[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]







              THE FUTURE OF THE CFTC: MARKET PERSPECTIVES

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

                                HEARING

                               BEFORE THE

                        COMMITTEE ON AGRICULTURE
                        HOUSE OF REPRESENTATIVES

                    ONE HUNDRED THIRTEENTH CONGRESS

                             FIRST SESSION

                               __________

                              MAY 21, 2013

                               __________

                            Serial No. 113-5



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                        COMMITTEE ON AGRICULTURE

                   FRANK D. LUCAS, Oklahoma, Chairman

BOB GOODLATTE, Virginia,             COLLIN C. PETERSON, Minnesota, 
    Vice Chairman                    Ranking Minority Member
STEVE KING, Iowa                     MIKE McINTYRE, North Carolina
RANDY NEUGEBAUER, Texas              DAVID SCOTT, Georgia
MIKE ROGERS, Alabama                 JIM COSTA, California
K. MICHAEL CONAWAY, Texas            TIMOTHY J. WALZ, Minnesota
GLENN THOMPSON, Pennsylvania         KURT SCHRADER, Oregon
BOB GIBBS, Ohio                      MARCIA L. FUDGE, Ohio
AUSTIN SCOTT, Georgia                JAMES P. McGOVERN, Massachusetts
SCOTT R. TIPTON, Colorado            SUZAN K. DelBENE, Washington
ERIC A. ``RICK'' CRAWFORD, Arkansas  GLORIA NEGRETE McLEOD, California
MARTHA ROBY, Alabama                 FILEMON VELA, Texas
SCOTT DesJARLAIS, Tennessee          MICHELLE LUJAN GRISHAM, New Mexico
CHRISTOPHER P. GIBSON, New York      ANN M. KUSTER, New Hampshire
VICKY HARTZLER, Missouri             RICHARD M. NOLAN, Minnesota
REID J. RIBBLE, Wisconsin            PETE P. GALLEGO, Texas
KRISTI L. NOEM, South Dakota         WILLIAM L. ENYART, Illinois
DAN BENISHEK, Michigan               JUAN VARGAS, California
JEFF DENHAM, California              CHERI BUSTOS, Illinois
STEPHEN LEE FINCHER, Tennessee       SEAN PATRICK MALONEY, New York
DOUG LaMALFA, California             JOE COURTNEY, Connecticut
RICHARD HUDSON, North Carolina       JOHN GARAMENDI, California
RODNEY DAVIS, Illinois
CHRIS COLLINS, New York
TED S. YOHO, Florida

                                 ______

                      Nicole Scott, Staff Director

                     Kevin J. Kramp, Chief Counsel

                 Tamara Hinton, Communications Director

                Robert L. Larew, Minority Staff Director

                                  (ii)



















                             C O N T E N T S

                              ----------                              
                                                                   Page
Conaway, Hon. K. Michael, a Representative in Congress from 
  Texas, submitted letters.......................................    59
Lucas, Hon. Frank D., a Representative in Congress from Oklahoma, 
  opening statement..............................................     1
    Prepared statement...........................................     2
Peterson, Hon. Collin C., a Representative in Congress from 
  Minnesota, opening statement...................................     3
    Prepared statement...........................................     4

                               Witnesses

Duffy, Hon. Terrence A., Executive Chairman and President, CME 
  Group, Inc., Chicago, IL.......................................     5
    Prepared statement...........................................     6
Sprecher, Jeffrey C., Founder, Chairman, and CEO, 
  IntercontinentalExchange, Inc., Atlanta, GA....................    10
    Prepared statement...........................................    11
Roth, Daniel J., President and Chief Executive Officer, National 
  Futures Association, Chicago, IL...............................    13
    Prepared statement...........................................    14
Lukken, Hon. Walter L., President and Chief Executive Officer, 
  Futures Industry Association, Washington, D.C..................    16
    Prepared statement...........................................    18
O'Connor, Stephen, Chairman, International Swaps and Derivatives 
  Association, Inc., New York, NY................................    21
    Prepared statement...........................................    23
Dunaway, William J., Chief Financial Officer, INTL FCStone, Inc., 
  Kansas City, MO................................................    28
    Prepared statement...........................................    30

 
              THE FUTURE OF THE CFTC: MARKET PERSPECTIVES

                              ----------                              


                         TUESDAY, MAY 21, 2013

                          House of Representatives,
                                  Committee on Agriculture,
                                                   Washington, D.C.
    The Committee met, pursuant to call, at 10:18 a.m., in Room 
1300 of the Longworth House Office Building, Hon. Frank D. 
Lucas [Chairman of the Committee] presiding.
    Members present: Representatives Lucas, Neugebauer, Rogers, 
Conaway, Gibbs, Austin Scott of Georgia, Tipton, Crawford, 
Noem, Fincher, LaMalfa, Hudson, Davis, Collins, Peterson, 
McIntyre, David Scott of Georgia, Costa, Walz, McGovern, 
DelBene, Negrete McLeod, Vela, Kuster, Nolan, Enyart, Vargas, 
and Bustos.
    Staff present: Debbie Smith, Jason Goggins, Josh Mathis, 
Kevin Kramp, Nicole Scott, Suzanne Watson, Tamara Hinton, Caleb 
Crosswhite, John Konya, C. Clark Ogilvie, Liz Friedlander, and 
Riley Pagett.

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

    The Chairman. This hearing of the Committee on Agriculture 
entitled, The Future of the CFTC: Market Perspectives, will 
come to order. I recognize myself for an opening statement. I 
apologize to the Ranking Member and the witnesses and the 
Committee Members for being a little late. Life has been a 
little bit challenging back home in Oklahoma in the last couple 
days, and I simply note that no matter how challenging Mother 
Nature may be, and no matter how sometimes our fellow citizens 
suffer, it is nonetheless in a small way redeeming to see how 
well in this country, whether it is in Oklahoma or on the East 
Coast or the West Coast, how well we still come together after 
a tragedy and how decently we treat each other, and how hard we 
help those who are hurt or hurting. I thank you for your 
indulgence.
    And with that, let me also note that we are all here today 
to discuss the reauthorization of the Commodity Futures Trading 
Commission. This is the first hearing on this issue, and the 
first in a series of hearings this Committee plans to hold in 
advance of writing legislation. CFTC reauthorization gives the 
Committee an opportunity to review the CFTC's operations, 
examine the pressing issues facing the futures and swaps 
markets, evaluate how regulations are impacting end-users and 
the agricultural community, and determine how to best protect 
consumer funds while restoring confidence in our markets. The 
reauthorization also allows the Committee to take stock of past 
events, such as the passage of the Dodd-Frank Act of 2010, the 
ensuing rulemaking process, and the failures of MF Global, and 
PFG Best.
    It is impossible to discuss the CFTC and the future of the 
CFTC without recognizing the impact of these events on the 
agency and its response to them. Today, nearly 3 years after 
the Dodd-Frank Act was enacted, numerous Main Street businesses 
are still waiting to understand how new regulations affect them 
and their operations. Our food producers, our manufacturers, 
our technology companies, and our public power companies have 
all been impacted by new financial regulations.
    The agency's process for writing rules has lacked 
sequencing and coordination. For example, the agency defined 
swap dealer before it defined swap, which does seem to kind of 
defy logic. How do you know if you are a dealer if you don't 
know what you are dealing? Also, the SEC and the CFTC have 
failed to coordinate on cross-border rules. So now we have two 
different definitions of U.S. person for trades with foreign 
counterparts.
    In the wake of missing implementation deadlines, the CFTC 
has also issued dozens of last-minute no action letters, which 
has only contributed to a greater sense of uncertainty as 
businesses try to understand how and when to comply, if ever. 
It is telling that the agency has issued more no action letters 
than finalized rules. It would be one thing if the CFTC missed 
deadlines as the result of a thoughtful rulemaking process that 
considers meaningful public comment and the unintended 
consequences of its actions, but that isn't the case. Rather, 
the agency has been moving in a haphazard way that defies 
Congressional intent and could jeopardize the United States 
competitiveness in the global marketplace.
    Today, we will hear perspectives from the futures and swaps 
marketplace, including the two largest derivative exchanges, a 
futures commission merchant whose customers are farmers and 
ranchers, and industry trade associations who represent 
hundreds of companies. We hope to gain a greater understanding 
of the challenges they will face.
    Moving forward, we will continue our hearings with 
perspectives from end-users, futures customers, and of course, 
the CFTC.
    [The prepared statement of Mr. Lucas follows:]

Prepared Statement of Hon. Frank D. Lucas, a Representative in Congress 
                             from Oklahoma
    Good morning.
    Thank you all for being here today to discuss the reauthorization 
of the Commodity Futures Trading Commission. This is the first hearing 
on the issue, and the first in a series of hearings this Committee 
plans to hold in advance of writing legislation.
    CFTC reauthorization gives the Committee an opportunity to review 
the CFTC's operations, examine the pressing issues facing the futures 
and swaps markets, evaluate how regulations are impacting end-users and 
the agricultural community, and determine how best to protect customer 
funds while restoring confidence in our markets.
    The reauthorization also allows the Committee to take stock of past 
events, such as the passage of the Dodd-Frank Act of 2010, the ensuing 
rulemaking process, and the failures of MF Global and PFG Best. It is 
impossible to discuss the CFTC and the future of the CFTC without 
recognizing the impact of these events on the agency and its response 
to them.
    Today, nearly 3 years after the Dodd-Frank Act was enacted, 
numerous Main Street businesses are still waiting to understand how new 
regulations affect them and their operations. Our food producers, our 
manufacturers, our technology companies, and our public power companies 
have all been impacted by new, financial regulations.
    The agency's process for writing rules has lacked sequencing and 
coordination. For example, the agency defined swap dealer before it 
defined swap, which defies logic. How do you know if you're a dealer if 
you don't even know what you're dealing? Also, the SEC and CFTC have 
failed to coordinate on cross-border rules, so now we have two 
different definitions of ``U.S. person'' for trades with foreign 
counterparts.
    In the wake of missing implementation deadlines, the CFTC has also 
issued dozens of last minute ``no-action'' letters, which has only 
contributed to a greater sense of uncertainty as businesses try to 
understand how or when to be in compliance--if ever. It is telling that 
the agency has issued more ``no-action'' letters than finalized rules.
    It would be one thing if the CFTC missed deadlines as the result of 
a thoughtful, rulemaking process that considers meaningful public 
comment and the unintended consequences of its actions. But, that isn't 
the case. Rather, the agency has been moving in a haphazard way that 
defies Congressional intent and could jeopardize the United State's 
competitiveness in the global marketplace.
    Today, we will hear perspectives from the futures and swaps 
marketplace, including the two largest derivatives exchanges, a futures 
commission merchant whose customers are farmers and ranchers, and 
industry trade associations who represent hundreds of companies. We 
hope to gain a greater understanding of the challenges they face.
    Moving forward, we will continue our hearings with perspectives 
from end-users, futures customers, and of course, the CFTC.

    The Chairman. With that, the chair recognizes the Ranking 
Member for any opening comments he might have.

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

    Mr. Peterson. Thank you, Mr. Chairman, and with all due 
respect, I have to take some issue with the way you 
characterized how this is going, looking at the CFTC, and I do 
not disagree with you that it certainly could have been a 
better process, but the amount of money that has been spent by 
these groups to stop these regulations and ball up the works is 
phenomenal, if you look into it. It is not only focused on the 
CFTC and the SEC, but focused on Congress. It is unreal the 
amount of money that has been poured into stopping these 
regulations, so it is no wonder that it is 3 years and we don't 
have it done. It is amazing we have as much done as we have.
    Why they took some of this stuff out of sequence and so 
forth I am not sure, but I point out to people that you have 
Republicans and Democrats on the CFTC. They haven't agreed, and 
it has been a difficult process.
    But, at the end of the day they listen to people. A good 
example of that is a SEF rule that was completed last week 
which I didn't agree with. They watered that down. Initially it 
was going to be five--there had to be five calls or contacts 
made to try to determine the price. That was reduced to two, 
and then, I guess, three after some kind of process like that. 
And they allowed for phone brokering as opposed to electronic, 
which isn't going to give people that are interested in the 
market making as much information. So there is an example that 
they listened to all of these lobbyists and all of this 
pressure. I don't agree with it, but they went ahead and moved 
the process.
    So, with that SEF rule out of the way now, they don't have 
that much left to do, and from everything I can tell, they are 
going to finish this up this summer. So again, my advice would 
be that we wait. You know, we are going to have hearings. 
Apparently we are going to have hearings at the Subcommittee 
level. That is good. But that we wait until these rules get 
completed so we know what we are dealing with, and we are not 
speculating about what might or might not happen.
    And to go along with that, we have the farm bill to deal 
with. It is not going to be an easy thing to get that through 
the Floor, and then if we get it through conference, then that 
is going to take us most of June and July anyway to get the 
farm bill done. And I would hope we wouldn't get distracted in 
that effort by the reauthorization of the CFTC.
    So I would, again, just encourage a little patience here, 
and not that I am defending the CFTC and everything that they 
have done, but they have had a tough job. And part of the 
problem, we created that last night when we did the conference 
on the Dodd-Frank bill when they required that the CFTC had to 
coordinate with the SEC and when that happened, I knew this was 
going to be a problem, and that bogged everything down. 
Hopefully they will get this thing resolved this summer and 
then we will know where we are at, and see if there is anything 
that needs to be changed in the reauthorization that regards 
the implementation of this Dodd-Frank rule or not.
    So with that, I would yield back.
    [The prepared statement of Mr. Peterson follows:]

  Prepared Statement of Hon. Collin C. Peterson, a Representative in 
                        Congress from Minnesota
    Thank you Chairman Lucas.
    Oversight of the CFTC and its implementation of Dodd-Frank has been 
the subject of numerous Committee hearings over the last few years, and 
at each of these hearings I've urged my colleagues to be patient. I'm 
maybe beginning to sound like a broken record, but as we begin today's 
hearing on CFTC reauthorization, I still think it's important we don't 
get ahead of ourselves.
    The CFTC is still in the process of implementing the reforms called 
for by Dodd-Frank, and I believe we need to give them the necessary 
time to get this right. In my discussions with Chairman Gensler, he 
seems optimistic that they will be finished with their rule-making 
sometime this summer. Again, we would be better served by exercising 
caution and waiting until the rules are finalized before moving ahead 
with CFTC reauthorization. Once the rules are completed, we will have a 
much clearer picture and the opportunity to fix anything that we feel 
needs to be fixed.
    Additionally, I don't want CFTC reauthorization to distract us from 
the Committee's primary task at hand--getting a 5 year farm bill across 
the Floor of the House. We passed a good, bipartisan bill last week, 
but we know there will be numerous challenges on the Floor. I think 
we're going to need all hands on deck to keep the Committee bill 
largely intact.
    Once that is done, conferencing the House farm bill with the Senate 
version will be another challenge. Having been through this in 2008, I 
know that trying to pass another major piece of legislation could 
inadvertently hurt or hinder our goal of getting a new farm bill 
enacted before current law expires. I think we owe it to our farmers, 
who have waited far too long, to remain focused on finishing the farm 
bill.
    Again, I thank the chair and welcome our witnesses.

    The Chairman. The gentleman yields back the balance of his 
time. The chair requests that other Members submit their 
opening statements for the record so that the witnesses may 
begin their testimony, and to ensure that there is ample time 
for questions.
    We call our first panel to the table. I would like to 
welcome the witnesses. Mr. Terrence A. Duffy, Executive 
Chairman and President, CME Group Incorporated, Chicago 
Illinois; Mr. Jeffrey C. Sprecher, Chairman and CEO, 
IntercontinentalExchange, Incorporated, Atlanta, Georgia; Mr. 
Daniel J. Roth, President and CEO of National Futures 
Association, Chicago, Illinois; the Honorable Walter L. Lukken, 
President and CEO, Futures Industry Association, Washington, 
D.C.; Mr. Stephen O'Connor, Chairman of the International Swaps 
and Derivatives Association, Incorporated, New York, New York; 
and Mr. William Dunaway, Chief Financial Officer of INTL 
FCStone Incorporated, Kansas City, Missouri.
    Mr. Duffy, please begin when you are ready, sir.

