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



 
                     LEGISLATIVE PROPOSALS TO BRING


                   CERTAINTY TO THE OVER-THE-COUNTER

                           DERIVATIVES MARKET

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


                                HEARING

                               BEFORE THE

                  SUBCOMMITTEE ON CAPITAL MARKETS AND

                    GOVERNMENT SPONSORED ENTERPRISES

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                               __________

                            OCTOBER 14, 2011

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 112-75


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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                   SPENCER BACHUS, Alabama, Chairman

JEB HENSARLING, Texas, Vice          BARNEY FRANK, Massachusetts, 
    Chairman                             Ranking Member
PETER T. KING, New York              MAXINE WATERS, California
EDWARD R. ROYCE, California          CAROLYN B. MALONEY, New York
FRANK D. LUCAS, Oklahoma             LUIS V. GUTIERREZ, Illinois
RON PAUL, Texas                      NYDIA M. VELAZQUEZ, New York
DONALD A. MANZULLO, Illinois         MELVIN L. WATT, North Carolina
WALTER B. JONES, North Carolina      GARY L. ACKERMAN, New York
JUDY BIGGERT, Illinois               BRAD SHERMAN, California
GARY G. MILLER, California           GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia  MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey            RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas              WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina   CAROLYN McCARTHY, New York
JOHN CAMPBELL, California            JOE BACA, California
MICHELE BACHMANN, Minnesota          STEPHEN F. LYNCH, Massachusetts
THADDEUS G. McCOTTER, Michigan       BRAD MILLER, North Carolina
KEVIN McCARTHY, California           DAVID SCOTT, Georgia
STEVAN PEARCE, New Mexico            AL GREEN, Texas
BILL POSEY, Florida                  EMANUEL CLEAVER, Missouri
MICHAEL G. FITZPATRICK,              GWEN MOORE, Wisconsin
    Pennsylvania                     KEITH ELLISON, Minnesota
LYNN A. WESTMORELAND, Georgia        ED PERLMUTTER, Colorado
BLAINE LUETKEMEYER, Missouri         JOE DONNELLY, Indiana
BILL HUIZENGA, Michigan              ANDRE CARSON, Indiana
SEAN P. DUFFY, Wisconsin             JAMES A. HIMES, Connecticut
NAN A. S. HAYWORTH, New York         GARY C. PETERS, Michigan
JAMES B. RENACCI, Ohio               JOHN C. CARNEY, Jr., Delaware
ROBERT HURT, Virginia
ROBERT J. DOLD, Illinois
DAVID SCHWEIKERT, Arizona
MICHAEL G. GRIMM, New York
FRANCISCO ``QUICO'' CANSECO, Texas
STEVE STIVERS, Ohio
STEPHEN LEE FINCHER, Tennessee

                   Larry C. Lavender, Chief of Staff
  Subcommittee on Capital Markets and Government Sponsored Enterprises

                  SCOTT GARRETT, New Jersey, Chairman

DAVID SCHWEIKERT, Arizona, Vice      MAXINE WATERS, California, Ranking 
    Chairman                             Member
PETER T. KING, New York              GARY L. ACKERMAN, New York
EDWARD R. ROYCE, California          BRAD SHERMAN, California
FRANK D. LUCAS, Oklahoma             RUBEN HINOJOSA, Texas
DONALD A. MANZULLO, Illinois         STEPHEN F. LYNCH, Massachusetts
JUDY BIGGERT, Illinois               BRAD MILLER, North Carolina
JEB HENSARLING, Texas                CAROLYN B. MALONEY, New York
RANDY NEUGEBAUER, Texas              GWEN MOORE, Wisconsin
JOHN CAMPBELL, California            ED PERLMUTTER, Colorado
THADDEUS G. McCOTTER, Michigan       JOE DONNELLY, Indiana
KEVIN McCARTHY, California           ANDRE CARSON, Indiana
STEVAN PEARCE, New Mexico            JAMES A. HIMES, Connecticut
BILL POSEY, Florida                  GARY C. PETERS, Michigan
MICHAEL G. FITZPATRICK,              AL GREEN, Texas
    Pennsylvania                     KEITH ELLISON, Minnesota
NAN A. S. HAYWORTH, New York
ROBERT HURT, Virginia
MICHAEL G. GRIMM, New York
STEVE STIVERS, Ohio
ROBERT J. DOLD, Illinois


                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    October 14, 2011.............................................     1
Appendix:
    October 14, 2011.............................................    43

                               WITNESSES
                        Friday, October 14, 2011

Bailey, Keith, Managing Director, Fixed Income, Currencies and 
  Commodities Division, Barclays Capital, on behalf of the 
  Institute of International Bankers.............................     8
Bernardo, Shawn, Senior Managing Director, Tullett Prebon, on 
  behalf of the Wholesale Market Brokers Association, Americas...    10
Boultwood, Brenda, Chief Risk Officer and Senior Vice President, 
  Constellation energy, on behalf of the End-User Coalition......    11
Cawley, James, CEO, Javelin Capital Markets, LLC.................    13
Mason, Kent, Davis & Harman LLP, on behalf of the American 
  Benefits Council and the Committee on Investment of Employee 
  Benefit Assets.................................................    15
Voldstad, Conrad, Chief Executive Officer, International Swaps 
  and Derivatives Association....................................    17

                                APPENDIX

Prepared statements:
    Bailey, Keith................................................    44
    Bernardo, Shawn..............................................    55
    Boultwood, Brenda............................................    78
    Cawley, James................................................    83
    Mason, Kent..................................................    86
    Voldstad, Conrad.............................................    99

              Additional Material Submitted for the Record

Garrett, Hon. Scott:
    Written statement of the American Bankers Association........   108
    Written statement of BlackRock...............................   112
    Written statement of Chatham Financial.......................   113
    Written statement of the Commodity Markets Council...........   115
    Written statement of the Coalition for Derivatives End-Users.   123
    Written statement of the Investment Company Institute........   126
    Written statement of the Working Group of Commercial Energy 
      Firms and the Commodity Markets Council....................   128
Hayworth, Hon. Nan:
    Written responses to questions submitted to Conrad Voldstad..   139


