[Senate Hearing 112-288]
[From the U.S. Government Publishing Office]



                                                       S. Hrg. 112-288
 
       EMERGENCE OF SWAP EXECUTION FACILITIES: A PROGRESS REPORT

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



                                HEARING

                               before the

                            SUBCOMMITTEE ON

                 SECURITIES, INSURANCE, AND INVESTMENT

                                 of the

                              COMMITTEE ON

                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                                   ON

     A PROGRESS REPORT ON THE EMERGENCE OF SWAP EXECUTION FACILITIES

                               __________

                             JUNE 29, 2011

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


                 Available at: http: //www.fdsys.gov /




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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  TIM JOHNSON, South Dakota, Chairman

JACK REED, Rhode Island              RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York         MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii              JIM DeMINT, South Carolina
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin                 PATRICK J. TOOMEY, Pennsylvania
MARK R. WARNER, Virginia             MARK KIRK, Illinois
JEFF MERKLEY, Oregon                 JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado          ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina

                     Dwight Fettig, Staff Director

              William D. Duhnke, Republican Staff Director

                       Dawn Ratliff, Chief Clerk

                     William Fields, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                 ______

         Subcommittee on Securities, Insurance, and Investment

                   JACK REED, Rhode Island, Chairman


              MIKE CRAPO, Idaho, Ranking Republican Member

CHARLES E. SCHUMER, New York         PATRICK J. TOOMEY, Pennsylvania
ROBERT MENENDEZ, New Jersey          MARK KIRK, Illinois
DANIEL K. AKAKA, Hawaii              BOB CORKER, Tennessee
HERB KOHL, Wisconsin                 JIM DeMINT, South Carolina
MARK R. WARNER, Virginia             DAVID VITTER, Louisiana
JEFF MERKLEY, Oregon                 JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado          ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina
TIM JOHNSON, South Dakota

                Kara Stein, Subcommittee Staff Director

         Gregg Richard, Republican Subcommittee Staff Director

                                  (ii)


                            C O N T E N T S

                              ----------                              

                        WEDNESDAY, JUNE 29, 2011

                                                                   Page

Opening statement of Chairman Reed...............................     1

Opening statements, comments, or prepared statements of:
    Senator Crapo................................................     2
        Prepared statement.......................................    36

                               WITNESSES

Kevin McPartland, Director of Fixed Income Research, TABB Group..     4
    Prepared statement...........................................    36
    Responses to written questions of:
        Senator Toomey...........................................    76
Neal B. Brady, Chief Executive Officer, Eris Exchange, LLC.......     6
    Prepared statement...........................................    39
    Responses to written questions of:
        Chairman Reed............................................    78
        Senator Toomey...........................................    80
Ben Macdonald, Global Head of Fixed Income, Bloomberg, L.P.......     8
    Prepared statement...........................................    53
James Cawley, Chief Executive Officer, Javelin Capital Markets...    10
    Prepared statement...........................................    59
William Thum, Principal and Senior Derivatives Counsel, The 
  Vanguard Group, Inc............................................    27
    Prepared statement...........................................    60
Stephen Merkel, Executive Vice President and General Counsel, BGC 
  Partners, Inc..................................................    29
    Prepared statement...........................................    62
Chris Bury, Cohead of Rates Sales and Trading, Jefferies & 
  Company, Inc...................................................    31
    Prepared statement...........................................    73

              Additional Material Supplied for the Record

Statement submitted by the Investment Company Institute..........    85
Paper submitted by the International Swaps and Derivatives 
  Association....................................................    93
Letter submitted by Stephen Merkel, Chairman, Wholesale Markets 
  Brokers' Association...........................................   114

                                 (iii)


       EMERGENCE OF SWAP EXECUTION FACILITIES: A PROGRESS REPORT

                              ----------                              


                        WEDNESDAY, JUNE 29, 2011

                                       U.S. Senate,
     Subcommittee on Securities, Insurance, and Investment,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Subcommittee met at 9:32 a.m., in room SD-538, Dirksen 
Senate Office Building, Hon. Jack Reed, Chairman of the 
Subcommittee, presiding.

            OPENING STATEMENT OF CHAIRMAN JACK REED

    Chairman Reed. Let me call this hearing to order. Senator 
Crapo and I want to welcome our witnesses. This morning we are 
going to focus on the topic ``Emergence of Swap Execution 
Facilities: A Progress Report.''
    The financial crisis revealed some significant weaknesses 
in our financial sector. One of the most problematic was the 
over-the-counter derivatives market. As a result, the Dodd-
Frank Wall Street Reform and Consumer Protection Act of 2010 
developed new rules for the OTC market to insulate both the 
U.S. economy and the American taxpayer from any future 
extraordinary losses in this area.
    In particular, Dodd-Frank mandated that all cleared trades 
be executed either on an exchange or on a new trading platform 
called a swap execution facility, or SEF. The Dodd-Frank Act 
defined a swap execution facility as ``a facility, trading 
system, or platform in which multiple participants have the 
ability to execute or trade swaps by accepting bids and offers 
made by multiple participants in the facility or system through 
any means of interstate commerce.''
    The development of SEFs should transform the current 
trading marketplace by providing significantly greater pre- and 
post-trade transparency for regulators and market participants 
alike.
    In addition, once a trade has been completed, a 
counterparty should be able to compare the price it receives on 
a particular trade with the price of similar trades that buy 
and force similarly standardized products. This information 
should also be useful to those analyzing the effectiveness of 
hedging strategies. Finally, increased transparency in the new 
trade reporting requirements will give regulators better 
information and additional tools to monitor the swaps market 
for possible market manipulation.
    The Commodity Futures Trading Commission and the Securities 
and Exchange Commission have both proposed rules to implement 
the SEF provisions of the Dodd-Frank Act for swaps or security-
based swaps under their respective jurisdictions.
    In addition, because standardized swaps that are cleared 
must be traded on an exchange or a SEF, Dodd-Frank Act requires 
clearinghouses to provide open access to various execution 
venues. Both the SEC and CFTC have proposed rules that 
implement the open access requirements of the Dodd-Frank Act to 
encourage competition in the SEF and clearinghouse market.
    All of us have a vested interest in making sure these new 
derivatives swap execution facilities function safely, 
efficiently, and fairly. Hopefully, our hearing this morning 
will help us understand best how we can accomplish this 
objective.
    Senator Crapo and I have invited witnesses that represent a 
variety of opinions and perspectives to our hearing. 
Unfortunately, due to scheduling difficulties, the large dealer 
bank we invited was unable to appear before the Subcommittee 
today. Nonetheless, we hope the conversations we have this 
morning spur deeper thought on these complicated issues, and we 
encourage participation by written testimony or comments after 
the fact, and that both industry and policy makers continue to 
work together to make our swaps markets the most transparent, 
competitive, and efficient in the world.
    I look forward to hearing from our witnesses, and at this 
time I would like to recognize the Ranking Member, Senator 
Crapo. Senator Crapo.

                STATEMENT OF SENATOR MIKE CRAPO

    Senator Crapo. Thank you very much, Senator Reed, and I 
appreciate the opportunity we have to work together on this 
Committee and also the fact that you have noticed this hearing 
with regard to SEFs.
    There are a number of different electronic trading models 
that could be potentially used for derivatives trading 
depending on the final rules the SEC and the CFTC and 
international regulators adopt. But I want to focus just on a 
couple of concerns that I see us facing right now in our 
current posture.
    While Title VII of the Dodd-Frank Act states that the SEC 
and the Commodity Futures Trading Commission shall consult and 
coordinate to the extent possible for the purpose of assuring 
regulatory consistency and compatibility, it appears that the 
lawyers for the two agencies, or maybe the other personnel at 
the agencies as well, have not been able to agree on what these 
terms mean.
    We should not then be surprised that the two agencies have 
proposed inconsistent approaches to the same rule sets. For the 
swap execution facility rules, the SEC approach, in my opinion, 
is a more principles-based approach and is in general far less 
prescriptive than that of the CFTC. While the Dodd-Frank Act 
missed a great opportunity, in my opinion, to merge the SEC and 
Commodity Futures Trading Commission and stop the bifurcation 
of futures and securities markets--we lost that opportunity 
then--we should at least continue to push for more coordination 
and consistent rules.
    Swap execution facilities are likely to dually register 
with both agencies, and it makes a lot of sense for the two 
regimes to be consistent.
    While I applaud the SEC for taking a more flexible approach 
relative to the CFTC, both agencies need to make their rules 
more accommodative of the different types of SEFs to provide 
the maximum choice in trade execution to market participants.
    Under the current CFTC SEF version, the proposed rule 
requires swap users to request prices from no fewer than five 
dealers at a time. This is generating a lot of controversy from 
the end user community, which argues that it may ultimately 
serve to unnecessarily disadvantage end users by limiting their 
ability to chose appropriate numbers of counterparties and the 
mode of execution in the way that they deem to be the most 
efficient and effective to hedge their commercial risk.
    Since Dodd-Frank stipulates that the transactions required 
to be cleared must also be evaluated on a SEF or designated 
contract market, there is significant interplay between the 
clearing, trading, and definition of block trades. According to 
the end users, this could create a problem for some less liquid 
trades that would be suitable for clearing but not necessarily 
for trade execution.
    I have also been advised that the SEC's SEF approach is 
more consistent with what the Europeans are looking at, but I 
have not actually seen the exact comparison.
    If we want to find a common international framework in 
order to avoid regulatory arbitrage and avoid competitive 
disadvantage to our markets, we need to provide greater 
coordination and harmonization to get the rules right rather 
than rushing them through.
    This is just a short summary of some of the issues that I 
am concerned about that I think we ought to focus on in today's 
hearing. I also welcome today's witnesses, and I look forward 
to what we will hear.
    Chairman Reed. Well, thank you very much, Senator Crapo. 
And before I ask Senator Corker if he has comments, let me 
associate myself with your comments about collaboration, the 
joint regulation between the SEC and CFTC. I hope one of the 
results of this hearing is to be able to focus their attention 
on coming up with a consistent rule for both agencies rather 
than two distinct sets of rules. I think that is going to--the 
intent clearly, as you point out, in Dodd-Frank was to have one 
set of consistent, appropriate, flexible rules. And I, again, 
second your very insightful comments in that regard.
    Senator Corker, do you have any comments?
    Senator Corker. Thank you, Mr. Chairman. I am looking 
forward, as usual, to the testimony, and I appreciate you 
having the hearing.
    Chairman Reed. Thank you very much.
    Let me introduce the first panel. Our first with is Mr. 
Kevin McPartland. He is a principal and director of fixed 
income research at TABB Group. Mr. McPartland joined the TABB 
Group as a senior research manager in 2007 from a management 
consultancy, Detica, where he was a senior manager in the 
Global Financial Markets Division. Prior to joining Detica, he 
held positions at JPMorgan Chase in equities and futures and 
options, managing development, and implementation of electronic 
trading systems. Thank you.
    Our next witness is Mr. Neal Brady. He is the chief 
executive officer of Eris Exchange. Prior to cofounding Eris 
Exchange and assuming the role of CEO, Mr. Brady served as 
managing director of business development at CME Group, where 
he was responsible for the growth of the CME Group's OTC and 
global business. Prior to CME, he founded and served as chief 
executive officer of Liquidity Direct Technology, a leading 
platform for interest rate derivatives trading that was 
acquired by CME in January 2004.
    Our next witness is Mr. Ben Macdonald. He is a naturalized 
U.S. citizen residing in New York City. Thank you for that, Mr. 
Macdonald. He is the global head of fixed income products for 
Bloomberg, L.P., a position he has held since May 2010, and in 
that capacity he heads up Bloomberg's Swap Execution Facility 
Development Initiative. Prior to joining Bloomberg, he worked 
at Goldman Sachs managing the credit default swap operations 
team and at JPMorgan Chase where he held several positions in 
interest rates derivatives.
    Our final member of the panel is Mr. James Cawley. Mr. 
Cawley is the chief executive officer of Javelin Capital 
Markets, an electronic execution venue for credit derivatives 
and interest rate swaps. Javelin expects to register as a swaps 
execution facility. He is also the founder of the Swaps and 
Derivatives Market Association, an industry trade group of 
several dealer and clearing brokers that advocates for 
successful OTC derivatives clearing, open access, and 
transparency. Mr. Cawley has 20 years of derivatives sales and 
trading experience, working for many years in the credit 
markets for Salomon Brothers, Lehman Brothers, and Bank of 
America. Most recently, Mr. Cawley ran IDX Capital, a credit 
derivatives interdealer broker.
    I thank you all for being here this morning. Senator 
Merkley, do you have any opening comments?
    Senator Merkley. No.
    Chairman Reed. Thank you. I would ask the witnesses to 
limit their remarks to 5 minutes. Your written statements will 
be completely incorporated into the record, so there is no need 
to read them.
    Mr. McPartland, if you would begin, please. Thank you..

    STATEMENT OF KEVIN McPARTLAND, DIRECTOR OF FIXED INCOME 
                      RESEARCH, TABB GROUP

    Mr. McPartland. Chairman Reed, Ranking Member Crapo, and 
Members of the Subcommittee, thank you for inviting me here 
today to discuss progress and concerns surrounding the creation 
of swap execution facilities.
    I am Kevin McPartland, a principal and the director of 
fixed income research at TABB Group. TABB Group is a strategic 
research and advisory firm focused exclusively on the 
institutional capital markets. Our clients span the entire 
investment landscape including investment banks, pension plans, 
mutual funds, hedge funds, high frequency traders, FCMs, 
exchanges, and clearinghouses.
    In order for this new market structure to be successful, 
swap execution facilities must be given broad latitude in 
defining and implementing their business models. This includes, 
but is not limited to, the mechanisms used for trading and the 
risk profiles of their members. This will promote the 
innovation and competition that has made the U.S. capital 
markets the envy of the world.
    It is also critical that the mechanisms to move trades 
quickly and easily from execution to clearing are well defined. 
If market participants worry that the trade they have just 
executed on a SEF might later in the day be canceled due to a 
clearinghouse rejection, confidence in the entire market model 
will erode quickly and severely limit the transparency and 
systemic risk reduction the Dodd-Frank Act was intended to 
improve.
    Let us examine these points in detail.
    First, SEFs should not be driven to a particular trading 
model. Despite the inclusion of the Request for Quote model in 
proposals from the CFTC and SEC, regulators are still keen to 
have swaps trade through an order book with continuous two-
sided quotes.
    TABB Group research shows that order book trading will 
emerge naturally; 81 percent of our study participants believe 
that we will have continuous order book trading of vanilla 
interest rate swaps within 2 years of SEF rule implementation. 
However, the existence of an electronic order book does not 
guarantee liquidity nor that market participants will trade 
there.
    For example, of the roughly 300,000 contracts available for 
trading in the highly electronic U.S. equity options market, 
trading in only the top 100 names makes up nearly 70 percent of 
the volume. The rest are seen as so illiquid that it is often 
easier to trade OTC with a broker rather than try and execute 
that same contract on the screen. Furthermore, despite the 
market's electronic nature, TABB Group research shows that in 
2010 as much as 97 percent of all options trading volume 
generated by asset managers was done over the phone.
    Second, we should encourage SEFs to set membership 
requirements to encourage a variety of liquidity pools. The 
U.S. equity market presents a good example. Thirteen registered 
exchanges and another 55 alternative execution venues exist to 
trade U.S. equities for a total of sixty-eight. Why are there 
so many? Because different market participants trade in 
different ways and have different needs. Some like to trade in 
large size, some small; some are very concerned about price 
while others are more concerned about getting a trade done 
quickly. Because of this, the equity market responded with new 
venues to meet those needs.
    In the current swaps market, a smaller player cannot trade 
in the interdealer market even if they had the capital and 
desire. In the new market, as long as a trading firm meets the 
requirements set forth by the SEF, they will be--and should 
be--allowed in to trade. The important point to note is that 
setting membership requirements for SEFs is not exclusionary, 
but instead intended to help market participants trade in the 
most suitable environment possible.
    Open access to clearing will play a huge role in the 
success or failure of all SEFs. It is central clearing, not the 
SEF construct itself, that will allow easier access to trading 
and new market participants to enter. But a clearinghouse 
providing only the ability to accept SEF executed trades is not 
enough.
    SEFs are intent on providing click-to-trade functionality, 
that when you accept a price on the screen with a click of the 
mouse, whether in an order book or via a request for quote, the 
trade is done. However, a trade is not done until it is 
accepted for clearing--something the SEFs have little if any 
control over. That raises the question: Can a SEF ensure a 
trade will be accepted for clearing before it allows the trade 
to execute? And even if it can, is that the SEF's 
responsibility?
    Either way, clearing certainty is crucial to the success of 
SEFs. If market participants do not trust that SEF-executed 
trades are firm, confidence in the entire market model will 
erode quickly. It is critical that a mechanism be put in place 
to formalize this process, ensuring the market can have full 
faith in the trades they execute on a SEF.
    There has been considerable speculation as to the number of 
SEFs that will exist. The wildest number I have heard is 100, 
which is simply unrealistic. If the U.S. equities market has 68 
venues and the U.S. futures market has three main players, the 
swaps market will fall somewhere in the middle.
    Our research shows also that nearly 60 percent of market 
participants believe the ideal number of SEFs per asset class 
is three to four, resulting in 15 to 20 SEFs covering interest 
rates, credit, FX, commodities, and equities. There will be 
many more than that to start but not 100. Our list at TABB 
Group shows as many as 40 firms that plan to apply. But 87 
percent of our study participants believe that SEF 
consolidation will begin 2 years or less from the date of rule 
implementation.
    We are now in the pre-SEF era. Business models and 
technology are still being finalized, but most SEFs are 
``registration-ready,'' and trade flow is beginning to pick up 
on the screen as most everyone has accepted that these changes 
are inevitable.
    Even if trading mandates do not take effect until the 
fourth quarter of 2012--a timeframe that seems more and more 
realistic--the change is so enormous for most swaps traders 
that getting started now should present just enough time to 
make the switch.
    As rules are finalized, it is critical that while putting 
in place necessary oversight, new OTC derivatives rules 
encourage the innovation and competition that have made the 
U.S. capital markets the most envied in the world.
    Thank you for your time.
    Chairman Reed. Well, thank you very much for your 
testimony.
    Mr. Brady.

   STATEMENT OF NEAL B. BRADY, CHIEF EXECUTIVE OFFICER, ERIS 
                         EXCHANGE, LLC

    Mr. Brady. Chairman Reed, Ranking Member Crapo, Members of 
the Committee, thank you for the opportunity to testify on the 
implementation of the Dodd-Frank Act, specifically the 
development of SEFs. I am Neal Brady, chief executive officer 
of Eris Exchange, LLC.
    Eris Exchange is an electronic futures exchange that began 
offering the trading of a cleared interest rate swap futures 
contract in July 2010 in response to the passage of the Dodd-
Frank Act. Since its inception, Eris Exchange has traded over 
$33 billion in notional value of its interest rate swap futures 
which are cleared at the Chicago Mercantile Exchange.
    Eris Exchange filed an application with the CFTC in April 
of this year to be designated as a contract market, or DCM. A 
DCM is a traditional exchange in which regulated futures 
contracts have been trade for over 100 years. As a DCM Eris 
Exchange will be permitted to list both financial futures as 
well as swaps. As such, Eris Exchange will satisfy the Dodd-
Frank execution mandate and will operate alongside SEFs in the 
cleared interest rate swaps base.
    My opening comments are focused on the regulatory 
incentives that can facilitate the successful development of 
SEFs. I will also comment on a few arguments heard in the 
industry recently related to perceived operational impediments 
to SEFs and how these concerns have already been solved for in 
the futures industry model.
    First, Eris Exchange believes that the most important 
regulatory incentive that the CFTC can provide for SEFs is to 
announce clear dates for the implementation of the clearing and 
trading mandates. The industry is ready to trade and clear 
interest rate swaps. SEF-like platforms and DCMs are already 
connected to the major clearinghouses and are operationally 
ready to transact swaps and equivalent futures contracts. The 
market is simply awaiting a clear timetable from the CFTC 
before committing the resources for final implementation. As 
soon as the timetable is announced, customers will select 
preferred clearing firms and trading platforms, complete 
documentation, and begin final testing.
    In announcing a timetable, one of the most market-based and 
competition-friendly actions that the CFTC can take is to 
implement the trading mandate soon after the clearing mandate. 
By mandating execution and ensuring open access to all clearing 
venues, regulators will foster true competition in swaps and 
create a level playing field for the emergence of new entrants 
and technology-driven innovation.
    If, on the other hand, there is a significant lag between 
the clearing and trading mandates, incumbent firms will be 
heavily motivated to direct clearing to their preferred 
clearing venue and will transact on closed platforms dominated 
by incumbent firms. Such a time lag runs the risk of severely 
constraining the ability of new entrants to effectively compete 
in the execution of cleared swaps.
    Second, I would like to address a few arguments heard in 
the industry today that are aimed at slowing down the 
implementation of the Dodd-Frank Act. Specifically, concerns 
have been raised that the documentation required for market 
participants to exit and clear swaps is so extensive that it 
will require untold hours of negotiation and impose burdensome 
legal costs on customers. This is an exaggerated concern.
    The futures documentation structure provides a model that 
should be utilized as a baseline for documentation in the 
cleared swaps market. In the futures model there is no need for 
each user to enter into detailed ISDAs with every other user. 
For example, to trade on Eris Exchange, a participant and a 
participant's clearing firm need only enter into a single 
agreement totaling two pages, one time.
    Another argument heard today in the industry is that it is 
impossible to trade interest rate swaps in an open, electronic 
order book and, therefore, the traditional OTC execution model 
must be maintained. Eris Exchange provides concrete evidence 
that this argument is flawed. Today Eris Exchange has a live, 
open, anonymous, electronic central limit order book offering 
trading for standard maturities of interest rate swap futures. 
Clearing firms guarantee each order and monitor risk using 
credit controls that are built centrally into our trading 
platform.
    I have submitted a screen shot of the Eris Exchange central 
limit order book, which shows live bids and offers on our 
screen that are fully transactable and for which users receive 
instant confirmations of cleared trades with the click of a 
mouse.
    In conclusion, it is worth noting that in the futures 
industry the migration from pit-based trading to screening-
based trading unleashed a tremendous wave of innovation in 
which the U.S. derivatives industry emerged as a world leader. 
If regulators announce a clear timeline and apply the proper 
incentives, the implementation of Dodd-Frank has the potential 
to spur a similar technological revolution that will deliver on 
the real benefits of the legislation, bringing greater 
transparency and a wider variety of counterparties into the 
swaps market and thereby reducing systemic risk.
    Thank you for your invitation to testify here today. I look 
forward to your questions.
    Chairman Reed. Thank you, Mr. Brady.
    Mr. Macdonald, please.

   STATEMENT OF BEN MACDONALD, GLOBAL HEAD OF FIXED INCOME, 
                        BLOOMBERG, L.P.

    Mr. Macdonald. Good morning, Chairman Reed and Members of 
the Subcommittee. It is a pleasure to appear before you today. 
My name is Ben Macdonald, and I am the global head of fixed 
income products for Bloomberg, L.P., a privately held company 
based in New York. Bloomberg is dedicated to registering as 
both a swaps execution facility and a security-based swaps 
execution facility under Title VII of the Dodd-Frank Act.
    Bloomberg's customer base is evenly distributed amongst the 
buy side and the sell side. Therefore, as an independent 
company, we are not beholden nor are we biased toward any 
particular element of the market.
    First of all, Bloomberg fully supports Title VII's 
mandatory clearing and post-trade reporting requirements. Clear 
and specific rules for those provisions will serve as the most 
significant tools for reducing systemic risk and attaining 
needed transparency for a reformed and financially sound 
derivatives marketplace that benefits all participants.
    As with all new regulations, however, the devil is in the 
detail, and today we have concerns that these regulations will 
be promulgated in a way that inhibits market trading 
flexibility and raises the cost to the end user and, therefore, 
does not fully achieve the goal set out by Dodd-Frank.
    We know that the systemic risk threats that arose in 2008 
and 2009 were associated with insufficient clearing and post-
trade price transparency and were not the result of execution 
failures. Trading protocols were not the problem.
    We believe that Federal regulators should not go to 
extravagant lengths to define the most favorable terms of 
execution for trading for what can only be characterized as a 
market of sophisticated users. Rather, what should be incumbent 
on Federal regulators is to ensure that the market is fair and 
competitive and that participants themselves have enough 
information to assess whether they know they got a fair price 
or not.
    One of the risks that Federal regulators run in 
micromanaging execution protocols is that they would increase 
the direct cost of trading with no real compensatory benefit to 
customers. In addition, they would impose artificial 
constraints and significant indirect costs that incentivize 
market participants to revert to forms of trading that evade 
the excessive regulation and its unnecessary costs. Ultimately, 
the threat is that market participants will easily find 
alternative ways to conduct their trading in non-SEF 
environments, including taking their trading to foreign 
jurisdictions where U.S. rules do not apply. Rather, we believe 
that Federal regulators should instead use a principles-based 
approach that encourages flexible trading protocols by SEFs.
    Second, the difference in rules promulgated by the CFTC and 
the SEC will create significant compliance costs. Though the 
Dodd-Frank Act requires the two agencies to coordinate their 
approaches, it remains to be seen whether they will 
sufficiently do so in their respective final regulations. If 
they do not, an entity designed to operate as both a SEF and a 
security-based SEF will be compelled to create two separate 
companies to trade similar instruments.
    Please note that this affects each potential SEF and 
security-based SEF but also their clients, many of whom 
currently use the same individual traders to execute both 
instruments. This barrier will drive a concentration in the 
SEF/security-based SEF space and could create a too-big-to-fail 
situation for the remaining SEFs in the marketplace, which is 
exactly the opposite of what Congress intended when it enacted 
Dodd-Frank.
    It is our opinion that costs can be reduced by providing 
the opportunity for SEFs to contract with third-party service 
providers for market surveillance and discipline duty as long 
as the SEFs meet the requirements within Dodd-Frank that they 
retain full, ultimate responsibility for decision making 
involving those functions. Practical, liberal utilization of 
third-party service providers would enable SEFs to reduce their 
capital and operational costs related to the infrastructure of 
those functions and thereby reduce the cost of entry into the 
SEF marketplace.
    In addition, SEFs should also be permitted to rely on the 
regulation and oversight performed by swaps clearinghouses 
rather than have to replicate essentially the same activity at 
the SEF level. For example, if a clearinghouse accepts a market 
participant or a swap for clearing, the SEF should be permitted 
to rely on that assessment for core principle compliance 
purposes under the SEF regulatory regime.
    In addition, the SEC's rules on governance and financial 
reporting should be strictly linked to the requirements in 
Dodd-Frank because extending the rules beyond the Act's 
requirements effectively inhibits the entry of new security-
based SEFs. For example, an aspiring security-based SEF such as 
Bloomberg, who is already independently owned and controlled, 
could be discouraged if faced with SEC rules that would force 
us to cede control of our affiliated SB-SEF to an independent 
board. While SEC has suggested they may require this result, it 
is not required by Dodd-Frank, nor is that a requirement 
written into the CFTC's proposed regulations.
    The goals of promoting competition among SEFs, lowering 
barriers to entry, and allowing a consistent trading 
environment demand that the two Federal regulators devise 
coordinated rules and not work in silos. It is our hope that 
Congress can assist in this process.
    In summary, we are concerned that we may be on the road to 
creating a too-big-to-fail and utility-style SEF landscape that 
would increase costs for the end user, encourage non-SEF 
trading, and ultimately reduce the benefits of central clearing 
and price transparency.
    Mr. Chairman, on behalf of Bloomberg, I want to thank you 
for this opportunity to share our views on this important 
issue, and I am happy to answer any questions that you may 
have.
    Chairman Reed. Thank you very much, Mr. Macdonald.
    Mr. Cawley, please.

