[Senate Hearing 112-680]
[From the U.S. Government Publishing Office]


                                                        S. Hrg. 112-680
 
 IMPLEMENTING DERIVATIVES REFORM: REDUCING SYSTEMIC RISK AND IMPROVING 
                            MARKET OVERSIGHT 

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

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                      ONE HUNDRED TWELFTH CONGRESS

                             SECOND SESSION

                                   ON

     EXAMINING THE IMPLEMENTATION OF THE NEW DERIVATIVES RULES AND 
RESPONSIBILITIES OF THE CFTC AND SEC AS MANDATED UNDER TITLE VII OF THE 
       DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT

                               __________

                              MAY 22, 2012

                               __________

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


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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

                       Charles Yi, Chief Counsel

                     Jeffrey Siegel, Senior Counsel

                     Laura Swanson, Policy Director

                 William Fields, Legislative Assistant

                 Jana Steenholdt, Legislative Assistant

                 Andrew Olmem, Republican Chief Counsel

                Mike Piwowar, Republican Chief Economist

                     Beth Zorc, Republican Counsel

                       Dawn Ratliff, Chief Clerk

                     Riker Vermilye, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                  (ii)



                            C O N T E N T S

                              ----------                              

                         TUESDAY, MAY 22, 2012

                                                                   Page

Opening statement of Chairman Johnson............................     1

Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     2

                               WITNESSES

Mary L. Schapiro, Chairman, Securities and Exchange Commission...     4
    Prepared statement...........................................    36
Gary Gensler, Chairman, Commodity Futures Trading Commission.....     5
    Prepared statement...........................................    39
    Response to written questions of:
        Senator Shelby...........................................    47

              Additional Material Supplied for the Record

Prepared statement of Bartlett Naylor, Financial Policy Advocates    74

                                 (iii)


 IMPLEMENTING DERIVATIVES REFORM: REDUCING SYSTEMIC RISK AND IMPROVING 
                            MARKET OVERSIGHT

                              ----------                              


                         TUESDAY, MAY 22, 2012

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:05 a.m. in room SD-538, Dirksen 
Senate Office Building, Hon. Tim Johnson, Chairman of the 
Committee, presiding.

           OPENING STATEMENT OF CHAIRMAN TIM JOHNSON

    Chairman Johnson. I will call this hearing to order.
    Today we will review the progress being made to reduce 
systemic risk and improve oversight of the derivatives market. 
But before we get to the main subject of this hearing, I want 
to make a few comments about recent news made by JPMorgan 
Chase.
    The company's massive trading loss is a stark reminder of 
the financial crisis of 2008 and the necessity of Wall Street 
reform. Since the firm's May 10 conference call, my staff and 
Ranking Member Shelby's staff have jointly held briefings with 
regulators and a briefing with the company itself. Following 
these briefings I announced last week that I intend to call 
JPMorgan's CEO Jamie Dimon to testify before the Committee.
    In calling for Mr. Dimon to testify, I expect him to inform 
the Committee of the details surrounding what has been reported 
to be a very complex trade. With today's hearing, our June 6th 
bank supervision hearing with other key regulators and 
Treasury, and the hearing with Mr. Dimon, the Committee is on 
its way to having a more complete understanding of the facts 
about the JPMorgan matter that will help us better oversee the 
implementation of Wall Street reform.
    This trading loss has been a wakeup call for many opponents 
of Wall Street reform and the need to fully fund the agencies 
responsible for overseeing the swap trades that appear to be at 
the core of the firm's hedging strategy. It is my hope that all 
of my colleagues who expressed such alarm about this matter 
will now join Democrats in advocating full funding for our 
regulatory ``cops on the beat'' to address the very issues that 
some now suddenly seem so concerned about.
    It is understandable that this high-profile trading loss 
has caused many to renew their interest in Wall Street reform, 
but as Chairman, I have never taken my eye off the ball. That 
is why we are here today continuing our oversight 
responsibilities.
    Much of the reaction to recent events has focused on other 
provisions of Wall Street reform, but what has gotten far less 
attention is the impact derivatives reform will most certainly 
have on reducing the likelihood that banks would want to engage 
in certain high-risk, complex swap transactions in the first 
place. Higher margin and capital requirements for uncleared 
swaps, increased clearing obligations, real-time reporting 
requirements, and new anti-fraud and anti-manipulation 
authorities included in Wall Street reform will reduce market 
risk and improve the integrity of swap trading between large 
financial firms.
    Chairman Schapiro and Chairman Gensler, I commend you and 
your staffs for your tireless efforts implementing these new 
reforms, and I look forward to hearing from you today. As you 
continue your efforts, I urge your agencies to take a single, 
unified approach to regulating cross-border transactions and to 
integrate this approach into all your swap rules. Differences 
between your two sets of rules and implementation efforts 
should be minimized to improve compliance and limit costs. And 
efforts by the United States to promote harmonization abroad 
will be more challenging if we cannot harmonize efforts by our 
agencies here at home.
    Last, I would like to apologize in advance to my 
colleagues, but I will need to excuse myself for a 10:30 markup 
in the Appropriations Committee for my MilCon-VA bill. Senator 
Merkley has graciously agreed to chair this hearing in my 
absence.
    To reserve time for questions, opening statements will be 
limited to the Chair and Ranking Member. However, I would like 
to remind my colleagues that the record will be open for the 
next 7 days for additional statements and other materials.
    I now turn to Senator Shelby for his opening remarks.

             STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Thank you, Mr. Chairman.
    Since the passage of the Dodd-Frank Act, its proponents 
have repeatedly claimed that both consumers and our financial 
markets will benefit from the new law. We now know that both of 
those claims are false.
    Since last year, Chairman Gary Gensler oversaw the largest 
consumer protection failure in the history of the CFTC. Under 
Chairman Gensler's watch, customers of MF Global had $1.6 
billion of funds improperly taken from their accounts.
    The first and most basic responsibility, I believe, Mr. 
Chairman, of the CFTC is to ensure that customer funds are not 
misappropriated. Yet, despite all the new authorities conferred 
on the CFTC by Dodd-Frank, the CFTC was still unable to fulfill 
this primary responsibility to MF Global customers.
    The CFTC's failure is especially troubling here because the 
funds went missing during a time when it was well known that 
the firm was under severe financial stress, and the risk of 
misappropriation there was very high. Even more embarrassing 
for the CFTC is the fact that there were numerous CFTC 
officials onsite at the firm when the funds went missing.
    While I am pleased to see that the MF Global trustee is 
making progress in returning funds to MF Global customers, 
Chairman Gensler nonetheless owes the public, I believe, a full 
accounting of how they failed to protect those customer assets 
in the first place.
    Unfortunately, Chairman Gensler continues to recuse himself 
from all matters pertaining to MF Global, which effectively 
insulates him from congressional scrutiny. Mr. Chairman, I 
believe the public deserves more from their financial 
regulators. We need regulators who are willing to explain their 
actions rather than run for the hills. If there were regulatory 
failures, the responsible parties need to be held accountable 
for their actions, and they need to admit what happened.
    Chairman Gensler's recusal has impeded Congress' ability to 
examine every facet of the MF Global failure. I hope that today 
Chairman Gensler will be more forthcoming about his involvement 
with MF Global so that Congress can finally begin to understand 
what role he played and how Congress should respond. I also 
hope that Chairman Gensler will be more forthcoming about his 
management of the CFTC's implement of Dodd-Frank.
    Chairman Gensler and SEC Chairman Mary Schapiro have 
jointly created widespread uncertainty about the regulation of 
derivatives. According to a recent report, regulators have met 
only one-third of their Dodd-Frank rulemaking deadlines. And 
while there is no question that the rulewriting process 
mandated by Dodd-Frank makes it very difficult to meet some of 
the deadlines, the regulators share culpability here.
    For example, although the CFTC and the SEC have proposed 
numerous new rules for derivatives, they have still not 
proposed rules that clarify the definition of a swap.
    Let me repeat that. Almost 2 years after the passage of 
Dodd-Frank, giving the CFTC and the SEC joint jurisdiction over 
the swap markets, they have still not agreed on the definition 
of a swap. Yet somehow they finalized rules based upon swap 
activities defining and governing swap dealers and major swap 
participants. If market participants do not know which of their 
activities will fall under the swap definition, how can they be 
expected to know whether these activities will be subject to 
the patchwork of registration, recordkeeping, clearing, and 
trading rules? And if market participants do not know if their 
activities will cause them to be classified as a swap dealer or 
a major swap participant, how can they be expected to know when 
to submit comments?
    This is just one example that I am bringing out here of how 
Dodd-Frank and its implementation have created unnecessary 
uncertainty in our markets. As the American economy continues 
to struggle with high unemployment, sluggish growth, and the 
fallout from the ongoing European crisis, the last thing I 
believe we need are self-inflicted wounds. This includes those 
inflicted by Congress, regulators, and most recently, poorly 
conceived trading and hedging activities in one of our largest 
banks.
    Today's hearing presents here in the Banking Committee an 
opportunity to discuss all of these and how they can be avoided 
in the future, and I thank you for calling this hearing, Mr. 
Chairman.
    Chairman Johnson. Thank you, Senator Shelby.
    Now I would like to briefly introduce our witnesses, 
neither of whom are strangers to this Committee. Chairman Mary 
Schapiro is the head of the U.S. Securities and Exchange 
Commission. Chairman Gary Gensler is the head of the Commodity 
Futures Trading Commission. We appreciate both of your taking 
time out of your schedules to be with us today.
    Chairman Schapiro, please begin your testimony.

    STATEMENT OF MARY L. SCHAPIRO, CHAIRMAN, SECURITIES AND 
                      EXCHANGE COMMISSION

    Ms. Schapiro. Chairman Johnson, Ranking Member Shelby, and 
Members of the Committee, I appreciate the opportunity to 
testify regarding the Securities and Exchange Commission's 
ongoing implementation of Title VII of the Dodd-Frank Act.
    As you know, Title VII creates an entirely new regulatory 
regime for over-the-counter derivatives and directs the 
Commission and the CFTC to write a number of rules necessary to 
implement it. Of course, Title VII is just one of the many 
areas ranging from credit rating agencies to private fund and 
municipal adviser registration, to specialized corporate 
disclosures where the SEC is charged with writing rules.
    The SEC already has proposed or adopted rules for over 
three-fourths of the more than 90 provisions in the Dodd-Frank 
Act that mandate SEC rulemaking. Additionally, the SEC has 
finalized 14 of the more than 20 studies and reports that the 
Dodd-Frank Act directs us to complete. And the Commission has 
proposed almost all of the rules required by Title VII. We are 
continuing to work diligently to implement all provisions of 
Title VII as well as the many other rules we are charged with 
drafting and to coordinate implement with the CFTC and other 
domestic and foreign regulators.
    Under the Dodd-Frank Act, regulatory authority over swaps 
is divided between the CFTC and the Commission. The law assigns 
the SEC the authority to regulate security-based swaps while 
the CFTC has primary regulatory authority over the bulk of the 
Title VII over-the-counter derivatives market called ``swaps.'' 
Our rulemakings are designed to improve transparency, to reduce 
information asymmetries, and facilitate the centralized 
clearing of security-based swaps to reduce counterparty risk. 
They are also designed to enhance investor protection by 
increasing disclosure regarding security-based swap 
transactions and mitigating conflicts of interest. By promoting 
transparency, efficiency, and stability, this framework is 
intended to foster a more stable and competitive market.
    In implementing Title VII, SEC staff is in regular contact 
with the staffs of the CFTC, the Federal Reserve Board, and 
other financial regulators. In particular, Commission staff has 
coordinated extensively with CFTC staff in the development of 
the definitional rules, including joint rules further defining 
key product terms, which we expect to finalize soon, and rules 
further defining categories of market participants, which we 
adopted last month. Although the timing and sequencing of the 
CFTC's and the SEC's rulemaking may vary, they are the subject 
of extensive interagency discussions, and the objective of 
consistent and comparable requirements will continue to guide 
our efforts.
    The Dodd-Frank Act also specifically requires that the SEC, 
the CFTC, and the prudential regulators ``consult and 
coordinate with foreign regulatory authorities on the 
establishment of consistent international standards.'' 
Accordingly, the Commission is actively working with regulators 
abroad to address the regulation of OTC derivatives, 
encouraging foreign regulators to develop rules and standards 
complementary to our own.
    The Commission expects to complete the last of the core 
elements of our proposal phase in the near term, in particular, 
rules related to the financial responsibility of security-based 
swap dealers and major security-based swap participants. The 
Commission is finalizing a policy statement regarding how the 
substantive requirements under Title VII within our 
jurisdiction will be put into effect. This policy statement 
will establish an appropriate and workable sequence and 
timeline for the implementation of these rules.
    As a practical matter, certain rules will need to go into 
effect before others can be implemented, and market 
participants will need a reasonable, but not excessive, period 
of time in which to comply with the new rules. This statement 
will let market participants know the Commission's expectations 
regarding the ordering of the compliance dates for various 
rules. Relevant international implementation issues will also 
be addressed in the single proposal.
    Finally, your invitation letter requested that I address 
recent trading losses reported by JPMorgan Chase. Our best 
information is that the trading activities in question took 
place in the bank in London and perhaps in other affiliates, 
but not in the broker-dealer that is directly supervised by the 
SEC. Although the Commission does not discuss investigations 
publicly, I can say that in circumstances of this nature where 
the activity does not appear to have occurred in one of our 
regulated entities, the SEC would be primarily interested in 
and focused on the appropriateness and completeness of the 
entity's financial reporting and other public disclosures.
    In conclusion, as we continue to implement Title VII, we 
look forward to continuing to work closely with Congress, our 
fellow regulators both at home and abroad, and members of the 
public. Thank you for the opportunity to share our progress on 
the implementation of Title VII, and I will, of course, be 
happy to answer any questions.
    Chairman Johnson. Thank you.
    Chairman Gensler, please begin your testimony.