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

    Mr. Duffy. Thank you, Mr. Chairman, and first, may I say 
that our thoughts and prayers are with you and all the people 
in Oklahoma for these tragic events that you are all suffering 
through down there. It is--as a father of two young sons, I 
just can't even imagine what the people of Oklahoma are going 
through, so our thoughts and prayers are with you, sir.
    That being said, Mr. Chairman, Ranking Member Peterson, 
Members of the Committee, I want to thank you for the 
opportunity to offer market perspectives on the future of the 
CFTC as the Committee considers agency reauthorization.
    Four critical issues to the future of the agency include 
agency funding, rulemaking, market structure, and customer 
protection. We support appropriate funding for the agency, but 
oppose the Administration's proposal to fund any of the $315 
million budget with a transaction tax for many reasons, the 
main reason being a proposed tax will substantially increase 
the cost of market making. For some market makers, this cost 
could go up as much as 100 percent. Market making is an 
essential source for market liquidity. Imposing this new tax 
would increase the cost of business for all customers because 
it would reduce liquidity, increase volatility, and impair 
efficiency. Hedging cost for farmers, ranchers, and other 
commercials will likewise increase and be passed on to the 
consumers in the form of higher prices of food and other goods.
    Although the Administration calls for an exemption for end-
users and some others by taxing market making liquidity pool, 
their costs will go up dramatically due to the lack of 
liquidity and efficiency in the market. The Commission's misuse 
of Dodd-Frank to expand its role is evident in unnecessary 
departure from the principal-based regulatory regime.
    Regulated futures markets performed flawlessly throughout 
the financial crisis. The Commission's efforts to micromanage 
markets and clearinghouses is inefficient, hampers innovation, 
and increases costs and budgets. The Commission's 
implementation of Dodd-Frank by an uncoordinated and often 
inflexible set of rules, resulted in conflicts, confusion, and 
over-inclusion. Our industry would have grounded to a 
standstill without dozens, as the Chairman has recognized, no 
action letters. I have illustrated these concerns in my written 
testimony.
    We urge the Committee to direct the agency to reexamine its 
rulemaking with genuine attention to a cost-benefit criteria 
and a commitment to return to a principle-based regulation. 
Dodd-Frank makes clear that futures and swaps are different 
products and should receive similar, but not identical 
regulation. Claims that futurization is leading to unfair 
competition or as a means to secure more favorable margin 
treatment are simply wrong. A well-run and regulated 
clearinghouse, like ours, does not set margin based on the name 
or label of a cleared contract. CME sets margins based on the 
underlying volatility and liquidity risk of that contract. Many 
of our most important futures contracts use 2 day volatility 
measures in excess of the CFTC's regulatory floor. Market 
participants will continue to use both customizable swaps and 
standardized futures. Innovation, competition, and customer 
choice among well-regulated markets is not only a positive 
development for customers and the public, but it is entirely 
consistent with Dodd-Frank's goals, including the goal of 
reducing risk through central clearing.
    I reported about the rules CME and NFA have implemented to 
strengthen the protection of customers' property at FCMs, 
timely access to aggregated customer balances at banks, for 
example. Facilities have risk-based reviews of the FCMs. The 
CFTC has proposed rules that codify our initiatives which we 
support, but the proposed rules would also change how the 
industry operates in fundamental ways. The industry is studying 
their impact, which could be significant on smaller FCMs that 
serve the agricultural community. We have urged the CFTC to let 
the industry complete its work before moving forward with the 
proposal. We believe that Congress could also further enhance 
customer protection to amendments to the Bankruptcy Code. 
Potential changes would enhance a clearinghouse's ability to 
transfer positions of non-defaulting customers or facilitate 
individual segregation of customer property.
    With respect to the question of insurance, CME, FIA, NFA 
and others are sponsoring a database study of insurance 
scenarios so policymakers can determine whether insurance for 
futures would be viable. The data provided in this study should 
inform decisions regarding the costs and benefits of various 
insurance approaches.
    I want to thank you for the opportunity this morning and 
look forward to your questions.
    [The prepared statement of Mr. Duffy follows:]

 Prepared Statement of Hon. Terrence A. Duffy, Executive Chairman and 
                President, CME Group, Inc., Chicago, IL
    Good morning, Chairman Lucas, and Ranking Member Peterson. Thank 
you for the opportunity to offer market perspectives on the future of 
the CFTC as the Committee considers reauthorization of the Agency. I am 
Terry Duffy, Executive Chairman and President of CME Group.\1\ Four 
critical issues to the future of the Agency include Agency funding, 
rulemaking, market structure and customer protection.
---------------------------------------------------------------------------
    \1\ CME Group Inc. is the holding company for four exchanges, CME, 
the Board of Trade of the City of Chicago Inc. (``CBOT''), the New York 
Mercantile Exchange, Inc. (``NYMEX''), and the Commodity Exchange, Inc. 
(``COMEX'') (collectively, the ``CME Group Exchanges''). The CME Group 
Exchanges offer a wide range of benchmark products across all major 
asset classes, including derivatives based on interest rates, equity 
indexes, foreign exchange, energy, metals, agricultural commodities, 
and alternative investment products. The CME Group Exchanges serve the 
hedging, risk management, and trading needs of our global customer base 
by facilitating transactions through the CME Group Globex electronic 
trading platform, our open outcry trading facilities in New York and 
Chicago, and through privately negotiated transactions subject to 
exchange rules.
---------------------------------------------------------------------------
Agency Funding
    We support adequate funding for the CFTC, but oppose the 
Administration's proposal to fund the entire amount with a ``user 
fee,'' which is just another name for a transaction tax. The 
Administration's FY 2014 Budget proposes to increase the CFTC's budget 
by $109 million to $315 million and to fund the entire amount with a 
``user fee'' levied on futures and derivatives trades. Such a ``user 
fee'' will impose a $315 million per year transaction tax on market 
making. For some market makers, this tax could represent a 100% cost 
increase. Market-making is an essential source of market liquidity. 
Imposing this new tax would increase the cost of business for all 
customers because it would reduce liquidity, increase volatility, and 
impair the efficient use of U.S. futures markets. It will make it more 
difficult and expensive for farmers, ranchers, and other end-users to 
hedge commodity price risk in the market. This will force farmers and 
other market participants to pass along these higher costs to consumers 
in the form of higher food prices.
    Moreover, the tax will change the competitive balance in favor of 
foreign and OTC markets with lower transaction costs where, in an 
electronic trading environment, market users can and will shift their 
business; lessen the value of the information provided to farmers and 
the financial services industry by means of the price discovery that 
takes place in liquid, transparent futures markets with low transaction 
costs; increase the cost to the government resulting from less liquid 
government securities markets; and fail to actually collect the funds 
anticipated when market participants choose lower cost alternative 
jurisdictions and markets.
    For all of these reasons, Congress should reject a transaction tax 
to fund the CFTC.
Rulemaking
    We have been strong advocates for the primary driver behind the 
Dodd-Frank Act: bringing transparency and clearing to the opaque over-
the-counter swaps market. However, the Commission has misused the DFA 
to expand its role, as primarily evidenced by its unnecessary departure 
from the principles-based regulatory regime which has operated so 
successfully. Regulated futures markets performed flawlessly throughout 
the financial crisis. The Commission's efforts to impose unnecessary 
new regulations on futures markets and clearing houses are inefficient, 
hamper innovation, and ultimately increase consumers' costs. 
Consequently, the use of regulated markets and clearing as risk 
management tools is becoming less appealing to market participants--
increasing overall risk in complete contravention of the intention of 
DFA
    The Commission implemented DFA with an uncoordinated and often 
inflexible set of rules resulting in conflicting rules, confusion and 
over inclusion. Our industry would have ground to a standstill without 
the issuance of dozens of no-action letters, most of which were issued 
as deadlines approached. A look at some rulemakings affecting the U.S. 
energy markets in recent months illustrates these problems.\2\
---------------------------------------------------------------------------
    \2\ I highlighted similar problems in my testimony before the 
Committee on February 10, 2011, and its Subcommittee on General Farm 
Commodities and Risk Management on April 13, 2011, respectively.
---------------------------------------------------------------------------
    The CFTC finalized its product definition rulemaking in the summer 
of 2012, with an effective date of October 12, 2012. This effective 
date triggered compliance obligations relating to products defined as 
``swaps'' under many different rulemakings previously finalized by the 
CFTC. However, because the CFTC had not yet completed critical 
rulemakings that would clarify whether certain types of contracts used 
in the energy markets were ``swaps.'', market participants, 
understandably, were unclear as to their responsibilities. Ultimately, 
and at the last minute before the compliance deadline, the CFTC issued 
an order delaying the implementation of these compliance obligations to 
allow the swaps and futures markets to continue operating without 
disruption until year end.
    A few months later, lack of clarity in the swap reporting 
rulemaking again led to confusion in the energy markets. When the swap 
data reporting obligations became effective, it was not clear to market 
participants whether they were required to provide historical trade 
data relating to certain energy contracts that have been listed and 
regulated as futures for over a decade. Notwithstanding the fact that 
this same trade data was already being reported to the CFTC under the 
existing futures rules, it was not clear, and remains unclear, whether 
this data was also subject to swap data reporting requirements. CME 
Group has submitted to the CFTC two requests for guidance, consistent 
with the CFTC's explicit indication in their proposed rulemaking that 
they would provide such guidance.\3\ To date, energy market 
participants still have not received clarity from the CFTC regarding 
their record-keeping or reporting obligations under the new swap rules, 
which for many of them will go into effect on May 29.
---------------------------------------------------------------------------
    \3\ In the rule proposal relating to historical data reporting 
requirements, the Commission stated that it ``expects to provide 
interpretive guidance concerning the determination of the reporting 
counterparty in situations where a historical swap was executed and 
submitted for clearing via a platform on which the counterparties to 
the swap do not know each other's identity.'' 77 Fed. Reg. 35200, 
35211, n. 43 (June 12, 2012).
---------------------------------------------------------------------------
    We ask the Committee to direct the Agency to re-examine its DFA 
rulemaking with genuine attention to a cost-benefit criteria and 
commitment to return to principles-based regulation.
Market Structure
    As previously indicated, one of the fundamental purposes of the DFA 
was to respond to the financial crisis by bringing regulatory oversight 
to the previously unregulated and opaque swaps market. The DFA 
accomplished this through two primary changes to the swaps market: (1) 
centralized clearing, to reduce systemic risk; and (2) reporting and 
trading on regulated platforms, to provide transparency. These policies 
mirror, in many ways, the regulatory structure under which the U.S. 
futures markets have operated for many decades.
    The DFA makes clear that futures and swaps are different product 
classes and should receive similar, but not identical, regulation. 
Claims that ``Futurization'' is an improper effort to secure more 
favorable margin treatment or other regulatory benefits are misplaced. 
Margin requirements permit the clearing house that is clearing a 
contract to mitigate the risk attendant to that specific contract. CFTC 
rules set a floor for the amount of initial margin that clearinghouses 
must collect. At a well-run and regulated clearing house, like ours, 
margin is determined by risk management policies and procedures 
designed to account for the actual risk profile of the product--its 
underlying volatility and liquidation risk of the contract--not its 
label as a swap or a future. In fact, many of our futures products 
require initial margin based on a 2 day volatility measure in excess of 
the CFTC's regulatory floor.
    The example provided by the Lehman bankruptcy is informative. From 
the time CME decided to liquidate Lehman's futures house positions 
cleared by CME to complete liquidation, 6 hours elapsed. This was a 
complex portfolio, across all of CME major product categories, with a 
margin required on the portfolio approaching $2 billion. We used a 
variety of market participants to liquidate, and did so within margin 
cover. In contrast, Lehman's cleared swaps portfolio--which consisted 
of ``vanilla'' swaps--was so complex that it took the clearinghouse 
that liquidated them over 3 weeks to fully liquidate the portfolio.
    This example illustrates that whether a swap and a future share an 
economic profile is not the determinative factor to a clearing house in 
setting margins. The determinative factor is the overall risk profile 
of the product. And the liquidity and transparency afforded by that 
product's market infrastructure is a critical element of the product's 
risk profile.
    It is consistent with the risk mitigation objectives of DFA to 
ensure that margin requirements be tailored to address the risk 
characteristics of different contracts. Market participants will 
continue to use both customizable swaps and standardized futures 
products. Innovation, competition and customer choice among well-
regulated markets is not only a positive development for customers and 
the public as a whole, but is entirely consistent with the goals of 
DFA.
Customer Protection
Industry Safeguards
    I have previously testified about the rules CME Group, together 
with the National Futures Association (``NFA'') and other U.S. futures 
exchanges have implemented to strengthen the protection of customer 
property (and its investment) at the FCM through strict and regular 
reporting and on-line access to customers' balances at banks and other 
depositories. They improve our work to mitigate the risk of and early 
detection of the improper transfer of customer funds and the improper 
reporting of customer asset balances, and to check compliance with CFTC 
requirements for the investment of customer funds. Our efforts to 
enhance our monitoring continue today through the use of an account 
balance aggregation tool. Timely, including daily, access to this 
additional information is enabling us to better direct our regulatory 
resources at risk-based reviews of customer balances at clearing 
members and FCMs and their activity with respect to those balances.
    Moreover, the CFTC has recently proposed additional rules on 
customer protection that include provisions codifying these 
initiatives, which we strongly support. However, this rulemaking also 
seeks to fundamentally change the way in which the futures marketplace 
operates. As we explained in our comment letter, if a proposed 
``protective'' measure is so expensive or its impact on market 
structure is so severe that customers cannot effectively use futures 
markets to mitigate risk or discover prices, the reason to implement 
that measure needs to be re-examined. Among the proposed rules to 
reevaluate is the rule that would require at all times an FCM's 
residual interest (its own funds) in segregated accounts to exceed the 
margin deficiencies of its customers. It does not appear that any 
system currently exists or could be construed in the near future the 
will permit FCMs to accurately calculate customer margin deficiencies, 
continuously in real-time. Without access to this data, FCMs will be 
required to maintain substantial residual interest in segregated 
accounts or require customers to significantly over-collateralize their 
accounts. We believe this will be a significant and unnecessary drain 
on liquidity that will make trading significantly more expensive for 
customers to hedge. We believe this rule and others could have a very 
significant impact on certain sectors in the marketplace, particularly 
smaller FCMs that serve the agricultural community. The industry is 
conducting an impact analysis of these rules. We have urged the CFTC to 
allow the industry to complete this impact analysis before proceeding 
further with the rulemaking process.
    Further, CME Group believes that proposed changes to Rule 1.52 
threaten the viability of the current regulatory structure. This rule 
governs the manner in which self-regulatory organizations (``SROs''), 
such as CME and NFA, conduct their risk-based reviews of FCMs. Among 
other things, the proposed rule improperly conflates the roles played 
by an FCM's outside auditor and its regulatory examiners (designated 
SROs or DSROs), in essence requiring SROs and DSROs to replicate the 
role of an external auditor. SROs and DSROs are not staffed to play 
such a role, nor should they be. One of the primary strengths of the 
current regulatory scheme is that SROs and DSROs play a role distinct 
from, yet complimentary to, that played by an outside auditor. Rather 
than simply replicating the work performed by outside auditors, the 
SROs and DSROs perform limited reviews that focus on particular areas 
of regulatory concern, including the segregation of customer funds and 
net capital requirements. This proposal would serve little regulatory 
purpose while imposing significant costs.
Bankruptcy Code Improvements
    We believe that Congress could further enhance customer protections 
through amendments to the Bankruptcy Code. Potential amendments range 
from fundamental changes that would facilitate individual segregation 
of customer property to narrower revisions that would enhance a 
clearinghouse's ability to promptly transfer positions of non-
defaulting customers. While amending the Bankruptcy Code is a 
significant undertaking, CME Group believes that modification to the 
bankruptcy regime in light of recent experience would benefit customers 
and the market as a whole.
Insurance for Futures Study
    In the wake of MF Global and Peregrine Financial, some have 
advocated establishing an insurance scheme to protect futures 
customers. Any such proposal must be analyzed in light of the costs and 
potentially limited efficacy of such an approach due the 
extraordinarily large amount of funds held in U.S. segregation.
    The futures industry, led by the Futures Industry Association,\4\ 
is researching various insurance mechanisms in order to provide a 
quantitative, data-based analysis that will enable policymakers and 
market participants to determine whether insurance for futures would be 
viable.
---------------------------------------------------------------------------
    \4\ CME Group, the Institute for Financial Markets (``IFM'') and 
the NFA are also sponsors of the study.
---------------------------------------------------------------------------
Conclusion
    As Congress considers reauthorization of the CFTC, we urge the 
Committee to continue its strong oversight of the CFTC to ensure that 
rulemaking is efficient and consistent with the DFA; regulation 
enhances the safety and soundness of futures and derivatives markets by 
a principles-based regulatory regime; and the U.S. competitive stance 
in the global financial marketplace is preserved. We look forward to 
working with the Committee during this process.

    The Chairman. Thank you, Mr. Duffy.
    Mr. Sprecher, you may begin when you are ready, sir.

