[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]
HEARING TO REVIEW H.R. 3283, H.R. 1838, AND H.R. 4235
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
GENERAL FARM COMMODITIES
AND RISK MANAGEMENT
OF THE
COMMITTEE ON AGRICULTURE
HOUSE OF REPRESENTATIVES
ONE HUNDRED TWELFTH CONGRESS
SECOND SESSION
__________
MARCH 28, 2012
__________
Serial No. 112-33
Printed for the use of the Committee on Agriculture
agriculture.house.gov
----------
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COMMITTEE ON AGRICULTURE
FRANK D. LUCAS, Oklahoma, Chairman
BOB GOODLATTE, Virginia, COLLIN C. PETERSON, Minnesota,
Vice Chairman Ranking Minority Member
TIMOTHY V. JOHNSON, Illinois TIM HOLDEN, Pennsylvania
STEVE KING, Iowa MIKE McINTYRE, North Carolina
RANDY NEUGEBAUER, Texas LEONARD L. BOSWELL, Iowa
K. MICHAEL CONAWAY, Texas JOE BACA, California
JEFF FORTENBERRY, Nebraska DENNIS A. CARDOZA, California
JEAN SCHMIDT, Ohio DAVID SCOTT, Georgia
GLENN THOMPSON, Pennsylvania HENRY CUELLAR, Texas
THOMAS J. ROONEY, Florida JIM COSTA, California
MARLIN A. STUTZMAN, Indiana TIMOTHY J. WALZ, Minnesota
BOB GIBBS, Ohio KURT SCHRADER, Oregon
AUSTIN SCOTT, Georgia LARRY KISSELL, North Carolina
SCOTT R. TIPTON, Colorado WILLIAM L. OWENS, New York
STEVE SOUTHERLAND II, Florida CHELLIE PINGREE, Maine
ERIC A. ``RICK'' CRAWFORD, Arkansas JOE COURTNEY, Connecticut
MARTHA ROBY, Alabama PETER WELCH, Vermont
TIM HUELSKAMP, Kansas MARCIA L. FUDGE, Ohio
SCOTT DesJARLAIS, Tennessee GREGORIO KILILI CAMACHO SABLAN,
RENEE L. ELLMERS, North Carolina Northern Mariana Islands
CHRISTOPHER P. GIBSON, New York TERRI A. SEWELL, Alabama
RANDY HULTGREN, Illinois JAMES P. McGOVERN, Massachusetts
VICKY HARTZLER, Missouri
ROBERT T. SCHILLING, Illinois
REID J. RIBBLE, Wisconsin
KRISTI L. NOEM, South Dakota
______
Professional Staff
Nicole Scott, Staff Director
Kevin J. Kramp, Chief Counsel
Tamara Hinton, Communications Director
Robert L. Larew, Minority Staff Director
______
Subcommittee on General Farm Commodities and Risk Management
K. MICHAEL CONAWAY, Texas, Chairman
STEVE KING, Iowa LEONARD L. BOSWELL, Iowa, Ranking
RANDY NEUGEBAUER, Texas Minority Member
JEAN SCHMIDT, Ohio MIKE McINTYRE, North Carolina
BOB GIBBS, Ohio TIMOTHY J. WALZ, Minnesota
AUSTIN SCOTT, Georgia LARRY KISSELL, North Carolina
ERIC A. ``RICK'' CRAWFORD, Arkansas JAMES P. McGOVERN, Massachusetts
MARTHA ROBY, Alabama DENNIS A. CARDOZA, California
TIM HUELSKAMP, Kansas DAVID SCOTT, Georgia
RENEE L. ELLMERS, North Carolina JOE COURTNEY, Connecticut
CHRISTOPHER P. GIBSON, New York PETER WELCH, Vermont
RANDY HULTGREN, Illinois TERRI A. SEWELL, Alabama
VICKY HARTZLER, Missouri
ROBERT T. SCHILLING, Illinois
Matt Schertz, Subcommittee Staff Director
(ii)
C O N T E N T S
----------
Page
Boswell, Hon. Leonard L., a Representative in Congress from Iowa,
opening statement.............................................. 21
Prepared statement........................................... 23
Conaway, Hon. K. Michael, a Representative in Congress from
Texas, opening statement....................................... 1
Prepared statement........................................... 2
Submitted legislation........................................ 4
Witnesses
Vice, Charles A., President and Chief Operating Officer,
IntercontinentalExchange, Inc., Atlanta, GA.................... 23
Prepared statement........................................... 24
Saltzman, Paul, President, The Clearing House Association L.L.C.;
Executive Vice President and General Counsel, The Clearing
House Payments Company L.L.C., New York, NY.................... 26
Prepared statement........................................... 28
Bailey, Keith A., Managing Director, Fixed Income, Currencies and
Commodities Division, Barclays Capital, New York, NY; on behalf
of Institute of International Bankers.......................... 33
Prepared statement........................................... 36
Bodson, Michael C., Chief Operating Officer, Depository Trust &
Clearing Corporation, New York, NY............................. 40
Prepared statement........................................... 42
Submitted letter............................................. 61
HEARING TO REVIEW H.R. 3283, H.R. 1838, AND H.R. 4235
----------
WEDNESDAY, MARCH 28, 2012
House of Representatives,
Subcommittee on General Farm Commodities and Risk
Management,
Committee on Agriculture,
Washington, D.C.
The Subcommittee met, pursuant to call, at 10:30 a.m., in
Room 1300 of the Longworth House Office Building, Hon. K.
Michael Conaway [Chairman of the Subcommittee] presiding.
Members present: Representatives Conaway, Neugebauer,
Crawford, Huelskamp, Ellmers, Hultgren, Hartzler, Schilling,
Boswell, McGovern, Scott, Sewell, and Peterson (ex officio)
Staff present: Tamara Hinton, Kevin Kramp, Ryan McKee, John
Porter, Debbie Smith, Heather Vaughan, Suzanne Watson, Liz
Friedlander, C. Clark Ogilvie, John Konya, and Jamie Mitchell.
OPENING STATEMENT OF HON. K. MICHAEL CONAWAY, A REPRESENTATIVE
IN CONGRESS FROM TEXAS
The Chairman. Good morning. I call this hearing of the
Subcommittee on General Farm Commodities and Risk Management to
review H.R. 3283, the Swap Jurisdiction Certainty Act, H.R.
1838 to repeal section 716 of the Dodd-Frank, and H.R. 4235,
the ``Swap Data Repository and Clearinghouse Indemnification
Correction Act of 2012,'' to come to order.
Well, good morning, and I want to thank all of you for
joining us. I would like to extend a warm welcome to our
panelists today, Mr. Chuck Vice of IntercontinentalExchange;
Mr. Paul Saltzman of The Clearing House; Mr. Keith Bailey,
Barclays Capital; and Michael Bodson, The Depository Trust &
Clearing Corporation. Gentlemen, thank you for being here. I
appreciate your time to come this morning and share your views
with the Committee and have a chance to have your thumbs
screwed to the table and grill you under hot lights. I am just
kidding.
Today's meeting of the General Farm Commodities and Risk
Management Subcommittee continues a series of hearings aimed at
examining and correcting some of the problems that have arisen
as regulators have worked through the Dodd-Frank rulemaking
process. To the surprise of almost no one in this room except
perhaps us here on the dais, Congress passed an imperfect bill.
That is right. You heard it here last. The Dodd-Frank bill has
some mistakes in it. That is about as funny as this CPA is
going to get so feel free to just have raucous laughter. There
you go, I appreciate you sucking up to the chair.
Fortunately, two of the bills we are going to examine today
are bipartisan solutions that will strengthen the underlying
bill and reduce the unintended consequences of poorly vetted
provisions and a third will provide clarity regarding the reach
of Dodd-Frank to activities that occur outside the United
States.
Our first bill, the ``Swap Data Repository and
Clearinghouse Indemnification Act,'' will remove requirements
from Dodd-Frank that foreign regulators indemnify U.S. swap
data repositories for any losses arising from the misuse of
information the regulator requests from the SDR. And I thank
you to both Ms. Sewell and Mr. Crawford--they are not here--for
leading on this important issue.
Our second bill is the Swap Jurisdiction Certainty Act.
This bill will provide clarity consistent with the
Congressional intent regarding the territorial reach of Dodd-
Frank provided this certainty will not only help market
participants prepare for the new regulations but it will
support coordination and organization with our international
counterparts.
And finally, we will examine H.R. 1838, which modifies
Section 718 of Dodd-Frank. Section 718 has the factor requiring
banks to push some of their swap activities into separate
standalone affiliates. H.R. 1838 would narrow the class of
swaps covered by the rule to assure that the intent of
segregating the riskiest swaps from a bank's balance sheet does
not have the unintended consequence of needlessly diverting
capital and introducing additional systemic risks.
As has been said many times, getting Dodd-Frank right is
more important than getting it done quickly. Part of that means
that Congress can never become complacent with its own
handiwork. Our work did not end when it was signed into law by
the President. Examining the rulemaking process for errors,
unfinished instructions, and unintended consequences, and then
fixing the mistakes is an essential part of our job.
I want to thank all Members of the Subcommittee on both
sides of the aisle for their continued commitment to good
oversight, support that Dodd-Frank, irrespective of our
ideological differences, is implemented in a way that is
logical, fair, and beneficial for the participants who depend
on the financial markets. The three bills we are discussing
today each improve Dodd-Frank in meaningful ways.
Finally, I want to again thank today's witnesses for their
time. We on the Committee appreciate the opportunity to
understand the unique perspectives each bring to this financial
reform process.
[The prepared statement of Mr. Conaway follows:]
Prepared Statement of Hon. K. Michael Conaway, a Representative in
Congress from Texas
Good morning, thank you all for joining us. I would like to extend
a warm welcome to our panelists today: Mr. Charles Vice of
IntercontinentalExchange; Mr. Paul Saltzman of The Clearing House; Mr.
Keith Bailey of Barclays Capital; and Mr. Michael Bodson of the
Depository Trust & Clearing Corporation.
Thank you each for taking the time to come to our Committee, to
share your views, and to answer our questions.
Today's meeting of the General Farm Commodities and Risk Management
Subcommittee continues a series of hearings aimed at examining and
correcting some of the problems that have arisen as regulators have
worked through the Dodd-Frank rulemaking process.
To the surprise of almost no one in this room--except perhaps to us
up here on the dais--Congress passed an imperfect bill. That's right,
you heard it hear last, Dodd-Frank has some mistakes.
Fortunately, two of the bills we are going to examine today are
bipartisan solutions that will strengthen the underlying bill and
reduce the unintended consequences of poorly vetted provisions; and a
third will provide clarity regarding the reach of Dodd-Frank to
activities that occur outside the U.S.
Our first bill, the ``Swap Data Repository and Clearinghouse
Indemnification Act,'' will remove requirements from Dodd-Frank that
foreign regulators indemnify U.S. swap data repositories for any losses
arising from the misuse of information the regulator requests from the
SDR. Thank you to both Ms. Sewell and Mr. Crawford for leading on this
important issue.
Our second bill is the ``Swap Jurisdiction Certainty Act.'' This
bill will provide clarity, consistent with Congressional intent,
regarding the territorial reach of Dodd-Frank. Providing this certainty
will not only help market participants prepare for the new regulations,
but it will support coordination and harmonization with our
international counterparts.
Finally, we will examine H.R. 1838, which modifies Section 716 of
Dodd-Frank. Section 716 has the effect of requiring banks to push some
of their swap activities into separate, stand-alone affiliates. H.R.
1838 would narrow the class of swaps covered by the rule, to ensure the
intent of segregating the riskiest swaps from a bank's balance sheet
does not have the unintended consequence of needlessly diverting
capital or introducing additional systemic risk.
As I have said many times, getting Dodd-Frank right is more
important than getting it done quickly. Part of that means that
Congress can never become complacent with its own handiwork; our work
did not end when this law was signed by the President. Examining the
rulemaking process for errors, unclear instructions, or unintended
consequences, and then fixing the mistakes is an essential part of our
job.
I want to thank all the Members of this Subcommittee, on both sides
of the aisle, for their continued commitment to good oversight. It is
important that Dodd-Frank, irrespective of our ideological differences,
is implemented in a way that is logical, fair, and beneficial for the
participants who depend on the financial markets. The three bills we
are discussing today each improve Dodd-Frank in meaningful ways.
Finally, I would like to again thank today's witnesses for their
time; we on the Committee appreciate the opportunity to understand the
unique perspectives each of you have on financial reform.
With that, I will turn to our Ranking Member, Mr. Boswell, for his
opening remarks and then to our witnesses for their thoughts on how we
can continue to improve Dodd-Frank.
Legislation
H.R. 3283, Swap Jurisdiction Certainty Act
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
H.R. 1838, To repeal a provision of the Dodd-Frank Wall Street Reform
and Consumer Protection Act prohibiting any Federal bailout of
swap dealers or participants.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
H.R. 4235, To amend the Securities Exchange Act of 1934 and the
Commodity Exchange Act to repeal the indemnification
requirements for regulatory authorities to obtain access to
swap data required to be provided by swaps entities under such
Acts.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
The Chairman. I would like to turn to my Ranking Member and
good friend, Mr. Boswell, for his opening remarks.
OPENING STATEMENT OF HON. LEONARD L. BOSWELL, A REPRESENTATIVE
IN CONGRESS FROM IOWA
Mr. Boswell. Well, thank you, Mr. Chairman.
It is preliminary for my short remarks here, but we don't
always agree. It is kind of interesting for us, the
relationship, because I like you. That is my attempt at
responding to humor but, no, it is true. I do like this man and
I know something about where he comes from; I know something
about the territory down there. I don't know if I have ever
told you I was a roughneck in the oilfields just north of
Monahans when I was a young man.
The Chairman. Let me see all five fingers. You got them
all?
Mr. Boswell. I got them all.
The Chairman. All right, good.
Mr. Boswell. And I did lee tones, I did backups, I did the
tower and it was an old standard tower where I got up there and
I was a youngster, and the old driller had me up there and he
said after--you know what I am talking about.
The Chairman. Yes.
Mr. Boswell. Yes. I bet you haven't done it but I bet you
know what I am talking about.
The Chairman. Au contraire.
Mr. Boswell. Okay.
The Chairman. I spent summers roughnecking for Parker
Drilling Company and Sharpe Drilling Company----
Mr. Boswell. Okay.
The Chairman.--and I still have all my fingers.
Mr. Boswell. Anyway, we are up in the tower and the well
was about to come in. It was the old standard tower before the
jackknives. I am kind of remembering the lingo here a little
bit. And so I was substituting for people going on vacation.
That was what my--the guy in the tower. I was a little nervous
about it. I didn't mind heights and that kind of helped later
on. I got into aviation, flying airplanes, and jumping out of
airplanes. But there I was up in the standard tower way up
there. And we were going to take the pipe out and change the
bit, going to be up there a while and so I finally asked. I
said what happens if there is a fire--because they kept telling
us about safety. Oh, he said. I was going to tell you that just
before I left and he showed me that little piece of cable with
the handles on it and that cable went way out to a stake. He
said if something happens, he said, your only escape is to wrap
that thing around that cable, grab those handles, and you are
going to slide down that and you are going to slow your speed
down by putting pressure on it. He said we don't have time for
you to practice. That was a sobering moment for a guy who was
not quite 18 years old.
The Chairman. Well, but you would have been motivated to do
it. It was called the Geronimo line and it is politically
incorrect today to call it that but----
Mr. Boswell. Yes. Well, anyway. So I do thank you for the
little dialogue there, but that is a little background.
And I want to thank our witnesses and everyone for joining
us today as we review the implementation of Dodd-Frank Wall
Street Reform Act, global derivatives, and so on. I am proud to
say that this Committee is genuinely the more bipartisan
operation in the House of Representatives and I think you have
just seen the reason why.
In this effort, Chairman Conaway and I have introduced
legislation not for today but legislation I hope makes it to
the House floor for passage, H.R. 1840, which would improve
cost-benefit analysis and operations of the CFTC.
Agricultural and the financial markets have a unique
relationship that we need to be reminded of more regularly.
Since the passage of Dodd-Frank, I have been wanting the change
in this bill and the regulations surrounding it to ensure that
farmers, producers, and their communities are not hurt by
another financial market crisis.
I think it is clear to financiers that the hedging risk is
a critical aspect of running a successful farm operation and
doing so is good business for rural cooperatives and banks and
producer communities. However, we must remind ourselves that
not only does the integrity of our financial market impact our
commodities but that our financial market relies on the
commodities that hard-working Americans produce. Without them,
there would be no basis for the derivatives traded among our
banking institutions today.
The market was created in the heartland to improve the
commodity market and preserve the value of both commodities and
seasonal goods in the face of unforeseeable risks such as
drought and flooding. This reliance and the integrity of our
markets are critical to our nation for jobs, a healthy economy,
and affordable food. Distortions of commodity values in trading
have a negative impact on our long-term economic outlook and
often place unfair costs on commodity consumers such as the
speculation on Wall Street that some of us think raises gas
prices on consumers.
I hope that we can have a healthy discussion of these
issues and that your testimony here will improve functions in
Congress and add to our understanding of the legislation before
us. So I look forward to hearing the coming testimonies and
working with you to ensure fair and practical implementation
both at home and with our global partners on behalf of American
taxpayers.
And I would say in closing that Dodd-Frank is not perfect.
I think we all knew that when we started out. And it wasn't
done overnight. A lot of pressure was on and I watched closely
as this Committee and the Finance Committee worked on that for
months, just not perfect. And I thought we all would surely
expect some tweaking as the rubber hits the road and we get out
there and put it in force. And that is what I am very willing
to do. Other major legislation has required that so why
wouldn't we expect this? But we don't want the debacle that
happened that caused us to do that extensive review to happen
again if we can prevent it.
