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



 
     OVERSIGHT OF THE SWAPS AND FUTURES MARKETS: RECENT EVENTS AND
                      IMPENDING REGULATORY REFORMS

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

                                HEARING

                               BEFORE THE

                        COMMITTEE ON AGRICULTURE
                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED TWELFTH CONGRESS

                             SECOND SESSION

                               __________

                             JULY 25, 2012

                               __________

                           Serial No. 112-34


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




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                        COMMITTEE ON AGRICULTURE

                   FRANK D. LUCAS, Oklahoma, Chairman

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

                                 ______

                           Professional Staff

                      Nicole Scott, Staff Director

                     Kevin J. Kramp, Chief Counsel

                 Tamara Hinton, Communications Director

                Robert L. Larew, Minority Staff Director

                                  (ii)


                             C O N T E N T S

                              ----------                              
                                                                   Page
Conaway, Hon. K. Michael, a Representative in Congress from 
  Texas, prepared statement......................................     5
Lucas, Hon. Frank D., a Representative in Congress from Oklahoma, 
  opening statement..............................................     1
    Prepared statement...........................................     2
Peterson, Hon. Collin C., a Representative in Congress from 
  Minnesota, opening statement...................................     3
    Prepared statement...........................................     4
Southerland II, Hon. Steve, a Representative in Congress from 
  Florida, submitted material....................................   114

                               Witnesses

Gensler, Hon. Gary, Chairman, Commodity Futures Trading 
  Commission, Washington, D.C....................................     6
    Prepared statement...........................................     8
    Supplementary material.......................................   105
    Submitted letter and response................................   108
    Submitted questions..........................................   111
Duffy, Hon. Terrence A., Executive Chairman and President, CME 
  Group, Inc., Chicago, IL.......................................    50
    Prepared statement...........................................    52
Roth, Daniel J., President and Chief Executive Officer, National 
  Futures Association, Chicago, IL...............................    55
    Prepared statement...........................................    57
Lukken, Hon. Walter L., President and Chief Executive Officer, 
  Futures Industry Association, Washington, D.C..................    59
    Prepared statement...........................................    61
Heck, John M., Senior Vice President, Business Development, The 
  Scoular Company; Member, Executive Committee and Board of 
  Directors, National Grain and Feed Association, Omaha, NE......    67
    Prepared statement...........................................    68
Conner, Hon. Charles F., President and Chief Executive Officer, 
  National Council of Farmer Cooperatives, Washington, D.C.......    74
    Prepared statement...........................................    76
McElroy, Paul E., Chief Financial Officer, JEA, Jacksonville, FL; 
  on behalf of American Public Power Association.................    79
    Prepared statement...........................................    81


     OVERSIGHT OF THE SWAPS AND FUTURES MARKETS: RECENT EVENTS AND
                      IMPENDING REGULATORY REFORMS

                              ----------                              


                        WEDNESDAY, JULY 25, 2012

                          House of Representatives,
                                  Committee on Agriculture,
                                                   Washington, D.C.
    The Committee met, pursuant to call, at 10:05 a.m., in Room 
1300 of the Longworth House Office Building, Hon. Frank D. 
Lucas [Chairman of the Committee] presiding.
    Members present: Representatives Lucas, Goodlatte, King, 
Neugebauer, Conaway, Schmidt, Thompson, Stutzman, Tipton, 
Southerland, Crawford, Huelskamp, Gibson, Hultgren, Hartzler, 
Schilling, Noem, Peterson, Holden, Boswell, Baca, David Scott 
of Georgia, Cuellar, Costa, Schrader, Kissell, Owens, Pingree, 
Courtney, Welch, Fudge, and McGovern.
    Staff present: Jason Goggins, Tamara Hinton, Kevin Kramp, 
Josh Mathis, Matt Perin, John Porter, Nicole Scott, Pete 
Thomson, Suzanne Watson, Liz Friedlander, C. Clark Ogilvie, 
John Konya, Margaret Wetherald, Jamie Mitchell, and Caleb 
Crosswhite.

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

    The Chairman. This hearing of the Committee on Agriculture 
entitled, Oversight of the Swaps and Futures Markets: Recent 
Events and Pending Regulatory Reforms, will come to order. I 
now recognize myself for an opening statement.
    Good morning, and thank you for joining us for this 
important hearing. I would like to first thank the Ranking 
Member and his staff for their efforts today, and I would also 
like to thank our witnesses for their time.
    It is beyond unfortunate that for a second time in less 
than a year, this Committee is examining the circumstances of a 
futures commission merchant bankruptcy where customer funds 
were not properly segregated. Once again the very cornerstone 
of the futures markets, customer funds' segregation, has been 
severely and suddenly called into question.
    For decades, futures markets have been a trusted tool for 
farmers, ranchers, and businesses seeking to manage risk. The 
bedrock of their trust in these markets is based on the 
fundamental protections provided by mandatory segregation of 
customer funds. Additionally, confidence in the futures and 
swaps markets stems from customers knowing that regulators are 
doing their job.
    As we all know, on July 10, the National Futures 
Association halted the operations of PFGBest and the CFTC filed 
a Federal suit against the firm and its founder alleging that 
the company had committed fraud, violated customer segregation 
laws, and falsified financial statements filed with the CFTC. 
Later that day, the company filed for bankruptcy. Press reports 
indicated that roughly $220 million in segregated client money 
is missing.
    The clients of firms like PFGBest and MF Global are our 
constituents. They are farmers and ranchers who until recently 
have never had cause for concern in using the futures markets. 
They have never had to worry that the tool for managing risk 
would one day turn risky and cast doubt on the integrity of the 
futures markets.
    In light of the bankruptcy, CFTC has adopted new rules to 
strengthen their controls over the treatment and monitoring of 
customer funds, and the self-regulating organizations have 
proposed several new initiatives that the Committee will 
examine today that would ensure another fraud in the futures 
markets cannot be carried out for years simply by opening a 
P.O. box.
    But the question remains: who is minding the store? There 
are some in this town who argue that we need more regulations. 
But the fact remains that new regulations mean nothing when 
regulators are not enforcing the existing rules on the books. 
What we need is regulators doing their job.
    And it is worth noting that CFTC gave itself high marks for 
direct examinations of futures brokers in a 2011 performance 
analysis. Yet billions of dollars in customer funds are missing 
today as the result of CFTC's failure to perform with MF Global 
and now PFGBest.
    Today we hope to gain a comprehensive understanding of the 
facts surrounding PFGBest's bankruptcy and the failure to miss 
such an outright fraud, in addition to an update on MF Global 
and recent Dodd-Frank rules that have been finalized by the 
CFTC.
    I thank everyone in attendance today. I look forward to 
hearing from our witnesses.
    [The prepared statement of Mr. Lucas follows:]

Prepared Statement of Hon. Frank D. Lucas, a Representative in Congress 
                             from Oklahoma

    Good morning.
    Thank you for joining us for this important hearing. I'd first like 
to thank the Ranking Member and his staff for their efforts today. I'd 
also like to thank our witnesses for their time.
    It is beyond unfortunate that for a second time in less than a 
year, this Committee is examining the circumstances of a futures 
commission merchant bankruptcy where customer funds were not properly 
segregated.
    Once again the very cornerstone of the futures markets, customer 
funds segregation, has been severely and suddenly called into question.
    For decades, futures markets have been a trusted tool for farmers, 
ranchers, and businesses seeking to manage risk. The bedrock of their 
trust in these markets is based on the fundamental protections provided 
by mandatory segregation of customer funds.
    Additionally, confidence in the futures and swaps markets stems 
from customers knowing that regulators are doing their job.
    As we all know, on July 10, the National Futures Association halted 
the operations of PFGBest and the CFTC filed a Federal suit against the 
firm and its founder, Mr. Russell Wasendorf, Sr., alleging that the 
company had committed fraud, violated customer segregation laws, and 
falsified financial statements filed with the CFTC. Later that day, the 
company filed for bankruptcy. Press reports indicate that roughly $220 
million in segregated client money is missing.
    The clients of firms like PFGBest and MF Global are our 
constituents. They are farmers and ranchers who until recently have 
never had cause for concern in using the futures markets. They've never 
had to worry that the tool for managing risk would one day turn risky 
and cast doubt on the integrity of the futures markets.
    In light of the bankruptcy, CFTC has adopted new rules to 
strengthen their controls over the treatment and monitoring of customer 
funds. And, the self regulatory organizations have proposed several new 
initiatives that the Committee will examine today that would ensure 
another fraud in the futures markets cannot be carried out for years 
simply by opening a P.O. box.
    But the question remains: who is minding the store? There are some 
in this town who argue that we need more regulations. But the fact 
remains that new regulations mean nothing when regulators are not 
enforcing the existing rules on the books. What we need is regulators 
doing their job.
    It is worth noting that CFTC gave itself high marks for direct 
examinations of futures brokers in a 2011 performance analysis. Yet, 
billions of dollars in customer funds are missing today as the result 
of CFTC's failure to perform with MF Global and now PFGBest.
    Today, we hope to gain a comprehensive understanding of the facts 
surrounding PFGBest's bankruptcy and the failure to miss such an 
outright fraud, in addition to an update on MF Global and recent Dodd-
Frank rules that have been finalized by the CFTC.
    Thank you. I look forward to hearing from our witnesses today.

    The Chairman. I now recognize the Ranking Member for his 
opening statement.

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

    Mr. Peterson. Thank you, Mr. Chairman, and thank you for 
this hearing.
    You know, I had an opportunity yesterday to visit with NFA 
trying to get an understanding. I am a CPA, as Mr. Conaway is, 
but I am not much of an auditor--I was more of a tax guy--the 
auditing I did do, you always sent the confirmation directly to 
the bank and the bank sent it directly back to you. I couldn't 
understand how you could have a situation where he could 
intercept that and forge that. Somehow or another he gave them 
a Post Office box that they thought was the bank. I don't know 
how that happened or what you can do about it. Now, they are 
moving toward e-audit, and that is what smoked this guy out and 
apparently precipitated his suicide attempt. They are going to 
now implement that and that sounds like that will fix this 
problem or largely fix it.
    But we are continuing to chase these problems all the time, 
and I am not sure that these regulators can ever get ahead of 
this. As with farmers, we can pass a farm bill but those guys 
are so far ahead of us that they sit on the tractor and they 
figure this stuff out before we ever decide how to work things. 
I think we have something going on like that in these markets.
    You know, these FCMs, as I understand it, no longer make 
their money by charging commissions for what they do. The way 
they have been making their money is by investing customer 
money and using the money they earn on the customer money to 
fund their business. Now, this is crazy, and especially in an 
interest-rate climate where we have zero percent interest and 
the government is going in and continuing zero percent 
interest. To some extent we are causing this problem because we 
are putting pressure on these guys to make enough money to stay 
in business, and then this is what happens.
    We have a self-regulatory situation: the CFTC doesn't have 
enough people to go out and audit all these folks. We are 
trying to cut their budget, not raise it. I think these 
hearings are good to look at these things, but we may need to 
step back and take a look at how we got into this situation. I 
would like to see us go back and look at the CFMA in 2000, and 
we never have really examined what we did with that bill when 
we deregulated these markets. That is one thing, but the second 
thing we did is give legal certainty to these swaps and created 
this huge--at the time, I think there was $80 billion in these 
derivative markets. It went to $600 trillion in 8 years because 
we gave them legal certainty. Well, this is the government, 
actually it is a regulation, us interfering in the marketplace 
to say that these things are not gambling. If we say it is not 
gambling when it actually is gambling, and if we would have 
left that alone, I don't think we would be dealing with some of 
these things that we are dealing with now.
    So, we should go back and look at what we did and get some 
people to give us some kind of a sense of what our culpability 
in this whole situation is. When we did Dodd-Frank, we would 
not bite the bullet and we have these regulators forced to 
harmonize regulations when they have completely different 
cultures. There are three different regulators involved in the 
same situation, and then you wonder why it doesn't work. So I 
don't know.
    The regulators are doing as best as they can given the 
tools that they have. But, these folks that are in these 
markets have not learned a damn thing from anything that has 
happened so far and there are apparently a bunch of dishonest 
people in here and you are not going to catch them all, all the 
time. I would like to see us spend some time taking a look at 
what we have done as we are looking at all these government 
regulations. Let us look, did we--by getting involved in this--
cause problems on the other side of things.
    I read the other day where now these securitization people 
that were making all this money by securitizing these 
mortgages, and that business dropped up because it all blew up. 
Now they can't even decide who should run these foreclosed 
houses and they are blaming different people and saying well, 
we are not in charge and they are in charge. Nobody is in 
charge and they are deteriorating, which is the fundamental 
problem with that whole deal. But now these guys are going out 
and buying these foreclosed properties. They are taking the 
rental income from the foreclosed properties and they are 
securitizing it so they can raise money to go buy more 
foreclosed property. This is another thing that is going to 
blow up if this gets to be a big deal. So we need to look at 
the bigger picture sometimes and not be chasing these problems 
all the time, for whatever it is worth.
    I yield back.
    [The prepared statement of Mr. Peterson follows:]

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

    Good morning. Thank you, Chairman Lucas, for yielding.
    I appreciate that we're meeting today to review some important 
issues. But frankly I'd rather be on the House floor debating the farm 
bill and think a majority of us on the Committee would agree. We still 
have a few days before the August recess; I hope everyone keeps the 
pressure on Leadership so we can wrap this up before leaving town. 
There's really no good excuse not to get this done.
    I know some in Leadership question whether there are enough votes 
to pass the farm bill. Now, if they want to pass a partisan, 
Republican-only bill, which seems to be the case around here, I wish 
them luck because they're going to need it. However, if they are 
willing to consider a bipartisan farm bill and work in the same 
bipartisan fashion as the Agriculture Committee, I stand ready to round 
up Democratic votes. When I was Chairman, I got 19 Republicans to join 
me when we first passed the farm bill in 2007. I know I can bring more 
Democrats than that onboard for the bipartisan bill passed by this 
Committee. Right now, I'm just waiting for Leadership to call.
    Until then, there is other work to do which is why we're here 
today.
    CFTC oversight has long been a priority for this Committee. Recent 
events including the fraud at Peregrine Financial Group and the LIBOR 
manipulation--both of which were occurring during the reign of previous 
CFTC Chairmen--on top of the MF Global bankruptcy, have again raised 
concerns regarding financial oversight. I hope that both Chairman 
Gensler and the witnesses on the second panel will be able to shed some 
light on who knew what when, and what steps are being taken to ensure 
we don't find ourselves discussing yet another financial scandal in the 
coming months.
    Of course, the CFTC is still in the process of finalizing many of 
the rules that will create a more open and transparent derivatives 
market. I've said repeatedly that we need to give them the time to get 
the rules right and, by and large, they are getting them right. We also 
need to give them the necessary resources to do their work.
    So, I look forward to hearing from our witnesses and thank the 
chair for holding today' s hearing.

    The Chairman. The Ranking Member yields back.
    The chair would request that other Members submit their 
opening statements for the record so the witnesses may begin 
their testimony, and to ensure that there is ample time for 
questions.
    [The prepared statement of Mr. Conaway follows:]

  Prepared Statement of Hon. K. Michael Conaway, a Representative in 
                          Congress from Texas

    Mr. Chairman, I want to thank you for convening this hearing today. 
Over the past several months, the financial services industry has 
continued to garner headlines; unfortunately not often for flattering 
reasons. We have seen a large trade go public awry; another Futures 
Commission Merchant has failed and lost significant amounts of customer 
funds; the first of many banks has faced an enforcement order for 
fixing international benchmark financial rates; and a large 
international bank has admitted to allowing drug cartels and 
international terrorists launder money.
    At the same time, the CFTC has continued to work through the 
remaining Dodd-Frank rulemakings. Earlier this month, the final product 
definition rules were issued, starting a 60 day clock running for swap 
dealers to register. Confounding this process, however, is that the 
guidance intended to clarify the extraterritorial application of the 
CFTC's new regulatory powers has only further confused market 
participants and raised the ire of international regulators.
    All in all, Mr. Chairman, today is a good day for a hearing to 
begin the process of sorting through some of these knotty issues. 
Today's hearing is not about assigning blame or finding fault for any 
particular event, it is about how to make the system work better for 
market participants and most importantly, the end-users who rely on the 
financial system to work correctly every single day.
    The recent failures and other shortcomings of the industry show 
that there is much work to be done. Each crisis we see erodes the 
publics' trust in the institutions--both private firms and the 
regulators alike--that are essential to our economic growth.
    Less visible to the public, but certainly no less important, are 
the barrage of rulemakings that the CFTC has been finalizing over the 
past year. These rules will be the new regulatory foundation that 
Americans believe will prevent another financial meltdown. The size, 
scope, and frequency of the failures that will inevitably occur under 
this new regime will determine the trust that Americans continue to 
place in regulators of high finance.
    I continue to worry about the sequencing and timing of the rules, 
as well as the refusal of the CFTC to conduct quantitative and 
qualitative cost-benefit analysis. In particular, with the 
Extraterritoriality guidance that was recently issued. I am troubled 
that by choosing to issue guidance instead of proposing a rule, the 
Commission has circumvented the need to perform any analysis of the 
costs or the benefits of its guidance to market participants or end-
users. The guidance may well have consequences that the Chairman's 
staff did not think of which could be detrimental to the ability for 
firms to participate in these newly regulated markets.
    I would like to close by thanking each of our panel participants 
for your participation today and your unfailing willingness to work 
with our Committee to improve the regulation and oversight of the 
futures and derivatives markets. While we may not always see eye to eye 
on every issue, I appreciate the honest and direct discussions that I 
have had with many of you about how to improve the financial systems we 
all care so deeply about.

    The Chairman. I would like to welcome first panel witness 
to the table, the Hon. Gary Gensler, Chairman of the U.S. 
Commodity Futures Trading Commission, Washington, D.C.
    Mr. Chairman, please begin when you are ready.

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

    Mr. Gensler. Good morning, Chairman Lucas, Ranking Member 
Peterson, and Members of the Committee.
    When we were all kids growing up, we learned in courses 
like history, science, and math that we have to rely on hard 
facts, figures and research, and the markets rely on hard 
facts, figures and research too. So when President Roosevelt 
and Congress came together in the 1930s with the great reforms 
in that era, I think they really said let us give the public 
the hard facts, figures and research on the securities and 
futures market. They knew that markets work best when the broad 
public has access to the same facts and figures as 
sophisticated insiders have. I believe these critical reforms 
of the 1930s are at the foundation of our strong capital 
markets and many decades of economic growth thereafter.
    Swaps subsequently emerged in the 1980s, as we know, to 
help companies manage their risk. The financial crisis in 
2008--revealed in part to be because the swaps market had not 
been regulated led to eight million Americans losing their 
jobs. Congress came together in response, similar to in the 
1930s, and said the public should have the facts, figures and 
research on the swaps marketplace so they can have confidence 
in this marketplace as they did in the 1930s reform that 
preceded it.
    The Commission has made significant progress in these 
commonsense reforms with 36 rules completed. We are 
increasingly moving from rule writing to implementation of 
reform. Light will begin to shine on the swaps market this fall 
when swaps price and volume information will be publicly 
reported in real time. Regulators will get a fuller picture by 
seeing information in data repositories and the dealers in the 
marketplace will begin to come under comprehensive regulation 
with phasing of those requirements following afterwards. We 
have just under 20 further rules to complete, and reform will 
also mean once complete that buyers and sellers will meet in a 
transparent market and compete with each other, and help end-
users get better prices.
    Standardized swaps will be centrally cleared, which will 
help lower risk in the marketplace and reform will include 
cross-border transactions that affect the U.S. economy. Time 
and again we find that crises come back to our shores from the 
Cayman Islands or London if it is an affiliate or branch of a 
U.S. entity.
    Let me now just turn to two recent enforcement matters, 
Barclays and Peregrine. Each of these matters reminds me of a 
saying that my grandfather, who had immigrated from Russia, 
used to say. Simply put, he said ``Figures don't lie but liars 
sure can figure.'' I heard this so many times from my mom 
growing up. LIBOR and Euribor, which Barclays attempted to 
manipulate and falsely reported, are at the center of the 
capital markets for both borrowing and derivatives contracts. 
One could say it is the mother of all benchmarks. Hundreds of 
trillions of dollars of transactions here and abroad are based 
on LIBOR. For instance, at the Chicago Mercantile Exchange, 
nearly 70 percent of the notional value of their futures 
markets--we are not even talking about swaps yet--nearly 70 
percent of the notional value of their futures contracts 
somehow settled to or priced off of these benchmark rates. If 
my grandfather were alive today, he would be shaking his head 
but he wouldn't be so surprised. LIBOR has a structural 
problem. It is supposedly based on what banks perceive to be 
their borrowing rates in the unsecured interbank market but 
what if facts, figures and research are limited? What if there 
is not such borrowings that exist? They have to put in their 
best estimates, I guess, but I believe it is critical for 
markets to have an honest transaction-based benchmark, whether 
that means changing LIBOR or moving to another rate for the 
markets to work off of. I am pretty sure my grandfather would 
agree with that.
    The recent events at Peregrine would have caught my 
grandfather's attention even more so. Simply put, the evidence 
points at the owner, Russ Wasendorf, taking customers' funds 
right out of the bank and lying about it for years. The 
National Futures Association, the self-regulatory organization 
responsible for frontline oversight of Peregrine, is required 
to conduct periodic audits of Peregrine's customer funds. In 
addition, independent certified public accountants audited 
Peregrine's annual financial statements. But just like the 
local police cannot prevent all bank robberies, market 
regulators cannot prevent all financial fraud. Having said 
that, the system clearly failed to protect Peregrine's 
customers and I believe we all must do better.
    The Commission has been actively working to improve 
protections of customer funds and we finalized four separate 
rules including rules related to investing of customer funds, 
which you may have heard was rule 1.25, gross margining that 
will go into effect later this year, segregation for swaps and 
rules working closely with the CME, FIA, and NFA that the SROs 
have various new requirements concerning customer segregated 
accounts.
    The CFTC is also implementing a significant restructuring 
of how we oversee the SROs and intermediaries. We hired new 
leadership about 9 months ago but there is much more to do. 
Looking forward, I believe it is critical that we further 
update our rules giving regulators direct electronic access to 
all bank and custodial accounts holding customer funds.
    We will conduct a full review of the CFTC's and SRO 
examination and audit oversight of futures commission merchants 
looking only for improvements including getting advice from the 
Public Company Accounting Oversight Board, who has graciously 
said that they will give us advice on how they look at the 
auditing profession and see how we can learn from the PCAOB and 
what they do.
    We must do everything within our authorities and resources 
to strengthen our oversight programs and protection of customer 
funds. We must do it for the public. I also think I want to 
keep my grandfather's values and wise admonition in mind about 
figures and liars. Thank you.
    [The prepared statement of Mr. Gensler follows:]

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

    Good morning, Chairman Lucas, Ranking Member Peterson, and Members 
of the Committee. I thank you for inviting me to today's hearing on 
oversight of the swaps and futures markets. I will review the Commodity 
Futures Trading Commission's (CFTC) implementation of the Dodd-Frank 
Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), as 
well as the recent events related to the London Interbank Offered Rate 
(LIBOR) and Peregrine Financial Group.
    I also thank my fellow Commissioners and CFTC staff for their hard 
work and commitment.
    The 2008 crisis--caused in part by swaps--was the worst economic 
crisis Americans have experienced since the Great Depression. Eight 
million Americans lost their jobs, millions of families lost their 
homes and thousands of businesses shuttered.
    Following the crisis, the President and the G20 leaders convened in 
Pittsburgh in September 2009 and agreed that swaps, which were 
basically not regulated in the United States, Asia or Europe, should 
now be brought into the light of regulation.
    In 2010, Congress and the President came together and passed the 
historic Dodd-Frank Act.
    The goal of the law's swaps market reforms is to:

   Bring public market transparency and the benefits of 
        competition to the swaps marketplace;

   Lower the risk of the interconnected financial system by 
        bringing standardized swaps into centralized clearing; and

   Ensure that swap dealers and major swap participants are 
        specifically regulated for their swaps activity.

    The Commission has made significant progress in implementing 
Congress' direction to ensure that common-sense standards are 
established for the swaps market.

Turning Point: Implementation of Swaps Market Reforms
    Throughout the rule-writing process, we have benefitted from 
significant public input. CFTC Commissioners and staff have met nearly 
1,800 times with the public, and we have held 18 public roundtables on 
important issues related to Dodd-Frank reform. The agency has received 
more than 35,000 comment letters related to Dodd-Frank rules.
    Last summer, we turned the corner and started finalizing rules. To 
date, we've completed 36 rules and now have fewer than 20 to go (see 
attachment).
    This month, we reached another major turning point in the swaps 
market reform process. The CFTC and the Securities and Exchange 
Commission (SEC) completed the rule to further define the terms 
``swap'' and ``security-based swap.'' These further product definitions 
mean many other critical swaps market reforms already completed by the 
Commission will come to life. We also finalized this month the rule on 
the end-user exception to clearing. With the completion of these 
foundational rules, we are increasingly moving from the rule-writing 
process to the implementation of reforms that bring transparency to the 
swaps marketplace and lower its risks to the public.
    Swap dealers, for the first time, will register and begin to come 
under comprehensive regulation. This includes implementing already 
completed external and internal business conduct standards that will 
lower swap dealers' risk to the economy and promote confidence in their 
integrity.
    Two months after the rule further defining the term ``swap'' is 
published in the Federal Register, light will begin to shine on the 
swaps market. Initially, likely by October, swaps price and volume 
information will be reported in real time to the public for interest 
rate and credit default swap (CDS) indices. Three months later, such 
real-time reporting will begin for energy and other physical commodity 
swaps.
    Swap data repositories (SDRs) will receive data on all swaps 
transactions, giving regulators their first full window into these 
markets. One SDR has already successfully registered with the 
Commission, and we have at least four other parties working on their 
applications.
    The rule further defining ``swap'' is especially meaningful for the 
implementation of position limits. For the first time, limits will 
apply to the aggregate spot-month positions, including both futures and 
swaps. Spot-month limits protect the markets against corners, squeezes 
and the burdens that may come from excessive speculation.
    I will now go into further detail on the Commission's swaps market 
reform efforts.

Transparency
    Transparency is critical to both lowering the risk of the financial 
system, as well as to reducing costs to end-users. The more transparent 
a marketplace is to the public, the more efficient it is, the more 
liquid it is, and the more competitive it is.
    We have completed the bulk of the Congressionally mandated 
transparency reforms for the swaps market. This fall real-time 
reporting to the public and to regulators will begin for swaps market 
transactions.
    Second, detailed and up-to-date reporting by large traders in the 
physical commodity swaps markets began last fall. This reporting allows 
regulators to better police for fraud, manipulation and other abuses.
    Third, the CFTC also plans to begin publishing aggregated swaps 
market data. The public has benefited for years from the Commitment of 
Traders futures data we publish. Our goal is to provide similar public 
transparency for the swaps market.
    Fourth, in May we completed rules, guidance and acceptable 
practices for designated contract markets (DCMs). DCMs will be able to 
list and trade swaps, helping to bring the benefit of pre-trade 
transparency to the swaps marketplace.
    Looking forward, we have two important transparency rules to 
complete related to block sizes and swap execution facilities (SEFs). 
These critical Dodd-Frank reforms will bring pre-trade transparency to 
the swaps market for the benefit of all the end-users that use swaps.
Central Clearing
    For over a century, through good times and bad, central clearing in 
the futures market has lowered risk to the broader public. Dodd-Frank 
financial reform brings this effective model to the swaps market. 
Standard swaps between financial firms will move into central clearing, 
which will significantly lower the risks of the highly interconnected 
financial system.
    The CFTC has made significant progress on central clearing for the 
swaps market. We have completed rules establishing new derivatives 
clearing organization risk management requirements.
    Second, to further facilitate broad market access, we completed 
rules on client clearing documentation, risk management, and so-called 
``straight-through processing,'' or sending transactions immediately to 
the clearinghouse upon execution.
    Third, we completed the rule on the end-user exception to clearing. 
Consistent with Congressional intent, this rule ensures that end-users 
using swaps to hedge or mitigate commercial risk will not be required 
to bring swaps into central clearing.
    Fourth, the CFTC this month also proposed a rule that would permit 
certain cooperatives to choose not to clear member-related swaps. 
Cooperatives act on behalf of and are an extension of their members. 
Thus, I believe it is appropriate that in certain circumstances, those 
cooperatives made up entirely of members that could individually 
qualify for the end-user exception should qualify as end-users.
    Fifth, yesterday the Commission adopted the final rule for phased 
implementation of compliance with the clearing requirement for various 
groups of financial entities.
    Sixth, the Commission also yesterday approved proposed clearing 
requirement determinations based upon clearinghouse submissions on 
swaps they already clear. The clearing determinations begin with 
standard interest rate swaps in U.S. dollars, Euros, British pounds and 
Japanese yen, as well as a number of CDS indices, including North 
American and European corporate names.
    In addition, the Commission has adopted four important customer 
protection enhancements: the amendments to rule 1.25, the gross margin 
rule, the LSOC rule for swaps and rules on the minimum requirements for 
SROs regarding their financial surveillance of FCMs.
    Based upon the Dodd-Frank 90 day clock for making clearing 
determinations, the first clearing determinations may be finalized in 
October just before the gross margin and LSOC rules go into effect 
November 8.
    The CFTC also has received substantial public input on the clearing 
of swaps among affiliates of the same financial entity. The staff 
recommendation, which would exempt certain affiliate swaps from the 
clearing requirement, is under review by Commissioners.

Swap Dealers
    Regulating banks and other firms that deal in swaps is central to 
financial reform. Prior to 2008, it was claimed that swap dealers did 
not need to be specifically regulated for their swaps activity, as they 
or their affiliates already were generally regulated as banks, 
investment banks, or insurance companies. The crisis revealed the 
inadequacy of relying on this claim. While banks were regulated for 
safety and soundness, including their lending activities, there was no 
comprehensive regulation of their swap dealing activity. Similarly, 
bank affiliates dealing in swaps, and subsidiaries of insurance and 
investment bank holding companies dealing in swaps, were not subject to 
specific regulation of their swap dealing activities. AIG, Lehman 
Brothers and other failures of 2008 demonstrate what happens with such 
limited oversight.
    The CFTC is well on the way to implementing reforms Congress 
mandated in Dodd-Frank to regulate dealers and help prevent another 
AIG. The Commission has finished sales practice rules requiring swap 
dealers to interact fairly with customers, provide balanced 
communications and disclose conflicts of interest before entering into 
a swap. In addition, the Commission has finalized internal business 
conduct rules to require swap dealers to establish policies to manage 
risk, as well as put in place firewalls between a dealer's trading, and 
clearing and research operations. Staff recently provided to 
Commissioners recommendations on a final rule on swap relationship 
documentation, confirmations and portfolio compression.
    We completed in April a joint rule with the SEC further defining 
the terms ``swap dealer'' and ``security-based swap dealer.''
    Based upon completed registration rules and the recently completed 
joint rule further defining the term ``swap,'' we anticipate dealers 
will begin registering with the National Futures Association (NFA) in 
the early fall.
    The CFTC has been working with the Federal Reserve, the other U.S. 
banking regulators, the SEC, and international regulators and 
policymakers to align margin requirements for uncleared swaps. It is 
essential that we align these requirements globally, particularly 
between the major market jurisdictions. The international approach to 
margin requirements in the consultative paper (sponsored by the Basel 
Committee on Banking Supervision and the International Organization of 
Securities Commissions) released this month is consistent with the 
approach the CFTC laid out in its margin proposal last year. It would 
lower the risk of financial entities, promote clearing and help avoid 
regulatory arbitrage. Consistent with the CFTC's proposal, it also 
excludes non-financial end-users from margin requirements for uncleared 
swaps.
    The CFTC reopened the comment period on our margin proposal so that 
we can hear further from market participants and the public in light of 
the work being done to internationally harmonize margin rules. As we 
work with international regulators on this coordinated approach, I 
would anticipate that the Commission would only take up the final 
margin rules toward the end of this year.
    Following Congress' mandate, the CFTC also is working with our 
fellow financial regulators to finalize the rulemaking to implement the 
Volcker Rule. In adopting the Volcker Rule, Congress prohibited banking 
entities from engaging in proprietary trading, an activity that may put 
taxpayers at risk. At the same time, Congress permitted banking 
entities to engage in certain activities, such as market making and 
risk mitigating hedging. One of the challenges in finalizing a rule is 
achieving these multiple objectives.
    Staff also has provided to Commissioners recommendations in two 
other areas. The first relates to proposed exemptions for certain 
transactions in the electricity markets. In particular, this includes 
possible exemptive orders for certain transactions executed on regional 
transmission organizations, as well as between and among rural electric 
cooperatives and municipal public power providers. Second, now that the 
Commission made significant progress on swaps market reforms, we will 
consider completing a number of conforming rules.

Market Integrity/Position Limits
    Financial reform also means investors, consumers, retirees and 
businesses in America will benefit from enhanced market integrity. 
Congress provided the Commission with new tools in Dodd-Frank to ensure 
the public has confidence in U.S. swaps markets.
    Rules the CFTC completed last summer close a significant gap in the 
agency's enforcement authorities. The rules implement important Dodd-
Frank provisions extending our enforcement authority to swaps and 
prohibiting the reckless use of manipulative or deceptive schemes. 
Thus, for example, the CFTC has clear anti-fraud and anti-manipulation 
authority regarding the trading of credit default swaps indices.
    Also, the CFTC now can reward whistleblowers for their help in 
catching market misconduct.
    Congress also directed the CFTC to establish aggregate position 
limits for both futures and swaps in energy, agricultural and other 
physical commodities. In October 2011, the Commission completed final 
rules to ensure no single speculator is able to obtain an overly 
concentrated aggregate position in the futures and swaps markets. With 
the recently completed joint rule further defining ``swap,'' compliance 
for all spot-month limits will go into effect in approximately 2 
months.
    The Commission approved a proposed rule in May that would modify 
the CFTC's aggregation provisions for limits on speculative positions. 
The proposal would permit any person with a 10 to 50 percent ownership 
or equity interest in an entity to disaggregate the owned entity's 
positions, provided there are protections and firewalls in place to 
ensure trading decisions are made independently of one another.
    Two associations representing the financial industry are 
challenging the agency's final rule establishing position limits in 
court. The Commission is vigorously defending the Congressional mandate 
to implement position limits in court.

Cross-Border Application of Dodd-Frank's Swaps Market Reforms
    The nature of modern finance is that large financial institutions 
set up hundreds, if not thousands, of ``legal entities'' around the 
globe. Many of these far-flung legal entities, however, are still 
highly connected back to their U.S. affiliates.
    The lessons of the 2008 crisis and earlier have demonstrated that 
time and again financial transactions executed offshore by U.S. 
financial institutions can send risk straight back to our shores. It 
was true with the London and Cayman Islands affiliates of AIG, Lehman 
Brothers, Citigroup and Bear Stearns. A decade earlier, it was true, as 
well, with the collapse of the hedge fund Long-Term Capital Management.
    During a default or crisis, the risk that builds up offshore 
inevitably comes crashing back onto U.S. shores. The recent events of 
JPMorgan Chase, where it executed swaps through its London branch, are 
a stark reminder of this reality of modern finance.
    Section 722(d) of the Dodd-Frank Act states that swaps reforms 
shall not apply to activities outside the United States unless those 
activities have ``a direct and significant connection with activities 
in, or effect on, commerce of the United States.'' Congress included 
this provision for swaps, but included a different provision with 
regard to the SEC's oversight of the security-based swaps market.
    The Commission, consulting closely with the SEC, the Federal 
Reserve and the Treasury Department, recently proposed guidance 
interpreting this section of the law. The Commission also proposed in a 
separate release phased compliance for foreign swap dealers (including 
overseas affiliates of U.S. swap dealers) of certain requirements of 
Dodd-Frank swaps market reform. Such phased compliance would enable 
market participants to comply with the Dodd-Frank Act in an orderly 
fashion and allow time for the CFTC to receive public comment on the 
cross-border interpretive guidance.
    The proposed guidance interpreting Section 722(d) includes the 
following key elements:
    First, it provides the guidance that when a foreign entity 
transacts in more than a de minimis level of U.S. facing swap dealing 
activity, the entity would register under the Dodd-Frank Act swap 
dealer registration requirements.
    Second, it includes a tiered approach for foreign swap dealer 
requirements. Some requirements would be considered entity-level, such 
as for capital, chief compliance officer, risk management, swap data 
record-keeping, reporting to swap data repositories and large trader 
reporting. Some requirements would be considered transaction-level, 
such as clearing, margin, real-time public reporting, trade execution, 
trading documentation and sales practices.
    Third, entity-level requirements would apply to all registered swap 
dealers, but in certain circumstances, foreign swap dealers could meet 
these requirements by complying with comparable and comprehensive 
foreign regulatory requirements, or what we call ``substituted 
compliance.''
    Fourth, transaction-level requirements would apply to all U.S. 
facing transactions. For these requirements, U.S. facing transactions 
would include not only transactions with persons or entities operating 
or incorporated in the United States, but also transactions with their 
overseas branches. Likewise, this would include transactions with 
foreign affiliates that are guaranteed by a U.S. entity, as well as the 
foreign affiliates operating as conduits for a U.S. entity's swap 
activity. Foreign swap dealers, as well as overseas branches of U.S. 
swap dealers, in certain circumstances, may rely on substituted 
compliance when transacting with foreign affiliates guaranteed by or 
operating as conduits of U.S. entities.
    Fifth, for certain transactions between a foreign swap dealer 
(including an overseas affiliate of a U.S. person) and foreign 
counterparties not guaranteed by or operating as conduits for U.S. 
entities, Dodd-Frank transaction-level requirements may not apply. For 
example, this would be the case for a transaction between a foreign 
swap dealer and a foreign insurance company not guaranteed by a U.S. 
person.

LIBOR
    I'd like now to review the CFTC's recent order against Barclays 
concerning the benchmarks LIBOR and Euribor.
    People taking out small business loans, credit cards and mortgages, 
as well as big companies involved in complex transactions, all depend 
upon the honesty of benchmark rates like LIBOR for the cost of their 
borrowings. Banks must not attempt to influence LIBOR, Euribor or other 
indices based upon concerns about their reputation or the profitability 
of their trading positions.
    LIBOR and Euribor are indices at the center of the capital markets 
for both borrowings and derivatives contracts. LIBOR is the reference 
index for the largest open interest of contracts in both the U.S. 
futures markets and swaps markets. As of the end of June, the 3 month 
Eurodollar futures contracts that settle to U.S. Dollar LIBOR make up 
about 70 percent of the notional value of all futures contracts traded 
on the CME Group exchanges. U.S. Dollar LIBOR's traded volume in 2011 
on the CME was a notional value exceeding $564 trillion. According to 
the British Bankers Association, swaps with a total notional value of 
approximately $350 trillion and loans amounting to $10 trillion are 
indexed to LIBOR.
    The CFTC initiated in April of 2008 a review of LIBOR after media 
reports raised questions about the integrity of the index. Thereafter, 
we began coordinating with the United Kingdom's Financial Services 
Authority (FSA), which helped us facilitate information requests. The 
FSA and the U.S. Department of Justice subsequently joined the CFTC 
with regard to the Barclays matter, and it has been a collaborative 
effort throughout.
    To conduct such a complicated case, the CFTC enforcement staff had 
to sift through a voluminous number of documents and audio recordings 
that spanned many years.
    The CFTC's Order found that Barclays traders and employees 
responsible for determining the bank's LIBOR and Euribor submissions 
attempted to manipulate and made false reports concerning both 
benchmark interest rates to benefit the bank's derivatives trading 
positions. The conduct occurred regularly and was pervasive. Barclays' 
traders located at least in New York, London and Tokyo asked Barclays' 
submitters to submit particular rates to benefit their derivatives 
trading positions. In addition, certain Barclays Euro swap traders 
coordinated with and aided and abetted traders at other banks in each 
other's attempts to manipulate Euribor.
    The Order also found that throughout the financial crisis, as a 
result of instructions from Barclays' senior management, the bank 
routinely made artificially low LIBOR submissions. Submitters were told 
not to submit at levels where Barclays was ``sticking its head above 
the parapet.'' The senior management directive was intended to fend off 
negative public perception about Barclays' financial condition.
    The CFTC's Order required Barclays to pay a $200 million civil 
monetary penalty for attempted manipulation of and false reporting 
concerning LIBOR and Euribor. In addition, Barclays is required to 
implement measures to ensure its future submissions are honest.
    Among other things, these requirements included:

   Making submissions based on a transaction-focused 
        methodology;

   Implementing firewalls to prevent improper communications, 
        including between traders and submitters;

   Preparing and retaining documents concerning submissions and 
        certain relevant communications; and

   Implementing auditing, monitoring and training measures 
        concerning submissions and related processes, including making 
        regular reports to the CFTC.

    The CFTC has and will continue vigorously to use our enforcement 
and regulatory authorities to protect the public, promote market 
integrity, and ensure that these benchmarks and other indices are free 
of manipulative conduct and false information. The Commodity Exchange 
Act (CEA) is clear in its prohibitions against attempted and actual 
manipulation of futures, swaps and commodity prices. Further, the CEA's 
Section 9(a)(2) prohibits knowingly making false reports of market 
information that affects or tends to affect the price of a commodity.
    The FSA is reviewing the LIBOR benchmark, and will be making 
suggestions as to how to improve it. Moving forward, the CFTC stands 
ready to assist the FSA on its review of LIBOR and how to best assure 
that LIBOR, or any alternative benchmark that might emerge, is not 
susceptible to attempted manipulation or false reporting. We look 
forward to working with regulators and market participants here and 
abroad to ensure that benchmarks for interest rates that touch 
borrowers and lenders around the globe are reliable and honest.
    If these key benchmarks are based on observable transactions, 
borrowers, lenders and derivatives users around the globe all benefit. 
If these key benchmarks are not based on observable transactions, I 
believe their integrity will continue to be subject to question. And if 
these key benchmarks are not based on honest submissions, we all lose.

Peregrine Financial Group, Inc.

Background
    On July 10, the CFTC filed a complaint in Federal court against 
Peregrine and its sole owner, Russell Wasendorf, Sr., alleging that 
they misappropriated customer funds from an account held at U.S. Bank.
    Criminal authorities arrested Mr. Wasendorf for lying to the CFTC, 
and they advised the court that they intended to file more criminal 
charges in the future.
    The CFTC's complaint, along with the criminal charges, tells a 
story of deliberate dishonesty and deception. In a written statement 
found when he attempted suicide, as quoted in the criminal charges, Mr. 
Wasendorf said he committed fraud, manufactured phony bank documents, 
and forged bank signatures. In short, the charges against him are that 
he took customers' funds right out of the bank, and lied about it for 
years.

The System of FCM Oversight
    Peregrine is a CFTC-registered FCM. The NFA, a futures industry 
SRO, is responsible for the firm's front-line oversight. The way our 
oversight system has been set up for decades, SROs are the primary 
regulators of FCMs, introducing brokers, commodity pool operators, and 
commodity trading advisors. In 2000, Congress affirmed the Commission's 
reliance on self-regulatory organizations by amending Section 3 of the 
CEA to state: ``It is the purpose of this Act to serve the public 
interests . . . through a system of effective self-regulation of trading 
facilities, clearing systems, market participants and market 
professionals under the oversight of the Commission.'' Further, based 
on this system and the realities of limited CFTC resources, in the wake 
of Dodd-Frank, the NFA also will take on additional examination and 
registration duties with regard to swap dealers.
    As part of its oversight responsibility, the NFA is required to 
conduct periodic audits of non-clearing member FCMs' customer funds in 
segregated and secured accounts. The CFTC oversees the NFA, examining 
them for the performance of their duties. We review the NFA's work 
papers only on a limited number of FCMs each year. In addition, the 
CFTC also does limited-scope reviews of FCMs in a ``for cause'' 
situation that are sometimes referred to as ``audits,'' but they are 
not full-scale audits as accountants commonly use that term.
    Under CFTC rules, FCMs must have their annual financial statements 
audited by an independent CPA using Generally Accepted Auditing 
Standards. As part of this certified annual report, the independent 
accountant also must conduct appropriate reviews and tests to identify 
any material inadequacies in systems and controls that could violate 
the Commission's segregation or secured amount requirements. Any such 
inadequacies are also to be reported to the SRO and the Commission.
The Oversight of Peregrine
    The NFA last completed an audit of Peregrine in May 2011, and was 
in the process of conducting another periodic audit over the last 
several weeks. Peregrine's financials for the year ending December 31, 
2011, were reviewed and certified by its independent CPA expressing a 
clean opinion on both the financial statements and internal controls 
report.
    In 2000, the CFTC brought an enforcement action against Peregrine, 
finding in an Order that the firm had violated net capital rules. At 
the time, Peregrine was much smaller than it was in 2012, with roughly 
$800,000 in net capital requirements and $23 million in customer 
segregation requirements. The firm was ordered to pay a civil penalty 
and to take steps to improve its financial controls, including 
retaining a second independent public accounting firm to perform 
reviews of certain financial accounts and to report its findings to the 
CFTC. The firm retained PricewaterhouseCoopers.
    The CFTC's Order in 2000, resolving the enforcement investigation, 
was the culmination of a process that began with limited-scope reviews 
conducted by the CFTC examinations staff in the 1990s. During these 
reviews, the staff noted a number of problems at Peregrine regarding, 
among other things, net capital, infusions of capital to avoid net 
capital violations, internal financial controls, and records of 
segregated and secured customer assets and liabilities. Other issues 
related to accounting for receivables and payables; transactions and 
agreements with affiliates; differences between journal entries on the 
company's books and the statements of one of its banks, Harris Bank; 
accuracy of books and records; the abilities of the firm's auditor; and 
providing customers with timely trade confirmations and monthly 
statements. In addition, CFTC staff questioned whether Peregrine had 
tried to mislead them concerning some of these accounting issues. The 
staff also noted issues regarding the sufficiency of NFA audits.
    Subsequently, in 2007 and 2008, the CFTC examinations staff 
reviewed Peregrine's classification and reporting of customer-owned 
securities and the investment of customer funds for compliance with 
CFTC Regulations. The limited reviews identified improperly titled 
segregation bank accounts, which were corrected during the examination. 
In addition, the staff in 2010 performed a limited, 2 day review of 
Peregrine's anti-money laundering compliance.
    Although we do not yet know the full facts of what happened in this 
matter, it is clear that the system failed to protect the customers of 
Peregrine. The NFA and CFTC staff over the years did not detect Mr. 
Wasendorf's alleged stealing of customer funds, which came to light 
only a few weeks ago. Though the local police cannot prevent every bank 
robbery and market regulators cannot prevent every financial fraud, we 
all must do better. We must do everything within our authorities and 
resources to strengthen oversight programs and the protection of 
customer funds.
Customer Protection

CFTC Customer Protection Reforms To Date
    The Commission has been actively working to improve protections for 
customer funds. This includes:

   The completed amendments to rule 1.25 regarding the 
        investment of funds bring customers back to protections they 
        had prior to exemptions the Commission granted between 2000 and 
        2005. Importantly, this prevents use of customer funds for in-
        house lending through repurchase agreements;

   Clearinghouses will have to collect margin on a gross basis 
        and futures commission merchants (FCMs) will no longer be able 
        to offset one customer's collateral against another and then 
        send only the net to the clearinghouse;

   The so-called ``LSOC rule'' (legal segregation with 
        operational commingling) for swaps ensures customer money is 
        protected individually all the way to the clearinghouse; and

   The Commission included customer protection enhancements in 
        the final rule for DCMs. These provisions codify into rules 
        staff guidance on minimum requirements for self-regulatory 
        organization (SROs) regarding their financial surveillance of 
        FCMs.

