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







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

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

                                HEARING

                               BEFORE THE

                        COMMITTEE ON AGRICULTURE
                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                               __________

                            OCTOBER 12, 2011

                               __________

                           Serial No. 112-25









          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
SCOTT R. TIPTON, Colorado            WILLIAM L. OWENS, New York
STEVE SOUTHERLAND II, Florida        CHELLIE PINGREE, Maine
ERIC A. ``RICK'' CRAWFORD, Arkansas  JOE COURTNEY, Connecticut
MARTHA ROBY, Alabama                 PETER WELCH, Vermont
TIM HUELSKAMP, Kansas                MARCIA L. FUDGE, Ohio
SCOTT DesJARLAIS, Tennessee          GREGORIO KILILI CAMACHO SABLAN, 
RENEE L. ELLMERS, North Carolina     Northern Mariana Islands
CHRISTOPHER P. GIBSON, New York      TERRI A. SEWELL, Alabama
RANDY HULTGREN, Illinois             JAMES P. McGOVERN, Massachusetts
VICKY HARTZLER, Missouri
ROBERT T. SCHILLING, Illinois
REID J. RIBBLE, Wisconsin
KRISTI L. NOEM, South Dakota

                                 ______

                           Professional Staff

                      Nicole Scott, Staff Director

                     Kevin J. Kramp, Chief Counsel

                 Tamara Hinton, Communications Director

                Robert L. Larew, Minority Staff Director

                                  (ii)










                             C O N T E N T S

                              ----------                              
                                                                   Page
Conaway, Hon. K. Michael, a Representative in Congress from 
  Texas, submitted statement on behalf of Hon. Glenn English, 
  CEO, National Rural Electric Cooperatives Association..........   111
Lucas, Hon. Frank D., a Representative in Congress from Oklahoma, 
  opening statement..............................................     1
    Prepared statement...........................................     2
    Submitted legislation........................................     4
Owens, Hon. William L., a Representative in Congress from New 
  York, prepared statement.......................................    31
Peterson, Hon. Collin C., a Representative in Congress from 
  Minnesota, opening statement...................................    29
    Prepared statement...........................................    30
Stivers, Hon. Steve, a Representative in Congress from Ohio, 
  submitted letter...............................................    32

                               Witnesses

Cordes, Scott, President, Country Hedging, Inc., Inver Grove 
  Heights, MN; on behalf of National Council of Farmer 
  Cooperatives...................................................    33
    Prepared statement...........................................    34
Williams, Douglas L., President and Chief Executive Officer, 
  Atlantic Capital Bank, Atlanta, GA.............................    39
    Prepared statement...........................................    40
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.............    44
    Prepared statement...........................................    45
Giancarlo, J.D., J. Christopher, Executive Vice President--
  Corporate Development, GFI Group Inc.; Board Member, Wholesale 
  Markets Brokers Association, Americas, New York, NY............    51
    Prepared statement...........................................    53
Boultwood, Brenda L., Chief Risk Officer and Senior Vice 
  President, Constellation Energy, Baltimore, MD; on behalf of 
  Coalition for Derivatives End-Users............................    67
    Prepared statement...........................................    69
Thul, Todd, Risk Manager, Cargill AgHorizons, Minneapolis, MN; on 
  behalf of Commodity Markets Council............................    72
    Prepared statement...........................................    73

                           Submitted Material

American Bankers Association, submitted statement................   113
Independent Community Bankers of America, submitted statement....   117

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

                              ----------                              


                      WEDNESDAY, OCTOBER 12, 2011

                          House of Representatives,
                                  Committee on Agriculture,
                                                   Washington, D.C.
    The Committee met, pursuant to call, at 10:08 a.m., in Room 
1300 of the Longworth House Office Building, Hon. Frank D. 
Lucas [Chairman of the Committee] presiding.
    Members present: Representatives Lucas, Goodlatte, Johnson, 
Neugebauer, Conaway, Schmidt, Stutzman, Gibbs, Austin Scott of 
Georgia, Tipton, Crawford, Gibson, Hultgren, Hartzler, 
Schilling, Ribble, Noem, Peterson, Holden, McIntyre, Boswell, 
Baca, David Scott of Georgia, Costa, Schrader, Owens, Courtney, 
Fudge, Sewell and McGovern.
    Staff present: Tamara Hinton, Kevin Kramp, Josh Mathis, 
Ryan McKee, Nicole Scott, Debbie Smith, Heather Vaughan, 
Suzanne Watson, Liz Friedlander, C. Clark Ogilvie, Anne 
Simmons, John Konya, and Caleb Crosswhite.

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

    The Chairman. This hearing of the Committee on Agriculture 
to review legislative proposals amending Title VII of the Dodd-
Frank Wall Street Reform and Consumer Protection Act will come 
to order.
    I want to thank all of you for joining us today and to our 
witnesses, each of whom traveled to appear before our 
Committee, and I would like to thank the many Members of this 
Committee on both sides of the aisle who have worked so hard in 
preparing legislation for us to consider today.
    This is the seventh hearing we have had regarding Title VII 
of the Dodd-Frank Wall Street Reform and Consumer Protection 
Act. We have heard from over 30 market participants from a wide 
range of organizations. In the course of those seven hearings, 
we have gathered a good deal of information on how the 
implementation of Dodd-Frank is affecting businesses across the 
country. We have heard that some regulations may impose 
significant costs that aren't being accounted for by the CFTC. 
We have heard that Congressional intent on many proposals 
including margin exemptions for end-users has not been adhered 
to. We have heard confusion about the order of regulations 
being proposed and concern about the scope of the regulatory 
definitions, and most importantly, we have heard from 
businesses that are concerned that some Dodd-Frank regulations 
will actually inhibit their ability to manage risk. That runs 
contrary to the purpose of Dodd-Frank, which was to increase 
stability and transparency in our financial markets. So today 
we will consider seven legislative proposals aimed at fixing 
some important areas in implementation where the regulators, my 
friends at CFTC in particular, simply haven't gotten it right.
    Now, none of these bills propose dramatic changes to Dodd-
Frank. They are aimed at ensuring that the regulators don't 
implement rules that conflict with, or are contrary, to what 
Congress intended. They do not undermine reform and they are 
not efforts to repeal Dodd-Frank. They are intended to restore 
the balance that I believe can exist between sound regulation 
and a healthy economy.
    Some may say that looking at legislative remedies is 
premature, that we should wait until the rules are finalized 
and let the regulators improve upon the proposed rules. It is 
my sincere hope that the rules improve. It is my hope that the 
agencies will listen to the comments that have been filed and 
to the feedback they have gotten from market participants and 
from Congress. But with unemployment stuck at nine percent, I 
am not willing to just stand by and keep my fingers crossed, so 
to speak, that the flaws in the proposed rules will be fixed. 
We are facing widespread and potentially severe unintended 
consequences from these regulations, and that will potentially 
have a dire effect on our economic recovery. When the rules are 
final, let us face it, they are final, and businesses across 
the country including farmers and ranchers need to prepare for 
the new regulations and related costs now. They will not be 
able to wait for Congress to act.
    I would also note that we will consider three discussion 
drafts today. I welcome and encourage feedback from our 
witnesses and Members on this Committee about ways in which we 
can and should improve upon these proposals. They are aimed at 
making sure that an overly broad swap dealer definition doesn't 
encumber our energy and ag sectors, that our pensions and 
government entities do not face prohibitive burdens when 
accessing swap markets, and that small financial institutions 
and farm credit banks can continue to pair credit with risk-
mitigating tools. All of these proposals aim to keep capital in 
the hands of businesses that we need to lead our economic 
recovery.
    Thank you again for coming here today. I look forward to 
hearing from our witnesses.
    [The prepared statement of Mr. Lucas follows:]

Prepared Statement of Hon. Frank D. Lucas, a Representative in Congress 
                             from Oklahoma
    Thank you for joining us today, and to our witnesses, each of whom 
traveled to appear before our Committee.
    I'd also like to thank the many Members of this Committee--on both 
sides of the aisle--who have worked so hard in preparing legislation 
for us to consider today.
     This is the seventh hearing we've had regarding Title VII of the 
Dodd-Frank Wall Street Reform and Consumer Protection Act. We've heard 
from over 30 market participants, from a wide range of organizations.
    In the course of those seven hearings, we've gathered a good deal 
of information on how the implementation of the Dodd-Frank Act is 
affecting businesses across the country.
    We've heard that some regulations may impose significant costs that 
aren't being accounted for by the CFTC.
    We've heard that Congressional intent on many proposals, including 
a margin exemption for end-users, has not been adhered to.
    We've heard confusion about the order of regulations being proposed 
and concern about the scope of regulatory definitions.
    And most importantly, we've heard from businesses that are 
concerned that some Dodd-Frank regulations will actually inhibit their 
ability to manage risk.
    That runs counter to the purpose of Dodd-Frank, which was to 
increase stability and transparency in our financial markets.
    So today, we will consider seven legislative proposals aimed at 
fixing some important areas in implementation where the regulators--the 
CFTC in particular--simply haven't gotten it right.
    None of these bills propose dramatic changes to Dodd-Frank. They 
are aimed at ensuring that the regulators don't implement rules that 
conflict with, or are contrary to, what Congress intended.
    They do not undermine reform, and they are not efforts to repeal 
Dodd-Frank.
    They are intended to restore the balance that I believe can exist 
between sound regulation and a healthy economy.
    Some may say that looking at legislative remedies is premature--
that we ought to wait until the rules are finalized and let the 
regulators improve upon the proposed rules.
    It is my sincere hope the rules improve. It is my hope that the 
agencies will listen to the comments that have been filed, and to the 
feedback they've gotten from market participants and from Congress.
    But with unemployment stuck at nine percent, I'm not willing to 
just stand by and keep my fingers crossed that the flaws in the 
proposed rules will be fixed.
    We are facing widespread and potentially severe unintended 
consequences from these regulations, that will have a direct effect on 
our economic recovery.
    When the rules are final, they're final. And businesses across the 
country, including our farmers and ranchers, need to prepare for the 
new regulations and related costs now. They will not be able to wait 
for Congress to act.
    I'd also note that we will consider three discussion drafts today. 
I welcome and encourage feedback from our witnesses and the Members on 
this Committee about ways in which we can and should improve upon these 
proposals.
    They are aimed at making sure that an overly broad swap dealer 
definition doesn't encumber our energy and agriculture sectors, that 
our pensions and government entities do not face prohibitive burdens 
when accessing swaps markets, and that small financial institutions and 
farm credit banks can continue to pair credit with risk mitigating 
tools.
    All of these proposals aim to keep capital in the hands of the 
businesses we need to lead our economic recovery.
    Thank you again for being here today, and I look forward to hearing 
from our witnesses.
                              Legislation
H.R. 1840, To improve consideration by the Commodity Futures Trading 
        Commission of the costs and benefits of its regulations and 
        orders. 
        
        
        
H.R. 2586, Swap Execution Facility Clarification Act 



H.R. 2682, Business Risk Mitigation and Price Stabilization Act of 2011




H.R. 2779, To exempt inter-affiliate swaps from certain regulatory 
        requirements put in place by the Dodd-Frank Wall Street Reform 
        and Consumer Protection Act.
        
        
        
                           Draft Legislation
H.R. __, Pension Plan Risk Reduction Act of 2011



H.R. __, Small Business Credit Availability Act



H.R. __, To amend the Commodity Exchange Act to clarify the definition 
        of swap dealer.
        
        
        

    The Chairman. And now I turn to the Ranking Member, the 
outstanding gentleman from Minnesota, for any comments he may 
have.

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

    Mr. Peterson. Thank you, Mr. Chairman, and thank you for 
calling this hearing.
    You know, we hear a lot of talk about concern that we need 
to see the big picture and we need to have certainty with these 
regulations and so forth. But, I would argue that what we are 
doing here to some extent is actually adding to the uncertainty 
and not necessarily focusing on what the real problems are. I 
understand that the House needs to move but the reality is that 
these bills are not going anyplace in the Senate. I think they 
just muddy the water, and frankly, some of the bills don't fix 
the problems that are some of the most significant problems 
that are not being caused by the CFTC, they are actually being 
caused by the Prudential Regulators. For example, the end-user 
issue which we tried to address in the bill and tried to make 
sure that end-users were not going to be subject to cash 
margins, the reason there is a cash margin issue is not because 
of the CFTC, it is because of the Prudential Regulators who are 
requiring their banks to have cash margins in the rules that 
they have adopted, which this Committee has no jurisdiction 
over. I am also told that apparently the Prudential Regulators 
have the authority to do this and had the authority prior to 
the passage of Dodd-Frank. So even if we repeal Dodd-Frank, the 
Prudential Regulators would have the authority to require the 
banks to have cash margin requirements on their counterparties.
    So one of the questions I have is, we have had seven 
hearings but we have not had the Prudential Regulators in and 
we have not had the SEC in in those seven hearings. Now, when I 
was Chairman, we had them in because they are part of the issue 
here. You know, the other thing that happened in Dodd-Frank is 
there was an agreement that they were going to work together, 
and I would argue that part of the challenge that they are 
having at the CFTC is trying to work in conjunction with the 
SEC. The SEC is still largely a dysfunctional agency that is 
operating 50 years ago with a rules-based regulatory system 
that is never going to keep pace with what is going on today in 
the financial community.
    So I would ask you, Mr. Chairman, to consider holding a 
hearing where we get the Prudential Regulators in and the SEC 
and the CFTC so we can talk about the problems that are being 
caused by trying to harmonize these rules. Now, we also have a 
situation where they are trying to harmonize these rules with 
Europe, which is an even bigger challenge, and that is entering 
into all of this stuff.
    Some of these bills are focused on issues that I am 
concerned about. I am not sure they are going to fix the 
problem. You know, we have problems being put on this country 
by what is going on in Europe, which is a mystery to me. It 
looks like a setup deal going on there. The entire economy of 
Greece is $260 billion. There is no way that the economy of 
Greece is going to take down this financial market by itself. 
And now, where we have had these dire warnings that the whole 
world is going to collapse because of Greece, it looks to me 
like they are trying to force Europe into a TARP kind of a 
deal, a panic kind of a deal similar to what happened in the 
United States. Yesterday when probably the most significant 
item that happened was when Slovakia voted down the deal in 
Europe--where is it? On the Internet this morning it is in the 
business section, the third one down. So why is it that Greece 
is the lead story every time but all of a sudden we are going 
to bury the thing that is actually the problem? I mean, I just 
wonder what the heck is going on here.
    So these bills, the first bill that is here, this cost-
benefit analysis by Mr. Conaway, I think it is a good bill. It 
codifies the Executive Order. But I have a bill, H.R. 3010, 
that I am a cosponsor of that actually goes much further, that 
is comprehensive, that doesn't just do it in the CFTC but does 
it in the whole government. We have other bills here that are 
trying to fix some of these definitions that are not finalized 
at this point. We have a bill on inter-affiliate swaps that 
appears to me would give the Wall Street guys a way to set up 
subsidiaries to get around these rules.
    So my point is, we just have to be careful about what we 
are doing here. I think we are sending signals out there--I 
have had people in my office that think that somehow or another 
this is all going to happen. I don't think any of this stuff is 
going to happen in the Senate.
    So I would just encourage this Committee to take a step 
back, take a look at the big picture, get the folks, everybody 
in the room here that is involved in this. As I have said from 
the start, if there is a way to fix some of these problems that 
is within our jurisdiction and we can actually get done, I am 
all for it, but frankly, in a lot of cases, some of these bills 
will do more harm than good.
    So with that tirade, I will yield back.
    [The prepared statement of Mr. Peterson follows:]

  Prepared Statement of Hon. Collin C. Peterson, a Representative in 
                        Congress from Minnesota
    Thank you Mr. Chairman. This is the seventh hearing this Committee 
has held concerning the Dodd-Frank Act. Today, we are hearing from 
witnesses regarding several bills that have been introduced or may be 
introduced or considered by this Committee to amend that law.
    As I have said at previous hearings, I believe amending Dodd-Frank 
is premature. The Commodity Futures Trading Commission has not 
finalized many of the rules that concern the issues we are discussing 
today. We should wait to see the final rules and if the CFTC gets them 
right or wrong before acting. If regulators don't implement the law as 
we intended, if they screw things up, I stand ready to help with 
legislative fixes. However, we need to give the regulators the 
opportunity to get things right.
    The Committee risks jeopardizing our credibility if we take a 
`Chicken Little' approach and pass legislation to fix problems that 
fail to materialize.
    That being said the Commission is on tap to vote on many of its 
proposed rules in the coming months. Therefore, I believe today's 
hearing is appropriate so the Committee may respond quickly should the 
CFTC ignore common sense and finalize a faulty rule.
    The legislative proposals under discussion this morning attempt to 
address a wide range of fears expressed by market participants at our 
earlier hearings. Some of these legislative proposals might work, 
others may not fix the problem at all and still others would create 
regulatory loopholes for the Wall Street banks so large you could drive 
a combine through them.
    I sympathize with the concerns we have already heard, and will hear 
yet again today, from our witnesses. These are not the folks who caused 
the 2008 financial collapse and subsequent recession. However, if the 
so-called solutions to their concerns weaken the law to permit another 
financial catastrophe, they will not get my support.
    Many of these legislative proposals attempt to address concerns 
that involve other regulators. For some reason, however, the Committee 
refuses to bring them in to testify. Our witnesses today will address 
the proposed margin rules by the Prudential Regulators, such as the 
Federal Reserve, but why haven't these regulators been brought before 
the Committee to answer our questions?
    We will also hear concerns regarding the consistency of rules 
between regulators, particularly the CFTC and the SEC, and the 
definitions which must be developed jointly by the CFTC and the SEC. 
When is Mary Schapiro, the SEC Chairman, scheduled to testify about 
these matters?
    In previous Congresses, we brought all the regulators before the 
Committee prior to moving on legislation that involved them. Why has 
the majority abandoned this practice?
    I believe it is imperative that the Committee's next hearing on 
this topic bring together the CFTC, SEC and Prudential Regulators to 
testify and answer our questions before the Committee moves forward on 
these legislative proposals. To do otherwise would be legislative 
malpractice and a disservice not only to ourselves, but to the 
witnesses here today and from previous hearings who have 
understandable, if premature, concerns
    Ultimately, I believe the CFTC is taking its time to get this 
right. And perhaps that is what some people are afraid of--that a 
regulator can listen to the public and respond appropriately. Maybe 
that is why many in the Republican Congressional leadership still seem 
dedicated to a total repeal of Dodd-Frank. They are afraid the law 
could succeed. Time will ultimately tell, but I'm holding out hope.
    I want to welcome our witnesses here today and with that Mr. 
Chairman, I yield back.

    The Chairman. The Ranking Member yields back, and the chair 
has always appreciated the Ranking Member's insights.
    With that, I would request that other Members submit their 
opening statements for the record so the witnesses may begin 
their testimony and to ensure that there is ample time for 
questions.
    [The prepared statement of Mr. Owens and submitted letter 
of Mr. Stivers follow:]

   Prepared Statement of Hon. William L. Owens, a Representative in 
                         Congress from New York
    I would like to thank Chairman Lucas and Ranking Member Peterson 
for their hard work on this issue. Over the last year, I have heard 
from many groups in my district that are concerned that the CFTC's 
proposed ``swap dealer'' definition would unfairly capture commercial 
energy companies, agricultural cooperatives and community banks, 
electric cooperatives and farm credit system institutions.
    Congress included two exceptions from the ``swap dealer'' 
definition in Dodd-Frank that were intended to exclude these entities 
from falling into this regulatory category. The first exception relates 
to the entity's transacting in a dealing capacity ``as a part of a 
regular business.'' In other words, because none of the witnesses here 
represent companies that engage in swap activity as their main or usual 
business, but rather use swaps to hedge their business risk, 
Congressional intent is clear--they should be exempt from these 
regulations. The second exception is the de minimis exception, which 
gives the CFTC broad discretion in determining which entities are 
exempt. Very few entities would qualify for the very low threshold in 
the proposal, which only exempts entities that engage in fewer than 
twenty swaps a year.
    In July, 71 of my colleagues joined Congressman Conaway and me in 
sending a letter to Chairman Gensler asking for clarification of the 
Commission's proposal. The Chairman's response indicated that the 
Commission is ``committed to implementing the statutory definition and 
closely following Congressional intent,'' but there was little 
explanation given regarding the discrepancies between the proposal and 
Congressional intent.
    As a cosponsor of H.R. 2682, I believe this legislation is 
necessary to ensure that the CFTC implements the intent of Congress in 
exempting true end-users from derivatives regulations. If forced to 
comply with the increased requirements for posting capital and margin, 
reporting requirements, record keeping and other regulations, the 
services currently offered by end-users could become cost prohibitive, 
impeding their ability to conduct business, resulting in higher prices 
for my constituents, and diverting of capital that could otherwise be 
invested in their business and used to help create jobs.
    These financial instruments are particularly important for dairy 
farmers in my district, who depend on their cooperatives for tools to 
manage price risk and lock in margins. For example, a dairy farmer 
might want to get a guaranteed price on future deliveries of milk from 
his co-op, but might be concerned that input costs for corn and soybean 
meal will fluctuate, cutting into expected returns. By purchasing a 
financially settled swap from their co-op, the dairy farmer can hedge 
his or her input costs, while receiving a guaranteed price for their 
milk. Without the co-op, the farmer would have to go to a futures 
exchange to hedge their input costs. The farmer would have to post 
margin and buy contracts that are larger than the volume of his feed 
needs and don't necessarily correspond with the farmer's monthly 
purchases. The co-op is able to aggregate the small contracts with its 
dairy farmers and then offset its exposure either in the futures market 
or with a more customized product in the swaps market.
    The derivatives market needs to be better regulated and certain 
participants need to post margin to cover these trades. However, this 
legislation is needed to ensure that community banks, agricultural 
coops, energy utilities, community banks and other end-users can 
continue to hedge against risk. It is imperative that we move forward 
with this legislation and I respectfully request that the other Members 
of this Committee support this bipartisan effort.
                                 ______
                                 
 Submitted Letter by Hon. Steve Stivers, a Representative in Congress 
                               from Ohio
    Dear Mr. Chairman:

    I have introduced, along with our colleague Ms. Fudge, H.R. 2779, 
which is set for a legislative hearing in your Committee today. The 
purpose of this legislation is simple and straightforward. The Federal 
Government should not penalize companies of any size by over-charging 
them for the way in which they do business.
    Regulators under Dodd-Frank were given broad authority to issue 
rules and regulations for reforming our nation's financial system, and 
there is a fear that those regulators will draft proposals that will 
decentralize the financial business model used by American corporations 
across the country and around the world.
    Inter-affiliate swap contracts are an accounting method used to 
assign ownership to a contract which has been collateralized by another 
corporate affiliate which aggregates risk across multiple companies, 
thus providing a method for managing that risk more efficiently. 
Companies that establish financial service corporations for the 
purposes of aggregating risk do so because it allows them to centralize 
financial transactions and utilize the skills and knowledge of 
financial experts who manage complicated financial transactions every 
day.
    Without this bill, the government could intrude into how businesses 
manage their finances by regulating even internal swaps transactions 
that do not create systemic risk. The legislation your Committee is 
discussing today provides an exemption for any swap contracts between 
two companies that are either in a parent-subsidiary relationship, or 
are under common control. In no way does it preclude the oversight or 
regulation of transactions between the parent company and the 
marketplace. This bill would simply prevent those companies employing a 
business structure, which allows it to manage risk more efficiently, 
from being charged twice or three times as much.
    I look forward to continuing to work with you and our fellow 
colleagues on this important issue.

    I would like to welcome our panel of witnesses to the 
table: Mr. Scott Cordes, President, Country Hedging, for the 
National Council of Farmer Cooperatives; Mr. Douglas Williams, 
President and Chief Executive Officer, Atlantic Capital Bank; 
Bella Sanevich, General Counsel, NISA Investment Advisors, for 
the American Benefits Council; Mr. Chris Giancarlo, Executive 
Vice President, GFI Group, for the Wholesale Markets Brokers 
Association, Americas; Brenda Boultwood, Chief Risk Officer and 
Senior Vice President, Constellation Energy for the Coalition 
for Derivatives End-Users; and Todd Thul, Risk Manager, Cargill 
AgHorizons for the Commodity Market Council.
    Mr. Cordes, please begin when you are ready, sir.

         STATEMENT OF SCOTT CORDES, PRESIDENT, COUNTRY
 HEDGING, INC., INVER GROVE HEIGHTS, MN; ON BEHALF OF NATIONAL 
                 COUNCIL OF FARMER COOPERATIVES

    Mr. Cordes. Chairman Lucas, Ranking Member Peterson and 
Members of the Committee, thank you for holding this hearing on 
proposed legislation to amend the Dodd-Frank Act.
    I am Scott Cordes, President of Country Hedging, a 
commodity brokerage subsidiary of CHS Inc. CHS is an energy, 
grains and food cooperative owned by approximately 55,000 
individual farmers and ranchers and approximately 1,000 local 
cooperatives. CHS is proud to be a member of the National 
Council of Farmer Cooperatives, and I am here today to testify 
on behalf of NCFC.
    Farmer cooperatives are an important part of success of 
American agriculture. By providing commodity price risk 
management tools to their member-owners, farmer co-ops help 
mitigate commercial risk in the production, processing and 
marketing of a broad range of agriculture, food and energy 
products.
    Please refer to my written statement for the record for 
greater details but at this time I would provide comment on 
four key provisions NCFC believes are critical to preserving 
risk management tools for farmers and their cooperatives.
    We ask for your support of the following. One, treat 
agriculture cooperatives as end-users. Two, exclude agriculture 
cooperatives from the definition of swap dealer. Three, 
consider the aggregate costs associated with new regulations 
that impact agriculture. And four, maintain a bona fide hedge 
definition that includes common commercial hedging practices.
    The end-user exemption: First and foremost, agriculture 
cooperatives should be treated as end-users because they 
aggregate the commercial risk of their individual farmer-
members. Due to market volatility in recent years, cooperatives 
are increasingly using swaps to better managing their exposure 
by customizing their hedges. The practice increases the 
effectiveness of risk mitigation and reduces cost to 
cooperatives, their farmer owners and customers. At CHS, 
entering into commodity swaps frees up working capital. This 
allows us to continue forward contracting grain from farmers. 
Therefore, we are concerned with the so-called Prudential 
Regulators market proposal that requires bank swap dealers to 
collect margin from end-users. We fear this would negatively 
affect our ability to continue offering forward contracts. We 
also fear mandatory margin would increase costs to hedging 
operations and ultimately discourage prudent hedge operations 
and practices. Congressional intent was clear on this point. 
End-users were not to be required to post margin. We support 
legislation that would reaffirm this intent.
    Swap dealer definition: The uncertainty created by the 
entity definition rules is NCFC's greatest concern as 
implementation continues. Specifically, we believe agriculture 
cooperatives should not be defined as swap dealers, and we 
support legislation to further clarify what entities would be 
classified and regulated as such. The proposed legislation 
clarifies swap dealers do not include those using swaps to 
hedge or which enter into swaps ancillary to one's business. It 
also provides for a commercially meaningful threshold under the 
de minimis exception. This would ensure there are options for 
hedgers to find commercial swap counterparties. However, some 
cooperatives are at risk of being designated as a swap dealer 
due to their unique structure. Unlike a traditional corporation 
structure, cooperatives look to transfer risk from the local 
level to the federated affiliated cooperative. Using swaps as a 
tool to transfer risk should not lead them to be defined as 
dealers. We are very interested in having those transactions 
addressed in the proposed inter-affiliate legislation.
    Regulatory costs to agriculture: As you know, agriculture 
is a high-volume, low-margin industry. Incremental increases in 
cost will trickle down and affect producers. Taken one rule at 
a time, the cost may not seem unreasonable, but to those who 
have to absorb or pass on collective costs of numerous 
regulations, it is evident those costs are significant. We 
encourage this Committee to seek a more thorough analysis to 
consider the aggregate affect of these regulatory actions.
    Bona fide hedge definition: Finally, we advocate 
maintaining a bona fide hedge definition that includes common 
commercial hedging practices. I bring this issue to your 
attention as the Commission is scheduled to vote on this rule 
in the near future. I would encourage the Committee to take a 
close look at the definition when the final rule is issued.
    In conclusion, we ask that you consider those four points I 
outlined above. Thank you again for the opportunity to testify 
today before the Committee on behalf of farmer-owned 
cooperatives. I look forward to answering any questions you may 
have. Thank you.
    [The prepared statement of Mr. Cordes follows:]

 Prepared Statement of Scott Cordes, President, Country Hedging, Inc., 
    Inver Grove Heights, MN; 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. I am pleased to 
be here representing the National Council of Farmer Cooperatives (NCFC) 
and provide input on the key issues concerning implementation of the 
Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank 
Act) as well as potential legislative reforms this Committee may take 
under consideration in the near future.
    I am Scott Cordes, President of Country Hedging, a commodity 
brokerage subsidiary of CHS Inc. CHS is a farmer-owned energy, grains 
and foods cooperative committed to providing essential resources that 
enrich lives around the world. CHS is owned by approximately 55,000 
individual farmers and ranchers who own shares by selling us grain 
directly or as customer-owners of one of five dozen CHS Country 
Operations retail units. We are also owned by about 1,000 local 
cooperatives who represent another 350,000 producers. You might also be 
interested to know I grew up on a grain and dairy farm in Southeastern 
MN that my brother still operates today.
    I also serve on NCFC's 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 CHS farmer-owners, and more broadly 
the more than two million farmers and ranchers who belong to farmer 
cooperatives, I thank the Committee for holding this hearing to discuss 
proposed legislation to amend the Dodd-Frank Act.
    Farmer cooperatives--businesses owned, governed and controlled by 
farmers and ranchers--are an important part of the success of American 
agriculture. This ownership structure that has served CHS owners well 
for 80 years helps individual family farmers and ranchers thrive 
despite the ups and downs of weather, commodity markets, and 
technological change. Through their cooperatives, producers are able to 
improve their income from the marketplace, manage risk, and strengthen 
their bargaining power, allowing farmers to compete globally in a way 
that would be impossible to replicate as individual producers. 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 and improving rural economies.
    In particular, by providing commodity price risk management tools 
to their member-owners, farmer cooperatives help mitigate commercial 
risk in the production, processing and selling of a broad range of 
agricultural and food products. America's farmers and ranchers must 
continue to have access to new and innovative risk management products 
that enable them to feed, clothe and provide fuel to consumers here at 
home and around the world. Any regulatory action that could jeopardize 
access to these tools should be avoided.
    As such, we have been working to ensure that the implementation of 
the Dodd-Frank Act preserves risk management tools for farmers and 
their cooperatives.
    During the rulemaking process, NCFC has advocated for the 
following:

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

   Exclude agricultural cooperatives from the definition of a 
        swap dealer;

   Consider aggregate costs associated with the new regulations 
        and the impact on the agriculture sector; and

   Maintain a bona fide hedge definition that includes common 
        commercial hedging practices.

    Even though it has been more than a year since the Dodd-Frank Act 
was signed into law, we are still uncertain as to how farmer 
cooperatives will be classified and what regulations they will be 
subject to. The resulting uncertainty has put business plans on hold 
and has delayed investment to increase the capacity for cooperatives to 
expand their risk mitigation services.
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. Due to market 
volatility in recent years, cooperatives are increasingly using OTC 
products to better manage their exposure by customizing their hedges. 
This practice increases the effectiveness of risk mitigation and 
reduces costs to the cooperatives and their farmer-owners.
    OTC derivatives are not just used for risk management at the 
cooperative level. They also give the cooperative the ability to 
provide customized products to smaller local cooperatives and 
individual farmer-members to help them better manage their risk and 
returns. Much like a supply cooperative leverages the purchasing power 
of many individual producers, or a marketing cooperative pools the 
production volume of hundreds or thousands of growers, a cooperative 
can aggregate its members-owners' commodity price risk. It can then 
offset that risk with a futures contract or by entering into another 
customized hedge via the swap markets.
    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 
        swap with an affiliated cooperative in a regional or federated 
        system.

   Since most individual farmers do not have the demand 
        necessary to warrant a standard 42,000 gallon monthly NYMEX 
        contract, individual farmers can hedge their fuel costs by 
        entering into swaps in 1,000 gallon increments through the co-
        op.

   Local supply cooperatives use swaps to mitigate their price 
        risk in both crop nutrients and propane.

   Cooperatives facilitate hedging for dairy farmers by 
        offering a fixed price for their milk and a swap to hedge their 
        feed purchases. Dairy cooperatives also use swaps to offset the 
        risk of offering forward contracts to their farmers, as well as 
        to hedge the risk of offering forward price sales contracts to 
        their customers.

   Cooperatives offer livestock producers customized contracts 
        at non-exchange traded weights to better match the 
        corresponding number of animal units they have while also 
        reducing producers' financial exposure to daily margin calls.