So with that again, Mr. Chairman, thank you so much and I
look forward to the hearing.
[The prepared statement of Mr. Boswell follows:]
Prepared Statement of Hon. Leonard L. Boswell, a Representative in
Congress from Iowa
Thank you, Chairman Conaway. I would like to thank our witnesses
and everyone for joining us today as we review implementation of the
Dodd-Frank Wall Street Reform Act and global derivatives reform.
I'm proud to say that this Committee is generally one of our more
bipartisan operations in the House of Representatives. In this effort,
Chairman Conaway and I have introduced legislation not before you
today, but legislation that I hope makes it to the House floor for
passage, H.R. 1840, which would improve cost-benefit analysis and
operations at the CFTC.
Agriculture and the financial markets have a unique relationship
that we need to be reminded of more regularly. Since the passage of
Dodd Frank, I have been monitoring the changes to this bill and the
regulations surrounding it to ensure that farmers, producers, and their
communities are not hurt by another financial market crisis.
I think it is clear to financiers that the hedging risk is a
critical aspect of running a successful farm operation, and doing so is
good business for rural cooperatives and banks in producer communities.
However, we must remind ourselves that, not only does the integrity
of our financial market impact our commodities, but that our financial
market relies on the commodities that hard working Americans produce.
Without them, there would be no basis for the derivatives traded among
our banking institutions today. The market was created in the heartland
to improve the commodity market, and preserve the value of bulk
commodities and seasonal goods in the face of unforeseeable risk such
as drought and flooding.
This reliance and the integrity of our markets are critical to our
nation for jobs, a healthy economy, and affordable food. Distortions of
commodity values in trading have a negative impact on our long term
economic outlook, and often place unfair costs on commodity consumers--
such as the speculation on Wall Street that raises gas prices on
consumers.
I hope that we can have a healthy discussion on these issues and
that your testimony here will improve functions in Congress and add to
our understanding of the legislation before us.
I look forward to hearing the coming testimonies and working with
you to ensure fair and practical implementation both at home and with
our global partners on behalf of American taxpayers.
Thank you.
The Chairman. I would like to thank the Ranking Member and
remind that the chair has requested other Members to submit
their opening statements for the record so the witnesses may
begin their testimony to ensure that there is ample time for
questions.
I would like to introduce our panel now. First up will be
Mr. Chuck Vice, President, Chief Operating Officer,
IntercontinentalExchange, Atlanta, Georgia; Mr. Paul Saltzman,
President of The Clearing House Association, L.L.C., Executive
Vice President and General Counsel, The Clearing House Payments
Company, L.L.C., New York, New York; Mr. Keith Bailey, Managing
Director, Fixed Income, Currencies and Commodities Division,
Barclays Capital, on behalf of the Institute of International
Bankers, New York, New York; and Mr. Michael Bodson, COO of The
Depository Trust & Clearing Corporation, New York, New York.
Thank you, gentlemen.
Mr. Vice, 5 minutes.
STATEMENT OF CHARLES A. VICE, PRESIDENT AND CHIEF
OPERATING OFFICER, IntercontinentalExchange, INC.,
ATLANTA, GA
Mr. Vice. Chairman Conaway, Ranking Member Boswell, my name
is Chuck Vice. I am President and Chief Operating Officer at
ICE. I appreciate the opportunity to appear before you today to
testify on the extraterritorial application of the Dodd-Frank
Wall Street Reform and Consumer Protection Act, and in
particular, the Swap Jurisdiction Certainty Act and ``Swap Data
Repository and Clearinghouse Indemnification Correction Act of
2012.''
Since the launch of our Atlanta-based electronic OTC energy
marketplace in 2000, ICE has expanded both in the United States
and internationally. Over the past 10 years, ICE has acquired
or founded derivative exchanges and clearinghouses in the
United States, the UK, and Canada. As such, ICE is uniquely
impacted by the financial reform efforts in the United States
and abroad.
ICE has been supportive of the global financial reform
efforts. Appropriate regulation of derivatives is of utmost
importance to the financial system. However, the broad mandates
of the Dodd-Frank Act create great uncertainty for
international transactions and global businesses. While the
CFTC and SEC have issued dozens of proposed and final
regulations implementing the Dodd-Frank Act to date neither
agency has defined what activity has a direct and significant
impact on the United States. In particular, many of the CFTC's
final rules require ICE to come into compliance without knowing
whether our business is within the scope of Dodd-Frank.
Therefore, ICE welcomes the introduction of H.R. 3283, the
Swap Jurisdiction Certainty Act, which would make two important
clarifications to Dodd-Frank by defining U.S. person and non-
U.S. person and by clarifying the applicability of Dodd-Frank
requirements on international transactions. ICE believes that
H.R. 3283 is an important step toward redefining what
transactions and participants are subject to Dodd-Frank.
In addition, I support the introduction of H.R. 4235, the
``Swap Data Repository and Clearinghouse Indemnification Act.''
One of ICE's subsidiaries, Trade Vault, has applied for
registration with the CFTC as a Swap Data Repository, or SDR.
Section 728 of Dodd-Frank requires foreign regulators to
indemnify an SDR for any expenses resulting from litigation for
data provided by the SDR to the foreign regulator. ICE believes
that this provision is an error as most foreign regulators
would be legally unable to indemnify an SDR. This would result
in forcing an SDR to create separate subsidiaries in other
countries to provide swaps transparency to foreign regulators.
ICE has always been and continues to be a strong proponent
of open and competitive markets and appreciates the opportunity
to work closely with Congress and regulators in the United
States and abroad to address the evolving regulatory challenges
presented by derivatives market.
Mr. Chairman, thank you for the opportunity to share our
views with you. I would be happy to answer any questions.
[The prepared statement of Mr. Vice follows:]
Prepared Statement of Charles A. Vice, President and Chief Operating
Officer, IntercontinentalExchange, Inc., Atlanta, GA
Chairman Conaway, Ranking Member Boswell, I am Chuck Vice,
President and Chief Operating Officer of IntercontinentalExchange,
Inc., (ICE). I appreciate the opportunity to appear before you today to
testify on the extraterritorial application of the Dodd-Frank Wall
Street Reform and Consumer Protection Act and in particular, the ``Swap
Jurisdiction Certainty Act'' and the ``Swap Data Repository and
Clearinghouse Indemnification Correction Act of 2012.''
Background
Since the launch of its Atlanta, Georgia based electronic OTC
energy marketplace in 2000, ICE has expanded both in the U.S. and
internationally. Over the past 10 years, ICE has acquired or founded
three derivatives exchanges and five clearing houses in the U.S., the
UK, Brazil and Canada. Through our global operations, ICE's exchanges
or clearing houses are directly regulated by the UK Financial Services
Authority (FSA), the U.S. Commodity Futures Trading Commission (CFTC),
the Securities and Exchange Commission (SEC) and the Manitoba
Securities Commission. In addition, each exchange and clearing house is
subject to lesser regulation or registration requirements with dozens
of other jurisdictions. As such, ICE is uniquely impacted by the
financial reforms efforts in the U.S. and abroad.
ICE has been supportive of the global financial reform efforts.
Appropriate regulation of derivatives is of utmost importance to the
financial system. ICE believes that increased transparency and proper
risk and capital management, coupled with legal and regulatory
certainty, are central to reform and to restoring confidence to these
vital markets.
However, regulators need clear lines of jurisdiction. Regulators
need certainty that they have the power to take actions to uphold the
public good. Likewise, market participants need the certainty that
their business transactions will not be held to conflicting standards
of conduct. Further, regulatory certainty eliminates the possibility of
regulatory arbitrage, or long-term damage to the competitiveness of the
U.S. in a highly competitive global environment.
The need for certainty extends beyond U.S. borders. It is vital to
recognize that the derivatives markets are international: the majority
of the large companies globally use derivatives, and they conduct these
transactions with U.S. counterparties. Thus, U.S. regulators must work
with international regulators from a common set of regulatory
principles. With this comes the recognition that no single country can
regulate the entire global derivatives market.
The Unclear Extraterritorial Application of Dodd-Frank Creates
Uncertainty
Unfortunately, the broad mandates of the Dodd-Frank Act create
great uncertainty for international transactions and global businesses.
The sole recognition of applicability of Dodd-Frank to international
transactions is in Section 722 of Dodd-Frank which states ``[t]he
provisions of this Act relating to swaps that were enacted by the Wall
Street Transparency and Accountability Act of 2010 . . . shall not
apply to activities outside the United States unless those activities:
(1) have a direct and significant connection with activities in, or
effect on, commerce of the United States, or
(2) contravene such rules or regulations as the Commission may
prescribe . . . or to prevent the evasion of any provision of
this Act . . .''
While the CFTC and SEC have issued dozens of proposed and final
regulations implementing the Dodd-Frank Act, to date, neither agency
has defined what activity has a direct and significant impact on the
United States. In particular, many of the CFTC's final rules require
ICE to come into compliance without ICE knowing whether our business is
within the scope of Dodd-Frank. For example, our UK-based clearing
house, ICE Clear Europe operates as a UK regulated Recognized Clearing
House and a U.S. CFTC regulated Derivatives Clearing Organization and
SEC regulated Clearing Agency. ICE Clear Europe clears European and
Asian energy contracts which have little to no U.S. participation.
However, it is unclear to ICE whether Dodd-Frank will apply to these
transactions, even though the U.S. connection is negligible. Moreover,
as an illustration of the complication of overlapping regulators, ICE
Clear Europe is expected to seek approval for energy swaps from UK FSA,
the CFTC and the SEC. Having to file approvals to clear swaps with
three primary regulators, including one, the SEC, with no expertise in
energy derivatives, hampers Dodd-Frank by making clearing swaps much
more difficult for a clearing house.
Before Dodd-Frank, this overlap in regulation was not the case.
Since 1984, Section 4(b) of the Commodity Exchange Act expressly
excluded foreign transactions from CFTC jurisdiction. The CFTC relied
on foreign regulators to regulate foreign transactions and worked with
regulators to adopt common principles that all regulated markets should
adopt. This approach was very successful, as it led to greater
harmonization of regulation, yet allowed foreign regulators to oversee
their institutions. Importantly, many of the key goals of Dodd-Frank,
such as swaps clearing and electronic trading, originally came from
foreign markets.\1\
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\1\ EUREX pioneered electronic trading and the London Clearing
House founded SwapsClear, an early clearing solution for OTC
derivatives.
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H.R. 3283, the Swap Jurisdiction Certainty Act
ICE welcomes the introduction of H.R. 3283, the Swaps Jurisdiction
Certainty Act, which would make two important clarifications to Dodd-
Frank by defining U.S. person and non-U.S. person and by clarifying the
applicability of Dodd-Frank requirements on international transactions.
ICE believes that H.R. 3283 is an important step forward to defining
what transactions and participants are subject to Dodd-Frank.
``Swap Data Repository and Clearinghouse Indemnification Correction Act
of 2012''
ICE also welcomes the introduction H.R. 4235, the ``Swap Data
Repository and Clearinghouse Indemnification Correction Act of 2012.''
One of ICE's subsidiaries, Trade Vault, has applied for registration
with the CFTC as a Swap Data Repository (SDR). Section 728 of Dodd-
Frank requires foreign regulators to indemnify a SDR for any expenses
resulting from litigation for data provided by the SDR to the foreign
regulator. ICE believes that this provision is in error as most foreign
regulators would be legally unable to indemnify a SDR. This would
result in forcing an SDR to create separate subsidiaries in other
countries to provide swaps transparency to foreign regulators. ICE
believes the Swap Data Repository and Clearinghouse Indemnification
Correction Act will correct this provision of Dodd-Frank and allow U.S.
SDRs to provide transparency for international swaps transactions.
Conclusion
ICE has always been and continues to be a strong proponent of open
and competitive markets, and appreciates the opportunity to work
closely with Congress and regulators in the U.S. and abroad to address
the evolving regulatory challenges presented by derivatives market.
Mr. Chairman, thank you for the opportunity to share our views with
you. I would be happy to answer any questions you may have.
The Chairman. Thank you, Mr. Vice.
Mr. Saltzman, 5 minutes.
STATEMENT OF PAUL SALTZMAN, PRESIDENT, THE CLEARING HOUSE
ASSOCIATION L.L.C.; EXECUTIVE VICE PRESIDENT AND GENERAL
COUNSEL, THE CLEARING HOUSE PAYMENTS COMPANY L.L.C., NEW YORK,
NY
Mr. Saltzman. Chairman Conaway, Ranking Member Boswell, and
Members of the Subcommittee, my name is Paul Saltzman and I am
President of The Clearing House Association. I appreciate the
invitation to appear before you this morning to share The
Clearing House views on legislation currently pending before
your Subcommittee.
The Clearing House was founded in 1853 and today is the
nation's oldest banking association. We are a nonpartisan
advocacy group that represents the interest of our owner banks
in a variety of legal, legislative, and regulatory issues. Our
members include the largest U.S. commercial banking
organizations including regional banks, as well as several
leading non-U.S. domiciled banks.
The Clearing House has been asked to testify on two of the
three legislative proposals on this morning's hearing agenda,
but before I do that, I would like to make clear that we are
not here to advocate for fundamental changes to Title VII of
Dodd-Frank nor do we take issue with the underlying policy
goals in Title VII to increase transparency in the derivatives
markets, identify and mitigate against risk in the financial
system, and promote overall market integrity. We embrace those
goals.
I am here, however, to express our strong support for two
thoughtful, targeted, balanced, and bipartisan bills neither of
which would in any way undermine the protections afforded by
the new regulatory regime established in Title VII.
Let me start with H.R. 1838 and one clarification of my
own. My comments today are addressed to the bipartisan
substitute amendment adopted by voice vote last month in the
House Financial Services Committee, not the original bill as
introduced in the House. The legislation would essentially do
four things. First, it would permit banks to engage in swap
activity for hedging and other similar risk-mitigating
activities that are directly related to the bank's activities.
Second, it would allow banks to engage in a broader range of
swap activity than currently permissible under Section 716
other than structured finance swaps. Third, it would eliminate
any ambiguity that bank exemptions to the push-out rule are
also available to uninsured U.S. branches and agencies of non-
U.S. banks. And finally, the bill would clarify that the push-
out rule does not apply to swap activity conducted outside the
United States between a non-U.S. swap entity which includes a
non-U.S. branch of U.S. depository institution or a non-U.S.
subsidiary and a non-U.S. counterparty.
We believe these modifications to Section 716 would
preserve benefits that are derived from centralizing swap
activity in a single entity. The enactment of H.R. 1838 would
also reduce the competitive disadvantages that U.S. banks
currently face under Section 716 as compared to their non-U.S.
bank counterparts that are not subject to the similar push-out
requirement and likely never will be.
Let me next turn to the Swap Jurisdiction Certainty Act,
H.R. 3283. H.R. 3283 also involves the scope of certain Title
VII requirements and is intended to provide clarity regarding
the extraterritorial impact of Title VII. The statutory
language itself makes it clear that the requirements of Title
VII do not apply to activity outside the United States unless
such activity has a direct and significant connection with
activities in or effect on commerce in the United States or an
entity seeking to evade U.S. law and regulation. We believe
that the application of Title VII's requirements to U.S.
banking organizations operations outside of the United States
would run contrary to the statutory provision. Concerns have
been raised that absent this statutory clarification, the CFTC
or the SEC could apply Title VII broadly to U.S. banks non-U.S.
operations in a manner that is inconsistent with Title VI.
Specifically, the regulators could seek to apply these
Title VII requirements both to non-U.S. subsidiaries of U.S.
banks, as well as to non-U.S. branches of U.S. banks that
register as swap dealers even when the activity conducted by
such non-U.S. operations occurs outside the United States. An
extraterritorial application of these requirements would create
an unlevel playing field for U.S. banking organizations that
compete outside the United States with non-U.S. banks that
would be required to register as swap dealers under Title VII.
Extending the scope of Title VII to non-U.S. transactions
will also have a negative impact on commercial end-users and
will make their hedging activities more costly and less
efficient. Although the scope of extraterritorial application
of Title VII remains uncertain and subject to final rulemaking
and regulatory interpretation, H.R. 3283 would provide the
legal certainty necessary for market participants and end-users
and more clearly defining Title VII's intended extraterritorial
scope.
In summary, The Clearing House and its members strongly
endorse swift passage and enactment of these two bipartisan
bills. Thank you very much for your time and consideration, I
appreciate the opportunity to testify and would be pleased to
answer any questions you might have.
[The prepared statement of Mr. Saltzman follows:]
Prepared Statement of Paul Saltzman, President, The Clearing House
Association L.L.C.; Executive Vice President and General Counsel, The
Clearing House Payments Company L.L.C., New York, NY
Chairman Conaway, Ranking Member Boswell and Members of the
Subcommittee, my name is Paul Saltzman, and I am President of The
Clearing House Association L.L.C. (``The Clearing House''). I
appreciate the invitation to appear before you this morning to share
The Clearing House's views on the important legislation currently
pending before your Subcommittee.
Established in 1853, The Clearing House is the oldest banking
association in the United States. We are a nonpartisan advocacy
organization and represent our owner banks on a variety of legal,
legislative, and regulatory issues. Our members include the largest
U.S. commercial banking organizations, including large regional banks,
as well as several leading non-U.S. domiciled banks. I am also
Executive Vice President and General Counsel of our affiliate, The
Clearing House Payments Company L.L.C., which provides payment,
clearing, and settlement services to its member banks and other
financial institutions. The Clearing House Payments Co. clears almost
$2 trillion and 63 million transactions every day in automated-
clearing-house, funds-transfer, and check-image payments made in the
United States.
