    [Senate Hearing 112-313]
    [From the U.S. Government Publishing Office]

                                                            S. Hrg. 112-313

          EXCESSIVE SPECULATION AND COMPLIANCE WITH THE DODD-FRANK ACT

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

                                    HEARING

                                   before the

                    PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

                                     of the

                                  COMMITTEE ON
                   HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS
                              UNITED STATES SENATE

                          ONE HUNDRED TWELFTH CONGRESS

                                 FIRST SESSION

                                   ----------

                                NOVEMBER 3, 2011

                                   ----------

             Available via the World Wide Web: http://www.fdsys.gov

                           Printed for the use of the
            Committee on Homeland Security and Governmental Affairs

          EXCESSIVE SPECULATION AND COMPLIANCE WITH THE DODD-FRANK ACT

                                                            S. Hrg. 112-313

          EXCESSIVE SPECULATION AND COMPLIANCE WITH THE DODD-FRANK ACT

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

                                    HEARING

                                   before the

                    PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

                                     of the

                                  COMMITTEE ON
                   HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS
                              UNITED STATES SENATE

                          ONE HUNDRED TWELFTH CONGRESS

                                 FIRST SESSION

                                   __________

                                NOVEMBER 3, 2011

                                   __________

             Available via the World Wide Web: http://www.fdsys.gov

                           Printed for the use of the
            Committee on Homeland Security and Governmental Affairs

                                   ----------
                             U.S. GOVERNMENT PRINTING OFFICE

    72-487 PDF                       WASHINGTON : 2011

    For sale by the Superintendent of Documents, U.S. Government Printing
    Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800;
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    Washington, DC 20402-0001

            COMMITTEE ON HOMELAND SECURITY AND GOVERNMENTAL AFFAIRS

                   JOSEPH I. LIEBERMAN, Connecticut, Chairman
    CARL LEVIN, Michigan                 SUSAN M. COLLINS, Maine
    DANIEL K. AKAKA, Hawaii              TOM COBURN, Oklahoma
    THOMAS R. CARPER, Delaware           SCOTT P. BROWN, Massachusetts
    MARK L. PRYOR, Arkansas              JOHN McCAIN, Arizona
    MARY L. LANDRIEU, Louisiana          RON JOHNSON, Wisconsin
    CLAIRE McCASKILL, Missouri           JOHN ENSIGN, Nevada
    JON TESTER, Montana                  ROB PORTMAN, Ohio
    MARK BEGICH, Alaska                  RAND PAUL, Kentucky

                      Michael L. Alexander, Staff Director
                   Nicholas A. Rossi, Minority Staff Director
                      Trina Driessnack Tyrer, Chief Clerk
                     Patricia R. Hogan, Publications Clerk
                                     ------

                    PERMANENT SUBCOMMITTEE ON INVESTIGATIONS

                         CARL LEVIN, Michigan, Chairman
    THOMAS R. CARPER, Delaware           TOM COBURN, Oklahoma
    MARY L. LANDRIEU, Louisiana          SUSAN M. COLLINS, Maine
    CLAIRE McCASKILL, Missouri           SCOTT P. BROWN, Massachusetts
    JON TESTER, Montana                  JOHN McCAIN, Arizona
    MARK BEGICH, Alaska                  RAND PAUL, Kentucky
                Elise J. Bean, Staff Director and Chief Counsel
                             David H. Katz, Counsel
              Christopher Barkley, Staff Director to the Minority
                   Anthony G. Cotto, Counsel to the Minority
                         Mary D. Robertson, Chief Clerk

                                C O N T E N T S

                                     ------
    Opening statements:
                                                                       Page
        Senator Levin................................................     1
        Senator Coburn...............................................     6
    Prepared statements:
        Senator Levin................................................    51
        Senator Coburn...............................................    57

                                   WITNESSES
                           Thursday, November 3, 2011

    Paul N. Cicio, President, Industrial Energy Consumers of America.     8
    Tyson T. Slocum, Director, Energy Program, Public Citizen........    10
    Wallace C. Turbeville, Derivatives Specialist, Better Markets,
      Inc............................................................    12
    Hon. Gary Gensler, Chairman, Commodity Futures Trading Commission    29

                         Alphabetical List of Witnesses

    Cicio, Paul N.:
        Testimony....................................................     8
        Prepared statement...........................................    59
    Gensler, Hon. Gary:
        Testimony....................................................    29
        Prepared statement...........................................    98
    Slocum, Tyson T.:
        Testimony....................................................    10
        Prepared statement...........................................    68
    Turbeville, Wallace C.:
        Testimony....................................................    12
        Prepared statement with attachments..........................    77

                                  EXHIBIT LIST

     1. a. GCommodity Index Participation in U.S. Commodity Futures
      and Swaps, 2007-2011, chart prepared by the Permanent
      Subcommittee on Investigations.................................   110

        b. GIncrease in Commodity Related Exchange Traded Products,
      2004-2011, chart prepared by the Permanent Subcommittee on
      Investigations.................................................   111

        c. GIncrease in Commodity Related Mutual Funds, 2008-2011,
      chart prepared by the Permanent Subcommittee on Investigations.   112

        d. GWTI Price and World Supply and Consumption, chart
      prepared by the U. S. Energy Information Administration........   113

     2. a. GCFTC Summary of Final Regulations on Position Limits for
      Futures and Swaps..............................................   114

        b. GCFTC Q&A--Position Limits for Futures and Swaps..........   116

     3. GPosition Limits and the Hedge Exemption, A Brief Legislative
      History, testimony of Dan M. Berkovitz, CFTC General Counsel,
      July 28, 2009..................................................   119

     4. GExecutive Summary and Findings and Recommendations from the
      June 25, 2007 Staff Report of the Senate Permanent Subcommittee
      on Investigations entitled, ``Excessive Speculation in the
      Natural Gas Market.''..........................................   146

     5. GExecutive Summary and Findings & Recommendations from the
      June 24, 2009 Staff Report of the Senate Permanent Subcommittee
      on Investigations entitled, ``Excessive Speculation in the
      Wheat Market.''................................................   156

     6. GCommodity Related Exchange Traded Products:

        a. GList of Selected Commodity Related Exchanged Traded
      Products.......................................................   176

        b. GInformation related to:
           --ETFS Physical Palladium Shares--PALL....................   179
           --ProShares Ultra DJ-UBS Commodity........................   181
           --United States Oil Fund LP...............................   183

     7. GCommodity Related Mutual Funds:

        a. GList of Selected Commodity Related Mutual Funds..........   185

        b. GInformation related to:
           --Direxion Commodity Trends Strategy Fund.................   186
           --Highbridge Dynamic Commodities Strategy Fund............   190
           --MutualHedge Frontier Legends Fund.......................   192
           --Oppenheimer Commodity Strategy Total Return Fund........   206
           --PIMCO CommodityRealReturn Strategy Fund.................   212
           --PIMCO CommoditiesPLUS Strategy Fund.....................   212
           --Rydex/SGI Long Short Commodities Strategy Fund..........   217
           --Rydex/SGI Managed Futures Strategy Fund.................   219
           --Van Eck CM Commodity Index Fund.........................   221

        c. GNational Futures Association correspondence to CFTC,
      dated August 18, 2010, to amend CFTC Regulation 4.5 which
      provides an exclusion from the definition of the term
      ``commodity pool operator.''...................................   223

        d. G72 IRS Private Letters Authorizing Commodity Investments
      by Mutual Funds, 2006-2011, chart prepared by the Permanent
      Subcommittee on Investigations.................................   235

     8. GAnalysis: High-frequency trade fires up commodities,
      Reuters, June 17, 2011.........................................   241

     9. GLetter from 450 economists to the G20 Finance Ministers
      regarding impact of speculation on food prices, October 11,
      2011...........................................................   244

    10. GStatement for the Record of Gerry Ramm, Inland Oil Company,
      Ephrata, Washington, on behalf of the Petroleum Marketers
      Association of America and the New England Fuel Institute
      (NEFI).........................................................   266

    11. GLetter from the Consumer Federation of America forwarding
      October 2011 study, Excessive Speculation and Oil Price Shock
      Recessions, A Case of Wall Street ``Deja Vu All Over Again.''..   273

    12. GResponse for the record provided by Gary Gensler, Chairman,
      Commodity Futures Trading Commission, to question posed at the
      hearing by Senator Levin regarding mutual fund participation in
      commodity markets..............................................   308

    13. GResponses to supplemental questions for the record submitted
      by Senator Coburn to Gary Gensler, Chairman, Commodity Futures
      Trading Commission.............................................   309

    14. GResponses to supplemental questions for the record submitted
      by Senator Tom Coburn to Paul N. Cicio, President, Industrial
      Energy Consumers of America....................................   313

    15. GResponses to supplemental questions for the record submitted
      by Senator Tom Coburn to Wallace C. Turbeville, Derivatives
      Specialist, Better Markets, Inc................................   317

          EXCESSIVE SPECULATION AND COMPLIANCE WITH THE DODD-FRANK ACT

                                  ----------

                           THURSDAY, NOVEMBER 3, 2011

                                         U.S. Senate,
                  Permanent Subcommittee on Investigations,
                    of the Committee on Homeland Security and
                                          Governmental Affairs,
                                                        Washington, DC.
        The Subcommittee met, pursuant to notice, at 9:07 a.m., in
    room SD-342, Dirksen Senate Office Building, Hon. Carl Levin,
    Chairman of the Subcommittee, presiding.
        Present: Senators Levin and Coburn.
        Staff Present: Elise J. Bean, Staff Director and Chief
    Counsel; Mary D. Robertson, Chief Clerk; David H. Katz,
    Counsel; Michael Wolf, Law Clerk; Lauren Roberts, Law Clerk;
    Christopher Barkley, Staff Director to the Minority; Anthony G.
    Cotto, Counsel to the Minority; William Wright, Kristin
    Boutchyard, Brian Murphy, Steven Hutchinson, and William Wright
    (Senator Brown).

                   OPENING STATEMENT OF SENATOR LEVIN

        Senator Levin. Good morning, everybody. Over the past 9
    years, this Subcommittee has held a series of hearings on the
    problem of excessive speculation in the commodity markets. For
    years now, commodity markets have taken the American people on
    an expensive and damaging roller coaster ride with rapidly
    changing prices for crude oil, gasoline, natural gas, heating
    oil, airline fuel, wheat, copper, and many other commodities.
    Commodity prices have whipsawed American families, farms, and
    businesses, run roughshod over supply and demand factors, and
    made our economic recovery that much harder and more chaotic.
        Unstable commodity prices are a key reason why Congress
    enacted, as part of the Dodd-Frank Wall Street Reform and
    Consumer Protection Act, new statutory requirements to put a
    lid on excessive speculation and price manipulation. Congress
    enacted the new law not only to protect consumers and
    businesses from unreasonable prices--prices disconnected from
    the usual supply and demand discipline of the marketplace--but
    also to protect the commodity markets themselves from losing
    investor confidence and looking more like a casino or rigged
    game than a marketplace where supply and demand determine
    prices.
        Commodities markets are not stock markets. Stock markets
    are intended to attract investors to provide new capital for
    U.S. businesses to invest and to grow.
        Commodity markets are supposed to serve a different
    function. Their purpose is not to attract investors, but to
    enable producers and users of physical commodities to arrive at
    market-driven prices for those goods and to hedge their price
    risks over time. Prices are intended to reflect supply and
    demand for the actual commodities being traded. Speculators,
    who by definition do not plan to use the commodities that they
    trade but profit from the changing prices, are needed only
    insofar as they supply the liquidity needed for producers and
    users to hedge their risks.
        Another big difference between stock and commodity markets
    involves trading limits. Stock markets do not have them, but
    U.S. commodity markets have been using trading limits to
    varying degrees for over 70 years to combat excessive
    speculation and price manipulation.
        Federal law has long authorized the Commodity Futures
    Trading Commission (CFTC), and U.S. commodity exchanges to
    impose so-called position limits to prevent individual traders
    from holding more than a specified number of futures contracts
    at a specified time, such as during the close of the so-called
    spot month when a futures contract expires, and buyers and
    sellers have to settle up financially or through the physical
    delivery of commodities. Position limits help ensure commodity
    traders cannot exercise undue market power, such as by
    cornering the market.
        The primary problem afflicting U.S. commodity markets today
    is an explosion of speculators who, instead of facilitating,
    have now come to dominate commodity trading, overriding normal
    supply and demand factors, distorting prices, and increasing
    price volatility.
        That explosion began in large part less than 10 years ago,
    with the rise of commodity index funds that enable participants
    to bet on the rise or fall in commodity prices. Commodity index
    funds are operated by swap dealers that enter into swap
    contracts with clients seeking to make speculative bets on
    commodity prices. Those clients typically bet that prices will
    go up and take the long side of the swap. The swap dealers
    usually take the short side of the swap and, to offset the
    financial risk, typically purchase long futures contracts.
    Within a few years, as the funds grew, commodity index swap
    dealers became regular purchasers of massive numbers of futures
    contracts for crude oil, natural gas, wheat, and other
    commodities. According to CFTC data, as shown in this chart
    which we are putting up, Chart 1a in our book,\1\ commodity
    index investors and swap dealers have spent about $300 billion
    in 2011 alone, mostly on long futures and swap contracts.
    ---------------------------------------------------------------------------
        \1\ See Exhibit No. 1a which appears in the Appendix on page 110.
    ---------------------------------------------------------------------------
        Sometimes referred to as ``massive passives,'' commodity
    index funds have created a massive, ongoing demand for futures
    contracts unconnected to normal supply and demand for the
    underlying commodities. Their steady purchases have created an
    artificial demand for futures contracts. In addition, the more
    index funds and their swap dealers push to buy long future
    contracts and outnumber the speculators seeking to buy shorts,
    the more their buying pressure, by the very nature of supply
    and demand, will drive up the price of the long contracts. The
    resulting higher futures prices then translate all too often
    into higher prices for the underlying commodities, in part
    because so many of commodity contracts for the underlying
    commodities use futures prices as the commodity's selling
    prices. In those cases, higher futures prices translate
    directly into higher costs for consumers of the commodities.
    That is why so many American consumers and businesses continue
    to condemn the speculative money that commodity index funds
    bring to the commodity markets.
        Commodity-related exchange traded products (ETPs), have
    added further fuel to the speculative fire. Exhibit 6 lists
    some of the many ETPs which offer securities that track the
    value of a designated commodity or basket of commodities, but
    trade like stocks on an exchange.\1\ ETPs are marketed to
    investors looking to make money off commodity price changes
    without actually buying any futures. The financial firms
    running the ETPs often support the value of the fund by
    purchasing commodity futures or using futures to offset risks.
    The result, as shown in this chart, which is Exhibit 1b,\2\ is
    that in 2011 alone, these ETPs have poured over $120 billion of
    speculative money into U.S. commodity markets.
    ---------------------------------------------------------------------------
        \1\ See Exhibit No. 6 which appears in the Appendix on page 176.
        \2\ See Exhibit No. 1b which appears in the Appendix on page 111.
    ---------------------------------------------------------------------------
        Now, that is not all. A third wave of commodity speculation
    has come from the $11 trillion mutual fund industry which,
    since 2006, has turned its attention to U.S. commodities in a
    big way. Hearing Exhibit 7a \3\ identifies more than 40
    commodity-related mutual funds that, by 2011, as shown in this
    chart, which is Exhibit 1c,\4\ have accumulated assets of over
    $50 billion. That chart shows the growth of the mutual fund
    purchases of these commodity futures. The sales materials from
    some of those mutual funds, which are included in Exhibit
    7b,\5\ show that they are marketing themselves to average
    investors as commodity funds and delving into every kind of
    commodity investment out there, from swaps to futures, putting
    additional speculative pressures on commodity prices.
    ---------------------------------------------------------------------------
        \3\ See Exhibit No. 7a which appears in the Appendix on page 185.
        \4\ See Exhibit No. 1c which appears in the Appendix on page 112.
        \5\ See Exhibit No. 7b which appears in the Appendix on page 186.
    ---------------------------------------------------------------------------
        Now, by law, mutual funds are supposed to derive 90 percent
    of their income from investments in securities and not more
    than 10 percent from alternatives like commodities. But the 40
    commodity-related mutual funds that we have identified have
    found ways around that law by, among other steps, setting up
    offshore shell companies that do nothing but trade commodities.
        Those offshore shell companies are typically organized as
    Cayman Island subsidiaries with no offices or employees of
    their own and with their commodity portfolios run from the
    mutual fund's U.S. offices. This blatant end-run around the 90/
    10 restriction has nevertheless been blessed by the IRS which
    has issued dozens of private letter rulings, which are listed
    in Exhibit 7d,\6\ which deem the offshore arrangements to be
    investments in securities rather than commodities, since the
    parent mutual funds hold all of the stock in those offshore
    subsidiaries. The IRS has recently put a moratorium on these
    private letter rulings while it studies the issues. In
    addition, the offshore shell corporations are currently exempt
    from CFTC registration requirements, despite operating as
    commodity pools, a situation the CFTC is reviewing as a result
    of a petition filed by the National Futures Association, as
    indicated in Exhibit 7c.\1\
    ---------------------------------------------------------------------------
        \6\ See Exhibit No. 7d which appears in the Appendix on page 235.
        \1\ See Exhibit No. 7c which appears in the Appendix on page 223.
    ---------------------------------------------------------------------------
        Now, I am glad the IRS and the CFTC are studying these
    offshore arrangements as well as the broader issue of mutual
    fund investment in commodities. If the mutual fund industry
    were to step up its commodities investments to even just 10
    percent of its overall assets, it would unleash another tidal
    wave of speculative money into the commodities markets.
        There is more. Over the last few years, high-frequency
    traders have also invaded the commodities markets, seeking to
    profit from the increasing price volatility. Those high-
    frequency traders have revved up commodity trading with day-
    trading strategies that further contribute to constantly
    changing prices.
        Put together the swap dealers, hedge funds, ETPs, mutual
    funds, and high-frequency traders, and the result is a tsunami
    of speculative money pouring into commodity markets at
    unprecedented levels. Today, speculators make up the bulk of
    the outstanding contracts in most commodity markets, providing
    typically more than 70 percent of the market. Producers and
    users of commodities now hold as little as 20 or 30 percent of
    the outstanding contracts in some markets. So it is no surprise
    that commodity prices have become increasingly volatile, with
    exaggerated swings that have little to do with hedging, little
    to do with supply and demand for the underlying commodities,
    and everything to do with folks betting and speculating on
    price changes.
        Take the U.S. crude oil market as an example. In 2007, a
    barrel of crude oil started out the year costing $50, but by
    the end of the year had nearly doubled in price. In 2008, oil
    prices shot up in July to over $145 per barrel and then, by the
    end of the year, crashed to $35 a barrel. In the beginning of
    2011, oil prices took off again, climbing to over $110 per
    barrel in May. Then they fell to a low of $77 per barrel in
    early October, a drop of more than 30 percent in 4 months.
    Three weeks later, they are back up to $92 per barrel, a 15-
    percent increase. This price volatility has taken place at the
    same time that world inventories were plentiful and basically
    matched world demand, as shown in this chart prepared for the
    Subcommittee by the Energy Information Agency, which is Exhibit
    1d.\2\ In other words, the price changes in West Texas
    Intermediate, the benchmark crude oil contract for the United
    States, cannot be explained simply as a function of supply and
    demand for oil.
    ---------------------------------------------------------------------------
        \2\ See Exhibit No. 1d which appears in the Appendix on page 113.
    ---------------------------------------------------------------------------
        During the same period crude oil prices went haywire,
    speculators have become the dominant players in the crude oil
    market. CFTC data indicates that speculators--traders who do
    not produce oil or use oil in their business--now hold over 80
    percent of the outstanding contracts in the oil futures market.
    While speculation is not necessarily the primary factor setting
    oil prices, the facts indicate that speculation is a major
    contributor.
        It is not just the numbers telling this story. Major
    players in the oil industry also point to the role of
    speculation in crude oil prices. For example, in May 2011,
    ExxonMobil CEO Rex Tillerson agreed that speculation was
    contributing to oil prices, estimating that the price of a
    barrel would be $60 to $70, instead of $110, if governed
    exclusively by supply and demand.
        The same complaint is heard with respect to other
    commodities. Recently, 450 economists from around the world
    stated in a joint letter to the G-20 leaders, which we include
    in the hearing record as Exhibit 9:\2\ ``Excessive financial
    speculation is contributing to increasing volatility and record
    high food prices exacerbating global hunger and poverty.'' And
    the CEO of Starbucks, Howard Schultz, who tracks coffee prices,
    had the following to say:
    ---------------------------------------------------------------------------
        \1\ See Exhibit No. 9 which appears in the Appendix on page 244.
    ---------------------------------------------------------------------------
        ``[W]hy are coffee prices going up? [A]nd in addition to
    that, why is every commodity price going up at the same time? I
    think what's going on is financial engineering; that financial
    speculators have come into the commodity markets and drove
    these prices up to historic levels and as a result of that the
    consumer is suffering.''
        Excessive speculation is not new. In fact, much of the law
    related to commodity markets can be understood as an effort to
    prevent excessive speculation and market manipulation from
    distorting prices.
        Over the years, one of the most powerful weapons developed
    to combat the twin threats of excessive speculation and price
    manipulation has been the imposition of position limits on
    traders. But over the years, Federal position limits have lost
    much of their punch due to a growing raft of loopholes, gaps,
    and exemptions. For example, prior to the Dodd-Frank Act,
    position limits didn't apply to some key futures contracts;
    they often applied only in the spot month instead of other
    times; and multiple market participants were given exemptions.
    In addition, until recently, the entire commodity swaps market
    had no position limits at all.
        The combination of increased speculation and weakened
    position limits has clobbered American consumers and businesses
    with unpredictable and inflated commodity prices. That is why,
    when Congress enacted the Dodd-Frank Act last year, Section 737
    directed the CFTC to establish position limits on all types of
    commodity-related instruments, including futures, options, and
    swaps. The Dodd-Frank Act also directed the CFTC to issue a
    rule establishing the new position limits by January 2011, one
    of the earliest implementation dates in the entire law.
        The CFTC missed that deadline but 2 weeks ago, after
    reviewing over 15,000 public comments, at long last issued a
    final rule. The good news is that the agency complied with the
    law's requirements to establish position limits to ``diminish,
    eliminate, or prevent'' excessive speculation, and rejected
    unfounded claims that excessive speculation had to be proven
    for each commodity before a limit could be established to
    prevent damage to consumers and the economy. That has never
    been the law, and it has no basis in the Dodd-Frank Act which
    is aimed at preventing problems, not waiting for them to occur
    and cleaning up afterwards.
        Also good news is that the CFTC rule applies position
    limits to 28 key agricultural, metal, and energy commodities;
    applies those limits to futures, options, and swaps; and covers
    all types of speculators.
        The bad news, from my perspective, is that while the limits
    appear designed to prevent any one trader from amassing a huge
    position that could lead to price manipulation in a particular
    month, the limits do not appear to be designed to combat the
    type of excessive speculation caused by large numbers of
    speculative investment funds. In addition, exempting multi-
    commodity index swaps from any position limits, failing to
    apply effective position limits to commodity index swap
    dealers, and delaying implementation of the swap position
    limits for another year are troubling.
        Roller coaster commodity prices and the growing flood of
    speculative dollars continue, while it will be another year
    before the full range of position limits in the new CFTC rule
    take effect. In the meantime, we are talking about ongoing
    gyrations in gasoline prices, heating and electricity costs,
    and food prices that affect every American family. We are
    talking about unstable prices for copper, aluminum, and other
    materials essential to industry. At stake are energy, metal,
    and food costs key to inflation, business costs, and family
    budgets nationwide.
        Until effective position limits are actually in place, the
    American economy will remain vulnerable to chaotic price swings
    that benefit speculators at the expense of American consumers
    and businesses.
        Today's hearing is intended to shine a spotlight on the
    ongoing role of speculation in U.S. commodity markets and how
    the new position limits can combat excessive speculation. We
    will hear today from a panel of experts representing business,
    consumers, and academia, as well as from CFTC Chairman Gary
    Gensler.
        Now let me invite our Ranking Member, Dr. Coburn, to share
    his views with us.