                     LEGISLATIVE PROPOSALS TO BRING


                   CERTAINTY TO THE OVER-THE-COUNTER


                           DERIVATIVES MARKET

                              ----------                              


                        Friday, October 14, 2011

             U.S. House of Representatives,
                Subcommittee on Capital Markets and
                  Government Sponsored Enterprises,
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to notice, at 9:05 a.m., in 
room 2128, Rayburn House Office Building, Hon. Scott Garrett 
[chairman of the subcommittee] presiding.
    Members present: Representatives Garrett, Schweikert, 
Lucas, Biggert, Hensarling, Neugebauer, Pearce, Posey, 
Fitzpatrick, Hayworth, Hurt, Grimm, Stivers, Dold; Waters, 
Sherman, Lynch, Miller of North Carolina, Maloney, Donnelly, 
Himes, Peters, Green, and Ellison.
    Also present: Representative Canseco.
    Chairman Garrett. Good morning. This hearing of the 
Subcommittee on Capital Markets and Government Sponsored 
Enterprises is called to order.
    Good morning to everyone on the panel. I think this is the 
first time we started a little bit late. I try to start these 
things right on time. I apologize to all of you.
    But we do welcome the gentleman from Texas for being with 
us here on the committee at the very beginning. This is a rare 
day, too, but thank you. Thank you, everyone.
    Today's hearing is entitled, ``Legislative Proposals to 
Bring Certainty to the Over-the-Counter Derivatives Market.''
    We have a fairly large panel to hear testimony from, but 
before we do that, we will have opening statements from the 
Members, 10 minutes or so on each side, if we actually consume 
that, and then we will look to each of you for your testimony. 
So I will begin by yielding myself 3 minutes, and say, again, 
welcome.
    I look forward to all of your testimony. I look forward to 
a good discussion on the legislation that is before us. It is 
my hope that at least several of these bills will have, as we 
have had with other bills, bipartisan support.
    I am pleased that my colleagues on the other side of the 
aisle have joined me and others in engaging in implementation 
of Title VII of the Dodd-Frank Act. We have had several 
proposals before today; and I believe it is appropriate to make 
sure that Dodd-Frank is--now that it is the law--implemented by 
regulators in a common-sense manner that actually works. For 
this to happen: first, regulations must not impose overly 
burdensome and unjustified costs on American businesses; 
second, they must not drive businesses overseas; and third, 
they must not unnecessarily place American businesses at a 
competitive disadvantage vis-a-vis countries overseas.
    While derivatives are often vilified, and have been at the 
very beginning of this process, they have served as an 
extremely important risk management tool for thousands of 
American businesses across the country and pension funds as 
well. Regulators must be mindful of this and must be mindful 
about not harming the functioning of a mature market. Instead, 
they should focus on a regulatory structure that allows them to 
understand where the risk in the system actually resides.
    In an effort to provide certainty and direction to the 
rulemaking process, I recently introduced the Swap Execution 
Facility Clarification Act with Mrs. Maloney, Mr. Hurt, and Mr. 
Meeks. Dodd-Frank gave the SEC and the CFTC broad latitude to 
get the rules right. Unfortunately, after these proposals were 
released, virtually the entire market--from the buy side, asset 
managers, pension funds, and commercial end-users, to the sell 
side, to the dealers and even prospective swap execution 
facilities, told me the regulators got it wrong.
    In order to respect the congressional intent reflected in 
the heavily negotiated language of the SEF definition, we 
carefully drafted the bill, H.R. 2586, to direct regulators to 
provide market participants with the flexibility--and this is 
key--that they need to obtain price discovery in the market and 
in the method of execution they use.
    In addition to allowing voice execution on SEF trade, the 
bill prohibits the 15-second rule, also, and includes 
restrictions on the RFQ model and sweep book requirements. I 
feel that the specific nature of this direction is necessary to 
promote the conditions for a competitive marketplace in the 
swaps area.
    Mr. Canseco here has a bill, H.R. 3045, which was also 
introduced, at least in part, because of concerns over 
regulatory interpretation of the statute. I heard from pension 
plans that the SEC and the CFTC rules would prohibit them from 
using swaps to hedge against market volatility and manage the 
obligations owed to their retirees. So H.R. 3045 ensures that 
ERISA pension plans can engage in swap transactions without 
their swap dealer counterparties incorrectly being labeled as 
fiduciaries. Of course, that would make it impossible for the 
transactions to take place in the first place.
    We also have Mr. Stiver's bill, H.R. 2779, which seems to 
be another common-sense solution to address inter-affiliate 
trades, along with Ms. Hayworth's bill, H.R. 1838, which 
repeals Section 716 of Dodd-Frank, otherwise known as the swap 
push-out provision.
    Now because there was no hearing on this issue, and as Ben 
Bernanke has said, it would make the U.S. financial system less 
resilient and more susceptible to systemic risk, I look forward 
to having a thoughtful discussion now about Section 716, which 
we have not had so far.
    Once again, I thank the entire panel, and I look forward to 
a healthy dialogue on this issue.
    And, with that, Mr. Peters is recognized for 1 minute.
    Mr. Peters. Thank you, Chairman Garrett, for holding this 
hearing.
    I also would like to thank the witnesses for taking the 
time to share their testimony with us today.
    I certainly understand the important role that derivatives 
play in our economy. They are safely used every day by 
companies that are managing risk. As a member of the Dodd-Frank 
Conference Committee, I worked to ensure that Title VII struck 
the appropriate balance between creating a safer, more 
transparent market for derivatives, and ensuring that these 
products were still widely available and affordable for those 
who choose to use them.
    In the year-and-a-half since the law was enacted, I have 
tried to work constructively with regulatory agencies to ensure 
that their rules make sense and are consistent with 
congressional intent. The issues that are being addressed in 
this hearing are very important. I think that many of them 
could probably be addressed by better coordination between the 
agencies and by greater feedback from the agencies to those who 
have submitted comments. Unfortunately, both the SEC and the 
CFTC are under a great deal of pressure, both in terms of time 
and in terms of the volume of work they are being asked to 
undertake. Adding to this pressure is the fact that they have 
so far not been given the resources commensurate with their 
increased workload.
    In any event, I think there are Members on both sides of 
the aisle who are committed to making sure the agencies get 
this right, and I look forward to working with my colleagues to 
make sure that happens.
    Chairman Garrett. The gentleman yields back. We will be 
turning to Mrs. Biggert next for 1 minute, but before we do 
that, I ask for unanimous consent that Mr. Canseco can 
participate in this hearing.
    Without objection, we welcome you.
    Mrs. Biggert, for 1 minute.
    Mrs. Biggert. Thank you, Mr. Chairman. Good morning to all 
of you, and thank you for being here.
    I am concerned that Title VII of the Dodd-Frank Act is 
shaping up to be one of the worst provisions in a bill loaded 
with provisions that stifle economic growth. This derivatives 
provision is poised to place our financial systems at a severe 
disadvantage with its global competitors and could actually 
increase risk in our system by forcing many derivatives into 
the unregulated shadow banking system.
    Federal Reserve Board Chairman Bernanke noted, as the 
chairman said, that Section 716 would make the U.S. financial 
system less resilient and more susceptible to systemic risk 
because forcing hedging activities out of insured depository 
institutions would weaken both financial stability and strong 
prudential regulation.
    Section 716 will also place U.S. financial institutions at 
a competitive disadvantage because non-U.S. jurisdictions have 
not implemented similar regulations. Despite being promised 
that U.S. regulators would coordinate with their international 
counterparts, Dodd-Frank is in the final stages of 
implementation, while other countries have completely failed to 
take action.
    While I support bringing better transparency to our 
derivatives market, it is absolutely critical that we do not 
inhibit the competitiveness of our U.S. institutions. With the 
struggling economy, we simply cannot afford it.
    Thank you again for being here, and I yield back.
    Chairman Garrett. The gentlelady yields back.
    The gentleman from Texas, Mr. Hensarling, for 1\1/2\ 
minutes.
    Mr. Hensarling. Thank you, Mr. Chairman.
    A week ago, we awoke to the bad news that once again we had 
an unemployment rate above 9 percent. I believe it has been so 
for 27 of the past 29 months.
    As I talk to investors, Fortune 50 CEOs, and small business 
owners in my district, it is evident that the lack of our job 
creation is resulting from, number one, a debt crisis. As one 
put it to me, I know one day I am going to have to pay for 
this. I am not going to go out and invest in a bunch of new 
equipment or hire people.
    It has do with our level of taxation and uncertainty. 
People don't know what their tax rate is going to be 16 months 
from now, but they know it will go up as part of the 
President's health care plan, as part of the snapback of tax 
rates that have been in place since 2001 and 2003, and it 
certainly is derived from a regulatory onslaught.
    Mr. Chairman, I thank you for calling this hearing, because 
it is far past time that this Congress starts to look at the 
jobs impact of each and every regulation. When it comes to our 
over-the-counter derivatives market, whether we are talking 
about Section 716 of Dodd-Frank, whether we are looking at the 
affiliate swap roles, whether we are looking at the special 
entity designation for ERISA plans, there is either: one, way 
too much uncertainty; or two, certainly bad regulations that I 
believe are going to harm capital formation and job creation. 
The legislation that we are talking about today goes to the 
heart of the matter, and I appreciate you calling this hearing. 
Hopefully, we can move these common-sense pieces of 
legislation.
    I thank you and I yield back.
    Chairman Garrett. The gentleman yields back.
    Mr. Hurt is recognized for 1 minute.
    Mr. Hurt. Thank you, Mr. Chairman. Thank you for holding 
today's hearing on these important legislative proposals. I 
appreciate the opportunity to work with you as well as 
Representatives Maloney and Meeks on the Swap Execution 
Facility Clarification Act.
    This legislation is necessary because the Federal 
regulators, particularly the CFTC, strayed outside of 
congressional intent in their SEF rulemaking and are attempting 
to impose a market structure that would be detrimental to the 
swaps market and its participants. These proposed rules would 
limit market efficiency and lead to negative consequences for 
farmers, manufacturers, small businesses, financial 
institutions, and pension funds.
    H.R. 2586 will ensure that Federal regulators do not 
implement a Washington-style market structure for SEFs. This 
bill will provide flexibility to the market and give 
prospective SEFs and SEF participants the ability to interact 
without constricting liquidity or limiting price discovery.
    The importance of getting the SEF rulemaking correct cannot 
be understated. A misstep could lead to significant increased 
costs for risk management and for capital formation for all 
Americans, and these increased costs jeopardize jobs. H.R. 2586 
ensures that future rulemaking by regulators will be consistent 
and will help maintain a functional and liquid swaps market so 
that businesses can mitigate risk and uncertainty in their 
operations.
    Thank you again, Mr. Chairman, for holding this hearing; 
and I want to thank each of the witnesses for being here today. 
I look forward to your testimony.
    I yield back.
    Chairman Garrett. The gentleman yields back. Thank you very 
much.
    Now, I will recognize the gentlelady from California for 3 
minutes.
    Ms. Waters. Thank you, Mr. Chairman. I thank you for 
holding this hearing on these legislative proposals related to 
the over-the-counter derivatives market.
    Last July, we passed the Wall Street Reform and Consumer 
Protection Act and gave the SEC and the CFTC the authority to 
regulate the use of derivatives. We created transparency in 
markets by requiring that most derivatives be traded on 
exchanges and that the details of these transactions, including 
price, be reported.
    The reason for this regulation was because we saw the 
systemic panic caused when AIG failed. We saw that Jefferson 
County, Alabama, was sold derivatives with hefty fees and 
complex terms that they didn't even understand. And now, we are 
seeing the uncertainty caused by a lack of transparency as it 
relates to credit default swaps on European debt.
    So I would like to underline just how important it is that 
our regulation of derivatives moves forward in a timely manner. 
I am very concerned by attempts to delay implementation of the 
derivatives provisions in Dodd-Frank, particularly the 2-year 
delay that passed this committee earlier this year under 
unanimous objection of Democrats on this committee. Given both 
the European crisis and the continued problems with speculation 
in the oil market, I think that this 2-year delay will be 
tremendously dangerous.
    I would also like to state my concern with back-door 
attempts to delay regulation by restricting funding to the SEC 
and the CFTC. Current House Republicans' proposals would hold 
SEC funding flat and would cut CFTC funding by 15 percent 
relative to Fiscal Year 2011. Such funding restrictions are 
simply unacceptable, given the new responsibilities provided to 
these agencies after the historic financial crisis of 2008.
    As for the four bills being considered today, I am, of 
course, open to refining what we did in Dodd-Frank to ensure 
that rules can be implemented effectively, but I am not certain 
that legislation is necessarily needed, given the tremendous 
flexibility we afforded to regulators.
    I would also add that on the issue of H.R. 1838, which is 
being considered today and would repeal Section 716 of Dodd-
Frank, I am very concerned about a step backwards in terms of 
ending the casino-style betting that got us into the 2008 
crisis. I think it makes good sense that banks with Federal 
backing, either through a discount window or through deposit 
insurance, be restricted from using that backstop to fund their 
derivatives business subject to some bona fide exception.
    I thank you, and I yield back the balance of my time.
    Chairman Garrett. And the gentlelady yields back. Thank you 
for that.
    Mr. Dold is recognized for 1 minute.
    Mr. Dold. Thank you, Mr. Chairman. I certainly want to 
thank you for holding the hearing, and I want to thank our 
witnesses for your time and for being here today.
    We do have an unemployment rate of 9.1 percent, and it has 
been extraordinarily high. It is the number one issue I think 
we face in this Congress, to try to jump-start the economy and 
put people back to work. It is going to be done, I think, in 
the private sector, and when I talk to people about 
uncertainty, that seems to be one of the major things people 
have in this.
    Whenever Congress passes legislation, especially a 2,000-
page bill like Dodd-Frank, I think we have an obligation to 
continually review and reevaluate the real-world results of the 
legislation. We must identify and correct unintended negative 
consequences that apply to a general cost-benefit analysis of 
the legislation's effects. Whether or not we voted for Dodd-
Frank, we are not eternally bound to support every single 
provision regardless of whether we were for the original bill 
itself. Instead, we are here to do the best we can for our 
constituents and for our country; and sometimes that means 
making corrections to bills that were previously supported when 
circumstances change or when new information arises.
    Today, we are here to consider doing that with respect to 
some of Dodd-Frank's derivatives provisions. Derivatives are 
very important for our international competitiveness, for 
American jobs, and for our economic prosperity. We can't afford 
to persist with these mistakes on these issues. So I look 
forward to hearing from each and every one of you and to 
working with my colleagues on the other side of the aisle for 
some common-sense reform.
    Chairman Garrett. That is what we are always looking for, 
the common-sense reform, thank you.
    And now, we look to the gentleman from New York, Mr. Grimm, 
for 1 minute.
    Mr. Grimm. Thank you, Mr. Chairman.
    First of all, I want to thank the witnesses for being here 
today. I appreciate your time.
    And the timing of this hearing could not be more 
appropriate. Just this week, the New York State Comptroller 
announced that New York City, the best portion of which I 
represent, stands to lose another 10,000 financial services 
jobs by the end of 2012. I believe it is clear that many of the 
regulations put into place by Dodd-Frank and Title VII in 
particular are playing a part in these job losses.
    In order to maintain the competitiveness of the U.S. 
financial markets, we must ensure that our regulatory structure 
does not put us at a disadvantage relative to the rest of the 
world. Therefore, I am encouraged by this committee considering 
these four pieces of legislation, two of which, I might add, 
were put together on a bipartisan basis. I look forward to our 
witnesses' views on these bills and how they can further ensure 
that our burdensome regulation does not put U.S. financial 
sector jobs needlessly at risk.
    I thank you, and I yield back the balance of my time.
    Chairman Garrett. I thank the gentleman.
    Did the gentleman wish to be recognized for 1 minute?
    Mr. Donnelly. Thank you, Mr. Chairman.
    I think we forget that hundreds of thousands of jobs in 
Indiana, Ohio, Pennsylvania, and other places were all lost due 
to the extraordinary destruction caused on Wall Street, due to 
the extraordinary destruction caused by derivatives and their 
failures.
    And, Mr. Grimm, I sympathize with the loss of those jobs, 
as I know you do, of the hundreds of thousands of jobs that 
went before that caused by the destruction from the derivatives 
and the conduct that occurred on Wall Street and with a number 
of these actions. And I look forward to getting these 
derivatives right as well, but I also want everyone to 
understand why we are here today, because of the actions that 
took place before.
    Thank you.
    Chairman Garrett. The gentleman yields back.
    Mr. Canseco for 1\1/2\ minutes and the final word.
    Mr. Canseco. Thank you, Mr. Chairman; and thank you for 
having me here in your subcommittee.
    Millions of Americans rely on income from employer pension 
plans during retirement, and managers of pension plans have a 
duty to prudently manage their portfolios in order to meet 
their long-term obligations to employees and retirees. A 
crucial part of managing investment risk, especially in a large 
and diversified pension portfolio, is having the ability to use 
swaps in order to hedge risk, notably interest rate risks. 
However, a provision included in the Dodd-Frank bill, and 
proposed rules from regulatory agencies, could seriously 
curtail the ability of pension plans to hedge these risks.
    On the proposed rules from the SEC, the CFTC, and the 
Department of Labor, a swap dealer that seeks to enter into a 
transaction with a pension plan could trigger a fiduciary 
obligation under ERISA, thereby precluding the dealer from 
engaging in such transactions. However, neither swap dealers 
nor pension plans have ever considered the dealer to be acting 
as a fiduciary in such a scenario.
    H.R. 3045, which I have introduced along with Chairman 
Garrett, would remove pension plans from the special-entity 
status conferred upon them in Dodd-Frank and allow them to 
continue to be able to use swap dealers in order to manage risk 
responsibly in their portfolios, regardless of how regulators 
implement the rules. This bill is an important step towards 
protecting the retirement income of millions of Americans, and 
I look forward to hearing from witnesses today on this matter.
    Thank you, and I yield back.
    Chairman Garrett. The gentleman yields back.
    Since there are no other opening statements, we look then 
to the panel.
    Again, we welcome the panel here today; and we thank you 
very much for the testimony you are about to give us. As 
always, your full written statements will be made a part of the 
record. You will each be recognized for 5 minutes.
    So, we will begin with Mr. Bailey. You are recognized.

  STATEMENT OF KEITH BAILEY, MANAGING DIRECTOR, FIXED INCOME, 
   CURRENCIES AND COMMODITIES DIVISION, BARCLAYS CAPITAL, ON 
        BEHALF OF THE INSTITUTE OF INTERNATIONAL BANKERS

    Mr. Bailey. Chairman Garrett, Ranking Member Waters, and 
members of the subcommittee, my name is Keith Bailey. I am 
managing director in the Fixed Income, Currencies and 
Commodities division of Barclays Capital.
    I am pleased to be here to testify on behalf of the 
Institute of International Bankers (IIB) regarding four 
discrete legislative proposals to amend Title VII. Many of 
these issues sought to be addressed by these bills are very 
important to the members of the IIB. The IIB represents 
internationally headquartered financial institutions from over 
35 countries around the world that have operations in the 
United States.
    International banks provide an important source of credit 
for U.S. borrowers and enhance the depth and liquidity of U.S. 
financial markets. Our U.S. operations contribute billions of 
dollars each year to the economies of major cities across the 
country by employing over 250,000 U.S. citizens and permanent 
residents.
    The IIB members support Title VII's objectives of reducing 
systemic risk and increasing transparency, and many of our home 
countries are working to implement similar reforms.
    As Title VII is implemented, it is important to note that 
foreign banks and U.S. banks alike seek to minimize the number 
of legal entities through which they conduct swap dealing 
business. This benefits both the banks and their customers by 
increasing efficiencies and decreasing risk through netting and 
offsetting of exposures. It also allows customers to transact 
with a more creditworthy entity.
    It is equally important to recognize that, as the swap 
market is a global one, it is imperative that derivatives 
reforms maintain a level global playing field.
    We believe that these two objectives will be better 
achieved if the legislative proposals before the subcommittee 
today are enacted into law. In particular, I would like to 
focus on H.R. 1838 and H.R. 2779.
    H.R. 1838, sponsored by Representative Hayworth, would 
repeal Section 716 of Dodd-Frank, also known as the swaps push-
out provision. Section 716's exclusions, grandfathering, and 
transitioning provisions apply only to insured depository 
institutions. Thus, our principal concern with Section 716 is 
its impact on uninsured U.S. branches and agencies of foreign 
banks which will not benefit from these exclusions.
    When Section 716 was enacted, Members of Congress 
acknowledged that the lack of parity between foreign bank 
branches and U.S.-insured depository institutions was 
unintended and inconsistent with the U.S. policy of national 
treatment. These same members acknowledge the need to ensure 
that foreign bank branches are treated the same as insured 
depository institutions. However, in the rush to complete the 
conference and finalize Section 716, there was no opportunity 
to rectify this significant oversight.
    Less than 2 years remain before the foreign bank branches 
will be forced to push out all of their swaps dealing business. 
In some cases, even existing positions will need to be pushed 
out. The implications of this impending deadline are serious.
    Swap dealing is typically conducted as an integrated part 
of a bank's overall business. Swap positions often hedge loans 
and other non-swap positions. Winding down or restructuring 
swap-dealing activities could have a material impact on foreign 
bank lending in this country. Customer agreements will be 
required to be modified, possibly resulting in significant tax 
consequences and possibly in litigation. These renegotiations 
of agreements will lead to delays in affording customers access 
to liquidity that is offered by foreign banks. The customers 
will lose their ability to net and set off collateral and 
payment obligations.
    The IIB strongly supports H.R. 1838 as it would effectively 
accord equal treatment to foreign banks. It also would 
eliminate the significant negative impacts on capital, netting, 
and risk management which would result from conducting 
derivative trading through multiple U.S. entities. In its 
current form, Section 716 will result in higher execution costs 
for our customers.
    The IIB also supports H.R. 2779 cosponsored by 
Representatives Stivers and Fudge. H.R. 2779 makes clear that 
many burdensome Title VII requirements do not apply to inter-
affiliate swaps. This is important because inter-affiliate 
swaps promote execution flexibility for clients and superior 
risk management by swap dealers.
    At the same time, H.R. 2779 preserves necessary regulatory 
oversight. Prudential regulators would continue through their 
supervisory role to have oversight of these transactions and to 
impose capital and other requirements as appropriate, both at 
the holding company and the subsidiary levels.
    The CFTC and the SEC as market regulators will continue to 
have access to inter-affiliate transaction data. To the extent 
that the Commissions uncover specific evasive conduct involving 
inter-affiliate transactions, they would retain their authority 
to address that conduct.
    We believe that H.R. 2779 strikes the right balance by: 
first, ensuring that the prudential supervisors and the market 
regulators have the requisite tools to perform their regulatory 
responsibilities; and second, ensuring that Dodd-Frank 
objectives of reducing systemic risk and increasing 
transparency are not undermined.
    I thank you for the opportunity to testify today on behalf 
of the Institute of International Bankers. I would be happy to 
answer any questions you might have.
    Thank you.
    [The prepared statement of Mr. Bailey can be found on page 
44 of the appendix.]
    Chairman Garrett. And I thank you.
    Mr. Bernardo, welcome to the panel and to the committee. 
You are recognized for 5 minutes.