    In addition, this month, we approved an NFA proposal that stemmed 
from a coordinated effort by the CFTC, the SROs, and market 
participants, including from the CFTC's 2 day roundtable earlier this 
year on customer protection.
    The three key areas of reform included in the NFA rules are:

   First, FCMs must hold sufficient funds in Part 30 secured 
        accounts (funds held for U.S. foreign futures and options 
        customers trading on foreign contract markets) to meet their 
        total obligations to customers trading on foreign markets 
        computed under the net liquidating equity method. FCMs will no 
        longer be allowed to use the alternative method, which had 
        allowed them to hold a lower amount of funds representing the 
        margin on their foreign futures;

   Second, FCMs must maintain written policies and procedures 
        governing the maintenance of excess funds in customer 
        segregated and Part 30 secured accounts. Withdrawals of 25 
        percent or more of excess funds in these accounts (that are not 
        for the benefit of customers) must be pre-approved in writing 
        by senior management and reported to the NFA; and

   Third, FCMs must make additional reports available to the 
        NFA, including daily computations of segregated and Part 30 
        secured amounts, as well as twice monthly detailed information 
        regarding the cash deposits and investments of customer funds.

CFTC Restructuring and Enforcement
    The CFTC also has implemented a significant restructuring, based on 
a new strategic plan, regarding our oversight of SROs and 
intermediaries.
    The CFTC last year established a new division dedicated solely to 
the oversight of the SROs and intermediaries. We created a branch 
within the division to specifically oversee examinations. We were able 
to attract talented individuals from the private sector with many years 
of relevant experience to lead this new division and branch. We have 
begun the process of strengthening our examination program, including 
adding risk and control elements. Separately, we also recently created 
a Consumer Outreach Office to help consumers get information about 
avoiding fraud.
    In addition, the CFTC's enforcement arm aggressively pursues bad 
actors in the markets. In the last 2 years, the Division of Enforcement 
has been filing cases and opening investigations at the highest rate in 
the CFTC's history. Roughly half of the cases involve fraud against 
customers.
    Since October 2009, the CFTC has brought 22 cases against 
registered FCMs, 13 of which involved supervision failures and one of 
which involved a failure to maintain customer secured funds properly. 
In the same period, the CFTC brought two cases in Federal court against 
FCMs, one for violating segregation rules and the other for failing to 
be properly capitalized and to maintain books and records.
    The Commission in April charged JPMorgan Chase Bank, N.A. for 
unlawful handling of Lehman Brothers, Inc.'s customer segregated funds 
and imposed a $20 million civil monetary penalty. In another case 
against a public accounting firm and a CPA partner of the firm, the 
Commission imposed sanctions for failing to conduct proper audits of a 
registered FCM. In one of our supervision failure cases, a registered 
FCM was sanctioned for failing to follow its own compliance procedures 
regarding ``know your customer'' requirements.

Customer Protection Reforms Ahead
    While the Commission's enhanced customer protection rules, staff 
reorganization and enforcement efforts to date have been significant, I 
believe we must do more. I believe we need to further enhance the 
agency's rules for customer protection. As outlined below, staff 
recommendations, based on substantial Commissioner and market 
participant feedback, are now drafted and in front of Commissioners.
    First, we must incorporate the NFA rules approved last week into 
the Commission's regulations so that the CFTC can directly enforce 
these important reforms.
    Second, I believe it is critical that we bring the regulators' view 
of customer accounts into the 21st century. We must give the SROs and 
the CFTC direct electronic access to FCMs' bank and custodial accounts 
for customer funds, without asking the FCMs' permission. Further, 
acknowledgement letters (letters acknowledging that accounts contain 
segregated customer funds) and confirmation letters must come directly 
to regulators from banks and custodians.
    Third, I believe we need more transparency to customers about their 
funds. Futures customers, if they wish, should have access to 
information about how their assets are held and with whom, similar to 
that which is available to mutual fund and securities customers.
    Fourth, I believe we need to consider enhanced controls at FCMs 
regarding how customer accounts are handled.
    In addition, I believe we need to carefully consider additional 
rules laying out the SROs' requirements for conducting examinations and 
audits.
    Regarding the Commission's oversight of SROs and intermediaries, 
though we're making progress through our reorganization and new rules, 
the recent events at Peregrine highlight the necessity of looking at 
the decades-old system of SROs and the Commission's role in overseeing 
SROs.
    I have directed the CFTC's staff to do a full review of how the 
agency conducts oversight of the SROs, as well as limited scope reviews 
of FCMs, to determine what improvements can and should be made. As part 
of this review, we have reached out to the Public Company Accounting 
Oversight Board (PCAOB), which oversees the audits of public companies. 
The Dodd-Frank Act gave the PCAOB oversight authority over the audits 
of brokers and dealers who are registered with the SEC. The PCAOB has 
agreed to give us the benefit of its insights and expertise.
    Building on the customer protection public roundtable earlier this 
year, I also have asked CFTC staff to hold another public roundtable 
discussion on customer protection issues, including examination 
techniques and procedures, which will take place during the 2nd week of 
August.

Resources
    Confidence in the futures and swaps markets is dependent upon a 
well-funded regulator. The CFTC is a good investment of taxpayer 
dollars. This hardworking staff of 710 is just ten percent more than 
what we had at our peak in the 1990s though the futures market has 
grown fivefold. The CFTC also will soon be responsible for the swaps 
market--eight times bigger than the futures market.
    The Commission's limited resources have historically not allowed 
for direct oversight of FCMs. There are 46 staff members, including 35 
audit staff, on the CFTC's examinations team who oversee four SROs, 
which in turn have responsibilities for more than 4,341 registered 
persons. On top of the current lack of staff for examinations, our 
responsibilities are expanding to include reviews of many new market 
participants. For instance, there are currently 115 FCMs, and staff 
estimates a similar number of swap dealers will ultimately register. 
More frequent and in-depth risk-based, control-oriented examinations 
are necessary to assure the public that firms have adequate capital, as 
well as systems and procedures in place to protect customer money. 
Greater coverage by regulators--like having more cops on a beat--will 
improve the integrity and heighten the deterrent effect of the review 
process.
    The President's FY 2013 budget, following a similar request in 
2012, asked for $308 million, investing in our technology and human 
resources, to better protect the public.
    Market participants depend on the credibility and transparency of 
well-regulated U.S. futures and swaps markets. Without sufficient 
funding for the CFTC, the nation cannot be assured that the agency can 
adequately oversee these markets.

Conclusion
    Nearly 4 years after the financial crisis and 2 years since the 
passage of Dodd-Frank, the CFTC has made significant progress in 
implementing Congress' common-sense reforms for the swaps market.
    With the foundational rules in place, it is critical that we 
complete the remaining reforms that will bring transparency and 
competition to the swaps market, lower costs for companies and their 
customers, and protect the public.
    It is also crucial that the CFTC, working with SROs and market 
participants, continues its efforts to enhance protections for the 
funds of both futures and swaps customers.
    Thank you and I look forward to your questions.

                               Attachment

CFTC Dodd-Frank Update
Final Rules & Guidance
   Agricultural Commodity Definition

   Agricultural Swaps

   Anti-Manipulation

   Business Affiliate Marketing and Disposal of Consumer 
        Information

   Client Clearing Documentation, Straight Through Processing, 
        Clearing Member Risk Management

   Commodity Options

   Commodity Pool Operators and Commodity Trading Advisors: 
        Amendments to Compliance Obligations

   Derivatives Clearing Organization--General Provisions and 
        Core Principles

   Designated Contract Markets--Core Principles

   End-User Exception

   External Business Conduct Standards

   Foreign Boards of Trade--Registration

   Implementation Phasing for Clearing

   Internal Business Conduct Standards (Risk Management, 
        record-keeping, & CCOs)

   Investment Advisor Reporting on Form PF (Jt. with SEC)

   Investment of Customer Funds (Regulation 1.25)

   Large Trader Reporting for Physical Commodity Swaps

   Position Limits for Futures and Swaps

   Privacy of Consumer Financial Information

   Process for Review of Swaps for Mandatory Clearing

   Process for Rule Certifications for Registered Entities 
        (Part 40)

   Real-Time Reporting for Swaps

   Removal of References to or Reliance on Credit Ratings

   Reporting Certain Post-Enactment Swap Transactions (IFR)

   Reporting of Historical Swaps

   Reporting Pre-Enactment Swap Transactions (IFR)

   Retail Commodity Transactions--Interpretive Guidance on 
        ``Actual Delivery''

   Retail Foreign Exchange Intermediaries--Regulations & 
        Registration

   Retail Foreign Exchange Transactions--Conforming Amendments

   Segregation for Cleared Swaps

   Swap, Security-Based Swap, Security-Based Swap Agreement--
        Further Definitions (Jt. with SEC)

   Swap Data record-keeping and Reporting Requirements

   Swap Data Repositories--Core Principles, Duties & 
        Registration

   Swap Dealers and Major Swap Participants--Registration

   Swap Dealers, Major Swap Participants, and Eligible Contract 
        Participants--Further Definitions (Jt. with SEC)

   Whistleblowers

Proposed Rules & Guidance
   Block Rule

   Capital for Swap Dealers & Major Swap Participants

   Clearing Exemption for Cooperatives

   Clearing Requirement Determinations

   Conforming Rules

   Cross-Border Application

   DCMs--Core Principle 9

   Disruptive Trade Practices

   Governance and Conflict of Interest (DCM, DCO, & SEF)

   Identify Theft (Jt. with SEC)

   Internal Business Conduct (Documentation, Confirmation, & 
        Portfolio Reconciliation)

   Margin for Uncleared Swaps

   Segregation for Uncleared Swaps

   Swap Data Repository Indemnification Interpretation

   Swap Execution Facilities--Core Principles, Registration, 
        and Process for ``Made Available to Trade'' Determinations

   Systemically Important Clearing Organizations--Additional 
        Provisions

   Volcker Rule

Yet to be Proposed Rules & Guidance

   Inter-Affiliate Clearing for Financial Entities

   RTO/ISO Exemptive Relief

   201(f) Exemptive Relief

   Stress Testing under Section 165

Final Orders
   Delegation to National Futures Association (NFA)--Certain 
        exemptions for Commodity Pool Operators

   Delegation to NFA--Foreign Exchange Intermediary 
        Registration function

   Delegation to NFA--Swap Dealer & MSP Registration function

   Exemptive orders--Effective Date for Swaps Regulation

   Treatment of Grandfather Relief Petitions--Exempt Boards of 
        Trade & Exempt Commercial Markets

   Treatment of Grandfather Relief Petitions--Transactions done 
        in Reliance on 2(h)

Studies & Reports
   Feasibility of Requiring Use of Standardized Algorithmic 
        Descriptions for Financial Derivatives (Jt. with SEC)

   International Swap Regulation (Jt. with SEC)

   Risk Management Supervision of Designated Clearing Entities 
        (Jt. With Board of Governors of the Federal Reserve System and 
        the SEC)

   Study on Oversight of Carbon Markets (Jt. with various other 
        Agencies)