The Clearing House has been asked to testify today on two of the
three legislative proposals on this morning's hearing agenda. But
before I do that, I would like to make clear that we are not here today
to advocate for any fundamental changes to the basic protections that
are embodied in Title VII of the Dodd-Frank Act (``Dodd-Frank''). Nor
does The Clearing House take issue with the overarching policy goals
expressed by Congress in Title VII to increase transparency in the
derivatives markets; identify and mitigate against risk in the
financial system; and promote overall market integrity. On the
contrary, we fully embrace those goals. Instead, I am here today, on
behalf of The Clearing House and its members, to express our strong
support for two thoughtful, targeted, balanced, and bipartisan bills,
neither of which would in any way undermine the new regulatory regime
established by Title VII. The two bills are H.R. 1838, which would
amend the so-called bank derivatives ``push-out'' provisions of Section
716 of Dodd-Frank; \1\ and H.R. 3283, the ``Swaps Jurisdiction
Certainty Act.'' We strongly support both bills and urge their swift
passage. These carefully crafted, bipartisan proposals would provide
clarity and help avoid unintended consequences. The first bill, H.R.
1838, would clarify the scope of swaps and security-based swaps
activities that may be conducted in a bank and would clearly extend the
exemptions to the push-out requirement in Section 716 to uninsured U.S.
branches and agencies of non-U.S. banks. The second bill, H.R. 3283,
would clarify the extent to which the requirements of Title VII
applicable to swap and security-based swap transactions would apply
extraterritorially and to inter-affiliate transactions. These bills
will enhance the efficiency of the risk management services provided by
banks to their commercial counterparties, and facilitate the banks'
management of the risks to which they are exposed in their business
activities.
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\1\ As requested, this testimony addresses the bipartisan
substitute amendment to H.R. 1838, adopted in the Financial Services
Committee on Feb. 16, 2012, not H.R. 1838 as originally introduced on
May 11, 2011.
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Although some of the concerns targeted by these bills could
potentially be addressed through appropriately tailored regulations and
interpretations by the Commodity Futures Trading Commission (``CFTC''),
the Securities and Exchange Commission (``SEC''), and the prudential
bank supervisors, we strongly believe that enactment of these two
bipartisan bills is a better approach, which will provide greater
certainty and address any limitations on the authority of the
regulators. Moreover, the bills would provide needed clarity regarding
the scope of these particular Title VII provisions and the
Congressional intent underlying them.
In short, we believe these bills provide balanced and reasonable
solutions to serious risks posed by the swaps push-out provision and
the application of certain Title VII requirements to extraterritorial
and inter-affiliate transactions, targeting, in each case, the most
troublesome, and likely unintended, consequences.
Swaps Push-Out and H.R. 1838
Section 716
In general, and unless amended prior to its effective date,\2\ Sec.
716 will require that U.S. insured depository institutions and U.S.
branches and agencies of non-U.S. banks ``push out'' certain types of
swaps dealing activity from the bank (or the branch). Sec. 716 provides
exemptions for ``insured depository institutions'' (but not explicitly
for uninsured U.S. branches and agencies, as discussed below) that
would permit them to engage in (i) hedging and risk-mitigating swaps
activity; and (ii) swaps involving rates, currencies, and other
underlying assets that are permissible for national banks, including
cleared credit default swaps. However--and importantly for commercial
and agricultural end-users throughout the country--most commodity swaps
currently conducted by banks,\3\ both large and small, are subject to
the push-out requirement in Sec. 716.
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\2\ Although there is some ambiguity regarding whether Sec. 716 is
effective 2 years after the date of enactment of Dodd-Frank (which
would be July 2012) or 2 years after the effective date of Title VII
(which would be July 2013), we believe the better reading of the
statutory language is that Sec. 716 is effective 2 years after the
effective date of Title VII. That July 16, 2013 is the effective date
is supported by the legislative history of the provision in which
Senator Lincoln stated that the effective date of the provision is 2
years from the effective date of the title. (Cong. Rec., July 15, 2010,
S5922)
\3\ As noted above, banks would not be prohibited from engaging in
swap dealing activity with respect to swaps with bank-permissible
commodity reference assets, such as precious metals, or with respect to
hedging and risk-mitigating activities.
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H.R. 1838 would amend Section 716 to:
permit banks to engage in swap activity for hedging and
other similar risk mitigating activities that are directly
related to the bank's activities;
permit banks to engage in swaps and security-based swaps
activity other than most types of structured finance swaps;
eliminate any ambiguity that the exemptions from the
requirement to push-out swaps activity that are clearly
available to insured depository institutions are also available
to uninsured U.S. branches and agencies of non-U.S. banks; and
clarify that the push-out requirement does not apply to swap
or security-based swap activity outside the United States
between a non-U.S. swap entity, which includes a non-U.S.
branch of a U.S. depository institution or a non-U.S.
subsidiary, and a non-U.S. counterparty.
Benefits of H.R. 1838
Because H.R. 1838 would permit banks to continue to engage in a
wider range of swaps and security-based swaps activity without creating
safety and soundness risk, it would be a significant step towards
addressing concerns that have been raised regarding the negative
unintended consequences of Sec. 716. Indeed, U.S. bank regulators have
raised concerns about the potential harm the push-out requirement could
have on the safety and soundness of institutions that are subject to
its prohibition, as well as its potential to increase systemic risk.
For example, in a May 12, 2010, letter to the Chairman of the Senate
Banking Committee, Chairman Bernanke wrote the following: ``Section 716
would force derivatives activities out of banks and potentially into
less regulated entities . . . The movement of derivatives to entities
outside the reach of the Federal supervisory agencies would increase,
rather than reduce the risk to the financial system.'' Similarly, then-
Chairman of the Federal Deposit Insurance Corporation (``FDIC'') Sheila
Bair, in an April 30, 2010, letter to then-Senators Dodd and Lincoln,
took issue with the entire concept of pushing derivatives activities
out of the bank and warned that ``one unintended outcome of this
provision would be weakened, not strengthened, protection of the
insured bank and the Deposit Insurance Fund.''
Promotes Efficient Risk Management
As a general matter, customers prefer to engage in derivatives
transactions with banks, rather than their non-bank affiliates, because
banks are typically more comprehensively regulated and more highly-
rated entities with stronger credit than their non-bank counterparts
and can therefore offer lending and derivative products at reduced cost
and with greater security. In addition, end-users typically establish
relationships with one or a limited number of banks and then depend on
those banks to service their hedging and other derivatives needs. This
approach has the advantages of allowing end-users to work with banks
that understand their businesses, needs and objectives, and have
previously reviewed and made determinations with respect to the end-
user's credit. In addition, end-users are able to execute transactions
based on agreements and documentation already in place with their
banks, without the need for separate review and negotiation of new
documentation. To the extent that end-users would be required to
establish relationships with additional banks for one-off transactions,
or for transactions in particular product categories, the process will
become slower, more costly and less efficient and will impede the end-
users' ability to engage in necessary hedging activities.
H.R. 1838 would avoid this result by allowing U.S. banking
organizations to provide their customers with a wider range of products
and services and maintain the scope of banks' lending opportunities. By
permitting a greater range of swaps activity in the bank, H.R. 1838
would also help maintain other benefits that are derived from
centralizing the activity in a single entity. In particular, these
additional benefits include the ability to set-off in the event of a
default where lending and derivatives activities are conducted in the
same entity and the cost savings to customers by restoring certain
netting opportunities, which can reduce their collateral obligations
without increasing risks to the bank or systemic risks. This in turn,
as noted above, facilitates more efficient and effective risk
management by banks and their counterparties. For example, a commercial
agricultural producer might enter into swaps on agricultural
commodities with its bank counterparty in order to hedge its price risk
to agricultural commodities arising from its production of such
commodities. If that activity is subject to push-out, as it would be
under Section 716, and the agricultural entity is also entering into
interest rate swaps with the bank to hedge its financing risks, it will
no longer be able to net the exposures arising in connection with the
two types of transactions. The agricultural entity will therefore not
be able to net its agricultural swaps against its interest rate swaps,
which will increase its margin requirements, thereby making its hedging
more costly--and potentially not cost-effective at all--and exposing it
to greater risk in the event of a default by the bank. These results
would increase systemic risk, reduce hedging opportunities (or make
them more costly) and serve no purpose in providing greater protection
to the markets or market participants.
Promotes U.S. Bank Competitiveness
Enactment of H.R. 1838 would also be a key step towards lessening
the competitive disadvantage that U.S. banks would face under Sec. 716,
as compared to their non-U.S. bank counterparts that are not subject to
similar requirements--and likely never will be. Indeed, there is a
general and growing recognition that the swaps push-out provision is
highly unlikely to be adopted in any other jurisdiction in any form, as
Federal Reserve Board Governor Tarullo recently acknowledged in
testimony before the Senate Banking Committee. Similarly, nearly 2
years ago, Chairman Bernanke warned Congress that ``foreign
jurisdictions are highly unlikely to push derivatives out of their
banks.'' \4\ In light of this practical reality, the broadening of the
scope of swap activities that a bank may continue to engage in
reflected in H.R. 1838 is even more critical, especially relative to
the lending business. In this regard, U.S. banks could be placed at a
serious competitive disadvantage in their traditional lending
businesses if borrowers migrate their loans to non-U.S. banks in order
to realize the benefits of set-off between their loans and their swaps
exposure. Set-off and netting are just as important to customers as
they are to banks.
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\4\ In fact, some non-U.S. jurisdictions actually require that
derivatives transactions be conducted in the bank, as opposed to an
affiliate, in part because of the supervisory benefits cited by Sheila
Bair, among others.
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Clarifies Treatment of U.S. Banks' Non-U.S. Operations
H.R. 1838 would also appropriately clarify that Sec. 716 does not
limit the swaps activities of foreign branches of U.S. banking
organizations. We believe this clarification to be wholly consistent
with the Congressional intent underlying Sec. 716. Indeed, the
legislative history of Sec. 716 is focused exclusively on domestic
application and demonstrates no intent by Congress to extend the push-
out requirement to the overseas branches of U.S. banks. Moreover, this
clarification is consistent with longstanding precedent in U.S. banking
law allowing U.S. banks to engage in a wider range of activities in
their overseas branches than is permissible in their U.S. offices. Most
importantly, however, extending the extraterritorial reach of Sec. 716
in this way would create undue and unnecessary competitive
disadvantages for U.S. banks operating abroad, by limiting their
ability to provide a full range of swaps to their overseas customers,
which include overseas affiliates of their U.S. customers.
Clarifies Treatment of Non-U.S. Banks' U.S. Operations
Without the technical correction in H.R. 1838, the swaps push-out
provision could also have a very negative impact on non-U.S. banking
organizations with U.S. operations. As the result of an acknowledged
drafting error in the statute,\5\ certain exemptions from Section 716
that permit banks to continue to engage in certain swaps activity may
be available only to ``insured depository institutions,'' a term that
could be read to exclude the uninsured U.S. branches and agencies of
non-U.S. banks. Accordingly, these exemptions may not apply to swaps
activities conducted in these U.S. branches and agencies, which would
leave all of their swaps activity potentially subject to the push-out
requirement. This result would violate longstanding principles of
national treatment and international comity and could, eventually,
expose U.S. banks operating abroad to reprisals by foreign regulators.
This issue is of most critical concern to The Clearing House member
banks that are headquartered outside the United States, but it is an
issue of concern for all of our members.
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\5\ In a colloquy with Senate Banking Committee Chairman Dodd
shortly after Senate passage of Dodd-Frank, Senator Blanche Lincoln,
who was the principal author of Sec. 716, acknowledged a ``significant
oversight'' in the technical drafting of Sec. 716 but stated
unequivocally that Congress intended the exemptions for ``insured
depository institutions'' to be available also to the U.S. branches of
non-U.S. banks. (156 Cong. Rec., S5869, 5903-5904 (daily ed. July 15,
2010))
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* * * * *
As noted above, we believe H.R. 1838, as reported in overwhelmingly
bipartisan fashion by the Financial Services Committee, is a balanced
and reasonable approach to addressing the unintended consequences of
Section 716. It is also an important step towards competitive equity-
extending exemptions to the push-out requirement to uninsured U.S.
branches of non-U.S. banks and clarifying that the push-out prohibition
does not apply to the non-U.S. operations of U.S. banking
organizations. This would be reinforced by the clarification of the
extraterritorial application of Title VII in H.R. 3283, described
below. Moreover, as noted earlier, enactment of this legislation would
in no way undermine Title VII's enhanced regulatory scrutiny of
derivatives or compromise bank safety and soundness.\6\ These
modifications to Sec. 716 are critically important, both to the banking
industry, end-users, and our overall economy, and we strongly support
their enactment.
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\6\ Congressman Barney Frank strongly backed this bipartisan
substitute in the Financial Services Committee and had this to say
during the full Committee markup last month: ``passing this bill . . .
will not in any way, shape or form reduce sensible regulation of
derivatives. It will not increase any exposure to the financial system
from derivatives. [Sec. 716] was an unnecessary and, I think, somewhat
unwise amendment. The bill before us . . . will restore this to what I
think is the appropriate balance.'' Congressman Frank also noted that
the legislation would in no way alter the application of the basic
substantive regulatory requirements of Title VII (i.e., swap dealer
registration, capital and margin requirements, and execution and
clearing).
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Extraterritorial Application of Title VII and H.R. 3283
Effect of H.R. 3283
H.R. 3283 \7\ would provide clarity regarding the scope of Title
VII's requirements by:
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\7\ This testimony addresses the text of H.R. 3283, as introduced
on Oct. 31, 2011.
Clearly defining who is a U.S. person and subjecting only
those transactions that involve U.S. persons to the
transaction-level requirements of Title VII. Importantly,
agencies or branches of a U.S. person located outside the
United States would be non-U.S. persons provided that they are
established for valid business reasons and subject to
---------------------------------------------------------------------------
substantive regulation in the local jurisdiction;
Permit a non-U.S. swap dealer or security-based swap dealer
to meet Title VII's capital requirements by complying with
comparable home country standards; and
Clarify that the transaction-level requirements of Title VII
do not apply to inter-affiliate transactions.
Extraterritorial Application
H.R. 3283 provides important clarity regarding the extent to which
Title VII may be applied to activities conducted outside the United
States--a critical issue for U.S. and non-U.S. banking organizations
alike, and one that has raised concerns in the banking industry, on
both sides of the aisle in Congress, and among U.S. and non-U.S.
regulators. Although Title VII's extraterritorial impact on U.S. and
non-U.S. banking organizations would differ, the effects would be felt
across all banking organizations and would have a negative impact on
the U.S. financial markets.
The statute itself makes clear that the requirements of Title VII
do not apply to activity outside the United States unless such activity
has a ``direct and significant connection with activities in, or effect
on, commerce of the United States'' or to prevent evasion of U.S. law
and regulation. Application of Title VII's requirements to U.S. banking
organizations' operations outside of the U.S. would run contrary to
this statutory prohibition and would place U.S. banks at a significant
competitive disadvantage to their non-U.S. counterparts in the global
markets. In addition, broad extraterritorial application of Title VII
could very well result in non-U.S. banking organizations pulling this
activity, and potentially their banking activities as well, out of the
United States.
Absent the statutory clarification provided in this legislation,
the CFTC or SEC could apply Title VII broadly to U.S. banks' non-U.S.
operations in a manner inconsistent with the statutory limitations set
out in Title VII. Specifically, certain statements by the CFTC indicate
an intent to apply the Title VII requirements both to non-U.S.
subsidiaries of U.S. financial institutions, as well as to non-U.S.
branches of U.S. banks that register as swap dealers, even when the
activity conducted by such non-U.S. operations occurs entirely outside
of the United States. For example, with respect to a U.S. banking
organization registered as a swap dealer, this could mean that even
transactions entered into by a non-U.S. branch of such U.S. bank with a
non-U.S. person may be subject to all the transaction-level
requirements of Title VII (including, most significantly, margin
requirements) even when the transactions take place entirely outside
the United States. Moreover, these non-U.S. transactions could
potentially become subject to U.S. execution and clearing requirements,
which is impractical and would not advance U.S. policy interests. For
non-U.S. banking organizations, Title VII requirements, if applied
broadly, may be imposed on their overseas transactions. These results
are particularly inappropriate given the fact that activities of non-
U.S. branches of U.S. banks are subject to the jurisdiction of, and
robust prudential supervision by, U.S. bank regulators.
An extraterritorial application of these requirements would create
an unlevel playing field for U.S. banking organizations that compete
outside the United States with non-U.S. banks that would not be
required to register as swap dealers under Title VII or would not be
subject to all of Title VII's requirements. The competitive
disadvantage that U.S. banking organizations would likely face would be
particularly pronounced through the application of Title VII margin
requirements to swaps conducted between two non-U.S. counterparties. An
example of the adverse impact the uneven application of margin
requirements could have is evident in the prudential regulators'
proposed rules regarding margin requirements for uncleared swaps. Those
proposed rules provide for an exemption from margin requirements that
would otherwise apply to a swap conducted between a non-U.S. swap
dealer and a non-U.S. counterparty, subject to certain conditions.
However, non-U.S. subsidiaries of U.S. financial institutions may not
avail themselves of this exemption. The competitive disadvantages
raised by such a limited exemption are obvious: if non-U.S.
counterparties are required to post margin on their derivatives
transactions with the non-U.S. branches and subsidiaries of U.S.
banking organizations, these transactions are likely to migrate to non-
U.S. competitors that do not have the same margin requirements.