STATEMENT OF GARY GENSLER, CHAIRMAN, COMMODITY FUTURES TRADING 
                           COMMISSION

    Mr. Gensler. Good morning, Chairman Johnson, Ranking Member 
Shelby, and Members of this Committee. I am pleased to testify 
along with SEC Chairman Schapiro. Today I am going to speak to 
the three topics of your invitation letter: first, where is the 
CFTC on swaps market reform; second, the CFTC's role in 
overseeing markets for credit derivative products such as those 
traded by JPMorgan Chase's Chief Investment Office; and, third, 
international progress on swaps reform and related issues of 
cross-border application. I also welcome Ranking Member 
Shelby's questions and look forward to chatting about that in 
public, as I would in private with any of the Members.
    The CFTC is a small agency that is tasked with overseeing 
the futures markets and now, with passage of Dodd-Frank, a 
market nearly 8 times larger, the swaps market. Given these new 
responsibilities, we are significantly underfunded, but you 
have heard me say that before.
    Our market oversight critically relies on market 
participants foremost complying with the laws and related rules 
and then the self-regulatory organizations, like the CME and 
the National Futures Association, that provide the first line 
of oversight. But in addition to that, we do rely on 
promulgating and implementing rules, and in that context, the 
CFTC has completed 33 swaps market reforms to date. We have 
just under 20 to go.
    What do they do? They bring transparency to this 
marketplace; second, they lower risk through something called 
``central clearing of standardized swaps''; and, third, lower 
risk by comprehensively regulating the dealers.
    We are on track to finish the reforms this year, but it is 
still very much standing up, and we are also giving the market 
time to phase in implementation to lower the costs and burdens 
on this very significant transition.
    To increase market transparency, we have completed eight 
key reforms, including real-time reporting to the public and to 
regulators that will begin later this summer. On clearing, we 
finalized risk management and will soon seek public comment on 
which contracts themselves would be under what was called ``the 
clearing mandate.''
    To promote market integrity, we have completed strong anti-
fraud and anti-manipulation rules as well as aggregation 
position limits, and we are looking soon to finalize the end-
user exception.
    To lower risk of the swap dealers posed to the economy at 
large, we have completed rules requiring robust sales practices 
and risk management in a joint rule with the SEC on the further 
definition of the words ``swap dealer'' and ``securities-based 
swap dealer.'' All of this is still, though, pending because it 
has to relate to us finalizing the further definition of the 
terms ``swap'' and ``securities-based swap.''
    It is essential that the two Commissions move forward 
expeditiously to finalize this rule, and I am glad to say that 
both Commissions now have a draft of this rule that has been 
worked out through staff, and hopefully we will be able to 
finalize this in the near term.
    We have made significant progress as well working with 
domestic and foreign regulators to bring a consistent approach 
to swaps market reform, and though not identical, Europe, 
Japan, and Canada now all have made real progress legislatively 
and now in rulewriting to bring similar reform. And, in 
particular, I want to say we are working on a consistent 
approach to global margin for uncleared swaps. It is important 
for a lot of reasons, but let me note one reason is that the 
CFTC proposed a rule that did not require financial end users 
to post margin, and we are advocating the same globally. I just 
wanted to make sure people know that in the end-user community.
    The Commission is also working on a balanced approach to 
cross-border application of swaps reform. I think Congress was 
guided by the experience of AIG with its London affiliate--
well, actually it was a London branch--Lehman Brothers, 
Citigroup, Bear Stearns, and even Long-Term Capital Management, 
when it applies reforms to transactions that might be booked 
offshore but nonetheless have a direct and significant effect 
on U.S. commerce and activities. That in essence is a stark 
reminder we got in the last 2 weeks when JPMorgan's trading 
losses were overseas from trades that lost multi-billions of 
dollars and the credit default swaps and indices on credit 
default swaps.
    The CFTC's Division of Enforcement has opened an 
investigation related to credit derivative products traded by 
JPMorgan Chase's Chief Investment Office, and although I am 
unable to provide any specific information about a pending 
investigation, I will touch upon the Commission's role in 
overseeing these markets. The CFTC has oversight and clear 
anti-fraud and anti-manipulation authority regarding the trade 
of credit default swaps indices. We also oversee the 
clearinghouses that already clear some of these products. 
Starting this summer, there will be real-time reporting to the 
public. And later this year, but not yet, we envision the 
dealers themselves to begin to register and that trading will 
commence on swap execution facilities. So we are in the midst 
of implementation that will take still some time.
    In conclusion, though we have made great progress in 
bringing common-sense reforms to the swaps market, promoting 
transparency and lowering risk, it is critical we complete 
these reforms for the protection of the public.
    Thank you.
    Chairman Johnson. I would like to thank both of our 
witnesses for their testimony.
    As we begin questions, I will ask the clerk to put 5 
minutes on the clock for each Member.
    Chairman Gensler and Chairman Schapiro, what role did your 
agencies have in monitoring the swap trades at issue in the 
JPMorgan matter? And were any concerns raised about these 
trades at either of your agencies? What changes will the 
derivative reforms bring to the regulation of these types of 
trades? And what are the potential implications for the Volcker 
Rule?
    Chairman Gensler, please start.
    Mr. Gensler. As I mentioned in more depth in my written 
remarks, we are in the midst of standing up a regime that will 
still take some time, but the credit default swap indices--
these are parts of the products that reported in the press that 
JPMorgan Chase's Chief Investment Office was trading--already 
come under our completed anti-fraud and anti-manipulation 
regime, and the clearinghouses--three of them, actually--
already clear credit default swap indices voluntarily. Later 
this year, we anticipate seeking public comment on actually 
having a clearing mandate so that more of these trades will 
come into the clearinghouse. Currently it is just dealers to 
dealers. Later this year, we will have a regime that I actually 
think dealers will start to register, but this bank was not yet 
registered as a swap dealer because we do not yet have complete 
rules to make that a true being. And later this year or maybe 
into 2013, you will start to see the commencement of trading 
transparent markets. We are not trying to do this against a 
clock. We are trying to get it balanced. I know that Congress 
gave us 1 year to get the job done, and we are pushing on 2 
years. I do think we need to get the job done to better protect 
the American public, but at the same time take in the 30,000 
comments we have received.
    You asked when did it come to our attention. With matters 
like this, I do not want to get into the specifics of an 
investigation, but as press reports have shown, these are 
credit default swap indices that are under our jurisdiction for 
anti-fraud and anti-manipulation and the clearinghouses we 
monitor on a very real-time daily basis for the completeness of 
the margin and the safety and soundness of the clearinghouses.
    Chairman Johnson. Chairman Schapiro?
    Ms. Schapiro. Thank you, Mr. Chairman. To the best of our 
understanding, none of the transactions were held in or 
executed in the U.S. broker-dealer. The activity took place in 
the London branch of the OCC-regulated bank and in a London-
based affiliate investment management unit. So the SEC did not 
have any direct oversight or knowledge of the transactions.
    I would reiterate what Chairman Gensler said. If the Dodd-
Frank rules had been in place when the activity was going on, 
these positions likely would have all been cleared. Some 
substantial majority were--or some substantial number were, but 
not all were cleared. They would have likely been exchange 
traded. They would have been reported to a swaps data 
repository, and there would have been detailed transparency to 
regulators and transparency to the public, and I would say 
under the SEC's proposed rules for reporting, we would have 
known the trading desk and the trader as well who put the 
positions on. The dealer would have been registered and subject 
to business conduct standards, and they would also operate 
under the new rules for enhanced prudential supervision for 
bank-holding companies with assets greater than $50 billion.
    So I think there are a number of pieces that would be in 
place once all the proposals to implement Dodd-Frank are 
completed.
    Chairman Johnson. Chairman Schapiro, can you commit to us 
that the SEC will issue the last of your proposed derivatives 
rules in the coming months and that you will prioritize within 
the SEC the importance of enacting the final rules in a timely 
manner?
    Ms. Schapiro. Absolutely, Mr. Chairman. We have the last 
piece of proposing rules for us, the financial responsibility 
rules for swap dealers and major swap market participants. I 
hope that we will issue that in the next couple of months.
    There are also the two other key pieces from the SEC's 
perspective. One is, as I spoke about in my testimony, the 
implementation plan that will lay out in a policy statement our 
views on how the rules should be sequenced and implemented, 
what the compliance timelines would look like, and we will see 
comment on that. And, finally, a cross-border release that will 
talk about the application of each of our rules potentially to 
cross-border activity or cross-border operating entities, and 
we want to propose that cross-border release before we adopt 
final rules beyond the definitional rules.
    Chairman Johnson. Senator Shelby.
    Senator Shelby. Thank you, Mr. Chairman.
    A lot of people have been basically saying, Chairman 
Gensler, that the CFTC and the SEC, Chairman Schapiro, were in 
the dark, that you did not know what was really going on at 
JPMorgan. We do not know that yet. But when did you first learn 
about these trades, Chairman Gensler?
    Mr. Gensler. I would say that the trades that came to, I 
think, many of our attention, personal attention, with press 
reports----
    Senator Shelby. Press reports.
    Mr. Gensler. But our staff was aware of trades that are in 
the clearinghouses because they monitor the clearinghouses 
daily in an aggregate basis for the clearinghouse risk and that 
the clearinghouse is fully collecting margin to protect the 
risk of the clearinghouses.
    Again, we do not regulate JPMorgan Chase as a swap dealer 
yet, but we do regulate the clearinghouses, and then have anti-
fraud and anti-manipulation authority.
    Senator Shelby. Did the CFTC really know what was going on 
there on such a large position that JPMorgan had taken here?
    Mr. Gensler. Well, again, our----
    Senator Shelby. Were you in the dark, or did you know what 
was going on? You said you learned about----
    Mr. Gensler. I would say that it is in transition to speak 
about this. Our oversight of the clearinghouses gives us a lot 
of window into the clearinghouse, which I think has 27 members 
in it, and the risks that are in that clearinghouse and the 
margin that is collected there. That is not the full JPMorgan 
picture, of course, because they have a lot of swaps that are 
not cleared. That would have been our principal regulatory 
role--in terms of the bank, we do not have any specific 
oversight there.
    Senator Shelby. So you really did not know what was going 
on or the problem with the trade until you read the press 
reports like all of us?
    Mr. Gensler. Well, that is what I have said, yes.
    Senator Shelby. Yes, sir. Chairman Schapiro, I will pose 
the same question to you.
    Ms. Schapiro. Certainly.
    Senator Shelby. Where was the SEC here? Did they know what 
was going on? And if not, why not?
    Ms. Schapiro. The SEC became aware of the activity, again, 
also through press reports back in April when the London Whale 
trading was first reported on. Just to remind everyone, this 
activity did not take place in a broker-dealer, and we do not 
have oversight responsibility over the broad-based CDS index 
products that were the subject of much of the trading, although 
I think there is still much to learn here about the full----
    Senator Shelby. And what was your responsibility, as you 
see it, as Chairman of the SEC, looking at what happened or 
trying to find out what happened at JPMorgan Chase? What is 
your responsibility?
    Ms. Schapiro. Well, clearly, our focus right now is on 
whether the company's public disclosure and financial reporting 
is accurate in light of what the press has teed up as what did 
they know and when did they know it.
    Senator Shelby. Absolutely.
    Ms. Schapiro. And so there were----
    Senator Shelby. And if they knew something, say, a month 
earlier that was going wrong, should they have disclosed that 
to the SEC, the CFTC? And is that what you are trying to find 
out now, or do you already know?
    Ms. Schapiro. That is what we are investigating right now. 
Were their earnings release statements and their Q1 financial 
reports accurate and truthful?
    Senator Shelby. But you are in the investigation of that 
now?
    Ms. Schapiro. Yes, sir.
    Senator Shelby. What did they know inside, when did they 
know it, and what should they have divulged; is that correct?
    Ms. Schapiro. Exactly.
    Senator Shelby. Is that correct, Chairman?
    Mr. Gensler. Yes, and as Congress gave the CFTC similar 
authority to the SEC--we did not formally have as strong an 
anti-fraud and anti-manipulation authority, which included also 
deceptive practices. That is part of this new authority that we 
have. We currently have oversight of the clearinghouses. I do 
not want to go into the particulars of this ongoing 
investigation that because it is really just best not to 
compromise the investigation itself. But it is in that realm 
of----
    Senator Shelby. As Chairman of the CFTC, though, in a 
derivative position like this, are you basically telling us 
that you did not know there was a problem there until you read 
the press reports? Is that basically correct?
    Mr. Gensler. I think that is accurate. We are also standing 
up a regime. We do not have any regulatory oversight of 
JPMorgan Chase National Association, the bank. We will, I 
think, at some point when they register as a swap dealer later 
this year, but they are not currently registered as a swap 
dealer. We have some oversight of their futures commission 
merchant, but that does not----
    Senator Shelby. Are you saying this is a no-man's land, 
there is nothing--there are things that have not crystallized 
in a regulatory fashion yet over such a big bank?
    Mr. Gensler. The bank is overseen by bank regulators, but 
under Dodd-Frank the market regulators, as market regulators, 
we will stand up and oversee swap dealing activity in a bank or 
an affiliate of a bank or securities-based swap dealing 
activity. But you are right, currently the American public is 
not protected in that way.
    Senator Shelby. Chairman Gensler, were any of the trades 
conducted through JPMorgan's futures commission merchant?
    Mr. Gensler. Not that I am aware of. Maybe upon further 
review we will find, but today our knowledge is no.
    Senator Shelby. OK. Thank you, Mr. Chairman.
    Senator Merkley. [Presiding.] Senator Menendez.
    Senator Menendez. Thank you, Mr. Chairman.
    At the last hearing the Committee had on MF Global, I asked 
the MF Global trustees--Mr. Freeh and Mr. Giddens who at the 
company was responsible for the wrongdoing there, and they 
informed me that their investigation was just beginning to 
determine that. I want to ask you both the same question. Can 
you shed any light at this point?
    Ms. Schapiro. Not at this point, no, sir.
    Senator Menendez. So you do not know at this point who is 
responsible for what took place at MF Global.
    Ms. Schapiro. No. I think the agencies collectively, 
including the criminal authorities, are working very hard to 
untangle exactly what happened at that firm.
    Senator Menendez. With reference to what happened at 
JPMorgan where the huge losses there take place, have you 
determine who was responsible at this point for that?
    Ms. Schapiro. No. As I said, our focus is very much--
because we did not regulate the London branch of JPMorgan Bank, 
that is an OCC-regulated entity. The Fed is the holding company 
regulator. Our focus is on the quality of their risk disclosure 
and their specific disclosures as a public company. When they 
talked about their potential--all the risks that they faced as 
a business, when they talk about potential losses under their 
VaR model, we are very focused on the accuracy and the 
timeliness of that disclosure.
    Senator Menendez. In your--yes.
    Mr. Gensler. I would just say that we are aware that it is 
primarily in the bank, that much of this emanated from the 
London branch of the bank. And as news reports have suggested, 
credit derivative products are at the center of it.
    Senator Menendez. In reference to these investigations, are 
they criminal or civil?
    Ms. Schapiro. The SEC's authority is simply civil, not 
criminal.
    Senator Menendez. Are you working with entities that are 
conducting criminal investigations?
    Ms. Schapiro. I believe the FBI has announced publicly that 
they have opened a criminal investigation, and we will all work 
closely together even though we have different aspects----
    Senator Menendez. Into which of the two that I am referring 
to?
    Ms. Schapiro. I am sorry?
    Senator Menendez. MF Global?
    Ms. Schapiro. I think actually with respect to both.
    Senator Menendez. With respect to both, OK. So, in essence, 
it is the agencies that are conducting civil reviews, I assume, 
and to the extent that there are criminal reviews that are 
being conducted, they are being conducted by law enforcement 
entities. Is that correct?
    Ms. Schapiro. That is right.
    Senator Menendez. So it is not the Senate Banking Committee 
that is conducting those.
    Ms. Schapiro. I would not deign to tell the Senate Banking 
Committee what to do or not to do.
    Senator Menendez. But at this point, as far as I know, we 
are not. So let me ask you this: Do you interpret--do you hope 
to interpret the Volcker Rule in a way that what took place at 
JPMorgan would not have been possible to have taken place, or 
would not have taken place without real consequences?
    Ms. Schapiro. I think we have obviously been thinking a lot 
about this, and the Volcker Rule is foremost in everyone's 
minds because of where we are in the process of reviewing 
comment letters, but also because of this activity. And it 
strikes me that the statute is pretty clear that in order to 
rely on the risk-mitigating hedging exemption to the Volcker 
Rule, there has to be some pretty strong criteria that needs to 
be met. Whether or not the JPMorgan trades out of their CIO 
meets those standards or not, I do not think we have a view 
yet. But they have to be correlated to the risk. They cannot 
give rise to significant new exposures. They have to be subject 
to continuous monitoring and management. They have to mitigate 
one or more specific risks on either individual positions or 
aggregated positions.
    The compensation of the persons doing the trading cannot 
contribute to their taking outsize risk or unnecessary risk. 
And they have to, importantly, I think, document the risk-
mitigating purpose of the trades when the hedge is being done 
at a desk that is different than the position that is being 
hedged was done at.
    So I think there is strong language there, and what we need 
to do is take what happened at JPMorgan and view it through the 
lens of those criteria and see how that helps to inform the 
rulemaking going forward.
    Senator Menendez. Well, I hope, as one of those who 
supported the Wall Street reform legislation, that the agencies 
are going to look at this broadly because if JPMorgan lost $2 
billion, or some report it as just slightly more, through these 
trades, what is to stop them from losing $10 billion the next 
time or, even worse, to stop another less capitalized bank from 
taking losses so large that it could bring it down? I mean, 
that is the whole effort that we tried to move here in the 
Senate, which is to have the type of reform that does not 
create the systemic risk that then places everybody in America 
responsible for the decisions of large entities such as this. 
And I hope that that is how the regulators at the end of the 
day understand that that was the mission that all of us who 
supported Wall Street reform wanted to see.
    Thank you, Mr. Chairman.
    Senator Merkley. Senator Corker.
    Senator Corker. Thank you, Mr. Chairman, and I thank both 
of you for your testimony.
    When an event like one that has just occurred happens in 
the middle of a rulemaking process, that affects things, does 
it not? Meaning that you have an example, a real-live example, 
and, you know, we have had this issue, we realize it is a blip 
on the radar as far as their earnings. But it does affect the 
way rules end up being promulgated. Would you both agree?
    Mr. Gensler. I think it gives us real live experience, like 
AIG and Lehman Brothers and Citigroup did in a more disastrous 
way. This is not that, but it----
    Senator Corker. So I think, you know, as the American 
people are watching, they wonder why in the world we are having 
these hearings, and I think the point is that there is a lot 
happening at the regulator level, and an event like this ends 
up affecting things, and it affects the rules that end up being 
created.
    I guess I have this fear, I think much of what we did was a 
punt to you guys. I mean, the fact that--and you did not do 
that. We did that. But the fact that it has taken you 2 years 
to define what a swap is is pretty incredible, and it is 
because we never defined it ourselves or did the work to 
understand what a swap is. But the thing I guess I fear is in a 
rush to make it look like the Dodd-Frank legislation addressed 
these kind of issues, what you may do--I mean, we never debated 
what these institutions should be. We just sort of layered a 
lot on top. We have these highly complex organizations where 
even the CEO itself realizes that he did not know what was 
happening in this London operation. And I fear that you are 
under pressure, that a lot of calls are being made, that the 
Administration is concerned that the American people are going 
to wake up and look at the last 3 years as a bad dream, you 
know, that maybe the health care bill become unconstitutional, 
this big Dodd-Frank bill really does not address real-time 
issues, and that what you are going to do is end up causing the 
Volcker Rule to be something that it was never intended to be. 
And I just would like for you to respond to that, and in the 
process possibly making these highly complex organizations even 
more risky than they already are. I would just like a couple of 
comments in that regard.
    Mr. Gensler. I think our job that you delegated or asked us 
to do is to be----
    Senator Corker. ``Punted'' was the word I used.
    Mr. Gensler. I was trying to be more respectful to 
Congress.
    Senator Corker. You do not need to be.
    [Laughter.]
    Mr. Gensler. And I appreciate that. I think it was to 
ensure that the American public gets the benefit of 
transparency and lower risk because firms will fail in the 
future, as they have in the past, and the critical thing is 
they have a freedom to fail, and the American public does not 
stand behind them. And it is like the one industry that we do 
this around the globe, and that is why I am so committed 
personally to getting this reform done.
    I think this circumstance is just a reminder in one area--I 
look at it more about cross-border application than the Volcker 
area, if I can say respectfully, because whether it was Lehman 
Brothers, AIG, Long-Term Capital--Long-Term Capital Management, 
you might recall, was this hedge fund in Connecticut, but it 
was set up in the Caymans. It is just a reminder to make sure 
that we get that part right. The London risk can come back and 
hurt the good folks of your State.
    Senator Corker. Is there a pressure, though, to define what 
has occurred here in such a way that you may end up in the 
short term making a piece of legislation look good, but in the 
process cause a highly complex institution like this to be in a 
position where they are not appropriately hedging the activity 
so that you actually make it more risky? I mean, is that the 
kind of thing that you all do talk about from time to time?
    Mr. Gensler. Well, we are most definitely public actors, as 
you are as a member of this great body, the Senate, and we are 
influenced by--we have had 30,000 comment letters, 1,600 
meetings with folks from the markets. So this will be part of 
the topic of the dialogue, absolutely, but I think we have to, 
just as we always do to get it balanced and get it right, not, 
if your concern is, tip too far one way or the other. But I 
think it is a good reminder that risks in London can come back 
here, and we cannot have the U.S. taxpayers stand behind them.
    Senator Corker. So my time is going to run out, and I know 
by previous history I will be cutoff immediately. I do want to 
just ask that when you are making the rules that you are 
making, that we really do it here to the process of cost/
benefit analysis. I am now moving to other types of 
regulations. I know that you know courts now are challenging 
some of the rules and regulations because regulators are not 
doing that.
    And, second, to ensure that we do not create another 
systemic risk by shifting off to these clearinghouses systemic 
risk that otherwise was held in other places.
    So, anyway, I thank you for what you do, and I look forward 
especially to the next hearing we have with the banking 
regulators that actually are supposed to oversee these 
activities.
    Thank you.
    Senator Merkley. Thank you, Senator Corker, and thank you 
all for your testimony.
    I wanted to start with returning to the basic premise of 
the Volcker Rule, which is to create a firewall between 
traditional banking, that is, deposit-taking/loan-making 
institutions, and hedge fund-style investing.
    In the effort to create that firewall, one of the issues 
was when banks were holding funds in between making loans, how 
would they be able to utilize those funds so that they had 
liquidity for making loans, but it was relatively safe, so it 
is clearly not in the world of proprietary trading or hedge 
fund investing, if you will? So the basic statute provided for 
a notion of investing in Government bonds as kind of the safe 
place to put your money, but allowed the regulators additional 
flexibility.
    The draft regulations have the liquidity management 
proposal, and it is not really clear in the end what would be 
allowed here. But if we look at JPMorgan, they have $381 
billion in funds that were awaiting, if you will, lending out, 
so in between loans. Unlike other institutions that largely put 
it into Government bonds, they took half of that and they put 
it into corporate bonds. That started this sequence of events 
that led to this $2 to $3 billion or greater loss, and that 
they then said, well, we have these corporate bonds, we better 
protect against them dropping in value, and they bought some 
insurance. And then they said, well, we have got to pay for 
that insurance, so we will sell another form of insurance to 
create the revenues to pay for that. And pretty soon they were 
in the position of doing what AIG did, which was to sell lots 
of insurance very cheaply, and then when the bets went bad, 
they had to pay off.
    So it begins with this liquidity management issue, and that 
really has not been focused on much here. But what is the 
appropriate place to put your funds in between making loans so 
that you are clearly in the deposit-taking/loan-making business 
and not in the hedge fund business?
    Ms. Schapiro. Senator, I think that is a great question, 
and the rationale behind the liquidity management exclusion 
that was included in the rules was to make sure that banking 
entities would have sufficient readily marketable assets to 
meet their short-term liquidity needs, and I think we can all 
agree that is really critical to the safe and sound operation 
of a banking entity. And there are requirements around that 
that there has to be a documented liquidity management plan, 
and there are criteria that are set out in the rule. But I 
think the question you raise really requires us to go back and 
look at that and see if we carried that to its logical extreme, 
could we have anticipated to JPMorgan and maybe we need to 
tighten this up and just look at it much more closely and much 
more carefully.
    That is why I think really in response to Senator Corker's 
question, this is very instructive. It would be wrong for us 
not to take this example that is a real-life, real-world 
example of what can happen, whether it is the application of 
the cross-border provisions or it is the Volcker Rule itself, 
to use this example and to see what the impact would be of all 
the things that we have proposed to do.
    Senator Merkley. So I would say if you take the situation 
that funds that are awaiting making new loans, if you will, can 
be invested in a huge variety of things, and essentially it is 
a gateway to be involved in proprietary trading, and it has two 
impacts. One is it diverts funds that were intended to be lent 
out the door, reducing liquidity or credit for businesses and 
families; and, second, it introduces a lot of risk and 
complexity.
    Chairman Gensler?
    Mr. Gensler. Well, as a derivatives and swaps regulator, we 
are mostly going to be focused on the implementation of the 
Volcker Rule with regard to swap dealers and futures commission 
merchants. I do not have as many views as Chairman Schapiro on 
the liquidity management piece, but if I could pick up on a 
second, I think implied in there, was we received a letter from 
JPMorgan all of us received on our side of the regulators--in 
February specifically saying that they thought we had to loosen 
up or widen out the hedging exemption. We are entrusted by 
Congress to figure out how to prohibit proprietary trading so 
taxpayers do not stand behind these institutions, but permit 
market making, which is important to markets, and permit 
hedging, which helps lower risk of these institutions. So it is 
that challenge--it is not an easy challenge, by the way. But I 
think you were very clear. It has got to be tied specifically 
to individual or aggregate positions, and I think Congress was 
pretty clear on that, and it is instructive to me that it was 
actually February 13th that JPMorgan sent in like a 65-page 
letter, and within that they said you have to loosen up this 
portfolio hedging. And so I think this has to be looked at in 
the context of their February letter as well.