    The Chairman. The chair wishes to thank the Chairman for 
those opening comments, and recognizes himself for 5 minutes.
    Chairman Gensler, on February 10, 2011, in testimony before 
this Committee, you stated that the resource needs of the CFTC: 
``Given the resource needs of the CFTC, we are working very 
closely with self-regulatory associations like the National 
Futures Association to determine the duties and roles that they 
can take on in the swap markets. Nevertheless, the CFTC has the 
ultimate statutory authority and responsibility for overseeing 
these markets,'' your comments from last year. Based on this 
statement, is it fair to say that you and your agency take 
responsibility for some of what is going on in regards to 
customer funds at PFGBest?
    Mr. Gensler. Yes, Mr. Chairman, I think that we have to 
take a close look at all that the CFTC did overseeing the NFA 
but also the FCMs such as Peregrine in this situation.
    The Chairman. Because I know your agency has been very busy 
on the rulemaking process, and I appreciate that. But even in 
the smallest town, the night watchman walks around and shakes 
the doorknobs to make sure they are locked, shines the 
flashlight through the front door to see that nothing is amiss. 
It just seems that perhaps in the aftermath, let us think for a 
moment about another one of these problems, MF Global. What 
should CFTC have done differently to ensure that customer funds 
were properly segregated in that failure?
    Mr. Gensler. I think both of these cases we have learned 
things. We have worked with the NFA and the Chicago Mercantile 
Exchange and the other SROs to put better rules in place. We 
were already doing this in terms of closing some of the gaps in 
the oversight of investment of customer funds. But we 
absolutely need to do more. We are also a very thinly staffed 
organization. We do not directly audit the futures commission 
merchants, and as I highlighted in that testimony you 
highlighted, swap dealers will be brought in as members of the 
NFA and directly examined by the NFA, not necessarily by the 
CFTC.
    The Chairman. Along the topic of MF Global, did CFTC 
coordinate with other regulators leading up to the MF Global 
bankruptcy? For example, did you consult with the Financial 
Industry Regulatory Authority and SEC when they forced MF 
Global to change their capital treatment of its foreign 
sovereign debt position?
    Mr. Gensler. Mr. Chairman, I can speak about what I was 
personally involved in, but as I am not involved in the MF 
Global matter, but over that weekend as it----
    The Chairman. Speak to the point in time up until which you 
recused yourself.
    Mr. Gensler. That is what I will do. Over that weekend, as 
the MF Global events transpired and we at the CFTC were working 
to try to move customer funds. We did work with the SEC, with 
FINRA and with the international regulators in London, the 
Financial Services Authority.
    The Chairman. Let us touch on LIBOR for just a moment. I 
asked the Federal Reserve Chairman, Ben Bernanke, last week 
when the Fed first heard about the possibility of LIBOR 
manipulation. He told me in a Financial Services hearing that 
he first learned about it in 2008 and that the Federal Reserve 
briefed other Federal agencies at that time including CFTC. 
Chairman Gensler, why is it that the LIBOR manipulation was 
able to continue at Barclays in 2009?
    Mr. Gensler. We at the CFTC started and opened an 
investigation in April of 2008 based on news reports in The 
Wall Street Journal, Financial Times, and elsewhere. That 
investigation culminated in what you learned of a few weeks 
ago.
    The Chairman. But isn't it true that Barclays also self-
reported the derivatives manipulation and it really wasn't the 
CFTC that discovered it, it is when they admitted it, and what 
does that say about the ability of regulators to discover 
wrongdoing? I suppose that is the bottom line, Chairman.
    Mr. Gensler. Well, the bottom line is that CFTC worked and 
reached out to law enforcement agencies in London, the FSA, and 
the Justice Department to develop this case. It is a very 
pervasive action that Barclays was involved in involving two 
regs, three cities, 4 years of misconduct on the part of 
Barclays, and involving senior management. So the CFTC reached 
out and developed the evidence also over two continents and 
different jurisdictions.
    The Chairman. It just seems, Chairman--and my time has 
expired--from the country perspective, we spent a lot of time 
putting up street signs but we haven't rattled enough doorknobs 
lately.
    I now recognize the Ranking Member for 5 minutes.
    Mr. Peterson. Thank you, Mr. Chairman.
    I would like to follow up on this LIBOR situation. So you 
were investigating it. Did any of the other regulators contact 
you about this or were they working on it, or were you guys 
doing this by yourself?
    Mr. Gensler. I am aware and we are aware that in June of 
2008, and the New York Federal Reserve has put this on their 
website, that there was a report to an interagency staff group 
about LIBOR--it is called the President's Working Group--that 
laid out some of the general concerns that the New York Fed had 
in June. But in terms of the law enforcement action, actually 
pursuing infractions of the Commodity Exchange Act of false 
reporting and attempting to manipulate this rate, that is 
something the CFTC did with other law enforcement agencies and 
took a long time to develop those facts and get evidence, hard 
evidence to take to court or to get Barclays to settle.
    Mr. Peterson. So these other folks, they didn't have any 
reason or any business to be investigating this, the Fed?
    Mr. Gensler. I can only speak to the CFTC, but we reached 
out to law enforcement agencies to the SEC and the Justice 
Department and the Financial Services Authority, which have law 
enforcement and the Financial Services Authority----
    Mr. Peterson. So you guys were all working together?
    Mr. Gensler. Yes. The Financial Services Authority 
initially was facilitating our document requests and 
information requests. They subsequently opened a live 
investigation, which they publicly said was in 2010.
    Mr. Peterson. There were reports in Barron's in July of 
2012 that the CME heard complaints from traders about the LIBOR 
rate, and I guess they went as far as contacting the British 
Bankers Association regarding these complaints. Did the CFTC 
ever receive any expression of concern about possible fraud 
manipulation or problems about LIBOR from CME?
    Mr. Gensler. I am aware that our staff knew that there were 
conversations, and it may have even been in the press at the 
time between the CME and the British Bankers Association. But 
in terms of actually developing a case with hard facts and 
evidence of manipulation or false reporting, that was done 
directly with law enforcement agencies, shaking the doorknobs, 
as the Chairman said.
    Mr. Peterson. I understand, but I guess what I am getting 
at is that I think you guys did the right thing. You went in, 
following the law and developing the case and all that stuff, 
but these other folks that are affected by this--and this was 
in the press--were they concerned about this? Did they ask 
questions? Did they know what you were doing and were they 
satisfied with that? Why weren't they concerned for 4 years 
that this potentially was a problem? That is what I don't get. 
I understand what you are doing, but I mean, the people that 
are affected by this, weren't they concerned about this?
    Mr. Gensler. Well, those are very important questions. I 
can tell you that law enforcement agencies, once we actually 
brought something real and actionable with evidence to the 
Justice Department, they were terrific, the FSA when they 
opened their live investigation, and we were rattling those 
doorknobs for quite some time to make sure. This market is so 
critical to borrowers and lenders in this country.
    Mr. Peterson. That is my point. So why weren't the 
borrowers and lenders screaming about this for 4 years, or 
didn't they know what was going on, or didn't they care?
    Mr. Gensler. There were academic reports, there were news 
reports, and I think that as I said earlier, that the market 
has become less and less transaction-based and more estimate-
based. This interbank borrowing market had--as Mervin King said 
in the fall of 2008, LIBOR is the rate at which banks aren't 
lending to each other. Our career staff, well before I got 
there, sir, started to focus on this. It takes a long time to 
build a case that you can take to court.
    Mr. Peterson. I don't understand enough about this to know, 
but it just seems to me that if these folks, that if everybody 
knew about this and nobody said anything, apparently it must 
have been benefiting them so they were just happy to have it 
continue. It is another case where these guys, the whole damn 
system is set up to benefit Wall Street and nobody else in this 
country. I am tired of this. You just wonder where these people 
are, and we commend you for what you do and working on this. We 
have a system that is so complicated that it takes you 4 years 
to nail it down. That tells you something right there.
    The Chairman. The gentleman's time has expired. The chair 
now recognizes the gentleman from Texas, Mr. Neugebauer, for 5 
minutes.
    Mr. Neugebauer. Thank you, Chairman Gensler, for being here 
this morning. Prior to the April 2008 Wall Street Journal 
article, your agency didn't have any knowledge that there were 
concerns about LIBOR? Is that your testimony?
    Mr. Gensler. We opened an investigation in April of 2008. 
In talking to some of the career staff, I wasn't there then, 
but in talking to them, they were aware of some of the academic 
and some of the news stories but it was that Wall Street 
Journal piece that they decided to open what is a live 
investigation into these matters.
    Mr. Neugebauer. So you weren't aware that as early as the 
latter part of 2007 that people at the Federal Reserve Bank in 
New York were made aware that there could be some problems with 
LIBOR? You didn't ever have any notice from the New York Fed of 
that?
    Mr. Gensler. Congressman, we haven't gone back to do 
forensics, but sitting here today, I am not aware that our 
staff was made aware of anything except for the news stories 
and academic research by April.
    Mr. Neugebauer. But it was the Wall Street Journal 2008 
article that kind of triggered the opening of a case in your 
organization?
    Mr. Gensler. That is right, and it was actually reviewed 
with Commissioners in late April. We have an every-Friday 
surveillance meeting with the surveillance team, and the 
enforcement folks talked to Commissioners in April of 2008.
    Mr. Neugebauer. Chairman Bernanke was here last week, and 
one of the things I asked him is, can one bank--I think there 
are 16 U.S. Dollar LIBOR banks that report to make up that 
index--could one bank alone influence that rate, and his 
response was that no. I think you have in your report or in 
your findings alluded that there are other banks involved or 
other banks that are under investigation at this time. Is that 
in fact, other banks are going under the same investigation 
that you did with Barclays?
    Mr. Gensler. I am going to try not to compromise an ongoing 
enforcement matter, but what we said in the Barclays situation 
was that in the case of Euribor, that there were four other 
banks that Barclays was aiding and abetting. That means that 
Barclays was trying to assist them but they were also asking 
these other four banks, which we called bank A, B, C and D, to 
assist Barclays in the setting of Euribor for the profits of 
their desk. But I might also add that in the Department of 
Justice findings and order, Barclays admitted--I can even give 
you the paragraph, 30--that in some occasions their 
manipulation of their submissions did affect the rate, and that 
is in the Barclays order with the Department of Justice.
    Mr. Neugebauer. But it would be difficult for one bank to 
do that on its own. Would you agree?
    Mr. Gensler. Though in the Department of Justice findings 
and settlement with Barclays, they did say that on some 
occasions it did affect it, because even a basis point 
averaged, to walk back for the Committee, 16 banks submit. Four 
low ones and four high ones are thrown out. The eight middle 
ones are averaged. Even one bank could possibly affect on some 
days.
    Mr. Neugebauer. So just the bottom line, but there will be 
other findings from the CFTC on this issue. Is that your 
testimony?
    Mr. Gensler. Again, not to compromise any ongoing 
enforcement matter, we are going to vigorously pursue 
enforcement matters around these benchmark rates. These rates 
need to be reliable but it is also the law. The law is, don't 
false report, don't attempt to manipulate or manipulate these 
rates.
    Mr. Neugebauer. I want to go back to Peregrine for just a 
minute. I think we are reading that one person was evidently 
falsifying a tremendous number of documents, daily reports, 
financial statements, bank statements, bank verifications. I 
mean, the list goes on and on. And so either we have a very 
unsophisticated regulatory structure or this was a very 
sophisticated gentleman that could carry off for as long a 
period of time as he did this fraud. I would hope, and we are 
going to hear today hopefully that we are going to have to jack 
our surveillance up, that if one person--and I don't believe 
one person could actually have pulled this off--but one person 
could defraud a fairly broad number of regulators that are 
supposed to be looking after on behalf of the customers of 
these institutions. So I am hopeful that we are going to hear 
some very positive steps but it doesn't speak well when one 
person can pull that off for that period of time.
    Mr. Gensler. I share our view that we have to up our 
auditing oversight both at the CFTC and the self-regulators, 
and I also would say, we don't know all the facts yet. There is 
going to be a lot more that we learn about the facts of this 
situation.
    Mr. Neugebauer. Thank you, Mr. Chairman.
    The Chairman. The gentleman's time has expired. The chair 
recognizes the gentleman from Iowa for 5 minutes, Mr. Boswell.
    Mr. Boswell. Thank you, Mr. Chairman.
    Thank you, Mr. Chairman Gensler, for being here to talk to 
us. Listening to what has been already said, yesterday or 
recently we also had some discussions with the NFA personnel 
and so on, and understand how they structure their toolbox to 
do their work, 2 cents per trade on both the borrower and the 
seller and so on. I understand that, and with that, they have 
managed to add about 25 percent annually to their toolbox, if 
you will. After the collapse of Wall Street, we passed Dodd-
Frank, which I have always felt like would probably need some 
tweaking and I have no quarrel with that, but we expanded the 
CFTC's responsibilities regarding oversight. Then we discovered 
the collapse of MF Global last October, made it apparent that 
we must provide our oversight bodies with tools.
    So I want to ask you this question. Do you think that the 
structure similar to the way we fund the SEC would benefit the 
CFTC based on a general growth rate? How do the investments of 
technology made by CFTC compare to those made by the SROs?
    But before you answer that, I would just say to Mr. Conaway 
and Mr. Lucas, I respect you guys very much. There is probably 
nobody in the room that has spent more time where you come from 
than I have. As a young man, I went to a place west of Odessa 
named Monahan. I was out there in an oil field--just a young 
farm kid who was willing to do hard work--and they hired me to 
substitute so everybody could take vacation on the drilling 
rig. I did all the jobs--lee tongs, backups, tower, mud mixer--
I did it all. And then later on I spent time in mineral wells, 
Fort Walters, a couple trips, Fort Bliss, Oklahoma, I am 
practically an Okie. Fort Sill, I have been there a lot of 
times, and so on. I was interested in what happens out there in 
agriculture and realized over the years that the technology has 
changed so much for farmers because of the intensity of capital 
invested. They have to be able to have marketing tools.
    And so we went through all this. Thank you, Mr. Peterson, 
for what you said about what is going on here and what are we 
going to do? I am not sure where--and I say this very 
respectfully: maybe we need to talk about this outside the room 
but where are you leading us to deal with this? Because I am 
ready to follow if I understand it, and I know I sat over there 
in the chair when we--after Dodd-Frank I was Chairman and I 
have now been Ranking Member with Mike, and I appreciate that. 
Maybe you can tell me, where are you trying to take us on this. 
I would like to know. Because we have a heavy responsibility. I 
want to help. I think we need tools. I guess you have combined 
a little wheat and you have certainly pulled a few calves, same 
as I, and so on. I could never go to the field even with a 
modern combine without a toolbox. I am not too sure that you 
have the toolbox. So I hope you can answer that. But I don't 
know. I would yield to anybody to help me out. I am kind of 
like you, Mr. Peterson. Where are we going and how are we going 
to get on top of this? Because if we need to tweak Dodd-Frank, 
let us do it, but let us not give them responsibility to do 
what we ask them to do and then say whoops, figure out some way 
to do it on your own.
    I yield.
    The Chairman. I thank the gentleman for yielding.
    I think we are in the process now of what has been a multi-
year effort. The Chairman regularly alludes to the fact that he 
is in the process of fulfilling all of his rulemaking 
responsibility under Dodd-Frank, has not completed that yet but 
is in the process.
    Mr. Boswell. But we still keep trying to take his resources 
away by cutting his budget.
    The Chairman. I think we have a responsibility on this 
Committee--we are not appropriators, we are authorizers--to 
provide oversight to make sure that the Chairman and his 
Commission are fulfilling the spirit of the law as well as the 
letter of law. All of that in addition to their mandated 
responsibilities under Dodd-Frank, they are fulfilling all the 
other responsibilities that are ongoing with this process. I 
used the country phrase about the night watchman shaking the 
doorknobs in referencing to that as well as putting up stop 
signs or street signs. I understand the Chairman has a 
difficult challenge but we also have a responsibility to 
provide oversight, to verify that he is following the rules, 
that he is doing what he needs to do. If he should deviate from 
the intent of the law, our responsibility is to guide him back 
to that point and to help move him forward. If there were 
indeed flaws in the law or flaws in the rule--I know what would 
surprise the Chairman to hear there might be a flaw in the rule 
somewhere--if there are flaws, then it is our responsibility to 
bring attention to that to help make sure changes can be made.
    Right now in the legislative environment we are working in, 
it is kind of challenging, as my good friend from Iowa knows, 
to get much of anything done. That is just the lay of the land 
as we face it. That is why we worked so hard the other night on 
a markup on a comprehensive farm bill.
    Mr. Boswell. You did a good job.
    The Chairman. That is what my main focus is and yours too, 
my good friend.
    Mr. Boswell. Absolutely.
    The Chairman. But we are going to fulfill our 
responsibilities. We are going to move this process forward and 
our friends are going to work doubly hard, I am sure, to 
fulfill their responsibilities.
    Mr. Boswell. Thank you very much. I appreciate that, and I 
like your analogy of shaking the doorknobs. I think it is kind 
of linked up with having the tools in the toolbox. Okay. I went 
past my time. I will yield back. You take all the time you 
want.
    The Chairman. I would say to my good friend, all of our 
time has expired, and now I turn to the gentleman from Texas, 
Mr. Conaway, for 5 minutes.
    Mr. Conaway. Thank you, Mr. Chairman. I appreciate the 
comments from Mr. Boswell.
    Chairman Gensler, thank you for the call the other day. We 
have a target-rich environment this morning for questions on 
the array of things that are in front of your Commission, but I 
want to talk about the extraterritorial guidance. I appreciate 
your call the other day and our conversation about that. I now 
know some more about it that I didn't know then, and some 
questions have just come up to me, so I am not saving these for 
you, I just didn't think about them at that point in time.
    This fits in the foundational kind of rules that some would 
argue require you to work with the SEC to put this rule or 
guidance, whatever we wind up calling it, in place. SEC has 
said they don't have the authority to issue guidance the same 
way that the CFTC did. Can you walk us through how you came to 
conclude this and why this isn't more coordinated with the SEC? 
Quickly, because I have a series of questions on this issue.
    Mr. Gensler. First, I would say I now have come to use the 
word cross border because I can pronounce it, but on the cross-
border issues, we do have a provision in Dodd-Frank that was 
not placed in the SEC's side of it. It is section 722(d). What 
it says specifically is, we are not to regulate something 
unless it has direct and significant effect on the commerce or 
activity of the United States. Those words that are in Dodd-
Frank are on our side, not the SEC's. And we received a lot of 
questions from many, many market participants: what do those 
words mean, can you interpret those words. Congress didn't say 
we shall do a rule or anything.
    Mr. Conaway. Okay.
    Mr. Gensler. So we are trying to interpret those words and 
leave some flexibility, frankly, that it is not as rigid.
    Mr. Conaway. In that regard then, where does guidance fall 
in the pecking order? If I am a cross-border firm and trying to 
look at this guidance and it is open for comment for some 45 
day period, so the guidance is not even final, I have a 60 day 
clock, soon to start running with respect to swap-dealer 
registration and I am going to make real-world decisions to 
spend money and to reflect that guidance. Are you expecting 
folks to comply with this as if it were a rule?
    Mr. Gensler. So we have also put out at the same time for 
30 day public comment something about phased compliance or an 
exemption for 1 year for these foreign-based swap dealers from 
many of the rules of Dodd-Frank--the entity-based rules. They 
would have to comply with transaction-based rules that are in 
effect like real-time reporting if they are doing something 
with a company in Texas. So if a bank in France was doing a 
trade with somebody in Texas, that would still have to come----
    Mr. Conaway. Under the transaction rule but not the entity 
itself would----
    Mr. Gensler. That is correct.
    Mr. Conaway. And do you expect working with your friends at 
the SEC that they will come to similar conclusions when they go 
through their actual rulemaking process on this?
    Mr. Gensler. I think they will be similar but not identical 
because again Congress did something different on their side of 
the statute than ours so that----
    Mr. Conaway. Well, that seems to be the cart driving the 
horse. In other words, what we want is regulations that work 
for everybody and allows them to comply. I haven't harassed you 
too much about the end run on cost-benefit analysis that this 
guidance proposal appears to allow you to not do cost-benefit 
analysis of what compliance under these guidance rules might 
cost and what those benefits are. But the idea is that they 
ought to be parallel with the SEC and not rely on a flawed law 
that Mr. Boswell said we probably need to fix some of that kind 
of stuff, but the idea is, then you would be able to comply 
with this and not let the law drive a goofy answer.
    Mr. Gensler. The SEC, the Treasury and the Federal Reserve 
have all given us advice and counsel for many months on this 
document we put out to public comment, and I believe we will be 
close whenever the SEC moves forward, but again, because they 
have different statutory framework, there will be some 
difference.
    Mr. Conaway. Let me ask in a similar vein, Barclays, which 
you guys did a good job and I was hoping you would brag more on 
your team this morning about that because I do think you did a 
good job. But the agreement that you made with Barclays Bank 
sets in place some things that they will now do with respect to 
their operations. Will that now become the industry standard 
for everybody else and is this another way to get at a rule 
without going through the normal rulemaking processes that we 
generally have put in place?
    Mr. Gensler. Let me first brag on the team, Vince McGonagle 
and Gretchen Lowe, Anne Termine, and David Meister, I mean, 
fabulous, tough, tough case, fabulous work they have done.
    In terms, yes, we had Barclays commit that as they make 
these submissions in the future, they have to be transaction-
based, focused on Barclays transactions, and if there aren't 
transactions in this unsecured market, they have to look to 
their secured borrowings. They have to have firewalls and----
    Mr. Conaway. That is fine, but I really wanted to focus on 
the impact this has on the rulemaking process. In other words, 
will you use this again in the future with legal operations to 
get at a back-door rule for everybody else?
    Mr. Gensler. I now understand your question. We were really 
focused on Barclays. I mean, Barclays had such pervasive 
activity that was not in compliance with the law, so pervasive 
we said no, you have to have these undertakings. We have 
undertakings in many of our settlements. They just don't get as 
much publicity as this here. And I would say that just as in 
other cases, people should read those undertakings and 
understand them but they are Barclays specific.
    Mr. Conaway. You mentioned the PCAOB helping you with 
auditing standards. They set the auditing standards for public 
companies. I would also refer you to the AICPA, which sets 
auditing standards for private companies, and the fellow that I 
suspect was auditing Peregrine was likely not registered under 
the PCAOB.
    Mr. Gensler. I think that is very good advice. I think that 
they were registered but it is still very good advice.
    Mr. Conaway. Thank you, Mr. Chairman.
    The Chairman. The gentleman's time has expired. The chair 
now recognizes the gentleman from North Carolina, Mr. Kissell, 
for 5 minutes.
    Mr. Kissell. Thank you, Mr. Chairman.
    Thank you, Chairman Gensler, for being here with us today. 
We had a hearing a while back on MF Global; and as Members of 
the Committee were questioning board members, Commissioners 
from the CFTC about some of the oversight things, it was 
pointed out, I believe by the Ranking Member, that MF Global 
had really transitioned from a commodities-based firm to a 
securities firm and really at that point in time when some of 
the bad things happened, it was more of an SEC responsibility 
than a CFTC responsibility.
    In that regard in that transition, and somewhat in follow-
up to Mr. Conaway's questions, as the CFTC moves forward in its 
definitions and its rulemakings, and as the comment time 
closes, and looking at the cross-border aspects of some things, 
some folks had come to me and talked about, they were concerned 
not wanting changes in laws and regulations, just looking for 
certainty, and they were concerned if you guys finished your 
work too much in advance of the SEC doing the same things. 
Looking at MF Global as an example of a company that switched, 
in between, are you concerned that if you get too far ahead of 
the SEC if there might be the gaps in there that might create 
problems in oversight, in the paperwork, in compliance issues 
if there is too much of a gap between these things being done? 
I just wonder what your thoughts are.
    Mr. Gensler. I am mostly concerned that 2 years into this 
and 4 years from the crisis we need to get these common-sense 
rules of the road and the traffic lights in place. The timing 
gap with the SEC, they are overseeing the securities-based 
swaps, which is a much smaller part of the market, does raise 
some concerns in clearing of credit default swaps, so that is 
something we have looked at very closely, especially the 
largest clearinghouse, the IntercontinentalExchange. I would 
hope that we could get portfolio margining, which is a very 
detailed issue, done, because that we need to do with the SEC.
    The timing gap that is probably more significant is with 
Europe and with the international regulators and this cross-
border issue, and that in part is a significant reason why we 
gave this 1 year period to sort through some of these 
international issues. We have a proposed exemption for another 
year on the international side.
    Mr. Kissell. Thank you, Mr. Chairman, once again for being 
here and I yield back my time.
    The Chairman. The gentleman yields back. The chair now 
recognizes the gentleman from Colorado, Mr. Tipton, for 5 
minutes.
    Mr. Tipton. Thank you, Mr. Chairman. Thank you, Chairman 
Gensler, for being here as well.
    I think that I would like to follow up a little bit on what 
Mr. Conaway and Mr. Kissell have been talking about in regards 
to some of the cost-benefit analysis of this. Our counterparts 
seem to have pretty much the same conversation, which is 
financial certainty in terms of what is being proposed by the 
CFTC. You have issued but not published in final form a number 
of rules that are going on. When we are talking in country, not 
extraterritorial, but in country on the proposed rules, are you 
expecting compliance because that seems to still be fluid, and 
some of the costs that are going to be associated from these 
various groups that they are going to have to try and comply 
and then change as that rulemaking process has not been 
finalized.
    Mr. Gensler. To answer your question, no, and we have been 
very clear and issued exemptive language. We are hopeful to get 
our proposals finalized by the end of this year. We have 
granted relief through the end of the year, and then as we 
finalize those we would put in place compliance schedules well 
into 2013 for the rules that might be finalized later this 
year. But only the final rules that are in place are actionable 
and enforceable.
    Mr. Tipton. Great. And one thing I would like you to maybe 
explain just a little more on, whenever there is a problem, we 
all want to make sure that the markets work well, people are 
held accountable, the people's resources are sound and we can 
count on the information. You had commented that are you doing 
some internal examination, that you stated in your testimony 
the system failed to protect Peregrine's customers, and that we 
need to take a close look at how the CFTC handled its 
oversight. Are you identifying, in lieu of new rules, where it 
failed internally and how to organizationally make this work 
better?
    Mr. Gensler. We are doing that. We had already restructured 
this group, the examination function and oversight of the self-
regulatory functions and hired a new head of examinations and 
also a new head on top of that, but that is not enough. I mean, 
they are terrific people but we really do look at this and say 
we have to do better. How do we, in essence, audit the 
auditors, how do we examine the SROs, because that front line 
of defense is embedded in statute? That is what we have had for 
decades. Now, how do we enhance that front-line defense and 
then the CFTC's responsibilities? As the Chairman says, we 
ultimately do have that responsibility and should be held 
accountable to make sure we look internally how we can do this 
better.
    Mr. Tipton. You know, and I think we probably agree, the 
majority of the players want to make sure that things are done 
properly and abiding by the law that is going on, but when it 
got into the extraterritorial rulemaking, the five 
Commissioners went ahead and moved through without the 
customary input for public comment. Moving on, you have now 
opened this up for 45 days. Do you think that is a prudent 
thing to do or would it be better maybe to talk to people that 
are actually in the business to be able to seek some guidance 
in terms of how to make sure that the rulemaking process moves 
forward for that interaction with the SEC as well?
    Mr. Gensler. Well, Congressman, with all due respect, we 
had gotten a lot of input from market participants, and we list 
those meetings on our schedule, but I would have no doubt there 
were dozens of meetings and dozens of letters from commenters, 
if not over 100 letters from commenters, about the cross-border 
application, and then we put that in this interpretation and 
the relief, the 1 year relief I referred to. We had input from 
the SEC before we did that and now we are going to get further 
public comment on that because it is critical to get the public 
comment.
    But I would say that if we followed the industry's approach 
completely, they would move the jobs and the markets to London 
or the Cayman Islands or somewhere but the risk still comes 
crashing back here. AIG Financial Products, that was located in 
Mayfair in London. Citicorp's special purpose vehicles, their 
off-balance-sheet vehicles, were originated in London and 
incorporated in the Caymans. I could go crisis by crisis. The 
risks come crashing back to the American public and so we think 
that when Congress said to oversee what is direct and 
significant that we have to find a way to make sure those 
branches and affiliates of U.S. financial parties have in place 
some common-sense transparency and risk-reducing rules.
    Mr. Tipton. I see my time has expired. Thank you, Mr. 
Chairman. I yield back.
    The Chairman. The gentleman's time has expired. The chair 
now recognizes the gentlelady from Maine for 5 minutes, Ms. 
Pingree.
    Ms. Pingree. Thank you very much, Mr. Chairman, and thank 
you for being here with us today.
    I am going to ask a slightly different question but it is 
on the same perspective of all the work that you are doing. 
There was a lot of attention this morning to the fact that 
Sandy Weill was, I guess, on CNBC and it has been covered in 
The New York Times so obviously the former chair of Citigroup, 
and one of his very thoughtful comments was that the big banks 
should be broken up into separate commercial banking and 
investment entities. So given his perspective, and obviously 
this is a clear change of opinion of himself and probably a lot 
of other people out there, how does that affect your view of 
the current Volcker Rule? Do you think maybe now we should be 
thinking about a more robust version as we are going through 
this process?
    Mr. Gensler. There is a lot in that question.
    Ms. Pingree. That is okay. I have 5 minutes.
    Mr. Chairman. And you tend to put a lot back in your 
answers.
    Mr. Gensler. I think we need common-sense rules of the road 
so that if a bank fails, there is a freedom to fail, that the 
taxpayers are not standing behind banks. I think that has got 
to be the heart of what we do in the derivatives regulations 
and otherwise in Dodd-Frank. I think in terms of the Volcker 
Rule, the approach Congress took is to lower some of the risk 
of this proprietary trading but of course at the same time 
still permit very important market-making and risk-reducing 
hedging. It is probably one of the most challenging rules in 
front of regulators, how to prohibit proprietary trading but 
permit these important activities, market making and hedging.
    Ms. Pingree. I know you are going to give a longer answer 
but I am going to just interject for a second because this is 
part of my follow-up question. In previous hearings, we have 
heard some people question whether you can make the distinction 
between a hedge or a proprietary trade, so actually I was going 
to ask you a little deeper on that and maybe you could at the 
same point comment about how you define it, have we gone far 
enough. If certain other bankers are thinking it is still too 
confusing, are we going far enough?
    Mr. Gensler. I think it is a challenge for regulators. I 
think Congress was clear that you can hedge specific risk, 
whether it is a specific position or an aggregate position. 
Congress decided that. But I don't think that Congress meant by 
that that it could just be, well, I am going to say this table 
here is a hedge. You see, I am just telling you this is a hedge 
and therefore it is hedge. It is hedging something. And it has 
to have reasonable relationship to the underlying positions, 
and I think that is the challenge. The JPMorgan Chase situation 
on credit derivatives and portfolio hedging, we have to learn 
from that and think about that. When is portfolio hedging 
really related to specific risks and when is it something that 
is mutating into just betting on the markets.
    Ms. Pingree. So are you imagining that portfolio hedging 
will somehow stay in the final rule?
    Mr. Gensler. Well, Congress already spoke to that, that it 
could be hedging aggregate risk of positions. My own experience 
when I was on Wall Street, that when you separate a hedge 
further and further from a trading desk and it has a separate 
profit-and-loss statement and separate managers, it tends to 
mutate into something else, but if it is actually related to 
aggregate positions and has a reasonable correlation to that, 
for instance, it loses monies when the positions make money and 
it makes money when the positions lose money, that probably 
tells you it is a real hedge. But otherwise it might be 
something else and Congress said let us lower that, let us 
prohibit that, in fact.
    Ms. Pingree. So I am not an expert in this field, but given 
how confusing that is, and if certain bankers are already 
saying it is confusing, why doesn't it make us want to go back 
and look at the Volcker Rule and say, ``Well, let us just go 
back to keeping them completely separate.'' Maybe it is not 
going far enough to have a really complex, difficult-to-enforce 
and difficult-to-understand rule, why not on the Volcker Rule 
do what Sandy Weill said, ``After years of history now looking 
back, we ought to just break up the banks?''
    Mr. Gensler. I am not familiar exactly with what he said 
this morning, but of course, that is part of what Congress 
debated and can debate in the future. We would work with you in 
any way on that.
    The Chairman. If the gentlelady would yield?
    Ms. Pingree. Yes.
    The Chairman. I think you are referencing that traditional 
separation of the two that was put in place in the 1930s under 
Glass-Steagall. There is much discussion about that, yes. I 
yield back.
    Ms. Pingree. And for the record, I am in favor of Glass-
Steagall and going back into that position, and you are right, 
I can't paraphrase him or anyone else, but it seems to me given 
some of the confusion around the complex way we are trying to 
make them separate but not, we should reinstate Glass-Steagall. 
Thank you.
    Mr. Gensler. I think the critical piece is that if any of 
these banks fail we not stand behind them.
    The Chairman. The gentlelady's time has expired. The chair 
now recognizes the gentleman from Florida, Mr. Southerland, for 
5 minutes.
    Mr. Southerland. Thank you, Mr. Chairman, and Mr. Gensler, 
thank you for appearing before us today.
    I have a couple questions. I wanted to read a little bit of 
information from--this is PFGBest customer account agreement 
that they sent to all of their customers. It says ``If your 
securities futures positions are carried in a futures account, 
they must be segregated from the brokerage firm's own funds and 
cannot be borrowed or otherwise used for the firm's own 
purposes. If the funds are deposited with another entity, 
(e.g., a bank, a clearing broker or a clearing organization) 
that entity must acknowledge that the funds belong to the 
customer and cannot be used to satisfy the firm's debt,'' and I 
would like, Mr. Chairman, to incorporate PFGBest Customer 
Account Agreement into the record.
    The Chairman. Seeing no objection, so ordered.
    [The information referred to is located on p. 110.]
    Mr. Southerland. So my question is, obviously there is 
proof that that was violated, I am curious, how do--why didn't 
CFTC monitor segregated funds and secured accounts held by 
JPMorgan Chase, who obviously knows that rule. There didn't 
seem to be a paper trail to prove that those funds were held in 
the account as they were supposed to be and that a proper usage 
of a withdrawal was proven before they released those funds.
    Mr. Gensler. If I understand the question, why wouldn't a 
bank have done that? We are going to learn a lot more facts but 
there are a number of points of outside auditors, self-
regulatory organizations like the NFA auditing and, yes, even 
the CFTC doing some limited-scope reviews. Acknowledgement 
letters, you referred to acknowledgement letters, may have been 
forged here as well so that it looks like from Russ Wasendorf's 
own words and his note found when he attempted to kill himself 
was that he was using PowerPoint to forge bank statements as 
well as some of these acknowledgement letters and confirmation 
letters. All of the points of protection--outside auditors, 
NFA, even our limited-scope reviews--did not find this. The 
system let down these investors. But I believe acknowledgement 
letters, confirmation letters, bank statements and custodial 
statements should be directly electronically available to the 
regulatory agencies. We are working with the NFA and the CME to 
try to get that in place shortly.
    Mr. Southerland. But it just seems to me that if JPMorgan 
Chase released these funds, they had a burden to confirm--and I 
understand what you are saying, that there were forged 
documents, but oftentimes many of the American people sometimes 
feel that investigators, bureaucrats, and many times regulators 
couldn't track an elephant in the snow, and when you look at 
this right here, I think that warrants their feelings.
    I want to say I know I am running out of time but I want to 
ask you this: Unlike stocks, future trades are not covered 
under the Securities Investor Protection Corporation, SIPC, 
which protects against losses from unauthorized transactions up 
to $500,000, or $250,000 limit for cash. Why shouldn't these 
futures be covered by SIPC as insurance protection for really 
honest investors who in good faith have made those investments?
    Mr. Gensler. Well, that is a debate that has come about. 
Commissioner Chilton, one of my fellow Commissioners, has 
recommended it, and I know that you will be considering that. I 
would say there are costs and benefits, and what we need to do 
at the CFTC is not frankly wait for that but really put in 
place stronger protections around these accounts, even building 
on what we have already done because we have done a lot to put 
in place further protections as that debate goes on.
    Mr. Southerland. Well, and I think that right now we are 
doing forensics. It would be nice--you made reference to your 
grandfather--my mom raised me on plenty of anecdotes too and 
she always said to me, an ounce of prevention is better than a 
pound of cure. I would encourage to look at how we can better 
protect our investors.
    And the last thing I would say, Mama also told me--and by 
the way, being a Member of Congress and the older I get, the 
more I realize my mom and dad were pretty smart--my mom would 
always say, if you wallow with the hogs, you are going to get 
dirty, and might I suggest that we monitor the hogs that Mr. 
Wasendorf wallowed with? You might find some other dirty hogs. 
I yield back.
    The Chairman. The gentleman's time has expired on that 
thought. The chair now recognizes the gentleman from Vermont 
for 5 minutes, Mr. Welch.
    Mr. Welch. Thank you very much.
    Mr. Gensler, a couple of things. Number one, good job, and 
I do hope that we adequately fund you. Much is being expected, 
and if you are going to do what is required in order to 
maintain the credibility of the futures market--we are going to 
have gentlemen and women testifying after you who are using 
that market for the purposes for which it is intended--we have 
to give you the resources. So I support full funding for your 
efforts.
    I want to ask you about derivatives and a little bit about 
what happened with JPMorgan Chase. One of your predecessors, 
James Stone from Massachusetts, wrote an article recently, and 
he pointed out that JPMorgan had, as many banks do, a huge 
exposure of derivatives notional value contracts. In the case 
of JPMorgan, it is about $75 trillion. That is an enormous 
outsize risk. And the question that I asked myself and he asked 
as well: are there regulations really that we can constantly be 
cooking up that somehow keep up with the level of risk and the 
level of creativity in the derivatives markets, or is it time 
to make some requirement that there be some money on the table 
from the big banks when they are putting so much of their 
shareholder and depositor money at risk and where obviously it 
has implications for the economy?
    Just to go through a few of the things that he pointed out, 
the risk is disconnected, as you were saying earlier, from the 
actual trading desk. I don't think that is true with folks who 
are going to be testifying next. There is a direct connection 
between what they are doing and how they are trying to offset 
that risk, and we support that. But where the three largest 
banks have 24,000 percent notional value risk compared to their 
assets, any deviation in their risk model where there may be a 
black swan, as they call it, where there may be a geopolitical 
event, \1/10\ of 1 percent is going to have a big exposure.
    Now, rather than doing all these rules and regulations, we 
are having fights about it that get reflected in our squeezing 
your budget because we can't come to some understanding, one of 
the things that Mr. Stone recommended is that those banks or 
those derivative players would have to put down \1/10\ of 1 
percent to offset that risk, and it means that the taxpayers 
may not be exposed. Seventy-five trillion dollars of notional 
value would be $75 billion in cash money that would be a factor 
that would reduce that counterparty risk, reduce the trading 
volumes and bring us back to what had been historically the 
purpose of the futures market and hedging, which is to offset.
    So rather than all this complicated regulation where I am 
starting to get to the view that my colleague here from Maine 
had that some of these institutions are too big to fail, they 
are too big to regulate as well, what would be your position 
about requiring that there be some exposure with a \1/10\ of 1 
percent just for discussion purposes on these derivatives 
contracts?
    Mr. Gensler. I actually think that is what Congress did in 
the Dodd-Frank Act by saying that the standard derivatives have 
to come into a clearinghouse, so clearinghouses collect margin, 
and that the non-standard contracts the banks have to collect 
margin, not on the non-financials, the end-users are out of 
this, but for the 90+ percent of the market that is insurance 
companies and banks and hedge funds, that they have to put up 
margin at the clearinghouses, put up margin. If they fail, that 
is money in the game, skin in the game that they can unwind 
that position and hopefully the taxpayers, the clearinghouse is 
not held to account. It is the JPMorgan that would lose in that 
circumstance. And so you did that actually. The question is 
whether, you might say, is it enough.
    Mr. Welch. And in your view, is it?
    Mr. Gensler. Well, I think that we put out very strong 
rules about the amount of margin that has to be at the 
clearinghouses. We haven't finalized the rule on the margin for 
the uncleared swaps. We are working internationally. We don't 
want to do it ahead of Europe. This is one where we want to 
time this with Europe around the end of this year or the first 
quarter of 2013. But yes, you should hold us accountable that 
there is enough in the uncleared swaps because you wouldn't 
want risk to go there inadvertently.
    Mr. Welch. Thank you.
    The Chairman. The gentleman's time has expired. The chair 
now recognizes the gentleman from Illinois, Mr. Hultgren, for 5 
minutes.
    Mr. Hultgren. Thank you, Mr. Chairman.
    Thank you, Chairman Gensler, for being with us today. A 
couple questions. Yesterday, CFTC published an initial list of 
swaps proposed to be subject to the clearing mandate. It 
appears that Europe will not be prepared to have any such 
clearing mandate in effect until 2013. What is the expected 
timing in Asia for an enforceable mandate clearing requirement?
    Mr. Gensler. Japan is a little ahead of us actually. They 
were targeting November of this year to have their mandate in 
place. Hong Kong and Singapore will be later, though, so Japan 
is a little ahead of us, Hong Kong and Singapore later.
    Mr. Hultgren. What effect do you expect the timing of these 
mandates will have since they are not coordinated?
    Mr. Gensler. Well, I think that it will lower the risk to 
the American public, and that is what we have been chatting 
about here, but it would only be a mandate on transactions that 
have a direct and significant effect on U.S. commerce or 
activity, so it is with U.S. persons. We phased in compliance. 
We said for 1 year, for instance, even if you are a large 
American bank and you operating out of Frankfurt and you are 
operating with some German insurance company, that mandate 
doesn't apply there. It is back to U.S. persons and direct and 
significant effect back here in the United States.
    Mr. Hultgren. Let me ask you briefly just about some of the 
cross-border guidance proposal that CFTC put together to inform 
market participants and end-users about the extent of overseas 
reach of U.S. derivatives regulations. I wondered why the CFTC 
chose to address this important issue via guidance rather than 
through a formal rulemaking. My concern is, by doing so, you 
essentially avoid cost-benefit requirements associated with a 
formal rulemaking. Did you take into account the cost of 
imposing and enforcing CFTC rules overseas?
    Mr. Gensler. To your last point, the cost of not putting 
them in place is another crisis. Risk comes back to our shores 
and the jobs are overseas. I mean, let me just talk about 
American jobs. They will move to London, they will move 
elsewhere where somebody thinks the regulation is lighter. 
Having worked at a large investment bank with hundreds of legal 
entities, you just pop another legal entity somewhere across 
the globe but the risk still comes back here in a crisis, so we 
did consider that. The reason we did interpretation is because 
there are legal words in the statute that a lot of people said 
can you interpret them, section 722(d), and so we are trying to 
interpret them but maintain some flexibility as well because 
each legal entity is going to have different facts and 
circumstances.
    Mr. Hultgren. Under Dodd-Frank, Congress required CFTC and 
SEC to jointly adopt foundational derivative rules such as 
those defining swap and swap dealer. Clearly, Congress 
expressed its intent that the rules governing the scope of the 
entities and products subject to Title VII should be defined by 
those two regulators in concert. In my view, the cross-border 
guidance is effectively part of that swap and swap dealer 
definitional rules. You can't know what a swap or swap dealer 
is without clearly understanding how cross-border issues are 
impacted, can you?
    Mr. Gensler. I think you can, sir, with all respect, and 
also as it relates to the SEC, there is no parallel section to 
722(d) on the SEC side. There would be no way frankly for us to 
do a joint interpretation when they don't have it in their 
statute and we do in the Commodities Exchange Act. So I think 
that we have coordinated very well with the SEC and gotten 
those joint rules behind us. On cross-border application, we 
are coordinating but, frankly, there is a different statutory 
framework to interpret.
    Mr. Hultgren. Well, I disagree. I think there is still 
significant amount of misunderstanding over those definitions. 
There is clear fear over it. It is paralyzing many entities.
    Switching gears a little bit, I come from Illinois. I have 
large electric co-ops, also large electric companies there in 
Illinois, and there have been some very serious concerns on 
those entities of what the impact of the definition of swap 
dealer and swaps will be on that. Why did the Commission 
appropriately raise the proposed overall de minimis level from 
$100 million to $3 billion but didn't raise the level for 
special entities such as public power companies and other 
utilities?
    Mr. Gensler. Because we put it out to public comment. We 
received a lot of comments with regard to the overall level. We 
didn't get comments--there was one small comment--comments on 
special entities. Just to refresh, Dodd-Frank said that if 
somebody was dealing with a municipal or a pension fund, they 
had to have additional sales practice and treat them as--
Congress called it--special entities. So we had a more narrow 
definition there. But we have worked very well with the rural 
electric cooperatives and the municipal power companies. They 
have a petition in front of us. We have that in front of our 
Commissioners to hopefully in the next few weeks or months put 
that out to public comment for an exemption for the municipal 
power companies dealing with what is called 201(f) rural 
electric cooperatives.
    Mr. Hultgren. Just a quick follow-up on that. My question 
really is, my understanding with Dodd-Frank was recognition of 
threats to market really in response to the financial crisis. I 
would just ask what role power companies had in creating the 
financial crisis.
    Mr. Gensler. We are working with the municipal power 
companies and the rural electric cooperatives to have an 
exemption for them, and we worked through that swap definition 
so that many, many electricity contracts that they had concerns 
with were addressed. I know the Edison Electric Institute put 
out some comments about what we had done. They continue to come 
in on very important but narrow issues, and we are going to 
continue to work with them on that, but I don't think that the 
municipals and the rural electric co-ops and so forth are going 
to become swap dealers and so forth.
    The Chairman. The gentleman's time has expired.
    Mr. Hultgren. Thanks, Mr. Chairman.
    The Chairman. The chair now recognizes the gentlelady from 
Ohio, Ms. Fudge, for 5 minutes.
    Ms. Fudge. Thank you very much, Mr. Chairman, and thank 
you, Chairman Gensler, for being here today.
    I just really have two questions. The first one is, in your 
testimony, you assert the need for increased appropriations for 
CFTC in order to allow it to better serve the American people 
by providing sufficient oversight. In light of the need for 
greater oversight and of course recent events as well, do you 
believe that the private regulator NFA is really up to the task 
or do you believe that the American people would be better 
served by having one centralized Federal regulator?
    Mr. Gensler. Well, this is embedded in our oversight for 
decades, this system of front-line regulators and then the 
Federal regulator overseeing this front-line regulator. So we 
are taking a deep dive and looking very closely at how to 
enhance this system. Frankly, we don't have the resources. I 
mean, this is not just decades old for other reasons but we 
don't have those resources.
    Ms. Fudge. Right. If you had the resources, my point is, 
does it work the way it is? Do you have the confidence in the 
private regulator that you should have?
    Mr. Gensler. We are doing everything to enhance it. We have 
worked closely with the self-regulatory organizations that you 
will hear from in the next panel to enhance it. I think in this 
circumstances of Peregrine and as evidenced, it did not serve 
the benefit of these people. But the reality is, this has been 
here for decades. It is enshrined in statute.
    Ms. Fudge. That is not my question.
    Mr. Gensler. I know. I respect that the challenges of this 
self-regulatory organization or Federal regulators is going to 
be similar. My answer is, whether it is at a self-regulatory 
organization or at the Federal regulator, we need to make sure 
that we have windows directly into these accounts, that we have 
enough enforcement and a culture of enforcement between them 
and ourselves. I think it can work either way, by the way. I 
think it is can work either way but this is what has been 
enshrined for decades.
    Ms. Fudge. Well, since you don't want to give me a direct 
answer, we will go to the next question.
    And this has been talked about, people have touched on it 
today, but I mean, certainly we understand that the public 
needs some real protection and some certainty. And people have 
asked you about timelines. Could you please discuss the 
timelines for completing the rulemaking under Dodd-Frank?
    Mr. Gensler. We have been at this about 2 years and we have 
just under 20 proposals that are out but haven't been 
finalized. I think the bulk of them, not all of them, will be 
finalized by December 31st. There are some we have chosen to 
wait like the international margining regime to line up with 
other regulators. The timeline beyond that is, we will still 
continue to phase compliance well into 2013 in terms of 
bringing people in because markets need time to adjust and to 
lower the burden and let this come into place.
    Ms. Fudge. Thank you very much, Mr. Chairman. I yield back.
    The Chairman. The gentlelady yields back the balance of her 
time. The chair now recognizes the gentleman who represents 
most of the great State of Kansas, Mr. Huelskamp, for 5 
minutes.
    Mr. Huelskamp. Thank you, Mr. Chairman, and Chairman 
Gensler, thank you for joining us here today. I would like to 
direct some questions to the Peregrine incident. How many years 
was wrongdoing occurring there based on information you have?
    Mr. Gensler. I am sorry. This is Peregrine?
    Mr. Huelskamp. Yes.
    Mr. Gensler. We are still trying to develop the facts. His 
note that he left when he attempted to take his life said that 
it had been for quite some time, maybe up to 20 years, but we 
do not have independently verifiable data to say that. In some 
cases, banks and others only have records for 7 years. So it 
may well be that we won't know the answer to that with 
certainty, but his note says maybe up to 20 years.
    Mr. Huelskamp. And during those 20 years, how many times 
was that company audited or reviewed by your entity?
    Mr. Gensler. It would have been audited by outside folks 
every year and the NFA every 9 to 15 months. The CFTC, as I 
laid out in the written testimony, conducted a number of 
limited-scope reviews in the 1990s that led to an enforcement 
action in 2000 where Peregrine had to bring others in--
PricewaterhouseCoopers. We also in 2007 and 2008 did some 
limited-scope reviews on matters that are outlined and then one 
more in 2010 on anti-money laundering. These limited-scope 
reviews are not audits in the full sense of the word but we 
look at papers and specific issues that have come to our 
attention.
    Mr. Huelskamp. Did you ever call the bank to verify the 
account balances that apparently this CEO was falsifying and 
submitting for your reviews?
    Mr. Gensler. Though I am not aware of all the details in 
all of these reports over the years that CFTC might have done, 
the first-line auditors would have been the CPAs and the 
National Futures Association, but I am not aware of any calls 
to the bank, U.S. Bank or Harris Bank or the other banks, but 
it may have occurred.
    Mr. Huelskamp. And you mentioned PricewaterhouseCoopers. 
Certainly they would have verified the account balances, would 
they have not? I mean, you directed them as part of a finding 
to find some outside help for this issue.
    Mr. Gensler. Under the rules of the CFTC, written 
enforceable rules, the yearly CPA has to use Generally Accepted 
Auditing Standards, and as I understand it, those auditing 
standards do require what you just said about the confirmations 
of assets, custodial arrangements in banks.
    Mr. Huelskamp. So if it was 20 years, if the suicide note 
was apparently the basis for your charges and been occurring 
for 20 years, then this outside entity that in 2000 actually 
should have looked at those records as well?
    Mr. Gensler. Again, there are a lot of facts we are going 
to learn but I think that you are correct, sir, that outside 
auditors and even in the audit routines of the National Futures 
Association is to confirm key balances.
    Mr. Huelskamp. On January 25th, Mr. Chairman, you have a 
press release still on your website, CFTC Releases Results of 
Limited Reviews of Futures Commission Merchants. That review 
did include this firm in question?
    Mr. Gensler. Yes, it was reviewed by the NFA as part of 
that limited-scope review.
    Mr. Huelskamp. And what was the role of the Commission in 
the review?
    Mr. Gensler. We looked at the top, I want to say 10 or 12 
largest futures commission merchants and then the Chicago 
Mercantile Exchange took the next group and then NFA took their 
direct regulated entities.
    Mr. Huelskamp. So the CFTC didn't review the entity in 
question here, it was NFA?
    Mr. Gensler. No. The last time we did a limited-scope 
review was on anti-money laundering. It was maybe a year and a 
half ago at Peregrine.
    Mr. Huelskamp. Obviously, Mr. Chairman, with the $1.6 
billion lost through MF Global and the uncertainty out there, 
why would you put anything out to the public assuring them 
that--and this was assurance to the marketplace and that is how 
it was treated--if you hadn't done the work and again we are 
relying on outside groups to determine the effectiveness of 
your regulatory system?
    Mr. Gensler. Sir, I will even go further. This was an 
attempt to deceive the regulators and the public for what may 
have been many years. The deception would have continued all 
the way until July of this year throughout this period of late 
last year, and I believe that we need to do more and we need to 
do better, but this was an outright fraud, forged bank 
statements, forged--so even this would have occurred in 
November or December when the NFA took their limited review at 
that point.
    Mr. Huelskamp. And I appreciate that. Thank you, Mr. 
Chairman. I find it troubling that we would put this type of 
assurance out, screwed up in MF Global, screwed up on this 
entity and then here we are telling the marketplace in January 
and then find out later at the various time this assurance was 
given that we had these problems still out there. I have 
constituents that lost funds in both entities through a massive 
failure, and so I appreciate the answers, Mr. Chairman. I look 
forward to your further research. I yield back.
    The Chairman. The gentleman's time has expired. The chair 
now recognizes the gentleman from Connecticut, Mr. Courtney, 
for 5 minutes.
    Mr. Courtney. Thank you, Mr. Chairman, and first of all, I 
just want to join my friend, Mr. Conaway, in complimenting the 
work that CFTC did in the Barclays case. Again, just for the 
record, the U.S. Treasury is collecting $160 million in fines 
from Barclays as a result of that enforcement action. Isn't 
that the----
    Mr. Gensler. It is actually $360 million, because it would 
be $200 million in our action and $160 million in the 
Department of Justice.
    Mr. Courtney. Great. So again, just sort of going back to 
your point about resources and CFTC's total budget cost to the 
taxpayer, again, the President's submission this year was for a 
budget of about $300 million. Is that correct?
    Mr. Gensler. That is correct.
    Mr. Courtney. Obviously we don't want you to be in the 
position of, to use another metaphor today, of a police officer 
writing speeding tickets to pay for his budget, but the fact of 
the matter is, is that having an adequately financed CFTC will 
in fact result in benefit to the taxpayer through enforcement 
actions that in some instances collect fines but also hopefully 
regulate behavior that is going to be a benefit to consumers 
and small businesses.
    Mr. Gensler. I think we are a good investment to the 
American public because markets will work better, end-users 
will get a better deal in these sophisticated markets, and you 
are right, occasionally there will be large enforcement fines 
but we have to knock on every door that the Chairman said we 
have to knock on.
    Mr. Courtney. And to follow up on Mr. Huelskamp's 
questions, I mean, the fact is, is that the situation at 
Peregrine, in my opinion, really demonstrates the weaknesses 
that existed pre-Dodd-Frank in terms of your ability to detect 
outright cases of fraud and deception. One of the rules that 
you have just promulgated, which is in your testimony, is that 
you are actually beefing up CFTC's ability to crack down on 
actual cases of deception by having whistleblower authority, 
which obviously didn't exist years ago when the Peregrine 
situation was unfolding. We can never know whether or not that 
would have flushed it out, but the fact is, is that when there 
are these outright cases of deception, having these more robust 
authorities through Dodd-Frank is actually going to help detect 
actual cases of fraud and deceit. Isn't that correct?
    Mr. Gensler. I think that is correct. You have also 
enhanced the anti-manipulation rules. We now have gone to a 
recklessness standard from intent-based. It would be easier to 
pursue cases around benchmark interest rates like LIBOR, so you 
have enhanced a lot.
    Mr. Courtney. And again, one of the other metaphors that 
you heard from my friend, Mr. Southerland, was that an ounce of 
prevention is worth a pound of cure. I mean, in fact, that is 
exactly what CFTC is doing by again sort of creating a new 
regulatory structure which you described in your opening 
comments so that we don't again end up in situations like 2008 
or MF Global, etc. I mean, that is exactly what you are trying 
to accomplish, isn't it, with the regulations?
    Mr. Gensler. That is true, but I would say we are never 
going to repeal human nature. We bring about 100 enforcement 
cases a year. We have Ponzi cases and we will be having Ponzi 
cases for decades to come, unfortunately. This Peregrine 
situation while technically not a Ponzi case has all of the 
sort of indicia of a similar fraud where somebody has deceived 
their customer base and stolen.
    Mr. Courtney. Right. And last, in terms of the Dodd-Frank 
position limits regulations which I usually ask you about every 
time you visit us, again, we are now sort of moving towards 
actually a launch date. Isn't that correct, in terms of the 
position limit rules going into effect?
    Mr. Gensler. That is correct. Two months after this joint 
definition of the word swap is in the Federal Register, swap-
month positions limits will be effective for 28 commodities for 
swaps and futures, so sometime in October most likely.
    Mr. Courtney. Well, I just want to say, Mr. Chairman, for 
the record, that there are a lot of small businesses, 
particularly people who are end-users in the energy sector, 
certainly in my state, who are looking forward to that date 
with great anticipation and happiness. Hopefully this measure 
which is moving forward in the House this week to freeze all 
regulations in its track, a chainsaw throughout the whole 
government, won't move forward because even though the stated 
purpose of that bill is to protect small businesses, the fact 
of the matter is, it is the end-users who rely on the futures 
market for energy who would be hurt by freezing that regulation 
from going into effect.
    And with that, I would yield back, Mr. Chairman.
    The Chairman. The gentleman yields back. The chair now 
recognizes the gentlelady from Ohio, Mrs. Schmidt, for 5 
minutes.
    Mrs. Schmidt. Thank you. Thank you very much.
    Mr. Chairman, I believe your core mission is oversight and 
enforcement and yet since you have been Chairman, two of the 
largest failures in future brokers have occurred under your 
watch, and listening to your testimony today, I mean, you told 
the gentleman from Colorado that you should be held 
accountable. That was your words. You told the gentleman from 
Florida that now you are going to be looking at electronic 
transactions to make sure that what is said to be put in a bank 
should be put in a bank. And I am a little confused because it 
was under your watch that these systems failed and shouldn't 
you have been doing that all along? I believe the buck stops 
with you. We can continue to put out more regulations but if 
you are not being the watchdog, then the systems are going to 
continue to be hurt. So I am just asking you, how did this 
occur under your watch?
    Mr. Gensler. The CFTC is very vigilant, but as you may be 
aware, the front-line regulation, the front-line examination 
function of intermediaries in these markets is with the 
National Futures Association or the Chicago Mercantile Exchange 
or other self-regulatory organizations. That is enshrined in 
statute. So we oversee the self-regulatory organizations. We 
have done a great deal to enhance the investment of customer 
funds and protections around that, sometimes even criticized 
that we were doing things that weren't in Dodd-Frank like 
saying we can no longer have what was called in-house 
repurchase agreements, taking customer money and lending it to 
others.
    But this situation here shows that we need to change the 
rules of how firms are audited and the direct electronic access 
to these accounts. This was deception, this was fraud, and that 
will occur from time to time, but I am agreeing with you that 
we need to do all we can do to protect the customers.
    Mrs. Schmidt. But you are relying on outside firms, the 
NFA, your last limited-scope review, you used their findings, 
and yet you look at certain things in the past that have 
occurred that should have put up red flags. If you are the 
watchdog, then maybe you should do your own internal 
investigation a little more diligently. I am looking at a lot 
of people who have lost money and this isn't the first time 
that we have had this discussion in this room, and all I hear 
is, we need more regulation, more rules, more authority. I am 
not seeing you or your organization doing its core mission 
right now, which is oversight and enforcement, and I am not 
sure any more rules are going to allow you to do the job 
better.
    So I am asking you, doesn't the buck stop with you and 
where is your leadership in this? I mean, are you spending so 
much time in rules and regulations that you don't have time to 
look at these audits and see if they are true and effective at 
what they are stating?
    Mr. Gensler. With all respect, we brought more enforcement 
actions last year than any time in the history of this agency: 
99. We have stepped up our enforcement of segregated accounts 
where for 7 years there hadn't been a case and then under the 
last 3 years----
    Mrs. Schmidt. But you had two of the largest failures in 
futures brokers under your watch.
    Mr. Gensler. I understand.
    Mrs. Schmidt. So regardless of everything else that you 
did, the big boys you didn't look at.
    Mr. Gensler. And we have restructured and hired new 
leadership in our examination and our intermediary oversight 
functions but yes, we need to do more. This Peregrine situation 
was direct deception. We have done a great deal, but I am 
agreeing with you----
    Mrs. Schmidt. But you did limited-scope reviews. Shouldn't 
you have done a little bit more? I mean, they had a red flag a 
few years ago. Shouldn't you have continually watched them to 
make sure that they were being good players in this and not 
just using a little checkmark and moving on?
    Mr. Gensler. With all due respect, with the funding we 
have, we are so limited in resources. I have been in front of 
this Committee over and over again so I am just going to say, 
we relied for decades on self-regulatory organizations as a 
front----
    Mrs. Schmidt. You relied on somebody else instead of your--
I am sorry. I yield back.
    The Chairman. The gentlelady yields back the balance of her 
time. The chair now recognizes the gentleman from California, 
Mr. Costa, for 5 minutes.
    Mr. Costa. Thank you very much, Mr. Chairman.
    I think the conversation that we have had here today really 
revolves around a transition that is taking place post-Dodd-
Frank. I am one of those that believes that as we are going 
through this transition, formulation of the rulemaking, the 
timelines that you started to explain in some of the 
questioning that progress has been made. You have been asked 
the question in a number of different ways. I think you just 
stated it in response to the last question. But do you really 
believe you have enough resources at this point in time to 
perform the role of risk assessment and risk management and 
enforcement that is necessary as the Commission?
    Mr. Gensler. No, we don't have enough to oversee the 
futures market that has grown five-fold since the 1990s and we 
are only ten percent larger than 20 years ago, and we don't 
have enough to ensure that we can oversee the swaps marketplace 
that is eight times larger.
    Mr. Costa. What would you anticipate you would need in 
terms of resources to address the question that was just asked 
by the Congresswoman to provide the level of scrutiny and 
enforcement necessary to avoid these kinds of frauds?
    Mr. Gensler. With all due respect to the question, though 
the President's budget is $308 million, which is about $100 
million than we are currently funded at, Congress in statute in 
2000 said we were to rely on self-regulatory organizations. If 
we were to be the front-line regulator to actually do the 
audits, that is not in the President's budget and it is not 
what I am recommending here today. I mean, we have a self-
regulatory system. What we need to do is ensure that the CFTC 
examines those self-regulatory functions better, that we do 
what we do and what Congress has directed us to do better in 
examining them and making sure that the system works for the 
American public.
    Mr. Costa. Do you anticipate being able to coordinate 
resources with clearinghouses? You are talking about the 
timelines in Japan, the timelines in Hong Kong, and the 
timelines for implementation in Europe with those other 
clearinghouses to try to provide a worldwide regulatory 
framework.
    Mr. Gensler. I think we are coordinating well but we have 
different politics and different cultures so there will be 
different timelines. In some countries, they might be 
significantly later than us but I am encouraged by Europe and 
Japan and Canada.
    Mr. Costa. For your discussion of those timelines, could 
you provide the Committee, because you talked about you are 
almost at the rulemaking now, what you see the timelines out 
for the next 2 years? Would that be possible?
    Mr. Gensler. I am sorry. Did you say for the next----
    Mr. Costa. Two years.
    Mr. Gensler. Two years? I think we can provide something to 
you in terms of the rules that are already finalized when there 
are compliance dates and then second, when we----
    Mr. Costa. Mr. Chairman, I would like that provided to the 
Committee so that we can all have a better understanding of 
that.
    [The information referred to is located on p. 105.]
    Mr. Costa. I want to understand the context that you made 
this statement. I thought I heard you say earlier in response 
to questioning that you would support letting the banks fail. I 
suspect we are talking about including those banks that are too 
large to fail?
    Mr. Gensler. I think a corner grocery store in America can 
fail, a farmer can fail. I mean, it is about risk and 
innovation.
    Mr. Costa. But you don't believe there is such concept of 
too large to fail?
    Mr. Gensler. I think that we are better if there is a 
freedom to fail in our economy, and then----
    Mr. Costa. So what is your definition of moral hazard?
    Mr. Gensler. If the markets believe that an institution 
will be backed by its government and that it is able to borrow 
at lower rates, it distorts markets.
    Mr. Costa. I have a local question, because my time is 
running out here. Do you recall the discussion we had earlier 
this year on several investor-owned utilities in California and 
California's regulatory environment, concerns that I expressed 
and some of my colleagues that the state's energy providers 
could inadvertently be swept up in the swap-dealer definition? 
We understand that you and the Commissioners have been working 
on this, with the stakeholders to provide a clarity needed to 
ensure that they and ultimately California ratepayers are not 
penalized. Can you give me a quick update on where you are on 
that?
    Mr. Gensler. I think we did well in the swap and swap-
dealer definition. It may have also been some issues about the 
environmental-rights contracts that we specifically addressed 
in the swap definition. The last important piece of business is 
that we have in front of us a petition from last month from the 
municipal electric co-ops and the rural electric co-ops for an 
exemption, and that document is in front of Commissioners and I 
am hoping that we will put it out for a short comment period in 
the next month or so.
    Mr. Costa. If I might, Mr. Chairman, my time has run out, 
but pertinent to this question, there is a timeline issue, the 
next 60 days, I understand, to comply with the documentation on 
that. Is there any flexibility in that 60 day timeline period?
    Mr. Gensler. I am sorry. For----
    Mr. Costa. To comply with information requests from real 
swap dealers and major participants while they are trying to 
implement their own compliance with the changes that you have 
made for these public- and investment-owned utilities.
    Mr. Gensler. Maybe we can follow up afterwards because I am 
not sure I--the question about the municipal co-op and so 
forth, we are going to be putting out hopefully very shortly to 
get public comment. They are not swap dealers, from what I 
understand, so I don't think they are going to----
    Mr. Costa. No. Well, I don't believe they are either, but 
as I understand it, in response to the earlier efforts that the 
Commission provided to work out this distinction because we 
don't believe they are swap dealers. But you have to comply in 
the case of California with the state's regulatory regime that 
they come in compliance, but they expressed to us that they had 
a concern about the timeline that you had provided for them.
    Mr. Gensler. I look forward to following up with your 
office to better understand that.
    Mr. Costa. Okay. Thank you, Mr. Chairman.
    The Chairman. The gentleman's time has expired. The chair 
now turns to the gentleman from Pennsylvania, Mr. Thompson, for 
5 minutes.
    Mr. Thompson. Thank you, Chairman.
    Chairman, thanks for being here and addressing these 
important issues. I have just two questions for you, pretty 
diverse questions, though, but both relate to the Dodd-Frank 
rulemaking but goes from impact on individual farmers and then 
also our market's access to other markets.
    So let me start with the local one first with farmers. You 
know, obviously many in rural America are concerned with the 
CFTC's requirement that telephone conversations with farmers 
about forward cash contracts need to be recorded and the 
records kept for 5 years. It seems like regulatory overkill 
really, at its finest. Can you give us any assistance--any 
assurance--I am sorry--that this is not the Commission's 
intention?
    Mr. Gensler. It is not, but this was included in a 
conforming rule where members of contract markets needed to 
record their conversation, and we have gotten a lot of comments 
and we are looking at how to dial that back in any final rule 
so that it is really just about that member and what they are 
doing directly on the exchange and so forth.
    Mr. Thompson. Well, I appreciate you looking at that and I 
appreciate your desire to stay with the original intention and 
dialing back on that.
    And then the opposite end, more about world market access. 
Mr. Chairman, you have repeatedly assured the Committee that 
CFTC has fully coordinated with international regulators but 
then we read letters from foreign regulators threatening to ban 
their country's firm from our marketing, and I have a copy of a 
letter from a Swiss regulator, the Swiss Financial Market 
Supervisor Authority, FINMA, and also in addition an op-ed in 
the Financial Times written by your European counterpart that 
seems to indicate that anything but coordination is happening. 
If the CFTC was really coordinating with international 
regulators, one would assume that they would not have to resort 
to writing opinion editorials in the newspaper to get your 
attention.
    Now, because our financial reform was so far ahead of the 
rest of the world, how can we at this point, how can you assure 
this Committee that the markets of the United States are not 
going to suffer due to the lack of international coordination, 
especially since it appears most of the rest of the world is 
playing catch-up.
    Mr. Gensler. They have made very good progress. I had a 
very good conversation with the author of the letter from 
Switzerland yesterday, and Michel Barnier, who wrote the 
opinion piece, and I have had a very good relationship and 
continue to even though he expressed his views in an opinion 
piece, as you say. What we are trying to ensure on the cross-
border side is that risks booked offshore don't come crashing 
back to our taxpayers here. That is really what--and that is 
the interpretation of direct and significant.
    With regard to the Swiss situation, they have a situation 
and France has something similar about secrecy laws. You are 
probably familiar with Switzerland and the banking system and 
so they have a set of issues as to how their banks can provide 
risk transactions to somebody in your home state or in any 
state in America and report that information to a data 
repository. That is kind of the core issue that he and I were 
talking about yesterday about their secrecy laws. It is not an 
easy issue but it has to do with a number of countries, 
particularly Switzerland and France.
    Mr. Thompson. Thank you, Chairman.
    Mr. Chairman, I yield back.
    The Chairman. The gentleman yields back the balance of his 
time. The chair with great enthusiasm now recognizes the 
gentleman from Georgia.
    Mr. David Scott of Georgia. Thank you, Mr. Chairman.
    Mr. Chairman, let me ask you this. I certainly appreciate 
your stated desire to increase capital efficiency through 
portfolio margining, particularly in the credit default swaps 
market, and certainly appreciate your work with Chairman 
Schapiro and the SEC on an agreement in this area. It is my 
understanding that some progress has been made but there are 
some significant issues that remain. I am particularly 
concerned that the lack of a regulatory solution will likely 
prevent clearing among credit default swap customers and that 
would occur if portfolio margining benefits were offered.
    Now, your agency and the other agency staff has worked on 
this for well over a year now. So Mr. Chairman, enough time 
certainly has been spent to understand this issue, and what I 
suspect is needed in this case for you and the other 
Commissioners including Chairwoman Schapiro of the SEC is to 
send a message that this issue needs to be resolved so that 
broad-based clearing of credit default swaps will go forward as 
Congress intended so that the taxpayers will be protected. Now, 
can I get your commitment that you will provide this 
leadership, Mr. Chairman?
    Mr. Gensler. I support portfolio margining between 
securities-based swaps, which are called single-name credit 
default swaps, and broad-based credit default swap indices, and 
there has been a petition in front of us with regard to that. I 
am supportive. It has a challenge at the Securities and 
Exchange Commission. It takes two sets of agencies to come 
together. We have made great progress on other things, joint 
rules, defining swaps and other things. This one, as you have 
rightly noted, is not over the line yet but I am supportive of 
portfolio margining.
    Mr. David Scott of Georgia. So you have been at it for a 
year now. I mean, the problem is that patience is wearing thin. 
How much longer do we have to wait and why can't we--what is 
the problem here? What is the holdup?
    Mr. Gensler. The Securities and Exchange Commission 
approach to this is different than the petitioner. The 
petitioner is IntercontinentalExchange in front of our two 
Commissions. They have a different approach to it, so it has to 
be worked through between the SEC and the ICE on these matters 
to see how to close that gap.
    Mr. David Scott of Georgia. Can you give us an estimate of 
about how much longer this would take?
    Mr. Gensler. I don't know because I am sorry to say that 
when it comes to portfolio margining and the markets, the 
margining regimes for futures and securities are quite 
different, and we could be very supportive at the CFTC but it 
needs both agencies.
    Mr. David Scott of Georgia. Let me ask you something else. 
I am struggling to understand why we continue to support this 
SRO model of regulation when we seem to have one large-scale 
process failure after another, whether it is Madoff or Stanford 
or MF Global or recently PFGBest, but my constituents, I tell 
you, back in Georgia are screaming for change. Our farmers are 
screaming for change. The people of America are sick and tired 
of seeing their livelihoods put at risk by greedy malefactors 
who are enabled by a system that seems to be little more than a 
good old boy network. We have seen it time and time again. What 
on Earth do you all say to them? What do you say to America 
when it is situation after situation after situation?
    Mr. Gensler. Well, I say the system in 2008 revealed it as 
well. The financial system needs common-sense rules of the road 
and we need to do more on customer protection. We have done a 
lot. We have restructured. We have put in place new rules. We 
have brought significantly more enforcement actions but even 
this case at Peregrine highlights that we have to take a very 
close look at the self-regulatory organizations and the CFTC, 
be self-reflective and where we have to change, change 
appropriately.
    Mr. David Scott of Georgia. Well, is there any value left 
in this self-regulatory organization model?
    Mr. Gensler. Well, we have had it for decades and it served 
the nation in many tough market environments, so what we are 
focused on is how to improve it, not to uproot the whole thing 
but to change it and enhance it.
    Mr. David Scott of Georgia. Thank you, Mr. Chairman. I 
yield back.
    The Chairman. The gentleman's time has expired.
    The chair now recognizes the gentleman from Iowa, Mr. King, 
for 5 minutes.
    Mr. King. Thank you, Mr. Chairman.
    I thank you, Chairman Gensler, for your testimony today. I 
spend part of my time over in the Judiciary Committee where we 
get some of the Cabinet Members testifying, and they don't come 
forward with the intent to try to inform the Committee as 
openly as you do. I know we have disagreements but I do believe 
your testimony has been directed at informing us with the best 
answers you can deliver in a truthful fashion.
    So I have a couple of things I would like to ask you to 
clarify, and that is, I was only half listening when one of the 
other Members of the Committee made a comment, and I just heard 
your response that this was an outright fraud, and I wasn't 
clear whether that was Peregrine or MF Global or Corzine or 
Barclays, whom that might be. Could you clarify that for me, 
please?
    Mr. Gensler. I thank you for the compliment. I think I was 
referencing Peregrine, but I would say on the LIBOR situation 
and Barclays, they have settled and that was false reporting 
under our Act, which some people would use the broader 
circumstance in question. It is not right to lie about such an 
important rate.
    Mr. King. So I will write false reporting and lying. Is 
that not also the definition of fraud?
    Mr. Gensler. Because I am not a lawyer, I am just going to 
be careful, but what we actually settled on is attempted 
manipulation and false reporting, but for your constituents and 
for my mom, I think they would see it about the same way as 
lying.
    Mr. King. I do agree with that, and again, as I listened to 
your testimony, when you said we need to change the way these 
firms are audited and have direct electronic access to these 
accounts, hasn't history pretty much shown us that regulation 
once it is established, the people that are intending to 
circumvent it, whether it is deception, lying or outright 
fraud, have found a way around regulation throughout history?
    Mr. Gensler. I think human nature shows that, so we have to 
stay abreast of it, and when we enhance this in the next few 
months, there might be another fraudster in 2014 or 2017 that 
will find another way to test the system.
    Mr. King. I would think sometimes about the history of 
warfare. When someone invents an offensive weapon, someone else 
invents a defensive weapon. The sword and the shield or the 
arrow and the shield would be an example, and now we have Star 
Wars to defend us from missiles from other continents. So I 
think that is an appropriate metaphor for what is going on here 
is that we are trying to regulate and build shields against the 
people that are engaging in or intending to engage in fraud in 
our financial markets, and I would like to say that is what 
these regulations are about.
    But I would like to turn this a little bit and take this to 
an understanding that we haven't been able to write regulations 
that are successful, at least always successful, and the 
creative people that are out there will find another way around 
it. The free markets have done a pretty good job of protecting 
the interest if they get a chance to see what those assets 
actually are, and so would it be your opinion that the 
restraint of markets without the promise of government bailout 
is an effective shield?
    Mr. Gensler. Well, I absolutely agree with the second part. 
There should not be government bailouts. I do think that 
common-sense rules of the road to bring transparency to markets 
help our economic well-being, and I think that has helped in 
the securities and futures markets, and that is what Congress 
said to bring to these swaps markets.
    Mr. King. Do you, though, get the sense that traders in the 
marketplace, especially these traders that happen to be members 
of the--I can see five farmers co-ops in my neighborhood that 
suffered a loss of $47.5 million altogether to MF Global. They 
get a sense that because government is regulating, that they 
are protected in their investments. How much of a factor do you 
think that is in the confidence in the marketplace that the 
government is the regulator and the protector?
    Mr. Gensler. Well, I think that farmers need to have 
confidence to use these markets so they can lower their risk. I 
mean, what is the price of corn going to be at harvest time and 
they can use a futures contract to lower that risk, lock in it. 
So that type of confidence is a good type of confidence. Is 
there is an effective cop on the beat? But I agree with you not 
to have the confidence that we are going to bail out banks or 
ensure against poor corporate behavior.
    Mr. King. So what we are really after here then is balanced 
restraint that investors have to control their speculation 
judging upon two things, and that is, how solid are the 
financials of the entity they are dealing with and how 
effective is the financial regulation that comes from the 
government. That would be the two pieces of this that would 
have to be kind of married together?
    Mr. Gensler. Right, so that investors have the facts and 
figures to make their investment choices, that they have 
markets that function well, that they can hedge these risk in 
these derivative contracts, and of course, that we don't stand 
behind----
    Mr. King. And you would like to have direct electronic 
access to the accounts but you wouldn't propose that to the 
investors to have that same access?
    Mr. Gensler. I actually think investors should know in 
these markets where their money is held, so just like they do 
in a mutual-fund statement, I actually do think that they 
should know where their money is.
    Mr. King. Thank you very much, Chairman, I appreciate your 
testimony, and I will submit some questions for the record.
    The Chairman. The gentleman's time has expired. The chair 
now recognizes the gentlelady from South Dakota, Mrs. Noem, for 
5 minutes.
    Mrs. Noem. Thank you, Mr. Chairman, and I appreciate this 
hearing. It is timely given it is the second anniversary of the 
Dodd-Frank and we need to look at these reforms and the related 
rules and see how they impact people on the ground. For 
example, in South Dakota, where I am from, some businesses and 
producers who are actively investing in the commodity market 
are still dealing with the failure of MF Global, so I just have 
a couple questions for you.
    Does the CFTC have the power to force a firm into 
bankruptcy?
    Mr. Gensler. We might need to get back to you, but I am not 
aware of that. Even in this Peregrine situation, we went into 
court to ask for a receiver to be appointed to freeze the 
assets, which we do in Ponzi schemes as well. So I think that 
is the route. I believe the answer is no but we seek a court to 
appoint a receiver.
    Mrs. Noem. Okay. That is the route that is generally 
followed? Well, if there is more information on that that you 
can give me later, I would appreciate that. That would be 
great.
    [The information referred to is located on p. 106.]
    Mrs. Noem. What role does the CFTC play in initiating the 
bankruptcy of such as like MF Global?
    Mr. Gensler. A broker dealer--I am not involved in that 
specific thing but a broker dealer goes into this proceeding 
under the Securities and Investor Protection Act, and that is 
under the securities law, so we don't have a direct role. But 
then we do have a role in appearing in front of the court and 
appearing in front of the trustee to ensure that the 
commodities exchange laws are followed, that the segregated 
funds are for the customers.
    Mrs. Noem. So is that more of an informational-type role 
that you fulfill with the courts. Are you summoned in a manner?
    Mr. Gensler. Well, it is both an informational role and 
also to advocate and file motions on behalf of those segregated 
accounts, as I understand it.
    Mrs. Noem. Excellent. Thank you. I appreciate that.
    With that, Mr. Chairman, I will yield back.
    The Chairman. The gentlelady yields back the balance of her 
time. The chair now recognizes the gentleman from Indiana, Mr. 
Stutzman.
    Mr. Stutzman. Thank you, Mr. Chairman.
    Thank you, Chairman Gensler, for being here. I would kind 
of like to follow up on the gentlelady's questions regarding MF 
Global. At what point did you alert your fellow Commissioners 
of your recusal from the MF Global investigation?
    Mr. Gensler. I informed the General Counsel on a Thursday, 
so it may have been that Friday. We have a weekly surveillance 
meeting on Friday. That goes back decades. And so the firm went 
into bankruptcy on a Monday. The first surveillance meeting was 
going to be that Friday, so I did not attend that surveillance 
meeting and informed various Commissioners. One, Commissioner 
Sommers, was on vacation but the other Commissioners----
    Mr. Stutzman. So you did notify them?
    Mr. Gensler. I believe it was that Friday.
    Mr. Stutzman. How did you notify them? By electronic----
    Mr. Gensler. If I remember, I had personal conversations 
with three of them and then General Counsel Berkovitz reached 
out to Commissioner Sommers, who was in Florida with her 
family.
    Mr. Stutzman. Okay. So your recusal, is that consistent 
with CFTC's process in recusals?
    Mr. Gensler. Well, the General Counsel and the ethics 
officers actually advised me that I did not under the laws need 
to step aside. I thought it was best not to participate. Jon 
Corzine, who had been the Chief Executive Officer there, had 
been way back when I was at Goldman Sachs a partner of mine and 
ultimately my boss at Goldman Sachs. So, I handed this off to 
the dedicated enforcement staff and other enforcement officers 
and the Commission, and not participate in this matter as it 
turns on an enforcement matter that might involve, personally, 
Jon Corzine.
    Mr. Stutzman. So help me understand, when did you first 
hear there was a loss in customer segregated accounts?
    Mr. Gensler. About 2:30 a.m. Monday morning.
    Mr. Stutzman. And then did you have any conversations with 
Mr. Corzine during the final week of October?
    Mr. Gensler. No, no personal conversations, no business 
conversations. There was a group conference call that Sunday 
when the CFTC, the SEC and regulators from London and the New 
York Federal Reserve were on a big conference call with the 
company and its advisors about moving the customers' funds. At 
that point Sunday, it was about moving the customer funds to 
some fund called Interactive Brokers, and I believe Mr. Corzine 
spoke up in that call that might have had 20 or 40 people on 
it.
    Mr. Stutzman. That was on Sunday?
    Mr. Gensler. Sunday, October 30th.
    Mr. Stutzman. And so you were notified at 2:30 a.m. Monday 
morning?
    Mr. Gensler. Yes, Monday morning. I was woken up.
    Mr. Stutzman. So during those conversations, or during that 
conversation, was there any discussion of the customer accounts 
and segregation of funds brought up?
    Mr. Gensler. In the regulators call, what we were focused 
on was moving those customer accounts to Interactive Brokers. 
We had laid out by that Sunday evening a number of conditions 
about that. Interactive Brokers agreed to those conditions and 
MF Global as well that they would be fully guaranteed and all 
the monies and positions would be moved to Interactive. Of 
course, then at 2:30 I was woken up.
    Mr. Stutzman. September 1, 2011, MF Global announces in a 
public filing that it would comply with FINRA's determination 
and increase its capital. Would such a filing trigger any red 
flags at CFTC?
    Mr. Gensler. As I am not participating, I don't know what 
the Commissioners or the agency looked at about that September 
1st filing. But just as a general matter, our examination staff 
will work with the self-regulatory organizations like FINRA and 
Chicago Mercantile Exchange and NFA on any filings about 
capital and try to understand what those filings are.
    Mr. Stutzman. So did that happen? Did your agency work with 
FINRA at all?
    Mr. Gensler. Again, I don't know because I haven't gone 
back and done the forensics. I haven't been involved since this 
whatever, November 2nd or 3rd period of time.
    Mr. Stutzman. Is that something you could find out and 
notify----
    Mr. Gensler. Our General Counsel, Dan Berkovitz, will 
follow up with you.
    [The information referred to is located on p. 107.]
    Mr. Stutzman. Thank you, Mr. Chairman. I will yield back.
    The Chairman. The gentleman yields back. The chair 
recognizes the gentleman from Iowa for a follow-up question.
    Mr. Boswell. Well, thank you. I am the temporary Ranking 
Member, I guess.
    Mr. Chairman, earlier on in questions, I didn't give you a 
chance to answer because I got into a dialogue with Chairman 
Lucas, and I agree with his points. At the same time, we have 
responsibility that even though we are not appropriators, we 
have the tools or the doorknockers or whatever you want to call 
it. The idea that I threw out about the funding, would you have 
any comment you would want to make about that? I think you told 
Mr. Costa earlier that you did not have the resources, and so 
just expand on that and then we will be finished.
    Mr. Gensler. We don't have enough resources to cover the 
futures industry that has grown so significantly from the 
1990s, or this new market that I would say is far more complex, 
this swaps marketplace that is eight times the size of the 
futures marketplace in notional value. It has at least twice as 
many actors on that stage.
    We would work with Congress in any way Congress would wish 
to get funding whether it is direct appropriations, whether it 
is also working on fees or transaction fees similar to what 
the----
    Mr. Boswell. The point of it is that this constant 
evaluation of the appropriations or coming from the 
Administration or whatever but if you had this fee system, it 
would kind of go with the ebb and flow of your need. It seems 
to be working for SEC. It seems to be working for NFA. That is 
one of the points. I want to know what you think about it.
    Mr. Gensler. I think that in the securities field, there 
has been a modest transaction fee to cover the cost to the SEC 
on an annual basis. I think President Obama has included that 
in his budget submissions. I believe previous Presidents, 
President Bush also did as well. So we would work with 
Congress. If you and the appropriators thought that was 
appropriate, we would be right at it with you, but if there are 
other ways to get the funding, I am kind of neutral on the way 
to do it but I am positive that we need more funding.
    Mr. Boswell. But you clearly don't have the resources you 
need?
    Mr. Gensler. That is correct, sir.
    Mr. Boswell. Okay. I yield back. Thank you, Mr. Chairman.
    Mr. Conaway [presiding.] I thank the gentleman for 
yielding.
    Chairman, one real quick follow-up. Section 722(d) is the 
section you cite that gives you the authority to do the 
guidance on the extraterritorial or cross-border; 722(c), we 
think gives the SEC similar authority. What is y'all's 
understanding or can you help us understand your interpretation 
of those two different sections?
    Mr. Gensler. Section 722(c) would be in the swaps section 
of the statute. It may well that you want to follow up with----
    Mr. Conaway. Okay, if you wouldn't mind getting back with 
us on that because----
    Mr. Gensler. Because I understood that it is all in the 
first part of that Title VII is swaps, which is the CFTC, and 
then of course the other section later in the chapter is there 
but 722(c), Dan? Maybe we will have to----
    Mr. Conaway. All right. We will follow up with you on that 
if you wouldn't mind.
    [The information referred to is located on p. 108.]
    Mr. Gensler. No, I appreciate that, and thank you.
    Mr. Conaway. Mr. Chairman, thank you for being here today. 
I appreciate your straightforward answers and look forward to 
visiting with you again soon.
    Mr. Gensler. Thank you very much.
    Mr. Conaway. All right. If we can have the other panel step 
forward, we will get this one moving.
    All right. While everybody is settling in, I will go ahead 
and introduce the witnesses. We have with us today Mr. Terry 
Duffy, Executive Chairman and President of CME Group, Chicago, 
Illinois; Mr. Dan Roth, President and Chief Executive Officer 
of the National Futures Association, Chicago; the Hon. Walt 
Lukken, President and CEO of Futures Industry Association here 
in D.C.; John Heck, Senior VP with The Scoular Company, Omaha, 
Nebraska, on behalf of the National Grain and Feed Association; 
and the Hon. Chuck Connor, President and Chief Executive 
Officer of the National Council of Farmer Cooperatives, 
Washington, D.C., and Mr. Paul McElroy, CFO of the JEA, 
Jacksonville, Florida, on behalf of the American Public Power 
Association.
    Mr. Duffy, begin when you are ready, sir.