                  OPENING STATEMENT OF SENATOR COBURN

        Senator Coburn. Thank you, Mr. Chairman.
        I want to thank Senator Levin for holding this hearing
    today. He has been a leader for years in Congress on efforts to
    better understand and monitor commodity markets, which should
    make us more capable of holding market regulators accountable
    in their efforts to ensure American exchanges remain the most
    dynamic, transparent, and desirable places to do business.
        Commodity markets and pricing have profound effects on the
    people in my home State of Oklahoma, who are invested in
    virtually all of the commodities covered by the rules we will
    discuss today. Whether it is oil, natural gas, wheat, or any of
    the other 28 commodities, market participants all the way from
    the producer to the end user will be affected by recent and
    upcoming regulatory changes.
        It is our obligation in Congress to make sure regulators
    act in the public interest, based on facts and data, rather
    than reflexively placing restrictions on unpopular market
    participants. While today's hearing will focus on the concept
    of ``excessive'' speculation, it is imperative that we remember
    one fundamental truth: That futures markets cannot function
    without speculators who make markets, provide liquidity for
    hedgers, aid in price discovery, and take risks.
        Two weeks ago, the CFTC issued its long-awaited position
    limits, imposing limits on the number of futures contracts
    individuals or institutions can hold. The most recent version
    of the rule was rushed through the Commission and applied
    across the board to 28 separate commodities. Much of this seems
    to have been done in response to intense pressure, and the
    unfortunate result is likely to be challenged in court.
        In addressing commodities, the Dodd-Frank Act said the CFTC
    ``shall by rule, regulation, or order establish limits on the
    amount of positions, as appropriate.'' In at least two
    Commissioners' views, those tests have not been met. Yet now
    every participant in the commodities market must comply with a
    final rule that is over 300 pages long.
        Commissioner Scott O'Malia indicated in his dissenting
    opinion that the Commission voted ``without the benefit of
    performing an objective factual analysis based on the necessary
    data to determine whether these particular limits and limit
    formulas will effectively prevent or deter excessive
    speculation.'' There is no question we want to limit excessive
    speculation, but it needs to be based on data and facts, not
    feelings.
        Commissioner Jill Sommers also worried that the CFTC ``is
    setting itself up for an enormous failure'' by issuing a
    position limits rule that ``ironically, can result in increased
    costs to consumers.''
        Position limits can be a very effective regulatory tool,
    but must be used in the right way. For example, we have limits
    on cotton--they are in place--yet the cotton No. 2 futures
    contract has hit 16 record-setting prices since December 1,
    2010. Why is that? Because of crop failures around the rest of
    the world, and because of a drought in the United States.
        Position limits must be set at the proper level for each
    individual commodity. Unfortunately, the CFTC chose to use the
    blunt weapon of across-the-board limits for nearly every
    commodity.
        While today's hearing will be a good opportunity to discuss
    the effects of that excessive speculation--and in that I agree
    with my Chairman--we need to be careful not to accuse investors
    of wrongdoing where none has occurred. Commodity index funds,
    exchange traded funds, and mutual funds are not diabolical
    schemes. They are simply financial instruments that some
    investors use as tools to hedge or gain exposure to commodity
    markets, thus protecting against inflation and other risks in
    their portfolios.
        Last, I would like to address my strong concerns with the
    Dodd-Frank Act in general, which itself was rushed through
    Congress last year. The law that was supposed to help fix our
    financial system has instead wreaked regulatory havoc,
    increasing uncertainty and compliance costs, doing nothing to
    address unemployment, and it did nothing to effect the
    initiation of the problems that we are presently faced with,
    basically Fannie Mae and Freddie Mac. The act required over 300
    new regulations and studies and has overwhelmed our regulatory
    agencies while causing widespread confusion in the marketplace.
        As we move forward, we in Congress must improve our
    understanding of the markets being regulated, as well as the
    internal and external challenges facing our regulators.
    Continuous oversight and transparency through hearings like
    this are essential to ensure our regulators do not overreach
    their mandates and that U.S. markets remain the envy of the
    world.
        One of my greatest concerns is every trader in the world is
    one click away from trading somewhere else, and there are
    tremendous markets in this country that are going to be put at
    risk through this new rule.
        The last thing we want to do is suffocate those markets and
    chase interested participants to other exchanges and trading
    venues abroad, many of whom would like nothing more than to
    take away America's business.
        Despite my concerns about the Dodd-Frank Act, it must be
    implemented in a thoughtful, responsible manner by our
    regulators. I look forward to a healthy discussion during this
    hearing, Mr. Chairman. I thank our witnesses for attending, and
    I look forward to hearing your views and recommendations today.
    Thank you.
        Senator Levin. Thank you very much, Dr. Coburn.
        We are now going to call our first panel of witnesses for
    this morning's hearing: Paul Cicio is President of the
    Industrial Energy Consumers of America. Tyson Slocum is Public
    Citizen's Emergency Program Director. Wallace Turbeville is a
    Derivatives Specialist with the nonprofit Better Markets,
    Incorporated.
        Now, the Subcommittee invited and we had hoped to have with
    us Dr. Craig Pirrong, who is professor of finance at the Bauer
    College of Business at the University of Houston. He was able
    to make our originally scheduled hearing, but was unable to
    make this hearing, which we regret that he could not be with us
    today to give us his views. But what we will do is invite him
    to provide his views in a written statement.
        We do appreciate each of the witnesses who were able to
    join us this morning. We look forward to your testimony.
    Pursuant to Rule VI, all witnesses who testify before the
    Subcommittee are required to be sworn. At this time I would ask
    our first panel to please stand and raise your right hand. Do
    you swear that the testimony you will give before this
    Subcommittee is the truth, the whole truth, and nothing but the
    truth, so help you, God?
        Mr. Cicio. I do.
        Mr. Slocum. I do.
        Mr. Turbeville. I do.
        Senator Levin. Now, we are going to use the timing system
    today. About 1 minute before the red light comes on, you will
    see the lights change from green to yellow, which will give you
    an opportunity to conclude your remarks. Your written testimony
    will be printed in the record in its entirety. We would ask
    that you limit your oral testimony to no more than 7 minutes.
        Mr. Cicio, we are going to have you go first, followed by
    Mr. Slocum, followed by Mr. Turbeville. After we have heard all
    the testimony, we will then turn to questions.
        So, Mr. Cicio, please proceed.

      TESTIMONY OF PAUL N. CICIO,\1\ PRESIDENT, INDUSTRIAL ENERGY
                          CONSUMERS OF AMERICA

        Mr. Cicio. Chairman Levin, Ranking Member Coburn, and
    Subcommittee Members, thank you for the opportunity to testify
    before you today. My name is Paul Cicio, and I am the President
    of the Industrial Energy Consumers of America (IECA).
    ---------------------------------------------------------------------------
        \1\ The prepared statement of Mr. Cicio appears in the Appendix on
    page 59.
    ---------------------------------------------------------------------------
        IECA has been a long-time supporter of setting responsible
    speculative position limits. Since all of our companies use
    substantial quantities of natural gas, we will use natural gas
    illustrations to address the Subcommittee questions.
        Speculative trading volumes have been explosive in growth,
    even though natural gas consumption in the country has only
    increased moderately. For example, natural gas open interest
    increased by 590 percent since 1995, even though U.S.
    consumption has increased only 6.5 percent. Almost all of the
    open interest is from noncommercial trades.
        Large speculative volumes can be a problem because they can
    move market price and they do increase volatility. Charts 1 and
    2 of our written testimony uses CFTC data to show that, in late
    2008, four trades controlled about 50 percent of the open
    interest in natural gas. Eight traders controlled 60 percent of
    the open interest. That means that only a handful of trading
    companies can have an incredibly important impact on the price
    of natural gas.
        High volatility will increase the cost of hedging to
    manufacturers because there is a direct relationship between
    volatility and, for example, the option price premium. Higher
    volatility also increases the bid-ask spread in the forward
    market.
        To illustrate the point, using the closing Henry Hub Index
    price of natural gas, just last Friday, at $4.04 per million
    Btu, a call option for 100,000 MM Btus with a 6-month
    expiration at the money would cost a manufacturer approximately
    $36,500. If we increased the implied volatility of only 5
    percent, the premium cost goes up 15 percent. If we increased
    the implied volatility 10 percent, the premium cost rises 31
    percent. And if we increase the implied volatility 20 percent,
    it increases the option premium a whopping 61 percent.
        IECA supports the imposition of speculative position
    limits, but setting the limit at 25 percent of the estimates
    deliverable supply is too large and will do little to reduce
    excessive speculation.
        Let us put in perspective what setting speculative position
    limits at 25 percent means by looking again at natural gas. If
    only 100 traders trade at the spec limit, they would control 25
    times the U.S. monthly demand. There are approximately 250 to
    350 traders that report to the large trader report at the CFTC
    from time to time. If only 100 trade, they would control 25
    times the entire consumption.
        Regarding commodity index funds and ETFs, we believe that
    passive speculators should be banned from the futures market.
    At minimum, they should be subjected to individual speculative
    position limits.
        The next best alternative is to set spec position limits on
    all commodity-related ETFs and index funds. Swap dealers and
    ETF managers should be subject to speculative position limits
    except for hedges associated with transactions with producers
    and consumers of the underlying commodity.
        There are several reasons that passive index funds should
    be banned. First, passive index funds put upward pressure on
    price. CFTC index investment data for natural gas between
    December 2007 and September 2011 show that index funds held a
    long position 86.2 percent of the time and only held short
    positions 17.4 percent of the time. And index funds continue
    explosive growth. CFTC data indicates that index open interest
    contracts increased by 294 percent just since December 2007.
        Second, passive index speculators also reduce liquidity by
    buying and then holding larger and larger quantities of futures
    contracts. This is inconsistent with the functioning of the
    futures market that serves consumable commodities that have a
    prompt month that expires.
        And last, they also buy without regard to price, supply, or
    demand, which, of course, impacts price discovery. Thank you.
        Senator Levin. Thank you, Mr. Cicio. Mr. Slocum.