           STATEMENT OF JEFFREY C. SPRECHER, FOUNDER,
       CHAIRMAN, AND CEO, IntercontinentalExchange, INC.,
                          ATLANTA, GA

    Mr. Sprecher. Thank you, Chairman Lucas, Ranking Member 
Peterson, and Committee Members, including my colleagues from 
Georgia. I am Jeff Sprecher. I am Chairman and Chief Executive 
Officer of ICE, and I am grateful for the opportunity to 
comment on the Commodity Exchange Act as this Committee 
undertakes its reauthorization.
    ICE is a leading operator of regulated global marketplaces 
for futures and OTC derivatives. On December 20 of last year, 
ICE announced its transaction to acquire NYSE Euronext, which 
will further expand our reach across commodities and equities 
markets.
    My testimony today focuses on some of the issues that we 
see in operating these diverse markets.
    In 2009 in response to the global financial crisis, the G20 
Nations met in Pittsburgh to agree on reforming the world's 
financial markets. This agreement led Congress to passing the 
Dodd-Frank Act. Today, the CFTC has passed the majority of 
applicable rules under Dodd-Frank, and ICE's U.S. businesses 
have largely implemented these new rules. We continue to 
support market participants who are doing the same thing.
    We are now turning towards rulemakings and implementation 
in Europe and in Asia, as they finalize their financial reform 
laws. As we look at the various regimes and work with global 
regulators, we have concluded that contrary to the G20 goals, 
global financial reform efforts are not being harmonized and 
substantial differences remain between regulatory regimes. If 
regulators fail to harmonize, the effects of uncertainty and 
the prospect for regulatory arbitrage will be damaging.
    The derivatives markets are international, and a majority 
of companies that operate globally use derivatives to manage 
price risk and they conduct these transactions with both U.S. 
and non-U.S. counterparties. The likely outcome will be that 
regulators deem other country's financial regulatory systems as 
being non-equivalent, which would lead to those countries 
erecting barriers to financial markets. It is crucial to 
understand that if countries erect barriers, markets and market 
participants will be damaged. Currently in the U.S., 
commodities markets are the home to global benchmark contracts 
because Asian and European market participants have direct 
access to our markets. Over the past year, ICE has been 
delivering this message to domestic and international 
regulators, yet regulations continue to diverge, particularly 
between the U.S. and Europe. We ask the Committee in its 
oversight role to impress upon the Commodity Futures Trading 
Commission the importance of working with European and Asian 
counterparts to harmonize their regulation and avoid creating 
unintended, unpredictable impacts on our markets and our users.
    Note the time for this agreement is closing, because in 
June, Europe will begin the process of deeming the U.S. 
equivalent or non-equivalent under its regulations, so these 
issues must be solved in the next few months.
    In passing the original Commodity Exchange Act, Congress 
wisely added a sunshine provision to the law to make sure that 
the CEA has kept pace with rapidly evolving commodities 
markets. Importantly, this CEA reauthorization marks the third 
anniversary of the passage of the Dodd-Frank Act. When Dodd-
Frank was passed, the financial markets were very different 
than today. In reviewing the CEA, ICE believes that the 
Commission should focus on two key areas.
    First, given the recent FCM bankruptcies, the Committee 
should focus on modifications to the bankruptcies provisions of 
the CEA to ensure that customer funds are protected in future 
bankruptcies. ICE has been working with other exchanges and 
market participants on this issue and we look forward to 
working with you and your staffs to advance this objective.
    Second, the market would benefit from a clarification of 
Dodd-Frank rules on position limits. Of particular concern is 
Dodd-Frank's definition and limitation on bona fide hedging, 
which is the exemption that is used by end-users. The narrowing 
of a definition of bona fide hedging will likely hurt 
commercial end-users that markets are here to serve. The 
support for the bona fide hedge exemption methodology that has 
been relied upon historically would bring greater certainty to 
our end-users.
    ICE appreciates the opportunity to work with Congress and 
global regulators to address evolving derivatives markets, and 
Mr. Chairman, thank you for the opportunity to share our views 
with you. I will be happy to answer your questions as they may 
arise.
    [The prepared statement of Mr. Sprecher follows:]

Prepared Statement of Jeffrey C. Sprecher, Founder, Chairman, and CEO, 
              IntercontinentalExchange, Inc., Atlanta, GA
    Chairman Lucas, Ranking Member Peterson, I am Jeffrey C. Sprecher, 
Chairman and Chief Executive Officer of IntercontinentalExchange, Inc., 
or ICE. I am grateful for the opportunity to comment on the Commodity 
Exchange Act (CEA) as this Committee undertakes reauthorization.
    As background, ICE was established in 2000 as an over-the-counter 
(OTC) marketplace with the goal of bringing needed transparency and a 
level playing field for the opaque, fragmented energy market that 
existed at the time. Since then, ICE has met that objective and 
expanded its markets through organic growth as a result of innovation. 
We have acquired futures exchanges and brought competition, new 
products, technology, and risk management services to a centuries-old 
business. Today ICE is a leading operator of regulated, global 
marketplace for futures and OTC derivatives across agricultural and 
energy commodities, foreign exchange, credit derivatives and equity 
indexes. Commercial market participants ranging from producers to end-
users rely on our liquid, transparent markets to hedge and manage risk.
    On December 20th of last year, ICE announced its transaction to 
acquire NYSE Euronext. As a result of this transaction, which we expect 
to close this year, ICE's range of products and our global reach will 
expand even further, adding to our operations in Europe, Asia, North 
America and South America across the derivatives and equities markets. 
ICE's businesses are regulated by multiple regulators in multiple 
jurisdictions, including the United State's Commodities Futures Trading 
Commission and the Securities and Exchange Commission, among others. My 
testimony today focuses on some of the issues we see in operating in 
such diverse markets.
International Harmonization
    In 2009, in response to a global financial crisis, the G20 nations 
met in Pittsburgh to agree on reforming the global financial markets. 
This agreement led to Congress passing the Dodd-Frank Wall Street 
Reform and Consumer Protection Act (Dodd-Frank Act), which was passed 
that same year and has been in the implementation process over the past 
3 years. Appropriate regulation of derivatives is of utmost importance 
to the proper functioning of the financial system. ICE believes that 
increased transparency, risk management and capital sufficiency, 
coupled with legal and regulatory certainty, are central to reform and 
to restoring confidence to these vital markets.
    Today, given that the CFTC has passed the majority of the 
applicable rules under Dodd-Frank, ICE's U.S. businesses have largely 
implemented the new rules, and continue to support market participants 
in doing the same. We are now turning toward rule-makings and 
implementation in Europe and Asia as they finalize their financial 
reform laws. As we look at the various regimes and work with global 
regulators, we have concluded that, contrary to the G20 goals, global 
financial reform efforts are not being harmonized and substantial 
differences remain between regulatory regimes.
    If regulators fail to harmonize, the effects of uncertainty and the 
prospect for regulatory arbitrage will be damaging. Because markets are 
global and capital flows across borders, no single country or 
regulatory regime oversees the derivatives market. In order to make 
long-term business decisions, market participants require certainty 
that their transactions will not be judged on conflicting standards. 
The derivatives markets are international: the majority of companies 
that operate globally use derivatives to manage price risks, and they 
conduct these transactions with both U.S. and non-U.S. counterparties. 
The likely outcome will be that regulators deem other countries' 
financial regulatory systems as ``nonequivalent'', which would lead to 
those countries erecting barriers to its financial markets. It is 
crucial to understand that if countries erect these barriers, WE 
markets and market participants will be damaged. Currently, the U.S. 
derivatives markets are home to vital global benchmark contracts in 
agriculture, energy, financial asset classes. These have become 
benchmark contracts because Asian and European market participants have 
direct access to U.S. markets. Importantly, the long-standing global 
nature of the derivatives markets and the resulting international 
competition has lead to advances in transparency, risk management, and 
historically, regulatory cooperation.
    Over the past year, ICE has been delivering this message to 
domestic and international regulators, yet regulations continue to 
diverge, particularly in the U.S. and Europe. We ask the Committee, in 
its oversight role, to impress upon the Commodity Futures Trading 
Commission the importance of working with European and Asian 
counterparts to harmonize regulation and avoid creating unintended, 
unpredictable impacts on financial markets and their users. The time 
for agreement is closing. In June, Europe will begin the process of 
deeming the U.S. equivalent or nonequivalent under its regulations. 
These issues must be solved in the next few months.
Commodity Exchange Act Reauthorization
    In passing the original Commodity Exchange Act, Congress wisely 
added a sunshine provision to the law. Every few years, Congress re-
examines the CEA to make sure that the law has kept pace with the 
rapidly evolving derivatives markets. Importantly, this CEA 
reauthorization marks the third anniversary of the passage of the Dodd-
Frank Act. When Dodd-Frank was passed, the derivatives markets were 
very different than today. Over the past 3 years, these markets have 
become more standardized, transparent, and key derivative contracts are 
now subject to mandatory clearing. Last week, the CFTC finalized rules 
to that will lead to mandatory trading on regulated Swap Execution 
Facilities. Last year, ICE itself transitioned its OTC energy contracts 
to regulated futures contracts.
    Given these sweeping changes, CEA reauthorization is a key 
opportunity for Congress to review the law, as well as the oversight of 
the CFTC, to ensure that the law and the Commission are in step with 
today's derivatives markets. In reviewing the CEA, ICE believes that 
the Commission should focus on two key areas. First, given the recent 
Futures Commission Merchant (FCM) bankruptcies, a focus on 
modifications to the bankruptcy provisions of the CEA to ensure that 
customer funds are protected in future FCM bankruptcies. ICE has been 
working with other exchanges and market participants on this issue and 
we look forward to working with you and your staff to advance this 
objective.
    Second, the market would benefit from a clarification of Dodd-Frank 
rules on position limits. As the U.S. District Court for the District 
of Columbia stated last year, the position limit rules in Dodd-Frank 
are contradictory. If position limits are applied incorrectly, markets 
could be constrained in serving a price discovery function. Of 
particular concern, is the Dodd-Frank Act's limitation of a bona fide 
hedge, which is the exemption used by end-users. The narrow definition 
of bona fide hedge will likely hurt commercial end-users that these 
markets are intended to serve, and thus support the bona fide hedge 
exemption relied upon historically would bring greater certainty to 
end-users in executing their risk management operations.
Conclusion
    ICE has always been and continues to be a strong proponent of open, 
regulated and competitive markets, and appreciates the opportunity to 
work with Congress and global regulators to address the evolving 
derivatives markets. We will continue to engage you and your staff on 
the wide variety of CEA-related issues under the Committee's 
jurisdiction.
    Mr. Chairman, thank you for the opportunity to share our views with 
you. I would be happy to answer any questions you may have.

    Mr. Conaway [presiding.] Thank you, Mr. Sprecher.
    Mr. Roth for 5 minutes.

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

    Mr. Roth. Thank you, Mr. Chairman. My name is Dan Roth and 
I am the President of National Futures Association.
    As we begin this reauthorization process, we at NFA, like 
all of you, are very focused on customer protection issues. The 
fact is that for a very long time, the futures industry had an 
impeccable reputation, and I might add, a well-deserved 
reputation, for safeguarding the integrity of customer funds. 
But in the last 2 years, we had first MF Global and then 
Peregrine, and in both of those instances, customers suffered 
real losses, hard losses, losses that regulators like me are 
supposed to prevent.
    Clearly, we had to make some dramatic improvements and I 
wanted to let you know that at NFA, we have been working very 
closely with the CFTC, with the CME, and other self-regulatory 
organizations to bring about those changes, and I have 
highlighted a number of those changes in my written testimony, 
but in the limited amount of time we have here, if I could 
focus on just one area, I would like to talk a little bit about 
something Mr. Duffy mentioned, and that is the daily 
confirmation process for segregated funds.
    At NFA, we have always required FCMs to file daily reports 
with us showing the amount of customer funds that they are 
holding. We monitor those reports. We look at them. We are 
trying to monitor not only compliance with the rules, but also 
looking for trends or dramatic changes that might be troubling.
    In 2012--I should mention, the confirmation process was--we 
would confirm those balances that we got on the daily reports 
as part of the annual examination process, and we did that 
confirmation through the traditional methodology. We would send 
a written confirmation request to the bank, and then the bank 
would mail a written response to NFA.
    In 2012, we started using an electronic confirmation 
process, an e-confirmation process, and that is essentially 
what uncovered the fraud at Peregrine. But even then with the 
e-confirmation process, that was still being done only as part 
of the annual examination, and we knew we had to do better, and 
so we have done better. We have partnered with the CME and 
together, we have developed and implemented a system that 
requires the daily confirmation of all seg bank balances. We 
still have FCMs that file reports daily with the CME and with 
NFA showing the amount of customer funds that they are holding, 
but now we get daily confirmation from the banks regarding 
those same accounts. We are talking about over 2,300 bank 
accounts which are being confirmed on a daily basis by NFA and 
the CME. We then do an automated comparison between what the 
FCM is saying and what the bank is showing so that we can 
identify any suspicious deviations.
    We are expanding that system further. We are expanding it 
to cover not just banks, but other depositories holding 
customer's segregated funds, such as clearinghouses and other 
clearing FCMs, and that expansion should be done by the end of 
the third quarter.
    Mr. Chairman, I wanted to spend some time on it, because it 
is a really big deal. This is a huge improvement. This is a 
giant step in the way we monitor for seg compliance, and we are 
a better industry because of it.
    The one other topic I wanted to discuss orally has to do 
with, again, a topic Mr. Duffy touched on, which is the 
customer account insurance. In the wake of MF Global and 
Peregrine, there have been calls for customer account insurance 
in the futures industry. Some people think we need some form of 
insurance to bolster public confidence. Well obviously, public 
confidence is a very important ingredient. It is essential to 
having the sort of liquid markets that make efficient markets, 
and we recognize that. Others, though, are concerned that the 
cost of the insurance would be so exorbitant that you would 
actually drain liquidity out of the markets and you would be 
doing more harm than good. I understand those concerns, too. In 
our view at NFA, we felt this issue was too important to be 
decided based on a hunch, that we needed real information and 
real data, and so we, as Terry has said, we have partnered with 
the CME and FIA and the Institute for Financial Markets. We 
have commissioned a consultant with deep expertise in the 
insurance industry and in the futures industry. He is analyzing 
several different insurance scenarios, and we have been 
providing him with very detailed, granular information about 
the account populations at 11 different FCMs, ranging in size 
from small to medium to large, and armed with that information, 
he can then go out and actually get prices from people in the 
insurance and reinsurance industry so that this Committee can 
ultimately have real information and make a more informed 
choice as to whether account insurance would work for this 
industry or whether it would do more harm than good.
    As this process goes forward, Mr. Chairman, we certainly 
look forward to working with Congress and the Commission and 
others, and try to continue the improvements that we are making 
in the regulatory structure here for the futures industry, and 
I would be happy to answer any questions.
    Thank you.
    [The prepared statement of Mr. Roth follows:]