    Senator Merkley. Great. I am out of time, so we are going 
to return to Senator Johanns. Thank you.
    Senator Johanns. Thank you, Mr. Chairman.
    Thank you both for being here. Madam Chair, let me follow 
up on a statement you have made a couple of times during the 
hearing that I just want to understand better. You said that 
SEC did not regulate the London branch, that that actually was 
something over on the OCC side. And I am trying to maybe take 
the next step here with my question. Could this risk management 
that was being done by JPMorgan have been done in such a way 
that it would be under your jurisdiction? Or are you just 
saying this does not fall within the purview of the powers 
given to me?
    Ms. Schapiro. If the trades were done in an SEC-regulated 
entity, broker-dealer or ultimately when the rules are 
finalized a security-based swap dealer, then it would clearly 
be under the jurisdiction of the SEC.
    Senator Johanns. OK. Which, of course, raises another 
question. If I were running JPMorgan, couldn't I just set this 
up in a way to avoid you?
    Ms. Schapiro. Well, that is an important issue that we are 
all wrestling with in the context of the cross-border release 
and how will we apply our rules to activities that might not 
take place in the U.S. entity but might face a U.S. customer or 
might take place in an affiliate of a U.S. entity but overseas 
or in a branch of a U.S. entity overseas. And those are the 
issues that we will lay out in our cross-border release.
    I think generally a foreign entity with a foreign customer, 
we can feel reasonably comfortable that our Title VII rules 
would not apply. But the foreign affiliate of a U.S. entity--
rather, a foreign entity that is registered with us doing 
business with a foreign customer would likely be subject to our 
rules. A U.S. entity, including a branch of a U.S. entity, 
operating in a different country or doing business with any 
U.S. person would have Title VII rules applying. So we want to 
lay this out in detail for commenters.
    Senator Johanns. One of the concerns about Dodd-Frank, and 
maybe even more specifically this area of Dodd-Frank, as you 
know, and it has been one of my concerns, is the more you crank 
it down, the more the regulations become more and more onerous, 
the greater the temptation is for smart people to hire smart 
lawyers and accountants and at the end of the day avoid you.
    Ms. Schapiro. That is right, and that is why the 
international efforts we are engaged in really are critical 
here, and they are painstakingly time-consuming as we sit on a 
bilateral basis and a multilateral basis with regulators in the 
other major markets and go through issues like pre-trade 
transparency, post-trade transparency, margin, the clearing 
mandate, the exchange trading or SEF mandate, and work through 
each and every one of these issues to try to get the regulatory 
regimes as comparable as possible so that there is not an 
opportunity for people to engage in regulatory arbitrage and 
just do their business in the least regulated market.
    But if it faces U.S. customers and has the potential to 
impact the U.S. financial system, we have to very seriously 
consider making that part of our mandate.
    Senator Johanns. Mr. Chairman, I want your comments on 
this, but before you comment, when you say--and I have no doubt 
you are working hard in the international arena and you want 
everybody to be as harmonized as they can be. But I have worked 
in that international arena in a position much like yours, and, 
you know, we would work days, weeks, months, years with the WTO 
process, for example, with 150 countries trying to get people 
on the same page for sanitary/phytosanitary issues in trade. 
And at the end of the day, they all had their own agenda, and 
they all had their own interest. And some saw an economic 
benefit in doing something very different than what we were 
proposing they do.
    And before I take all the time, go ahead, Mr. Chairman, 
because I could go on and on. I think this is a very serious 
problem.
    Mr. Gensler. I think, Senator, you are right on both 
points, that we will ultimately have differences. We are 
working well together, but there are different cultures, 
different political systems, different agendas. There will be 
some differences. And, two, I think you are correct that modern 
finance, large complex financial institutions will rationally 
look to see whether they can find the lowest tax regime and 
accounting regime that favors them or regulatory regime that 
they can put customer money at risk or have less capital and so 
forth.
    So knowing those two things--that there will be differences 
and that rationally these large firms will do all this--I did 
it once when I was a co-finance officer of a large firm. I 
mean, you know, we set up four to six legal entities in every 
jurisdiction, and Long-Term Capital Management's was in the 
Cayman Islands, and Citibank's SIVs were originated in London 
but set up in the Caymans. And AIG financial products that we 
think were in Connecticut, they needed a bank license, so they 
went to France and they got a bank license, and they put a 
branch in London. Joseph Cafano, the gentleman who ran it, was 
running it out of London. All that risk came back here.
    So we have to be very careful, as Chairman Schapiro said, 
to say, yes, there are costs on financial institutions, yes, 
there will be differences overseas, but the bigger cost is if 
we let the American taxpayer be at risk. So we are trying to 
cast this appropriately where there is direct and significant 
effect on U.S. commerce or activities.
    Wall Street rationally is advocating something different. 
If I was on the other side of the table representing them, I 
would advocate something different than I am in this job right 
now. And so it is an interesting challenge, and we are not 
going to be as good as we hope to be. They will get something 
by us. In probably 3 to 6 years or 10 years somebody is going 
to say you missed something, they figured out something in the 
Mauritius islands or something.
    Senator Johanns. Mr. Chairman, thank you.
    Senator Merkley. Senator Reed.
    Senator Reed. Well, thank you very much. Chairman Schapiro, 
you have already indicated that you do not have direct 
jurisdiction over the activities of the JPMorgan entity, but in 
this joint rulemaking, this collaborative rulemaking, you are 
trying to define hedges in a way that covers the legitimate 
operations of financial institutions minimizing their risk, 
without allowing speculation.
    There is this tension, it seems, the tension between risk 
management and profit making, and I know you have suggested 
sort of the criteria. Do you have anything else to add in terms 
of this dilemma of defining a hedge so that it is properly 
protecting clients and protecting investments of the bank but 
not opening it up to, you know, speculation?
    Ms. Schapiro. Well, I think that is the hard challenge that 
Congress has given us, and I would say it is also true with the 
market-making exemption as well. And we believe deeply that 
businesses have to be able to engage in both activities, market 
making to ensure our markets are operating as efficiently as 
possible and hedging to reduce businesses' risk. And I think 
the criteria that are laid out are actually pretty good in 
terms of helping us keep the focus on hedging as truly hedging, 
you know, mitigating one or more specific risks of either 
individual positions or aggregated positions, the hedge itself 
not giving rise to significant exposures, at least at the 
inception, but also monitoring and adjusting hedges if, as we 
have seen in some of the newspaper articles about the JPMorgan 
transactions, they morph into something else over time, that 
there not be compensation programs, and as you know, we have 
been working hard in the disclosure area with respect to 
compensation, that really incentivize this outside risk taking 
in a way that threatens the franchise by encouraging people to 
take bigger risks than they should.
    So I think the criteria are there. I think it is really 
incumbent upon the regulators to figure out how to write a rule 
that allows legitimate hedging to go forward as it needs to, 
but it must be really, genuinely risk-mitigating hedging, and 
not anything people want to do called hedging.
    Senator Reed. There is another variation on this that you 
have to deal with, and that is, we in Dodd-Frank have end-user 
exemptions. For a nonfinancial company, you could be doing 
hedging as an end user, but you could also be very aggressive 
in your hedging. We saw the example of Enron, which was not, 
you know, a financial company, but it collapsed because of very 
aggressive use of derivatives.
    Is there anything that you are contemplating in your rules 
or anything you are going to do to anticipate this type of 
problem, Chairman Gensler?
    Mr. Gensler. Well, I think actually Congress anticipated it 
because they included another category called major swap 
participant. And I think Congress said that if you are 
nonfinancial, you get to choose whether you are involved in 
this clearing and trading, and we are suggesting through our 
margin rule that you get to choose on that, too. But if you are 
so big that you are a major swap participant and you could be 
systemic, then you would be brought into this.
    Could I answer your first question just a little bit?
    Senator Reed. Yes, please.
    Mr. Gensler. I think that Chairman Schapiro said it very 
well. One thing I would add is that this concept of portfolio 
hedging can mean different things to different people. I think 
what Congress said, it has to be tied to specific risk of 
individual or aggregate positions, and this experience reminds 
us maybe we have to go back and make sure. It really is tied to 
specific aggregate positions. It is not sort of like, well, we 
think revenues will go up or we like the European debt markets 
these days. And one thing from my experience is that these 
things sometimes morph or mutate into something else, 
particularly when they are set up as a separate business unit 
and they have a separate profit and loss statement and separate 
compensation, because hedges, to really be hedges, generally 
lose money just about as many days as they make money because 
they are hedging something, the position is going up, the 
position makes money, the hedge loses money; and if the 
position goes down, vice versa. When you set it up as a really 
separate unit somewhere else, maybe in a different country, 
different leadership, you start to--it is prone to morph.
    Senator Reed. Yes, I guess one of the--it is just an 
initial reaction, and maybe it is untooted, is that when your 
entity that is designed to be sort of the risk manager and 
chastise everybody in the institution for being too aggressive 
or not responsive to risk is really one of your major profit 
centers, and I think that might be a sign that the role is 
emerging in a sort of unpredictable and maybe unproductive way.
    Just a final point I want to make, not in response to a 
question, is that you pointed out, Chairman Gensler, the 
international interconnections here, which suggests very 
strongly that our regulations have to be not only strong and 
internationally applicable, but we have to have people on the 
ground looking at these institutions. If an American 
institution is going to locate their activities overseas, the 
comparable regulator, in this case OCC, should not only have 
been there, but been there in force with adequate personnel to 
look very closely at what was happening and be the first line 
of defense, if you will.
    Mr. Gensler. Well, I cannot speak to them, but I think the 
system we have at the CFTC, unfortunately--or fortunately--does 
not contemplate that. We really have been kept reasonably 
small. We are just 10 percent larger than we were in the 1990s. 
And we rely foremost on the law and people complying with the 
law, on the rules, and then the self-regulatory organizations. 
We do examine the self-regulatory organizations, but we do not 
have people onsite at any futures commission merchant. We do 
not have people onsite at the clearinghouses. That is just the 
reality of our funding and the decisions that have been made 
over decades in a bipartisan way.
    Senator Reed. But just a point, I mean, there have been 
questions consistently here today. When did you know? When were 
you aware of it? Could you have anticipated it? Recognizing it 
is OCC's responsibility, if they do not have people on the 
ground sitting day to day at the desk, you will not know until 
some enterprising reporter breaks the news, and by then a lot 
of damage could be done.
    Mr. Gensler. Agreed.
    Ms. Schapiro. The other tremendous benefit we do get, 
though, will be when we have full reporting of these 
transactions and there is transparency to regulators I think 
will make a big difference.
    Senator Reed. Thank you, Mr. Chairman.
    Senator Merkley. Senator Toomey.
    Senator Toomey. Thank you, Mr. Chairman, and thank you both 
for being here. I would like to follow up on the discussion 
that Chairman Gensler has been touching on but I am a little 
bit confused about, and that is, your views on the 
permissibility of hedging in the aggregate. I think you just 
used the expression just a moment ago about portfolio hedging 
that is tied to specific positions. So I am wondering if you 
could clarify that, because if you tie hedges to individual 
specific positions on a one-off basis, that is obviously the 
opposite of hedging in an aggregate portfolio that has some 
kind of cumulative net risk.
    So my question is: Is it your view that it is and will 
continue to be permissible as well as cost-effective to manage 
interest rate and currency and credit risk in the aggregate in 
these portfolios rather than limiting it to a one-off 
individual basis?
    Mr. Gensler. I think Congress actually addressed themselves 
to this and said that it had to be tied to the specific risk of 
either individual or aggregate positions, but tied to the 
specific risk of some aggregate positions, to answer----
    Senator Toomey. OK. So----
    Mr. Gensler. But it has got to be tied to some----
    Senator Toomey. So, for instance, it could be the aggregate 
interest rate risk of a bond portfolio----
    Mr. Gensler. That may have 170 bonds in it, and then they--
--
    Senator Toomey. All across the maturity spectrum, so you 
could measure that and quantify that and then hedge that. And 
then would the rule prescribe the kinds of instruments that 
would be permissible to use to hedge that kind of portfolio?
    Mr. Gensler. As written now, it speaks to--and this may 
change in a final rule, but as written now, it talks to 
instruments that are reasonably correlated with the risk. So it 
is all in that word ``reasonably.''
    Senator Toomey. And who decides what is reasonably 
correlated to the risk? Ultimately the regulator do.
    Mr. Gensler. Well, I think a first order, the institution 
does, the firm does, but then there is a compliance program, 
and the regulators would----
    Senator Toomey. But the whole point of the rule is 
ultimately for you to set bans and say this is permitted and 
this is not. And that is the purpose of the rule.
    Mr. Gensler. It is, though as written, I would consider it 
more a principles-based and compliance regime that the firm has 
to have policies and procedures to ensure that their hedges are 
reasonably correlated to the specific risk.
    Senator Toomey. But, again, I think the ultimate question 
in hedging is a question of who gets to decide, I think. There 
is an inherent risk in hedging. That is why it is called a 
``hedge,'' right? It is not a complete offset. And so there is 
always some residual risk, and there is always a subjective 
judgment call since in large, sophisticated, complex, liquid 
markets like ours, there are a lot of choices available to 
someone who wants to hedge any given portfolio. And my concern, 
Mr. Chairman--and it goes to the heart of what Dodd-Frank is 
all about, and these folks are doing their job of trying to 
implement it, but I think they are given an impossible task, 
and the task is to micromanage the activities of these 
institutions. That is what Dodd-Frank attempts to do. It says 
we are going to limit systemic risk by controlling everything 
you can do in great minute detail.
    Let me give an example. Chairman Schapiro alluded earlier 
to the challenges of establishing the market-making exemption. 
My understanding is among the many specific rules that we are 
going to impose on financial institutions, we are going to 
establish metrics that will quantify, for instance, how much 
income can be earned from the day one bid-offer spread versus 
what can be earned from subsequent market moves. We are going 
to have rules that will prescribe how much business a market 
maker must do with end users versus that which would be done 
with the inter-dealer community. We are going to have to decide 
and have rules that will dig down into whether we are going to 
quantify these things at the level of the individual trader--or 
will we aggregate several traders? Or will we aggregate the 
entire trading floor? How will we do this?
    We are going to have to have rules that will establish 
which kinds of asset classes are permitted to hedge which kinds 
of risks. So if you have got a corporate bond portfolio, that 
has credit risk. Can you short the S&P 500 against that as a 
proxy for credit risk? Or can you use credit default swaps?
    My point is this has a huge cost, not just the direct 
staggering cost of compliance, but it also has a cost of less 
liquidity because traders have fewer options. It is going to 
lead to less innovation because people are going to be 
prescribed very narrowly in what they can do. And it is going 
to have who knows what kind of unintended consequences, as 
Senator Johanns observed, when people decide, you know what, it 
is better to just avoid this incredible micromanagement and go 
somewhere else, which is why, I think, Mr. Chairman, we have 
gone down the wrong road here. The better solution is require 
more capital so that we can let people do what they want to do, 
let the people in the marketplace make the decisions they will 
make, and then let them live with the consequences without 
having the taxpayer at risk because we have required a 
sufficient buffer that a firm could lose 1 percent of their 
capital in a recent example and not have everybody sweating 
bullets about it.
    Frankly, firms ought to be able to make decisions and then 
live with the consequences, and taxpayers should not be at 
risk. I do not think you achieve that by trying to control 
every aspect of their business, which is what these folks, 
unfortunately, have to do. I think the alternative of a tougher 
capital regime achieves the goal of reducing systemic risk 
without putting us in the impossible position of trying to run 
these institutions.
    Senator Merkley. Senator Hagan.
    Senator Hagan. Thank you, Mr. Chairman. And, Chairman 
Gensler and Chairman Schapiro, thanks for your comments today 
and your commitments.
    Chairman Schapiro, in Senator Reed's discussion, you 
mentioned data collection. When will the SEC start collecting 
that data? And where does the implementation stand?
    Ms. Schapiro. The security-based swap reporting data 
collection will begin when the rules are finalized, which they 
are not yet, for Regulation SBSR. It is hard for me to predict 
with a five-member Commission exactly when we will have final 
adopting rules, hopefully sometime later this year. We have one 
set of rules left to propose, and then we have done one final. 
We will do another final in the next month or so, hopefully, 
and then a steady stream after that.
    It is important, obviously--I am a big believer in 
transparency in the marketplace, and we have seen it work 
extremely well in other markets. We think it is critical for 
the public to have access to this information and very critical 
for regulators to have access to this information. It is a 
discipline that ultimately translates to, I think, management 
as well to know that the regulators and the public can see the 
information.
    So when we do have the rules in place, we will have quit 
granular information right down to the trader and the trading 
desk from which a particular transaction emanated.
    Mr. Gensler. And I would say, and maybe to Senator Toomey's 
comments earlier, I think transparency is so critical, too, so 
I am hoping that I could maybe convince you that, in addition 
to capital, transparency, because as Senator Hagan said, in the 
credit default swap indices area and in interest rates and so 
forth, it will be later this summer, probably as soon as--
possibly as soon as August. And then in the commodity--oil and 
gas and the others--3 months after that, because we have 
already completed the rules both for the public to see the 
trades, which I think is very big, and then for the regulators 
as well.
    Senator Hagan. Chairman Gensler, speaking about 
transparency, you and I have talked at length about that, 
especially in the swaps market, and I think we all do agree 
that transparency obviously is critical to reducing the risk 
and creating the efficient markets.
    The Markit's CDX North American Investment Grade you 
mentioned in your testimony. It certainly has received 
attention recently for the role it played in the losses at 
JPMorgan. And this index of credit default swaps contracts is a 
relatively transparent product that is tradable, that is 
standardized, and it is priced daily.
    I would like to hear your thoughts on the transparency of a 
product such as the CDX index and how that can reduce risk in 
the financial system. And then how could we see such large 
losses in this tradable product? And what lessons do you think 
our financial institutions will take from this incident?
    Mr. Gensler. Well, I think you are correct that it is a 
rather standardized product. Right now the dealers are into a 
clearinghouse, but as we complete the rules, the nondealer, the 
hedge fund positions, will also come into the clearinghouse. 
Regulators will get more transparency seeing all of the trades 
not only in the clearinghouse but in the data repository.
    For the public, right now there is not mandatory post-trade 
transparency, and I think as that comes into being in the next 
several months, there will be a benefit in that the public 
would see the pricing.
    Now, we mask the sizes. If somebody did a very large size 
trade, it just gets a plus at the end. I apologize. I cannot 
remember where it gets a plus, whether it is at $100 million 
size or $200 million in credit default swaps. But I think the 
public will greatly benefit from such transparency in addition 
to the regulators.
    Senator Hagan. Thanks.
    Chairman Schapiro, I wanted to ask about the value-at-risk, 
an industry standard reporting metric that I think most of the 
financial institutions include in their 10-K filings. Can you 
discuss the value-at-risk and how it is used by the financial 
institutions and what are the rules regarding its disclosure?
    Ms. Schapiro. Sure. The VaR estimates, or value-at-risk 
estimates, give you at a particular confidence level, 95 
percent, 99 percent, the potential decline in the value of a 
position or a portfolio under normal market conditions. And I 
would say that raises one of the weaknesses of VaR, is that it 
does not measure for you the maximum possible losses in a 
portfolio that could occur, could be incurred, particularly 
during very stressed market conditions. So it has its 
limitations.
    Nonetheless, public companies are required to discuss their 
risk, and they are given an option really of three ways to go 
forward in their Item 305 Regulation S-K disclosure. When they 
have to give quantitative information about market risk, they 
can use a tabular presentation of information; they can do a 
sensitivity analysis; or they can do a VaR disclosure. And most 
financial institutions, in fact, choose to do that.
    They also have to disclose at the same time, though, any 
material limitations on the model, what it is not telling about 
risk exposures, and when there are changes to the VaR model as 
newspapers have reported was done at JPMorgan, they changed 
their VaR model those changes have to be disclosed, too. The 
changes to the model characteristics also have to be publicly 
disclosed.
    Senator Hagan. And have you followed that at some of these 
other losses that have taken place in the recent past, how it 
impacted from the SEC evaluations?
    Ms. Schapiro. Our staff would look at--well, particularly 
in the capital context, where VaR is also used to allow firms--
certain firms, a very small number of firms, in fact--to use 
VaR to compute the market risk deduction from net capital. If 
they have large losses, we actually make them back-test and 
provide us with full information about why their estimates of 
losses were so far of.
    Senator Hagan. Thank you.
    Senator Merkley. Senator Schumer.
    Senator Schumer. Thank you, Mr. Chairman.
    My first question relates a little bit to funding. We have 
heard a lot of people being critical, why didn't you know more 
about this. And, obviously, that takes staff, and you have been 
given huge amounts of responsibilities but without, in my 
judgment, the concomitant resources to fulfill all those 
responsibilities. That is one of the reasons things are taking 
longer than they should. That is one of the reasons you are not 
everywhere.
    I think one of my greatest regrets in the Dodd-Frank bill 
is we had a proposal--it did not affect the CFTC, but it 
affected the SEC--that would have allowed all of the--a little 
levy on transactions that is supposed to fund the SEC to 
actually fund the SEC, and, unfortunately, we had an 
internecine fight here, and the Appropriations Committee 
insisted on not doing that. They have increased your funding, 
but not to the extent that it would have been under Dodd-Frank, 
the proposal I had in Dodd-Frank.
    So could you talk for a minute about the funding issue and 
how vital it is, especially in relationship to the oversight 
that you are being asked to do by everyone on both sides of the 
aisle?
    Ms. Schapiro. Sure, I would be happy to start. As you point 
out, we have been asked to take on very significant new 
responsibilities, not just over-the-counter derivatives but 
hedge funds that are now registered and overseen by the SEC, 
municipal advisers, which will add many new registrants, 
specialized corporate disclosure, a whistleblower program, 
quite a lot of new responsibilities.
    In fiscal year 2012, the current fiscal year, we asked for 
116 new positions for Dodd-Frank implementation. We did get a 
very good budget for fiscal year 2012--again, not as good as 
had we been self-funded, but we were very grateful to get an 
increase at a time when many agencies did not.
    So the hiring is going on right now for those new 
positions, and I will say we have fortunately been able to 
attract tremendous talent to the SEC and very different skill 
sets than we have traditionally had.
    Senator Schumer. What about investment in technology, which 
is often more than a 1-year deal?
    Ms. Schapiro. Yes, it is, and we have made technology 
investment a significant focus of our additional resources and 
have been able to make dramatic improvements, I think, in the 
agency's core technology.
    That said, we are still way outgunned by the firms that we 
regulate in terms of technology, but we are making, I would 
say, steady progress in that regard.
    For fiscal year 2013, when many of these new rules will 
actually start to be in effect and we will have the clear 
responsibilities for oversight and monitoring of the security-
based swaps market, we have asked for an additional 273 
positions.
    Senator Schumer. So that is a lot.
    Ms. Schapiro. It is a lot.
    Senator Schumer. What are the vibes on the Appropriations 
Committee?
    Ms. Schapiro. They do not show their cards.
    Senator Schumer. Well, we hope they do soon.
    Chairman Gensler?
    Mr. Gensler. Thank you. I applaud your efforts in the Dodd-
Frank Act to get Mary's agency self-funded.
    Senator Schumer. You were in the conference committee 
trying to do the same thing, but we failed in both cases.
    Mr. Gensler. I think that this is a good investment for the 
American public. The CFTC is funded at about $205 million. But 
I liken it to football, if you are a football fan. Imagine if 
all of a sudden there was 8 times the number of teams but no 
more referees, and then instead of having seven refs on the 
field you had one on the field. What would happen? There would 
be mayhem on the field. There is sometimes mayhem in the 
financial markets anyway, but hopefully with seven refs, there 
is less of it. And the fans lose confidence, in this case 
market participants. And ultimately in these derivatives 
markets, you need the corporate end users to have confidence 
that when they enter the market, they can do it free of fraud 
and manipulation. They can enter the market with speculators on 
the other side. That is not a bad word. But that they feel that 
the market is a fair and accurate reflection of the pricing of 
risk. And so we are way underfunded at the CFTC.
    Senator Schumer. OK. I agree with your comment in reference 
to Senator Toomey that even if you think capital requirements 
are the major protection here to provide the cushion, maybe 
because you cannot regulate every single little trade, that 
transparency--that does not gainsay the need for transparency, 
so I would like to follow up on my good colleague from North 
Carolina's questions on that.
    We know from media reports that the JPMorgan losses 
involved large positions in broad-based indexes comprised of 
credit default swaps on over 100 companies. As I understand it, 
the vast majority of trades in this index are recorded in 
DTCC's Trade Information Warehouse. So that would mean 
regulators have access to some information about overall 
activity in the markets, but may not have information about 
exactly who was buying and who was selling. Is that correct?
    Mr. Gensler. That is correct, though I think as our rules 
go into effect over the course of the next several months, we 
will have that information more specifically, and we already do 
have it in the clearinghouses. A significant portion of these 
transactions dealer to dealer are in the clearinghouse.
    Senator Schumer. Right. And as I take it, the counterparty 
coding system is what you are talking about? Or will that add 
additional information?
    Mr. Gensler. Well, that will add additional information 
through--it is an international arrangement on legal----
    Senator Schumer. Right. What is the prognosis of that 
coming into effect? When?
    Mr. Gensler. Well, on the index credit default swaps, we 
finalized rules last year which go into effect 2 months after 
we finish our joint product rule--another reason we need to 
finish the joint product rule--and the legal identifiers to 
which the Senator refers, we are actually, I think, going to 
announce in a week or 2 weeks that we put it out to a service. 
Four parties came in and it looks very close that we will pick 
somebody, and that will be up and running.
    Senator Schumer. Just one more quick question, which is a 
consequence of this. Would it be possible to set up an early 
warning system that would warn us if, say, a single company 
accumulates unusually large positions in any single product? Is 
there any warning system that regulators could develop that 