    While my colleagues from dairy or 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 CHS member-owners. We enter into 
OTC derivatives to hedge the price risk of commodities that we 
purchase, supply, process or handle for our members.
    Swaps also play a critical role in the ability of cooperatives to 
provide forward contracts, especially in times of volatile markets. 
Because commodity swaps are not currently subject to the same margin 
requirements as the exchanges, cooperatives can use them to free up 
working capital.
    For example, considerable amounts of working capital have been tied 
up to cover daily margin calls as a result of increased volatility in 
grain and oilseed markets. For farmers to continue to take advantage of 
selling grain forward during price rallies, cooperatives have to either 
increase borrowing or look for alternative ways to manage such risk. 
Using the OTC market has become that alternative. In 2008, 
multinational grain companies were running out working capital due to 
extreme grain volatility. CHS was able to enter into swaps to free up 
working capital so that it could continue to contract and forward price 
grain with its members. As was the case during the volatile markets in 
2008, swaps today allow cooperatives to free up working capital and 
continue to forward contract with farmers.
Definition of Swap Dealer
    The uncertainty created by the ``definitions'' rules is NCFC's 
greatest concern as implementation continues. While the CFTC has 
proposed regulations for swaps and swap dealers, it is unclear to us 
who, or what transactions, will be subjected to those additional 
regulations. As the rule was proposed, some activities of cooperatives 
such as those previously mentioned would appear to push cooperatives 
into the ``swap dealer'' category.
    Regulating farmer cooperatives as dealers would increase 
requirements for posting capital and margin on swaps it uses with other 
dealers to offset the risk of providing risk management products and 
services to its members and customers. This requirement, combined with 
the cost of complying with other regulatory requirements intended for 
large financial institutions, could make providing those services to a 
cooperative's member-owners uneconomical. Such action would result in 
the unintended consequence of increasing risk in the agricultural 
sector. In addition, it would severely limit the number of non-
financial entities that could provide risk management tools in the form 
of financially settled instruments (swaps).
    The two main issues in the proposed rule are the application of the 
``interpretive approach for identifying whether a person is a swap 
dealer,'' and the very low thresholds on the ``de minimis exception.'' 
As such CFTC would likely capture a number of entities, including 
farmer cooperatives, which were never intended to be regulated as swap 
dealers. Yet farmer cooperatives do not resemble what is generally and 
commonly known in the trade as a swap dealer--ones that profit from the 
spread between the buying and selling of swaps. Cooperatives are not 
driven by that profit motive, but rather are hedging, or assisting 
their members and customers in hedging the price risks inherent to the 
agriculture industry. Farmer cooperatives mitigate risk as opposed to 
others in the marketplace who take on risk for profit.
    Therefore, we support legislation to clarify what entities would be 
classified and regulated as swap dealers. The proposed legislation 
clarifies that swap dealers do not include those using swaps to hedge, 
or which enter into swaps ancillary to one's business as a producer, 
processor, or commercial user of a commodity. Both of those ``prongs'' 
capture the essence of farmer cooperatives' and their members' 
utilization of swaps. By providing for a commercially meaningful 
threshold under the ``de minimis exception,'' the bill would ensure 
there are options for hedgers to find commercial swap counterparties 
other than just financial entities.
    Further, some cooperatives, such as CHS, are currently at risk of 
being designated as swap dealers due to their unique structure. For 
example, a federated grain or farm supply cooperative is owned by many 
local cooperatives which are separate business entities. Unlike a 
traditional corporate structure where risk can be transferred 
internally, the ability to transfer risk from the local level to the 
federated cooperative--in this case in the form of a swap--is treated 
as an external transaction under the draft rules. Thus we are very 
interested in having those transactions addressed in the ``inter-
affiliate'' legislation introduced by Representatives Marcia Fudge and 
Steve Stivers. While their legislation as introduced is specific to 
affiliate transactions between parties under common control, the same 
justification can be made for similar transactions between affiliated 
cooperatives and their affiliated member-owners. Because of the bottom-
up ownership structure of a cooperative, the affiliates are not under 
``common control'' of the larger cooperative. Therefore, we would like 
to see an additional provision included in this legislation to include 
transactions between a cooperative and its member-affiliates, taking 
into account the differing structure of cooperative ownership from that 
of a traditional corporate entity.
    Many agricultural cooperatives, like CHS, borrow from CoBank, which 
is also a cooperative. We are concerned that CFTC would classify CoBank 
as a swap dealer because CoBank sells swaps to its customers in 
conjunction with providing loans. Congress specifically exempted these 
types of swaps from qualifying a commercial bank as a swap dealer. The 
exemption, however, was inadvertently limited only to ``insured 
depository institutions,'' and as a Farm Credit System institution, 
CoBank is not an insured depository institution. We urge CFTC to ensure 
CoBank's swaps are treated the same as other regulated lenders and do 
not qualify the bank as a swap dealer. Otherwise, our co-op, as well as 
others like us who borrow from CoBank, will be penalized.
Cost-Benefit Analysis
    Agriculture is a high-volume, low-margin industry. Incremental 
increases in costs, whether passed on from a swap dealer or imposed 
directly on a cooperative, will trickle down and affect producers. It 
is important to keep in mind the aggregate costs associated with the 
many new regulations and the implications it will have for the 
agriculture sector. Taken one rule at a time, the costs may not seem 
unreasonable to those who are writing the rules. But to those who have 
to absorb or pass on the collective costs of numerous regulations, it 
is clearly evident those costs are significant. While the Commission 
believes it is doing its due diligence in providing cost-benefit 
analyses of the regulations it is proposing, we think better analysis 
is called for to consider their aggregate effect.
    For example, one so-called ``small'' change in the regulations is 
contained in the conforming amendments proposed rule and has to do with 
additional recording requirements. We are concerned this proposal would 
not only add swaps to the new recordkeeping requirements, but also 
extend the new requirements to cash purchase and forward cash contracts 
entered into by any member of a designated contract market (DCM).
    As a result, all farmer cooperatives that are members of DCMs 
(Chicago Mercantile Exchange, Kansas City Board of Trade, Minneapolis 
Grain Exchange, etc.), and by extension every one of their local 
facilities, to be bound by this regulation. Farmer cooperatives that 
are members of DCMs have an integrated network of grain elevators to 
originate and store grain purchased from farmers. The proposed change 
would require those elevators to record, among other things, all oral 
communications (telephone, voicemail, facsimile, instant messaging, 
chat rooms, electronic mail, mobile device or other digital or 
electronic media) that lead to execution of cash transactions with 
farmers. In addition, each transaction record must be maintained as a 
separate electronic file identifiable by transaction and counterparty 
and kept for 5 years.
    While some traders now record certain conversations in order to 
provide a record of order execution, the CFTC's proposal would require 
employees at hundreds of operations to record all face-to-face and 
phone conversations with farmers, even when tape recording has never 
been their practice in the past. Such a requirement would impose huge 
regulatory burdens and costs on cooperatives and other businesses and 
farmers in rural America. For example, CHS buys grain at over 350 grain 
elevators across the United States. To install and maintain such 
recordkeeping systems would cost us over $6 million. In fact, the 
necessary investment to put in place and maintain such a system would 
not only greatly add to the cost of doing business, but would be an 
extreme compliance burden for the cash grain community. Since farmers 
would not be too keen having all their marketing conversations recorded 
and kept for 5 years, this would penalize those who are members of DCMs 
relative to other facilities. For those reasons, we believe this will 
have a net effect of driving grain industry participants to drop their 
membership in the exchanges. Further, we do not believe this regulatory 
burden is necessary to achieve the stated goals in the cash commodity 
markets. I would note that this ``small'' change tucked into one of the 
thousands of pages of proposed rules was not called for under the Dodd-
Frank Act but rather has been initiated by the CFTC.
End-User Exemption From Margin Requirements
    Consistent with Congressional intent, NCFC supports the CFTC's 
proposed rules to clarify that it ``would not impose margin 
requirements on non-financial entities,'' and that ``parties would be 
free to set initial and variation margin requirements in their 
discretion and any thresholds agreed upon by the parties would be 
permitted.'' Farmer cooperatives are an extension of their members who 
are end-users. By extension, a farmer cooperative should also be an 
end-user.
    However, we are concerned the so-called ``Prudential Regulators'' 
margin proposal requires bank swap dealers to collect margin from end-
users. As I noted earlier, swaps play a critical role in the ability of 
cooperatives to provide forward contracts, especially in times of 
volatile markets. This is because commodity swaps are not currently 
subject to margin requirements such as contracts on the exchanges and t 
can be used to free up working capital.
    As end-users, cooperatives use swaps to hedge interest rates, 
foreign exchange, and energy in addition to agricultural commodities. 
Often, cooperatives look to their lender to provide those swaps. Under 
the proposed rule requiring end-users to post margin, costs to 
businesses will increase as more cash is tied up to maintain those 
hedges. The additional capital requirements will be siphoned away from 
activities and investment in cooperatives' primary business ventures. 
Furthermore, cash for margin is often borrowed from lenders through the 
use of credit lines. As a result, we could see a situation where a 
commercial end-user would have to borrow cash from its lender, and pay 
interest on it, just to give it back to the same lender to hold as 
margin. Congressional intent was clear on this point--end-users were 
not to be required to post margin. We support legislation that would 
reaffirm this intent.
Bona Fide Hedge Definition
    Although legislation has not yet been introduced to address the 
bona fide hedge definition in the position limits rule, I bring this 
issue to your attention as the Commission is scheduled to vote on that 
rule in the near future. Once again, it appears the Commission may be 
going well beyond what Congress intended in the Dodd-Frank Act. In the 
draft rule, CFTC has classified common commercial hedging practices as 
speculative in nature. These include such practices as anticipatory 
hedging and cross hedging. For example, an anticipatory hedge could 
involve selling a corn future Friday afternoon, knowing that grain will 
be bought throughout the weekend. Common cross hedges would include 
hedging a dried distillers grain position with corn or hedging a cheese 
position with Class III milk, butter and whey.
    For NCFC's dairy cooperative members, the ``5 day rule'' poses a 
significant problem. Six of the seven dairy futures contracts, and the 
swaps that use these futures for settlements, are cash-settled 
instruments. Five of the six cash-settled futures contracts have open 
interest of less than 5,000--spread across 24 months of futures 
contracts. One of the dairy contracts that has physical delivery 
currently has zero open interest.
    Due to these instruments settling against U.S. Department of 
Agriculture determined cash prices, there is perfect convergence of 
futures to cash. There are not any issues associated with deliverable 
contracts held during the last few days prior to settlement. Since this 
is the case, the dairy industry users hold these instruments until 
their positions close out on the settlement date. If these instruments 
were required to close out prior to settlement date, it would result in 
unusual price changes in the last few days--especially for the 
contracts that have very low open interest. Imposing the 5 day rule in 
the dairy sector would reduce the effectiveness of hedges and possibly 
reduce the use of these instruments by dairy farmers and their 
cooperatives, resulting in increased risk.
    I would encourage this Committee to take a close look at this 
definition when the final rule is issued. The implications are not only 
contained to the position limits themselves, but also other rules, such 
as what will be considered hedging or mitigating commercial risk for 
the purposes of commercial end-users being able to access the end-user 
exception to the clearing requirement.
    In summary, we hope you will give consideration to the following: 
treating agricultural cooperatives as end-users; excluding agricultural 
cooperatives from the definition of a swap dealer; consider the 
aggregate costs associated with the new regulations that impact 
agriculture; and, maintain a bona fide hedge definition that includes 
common commercial hedging practices.
    Thank you again for the opportunity to testify today before the 
Committee on behalf of farmer-owned cooperatives. Your leadership and 
oversight in the implementation of the Dodd-Frank Act is to be 
commended. We especially 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. I look forward to answering any 
questions you may have.
    Thank you.

    The Chairman. Thank you.
    Mr. Williams, when you are ready.

STATEMENT OF DOUGLAS L. WILLIAMS, PRESIDENT AND CHIEF EXECUTIVE 
                OFFICER, ATLANTIC CAPITAL BANK,
                          ATLANTA, GA

    Mr. Williams. Chairman Lucas, Ranking Member Peterson, and 
Members of the Committee, I appreciate the opportunity to 
testify today regarding the impact of derivatives regulation on 
community banks and to add my support for legislation under 
consideration by the Committee.
    My name is Douglas Williams and I am the President and 
Chief Executive Officer of Atlantic Capital Bank. Located in 
Atlanta, Georgia, Atlantic Capital is a commercial bank with 
assets of approximately $870 million. We focus primarily on 
serving the banking needs of small- to mid-sized enterprises 
across Georgia. These enterprises are the engine of economic 
recovery and job creation in our region.
    Since opening in 2007, we have provided our customers with 
superior levels of service and local knowledge of a community 
bank by offering access to the expertise and capital typically 
found at larger banks. In 4 short years, we have created a 
better banking experience for over 350 companies and are proud 
of the relationships we have built with them.
    Atlantic Capital uses interest rate derivatives to manage 
risks that are inherent in banking and to help our customers 
manage their risks. We do not enter into credit default swaps 
or speculate with derivatives. Neither our use, nor our 
customers' use, of derivatives poses systemic risk. Systemic 
risk in the derivatives market is concentrated among a few 
large financial institutions. Just 25 banks hold 99.86 percent 
of the total notional volume. The remaining banks together 
comprise just .14 percent of the notional volume held at all 
U.S. banks. Certain proposed rules released by the CFTC could 
unnecessarily jeopardize our ability to manage risk, provide 
the services our clients need and remain competitive against 
larger institutions. I will focus on two issues: the swap 
dealer definition and the potential exemption from the 
financial entity definition for small banks.
    Community and regional banks are concerned that the swap 
dealer definition in the CFTC's proposed rule could capture 
hundreds of smaller banks that offer risk management products 
to commercial customers. Title VII provided an exemption from 
this definition for any swap offered by a bank to a customer in 
connection with originating a loan with that customer. However, 
the CFTC's proposed rule interpreting this exemption is 
unnecessarily narrow. In my written testimony, I elaborate on 
the specific ways in which this rule could hurt small banks.
    The Small Business Credit Availability Act clarifies that 
swaps offered by a bank in connection with an extension of 
credit that the bank has facilitated should be excluded from 
the definition of swap dealer. This bill will decrease the 
likelihood that many smaller banks will be forced to choose 
between limiting the services they offer to customers and 
complying with the same substantial regulatory burdens imposed 
on Wall Street dealers. Additionally, we are concerned that the 
CFTC's proposed thresholds for the de minimis exception are 
extremely low. Absent an increase in these thresholds, many 
small banks will be forced to cease offering these services to 
customers to avoid facing the regulatory burden applicable to 
swap dealers. The bill to amend the Commodity Exchange Act to 
clarify the definition of swap dealer modifies the de minimis 
exception to the swap dealer definition to alleviate this 
unnecessary burden for small banks.
    Additionally, many community banks are concerned that the 
clearing and trading requirements attendant to classification 
as financial entities could have the effect of shutting them 
out of the derivatives market. Initial estimates suggest that a 
community bank may have to pay a clearing member over $100,000 
per year just to maintain the ability to clear swaps. While 
large buy-side firms and hedge funds may do enough trading per 
year to justify these costs, smaller banks may have no choice 
but to stop using derivatives. These banks would no longer be 
able to offer customers the risk management products they need 
and would have a more difficult time managing basic risks that 
are inherent in banking.
    We urge the Committee to pass the Small Business Credit 
Availability Act, which would provide an explicit exemption for 
the financial entity definition for small banks and smaller 
institutions that have $30 billion or less in assets or whose 
swaps exposure is no greater than $1 billion. Notably, the 
notional amount held at U.S. banks with $30 billion or less in 
assets comprises just .09 percent of the total notional amount 
held by all U.S. banks.
    We applaud the work of the Committee and the regulators to 
strengthen the OTC derivatives market, and we appreciate the 
Committee's consideration of these important pieces of 
legislation to address the specific concerns of small banks. I 
thank you for opportunity to testify today and I am happy to 
answer any questions.
    [The prepared statement of Mr. Williams follows:]

    Prepared Statement of Douglas L. Williams, President and Chief 
         Executive Officer, Atlantic Capital Bank, Atlanta, GA
    Chairman Lucas, Ranking Member Peterson, and Members of the 
Committee, I appreciate the opportunity to testify today regarding the 
impact of derivatives regulation on community banks, and to add my 
support for three pieces of legislation under consideration by the 
Committee. My name is Douglas Williams, and I am the President and 
Chief Executive Officer of Atlantic Capital Bank (``Atlantic 
Capital'').
    Located in Atlanta, GA, Atlantic Capital is a commercial bank with 
assets of approximately $870 million and deposits of more than $720 
million. We focus primarily on serving the banking needs of small to 
mid-sized enterprises in metropolitan Atlanta and across Georgia. These 
enterprises are the engine of economic recovery and job creation in our 
region.
    Since opening our doors in 2007 we have provided our customers with 
the superior levels of service and local market knowledge often 
associated with smaller community banks while offering access to the 
banking expertise and capital typically found at larger money center 
banks. At Atlantic Capital Bank, our bankers have, on average, more 
than twenty-five years of banking experience.
    We take a relationship approach--rather than a transactional 
approach--to banking. In 4 short years we have created a better banking 
experience for over 350 emerging growth companies, small businesses and 
mid-market enterprises, and we are proud of the relationships we have 
built with them.
    As is the case with hundreds of community and regional banks, 
Atlantic Capital uses interest rate derivatives to prudently manage 
risks that are inherent in the business of commercial banking and to 
help our customers meet their risk management needs. We do not enter 
into credit default swaps or use derivatives for speculation, trading 
or proprietary investment. At Atlantic Capital, we use derivatives to 
hedge the interest rate risk associated with financing we provide to 
our clients.
    Here are three brief examples:

    (1) We offered a borrower a competitive construction financing that 
        upon completion converted to a long-term financing. This 
        allowed our customer to meet its objective of locking in its 
        future interest expense on the long-term financing, while also 
        allowing the bank to avoid taking on any incremental interest 
        rate risk. Importantly, we could not have assisted this 
        customer without interest rate swaps.

    (2) Atlantic Capital provided financing to a small developer in a 
        low-income area of downtown Atlanta that was leased to a 
        commercial user. Our interest rate swap fixed the rate so that 
        the lease payments exceed the cost of debt in any interest rate 
        environment.

    (3) Atlantic Capital financed a Georgia-based exporter of 
        agricultural products and helped them lock in their interest 
        expense with an interest rate swap, allowing them to reduce 
        uncertainty in their business.

    Neither our use nor our customers' use of derivatives poses 
systemic risk. As was shown during the financial crisis, systemic risk 
in the derivatives market is concentrated among a few very large and 
interconnected financial institutions. According to the Office of the 
Comptroller of the Currency's (OCC's) Quarterly Report on Bank Trading 
and Derivatives Activities, the derivatives market is ``dominated by a 
small group of large financial institutions.'' While 1,071 banks and 
trust companies in the U.S. use derivatives, five banks hold 96% of the 
total notional volume and 86% of the total credit exposure. Looking 
beyond the top five, just 25 banks hold 99.86% of the total notional 
volume, and the remaining 1,046 banks together comprise just 0.14% of 
the entire notional volume held at all U.S. banks.\1\
---------------------------------------------------------------------------
    \1\ Please see the attached  and refer to page 1 of the report at: 
http://www.occ.treas.gov/topics/capital-markets/financial-markets/
trading/derivatives/dq211.pdf.
     [This document is retained in Committee files.]
---------------------------------------------------------------------------
    In addition to the vast differences in the size and volume of 
trades done by small banks as compared to the largest financial 
institutions, there are important differences in the types of 
derivatives used by smaller banks and their purposes. Small banks 
typically use derivatives to hedge their own balance sheet risk or to 
facilitate the risk management needs of their customers. Small banks 
generally use interest rate, foreign exchange and, to a lesser extent, 
commodity derivatives. Use of credit derivatives among small banks is 
rare. Indeed, only 18 commercial banks in the U.S. currently use the 
credit default swaps made infamous by AIG Financial Products.\2\
---------------------------------------------------------------------------
    \2\ Based on publicly available call report data on the website of 
the Federal Deposit Insurance Corporation.
---------------------------------------------------------------------------
    My comments today reflect concern that certain proposed rules 
released by the Commodity Futures Trading Commission (``CFTC'')--
including those relating to the key definitions in Title VII--could 
unnecessarily jeopardize our ability to manage risk, provide the 
services our clients need and remain competitive against much larger 
financial institutions. Indeed, this Committee has heard the testimony 
of representatives from two other community banks, Susquehanna Bank and 
Webster Bank, regarding the potential consequences of being swept into 
the ``financial entity''--or worse--``swap dealer'' definition in Title 
VII of Dodd-Frank. We share those concerns and strongly support the 
common-sense legislation recently introduced in the House that seeks to 
protect smaller banks from the substantial and unnecessary regulatory 
burden associated with the financial entity and swap dealer 
classifications. This legislation does not dilute or detract from the 
important features of Title VII designed to protect against systemic 
risk and promote transparency in the OTC derivatives market; rather, 
these bills strengthen the framework established in Title VII.
    I would like to focus today on two key issues: the swap dealer 
definition and the potential exemption from the financial entity 
definition for small banks.
(1) Swap Dealer Definition
    Several community and regional banks have expressed concern that 
the swap dealer definition in the CFTC's proposed rule could capture 
hundreds of community and regional banks that offer risk management 
products to commercial customers. One only need look at the comment 
file on the CFTC's website for the entity definitions rule to get a 
sense for the concerns that numerous smaller banks have regarding an 
overly broad swap dealer definition.\3\ A broad definition would hamper 
the ability for many smaller banks to compete with larger financial 
institutions without any appreciable benefit in terms of enhanced 
market oversight or reduction in systemic risk.
---------------------------------------------------------------------------
    \3\ Please see comment file here: http://comments.cftc.gov/
PublicComments/CommentList.aspx?id=933.
---------------------------------------------------------------------------
    Title VII provided an exemption from the swap dealer definition for 
any swap offered by a bank to a customer in connection with originating 
a loan with that customer; however, the CFTC's proposed rule 
interpreting this exemption is unnecessarily narrow. While not required 
by Title VII, the CFTC is considering whether to limit the exemption to 
swaps offered ``contemporaneously'' with origination of the loan. It is 
important to stress that the word ``contemporaneously'' is not found in 
the statute. As it is common for a borrower to enter into an interest 
rate swap before or after origination of the corresponding loan, the 
exemption should not be limited to any swap entered into 
contemporaneously with a loan. In addition, we would urge the CFTC to 
consider excluding from the swap dealer definition swaps offered by a 
bank in connection with syndicated loans, loan participations and bond 
issuances that are facilitated by the bank, as bank customers that 
benefit from these financings often use derivatives to hedge the 
associated interest rate risk.\4\
---------------------------------------------------------------------------
    \4\ Please refer to pages 2-3 of the comment letter submitted by 
Atlantic Capital and 18 other community and regional banks to the CFTC 
for examples.
---------------------------------------------------------------------------
    The Small Business Credit Availability Act modifies the swap dealer 
definition to clarify that swaps offered by a bank in connection with 
an ``extension of credit'' that the bank has facilitated should be 
excluded from the definition of swap dealer. This language is intended 
to clarify that the CFTC should not take an overly narrow read of the 
exclusion for these important transactions. This bill will decrease the 
likelihood that many smaller banks will be forced to choose between 
limiting the services they offer to customers and complying with the 
same substantial regulatory burdens imposed on the big Wall Street 
dealers.
    Additionally, we are concerned that the CFTC's proposed thresholds 
for the so-called ``de minimis exception'' from the swap dealer 
definition are extremely low and should be increased. For example, if a 
bank were to offer just 21 hedges to customers in one year, it could be 
subject to the full panoply of regulation applicable to swap dealers, 
depending on the CFTC's interpretation of the swap dealer definition. 
Atlantic Capital has been offering interest rate risk management 
products to our customers for only 18 months, and we currently have 21 
swaps with an aggregate notional amount of $88 million on our books. We 
fear that many small banks, including Atlantic Capital, would simply be 
forced to cease offering these risk management services to customers to 
avoid facing the costly regulatory burden associated with registration 
as a swap dealer.
    We urge regulators to compare the thresholds for the de minimis 
exception against the volume of dealing done by the large financial 
institutions that control the vast majority of the OTC derivatives 
market. Available data \5\ suggest that the CFTC could substantially 
increase the thresholds without running afoul of Congressional intent. 
For example, at number one on the OCC's list of banks with the largest 
derivatives books, J.P. Morgan has more than $78 trillion in notional 
volume of active trades in place. The number ten firm on the OCC's 
list, PNC Bank, has 0.43% of J.P. Morgan's book, at around $337 billion 
in notional volume. Assuming that just 10%, or $33 billion, of PNC's 
total book was done with customers and that these trades were spread 
over 10 years would give you $3.3 billion per year--33 times the 
threshold above which a firm would be deemed a swap dealer under the 
current de minimis threshold of $100 million. Given the relatively 
infinitesimal level of activity by small financial institutions and the 
substantial regulatory burden that would be imposed if these 
institutions were deemed swap dealers, we believe the cost of 
additional oversight over smaller financial institutions would 
substantially outweigh any benefits to the financial system.
---------------------------------------------------------------------------
    \5\ Please refer to pages 5-6 of the comment letter submitted by 
Atlantic Capital and 18 other community and regional banks to the CFTC 
for additional comparative data: http://www.chathamfinancial.com/wp-
content/uploads/2011/02/Coalition-Comments-Small-Banks.pdf.
---------------------------------------------------------------------------
    The discussion draft that amends the Commodity Exchange Act to 
clarify the definition of swap dealer modifies the de minimis exception 
to the swap dealer definition to exempt entities from registering as a 
swap dealer if the average aggregate gross notional volume of its 
outstanding swaps over the preceding 12 months does not exceed $3 
billion as adjusted by the Consumer Price Index for the 12 month period 
ending the preceding April 30. The bill's modifications to the swap 
dealer definition and the inclusion of a specific threshold for the de 
minimis exception would result in the regulatory capture of firms which 
dominate the derivatives market while alleviating the burden for small 
banks which collectively comprise a fraction of the derivatives market.
(2) Potential Exemption for Small Banks
    Congress provided the regulators with the authority to exempt small 
banks from the financial entity definition. If such an exemption were 
granted, these small banks would only be exempt from the clearing and 
trading requirements if they are hedging commercial risk and report 
certain information to the regulators.\6\ Moreover, small banks already 
are subject to existing regulations and supervisory guidance aimed at 
protecting against counterparty credit risks, including rules that 
require adequate capital to be held against all assets, including 
derivatives, and that dictate the maximum exposures a bank could take 
to one customer or counterparty. Furthermore, existing regulations 
allow examiners to take certain actions to prevent default, or to limit 
bank losses in the event of default. Atlantic Capital and other small 
banks employ sound risk management practices to manage our exposures to 
bank counterparties to a modest level including the use of collateral 
agreements with these counterparties which require them to post liquid 
collateral for our benefit as exposure is created. These protections 
adequately mitigate risks associated with an exception for small banks.
---------------------------------------------------------------------------
    \6\ Any exempt small financial institution still would have to meet 
the conditions required for the end-user exception to mandatory 
clearing and trading.
---------------------------------------------------------------------------
    Many community banks are concerned that the clearing and trading 
requirements attendant to classification as ``financial entities'' 
could have the effect of shutting them out of the derivatives market 
altogether. Initial estimates of clearing costs suggest that a 
community bank may have to pay a clearing member--in most cases an 
affiliate of a large Wall St. bank--over $100,000 per year just to 
maintain the ability to clear swaps. Additional fees would be charged 
by the clearinghouses and trading platforms, and legal counsel may be 
required to negotiate clearing-related documentation.
    While large buy-side firms and hedge funds may do enough trading 
per year to justify these costs, smaller banks may have no choice but 
to stop using derivatives. If so, these banks would no longer be able 
to offer customers the risk management products they need and would 
have a more difficult time managing basic risks that are inherent in 
banking. These would be unfortunate and entirely avoidable outcomes 
that would have the effect of weakening the banking system and the 
economy.
    We urge the Committee to prevent such outcomes by passing the Small 
Business Credit Availability Act which would provide a targeted 
exemption for smaller banks from the financial entity definition. The 
bill would modify Title VII and provide an explicit exemption from the 
financial entity definition for small banks, savings associations, 
credit unions and farm credit system institutions that have $30 billion 
or less in assets or whose current and potential future exposure for 
swaps is no greater than $1 billion. It should be noted that this $1 
billion exposure threshold is just \1/8\ the exposure threshold 
proposed by the CFTC in its definition for so-called ``major swap 
participants'' that have derivatives exposures large enough to pose a 
threat to the financial system. In addition, the OCC's stats show that 
the notional amount held at U.S. banks and trust companies with $30 
billion or less in assets comprises just 0.09% of the total notional 
amount held by all U.S. banks and trust companies.
    We recognize that it is important to resist legislative changes 
that run counter to the core objectives of Dodd-Frank by creating 
loopholes that would permit firms or activities that pose a risk to our 
financial system to escape regulatory capture; however, neither of 
these bills would have such an effect. Indeed, the targeted application 
and careful wording of these bills would strengthen Dodd-Frank by 
limiting unintended harm to smaller banks. The large dealers and major 
market players would still be subject to registration, supervision and 
substantial regulations aimed at reducing systemic risk and promoting 
transparency in the derivatives market. In addition, any market 
participant using derivatives for speculating, trading or investing 
still would be subject to the clearing, trading and margin 
requirements.
    I also wish to show support for H.R. 1840, an extremely important 
piece of legislation that enhances Title VII for the benefit of all 
market participants, including small banks. H.R. 1840 requires the CFTC 
to perform a qualitative and quantitative cost-benefit analysis and to 
make a reasoned determination that the benefits of new regulatory 
requirements justify the costs. H.R. 1840 lists specific factors, 
including available alternatives to regulation, that the CFTC must 
consider as part of its cost-benefit analysis. We urge the Committee to 
pass H.R. 1840 and to take steps to ensure that the regulators 
prioritize quality over expedience in their rulemaking effort.
Conclusion
    It is essential that small banks have continued access to interest 
rate risk management tools to support recovery and job creation at the 
small and middle-market businesses that form the foundation of the U.S. 
economy. We applaud the work of the Committee and the regulators to 
strengthen the OTC derivatives market, but we urge caution against 
finalizing rules that would place undue burdens on small banks that are 
incapable of posing future systemic risk and collectively engage in a 
fraction of the derivatives traded by the large dealers. We urge this 
Committee to address the specific concerns of small banks by passing 
the Small Business Credit Availability Act and the bill that would 
amend the Commodity Exchange Act to clarify the definition of swap 
dealer.
    I thank you for the opportunity to testify today, and I am happy to 
answer any questions that you may have.

    The Chairman. Thank you.
    And Ms. Sanevich, whenever you are ready.

    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 morning. Thank you for holding this 
hearing. My name is Bella Sanevich, and I am the General 
Counsel of NISA Investment Advisors. NISA is an investment 
advisor with over $75 billion under management for over 130 
clients including private and public plans. I am testifying 
today on behalf of the American Benefits Council and the 
Committee on Investment of Employee Benefits Assets. These two 
organizations represent the vast majority of the nation's 
private pension plans. Thank you for the opportunity to testify 
on the issues raised for ERISA plans by the proposed swap 
regulations.
    We very much appreciate the open and frank dialogue we have 
had with the agencies to date. The agencies have been very open 
to hearing our concerns. However, a number of issues remain, 
and I will focus on two critical issues for ERISA pension plans 
under the proposed business conduct standards and the need to 
modify the anomalous treatment of ERISA plans under the 
proposed margin regulations.
    ERISA pension plans use swaps to manage risk inherent in a 
pension plan's liability and to manage plan funding 
obligations. If swaps are less available or more costly to 
pension plans, funding volatility and cost would increase 
substantially. This would put Americans' retirement security at 
very great risk. It would also force companies to reserve 
billions of additional dollars to satisfy possible funding 
obligations, thus diverting those assets from job creation and 
economic growth.
    With respect to the business conduct standards, there are 
three main issues: the fiduciary issue, the advisor issue and 
the dealer retail issue. On the fiduciary issue, the rules 
proposed by the CFTC and the SEC would require swap dealers to 
review the qualification of an ERISA plan's advisor. Such a 
review would make the dealer a fiduciary under current ERISA 
rules. Under ERISA, a fiduciary to a plan is not permitted to 
enter into a transaction with the plan, so if the swap dealer 
is a plan fiduciary, then any swap entered into with an ERISA 
is an illegal prohibited transaction. The solution is clear: No 
action required by the business conducts standards should cause 
a swap dealer to be treated as a fiduciary. This would simply 
be a clarification that there is not an irreconcilable conflict 
between two sets of regulations. The legislative discussion 
draft does exactly this and should be enacted.
    With respect to the advisor issue, under the Dodd-Frank 
Act, if a swap dealer acts as an advisor to a plan, then the 
swap dealer must act in the best interests of the plan. 
Unfortunately, the CFTC's proposed rules interpret acting as an 
advisor so broadly that virtually every dealer would be treated 
as an advisor. This is an unworkable conflict of interest that 
would render swaps unavailable to plans. The reality is that 
contrary to the CFTC's apparent assumptions, ERISA plans are 
prohibited by law from relying on their counterparty for 
advice. The business conduct standards should state that a 
dealer is not an advisor to a plan if the dealer represents 
that it is functioning as a counterparty and not as an advisor 
and the plan represents that it has its own internal or 
external advisor. In general, this is a structure adopted by 
the SEC in its proposed rules and by the legislative discussion 
draft. We strongly support these solutions.
    On the dealer veto issue, under the proposed CFTC and SEC 
rules, dealers have significant leverage over plans, contrary 
to Congressional intent. Congress's intent to ensure that 
special entities are advised by a qualified advisor is 
satisfied by current ERISA law. This must be reflected in the 
business conduct rules, and the legislative discussion draft 
would do this with respect to ERISA plans.
    Last, the proposed margin regulations issued by the CFTC 
and the Prudential Regulators would, without consideration of 
the unique nature of ERISA plans, treat plans as high-risk 
financial end-users and impose the same burdensome margin 
requirements as are imposed on, for example, hedge funds. This 
classification is inconsistent with Congressional intent 
because ERISA plans are among the lowest risk end-users. They 
are highly regulated, subject to mandatory funding requirements 
and cannot file for bankruptcy. Treating ERISA plans as high-
risk financial end-users will actually create an increased risk 
by significantly reducing or eliminating the use of a very 
powerful risk mitigation tool. This would have significant 
adverse consequences on the retirement security of millions of 
Americans and divert assets from job creation. As one of the 
safest counterparties, no mandated margin requirements should 
apply to ERISA plans on cleared swaps.
    We thank the Committee for holding this hearing and for the 
opportunity to testify. I will be happy to answer any 
questions.
    [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 $75 
billion under management for over 130 clients, including private and 
public retirement plans. I am testifying today on behalf of the 
American Benefits Council (the ``Council''), with respect to which NISA 
is a member, and the Committee on Investment of Employee Benefit Assets 
(``CIEBA'').
    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 the Dodd-Frank Wall Street Reform and Consumer 
Protection Act (the ``Dodd-Frank Act'') for private retirement plans 
governed by the Employee Retirement Income Security Act of 1974 
(``ERISA'') \1\. And we applaud the Committee for holding a hearing on 
this critical set of issues.
---------------------------------------------------------------------------
    \1\ For convenience of presentation, the references in this 
testimony to swaps, swap dealers, and major swap participants include 
security-based swaps, security-based swap dealers, and major security-
based swap participants, respectively.
---------------------------------------------------------------------------
    We believe that the agencies--the Commodity Futures Trading 
Commission (``CFTC''), which has jurisdiction over the types of swaps 
most important to plans, the Securities and Exchange Commission 
(``SEC''), and the Prudential Regulators--have been working extremely 
hard to provide needed guidance. Also, the agencies have been very open 
to input on the swap issues from the ERISA plan community. We very much 
appreciate the open and frank dialogue we have had with the agencies to 
date.
    However, certain proposed regulations affecting ERISA plans could 
have very adverse effects on plans, none of which were intended by 
Congress. Accordingly, for reasons discussed in more detail below, we 
testify today in support of:

   This hearing's legislative discussion draft that would 
        address critical issues arising under the proposed business 
        conduct standards;

   Needed legislation that would modify the anomalous treatment 
        of ERISA plans under proposed regulations addressing margin 
        requirements; and

   H.R. 1840, which would set forth specific factors that must 
        be considered by the CFTC in connection with a cost-benefit 
        analysis of any regulation or proposed regulation.
Importance of Swaps to ERISA Plans
    At the outset, it is important to discuss why the use of swaps is 
so important to ERISA pension plans and why any material disruption of 
that use could have significant adverse effects on plans, the companies 
sponsoring plans, and the participants whose retirement security 
depends in large part on plans.
    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. The risk being managed 
is largely interest rate risk. If swaps were to become materially less 
available or become significantly more costly to pension plans, funding 
volatility and cost could increase substantially. This would put 
Americans' retirement assets at greater risk and force 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, the present value of 
liabilities can grow, 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 using bonds in lieu 
of interest rate swaps 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, the U.S. markets, and the economy in 
general.
Summary of Key Concerns
    We have four main concerns to discuss today. Those concerns are 
summarized below.

   Business conduct standards. The Dodd-Frank Act directed the 
        SEC and the CFTC to impose business conduct standards on swap 
        dealers and major swap participants (``MSPs''), with heightened 
        standards applicable when dealers and MSPs enter into swaps 
        with a ``Special Entity'' (which includes ERISA plans). These 
        rules were intended to protect ERISA plans that enter into 
        swaps. As proposed by the CFTC and, to a lesser extent, the 
        SEC, these standards would have very harmful effects on ERISA 
        plans and could operate to eliminate their ability to use 
        swaps. The legislative discussion draft raised for discussion 
        in connection with this hearing would address this issue very 
        effectively.

   Margin requirements. The CFTC and the Prudential Regulators 
        have proposed margin requirements that would treat ERISA plans 
        as high-risk financial end-users (i.e., treating ERISA plans as 
        entities that pose a systemic risk to the financial system). 
        Accordingly, the proposed rules would impose very costly margin 
        requirements on ERISA plans that enter into swaps. These 
        requirements will create more risk for ERISA plans, and will 
        divert plan assets away from more productive uses that could 
        benefit participants. In some cases, the requirements could 
        even discourage plans from entering into swaps due to the 
        significant increase in opportunity cost as well as actual 
        cost. These results are clearly unjustified, since ERISA plans 
        are among the safest counterparties, for reasons discussed 
        below. Legislation may well be needed to solve this problem.

   Cost-benefit analysis. We believe that an appropriately 
        thorough cost/benefit analysis would clearly reveal that the 
        treatment of ERISA plans in the proposed business conduct 
        standards and the margin requirements would have significant 
        costs and no real benefit. We are concerned that the unique 
        nature of ERISA plans has not been taken into account in the 
        regulatory process, and a more detailed cost-benefit analysis 
        is needed to avoid serious unintended consequences. H.R. 1840, 
        as introduced by Representatives Conaway, Quigley, McHenry, 
        Boswell, and Neugebauer, would be very helpful in addressing 
        this issue.

   Effective date. The retirement plan community will need 
        substantial time to prepare to comply with an entirely new 
        system. Near-term effective dates can only bring substantial 
        harm by triggering confusion and misunderstandings that 
        undermine our country's retirement security. In this regard, it 
        is essential that the rules have sufficiently long 
        implementation dates so that plans and their advisors can plan 
        for an orderly transition to the new system without 
        unnecessary, harmful, and costly disruptions. Moreover, plans 
        and their advisors will need to establish additional 
        operational and compliance systems, and the rules should be 
        sequenced in a manner so that new systems do not have to be 
        modified to take into account rules issued subsequently. Of 
        course, it is also critical that no rules apply to swaps 
        entered into before the regulatory effective date.
Discussion
Business Conduct Standards
    Under the proposed business conduct rules, a swap dealer or MSP 
entering into a swap with an ERISA 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. 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 surely have no 
interest in counsel from their counterparty. So at best, the rules have 
no effect. Unfortunately, the rules as proposed by the CFTC and, to a 
lesser extent, the SEC would actually have very serious adverse 
effects. Here are just three 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 rules proposed by the CFTC would make the swap dealer 
        a plan fiduciary under ERISA; the SEC's rules may have the same 
        effect. This is the case because the proposed rules would 
        require the swap dealers and MSPs to review the qualifications 
        of the plan's advisor. Such a review would make the swap dealer 
        or MSP a fiduciary under ERISA. (Under the proposed regulations 
        issued by the Department of Labor (``DOL'') regarding the 
        definition of a ``fiduciary,'' other actions required by the 
        proposed business conduct standards would also convert a swap 
        dealer or MSP into a fiduciary. The announcement that the DOL 
        will re-propose the fiduciary regulations provides some help on 
        these issues, but does not address the present-law problem.)

    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 or MSP is a plan fiduciary, then any swap 
        entered into with an ERISA plan is an illegal prohibited 
        transaction under the DOL rules applicable to plans. Thus, the 
        business conduct rules would require a swap dealer or MSP to 
        perform an illegal action or refrain from entering into a swap 
        with a plan. Generally, the only way to avoid violating the law 
        would be for swaps with plans to cease, with the adverse 
        results described above.

    Congress clearly never intended to indirectly prohibit plans from 
        utilizing swaps. The CFTC, SEC, and DOL should jointly announce 
        that no action required by the business conduct rules will 
        cause a swap dealer or MSP to be treated as fiduciary. This 
        would simply be a clarification that there is not an 
        irreconcilable conflict between two sets of regulations. If the 
        agencies do not do this, Congress needs to step in and enact 
        the legislative discussion draft which does exactly this.

   Acting as an advisor. Under the Dodd-Frank Act, if a swap 
        dealer acts as an advisor to a Special Entity, such as an ERISA 
        plan, the swap dealer must act in the best interests of the 
        Special Entity. Unfortunately, the CFTC's proposed business 
        conduct standards interpret ``acting as an advisor'' so broadly 
        that all swap dealers would be treated as advisors, e.g., by 
        reason of providing information on the risks of the swap. Even 
        if that were not the case, the CFTC's proposed business conduct 
        standards do not distinguish between selling (e.g., a dealer 
        pitching a swap might describe a swap as meeting the objectives 
        of a plan) and advising (where a relationship of reliance 
        exists based on shared objectives).

    If a dealer is treated as an advisor and thus must act in the best 
        interests of its counterparty, this is an unworkable conflict 
        of interest that in virtually every circumstance would render 
        swaps unavailable to plans. It is not clear to us how a swap 
        dealer that owes a fiduciary duty to its shareholders to obtain 
        the best possible deal with the plan can simultaneously act in 
        the best interests of the plan, which is the dealer's 
        counterparty. Absent clarification of this issue, if the 
        proposed business conduct standards are finalized as proposed, 
        we are concerned that virtually all swaps with ERISA plans 
        would likely have to stop, due to this conflict.

    The core point is that it would be a violation of ERISA for an 
        ERISA plan to rely on its counterparty for advice. Based on 
        that point and business common sense, our members do not rely 
        on their counterparty for advice. A dealer makes its pitch to 
        an ERISA plan. The plan representatives then take the dealer's 
        pitch and fully analyze it with their own advisors. That is how 
        the ERISA plan world works. ERISA plans may not, and do not, 
        rely on their counterparties. The CFTC needs to revise its 
        regulations to reflect this.

    We believe that the business conduct standards should state that a 
        dealer is not an ``advisor'' if (1) the dealer represents in 
        writing that it is functioning as a counterparty and not as an 
        advisor, and (2) the Special Entity represents in writing that 
        it has its own internal or external advisor. In general, this 
        is the structure adopted by the SEC in its proposed business 
        conduct standards and by the legislative discussion draft. We 
        believe this provides a very workable framework on this issue.

   Dealers' right to veto plan advisors. Under the proposed 
        CFTC and SEC rules, swap dealers and MSPs are required to 
        carefully review the qualifications of a plan's advisor; as 
        noted above, this could effectively preclude swaps with plans 
        by making the swap dealer or MSP a fiduciary. In addition, this 
        requirement would give swap dealers and MSPs the ability to 
        veto any advisor advising a plan with respect to a swap. We are 
        not suggesting that a dealer or MSP would use this power, but 
        the fear of that result could have a significant effect on 
        advisors' willingness to zealously represent plans' interests 
        against a dealer or MSP. In addition, a dealer or MSP could use 
        this requirement to demand information regarding the plan or 
        the advisor, potentially giving the dealer or MSP an unfair 
        informational advantage in the swap transaction.