Extending the scope of Title VII to non-U.S. transactions will also
have a negative impact on commercial end-users and will make their
hedging activities more costly and less efficient. For example, if the
Title VII scope of application were to extend to a non-U.S. branch of a
U.S. bank, or a non-U.S. bank operating outside the U.S., and an end-
user that is a non-U.S. subsidiary of a U.S. parent wishes to trade
with that branch or bank, its transactions would become more costly,
due to the associated compliance obligations. That, in turn,
potentially makes the end-user's hedging less effective.
Although the scope of extraterritorial application of Title VII
remains uncertain, subject to final rulemaking and regulatory
interpretation, H.R. 3283 would be helpful in more clearly defining
Title VII's scope. Resolution of this issue is critical because today's
swap markets are global, and conflicting or overlapping requirements
across jurisdictions harm all market participants. We recognize and
appreciate the ongoing efforts among regulators to work towards global
harmonization of the OTC derivatives regimes. At this point, however,
broad harmonization of requirements across all jurisdictions most
active in these markets remains unlikely. Even if such international
harmonization could be achieved, U.S. requirements are likely to become
effective earlier, which would subject U.S. banking organizations to a
substantial competitive disadvantage before comparable requirements
emerge (if at all) in other jurisdictions. Once lost, experience
suggests that these relationships will never return.
Inter-affiliate Transactions
The treatment of inter-affiliate swaps transactions under Title VII
is also of critical importance to all banking organizations. Title VII
itself does not differentiate between affiliate and non-affiliate swap
transactions and, as a result, it remains unclear whether the full
range of requirements would apply to affiliate transactions.
U.S. and non-U.S. banking organizations alike rely on inter-
affiliate swaps transactions for internal hedging and risk management
purposes. Imposing requirements such as margin on these trades may
increase operational and credit risk associated with the transactions
with no offsetting benefits to the institutions themselves or U.S.
financial stability, and imposing clearing and execution requirements
on these transactions would effectively eliminate their utility. These
inter-affiliate transactions do not threaten the safety and soundness
of the individual institutions nor do they contribute to systemic risk.
These amendments would in no way undermine the overarching goals of
Title VII to increase transparency in the derivatives markets, to
mitigate against systemic risk in the broader financial system, and to
promote overall market integrity.
* * * * *
Conclusion
In summary, The Clearing House and its members strongly endorse
swift passage and enactment of these two bipartisan bills, each of
which is carefully crafted to address these specific but significant
concerns in a manner that does not imperil financial stability,
undermine the regulation of derivatives or the safety and soundness of
our banks, or jeopardize the international competitiveness of our
institutions and markets. Mr. Chairman, The Clearing House and its
members stand ready to assist you in this endeavor in any way we can.
Again, we appreciate your invitation to testify before you today and
would be pleased to answer any questions you may have.
The Chairman. Thank you, sir.
Mr. Bailey for 5 minutes.
STATEMENT OF KEITH A. BAILEY, MANAGING DIRECTOR, FIXED INCOME,
CURRENCIES AND COMMODITIES DIVISION, BARCLAYS CAPITAL, NEW
YORK, NY; ON BEHALF OF
INSTITUTE OF INTERNATIONAL BANKERS
Mr. Bailey. Chairman Conaway, Ranking Member Boswell, and
Members of the Subcommittee, my name is Keith Bailey. I am a
Managing Director in the Fixed Income, Currencies and
Commodities Division of Barclays where I have responsibilities
for evaluating and implementing the changes to our derivatives
businesses globally resulting from the enactment of Dodd-Frank.
I am very pleased to be here today to testify on behalf of the
Institute of International Bankers, the IIB, in support of H.R.
3283, H.R. 1838, and the ``Swap Data Repository and
Clearinghouse Indemnification Correction Act of 2012.''
The IIB represents internationally headquartered financial
institutions from over 35 countries around the world. Its
members include international banks that operate branches and
agencies, bank and broker dealer subsidiaries in the United
States. In the aggregate, our members' U.S. operations have
approximately $5 trillion in assets, contribute to the depth
and liquidity of U.S. financial markets, and provide 25 percent
of all commercial and industrial bank loans made in this
country, which includes agricultural lending.
H.R. 3283, the Swaps Jurisdiction Certainty Act, introduced
by Representatives Himes and Garrett was approved yesterday by
the Financial House Services Committee. This bill provides
certainty with respect to the extraterritorial application of
the Dodd-Frank Act, allowing for the harmonization of
derivative regulations and ensuring there is a level playing
field between U.S. and foreign banks with respect to their
cross-border swap activities.
The swap markets are global markets that permit investors
access to a range of risk-management products and investment
opportunities across a range of international financial
markets. Many countries are working to supplement their
existing regimes to incorporate derivatives clearing and market
transparency reforms similar to those of Dodd-Frank pursuant to
the commitments made by the G20 leaders in September of 2009.
The Dodd-Frank Act recognizes the need for international
coordination of swaps regulations, as well as the need to limit
the extraterritorial application of Title VII.
The extraterritorial application of Title VII is a very
real concern. For example, different regions may take different
approaches regarding what products need to be cleared, what
exemptions if any there will be for certain market sectors, and
how collateral is to be protected by clearinghouses and
clearing members.
H.R. 3283 brings much-needed certainty to the question of
extraterritorial reach of Title VII. The bill makes certain
that internationally headquartered banks, non-U.S. swap and
security-based swap transactions will not be subject to U.S.
regulatory requirements. The bill also provides certainty for
both U.S. banks and the U.S. operations of internationally
headquartered banks with respect to their swap and security-
based swap transactions with non-U.S. persons.
With respect to internationally headquartered banks that
register as swap dealers under Title VII, the bill makes
certain that such banks may satisfy the capital requirements of
Title VII by relying on their home country capital requirements
provided that such home country requirements are comparable to
those expressed under Title VII and the bank's home country is
a signatory to the Basel Capital Accords. In this way, the bill
recognizes the resource constraints of U.S. regulators and that
U.S. regulators should leverage rather than duplicate effective
foreign supervision while still retaining their ability to
apply U.S. regulations where inadequate protections exist.
The bill recently approved by the House Financial Services
Committee, H.R. 1838, was amended to modify rather than repeal
Section 716. The IIB supported that amendment cosponsored by
Representatives Himes and Maloney and the bill's sponsor,
Representative Hayworth, as it provided U.S. branches and
agencies of foreign banks parity with insured depository
institutions. The bill was reported by the Committee on a voice
vote. The bill fixes an unintended and acknowledged oversight
in the drafting of Section 716 that has resulted in the
disparate treatment of uninsured U.S. branches and agencies of
foreign banks as compared to IDIs.
The general prohibition under Section 716 relating to
Federal assistance applies to both U.S. FDIC-insured banks and
uninsured U.S. branches and agencies of foreign banks that are
swap entities. The general prohibition is, however, subject to
several important exclusions--grandfathering provisions and
transition periods--but these apply only to IDIs. As a result,
Section 716 IDIs can continue to engage in certain traditional
swap dealing activities, including dealing in interest rate
swap and foreign currency swaps and to use swaps for hedging
and other similar risk-mitigating activities.
Uninsured U.S. branches and agencies are facing a cliff
come July 2013 by which time they must have pushed out all of
their existing swap positions and ongoing swaps activities.
This will be very disruptive to markets and end-users. Many
swap dealers have thousands of clients that would be affected.
The assignment or novation of these agreements would almost
always require counterparty consent. Under that agreement,
there is the prospect of litigation. Given that swap dealing is
typically conducted as an integral part of a bank's overall
lending and other non-swap business, the failure to rectify
this situation could have a major impact on the commercial and
industrial lending in the United States by international banks.
Uninsured U.S. branches and agencies of foreign banks are
subject to the same type of safety and soundness examination
and oversight as U.S. banks, and there is no reason to treat
them differently than U.S. banks. Indeed, doing so represents a
significant departure from the longstanding U.S. policy that
U.S. branches and foreign agencies and agencies of foreign
banks are subject to the same rules, regulations, and
oversight--i.e., national treatment as U.S. banks.
In this connection, we would like to bring to the Committee
Members' attention another instance in Dodd-Frank where the
term insured depository institution is used unintentionally
excluding the U.S. branches and agencies of foreign banks. The
definition swap dealer in Section 721 provides that an IDI
shall not be considered a swap dealer to the extent it offers
to enter into a swap with a customer in connection with
originating a loan with that customer. As a result, potentially
any uninsured U.S. branch or agency of a foreign bank will have
to register with the CFTC if it enters into a swap in
connection with its lending activities. Requiring these
uninsured U.S. branches and agencies to register would have an
impact on their willingness to lend in this country and strain
the supervisory resources of the CFTC
In closing, I would like to express my support for the
``Swap Data Repository and Clearinghouse Indemnification Act of
2012,'' and I thank you for the opportunity to testify today on
behalf of the IIB. We urge the Committee to consider and
approve these important bills and I am happy to answer any
questions.
[The prepared statement of Mr. Bailey follows:]
Prepared Statement of Keith A. Bailey, Managing Director, Fixed Income,
Currencies and Commodities Division, Barclays Capital, New York, NY; on
Behalf of Institute of International Bankers
Chairman Conaway, Ranking Member Boswell and Members of the
Subcommittee:
My name is Keith Bailey. I am a Managing Director in the Fixed
Income, Currencies and Commodities Division of Barclays where I have
responsibilities for evaluating and implementing the changes to our
derivative businesses globally resulting from enactment of the Dodd-
Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank). I
have over twenty-five years of experience in the derivatives market
both here in the U.S. and abroad. I am very pleased to be here today to
testify on behalf of the Institute of International Bankers (IIB) in
support of H.R. 3283, H.R. 1838, and ``the Swap Data Repository and
Clearinghouse Indemnification Correction Act of 2012.'' H.R. 1838
addresses a technical correction of critical importance to IIB's
membership. The other two pieces of legislation will provide greater
certainty with respect to the cross-border regulation of swaps, while
preserving the protections put in place by Dodd-Frank and helping to
insure that the global swaps market operates optimally for the benefit
of both investors and end-users.
The IIB represents internationally headquartered financial
institutions from over 35 countries around the world; its members
include international banks that operate branches and agencies, as well
as bank, securities broker-dealer and futures commission merchant
subsidiaries, in the United States. In the aggregate, our members' U.S.
operations have approximately $5 trillion in assets and provide 25% of
all commercial and industrial bank loans made in this country, which
includes agriculture lending, and contribute to the depth and liquidity
of U.S. financial markets. Our members also contribute more than $50
billion each year to the economies of major cities across the country
in the form of employee compensation, tax payments to local, state and
Federal authorities, as well as other operating and capital
expenditures.
At the outset, let me say that the IIB and its members support
Dodd-Frank's objectives of reducing systemic risk and increasing
transparency in the financial markets. Many IIB members' home country
jurisdictions are also working to supplement their existing regimes to
incorporate derivatives clearing and market transparency reforms to
achieve regulatory objectives similar to those in Dodd-Frank and to
support the commitments of the G20 leaders to setting high,
internationally consistent requirements for OTC derivatives (see
below).
The swap markets are liquid, global markets that permit investors
access to a range of risk management products and investment
opportunities across a wide range of international financial markets.
Unlike the futures and securities markets, swap markets are not
dominated by regional exchanges. The global nature of the swap markets
brings important benefits to U.S. end-users and other market
participants by increasing competition and liquidity.
H.R. 3283
H.R. 3283, the Swaps Jurisdiction Certainty Act, introduced by
Representative Himes and Garrett provides certainty with respect to the
extraterritorial application of Title VII and will ensure there is a
level playing field between U.S. and foreign banks with respect to
their cross-border swap activities.
While Title VII of Dodd-Frank lays the framework for the U.S.
regulation of swaps, it also recognizes the need for international
coordination of swaps regulations and, in Sections 722(d) and 772(c),
the need to limit the extraterritorial application of Title VII. Many
other countries have regulated swap dealers, including branches and
affiliates of U.S. firms, for years under their existing regimes for
regulation of market professionals. G20 leaders agreed to OTC
derivatives regulatory objectives in September 2009, which called for:
the trading of all standardized OTC derivative contracts on exchanges
and their clearance through central counterparties; reporting of OTC
derivatives contracts to trade repositories; and the imposition of
higher capital requirements on OTC derivatives contracts that are not
centrally cleared.
Consistent with that agreement, the European Union (``EU''), for
example, is undertaking regulatory reforms with respect to enhanced
pre- and post-trade transparency requirements, clearing of OTC swaps,
segregation of client collateral, and the use of organized trading
venues. Existing and proposed EU legislation also broadly address
business conduct by market professionals. Similar measures are being
contemplated by the Commodity Futures Trading Commission (CFTC) and the
Securities Exchange Commission (SEC).
However, when these regulatory efforts are neither coordinated nor
take into account their extraterritorial impact they can lead to
conflicting requirements. For example, firms may be subject to an
obligation to clear the same OTC swap as a matter of both U.S. and
European regulation. We are hopeful that there will be an agreement
between the CFTC and the SEC and regulators from other regions and
countries, including the EU, Asia and Canada, to address this issue, as
it is impossible to clear the same contract through two clearinghouses.
Even with such agreement, issues of likely greater divergence may
exist, such as when differing regions implement differing approaches to
which products need to be cleared; what exemptions, if any, there will
be for any sectors of the markets; and, how collateral is to be
protected by clearinghouses and clearing members. Finally, there is no
guarantee that the rules being drafted in the U.S. and the EU relating
to the permitted execution venue for swaps will be sufficiently similar
to allow mutual recognition.
These conflicts, which can occur as a result of the
extraterritorial application of swaps regulations, can result in a
number of other harmful results. It is not disputed that
internationally headquartered banks' transactions with U.S. persons
from outside the United States may trigger the registration and
regulatory requirements prescribed under Title VII. However, if
internationally headquartered firms with U.S. operations are subject to
U.S. regulation of business conducted with non-U.S. persons, they face
the risk of operating at a competitive disadvantage relative to an
international firm that lacks a sufficient U.S. nexus to be subject to
such rules. As a result, international firms with operations in the
U.S., many of which use a single internationally located ``central
booking location'' to book swaps, may choose to establish separate
subsidiaries in the U.S. to try to limit these conflicts. However, this
would be capital inefficient, introduces risk management concerns, is
disadvantageous to large clients (who themselves prefer to transact
globally), and potentially leads to inconsistent prudential regulation.
This ``silo'' or ``fragmented'' approach may also result in U.S. end-
users having difficulty accessing overseas markets directly.
The extraterritorial application of Title VII is a very real
concern. The industry has been engaged in ongoing dialogue with the
CFTC, SEC and other regulators, and has sought guidance on the
territorial scope of Dodd-Frank from the inception of the rulemaking
process. Nevertheless, nearly every question on this topic and related
issues, such as the treatment of inter-affiliate transactions,
guarantees and branches, remains open.
Against this backdrop, it is challenging that the CFTC finalized
rules on January 11, 2012 requiring companies to register provisionally
as swap dealers or major swap participants as soon as the definitional
rules under Dodd-Frank go into effect. All indications are, however,
that the CFTC will not have finalized its extraterritorial guidance by
that time, and possibly without a sufficient transition period for
companies to come into compliance. Other significant CFTC rules have
yet to be finalized as well, making the business decision on how best
to comply with the CFTC's provisional registration rules difficult.
H.R 3283 brings much-needed certainty to the question of the
extraterritorial reach of Title VII. The bill makes certain that
internationally headquartered banks' non-U.S. swap and security-based
swap transactions will not be subject to U.S. regulatory requirements.
The bill also provides certainty for both U.S. banks and the U.S.
operations of internationally headquartered banks with respect to their
swap and security-based swap transactions with non-U.S. persons.
With respect to internationally headquartered banks that register
as swap entities under Title VII based on their transactions with U.S.
persons, the bill makes certain that such banks may satisfy the capital
requirements of Title VII by relying on their home country capital
requirements, provided that such home country requirements are
comparable to the requirements under Title VII and the bank's home
country is a signatory to the Basel Capital Accords. This approach
conforms to the approach that has been taken for many years by the
banking regulators in assessing the capital of foreign banks for U.S.
regulatory purposes. It also ensures that appropriate protections are
in place with respect to transactions that involve U.S. persons.
H.R. 1838
This bill, as introduced and referred to the Committee, would
repeal Section 716 of Dodd-Frank, also known as the swaps ``push-out''
provision. Our principal concern with Section 716 is the unintended and
acknowledged oversight in according significantly different and
negative treatment for uninsured U.S. branches and agencies of foreign
banks compared to that provided to insured depository institutions.
Many foreign banks operate uninsured branches and agencies in the U.S.
In the aggregate, these branches and agencies have more than $2
trillion in assets. In addition to lending and engaging in certain
securities, asset management and other similar activities, many such
branches and agencies also engage in swap dealing. Dodd-Frank provides
that branches and agencies engaged in swap dealing activity be required
to register with the CFTC and/or the SEC with respect to their swap
dealing activity. Accordingly, they will be ``swap entities'' under
Section 716.
Section 716 generally provides that no ``Federal assistance'' may
be provided to any swaps entity with respect to any swap, security-
based swap or other activity of the swap entity. ``Federal assistance''
is defined to include advances from the discount window and FDIC
insurance. Uninsured U.S. branches and agencies of foreign banks are
licensed by a Federal or state banking authority; they are subject to
the same type of safety and soundness examination and oversight as U.S.
banks, and, like U.S. banks, they are eligible to borrow from the
Federal Reserve discount window so long as the advance is secured by
high quality collateral and subject to discount.\1\ From the Federal
Reserve's perspective, maintaining U.S. branches' and agencies' access
to the discount window is an important tool for maintaining a sound and
orderly financial system.