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

    Mr. Duffy. Thank you, Mr. Chairman and Mr. Boswell.
    We at the CME Group are appalled by PFG's theft of customer 
segregated funds. This fraud following MF Global has shaken the 
very core of our industry. Any breach of trust related to 
customer funds is absolutely unacceptable, whether at PFG, MFG 
or any other firm.
    Since the failure of MF Global, CME Group and others in our 
industry have committed to strengthening the protections that 
guard customer property. The industry has recently implemented 
new regulatory measures, one of which was a new electronic 
confirm tool that uncovered Mr. Wasendorf's misreporting, 
forgery and theft, but more needs to be done.
    CME and the National Futures Association have adopted four 
measures to deter, detect and prevent misuse of customer funds. 
Three have been implemented. The fourth will be made effective 
in coordination with the NFA next month. We have been 
conducting surprise reviews of customer segregated accounts 
since last December. We have implemented mandatory daily 
reporting of segregated statements by all FCMs and now we 
require bimonthly reporting to ensure that segregated funds are 
properly invested and held at approved depositories. Also in 
mid-July, CME began using Confirmation.com, an electronic 
method of receiving statements directly from third-party 
depositories to verify investment reports. We also began using 
Confirmation.com as a tool in our regulatory audits and plan to 
require banks to confirm segregated funds using this tool.
    In direct response to the MF Global disaster, we will be 
implementing the Corzine rule on September 1st. The new rule 
requires that FCMs' CEO or CFO sign off on any withdrawals of 
customer segregated funds that exceeds 25 percent of excess 
segregated funds. Then they must also inform CME at the same 
time.
    As I have said, more can be done. At the same time, CME 
believes that regulators and industry must be careful in 
weighing the costs and benefits of all proposals that may 
enhance protection for the segregated funds of our clients.
    Some have suggested the creation of an industry-funded 
insurance program covering fraud and failure losses, possibly 
supplemented by privately-arranged insurance. Such a fund would 
certainly boost confidence but needs to be balanced against 
known negatives. The negatives are the obvious: it being cost-
prohibitive and ineffective due to the amount of funds held in 
U.S. segregation. We need to develop procedures and systems 
that give regulators direct real-time access to customer 
segregated account balances, and we are working with regulators 
to do so. And while it may be controversial and perhaps have 
disruptive consequences, we should explore whether customer 
property not required as collateral at clearinghouses should 
nonetheless be held by clearinghouses or other custodians and 
whether safeguards should be into place to limit the ability of 
FCMs to transfer such property except to authorized recipients.
    In addition, CME Group proposes that Congress amend the 
Bankruptcy Code to permit clearinghouses that hold sufficient 
collateral to support customer positions of a failed clearing 
member to transfer those positions of all non-defaulting 
customers with the supporting collateral to another stable 
clearing member.
    While we expect that the misconduct of MF Global and PFG 
will renew calls for the elimination of the role of exchanges 
and clearinghouses in auditing and enforcement of their 
members, we do not believe that a legitimate case can be made 
to transfer these responsibilities to a government agency. CME 
Group is committed to working with the Congress, CFTC, NFA, 
FIA, and the market participants to reevaluate the current 
system to find solutions to further protect customer funds at 
the FCM level. We are also committed to restoring confidence in 
the markets that so many rely on for their risk management 
needs.
    I thank you for the opportunity to testify before the 
Committee and I look forward to answering your questions.
    [The prepared statement of Mr. Duffy follows:]

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

    Chairman Lucas, Ranking Member Peterson, Members of the Committee, 
thank you for the opportunity to testify regarding the industry's 
efforts to deter, detect and prevent the misuse of customer funds. We, 
at CME Group, are appalled by the theft by Mr. Wasendorf of Peregrine 
Financial Group (``PFG'') of customer segregated funds. This fraud, 
following MF Global Inc. (``MFG''), has shaken the very core of our 
industry.
    Any breach of trust relating to customer funds is absolutely 
unacceptable, period--whether at PFG or MFG, or any firm. Since the 
failure of MFG, CME Group and others in our industry have been 
committed to strengthening the protections that guard customer 
property. The industry has recently implemented new regulatory 
measures, one of which was the new electronic confirm tool that 
uncovered Mr. Wasendorf's misreporting, forgery and theft. But more 
needs to be done.
    In addition to the pressing issues raised by these recent 
deplorable actions, the Committee is examining at this hearing issues 
relating to the ongoing regulatory implementation of Dodd-Frank which I 
will also address at the end of my written testimony. Our concerns 
regarding the implementation of the statute center on ensuring that the 
rules do not needlessly hamper the strength, competitiveness and 
efficiency of the U.S. derivatives markets.

Industry Proposals to Protect Customers in the wake of MFG's Failure
    On March 12th, a special committee composed of representatives from 
the futures industry's regulatory organizations, including CME (the 
``SRO Committee''), offered four recommendations to strengthen current 
safeguards for customer segregated funds held at the firm level. The 
first three have been implemented, and the fourth will be made 
effective in coordination with the National Futures Association 
(``NFA'') in September:

   Requiring all Futures Commission Merchants (FCM) to file 
        daily segregation reports.

   Requiring all FCMs to file bi-monthly Segregation Investment 
        Detail Reports (``SIDR''), reflecting how customer segregated 
        funds are invested and where those funds are held.\1\
---------------------------------------------------------------------------
    \1\ Daily segregation reporting and bimonthly SIDRs were also 
recommended by the Futures Industry Association in its proposed initial 
recommendations made on February 29th. http://www.futuresindustry.org/
downloads/Initial_Recommendations_for_Customer_
Funds_Protection.pdf.

   Performing more frequent periodic spot checks to monitor FCM 
---------------------------------------------------------------------------
        compliance with segregation requirements since last December.

   In direct response to the MFG collapse, the ``Corzine Rule'' 
        will be implemented on September 1st. The ``Corzine Rule'' 
        requires the CEO or CFO of the FCM to pre-approve in writing 
        any disbursement of customer segregated funds not made for the 
        benefit of customers and that exceeds 25% of the firm's excess 
        segregated funds. The CME (or other SROs) must be immediately 
        notified of the pre-approval.

In addition, to enhance intra-regulator coordination, we have 
established routine communications with FINRA for all of our common 
firms--the firm coordinators/relationship managers will reach out to 
each other to have these communications.
    The SRO Committee has also implemented, or is in the process of 
implementing, the following initiatives:

   Using Confirmation.com--an electronic method of receiving 
        account statements or balances from a third party bank or 
        depository to check information provided by FCMs to regulators. 
        NFA's use of Confirmation.com uncovered the initial statement 
        and reporting irregularities at PFG.

    The SRO Committee plans to use the Confirmation.com tool as 
        follows:

     In regulatory audits now and going forward;

     To verify bi-monthly SIDRs (investment reports). CME 
            started using the tool for this purposed in mid-July; and

     To periodically review the accuracy of daily 
            segregation statements.

   Also, the SRO Committee agreed to develop rules to require 
        all FCMs to provide them with direct online access to their 
        bank or depository accounts to confirm segregated funds 
        balances.

    The Futures Industry Association's internal controls 
recommendations will be presented to the FCM Advisory Committee in 
August. These include:

   Requiring FCMs to assure the appropriate separation of 
        duties among individuals working at FCMs who are responsible 
        for compliance with the rules protecting customer funds;

   Requiring FCMs to document their policies and procedures in 
        several critical areas, including the valuation of securities 
        held in segregated accounts, the selection of banks, custodians 
        and other depositories for customer funds, and the maintenance 
        and withdrawal of ``residual interest,'' which consists of the 
        excess funds deposited by firms in the customer segregated 
        accounts.

    NFA's Website Access to FCM capital ratios and investment reports 
(SIDRs) will be presented to the NFA's Board of Directors in August.

CME Group Initiatives
    Notwithstanding the fact that MFG's misconduct was the cause of the 
shortfall in customer segregated funds, CME Group's efforts in the wake 
of these events speak to the level of our commitment to ensuring our 
customers' confidence in our markets:

   Guarantee for SIPC Trustee. We made an unprecedented 
        guarantee of $550 million to the SIPC Trustee in order to 
        accelerate the distribution of funds to customers.

   CME Trust Pledge. CME Trust pledged virtually all of its 
        capital--$50 million--to cover CME Group customer losses due to 
        MFG's misuse of customer funds.

   CME Group Family Farmer and Rancher Protection Fund. On 
        April 2, 2012, CME Group launched the CME Group Family Farmer 
        and Rancher Protection Fund to protect family farmers, family 
        ranchers and their cooperatives against losses of up to $25,000 
        per participant in the event of shortfalls in segregated funds. 
        Farming and ranching cooperatives also will be eligible for up 
        to $100,000 per cooperative.

    The Protection Fund is available to PFG customers that qualify 
        under Program terms.

   Agreement with MFG Trustee. On June 14, 2012, the agreement 
        between the SIPC Trustee for MFG and CME Group was filed in the 
        Bankruptcy Court. It provides for the distribution of 
        approximately $130 million of MFG proprietary assets, on which 
        CME and its members held perfected security interests, to MFG 
        customers. The agreement is currently under review by the 
        Bankruptcy Court.

   Bankruptcy Code. The shortfall in customer segregated funds 
        occurred only in regard to funds under MFG's control. The 
        customers' funds held in segregation at the clearing level at 
        CME and other U.S. clearinghouses were intact. However, the 
        clearinghouses were not able to avoid market disruptions by 
        immediately transferring those customer positions and any 
        related collateral because of limitations under the Bankruptcy 
        Code. We propose that Congress amend the Bankruptcy Code to 
        permit clearinghouses that hold sufficient collateral to 
        support customer positions of a failed clearing member promptly 
        to transfer all customer positions with supporting collateral, 
        except defaulting customer positions, to another stable 
        clearing member.

More Can Be Done
    However, CME Group believes that more can be done, especially in 
light of the recent fraud at PFG and its impact on public confidence. 
CME believes that the regulators and industry need to carefully weigh 
the costs and benefits of even the most far-reaching proposals that 
might enhance protection for the segregated funds of our customers.
    Some have suggested creating an industry-funded insurance program 
covering fraud and failure losses, possibly supplemented by privately 
arranged insurance. Such a program would certainly boost confidence but 
needs to be balanced against known negatives. It is likely to be cost 
prohibitive and ineffective given the size and scope of the accounts in 
our business, and may encourage the ``moral hazard risk'' that comes 
into play when customers feel they don't need to worry about their 
choice or stability of their FCMs.
    We need to develop procedures and systems that give regulators 
direct, real time access to customer segregated account balances, and, 
as stated above, the SRO Committee is working to do so.
    And, while it will be controversial and perhaps have disruptive 
consequences, we should explore whether customer property not required 
as collateral at clearing houses should, nonetheless be held by 
clearing houses or other custodians (while returning interest earned on 
that money back to the FCMs) and whether safeguards should be put in 
place to limit the ability of FCMs to transfer such property except to 
authorized recipients. We believe a look at these proposals in 
conjunction with our other efforts is necessary to restore public 
confidence in the derivatives markets while preserving the operating 
model for the vast majority of firms who respect and comply with the 
rules.
    Finally, while we expect that the misconduct of MFG and PFG will 
renew calls to eliminate the role of exchanges and clearing houses in 
auditing and enforcement of their members, we do not believe that a 
legitimate case can be made to transfer these responsibilities to a 
government agency. Our regulatory systems are resilient, adaptive to 
address the challenges and efficient. The next section of my testimony 
focuses on why it is more important than ever to not only retain, but 
strengthen the self-regulatory structure.

Current Regulatory Structure Should Not Be Abandoned
    Some critics suggest that the current regulatory framework is 
somehow to blame for MFG's and PFG's misconduct. As further detailed in 
the discussion below, ``self-regulation'' in the context of futures 
markets regulation is a misnomer, because the regulatory structure of 
the modern U.S. futures industry is in fact a comprehensive network of 
regulatory organizations that work together to ensure the effective 
regulation of all industry participants.
    The CEA establishes the Federal statutory framework that regulates 
the trading and clearing of futures and futures options in the United 
States, and following the recent passage of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act, its scope has been expanded to 
include the over-the-counter swaps market as well. The CEA is 
administered by the CFTC, which establishes regulations governing the 
conduct and responsibilities of market participants, exchanges and 
clearing houses.
    With respect to MF Global, CME was the designated self-regulatory 
organization (``DSRO''). As MFG's DSRO, CME was responsible for 
conducting periodic audits of MFG's FCM-arm and worked with the other 
regulatory bodies of which the firm is a member. Some critics have 
suggested that the failure of MFG demonstrates that the current system 
of front line auditing and regulation by clearing houses and exchanges 
is deficient because of conflicts of interest. However, there is no 
conflict of interest between the CME Group's duties as a DRSO and its 
duties to its shareholders--both require that it diligently keep its 
markets fair and open by vigorously regulating all market participants.
    Federal law mandates an organizational structure that eliminates 
conflicts of interest. In addition, we have very compelling incentives 
to ensure that our regulatory programs operate effectively. We have 
established a robust set of safeguards designed to ensure these 
functions operate free from conflicts of interest or inappropriate 
influence. The CFTC conducts its own surveillance of the markets and 
market participants and actively enforces compliance with the CEA and 
Commission regulations. In addition to the CFTC's oversight of the 
markets, exchanges separately establish and enforce rules governing the 
activity of all market participants in their markets. Further, the NFA, 
the registered futures association for the industry, establishes rules 
and has regulatory authority with respect to every firm and individual 
who conducts futures trading business with public customers. The CFTC, 
in turn, oversees the effectiveness of the exchanges, clearing houses 
and the NFA in fulfilling their respective regulatory responsibilities.
    In summary, the futures industry is a very highly-regulated 
industry with several layers of oversight. The industry's current 
regulatory structure is not that of a single entity governed by its 
members regulating its members, but rather a structure in which 
exchanges, most of which are public companies, regulate the activity of 
all participants in their markets--members as well as non-members--
complemented with further oversight by the NFA and CFTC.
    CME Group is committed to working with Congress, CFTC, NFA, FIA and 
market participants to re-evaluate the current system to find solutions 
to further protect customer funds at the FCM level, and to restoring 
confidence in derivatives markets. Finding solutions continues to be or 
highest priority. We are prepared to lead.

Dodd-Frank
    Turning to Dodd-Frank, as the CFTC and other regulators finalize 
the rules implementing the statute, CME Group continues to work with 
the CFTC to ensure that these rules promote the fundamental principles 
of Dodd-Frank without compromising the growth and strength of the 
robust and globally competitive U.S. derivatives markets. For example, 
statutory Core Principle 9 was written by Congress to apply flexibly, 
allowing all DCMs to develop their means to achieve a ``competitive, 
open and efficient market and mechanism'' for trading. The CFTC's 
current rule proposal to implement Core Principle 9 would impose a 
rigid rule that will require an arbitrary percentage of transactions 
(now set at 85%) to take place on the central order book of an exchange 
regardless of the underlying products, the market characteristics or 
the bona fide needs of customers. At the CFTC's recent roundtable on 
this proposal, every market participant opposed the rule as proposed 
and expressed strong concerns about the proposal's implications. The 
rule would make it impossible for U.S. futures exchanges to develop new 
products, force futures exchanges to delist hundreds of successful 
products, and force trading into unregulated, less regulated or foreign 
markets with less transparency. Moreover, the proposal would 
exponentially increase the trading costs, market risk and adverse 
regulatory and tax consequences for market users, which costs 
ultimately will be reflected in commodity prices. We urge the 
Commission to consider this consensus assessment, and avoid adopting 
any rule under Core Principle 9 that would have the adverse effects 
stated above.
    With respect to the reporting of cleared swaps data, the Commission 
should allow for implementation of a clearing regime that permits 
clearing houses to choose the Swap Data Repository to which it must 
report, including their own affiliated SDR. Doing this will make it 
possible for SDRs to be up and running for cleared swaps almost 
immediately, which would be in the greatest interest of not only the 
regulators seeking to implement the statute, but also the marketplace 
seeking the most efficient and cost-effective mechanism with which to 
comply. The CFTC-adopted regulatory reporting regime does not 
appropriately utilize the existing infrastructure available in 
derivatives clearing organizations (``DCOs'') as far as cleared trades 
are concerned. Any system that requires a DCO that clears a swap trade 
to make reports to an external non-DCO data warehouse is inefficient, 
costly and unnecessary. A much better approach is to build reporting 
requirements that ensure that the DCO that clears a swap trade houses 
the complete set of non-public swap information. This is the lowest 
cost and least burdensome method for implementing regulatory reporting 
requirements and it can be implemented quickly. It is also the best way 
to ensure regulators have access to the most accurate swap information 
including the ability to view the true positions of market 
participants.
    Thank you for the opportunity to testify before the Committee today 
and for the Committee's continued strong oversight of the 
implementation of this seminal statute.

    Mr. Conaway. Thank you, Mr. Duffy.
    Mr. Roth, 5 minutes.

        STATEMENT OF DANIEL J. ROTH, PRESIDENT AND CHIEF
  EXECUTIVE OFFICER, NATIONAL FUTURES ASSOCIATION, CHICAGO, IL

    Mr. Roth. Thank you, Congressmen. My name is Dan Roth and I 
am the President of National Futures Association. As has been 
noted earlier, this is the second time in 9 months that we are 
involved with a fraud involving an FCM's misuse of customer 
segregated funds.
    In the Peregrine case, it has resulted in a shortfall of 
customer segregated funds of approximately $200 million. This 
fraud was achieved through a sea of forged documents. Peregrine 
was required to report daily to NFA on the amount of customer 
funds that it was holding and where those funds were being 
held. Those reports were false and they were supported by 
forged daily bank activity statements, forged monthly 
statements, forged acknowledgment letters, forged deposit 
slips, forged cashier's checks and forged bank confirmations.
    We began our most recent exam of Peregrine in mid-June. 
When we began that examination, we informed the firm that we 
were switching the way that we had done bank confirmations, 
that we were switching to what Terry referred to as the 
Confirmation.com. We were switching to a web-based e-
confirmation process. In the past, we had used a traditional 
bank confirmation process in which the firm would sign an 
authorization to the bank authorizing the bank to release 
information to NFA. We would then take that signed document 
from the firm and mail it directly to the bank, and the bank 
would then mail a response to NFA and then we would compare the 
bank's numbers to the numbers that had been provided by the 
firm.
    As part of the e-confirmation process that we switched to, 
we told the firm that they would authorize the firm's 
participation in that process. Mr. Wasendorf Sr. executed the 
necessary authorization on Sunday, July 8th, and the next day 
attempted suicide. We were immediately contacted by the firm, 
by Peregrine. They contacted both NFA and the CFTC, and we had 
conference calls immediately. As of the previous Friday, the 
firm had reported to us that it was holding approximately $380 
million in customer segregated funds with a little over \1/2\ 
of that being held at U.S. Bank, the Cedar Falls branch office 
of U.S. Bank.
    During the teleconferences on Monday, we had the branch 
manager of the bank on the phone, and he told us that the 
actual balance in the account as of Friday was approximately $5 
million. We also then reviewed with him--we told him that we 
had signed bank confirmations from our two previous audits in 
front of us and we went over with him the balances for each of 
those two dates. We told him the balances that had been 
reflected on the dates for which we had written confirmations, 
and he confirmed for us that those confirmations were false.
    It is clear, after both MF Global and Peregrine, certain 
facts are abundantly clear to all of us. Number 1, customers 
have to know that their money is safe. Number two, it is up to 
the regulators to provide the highest level of assurance that 
we can that their money is safe, and that is both government 
regulators and self-regulators. Number three, NFA followed 
standard audit steps and audit procedures in conducting our 
exams of Peregrine, and number four, that doesn't matter. The 
fact is, the Generally Accepted Audit Standards, the standard 
practices, weren't good enough. They didn't catch this fraud. 
We didn't uncover the fraud for longer than we would have 
liked. We have to do better.
    We began the process of trying to find ways to do better 
immediately after MF Global. We formed two committees. We 
formed an SRO committee and we formed a special committee of 
our public directors, and both of those committees worked on a 
package of rules that Mr. Duffy referred to that were presented 
to our board of directors in May and that are described in my 
written testimony. But we also began working on the second wave 
of rules because we recognize that we had to make better use of 
technology to monitor our members' compliance with the rules. 
So we have a rule that has been in development and that is 
going to our August board meeting that will require all FCMs to 
provide direct online access, view-only access to their DSRO of 
all customer seg bank balances. With that authority, we will be 
able to check bank confirms or basically conduct bank confirms, 
check those balances on our own without the firm, without the 
bank. We can do it for any FCM and for any bank account that we 
want to.
    But we want to go beyond that. What we are actually going 
to try to build is a system which will take the e-confirmation 
process that uncovered this fraud and basically make that a 
daily event. We intend to build a system in which all seg 
depositories will report on a daily basis to NFA on the funds 
that they are holding and then on an automated basis will do a 
comparison between that and what the firms are reporting to us 
and generate alerts for any suspicious discrepancies.
    Mr. Chairman, it is another obvious point, I guess, that we 
will never be able to completely eliminate fraud but we have to 
strive for that. That is what we strive for. That is what we 
are working on. That is what we have been working on all along 
but with renewed effort after MF Global. We will continue that 
process. We look forward to working with the Commission, the 
industry, the Congress and hopefully together we can continue 
to try to make things harder and harder so that these frauds do 
not occur in the future.
    Thank you, Mr. Chairman. I would be happy to answer any 
questions.
    [The prepared statement of Mr. Roth follows:]

  Prepared Statement of Daniel J. Roth, President and Chief Executive 
           Officer, National Futures Association, Chicago, IL

    Thank you, Mr. Chairman. My name is Daniel Roth and I am the 
President of National Futures Association. For years the futures 
industry has built an impeccable reputation for safeguarding customer 
funds deposited at FCMs in connection with futures trading. Now, for 
the second time in just 9 months, we are dealing with a shortfall in 
customer segregated funds at an FCM. Once again, customers have 
suffered real harm, the type of harm that all regulators attempt to 
prevent.
    The full facts are not yet known, but it appears that Peregrine's 
customer losses are the result of an elaborate fraud achieved through a 
set of forgeries and falsities rooted in both the firm's external and 
internal financial records. Forged external records included bank 
statements, bank confirmations, print-outs of daily online summary 
reports of bank balances, cashier's checks, bank acknowledgement 
letters, bank deposit tickets and bank receipts all purportedly from 
U.S. Bank. The firm's internal financial records, including daily and 
month-end account reconciliations, general ledgers and trial balances 
were also false to the extent they were based on forged U.S. Bank 
records. Moreover, Peregrine submitted to NFA false daily segregation 
reports, monthly financial statements and segregated investment detail 
reports, and annual certified financial statements. Even the firm's 
customer statements were false to the extent the firm led customers to 
believe that sufficient assets were on deposit to cover customers' 
liabilities.
    I would like to review for this Committee the recent chronology of 
events surrounding the Peregrine fraud, the fundamental changes that 
need to be made in the way we protect customer funds and monitor firms 
for compliance with the rules, how we are going to make those changes 
and the steps we have already taken.
    NFA began an examination of Peregrine in mid-June. During the 
audit, we informed Peregrine staff that NFA was changing its method for 
obtaining bank confirmations to a web-based e-confirmation process. We 
had completed the necessary data entry for this process by the first 
week in July, and told Peregrine staff that the firm must authorize its 
participation in the e-confirmation process. On Sunday, July 8, Mr. 
Wasendorf, the Chairman of Peregrine, provided the required 
authorization that was sent to him a week earlier. The next day he 
attempted suicide.
    As of the close of business on July 6th, the previous Friday, 
Peregrine had reported to us that the firm was holding approximately 
$380 million in customer segregated funds, with just over \1/2\ of that 
amount on deposit at U.S. Bank. On July 9th, Peregrine notified the 
CFTC and NFA of Wasendorf's attempted suicide and we immediately joined 
in a teleconference with Peregrine staff. We directed firm personnel to 
go to the bank and have the bank manager join the conference call to 
confirm the balances as of the previous Friday. The bank manager 
informed us that the actual balance in the account was approximately $5 
million.
    We then asked about the balances on the dates for which NFA had 
received written bank confirmations in our two most recent audits--in 
2010 and 2011. Those bank confirmation requests had been mailed by NFA 
to the P.O. Box on the purported bank acknowledgment letter we had 
received for the customer segregated account. (In our experience, it is 
not at all uncommon for banks holding customer segregated funds to use 
P.O. Boxes to receive confirmation requests since it is a means for 
them to control the vast amount of paperwork they receive.) In this 
case, the bank manager informed us that the balances reflected on the 
two most recent confirmations received by NFA in 2010 and 2011 were 
similarly inflated.
    NFA immediately issued an emergency Member Responsibility Action, 
freezing the firm's accounts and restricting it to trading for 
liquidation only. That night the firm's clearing FCM issued margin 
calls that were not met and began liquidating open positions. The next 
day the CFTC filed its injunctive action and the firm filed its 
bankruptcy petition. By then approximately 98% of customer futures 
positions had been liquidated.
    This is certainly not the first time that NFA has taken emergency 
action in a fraud case involving forgery. We issue eight to ten Member 
Responsibility Actions per year, most after detecting some form of 
fraud, many of them Ponzi schemes. In most cases we uncover the fraud 
relatively quickly and close the firm before the losses mount too high. 
In a few cases, though, we have uncovered major frauds involving well 
over $100 million. Several of our cases, both large and small, have 
involved forged bank documents that were identified by our staff. What 
sets this case apart is that it involves a registered FCM, an 
elaborate, pervasive and convincing level of forgeries, and worst of 
all the loss of segregated customer funds.
    This most recent case is an extremely painful reminder of the 
lessons we learned, and have acted on, after MF Global. The following 
points are clear:

   For our markets to thrive, customers must know that their 
        funds are safe.

   It is the job of the regulators, both government regulators 
        and SROs, to provide the public with the highest level of 
        assurance possible.

   NFA followed audit steps developed by the Joint Audit 
        Committee that were consistent with CFTC Financial and 
        Segregation Interpretation No. 4-1 in all of our examinations 
        of Peregrine. But to assure ourselves of that, a committee of 
        our public directors has directed the commission of an internal 
        review of our audit practices and procedures, and the execution 
        of those procedures in the specific instance of Peregrine.

   Notwithstanding that, and notwithstanding it was NFA's 
        actions that uncovered this fraud in our most recent exam, the 
        simple fact is that Wasendorf's forgeries fooled us, and fooled 
        us for longer than any of us would like.

   Our audit steps alone are not good enough anymore. We are 
        implementing better ways to monitor members for compliance, 
        especially with regard to customer segregated funds, and are 
        looking for even more ways to improve monitoring of firms for 
        compliance with the rules.

    Shortly after the demise of MF Global, we formed an SRO Committee 
with the CME and representatives of other exchanges, including ICE, the 
Kansas City Board of Trade and the Minneapolis Grain Exchange. As 
discussed below, the SRO Committee developed a number of rule proposals 
that have already been approved by our Board. Early on in its 
deliberations, the committee recognized that we need to make better use 
of technology to monitor firms for compliance with segregation 
requirements.
    The committee has developed a proposed rule that will be presented 
at NFA's August Board meeting that would require FCMs to provide 
online, view-only access to bank balances for customer segregated and 
secured amount accounts to the firm's designated SRO. We understand the 
CME will adopt the same rule. Under this rule, SROs will be able to 
check any customer segregated bank account balance for any FCM any 
time, without asking the firm or the bank, and compare those balances 
to the firm's daily segregation report. NFA intends to expand this 
approach, once it is implemented, to receive daily reports from all 
depositories for customer segregated accounts, including clearing FCMs. 
We will develop a program to compare these balances with those reported 
by the firms in their daily segregation reports. While there may be 
reconciling items due to pending additions and withdrawals, the system 
will generate an immediate alert for any material discrepancies.
    We have also agreed with the CME to perform an immediate 
confirmation of all customer segregated bank accounts for all of our 
FCM Members using the e-confirmation process I referred to earlier. The 
completion of this work within the next week or so should help ensure 
that another Peregrine is not lurking in the industry.
    All of this is in addition to the rule changes already approved by 
NFA's Board in May and just recently approved by the CFTC. Those 
changes include rules requiring that:

   All FCMs must report certain information concerning the 
        FCM's financial condition that will then be made available to 
        the public on NFA's website. This information includes the 
        firm's capital requirements; its excess capital; the amount of 
        customer segregated funds held by the firm; the amount of 
        excess segregated funds maintained by the firm; whether the 
        firm engages in proprietary trading, once that term is defined 
        in the context of the Volcker rule; and whether any custodial 
        bank holding customer funds is an affiliate of the FCM.

   All FCMs must report to NFA detailed information on how 
        customer segregated funds are invested, and that information 
        will also be made available to the public through NFA's 
        website.

   If any FCM reduces its level of excess segregated funds by 
        25% in any one day by making disbursements that are not for the 
        benefit of customers, a financial principal of the firm must 
        approve the disbursement, must immediately notify the firm's 
        DSRO, and must certify that the firm remains in compliance with 
        all segregation requirements.

    All of these rule changes promote greater transparency for both 
customers and regulators and should help prevent a recurrence of the 
type of problems we saw at MF Global. These rule changes, however, are 
only the beginning. The MF Global and Peregrine customer losses are a 
painful reminder that we must continuously improve our surveillance, 
audit and fraud detection techniques to keep pace with changing 
technology and an ever-more-complicated financial marketplace.
    Mr. Chairman, for so long as there have been financial markets, 
there has been fraudsters who attempt to steal other people's money, 
and no regulator can provide assurance that fraud can be completely 
eliminated. But this is the second time in 9 months that customers have 
suffered losses due to misconduct or fraud on the part of an FCM, and 
when customers suffer those devastating losses, it is also devastating 
for the industry. We know that we can never completely eliminate fraud, 
but we must continue to adopt rules and surveillance techniques to try 
to eliminate the possibility that this could happen again. The steps we 
took at our May Board meeting and the proposed steps outlined above are 
a start in that process. We look forward to working with Congress, the 
Commission and the industry to achieve that goal and no ideas should be 
off the table in this process.

    Mr. Conaway. Thank you, Mr. Roth.
    Mr. Lukken for 5 minutes.

    STATEMENT OF HON. WALTER L. LUKKEN, PRESIDENT AND CHIEF 
              EXECUTIVE OFFICER, FUTURES INDUSTRY
                 ASSOCIATION, WASHINGTON, D.C.

    Mr. Lukken. Thank you, Chairman Conaway and Members of the 
Committee. I testify today on behalf of the Futures Industry 
Association, the leading U.S. trade association for futures, 
options and cleared derivatives in the United States.
    We now know that over $200 million in customer funds is 
missing from Peregrine Financial and that the fraud appears to 
date back 20 years. On the heels of the MF Global collapse, 
this is appalling and absolutely devastating news in our 
industry, and most of all, customers who are the victims of 
this egregious fraud.
    In the futures industry, we took considerable pride in the 
knowledge that the regulated futures markets had come through 
the financial crisis of 2008 with relatively few problems. 
During those difficult weeks, the futures markets continued to 
operate without significant incident to manage the volatile 
risks stemming from the financial crisis and to discover 
transparent prices when confidence was lost in the over-the-
counter markets.
    Today we can no longer say the futures markets came through 
these times unblemished. The failures of MF Global and 
Peregrine Financial are a stark reminder that diligent efforts 
by regulators and the firms themselves are essential to prevent 
losses to customers from mismanagement and fraud.
    The industry and regulators have already taken a number of 
important steps in the wake of the MF Global collapse. In 
February, FIA released its initial recommendation for customer 
funds protection calling on each FCM to adopt certain 
recommended internal control policies and procedures relating 
to the protection of customer funds. It is my understanding 
that the CFTC and the SROs have adopted or are actively 
considering adopting all of these suggestions. FIA has also 
taken efforts to educate customers. In February, we issued FAQs 
for customer fund protections which is being used by the FCMs 
to provide their customers with increased disclosure on how 
customer funds are secured.
    However, the recent events involving Peregrine make it 
evident that more must be done. In this respect, I would like 
to discuss the FIA's transparency initiative that I announced 
last week. First, FIA strongly supports providing regulators 
with the independent ability to electronically review and 
confirm customer segregated balances across every FCM at any 
time, period.
    Second, FIA supports the creation of an automated 
confirmation process for segregated funds that will provide 
regulators with the timely information that customer funds are 
secure. Technology solutions can help prevent this type of 
event from occurring again.
    Third, FIA supports the creation of an FCM informational 
portal that will centrally house firm-specific financial and 
related information regarding FCMs so customers can more 
readily access material information when evaluating an FCM.
    Fourth, FIA recommends that FCMs publicly certify as soon 
as practicable that they are in compliance with the initial 
recommendations for customer funds protections that FIA issued 
in February and that I referred to earlier.
    I was encouraged by Chairman Gensler's remarks that the 
Commission will be supporting and adopting many of these 
sensible industry recommendations. The blocking and tackling of 
regulation depends on ensuring that firms have proper internal 
risk controls in place and that these are independently 
reviewed and verified. Those basics of smart regulation have 
not changed over time, and we look forward to working with the 
Commission to prioritize initiatives aimed at protecting 
customers.
    Turning now to Dodd-Frank, FIA has been an active 
participant in the rulemaking process undertaken by the 
Commission over the last 2 years filing over 50 comment letters 
during that time. Having run a derivatives clearinghouse, I 
understand the difficulty in complex system builds, and Dodd-
Frank indeed is that. The key to any major project 
implementation is prioritization and sequencing. The industry 
would greatly benefit from the Commission prioritizing the 
critical rules that must be in place and developing a 
sequencing of those critical rules to bring certainty of 
planning to many of our firms. In fact, the SEC has done just 
that with the publishing of its Implementation Policy Statement 
aimed at avoiding, ``the disruption and costs that could result 
if compliance with all rules where required simultaneously or 
haphazardly.''
    Unless the Commission acts to establish a well-designed 
implementation policy, a significant number of rules will come 
into effect in the next few months in a haphazard manner, 
imposing a substantial burden on the market participants and 
exposing the industry to potential market disruption. These 
challenging times have also been compounded by the Commission's 
decision to move forward concurrently with significant rule 
proposals that are not mandated by Dodd-Frank such as Core 
Principal 9 on centralized trading and the redesign of the 
ownership and control reports at a cost of $18.8 million per 
firm in the industry.
    Of the Dodd-Frank rules that are critical, and there are 
many, one of the most important is the recent publication of 
proposed Commission guidance on the cross-border application of 
certain swap provisions. This guidance is not a rule under the 
APA and therefore does not require the Commission to conduct a 
cost-benefit analysis. It is evident, however, that its cost 
may be considerable, given the guidance's broad interpretation 
of the definition of U.S. person and, ``activities that would 
be deemed to have a direct and significant connection with 
commerce in the United States.'' The result would be a complex 
and confusing regulatory regime that would expose U.S. FCMs and 
swap dealers to consider regulatory risk and would extend the 
CFTC's reach to many jurisdictions around the world. On this 
theme of prioritization and sequencing, it would be imperative 
that the CFTC first clarify this guidance before the swap 
regulations and other Dodd-Frank requirements go into effect.
    These are challenging times for our industry, not only due 
to the regulatory changes described above but also due to the 
fundamental shift to the business model. With depressed futures 
volumes, historically low interest rates and ultracompetitive 
pricing models, FCMs are under tremendous strain financially. 
Many are concerned that the business is reaching a point where 
it cannot absorb additional costs and a seismic shift in the 
model may occur--whether that is a significant consolidation of 
FCMs or FCMs leaving the business altogether. This would have 
an unfortunate effect of limiting customer choice and reducing 
the number of firms that backstop the clearing system, making 
it vulnerable to catastrophic losses.
    So in conclusion, as we consider these regulatory changes, 
it would be wise to carefully weigh the costs of any new 
regulatory mandates and concentrate our resources on 
implementing only the highest priority reforms ahead of all the 
rest.
    Thank you, Mr. Chairman.
    [The prepared statement of Mr. Lukken follows:]

   Prepared Statement of Hon. Walter L. Lukken, President and Chief 
   Executive Officer, Futures Industry Association, Washington, D.C.