STATEMENT OF SHAWN BERNARDO, SENIOR MANAGING DIRECTOR, TULLETT 
PREBON, ON BEHALF OF THE WHOLESALE MARKET BROKERS ASSOCIATION, 
                            AMERICAS

    Mr. Bernardo. Thank you.
    My name is Shawn Bernardo. I am a senior managing director 
for Tullett Prebon, a leading global inter-dealer broker of 
over-the-counter financial products. I am also the chairman of 
the Wholesale Market Brokers Association, Americas (WMBAA), an 
independent industry body whose membership includes the largest 
North American inter-dealer brokers.
    I am testifying today on behalf of the WMBAA. Our trading 
systems are the prototypes for swap execution facilities under 
Dodd-Frank.
    Mr. Chairman, we thank you and your colleagues, 
Representatives Maloney, Meeks, and Hurt, for your leadership 
in introducing H.R. 2586, the SEF Clarification Act. The WMBAA 
supports the bipartisan effort to ensure the congressional 
intent is followed in the SEF rulemaking process.
    For example, before John Deere enters into a contract to 
sell tractors to an Argentinean farm 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 risk knowing it can offset that exposure on one of the 
hybrid platforms we operate.
    So how is this done? Imagine a large room filled with long 
desks not just in New York City but also in Kentucky, New 
Jersey, and Texas. Each desk has a group of professionals with 
several computer screens and telephone squawk boxes that 
transmit prices to our customers. There are thousands of these 
professionals in the United States who use a wide array of 
trading technologies to meet the demands of the marketplace and 
their customers.
    It is what CFTC Commissioner Bart Chilton described in a 
press interview as ``big dynamic operations, not just a couple 
of guys in a back room with a phone.'' Each method we use is 
geared to the specific dynamics of financial products we 
broker. We call this range of training methods hybrid 
brokerage.
    Swap markets have unique characteristics. They are full of 
institutional and not retail participants. There is a much 
larger number of complex products compared to the highly 
commoditized futures markets. And while the product range is 
wider, the trading volume is quite variable. The most active 
single-name credit default swap contracts trade a little over 
20 times per day, and the majority trade once per day.
    It is because of these unique trading and liquidity 
characteristics of swaps that our firms develop the hybrid 
brokerage methods I have described. In my 15 years in the 
industry, I have seen many products transition from voice or 
hybrid to electronic platforms as the liquidity increases. For 
others, however, hybrid trading systems are necessary to create 
the liquidity needed for businesses to adequately hedge risk. 
Developing and operating hoses hybrid systems creates thousands 
of American jobs.
    The SEF provision of Dodd-Frank requires post-trade 
reporting and promotes pre-trade transparency as an 
aspirational goal. In fact, Dodd-Frank requires reporting to be 
balanced against the impact on liquidity.
    Today, the members of the WMBAA create active price 
discovery by providing their platforms prepaid transparency 
regardless of the method of trade execution. As registered 
SEFs, WMBAA members will provide fully electronic reporting of 
the transaction to the regulators and the swap data 
repositories.
    While my written testimony addresses the SEF rulemaking in 
more detail, I would like to discuss one key issue this 
morning.
    Congress made clear in Dodd-Frank that SEFs may conduct 
business using ``any means of interstate commerce.'' Congress' 
words are clear: ``Any means of interstate commerce.'' And that 
includes the full range of hybrid brokerage methods I have 
described.
    We are concerned with the CFTC's proposed SEF rules 
restricting trading methods to only electronic central limit 
order book or RFQ systems for non-block clear trades. This 
approach is inconsistent with a plain reading of the statute 
and its legislative history. Imagine if Apple were told by 
Congress that they could sell their products through any means 
of interstate commerce, but then a regulator told them that 
they had to fire their sales associates, close their retail 
stores, shut down their toll-free sales line, and customers 
could only purchase Apple products online without human 
interaction at apple.com. That would obviously be an 
overreaching restriction on the clear statutory language.
    Here, the CFTC is interpreting Dodd-Frank to say that for 
many trades, SEFs can use any means of interstate consumers as 
long as it is only purely electronic systems.
    Getting the rules wrong will impact American businesses 
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 
don't mess up platforms that are currently working well.'' This 
is a delicate balancing act.
    Mr. Chairman, consideration and passage of the bipartisan 
SEF Clarification Act will provide regulators with a clear 
expression of Congress' intent to permit SEFs to use any means 
of interstate commerce to execute swap transactions.
    Thank you for your time today.
    [The prepared statement of Mr. Bernardo can be found on 
page 55 of the appendix.]
    Chairman Garrett. I thank you and thank you for drawing 
that picture for us of what the market actually looks like.
    Ms. Boultwood is recognized for 5 minutes. Welcome.

 STATEMENT OF BRENDA BOULTWOOD, CHIEF RISK OFFICER AND SENIOR 
VICE PRESIDENT, CONSTELLATION ENERGY, ON BEHALF OF THE END-USER 
                           COALITION

    Ms. Boultwood. Good morning, Chairman Garrett, Ranking 
Member Waters, and members of the subcommittee. 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 of Constellation Energy.
    On behalf of Constellation, and the Coalition of End-Users, 
I am privileged to talk to you today about steps Congress 
should take to fix three problems with the proposed regulations 
implementing Dodd-Frank legislation: first, inter-affiliate 
swaps should not be subjected to margin requirements in order 
to transact; second, swap execution facility (SEF) rules should 
not place end-users at a competitive disadvantage by limiting 
our choice of counterparty options and modes of execution; and 
third, we need a proper swap dealer definition and a de minimis 
exception to ensure that end-users are not regulated as swap 
dealers.
    The End-User Coalition includes a diverse group of 
companies that provide goods and services, including 
agriculture, manufacturing, vehicles, electricity, and natural 
gas. From the outset, our Coalition has supported greater 
transparency, but we think end-users like us create jobs, not 
systemic risk, and should not be further burdened by 
regulations that Congress intended for financial dealers who 
caused the crisis.
    I have been involved in risk management for more than 25 
years in a variety of settings from academia to financial 
institutions to commercial entities and as a consultant. I 
serve on the boards of the Committee of Chief Risk Officers, 
and the Global Association of Risk Professionals, and I am a 
member of the CFTC's 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 44 States. We are the largest due 
to a variety of risk-management tools we employ to the benefit 
of our customers. Physical energy markets are volatile and 
unpredictable, but derivatives allow us to stabilize this 
volatility. We pass these benefits on to our customers in the 
form of low fixed prices for the energy they need to run their 
businesses and power their homes.
    Now, I would like to specifically address some of the 
proposed pieces of legislation. First, we strongly support H.R. 
2779, the Stivers-Fudge bill, because it recognizes that inter-
affiliate swaps do not create systemic risks and should not be 
subject to burdensome margin costs. Like many other companies, 
Constellation uses inter-affiliate swaps because it is more 
efficient to manage our corporate risk in total, rather than on 
an affiliate-by-affiliate basis. And we can get better prices 
by buying our derivatives in bulk through one part of our 
organization. Inter-affiliate swaps are used to allocate these 
derivatives and are largely bookkeeping in nature and do not 
create systemic risk.
    I would also like to speak briefly in support of H.R. 2586, 
the Swap Execution Facility Clarification Act. This measure 
provides clarity for existing voice broker markets so that they 
can qualify as SEFs. Preserving these markets is important as 
voice brokers are often the primary means to facilitate 
transactions for many illiquid products. Limiting the methods 
market participants may use to execute trades may result in 
unintended consequences, a reduced market liquidity, price 
discovery, and access to markets that are simply not developed 
enough to justify the cost of mandatory screen-based trading.
    Congress intended for swap trading on SEFs to develop over 
time in a transparent way that maximizes competition through 
multiple methods of interstate commerce and consistent 
regulation. That is why we support the goals of H.R. 2586, 
which seek to ensure that end-users will continue to have a 
variety of options for hedging their risks.
    Finally, legislation will soon be introduced to fix 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 
much be large enough that it does not capture firms like ours 
that had nothing to do with the financial crisis. We would 
never rise to the level of too-big-to-fail and are not 
interconnected to the broader market in a way that would create 
systemic risk.
    The CFTC's proposed exemptions are too narrow and would 
catch many other end-users in swap dealer rules, like margin, 
clearing, real-time reporting, and capital requirements. Even 
the Administration's proposal and the testimony of regulatory 
officials during the Dodd-Frank legislative process spoke of 
regulating financial institutions, not energy providers or end-
users like ourselves.
    In conclusion, I want to thank Chairman Garrett, Ranking 
Member Waters, and members of the subcommittee for convening 
this hearing. Ensuring the CFTC follows congressional intent 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 captured as swap dealers, and the end-user 
exemptions included in the bill will be null and void. It is 
important to remember that end-users rely on derivatives to 
reduce risk, bring certainty and stability to our businesses, 
and ultimately to benefit our customers. We create jobs, not 
systemic risk, and we should not be further burdened by 
regulations Congress intended for financial dealers. Thank for 
your time, and I look forward to your questions.
    [The prepared statement of Ms. Boultwood can be found on 
page 78 of the appendix.]
    Chairman Garrett. And I thank you for your testimony.
    Mr. Cawley, you are recognized and welcome to the 
committee.

  STATEMENT OF JAMES CAWLEY, CEO, JAVELIN CAPITAL MARKETS, LLC

    Mr. Cawley. Thank you. Chairman Garrett, Ranking Member 
Waters, and members of the subcommittee, my name is James 
Cawley. I am chief executive officer of Javelin Capital 
Markets, an electronic execution venue of OTC derivatives that 
will register as a swaps execution facility under the Dodd-
Frank Act.
    I am also here today to represent the interest of the Swaps 
Derivatives Market Association (SDMA), which is comprised of 
several independent derivatives dealers and clearing brokers, 
some of whom are the largest in the world.
    Thank you for inviting me here today to testify. Let me 
first address H.R. 1838, that calls for repeal of Section 716 
of the Dodd-Frank Act. Section 716 requires that the U.S. 
Government can no longer bail out swap dealers that do not hold 
deposits from the American public.
    The SDMA respectfully opposes H.R. 1838 because it would 
allow for future bailouts of Wall Street by Main Street. We 
oppose 1838 because it is not the role of government to 
intervene in private business by picking winners or losers.
    Government bailouts of private business run contrary to the 
fundamental tenants of free enterprise in this country. Swap 
dealers, like all other private businesses, must be allowed to 
succeed or fail on their own merits. Swap dealers serve no 
prudential role to the economy. To be sure, as we have seen 
from the financial crisis of 2008, systemic risk borne at the 
bilateral construct of an uncleared swap increases the systemic 
risk of these firms. But the swap-clearing mandate under Dodd-
Frank substantially mitigates such risk, and thus, in the 
future, these firms will be allowed to fail without threatening 
our economy.
    We oppose 1838 because of the moral hazard implications. 
For swap traders to know that somehow their firms and their 
jobs would be protected by the U.S. taxpayer would only 
encourage further high-risk behavior and drastically increase 
the likelihood of another bailout.
    Lastly, the SDMA opposes such a bill because even if the 
U.S. taxpayer wanted to bail out Wall Street it simply can't 
afford it. With budget deficits running close to 100 percent of 
GDP, the U.S. taxpayer doesn't have the funds. Moreover, one 
need only look to the paralyzed economies of Ireland, Portugal, 
and Greece to appreciate the ills of taking bailouts a bridge 
too far. As unfortunate as it is, bad actors in finance should 
be rewarded as bad actors in other industries, not with 
bailouts but with bankruptcy.
    With regard to the Swap Execution Clarification Act that 
calls for an override of various pre-trade transparency 
provisions under the Dodd-Frank Act, the SDMA respectfully 
opposes that, too. To not require SEFs to show live firm bids 
and offers to the entire market so that participants can 
transact on them would dangerously limit fair dealing, restrict 
competition, and increase systemic risk.
    As empirical evidence and academic research show, the 
dissemination of live actionable prices to all market 
participants simultaneously increases market integrity, 
promotes a level playing field, and increases liquidity. Fair 
and open markets attract more dealers and buy-side 
participants, which, in turn, foster even greater liquidity. As 
evidenced by the financial crisis of 2008, the credit default 
swap and interest rate swap markets can never have enough 
liquidity.
    The SDMA opposes H.R. 2586 because it would increase 
transaction costs. With regard to transaction costs in the swap 
markets today, it is estimated that market participants pay $50 
billion annually. By fostering greater pre- and post-trade 
transparency, it is estimated that such transaction costs would 
fall by 30 percent, or $15 billion, annually in the first few 
years after Dodd-Frank. That is $15 billion that corporations 
can use on their own balance sheets to invest in research and 
development or hire more American workers. That is $15 billion 
that loan portfolios can pass back to consumers in the form of 
cheaper small business loans or mortgages for American 
families. To be clear, the current SEF rules promote 
transparency fair dealing and lower transaction costs. The SEC 
and the CFTC have mindfully permitted different execution 
methods, such as exchange-like anonymous central limit order 
books and requests for quote methodologies.
    Moreover the Commissions do not restrict voice hybrid 
broking methodologies; they merely require that they operate 
with certain pre-trade transparency precepts. The Commissions 
have wisely allowed the markets to decide which method works 
best in each market context. The SDMA, too, has several voice 
brokering constituent firms, with many hundreds, if not 
thousands, of voice brokers. And after our careful review, we 
support the Dodd-Frank Act as passed.
    To be sure, to change the rules now would be expensive to 
roll back. Clearinghouses dealers, buy-side, and trading venues 
have already invested hundreds of millions of dollars in 
anticipation of such rules. To reverse these rules now would be 
costly, inhibit capital formation, cost jobs, and sacrifice 
economic growth.
    To conclude, the SDMA calls on the members of this 
subcommittee to forego proposed bills H.R. 1838 and 2586 and 
instead request an immediate finalization of clearing, 
execution, and trade reporting rules by the regulators. As we 
enter now our second global financial crisis in 3 years, we 
should be mindful that the swap markets are no better protected 
today than they were back in 2008. The sooner we implement 
Dodd-Frank, the safer the American economy will be. I thank you 
for your time. And I am glad to answer any of your questions.
    [The prepared statement of Mr. Cawley can be found on page 
83 of the appendix.]
    Chairman Garrett. Thank you, Mr. Cawley.
    Mr. Mason, you are recognized for 5 minutes, and welcome to 
the panel.

