess of $96.4 billion, or nearly 71% of customers' segregated funds (as
  of July 31, 2010, according to monthly financial reports filed with the CFTC).
* Firm did not provide cost estimates for the CFTC Proposed Rule.

FCMs' OCR Implementation Cost Estimates
CFTC Proposed Rule vs. Industry Solution



                               APPENDIX B

Proposed OCR File
    Below is a summary of the fields in the proposed OCR File that 
would be sent weekly from the clearing FCM to the Commission and/or 
exchanges. The file includes information that exists in current systems 
and on the Form 102.

----------------------------------------------------------------------------------------------------------------
                     Exists in
                     Firm Back-                 Description and
    Field Name         Office    Form 102          Comments                   Values             Format    Size
                      Systems
----------------------------------------------------------------------------------------------------------------
Trading Account              X             Account for which trade   Alphanumeric ID that             AN      20
 Number                                     was executed              identifies the
                                                                      customer(s) on the
                                                                      associated trade record
Special Account/             X             Large Trader reportable   Alphanumeric ID used to          AN      12
 Reportable                                 position account, if      aggregate trading
 Account                                    assigned.                 accounts for large
                                                                      trader position
                                                                      reporting.
Short Code                                 Account identifier used   Alphanumeric ID that             AN      20
Short codes must                            upon execution that is    identifies the
 be accompanied by                          translated into a         customer(s) on the
 a trading account                          trading account number    associated trade record
 number but may                             by back office systems.
 not have a
 special account
 number.
Owner Last Name              X             Last name of account      Smith                            AN      30
 (Person)                                   owner, if the owner is
                                            a natural person.
Owner First Name             X             First name of the         James                            AN      30
 (Person)                                   account owner, if the
                                            owner is a natural
                                            person.
Owner Name                   X             Name of the business or   Proprietary Trading Firm         AN      60
 (Organization)                             organization that owns    Inc.
                                            the account, if the
                                            owner is not a natural
                                            person.
Owner Address 1              X             Primary address of the    123 Main St.                     AN      40
                                            account owner
Owner Address 2              X             Primary address of the    #500                             AN      40
                                            account owner
Owner Address 3              X             Primary address of the                                     AN      40
                                            account owner
Owner City                   X             City of the owner's       Chicago                          AN      25
                                            primary address
Owner State/                 X             State or province         IL                               AN       5
 Province                                   abbreviation for the
                                            owner's primary
                                            address.
Owner ZIP/Postal             X             ZIP Code or postal code   60601-9999                       AN      10
 Code                                       for the owner's primary
                                            address.
Owner Country                X             Country code for the      U.S.                             AN       2
                                            owner's primary address
Owner E-mail                               E-mail address of the     James.Smith@tradingfirm.         AN     100
 Address (Person)                           account owner, if the     com
                                            account is owned by a
                                            natural person.
Controller Last                        X   Last name of account      Smith                            AN      30
 Name (Person)                              controller, if the
                                            controller is a natural
                                            person.
Controller First                       X   First name of the         James                            AN      30
 Name (Person)                              account controller, if
                                            the controller is a
                                            natural person.
Controller Name                        X   Name of the business or   Proprietary Trading Firm         AN      60
 (Organization)                             organization that         Inc.
                                            controls the account,
                                            if the controller is
                                            not a natural person.
Controller Address                     X   Primary address of the    123 Main St.                     AN      40
 1                                          account controller
Controller Address                     X   Primary address of the    #500                             AN      40
 2                                          account controller
Controller Address                     X   Primary address of the                                     AN      40
 3                                          account controller
Controller City                        X   City of the owner's       Chicago                          AN      25
                                            primary controller
Controller State                       X   State or province         IL                               AN       5
                                            abbreviation for the
                                            controller's primary
                                            address.
Controller ZIP                         X   ZIP Code or postal code   60601-9999                       AN      10
 Code                                       for the controller's
                                            primary address.
Controller Country                     X   Country code for the      U.S.                             AN       2
                                            controller's primary
                                            address
Controller E-mail                      X   E-mail address of the     James.Smith@tradingfirm.         AN     100
 Address (Person)                           account controller, if    com
                                            the account is
                                            controlled by a natural