  STATEMENT OF JAMES CAWLEY, CHIEF EXECUTIVE OFFICER, JAVELIN 
                        CAPITAL MARKETS

    Mr. Cawley. Chairman Reed, Ranking Member Crapo, and 
Members of the Subcommittee, my name is James Cawley. I am 
chief executive officer of Javelin Capital Markets, an 
electronic execution venue of OTC derivatives that will 
register as a SEF or swap execution facility--under the Dodd-
Frank Act.
    I am also here today to represent the interests of the 
Swaps & Derivatives Market Association, which is comprised of 
several independent derivatives dealers and clearing brokers, 
some of whom are the largest in the world. Thank you for 
inviting me here today to testify.
    Without a doubt, it is mission critical that central 
clearing, increased transparency, and broader liquidity is 
properly achieved under the act for the OTC derivative 
marketplace. Toward that goal, it is important that SEFs be 
allowed to properly function and compete with each other 
whereby Congress and the regulators ensure that such 
organizations and various execution models be neither 
discriminated against nor penalized by trade work flow or 
documentation efforts that show preference for one SEF over 
another.
    Only by access to a fair, level, and open playing field 
will SEFs be properly able to play their part in the lessening 
of systemic risk to which the derivative marketplace 
contributed during the global financial crisis of 2008.
    With regard to product eligibility, clearinghouses should 
recognize that the fair majority of interest rate and credit 
derivative products do qualify for clearing.
    Regulators should be mindful to ensure that clearinghouses 
do not favor acceptance of certain products that have built in 
trade restrictions that impede open access or customer choice.
    While intellectual property rights may protect innovation 
in the short term, with regard to certain swap products or 
indices, they may restrict trade and liquidity in the long run. 
Market participants should be allowed to trade such products to 
meet their investor or hedging objectives. Intellectual 
property rights for such products should adapt with the post 
Dodd-Frank marketplace where anonymous and transparent markets 
flourish.
    Regulators should work with such IP holders to both ensure 
that their rights are properly protected but that the 
prudential need of the broader market is also addressed.
    With regard to SEF access to clearinghouses, clearinghouses 
and their constituent clearing members should do as the act 
requires--accept trades on an ``execution blind'' basis. DCOs 
should not discriminate against trades simply because they or 
they shareholders dislike the method in which such trades 
occur.
    Clearinghouses should refrain from using SEF sign-up 
documentation as a vehicle through which to restrict trade. As 
a precondition to access, clearinghouses should not require 
that SEFs sign ``noncompete'' clauses, such that a 
clearinghouse's other businesses--be they execution based or 
not--are inappropriately protected from outside competition.
    Likewise, clearing firms should not require that SEFs 
contract with them to restrict the rights or privileges of end 
users as a precondition to SEF-DCO connectivity. Such 
requirements serve no prudential role with regard to risk 
mitigation and run contrary to the open access provisions of 
the act.
    Clearinghouses should not require that a SEF purposely 
engage in a trade work flow that adds latency or creates 
unnecessary steps in the post-trade settlement process.
    Instead, clearinghouses and their constituent clearing 
firms should draw from their own proven and well-tested 
experience in listed derivatives space. They should accept 
trades symmetrically and in real time.
    Immediate acceptance of swaps trades into clearing is 
critical to accomplishing the goals of the Dodd-Frank Act to 
reduce systemic risk, increase trade integrity, and promote 
market stability.
    Settlement uncertainty caused by time delays between the 
point of trade execution and the point of trade acceptance into 
clearing can destroy investor confidence in the cleared OTC 
derivatives markets.
    As the CFTC has correctly asserted, such a time delay or 
trade latency, which in the bilateral swaps markets can be as 
long as a week, directly constrains liquidity, financial 
certainty, and increases risk.
    Clearinghouses and their clearing members should do as the 
regulators have required and accept trades into clearing 
immediately upon execution on a SEF.
    Regulators should be wary of certain incumbent efforts that 
claim to bring execution certainty through documentation. Such 
documentation sets in place work flow that clearly favors 
Request for Quote execution models over exchange-like central 
limit order books.
    Such documentation denies the customer the right to trade 
anonymously with multiple counterparties because under such a 
work flow, the dealer counterparty requires the identity of the 
customer be known before the trade occurs.
    This is not the case with documentation and work flow 
requirements in the cleared derivatives markets currently of 
futures and options. In those markets, buyers and sellers trade 
in multiple trade venues where trade integrity, counterparty 
anonymity, and optimal liquidity is assured through access to 
multiple counterparties.
    Such restrictive work flow and documentation should be seen 
for what it is--nothing more than a transparent attempt to 
limit customer choice, restrict trade, and drain liquidity.
    In conclusion, the role of the swap execution facility with 
regard to lessening systemic risk should not be understated. To 
fulfill the SEF's role in fostering greater liquidity and 
transparency, Congress and the regulators should continue to be 
proactive and protect the market against Dodd-Frank 
implementation choke points. They should continue to ensure 
that all SEFs have fair and open access to clearing and the 
marketplace.
    I thank you for your time, and I am open to any questions.
    Chairman Reed. Thank you very much, gentlemen, for your 
very thoughtful testimony.
    Let me just sort of lay out the logistics. We have a vote 
at 11, and we have another panel. I would propose 7-minute 
rounds, and I know we are not going to be able to ask all the 
questions we want to ask, so be prepared for additional 
questions following up the hearing. But let me begin again by 
thanking you for your insightful testimony.
    I will address a question to the whole panel, and it has 
been touched upon. Specifically, in response to the CFTC's 
Notice of Comment, the Justice Department Antitrust Division 
raised some concerns about their proposed rules with respect to 
the ability of major dealers to control access to the markets 
unless there is--and the SEFs, unless there are some ownership 
limits, aggregate ownership limits or individual ownership 
limits, together with governance issues. I know you all have 
talked about it, but the goal I think we all share is to 
maximize competition while at the same time limiting barriers 
to entry into these platforms and into these processes.
    So if you might elaborate, starting with Mr. McPartland and 
down to Mr. Cawley.
    Mr. McPartland. It is important that we still have the 
major dealers involved actively. This is their market. If we 
talk in other areas of finance, we talk about having skin in 
the game. The last thing is we want are some of the biggest 
traders in these products not actively involved and invested in 
the success of these entities.
    I think the language of Dodd-Frank and some of the proposed 
rules will ensure that we will still have open access. The 
access to clearing is really what will open these markets up, 
because it takes out a good amount of the counterparty risk, 
whereas now in the bilateral world, a dealer could quite 
rightly choose to not trade with a counterparty if they felt 
their credit was not up to war. The clearinghouse helps to 
mitigate those concerns.
    But the short answer here is we need the dealers still 
involved. This is not about pushing them out. It is about 
keeping them in the position they are in and then opening up 
the market to more competition beyond that.
    Chairman Reed. Mr. Brady.
    Mr. Brady. Yes. At Eris Exchange, we do not think research 
and ownership are going to do everything. The people most 
likely to actually be new entrants and provide a credible 
alternative and increase competition in the space are precisely 
those people like the founders of our exchange who are in the 
market and are able to drive forward with a platform like this. 
We think the focus instead should be on the issues like open 
access, real time trade acceptance, making sure the SEFs and 
the clearinghouses are open and available for people to trade 
on.
    Chairman Reed. But just to follow up, so your notion is 
ownership is not the issue, open access. So the rules that SEC 
and CFTC have to come up with have to really provide an 
incentive for broad-based participation and prevent, regardless 
of ownership, so favoring one entity--I think I am restating 
what you said.
    Mr. Brady. Yes. I mean, that is absolutely vital, to allow 
anyone who is qualified and fulfills certain requirements to 
have access to a cleared product and access on a SEF, whether 
the owner of that platform, yes, I think that is less 
relevant----
    Chairman Reed. One of the issues that has come up in the 
context of the presence sort of an ad hoc system is the 
requirements for capital to participate are being set by the 
big players, basically----
    Mr. Brady. Yes.
    Chairman Reed. ----and there is at least some suggestion 
that these requirements are not necessary the market to 
function----
    Mr. Brady. Right.
    Chairman Reed. ----but they are quite conducive to 
continued dominance.
    Mr. Brady. Right.
    Chairman Reed. Do you have any comments?
    Mr. Brady. Yes. In our view at Eris Exchange and the 
partners that I represent, that is a much more critical issue 
than the actual ownership. It is the researchers on clearing or 
membership to clearing ought to be based on risk-based criteria 
and who can step in in the case of a default. In the case of 
the futures industry, the people who took care of the Lehman 
bankruptcy, for example, it was an open auction. A number of 
the players who actually ended up picking up the portfolio were 
not clearing members or non-clearing members. It was like a 
market-based solution, and criteria like that are much more 
important than ownership restrictions.
    Chairman Reed. Let me go to Mr. Macdonald and Mr. Cawley. 
Mr. Macdonald, please.
    Mr. Macdonald. Yes. I think this is a quite interesting 
question. From our perspective, we already are an independent 
company, so it is kind of disincentivizing, if you will, from a 
commercial perspective, to try and build a business in the SEF 
space that is competitive and then have to concede control of 
the board of that SEF. It does not really make sense. We 
understand and we recognize the need for governance and 
independence and we think that is a good thing. However, we 
also think there needs to be a mechanism for companies such as 
ourselves and other companies who are already independent to 
operate in this space without being penalized for being 
independent, and I think that goes to the crux of our issue.
    I do think there is one other point which kind of touches 
on what Neal was saying, which is that SEFs have different 
models. In some cases, they take on principal risk because of 
the nature of their business and in some cases they do not, and 
I think, again, when we look at capital requirements, we need 
to make sure that they are commensurate with the style of SEF 
that we are talking about, because there clearly is not a one-
size-fits-all in the SEF landscape, and there should not be.
    Chairman Reed. I can presume, though, that you would not 
object to a certain number of independent directors, for 
example, in the governance of these----
    Mr. Macdonald. No, no----
    Chairman Reed. ----the control issue.
    Mr. Macdonald. No, and we understand and we totally--I 
mean, we think it is a very good idea. We just think that there 
is a practical limit which kind of, you know, goes a little bit 
too far.
    Chairman Reed. Mr. Cawley, please.
    Mr. Cawley. We think that whenever the dramatic change in 
market structure such that we are currently undergoing as a 
result of the crisis in 2008, one has to--the Government and 
regulators really should monitor and engage when necessary 
whenever you--when you have a marketplace moving from the haves 
to the have-nots. So whereas the old market in the bilateral 
space had ten or 15 dealers, I do not think anyone is trying to 
exclude them from the future. I think it is more a function of 
including another 25 or 30 dealers and broadening the 
competitive range.
    And as you go and experience that change, it is important 
that any governance structure, whether it be at a DCO or 
clearinghouse or, indeed, at a SEF, have a fair degree of 
transparency and a fair degree of market participation on 
material committees that address the prudential issues 
concerning these organizations. It is not enough to come in and 
say, look, shareholders have a right, or the management have 
the right to enhance shareholder value. That is clear.
    But SEFs, and more specifically DCOs, share a broader 
prudential need to the marketplace and in so doing need to 
address that and have open governance, which you can separate 
from economic interest. We just ask that it be open, 
transparent, and be truly representative of the marketplace, 
not only in terms of dealers, but also in terms of clearing 
members and also market participants and end users.
    Chairman Reed. Thank you all, gentlemen.
    Senator Crapo.
    Senator Crapo. Thank you very much, Mr. Chairman, and in 
light of the time restraint we have, I am going to ask just one 
question and then try to give each of you an opportunity to 
comment on it, if you would like, so I encourage you also to be 
concise in your responses.
    My question relates to the fact that the end users have 
expressed concern to me that many of their large or less liquid 
transactions may not fit within the definition of a block trade 
that is being proposed because of its limited nature, and they 
are concerned also with things like the requirement to bid 
trades to no fewer than five market participants or the delay 
built in in terms of the processing of blocked trades, and 
these things may create a dynamic in the market that will then 
drive up the cost of operations.
    I would like to know--my question is, do you agree with 
these concerns, and if so, what can we do to address them?
    Mr. Cawley. If I can--Kevin, do you want to go first, or--I 
think if you look at block trades, you have to consider the 
tension, Senator, on both sides. Whereas on one side there is 
the market need for transparency, the most important aspect or 
the most important information that any trader or any market 
participant can have is where the last trade occurred, at what 
price and at what time, and to go into a marketplace and not 
know that is putting that individual or that entity at a 
disadvantage.
    So on one side, the customer has the right to know, or 
should have the right to know, consistent with other markets, 
where the last trade occurred. But then on the other side, 
large dealers and large participants are less incented to 
create liquidity for block trades.
    So it really falls down, if you look to other markets, A, 
what should the size of a block trade be, and what should there 
be a delay, how long that delay should be such that the market 
maker has the opportunity to hedge their risk on such a block 
trade. If that time period is too short, then the market maker 
is loathe to make a market in such size. If it is too long, 
then the end user is disadvantaged.
    The way we have suggested you consider that is to look to 
other markets, especially in the interest rate futures swap 
context--or in the interest rate futures context, and set a 
rate or a block size notional that is consistent with those 
markets and also a timeframe that is consistent with those 
other markets, as well, as a base from which to go.
    Senator Crapo. Thank you.
    Mr. McPartland, did you want to comment?
    Mr. McPartland. Sure. Information leakage is a big concern 
for all end users and by said market participants, and if we 
look at the swaps market, the size of the transactions and the 
infrequency that many of these contracts are traded makes it 
even more of a concern, and I think that echoes some of Jamie's 
points. This is why--and again, it is sort of a parallel in the 
equities world--this is why crossing networks developed, for 
example. Buy-side firms that needed to do large-side trades had 
a hard time doing that in the open market, so they found a new 
mechanism.
    It goes back to my earlier comments that if we provide or 
allow latitude for SEFs to create market models that suit 
different market participants, we could end up with an 
environment that is suitable to doing those large-side trades. 
If we do not allow for that type of environment, you could 
force end users to look to more liquid products that they would 
have to do in smaller size to get their large size done. It 
could result in an imperfect hedge. An imperfect hedge then 
means more risk rather than less risk for those end users.
    Senator Crapo. Thank you.
    Mr. Brady.
    Mr. Brady. Yes. We think this issue, it is a very important 
issue and we think it is an issue that really highlights the 
need for a principles-based approach to regulation because the 
issues are very interrelated, whether you should require five 
counterparties to be pinged on a request for quote and the 
block trade limit. If you set the block trade threshold 
correctly, you could have a stricter requirement to send the 
RFQ because if you believe in larger size, you have the 
flexibility to do the blocks. But every market is different. 
Standardized products are different than very bespoke products, 
and I think the futures industry is a great example of how this 
works. There are block trades allowed. They are set at a 
certain threshold that is principles-based and large size is 
able to be transacted when needed, but then the rest of the 
trades occur either in the central order book or through a very 
wide open request for quote process.
    Senator Crapo. Thank you.
    Mr. Macdonald.
    Mr. Macdonald. I would echo all of the points that have 
been made. I think the key point here is actually that the end 
user needs to have the flexibility of means of execution. I 
think for the same trade, the ability to get executed or get 
liquidity will vary depending on a given set of market 
circumstances. So it is very hard to put down a set of very 
defined rules and think that they will work in every 
circumstance. They will not. And I do think that the market 
will, as long as it is a principle-based approach and as long 
as there are guidelines around execution to manage that 
process, I think the market will, as Kevin pointed out, reach a 
medium where it provides the necessary means of execution for 
different circumstances.
    Senator Crapo. Thank you. I will yield back a couple 
minutes to you, Mr. Chairman.
    Chairman Reed. Senator, thank you very much.
    Senator Merkley, please.
    Senator Merkley. Thank you, Mr. Chair, and thank you to all 
of you for your testimony.
    I wanted to start, Mr. Brady, with your comments about the 
value of setting effective dates, for the CFTC to set clear 
dates for both trading and clearing, and I thought maybe I 
would just give you a chance to, if you wanted to advise the 
CFTC, what dates should be recommending that they set and why.
    Mr. Brady. Yes. I mean, the general point that we would 
like to stress is we believe the marketplace is ready. I mean, 
you have examples of platforms and swap execution facilities 
that are ready and operational today, connected back to 
clearinghouses. In our view, the market is really looking for a 
clear signal to focus around and then motivate people to make 
decisions, commit resources, and a lot of the issues we are 
discussing today in the industry really can be settled with 
people who are highly motivated and with a deadline to reach a 
lot of sort of the documentation issues, the credit control 
issues, these sorts of issues.
    We have put forth in various comment letters a timeframe 
that talks about completing all the final rules through the end 
of this year, allowing provisional registration of SEFs so we 
do not slow down that process, you know, beginning with some 
clear mandates starting first quarter, second quarter of next 
year, starting with the most sophisticated users, mandates on 
those users and then moving in sort of a sequenced process 
through the less sophisticated people who have more operational 
issues. So we think that is the type of time table. If it were 
laid out clearly from the regulators, you would see a 
tremendous amount of focus and innovation and sort of work 
toward achieving those goals.
    Senator Merkley. And do you picture between the 
sophisticated users and the balance of the marketplace a 3-
month transition, a 6-month transition, a year transition?
    Mr. Brady. Yes. I mean, I think that is--we do not have a 
specific recommendation, but we think sort of quarterly rolling 
in different layers of participants would make some sense.
    Senator Merkley. So let us say the initial deadline on 
trading was, say, March 2012. Do you picture the clearing date 
being the same date, or a difference there?
    Mr. Brady. You know, I think--we think some type of lag 
between those two would make some sense operationally, but not 
a significant one. So lagging it by a couple of months or a 
quarter could make some sense. We also think allowing for some 
voluntary compliance, maybe the first quarter of 2012 includes 
voluntary compliance with the clearing mandate. People work out 
the plumbing and test rates would certainly seem to make a lot 
of sense.
    Senator Merkley. Does anybody have a radically different 
opinion they want to share on this?
    So I wanted to turn, second, to a point a couple of you 
mentioned, which was a separation of the trading and clearing 
dates and the lack of confidence if your trade is not a trade 
until it is cleared at some future point. It is my 
understanding in the commodities market that these are done 
simultaneously. What is driving that separation and how long of 
a time lag are we talking about, and is it a startup problem to 
have those things happen simultaneously or some type of long-
term structural philosophical fight going on here?
    Mr. Brady. If I could, maybe I will just start by talking 
about how it works in the futures model----
    Senator Merkley. Great.
    Mr. Brady. ----and then hand it over to the other 
participants here. I mean, the futures model, the essence of it 
is that there is a pretrade credit check. So, for example, in 
the Eris exchange platform, there are credit controls on the 
platforms and if you see a bid or an offer for a 200-million 
size 5-year swap quote, that has been preapproved and there is 
a clearing firm standing behind that quote. In addition, when 
you submit a block trade, we have credit controls at the 
clearinghouse, I mean, on entry to the clearinghouse. So either 
the trade is submitted and it is good or the trade never 
existed. It is rejected for credit.
    The SEF model, and I will let the others comment on that, 
today, we are working through those issues where the SEF is not 
directly connected to the clearinghouse, and I will let others 
comment on how that is being worked out.
    Senator Merkley. OK.
    Mr. Cawley. So on its face, Neal is correct, Senator. Real-
time acceptance of trades in the futures context works and has 
worked well for many years, whether it be on an exchange or in 
the clear port example with CME in a more decentralized basis. 
That is something that the CFTC and regulators have called for 
with suggested rules for the OTC space and we do not see from 
where we sit a problem with that. The MFA has also come out in 
support of, as has the STMA, come out in support of real-time 
acceptance of clearing.
    And if you think about it, it is really mission critical to 
the success of clearing because it really comes down to the 
fundamental integrity of the marketplace. Whereas in the 
bilateral market space, trades would go unsettled a few years 
ago, even for as many as 3 or 4 years, now, that window is down 
to a few days or a week. But that is still, relative to other 
markets, quite a long time. So it creates an uncertainty 
between the SEF and the DCO and ultimately it ends up with a 
customer having lost faith in the marketplace. So the 
technology is there now to use and is available and people are 
working toward these.
    Senator Merkley. So I want to back up and see if I heard 
you correctly. You say that commodity trades in the near past 
sometimes were unsettled for 3 or 4 years?
    Mr. Cawley. CDS trades, certainly, yes. Back in 2003 to 
2004, there were many trades that have been unsettled. Some 
trades have actually gone--had matured before they had settled.
    Senator Merkley. Hmm. OK.
    Mr. McPartland. So one of the big differences between the 
futures market and the new sort of SEF cleared swaps 
environment, in the futures market, you have one exchange 
feeding one clearinghouse. In the swaps environment going 
forward, we are going to have many execution venues feeding 
many clearinghouses. So that makes ensuring that the execution 
venues and the clearinghouses all have the most up-to-date 
information a much more complex process.
    Now, to Jamie's point, the technology certainly exists to 
allow that. There are a few thoughts about how this would work. 
Some think that we should have a central utility that will look 
at all of the limits and the client accounts at the 
clearinghouse and hold that and feed that information out to 
all the SEFs and clearinghouses. There is also a thought that 
the clearinghouses, since it is about the clearing account, 
that they will hold the information and when they get a new 
trade they will broadcast that out to all the relevant SEFs and 
the other clearinghouses.
    Many of the dealers, though, are concerned that they do not 
want to have to give up essentially their risk models that they 
use to determine how much a client can trade to an outside 
party. So many of the big dealers would rather--as they say, we 
will tell you when to stop a certain client from trading. We 
will let you know.
    So, again, as Jamie said, the technology is certainly 
there, but I think it is more of an operational concern than it 
is a technology concern.
    Senator Merkley. All right. Thank you very much.
    Chairman Reed. Thank you, Senator Merkley.
    Senator Corker, please.
    Senator Corker. Thank you, Mr. Chairman, and I thank each 
of you for your testimony, and for what it is worth, I thought 
your answer to Senator Crapo's question, considering that each 
of you sort of benefit from these new regulations, was pretty 
judicious, and I thank you for that and for being forthcoming 
in that regard.
    I would ask this question. Back home in Tennessee, people 
are saying, you know, we wish that you guys would quit helping 
us the way that you are in Washington. Who is it that we are 
actually helping with the creation of these SEFs? You know, we 
met with some of the big traders Monday and the big market 
makers obviously are not being helped by this in any way. So 
who is it that we are helping?
    Mr. Brady. I would be happy to start with that. If 
implemented correctly--you know, it is a big if--we believe 
principles-based is the way to go. But if implemented 
correctly, we believe the ultimate end users, the asset 
managers, the people who are the end users of swaps products 
would have more transparency if these systems were able to 
connect correctly, there were real-time trade acceptance, and 
you had price feeds on which you could rely for transactable 
swap prices.
    Senator Corker. So, I mean, I thought you all, again, 
judiciously answered the question, but when you have got a 
large block trade and you are used to dealing--your client, a 
BlackRock or a PIMCO, is used to dealing with a certain dealer 
and they want to unload a position and they are willing to take 
it, it does seem that this is a problem as it relates to people 
being able to front run, if they have got to report too 
quickly. I mean, that is a heck of a problem, is it not?
    Mr. Brady. Yes, and that is why it is absolutely critical 
to get that block trade threshold right. And again, just to 
point to the futures market, the BlackRocks, the PIMCOs, those 
players are very active participants in the futures market and 
they use the transparent order book, and then when they need 
to----
    Senator Corker. Yes, but futures are a little bit 
different. That is a little bit more of a plain vanilla market 
than can happen with swaps, is that not correct?
    Mr. Brady. Well, there are a number of standardized vanilla 
swaps that are actually very like futures. I mean, that is the 
issue of for standardized swaps. That is generally what we are 
talking about trading in a central limit order book or----
    Senator Corker. So let me ask you this question. So let us 
say that you are involved in a large trade and you are creating 
liquidity for a client, and right now, I know the CFTC is 
talking about reporting in 15 minutes. It is pretty hard to 
unload a big book in 15 minutes. What is--why not end of day 
reporting? Why have a 15-minute reporting guideline?
    Mr. Brady. I mean, again, I think that is our position on 
that and the partners in our exchange would be that is where 
principles-based regulation is important----
    Senator Corker. So end of day would be fine on the large--
--
    Mr. Brady. I think it depends on the marketplace. I think 
every market is different. Different swaps require different 
treatment.
    Mr. Cawley. Senator----
    Senator Corker. I would love to have some other input here. 
It sounds like you all are actually in agreement that 15 
minutes is way too short.
    Mr. Cawley. Well, it really--we are not in agreement with 
that, Senator. I think 15 minutes for the futures market is 
pretty consistent with the liquidity that is offered within the 
interest rate swap market and certainly indices, which is 40 
percent of the credit derivatives market. Fifteen minutes by 
certain market participants is viewed as too long.
    I think it really comes back to Neal's point, which is it 
is specific to the liquidity in a particular marketplace. If 
you look to the futures world or the exchanges today, it is 15 
minutes. At some point, it was an hour, and at some point, it 
was end of day when the markets were less liquid.
    So the key thing, then, is to measure the amount of 
liquidity within the marketplace that allows that market maker 
the opportunity to trade out of that position and to hedge it 
appropriately. And when you are talking about 2-year interest 
rate swaps that their average ticket size is $400 million at a 
clip, that is pretty good liquidity.
    Senator Corker. So it is kind of interesting, do you not 
agree, that on one hand, we have castigated the heck out of 
high-frequency trading in equities and yet we are moving toward 
sort of algorithm-type trading on the swap side. I mean, is 
that an interesting----
    Mr. McPartland. Yes. Well, I can comment on that, Senator.
    Senator Corker. OK.
    Mr. McPartland. So the alternative, if the block trading 
rules are too onerous and the market sees that that will create 
too much information leakage, the alternative will be to then 
take your $400 million and use an algorithm to split it up 
into----
    Senator Corker. Right.
    Mr. McPartland. ----400 trades and spread it all across a 
variety of SEFs, which is exactly what happened in the equities 
market and I think some feel that that has made the equities 
market more liquid, but others feel that it has made it much 
more complex to understand who is doing what and what is going 
on.
    Senator Corker. But you would agree that we sort of have a 
bipolar way of thinking here. On one hand, we want to move away 
from that on equities, but on the other hand, we are driving 
toward that in swaps.
    Mr. McPartland. There is no question, and I am in the 
process of research now where we have been talking to a number 
of the proprietary trading firms about this issue. Now, let us 
remember that in equities, as well, they provide a lot of 
liquidity to the market and then it also brings--ensures that 
prices are much more in line. So futures prices, swaps prices, 
everything will line up much more closely than it does today, 
and that should ultimately result in better prices for the end 
user who needs to do an interest rate swap to hedge their loan 
book.
    Senator Corker. So we actually watched--I watched one 
occur. It is not that interesting, actually. But we watched 
this occur a little bit on Monday, and it is kind of, like, if 
I am a client and I have been used to dealing with X dealer and 
now I have got to get five bids, if you will, that just seems 
ridiculous to me. I mean, if I want to--if you look at the 
spread difference, it is very, very minor in these trades. Is 
that not onerous to make a client that does this on a daily 
basis have to get five bids? Is that not just ridiculous?
    Mr. Macdonald. Senator, I think what we are really talking 
about here--we keep on going back to the point of flexibility. 
The reality is that in any given set of circumstances----
    Senator Corker. But the CFTC is not acting as if they are 
giving flexibility. They are talking 15 minutes and five bids. 
So you are saying that is wrong, is that correct?
    Mr. Macdonald. Our thought currently is that it is very 
hard. Two things will likely happen if you are prescriptive 
about exactly what RFQ needs to do and about reporting 
deadlines. As the market evolves and liquidity changes, people 
may not actually be able to get execution or may not actually 
want to go out to that level of market players for their own 
shareholders' reasons and dispute what we thought we are 
actually creating--we actually may be creating more risk by 
being prescriptive about protocols versus having a principles-
based approach which gives people a framework to operate and 
gives them the flexibility to adapt to their business models.
    Senator Corker. And just--I know my time is up--a lot of 
concern about folks with these new rules that we are putting in 
place with developing markets going elsewhere, not sort of the 
industrialized countries, but Latin America and other places, 
living, having to live by our rules, will go outside of the 
U.S. to execute. Do you all not have similar concerns based on, 
again, what CFTC and others have laid out thus far?
    Mr. Macdonald. Well, I think, clearly, we operate in a very 
global market and a lot of entities are--there are a lot of 
U.S.-based entities, but there are also a lot of other regional 
entities, and I think that insofar as we create difference in 
regulation, although it exists, different regulation regimes, I 
think at the end of the day, entities will go to wherever they 
feel the regime is most appropriate for their activities.
    Senator Corker. So the answer is yes.
    Mr. Macdonald. Yes.
    Senator Corker. So, Mr. Chairman, this has been a great 
hearing. I do hope, maybe--in listening to the testimony, these 
guys all benefit from what we are doing, I mean, and I am glad 
they are here. They are going to make a lot of money off what 
we have done and I am glad they are. But they themselves are 
talking about some of the frailties and maybe there is 
something we might do together letter-writing-wise to CFTC to 
make sure that what they do is not so rigid and prescriptive 
that we actually have unintended consequences. I thank you for 
the hearing and thank you for the time.
    Chairman Reed. Thank you, Senator Corker. And just let me 
return to the point that Senator Crapo made, which is the idea 
of coordinating as much as we can imagine, a unified set of 
rules that apply to the SEC-regulated entities, which is our 
jurisdiction, and the CFTC entities, which is the jurisdiction 
of the Agriculture Committee, but I think one strong message 
that you want to send today based on this testimony and based 
on Senator Corker's comments is a notion of sensible unified 
rules that our industries can profit by, and not only 
industries, but the end users and the community at large.
    I think one of the points, and raise your hand if I am way 
off base, but we have seen in equity trading, because of the 
efficiencies brought to the market, that the spreads have come 
down considerably with the benefit of people who buy and sell 
stocks every day, and that is a lot of people, pension funds, 
all sorts of folks. And I think my sense is, based on your 
testimony, we will see the same thing if we get this right in 
terms of the swaps market, and that would be useful to the 
whole economy, a more efficient economy. But I think, Senator 
Corker, we certainly hope that our colleagues across the way in 
CFTC and SEC pay close attention to what is said today, and we 
can follow up with them.
    Senator Hagan, you have arrived. We have a panel. Your 
questions.
    Senator Hagan. Yes. Thank you, Mr. Chairman. I appreciate 
that.
    Mr. Macdonald, in your testimony, you state that Bloomberg 
intends to be prepared to begin swap execution facility 
operations on the implementation of regulations by the CFTC and 
the SEC, provided that the two regulators create synchronized 
rules governing trading protocols, board composition, and 
financial reporting. Would you like to comment quickly on how 
that synchronization is progressing, and also, I would like to 
ask, why are trading protocols, board composition, and 
financial reporting important to your ability to begin 
operations, and can you address each one individually?
    Mr. Macdonald. Sure. So from our perspective, we are ready 
to operate as both a swaps execution facility and a security-
based execution facility. I cannot talk specifically to the 
cooperation between the CFTC and the SEC because obviously I 
spend most of my time in New York. That said, when we look at 
the facts as we know them today, there are a couple of areas 
that raise some concern for us when we look at becoming both a 
swaps execution facility and a security-based execution 
facility, namely the one that we will have to actually create 
two companies that have different board requirements in order 
to operate in markets that are very similar in terms of the end 
user base. So our concerns are really more around--and I will 
address, first of all, the governance and the independence, and 
then I will address the trading protocols.
    From a governance and independence perspective, we 
understand and we recognize the need for independence in both 
the kind of the company structure and the governance around the 
swaps execution facility for obvious reasons. Our point is that 
we are already an independent company, so forcing us to put 
independence on top of independence does not really make sense 
from both a commercial and a structural perspective, and that 
is one of the things we are looking at. We know that the CFTC 
has slightly different rules in that regard than the SEC. The 
SEC requires a majority of the board to be independent, whereas 
the CFTC only requires 35 percent.
    When we talk about trading protocols, our point is really 
that of our customers. We are, as an institution, just an 
intermediary between buyers and sellers, and our view from a 
very long experience in this market is that it is very hard to 
have a one-size-fits-all when you talk about RFQ or, indeed, 
any trading protocol, and there are two main reasons for that.
    First, if you define a specific protocol, the issue that 
you will face is that as the market evolves and the liquidity 
does change in these markets, that protocol may become 
inappropriate and actually increase more risk in a given set of 
market circumstances than it would reduce risk.
    The other point that we would make is that by not using a 
principles-based approach and by being prescriptive about the 
types of protocols, what happens is that it will make the 
market less competitive and more utility style because people 
will not be able to innovate because they are constrained in 
terms of what they can do as a SEF. So those would be the 
points we would make.
    Senator Hagan. Thank you.
    Let me ask also Mr. Macdonald, also in your testimony you 
noted that elaborate execution protocols will increase the 
direct cost of trading and could drive business off of the swap 
execution facilities or, what I would hate to see, into foreign 
jurisdictions. How would you judge the proposed rules that are 
coming out of the CFTC and the SEC against this standard?
    Mr. Macdonald. Well, you know, we think--and, you know, 
when I talk about an RFQ, a minimum of five or in the SEC's 
case an RFQ with resting orders for the winning bid. I think 
the issue with these is really what will happen is they can 
create direct costs for a number of reasons, firstly, because 
of this element of what people call the winner's curse, i.e., 
the fact that I know that I have got four other people in 
competition with me on that trade means that people are not 
necessarily in every circumstance going to want to show the 
best price as possible because the result of four people 
knowing that that trade got executed in the market means when 
the entity that did win the trade has to turn around and go and 
hedge that out, then there are four people in the market who 
know that that hedge activity is about to happen in the 
interdealer market, and that will have an impact on price and, 
therefore, a direct impact on the end user.
    Another point which is perhaps a little bit less obvious is 
that what may happen in order to mitigate that risk is the 
execution size will get reduced, and so people will actually 
execute in smaller sizes in order for that kind of winner's 
curse or information not to be as apparent in the market. What 
that has is a direct operational cost on the end user, so I 
will give you an example. If I am a fund manager and I have to 
do an allocation on a trade, so I may want to do a block trade 
for, let us say, 100 million and want to allocate that out to 
50 funds, if I go out and I actually have to--instead of just 
doing one trade and one set of allocations, I actually have to 
go out and do five trades to reduce the size. I now have to do 
250 allocations, which significantly raises the cost on me as 
an end user in terms of processing that trade.
    So that is what we mean by raising the direct cost.
    Senator Hagan. And how about the threat of sending those 
offshore?
    Mr. Macdonald. Well, I think it is clear, you know, that 
this is a global market, and I think when we look at the 
regulatory proposals that we see in the U.S. versus what we see 
in Europe and other jurisdictions, the risk that we highlight 
is one where different regions have different regulations, and 
then, you know, companies that are not subject to U.S. rules 
will make the decision as to whether they want to operate 
inside the U.S. or outside the U.S. for trading activity. And, 
you know, that I think is a valid risk.
    Senator Hagan. Thank you.
    Mr. McPartland, you raised what I think is an important 
issue, and with the proliferation of SEFs and clearinghouses, 
how will credit risk be managed across entities? And do you see 
this as a potential source of systemic risk?
    Mr. McPartland. The technology certainly exists to manage 
the problems, but operationally it is very, very complicated 
when we have a number of different entities with different 
needs and different end games. We should not try to regulate 
how this should work; however, the industry needs to come to 
some consensus as to how these issues will be resolved before 
the market can move forward effectively.
    The faith in a SEF execution is very much based on the 
industry's knowledge that it will be accepted for clearing, and 
that goes to the point of ensuring that the interconnectivity 
between the SEFs, the clearinghouses, the swap data 
repositories is all very well defined and available to the 
market participants.
    Senator Hagan. And how will the industry come together to 
make these decisions?
    Mr. McPartland. Well, the industry has been working 
together for the last few years obviously on many of these 
issues through the industry bodies. It is in everybody's best 
interest to ensure that this does work. The changes are coming. 
So, you know, to that, the more efficient that the process can 
be, the easier it will be for everybody to modify their 
strategies and their business approach to work in the new 
environment.
    Senator Hagan. Thank you, Mr. Chairman.
    Chairman Reed. Thank you very much.
    Please, Senator Toomey.
    Senator Toomey. Thank you very much, Mr. Chairman.
    I just have one quick question for any of the panelists who 
would like to respond to it. That is, the fact that the SEC and 
the CFTC have different rules, rules that are--especially with 
respect to, for instance, the number of dealers who would have 
to quote on a price, the timing that would be required to 
intervene before the disclosure of block trades, frankly it 
does not make a lot of sense to me. I understand they regulate 
slightly different kinds of contracts, but at the end of the 
day, is it your view that we ought to harmonize this and we 
ought to have the same requirements between the CFTC and the 
SEC?
    Mr. Cawley. Well, Senator, let me attempt to answer that. 
The SEC regulates credit derivatives, and the CFTC regulates 
interest rate swaps and indices. And I think when you consider 
those three different swap classes, there are different 
liquidity considerations in each. So consequently there should 
be different block size of block trade reporting requirements 
in terms of size and also in terms of time. So it is certainly 
consistent that they would have different views for each 
particular class, especially when you look to other asset 
classes where similar rules exist, but be it in futures or 
options or even in the equity markets.
    With regard to your concern vis-a-vis RFQ and the potential 
limitations that that may have on liquidity, whereas on the one 
hand a customer is loath to put their name, size, and direction 
out on a particular trade to multiple counterparties, one also 
has to measure it against the tension by giving it out to too 
few. One of the suggestions from the SEC, for example, has 
required that an RFQ go out to one entity. We think that that 
is fraught with danger from a market manipulation standpoint, 
and we should protect against that.
    Our customers certainly have the ability to go out to five 
or three or whatever the number is. I do not think they are 
looking to go out to see 10 or 15 or 20.
    Under those certain rules, they do not necessarily have to 
show their name in addition to size and direction. They can 
initiate what are known as ``anonymous RFQs,'' and they can 
certainly access the central limit order book or the exchange 
marketplace as well so they can avoid the RFQ requirement 
altogether. So there are certainly many avenues for customers 
to come in and trade.
    Senator Toomey. Mr. McPartland, I wonder if you have a 
different perspective on this.
    Mr. McPartland. I think Jamie raises some very valid 
points. The credit market, the rates market are very different. 
They have very different users, very different uses for those 
products.
    However, I would suggest that the regulations should be 
considerably more harmonized than they are, and it would be 
left then to the SEFs and the market participants to ensure 
that the SEFs that are focused on trading credit derivatives 
are designed in such a way that it helps liquidity in those 
markets, and the same for the interest rate markets. So rather 
than regulatory differences, we would have differences in 
business models in the SEFs that are trading in those products.
    Senator Toomey. Mr. Brady, anything you would care to add?
    Mr. Brady. I think we are returning to the theme, a number 
of us, of urging the regulators to take a principles-based 
approach. Certainly more harmonization between the CFTC and SEC 
is welcome. But I think we also recognize that markets are 
different, and both agencies should strive to take a 
principles-based approach.
    Senator Toomey. Thank you.
    Mr. Macdonald.
    Mr. Macdonald. Sure. I think there are broadly three things 
here. The first is that as it pertains to block sizes and trade 
reporting requirements, I think clearly there are nuances 
between each element in these markets, and whatever the end 
regulations will be should be reflective of that.
    I think when we talk about execution protocols, you know, I 
would echo what Neal said, which is that it needs to be a 
principles-based approach. I think it is important to note that 
there is quite a strong correlation between the single-name 
space, which would be regulated by the SEC, and the index 
space, which would be regulated by the CFTC, and, therefore, it 
is important that users have a similar experience on executing 
on both of those platforms.
    The last point I would like to make is really the one about 
governance within thesecurities-based SEF space. I think it is 
clear that the population and size of the market that will be 
regulated by the SEC is much smaller than the one which is 
going to be regulated by the CFTC. And I think that if the 
barriers to entry to the SB-SEF space and the governance rules 
that will be put in place by the SEC are prohibitive, I think 
what you may end up having is a mismatch between the platforms 
that operate in the index and swap space versus the platforms 
that operate in the single-name space, because it may not be 
commercially viable for somebody to build an entity or a 
company to operate in the SEC space.
    Senator Toomey. Thanks, Mr. Chairman.
    Chairman Reed. Thank you, Senator.
    Thank you, gentlemen for your excellent testimony, and I 
will ask the next panel to come forward. Thank you.
    [Pause.]
    Chairman Reed. I would like to recognize my colleague, 
Senator Toomey, to introduce Mr. Thum. Senator.
    Senator Toomey. Thank you very much, Chairman Reed, for 
giving me this opportunity to introduce Mr. William Thum, a 
principal of the Vanguard Group in Valley Forge, Pennsylvania. 
Vanguard is, of course, one of the world's largest investment 
management companies, employing over 12,000 people in the 
United States and abroad. Mr. Thum is currently the senior 
derivatives transactional and regulatory specialist in 
Vanguard's Legal Department. Try saying that five times fast.
    Prior to joining Vanguard in 2010, Mr. Thum was a partner 
with Fried Frank Harris Shriver & Jacobson, LLP. From 1998 to 
2007 he was an executive director and head of institutional 
securities documentation for the Americas at Morgan Stanley. 
From 1996 to 1998 Mr. Thum was a vice president and head of 
derivatives documentation at UBS. He also worked at BNP Paribas 
in New York and at Dresdner Klein Ward in London as legal 
counsel. Mr. Thum has been an active contributor to industry 
efforts to develop market standard documents for derivatives 
trading. He is a frequent lecturer on legal and regulatory 
issues relating to derivatives and has participated in several 
joint CFTC/SEC public roundtables on Dodd-Frank Act-related 
rulemaking.
    Mr. Thum received his J.D. from the American University 
Washington College of Law and his B.A. from Bucknell. He is 
admitted to the bar in both New York and Pennsylvania, and I am 
very pleased that Mr. Thum could be with us today. I welcome 
his testimony, and I thank you, Mr. Chairman.
    Chairman Reed. Thank you, Senator. Let me introduce our 
other panelists.
    Stephen Merkel is executive vice president, general 
counsel, and secretary of BGC Partners, positions he has held 
since the formation of BGC's predecessor eSpeed in 1999. He is 
the current chairman and a founding board member of the 
Wholesale Market Brokers' Association, Americas, the 
independent industry body representing the largest interdealer 
brokers operating in North America wholesale markets across a 
broad range of financial products. He serves as a member of the 
supervisory board of ELX Futures, L.P., a fully regulated 
electronic U.S. futures exchange. He is currently also 
executive managing director, general counsel, and secretary of 
Cantor Fitzgerald, L.P., which he joined in 1993. Thank you, 
Mr. Merkel, for joining us.
    Christopher Bury is a managing director at Jefferies & 
Company in the fixed income's New York office and cohead of 
rates trading and sales. Under Mr. Bury's leadership, Jefferies 
has expanded its global rates trading and sales capabilities, 
including attaining primary dealer status with the Federal 
Reserve Bank of New York as well as the equivalent dealer 
recognition in multiple European countries. Prior to joining 
Jefferies in January 2009, Mr. Bury spent more than 13 years in 
fixed income trading at Merrill Lynch, where he most recently 
headed Merrill Lynch Government Securities, Inc., and was 
trading manager of the USD agency desk. Prior to trading agency 
debt, Mr. Bury traded USD interest rate swaps and options for 
Merrill Lynch.
    Gentlemen, your testimony will be made part of the record. 
Please use your 5 minutes to make any comments that you would 
like. Mr. Thum, please.