 STATEMENT OF KENT MASON, DAVIS & HARMAN LLP, ON BEHALF OF THE 
 AMERICAN BENEFITS COUNCIL AND THE COMMITTEE ON INVESTMENT OF 
                    EMPLOYEE BENEFIT ASSETS

    Mr. Mason. Thank you.
    My name is Kent Mason. I am a partner in the law firm of 
Davis & Harman. I have been working in the pension area for 
almost 30 years. And I can assure you that time flies in the 
pension area.
    I am testifying today on behalf of the American Benefits 
Council and the Committee on Investment of Employee Benefit 
Assets. Those two organizations together represent the vast 
majority of this country's private retirement plans. I want to 
thank you very much for holding this hearing and for inviting 
us to testify.
    ERISA pension plans use swaps to manage investment risk and 
liability risk. Without swaps, pension funding obligations for 
companies would become much more volatile. That volatility 
would have two main effects: one, it would undermine the 
security of employees retirement benefits; and two, it would 
cause the company sponsoring these plans to have to reserve in 
the aggregate billions of additional dollars to hold for 
funding obligations. Those reserves would divert assets away 
from job creation and investments in the economy.
    I am going to focus today on three issues: one, the 
business conduct standards, which are our highest priority; 
two, the SEF rules; and three, the margin rules. I am going to 
start with the business conduct rules. In the business conduct 
issue, we have three issues there. The first is the fiduciary 
issue, as Mr. Canseco explained better than I am going to here. 
Under the business conduct rule, proposed business conduct 
rules, a swap dealer has the obligation to review the 
qualifications of a plan's advisor. That review, under current 
ERISA law would make the swap dealer a fiduciary. As a 
fiduciary, the swap dealer could not enter into a swap with a 
plan; it would be a prohibited transaction, and thus, all swaps 
with plans would have to cease. The answer here is actually 
very straightforward. We need a simple rule that says no action 
required by the business conduct standards will make a swap 
dealer a fiduciary. That is exactly what H.R. 3045 would do, 
and we support it.
    The second issue, the advisor issue, under Dodd-Frank, if a 
swap dealer acts as an advisor to a special entity, such as a 
retirement plan, the swap dealer must act in the best interest 
of that special entity. Unfortunately, the CFTC's proposed 
regulations would define advisors so broadly that all swap 
dealers would be required to be advisors. This sets up an 
unworkable conflict of interest. That would mean that swap 
dealers would be required to act in the best interest of 
themselves, do their fiduciary duty to their shareholders, and 
in the best interest of their counterpart. That is unworkable. 
If that were to hold, again, all swaps with plans would cease.
    Again, H.R. 3045 addresses this very well by removing ERISA 
plans from the definition of a special entity.
    The third issue under the business conduct rules is what I 
call the dealer veto issue. Under the proposed regulations, the 
swap dealer would have the ability to veto the advisor of a 
special entity, such as a pension plan, based on the swap 
dealers opinion of the advisor's qualifications. This would 
give the swap dealer enormous leverage over the plan and over 
the advisor.
    Again, H.R. 3045 would deal with this very effectively by 
removing ERISA plans from the definition of a special entity 
and remove this counterproductive veto power, which hurts plans 
rather than products them.
    The SEF bill, the CFTC's proposed rules would raise costs 
very substantially for all counterparties, including ERISA 
plans. For example, by requiring that plans and other 
counterparties expose at least five RFQs to other market 
participants--this would cause the market to know too much 
about a trade before it happens and sort of mean that the 
ultimate counterparty would have much more trouble hedging that 
trade after it happens. That will obviously--the ultimate 
counterparty will pass on that cost to the plan or other end-
user, raising costs significantly.
    H.R. 2586 would solve this problem and the other issues 
arising under the SEF rules.
    Lastly, very quickly, I just want to mention the margin 
requirements. The proposed margin requirements issued by the 
CFTC and the prudential regulators would treat ERISA plans as 
high-risk financial end-users and would classify them in the 
same category as hedge funds, imposing very onerous margin 
requirements. This is simply a mistake and a very costly one. 
ERISA plans are among the safest counterparties. We need 
corrective legislation. I thank you for your time, and I would 
be happy to answer any questions.
    [The prepared statement of Mr. Mason can be found on page 
86 of the appendix.]
    Chairman Garrett. Thank you, Mr. Mason.
    Mr. Voldstad, you are recognized for 5 minutes, and welcome 
to the committee.