                                            person.
Controller Type                        X   Describes the type of     F--Fund                          AN       1
                                            controller(s) listed on  C--CTA/CPO
                                            the respective account.
CFTC Firm ID                 X             CFTC provided firm        AN                                3
                                            identifier assigned to
                                            the firm.
Omnibus Account              X             Yes or No indicator to    Y--Omnibus                       AN       1
 Flag                                       denote the type of       N--Not Omnibus
                                            account
Trading Account              X         X   The day account was       YYYYMMDD--Date on which           N       8
 Effective Date                             established in the        the trading account is
                                            firm's back office        effective
                                            system.
Trading Account                            Expiration date/end date  YYYYMMDD--Date on which           N       8
 Expiration Date                            of the trading account.   the trading account has
                                            Could have a default of   expired
                                            99991231, denoting no
                                            expiration.
EFS Owner Exchange                         For member accounts, the  CME--Could optionally            AN       5
                                            exchange at which the     use ISO MIC.
                                            account owner holds a
                                            membership.
EFS Non-Member                             Indicator to denote if    Y--Indicates account is          AN       1
 Owned Indicator                            the account is fully      a joint account between
                                            member owned or if non-   a member and nonmember
                                            members are joint        N--Non-members do not
                                            owners on the account.    exist on the account
EFS Main Account                           Description of the group  Contains company name,           AN      40
 Description                                of accounts which often   trading group,
                                            includes the legal name   partnership, etc.
                                            of the 100% owned
                                            subsidiary. This is
                                            often referred to as
                                            ``Account Title''.
EFS Main Account                           Grouping/roll up account  Alphanumeric ID that             AN      20
 Number                                     that associates all       identifies the Fees
                                            trading accounts with     grouping account.
                                            the same account
                                            owners(s) and
                                            controller(s)
EFS Owner Type                             Describes the type of     I--Individual                    AN       1
                                            owner(s) listed on the   N--Non-Member
                                            respective account.      F--Firm
                                                                     J--Joint Account
EFS Owner Middle             X             Middle name or middle     R                                AN      15
 Name (Person) if                           initial of the account
 available                                  owner, if the owner is
                                            a natural person.
EFS Controller                         X   Middle name or middle     R                                AN      15
 Middle Name                                initial of the account
 (Person) if                                controller, if the
 available                                  controller is a natural
                                            person.
EFS Exchange                 X             Exchange Acronym          AN                                5
                                           CBT--Could optionally
                                            use ISO MIC.
EFS Clearing Firm            X             Clearinghouse assigned    999--Existing 3-5                AN       5
 Number                                     clearing firm number/     character firm code.
                                            firm number
EFS Clearing Firm            X             Clearing Firm Name        Name of the clearing             AN      60
 Name                                                                 firm
EFS Main Account                           Effective date/start      YYYYMMDD--Date on which           N       8
 Effective Date                             date of the main          the main account is
                                            account. Could            effective
                                            potentially be derived
                                            from the reporting of
                                            the change record.
EFS Main Account                           Expiration date/end date  YYYYMMDD--Date on which           N       8
 Expiration Date                            of the main account.      the main account has
                                            Could have a default of   expired
                                            99991231, denoting no
                                            expiration.
EFS Owner                                  Effective date/start      YYYYMMDD--Date on which           N       8
 Effective Date                             date of the owner         the owner was
                                            relationship to the       associated with the
                                            account. Could            account
                                            potentially be derived
                                            from the reporting of
                                            the change record.
EFS Owner                                  Expiration date/end date  YYYYMMDD--Date on which           N       8
 Expiration Date                            of the owner              the owner relationship
                                            relationship to the       has expired.
                                            account.
EFS Controller                         X   Effective date/start      YYYYMMDD--Date on which           N       8
 Effective Date                             date of the controller    the controller was
                                            relationship to the       associated with the
                                            account. Could            account
                                            potentially be derived
                                            from the reporting of
                                            the change record.
EFS Controller                             Expiration date/end date  YYYYMMDD--Date on which           N       8
 Expiration Date                            of the controller         the controller
                                            relationship to the       relationship has
                                            account.                  expired.
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