  Prepared Statement of Daniel J. Roth, President and Chief Executive 
           Officer, National Futures Association, Chicago, IL
    Thank you, Mr. Chairman. My name is Daniel Roth and I am the 
President of National Futures Association. As Congress begins the 
reauthorization process, customer protection issues should be front and 
center in everybody's mind. Customer protection is the heart and soul 
of what we do at NFA, and for years the futures industry had an 
impeccable reputation for safeguarding customer funds. Since Congress 
last considered reauthorization, though, that reputation has taken a 
serious hit. First at MF Global and then at PFG, customers suffered 
very real harm from shortfalls in customer segregated funds, the kind 
of harm that all regulators seek to prevent. Clearly, dramatic 
improvements had to be made. In the wake of MF Global and PFG, NFA has 
worked very closely with the CME, other self-regulatory organizations 
and the CFTC to bring about those improvements. Let me start by 
highlighting the steps we have already taken.
Daily Confirmation of Segregated Account Balances
    For years NFA and other SROs confirmed FCM reports regarding the 
customer segregated funds held by the FCM through traditional paper 
confirmations mailed to the banks holding those funds. These 
confirmations were done as part of the annual examination process. In 
early 2012 NFA began confirming bank balances electronically through an 
e-confirm process. That change led to the discovery of the fraud at 
PFG, but e-confirms were still done as part of the annual examination. 
We had to find a better way and we did.
    We partnered with the CME and developed a process by which NFA and 
the CME confirm all balances in all customer segregated bank accounts 
on a daily basis. FCMs file daily reports with NFA and the CME, 
reflecting the amount of customer funds the FCM is holding. Through a 
third party vendor, NFA and CME get daily reports from banks for the 
over 2,000 customer segregated bank accounts maintained by FCMs. We 
then perform an automated comparison of the reports from the FCMs and 
the reports from the banks to identify any suspicious discrepancies. In 
short, Mr. Chairman, the process by which we monitor FCMs for 
segregated fund compliance is now far ahead of where it was just 1 year 
ago.
    We are working with the CME to expand this system to also obtain 
daily confirmations from other types of depositories, such as clearing 
firms and clearinghouses. That expansion should be complete by the 
fourth quarter of this year.
Customer Account Insurance
    In light of the failures of MF Global and PFG there have been 
renewed calls for some form of customer account insurance. As we begin 
this discussion, we should bear in mind three points. First, customer 
account insurance can take many forms. There are alternatives to the 
SIPC, government sponsored model. Private insurance solutions can take 
several forms in terms of who is covered and to what extent. Second, 
public confidence in the markets is critical, but it is a means to an 
end. The real goal is to ensure that futures markets are effective and 
efficient and a benefit to the economy. Markets must therefore be 
liquid and that requires public confidence. However, attempting to 
bolster public confidence through insurance programs that prove to be 
cost prohibitive is self-defeating and would damage the liquidity we 
are trying to foster. Finally, this question is too important to be 
dismissed out of hand because various forms of insurance might be too 
expensive.
    We need data, not hunches. We need to know what kind of insurance 
we would be buying and what we would be paying for it. Only then can 
Congress make an informed decision. With this in mind, NFA has joined 
with the CME, FIA and the Institute for Financial Markets to commission 
a detailed analysis of various alternative approaches to customer 
account insurance. Armed with detailed customer account information 
from small, medium and large FCMs, the study will calculate the 
estimated costs of each of the alternatives studied. We hope to have 
the results of the study in June.
FCM Transparency
    One of the lessons we learned from MF Global is that customers 
should not have to study the footnotes to an FCM financial statement to 
find out how their segregated funds are invested or other financial 
information about their FCMs. We had to make it easier for customers to 
do their due diligence on financial information regarding FCMs. We now 
require all FCMs to file certain basic financial information with NFA, 
and that information is then posted on NFA's website for customer 
review. The information includes data on the FCM's capital requirement, 
excess capital, segregated funds requirement, excess segregated funds 
and how the firm invests customer segregated funds. This information is 
displayed for each FCM and includes historical information in addition 
to the most current data. The display of FCM financial information on 
NFA's website began in November 2012 and so far these web pages have 
received over 15,000 hits.
MF Global Rule
    All FCMs maintain excess segregated funds. These are funds 
deposited by the FCM into customer segregated accounts to act as a 
buffer in the event of customer defaults. Because these funds belong to 
the FCM, the FCM is free to withdraw the excess funds, but after MF 
Global, NFA and the CME adopted rules to ensure notice to regulators 
and accountability within the firm. Now all FCMs must provide 
regulators with immediate notification if they draw down their excess 
segregated funds by 25% in any given day. Such withdrawals must be 
approved by the CEO, CFO or a financial principal of the firm and the 
principal must certify that the firm remains in compliance with 
segregation requirements. This rule became effective on September 1, 
2012.
FCM Internal Controls
    NFA, CME and other SROs developed more specific and stringent 
standards for the internal controls that FCMs must follow to monitor 
their own compliance with regulatory requirements. NFA has drafted an 
interpretive notice that contains specific guidance and identifies the 
required standards in areas such as separation of duties; procedures 
for complying with customer segregated funds requirements; establishing 
appropriate risk management and trading practices; restrictions on 
access to communication and information systems; and monitoring for 
capital compliance. NFA will submit the interpretive notice to the CFTC 
shortly for its review and approval.
Review of NFA Examination Procedures
    NFA's Special Committee for the Protection of Customer Funds--
consisting of all public directors--commissioned an independent review 
of NFA's examination procedures in light of the PFG fraud. The study 
was conducted by a team from the Berkeley Research Group (``BRG'') that 
included former SEC personnel who conducted that regulator's review of 
the SEC's practices after the Madoff fraud. BRG's report was completed 
in January 2013. The report stated that ``NFA's audits were conducted 
in a competent manner and the auditors dutifully implemented the 
appropriate modules that were required.'' The report, however, also 
included a number of recommendations designed to improve the operations 
of NFA's regulatory examinations in the areas of hiring, training, 
supervision, examination process, risk management, and continuing 
education. NFA has already taken a number of steps to implement BRG's 
recommendations. A Special Committee appointed by NFA's Board will 
oversee the timely implementation of these recommendations.
    Both the PFG and MF Global bankruptcies highlighted the need for 
greater customer protections to not only guard against the loss of 
customer funds but also in the event of an FCM's insolvency. As 
discussed above, NFA has made and continues to implement changes to 
enhance the safety of customer segregated funds and guard against a 
shortfall in customer funds in the event of any future FCM failures.
    NFA believes, however, that Congress should consider a number of 
possible changes to Bankruptcy Code provisions that govern an FCM's 
liquidation that would likely strengthen customer protections and 
priorities in the event of a future FCM bankruptcy. We fully recognize 
that any changes to the Bankruptcy Code regarding FCM insolvency 
protections will not be easy to achieve. Yet we strongly believe that 
the two recent FCM failures have highlighted the need for enhanced 
customer protections that can only be achieved via changes to the 
Bankruptcy Code.
    We are in discussions with all facets of the industry to arrive at 
a consensus view on changes that should be made. Chief among NFA's 
concerns in this area is removing the uncertainty over the validity of 
the CFTC's definition of customer property. Other issues may include 
reviewing whether it is appropriate that all joint FCM/broker-dealer 
bankruptcies be administered under SIPA.
    Detecting and combating fraud is central to our mission. No system 
of regulation can ever completely eliminate fraud, but we must always 
strive for that goal. The process of refining and improving regulatory 
protections is ongoing and the initiatives outlined above do not mark 
the end of our efforts. We look forward to working with Congress, the 
CFTC, SROs and the industry to ensure that customers have justified 
confidence in the integrity of the U.S. futures markets.

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

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

    Mr. Lukken. Thank you, Mr. Chairman, Ranking Member 
Peterson, and other Members of the Committee. I appreciate the 
opportunity to testify today. My name is Walt Lukken. I am the 
President and CEO of the Futures Industry Association. FIA is 
the leading trade association for the futures, options, and 
over-the-counter cleared derivatives markets. FIA's mission 
since its inception has been ``to protect the public interest 
through adherence to high standards of professional conduct and 
financial integrity.''
    As you know, clearing is an integral part of the futures 
market structure. Clearing ensures that parties to a 
transaction are protected from a failure by a counterparty to 
perform its obligations. The FCMs that FIA represents play a 
critical role in guaranteeing the transactions and ensuring 
they are secured with appropriate customer margin to facilitate 
the clearing process.
    As you know, the failures of MF Global and Peregrine 
Financial Group resulted in severe and unacceptable 
consequences for futures customers and the markets generally. 
The entire industry has been working collaboratively to 
identify and improve procedures required to better protect the 
integrity of the markets, and much has been accomplished over 
the last year. FIA formed a customer protection task force in 
the aftermath of these insolvencies and recommended a number of 
changes that have been adopted by the regulators. Some of the 
highlights include the enhancement of FCM record-keeping, 
reporting, and early warning indicators, including the filing 
of daily segregation balances with regulators, creating of an 
automated daily verification, as Mr. Roth has mentioned, for 
customer segregation balances directly with banks, and other 
depository institutions, the collection and posting of 
additional FCM financial information to NFA's online system, 
Basic, to help customers monitor and assess the health of their 
FCM, just to name a few.
    The Committee may also be interested to know that, as 
mentioned before, that FIA and CME, the IFM, and NFA have 
joined together to fund a study of the costs and benefits of 
various insurance proposals, and we look forward to sharing the 
findings of this with the Committee when they are available 
early this summer.
    In addition to the efforts undertaken by the industry, the 
CFTC has recently proposed a set of comprehensive regulations 
to further enhance customer protection, and we support much of 
what have been suggested in this rulemaking, including the 
codification of many of FIA's recommendations. However, the 
proposed change related to residual interest drastically 
reinterprets the longstanding application of the statute 
regarding customer margin collections, and will make trading 
significantly more expensive for customers hedging their 
commercial risks. Specifically, this reinterpretation would 
require FCMs in collecting customer margin to assume all 
customer margin call deficits are simultaneously not collected, 
requiring either customers to prepay their margin or firms to 
fund customer margins on their behalf. When the proposal was 
released by the Commission, the Commission did not conduct a 
cost-benefit analysis because it did not have adequate 
information to determine the costs of this reinterpretation. As 
such, FIA engaged in its own cost analysis, estimating that 
this change would require an additional $100 billion in 
customer margin. Many agricultural customers have expressed 
strong concerns with this proposal, which will increase the 
cost of hedging, cause consolidation among small FCMs, and 
limit execution choices for customers. We believe this part of 
the CFTC rule warrants further review before changing the 
existing interpretation.
    Moving to swap clearing, Congress looked to the reliability 
and stability of the clearing system for futures when it 
determined to extend clearing for swaps under the Dodd-Frank 
Act. To date, much of the debate surrounding the implementation 
of the swap clearing requirement under Dodd-Frank has been 
focused on what products and entities might be subject to the 
mandatory clearing requirement, rather than how the operations 
and mechanics of clearing would work for swaps. Unfortunately, 
the reality is that the rules being written to facilitate the 
clearing for swaps are reinventing the already proven clearing 
process that is familiar and well-tested for futures, thereby 
creating an overly complicated web of regulations for both 
swaps and futures. Even those entities in the existing futures 
clearing environment are being forced to seek temporary relief 
from the new regulation while they sort through compliance 
issues. Without such relief, market participants face the 
reality of either shutting down existing commercial activity, 
or inadvertently being out of compliance as they seek to 
implement ambiguous, confusing, or misaligned regulations.
    Also of concern is the manner in which the needed relief is 
being granted. Relief is either commonly provided at the very 
last minute, causing disruption for customers in both the 
futures and the swap markets, or causing tremendous resources 
to be wasted while market participants prepare and wait for a 
last-minute action.
    While the industry appreciates the opportunity to seek 
temporary relief in these circumstances, what necessitates this 
relief and the manner in which this relief is granted remains 
troubling.
    With that, Mr. Chairman, I will end my testimony. Thank you 
very much.
    [The prepared statement of Mr. Lukken follows:]

   Prepared Statement of Hon. Walter L. Lukken, President and Chief 
   Executive Officer, Futures Industry Association, Washington, D.C.
    Chairman Lucas, Ranking Member Peterson, and Members of the 
Committee, thank you for the opportunity to provide our perspective on 
matters affecting the derivatives industry and in particular the 
regulation of our markets by the Commodity Futures Trading Commission 
(CFTC). As you turn your attention to reauthorizing the CFTC, the 
Futures Industry Association (FIA) stands ready to assist in any way we 
can. FIA is the leading trade organization for the futures, options and 
over-the-counter cleared derivatives markets. It is the only 
association representative of all organizations that have an interest 
in the listed derivatives markets. Its membership includes derivatives 
clearing firms, traders and exchanges from more than 20 countries. 
FIA's core constituency consists of futures commission merchants, 
commonly known as FCMs, and the primary focus of the association is the 
global use of exchanges, trading systems and clearinghouses for 
derivatives transactions.
    As you know, clearing has long been an integral part of the futures 
market structure. Clearing ensures that parties to a transaction are 
protected from a failure by the opposite counterparty to perform their 
obligations, and the FCMs that FIA represents play a critical role in 
ensuring that transactions are secured with appropriate margin to 
facilitate this clearing process.
Improving Customer Protection
    I would like to take this opportunity to update the Committee on 
recent efforts to improve the handling of customer funds, or what is 
often called margin or collateral. As you know, the failures of MF 
Global Inc. and Peregrine Financial Group resulted in severe and 
unacceptable consequences for futures customers and the markets 
generally. The entire industry has been working collaboratively to 
identify and improve procedures required to better protect the 
integrity of these markets. A number of changes are already being 
implemented, many of which were recommended by FIA in the aftermath of 
these insolvencies: \1\
---------------------------------------------------------------------------
    \1\ See Futures Industry Association, Futures Markets Financial 
Integrity Task Force--Initial Recommendations for Customer Funds 
Protection: http://www.futuresindustry.org/downloads/
Initial_Recommendations_for_Customer_Funds_Protection.pdf.

   The National Futures Association (NFA) and the CME Group 
        (CME), the industry's principal self-regulatory organizations, 
        have adopted rules that subject all FCMs to enhanced record-
        keeping and reporting obligations. For example, chief financial 
        officers or other appropriate senior officers are now required 
        to authorize in writing and promptly notify the FCM's DSRO 
        whenever an FCM seeks to withdraw more than 25 percent of its 
        excess funds from the customer segregated account in any day--
        these are funds deposited by the FCM into customer segregated 
---------------------------------------------------------------------------
        accounts to guard against customer defaults.

   NFA and CME have begun building an automated system for the 
        daily monitoring of all customer segregated, secured, and 
        cleared swaps amounts held by FCMs. As part of this project, 
        NFA and CME contracted with AlphaMetrix360, a subsidiary of 
        AlphaMetrix Group, to aggregate the data on customer 
        segregated, secured, and cleared swaps amount accounts. The new 
        system will allow NFA and CME to run an automated comparison of 
        the balances in customer segregated, secured, and cleared swaps 
        accounts at the depositories with the daily reports they 
        receive from FCMs, and then quickly identify any discrepancies.

   NFA is also collecting additional financial information from 
        FCMs and posting that information on its online Background 
        Affiliation Status Information Center (Basic) system, a key 
        step in giving customers the tools they need to monitor the 
        assets they deposit with their FCMs. The new service provides 
        the public with access to specific information about an FCM, 
        such as the firm's adjusted net capital, the amount of funds 
        held in segregated, secured, and cleared swaps accounts, and 
        the types of investments that the FCM is making with those 
        customer funds.

   It is my understanding that NFA is in the process of 
        drafting an interpretive notice that contains specific guidance 
        and identifies the minimum required standards for FCM internal 
        controls such as separation of duties; procedures for complying 
        with customer segregated and secured amount funds requirements; 
        establishing and complying with appropriate risk management and 
        trading practices; restrictions on access to communication and 
        information systems; and monitoring for capital compliance.

   A set of frequently asked questions on customer funds 
        protection \2\ has also been developed by FIA, which is being 
        used by FCMs to provide their customers with increased 
        disclosure on the scope of how the laws and regulations protect 
        customers in the futures markets.
---------------------------------------------------------------------------
    \2\ See Protection of Customer Funds, Frequently Asked Questions: 
http://www.futuresindustry.org/downloads/PCF-FAQs.PDF.

   Additionally, FIA, CME Group, NFA, and the Institute for 
        Financial Markets have partnered to fund an evaluation of the 
        costs and benefits of various asset protection insurance 
        proposals. We look forward to sharing these findings with the 
---------------------------------------------------------------------------
        Committee when available.