    STATEMENT OF CONRAD VOLDSTAD, CHIEF EXECUTIVE OFFICER, 
        INTERNATIONAL SWAPS AND DERIVATIVES ASSOCIATION

    Mr. Voldstad. Thank you, Chairman Garrett, Ranking Member 
Waters, and members of the subcommittee. Thank you for the 
opportunity to testify today.
    My name is Conrad Voldstad. I am CEO of the International 
Swaps and Derivatives Association, a 25-year old institution 
that has over 800 members in over 50 countries, including in 
our membership over 60 government and supranational bodies.
    I myself started in the derivatives business back in 1983 
before ISDA was around. I managed global swaps and fixed-income 
operations for two large American firms, helped unwind long-
term capital, and later managed my own hedge fund.
    In my brief testimony today, I will briefly comment on H.R. 
3045. We agreed both with Congressman Canseco's statement and 
Mr. Mason's testimony. We support this bill because it would 
correct an unintended consequence of the Dodd-Frank Act, one 
that would preclude retirement plans from using derivatives to 
manage their assets and liabilities.
    Regarding the other bills, H.R. 2586 would rectify a number 
of the serious issues related in particular to the CFTC's 
proposals for how swap execution facilities, or SEFs, must 
operate. We strongly support its passage.
    OTC interest rate and credit default swaps, the products 
that will be the first to be executed on SEFs, are the most 
common and liquid products with very competitive pricing. 
However, while they are common and liquid, they trade very 
infrequently, and they trade in very large size. The interest 
rate swap market in particular is similar to the U.S. 
Government bond market, where many investors rely on dealer 
prices for certain types of trades. U.S. Government bond 
investors have the ability to execute electronically or through 
market makers. They have a choice of venues in which to trade.
    It appears the CFTC would like to reduce the choice of end-
users. They would do so by specifying that SEFs require the 
requests-for-quotes process to include at least five market 
participants. What dealer will put capital at risk in very 
large size if at least four others see the trade? The result 
will be reduced liquidity and higher prices for end-users.
    We also believe that end-users would have to execute large 
trades in a piecemeal fashion, taking execution risks they do 
not have to take today.
    It is interesting to see that the SEC does not require RFQs 
to be sent to more than one participant and has not reduced 
choice of execution to the extent the CFTC has.
    It is very important to note that unlike the requirements 
for clearing and trade repositories, SEF execution is not an 
element of Dodd-Frank that reduces systemic risk. It does not 
touch the AIG-type issues that cause losses in the financial 
markets. It is a structural change that should, in my opinion, 
be subject to a more careful cost-benefit analysis and safety 
and soundness provisions. This, of course, has not been done.
    With respect to H.R. 2779, ISDA also believes that inter-
affiliate swaps play an important part in the risk-management 
practices of end-users and dealer firms. For a variety of 
reasons, they may choose to book transactions in a centralized 
risk-management subsidiary and then book that risk internally 
to another subsidiary via inter-affiliate transactions. Dealer 
firms of course might do the opposite, have a local entity be 
the booking firm and manage the risk centrally.
    We do not believe that transactions within a corporate 
family should be subject to Dodd-Frank clearing and execution 
requirements. Treating inter-affiliate transactions as if they 
are third-party swaps will not reduce risk to the financial 
system. They will not increase transparency in a meaningful 
way, nor will they improve market integrity.
    My last subject will be H.R. 1838, which would repeal 
Section 716 of the Dodd-Frank Act. We see four issues 
associated with Section 716. First, dealers will deal through 
one entity for one set of products and through a second entity 
for another set of products. As a result, netting benefits 
could be lost and risk would increase throughout the system.
    Second, dealers in jurisdictions without a 716 requirement 
will have an advantage relative to their U.S. peers that may 
result in a loss of jobs and business in the United States.
    Third, the non-bank subsidiary required by Section 716 will 
need to be separately capitalized. These capital requirements 
will be greater than the capital savings at the bank that will 
result from the 716 pushout. This extra capital and the capital 
needed to offset lost netting benefits would be far better used 
to create jobs and economic growth in the United States.
    Finally, the non-bank companies set up as a result of 716 
will have to duplicate functions that are also carried out in 
the bank. This, of course, will create costs that will be 
passed on to derivative users. What Section 716 will ultimately 
do is put risk into an entity that is owned by the same parent 
that owns the bank that would otherwise house the business. Is 
risk in the financial system reduced at all? Will the risk be 
as transparent if it is moved from a bank to a bank affiliate? 
And more importantly, might it move to entirely different non-
bank entities?
    This concludes my testimony. ISDA appreciates the 
opportunity to testify on these important bills. And I look 
forward to answering any questions you may have. Thank you.
    [The prepared statement of Mr. Voldstad can be found on 
page 99 of the appendix.]
    Chairman Garrett. And likewise, Mr. Voldstad, thank you for 
your testimony.
    Since everyone here said they look forward to our 
questioning, let's go to some questioning.
    I will begin with my questioning.
    I will throw this out, I guess, to Mr. Cawley for a brief 
answer, and then maybe I will throw it out to Ms. Boultwood to 
follow up on an answer, same sort of thing.
    Mr. Cawley, your testimony was it might be a little 
different with regard to how things would play out as far as 
whether everything would be forced onto a central order book or 
not. And even if it was not all forced on there, whether or 
not--since your testimony seemed to indicate that there would 
be some flexibility out there whether--the question that comes 
up in my mind is whether, even if there is some flexibility 
there, whether you still would have to first go to a central 
order book to check that, so to speak, for the pricing over 
there. If it were the case that everything had to go there, 
then some of us would disagree that that was the intention of 
Congress, that Congress was not intending to micromanage the 
operation of the markets in that place. And even if it is not, 
the effect of the rules, that everything goes there per se, but 
things have to go there indirectly as far as to having to at 
least check the central order book, still I would say that is 
not the intention of Congress. I would like your comments on 
that.
    And Ms. Boultwood, I would like your comments on that as 
well.
    Before that, though, I will just share with you what some 
other folks who are not on the panel, from the ICI in general, 
wrote in support of the legislation, the SEF legislation. I am 
not going to read all of it, but they say, the appropriate 
regulation of SEFs will be of critical importance to the 
success of Title VII of regulation rulemaking. ICI believes 
that the proposed trading restrictions and the Commission SEFs 
related proposals--the current rules, which you say, let go 
into affect--do not strike the right balance of proposed 
restrictions, enhance transparency at the expense of liquidity 
and efficient pricing, which could discourage the use of SEFs. 
It jumps down and says to another piece of it, the fund is 
required to go to five swap dealers prior to executing swap 
transactions; to that point, it would likely suffer from 
information leakage and signaling, so they have concerns there.
    Just two other ones really quick, from Chatham Financial. 
These are advisors to the end-user folks, right? Again, they 
speak in general support of the legislation that we are talking 
about, the Swap Execution Facility Clarification Act. Here is 
the interesting--in a comment letter to regulators, the 
Coalition for Derivatives End-Users highlighted the 
communicating of the details of these language transactions to 
more than one or two parties could adversely affect end-users' 
ability to execute trade efficiency. The Coalition further 
emphasized that this would frustrate rather than fulfill the 
goals of promoting SEF usage; it could work against the goals 
of price transparency and price efficiency, right?
    Then they go on, interesting also; it says the New Democrat 
Coalition expressed similar concerns in its letter to 
regulators. They noted that Congress also recognized, however, 
that there is not always sufficient liquidity in exchanges in 
support of all types of swaps. So you have those people who 
sort of side with where we are standing on this.
    And then last would be, well, last but not least, 
BlackRock--and we are all familiar with them--Asset Management 
fully supports the objectives of the legislation. We believe 
the Swap Execution Facility Clarification Act is consistent 
with these objectives as put in Dodd-Frank but not as--I am 
paraphrasing them--as being implemented.
    So I will give you just quick time, Mr. Cawley, because my 
time is limited, and then Ms. Boultwood on this.
    Mr. Cawley. So by our read, Mr. Chairman, of the rules as 
proposed, we see two or three different methods, so central 
limit order books, as you probably know, allow customers to see 
live real-time prices, bids and orders, bids and offers, 
exchange like.
    Chairman Garrett. But would it have to go--my time is 
limited.
    Mr. Cawley. No, it would not.
    Chairman Garrett. But would it have to go there first for a 
check?
    Mr. Cawley. By our read, the rules offer either the choice 
of going to a central limit order book or to go to an RFQ. Now, 
voice hybrid brokering works today, as Shawn Bernardo talked 
about, very well in the interdealer markets today. But one 
thing that also works well today in those voice hybrid markets 
is the fact that it itself is a central limit order book. 
Dealers today trade with each other using a wholesale central 
limit order book. They do so with the assistance of voice when 
the market is not as liquid as it might be. With interest rate 
swaps, they are highly liquid.
    Chairman Garrett. That I understand. Ms. Boultwood, then?
    Ms. Boultwood. I will respond in two ways: one is just 
practical concerns; and the other is, I guess, more conceptual. 
In our business, hedging output from generation plants as well 
as supply that we provide around the country, there are many 
locations and types of products that we transact in for hedging 
purposes that either you have a very limited number of market 
participants, you may not get to five, for example, or the 
volumes are very low in those transactions. So the point is, 
for physical transactions where you are hedging financially, 
your mode of communication with parties on the other side of 
the transaction is very critical. You can't--you don't want to 
restrict those modes of communication.
    And then second, and more conceptual I think, aligned with 
ICI and Chatham is that this is about interstate commerce and 
the importance of not having rules and having legislation that 
would prohibit certain types of interstate commerce just is 
very important. And that is why your legislation is critical 
and provides clarity that isn't being provided by the current 
set of rules.
    Chairman Garrett. Okay. I appreciate both of your 
testimonies. The ranking member is recognized.
    Ms. Waters. Thank you very much, Mr. Chairman.
    Mr. Cawley, section 716 of Dodd-Frank requires banks that 
have access to Federal assistance, such as deposit insurance 
and access to the discount window, to push out their 
derivatives business subject to some exceptions. Many of the 
witnesses here likely think that this proposal is unworkable or 
impossible to implement. I guess I can conclude from your 
testimony that you don't believe that it is necessary to repeal 
section 716, or do you think that the industry can collaborate 
with regulators to make it workable?
    And in answering that--and this may be a little bit 
unfair--our first witness, Mr. Bailey, comes from a company 
that received about a billion dollars in bailout from the 
discount window. Are you saying that the American taxpayers 
should not be responsible for bailing out under the same kind 
of circumstances that they received their bailout? Please help 
me understand this.
    Mr. Cawley. That is exactly what we are saying. We are 
saying that swap dealers serve no prudential need in the 
economy, and notwithstanding the fact that a bailout was 
necessary because of the bilateral nature of the swaps 
contract--and we saw that with AIG, and we saw that then with 
TARP, and we saw that then with subsidies of guaranteeing bonds 
issued by various broker-dealers. That is not a good--although 
we got through that, it is not a good way to do business. 
Fundamentally it is not, from the SDMA standpoint and from 
several other standpoints in the American public. Swap dealers 
should be treated the same way as any other business, whether 
it is Javelin Capital Markets or a restaurant on the corner. 
You live and die by the decisions that you make, and if the 
collection of decisions that you make are so catastrophic that 
it results in the demise of the company, that is really 
unfortunate, but so be it. And that is how the capitalist 
system works.
    So what 716 asks for is merely that for those institutions 
who are swap dealers that don't hold deposits, there is really 
no prudential need to protect them, and we really need to get 
away from protecting entities or giving them special status 
when they really serve no prudential need in the economy.
    Banks, to the extent that they allow the flow of funds to 
flow through our economy, have a prudential or serve a 
prudential need within the economy. That being said, it is well 
established that with that prudential responsibility comes 
regulation, that they themselves can't get over their skis and 
bring the economy to its knees.
    When we look back at 2008, Congresswoman, I think it is 
fair to say we came very close to the cash machines not working 
on Main Street, and it scared a lot of us on Wall Street, 
because it was getting out of control. We can't go back there 
again, and one only needs to look across the Atlantic to see 
what is happening with the paralyzed economies with Ireland, 
Greece, and Portugal. We can't bail them out. Dexia last week 
was the first bank victim of the financial crisis, part 2. It 
was liquidated. It has now become the charge of the Belgian and 
French taxpayer. So what you see is the second notion, which is 
that the U.S. taxpayer simply can't afford it. We can't afford 
to bail out companies that serve no prudential interest.
    Dodd-Frank goes to solving this issue by bringing in 
clearing. What it does is, it says something very, very simple. 
It says if you are going to trade swaps, they are going to 
trade in a clearinghouse. So if you go down, if you file for 
bankruptcy, you are not going to pull four or five firms with 
it.
    Back in the late 1980s, when I was in college in 
Philadelphia, I remember one day I had an interview at a 
company called Drexel Burnham, and my interview was scheduled 
for the day after they filed for bankruptcy. It was unfortunate 
for me. It was also unfortunate mostly for the workers of 
Drexel and for the bondholders and shareholders of Drexel, but 
by Friday of that week; the market had moved on. It was 
unfortunate that Drexel saw its own demise, but it didn't 
create a systemic risk in the system. And this was something 
that was highlighted that is unique to derivatives, which is 
the bilateral nature of a swap. If AIG was allowed to go down, 
they had written, I believe, $300 billion of protection that 
they had taken no reserve against. So it is necessary that we 
recognize that today, and it is necessary that we don't 
encourage it in the future.
    Ms. Waters. Thank you very much. You make a very good case. 
I yield back the balance of my time.
    Mr. Bailey. May I respond?
    Chairman Garrett. I thank the gentlelady. The gentleman 
from Texas is recognized for 5 minutes.
    Mr. Bailey. I beg your pardon; may I respond?
    Mr. Hensarling. Thank you, Mr. Chairman. As one who 
participated in the legislative process for Dodd-Frank and 
served on the conference committee, I was consistently told 
that the whole reason for being for the legislation was to 
reduce and minimize systemic risk. And now in the testimony 
that I hear today, if I understood properly, Mr. Voldstad, you 
testified that, ``Some parts of the proposed regulatory 
application of this legislation, however, work against the goal 
of systemic risk reduction.''
    Mr. Mason, I believe in your testimony you said, ``Treating 
ERISA plans as high-risk financial end-users will actually 
create risk rather than reduce it, thereby adversely affecting 
plan participants.''
    Ms. Boultwood, I believe I heard you say, ``We create jobs, 
not systemic risk. There may be others who for whatever reason 
disagree with that assessment.''
    So my first question is, I would really like, Mr. Voldstad, 
for you to elaborate on how the aspects of Dodd-Frank that we 
are discussing today actually could work against the goal of 
systemic risk reduction.
    Mr. Voldstad. Thank you, Congressman. Number one, ISDA is 
very much in favor of safety and efficiency of the markets in 
which we operate or our members operate, and I think there has 
been an awful lot of progress. The main things that actually 
improve the safety and soundness of the markets that are in 
Dodd-Frank relate to clearing and the trade repositories. Trade 
repositories have been set up largely through our guidance, and 
are being set up in the asset classes that haven't been done. 
Clearing is a very good process. It does reduce systemic risk. 
Our issues relate to the processes where through a 
proliferation of clearinghouses, you start introducing risk in 
the clearinghouses themselves. You also find that as you move 
transactions into clearinghouses, you often find that those 
transactions themselves were hedging other transactions which 
can't be cleared and which will now create risk. I mentioned in 
my oral testimony that as you push certain swap activities into 
a 716 subsidiary, you will also reduce netting benefits. I 
should point out--
    Mr. Hensarling. I am sorry, let me interrupt. My time is 
limited here.
    I would like to move to Mr. Mason and get your views. I am 
particularly concerned, at least the latest figures I have seen 
on the PBGC say that we have a debt of $23.03 billion, and we 
have a potential exposure from underfunding of plan sponsors of 
perhaps $190 billion. So when one tells me that a potential 
interpretation of Dodd-Frank could create even greater risk 
with ERISA plans, you certainly get my attention. Could you 
elaborate, please?
    Mr. Mason. Absolutely. Because of the way the funding rules 
work, it is absolutely essential that pension plans be able to 
use swaps to manage risk, such as investment risk, but 
primarily interest rate risk. I was sitting with someone 
recently who said that an interest rate swing in 2009 created 
for them almost overnight a $2 billion additional liability, 
and that was almost overnight, and the only way they can 
effectively manage that possibility is through the use of 
swaps. Swaps are a very effective tool to say, I can prevent 
that sudden emergence of $2 billion of liability. Without 
swaps, we couldn't do it. And the proposed business conduct 
regulations would take swaps out of the hands of the pension 
plans and expose them to that sort of enormous volatility and 
risk, so this is a creation of risk. This is not a diminution.
    Mr. Hensarling. In the very brief time I have remaining, I 
am curious about what level of concern people on the panel have 
regarding if the SEC and the CFTC do not harmonize their SEF 
rules and whether one sees any particular harmonization between 
U.S. rules and international rules, and what impact could that 
have on moving these swaps offshore. Anyone who would care to--
    Mr. Bernardo. I think if the SEC and the CFTC don't 
harmonize their rules, just to give you a real-world 
experience, you could have a credit default swap desk in our 
corporate area, where a single broker who brokers both credit 