  STATEMENT OF WILLIAM THUM, PRINCIPAL AND SENIOR DERIVATIVES 
               COUNSEL, THE VANGUARD GROUP, INC.

    Mr. Thum. Chairman Reed, Ranking Member Crapo, and Members 
of the Subcommittee, thank you for having me here today. My 
name is William Thum, and I am a principal and senior 
derivatives counsel at Vanguard.
    Headquartered in Valley Forge, Pennsylvania, Vanguard is 
one of the world's largest mutual fund firms. We offer more 
than 170 U.S. mutual funds with combined assets of 
approximately $1.7 trillion. We serve nearly 10 million 
shareholders including American retirees, workers, families, 
and businesses whose objectives include saving for retirement, 
for children's education, or for a downpayment on a house or a 
car.
    Vanguard's mutual funds are subject to a comprehensive 
regulatory regime and are regulated under four Federal 
securities laws. As a part of the prudent management of our 
mutual funds, we enter into swaps to achieve a number of 
benefits for our shareholders including hedging portfolio risk, 
lowering transaction costs, and achieving more favorable 
execution compared to traditional investments.
    Vanguard has been supportive of the Dodd-Frank Act's 
mandate to bring regulation to the derivatives markets to 
identify and mitigate potential sources of systemic risk.
    Vanguard supports a phased implementation schedule over an 
18- to 24-month period following rule finalization based on the 
following objectives:
    Number one, prioritizing risk reduction over changes to 
trading practices and market transparency; Prioritizing data 
reporting to inform future rulemaking related to trading 
practices and market transparency to minimize a negative impact 
on liquidity; Harmonizing overlapping U.S. and global 
regulatory efforts; and Allowing immediate voluntary access for 
all party types to the new platforms with mandated compliance 
to apply initially to swap dealers and to major swap 
participants.
    In view of the time needed to digest the final rules and to 
develop industry infrastructure; to implement complex 
operational connections required for reporting, clearing, and 
exchange trading; to educate clients on the changes and to 
obtain their consent to trade in the new paradigm; and to 
negotiate new trading agreements across all trading 
relationships, Vanguard supports the following implementation 
schedule:
    Six months from final rules, the swap data repositories, 
derivatives clearing organizations, SEFs, and middleware 
providers must complete the build-out of their respective 
infrastructures.
    Six to 12 months from final rules, all participants should 
voluntarily engage in reporting, clearing, and trading 
platforms.
    Twelve months from the final rules, all participants should 
be mandated to report all swaps involving all parties. Dealers 
and major swap participants should be mandated to clear the 
first list of standardized swaps.
    Eighteen months from the final rules, all participants 
should be mandated to clear the first list of standardized 
swaps. SEFs and commissions can analyze SDR swap data for 
liquidity across trade types to make informed SEF trading 
mandates, block trade size, and reporting delays. Dealers and 
major swap participants should be mandated to trade the first 
list of standardized swaps made available for trading on SEFs.
    And 2 years from the final rules, all participants should 
be mandated to trade the first list of standardized swaps made 
available for trading on SEFs with delayed public reporting of 
block trades based on historical relative liquidity.
    The need for a phased implementation schedule is supported 
by studies which have identified significant differences in 
liquidity between the swaps and futures markets. While futures 
trading is characterized by high volumes of a limited range of 
trade types of small sizes and limited duration, the swaps 
market has an almost unlimited range of trade types of much 
larger sizes with a much longer duration. Swaps liquidity 
varies dramatically with high liquidity for 2-year U.S. dollar 
interest rate swaps and much smaller liquidity in credit 
default swaps on emerging market corporate entities.
    The potential negative consequences to liquidity are best 
demonstrated by the impact of the premature public reporting of 
large-sized block trades. When quoting a price for a block 
trade, dealers typically charge a slight premium to the then 
current market price for a similar trade of a more liquid size. 
Once the trade is executed, the dealer executes one or more 
liquid-sized mirror trades at current market prices to lay off 
its position and to flatten the market exposure.
    The premature public dissemination of block trades will 
provide the market with advance knowledge of the dealer's 
imminent trading and is, therefore, likely to move the market 
against the dealer. Fund investors will ultimately bear the 
increased price of relevant trades or the increased costs of 
establishing positions using multiple trades of liquid sizes.
    The CFTC's proposed test for block trade size and the CFTC 
and SEC's proposed time delay for the public dissemination of 
block trade data are too conservative and are likely to have a 
serious negative impact on liquidity. Particularly as such 
proposals address market transparency and not market risk, the 
more prudent approach would be to make informed decisions based 
on a thorough analysis of market data with larger block trade 
sizes and more prompt public reporting for the most liquid 
products and lower sizes and delayed reporting for less liquid 
products.
    There are a number of other significant issues related to 
SEF trading mandates proposed by each of the CFTC and SEC which 
I am happy to discuss. Such issues include the CFTC's proposed 
requirement for Requests for Quotes to be distributed to a 
minimum of five dealers, the CFTC's and SEC's mandate for 
participants to take into account or to interact with other 
resting bids and offers, the CFTC's requirement for there to be 
a 15-second delay involving crossing trades, and the need for 
harmonization across the CFTC and SEC rulemaking to avoid 
unnecessary complexities.
    Thank you for the opportunity to share our views with the 
Subcommittee, and we will be pleased to serve as a resource for 
the Members with respect to the swaps rulemaking exercise.
    Chairman Reed. Thank you very much.
    Mr. Merkel, please.

   STATEMENT OF STEPHEN MERKEL, EXECUTIVE VICE PRESIDENT AND 
              GENERAL COUNSEL, BGC PARTNERS, INC.

    Mr. Merkel. Thank you, Chairman Reed and Ranking Member 
Crapo, for providing this opportunity to participate in today's 
hearing.
    My name is Stephen Merkel, and in addition to my role at 
BGC Partners, I am the chairman of the Wholesale Markets 
Brokers' Association, Americas, an independent industry body 
whose membership includes the largest North American 
interdealer brokers. I am here today representing the members 
of the WMBA.
    The WMBA recently filed a comment letter to the SEC and 
CFTC summarizing the positions we have taken on several of 
their proposals over the last year. I would ask permission to 
submit this letter for the record.
    Chairman Reed. Without objection.
    Mr. Merkel. Thank you.
    Wholesale brokers are today's marketplaces in the global 
swaps market and, as such, can be a prototype for prospective 
independent and competitive swap execution facilities, or SEFs. 
As we sit here today, interdealer brokers are facilitating the 
execution of hundreds of thousands of over-the-counter trades 
corresponding to an average of $5 trillion in notional size 
across a wide range of asset classes. Although the Dodd-Frank 
Act created the term ``SEF,'' the concept of counterparties to 
a trade utilizing an intermediary to execute transactions has 
been around for a very long time.
    At the core of Title VII is a competitive marketplace. The 
Dodd-Frank Act specifically did not dictate that all mandatory 
trades go through monopolistic exchanges and instead permits 
these trades to be executed across an array of over-the-counter 
competitive SEFs. SEFs do not operate as siloed, monopolistic 
exchanges. Instead, we operate as competing execution venues 
where BGC and its competitors aggressively vie with each other 
to win their customers' business through better price, 
provision of superior market information and analysis, deeper 
liquidity and better service. It is vital to ensure that SEFs 
are brought under the new regulatory regime in such a way that 
fosters the competitive nature of OTC markets and continues to 
provide a deep source of liquidity for market participants.
    WMBA member firms are currently fully functional, having 
the capacity to electronically capture and transmit trade 
information with respect to transactions executed on our 
trading platforms as well as the ability to execute or trade 
swaps by accepting bids and offers made by multiple 
participants through any means of interstate commerce, 
including use of electronic and voice trading platforms.
    I would suggest that there are four critical elements 
regulator need to get right.
    First, SEFs must not be restricted from deploying the many 
varied trade execution methods successfully used today.
    Second, regulators need to carefully structure a public 
trade reporting system that takes into account the unique 
challenges of swaps trading. If the rules do not properly 
define the size of block trades, information, and time delays, 
it will sure cause a negative impact on liquidity, disturbing 
end users' ability to hedge commercial risk and to plan for the 
future.
    Third, the goal of pretrade transparency must be realized 
through means that are already developed by wholesale brokers 
to garner and disseminate pricing information, and not by 
artificial mechanisms that may restrict market liquidity for 
end users and traders.
    Finally, regulations should support the formation of a 
common regulatory organization for SEFs to implement and 
facilitate compliance with the new regulatory regime to prevent 
a ``race to the bottom'' for rule compliance and enforcement 
programs. As it relates to modes of execution, Dodd-Frank Act 
expressly permits swaps to be executed by SEFs using any means 
of interstate commerce. The WMBA believes the SEC's 
interpretation of the SEF definition is consistent with the 
statute as it allows trade execution through any means of 
interstate commerce including requests for quotes systems, 
order books, auction platforms, or voice brokerage trading.
    WMBA believes that this approach should be applied 
consistently to all trading systems or platforms and will 
encourage the growth of a competitive marketplace for trade 
execution facilities. By contrast, the CFTC's pending rule is 
much more restrictive than Dodd-Frank's express language and 
prescribes specific modes of execution for different types of 
trades.
    In fact, the CFTC's proposed rule would severely limit the 
ability of SEFs to communicate with their customers 
telephonically in the course of a transaction. Such a 
limitation of voice communications is completely inconsistent 
with the statute.
    I thank you for your time and look forward to answering any 
questions that you may have.
    Chairman Reed. Thank you very much.
    Mr. Bury, please.