      TESTIMONY OF TYSON T. SLOCUM,\1\ DIRECTOR, ENERGY PROGRAM,
                             PUBLIC CITIZEN

        Mr. Slocum. Chairman Levin and Ranking Member Coburn, thank
    you very much for the opportunity to allow me to testify today.
    I am Tyson Slocum, and I direct Public Citizen's Energy
    Program. We are one of America's largest consumer advocacy
    groups, and we are proud to be celebrating our 40th anniversary
    this year. We work on a range of issues, and I head up our
    energy work.
    ---------------------------------------------------------------------------
        \1\ The prepared statement of Mr. Slocum appears in the Appendix on
    page 68.
    ---------------------------------------------------------------------------
        I am tasked at Public Citizen with promoting those policies
    that are going to produce affordable, reliable, and clean
    energy, and it is clear from my personal work on this issue
    over a decade that current energy markets are driven not by the
    supply-demand fundamentals but by speculation.
        There has been a lot of great work, Mr. Chairman, by this
    Committee over the years, as you mentioned in your opening
    statement, that has helped make that case. But it is not just
    this Committee, it is not just industrial consumers, and it is
    not just household consumers, but members of industry as well.
    You mentioned in your opening statement that the chairman and
    CEO of ExxonMobil noted the role that speculation plays in the
    current price of a barrel of oil, and even the investment bank
    Goldman Sachs earlier this year revealed that they believe the
    speculation price is around $27 a barrel for 2011. And Dr. Mark
    Cooper, a colleague at the Consumer Federation of America,
    estimated that around $30-a-barrel-oil of a speculation tax
    equates to about $600 in increased gasoline costs for the
    average family and about $200 billion across the economy.
        So when I am taking a look at these markets, it is clear
    that around a $30 speculation tax, which translates to about
    $600 costs to the average family over the course of a year is
    indeed excessive levels of speculation, and it is the duty of
    Congress and regulators to help protect household consumers and
    businesses from these excessive costs.
        Does the Dodd-Frank Act and the way that it has been
    implemented by the CFTC effectively address that? And Public
    Citizen's analysis is that the proposed position limit
    rulemaking does not go far enough. As my colleague, Mr. Cicio,
    pointed out, the speculation limit of 25 percent and then 10
    percent and then 2.5 percent, depending on the contracts,
    allows for too great of holdings. There was some recently
    leaked data by a U.S. Senator to the media that detailed the
    positions of individual traders, and this clearly showed that
    the largest five operators in the WTI market--Goldman Sachs,
    Vital, Morgan Stanley, Deutsche Bank, and Barclays--had
    positions that were between 5.3 and 8.7 percent. And that is
    why Public Citizen believes that speculation limit needs to be
    more in line with proposed legislation that has sponsorship in
    both the Senate and the House, S. 1598 and H.R. 3006, that
    would establish a statutory position limit of 5 percent that
    would get at the concentrations that the leaked data clearly
    shows.
        It is not just banks that are involved in these markets and
    making profits. Again, a leaked document that Chevron
    inadvertently leaked to the public this summer showed that the
    company earned $360 million over the first 6 months of this
    year not from doing what it is supposed to do, which is
    providing the American public with oil that it works hard and
    spends a lot of money to get out of the ground in the United
    States and elsewhere and refine into useful products, but in
    speculating, that Chevron was speculating far and above their
    hedging needs and using the commodity markets to make money the
    same way that investment banks do. And when the Wall Street
    Journal reported this, they noted that Chevron, like other
    major proprietary traders that also feature control or
    ownership over energy infrastructure assets, utilized those
    energy infrastructure assets to have a sneak peek at the market
    and give them a massive competitive advantage.
        Mr. Chairman, like you said, they do not like to gamble.
    They want to have more certainty, and having a large control
    over the market in terms of their positions and having access
    to energy infrastructure assets provides them that advantage.
    We have seen Goldman Sachs through its control over Kinder
    Morgan now is going to have control over about 67,000 miles of
    petroleum product and natural gas pipelines throughout the
    United States. They have ownership interests now in two
    refineries in the United States. Morgan Stanley spends hundreds
    of millions of dollars a year on acquiring control over storage
    capacity. None of this is adequately regulated, and another
    issue that Public Citizen promotes is having firm rules
    limiting the communications between energy infrastructure
    affiliates and trading affiliates.
        In addition, Public Citizen shares the concerns of this
    Subcommittee and the research that was presented to us in your
    opening statement that the rise of index funds is highly
    disruptive, and like my colleague, Mr. Cicio, I believe that
    index funds do not have a legitimate role in these markets. And
    I applaud the efforts of the Subcommittee to examine problems
    of mutual funds getting involved in these markets as well.
        Thank you very much for your time, and I look forward to
    your questions.
        Senator Levin. Thank you, Mr. Slocum. Mr. Turbeville.

    TESTIMONY OF WALLACE C. TURBEVILLE,\1\ DERIVATIVES SPECIALIST,
                          BETTER MARKETS, INC.