default swaps and indices following, two sets of rules. So he 
could be doing a trade, trying to follow the rules for indices 
of the CFTC and doing a single-name credit default swap 
following rules of the SEC. So it is quite burdensome.
    Mr. Hensarling. Thank you. I see my time has expired.
    Chairman Garrett. We are going now to the gentleman from 
Massachusetts, but before--just to indicate to the committee, 
after you, we are going to take a 10-minute recess. We have 2 
votes on the Floor, so we can all go and vote for the 15-minute 
vote, and the 5-minute vote, and then come back and reconvene, 
so that gives the panel a 10-minute recess as well.
    The gentleman is recognized for 5 minutes.
    Mr. Lynch. I thank the chairman and the ranking member for 
holding this hearing. I also want to thank the witnesses for 
coming before us and helping us with this very important issue.
    I would like to talk about H.R. 3045, which we were just 
speaking of, Mr. Mason was, regarding the ERISA plans. I am a 
former trustee of a union ERISA plan for the ironworkers, and I 
understand--first of all, the mission of preserving those 
resources in retirement for the beneficiaries, in this case 
ironworkers, is more conservative--with a lowercase ``c''--with 
the eye towards steady growth, and lack of risk. And I don't 
dispute the appeal and the effectiveness of the use of some 
swaps in terms of balancing risk within the plan, especially 
with respect to interest rate swaps, currency swaps where the 
underlying actually changes hands, there's no leverage there, 
but you have to admit with the AIG example back in 2008, we had 
many ERISA plans that had billions of dollars in credit default 
swaps, in more speculative swaps that, but for the taxpayers' 
rescue and pumping $700 billion to satisfy the calls of Goldman 
Sachs and a lot of these pension funds, there would have been 
some--a fair number of ERISA plans that would have been put at 
risk, possibly even failed because the swaps, the counterparty 
there, AIG, would not have been able to meet the obligations, 
so there would have been some failure.
    Apart from the swaps that you have talked about, interest 
rate swaps, I guess what we are getting at, and I think what 
the goal of Dodd-Frank was, is to get away from the speculative 
swap activity that might create some risk within those plans 
and really provide a greater stability within those plans.
    Is there a balance that we could strike here that would 
lend the advantages that interest rate swaps for your example 
provide, yet stay away from some of the more speculative 
activities that unfortunately some pension funds--and you have 
folks who, like me, when I was an ironworker, you would go to a 
couple of meetings a month as a trustee and you would be asked 
to vote on investment strategy and things like that. So I am 
sure there are a lot of smaller ERISA pension funds where 
perhaps all the trustees are not fully up to speed on complex 
derivatives and the different type of swap arrangements.
    Mr. Mason. I think, really, I find myself really agreeing 
with much of what you just said. The overwhelming portion of 
swaps by pension plans are hedges. They are not speculative. 
Interest rate hedging, currency hedging, just as you mentioned, 
some equity hedging. Credit default swaps have historically not 
been a major element. And in our discussions with regulators, 
with the legislators during Dodd-Frank, we have never defended 
the use of widespread credit default swaps.
    What we have done, for example--last spring or the spring 
when Dodd-Frank was being considered--was come in to say, for 
example, on the major swap participant definition, we want 
exemptions when we are hedging. When we are speculating, we are 
not looking for that same kind of protection.
    Mr. Lynch. Right.
    Mr. Mason. So I think we have common ground, and I guess 
what we are saying here today is, let's not throw out the vast 
majority of sound swaps by these rules, which is what these 
rules would do.
    Mr. Lynch. Right.
    Mr. Mason. And let's look for other tools to be effective 
in sort of accomplishing the objectives, the worthy objectives 
that you just articulated. So I don't think there is a lot of 
space here.
    Mr. Lynch. Mr. Mason, to your point, I could see where the 
steelworkers' pension fund might want to enter into some type 
of commodity swap dealing with the price of steel, because that 
is going to affect their work hours, contributions in there, 
the health of their plan in general. They may want to balance 
that off with a swap so that it doesn't adversely affect the 
pension fund. So I certainly understand that instance. But 
there were some cases where pension funds got involved in swaps 
where it was completely gratuitous, it was real estate halfway 
across the country, there was no real physical connection, 
collateral connection between the--it wasn't a hedge is what I 
am saying; it was more gratuitous or speculative. And, I just 
think it might help us greatly if we could get away from that 
type of swap activity.
    Mr. Mason. And I think we would love to sort of follow up 
afterwards because our objective here is to be able to hedge 
our risk, and there may be some minuscule sort of speculation, 
but I think we should talk about it in terms of what we can do 
together to preserve our ability to hedge without crossing 
lines, and we look forward to that discussion.
    Mr. Lynch. I thank the gentleman. I yield back.
    Chairman Garrett. The gentleman yields back. We are going 
to reconvene at exactly 20 minutes of--that will give us enough 
time to go over, vote, and come back, and take a break. So we 
will see you at 20 of.
    [recess]
    Chairman Garrett. We are pretty close to 20 of. The 
committee reconvenes, and I think we are ready for the next 
series of questions from the gentleman from Arizona, and he is 
recognized for 5 minutes.
    Mr. Schweikert. Thank you, Mr. Chairman, proving once again 
you will just let anyone ask questions here.
    Mr. Bailey, one of the questions I have been somewhat 
interested in is the threat of sort of a regulatory arbitrage 
around the world. I know you are not necessarily speaking for 
Barclays, but that does provide you quite a world view and 
expertise. How much of a threat are we in if we made no 
changes, if we left the Dodd-Frank law as it is; that I wake up 
one day and someone like Barclays is moving employees or their 
trading to London or Singapore or somewhere else around the 
world? And I would love also some insight from everyone else on 
the panel on that.
    Mr. Bailey. Thank you. I think in relation to the global 
harmonization point, we do think it is terribly important that 
in certain particular regards, the regulators across the world 
land in more or less--and it doesn't have to be exactly the 
same--the same as to particular facets of the legislation that 
is being adopted globally. In one respect, I think we think 
that clearing is likely to be a fairly universal and reasonably 
harmonized activity globally, provided there is mutual 
recognition of clearinghouses by the respective regulators 
globally, and so that aspect of it, I think will likely be all 
right.
    The issue around execution styles and execution venues and 
what the European MiFID regulations will eventually require in 
terms of the protocols for derivative trading is still somewhat 
unknown. We do expect some information from the European Union, 
I think next week, which will give us more definition as to 
what their intentions are in that regard. But we really would 
depend on where those liquidity pools go, which in turn I think 
depends largely on where our customers go. And if customers 
have a preference for transacting on a certain location or 
certain environment, then that is where we would want to be 
reciprocating with our own liquidity in order to service the 
needs of our customers.
    I actually think one has to recognize that there are many 
products that--where the underlying elements are traded in the 
United States, will remain traded in the United States, 
particularly so in credit products and certain other interest 
rate products and commodities. It actually seems unlikely that 
there would be a massive exodus from our trading population out 
of the United States. But one has to respect that there are 
other markets, like FX, where it is very much a key stroke, it 
is a click of a button that will take your transaction almost 
anywhere you want to trade it in the world, and so I think we 
would--
    Mr. Schweikert. Forgive me, but the 5 minutes goes by very, 
very fast when we are doing some of these. Our concern for us 
as policymakers often is how far ahead of the curve we are. Mr. 
Cawley?
    Mr. Cawley. Yes.
    Mr. Schweikert. Your specialty is you actually provide a 
platform?
    Mr. Cawley. Yes.
    Mr. Schweikert. From what you are seeing around the world, 
are we coming in to--is the world sort of heading towards a 
common regulatory scheme?
    Mr. Cawley. Yes, from what we see. And Mr. Bailey is 
totally correct, there is definitely a global consensus that 
clearing is good, and execution then is up to debate as to how 
products trade. The notion that--and we agree with Mr. Bailey's 
thought that the domestics, certainly credit default swaps 
trading U.S. credits would stay here, and dollar credits would 
stay here as well for interest rate swaps. So, investors look 
for good execution. They also look to trade in fair markets 
where they know that they are going to--
    Mr. Schweikert. One of my concerns is I have actually seen 
a number of articles talking about the hunger of some of the 
Singapore Exchange to try to find a regulatory edge, and very 
stable, so I am constantly concerned that we are going to see 
that regulatory arbitrage.
    My last 30 seconds, is it Mr. Mason, forgive me, I am not 
wearing my glasses so I can't even read something that is a 
little esoteric, but I am trying to get my head around it. 
Would a pension plan ever do a very custom hedge--and I was 
actually thinking before the previous discussion with our 
friend from Massachusetts--I am in a steelworkers' union and in 
our pension plan, we actually take some ownership as part of 
our salary negotiations. Would a pension plan do a custom hedge 
on default of that particular entity?
    Mr. Mason. The defaults, default swaps are really the 
exception in our world. In terms of your question, are there 
customized swaps in our world? Absolutely, because actually the 
interest rate swaps, the currency swaps, the equity swaps are 
all very customized.
    Mr. Schweikert. But my fear is with the way the rules are 
working, if you are doing something with that level of 
customization, is the platform we are heading towards or the 
requirements, is that going to make it much more difficult to 
do those highly customized swaps?
    Mr. Mason. No. I think--and this is something we are 
working a tremendous amount with the agencies on because we are 
completely on board with sort of the clearing structure. But a 
lot of the clearing structure, the sort of customization, is 
inconsistent with the fact that every pension plan has very 
different demographics, and you need to coordinate with the 
precise demographics to create the right hedge, and so we are--
I am sorry.
    Mr. Schweikert. I hope you will forgive me. I am just way 
over my time. Thank you for your tolerance, Mr. Chairman.
    Chairman Garrett. Sure. The gentlelady from New York is 
recognized for 5 minutes.
    Mrs. Maloney. Thank you. I regret that I had a conflict 
with another hearing. I would like to ask a question that is 
affecting really the district I represent, the fact that the 
SEC rule and the CFTC rule have come out different. And I would 
like to in a general sense ask what is it about the SEC rule 
that is better or worse, in your opinion, and what is it about 
the CFTC rule--compare the two rules and what is better and 
worse. And I guess, Mr. Voldstad, since you are the 
International Swaps and Derivatives Association, can you 
explain what it will mean for brokers who are engaged in 
business in the equities market and in the commodities market 
to have two different sets of rules for swap execution 
facilities? And then, if people could comment on the two rules, 
and what it means to commerce in the industry competitiveness.
    Mr. Voldstad. I will start, I think, just by comparing the 
two rules. We talked before about the RFQ process that the CFTC 
has, and they say that any request for a ``transaction'' has to 
be put in front of five participants. The SEC does not require 
that. They are not out to change significantly the structure of 
the marketplace. And Mr. Bernardo said earlier that the CFTC 
will apply to credit default swap indices and the SEC will 
apply to single-name reference entities. So if you are a 
dealer, you will have to transact your single-name default 
swaps under one set of rules, and you will then have to use--
then if you are hedging through an index, you will have to do 
that through another set of rules. And you will also have 
different reporting requirements, and this is very important. 
The SEC has pretty reasonable reporting requirements that can 
go out as long as essentially 20-some-odd hours, whereas the 
CFTC will require near instantaneous reporting requirements, 
except if it is a block. Then you will have a 15-minute delay, 
but the block thresholds are very, very high in the CFTC rules, 
so the SEC rules look quite a bit more reasonable from that 
standpoint. We don't yet know how the SEC will apply rules with 
respect to equity derivatives, but I would imagine that they 
will be a bit more reasonable than what we have seen from the 
CFTC.
    Mrs. Maloney. It sounds complicated. Does anyone else want 
to--
    Mr. Bernardo. Just to add on to that, the SEC rules are 
much more flexible as far as the execution of these trades. 
They allow for voice, electronic, and hybrid means of 
execution. They allow for the wholesale market brokers and my 
competitors to be innovative and come up with new ways to trade 
certain products, whether it be a matching engine or an auction 
platform. The CFTC rules are really based off the futures 
market, and they are relying on an exchange model that doesn't 
necessarily work in all the products that we are looking to 
regulate.
    Mrs. Maloney. Just getting to voice, so the SEC allows 
voice and the CFTC does not allow voice; is that correct?
    Mr. Bernardo. That is correct. To tie that back actually to 
what the Congressman was asking before, even in Europe, the 
rules are much, much less flexible--or much, much more flexible 
on the modes of execution. They are not dictating how trades 
should happen. They are allowing for the market to have the 
ability to trade electronically, via voice or hybrid. Our 
companies--
    Mrs. Maloney. Now, NASDAQ trades in voice, right?
    Mr. Bernardo. NASDAQ, they have voice brokers, but yes.
    Mrs. Maloney. Can anyone tell me any reason why you 
shouldn't have voice? I, for one, like talking to people when I 
am making decisions.
    Mr. Cawley. Congresswoman, maybe I can help. James Cawley 
from the SDMA. We, too, have several firms who have voice 
brokers who operate quite well today in the City and State of 
New York. By our read of the CFTC rules, we do not see that 
they restrict voice hybrid trading. They merely request that 
trades occur on a screen, on a hybrid basis with voice, which 
is consistent with many OTC markets today in the bond context, 
certainly within the wholesale market context. Voice, we should 
be clear, voice hybrid works within the central limit order 
book context, and so from our read of the rules, we do not see 
that there is an explicit restriction on people trading and 
using voice brokers in concert with screens so long as they 
meet their pre-trade trading objectives.
    I would also say you can trade without a screen where you 
have two individuals purely voice broke a trade. Even in that 
context on a broker desk, there is a prohibition against what 
is known as ``armpitting,'' so the notion is that me as a 
broker will see both inquiry from one customer and another, 
cross the trade myself without showing it to my own desk; so we 
see that on a broader context, this is what the rules that have 
been suggested or promulgated by the CFTC to be an extension 
of. So even within interdealer brokers, there is a prohibition 
on armpitting, which is not showing the rest of the market that 
a trade is about to occur.
    Mrs. Maloney. How have companies in your industry improved 
your risk management practices?
    Chairman Garrett. Gentlelady, this will be the last 
question since you are over by a minute-and-a-half.
    Mrs. Maloney. I am over? I will wait for the second round 
then.
    Chairman Garrett. Okay. Then, Mr. Stivers is recognized.
    Mr. Stivers. Thank you, Mr. Chairman. I would like to thank 
the chairman for holding this hearing. I would like to thank 
the witnesses for sharing their time and expertise on many 
issues. And I am going to focus in on H.R. 2779. Not a lot of 
questions have been asked about that one. I would like to start 
with Ms. Boultwood. You represent an end-user, Constellation 
Energy; is that correct?
    Ms. Boultwood. That is correct; yes, sir.
    Mr. Stivers. Can you tell me without H.R. 2779, what would 
happen to the cost of risk management for companies that choose 
to perform their risk management function by using a central 
entity with experts and then using an accounting swap, for lack 
of a better term, to assign ownership to that internally? What 
would happen to your costs if this bill is not passed, and what 
could potentially happen to you?
    Ms. Boultwood. Congressman Stivers, our costs would rise. 
We would be forced to execute hedges for generation that we 
might have in Alberta, Canada, hedges that we might--or 
generation that we have in the United States. And with an 
inability to consolidate that risk and hedge centrally, we 
would be charged transaction fees as well as be forced to 
transact in markets that may in their location not be as liquid 
as other markets where we could potentially more efficiently 
execute that hedge.
    Mr. Stivers. And you could potentially be caused to raise 
your expense 3 times for collateralizing those swaps because 
you would have to collateralize the one side with an external 
entity and both sides of a second transaction, which is merely 
an accounting transaction that does not increase your risk; is 
that correct?
    Ms. Boultwood. That is correct. Mr. Bailey pointed that out 
in his testimony.
    Mr. Stivers. Right, and I heard him say that, but I wanted 
to make sure we were clear.
    Ms. Boultwood. Same impact.
    Mr. Stivers. Tell me what would happen if you had an 
incentive to do that, then, and your costs went up 3 times; do 
you think you would continue to have an external facing entity 
to execute your swaps or would you probably push it into your 
subsidiaries; and in doing so, would you have the same amount 
of expertise in each subsidiary that you are able to have in an 
external entity?
    Ms. Boultwood. So, two questions. We believe on the first, 
we would have higher costs of hedging that we would pass on to 
our wholesale and retail customers. That is the first item. And 
then second, the process that we undertake to hedge would be a 
lot less efficient and we would in many markets be forced to 
what might be called ``dirty hedge'' because we couldn't find 
an appropriate hedge for that specific location, that 
particular product in that location, that we might more 
efficiently find through a centralized transaction.
    Mr. Stivers. Great. Thank you. I know Mr. Bailey brought up 
some great points earlier on the cost as well, and I think Mr. 
Voldstad quickly mentioned that he supports this bill because 
he thinks it will make things more efficient. Do either of you 
have anything that you want to add to why you believe this bill 
makes sense that Ms. Boultwood didn't already cover?
    Mr. Voldstad. I might add something, if I may, Keith. I 
think if you have a plethora of individuals around the world 
executing swaps, there is an issue of expertise but there is 
also an issue of control. I have managed worldwide businesses, 
and I found that as you dispersed risk and authority around the 
world, it was difficult to control that, and typically, you 
would have much tighter risk controls in terms of how far 
somebody was from you and in terms of what kind of market they 
were operating in.
    Mr. Stivers. Anything to add, Mr. Bailey?
    Mr. Bailey. No.
    Mr. Stivers. Great. I yield back the balance of my time, 
Mr. Chairman.
    Chairman Garrett. Thank you.
    Mr. Stivers. Thank you to all of you.