    Chairman Lucas, Ranking Member Peterson, and Members of the 
Committee, FIA is the leading trade organization for the futures, 
options and over-the-counter cleared derivatives markets. Our 
membership includes the world's largest derivatives clearing firms as 
well as leading derivatives exchanges and clearinghouses from more than 
20 countries. Our core constituency consists of futures commission 
merchants (FCMs), those regulated businesses that transact and 
guarantee the futures trades of customers and end-users. All of our 
membership is working overtime to implement the many reforms in the 
Dodd-Frank Wall Street Reform and Consumer Protection Act. Significant 
progress has been made in finalizing these reforms and I will address 
the rulemaking process later in my remarks. First, however, I would 
like to focus my remarks on the recent failure of Peregrine Financial 
Group (PFG).
    We now know that more than $200 million in customer funds is 
missing and that the falsification of financial records appears to go 
back 20 years. On the heels of the MF Global collapse, this is 
appalling and absolutely devastating news for everyone in our industry, 
and most of all the customers who are victims of this egregious fraud. 
PFG was not a big firm, but its demise resonates throughout the 
industry.
    In the futures industry, we took considerable pride in the 
knowledge that the regulated futures markets had come through the 
financial crisis of 2008 with relatively few problems. During those 
difficult weeks, the futures markets continued to operate without 
significant incident to manage the volatile risk stemming from the 
financial crisis and to discover transparent prices when confidence was 
lost in the pricing of the over-the-counter markets. The regulated 
futures markets, and the regulatory regime that underpins them, became 
the foundation of mandated swap clearing of Title VII of the Dodd-Frank 
Act.
    We can no longer say that the futures markets came through these 
times unblemished. The failures of MF Global and Peregrine Financial 
Group are a stark and unwelcome reminder that, no matter how well 
designed a regulatory structure may be, diligent and sustained efforts 
by regulators and the firms they regulate are essential to prevent 
losses to customers from mismanagement or fraud.
    In addition to the losses suffered by Peregrine's customers, the 
most damaging consequence of Peregrine's fraud is the effect on 
customer confidence, in particular in the sanctity of customer funds 
protections provided under the Commodity Exchange Act (Act) and the 
Commission's rules. This confidence was earned over decades by the many 
individuals that comprise the regulated futures industry. 
Unfortunately, one person's conduct has instantaneously shattered this 
trust and now overshadows the hard work and honorable behavior of 
everyone else.
    At FIA, we understand that it is going to take time to regain 
public trust and we are committed to doing whatever it takes to restore 
confidence in the safeguards for customer funds. Doing nothing is not 
an option.
    We also recognize that this is a collective problem, calling for 
collective solutions. Firms, exchanges, end-users and regulators must 
work together to identify the additional tools that are needed to 
protect customer funds and restore confidence and then implement them 
promptly and efficiently.

Post-MF Global Reforms
    The industry and regulators have already taken a number of 
important steps in the wake of the MF Global collapse to strengthen the 
customer protection regime in the futures markets. In February, FIA 
released its Initial Recommendations for Customer Funds Protection. 
These recommendations called on each FCM to adopt and document--to the 
extent not already in place--internal control policies and procedures 
relating to the protection of customer funds. In particular, FIA 
recommended that FCMs maintain appropriate separation of duties among 
individuals responsible for compliance with customer funds protections 
and develop a training program for chief financial officers and other 
relevant employees to help ensure that the individuals responsible for 
the protection of customer funds are appropriately qualified.
    We also recommended and supported rules adopted by the Chicago 
Mercantile Exchange and National Futures Association that subject all 
FCMs to enhanced record-keeping and reporting obligations, including: 
(i) transmitting daily customer segregation balances to their 
respective designated self-regulatory organization (DSRO); and (ii) 
requiring the chief financial officer or other appropriate senior 
officer to authorize in writing and promptly notify the FCM's DSRO 
whenever an FCM seeks to withdraw more than 25 percent of its excess 
funds from the customer segregated account in any day. These changes 
have now been approved by the Commission.
    Another of our recommendations calls on the Commission to require 
that each FCM certify annually that there are no material inadequacies 
in its internal controls regarding maintenance and calculation of 
adjusted net capital and compliance with the rules regarding the 
protection of customer funds. FIA encourages the Commission to adopt 
this recommendation as part of its package of audit improvements.
    Clearly, these recommendations for strengthening internal controls 
are relevant to both MF Global and Peregrine Financial. We have 
witnessed over the years a number of instances where lax auditing 
controls or a lack of separation of duties related to the movement and 
protection of customer money have led to wrongful activity and fraud. 
The adoption of these basic audit and internal control recommendations 
will go a long way to detect and deter inappropriate behavior, going 
forward.
    FIA also has taken efforts to educate customers on the scope of the 
protections for their funds so they can make well-informed decisions 
when choosing where to do business. In February, we issued Frequently 
Asked Questions on Customer Funds Protections, which is being used by 
FCMs to provide their customers with increased disclosure on the scope 
of how the laws and regulations protect customers in the futures 
markets. This document continues to be updated as we gather comments 
from regulators on other areas that should be covered. In addition, we 
will be expanding this document to ensure that customers have material 
information when evaluating an FCM.

FIA's Transparency Initiative
    Even with all that has been done, the recent events involving 
Peregrine Financial make it evident that more must be done. In this 
respect, I would like to discuss the ``Transparency Initiative'' that I 
announced last week.
    First, FIA strongly supports providing regulators with the 
independent ability to electronically review and confirm customer 
segregated balances across every FCM at any time.
    Second, FIA supports the creation of an automated confirmation 
process for segregated funds that will provide regulators with timely 
information that customer funds are secure. Technology solutions can 
help prevent this type of event from occurring again.
    Third, FIA supports the creation of an ``FCM Information Portal'' 
that will centrally house firm-specific financial and related 
information regarding FCMs so customers can more readily access 
material information when evaluating an FCM. FIA's board is actively 
considering ways to construct and populate such a system.
    Fourth, FIA recommends that FCMs publicly certify as soon as 
practicable that they are in compliance with the Initial 
Recommendations for Customer Funds Protection that FIA issued in 
February, specifically that they have adopted and implemented the 
internal control policies and procedures related to the protection of 
customer funds. These controls should be subject to independent review 
and oversight by the SROs and independent auditors.
    I was encouraged by Chairman Gensler's remarks before the Senate 
Agriculture Committee last week that the Commission will be supporting 
and adopting many of these sensible industry recommendations. The 
``blocking and tackling'' fundamentals of regulation depend on ensuring 
that firms have proper internal risk controls in place and that these 
are independently reviewed and verified. Those basics of smart 
regulation have not changed over time, and we look forward to working 
with the Commission to prioritize initiatives aimed at protecting 
customers.

Dodd-Frank Rulemaking
    Turning now to Title VII of the Dodd-Frank Act, FIA broadly 
supports the regulatory goals set out therein, which are designed to 
implement the G20 commitment that:

        All standardised OTC derivative contracts should be traded on 
        exchanges or electronic trading platforms, where appropriate, 
        and cleared through central counterparties by end 2012 at the 
        latest. OTC derivative contracts should be reported to trade 
        repositories.

    As with the regulated futures markets, centralized trading and 
clearing of swaps will reduce financial and operational risks of all 
market participants and bring necessary transparency to this critical 
segment of our financial system.
    FIA has been an active participant in the rulemaking process 
undertaken by the Commission over the past 2 years, filing more than 50 
comment letters and taking part in several Commission staff 
roundtables. We have also met numerous times with the Commissioners and 
Commission staff on various issues, which meetings have been reported 
on the Commission's website.
    Our comments have generally been supportive of the regulatory 
goals, while (i) seeking clarification of the obligations that would be 
imposed under certain provisions, (ii) noting the operational burdens 
in complying with others, (iii) raising cost-benefit issues where 
appropriate, and (iv) recommending alternatives that would achieve the 
Commission's regulatory goals more effectively and efficiently. Our aim 
is smarter regulation, not necessarily less regulation.
    I should emphasize that our concerns are not limited to swap-
related rulemakings. Although the primary focus of Title VII is the 
over-the-counter swaps markets, the Commission's rules also require 
FCMs to restructure significantly the way in which they have been 
conducting their regulated futures businesses for decades and, in the 
process, to undertake substantial changes to their record-keeping and 
reporting systems. Several such rules, discussed below, have posed a 
significant challenge to both FCMs and the Commission.
    Large Trader Reports. In July 2011, the Commission published rules 
requiring large trader reports for swaps and swaptions on physical 
commodities, which became effective on September 20, 2011. The rules 
raised a number of questions for which the industry sought guidance 
from the Commission staff. However, it was not until December 2011 that 
the staff was able to issue a Guidebook that provided additional 
guidance and detailed instructions for submitting large swaps trader 
reports to the Commission. In May 2012, the staff issued a revised 
Guidebook. Because of broad uncertainty surrounding compliance in this 
area, the Commission staff has found it necessary to issue temporary 
relief from the large trader reporting requirements five times.
    Position Limits and the Aggregation of Positions. The Commission's 
rules establishing position limits for 28 exempt and physical 
commodities generally require that, unless a particular exemption 
applies, a person must aggregate all positions for which that person 
controls the trading decisions with all the positions for which that 
person has a ten percent or greater ownership interest in an account or 
position, even if the person does not control trading in the other 
accounts. In May, in response to a petition from the Working Group of 
Commercial Energy Firms and the Commercial Energy Working Group 
(Working Groups), the Commission proposed to amend its policy requiring 
the aggregation of positions. As proposed to be amended, the 
aggregation policy would permit persons with an ownership that does not 
exceed 50 percent to file for disaggregation relief, if they can 
demonstrate independence by meeting Commission-established criteria.
    In support of their petition, the Working Groups argued, among 
other things, that the rules would force information sharing and the 
coordination of trading between entities that would be contrary to 
existing best practices for antitrust compliance. Moreover, entities 
with complex corporate structure arrangements that include established 
information barriers to ensure compliance with other regulatory 
requirements would face significant costs to monitor positions on an 
intra-day basis, notwithstanding the current lack of control over such 
trading.
    FIA supported the Working Groups' petition and is pleased that the 
Commission has proposed to amend its aggregation policy. Nonetheless, 
we believe the proposed amendment does not go far enough. The 
Commission should permit disaggregation without regard to ownership 
interest when entities can demonstrate separate management and control 
of trading and positions.
    Such a policy is consistent with section 4a of the Act, which calls 
for aggregation of positions that are subject, directly or indirectly, 
to common control. Section 4a does not require aggregation of positions 
arising from common ownership. Such a policy would also recognize 
commercial reality in an economy in which companies have passive 
ownership interests in scores, if not hundreds, of companies. Without 
coordinated trading, there is no increased risk of excessive 
speculation or manipulation.
    A decision on the proposed amendment to the Commission's 
aggregation policy is only one of several issues on which the industry 
requires guidance before it can develop the systems necessary to 
implement the Commission's position limit rules. Other critical open 
issues include: (i) the scope and logistics of grandfathering existing 
futures and swaps positions; (ii) the scope of grandfathered risk 
management positions; (iii) the scope of bona fide hedging 
transactions; and (iv) the unavailability of technology necessary to 
monitor for compliance with position limits intra-day. To date, 
however, the Commission has not provided a forum for working through 
these issues, leaving the industry struggling with how it is to comply 
with this rule.
    Legally Separate Operationally Commingled (LSOC) Rules. More 
recently, the industry has been meeting with representatives of the 
several derivatives clearing organizations (DCOs) that clear swaps to 
discuss the operational issues that arise in implementing the 
Commission's rules for providing protection for cleared swaps customer 
collateral.
    On their face, these rules, commonly referred to as the LSOC rules, 
appear relatively straightforward and FIA has supported the adoption of 
this new framework. Each day, clearing member FCMs must provide to the 
DCOs at which customer positions are carried information regarding (i) 
the identity of the customers whose positions make up the omnibus 
account, (ii) the positions carried on behalf of each customer, and 
(iii) the value of the margin posted with the DCO that supports each 
customer's portfolio of positions. Nonetheless, a number of very 
difficult operational questions have arisen that will take time to 
resolve. Until they are, there is not enough certainty or consensus on 
certain fundamental issues to permit FCMs and DCOs to build the systems 
necessary to implement the LSOC rules, which are scheduled to go into 
effect in November.
    Core Principle 9. Certain pending rules also threaten to have a 
significant impact on the conduct of regulated futures activities. One 
such rule is the proposed rule implementing Core Principle 9. This 
principle requires a designated contract market (DCM) to provide ``a 
competitive, open, and efficient market and mechanism for executing 
transactions that protects the price discovery process of trading in 
the centralized market.'' To implement this principle, the Commission 
has proposed to prohibit a DCM from continuing to list a futures 
contract unless at least 85 percent of the volume in such contract is 
traded through the DCM's centralized order book. If a futures contract 
no longer met the 85 percent test, the DCM would be required to de-list 
the contract and either liquidate the open positions or transfer the 
positions to a swap execution facility.
    This simple renaming of the instrument from a future to a swap 
would have dramatic effects, including substantially increasing the 
amount of initial margin required by the DCO to open the position and 
changing the tax treatment of the contract for non-hedge positions. 
Consequently, as we noted in our comment letter on the proposed rule, 
adoption of the proposed rule would result in significant legal and 
regulatory uncertainty and would have the curious effect of placing the 
regulated futures markets at a competitive disadvantage to the cleared 
swaps markets. In particular, start-up exchanges and new product 
offerings would find it difficult to meet this litmus test, thus 
lessening competition and innovation in the industry. Again, this 
rulemaking was not mandated by Dodd-Frank and its primary aim is the 
futures markets, not the swaps market where the financial crisis 
largely stemmed.
    Cross-Border Guidance. More recently, the Commission has published 
for comment what it has termed interpretative guidance on the cross-
border application of certain swaps provisions of the Commodity 
Exchange Act. The interpretative guidance is not a ``rule'' under the 
Administrative Procedure Act and, therefore, does not require the 
Commission to conduct a cost-benefit analysis before adopting it as 
final. Although we are still studying its terms, it is evident that the 
Commission has proposed to adopt a broad interpretation of the 
definition of a ``U.S. person'' and of the activities that would be 
deemed to have ``a direct and significant connection with activities 
in, or effect on, commerce of the United States.'' The result would be 
a complex and confusing regulatory scheme that would expose U.S. FCMs 
and swap dealers to considerable regulatory risk and would effectively 
extend the CFTC's reach into many jurisdictions around the world. It is 
imperative that the CFTC clarify this guidance before the registration 
and other Dodd-Frank requirements go into effect so that firms 
understand and can plan for the scope of Dodd-Frank's impact on their 
global businesses.
    Implementation Timetable. In light of this complex and legally 
uncertain regulatory environment, we believe it is essential that the 
Commission follow the lead of the Securities and Exchange Commission 
(SEC), which developed and recently published for comment an 
implementation policy statement. As Robert Cook, the Director of the 
SEC's Division of Trading and Markets, explained in testimony last 
week, the policy statement sets out the order in which the SEC expects 
to require compliance by market participants with the final rules to be 
adopted under Title VII, with the goal of avoiding ``the disruption and 
cost that could result if compliance with all rules were required 
simultaneously or haphazardly.''
    The implementation policy statement divides the final rules to be 
adopted by the SEC into five broad categories and describes the 
interconnectedness of the compliance dates of the final rules within 
each category, and where applicable, the impact of compliance dates of 
final rules within one category upon those of another category. The 
statement emphasizes that those subject to the new regulatory 
requirements arising from these rules will be given adequate, but not 
excessive, time to come into compliance with them.
    This is not a new idea. CFTC Commissioners have urged the 
Commission to adopt a similar policy statement, as have numerous market 
participants and trade associations, including FIA. However, time is 
running out. Unless the Commission acts promptly to establish a well-
designed implementation policy, a substantial number of substantive 
rules will come into effect in the next few months in a haphazard 
manner, imposing a substantial burden on the industry and exposing the 
industry to significant risk of enforcement proceedings. In this latter 
regard, in order to assure that market participants acting in good 
faith to comply with these rules are not unnecessarily exposed to the 
threat of enforcement action, it is essential that the Commission 
provide all market participants with ``adequate, but not excessive, 
time to come into compliance'' with these rules.
    I want to point out that the challenges that the industry is facing 
in implementing the Dodd-Frank Act have been exacerbated by the 
Commission's decision to move forward concurrently with significant 
rule proposals that are unrelated to the Dodd-Frank Act. I have already 
mentioned the Core Principle 9 rulemaking, which was not a mandated 
rule by Dodd-Frank. Another such proposal is the Commission's proposal 
to require DCMs and other reporting entities to file ownership and 
control reports (OCR) to the Commission on a weekly basis. As 
originally proposed, the OCR rules would have required FCMs to collect 
and report a substantial amount of information that either is not 
collected in the manner the Commission anticipated or is not collected 
at all. As a result, the proposed rules would have required a complete 
redesign of the procedures, processes and systems pursuant to which 
FCMs create and maintain records with respect to their customers and 
customer transactions.
    To prepare our comment letter on the proposed OCR rules, FIA formed 
an OCR Working Group to analyze their potential impact. We found that 
the median firm would face total costs of roughly $18.8 million and 
ongoing costs of $2.6 million annually. These costs, combined with the 
unwarranted structural change in the conduct of business among U.S. 
futures markets participants that the proposed rules would require, 
could force a number of FCMs to withdraw from the business and raise 
the barrier to entry for potential new registrants.
    In its comment letter, FIA presented an alternative OCR proposal 
that we believe would achieve the essential regulatory purposes of the 
Commission's proposed rules. The cost of the alternative OCR was 
considerably less than the estimated cost of implementing the OCR 
rules, but they are substantial nonetheless. FIA and the DCMs continued 
talking with Commission staff following the comment period. The 
Commission recently proposed a revised OCR structure that we understand 
is closer to the alternative that the industry recommended. We look 
forward to analyzing the proposal.
    We must emphasize that the FIA alternative was not developed within 
the 60 day comment period originally proposed by the Commission. It 
took several months of detailed analysis by industry representatives 
who otherwise perform critical operational and risk management 
responsibilities in their firms. We also want to emphasize that the OCR 
rule exemplifies a broader problem; the firms are being overwhelmed 
with the volume and complexity of the record-keeping and reporting 
programs they are being asked to implement in a very short time frame.
    Another rulemaking not directly mandated by Dodd-Frank is the 
Commission's recent adoption of rule 1.73 requiring clearing member 
FCMs to establish risk-based credit limits for all customers and 
implement procedures to screen all orders for compliance with these 
limits prior to execution. In particular, an FCM would be required to 
screen by automated means all orders received or executed by automated 
means. However, no systems currently employed by, or available to, 
clearing member FCMs, or the DCMs on which the trade may be executed, 
permit a trade to be screened prior to execution for its potential 
effect on the customer's existing portfolio of positions. Risk 
management systems are designed to monitor a customer's risk on a post-
execution/post-cleared basis. Moreover, the rule appears to require 
significant changes in the operational and contractual relationships 
among clearing member FCMs, executing brokers and investment managers 
as well as substantial systems changes.
    FIA is requesting the Commission staff to clarify the intended 
scope of the rule, and we are hopeful that the staff will approve an 
interpretation of the rule that will be technologically practicable, 
while meeting the Commission's regulatory goals.
    Conclusion. These are challenging and difficult times for our 
industry, not only due to the regulatory changes described above but 
also due to fundamental shifts in the business model that underlies the 
futures industry. With depressed futures volumes, historically low 
interest rates, and an ultra-competitive pricing model, FCMs are under 
tremendous strain financially. Many are concerned that the business is 
reaching a point where it cannot absorb additional costs without a 
seismic shift in the model--whether that is significant consolidation 
among FCMs or FCMs leaving the business altogether. This would have the 
unfortunate effect of limiting customer choice and reducing the number 
of firms that backstop the clearing system, making it more vulnerable 
to catastrophic losses. So as we consider regulatory changes, it would 
be wise to carefully weigh the costs of any new regulatory mandates and 
concentrate our resources on implementing the highest priority reforms 
ahead of all the rest.
    As discussed above, the industry is working against a short 
deadline while faced with considerable uncertainty about how the 
Commission plans to implement a wide swathe of its rules and how those 
rules will fit in a global regulatory structure. As we move forward, it 
is essential that the unintended consequences of any reforms be 
eliminated and the many positives that this industry has delivered to 
the customers of our markets be preserved.
    Thank you and I will be happy to answer any questions.

    Mr. Conaway. Mr. Lukken, thank you.
    Mr. Heck for 5 minutes.

  STATEMENT OF JOHN M. HECK, SENIOR VICE PRESIDENT, BUSINESS 
               DEVELOPMENT, THE SCOULAR COMPANY;
            MEMBER, EXECUTIVE COMMITTEE AND BOARD OF
   DIRECTORS, NATIONAL GRAIN AND FEED ASSOCIATION, OMAHA, NE

    Mr. Heck. Thank you, Mr. Chairman and Members of the 
Committee. I am John Heck, Senior Vice President of the Scoular 
Company. I appear today testifying on behalf of the National 
Grain and Feed Association. We appreciate the opportunity to 
appear before the Committee today.
    I serve as Co-Chairman of the NFGA's MF Global Task Force, 
which was formed to develop responses and recommendations in 
response to the failure of MF Global. Many NGFA member firms 
have been deeply affected by the liquidation of MF Global. 
Customer accounts were frozen, then transferred to other FCMs 
in chaotic fashion and with a dearth of information to 
customers so they could possibly manage their financial 
exposure. These customer funds were required to be segregated 
and held safe by MF Global. We believed for years that 
segregated customer funds were completely safe but now we see 
that was not the case. The unprecedented loss of customer funds 
has led to a loss of confidence in futures markets.
    Our task force asked the question: was MF Global a one-time 
situation or is the level of customer risk still significant? 
Unfortunately, we know today that serious risk still is 
present. The apparent long-term fraud and misappropriation of 
customer funds at Peregrine Financial Group highlights the need 
for more effective regulatory oversight and enhanced safety for 
customer funds. The cumulative effect of MF Global and now the 
PFG failure, especially at a time when regulators were on 
heightened alert, has been a huge loss of confidence in 
regulators and in the rules that protect customers. We believe 
steps should be taken to help restore confidence and improve 
customer protection now.
    In early April, the NGFA submitted preliminary 
recommendations to the CFTC for enhanced reporting, 
transparency and accountability. Those recommendations are 
attached to my written testimony in addition to a second set of 
recommendations we submitted last month to leadership of the 
House and Senate Agriculture Committees. I would like to 
highlight several of these today.
    The Commodity Exchange Act, CFTC regulations and the 
Bankruptcy Code should be harmonized for greater clarity and to 
avoid interpretative inconsistencies. Second, strengthen the 
CFTC's authority to appoint a trustee who exclusively 
represents the interests of commodity customers in a 
bankruptcy. Third, the Bankruptcy Code should state clearly 
that customers with segregated funds always are first in line 
for distribution of funds. Fourth, the Bankruptcy Code should 
include authority for commodity customer committees in an FCM 
liquidation. And last, safe-harbor provisions of the Bankruptcy 
Code should not limit powers of a trustee to recover customer 
funds. Reforming the Bankruptcy Code is a major undertaking. We 
would welcome working with other organizations that have 
similar goals so Congress can act on legislation soon.
    The NGFA also recommends establishment of a new type of 
voluntary account structure that fully segregates customer 
assets. Full segregation will result in additional costs so we 
suggest the use of such accounts would be on a voluntary basis 
at the agreement of an FCM and its customers. We believe that a 
pilot program could be implemented quickly and without 
legislation, and we would find a useful way to test the 
mechanics of this new account structure and begin to judge its 
true costs and benefits.
    Because full segregation might not be attractive to all 
customers, the NGFA also recommends that insurance coverage be 
extended to commodity futures customers in much the same way 
that insurance protection now exists for securities customers 
under the SIPC.
    I would like to close my testimony with some comments about 
a proposed rule by the CFTC that has generated serious and 
widespread concern among NGFA member firms and agricultural 
producers. It has also been mentioned by a Member of the 
Committee this morning. It would require that any member of a 
designated contract market like the Chicago Board of Trade or 
the Kansas City Board of Trade record all oral communications 
that could lead to a cash transaction and keep records for CFTC 
inspection for 5 years. Many country elevators would be 
required to record telephone conversations with farmers about 
possibly entering into a forward cash contract to purchase the 
farmer's grain, even though forward contracts are specifically 
exempted in the Commodity Exchange Act from CFTC's 
jurisdiction. This proposal would require substantial new 
investment in communications technology for many small 
businesses. In addition, it would create a bifurcated cash 
marketplace in which some grain purchasers would be required to 
record communications and maintain records while others would 
not be covered by the rule. We are happy to hear the 
Commissioner's comments this morning that he may be able to 
dial back on those requirements.
    Thank you for the opportunity to share the views of the 
National Grain and Feed Association. I would be happy to 
respond to any questions.
    [The prepared statement of Mr. Heck follows:]

  Prepared Statement of John M. Heck, Senior Vice President, Business
Development, The Scoular Company; Member, Executive Committee and Board 
      of Directors, National Grain and Feed Association, Omaha, NE

    Good morning, Chairman Lucas, Ranking Member Peterson, and Members 
of the Committee. I am John Heck, Senior Vice President of The Scoular 
Company in Omaha, Nebraska. The Scoular Company, founded in 1892, 
manages commodity supply-chain risk for customers in food, feed and 
renewable fuel markets. From more than 70 locations across North 
America, nearly 700 Scoular employees tailor risk-management solutions 
for their customers by buying, selling, storing, and transporting grain 
and ingredients.
    This morning, I am testifying on behalf of the National Grain and 
Feed Association (NGFA), the national trade association representing 
grain elevators, feed manufacturers, processors and other commercial 
businesses that utilize exchange-traded futures contracts to hedge 
their risk and to assist producer in their marketing and risk 
management strategies. We appreciate the opportunity to testify before 
the Committee today.
    I serve on the NGFA's Executive Committee and Board of Directors, 
and I also serve as Chairman of the Association's Finance and 
Administration Committee. More recently, I was asked to co-chair the 
NGFA's MF Global Task Force, formed to develop responses and 
recommendations to the failure of MF Global. Our priorities are to 
advocate regulatory and policy changes that will help ensure that 
another similar situation does not recur and to enhance protections for 
commodity futures customers.
    Many NGFA-member firms have been deeply affected by the MF Global 
Holdings bankruptcy and the subsequent liquidation of futures 
commission merchant (FCM) MF Global Inc. Following the bankruptcy, 
customers' accounts were frozen, then transferred to other FCMs in 
chaotic fashion and with a dearth of information to help customers 
manage their financial exposure. Today, another distribution of funds 
from the MF Global trustee has begun with the goal of bringing all 
commodity customer distributions to about 80% of account value, but 
many firms still have received only 72% of their funds with no 
assurance they ever will be made whole.
    It is worth emphasizing again that these customer funds were 
required to be segregated and held safe by MF Global. Our industry had 
believed for years that segregated customer funds were completely safe, 
but we now see that was not the case. The unprecedented loss of 
customer funds in the MF Global debacle has led to a loss of confidence 
in futures markets and in the ability of the current system to protect 
customer funds.
    As our Task Force considered regulatory and policy changes in the 
aftermath of MF Global, we asked ourselves: ``Was MF Global a one-time 
situation, or is the level of customer risk still significant? Did the 
MF Global failure and its consequences rise to the level that merited 
significant change?''
    Unfortunately, we know today that serious risk still is present. 
The discovery of apparent long-term fraud and misappropriation of 
customer funds at Peregrine Financial Group (PFG) highlights again the 
need for more effective regulatory oversight and meaningful change that 
will provide additional safety for customer funds both before a failure 
occurs and in the event of future FCM liquidations.
    We are still awaiting details of the situation surrounding the PFG 
situation. On its face, the PFG failure appears to have some key 
differences from MF Global--namely, that customer funds were 
intentionally misappropriated for a variety of illegitimate purposes 
over a very long period of time. However, the cumulative effect of MF 
Global and PFG failures within a relatively short time--and especially 
the failure of PFG at a time when regulators presumably were on 
heightened alert for problems--has been a huge loss of confidence in 
regulators and in the adequacy of current rules to protect customer 
funds. We look forward to a full explanation by regulators of exactly 
what happened at PFG. In the meantime, we believe there are steps that 
should be taken to begin restoring confidence and to bolster 
protections for segregated customer funds.
    In early April, the NGFA submitted to the Commodity Futures Trading 
Commission (CFTC) preliminary recommendations for enhanced reporting, 
transparency and accountability. Generally, these recommendations were 
developed with the intent of assisting customers by providing them with 
more information to evaluate FCMs with whom they do business. In 
addition, several of our recommendations were aimed at requiring 
greater scrutiny by the CFTC and self-regulatory organizations of FCM 
practices and financial reporting, and requiring FCMs to develop and 
adhere to policies and procedures that rigorously will ensure proper 
safeguarding of customer funds. Those recommendations are attached, and 
I would be happy to discuss them in greater detail.
    Late last month, the NGFA submitted a second set of recommendations 
to leadership of both the Senate and House Agriculture Committees. 
These recommendations involve significant changes in customer account 
structure, reforms to the U.S. Bankruptcy Code to enhance customer 
rights and protections, and the potential extension of insurance 
coverage to commodity futures customers. The NGFA's letter transmitting 
our latest recommendations is attached, and I would like to highlight 
several of our recommendations today:

Reforms to the U.S. Bankruptcy Code
   The Commodity Exchange Act, CFTC regulations and the 
        Bankruptcy Code should be harmonized to provide greater clarity 
        and avoid interpretive inconsistencies in the event of future 
        FCM liquidations.

   The CFTC's authority to appoint a trustee to represent 
        exclusively the interests of commodity customers should be 
        strengthened. In a situation like MF Global, where over 95% of 
        assets and accounts affected were those of commodities 
        customers, we believe the CFTC should play a larger role and 
        that a trustee with commodities expertise should be involved.

   The Bankruptcy Code should state clearly that customers 
        always are first in line for distribution of funds, ahead of 
        creditors, and that all proprietary assets of affiliates should 
        go to reimburse segregated customer accounts first.

   The Bankruptcy Code clearly should state authority for 
        establishment of commodity customer committees to represent 
        their interests in an FCM liquidation.

   Regardless of the intent behind transfer of customer funds, 
        ``safe harbor'' provisions of the Bankruptcy Code should not 
        limit powers of a trustee to recover customer funds.

    We understand that significant reforms to the U.S. Bankruptcy Code 
are a major undertaking. For that reason, the NGFA would welcome 
working together with other organizations that have similar goals in 
order that legislation can be moved expeditiously by Congress.

Fully Segregated Customer Accounts
    Current legal authority provides for pro rata distribution by the 
trustee of customer property that was held by a failed FCM. That means 
that all customers must share equally in losses in the event of a 
shortfall of funds. The NGFA recommends establishment of a new type of 
account structure for use by FCM customers on a voluntary basis that 
provides for full segregation of customer assets, not commingled with 
FCM funds or other customer funds. It will be important in establishing 
a new fully-segregated structure that customer funds not fall under the 
``customer funds'' definition in the Bankruptcy Code, thereby exposing 
them to pro rata distributions and loss-sharing. Creation and 
maintenance of fully-segregated accounts necessarily will result in 
some additional costs that likely will be borne by customers. For that 
reason, we prefer that use of such accounts would be on a voluntary 
basis, at the agreement of an FCM and its customers.
    We believe that a pilot program would be a useful way to test the 
mechanics of this new account structure and to begin to judge its true 
costs. The NGFA will look to work with commodity customers, FCMs, 
lenders and regulators to identify potential participants. We believe a 
pilot program leading to fully-segregated accounts can be implemented 
relatively quickly without the need for legislation.

Insurance for Commodity Futures Customer Accounts
    Because a fully-segregated account structure may not prove to be a 
practical alternative for all customers, the NGFA also has recommended 
that insurance coverage be extended to commodity customers, in much the 
same way that insurance protection currently exists for securities 
customers under the Securities Investor Protection Corporation (SIPC). 
Details involving the appropriate level of coverage and funding will 
need to be determined, but we believe the added protection for 
customers will be perceived as significant and meaningful in today's 
environment.

Dodd-Frank Implementation
    Finally, I would like to share with the Committee the NGFA's views 
on the ongoing implementation by CFTC of the Dodd-Frank law. We 
believed from the beginning that agriculture, and the use of 
agricultural risk management tools, had nothing to do with the 
financial crisis that served as the catalyst for passage of Dodd-Frank. 
Responding to the barrage of proposals from the CFTC to implement Dodd-
Frank has required much time and effort by agriculture and agribusiness 
firms.
    While some uncertainties still exist in how the law will be 
implemented by the CFTC, the NGFA generally has appreciated the 
Commission's openness and responsiveness to agriculture and 
agribusiness concerns. However, I would like to close my testimony with 
some comments about one proposal that has generated serious and 
widespread concern among NGFA-member firms and the agricultural 
producers with whom they work so closely.
    Briefly, the proposal would require that any member of a designated 
contract market (DCM)--like the Chicago Board of Trade, Kansas City 
Board of Trade or Minneapolis Grain Exchange--record all oral 
communications that could lead to a cash transaction. In addition, 
records would need to be kept for CFTC inspection for up to 5 years, 
identifiable by counterparty and transaction. There are several 
problems with the proposal as currently written:

   The proposal would require, for example, a country elevator 
        operated by a company that is a member of a commodity futures 
        exchange to record telephone conversations with farmers about a 
        forward cash contract--contracts that specifically are exempted 
        in the Commodity Exchange Act from CFTC's jurisdiction. Taken 
        even farther, a country elevator manager's conversation behind 
        the stands at the high school football game on Friday night 
        with a farmer in the community about buying cash grain the next 
        day would be required to be recorded. Clearly, this would 
        constitute a huge expansion of CFTC's authority in the cash 
        marketplace.

   Country elevators are not equipped with the technology to 
        record conversations and maintain a record of them. The 
        proposal would require a huge new investment in communications 
        technology for many small businesses.

   The proposal would create a bifurcated cash marketplace in 
        which some grain purchasers would be required to record 
        communications and maintain records, while others not operated 
        by a member of a DCM would not be covered by the rule. Will a 
        farmer call the elevator where all conversations must be 
        recorded and records kept for CFTC inspection, or the elevator 
        down the road where no such requirement exists? Serious 
        competitive issues are involved.

    The NGFA respectfully suggests that the enforcement goals of the 
Commission can be effectively accomplished and better served without 
this huge new intrusion into the cash grain marketplace.
    Thank you for the opportunity to share the views of the National 
Grain and Feed Association. I would be happy to respond to any 
questions.
                              Attachment 1
April 2, 2012

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

    Dear Chairman Gensler:

    The demise of MF Global has shaken the confidence of many futures 
market participants with regard to the safety of segregated customer 
funds. Many NGFA-member companies continue to struggle to recover their 
funds and property.
    The NGFA respectfully submits the following preliminary 
recommendations as first steps to begin re-establishing confidence 
among futures market participants and to help safeguard customer funds. 
However, it is extremely important that these types of changes--
designed to enhance reporting, transparency and accountability, with 
recommendations we believe should be relatively easily implemented--are 
not the end of efforts to ensure that another MF Global-type situation 
never recurs.
    The NGFA's MF Global Task Force continues its work to examine 
various models for segregating and safeguarding customer funds; to 
explore the viability and costs of extending insurance coverage to 
commodities accounts; and to analyze potential changes to the U.S. 
Bankruptcy Code to provide customers with needed protection, especially 
to protect customer segregated funds from being swept into liquidation 
proceedings and to ensure that ``safe harbor'' rules under the 
Bankruptcy Code aren't used to preclude retrieving customer funds. We 
expect to issue additional recommendations in these areas soon. In all 
these efforts, our bedrock principle will be:
``Customers Come First''
    The preliminary recommendations of the NGFA are as follows:

   The CFTC should require daily reporting of segregated fund 
        positions by FCMs to both their Self-Regulatory Organization 
        (SRO) and to the CFTC.

   The CFTC should require daily reporting of segregated fund 
        investments by FCMs, detailed by maturity and quality, to both 
        their SRO and to the CFTC.

   The CFTC should conduct a formal review of FCM investment 
        options for customer funds, with a view to whether the 
        Commission should further limit allowable investments only to 
        very safe instruments.

   The CFTC should require reporting by FCMs to their SRO and 
        to the CFTC of significant changes in investment policies or 
        holdings.

   FCMs should be required to provide greater transparency to 
        customers of where customer funds are invested, potentially 
        achieved through means such as posting on the CFTC website, FCM 
        websites and/or publication in a customer ``prospectus.''

   The CFTC and SROs should enhance monitoring of FCM 
        reporting. Both regulators should conduct more detailed and 
        more frequent audits, and unannounced spot checks of FCMs.

   To assign accountability and to aid in establishing that 
        fraudulent activity has occurred in the event customer funds 
        are misappropriated, CFTC should require the signature of two 
        authorized principals of an FCM (e.g., CEO, CFO or other senior 
        officers) to move funds out of segregated customer fund 
        accounts to non-customer accounts.

   FCMs should be required to provide immediate notice to their 
        SRO and to the CFTC if the firm moves more than some 
        percentage, to be determined by the CFTC, of excess segregated 
        funds to non-customer accounts.

   FCMs should be required by their SRO to periodically certify 
        policies and procedures to ensure the safeguarding of customer 
        segregated accounts and compliance with applicable laws and 
        regulations regarding such accounts. As part of all 
        examinations by SROs, principals of FCMs must certify that 
        policies and procedures are adequate, effective and being 
        observed by the FCM. At least annually, SROs should be required 
        by CFTC to review policies and procedures to determine adequacy 
        and compliance.

   A rigorous review by the CFTC of capital requirements for 
        FCMs and broker-dealers needs to be conducted, with a view to 
        scrutinizing the current practice of allowing double-counting 
        of required capital when a firm operates as both an FCM and a 
        broker-dealer.

    We appreciate the opportunity to share these recommendations with 
you, and we look forward to working with you to ensure that customer 
funds truly are segregated and safe from future misappropriation.
            Sincerely,

            
            




Matt Bruns,                          John Heck,
Chair,                               Chair,
Risk Management Committee;           Finance and Administration
                                      Committee.


                              Attachment 2
June 29, 2012




Hon. Frank D. Lucas,                 Hon. Collin C. Peterson,
Chairman,                            Ranking Minority Member,
House Committee on Agriculture,      House Committee on Agriculture,
Washington, D.C.;                    Washington, D.C.



    Dear Chairman Lucas and Ranking Member Peterson:

    As you are well aware, companies and individuals that were 
customers of MF Global Inc.'s futures business continue to deal with 
the aftermath of parent company MF Global Holdings' bankruptcy and the 
subsequent liquidation of the futures commission merchant (FCM). Most 
customers so far have received distributions from the trustee of about 
72% of their funds--funds that were supposed to have been segregated 
and protected--with no assurance of being made whole.
    Shortly following MF Global's demise, the National Grain and Feed 
Association (NGFA) established a task force to formulate 
recommendations for change to help ensure that another MF Global-type 
situation does not occur. On April 2, we submitted to Congress and to 
the Commodity Futures Trading Commission (CFTC) a number of preliminary 
recommendations for enhanced reporting, transparency and accountability 
(attached).* We are pleased that the CFTC and the regulated exchanges 
have begun to implement some changes quite similar to the NGFA's 
preliminary recommendations.
---------------------------------------------------------------------------
    * Editor's note: the document referred to is the preceding attached 
letter dated April 2, 2012.
---------------------------------------------------------------------------
    This letter transmits a second set of NGFA policy recommendations. 
Many of these changes will require action by Congress and/or the CFTC, 
and we urge expeditious consideration to protect customers' funds and 
to reinforce the principle that ``Customers Come First.''
    The NGFA's recommendations are as follows:
    Reforms to U.S. Bankruptcy Code--The NGFA believes strongly that 
reforms to the U.S. Bankruptcy Code are critically important to 
preserving customers' rights and protecting customers' assets in the 
event of future FCM insolvencies. To that end, the NGFA recommends the 
following statutory changes:

   Generally, the Bankruptcy Code provides a limited 
        description of the liquidation process of a commodity futures 
        broker. The Commodity Exchange Act and bankruptcy regulations 
        drafted by the CFTC provide much greater and more detailed 
        guidance for the liquidation of a commodity broker or FCM. The 
        NGFA recommends that Part 190 regulations of the CFTC should be 
        incorporated into Subchapter IV of Chapter 7 of the Bankruptcy 
        Code to harmonize the statutes and avoid interpretative 
        inconsistencies.

   Under SIPA, the SIPC is authorized to select a trustee and 
        to oversee the trustee's compensation, while the CFTC has a 
        limited role. Further, the SIPA trustee is obligated to protect 
        the interests of both securities and commodities customers. In 
        order to strengthen commodity customer protection, the NGFA 
        recommends that CFTC should have a specifically identifiable 
        role in the liquidation of an FCM. The CFTC should have the 
        authority to appoint its own trustee to represent exclusively 
        the interests of commodities customers. (This recommendation is 
        not intended as a criticism of the SIPA trustee appointed to 
        oversee liquidation of MF Global Inc. However, in a case where 
        over 95% of the assets and accounts affected were those of 
        commodities customers, we believe the CFTC should play a much 
        larger role.)

   Currently, an FCM is required to keep customer funds 
        segregated from the firm's proprietary funds, but customer 
        property is commingled. As a result, under the current 
        statutory scheme, all customers share pro rata in the event of 
        a shortfall. The NGFA recommends that the Bankruptcy Code 
        should state clearly that customers always are first in line 
        for distribution of funds, ahead of creditors, and that all 
        proprietary assets including those of affiliates must go to 
        customers first. Knowing that their claims could be 
        subordinated in the event of a shortfall would provide 
        incentives to the FCM and any controlling parent firm to ensure 
        adequate internal controls to prevent segregation violations. 
        Further, this provision would provide clarity to regulators and 
        to the courts in terms of prioritization of claims, an area in 
        which precedent has not been established.

   In the MF Global situation, creditor committees were 
        established under the MF Global Holdings Chapter 7 proceeding, 
        but there was no statutory provision under the SIPA liquidation 
        of the MF Global Inc. FCM for establishment of customer 
        committees. The NGFA recommends that the Bankruptcy Code 
        expressly should authorize the establishment of customer 
        committees to represent customer interests.

   Under current bankruptcy law, powers of a trustee to recover 
        customer funds are limited under so-called ``safe harbor'' 
        provisions unless actual intent to defraud customers/creditors 
        can be shown. The NGFA strongly recommends that any transaction 
        involving the misappropriation of an FCM's customer property 
        should not be protected under safe harbor provisions, 
        regardless of the intent behind a fund transfer.

    We are aware that other organizations also are working toward 
specific recommendations for changes in the Bankruptcy Code that will 
enhance customer protections. The NGFA would welcome the opportunity to 
work cooperatively with such groups to develop consensus reforms that 
can be moved by Congress expeditiously.
    Fully Segregated Customer Accounts--Currently, the Commodity 
Exchange Act and U.S. Bankruptcy Code provide for pro rata distribution 
of all customer property that was held by a failed futures commission 
merchant (FCM). In the case of MF Global, the result has been that 
former customers of the firm so far have received only 72% of their 
supposedly safe segregated funds back through distributions from the 
trustee, with no assurance that they ever will receive all of their 
funds. We believe strongly that a new type of account structure needs 
to be established for use by FCM customers on a voluntary basis that 
will shield customer assets from pooled losses in the event of an FCM 
bankruptcy.
    It will be of paramount importance in establishing this new 
structure that fully-segregated customer funds not fall under the 
``customer funds'' definition of the Bankruptcy Code, thereby exposing 
them to pro rata distributions (as discussed above in recommendations 
for changes in the Bankruptcy Code.)
    Creation of a fully-segregated account structure necessarily will 
result in some additional costs that likely will be borne by customers 
utilizing this voluntary option. If that is the case, it is likely that 
some customers will opt for the added protections despite extra costs, 
and some customers will be unwilling or unable to bear those extra 
costs. For that reason, we propose that the full-segregation option be 
utilized on a voluntary basis at the agreement of an FCM and its 
individual customers. The NGFA will look to work with like-minded 
organizations to design a full-segregation option that responds to 
customer needs.
    Pilot Program for Full-Segregation Option--We suggest that a pilot 
program involving commodity futures customers, FCMs, banks and 
regulators could be a useful means of testing the mechanics and 
beginning to judge the true costs of a full-segregation structure--and 
in the process, moving as quickly as possible toward a more generally 
available full-segregation option for customers. The NGFA recommends a 
pilot program at the earliest possible date, and commits here to 
working with its member firms, the CFTC and other parties to identify 
potential participants.
    SIPC-Like Insurance for Commodity Futures Customer Accounts--
Because the full-segregation option discussed above may not prove to be 
a practical alternative for all market participants, the NGFA 
recommends that insurance coverage in the event of an FCM bankruptcy be 
extended to commodity futures accounts similar to that currently 
provided for securities customers.
    Much in the way that the Securities Investor Protection Corporation 
(SIPC) has provided insurance protection for securities accounts, the 
NGFA recommends creation of a similar structure for commodities. We 
believe that a significant fund could be established through very 
modest dedicated assessments on commodity futures transactions. Details 
concerning the appropriate size of such a fund and the appropriate 
level of assessment will need to be determined, but we believe the 
customer protections provided will be significant and meaningful to 
market participants.
    The NGFA does not recommend herein whether housing a commodity 
futures insurance fund within the existing structure of the SIPC is the 
correct solution, or whether a new and separate entity resembling the 
SIPC but dedicated to providing insurance protection for commodity 
futures accounts should be established. However, we believe strongly 
that insurance protection for commodity futures accounts should be 
established, action that likely will require authorizing legislation. 
We look forward to working with Congress to achieve that goal.
    We look forward to working with Congress, the CFTC and other 
stakeholders to achieve the afore-mentioned changes with the goal of 
protecting customer funds, both prior to and following a bankruptcy or 
an FCM insolvency. Please do not hesitate to contact the NGFA with any 
questions.
            Sincerely,

            
            




Matt Bruns,                          John Heck,
Chair,                               Chair,
Risk Management Committee;           Finance and Administration
                                      Committee.