        Mr. Turbeville. Good morning, Chairman Levin and Ranking
    Member Coburn. Thank you for the opportunity to speak today. My
    name is Wallace Turbeville, and I am a derivatives specialist
    at Better Markets, Inc. Better Markets is a nonprofit,
    nonpartisan organization whose mission is to promote the public
    interest in the domestic and global capital and commodity
    markets.
    ---------------------------------------------------------------------------
        \1\ The prepared statement of Mr. Turbeville with attachments
    appears in the Appendix on page 77.
    ---------------------------------------------------------------------------
        Personally, I have worked in the securities industry for 31
    years as a practicing attorney first, as an investment banker
    at a Wall Street firm, and managing companies as a principal.
        In the 10 years since deregulation, commodities markets
    have changed dramatically, and the public has been plagued by
    boom-and-bust price cycles. Prior to that time, physical
    hedgers consistently represented about 70 percent of the
    futures markets. Now the ratio of participants has reversed.
    Speculators now account for about 70 percent or more of the
    open interest in many markets, while physical hedgers have
    fallen to only about 30 percent. This increased speculation is
    in large part driven by commodity index funds, which are
    predominantly sponsored by large dealer banks. These are
    vehicles reminiscent of residential mortgage structures
    designed to synthetically convert barrels of oil and bushels of
    corn into investment asset classes. These changes have
    profoundly affected prices and price discovery.
        Now, the CFTC adopted position limits in response to the
    congressional mandate to address the issues in energy,
    agriculture, and metals just recently. This rule establishes
    some very important principles, but much remains to be done to
    improve limits on speculators, in particular commodity index
    traders.
        Since 2004, highly structured commodity index investment
    vehicles have become dominant forces in the futures markets
    with dramatic impacts in the physical markets as well. Not
    surprisingly, we are now in a period of boom-and-bust commodity
    prices as a result. These investments have been marketed to
    large institutional investors as a new asset class for
    diversifying investment portfolios, and they have responded
    quite well for the marketers.
        Index investors have injected amounts which have been
    estimated to be between $200 and $300 billion into the market,
    fundamentally changing the way the futures markets work.
        Analysis of commodity speculation is now in the hands of
    academics, self-interested market participants, and the CFTC.
    Each seeks the answer to a single question: Are the boom-bust
    price cycles in basic commodities related to the explosion of
    speculative and highly structured trading activities? Or is it
    just merely a coincidence that these happened at the same time?
        Now, commodity index investments were created to
    synthetically mimic ownership of market baskets of physical
    commodities and are valued using indices. It is kind of an
    interesting thing. I am not aware that anybody considered the
    possibility that if you synthetically created a huge ownership
    interest in barrels of oil and bushels of wheat and corn,
    whether that synthetic ownership interest in large size would
    actually affect the market because the market would interpret
    that as hoarding activity when these vehicles were first
    created. But the consequences, as it has turned out, are very
    serious.
        Unlike a business with shares that trade, the value of a
    barrel of oil or bushel of corn derives from its consumption,
    at which point that value ends. If it can never be consumed, it
    has no value. However, commodity index funds are, in theory,
    perpetual. It is a synthetic ownership interest that goes on
    forever.
        To synthesize perpetual ownership and make it look more
    like a share of stock, the commodity index fund bank sponsors
    take large futures and physical commodity positions and roll
    them over continuously in massive amounts at specified times.
    So everyone in the whole market knows that at specified times
    during each month this large rollover of futures contracts
    occurs.
        Like the Phoenix, the index hedges, all of them, and
    repeatedly, are destroyed and re-created with longer maturities
    at each roll in order to create synthetic perpetual ownership.
    These repeated events are so important to the market that many
    trades focus a bulk of their activities on the commodity index
    rolls.
        The concern is that the rolls affect the price curves.
    Price curves are very important. The price curve is how the
    market tells the world what prices are likely to be this month
    and in the month to come. When it slopes upward--that is to
    say, November prices are higher than October--the futures
    market is telling producers and consumers that prices are
    likely to rise. When it is flat or downward sloping, the
    message is that the prices will be stable or fall. This is
    tremendously important because businesses organize themselves
    along these lines.
        The shape of the price curve has changed. Historically, it
    was flat to downward sloping most of the time. Since 2004, it
    has been upward sloping almost all of the time. The message is
    that prices are rising, and it is a constant message that is
    repeated over and over.
        Better Markets recently released a study of price curve
    dynamics in the roll. We isolated the predominant roll periods
    for each trading month over the last 27 years and compared them
    to determine whether there was a tendency for prices to rise--
    sorry, for the price curve to rise at the time of the roll. We
    found that starting in 2004, when index trading expanded, the
    correlation between the roll period and its bias was
    pronounced. In fact, the price bias in the crude oil futures
    markets was correlated at 99 percent level with the roll. For
    every other 5-day period in every other month over that 27
    years, there was no correlation between upward or downward
    prices for these periods. So we concluded that the forces which
    were signaling increased prices were specific to the roll
    period and were caused by commodity index roll trading.
        The market as a whole reacted to the signal, and a price
    bubble emerged. Eventually, supply-and-demand forces must
    overcome the trading-driven sentiment, and the bubble bursts.
        Thank you for the opportunity to discuss these crucial
    questions. I am pleased to answer any questions you may have
    now or in the future.
        Senator Levin. Thank you very much, Mr. Turbeville, and
    each one of you. We will try an 8-minute first round. I expect
    we will have a number of rounds for each panel.
        Mr. Cicio, first, tell us again very directly how
    businesses are harmed when oil futures prices are subject to
    roller coaster prices like the ones that are pushed up to
    artificial levels and then plummet down and then climb back up.
        Mr. Cicio. The example that we have provided in our
    testimony is very clear. When there is increased volatility, it
    increases the cost of hedging. Manufacturers are consumers.
    They are only going to hedge as much as they are going to
    consume, or they may hedge less than they will consume. The
    example that we have provided is an option on natural gas and
    it illustrates that increased implied volatility has a
    substantial cost increase on the premium of that option. The 5-
    percent increase in implied volatility increases the premium
    cost of that option 15 percent. Fifteen percent all by itself
    is a large amount for a company to lay out. Anything they lay
    out above that existing on-the-money option is cash that they
    have to put up. That is working capital that could be used for
    other things.
        Senator Levin. Is that usually passed down to consumers?
        Mr. Cicio. Manufacturers compete in a very globally
    competitive environment. If it is possible for us to pass that
    through to our customers, we would. But in most cases, costs of
    this nature cannot be passed through because of global
    competition.
        Senator Levin. And the hedging that they want to do is to
    provide themselves with a stable economic environment so that
    they can know what the costs of oil or any other commodity is.
    Is that correct?
        Mr. Cicio. Yes, that is correct. Think of it this way: One
    of the first things we do is buy basic raw materials like
    natural gas or crude oil that is used to produce our products.
    The time frame from producing the product to making a widget, a
    manufactured product, and then getting it out to the customer,
    is a long time. We price our product out a long time. If we
    price the product out and in the interim the price of the raw
    materials continues to escalate, then we have a price with
    rising costs that reduce our margins.
        Senator Levin. Now, according to the Consumer Federation of
    America--and this I will address to you, Mr. Slocum--excessive
    speculation has added about $30 per barrel to the cost of crude
    oil in 2011, and as you pointed out, that added $600 to the
    average household expenditure for gasoline in 2011. The total
    drain on the economy in 2011 from speculation-driven excessive
    cost is more than $200 billion, and the report concludes,
    ``Transferring that much purchasing power from consumers on
    Main Street to speculators on Wall Street puts a severe drag on
    the economy'' and has ``already dampened economic growth.''
        What do you think of those findings?
        Mr. Slocum. I agree with it. And like I said, it is also in
    line with what Goldman Sachs itself said in a research note to
    its investors. So the estimate provided by Dr. Mark Cooper that
    you just cited is absolutely in line with what one of the
    largest speculators in the country, Goldman Sachs, also
    estimated. And just like Mr. Cicio's members are hit hard by
    these increasing prices and the volatility, so are working
    families across the country. And people are beginning to
    understand the role that Wall Street plays in this. We see
    citizens of all walks of life participating in activities
    around the country directed at frustrations with Wall Street
    profits while families are really struggling to make ends meet.
        Senator Levin. Mr. Turbeville, speculators, according to
    your testimony, are now overwhelming the commodity markets and
    dwarfing the participation by commercial hedgers. They now
    account, I believe your testimony was, for 70 percent or more
    of the outstanding contracts in many commodity markets while
    actual hedgers have fallen to only 20 or 30 percent
    participation, and even lower in some markets.
        You have, I think, indicated that this is a historically
    new shift. Is that correct?
        Mr. Turbeville. That is correct.
        Senator Levin. In other words, a few years ago it was very
    different, perhaps the opposite, but at least very different
    from what it is now. Are there any barriers to speculators
    making up 90 percent of the commodity market, or even 99
    percent?
        Mr. Turbeville. No. In fact, the new position limit rules
    go to the percentage of open interest that an individual
    speculator might have, so that the aggregate amount of
    speculation in a market, in fact, is not limited. And that is a
    real concern. It is not just the size of speculation. It is
    also the structure of speculation and how speculation has
    created this--has been created in sort of an ecosystem around
    the big bank traders that are trading these roll period
    contracts that I described.
        So it is both the size, absolute size, and the actual
    structure of the speculation that is very much a concern.
        Senator Levin. The most important question is the
    relationship between the amount of speculation in commodities
    and the prices of those commodities. We had a chart we put up
    there which shows that most of the speculative interest is on
    the long side, but there is obviously a short for every
    long.\1\ But, nonetheless, when the speculative interest is on
    the long side and is pushing prices upward, sooner or later
    there may be a short side to make to be on the other side of
    the deal, but that has an upward price pressure on futures
    contracts. Like any market, if there is a greater demand for
    the paper, it is going to push the price of the paper up, if
    there is a great demand for the long side of that paper.
    ---------------------------------------------------------------------------
        \1\ See Exhibit 1a which appears in the Appendix on page 110.
    ---------------------------------------------------------------------------
        Now, how does that get translated into the price of the
    commodity? I think that is what we really need to drive home,
    that these futures contracts and the demand for futures
    contracts and the demand for the long side on futures
    contracts, which will be met by somebody willing to go short,
    but, nonetheless, as the demand goes up for that long side--or
    the bet that the price is going to go up--will not just affect
    the price of the futures contract but that huge demand will be
    translated somehow into a demand for the underlying commodity.
        In my opening statement, I tried to describe how that is
    done in a very simple way, but could each of you now take a try
    at that issue. Let us start with you, Mr. Cicio.
        Mr. Cicio. One just needs to look at the index fund data
    that we cited earlier that shows that 86-plus percent of all of
    the positions are long.
        Senator Levin. This is for the index fund people.
        Mr. Cicio. For the index funds, that is correct.
        Senator Levin. OK.
        Mr. Cicio. And when that happens, there is mounting
    pressure month after month because they roll their volumes
    forward. When it comes to speculation and what impact it has on
    price really depends upon the specific commodity. Like in the
    case of natural gas today, you saw the numbers. We have a lot
    more speculators open interest than hedgers and producers.
    Because there is a lot more of physical natural gas--there is
    more supply today than there is demand for natural gas--the
    speculators are having a very difficult time creating that
    speculation because the physical product is so overwhelming
    that it is keeping the trading within a narrow range. So in
    that situation, having tight speculative position limits is not
    all that important. The reverse is what we are really worried
    about. If you have a market, a physical market that is
    basically in supply and demand, or there is more demand than
    there is supply, is when you need spec limits. That is when it
    is crucial that those be in place because speculators have a
    herding effect. They make money on the changes in price. They
    love speculation. They thrive on it. That is when their
    profitability increases. And they go to specific commodities
    when they sense that supply and demand of the physical
    commodity is in their favor to create speculation. So these
    things all tie together to impact the price, but it is on a
    commodity basis.
        Senator Levin. It depends on the supply-and-demand
    situation for the underlying physical commodity in your
    judgment.
        Mr. Cicio. Yes, sir.
        Senator Levin. Mr. Slocum, do you want to try to address my
    question? How does the speculation get translated into impact
    on price?
        Mr. Slocum. I would be happy to. I think what you see--and
    you kind of alluded to this--is this manufactured demand of
    these entities buying and selling these contracts and
    controlling such a big chunk of it, and particularly the
    disruptive influence that the index funds play, particularly as
    the contract month comes to expiration, where it is crowding
    out the folks that are looking to legitimately hedge. And so it
    is increasing prices for the market as a whole, and a lot of
    this has to do with the fact that we do not have adequate
    limits on the size of the positions that the banks can take.
        You also see a lot of other effects go on. Markets are
    based on fundamentals. They are based on opportunities. They
    are also psychological. Everyone knows that a Goldman Sachs is
    a major presence and player in the market, so when their
    analysts produce a report that say oil is going to hit $90 a
    barrel or go up to $100, it has a phenomenon of saying, well,
    that is where Goldman is headed and that is where we need to
    head because they are driving the market. And so I think that
    is an issue that also needs be examined.
        Senator Levin. OK. Mr. Turbeville.
        Mr. Turbeville. When the rollover occurs, you see firms
    like Goldman Sachs and JPMorgan and all the very sophisticated
    firms selling the November contract and then buying the
    December contract at a higher price because they are
    insensitive to the actual prices they get on the contracts,
    that all gets passed through to the investors. So they are
    really doing this rollover on behalf of the investors and
    passing the prices through.
        So what happens is that the message goes through to the
    market that sophisticated folks believe that prices are on the
    rise, prices will rise, and it really changes the information
    that the market has about supply and demand. The assumption is
    that those sophisticated folks must have some really good
    supply-and-demand information. That message is very important,
    and it passes through to prices.
        Mechanically, buying the December contract means that for
    many of the markets the physical delivery of product is indexed
    usually to the next maturing contract. So if the price curve is
    sloping upward, upward, upward, and pushed up, up, up, then
    what gets translated through is next month's future contract is
    higher; therefore, that gets indexed to the actual delivery
    contracts for physicals so----
        Senator Levin. I want to end my questions, but I want you
    to just drive that point home.
        Mr. Turbeville. Yes.
        Senator Levin. Because this to me is where there is a link,
    a direct link----
        Mr. Turbeville. Absolutely.
        Senator Levin. A direct link between a futures contract
    going up in price because of that last month, and that is used
    by the people who are actually buying and selling the
    commodity.
        Mr. Turbeville. That is right.
        Senator Levin. So that there is a direct link between the
    futures contract price going up and the commodity price going
    up because people buying and selling the actual commodity use
    that next month's futures price as the basis for their price in
    the actual commodity purchase and sale. Is that correct?
        Mr. Turbeville. That is absolutely the truth. The first
    thing you would look to, not only is it in the contracts, not
    only is it in the procedures for Platts and others that create
    indices like in the oil markets, it actually makes common
    sense. The first price that you would look to is the price that
    occurs--that is indicated for the next month. That will tell
    you whether you should hold onto your commodity or sell it now,
    which means that the next price is absolutely feeding into by
    contract, by indices, and by common sense the price for
    delivery of product in the current month.
        Senator Levin. Real product.
        Mr. Turbeville. Real product.
        Senator Levin. In the real current time.
        Mr. Turbeville. That is right.
        Senator Levin. Thank you. Dr. Coburn.
        Senator Coburn. Let me just follow up on that for a minute.
    What you are saying is this is divorced from supply and demand,
    real supply and real demand.
        Mr. Turbeville. Actually, what I am saying is that real
    supply and real demand, there is not a chart that producers and
    consumers go look up supply and demand, here is the price.
        Senator Coburn. No, but take the example--that is not
    happening on natural gas contracts right now.
        Mr. Turbeville. That is correct.
        Senator Coburn. And the reason is because there is an
    absolute excess supply of domestic natural gas in this country.
    Correct?
        Mr. Turbeville. I think there are two reasons. One is that
    prices are low because of excess supply. The other reason is
    that natural gas is structure--we have looked at this actually
    in our research, that natural gas is structurally different
    from products like oil and wheat. Natural gas comes through
    pipelines and is largely unstorable, so that the best predictor
    of price during a delivery month is actually the price in the
    nearest maturing futures contract, not the next one. And that
    is how people actually contract for natural gas.
        Senator Coburn. Except it is storable because I can show
    you all the wellheads that are turned off in Oklahoma because
    there is so much gas and there is no place to put it, so they
    are leaving it in the ground.
        Mr. Turbeville. You are absolutely right. It is relatively
    less storable----
        Senator Coburn. Let me go to each of you. One of our
    problems is volatility, which the Chairman has talked about,
    which we are seeing, and the connection of volatility to excess
    speculation. So would each of you give me what your definition
    of ``excessive speculation'' is?
        Mr. Cicio. Let me give you a reference point. Prior to
    2000, prior to deregulation of this market, producers and
    consumers of natural gas were about 70 percent of the market,
    and speculators were 30 percent. And I will tell you, from the
    energy managers that are a part of our organization, the market
    worked very well. The prices that we hedged reflected the
    underlying supply and demand of the market all the time. Now,
    these same people would say that the underlying price of the
    commodity does not always do that, and it is because of the
    influx of a lot of speculators who want to do a deal--but
    because the producer and the consumer have already taken care
    of their hedging, speculators will speculate with speculators.
    They are looking for deals to turn, and, again, the only way
    the speculators can turn a profit thru relative volatility.
        And so when you have large traders like the kind I talked
    about earlier, five traders or eight traders controlling 60
    percent of the natural gas market in 2008, these are companies
    with large amounts of cash, and they can move markets.
        Senator Coburn. All right. But let me go back to my
    question. What is ``excessive speculation''? Because that is
    our whole problem. And as you answer this, think about this one
    thing. Can we change the rules here, in our country can we
    change the rules on our exchanges and solve this problem?
    Because unless they are doing it in London, unless they are
    doing it in the rest of the trading centers around the world,
    my fear is, no matter what we do or how we do it and whether we
    are right or we are wrong, what we are going to do is the same
    behavior is going to take place unless all the exchanges
    throughout the world--because we will just trade somewhere
    different. We are just one click away.
        So you agree we have to have some speculators in the market
    to make a market.
        Mr. Cicio. Yes, sir, absolutely.
        Senator Coburn. So what is your definition of
    ``excessive''?
        Mr. Cicio. The only reference point--and this is not a good
    one. But the only reference point would be the one I mentioned
    earlier. Prior to deregulation, with 30 percent speculators----
        Senator Coburn. So compared to what it was then.
        Mr. Cicio. We had deals getting done, producers, consumers,
    and speculators, and so I would say--this is not an
    organization statement, but anything more than 30 percent.
        Senator Coburn. All right. And I would just say that
    discounts the change from 2000 to 2011 in terms of the
    globalization of all this trading, right? I mean, we have a lot
    of participants in our market that are not Americans.
        Mr. Cicio. But, Senator, this market is all about a
    commodity, a physical commodity, and the players, the number of
    players and the physical product in this case, natural gas, has
    hardly changed at all. It has only increased 6.5 percent since
    1995, but the volume of trades has increased 600 percent.
        Senator Coburn. So it has not had any effect on price.
        Mr. Cicio. Today, that is correct because of the
    oversupply. But just go back a few years ago, and, yes, sir, we
    did have high volatility and erratic pricing and prices higher
    than what we should have had.
        Senator Coburn. Yes, OK. Mr. Slocum, thank you.
        Mr. Slocum. Yes, I would like to just build on Mr. Cicio's
    comment, but it is clear that the data indicate a rise in the
    level of speculators, and to specifically answer your question,
    I think it is when those that do not have physical delivery or
    production contacts to the underlying commodity have a
    dominating presence in the market. Those that have delivery
    commitments or want to hedge--or if they are suppliers and want
    to hedge their exposure, when they are vastly outnumbered, and
    particularly with the rise of the index funds, where there is
    no interest in the physical delivery or supply of the
    underlying commodity, I think that the markets have become
    skewed. And transparency and disclosure I think is essential
    because the more transparent the marketplace is, the better
    functioning it is going to be for all participants, and we
    still do not see enough transparency. And I really think we
    need to see trader- specific-level data, not instantaneous
    because that would violate some proprietary issues, but for too
    long the banks have enjoyed their relative obscurity in not
    being publicly identified.
        I remember I was at a hearing at the CFTC, and I was making
    comments critical of some of the large investment banks for
    their speculative activities. And there was a gentleman from a
    hedge fund who sounded a lot like me, and I had to talk to this
    guy and figure out why a hedge fund guy was sounding a lot like
    the Energy Program director at Public Citizen. And it was
    because he was complaining that the banks control the market,
    that it is too secret. This is a large hedge fund, one of the
    largest in the country, and he felt that he was at a massive
    disadvantage to Goldman Sachs. So imagine if you are one of
    those smaller independent gas producers in Oklahoma or a
    manufacturer trying to compete in a global economy. The deck is
    stacked against them as long as the banks are able to operate
    in secret and do not have adequate controls over the size of
    their positions.
        Senator Coburn. So it is your assumption that it is all the
    banks that are creating the excessive speculation?
        Mr. Slocum. I think the data indicates, and especially the
    leaked data that finally named some individual names, that the
    banks clearly are at the top of the list in terms of their
    positions. But it is also clear that there are major,
    especially vertically integrated players in the petroleum
    sector that are also big. Chevron inadvertently disclosed that
    it----
        Senator Coburn. Yes, that is a repeat. Mr. Turbeville.
        Mr. Turbeville. I think you start with what excessive
    speculation is. There is actually some fairly good knowledge on
    what the required amount of speculation is, and that tends to
    be somewhere about a third of the whole market. Two-thirds
    hedging/one-third speculation makes the market work.
        Speculation in excess of that really ties into the very
    purpose of the market, which, interestingly, sort of reflects
    the language of the Commodities Exchange Act. When they
    originally talked about back in the old days excessive
    speculation, they described it as ``unwarranted and
    inappropriate higher prices in volatility.'' I think that ties
    into the purpose of the market. To the extent that speculation
    is not required but is in excess of what is required, it is
    excessive, meaning it is bad, if it damages the price discovery
    function so that suppliers and consumers can know what the
    forward price is--in other words, it damages the forward price
    curve that I was talking about before--or it inhibits in anyway
    hedgers actually hedging their positions in the market--the two
    real functions of the market, hedging and price discovery,
    which are related.
        So if volatility causes it to be very expensive to hedge,
    that is a bad thing, and if excessive speculation causes that,
    it should be ended. If the price discovery function is damaged,
    meaning I do not know where prices are going because of things
    that are being done in the speculative market, that is a bad
    thing.
        So speculation is excessive if it damages price discovery