    Chairman Garrett. The gentleman from New York, Mr. Grimm.
    Mr. Grimm. Thank you, Mr. Chairman. Let me ask Mr. Cawley, 
do you think that ERISA plans, those subject to ERISA, should 
be able to engage in swaps transactions?
    Mr. Cawley. I am no expert on ERISA. We are more on the 
execution side, so I really don't have a view on that.
    Mr. Grimm. Okay. Mr. Mason? My understanding is that even 
at a most basic level of understanding, it is almost essential 
to properly managing such a portfolio. Is that correct? Could 
you expand on that?
    Mr. Mason. Absolutely. Particularly interest rate risk. 
Interest rate risk can create enormous volatility and 
liabilities almost overnight, and the way that pension plans 
manage that liability, by far the most efficient, the most 
inexpensive is through swaps, and so--
    Mr. Grimm. But am I correct that under Dodd-Frank, as it is 
now, they would be precluded from those transactions?
    Mr. Mason. Under the proposed regulations, they would be 
precluded, yes.
    Mr. Grimm. Okay. Mr. Bailey, you spoke very briefly about 
regulatory arbitrage, and one example would be the FX markets. 
Do you have any concern that traditional end-users--we spoke 
about some here--but even American companies like John Deere or 
Caterpillar, end-users in the most traditional sense, would be 
forced to send their business offshore where they don't have to 
post margin, things like that? Does that weigh into the 
regulatory arbitrage equation?
    Mr. Bailey. It does, absolutely, as to margin. We are 
hopeful, I think, that the margin treatments and the collateral 
and what has to clear will be sufficiently harmonious between 
the European and the U.S. environments to not have that be an 
issue. But absolutely, that would be a concern.
    Mr. Grimm. And whoever wants to weigh in, one of my--I 
would like to be as optimistic--but after Basel 2, I think we 
can definitely be concerned that the international markets may 
not move as quickly to promulgate the rules. I think it would 
also be safe to say that even if they promulgate the rules, 
there will be certain markets that will probably not implement 
nor enforce the rules to the standards that the United States 
would, and there would be a disparity. Am I completely off the 
mark? Maybe Mr. Bernardo could talk about that?
    Mr. Bernardo. I think you are spot-on. I think that, as I 
said before, the EU's rules on modes of execution are much more 
flexible than ours, so if we don't accept the clarification 
act, we are going to have an issue. Our companies are global 
companies. It is very, very easy for my company to move its 
employees literally at the click of a button over to Europe, 
over to Singapore, as you suggested. It doesn't take much, 
given that if the rules are too prescriptive and it is going to 
inevitably impact firms, they are not going to look to execute 
here; they are going to look to execute someplace else.
    Mr. Grimm. And lastly, Mr. Cawley, as you look at--I think 
your testimony, and correct me if I am wrong, but overall I 
think you said that the proposed rules for Dodd-Frank are close 
to spot-on, and it is what we need to prevent the systemic risk 
and future bailouts. Within your analysis, does U.S. 
competitiveness weigh in there, and if so, to what degree?
    Mr. Cawley. Without a doubt, U.S. competitiveness weighs 
in, Congressman. And speaking directly to competitiveness, we 
only need to look at the hit that our GDP took and the 
unemployment rate skyrocketing as a result of the financial 
crisis back in 2008. So the notion of American competitiveness, 
specifically within the financial markets, is an area where the 
United States has led the charge.
    Mr. Grimm. If I could, because I am running out of time, 
would you say that the extremely high unemployment rate is 
solely due to the financial breakdown? It has nothing to do 
with the crash of the housing market, has nothing to do with 
the policies coming out of Washington from both sides of the 
aisle, maybe some overregulation and the lack of uncertainty in 
the marketplace overall?
    Mr. Cawley. I wish the world worked in black and white. It 
doesn't. It works in gray, so I wouldn't use the term 
``solely,'' but I would say that the financial crisis and the 
role that derivatives played with the bilateral construct that 
is baked into an interest rate or credit default swap certainly 
brought about unnecessary bailouts of companies that shouldn't 
have existed.
    Mr. Grimm. My time has expired. I just want to make note, I 
think when you really analyze it at its core, derivatives 
definitely played a major role, but it was mostly the firms 
that were speculating as a business speculation. And Dodd-
Frank, when you really look at it, goes way beyond speculation 
of derivatives and more into the end-users and legitimate users 
such as pensions, which you admitted you don't know very much 
about. But thank you, and my time has expired.
    Chairman Garrett. The gentleman from New Mexico, Mr. 
Pearce, is recognized for 5 minutes.
    Mr. Pearce. Thank you, Mr. Chairman. Ms. Boultwood, Mr. 
Cawley mentions on page 2 of his testimony that transaction 
costs would fall by 30 percent under the current provisions 
that are being implemented; yet, you come out in support of the 
provision, and he opposes it. Can you help me harmonize those 
two positions? You are an end-user. It seems like you would 
want to be getting these 30 percent cost reductions.
    Mr. Cawley. Indeed. So--
    Mr. Pearce. No, I was asking Ms. Boultwood.
    Ms. Boultwood. I would say--I am not familiar with the 
study that Mr. Cawley refers to, but in our markets we transact 
in very often illiquid markets. In the products we require to 
hedge, there aren't many market participants willing to offer 
bids or offers on sale or purchase of a particular commodity in 
that location. Our transaction costs in terms of both the bid-
ask spread and the level of market liquidity would clearly rise 
as a result of, say, for example, a broad definition of a swap 
dealer and the fallout of certain of our market participants 
from those markets; but also the fact that the SEF rules, if 
they, as Mr. Cawley supports, require either that we submit an 
RFQ or we only transact on a live screen, we will either be 
forced to hedge in very dirty ways in liquid markets and not 
match the underlying asset volatility that we are trying to 
hedge, or we would be posting information in a very public way 
about an intent to hedge often very large amounts of generation 
in a particular region and in such a way that our intentions 
would be known so early in the market that getting a fair price 
would be near impossible.
    Mr. Pearce. Mr. Mason, you might address the same thing. It 
looks like you all would be interested in reducing your costs 
by 30 percent.
    Mr. Mason. Yes. Again, I have not had the opportunity to 
study the numbers from Mr. Cawley. The input we have gotten 
from the pension plans is that the SEF rules proposed by the 
CFTC would drive costs up dramatically, and the one thing that 
was most identified was the requirement that you expose your 
RFQs to at least five market participants, which would make it 
immensely difficult for your eventual counterparty to hedge the 
trade, and that anticipated difficulty would be passed on in 
terms of higher costs. So that is the issue that at least the 
pension plans have identified.
    I think some of my colleagues here are certainly more 
qualified to talk in more detail about the SEF mechanics, but 
for the pension plans, that was the issue which gave us by far 
the most heartburn.
    Mr. Pearce. Mr. Voldstad, is that volunteering that I see 
there? You might want to be hesitant of volunteering in front 
of Congress.
    Mr. Voldstad. I am volunteering, Congressman, and thank you 
for letting me weigh in. I saw the $50 billion transaction cost 
number last night, and I was surprised about it, which is what 
was in Mr. Cawley's testimony, and I ran some numbers. I am an 
old derivatives guy, so I do this. Let's assume that interest 
rate products represent 80 percent of the market, so they 
represent 80 percent of the $50 billion. That is $40 billion. 
And so he is going to eventually--that was $40 billion to exist 
in the marketplace. Let's look at the bid-offer spread on 
interest rate swaps. We did a study last year that showed there 
is essentially a two-tenths of a basis point bid/offer spread. 
Bring it down to zero, you save a tenth of a basis point per 
annum. If you take the $40 billion and divide it by the savings 
or create the total amount of notionals that you were required 
to do, you get an amount of $800 trillion a year of interest 
rate products. That compares with probably $25 trillion a year 
that is actually done. So I would like to see Mr. Cawley's 
source for that information.
    Mr. Cawley. If I may respond?
    Mr. Pearce. Okay, thank you. Mr. Cawley, you have 20 
seconds if you want to--
    Mr. Cawley. I would be more than happy to share the numbers 
with Mr. Voldstad and anyone else who would care to see them. 
What we looked at specifically was CDS, credit default swaps, 
being approximately $25 billion, and interest rate swaps being 
$25 billion. We saw the study that the ISDA had done last year. 
We don't think that it is--we thought it was a good study. 
There are other studies out there, but we would be more than 
happy to walk the ISDA and anybody else through the numbers by 
using essentially the same math that Mr. Voldstad is using.
    Mr. Pearce. Do you have that study available if our staff 
were to check with you after the hearing?
    Mr. Cawley. Yes.
    Mr. Pearce. Thank you. I appreciate that, and I yield back.
    Chairman Garrett. Thank you. The gentlelady, also from New 
York, is recognized for 5 minutes.
    Dr. Hayworth. Thank you, Mr. Chairman. It strikes me as I 
am listening, what we are endeavoring to do, Dodd-Frank is the 
equivalent of sending out a net to catch tuna and catching a 
lot of innocent species like dolphins, those being the dollars 
and the entities that we would like to devote to job creation.
    I want to address for a moment, I did speak with the 
gentlelady from California, Ms. Waters, about H.R. 1838, and 
there are provisions in Section 716 which we are seeking to 
repeal with H.R. 1838 that are redundant with other provisions 
of Dodd-Frank, I believe, that would prohibit a bailout. So I 
have offered to Ms. Waters that I will be happy to work with 
her and her staff to reassure that essential protections 
against taxpayer risk are in place. That is an important 
concern for all of us.
    Mr. Bailey, could you address a bit further the whole issue 
of--vis-a-vis what we were just talking about--the whole issue 
of access to the discount window and its equivalency or 
nonequivalency to a bailout concept?
    Mr. Bailey. Thank you. The foreign banks have access to the 
discount window on the very same terms that the U.S. banks do. 
They have the same rate, they have to post the same quality of 
collateral at the same discount. It is understood to be a part 
of a foreign bank's prudential risk management liquidity 
process to have that access.
    We also understand that the Federal Reserve has for a long 
time regarded it as a prudential tool, it is a monetary policy 
tool, and that it is a valuable means by which the Federal 
Reserve can maintain a sound financial system. The foreign 
banks in the United States lend about 18 percent of the 
commercial loans that are made in the United States, so they 
are part of a system, and they do benefit from the access to 
the window on those terms, but those terms are the same as the 
U.S. banks do.
    Dr. Hayworth. So essentially, what we are saying is it is a 
mechanism--I am a physician, so it is a mechanism for 
maintaining a certain amount of what we would call homeostasis, 
if you will; it is a way of keeping things on an even keel as 
opposed to then having to go in and exert extraordinary 
resources to correct a large risk, if you will. Is that a fair 
way to think about it?
    Mr. Bailey. Yes.
    Dr. Hayworth. Okay. Thank you--
    Mr. Bailey. I should just qualify that. My earlier response 
refers to the U.S. branches, of course, of the foreign banks.
    Dr. Hayworth. Yes, and I appreciate that clarification.
    Mr. Voldstad, we have been talking about Section 716. The 
formation of subsidiaries under a swaps pushout provision 
would, of course, require a certain allocation of capital that 
I think we would agree is better spent in other ways or better 
deployed in other ways. Could you talk a bit more about the 
potential cost of this kind of activity?
    Mr. Voldstad. I think one first must recognize that the 
interest rate swap market will remain in the bank, that the 
credit default swap market with respect to investment grade 
securities will remain in the bank, as will the costs, the 
transactions involving precious metals and so on, so a large 
majority of the business will stay in the bank and continue to 
be regulated by the bank regulators.
    The costs, I don't think we have quantified the costs, but 
the costs would arise out of doing transactions where you might 
be dealing with a hedge fund who wants to take a spread risk 
between a high-yield transaction and an investment grade 
transaction, so he is buying protection on one side, selling 
protection on the other side. If those two transactions are 
within the same legal entity, they could be netted for purposes 
of managing the counterparty risk. If you split them apart, you 
end up having risk in both of those entities. I don't know how 
much that would actually create in terms of a loss of netting, 
but it would be a reasonably good-size amount.
    If you also then look at how much money will you have to 
put into a new standalone entity to make it creditworthy 
enough, that to me would be a very, very large number. And if 
anybody wants to be a significant swap dealer for high-yield 
and equity transactions, you would have to, I would think, have 
a swap dealer with multiple billion dollars' worth of capital 
that wouldn't otherwise be needed.
    Dr. Hayworth. So there are issues of ballasting, if you 
will, and stability when we talk about this, and that requires 
the deployment or the deferral, if you will, to other entities 
and a lot of capital that otherwise would be used in better 
ways by these banks?
    Mr. Voldstad. Because you are capitalizing a separate 
entity, you are creating extra capital that is needed. That 
extra capital could be used otherwise in the operations of the 
bank.
    Ms. Hayworth. Thank you, Mr. Voldstad, and all of our 
panel.
    Thank you, Mr. Chairman.
    Chairman Garrett. The gentlelady yields back.
    The gentleman from California.
    Mr. Sherman. Thank you.
    Are there any parties to these over-the-counter derivatives 
which are too-big-to-fail or too-interconnected-to-fail as AIG 
was? Is there any entity in the market today which, if they 
went completely bankrupt and paid zero dollars and zero cents 
to all creditors, would pose a systemic threat to the United 
States economy? I don't see a volunteer, so I will go with Mr. 
Bailey.
    Mr. Bailey. I believe that Dodd-Frank is, through the means 
of living wills and a variety of other provisions, recognizing 
that there are still risks in the system for interconnectivity 
across banks--
    Mr. Sherman. So until we either limit the size of the 
entities involved or we limit their participation in over-the-
counter derivatives, we, every day could come into this 
Congress and be told, oh, my God, we need another $7 billion in 
unmarked bills; is that the current situation?
    Mr. Bailey. I think part of--Dodd-Frank is attempting to 
make certain--
    Mr. Sherman. I know what it is attempting to do. I am 
asking, is it successful? Is there any entity in the market 
whose destruction tomorrow would imperil the U.S. or world 
economy? Is there anyone else with a firmer answer?
    Mr. Cawley. Let me just--one other way, Congressman, is to 
actually not limit participation or limit the--there is 
activity. One way which I think the Dodd-Frank Act does 
cleverly is to restructure the derivative itself. So, by making 
it--taking the leverage out of it and making it a little safer 
to trade--
    Mr. Sherman. So that makes it less likely that this 
problem--is anyone on this panel going to guarantee the United 
States Congress that is there is no one in the derivative 
markets today that we are going have to bail out tomorrow come 
hell or high water, no matter what? I don't see any hands. 
Let's go on to the next question.
    How do you anticipate the Department of Labor's withdrawal 
of their role on fiduciary duty under ERISA will impact the 
final role on business conduct standards for swap deals?
    Mr. Mason?
    Mr. Mason. I think there has been a perception that the 
fiduciary conflict between the Department of Labor rules and 
the business conduct rules has gone away with the withdrawal of 
the proposed fiduciary rules, and that is not the case. Under 
current law, current DOL law, if a swap dealer is required, as 
the proposed business conduct rules would do, is required to 
review the qualifications of a swap--of a plan's advisor, that 
would, under current ERISA law, make the swap dealer a 
fiduciary, which would mean all swaps with plans would have to 
cease.
    So the withdrawal took away other bases on which the swap 
dealer would become a fiduciary, but it left one under current 
law, and you don't need to die 3 times. It is enough to die 
once, and we, unfortunately would, not be able to enter into 
swaps.
    Mr. Sherman. I thank you for your answer.
    I thank the gentlelady from New York for her indulgence. I 
have to rush back to the Foreign Affairs Committee.
    Chairman Garrett. Does the gentleman yield to the 
gentlelady from New York?
    Mr. Sherman. I do yield to the gentlelady from New York so 
that she will have more than the 5 minutes that she would be 
entitled to otherwise.
    Mrs. Maloney. That is kind of you. Thank you for your 
question. It was an important one.
    I would like to ask all of you or anyone who would like to 
comment, how have companies in your industry improved their 
risk management practices since the financial crisis? What is 
different? What is improved in risk management specifically? 
Nothing?
    Mr. Bernardo. I can speak for the Wholesale Markets Brokers 
Association. We act as intermediaries, so we do not take risks. 
We are just matching buyers and sellers. We help facilitate 
trades, and we generate liquidity for the markets that we are 
speaking about, but all of our companies have invested 
previously and continue to invest hundreds of millions of 
dollars in technology to make these markets more efficient. So 
if certain products can be electronic, we make them electronic. 
We provide efficiencies for straight through processing, so 
once a trade is executed, we will send that trade 
electronically to the counterparties of the trade or send it 
off to a clearing. We even at this point in time send it to a 
swap--what you would consider a swap data repository in the 
future.
    Ms. Boultwood. May I make a comment? I think there has been 
significant advancement. I think there has been a natural 
movement in the market toward more clearing of products as 
cleared products have become available on exchanges. I think, 
to the point Mr. Bernardo made, there have been massive IT 
investments, and many companies have invested more in the 
analysis of their own liquidity risk in understanding the 
boundaries of their own balance sheet and how large their 
businesses can be become before they would be vulnerable to a 
large price swing.
    I want to make the point also that risk doesn't go away 
because we change the structure of the market; it simply 
changes form. So in saying that we want to move toward 
clearing, we may be reducing the amount of counterparty credit 
risk in a system, but we are increasing the amount of liquidity 
risk because we are increasing the amount of capital that would 
be posted and held aside in separate accounts as collateral or 
margin.
    We are increasing the amount of potential operational risk 
because we are centralizing where transactions occur in 
clearinghouses and exchanges. So the point is, unless we 
significantly curtail or eliminate business activity, you are 
not reducing--or you are not eliminating risk; you are simply 
changing its form.
    Chairman Garrett. Thank you. The gentlelady's time has 
expired.
    Mrs. Maloney. Could Mr. Bailey answer this, too, from his 
perspective? I am going into my next 5 minutes, right?
    Chairman Garrett. No.
    Mrs. Maloney. I am finished? Okay.
    Chairman Garrett. You are not finished, but you are a 