---------------------------------------------------------------------------
\1\ See Federal Reserve Regulation A, 12 CFR 201.1 (extending
rules relating to eligibility for Federal Reserve Bank lending to
``United States branches and agencies of foreign banks'').
---------------------------------------------------------------------------
The general prohibition under Section 716 relating to Federal
assistance applies to both U.S. FDIC-insured banks and uninsured U.S.
branches and agencies of foreign banks that are swap entities. The
general prohibition is, however, subject to several important
exclusions, grandfathering provisions and transition periods, but these
provisions apply only to ``insured depository institutions'' (IDIs). As
a result, uninsured U.S. branches and agencies would appear not to be
eligible for the exclusions, grandfathering and transition provisions
applicable to IDIs.
When Section 716 was enacted, Members of Congress acknowledged that
this differential treatment of uninsured U.S. branches and agencies of
foreign banks was ``clearly unintended'' and recognized the need ``to
ensure that uninsured U.S. branches and agencies of foreign banks are
treated the same as insured depository institutions,'' consistent with
the U.S. policy of national treatment.\2\ However, as was explained at
the time, in the rush to complete the conference and finalize Section
716 there was no opportunity to rectify this ``significant oversight.''
\3\
---------------------------------------------------------------------------
\2\ 156 Cong. Rec. S5903-S5904 (daily ed. July 15, 2010) (colloquy
between Senator Dodd and Senator Lincoln).
\3\ Id.
---------------------------------------------------------------------------
As a result, the exclusion in Section 716(d) that permits IDIs to
continue to engage in certain traditional swap dealing activities,
including dealing in interest rate and foreign currency swaps, and to
use swaps for hedging and other similar risk-mitigating activities,
would appear not to be available to uninsured U.S. branches and
agencies of foreign banks. If uninsured branches and agencies that are
swap entities were ineligible for this exclusion, then their U.S.
customers would lose the benefit of trading with them. These customers
would have to establish new trading relationships away from the U.S.
branch or agency in order to engage in traditional swap transactions,
as well as those swap activities that are not covered by the Section
716's exceptions. This would significantly reduce competition and
worsen pricing in the U.S. swaps market, especially given that 8 of the
14 largest global derivatives dealers are foreign banks.
In addition, the resulting differential treatment relative to U.S.
FDIC-insured banks would overtly discriminate against and competitively
disadvantage foreign banks. This represents a significant departure
from the long-standing U.S. policy that U.S. branches and agencies of
foreign banks are subject to the same rules, regulations and oversight,
i.e., national treatment, as U.S. banks. Finally, it would provide
precedent for foreign jurisdictions to provide advantages to their
local banks at the expense of the foreign operations of U.S. banks, if
not in the context of swaps then potentially in other contexts.
Section 716(b)(2)(B) also excludes from the scope of Section 716 an
IDI that is a major swap participant or major security-based swap
participant. This exclusion is important to those IIB members that may
be deemed to be major swap or security-based swap participants. The
definition of major swap participant encompasses not only persons
engaged in ongoing swap activities but also potentially persons with
only legacy positions. Thus, if uninsured branches and agencies were
not treated as IDIs for this purpose, then they could be subject to
Section 716 as a result of legacy positions in a way that a U.S. FDIC-
insured bank would not.
Finally, Section 716(e) provides that Section 716's prohibition on
Federal assistance ``shall only apply to swaps or security-based swaps
entered into by an insured depository institution after the end of
[Section 716's] transition period.'' Therefore, the existing swaps of
IDIs are grandfathered from Section 716. Relatedly, Section 716(f)
gives an IDI's appropriate Federal banking agency the authority to
grant the institution a transition period of up to 3 additional years
beyond Section 716's July 16, 2013 effective date before the
institution must divest or cease its swap activities. The purpose of
this transition period is to prevent the restructurings necessary to
comply with Section 716 from adversely disrupting the institution's
lending and other non-swaps activities. But this provision is available
only to IDIs.
The implications of these issues are potentially serious. There are
approximately 16 months before uninsured U.S. branches and agencies
that are swap entities must ``push out'' all their existing swap
positions and ongoing swaps activities, which is precious little time,
particularly relative to the longer period--up to more than 4 years--
before IDIs will have to make their transition. Moreover, the absence
of any grandfathering of existing positions would mean that the
transition for foreign banks and their counterparties would be much
more disruptive, more similar to insolvency in many respects than to an
orderly business restructuring. This is true because:
Swap dealing is typically conducted as an integrated part of
a bank's lending and other non-swap businesses. Swap positions
often hedge loan and other non-swap positions, and risk
management and other systems are often shared across many
different types of trading activities, not just those involving
swaps. Winding down or restructuring swap dealing activities
will as a result tend to decrease lending and market-making
activity, with material adverse effects on the U.S. economy.
A significant number of customers have master agreements
directly with the uninsured U.S. branches and agencies of
foreign banks, or have multi-branch netting agreements to which
one or more uninsured U.S. branches or agencies are parties.
The assignment or novation of these agreements, even to an
affiliate, almost always requires counterparty consent, forcing
customers and foreign banks to negotiate the terms for
assigning, novating or modifying agreements for swap portfolios
held with uninsured U.S. branches and agencies. Major swap
dealers have thousands of clients who would be affected.
International banks and their customers may not always agree
to the terms of an assignment or novation, thereby forcing the
parties to litigate over whether Section 716 triggers
``illegality'' and similar provisions in those agreements.
Renegotiation and litigation will lead to delays in trading;
resulting in diminished liquidity and higher spreads for
customers.
Assignment or novation could also potentially trigger other
requirements under Dodd-Frank, such as mandatory clearing and
trading requirements inasmuch as any such novated or assigned
swap potentially would constitute a new swap that would be
subject to those requirements.
There are significant capital and technology costs
associated with using a new booking structure, and the
modification of existing systems to track new booking
structures will put a very heavy strain on information
technology resources that are already overwhelmed with the
other changes necessary because of Dodd-Frank.
While the underlying bill deals with this disparate treatment of
uninsured branches and agencies of foreign banks by striking Section
716 in its entirety, the bill recently approved by the House Financial
Services Committee modifies Section 716. The IIB supported this
amendment, which was cosponsored by Representatives Himes and Maloney
and the bill's sponsor Representative Hayworth, as it provided U.S.
branches and agencies parity with insured depository institutions.
Swap Dealer Definition
In this connection, we would like to thank Chairman Lucas for his
attention to another instance in Dodd-Frank where uninsured U.S.
branches and agencies of foreign banks are similarly harmed compared to
insured depository institutions. Section 721 defines ``Swap Dealer''
(Section 1a(49) of the Commodity Exchange Act (CEA)) to exclude
``insured depository institutions'' which ``enter into a swap with a
customer in connection with originating a loan with that customer.''
Because the exclusion is limited to IDIs, any uninsured U.S. branch or
agency of a foreign bank potentially will have to register with the
CFTC if it enters into a swap in connection with its lending
activities. Requiring these uninsured U.S. branches and agencies to
register could have an impact on their willingness to lend in this
country and strain the supervisory resources of the CFTC. We would urge
Members to support a fix to this definition that would provide
uninsured U.S. branches and agencies of foreign banks the same
treatment accorded IDIs under Section 1a(49) of the CEA.
Swap Data Repository and Clearinghouse Indemnification Correction Act
of 2012
Under Dodd-Frank, OTC derivatives transactions are required to be
reported to swap data repositories and securities-based swap data
repositories. Dodd-Frank contemplates that information reported to the
CFTC by derivatives clearinghouses and information reported to data
repositories can be accessed by U.S. and foreign regulators. However,
access to such information is conditioned on the recipient agreeing to
keep such information confidential and to indemnify the CFTC or data
repository, as the case may be, for ``any expense arising from
litigation relating to the information provided.'' This indemnification
requirement is a significant barrier to foreign regulators and, in some
instances, to U.S. regulators to obtaining this data. The Swap Data
Repository and Clearinghouse Indemnification Correction Act of 2012
would eliminate this barrier. The IIB supports the bill and urges its
approval by the Committee.
Conclusion
Thank you for the opportunity to testify today on behalf of the
IIB. We urge the Committee to consider and approve these important
bills.
The Chairman. Thank you, Mr. Bailey.
Mr. Bodson?
STATEMENT OF MICHAEL C. BODSON, CHIEF OPERATING
OFFICER, DEPOSITORY TRUST & CLEARING CORPORATION, NEW YORK, NY
Mr. Bodson. Thank you. Chairman Conaway, Ranking Member
Boswell, and Members of the Subcommittee, my name is Michael
Bodson and I am COO of the Depository Trust & Clearing
Corporation. DTCC is creating global trade data repository
system for all swap asset classes, including interest rates,
credit default swaps, foreign exchange, and commodities. We
applaud the leadership of this Subcommittee and the sponsors of
the bills--Representatives Sewell and Crawford--for holding
today's hearing on bipartisan legislation to ensure effective
swap transaction reporting for monitoring systemic risk in
global financial markets.
DTCC has been working diligently with regulators in the
United States and globally to address these issues, but it is
clear that a legislative fix is needed. Today, I will address
two technical provisions in the Dodd-Frank Act that make it
more difficult for regulators around the world to share
information. They are referred to as indemnification and
plenary access and both may result in data fragmentation.
The first issue, indemnification, is an immediate problem.
Many regulators worldwide are unable or unwilling to provide an
indemnity agreement. The concept of indemnification is
unfamiliar to them and inconsistent with their traditions and
legal structures. More plainly, though, foreign government
agencies will not indemnify private, third-party entities such
as SDRs. The indemnification provision is also not needed in
light of the current international data sharing guidelines
developed through the cooperative efforts of more than 40
regulators worldwide, including the CFTC, SEC, and Federal
Reserve.
Without an indemnity agreement, U.S.-based repositories
would be legally prohibited from providing regulators outside
the United States with market data on OTC derivative
transactions under their jurisdictions. The clear risk is that
global supervisors will have no viable option other than to
fragment data globally by creating local repositories to avoid
indemnification.
DTCC strongly supports H.R. 4235, which would remove the
indemnification provisions from Dodd-Frank and make U.S. law
consistent with existing international protocols. This
legislation will go a long way to ensuring global regulators
can effectively monitor systemic risk. However, resolving
indemnification without addressing the second issue, plenary
access over the data held within an SDR, still makes it likely
that swap data will be fragmented by jurisdiction. Addressing
both issues concurrently can preempt the future crisis for
information sharing.
Dodd-Frank gives U.S. regulators direct electronic access
to data held by the SDR. This provision was intended to insure
immediate access to swap data in machine-readable format.
However, non-U.S. regulators are concerned that direct
electronic access may be interpreted too broadly by the U.S.
agencies to gain plenary access to all swap data they hold,
including data for transactions with no identifiable nexus to
U.S. regulation. This is unworkable because the scope of an SDR
can be broader than just U.S. data and regulators should have
access to only that data to which they have a material
interest. Concerns over plenary access will again lead to data
fragmentation.
DTCC fully supports regulators having plenary access for
SDR supervision activities related to the operation of the SDR
and transactions held within it with a U.S. nexus. However, we
oppose plenary access for other purposes because non-U.S.
financial firms executing transactions without a U.S. nexus
will avoid reporting their trade data to a global repository if
that data could become subject to U.S. regulatory access.
As an example, global data may be held in the United States
for purposes of aggregation for public transparency and system
risk oversight. However, if this leads to U.S. regulators
claiming access to non-U.S. transactions, foreign participants
and regulators will raise concerns over confidentiality and
prevent the data from being aggregated. If data fragmentation
occurs, regulators, including the SEC, CFTC, and Office of
Financial Research will face the daunting and time-consuming
challenge of having to aggregate data from multiple
repositories for purposes of market oversight and systemic risk
mitigation.
Additionally, in meetings with regulators worldwide over
the past year, these supervisors have said they will not permit
the use of a U.S.-based trade repository for its domestic
transactions if there are asymmetric access rights and no
protection of confidentiality for the market participants.
To illustrate the combined impact of these provisions,
let's examine the case of two British banks executing an
interest rate swap in the UK involving the Euro. There is no
direct U.S. connection. Under plenary access, if the trade was
reported to a European-based global repository but the
transaction was sent to the United States for aggregation, U.S.
regulators could claim a legal right to view data on this
transaction even though the U.S. regulator has no material
interest in it. Even worse, the indemnification provision could
require the British regulator to indemnify the U.S.-registered
SDR to access the same data despite the fact that the entirety
of the trade falls within the British regulators' jurisdiction.
Mr. Chairman, the issues of indemnification and plenary
access must be dealt with together to prevent data
fragmentation from occurring. Congress needs to address plenary
access by clarifying the intent of the statute and reinforcing
that regulators only have access to the data in which the
regulator has a material interest. By amending and passing the
H.R. 4235 to ensure technical corrections to both
indemnification and plenary access, Congress will create the
proper environment for the development of a global trade
repository system to support systemic risk management and
oversight.
Thank you for your time this morning.
[The prepared statement of Mr. Bodson follows:]
Prepared Statement of Michael C. Bodson, Chief Operating Officer,
Depository Trust & Clearing Corporation, New York, NY
Chairman Conaway and Ranking Member Boswell:
Thank you for scheduling today's hearing on Representatives Rick
Crawford (R-AR) and Terry Sewell's (D-AL) bipartisan legislation,
introduced with Representatives Robert Dold (R-IL) and Gwen Moore (D-
MI), to address the indemnification provisions and modify the
confidentiality requirements in the Dodd-Frank Wall Street Reform and
Consumer Protection Act (DFA). I appreciate the opportunity to testify
and bring greater attention to the unintended consequences of these
provisions, which have the potential to fragment the current global
data set for over-the-counter (OTC) derivatives and derail efforts to
increase transparency and help regulators mitigate risk in this
marketplace.
Over the past year, DTCC, among others, has been raising concerns
over the impact of the DFA's broad extraterritorial reach, particularly
as it relates to the confidentiality of market data and the
indemnification agreement provisions of the law. These concerns have
been echoed by regulatory officials and policymakers globally,
including by Representatives of the European Parliament, European
Commission and Council, by Asian governments and by both Republican and
Democratic Members of the U.S. Congress.
The House Agriculture Committee's leadership is vital as there is a
clear need to shine a light on these technical provisions of the DFA--
provisions that, if not addressed, risk decreasing the current level of
transparency into OTC derivatives markets. Having a bipartisan group of
Members in both the House and Senate recognize the unintended
consequences of these provisions and commit to working within Congress
and with policymakers internationally to develop a mutually agreeable
resolution is very promising.
Two Important DFA Extraterritorial Provisions Require Congressional
Action
The two key extraterritorial provisions in the DFA that risk
fragmenting global swap data are the confidentiality and
indemnification provisions and the so-called ``plenary access'' duties
imposed on swap data repositories (SDRs). These issues merit further
examination by Congress and require legislative resolution.
First, Sections 728 and 763 of the DFA require SDRs registered with
the Commodity Futures Trading Commission (CFTC) or Securities and
Exchange Commission (SEC) to receive a written agreement from ``third-
party'' non-U.S. regulators confirming that the supervisory agency
requesting the information will abide by certain confidentiality
requirements and indemnify the SDR and the regulating U.S.
Commission(s) for any expenses arising from litigation relating to the
information.
Second, the duties imposed on a registered SDR--both with the CFTC
and the SEC--require, among other things, that the SDR provide ``direct
electronic access to the Commission (or any designee of the Commission,
including another registered entity).'' The phrase ``direct electronic
access'' has been identified by non-U.S. regulators as problematic
because it creates an unnecessary degree of ambiguity and may be
interpreted by the regulatory agencies and others as a requirement that
a registered SDR must provide access to all swap data retained by the
SDR--even when that SDR might maintain swap data for transactions with
no identifiable nexus to U.S. regulation.
The concern that a U.S. regulator might demand data that falls
wholly outside its jurisdiction as part of its ``direct electronic
access,'' coupled with the lack of clear extraterritorial guidance from
the CFTC and the SEC, would functionally prevent non-U.S. SDRs from
registering in the United States. If this occurs, swap data would
fragment across jurisdictions and frustrate regulators' abilities to
monitor global systemic risk.
Plenary Access & Indemnification in Dodd-Frank: Solving a Problem That
Does Not Exist
The original indemnification and plenary access provisions, while
well-intended, are unworkable as currently drafted and threaten to undo
the existing system for data sharing that was developed through the
cooperative efforts of more than 50 regulators worldwide under the
auspices of the OTC Derivatives Regulators' Forum (ODRF) and, more
recently, taken up by the Committee on Payment and Settlement Systems
and the International Organization of Securities Commissions (CPSS
IOSCO).
For nearly 2 years, regulators globally have followed the ODRF
guidelines to access the information they need for systemic risk
oversight. It is the standard that DTCC uses to provide regulators
around the world with access to global credit default swap (CDS) data
in its Trade Information Warehouse (TIW), which holds more than 98% of
all CDS trades globally. It is accurate to say that the plenary access
and indemnification provisions attempt to solve a problem that does not
exist--and, in doing so, create several new problems that heretofore
did not exist.
Asian and European regulators have identified indemnification and
plenary access as among the most troubling extraterritorial provisions
of the DFA because of their potential to fragment the current global
data set for OTC derivatives. They recognize, as do many Members of the
House and Senate here in the United States, that these provisions would
reduce the level of transparency that currently exists in these
markets.