  STATEMENT OF CHRIS BURY, COHEAD OF RATES SALES AND TRADING, 
                   JEFFERIES & COMPANY, INC.

    Mr. Bury. Good morning. My name is Chris Bury and I am the 
Cohead of Rates Sales and Trading for Jefferies and Company. 
Chairman Reed and Ranking Member Crapo, thank you for inviting 
me to testify this morning regarding the emergence of swap 
execution facilities, or as they have come to be known, SEFs.
    Jefferies is a full-service global securities and 
investment banking firm that, for almost 50 years, has been 
serving issuers and investors. We provide investment banking 
and research, sales, and trading services and products to a 
diverse range of corporate clients, Government entities, 
institutional investors, and high net worth individuals. Over 
the last 5 years, our firm's annual revenue, equity market 
capitalization, and global head count have increased 
significantly, with now almost $3 billion in annualized net 
revenue, over $4 billion in equity market value, and soon to be 
3,600 employees.
    It bears noting that during the same period, that is, 
during the financial crisis, at no time did Jefferies seek or 
receive taxpayer assistance. As a publicly traded company on 
the New York Stock Exchange, our capital comes solely from the 
markets, and Jefferies' ability to persevere and emerge from 
the financial crisis positioned for growth and diversification 
can best be attributed to the firm's focus on a strong capital 
position, ample liquidity, and sound risk management.
    There are a few key points that Jefferies would like to 
convey to the Subcommittee. First, we are ready to go. From our 
perspective, the architecture, infrastructure, and technology 
necessary to bring the over-the-counter derivatives markets 
into an era of transparency, disperse counterparty risk, and 
open access are in place. Just as we are a leading provider of 
liquidity and execution in stocks and bonds, we believe we can 
become a leading provider to buyers and sellers of derivatives. 
The market awaits the adoption of final rules. It is a fallacy 
to suggest that rules should be delayed to allow more time for 
this market structure to develop.
    Second, we believe that those sections of Title VII of 
Dodd-Frank pertaining to SEF trading of derivatives are 
necessary to remedy the artificial barriers to entry in the OTC 
derivatives market.
    Third, implementation time lines should be the top priority 
at this juncture. The proposed rules are generally clear and 
understandable. The market needs the certainty of when the 
rules will become applicable far more than it needs any more 
suggestions about how bilateral agreements offer an alternative 
to central clearing.
    Fourth, it is vitally important to guard against the 
development of market structures that enable opaque, bilateral 
contract relationships to continue to exist. Current 
standardized execution agreement proposals for centrally 
cleared swaps do nothing but preserve the closed and 
anticompetitive elements of these markets as they existed prior 
to the financial crisis.
    Fifth, the adoption of the rules and a clear time line for 
implementation for Title VII will bring to the markets the same 
clear benefits gained from similar developments in equities and 
futures markets: Increased access, expanded competition, 
improved price transparency, and decentralized risk. For years, 
firms such as Jefferies were effectively locked out of being a 
dealer in the OTC market by virtue of a series of artificial 
barriers and requirements that perpetuated a closed system. The 
weaknesses and lack of true competition of that closed system 
exacerbated the credit crisis of 2008 to the great expense of 
our economy.
    We support the implementation of SEF trading as quickly and 
responsibly as possible. We believe that these provisions will 
increase transparency, reduce systemic risk, increase 
competition, and broaden access to centralized clearing within 
the derivatives marketplace, all of which will benefit the 
American taxpayer.
    Our industry is approaching full readiness for standardized 
OTC derivatives contracts to begin trading on SEFs. If the 
proposed rules are implemented by the end of 2011, Jefferies 
would anticipate that trading volumes will begin increasing by 
the fourth quarter of this year, and then increase 
significantly into 2012 as we approach final implementation of 
mandatory SEF trading of standardized derivatives. A firm time 
for mandatory SEF trading on the most standardized swaps will 
be instrumental for the market to achieve its full potential.
    In conclusion, Jefferies believes that implementation of 
Title VII reforms will unless full market forces held in check 
by entrenched business models and we are ready and eager to 
compete in the derivatives marketplace.
    Thank you for inviting me to testify today and I look 
forward to any questions the Subcommittee may have.
    Chairman Reed. Well, thank you, gentlemen, for your 
excellent testimony.
    Senator Toomey and I await momentarily a vote. We have a 
few minutes to get over there, but I think the best way to 
proceed would be to allow me to ask a general question to the 
panel and then recognize Senator Toomey for a question, and 
then be prepared for an avalanche of written questions because 
we, unfortunately, will not be able to explore in as much 
detail at this moment as we wanted to.
    But just picking up on something Mr. Bury said about these 
model contracts that are being developed that you suggest might 
be literally a choke point for access to the SEFs and the 
different trading platforms, can you comment further on that in 
terms of your experience or what you see, and then I will just 
ask Mr. Merkel and Mr. Thum to comment, too, about this, 
because I believe some of the major associations are beginning 
to develop these types of contracts as an alternative to wider 
use of the SEFs. I think it is an important question. Mr. Bury, 
please.
    Mr. Bury. OK. One example currently that is taking place in 
the marketplace is an execution agreement on cleared swaps. 
There has to be some market framework and work flow by which 
people can start to transact in the cleared environment. So 
there is currently an industry documentation effort that is 
underway where people can identify their counterparties and 
their clearing members for cleared derivatives.
    Unfortunately, at this point, we feel that it is overly 
complex and contains too many complicated built-in credit 
checking limits that, at the end of the day, somewhat limit 
people's ability and potential to transact on other venues or 
engage other counterparties. It is overly complex, and I think 
if the market shifts and market participants combined with 
regulators overseeing the effort and helping the process along 
focus on, I guess, the mandated clearing and acceptance, 
immediate acceptance of clearing of transactions, then you will 
not have to rely on a byzantine or complicated documentation 
framework.
    Chairman Reed. Thank you.
    Mr. Merkel, then Mr. Thum, and thank you.
    Mr. Merkel. I would agree that there are real pressures and 
forces that work against breaking the status quo and opening up 
areas for competition, whether it is in clearing, whether it is 
in execution, whether it is in modes of execution, and I think 
that those, in many cases, those barriers to changing the 
status quo are subtle and difficult to discern. I do think 
there is an issue that I do not think the agencies are as 
focused on as they might be, and I think that is a considerable 
problem. There are some protections in Dodd-Frank with respect 
to this issue, with respect to impartial access, with respect 
to nondiscriminatory clearing. I have not seen in the 
regulations that have come out much sensitivity to getting into 
that in detail.
    I have seen in the regulations, to the contrary, there are 
almost no references to them other than parroting what is in 
the statute, and what regulations we are seeing that come out 
in detail are not even part of Dodd-Frank. So I think the 
regulators are focusing very much on recreating marketplaces or 
reengineering marketplaces without regard to the effects on 
liquidity, but spending almost no time looking at trying to 
foster a competitive landscape.
    Chairman Reed. Mr. Thum, please.
    Mr. Thum. Before you can have mandated SEF trading, you 
have to have mandated clearing. Before you can have mandated 
clearing, you have to have the documentation in place. Indeed, 
ISDA and the FIA are developing standard addendums to overlay 
over existing futures agreements which the market has in place. 
Unfortunately, there is no standard futures agreement in the 
market. Every dealer has its own unique futures agreement. 
Those futures agreements are developed for futures. They are 
not developed for swaps.
    There are business issues related to the trading of swaps, 
even clearing swaps, that are unique to swaps that are 
different from futures that will have to be addressed. There is 
an overlay that ISDA and the FIA have developed to supplement 
the existing futures agreement to allow central clearing. 
Unfortunately, those have to be negotiated bilaterally between 
every client and every clearinghouse and the existing futures 
agreement may have to be upgraded, as well. This is an enormous 
effort.
    Certainly, Vanguard is engaged in this at present, but the 
pipeline is limited in terms of the dealer's ability to digest 
renegotiating all of their existing futures agreements and have 
the addendum put in place. This will be a big problem in terms 
of having a very condensed implementation schedule, which is 
one of the reasons why I have laid out the sequence of having, 
first, reporting to informed decision making on block trade 
size and delays, then have clearing layered in, first through 
swap dealers and major swap participants, then have clearing 
laid in for the rest of the market, allowing 18 months to get 
these documents signed up, and then, finally, SEF trading after 
that.
    Chairman Reed. Thank you very much.
    Senator Toomey.
    Senator Toomey. Thank you, Mr. Chairman.
    Mr. Thum, I would like to follow up with you on this. First 
of all, I would like to commend you. I think this is a very 
sensible and very thoughtful proposal that lays out a phased 
implementation that makes a lot of sense and, frankly, is very 
helpful. My sense is that there is increasing consensus that 
there needs to be a phased implementation, but it is not yet 
clear to me that there is a complete consensus on what the 
sequence will be, nor necessarily on the overall timing.
    So you have touched on several reasons why this is 
important, the comments you just made about the necessity of 
getting the documentation in order. As I understand it, your 
testimony suggests that there could be a negative impact on 
liquidity if some of the rules, reporting rules, for instance, 
are not informed by the market data. Could you elaborate a 
little bit and maybe touch on other aspects, negative aspects 
that you are concerned about in the marketplace if there is not 
sufficient time for this implementation to occur?
    Mr. Thum. Sure, and I think that is an excellent question. 
I think that the problem is that, particularly as mandates are 
layered in place, you could have a situation where those that 
cross the finish line at an appropriate time consistent with 
the mandate are allowed to continue to trade swaps, clear and 
trade swaps, and those that do not get past the finish line, 
either because their business is not large enough to allow them 
through the pipeline at the dealer to get the documentation 
signed up, to have their infrastructure developed, to have all 
the operational connectivity in place, they will be effectively 
locked out of the market because of an arbitrary time line that 
does not take into consideration all the things that need to be 
done.
    In recent CFTC and SEC roundtables, a focus has been on 
SDRs and gathering information. Once the final rules are in 
place, the SDRs think it will be three to 6 months before they 
are ready to be collecting the data and then have the data to 
allow the commissions and the SEFs to make decisions on block 
trade size and delays.
    So there is a whole sequence of getting the data, having 
the SDRs set up, getting the data in the door, allowing time 
for the documentation to get clearing in place, and then once 
you have the data, analyze the data, assess liquidity, set 
appropriate block trade sizes and delays so that you can 
effectively allow for SEF trading. But all these things have to 
happen and they have to happen in sequence and they have to 
happen once the rules are finalized.
    Senator Toomey. And I gather the bottom line is your 
concern is if it happens on too compressed a schedule, then 
there are significant participants that could be actually just 
frozen out of the activity until they are able to get up to 
compliance, and I suppose, also, the danger of inappropriate 
rules because they would not be informed by sufficient history.
    Mr. Thum. Exactly, and the largest players, some of which 
were mentioned today in the earlier panel, will probably get to 
the finish line very quickly.
    Senator Toomey. Right.
    Mr. Thum. But the rest of the market may be left behind. 
And, of course, the problem--the impacts on liquidity that have 
been talked about in the various panels will be significant.
    Senator Toomey. Thank you. Thank you, Mr. Chairman.
    Chairman Reed. Thank you very much, Senator Toomey.
    Gentlemen, thank you for your excellent testimony. We have 
a vote that is underway, but again, we will, I am sure, be 
responding, not just Senator Toomey and I, but others with 
questions for you.
    I want to thank all the witnesses for testifying today. We 
appreciate both the time and effort you made to join us this 
morning, your excellent testimony. It has been thoughtful. It 
is also of great assistance to us, and I hope it is of great 
assistance to the agencies, the SEC and the CFTC, because one 
of the messages that has been consistent is coordination and 
accommodation and synchronization of their efforts to regulate 
the market.
    I would also like to submit, without objection, for the 
record a written statement from the Investment Company 
Institute, ICI.
    If Members of the Committee have their own written 
statements or additional questions for the witnesses, please 
submit them no later than close of business next Wednesday. The 
witnesses' complete written testimony will become part of the 
hearing record and we are happy to include supporting 
documentation for the record. We ask that the witnesses respond 
to any questions within 2 weeks, and note that the record will 
close after 6 weeks in order for the hearing print to be 
prepared.
    Without further business, I will call the adjournment of 
the hearing. Thank you.
    [Whereupon, at 11:16 a.m., the hearing was adjourned.]
    [Prepared statements, responses to written questions, and 
additional material supplied for the record follow:]
                PREPARED STATEMENT OF SENATOR MIKE CRAPO
    Thank you, Mr. Chairman for holding this hearing on the development 
of Swap Execution Facilities (SEFs).
    There are a number of different electronic trading models that 
could potentially be used for derivatives trading depending upon final 
rules by the SEC, CFTC, and international regulators.
    While Title VII of the Dodd-Frank Act states that the SEC and CFTC 
shall consult and coordinate to the extent possible for the purposes of 
assuring regulatory consistency and comparability, the lawyers for the 
two agencies have not been able to agree what these terms means.
    We should not then be surprised when the two agencies propose 
inconsistent approaches to the same rule sets. For the Swap Execution 
Facility rules, the SEC approach is more principles-based and is in 
general far less prescriptive than that of the CFTC.
    While the Dodd-Frank Act missed a great opportunity to merge the 
SEC and CFTC and stop the bifurcation of the futures and securities 
markets we should continue to push for more coordination and consistent 
rules.
    Swap Execution Facilities are likely going to dually register with 
the two agencies and it makes a lot of sense for the two regimes to be 
consistent.
    While I applaud the SEC for taking a more flexible approach 
relative to CFTC, both agencies need to make their rules more 
accommodative of the different types of SEFs to provide maximum choice 
in trade execution to market participants.
    Under the CFTC SEF version, the proposed rule requires swap users 
to request prices from no fewer than five dealers at a time.
    This is generating a lot of controversy from the end user community 
which argues it may ultimately serve to unnecessarily disadvantage end 
users by limiting their ability to choose the appropriate number of 
counterparties and mode of execution in the way they deem most 
efficient and effective to hedge their commercial risk.
    Since the Dodd-Frank Act stipulates that transactions required to 
be cleared must also be executed on a SEF or designated contract market 
there is significant interplay between the clearing, trading, and the 
definition of block trades.
    According to the end users, this could create a problem for some 
less liquid trades that could be suitable for clearing, but not for 
trade execution.
    I have also been advised that the SEC's SEF approach is more 
consistent with what the Europeans are looking at but have not acted 
upon.
    If we want to find a common international framework in order to 
avoid regulatory arbitrage and avoid competitive disadvantages we need 
to provide greater coordination and harmonization to get the rules 
right rather than rushing them through.
                                 ______
                                 
                 PREPARED STATEMENT OF KEVIN McPARTLAND
             Director of Fixed Income Research, TABB Group
                             June 29, 2011
    Chairman Reed, Ranking Member Crapo, and Members of the 
Subcommittee, thank you for inviting me today to discuss progress and 
concerns surrounding the creation of swap execution facilities.
    I'm Kevin McPartland, a Principal and the Director of Fixed Income 
Research at TABB Group. TABB Group is a strategic research and advisory 
firm focused exclusively on the institutional capital markets. Our 
clients span the entire investment landscape including investment 
banks, pension plans, mutual funds, hedge funds, high frequency 
traders, FCMs, exchanges, and clearinghouses. We also operate 
TabbFORUM.com, a peer-to-peer community site where top level industry 
executives share thought leadership on important issues affecting the 
global capital markets.
    In order for this new market structure to be successful, swap 
execution facilities must be given broad latitude in defining and 
implementing their business models--this includes, but is not limited 
to, the mechanisms used for trading and the risk profiles of their 
members. This will promote the innovation and competition that has made 
the U.S. capital markets the envy of the world.
    It is also critical that the mechanisms to move trades quickly and 
easily from execution to clearing are well defined. If market 
participants worry that the trade they have just executed on a SEF 
might later in the day be canceled due to a clearinghouse rejection, 
confidence in the entire market model will erode quickly, and severely 
limiting the transparency and systemic risk reduction Dodd-Frank was 
intended to improve.
New Market Structure
    Despite these open concerns, industry sentiment toward the creation 
of swap execution facilities has turned positive. Based on a TABB Group 
poll published in April 2011, of more than 140 market participants, 87 
percent believe the creation of swap execution facilities will 
ultimately be good for the swaps market. Of course, everyone defines 
``good'' differently--good for liquidity, for transparency, for 
profits. Regardless, this demonstrates how the market's view that 
nearly every business model can--and most will--be adapted to work 
under the proposed SEF rules.
    That being said, no solution will satisfy all market participants--
nor should it. Regulators should not try to appease everyone in the 
market but instead focus their efforts on creating a set of rules that 
work.
    To finalize the new swaps-market rules, regulators can either 
attempt to fit these products into old structures (such as a futures 
structure), or develop new mechanisms to manage these products. TABB 
Group believes regulators should look toward the new rather than wrap a 
new product in an old package. To that end, we are all presented with 
the rare opportunity to build up this market from scratch in such a way 
that it will function effectively for farmers who need to hedge crop 
prices and global financial institutions working to keep the world's 
economy flowing.
    The exchange model was created over 200 years ago long before 
electronic trading and high-speed market data. Today we're creating a 
new 21st-century market, but why would a paradigm from the 1800s make 
sense as a starting point? With little legacy legislation, rules can be 
written based on what we know now, not based on the structures 
developed in 1934 via the Securities and Exchange Act.
Trading Style and Membership Requirements
    In order to develop the most suitable market structure for swaps, 
we must provide swap execution facilities with the freedom to utilize 
trading styles and different business models, ensuring every market 
participant has the most efficient access to liquidity possible.
    Firstly, SEFs should not be driven to a particular trading model. 
Despite the inclusion of the Request for Quote model in proposals from 
the CFTC and SEC, regulators are keen to have swaps trade through an 
order book with continuous two-sided quotes.
    TABB Group research shows that order-book trading will emerge 
naturally--81 percent believe we will have continuous order book 
trading of vanilla interest rate swaps within 2 years of SEF rule 
implementation. However, the existence of an electronic order book does 
not guarantee liquidity nor that market participants will trade there.
    For example, of the roughly 300,000 contracts available for trading 
in the electronic U.S. equity options market, only 100 of those make up 
about 70 percent of the volume. The rest are seen as so illiquid that 
it is often easier to trade OTC with a broker rather than try and 
execute that same contract on the screen. Furthermore, despite the 
market's electronic nature, TABB Group research shows that in 2010 as 
much as 97 percent of all options trading volume generated by asset 
managers was done over the phone.
    Second, we should encourage SEFs to set membership requirements to 
encourage a variety of liquidity pools. The U.S. equity market presents 
a good example. Thirteen registered exchanges and another 55 
alternative execution venues exist to trade U.S. equities for a total 
of sixty-eight. Why? Because different market participants trade in 
different ways and have different needs. Some like to trade in large 
size, some small; some are very concerned about price while others are 
more concerned about getting a trade done quickly. Because of this, the 
equity market responded with new venues to meet those needs.
    Although the equities market is very retail focused and the swaps 
market is purely institutional, a similar dynamic exists. The trading 
style and needs of a mutual fund are very different from those of a 
major dealer or a hedge fund. We therefore should encourage swap 
execution facilities to develop business models that help all market 
participants, and allow SEFs to compete with each other for whichever 
client base they chose to serve. This means allowing SEFs to not only 
define the method of trading, but requirements for entry.
    For example, if you were willing to pay the membership fee, a 
restaurant supply store would be willing to sell you food for your 
family in the same bulk sizes they provide for restaurants. But since 
most American families do not need to buy food in bulk, we choose 
instead to shop at a local supermarket. The price per unit might be 
higher, but it is a more suitable way to shop for a family of four. 
Although the analogy might appear flippant, it explains why loosely 
defined tiers must still exist for trading swaps.
    In the current market, a smaller player cannot trade in the 
interdealer market even if they had the capital and desire. In the new 
market, as long as a trading firm meets the requirements set forth by 
the SEF, they will be--and should be--allowed in to trade. The 
important point to note is that setting membership requirements for 
SEFs is not exclusionary, but instead intended to help market 
participants trade in the most suitable environment possible.
Clearing
    Open access to clearing will play a huge role in the success or 
failure of all SEFs. It is central clearing, not the SEF construct 
itself, that will allow easier access to trading and new market 
participants to enter. But a clearinghouse providing only the ability 
to accept SEF executed trades is not enough.
    SEFs are intent on providing click-to-trade functionality, that 
when you accept a price on the screen with a click of the mouse, 
whether in an order book or via a request for quote, the trade is done. 
However, a trade is not done until it is accepted for clearing--
something the SEFs have little if any control over. That raises the 
question: can a SEF ensure a trade will be accepted for clearing before 
it allows the trade to execute? And even if it can, is that its 
responsibility?
    Either way, clearing certainty is crucial to the success of SEFs. 
If market participants worry that the trade they have just executed on 
a SEF might later in the day be canceled due to a clearinghouse 
rejection, confidence in the entire market model will erode quickly and 
limit severely the transparency and systemic risk reduction Dodd-Frank 
was intended to improve. It is critical that a mechanism be put in 
place to formalize this process, ensuring the market can have full 
faith in the trades they execute on a SEF.
Size of the Market and Open Issues
    There has been considerable speculation as to the number of SEFs 
that will exist. The wildest number I've heard is 100 which is simply 
unrealistic. If the U.S. equities market has 68 venues and the U.S. 
futures market has 3 main players, the swaps market will fall somewhere 
in the middle.
    Our research shows also that nearly 60 percent of market 
participants believe the ideal number of SEFs per asset class is three 
to four, resulting in 15 to 20 SEFs covering interest rates, credit, 
FX, commodities, and equities. There will be many more than that to 
start but not 100--our list at TABB Group shows as many as 40 firms 
that plan to apply--but 87 percent of our study participants believe 
that SEF consolidation will begin 2 years or less from the date of rule 
implementation.
Timing
    Rulewriting delays at the CFTC and SEC are unfortunate but 
necessary. The financial services industry is ready to move ahead to 
the next chapter, but it is more important that these rules are written 
properly rather than in haste. Despite the fact that so much 
uncertainty remains, the industry is moving ahead with preparations for 
SEF trading, central clearing, trade reporting and the myriad of other 
new requirements.
    We are now in the pre-SEF era. Business models and technology are 
being finalized, but most SEFs are ``registration-ready'' and trade 
flow is beginning to pick up on the screen as most everyone has 
accepted that these changes are inevitable. Tradeweb, a trading 
platform set to register as a SEF, tells us their trading volume is up 
47 percent from last year. We see this level of growth happening with 
several of the existing platforms. Even if trading mandates don't take 
effect until the fourth quarter of 2012--a timeframe that seems more 
realistic--the change is so enormous for most swaps traders that 
getting started now should present just enough time to make the switch.
    Winners and losers, however, will not be chosen until after 
regulatory mandates are in place. Too many market participants still 
exist and see little economic incentive to shift, in addition to those 
new market participants waiting in the wings. But even still, working 
together, regulators and the industry have made significant progress 
during the past year, clarifying the view of what the post- Dodd-Frank 
world of swaps trading will look like.
    As rules are finalized, it is critical that while putting in place 
necessary oversight, new OTC derivatives rules encourage the innovation 
and competition that have made the U.S. capital markets the most envied 
in the world.
    Thank you.
                  PREPARED STATEMENT OF NEAL B. BRADY
              Chief Executive Officer, Eris Exchange, LLC
                             June 29, 2011






