    In addition to the efforts undertaken by the industry, the CFTC has 
recently proposed a set of comprehensive regulations to further enhance 
customer protection. To a significant extent, the proposed rules build 
upon and codify the recommendations that FIA made and rules that the 
NFA and CME adopted in early 2012. FIA strongly endorses the regulatory 
purposes underlying the proposed amendments. We nonetheless submitted 
an extensive comment letter designed, in substantial part, to assist 
the Commission in striking an appropriate balance among its several 
proposals to assure that the producers, processors and commercial 
market participants that use the derivatives markets to manage the 
risks of their businesses will be able to continue to have cost-
effective access to the markets and a choice of FCMs. In particular, 
the proposed change related to residual interest drastically re-
interprets the long-standing application of the statute and will result 
in a tremendous drain on liquidity that will make trading significantly 
more expensive for customers hedging their financial or commercial 
risks, and will adversely affect the ability of many FCMs to operate 
effectively. The current interpretation was essential to the 
performance of the futures industry during the 2008 crisis and its 
application is not related to the shortcomings identified after the 
recent failures. When the proposal was released the Commission did not 
have adequate information to determine the costs of the modified 
residual interest requirement.\3\ As such, FIA engaged an accounting 
consultant to sample FCMs on the potential costs of the residual 
interest proposal; the results show that this change could require an 
additional $100 billion obligation to the customer funds accounts, 
beyond the sum required to meet initial margin requirements. Many of 
the very customers this proposal is designed to benefit have expressed 
concerns as they rightfully realize this will significantly increase 
the costs of hedging and likely have the largest impact on small to 
mid-sized FCMs which could potentially lead to consolidation and fewer 
choices for them as customers. As previously mentioned, the FIA 
supports many of the customer protection measures that the Commission 
has proposed, we simply believe this one in particular warrants further 
review as to why the existing statutory interpretation should be 
changed.
---------------------------------------------------------------------------
    \3\ See 77 FR 67916.
---------------------------------------------------------------------------
    The FIA is very engaged in the development of industry and 
Commission-initiated efforts to proactively address many of the issues 
presented by these recent failures. While the derivatives industry is 
strong, and clearing continues to be the gold standard in protecting 
market participants from the unexpected failure of a counterparty, we 
have learned that the collateral necessary for a robust clearing 
system, and the customers who post such margin, are better protected 
through enhanced disclosures, reporting, and internal controls. Our 
members commit a substantial amount of their own capital to guarantee 
customer transactions. We have every incentive to ensure that the 
integrity of the derivatives clearing system is well-regarded as safe 
and reliable.
Clearing Under the ``Dodd-Frank Act''
    Under the ``Dodd-Frank Act'', Congress determined to extend 
clearing beyond futures to swaps, and as such the role of the FCM has 
also expanded. Because FCMs play a critical role in achieving the 
newly-established clearing regime for swaps, we are happy to offer our 
thoughts on the implementation of these requirements.
    To date, much of the debate surrounding the implementation of the 
swaps clearing requirements under the ``Dodd-Frank Act'' has been 
focused on who, what, when and where, rather than how. Often, public 
attention to Title VII implementation has been devoted to what products 
will be subject to the clearing mandate; who will be expected to comply 
with the mandate; when they will be expected to comply; and where, 
within the global markets, the products and participants will be 
regulated--all very important questions, but far less discussion has 
been devoted to how the mechanics of clearing are being impacted. This 
is probably a result of the fact that as the legislation was being 
constructed there were very few questions about how the actual act of 
clearing swaps would work--I believe most assumed that the process 
already established for futures would simply be applied to swaps. 
Certainly, the regulatory policies that have historically existed for 
clearing futures can largely be applied to swaps, with the occasional 
exception necessitated by the fact that swaps and futures have evolved 
in different environments. Unfortunately, the reality is that the rules 
being written to facilitate the clearing of swaps are in some cases re-
inventing the already proven clearing process that is familiar and 
tested for futures, thereby creating an overly-complicated web of 
regulations for both swaps and futures. Even those who have for many 
years operated within the existing futures clearing environment are 
being forced to seek temporary relief from the new regulations while 
they sort through compliance options. Without such relief, market 
participants face the reality of either shutting down existing 
commercial activity or inadvertently being out of compliance as they 
seek to implement confusing regulations.
    Also of concern is the manner in which the needed relief is being 
granted. Relief is commonly provided at the very last minute causing 
disruptions for customers in both the futures and the swaps markets and 
causing tremendous resources to be wasted while market participants 
prepare and wait.
    While the industry appreciates the opportunity to seek temporary 
relief in these circumstances, what necessitates this relief and the 
manner in which the relief is granted remain troubling. Let me be 
clear, we support properly designed and effective clearing rules. Our 
members provide the majority of the funds that support derivatives 
clearinghouses and commit a substantial amount of their own capital to 
guarantee customer transactions. We have every incentive to ensure that 
the actual process of clearing derivatives--both futures and swaps--is 
properly regulated.
    However, at this critical juncture, when the newly required 
clearing mandate for swaps is beginning to take effect, we are 
concerned that so much complexity and disorder exists especially given 
the existence of rules that have long governed the clearing of futures. 
FCMs stand ready and willing to facilitate the clearing of swaps, just 
as they have for futures, but the wide-spread confusion as to the 
mechanics of clearing under these new regulations may be hindering the 
process.
State of the Derivatives Industry
    I want to take some time to update you on the general state of the 
derivatives industry. As the swaps market developed and Congress, 
through the ``Dodd-Frank Act'', determined that certain swaps are now 
likely suitable for the clearing protections that have long been 
required for futures, some have claimed that there is regulatory 
arbitrage occurring, with futures and swaps competing against each 
other. I believe that most market participants welcome the broadened 
array of products available in a cleared environment and will continue 
to use both swaps and futures products to meet their individual risk 
management needs as appropriate. And as these products continue to 
evolve, so will their demand. That is the nature of the derivatives 
industry which has long been dynamic.
    In 2012, the total number of futures and options contracts traded 
on exchanges worldwide dropped by 15.3%. However, overall trading and 
clearing volumes have risen over the past 10 years. Even before the 
clearing mandate for certain swaps and swap market participants took 
effect in March, the volume of swaps submitted voluntarily for clearing 
was up in January:

   LCH.Clearnet experienced a major surge in interest rate swap 
        clearing, with volume exceeding $55 trillion in notional value 
        in January, an all-time high.

   CME Group also saw all-time highs in interest rate swap 
        clearing, with January volume of more than $250 billion 
        notional cleared and $750 billion in open interest.

   The notional volume of credit default swaps cleared by ICE 
        Clear Credit totaled $400 billion in January.

    As the clearing mandate took effect in March for swap dealers, 
major swap participants and active funds the infrastructure responded 
relatively well--as noted many of these entities had been engaged in 
voluntary clearing efforts prior to the March date. It should be noted 
that the next effective date of June 10 will bring in many more 
participants and will likely present many more challenges to the new 
regulatory regime. Given the timing, these implementation challenges 
will likely become apparent and coincide with the Committee's 
consideration of the CFTC reauthorization--I encourage you all to 
continue your long-standing tradition of bipartisan oversight as you 
focus on these issues absent political pressure.
    I am fortunate to represent a wide array of stakeholders in the 
derivatives industry--all of whom want to see this industry continue to 
support the risk management needs of its customers in a productive way. 
This is a goal I know the Members of this Committee share and I look 
forward to working with you as you consider the CFTC's role in 
achieving this mutual objective.

    Mr. Conaway. Thank you, Mr. Lukken.
    Now Mr. O'Connor for 5 minutes.

            STATEMENT OF STEPHEN O'CONNOR, CHAIRMAN,
  INTERNATIONAL SWAPS AND DERIVATIVES ASSOCIATION, INC., NEW 
                            YORK, NY

    Mr. O'Connor. Chairman Lucas, Ranking Member Peterson, 
Members of the Committee, thank you for the opportunity to 
testify today.
    In the 5 years since the onset of the financial crisis, 
significant progress has been made in building a more robust 
financial system and safer, more transparent, over-the-counter 
derivative markets. ISDA squarely supports these initiatives 
and regulatory reforms designed to improve systemic resiliency, 
and ISDA has been working hard alongside regulators to 
implement those reforms.
    However, improvements can and should be made the regulatory 
reform process. Contrary to Congress' stated intentions, the 
Dodd-Frank Act contains provisions that could actually 
increase, rather than decrease, systemic risks. Such provisions 
include the law's Section 716, swaps push-out provision, and 
also the requirement for mandatory initial margin for OTC 
derivative transactions. The rationale for and value of these 
provisions are uncertain, but what is certain is that such 
provisions will impose significant costs and drags on the 
economy without any clear countervailing benefits.
    We also have concerns with regard to the interpretation and 
implementation of the Act by the CFTC and the SEC. In some 
cases, sections of the law are being construed differently by 
the two regulators; in others, regulators are interpreting and 
implementing the laws in ways that do not reflect the intent of 
Congress. For example, there are significant risks that the 
goal of increased regulatory transparency is being undermined 
by the fragmentation of derivatives trade reporting. U.S. 
regulators and their international counterparts have failed to 
reach agreements on the implementation of key regulations, and 
lack of international coordination and jurisdictional overreach 
has created barriers to international capital flows and to 
international commerce.
    Here in the United States, the CFTC and the SEC have taken 
different approaches to the cross-border application of 
derivative laws, which can seriously impact market liquidity 
and the competitiveness of U.S. firms in the global economy. 
The two U.S. regulators also have different interpretations of 
the law's trade execution requirements, which could lead to 
bifurcated market practices, and the law's business conduct 
standards are being applied in a very prescriptive manner, not 
envisioned by legislators, adding unnecessary costs and 
complexity to the system. And in some instances, the cost-
benefit analysis required under the law is not being 
appropriately conducted, which could result in the imposition 
of rules that wind up doing more harm than good. In these and 
in other areas, there is significant concern that the law will 
be inconsistently and inappropriately applied.
    It is vitally important that we, industry and regulators, 
focus our resources on those aspects of regulatory reform that 
address the most important issue: reducing systemic risk. This 
includes capital, central clearing, and variation margin 
frameworks as well as regulatory transparency. It is vitally 
important to avoid enacting measures that harm liquidity or 
reduce systemic resiliency in the very markets they are trying 
to protect, resulting in a direct and harmful impact on the 
economy. This is particularly critical given the slow and 
uneven growth of the U.S. and the broader global economy.
    Dodd-Frank is an important step forward for our country and 
our markets, and the CFTC deserves our sincere appreciation and 
support for its efforts in implementing wide-ranging provisions 
in a relatively short period of time. It is clear, however, 
that our experience over the past several years has shown that 
not all of the law's provisions are appropriate and contribute 
to the overriding goal of a safer financial system, and some 
efforts by the regulators to implement the law are inconsistent 
with the intent of Congress, are being interpreted in different 
ways by different agencies, or impose costs that far exceed any 
resulting benefits.
    In light of these concerns and observations, ISDA 
respectfully requests this Committee to, first, consistent with 
H.R. 1256, stress to the CFTC the necessity of applicable, 
prudent interpretation of the law, including in the area of 
margin, and work closely with the industry to adopt financial 
regulations that ensure the safety of markets, but regulations 
that do not harm market liquidity or harm market participants, 
and second, urge the SEC and the CFTC to harmonize their cross-
border approach as soon as possible so that U.S. regulators 
first speak with one voice, and then engage together 
proactively in the ongoing global debate on international 
harmonization, since proper global coordination is essential to 
ensure the competitiveness of the U.S. markets, U.S. 
businesses, and the U.S. economy.
    Thank you.
    [The prepared statement of Mr. O'Connor follows:]

 Prepared Statement of Stephen O'Connor, Chairman, International Swaps 
            and Derivatives Association, Inc., New York, NY
    Chairman Lucas, Ranking Member Peterson, and Members of the 
Committee: Thank you for the opportunity to testify today.
    In the nearly 5 years since the onset of the financial crisis, 
significant progress has been made in building a more robust financial 
system and a safer, more transparent over-the-counter (OTC) derivatives 
markets. Rule-making is effectively a two stage process. First, the 
Dodd-Frank Wall Street Reform and Consumer Protection Act (the Act) 
created a legal framework for reform, and then the Commodity Futures 
Trading Commission (CFTC) and the Securities and Exchange Commission 
(SEC) have been charged with responsibility for creating market rules, 
effectively the implementation of the Act. Through this mechanism, a 
great deal of progress has been made towards a safer more robust 
financial system.
    However, improvements can and should be made at both stages of this 
process. Contrary to Congress' stated intentions, the Dodd-Frank Act 
contains provisions that could actually increase, rather than decrease, 
systemic risk. This includes, for example, the law's Section 716 swaps 
push-out provision and also the requirement for mandatory initial 
margin for derivatives transactions. The rationale for, and value of, 
these provisions are uncertain. What is certain is that such provisions 
will impose significant costs and drags on the economy, without any 
clear countervailing benefits.
    We also have concerns with regard to stage two, the interpretation 
and the implementation of the Act by the CFTC and the SEC. In some 
cases, different sections of the law are being construed differently by 
the different regulators. In others, regulators are interpreting and 
implementing the laws in ways that do not reflect the intent of 
Congress. For example:

   There is a significant risk that the goal of increased 
        regulatory transparency is being undermined by the 
        fragmentation of derivatives trade reporting;

   The CFTC and the SEC have taken different approaches to the 
        cross-border application of derivatives rules, which could 
        seriously impact market liquidity and the competitiveness of 
        U.S. firms in the global economy;

   The two U.S. regulators also have different understandings 
        of the law's trade execution requirements, which could lead to 
        bifurcated market practices;

   The law's business conduct standards are being applied in a 
        very prescriptive manner not envisioned by legislators, adding 
        unnecessary costs and complexity to the system; and

   In some instances, the cost-benefit analysis required under 
        the law is not being appropriately conducted, which could 
        result in the imposition of rules that wind up doing more harm 
        than good.

    In these and other areas, there is significant concern that the law 
will be inconsistently and inappropriately applied. This could increase 
rather than decrease risk, raise costs and prevent the sound 
application of risk management practices that are essential to the 
proper functioning of markets and to a healthy, productive American 
economy.
    I will address each of these points in more detail, but before I 
do, it's important to state quite clearly: The International Swaps and 
Derivatives Association squarely supports financial regulatory reform 
that is designed to build a strong, safe financial system, reduce 
systemic risk, decrease counterparty credit risk and improve regulatory 
transparency. This, indeed, is our mission: to foster safe and 
efficient derivatives markets for all users of derivatives products. 
ISDA has worked for 25 years on measures such as the significant 
reduction of credit and legal risk by developing a framework of legal 
certainty which includes the ISDA Master Agreement and related 
standardized collateral agreements. The Association has also been a 
leader in promoting sound risk management practices and processes and 
has for 12 years been a strong advocate of the appropriate use of 
central clearinghouses
    Today, ISDA has more than 800 members from 60 countries on six 
continents, including corporations, investment managers, government and 
supranational entities, insurance companies, energy and commodities 
firms, as well as international and regional banks. In addition to 
market participants, members also include key components of the 
derivatives market infrastructure including exchanges, clearinghouses 
and repositories, as well as law firms, accounting firms and other 
service providers. The Association's broad market representation is 
further reflected by the number of non-dealer firms on our board of 
directors and their representation on key ISDA committees.
    ISDA believes that the most effective way to achieve the goal of 
greater systemic resiliency is through a regulatory framework that 
includes: appropriate capital standards, mandatory clearing 
requirements where appropriate, robust collateral requirements and 
mandatory trade reporting obligations. We have worked actively and are 
engaged constructively with policymakers in the U.S. and around the 
world on these important initiatives. Great strides have been made in 
all of these areas.
    For example, trade repositories have been established covering 
derivatives in all major asset classes--interest rates, credit, 
equities, commodities and foreign exchange. Regulators around the world 
now have comprehensive access to information about trading activity in 
the derivatives market. Regulators will now be able to readily identify 
where risk may be building up in the system as well as detect improper 
behavior, observe transaction flows and identify trends in liquidity in 
the OTC markets. However, as discussed in greater detail below, 
significant work remains to ensure that this information is completely 
visible to regulators and a major opportunity is not lost.
    With regard to clearing of derivatives through central 
counterparties, nearly \2/3\ of the interest rate swap market is 
already centrally cleared, largely due to voluntary initiatives and 
commitments by banks to global regulators in advance of the Dodd-Frank 
Act required mandates. Clearing will increase significantly in the next 
twelve to twenty-four months as trades between dealers and their 
clients become subject to mandatory clearing, which began in the U.S. 
in March 2013.
          * * * * *
    Let me turn briefly to what we believe are two of the most 
significant areas of the Dodd-Frank Act that could benefit from action 
by Congress: the swaps push-out provision and the initial margin 
requirements.
Section 716 Swaps Push-Out Provision
    The Dodd-Frank Act's Section 716, commonly called the ``Swap Push-
Out'' provision, requires banks to separate and segregate portions of 
their derivative businesses, including equity derivatives, certain CDS 
and commodity derivatives transactions, outside of entities that 
receive Federal assistance, including the Federal deposit insurance 
program or access to the Federal Reserve's discount window. These 
activities would have to be conducted in separately capitalized 
affiliates, legally apart from entities such as FDIC-insured banks. We 
should also note that, due to a drafting error, certain non-U.S.-based 
firms with significant U.S. operations and U.S. employees could be 
harmed further, as they would not be able to take advantage of certain 
statutory exemptions contained in Section 716.
    While the ostensible purpose of Section 716 is to reduce risk, 
forcing derivatives activities outside of a better-capitalized, better-
regulated bank into new standalone subsidiaries could actually increase 
risk to the system. This perverse outcome has been noted by the FDIC, 
Federal Reserve, former Treasury Secretary Geithner and even former 
Federal Reserve Chairman Paul Volcker. Section 716 will also lead to 
greater inefficiencies and the loss of exposure netting as it requires 
firms to conduct swaps across multiple legal entities.
    There are other disadvantages to Section 716 as well. It will tie 
up additional capital that might better be used to support investment, 
and create higher funding and operational costs for the financial 
institutions that are required to implement it.
    Those financial institutions currently include only firms doing 
business in the U.S., as there is no similar law or regulation in place 
in any major foreign jurisdiction. These firms will be at a competitive 
disadvantage to their non-U.S. counterparts. American customers of 
these firms would therefore face higher costs, or will seek out lower 
cost non-U.S. firms to assist with their risk management initiatives 
and transactions.
    Customers will also need to evaluate the strength and capital of 
each Section 716 subsidiary that they may do business with, rather than 
that of the parent company, which will also impact these subsidiaries' 
competitiveness. Section 716 also complicates the ability of financial 
institutions to net their exposures and to manage their risks most 
efficiently.
    Due to the above noted issues, ISDA has expressed support for H.R. 
992, legislation passed by this Committee and the Financial Services 
Committee.
Initial Margin Requirements
    The Dodd-Frank Act adds section 4s(e) to the Commodity Exchange Act 
to address capital and margin requirements for swap entities.
    ISDA and the industry support the intent of global policymakers to 
develop a regulatory framework that improves the safety of the global 
over-the-counter derivatives markets, and further recognize the need 
for robust variation margin requirements, particularly for systemically 
important firms. That said, we harbor grave concerns regarding Dodd-
Frank's initial margin (IM) requirements.
    IM is designed to cover the replacement costs if a counterparty 
defaults. It is an extra payment made between parties in excess of 
amounts owed, and as such, it improves the situation of the non-
defaulting party.
    While initial margin has benefits, it is important to understand 
the very real and very significant costs that it would impose. 
Depending on how IM requirements are developed and implemented:

   The initial margin requirement has the potential to 
        significantly strain the liquidity and financial resources of 
        the posting party;

   In stressed conditions, the initial margin requirements will 
        result in greatly increased demand for new funds at the worst 
        possible time for market participants; and

   The initial margin requirements could cause market 
        participants to reduce their usage of non-cleared OTC 
        derivatives and: (1) choose less effective means of hedging, 
        (2) leave the underlying risks unhedged, or (3) decide not to 
        undertake the underlying economic activity in the first 
        instance due to increased risk that cannot be effectively 
        hedged.