In an effort to avoid unintended consequences, European
policymakers specifically considered and rejected an identical
indemnification requirement in the European Market Infrastructure
Regulation (EMIR). This was a positive development because, as the SEC
noted in testimony before the House Financial Services Committee last
week, the agency ``would be legally unable to meet any such
indemnification requirement and has argued vigorously against similar
requirements in other contexts.'' The CFTC would have a similar
challenge.
In addition, the early EMIR texts in Europe, which called for
``direct access,'' were amended to call for ``immediate access.'' In
Asia, the Monetary Authority of Singapore (MAS) has indicated in its
public consultation that it will align its regulations with the
Europeans in this area, and we expect the Japanese FSA, whose draft
regulations are due shortly, to be similarly aligned. However,
policymakers in Hong Kong have responded by beginning to move forward
with the development of a national repository for its swap data.
Indemnification Would Fragment the Global Data Set and Impede
Regulatory Oversight
It is highly unlikely third-party regulators will comply with the
DFA requirement that they must provide indemnification in order for
U.S.-registered SDRs to share critical market data with them for two
primary reasons.
First, the concept of indemnification is based on U.S. tort law
and, therefore, inconsistent with many of the traditions and legal
structures in other parts of the world. Many regulators worldwide have
indicated that they would be unable or unwilling to provide an
indemnity agreement to a private third party as required under the DFA.
Second, these same regulators have noted that they are already
following policies and procedures to safeguard and share data based on
both the ODRF and IOSCO's Multi-Lateral Memorandum of Understanding.
Without an indemnity agreement, U.S.-based repositories may be
legally precluded from providing regulators outside the U.S. with
market data on transactions that are under their jurisdiction. The
clear risk is that global supervisors will have no viable option other
than to create local repositories to avoid indemnification--a move that
is the definition of data fragmentation. While each jurisdiction would
have an SDR for its local information, it would be extremely difficult
and time consuming to effectively share information between regulators.
A proliferation of local repositories would undermine the ability
of regulators to obtain a comprehensive and unfragmented view of the
global marketplace. If a regulator can only ``see'' data from the SDR
in its jurisdiction, then that regulator cannot get a fully aggregated
and netted position of the entire market as a whole. And if a regulator
cannot see the whole market, then the regulator cannot see risk
building up in the system or provide adequate market surveillance and
oversight. In short, regulators will be blind to market conditions as a
direct result of the indemnification provision. In the name of
transparency, this provision creates opacity.
The CFTC and the SEC have carefully reviewed the impact of the
indemnification provision and in a joint report concluded, ``Congress
may determine that a legislative amendment to the indemnification
provision is appropriate.''
Furthermore, the SEC testified in support of removing the
indemnification provision from the DFA during a hearing of the House
Financial Services Capital Markets Subcommittee last week. The agency
said the ``indemnification requirement interferes with access to
essential information, including information about the cross-border OTC
derivatives markets. In removing the indemnification requirement,
Congress would assist the SEC, as well as other U.S. regulators, in
securing the access it needs to data held in global trade repositories.
Removing the indemnification requirement would address a significant
issue of contention with our foreign counterparts, while leaving intact
confidentiality protections for the information provided.''
Plenary Access: Congress Needs to Clarify Intent of Statute and Rules
Direct oversight is necessary to ensure thorough examination of the
SDR's operations, guaranteeing the completeness and accuracy of the
data published by the SDR. This type of access, which could more easily
be achieved by imposing a statutory books and records obligation
related to the operation of the SDR, is distinct from that required by
non-supervisory regulators who rely upon the SDR's data for systemic
risk oversight. The level of access to an SDR's data should reflect the
purpose for which a regulator seeks to review the SDR's information and
remain within the regulator's authority.
The DFA rules proposed and adopted by the CFTC and SEC are helpful,
but they do not adequately address this problem. The concern remains
that it can be interpreted too broadly, giving U.S. regulators access
to data in which a U.S. nexus does not exist.
While DTCC fully supports regulators having plenary access for SDR
supervision activities, we oppose plenary access for other purposes
because, as a result of this provision, non-U.S. financial firms
executing transactions without a U.S. nexus will avoid reporting their
trade data to a U.S.-registered SDR. Much like indemnification, plenary
access would fragment swap transaction data across countless
repositories that reside around the world, frustrating systemic risk
oversight efforts.
In the course of dozens of meetings with global regulators,
including discussions we held last week in several Asian countries and
at the ODRF, non-U.S. supervisors have consistently indicated that they
will not permit the use of a U.S.-based trade repository for its
domestic transactions if there are asymmetric access rights and no
protection of the confidentiality for their market participants,
particularly their private individual and sovereign data.
If data fragmentation occurs, U.S. regulators like the SEC would
face the daunting, expensive and time-consuming challenge of having to
aggregate data with a U.S. nexus for purposes of market oversight and
surveillance and systemic risk mitigation. This creates several
significant burdens for the agency, including (1) the need to develop
and enter into information-sharing agreements because current Memoranda
of Understanding (MOU) limit transfer of data for only certain
situations, such as market abuse investigations, and (2) the need to
harmonize their rules with the European standard of equivalent
recognition contained in EMIR.
Data fragmentation would also impose a significant financial burden
on the SEC, CFTC as well as the Office of Financial Research (OFR),
which would be responsible for aggregating and standardizing data and
resolving issues of data omission and duplication. Furthermore, the
resulting fragmentation of data would negatively impact systemic risk
analysis--if not make it completely impossible.
DTCC has analyzed potential methods to resolve this complicated
issue and remains ready and willing to assist legislators in fashioning
a remedy to ensure regulators can access the information they need.
Congress should seriously consider finding an appropriate legislative
solution that clarifies that U.S. regulators may access the swap data
of its registrant SDRs only to the extent necessary to perform its
oversight and surveillance responsibilities or to regulate the
operation of the SDR.
Within the context of considering legislation that would repeal the
indemnification provisions, addressing the concerns over plenary access
would complement these efforts and help create a framework for global
swaps data that is accessible to regulators in the United States and
around the world. The goal of any amendment to the bill should be to
appropriately position the DFA and U.S. regulators on plenary access.
The SEC, CFTC, foreign regulatory agencies, governmental staff and
lawmakers should be more comfortable that the intent of the ultimate
regulatory interpretations of statute is designed to respect privacy
and confidentiality, where there is no risk to the U.S. financial
system.
Indemnification and Plenary Access: A Case Study
To illustrate the combined impact of indemnification and plenary
access and underscore why it has emerged as a major source of concern
for regulators worldwide, let's examine the case of two British banks
executing an interest rate swap in the UK involving a Sterling
reference rate. Under the plenary access provision, if the trade was
reported to a UK-based but U.S.-registered SDR, U.S. regulators could
claim, as the regulator of the SDR, a legal right to view data on this
transaction--even though the U.S. SDR regulator has no material
interest in the counterparties, the transaction, or the underlying
entity (as opposed to a Prudential Regulator seeking data for market
oversight purposes). To compound the situation, the indemnification
provision would require the British regulator to indemnify the U.S.-
registered SDR in order to access this same data--despite the fact that
the entirety of the trade falls within the British regulator's
jurisdiction.
Just as a U.S. regulator would not be inclined to have sensitive
data on U.S. trades available to non-U.S. supervisors--or, for that
matter, have to provide indemnity to access data that is rightly theirs
to view--regulators globally consider this extraterritorial reach
inappropriate and inconsistent with widely established and agreed upon
data sharing practices.
In contrast, under both the current ODRF guidelines that have
served regulators and the markets well, supervisors are authorized to
access data where there is a nexus to the jurisdiction or entity.
Therefore, U.S. regulators can view data where there is a U.S. nexus
and, equally, British regulators can view data with a UK nexus. And in
no case is an indemnification agreement needed before access to data is
provided.
``Swap Data Information Sharing Act of 2012'': A Potential Legislative
Solution
The Swap Data Information Sharing Act of 2012 (H.R. 4235),
introduced by Representatives Dold, Moore, Crawford and Sewell, would
make U.S. law consistent with existing international protocols by
removing the indemnification provisions from sections 728 and 763 of
the DFA. DTCC strongly supports this legislation, which represents the
only viable solution to the unintended consequences of indemnification.
The Swap Data Information Sharing Act of 2012 is necessary because
the statutory language in the DFA leaves little room for regulators to
act without U.S. Congressional intervention. This point was reinforced
in the recent CFTC/SEC Joint Report on International Swap Regulation.
The Report noted that the Commissions ``are working to develop
solutions that provide access to foreign regulators in a manner
consistent with the DFA and to ensure access to foreign-based
information.'' It goes on to say, as noted earlier, ``Congress may
determine that a legislative amendment to the indemnification provision
is appropriate.''
This bill would send a strong message to the international
community that the United States is strongly committed to global data
sharing and determined to avoid fragmenting the current global data set
for OTC derivatives.
However, resolving indemnification without addressing plenary
access leaves open the likelihood that global swap data will be
fragmented by jurisdiction. The two pieces must be dealt with together.
Resolving one without the other does not diminish the likelihood of
data fragmentation occurring. While this legislation is a strong step
in the right direction, it is one of two key technical corrections that
is required to ensure regulators continue to have the highest degree of
transparency into OTC derivatives markets.
Congress needs to address the issue of plenary access by simply and
clearly clarifying the intent of the statue and reinforcing that
regulators have access to the data in which the regulator has a
material interest. We are pleased that several Members of the House
Capital Markets Subcommittee voiced their concerns with plenary access
during last week's hearing on H.R. 4235 and indicated their interest in
crafting a legislative solution to address this problem. We stand ready
to work with them and their colleagues on a technical correction to
clarify the intent of the law.
Toward that end, under the attached suggested amendment, which
would add the so-called ``books and records'' provision to the law,
regulators in the U.S. would continue to have full and complete access
to any and all data to which there is a U.S. nexus and according to
their regulatory domain. This would align U.S. policy with the current
global data sharing standards that have been in place since 2010 and
which have provided regulators with all of the information needed to
oversee market participants and activity in their jurisdiction.
By amending and passing this legislation to ensure that technical
corrections to both indemnification and plenary access are addressed,
Congress will help create the proper environment for the development of
a global trade repository system to support systemic risk management
and oversight.
Bipartisan, Bicameral Congressional Support for Resolving
Indemnification
As the unintended consequences of the indemnification provisions
have been brought to light, there is bicameral, bipartisan support to
resolve this issue. For example, Senator Agriculture Committee
Chairwoman Debbie Stabenow (D-MI) and Ranking Member Pat Roberts (R-
KS), and House Appropriations Agriculture Subcommittee Congressman Jack
Kingston (R-GA) and Ranking Member Sam Farr (D-CA), authored separate
letters last year to their counterparts in the European Parliament
expressing interest in working together on a solution to the issue.
In addition, several other Members of Congress have also publicly
declared their support for a technical correction to the provision. As
CFTC Chairman Gary Gensler indicated in testimony to this Committee in
June 2011, both he and SEC Chairman Schapiro have written to European
Commissioner Michel Barnier regarding the indemnification provisions of
the DFA and are currently engaged in efforts to find a solution to the
challenges of this section.
DTCC Has Deep Experience Operating Global Trade Repositories
DTCC currently operates two subsidiaries specifically responsible
for providing repository services to the global derivatives community:
the TIW operated by The Warehouse Trust Company LLC for credit
derivatives, a U.S. regulated entity; and DTCC Derivatives Repository
Limited (DDRL) for equity derivatives, a UK regulated entity.
In response to the G20 commitments made at the September 2009
Pittsburgh Summit, the Financial Stability Board (FSB) Report on OTC
Derivatives Market Reform, and forthcoming statutory legislation in
various jurisdictions, the international financial community recently
selected DTCC's DDRL entity to provide global repository services for
interest rates and FX swaps. DTCC also was selected to operate the
commodities repository (together with the European Federation of Energy
Traders) under its newly established Netherlands entity, Global Trade
Repository for Commodities B.V.
DTCC is working closely with global partners and asset class
experts to design repositories to meet the regulatory reporting
requirements identified in the respective regional or national
jurisdictions. DTCC has completed its first phase of creating and
operating the new Global Trade Repository for Interest Rates (GTR for
Rates) and Commodities (GTR for Commodities). The GTR for Rates
recently began regulatory test reporting. DTCC is currently in
discussions with industry and regulatory authorities, developing
consensus on the right framework for the GTR for Commodities'
reporting.
DTCC has extensive experience operating as a trade repository and
meeting transparency needs. In November 2008, in response to mounting
concerns and speculation regarding the size of the CDS market following
the collapse of Lehman Brothers, DTCC began public aggregate reporting
of the CDS open position inventory. Today, this reporting includes open
positions and volume turnover, providing aggregate information that is
extremely beneficial to both the public and regulators in understanding
the size of the market and activity.
Further, following the ODRF data access guidelines for the TIW,
DTCC launched a regulatory portal in February 2011, which provides
automated counterparty exposure reports and query capability for market
and prudential supervisors and transaction data for central banks with
aggregate report views by currency and concentration. Nearly 40
regulators world-wide have signed up to the portal. DTCC plans to
expand on this portal as it launches its global trade repository
services for the other asset classes.
Thank you for your time and attention this morning. I am happy to
answer any questions that you may have.
The Chairman. Well, thank you so much, I appreciate those
opening remarks. The chair will remind Members they will be
recognized for questioning in order of seniority for Members
who were here at the start of the hearing. After that, Members
will be recognized in order of arrival and I appreciate the
Members' understanding.
All right. I will reserve my time for the end and will
recognize Mrs. Ellmers--you were here next--for 5 minutes.
Mrs. Ellmers. I would like to ask a question of Mr. Bodson
since we were talking about the plenary access in your
testimony, and basically, you argue that this legislation,
there is a need to change the plenary access provisions in
addition to indemnification, why aren't the actions of the
agency sufficient? Can you restate again for us why you feel it
is not sufficient?
Mr. Bodson. Well, I think there is legal uncertainty with
global regulators over the issue of plenary access. It is in
the legislation. People respect the law. And while we are
working with both the CFTC and SEC to clarify their approach,
the level of certainty that is encompassed in having
legislation fix the issue and clarify exactly what plenary
access means would provide a great level of comfort and avoid
the data fragmentation. So it really is a legislative issue.
Mrs. Ellmers. Yes.
Mr. Bodson. Legislation should fix it.
Mrs. Ellmers. Okay. For Mr. Bailey and Mr. Saltzman, as you
know, the CFTC recently finalized a swap dealer registration
rule. In the absence of guidance on the territorial scope of
Dodd-Frank, how are you preparing to comply with the rule once
it is in effect? And I will start with Mr. Saltzman and then
Mr. Bailey.
Mr. Saltzman. I think our member banks are engaged in a
duplicative exercise of planning for every possible
contingency. Obviously, our members are committed to complying
with the law, but unfortunately, the regulatory agencies have
not yet issued any pronouncement, and it is very, very
difficult. There are corporate structural issues, there are
documentation issues----
Mrs. Ellmers. Yes.
Mr. Saltzman.--capital issues, funding issues, and
unfortunately, banks and swap dealers are having to plan for a
multiplicity of contingencies, which obviously adds a layer of
inefficiency and cost. But there is tremendous legal
uncertainty right now, which is why we urge the Committee to
swiftly pass H.R. 3283.
Mr. Bailey. I agree with the comments of Mr. Saltzman. This
issue is presenting some very real difficulties for a number of
international banks who do not know which entities they need to
register----
Mrs. Ellmers. Yes.
Mr. Bailey.--the extent of that registration requirement,
and the obligations that registration brings in terms of
requirements to have accounting requirements, a compliance
officer, and a whole variety of regulations that rightly stem
from registration. It is impossible to properly assess which
entities you register. And that can affect the entire structure
of the business. So we think this is unfortunate. The approach
that I think the banks have little option but to take is to
explore every avenue as to which may wind up that they have to
do something that is unexpected. So they are having to ready
themselves for every outcome and that is an expensive exercise.
Mrs. Ellmers. Sure. That is very difficult to do.
And I have a little more time so, Mr. Vice, do you
anticipate that the U.S. rules governing clearinghouses will be
comparable to the regulations in foreign jurisdictions and what
is the risk if they are not?
Mr. Vice. I think we are very concerned about that. The
United States is pretty far out in front of the rest of the
world, we operate a large clearinghouse in the UK, clearing
CDS, commodities, and so, as managers of those businesses, we
are trying to plan--we are looking at Dodd-Frank capital
requirements for members, all of the other implications there.
That clearinghouse is also a U.S. DCO, which means that it is
registered with the CFTC and capable of clearing U.S. swaps
businesses as well as U.S. futures. So that kind of dual
registry, which is important for serving global markets like
commodities, like FX, it is going to be critical that those
rules are harmonized and that they are as close as possible.
Otherwise, it is going to be pretty messy quite honestly.
I think there is a good history between the CFTC and the
FSA in terms of mutual recognition, cooperation, information
sharing, recognition of comparable regulation not exactly the
same regulation, and so our hope is that as the rulemaking
continues that there will be some harmonization there.
Mrs. Ellmers. Great, thank you.
Mr. Chairman, I yield back the remainder of my time.
The Chairman. The gentlelady's time has expired. Mr.
Boswell for 5 minutes.
Mr. Boswell. Well, thank you, Mr. Chairman.
A couple of questions and we have had several Members
arrive, so I want them to have some time.
The whole panel, those supporting H.R. 3283, in the past
our regulators and foreign regulators have worked together to
respect each other's respective jurisdictions and, in the words
of Mr. Vice, lead to greater harmonization of regulation yet
allow foreign regulators to oversee their institutions. Is
there anything in the law that prevents the regulators from
continuing this approach? The language of concern that you cite
has not been interpreted yet by the CFTC and the SEC. Can they
not read the language in a manner consistent with this past
cooperative approach of foreign regulators? We will just go
across. I would like for all to comment if you care to. Mr.