    Also, the specter of liability for not vetoing an advisor that 
        subsequently makes an error may have an adverse impact on the 
        dealers' or MSPs' willingness to enter into swaps with plans; 
        this may result in the dealers and MSPs demanding additional 
        concessions from the plans or their advisors, or may cause the 
        dealers and MSPs to cease entering into swaps with plans. In 
        all of the above cases, the effect on plans' negotiations with 
        dealers and MSPs would be extremely adverse. This, too, was 
        never intended by Congress.

    Congress' intent in the business conduct standards was to ensure 
        that Special Entities are being advised by a qualified advisor. 
        Congress' objective is by law met in the case of an ERISA plan, 
        so there is no need for swap dealers or MSPs to be given a 
        counterproductive veto power. By law, ERISA fiduciaries must 
        have expertise in the area in which they are advising and must 
        use their expertise prudently. Consistent with the statute, a 
        dealer or MSP should be deemed to meet the business conduct 
        standards relating to dealers or MSPs acting as counterparties 
        if a plan represents that it is being advised by an ERISA 
        fiduciary. The legislative discussion draft would do exactly 
        this with respect to ERISA plans.
Margin Requirements
    The CFTC and the ``Prudential Regulators'' (i.e., banking 
regulators such as the Board of the Federal Reserve System and the 
FDIC) have proposed very burdensome margin requirements on uncleared 
swaps entered into by ERISA plans. The CFTC and Prudential Regulators 
would treat ERISA plans as ``high-risk financial end-users'' and impose 
the same margin requirements on ERISA plans as are imposed on, for 
example, hedge funds. As explained below, this treatment is 
inappropriate and inconsistent with Congressional intent because ERISA 
plans are highly regulated, and subject to mandatory funding 
requirements, and cannot file for bankruptcy; thus, they are actually 
the lowest risk end-users. Treating ERISA plans as high-risk financial 
end-users will actually create risk, rather than reduce it, thereby 
adversely affecting plan participants. We strongly believe that, as one 
of the safest counterparties, no mandated margin requirements should 
apply to the uncleared swaps entered into by ERISA plans.
    Background. The Dodd-Frank Act directed the CFTC, the SEC, and the 
Prudential Regulators to adopt rules for swap dealers and MSPs that 
impose margin requirements on uncleared swaps. The Dodd-Frank Act 
directed the agencies to use this authority to protect the financial 
integrity of the markets by ensuring that the margin requirements are 
appropriate in light of the risk associated with an uncleared swap.
    The precise nature of the statutory direction to the agencies is 
not clear. But, as described below, the agencies have used this 
statutory provision to impose margin requirements on all end-users, 
which is hardly consistent with the statute.
    Proposed regulations. The CFTC and the Prudential Regulators have 
issued proposed regulations under the Dodd-Frank provisions described 
above. The proposed regulations establish three levels of risk, and 
place all end-users in one of the following categories:

   High-risk financial end-users (the riskiest),

   Low-risk financial end-users, and

   Non-financial end-users (the lowest risk).

    The ``high-risk financial end-users'' include, for example, hedge 
funds and ERISA plans. End-users in the ``high-risk'' category are 
subject to the most onerous margin requirements. The ``low-risk 
financial end-users'' are financial entities that are subject to 
regulatory capital requirements, like insurance companies and banks. 
End-users in the ``low-risk'' category are subject to somewhat less 
onerous margin requirements. Non-financial end-users are considered the 
lowest risk group under the rules and are subject to the least onerous 
requirements.
    Our view. The treatment of ERISA plans as high-risk financial end-
users does not make sense; ERISA plans are at the least some of the 
lowest risk end-users:

   Unlike almost any other counterparty, ERISA plans cannot 
        avoid their obligations to their counterparties by filing for 
        bankruptcy. If an ERISA plan's sponsor files for bankruptcy and 
        the plan has outstanding liabilities, the PBGC assumes those 
        liabilities. We are not aware of any instance where the PBGC 
        has avoided, or could have avoided, any assumed swap 
        liabilities.

   ERISA plans are subject to stringent funding requirements. 
        In addition to ERISA plans having their own assets, plan 
        sponsors are obligated to make contributions to satisfy plan 
        liabilities. Virtually no other counterparty has that type of 
        ``credit enhancement''.

   ERISA plans are not operating entities with the 
        corresponding business risks.

   ERISA plans are tightly regulated by, for example, prudent 
        diversification rules and strict fiduciary rules.

   ERISA plan assets must be held in a trust that is not 
        subject to the creditors of the plan sponsor.

   Informal surveys indicate that no ERISA plan has ever failed 
        to pay off its swap liabilities.

    In this context, onerous margin requirements for ERISA plans do not 
make sense. The margin requirements would result in a significant 
increase in both opportunity cost as well as the actual cost of swaps. 
The proposed margin requirements are so onerous that some plans will 
find it prohibitively expensive to enter into the swaps necessary to 
hedge their risks. This would undermine the retirement security of 
millions of Americans, and leave plans and plan sponsors exposed to 
very significant market and interest rate risk. To the extent some 
plans continue to use some swaps, the increased costs will result in 
more potential risk (due to a reduction of a risk mitigating strategy, 
such as interest rate swaps), benefit reductions, and freezes, thus 
hurting the plan participants we are all trying to protect. In light of 
the absence of risk posed by ERISA plans, we believe that ERISA plans 
should not be subject to any mandated margin requirements.
Cost-Benefit Analysis
    ERISA plans are subject to a regulatory regime under ERISA which 
makes them unlike any other counterparty. We are not suggesting that 
ERISA plans deserve better treatment, but they do deserve the right 
treatment taking into account their unique circumstances. As 
demonstrated above, the agencies have not recognized these unique 
aspects in their rulemaking. We believe that a requirement that, prior 
to issuing any proposed or final regulation, the agencies must engage 
in an appropriately thorough cost-benefit analysis might well address 
this shortcoming. If ERISA plans are already required by law to have 
expert advisors, there is no benefit and there is substantial cost to 
giving dealers and MSPs veto power over plan advisors. Similarly, if it 
is illegal for an ERISA plan to rely on a dealer to act as its advisor, 
and there is no evidence that this has ever happened, there is no 
benefit attributable to a rule that treats dealers as advisors based on 
normal selling activities. In contrast, the cost of effectively 
precluding ERISA plans from using swaps is enormous.
    The agencies need a more effective and more specific means of 
assessing the costs and benefits of their regulations. H.R. 1840 would 
be a major step forward in that regard.
Effective Date
    A $600 trillion market cannot be restructured overnight without 
devastating consequences. As discussed above, the use of swaps is 
critical to the ability of plans to manage very significant risks. If a 
regulatory structure is imposed in haste, the possibilities for damage 
to the retirement system and the retirement security of millions of 
Americans are very high. In that context, three principles should be 
followed.
    Time to comply. Plans and their advisors will need substantial time 
to comply with complex and significant new rules. A sufficiently long 
implementation time is essential so that plans and their advisors can 
plan for an orderly transition to the new system without unnecessary, 
harmful, and costly disruptions. If there is not sufficient time to 
design compliance systems, plans may be unable to enter into needed 
swaps. In other cases, confusion and misunderstandings will lead to 
unnecessary disputes, which will in turn create costs and disruption.
    Ordering guidance. When an entire market is being restructured, 
there are substantial interrelationships between the different parts of 
the restructuring. If one set of rules has an earlier effective date, 
systems will have to be built to accommodate those rules. In building 
those systems, ERISA plans and others will need to make judgments about 
how to comply with other parts of the Dodd-Frank Act for which there is 
no guidance. When subsequent rules are issued, and those rules 
inevitably vary in some respect from the systems built by market 
participants, the compliance systems will need to be rebuilt, requiring 
a whole new transition period. This is very costly and disruptive. To 
avoid this, it is essential that the agencies coordinate the timing of 
guidance on related issues, including providing guidance first on 
definitional issues.
    Prospective effect. It almost goes without saying that no new rules 
should apply directly or indirectly to swaps entered into prior to the 
effective date of such rules. The dollars involved in swap transactions 
can be enormous, and accordingly, the transactions are very carefully 
negotiated. In that context, it would be fundamentally unfair to impose 
new rules on prior transactions that were negotiated by the parties in 
good faith based on the law in effect at the time. Moreover, the effect 
of disrupting the financial arrangement of the parties could be 
extremely adverse for one or both of the parties.
Conclusion
    We thank the Committee for holding this hearing and for the 
opportunity to testify. Swaps are very important instruments for ERISA 
plans, giving plans a means to manage risks that are potentially very 
disruptive. We applaud the agencies for their hard work and openness to 
input. However, we remain very concerned that certain proposed rules 
have been issued that are inconsistent with the structure of ERISA 
plans and could cause very significant disruption for ERISA pension 
plans and the participants who rely on those plans for retirement 
security. We would like to continue to work with this Committee, the 
other Committees of jurisdiction, and the agencies to address these 
concerns so that we have a system that provides the important 
protections intended by the Dodd-Frank Act without unintended adverse 
consequences.
    I would be happy to answer any questions.

    The Chairman. Thank you.
    Mr. Giancarlo, when you are ready.

          STATEMENT OF J. CHRISTOPHER GIANCARLO, J.D.,
  EXECUTIVE VICE PRESIDENT--CORPORATE DEVELOPMENT, GFI GROUP 
  INC.; BOARD MEMBER, WHOLESALE MARKETS BROKERS ASSOCIATION, 
                     AMERICAS, NEW YORK, NY

    Mr. Giancarlo. Thank you, Mr. Chairman, Ranking Member, and 
Members of this Committee. My name is Chris Giancarlo. I am 
Executive Vice President of GFI Group. I testify today on 
behalf of the Wholesale Markets Brokers Association, Americas, 
the WMBAA, representing the largest inter-dealer brokers 
operating in wholesale markets across a broad range of swap and 
other products. Our trading systems are the prototypes for swap 
execution facilities, or SEFs, under Dodd-Frank. We support 
H.R. 2586, the SEF Clarification Act.
    As we speak this morning, GFI and other WMBAA member firms 
are hard at work employing many thousands of people, executing 
billions of dollars of swaps that account for over 90 percent 
of brokered swap trades taking place around the globe. The 
liquidity created by WMBAA members helps to reduce the cost of 
risk management for American businesses. Before John Deere 
enters into a contract to sell tractors to an Argentinean co-
op, it generally finds a hedge for the foreign exchange risk. 
That hedge is often provided by a dealer firm or a bank that 
undertakes the balance sheet knowing it can offset the exposure 
on one of the hybrid systems that we operate for wholesale 
transactions.
    So how is this done? Imagine a large room filled with long 
desks, not just in New York City but in places like Louisville, 
Kentucky, Jersey City, New Jersey, and Sugarland, Texas. Each 
desk has a group of professional men and women set up with 
several computer screens and telephone squawk boxes that 
transmit prices to our customers. These professionals use 
sophisticated trading technology such as central limit order 
book, request for quote, or RFQ systems, electronic workup and 
auction and matching sessions. Each method we use is geared to 
the specific dynamics of the financial products we broker. We 
call this range of trading methods hybrid brokerage. It is what 
CFTC Commissioner Bart Chilton described in a press interview 
after touring our firm as ``big dynamic operations, not just a 
couple of guys in a back room with a phone.''
    Swap markets are different than futures markets. 
Participants are all institutional, not retail. We deal with an 
infinitely larger number of complex products than in the highly 
commoditized futures markets. Even in the most liquid swaps 
products, trading is quite variable. The most active single 
named credit default swap contracts trade a little over 20 
times a day and the majority trade less than once a day. It is 
because of this trading on liquidity characteristic of swaps 
that are so unique that our firms have developed the hybrid 
brokerage methods I have described. Developing and operating 
these hybrid systems creates thousands of well-paying American 
jobs.
    Turning to the regulatory process, I include in my written 
testimony a recent comment letter that lays out simple, 
straightforward recommendations for changes to the proposed SEF 
rules to better accord with the law. For example, Congress made 
very clear in Dodd-Frank that SEFs may conduct business using 
``any means of interstate commerce.'' Congress's words are 
clear. Any means of interstate commerce includes the full range 
of hybrid brokerage methods that I have described.
    We are very concerned with the CFTC's proposed SEF rules 
restricting trading methods to only electronic central limit 
order book or RFQ systems for non-block cleared swaps. This 
approach is inconsistent with the plain reading of Dodd-Frank 
and its legislative history. Henry Ford famously told Model T 
buyers that they could have any color they wanted as long as it 
was black. Here, the CFTC is interpreting Dodd-Frank to say 
that for many trades, SEFs can use any means of interstate 
commerce as long as it is limited to electronic systems.
    We also question what substantive analysis has been done on 
the economic effect of these restrictions which may diminish 
trading liquidity and run up transaction costs for American 
companies and businesses. Getting those rules wrong will impact 
not just banks and investment managers but thousands of 
American companies that use swaps to hedge risk and better 
manage their capital for growth and reinvestment into the 
economy. As Commissioner Chilton said in a recent interview, it 
is important that ``we do not mess up platforms that are 
currently working well. This is a delicate balancing act.''
    Mr. Chairman, consideration and passage of the SEF 
Clarification Act will provide regulators with a clear 
expression of Congress's intent to permit SEFs to use any means 
of interstate commerce to execute swaps transactions. We 
commend this Committee for considering these bipartisan 
proposals. Thank you for your time this morning.
    [The prepared statement of Mr. Giancarlo follows:]

  Prepared Statement of J. Christopher Giancarlo, J.D., Executive Vice
    President--Corporate Development, GFI Group Inc.; Board Member, 
     Wholesale Markets Brokers Association, Americas, New York, NY
Introduction
    Thank you Chairman Lucas, Ranking Member Peterson, and Members of 
the Committee for providing this opportunity to participate in today's 
hearing.
    My name is Chris Giancarlo. I am Executive Vice President of GFI 
Group Inc., a global wholesale broker of swaps and other financial 
products. I am also a member of the Board and former Chairman of the 
Wholesale Markets Brokers Association, Americas (the ``WMBAA'').\1\ I 
am testifying today on behalf of the WMBAA.
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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 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.
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    I welcome the opportunity to discuss with you legislative proposals 
amending Title VII of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act (``Dodd-Frank'') from the perspective of the primary 
intermediaries of over-the-counter (``OTC'') swaps operating today here 
in the United States and across the globe.
    My company, GFI, and the other members of the WMBAA, each have 
generations of experience operating at the center of the global 
wholesale financial markets by aggregating and disseminating prices and 
fostering trading liquidity for financial institutions around the 
world. While I am speaking to you now, wholesale brokers, sometimes 
called ``inter-dealer'' brokers, are facilitating the execution of 
hundreds of thousands of OTC trades corresponding to an average of $5 
trillion in size across the range of foreign exchange, interest rate, 
Treasury, credit, equity and commodity asset classes in both cash and 
derivative instruments.
    Our trading systems or platforms are the prototypes for ``swap 
execution facilities,'' or ``SEFs'' under the Dodd-Frank Act. There is 
a misconception that a ``swap execution facility'' is a new concept 
created by the Dodd-Frank Act. In fact, long before, during and after 
the financial crisis, GFI and my WMBAA brethren have been hard at work, 
employing thousands of people--many here in the United States--
executing swaps transactions that account for over 90% of intermediated 
swaps transactions taking place around the globe.
    CFTC Commissioner Bart Chilton had this to say about a recent visit 
he made to GFI's New York brokerage floor, ``I was surprised by what I 
didn't know. GFI and others like them were always in OTC land. Why 
would I know about what they do? 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.'' \2\
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    \2\ Energy Metro DESK, February 7, 2011. p. 6. The article further 
states, ``Chilton says his trip North to GFI 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.''
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SEF Proposed Rulemakings
    In the past year, the WMBAA has carefully considered and publicly 
responded to the many SEF rule proposals announced by the CFTC and SEC. 
For your reference, I have included a recent comment letter as an 
appendix to this testimony that lays out our primary concerns and makes 
simple, straightforward recommendations for changes to the proposed 
rulemakings.
    The WMBAA appreciates the thoughtful approach of both Commissions 
and their staffs in implementing Dodd-Frank. It is clear that the two 
staffs have worked hard to generally try to balance the compelling 
interests of fostering growth in competitive OTC markets while ensuring 
that regulatory oversight will be in place to monitor for risks to 
these vital markets.
    The WMBAA generally supports the SEC's interpretation of the SEF 
definition as it applies to trade execution through ``any means of 
interstate commerce,'' including the full range of request-for-quote 
(``RFQ'') systems, order books, auction platforms or voice brokerage 
trading that are used in the market today.\3\ Such an approach is 
consistent with the letter and spirit of the Dodd-Frank Act and ensures 
flexibility in the permitted modes of execution.
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    \3\ Wholesale brokers provide highly sophisticated trade execution 
services, combining teams of traditional ``voice'' brokers with 
sophisticated electronic trading technology. 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 diverse and global, these systems have advanced to meet 
the changing needs of the market. Today, these systems include fully 
electronic central limit order books, RFQ systems, automated ``work 
up,'' auction and matching sessions and pricing screens. The particular 
blend of human interaction and trading technology utilized is based on 
the unique liquidity characteristics and market dynamics of individual 
swaps products for the purpose of best enhancing trading liquidity. We 
refer to this integration of voice brokers with the range of electronic 
brokerage systems as ``hybrid brokerage''.
---------------------------------------------------------------------------
    On the other hand, the WMBAA is concerned with the CFTC's proposed 
SEF rules that work to restrict trading methods that are not 
exclusively central limit order book or RFQ for non-block, cleared 
swaps. We believe this approach is inconsistent with the requirement in 
the statute that SEFs may utilize ``any means of interstate commerce.'' 
The CFTC's proposed rule is a one size fits all approach that limits 
market efficiency and customer choice.
    Henry Ford famously told Model T buyers that they could have any 
color they wanted as long as it was black. Here, the CFTC is 
interpreting the Dodd Act to say that, for many trades SEFs can use any 
means of interstate commerce, as long as it is limited to RFQ or 
central limit order book systems.
    The commercial flaw with the CFTC's approach is that it is largely 
the liquidity characteristics of a given swap product, not whether or 
not the instrument is cleared or part of a block transaction, that 
determines which blend of hybrid brokerage is most suited for trade 
execution. We know from decades of experience that, if a swap trades in 
high volume with great liquidity, then central limit order book systems 
may work fine. If, however, the particular swap instrument trades in 
lower volume with limited liquidity, then electronic order book systems 
will not succeed and other ``hybrid'' methods are more suitable. For 
these reasons, it is the position of the WMBAA that hybrid brokerage 
should be clearly recognized as an acceptable mode of trade execution 
for all swaps whether ``Required'' or ``Permitted'' under the CFTC's 
proposal.
    We believe this rule proposal is not supported by a plain reading 
or the legislative history of the Dodd-Frank Act. Worse, it will 
constrain the very ``hybrid'' systems that are currently relied upon 
for liquidity formation in U.S. swaps markets. In swaps markets without 
retail customer participation, the WMBAA questions what useful 
protections are afforded to swap dealers and major swap participants by 
regulations that would limit the methods by which they may execute 
their swaps transactions.
    These regulatory proposals need to be carefully considered not only 
in their own right, but more so for their snowball effect that could 
impact U.S. economic growth, competitiveness and, most critically, much 
needed American job creation. Getting those rules wrong will impact not 
just banks and investment managers, but thousands of American 
businesses that use swaps to hedge risk and better manage their capital 
for growth and reinvestment into the economy.
SEF Clarification Act
    Mr. Chairman, introduction, consideration, and passage of the SEF 
Clarification Act will provide regulators with a clear expression of 
Congress' legislative intent and ensure that the final rules remain 
within the framework of competitive OTC markets. The WMBAA commends 
this Committee for considering this very important bipartisan proposal. 
This hearing is sending a loud and clear message to the CFTC that its 
proposed SEF rule is inconsistent with the intent of the authors of 
Section 733 of the Dodd-Frank Act.
    The WMBAA appreciates the bipartisan efforts of Congressmen Scott 
Garrett, Robert Hurt, Gregory Meeks and Congresswoman Carolyn Maloney 
to try and make sure that the interpretations of the Dodd-Frank Act 
rules governing swap execution facilities foster competitive sources of 
liquidity for market participants. We agree with their concern to 
promote the transparent evolution of swaps trading on SEFs to ensure 
that a vibrant swap market continues to develop in the U.S.
    The WMBAA continues to work with the CFTC and SEC to help create a 
regulatory framework that promotes a competitive marketplace for SEFs. 
The WMBAA remains concerned, as it has expressed in its comment letters 
to the SEC and the CFTC, that limitations on permitted modes of trade 
execution or requirements to display or delay quotes will cause 
significant disruptions to OTC swaps markets with the potential to 
drive trading offshore. We question what substantive analysis has been 
done on the economic effects of the CFTC proposed rule, which could run 
up transaction costs in the U.S. swaps markets.
    Similarly, the WMBAA does not believe that there is any 
justification or legislative authority for the RFQ requirement of five 
possible respondents. Rather, consistent with the Dodd-Frank Act's SEF 
definition, the threshold analysis should consider whether the system 
meets the ``multiple to multiple'' requirement set forth in the SEF 
definition. The WMBAA finds it inconsistent that the CFTC's proposed 
rules permit a SEF to operate a ``multiple to one'' RFQ system, while 
at the same time (without clear explanation), impose arbitrary limits 
on the various multiple-to-multiple hybrid execution platforms utilized 
by wholesale brokers. By contrast, the SEC's proposed rule merely 
requires that a RFQ system has the ``ability'' to send the request to 
many participants, but not an obligation. We believe that the SEC's 
approach is more consistent with the statutory language of the Dodd-
Frank Act.
    Just as regulators were intimately involved in the debate 
surrounding the legislation that resulted in the Dodd-Frank Act, we 
encourage Congress to remain vigilant in its oversight of the 
regulatory rulemaking process. We applaud legislators for providing 
additional guidance to a regulatory agency misinterpreting statutory 
language and Congressional intent.
WMBAA Suggested Revisions to the CFTC SEF Rulemaking
    In our most recent comment letter to the CFTC, the WMBAA identified 
the following as highest priority issues for attention:

   ``Permitted''/``Required'' Transaction Classification 
        System. The WMBAA does not believe that distinguishing between 
        ``Permitted'' and ``Required'' swaps is beneficial to the 
        continued operation of competitive, liquid OTC markets. Such 
        artificial designations of swap transactions may result in 
        perverse consequences to OTC swaps markets. Further, the 
        proposed restriction for ``Required Transactions'' to only 
        those traded on order books or RFQ systems is contrary to the 
        Commodity Exchange Act (``CEA's'') permitted transaction of 
        swaps ``by any means of interstate commerce'' (emphasis added). 
        Under the current classifications, many hybrid brokerage 
        methodologies may be prohibited or face an uncertain future, as 
        each would require individual analysis by the Commission for 
        compliance with the core principles. While certain requirements 
        should be mandated during trade execution (i.e., audit trail, 
        trade processing, and reporting), limitations on methodologies 
        used in trade execution should be considered in accordance with 
        Congress' authorization of trade execution through ``any means 
        of interstate commerce'' and weighed against any potential 
        implications on liquidity formation and American market 
        competitiveness.

   The ``15 Second Rule.'' The WMBAA believes that the CFTC's 
        proposed 15 second timing delay before a trader can execute 
        against a customer's order or a SEF can execute two customers 
        against each other is not contemplated by CEA, as amended by 
        the Dodd-Frank Act, nor is it supported by legislative history. 
        This concept, which seems to have originated in the futures 
        exchange markets, will create uncertainty and risk in the swaps 
        markets. This requirement does not appear to be consistent with 
        the protection of investors. Even asset management firms, 
        acting on behalf of state and local government pension funds, 
        endowments, ERISA funds, 401(k) and similar types of retirement 
        funds, all of whom have a statutory fiduciary duty to their 
        clients, are opposed to this requirement.\4\ The WMBAA 
        recognizes that this approach may work in the highly liquid 
        futures market. However, the 15 second delay ignores the 
        episodic nature of liquidity in the swaps markets and will have 
        a detrimental impact on transactional efficiency, cost and 
        market liquidity. The WMBAA questions what substantive analysis 
        has been done on the economic effects of 15 Second Rule, which 
        could run up transaction costs in the U.S. swaps markets 
        frustrating American companies' ability to hedge commercial 
        risk, particularly end-users.
---------------------------------------------------------------------------
    \4\ See, e.g., letter from Timothy W. Cameron, Esq., Managing 
Director, Asset Management Group, Securities Industry and Financial 
Markets Association, to CFTC, dated March 8, 2011.

   SEF Impartial Access. The WMBAA has requested that the CFTC 
        delete the provision in the Proposed Rules providing impartial 
        access to SEFs for independent software vendors (``ISVs''). The 
        WMBAA believes this requirement is beyond the legal authority 
        granted in the CEA and expands the impartial access statute 
        beyond ``market participants'' to include entities lacking any 
        intent to transact in swaps. There is no Congressional intent 
        or legislative history to indicate that the term ``market 
        participants'' should be read beyond the commonly understood 
---------------------------------------------------------------------------
        definition as used by the industry today.

   Margin Assumptions. In the CFTC's proposed rule for risk 
        management requirements for derivatives clearing organizations 
        (``DCOs''), DCOs must establish initial margin requirements 
        that, in part, take into account the amount of time needed to 
        liquidate a defaulting clearing member's position. To that end, 
        the DCO must use a five business day liquidation horizon for 
        cleared swaps not executed on a designated contract market 
        (``DCM''), but a one business day liquidation horizon for all 
        other products that it clears. The result of this proposed 
        arrangement would be that DCOs would impose higher margin 
        requirements for swaps executed on SEFs than swaps executed on 
        DCMs. This result would be inconsistent with the competitive 
        trade execution landscape envisioned by the Dodd-Frank Act. 
        Such a regulatory scheme may also violate specific provisions 
        of the Dodd-Frank Act which require a DCO to adopt rules 
        providing that all swaps with the same terms and conditions 
        submitted to the DCO for clearing are economically equivalent 
        within the DCO and may be offset with each other within the 
        DCO.
Harmonization
    While the substance of the proposed requirements for SEF 
registration and core principles are extremely important, it is 
equally, if not more, important that the final regulatory frameworks 
are harmonized between the two agencies. A failure to achieve 
harmonization will lead to regulatory arbitrage and unreasonably burden 
market participants with redundant compliance requirements. As the 
recent SEC-CFTC joint proposed rule recognized, ``a Title VII 
instrument in which the underlying reference of the instrument is a 
`narrow-based security index' is considered a security based swap 
subject to regulation by the SEC, whereas a Title VII instrument in 
which the underlying reference of the instrument is a security index 
that is not a narrow-based security index (i.e., the index is broad-
based) is considered a swap subject to regulation by the CFTC.'' Any 
discrepancy in the Commissions' regulatory regimes will give market 
participants incentive to leverage the slight distinctions between 
these products to benefit from more lenient rules.
    Similarly, 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 balance 
execution flexibility with participant protections. For example, GFI 
businesses are operating and subject to oversight in the UK by the FSA 
and globally by regulatory agencies in France, Singapore, Hong Kong, 
Japan and Korea. European and Asian markets are not imposing 
restrictions on methods of execution. U.S. regulations need to be in 
harmony with those of foreign jurisdictions to avoid driving trading 
liquidity away from U.S. markets to those offering greater flexibility 
in modes of trade execution.
``Rule of Construction''--Pre-Trade Price Transparency
    Section 5h of the CEA, as amended by Section 733 of the Dodd-Frank 
Act, includes a ``rule of construction'' indicating that ``the goal of 
this section is to promote the trading of swaps on swap execution 
facilities and to promote pre-trade price transparency in the swaps 
market.''
    This rule of construction, which was added during the House-Senate 
Conference Committee, is an aspirational and undefined goal. It must be 
considered subordinate to the required statutory provisions of the 
Dodd-Frank Act. According to a Congressional Research Services report, 
longstanding principles of statutory interpretation indicate that 
particular substantive requirements, such as the mandate that 
regulators consider the impact of certain actions on market liquidity, 
override general canons of statutory construction. There are no 
operative provisions for pre-trade price transparency in the Dodd-Frank 
Act that correspond to the non-binding rule of construction. However, 
there exist other substantive provisions which were designed to 
increase transparency in OTC swaps markets.
    For example, Section 2a(13)(E) of the CEA requires that, for rules 
providing for the public availability of transaction and pricing data 
for swaps, the CFTC shall contain provisions ``that take into account 
whether the public disclosure will materially reduce market 
liquidity.'' The same provision requires that the CFTC consider an 
``appropriate time delay for reporting large notional swap transactions 
(for block trades) to the public.'' These post-trade reporting 
requirements are indicative of Congressional recognition that OTC swaps 
markets thrive when the need for transparency is balanced against the 
impact on market liquidity. Congress clearly sought to preserve market 
liquidity and protect businesses' ability to hedge commercial risk and 
to appropriately plan for the future, promoting economic growth and job 
creation.
    Further, the SEF core principles in Section 5h(f) of the CEA 
require a SEF to make public timely information on price, trading 
volume, and other trading data on swaps and electronically capture and 
transmit trade information with respect to transactions executed on the 
facility. These statutory requirements precede any legislative 
``goals'' that may be imposed by regulatory rulemakings. The SEF core 
principles ensure that market information is promptly and accurately 
reported to both regulators and to market participants without 
materially impeding liquidity formation. To impose requirements in any 
other manner would disrupt the competitive trade execution marketplace, 
where trading systems or platforms vie with each other to win their 
customers' business through better price, provision of superior market 
information and analysis, deeper liquidity and better service.
    It is important to recognize that the ``goal'' of pre-trade price 
transparency is not inconsistent with the traditional operations of 
wholesale brokers. Because revenue is generated from commissions paid 
on executed trades, wholesale brokers seek to complete more 
transactions with more customers. It is in each wholesale brokers 
economic interest to naturally and consistently disseminate pre-trade 
price information--bids and offers--to the widest practical range of 
customers with the express purpose of price discovery and the matching 
of buyers and sellers. The trading systems and platforms employ a 
number of means of pre-trade transparency, including software pricing 
analytics, electronic and voice price dissemination, and electronic 
price work up technology.
    Wholesale brokers generally maintain extensive trade reporting 
systems supported by sophisticated technology that can provide 
regulators with real-time trading information, increasing transparency 
and providing critical information on financial conditions and market 
dynamics. Wholesale brokers also increase transparency in OTC markets 
by publishing market and pricing data and facilitating enhanced audit 
trails to monitor against market fraud and manipulation.
Different Characteristics of Futures and OTC Markets
    While the relationship between exchange-traded and OTC markets 
generally has been complementary, 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, 
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 comparison, many swaps markets and other less commoditized cash 
markets feature a broader array of less-standardized 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. 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.\5\ Such thin liquidity can often be episodic, with liquidity peaks 
and troughs that can be seasonal (certain energy products) or more 
volatile and tied to external market and economic conditions (e.g., 
many credit, energy and interest rate products).
---------------------------------------------------------------------------
    \5\ 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 6
------------------------------------------------------------------------
       Characteristic              OTC Swaps           Listed Futures
------------------------------------------------------------------------
Trading Counterparties        10s-100s (no         100,000s (incl.
                               retail)              retail)
\6\ See ISDA/SIFMA Block
 Trade Study.
Daily Trading Volume          1,000s               100,000s
Tradable Instruments          100,000s 7           1,000s
\7\ Inclusive of all tenors,
 strikes and duration.
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 the Dodd-Frank Act. The 
distinct nature of swaps liquidity has been the subject of several 
studies and comment letters presented to the CFTC and the SEC.\8\
---------------------------------------------------------------------------
    \8\ ISDA/SIFMA Block Trade Study; Comment Letter of JPMorgan 
(January 12, 2011).
---------------------------------------------------------------------------
    The unique nature of swaps markets liquidity was recently analyzed 
by the New York Federal Reserve.\9\ Their study found that the most 
active of single-name CDS contracts traded a little over 20 times per 
day, and the majority of single name CDS contracts trade less than once 
a day, but in very large sizes. This is wholly different than the 
hundreds of thousands of trades that take place each day in many 
exchange traded instruments.
---------------------------------------------------------------------------
    \9\ Kathryn Chen, Michael Fleming, John Jackson, Ada Li, and Asani 
Sarkar, An Analysis of CDS Transactions: Implications for Public 
Reporting (September 2011), available at http://www.newyorkfed.org/
research/staff_reports/sr517.pdf.
---------------------------------------------------------------------------
    It is because of the limited liquidity in many 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 such as GFI Group. 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.
American Capital Markets Risk Being Driven Offshore--Again
    In closing, it is clear that the U.S. over-the-counter swaps 
markets are on the cusp of seismic changes that could have unintended, 
yet far reaching, consequences if not enacted with prudence and common 
sense.
    We are reminded of the sensitivity of the regulatory process by the 
effects of a whole other set of U.S. financial market regulations that 
were put in place several decades ago. Those regulations remind us of 
the eternal law of unintended consequences.
    Many professionals in the swaps brokerage industry began work in 
the late 1970s and 1980s in London. In those days, London was the 
central marketplace for bank deposits of billions of U.S. Dollars held 
outside the U.S.--the so-called Euro-dollar market. The most critical 
stimulus for the development of the Euro-dollar market was Regulation Q 
promulgated under the Glass-Steagall Act. Under Reg Q, the Federal 
Reserve fixed maximum interest rates that U.S. member banks could pay 
on U.S. Dollar deposits. Because of these ceilings, Dollar deposits in 
non-U.S. banks, paying a higher interest rate, became more attractive 
than deposits in U.S. banks. As a result, the overseas Euro-dollar 
market grew rapidly. Combined with various U.S. foreign exchange 
controls, Reg Q led to the development of a major non-U.S. marketplace 
for deposits of U.S. currency. That non-U.S. marketplace stimulated all 
manner of economic development and job creation--NOT jobs here in the 
United States, but overseas in London and elsewhere.
    It is useful to keep in mind this ill-fated financial regulation in 
the course of today's hearing of proposed U.S. regulations of SEFs. We 
must look carefully at these regulations not only in their own right, 
but also for their impact on U.S. economic growth, market vibrancy and, 
most critically, job creation. It is well worth our time to ask 
ourselves:

   Which regulations being proposed today will constrict 
        liquidity tomorrow in U.S. swaps markets?

   Will the ``15 second rule'' be the new Reg. Q shifting U.S. 
        markets offshore?

   Will regulatory bias toward electronic trading for 
        clearable, non-block swaps drive markets to places that allow 
        trading to be done through the greater flexibility of hybrid 
        execution?

   Will certain rule proposals lead to the loss of jobs for 
        U.S. hybrid brokerage employees and their replacement with 
        workers abroad?

    In posing these questions, we should be aware that the answers are 
not only important to us in America, but are also being weighed by the 
Lord Mayors of London and Geneva, the exchange operators of Singapore 
and the financial industrialists of Hong Kong and Beijing. Their gain 
is our loss. As American businesses and employers, we must get it right 
for the sake of the American economy and jobs.
         Appendix--WMBAA Letter to the SEC & CFTC--June 3, 2011
June 3, 2011
 Hon. Gary Gensler,                   Hon. Mary Schapiro,
Chairman,                            Chairman,
Commodity Futures Trading            Securities and Exchange Commission
 Commission,
Washington, D.C.;                    Washington, D.C.