little bit over. And we have a few other Members who have yet 
to ask a question.
    So we will go to Mr. Hurt.
    Mr. Hurt. Thank you, Mr. Chairman.
    I thank you all for your testimony today and your 
appearance.
    Mr. Cawley, I wanted to explore with you what I thought was 
a very rousing defense of the taxpayer and of free markets. And 
so I am surprised to hear you also in the same breath talk 
about having the government come in and define these exchanges 
in such a way that, according to the other witnesses, will not 
lead to efficiency, will not lead to true price discovery; you 
have the government coming in saying, this is the way we want 
you to do it.
    At the same time, when you have, from my understanding, 
derivatives markets that have been migrating to clearing, which 
I think everybody seems to say is necessary to secure the 
marketplace, and then also reporting, these are things that 
seem to me there is universal agreement on. So why is it you 
think that the government is better positioned to be able to 
impose an exchange structure that somehow makes the market more 
efficient when we hear from both sides, buy and sell, that we 
don't want this? After you are finished, I would love to hear 
from Mr. Bernardo and Ms. Boultwood, as well.
    Mr. Cawley. We don't see a conflict between both points of 
view, but speaking specifically to government interaction in 
private markets, there is certainly precedence where those 
markets serve a systemic need or a prudential need. So we 
disagree, obviously, with most everybody here on the panel, but 
when we go out to speak to customers, who are the end-users of 
derivatives, when we speak to them, they tell us that they want 
to have a choice of execution. Now, we don't see a conflict 
with the rules that have been promulgated by the CFTC. We 
frankly don't see that. We see a choice there between central 
limit order books, which are anonymous. We see a choice there 
that if you want to use an RFQ, you can. You can use anonymous 
RFQ, and you can use regular RFQ. If you want to shield your 
identity to get a better price, you can execute on a central 
limit order book anonymously. We don't see a conflict with our 
restriction on voice hybrid broking because as I understand it 
and as we understand it and after having been a broker and a 
trader and being a hybrid broker and using its services, it is 
in context a central limit or wholesale market construct--let 
me explain that--where buyer and seller have the ability to 
cross the bid offer spread and thereby make savings.
    So, with regard to government interaction there, let me 
just say we see there is a systemic need because of liquidity--
    Mr. Hurt. Thank you. That is very helpful.
    Because my time is limited, I would like to allow Ms. 
Boultwood and Mr. Bernardo speak to the question of, okay, if 
you don't want this imposed on you because there are real 
consequences, real costs to having to have the exchange, the 
execution facility operate this way, please, what are those 
costs? I would like for us to--what are the costs of going with 
Dodd-Frank the way it is currently constructed and setting up 
these execution facilities that way?
    Mr. Bernardo. The CFTC rules are too prescriptive.
    Mr. Hurt. Could you speak into the microphone?
    Mr. Bernardo. The CFTC rules are too prescriptive. Again, 
if we use a real-world analogy, when we are talking about the 
RFQ, request for quote, and you are asking five people to send 
in a quote, if five of you indicated that you wanted to buy 
something at a certain price, that is going to indicate to the 
entire market, it is probably going higher, and you are going 
to give people the ability or the opportunity to get in front 
and push those markets higher.
    Now, if you were with someone who was willing to sell at 
that time, would you actually be willing to sell knowing that 
the market is going to immediately go against you? It wouldn't 
make sense; you wouldn't do that. Even if we talk about the 15-
second rule, which is also in there, why would somebody take 
risk and create uncertainty in the market when you are asking a 
buyer and the seller that we have matched up, we already have 
an executed trade, so you are allowing someone to offset risk, 
why would you then allow the market to view that price that 
something is going to trade at, again, to jump ahead of them 
and move the market in a direction?
    Mr. Hurt. Again, my time is running out.
    Ms. Boultwood, if you have any comment on that, I would 
appreciate it.
    Ms. Boultwood. Sure, with respect to the specific rule 
around SEFs, there are practical implications that really make 
the rules as currently drafted very impractical for an energy 
end-user in our market. Often, we are hedging in markets with 
less than five potential buyers or sellers. And that market is 
very--once they know you are selling, they will be on the other 
side of that sale looking for the price to go down and can wait 
or time your sale. We do not believe we will get the fair price 
for, as we do in today's market, for what we are selling the 
physical asset.
    And beyond SEF rules, I think what we are seeing is 
regulatory overreach, way beyond congressional intent. We all 
want the goal of transparency to be a point. That can be 
achieved through clearing and reporting, not by forcing all 
entities in the United States to become swap dealers.
    Mr. Hurt. Thank you. My time has expired. Thank you for 
your answers.
    Chairman Garrett. Mr. Canseco for 5 minutes.
    Mr. Canseco. Mr. Mason, the Dodd-Frank Act classified ERISA 
plans as a special entity, which could end up triggering 
fiduciary liability for swap dealer that wishes to enter into a 
transaction with such a plan. Given the historical role of swap 
dealers as near counterparties in transactions with ERISA 
plans, and the fact that the law already requires ERISA plans 
to hire fiduciary that has expertise in the area they are 
advising, does the new standard make sense for the swap dealer/
ERISA plan relationship?
    Mr. Mason. Absolutely not. I would say one point is that 
the creation of the concept of a special entity was supposed to 
identify entities that were not as capable as the swap dealer 
and thus needed more assistance with respect to entering into a 
swap. That has by law no application to ERISA plans. ERISA 
plans by law are required to hire a prudent expert in the field 
before they can enter into the swap world. So the idea that 
they need help from their counterparties, just simply doesn't 
make any sense. And that has been the consistent theme. We have 
talked to pension plans around the country, and the idea that 
they would ever look to their dealer for advice just is sort of 
beyond the pale. And by law, it really makes no sense.
    Mr. Canseco. So if a swap dealer were to be considered a 
fiduciary to an ERISA plan, that would preclude them from 
transacting any business with them, is that correct?
    Mr. Mason. That is absolutely correct.
    Mr. Canseco. So under Dodd-Frank law, and subsequent agency 
rulewriting, pension plans now would be unlikely to have the 
ability to use swap dealers to hedge risk in their portfolios; 
is that correct?
    Mr. Mason. That is correct.
    Mr. Canseco. And for millions of Americans who rely on 
income from pension plans, you would say that the special 
entity status conferred by ERISA plans in Dodd-Frank is not a 
good deal for them; is that correct?
    Mr. Mason. That is absolutely right.
    Mr. Canseco. Could you walk us again through a scenario 
where a pension plan is unable to use swaps to hedge their 
interest rate risk? And how would this affect their portfolio? 
And what alternative methods would they be forced to use?
    Mr. Mason. I was actually in a meeting, and I started 
giving a hypothetical. One of the people next to me was a chief 
investment officer for a company and jumped in and gave a real-
life example, so I will give her example. She was in a 
situation where her pension plan had $15 billion of assets, and 
$15 billion of liabilities. Interest rates dropped rather 
quickly 100 basis points. What that did to her liability is it 
took her liabilities from $15 billion to $17 billion. That 
created a $2 billion shortfall almost overnight. That would 
have required her and her company to fund approximately $250 
million a year for 7 years.
    The way that people use swaps is they use a swap to hedge 
against that possibility. In other words, by creating an asset, 
the swap, that in a perfectly hedged transaction, the swap 
would go up by the same $2 billion, so they would stay at 100 
percent funded. That is an enormously useful and popular tool 
to manage risk in a pension plan. If we didn't have it, you 
would have two choices. One is, you would have to reserve that 
$2 billion; take $2 billion out of operating assets and say, I 
am not using this to create jobs; I am not using this to invest 
in a company, but I am putting this aside because I might have 
a $2 billion liability over the next few years. That would 
obviously be disastrous.
    The other thing to do is to invest in bonds. The problem 
with investing in bonds--there are several problems. One, there 
are not enough of them to hedge these risks. They are not of 
the right duration. They have a lower yield. And if pension 
plans poured tens and hundreds of billion dollars into bonds, 
the bond yield would go down, further exacerbating this 
problem. So there is not currently an effective way to prevent 
that very frightening scenario, that $2 billion shortfall, 
under current law.
    Mr. Canseco. So the result would be that the pension plans 
would invest in less risk-averse assets and reducing future 
returns; is that correct?
    Mr. Mason. Absolutely.
    Mr. Canseco. I see that my time has expired, and I thank 
you very much.
    Chairman Garrett. The gentleman's time has expired.
    We have a question here from one of our Members who is out, 
so I ask unanimous consent to allow 2 more minutes from each 
side for questions, so, without objection, 2 more minutes to 
the other side, and then 2 minutes to answer this question that 
one of the other chairs of the other subcommittee asked that we 
ask and be done.
    Mrs. Maloney. I would like to ask the panelists to respond 
to the CFTC's 15-second rule. I have been getting comments on 
it. Can you describe what it is and why it is important?
    Mr. Bernardo. The 15-second rule is derived from the 
futures market, and it really isn't conducive with the OTC 
markets. In the OTC markets, again, you are talking about 
liquidity that is episodic; it is not liquid if trades are not 
happening every second. So 15 seconds in our markets is an 
eternity. Once you have a buyer and a seller that are matched 
at a certain price, you are then saying, 15 seconds, let's take 
a pause and let's let the rest of the market see where that is 
about to trade, which would allow other people, again, to front 
run or move the market in a certain direction, which would 
inevitably impact companies like Constellation when they are 
trying to do a trade. Again, it doesn't fit in with the OTC 
markets; it is being cut and pasted from the CFTC rules.
    Mrs. Maloney. And you are saying that 15 seconds is an 
eternity in the markets. Could you just explain to me how a 
company actually executes transactions? Why is 15 seconds an 
eternity in the markets? I think a day is an eternity in 
politics, but if 15 seconds is an eternity, I want to 
understand why it is an eternity.
    Mr. Bernardo. In these markets, you don't want to create 
unwanted uncertainty. There is no reason for it. So if you have 
a customer who rings in--so let's hypothetically say they ring 
in to me as a voice broker, and I have Barclays Bank on one 
side, and I have Goldman Sachs on the other side. And I am 
willing to execute--they are willing to execute at a certain 
price. Once they are willing to execute that trade, it has 
probably taken a long time to get us to that price they are 
willing to execute at. For us to then say, all right, guys, 
hold on, we are not going to execute at this price--we are 
going to execute at this price--we are going to let the rest of 
the market see what you want to do. If it is a big size trade, 
if it is a $1 billion trade or a $2 billion trade, if other 
people see that somebody is willing to buy at that level, it is 
going to go higher. So you would entice people to come in and 
front run and move the market up or move the market down. And 
again, us as intermediaries, we are not taking the risk, but it 
is going to impact the end-users, which is exactly what you 
don't want to do.
    Mrs. Maloney. In the proposed SEF Clarification Act, which 
would allow voice to clarify that there is voice, would you see 
that as an improvement or a rollback of the trading 
requirements of Dodd-Frank, or is it the same?
    Mr. Bernardo. Voice is part of any means of interstate 
commerce. Congress had the opportunity to say we wanted to be 
fully electronic in an exchange like trading, but they realized 
a lot of these products don't necessarily trade fully 
electronic. You need multiple modes of execution. You need to 
be able to trade by voice. You need to be able to trade via a 
hybrid platform. So you are allowing flexibility. And along 
with the flexibility, you are allowing innovation. My company, 
Tullett Prebon, as well as the other members of the Wholesale 
Markets Brokers Association innovate in these markets. We 
created other systems before legislation even came about. So we 
have auction platforms. We have risk-mitigation tools. We have 
a lot of things that would be ruled out if we kept the 
legislation as it currently is.
    Chairman Garrett. Thank you.
    Mrs. Maloney. Thank you, Mr. Chairman.
    Chairman Garrett. I think I just started something here. By 
allowing that now to go over about a minute and 30 seconds, I 
have another request on the other side. So I will yield my--I 
will be brief on my 2 minutes and maybe just wrap this up.
    Mrs. Biggert asks, there has been discussion about the need 
for swaps definition to exclude instruments and products, such 
as those used by the insurance industry, for example, those 
that mitigate risk of life insurance products, which did not 
cause a financial crisis. Why are narrow swap definitions 
important? What can the impact of a broad definition have on 
insurance consumers, pension plans, and other low-risk 
financial end-users?
    Mr. Mason?
    Mr. Mason. I can speak to one. Probably the most popular 
investment in a 401(k) plan is a stable value fund, which is 
really--it is similar in some ways to a money market fund, 
capital preservation, but with a higher rate of return. Because 
of the sort of extreme breadth of the definition of a swap and 
sort of lack of clarity, there is a concern the stable value 
contracts would be treated as swaps. The SEC and the CFTC are 
studying that. If they are classified as swaps, the regulatory 
structure doesn't fit. It would drive costs so far up that this 
investment, which is the most popular investment in 401(k) 
plans, would simply be wiped out.
    Chairman Garrett. Got it.
    I yield the remainder of my time to the gentleman from New 
Mexico.
    Mr. Pearce. Thank you, Mr. Chairman. I will use all 40 
seconds wisely.
    Mr. Cawley, I find myself nodding in agreement with a lot 
of what you say; no more bailouts, government shouldn't be 
picking winners and losers. I would like to drill down a little 
bit on the intervention of the government should not intervene. 
Yet, at the end of your testimony, you say that we should get 
out of the intervening business from Congress, throw the two 
bills out, and immediately request the finalization of 
clearing, execution, and trade reports done by the regulators. 
Now, the regulators are saying that we can't use the telephone 
trades, but we can use electronic trades. So you don't favor 
intervention in the first party or anything, or favor the 
intervention to not allow the competitors to your business. Is 
that--am I misreading?
    Mr. Cawley. It is a good question. Let me be clear, we 
don't favor intervention, but we recognize that there is a need 
under certain circumstances for intervention. We would love as 
free marketeers to have no government intervention. We 
recognize that in certain instances, the government is required 
to step in to maintain the stability of the economy. And we 
certainly saw that, whether some of us liked it or disliked it, 
we certainly saw that back in 2008, and hopefully, we won't see 
that again.
    We recognize that government intervention is sometimes 
necessary, and the test then is, is the systemic test that goes 
into that is, what would require the government through its 
agencies to intervene either directly or indirectly?
    Within the context of execution, and I think this debate 
has really fallen down to one thing, if I can be blunt, and 
that is the RFQ for five. We see that within--we don't see a 
conflict, first of all, when we see government coming in 
through the CFTC or the SEC to say, we view this as 
systemically important to the execution of contracts, not just 
the clearing of contracts, but the execution of contracts and 
the notion of transparency, pre-trade transparency and post-
trade transparency.
    Now, ideally, it is my own personal opinion that pre-trade 
transparency is not met by the RFQ scenario, simply put 
because, as Shawn has mentioned, you cannot have several people 
once that bidder offer is exposed, only one person can hit it. 
With that said, we do recognize that in certain market 
contexts, certainly credit default swaps--less so indices and 
less so interest rate swaps--but certainly credit default 
swaps, the idea of having RFQ certainly works.
    We do say that we see no tension and no discord between 
either rule sets promulgated that deny a voice broker from 
interacting with a trade, so long as that trade has some 
modicum of pre-trade transparency. That operates, Congressman, 
with lots of OTC markets, with lots of products that tell it 
and other firms that his organization trade and also that they 
may trade today.
    Chairman Garrett. Since these answers are going much longer 
than we thought, is there any objection to giving the final 
word to Mr. Canseco for 1 minute?
    Mr. Canseco. Thank you, Mr. Chairman.
    Again, I want to go back to Mr. Mason. Some have labeled 
ERISA employee benefit plans as high-risk financial entities 
that should be subject to initial margin and daily variation 
margins. What is your opinion of that classification?
    Mr. Mason. It was, in our mind, simply a mistake. We are 
being classified with hedge funds. ERISA plans cannot go 
bankrupt. Even if the plan sponsor goes bankrupt, the PBGC 
steps in and honors our swap liabilities. We are not operating 
companies. In fact, in all the discussions we have had, with 
dealers and companies, and we sort of talked to a wide range of 
folks who are integral to this business, we have never heard of 
any pension plan ever failing to pay off its swap liabilities. 
So for us to be treated as high-risk financial end-users, we 
think, and based on conversations with some of the regulators, 
was simply an oversight. But it is a very dangerous oversight 
and needs to be corrected because it would create enormous 
costs and real risk for pension plans. Our folks are telling us 
they would have to cut back their risk mitigation strategies, 
and that is not what we want.
    Mr. Canseco. Thank you very much, Mr. Mason.
    Chairman Garrett. I thank you for yielding back. I thank 
all the members of the panel.
    And I thank everyone here on the committee.
    Before you leave, I ask unanimous consent to insert into 
the record the following statements: the Commodity Market 
Council; the Coalition for Derivatives End-Users; and the 
American Bankers Association.
    Also, there were letters I referenced earlier today in 
support of the legislation: Chatham Financial; ICI Investment 
Company Institute; and last but not least, BlackRock. Without 
objection, it is so ordered.
    And again, I thank the members of the panel.
    The Chair notes that some members may have additional 
questions for these witnesses which they may wish to submit in 
writing. Without objection, the record will remain open for 30 
days for members to submit written questions to these witnesse 
and to place their responses in the record. And if it is done, 
as always, we appreciate your response to those.
    With that, the committee is adjourned. Good day.
    [Whereupon, at 12:00 p.m., the hearing was adjourned.]

                            A P P E N D I X



                            October 14, 2011

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