                  PREPARED STATEMENT OF BEN MACDONALD
              Global Head of Fixed Income, Bloomberg, L.P.
                             June 29, 2011
    My name is Ben Macdonald and I am the Global Head of Fixed Income 
for Bloomberg L.P., a privately held independent limited partnership 
headquartered in New York City. Bloomberg is not owned by any swap 
market participants and does not itself engage in trading of swap 
instruments on a proprietary basis. Our customer base for our 
information and news services, market analytics and data services, and 
for our platforms for electronic trading and processing of over-the-
counter (OTC) derivatives is evenly distributed among buy-side and 
sell-side entities. We serve the entire spectrum of the financial 
market and, being independent, we do not have a bias toward nor are we 
beholden to any particular element of the market.
    Bloomberg's core business is the delivery of analytics and data on 
approximately 5 million financial instruments, as well as information 
and news on almost every publicly traded company through the Bloomberg 
Professional service. \1\ More than 300,000 professionals in the 
business and financial community around the world are connected via 
Bloomberg's proprietary network. Over 17,000 individuals trade on our 
system across all fixed income product lines alone, with over 50,000 
trading tickets a day coming over that network. Virtually all major 
central banks and virtually all investment institutions, commercial 
banks, Government agencies and money managers with a regional or global 
presence are users of the Bloomberg Professional service, giving 
Bloomberg extraordinary global reach to all relevant financial 
institutions that might be involved in swap trading.
---------------------------------------------------------------------------
     \1\ Bloomberg employs over 12,900 employees around the world, 
including more than 2,300 news and multimedia professionals at 146 
bureaus in 72 countries, making up one of the world's largest news 
organizations.
---------------------------------------------------------------------------
    I lead Bloomberg's team of professionals dedicated to establishing 
a registered Swaps Execution Facility (SEF) and Security-Based Swaps 
Execution Facility (SB-SEF) under Title VII of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act of 2010. As the largest 
independent player in the market in terms of electronic trading and 
processing of OTC derivatives, Bloomberg has an extensive suite of 
capabilities, experience, technical expertise, infrastructure, 
connectivity, and community of customers that uniquely position our 
fIrm to provide unbiased, independent intermediary SEF and SB-SEF 
services to both the buy-side and the sell-side in the domestic and 
international swaps market. All major swaps dealers utilize our 
platform. Over 600 firms use Bloomberg's existing platform to trade 
interest rate swaps and credit default swaps. We provide connectivity 
for both the buy-side and the sell-side to multiple clearinghouses. We 
facilitate exchange-traded as well as voice brokered swaps on our 
system.
    Bloomberg fully supports the creation of the regulated swaps 
marketplace envisioned by Dodd-Frank. We believe that the Dodd-Frank 
mandatory clearing and reporting requirements will significantly 
mitigate systemic risk, promote standardization, and enhance 
transparency. We enthusiastically anticipate being a robust and capable 
competitor in the SEF and SB-SEF markets, and we believe our 
participation as an independently owned firm will bring innovation, 
reliability, efficiency, transparency, and reduction of systemic risk 
to the markets.
Bloomberg's Existing Electronic Swaps Platforms: Experience and 
        Innovative Leadership
    Our views on the subject of SEF \2\ regulation are significantly 
informed by our long and successful experience derived from our 
existing OTC swaps trading platforms. We believe that body of expertise 
and experience provides Bloomberg the opportunity to engage the new 
world of SEF registration and operation from a considerable position of 
strength. Our current OTC derivatives trading platforms were built on 
the idea of adding transparency to the market by creating electronic 
functions that streamline trading in swaps and provide efficient, 
competitive access to swaps pricing, all of which aligns very well with 
the goals of Title VII of Dodd-Frank.
---------------------------------------------------------------------------
     \2\ Our reference to ``SEFs'' in this testimony is intended to 
include SB-SEFs as well unless otherwise indicated.
---------------------------------------------------------------------------
    Bloomberg's current ``single-dealer'' and ``multidealer'' 
derivatives trading tools allow multiple participants to view and trade 
swaps with multiple dealers. In Bloomberg's single-dealer page system, 
enabled participants are readily able to view different dealer pages 
(simultaneously if preferred) that display the price and volume at 
which each dealer has indicated it will trade. After reviewing the 
displayed prices a participant can then request to execute against a 
single-dealer page's displayed price with the understanding that the 
dealer can accept, counter, or reject execution. Multidealer pages 
display a ``composite price'' reflecting the general market based on 
participating dealers' respective price submissions. After reviewing 
the displayed ``composite price'' a participant can request specific 
prices from 3 dealers. The participant then has a limited time to 
accept or reject a trade with any of the dealers. Under both models, 
Bloomberg provides real-time trade reporting to warehouses, data 
repositories, and clearing venues.
    Bloomberg also has hosted various ``request for quote'' (RFQ) 
systems for OTC derivatives for the past 5 years. These RFQ systems 
allow entities seeking liquidity to secure bids and offers from 
particular market participants they would like to engage in a 
transaction. Our Bloomberg Bond Trader System, a competitive 
multidealer RFQ platform for U.S. and foreign government securities, 
has been active for more than 13 years. We are confident that these 
very successful RFQ models provide directly relevant experience and are 
the proper conceptual paradigm for establishing a SEF under Dodd-Frank.
    In addition to operating a very robust RFQ system, we also operate 
our ``AllQ'' system that shows market participants on one screen the 
stack of liquidity reflected in the range of streaming bids and offers 
from multiple dealers in the market. Users can perform their price 
discovery, and then click and trade with their dealer of choice.
    Both our RFQ and our AllQ systems empower properly enabled market 
participants to hit on executable bids and offers, or engage in 
electronic negotiation with counterparties on indicative bids. Our 
experience and success with our RFQ and AllQ platforms provide us 
confidence that we will be able to satisfy the operational requirements 
established by Dodd-Frank for SEF registration. We intend to be 
prepared to begin SEF operations on the implementation date of the 
relevant SEF regulations issued by Commodity Futures Regulatory 
Commission (CFTC) and the Securities Exchange Commission (SEC), 
provided that the two regulators create synchronized rules governing 
trading protocols, board composition and financial reporting.
Responses to the Committee's Specific Areas of Inquiry
    Bloomberg most certainly supports Dodd-Frank's call for the 
emergence of SEF-style trading, increased mandatory clearing and post-
trade transparency through reporting. In particular, Bloomberg is very 
supportive of the Federal regulators providing clear and specific rules 
for clearing, and post-trade transparency, which together serve as the 
most significant tools for reducing systemic risk and attaining a 
reformed, financially sound derivatives marketplace that benefits 
market participants and the Nation as a whole. The systemic risk 
threats that arose in 2008-2009 were associated with insufficient 
clearing and post-trade transparency and were not the result of 
execution failures. Indeed, market participants know very well what 
they want and need regarding fair and efficient execution on electronic 
platforms. Sophisticated market participants do not really need or want 
Federal regulators micro-managing execution protocols; no one should 
expect that market participants will necessarily want to trade the way 
the Federal Government prefers that they trade. It is also not the 
proper role of the Federal regulators to go to extravagant lengths to 
define the most favorable terms of execution for trading by 
sophisticated investors. Rather, while it is clearly a very important 
function, what is incumbent on Federal regulators is only to insure 
that the market is fair and competitive and that participants 
themselves have enough information to assess whether they know that 
they are getting a fair price.
    The risk that Federal regulators run in micromanaging execution 
protocols is that they will increase the direct cost of trading--with 
no compensating benefit to customers--and impose significant 
constraints and indirect costs that incentivize market participants to 
revert to forms of trading that evade the excessive regulation and 
those costs. It will not be difficult for market participants to find 
wholly lawful ways to conduct their trading in non-SEF environments, 
including taking their trading to foreign jurisdictions where the U.S. 
rules do not apply.
    Consequently, we do not believe that the same degree of regulation 
warranted for clearing and post-trade reporting is desirable from a 
public policy perspective with regard to trade execution protocols. 
Rather, in providing rules on trading protocols, Federal regulators 
should specifically avoid over-regulation and imposing ``one size fits 
all'' mandates, but should instead use a principles-based approach 
which encourages flexibility by SEFs that will maximize their 
innovation, competition and responsiveness to the needs of the market. 
Failure to invest SEFs with the ability to employ flexibility in their 
trade execution protocols actually jeopardizes the realization of the 
public policy objectives that Dodd-Frank seeks to attain.
    In his letter of invitation to this hearing, Chairman Reed outlined 
six specific areas of inquiry of interest to the Subcommittee. In 
response, Bloomberg offers the following views:
Question 1: What is the status of industry readiness for trading on 
        SEFs? What in your view is the timeline for the movement of 
        substantial volumes of derivatives activity onto SEFs? What, if 
        any, documentation is necessary for market participants to 
        migrate their trading activity onto SEFs?
    There are different degrees of readiness for trading on SEFs among 
market participants and among products. Some market participants, 
including banks, hedge funds, insurers, and other sophisticated 
entities, are very eager and ready to begin trading on SEFs; other 
market participants will require more time to prepare themselves for 
SEF trading. The same is true with regard to the ``readiness'' of 
different products for SEF trading. The volume and liquidity of what 
are viewed as ``plain vanilla'' interest rate swaps, credit default and 
currency swaps make them prime candidates for early movement to SEF 
trading; but other products will take more time. The CFTC and SEC are 
currently engaged in the process of determining how to properly phase 
in participants and products as part of their effort to effectively 
sequence the implementation of the range of Dodd-Frank regulations and 
we believe the relative ``readiness'' of market participants and 
products ought to play a significant role in that phasing/sequencing 
determination.
    It is also worth noting however that if ``readiness'' is viewed in 
the context of capability to conduct the type of electronic trading 
envisioned for SEFs, Bloomberg in specific and the financial industry 
in general are very ready to commence SEF trading. The volume of 
electronic trading over the past decade has been enormous and the 
infrastructure to create the connectivity for SEF trading certainly 
exists. We have witnessed ever increasing migration of trading to a 
variety of electronic trading formats. Bloomberg itself has witnessed 
an accelerated use of our electronic platforms since the passage of 
Dodd-Frank a year ago. That said, SEF-style trading which entails 
multilateral trading and direct routing to clearinghouses remains rare 
since most current OTC swaps trading is bilateral and not submitted for 
clearing.
    We further note that if ``readiness'' is viewed from the 
perspective of the state of the legal framework for the clearing and 
increased transparency imposed by Dodd-Frank for SEF trading, there is 
considerable work still ahead for the industry. Clearing and 
transparency are certainly priority objectives of Dodd-Frank's SEF 
regime as means to mitigate systemic risk, but those rules have not yet 
been articulated in final form by the CFTC and SEC. We expect those 
rules, once promulgated in final form, will be novel in many ways and 
costly, and it will take time for market participants to do all the 
things necessary to accommodate those rules in terms of legal 
documentation, installation of technology, and other critical 
responses. With regard to documentation alone, there is a significant 
number of necessary items that will require time for negotiation 
between interested parties and for careful drafting by lawyers. \3\ 
Ultimately, how much swaps trading moves to SEF platforms will be 
influenced by the complexity of the agencies' final rules and the cost 
of those rules for clearing, documentation, reporting and the like that 
must be borne by SEFs and their customers. The objective of those rules 
should be to minimize their cost and complexity in order to incentivize 
optimal movement of swaps trading to properly regulated SEF platforms 
and to minimize avoidance of those newly regulated SEF platforms.
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     \3\ While not an exhaustive list, the large and complex range of 
documents that need to be negotiated and drafted include: derivative 
clearing organization agreements, swaps data repository agreements and 
protocols, platform participant agreements and end user agreements, 
independent service vendor agreements, and information sharing 
agreements with corresponding SEFs and Designated Contract Markets 
trading swaps to effectuate compliance relating to position limits and 
manipulation issues. In addition, SEFs will have to draft participant 
rulebooks, compliance manuals, connectivity agreements, antimoney 
laundering documentation, and numerous other vital documents.
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Question 2: How do you expect the open access requirements for 
        clearinghouses to impact the development of SEFs? Are there any 
        obstacles to clearinghouses meeting this open and 
        nondiscriminatory access requirement?
    Bloomberg has been successful in securing access to various 
clearinghouses for its existing OTC trading platforms. While mandatory 
swaps clearing as envisioned by Dodd-Frank is not completely worked out 
in all regards, we are cautiously optimistic that in a reasonable time 
we will have no significant problems with clearing for trades on our 
registered SEF platforms. We believe that our connectivity to a range 
of clearinghouses will provide end users a desirable choice in where to 
clear their swaps, which effectuates one of the objectives of Dodd-
Frank which was to empower end users in that regard. It should be 
emphasized however that the cost and uncertainty of the rules on 
clearing swaps under the Dodd-Frank regime could be impediments to the 
proliferation of SEFs.
Question 3: What regulatory and market-based incentives can facilitate 
        the development and success of SEFs?
    Bloomberg believes that the Federal regulatory agencies should 
focus on creating well-articulated rules for clearing and post-trade 
market transparency, and to the maximum extent possible allow SEFs 
flexibility in fashioning their own trading protocols. In our judgment 
the most important incentive that can facilitate the development and 
success of SEFs is to give the SEFs significant latitude on the trading 
protocols they use. Maximizing the flexibility for SEFs to devise and 
implement their trading protocols will encourage innovation, 
competition and market responsiveness. In contrast, prescribing trading 
protocols by regulation will inhibit attainment of those public policy 
objectives and decrease overall SEF participation and market liquidity. 
It is noteworthy that the swaps market evolved to give swaps users 
highly customizable products that allowed them to meet specific 
investment objectives. Losing that tradition of flexibility to overly 
constrictive trading requirements would be destructive to the goal of 
encouraging a vibrant, competitive, and innovative SEF market.
Question 4: Do any barriers currently exist in the derivatives market 
        that would inhibit the entrance of additional SEFs into the 
        marketplace? Are there ways to mitigate those barriers, and how 
        would those changes impact the derivatives market?
    Given the technology afforded by the Internet and connectivity, 
technological barriers to entry are relatively low. However, we do 
perceive several elements of the Dodd-Frank regime that could create 
barriers to entry in terms of increased risk and cost for entities 
considering registering as SEFs.
            Micromanagement and Overregulation of Trading Protocols
    Central clearing ensures that there is sufficient capacity for the 
market to absorb losses within its own structure and trade reporting 
promotes price transparency which ensures price fairness. Both of these 
elements of Dodd Frank are beneficial to the market and ultimately to 
the individual investor and taxpayer. But trying to regulate with 
specificity the trading protocols may discourage the use of SEFs, and 
undermine the benefits that Dodd-Frank was designed to deliver through 
SEFs by reintroducing risk and removing liquidity. For example, 
mandating the use of a central limit order book would encourage the 
style of algorithmic and speculative trading that were at the center of 
the equities flash crash in 2010. Such an event would not be possible 
with today's fixed income trading structure.
    Similarly, mandating the number of dealers that can participate in 
an RFQ may actually create liquidity risk because investors will only 
be able to trade if there are the mandated minimum number of market 
participants available. The proposed minimum requirement of having 5 
respondent dealers for a SEF's RFQ platform reduces the end user's 
ability to achieve best execution because they will be forced to 
advertise their activities to a broader set of market participants than 
they may want. This problem is particularly acute with regard to block 
trades. The same can be said of imposing mandatory protocols that would 
require a block trade to interact with any resting interests on a SEF.
    Liquidity providers responding to a block trade RFQ need to factor 
in the size of the trade when quoting a price. Imposing a trading 
protocol that could materially alter the size of a block trade would 
inject uncertainty for the liquidity provider responding to an RFQ. 
Rather, liquidity providers should be given the option of interacting 
with resting bids (i.e., standing bids posted on platforms without 
reference to any particular RFQ) if it is consistent with their trading 
strategy and best execution, and SEFs should be allowed to offer that 
flexibility to the market. \4\ Similarly, liquidity seekers tend to 
vary their strategies as to the number of liquidity providers they 
include in an RFQ. Their strategies typically depend on the particular 
instrument (and its relative liquidity), the direction (long or short), 
and the size of the transaction they are seeking to execute. Liquidity 
seekers should have the flexibility in any given transaction to 
identify the optimal number of liquidity providers from which to seek 
bids.
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     \4\ So too, forcing a minimum number of dealers into the RFQ 
process will likely increase cost with no compensating offset or 
benefit. We observe that the SEC's proposed SBSEF rules do not mandate 
transmission of an RFQ to a minimum or maximum number of liquidity 
providers.
---------------------------------------------------------------------------
    Nor should SEFs be limited to one model or methodology in 
disseminating composite indicative quotes to the market. Developing a 
meaningful composite is a complex process involving intricate 
proprietary algorithms and each SEF has a compelling reason to develop 
a composite indicative quote that represents the most accurate 
reflection of the markets that meets participant needs and expectations 
for accuracy. A SEF that offers a composite that is consistently 
``away'' from the actual market will quickly be disciplined and 
marginalized by participants' disuse of that SEF.
    There are other examples of the wisdom and value of allowing SEFs 
flexibility at the trading protocol level but the above illustrations 
convey the point that overly prescriptive mandates in this area are 
both unnecessary to the desirable functioning of SEFs and will 
effectively create barriers to SEFs coming into the market.
            Cost of Compliance
    The greatest current cost of compliance lies in the different rules 
promulgated by the CFTC and SEC. While Dodd-Frank requires these two 
agencies to coordinate their approach, it remains to be seen whether 
they will sufficiently do so in their respective final regulations. If 
they fail to do so, the result will be that to operate as both a SEF 
and a SB-SEF an entity will be compelled to create two separate 
companies to trade what in essence are the same type instruments. This 
not only affects each potential SEF and SBSEF but also their clients, 
many of whom use the same individual traders to trade both instruments 
types. The effective doubling of costs due to the inability of the two 
regulatory bodies to sufficiently coordinate their rules would not only 
be regrettable but creates a barrier to entry for the independent firms 
wishing to become SEFs and SBSEFs. It is fair to ask whether that may 
only auger concentration in the SEF space and a ``too-big-to-fail'' 
situation for the remaining SEF's in the marketplace, which is exactly 
the opposite of what Congress intended when they included the idea of 
SEFs in Dodd-Frank.
    The creation of a complex set of overly detailed rules to manage 
trading protocols within the SEF market will generate significant 
regulatory compliance costs for SEFs which will have to be borne 
ultimately by the end users of the SEF platforms. Such costs can be 
mitigated by allowing the SEFs maximum flexibility to create their own 
trading protocols.
    Costs can further be reduced by providing a robust opportunity for 
SEFs to contract with third party service providers for such things as 
market surveillance, trade practice surveillance, real-time market 
monitoring, investigations of possible rule violations and disciplinary 
actions. In contracting for such services--while maintaining Dodd-
Frank's requirement that SEFs retain full, ultimate responsibility for 
decision making involving those functions--SEFs can avoid the capital 
and operational costs of creating the infrastructure of those functions 
for themselves internally and thereby reduce both the cost of entry 
into the SEF market and the cost of ongoing SEF operations.
    Beyond being allowed to use the expertise of third party service 
providers, SEFs also should be permitted to rely on the regulation and 
oversight of market participants and swap products by swaps 
clearinghouses rather than have to replicate essentially the same 
activity at the SEF level. For example, if a clearinghouse accepts a 
market participant for clearing purposes or accepts a swap for 
clearing, the SEF should be permitted to rely on that assessment for 
Core Principle compliance purposes regarding its obligation to 
establish that the market participant is an eligible swap participant 
or that the swap is not susceptible of manipulation under the SEF 
regulatory regime.
            Governance Constrictions
    Dodd-Frank requires the agencies to minimize opportunity for 
conflicts of interest in the governance of SEFs which would allow 
anticompetitive behavior injurious to other market participants. Both 
the CFTC and SEC have proposed regimes for mitigating conflicts of 
interests through ownership limitations and structural governance 
requirements. These rules were written to address risks arising from a 
situation where a SEF would be owned and controlled by other market 
participants who would be tempted to set SEF policy to advance their 
own interests and to the detriment of other market participants and the 
market in general.
    Requiring all SEFs to meet these ownership and governance 
constrictions is a serious and unnecessary barrier to entry in the case 
of SEFs whose ownership structure does not present the risks that Dodd-
Frank's conflict of interest provisions were intended to prevent. \5\ 
Bloomberg is an independently owned entity, meaning that other market 
participants do not have an ownership interest in the company. We are 
not beholden to either buy side or sell side interests. There is no 
public policy purpose in requiring Bloomberg or any other an 
independently owned firm to jump through unnecessary hoops and contort 
its governance to prescribed forms designed to prevent conflicts of 
interest risks that demonstrably do not exist due to their independent 
ownership structure and business model. We believe that where a SEF is 
not owned by its customer-members or other market participants and 
where the SEF can demonstrate a sufficient mitigation of legitimate 
potential conflicts of interests the agencies should permit that SEF an 
exemption from the governance restrictions which were designed to 
redress conflicts arising from cases where market participants own and 
control the SEF. Such an exemption would mitigate prospects that the 
governance rules would serve as an unproductive barrier to entry for 
independently owned SEFs who can bring to the market the competition 
that Dodd-Frank sought to generate in swaps trading.
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     \5\ While SEC has suggested they may require universal compliance 
with these conflict/governance rules even for independent entities, 
that view is not required by Dodd-Frank, nor is that interpretation a 
requirement written into the CFTC's proposed rules. Beside being 
irrational because independent entities do not present the governance 
conflict risks the rules were designed to address, applying those rules 
would add unnecessary cost to independent entities operations without 
any countervailing public policy benefit.
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            Extraterritoriality and International Harmonization
    The swaps marketplace is a global business. A large percentage of 
transactions on Bloomberg's swap platforms involve non-U.S. banks and 
other foreign institutions. An entity seeking to register as a SEF 
desires to have consistent standards applicable to both SEFs and market 
participants across different jurisdictions. Without such coordination 
a SEF may be put in the untenable position of enforcing rules against 
certain participants that are inconsistent, or worse, conflicting with 
foreign rules. Moreover, without harmonized and consistent standards a 
SEF could be required to have one set of rules for U.S. participants 
and another set of rules for non-U.S. participants, with a further set 
of transaction-level rules based on the counterparties or underlying 
instruments. The resulting legal uncertainty associated with an uneven 
playing field and regulatory arbitrage can be a significant 
disincentive to becoming a SEF, to maximizing a SEF's availability to 
market participants, or to the scope of the products offered for 
trading on the SEF.
Question 5: How do you expect the SEF marketplace to develop over time? 
        How many SEFs would you imagine operating in the United States 
        and around the world 5, 10, and 20 years after full 
        implementation of the derivatives title?
    The existence of multiple SEFs will at least initially be a 
function of asset classes (credit, interest rates, currencies, 
commodities, equities) and market function (liquidity seekers versus 
liquidity providers). Initially, one can fairly assume that there may 
well be a larger number of SEFs in each asset class and market 
function, which over time may yield to consolidation based on the 
gravitation of the pool of liquidity to certain SEFs based on their 
superior performance and their more favorable system functionality.
    Having said that, predicting the number of SEFs globally is 
complicated by the fact that outside the U.S. there are no specific 
regimes to regulate swaps as SEFs are envisioned by Dodd-Frank. It can 
be said that in terms of U.S.-registered SEFs, the number of SEFs will 
be inversely proportional to the number and strength of barriers to 
entry. In this regard, the problem we foresee with unnecessary and 
unwise limitations on the flexibility of SEFs to determine their own 
trading protocols will be paramount. To the extent that SEFs are 
homogenous, required to fit a specific ``one size fits all'' regime on 
trading protocols, they will increasingly resemble cookie cutter 
utilities, providing less innovation and responsiveness to market 
participants' evolving needs for those SEFs in the market and less 
incentive for new SEFs to enter the market to compete with incumbent 
SEFs. But the more flexible SEFs can be with their trading protocols 
the more incentive there will be for all SEFs to distinguish themselves 
with innovation, vigorous competition and increasingly more cost 
effective functionality for the market--all of which enhances the 
incentive for SEFs to come into the market in greater numbers.
Question 6: What policy considerations, if any, should Congress or the 
        regulators consider in order to better support the successful 
        development of SEFs?
    The key public policy element we would suggest to Congress and the 
Federal regulators to better support successful development of SEFs 
relates to flexibility of trading protocols. There is little 
disagreement that clearing and transparency are good for the market and 
will reduce systemic risk created by large concentrations of derivative 
positions. However, overly prescriptive methods of execution threaten 
market liquidity and create risks of unintended adverse consequences 
such as incentivizing trading that avoids SEFs (dark pools) and flight 
to less regulated foreign markets. Enabling SEFs to rely on aspects of 
the DCO compliance regime that would otherwise replicate compliance 
obligations imposed on SEFs would reduce SEF costs and incentivize SEFs 
to focus productively on their trading protocols which will maximize 
innovation, competition and market responsiveness.
Conclusion
    SEFs represent a very valuable opportunity to achieve the reduction 
of systemic risk and transparency objectives of Dodd-Frank. Overly 
constrictive swaps trading rules will seriously diminish the 
contribution that SEFs can make to achieving those laudable public 
policy objectives. It is imperative, especially at the outset of the 
Dodd-Frank regime, that the regulations pertaining to SEFs do not 
mitigate the promise SEFs represent to achieve those legislative 
objectives which will keep the U.S. markets at the vanguard of 
international finance. In our view, this means the Federal regulators 
should not approach regulation of trade execution protocols from the 
same conceptual perspective as may be required for clearing and post-
trade transparency. SEFs need operational flexibility at the trade 
execution level and without it one should not expect a robust emergence 
of SEFs or the ongoing innovation, competition and customer 
responsiveness they can bring to the market.
    On behalf of Bloomberg, I want to extend my appreciation for having 
this opportunity to appear before the Subcommittee to express our 
views. We are happy to be of further assistance to you as you continue 
your deliberations on these extremely important issues.
                                 ______
                                 
                   PREPARED STATEMENT OF JAMES CAWLEY
            Chief Executive Officer, Javelin Capital Markets
                             June 29, 2011
    Chairman Reed, Ranking Member Crapo, and Members of the 
Subcommittee, my name is James Cawley. I am Chief Executive Officer of 
Javelin Capital Markets, an electronic execution venue of OTC 
derivatives that will register as a SEF (or ``Swaps Execution 
Facility'') under the Dodd Frank Act.
    I am also here to represent the interests of the Swaps & 
Derivatives Market Association or ``SDMA,'' which is comprised of 
several independent derivatives dealers and clearing brokers, some of 
whom are the largest in the world.
    Thank you for inviting me to testify today.
    Without a doubt, it is mission critical that central clearing, 
increased transparency, and broader liquidity is properly achieved 
under the Dodd-Frank Act for the OTC derivative markets. Toward that 
goal, it is important that SEFs be allowed to properly function and 
compete with each other whereby Congress and the Regulators ensure that 
such organizations and their various execution models be neither 
discriminated against, nor be penalized by trade workflow or 
documentation efforts that show preference for one SEF over another.
    Only by access to a fair, level, and open playing field, will SEFs 
be properly able to play their part in the lessening of systemic risk, 
to which the derivative marketplace contributed during the global 
financial crisis of 2008.
Product Eligibility and Open Access
    With regard to product eligibility to clearing, clearinghouses 
should recognize that the fair majority of interest rate and credit 
derivative products do qualify for clearing.
    Regulators should be mindful to ensure that clearinghouses do not 
favor acceptance of certain products that have built in trade 
restrictions that impede open access or customer choice.
    While intellectual property rights may protect innovation in the 
short term, with regard to certain swap products or indices, they may 
restrict trade and liquidity in the long term. Market participants 
should be allowed to trade such products to meet their investor or 
hedging objectives. Intellectual property rights for such products 
should adapt with the post Dodd-Frank market place where anonymous and 
transparent markets flourish.
    Regulators should work with these IP holders to both ensure that 
their rights are properly protected, and the prudential need of the 
broader market is also protected.
Open Access to Clearinghouses
    With regard to SEF access to clearinghouses, clearinghouses and 
their constituent clearing members should do as the act requires--
accept trades on an ``execution blind'' basis. DCOs should not 
discriminate against trades simply because they or they shareholders 
dislike the method in which such trades occur.
    Clearinghouses should refrain from using their SEF sign-up 
documentation as a vehicle to restrict trade. As a precondition to 
access, clearinghouses should not require that SEFs sign ``noncompete'' 
clauses, such that a clearinghouse's other businesses--be it execution 
based or not--are inappropriately protected from outside competition.
    Likewise clearing firms should not require that SEF's contract with 
them to restrict the rights or privileges of end users, as a 
precondition to SEF-clearinghouse connectivity. Such requirements serve 
no prudential role with regard to risk mitigation and run contrary to 
the open access provisions of the Dodd-Frank Act.
Real Time Trade Acceptance
    Clearinghouses should not require that a SEF purposefully engage in 
a trade workflow that adds latency or creates unnecessary steps in the 
settlement process.
    Instead, clearinghouses and their constituent clearing firms should 
draw from their own proven and well tested experience in listed 
derivatives. They should accept trades symmetrically and in ``real 
time.''
    Immediate acceptance of swaps trades into clearing is critical to 
accomplishing the goals of the Dodd-Frank Act to reduce systemic risk, 
increase trade integrity, and promote market stability.
    Settlement uncertainty, caused by time delays between the point of 
trade execution and the point of trade acceptance into clearing, can 
destroy investor confidence in the cleared OTC derivatives markets.
    As the CFTC has correctly asserted such a time delay or ``trade 
latency,'' (which in the bilateral swaps markets can be as long as a 
week) directly constrains liquidity, financial certainty, and increases 
risk. \1\
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     \1\ P. 13101. (Federal Register, Volume 76, No. 47, 3/10/11).
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    Clearinghouses and their clearing members should do as the 
regulators have required, accept trades into clearing immediately upon 
execution on a SEF.
Execution Documentation Efforts
    Regulators should be wary of certain incumbent efforts that claim 
to bring execution certainty through documentation. Such documentation 
sets in place workflow that clearly favors RFQ (Request for Quote) 
execution models over exchange like central limit order books.
    Such documentation denies the customer the right to trade 
anonymously with multiple counterparties, because under such a 
workflow, the dealer counterparty requires the identity of the customer 
be known before a trade occurs.
    This is not the case with documentation and workflow requirements 
in the cleared derivatives markets of futures and options. In those 
markets, buyers and sellers trade in multiple trade venues where trade 
integrity, counterparty anonymity and optimal liquidity is assured 
through access to multiple counterparties.
    Such restrictive workflow and documentation should be seen for what 
it is--nothing more than a transparent attempt to limit customer 
choice, restrict trade, and drain liquidity.
Conclusion
    In conclusion, the role of the Swap Execution Facility with regard 
to lessening systemic risk should not be understated.
    To fulfill the SEF's role in fostering greater liquidity and 
transparency, Congress and the regulators should continue to be 
proactive and protect the market against Dodd-Frank implementation 
``chokepoints.'' They should continue to ensure that all SEFs have fair 
and open access to clearing and the marketplace.
                                 ______
                                 
                   PREPARED STATEMENT OF WILLIAM THUM
   Principal and Senior Derivatives Counsel, The Vanguard Group, Inc.
                             June 29, 2011
    Chairman Reed, Ranking Member Crapo, and Members of the 
Subcommittee, thank you for having me here today. My name is William 
Thum and I am a Principal and Senior Derivatives Counsel at Vanguard.
    Headquartered in Valley Forge, Pennsylvania, Vanguard is one of the 
world's largest mutual fund firms. We offer more than 170 U.S. mutual 
funds with combined assets of approximately $1.7 trillion. We serve 
nearly 10 million shareholders including American retirees, workers, 
families, and businesses whose objectives include saving for 
retirement, for children's education, or for a downpayment on a house 
or a car.
    Vanguard's mutual funds are subject to a comprehensive regulatory 
regime and are regulated under four Federal securities laws. As a part 
of the prudent management of our mutual funds, we enter into swaps to 
achieve a number of benefits for our shareholders including hedging 
portfolio risk, lowering transaction costs, and achieving more 
favorable execution compared to traditional investments.
    Vanguard has been supportive of the Dodd-Frank Act's mandate to 
bring regulation to the derivatives markets to identify and mitigate 
potential sources of systemic risk.
    Vanguard supports a phased implementation schedule over an 18- to 
24-month period following rule finalization based on the following 
objectives:

    prioritizing risk reduction over changes to trading 
        practices and market transparency;

    prioritizing data reporting to inform future rulemaking 
        related to trading practices and market transparency (to 
        minimize a negative impact on liquidity);

    harmonizing overlapping U.S. and global regulatory efforts; 
        and

    allowing immediate voluntary access for all party types to 
        the new platforms with mandated compliance to apply initially 
        to swap dealers and major swap participants.