    or the ability to hedge well.
        Senator Coburn. Excessive speculation leads to markedly
    increased volatility, what you should expect some market force
    on real supply and demand to have some influence on.
        Mr. Turbeville. You would.
        Senator Coburn. In up movements you should see exaggerated
    up movements. In down movements you should see exaggerated down
    movements. And from the testimony I hear, I am not hearing that
    there is an excessive down movement. Explain that to me on
    speculation, when there is a marked excess supply, why we do
    not see an excessive down movement.
        Mr. Turbeville. That is really an interesting point, and it
    goes to the issue--you would expect to see it. We have all
    grown up in the Chicago School of Economics that markets work
    perfectly and are very efficient, which I think sometimes makes
    it hard for some of the academics to understand what is going
    on in the commodities markets right now. I am not an academic,
    so maybe that is easier for me somehow.
        Senator Coburn. So maybe you can understand it.
        Mr. Turbeville. Exactly. [Laughter.]
        I think the reason is the market is actually imperfect. If
    you have a huge sector of the market that is long only and is
    insensitive to price and trades on specific days that everybody
    knows about, what you have is this force, this bias, if you
    will, towards upward prices. So I think what you see in sort of
    the boom-bust cycle, what is suggestive, as our research
    suggested, is that, in fact, what is happening, this constant
    trading without regard to what the price is, I do not care what
    price----
        Senator Coburn. I know if that is the case, that means the
    investors in those instruments are price insensitive as well.
        Mr. Turbeville. That is correct.
        Senator Coburn. And why are they?
        Mr. Turbeville. Because they actually are investing to
    create a portfolio effect in a larger----
        Senator Coburn. Then why is not everybody doing that? Why
    isn't all the money moved there? If it is a sure deal, if it is
    a sure bet and that price is on the come and it is going to
    rise, why isn't everybody doing it? You cannot have it both
    ways.
        Mr. Turbeville. Right.
        Senator Coburn. If they are price insensitive, if they do
    not care what the price is because they are sure they are going
    to make money on the next month as they roll it over, why isn't
    everybody doing that?
        Mr. Turbeville. Well, OK. There are two questions. If you
    would, indulge me here. The investors are not in it to make
    money like you would make money on a stock. They are in it
    because they want to have part of their portfolio that moves
    just like commodities move.
        The other side of the coin, which is a really interesting
    one, which is our premise is that because of the trading
    activity, the curve moves up, right? Why don't the arbitragers
    squeeze that out instantaneously? That is a really good
    question, and efficient markets theorists would say that would
    happen. Our data suggests that it actually does not happen, so
    you sort of ask yourself the question why.
        I personally believe that the reason why is that the market
    as a whole--remember, the trading is done by Goldman Sachs and
    JPMorgan, those folks. As they see those traders pricing those
    contracts, their interpretation is, well, they must know
    something that we do not. And it is not random trading
    activity. But it is not trading activity based on the rationale
    of profit and loss.
        Senator Coburn. Of a transparent market.
        Mr. Turbeville. Right. So it confuses the world about what
    the supply and demand is. I actually think that is what is
    going on, is that the prices are distorted. So going back to
    excessive speculation, if the price discovery function is being
    injured, that is a problem, and I would consider that excessive
    speculation and speculation that should be corrected.
        Senator Coburn. Thank you very much.
        Mr. Slocum. Dr. Coburn, may I quickly add something?
        Senator Coburn. Sure.
        Mr. Slocum. As part of my written testimony, I took a look
    at the Goldman Sachs Commodity Index (GSCI), and so your
    question is, if these index funds are such a good deal, why
    isn't everyone moving into them? According to SEC filings by
    GSCI, in January 2009 there were 135 shareholders or entities
    that were investors in GSCI. Two years later, in January 2011,
    there were 49,120. Now, they do not provide any explanation of
    whether or not there was some sort of plausible explanation of
    this or whether or not Goldman's sales reps are doing a heck of
    a job selling to institutional investors and high-net-worth
    individuals. But those numbers are staggering, and it is clear
    that Goldman is promoting this as an investment vehicle for
    certain key audiences.
        Senator Levin. All right. Let us try another round. I want
    to move to high-frequency trading. Are you aware, each of you,
    of an increased presence of high-frequency traders in the
    commodity markets? And if so, are those high-frequency traders
    exacerbating volatility and price distortion? Let us start with
    you, Mr. Cicio.
        Mr. Cicio. Well, yes, high-frequency trading is putting a
    lot of pressure on volatility. As stated earlier, traders make
    their profits on price movements. It does not matter whether it
    is up or down. And so the high-frequency trades is having a
    direct impact on moving the market, and that is not good for
    price discovery when we are looking at a consumer for a price
    that reflects the supply and demand rather than reflecting
    high-frequency, computer-driven, technical trading, speculator-
    driven type of decisionmaking.
        Senator Levin. Mr. Slocum, do you agree with that?
        Mr. Slocum. Absolutely. Mr. Chairman, I testified before a
    panel that the CFTC put together a year or so ago, and after
    our research at Public Citizen, we deemed that high-frequency
    traders do not serve a legitimate function in these markets.
        With all due respect to the hard-working career staff at
    the CFTC, which are doing a heck of a lot with relatively
    little resources----
        Senator Levin. And they are looking right at you as you
    testify.
        Mr. Slocum. Right. They cannot compete with the types of
    strategies, computers, and resources. It is overwhelming for
    enforcement staff to keep up with the activities and the volume
    and the constantly evolving strategies of these high-frequency
    traders. And as long as our hard-working regulators are unable
    to get a handle on how these high-frequency traders are
    operating, it is clear that they are not serving a legitimate
    market function. It is clearly disadvantaging those that are
    seeking to enter the market for legitimate hedging purposes.
        Senator Levin. OK. Mr. Turbeville.
        Mr. Turbeville. I agree with the other panelists in what
    they have said. The high-frequency trading is to gain advantage
    based on a different level of knowledge that others in the
    market have. That is the whole point of it. And in the
    commodities markets, that is a very dangerous thing. It is
    different from the stock markets and bond markets which are
    really--there is no such thing, for instance, as excessive
    speculation in the stock market. So that kind of activity in
    the commodities market can be more damaging to the market
    itself because of the functions that we described, hedging and
    price discovery being the main ones.
        I am also concerned about this: I am concerned that as the
    markets evolve into markets with swap execution facilities so
    that everything is electronic but that there are multiple
    venues in which transactions can be matched, that the ability
    of high-frequency trading to actually move around from venue to
    venue to venue to take advantage of things like payment for
    volume--in other words, a swap execution facility could well
    pay for volume because they get value from the other side of
    the trade--that you might see the kind of activity from high-
    frequency traders that is actually gaming the system that is
    actually created to maximize full disclosure of what is going
    on. So the full disclosure is really good, but without some
    kind of a control to make sure that HFT types do not move
    transactions around, that could actually allow those folks to
    game the system to the detriment of others and make it an
    unfair system.
        Senator Levin. Let me ask you about Exhibit 1b,\1\ which is
    a chart which shows total assets invested in commodity-related
    exchange traded products. These totaled over $100 billion last
    year, these commodity-related ETPs, as they are called. And we
    have listed a lot of those in Exhibit 6 \2\ in our book. ETPs
    offer securities now that track the value of a commodity--or a
    basket of commodities, but they trade like stocks on an
    exchange.
    ---------------------------------------------------------------------------
        \1\ See Exhibit No. 1b which appears in the Appendix on page 111.
        \2\ See Exhibit No. 6 which appears in the Appendix on page 176.
    ---------------------------------------------------------------------------
        Are ETPs adding to speculative pressures on the commodity
    markets? Let us start with you, Mr. Turbeville.
        Mr. Turbeville. There is no question. If you look at it
    from a more cosmic level, the 30,000-foot level, one of the
    things happening is you are creating a huge amount of synthetic
    ownership of commodities as if they were hoarded, and the
    market is actually interpreting that at some level the
    commodities are being hoarded, therefore, the prices move up
    until something happens and the bubble bursts and everybody
    say, oh, yes, I remember now, those were just synthetically
    hoarded. So it is absolutely a similar kind of thing.
        To be honest with you, there is one question that the world
    should ask itself. This desire to own commodities, if you own a
    basket of commodities for 125 years, should we all live that
    long? You will have made something like the inflation rate on
    that market basket. That is all.
        The world should ask itself: Why is this such a popular
    thing to do? Is it because it is a good thing to sell by the
    sales folks? Or are people actually making sensible investment
    decisions by actually putting their money into commodities if,
    in fact, what I said is true, is after 100 years you have just
    got inflation after all?
        Senator Levin. Just very quickly, because I have some other
    questions, Mr. Slocum, would you agree with that, that ETPs are
    adding to speculative pressures on the commodity market?
        Mr. Slocum. I would, absolutely, and I really applaud the
    efforts of this Subcommittee to address some of the issues of
    this, particularly what you outlined in your opening statement
    about mutual funds using their investments in this to kind of
    get around some existing regulations. That is clearly
    problematic.
        Senator Levin. OK. Mr. Cicio.
        Mr. Cicio. Most certainly.
        Senator Levin. And now let us go to the mutual funds
    question. As I mentioned, we have an exhibit, Exhibit 7a,\1\
    that identifies 40 mutual funds that primarily trade in
    commodities. The commodity-related mutual funds over the last
    several years have gotten into the game big time. We have come
    across one mutual fund that has over $25 billion in assets with
    one of its primary purposes to trade in commodities.
    ---------------------------------------------------------------------------
        \1\ See Exhibit No. 7a which appears in the Appendix on page 185.
    ---------------------------------------------------------------------------
        Are mutual funds that trade in commodities also
    contributing to commodity price speculation? And do you believe
    that we ought to keep the 90-percent rule that investment
    revenues accrued by mutual funds must be realized from
    investments in securities and no more than 10 percent should be
    realizable from alternative investments, including commodities?
    Can you give me a yes, no, or maybe? Mr. Cicio.
        Mr. Cicio. We think that mutual funds should not be
    participating in commodities period because, again, it has
    nothing to do with supply and demand and price discovery.
        Senator Levin. We currently have a 10-percent rule, so you
    at least would want us to hold to that.
        Mr. Cicio. Yes, sir.
        Senator Levin. Mr. Slocum.
        Mr. Slocum. I agree, absolutely, yes.
        Senator Levin. OK. Mr. Turbeville.
        Mr. Turbeville. The numbers are just staggering. Any
    percentage of mutual funds added compared to an open interest
    in commodities, in physical commodities of around $900 billion
    would just swamp it, yes.
        Senator Levin. And there is no stopping it now if they are
    allowed to continue to have these offshore deals that they
    wholly own and if they are allowed to in other ways circumvent
    the 10-percent rule?
        Mr. Turbeville. There is no stopping it, and the sales
    forces must be very effective, as I pointed out before.
        Senator Levin. By the way, we did actually stop it in the
    Senate. We had a House bill which would have eliminated that
    limit of 90 percent and said you can have as many speculative
    investments as you want in commodities. It came over from the
    House with the abolition of the 10 percent. We were able to
    strike it here. And the Senate sent it back to the House
    without that. There were some other things, mutual funds
    requested, but it did not get that one. And I think there has
    been very little attention paid to this issue, and I would hope
    that one of the things this hearing will do is to focus on this
    question really for the first time as to whether we ought to
    have this circumvention, through the offshore--these
    corporations which are shell corporations, and who is going to
    regulate them, and that is a big issue which we will also get
    into with Mr. Gensler.
        I think I am over my time on the second round. Dr. Coburn.
        Senator Coburn. Thank you. Let us go back to what we have
    kind of created. It is very interesting. I am trying to get a
    balance on where this bubble, if we do not do something about
    what is going on, is going to end, because it is not going to
    go up forever. In other words, there is going to be a point in
    time where somebody says, well, these guys are trading this
    next month. They are saying, ``How do I make money off that?''
    And then there is going to be the opposite of that.
        So, we are always going to have to have speculators to make
    a market. We really cannot make a market without some
    speculation in it. If we could, we would not be where we are
    today. If we go too far or if we do not go far enough, we are
    going to have price exaggerations, either below or above, and I
    think everybody would agree with that. And we are always going
    to have some price exaggeration based on world events, whether
    it be Libya causing oil to cost $15 to $17--maybe that was
    exaggerated based on what we are seeing today, but the fact is
    there was a world event that put world oil supplies at risk and
    that should have some effect on commodity prices. The same
    thing on cotton, as I mentioned before. You had crop failures.
    You had $4 cotton in this country, which nobody had ever seen.
        Was that an exaggeration because of this? Was it made
    worse? So I would like your comment on how you tie in true
    supply-demand effects and what we are seeing. How are those
    true supply-demand effects that enter the market, that are
    fundamental differences in available supply or excess supply or
    marked increase in demand for some reason or another, how do
    those interact with what we are seeing going on in the market?
        Mr. Slocum. I think that there is no question that the
    supply-demand fundamentals play a role in these markets. It is
    why you have seen this big disconnect with natural gas and
    crude oil. It is because natural gas is not globally priced,
    and we do have enormous supply. That will definitely change if
    we start switching more and more of our coal plants to gas or
    if T. Boone gets his way and we have got more trucks on the
    road using natural gas. And as Mr. Cicio noted, it was in the
    very recent past that we saw significant price increases and
    volatility. Natural gas has a long history of that kind of
    volatility.
        But it shows that with massive amounts of supply-demand
    evidence that is dominating the market, supply-demand can play
    a role, but in a globally priced commodity like crude oil,
    where you have speculators playing a significant role, I think
    that what we see is the volume being driven by these
    speculators and by the index.
        Senator Coburn. With the marked excess in supply of natural
    gas, why isn't it significantly lower than it is today if these
    guys are playing? Why isn't it $2 instead of $3.60 or $3.90?
        Mr. Slocum. Right.
        Senator Coburn. Why isn't it $2?
        Mr. Cicio. That is what manufacturers are asking.
        Senator Coburn. But I am asking it on the basis if we have
    excess speculation based on market forces or intended market
    forces, why aren't we seeing an exaggeration on decreased
    price? That is my whole problem with what we are being
    presented with here today. Everything seems to be rigged for an
    upward bias, but when there is fundamental market indices that
    say there is absolute two to three times as much natural gas as
    this country can consume available right now, why aren't you
    seeing the other side of this? Where is the market failure in
    that?
        Mr. Cicio. Well, actually, Senator, as consumers, given the
    increased supply of physical natural gas, we think that prices
    probably should be lower than they are. But because of the ETFs
    and the ongoing long positions that I talked about, remember,
    86 percent of all of the index positions historically have been
    long. There is this growing amount in volume of long positions
    that keeps encouraging the upward pricing pressures versus a
    reflection of the oversupply of the marketplace.
        But interesting about natural gas is that if you look at
    the Chicago Mercantile Exchange, which I did last week, and
    look out 5 years to see what the price of natural gas is, given
    our vast supply of natural gas, one would think that there
    would be a downward price curve, much like what was talked
    about earlier, which is historically what commodities had. They
    had a downward pricing curve. Natural gas prices 5 years out
    show a 52-percent increase.
        Senator Coburn. Yes, but that is readily explainable. We
    are building LNG terminals. We are going to ship it to the
    Chinese and Europe. The other factor is we are going to see
    massive inflation in this country in 2 or 3 years, and people
    are anticipating that. So maybe that is the reason that there
    is not the downward side to it. But I still have problems. Mr.
    Turbeville.
        Mr. Turbeville. One of the things that occurs to me about
    natural gas is something you mentioned, which is that natural
    gas gets stored in the ground as opposed to next to its use. So
    there is a limit on how low natural gas can go because no
    matter how much the supply is, the constraint is actually the
    transmission associated with it. But the fact is that one way
    to approach all of this is to try to decide how much--or what
    really is the effect of trading as opposed to supply and
    demand, is to look at elements that are unrelated to supply and
    demand--I am sort of promoting what we did, but that is
    specifically why we did it.
        We looked at the 5-day roll periods--over 27 years, which
    has nothing to do with supply and demand, and looked at the
    bias associated with that. The law of supply and demand has not
    been repealed. Nobody should think that is true. However, it is
    fairly certain that this inefficiency does occur on the margin,
    and how much is it? It is hard to say. The St. Louis Fed has
    said it is something like 17 percent of the price. It probably
    changes over time. But it also is biased towards upward levels,
    and it is because of this huge price-insensitive long that is
    in the market. I believe that is true, too.
        Senator Coburn. All right. Thank you.
        Senator Levin. The rule that came from the CFTC makes a
    distinction between commodity swaps that reference a single
    commodity, like oil, and those that reference a basket of
    different kinds of commodities, like oil, gold, and wheat. The
    rule applies position limits to single commodity swaps but no
    limits at all to multiple commodity swaps.
        Can you give us your opinion as to the basis for that
    distinction? And how does it affect the effort to combat
    excessive speculation? Let us start with you, Mr. Slocum.
        Mr. Slocum. Well, in terms of why the CFTC has taken this
    approach, I think Mr. Gensler is following us, and I think he
    is a lot more qualified to----
        Senator Levin. We will ask him, too, but do you----
        Mr. Slocum. Yes, I do not know why they have done that. I
    am concerned that differing treatment is problematic and will
    encourage levels of speculation because of that loophole that
    are going to be problematic for consumers.
        Senator Levin. OK. Mr. Turbeville.
        Mr. Turbeville. I guess we are mostly interested in the
    result, right? Do commodity index funds get effectively
    regulated and limited? They have taken this approach of saying
    a multiple index swap is not disaggregated into its component
    parts. It is just a swap that exists out there and is not
    subject to----
        Senator Levin. Does that trouble you? Are you OK with it?
        Mr. Turbeville. I am OK with it as long as the actual
    limits themselves--because what happens is, of course, the
    bankers then have to go do swaps and futures on the other side
    of that. If those swaps and futures really got effectively
    regulated, it would not be a problem. My concern is that there
    are too many ways to use the single entity limits in such a way
    and to manipulate them so that the bankers never will get
    regulated. So the better result would have been to say a
    multiple swap is regulated and limited.
        Senator Levin. What happens if a basket is 99 percent oil
    and 1 percent something else? Doesn't that kind of make the
    position limits ineffective?
        Mr. Turbeville. Yes.
        Senator Levin. I know you are worried about that. We are
    just warming up for Mr. Gensler. [Laughter.]
        Mr. Turbeville. I understand. Yes, I would have been
    personally, and as an organization, more comfortable to go
    ahead and address the issue straight on and say let us talk
    about the swaps themselves rather than indirectly trying to
    get--you are right. What happens is it becomes a metaphysical
    concept.
        There is by analogy in other rules, agricultural rules,
    that more than 50 percent will constitute that swap, an oil
    swap, but it does not actually apply to oil.
        Senator Levin. OK. Mr. Cicio, do you have a thought on
    that?
        Mr. Cicio. Well, just briefly. We were troubled by the
    differing treatment as well, and we would rather have the spec
    position limits apply to all, so undifferentiated.
        Senator Levin. OK. Just one last question about a netting
    rule in the final rule of the CFTC which allows a swap dealer
    who sponsors a single commodity index fund to net any short
    position created by the sale of a commodity swap to a client
    with a long future involving the same type of commodity. So the
    netting rule means that to the extent the swap dealer is
    hedging its financial risk by buying long futures to offset its
    client's speculative bet, the swap dealer can claim his
    position is flat and not subject to any position limits.
        So the swap dealer then could sell $1 billion in swaps to a
    lot of clients and then offset that risk by buying $1 billion
    in futures, affect the price of those futures it is buying, but
    still not be subject to any position limit. Does that netting
    rule open up a loophole for swap dealers who will be able to
    sell and offset as many single commodity swaps as they want
    even if that activity floods the commodity markets with
    speculative money? Is there a loophole created by that rule,
    Mr. Turbeville?
        Mr. Turbeville. That was a change to the proposed rule that
    was in the final rule. The concern there is that what the rule
    suggests is that the swaps market and the futures markets are
    all one market and should be viewed as such. We think that is
    not appropriate. We think that the futures market is a very
    specific market that creates a very important--it has a very
    important role in price formation and price discovery. And so
    the netting across those two clearly should not be allowed,
    although it is.
        Senator Levin. OK. Mr. Slocum, do you want to comment on
    that?
        Mr. Slocum. I definitely share your concern. I think you
    articulated a potential abuse, and I think it underlies the
    fallacy of creating this potential for loopholes.
        Senator Levin. OK. Mr. Cicio.
        Mr. Cicio. And we agree with you, sir.
        Senator Levin. I said that was my last question, but I do
    have one other comment I want to make, and that has to do with
    a comment of the CEO of the Intercontinental Exchange (ICE). It
    is headquartered in Atlanta, and Jeffrey Sprecher was quoted in
    a September investment bank research report as saying that the
    energy markets may work better with position limits in place.
    It is a very important comment because it is coming from the
    CEO of ICE, but it has not been, I think, widely quoted yet,
    and I hope this may help a little bit if I quote it:
        ``It is not necessarily a bad thing for exchanges to
    prevent one large player from having concentration. ICE imposed
    its own version of position limits in its markets. The volume
    had actually increased. There was a healthier market with more
    and smaller players as a result.''
        And here is what he then said: ``A lot of people do not
    like the thought of being limited in any way, but the reality
    is, and the evidence so far at ICE is, that we have grown very
    well during a position limit regime.''
        I am just wondering whether each of you would welcome that
    kind of a comment from a person in that position. Mr. Cicio.
        Mr. Cicio. Clearly, yes, sir.
        Senator Levin. OK. Mr. Slocum.
        Mr. Slocum. Yes, I think it underlies how much of the
    debate on this issue, and sometimes others, where you have some
    powerful interests where their status quo is threatened and
    they will claim that the sky is falling is very basic
    regulatory oversight is applied to their sprawling complex
    operations. And every once in a while you get a moment of truth
    in that, like apparently the CEO of ICE. So I am glad that you
    are quoting him on that.
        Senator Levin. Mr. Turbeville.
        Mr. Turbeville. I not only welcome it, I agree with
    everything he said.
        Senator Levin. Thank you all. We are going to make all the
    statements part of the record, and there is an additional
    request for a statement to be made part of the record by the
    Petroleum Marketers Association of America and the New England
    Fuel Institute, and we will make that testimony part of the
    record. We will leave the record open for other organizations
    that might wish to file statements.\1\
    ---------------------------------------------------------------------------
        \1\ The prepared statement of Mr. Ramm, Petroleum Marketers
    Association of America and the New England Fuel Institute which appears
    in the Appendix as Exhibit No. 10 on page 266.
    ---------------------------------------------------------------------------
        We will thank this panel. It has been very useful and
    helpful testimony. Thank you all.
        [Pause.]
        Mr. Gensler, we welcome you. We appreciate your not just
    coming here to testify but taking some extra time to listen to
    our other witnesses. We very much appreciate that. We look
    forward to your testimony.
        I think as you know, all the witnesses who testify before
    our Subcommittee are required by our rules to be sworn, so I
    would ask you to please stand and raise your right hand. Do you
    swear that the testimony you are about to give will be the
    truth, the whole truth, and nothing but the truth, so help you,
    God?
        Mr. Gensler. I do.
        Senator Levin. The light will go on from green to yellow
    about a minute before the 10-minute period is up, so we would
    ask you to try to limit your oral testimony to no more than 10
    minutes. There will be whatever time we need, obviously, to get
    your entire testimony in one way or another. So we again thank
    you for being here and please proceed.