Re: Implementation of the Dodd-Frank Wall Street Reform and Consumer 
    Protection Act; Core Principles and Other Requirements for Swap 
    Execution Facilities (RIN 3038-AD18); Real-Time Public Reporting of 
    Swap Transaction Data (RIN 3038-AD08); Reporting and Dissemination 
    of Security-Based Swap Information (File 3235-AK80); Registration 
    and Regulation of Security-Based Swap Execution Facilities (RIN 
    3235-AK93)

    Dear Chairman Gensler and Chairman Schapiro:

    As a follow-up to the participation of Wholesale Markets Brokers' 
Association Americas (``WMBAA'') \1\ members in the joint staff 
roundtable hosted by the Commodity Futures Trading Commission (``CFTC'' 
or ``Commission'') and the Securities and Exchange Commission (``SEC'' 
or ``Commission'') on May 3 and May 4, 2011 dedicated to discussing the 
implementation of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act (``Dodd-Frank Act''), the WMBAA appreciates the 
opportunity to provide additional comments related to the importance of 
proper harmonization of and implementation by the two agencies as the 
rulemaking process advances.
---------------------------------------------------------------------------
    \1\ The Wholesale Markets Brokers' Association 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 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 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 WMBAA sees a major opportunity to assist in the monitoring and 
consequent reduction of systemic risk in the country's capital markets. 
For more information, please see www.wmbaa.org.
---------------------------------------------------------------------------
    The WMBAA believes that it is vital to the stability and liquidity 
provided by OTC swaps and security-based swaps (collectively referred 
to as ``swaps'') markets to ensure that swap and security-based swap 
execution facilities (collectively referred to as ``SEFs'') are brought 
under the new regulatory regime in such a way that fosters the 
competitive nature of OTC markets and continues to provide a deep 
source of liquidity for market participants.
    In addition to the formal comments previously submitted with 
respect to the CFTC and SEC's proposed rules,\2\ the WMBAA offers 
additional comments on the appropriate implementation of the proposed 
rules and substantive requirements that would pose significant burdens 
unless harmonized between the CFTC and SEC.
---------------------------------------------------------------------------
    \2\ See, e.g., letter from J. Christopher Giancarlo, Chairman, 
WMBAA, to SEC and CFTC, dated July 29, 2010; see also letter from 
Julian Harding, Chairman, WMBAA, to SEC and CFTC, dated November 19, 
2010; letter from Julian Harding, Chairman, WMBAA, to SEC and CFTC, 
dated November 30, 2010; letter from Julian Harding, Chairman, WMBAA, 
to SEC, dated January 18, 2011; letter from Stephen Merkel, Chairman, 
WMBAA, to CFTC, dated February 7, 2011; letter from Stephen Merkel, 
Shawn Bernardo, Christopher Ferreri, J. Christopher Giancarlo and 
Julian Harding, WMBAA, to CFTC, dated April 4, 2011.
---------------------------------------------------------------------------
    The WMBAA also recognizes that certain provisions of the Commodity 
Exchange Act (``CEA'') and the Securities Exchange Act of 1934 (``1934 
Act''), as amended by the Dodd-Frank Act, impose specific requirements 
on market participants as of the effective date, July 16, 2011. In 
particular, we note the statutory provisions could be read to require 
on and after July 16, 2011 the ``trading'' of swaps only on registered 
designated contract markets (``DCMs''), national securities exchanges 
and SEFs.
    Congress envisioned that the Title VII rulemaking process would 
move quickly and that all rules and regulations would be in place prior 
to the July 16, 2011 effective date. It is clear that final rules for 
the registration of SEFs will not be in place by the July 16, 2011 
effective date. Further, the Commissions have not made any 
determinations about which swaps will be subject to the mandatory 
clearing requirement, which will dictate which swaps are required to be 
traded on a SEF.
    The WMBAA is concerned that, absent regulatory relief by the 
Commissions, existing trade execution systems or platforms such as 
those provided by WMBAA members, and the swaps transactions entered 
into thereon will be subject to significant legal uncertainty due to 
the incomplete rulemaking process. Further, we believe IDBs should not 
be required to register as futures commission merchants (``FCMs''), 
introducing brokers (``IBs'') or broker-dealers to ``broker'' swaps 
while the Commissions are in the process of finalizing the SEF 
registration and regulation rules.\3\ The WMBAA strongly encourages the 
Commissions to issue as soon as possible a legal opinion, no action 
position or guidance which clarifies that swaps entered into after July 
15, 2011 are not required to be traded on a registered DCM, national 
securities exchange and/or SEF or brokered by a registered FCM, IB or 
broker-dealer until the Commissions have issued final rules which are 
effective regarding the registration of SEFs and issued final rules 
which are effective with respect to the mandatory trading of swaps. The 
WMBAA looks forward to discussing the impact of the self-effectuating 
provisions in the CEA and 1934 Act with the Commissions.
---------------------------------------------------------------------------
    \3\ The WMBAA notes that, among the extensive Dodd-Frank Act 
rulemakings, the CFTC has not comprehensively addressed the regulation 
of brokers engaged in swap-related activities. Section 721 of the Dodd-
Frank Act amends the definitions of ``futures commission merchants'' 
and ``introducing brokers'' in the CEA to permit these intermediaries 
to trade swaps on behalf of customers. As of the effective date, these 
intermediaries may be required to register with the CFTC and become 
members of the National Futures Association. As such, these 
intermediaries would be subject to the National Futures Association's 
rules and examinations, for example Series 3 examination, which is 
based on futures-related activity. The WMBAA urges the CFTC to provide 
clarity on this issue by delaying the implementation of swap 
introducing broker and futures commission merchant registration and 
issuing interpretive guidance to assist swap intermediaries in 
understanding what activities might mandate registration and the 
requirements for Commission registration.
---------------------------------------------------------------------------
Importance of Harmonization between Agencies and Foreign Regulators
    While the substance of the proposed requirements for SEF 
registration and core principles are extremely important, it is 
equally, if not more, important that the final regulatory frameworks 
are harmonized between the two agencies. A failure to achieve 
harmonization will lead to regulatory arbitrage and unreasonably burden 
market participants with redundant compliance requirements. As the 
recent SEC-CFTC joint proposed rule recognized, ``a Title VII 
instrument in which the underlying reference of the instrument is a 
`narrow-based security index' is considered a security-based swap 
subject to regulation by the SEC, whereas a Title VII instrument in 
which the underlying reference of the instrument is a security index 
that is not a narrow-based security index (i.e., the index is broad-
based), the instrument is considered a swap subject to regulation by 
the CFTC.'' \4\ Any discrepancy in the Commissions' regulatory regimes 
will give market participants incentive to leverage the slight 
distinctions between these products to benefit from more lenient rules.
---------------------------------------------------------------------------
    \4\ Further Definition of ``Swap,'' ``Security-Based Swap,'' and 
``Security-Based Swap Agreement''; Mixed Swaps; Security-Based Swap 
Agreement Recordkeeping, 76 Fed. Reg. at 29 845 (May 23, 2011).
---------------------------------------------------------------------------
    The Dodd-Frank Act's framework was constructed to encourage the 
growth of a vibrant, competitive marketplace of regulated SEFs. Final 
rules should be crafted that encourage the transaction of OTC swaps on 
these trading systems or platforms, as increased SEF trading will 
increase liquidity, and transparency for market participants and 
increase the speed and accuracy of trade reporting to swap data 
repositories (``SDRs''). Certain provisions relate to these points, 
such as the permitted methods of trade execution, the scope of market 
entities granted impartial access to SEFs, the formulation of block 
trade thresholds and compliance with SEF core principles in a flexible 
manner that best recognizes the unique characteristics of competitive 
OTC swaps markets.
    Based upon its review of both the SEC and the CFTC's Proposed 
Rules, the WMBAA suggests that the agencies consider the release of 
further revised proposed rules incorporating comments received for 
additional review and comment by market participants. This exercise 
would ensure that the SEC and CFTC have the opportunity to review each 
of their proposals and integrate appropriate provisions from the 
proposed rules and comments in order to arrive at more comprehensive 
regulations. Further, the WMBAA encourages the CFTC and SEC to work 
together to attempt to harmonize their regulatory regimes to greatest 
extent possible. While some of the rules will differ as a result of the 
particular products subject to each agency's jurisdiction, inconsistent 
rules will make the implementation for SEFs overly burdensome, both in 
terms of time and resources.
    As an example, the WMBAA encourages the CFTC and the SEC to adopt 
one common application form for the registration process. While 
regulatory review of the application by the two agencies is 
appropriate, reducing the regulatory burden on applicant SEFs to one 
common form would allow for a smoother, timelier transition to the new 
regulatory regime. Because the two proposed registration forms are 
consistent in many respects, the WMBAA believes the differences between 
the two proposed applications could be easily reconciled to increase 
regulatory harmonization and increase efficiency.
    Similarly, there needs to be a consistent approach with respect to 
block trades. Not only should the threshold calculations be derived 
from similar approaches, allowing for tailored thresholds that reflect 
the trading characteristics of particular products, but the methods of 
trade execution permitted by the Commissions should both be flexible 
and within the framework of the SEF definition.
    U.S. regulations also need to be in harmony with regulations of 
foreign jurisdictions to avoid driving trading liquidity away from U.S. 
markets toward markets offering greater flexibility in modes of trade 
execution. In particular, European regulators have not formally 
proposed swap execution rules with 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 an OTC swaps market that excludes retail participants, 
the WMBAA questions what useful protections are afforded to swap 
dealers and major swap participants by regulations that would limit the 
methods by which they may execute their orders. 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.
Implementation of Final Rules
Compliance Timeline
    The WMBAA believes that the timeline for implementation of the 
final rules is as important, if not more important than, the substance 
of the regulations. The WMBAA members recognize and support the 
fundamental changes to the regulation of the OTC swaps markets 
resulting from the passage of the Dodd-Frank Act and will commit the 
necessary resources to diligently meet the new compliance obligations. 
However, the CFTC and SEC must recognize that these changes are 
significant and will result in considerable changes to the operations 
and complex infrastructure of existing trading systems and platforms.
    It is necessary that any compliance period or registration deadline 
provides sufficient opportunity for existing trade execution systems or 
platforms to modify and test systems, policies and procedures to ensure 
that its operations are in compliance with final rules. It is very 
difficult to determine the amount of time needed to ensure compliance 
with the rules until the final requirements are made available. 
However, providing market participants with an insufficient time frame 
for compliance could harm the efficient functioning of the markets if 
existing entities can no longer operate until they have built the 
requisite platforms to comply with every measure in final rules.
    The vast number of changes required to existing trading systems or 
platforms to register as a SEF will impose a substantial burden in the 
short term. Upon implementation of the Dodd-Frank Act and final rules, 
wholesale brokers that register as SEFs will be required to undertake 
activities that include, but are not limited to: (i) developing 
extensive rulebooks; (ii) meeting new substantive and reporting-related 
financial requirements; (iii) implementing sophisticated trading, 
surveillance, monitoring and recordkeeping processes and technology; 
(iv) creating extensive self-regulatory capabilities and entering into 
arrangements with their customers setting forth the terms of this new 
arrangement; (v) potentially restructuring the governance structure of 
their companies, including identifying and recruiting independent board 
members and establishing required governance committees; (vi) 
potentially altering the mix of their existing customer base and adding 
new customers; (vii) implementing appropriate contractual and 
technological arrangements with clearing houses and SDRs; (viii) hiring 
staff and creating a compliance program structured to meet the 
Commissions' specifications; and (ix) educating staff on the 
requirements relating to trade execution, clearable vs. non-clearable 
trades, blocks vs. non-blocks, bespoke and illiquid trades, end-users 
vs. non-end-users and margin requirements.
    As this list indicates, these undertakings are monumental. This 
burden is compounded when considering that the users of intermediary 
services will themselves be going through dramatic change, responding 
to new clearing, margin and capital requirements, new business conduct 
standards and changes to the means by which they are able to interact 
with their end customers. The WMBAA would suggest the SEC and CFTC 
consider the implementation of other regulatory regimes with lesser 
burdens than the Dodd-Frank Act, such as the introductions of TRACE 
reporting for corporate bonds and Regulations SHO and NMS in the equity 
markets. The imposition of these new regimes was far less drastic of a 
change to the markets and required participants to expend far fewer 
resources. Yet, the imposition of these regimes, particularly 
Regulation NMS, was conducted over a staged period to allow market 
participants sufficient time to comply.
Appropriate ``Phasing'' of Final Rules
    Based upon the plain language of the Dodd-Frank Act, the mandatory 
trade execution requirement will become effective at the time that 
swaps are deemed ``clearable'' by the appropriate Commission. Accepting 
the premise that the mandatory trade execution requirement cannot be 
enforced until there are identified ``clearable'' swaps and swaps are 
``made available for trading,'' the Commissions need to ensure that a 
functioning and competitive marketplace of registered SEFs exists at 
the time the first trade is cleared and made available for trading. As 
such, it is necessary that SEFs be registered with the CFTC or SEC, as 
applicable and available to execute transactions at the time that 
trades begin to be cleared under the new laws. The WMBAA estimates that 
its members currently account for over 90% of inter-dealer 
intermediated swaps transactions taking place around the world today. 
If the SEF registration process is not effectively finalized by the 
time various swaps are deemed clearable, there could be serious 
disruptions in the U.S. swaps markets with adverse consequences for 
broader financial markets.
    Furthermore, requiring absolute compliance with final rules within 
a short time frame is particularly troublesome for likely future SEFs, 
as such a result may provide DCMs or national securities exchanges with 
an unfair advantage in attracting trading volume due to their ability 
to quickly meet the regulatory burdens. Congress distinguished between 
exchanges and SEFs, intending for competitive trade execution to be 
made available on both platforms. Congress also recognized the 
importance of SEFs as distinct from exchanges, noting that a goal of 
the Dodd-Frank Act is to promote the trading of swaps on SEFs. The 
phasing in of final rules for both exchanges and SEFs should be done 
concurrently to ensure that this competitive landscape remains in place 
under the new regulatory regime.
    Not only will implementation of the final rules impact market 
infrastructure, but the timing in which these rules are implemented 
could significantly impact U.S. financial markets. As Commissioner Jill 
Sommers recently remarked before the House Agriculture General Farm 
Commodities and Risk Management Subcommittee, ``a material difference 
in the timing of rule implementation is likely to occur, which may 
shift business overseas as the cost of doing business in the U.S. 
increases and create other opportunities for regulatory arbitrage.'' 
\5\ If the U.S. regulations are implemented before foreign regulators 
have established their intended regulatory framework, it could put U.S. 
markets at a significant disadvantage and might result in depleted 
liquidity due to regulatory arbitrage opportunities.
---------------------------------------------------------------------------
    \5\ Statement of Jill E. Sommers before the Subcommittee on General 
Farm Commodities and Risk Management, House Committee on Agriculture, 
May 25, 2011, available at http://agriculture.house.gov/pdf/hearings/
Sommers110525.pdf.
---------------------------------------------------------------------------
    As the rulemaking process moves forward, the WMBAA suggests the 
following progression of rules be completed:

   First, finalize product definitions. Providing the market 
        with certainty related to the scope of what constitutes a 
        ``swap'' and ``security-based swap'' will allow market 
        participants to accurately gauge the impact of the other 
        proposed rules and provide constructive feedback on those 
        rules.

   Second, implement final rules related to real-time reporting 
        for regulatory oversight purposes. The submission of 
        information to SDRs is an activity that takes place in many OTC 
        markets today and will not unduly burden those who must comply 
        with the requirement. Ensuring that the Commissions receive 
        current, accurate market data is a cost-effective method to 
        mitigate systemic risk in the short-term.

   Next, establish block trade thresholds and finalize public 
        reporting rules. The information gathered by SDRs since the 
        implementation of the mandatory trade reporting requirement, 
        along with historical data made available by trade repositories 
        and trade execution facilities, can be used to determine the 
        appropriate threshold levels on a product-by-product basis. At 
        the same time, public reporting rules can be put into place, 
        including an appropriate time delay (that is consistent with 
        European and the other major global market rules) for block 
        trades.

   After the reporting mechanics have been established, the 
        clearing mandate can be implemented. During this step, the 
        Commissions can determine what swaps are ``clearable'' and 
        subject to the clearing mandate, and clearinghouses can 
        register and begin to operate within the new framework.

   Finally, once swaps are deemed clearable, the mandatory 
        trade execution requirement can be put into place for SEFs and 
        DCMs for those products made available for trading. The WMBAA 
        believes that all clearable swaps will be made available for 
        trading by SEFs, as these trade execution platforms compete to 
        create markets and match counterparties. With the trade 
        execution requirement's implementation, it is imperative that 
        rules for SEFs and DCMs are effective at the same time, as 
        implementing either entity's rules prior to the other will 
        result in an unfair advantage for capturing market share of 
        executable trades simply because they could more quickly meet 
        the regulatory burdens.
Flexible Approach to SEF Registration, Permitted Modes of Trade 
        Execution, Impartial Access
    The WMBAA members have long acted as intermediaries in connection 
with the execution of swaps in the OTC market. While a regulated OTC 
market is new to the swap markets, the WMBAA members are already 
subject to oversight by financial regulators across the globe, 
including the SEC and the CFTC, for services offered in a range of 
other products and markets. The WMBAA members have acted as OTC swap 
execution platforms for decades and, as a result, understand what is 
necessary to support and promote a regulated, competitive and liquid 
swaps market. Although a SEF might be a new concept originating in the 
Dodd-Frank Act, the effective role of existing intermediaries in the 
OTC swaps marketplace is not.
    The WMBAA supports a flexible approach to evaluating applicant 
SEFs. As Congress recognized and mandated by law, to promote a 
competitive and liquid swaps market, trade execution ``through any 
means of interstate commerce'' establishes a broad framework that 
permits multiple modes of swap execution, so long as the proposed mode 
of execution is capable of satisfying the statutory requirements.
    The WMBAA believes that any interpretation of the SEF definition 
must be broad, and any trading system or platform that meets the 
statutory requirements should be recognized and registered as a SEF. 
The WMBAA supports a regulatory framework that allows any SEF applicant 
that meets the statutory requirements set forth in the Dodd-Frank Act 
to be permitted to operate under each Commission's rules in accordance 
with the Dodd-Frank Act.
    The WMBAA strongly supports the SEC's interpretation of the SEF 
definition as it applies to trade execution through any means of 
interstate commerce, including request for quote systems, order books, 
auction platforms or voice brokerage trading, because such an approach 
is consistent with the letter and spirit of the Dodd-Frank Act and 
ensures flexibility in the permitted modes of execution. The WMBAA 
believes that this approach should be applied consistently to all 
trading systems or platforms and will encourage the growth of a 
competitive marketplace of trade execution facilities.
    Further, the WMBAA is concerned with the CFTC's interpretation of 
the SEF definition, as it limits the permitted modes of trade 
execution, specifically restricting the use of voice-based systems to 
block trades. The SEF definition and corresponding requirements on the 
CEA, as amended by the Dodd-Frank Act, do not provide any grounds for 
this approach and will severely impair other markets that rely on 
voice-based systems (or hybrid systems, which contain a voice 
component) to create liquidity.
Permitted Use of Voice and Hybrid Trade Execution Platforms
    The CFTC's proposed mandate precludes the use of voice-based 
systems for ``Required Transactions'' without any explanation of why 
the permitted modes of execution should be more restrictive than the 
statute dictates. The WMBAA is concerned that such a rigid 
implementation of the SEF framework will devastate existing voice and 
``hybrid'' systems (described below) that are currently relied upon for 
liquidity formation in global swaps markets. ``Hybrid brokerage,'' 
which integrates voice with electronic brokerage systems, should be 
clearly recognized as an acceptable mode of trade execution, for all 
swaps trade execution. The combination of traditional ``voice'' brokers 
with sophisticated electronic trading and matching systems is necessary 
to provide liquidity in markets for less commoditized products where 
liquidity is not continuous. Failure to unambiguously include such 
systems is not only inconsistent with the Dodd-Frank Act but will 
severely limit liquidity production for a wide array of transactions. 
The WMBAA remains concerned that such a restrictive SEF regime will 
lead to market disruption and, worse, liquidity constriction with 
adverse consequences for vital U.S. capital markets.
    What determines which blend of hybrid brokerage is adopted by the 
markets for any given swap product is largely the market liquidity 
characteristic of that product, whether or not the instrument is 
cleared. For example, a contract to trade Henry Hub Natural Gas 
delivered in Summer 2017, though cleared, will generally be 
insufficiently liquid to trade on a central limit order book. This is 
true the farther out the delivery date for many cleared products, where 
market makers are unwilling to post executable bids and offers in 
instruments that trade infrequently. In markets where price spreads are 
wide or trading is infrequent, central limit order books are not 
conducive to liquidity, but rather may be disruptive to it.
    Critically, what determines which blend of hybrid brokerage is 
adopted by the markets for any given swap product also has little to do 
with whether the size of a transaction is sufficient or not to be a 
block trade. Block trades concern the size of an order, as opposed to 
the degree of market liquidity or presence of tight bid-offer spreads. 
Depending on where block trade thresholds are set, block trades can 
take place in markets from very illiquid to highly liquid. Yet, central 
limit order book trade execution generally only works well in markets 
with deep liquidity, and such liquidity is not always available even 
within a usually liquid market. For less liquid markets, even non-block 
size trades depend on a range of trading methodologies distinct from 
central limit order book or request for quote. For these reasons, 
hybrid brokerage should be clearly recognized as an acceptable mode of 
trade execution for all swaps whether ``Required'' or ``Permitted.''
    In addition, the regulatory framework for the swaps market must 
take into consideration the significant differences between the trading 
of futures on an existing exchange and the trading of swaps on SEF 
platforms. While it may be appropriate, in certain instances, to look 
to the futures model as instructive, over-reliance on that model will 
not achieve Congress' goal. Congress explicitly incorporated a SEF 
alternative to the exchange-trading model, understanding that 
competitive execution platforms provide a valuable market function. 
Final rules governing SEFs should reflect Congressional intent and 
promote the growth of existing competitive, vibrant markets without 
impeding liquidity formation.
Impartial Access to SEFs
    The WMBAA is concerned that the CFTC's proposed mandate that SEFs 
provide impartial access to independent software vendors (``ISVs'') is 
beyond the legal authority in the CEA because it expands the impartial 
access provision beyond ``market participants'' to whom access is 
granted under the statute. Moreover, because SEFs are competitive 
execution platforms, a requirement to provide impartial access to 
market information to ISVs who lack the intent to enter into swaps on a 
trading system or platform will reduce the ability for market 
participants to benefit from the competitive landscape that provides 
counterparties with the best possible pricing. Further, given the lack 
of a definition of what constitutes an ISV and the significant 
technological investments made by wholesale brokers to provide premiere 
customer service, the ISV impartial access requirement leaves open the 
possibility that SEFs could qualify as ISVs in order to seek access to 
competitors' trading systems or platforms. This possibility would 
defeat the existing structure of competitive sources of liquidity, to 
the detriment of market participants, including commercial end-users. 
The WMBAA strongly urges the CFTC to carefully consider the SEC's 
impartial access proposal, which is well aligned with both the express 
statutory provisions and the broader goals of Title VII of the Dodd-
Frank Act to promote a marketplace of competing swaps execution venues.
    The WMBAA also believes the SEC should review its proposed 
impartial access provisions to ensure that impartial access to the SEF 
is different for competitor SEFs or national exchanges than for 
registered security-based swap dealers, major security-based swap 
participants, brokers or eligible contract participants. Congress 
clearly intended for the trade execution landscape after the 
implementation of the Dodd-Frank Act to include multiple competing 
trade execution venues, and ensuring that competitors cannot access a 
SEF's trading system or platform furthers competition, to the benefit 
of the market and all market participants.
Interim or Temporary SEF Registration
    The implementation of any interim or temporary registration relief 
must be in place for registered trading systems or platforms at the 
time that swaps are deemed ``clearable'' by the Commissions to allow 
such platforms to execute transactions at the time that trades begin to 
be cleared. Interim or temporary registration relief would be necessary 
for trading systems or platforms if sequencing of rules first addresses 
reporting to SDRs and mandatory clearing prior to the mandatory trade 
execution requirement. The WMBAA strongly encourages the Commission to 
provide prompt provisional registration to existing trade execution 
intermediaries that intend to register as a SEF and express intent to 
meet the regulatory requirements within a predetermined time period. To 
require clearing of swaps through derivatives clearing organizations 
without the existence of the corresponding competitive trade execution 
venues risks consistent implementation of the Dodd-Frank Act and could 
have a disruptive impact on market activity and liquidity formation, to 
the detriment of market participants.
    At the same time, a temporary registration regime should ensure 
that trade execution on SEFs and exchanges is in place without 
benefitting one execution platform over another. Temporary registration 
for existing trade execution platforms should be fashioned into final 
rules in order to avoid disrupting market activity and provide a 
framework for compliance with the new rules. The failure of the 
Commission to provide interim or temporary relief for existing trading 
systems or platforms may alter the swaps markets and unfairly induce 
market participants to trade outside the U.S. or on already-registered 
and operating exchanges.
The 15 Second Rule
    Finally, there does not appear to be any authority for the CFTC's 
proposed requirement that, for ``Required Transactions,'' SEFs must 
require that traders with the ability to execute against a customer's 
order or execute two customers against each other be subject to a 15 
second timing delay between the entry of those two orders (``15 Second 
Rule''). One adverse impact of the proposed 15 Second Rule is 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 costly implications for buy-side 
customers and end-users.
    While this delay is intended by the Commission to ensure sufficient 
pre-trade transparency, under the CEA, transparency must be balanced 
against the liquidity needs of the market. Once a trade is completed 
when there is agreement between the parties on price and terms, any 
delay exposing the parties to that trade to further market risk will 
have to be reflected in the pricing of the transaction, to the 
detriment of all market participants.
Ensuring that Block Trade Thresholds are Appropriately Established
    As noted in previous remarks submitted to each Commission, from the 
perspective of intermediaries who broker transactions of significant 
size between financial institutions it is critical that the block trade 
threshold levels and the reporting regimes related to those 
transactions are established in a manner that does not impede liquidity 
formation. A failure to effectively implement block trading thresholds 
will frustrate companies' ability to hedge commercial risk. 
Participants rely on swaps to appropriately plan for the future, and 
any significant changes to market structure might ultimately inhibit 
economic growth and competitiveness.
    Establishing the appropriate block trade thresholds is of 
particular concern for expectant SEFs because the CFTC's proposal 
regarding permitted modes of execution restricts the use of voice-based 
systems solely to block trades. While WMBAA believes that this approach 
is contrary to the SEF definition (as discussed herein and in previous 
letters), which permits trade execution through any means of interstate 
commerce, this approach, if combined with block trade thresholds that 
are too high for the particular instrument, would have a negative 
impact on liquidity formation.
    With respect to block trade thresholds, 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. Compared to commoditized, 
exchange-traded products and the more standardized OTC instruments, 
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, 
trade execution 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 transactions of significant size in a manner that retains incentives 
for market participants to provide liquidity and capital without 
creating opportunities for front-running and market distortion.
    To that end, the WMBAA supports the creation of a Swaps Standards 
Advisory Committee (``Advisory Committee'') for each Commission, 
comprised of recognized industry experts and representatives of 
registered SDRs and SEFs to make recommendations to the Commissions for 
appropriate block trade thresholds for swaps. The Advisory Committee 
would (i) provide the Commissions 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 and (ii) 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 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 
Commissions' 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. In fact, WMBAA members possess 
historical data for their segment of the OTC swap market which could be 
analyzed immediately, even before final rules are implemented, to 
determine appropriate introductory block trade thresholds, which could 
be revised after an interim period, as appropriate.
Conclusion
    The WMBAA thanks the Commissions for the opportunity to comment on 
these very important issues. We look forward to continuing our 
conversations with the Commissioners and staff as the new regulatory 
framework is developed and implemented in a way that fosters 
competition and liquidity for market participants.
    Please feel free to contact the undersigned with any questions you 
may have on our comments.
            Sincerely,
            
            
Stephen Merkel, Chairman.

    The Chairman. Thank you.
    And when you are ready, Ms. Boultwood, you may begin.

          STATEMENT OF BRENDA L. BOULTWOOD, CHIEF RISK
   OFFICER AND SENIOR VICE PRESIDENT, CONSTELLATION ENERGY, 
BALTIMORE, MD; ON BEHALF OF COALITION FOR DERIVATIVES END-USERS

    Ms. Boultwood. Good morning, Chairman Lucas, Ranking Member 
Peterson, Members of the Committee. It is a pleasure to appear 
before you this morning.
    My name is Brenda Boultwood and I serve as Chief Risk 
Officer and Senior Vice President for Constellation Energy. On 
behalf of Constellation, as well as the End-User Coalition, I 
am privileged to talk to you today about steps we believe 
Congress should take to fix three problems with proposed 
regulations implementing Dodd-Frank legislation.
    First, a proper swap dealer definition and de minimis 
exception are needed to ensure end-users are not regulated as 
swap dealers. Second, end-users should be allowed to continue 
to transact without the threat of large margin requirements and 
we believe inter-affiliate swaps should not be subjected to 
these requirements as well. And third, the CFTC should have to 
follow the high standards for cost-benefit analysis.
    The End-User Coalition includes a diverse group of 
companies that make and produce goods and services including 
agriculture, manufacturing, vehicles, electricity and natural 
gas. Let me be clear from the outset: Our coalition is not 
opposed to greater transparency in these markets but end-users 
did not create systemic risk and none in our coalition was 
behind the near-collapse of the economy in 2008.
    I have been involved in risk management practices in a 
variety of capacities--academia, commercial entities, financial 
institutions and consulting--for more than 25 years. I serve on 
the boards of the Committee of Chief Risk Officers and the 
Global Association of Risk Professionals as well as serving as 
a member on the CFTC Technology Advisory Committee. 
Constellation Energy is a Fortune 200 company located in 
Baltimore, Maryland, and is the largest competitive supplier of 
electricity in the country with more than 36,000 commercial and 
industrial customers in 36 states. We are the largest 
competitive supplier due to a variety of risk management tools 
we employ for the benefit of our customers. Because physical 
energy markets are volatile and unpredictable, we utilize 
exchange trading and over-the-counter derivatives to better 
manage our risks. These derivatives allow us to provide our 
customers with a low fixed price for the products and services 
they demand.
    Legislation will soon be introduced aimed at fixing the 
swap dealer definition. A proper definition of swap dealer is 
crucial to ensure that burdensome requirements such as 
mandatory margin capital and clearing are not improperly forced 
upon non-financial end-users. The de minimis exception must be 
set large enough to avoid capturing firms that had nothing to 
do with the financial crisis, that would never rise to the 
level of too big to fail simply because they are not and never 
were systemically risky. The CFTC's proposed definition 
includes exemptions that are too narrow and would leave energy 
firms and other end-users to be unintentionally caught up in a 
swap dealer definition and rules that would require onerous 
margin clearing, real-time reporting and capital requirements.
    H.R. 2682 focuses on margin requirements for end-users. 
Today, an end-user decides whether to execute a derivative 
hedge through an exchange or over the counter. If the hedge is 
conducted through an exchange, initial margin is posted. If we 
transact over the counter, we may utilize unsecured lines of 
credit with counterparties and post margins when exposures 
exceed these limits. In other words, we navigate between 
liquidity risk and posting margins and counterparty credit 
risk. Today, this credit risk can be mitigated with all types 
of collateral--letters of credit, parental guarantees, asset 
liens, and sometimes even cash. At the time of the passage of 
the Dodd-Frank Act, the intent was that the end-user would be 
exempted from any requirements to post cash margin. 
Consequently, we need Congress to step in and clarify the 
ability of end-users to continue to manage counterparty risk 
without unnecessary margin requirements.
    Let me briefly offer my thoughts on the Stivers-Fudge bill. 
Constellation Energy, like many other companies, uses the 
business model through which we limit the number of affiliates 
within our corporation that enter into derivative transactions 
with external counterparties in order to more effectively 
manage our enterprise risks and to secure better pricing on our 
derivative transactions. We strongly support the Stivers-Fudge 
bill, which recognizes that inter-affiliate swaps are internal, 
largely bookkeeping in nature, and do not create systemic risk.
    Let me turn to H.R. 1840, which focuses on cost-benefit 
analysis for any proposed rules. We firmly believe that 
rigorous cost-benefit analysis creates better rules and helps 
avoid making the mistake of putting a rule in place that would 
create unintended effects. As we saw with the SEC's proxy 
access rule, which was overturned by the courts, inadequate 
consideration of costs, benefits and comments made during the 
rulemaking process does not establish a foundation that can 
sustain rulemaking. The Conaway-Quigley bill would require the 
CFTC to undertake structured and rigorous cost-benefit 
analysis.
    In conclusion, I want to thank you, Chairman Lucas, Ranking 
Member Peterson, and Members of the Committee for convening 
this hearing. Ensuring that Congressional intent is followed by 
the CFTC is critically important to the entire end-user 
community. However, if legislation is not passed to clarify the 
statute's intent, end-users risk being caught up in the 
unintended consequences of the Dodd-Frank implementation. It is 
important to remember that end-users rely on derivatives to 
reduce risk, bring certainty and stability to our business, and 
ultimately to benefit our customers. We did not contribute to 
the financial crisis and we don't pose a threat to the 
financial system.
    Thanks for your time, and I look forward to your questions.
    [The prepared statement of Ms. Boultwood follows:]

   Prepared Statement of Brenda L. Boultwood, Chief Risk Officer and 
 Senior Vice President, Constellation Energy, Baltimore, MD; on Behalf 
                                   of
                  Coalition for Derivatives End-Users
    Good morning, Chairman Lucas, Ranking Member Peterson, Members of 
the Committee, it is a pleasure to appear before you this morning. My 
name is Brenda Boultwood and I serve as Chief Risk Officer and Senior 
Vice President for Constellation Energy. I am here today in my capacity 
as an officer with Constellation; but, I am also here representing the 
broader end-user coalition, which is comprised of a variety of entities 
from agricultural interests, to manufacturers, car companies, airlines, 
and energy companies. While it may seem odd to have such a diverse and 
broad coalition coalescing around the same set of legislative 
proposals, I want to assure the Committee that we appreciate your hard 
work in helping to address some of the unintended consequences of the 
Dodd-Frank Act, as well as some of the broadly interpreted proposed 
rules that we believe go well beyond Congressional intent. Let me be 
clear from the outset, our coalition is not opposed to greater 
transparency in these markets. In fact, we are highly supportive of 
greater transparency. But, you achieve transparency through reporting, 
not classifying end-users as swap dealers. Simply put, end-users do not 
create systemic risk and none in our coalition were behind the collapse 
of the economy in 2008. Therefore, we are here today to offer our 
thoughts to several legislative proposals that we believe will help 
resolve those unintended consequences.
    Before I begin my testimony on the proposed legislation, I would 
like to give a brief background about myself, who Constellation is, and 
how and why we use derivatives to help manage our customer's risk.
    I have been involved in risk management practices in a variety of 
capacities--academia, commercial entities, financial institutions, and 
consulting--for more than thirty years. I serve on the Boards of the 
Committee of Chief Risk Officers (CCRO) and the Global Association of 
Risk Professionals (GARP), as well as serving as a member of the CFTC's 
Technology Advisory Committee. As you may recall, the CCRO began as a 
result of the accounting scandals from the early part of the last 
decade and is comprised of CRO's across the entire energy spectrum.
    Constellation Energy is a Fortune 200 company located in Baltimore, 
MD, and is the largest competitive supplier of electricity in the 
country. We serve more than 30,000 megawatts of electricity daily and 
own approximately 12,000 megawatts of generation that comes from a 
diversified fleet across the U.S. To put that in perspective, our load 
obligation is approximately the same amount of power consumed by all of 
New England on a daily basis. We serve load to approximately 36,000 
commercial and industrial customers in 36 states and we provide natural 
gas and energy products and services for homes and businesses across 
the country. Finally, the company delivers electricity and natural gas 
through the Baltimore Gas and Electric Company (BGE), our regulated 
utility in central Maryland.
    One of the reasons we have been so successful in growing our 
competitive supply business is due in large part to our ability to win 
load serving auctions by being the low cost provider. We are able to be 
the low cost provider due to a variety of risk management tools we 
employ to the benefit of our customers. We utilize exchange trading, 
clearinghouses and over-the-counter (OTC) derivatives to help manage 
these risks.
    For example, electricity--it must be produced and consumed 
simultaneously; cannot be stored; and has some very volatile fuel 
exposure--coal, natural gas, and uranium. Furthermore, electricity gets 
delivered to thousands of points along the grid at a moment's notice. 
Physical energy markets are volatile and unpredictable, but hedging 
with derivatives allows Constellation to manage these risks and provide 
its thousands of customers with electricity and natural gas at a low 
fixed price.
    Now, I would like to specifically address some of the proposed 
pieces of legislation that will help to resolve some of the unintended 
consequences that are emanating from the Commodity Futures Trading 
Commission's (CFTC) proposed rules.
    For instance, H.R. 2682 is a bill that focuses on margin 
requirements for end-users. Today, an end-user decides whether to 
execute a derivative hedge through an exchange or over-the-counter 
(OTC). If it is conducted through an exchange, initial margin is posted 
and variation margin is required or returned depending on price 
fluctuations. If we transact OTC, we may utilize unsecured lines with 
counterparties and post margin when exposures exceeds the size of a 
credit line. In other words, we navigate between liquidity risk, or 
posting margin, and counterparty credit risk. Today, this credit risk 
can be mitigated with collateral of all kinds--Letters of Credit (LCs), 
Parental Guarantees (PGs), asset liens and sometimes cash. At the time 
of passage of the Dodd-Frank Act, we understood from the legislative 
language, as well as from letters and statements by the principal 
authors of the legislation, that end-users would be exempted from any 
requirement to post cash margin. Unfortunately, margin rules proposed 
by the prudential banking regulators this past summer create 
uncertainty by reserving to the regulators the authority to, de facto, 
impose margin on end-users by requiring that such margin be collected 
by our swap-dealer counterparties. While the Coalition supports the 
Grimm-Peters-Owens-Scott bill, we are hopeful that, as it works its way 
through the legislative process, the bill can be expanded to cover 
financial end-users such as small banks, as well as non-financial end-
users.
    We are also very concerned about the regulators' proposed 
restrictions on using non-cash collateral to satisfy margin 
requirements. These restrictions could force companies to either 
abandon effective risk-mitigation strategies or critical capital 
expenditures. Furthermore, based on Federal Reserve data for bank 
lending (drawn facilities) in the U.S. of $550BN, additional interest 
charges passed on to corporations are estimated to be $2.8BN annually 
as a result of the Dodd-Frank Act. And, a survey conducted by the 
Coalition found that companies would have to hold aside on average $269 
million of cash or immediately available bank credit to meet a 3% 
initial margin requirement. Though the rule proposed by banking 
regulators may or may not require this magnitude of collateral, in our 
world of finite resources and financial constraints, this is a direct 
dollar-for-dollar subtraction from funds that we would otherwise use to 
expand our plants, build inventory to support higher sales, undertake 
research and development activities, and ultimately sustain and grow 
jobs. The aforementioned study extrapolated the effects across the S&P 
500 to predict the consequent loss of 100,000 to 130,000 direct and 
indirect jobs. The effect on the many thousands of end-users beyond the 
S&P 500 would be proportionately greater. We would also have to make a 
considerable investment in information systems that would replicate 
much of the technology in a bank's trading room for marking to market 
and settling derivatives transactions, thus further depleting our 
working capital. A potential consequence of margin rules is liquidity 
risks for end-users that require us to increase debt levels and funnel 
cash from productive investments. In fact, a June 13, 2011, an Office 
of the Comptroller of the Currency (OCC) study provided an estimate of 
incremental initial margin requirements for large banks of $2TR, much 
of which we believe will be collected from their end-user 
counterparties. Consequently, we need Congress to step in and clarify 
the ability of end-users and banks to continue to manage counterparty 
risk without unnecessary initial and variation margin requirements.
    Now, let me turn to the not yet introduced legislative proposal 
that seeks to clarify the swap dealer definition. A properly-tailored 
definition of ``swap dealer'' is another crucial element to ensuring 
that burdensome requirements such as mandatory margin, capital and 
clearing are not improperly forced upon non-financial end-users. The 
Dodd-Frank Act regulates swap dealers and major swap participants 
differently than end-users and appropriately so. But it is very 
important that the definition be tailored to capture persons that are 
actually in the business of providing dealer services to end-users, not 
the end-users themselves. Furthermore, to the extent end-users engage 
in only a small amount of customer-facing swap activity that is tied to 
their core non-financial businesses (e.g., manufacturing, processing, 
marketing), and whose dealing does not create systemic risk, they 
should not be treated as swap dealers. To that end, the de minimis 
exception to the definition of ``swap dealer'' must be set in 
legislation at a reasonable level that protects end-users from being 
regulated the same as the largest swap dealers that are potentially 
systemically risky. In addition, a company should not be regulated as a 
swap dealer simply because it makes a market for its own affiliates. 
Inter-affiliate trades should not be subject to regulations designed 
for market-facing transactions, and should not be a factor for 
determining whether a company is a swap dealer.
    With that in mind, let me briefly offer my thoughts on H.R. 2779, 
also referred to as the Stivers-Fudge bill. Constellation Energy, like 
many other companies, uses a business model through which we limit the 
number of affiliates within our corporation that enters into 
derivatives transactions with external and other swap dealer 
counterparties. Rather than having each corporate subsidiary transact 
individually with external counterparties, a single or limited number 
of corporate entities face dealers and other counterparties in the 
market. This helps our company centralize risk taking, accountability 
and performance management. These entities then allocate transactions 
to those affiliates seeking to mitigate the underlying risk. This 
allocation is done by way of ``inter-affiliate swaps''--or swaps 
between commonly controlled entities. This structure allows us to more 
effectively manage our corporate risk on an enterprise basis and to 
secure better pricing on our derivatives transactions. The transactions 
are largely ``bookkeeping'' in nature and do not create systemic risk. 
Using affiliates to transact has always been a healthy part of the way 
many companies internally centralize risk and manage overall 
performance. For example, small farmers and ranchers, utilities, and 
car manufacturers, to name a few, perform their hedging transactions in 
this way.
    As we understand it, however, regulators are considering whether to 
subject inter-affiliate swaps to the same set of requirements that 
would apply to swaps with external dealer counterparties--possibly 
including margin, clearing, real-time reporting, and other 
requirements. In my mind, this would be a mistake, imposing substantial 
costs on the economy and on consumers. That is why we strongly support 
the Stivers-Fudge bill, which recognizes that inter-affiliate swaps do 
not create systemic risk and that consequently, as a category, inter-
affiliate swaps should not be subject to regulation as if they were 
outward-facing. The Stivers-Fudge bill would exempt a category of 
swaps, not a particular type of entity from regulation. That is 
precisely what the Administration did in exempting foreign exchange 
swaps and forwards and it is the right approach here as well.
    Finally, let me turn to H.R. 1840, which focuses on cost-benefit 
analysis for any proposed rules. We firmly believe that rigorous cost-
benefit analysis creates better rules. By first analyzing how a 
regulation will affect individuals, companies, other stakeholders, and 
the integrity of the overall market, a regulatory agency can avoid 
making the mistake of putting a rule in place that has adverse and 
unintended effects. The CFTC is subject to a cost-benefit analysis 
requirement, but it does not require the regulator to consider such key 
factors as available alternatives to regulation, whether the regulation 
is tailored to impose the least burden possible while achieving its 
goals, and whether the regulation maximizes net benefits. These and 
other factors would be required to be considered under the Conaway-
Quigley bill. The CFTC should conduct a rigorous cost-benefit analysis 
for each proposed rules' impact on market liquidity, price discovery, 
as well as the potential costs to existing market participants and 
participants that may consider entering the market in the future.
    As we saw when the SEC's proxy access rule was overturned by the 
courts, inadequate consideration of costs, benefits, and comments made 
during the rulemaking process does not establish a foundation that can 
sustain a rulemaking. The Conaway-Quigley bill would require the CFTC 
to undertake a structured and rigorous cost-benefit analysis when it 
promulgates rules; thus, ensuring a better process more likely to 
achieve statutory goals while limiting substantial societal costs.
    In conclusion, I want to thank Chairman Lucas, Ranking Member 
Peterson and Members of the Committee for convening this hearing and 
affording me the opportunity to testify. Ensuring that Congressional 
intent is followed by the CFTC is critically important to the entire 
end-user community. I had hoped after passage of the Dodd-Frank Act 
that future legislation would not be required to deal with the concerns 
I have outlined here today. However, if legislation is not passed to 
clarify the statute's intent, end-users risk being captured as swap 
dealers and the end-user exemptions included in the bill would be null 
and void. It is important to remember that end-users rely on 
derivatives to reduce risk; bring certainty and stability to their 
businesses; and, ultimately to benefit their customers. We did not 
contribute to the financial crisis and we do not pose a threat to the 
financial system.
    I would like to leave you with this final comment. As you probably 
know, the electricity industry is comprised of a number of types of 
entities, which include electric co-ops; investor owned utilities, 
which could be vertically integrated or merchant generators; and, 
public power organizations. These groups represent every electric 
customer in the United States and rarely agree on any public policy. 
However, if these regulations are improperly implemented by the CFTC, 
then it could cause electricity prices to rise for every consumer in 
America. That is why when it comes to Title VII of the Dodd-Frank Act 
we are in 100% alignment that end-users must not be captured as swap 
dealers or forced to clear all of their transactions.
    Thank you for your time and I look forward to your questions.