    In view of the time needed to digest the final rules and develop 
industry infrastructure; to implement complex operational connections 
required for reporting, clearing, and exchange trading; to educate 
clients on the changes and obtain their consent to trade in the new 
paradigm; and to negotiate new trading agreements across all trading 
relationships, Vanguard supports the following implementation schedule:

    6 months from final rules: Swap Data Repositories, 
        Derivatives Clearing Organizations, SEFs, and middleware 
        providers must complete the build-out of their respective 
        infrastructures.

    6 to 12 months from final rules: All participants should 
        voluntarily engage in reporting, clearing, and trading 
        platforms.

    12 months from final rules: All participants should be 
        mandated to report all swaps involving all parties. Dealers and 
        major swap participants should be mandated to clear the first 
        list of ``standardized swaps.''

    18 months from final rules: All participants should be 
        mandated to clear the first list of ``standardized swaps.'' 
        SEFs and Commissions can analyze SDR swap data for liquidity 
        across trade types to make informed SEF trading mandates, block 
        trade size and reporting delays. Dealers and major swap 
        participants should be mandated to trade the first list of 
        ``standardized swaps'' ``made available for trading'' on SEFs.

    2 years from final rules: All participants should be 
        mandated to trade the first list of ``standardized swaps'' 
        ``made available for trading'' on SEFs with delayed public 
        reporting of block trades based on historical relative 
        liquidity.

    The need for a phased implementation schedule is supported by 
recent studies which have identified significant differences in 
liquidity between the swaps and futures markets. While futures trading 
is characterized by high volumes of a limited range of trade types of 
small sizes and limited duration, the swaps market has an almost 
unlimited range of trade types of much larger sizes with a much longer 
duration. Swaps liquidity varies dramatically with high liquidity for 
2-year U.S. dollar interest rate swaps, and much smaller liquidity in 
credit default swaps on emerging market corporate entities.
    The potential negative consequences related to liquidity are best 
demonstrated by the impact of the premature public reporting of large-
sized block trades. When quoting a price for a block trade, dealers 
typically charge a slight premium to the then current market price for 
a similar trade of a more liquid size. Once the block trade is 
executed, the Swap Dealer executes one or more liquid-sized mirror 
trades at current market prices to lay-off its position and to flatten 
its market exposure.
    The premature public dissemination of block trade details will 
provide the market with advance knowledge of the dealer's imminent 
trading and is therefore likely to move the market against the dealer. 
Fund investors will ultimately have to bear either the increased price 
of relevant trades, or the increased costs of establishing positions 
using multiple trades of liquid sizes.
    The CFTC's proposed test for block trade size, and the CFTC and 
SEC's proposed time delay for the public dissemination of block trade 
data are too conservative and are likely to have a serious negative 
impact on liquidity. Particularly as such proposals address market 
transparency and not market risk, the more prudent approach would be to 
make informed decisions based on a thorough analysis of market data 
with larger block trade sizes and more prompt public reporting for the 
most liquid products and smaller sizes and delayed reporting for less 
liquid products.
    In addition to the need for SDRs, DCOs, and SEFs to establish fully 
functional platforms, the central clearing of derivatives will require 
the negotiation (and possibly renegotiation) of all existing master 
trading agreements to establish the required clearing relationships for 
swaps. While ISDA and the Futures Industry Association are working on a 
standard form of addendum for cleared swaps to add to parties' futures 
agreements, as there is no market standard form of futures agreement, 
and existing futures agreements may not address a number of key 
business issues related to the clearing of swaps, the futures agreement 
itself is likely to require significant renegotiation.
    Even if the larger market participants can promptly work through 
the process with dealers, many smaller participants could effectively 
be cut out of the swaps market altogether if the documentation process 
is not completed ahead of the clearing deadline.
    There are a number of other significant issues related to the SEF 
trading mandates proposed by each of the CFTC and SEC which I am happy 
to discuss in the question and answer period. Such issues include the 
CFTC's proposed requirement for ``Requests for Quotes'' to be 
distributed to a minimum of 5 dealers, the CFTC's and SEC's mandate for 
participants to ``take into account'' or to ``interact with'' other 
resting bids and offers (including indicative bids and offers), the 
CFTC's requirement for there to be a ``15 second delay'' involving 
crossing trades, and the need for harmonization across the CFTC and SEC 
rulemaking to avoid unnecessary complexities.
    Thank you for this opportunity to share our views with the 
Subcommittee and we will be pleased to serve as a resource for the 
Members with respect to the swaps rulemaking exercise.
                                 ______
                                 
                  PREPARED STATEMENT OF STEPHEN MERKEL
    Executive Vice President and General Counsel, BGC Partners, Inc.
                             June 29, 2011
    Chairman Reed, Ranking Member Corker, and Members of the 
Subcommittee, thank you for providing this opportunity to participate 
in today's hearing.
    My name is Stephen Merkel. I am the Executive Vice President, 
General Counsel, and Secretary for BGC Partners, a leading global 
interdealer broker of over the counter financial products. \1\ BGC 
Partners was created in August 2004, when Cantor Fitzgerald separated 
its interdealer brokerage business to create BGC Partners. We are a 
leading global intermediary to the wholesale financial markets, 
specializing in the brokering of a broad range of financial products 
including fixed income, rates, foreign exchange, equities, equity 
derivatives, credit derivatives, futures, and structured product 
markets.
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     \1\ BGC Partners, Inc. (NASDAQ: BGCP) (www.bgcpartners.com) is a 
leading global intermediary to the wholesale financial markets, 
specializing in the brokering of a broad range of financial products 
including fixed income, rates, foreign exchange, equities, equity 
derivatives, credit derivatives, futures, and structured product 
markets. BGC offers a full range of brokerage services including price 
discovery, trade execution, straight through processing and clearing, 
settlement and access to electronic trading services through its 
eSpeed, BGC Trader and BGC Pro brands. On April 1, 2008, BGC merged 
with eSpeed to form a world-class provider of voice and electronic 
brokerage services in the global marketplace. The combined company is 
BGC Partners, Inc. Since its separation from Cantor Fitzgerald in 2004, 
BGC has expanded to 24 offices worldwide with over 1,700 brokers and 
approximately 2,700 employees. In 2005, BGC merged with Maxcor 
Financial Group, integrating two leading brokerage firms. This was 
followed by the acquisitions of ETC Pollak and Aurel in Paris.
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    I am testifying today in my capacity as the Chairman of the 
Wholesale Markets Brokers' Association, Americas (the ``WMBAA''), an 
independent industry body whose membership includes the largest North 
American interdealer brokers: my firm, BGC Partners, as well as GFI 
Group, ICAP, Tradition and Tullett-Prebon. \2\
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     \2\ The WMBAA is an independent industry body representing the 
largest interdealer brokers operating in the North American wholesale 
markets across a broad range of financial products. The WMBAA and its 
member firms have developed a set of Principles for Enhancing the 
Safety and Soundness of the Wholesale, Over-The-Counter Markets. Using 
these Principles as a guide, the WMBAA seeks to work with Congress, 
regulators, and key public policy makers on future regulation and 
oversight of institutional markets and their participants. By working 
with regulators to make wholesale markets more efficient, robust, and 
transparent, the WMBAA sees a major opportunity to assist in the 
monitoring and consequent reduction of systemic risk in the country's 
capital markets. The five founding members of the WMBAA are BGC 
Partners; GFI Group; ICAP; Tradition, and Tullett-Prebon. More about 
the WMBAA can be found at: www.WMBAA.org.
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    I welcome this opportunity to discuss with you the emergence of 
swap execution facilities (SEFs) under the Dodd-Frank Wall Street 
Reform and Consumer Protection Act (``Dodd-Frank'' or ``DFA''). I hope 
to share the perspective of the primary intermediaries of over-the-
counter (OTC) swaps operating today, both here in the United States and 
across the globe.
    In my written testimony, I plan to cover the following points:

    Readiness. In terms of readiness, BGC and its fellow WMBAA 
        member firms are currently fully functional as market 
        intermediaries in the OTC derivatives markets and will be ready 
        to initiate SEF operations on day one. Wholesale brokers are 
        today's central marketplaces in the global swaps markets and, 
        as such, can serve as a prototype for prospective independent 
        and competitive SEFs.

    Voice and electronic modes of trade execution. Wholesale 
        brokers are experts in fostering liquidity and transparency in 
        global swaps markets by utilizing trade execution methodologies 
        that feature a hybrid blend of knowledgeable and qualified 
        brokers, as well as sophisticated electronic technology. The 
        CFTC's proposed rules are inconsistent with the statute in the 
        way that they limit how trades are executed, most particularly 
        in how they limit trades that occur utilizing voice or 
        telephonic communication. Such a limitation is inconsistent 
        with the statute's clear language that ensures that SEFs can 
        utilize ``any means of interstate commerce.'' The SEC's 
        proposed rule is much more flexible and consistent with the 
        statute.

    Block trade size and preserving liquidity and anonymity in 
        the market. Liquidity in today's swaps markets is fundamentally 
        different than liquidity in futures and equities markets, and 
        the unique characteristics of this liquidity are what naturally 
        determine the optimal mode of market transparency and trade 
        execution. The CFTC's proposal could jeopardize liquidity in 
        the markets by relying on inappropriate factors to determine a 
        block trade. This would harm the ability of investors to manage 
        large positions, impact the ability of counterparties to engage 
        in anonymous price discovery and, ultimately, increase the cost 
        of risk management to end users. The definition of block trade 
        must be based on hard market data to minimize unintended 
        negative consequences.

    Competition. It is vital that the rules be consistent with 
        the clear and unambiguous provisions in the statute ensuring 
        that clearinghouses provide SEFs ``nondiscriminatory access'' 
        to clearing. To be consistent with the statute this must 
        include direct and indirect actions that not only inhibit 
        access to clearing, but also actions that would bundle the 
        services of a clearinghouse that operates an execution facility 
        (exchange or SEF), thereby providing favorable treatment to 
        their own affiliates over their independent competitors. 
        Another form of discrimination includes treating differently 
        SEF traded contracts and those traded on exchanges in 
        liquidation. The CFTC's proposed rule needs to be changed to 
        ensure that in liquidation there is identical treatment of the 
        cleared contract regardless of the venue it traded.
Essential Elements That Regulators Need To Get Right Under Title VII
    The final regulations enacted by the Commodity Futures 
        Trading Commission (``CFTC'' or ``Commission'') and Securities 
        and Exchange Commission (``SEC'' or ``Commission'' and, 
        together with the CFTC, the ``Commissions'') must be consistent 
        with the plain language of Dodd-Frank and allow for multimodes 
        of execution as Congress intended. SEFs must not be restricted 
        from deploying the many varied and beneficial trade execution 
        methodologies and technologies successfully used today to 
        execute swaps transactions.

    There must be harmonization between the CFTC and SEC, as 
        well as consistency in international regulation.

    New regulations must be phased-in appropriately to prevent 
        unnecessary disruption to the markets.

    Regulators must use a flexible approach to SEF 
        registration, permitted modes of trade execution and impartial 
        access. Regulations should support the formation of a common 
        regulatory organization (CRO) for SEFs to implement and 
        facilitate compliance with the Commissions' rules. The CRO 
        would ensure that a single, consistent standard is applied 
        across multiple SEFs and prevent a ``race to the bottom'' for 
        rule compliance and enforcement programs.
Background on Wholesale Brokers
    In terms of actual operations, WMBAA members provide a marketplace 
for a relatively small number of sophisticated institutional buyers and 
sellers of OTC financial products where their trading needs can be 
matched with other sophisticated counterparties having reciprocal 
interests in a transparent, yet anonymous, environment. To persons 
unfamiliar with our business, I often describe interdealer brokers as a 
virtual trading floor where large financial institutions buy and sell 
financial products that are not suited to, and therefore rarely traded 
on, an exchange.
    As we sit here today, interdealer brokers are facilitating the 
execution of hundreds of thousands of OTC trades corresponding to an 
average of $5 trillion in notional size across the range of foreign 
exchange, interest rate, U.S. Treasury, credit, equity, and commodity 
asset classes in both cash and derivative instruments. WMBAA member 
firms account for over 90 percent of intermediated swaps transactions 
taking place around the world today.
    Wholesale brokers provide highly specialized trade execution 
services, combining teams of traditional ``voice'' brokers with 
sophisticated electronic trading and matching systems. As in virtually 
every sector of the financial services industry in existence over the 
past 50 years, wholesale brokers and their dealer clients began 
connecting with their customers by telephone. As technologies advanced 
and markets grew larger, more efficient, more diverse and global, these 
systems have advanced to meet the changing needs of the market. Today, 
we refer to this integration of voice brokers with electronic brokerage 
systems as ``hybrid brokerage.'' Wholesale brokers, while providing 
liquidity for markets and creating an open and transparent environment 
for trade execution for their market participants, do not operate as 
single silo and monopolistic ``exchanges.'' Instead, we operate as 
competing execution venues, where wholesale brokers vie with each other 
to win their customers' business through better price, provision of 
superior market information and analysis, deeper liquidity and better 
service. Our customers include large national and money center banks 
and investment banks, major industrial firms, integrated energy and 
major oil companies and utilities.
    Increasingly, the efficiencies of the market have inevitably led to 
a demand for better trading technology. To that end, we develop and 
deploy sophisticated trade execution and support technology that is 
tailored to the unique qualities of each specific market. For example, 
BGC's customers in certain of our more complex, less commoditized 
markets may choose among utilizing our electronic brokerage platforms 
to trade a range of fixed income derivatives, interest rate 
derivatives, foreign exchange options, repurchase agreements and energy 
derivatives entirely on screen. Alternatively, they can execute the 
same transaction through instant messaging devices or over the 
telephone with qualified BGC brokers supported by sophisticated 
electronic technology. It is important to note that the migration of 
certain products to electronic execution was not, and has never been, 
because of a regulatory or legal mandate but simply part of the natural 
evolution and development of greater market efficiencies in particular 
markets. Conversely, the persistence of customer preference for trade 
execution through telephonic communications for certain products, 
despite the apparent efficiencies associated with electronic trading in 
other similar products in the same markets, reflects those customers' 
preference for the unique advantages that ``voice'' brokers can provide 
in liquidity formation with respect to less-liquid or more bespoke 
products.
    The critical point is that competition in the marketplace for 
transaction services has led interdealer brokers to develop highly 
sophisticated transaction services and technologies that are well 
tailored to the unique trading characteristics of the broad range of 
swaps and other financial instruments that trade in the OTC markets 
today. Unlike futures exchanges, we enjoy no execution monopoly over 
the products traded by our customers. Therefore, our success depends on 
making each of our trading methods and systems right for each 
particular market we serve. From decades of competing for the business 
of the worlds' largest financial institutions, we can confirm that 
there is no ``one size fits all'' method of executing swaps 
transactions.
Dodd-Frank Impact on Swaps Market Structure: Clearing and Competing 
        Execution
    Title VII of Dodd-Frank was an earnest and commendable effort by 
Congress to reform certain aspects of the OTC swaps market. The DFA's 
core provisions relating to clearing and trade execution are: (1) 
replacing bilateral trading where feasible with central counterparty 
clearing; and (2) requiring that cleared swaps transactions between 
swaps dealers and major swaps participants be intermediated by 
qualified and regulated trading facilities, including those operating 
under the definition of ``swap execution facilities'' through which 
``multiple participants have the ability to execute or trade swaps by 
accepting bids and offers made by multiple participants in the facility 
or system, through any means of interstate commerce . . . .'' \3\
---------------------------------------------------------------------------
     \3\ See, Commodity Exchange Act (CEA) Section 1a(50).
---------------------------------------------------------------------------
    These two operative provisions seek to limit the current market 
structure where swaps and the underlying counterparty risk may be 
traded directly between counterparties without the use of trading 
intermediaries or clearing and to replace it for most transactions with 
a market structure in which a central clearing facility acts as the 
single counterparty to each market participant (i.e., buyer to each 
seller and seller to each buyer) and where those cleared transactions 
must be traded through SEFs and other intermediaries and not directly 
between the counterparties.
    In enacting these structural changes, DFA wisely rejected the 
anticompetitive, single silo exchange model of the futures industry, in 
which clearing and execution are intertwined, thereby giving the 
exchange an effective execution monopoly over the products that it 
clears. \4\ Rather, by requiring central clearing counterparties to 
provide nondiscriminatory access to unaffiliated execution facilities, 
DFA promotes a market structure in which competing SEFs and exchanges 
will vigorously compete with each other to provide better services at a 
lower cost in order to win the execution business of sophisticated 
market participants. In this regard, DFA preserves the best competitive 
element in the existing swaps landscape: competing wholesale brokers.
---------------------------------------------------------------------------
     \4\ As the Justice Department observed in a 2008 comment letter to 
the Treasury Department, where a central counterparty clearing facility 
is affiliated with an execution exchange (such as in the case of U.S. 
futures), vertical integration has hindered competition in execution 
platforms that would otherwise have been expected to: result in greater 
innovation in exchange systems, lower trading fees, reduced ticket size 
and tighter spreads, leading to increased trading volume and benefits 
to investors. As noted by the Justice Department, ``the control 
exercised by futures exchanges over clearing services . . . has made it 
difficult for exchanges to enter and compete.'' In contrast to futures 
exchanges, equity and options exchanges do not control open interest, 
fungibility, or margin offsets in the clearing process. The absence of 
vertical integration has facilitated head-to-head competition between 
exchanges for equities and options, resulting in low execution fees, 
narrow spreads, and high trading volume. See, Comments of the 
Department of Justice before the Department of the Treasury Review of 
the Regulatory Structure Associated With Financial Institutions, 
January 31, 2008. Available at http://www.justice.gov/atr/public/
comments/229911.html.
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    BGC and the WMBAA members heartily support Dodd-Frank's twin 
requirements of clearing and intermediation. Their advocacy of swaps 
intermediation is fundamental to their business success in fostering 
liquidity, providing price transparency, developing and deploying 
sophisticated trading technology tools and systems and operating 
efficient marketplaces in global markets for swaps and other financial 
products.
Critical Elements To Get Right
    There are many things to get right under DFA. Given that DFA 
requires all clearable trades to be transacted through an intermediary 
(either an exchange or a SEF), it is essential that regulators get the 
following aspects of this new regime right:

  1.  Permit multimodes of swap execution, consistent with 
        Congressional intent.

  2.  Ensure harmonization between agencies and foreign regulators.

  3.  Allow for the appropriate implementation of final rules.

  4.  Utilize a flexible approach to SEF registration, permitted modes 
        of trade execution, and impartial access.

  5.  Recognize the important role a common regulatory organization can 
        play in ensuring the integrity of the SEF industry.
1. Permitted Modes of Execution
    As previously stated, DFA defines SEFs as utilizing ``any means of 
interstate commerce'' to match swaps counterparties. This is an 
appropriate allowance by Congress, as the optimal means of interaction 
in particular swaps' markets varies across the swaps landscape. 
Congress recognized that it was best left to the marketplace to 
determine the best modes of execution for various swaps and, thereby, 
foster technological innovation and development. Congress specifically 
did not choose to impose a federally mandated ``one-size-fits-all'' 
transaction methodology on the regulated swaps market.
    As the swaps market has developed, it has naturally taken on 
different trading, liquidity and counterparty characteristics for its 
many separate markets. For example, in more liquid swaps markets with 
more institutional participants, such as certain U.S. Treasury, foreign 
exchange and energy products, wholesale brokers operate fully 
interactive electronic trading platforms, where counterparties can view 
prices and act directly through a trading screen and also conduct a 
range of pre- and post-trade activities like online price analysis and 
trade confirmation. These electronic capabilities reduce the need for 
actual voice-to-voice participant interaction for certain functions, 
such as negotiation of specific terms, and allow human brokers to focus 
on providing market intelligence and assistance in the execution 
process. And yet, even with such technical capabilities, the blend of 
electronic and voice assisted trading methods still varies for 
different contracts within the same asset class.
    In markets for less commoditized products where liquidity is not 
continuous, BGC Partners and its competitors provide a range of 
liquidity fostering methodologies and technologies. These include 
hybrid modes of: (1) broker work-up methods of broadcasting completed 
trades and attracting others to ``join the trade;'' and (2) auction 
based methods, such as matching and fixing sessions. In other swaps 
markets, brokers conduct operations that are similar to traditional 
``open outcry'' trading pits where qualified brokers communicate bids 
and offers to counterparties in real time through a combination of 
electronic display screens and hundreds of installed, always-open phone 
lines, as well as through other email and instant messaging 
technologies. In every case, the technology and methodology used is 
well calibrated to disseminate customer bids and offers to the widest 
extent and foster the greatest degree of liquidity for the particular 
market.
Permitted Use of Voice and Hybrid Trade Execution Platforms
    The WMBAA feels strongly that the CFTC's proposed rules regarding 
SEFs do not reflect the DFA's requirement that SEF transactions can be 
executed ``through any means of interstate commerce.'' Specifically, in 
restricting the use of voice-based systems for those clearable trades 
that must be executed on a SEF, the CFTC has proposed a more 
restrictive regime than the statute dictates. A rigid implementation of 
the SEF framework will devastate existing voice and ``hybrid'' systems 
that are currently relied upon for liquidity formation in global swaps 
markets. ``Hybrid brokerage,'' which integrates voice with electronic 
brokerage systems, should be clearly recognized as an acceptable mode 
of trade execution for all clearable trades. The combination of 
traditional ``voice'' brokers with sophisticated electronic trading and 
matching systems is necessary to provide liquidity in markets for less 
commoditized products where liquidity is not continuous. Failure to 
unambiguously include such systems is not only inconsistent with Dodd-
Frank but will severely limit liquidity production for a wide array of 
transactions. BGC and our fellow WMBAA members are concerned that such 
a restrictive SEF regime will lead to market disruption and, worse, 
liquidity constriction with adverse consequences for vital U.S. capital 
markets.
    The WMBAA strongly supports the SEC's interpretation of the SEF 
definition as it applies to trade execution through any means of 
interstate commerce, including request for quote systems, order books, 
auction platforms or voice brokerage trading, because such an approach 
is consistent with the letter and spirit of the Dodd-Frank Act and 
ensures flexibility in the permitted modes of execution. The WMBAA 
believes that this approach should be applied consistently to all 
trading systems or platforms and will encourage the growth of a 
competitive marketplace of trade execution facilities.
    What determines which blend of hybrid brokerage is adopted by the 
markets for any given swap product is largely the market liquidity 
characteristic of that product, whether or not the instrument is 
cleared. For example, a contract to trade Henry Hub Natural Gas 
delivered in Summer 2017, though cleared, will generally be 
insufficiently liquid to trade on a central limit order book. This is 
true for many cleared products with delivery dates far in the future, 
where market makers are unwilling to post executable bids and offers in 
instruments that trade infrequently. In markets where price spreads are 
wide or trading is infrequent, central limit order books are not 
conducive to liquidity, but rather may be disruptive to it.
    Critically, what determines which blend of hybrid brokerage is 
adopted by the markets for any given swap product also has little to do 
with whether the size of a transaction is sufficient or not to be 
considered a block trade. Block trades concern the size of an order, as 
opposed to the degree of market liquidity or presence of tight bid-
offer spreads. Depending on where block trade thresholds are set, block 
trades can take place in all markets--from very illiquid markets to 
highly liquid markets. Yet, central limit order book trade execution 
generally only works well in markets with deep liquidity, and such 
liquidity is not always available even within a usually liquid market. 
For less liquid markets, even nonblock size trades depend on a range of 
trading methodologies distinct from central limit order book or request 
for quote systems. For these reasons, hybrid brokerage should be 
clearly recognized as an acceptable mode of trade execution for all 
swaps whether ``required'' or ``permitted.''
    In addition, the regulatory framework for the swaps market must 
take into consideration the significant differences between the trading 
of futures on an existing exchange and the trading of swaps on SEF 
platforms. While it may be appropriate, in certain instances, to look 
to the futures model as instructive, overreliance on that model will 
not achieve Congress' goal. Congress explicitly incorporated a SEF 
alternative to the exchange-trading model, understanding that 
competitive execution platforms provide a valuable market function. 
Final rules governing SEFs should reflect Congressional intent and 
promote the growth of existing competitive, vibrant markets without 
impeding liquidity formation.
    While certain requirements should be mandated during trade 
execution (i.e., audit trail, trade processing, and reporting), 
limitations on methodologies used in trade execution should be 
considered carefully and weighed against potential implications on 
liquidity formation. A rules regime that is overly prescriptive will 
reduce the ability for SEFs to match buyers and sellers and restrict 
trading liquidity, to the detriment of all market participants, 
including end users.
2. Importance of Harmonization Between U.S. Agencies and Foreign 
        Regulators
    While the substance of the proposed requirements for SEF 
registration and core principles are extremely important, it is 
equally, if not more, important that the final regulatory frameworks 
are harmonized between the CFTC and SEC. A failure to achieve 
harmonization will lead to regulatory arbitrage and unreasonably burden 
market participants with redundant compliance requirements. As the 
recent SEC CFTC joint proposed rule recognized, ``a Title VII 
instrument in which the underlying reference of the instrument is a 
``narrow-based security index'' is considered a security-based swap 
subject to regulation by the SEC, whereas a Title VII instrument in 
which the underlying reference of the instrument is a security index 
that is not a narrow-based security index (i.e., the index is broad-
based), the instrument is considered a swap subject to regulation by 
the CFTC.'' \5\
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     \5\ Further Definition of ``Swap,'' ``Security-Based Swap,'' and 
``Security-Based Swap Agreement''; Mixed Swaps; Security-Based Swap 
Agreement Recordkeeping, 76 Fed. Reg. 29,818, 29, 845 (May 23, 2011).
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    Any discrepancy in the Commissions' regulatory regimes will give 
market participants incentive to leverage the slight distinctions 
between these products to benefit from more lenient rules. Dodd-Frank's 
framework was constructed to encourage the growth of a vibrant, 
competitive marketplace of regulated SEFs. Final rules should be 
crafted that encourage the transaction of OTC swaps on these trading 
systems or platforms, as increased SEF trading will increase liquidity 
and transparency for market participants and increase the speed and 
accuracy of trade reporting to swap data repositories (SDRs). Certain 
provisions relate to these points, such as the permitted methods of 
trade execution, the scope of market entities granted impartial access 
to SEFs, the formulation of block trade thresholds and compliance with 
SEF core principles in a flexible manner that best recognizes the 
unique characteristics of competitive OTC swaps markets.
    Based upon the WMBAA's review of both the SEC and the CFTC's 
proposed rules, the Commissions should consider the release of further 
revised proposed rules incorporating comments received for additional 
review and comment by market participants. This exercise would ensure 
that the SEC and CFTC have the opportunity to review each of their 
proposals and integrate appropriate provisions from the proposed rules 
and comments in order to arrive at more comprehensive regulations. 
Further, the CFTC and SEC are encouraged to work together to attempt to 
harmonize their regulatory regimes to the greatest extent possible. 
While some of the rules will differ as a result of the particular 
products subject to each agency's jurisdiction, inconsistent rules will 
make the implementation for SEFs overly burdensome, both in terms of 
time and resources. As an example, the CFTC and the SEC should adopt 
one common application form for the registration process. While 
regulatory review of the application by the two agencies is 
appropriate, reducing the regulatory burden on applicant SEFs to one 
common form would allow for a smoother, timelier transition to the new 
regulatory regime. Because the two proposed registration forms are 
consistent in many respects, the differences between the two proposed 
applications could be easily reconciled to increase regulatory 
harmonization and increase efficiency.
    Similarly, there needs to be a consistent approach with respect to 
block trades. Not only should the threshold calculations be derived 
from similar approaches, allowing for tailored thresholds that reflect 
the trading characteristics of particular products, but the methods of 
trade execution permitted by the Commissions should both be flexible 
and within the framework of the SEF definition. U.S. regulations also 
need to be in harmony with regulations of foreign jurisdictions to 
avoid driving trading liquidity away from U.S. markets toward markets 
offering greater flexibility in modes of trade execution. In 
particular, European regulators have not formally proposed swap 
execution rules with proscriptive limits on trade execution 
methodology. We are not aware of any significant regulatory efforts in 
Europe to mandate electronic execution of cleared swaps by 
institutional market participants.
    In a world of competing regulatory regimes, business naturally 
flows to the marketplace that has the best regulations--not necessarily 
the most lenient, but certainly the ones that have the optimal balance 
of liquidity, execution flexibility and participant protections. U.S. 
regulations need to be in harmony with regulations from foreign 
jurisdictions to avoid driving trading liquidity away from U.S. markets 
toward markets offering greater flexibility in modes of trade 
execution.
3. Implementation of Final Rules
Compliance Timeline
    The timeline for implementation of the final rules is as important 
as, if not more important than, the substance of the regulations. We 
recognize and support the fundamental changes to the regulation of the 
OTC swaps markets resulting from the passage of the Dodd-Frank Act and 
will commit the necessary resources to diligently meet the new 
compliance obligations.
    However, the CFTC and SEC must recognize that these changes are 
significant and will result in considerable changes to the operations 
and complex infrastructure of existing trading systems and platforms. 
It is necessary that any compliance period or registration deadline 
provides sufficient opportunity for existing trade execution systems or 
platforms to modify and test systems, policies and procedures to ensure 
that its operations are in compliance with final rules. It is very 
difficult to determine the amount of time needed to ensure compliance 
with the rules until the final requirements are made available. 
However, providing market participants with an insufficient time frame 
for compliance could harm the efficient functioning of the markets if 
existing entities can no longer operate until they have built the 
requisite platforms to comply with every measure in final rules.
Appropriate ``Phasing'' of Final Rules
    Based upon the plain language of Dodd-Frank, the mandatory trade 
execution requirement will become effective at the time that swaps are 
deemed ``clearable'' by the appropriate Commission. Accepting the 
premise that the mandatory trade execution requirement cannot be 
enforced until there are identified ``clearable'' swaps and swaps are 
``made available for trading,'' the Commissions need to ensure that a 
functioning and competitive marketplace of registered SEFs exists at 
the time the first trade is cleared and made available for trading. As 
such, it is necessary that SEFs be registered with the CFTC or SEC, as 
applicable, and available to execute transactions at the time that 
trades begin to be cleared under the new laws. As stated previously, 
the WMBAA estimates that its members currently account for over 90 
percent of interdealer intermediated swaps transactions taking place 
around the world today. If the SEF registration process is not 
effectively finalized by the time various swaps are deemed clearable, 
there could be serious disruptions in the U.S. swaps markets with 
adverse consequences for broader financial markets.
    Furthermore, requiring absolute compliance with final rules within 
a short time frame is particularly troublesome for likely future SEFs, 
as such a result may provide DCMs or national securities exchanges with 
an unfair advantage in attracting trading volume due to their ability 
to quickly meet the regulatory burdens. Congress distinguished between 
exchanges and SEFs, intending for competitive trade execution to be 
made available on both platforms. Congress also recognized the 
importance of SEFs as distinct from exchanges, noting that a goal of 
Dodd-Frank is to promote the trading of swaps on SEFs. The phasing in 
of final rules for both exchanges and SEFs should be done concurrently 
to ensure that this competitive landscape remains in place under the 
new regulatory regime.
    Not only will implementation of the final rules impact market 
infrastructure, but the timing in which these rules are implemented 
could significantly impact U.S. financial markets. As Commissioner Jill 
Sommers recently remarked before the House Agriculture General Farm 
Commodities and Risk Management Subcommittee, ``a material difference 
in the timing of rule implementation is likely to occur, which may 
shift business overseas as the cost of doing business in the U.S. 
increases and create other opportunities for regulatory arbitrage.'' 
\6\ If the U.S. regulations are implemented before foreign regulators 
have established their intended regulatory framework, it could put U.S. 
markets at a significant disadvantage and might result in depleted 
liquidity due to regulatory arbitrage opportunities.
---------------------------------------------------------------------------
     \6\ Statement of Jill E. Sommers before the Subcommittee on 
General Farm Commodities and Risk Management, House Committee on 
Agriculture, May 25, 2011, available at http://agriculture.house.gov/
pdf/hearings/Sommers110525.pdf.
---------------------------------------------------------------------------
    As the rulemaking process moves forward, we suggest the following 
progression of rules be completed:

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

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

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

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

    Finally, once swaps are deemed clearable, the mandatory 
        trade execution requirement can be put into place for SEFs and 
        DCMs for those products made available for trading. All 
        clearable swaps will be made available for trading by SEFs, as 
        these trade execution platforms compete to create markets and 
        match counterparties. With the trade execution requirement's 
        implementation, it is imperative that rules for SEFs and DCMs 
        are effective at the same time, as implementing either entity's 
        rules prior to the other will result in an unfair advantage for 
        capturing market share of executable trades simply because they 
        could more quickly meet the regulatory burdens.

    Taking adequate time to get the Title VII regulations right will 
expedite the implementation of the worthy goals of Dodd-Frank: central 
counterparty clearing and effective trade execution by regulated 
intermediaries in order to provide end users with more competitive 
pricing, increased transparency and deeper trading liquidity for their 
risk management needs.
4. Flexible Approach to SEF Registration, Impartial Access, and Other 
        Areas of Concern
    We support a flexible approach to evaluating applicant SEFs. As 
noted above, Congress recognized and mandated by law trade execution 
``through any means of interstate commerce,'' establishing a broad 
framework that permits multiple modes of swap execution, so long as the 
proposed mode of execution is capable of satisfying the statutory 
requirements.
    Moreover, any interpretation of the SEF definition must be broad, 
and any trading system or platform that meets the statutory 
requirements should be recognized and registered as a SEF. The new 
regulatory framework should allow any SEF applicant that meets the 
statutory requirements set forth in Dodd-Frank to be permitted to 
operate under each Commission's rules in accordance with Dodd-Frank.
    BGC and the WMBAA strongly support the SEC's interpretation of the 
SEF definition as it applies to trade execution through any means of 
interstate commerce, including request for quote systems, order books, 
auction platforms or voice brokerage trading, because such an approach 
is consistent with the letter and spirit of Dodd-Frank and ensures 
flexibility in the permitted modes of execution. The WMBAA believes 
that this approach should be applied consistently to all trading 
systems or platforms and will encourage the growth of a competitive 
marketplace of trade execution facilities.
    Further, we are concerned with the CFTC's interpretation of the SEF 
definition, as it limits the permitted modes of trade execution, 
specifically restricting the use of voice-based systems to block 
trades. The SEF definition and corresponding requirements in the CEA, 
as amended by the Dodd-Frank Act, do not provide any grounds for this 
approach and will severely impair other markets that rely on voice-
based systems (or hybrid systems, which contain a voice component) to 
create liquidity.
Impartial Access to SEFs
    The WMBAA is concerned that the CFTC's proposed mandate that SEFs 
provide impartial access to independent software vendors (ISVs) is 
beyond the legal authority in the CEA because it expands the impartial 
access provision beyond ``market participants'' to whom access is 
granted under the statute. Moreover, because SEFs are competitive 
execution platforms, a requirement to provide impartial access to 
market information to ISVs who lack the intent to enter into swaps on a 
trading system or platform will reduce the ability for market 
participants to benefit from the competitive landscape that provides 
counterparties with the best possible pricing. Further, given the lack 
of a definition of what constitutes an ISV and the significant 
technological investments made by wholesale brokers to provide premiere 
customer service, the ISV impartial access requirement leaves open the 
possibility that SEFs could qualify as ISVs in order to seek access to 
competitors' trading systems or platforms. This possibility would 
defeat the existing structure of competitive sources of liquidity, to 
the detriment of market participants, including commercial end users.
    The WMBAA also believes the SEC should review its proposed 
impartial access provisions to ensure that impartial access to the SEF 
is different for competitor SEFs or national exchanges than for 
registered security-based swap dealers, major security-based swap 
participants, brokers or eligible contract participants. Congress 
clearly intended for the trade execution landscape after the 
implementation of Dodd-Frank to include multiple competing trade 
execution venues, and ensuring that competitors cannot access a SEF's 
trading system or platform furthers competition, to the benefit of the 
market and all market participants.
Regulations Should Not Favor Execution on Particular Venues
    The WMBAA believes that it is critically important that the 
Commissions' regulations not favor trade execution on exchanges over 
SEFs. An important part of the Dodd-Frank competitive landscape is that 
derivatives clearing organizations (DCOs) accept trades from all 
execution platforms and not advantage certain trading systems or 
platforms over others.
    WBMAA is concerned that certain proposed regulations will frustrate 
the development of a truly competitive landscape. For instance, one of 
the CFTC's proposed rules (proposed Regulation 39.13(g)(2)) would 
require a DCO to use a five-business day liquidation horizon for 
cleared swaps that are not executed on a designated contract market 
(DCM), but would permit a DCO to use a one-business day liquidation 
horizon for all other products that it clears, including swaps that are 
executed on an affiliated DCM.
    The WMBAA believes that this disparity is ill-founded. In the case 
of two economically identical instruments--one executed on a SEF and 
one executed on a DCM--the liquidation horizon for each should depend 
upon liquidity characteristics such as average daily volume, standard 
deviation of average daily volume and open interest. To require a 
longer horizon simply because one of the two is traded on a SEF rather 
than on a DCM is harmful, discriminatory and based upon a flawed 
understanding of market dynamics. More fundamentally, the WMBAA 
believes that this disparity is inconsistent with the provisions of 
Section 2(h)(1)(B) of the Commodity Exchange Act.
    The WMBAA also believes that eliminating the disparity described 
above is consistent with the competitive landscape that Congress 
intended to establish for SEFs and DCMs. Dodd-Frank is designed to 
encourage competition between SEFs and DCMs with respect to the trading 
of swaps, in part by rejecting the ``vertical silo'' model that has 
traditionally been employed in the futures markets.
Interim or Temporary SEF Registration
    The implementation of any interim or temporary registration relief 
must be in place for registered trading systems or platforms at the 
time that swaps are deemed ``clearable'' by the Commissions to allow 
such platforms to execute transactions at the time that trades begin to 
be cleared. Interim or temporary registration relief would be necessary 
for trading systems or platforms if sequencing of rules first addresses 
reporting to SDRs and mandatory clearing prior to the mandatory trade 
execution requirement. The Commission is strongly encouraged to provide 
prompt provisional registration to existing trade execution 
intermediaries that intend to register as a SEF and express intent to 
meet the regulatory requirements within a predetermined time period. To 
require clearing of swaps through derivatives clearing organizations 
without the existence of the corresponding competitive trade execution 
venues risks inconsistent implementation of the Dodd-Frank Act and 
could have a disruptive impact on market activity and liquidity 
formation, to the detriment of market participants.
    At the same time, a temporary registration regime should ensure 
that trade execution on SEFs and exchanges is in place without 
benefiting one execution platform over another. Temporary registration 
for existing trade execution platforms should be fashioned into final 
rules in order to avoid disrupting market activity and provide a 
framework for compliance with the new rules. The failure of the 
Commissions to provide interim or temporary relief for existing trading 
systems or platforms may alter the swaps markets and unfairly induce 
market participants to trade outside the U.S. or on already registered 
and operating exchanges.
The 15 Second Rule
    There does not appear to be any authority for the CFTC's proposed 
requirement that, for ``Required Transactions,'' SEFs must require that 
traders with the ability to execute against a customer's order or 
execute two customers against each other be subject to a 15 second 
timing delay between the entry of those two orders (15 Second Rule). 
One adverse impact of the proposed 15 Second Rule is that the dealer 
will not know until the expiration of 15 seconds whether it will have 
completed both sides of the trade or whether another market participant 
will have taken one side. Therefore, at the time of receiving the 
customer order, the dealer has no way of knowing whether it will 
ultimately serve as its customer's principal counterparty or merely as 
its executing agent. The result will be greater uncertainly for the 
dealer in the use of its capital and, possibly, the reduction of dealer 
activities leading, in turn, to diminished liquidity in and 
competitiveness of U.S. markets with costly implications for buy-side 
customers and end users.
    While this delay is intended by the CFTC to ensure sufficient 
pretrade transparency, under the CEA, transparency must be balanced 
against the liquidity needs of the market. Once a trade is completed 
when there is agreement between the parties on price and terms, any 
delay exposing the parties to that trade to further market risk will 
have to be reflected in the pricing of the transaction, to the 
detriment of all market participants.
Ensuring That Block Trade Thresholds Are Appropriately Established
    The most important aspect to ensuring that appropriate block sizes 
are set, is for the Commission to integrate the new reporting 
requirements first, and than establish block trade thresholds based on 
the comprehensive and reliable market data produced from these 
reporting requirements. From the perspective of intermediaries who 
broker transactions of significant size between financial institutions, 
it is critical that the block trade threshold levels and the reporting 
regimes related to those transactions are established in a manner that 
does not impede liquidity formation. A failure to effectively implement 
block trading thresholds will frustrate companies' ability to hedge 
commercial risk. Participants rely on swaps to appropriately plan for 
the future, and any significant changes to market structure might 
ultimately inhibit economic growth and competitiveness.
    Establishing the appropriate block trade thresholds is of 
particular concern for expectant SEFs because the CFTC's proposal 
regarding permitted modes of execution restricts the use of voice-based 
systems solely for block trades. While WMBAA believes that this 
approach is contrary to the SEF definition (as discussed above), which 
permits trade execution through any means of interstate commerce, this 
approach, if combined with block trade thresholds that are too high for 
the particular instrument, would have a negative impact on liquidity 
formation.
    With respect to block trade thresholds, the liquidity of a market 
for a particular financial product or instrument depends on several 
factors, including the parameters of the particular instrument, 
including tenor and duration, the number of market participants and 
facilitators of liquidity, the degree of standardization of instrument 
terms and the volume of trading activity. Compared to commoditized, 
exchange-traded products and the more standardized OTC instruments, 
many swaps markets feature a broader array of less-commoditized 
products and larger-sized orders that are traded by fewer 
counterparties, almost all of which are institutional and not retail. 
Trading in these markets is characterized by variable or noncontinuous 
liquidity. Such liquidity can be episodic, with liquidity peaks and 
troughs that can be seasonal (e.g., certain energy products) or more 
volatile and tied to external market and economic conditions (e.g., 
many credit, energy, and interest rate products).
    As a result of the episodic nature of liquidity in certain swaps 
markets combined with the presence of fewer participants, I and my 
fellow WMBAA members believe that the CFTC and SEC need to carefully 
structure a clearing, trade execution and reporting regime for block 
trades that is not a ``one size fits all'' approach, but rather takes 
into account the unique challenges of fostering liquidity in the broad 
range of swaps markets. Such a regime would provide an approach that 
permits the execution of transactions of significant size in a manner 
that retains incentives for market participants to provide liquidity 
and capital without creating opportunities for front-running and market 
distortion.
    To that end, we support the creation of a Swaps Standards Advisory 
Committee (Advisory Committee) for each Commission, comprised of 
recognized industry experts and representatives of registered SDRs and 
SEFs to make recommendations to the Commissions for appropriate block 
trade thresholds for swaps. The Advisory Committee would (1) provide 
the Commissions with meaningful statistics and metrics from a broad 
range of contract markets, SDRs and SEFs to be considered in any 
ongoing rulemakings in this area and (2) work with the Commissions to 
establish and maintain written policies and procedures for calculating 
and publicizing block trade thresholds for all swaps reported to the 
registered SDR in accordance with the criteria and formula for 
determining block size specified by the Commissions.
    The Advisory Committee would also undertake market studies and 
research at its expense as is necessary to establish such standards. 
This arrangement would permit SEFs, as the entities most closely 
related to block trade execution, to provide essential input into the 
Commissions' block trade determinations and work with registered SDRs 
to distribute the resulting threshold levels to SEFs. Further, the 
proposed regulatory structure would reduce the burden on SDRs, remove 
the possibility of miscommunication between SDRs and SEFs and ensure 
that SEFs do not rely upon dated or incorrect block trade thresholds in 
their trade execution activities. In fact, WMBAA members possess 
historical data for their segment of the OTC swap market which could be 
analyzed immediately, even before final rules are implemented, to 
determine appropriate introductory block trade thresholds, which could 
be revised after an interim period, as appropriate.
5. Wholesale Brokers, CROs, and the Responsible Oversight of SEFs
    The WMBAA members look forward to performing our designated roles 
as SEFs under DFA. The wholesale brokerage industry is working hard and 
collaboratively with the two Commissions to inform and comment on 
proposed rules to implement DFA. The WMBAA has submitted several 
comment letters \7\ and expects to provide further written comments to 
the CFTC and SEC. The WMBAA has also hosted the first conference, 
SEFCON 1, \8\ dedicated specifically to SEFs, and is currently making 
arrangements for a second SEFCON later this year. Further, the WMBAA 
has conducted numerous meetings with Commissioners and staffs. We and 
the wholesale brokerage industry are determined to play a constructive 
role in helping the SEC and the CFTC to get the new regulations under 
Title VII of DFA right.
---------------------------------------------------------------------------
     \7\ See, Comment Letter from WMBAA (November 19, 2010) (11/19/10 
WMBAA Letter); Comment Letter from WMBAA (November 30, 2010) (11/30/
2010 WMBAA Letter); 1/18/11 WMBAA Letter; Comment Letter from WMBAA 
(February 7, 2011) (2/7/11 WMBAA Letter); and Comment Letter from WMBAA 
(June 3, 2011) (6/3/11 WMBAA Letter).
     \8\ SEFCON 1 was held in Washington, DC, on October 4, 2010. The 
keynote address was given by CFTC Commissioner Gary Gensler.
---------------------------------------------------------------------------
    It is clear, however, that the implementation of Dodd-Frank will 
create a host of new obligations for both SEFs and regulatory agencies. 
These include requirements that are typical for exchanges and self-
regulatory organizations, such as requirements to (1) establish, 
investigate, and enforce rules; and (2) monitor trading and obtain 
information necessary to prevent manipulation.
    Many likely SEFs are not currently regulated as exchanges, but 
rather as futures commission merchants (FCMs), broker-dealers or, where 
applicable, as alternative trading systems (ATS). As a result, these 
entities have familiarity with the rules of one or more self-regulatory 
organizations, such as FINRA or the NFA, which together with the 
Commission and the CFTC, will perform many of the regulatory functions 
assigned by the Dodd-Frank Act to SEFs.
    In order to facilitate the development and success of SEFs, the 
WMBAA proposes the establishment of a CRO that will facilitate all SEFs 
compliance with the core principles. Membership in the CRO would be 
voluntary and open to any entity intending to register as SEF, though 
member SEFs would be contractually bound to abide by the rules. 
Further, as a voluntary organization, the CRO would not necessarily 
need legislative or rulemaking authority to proceed. The creation of a 
CRO would also prevent market participants from selectively choosing 
which SEF to use based upon the leniency of its rules regime. The WMBAA 
believes that an industry-wide standards body would best ensure the 
integrity of the swaps market and protect market participants from 
abusive trading practices. Moreover, by acting as an intermediary for 
compliance by its members, the CRO would simplify the CFTC's and SEC's 
oversight responsibilities for SEFs.
Conclusion
    Dodd-Frank seeks to reengineer the U.S. swaps market on three key 
pillars: record keeping and reporting; central counterparty clearing; 
and the mandatory intermediation of clearable trades through registered 
intermediaries such as SEFs. Wholesale brokers are today's central 
marketplaces in the global swaps markets and, as such, can be the 
prototype of SEFs.
    Liquidity in today's swaps markets is fundamentally different than 
liquidity in futures and equities markets and naturally determines the 
optimal mode of market transparency and trade execution. Wholesale 
brokers are experts in fostering liquidity in noncommoditized 
instruments by utilizing methodologies for price dissemination and 
trade execution that feature a hybrid blend of knowledgeable qualified 
voice brokers and sophisticated electronic technology. Wholesale 
brokers' varied execution methodologies are specifically tailored to 
the unique liquidity characteristics of particular swaps markets.
    It is critical that regulators gain a thorough understanding of the 
many modes of swaps trade execution currently deployed by wholesale 
brokers and accommodate those methods and practices in their SEF 
rulemaking. Too many of the SEC's and CFTC's Title VII proposals are 
based off of rules governing the equities and futures markets and are 
ill-suited for the fundamentally different liquidity characteristics of 
today's swaps markets.
    We appreciate the Commissions' recognition of the deliberation and 
thought necessary to get these rules right, and are generally 
supportive of the phase-in approach being pursued. Rushing the 
rulemaking process and getting things wrong will negatively impact 
market liquidity in the U.S. swaps markets, disturbing businesses' 
ability to hedge commercial risk, to appropriately plan for the future 
and, ultimately, stifle economic growth and job creation. Taking 
adequate time to get the Title VII regulations right will expedite the 
implementation of the worthy goals of Dodd-Frank: central counterparty 
clearing and effective trade execution by regulated intermediaries in 
order to provide end users with more competitive pricing, increased 
transparency and deeper trading liquidity for their risk management 
needs.
    With Congress' help, and the input and support of the swaps 
industry, regulators can continue their dedicated efforts at well-
crafted rulemaking. If we are successful, our U.S. financial system, 
including the U.S. swaps markets, can once again be the well ordered 
marketplace where the world comes to trade.
    Thank you for your consideration. I look forward to answering any 
questions that you may have.
                                 ______
                                 
                    PREPARED STATEMENT OF CHRIS BURY
      Cohead of Rates Sales and Trading, Jefferies & Company, Inc.
                             June 29, 2011
    Good morning. My name is Chris Bury and I am the Cohead of Rates 
Sales and Trading for Jefferies & Company, Inc. Chairman Reed and 
Ranking Member Crapo, thank you for inviting me to testify this morning 
regarding the emergence of swap execution facilities or, as they have 
come to be known, SEFs.
    Jefferies is a full-service global securities and investment-
banking firm that, for almost 50 years, has been serving issuers and 
investors. We provide investment banking, and research sales-and-
trading services and products to a diverse range of corporate clients, 
Government entities, institutional investors and high net worth 
individuals. The last few years have been a pivotal time for Jefferies 
as we gained market share and built significant momentum by 
capitalizing on strategic opportunities to expand and diversify on 
multiple levels and across all business lines. Over the last 5 years, 
our firm's annual revenue, equity market capitalization and global 
headcount have increased significantly, with now almost $3 billion in 
annualized net revenue, over $4 billion in equity market value, and 
soon-to-be 3,600 employees.
    It bears noting that during that same period--that is, during the 
financial crisis--at no time did Jefferies seek or receive taxpayer 
assistance. As a publicly traded company on the New York Stock 
Exchange, our capital comes solely from the markets, and Jefferies' 
ability to persevere and emerge from the financial crisis positioned 
for growth and diversification can best be attributed to the firm's 
focus on a strong capital position, ample liquidity, and sound risk 
management.
    There are a few key points that Jefferies would like to convey to 
the Subcommittee:

    First, we are ready to go. From our perspective, the 
        architecture, infrastructure and technology necessary to bring 
        the over-the-counter derivatives markets into an era of 
        transparency, dispersed counterparty risk and open access are 
        in place. Just as we are a leading provider of liquidity and 
        execution in stock and bonds, we believe we can become a 
        leading provider to buyers and sellers of derivatives. The 
        market awaits the adoption of final rules--it is a fallacy to 
        suggest that rules should be delayed to allow more time for 
        this market structure to develop.