      TESTIMONY OF THE HON. GARY GENSLER,\2\ CHAIRMAN, COMMODITY
                       FUTURES TRADING COMMISSION

        Mr. Gensler. Good morning, Chairman Levin and Ranking
    Member Coburn.
    ---------------------------------------------------------------------------
        \2\ The prepared statement of Mr. Gensler appears in the Appendix
    on page 98.
    ---------------------------------------------------------------------------
        Senator Levin. We expect he will be able to return. He had
    another important mission here this morning.
        Mr. Gensler. Well, if Ranking Member Coburn is listening
    somewhere, I thank him as well.
        I thank you for inviting me here today to talk about the
    changing nature of the derivatives markets and on position
    limit rules.
        The derivatives markets have changed significantly since
    the CFTC opened its doors back in 1975, and you have noted in
    some of your excellent charts these changes. But, first, there
    is the swaps market as well. This emerged in the 1980s, and it
    is now seven times the size of the futures market.
        Second, instead of being traded just in the trading pits in
    Chicago and New York and elsewhere around the globe, much of
    the market, over 80 percent, is traded electronically, a click
    of a button.
        Third, while the futures market has always been where
    hedgers and speculators meet in a marketplace, a significant
    majority of the market is made up of now swap dealers, hedge
    funds, and other financial traders.
        Fourth, the vast majority of trading is now day trading or
    trading in what is called calendar spreads, between 1 month and
    a later month, but not necessarily to go outright long or
    outright short. And I would add, as your charts suggest also, a
    fifth point is that a significant portion of the market is now
    in these index investments, more on the long side than on the
    short side.
        Now, the CFTC is focused on ensuring our regulations are
    responsive to today's markets. We are an agency that is not set
    up to be a price-setting agency, but it is an agency to promote
    transparency in markets, to police against fraud, manipulation,
    and other abuses, and to ensure that there is integrity in
    markets and the price discovery in the market has integrity for
    all the hedgers in this market.
        This summer, of course, with the Dodd-Frank Act's passage,
    we turned a corner and began finalizing many rules with regard
    to the swaps market but also updating some of the market rules
    on the futures market, and to date, we have completed 18 final
    rules and have a busy schedule throughout the rest of the year
    and into next year.
        We have completed rules giving the CFTC enhanced anti-
    manipulation and anti-fraud authority, and it extended the
    Commission's reach to include reckless use of fraud-based
    manipulative schemes. And I know we have chatted about this in
    the past as a very important extension of our authority to fill
    a gap in our enforcement tools.
        The CFTC also approved a final rule on large trader
    reporting for physical commodity swaps. For the first time, the
    clearinghouses and the dealers, the swap dealers themselves,
    must report to the Commission information about swaps activity
    on the large trades, and that rule actually went effective last
    month--well, now 2 months ago, September.
        The CFTC also completed the rules that are the center of
    this hearing, the aggregate position limits rules for physical
    commodities. A position limit regime is a critical component of
    comprehensive regulatory reform of the derivatives markets.
    Position limits have served since the Commodities Exchange Act
    passed in 1936 as a tool to curb or prevent excessive
    speculation that may burden interstate commerce, and the
    emphasis might be on prevent, as the Chairman mentioned
    earlier, and it has been used since, I think, we first put in
    place our predecessor's position limits in 1938 using that
    initial authority. I think it was then in bushels. It might
    have been 2 million bushels of a certain grain.
        And though, as I mentioned, the CFTC is not a price-setting
    agency, at the core of our obligations is to promote market
    integrity, which the agency has historically interpreted to
    include ensuring markets do not become too concentrated. You
    mentioned that quote of an exchange leader--but I think that
    was really at the core of what Mr. Sprecher's quote was--about
    concentration of markets and making sure that there is no one
    who has an outsize position.
        In the Dodd-Frank Act, Congress mandated the CFTC to set
    aggregate positions for physical commodity derivatives, and
    this would include for the first time and historically position
    limits on swaps as well as futures, which I mentioned are seven
    times the size of the market, and even certain linked contracts
    on foreign boards of trade that might be trading overseas but
    linked to these contracts. And the final rule achieved that.
        The Dodd-Frank Act also tightened the definition of bona
    fide hedging. Since the 1930s, the concept was this was a limit
    on speculators not hedgers, but over time there had been some
    creeping and widening of that by the CFTC, various rules and
    interpretations and sometimes no-action letters. Congress
    addressed that and said it should be narrowed such that the
    exemption only be for transactions and positions that served to
    mitigate risk in the cash market for a physical commodity, and
    I believe the final rule achieved that as well.
        The Dodd-Frank Act also mandated that we set position
    limits for energy, metals, and agriculture for the spot month
    and something called individual month and all months combined,
    and I believe the final rule achieved this on the 28 physical
    commodities. I would mention that the rule re-establishes
    position limits for all months combined and individual months
    for energy and metals, which had existed actually, but had been
    taken off in 2001 in energy and in the late 1990s in the metals
    markets.
        Before I close, I would like to briefly mention the events
    this week of MF Global, if I might. Earlier this week the CFTC
    and SEC determined that the Securities Investor Protection
    Corporation-led bankruptcy proceeding would be the safest and
    most prudent course of action to protect customers of this
    failing financial institution. The most troubling aspect about
    MF Global's situation is the shortfall of customer money in the
    firm. Segregation of customer funds is at the core, and it is
    really a foundation of customer protection in the commodity
    futures and swaps markets. Segregation must be maintained at
    all times. Simply put, that is at every moment of every day
    down to the nanosecond.
        The Commission intends to take all appropriate action
    within the purview of the Commodities Exchange Act and the
    Bankruptcy Code to ensure that customers maximize the recovery
    of funds and, I say, to discover the reason for the shortfall
    in the segregated customer money. The CFTC and SEC and other
    regulators will continue to closely coordination actions, and I
    thank you. I would be happy to take any questions.
        Senator Levin. Well, thank you very much, Mr. Gensler.
    Since you made reference to the MF Global, let me just start
    with that. Is there any risk of a taxpayer bailout in this
    case?
        Mr. Gensler. No, I think this was an example, actually, of
    a financial institution having the freedom to fail.
        Senator Levin. So there is no risk of a taxpayer bailout.
        Mr. Gensler. I think that is right. I think when the
    Chairman of the SEC and I were on these middle-of-the-night
    conference calls from 2:30 a.m. to about 7 a.m. on Monday and
    we not only informed that there was not somebody to take the
    customer positions over but that there was the shortfall in the
    customer accounts, we really saw no alternative but to protect
    the customers, put it into bankruptcy, and it is in
    liquidation. But, Chairman, I do not think that there is any
    taxpayer money behind this.
        Senator Levin. Or at risk.
        Mr. Gensler. Or at risk.
        Senator Levin. Now, you made reference to what the CFTC is
    going to do or continue to do, I think was your word. Can you
    tell us just briefly what you have done and what actions you
    can take or will take to protect their clients?
        Mr. Gensler. Well, throughout this week we have worked very
    closely with the court-appointed trustee who is now in place
    over this company, and we have worked very closely with the
    various clearing organizations and other clearing firms to try
    to move the positions. We were successful yesterday that the
    bankruptcy court did an order to allow customer positions to
    move. But the monies themselves may have to wait a bit because
    the trustee and the bankruptcy court have to really do a full
    accounting. We are in there as well. We have had people at MF
    Global since last Thursday really trying to assess this, but,
    of course, events changed dramatically on Monday with the
    shortfall.
        Senator Levin. OK. Now, getting back to the subject of the
    hearing today, let me start by asking you about the Dodd-Frank
    Act requirement that you have attempted to implement in your
    rule and trying to curb excessive speculation and manipulation
    in the commodity markets by imposing position limits on
    commodity traders. I am just wondering whether you feel, as the
    Dodd-Frank Act believes and reflects, that it is critical to
    put this rule in place for jobs, for economic recovery, to help
    ensure that prices for vital commodities like crude oil will
    reflect supply and demand rather than speculative pressures.
        Mr. Gensler. I do think it was critical to put this in
    place and to fully implement it. I think it is critical that
    these markets have only--that they not have outsize
    concentration by one party or another, and particularly as
    Congress intended for us to do to place these limits on
    speculators. I think that markets work best when they have a
    diversity of points of view and a diversity of speculative
    interest. They are really primarily, as I think you and others
    have said, for hedgers to hedge. It was originally somebody
    growing corn or wheat to lock in the price at harvest time, and
    then, yes, there was a speculator on the other side who locked
    in that price and in a sense was taking a bet on where corn or
    wheat would trade.
        Senator Levin. But the speculation has now gone way beyond
    providing the needed liquidity for that kind of hedging, so now
    speculation is a greater part of the market than the actual
    trading that is needed if you are going to hedge. Would you
    agree with that?
        Mr. Gensler. Yes. I remember discussing this with you about
    3 years ago when we were in your office, when I was just a
    nominee for this job. But I think I share that view.
        Senator Levin. And do you believe that the price swings in
    oil futures in 2008 and 2001 were caused in part by speculation
    and that became disconnected to the fundamentals of supply and
    demand, that these broad price swings in oil obviously have an
    actual market connection to the real fundamentals of supply and
    demand, but that there is a significant part of these price
    swings in oil futures that are the result of speculation.
        Mr. Gensler. We are not a price-setting agency, but when
    the markets are made up of--I will use oil--approximately 12 or
    13 percent of the long positions of producers and merchants,
    and if I recall, maybe 18 percent of the shorts. And we publish
    these figures every Friday. They are public. So that means 80
    to 87 percent of the market are financial participants, swap
    dealers, hedge funds, and other financials.
        Senator Levin. Those are the speculators we are talking
    about.
        Mr. Gensler. People generally use that word.
        Senator Levin. Right.
        Mr. Gensler. But I think it is both hedgers and
    speculators, and financials have an influence on price, so on
    any given day it is hard to determine whether it is up or down,
    but I think it is uncontroversial that speculators, when they
    are 80-plus percent of the oil market, and some of the
    agricultural markets at 60 percent, have a role to play, as has
    been known since the 1930s, and then we police for fraud and
    manipulation. We promote transparency, and then we use position
    limit regimes to ensure against any concentrated position and
    also to police against manipulation.
        Senator Levin. So there is a legitimate role that is played
    by people who obviously have to fund people who want to hedge.
    That is a legitimate role.
        Mr. Gensler. That is correct.
        Senator Levin. In terms of the excessive amount of
    speculation, you do not consider that to be legitimate? If it
    is excessive, it is not legitimate.
        Do you agree that excessive speculation, however it is
    defined, is not legitimate? By definition do you agree?
        Mr. Gensler. Well, I think Congress made a finding, and
    what we were asked to do is then to set position limits, which
    we have done not only just 2 weeks ago but since the 1930s, to
    ensure against the burdens that may come. The burdens can be
    just that a large position wants to sell at an inappropriate
    time for everybody else. It is their right to sell, but it
    could distort prices in the midst of a crisis or even in clear
    times. Or the burden could come from either direction because
    it is an outsize position that pushes the price down or up. So
    we have used it to sort of ensure against the concentration of
    positions in the marketplace.
        Senator Levin. And are price distortions and large price
    swings a problem?
        Mr. Gensler. Well, these markets--and again, we are not a
    pricing agency--will have volatility, just like securities
    markets will have volatility. But what producers and merchants
    want to do is lock in a price so that they can do what they are
    really good at. What they are really good at is either tilling
    the field or merchandising product to consumers. And so it is
    important that they have confidence in the markets and can
    ensure that the markets have supply and demand at their core of
    the price discovery.
        Senator Levin. And is it important that supply and demand
    be at the core of price discovery?
        Mr. Gensler. Yes.
        Senator Levin. And is that frustrated when there is a large
    amount of speculators, as we have defined it here, in the
    market where that dominates?
        Mr. Gensler. It is an excellent question, is there, in
    essence, a percent, as was asked earlier.
        Senator Levin. I am not asking you what the percent is. Is
    that legitimate function for hedging frustrated when there are
    large amounts of speculation as we have defined it?
        Mr. Gensler. I think at our core is to ensure that the
    markets are free of manipulation and fraud--I am thankful that
    you and others helped us get better manipulation authority--and
    then to use these position limits to ensure that no one is
    greater than a certain percent. For instance, at the core of
    our rule is that no one is greater than approximately 2.5
    percent of these markets for the all-months combined. I mean,
    if they are a smaller market, there is another percent. And so
    that means there in essence would have to be a diverse number
    of speculators, not one that necessarily has an outsize
    position.
        Senator Levin. Do you believe that the purpose of our
    congressional enactment is to prevent excessive speculation?
    The word ``prevent,'' which is in the law, do you believe that
    is the congressional intent?
        Mr. Gensler. I am well advised by counsel that once worked
    with you who tells me it is to prevent the burdens that may
    come from excessive speculation. So it is preventative and
    forward-looking, and that is how we have used it in the past,
    and I think Congress understood that, and it is the clear
    intent of the statute, Dodd-Frank Act, that we set these
    aggregate positions.
        Senator Levin. Let me read Section 737 of the Dodd-Frank
    Act to you: The CFTC ``shall set limits . . . to the maximum
    extent practicable . . . to diminish, eliminate, or prevent
    excessive speculation . . . '' So is that one of the purposes
    of the Dodd-Frank Act, to prevent excessive speculation?
        Mr. Gensler. I do not have the actual words. I always
    thought it was ``the burdens that come from,'' but I trust----
        Senator Levin. Is the word ``burdens'' in there?
        Mr. Gensler. I thought, but if not--but I trust whatever
    the Chairman's reading.
        Oh, I see. I am thinking of 4(a)(1), and there is----
        Senator Levin. I am reading Section 737. In that section,
    would you agree I read it correctly?
        Mr. Gensler. Yes.
        Senator Levin. That is good. Did you hear me when I quoted
    the head of ICE, Mr. Sprecher?
        Mr. Gensler. Yes.
        Senator Levin. Were you familiar with that comment before
    that?
        Mr. Gensler. I was familiar with his thinking, though maybe
    not the exact quote, but he had shared that thinking with us,
    yes.
        Senator Levin. And do you agree with him about the
    potential benefits of position limits creating healthier
    commodity markets?
        Mr. Gensler. I do. I voted for the rule. I did because I
    think Congress mandated that we do it, but I also believe that
    it helps promote the integrity of markets.
        Senator Levin. Much of the new speculation comes from the
    commodity index fund investors and swap dealers who sponsor
    those funds, hedge their risk on their client's speculative
    bets by purchasing long futures contracts. Do you know
    approximately what percentage of the demand for long futures
    contracts across the futures markets is attributable to
    commodity index funds, approximately?
        Mr. Gensler. The figures that we put out monthly show--and
    I think they were summarized in the charts--approximately this
    $250 or $260 billion equivalent in futures because some of that
    is swaps investment. The marketplace in the commodities, the
    most recent figures, is about $1 trillion in notional amount of
    futures. So it is a little bit of apples-to-oranges, but you
    can think of it roughly as about 25 percent of the longs and,
    because the shorts are about $70 billion, about 7 or 8 percent
    of the shorts, though I would note there is a little apples and
    oranges there.
        Senator Levin. OK. When you testified before the
    Subcommittee before regarding excessive speculation in the
    wheat market in 2009, I asked if the CFTC as part of its work
    would look at the question of whether or not commodity index
    trading constitutes excessive speculation in the wheat market,
    and you told us that the CFTC would be looking at it not only
    for index investors but also for the broader class of
    speculators in financial markets. I am wondering if you have
    conducted that review.
        Mr. Gensler. Well, I think since then--and I apologize, I
    do not remember the exact date of that hearing--we had three
    public hearings in the oil markets and one in the metals
    markets, and then we have had two public meetings on this rule
    itself and conducted a great deal of inquiry, including 8,000
    comments on the initial rule and 15,000 on the latter and
    hundreds of meetings. So collectively, yes, we have also looked
    at over 50 studies that were referenced in the comment file on
    position limits and reviews those and had our Office of the
    Chief Economist review those studies.
        Senator Levin. We have talked this morning about the
    commodity-related exchange rate traded products (ETPs), which
    are set up as securities but are designed to enable speculators
    to bet on changes in commodity prices without buying the
    underlying commodities. These are hybrids that combined
    securities and commodities. They can directly affect
    commodities futures prices. They are currently responsible for
    about $120 billion in commodity investments. Do you believe
    that exchange traded products that offer investors the chance
    to invest in baskets of commodities have added to the
    speculative money in the commodity markets and that they have
    contributed to speculative pressures on commodity prices?
        Mr. Gensler. Well, they are a group of financial investors
    that are speculating. Again, as hedgers and speculators meet in
    markets, this is a new vehicle for the retail public for the
    person to invest rather than maybe buying a bar of gold or--
    when I was growing up, my dad used to have a couple of gold
    coins, I remember he would show them to me every once in a
    while. He thought it was good always to have a little gold.
    This is a new vehicle to have that.
        Senator Levin. My dentist, by the way, is telling me the
    same thing. It is good to have a little gold.
        Mr. Gensler. I see.
        Senator Levin. Anyway, I interrupted you.
        Mr. Gensler. No.
        Senator Levin. The Dodd-Frank Act acknowledged the
    existence of these mixed swaps as hybrid instruments that
    warrant oversight from the SEC and the CFTC, and I am wondering
    if ETPs are not the same, essentially, set up as securities but
    intended to function as commodity investments. Would you agree?
        Mr. Gensler. Yes. One of our staff calls it a ``securitized
    warehouse receipt.'' In a warehouse somewhere there is gold or
    silver, but it is traded in the securities market. Not all of
    these are that, but the majority of them are.
        Senator Levin. And, therefore, does it require oversight
    from either or both the SEC and the CFTC?
        Mr. Gensler. Well, the SEC does have oversight. We have
    coordinated with them for the last 6 or 7 years when this
    market started on that. But most directly it is the SEC's
    oversight, though they have done it in a cooperative way with
    us.
        Senator Levin. Are the commodity-related issues looked at
    by the SEC? Their function is not to look at the issues
    involved in commodities trades, so I want to know who is
    looking at the commodity-related issues in these instruments.
        Mr. Gensler. On these instruments, if they were used with
    regard to a manipulative scheme in the commodity futures
    markets or shortly in the commodity swaps markets, we would.
    But if it were just the trading of these and they did not come
    into a manipulative scheme, then it would be separate. But it
    would also, if I might say, be somewhat like if somebody was