    The Chairman. Thank you.
    Mr. Thul, whenever you are ready, you may begin.

   STATEMENT OF TODD THUL, RISK MANAGER, CARGILL AgHorizons, 
    MINNEAPOLIS, MN; ON BEHALF OF COMMODITY MARKETS COUNCIL

    Mr. Thul. Thank you. Chairman Lucas, Ranking Member 
Peterson, and Members of the House Committee on Agriculture, 
thank you for convening today's hearing. I am Todd Thul, Risk 
Manager for Cargill AgHorizons, which offers a wide variety of 
marketing alternatives for producers of all sizes. I am 
testifying today on behalf of the Commodity Markets Council, a 
trade association that represents the exchanges and the 
industry.
    The CFTC has been implementing the regulations required 
under Dodd-Frank. Today, I would like to provide perspectives 
on a number of these issues.
    Issue number one: Many firms use inter-affiliate swaps to 
limit the number of entities transacting with external dealer 
counterparties. This structure allows the company to 
effectively manage risk on an enterprise basis and to secure 
better pricing on derivative transactions. The agreements are 
largely bookkeeping in nature and do not create systemic risk. 
Inter-affiliate swaps should not be regulated in the same 
manner as swaps with external dealers including margin, 
clearing and real-time reporting. These requirements would 
impose substantial costs on the economy, consumers and end-
users.
    Issue number two: The CFTC has proposed that all members of 
a designated contract market capture and maintain extensive 
records of all communications related to commodity 
transactions. The proposal presents steep technology and cost 
challenges across the entire grain industry including country 
elevators who deal with producers in person and on the phone 
when executing cash contracts. This proposal raises anti-
competitive concerns by creating a divided cash marketplace, 
imposing the requirement on some country elevators but not all. 
Dodd-Frank was intended to address concerns about systemic 
risks created by an unregulated over-the-counter market. The 
CFTC's proposed recording and recordkeeping rule would add 
costs to the cash market that will ultimately be shared through 
the entire value chain.
    My final issue: Under Dodd-Frank, Congress created a 
statutory definition of bona fide hedge transactions, which 
enumerates various types of hedging, among them, anticipatory 
merchandising positions. An anticipatory hedge occurs when a 
commercial entity takes a position in the futures market to 
meet a physical need for a commodity it anticipates buying or 
selling in the future. Congress made clear in its bona fide 
hedge definition that companies engaged in the physical trade 
should receive an exemption for anticipatory merchandising 
positions. However, the CFTC through its proposed rules would 
deny companies the exemption and would re-characterize them as 
speculative. This is not consistent with the law and has the 
potential to have negative effects in the cash commodity 
markets.
    The Act provides that a bona fide hedge may be defined to 
permit producers, purchasers, sellers, middlemen and users of a 
commodity to hedge their legitimate anticipated business needs. 
The CFTC's proposed rule, which may be finalized as early as 
next week, would limit bona fide hedge exemptions to five 
specific transactions called enumerated hedges. This will 
greatly reduce the industry's ability to offer the same suite 
of marketing tools to our invaluable farmer suppliers.
    Serious questions have been raised on how to provide bids 
for farmers overnight or through the weekend to manage risk 
appropriately. Merchandising of grain could be curtailed 
because of the inability to manage risk if the hedge is 
considered speculative and not bona fide under this rule. From 
a risk management perspective, a better limitation on 
anticipatory hedging would be annual volume. Unless revised, 
the CFTC's approach will severely limit the ability of grain 
handlers to participate in the market and impede the ability to 
offer competitive bids to farmers, to manage risk, to provide 
liquidity and to move agricultural products from origin to 
destination. The irony is that limiting commercial 
participation in the market actually introduces volatility. 
Clearly, this is not what Congress intended.
    In summary, the proposed restriction on anticipatory 
hedging is not consistent with current commercial practice 
which did not contribute to the financial conditions that led 
to passage of Dodd-Frank. The modest proposals suggested to the 
Commission would allow farmers and the industry to maintain 
recognized risk management practice while remaining consistent 
with the statute and subject to CFTC oversight. This will allow 
the U.S. farmer to maintain access to risk management products, 
price discovery and competitive marketing options. Limiting 
anticipatory hedging will result in risk that must otherwise be 
managed, which could manifest itself in wider basis spreads, 
more volatile basis or limited bids, all of which run counter 
to the intent of Congress, the statute and the marketplace.
    Thank you.
    [The prepared statement of Mr. Thul follows:]

  Prepared Statement of Todd Thul, Risk Manager, Cargill AgHorizons, 
        Minneapolis, MN; on Behalf of Commodity Markets Council
    Chairman Lucas, Ranking Member Peterson and Members of the House 
Committee on Agriculture: Thank you for convening this hearing on 
various elements of the Dodd-Frank Act. I am Todd Thul, Risk Manager 
for Cargill AgHorizons. AgHorizons is our business that works directly 
with farmers. Many of them are your constituents and all of them are 
constituents of this Committee. We offer a wide variety of grain 
marketing options for producers of all sizes. We provide many forms of 
risk management and price protection that meet individual producers' 
desired level of opportunity and control. We also offer agronomic 
services, seed, fertilizer, consulting services and crop input 
financing to help producers manage their operations. Our goal is to be 
the partner of choice for our farmer customers.
    Today, I am testifying on behalf of the Commodity Markets Council 
(CMC). CMC is a trade association that brings together exchanges and 
their industry counterparts. The activities of CMC members include the 
complete spectrum of commercial end-users of all futures markets 
including energy and agriculture. Specifically, our industry member 
firms are regular users of the Chicago Board of Trade, Chicago 
Mercantile Exchange, ICE Futures U.S., Kansas City Board of Trade, 
Minneapolis Grain Exchange and the New York Mercantile Exchange. CMC, 
in conjunction with the Coalition for Derivatives End Users, is well-
positioned to provide the consensus views of commercial end-users of 
derivatives. Our comments represent the collective view of CMC's 
members.
    The Commodity Futures Trading Commission (CFTC) has been working 
aggressively to implement the regulations required under the Dodd-Frank 
Act. Today, I would like to provide perspectives on a number of these 
issues.
Inter-Affiliate Swap Transactions
    Many firms use a business model through which the number of 
affiliates within the corporate group that enter into derivatives 
transactions with dealer counterparties are limited. Rather than having 
each corporate subsidiary individually transact with dealer 
counterparties, a single or limited number of corporate entities face 
dealers. These entities then allocate transactions to those affiliates 
seeking to mitigate the underlying risk. This allocation is done by way 
of ``inter-affiliate swaps''--swaps between commonly controlled 
entities. This structure allows the company to more effectively manage 
corporate risk on an enterprise basis and to secure better pricing on 
derivatives transactions. The transactions are largely ``bookkeeping'' 
in nature and do not create systemic risk. Regulators are reportedly 
considering whether to subject inter-affiliate swaps to the same set of 
requirements that apply to swaps with external dealer counterparties--
possibly including margin, clearing, real-time reporting, and other 
requirements. This would be a mistake and would impose substantial 
costs on the economy, on consumers and on end-users. Accordingly, the 
CMC strongly endorses the thrust of the Stivers-Fudge bill. It is the 
right thing to do. CMC understands the intent of the bill is to cover 
all business operating models that might be negatively affected by the 
inter-affiliate interpretation and therefore would like to work with 
the sponsors to be sure the proposed legislation accomplishes that 
objective.
Bona fide and Anticipatory Hedges
    One area of ongoing rulemaking which has recently garnered a lot of 
attention by our industry is the CFTC's proposed rules on position 
limits and, more specifically, the proposed definition of bona fide 
hedge transactions.
    Under Dodd-Frank, Congress for the first time created a statutory 
definition of bona fide hedge transactions. The statutory definition 
enumerates various kinds of hedging transactions, among them 
anticipatory merchandising positions.
    An anticipatory hedge occurs when a commercial entity takes a 
position in the futures market to offset a position that it anticipates 
taking in the cash market in the future. A simple example is the buying 
of corn futures now in anticipation of buying physical corn at harvest 
from farmers, or the selling of cotton futures now in anticipation of 
selling physical cotton at some point in the future. In these cases, a 
commercial entity is taking a position in the futures market to meet a 
physical need for a commodity it anticipates buying or selling in the 
future.
    While Congress made clear in its bona fide hedge definition that 
companies engaged in the physical trade should receive an exemption for 
anticipatory merchandising positions, the CFTC through its proposed 
rules would deny companies the exemption and would recharacterize them 
as ``speculative''. This is not only inconsistent with the law, but has 
the potential to have calamitous effects in the cash commodity markets 
in the physical commodity marketplace.
    The CFTC is taking a narrower view of bona fide hedging than that 
defined by Congress in the Dodd-Frank law. The CFTC's proposed rules 
would limit bona fide hedge exemptions to five specific transactions 
called ``enumerated'' hedges. The Commodity Exchange Act, as amended by 
the Dodd-Frank Act (``Act'') provides that position limits shall not 
apply to transactions or positions shown to be bona fide hedges, as 
defined by the CFTC consistent with the purposes of the Act. Section 
4a(c)(1) of the Act also provides that a bona fide hedge may be defined 
to permit producers, purchasers, sellers, middlemen and users of a 
commodity to hedge their legitimate anticipated business needs. Thus 
the statutory language provides for hedges of legitimate business needs 
at each step as the commodity moves from producer to user, and 
recognizes that merchandiser are entitled to hedge anticipated needs.
    The Act [Sec. 4a(c)(2)] also provides its own definition of bona 
fide hedge, and states that the CFTC shall define what constitutes a 
bona fide hedge. This statutory hedge definition includes an 
anticipatory merchandising hedge, because it permits hedges of the 
potential changes in value of assets that a person anticipates owning 
or merchandising, as long as the transactions are a substitute for 
physical transactions to be made at a later time and they are 
economically appropriate to the reduction of risks in the conduct and 
management of a commercial enterprise.
    The Commodity Markets Council and the Working Group of Commercial 
Energy Firms filed public comments to the CFTC on June 5, 2011, urging 
the Commission to reconsider its proposed rules and, in particular, the 
proposed bona fide hedge definition. The CMC subsequently transmitted 
in a June 10, 2011 letter its concerns about these types of hedges to 
the respecting Chairs and Ranking Members of the House and Senate 
Agriculture Committees, Senate Banking Committee, and House Financial 
Services Committee. I would ask that copies of these letters be 
included in the hearing record.
    Through the summer, the CMC, its member companies and other 
interested parties also engaged in direct meetings with the CFTC to 
respond to requests for additional information about the relationship 
between anticipatory hedges and cash market efficiencies.
    We remain hopeful that the CFTC will take into account these 
comments and provide the commercial trade with a meaningful exemption 
for anticipatory hedges. However, recent press accounts suggest the 
final rule may disappoint in this area. We understand that the CFTC is 
considering limiting anticipatory merchandising hedging to unfilled 
storage capacities through calendar spread positions for one year. If 
this turns out to be the case, the CFTC's action will reduce the 
industry's ability to continue offering the same suite of marketing 
tools to farmers that they are accustomed to using because the 
management of the risk associated with those tools may be constrained 
if the hedge of that risk is deemed to be anticipatory. Serious 
questions have been raised about how to provide weekend bids for 
farmers going in to large harvest weekends, or manage risk associated 
with export elevators that might have limited one-time capacity but 
very large throughputs. Merchandising of grain could be curtailed 
because of the inability to manage the risk if the hedge is considered 
speculative and not bona fide under this rule. As serious as all these 
issues are for farmers, the implications are far broader with the 
potential to impact energy markets as well.
    From a risk management perspective, a better limitation on 
anticipatory hedging would be annual throughput--or volume--actually 
handled on a historic basis by each company. For example, an export 
elevator may have 4 million bushels of physical storage capacity, but 
might handle 100 million bushels on an annual basis. If it is full, how 
will it establish a bid and manage the risk on the 96 million bushels 
of grain it has yet to purchase from farmers that it not only 
anticipates, but knows it will be exporting from that facility? Unless 
revised, the CFTC's approach will severely limit the ability of grain 
handlers to participate in the market and impede the ability to offer 
competitive bids to farmers, manage risk, provide liquidity and move 
agriculture products from origin to destination. The irony is that 
limiting commercial participation in the market actually introduces 
volatility. Clearly this is not what Congress intended.
Recording and Recordkeeping Requirements
    In a proposed rule described only as conforming amendments, the 
CFTC has proposed imposing expensive and burdensome recording and 
recordkeeping requirements across a broad swath of the cash grain 
marketplace. The proposal would require all members of a designated 
contract market (DCM) such as the Chicago Board of Trade, Kansas City 
Board of Trade or MGEX to capture and maintain extensive records of all 
communications related to a commodity transaction. Even country 
elevators operated by those firms would be required to record telephone 
conversations with producers when discussing cash sales or contracts.
    The proposal presents steep technology and cost challenges to 
small-town country elevators who deal extensively with producers on the 
phone when arranging cash sales and forward cash contracts. This 
proposal raises anti-competitive concerns because it could create a 
bifurcated cash marketplace by imposing the requirement on country 
elevators who are owned by members of DCMs but not on other companies. 
Who will the producer call to sell his cash grain: the elevator that 
has to inform him they are recording his phone calls, or the elevator a 
few miles down the road that is not required to do so? The CMC believes 
the proposal may prompt companies who are members of a DCM to 
reconsider their membership in order to avoid the regulatory burden. 
This result exposes not only the discriminatory application of the 
rule, but also highlights the fundamental question within the industry 
about the proposed rule. Dodd-Frank was intended to address concerns 
about systemic risks created by an unregulated over-the-counter market. 
The CFTC's proposed recording and recordkeeping rule does not address 
any of those concerns. Rather it seems targeted at the cash market and 
the real commercial trade, neither of which were responsible for the 
financial crisis and both of which suffered because of that crisis. All 
this proposal will do is add cost to the real economy--costs that are 
ultimately shared throughout the value chain from farmer to consumer.
Swap Dealer Bill (not yet introduced)
    It is important that end-users who engage in only a small amount of 
swap dealing relative to their non-dealing activities and whose dealing 
does not create systemic risk not be treated as swap dealers. As such, 
the de minimis exception to the definition of ``swap dealer'' must be 
expanded to a reasonable level that protects end-users from being 
regulated the same as the largest swap dealers.
Cost-Benefit Analysis Bill (H.R. 1840)
    Rigorous cost-benefit analysis creates better rules. The CFTC is 
subject to a cost-benefit analysis requirement but it does not require 
the regulator to consider such key factors as available alternatives to 
regulation, whether the regulation is tailored to impose the least 
burden possible while achieving its goals, and whether the regulation 
maximizes net benefits. These and other factors would be required to be 
considered under the Conaway-Quigley bill, which CMC strongly supports.
Summary
    The proposed restriction on anticipatory hedging is inconsistent 
with current commercial practice which did not contribute to the 
financial conditions that led to passage of the Act. The proposed 
restriction significantly narrows the hedging definition included in 
the Act by Congress and without question will curtail our ability to 
serve farmers with risk management programs. The Act states that bona 
fide hedge term shall be defined by the CFTC consistent with the 
purposes of the Act. The proposed restriction is not consistent with 
these purposes:

    (a) The express purpose of the position limits is to prevent 
        excessive speculation which causes sudden or unreasonable 
        fluctuations or unwarranted changes in commodity prices. [Act, 
        sec. 4a(a)(1)]. An anticipatory merchandising hedge, done in 
        accordance with current commercial practice, is not speculation 
        and does not cause unreasonable or unwarranted price changes.

    (b) The Act says hedges of legitimate anticipated business needs by 
        middlemen are permissible hedging to be the subject of CFTC 
        rulemaking. Under current commercial practice, anticipatory 
        merchandising hedges are for the purpose of satisfying 
        legitimate anticipated business needs for merchandisers, and it 
        would be contrary to the purposes of the Act to prohibit them.

    (c) Congress recognized in the statutory definition that 
        anticipatory hedges can include those which hedge commodities 
        that are anticipated to be owned or merchandised, and the 
        proposed restrictions relating to dedicated unfilled capacity 
        and calendar spreads undermine Congressional intent as 
        reflected in the broader statutory definition.

    The CMC along with the Working Group of Commercial Energy Firms has 
submitted specific comments and proposals for the CFTC to consider 
during its rulemaking. Absent the adoption of significant change, the 
new rules defining bona fide hedging and by negative inference 
speculation will create cash market inefficiencies. Moreover, the 
proposed rule would make CFTC reports on market participation 
meaningless because they would no longer reflect real cash market 
activities.
    The modest proposals suggested to the Commission would allow 
farmers and the industry to manage risk consistent with longstanding 
practices while remaining consistent with the statute and subject to 
CFTC oversight. They will allow farmers and the grain industry to 
continue to have access to risk management, price discovery and 
marketing options that have long served the industry well. Limiting 
anticipatory hedging will result in risk that must somehow otherwise be 
managed. This risk was heretofore managed in the futures market--now 
the risk could manifest itself in wider basis spreads, more volatile 
basis, limited bids, or wider bid-ask spreads, all of which run counter 
to the intent of Congress, the statute, the interest of farmers, the 
marketplace, end-users and market participants.
                               Attachment
June 10, 2011
 Hon. Debbie Stabenow,                Hon. Frank D. Lucas,
Chairman,                            Chairman,Hon. Pat Roberts,                    Hon. Colin C. Peterson,
Ranking Member,                      Ranking Minority Member,
Senate Committee on Agriculture,     House Committee on Agriculture,
 Nutrition & Forestry,
Washington, D.C.;                    Washington, D.C.;Hon. Tim Johnson,                    Hon. Spencer Bachus,
Chairman,                            Chairman,Hon. Richard Shelby,                 Hon. Barney Frank,
Ranking Member,                      Ranking Minority Member,
Senate Committee on Banking,         House Committee on Financial
 Housing, and Urban Affairs,          Services,
Washington, D.C.;                    Washington, D.C.

Re: CFTC Proposed Treatment of Bona Fide Hedging

    Dear Chairmen Stabenow, Johnson, Lucas, Bachus and Ranking Members 
Roberts, Shelby, Peterson and Frank:

    We are extremely concerned about the direction taken by the 
Commodity Trading Futures Commission (``CFTC'') in its proposed rules 
with respect to bona fide hedging. We believe the proposed regulations 
are unnecessarily narrow, impose onerous reporting obligations on 
commercial market participants, and lack the flexibility necessary to 
ensure that the legitimate hedging activities of corporations who carry 
cash market risks in physical commodities continue to receive treatment 
as ``bona fide'' hedges under the rules. Left unchanged, the current 
rules will adversely affect agriculture and energy commodity markets.
    Specifically, we fear the proposed rules may result in the 
following:

   Reduced liquidity in physical futures markets as a 
        significant amount of trading currently considered hedging is 
        recharacterized as speculative, and as the daily reporting 
        requirements mandate a prescriptive accounting of total cash 
        transactions on a global basis for commercial concerns of any 
        significant size;

   Increased risk held by farmers and small and medium sized 
        energy producers because transactions currently held as hedging 
        positions by the commercial trade would no longer qualify, thus 
        significantly reducing commercial firms' use of those 
        strategies as a way to provide attractive cash forward markets 
        to market participants;

   Increased confusion among market participants and analysts 
        as the rules would make public reports less transparent by 
        requiring hedgers to report hedges as speculative positions, 
        thereby decreasing ``bona fide'' hedging open interest and 
        increasing ``speculative'' open interest in a misleading 
        manner; and

   Increased hedging costs for all end-users resulting from 
        decreased ability to robustly manage price risks inherent in 
        physical commodity markets.

    We believe the CFTC needs to seriously consider major structural 
changes in its approach, both in defining what constitutes a bona fide 
hedge, the process for making bona fide hedge determinations, and in 
its proposed reporting regime. We support regulation that brings 
transparency and stability to the agriculture and energy commodity 
markets in the United States. However, the CFTC proposal in its present 
form seems likely to achieve neither of these objectives, and instead 
will reduce liquidity, hamper legitimate risk mitigation activities, 
and generally increase the level of risk held by farmers, producers and 
commercial agriculture and energy companies that today provide a 
valuable service in getting much-needed agricultural and energy 
commodities from producers into the hands of end-users. This ironic 
outcome would be both unfortunate and completely opposite to the goals 
of the Dodd-Frank legislation.
    Attached you will find a comment letter jointly sent by the 
Commodity Markets Council and the Energy Working Group that details our 
specific concerns to the CFTC on the proposed rules. As CFTC's 
rulemaking process continues forward, we would respectfully ask that 
you request from the CFTC briefings or status updates, as appropriate, 
with respect to this vitally-important issue. If you have any questions 
or need any further information, please contact me at [Redacted] or 
[Redacted].
            Regards,
            
            
Christine M. Cochran,
President.
Commodity Markets Council Membership
Exchange Members
Chicago Board of Trade
Chicago Mercantile Exchange
ICE Futures U.S.
Kansas City Board of Trade
Minneapolis Grain Exchange
New York Mercantile Exchange
Industry Members
ABN AMRO Clearing Chicago, LLC
Archer Daniels Midland
Avena Nordic Grain
BNSF Railway
BM&F Bovespa
Brooks Grain, LLC
Bunge
Cereal Food Processors
Farms Technology, LLC
FCStone, LLC
Gavilon, LLC
Gresham Investment Management, LLC
Infinium Capital Management
JP Morgan
Kraft Foods
Laymac, Inc.
Lincoln Grain Exchange
Louis Dreyfus Commodities
Macquarie Bank Limited
Mocek, Greg
Penson Futures
Pia Capital Management LP
Rand Financial Services, Inc.
Red Rock Trading, LLC
RJ O'Brien
Rich Investments
Riverland Ag
State Street Global Markets
TENCO, Inc.
The Scoular Co.
Vermillion Asset Management
                               attachment
June 5, 2011

Via Electronic Submission

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

Re: Position Limits for Derivatives, RIN 3038-AD15 and 3038-AD16

    Dear Secretary Stawick:
I. Introduction
    On behalf of the Working Group of Commercial Energy Firms (the 
``Working Group'') \1\ and the Commodity Markets Council (``CMC'') \2\ 
(collectively, the ``Commercial Alliance''),\3\ Hunton & Williams LLP 
hereby submits these comments to supplement the individually filed 
comments of the Working Group and the CMC submitted in response to the 
Commission's Notice of Proposed Rulemaking, Position Limits for 
Derivatives (the ``Proposed Position Limits Rule'').\4\ While the 
Working Group and the CMC individually filed comments in response to 
the Proposed Position Limits Rule, the Commercial Alliance is filing 
the comments set forth herein because further issues were discovered 
that had not previously been addressed. Specifically, these comments 
address the Commercial Alliance's concerns with the bona fide hedging 
exemption as set forth in the Proposed Position Limits Rule.
---------------------------------------------------------------------------
    \1\ The Working Group is a diverse group of commercial firms in the 
energy industry whose primary business activity is the physical 
delivery of one or more energy commodities to others, including 
industrial, commercial and residential consumers. Members of the 
Working Group are energy producers, marketers and utilities.
    \2\ CMC is a trade association bringing together commodity 
exchanges with their industry counterparts. The activities of our 
members represent the complete spectrum of commercial users of all 
futures markets including agriculture. Specifically, our industry 
member firms are regular users of the Chicago Board of Trade, Chicago 
Mercantile Exchange, ICE Futures U.S., Kansas City Board of Trade, 
Minneapolis Grain Exchange, and New York Mercantile Exchange. Please 
note that Hunton & Williams LLP is not counsel to CMC.
    \3\ The Commercial Alliance is a combined effort among commercial 
agriculture and energy companies to address significant issues under 
the Commission's rulemakings to implement derivatives reform under 
Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection 
Act (``Dodd-Frank Act'').
    \4\ Position Limits for Derivatives, Notice of Proposed Rulemaking, 
76 Fed. Reg. 4752 (Jan. 26, 2011).
---------------------------------------------------------------------------
II. Comments of the Commercial Alliance
    Participants in the Commercial Alliance share a common concern that 
the Commission's proposed rules implementing Title VII of the Act, 
while primarily designed to address problems in the financial markets, 
will materially and adversely affect the commercial markets through 
which agricultural and energy-related commodities are ultimately 
delivered to United States consumers. The Working Group and CMC 
separately filed comments in response to the Proposed Position Limits 
Proposed Rule, presenting arguments opposing the imposition of position 
limits set forth in the Proposed Position Limit Rule.\5\
---------------------------------------------------------------------------
    \5\ See Position Limits for Derivatives, Comments of the Working 
Group of Commercial Energy Firms (Mar. 28, 2011); Position Limits for 
Derivatives, Comments of the Commodity Markets Council (Mar. 28, 2011).
---------------------------------------------------------------------------
    In this letter, we are not addressing whether the imposition of 
Federal speculative position limits is appropriate as a legal or policy 
matter. Rather, the Commercial Alliance seeks to focus the Commission's 
attention on certain flaws in the proposed definition of a bona fide 
hedging transaction set forth in proposed CFTC Rule 151.5(a), which, if 
adopted as proposed, will disrupt the use of commercial markets for 
hedging purposes.
A. Definition of Bona Fide Hedge
    As addressed by CMC and the Working Group in their individually 
filed comments on the Proposed Position Limits Rule, the Commission has 
taken a narrower view of bona fide hedging than as defined by Congress 
in the Act. Specifically, the Commission has proposed to allow as bona 
fide hedges only transactions that fit within five specific categories 
of hedges, referred to as ``enumerated hedges.''
    In addition, while Congress permitted the Commission to exempt 
``any transaction or class of transactions'' from any position limits 
that it establishes pursuant to the Act, the Proposed Position Limits 
Rule has eliminated the opportunity for participants transacting in 
exempt and agricultural commodities to apply for exemptions from 
position limits for what have historically been known, and permitted, 
as ``non-enumerated hedges.'' As a consequence, certain traditional 
risk-reducing commercial transactions executed in energy and 
agricultural markets would not fall within the definition of a bona 
fide hedging transaction under the Commission's Proposed Position 
Limits Rule.\6\ Such transactions include, but are not limited to, the 
following:
---------------------------------------------------------------------------
    \6\ See proposed CFTC Rule 151.5(a). The problems manifest 
themselves, in many circumstances, because cash settled swaps and DCM 
physically-settled futures do not offset each other in position 
calculations for purposes of these rules.

---------------------------------------------------------------------------
   Unfixed price commitments in the same calendar month;

   Unfixed price commitments in a different commodity;

   Hedges relating to assets that a person anticipates owning 
        or merchandising;

   Hedges of services;

   Hedges of ``spread'' and ``arbitrage'' positions;

   Hedging in the last 5 days of trading an expiring contract; 
        and

   Hedges on assets.

    The Commercial Alliance provides in Attachment A hereto specific 
examples of commercial transactions executed in energy and agricultural 
markets that would not fall within the definition of a bona fide 
hedging transaction under the Commission's Proposed Position Limits 
Rule.
B. The Commission Should Incorporate All of the Activities Described in 
        the Attached Examples Into the Final CFTC Rule 151.5(a)(2)--
        Enumerated Hedges
    All of the examples in Attachment A represent commercial activities 
that fall within the definition of bona fide hedge set forth in Section 
737 of the Act and CFTC Rule 151.5(a)(1) of the Proposed Position 
Limits Rule. Accordingly, they should be incorporated into the list of 
enumerated hedges to establish, beyond doubt, that such transactions 
would qualify as bona fide hedges under any final Commission rules.
C. The Commission Should Retain the Flexibility of Former CFTC Rule 
        1.3(z)(3)--Non-Enumerated Hedges and Related Processes
    In addition to providing certainty for the types of transactions 
set forth in Attachment A, the Commission should preserve the rule and 
process for obtaining exemptions for non-enumerated hedges. Markets are 
dynamic and are subject to change. The Commercial Alliance submits that 
it is neither in the public interest nor in its own interest as a 
market regulator for the Commission to adopt a rule that effectively 
eliminates its discretion and flexibility to grant an exemption for a 
bona fide hedging strategy that it could not foresee today (or, for 
that matter, that was simply overlooked during this process). While the 
Commission would be permitted to amend CFTC Rule 151.5(a)(2) to 
accommodate any unforeseen bona fide hedging strategies, the Commercial 
Alliance submits that the process to amend such Rule would not be in 
the best interests of the markets or the economy, as it would 
effectively delay the applicant hedger from the opportunity to timely 
establish that legitimate hedge position. Therefore, the Commission 
should retain CFTC Rule 1.3(z)(3) to give it the flexibility to adapt 
to changing market circumstances.
D. Compliance With the Daily Reporting Requirement Will Be Unduly 
        Burdensome
    As discussed in both the CMC and Working Group individual comments 
on the Proposed Position Limits Rule, requiring market participants to 
report daily on their cash market positions will be extremely and 
unduly burdensome and is not justified by any corresponding benefit.\7\ 
In addition to the operational burdens of building and maintaining a 
compliance system to perform such reporting, the process, or lack 
thereof, for applying for an exemption in advance of exceeding any 
position limit creates significant uncertainty for market participants 
seeking to accommodate both their short-term and long-term hedging 
needs. Accordingly, the Commercial Alliance requests that the 
Commission consider these concerns and provide market participants 
clear guidance on the process for applying for, and complying with, 
exemptions from speculative position limits.
---------------------------------------------------------------------------
    \7\ See Position Limits for Derivatives, Comments of the Working 
Group of Commercial Energy Firms at Part III.C (Mar. 28, 2011); 
Position Limits for Derivatives, Comments of the Commodity Markets 
Council at Part 4 (Mar. 28, 2011).
---------------------------------------------------------------------------
IV. Conclusion
    The Commercial Alliance supports regulation that brings 
transparency and stability to the agriculture and energy swap markets 
in the United States. The Commercial Alliance appreciates this 
opportunity to comment and respectfully requests that the Commission 
consider the comments set forth herein prior to the adoption of any 
final rule implementing Title VII of the Act. The Commercial Alliance 
expressly reserves the right to supplement these comments as deemed 
necessary and appropriate.
    If you have any questions, please contact Christine Cochran, 
President, CMC, at [Redacted], or R. Michael Sweeney, Jr., counsel to 
the Working Group, at [Redacted].
            Respectfully submitted,

R. Michael Sweeney, Jr.;
David T. McIndoe;
Mark W. Menezes;
on behalf of the Commercial Alliance.

CC:

Hon. Gary Gensler, Chairman;
Hon. Michael Dunn, Commissioner;
Hon. Bart Chilton, Commission;
Hon. Jill Sommers, Commissioner;
Hon. Scott O'Malia, Commissioner;
Dan Berkovitz, General Counsel, Office of General Counsel;
Bruce Fekrat, Special Counsel, Division of Market Oversight.
                              attachment a
Examples of Transactions That Do Not Qualify as Bona Fide Hedging Under 
        the Proposed Position Limits Rule
    The following provides examples of hedging transactions commonly 
entered into by commercial firms in agricultural and exempt commodity 
markets that will be effectively excluded from the definition of bona 
fide hedge as set forth under the Commission's Proposed Position Limits 
Rule.
I. Unfixed Price Commitments
A. In the Same Calendar Month
    Proposed CFTC Rule 151.5(a)(2)(iii) would permit a hedge of 
offsetting unfixed price purchase and sale commitments only if they 
were based on different delivery months. The following example 
demonstrates the potential need to hedge basis risk in the same 
delivery month, but at a different delivery location. If one used a 
cash-settled swap in one location and a physical delivery futures 
contract at the other, these positions would not offset, and would not 
qualify as bona fide hedge positions.

          Example: A natural gas (``NG'') wholesaler buys gas at (Point 
        1) and sells it at another point on the same pipeline (Point 2) 
        to a different counterparty. Both contracts are at an index 
        price plus or minus a differential. In order to lock in the 
        current spread relationship between the prices at the two 
        delivery locations, NG wholesaler sells a NYMEX Henry Hub 
        futures contract and enters into a ``long'' swap on the price 
        at Point 2, hedging the risk that the price at Point 2 will 
        decline relative to the price at Point 1. Since the purchase 
        and sale will occur during the same delivery month, this hedge 
        would not constitute a bona fide hedge under proposed CFTC Rule 
        151.5(a)(2).
B. In a Different Commodity
    Proposed CFTC Rule 151.5(a)(2)(iii) would permit a hedge of 
offsetting unfixed price purchase and sale commitments only if they 
were in the same commodity. The following example demonstrates the 
potential need to hedge basis risk between two different commodities.

          Example 1: Power plant operator buys natural gas from which 
        it generates and sells power. It buys gas from one party at an 
        index plus or minus a differential and it sells power to a 
        different party at an index plus or minus a differential. In 
        order to lock in the basis between gas and power prices, it 
        enters into a swap on the power price and Henry Hub futures 
        contracts in natural gas, effectively hedging the risk that the 
        price of power will decline relative to the price of gas. Since 
        the two prices are referencing different commodities, this 
        hedge would not constitute a bona fide hedge under proposed 
        CFTC Rule 151.5(a)(2).
II. ``Anticipated'' Transactions
    Although hedges of ``anticipated ownership'' and ``anticipated 
merchandising'' transactions would be bona fide hedges under the 
language in the Dodd-Frank Act and seemingly under proposed CFTC Rule 
151.5(a)(1), they would not be treated as such because there is no 
provision for them as ``enumerated hedges'' under proposed CFTC Rule 
151.5(a)(2).