    Perhaps most importantly, we do not believe that initial margin 
will contribute to the shared goal of reducing systemic risk and 
increasing systemic resilience. When robust variation margin practices 
are employed, the additional step of imposing initial margin imposes an 
extremely high cost on both market participants and on systemic 
resilience with very little countervailing benefit.
    The Lehman and AIG situations highlight the importance of variation 
margin. AIG did not follow sound variation margin practices, which 
resulted in dangerous levels of credit risk building up, ultimately 
leading to its bailout. Lehman, on the other hand, posted daily 
variation margin, and while its failure caused shocks in many markets, 
the variation margin prevented outsized losses in the OTC derivatives 
markets.
    While industry and regulators agree on a robust variation margin 
regime including all appropriate products and counterparties, the 
further step of moving to mandatory IM does not stand up to any 
rigorous cost-benefit analysis.
    We recognize that it would take Congressional action to amend the 
Act and the IM requirement. In the absence of such amendment, we 
believe it imperative that the regulators implement the IM requirement 
in a prudent way that does not introduce overwhelming costs, reduce 
liquidity and directly harm the U.S. economy.
          * * * * *
    Moving to further comments on implementation, as noted above, there 
are challenges related to an inconsistent interpretation of the law, 
and an interpretation that does not reflect the original intent of the 
legislation.
Swap Data Repositories
    Perhaps the most important of these issues is related to 
fragmentation of trade reporting by OTC derivatives markets 
participants.
    One of the major lessons learned of the financial crisis is the 
need for regulators and supervisors to have clear and comprehensive 
access and insights into the level and type of risk exposures at 
financial institutions and their counterparties. One of the most 
important achievements of policymakers and market participants in the 
past 5 years has been the establishment of global trade databases, or 
swaps data repositories, that accomplish this goal. Such repositories 
have been built for all major derivatives asset classes. The level of 
information they contain is unparalleled in the global financial 
markets.
    This progress is now at risk. Because of current regulatory 
interpretation regarding collection and reporting of cleared trades, it 
seems likely that there will not be one central information warehouse 
that collects all derivatives market data. This data could be 
splintered into multiple warehouses. If this happens, then regulators 
would essentially be forced to follow their previous, pre-crisis 
practices. They would have to go from repository or repository to 
collect and to attempt to aggregate exposures, just as they used to go 
from firm to firm for data. Such attempts to aggregate will be near-
impossible if fragmentation really takes hold. Systemic risk would not 
be reduced. Regulatory visibility and the ability to identify where 
risk is building up in the system would be fatally impaired.
    A fantastic opportunity will have been missed. The amount and 
completeness of information that could be available to regulators is 
unprecedented in global financial markets. For no other financial 
instrument, in any asset class, has there ever been a way for 
authorities to access a complete database of the entire global 
transaction population.
Cross-Border Application of Rules
    Concerns are also growing about the potential application, impact 
and consistency of the U.S. regulatory framework in other 
jurisdictions. This was most recently and pointedly evidenced by the 
April 18 letter from finance officials representing nine of the world's 
largest countries--imploring Treasury Secretary Lew to limit the cross-
border reach of Dodd-Frank Act swaps rules. These issues are raising 
the prospect that market participants will be subject to duplicative 
and/or contradictory regulatory mandates from the EU and other non-U.S. 
jurisdictions that would impose significant costs, fragment market 
liquidity and potentially create an uneven playing field. As the letter 
states, ``An approach in which jurisdictions require that their own 
domestic regulatory rules be applied to their firms' derivatives 
transactions taking place in broadly equivalent regulatory regimes 
abroad is not sustainable.''
    ISDA and our members believe that a globally harmonized approach to 
cross-border regulation is of paramount importance. What they face now 
is considerable uncertainty. Uncertainty is never a good thing in 
financial markets, as there are typically only two things to do in face 
of that uncertainty. One response is to pull back and wait until such 
time as greater certainty is provided. On a firm level, that means 
missed opportunity. On a market level, that translates to less 
efficient, less liquid and more volatile markets, material harm to 
financing and investing activities and a drag on the economy in 
general.
    The other response is to try to anticipate various possible 
results. This can lead to costly, duplicative efforts with no guarantee 
that all that planning will prove effective once the rules are 
finalized.
    Either path runs the risk of undermining the safe, efficient 
markets that ISDA, regulators and the industry all desire.
    To achieve the goal of a globally harmonized framework, the CFTC 
and SEC should work together to achieve consensus with global 
regulators. H.R. 1256 would help the U.S. regulators to provide a 
unified front when addressing the extraterritorial application of U.S. 
rules and when dealing with non-U.S. regulators. Harmonization of 
regulatory approaches, particularly on issues with systemic risk 
implications, and a concerted program of mutual recognition of 
regulatory regimes by global regulators are essential parts of the 
solution to ET.
Trade Execution Requirements
    The inconsistent interpretation of the law by the CFTC and the SEC 
is apparent in the recently finalized CFTC swap execution facility 
(SEF) requirements which mandate initially two, and later three, 
requests for quotes (RFQs).
    To our knowledge, no objective or empirical evidence exists as to 
why multiple RFQs are beneficial to the market and no research has been 
done to this effect. In fact, ISDA's members from the buy-side 
community have expressed concern that a multiple-RFQ model will harm, 
rather than help, their execution.
    For example, the CFTC rule may result in increased transaction 
costs, and in an ISDA survey of the buy-side, 70 percent of respondents 
indicated they would migrate to other markets if required to post 
multiple RFQs. In fact, 76 percent indicated it would have a negative 
effect on liquidity.
    Many buy-side firms have very serious concerns about being forced 
to request a quote from more than one dealer because that can cause a 
signaling effect, exposing their investment strategy to multiple market 
participants. A provision that has been put forth as a benefit for end-
users is being soundly rejected by them.
    In addition to these issues, the CFTC regulation for SEFs will 
limit the means by which swaps can be executed to two types of 
platforms: an electronic order book and an RFQ system.
Business Conduct Rules
    Dodd-Frank required the development of Business Conduct rules as a 
form of customer protection in the swaps market. Regulators have in the 
past several years developed business conduct rules required of market 
participants, particularly swap dealers. These rules are extremely 
detailed and prescriptive and they impose a large compliance burden on 
market participants that is well outside the scope of what Congress 
apparently intended.
    The rules impose significant additional requirements on swap 
dealers in respect to their relationships with their customers. Since 
the majority of external business conduct rules became effective May 1, 
we have yet to see whether the significant compliance requirements 
translate into increased customer protection.
    To facilitate compliance with these requirements, ISDA has created 
and managed two industry-spanning protocols directly related to Dodd-
Frank. Protocols intend to get the majority of market participants to 
agree to new transaction terms that reflect the regulatory changes in 
the law, by adhering to these changes through an electronic market-wide 
process. The August 2012 Dodd-Frank ISDA Protocol addresses compliance 
with the CFTC's External Business Conduct Rules; a second protocol 
facilitates compliance with the CFTC's rules on Swap Trading 
Relationship Documentation and Clearing Requirements.
Cost-Benefit Analysis
    The business conduct standards rules described above, and ISDA's 
work to fulfill those that have been finalized, clearly illustrate the 
cost and expense related to certain Dodd-Frank provisions. What is less 
clear, however, are the benefits that these and other aspects of the 
law and their regulatory interpretation bring to our country's 
financial system and the thousands of companies that use OTC 
derivatives.
    An appropriate cost-benefit analysis was both required and 
desirable prior to finalization of rules; however in a number of 
instances the CFTC's analysis did not comply with the regulatory 
standard.
    As the Jun. 2012 report by the CFTC Inspector General stated:

        ``. . . Generally speaking, it appears CFTC employees did not 
        consider quantifying costs when conducting cost-benefit 
        analyses for the definitions rule. As indicated in the rule's 
        preamble, the costs and benefits associated with coverage under 
        the various definitions (in light of the various regulatory 
        burdens that could eventually be associated with coverage) were 
        not addressed . . .''

    The lack of an appropriate cost-benefit analysis makes it 
especially important that the application and implementation of the 
final rules be phased in a flexible manner. Doing so would help ensure 
that rules achieve the purposes for which they are intended and do not 
impose burdensome costs on the financial system. It would also help 
regulators to identify and avoid unintended consequences of their 
actions. And it would encourage regulators to properly allocate limited 
resources.
          * * * * *
    In conclusion, ISDA remains committed to achieving a safer, more 
efficient and more robust financial system and OTC derivatives markets.
    Toward that end, it is vitally important that we, industry and 
regulators, focus our resources on those aspects of regulatory reform 
that address the most important issue--reducing systemic risk. This 
includes appropriate capital, central clearing and variation margin 
frameworks as well as regulatory transparency.
    At the same time, it is vitally important that we seek to avoid 
burdensome measures that do not pose any clear, tangible benefit, and 
that divert resources from being allocated more efficiently elsewhere 
and impede progress in more important areas. Or worse still, enacting 
measures that harm liquidity or reduce systemic resiliency in the very 
markets they are trying to protect, resulting in a direct and harmful 
impact on the economy. This is particularly critical given the slow and 
uneven growth of the U.S. and the global economy.
    Dodd-Frank is an important step forward for our country and our 
markets. And the CFTC deserves our sincere appreciation and support for 
its efforts in implementing its wide-ranging provisions in a relatively 
short period of time. It is clear, however, that our experience over 
the past several years has shown that not all of the law's provisions 
are appropriate and contribute to the overriding goal of a safer 
financial system. Similarly, some efforts by the regulators to 
implement the law are inconsistent with the intent of Congress, are 
being interpreted in different ways by various agencies, or impose 
costs that far exceed any resulting benefits.
    In light of these concerns and observations, ISDA respectfully 
requests this Committee to (1) support the amending of Section 716, 
which could be done in an effective way through passage of H.R. 992 (2) 
consistent with H.R. 1256, stress to the CFTC the necessity of a 
flexible, prudent interpretation of the statutory provisions on margin 
and work closely with the industry to adopt final regulations that 
ensure the safety of the markets but do not harm liquidity and market 
participants; (3) urge the SEC and CFTC to harmonize their cross-border 
rules as soon as possible so U.S. regulators speak with one voice in 
the ongoing global debate on extraterritoriality since this is 
necessary to ensure the competitiveness of U.S. markets and the 
efficient flow of capital throughout all the global markets in which 
U.S. businesses operate.
    Thank you.

    Mr. Conaway. Thank you, Mr. O'Connor.
    Mr. Dunaway for 5 minutes.

STATEMENT OF WILLIAM J. DUNAWAY, CHIEF FINANCIAL OFFICER, INTL 
                 FCStone, INC., KANSAS CITY, MO

    Mr. Dunaway. Chairman Lucas, Ranking Member Peterson, and 
other Committee Members, thank you for inviting me to testify. 
I serve as the CFO of both FCStone, LLC, a registered FCM, and 
INTL Handling, a registered swap dealer. INTL was one of the 
first to register as a swap dealer under Dodd-Frank, and we 
were the first non-bank to register. My oral testimony will 
summarize my written statement submitted to the Committee, 
which goes into these complex topics in greater detail.
    Dating back to 1924, INTL FCStone is now a global firm that 
services more than 20,000 mostly midsize commercial customers 
who are producers and end-users of virtually every major traded 
commodity. The largest market we serve is agriculture. Our 
customers handle about 20 percent of the grain production in 
Texas, 40 percent in Kansas, and 50 percent of the grain 
production in both Iowa and Oklahoma. INTL FCStone supports the 
Dodd-Frank Act; however, there are rules implementing the Act 
that may prohibit end-users from using our products to hedge 
their risk.
    Other proposals, if unchanged, could push independent firms 
like INTL FCStone out of the market, leaving thousands of 
smaller end-users with nowhere to turn for hedging. In our 
conversations with the CFTC staff about the capital and margin 
rules, we have learned that our non-bank swap dealer may be 
required to hold regulatory capital up to hundreds of times 
more than that of a bank-affiliated swap dealer for the same 
portfolio of positions. Other non-bank commodity swap dealers 
will be in the same disadvantaged position.
    There are two reasons for this discrepancy. First, under 
the new rules, bank-affiliated swap dealers can use internal 
models to calculate the risk associated with customer 
positions. Non-banks cannot. Internal models allow for more 
sophisticated netting of commodity positions to determine 
market risk capital charges. The CFTC's approach will permit 
only limited netting for non-bank dealers, forcing non-banks to 
hold capital against economically offsetting commodity swap 
positions. This means higher capital requirements overall and 
relative to those of bank-affiliated swap dealers using 
internal models.
    In addition, the CFTC's approach relies on Basel II, which 
treats commodity derivatives more harshly than any other type 
of derivative when calculating risk. As a result, the same 
derivatives portfolio that would require a bank-affiliated swap 
dealer to hold $10 million in regulatory capital would require 
us to set aside $1 billion in capital. This is entirely 
unsustainable, and will cause non-bank swap dealers to exit the 
business. The direct result will be higher costs for end-users, 
and then for consumers.
    Increasing concentration in the industry until only the big 
banks are left will leave the smaller end-user with no place to 
go. It is not too late to fix this. The Commodity Exchange Act 
requires regulators to maintain comparable minimum capital 
requirements for all swap dealers. We believe the CFTC should 
revise its proposed capital rules to ensure that the 
requirements applicable to non-banks and bank-affiliated swap 
dealers are comparable by altering the non-bank rules to allow 
for full netting of offsetting commodity swap positions, allow 
match positions offering offsetting, or permit all swap dealers 
to use internal models. If the CFTC fails to make these 
changes, we request this Committee codify one or more of these 
alternatives as part of the CEA reauthorization.
    Turning to our FCM, the CFTC has proposed rules requiring 
that FCMs residual interest exceed margin deficiencies at all 
times, and to reduce the margin call collection period to 1 
day. These rules will have a substantial negative impact on 
some customers' ability to hedge their commercial risks, and 
will severely challenge small and midsize FCMs continued 
operation. The CFTC should study these issues and conduct a 
cost-benefit analysis before proceeding.
    It is simply not feasible for an FCM to determine whether 
margin deficiencies are present at all times throughout a day; 
therefore, FCMs will have to hold margin that assumes the 
failure of all customers every day. Such a worst case scenario 
is unheard of and is not applied to any other financial 
entities. Under the new rule, FCMs will require customers to 
put up more money at all times, possibly doubling margins and 
likely resulting in customers being required to prefund their 
margin.
    In addition, we feel the Commission's proposal mandating 
what amounts to a 1 day margin call collection period for FCM 
customers as opposed to the current 3 business days is not 
realistic. Our customers include a large number of farmers and 
ranchers who meet margin calls by using checks. They may be 
required to double or triple their margin payments to be able 
to meet the 1 day payment requirement. Many of our customers 
also finance their margin calls, requiring more time to arrange 
wire transfers. Foreign customers have different time zones 
that make the 1 day deadline impossible. We strongly believe 
that 2 day deadline is more reasonable and equitable for our 
customer base.
    Finally, as a result of the external business conduct rules 
now in effect, many of our customers have abandoned OTC 
derivatives, even though OTC is the most effective hedging 
tool, because the paperwork requirements are simply too 
burdensome. Others have asked us to refrain from providing a 
mid-market mark, because they can either derive this 
information themselves or prefer immediate execution at market 
price and cannot even afford seconds delay in their execution. 
The proposed rule on capital margin allows customers to opt in 
or opt out of certain protections, including the segregation 
requirement, and we ask that this same option be extended to 
some of the business conduct rule disclosures.
    INTL FCStone also has some concerns about the 
extraterritorial application of Title VII of Dodd-Frank, the 
definition of eligible contract participant as it pertains to 
farmers, and the issue of the futurization of swaps, and I 
address each of these in my written comments. INTL FCStone is 
not interested in dismantling Dodd-Frank; in fact, most of the 
concerns I have outlined here are about the implementation of 
the rules, not the Act itself. We are simply trying to ensure 
the final rules function as intended and commercial end-users 
in the firms like INTL FCStone who serve them do not face 
greater regulatory burdens than those in the market who 
speculate or create systemic risk.
    Thank you for inviting me to testify today, and I look 
forward to any questions that you may have.
    [The prepared statement of Mr. Dunaway follows:]