    just trading gold but it was not part of a manipulative scheme,
    we would not necessarily be looking at that either.
        Senator Levin. And are you taking steps to prevent them
    from being used as manipulative schemes, or are you waiting for
    something to happen? In other words, are you doing the
    oversight of these securities and the way they are used as
    commodity trades? Is that something you are trying to prevent
    manipulative schemes from being used, or you are just saying,
    well, the SEC is looking at the trades and we are going to wait
    until there is some evidence that accumulates somewhere?
        Mr. Gensler. I think, frankly, this would have to be a
    little bit more evidence-based, if we saw something in our
    futures markets we oversee or a whistleblower or somebody comes
    to us. Frankly, with the 700 people that we have, the resources
    are not such--nor do we necessarily just go to see if somebody
    is doing something with gold. But if it comes into our markets,
    comes into the futures markets that we oversee or shortly the
    swaps market and becomes part of a manipulative scheme or
    device, we have in the past and will in the future do so.
        Senator Levin. So the oversight of these particular types
    of products is different from the futures.
        Mr. Gensler. That is correct, sir.
        Senator Levin. And isn't that a problem?
        Mr. Gensler. It may be. I do believe that if it came to our
    attention it was being used as part of a manipulative scheme,
    we would certainly use everything that we have in our
    resources, but I think you have the accurate picture.
        Senator Levin. Thank you. Senator Coburn.
        Senator Coburn. Welcome. Sorry I was not here to hear your
    oral testimony.
        How does the CFTC define ``excessive speculation''?
        Mr. Gensler. Congress actually had a finding in the 1930s,
    and we first put position limits in in 1938 based on that
    finding. And though some of the language has changed over the
    years, it is really that we were to use position limits to help
    curb or prevent some of the burdens that may come from
    excessive speculation. And so what we did then and have over
    the decades is really looked to ensure two things: In the spot
    month, when somebody is actually delivering the natural gas
    down in a certain spot in Louisiana or delivering the oil in
    Cushing, Michigan, which you know well, that there is not a
    corner or a squeeze or a manipulation in that delivery period;
    and then, second, that over all of the contracts, which we call
    all-months combined, that there is not a concentration or an
    outsize position. It used to be labeled in numbers of bushels
    of grain, the first position limits were that way, and then
    subsequently, by the 1970s and 1980s, we turned to a percentage
    of the market. This most recent rule really used a formula that
    we put in place through notice and public hearings in the late
    1980s and early 1990s, so it is about 20 years ago, and it is
    roughly 2.5 percent of the speculators. The speculators could
    not each have more than 2.5 percent.
        Senator Coburn. So is excessive speculation happening now?
    We did not really get to a definition. So whatever it is, is it
    happening now?
        Mr. Gensler. The markets are made up of hedgers and
    speculators coming together, and one of the increasing features
    of the market is more and more financial parties. In the oil or
    natural gas markets, about 13 to 18 percent of the market are
    producers and merchants, and the other 80-plus percent are
    hedge funds and swap dealers and other financial actors. What
    we do is we use our authorities to police against fraud and
    manipulation and ensure transparency, that people see that
    price function, and then also to have positions to help prevent
    against manipulation, corners and squeezes, as I mentioned,
    help ensure the integrity of the market with regard to the all-
    months combined, that no one speculator has an outsize
    position.
        Senator Coburn. So I will go back to my question. Is
    excessive speculation happening now?
        Mr. Gensler. Well, we know that the speculative group in
    the market can be anywhere from 50 or 60 percent in the grain
    markets to 80 to 88 percent or so in the energy market.
    Congress made the finding not only in the 1930s but also in the
    Dodd-Frank Act, once again came back to it, added more words
    that the Chairman and I just were--he was good enough to remind
    me of the additional words--and asked us, really mandated for
    us to put in place these regimes to help as a preventative
    matter moving forward.
        Senator Coburn. So you do not know whether excessive
    speculation is happening now? Or you do know and do not want to
    define it? Or you are just responding to Congress and the
    assumption that there is?
        Mr. Gensler. Well, I think that we have been responding to
    Congress for 70-plus years on this, and it has been reaffirmed
    by Congress just last year that to ensure for the integrity of
    markets that we have a per se limit, that it is a specific
    limit that we set in place. So we use these well-worn formulas
    that have worked. We had limits in the energy and metals
    markets before.
        Senator Coburn. I am not debating that. Is the assumption
    by the CFTC there is excess speculation now so, therefore, you
    wrote new position limits?
        Mr. Gensler. No, I think that what we took was Congress'
    clear mandate to do this, and with the regime that we have used
    in the past----
        Senator Coburn. The language says ``as necessary,'' so how
    do you decide whether it is necessary unless you assume there
    is excess speculation?
        Mr. Gensler. Well, we took this up and had many comments,
    some on both sides of this very issue that you just raised,
    Senator. It is the Commission's belief in finalizing this rule
    that Congress mandated that we move forward and that it is not
    necessary to find that there had been a burden, that these are
    also preventative, these are forward-looking, so ensure that
    there is not manipulative schemes, corners, and squeezes.
        Senator Coburn. So the new regulation is not based on the
    fact that there is an assumption that there was excessive
    speculation. It is to prevent any future excessive speculation.
    Is that what you are telling me?
        Mr. Gensler. That is what the statute actually says, and
    the Commission's finding on this is that. But in addition, we
    had over 50 studies referenced in the file, and about half of
    them are on one side and about half of them are on the other. I
    do not want to say a percentage, but they are mixed, the
    economic studies.
        Senator Coburn. So for clarity for the American people,
    either there is or there is not excessive speculation, and we
    have put forward regulations to prevent the potential for that
    in the future.
        Mr. Gensler. To prevent the burdens that may come from
    excessive speculation.
        Senator Coburn. Well, position limits are designed to stop
    excessive speculation, correct?
        Mr. Gensler. I believe that the statute has in 4(a)(1) the
    words to curb or prevent the burdens that may come to
    interstate commerce from excessive speculation, and then in
    4(a)(2), as the Chairman pointed out, there were added four
    factors, and so it was also about manipulation, it was about
    promoting liquidity in the markets, and promoting the price
    discovery----
        Senator Coburn. So you could have written a rule that would
    have allowed for excessive speculation but would not have had a
    burden.
        Mr. Gensler. I am not sure I am following that.
        Senator Coburn. Well, you just said the statute is to
    prevent the burden in terms of the price to the markets and to
    the country. So you could have had a rule that allowed for
    excessive speculation as long as the excessive speculation did
    not affect the price.
        I will not go any further on it. The point is the factual
    basis of determining excessive speculation needs to be based on
    something that is concrete, not an aftereffect but something
    that is concrete. And my worry is you are going to get tied up
    in a lawsuit that is going to--the well-intentioned thought of
    eliminating excessive speculation and decreasing volatility so
    that people are not paying too high of a price for something
    that the market truly is not saying--that speculation caused it
    to be higher, more speculation than necessary to then create
    the market. What my worry is is two things: One is that you are
    going to get tied up and spend a lot of your budget defending
    it; and two is what we have written here is a click away from
    not having any effect at all because they are going to go to
    some other market.
        What do you think will happen in the rest of the commodity
    exchanges around the world on the basis of the new rule that
    you all have put out?
        Mr. Gensler. I think we have made very good progress. In
    September, working along with international regulators in
    something called--I do not know that you are familiar with it,
    but it is the International Organization of Securities (IOSCO)
    regulators--put forward a joint report, and then that was moved
    up actually to the G-20, the 20 countries that form the
    Financial Stability Board, to put in place regimes that have
    anti-manipulation rules similar to what we have that could go
    after attempted manipulation, have more transparency. We
    actually have some of the best transparency here. And, also, it
    included--they called it ``position management regimes,'' a
    little bit different word. We would be glad to brief your staff
    on that.
        So I think we have made good progress, but you are
    absolutely right, capital and risk knows no geographic
    boundary. So Congress also included that if there was a foreign
    exchange that linked their contract to contracts here, for
    instance, if somebody in London linked the contract to
    something in your State, Oklahoma--it is called West Texas, the
    WTI contract. If it were linked, that has to come under the
    position limits, and we finalized a rule that said if anywhere
    around the globe a foreign board of trade links it to one of
    the contracts here, then it has to be in that same regime.
        Senator Coburn. Yes, but none of that is implemented
    anywhere yet, correct? Those are proposals to be implemented.
        Mr. Gensler. That is right.
        Senator Coburn. We have a rule that is going to be in
    effect, questions about it, lots of learning curve on it. What
    is going to happen in the meantime? Let me just assume for a
    minute, since Europe is functioning so well--they are
    functioning just about as poorly as we are as a legislative
    body. What happens if those do not get put in effect given ours
    goes into effect? What do you foresee--what is the downside for
    American jobs, American price discovery, American valuation for
    products and commodities that are made here, what is the
    downside for our country if that does not happen in the rest of
    the trading centers around the world? What is the downside?
        Mr. Gensler. I think we saw some of the downside of weak
    regulation in 2008. I think our financial system failed in part
    because our regulatory system failed in 2008, and 8 million
    Americans are out of work today because of that, not because of
    position limits but because of our weak regulatory system.
        Senator Coburn. Well, let us talk about what I asked you.
    What is the downside if they do not do it and we have?
        Mr. Gensler. But I think that Congress mandated us to do
    this and a lot of other pieces of----
        Senator Coburn. I understand. What is the downside?
        Mr. Gensler. I think the downside is if we do not protect
    our markets, the price discovery and the integrity of these
    markets are weakened. So I think what Congress recognized and
    what the Commission recognized is that we have to promote the
    integrity of the markets and the price discovery function here.
    Congress also did ask--and we will do this--1 year after these
    rules go into effect, we have to report back to Congress, and
    one of the specific things Congress asked us to report on is
    exactly that which you raise, about the overseas effect, where
    are we at that point in time and report back, whether it is--I
    do not remember the exact words, but any effects of where we
    are overseas versus here. And I think that was very
    appropriate.
        Senator Coburn. So I take it from your answer you are not
    extremely concerned that disconnecting from WTI, disconnecting
    from the Chicago Board, disconnecting from all these others,
    that people decide that they will speculate somewhere else, and
    given that we are in a global economy, we cannot regulate the
    global economy by only regulating us, and the very things that
    we are trying to limit, excessive speculation, whatever that
    is--since nobody will define that for me except Mr.
    Turbeville--excessive speculation is going to occur somewhere
    else outside, and we are still going to have the same price
    swings in our market. Is that not the downside?
        Mr. Gensler. I think that we are working very closely with
    international regulators, and I share your view that we should
    harmonize as much as we can. But we do have, as you mentioned,
    different political systems, different cultures, and it is
    possible, it is even likely that we will end up with some
    differences in not only position limits but anti-manipulation,
    the oversight of swap dealers, and the like.
        Senator Coburn. How many people are employed in commodity
    trading in this country?
        Mr. Gensler. I know the figures for the whole financial
    industry is into the hundreds of thousands. I do not know the
    specific number to your question, but we could try to get back
    to you on that.
        Senator Coburn. Well, we have got it. The point I am saying
    is we have a problem, the Chairman has identified a problem. We
    know we want real price discovery. We know we want real
    transparency in our markets. We know we have to have
    speculators to create a market. We know we do not want
    excessive speculation. We know we want the CFTC when they are
    cornering markets or abnormal. Is the regulatory framework that
    you put up, without that being put up around the rest of the
    world, going to be effective in accomplishing what--even if
    Congress told you to do it or whether it was apparent as
    necessary you should do it, is it going to accomplish its goal?
        Mr. Gensler. I think that it is important that we promote
    the price discovery and the integrity of the markets that we
    can oversee here. You are absolutely right. We do not oversee
    all the markets around the globe. If it is linked back to these
    markets, we do. We have that hook. But you are right----
        Senator Coburn. Yes, but all they will do is delink it. I
    mean, think oil. Where is the vast majority of the oil
    produced? Not here. So if, in fact, we have trading limits here
    and the rest of the world does not put them in, the oil is not
    going to be traded here. It is going to be traded in London, or
    it is going to be traded in Singapore. It is going to be traded
    somewhere else besides here, and we will not have accomplished
    the purpose. And what needs to happen is the effective
    implementation of transparency and price stability in all the
    markets, not here. Because what my worry is is we are one click
    away--my computer, one additional click, I can go to London and
    trade.
        Mr. Gensler. No, that is my worry about the European crisis
    right now. We are one click away the other direction. So we are
    working pretty hard to finish our rules to make sure our
    financial institutions are less at risk, less interconnected
    through the swaps market, and that the more transparency in the
    markets that we can oversee actually have greater transparency
    and greater integrity.
        Senator Coburn. Let me go to one other area if I might for
    a moment.
        Senator Levin. Sure.
        Senator Coburn. Have you all created a true definition of
    what a swap is?
        Mr. Gensler. I think that Congress had a very good
    definition. We were asked by Congress to further define the
    word ``swap,'' working along with the Securities and Exchange
    Commission. We had a lot of public input through what is called
    an Advanced Notice of Proposal, and we are working to finalize
    that in the next several months.
        Senator Coburn. So you cannot regulate it until we define
    it, correct? You are going to have trouble applying a position
    limit on a swap until you have a definition of what a swap is.
        Mr. Gensler. We have actually envisioned exactly that these
    rules go into effect for certain futures products in the spot
    month, but to the extent that they relate to swaps, because
    Congress asked us to ``further define'' it with the SEC, we
    need to finalize that role. As I say, we are envisioning----
        Senator Coburn. When does that have to be done by?
        Mr. Gensler. Well, Congress asked us to finish it by this
    past July, but we are not working against a clock. We are
    working to get this in a balanced way.
        Senator Coburn. And when do the regulations on swap
    position limits take effect?
        Mr. Gensler. The spot month limits that are on certain
    futures will take effect, but the ones that relate to swaps we
    need to finalize that further definition, as the Senator says,
    and that is probably several months away.
        Senator Coburn. Yes, it is not going to take effect--there
    are no limits on a swap until you have defined a ``swap.'' Is
    that what you are telling me?
        Mr. Gensler. That is generally correct. There are some
    exceptions because in a law passed in 2008 around significant
    price discovery contracts, there are some in natural gas, but--
    we do have some.
        Senator Coburn. So there is not going to be any position
    limits enforced by the CFTC until the definition of what a swap
    is is out, with the exception of what you described in----
        Mr. Gensler. That is generally correct.
        Senator Coburn. All right. You already have position limits
    for legacy contracts, correct?
        Mr. Gensler. That is correct.
        Senator Coburn. And is cotton No. 2 one of those?
        Mr. Gensler. Yes, sir.
        Senator Coburn. And yet cotton hit 16 record-setting prices
    in the last 12 months, did it not?
        Mr. Gensler. If that is the number you have, sir, I trust
    the number.
        Senator Coburn. Did the position limits in place prevent
    wheat, corn, and soybean volatility in 2007 and 2008?
        Mr. Gensler. We are not a price-setting agency. I think
    that position limits are to help ensure the integrity of
    markets, that no one party has an outsized or concentrated
    position in the markets.
        Senator Coburn. I know, but the reason I ask the question
    is the panel before you, based on these new methods of trading,
    outside of true commodity users and people who are hedging, the
    implication was that the price is on the way up regardless of
    supply-demand, essentially, unless extreme supply-demand
    differences. And yet in wheat, corn, and soybeans, from 2007 to
    2008, we saw tremendous price increases, yet we had position
    limits on them. We saw a tremendous increase in volatility. And
    I agree with you, you are not in the position to control price.
    You are in the position to create transparent and stable
    markets.
        Mr. Gensler. We agree on that.
        Senator Coburn. So the point I am making is we had position
    limits on those commodities, yet we saw tremendous swings,
    tremendous increased speculation, and tremendous increased
    volatility. So my point is we are not necessarily going to
    change pricing, which was our testimony of the first panel,
    that the bias is for an increased price, that there are no real
    market forces in the long term to drive price the other way on
    the other side of the trading with position limits. The whole
    goal for position limits is to make sure not anybody is
    manipulating the market, correct?
        Mr. Gensler. I think that it is--in my own words, we are
    not a price-setting agency. It is to ensure that the price
    discovery function has integrity, and that is integrity against
    manipulation, but also, as the agency has for decades, that
    there is not concentrated parties that can distort on the way
    down or distort on the way up, just that there is a diversity
    of actors. There are more actors on a stage, there is more
    competition in the market, less likely that one party distorts
    the market.
        Senator Coburn. But you would agree that the prices on
    corn, soybeans, and wheat had good price integrity during this
    period of increased volatility, increased speculation? I mean,
    corn is still at $6.40 a bushel. Three years ago it was at $3.
    There is nothing wrong with that pricing mechanism, is there?
    It worked.
        Mr. Gensler. Well, in some of these there are issues about
    the pricing mechanism with regard to convergence, which was an
    earlier hearing, in the wheat markets.
        Senator Coburn. Right.
        Mr. Gensler. And there is still very much focus----
        Senator Coburn. You mean in terms of the close-out month.
        Mr. Gensler. The close-out month, and there are very
    serious issues still in a couple of contracts that we watch on
    a very regular basis. We also look in closed-door sessions at
    surveillance and look at issues of enforcement matters. I do
    not want to ever say that there are not things that we look at
    on a very regular, intensive way.
        Senator Coburn. I appreciate that.
        Mr. Gensler. But I think I share your view that position
    limits are about--I believe our whole regime, position limits,
    anti-manipulation, transparency, and the other rules we have,
    is to ensure for the integrity of markets and the price
    discovery. It is not about whether prices should be higher or
    lower.
        Senator Coburn. Right.
        Mr. Gensler. It is to allow the markets to come together
    and these hedgers and speculators to meet in this market.
        Senator Coburn. Yes. I want to thank you for your
    testimony, also for your service. I will have some additional
    questions for the record, if you would not mind responding to
    those.
        Mr. Gensler. I would look forward to it and meeting with
    you at any time.
        Senator Coburn. And I would just re-emphasize my worry, Mr.