    The Chairman [presiding.] Thank you, sir.
    Mr. Conner, you are recognized for 5 minutes.

   STATEMENT OF HON. CHARLES F. CONNER, PRESIDENT AND CHIEF 
             EXECUTIVE OFFICER, NATIONAL COUNCIL OF
             FARMER COOPERATIVES, WASHINGTON, D.C.

    Mr. Conner. Chairman Lucas, Congressman Boswell, and 
Members of the Committee, on behalf of the nearly 3,000 farmer-
owned cooperatives and their producer-members, thank you for 
the opportunity to testify today to discuss implementation of 
the Dodd-Frank Act.
    The over-the-counter markets have given cooperatives and 
their producer members important tools to manage their exposure 
and hedge their risk during the volatile commodity markets that 
we have seen over the last few years. This Committee's 
oversight of CFTC as they have written the rules regulating the 
over-the-counter markets has been instrumental in ensuring that 
co-ops and farmers continue to have access to those innovative 
risk-management tools. I would simply like to personally thank 
you for your work and your staff's work in this area.
    This continued oversight is important as the process now 
turns from one of rulemaking to one of compliance. This shift 
is something that NCFC members are now grappling with. They 
must clearly understand the provisions of the regulations while 
also figuring out how different regulations will fit together 
into a coherent regulatory framework. Our members are finding 
it very challenging to understand exactly what needs to be done 
in order to be in compliance at the end of the day, and of 
course, they want to be in compliance.
    Part of the concern also lies with CFTC's eventual 
enforcement of new regulations. As we have throughout the 
process, we do urge the CFTC to continue to work closely with 
industry and take a collaborative approach to compliance. We 
hope the CFTC will lend a hand and help and educate us, not as 
a regulator looking to make an example out of honest mistakes, 
misunderstandings and oversights but rather as a partner 
determined to see us meet these requirements.
    This would be a continuation, Mr. Chairman, of the 
willingness that CFTC has shown to listen to our concerns 
throughout this rulemaking process. As an example, much of the 
regulatory uncertainty for farmer co-ops has recently been 
resolved. Most significant is the definition of swap dealer. 
The Commission under Chairman Gensler's leadership took the 
time to understand farmer co-ops and made a significant 
improvement in the final rule. As such, farmer co-ops will not 
be regulated as swap dealers.
    Other rules that have not yet been finished continue to 
cause uncertainty over the new costs that will be imposed on 
farmers and their co-ops. Incremental increases in cost, 
whether passed on from a swap dealer or imposed directly on the 
cooperative, of course will trickle down and impact our 
producer-owners. For example, one CFTC proposal imposes 
additional record-keeping requirements in the cash commodity 
markets has been noted. We appreciate Chairman Gensler's 
earlier comments stating that he has no intention of imposing 
this new requirement, and we would encourage the Committee to 
follow up on this commitment.
    Other regulatory burdens could also impact our members' 
hedging activities. For instance, swap dealers who co-ops often 
use to lay off the risk of offering forward contracts must 
comply with capital and margin requirements, which has not yet 
been finalized by the agency. How these costs will be passed on 
to end-users remains to be seen and again could dramatically 
impact the cost-effectiveness of commercial hedging via the 
over-the-counter market.
    Finally, Mr. Chairman, there is still a question of whether 
the so-called Prudential Regulators will require bank swap 
dealers to collect margin from end-users. We appreciate very 
much this Committee's work on this issue, and of course the 
House passage of the Business Risk Mitigation and Price 
Stabilization Act by an overwhelming vote. Clearly, mandatory 
margin would increase the cost again of hedging operations and 
ultimately discourage this very prudent business practice.
    Thank you again for the opportunity to testify today, Mr. 
Chairman, and I look forward to any questions you may have.
    [The prepared statement of Mr. Conner follows:]

   Prepared Statement of Hon. Charles F. Conner, President and Chief
Executive Officer, National Council of Farmer Cooperatives, Washington, 
                                  D.C.

    Chairman Lucas, Ranking Member Peterson, and Members of the 
Committee, thank you for the invitation to testify today on the 
implementation of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act (Dodd-Frank Act).
    I am Chuck Conner, President and Chief Executive Officer of the 
National Council of Farmer Cooperatives (NCFC). NCFC represents the 
nearly 3,000 farmer-owned cooperatives across the country whose members 
include a majority of our nation's more than two million farmers.
    Farmer cooperatives--businesses owned, governed and controlled by 
farmers and ranchers--are an important part of the success of American 
agriculture. They are a proven tool to help individual family farmers 
and ranchers through the ups and downs of weather, commodity markets, 
and technological change. Through their cooperatives, producers are 
able to improve their income from the marketplace, manage risk, and 
strengthen their bargaining power, allowing individual producers to 
compete globally in a way that would be impossible to replicate as 
individual producers.
    In particular, by providing price risk management tools to their 
farmer-owners, farmer cooperatives help mitigate commercial risk in the 
production, processing and selling of a broad range of agricultural and 
food products. America's farmers and ranchers must continue to have 
access to new and innovative risk management products that enable them 
to feed, clothe and provide fuel to consumers here at home and around 
the world. The ongoing drought across much of the country, which is 
impacting so many producers so severely, once again illustrates the 
need for a multilayered risk management strategy in agriculture.
    We greatly appreciate the ongoing oversight this Committee has 
provided as the Dodd-Frank rules have been written. Your work in 
encouraging the Commodity Futures Trading Commission (CFTC) to ensure 
that the agriculture industry has affordable access to innovative risk 
management tools once the Act is implemented is commendable. With your 
continued leadership, agriculture will hopefully avoid being subject to 
a one size fits all type of regulation intended for Wall Street.

Cooperatives' Use of the OTC Market
    As processors and handlers of commodities and suppliers of farm 
inputs, farmer cooperatives are commercial end-users of the futures 
exchanges as well as the over-the-counter (OTC) derivatives markets. 
Due to market volatility in recent years, cooperatives are increasingly 
using OTC products to better manage their exposure by customizing their 
hedges. This practice increases the effectiveness of risk mitigation 
and reduces costs to the cooperatives and their farmer-owners. Swaps 
also play a critical role in the ability of cooperatives to provide 
forward contracts, especially in times of volatile markets. Because 
commodity swaps are not currently subject to the same margin 
requirements as the exchanges, cooperatives can use them to free up 
working capital.
    OTC derivatives are not just used for risk management at the 
cooperative level, however. They also give the cooperative the ability 
to provide customized products to farmers and ranchers to help them 
better manage their risk and returns. Much like a supply cooperative 
leverages the purchasing power of many individual producers, or a 
marketing cooperative pools the production volume of hundreds or 
thousands of growers, a cooperative can aggregate its owner-members' 
small volume hedges or forward contracts. It can then offset that risk 
by entering into another customized hedge via the swap markets.

Implementation of the Dodd-Frank Act
    NCFC supports elements of the Dodd-Frank Act that bring more 
transparency and oversight to the OTC derivatives markets. We also 
recognize the complexity in crafting rules for the implementation of 
Dodd-Frank that best fit cooperatives and have had a number of 
opportunities to express our concerns to the CFTC. With the sheer 
volume of rules, the challenges in clearly understanding what is 
contained in those regulations, and the complexity of how they will fit 
together, NCFC members are now turning their attention to compliance. 
Our members are doing their best to put into place policies and 
procedures, but they are finding it a challenge to understand what 
exactly needs to be done to address the complex regulations.
    Our members also have concerns regarding how CFTC will enforce the 
regulations. Because the regulations will be very complex, we urge CFTC 
to work closely with industry to ensure clear understanding by all 
parties.
    During the rule writing process, we have worked to ensure that the 
implementation of the Dodd-Frank Act preserves risk management tools 
for farmers and their cooperatives, and have advocated for the 
following:

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

   Excluding agricultural cooperatives from the definition of a 
        swap dealer;

   Exempting agricultural cooperatives from mandatory clearing 
        or margining but allowing them to perform either at their 
        discretion; and

   Considering aggregate costs associated with the new 
        regulations and the impact on the agriculture sector.

    I am pleased to report that with the recent rulemakings, some of 
the uncertainty that created concern for farmer cooperatives over the 
past 2 years has been resolved. Most significant is the defining of 
``Swap Dealer.'' CFTC provided a definition in the final ``entities'' 
rule that will allow farmer cooperatives to provide risk management 
services to their members and customers without the fear of having to 
comply with the additional regulatory requirements intended for 
systemically important institutions. We appreciate the work of the 
Commission in addressing our concerns, which resulted in significant 
improvements in the final rule.
    While we now know farmer cooperatives will not be treated as swap 
dealers, there are still many unknowns as to how implementation of the 
rules will affect cooperatives and their farmer members. Uncertainty 
over ultimate costs remains an ongoing a concern. As you know, 
agriculture is a high-volume, low-margin industry. Incremental 
increases in costs, whether passed on from a swap dealer or imposed 
directly on a cooperative, will trickle down and impact producers. 
Taken one rule at a time, the costs may not seem unreasonable, but to 
those who have to absorb or pass on the collective costs of numerous 
regulations, it is clearly evident those costs are significant.
    For example, one ``small'' change in the proposed conforming 
amendments rule has to do with additional recording requirements. We 
are concerned this proposal would not only add swaps to the new record-
keeping requirements, but also extend the new requirements to cash 
purchase and forward cash contracts entered into by any member of a 
designated contract market. One NCFC member estimates that installation 
of record-keeping systems in all of their facilities would cost over $6 
million. In fact, the necessary investment to put in place and maintain 
such a system would not only greatly add to the cost of doing business, 
but would be an extreme compliance burden for the cash grain community 
(attached are the comments NCFC submitted to CFTC on this issue). We 
are hopeful CFTC will reconsider this requirement as it finalizes the 
rule in the coming months.
    It is also unclear how other costs will be forced down to end-users 
and impact their ability to hedge. For example, recent movements in 
grain and oilseed markets have caused a considerable amount of working 
capital to be used to cover daily margin calls. The drought affecting 
the U.S. has caused corn prices to increase over 50 percent in the last 
month. While this creates an opportunity for farmers to price more of 
their crop, (if they haven't been impacted by the drought), it also 
causes additional margin calls on the production that has been priced. 
For farmers to continue to take advantage of selling grain forward 
during price rallies, cooperatives have to either increase borrowing or 
look for alternative ways to manage such risk, such as the OTC market. 
As was the case during the volatile markets in 2008, swaps allow 
cooperatives to free up working capital and continue to forward 
contract with farmers.
    As commercial end-users, cooperatives often use swap dealers in 
utilizing the OTC market to lay off the risk of offering those forward 
contracts. However, the costs associated with dealers' compliance with 
capital, margin and other regulatory requirements are still unclear. We 
will have to wait to see how those costs are passed on to end-users and 
how cost effective the OTC market remains for hedging activities.
    Consistent with Congressional intent, NCFC supports the CFTC's 
proposed rules clarifying that it ``would not impose margin 
requirements on non-financial entities,'' and that ``parties would be 
free to set initial and variation margin requirements in their 
discretion and any thresholds agreed upon by the parties would be 
permitted.''
    However, we are concerned the so-called ``Prudential Regulators'' 
margin proposal requires bank swap dealers to collect margin from end-
users. As end-users, cooperatives use swaps to hedge interest rates, 
foreign exchange, and energy in addition to agricultural commodities. 
Often, cooperatives look to their lenders to provide those swaps. Under 
the proposed rule requiring end-users to post margin, costs to 
businesses will increase as more cash is tied up to maintain those 
hedges. The additional capital requirements will be siphoned away from 
activities and investment in cooperatives' primary business ventures. 
Furthermore, cash for margin is often borrowed from lenders through the 
use of credit lines. As a result, we could see a situation where a 
commercial end-user would have to borrow cash from its lender, and pay 
interest on it, just to give it back to the same lender to hold as 
margin. Congressional intent was clear on this point--end-users were 
not to be required to post margin. We appreciate the House of 
Representatives reaffirming this by passing the Business Risk 
Mitigation and Price Stabilization Act back in March.
    Thank you again for the opportunity to testify today before the 
Committee. We appreciate your role in ensuring that farmer cooperatives 
will continue to be able to effectively hedge commercial risk and 
support the viability of their members' farms and cooperatively owned 
facilities. I look forward to answering any questions you may have.


                               Attachment
August 8, 2011

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

RE: Adaptation of Regulations to Incorporate Swaps; Notice of Proposed 
            Rulemaking (Federal Register/Vol. 76, No. 109)

    Dear Mr. Stawick:

    On behalf of the more than two million farmers and ranchers who 
belong to farmer cooperatives, the National Council of Farmer 
Cooperatives (NCFC) submits the following comments in response to the 
Commodity Futures Trading Commission's (the Commission) request for 
comments: Adaptation of Regulations to Incorporate Swaps; Notice of 
Proposed Rulemaking, to amend the Commodity Exchange Act regulations to 
implement regulatory requirements contained in Title VII of the Dodd-
Frank Wall Street Reform and Consumer Protection Act.
    Since 1929, NCFC has been the voice of America's farmer 
cooperatives. Our members are regional and national farmer 
cooperatives, which are in turn composed of over 2,500 local farmer 
cooperatives across the country. NCFC members also include 21 state and 
regional councils of cooperatives.
    America's farmer-owned cooperatives provide a comprehensive array 
of services for their members. These diverse organizations handle, 
process and market virtually every type of agricultural commodity 
produced. They also provide farmers with access to infrastructure 
necessary to manufacture, distribute and sell a variety of farm inputs. 
For example, a cooperative may consist of a closely coordinated network 
to ensure timely and cost-efficient origination, storage, 
transportation and marketing of grain and oilseeds.

Proposed Changes to Regulation 1.35
    NCFC is concerned with this proposal because it would not only add 
swaps to the new record-keeping requirements, but also would extend the 
new record-keeping requirements to cash purchase and forward cash 
contracts entered into by any member of a designated contract market 
(DCM).
    This would require all farmer cooperatives that are members of DCMs 
(CME, KCBT, MGE, etc.), and by extension every one of their local 
facilities, to be bound by this regulation. For example, cooperatives 
that are members of DCMs have an integrated network of grain elevators 
to originate and store grain purchased from farmers. As such, the 
proposed change to 1.35(a) would require those elevators to record, 
among other things, all oral communications that lead to execution of 
cash transactions with farmers. The proposal includes (proposed 
additions in italics):

        Included among such records shall be all orders (filled, 
        unfilled, or canceled), trading cards, signature cards, street 
        books, journals, ledgers, canceled checks, copies of 
        confirmations, copies of statements of purchase and sale, and 
        all other records, which have been prepared in the course of 
        its business of dealing in commodity interests and cash 
        commodities, and all oral and written communications provided 
        or received concerning quotes, solicitations, bids, offers, 
        instructions, trading, and prices, that lead to the execution 
        of transactions in a commodity interest or cash commodity, 
        whether communicated by telephone, voicemail, facsimile, 
        instant messaging, chat rooms, electronic mail, mobile device 
        or other digital or electronic media. Each transaction record 
        shall be maintained as a separate electronic file identifiable 
        by transaction and counterparty.

    Additionally, all such recorded communications would be required to 
be maintained for 5 years.
    A requirement to record all communication leading to a cash 
purchase or cash forward contract would impose huge regulatory burdens 
and costs on cooperatives and other businesses and farmers in rural 
America. In fact, the necessary investment to put in place and maintain 
such a system would not only greatly add to the cost of doing business, 
but would be an extreme compliance burden for the cash grain community.
    The Commission states these record-keeping requirements would 
protect customers from abusive sales practices; protect registrants 
from risks associated with transactional disputes; allow registrants to 
follow up more effectively on customer complaints; and preserve 
evidence that could increase the effectiveness of the Commission's 
enforcement actions. We do not believe that requiring this additional 
information to be recorded and maintained is necessary to achieve the 
stated goals in the cash commodity markets.
    Additionally, we do not believe the intent of the Dodd-Frank Act 
was to subject cash purchases and forward cash contracts to the 
additional new record-keeping requirements proposed under regulation 
1.35. In fact, cash and forward contracts have been excluded from the 
definition of a swap in the proposed product definitions rule. 
Commission Chairman Gary Gensler has highlighted that point on several 
occasions while testifying before Congress. We believe this proposed 
regulation, as written to apply to the cash market, is in direct 
contradiction to that exclusion and to the Congressional intent of the 
Dodd-Frank Act.
    We would be pleased to discuss with the Commission our concerns 
with proposed regulation 1.35. Thank you taking our views into account 
as the Commission finalizes rules in the coming months. We appreciate 
the opportunity to provide input throughout the process of 
implementation of Title VII of the Dodd-Frank Act.
            Sincerely,

            
            
Charles F. Conner,
President & CEO.

    The Chairman. Thank you.
    Mr. McElroy, you are recognized for 5 minutes. You may 
proceed whenever you are ready.

  STATEMENT OF PAUL E. McELROY, CHIEF FINANCIAL OFFICER, JEA, 
     JACKSONVILLE, FL; ON BEHALF OF AMERICAN PUBLIC POWER 
                          ASSOCIATION

    Mr. McElroy. Chairman Lucas, Ranking Member Boswell, and 
Committee Members, thank you for the opportunity to testify 
this morning. I am Paul McElroy, Chief Financial Officer for 
JEA. JEA proudly serves more than 400,000 electric customers in 
and around Jacksonville, Florida. Our business is ensuring that 
our customers' electric demands are met reliably and 
economically today and for generations to come.
    I am testifying on behalf of the American Public Power 
Association, APPA, the national service organization 
representing over 2,000 government-owned electric utilities 
providing power to more than 46 million people. Additionally, 
my comments are supportive of the positions of the Large Public 
Power Council, which represents the 26 largest municipal 
entities in the country.
    Today I will discuss the swap-dealer rule under the Dodd-
Frank Act. APPA supports Dodd-Frank and continues to work with 
the CFTC and others to improve its implementation. Chairman 
Gensler mentioned our involvement earlier today. However, we 
remain concerned that the CFTC's swap-dealer rule, which took 
effect Monday, will hinder our members' ability to hedge 
commercial price and operational risks.
    We have a long and successful history of hedging commercial 
risk for the benefit of our customers, often utilizing swaps of 
physical commodities such as natural gas, electric capacity and 
energy, and coal, all of which are needed for our commercial 
operations. This is not different than swap activity used in 
the operations-related hedging activity of any other electric 
utility. At issue are the de minimis thresholds set by the CFTC 
to determine whether a swap participant is a swap dealer. Under 
the rule, a swap participant will be considered a swap dealer 
if it engages in more than $3 billion in swap dealing but just 
$25 million if dealing with special entities. Special entities 
are governmental entities including government-owned utilities 
such as APPA's members. The CFTC says it imposed the $25 
million threshold in light of the protections that Dodd-Frank 
provides for special entities. However, Dodd-Frank never 
mentions forcing a non-financial participant into the swap-
dealer regime for entering into swaps with a special entity.
    Our concern is that non-financial entities on whom we rely 
for hedging such as natural gas producers, independent 
generators and investor-owned utility companies will stop 
dealing with us to avoid the $25 million threshold because but 
for those dealings with us, they would not be pulled into the 
Dodd-Frank swap-dealer regime. We are also concerned that large 
financial firms, ones which will be considered swap dealers in 
any case, will not fill this gap. Electric power is regionally 
diverse in both supply and demand. Because of this diversity, 
there are often limited counterparties for operations-related 
swaps. Large financial institutions may neither have the 
ability nor the desire to provide such highly customized, 
localized transactions.
    The loss of non-financial swap partners will put us at a 
disadvantage to other utilities in our ability to effectively 
manage power supply costs and operations for our customers. 
Each swap counterparty in the market brings important market 
liquidity and diversity. If non-financial parties refuse to 
enter into swaps with us, price competition will be reduced, 
operational risk will increase, and our ratepayers will be 
hurt. This will affect all APPA members and so APPA and other 
government-owned utility groups have petitioned the CFTC to 
amend the swap-dealer rule.
    Our proposed amendment would not, and I will repeat, would 
not remove the overall swap-dealer threshold nor the sub-
threshold. It simply asks that our operations-related swaps not 
count toward the special-entities sub-threshold. Local- and 
state-owned utilities have experience and expertise to 
understand the operations-related swaps transactions they use 
to manage their commercial risk and do not need the special 
protections intended by the $25 million sub-threshold. In fact, 
and ironically, these protections will likely expose us and our 
customers to greater risk.
    Thank you for this opportunity again to testify.
    [The prepared statement of Mr. McElroy follows:]

 Prepared Statement of Paul E. McElroy, Chief Financial Officer, JEA, 
    Jacksonville, FL; on Behalf of American Public Power Association

    Mr. Chairman and Members of the Committee, I am Paul McElroy, Chief 
Financial Officer for JEA testifying today on behalf of the American 
Public Power Association (APPA). APPA is the national service 
organization representing the interests of over 2,000 municipal and 
other state- and locally-owned, not-for-profit electric utilities 
throughout the United States (all but Hawaii). Collectively, public 
power utilities deliver electricity to one of every seven electricity 
customers in the United States (approximately 46 million people), 
serving some of the nation's largest cities. However, the vast majority 
of APPA's members serve communities with populations of 10,000 people 
or less.
    JEA is a member of APPA. We are located in Jacksonville, Florida, 
and proudly serve an estimated 420,000 electric, 305,000 water, and 
230,000 sewer customers in Northeast Florida. JEA was created by the 
City of Jacksonville to serve those who live there and in the 
surrounding communities. The sole purpose of our business is to ensure 
that the electric, water and sewer demands of our customers are met, 
both today and for generations to come. Our goal is to provide reliable 
services at a good value to our customers while ensuring that our 
areas' precious natural resources are protected.

Public Power Utilities and Implementation of the Dodd-Frank Act
    APPA supports the goals of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act (Dodd-Frank Act) and has worked closely with 
the Commodity Futures Trading Commission (CFTC) and other interested 
parties hoping to improve its implementation, particularly related to 
regulations affecting ``end-users'' of energy such as JEA and other 
APPA members. Even today, now 2 years after enactment, the full effect 
of the Dodd-Frank Act on public power utilities is unclear as 
regulations implementing the statute continue to be promulgated. We 
strongly support the CFTC's efforts to issue these regulations in a 
timely fashion while also accommodating a necessary discussion among 
stakeholders to fully vet these rules for unintended or adverse 
consequences.
    One such instance is the final swap-dealer rule,\1\ which took 
effect on July 23, 2012. As written, the rule will substantially hinder 
public power and public gas utilities' ability to hedge against 
operational risks. Just like JEA, these utilities have no shareholders, 
so the costs imposed by this regulatory decision will be borne by only 
one group: our ratepayers.
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    \1\ CFTC Regulation 1.3(ggg)(4); see 77 Fed. Reg. 30596, at 30744.
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    As you know, the Dodd-Frank Act requires swap dealers and major 
swap participants to register with the CFTC and meet capital, margin, 
and reporting and record-keeping requirements, as well as to comply 
with rigorous business conduct and documentation standards. The Dodd-
Frank Act provides additional standards for swap dealers or major swap 
participants advising or entering into swaps with government-owned 
utilities and other government entities (referred to under the statute 
as ``special entities''). For swap dealers advising or seeking to 
advise a special entity, the law states that it is ``unlawful'' to 
defraud that special entity.\2\ For swap dealers or major swap 
participants entering into swaps with special entities, the law states 
that these dealers and swap participants must comply with rules set by 
the CFTC requiring special entities to have an independent 
representative before trading with a swap dealer or major swap 
participant.\3\
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    \2\ 7 USCA  6s(h)(4).
    \3\ 7 USCA  6s(h)(5).
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    In December 2010, the CFTC (jointly with the Securities and 
Exchange Commission) issued a proposed rule to define the term ``swap 
dealer,'' including (as required by the Dodd-Frank Act) \4\ an 
exemption from the swap-dealer designation for those entities that 
engage in a de minimis quantity of swap dealing.
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    \4\ 7 USCA  1a(49)(D).
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    In the proposed rule, CFTC proposed two separate de minimis 
thresholds relating to the dollar quantity of swaps: $100 million 
annually for an entity's total swap-dealing activity; and, $25 million 
annually for an entity's swap-dealing activity with special entities, 
including, as noted above, public power, public gas, and Federal 
utilities (government-owned utilities).
    In February, 2011, the Not-For-Profit Electric End User Group (NFP 
EEU)--which includes APPA-filed comments on the proposed swap dealer 
rule. The comments recommended that the CFTC substantially increase the 
de minimis thresholds both for total swaps and for swaps with special 
entities.
    A final rule was approved by the CFTC on April 18, 2012, and was 
published in the Federal Register on May 23, 2012. The final rule 
greatly increased the overall de minimis threshold from the proposed 
rule, raising it from $100 million to $3 billion. During an initial 
phase-in period, this threshold will be $8 billion. But, the final rule 
did not change the proposed rule's $25 million sub threshold for swap-
dealing activities with special entities. Thus, the disparity between 
the two thresholds is now substantially greater. This $25 million sub-
threshold is smaller still when you consider that it is the aggregate 
of a swap partner's transactions with all special entities during any 
12 month period.\5\
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    \5\ By way of reference a single, 1 year 100 MW swap could have a 
roughly $25 million notional value. One-hundred MWs of power is enough 
to serve the average demand of approximately 75,000 residential 
customers.
---------------------------------------------------------------------------
    As a result, non-financial entities (such as natural gas producers, 
independent generators, and investor-owned utility companies) that do 
not want to be swap dealers will severely limit their swap-dealing 
activities with government-owned utilities to avoid exceeding the $25 
million threshold.

Why Hedging Is Necessary
    Government-owned utilities depend on nonfinancial commodity 
transactions, trade options and ``swaps,'' as well as the futures 
markets, to hedge commercial risks that arise from their utility 
facilities, operations and public service obligations. Together, 
nonfinancial commodity markets play a central role in the ability of 
government-owned utilities to secure electric energy, fuel for 
generation, and natural gas supplies for delivery to consumers at 
reasonable and stable prices. Specifically, many government-owned 
utilities purchase firm electric energy, fuel and gas supplies in the 
physical delivery markets (in the ``cash'' or ``spot'' or ``forward'' 
markets) at prevailing and fluctuating market prices, and enter into 
bilateral, financially-settled nonfinancial commodity swaps with 
customized terms to hedge the unique operational risks to which many 
government-owned utilities are subject.
    In hedging, mitigating or managing the commercial risks of their 
utility facilities' operations or public service obligations, 
government-owned utilities are engaged in commercial risk management 
activities that are no different from the operations-related hedging of 
an investor-owned utility or an electric cooperative located in the 
same geographic region.

Why Nonfinancial Counterparties Are Necessary
    Electric power touches virtually every home and business in the 
United States. This near universality gives a false appearance of 
homogeneity. It is important to remember that what is being delivered 
is a physical commodity, e.g., electricity, coal, or natural gas. 
Ownership of a stock can be transferred coast to coast with a click of 
a button, but electricity must be delivered to the place it is to be 
used.
    Each regional geographic market has a somewhat different set of 
demands driven by climate, weather, population, and the like. Each 
regional geographic market also has a somewhat different group of 
financial entity counterparties and nonfinancial entity counterparties 
available to meet these demands and thus able to enter into customized 
utility operations-related swaps needed for hedging price and supply 
risks. For example, a large merchant electric generation station in 
western Alabama might be available as a nonfinancial counterparty for a 
swap transaction to provide electricity to a specific site in Alabama. 
But that same entity would not necessarily be able to offer the 
electricity in Oregon, and so would not be able to help an Oregon-based 
utility hedge its risks.
    Because there are a limited number of counterparties for any 
particular operations-related swap sought by a utility, each financial 
or nonfinancial swap counterparty brings important market liquidity and 
diversity. The greater the number of counterparties, the greater the 
price competition. Conversely, reduced price competition necessarily 
increases prices.
JEA and the Special Entity Sub Threshold
    I would like to illustrate these points with examples from my JEA's 
perspective.
    As discussed above, the primary mission of JEA's electric system is 
to provide reliable and low cost electricity to our customers. I will 
say that again. While ensuring sufficient supply to serve our customers 
is primary, running a very close second is managing commodity fuel and 
purchased power costs. We accomplish this by efficiently and cost-
effectively managing supply and price risks inherent in the procurement 
of fuel and power.
    Take, for example, a capacity and energy swap between JEA and 
another municipal utility. This swap is intended to diversify our 
electric generation capability. By way of background, JEA has a large 
commitment solid fuel, while our swap partner in this example has a 
significant commitment to natural gas. And, history has taught us the 
importance of diversification time and time again.
    This swap would be governed by Dodd-Frank: it would qualify for the 
end-user exception so would not have to be cleared, but one of the 
parties would have to report the transaction. However, the notional 
amount of the swap would exceed $25 million, and, if it were considered 
``dealing'' activity under the rules' facts and circumstances 
guidelines, would invoke the sub-threshold provision.
    This leaves us with the options of (1) having one party register as 
a dealer, (2) placing a registered dealer between the parties, or (3) 
affecting a physical exchange instead of a swap.\6\ All of these 
solutions add complexity and cost, do nothing to reduce systemic 
financial risk, and will cause the transaction to be abandoned. That 
said, the same transaction, were it not to involve special entities, 
would impose none of the added cost and complexity. This seems neither 
appropriate, nor fair.
---------------------------------------------------------------------------
    \6\ A physical exchange would be structured as two separate 
purchase power agreements, incorporating the costs of transmission and 
ancillary services.
---------------------------------------------------------------------------
    Likewise, JEA seeks to maximize flexibility regarding terms and 
conditions governing supply and price in all long-term fuel and 
purchased power contracts. This gives us the flexibility to efficiently 
and cost-effectively manage supply and price risks in fuel and power 
procurement. However, we have been told by several non-financial energy 
suppliers who currently serve as swap partners, none of whom are 
currently dealers, that they are looking closely at the ``special 
entity sub-threshold'' to determine the terms and conditions they may 
be willing to extend to us in the future.
    When a major fuel supplier says they are ``reevaluating'' 
contractual terms and conditions, it almost certainly means that the 
level of flexibility we currently enjoy will be curtailed or eliminated 
and our costs and risk profile will increase. Again, however, this 
supplier can continue to extend to utilities that are not special 
entities contracts under the existing terms. And again, this seems 
neither appropriate, nor fair.
    These are just two examples of how the sub threshold will affect 
JEA. As noted above there is a great deal of heterogeneity among APPA 
members, including in the use of hedging. Some make substantial use of 
hedging: others do not. Likewise, of APPA members who do make use of 
hedging, a recent informal survey of members showed great diversity in 
terms of the volume of hedging and the extent to which members relied 
on non-financial entities.
    However, the rules could still affect all of our members. Members 
currently hedging will be affected, but so will smaller members who buy 
power from larger members who do. For example, while a small municipal 
electric distribution utility \7\ in Oklahoma might not hedge its 
risks, it may buy its power from a larger public power provider--such 
as the Oklahoma Municipal Power Authority--which does. Also, those who 
do not currently hedge will be restricted in their ability to do so in 
the future.
---------------------------------------------------------------------------
    \7\ An electric distribution utility is one which solely 
distributes electricity, as distinguished from one which generates and 
distributes electricity.
---------------------------------------------------------------------------
    The CFTC has said that it retained the $25 million threshold in 
light of the special protections that the Dodd-Frank Act affords to 
special entities. However, the statute does not require--even mention--
special protections for special entities in regard to the swap dealer 
definition. As noted above, the law imposes requirements on swap 
dealers and major participants advising or entering into swaps with 
special entities. Nowhere does the law mention deeming a participant to 
be a swap dealer solely because they happen to be entering into swaps 
with a government-owned utility.
    APPA thinks the distinction in the law is appropriate. Government-
owned utilities understand the operations-related swap transactions 
they use to manage their commercial risks and do not need the special 
protections provided by the $25 million sub-threshold. In fact, and 
ironically, these ``protections'' are likely to limit the ability of 
these utilities to hedge operational and price risks rather than to 
protect these utilities and their customers from risk.

Government-Owned Utilities' Petition for Rulemaking
    On July 12, 2012, APPA, the Large Public Power Council (LPPC), the 
American Public Gas Association (APGA), the Transmission Access Policy 
Study Group (TAPS), and the Bonneville Power Administration (BPA), 
filed with the CFTC a ``Petition for Rulemaking to Amend CFTC 
Regulation 1.3(ggg)(4).'' The petition (see the attachment to this 
testimony) requests that the CFTC amend its swap-dealer rule to exclude 
utility special entities' operations-related swap transactions from 
counting towards the special-entity threshold. This amendment to the 
swap-dealer rule would allow producers, utility companies, and other 
non-financial entities to enter into energy swaps with government-owned 
utilities without danger of being required to register as a ``swap 
dealer'' solely because of their dealings with government-owned 
utilities.
    Specifically, the petition asks for a narrow exclusion:

   A government-owned utility's swaps related to utility 
        operations would not count towards the special entity de 
        minimis threshold, but would count towards the total de minimis 
        threshold.

   Utility operations-related swaps are those entered into to 
        hedge commercial risks intrinsically related to the utility's 
        electric or natural gas facilities or operations or to the 
        utility's supply of natural gas or electricity to other special 
        entities. For example, these would include swap transactions 
        related to the generation, production, purchase or sale, or the 
        transportation of electric energy or natural gas, or related to 
        fuel supply of electric generating facilities.

   Utility operations-related swaps do not include interest 
        rate swaps. Those swaps would remain subject to the $25 million 
        special entity sub-threshold.

    We urge Committee Members to support this petition.

Conclusion
    In conclusion, the protections the CFTC is trying to afford through 
the $25 million special entity sub-threshold were not contemplated by 
the Dodd-Frank Act and are not needed for government-owned utility 
swaps related to utility operations. Government-owned utilities are 
well-versed in the markets in which they are hedging their risks and 
rely on these swaps solely to manage price and operational risks. More 
importantly, the assumption that financial firms will be able to 
replace all the swaps offered currently by our nonfinancial swap 
partners reflects a dangerous misunderstanding of how electricity is 
delivered and an indifference to the price Wall Street will impose in 
the absence of adequate competition and to the risk to supply if that 
price cannot be afforded. In sum, a failure to allow the narrow 
exclusion sought in our petition will limit our members' ability to 
hedge against risks and lead to increased risk and costs to the 
millions of ratepayers they serve.
    Thank you again for this opportunity to testify, and I would be 
more than happy to answer any questions you might have.
                               Attachment
July 12, 2012

David Stawick,
Office of the Secretariat,
Commodity Futures Trading Commission,
Washington, D.C.

Re: Petition for Rulemaking to Amend CFTC Regulation 1.3(ggg)(4)

    Dear Mr. Stawick:

    The American Public Power Association (``APPA''), the Large Public 
Power Council (``LPPC''), the American Public Gas Association 
(``APGA''), the Transmission Access Policy Study Group (``TAPS'') and 
the Bonneville Power Administration (``BPA'') (collectively, the 
``Petitioners'') respectfully petition the Commodity Futures Trading 
Commission (the ``Commission'' or the ``CFTC'') under CFTC Regulation 
13.2 to amend CFTC Regulation 1.3(ggg)(4),\8\ which implements the de 
minimis exception to the definition of ``swap dealer.'' The Petitioners 
specifically request that the rule amendment exclude from the ``special 
entity sub-threshold,'' which appears in Regulation 1.3(ggg)(4)(i), 
``Utility Operations-Related Swaps'' to which the Petitioners and other 
``Utility Special Entities'' are, or may in the future be, 
counterparties. The definitions of ``Utility Operations-Related Swap'' 
and ``Utility Special Entity'' are included directly in the text of the 
proposed rule amendment, and narrowly circumscribe the scope of the 
proposed rule amendment.
---------------------------------------------------------------------------
    \8\ 77 Fed. Reg. 30596, at 30744.
---------------------------------------------------------------------------
    Such a rule amendment is permitted by Section 1a(49)(D) of the 
Commodity Exchange Act (``CEA'') as amended by the Dodd-Frank Wall 
Street Reform and Consumer Protection Act of 2010 (the ``Dodd-Frank 
Act''),\9\ and is specifically contemplated by CFTC Regulation 
1.3(ggg)(4)(v).\10\ The rule amendment is necessary in order to 
preserve uninterrupted and cost-effective access to the customized, 
nonfinancial commodity swaps that Petitioners and other Utility Special 
Entities use to hedge or mitigate commercial risks arising from their 
utility facilities, operations and public service obligations.
---------------------------------------------------------------------------
    \9\ Pub. L. No. 111-203, 124 Stat. 1376 (2010).
    \10\ 77 Fed. Reg. 30744-30745.
---------------------------------------------------------------------------
    The information required by CFTC Regulation 13.2 follows:

I. The Text Of The Proposed Rule Amendment (Additional language is 
        underlined and italicized)

  PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
          * * * * * * *
  Section 1.3  Definitions.
          * * * * * * *
        (ggg) Swap Dealer.
          * * * * * * *
                  (4) De minimis exception. (i) Except as provided in 
                paragraph (ggg)(4)(vi) of this section, a person that 
                is not currently registered as a swap dealer shall be 
                deemed not to be a swap dealer as a result of its swap 
                dealing activity involving counterparties, so long as 
                the swap positions connected with those dealing 
                activities into which the person--or any other entity 
                controlling, controlled by or under common control with 
                the person--enters over the course of the immediately 
                preceding 12 months (or following the effective date of 
                final rules implementing Section 1a(47) of the Act, 7 
                U.S.C. 1a(47), if that period is less than 12 months) 
                have an aggregate gross notional amount of no more than 
                $3 billion, subject to a phase in level of an aggregate 
                gross notional amount of no more than $8 billion 
                applied in accordance with paragraph (ggg)(4)(ii) of 
                this section, and an aggregate gross notional amount of 
                no more than $25 million (the ``special entity sub-
                threshold'' with regard to swaps in which the 
                counterparty is a ``special entity'' (as that term is 
                defined in Section 4s(h)(2)(C) of the Act, 7 U.S.C. 
                6s(h)(2)(C), and  23.401(c) of this chapter); provided 
                that such $25 million special entity sub-threshold 
                shall not apply with regard to ``utility operations 
                related swaps'' to which the counterparty is a 
                ``utility special entity.'' For purposes of this 
                paragraph, (A) a ``utility special entity'' means a 
                government ``special entity'' (as described in clause 
                (i) or (ii) of Section 4s(h)(2)(C) of the Act or in 
                clause (1) or (2) of  23.401(c) of this chapter) that 
                owns or operates electric or natural gas facilities or 
                electric or natural gas operations (or anticipated 
                facilities or operations), supplies natural gas and/or 
                electric energy to other utility special entities, has 
                public service obligations (or anticipated public 
                service obligations) under Federal, state or local law 
                or regulation to deliver electric energy and/or natural 
                gas service to utility customers, or is a Federal power 
                marketing agency as defined in Section 3 of the Federal 
                Power Act (16 U.S.C. 796(19)), and (B) a ``utility 
                operations-related swap'' shall mean any swap that a 
                utility special entity enters into ``to hedge or 
                mitigate commercial risks'' (as such phrase is used in 
                Section 2(h)(7)(A)(ii) of the Act) intrinsically 
                related to the electric or natural gas facilities that 
                the utility special entity owns or operates or its 
                electric or natural gas operations (or anticipated 
                facilities or operations), or to the utility special 
                entity's supply of natural gas and/or electric energy 
                to other utility special entities or to its public 
                service obligations (or anticipated public service 
                obligations) to deliver electric energy or natural gas 
                service to utility customers. For the avoidance of 
                doubt, ``intrinsically related'' shall include all 
                transactions related to (i) the generation or 
                production, purchase or sale, and transmission or 
                transportation of electric energy or natural gas, or 
                the supply of natural gas and/or electric energy to 
                other utility special entities, or delivery of electric 
                energy or natural gas service to utility customers, 
                (ii) all fuel supply for the utility special entity's 
                electric facilities or operations, (iii) compliance 
                with electric system reliability obligations applicable 
                to the utility special entity, its electric facilities 
                or oper-
                ations, (iv) compliance with energy, energy efficiency, 
                conservation or renewable energy or environmental 
                statutes, regulations or government orders applicable 
                to the utility special entity, its facilities or 
                operations, or (v) any other electric or natural gas 
                utility operations-related swap to which the utility 
                special entity is a party. Utility operations-related 
                swaps shall not include a swap based or derived on, or 
                referencing, commodities in the interest rates, credit, 
                equity or currency asset classes, or a product type or 
                category in the ``other commodity'' asset class that is 
                based or derived on, or referencing, metals, or 
                agricultural commodities or crude oil or gasoline 
                commodities of any grade not used as fuel for electric 
                generation. For purposes of this paragraph, if the 
                stated notional amount of a swap is leveraged or 
                enhanced by the structure of the swap, the calculation 
                shall be based on the effective notional amount of the 
                swap rather than on the stated notional amount.

II. The Petitioners
    APPA is the national association that represents the interests of 
approximately 2000 government-owned electric utilities in the United 
States. APPA's member utilities are not-for-profit utility systems that 
were created by state or local governments to serve the public 
interest. Government-owned electric utilities provide over 15% of all 
KWh sales to retail electric customers.
    LPPC is an organization representing 26 of the largest government-
owned electric utilities in the nation. LPPC members own and operate 
over 86,000 megawatts of generation capacity and nearly 35,000 circuit 
miles of high voltage transmission lines, representing nearly 90% of 
the transmission investment owned by non-Federal Government-owned 
electric utilities in the United States.
    TAPS is an association of transmission dependent electric utilities 
located in more than 30 states. All of TAPS member electric utilities 
except one are government-owned electric utilities.
    APGA is the national association that represents government-owned 
natural gas distribution systems. There are approximately 1,000 public 
gas systems in 36 states and over 720 of these systems are APGA 
members. Government-owned natural gas distribution systems are not-for-
profit entities owned by, and accountable to, the citizens they serve. 
They include municipal gas distribution systems, public utility 
districts, county districts, and other government agencies that have 
natural gas distribution facilities.
    Some government-owned utilities are both electric utilities and 
natural gas distribution utilities, and are therefore members of both 
APPA and APGA. The purpose of a government-owned electric utility or 
natural gas distribution system is to provide reliable, safe and 
affordable electric energy and/or natural gas service to the community 
it serves.
    BPA is a self-financed, nonprofit Federal agency created in 1937 by 
Congress that primarily markets electric power from 31 federally owned 
and operated projects, and supplies over \1/3\ of the electricity used 
in the Pacific Northwest. BPA also owns and operates approximately 75 
percent of the high-voltage transmission in the Pacific Northwest. 
BPA's primary statutory responsibility is to market its Federal system 
power at cost-based rates to its ``preference customers.'' \11\ BPA 
also funds one of the largest wildlife protection and restoration 
programs in the world.
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    \11\ BPA has 130 preference customers made up of electric utilities 
which are not subject to the jurisdiction of the Federal Energy 
Regulatory Commission (``FERC''), including Indian tribes, electric 
cooperatives, state and municipally chartered electric utilities, and 
other Federal agencies located in the Pacific Northwest.
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III. Nature of the Petitioners' Interest
    APPA, LPPC, TAPS and APGA represent thousands of government-owned 
electric and natural gas utilities throughout the United States, all of 
which are ``special entities'' as that term is defined in Section 
4s(h)(2)(C) of the Commodity Exchange Act, as amended by the Dodd-Frank 
Act, and  23.401(c) of the Commission's regulations. BPA and the other 
Federal power agencies are ``special entities'' as well.\12\ The 
Petitioners respectfully seek the rule amendment for the benefit of all 
``Utility Special Entities'' that currently, or may in the future, 
enter into Utility Operations-Related Swaps with counterparties that 
are not registered with the Commission as ``swap dealers.''
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    \12\ According to the Energy Information Administration, there are 
nine Federal electric utilities in the United States, which are part of 
several agencies of the United States Government (see, http://
www.eia.gov/cneaf/electricity/page/prim2/toc2.html): the Army Corps of 
Engineers; the Bureau of Indian Affairs and the Bureau of Reclamation 
in the Department of the Interior, the International Boundary and Water 
Commission in the Department of State, the Power Marketing 
Administrations in the Department of Energy (BPA, Western Area Power 
Administration, Southwestern Area Power Administration, and 
Southeastern Area Power Administration), and the Tennessee Valley 
Authority (TVA).
    In addition, three Federal agencies operate electric generating 
facilities: TVA, the largest Federal power producer; the U.S. Army 
Corps of Engineers; and the U.S. Bureau of Reclamation.
---------------------------------------------------------------------------
    ``Utility Special Entities,'' as defined in the proposed rule 
amendment, are a narrow category of special entities distinguishable by 
their electric energy and/or natural gas utility facilities, operations 
and public service obligations. None of the Utility Special Entities is 
a ``financial entity;'' all are nonfinancial entities and ``commercial 
end-users'' as such term is used by Congress and regulatory policy 
makers. ``Utility Operations-Related Swaps,'' as defined in the 
proposed rule amendment, are a narrow category of ``swaps'' \13\ in the 
nonfinancial or ``other commodity'' asset class. Such swaps are, by 
definition, of product types intrinsically related to the commercial 
risks associated with utility facilities, operations and public service 
obligations, and are used to hedge or mitigate such commercial risks. 
Such customized nonfinancial commodity swaps are typically not 
available on exchanges or electronic trading platforms, due to the 
myriad non-numeric operational conditions, requirements and 
permutations embedded in such swaps.
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    \13\ This term has not yet been defined by the Commission to the 
extent required to provide regulatory clarity to Petitioners and others 
in the utility industry. The Petitioners and others in the utility 
industry await publication in the Federal Register of rules further 
defining ``swap,'' along with the Commission's response to public 
comments on any further questions asked by the Commission in the most 
recent statutory interpretations relevant to the definition of 
``swap,'' the Commission's response to comments solicited on the 
nonfinancial commodity ``trade option'' Interim Final Rule, the CFTC/
FERC jurisdictional Memoranda of Understanding called for by Section 
720 of the Dodd-Frank Act, the ``tariffed transaction exemption(s)'' 
and ``between FPA 201(f) transaction exemption'' called for in new CEA 
Sections 4(c)(6), and other final rules, interpretations and 
exemptions. See the comment letter filed by the Electric Trade 
Associations in the ``Product Definitions'' or ``Definition of ``Swap'' 
docket at: http://comments.cftc.gov/PublicComments/
ViewComment.aspx?id=47934&SearchText=Wasson, and other comment letters, 
applications and petitions filed by the Petitioners and others in the 
utility industry.
    There is no need to wait to consider the proposed rule amendment 
for the effective date of the Commission's final rules further defining 
the term ``swap.'' The proposed rule amendment, as drafted, will only 
be applicable to those utility operations-related transactions which 
are ultimately subject to the Commission's jurisdiction as ``swaps,'' 
and would therefore be considered part of an entity's ``swap dealing 
activity,'' and counted against either the general de minimis threshold 
or the special entity sub-threshold. In this manner, the proposed rule 
amendment is similar to all the Commission's regulations that include 
the term ``swap,'' including the Entity Definition rules themselves. 
None of these regulations can be fully understood or applied to 
Petitioners' and other market participants' businesses until the 
Commission's final rules further defining ``swap'' and other 
foundational terms that include the term ``swap'' are effective for 
relevant asset classes and product types.
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    The Petitioners commented on the Commission's proposed rules 
further defining ``swap dealer'' raising concerns that both the general 
de minimis threshold and the ``special entity sub-threshold'' needed to 
be raised significantly. See comments filed by NFP Electric End User 
Coalition, including APPA and LPPC with assistance from TAPS, in the 
Commission's ``Entity Definitions'' docket, a link to which appears at: 
http://comments.cftc.gov/PublicComments/ViewComment.aspx?id=27917&
SearchText=rural at 18-19, supporting the comments filed by the Edison 
Electric Institute and the Electric Power Supply Association in the 
same docket requesting significantly higher thresholds for both the 
general de minimis threshold and the special entity sub-threshold than 
were proposed by the Commission, a link to which appears at: http://
comments.cftc.gov/PublicComments/ViewComment.aspx?id=
27918&SearchText=.
    The Commission acknowledges the Petitioners' comments in numerous 
places in the Adopting Release for the Entity Definitions rules (the 
``Adopting Release''). See, for example, 77 Fed. Reg. 30627 and 30707. 
In the final rules, however, the Commission raised the general de 
minimis threshold by a factor of 80 during the phase in period (and by 
a factor of 30 thereafter)--from $100 million to $8 billion during the 
phase in period (and $3 billion thereafter). In contrast, the 
Commission left the special entity sub-threshold unchanged at $25 
million. The Petitioners' concern about the competitive disadvantage 
represented by the discrepancy between the two thresholds in the final 
rules is the reason for this Petition.