Prepared Statement of William J. Dunaway, Chief Financial Officer, INTL 
                     FCStone, Inc., Kansas City, MO
    Chairman Lucas, Ranking Member Peterson, and other Members of the 
Committee, thank you for inviting me to testify at this important 
hearing. I am the Chief Financial Officer (``CFO'') of INTL FCStone 
Inc., a position I have held since the merger of International Assets 
Holding Corporation and FCStone Group, Inc. in September 2009. In 
addition, I am the CFO of both, FCStone, LLC, a registered Futures 
Commission Merchant (``FCM''), and INTL Hanley, LLC, a registered Swap 
Dealer. Prior to the merger, I was the CFO of FCStone Group, Inc. I 
began my career more than 19 years ago as a staff accountant with Saul 
Stone and Company LLC, and since that time, I have served in various 
capacities, all of which included regulatory accounting and financial 
reporting, including CFO of Saul Stone and Company LLC, Executive Vice 
President and Treasurer with responsibility over the regulatory 
accounting of FCStone, LLC, the successor FCM to Saul Stone and Company 
LLC.
    INTL FCStone Inc. and its affiliates (collectively, ``We'', ``INTL 
FCStone'' or the ``Company''), a publicly held, NASDAQ listed company, 
dates back to 1924 when a door-to-door egg wholesaler formed Saul Stone 
and Company, which went on to become one of the first clearing members 
of the Chicago Mercantile Exchange. In June of 2000, Saul Stone was 
acquired by Farmers Commodities Corporation, which at the time was a 
cooperative, owned by approximately 550 member cooperatives, and was 
renamed FCStone LLC. Through organic growth, acquisitions and the 2009 
merger between International Asset Holding Corp. and FCStone Group, we 
have become a global financial services organization with customers in 
more than 100 countries serviced through a network of 33 offices around 
the world.
    INTL FCStone offers our customers a comprehensive array of products 
and services, including our proprietary Integrated Risk Management 
Program, as well as exchange and OTC execution and clearing services, 
designed to limit risk, reduce costs, and enhance margins and bottom-
line results for our customers. We also offer our customers physical 
trading in select soft commodities including agricultural oils, animal 
fats and feed ingredients, as well as precious metals. In addition, we 
provide global payment services in over 130 foreign currencies as well 
as clearing and execution services in foreign exchange, unlisted 
American Depository Receipts and foreign common shares, while also 
providing asset management and investment banking advisory services.
    Today, INTL FCStone services more than 20,000 mostly mid-sized 
commercial customers, including producers, processors and end-users of 
virtually every major traded commodity whose margins are sensitive to 
commodity price movements. Although we have become a global company, 
our largest customer base is serviced from offices in the agricultural 
heartland, such as West Des Moines, Iowa, Omaha, Nebraska, Minneapolis, 
Minnesota and Kansas City, Missouri. We are successful because we are a 
customer-centric organization, focused on acquiring and building long-
term relationships with our customers by providing consistent, quality 
execution and value-added financial solutions. The primary markets we 
serve include: commercial grains; soft commodities (coffee, sugar, 
cocoa); food service and dairy (including feed-yards); energy; base and 
precious metals; renewable fuels; cotton and textiles; forest products 
and foreign exchange. Our offices are located near the customers we 
serve and our customers are the constituents of the Members of this 
Committee--the farmers, feed yards, grain elevator operators, renewable 
fuel facilities, energy producers, refiners and wholesalers as well as 
transporters, who are in involved in the production, processing, 
transportation and utilization of the commodities that are the backbone 
of our economy. As an example, we believe our customers handle more 
than 40% of domestic corn, soybean and wheat production, including 20% 
of the grain production in Texas, 40% of grain production in Kansas, 
and 50% of grain production in Iowa and Oklahoma.
    We offer our clients sophisticated financial products, but are not 
a Wall Street firm. Our mid-sized Futures Commission Merchant 
(``FCM''), FCStone LLC, according to recent industry publications, is 
the 20th largest FCM based upon customer segregated assets on deposit. 
However, it is the third largest independent FCM not affiliated with a 
banking institution or physical commodity business. As the Committee 
may know, our wholly owned subsidiary INTL Hanley LLC was one of the 
first to register as a Swap Dealer under the Dodd-Frank regulations. At 
that time, we were the only organization not affiliated with a bank to 
register.
Support for Dodd-Frank
    INTL FCStone supports the goals of the Dodd-Frank Act and we are 
deeply committed to safe, efficient OTC derivatives markets that 
support the health and growth of the real economy. We likewise support 
the G20's efforts to reduce systemic risk by focusing on improving 
counterparty credit risk management and transparency in the OTC 
derivatives markets. Much of the Dodd-Frank Act works toward those 
goals, and we support those provisions that do so.
    However, it is our view that some of the regulations that were 
drafted to carry out the objectives of Dodd-Frank undermine or do not 
support the goal of systemic risk reduction. Other changes do not 
appear mandated by the Act, nor called for by policy concerns. Instead, 
these regulations seek to impose changes to the market's structure 
without posing any quantifiable benefit. In addition, they embed an 
uneven and uncompetitive operating environment for firms doing business 
in the U.S. compared to our competitors abroad.
    We believe these changes will adversely affect the markets' 
functioning, impose unnecessary costs on us and our customers, and will 
limit our customers' ability to manage their risks.
Capital and Margin Requirements--Swap Dealer Issues
    Ensuring that swap-dealers have an adequate capital base and that 
customer collateral arrangements do not add to systemic risk are 
positive and commendable objectives under Dodd-Frank. However, the 
capital and margin requirements, as proposed,\1\ would significantly 
disadvantage Swap Dealers that, like INTL FCStone, are not affiliated 
with a bank, in favor of the bank-affiliated Swap Dealers--the very 
entities that contributed to the financial crisis.
---------------------------------------------------------------------------
    \1\ Sections 731 and 764 of the Dodd-Frank Act require regulators 
to adopt rules setting capital and margin requirements for uncleared 
swaps for swap entities (Swap Dealers and major swap participants) and 
security-based swap entities (security-based Swap Dealers and major 
security-based swap participants). The ``Prudential Regulators''--the 
Federal Reserve, Federal Deposit Insurance Corporation, Office of the 
Comptroller of the Currency, Farm Credit Administration and Federal 
Housing Finance Authority--are required jointly to adopt these rules 
for the banks and related swap entities and security-based swap 
entities (Bank Holding Company-affiliated or ``Bank Swap Entities'') 
under their jurisdiction, and the Commodity Futures Trading Commission 
(``CFTC'') and the Security and Exchange Commission (``SEC'') are 
required to adopt these rules for other swap entities and security-
based swap entities, respectively.
---------------------------------------------------------------------------
    Before I explain this issue in detail, I want to stress to the 
Committee that the competitive advantage given to the bank-affiliated 
Swap Dealers under the proposed rules is not modest. In fact, the 
opposite is true. Our conversations with CFTC staff about the 
anticipated operation of the rule suggests that our Swap Dealer, INTL 
Hanley, will be required to hold regulatory capital potentially 
hundreds of times more than that required for a bank-affiliated Swap 
Dealer for the same portfolio of positions. Part of this stems from the 
fact that bank-affiliated Swap Dealers can use internal models to 
calculate the risk associated with customer positions, while non-banks 
cannot.\2\ The use of internal models is an important tool because 
these models generally provide for more sophisticated netting of 
commodity positions to determine applicable market risk capital 
charges. As a result of limited netting under the CFTC's ``standardized 
approach,'' a non-bank Swap Dealer will have to hold market risk 
capital against economically offsetting commodity swap positions, 
resulting in a higher capital requirement \3\ overall, and relative to 
the capital requirement for a bank-affiliated Swap Dealer using an 
internal model.\4\ This increased capital requirement would have the 
perverse effect of actually incentivizing a non-bank affiliated Swap 
Dealer to not fully offset the risk of an customer OTC transaction and 
thus incurring potentially unlimited market risk.
---------------------------------------------------------------------------
    \2\ The ``standardized approach'' for calculating the market risk 
component of regulatory capital for Commodity Swap Dealers is based 
largely on the ``Standardized Measurement Method'' in the Market Risk 
Amendment. Conceptually, the Standardized Measurement Method applies a 
market risk charge to an entity's net position in a financial 
instrument. In the Proposed Capital Rule, offsetting of equity 
positions is allowed for positions ``in exactly the same instrument,'' 
and for single-name credit positions offsetting is allowed for 
``identical'' positions. Similarly, market risk calculations that apply 
to non-commodity asset classes under the Standardized Measurement 
Method (i.e., interest rate, equity, and foreign exchange) permit 
offsetting of ``matched'' positions. In contrast, the CFTC's 
``standardized approach,'' as described in discussions with CFTC Staff, 
does not provide comparable guidelines for identifying the extent to 
which commodity positions are offsetting.
    \3\ Dealers should depend primarily on spreads between transactions 
for earnings, not on directional price change speculation. This is an 
underlying intent of many provisions of Dodd-Frank (e.g., the Volcker 
Rule). In the ordinary course of their operations, Swap Dealers relying 
on spreads are incentivized to run flat books, which in turn reduces 
risk in the market. Based upon our conversations with staff, we 
understand that the CFTC does not intend to allow Swap Dealers to 
recognize commodity position offsets as to maturity and delivery 
location. If this is true, it seems counterproductive from a capital 
and a risk standpoint. A capital rule that adequately risk-adjusts 
offsetting positions would properly incentivize Swap Dealers to run 
flatter portfolios (thereby decreasing systemic risk) because the Swap 
Dealer would be able to lower its capital requirement by entering into 
offsetting positions.
    \4\ We consider it significant that the SEC's proposed rules on 
capital, margin and collateral segregation for non-bank Security-Based 
Swap Dealers and non-bank Major Security-Based Swap Participants permit 
the use internal value-at-risk models. So the CFTC really is the 
outlier with its capital and margin rules.
---------------------------------------------------------------------------
    Another factor of major concern under the ``standardized 
approach,'' which is based on European banking standards (i.e., Basel 
II) , is that commodity derivatives like the ones we offer our 
agricultural client base are treated more harshly than any other 
derivatives asset class in terms of calculating risk. Taken in 
conjunction, the same derivatives portfolio that would require a bank-
affiliated Swap Dealer to hold $10 Million in regulatory capital using 
standard internal models would require us to set aside up to $1 Billion 
in capital in a worst case scenario. Regulatory capital requirements of 
this magnitude are wholly unsustainable for a company our size and 
economically unfeasible for a company of any size. The calculations 
supporting these estimates are attached to this testimony as Addendum 
A. INTL FCStone submitted these same calculations to the CFTC with our 
comment letter on this issue.
    As I mentioned, INTL FCStone was the first non-bank to register as 
a Swap Dealer. As other non-banks register, particularly those in the 
agricultural and energy space, additional market participants will be 
caught in this position and either squeezed out of the market, or at 
least seriously disadvantaged relative to the bank-affiliated dealers.
    Obviously, this regulatory capital disparity is not a small hurdle 
for the already disadvantaged independent dealers to overcome. If left 
unchanged, these capital rules will eventually cause non-bank Swap 
Dealers to exit the business. The direct result will be higher costs 
for end-users, and then for consumers. Increasing concentration in the 
industry until only the big banks are left will leave many customers 
with no place to go. Serving farmers, ranchers and grain elevators has 
not been a focus or a profitable business model for the large dealers.
    Even larger customers who might be able to access to OTC hedging 
tools through bank-affiliated dealers will still face higher costs as 
the big bank dealers will be able to take advantage of decreased market 
competition. A larger percentage of customers carried through a handful 
of large, bank affiliated Swap Dealers will increase systemic risk.
    The Members of this Committee, obviously, do not see eye-to-eye on 
every issue. But one thing I think that every Member of this Committee 
would agree on is that Dodd-Frank was not intended to preclude small 
commodity producers from hedging, to increase swap concentration at the 
banks, or to create greater potential for systemic risk. But with the 
capital and margin rules as proposed, that is the result that will 
follow.
    We believe that this problem can be easily corrected. The Commodity 
Exchange Act requires the CFTC, the prudential regulators, and the SEC 
to establish and maintain ``comparable'' minimum capital requirements 
for all Swap Dealers. However, the proposed Capital Rules clearly are 
not ``comparable.'' Pursuant to its mandate under the CEA, we believe 
that the CFTC should revise its proposed capital rules to ensure that 
the capital and margin requirements applicable to non-bank Swap Dealers 
are comparable to those applicable to bank-affiliated Swap Dealers. 
This can be accomplished by altering the rules to permit the following:

   Full Netting--Revising the ``standardized approach'' in the 
        CFTC's proposed capital rules to make clear that it allows full 
        netting of offsetting commodity swap positions, which will 
        create a capital requirements framework that is more similar to 
        the prudential regulators;

   Matched Position Offsetting--Alternatively, the CFTC could 
        allow position offsetting for ``matched positions,'' either on 
        a per commodity/per expiry basis, or by using a ``maturity 
        ladder'' approach to netting, as described in the Basel 
        Committee's Amendment to the Capital Accord to Incorporate 
        Market Risks (the ``Market Risk Amendment''), in order to 
        facilitate the netting of commodity swap positions; or

   Internal Models--The CFTC could permit all Swap Dealers, 
        including Commodity Swap Dealers, to request approval of, and 
        rely upon, internal models to measure market risk. To the 
        extent that the CFTC currently lacks the resources to review 
        and approve such internal models, it should permit Swap Dealers 
        to certify to the CFTC or the NFA that their models produce 
        reasonable measures of risk, subject to verification by the 
        CFTC when its resources enable it to do so.

   Flat Book Incentives--Default risk is reduced when an entity 
        maintains a relatively flat book. The CFTC should incentivize 
        dealers to reduce default risk by decreasing capital 
        requirements for operating a flat book. This incentive can be 
        achieved by revising the Capital Rules to recognize netting for 
        economically offsetting commodity swap positions (whether 
        through the maturity ladder approach, or otherwise). Under the 
        current proposal, dealers get no credit, from a capital 
        perspective, for running a flat book and in fact are penalized.