could help identify risky positions?
    Mr. Gensler. I think on the first part, yes. The second, it 
is a little harder. Early warning, that is what we do now in 
the futures world, in corn and wheat, and even interest rate 
products.
    Senator Schumer. Right.
    Mr. Gensler. We hope and plan to do that in the swaps 
products.
    Senator Schumer. It is harder to do, I guess, because they 
are more complicated?
    Mr. Gensler. More complicated, but once we have the 
information and tie into it and have the funding, we meet every 
Friday in a closed-door surveillance meeting where we go over 
significant positions in the markets.
    Senator Schumer. So you think your surveillance is going to 
get better?
    Mr. Gensler. It is going to get better, but underfunded, it 
is stretched and thin, and something is going to give. It could 
give in the wheat market. It could give in the oil markets. But 
something will give.
    Senator Schumer. Do you have any comment on that, Chairman 
Schapiro?
    Ms. Schapiro. No, I think the clearinghouses also 
obviously, to the extent these instruments are mandatorily 
cleared, will have clear insight into early warning levels, 
concentrations by particular firms, and be in a position to 
adjust the margin requirements to account for that.
    Mr. Gensler. I might just add, the clearinghouses, the two 
main clearinghouses, one is called ICE Clear Credit here in the 
United States and ICE Clear Europe over in Europe, have a 
concentration where, when positions get large, they actually 
add additional margin on top, and without getting into the 
details, you can imagine what happened here.
    Senator Schumer. Yes, you can.
    Thank you, Mr. Chairman.
    Senator Merkley. So we are going to have additional 5-
minute rounds. Senator Shelby.
    Senator Shelby. Thank you. I would like to go back to MF 
Global, if I could, Mr. Chairman. Chairman Gensler I am 
referring to. Chairman Gensler, this Banking Committee's due 
diligence has basically revealed to a lot of us that you played 
an active role in the oversight of MF Global during the week 
leading up to its failure. We would like to know how many 
conversations did you have with MF Global CEO Jon Corzine 
during MF Global's final week. And during these conversations, 
were there any discussions about possible shortfalls in 
customer accounts? This is central to what we are looking at.
    Mr. Gensler. I thank you for that question. I had no 
individual conversations with Jon Corzine. I did participate on 
that Sunday on a group call with Chairman Schapiro, our staff, 
her staff--I think New York Fed and the London regulators were 
on as well--with presentations coming over a conference call 
with 40, 60 people on it, which I believe once or twice Jon 
Corzine spoke up and gave some information.
    If I could answer your further question, I think, about 
what was my role that weekend, would that be helpful? During 
that week----
    Senator Shelby. You were the Chairman--and you still are--
on that day.
    Mr. Gensler. Yes, yes, yes.
    Senator Shelby. Of the CFTC. Go ahead. What was your role 
as Chairman?
    Mr. Gensler. My role as Chairman of the CFTC, as that week 
developed and the firm looked to be in a frail state, to ensure 
for the movement of customer money, over that weekend we were 
informed by other regulators--FINRA, actually, I think was the 
first one to inform us, and I compliment them for that--that 
there were negotiations going on to move the position. So we 
wanted to ensure that those customer monies and positions were 
moved. We were assured from the company and from the first-line 
regulators, Chicago Mercantile Exchange, that all the monies 
were there. It was only about 2:30 in the morning when I was 
woken on Monday, the 31st of October, that I learned of the 
shortfall. But the Sunday was really about moving the 
customers, and the key focus--we did not care beans about Jon 
Corzine. We cared about the thousands of customers that needed 
those monies moved, and we were assured all the money was there 
and CME had been checking the books.
    Senator Shelby. How many people did you roughly have onsite 
at MF Global?
    Mr. Gensler. I am not aware of the number, whether it was--
it was less than a handful, but I think starting Thursday, we 
sent some folks in on Thursday. Friday, the full Commission in 
our surveillance meeting got a briefing that Friday morning. 
And the briefing was that they were in what is called 
``segregation compliance.'' But then over the weekend, we kept 
asking questions for more details because, you know, we wanted 
to see the details. It was not fully forthcoming, but by 
Sunday, we were on these joint calls together, the SEC and 
others, and hearing, no, it is all there. And then we actually 
asked to talk to the buyer late Sunday night--Interactive 
Brokers it was at the time--to see that they were guaranteeing 
that they would ensure all the monies as well.
    Senator Shelby. So that was the steps you are relating that 
you took to protect the customers' assets after learning that 
customer assets were missing?
    Mr. Gensler. Well, no. All throughout the weekend, we were 
assured by the company and also the front-line regulators they 
were in compliance. The law is that 24 hours a day, every 
minute of every day, one is to be in compliance, and one must 
report if you are not.
    Senator Shelby. You are either in compliance or you are 
not, right?
    Mr. Gensler. Yes, it is just--it is really straightforward.
    Senator Shelby. And you are supposed to protect your 
customers' funds separately. Is that right?
    Mr. Gensler. Absolutely. It is at the critical heart of 
the----
    Senator Shelby. So when we talk about segregated accounts, 
that is what you are talking about?
    Mr. Gensler. That is what we are--and people here, I agree 
with you, sir, were hurt because that did not happen. I am not 
involved in the specific investigation, and I chose--even 
though the General Counsel and the Chief Ethics Officer said I 
could be, I said I thought that once it turned to an 
investigation that specifically was about Jon Corzine possibly, 
I thought that made sense to step aside.
    Senator Shelby. Let me ask you this question, Mr. Chairman. 
On what date and at what time did the CFTC staff first learn 
that there was a possible shortfall in the customer segregated 
accounts?
    Mr. Gensler. Well, I can only speak to what I remember, but 
what I remember was being woken up at 2:30 in the morning by--
--
    Senator Shelby. Was that on Sunday?
    Mr. Gensler. No. Monday.
    Senator Shelby. Monday morning.
    Mr. Gensler. Well, technically the 31st of October.
    Senator Shelby. OK. And after you learned there at 2:30 in 
the morning on Monday or Sunday night of the missing customer 
assets, what specific steps did you take to ensure that 
customer funds were not improperly transferred over the weekend 
before the firm failed?
    Mr. Gensler. Well, this was already Monday. I put on my 
bathrobe and I went to a conference call and joined it with 
other regulators, and I think it was 4 to 6 hours later that it 
was put into a SIPC proceeding.
    Senator Shelby. On October 30, 2011, a CFTC employee gave 
to CME, Chicago Mercantile Exchange, employees a disk 
containing documents to support MF Global's October 26, 2011, 
segregated funds statement, which initially showed no 
shortfall. When did the CFTC, Mr. Chairman, receive this disk 
from MF Global?
    Mr. Gensler. I am not familiar with the disk, Senator.
    Senator Shelby. You are not familiar. OK. It is our 
understanding that the CFTC did receive the disk and that the 
CFTC began reviewing the documents of the disk, and we would 
like to know when, and I will ask you for the record. And what 
was the result of this review of these documents? And did it 
show any shortfall? I think we would like to know, and if you 
do not know, you can get this information----
    Mr. Gensler. So if the General Counsel could follow up and 
make sure that you get the information that you asked for.
    Senator Shelby. For the record.
    Mr. Gensler. For the record.
    Senator Shelby. OK.
    Senator Shelby. Chairman Gensler, in May, about a year ago, 
May 2011, FINRA determined that MF Global had a capital 
deficiency. MF Global CEO Jon Corzine personally appealed that 
decision to the SEC, chaired by Chairman Schapiro. The SEC 
upheld FINRA's determination, and MF Global publicly reported 
the deficiency in August of 2011.
    When did the CFTC first learn that MF Global had a capital 
deficiency?
    Mr. Gensler. Again, if I----
    Senator Shelby. Did you learn it then? Or did you never 
learn it. Go ahead.
    Mr. Gensler. Again, if I could have the General Counsel 
follow up on the specifics, but as I recall, my own memory was 
over the course of that summer. But they could follow up as to 
specifics if there was a date that the staff learned it.
    Senator Shelby. Well, that goes to the heart--and I would 
be interested in the answer--of the SEC and the CFTC's 
coordination of the regulation. So if the SEC did something 
that they should have, upheld the FINRA determination, and if 
the CFTC did not know that, then there is a problem. But if you 
did know it and did not do anything about it, that is a 
problem.
    Mr. Gensler. My memory is that there was coordination, but 
as to the specific dates and times, that I do not recall.
    Senator Shelby. Thank you, Mr. Chairman.
    Senator Merkley. Senator Warner.
    Senator Warner. Thank you, Mr. Chairman, and I apologize 
for being out for so long. Maybe I will--I do not have a 
specific question on MF Global, but there are two quick 
questions I would like to ask and get on the record. One is, I 
mean, some of the items that Senator Shelby was mentioning was 
this issue of coordination between your two agencies on 
approach to rule implementation. One of the things that I have 
been concerned for some time on is that in Dodd-Frank, very 
active in Title I and Title II, and we created the Financial 
Stability Oversight Council to try to have this forum for what 
I thought at least or hoped would be resolution of areas where 
there might be this rubbing. I was particularly interested in 
one area. I think Senator Shelby did not agree with me on this 
one, but on the OFR, which would be, in effect, the independent 
repository of data and information so that the FSOC could have 
the ability to adjudicate, if need be, between different 
interpretations or conflicts on agency promulgation or on rule 
promulgation.
    We are very concerned that the Administration has been a 
little bit slow on getting the OFR nominee. They now have one 
together to get passed, but I would like you to weigh in on 
FSOC's ability to--maybe not so much with the MF Global 
circumstance but be that adjudicating body where issues rise 
up, and has it been effective or not. Either one--and I have 
got one follow-up as well.
    Ms. Schapiro. I am happy to start. I actually think FSOC 
has turned out to be a very good forum for the agencies to 
share concerns and ideas and differences as they arise and have 
a discussion and hear the views of other people from their 
unique perspectives regulating different types of institutions 
but all connected within the financial markets. So I think we 
are working on our next annual report that will try to lay out 
the systemic risk issues that we see facing the economy. Every 
agency contributes to that, and those particular issues become, 
you know, very lively discussions for how to approach 
particular problems.
    I think OFR hopefully is starting to get going in a more 
meaningful way, and I think it can be an important adjunct to 
the work of the individual agencies with respect to data 
collection and analysis in particular. But I think it is 
working pretty well, and I think one of the real side benefits 
of FSOC has been it has enabled us to develop much stronger 
bilateral relationships within FSOC as well, and Dodd-Frank has 
done that because of the necessity to write joint rules.
    Senator Warner. Thank you.
    Chairman Gensler?
    Mr. Gensler. I would say having witnessed what was its 
predecessor, the President's Working Group, both in the 1990s--
being honored to serve then--and in this Administration, I 
think it is a real enhancement. It is more formal, and so with 
formality sometimes there is not as much flexibility, but I 
think it is a big enhancement. It has not been tested in two 
ways yet. It really has not been tested in a real crisis again. 
So, I mean, that has yet to happen. But I think it will serve 
better than just the old President's Working Group. And it has 
not truly been tested, as you say, when two agencies have a 
knock-down, drag-out disagreement. It has been helpful, though, 
to smooth through some smaller differences, and I think it has 
been positive in that way.
    Senator Warner. Well, my hope would be that the OFR would 
be that kind of--at least the data analysis--because my concern 
is you are going to get data from different agencies coming in 
that may be completely counter to each other. And somebody--you 
have got to have a trusted independent entity in there sorting 
through that.
    I know my time is about up. Let me ask one last question 
and, again, not directly related to the JPMorgan issue, but, 
you know, one of the challenges we have on the international 
implementation is when we have a large American entity that has 
got a foreign sub and you have got then a foreign counterparty 
to that American foreign-based subsidiary, and how we deal with 
the extraterritorial application of U.S. laws, how do we do 
that vis-a-vis foreign laws, you know, what is your state on--
what is your sense on the whole international implementation 
question, and particularly in terms of counterparties, foreign 
counterparties?
    Mr. Gensler. I think we have made real progress, but there 
will be differences between Europe, the United States, Canada, 
Japan, and other jurisdictions. So then you get to this 
question of cross-border transactions. We are a believer in 
substituted compliance where we rely on some compliance regime 
overseas, but we also are a believer in learning from 
experience. And in 2008, in the three or four biggest 
circumstances--AIG, Lehman Brothers, Citigroup, Bear Stearns--
they all had offshore entities either in the Cayman Islands or 
in London or branches of French banks in London. And we have to 
learn from those experiences and not be, excuse me, naive that 
Wall Street will structure around these things. Some of these 
large institutions have thousands of legal entities. Long-Term 
Capital Management was the same. It was in the Cayman Islands, 
actually, even though it operated out of Connecticut.
    So we have to be thoughtful and cover a lot of those 
transactions and not just leave it to say, well, my guaranteed 
affiliate will meet your guaranteed affiliate in London, 
because that is the worst outcome. The risk will all flow back 
here, but the jobs will move overseas. And that seems like that 
is a bad place to be.
    The second thing, though, I think we can, even if it is our 
guaranteed affiliate meeting your guaranteed affiliate in 
London, that still might be that we rely on substituted 
compliance where we can.
    Ms. Schapiro. I would just add that rather than deal with 
these issues rule by rule, we are going to lay out sort of a 
comprehensive approach to cross-border application, and we will 
propose that before we start to adopt final rules other than 
the definitional rules so that it can inform actually the reach 
of each and every rule as we go ahead and adopt them. And I 
think that will give everybody an opportunity to sort of see 
the entire picture of proposed rules and how we expect them to 
apply extraterritorially and comment to us on that.
    We know foreign regulators have a deep interest in this, 
and it is a very intense part of the discussion that Gary and I 
have with our foreign counterparts.
    Mr. Gensler. And I would also add that if an overseas 
affiliate, not a branch, but if an overseas affiliate is 
dealing with some insurance company in Germany, we want to make 
sure that they have a competitive field, that they can compete 
just like, you know, a Barclays Bank or Deutsche Bank might do 
as well. So it is trying to get that balance as well.
    Senator Warner. Thank you, Mr. Chairman.
    Senator Merkley. Thank you, Senator Warner.
    Chairman Schapiro, you mentioned twice the list of factors 
that were essentially the ways to define risk mitigation that 
were in the Volcker Rule statute, and related issues in there 
were that you were addressing a specific risk, that it is 
correlated, and it does not give rise to significant exposure 
that you did not have to begin with. And often if you think 
about, for example, a company that has funds in between making 
loans under the liquidity rule and chooses to do some corporate 
bonds, assuming those will be allowed, then the first easiest 
thing, if you get worried about the quality of those bonds, 
which had been described as kind of extraordinarily high-
quality bonds, but you get worried about it, you can reduce 
your exposure just by selling the bonds. So that is strategy 
one.
    Strategy two is you can take insurance directly against 
those bonds. That is certainly specifically insurance on a 
specific position you have.
    Then you start getting further and further afield. You can 
kind of imagine this spectrum of positions that are further 
afield where then you choose to do an index rather than insure 
the specific bonds that you have. And then you choose to do a 
particular tranche in the waterfall, and then you decide you 
need to raise income to pay for your insurance, so you sell 
some insurance against something else.
    At that point, it seems to me you have clearly crossed the 
line in which you have introduced by selling insurance to 
others. You are in a whole different world of risk 
introduction.
    So you have these two components being correlated to begin 
with and not introducing additional risk. Part of the challenge 
of the regulators is to kind of define this world. One of you 
cross the line from risk mitigation to simply having an excuse 
to do hedge fund-style trading.
    Where do you see that line being drawn in that kind of 
progression of tightly correlated direct insurance to remotely 
correlated?
    Ms. Schapiro. Well, I agree with you it is a continuum, and 
there are very plain vanilla ways to hedge, and those may even 
be more or less perfect hedges, and then there is a long 
continuum to something like portfolio hedging or maybe perhaps 
stepping off the hedging bandwagon entirely and being in the 
world of prop trading or speculating. And I think--we recognize 
that all hedges will not be perfect and that this is a 
continuum, and finding that point will be difficult. I think 
that is what the metrics are designed to help us do, and we 
proposed lots of metrics, and Senator Toomey mentioned some of 
them. I do not think there is an expectation that all of those 
will make it into the final rule. But the goal there is to help 
us see how behavior changes over time within a firm, how 
transactions change over time as a way to see whether things 
that are hedging are moving into a different realm.
    But that is clearly the difficult piece of this, is to find 
where something is no longer a hedge and how we can define 
that, and not in so specific a way that we have just opened the 
door to lots of other conduct.
    Senator Merkley. Would you say that it would be a red flag 
if--I will give you some examples. One, if the hedges only 
loosely correlated when there was a tightly correlated 
instrument available, would it be a red flag if you are buying 
insurance to insure a larger quantity than you actually are 
holding? And would it be a red flag if you are suddenly in the 
business of selling insurance?
    Ms. Schapiro. It might well be because then you have got a 
hedge transaction that is giving rise potentially to 
significant exposures that were not there at that inception 
because you have overhedged the position.
    You have to be able, it seems to me, to identify the 
positions that are being hedged and demonstrate that the hedge 
is, in fact, risk reducing. And to me, I keep going back to--
and you and I have talked about this--the risk mitigation is an 
important piece of how we are describing the hedging here. But 
I think if you take all those factors together, you can build a 
pretty strong wall around this conduct.
    Senator Merkley. One of the things that Senator Levin and I 
had said on the floor in our colloquy was you really need--and 
you just said it so I want to re-emphasize it. You need to 
identify the specific assets, and you need to identify the 
specific risk that you are hedging, so that then at least gives 
the regulators a sense of, well, what was this trade all about. 
If you cannot identify the risk that you are hedging, then it 
is very hard to get your hands around it whether was 
appropriate or not.
    Ms. Schapiro. Right, and I think to Senator Toomey's point, 
that does not mean it has to be positioned--extraordinarily 
expensive to hedge and counterproductive, frankly, to hedge 
position by position. But there is something between position 
by position and complete speculation.
    Senator Merkley. Chairman Gensler?
    Mr. Gensler. I said earlier I think this is one of the more 
challenging tasks that the regulators have been given, to ban, 
prohibit proprietary trading, permit market making, permit 
hedging
    To your question about hedging, I think hedging really does 
have to lower risk. That is what Congress wanted, I think, in 
this provision. And they come and they do overlap. I mean, it 
is not a perfect circumstance. So it is our challenge amongst 
the regulators to do as Congress said, to say if it is hedging 
a specific risk, individual or aggregate positions, but it 
should be--we put in the rule proposal ``reasonably 
correlated.'' Maybe that word ``reasonably'' needs more 
definition. I think that it can start to morph and mutate when 
you have a separate desk and they have a separate profit and 
loss and they are motivated at times to take on positions or 
even swing for the fences for a little bit of the extra 
potential for that desk to have profits.
    My own experience on Wall Street is long ago, but I will 
say that when I saw these desks, they sometimes worked for 18 
to 24 or 36 months, and then they usually took a big loss, and 
then they would be maybe shut down. Then several years later, 
they would sort of come up again. I might be old-fashioned. I 
liked it when you could tie the hedge somewhere reasonably to 
the positions.
    Senator Merkley. Well, indeed, that word ``reasonably'' is 
in the statute, and the reason it was put there is because the 
word ``correlated'' by itself would suggest that something 
could be barely coordinated and meet the--or correlated and 
meet the test. So it did place the--you know, the challenge to 
the regulators is define ``reasonably.'' But it certainly was 
in all of the conversation meant to identify the specific risk 
and have something as directly related to insuring against that 
risk or hedging that risk as possible.
    Senator Warner, did you want to take an additional time 
period? We have each had our second period.
    Senator Warner. I will just add one question I was----
    Senator Shelby. No, go ahead. Let him go.
    Senator Warner. Are you sure?
    I was interested in the line that Senator Merkley was 
pursuing because I do think it is where the rubber hits the 
road. What is reasonable? What is that connectivity? In a 
certain sense, it may be--you know, if we were going to have an 
incident like this, it could be a blessing that it was 
happening with the strongest financial institution we have in 
the country, and thank goodness we already have in place higher 
capital requirements, so there is not a systemic risk or a risk 
to the institution, at least at this point. But I do want to 
get to the point of liquidation and how it relates to 
derivatives a little bit.
    One of the things--thank goodness, the case that Senator 
Merkley was talking about did not result in an institution 
going down, but one of the things I think we all worked very 
hard together--and actually, Senator Shelby, on Title I and II 
we got 85 votes on your and Senator Dodd's approach on that--
was to make sure that any institution that goes into 
liquidation, while we maintain the systemic important parts, 
the institution is liquidated. And while neither one of your 
agencies is going to be--and we do not have taxpayer support, 
and that while neither one of your agencies is going to be 
directly involved in that liquidation process, clearly the 
question of how you clear and handle the derivatives that might 
be involved in that institution, the swaps, is an issue that is 
terribly important. I would just be curious, you know, how you 
are doing on thinking through that portion of the liquidation 
process.
    Mr. Gensler. I think that central clearing does help that. 
In these credit default swap indices, there is central clearing 
currently just dealer to dealer. So the dealers facing a hedge 
fund are not yet in, and I think that will help a lot.
    We have spent a lot of time at the CFTC with the FDIC on 
Title II just to give them advice and thoughts on it. I think 
the most challenging piece is on the swaps that are not cleared 
because they still leave this tangled web of 
interconnectedness, and that is why it is so critical, we also 
think, to get the margin rules right, the dealer-to-dealer, 
particularly that there is margin being collected--not against 
the commercial end users--I always have to say that--but 
between the financial institutions and particularly between the 
dealers.
    Senator Warner. And you think you are--are you dealing with 
both FDIC and the Fed on this?
    Mr. Gensler. Yes, and we have had some even, I will call 
them colloquially, ``tabletops'' where we take hypothetical--
not a real company, but we sort of think it through.
    There is a challenge in one provision in Title II with the 
uncleared swaps, the stay provision, and if they are stayed for 
a day, you might remember----
    Senator Warner. I do remember that----
    Mr. Gensler.----worked on that.
    Senator Warner. Very much.
    Mr. Gensler. What uncertainty would be in the market. It 
seems that these weekends, everything is challenging to get it 
done before the Japan or Australia opens, which is Sunday 
around 5 o'clock. But then there might be this 24-hour stay in 
the uncleared swaps, and that is an interesting set of 
challenges I hope I never face.
    Senator Warner. Chairman Schapiro.
    Ms. Schapiro. I really agree with what Chairman Gensler 
said.
    Senator Warner. Thank you, Mr. Chairman.
    Senator Merkley. Senator Shelby.
    Senator Shelby. Thank you, Mr. Chairman.
    Mr. Chairman, I have a few observations. Do both of you 
agree that you cannot take risk out of a marketplace?
    Mr. Gensler. Absolutely. Risk is part of a marketplace and 
these large financial institutions help our society manage that 
risk.
    Senator Shelby. Right, right.
    Do you agree with that?
    Ms. Schapiro. You cannot take it out, and we should not 
try.
    Senator Shelby. OK. So if you micromanage what entities are 
doing--for example, JPMorgan. JPMorgan is a huge bank. 
Obviously, it would be hard to micromanage them to begin with. 
But if they have got capital and if it is no risk to the 
taxpayer--I was thinking about what Senator Toomey was talking 
about, which I associate my remarks with--I do not know of 
any--I have said it here for years--bank or financial 
institution that has been well capitalized, first; second, well 
managed and well regulated that has gotten in trouble. I do not 
know of any. If you have got one, tell us about it.
    So capital I believe is number one, to make sure that the 
banks are adequately capitalized. And I guess it is up to you 
to determine the difference between speculation and investment. 
It might be hard at times. I probably could recognize it if I 
saw it, but maybe not, because somebody might be speculating 
and call it an investment. I do not know how you get around 
that. But I do believe that you cannot take risk out of the 
marketplace, and I hope you as regulators will not try to do 
that.
    Mr. Gensler. I agree with that, but I would hope--if I can 
one more time say I think the transparency--the more 
transparent markets are, it is harder to misunderstand the 
risks that you have. The risk gets priced in a marketplace, and 
it might not be pleasant. I might be actually quite painful at 
times. But if you are well managed and you say, look, that risk 
is being priced differently than I thought, I am just going to 
have to eat my beans here and, you know, mark the position 
differently. Without that transparency, a lot of times things 
then start to get poorly understood, poorly managed, and so 
forth.
    Senator Shelby. Well, I agree. We should not let, you 
should not let institutions that you regulate operate in a dark 
hole somewhere. They cannot do it.
    Thank you, Mr. Chairman.
    Senator Merkley. Thank you. I think we are on the point of 
wrapping up. I will----
    Senator Warner. Mr. Chairman, could I just add----
    Senator Merkley. Senator Warner.
    Senator Warner. I love my friend Senator Shelby, and I 
agree you cannot take risk out, and I agree capital--but there 
is some point we can have such high capital standards we make 
our banks noncompetitive, too. So getting that balance right I 
do think the leverage ratios, having this view that looks 
beyond the single institution because, as I think was made 
mention, many of these institutions have literally thousands of 
subs. That is why the FSOC having that ability to raise up 
these issues to some higher level above the silos I think is 
important. But I could not agree with you more. You cannot take 
risk out of the marketplace.
    Senator Merkley. Well, and I would add to that. I would add 
that if you think about hedge fund-style investing, the 
aggregation of capital, and it is going to go wherever, the 
question is not whether it is risky. Yes, of course, it is 
risky. The question is: Is it going to be subsidized by 
taxpayer-insured deposits? And the second question is, when 
occasionally those investments or those bets go bad, whether it 
is simply going to, if you will, blow up or melt down the 
investments of the investors or whether it is going to 
reverberate in a way that affects a broader access to capital 
by businesses and families. And that is, of course, back to the 
whole theory of the firewall between traditional deposit-
taking/loan-making banking and hedge funds. So I think it is 
compatible with that notion that you cannot take out the risk.
    I thank you all very much for your testimony and for the 
dialogue and for the Members. Oversight of the derivatives 
markets remains an important issue for this Committee, and the 
Committee Members look forward to working with both of you and 
your agencies to ensure that the implementation of derivatives 
reform improves protections for the American people and our 
financial system.
    Thank you. The hearing is adjourned.
    [Whereupon, at 11:58 a.m., the hearing was adjourned.]
    [Prepared statements, responses to written questions, and 
additional material supplied for the record follow:]
                 PREPARED STATEMENT OF MARY L. SCHAPIRO
              Chairman, Securities and Exchange Commission
                              May 22, 2012
    Chairman Johnson, Ranking Member Shelby, and Members of the 
Committee:

    I appreciate the opportunity to testify regarding the Securities 
and Exchange Commission's ongoing implementation of Title VII of the 
Dodd-Frank Wall Street Reform and Consumer Protection Act (``Dodd-Frank 
Act'' or ``Act'').
    As you know, Title VII creates an entirely new regulatory regime 
for over-the-counter (``OTC'') derivatives. To that end, it directs the 
Commission and the Commodity Futures Trading Commission (``CFTC'') to 
write a number of rules necessary to implement the statutory regime. 
Since the Dodd-Frank Act was enacted in July 2010, the Commission has 
proposed most of the rules required by Title VII. We are continuing to 
work diligently to implement all provisions of Title VII, and to 
coordinate implementation with the CFTC and our fellow regulators 
overseas.
    My testimony today will provide an overview of these efforts to 
implement Title VII, emphasizing the Commission's activities since I 
last testified before this Committee on Dodd-Frank Act implementation 
in December.
Background
Title VII of the Dodd-Frank Act
    Title VII of the Dodd-Frank Act mandates the oversight of the OTC 
derivatives marketplace and requires that the Commission and the CFTC 
write rules that address, among other things, mandatory clearing, the 
operation of security-based swap and swap execution facilities and data 
repositories, capital and margin requirements and business conduct 
standards for security-based swap and swap dealers and major 
participants, and regulatory access to--and public transparency for--
information regarding security-based swap and swap transactions.
    Under the Dodd-Frank Act, regulatory authority over swaps is 
divided between the Commission and the CFTC. The law assigns the 
Commission the authority to regulate ``security-based swaps.'' The 
CFTC, on the other hand, has primary regulatory authority over 
``swaps,'' which represent the overwhelming majority of the overall 
market for over-the-counter derivatives subject to Title VII.
    With respect to the Commission's efforts, this series of 
rulemakings is designed to improve transparency and facilitate the 
centralized clearing of security-based swaps, helping, among other 
things, to reduce counterparty risk. It also is designed to enhance 
investor protection by increasing disclosure regarding security-based 
swap transactions and helping to mitigate conflicts of interest 
involving security-based swaps. By promoting transparency, efficiency, 
and stability, this framework is intended to foster a more nimble and 
competitive market.
Ongoing Regulatory Coordination with the CFTC and Other Regulators
    In implementing Title VII, our staff is in regular contact with the 
staffs of the CFTC, Federal Reserve Board, and other financial 
regulators. In particular, Commission staff has consulted and 
coordinated extensively with CFTC staff in the development of the joint 
definitional rules arising under Title VII, including joint rules 
further defining key terms related to the products covered by Title 
VII, which we expect to finalize in the near term, and other joint 
rules further defining certain categories of market participants, which 
we adopted last month. Although the timing and sequencing of the CFTC's 
and Commission's proposal and adoption of rules may vary, they are the 
subject of extensive interagency discussions. As we continue with the 
implementation of the rules contemplated by Title VII, the objective of 
consistent and comparable requirements will continue to guide our 
efforts.
    The Dodd-Frank Act also specifically requires that the Commission, 
the CFTC, and the prudential regulators ``consult and coordinate with 
foreign regulatory authorities on the establishment of consistent 
international standards'' with respect to the regulation of OTC 
derivatives.
    Accordingly, the Commission is actively working on a bilateral and 
multilateral basis with our fellow regulators abroad to address the 
regulation of OTC derivatives.
    Through these discussions and our participation in various 
international task forces and working groups, we have gathered 
extensive information about foreign regulatory reform efforts, 
identified potential gaps, overlaps and conflicts between United States 
and foreign regulatory regimes, and encouraged foreign regulators to 
develop rules and standards complementary to our own under the Dodd-
Frank Act. Such efforts include frequent communications and meetings 
with the European Union and other major foreign regulatory 
jurisdictions in Asia and North America. Representatives from the 
Commission also participate in the Financial Stability Board's Working 
Group on OTC Derivatives Regulation, of which a Commission 
representative serves as one of the co-chairs on behalf of the 
International Organization of Securities Commissions (``IOSCO''), and a 
Commission representative serves as one of the four co-chairs of the 
IOSCO Task Force on OTC Derivatives Regulation. In addition, 
representatives from the Commission, the CFTC, and a number of 
international regulators have met twice, most recently this month, to 
address cross-border issues related to the implementation of new 
legislation and rules to govern the OTC derivatives markets in their 
respective jurisdictions.
    As we continue with the adoption of the Title VII rules, we remain 
committed to consulting with other regulators at home and abroad in an 
effort to foster the development of common frameworks and to help 
ensure a level playing field for market participants.
Next Steps for Implementation of Title VII
    In the near term, the Commission expects to complete the last of 
the core elements of our proposal phase, in particular, rules related 
to the financial responsibility of security-based swap dealers and 
major security-based swap participants. We also expect to complete our 
joint rulemaking on the product definitions with the CFTC in the very 
near term. Final product definitions will help inform derivatives 
market participants what products would be subject to the new swap and 
security-based swap requirements, which we view as a crucial step in 
establishing the Title VII regulatory regime. Importantly, the adoption 
of final product definitions will not trigger compliance with any rules 
the Commission is adopting under Title VII, or related statutory 
requirements. Instead, the compliance dates applicable to specific 
rules adopted by the Commission under Title VII, and related statutory 
requirements, will be set forth in those final rules.
    The Commission also is continuing to develop a policy statement 
regarding how the substantive requirements under Title VII within its 
jurisdiction will be put into effect. This policy statement would be 
designed to establish an appropriate and workable sequence and timeline 
for the implementation of these rules. As a purely practical matter, 
certain of these rules will need to go into effect before others can be 
implemented, and market participants will need a reasonable, but not 
excessive, period of time in which to comply with the new rules 
applicable to security-based swaps. This statement should give market 
participants a degree of clarity as to how the Commission, in general, 
is thinking of ordering the compliance dates of the various sets of 
rules under Title VII. We intend to publish this policy statement for 
public comment in the very near term.
    Additionally, because the OTC derivatives market has grown to 
become a truly global market in the last three decades, we are 
continuing to evaluate carefully the international implications of 
Title VII. The development of our cross-border approach is being 
informed by our discussions with the CFTC and our fellow regulators in 
other jurisdictions.
    Rather than deal with the international implications of Title VII 
piecemeal, we intend to address the relevant issues holistically in a 
single proposal. The publication of such a proposal is intended in part 
to give investors, market participants, foreign regulators, and other 
interested parties an opportunity to consider as an integrated whole 
our proposed approach to the registration and regulation of foreign 
entities engaged in cross-border transactions involving U.S. parties. 
The Commission therefore anticipates that this release will be 
published prior to the finalization of the rules discussed therein so 
that the comments received can be taken into account in drafting the 
final rules.
    The application of Title VII to cross-border transactions raises a 
substantial number of complex issues. Among other things, it requires 
consideration and appreciation of foreign regulatory frameworks and of 
competition concerns. This is not an easy task. However, I believe that 
the publication of a fully developed, comprehensive SEC proposal to 
address these issues, and the opportunity for all interested parties to 
comment on this proposal, will significantly advance the level of 
understanding, and greatly facilitate public dialogue, on these issues.
Title VII Implementation to Date
Adoption of Entity Definitions Rulemaking
    Since I last testified before this Committee on Dodd-Frank Act 
implementation, the Commission has adopted final rules and 
interpretations jointly with the CFTC that further define the terms 
``swap dealer'', ``security-based swap dealer'', ``major swap 
participant'', ``major security-based swap participant'', and 
``eligible contract participant''. In developing these definitions, the 
Commission was informed by existing information regarding the single-
name credit default swaps market, which will constitute the vast 
majority of security-based swaps. The finalization of the entity 
definitions rulemaking is a foundational step toward the complete 
implementation of Title VII.
    The entity definitions rulemaking defines the term ``security-based 
swap dealer'' and adopts interpretations providing guidance as to how 
the dealer-trader distinction applies to activities involving security-
based swaps. This guidance describes what constitutes dealing activity 
and distinguishing dealing from nondealing activities such as hedging.
    The rulemaking also implements the Dodd-Frank Act's statutory de 
minimis exception to the security-based swap dealer definition in a way 
that is tailored to reflect the different types of security-based 
swaps. To do so, the rulemaking exempts those entities or individuals 
who engage in dealing activity in security-based swaps below a certain 
notional dollar amount over a 1-year period. The rule includes a phase-
in of the exemption over time in a way that promotes the orderly 
implementation of Title VII.
    In establishing who is a security-based swap dealer, Title VII gave 
us the task of identifying those entities that engage in dealing 
activity in security-based swaps. Title VII does not require most 
market participants that engage in security-based swaps--such as mutual 
funds and pension funds--to be regulated as dealers. In addition, Title 
VII calls for only those dealers acting above a de minimis level to be 
regulated as dealers. We followed the statutory language to bring 
dealers acting above a de minimis level under the Commission's direct 
oversight, and in so doing we have ensured that the vast majority of 
notional dealing activity in this market will be subjected to the SEC's 
Title VII dealer regulatory regime.
    Additionally, the rulemaking implements the Dodd-Frank Act's 
``major security-based swap participant'' definition through the use of 
three objective tests.
    The analysis of single-name credit default swap data conducted by 
the Commission's Division of Risk, Strategy, and Financial Innovation 
was especially informative in the development of this rule. This 
analysis provided critically important information regarding potential 
dealing activity in the credit default swap market, which helped the 
Commission shape the final rules and evaluate the economic consequences 
of these rules. Nonetheless, the Commission has directed the staff to 
report to the Commission on whether changes are warranted to the rules 
based on an analysis of data after relevant provisions of Title VII are 
implemented. This report stems, in part, from the fact that the entity 
definition rules were developed based on our understanding of the 
existing market and currently available data. The report--together with 
the associated public comment--is intended to help the Commission 
thoroughly evaluate the practical implications and effects of the 
entity definition rules following the regulation of dealers and major 
participants pursuant to Title VII, using data reflective of the newly 
regulated market.
    Although the entity definition rules technically will be effective 
in the near term, security-based swap dealers and major security-based 
swap participants will not be required to register with the Commission 
until the dates provided in the Commission's final rules for the 
registration of security-based swap dealers and major security-based 
swap participants, which are to be adopted at a later point in time.
Additional Actions
    The Commission staff continues to work diligently to develop 
recommendations for the Commission to adopt final rules in each of the 
twelve areas required by Title VII where rules have been proposed:

    Joint rules with the CFTC regarding further definitions of 
        the terms ``swap,'' ``security-based swap,'' and ``security-
        based swap agreement;'' the regulation of mixed swaps; and 
        security-based swap agreement recordkeeping;

    Rules prohibiting fraud and manipulation in connection with 
        security-based swaps;

    Rules regarding trade reporting, data elements, and real-
        time public dissemination of trade information for security-
        based swaps that would lay out who must report security-based 
        swaps, what information must be reported, and where and when it 
        must be reported;

    Rules regarding the obligations of security-based swap data 
        repositories that would require them to register with the 
        Commission and specify the extensive confidentiality and other 
        requirements with which they must comply;

    Rules relating to mandatory clearing of security-based 
        swaps that would establish a process for clearing agencies to 
        provide information to the Commission about security-based 
        swaps that the clearing agencies plan to accept for clearing;

    Rules regarding the exception to the mandatory clearing 
        requirement for hedging by end users that would specify the 
        steps that end users must follow, as required under the Dodd-
        Frank Act, to notify the Commission of how they generally meet 
        their financial obligations when engaging in security-based 
        swap transactions exempt from the mandatory clearing 
        requirement;

    Rules regarding the confirmation of security-based swap 
        transactions that would govern the way in which certain of 
        these transactions are acknowledged and verified by the parties 
        who enter into them;

    Rules defining and regulating security-based swap execution 
        facilities, which specify their registration requirements, and 
        establish the duties and implement the core principles for 
        security-based swap execution facilities specified in the Dodd-
        Frank Act;

    Rules regarding certain standards that clearing agencies 
        would be required to maintain with respect to, among other 
        things, their risk management and operations;

    Rules regarding business conduct that would establish 
        certain minimum standards of conduct for security-based swap 
        dealers and major security-based swap participants, including 
        in connection with their dealings with ``special entities,'' 
        which include municipalities, pension plans, endowments and 
        similar entities;

    Rules regarding the registration process for security-based 
        swap dealers and major security-based swap participants; and

    Rules intended to address conflicts of interest at 
        security-based swap clearing agencies, security-based swap 
        execution facilities, and exchanges that trade security-based 
        swaps.

    To facilitate clearing of security-based swaps, the Commission 
adopted final rules providing exemptions for security-based swaps 
transactions involving certain clearing agencies satisfying certain 
conditions. We also readopted certain of our beneficial ownership rules 
to preserve their application to persons who purchase or sell security-
based swaps.
    Moreover, the Commission took a number of steps to provide legal 
certainty and avoid unnecessary market disruption that might otherwise 
have arisen as a result of final rules not having been enacted by the 
July 16, 2011, effective date of Title VII. Specifically, we have:

    Provided guidance regarding which provisions in Title VII 
        governing security-based swaps became operable as of the 
        effective date and provided temporary relief from several of 
        these provisions;

    Provided guidance regarding--and where appropriate, interim 
        exemptions from--the various pre-Dodd-Frank provisions that 
        would otherwise have applied to security-based swaps on July 
        16; and

    Taken other actions to address the effective date, 
        including extending certain existing temporary rules and relief 
        to continue to facilitate the clearing of certain credit 
        default swaps by clearing agencies functioning as central 
        counterparties.
Conclusion
    The Dodd-Frank Act provides the Commission with important tools to 
better meet the challenges of today's financial marketplace and fulfill 
our mission to protect investors, maintain fair, orderly, and efficient 
markets, and facilitate capital formation. As we continue with 
implementation of Title VII, we look forward to continuing to work 
closely with Congress, our fellow regulators both home and abroad, and 
members of the public. Thank you for the opportunity to share our 
progress on the implementation of Title VII. I will be happy to answer 
any questions.
                                 ______
                                 
                   PREPARED STATEMENT OF GARY GENSLER
             Chairman, Commodity Futures Trading Commission
                              May 22, 2012
    Good morning Chairman Johnson, Ranking Member Shelby and Members of 
the Committee. I thank you for inviting me to today's hearing on 
implementation of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act (Dodd-Frank Act), international harmonization of swaps 
market reforms, and the Commodity Futures Trading Commission's (CFTC) 
role in overseeing markets for credit derivative products, such as 
those traded by JPMorgan Chase's Chief Investment Office. I also thank 
my fellow Commissioners and CFTC staff for their hard work and 
commitment on implementing the legislation. I'm pleased to testify 
along with Securities and Exchange Commission (SEC) Chairman Schapiro.
    Swaps, now comprising a $700 trillion notional global market, were 
developed to help manage and lower risk for commercial companies. But 
they also concentrated and heightened risk in international financial 
institutions. And when financial entities fail, as they have and surely 
will again, swaps can contribute to quickly spreading risk across 
borders.
    As the financial system failed in 2008, most of us learned that the 
insurance giant AIG had a subsidiary, AIG Financial Products, 
originally organized in the United States, but run out of London. The 
fast collapse of AIG, a mainstay of Wall Street, was again sobering 
evidence of the markets' international interconnectedness. Sobering 
evidence, as well, of how transactions booked in London or anywhere 
around the globe can wreak havoc on the American public.
    Recently, we've had another stark reminder of how trades overseas 
can quickly reverberate with losses coming back into the United States. 
According to press reports, the largest U.S. bank, JPMorgan Chase, just 
suffered a multi-billion dollar trading loss from transactions in 
London. The press also is reporting that this trading involved credit 
default swaps and indices on credit default swaps. It appears that the 
bank here in the United States is absorbing these losses. And as a U.S. 
bank, it is an entity with direct access to the Federal Reserve's 
discount window and Federal deposit insurance.
    I am authorized by the Commission to confirm that the CFTC's 
Division of Enforcement has opened an investigation related to credit 
derivative products traded by JPMorgan Chase's Chief Investment Office. 
Although I am unable to provide any specific information about a 
pending investigation, I will describe generally the Commission's 
oversight of the swaps markets, the entities and products in our 
jurisdiction, and the Dodd-Frank reforms relevant to credit default 
swaps, and in particular index credit default swaps.
    The role the unregulated swaps market played in the 2008 crisis led 
to a new international consensus that the time had come for 
comprehensive regulation. Swaps, which were basically not regulated in 
Asia, Europe and the United States, should now be brought into the 
light of regulation.
    When President Obama gathered together the G-20 leaders in 
Pittsburgh in 2009, they agreed that the swaps market needed to be 
reformed and that such reform should be completed by December 2012.
    In 2010, Congress and the President came together and passed the 
historic Dodd-Frank Act.
    The goal of the law is to:

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

    Protect against Wall Street's risks by bringing 
        standardized swaps into centralized clearing; and

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

Despite different cultures, political systems and financial systems, 
we've made significant progress on a coordinated and harmonized 
international approach to reform. Japan passed reform legislation in 
2010, and has made real progress on their clearing mandate. Further, 
they have a proposal before their Diet on the use of trading platforms, 
as well as post-trade transparency. The European parliament last month 
adopted the European Market Infrastructure Regulation (EMIR) that 
includes mandatory clearing, reporting and risk mitigation for 
derivatives. And the European Commission has published proposals 
providing for both pre-trade and post-trade transparency. Other major 
jurisdictions, including the largest provinces in Canada, have the 
legislative authority and have made progress on swaps reform.
Implementation of Dodd-Frank Swaps Market Reforms
    The CFTC has made significant progress in completing the reforms 
that will bring transparency to the swaps market and lower its risk to 
the rest of the economy.
    During the rule-writing process, we have benefited from significant 
public input. CFTC Commissioners and staff have met over 1,600 times 
with the public and we have held 16 public roundtables on important 
issues related to Dodd-Frank reform.
    We are consulting closely with other regulators on Dodd-Frank 
implementation, including the SEC, the Federal Reserve, the Federal 
Deposit Insurance Corporation, the Office of the Comptroller of the 
Currency and other prudential regulators. This coordination includes 
sharing many of our memos, term sheets and draft work product. In 
addition, we are actively consulting with international regulators to 
harmonize our approach to swaps oversight, and share memos, term sheets 
and draft work product with our international counterparts as well.
    We substantially finished our proposal phase last spring, and then 
largely reopened the mosaic of rules for additional public comments. We 
have accepted further public comment after the formal comment periods 
closed. The agency received 3,000 comment letters before we proposed 
rules and more than 28,000 comment letters in response to proposals.
    Last summer, we turned the corner and started finalizing rules. To 
date, we've completed 33 rules with less than 20 more to go. The 
Commission is turning shortly to the rule to further define the terms 
``swap'' and ``security-based swap,'' the second of the two key joint 
further definition rules with the SEC. The staff recently has put forth 
to the Commission a final rule for our consideration. It is essential 
that the two Commissions move forward on the further product definition 
rulemaking expeditiously.
    Consistent with the provisions of the Dodd-Frank Act, the proposal 
states the CFTC regulates credit default swaps on broad-based security 
indices, while the SEC regulates them on narrow-based security indices 
(as well as credit default swaps on single name securities or loans). 
Under the proposal, most of the credit default swap indices compiled by 
the leading index provider, Markit, generally would be broad-based 
indices. These indices would generally include, but not be limited to, 
Markit's CDX North American Investment Grade, as well as its CDX North 
American High Yield. While the credit default swaps based on these 
indices would be swaps under CFTC jurisdiction, the SEC would retain 
certain anti-fraud and anti-manipulation enforcement authorities over 
them as well, as it had prior to Dodd-Frank.
Transparency
    The Dodd-Frank financial reform shines bright lights of 
transparency--to the public and to regulators--on the swaps market for 
the benefit of investors, consumers, retirees and businesses in 
America. Transparency is critical to both lowering the risk of the 
financial system, as well as reducing costs to end-users. The more 
transparent a marketplace is to the public, the more efficient it is, 
the more liquid it is, and the more competitive it is.
    The CFTC has completed key rules on transparency that, for the 
first time, provide a detailed and up-to-date view of the physical 
commodity swaps markets so regulators can police for fraud, 
manipulation and other abuses. We have begun to receive position 
information for large traders in the swaps markets for agricultural, 
energy and metal products.
    We also finished a rule establishing registration and regulatory 
requirements for swap data repositories, which will gather data on all 
swaps transactions.
    Starting this summer, real-time reporting to the public and to 
regulators will begin for interest rate and credit default swaps with 
similar reporting on other swaps later this year. Also later this year, 
market participants will benefit from the transparency of daily 
valuations over the life of their swaps.
    By contrast, in the fall of 2008, there was no required reporting 
about swaps trading.
    This month, we completed rules, guidance and acceptable practices 
for designated contract markets (DCMs). DCMs will be able to list and 
trade swaps, helping to bring the benefit of pre-trade transparency to 
the swaps marketplace.
    Looking forward, we have two important remaining transparency rules 
to complete related to block sizes and swap execution facilities 
(SEFs). The trading of credit default swap indices will benefit from 
the transparency provided on SEFs.
    The Japanese and European transparency proposals, as well as 
initiatives well underway in other jurisdictions, will further align 
international reform efforts and benefit the public.
Central Clearing
    For over a century, through good times and bad, central clearing in 
the futures market has lowered risk to the broader public. Dodd-Frank 
financial reform brings this effective model to the swaps market. 
Standard swaps between financial firms will move into central clearing, 
which will significantly lower the risks of the highly interconnected 
financial system.
    The CFTC has made significant progress on central clearing for the 
swaps market. We have completed rules establishing new derivatives 
clearing organization risk management requirements. To further 
facilitate broad market access, we completed rules on client clearing 
documentation, risk management, and so-called ``straight-through 
processing,'' or sending transactions immediately to the clearinghouse 
upon execution.
    In addition, the Commission has adopted important customer 
protection enhancements. The completed amendments to rule 1.25 
regarding the investment of funds bring customers back to protections 
they had prior to exemptions the Commission granted between 2000 and 
2005. Importantly, this prevents use of customer funds for in-house 
lending through repurchase agreements. Clearinghouses also will have to 
collect margin on a gross basis and futures commission merchants will 
no longer be able to offset one customer's collateral against another 
and then send only the net to the clearinghouse. And the so-called 
``LSOC rule'' (legal segregation with operational commingling) for 
swaps ensures customer money is protected individually all the way to 
the clearinghouse.
    Furthermore, Commissioners and staff have gotten a lot of feedback 
from market participants on additional customer protection 
enhancements, including through a public roundtable. Staff is actively 
seeking further public input through our Web site and further meetings. 
Staff will use this outreach and review to put forward recommendations 
to the Commission for consideration. In addition, the National Futures 
Association and the CME Group have proposals for greater controls for 
segregation of customer funds. CFTC staff is working with these self-
regulatory organizations on their proposals.
    CFTC staff now is preparing recommendations for the Commission and 
for public comment on clearing requirement determinations. The 
Commission's first determinations will be put out for public comment 
this summer and hopefully completed this fall. They will begin with key 
interest rate products, as well as a number of CDX and iTraxx credit 
default swap indices. There is a great deal of consistency among the 
major jurisdictions on the clearing requirement, and the CFTC's 
timeframe broadly aligns with both Japan and Europe.
    Currently, clearing exists for much of the standardized interest 
rate swaps, as well as for credit default swap indices, done between 
dealers. The major clearinghouses providing swaps clearing are 
registered with the CFTC.
    Moving forward, the Commission will consider a final rule on the 
implementation phasing of the clearing requirement and the end-user 
exception related to nonfinancial companies.
Swap Dealers
    Regulating banks and other firms that deal in derivatives is 
central to financial reform. Prior to 2008, it was claimed that swap 
dealers did not need to be specifically regulated for their swaps 
activity, as they or their affiliates already were generally regulated 
as banks, investment banks, or insurance companies. The crisis revealed 
the inadequacy of relying on this claim. While banks were regulated for 
safety and soundness, including their lending activities, there was no 
comprehensive regulation of their swap dealing activity. Similarly, 
bank affiliates dealing in swaps, and subsidiaries of insurance and 
investment bank holding companies dealing in swaps, were not subject to 
specific regulation of their swap dealing activities. AIG, Lehman 
Brothers and other failures of 2008 demonstrate what happens with such 
limited oversight.
    The CFTC is well on the way to implementing reforms Congress 
mandated in Dodd-Frank to regulate dealers and help prevent another 
AIG. The Commission has finished sales practice rules requiring swap 
dealers to interact fairly with customers, provide balanced 
communications and disclose conflicts of interest before entering into 
a swap. In addition, this agency has finalized internal business 
conduct rules to require swap dealers to establish policies to manage 
risk, as well as put in place firewalls between a dealer's trading, and 
clearing and research operations.
    We completed in April a joint rule with the SEC further defining 
the terms ``swap dealer'' and ``securities-based swap dealer,'' which 
is pivotal to lowering the risk they may pose to the rest of the 
economy.
    Based on completed registration rules, dealers will register after 
we finalize the second major definition rule with the SEC: the further 
definition of the terms ``swap'' and ``securities-based swap.'' Swap 
dealers who make markets in credit default swap indices would be 
amongst those dealers who may have to register with the CFTC.
    Following Congress' mandate, the CFTC also is working with our 
fellow financial regulators to complete the Volcker rule, which 
prohibits certain banking entities from engaging in proprietary 
trading. In adopting the Volcker rule, Congress prohibited banking 
entities from proprietary trading, an activity that may put taxpayers 
at risk. At the same time, Congress permitted banking entities to 
engage in certain activities, such as market making and risk mitigating 
hedging. One of the challenges in finalizing a rule is achieving these 
multiple objectives.
    The international community is closely coordinating on margin 
requirements for uncleared swaps, and is on track to seek public 
comment in June on a consistent approach. This is critical to reducing 
the opportunity for regulatory arbitrage. The CFTC's proposed margin 
rule excludes nonfinancial end-users from margin requirements for 
uncleared swaps. I've been advocating with global regulators that we 
all adopt a consistent approach.
    The Commission is working with fellow regulators here and abroad on 
an appropriate and balanced approach to the cross-border application of 
Dodd-Frank swaps market reforms. The CFTC will soon seek public comment 
on guidance regarding the cross-border application of Title VII rules.
Market Integrity/Position Limits
    Financial reform also means investors, consumers, retirees and 
businesses in America will benefit from enhanced market integrity. 
Congress provided the Commission with new tools in Dodd-Frank to ensure 
the public has confidence in U.S. swaps markets.
    Rules the CFTC completed last summer close a significant gap in the 
agency's enforcement authorities. The rules implement important Dodd-
Frank provisions extending our enforcement authority to swaps and 
prohibited the reckless use of manipulative or deceptive schemes. Thus, 
for example, the CFTC has clear anti-fraud and anti-manipulation 
authority regarding the trading of credit default swaps indices.
    Also, the CFTC now can reward whistleblowers for their help in 
catching market misconduct.
    Congress also directed the CFTC to establish aggregate position 
limits for both futures and swaps in energy and other physical 
commodities. In October 2011, the Commission completed final rules to 
ensure no single speculator is able to obtain an overly concentrated 
aggregate position in the futures and swaps markets. The Commission's 
final rules require compliance for all spot-month limits 60 days after 
the CFTC and SEC jointly adopt the rule to further define the term 
``swap'' and ``securities-based swap'' and for certain other limits, 
following a collection of a year's worth of large trader swap data. Two 
associations representing the financial industry, however, are 
challenging the agency's final rule establishing those limits in court. 
The Commission is vigorously defending the Congressional mandate to 
implement position limits in court.
    Last week, the Commission approved a proposed rule that would 
modify the CFTC's aggregation provisions for limits on speculative 
positions. The proposal would permit any person with a 10 to 50 percent 
ownership or equity interest in an entity to disaggregate the owned 
entity's positions, provided there are protections and firewalls in 
place to ensure trading decisions are made independently of one 
another. The proposal was a response to a Working Group of Commercial 
Energy Firms (WGCEF) petition seeking relief from the aggregation 
provisions of the position limits rule.
    Position limits is another area where there has been close 
international coordination. The G-20 leaders endorsed an International 
Organization of Securities Commissions (IOSCO) report last November 
noting that market regulators should use position management regimes, 
including position limits, to prevent market abuses. The European 
Commission has proposed such a position management regime to the 
European Parliament.
Cross-border Application of Dodd-Frank's Swaps Reforms
    The Dodd-Frank Act states in Section 722(d) that swaps reforms 
shall apply to activities outside the United States if those activities 
have ``a direct and significant connection with activities in, or 
effect on, commerce'' of the United States.
    CFTC staff will soon be recommending to the Commission to publish 
for public comment a release on the cross-border application of swaps 
market reforms. It will consist of interpretive guidance on how these 
reforms apply to cross-border swap activities. It also will include an 
overview as to when overseas swaps market participants, including swap 
dealers, can comply with Dodd-Frank reforms through reliance on 
comparable and comprehensive foreign regulatory regimes, or what we 
call ``substituted compliance.''
    There is further work to be done on the CFTC cross-border release, 
but the key elements of the staff recommendations are likely to 
include:

    First, when a foreign entity transacts in more than a de 
        minimis level of U.S. facing swap dealing activity, the entity 
        would register under the CFTC's recently completed swap dealer 
        registration rules.

    Second, the release will address what it means to be a U.S. 
        facing transaction. I believe this must include transactions 
        not only with persons or entities operating in the United 
        States, but also with their overseas branches. In the midst of 
        a default or a crisis, there is no satisfactory way to really 
        separate the risk of a bank and its branches. Likewise, I 
        believe this must include transactions with overseas affiliates 
        that are guaranteed by a U.S. entity, as well as the overseas 
        affiliates operating as conduits for a U.S. entity's swap 
        activity.

    Third, based on input the Commission has received from 
        market participants, the staff recommendations will include a 
        tiered approach for requirements for overseas swap dealers. 
        Some requirements would be considered entity-level, such as for 
        capital, risk management and recordkeeping. Some requirements 
        would be considered transaction-level, such as clearing, 
        margin, real-time public reporting, trade execution and sales 
        practices.

    Fourth, such entity-level requirements would apply to all 
        registered swap dealers, but in certain circumstances, overseas 
        swap dealers could comply with these requirements through 
        substituted compliance.

    Fifth, such transaction-level requirements would apply to 
        all U.S. facing transactions, but for certain transactions 
        between an overseas swap dealer (including a foreign swap 
        dealer that is an affiliate of a U.S. person) and 
        counterparties not guaranteed by or operating as conduits for 
        U.S. entities, Dodd-Frank may not apply. For example, this 
        would be the case for a transaction between a foreign swap 
        dealer and a foreign insurance company not guaranteed by a U.S. 
        person.

In putting together this release, we've already benefited from 
significant input from market participants. Throughout our nearly 60 
rule proposals, we've consistently asked for input on the cross-border 
application of swaps reforms.
    Commenters generally say they support reform. But in what some of 
them call a ``clarification,'' we find familiar narratives of the past 
as to why many swaps transactions or swap dealers should not be 
regulated. Some commenters have expressed the view that if a 
transaction is done offshore, it should not come under Dodd-Frank. 
Others contend that as long as an offshore dealer is regulated in some 
capacity elsewhere, many of the Dodd-Frank regulations applicable to 
swap dealers should not apply.
    The law, the nature of modern finance, and the experiences leading 
up to the 2008 crisis, as well as the reminder of the last 2 weeks, 
strongly suggest this would be a retreat from much-needed reform.
    When Congress and the Administration came together to draft the 
Dodd-Frank Act, they recognized the lessons of the past when they 
expressly set up a comprehensive regulatory approach specific to swap 
dealers. They were well aware of the nature of modern finance: 
financial institutions commonly set up hundreds if not thousands of 
``legal entities'' around the globe with a multitude of affiliate 
relationships. When one affiliate of a large, international financial 
group has problems, it's accepted in the markets that this will infect 
the rest of the group.
    This happened with AIG, Lehman Brothers, Citigroup, Bear Stearns 
and Long-Term Capital Management.
Implementation Phasing
    As we move on from the rule-writing process, a critical part of our 
agenda is working with market participants on phased implementation of 
these reforms. We have reached out broadly on this topic to get public 
input. Last spring, we published a concepts document as a guide for 
commenters, held a 2-day, public roundtable with the SEC, and received 
nearly 300 comments. Last year, the Commission proposed two rules on 
implementation phasing relating to the swap clearing and trading 
mandates and the swap trading documentation and margin requirements for 
uncleared swaps. We have received very constructive public feedback and 
hope to finalize the proposed compliance schedules in the next few 
months.
    In addition to these proposals, the Commission has included phased 
compliance schedules in many of our rules. For example, both the data 
and real-time reporting rules, which were finalized this past December, 
include phased compliance. The first required reporting will be this 
summer for interest rate and currency swaps. Other commodities have 
until later this fall. Additional time delays for reporting were 
permitted depending upon asset class, contract participant and in the 
early phases of implementation.
    The CFTC will continue looking at appropriate timing for 
compliance, which balances the desire to protect the public while 
providing adequate time for industry to comply with reforms.
Resources
    Confidence in the futures and swaps markets is dependent upon a 
well-funded regulator. The CFTC is a good investment of taxpayer 
dollars. This hardworking staff of 710 is just 10 percent more than 
what we had in the 1990s though the futures market has grown fivefold. 
The CFTC also will soon be responsible for the swaps market--eight 
times bigger than the futures market.
    Picture the NFL expanding eightfold to play more than 100 football 
games in a weekend, leaving just one referee per game, and, in some 
cases, no referee. Imagine the mayhem on the field, the resulting 
injuries to players, and the loss of confidence fans would have in the 
integrity of the game.
    Market participants depend on the credibility and transparency of 
well-regulated U.S. futures and swaps markets. Without sufficient 
funding for the CFTC, the Nation cannot be assured that the agency can 
adequately oversee these markets.
Conclusion
    Nearly 4 years after the financial crisis and 2 years since the 
passage of Dodd-Frank, it's critical that we fully implement the 
historic reforms of the law. It's critical that we do not retreat from 
reforms that will bring greater transparency and competition to the 
swaps market, lower costs for companies and their customers, and 
protect the public from the risks of these international markets.
    In 2008, the financial system and the financial regulatory system 
failed. The crisis plunged the United States into the worst recession 
since the Great Depression with eight million Americans losing their 
jobs, millions of families losing their homes and thousands of small 
businesses closing their doors. The financial storms continue to 
reverberate with the debt crisis in Europe affecting the economic 
prospects of people around the globe.
    The CFTC has made significant progress implementing reform having 
largely finished the rule proposals, and now having completed well over 
half of the final rules.
    We are on schedule to complete the remaining reforms this year, but 
until we do, the public is not fully protected.
   RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM GARY 
                            GENSLER

Q.1. Chairman Gensler, during the week leading up to the 
bankruptcy of MF Global, how many times did you brief the other 
Commissioners on the CFTC's management of the crisis? Please 
explain.

A.1. During the week of October, 24, 2011, as MFG's financial 
condition deteriorated, CFTC staff became involved in 
monitoring the firm's financial condition. During that week, 
the other Commissioners and I were briefed by Commission staff 
about ongoing developments, including during the Commission's 
senior staff briefing on Wednesday and its surveillance meeting 
on Friday.

Q.2. Chairman Gensler, during the week leading up to the 
bankruptcy of MF Global, at any time did you indicate to the 
other Commissioners or CFTC staff that you were concerned about 
customer assets at MF Global? Please explain.

A.2. Yes. During that week and increasingly over the last 
weekend of October, I was involved in discussions with other 
regulators regarding the developments. During some of the calls 
with regulators on October 29-30 and into the morning of 
October 31, MFG representatives and representatives of a firm 
considering facilitating the transfer of MFG customer positions 
also participated. As of October 28, my understanding from 
staff at the time was that MFG was not reporting a deficiency, 
under CFTC regulations, in the customer funds accounts. Given 
the firm's deteriorating financial condition, however, we 
requested certain detailed back-up documentation regarding the 
segregated customer funds under section 4d of the Commodity 
Exchange Act and secured funds under Part 30 of the 
Commission's regulations. We pressed for the information over 
the course of the weekend. Even though the firm had provided 
some summary information, the firm's failure to provide the 
requested detailed supporting information was a source of 
concern to me. My involvement was in furtherance of the CFTC's 
effort to ensure to the maximum extent possible the protection 
of customer property that had been entrusted to MFG.

Q.3. Chairman Gensler, in an attempt to justify your MF Global 
recusal, you stated that you did not want your relationship 
with MF Global CEO Jon Corzine to ``be a distraction.''

   LWhy were you not concerned that your relationship 
        with Mr. Corzine would be a distraction from any 
        previous matter involving MF Global?

   LPrior to the MF Global bankruptcy, Mr. Corzine had 
        met with you on matters related to Rule 1.25, which 
        regulates the investment of customer segregated funds. 
        Why did you not recuse yourself from those 
        conversations?

A.3. In keeping with the consistent advice of our General 
Counsel and Alternate Designated Ethics Officer, I participate 
in all rulemakings, including Rule 1.25, as they are matters of 
general applicability. I was advised by the Commission's 
General Counsel that I was not required to withdraw from 
participation. However, as it turned to a specific enforcement 
matter that could involve not just the company but specific 
individuals, including Jon Corzine, I informed the General 
Counsel of my decision on November 3 that I would not 
participate. My decision was in order to ensure that my 
participation did not serve as a distraction from the 
Commission's important duties to locate customer funds and 
conduct an enforcement matter. Subsequently, I executed a 
``Statement of Non-Participation'' to document my decision.

Q.4. Chairman Gensler, you have stated that you ``will not 
participate in any enforcement-related matters involving MF 
Global and any matter directly related thereto.'' This language 
appears to prohibit you from participating in any of the CFTC's 
efforts to develop recommendations based on lessons learned 
from the collapse of MF Global. In your absence, who is leading 
the CFTC's efforts to develop recommendations based on lessons 
learned?

A.4. I have tremendous confidence in the ability of my fellow 
Commissioners and the Commission's dedicated staff to develop 
appropriate recommendations based on lessons learned. With 
respect to the matters in which I am not participating, 
Commissioner Jill Sommers is exercising the Commission's 
executive and administrative functions that otherwise would be 
exercised by the Chairman in accordance with section 2(a)(6) of 
the Commodity Exchange Act. In keeping with the consistent 
advice of our General Counsel and Alternate Designated Ethics 
Officer, I participate in all rulemakings, as they are matters 
of general applicability.

Q.5. Chairman Gensler, in Chairman Schapiro's written testimony 
from the hearing on May 22, 2012, she said that the SEC will 
publish an implementation plan for their Dodd-Frank derivatives 
rules and allow the public to comment on it. Will you commit to 
publishing the CFTC's implementation plan for the Dodd-Frank 
derivatives rules and allow the public to comment on it?

A.5. The Commission has taken a number of actions to facilitate 
implementation of Dodd-Frank regulations. These include:

March 16, 2011--Implementing the Dodd-Frank Act, FIA's Annual 
International Futures Industry Conference, Boca Raton, Florida. 
Remarks of Chairman Gary Gensler (as posted on CFTC Web site 
and including listing of order in which rules might be 
considered).

April 12, 2011--June 10, 2011--Comment period open (292 written 
comments filed); Concepts document published as a guide for 
commenters.

May 2, 2011 and May 3, 2011--CFTC-SEC Staff-led Roundtable 
Discussion on Dodd-Frank Implementation.

May 4, 2011--Notice published in Federal Register re-opening 
and extending comment periods (through June 30) in order to 
``provide interested parties with an additional opportunity to 
participate in'' Dodd-Frank Rulemakings. Also requesting 
comment on the order in which the Commission should consider 
final rulemakings.

June 17, 2011--Commission seeks public comment on proposed 
order to grant exemptive relief from the application of Dodd-
Frank Act effective dates.

July 14, 2011--Commission publishes final order providing 
exemptive relief from effective dates of Dodd-Frank Act 
provisions in order to facilitate a smooth transition for 
market participants (expiring on December 30, 2011; extended on 
Dec. 23, 2011).

September 8, 2011--Outline published of Dodd-Frank Title VII 
Rules the CFTC May Consider in 2011 and the First Quarter of 
2012.

September 8, 2011--The Commission sought public comment on 
proposed rules specifically to establish schedules to phase in 
compliance with the swap clearing and trade execution 
requirement provisions of the Dodd-Frank Act. At that meeting, 
the Commission also approved a proposed rule to phase in 
compliance with previously proposed requirements, including the 
swap trading relationship documentation requirement and the 
margin requirements for uncleared swaps.

December 23, 2011--Commission publishes amendment to July 14 
order extending effective date relief through July 16, 2012.

January 11, 2012--Update of order of consideration of final 
rules posted on Commission Web site.

July 3, 2012--Commission approves amendment to July 14 order 
extending effective date relief through December 31, 2012.

July 30, 2012--Final rule published in Federal Register 
detailed phasing of compliance requirements for swaps subject 
to mandatory clearing
Individual proposed rules specifically request public comment 
regarding implementation and sequencing. Examples of such rules 
include: Reporting, Recordkeeping and Trading Records 
requirements; Real-Time Public Reporting of Swap Transaction 
Data; Registration of Swap Dealers and Major Swap Participants; 
and Protection of Collateral of Counterparties to Uncleared 
Swaps Commission staff--along with staff from the SEC and other 
implementing agencies--have conducted a number of roundtables 
(transcripts available on CFTC.gov):

August 20, 2010--Conflicts of interest in the clearing and 
listing of swaps

September 14, 2010--Swap Data and Swap Data Repositories

September 15, 2010--Swap Execution Facilities

October 22, 2010--Credit Default Swaps

October 22, 2010--Customer Collateral Protection

December 2, 2010--Disruptive Trading Practices

December 12, 2010--Capital and Margin

June 3, 2011--Protection of Cleared Swaps Customer Collateral

June 8, 2011--Swap Data Recordkeeping and Reporting

June 16, 2011--Definition of Swap Dealer and Major Swap 
Participant

July 6, 2011--Changes related to Commodity Pool Operators and 
Commodity Trading Advisors

August 1, 2011--International issues

January 30, 2012--``Available to Trade'' Provision for SEFs and 
DCMs
  Feb 29 and March 1, 2012--Roundtables to discuss additional 
  customer collateral protection

May 31, 2012--The Volcker Rule

June 5, 2012--Core Principle 9 for Designated Contract Markets

August 9, 2012--Additional Customer Protections

Q.6. Chairman Gensler, the Dodd-Frank Act includes 
indemnification provisions that make it difficult, if not 
impossible, for foreign regulators to obtain information on 
swap transactions. All five SEC Commissioners support repealing 
the indemnification requirements. Two CFTC Commissioners agree, 
saying that the CFTC's recent interpretive guidance does not 
fix the problem. Do you agree with the seven SEC and CFTC 
Commissioners that the indemnification provisions should be 
repealed?

A.6. The CFTC is working to ensure that both domestic and 
international regulators have access to swap data to support 
their regulatory mandates. The CFTC adopted proposed 
interpretative guidance stating the view that foreign 
regulators seeking access to swap data repositories will not be 
subject to the indemnification provisions if the trade 
repository is regulated by foreign law and the data is reported 
under foreign law. The CFTC requested public comment on all 
aspects of the interpretative guidance.

Q.7. Chairman Gensler, the SEC's swap entity definition 
rulemaking contains a lengthy discussion of how they determined 
that $8 billion is the appropriate de minimis level to be 
regulated as a dealer in the derivatives markets they oversee.

   LHow did the CFTC determine that the same $8 billion 
        figure is appropriate for the markets that you oversee?

   LWhat credit default swap data did the CFTC use in 
        its analysis?

   LWhat interest rate swap data did the CFTC use in 
        its analysis?

   LWhat commodity swap data did the CFTC use in its 
        analysis?

   LWhat agricultural swap data did the CFTC use in its 
        analysis?

A.7. After reviewing comments received regarding the CFTC and 
SEC joint proposed rule to further define the terms ``swap 
dealer'' and ``major swap participant,'' the Commissions 
arrived at the determination that, generally, a $3 billion 
notional value in swaps activity over the prior 12 months 
represented an appropriate de minimis threshold. The amount was 
based on input from commenters and supported by several 
rationales, including the estimated size of the domestic swap 
market. Commenters who addressed the question proposed that the 
standard be set at a level between $200 million and $3.5 
billion in notional amount entered into over a period of 12 
months. Data and other market descriptions were provided 
through written comments as well as through input in roundtable 
discussions hosted by staffs of the two Commissions, as well as 
index CDS data provided by the SEC and data contained in the 
Quarterly Report on Bank Trading and Derivatives Activities 
issued by the Office of the Comptroller of the Currency. The 
Commissions also determined it to be appropriate to establish a 
de minimis threshold phase-in period during which higher de 
minimis thresholds would apply. During this phase-in period, 
the joint final rule provides generally for a de minimis level 
of swap dealing activity over the prior 12 months of a gross 
notional value of $8 billion. The Commissions noted 
particularly that the implementation of swap data reporting 
under the Dodd-Frank Act may result in new data that would be 
useful in confirming the Commissions' determination to 
establish the $3 billion threshold which applies after the 
phase-in period.