    Second, we believe that those sections of Title VII of 
        Dodd-Frank pertaining to SEF trading of derivatives are 
        necessary to remedy the artificial barriers to entry in the OTC 
        derivatives market. It is with the intention of enhancing 
        market participation and fostering competition that we support 
        prompt implementation of these requirements.

    Third, implementation timelines should be the top priority 
        at this juncture. The proposed rules are generally clear and 
        understandable. The market needs the certainty of when the 
        rules will become applicable far more than it needs any more 
        suggestions about how bilateral agreements offer an alternative 
        to central clearing.

    Fourth, it is vitally important to guard against the 
        development of market structures that enable opaque bilateral 
        contract relationships to continue to exist. Current 
        standardized-execution-agreement proposals for centrally 
        cleared swaps do nothing but preserve the closed and 
        anticompetitive elements of these markets as they existed prior 
        to the financial crisis.

    Fifth, the adoption of the rules and a clear timeline for 
        implementation of Title VII will bring to the markets the same 
        clear benefits gained from similar developments in equities and 
        futures markets: increased access, expanded competition, 
        improved price transparency, and decentralized risk. SEF 
        trading will lead to lower transaction costs, greater 
        liquidity, strengthened market structures and reduced implicit 
        risks to market participants and the American taxpayer.

    For years, firms such as Jefferies were effectively locked out of 
being a dealer in the OTC markets by virtue of a series of artificial 
barriers and requirements that perpetuated a closed system. Market 
participants were reliant upon bilateral contract arrangements with a 
self-selected group of large interconnected banks, dealers and 
insurers. The weaknesses and lack of true competition of that closed 
system exacerbated the credit crisis of 2008 to the great expense of 
our economy. We support the implementation of SEF trading as quickly 
and responsibly as possible. We believe that these provisions will 
increase transparency, reduce systemic risk, increase competition, and 
broaden access to centralized clearing within the derivatives market 
place.
    From our perspective, the development of the SEF market and access 
to SEFs are fairly straightforward. In addition, the rules as jointly 
proposed by the Commodity Futures Trading Commission and Securities and 
Exchange Commission with regard to mandatory exchange or SEF trading 
are clear.
    Jefferies' main concern, therefore, is not centered around a lack 
of understanding of the rules, nor around the notion that the rules are 
being implemented before the SEF market has developed. Quite to the 
contrary: Jefferies is concerned that a rule delay is one of the 
biggest risks facing this emerging SEF marketplace today. We believe 
the market will successfully transition to SEF trading once a timeline 
is established in terms of what types of swaps will be required to 
transact on a SEF.
    Another risk to the development of the cleared derivatives market 
is the potential for the handful of too-big-to-fail banks that were 
bailed out by taxpayers to undermine and delay implementation of 
derivatives reform. We believe that recent suggestions from those banks 
regarding alternative documentation and workflow issues are nothing 
more than an effort to stifle competition and maintain the status quo.
    We believe that the concern over these workflow issues and ``what-
if'' scenarios will rapidly fade once the scale and scope of the 
technological investment in SEFs and a centrally cleared derivatives 
marketplace is better understood. Significant technological, financial 
and intellectual resources have been committed by a wide variety of 
market participants to get SEFs up and running as quickly as possible. 
Those investments have paid off, as the Financial Times noted last 
month in its special report on derivatives: ``[T]he main participants, 
banks, interdealer brokers and `big end users' are ready to go when it 
comes to electronic trading and clearing.'' (Financial Times Special 
Report, May 31, 2011, as quoted in SDMA Letter to CFTC and SEC dated 
June 1, 2011.)
    The article went on to note that SEF-compliant trades between swap 
dealers and major swap participants have been reported on Javelin, 
TradeWeb, MarketAxess, and Bloomberg in both interest rate swap and 
credit default swap products.
    Our industry is, indeed, approaching full readiness for 
standardized OTC derivatives contracts to begin trading on SEFs. If the 
proposed rules are implemented by the end of 2011, Jefferies would 
anticipate that trading volumes will begin increasing by the fourth 
quarter of this year and then increase significantly into 2012 as we 
approach final implementation of mandatory SEF trading of standardized 
derivatives. A firm timeline for mandatory SEF trading of the most 
standardized swaps will be instrumental for the market to achieve its 
full potential.
    More importantly, delaying the implementation process will provide 
opportunities for entrenched interests to promote agreements that will 
degrade and deter free market forces from operating in the derivatives 
arena. The recently released Futures Industry Association (FIA) Cleared 
Swap Agreement is one such example. Although it is marketed as an 
industry-wide document developed by a variety of market participants, 
we are concerned that the published version, were it broadly adopted by 
market participants, would embed chokepoints into the system. Customer 
agreements that provide for either fallback provisions to bilateral 
relationships or workflows that require complicated credit limit 
checking arrangements, as the current FIA offering proposes, will not 
foster a fully transparent, open, and competitive market. Congress and 
the regulators should encourage market participants to adopt agreements 
and market frameworks that provide for immediate certainty of clearing 
in order to advance the open access provisions and central clearing 
mandate of Dodd-Frank.
Conclusion
    Jefferies believes that implementation of Title VII reforms will 
unleash free market forces held in check by entrenched business models, 
and we are ready and eager to compete in the derivative marketplace. 
Thank you for inviting me to testify today, and I look forward to any 
questions the Subcommittee may have.
        RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
                     FROM KEVIN McPARTLAND

Q.1. The reporting requirements that the CFTC/SEC has proposed 
for all SEFs transactions will require virtual real-time 
reporting of key transaction data. Won't liquidity providers 
(i.e., dealers) increase their bid/ask spreads to reflect the 
increased risks associated with communicating key data to the 
marketplace (since dealers will not be able to hedge these 
positions before they are front-run)? In order to justify this 
risk, won't liquidity providers necessarily pass these 
increased costs to end users? In your view, does moving to SEFs 
justify these increased costs and reduced liquidity?

A.1. In the most liquid products reporting requirements will be 
of little long term consequence. To those in the market 
already, pricing data is in fact quite transparent and so 
additional dissemination will have little impact on spreads. 
For less liquid products however, it is very likely that a risk 
premium will now be embedded in the quoted price. However, even 
in today's market brokers often hedge new positions using other 
instruments such as futures and bonds to avoid being ``picked 
off'' by other market participants who are aware a trade just 
took place. This approach will become more prevalent in the new 
world.
    It is important to note however that as the market becomes 
more electronic and more efficient, new liquidity providers 
will emerge to keep the prices between futures, bonds, and 
swaps very closely aligned. This will only make it easier to 
hedge a new swap position elsewhere with little market impact.

Q.2. The CFTC's proposed SEFs rules would require that market 
participants put out a minimum of five Requests for Quotes 
before they complete a transaction. Given that most of the OTC 
market currently trades in a nonstandardized form, wouldn't 
this requirement to garner five RFQs cause participants to 
share important information to the marketplace, which the 
market could use against that participant? In other words, 
wouldn't this requirement to trade with the RFQ model increase 
bid/ask spread for end users and potentially increase 
volatility?

A.2. It is first important to note that the majority of trading 
in interest rate swaps and credit default swaps occurs on 
standardized contracts. Vanilla U.S. Dollar interest rate swaps 
of standard durations (2 yr., 5 yr., 7 yr., 10 yr., 30 yr.) and 
index credit default swaps are in fact viewed as quite liquid 
by market participants. TABB Group's conversations with buy 
side traders, bulge bracket swaps dealers and midsized swaps 
dealers confirm this point.
    That all said, these same market participants all believe 
that requiring an RFQ to be sent to five market participants 
would in fact widen spreads, decrease liquidity and drive 
trading to other products that did not have the same 
requirement. TABB Group believes that five is an arbitrary 
number and one that is not supported by historical precedent in 
this or any other financial market. Yet although we firmly 
believe a principles based approach to SEF regulation, one in 
which they are free to compete with each other based solely on 
their merits is best, in keeping with the goals of Dodd-Frank 
changing the RFQ requirement to read ``more than one'' would 
act as a reasonable compromise that would not impact the 
majority of RFQ trades done today.

Q.3. If the CFTC defines the size of a ``block trade'' too 
narrowly, then very few trades will be permitted off the SEFs. 
Given that most of the interest rate and credit default swaps 
trade in blocks too small to qualify as ``blocks'' under the 
new rules, wouldn't a phased-in approach be more appropriate 
than a cold-turkey move to the various SEFs rules? With regard 
to the CFTC's block rules, does the CFTC's one-size-fits-all 
approach make sense? Not all swaps have the same risk 
characteristics and lumping all interest rate swaps into one 
bucket for blocks (and similarly for CDS) does not seem 
consistent with market convention.

A.3. Setting the block trade size as a multiple of the current 
average trade size is unreasonable. The majority of swaps 
trades done today are in fact block trades. The average size of 
an interest rate swap is $129 million--but that is because much 
of the trading in this market is done by financial and 
commercial end users hedging real positions. That is in stark 
contrast to the highly electronic futures market where most 
market participants are looking for short term exposure to a 
particular reference entity. One can reasonably conclude that 
once the vanilla interest rate swap market is centrally cleared 
and traded electronically the average trade size could decrease 
by a factor of ten. That said, block sizes must be forward 
looking and take into account how these products are used and 
by whom.

Q.4. Do you envision that block trades will be treated 
differently by SEFs versus DCMs? If so, how and why?

A.4. Block trade rules are and should be focused on reporting 
and not on method of execution. As stated in our testimony, 
TABB Group strongly believes a principals based approach is 
best for the swap execution space allowing SEFs and DCMs alike 
to compete for liquidity based on trading mechanisms provided, 
price, technology and other competitive factors. That said, the 
time delay for reporting a block trade as well as the size of a 
block trade must be consistent regardless of where a trade is 
done. If one venue sets the block size lower than another we 
will quickly see liquidity move to the venue with the lower 
threshold. So ultimately, execution method should be left open 
to the venue but the block definition must be consistent 
systemwide.

Q.5. The margin calculation for SEFs (which requires a minimum 
5-day liquidation period) v. DCMs (1-day liquidation period) 
has a significant impact on required margin. Why were these 
arbitrary liquidation periods established?

A.5. Market convention uses liquidation periods of between 1 
and 10 days. 5-day liquidation is not uncommon. The liquidation 
period used to calculate margin is influenced by liquidity. The 
lower expected or perceived liquidity of an instrument, the 
wider the liquidation period (up to 10 days.) But since margin 
can be changed often, it is not critical to fixate on a 
particular look-back period as long as it is in the acceptable 
range. Furthermore, it makes sense that margin levels for newly 
clearable products would start out at a conservative point.
    The longer the duration of a contract the greater the risk 
to the clearinghouse. As swaps tend to be of much longer 
duration (the 10-year interest rate swap is one of the most 
common) as compared to futures (often 3-6 months) the risk and 
hence the margin requirements are greater for swaps. TABB Group 
research has found that on the short end of the curve margin 
levels are in fact quite similar for swaps and futures. But as 
duration increases the gap widens considerably.

Q.6. We understand the CFTC is considering a different 
segregation regime for customer margin for SEFs v. DCMs. Why? 
What is the benefit?

A.6. Independent of the vernacular, there are two margin 
segregation schemes being contemplated. One is like the futures 
markets where customer funds are comingled in an omnibus 
account of the clearing member. The problem with this structure 
is that customers do not want to have exposure to one another 
for OTC derivative trades. The other segregation method is 
described as legally separated but operationally comingled. 
This format is intended to provide the margin benefits of the 
futures model without the exposure to defaulting parties.
    In all cases, the benefit of pooling more margin funds is 
that it gives the clearinghouse the potential to offer margin 
offsets between more products, such futures and swaps (which 
are often used to hedge one another). In short, fund 
segregation regimes can determine the level of margin offsets 
(offered to spread products), and margin offsets are the 
primary key to lowering and ultimately minimizing the oncoming 
burdens of initial margin requirements for OTC derivatives.

Q.7. Why do the proposed SEF rules not allow for derivatives 
voice trading?

A.7. Yes, and they should. Swap transactions are often complex 
and very large. Following TABB Group conversations with real 
money buy side accounts, it became quite clear that the ability 
to speak with a broker is critical in the trading process for 
many. As a case in point, there is a reason why your average 
retail investor is still willing to pay $50 per trade to call 
in an order even though trading online is available for under 
$10 per trade. That said, we firmly believe that even for 
transactions discussed over the phone prompt entry into an 
execution platform for reporting purposes is critical to the 
ultimately transparency and success of the swaps market going 
forward.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN REED
                       FROM NEAL B. BRADY

Q.1. A number of participants have expressed concern about a 
potential lag between execution and clearing that could leave 
counterparties exposed to a trade that will be eventually 
unwound. Mr. Brady, in your testimony, you state that this 
concern ``is exaggerated.'' Would you go into more detail on 
your views regarding swap trades that fail to clear or so-
called clearing ``fails''?

A.1. Eris Exchange believes that concern about ``fails'' on 
SEFs is exaggerated and addressable by applying a futures 
industry solution that has been in place for a long time; 
namely, pretrade credit checks and credit guarantees at the 
clearing firm level. By applying pretrade credit checks, the 
futures market model avoids the complexity of resolving post-
trade operational issues that could result in a ``fail.'' In 
addition, by applying pretrade credit checks, the futures 
market model ``prequalifies'' individual participants to trade 
with each other as long as each participant is guaranteed by a 
registered clearing firm. This market model vastly simplifies 
documentation requirements for end users, eliminates the need 
for end users to enter into complex trilateral agreements, 
greatly expands access, and allows end users to transact 
cleared swaps while preserving anonymity.
    Under the futures market model, and, specifically, at Eris 
Exchange, clearing firms manage and administer pretrade credit 
checks themselves, and therefore there is no risk of trade 
rejection at the Clearinghouse due to insufficient credit or 
any other post-trade operational issue. The acceptance of a 
trade by the Clearinghouse occurs in milliseconds. Importantly, 
in the futures market model, executing brokers are also 
guaranteed by their primary clearing firm. Thus, at every point 
in the execution chain, a clearing member stands behind every 
futures contract trade.
    If SEFs were to conform more closely to the futures 
industry model, this would alleviate the need for end users on 
SEFs to enter into complicated trilateral documentation 
negotiations and would also address another significant concern 
raised by major buy side participants--end users' desire not to 
reveal their identity--to remain anonymous--during the 
execution process.
    In the futures exchange model and at Eris Exchange, each 
participant enters into a single agreement totaling two pages 
with a clearing firm, one time, and then the participant is 
eligible to trade, anonymously, with any other participant 
backed by any other registered clearing firm.
    In sum, the futures model: (1) does not subject end users 
to ``trade uncertainty'' and the potential for ``fails''; (2) 
greatly streamlines the documentation process; (3) opens up 
access to a much wider and diversified range of market 
participants; and (4) preserves anonymity during the trade 
process, therefore ensuring the most competitive and cost 
effective execution for end users.
    The CFTC has recently proposed rules in response to the 
``fails'' and documentation debate that applies the futures 
exchange model to the execution of swaps. See, 76 FR 45724 
(Clearing Member Risk Management) and 76 FR 45730 (Customer 
Clearing Documentation and Timing of Acceptance for Clearing). 
The proposed rulemaking on clearing member risk management 
would, among other things, require swap dealers, major swap 
participants, and futures commission merchants that are 
clearing members to use automated means to screen orders for 
compliance with the risk-based limits. The proposed rulemaking 
on customer clearing documentation and timing of acceptance for 
clearing would, among other things permit derivatives clearing 
organizations (DCOs) to screen trades against applicable 
product and credit criteria before accepting or rejecting them 
``as quickly as would be technologically practicable if fully 
automated systems were used.'' Eris Exchange is supportive of 
these proposed rules for the reasons set forth above, as well 
as in the Exchange's testimony.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
                       FROM NEAL B. BRADY

Q.1. The reporting requirements that the CFTC/SEC has proposed 
for all SEFs transactions will require virtual real-time 
reporting of key transaction data. Won't liquidity providers 
(i.e., dealers) increase their bid/ask spreads to reflect the 
increased risks associated with communicating key data to the 
marketplace (since dealers will not be able to hedge these 
positions before they are front-run)? In order to justify this 
risk, won't liquidity providers necessarily pass these 
increased costs to end users? In your view, does moving to SEFs 
justify these increased costs and reduced liquidity?

A.1. Eris Exchange strongly disagrees with the assumption 
embedded in the question above--that price transparency and 
real-time reporting leads to increased costs for end users. To 
the contrary, price transparency decreases end users' execution 
costs.
    As has been empirically shown in cash Treasury markets, 
Treasury futures markets, Eurodollar futures markets, and a 
host of other asset classes that have evolved to screen-based 
trading, real-time reporting leads to narrower bid/ask spreads, 
greater price transparency, and therefore decreased costs for 
end users. Real-time reporting also leads to deeper liquidity 
from a more diversified pool of liquidity providers, and 
therefore spreads trading inventory across a broader range of 
counterparties, which decreases systemic risk. Furthermore, 
real-time price reporting substantially decreases systemic risk 
by providing clearinghouses, regulators, clearing firms and end 
user participants with the trade information necessary to 
monitor and manage intraday risk.
    As for the concern about ``front running'' of liquidity 
provider hedges, this is best addressed by an appropriate and 
flexible block trading requirement. The futures market is a 
great example of how bilateral block trades and a transparent 
Central Limit Order Book (CLOB) can exist and thrive operating 
side-by-side. In the futures markets, all trades below the 
block threshold are transacted centrally, and prices are 
reported instantaneously. Above the block trade threshold, 
where end user trades are large enough that liquidity providers 
have a legitimate concern about being ``front run'' on their 
hedges, market participants are allowed to transact 
bilaterally, and report these trades within an exchange-defined 
time limit. This framework has worked extremely well in the 
futures markets for many decades and has led to much tighter, 
rather than wider, bid-ask spreads. In other words, the 
efficiencies in the transparent, yet flexible, futures industry 
marketplace have allowed liquidity providers to pass on lower 
execution costs to end user clients.
    While certain flexibilities for block trades are 
appropriate, such rules must be balanced with the harm that can 
result from too many block trades. Specifically, an excessive 
number of block trades in a given market can impact the quality 
of the markets offered in the CLOB. In a market that has 
excessive block trading, liquidity providers active in the CLOB 
are forced to make markets without access to critical price 
information. In addition, many of the trades that come into the 
CLOB are simply hedging activity resulting from block trades 
that have occurred outside the centralized market. In this 
market scenario, liquidity providers in the CLOB are forced to 
widen their bid/ask, which in turn results in more block 
trades.
    Given the potential for harm to the CLOB of excessive block 
trading, it is important to set block trade thresholds high 
enough so that the only block trades permitted are those that 
would have otherwise materially impacted the market. The CFTC's 
proposed rule for futures block trades on designated contract 
markets (DCMs) provides guidance on how block size should be 
determined, including that the acceptable ``minimum block trade 
size should be a number larger than the size at which a single 
buy or sell order is customarily able to be filled in its 
entirety in that product's centralized market without incurring 
a substantial price concession.'' See, 75 FR 80572, 80630 
(Acceptable practices for block size determination).

Q.2. The CFTC's proposed SEFs rules would require that market 
participants put out a minimum of five Requests for Quotes 
before they complete a transaction. Given that most of the OTC 
market currently trades in a nonstandardized form, wouldn't 
this requirement to garner five RFQs cause participants to 
share important information to the marketplace, which the 
market could use against that participant? In other words, 
wouldn't this requirement to trade with the RFQ model increase 
bid/ask spread for end users and potentially increase 
volatility?

A.2. When discussing the issue of appropriate market protocols, 
it is important to distinguish between standardized (liquid) 
products and nonstandardized (illiquid) products. Eris Exchange 
is live and operational today in a very liquid and standardized 
market for vanilla interest rate swaps derivatives.
    For highly liquid and standardized markets like markets in 
``plain vanilla'' interest rate products, which is estimated to 
account for more than 50 percent of OTC turnover, swaps or 
futures equivalents can be readily traded with a ``5 RFQ'' 
protocol, as well as a CLOB. Specifically, at Eris Exchange, 
which has applied to become a DCM, trades in the Eris interest 
rate swap futures contract can only be done via either the CLOB 
or an RFQ that initiates an all-to-all central limit order 
book. While some may view this DCM requirement for transparency 
as a deterrent for liquidity providers to publish tight bid-
ask, the empirical evidence points to the contrary: 
transparency, open access, and protocols that create a level 
playing field for competition have historically resulted in 
lower costs for end users. For DCOs, transparency also means 
there will be ample data available that is necessary for 
valuing and settling contracts, which ultimately allows for 
lower margin and better management in default situations. And, 
finally, for regulators, transparency means better monitoring 
of the marketplace.
    While a CLOB represents the most developed trading 
platform, Eris Exchange believes that in this time of 
transition, ``principles-based'' regulation--meaning the 
Commission provides concepts for compliance with the Act--will 
permit SEFs with the flexibility to comply with the Act.
    As for nonstandardized products, there is still question as 
to whether or not such products will be subject to the clearing 
mandate.

Q.3. If the CFTC defines the size of a ``block trade'' too 
narrowly, then very few trades will be permitted off the SEFs. 
Given that most of the interest rate and credit default swaps 
trade in blocks too small to qualify as ``blocks'' under the 
new rules, wouldn't a phased-in approach be more appropriate 
than a cold-turkey move to the various SEFs rules? With regard 
to the CFTC's block rules, does the CFTC's one-size-fits-all 
approach make sense? Not all swaps have the same risk 
characteristics and lumping all interest rate swaps into one 
bucket for blocks (and similarly for CDS) does not seem 
consistent with market convention.

A.3. As was stated in the Exchange's testimony, Eris Exchange 
believes that (1) a one-size-fits-all approach to block trading 
rules does not make sense and (2) a principles-based approach 
works best. The principles-based approach to block trading 
limits has worked extremely well in the futures industry where 
DCMs determine their block trading rules.
    The challenge the CFTC and the industry faces is that there 
will be multiple SEFs offering the execution of the same swap, 
so there should be consistency across SEFs. The CFTC addresses 
this challenge by including a proposed rule that requires Swap 
Data Repositories to set block trading sizes based on a 
prescribed formula. Instead of this prescriptive approach, the 
CFTC should consider having the SDRs use a principles-based 
approach to set block sizes, which will eliminate the need for 
a phased-in approach. The Commission can then periodically 
review the block trade thresholds and require SEFs to raise or 
lower these thresholds depending on how the market evolves.
    As we also stated in our opening statement and in response 
to questions during the hearing, Eris Exchange believes that 
each asset class is unique and should have block limits that 
are tailored and appropriate for that particular asset class. 
Lumping interest rate swaps and CDS into a single bucket and 
treating these assets classes the same with regard to blocks is 
not consistent with market convention.

Q.4. Do you envision that block trades will be treated 
differently by SEFs versus DCMs? If so, how and why?

A.4. Eris Exchange believes that the Commission intentionally 
differentiated between the regulatory treatment of SEFs and 
DCMs. Specifically, SEFs and DCMs are held to very different 
standards of price transparency for swaps trades below the 
block trade threshold and therefore it makes sense to 
differentiate with respect to block trade thresholds and 
reporting requirements for swaps in these two very different 
types of markets.

Q.5. The margin calculation for SEFs (which requires a minimum 
5-day liquidation period) v. DCMs (1-day liquidation period) 
has a significant impact on required margin. Why were these 
arbitrary liquidation periods established?

A.5. Eris Exchange does not believe that these proposed 
liquidation periods are arbitrary; rather, in proposing the 
rules related to minimum 5-day VaR for a SEF and 1-day VaR for 
a DCM, the CFTC clearly recognized the important distinction 
between executing trades on a DCM, as opposed to on a SEF. 
Specifically, DCMs are held to a higher standard of price 
transparency (i.e., a CLOB) and therefore, should be allowed to 
receive margining treatment more akin to standardized futures 
markets than to SEF markets with more opaque execution methods. 
Given the execution standards for a DCM, the DCO can better 
ensure a liquidation time due to the active CLOB trading on a 
DCM. The DCM, anonymous CLOB model allows participants to trade 
in and out of products in a cost-effective and time-effective 
manner. The Exchange believes that the transparency of a CLOB-
driven DCM swaps market is a very valuable addition to the post 
Dodd-Frank marketplace and a clear example of some of the 
benefits that will be delivered to end user clients as a result 
of the regulatory reform.

Q.6. We understand the CFTC is considering a different 
segregation regime for customer margin for SEFs v. DCMs. Why? 
What is the benefit?

A.6. As a futures market, Eris Exchange contracts will be 
placed in the traditional futures account, the 4d account. It 
is worth noting that the CFTC has proposed using different 
segregation regimes for swaps regardless of whether the 
transaction is executed on a SEF or DCM. Therefore, if a DCM 
offers the trading of futures and swaps, it is possible that a 
given client's futures contracts will be in one account for 
futures (i.e., Futures or Baseline Model) and a different 
account for swaps (e.g., Complete Legal Segregation Model).
    In general, Eris Exchange operates under a futures 
margining framework and believes that this framework has worked 
extremely well for the futures industry.

Q.7. Why do the proposed SEF rules not allow for derivatives 
voice trading?

A.7. The proposed SEF rules do provide a role for voice 
trading; however, the proposed rules balance this role with the 
transparency requirements of the Dodd-Frank Act. As discussed 
in the CFTC's proposal:

        While not acceptable as the sole method of execution of 
        swaps required to be traded on a SEF or DCM, the 
        Commission believes voice would be appropriate for a 
        market participant to communicate a message to an 
        employee of the SEF, whether requests for quotes, 
        indications of interest, or firm quotes. For instance, 
        voice-based communications in the proposed SEF context 
        may occur in certain circumstances, such as when an 
        agent: (1) assists in executing a trade for a client, 
        immediately entering the terms of the trade into the 
        SEF's electronic system; or (2) enters a bid, offer or 
        request for quote immediately into a SEF's electronic 
        multiple-to-multiple trading system or platform. [76 FR 
        1214, 1221]

    It is also important to note that voice trading is 
permitted with regard to block trades or other ``permitted 
Transactions'' as defined in the CFTC's SEF proposed rule. Id. 
at 1241.
    As an electronic futures exchange, Eris Exchange does not 
permit voice trading to execute standard/nonblock trades. 
However, the Exchange does have rules related to block trades, 
which can be voice brokered.
              Additional Material Supplied for the Record
        STATEMENT SUBMITTED BY THE INVESTMENT COMPANY INSTITUTE
















 PAPER SUBMITTED BY THE INTERNATIONAL SWAPS AND DERIVATIVES ASSOCIATION










































    LETTER SUBMITTED BY STEPHEN MERKEL, CHAIRMAN, WHOLESALE MARKETS 
                          BROKERS' ASSOCIATION






















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