    Chairman. If this is not a global regulatory scheme on
    commodity pricing, what you have done will have no significant
    effect. This is a global market. We live in a global world in
    terms of commerce, and what we will do in our attempt to do
    something good, we will actually hurt our country, hurt a lot
    of jobs that are employed in the commodities exchanges and
    trading in this country, and what we are going to do is shift
    it, like we have the medical device industry, to Europe or to
    Singapore.
        Senator Levin. Would you agree, Mr. Gensler, that the goal
    of making our markets more transparent and greater integrity is
    an attraction to investors?
        Mr. Gensler. I do.
        Senator Levin. And so even if other markets do not have
    integrity that we do, do not have transparency that we do, do
    not follow rules that help a market have integrity, that those
    markets are not necessarily going to be attracting investors;
    they may be, as a matter of fact, putting investors off that
    want markets that have integrity. Would you agree with that?
        Mr. Gensler. I do. Market participants want to come to deep
    pools of liquidity where a lot of other actors are, where no
    one party can control the market--and in that regard I think
    position limits help--and where there is market integrity and
    when there is a cop on the beat.
        Senator Levin. And removing a cop on the beat is what we
    tried before, and we saw the result of it with the 2008 problem
    that we had. Would you agree with that?
        Mr. Gensler. I think that was certainly part of it. There
    are a lot of other reasons as well, of course.
        Senator Levin. There are good reasons to have a global
    regime. I happen to agree with that. But we want to have
    markets that have integrity, investor confidence, even if
    markets in other places do not, and rather than money flowing
    out, we are going to have money flowing into a market that has
    integrity if it is competing with markets that do not have
    integrity, do not have the kind of transparency, do not have
    the kind of anti-manipulation regulators in place.
        Mr. Gensler. I agree with that, but if I might add, I also
    think that market integrity helps protect the taxpayers against
    some of the bailouts that so unfortunately our public had to
    face in 2008 and unfortunately then Europe is struggling with
    now.
        Senator Levin. I think we all would agree with that. There
    are a lot of reasons for assuring market integrity.
        Would you agree with me, without having to go back and read
    the Dodd-Frank Act, that the CFTC is allowed to prohibit
    foreign countries from installing trading terminals here in the
    United States unless they have similar position limits?
        Mr. Gensler. Yes.
        Senator Levin. So you can use that authority to level the
    playing field. Is that correct?
        Mr. Gensler. Yes.
        Senator Levin. On the question of mutual funds, we have an
    existing law which says that for certain tax benefits, mutual
    funds can invest no more than 10 percent in alternative
    investments, including in commodities. Alternative investments
    meaning alternatives to investments in securities. Mutual funds
    are getting around this 10-percent limit in one of two ways,
    both of which have been so far approved by the IRS but which
    the IRS is now reviewing. One, they are investing in commodity-
    related ETPs which qualify as securities; and, two, some mutual
    funds have established offshore entities that they use to
    invest in commodities, doing indirectly what they cannot do
    directly by creating shell corporations offshore which they
    control.
        Now, we have identified in Exhibit 7,\1\ 40 mutual funds
    whose primary focus is to invest in commodities, adding tens of
    billions of dollars of additional speculative pressures on
    commodity prices. What is your understanding of the extent to
    which mutual funds are active in commodity markets now, either
    directly through ETPs or indirectly through offshore shell
    entities?
    ---------------------------------------------------------------------------
        \1\ See Exhibit No. 7 which appears in the Appendix on page 185.
    ---------------------------------------------------------------------------
        Mr. Gensler. Well, I think this is an excellent exhibit for
    the public and for us as well. But this is part of that other
    number, the $250 billion or so that is in our monthly reports
    on commodity index investment. So this is a piece of that
    larger pie.
        Senator Levin. My staff is saying that they are not a
    subset; they are an overlap here.
        Mr. Gensler. It is not a perfect subset; that is correct.
    There is some overlap because the way that we collect that data
    is not this entire universe. We collect that data through swap
    dealers and some large index investors. So there is an overlap,
    which I think it would take a bit of research to see what the
    extent of the overlap is. When I meant ``part of this,'' it
    might make it 280 or 290, but it is part of the same overall
    investment piece.
        We did propose something earlier this year--it could have
    been late in December of last year--which we have yet to
    finalize, which is with regard to certain exemptions that were
    granted, I think in 2003, for commodity pool operators and
    whether they file with us as a commodity pool operator that
    also relates to some of these exemptions that you are referring
    to in the mutual fund area. And we actually proposed revising
    and in some cases repealing them--this is Section 4.5--that
    would, if we were to finalize it, I think give us greater
    transparency as an agency. It just means they are filing their
    financials. But it still is a helpful piece to have them file
    as a commodity pool operator, some that had been getting
    exemptions for their offshore pieces.
        Senator Levin. All right. So you are looking at eliminating
    that exemption.
        Mr. Gensler. We have actually proposed that exemption from
    2003 with regard to certain Section 4.5, so to speak, entities.
        Senator Levin. All right. So as I understand it, these
    offshore affiliates of mutual funds that do not now have to
    register as commodity pool operators with you, even if they
    market themselves to investors as commodity funds and actually
    operate a commodity pool. This is allowed because of Rule 4.5,
    which is a regulation exempting them from the registration
    requirement on the ground that they are subsidiaries of mutual
    funds which are regulated by the SEC. And so the question that
    you are addressing, as I understand your testimony, is given
    their exclusive or primary activity in the commodity markets,
    they are going to have to register? Is that correct?
        Mr. Gensler. Well, we have not yet finalized the rule, and
    we have a lot of comments. We have had mutual funds come in and
    remind us, ``Well, we do not have to file right now.'' I would
    say they did not remind me. I did not quite know that we had
    somehow missed this in 2003. But they were exempted in 2003. We
    proposed revising and repealing in certain parts that, and we
    are looking at how to finalize it. The mutual fund companies
    have a point of view, and they have expressed it in their
    comment letters.
        Senator Levin. Is there a proposed rule change then that
    you have published?
        Mr. Gensler. Yes. I am sorry, in the Federal Register, I
    think, last December or January.
        Senator Levin. So when is that due to be finalized?
        Mr. Gensler. I would think in the first quarter.
        Senator Levin. All right. Getting back to Dr. Coburn's
    important question about a definition of ``swap,'' his point is
    you are going to have to define ``swap'' before the new rule
    affecting swaps comes into place. And I could not agree with
    him more.
        My understanding is that your definition is due to be
    published fairly soon. Is that not true?
        Mr. Gensler. That is true. It is a joint rule with the SEC,
    and we are sorting through a lot of things. We also had the
    events of MF Global this week, as the news reports, that we
    were doing some other things, Chairman Mary Schapiro and I.
        Senator Levin. But is it fair to say that we could expect
    that definition this month or no later than the end of this
    year? Is that fair?
        Mr. Gensler. It would be every bit my hope, but I would say
    this to be transparent: The next joint role with the SEC that
    is in our docket is the joint swap dealer definition, and these
    are the two definitional things. So we are looking at trying to
    finalize the ``swap dealer'' definition first, and we are very
    close on that, and then the ``swap'' and ``security-based
    swap'' thereafter. So I would say in the next several months,
    but I would not say in the next month.
        Senator Levin. But it is clear that it has to be defined
    before the rule takes effect using the word which needs to be
    defined.
        Mr. Gensler. Yes, though it was----
        Senator Levin. I think that is what Dr. Coburn----
        Mr. Gensler. No, I am agreeing with both of you.
        Senator Levin. I think that is what his point was. It is
    obvious, isn't it?
        Mr. Gensler. It is interesting. Congress actually defined
    the word ``swap'' and then said we were supposed to ``further
    define'' it. So it is all in this, what does it mean, ``further
    define.''
        Senator Levin. Well, that is what regulators do. We adopt
    laws and you guys implement it, and in your discretion you
    further define things. Isn't that your function to do that? We
    have a law, in the Dodd-Frank Act, which says you are supposed
    to ``set limits to the maximum extent practicable'' in your
    discretion--the limits would be in your discretion--to
    ``prevent excessive speculation.'' That is what we say,
    ``prevent excessive speculation.'' But what is the maximum
    extent practicable? You have got discretion to determine that;
    isn't that just your ordinary function?
        Mr. Gensler. Right. So we will finalize--one of the reasons
    I say that, I think most people know what 2-year interest rate
    swap is.
        Senator Levin. All right. My time is up. Dr. Coburn.
        Senator Coburn. I am going to send you some questions on MF
    Global just simply because here we now have a regulatory
    scheme. If, in fact, it is true investor money was used
    inappropriately, that is a regulatory concern for me. I am very
    interested in how in the world did that get past you all, how
    it got past the SEC. Here we now have a new regulatory scheme.
    We have done a lot of changing since what happened in 2007 and
    2008, and it is concerning that we have another company that
    has just potentially blatantly violated the rules. So I will
    send you some letters on that.\1\
    ---------------------------------------------------------------------------
        \1\ See Exhibit No. 13 which appears in the Appendix on page 309.
    ---------------------------------------------------------------------------
        Again, I thank you for your service. You do not have an
    easy job. You have a tough budget. I understand that. It is not
    going to get any better, the budget. The job is probably not
    going to get any better either, but I appreciate the work of
    you and your staff, and I am concerned about the challenge to
    this rule. I hope you do not end up spending a lot of time in
    court defending it because of some of the lack of definition.
        Mr. Gensler. I appreciate your advice, your questions, and
    it is an honor to be in this job. It truly is. And I think it
    is about protecting the taxpayers and promoting these markets,
    and as relates to MF Global, and all companies, protecting
    customers. I said--and I will repeat it because you were not in
    the room at the time--that I think at the core of our regime is
    customer money, the sanctity of it. It is supposed to be
    segregated. It is sort of like you do not put your hand in the
    cash register. You just do not. It is the customer's money, and
    it is supposed to be there every nanosecond of the day,
    segregated.
        Senator Coburn. Thank you. Thank you, Mr. Chairman.
        Senator Levin. I think we all agree on that, by the way.
    Thank you, Dr. Coburn. There may be some disagreements on some
    subjects, but when it comes to protecting the taxpayer, we are
    going to take steps to do that, and that is going to require
    regulators being put back on the beat. We are going to protect
    the taxpayers from companies that are too big to fail. We are
    going to try to make sure we take steps that we do not see the
    taxpayers bailing out companies again. The issue, as I
    understand it, with the fund that went bankrupt is that the
    customers may have gotten injured by improper activity, or they
    may have gotten injured by taking risks. But to me, it is your
    function to help protect customers of that hedge fund, but it
    is doubly important that we understand that there is no
    taxpayer liability here that you know of.
        Mr. Gensler. This is an example of freedom to fail, and I
    was part of that decision set of putting it into bankruptcy,
    and no taxpayer money is behind this at all.
        Senator Levin. If there was improper activity here that
    impacted their customers and their clients, that needs to be
    taken up as well.
        Mr. Gensler. We are going to fully pursue this.
        Senator Levin. We are, but it is a very different issue
    from the battles which we have been waging here to try to
    protect taxpayers and the Treasury from companies that are too
    big to fail, either getting bailed out or going under and there
    being some kind of a governmental obligation. That is not the
    case here, thank God, but what may be the case here is
    something which should not be allowed to happen either because
    we do not want customers to be either defrauded or to be
    improperly dealt with. We do not know that is the case here,
    but we have cops on the beat to help prevent that as well, and
    you folks are into it.
        On the high-frequency trader, we have CFTC data showing
    that up to 80 percent of trading in key futures markets is day
    trades or trading around the expiration of contracts. The day
    trading is conducted in part by high-frequency traders that use
    computers to engage in rapid-fire trades, usually profiting
    from slight price increases over a brief period of time. Do you
    believe that this day-trading activity is adding to the
    volatility in the commodity markets?
        Mr. Gensler. I think that there are a number of things that
    have changed in our marketplace, and you have addressed one
    important one. What was once day trading in a sense on the
    floor of the futures market or even the floor of the securities
    markets is now in a computer group, and it is called high-
    frequency trading. I think that while in calm markets they
    can--and there are studies that have shown they can--even
    narrow the difference between the bids and the offers and, so
    to speak--narrow the big-offer spread, that in times that are
    not so calm, like a year and a half ago on May 6, 2010, they
    can sometimes step away from a marketplace, and the liquidity--
    sometimes people confuse volume in a market for liquidity. And
    they have added greatly to the volume in the market. It is not
    clear that at all times they are adding to liquidity in the
    market.
        So we have come forward with proposals. These are not final
    rules, but we have proposed that exchanges and clearinghouses
    have to have new pre-trade risk filters and pre-trade risk
    controls with regard to protecting the markets and the
    integrity of the markets better in these circumstances.
        Senator Levin. There has been some discussion here this
    morning about position limits not applying to the
    multicommodity swaps. You have made that distinction. These are
    extremely common in the commodities markets. Some of our
    earlier witnesses did not know why you made that distinction.
    Why did you?
        Mr. Gensler. I would say a number of reasons. One, if I
    might say because you mentioned it, the Goldman Sachs Commodity
    Index, there is actually a futures commodity, that index, on
    CME, and they do have a position limit, a hard 10,000-contract
    limit. So we addressed ourselves to that is not the only
    reason, but that is one reason. But what we addressed ourselves
    to is these 28 individual commodities and trying to reimpose or
    bring back in the energy and metals markets where there had not
    been for all months combined, and trying to sort through a
    really significant docket with regard to what Congress mandated
    to do.
        The commodity index is not really about the corner and
    squeeze issue in the same way because it is an index across
    many products and you cannot deliver oil or wheat or corn into
    the commodity index. It is an index. It is not--has the same
    delivery function. So I think given the full docket of trying
    to take on the 28, given that the exchange actually right now
    does have this limit on this one contract, and that it is less
    about the spot month and the delivery period, these are some of
    the factors that influenced us. It is also something we can
    still take up. I mean, it is not that we cannot take it up.
        Senator Levin. Do you expect you will take that up?
        Mr. Gensler. I do not know, sir, just given the full docket
    of what we are doing, and also we are supposed to report back
    to Congress in a year as to how the current regime is working.
        Senator Levin. Would it be useful for you to take that up?
        Mr. Gensler. Well, I think there are a number of questions,
    that plus there are these questions that were raised on the
    earlier panel and that you have raised about limits across a
    certain sector and so forth that I think are additional issues
    that--whether it be in the study that we report back to
    Congress or otherwise, are things that many people will
    continue to review.
        Senator Levin. You made reference to the mutual fund
    industry's effort to eliminate the 10-percent restriction on
    alternative investments, in particular because they want to
    increase the percentage of their portfolio investments in
    commodities. They did not succeed in that bill. I am glad for
    that and had something to do with that, but in any event, they
    are trying to apparently continue their efforts to remove that
    restriction.
        What would be the impact in your estimation as to the
    amount of speculation in commodity markets if that 10-percent
    restriction on mutual funds' alternative investments was
    removed?
        Mr. Gensler. I do not have a developed view.
        Senator Levin. Do you have a hunch as to whether it would
    increase speculation?
        Mr. Gensler. I frankly----
        Senator Levin. That is why they want to get it removed, so
    would you think that if that is their motive in getting it
    removed that it would have the effect they seek, which is that
    they would be able to speculate more than 10 percent of their
    funds in the commodities markets?
        Mr. Gensler. Well, it would open up a broader class of
    investors in the marketplace or broader class of speculators,
    but I just will pause there and say I am just not familiar
    enough with the provision that they were seeking to pull----
        Senator Levin. Are you familiar with the 10-percent limit
    on alternative investments that mutual funds have?
        Mr. Gensler. I mean, just generally, but I am not familiar
    with what they are trying to change.
        Senator Levin. They are trying to get rid of it.
        Mr. Gensler. They are trying to get rid of it, so it would
    broaden the class of potential speculators.
        Senator Levin. A hundred percent of $11 trillion could go
    into speculation in commodities if they so chose.
        Mr. Gensler. So some of these ratios that we had earlier
    could go up. There would be more financial actors.
        Senator Levin. Do you have an opinion as to whether or not
    if they got rid of that limit and there is now a possibility of
    $11 trillion getting into speculation in commodities, whether
    or not, in fact, there would be a significant increase in
    mutual funds' purchase of those investments or betting on
    commodities? Do you think there would be an increase? You do
    not have an opinion on it?
        Mr. Gensler. I just have not developed a view. I mean, this
    is the first discussion I have had on it. I am glad to look at
    it and come back and meet with you or at the least----
        Senator Levin. No, you do not have to do that. I would just
    ask you that question for the record so you can discuss that
    with your staff as to whether the elimination of that 10-
    percent limit on mutual fund purchases and investments so that
    they could invest more than 10 percent of their funds in
    commodity speculation, whether or not that would have an
    increase--whether there would be an increase in speculation in
    commodities. That is my question. You can take that for the
    record.\1\
    ---------------------------------------------------------------------------
        \1\ See Exhibit No. 12 which appears in the Appendix on page 308.
    ---------------------------------------------------------------------------
        Mr. Gensler. It certainly would expand the pool of parties
    that could invest.
        Senator Levin. How about the amount of money that would be
    or could be invested?
        Mr. Gensler. It would expand the pool of money.
        Senator Levin. But you do not have an opinion as to whether
    it would lead to that?
        Mr. Gensler. I have not talked to any mutual funds. I am
    not familiar with the----
        Senator Levin. Could you get yourself familiar with us and
    let us know?
        Mr. Gensler. Sure. I will try my best.
        Senator Levin. For the record--I assume if you try your
    best that we can count on you to give us an answer for the
    record to that question.\1\
        Mr. Gensler. Yes, of course.
        Senator Levin. Well, we thank you. It has been a long
    morning. You have a huge amount on your plate, and you are
    doing the very best that you can to follow the congressional
    wishes and intent, which are the wishes of our people, to get a
    cop back on the beat, and Wall Street needs it big time. And
    you are one of the folks that can bring it back. We hope you do
    it with gusto, and we will stand adjourned.
        Mr. Gensler. Thank you.
        [Whereupon, at 12:08 p.m., the Subcommittee was adjourned.]

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