A. Utility Special Entities Require Customized Utility Operations-
        Related Swaps.
    Utility Special Entities depend on nonfinancial commodity 
transactions, trade options and ``swaps,'' as well as the futures 
markets, to hedge commercial risks that arise from their utility 
facilities, operations and public service obligations. Together, these 
nonfinancial commodity markets play a central role in government-owned 
utilities securing electric energy, fuel for generation and natural gas 
supplies for delivery to consumers at reasonable and stable prices. 
Specifically, many government-owned utilities purchase firm electric 
energy, fuel and gas supplies in the physical delivery markets (in the 
``cash'' or ``spot'' or ``forward'' markets) at prevailing and 
fluctuating market prices, and enter into bilateral, financially-
settled nonfinancial commodity swaps with customized terms to hedge the 
unique operational risks to which each Utility Special Entity is 
subject.
    The Utility Special Entities use Utility Operations-Related Swaps 
to ensure reliability of utility service and to reduce utility 
customers' exposure to future commodity price fluctuations and to 
stabilize utility rates. In hedging, mitigating or managing the 
commercial risks of its utility facilities operations or public service 
obligations, the Utility Special Entity are engaged in commercial risk 
management activities that are no different from the operations-related 
hedging of an investor-owned utility or an electric cooperative located 
in the same geographic region.

B. The ``Market'' for Each Particular Utility Operations-Related Swap 
        is Illiquid.
    Utility Special Entities enter into these bilateral customized 
swaps in illiquid regional or local ``markets.'' \14\ Some 
counterparties available to transact with Utility Special Entities will 
be major financial institutions or other financial entities, such as 
hedge funds, that may or may not transact in other swap asset classes 
or product types. Other available counterparties will be nonfinancial 
counterparties, those which are not ``financial entities'' as such term 
is defined in CEA Section 2(h)(7)(C).
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    \14\ The word ``markets'' is used in quotations in this context, as 
Utility Operations-Related Swaps do not occur with anywhere near the 
frequency or uniformity that financial ``swaps'' occur, or that 
agricultural, metals, global oil or other product types of ``swaps'' in 
the ``other commodity'' asset class occur. Utility Operations-Related 
Swaps are, in some cases, negotiated over a period of days, weeks or 
months. Some may be documented based on a master agreement template, 
with many pages of specialized operational, credit and other risk 
management provisions included by the bilateral counterparties as 
schedules. Transacting under standardized master agreement templates 
(with bilaterally negotiated schedules and transaction documents) 
should not be confused with a conclusion or an assumption that there is 
a trading ``market'' for Utility Operations-Related Swaps having, 
standardized or ``market'' terms.
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    Each Utility Special Entity actively seeks out available swap 
counterparties in order to hedge its unique, ongoing and dynamically-
changing commercial risks.\15\ Commercial risk management policies in 
the energy industry typically require diversification of suppliers and 
swap counterparties, limited concentration of supplier/vendor/
counterparty credit risk, and other commercial risk management metrics 
to prudently manage the commercial risks of bilateral contracting 
processes.
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    \15\ Utility Special Entities may also be called upon from time to 
time by other utilities located in the same geographic region, by or in 
coordination with electric reliability organizations, to act as 
counterparties in Utility Operations-Related Swaps for electric system 
reliability purposes. Such swaps should not be considered ``swap 
dealing activity'' by the utility counterparty or counterparties to 
such swaps. Otherwise, the Utility Special Entities may not be able to 
participate in such swaps for reliability purposes without causing the 
counterparty to exceed the Special Entity Sub-Threshold, which may 
compromise the reliability of the interconnected electric system.
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    Each regional geographic market has a somewhat different group of 
financial entity and nonfinancial counterparties available to enter 
into customized Utility Operations-Related Swaps. An available 
counterparty may own or operate commercial businesses related to the 
particular nonfinancial commodity that underlies the Utility 
Operations-Related Swap. It may be a neighboring utility or electric 
cooperative, the owner of a merchant electric generation facility 
located in the area, or a natural gas or coal company with production 
assets in the region.
    For example, a large natural gas utility or the owner of a large 
merchant electric generation station in western Alabama might be 
available as a nonfinancial counterparty for swaps referencing an 
Alabama delivery point. But that same entity would not necessarily 
offer the type of customized Utility Operations-Related Swap required 
by a Utility Special Entity located in Oregon. Or, a natural gas 
producer or coal producer with production assets in Wyoming might offer 
Utility Operations-Related Swaps required by a California-based or 
Oregon-based Utility Special Entity. But the same counterparty would 
not necessarily enter into a similar Utility Operations-Related Swap 
referencing a nonfinancial commodity delivered in the Southeast. Nor 
would it necessarily offer a Utility Operations-Related Swap 
referencing electric energy in any regional market.

C. Utility Special Entities Need All Available Utility Operations-
        Related Swap Counterparties.
    Due to the limited number of counterparties for any particular 
Utility Operations-Related Swap in any particular region, each 
available financial or nonfinancial swap counterparty, whether or not a 
registered ``swap dealer,'' brings important market liquidity or 
supplier/counterparty diversity for a Utility Special Entity. Multiple 
available counterparties create price competition for the customized 
swaps that a Utility Special Entity requires to cost-effectively hedge 
or mitigate unique commercial risks.\16\
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    \16\ In the Adopting Release, the Commission cites comments made by 
Petitioners' representatives and other energy industry market 
participants at the Commission Roundtable and meetings on these 
important points. See 77 Fed. Reg. at 30707-30708. Although a Utility 
Special Entity may be able to seek out a CFTC-registered Wall Street 
``swap dealer'' or another financial entity, such as a hedge fund, to 
provide such a customized Utility Operations-Related Swap, if the 
``swap dealer'' does not have assets in the region or is not otherwise 
active in the particular regional nonfinancial commodity swap market, 
the pricing and customization of the Utility Operations-Related Swap it 
offers are unlikely to be competitive.
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    Based on an informal survey of some of the larger Utility Special 
Entities, a substantial percentage of the counterparties that are 
currently available to enter into Utility Operations-Related Swaps with 
such Utility Special Entities are nonfinancial entities engaged in the 
electric, natural gas, coal or another aspect of the energy industry in 
the same geographic area as the specific Utility Special Entity.
    Wall Street financial institutions and other financial entities 
tend to offer such swaps only where there is standardization of 
transaction terms and liquid trading markets: at trading hubs where the 
financial entity's swaps can be promptly and effectively hedged to 
maintain a ``balanced book.'' Nonfinancial entities with assets or 
operations located in the geographic region may, as a result, face 
parallel commercial risks and can use the Utility Operations-Related 
Swap to manage some portion or aspect of the commercial risks inherent 
in its own physical assets, liabilities and commercial obligations.\17\
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    \17\ The nonfinancial counterparty may itself be entering into a 
Utility Operations-Related Swap ``for the purpose of hedging physical 
positions,'' as that phrase appears in CFTC Regulation 1.3(ggg)(6)(iii) 
and about which the Commission is seeking further comment in the 
Adopting Release. That regulation is identified as an ``interim final 
rule,'' and therefore presumably is still subject to further Commission 
rulemaking before the rules defining ``swap dealer'' are, indeed, 
final. See 77 Fed. Reg. 30612. See also footnote 6 with reference to 
the Commission's anticipated further rulemakings on the definition of 
``swap'' and nonfinancial commodity ``trade options.''
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    Because the Utility Special Entity is hedging a commercial risk, 
its focus is to align the Utility Operations-Related Swap as closely as 
possible with the underlying and unique commercial risk being hedged, 
rather than to settle for a more standardized, shorter-term, and 
therefore less ``perfect'' (and consequently less cost-effective) hedge 
for such commercial risk.\18\
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    \18\ We have discussed the Special Entity Sub-Threshold issue with 
energy trade associations and with large nonfinancial entities that 
currently act as regular counterparties to Utility Special Entities in 
these types of swaps. A number of these entities have indicated to 
Petitioners that they share our concern about the sub-threshold, and 
that they are prepared to file comments in support of this Petition. 
See footnote 16.
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D. Utility Operations-Related Swaps Often Have Large Notional Amounts.
    Many Utility Operations-Related Swaps have longer terms than may be 
typical in other swap asset classes or product types, as a result of 
the long-term commercial risks being hedged--risks arising from long-
term utility service obligations, construction projects, generation 
outage or availability projections, or long term fuel needs. 
Consequently, the notional amount of such swaps can be quite large. In 
addition, due to the volatile nature of the market prices of these 
nonfinancial commodities, the notional amounts can fluctuate 
dramatically over the term of a Utility Operations-Related Swap. The 
prices of electric energy, fuel and natural gas are among the most 
volatile of traded commodities, especially prices for illiquid delivery 
points, subject to regional supply and demand factors such as weather, 
and with customized operational conditions and terms.
    A single 1 year 100 MW swap or a single 3 year 10,000 mmBtu/day 
swap may have a notional value of $25 million.\19\ A nonfinancial 
entity would, therefore, be available to enter into only one such swap 
with Utility Special Entity counterparties in any rolling twelve-month 
period. Otherwise, the nonfinancial entity risks exceeding the special 
entity sub-threshold, and would be required to register with the 
Commission as a ``swap dealer.''
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    \19\ These examples are based on available quotes for 100 MWs of 
7x24 electric energy for calendar year 2013 at Mid-C, PJM West and SP-
15 for ``Firm LD'' power, and on Henry Hub calendar strip prices for 
natural gas. Each of these examples is for a relatively liquid delivery 
point, and for swaps that are not customized as are many Utility 
Operations-Related Swaps. To put these examples (and the $25 million 
Sub-Threshold) in context, the Los Angeles Department of Water and 
Power owns or operates 6,000 MWs of electric generation, and the New 
York Power Authority owns or operates 7,400 MWs of electric generation. 
JEA, formerly the Jacksonville Electric Authority, hedges approximately 
13.8 million mmBtus of natural gas in an average year as part of its 
fuel procurement process for electric operations, based on the past 5 
years actual hedging activity. If each of these Utility Special 
Entities was limited to one $25 million hedge per year with each non-
``swap dealer'' counterparty, it would dramatically limit the ability 
of these Utility Special Entities to hedge or mitigate commercial risks 
arising from everyday utility operations.
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E. Utility Special Entities are At a Competitive Disadvantage to 
        Similarly-Situated Market Participants due to the Special 
        Entity Sub-Threshold.
    If the Commission denies the proposed rule amendment, Utility 
Special Entities could still look to CFTC-registered swap dealers for 
these types of swaps, or could use less customized, more expensive 
commercial risk management solutions that might be available on an 
exchange. Or Utility Special Entities could simply forego using 
nonfinancial commodity swaps for commercial risk management purposes 
entirely. At the same time, the available counterparties for Utility 
Operations-Related Swaps could enter into up to $8 Billion notional in 
swaps, or even $8 Billion in Utility Operations-Related Swaps, with 
counterparties other than Utility Special Entities, including 
neighboring investor-owned utilities and electric cooperatives. As a 
direct result of the Special Entity Sub-Threshold, Utility Special 
Entities are denied a level playing field in the competition for 
available counterparties for these commercial risk hedging swaps. 
Utility Special Entities are denied comparable, cost-effective access 
to such commercial risk management tools that will instead be offered 
to neighboring investor-owned utilities and electric cooperatives by 
otherwise available market participants.\20\
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    \20\ An unintended consequence of the $25 million Special Entity 
Sub-Threshold applied to Utility Operations-Related Swaps will be to 
limit the Utility Special Entities' available counterparties and force 
Utility Special Entities to engage in Utility Operations-Related Swaps 
with financial institutions and other entities that are registered with 
the CFTC. This would concentrate, not disperse, risk to the United 
States financial system. For financial institutions, such activity may 
or may not be an activity in which such financial institutions or their 
``banking entity'' affiliates are permitted to engage once the 
regulations implementing the Volcker Rule and other provisions of the 
Dodd-Frank Act rulemakings are finalized. Such Utility Operations-
Related Swaps with ``swap dealer'' counterparties may also require the 
posting of margin by Utility Special Entities (depending on the 
applicable regulators' final rules on capital and margin).
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    In today's regional markets, a Utility Special Entity is equally as 
likely as an investor-owned utility in the same region to be an 
attractive counterparty for an entity that chooses to ``deal'' in 
Utility Operations-Related Swaps, whether the entity is a nonfinancial 
company hedging its own commercial risks (or ``hedging a physical 
position'' as such phrase is more narrowly defined in the CFTC's 
definition of ``swap dealer''), trading for profit (speculating), or 
engaging in a regular business of dealing in such swaps. The ``playing 
field'' between the Utility Special Entity and the investor-owned 
utility, electric cooperative or any other counterparty is currently 
``level.''
    Moreover, in today's regional markets, if a market participant 
(such as the Alabama merchant generator or the Wyoming natural gas or 
coal producer referenced above) is considering establishing a new 
entrant ``swap dealing'' business in specific regional product types of 
Utility Operations-Related Swaps, it will similarly consider the 
Utility Special Entity as a potential counterparty with the same 
ability to transact as any other potential counterparty. The Utility 
Special Entity benefits from any new or additional price competition.
    Once the CFTC's Entity Definition rules are effective, as a result 
of the significant disparity between the general de minimis threshold 
and the special entity sub-threshold, the Alabama-based merchant 
generator or the Wyoming-based natural gas or coal producer, or any 
other market participant not intending to register as a ``swap 
dealer,'' will substantially limit its swap dealing activity in Utility 
Operations-Related Swaps with Utility Special Entities. Indeed, in 
regions like California and the Southeast United States, where there 
are geographic concentrations of Utility Special Entities, a non-``swap 
dealer'' counterparty may only be able to execute one such Utility 
Operations-Related Swap with one such Utility Special entity in a 12 
month period without the risk of exceeding the $25 million sub-
threshold. The entity will set up its swap dealing activity business, 
its business processes, its documentation and its compliance programs 
to transact with counterparties other than the Utility Special 
Entities, including neighboring investor-owned utilities and electric 
cooperatives.\21\ The unworkably low, and comparatively 
disadvantageous, Special Entity Sub-Threshold threatens the Utility 
Special Entities' uninterrupted access to these important and cost-
effective commercial risk management tools.
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    \21\ The Adopting Release notes that the statute's de minimis 
exception intended to increase competition within markets for swaps by 
encouraging new entrants, thereby decreasing costs for commercial end-
users and decreasing systemic risks by lessening concentration of 
dealing activity among a few major financial market participants. See 
77 Fed. Reg. 30629. Ironically the special entity sub-threshold acts 
directly contrary to this stated statutory and regulatory objective. 
For Utility Special Entities hedging commercial risks, the sub-
threshold will serve to discourage new entrants and concentrate the 
Utility Special Entity's counterparty credit risk. The proposed rule 
amendment would restore this competitive, and less risky, market 
structure.
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IV. Supporting Arguments
    For the following reasons, the Commission should approve the 
proposed rule amendment as soon as possible:

A. The Commission has the Authority to Approve the Rule Amendment.
    Section 1a(49)(D) of the Commodity Exchange Act (``CEA'') as 
amended by the Dodd-Frank Act, and new CFTC Regulation 1.3(ggg)(4)(v) 
authorize the Commission to change or modify the requirements of the de 
minimis exception to the ``swap dealer'' definition by rule or 
regulation, without engaging in further joint rulemaking or joint 
interpretative guidance with the Securities and Exchange Commission. 
The Adopting Release acknowledges this. See footnote 464 at 77 Fed. 
Reg. 30634, and related text.
    Section 1a(49)(D) provides as follows:

        ``. . . (D) De minimis exception.--The Commission shall exempt 
        from designation as a swap dealer an entity that engages in a 
        de minimis quantity of swap dealing in connection with 
        transactions with or on behalf of its customers. The Commission 
        shall promulgate regulations to establish factors with respect 
        to making of this determination to exempt.''

    As the Commission notes on page 30702 of the Adopting Release, ``. 
. . CEA Section 1a(49)(D) directs the CFTC to promulgate regulations to 
establish factors with respect to the making of the determination to 
apply the de minimis exceptions to the definition of the term `swap 
dealer.' ''
    New CFTC Regulation 1.3(ggg)(4)(v) provides as follows:

        ``. . . (v) Future adjustments to scope of the de minimum 
        exception. The Commission may by rule or regulation change the 
        requirements of the de minimis exception described in 
        paragraphs (ggg)(4)(i) through (iv) of this section.''

    Clearly the Commission has the authority to approve the proposed 
rule amendment.

B. The Factors Set Forth the Proposed Rule Amendment are Distinctly and 
        Uniquely Applicable to Utility Operations-Related Swaps and to 
        Utility Special Entities.
    The proposed rule amendment will have no affect on the de minimis 
exception to the ``security-based swap dealer'' definition. Nor will 
the proposed rule amendment have any affect on the de minimis exception 
to the Commission's ``swap dealer'' definition as it applies in general 
to special entities (including Utility Special Entities) engaging in 
financial swaps or nonfinancial ``other commodity'' swaps, other than 
those product types critical to hedging or mitigating commercial risks 
in the utility industry.
    The factors set forth in the proposed rule amendment are not 
applicable to security-based swap dealers or to their counterparties. 
Counterparties to security-based swaps do not need such security-based 
swaps to ``hedge or mitigate commercial risks'', as is the case with 
commercial end-users' need for nonfinancial commodity swaps to hedge or 
mitigate commercial risks. Congress specifically recognized the 
importance of protecting ``commercial end-users'' access to 
nonfinancial commodity swaps when it emphasized that the Dodd-Frank 
Act's focus on financial market stability and price and market 
transparency should not be achieved without also preserving commercial 
end-users' access to swaps used to hedge or mitigate commercial 
risks.\22\
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    \22\ See 156 Cong. Rec. H5238 (the ``Dodd-Lincoln letter'').
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    The factors that argue in favor of the Commission approving the 
proposed rule amendment are also inapplicable to entities involved in 
agricultural or metal commodities transactions and swaps. Such entities 
are simply not subject to public service obligation comparable to those 
that apply to utilities that require Utility Operations-Related Swaps 
to hedge commercial risks associated with utility facilities, 
operations and public service obligations. Utilities (including Utility 
Special Entities) have public service obligations under Federal, state 
and local laws and regulations, and utility reliability obligations, 
that other industries simply do not share. Congress recognized these 
important obligations throughout the Dodd-Frank Act as deserving of the 
Commission's regulatory deference. See Section 720 of the Dodd-Frank 
Act calling for FERC/CFTC Memoranda of Understanding, new CEA Section 
2(a)(1)(I) regarding jurisdiction of the various energy regulatory 
agencies, and new CEA Section 4(c)(6) directing the Commission to 
consider public interest waivers of its jurisdiction.
    The Commission clearly has the authority to approve the proposed 
rule amendment. The factors that argue in favor of the proposed rule 
amendment, and limit its affect, reflect the unique and the different 
characteristics of these types of ``swaps'' and these market 
participants, and recognize the differing applicable laws and 
regulations, and statutory and regulatory policies The Commission 
should approve the proposed rule amendment and do so as soon as 
possible.

C. Nothing in the Dodd-Frank Act or the CEA Requires the Special Entity 
        Sub-Threshold.
    The proposed rule amendment is narrowly tailored to achieve both 
the statutory goals and Congressional intent underlying the Dodd-Frank 
Act, and to leave in place the supplemental investor protection 
objectives of the Commission in including the Special Entity Sub-
Threshold in the ``swap dealer'' definition.
    In the Dodd-Frank Act, Congress imposed on registered ``swap 
dealers'' heightened business conduct standards when advising, offering 
or entering into swaps with ``special entities.'' Nothing in the Dodd-
Frank Act imposes or requires the Commission to impose business conduct 
standards on entities that are not required to register as ``swap 
dealers.'' Nothing in the Dodd-Frank Act requires the Commission to 
impose an exponentially smaller de minimis sub-threshold for 
counterparties that are not registered ``swap dealers'' and that enter 
into swaps to which ``special entities'' are counterparties. The 
Adopting Release acknowledges as much, characterizing the lower 
threshold as ``consistent with the fact that Title VII's requirements 
applicable to swap dealers . . . provide heightened protection to these 
types of entities.'' 77 Fed. Reg. at 30630 (emphasis added).
    The Adopting Release cites the Dodd-Frank Act provisions that 
impose on registered swap dealers and major swap participants (those 
market professionals whose activities are directly regulated by the 
Commission) heightened business conduct standards and documentation 
requirements for interacting with ``special entities.'' The Adopting 
Release then extrapolates without explanation as to why it is 
consistent for the Commission to extend its regulatory reach beyond the 
market professionals registered as ``swap dealers,'' whose conduct the 
statute intends it to regulate, to impose restrictions on the 
activities of entities that are not swap dealers, and whose de minimis 
``swap dealing activities'' do not require such registration. The 
Special Entity Sub-Threshold is a clear regulatory overreach by the 
Commission, and should be modified where such regulatory overreach 
negatively affects the ability of yet another group of entities that 
are not ``swap dealing''--the ``Utility Special Entities''--to hedge or 
mitigate the commercial risks of their nonfinancial, public service 
enterprises.
    The Adopting Release gives examples of situations where the special 
entity ``lacked the requisite sophistication and experience to 
independently evaluate the risks of the investment and exposed the 
[special entity] to a heightened risk of catastrophic loss ultimately 
led to a complete loss of their investments.'' See footnote 425 and 
text accompanying at 77 Fed. Reg. 30630 (emphasis added). In the 
examples, the special entities were acting outside the scope of their 
core operations as investors in financial derivatives, interacting with 
financial institution or ``financial entity'' market professionals, 
using cash reserves or other cash assets of the special entity to 
invest (for profit or loss) in financial derivatives instruments. By 
contrast, the Utility Special Entities use Utility Operations-Related 
Swaps to hedge the commercial risks of their core utility operations, 
not to invest for profit.

D. The Proposed Rule Amendment is Consistent with Both Congressional 
        Intent of the Dodd-Frank Act and Will have No Affect on the 
        Commission's Investor Protection Policy Objectives.
    The investor protection objectives of the Dodd-Frank Act, and the 
Commission's own ``consistent'' and supplemental investor protection 
objectives as expressed in the Adopting Release, would not be affected 
or compromised by the proposed rule amendment. As is clear from the 
proposed definition of ``Utility Operations-Related Swap,'' the Utility 
Special Entity enters into such a nonfinancial commodity swap to hedge 
commercial risks that arise from its utility facilities, operations and 
public service obligations.
    The proposed rule amendment is drafted narrowly to respect the 
Commission's investor protection policies but to achieve the distinct, 
but equally important, Congressional intent of the Dodd-Frank Act: to 
preserve cost-effective (and comparative, competitively equal) access 
to nonfinancial commodity swaps that Utility Special Entities use ``to 
hedge or mitigate commercial risks.''
    The proposed rule amendment does not amend either the general de 
minimis threshold for swap dealing activity. The general de minimis 
threshold would continue to apply to Utility Operations-Related Swaps 
to which Utility Special Entities are counterparties. Nor does the 
proposed rule amendment change the ``special entity sub-threshold'' for 
swaps in asset classes or product types other than Utility Operations-
Related Swaps to which Utility Special Entities are counterparties.
    In defining the term ``Special Entity'' in Section 4s(h)(2)(C) of 
the Dodd-Frank Act and establishing the heightened business conduct 
standards for registered ``swap dealers,'' Congress did not intend for 
the Commission expand its regulatory oversight beyond oversight of 
regulated ``swap dealers'' to place restrictions on entities that are 
not required to register as ``swap dealers.'' In establishing the 
Special Entity Sub-Threshold and then not substantially raising it when 
it raised the general de minimis threshold, the Commission restricted 
Utility Special Entities' competitive abilities, and severely 
restricted Utility Special Entities' access to the nonfinancial 
commodity swaps needed to cost-effectively hedge or mitigate commercial 
risks.

V. Process and Timeline for Petition
    The Petitioners respectfully request the Commission to act as soon 
as possible on the proposed rule amendment--to remove continuing 
regulatory uncertainty for the Utility Special Entities and 
counterparties that would, but for the Special Entity Sub-Threshold, be 
available to enter into Utility Operations-Related Transactions with 
Utility Special Entities. As the Commission's new ``swap'' regulations 
are proposed, become final and implementation begins, market 
participants are evaluating whether and how to participate in the new 
market structure for ``swaps.'' At the same time, Utility Special 
Entities have continuing utility public service obligations to provide 
affordable, reliable utility service to their customers, and 
consequently have both short-term and long-term commercial risks to 
hedge.
    As the effective dates and compliance dates approach for the new 
``swap'' regulatory regime, market participants are beginning to turn 
their attention away from current activities in nonfinancial 
commodities and commodity swaps in general. The challenges of the new 
regulatory requirements applicable to ``swaps,'' including challenges 
for systems, staffing, compliance, documentation and reporting are 
overwhelming, even for the largest financial institutions and financial 
markets professionals, especially given the tight and interrelated 
compliance timelines.
    The added challenge of determining whether to register as a ``swap 
dealer'' for one or more asset classes or product types of ``swaps'' 
are even more daunting for a nonfinancial entity, whose primary and 
ongoing business is not trading or investing or dealing in the 
financial markets, but drilling for natural gas, mining coal, or 
generating, transmitting and/or delivering electric energy or natural 
gas to consumers.\23\
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    \23\ A number of the nonfinancial entities with whom the 
Petitioners (or the trade association Petitioners' members) transact in 
Utility Operations-Related Swaps have told us that they are currently 
evaluating their nonfinancial commodity ``swap'' activities in light of 
the final Entity Definitions rules, the Interim Final Rule in Section 
1.3(ggg)(6)(iii), and the statutory guidance provided in the Adopting 
Release and elsewhere in the CFTC's regulations, interpretations and 
precedents. Such nonfinancial entities are also awaiting the CFTC's 
final rules defining the term ``swap,'' which is the foundational 
rulemaking which will enable the energy industry to understand the 
scope of the CFTC's jurisdiction over our industry's transactions. As 
of July 10, 2012, for the electric and natural gas utility industry, 
the challenges are compounded by the continuing uncertainty as to what 
is and isn't a ``swap,'' a ``nonfinancial commodity forward'' 
transaction, a nonfinancial commodity forward with embedded 
optionality, or a ``trade option.'' See footnote 6 above. Once the 
rules defining ``swap'' are final with respect to our industry's 
transactions, each nonfinancial entity will then (and can only then) 
analyze which of its activities will fall within the definition of 
``swap,'' and therefore would or could be ``swap dealing,'' which of 
its activities will be excluded as ``hedging a physical position'' 
(depending on the outcome of that final rulemaking), or fit within 
other safe harbors under the interpretive guidance provided by the 
Commission. Then and only then can the nonfinancial entity decide, as a 
business matter, whether to continue all or any of its swap dealing 
activities, and whether to register as a ``swap dealer'' or to register 
for a limited designation as a ``swap dealer'' for certain asset 
classes and product types (that may or may not include particular 
Utility Operations-Related Swaps). Alternatively, only then can such a 
nonfinancial entity alternatively decide to wind down any swap 
activities which the Commission might consider to be ``swap dealing 
activities.'' Nothing requires a nonfinancial entity (whose primary 
business is not to engage in financial markets transactions like 
``swaps'') to continue its past or current business strategies. If a 
particular nonfinancial entity decides to continue some level of swap 
dealing activity, it may decide not to continue such activity as a 
registered ``swap dealer.'' At last decision point, once the new Dodd-
Frank Act rules are effective and as compliance dates approach, these 
entities will restrict their swap dealing activity to stay well below 
the two very different de minimis exception thresholds in the CFTC's 
swap dealer definition.
---------------------------------------------------------------------------
    If a market participant decides to continue some amount of ``swap 
dealing activity'' in Utility Operations-Related Swaps, it will 
carefully evaluate and then establish compliance procedures to monitor 
the two de minimis thresholds. In doing so, it will certainly hesitate 
or delay incurring the expense of setting up specially calibrated 
systems, compliance processes and staff training in order to engage in 
one or two such swaps with Utility Special Entities within a 12 month 
period. A nonfinancial counterparty that does not choose to register as 
a ``swap dealer'' will instead understandably focus on modifying its 
business processes and documents to engage in swaps with counterparties 
other than Utility Special Entities, under the general de minimis 
exception threshold.
    We request that the Commission promptly publish the proposed rule 
amendment for comment in the Federal Register, without waiting for the 
effective date of the Entity Definitions rules. We recommend a public 
comment period of no longer than 20 days, and respectfully request 
publication of the Commission's final approval or grounds for denying 
the rule amendment within 10 days thereafter.\24\ The Petitioners 
request that the amended rule be retroactive and prospective for all 
Utility Operations-Related Swaps to which a Utility Special Entity is a 
counterparty entered into after the effective date of the Entity 
Definition rules.
---------------------------------------------------------------------------
    \24\ The proposed rule amendment relieves a competitive restriction 
on Utility Special Entities, and modifies the special entity sub-
threshold to the de minimis exception to the definition of ``swap 
dealer.'' The Commission and interested persons in the electric and 
natural gas industry have been on notice of the Utility Special 
Entities' concerns since early May 2012. As a result, the proposed rule 
amendment is entitled to the earlier effective date permitted by CFTC 
Regulation 13.6.
---------------------------------------------------------------------------
VI. Conclusion
    The Petitioners respectfully petition the Commission under CFTC 
Regulation 13.2 to amend CFTC Regulation 1(ggg)(4), which implements 
the de minimis exception to the definition of ``swap dealer,'' as 
described above.
Signature Page--Special Entity Sub-Threshold Petition
    Please contact any of the individuals below or Patricia 
Dondanville, Reed Smith LLP, 10 South Wacker Drive, 40th Floor, Chicago 
Illinois 60606, telephone (312) 207-3911, or e-mail 
[email protected], if you have questions regarding this 
Petition.
            Respectfully submitted,




American Public Power Association    Large Public Power Council

Susan Kelly                          Noreen Roche-Carter

Susan Kelly                          Noreen Roche-Carter
Senior Vice President of Policy      Chair, Tax and Finance Task Force
 Analysis and General Counsel        c/o Sacramento Municipal Utility
                                      District
1875 Connecticut Avenue, N.W.        6201 S Street
Suite 1200                           Sacramento, CA 95817-1899
Washington, D.C. 20009-5715
Tel: (202) 467-2933                  Tel: (916) 732-6509
E-mail: [email protected]       E-mail: [email protected]

Transmission Access Policy Study     American Public Gas Association
 Group

John Twitty                          David Schryver

John Twitty                          David Schryver
Executive Director                   Executive Vice President
4203 East Woodland Street            201 Massachusetts Avenue, NE
                                     Suite C-4
Springfield, MO 65809                Washington, DC 20002
Tel: (414) 838-8576                  Tel: (202) 464-0835
E-mail: [email protected]      E-mail: [email protected]

Bonneville Power Administration

Virginia Schaeffer

Virginia K. Schaeffer
Attorney
Office of the General Counsel--LC-7
P.O. Box 3621
Portland, Oregon 98208-3621
Tel: (503)230-4030
E-mail: [email protected]



CC:

Honorable Gary Gensler, Chairman

Honorable Bart Chilton, Commissioner

Honorable Jill E. Sommers, Commissioner

Honorable Scott O'Malia, Commissioner

Honorable Mark Wetjen, Commissioner

Office of the CFTC General Counsel

    The Chairman. Thank you for your testimony, and I would 
note to my colleagues on the Committee that at approximately 
1:05, maybe 1:15, we will begin a series of votes, so we will 
endeavor to conclude all of our business in a timely fashion. I 
recognize myself for 5 minutes.
    Mr. Duffy, does the CME's recent designation by the FSOC 
and the regulatory requirements associated with it put CME in a 
better position to hold customer segregated funds instead of a 
third-party custodian?
    Mr. Duffy. Well, I don't know if the designation has 
anything to do with CME or a third party holding the funds. You 
know, this is something that we had put out there just to--we 
don't have all the details worked out yet. We still believe 
that the FCMs are very capable of holding the customer funds, 
but at the same time, we know there needs to be confidence in 
the marketplace so if in fact the customers felt safer with CME 
Group or a third-party depository, we would be prepared to move 
forward with that.
    The Chairman. Very good point.
    Mr. Roth, your testimony states that you began an 
examination of PFGBest in mid-June. Was it a scheduled audit or 
inspired by some anomaly?
    Mr. Roth. The audit that we began in mid-June was part of 
our regular cycle of audits for FCMs where we try to see each 
FCM each year. I don't want to suggest that that is the only 
time we ever examined PFG. We had a number of limited-scope 
audits involving sales practice-type issues and their 
supervision of IBs but the June audit was part of the regular 
cycle.
    The Chairman. For the regular audits that you conducted of 
PFGBest, was Mr. Wasendorf, Sr. ever personally involved in 
those audits?
    Mr. Roth. When we would ask questions of staff, I am sure 
there were certain questions that we posed to staff that were 
answered by Mr. Wasendorf, Sr. I can't say specifically which 
questions were directed to him and which were to the chief 
compliance officer or the chief financial officer. It would not 
surprise me if we had posed certain questions directly to Mr. 
Wasendorf.
    The Chairman. Based on NFA's internal investigations of 
PFGBest, was this a Ponzi scheme in the classic sense?
    Mr. Roth. It is a distinction that no one but a regulator 
would care about. It is not a Ponzi scheme in the sense that 
they were reporting false profits to customers and paying old 
customers off with new customer money. It was really just more 
of an outright theft of customer funds.
    The Chairman. Thinking about the description both in your 
written testimony and your oral, do you believe that more than 
one person would be required to be involved in such a 
defrauding of customers and regulators alike. I mean, getting 
both the customers and the regulators is a pretty impressive 
accomplishment.
    Mr. Roth. You know, obviously there is an ongoing 
investigation conducted by the Justice Department. I don't have 
any firsthand facts. I can just tell you that the volume, the 
sheer volume of forged documents produced on a daily basis was 
fairly staggering, and again had to be produced on a daily 
basis, and Mr. Wasendorf obviously traveled occasionally and 
wasn't in the office, but I really don't have any firsthand 
knowledge. I hope that the investigation will ultimately 
uncover that.
    The Chairman. Thank you.
    Mr. Lukken, the CFTC and the SEC have different approaches 
to writing and disseminating rules as required by Dodd-Frank. 
CFTC has formalized the rules basically one at a time, in some 
cases involving an effective date until 60 days after issuing 
the final rules on the entity or the product definitions. The 
SEC, on the other hand, is holding rules basically until all of 
the rules are completed. It will then issue a sequencing 
document, as I understand it, and solicit public comment. Which 
agency approach is right? You have a little bit of insight 
here. And why?
    Mr. Lukken. Well, as I mentioned, the Dodd-Frank 
implementation, although conceptually most people are in 
agreement with what came out of the G20 commitment in 
Pittsburgh after the financial crisis, but the implementation 
of that has been very tricky and complex within the industry. 
As I mentioned in my testimony, the SEC has actually put 
forward a good way to try to give certainty to the industry of 
how they are going to implement this rather than devote 
resources, time and energy potentially wasted if you are either 
in and it turns out that you are out and you may devote 
resources unnecessarily, or the opposite where you are caught, 
where you think you are not in, but you turn out to be in. The 
SEC seems to have taken a logical approach, a measured 
approach, and I would encourage the CFTC to do the same.
    The Chairman. Mr. Heck and Mr. Conner, I believe we all 
heard together here today the CFTC Chairman indicate that he 
would address the issues pertaining to the recording of 
farmers' conversation as it comes to contracts. Do you find 
that to be a reassuring public, stressing public, statement by 
the Chairman in that regard?
    Mr. Conner. Mr. Chairman, I do, and we have worked very 
closely with Chairman Gensler throughout the rulemaking process 
and he has been good to his word, and he was pretty clear 
today. We look forward to seeing the follow-through on that on 
what we think is really a pretty absurd concept, when you 
really get down to putting it in place out there on the ground.
    Mr. Heck. I believe, Mr. Chairman, at the NGFA, we would 
agree with Mr. Conner's comments. I think the CFTC is open to 
dialogue on this point and we will certainly take advantage of 
that.
    The Chairman. Mr. McElroy, with my colleagues indulging me 
for one last question on the final swap rule, you mentioned the 
public power and public gas utilities and the new costs and how 
that will be moved on down to the ratepayers, because 
ultimately that is who pays the bills in regards to utilities. 
One last question, and it is more rhetorical and you can answer 
if you care to. What did the customers of public power and gas 
companies have to do with the financial crisis to deserve this?
    Mr. McElroy. That is a question we have asked over and over 
again, and we don't have a good answer for that.
    The Chairman. My time has expired. I turn to the fine 
gentleman from Iowa for his 5 minutes.
    Mr. Boswell. Well, thank you, Mr. Chairman, and I just--
again, our earlier dialogue, you got it right what you were 
trying to do as far as the authorization committee but the 
appropriations side of it is a concern of mine, and I kind of 
want to talk about that just a little bit.
    First off, I guess I will go to Mr. Roth. Mr. Wasendorf had 
been a member of the NFA advisory committee and the chief 
compliance officer of this had been a senior compliance officer 
at NFA as well. It indicates to me in looking at the magnitude 
of this whole thing, there must be quite a few, or could be 
quite a few others implicated. What is your thought about that, 
and if you think there could be others, what are we doing to 
find out?
    Mr. Roth. Well, let me first state with respect to the 
chief compliance officer, she had been a former employee of NFA 
but she left NFA 15 years ago, so that is a pretty long 
departure. I don't think any of the people that were involved 
in our audits had overlapped with her at NFA.
    Mr. Boswell. So her information having been on the inside 
wouldn't necessarily be applicable to how she would try to 
defraud us now?
    Mr. Roth. Well, obviously, the procedures that we follow 
now aren't the procedures that we followed 15 years ago, but I 
would also point out, I think there were reports trying to 
portray her as having been a high-level executive at NFA, and 
she wasn't. She was a member of the compliance department but 
she didn't have any sort of senior management position at all.
    You mentioned Mr. Wasendorf's position on our FCM advisory 
committee. The FCM advisory committee is a committee that does 
just that. It has no authority to take any action. It advises 
the board on any such rulemaking issues that are coming before 
the board. Mr. Wasendorf was one of the nine or ten members on 
that committee.
    Mr. Boswell. Okay. I am satisfied with that answer.
    Again, the magnitude, it seems to me like there has to be a 
lot of people involved in this day-to-day operation of the 
fraud that took place.
    Mr. Roth. Congressman, one point, when we talk about 
preventing this type of fraud in the future, and I have tried 
to describe the steps we are taking to really make the 
surveillance of customer segregated funds as tight as we 
possibly can, but let me just mention an obvious point, I 
guess. One way to prevent fraud is to deter fraud through 
vigorous prosecutions of the laws that are on the books now, 
and everybody would agree with that and I would certainly hope 
that the ongoing investigation conducted by the Justice 
Department will uncover all the evidence and ultimately make 
that judgment as to whether other people were involved or not.
    Mr. Boswell. Well, I also in our conversation understand 
that because of your funding system, you are actually expanding 
the size of your operation, personnel, equipment and so on. To 
what extent are you expanding and where do you intend to go?
    Mr. Roth. I would say that over the last 5 to 6 years, we 
have had a 33 percent increase in the size of our compliance 
department just because of increased demands. Our budget this 
year that was just approved by the board calls for a 27 percent 
increase in administrative spending. That is in anticipation of 
the increased responsibilities under Dodd-Frank. We frankly 
anticipate we will----
    Mr. Boswell. Thank you. I understand it well.
    And then I guess it picks up, Mr. Chairman, my point is, 
how does CFTC do their job, and I continue to be concerned 
about that.
    Mr. Conner, I haven't seen you for a while. You know my 
respect and appreciation for co-ops and farmers and ranchers 
and what it means to us, and I would guess that we have a lot 
of people out there that were involved in this recent thing 
that have really been whacked pretty hard. Would you agree to 
that?
    Mr. Conner. Well, we certainly know we have members and 
farmer-owners, Congressman, who were caught up in the MF Global 
circumstance. I think it is a little too early to say in the 
other Sioux City circumstance exactly the impact but certainly 
you can expect some.
    Mr. Boswell. You heard Mr. Roth--thank you, Mr. Roth, for 
your straightforwardness about how you intend to expand and how 
you are doing it and so on. Are the rest of you, are you doing 
the same thing? And also today's electronics, are you actually 
looking at what the bank is doing as you look at the reports 
you are getting back? Are you doing that now? Maybe you might 
comment on that, any and all.
    Mr. Duffy. Well, Mr. Boswell, at the CME, we are working in 
conjunction with the NFA and the CFTC to have that ability to 
go ahead and look straight through into the bank records.
    Mr. Boswell. You are looking at it, but are you doing it?
    Mr. Duffy. We have the ability today to call the FCM and 
say we want to have a look at the bank statement to make sure 
the monies are there. Now, it will go on a more real-time basis 
but at the moment right now we can today as of recently go 
ahead and deploy this technology.
    Mr. Boswell. My time is running out, but any of the rest of 
you doing it any different than what we just have heard?
    Mr. Lukken. I wouldn't say differently but the FCMs, the 
problem needs to be solved at all levels, at the Federal 
regulatory level, and Chairman Gensler testified this morning 
that he is looking at this, at the self-regulatory level, but 
the firms themselves who our trade association represent. They 
are implementing internal controls, making sure there is 
separation of duties between CFOs and compliance people, making 
sure that all the controls are in place and disclosures are 
happening so that this can be ferreted out earlier so that this 
doesn't occur over a 20 year period of time.
    Mr. Boswell. Mr. Chairman, my time is up. Could we indulge 
the rest of them to see if they want to comment on that 
particular question?
    The Chairman. The panel is most welcome to address any 
thoughts to the Member's question they care to.
    It looks like the gentleman's time has expired.
    Mr. Boswell. Thank you.
    The Chairman. The chair now recognizes the gentleman from 
Florida for 5 minutes.
    Mr. Southerland. Thank you, Mr. Chairman.
    I have to take a deep breath because you guys have some 
major problems, and it would be very convenient to blame the 
lack of regulation. You know, I have been a state regulator or 
appointed to serve as Chairman of regulatory boards. Mr. 
Lukken, you mentioned educating customers. Well, that is great. 
That is great. You mentioned that with depressed futures 
volumes, historically low interest rates and an 
ultracompetitive pricing model, FCMs are under tremendous 
strain financially. Well, bless your heart. My heart bleeds for 
you. I am being a little facetious there because it doesn't. My 
heart bleeds for the thousands of hardworking men and women 
that have been damaged permanently because of your inaction. 
You know, it is not a sin of commission that you are guilty of. 
It is a sin of omission.
    My family business is in an industry that we helped self-
regulate, and as the Chairman of boards in the State of 
Florida, I have handed down death sentences to businesses who 
have violated the public trust. Now, your challenges are not 
depressed futures volumes. Your challenges are not historically 
low interest rates. Your challenges are not ultracompetitive 
pricing models or the tremendous strain financially. Gentlemen, 
you represent an industry that has an integrity crisis, an 
integrity crisis, and you can't build a marriage, a family, a 
small business, a state, a country, you can build nothing of 
value that can withstand the long haul apart from integrity.
    I am led to believe here that for 20 years this company 
fooled you. You are the front line. You are it to whom much is 
given, much is expected. I have little pity for you. I have 
anger for what I have heard here today.
    You know, we talk about studying. Well, that is great. 
Studying? Do something. We talked about--one of the things that 
I hear--we talk about the insurance, the Securities Investor 
Protection Corporation, how it needs to be spread to protect 
the customers. We have talked about that. Well, by God, do it. 
Make it happen. Restore public trust. You have an integrity 
problem, and we as Members of Congress, we can't solve your 
problems. We can sit here and express anger from those that we 
represent that have been harmed by the inaction of this 
industry.
    I shiver to think what else is out there. It terrifies me. 
And Mr. Chairman, I have to tell you, my blood is boiling 
because you have not earned the right--you shared here, Mr. 
Duffy, you talked about you caution us to move authority to the 
government and away from the industry. What have you done to 
deserve self-regulation? Your inaction is destroying lives, and 
it angers me, and I know that down here on the other end, APPA, 
I know that Mr. McElroy, you talk about the great things in 
Dodd-Frank. Well, let me tell you some unintended consequences 
as a small business owner. I will tell you, Mr. Conner, the 
small businesses that you represent, we can't get capital from 
our community banks because of Dodd-Frank. There are unintended 
consequences of that regulation, and so when you sit here and 
you talk about you support it, well, that is wonderful, but to 
the small businesses that represent the American economy, Dodd-
Frank is killing our community banks, and you have now created 
the legitimacy of regulation, and it will have unintended 
consequences on good, hardworking men and women that are doing 
everything right, and my family is one of those. I have a 
brother that got up this morning at 3:30 to go to the log woods 
to haul timber to mills. More regulation? He can't work any 
harder. To whom much is given, much is expected. I am terribly 
disappointed.
    And Mr. Chairman, I know I have gone over my time, but 
there are some things that I think need to be said.
    The Chairman. The gentleman's time has expired. The chair 
now turns to the gentleman from California for 5 minutes, Mr. 
Baca.
    Mr. Baca. Well, thank you very much, and I want to thank 
the witnesses, and I am on the other side and I appreciate the 
Dodd-Frank legislation because it is important that we do have 
accountability and we have those kind of regulations that are 
important for us and that we have the transparency. We also 
have the oversight, and if we didn't have this, that is why the 
abuse would be there. And so it is very important when we talk 
about it, it is easy to talk about not having the regulations. 
That is what led us to the problems that we have. We didn't 
have a lot of the regulations in the banking industry and Wall 
Street, and then we used to have a gentleman that says trust 
me, we are making the right kind of decisions. We didn't make 
the right kind of decisions. That is why we have come up with 
the Dodd-Frank. We have to allow it to grow and develop and 
hold those accountabilities to allow community banks and others 
to do the right thing for the American people, and unless we do 
that and we have those regulations in place, it is not going to 
happen. I just wanted to state that because my good friend from 
Florida indicated different. I just wanted to make sure that I 
presented my side that is a little bit different than him 
because he comes from an area that he would like to do whatever 
he wants. I don't believe that is the way we should be and we 
should have regulations in place. So thank you very much.
    With that, I would like to ask a question of Mr. Roth in 
terms of how does--in lay terms, how does the e-confirmation 
process of customer segregated bank accounts work for the FCM 
members? And this is for Mr. Roth.
    Mr. Roth. The e-confirmation process that we began using 
after the first of the year basically makes the confirmation 
process much less paper-intensive, more efficient and really is 
no additional cost to the FCM at all. There is a cost that is 
paid by NFA to the vendor of this service. But it has really 
improved both efficiency and in this particular case helped 
uncover a fraud.
    Mr. Baca. Thank you, and that is why the regulations are 
important and that is the reason the Dodd-Frank is there, and 
if we didn't have it, we wouldn't be able to detect that. And 
do you think that online confirmation will be an effective 
oversight and fraud-prevention tool? Why or why not?
    Mr. Roth. I think it is a good step but I don't think it is 
enough. That is why we are going to our board and asking for 
this direct view-only online access and then moreover building 
a system in which we will get daily reports from all 
depositories for customer segregated funds. So the e-confirm 
process has been a huge help, and it is a step along the way, 
but there are certainly bolder steps that we are taking and 
starting at our August board meeting and moving on from there 
to build the system I described in my testimony.
    Mr. Baca. Thank you. Let me ask just a general question 
because it is a topic that we were discussing and my good 
friend from Florida was saying that we didn't need the 
regulations. Do you believe that we should have regulations and 
regulations should be in place whether it is the Dodd-Frank 
legislation or any others? Do you believe that regulations are 
good for us? And I open it to all of you. Or should we just 
allow everybody to say trust me, I am going to do the right 
thing? And I open it up for all of you?
    Mr. Roth. Could I go first?
    Mr. Baca. Yes.
    Mr. Roth. I have been a regulator for 29 years so I may 
bring a little bias to this question, but obviously the whole 
point of regulation is based on the recognition that these 
markets are vital to our economy. For the markets to thrive, 
there has to be public confidence in the integrity of the 
markets, and the regulatory process is designed to ensure that 
integrity and foster that public confidence--so regulation is 
essential. The question is, how to do it right, how to do it 
smart and how to do it in a way that the bad guys can't win?
    Mr. Baca. That is the only way that we can also restore 
that public trust that the gentleman from Florida said that we 
needed to do, but thank you.
    I will open it up for the rest, any one of you that would 
like to address it.
    Mr. Lukken. I will quickly address it. I am a former 
regulator so I am supportive, as Dan mentioned, smart 
regulation, making sure that it makes sense for the 
marketplace, that it stops this type of behavior but also 
proper enforcement of that regulation. I think that is where we 
need to concentrate. There are lots of rules to the road. Let 
us make sure that those are being properly enforced, and 
certainly some of the things that have been mentioned today, 
the e-confirm system, giving access to regulators, those are 
all great tools that will allow them to enforce these rules and 
make sure this is ferreted out quickly.
    Mr. Baca. Thank you.
    Anyone else?
    Mr. McElroy. I think we are generally supportive but if it 
goes so far and we do have unintended consequences, we have to 
be careful of that. From our industry standpoint, looking at 
some of the regulations that appear to potentially affect, 
adversely affect our customers in public power and small 
businesses is a little bit of a challenge given the cost-
benefit, and it is an unintended consequence. On a broad scheme 
in terms of the regulatory regimes and issues, I couldn't agree 
more, couldn't agree more, but when it gets down to such a low 
level and unintended consequences, there needs to be a way to 
address that and ensure that those small folks, small 
businesses on Main Street don't get hurt.
    Mr. Baca. Right, and those are areas that we need to work 
on and try to define to allow that public trust and allow that 
entity to grow, so all of us can agree on that.
    Anybody else? If not, I know my time has expired. If not, I 
would like to thank the Chairman for allowing me to ask a few 
questions. Thank you very much.
    The Chairman. The gentleman's time has expired, and the 
Chairman will just note that his good friends on the West Coast 
and East Coast always have very sincere discussions about 
philosophy and policy.
    And with that, the gentleman from Illinois is recognized 
for the final set of questions for 5 minutes.
    Mr. Hultgren. Thank you, Mr. Chairman, and I do thank you 
all for being here. These are tough times. This is difficult. 
You know, it is not new that we have corrupt people who break 
the law, but we have to do everything we can to go after them 
and to be working together to make sure that this doesn't 
happen, that we keep the integrity in a system that is so 
important to the viability of our nation, of our future.
    I want to just follow up on a couple questions I had for 
Chairman Gensler just to see if you have any thoughts on this. 
I had mentioned about yesterday the CFTC publishing the initial 
list of swaps proposed to be subject to the clearing mandate, 
talked about that Europe will not be prepared to have any such 
clearing mandate in effect until at least 2013. The Chairman 
talked a little bit about Asia and where they are coming in, 
also a different timing. So it sounds like again there are 
going to be different timings that these mandates will come in. 
I wanted to ask you what impact you expect the timing of these 
mandates to have since they are not coordinated.
    Mr. Duffy. I will just quickly answer. I think that any 
time you don't have universal coordination on markets that are 
global in nature, it could always be an issue. So obviously we 
are a bit concerned about the United States always being the 
leader in regulation and nobody else following because 
sometimes business will go along with it. I know the financial 
services industry has not exactly been the shining star in the 
room over the last several years, but I assure you, it is one 
of the most important things that the United States of America 
has going for it is the United States financial system. I would 
hate to see us get overregulated to a point or have rules put 
upon us that put us in a very--a place that is very anti-
competitive, so that is really my biggest concern, sir.
    Mr. Hultgren. I am concerned of that as well. Any other 
thoughts that anyone has? Otherwise I have a couple other 
questions.
    LIBOR has been a big issue obviously through this process, 
and given the impact that LIBOR has had on lending for 
mortgages and credit cards and now suspicion cast on the 
integrity of that rate. I wonder if there are any other 
benchmarks that are out there that may be more reliable from 
your perspective?
    Mr. Duffy. There are several benchmarks out there, sir, but 
you have to realize that there is $377 trillion benchmarked to 
LIBOR with an additional $10 trillion in loans. This is 
probably the largest amount of money benchmarked to any 
particular one asset class, and there are other rates such as 
Fed funds that could maybe potentially substitute. I think that 
many people believe that with the now-discovery of what CFTC 
has done with Barclays that the LIBOR process as it goes 
forward may become the most reliable index, not the most 
vaulted index.
    Mr. Hultgren. Let me stick with you, Mr. Duffy, if that is 
all right, just a couple more questions. I know that you 
testified about hundreds of millions of dollars that the CME 
has dedicated to SIPC trustee and you talked about the CME 
trust pledge. I wonder if the trustee had taken advantage of 
the CME guarantee. Why, if so, or why not?
    Mr. Duffy. Congressman, as everybody knows, CME Group 
pledged $550 million to the clients of MF Global to the trustee 
in order to get money back as quickly as possible. The trustee, 
I believe, is up to 82 on the dollar and working its way north 
of that. I don't believe the trustee has taken advantage of CME 
Group in any which way. I think the trustee has had the ability 
to move fast because of what CME did, so I don't believe it was 
taken advantage of. I think it was the right thing for us to do 
and the right thing for the clients to get.
    Mr. Hultgren. Again, Mr. Duffy, Mr. Roth, maybe if you 
could comment on this, and this is just a fundamental question 
of who has more interest in the integrity of the futures 
market? The exchanges or the government? I would like to hear 
your point of view of how important integrity is.
    Mr. Duffy. I have a real philosophical view on this since I 
spent my first 22 years never getting a paycheck in my life and 
the only way I made a paycheck is by trading. I believe that 
the fundamental core of the futures market is the credibility 
of it, and that is where I sit today as Chairman and President 
of the company. That is the philosophy, is the credibility, 
contrary to what Mr. Southerland said, and the core of this 
business, and we will do whatever it takes. So whether we are 
now a for-profit public company, if we don't have a credible 
business line, we don't have a credible for-profit public 
company, and that is the way we put it in order.
    Mr. Roth. From my point of view, Congressman, the 
suggestion that the fraud at Peregrine would have been 
uncovered more quickly if the examiners had been on the 
government's payroll instead of our payroll is something that I 
just don't think has a rational basis in fact. I think to me, 
the key question is less who is doing the looking than it is 
how are they doing the looking. That is why we immediately 
after MF Global started trying to incorporate as much 
technology as we can in this process and why we are taking the 
steps that I outlined in my testimony.
    Mr. Hultgren. Well, my time has expired. I appreciate again 
you being here. These are again very difficult times. All of us 
are committed to the integrity of our financial system, so I 
ask just to continue to work together. I know you are 
passionately committed to that as well as we are to make sure 
that that confidence is there but also to make sure that our 
constituents aren't hurt, our farmers, ranchers, people who are 
engaged in these markets aren't hurt. We want to do that.
    So thanks for being here. We are going to need to continue 
to work together again to make sure that we solidify that 
integrity of the markets and continue to protect our 
constituents. With that, I yield back. Thank you, Mr. Chairman.
    The Chairman. The gentleman's time has expired. The 
gentleman yields back. With that, all time has expired.
    I wish to thank our panel as we dismiss them for your 
insights and your answers to our questions, and to note before 
we adjourn, I invite my acting Ranking Member, any closing 
comments, Mr. Acting Ranking Member?
    Mr. Boswell. I just appreciate that we have had this today. 
Thank you for your work, and I am taking it from here that you 
are going to go out there and work harder and increase your 
resources to get it done.
    Thank you very much, and with that, I yield back.
    The Chairman. The gentleman yields back.
    Under the rules of the Committee, the record of today's 
hearing will remain open for 10 calendar days to receive 
additional material and supplemental written responses from the 
witnesses to any questions posed by a Member.
    This hearing of the Committee on Agriculture is adjourned.
    [Whereupon, at 11:18 a.m., the Committee was adjourned.]
    [Material submitted for inclusion in the record follows:]

   Supplementary Material Submitted by Hon. Gary Gensler, Chairman, 
                  Commodity Futures Trading Commission

    During the July 25, 2012 hearing entitled, Oversight of the Swaps 
and Futures Markets: Recent Events and Impending Regulatory Reforms, 
requests for information were made to Mr. Gensler. The following are 
his information submissions for the record.
Insert 1
          Mr. Costa. Do you anticipate being able to coordinate 
        resources with clearinghouses? You are talking about the 
        timelines in Japan, the timelines in Hong Kong, and the 
        timelines for implementation in Europe with those other 
        clearinghouses to try to provide a worldwide regulatory 
        framework.
          Mr. Gensler. I think we are coordinating well but we have 
        different politics and different cultures so there will be 
        different timelines. In some countries, they might be 
        significantly later than us but I am encouraged by Europe and 
        Japan and Canada.
          Mr. Costa. For your discussion of those timelines, could you 
        provide the Committee, because you talked about you are almost 
        at the rulemaking now, what you see the timelines out for the 
        next 2 years? Would that be possible?
          Mr. Gensler. I am sorry. Did you say for the next----
          Mr. Costa. Two years.
          Mr. Gensler. Two years? I think we can provide something to 
        you in terms of the rules that are already finalized when there 
        are compliance dates and then second, when we----
          Mr. Costa. Mr. Chairman, I would like that provided to the 
        Committee so that we can all have a better understanding of 
        that.

    A core provision of title VII of the Dodd-Frank Act is the 
requirement that standardized swaps be centrally cleared. The Act 
includes an exception for non-financial end-users, with the requirement 
only applying to a transaction where both counterparties are subject to 
it.
    For swaps submitted to the Commission for mandatory clearing, the 
Commission will review the submission and determine whether the swap, 
or group, category, type, or class of swaps described in the submission 
is required to be cleared. The Commission, generally, is to make its 
determination within 90 days after a complete submission. The 
Commission recently finalized a mandatory clearing requirement that 
covers specified classes of interest rate and credit default swaps.
    Commission rules regarding the clearing requirement include phased 
compliance for different categories of market participants. 
Transactions involving only swap dealers will be subject to earlier 
compliance than those between swap-dealers and non-swap dealers. 
Additional time is provided before compliance is required with respect 
to a transaction that does not have a swap dealer as a counterparty.
    U.S. timing regarding the clearing requirement broadly aligns with 
both Japan and Europe.
    The legislature in Japan adopted legislation in May 2010 which 
mandates clearing of certain swaps. Japanese regulators recently 
published the requirement that certain index-based CDS and certain yen-
denominated interest swaps to be subject to mandatory clearing. In 
addition, the Japanese Financial Services Agency is considering 
expanding its mandatory clearing coverage to include U.S. dollar- and 
euro-denominated interest rate swaps, as well as yen-denominated 
interest rate swaps referencing TIBOR.
    The European Securities and Markets Authority has published its 
technical standards for clearing, reporting and certain risk mitigation 
rules for adoption by the European Commission.
    The Commission continues to consult closely with fellow regulators 
in Australia, Hong Kong Singapore, and other jurisdictions.
    In June, the Commission--consulting closely with domestic and 
foreign regulators--proposed guidance interpreting the cross-border 
application of the swaps market reforms of the Dodd-Frank Act. In a 
separate release, the Commission proposed phased compliance for foreign 
swap dealers (including overseas affiliates of U.S. swap dealers) 
regarding certain requirements of Dodd-Frank swaps market reform.
    Such phased compliance would enable market participants to comply 
with the Dodd-Frank Act in an orderly fashion. It would allow time for 
the CFTC, international regulators and market participants to continue 
coordinating on regulation of cross-border swaps activity. And it would 
allow for appropriate implementation of substituted compliance, or 
allowing market participants to comply with Dodd-Frank through 
comparable and comprehensive foreign regulatory requirements.
    The CFTC has a consistent record of relying on comparable home 
country regulation where appropriate. We are very much committed to 
recognition regimes for swaps market reforms as well, where there are 
comparable and comprehensive requirements.
    The CFTC also has had a long history of working with international 
regulators to coordinate oversight of cross-border entities. We have 
done so with regard to clearinghouses, futures commission merchants and 
foreign boards of trade.
Insert 2
          Mrs. Noem. Thank you, Mr. Chairman, and I appreciate this 
        hearing. It is timely given it is the second anniversary of the 
        Dodd-Frank and we need to look at these reforms and the related 
        rules and see how they impact people on the ground. For 
        example, in South Dakota, where I am from, some businesses and 
        producers who are actively investing in the commodity market 
        are still dealing with the failure of MF Global, so I just have 
        a couple questions for you.
          Does the CFTC have the power to force a firm into bankruptcy?
          Mr. Gensler. We might need to get back to you, but I am not 
        aware of that. Even in this Peregrine situation, we went into 
        court to ask for a receiver to be appointed to freeze the 
        assets, which we do in Ponzi schemes as well. So I think that 
        is the route. I believe the answer is no but we seek a court to 
        appoint a receiver.
          Mrs. Noem. Okay. That is the route that is generally 
        followed? Well, if there is more information on that that you 
        can give me later, I would appreciate that. That would be 
        great.

    The attached CFTC staff memorandum discusses the applicable laws 
that affect the insolvency of a futures commission merchant that is 
also a broker dealer.

                               ATTACHMENT

Memorandum
    From: Robert B. Wasserman, Chief Counsel, Division of Clearing and 
    Risk
    Re: SIPA Proceedings for insolvent FCMs
    Date: April 1, 2012
Introduction
    The following is an analysis of the circumstances where the 
insolvency of a Futures Commission Merchant that is also a Broker 
Dealer would proceed under the Securities Investors Protection Act, 15 
U.S.C.  78aaa, et. seq. (SIPA) rather than as a commodity broker 
bankruptcy under Subchapter IV of Chapter 7 of the Bankruptcy Code, 11 
U.S.C.  761, et. seq. (Subchapter IV).
    As discussed further below, jurisdiction under SIPA is based on the 
existence of at least one securities customer whose claims may be 
satisfied by SIPC, rather than on the predominance of securities 
customers versus commodity customers. However, as also discussed 
further below, the interests of commodity customers are not ignored 
under SIPA.

Discussion
    Futures Commission Merchants (``FCMs'') are the financial 
intermediaries for futures market transactions.\1\ A bankrupt FCM which 
has a ``customer,'' as that term is defined in the Bankruptcy Code, is 
known as a ``commodity broker.'' \2\ A commodity broker bankruptcy must 
proceed as a liquidation under Chapter 7 of the Bankruptcy Code, rather 
than a reorganization under Chapter 11, and the trustee has duties 
specified in Subchapter IV of Chapter 7.\3\ Chief among those duties is 
the duty to endeavor to transfer the positions of customers of the FCM 
to a solvent FCM.\4\ The financial intermediaries for securities are 
known as broker dealers (``BDs''), and the insolvency of a BD proceeds 
under SIPA. For the reasons that follow, the insolvency of an entity 
that is both a commodity broker and a BD (a ``BD/FCM'') will, so long 
as there is at least one securities customer, proceed under SIPA.
---------------------------------------------------------------------------
    \1\ See generally, Commodity Exchange Act (``CEA'')  1a(28), 4d, 
7 U.S.C.  1a(28), 6d.
    \2\ See Bankruptcy Code (hereinafter ``Code'')  101(6), 11 U.S.C. 
 101(6).
    \3\ See Code  109(d),  761 et. seq.
    \4\ See 17 CFR  190.02(e)(1).
---------------------------------------------------------------------------
    Section 5(a)(1) of SIPA \5\ provides that ``[i]f the [SEC] is aware 
of facts which lead it to believe that any broker or dealer subject to 
its regulation is in or is approaching financial difficulty, it shall 
immediately notify SIPC.''
---------------------------------------------------------------------------
    \5\ Section 5 of SIPA is codified at 15 U.S.C.  78eee.
---------------------------------------------------------------------------
    Section 5(a)(3)(A)(A) provides that SIPC may file an application 
for a protective decree with respect to a member with any (securities) 
customers if it determines that the member ``has failed or is in danger 
of failing to meet its obligations to customers'' and one of the 
conditions specified in  5(b)(1) of SIPA exists.\6\ Those latter 
conditions include (a) that the debtor is insolvent, or (b) that a 
proceeding is pending before any court or agency of the United States 
in which a receiver, trustee, or liquidator for such debtor has been 
appointed, or (c) that the debtor is not in compliance with the rules 
of the SEC or an SRO with respect to financial responsibility or 
hypothecation of customer securities, or (d) that the debtor is unable 
to make such computations as may be necessary to establish compliance 
with such financial responsibility or hypothecation rules.
---------------------------------------------------------------------------
    \6\ SIPA  5(a)(3)(A) provides that no application shall be filed 
by SIPC with respect to a member, the only customers of which are 
persons whose claims could not be satisfied by SIPC advances pursuant 
to Section 9 of SIPA. MFG did not fall within this exception.
---------------------------------------------------------------------------
    There is no means for the CFTC to effect the placement of a BD/FCM 
into a Chapter 7, Subchapter IV proceeding that avoids SIPA. If the BD/
FCM were to file for relief under Chapter 7 of the Bankruptcy Code, the 
U.S. Trustee would appoint a trustee from among the panel of persons 
established by the U.S. Trustee for that jurisdiction.\7\ If the CFTC 
were to take action to appoint a receiver for an FCM with the intention 
that the receiver file for bankruptcy, that would, by assumption, 
involve the appointment of a receiver. In either case, the condition in 
(b) above would be established. Moreover, pursuant to  5(a)(3)(B) of 
SIPA, ``[n]o member of SIPC that has a customer may enter into an 
insolvency, receivership, or bankruptcy proceeding, under Federal or 
State law, without the specific consent of SIPC, except as provided in 
title II of the Dodd-Frank Wall Street Reform and Consumer Protection 
Act.''
---------------------------------------------------------------------------
    \7\ Code  701(a)(1).
---------------------------------------------------------------------------
    Accordingly, so long as there is at least one securities customer, 
the CFTC has no way to prevent SIPC from initiating a SIPA proceeding, 
and SIPA prevents the initiation of a Chapter 7, Subchapter IV 
proceeding without SIPC's specific consent.
    Additionally, once SIPC initiates a SIPA proceeding, the district 
court is, pursuant to Section 5(b)(2)(B)(i) of SIPA, obligated to 
``stay any pending bankruptcy, mortgage foreclosure, equity 
receivership, or other proceeding to reorganize, conserve, or liquidate 
the debtor or its property and any other suit against any receiver, 
conservator, or trustee of the debtor or its property, and shall 
continue such stay upon appointment of a [SIPC] trustee.'' Thus, any 
Subchapter IV proceeding must be stayed by the district court in a SIPA 
proceeding.
    Thus, the only effect that FCM or CFTC action to cause the 
initiation of a Subchapter IV proceeding with respect to a BD/FCM can 
have is to confuse and complicate the insolvency of the BD/FCM. 
Moreover, the succession of trustees and confusion with respect to 
jurisdiction is likely to delay the circumstances in which the 
commodity customer positions and any available associated collateral 
are transferred from the insolvent FCM to other FCMs.
    This does not mean that the interests of commodity customers are 
ignored in a SIPA proceeding. Specifically, SIPA  7(b) \8\ provides 
that
---------------------------------------------------------------------------
    \8\ 15 U.S.C. 78fff-1(b).

        ``To the extent consistent with the provisions of this chapter 
        or as otherwise ordered by the court, a trustee shall be 
        subject to the same duties as a trustee in a case under chapter 
        7 of Title 11, including, if the debtor is a commodity broker, 
        as defined under section 101 of such title, the duties 
        specified in subchapter IV of such chapter 7, except that a 
        trustee may, but shall have no duty to, reduce to money any 
        securities constituting customer property or in the general 
---------------------------------------------------------------------------
        estate of the debtor.''

    Thus, commodity customers in a SIPA proceeding do not, pursuant to 
SIPA, suffer any disadvantage relative to commodity customers in a 
Subchapter IV proceeding.

Insert 3
          Mr. Stutzman. September 1, 2011, MF Global announces in a 
        public filing that it would comply with FINRA's determination 
        and increase its capital. Would such a filing trigger any red 
        flags at CFTC?
          Mr. Gensler. As I am not participating, I don't know what the 
        Commissioners or the agency looked at about that September 1st 
        filing. But just as a general matter, our examination staff 
        will work with the self-regulatory organizations like FINRA and 
        Chicago Mercantile Exchange and NFA on any filings about 
        capital and try to understand what those filings are.
          Mr. Stutzman. So did that happen? Did your agency work with 
        FINRA at all?
          Mr. Gensler. Again, I don't know because I haven't gone back 
        and done the forensics. I haven't been involved since this 
        whatever, November 2nd or 3rd period of time.
          Mr. Stutzman. Is that something you could find out and 
        notify----
          Mr. Gensler. Our General Counsel, Dan Berkovitz, will follow 
        up with you.

    At the end of August 2011, SEC staff contacted CFTC staff regarding 
MF Global's repo to maturity transactions.
    On September 19, 2011, CFTC staff held a teleconference with FINRA 
staff to obtain further information regarding the repo to maturity 
transactions.
    On October 25, 2011, CFTC staff spoke with FINRA staff regarding MF 
Global. During this call, FINRA discussed certain additional steps it 
had taken to monitor MF Global.
    On October 27, 2011, staff in the CFTC New York Regional office was 
contacted by SEC staff. CFTC staff ultimately joined the SEC staff in a 
meeting at MF Global that was the initiation of an SEC examination of 
the firm.
    On October 28, 2011, CFTC staff spoke with FINRA staff regarding 
the status of MF Global.
    On October 30, 2011, CFTC and SEC staff participated in a 
conference call with MF Global regarding MF Global's financial status 
and the production of documents related to that status.
Insert 4
          Mr. Conaway . . . Chairman, one real quick follow-up. Section 
        722(d) is the section you cite that gives you the authority to 
        do the guidance on the extraterritorial or cross-border; 
        722(c), we think gives the SEC similar authority. What is 
        y'all's understanding or can you help us understand your 
        interpretation of those two different sections?
          Mr. Gensler. Section 722(c) would be in the swaps section of 
        the statute. It may well that you want to follow up with----
          Mr. Conaway. Okay, if you wouldn't mind getting back with us 
        on that because----
          Mr. Gensler. Because I understood that it is all in the first 
        part of that Title VII is swaps, which is the CFTC, and then of 
        course the other section later in the chapter is there but 
        722(c), Dan? Maybe we will have to----
          Mr. Conaway. All right. We will follow up with you on that if 
        you wouldn't mind.

    Section 722(d) of the Dodd-Frank Act relates to the CFTC's 
extraterritorial jurisdiction over swaps. Subtitle B of Title VI, 
sections 761 through 744, applies to securities-based swaps under the 
jurisdiction of the Securities and Exchange Commission.
                                 ______
                                 
  Submitted Letter to Hon. Gary Gensler, Chairman, Commodity Futures 
 Trading Commission from Hon. K. Michael Conaway, a Representative in 
                    Congress from Texas and Response

August 21, 2012

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

    Dear Chairman Gensler:

    Thank you for your recent testimony before the House Committee on 
Agriculture hearing entitled, Oversight of the Swaps and Futures 
Markets: Recent Events and Impending Regulatory Reforms. This letter 
serves as a follow-up to my questions inquiring about the coordination 
between the Commodity Futures Trading Commission (CFTC) and the 
Securities and Exchange Commission (SEC) with respect to the 
extraterritorial application of Title VII of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act (P.L. 111-203). As you will recall, 
I asked you during the hearing to clarify why the statutory language 
found in Section 722(d) of Title VII of the Dodd-Frank Act serves as 
the legal rationale for the CFTC's inability to issue a joint rule with 
the SEC on cross-border jurisdiction.
    As a follow-up, could you please explain why Section 722(d), which 
governs swaps under the CFTC's jurisdiction, and Section 772(c), which 
governs security-based swaps under the SEC's jurisdiction, prevents the 
two Commissions from coordinating on a single joint rulemaking?
    As you know, Section 722(d) of Dodd-Frank provides that Title VII 
``shall not apply to activities outside the United States'' unless 
those activities ``have a direct and significant connection with 
activities in, or effect on, commerce of the United States'' or 
``contravene such rules or regulations as the Commission may prescribe 
or promulgate as are necessary or appropriate to prevent the evasion of 
any provision of this Act that was enacted by [Title VII].'' Similarly, 
Section 772(c) of Dodd-Frank provides that ``[n]o provision of [Title 
VII] shall apply to any person insofar as such person transacts a 
business in security-based swaps without the jurisdiction of the United 
States, unless such person transacts such business in contravention of 
[SEC rules].''
    My plain-language reading of Sections 722(d) and 772(c) appears to 
be a limitation on the extraterritorial reach of both agencies, not a 
mandate that prohibits the CFTC from engaging with the SEC on a joint 
rulemaking. In fact, Sections 712(a)(1) and 712(a)(2) of Dodd-Frank 
both require that the CFTC and SEC ``consult and coordinate . . . for 
the purposes of assuring regulatory consistency and comparability, to 
the extent possible.''
    Section 712(a)(7)(A) further reinforces this point by stating that 
the CFTC and SEC ``shall treat functionally or economically similar 
products or entities . . . in a similar manner.'' As you well 
understand, no joint rulemaking between the CFTC and SEC on the 
extraterritorial regulation of swaps and security-based swaps would 
require that both types of contracts be treated identically by the two 
agencies. Rationales to provide different regulatory treatment for very 
specific types of contracts would certainly exist within a jointly-
written rule. Indeed, Dodd-Frank Section 712(a)(7)(B) expressly 
provides the CFTC and SEC with the flexibility that economically 
similar products need not be treated in an identical manner. Read 
together, all of the Dodd-Frank sections referenced above seem to 
logically point to a thorough joint rulemaking on cross-border 
regulation from the CFTC and SEC.
    However, I am concerned that the CFTC's proposed cross-border 
guidance released on June 29, 2012, is the first action which will 
ultimately result in swaps and security-based swaps being governed by 
two very different regulatory regimes. From a regulatory compliance 
standpoint, the most-restrictive guidance or rulemaking will likely 
become the de facto standard for the entire swaps and security-based 
swaps marketplace. Nevertheless, we must avoid the illogical creation 
of a disparate regulatory environment that would result in the same 
market participant being a ``U.S. person'' for trading in swaps while 
simultaneously considering them a ``non-U.S. person'' for trading in 
security-based swaps.
    Finally, Section 752(a) of the Dodd-Frank Act requires the CFTC and 
SEC to seek harmonization on an international level by consulting and 
coordinating ``with foreign regulatory authorities on the establishment 
of consistent international standards'' for swaps regulation. Absent 
consistent regulatory standards proposed by our own domestic 
regulators, effective coordination between U.S. and foreign regulators 
would seem virtually impossible. How does the CFTC plan to coordinate 
with international regulators if swaps and security-based swaps are 
governed by two different extraterritorial regulatory regimes?
    Thank you again for answering the questions above related to the 
creation of a consistent regulatory regime for the swaps and security-
based swaps marketplace. I look forward to receiving your written 
response by Friday, September 7, 2012, so it can be included in the 
official Committee hearing record.
            Sincerely,

            
            
Hon. K. Michael Conaway,
Chairman,
Subcommittee on General Farm Commodities and Risk Management.

October 10, 2012

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

    Dear Chairman Conaway:

    Thank you for your letter of August 21, 2012, following up on our 
discussion during the Committee on Agriculture's hearing of July 25, 
2012.
    The Commodity Exchange Act (CEA)--as amended by the Dodd-Frank Wall 
Street Reform and Consumer Protection Act--directs the Commodity 
Futures Trading Commission (CFTC) to implement swaps market reforms, to 
coordinate closely with other domestic regulatory agencies, and to 
coordinate as well with regulators in foreign jurisdictions. In 
addition, in particular instances, Congress has directed the CFTC to 
conduct rulemakings jointly with the Securities and Exchange Commission 
(SEC). The two Commissions worked well and closely together to complete 
this year final joint rules that further define important terms.
    In addition to cooperating on joint rules, the CFTC and the SEC are 
coordinating closely in writing other rules to implement the 
derivatives provisions of the Dodd-Frank Act. We coordinate and consult 
on each rulemaking, including sharing many of our memos, term sheets 
and draft work product. This close working relationship has benefited 
the rulemaking process, and will continue throughout completion of 
rulemaking and implementation. Staffs of the SEC and CFTC have jointly 
held a number of roundtable discussions to obtain the public's views.
    This process of consultation and coordination has been followed 
with regard to considerations of the cross-border application of Dodd-
Frank. On August 1, 2011, staffs of the two Commissions hosted a 
roundtable discussion on international issues relating to the 
implementation of title VII of the Dodd-Frank Act. This meeting as well 
as public comments and other meetings have facilitated the agencies' 
understanding of related issues as well as helped us to share a common 
understanding with regard to the important matters to be addressed by 
both Commissions in our joint and separate rulemakings.
    Section 722(d) of the Dodd-Frank Act states that swaps market 
reforms under the CEA shall not apply to activities outside the United 
States unless those activities have ``a direct and significant 
connection with activities in, or effect on, commerce of the United 
States.'' The Commission has received requests from market participants 
seeking the agency's interpretation of swap market reforms in light of 
that provision.
    In June, the Commission--consulting closely with domestic and 
foreign regulators--proposed guidance interpreting the cross-border 
application of the Dodd-Frank Act. In a separate release, the 
Commission proposed phased compliance for foreign swap dealers 
(including overseas affiliates of U.S. swap dealers) regarding certain 
requirements of Dodd-Frank swaps market reform.
    Such phased compliance would enable market participants to comply 
with the Dodd-Frank Act in an orderly fashion. It would allow time for 
the CFTC, international regulators and market participants to continue 
coordinating on regulation of cross-border swaps activity. And it would 
allow for appropriate implementation of substituted compliance, or 
allowing market participants to comply with Dodd-Frank through 
comparable and comprehensive foreign regulatory requirements.
    The CFTC has a consistent record of relying on comparable home 
country regulation where appropriate. We are very much committed to 
recognition regimes for swaps market reforms as well, where there are 
comparable and comprehensive requirements.
    The CFTC also has had a long history of working with international 
regulators to coordinate oversight of cross-border entities. We have 
done so with regard to clearinghouses, futures commission merchants and 
foreign boards of trade. The Commission has sought public comment 
regarding these releases and the Commission staff is closely reviewing 
that input in preparation for final action.
    As the process of swaps market reform implementation proceeds, the 
Commission will continue to work closely with the SEC and other 
domestic regulators. The Commission is also working closely with 
regulators in foreign jurisdictions--often sharing memos, term sheets 
and draft work product as we do with other domestic agencies. These 
efforts are designed to assure regulatory consistency and comparability 
to the extent possible, taking into consideration differences in 
markets and in the applicable statutory requirements.
    Thank you for your letter and for your support of the work of the 
CFTC. If I can be of further assistance, please do not hesitate to let 
me know.
            Sincerely,

            
            
Hon. Gary Gensler,
Chairman,
Commodity Futures Trading Commission.
                                 ______
                                 
                          Submitted Questions
Response from Hon. Gary Gensler, Chairman, Commodity Futures Trading 
        Commission
Questions Submitted by Hon. Frank D. Lucas, a Representative in 
        Congress from Oklahoma
    Question 1. Chairman Gensler, I received the following questions on 
August 2, 2012, in a letter from the following members of the Florida 
Congressional delegation: Representatives Stearns, Posey, Mica, Nugent, 
Ross, West, Rivera, Buchanan, Ros-Lehtinen, Young, and Miller:
    How has the [LIBOR] manipulation affected the housing market in 
Florida?

    Question 2. With such a large population of older Americans in 
Florida, have our constituents' retirement savings been 
disproportionately affected compared to the rest of the country?

    Question 3. How has the LIBOR manipulation affected private student 
loan interest rates, which according to the Consumer Financial 
Protection Bureau, has surpassed credit card debt as the biggest source 
of unsecured debt for U.S. consumers?
    Answer 1-3. The Commission does not have data on the on the Florida 
housing market or on private student loans, nor did the Commission's 
order find the effect of Barclays actions on LIBOR. The Commission's 
order stated that Barclays repeatedly attempted to manipulate and made 
false, misleading or knowingly inaccurate submissions concerning LIBOR.

    Question 4. What work is the CFTC doing to aid the Department of 
Justice in civilly and criminally charging those involved?
    Answer. The Commission's Division of Enforcement referred the 
Barclays matter to the Department of Justice. That referral culminated 
in an agreement with the Fraud Section of the U.S. Justice Department's 
Criminal Division, in which Barclays agreed to pay a $160 million 
penalty and to continue to cooperate with the Department.

    Question 5. How does the CFTC plan to help state governments assess 
the impact the LIBOR fraud has had on them as individual states?
    Answer. In appropriate circumstances and with appropriate 
confidentiality agreements in place, we can and often do share 
information with state law enforcement authorities. In fact, the 
Commission's Office of Cooperative Enforcement, a unit of the Division 
of Enforcement, has the goal of ensuring that enforcement of the 
commodity futures laws is addressed through civil, criminal, or 
administrative actions by state and Federal agencies or branches of 
government whenever possible.

Question Submitted by Hon. K. Michael Conaway, a Representative in 
        Congress from Texas
    Question. Chairman Gensler, do you have any reason to believe the 
CFTC would have uncovered this fraud sooner had it been tasked with the 
audit of Peregrine instead of the NFA? If the CFTC had the sole 
authority to audit market participants, what would you and your staff 
have done differently?
    Answer. The regulatory system did not adequately protect 
Peregrine's customers. More needs to be done to protect customers. The 
Commission is proceeding to consider staff recommended proposed rules 
that incorporate three key reforms recently adopted by the NFA and 
would require:

   FCMs to hold sufficient funds in Part 30 secured accounts 
        (funds held for U.S. foreign futures and options customers 
        trading on foreign contract markets) to meet their total 
        obligations to customers trading on foreign markets computed 
        under the net liquidating equity method. FCMs would no longer 
        be allowed to use the alternative method, which had allowed 
        them to hold a lower amount of funds representing the margin on 
        their foreign futures;

   FCMs to maintain written policies and procedures governing 
        the maintenance of excess funds in customer segregated and Part 
        30 secured accounts. Withdrawals of 25 percent or more would 
        necessitate pre-approval in writing by senior management and 
        must be reported to the designated SRO and the CFTC; and

   FCMs to make additional reports available to the SRO and the 
        CFTC, including daily computations of segregated and Part 30 
        secured amounts.

    Additional reforms in the staff recommendations include requiring 
that SROs and the CFTC have direct electronic access to FCMs' bank and 
custodial accounts for customer funds, that acknowledgement letters and 
confirmation letters come directly to regulators from banks and 
custodians, enhanced risk disclosures to customers, setting standards 
for the SROs' examinations and the annual certified financial statement 
audits, including raising minimum standards for independent public 
accountants who audit FCMs and implementing a more effective early 
warning system for the Commission and the SROs that alert them to 
material events.
    If the Commission approves the staff recommendations, further 
public comment will be of great value to the agency in devising final 
rules that best ensure the protection of customer funds.
    Regarding the Commission's oversight of SROs and intermediaries, 
though we're making progress through our reorganization at the CFTC and 
new rules, the recent events at Peregrine highlight the necessity of 
looking at the decades-old system of SROs and the Commission's role in 
overseeing SROs.
    I have directed the CFTC's staff to do a full review of how the 
agency conducts oversight of the SROs, as well as limited scope reviews 
of FCMs, to determine what improvements can and should be made. As part 
of this review, we have reached out to the Public Company Accounting 
Oversight Board (PCAOB), which oversees the audits of public companies. 
The Dodd-Frank Act gave the PCAOB oversight authority over the audits 
of brokers and dealers who are registered with the Securities Exchange 
Commission. The PCAOB has agreed to give us the benefit of its insights 
and expertise.

Questions Submitted by Hon. Scott R. Tipton, a Representative in 
        Congress from Colorado
    Question 1. The FCS is a government sponsored enterprise (GSE) that 
is made up of 4 Federal Farm Credit Banks and approximately 80 lending 
associations. All System entities are jointly and severally liable for 
the actions of each other component of the System--in other words, the 
actions of one FCS lender ultimately will impact the entire System. 
Congress designed it that way. With this system of interlocking 
liability in mind, the FCS could be considered a $231 Billion financial 
services institution. Did the Chairman consider this fact when he 
issued the ``Clearing Exemption for Certain Swaps Entered into by 
Cooperatives''?

    Question 2. The central idea advanced by the CFTC in the recently 
proposed ``Clearing Exemption for Certain Swaps Entered into by 
Cooperatives'' is that the FCS banks lend to the FCS associations, 
which lend to farmers, and farmers own the FCS associations, which own 
the FCS banks--principally that the Farm Credit System is a 
cooperative. CFTC then proposes that ``cooperatives meeting certain 
conditions are the class of persons that should be exempted from the 
clearing requirement for certain types of swaps. cooperatives act on 
behalf of their members in certain financial matters. The proposed rule 
provides for passing through the end user exemption available to such 
cooperative's members.'' I find your logic lacking here. Why does who 
owns an entity make any difference in the regulation of the derivatives 
market?

    Question 3. You observe in the proposed rule: ``cooperatives have a 
member ownership structure in which the cooperatives exist to serve 
their member owners and not act for their own profit. In a real sense 
the cooperative is not separable from its member owners.'' What is 
unique about the ownership structure of cooperatives that would prevent 
a large financial institution like the Farm Credit System from making 
stupid, imprudent, wrong, or costly mistakes? Haven't you have been 
charged to regulate the derivatives market to protect the financial 
system from stupid, imprudent, wrong and costly mistakes? Doesn't 
exempting a financial cooperative with assets of more than $230 billion 
from certain derivatives activities expose the entire financial system 
to unintelligent, imprudent, wrong or costly mistakes?
    Answer 1-3. The comment period for the CFTC's proposed rule on a 
``Clearing Exemption for Certain Swaps Entered into by Cooperatives'' 
ended on August 16, 2012. In response to this proposal, the CFTC 
received comment letters from market participants and interested 
members of the public. The Commission is reviewing these letters and 
evaluating the various issues raised by commenters. The CFTC will 
consider the issues surrounding the proposed exemption for certain 
cooperative swaps and cooperative structure.

Question Submitted by Hon. Mike McIntyre, a Representative in Congress 
        from North Carolina
    Question. Chairman Gensler, in the proposed rule on Product 
Definitions you asked a number of questions of the electric industry, 
and I understand that the electric utilities responded and answered the 
staff's questions. As you know, the Products Definitions final rule 
subjected the capacity and transmission contract language to further 
comment. It is my understanding that these transactions--capacity 
contracts, transmission contracts and tolling agreements--are forwards 
or forwards with embedded options, and not swaps. I believe it was not 
the intent of Congress to consider such transactions swaps under the 
Dodd-Frank Act. Would you please clarify the CFTC's need for further 
comment on capacity and transmission contracts (used to ensure delivery 
of electric power to utilities and their consumers) in the Products 
Definition final rule?
    Answer. Under the Commission's final Product Definition rule, 
depending on the relevant facts and circumstances involved, capacity 
contracts, transmission contracts, and tolling agreements may qualify 
as forwards. The Commission issued interpretive guidance in this regard 
for market participants.
    The Commission also believed that it would benefit from further 
input about that guidance and requested public comment by Oct. 12, 
2012. Once this comment period has closed, the Commission will analyze 
the issues raised by the commenters.

 Submitted Material By Hon. Steve Southerland II, a Representative in 
                         Congress from Florida



















































                                  
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