Vice?
Mr. Vice. Is the question is there anything preventing
regulators from cooperating in the future as they have in the
past? Not to my knowledge.
Mr. Boswell. Can they?
Mr. Vice. Can they? I think they can. I think from a
practical standpoint as we sit here today, regulators--
certainly the FSA and the CFTC--are struggling with staffing.
There is a lot of attrition in those agencies. They are
struggling with budget challenges while they are trying to
write rules, anticipate unintended consequences, and then
probably last on the list is harmonizing with international
regulators. So it is an enormous amount of work that they are
having to do in a very short amount of time.
Mr. Saltzman. Several agencies are involved in the picture.
It is the SEC, the CFTC, the Fed. Obviously, we have been
focusing an awful lot on the UK regulators but the derivatives
market is a global marketplace, and as we indicated, legal
certainty is critically important. So even if you could get to
that normative goal of perfect harmonization, you have a
sequencing and timing issue where the United States is readily
apace at appropriately adopting many of the implementing
regulations that provide the protections that we support, but
you do have complexities as a result of that timing. So legal
certainty at a statutory level would bring together the
agencies and provide clarity to the marketplace.
Mr. Bailey. And as you know, the provision in the statute
requires that the regulators reach out and try to reach
harmonization with the international regulators. I think that
they are attempting to do that. It is a challenging issue which
is accentuated by the timing differences that are arising
between the U.S. rules and the rules that are coming into play
in Europe and Asia, but there is absolutely a requirement that
they do so and we believe that that is an achievable objective.
Mr. Bodson. I think it is more H.R. 4235. I think the
uncertainty that has been created for the indemnification and
the plenary access issues breach this trust to a certain extent
and puts up barriers to global cooperation. And the issue of
data fragmentation is very much about everybody being able to
see the data or the information they should see as a regulator,
while also providing global systemic risk management. But when
there are rules that appear to allow U.S. regulators to have a
farther reach than their global colleagues may have,
cooperation starts to fail.
Mr. Boswell. Thank you, Mr. Chairman. I yield back.
The Chairman. The gentleman yields back.
Mr. Huelskamp, 5 minutes.
Mr. Huelskamp. Thank you, Mr. Chairman.
A question for all the members of the panel, we have been
hearing about increased risk that foreign countries are
threatening to potentially retaliate for U.S. actions on
financial reform they may view as an overreach. In your
opinion, do these threats in fact exist and how and where would
you think the risk is the greatest, and what could be a
potential response on our side to avoid that? I open that to
anyone who would like to answer that question.
Mr. Bodson. Well, we saw in the European draft and your
legislation that when they saw the indemnification and the
plenary access issues, they were putting similar wording into
their legislation. They have since pulled back from that. Other
countries have followed suit such as Singapore, but that
possibility of it arising again could always be out there. We
have seen Hong Kong for a variety of reasons but one of which
is the indemnification issue choose to go with a local
repository and again starts the process of data fragmentation.
Now we are working with them to get feeds of information in so
there is a global view when there are global products involved.
But you see the instance is already there, so we are working
with legislators to get the wording out, but they are
retaliating. And rather than taking an offensive stance on
this, I think this is one where by fixing the issues here in
legislation we avoid having the retaliation, or the issue come
up at all.
Mr. Heulskamp. Okay.
Mr. Bailey. I agree with that. I would also note that in
the earlier legislation that was recently agreed in Europe
which deals principally with the clearing issue and the market
infrastructure issues, at the last minute they introduced a
provision which is extremely comparable to the Dodd-Frank
extraterritorial provision, that the language is very slightly
different but it deals with direct and foreseeable impact on
the EU. It allows another regulatory body to impose a clearing
in uncleared margin of requirements on transactions that are
outside the EU, which meet that standard and are having a
direct and foreseeable impact on the EU. Our understanding is
that was inserted as a cautionary available tool to allow them
to take essentially whatever action the United States--at least
the interpretation of Dodd-Frank may choose to direct towards
Europe. It is a very real risk that the Europeans will take a
corresponding view on wherever the United States lands on this
issue.
Mr. Heulskamp. Yes. Mr. Bodson?
Mr. Bodson. Just prudentially, there are appropriate
theories for the jurisdictional nexus and it really requires
some nexus to the United States. And, as we hear from some of
the domestic regulators, they really are breaking new ground,
possibly regulating overseas activities that will undoubtedly
result in retaliatory measures. It is literally breaking ground
by regulating activities that have no foreseeable nexus to the
United States. I think it should be a source of concern for
everyone.
Mr. Heulskamp. I yield back. Thank you, Mr. Chairman.
Mr. Bailey. Maybe just one more point. In relation to the
Volcker Rule, which is obviously a very different context, I
think you have seen a sense of the regulatory response from the
offshore regulators as to the potential impact that that will
have on their shores and on their markets. And last, it is a
different context. I think it sets the tone.
Mr. Heulskamp. Okay. Thank you.
The Chairman. I thank the gentleman.
Ms. Sewell for 5 minutes.
Ms. Sewell. First, I would like to thank the Chairman
Conaway as well as Ranking Member Boswell for having this
hearing today and to our witnesses for testifying before us.
This hearing has given us the opportunity to really hear
from practitioners in the area of swaps and understand better
why modifications to the confidentiality in the swap
jurisdiction requirements in Dodd-Frank need to be made. As we
continue to move forward with the rulemaking and implementation
process provisions of Dodd-Frank, we must be mindful of the
original purpose and intent behind the passage of such
legislation. Dodd-Frank was intended to provide more
transparency and oversight to our financial markets and to
ensure that another financial crisis and meltdown does not
occur.
I want to applaud the diligent work of both the CFTC as
well as the SEC in drafting and implementing critical new
regulations. And I also would like to remind Members of
Congress that we must continue to make sure that we hone and
refine and clarify any provisions that may be unintended
consequences of such regulation.
Having said that, as a former practitioner in the
securities industry--I was a lawyer at Davis Polk & Wardwell
for over 7 years--and as a practitioner myself drafting swap
contracts as well as derivatives, I understand fully the
implications of the unintended consequences with respect to
especially the indemnification provisions that are currently
being required by Dodd-Frank. And that is why I am a cosponsor
of H.R. 4235.
My comments or questions are really directed to Mr. Bodson.
I want you to talk a little bit more about the systemic risks
involved in not correcting the indemnification provisions as
well as helping to eliminate data fragmentation, and talk a
little bit more about the data fragmentation that would occur
if we don't correct that provision.
Mr. Bodson. Sure. Thank you very much. Transparency of
accurate and comprehensive data is a very powerful tool for the
markets and for regulators. Uncertainty over that data breeds
risks and breeds inappropriate actions. So let's roll the clock
back a little bit and go back to the Lehman event and that
weekend when the markets obviously were in a state of flux and
high anxiety. There were market rumors about what was going to
be happening with Lehman, whether Barclays was going to buy
portions of the business and the debt.
And if you think back to that weekend in September of 2008,
you had The Washington Post and The Financial Times and The New
York Times started speculating about what would the level of
payments that were going to be made on credit default swaps on
Lehman debt. And the numbers started going from $50 billion to
$100 billion to $200 billion and it culminated with a $400
billion number. You could see the markets starting to quiver
saying, where is everybody going to come up with $400 billion
given what was going on in the marketplace? At that point,
Federal Reserve Bank of New York President Geithner was asking,
what is the real number? As a result of a trade information
warehouse we have for credit default swaps, we knew with a
pretty high level of certainty that the actual number was $6
billion. We knew because we had a comprehensive database of
global positions. It was clean data, it was active data, and we
knew the number was a very accurate number so we issued a press
release. And you could see the tension going down immediately.
It is just an example of what happens when you know you
have a certainty over a number that you can provide the markets
and the regulators with a clear picture of what is happening.
If that $400 billion number had continued to float out there,
the Asian markets would have melted down and it would have just
exacerbated what was already a horrible situation in the
marketplace. So comprehensive global data gives regulators the
ability to manage systemic risk. They still have the access to
the underlying data for their constituents or their parties of
interest, but having that global view allows things to be put
into context. If it starts fragmenting, putting the pieces
together again; it is Humpty Dumpty revisited.
Ms. Sewell. Thank you for that. I understand that your
company is currently operating a trade repository for credit
default swaps. Can you please explain the impact of the
indemnification and plenary access requirements on how your
company shares information with global regulators?
Mr. Bodson. Sure. There has been a great level of global
cooperation through the OTC Derivative Regulators Forum, this
group of 40 regulators who have come together to create a
protocol and the CFTC, SEC, and the Fed have all been involved
in creating that protocol to allow regulators to come in and to
get comprehensive data on credit default swaps. They go to one
place. They come in through what we call a regulatory portal.
They can do their inquiries as to the parties of interest and
get that information back immediately. If we did not have the
trade information warehouse, they would not be able to do that.
They would have to go to repositories around the world, pull
the information together, get rid of duplicative transactions,
try to standardize the data schemas. They would never be able
to get a comprehensive view on a regular day much less during a
period of stress. Right now, they get it.
Ms. Sewell. Thank you so much for your testimony.
Mr. Bodson. Thank you.
The Chairman. I recognize Mr. Neugebauer for 5 minutes.
Mr. Neugebauer. Thank you, Mr. Chairman. This is a question
for Mr. Bailey and Mr. Saltzman. You know, commodity swaps
particularly for agricultural products are very important to
producers in my Congressional District and other Members, and
it would be interesting to see what your perspective on Section
716 and what its effects if any it would have on hedging
opportunities for the farmers and ranchers?
Mr. Bailey. Section 716 as you know would require the push-
out of the commodity business into a subsidiary, which is not
having access to discount window. And the cost of doing that is
multiple. That decision would have to be independently
capitalized. And that isn't a zero-sum game. That isn't simply
a matter of moving capital from the exiting bank and putting it
into the subsidiary. It is an additive requirement. That
subsidiary would have to meet basic creditworthiness in order
to be a sustainable counterparty to the agricultural community.
It is unfavorable in terms of the risk management treatment
both on the client side and the bank side. It requires
additional dedicated risk management people. And we see this is
a very real concern in terms of its translation into higher
costs.
I can certainly speak for Barclays, who is a meaningful
player in the space in the commodities markets. We are quite
concerned about that issue in terms of what it would do to our
ability to provide the kinds of prices that we do currently to
our customers. And obviously that isn't simply a matter of the
trading customers or investment banking clients for whom we
transact significant deals where the kind of larger hedges that
attain to those and are important to be able to be done.
Otherwise, the transaction really is at risk of failing to
achieve completion.
So we think that your question is very pertinent and it is
something that will translate to significant increased costs
for those banks that are having to move down that subsidiary
route. It is possible that others will find that it is simply
too expensive a proposition to do that and may in fact find
themselves with little options but to withdraw from the
marketplace which gives the customers less ability to clear as
market participants.
Mr. Neugebauer. Mr. Saltzman?
Mr. Saltzman. I would just add a few thoughts. Clients lose
the benefit of setoff and netting, which is likely to
artificially increase collateral and margin requirements to the
benefit of no one. You also have various operational risks
associated with the segregation of both--as Mr. Bailey said--
from a bank's perspective as well as from the end-user's
perspective. A whole new set of documentation, a whole new set
of parameters around that really to no advantage. You are
really creating just a completely duplicative architecture that
in and of itself is likely to increase costs substantially to
the end-user, and in some cases obviously crowd out those who
are at the edge in terms of the price and cost-benefit.
Mr. Neugebauer. So I wanted to kind of say back, what I
heard: there are really two costs. One probably would increase
the transactional cost because you have to go and duplicate the
capital structure and the architecture in another entity, but
second, that some current market participants may just decide
not to make a market or to be involved in those activities. Is
that a possibility?
Mr. Saltzman. Very much so. I would also add from the swap
dealer's perspective, you are materially increasing operational
risks, and as Mr. Bailey said, risk management, risks which in
and of itself would also translate into credit appetite, which
in and of itself could have an inhibiting impact on providing
the investing and hedging activities that swap dealers do need
to provide to commodity end-users.
Mr. Neugebauer. Mr. Bailey, do you want to amplify on that?
Mr. Bailey. I agree with your assessment.
Mr. Neugebauer. Thank you very much, Mr. Chairman. I yield
back.
The Chairman. The gentleman yields back. Mr. Scott for 5
minutes.
Mr. Scott. Thank you very much, Mr. Chairman. You know, no
legislation is ever perfect, especially one that is as large
and as complex in scope as Dodd-Frank is, and as such, we
shouldn't be afraid to revisit the issue, make changes and
alterations where they are due. And the bills before us do just
that on swap jurisdiction, repeal of Section 716, and the swap
data repository clearinghouse indemnification. They are, in
large part, just clarifications and revisions that do not
undermine the letter or the spirit of this historic financial
reform bill that was passed by this body and of which I am a
cosponsor.
I also think it is worth noting that the manner in which
these bills were evolved, this is very important. The sponsors
of these bills and their staff, both on the Majority and the
Minority side of the aisle in this Committee and in the
Committee on Financial Services, both of which I serve on,
worked very closely together and with great consideration to
one another's concerns to ensure that these bills were narrow,
that they were targeted and addressed real problems. And that
is why we have seen these bills move with strong bipartisan
support, including mine through the Committee on Financial
Services, and it is my hope, Mr. Chairman, that the same spirit
of cooperation will reign in our Agriculture Committee as well
and that we continue to see these bills progress smoothly
through the legislative process.
So let it be noted, Mr. Chairman, that in spite of what
many may say, bipartisanship and cooperation is alive and well
as demonstrated by our work on this bill.
Now, let me turn to you, Mr. Vice, to discuss H.R. 3283 and
some of the concerns you mentioned in your testimony with
respect to the extraterritorial reach of certain provisions of
Dodd-Frank. It is my understanding that you are already
experiencing potentially duplicative regulation on your
activities conducted at your clearinghouse in Europe. Perhaps
you could elaborate for us on what you think the SEC is
attempting to accomplish by venturing into territory--that is
to say your energy swaps activity which is already, as I
understand, regulated by the CFTC here in the United States and
the FSA in the UK. How would H.R. 3283 address or remedy this
situation?
Mr. Vice. Well, just for background there, we have a
London-based clearinghouse. We started about 5 years ago and of
course it is regulated by the FSA clearing commodities swaps. A
couple years after that we began clearing credit default swaps
including index and single name. Excuse me. Prior to that, we
registered as a U.S. DCO in preparation for Dodd-Frank to be
able to clear U.S. OTC swaps and potentially even U.S. futures.
So with that we were essentially dually regulated by the CFTC
and the FSA.
Subsequent to that, we did begin clearing credit default
swaps, which for the single-name CDS brought in SEC oversight,
appropriately so----
Mr. Scott. Yes.
Mr. Vice.--and so we have been in that business we have
been overseen by three regulators. Some of the obscure
language, an artifact of Dodd-Frank, gives the SEC some
oversight of commodity swaps, believe it or not. In informal
discussions with SEC staff, everyone can look at that and
conclude that wasn't really the intent, but at the same time,
they have proceeded on with essentially regulating our
commodity swaps business. And we clear hundreds of commodity
swaps in that clearinghouse and we add new swaps all the time.
We are at a point now where each time we want to clear an
additional swap that is already existing, is traded bilaterally
on a global basis in some cases not even with any nexus to the
United States, maybe traded largely in Asia, we are required to
get FSA approval, CFTC approval, and now SEC approval. So it
has dramatically slowed down our process there.
Mr. Scott. There are some concerns that because of
technology and because of electronic transactions that this
business is highly mobile and it will naturally shift overseas
to less regulated markets. What are your opinions on whether or
not this is a real risk? And are there ways we can strengthen
the language in this bill to prevent this from occurring while
still accomplishing our goals?
Mr. Vice. Yes, it is definitely a real risk. In fact, the
primary reason we built our own clearinghouse in 2008--we were
clearing at the London clearinghouse at the time--and the speed
with which they could clear additional products for us was
costing us business and was going to put us out of business
eventually, so we needed to be in control of that part of our
service, which includes getting regulatory approval for those
products. So we have seen firsthand it is a very competitive
environment out there between clearinghouses globally. All of
these markets, whether it is FX, commodities, interest rates,
they are global markets and so I guess the good news there,
there is healthy competition among exchanges and clearinghouses
and so we are very sensitive to unlevel playing field things
like this. So this is again much like the indemnification issue
which seemed like an obvious technical fix. I don't think
anyone in Washington intended for the SEC to regulate
commodities laws.
Mr. Scott. Thank you, Mr. Vice.
Thank you, Mr. Chairman.
The Chairman. The gentleman yields back.
Mr. Crawford for 5 minutes.
Mr. Crawford. Thank you, Mr. Chairman.
Mr. Bodson, I just have a couple questions for you. Can you
cite a specific example of when your trade repository has been
able to provide regulators with accurate, timely information
during a time of crisis?
Mr. Bodson. I think, too, of the scenario I explained
before during the Lehman Brothers crisis. There was obviously a
lot of misinformation in the marketplace, which created
uncertainty which created risk, and could have had a
snowballing effect into the Asian marketplace providing that
certainty over the exposure of its Lehman Brothers to the
anxiety out.
The other most recent event really is the Greek default
situation where we were able to provide regulators throughout
Europe primarily insight just to exactly what the exposures
were for their financial institutions. And again, by coming in
they were able to get a complete view not only of the positions
but the counterparty risk that was involved, and that allowed
them to focus their efforts on where the exposure would be. So
again, without a global view, they would be having to go
through regulators or SDRs around the world, try to get that
information, try to normalize it, and try to get a view. In
times of crisis, that is not the approach you want to take. So
those are two instances where the regulators were able to do
their job effectively by having a comprehensive global view.