          Example 1: Commercial entity X, a wholesale marketer of crude 
        oil, has purchased a cargo of oil currently transiting the 
        Atlantic from Europe to the U.S. at the price of ICE Brent 
        futures plus or minus a differential. It is negotiating to sell 
        that cargo in the U.S. gulf coast at a price of NYMEX WTI plus 
        or minus a differential. Although it has not concluded 
        negotiations on the sale, it believes that it will do so in the 
        next several days. Believing that prices may fall over the next 
        several days, it places a hedge in NYMEX WTI futures. Under 
        proposed CFTC Rule 151.5(a)(2), this would not constitute a 
        bona fide hedge.
          Example 2: In the example above, the parties have concluded 
        their negotiations and, as is standard in the industry, agreed 
        to the transactions subject to credit terms and legal review of 
        documentation. Again, the NYMEX WTI hedge placed by Commercial 
        entity X would not constitute a bona fide hedge under the 
        proposed CFC Rule 151.5(a)(2).
          Example 3: Farmers Elevator, a grain merchandiser, owns a 3 
        million bushel storage facility in Farmville, a town surrounded 
        by thousands of acres of growing corn, soybeans, and wheat. As 
        part of its normal business practices, Farmers Elevator expects 
        in the future to enter into forward contracts with area farmers 
        under which Farmers Elevator agrees to pay farmers a fixed 
        price for their grain at harvest. In order to hedge this risk, 
        Farmers Elevator ``goes short'' on CME by selling futures 
        contracts. Under the proposed rule, this would not constitute a 
        bona fide hedge since at the time of the futures position by 
        Farmers Elevator there in fact is no underlying physical 
        contract. The result would be that Farmers Elevator may no 
        longer be able to provide attractive forward cash market 
        contracts to its farm customers.
          Example 4: In February of 2011, prior to spring wheat 
        planting, Elevator X, which has storage capacity that is 
        currently sitting completely empty, locks in a spread of $1.40 
        on a portion of its expected throughput for the crop year by 
        buying July 2011 Wheat futures and selling July 2012 Wheat 
        futures. Regardless of whether Elevator X actually buys wheat 
        in 2011, this transaction represents a hedge by Elevator X of 
        its capacity (i.e., the value of its grain storage assets). If 
        there is a crop failure during the 2011 harvest resulting in 
        little to no wheat deliveries at Elevator X, the spread 
        position hedge will perform by providing Elevator X the 
        economic value of the position hedging against such an event. 
        Alternatively if Elevator X (as expected) buys wheat, it will 
        hedge these specific price risks by taking appropriate futures 
        positions and reducing the July/July Wheat spread. This 
        ``hedging of capacity'' strategy would not be a bona fide hedge 
        under the proposed CFTC proposed Rule 151.5(a)(2).
III. Hedging of Services
    Although hedges on the value of ``services that a person provides 
or purchases, or anticipates providing or purchasing'' would be bona 
fide hedges under the language in the Dodd-Frank Act and seemingly 
under proposed CFTC Rule 151.5(a)(1), they would not be treated as such 
because there is no provision for them as ``enumerated hedges'' under 
proposed CFTC Rule 151.5(a)(2).

          Example 1: Commercial energy firm Z is a wholesale marketer 
        of natural gas. It has an opportunity to acquire one year of 
        firm transportation on Natural Gas Pipeline (``NGPL'') from the 
        Texok receipt point to the Henry Hub delivery point for an all-
        in cost of $.30/mmbtu. The ``value'' of that service at that 
        time is $.33/mmbtu, measured as the difference between the 
        price at which one can sell the natural gas at the delivery 
        point minus the price at which one can purchase the gas at the 
        receipt point. At that time, commercial energy firm Z can enter 
        into a swap locking in the calendar 2012 strip at Texok at a 
        price of $4.00/mmbtu and sell a calendar strip of NYMEX Henry 
        Hub natural gas futures contracts locking in a sale price at a 
        weighted average of $4.33/mmbtu. Entering into those two 
        separate transactions without having actually purchased or sold 
        natural gas to transport has allowed commercial energy firm Z 
        to hedge the value of the firm transportation service that it 
        holds or can acquire.\8\ However, under the Commission's 
        proposal, the transactions would not qualify as bona fide hedge 
        transactions.
---------------------------------------------------------------------------
    \8\ Note that this ``value'' exists whether commercial energy firm 
Z ever owns or intends to own the physical commodity. In some 
circumstances, the firm might choose to release the capacity to a 
third-party and realize the value of the transportation service from 
the capacity release transaction.
---------------------------------------------------------------------------
          Example 2: Natural Gas Producer X has new production coming 
        on line over the next few years in the Gulf of Mexico. The 
        production is located near Point A on Pipeline Y's interstate 
        natural gas pipeline system. Producer X has the desire to sell 
        gas to customers in Region B as the price for natural gas in 
        Region B is significantly higher than at Point A, where natural 
        gas would currently be delivered into Pipeline Y's system. 
        Producer X contacts Pipeline Y and negotiates a Precedent 
        Agreement with the pipeline under which Pipeline Y will build 
        new transportation capacity from Point A to Region B. Under the 
        Precedent Agreement, Producer A is obligated to pay demand 
        charges to the pipeline for a term of 5 years from the date the 
        pipeline goes into commercial operation, if Pipeline Y is able 
        to complete a successful open season and obtains the necessary 
        permits to construct and operate the new section or expansion 
        of its pipeline system from Point A to Region B. The open 
        season is designed to attract commitments from other potential 
        shippers to help support the cost of building and operating the 
        pipeline expansion. The schedule calls for a completion of 
        construction and commercial operation of the pipeline expansion 
        on March 31, 2013.
          Producer X is concerned that the natural gas price 
        differential between Point A and Region B could collapse and is 
        fairly confident the expansion project will be completed. In 
        order to manage the risk associated with the 5 year financial 
        commitment to Pipeline Y, i.e., pipeline demand charges, 
        Producer X enters into swaps at Point B for a term of April 1, 
        2013 to March 31, 2018, to lock-in the price spread between 
        Point A and Region B. Under the Commission's Proposed Rule, the 
        swap transactions would not qualify as bona fide hedges. In 
        this case, the expansion of the pipeline system that would 
        afford customers in Region B more access to lower priced gas 
        might not occur without the ability to count the swaps 
        associated with this transaction as a bona fide hedge.
          Example 3: Commercial energy firm A is an electric utility 
        that owns coal-fired generation facilities. Firm A enters into 
        contracts with major railroads to transport coal from producing 
        regions to its various generating facilities. One or more of 
        these contracts are subject to a fuel surcharge, whereby rates 
        paid by firm A to transport coal are indexed to the price of 
        diesel fuel. As prices for the diesel fuel rise, the rate paid 
        by firm A to transport coal also rises. To mitigate this risk, 
        firm A could enter into a long position in futures contracts or 
        swaps for the diesel fuel, whereby gains realized on these 
        instruments should prices rise would off-set any increase in 
        the rate paid by firm A to transport coal. Under the Proposed 
        Rule, however, these transactions would not qualify as bona 
        fide hedge transactions since they would be entered into as a 
        hedge of services--in this case, coal transportation services.
IV. Hedges of ``Spread'' Or ``Arbitrage'' Positions
    Although hedges on the value of spread or arbitrage positions would 
be bona fide hedges under the language in the Act and seemingly under 
proposed CFTC Rule 151.5(a)(1), they would not be treated as such 
because there is no provision for them as ``enumerated hedges'' under 
proposed CFTC Rule 151.5(a)(2).

          Example 1: The business model of Company X is to import crude 
        oil from Europe to the United States. On an average year it 
        imports 48 million barrels of crude oil. Its purchases in 
        Europe are generally priced against Brent oil and its sales in 
        the United States are priced against WTI. Those prices are 
        readily available across the price curve, more than a year in 
        advance. There are times when Company X believes the 
        differential for a particular month is favorable and it seeks 
        to lock in that differential by buying Brent swaps and selling 
        NYMEX WTI futures, knowing that it will ultimately buy the oil 
        priced in Brent and sell the oil priced in WTI. Under the 
        proposed rule, even though this transaction allows Company X to 
        hedge the risk of its business strategy and expected 
        transactions, this would not be a bona fide hedge under 
        proposed CFTC Rule 151.5(a)(1).
          Example 2: Grain Merchandiser X is in the business of buying 
        wheat in, among other places, North Dakota, using a Minneapolis 
        Grain Exchange (MGEX) reference price. Grain Merchandiser X is 
        also in the business of selling wheat to Italian flour mills, 
        using a Euronext France (MATIF) price. These prices are readily 
        available across the price curve, more than a year in advance. 
        As such, there are times when Grain Merchandiser X believes the 
        differential for a particular month is favorable and it seeks 
        to lock in the differential by selling MATIF futures (or swaps) 
        and buying MGEX futures, even though it will ultimately buy 
        North Dakota wheat priced in MGEX futures. This transaction, 
        which allows Grain Merchandiser X to hedge the risk of the 
        expected transactions in its business strategy, would not be a 
        bona fide hedge since it is not enumerated under proposed CFTC 
        Rule 151.5(a)(2).
V. Hedging in the Last Five Days of Trading an Expiring Contract
    The following examples illustrate the uneconomic consequences of 
prohibiting a bona fide hedge positions from being held in the last 5 
days of trading.
A. Unsold Anticipated Production--Proposed CFTC Rule 151.5(a)(2)(i)(B)
          Example 1: Company A anticipates producing 2000 barrels of 
        crude oil in July. That production is currently unsold. To 
        hedge its risk that the value of those barrels may decline 
        prior to their sale, Company A will sell two July NYMEX WTI 
        crude oil futures contracts, which represent delivery ratably 
        during the month of July. The last trading day of the July 
        futures contract is June 21st. The last day that Company A 
        could hold the position as a bona fide hedge under the proposal 
        is June 14th. This means that if Company A holds the contract 
        from June 15th through June 21st and delivers its oil under the 
        July futures contract, it could not treat those positions as a 
        bona fide hedge during that period. Alternatively, in order to 
        maintain bona fide hedge status, it would be required to roll 
        its hedge into the August contract on June 14th, taking basis 
        risk on the July/August spread for the additional 5 days.
B. Unfixed Price Contracts--Proposed CFTC Rule 151.5(a)(2)(iii)
          Example 1: Company B has a contract to buy natural gas at the 
        Henry Hub in July at NYMEX + $.10 and a contract to resell it 
        at the Henry Hub in August at NYMEX + $.15. To hedge the basis 
        risk, it sells NYMEX July futures and buys NYMEX August 
        futures. Under the Commission's proposal, this position would 
        not be a bona fide hedge if it was carried into the last 5 days 
        of trading of the NYMEX July futures contract. Company B would 
        be forced to roll its position to a less efficient hedge.
C. Cross-Commodity Hedges--Proposed CFTC Rule 151.5(a)(2)(v)
          Example 1: Commercial energy firm J supplies jet fuel to 
        airlines at a variety of airports in the United States, 
        including Houston Intercontinental Airport. It has a fixed-
        price contract to purchase jet fuel from a refinery on the gulf 
        coast during early June. Because there is no liquid jet fuel 
        futures contract, commercial energy firm J uses the June NYMEX 
        physically-delivered WTI crude oil futures contract to hedge 
        its price risk. Under the Proposed Rule, commercial energy firm 
        J would be required to liquidate its hedge during the last 5 
        trading days of the June contract and either remain unhedged or 
        replace its June hedge with a contract that represents a 
        different delivery period and, therefore, a different supply/
        demand and pricing profile.
          Example 2: AgriCorp, a grain warehouse, grain merchandiser 
        and feed ingredient wholesaler, buys wheat from farmers. At the 
        same time, Agricorp enters into a fixed price agreement with a 
        feedyard to supply feed (the exact components of which could be 
        satisfied using wheat, corn, DDGs, or other ingredients). In 
        order to hedge its risk, AgriCorp enters into a swap, hedging 
        the risk that the price of wheat will decline relative to the 
        price of corn (the corn futures price better correlates to feed 
        prices, thereby providing a more effective hedge). Since the 
        two prices are referencing different commodities, this hedge 
        would not constitute a bona fide hedge if held in the last 5 
        days of trading.
VI. Hedges on Assets
          Example: XYZ Corp. is planning on buying a liquefied natural 
        gas (``LNG'') vessel. The value of that asset is based upon the 
        spread between natural gas prices between and among various 
        continents. XYZ will need financing in order to make the 
        purchase. The lenders will only make a loan if XYZ can 
        demonstrate a level of certainty as to its future revenue 
        stream. As it negotiates with the shipbuilder and as it 
        negotiates with lenders, the current differentials are 
        favorable for robust demand for LNG. XYZ wants to enter into 
        separate swaps and/or futures positions in the U.S., Europe and 
        Asia to lock in the potential purchase prices in producing 
        regions and the potential sales prices in consuming regions at 
        current differentials. This will allow it to lock in the value 
        of LNG transportation and satisfy lenders that this is a good 
        credit risk for them to take on. Those swaps and/or futures 
        positions would not be bona fide hedges under the Proposed 
        Position Limit Rule because the ship-owner does not own or 
        anticipate owning the underlying commodities.