Q.8. Chairman Gensler, the Depository Trust and Clearing 
Corporation (DTCC) has made a comprehensive global database of 
detailed credit default swap transaction and position data 
available to regulators for more than a year. It is my 
understanding that all of the financial regulators, except the 
CFTC, have made use of this data as of the date of the hearing.

   LWhen the press began to report that JP Morgan's 
        London office had taken extremely large positions in 
        credit default swap indexes--which fall under the 
        jurisdiction of the CFTC--why didn't the CFTC 
        immediately begin examining the DTCC data?

   LIf the CFTC had made use of the DTCC data, would 
        you have had a better line of sight into the JP Morgan 
        trades that are the subject of so much scrutiny?

A.8. The CFTC's Division of Enforcement has opened an 
investigation related to credit derivative products traded by 
JPMorgan Chase's CIO. I am unable to provide any specific 
information about a pending investigation.

Q.9.-1. Chairman Gensler, according to Mr. Corzine's 
Congressional testimony, he met with you on May 5, 2010 at the 
CFTC.

   LWhat issues were discussed at that meeting? Who 
        else was present at that meeting?
Q.9.-2. Chairman Gensler, on November 17, 2010, MF Global 
submitted a comment letter on a CFTC regulation. Five days 
later, you were a guest lecturer on Government regulation at 
Mr. Corzine's class at Princeton University.

   LWere any of the issues related to MF Global's 
        comment letter discussed at any time while you were at 
        Princeton, inside of class or outside of class? Please 
        explain.
Q.9.-3. Chairman Gensler, according to Mr. Corzine's 
Congressional testimony, he met with you in December 2010 at 
the CFTC.

   LWhat issues were discussed at that meeting? Who 
        else was present at that meeting?

A.9.-1.-3. For the convenience of the Committee, I include a 
document that will address these questions. The included 
document is a Memorandum detailing my activities prior to my 
withdrawal from participation in the matter. The document 
includes details, to the best of my recollection, of contacts 
with Mr. Corzine.
    Insert 1 [Confidential Memorandum follows:]

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Q.10. Chairman Gensler, according to a March 1, 2011 MF Global 
filing at the Securities and Exchange Commission (SEC), the 
compensation committee of MF Global's board ``believes that Mr. 
Corzine's leadership improved posture with regulators.''
    How did MF Global's posture improve with the CFTC under Mr. 
Corzine's leadership?

A.10. I have no information regarding the basis of the 
statement in the filing.

Q.11.-1. Chairman Gensler, according to Mr. Corzine's 
Congressional testimony, you gave a luncheon speech at a 
conference sponsored by the investment firm of Sandler & 
O'Neill on June 9, 2011. During the question and answer 
session, Mr. Corzine asked you about proposed changes to Rule 
1.25.

   LWhat specific question did he ask? What was your 
        answer?

   LDid you have any other discussions about Rule 1.25 
        with Mr. Corzine?

Q.11.-2. According to a memo posted on the CFTC's Web site, on 
July 20, 2011, Mr. Corzine called you regarding Rule 1.25. 
Discussion included ``MMMFs, asset-backed and issuer-based 
concentration limits, counterparty concentration limits, in-
house transactions and repurchase agreements with affiliates.''

   LPlease provide more details about the discussion.

   LWho else participated on the call?

A.11.-1.-2. For the convenience of the Committee, I include a 
document (Insert 1 previously referenced) that will address a 
number of questions. The included document is a Memorandum 
detailing my activities prior to my withdrawal from 
participation in the matter. The document includes details, to 
the best of my recollection, of contacts with Mr. Corzine.

Q.12. Chairman Gensler, according to Mr. Corzine's 
Congressional testimony, you and Mr. Corzine attended a wedding 
celebration of mutual friends on September 14, 2011.
    Please provide the details of any discussions you had with 
Mr. Corzine regarding MF Global or CFTC regulation while 
attending that wedding celebration.

A.12. For the convenience of the Committee, I include a 
document (Insert 1 previously referenced) that will address a 
number of questions. The included document is a Memorandum 
detailing my activities prior to my withdrawal from 
participation in the matter. The document includes details, to 
the best of my recollection, of contacts with Mr. Corzine.

Q.13.-1. Chairman Gensler, when did you first learn that 
Moody's had downgraded MF Global on October 24, 2011? What 
specific actions did you take based upon the downgrade?

Q.13.-2. Did you have direct conversation, or were you part of 
conversations, with any firms that were considering buying part 
or all of MF Global's business over the weekend of October 29, 
2011 and October 30, 2011? If so, what was the nature of those 
conversations, and who was involved?

Q.13.-3. Please provide details (including dates, times, and 
topics discussed) of the communications (e.g., phone calls, 
emails, text messages, etc.) you had with Jon Corzine, or any 
of his agents or representatives, or any senior members of MF 
Global, or any of their agents or representatives, from October 
24, 2011 through November 1, 2011.

A.13.-1.-3. During the week of October 24, 2011, as MFG's 
financial condition deteriorated, CFTC staff became involved in 
monitoring the firm's financial condition. During that week, 
the other Commissioners and I were briefed by Commission staff 
about ongoing developments, including that the firm had been 
downgraded by Moody's. During that week and increasingly over 
the last weekend of October, I was involved in discussions with 
other regulators regarding the developments. During a call with 
regulators on the evening of October 30, representatives of a 
firm, Interactive Brokers, considering facilitating the 
transfer of MFG customer positions also participated. My 
involvement was in furtherance of the CFTC's effort to ensure 
to the maximum extent possible the protection of customer 
property that had been entrusted to MFG. Though it was not 
always apparent which representatives from MFG were present on 
calls with regulators over the weekend of October 29-30 and 
into the morning of October 31, to the best of my knowledge and 
recollection, Mr. Corzine was on the line for at least part of 
one of these calls, and discussed matters regarding MFG's 
European bond positions.

Q.14. Chairman Gensler, over the weekend of October 29, 2011 
and October 30, 2011, MF Global employees were trying to 
reconcile a $900 million under segregation figure. When did you 
first learn about it?

A.14. I first learned in the early morning hours of October 31, 
2011, that the firm was reporting a shortfall in the segregated 
accounts under section 4d of the Commodity Exchange Act.

Q.15. Chairman Schapiro and Chairman Gensler, under your 
management, the SEC and the CFTC have been in violation of the 
law for failing to meet 73 statutory deadlines for rulemaking 
set by Dodd-Frank.
    Can you assure this Committee that your agencies will be in 
compliance with all applicable Dodd-Frank deadlines that are 
due by the end of this year? If not, please explain why your 
agencies are missing so many statutory deadlines.

A.15. The Dodd-Frank Act had a deadline of 360 days after 
enactment for completion of the bulk of our rulemakings--July 
16, 2011. Both the Dodd-Frank Act and the Commodity Exchange 
Act (CEA) give the CFTC the flexibility and authority to 
address the issues relating to the effective dates of Title 
VII. This flexibility has allowed us to approach the rulemaking 
process thoughtfully--not against the clock. We have 
coordinated closely with the SEC on these issues. Last year, 
the CFTC granted temporary relief from certain provisions that 
would otherwise have applied to swaps or swap dealers on July 
16, 2011. The Commission has extended that relief to 
accommodate its implementation schedule.

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM CFTC STAFF

Q.1. As I mentioned at the hearing, according to the CME's 
timeline, a CFTC employee gave two CME employees a disc 
containing documents to support the October 26, 2011 segregated 
funds statement on the evening of October 30.

   LWhen did the CFTC receive the disc from MF Global?

   LWhen did the CFTC begin reviewing the documents on 
        the disc?

   LWhat was the result of the review of these 
        documents? Did it show any shortfall?

   LWhat specific actions did the CFTC take after 
        reviewing the documents?

   LCould you provide the Committee with copies of the 
        documents on the disc?

A.1. At some point after 5 p.m. CDT, and possibly at 
approximately 5:30 p.m. CDT, on October 28, 2011, MF Global 
gave a CFTC employee three computer discs. Staff did not at 
that time undertake a comprehensive review of the discs. A 
subsequent review of a larger set of records including the 
information on the discs reflected a shortfall in the customer 
segregated funds as of Wednesday October 26, 2011.

Q.2. The CFTC had staff onsite at MF Global's Chicago offices 
the weekend before the firm's bankruptcy filing.

   LWhat specific steps did your agency take to protect 
        customer assets prior to learning that customer assets 
        were missing?

   LWhat date and time did CFTC staff first learn that 
        there was a possible shortfall in the customer 
        segregated accounts? How did the CFTC staff learn about 
        the possible shortfall?

   LWhat date and time did CFTC staff first learn that 
        there was a definite shortfall in the customer 
        segregated accounts? How did the CFTC staff learn about 
        definite shortfall?

   LAfter you learned of the missing customer assets, 
        what specific steps did your staff take to ensure that 
        additional customer funds were not improperly 
        transferred?

A.2. Between 2 p.m. and 2:30 p.m. CDT, Sunday October 30, 2011, 
a CFTC employee and MF Global employee had a brief conversation 
from which the CFTC employee understood there was a deficiency 
or discrepancy in the segregated account. On October 31, the 
Securities Investors Protection Corporation with the support of 
the CFTC and the consent of MF Global initiated a liquidation 
proceeding under the Securities Investors Protection Act of 
1970 (SIPA) to protect the customers of MF Global. In FCM 
bankruptcies, commodity customers have, pursuant to section 
766(h) of the Bankruptcy Code, priority in customer property. 
If customer property is insufficient to satisfy in full all the 
claims of customers, Part 190 of the Commission's regulations 
allows other property of the debtor's estate to be classified 
as customer property to make up any shortfall.

Q.3. Who is responsible for the protection of commodity 
customer funds at a futures commission merchant (FCM)?

A.3. Under the Commodity Exchange Act, an FCM must treat all 
money, securities and property received from a customer as 
margin for the trades or contracts of that customer as 
belonging to that customer. Furthermore, all customer money, 
securities, and property must be separately accounted for and 
segregated from the FCM's proprietary funds. The FCM cannot use 
funds deposited by one customer to margin or secure trades for 
another customer. Commission Regulation 1.20 requires that 
accounts holding segregated funds be titled specifically to 
identify the contents of the account as separate from the 
ownership of the FCM. In addition, FCMs must obtain letters 
from their depositories acknowledging that the funds deposited 
in those accounts are customer funds and must be treated as 
such under the CEA--i.e., such depositories are prohibited from 
treating them as belonging to the FCM or any person other than 
the customer. Commission Regulation 1.12 requires FCMs to 
notify the Commission immediately of any occurrence of under-
segregation.

Q.4. As I mentioned at the hearing, according to the CME's 
timeline, a CFTC employee gave two CME employees a disc 
containing documents to support the October 26, 2011 segregated 
funds statement on the evening of October 30.

   LWhen did the CFTC receive the disc from MF Global?

   LWhen did the CFTC begin reviewing the documents on 
        the disc?

   LWhat was the result of the review of these 
        documents? Did it show any shortfall?

   LWhat specific actions did the CFTC take after 
        reviewing the documents?

   LCould you provide the Committee with copies of the 
        documents on the disc?

A.4. At some point after 5 p.m. CDT, and possibly at 
approximately 5:30 p.m. CDT, on October 28, 2011, MF Global 
gave a CFTC employee three computer discs. Staff did not at 
that time undertake a comprehensive review of the discs. A 
subsequent review of a larger set of records including the 
information on the discs reflected a shortfall in the customer 
segregated funds as of Wednesday October 26, 2011.

Q.5. What authorities does the CFTC have to protect customer 
segregated accounts at a futures commission merchant (FCM) 
during an emergency situation?

A.5. An FCM is required to hold sufficient funds in segregated 
accounts to meet the aggregate total account balances of each 
of the FCM's customers trading on designated contract markets. 
When the firm does not hold sufficient funds in segregation to 
meet the account balances of each of its customers, the 
Commission can initiate an enforcement action to freeze the 
customer segregated accounts at the FCM to prevent the FCM from 
removing funds without appropriate court approvals. If the FCM 
also is undercapitalized, Commission Regulation 1.17 provides 
that the FCM must transfer customer accounts to another FCM, 
and cease operating as an FCM. If the FCM can immediately 
demonstrate to the satisfaction of the Commission that it has 
the ability to come back into compliance with the minimum 
capital requirements, the Commission may grant the FCM up to a 
maximum of 10 business days to achieve compliance without 
having to transfer customer accounts. It is often preferred in 
an emergency situation to transfer customer accounts and margin 
funds from the failing FCM to a financially sound FCM. The 
transfer of the customer accounts and margin funds may pose 
less of a disruption to customers than a court order freezing 
customer accounts.

Q.6. In May 2011, FINRA determined that MF Global had a capital 
deficiency. MF Global CEO Jon Corzine personally appealed that 
decision to the SEC. The SEC upheld FINRA's determination and 
MF Global publicly reported the deficiency in August 2011.

   LWhen did the CFTC first learn that MF Global had a 
        capital deficiency? How did the CFTC learn about it?

   LIn your view, how effective was the SEC's and 
        CFTC's coordination of the regulation of MF Global?

A.6. The CFTC learned that MF Global had a capital deficiency 
in or about late August 2011. In particular, MF Global 
submitted a letter to the Commission dated August 25, 2011 
stating that on August 24, 2011 FINRA had advised the firm that 
its capital treatment of certain repo to maturity transactions 
should be modified resulting in increased capital requirements 
under SEC Rule 15c3-1. The letter further stated that the firm 
had increased its capital prior to being advised of the 
increased capital requirement by FINRA, and that its excess net 
capital on August 24, 2011 was approximately $113 million after 
giving effect to the additional capital requirements for the 
repo to maturity transactions. By letter dated August 30, 2011, 
and received by the Commission on August 31, 2011, MF Global 
stated that on August 29, 2011, FINRA had directed the firm to 
restate its July 2011 FOCUS Report with the revised capital 
treatment for the repo to maturity transaction. The restated 
FOCUS Report was filed with the Commission on August 31, 2011 
and showed MF Global to be undercapitalized at the end of July 
2011.

Q.7. In December 2009, MF Global settled an enforcement action 
with the CFTC arising from multiple risk supervision failures.

   LFollowing that enforcement action, what specific 
        steps did you take to ensure that MF Global customer 
        assets were not at risk of being misappropriated?

A.7. The Commission's order imposed a $10 million civil 
monetary penalty and required MF Global to comply with several 
undertakings, including enacting policies and procedures to 
enhance risk monitoring procedures, training, compliance 
procedures and compliance audit procedures. MF Global was also 
required to undertake an independent review and assessment. The 
assessment, among other things, was to review the effectiveness 
of existing and future risk management, supervisory and 
compliance policies and procedure at MF Global.

Q.8. MF Global filed its 10-K for the fiscal year ended March 
31, 2011, disclosing detailed information about its exposure to 
European sovereign debt in its repo-to-maturity portfolio. What 
specific actions did the CFTC take based upon the information 
contained in MF Global's 10-K?

A.8. MF Global was placed on heightened financial surveillance 
in March 2008 by its designated self-regulatory organization, 
the CME. The heightened financial surveillance required MF 
Global to provide the CME, on a daily basis, with a net capital 
computation and computations demonstrating its compliance with 
its obligation to segregate customer funds under Section 4d of 
the Commodity Exchange Act and to set-aside customer funds for 
trading on non-U.S. contract markets under CFTC Regulation 
30.7. MF Global also filed copies of its daily capital and 
customer funds calculations with the CFTC. Staff of the CME and 
CFTC reviewed the daily submissions to assess MF Global's 
compliance with the CFTC's capital and customer funds 
protection requirements.

Q.9. On August 31, 2011, MF Global amended its FOCUS report for 
July to report a capital deficiency of $150 million as of July 
31, 2011. What specific actions did the CFTC take based upon 
the amended FOCUS report?

A.9. The CFTC learned that MF Global had a capital deficiency 
in or about late August 2011. In particular, MF Global 
submitted a letter to the Commission dated August 25, 2011 
stating that on August 24, 2011 FINRA had advised the firm that 
its capital treatment of certain repo to maturity transactions 
should be modified resulting in increased capital requirements 
under SEC Rule 15c3-1. The letter further stated that the firm 
had increased its capital prior to being advised of the 
increased capital requirement by FINRA, and that its excess net 
capital on August 24, 2011 was approximately $113 million after 
giving effect to the additional capital requirements for the 
repo to maturity transactions. By letter dated August 30, 2011, 
and received by the Commission on August 31, 2011, MF Global 
stated that on August 29, 2011, FINRA had directed the firm to 
restate its July 2011 FOCUS Report with the revised capital 
treatment for the repo to maturity transaction. The restated 
FOCUS Report was filed with the Commission on August 31, 2011 
and showed MF Global to be undercapitalized at the end of July 
2011.

Q.10. Please provide the details regarding any discussions of 
MF Global at any of the Intermarket Financial Surveillance 
Group's (IFSG's) meetings or calls in 2011, including IFSG's 
annual meeting on October 19, 2011.

A.10. The IFSG is comprised of securities and futures self-
regulatory organizations. Though the CFTC is not a member, CFTC 
staff did attend the meeting on October 19, 2011. The SEC and 
FINRA led the discussion of the topic of European sovereign 
debt and the potential impact on broker-dealers. FINRA 
discussed how it had reviewed the largest broker-dealers and 
did not identify any material exposures to European sovereign 
debt with the exception of MF Global. The SEC also had reviewed 
the broker-dealers for exposure to foreign sovereign debt, and 
noted no major concerns (other than MF Global). FINRA also 
discussed how FINRA and the SEC had required MF Global to take 
additional capital charges on its European sovereign debt 
positions. The capital charges were retroactive to the end of 
July 2011. MF Global increased its capital in August, when 
informed of the capital charges. The retroactive application of 
the charges to the end of July 2011, however, caused MF Global 
to be undercapitalized as of the end of July 2011. FINRA 
discussed how it was going to continue to monitor broker-dealer 
exposure to foreign sovereign debt on an ongoing basis.

Q.11. When did you first learn that MF Global had retained 
Evercore to explore selling its FCM business? When did you 
first learn that MF Global had instructed Evercore to explore 
selling the entire firm?

A.11. CFTC staff do not recall any direct interaction with 
Evercore partners. However, often in the case of a failing FCM, 
a preferred option is to accomplish the transfer of customer 
accounts and margin funds from the failing firm to a 
financially sound FCM. Such a transfer would normally pose less 
of a disruption to customers.

Q.12. Over the weekend of October 29, 2011 and October 30, 
2011, MF Global employees were trying to reconcile a $900 
million under segregation figure. When did CFTC staff first 
learn about this reconciliation?

A.12. Between 2 p.m. and 2:30 p.m. CDT, Sunday October 30, 
2011, a CFTC employee and MF Global employee had a brief 
conversation from which the CFTC employee understood there was 
a deficiency or discrepancy in the segregated account.

Q.13. What CFTC staff members were onsite at MF Global on each 
of the following days?

   LMonday, October 24, 2011

   LTuesday, October 25, 2011

   LWednesday, October 26, 2011

   LThursday, October 27, 2011

   LFriday, October 28, 2011

   LSaturday, October 29, 2011

   LSunday, October 30, 2011

   LMonday, October 31, 2011

A.13. Roughly, up to seven CFTC staff members were present at 
various times at MF Global's offices in Chicago and New York 
from October 27 to October 30, 2011.

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