Mr. Crawford. Okay. If the indemnification provision is not
removed from Dodd-Frank, in your opinion would it hurt
regulators' ability to oversee global systemic risk?
Mr. Bodson. Most definitely. I think the key is that being
able to rely on a comprehensive data set that shows the full
content and allows a full understanding of what is happening in
the marketplace, allows for regulators to pinpoint their focus
on where areas of risk may be arising, is critical. When you
don't have that comprehensive view, when you have inaccurate
data, you have inaccurate information, you are going to have
the wrong actions. You are going to be focused on the wrong
issues. Very simply, I mean the case that has been pointed out
is AIG. If regulators had a sense of what was going on at AIG,
would the issue have arisen to the level? You know, you are not
going to be able to see it just by looking at an SDR but it
will give you the telltale signs that I should be going in
there, I should be looking at what is going on, I should be
able to understand where that exposure is on a global basis.
Without that information, when you start fragmenting it, you
are never going to get that full view.
It doesn't stop regulators from going into the firms or
looking at specific transactions for market manipulation. They
have those rights under their jurisdictions for the areas of
interest. But by having that global comprehensive view also
gives them a context they wouldn't have otherwise.
Mr. Crawford. I understand these two issues indemnification
and plenary access are separate and distinct. Can you explain
why Congress should legislate a resolution of both
indemnification and plenary access, and are both of those
issues adequately addressed in H.R. 4235?
Mr. Bodson. They are addressed in H.R. 4235. You can almost
view them as two sides of the same coin. I mean in one case you
are asking overseas regulators to provide an indemnification,
which is not a concept they are used to; it is a U.S. tort law
issue. And they really are not going to be willing to give an
indemnification to a private entity such as the SDRs. That will
cause the fragmentation. The plenary access issue is one where
there is concern that confidentiality will be breached. You
know, under the ODRF, as I mentioned before, there are great
levels of global cooperation and trust in terms of respecting
each other's boundaries in terms of what information will be
accessed, who has the supervisory rights. If that trust is
broken, you will see the same issue as indemnification.
Regulators will not feel comfortable putting information into
global trade repository. They will start pulling the
information back to local repositories and you will get data
fragmentation. Back to my previous answer, systemic risk
therefore becomes that much more difficult.
Mr. Crawford. Thank you, Mr. Bodson. I appreciate all of
you being here today.
I yield back.
The Chairman. The gentleman yields back.
Mrs. Hartzler for 5 minutes.
Mrs. Hartzler. Thank you, Mr. Chairman.
Thank you, gentlemen. I apologize for my tardiness as well,
I had another committee meet at the same time so it is kind of
frustrating.
But I was just wanting to ask the panel a couple of
questions and then another one specifically if we have time to
Mr. Saltzman. But the first question, where do you see the
greatest diversions between the United States and other
countries implementing derivatives reforms? Mr. Bailey?
Mr. Bailey. If I could just take that. And I speak
principally in relation to Europe. There are very different
approaches to a number of issues between the United States and
the European regulators, but within the foundation of it, the
broad commitments that were made as to derivatives. So it is
all within the context of a requirement to clear appropriate
transactions, who should be exempt, and a requirement to
transact on regulated venues. While in the clearing space there
is, in large part, a parity and we are very optimistic that
there will be a position where regulators can mutually
recognize clearinghouses in other jurisdictions because the
protections are adequate.
But, one of the more difficult areas may be in the
execution space, the requirement that was in Dodd-Frank, of
course, to trade certain products on SEFs is narrowed in the
current negotiations of the documents around the market and
financial instruments directly, which is the upgrade for the
current regulations pertaining to execution in Europe. But the
approach may be a little different there and it is still at an
earlier stage. We haven't seen anything yet in the sense of
rulemaking from ESMA (European Securities and Markets
Authority). That is clearly a risk for some divergence and that
would create some clear difficulties if Dodd-Frank were to have
extraterritorial application into Europe where for the same
transaction you would be obliged to execute all and that
obviously means that the trade wouldn't happen. So we think
that is an area of concern.
As to reporting again we are hopeful that even real-time
reporting of transactions to the market, we think that there
will be sufficient consensus there, not to be too problematic.
And as to issues around code of conduct, there are instances
where you can see real conflicts, but in most cases it is a
matter of avoiding duplication and layering of different
requirements. Clearly, if we are transacting out of London to
the Italian customer as it relates to the Investor Protection
Rules, we principally think the Italians would hold sway on
that, and secondary would be the London FSA because of where we
are situated if we are transacting out of London. Whether the
CFTC should be engaged in the matter in which that trade is
executed we think is highly questionable. So it is really in
execution that I think we have the concerns.
Mrs. Hartzler. Can I follow up on that? And then I want to
hear Mr. Saltzman. So are the execution concerns dealing with
proposed regulations, concerns you think that might come down
from Dodd-Frank, or are there already concerns in the
legislation that you think clearly are going to be problematic?
Mr. Bailey. It is at the regulation stage so it is not yet
certain that it is problematic. It is potentially problematic.
Mrs. Hartzler. So is there any legislation in the works to
try to address those concerns right now, that aspect,
proactively----
Mr. Bailey. Well, the legislation that is before this
Committee which would limit the jurisdiction of the United
States imposing a particular execution requirement for
transactions outside the United States would obviate that, so
yes.
Mrs. Hartzler. Very good. So it does address that.
Mr. Bailey. Yes.
Mrs. Hartzler. Perfect. Yes, Mr. Saltzman?
Mr. Saltzman. Just very briefly I would also add no other
jurisdiction is contemplating the push-out of swaps as we have
in Section 716 and that is confirmed by Governor Tarullo, who I
believe spoke before the Senate Banking Committee this week
where he indicated that we are a loner in that respect. I think
that is obviously a material structural difference between our
approach to these issues and other jurisdictions.
Mrs. Hartzler. Okay. One of the principal goals of Dodd-
Frank is to reduce systemic risk, so could you please discuss
how the bills that we are considering today, how they would
impact regulators' ability to monitor and to mitigate systemic
risks?
Mr. Vice. I will speak on the indemnification piece. I will
let the banks respond to the extraterritoriality bill. ICE
operates a repository much like DTCC. We are also in full
agreement and support of this bill to address the
indemnification issue, the full access issue for all the
reasons that I think DTCC articulately laid out. I think we
probably have a little different--it is important to
differentiate some of the reasoning that DTCC has given for
that. I mean Dodd-Frank allowed--the CFTC promulgated rules to
allow multiple repositories, in other words, much like the
clearing business or the exchange business allow that to be a
competitive landscape. That means that by default there will be
some aggregation of data across repositories. Regulators,
particularly the CFTC, are very adept at doing this. They
already aggregate data across exchanges and across
clearinghouses. So SDR can readily be done as well.
I think the unique problem that these issues bring up where
we are in agreement with DTCC is it gives rise to the
possibility that a trade could actually end up in two different
repositories. So until you had a foreign exchange trade, a
Euro-dollar trade with a U.S. bank and a UK bank, if those
provisions are allowed to stand, the U.S. bank to be compliant
or the set that it is trading on to be compliant may have to
get that trade to a U.S.-registered SDR, which EU doesn't have
access to, and similarly, it may go to any U.S. SDR. So you can
see that type of duplication or data integrity that you would
want to try to avoid. But, the more operational issue of
aggregating data is, I mean that is the business we are all in,
running computer systems. That is not rocket science.
Mrs. Hartzler. Okay. Thank you very much, gentlemen, I
appreciate it. I think my time has expired.
The Chairman. The gentlelady's time has expired.
Staying on that same theme, could each of you comment
quickly or briefly on what the costs to you will be if we don't
pass these corrections bills today, or if they don't get the
President's signature relatively quickly?
Mr. Vice. Again, I will say on the indemnification issue we
are assuming it doesn't go away. We are hopeful it does but we
will be registering separate entities with their own staff and
resources and overhead. Certainly for starters we already have
an application in with the CFTC for a U.S.-registered SDR and
once the rules are out on the EU we would be registering as an
SDR there. We will have to have what presumably will be all of
the physical plant and chief compliance officers and people on
the ground, essentially, duplicating what we are doing in the
United States, and then I assume probably in other
jurisdictions as well outside the EU.
The Chairman. Mr. Saltzman?
Mr. Saltzman. I think certainly with respect to H.R. 1838,
the costs of running duplicative derivatives activity out of
two separate legal entities and the ensuing risk management,
collateral management, pricing, costs will be Draconian,
including, as indicated earlier, many market participants on
both sides of the transaction potentially leaving the business,
thereby creating more systemic risk. I think Chairman Bernanke
and former FDIC chair Sheila Bair during the course of the
debate recognized the systemic risk associated with pushing the
derivatives out to a less regulated, less well capitalized
legal entity. And I would say with respect to the H.R. 3283,
extraterritoriality, the tremendous legal uncertainty that
continues to hang over the marketplace. It is very easy to
quantify hard costs, but it is very difficult to quantify the
soft costs of really not knowing how your business is going to
be structured. It is almost proving the negative, what
businesses are you not entering into, what business are you not
doing because of that legal uncertainty.
So we would urge the Chairman and the rest of the Members
of the Committee to promptly and swiftly pass both bills. But
thank you very much.
The Chairman. Mr. Bailey, quickly?
Mr. Bailey. I totally agree with Mr. Saltzman's comments in
relation to the push-out bill which we have kind of covered
before as well, highly expensive and likely to involve
additional cost to customers of all segments of the
marketplace.
Just make one comment additionally on the extraterritorial
bill, to the extent that there are conflicts that arise because
or irreconcilable rules applying either here or in Europe or in
Asia, that will result in transactions not occurring. Even if
those are merely duplicative rules, it is creating an acquiring
expense to make sure you are compliant with the higher standard
and they may itself be sufficient to cause a firm to feel that
they have to move their businesses to a ``subsidiary-ized''
structure in order to have only one set of those rules apply.
And so you get the cost increment through that process.
The Chairman. And Mr. Bodson?
Mr. Bodson. It is hard to identify pure cost of what
happens when you have repositories popping up all over. We are
creating five asset class repositories, three data centers. It
is about $\1/4\ billion spending in the next 5 years. But that
is the hard dollar cost. That is easy to kind of estimate.
Really it is what is the cost to the financial system of the
uncertainty of not having comprehensive overview of what is
happening in the marketplace? What happens in the next crisis
when regulators or market participants are reacting
inappropriately because they don't have a full view? That is
the cost that is almost impossible to gauge.
I do want to clarify by the way H.R. 4235, this deal with
the indemnification and not the plenary access when we spoke
before. I think that is the harder number to quantify is what
happens when you don't have a full comprehensive view of what
is happening in the marketplace? The SEC and CFTC can answer
that better.
The Chairman. The SEC has actually come and encouraged
Congress--speaking of the indemnification--pass this fix. Yet
the CFTC is saying they can actually just do that by some sort
of an interpretive guidance. Mr. Bodson, your comments on which
approach you would prefer? That is a leading question.
Mr. Bodson. Yes. Well, let me see if I can swing and not
miss this one. As I said before, it is a legislative issue and
legislation fix it. I think while guidance may provide some
comfort, at the end of the day, foreign regulators are very
focused on what is the rule of the law, what does the
legislation say and not what guidance says. So fixing this
through legislation will provide the certainty that regulators
want to have.
The Chairman. Well, thank you. It would be helpful as we
continue to build a case as to why this is important. If you
could provide the Committee--this is a request, not any kind of
a requirement--your thoughts on those hard costs of what you
see occurring in your organizations if we don't do these things
and do them on a timely basis, and as well as some thoughts on
those soft costs no one really can quantify is what impact does
it have from your intuition on the markets on people either
entering businesses or not entering businesses. If you could
provide that to the Committee over the next several days, we
would most appreciate it. If you don't want to do that, that is
fine as well because I do appreciate all four of you coming
today to visit with our Committee and help add more momentum.
Obviously, these came out of Financial Services yesterday
afternoon. We will have a markup on them I am told in the
Agriculture Committee and move these to the floor.
So again, gentlemen, thank you for coming here to help us
with that process.
Under the rules of the Committee, the record of today's
hearing will remain open for 10 calendar days to receive
additional material and supplementary written responses from
the witnesses to any questions posed by a Member.
This hearing of the Subcommittee on General Farm
Commodities and Risk Management is adjourned.
[Whereupon, at 11:48 a.m., the Subcommittee was adjourned.]
[Material submitted for inclusion in the record follows:]
Letter Submitted by Michael C. Bodson, Chief Operating Officer,
Depository Trust & Clearing Corporation
April 10, 2012
Hon. K. Michael Conaway,
Chairman,
Subcommittee on General Farm Commodities and Risk Management,
House Committee on Agriculture
Washington, D.C.
The Chairman. Well, thank you. It would be helpful as we
continue to build a case as to why this is important. If you
could provide the Committee--this is a request, not any kind of
a requirement--your thoughts on those hard costs of what you
see occurring in your organizations if we don't do these things
and do them on a timely basis, and as well as some thoughts on
those soft costs no one really can quantify is what impact does
it have from your intuition on the markets on people either
entering businesses or not entering businesses. If you could
provide that to the Committee over the next several days, we
would most appreciate it. If you don't want to do that, that is
fine as well because I do appreciate all four of you coming
today to visit with our Committee and help add more momentum.
Obviously, these came out of Financial Services yesterday
afternoon. We will have a markup on them I am told in the
Agriculture Committee and move these to the floor.
Attn: Paul Balzano
Mr. Chairman,
In response to your question regarding the ``hard'' costs of
establishing the Global Trade Repositories, the following is a high-
level, thumbnail sketch of the challenges and costs to develop the
infrastructure necessary to provide global regulators the transparency
requisite for them to supervise the five major derivative asset classes
(Credit, Interest Rates, Equities, FX and Commodities).
Estimating the financial costs of developing software and
implementing necessary infrastructures to develop and aggregate global
data sets involves many variables. While fixed costs can easily be
estimated, it also necessitates that some broad assumptions be made to
estimate the variable costs over time. More consequentially, the hard
dollar cost to construct the GTR network is relative to the potential
risk caused by the failure to modify the indemnification provision and
the resultant diminishment in market oversight resulting from lack of
transparency; that section of U.S. law will have a more critical impact
on systemic risk than just adding up the infrastructure investment.
The hard cost investment of setting up a Trade Repository (TR or
SDR), is between $20-$25 million per data center--just for physical
facilities and core infrastructure. While the DTCC standard for
infrastructure build-out is heavily focused on ensuring that
appropriate safeguards are in place regarding issues such as
resiliency, data protection, and redundancy, the range is a reasonable
proxy for the cost of establishing one data center. Note however that
in order to provide certainty over disaster recovery and continuous
data access, DTCC is establishing three data-centers globally. This
hard dollar estimate does not include the direct financial impact on
member firms expected to report the data to the repository such as
their connection costs to the resultant data reporting regiment(s) and
other related regulatory obligations. Beyond the cost of establishing
and maintaining multiple points of connectivity, the inevitable
deterioration in common standards will add another layer of complexity
and expense which firms will be required to deal with in order to meet
regulatory reporting requirements. These costs are difficult to
estimate but will increase over time.
It is difficult to estimate the software development costs
associated with a de novo establishment of an SDR but DTCC will be
incurring costs of approximately $50mm over 3 years to build the GTR
system worldwide. In addition, on an ongoing basis, direct support
costs for the datacenters will be approximately $9mm per site per year.
The global business management team supporting the GTR will cost
approximately $10mm. While the scale of the GTR system is much larger
than that of a single national repository, DTCC also has the benefit of
years of experience in the repository space which has been critical in
designing the GTRs and in executing the global roll-out of them. No
value to these capabilities has been estimated.
If the Indemnification provision remains in U.S. law, there is a
high probability that derivative trade data will fragment into multiple
local TRs in different jurisdictions globally. The decision by Hong
Kong, and potentially other sovereigns, to have national repositories
in order to meet both local needs and avoid the indemnification issue
will complicate global TR development. While cooperation with these
jurisdictions should minimize their impact, having additional multiple
national repositories will make the problem of aggregating data
increasingly impossible to do, especially in times of stress.
But the real ``hard'' cost is the systemic risk of failing to
provide aggregated and netted data to allow regulators to mitigate risk
concentrations during times of financial bubbles and market downturns.
That cost, as 2008 nearly proved, would be catastrophic. Once data is
fragmented, timely ``defragmentation'' in times of crisis is a near
impossible challenge that risks global financial markets to the luck of
guesswork, rather than a reasoned response to market conditions.
Once data is fragmented, the further uncertainty created by the
plenary access concerns further compounds the issue by making
aggregation and netting of data impossible to do, especially for U.S.
regulators. In order to aggregate data in the U.S., non-U.S. nexused
data must be combined with U.S.-nexused data. However, the moment the
data is brought into a U.S. domiciled repository, it could be subject
to plenary access claims by U.S. regulators. In order to avoid this
issue, non-U.S. based repositories would by necessity avoid sending
data into the U.S. The end-result is an inability to aggregate data
with the resultant lack of market transparency which Dodd-Frank sought
to achieve in the first place.
Thank you for the opportunity to provide a more detailed and
thoughtful answer to your question. Please do not hesitate to contact
me, or Dan Cohen in Washington, D.C. [Redacted], for additional
information.
Sincerely,
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Michael C. Bodson,
Chief Operating Officer,
President of DTC, NSCC and FICC,
Chairman, EuroCCP and MarkitSERV.