    The Chairman. Thank you, and the chair would like to remind 
Members that they will be recognized for questioning in order 
of seniority for Members who were here at the start of the 
hearing, and after that, Members will be recognized in order of 
arrival. I do appreciate the Members' understanding, and just 
to provide a little clarity, on the majority side, the first 
three or so will be myself, Mr. Johnson, Mr. Conaway. On the 
minority side, it will be Mr. Holden, Mr. Peterson and Mr. 
Boswell. And with that, I turn to myself.
    Throughout this process, I have argued that regulation and 
a healthy economy can go together. A robust regulation, yes, 
and a healthy economy can go hand in hand. Unfortunately, we 
have not seen that balance, I believe, in many of the proposed 
rules. Certain regulatory proposals will impose costs to the 
real economy that may very well exceed the benefits achieved in 
Dodd-Frank's objectives, and that is what we are here today to 
address. That is our job.
    Yesterday, the Chairman of the CFTC gave a speech before 
the Futures Industry Association in which he said, ``It has 
been just over a year since Dodd-Frank reforms became law. 
There are those who might like to roll them back and put us 
back in the regulatory environment that preceded the crisis 3 
years ago.'' So I ask this first couple of questions to the 
panel, and anyone can answer that chooses to. Do you believe 
that if the proposals considered today were enacted, that they 
would roll back Dodd-Frank reforms, number one, and if the 
proposed changes were made, will your regulatory environment be 
the same as it was 3 years ago? Fair question. Do you believe 
what we are discussing today would roll back Dodd-Frank's 
reforms, and if these bills were indeed to be signed into law, 
do you believe that the regulatory environment would be where 
it was 3 years ago? Whoever would care to step into that? 
Please.
    Ms. Sanevich. Certainly, speaking for the ERISA plans, the 
regulatory requirement would indeed change even if the 
proposals that are presented today, at least as they related to 
ERISA plans were enacted, what these proposals would do in our 
view is really reflect better what the Congressional intent 
was. In some of the cases that particularly affect ERISA plans, 
the regulations that have been proposed currently are not 
within the spirit of what Congress intended and in some cases 
would essential eliminate the ability of ERISA plans to use 
swaps, which is clearly what Congress did not intend in 
enacting Dodd-Frank. So things would not be business as usual 
as they were 3 years ago but they would certainly clarify and 
move us closer to what we think Congress had intended with 
enacting certain provisions of the Dodd-Frank.
    The Chairman. Thank you.
    Anyone else wish to comment? Yes, Mr. Williams.
    Mr. Williams. Mr. Chairman, it appears to us that the 
implementation of the legislation considered today would only 
allow the practical implementation of Dodd-Frank as envisioned, 
and the regulatory environment compared to 3 years ago would be 
substantially different.
    The Chairman. Thank you.
    Mr. Giancarlo. Mr. Chairman, these proposals are not meant 
to roll back Dodd-Frank, and I could say for the record, we are 
not in favor of rolling back Dodd-Frank. Dodd-Frank imposes 
substantial changes on the wholesale swaps industry, many of 
which in fact we were advocating for before Dodd-Frank, such 
things as moving to more of a cleared market structure. We 
wholly support that major accomplishment of Dodd-Frank and 
think that will improve transparency and access to the markets 
for many participants.
    The mandatory execution provision is also one that we are 
very supportive of but we are supportive of it if it is in 
accord with Congress's clear intent that execution facilities 
could use any means of interstate commerce. So we see the Swap 
Clarification Act and these other bills as purely clarification 
and not a rollback of the operative provisions of Dodd-Frank.
    Ms. Boultwood. So I will add to that answer. You know, 
Dodd-Frank was put in place as a statute to protect and control 
the economy against systemic risk and also create greater 
transparency with respect to Title VII and our world of 
derivatives. So neither of those would be lessened, if you 
will, by the rules that we are considering or the legislation 
that we are considering today. This legislation in fact ensures 
that those that created the systemic risk are treated under the 
rules from the SEC and CFTC and would exclude, for example, 
end-users who are well known through history of having not 
created, or are sources, of systemic risk. There are reporting 
provisions, even for end-users, that are a part of the 
rulemaking under Title VII which would be in place that really 
further that goal of transparency in the derivatives markets. I 
think the provision of clearing maintains a very new aspect of 
transparency that would be preserved even when these proposed 
legislative bills are approved.
    The Chairman. One last question, and I understand the 
answers to these from your comments but just for the record, do 
you think it is important for Congress to legislate in the 
areas proposed today or should we wait until the agencies 
finalize the rules? Yes, ma'am.
    Ms. Sanevich. We definitely think Congress should act 
because, frankly, if the rules are adopted and finalized, by 
then at least for the ERISA plans, it would be too late. They 
will not be able to engage in swaps as of the time the rules 
are set for implementation and that would be a disastrous 
result for the millions of Americans that depend on defined 
benefit plans for their retirement security.
    The Chairman. Yes, Mr. Cordes?
    Mr. Cordes. Mr. Chairman, I would agree with that. The 
bills need to be enacted today. We need to get some 
clarification on some of these things. We have cooperatives 
today that are putting their businesses on hold from going 
forward, and part of that is the uncertainty. We need this 
clarification. Our concern is down the road if we don't have 
that clarification, will we have the proper risk management 
tools to put through the cooperative network that ultimately 
get down to the farmer level? I don't think it is any surprise 
today with the volatility in the markets out there, farmers are 
faced with greater challenges about protecting and managing 
their margins and their operations that will be subject to 
risk.
    Mr. Giancarlo. Mr. Chairman, we operate global marketplaces 
in addition to Louisville, Kentucky, and Sugarland, Texas, that 
I mentioned earlier. We also operate marketplaces in London, in 
Geneva, in Dubai and Singapore and places like that, and with 
the restrictions placed on modes of execution proposed by the 
CFTC, the operators of markets in those jurisdictions are 
licking their chops as they are waiting for markets to migrate 
offshore. In the modern world of swaps, markets move at a flick 
of a mouse. It is not as if they have to move buildings or 
bridges. They can move to foreign marketplaces. If we set 
restrictions on the methods of execution that are unsuitable 
for the nature of the instruments, we will see those 
instruments trade in foreign markets almost overnight. It is 
very, very important that Congress's intent that the mode of 
execution be suitable for the instrument and any means of 
interstate commerce be interpreted as it is meant to be, be 
enacted as soon as possible.
    The Chairman. Thank you. One last comment, and my time will 
have expired.
    Mr. Thul. Just to add on, Mr. Chairman, I would say that 
the comment that you made at the beginning of your questioning 
was just adding real cost to the economy and if this goes 
through as it is today, we have lack of clarity around what 
many of the definitions are and then also the potential to 
introduce a lot of added incremental costs to the commercial 
businesses that we are dealing with that are not in place today 
and could hurt the competitiveness of the United States.
    The Chairman. Thank you. My time has expired. I now 
recognize the gentleman from Pennsylvania, Mr. Holden, for 5 
minutes.
    Mr. Holden. Thank you, Mr. Chairman.
    Mr. Williams, to which Prudential Regulators does your bank 
answer to?
    Mr. Williams. To what regulators do we answer?
    Mr. Holden. Yes.
    Mr. Williams. We have at least three regulators: the 
Georgia Department of Banking and Finance, the FDIC and the 
Federal Reserve System.
    Mr. Holden. Now, if Dodd-Frank had never been enacted into 
law, would your regulators have the authority to require you to 
collect margin from your swap counterparties whether they be 
financial or commercial using their preexisting statutory 
authority to oversee your bank's safety and soundness?
    Mr. Williams. They have the authority to oversee our safety 
and soundness. I don't believe they have the statutory 
authority to specify specific margin requirements or collateral 
requirements on specific transactions.
    Mr. Holden. Well, it is my understanding that the 
regulators do have that authority, so Mr. Chairman, I suggest 
maybe we can get the Prudential Regulators in here and get 
clarification on this.
    For other members of the panel, if we do discover the 
Prudential Regulators, as I understand it, can still require 
margin despite H.R. 2682, how do we address your concerns? In 
other words, I believe they can have you impose margins, if we 
find out that that is correct as they are telling me, what does 
this legislation do and how do we address your concerns?
    Mr. Williams. I am not familiar with the specific 
legislation you mentioned, and I don't know about the 
Prudential Regulators' specific authority to regulate specific 
transactions. I will be happy to get back to you on that.
    Mr. Holden. Does anyone else care to comment? Because it is 
my clear understanding that they believe that they can have 
margins imposed.
    Ms. Boultwood. Yes, that is correct, so they can either 
impose margin on counterparties, and that is initial margin and 
variation margin, and if they choose not to impose that margin, 
then they will be required to hold additional capital. So 
either presents a cost because this capital, if it is held by 
the bank, will be passed through as a charge, which would be 
reflected in the bid ask spread. That is the price of the 
derivative that is transacted. And if it is a margin 
requirement, initial margin and variation margin, then it is a 
direct capital cost to the counterparty.
    Mr. Holden. Okay. Well, help me--this is complicated stuff, 
so you said they do have the authority, so if they do have the 
authority, how would H.R. 2682 if enacted into law affect the 
concern? They can do it anyway, correct?
    Ms. Boultwood. That is a good question. I think it would 
require cooperation in kind of this unprecedented environment 
of regulatory change between authorities like the CFTC, the SEC 
and Prudential Regulators which, honestly, we haven't seen 
before. How does that get legislated? I leave it to more 
experienced minds than mine, but I do think that there has to 
be a way to force the cooperation across Prudential Regulators 
and independent Commissions.
    Ms. Sanevich. I guess I have a couple of observations. 
Obviously, I don't know the jurisdictional lines between 
Prudential Regulators and Congress but the Prudential 
Regulators came out with these margin rules as a direct result 
of the Dodd-Frank Act. Something in the Act must have made them 
stop and think and go ahead and start regulating margin 
requirements. Moreover, the CFTC also has tacked onto the 
Prudential Regulators with respect to margin requirements for 
anyone who will not be caught by the Prudential Regulators. So 
certainly the CFTC since it is empowered under the Dodd-Frank 
Act to do what it is doing, there has to be some sort of cross-
jurisdictional issue.
    And last, I believe the Chairman had mentioned and maybe 
the Ranking Member as well the cost-benefit analysis issue, and 
perhaps that is where some solution can be found, because with 
respect to the ERISA pension plans, they are called high-risk 
end-users by default. It is not like the regulators had thought 
about what pension plans do, how they manage their risk or what 
they use interest rate swaps for, they just said if you are not 
this and you are not this, you must be a high-risk financial 
end-user, and that is clearly a ludicrous result with respect 
to pension plans. Maybe that is a way to force the issue and 
make folks think about exactly how these margin requirements 
will be implemented and how they will affect the various end-
users that will be affected.
    Mr. Holden. Thank you.
    Mr. Chairman, based on the answer, it is just more apparent 
that we need to have the regulators come before us so we can 
have some clarity, and I yield back.
    Mr. Conaway [presiding.] One clarification. Ms. Boultwood, 
were you talking in your answer about the current regulations 
or the proposed regulations?
    Ms. Boultwood. As Ms. Sanevich indicated, it is the 
regulations that have come about for banks as a result of Dodd-
Frank.
    Mr. Conaway. Okay. So the proposed regulations?
    Ms. Boultwood. Correct, and whether they are in--I don't 
know the timeline for when they go into effect but they are 
proposed.
    Mr. Conaway. Mr. Tim Johnson for 5 minutes.
    Mr. Johnson. Thank you, Mr. Chairman.
    Let me address this to all the panelists, and I don't need 
ad seriatim but maybe a select response. You are all in some 
form or another an integral part of the agricultural sector in 
the United States. How do you feel that the CFTC regulations as 
proposed without any guiding legislation will impact American 
agriculture?
    Mr. Cordes. I would say without some clarification on the 
rules as things are proposed, you are going to have agriculture 
not knowing exactly where they stand. They will be hesitant to 
offer some of the risk management tools that they do in the 
industry today. I would say if you get these volatile markets 
like we saw in 2008, which we are very close at today, some of 
the impact you will see in rural America, you will probably 
find that as farmers want to sell grain into the future, say 6 
months to a year out or maybe a year and a half, won't have 
that opportunity because there won't be buyers there to post 
those bids because without these tools, they can't manage that. 
So they need clarification so we can offer the proper tools.
    Mr. Johnson. So would the whole panel basically have a 
sense that a lack of certainty causes some degree of 
instability and lack of predictability in the process? Is that 
a fair statement?
    Let me ask Mr. Thul from Cargill, you are a major player in 
my district and the agricultural sector around the country. 
Your company is facing a significant number of new regulatory 
requirements that could greatly change--I think that is an 
understatement--your risk management practices. What would be, 
in your judgment, the cumulative effect of those regulations, 
or these regulations, for Cargill, and more particularly for 
its customers?
    Mr. Thul. Thank you. I think it would be a drastic change 
for us. You know, if you look at the anticipatory hedging piece 
of this and even the bona fide hedge definition, it could 
greatly reduce our ability to be able to handle the grain crops 
and service our customers, and at its worst case, that could 
translate into not being able to accept nearby delivery in 
times when the marketplace absolutely needs it. So I think it 
could be----
    Mr. Johnson. That is good. I appreciate that.
    The Ranking Member, my good friend, Mr. Peterson, has 
expressed some concerns about this series of three bills and 
three discussion drafts that they might be premature and that 
they not be geared in at least time-wise to what we need to do. 
Do any of you have any thoughts or response to that? Don't all 
speak at once.
    Ms. Boultwood. Also, it is in part related to the last 
question, just in terms of the costs we are already seeing. So 
behavior is changing. We have observed in the energy markets 
already decreases in liquidity in those markets. There could be 
a number of reasons to explain that, but certainly the 
uncertainty and potential for regulations, costly regulations, 
is one large reason. When we look at our costs internally, 
there will be significant costs of implementation if we don't 
properly as proposed under this proposed legislation define the 
end-user and the appropriate size of its de minimis exception 
to the swap dealer definition. We will also have technology 
costs as well as those costs we see in the market.
    Mr. Johnson. I guess my last question is in the form of a 
comment. Ranking Member Costa and I recently held a field 
hearing in central Illinois with respect to rural development, 
broadband services and so forth, which really raises the larger 
issue of where rural America, where small-town America is 
going. I am presuming that the members of the panel here like 
most of the Members of the Committee would agree that there is 
going to be an impact on small-town America, rural America, 
particularly during an era when there is at best a decline and 
at worst a rapid decline in terms of the infrastructure and 
economic future of that area. Would you say that is a fair 
summation of the impact of the rules without any guiding 
legislation?
    Mr. Thul. I absolutely would agree with that, and I think 
that it is going to put unnecessary costs in an already low 
margin-type environment that we have in our agricultural 
system.
    Mr. Johnson. My time has expired. Let me just make a 
concluding remark. I think this has been a very instructive 
hearing so far, and a lot of good input, good witnesses and 
actually good proposals for change, but I would suggest that 
when we deal in a mega cosmic sense, we oftentimes have a 
microcosmic effect in terms of people's real lives in the 
Central Valley of California or in Decatur, Illinois, and I am 
hopeful we as Members of Congress, the CFTC and you all are 
mindful of what the impact could be.
    Mr. Conaway. The gentleman yields back.
    Mr. Peterson for 5 minutes.
    Mr. Peterson. Thank you, Mr. Chairman.
    Does anybody here remember Enron? You know, we had an 
energy company that became a financial trading company, and 
like a swap dealer, it served as a counterparty to a wide range 
of energy swaps with a wide range of customers and operated in 
the dark without oversight, without regulation, created 
separate entities and moved risk to those entities to hide it 
from its own balance sheet and again with little oversight. Out 
of that fiasco, that is part of the reason we got the Sarbanes-
Oxley legislation, which typically overreacted and put costs on 
people that weren't the problem, and some of the issues that 
you are raising here today, but as part of the cost of getting 
that done, we got rid of Glass-Steagall, which caused part of 
this problem. And then we in this Committee passed the CFMA in 
2000, which further caused this problem, and I have to admit as 
a junior Member of the Committee, and for those of you that are 
new here, this might be instructive--I bought into this. The 
argument was, these guys are a bunch of rich guys that are 
gambling their own money and so it is none of our business what 
they do, and they almost took down the whole damn world 
economy.
    And the other thing that happened in the CFMA is that a lot 
of this swap business was gambling, especially these naked 
CDS's, and so there was a question about whether there was 
legal backing of these contracts, and so in the CFMA, we gave 
legal certainty to these swaps, and at the time we had $80 
billion in the swap market, and from 2000 to 2008, it went to 
$600 or $700 trillion with no regulation, nobody knowing who 
was doing what, and that is what we are trying to get at here.
    So today you come before us with one proposed bill that 
would give energy companies the ability to make markets and 
engage in dealing activities and energy swap with little or no 
chance of being designated as a swap dealer regardless of how 
much dealing businesses you do, and we know that some of you do 
a significant amount of dealing.
    Another bill would exempt even from the definition of swap 
those swaps conducted between affiliates of your company, and 
so there are Members who see what you are asking for and point 
their fingers and say Enron. Clearly, none of you are Enron, I 
understand that, I am not accusing you of that, but what do you 
say? What can I say to those that fear that these bills are 
going to reinstate the condition for the rise and subsequent 
collapse of another Enron kind of situation?
    Ms. Boultwood. I can start the response. We all remember 
Enron. It is a great thing to discuss as we think about this 
proposed legislation, but Enron as well as certain telecom 
companies in that era, there were large accounting scandals and 
Enron had a lot to do with financing off balance sheet in 
entities that weren't legitimate and didn't have legitimate 
assets backing them. Now, Enron, at the same time they were 
perpetrating an accounting fraud were also transacting in 
derivative markets. That is true. They were dealing, they were 
market making often without physical assets to support that 
activity.
    Mr. Peterson. Well, and so was AIG.
    Ms. Boultwood. Well----
    Mr. Peterson. I mean, there were a number of people that 
were doing these swaps----
    Ms. Boultwood. And so----
    Mr. Peterson.--and not putting any money up, and that is 
part of what we are trying to get at here. I mean, you keep 
saying that this is going to add cost. Well, yes, it is going 
to add cost in some places that should add cost because people 
were operating and doing these deals and pretending that there 
wasn't any risk and any potential problem, and the government 
ended up picking up the bill. And then Goldman goes over and 
makes this deal in Greece and now the taxpayers in Europe are 
going to pick up the bill for that, and we are still allowing 
people to do this stuff, and these are the major folks that are 
involved in this. So I said from the start that the legitimate 
end-users did not cause the problem and should not be swept up 
in this, but some of these bills create loopholes that are 
going to allow this stuff to go on, and I am just not going to 
stand for that. Maybe there will be some collateral damage in 
this but I am not going to be one that is going to sit here and 
have another collapse happen and happen the second time on my 
watch. I made a big enough mistake the first time by supporting 
the CFMA, so some of us that have been around want to err on 
the side of caution here.
    Ms. Boultwood. Just on Enron, since we started there, I 
would just like to remind the Committee that never did any 
power or natural gas cease to flow. The end-using customers 
continued to receive their commodities and the collapse of 
Enron was a failure of a corporate strategy and, we can look 
back rightfully so, and so businesses take risks, they fail.
    Mr. Peterson. The collapse of Lehman was a failure of a 
corporate strategy, and there would have been a lot more 
collapses if the government wouldn't have come in and bailed 
them out, and so now we have just put in law the ability to 
have the government bail these people out no matter how stupid 
they are. That is part of what we did in Dodd-Frank. So that is 
my concern. We are letting people go out and do this stuff and 
then at the end of the day we are going to bail them out? I 
mean, the taxpayers are tired of this, and you see what is 
going on on Wall Street, and I don't know that they are focused 
on the right things necessarily but I understand their 
frustration. I have the people in my district that feel the 
same way, and if we don't respond to this, that Wall Street 
protest is going to get bigger, not smaller.
    Mr. Giancarlo. Congressman, the basic reforms of Dodd-
Frank, of clearing, central counterparty clearing of greater 
transparency, of regulated execution, stands unchallenged by 
certainly my organization, myself and most of my fellow members 
of this panel. What these reforms that we are talking about 
today are about clarifications of issues, not about repeal, not 
about going back. And in fact, in some ways Enron was a very 
good model, what happened in Enron for the drafters of Dodd-
Frank. I think a number of lessons were learned. The U.S. 
energy market as it exists today has very much risen out of the 
ashes of Enron. Following Enron, we went to a cleared 
environment where market participants have a choice of clearing 
entity. We went to a multiple execution environment where 
market participants have a choice of execution venue and they 
are not limited to a single silo as we have in a number of 
futures markets. And that is really the model for Dodd-Frank 
where market participants will be required to clear but they 
will have a choice of clearing venue. They will be required to 
execute through a SEF or an exchange, but they will have a 
choice of execution facility, and in the language I noted in my 
opening testimony, through any means of interstate commerce, 
market participants should have a choice of how to execute the 
trade. In the SEF Clarification Act, all that is being asked is 
that Congress's intent be stated clearly so that regulators 
fulfill the intent of Dodd-Frank, which in a number of ways 
picked up on a number of the mistakes that were made in the 
Enron situation and are trying to get it right, and we are very 
supportive of that.
    Mr. Peterson. Thank you.
    Thank you, Mr. Chairman.
    Mr. Conaway. I thank the gentleman.
    Turning back to the cost-benefit analysis rules and the 
procedure that were used with this current set, just for a 
point of clarification, my good friend from Minnesota bragged 
ever so briefly on the bill to clarify the rules on behalf of 
the CFTC. That is a prospective change to their cost-benefit 
analysis and would not affect anything that is going on right 
now, so it would just require the agency in the future to abide 
by the rules that even the President in his January letter set 
out.
    I would like each panelist to briefly talk about if the 
cost-benefit analysis that was done, how it would have changed 
perhaps the rules that you are interested as relates to each of 
your entities, so we will just come down the list and kind of 
briefly talk on how that might have impacted what you are 
worried about, what you are not worried about.
    Mr. Cordes. Yes, the cost-benefit analysis, if you get a 
good weighting about how disruptive to commerce and liquidity 
in the industry, in the cooperative world, what we are thinking 
about, and more importantly, closer to home I am thinking for 
my own company, CHS, where do these become and where you weight 
that out. We are not swap dealers yet we feel there is enough 
wiggle room in this language and that is what we are asking for 
clarification today: let us set that aside so we don't get 
labeled into that category because there are costs along with 
being that. If you are in that category, that is going to 
inhibit some things we can do, activities with our members 
through the local cooperative network down to the farmer 
network. What does that do for commerce in rural America? If 
you can get that balance right between there, I think that 
would make a big difference.
    Mr. Conaway. Mr. Williams, you mentioned $100,000 charge or 
fee for a clearing member for a small bank. Was that reflected 
anywhere in the CFTC's analysis?
    Mr. Williams. That is not reflected in the CFTC's analysis. 
That is the feedback we get from potential clearinghouse 
partners that we would work with.
    Mr. Conaway. The broader question is still for anybody.
    Mr. Williams. It is clear that small banks have a minuscule 
participation in the derivatives market. These costs that would 
be a result of the legislation would significantly increase the 
cost of participating in the market and probably make it 
prohibitive for us to participate.
    Ms. Sanevich. Certainly with respect to the ERISA plans, 
the fact that there is an overarching regulatory scheme already 
in place certainly fits in within the President's January 
letter as well as this cost-benefit issue in that the ERISA 
plans' case, not only is there no benefit, there is a lot of 
cost, I mean, the cost is huge. In some cases, ERISA pension 
plans will be unable to in the future engage in these very 
important risk mitigation strategies. To take that authority 
away from those that manage the pension assets would be a grave 
mistake, and you can also easily see the lack of a thorough 
cost-benefit analysis. Back to this margin issue, I mean, 
anyone who would actually put an ERISA pension plan in the same 
bucket as a hedge fund and call an ERISA pension plan a high-
risk financial end-user, I mean, clearly the uniqueness of an 
ERISA pension plan has not been taken into account.
    Mr. Giancarlo. If I can use an analogy to describe global 
markets for swaps, it would be sort of like a balloon. If you 
squeeze it here, it pops out there. Markets can move around the 
globe, overnight, if they become too restrictive. The goal is 
not to find the lowest level of restrictions but in fact it is 
the right balance of restrictions and regulations for any given 
marketplace. The jurisdiction that has the right balance, the 
right balance of transparency and liquidity as Congress in 
Dodd-Frank said, liquidity must be balanced against 
transparency. The jurisdiction of the right balance are where 
markets move. Our concern with some of the restrictions coming 
out of the CFTC whether it is restrictions on mode of access, 
modes of execution, whether it is on something that has become 
known as the 15 second rule, which I won't go into but it is 
addressed in my testimony----
    Mr. Conaway.--in order to be respectful of the other 
panelists' time. The point, though is----
    Mr. Giancarlo. The point is that there has not been a cost-
benefit analysis for some of the restrictions, and my worry is 
that we don't know what will be the effect. The effect could 
very well be to force markets offshore, which would be 
detrimental for American business interests, which would either 
not be able to source their hedging needs here or have to go 
offshore to find them.
    Ms. Boultwood. Can I add to that? Just in terms of the swap 
dealer definition if left as is will have an overly broad 
reach, and this will, to earlier points, limit market 
participation, increase the cost of hedging as market liquidity 
falls, and we will see those that can transact in other 
jurisdictions, other markets with certainty. You know, these 
contracts, whether it is when we are hedging oil or we are 
hedging gas, we can transact internationally, and if an entity 
has a capitalized sub in a foreign country, it is not a major 
issue to move to that other jurisdiction that has regulatory 
certainty. So the costs to the company, to the market as well 
as to the taxpayer just haven't been assessed and set off 
against the benefits to society of all these controls to help 
mitigate systemic risk or the fear of a future bailout.
    Mr. Conaway. Quickly, Mr. Thul.
    Mr. Thul. One last comment. So in addition to the costs, 
which I don't think we know what the true effect will be today, 
it is going to have the unintended consequence of pushing risk 
on to the actual end-users with more volatility in the markets 
and unduly creating speculation by default in a lot of these 
cash markets if we can't get clarity around these issues.
    Mr. Conaway. I would like to ask unanimous consent to 
submit a statement from the National Rural Electric Cooperative 
Association. Hearing no objections.
    [The document referred to is located on p. 111.]
    Mr. Conaway. Mr. Courtney for 5 minutes.
    Mr. Courtney. Thank you, Mr. Chairman. I want to thank the 
witnesses for being here today. As the Member of Congress who 
represents Senator Chris Dodd, who last night former Speaker 
Gingrich said should be arrested for his work on this, I want 
to thank Mr. Giancarlo for at least acknowledging that this 
legislation was intended to deal with a problem which Mr. 
Peterson said almost brought the whole world down. When I 
listen to the complaints here today about the speculative ideas 
about where costs are going to be, Mr. Thul, you have customers 
in eastern Connecticut, farmers who buy Cargill products, and 
when I talked to them last spring and summer about their 
challenges that they face right now, it was the outrageous 
spike in energy costs which was completely indecipherable to 
them in terms of why it was happening. I just say to you, the 
notion that the status quo is something that end-users, real 
end-users like dairy farmers can count on in terms of having 
any kind of predictability or confidence in their own costs 
looking out on the horizon, I mean, it does not exist right 
now. You cannot find an oil dealer in Connecticut that will 
hedge for this winter's fuel for their customers because they 
have totally lost confidence in energy markets. It is gone. 
They are totally hostile to it, let alone suspicious of it. And 
one of the rules that Dodd-Frank included was to try and put 
some position limits in terms of the traders that deal with 
this market. Chairman Gentzler has been here four times talking 
about the fact that they are trying to move this rule forward. 
They have had over 20,000 comments. I am sure every single 
group here has had an opportunity to wade in just as 
administrative law allows for the public and for interested 
parties to have their opportunity to be heard. What I am 
hearing at home is, what is taking so long in terms of trying 
to stabilize a market that again people just have absolutely no 
confidence in right now and it is just killing them with real 
costs and real lives, which we have heard a lot of talk about 
here today.
    So I guess the question I want to ask is that the cost-
benefit measure that is being proposed here, I mean, do you see 
that bill as basically restarting the regulatory process for 
the position limits rule, just to take one item out of Dodd-
Frank that the Commission has been working assiduously on and 
some would say far too slowly on? I mean, is it your hope that 
if we pass that bill that we go back to square one and just 
start this process all over again? Again, if someone could help 
me in terms of their legislative interpretation of that 
measure.
    Mr. Conaway. If the gentleman will suspend, the proposed 
law is prospective. It would have nothing to do with anything 
that has been proposed so far.
    Mr. Courtney. So the bill that we have before us----
    Mr. Conaway. It is not a restart.
    Mr. Courtney. Okay. Then I will change my question then and 
just ask whether or not any of you think that what has happened 
last spring when the price of oil per barrel went up to $115 a 
barrel had anything to do with over-speculation, and maybe our 
friend here from the energy association can answer that 
question.
    Ms. Boultwood. It used to be that many commodity prices 
were set in the United States. We were the marginal buyer and 
it was our supply and demand that drove the price of a 
commodity whether it was oil, gas or copper. You know, the 
market has globalized and now the marginal buyers are often not 
in the United States, and you can have supply-and-demand 
factors in China and the Middle East and so on impacting the 
way those market curves shift, and it can seem inexplicable to 
Americans, rural Americans, Americans in big cities, but we are 
going through a globalization of these markets. We will not be 
able to explain based on domestic activity all changes in oil 
prices or all changes in gas prices.
    And to try to use a tool, in my view, to use a tool like 
position limits, that will limit activity in the United States 
and ultimately growth within our own country, but to think that 
it will limit activity in futures markets and in physical 
markets around the world is unlikely.
    Mr. Courtney. You know, it is sort of funny because you 
hear a lot of people in this town talk about American 
exceptionalism and how we should be a leader, but when we talk 
about, again, just trying to have, in my opinion, some 
commonsense regulation, then suddenly there is this feeling 
that we have to fear to sort of stake out a position. I mean, 
the fact is, as I am sure you know, G20 conferences, 
governments now are talking about trying to sort of harmonize 
regulation in this, and at some point, somebody has to move 
here in terms of trying to at least show the way that we are 
just not going to be powerless and helpless in terms of forces 
that--again, small businesses and farmers are getting killed in 
terms of trying to keep up with costs that again just have 
nothing to do with real supply and demand, as you said.
    Mr. Giancarlo?
    Mr. Giancarlo. Yes. On the subject of harmonization, that 
is a great concern to us. The Europeans are not taking the 
approach that the CFTC is taking, that the modes of execution 
of swaps needs to be limited to electronic systems, and in 
fact, what we are concerned about is that they will allow these 
multiple modes of execution to be used and that may actually 
attract trading to go from U.S. markets to European markets 
where it may be a more natural form of executing these less 
liquid swaps products. So it is a great concern to us.
    Mr. Courtney. So when President Sarkozy and others have 
really publicly talked about the fact that they want to try and 
get some coherence internationally, I mean, how do we make that 
happen? Do we just do nothing here and go to meeting after 
meeting?
    Mr. Giancarlo. Harmonization would be great, and some 
leaders talk about it, but at the underlying administrative 
level, it is not happening in a number of key areas.
    Mr. Courtney. Well, it is kind of a sad message to have to 
take back to real end-users who basically are looking to us to 
try and get some rationality in terms of these markets.
    Mr. Conaway. The gentleman yields back.
    Mr. Scott, 5 minutes.
    Mr. Austin Scott of Georgia. Yes, sir. Thank you, Mr. 
Chairman.
    If you look at the CFTC website, it says that swaps were 
the center of the 2008 financial crisis, and I would think that 
maybe an improper use of swaps or abuse of swaps might be a 
better description of what happened there, but I have a couple 
of questions, and part of it gets back to the 15 second rule 
that has been discussed. Mr. Giancarlo, if you only trade one 
to 20 times a day, why does the 15 second rule cause a problem? 
I get calls from people all the time where just in the fraction 
of a second that a trade is executed on the stock exchange, you 
may see a 3\1/2\, 4\1/2\, 5 percent change in value just during 
the fraction of a second it takes to execute. So why does the 
15 second rule cause problems?
    Mr. Giancarlo. Let me try to just paint a little example. I 
used in my opening remarks an example of John Deere wanting to 
expand and calling a dealer to provide them with a hedge 
against foreign exchange risk. That dealer takes the call or 
receives the message or maybe electronic message from their 
customer, maybe through an RFQ system, and wants to serve their 
customer's interest, wants to actually take on that hedge, but 
in so doing, they are taking balance sheet risks themselves.
    Mr. Austin Scott of Georgia. Sure.
    Mr. Giancarlo. So they are actually looking to the 
wholesale market to find a counterparty that they may be able 
to trade directly to, and they may actually find it, or maybe 
not a full hedge but a partial hedge. The 15 second rule says 
that when that dealer calls us in the wholesale market to take 
both sides of the trade, we are going to buy our customer's 
need, we are going to sell it to another customer, we have to 
actually delay that. We can put one order in and wait 15 
seconds during which time a competitor to that dealer may step 
in front and take the other side. So at the time of taking the 
customer order from John Deere, the dealer doesn't know because 
of this 15 second rule whether at the end of 15 seconds he is 
going to actually have fully hedged the risk he is taking on. 
So when you have more uncertainty, you always have more cost, 
and that cost is going to get passed down the chain to the 
corporate end-user. So our concern with the 15 second rule is--
--
    Mr. Austin Scott of Georgia. Let me stop you. I am getting 
short on time. Would 5 seconds make a difference?
    Mr. Giancarlo. You are adding risk. The markets in this 
regard work well today. There was nothing in the 15 second rule 
that addressed that was in the financial crisis that----
    Mr. Austin Scott of Georgia. All right. Let me stop you 
there because I am sorry but I am limited to 5 minutes.
    I want to go back to what we were talking about with the 
banking, Mr. Williams, and one of the things that I don't--when 
we talk about exempting the smaller banks, I guess one of my 
questions would be some banks, the trading is as much as 60 
percent of their revenue.
    Mr. Williams. That is right.
    Mr. Austin Scott of Georgia. For your bank, as a percentage 
of revenue, what is it?
    Mr. Williams. It would be less than three percent or so, 
and we are not trading like the participants that you mentioned 
where 60 percent may be a much more significant portion of 
their revenue.
    Mr. Austin Scott of Georgia. Yes, sir, it truly is a 
hedging of risk.
    Mr. Williams. It is a hedging of risk related to specific 
loan transactions.
    Mr. Austin Scott of Georgia. And I guess the question I 
have is, on average, as I understand it, it is less than five 
percent of revenue, but the rules are being drafted so that if 
it is 60 percent of your bank's revenue, or of it is three 
percent of your bank's revenue, you are going to have to abide 
by the same rules.
    Mr. Williams. That is right.
    Mr. Austin Scott of Georgia. And so would we be better 
serving the public if we base the exemption on a percentage of 
revenue instead of on any individual dollar figure?
    Mr. Williams. I wouldn't advocate a rule based on 
percentage of revenue because that would be a relative measure, 
and while the percentage of revenue for a given institution may 
be relatively high, that particular institution's participation 
in the market may be very insignificant. So you would capture 
them despite the fact that they are not posing any particular 
systemic risk.
    I think the de minimis exemptions as proposed in the Small 
Business Credit Availability Act are good ones, and would 
create exemptions for institutions that are fairly 
insignificant players in the market overall and don't pose a 
systemic risk.
    Mr. Austin Scott of Georgia. If a small bank, though, say 
50 percent of that small bank's revenue were from the trading, 
would you still think that they should get the same exemption 
that your bank does?
    Mr. Williams. I would think so. I don't think there are any 
small banks that get 50 percent of their revenue from trading 
derivatives.
    Mr. Austin Scott of Georgia. Thank you, Mr. Chairman. I 
just once again would like to point out that end-users didn't 
cause this problem, and I hope that we are able to work in a 
bipartisan fashion to get the exemptions for the end-users.
    Mr. Conaway. Thank you. The gentleman yields back.
    Ms. Fudge for 5 minutes.
    Ms. Fudge. Thank you, Mr. Chairman.
    Mr. Cordes, help me understand how if cooperatives are 
owned by local members and farmers, how can a cooperative be 
considered a swap dealer?
    Mr. Cordes. Some of the concern we have within that being 
owned where a swap dealer is, we don't have common control all 
the way down, so the local level is owned by its farmers. That 
local cooperative then would have ownership in the higher 
structure up through the affiliated cooperative, so it would 
have some common ownership but doesn't have control of it. When 
you do transactions with that affiliate to help them manage 
their risk, you need to write up a transaction, a contract, a 
swap. By doing that, you now put that--and some people look at 
it and say okay, are you dealing swaps or what are you doing. 
We would maintain that we are helping that local cooperative 
mitigate risk that they are passing on to help manage risk with 
their farmers.
    Ms. Fudge. Okay, and just a question for the entire panel. 
You know, I am a cosponsor of H.R. 2779, which would exempt 
inter-affiliate swaps from some, not all, some regulatory 
requirements instituted under Dodd-Frank. Given the diversity 
of the panel, I would like to hear from each of you about how 
internal risk management procedures would be affected, 
particularly can you discuss the differences between the 
different sectors that are seeking to hedge risks, for example, 
a manufacturing company versus a bank? Each one, wherever you 
would like to start
    Mr. Thul. Thank you. Within our organization, we are 
centralizing that activity and so we have businesses operating 
across multiple geographies and across multiple industries and 
so we are taking advantage looking at it as an enterprise, 
centralizing it so we can take advantage of a center of 
expertise in the marketplace and to try to leverage our costs 
of executing the transaction. So our argument, and we are in 
favor of the intent of the bill because we do think it captures 
the fact that we are going to protect what is truly something 
that is not individual and that can be looked at on an 
enterprise approach.
    Ms. Fudge. Thank you. I am going to ask to kind of go a 
little quickly if you can so I can get an answer from 
everybody. Thank you.
    Ms. Boultwood. At Constellation, we have a power plant in 
Canada, and when we hedge the output of that plant, we create 
exposure in Canadian dollars. We also, in different areas, have 
retail businesses and generate earnings in foreign currencies, 
mostly Canadian dollars, and what we do is, we need to pull 
that exposure from different entities to centralize the foreign 
exchange exposure because we are a commodities company and our 
expertise is in the commodities market, and we don't want our 
exposures to be dispersed across the company. So this is one 
example of the risk management benefit of that centralization 
across affiliates so we can centralize risk-taking and bring 
the expertise in that foreign exchange hedging to one spot, but 
it also applies even in commodities. You know, we have 
transactors in different parts of the country transacting power 
and gas. We are not letting them face to the market in each of 
those regions. We centralize that activity so that we can get 
the best centralized risk management across the different 
commodities to execute most efficiently.
    Ms. Fudge. Thank you.
    Mr. Giancarlo. Congresswoman, we are an intermediary, a 
broker of swaps products, but we really don't use swap products 
in our business themselves. The analogy would be to real estate 
agents, we match buyers and sellers of homes but we actually 
don't own underlying homes ourselves. We are not in the 
business so we really don't use swaps products.
    The bill that you are cosponsoring seems like a very 
sensible bill for those that have that area but it is not an 
area that we have taken a position on or that I can really 
sensibly comment to you.
    Ms. Fudge. Thank you.
    Ms. Sanevich. ERISA plans, as I mentioned, are already so 
heavily regulated that they are already prohibited and 
restricted in so many ways from doing anything with any 
affiliates. The affiliate issue is not an issue for ERISA plans 
because they have a whole body of regulations and laws 
preventing them from doing that kind of stuff.
    Ms. Fudge. Thank you.
    Mr. Williams. Atlantic Capital Bank is the operating 
subsidiary of a one-bank holding company, Atlantic Capital Bank 
Shares, and we don't conduct inter-affiliate transactions, swap 
transactions, and I think that would be true of most small 
banks.
    Ms. Fudge. Thank you.
    Mr. Cordes. I can speak for the cooperative network. Most 
local cooperatives, their boards would have policies and 
procedures around position limits and risks that they can take. 
As they roll that up on a daily basis, they would look to lay 
off that risk. They would then look through the federated 
system to maybe aggregate that risk and then put on a swap or 
some transaction to manage that risk, so we would need to be 
able to handle that from inter-affiliates as you go along that 
risk mitigation curve.
    Ms. Fudge. Thank you, Mr. Chairman.
    Mr. Conaway. The gentlelady yields back. Mr. Crawford for 5 
minutes.
    Mr. Crawford. Thank you, Mr. Chairman. I want to thank the 
panelists for being here today.
    I am going to start off real quick with Mr. Thul. Can you 
provide some examples of the types of hedges that would be 
restricted under CFTC's position limits proposal?
    Mr. Thul. Yes. The best example of that, I mean, this comes 
down to the definition of what is a bona fide hedge and 
anticipatory hedges and so at the simplest level, it would be 
grain purchases over a weekend when the exchange is not open. 
We need to pre-position for that and put on a futures position 
in anticipation of handling the cash commodity; not being able 
to do that is how we are reading this as a potential 
limitation.
    Mr. Crawford. How would you recommend the CFTC draw a line 
between hedging and spec trading for the position limits 
proposal?
    Mr. Thul. I think it comes down to just truly what is the 
definition of a bona fide hedger and are you involved in the 
commercial business or not. We are all for transparency as long 
as we are protecting the needs of the legitimate business, the 
commercial business. And so if you are tied to commercial 
operations and the underlying cash businesses, we feel that 
that should be exempted underneath the bona fide hedge.
    Mr. Crawford. I am going to switch gears and go to Mr. 
Williams. My constituents in the 1st District of Arkansas 
almost exclusively use community banks to access credit, 
whether it be families, small business owners, farmers. In your 
testimony you note that absent changes to the legislation we 
are discussing today, you would have difficulty remaining 
competitive against larger financial institutions. Can you 
explain the impact on your ability to compete?
    Mr. Williams. Well, first of all, it would be the cost 
associated with being a clearinghouse member or affiliating 
with a clearinghouse member, and as I indicated, we think that 
cost may be north of $100,000 per year. If we compare that to 
the revenue we receive from doing interest rate swap 
transactions for our borrowers, it would impair the 
profitability of those activities significantly.
    Second, the current, the proposed de minimis exemption 
limits from the CFTC would even eliminate--the activity that my 
institution has conducted within the last 18 months--would be 
above those de minimis limitations. So we would be classified 
as a swap dealer or financial under the proposed regulations 
and would add significantly to our costs.
    Mr. Crawford. Let me ask Mr. Cordes, what is the difference 
between the swap activities that your companies engage in and 
those engaged by swap dealers?
    Mr. Cordes. Yes, typically one would hold out a swap dealer 
makes a market. They are out there, they have a bid and offer-
type thing. What our organization is doing is, we would be 
looking at our membership, we would be looking at, internally 
we would be looking at our customers, looking at how can we 
mitigate that risk, what risk do they have that they want to 
mitigate. Then, we would go find a product to manage that risk, 
so we would put that transaction together. So it is really 
mitigating risk versus making a market.
    Mr. Crawford. Okay. And then I have this question for both 
you and Ms. Boultwood. Why does the broad definition of swap 
dealer have a disproportionate impact on the energy and ag 
industries as opposed to other sectors? We will start with Mr. 
Cordes.
    Mr. Cordes. Yes, I would say for us in the cooperative 
world, I mean, we are in the business around agriculture of 
whether it is buying grain, processing grain products, whether 
it is on the energy side, distribution and fuel. It has a lot 
of bricks and mortar to it. It has got a lot of hard assets to 
it so a lot of your investment capital is tied up to run those 
operations. It also takes a lot out of working capital to run 
those operations. And now if you start throwing in a swap 
dealer portion of it with margin requirements and other capital 
requirements, it is just another burden on top of a big hurdle 
to get over that is already taking place around working capital 
and investment.
    Mr. Crawford. Ms. Boultwood?
    Ms. Boultwood. I think the story is similar. We have a lot 
of assets that generate revenues that are volatile because of 
changing commodity prices but also energy is subject to natural 
hazards like weather risks. It is through swap products that we 
are able to even when we have volatile commodity prices, you 
have unknown weather patterns, you are able to create stability 
in the pricing that you are able to offer your customers.
    Mr. Crawford. Thank you.
    Mr. Thul, just a final thought from your perspective. Does 
lower liquidity increase volatility and vice versa?
    Mr. Thul. Yes, we would agree with that, and part of what 
we are shooting for is to have liquidity in markets along with 
transparency.
    Mr. Crawford. Great. Thank you. I yield back.
    Mr. Conaway. I thank the gentleman.
    The gentleman from New York, Mr. Owens, for 5 minutes.
    Mr. Owens. Thank you, Mr. Chairman.
    I assume that most of you have the opportunity to interact 
with the CFTC on a fairly regular basis as you go through this 
process. Do you have any sense relative to the legislation that 
we are discussing today that those proposals will be ultimately 
included in the final regulations that will be issued by the 
CFTC?
    Ms. Boultwood. I will just start. I would say, none of us 
has a crystal ball but I described the CFTC Commissioners as 
deeply divided on many of the topics that we are discussing 
today in terms of proposed legislation. For example, the swap 
dealer definition, there are Commissioners on record as saying 
it is overly broad, we need to better understand a de minimis 
exception in order to ensure that those that didn't cause 
systemic risk in the past and really aren't capable of it in 
the future are not subject to the same rules as the swap 
dealers that do hold themselves out for customers making 
markets and so on. So I would say that there are great 
divisions, and based on all the interactions, they seem to be 
headed down a path that will have rulemaking that will look 
very much like the drafts that we have all reviewed and 
commented on. To date, we haven't seen the comments and all the 
interactions have much of an effect over the idea that there 
are fears of potential future bailouts or there are fears of 
loopholes, and this desire to create regulation and rulemaking 
to close any loophole, and then think about what does that cost 
in terms of business activities, and not only the markets 
themselves, but real costs to end-users in our economy.
    Mr. Giancarlo. Congressman, a concern that we have in our 
conversations with the CFTC is their orientation is toward the 
futures markets, which they know well through their experience, 
which are markets that are very different than the swap 
markets. They are markets that have a single silo, monopolistic 
structure over the products they handle and they are markets 
that are not open to multiple execution venues or multiple 
clearing venues. There are also markets that have a retail 
component which is a great concern to the regulators and ones 
that have highly commoditized instruments that trade in those 
markets. Those are very different characteristics to the swaps 
markets and so our concern is that this institution, which is 
very knowledgeable in the areas that it has historically 
regulated, is struggling to understand these aspects of the 
swaps markets that are very different, aspects of the swaps 
markets that Congress made very clear in Dodd-Frank that had to 
be handled separately than what was done in the futures market. 
They have to be more competitive for execution, more 
competitive for clearing and have to take account of liquidity 
while balancing that with transparency.
    Mr. Owens. Thank you. I just wanted to make sure that as we 
move forward, we did it on the basis that you had some 
underlying belief that in fact these were not going to be 
addressed, because I think that that is important as a baseline 
for moving forward.
    The second question I have really is maybe more conceptual, 
but is there any risk associated with the end-user marketplace 
or do you completely discount end-user risk and its impact on 
the system?
    Mr. Cordes. I would say from our perspective, looking as an 
end-user that uses some swaps, the risk you need to understand 
as an end-user, yes, you are mitigating your risk. You have 
some other side of the ledger but you also need to be concerned 
with your counterparty risk that you are entering into, and 
lots of times we will use credit annexes to perform around 
those functions to make sure that we have security behind that, 
but it is not a margin, per se.
    Mr. Owens. But that is really what you are doing is you are 
netting your risk in that process?
    Mr. Cordes. As an end-user, yes, you would have some 
physical exposure that you are looking to mitigate. You would 
use a swap to offset that.
    Mr. Owens. To go back to something that Mr. Peterson said 
before, is there any threat systemically that you could have 
someone who initially is not regulated growing in a fashion 
that would not bring them under the regulatory scheme?
    Ms. Boultwood. I would say that to Mr. Peterson's, to 
address his concerns, we remind ourselves that there was no 
bailout for Enron and the energy continued to flow. Everything 
was normal. A company did fail as did a few others in that 
period because of the broader accounting scandals. But, there 
are risks in an end-user and how you think about what is 
systemically important in the economy that could cause the 
broader marketplace to be at risk is really important as we 
consider here what a de minimis exception means to a swap 
dealer definition. When you think about the $3 billion proposal 
for initial derivative size in that proposed legislation, that 
is \1/1000\ of the total size of the notional value of U.S. 
derivatives marketplace. We are talking $600 trillion 
globally--$3 billion is really nothing in the scheme of that. 
So is it \1/1000\ that isn't systemic or \3/1000\ or \10/1000\? 
You know, there is probably room to move upwards because the 
risk to us right now is that you define a de minimis exception 
that is too narrow and you include so many firms and they have 
all the costs of implementing them, the Dodd-Frank swap dealer 
requirements, and then we find out they are really not 
systemically risky and the costs in terms of the market 
liquidity that disappears, maybe a lot of activity moves 
offshore. The costs are much more significant than any benefit 
we got from capturing that entity.
    So it seems that the $3 billion, it can seem like a big 
number but relative to the overall size of the swap market, it 
is small and maybe it is a better approach to start higher and 
then if we find that there are those companies that grow, we 
can always reduce it.
    Mr. Owens. Thank you. I appreciate that.
    I yield back.
    Mr. Conaway. The gentleman's time has expired.
    Mr. Randy Hultgren for 5 minutes.
    Mr. Hultgren. Thank you, Mr. Chairman.
    Thank you all for being here and thank you for your input 
on this very important discussion today. I have been hearing 
from many of the co-ops in my district, heard from River Valley 
Cooperative in Geneseo and Patriot Renewable Fuels in Annawan, 
who are holding back with their business plans because of 
uncertainty while at the same time farmers are asking for ways 
to manage risk, so this is so important for us to be discussing 
this today.
    The first question I want to address to Mr. Cordes, if I 
could. I wonder if you would fall under the current threshold 
of $100 million, and if you know who else might?
    Mr. Cordes. Fall under $100 million?
    Mr. Hultgren. Yes, under the current level of the $100 
million.
    Mr. Cordes. I have to preface the answer a little bit. It 
partly depends. There is clarification of rules, what you are 
counting, what you are not. If it gets pretty broadly defined 
like it looks today, we would easily fall beyond the $100 
million, and quite a few cooperatives in the network would as 
well.
    Mr. Hultgren. So even at that level, there is still a large 
amount of uncertainty of actually what is counted and what 
isn't?
    Mr. Cordes. That is correct.
    Mr. Hultgren. I wondered if I could have others of you, Mr. 
Cordes and others, have just your thoughts, and if you could 
discuss why you think the swap dealer definition discussion 
draft proposal to increase the de minimis threshold to $3 
billion is an appropriate threshold. So I wondered if you could 
maybe talk about that briefly.
    Mr. Cordes. I will take a first run at it a little bit. I 
think partly you need to look at the volatility in the 
marketplace, and we are not only talking about what should that 
threshold be today, we are looking at some legislation that is 
going to be talking for the future. You look at commodity 
levels today, I mean, it wasn't that many years ago corn was at 
$2, $3. We are sitting at $6, $7, $8 at times. So even if you 
look at the $100 million threshold, it only takes about 14 
million bushels of corn to get to that level, which is a pretty 
small percentage in the big marketplace. It needs to have a 
discussion around size and scale.
    Mr. Thul. And I would just add to that that I think there 
are two other objectives that you can hit on on the de minimis 
ruling, and one of them is number of counterparties, and that 
would be extremely limiting for many people because it is 
either 15 or 25 counterparties, which when you are dealing at a 
country facility operation, you are going to have many more 
participants than that. And more important, our objective is to 
just not be defined as a swap dealer and avoid de minimis 
altogether.
    Ms. Boultwood. So I will go back to an earlier point. It is 
really important that we, in thinking about dealing, decide 
what do we mean by dealing, who is the dealer, and I joke 
sometimes that on the streets of Baltimore it is easy to know 
who is the dealer and who is the user for certain commodities, 
you could call them. But, when you are talking about a company, 
there are legitimate hedging activities. There might be some 
speculation. There might be markets we exist in where we have 
to be out there finding counterparties to transact with us, but 
both hedging and speculation we do with our own capital. We do 
that to preserve our own earnings or take the risks we want to 
take, and it is that third category of holding yourself out to 
a customer and saying look, we want to be your middleman, we 
want to earn the spread on a trade that will perform for you 
and we will go offset that risk potentially somewhere else, and 
so it is that customer trading that we are really focused on or 
transactions. And here then the question is, is $3 billion 
large enough, and, earlier I was saying that that is \1/1000\ 
of the total size of the U.S. notional swap market. Is \1/1000\ 
systemic to the economy? I would offer no. Is the right 
fraction \10/1000\, \100/1000\? You know, we have to draw a 
line somewhere. You would rather start higher, and if you find 
that there are firms that are doing things that should be 
considered dealing and they are finding a way out of that, we 
can always reduce it, but why start small and create the risk 
that so many companies get drawn in and either decide not to 
hedge, not to participate in markets, which would drive down 
liquidity, and find ourselves in a very different marketplace 
for our basic food, agriculture and energy commodities in 
America.
    Mr. Hultgren. I wonder quickly if someone could address, 
what does aggregate gross notional measure?
    Ms. Boultwood. Price times quantity. So if you have a 
contract that is covering 100 barrels of oil, there is the 
price of oil at the time you enter into that contract and then 
there is a quantity of oil, right, and that creates a value and 
that is your gross notional, and then someone mentioned 
earlier, commodity prices are highly volatile, you think about 
oil prices. There are risks in setting a static de minimis 
exception amount in that, if price levels doubled, for example, 
you could have firms that in one instance aren't considered a 
swap dealer but then when price levels change, they are then a 
swap dealer and you see this idea of firms flipping in and out 
of this dealing definition which really would make no sense at 
all.
    Mr. Hultgren. Thank you all again for being here. Thank 
you, Mr. Chairman. I yield back.
    Mr. Conaway. The gentleman yields back.
    Mr. Costa for 5 minutes.
    Mr. Costa. Thank you very much, Mr. Chairman.
    I want to kind of revisit some of the points that a number 
of my colleagues have raised here because there is an 
underlying theme here about the concerns of having the sort of 
regulatory framework that calls balls and strikes fairly and 
allows the economy to compete in this global market that we all 
talk about, but at the same time doesn't create circumstances 
as we all know that are still fresh in many of our minds in 
2008, or going further back with Enron, and trying to get it 
right as we have all discussed here this morning is the 
challenge at hand.
    For me, you keep talking about systemic risk, but a former 
Secretary of the Treasury also commented at great length about 
the moral hazard, and I am not so sure where you folks think 
the moral hazard lies in terms of the responsibility, in terms 
of the conditions we create. Certainly we proved that we are 
willing to pick winners and losers if recent history 
demonstrates that, and I would like you to comment, but if I 
have a couple of specific questions that relate to the wild 
speculation and radical price swings that we have seen.
    Mr. Cordes, you talk about trading in the corn market a 
great deal, I believe, right?
    Mr. Cordes. That is correct.
    Mr. Costa. We have been discussing here in the last several 
weeks about the whole use of ethanol from corn-based fuel 
versus other alternatives, and a lot of the ethanol producers--
and of course, I deal with my feed producers, the dairy folks, 
the cattle operations, the poultry, the pork, and they are very 
concerned that they think that ethanol from corn has had a 
factor. The ethanol producers tell me no, that is not really 
the case, that really the price has really been a result of 
speculators. Would you care to comment on whether or not you 
think that has been a factor?
    Mr. Cordes. I think to get to the correct answer, you need 
to look at the whole situation that is going on. The corn 
market is affected by many factors.
    Mr. Costa. Of course, but how do you gauge those wild price 
swings based upon speculators versus the other factors?
    Mr. Cordes. Yes, the other factors we would look at, we 
look at the tight carryouts in this country that we have on 
corn, we do not have a lot of stock so we carry over from crop 
to the next. I think the other thing I would point out is, we 
have a robust livestock industry that has decent margins, that 
has an appetite for corn and probably has an appetite for DDGs 
that comes from the ethanol industry. We also have a world 
market. In the last few days we had have China looking to 
purchase corn as their economy continues to move along.
    Mr. Costa. No, I know that, but I mean, I don't--still, we 
can't quantify, and to Mr. Courtney's comments to the dairymen 
and to the other people, our constituents, they don't get it. 
They see that a lot of folks are making money and they are not 
making anything except profits for themselves, and I don't want 
to belabor that point.
    Mr. Giancarlo, you talked about, and all of you talked 
about the global markets, and some of us have spent some time 
with our European colleagues in Frankfurt and in London with 
clearinghouses. I am not so sure that your description of what 
is taking place there is the final word. They are still going 
through the vetting of their own efforts to develop a 
regulatory structure, as I understand it, and you talk about 
leadership. I think both sides are trying to figure out where 
that happy medium is. You seem to say that we have already 
preordained this to lose these markets. I don't think that is 
the case.
    Mr. Giancarlo. Thank you for the question. We follow the 
developments in the European market very closely, and clearly, 
we don't have a crystal ball. In key areas, you are quite 
right. We are quite aligned with the Europeans. They are moving 
to a clearing environment as we are in the United States. They 
are moving to greater regulatory transparency and reporting as 
we are in the United States. They are recognizing in the 
regulation their version of swap execution facilities, what 
they call organized trading facilities, or OTFs, but where they 
are different, and at least everything I have seen in the 
regulations and we stay pretty close to it is, they are not 
mandating how those OTFs must execute swaps transactions. They 
are not requiring that it be done electronically only, and 
quite frankly, Congress did not require that they be done 
electronically only in Dodd-Frank. It says, ``by any means of 
interstate commerce.'' Our concern, and the reason we support 
the SEF Clarification Act, is to make Congress's intent clear 
to the CFTC which alone, not the SEC, but alone the CFTC has 
taken the view that for cleared non-block swaps, they must be 
executed electronically only and that is not the direction the 
Europeans are going. We are truly concerned that if certain 
instruments need to be traded in other mechanisms other than 
purely electronic, they will migrate to Europe, which has not 
taken the same approach as the CFTC in that one regard.
    Mr. Costa. Okay.
    Mr. Conaway. The gentleman's time has expired.
    Mr. Costa. My time has expired, but I will submit further 
questions for the record.
    Mr. Conaway. Thank you.
    Mrs. Hartzler for 5 minutes.
    Mrs. Hartzler. Thank you, Mr. Chairman.
    I would like to thank you for coming to discussed the 
proposed bills for today. I think the overriding principles of 
Dodd-Frank was supposed to reign in the big banks, risky 
derivative trading activities and reduce the concentration and 
consolidation for a financial system. My concern, however, is 
that the law imposes so many burdens on financial entities that 
they will not have the resources to comply and that therefore 
they will get out of the business of all but most vanilla 
loans. This would push any larger or more complex business up 
to the gigantic banks, thereby increasing concentration and 
consolidation even more.
    I don't think there is a sole Democratic or Republican who 
believes that the 2,300 page bill can be drafted with no 
mistakes, no oversights and no tweaks or corrections needed, 
and I feel that these changes utilize common sense and do not 
put the system at risk, and specifically, I am going to be the 
sponsor of the Small Business Credit Availability Act. I wanted 
to ask you, Mr. Williams--and I apologize for missing your 
opening comments. I was at a House Armed Services Committee 
meeting at the same time. But I am reading your testimony and 
some of the questions I have I would just like to get on the 
record. How do you think this draft of the bill that we are 
going to put forth facilitates the availability of credit for 
businesses?
    Mr. Williams. Well, as you know, small banks are the 
primary lenders to small- mid-sized businesses across the 
country, and our ability to offer interest rate swaps, to offer 
fixed-rate financing or floating-rate financing as our 
borrowers may require is essential to our role as a financial 
intermediary and financing these small businesses. The Small 
Business Credit Availability Act raises the de minimis 
exemptions, changes the financial entity definition in a 
favorable way to us that allows us to continue to participate 
in the derivatives market and offer these important services to 
our borrowers.
    Mrs. Hartzler. And that is important. I represent a very 
rural part of Missouri, and small banks are the backbone of 
most of the lending, and they are the ones that are doing a 
good job. They know the individuals who come in. They have a 
relationship with them. They know if they would be a good 
credit risk or not. They had the collateral required and yet 
they are being impacted by the Dodd-Frank bills. So I 
appreciate that.
    Let me continue, though. If small banks are provided the 
exemption proposed in the discussion draft, does that mean that 
they would be able to engage in speculative trading and still 
not be subjected to the clearing requirement?
    Mr. Williams. No, the intent of Title VII under Dodd-Frank 
is clear in limiting these exemptions to financing 
transactions, to credit transactions, and those are loan-level 
hedges. They are very specific to those transactions and I 
don't think that would allow the opportunity for speculation.
    Mrs. Hartzler. I think that is important to make clear and 
have that on the record because we are just trying to allow the 
small and regional banks to be able to continue to help the 
small businesses in their area and provide the services that 
they need in order to help their businesses expand and grow. 
How expensive would it be for you to comply with the swap 
dealer and clearinghouse regulations? I believe you said 
something about $100,000 for the clearinghouse.
    Mr. Williams. As we talked to potential clearinghouse 
partners, we think that $100,000 number is representative of 
the type of costs we would incur if we were not exempted from 
the swap dealer definition.
    Mrs. Hartzler. How would you recoup those costs if you were 
to have to participate in that?
    Mr. Williams. We would look for more profit from the spread 
income that we get from swap transactions to offset that cost, 
which would result in higher costs to the end-user.
    Mrs. Hartzler. Very good. And just one more time, I believe 
you addressed this perhaps with Mr. Scott's question, but could 
you explain the impact of the current regulations on your 
business if we don't make these changes? How would it impact 
your ability to compete and to provide credit to small 
businesses?
    Mr. Williams. Under the CFTC's de minimis rules as 
currently proposed, we would not be exempt and would incur the 
higher cost associated with being part of a clearinghouse. We 
would have the same regulatory burden and cost burden that a 
Wall Street dealer would have, and we are anything but a Wall 
Street dealer. We are a Main Street financier.
    Mrs. Hartzler. Absolutely. Thank you very much, ladies and 
gentlemen.
    Mr. Conaway. The gentlelady yields back.
    Mr. Stutzman for 5 minutes.
    Mr. Stutzman. Thank you, Mr. Chairman, and thank you to the 
panelists for being here. I would like to follow up just a 
little bit on Mr. Costa's comments with you, Mr. Cordes, about 
speculation being built in the market in ethanol. There is 
global demand and there obviously has to be supply, and we have 
had some rough yields this year and last year. I guess when we 
have these huge swings in commodity prices, it does create 
volatility. At $6, 25 cents is a big deal because we are used 
to $2, $3 corn and when 25 cents swung back then, that was a 
big, big deal. I guess I would just make this statement and ask 
if you would agree. I think it is easy to point the finger at 
the private sector and say there is speculation in the private 
sector but there is also speculation over at USDA in crop 
reports. Huge swings can happen in commodity prices just on 
USDA crop reports. Would you agree with that? We are all 
speculators to some extent.
    Mr. Cordes. Yes, I would say that the marketplace uses USDA 
reports as the benchmarks, so when those reports come out, they 
are going to react one way or the other, is it more or less 
than what we thought. The market participants in the 
marketplace will have their own opinion but ultimately they are 
going to go back and use it as the guidepost. I think if you 
want to look at past history, and it is pretty clear if you 
look back in the last 10 years, yes, we are living in much more 
volatile times today, but you can also go back, and I don't 
have a chart with me today, you can go back and look at 
carryouts of the principal commodity in the crops--corn, 
soybeans, wheat--and you will see volatility goes up when 
carryouts go down. There is a very strong correlation over time 
of what is driving that.
    Now, there are many factors going into what those carryouts 
are. You know, we can talk about speculation, we can talk about 
demand, we can talk about supply, but there is an 
interrelationship there as it goes on.
    Mr. Stutzman. I just think it is easy to point the finger 
at certain entities when in the big picture of everything, 
agriculture has changed, and in positive ways that we are 
trying to adjust. I know for us in our operation back in 
Indiana, these tools are important to us to cover our risk as 
we manage through some volatile times but there are some great 
opportunities at the same time.
    I would like to ask this question just of the entire panel. 
If we aren't successful in changing the proposed Dodd-Frank 
regulations, how many of you will stop or at least greatly 
curtail your current risk management activities or the services 
that you provide to facilitate the risk management practices of 
other market participants?
    Mr. Cordes. Our concern here would be if it is not narrowly 
defined where it is, do we get caught up as a swap dealer, 
which we believe we are not. We are hedging; we are mitigating 
risk. If that becomes the case, as you mentioned rural America, 
they are looking for tools. There is more volatility out there. 
You have more at risk. We would have to curtail those offerings 
that we can give to rural America.
    Mr. Thul. And the other outcome from that could be just a 
cost going up dramatically, so if you decide to stay in the 
business, you could either increase your costs, as somebody 
else mentioned here earlier, or you are just going to transfer 
risk down the chain to the end-user.
    Mr. Stutzman. Could you just touch on that real quick, Mr. 
Thul? How does that impact the farmer? I mean, if you can't 
have these tools, what does that do to the farmer?
    Mr. Thul. It exposes them completely to the volatility that 
you were talking about, that you were alluding to earlier, so 
they are not going to have any form of protection over what 
they are looking at. We are in a cyclical business to begin 
with and it is going to remove any opportunity to protect 
themselves from the risk.
    Mr. Stutzman. One last question, Mr. Chairman, and again, 
this is for any of you, but Mr. Thul maybe particularly. CFTC 
may finalize the position limits proposal before the EU even 
proposes theirs. Any comments?
    Mr. Thul. Yes, we feel very strongly that we need to have a 
good definition of--these things all work together--bona fide 
hedge, anticipatory hedge and the position limit, and so in 
order to have a firm ruling on what a position limit might be, 
we need to have definitions around bona fide hedge, swap dealer 
and anticipatory hedging, and it feels too early.
    Mr. Stutzman. Anyone else?
    Ms. Boultwood. Well, while we are focused on Europe, there 
is a whole other marketplace in Asia and there are many 
jurisdictions in Asia that have been very public and said, ``We 
are offering regulatory certainty today, we have no plan to 
change our rules, we are fine with the current regime.'' Europe 
is potentially one area, but I would be more concerned about 
Asia and public announcements that have already been made 
there, and this is probably not an area where the United States 
necessarily needs to lead.
    Mr. Stutzman. Thank you, Mr. Chairman. I will yield back.
    Thank you to the panelists as well.
    Mr. Conaway. I want to thank our six panelists today. You 
guys did a great job.
    All actions have future consequences, and you can divide 
those consequences into those that are unforeseen and we don't 
have a clue what might happen, and those that you can foresee. 
You six today have given us a good, clear understanding of the 
foreseeable consequences to the current regulatory scheme being 
proposed by the CFTC that is negative to a good swath of folks 
that had nothing to do with the circumstances that related to 
either the Enron wreck or the wreck in 2008. The most graphic 
example today is that the disruption caused by Dodd-Frank and 
the relationships between merchants and banks with respect to 
debit cards that was caused by that, we now see the hue and cry 
among the folks out there because banks are looking for another 
way to try to figure out how to make up for the costs, the 
differential in that revenue with debit card fees. So when the 
government steps into things, they should have known ahead of 
time, all of us could have predicted that if you disrupt that 
commercial relationship, and I am not picking sides between 
either one of them, there will be consequences that are 
foreseeable in this instance with a debit card. The consumer 
takes it in the pocketbook over and over when we don't get this 
correct, and we are encouraging CFTC to take a look at these 
foreseeable consequences and the impacts they have on consumers 
as they finalize these rules.
    Again, I want to thank our panelists for coming today. 
Thank you for the prep work, clear answers and the travel that 
you did.
    Under the rules of the Committee, the record of today's 
hearing will remain open for 10 calendar days to receive 
additional material and supplemental written responses from the 
witnesses to any questions posed by a Member.
    This hearing of the Committee on Agriculture is adjourned.
    [Whereupon, at 12:18 p.m., the Committee 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 Cooperative Association
    Mr. Chairman, Mr. Peterson, and Members of the Committee, thank you 
for holding this hearing to review legislative proposals amending Title 
VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act, 
including legislation to clarify the ``swap dealer'' definition. We 
appreciate the opportunity to again discuss how the implementation of 
the Dodd-Frank Act negatively impacts the rural electric cooperatives. 
Cooperatives use derivatives to help keep electric bills affordable for 
our consumer-members on Main St., and on the farm. Any costs for the 
rural electric cooperatives through the Commodity Futures Trading 
Commission's (CFTC) regulatory overreach will come out of the pockets 
of our consumer-members who live in some of the poorest areas in the 
country.
    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 utilities, 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 over 17.5 million member-owners 
in the states represented on this Committee.
    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 when I served on the House Agriculture 
Committee. Accordingly, I am grateful for your leadership in pursuing 
the reforms necessary to increase transparency and prevent manipulation 
in this complex global marketplace.
    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, including farmers in 
your state. 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 the necessary inputs for our 
operations. It is important to understand that electric co-ops are 
engaged in activities that are pure hedging, or commercial risk 
management. We DO NOT use derivatives for speculation or other non-
hedging purposes. We do not ``deal'' in derivatives, buying and selling 
derivatives to make a profit. We are in a difficult economic 
environment, and we support additional regulation of the financial 
markets to protect against systemic risk, but over-the-counter (OTC) 
derivatives are an important tool for managing risk on behalf of our 
members.
    Most of our hedges are bilateral commercial transactions in the OTC 
market. Many of these transactions are entered into by cooperatives 
using as an agent a risk management provider called the Alliance for 
Cooperative Energy Services Power Marketing or ACES Power Marketing. 
ACES 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 global derivatives markets, 
which is estimated at $600 trillion. Our members participate in only a 
fraction of that market, and are simply looking for an affordable way 
to manage commercial 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 becomes 
unaffordable, then these price risks will be left unhedged and 
resulting cost increases will be passed on dollar-for-dollar to the 
consumer, where these risks would be 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.
The Definition of ``Swap Dealer''
    The National Rural Electric Cooperative Association is concerned 
that the CFTC may interpret the statutory term ``swap dealer'' broadly 
enough to sweep in our electric cooperative members, which we believe 
could be one of the more damaging unintended consequences of the Dodd-
Frank Act. Therefore, we appreciate the Committee and Representative 
Randy Hultgren's (IL-14) work on legislation that would eliminate the 
rural electric cooperatives' concerns with the CFTC's interpretation of 
the Dodd-Frank Act.
    The definition of ``swap dealer'' is a relatively recent concern 
for the rural electric cooperatives. We have heard from CFTC staff over 
the past several months that they believe some of our members may be 
considered ``swap dealers.'' If this is the case, those cooperatives 
would be subject to a slew of new capital-draining registration and 
business practices requirements and financial markets regulations that 
Congress intended to impose on Wall Street derivatives dealers. To put 
it bluntly--it would be an incredible regulatory overreach for the CFTC 
to apply the definition of ``swap dealer'' to rural electric 
cooperatives--who are obviously not in the business of derivatives 
dealing. Cooperatives are not-for-profit end-users hedging commercial 
risk and protecting consumers from price volatility in wholesale power 
markets. The rural electric cooperatives' core mission is keeping the 
lights on for farmers, families and small businesses in rural America, 
not dealing in the global swaps markets. There are no ``Wall Street 
derivatives dealers'' in our membership. Our members keep the lights on 
on Main Street, and on the farm. We believe it should be obvious to the 
CFTC that Congress did not intend for end-users, particularly not-for-
profit end-users, to be regulated as ``swaps dealers.'' We are happy to 
continue to explain our business to the regulatory staff, but we will 
also continue to urge the CFTC to keep a clear focus on legislative 
intent.
    Given the uncertainty of how broadly the CFTC may interpret the 
term ``swap dealer'' under Dodd-Frank, NRECA supports draft legislation 
authored by Representative Randy Hultgren that is under discussion 
today. The legislation as drafted states clearly the intent of Congress 
that commercial end-users, who use derivatives to hedge or mitigate the 
commercial risks that arise from their electric operations, are not 
``swap dealers.'' Further, the legislation also unambiguously clarifies 
that all trading or transacting in swaps ``for your own account'' is 
not ``dealing.''
    Importantly, the legislation also provides an increase to the de 
minimis exception to further protect energy end-users and maintain 
liquidity in the swaps markets. Even if the CFTC counted all swaps, not 
just swaps that are part of a ``dealing business,'' our members' 
transactions would likely not reach the $3 billion de minimis level. 
But energy end-users like electric cooperatives support this higher de 
minimis notional level to encourage non-financial market participants, 
like natural gas producers, to continue to participate actively in 
regional electricity and natural gas markets.
    The initial CFTC registration as a ``swap dealer'' brings with it 
enormous and costly regulatory burdens like capital, margin, clearing, 
business conduct and documentation requirements. Energy end-users 
cannot allow the new CFTC regulatory costs to drive non-bank 
counterparties out of our markets, or deter others from starting to 
``deal'' in these important regional markets.
    Given the illiquidity of regional power and natural gas markets, 
and the volatility of prices for long-term swaps on such commodities, 
the $3 billion notional amount is appropriate for long-term power or 
natural gas ``swaps'' in illiquid regional markets.
The Definition of ``Swap''
    While the purpose of our testimony is to express support for the 
Hultgren draft legislation clarifying the definition of ``swap 
dealer'', we would like to take the opportunity to discuss the most 
important term in the Dodd-Frank Act--``swap.'' As this Committee 
knows, the term ``swap'' defines the scope of the CFTC's authority, 
impacts nearly every rule the CFTC has proposed to date, yet has not 
yet been finalized under the Dodd-Frank Act. In fact, the rule defining 
``swap dealer'' is expected to be finalized before the CFTC even 
defines ``swap.''
    NRECA is concerned that if the CFTC defines that term too broadly, 
it could bring under the CFTC's jurisdiction numerous commercial 
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 on non-financial 
commodities, or physical commodity contracts that contain option 
provisions, including full requirement contracts that even the smallest 
cooperatives use to hedge their need for physical power and natural 
gas. Further, CFTC should acknowledge in its rules that ``swap'' does 
not include power supply and generation capacity contracts, reserve 
sharing agreements, transmission contracts, emissions allowances, 
renewable energy credits or other transactions that are subject to 
FERC, EPA, or state energy or environmental regulation.
    These instruments are non-financial transactions between non-
financial entities that have never been considered ``products'' or 
``derivatives.'' They were not created to ``trade'', they were 
developed to protect the reliability of the grid by ensuring that 
adequate generation resources will be available to meet the needs of 
consumers. These transactions do not pose any systemic risk to the 
global financial system. Yet, if they were to be regulated by the CFTC 
as ``swaps,'' such regulation 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--and 
insist that the CFTC draft clear rules to exclude from regulation these 
kinds of normal course transactions which utilities use to hedge 
commercial risks and meet the needs of electric consumers.
Conclusion
    Mr. Chairman, at the end of the day, we are looking for a 
transparent market for standardized trading products, and continued, 
cost-effective access to the OTC transactions which allow cooperatives 
to hedge risk and volatility for our members. If we are to do that, the 
CFTC must define ``swap'' in clear terms to exclude those pure hedging 
transactions in non-financial commodities that the industry uses to 
preserve reliability and manage long-term power supply costs. The CFTC 
must not consider commercial end-users who hedge or mitigate commercial 
risks as ``swap dealers.'' And the CFTC must give real meaning to Dodd-
Frank's end-user exemption; limit unnecessary recordkeeping and 
reporting costs for end-users; and limit duplicative and unnecessary 
regulation of cooperatives and other electric utilities.
    Rural electric cooperatives are not financial entities, and 
therefore should not be burdened 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 inherent in our non-financial 
business--our mission is to provide reliable and affordable power to 
American consumers and businesses.
    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 Statement by American Bankers Association
    Chairman Lucas, Ranking Member Peterson, and Members of the 
Committee, the American Bankers Association (ABA) appreciates the 
opportunity to submit this statement for the record on legislative 
proposals amending Title VII of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act. The ABA represents banks of all sizes and 
charters and is the voice of the nation's $13 trillion banking industry 
and its two million employees.
    ABA appreciates the efforts of this Committee to ensure that 
implementation of the derivatives title of the Dodd-Frank Act agrees 
with the intent of the Congress. ABA has consistently supported the 
objective of increasing transparency and appropriate supervision of 
credit default swaps and other financial products of systemic 
importance. Several pieces of legislation being reviewed by the 
Committee today achieves that goal and also preserves the ability of 
banks to serve as engines for economic growth and job creation.
    The Committee is considering today multiple pieces of legislation 
that would further define and clarify elements of Title VII of the 
Dodd-Frank Act including the following:

  b The Discussion Draft would clarify the definition of a swap dealer 
        and the clearing exemption for certain banks, savings 
        associations, farm credit system institutions, and credit 
        unions. Among other things, it would mandate a clearing 
        exemption for institutions with an asset threshold of $30 
        billion or less. It would also include an alternative clearing 
        exemption for institutions with an aggregate uncollateralized 
        outward swaps exposure plus aggregate potential outward swaps 
        exposure that does not exceed $1 billion. Moreover, the 
        legislation would modify the language for swaps made in 
        connection with loans. ABA believes that the Discussion Draft's 
        small institution exclusion is a significant improvement, as is 
        the clarity the legislation would provide for the existing 
        exclusion from the swap dealer definition for transactions in 
        connection with originating loans. We remain opposed to 
        excluding the $230 billion Federal Farm Credit System from any 
        provisions of Title VII of the Dodd-Frank Act because it is a 
        Government Sponsored Enterprise.

  b H.R. 2682, the Business Risk Mitigation and Price Stabilization Act 
        of 2011, would clarify that end-users would not be subject to 
        margin requirements for uncleared swaps. However, the 
        legislation would limit the margin exemption to end-users that 
        are not financial entities. ABA supports an end-user exemption 
        from margin requirements for uncleared swaps and believes that 
        all end-users_including banks that use swaps to hedge or 
        mitigate risk_should be exempt.

  b A second Discussion Draft amends the Commodity Exchange Act to 
        clarify the definition of a swap dealer would include 
        additional criteria for determining which persons may be 
        characterized accurately as swap dealers. Specifically, the 
        legislation would exclude from the definition of a swap dealer 
        those persons engaging in swaps transactions for the purpose of 
        hedging or mitigating commercial risk or that are ancillary to 
        a person's regular business as a producer, processor, handler, 
        or commercial user of certain products. The Discussion Draft 
        also adds a specific gross notional amount threshold test to 
        the existing Dodd-Frank Act de minimis exception from the 
        definition of a swap dealer. ABA supports establishing clearly 
        defined criteria for the de minimis exception and stands ready 
        to work with the Committee to develop appropriate standards for 
        this exception.

  b H.R. 2779 would exempt inter-affiliate swaps from certain 
        regulatory requirements put in place by the Dodd-Frank Act. 
        H.R. 1840 would improve consideration by the Commodity Futures 
        Trading Commission (CFTC) of the costs and benefits of its 
        regulations and orders. ABA supports exempting inter-affliate 
        swaps from many of the anticipated swap regulations, as failing 
        to do so would undermine bank internal risk management 
        procedures and distort market information. ABA also supports a 
        stronger requirement for full assessment of the costs and 
        benefits of CFTC regulations.

    The remainder of this statement provides more detail on ABA's 
position on these bills.
Banks With Limited Swap Activities Should Be Exempt From Clearing 
        Requirements
    ABA has a diverse membership including banks of all sizes that use 
swaps in a variety of ways depending on the complexity of their 
business activities. Hundreds of our member banks use swaps to mitigate 
the risks of their ordinary business activities. Margin and clearing 
requirements would make it difficult or impossible for many banks to 
continue using swaps to hedge the interest rate, currency, and credit 
risks that arise from their loan, securities, and deposit portfolios. 
Such requirements would increase the risk in the system, not reduce it, 
and reducing risk is the primary purpose of hedging.
    The vast majority of banks use derivatives as part of the delivery 
of fixed-rate loans or long-term financing to customers, not as a means 
for speculation. For example, a bank will use swaps to hedge the 
interest rate risk on its own balance sheet, thus lowering the bank's 
risk in providing customer loans. Moreover, interest-rate swaps help to 
provide long-term fixed-rate financing to manufacturers, small 
businesses, universities, not-for-profit organizations and other bank 
customers, thus helping customers safely manage their interest rate 
risk and focus on their core business rather than the prospect of 
rising interest rates.
    Many banks cannot afford the expense of establishing and 
maintaining a clearing relationship for the limited amount of swaps 
transactions that they undertake in the service of their customers. A 
costly clearing requirement imposed on these institutions would 
adversely affect them and their business customers as they try to 
weather an uncertain economy. Without passage of several pieces of 
legislation before the Committee today, or proper implementation of the 
Dodd-Frank Act by the regulatory agencies, the result will be reduced 
credit options for many businesses and organizations across the country 
that are working to create jobs.
    As we have stated in previous testimony to this Committee, ABA 
believes that:

  b Banks with limited swaps activities should be exempt from the new 
        clearing requirements in the same way as other ``end-users''

  b All common lending practices should be included in the exemption 
        from the swap dealer definition for swaps entered into in 
        connection with originating a loan

  b End-users_including banks with limited swaps activities_should not 
        be subject to margin requirements

    The ABA believes that the Discussion Draft regarding the small 
institutions exclusion from clearing is a significant improvement to 
underlying law. The Discussion Draft recognizes that many banks use 
swaps in the same way as other end-users, to hedge or mitigate 
commercial risk. Moreover, banks using swaps to hedge or mitigate 
commercial risk have standard risk management practices that are 
subject to regulatory oversight (including on-site examinations every 
12 to 18 months) and they have explicit legal limits on the overall 
credit exposure that they can have to any individual or entity. Banks 
engaging in these limited swaps activities should be exempt from the 
clearing requirements because they do not pose a risk to the swaps 
market or the safety and soundness of the banks. In fact, banks and 
savings associations below the Discussion Draft's $30 billion asset 
threshold for a clearing exemption account for only 0.09 percent of the 
notional value of the bank swaps market as of June 2011.
    The Discussion Draft provides needed certainty to the underlying 
law for banks that enter into swaps transactions in connection with 
originating loans for customers. Banks commonly enter into swaps with 
customers so that customers can hedge their interest rate or loan-
related risks. While some swaps are entered into simultaneously with 
loans, many swaps are entered into before or after a loan is made. For 
example, it is common for a customer to enter into a swap to lock in an 
interest rate in anticipation of a future loan. The Discussion Draft 
ensures that these essential risk-mitigating services conducted as part 
of the loan making process are not brought into the swap dealer 
definition. In this way, the Discussion Draft will protect a variety of 
credit options for businesses of all sizes working to create jobs and 
grow the economy.
    The ABA is concerned that the swaps exposure measurement 
alternative proposed in the legislation would constitute an undue 
administrative burden for banks. Although we agree that a risk-based 
measurement is appropriate for determining which institutions may 
qualify for the exclusion, we are concerned that the proposed 
measurement would be extremely cumbersome for banks to undertake. Banks 
with limited swaps activities are least able to afford additional 
regulatory or administrative burdens related to their swaps 
transactions and are likely to stop using swaps altogether if costs or 
complexities are significantly increased. As a result, they would lose 
an important risk management tool. The ABA will continue to work with 
the Committee on alternative risk-based measurements as the legislative 
process moves forward.
The $230 Billion Federal Farm Credit System Should Not Be Given Special 
        Treatment
    The ABA would like to reiterate that it strongly disagrees that the 
$230 billion Federal Farm Credit System (FCS) should be exempted from 
an asset test regarding their derivatives activities. We urge this 
Committee to reject its request for special treatment. The Federal Farm 
Credit System is a tax-advantaged, retail lending, Government Sponsored 
Enterprise (GSE). The Federal Farm Credit System suggested to this 
Committee that regulators ``look through'' their corporate structure to 
the smallest entities that make up the System, the retail lending 
associations. Each of these entities are jointly and severally liable 
for each other's financial problems. The FCS proposes that the joint 
and several liability requirement be overlooked so that it may be 
considered a collection of small entities, when in fact this is not the 
case.
    The Federal Farm Credit System presents the same kind of potential 
liability to the American taxpayer as other GSEs. Taxpayers are the 
ultimate backstop in the event that the Federal Farm Credit System 
experiences financial problems. In fact, this has already happened. The 
near collapse of the Federal Farm Credit System in the late 1980s--
which was a result of irresponsible farm lending by Federal Farm Credit 
System institutions--foreshadowed what taxpayers would confront more 
than twenty years later with the housing GSEs. At that time, the 
Federal Farm Credit System received $4 billion in financial assistance 
from the U.S. taxpayer. Therefore, due to its enormous size and the 
potential risk it poses to the economy, we urge this Committee to 
reject the Federal Farm Credit System's arguments for exemptions from 
the derivatives title of the Dodd-Frank Act and ensure that the 
implementation of these requirements by regulators does not permit such 
a look-through.
End-Users Should Not Be Subject to Margin Requirements for Uncleared 
        Swaps
    The Dodd-Frank Act does not require regulators to impose margin 
requirements on end-users and the legislative history makes it clear 
that Congress did not intend to impose margin requirements on end-
users. Nonetheless, end-users currently face uncertainty about whether 
they will be subject to margin requirements and this legislation would 
provide much-needed clarity.
    The margin requirements are intended to offset the greater risk to 
swap entities and the financial system from uncleared swaps. However, 
imposing margin requirements on end-users would discourage the use of 
swaps to hedge or mitigate risk, so it would both increase risk in the 
system and vitiate the end-user clearing exemption.
    Furthermore, the vast majority of banks use swaps to hedge and 
mitigate the risks of their ordinary business activities, just as other 
end-users do. Banks are also subject to comprehensive regulation and 
use swaps to meet regulatory expectations for asset-liability 
management. Adding initial and variation margin requirements and 
imposing clearing requirements would make it difficult or impossible 
for many banks to continue using swaps to hedge the interest rate, 
currency, and credit risks that arise from their loan, securities, and 
deposit portfolios. The result would increase risk in the system, not 
reduce risk, which is the primary purpose of hedging.
    If the Committee wants to make a distinction between the margin 
requirements for bank end-users and other end-users, then we urge the 
Committee to consider imposing only variation margin for end-user banks 
rather than both initial and variation margin requirements. Current 
market practice is for swap counterparties to negotiate whether any 
collateral or margin requirements should be required and banks are 
already required to periodically reassess changes in the value of their 
assets and liabilities. Accordingly, at most end-user banks should be 
subject to mark-to-market variation margin requirements as they 
reassess the value of any negotiated collateral. The ABA stands ready 
to assist the Committee if it decides to distinguish between margin 
requirements for bank end-users and other end-users.
ABA Supports Clearly Defined Criteria for the De Minimis Exception
    The ABA believes that the Discussion Draft clarifying the 
definition of a swap dealer is an important step forward. The 
legislation proposes clearly defined criteria for the de minimis 
exception, a goal which ABA fully supports. It is important for 
Congress to give clear guidance to the regulators on this point to 
ensure that institutions presenting nominal risk to the system are not 
saddled with undue costs and complications. ABA will continue to work 
with the Committee on the criteria for an appropriate de minimis 
exception.
ABA Supports Full Assessment of the Costs and Benefits of CFTC 
        Regulations
    The ABA supports H.R. 1840, legislation providing for a full 
assessment of the costs and benefits of the Commodity Futures Trading 
Commission (CFTC) regulations. Regulatory burden on the banking 
industry has grown dramatically as a result of the Dodd-Frank Act and 
is stretching the resources of banks across the country. The median-
size bank has just 37 employees and is struggling to pay for new 
auditing, legal, and compliance costs resulting from a mountain of new 
regulations. H.R. 1840 would ensure that the best possible assessment 
is made of the costs and impacts of new regulations so that regulated 
entities are not subject to unnecessary costs that outweigh any 
potential regulatory benefit.
ABA Supports Exempting Inter-Affiliate Swaps From Certain Regulatory 
        Requirements
    The ABA believes that H.R. 2779, legislation exempting inter-
affiliate swaps from certain regulatory requirements, significantly 
improves underlying law. For certain financial institutions, inter-
affiliate swaps are an important tool for accommodating customer 
preferences and managing interest rate, currency exchange, or other 
balance sheet risks that arise from the normal course of business. 
Inter-affiliate swaps do not create additional counterparty exposure 
and should not be subject to the same rules intended for swaps entered 
into with a third party. In addition, H.R. 2779 would require reporting 
of inter-affiliate transactions. This requirement would not add 
relevant market information. Rather, it would be duplicative and would 
distort market information. ABA would like to continue to work with the 
Committee on this reporting provision going forward.
Conclusion
    ABA thanks the Committee for its strong leadership in this area. 
The Committee's efforts will facilitate better functioning of credit 
markets and maximize credit options for businesses large and small that 
are critical to job growth. ABA believes that treating end-user banks 
the same way as other end-users is an essential component of this 
effort. ABA member banks, like commercial end-users, use swaps to 
mitigate the risks of ordinary business activities and should be 
exempted from mandatory clearing and margin requirements.
                                 ______
                                 
    Submitted Statement by Independent Community Bankers of America
Derivatives Concerns of Community Banks
    Mr. Chairman and distinguished Members of the House Committee on 
Agriculture, ICBA is presenting this testimony for the hearing record 
to highlight important issues regarding title VII of the Dodd-Frank Act 
(DFA). As proposed by Federal regulators, these issues could have a 
significant impact on whether or not the 1,000 community banks that 
currently utilize the swaps market will be able to do so. As regulators 
have previously stated, access to the derivatives marketplace is 
important to banks desiring to hedge their own interest rate risks or 
provide long-term, fixed-rate products to their customers.
    The Dodd-Frank Act includes provisions designed to create greater 
transparency and reduce conflicts of interests and systemic risks in 
the derivatives marketplace. ICBA agrees with these objectives but 
believes that proposed regulations by the SEC, the CFTC and the so 
called ``prudential'' regulators should not disadvantage community 
bankers' participation in the use of derivatives, either in working 
with their borrowers or in hedging their interest rate risks. We will 
seek to work with regulators to address these issues and like-minded 
Members of Congress.
    Two specific proposals may profoundly impact whether our members 
can access these markets: (1) the prohibition against rehypothecation 
or transferring of margin to complete swap transactions; and (2) the 
potential to count all swaps used by commercial banks except those 
swaps completed only at the time of origination of a loan as counting 
toward the swap dealer definition, thus causing community banks to be 
classified as ``swap dealers.'' These and other issues are reflected in 
a comment letter to Federal regulators submitted by ICBA on July 11, 
2011.
Rehypothecation
    Community banks use low-risk interest rate swaps designed to hedge 
the underlying risk exposure associated with their balance sheets and/
or to convert variable rate loans into fixed rate loans on behalf of 
their customers. These interest rate swaps are ``customized'' to meet 
the underlying characteristics of their customers' individual loans in 
order to be an effective hedge and to meet GAAP accounting 
requirements.
    For example, these swaps are often much smaller than standardized 
swap agreements; or have repayment frequencies or other characteristics 
that differ from cleared swaps. Their risk levels are small. They are 
essentially the same as the plain vanilla interest rate swaps that are 
cleared by clearing houses but due to their customized nature are not 
at this time accepted for clearing.
    Therefore, the customization required for these swaps transactions 
means they are relegated to the over the counter (OTC) market.
    In their capital and margin regulations, regulators have proposed 
to prohibit rehypothecation of initial margin. The margin that many 
community banks now hypothecate to middle market swap dealers typically 
is rehypothecated upstream into a separate account, identified as 
belonging to the community bank that put up the initial margin, but 
available to their counterparties in the swap transaction to cover any 
losses.
    By prohibiting the rehypothecation of margin by the handful of 
middle market dealers that serve community banks, the regulators would 
be requiring these dealers to put their own capital into swaps 
transactions. This prohibition on rehypothecation will substantially 
and unnecessarily increase the amount of capital needed to complete 
these swap transactions. This will either result in making the cost of 
the swap transaction uneconomical or will cause the middle market 
dealers that community banks utilize to exit the market, thus denying 
access to the swaps market for community banks.
    We note that the Farm Credit Council (FCC) expressed very similar 
concerns in their July 11 letter to Federal regulators regarding the 
impact if rehypothecation restrictions are applied, in this case to 
Farm Credit System (FCS) institutions. FCS institutions, due to their 
status as a Government Sponsored Enterprises (GSE) are granted the same 
credit rating as the U.S. Government. Due to this rating, FCS 
institutions apparently do not have to put up initial margin because 
their swap dealers are willing to have credit exposure to such highly 
rated, government-backed, entities. However, the FCC notes that having 
to now post initial margin will cause the swap dealers to, ``in turn, 
be forced to recover those costs by raising prices'' on FCS entities. 
By contrast, many community banks do post initial margin and do indeed 
face these higher costs in their swaps transactions. Community banks 
are already at a disadvantage in terms of the pricing they receive on 
swaps transactions, and by having to compete with a GSE with tax and 
funding advantages at the retail level in the agricultural marketplace.
    The FCC goes on to state that ``Because swap entities often offset 
their own transactions with other swaps, they typically rehypothecate 
variation margin to other counterparties to satisfy their own variation 
margin requirements . . . prohibiting rehypothecation would therefore 
force swap entities to bear much higher costs and to pass those costs 
on . . . in the form of higher prices.''
    The prohibition on the reuse of the capital of community banks, 
whether initial or variation margin, to complete the swaps transaction 
would likewise raise the costs of those transactions for community 
banks. This outcome will force middle market swap dealers to come up 
with costly capital--hard earned, scarce resources set aside to cover 
potential exposure on the swaps transactions in addition to the margin 
already put in place by the community bank for the same swap 
transaction. This will dramatically increase the costs of swap 
transactions for those serving the community banking market. Either the 
cost of utilizing these swaps will be economically prohibitive or 
middle market swap dealers will be forced out of the business of 
facilitating swaps for community banks.
    One result is that risks to the community bank sector would 
increase as banks would have greater interest rate risks as they use 
short term deposits to fund long term, fixed-rate loans. The Savings 
and Loan crisis occurred because S&Ls borrowed short to lend long. 
Therefore, the ability of community banks to offer important fixed-rate 
products with longer maturities to their customers would also be placed 
in jeopardy. The amount of actual derivatives risk reduction in the OTC 
market would be insignificant if it occurred at all.
    Keep in mind that community banks use low risk interest rate swaps 
and do not and did not utilize the risky credit default swaps used by 
AIG and Lehman that resulted in causing panic in financial markets due 
to potential systemic risks. Moreover, the statute does not prohibit 
rehypothecation of initial margin as is being proposed by regulators.
    Contrary to the broad brush painted by some Federal regulators, not 
all swaps utilized in the OTC market pose greater risks than cleared 
swaps. Certainly, low risk interest rate swaps used by community banks 
do not put swap dealers at risk nor do they pose systemic risks. 
Therefore, regulators should make distinctions between products within 
the OTC market instead of assuming that all swaps in the OTC market are 
risky simply because they are not accepted for clearing by clearing 
houses..
    For example, proposed regulations have noted the problems of AIG in 
the OTC market as a reason to generally assert that swaps traded in the 
OTC market are supposedly riskier than those traded in clearing houses. 
However, AIG's problems resulted from using credit default swaps (CDS), 
an insurance-like product, not from the low-risk interest rate swaps 
used by community banks.
    These are important distinctions since the Dodd-Frank Act requires 
that margin requirements be based on the risks posed by the non-cleared 
derivatives.
    Therefore, if implemented as proposed, regulations designed to 
address the problems caused by a few very large financial institutions 
would have the perverse and unintended consequence of penalizing 
community banks, much smaller institutions which did not cause the 
financial crisis and which were not the intended target of title VII.
    Regulators have asked whether certain types of rehypothecation 
should be allowed. We believe that one option would be to provide an 
exemption to the prohibition on rehypothecation of margin associated 
with interest rate swaps entered into by a community bank with a swap 
dealer, where the swap is related to hedging the community bank's 
interest rate risks or providing long-term, fixed-rate products to 
their customers. This would be appropriate since the capital or margin 
being rehypothecated will be used for the same swaps transactions. We 
have drafted narrow legislative language to accomplish this.
Avoid a One-Size-Fits-All Approach
    We believe it is important to understand what is occurring through 
title VII and related regulations. Congress adopted title VII to 
address the risky activities of the very large Wall Street investment 
firms and of the nation's largest banks. It has been reported that only 
a handful of these mega institutions control roughly 95 percent of the 
derivatives marketplace. Therefore, Congress imposed title VII in an 
effort to force many swaps into clearinghouses where there will be 
little if any unsecured risk. However, due to the extremely large 
amount of capital and market resources required to become a 
clearinghouse member, several of the very large institutions (the 
member/owners) that were intimately involved in causing the financial 
meltdown and systemic risk issues in the first place will now also be 
the very institutions that reportedly will be the primary owners who 
control and profit most from the clearinghouses.
    The Federal regulators, not wanting these large entities to ``game 
the system'' by also placing risky swaps into the OTC market, are now 
attempting to overlay the clearing model onto the OTC marketplace and 
onto all or many of the minor and peripheral players involved in the 
OTC market. The proposed requirements and/or restrictions regarding 
margin, clearing requirements and rehypothecation are intertwined and 
driven by this attempt to impose the clearing model, with its high 
costs, onto the OTC marketplace.
    As noted above, many community banks post initial margin. However, 
whether or not initial margin is posted is often negotiated between 
counterparties within the ISDA master agreement. Regulators should not 
require initial margin, but rather allow for it to be negotiated 
between parties as needed. Likewise, whether rehypothecation is allowed 
is also an option within the ISDA master agreement. Further, 
requirements to clear would impose significant costs on community 
banks, even though their swaps are not clearable due to their 
customized nature, resulting in another example of why community banks 
would lose access to the swaps market for the limited number of swaps 
they engage in.
    These terms should not be dictated by Federal regulators who are 
proposing to impose the clearinghouse model onto the OTC market with 
few, if any, distinctions. By requiring initial margin, by requiring 
clearing and by prohibiting rehypothecation, either separately or in 
combinations, regulators are increasing costs upon all parties at every 
stage of OTC transactions. This will increase the costs of doing swaps, 
most likely making them uneconomical and unavailable. The end-users, 
whether farmers or small or large businesses and community banks will 
suffer the unintended consequences if the final regulations are not 
carefully and skillfully written. Otherwise, the result will be greater 
risks throughout various sectors of the economy--NOT--greater safety 
and soundness as intended.
Swap Dealer Definition
    A second major concern rises from Dodd-Frank's exemption of 
commercial banks being classified as swap dealers to the extent they 
enter into a swap with a customer in connection with originating a loan 
with that customer. Federal regulators have requested comments as to 
whether this exclusion should apply only to swaps entered into 
contemporaneously with the bank's origination of the loan and how 
``contemporaneously'' should be defined for this purpose.
    Regulators and/or Congress need to ensure that this exemption 
applies to swaps entered into before, during or after origination of 
loans to provide enough flexibility to serve their customers' timing 
and needs for swaps to facilitate fixed rate financings. Otherwise, 
community banks will be considered swap dealers and will stop using 
swaps.
    We appreciate legislation before the Committee that would help 
ensure this objective and look forward to working with Congress on this 
matter.
Other Legislative Goals
    Prudential Regulators asked in their proposed regulations on margin 
and capital requirements for covered swap entities whether non-
financial end-users should be exempt from mandatory clearing 
requirements. ICBA responded that they should. Prudential regulators 
then asked whether counterparties that are small financial institutions 
using derivatives to hedge their risks should be treated in the same 
manner as non-financial end-users for the purposes of the margin 
requirements. ICBA indicated that small financial institutions should 
receive the same exemption as non-financial end-users since community 
banks are basically end-users as well. ICBA supports legislation to 
ensure these goals are met.
    In addition, Congressman Conaway and several other cosponsors have 
introduced H.R. 1840, bipartisan legislation that requires a thorough 
cost-benefit analysis of CFTC regulations. ICBA supports such efforts 
and has indicated support for even broader legislation (e.g., S. 1615) 
as we believe that regulations must not be onerous or imposed on a one-
size-fits-all basis.
    Community banks contend with costly, unwieldy regulatory burdens 
that often jeopardize their capacity to raise capital, lend to small 
businesses and consumers, and support job creation. Similar to H.R. 
1840, S. 1615 would require agencies to subject proposed new rules to a 
more rigorous, 12 point analysis to ensure that they are truly needed, 
are designed to pose as little burden and cost as possible, and pass a 
basic cost-benefit test. Importantly, the legislation would also 
require a retrospective `look-back' every 5 years so that regulators 
could evaluate rules after they've been put in place. This concept may 
also be useful to incorporate into H.R. 1840 due to the complexity and 
omnibus nature of title VII rulemaking. In this case, a 2 or 3 year 
`look-back' would be even more appropriate.
    In our current difficult economic environment, it is important to 
ensure a reasonable check on new regulations, ensuring that they do not 
jeopardize community banks' viability by imposing costs that outweigh 
any benefit. This includes requiring Federal agencies to more fully 
analyze alternative approaches to new regulations and to determine ways 
to streamline existing regulations.
Farm Credit System Exemptions
    The FCS has suggested that it be treated as small financial 
institutions although it is collectively over $200 billion in assets. 
The FCS has suggested that regulators ``look through'' to their 
individual associations. This would be like looking at the individual 
branches of a large national bank and determining that the branches 
themselves are not swap dealers. However, FCS institutions have joint 
and several liability, making their institutions responsible for each 
other's losses.
    CFTC Chairman Gensler stated in his statement on CFTC's margin 
proposal: ``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 failures to cause uncertainties and possible runs on the 
funding of other financial entities, which can spread risk and economic 
harm throughout the economy.''
    While the FCS does not share the blame of the nation's largest 
banks and Wall Street firms in causing this recent financial crisis, 
their institutions were engaged in reckless lending that led to the 
1980's farm credit crisis and its resulting misery. As a GSE, the 
System is indeed interconnected and Congress would be tempted to step 
in and bail out the System if it were to once again fail as it did in 
the 1980s when the System was a much smaller entity. By contrast to the 
recent bailout of the nation's largest banks and the FCS's 1980's 
bailout, hundreds of independent community banks--institutions that are 
not interconnected--have been allowed to fail during these different 
times of crisis.
    Therefore, the FCS should not be granted special exemptions or 
advantages over other financial institutions in the swaps marketplace. 
The System has tax; funding and other advantages as a privileged GSE 
that competes against private sector lenders in the retail marketplace 
and it receives lax oversight of its mission area by its charitable 
regulator, the Farm Credit Administration (FCA).
Conclusion
    The low risk interest rate swaps being utilized by community banks 
pose no systemic risks to the financial markets. Due to the low risks 
involved, community banks' customized swaps should not be subject to 
higher capital and margin requirements particularly compared to the 
plain-vanilla swaps that will be cleared. Banks, who utilize swaps to 
hedge their own interest rate risks and to serve the needs of their 
customers, should not be considered swap dealers.
    There should not be a prohibition on rehypothecation of margin when 
used to complete swap transactions.
    Otherwise, capital costs would become too great and the use of low 
risk interest rate swaps by community banks would be uneconomical. 
Farmers and small businesses would suffer. Risks within the banking 
sector would increase.
    A June 20 letter from the House and Senate Chairmen of the 
respective Agriculture Committees to Federal regulators states: 
``Lastly, we urge regulators to ensure that any new capital 
requirements are carefully linked to the risk associated with the 
uncleared transactions, and not used as a means to deter over-the-
counter derivatives trading.'' This would indeed be the unfortunate 
outcome if the prohibition on rehypothecation is allowed to occur.
    We urge Congress to ensure that rehypothecation of margin is 
allowed when necessary to complete swaps transactions and we urge 
careful consideration of legislative initiatives that would address the 
other issues referenced in our testimony. ICBA stands ready to assist 
Congress and regulators in these efforts.
    Thank you.

                                  
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