    If the CFTC fails to make these changes, INTL FCStone requests that 
this Committee consider codifying one or more of these alternatives as 
part of the CEA reauthorization.
Capital and Margin Requirements for FCMs--Residual Interest/Customer 
        Funds
    As I mentioned before, I have spent virtually my entire career 
working with issues relating to regulatory accounting, FCM capital, and 
customer segregated assets. In November of 2012, the CFTC proposed new 
comprehensive regulations relating to residual interest and the 
handling of customer funds by FCMs. These proposed changes were part of 
the CFTC's efforts to address customer protection issues that arose 
during the recent MF Global and Peregrine Financial Group bankruptcies. 
Customer confidence in the safety of segregated funds and FCM stability 
are crucial to the continued success of our markets. INTL FCStone 
supports efforts to enhance customer confidence through appropriate 
regulation, and fully agree that additional regulation can provide 
meaningful additional protections and assurances to market 
participants.
    However, certain aspects of the CFTC's proposed rules--
specifically, the requirement that FCM's residual interest in futures 
customer funds exceeds the sum of all of its customers margin 
deficiencies at all times, and the proposal to require FCMs take a 
capital charge for margin deficiencies that are outstanding for 1 day 
or more--will dramatically alter the way that FCMs and their customers 
have done business for decades These proposals will also have a 
substantial negative impact on most customers' ability to hedge their 
commercial risks, and will severely challenge small and mid-sized FCMs' 
ability to continue to operate.
Residual Interest
    The Commission has proposed to add a new Rule 1.20(i)(4), and to 
amend Rule 1.22(a), to require that ``an FCM must be in compliance with 
its segregation obligations at all times and . . . [i]t is not 
sufficient for an FCM to be in compliance at the end of a business day, 
but to fail to meet its segregation obligations on an intra-day 
basis.'' This proposal represents a massive shift in the current 
policy, which allows FCMs to ``net'' excess funds of other customers 
against the margin deficits of others.
    There is also a practical dimension to note. Because it is not 
feasible for FCMs to determine whether residual interest exceeds the 
sum of all margin deficiencies at all times throughout a day, the new 
interpretation suggests that FCMs should model for the failure of ALL 
customers, EVERY day. Such a worst-case scenario is unheard of, and is 
not applied to any other financial entities. Basel III does not require 
banks to hold a dollar for dollar reserve in anticipation of loan 
losses of ALL customers. CFTC regulations do not require clearinghouses 
to hold dollar for dollar reserves in anticipation of ALL clearing 
members failing.
    In the end, this new interpretation will result in FCMs requiring 
customers to put up more money at all times, likely resulting in 
customers being asked to pre-fund their margin. In addition to 
requiring customer pre-funding, some have suggested that this rule will 
likely require an FCM to double a customers' overall margin 
requirements: in essence requiring customers to fund their potential 
margin deficiencies. As such, the customer would be required to keep 
margin funds far in excess of exchange minimum margin requirements. Our 
mid-sized commercial customers rely upon their lending institutions, 
such as CoBank, a member of the Farm Credit System, to fund their 
commercial activities including their hedging activities. A potentially 
doubling of their funding needs to support their hedging activities 
would significantly impact the profitability of such customers.
    In addition to the negative customer impact, the rule will also put 
significant financial pressure on FCMs. If the sum of an FCM's customer 
margin deficits is greater than the residual interest an FCM typically 
maintains in their customer accounts, then the FCM would have to 
increase the amount of residual interest it maintains in customer 
segregated accounts. On ``limit up'' or ``limit down'' days in the 
agricultural exchange traded markets, our firm may be required to 
deposit up to $400 million to satisfy exchange demands for margin. In 
order to ensure that our residual interest would be in excess of the 
sum of all of our customers margin deficiencies in such a situation, we 
would need to require our customer pre-fund their potential margin 
deficiencies or in effect require us to pre-fund their potential margin 
requirements by maintaining our capital in customer segregated 
accounts. Requiring massive additional injections of our own capital to 
support the new residual interest requirements will, at some point, 
become unsustainable for us and others, again leading to the real and 
substantial risk of increased concentration in an already shrinking 
market.
One-Day Margin Call
    The Commission has also proposed to amend Rule 1.17(c)(5)(viii) to 
require an FCM to take a capital charge with respect to any margin call 
that is outstanding more than 1 business day. The rule currently allows 
an FCM 3 business days to collect margin before taking take a capital 
charge. INTL FCStone opposes this proposal because it is impractical 
and will result in substantial negative consequences for agricultural 
customers and for the FCMs that serve them.
    INTL FCStone understands the CFTC's objective in proposing to 
shorten the time in which an FCM must take a capital charge for 
accounts that are undermargined. Clearly, margin collection is a 
critical component of an FCM's risk management program. But it is not 
realistic to expect that all margin calls can or will be met in one 
day. There are several reasons for this.
    First of all, INTL FCStone's customers include a large number of 
farmers and ranchers, many of whom meet margin calls by using checks 
because of the expense and impracticality of wire transfers in their 
circumstances. Check-paying customers are likely to have to double or 
triple their margin payments in order to make sure that they can meet 
the 1 day requirement. This would be very costly for many farmers and 
ranchers.
    Second, many of our customers finance their margin calls, which can 
require additional time to arrange for delivery of margin call funds 
due to routine banking procedures. Finally, foreign customers often 
have considerable difficulty meeting margin calls in 1 business day due 
to time zone differences and varying bank holidays. In some countries 
customers face regulatory restrictions or formalized processes in 
connection with any transfers of funds out of their country. This can 
often impact such customers' ability to meet margin calls in one day 
and, in some cases, make it legally impossible.
Combined Impact
    These proposals, taken together, will result in very substantial 
costs for FCMs and their customers. For many small and medium-sized 
FCMs, the costs of obtaining the required additional capital to cover 
increased margins--either in the form of general credit or permanent 
capital--could be insurmountable. In order to lower some of these costs 
or meet these requirements, FCMs would have to require customers to 
prefund some or all of their potential margin obligations, increasing 
costs to the end-users and ultimately may have the unintended 
consequence of giving smaller commercial customers no alternative to 
hedge their commodity price risk.
    The increased financial requirements for FCMs will negatively 
impact the ability of non-bank FCMs to compete effectively, leading to 
a greater concentration of customers at the remaining FCMs and 
potentially increasing systemic risk. At the same time, neither of 
these proposals brings greater transparency to protect customer funds, 
which is what brought down MF Global and Peregrine.
    Before making these significant changes, the CFTC should conduct a 
more thorough study and then conduct a cost-benefit analysis of the 
affects the proposals would have on FCMs, their customers and the 
markets. Should the CFTC proceed in a rulemaking that that will shorten 
the time period in which an FCM must take a capital charge for under-
margined accounts, we strongly believe that a 2 day deadline is more 
reasonable and equitable. Increasing the time to meet a margin call by 
an extra day takes into account the challenges and cost considerations 
facing many key market participants, such as the agricultural clients 
that make up a significant portion of INTL FCStone's customer base. 
From our experience, making the margin call deadline 2 business days 
would take care of about 90% of the situations where the customer faces 
a delay in meeting a margin call.
Customer Issues
External Business Conduct Requirements
    I would like to briefly touch on another set of rules that are 
having a negative impact on customers of INTL Hanley, our registered 
swap dealer: namely, the External Business Conduct Rules that went into 
effect on May 1st of this year. As this Committee is well aware, these 
Rules generally attempt to enhance protections for counterparties of 
Swap Dealers and major swap participants through due diligence, 
disclosure, fair dealing and anti-fraud requirements. These External 
Business Conduct Rules require the Swap Dealer to deliver pre-trade, 
product risk disclosures and a ``mid-market mark'' for the transaction. 
Substantial information gathering about our customers is also required 
to satisfy new ``know your customer'' and suitability requirements. As 
a result, all of our customers have been required to complete extensive 
new account forms, and amend their swap documentation so that we, in 
turn, can comply with these new rules.
    Although these requirements may seem innocuous and un-burdensome to 
the regulators, a substantial number of our customers have abandoned 
OTC derivatives altogether because the paperwork requirements are 
simply too burdensome. Others have asked us to refrain from providing a 
mid-market mark because they can either derive this information 
themselves, or prefer immediate execution at the market price and 
cannot afford even seconds delay in execution.
    The proposed rules on capital and margin allow customers to opt-in 
or opt-out of certain protections, including, most significantly, the 
requirement that collateral be segregated. More than anything else, 
segregation of customer funds and prompt transfer of those funds to 
customers in the event of a bankruptcy is a core protection embedded in 
the Commodity Exchange Act. Because there is an existing regulatory 
recognition that customers can make informed choices about whether to 
opt-in or opt-out of certain protections, we believe that giving 
customers the right to opt-out of certain Business Conduct Rule 
disclosures--such as receiving a mid-market mark--would be highly 
beneficial.
Eligible Contract Participant Rules
    Even prior to Dodd-Frank, CFTC rules limited participation in the 
OTC markets to transactions between ``Eligible Contract Participants'' 
(``ECPs''), i.e., entities with $10 million in total assets or with a 
net worth of at least $1 million, who are engaged in hedging qualify as 
ECPs. However, Dodd-Frank amended the standard for individuals to 
qualify as ECPs by replacing the ``total assets'' test with an 
``amounts invested on a discretionary basis test.'' The term ``amounts 
invested on a discretionary basis'' is not defined in the Dodd-Frank 
Act, and it is unclear from the legislative history what Congress 
intended by this amendment. At this point, it is not clear whether a 
farmer's ownership interests in legal entities that hold farm and 
related assets (which may include the farmer's residence) would 
constitute ``amounts invested on a discretionary basis'' under the new 
ECP definition for individuals.
    INTL FCStone would urge the CFTC and the SEC to use their broad 
rulemaking authority to provide guidance on the meaning of the phrase 
``amounts invested on a discretionary basis,'' and we request that such 
guidance interpret the phrase broadly to permit individuals with 
significant farming operations to be deemed ECPs and, therefore, 
permitted to use OTC swaps.
    Absent such regulatory guidance, we request that this Committee 
include a definition of the phrase ``amounts invested on a 
discretionary basis'' in the CEA reauthorization bill, and that such 
definition be broad enough to capture individuals with significant 
farming operations.
Extraterritorial Application of Dodd Frank
    Another issue of concern to most market participants is the 
international reach of Title VII of the Dodd-Frank Act. As everyone 
here knows, the CFTC has issued proposed rules that would essentially 
grant the broadest possible extraterritorial reach to U.S. swaps 
regulations. According to the CFTC's proposed rules and interpretive 
guidance, any swap between a U.S. person and a non-U.S. person will 
generally be subjected to U.S. swap regulation. This presents obvious 
conflicts with foreign regulations. For example, a cross-border swap 
cannot be cleared in both a U.S.-registered clearinghouse and 
separately in a different clearinghouse registered in the European 
Union.
    Although its latest guidance is a move in the right direction, 
throughout the regulatory process, the CFTC has consistently insisted 
on a broad interpretation of the definition of a ``U.S. person'' and of 
the activities that would be deemed to have ``a direct and significant 
connection with activities in, or effect on, commerce of the United 
States.'' The result is a complex and confusing regulatory scheme that 
threatens to expose U.S. Swap Dealers and FCMs to considerable 
regulatory risk and would effectively extend the CFTC's reach into any 
jurisdiction around the world.
    This issue is of great concern to INTL FCStone because our largest 
geographic area of growth for our OTC swaps is Brazil. Brazil is a 
fast-growing, but still developing market that desperately needs good 
hedging tools. INTL FCStone can provide these hedging tools and we can 
bring the business from Brazil and other countries into the U.S., so 
long as the Dodd-Frank rules do not put us at a disadvantage. But, if 
local agriculture producers in Brazil have to comply with Dodd-Frank 
requirements if they hedge with us and do not have any comparable 
requirements or burdens if they hedge with a non-U.S. firm, they will 
go with the non-U.S. firm and we will lose the business.
    Other U.S. market participants share our general views on the 
cross-border topic, but INTL FCStone wants the Committee to be aware 
that the cross-border issue is not one that is only of concern to the 
Wall Street firms and the other large players.
    The Securities and Exchange Commission's (``SEC'') recent proposal 
is a significant improvement over the CFTC's, especially with respect 
to the broad view taken by the SEC on the issue of substituted 
compliance. By basing its determination of equivalency on outcomes, 
rather than requiring a rule-by-rule comparison of the regulations, as 
stipulated by the CFTC, the SEC is, I hope, moving us toward a workable 
solution where non-U.S. rules that attempt to address the same issues 
and get to the same end point should be deemed comparable.
    Bottom line--subjecting swaps transactions to multiple, and 
potentially conflicting rules and requirements is simply unworkable. It 
is imperative that the U.S. regulators work together to promulgate one 
set of clear, simple and workable cross-border rules before firms are 
expected to comply. In addition, U.S. firms need enough lead time to 
digest and comprehend the rules so that we can plan for the scope of 
Dodd-Frank's impact on our global businesses.
``Futurization of Swaps''
    I want to briefly address an issue that has been called the 
``Futurization of Swaps'' because I understand that at least one House 
Subcommittee has held a hearing on this issue and the CFTC held a staff 
roundtable to discuss it, so I know it is a matter that at least some 
in Washington are reviewing. Of course, the ``Futurization of Swaps'' 
refers to the post-Dodd-Frank Act evolution of end-users bypassing 
swaps transactions in favor of futures.
    We have been told by a number of our customers that they have 
determined that they will no longer use ``vanilla'' or ``look-alike'' 
OTC instruments, and instead will rely exclusively on exchange traded 
futures. It is important to note, however, that this decision has not 
been the result of a considered decision about which instrument serves 
as the most cost-effective risk management tool, but instead, is wholly 
the result of the regulatory burdens associated with swaps as opposed 
to futures.
    For instance, we have a number of customers who have told us that 
the extensive new reporting and record-keeping requirements for swaps 
(both cleared and un-cleared) are the factor that has lead them to exit 
the OTC markets, although that was never the intent of Congress in 
enacting Dodd-Frank. Although exchange-traded futures are often an 
appropriate and suitable risk management tool, there are other 
instances where futures may not be as beneficial from the customer's 
perspective
    In our experience, for farmers and others in the agriculture space, 
vanilla OTC in fact may be the most cost-effective and practical 
hedging vehicle available to them based on the ability to offer 
customized credit arrangements, or because there is greater liquidity 
in OTC markets. But, due to concerns over the burdens associated with 
record-keeping requirements and the likelihood of increased costs of 
using swaps, some of our customers have taken a short-sighted view and 
have fled the OTC markets for futures. Others have decided not to hedge 
at all. This trend runs counter to the intention of Dodd-Frank to allow 
end-users a continued ability to access the OTC markets.
Conclusion
    INTL FCStone is not interested in dismantling Dodd-Frank. In fact, 
most of the concerns expressed in this testimony are about the 
implementation of rules, not the Dodd-Frank Act itself. We are simply 
trying to ensure that the final rules function as intended and that the 
commercial end-users, and the firms like INTL FCStone, who serve them 
do not face the same regulatory burden as those in the markets who 
speculate and create systemic risk.
    Firms like INTL FCStone and our customers did not contribute to the 
financial crisis and we support common-sense reforms that strengthen 
and bring more transparency to these markets, but we are now being 
asked to bear additional regulatory burdens that actually put us at a 
competitive disadvantage to the very firms that caused the financial 
crisis. This is unfair and, quite frankly, is not good policy. But, we 
will continue to work with the regulators throughout this process to 
ensure that firms like INTL FCStone will be here well into the 
foreseeable future to help our customers manage their risk. And we will 
continue to advocate for our customers in seeking regulations that are 
drafted in such a way that they continue to allow even the smallest 
end-users to have access to hedge against market risk.
    These are challenging times for our industry, not only due to the 
regulatory changes described above, but also due to fundamental shifts 
in the business model that underlies the futures industry. With 
depressed futures volumes, historically low interest rates, and 
extremely competitive pricing, FCMs are under tremendous strain 
financially. Many of us are concerned that the business is reaching a 
point where it cannot absorb additional costs without a substantial 
shift in the model--whether that is considerable consolidation among 
FCMs or some firms leaving the business altogether. This type of risk 
concentration in a few firms is not, in my opinion, what was intended 
by Dodd-Frank, and it will make the clearing system--and our broader 
economy--more vulnerable to catastrophic losses. So as our regulators 
consider the pending rules and this body continues to execute its 
oversight mandate, I urge you to consider both the immediate and the 
long-term consequences that these rules bring for the small and mid-
sized commodity producers, processors and end-users that are so 
important to a strong U.S. economy.
    Thank you for inviting me to testify today. INTL FCStone greatly 
appreciates the ongoing work and support that the Committee has 
provided during some very trying times for our nation, and I look 
forward to answering any questions that you may have.
   Addendum A: Capital Cost of Alternative Approaches To Netting of 
                        Commodity Swap Positions
    The necessity of the revisions to the Proposed Capital Rule 
recommended by INTL FCStone is evident when an analysis of the various 
capital requirement approaches is conducted based on a hypothetical 
portfolio. Below we apply the ``standardized approach'' to a 
hypothetical commodity swap portfolio held by a swap dealer. This 
analysis illustrates how the Proposed Capital Rule's failure expressly 
to permit the netting of commodity positions results in significantly 
higher capital costs for Commodity Swap Dealers as compared to all 
other swap dealers.
    As demonstrated above, the commodity position market risk charges 
under the ``standardized approach'' are not ``comparable'' to the rules 
of the banking regulators. This lack of comparability is inconsistent 
with the CFTC's statutory mandate under Section 731 of the Dodd-Frank 
Act. In addition, the Proposed Capital Rule's disregard for netting of 
commodity swap positions under the ``standardized approach'' is 
inconsistent with the fundamental goal of a capital regime, which is to 
incentivize prudent risk management by a swap dealer. Keeping all other 
factors equal, maintaining a flatter portfolio should yield lower risk 
capital charges.
    The table below compares the impact of these alternative approaches 
to netting of commodity positions under existing approaches to market 
risk, including (i) gross calculation with absolutely no offsets, (ii) 
the standardized measurement method with offsetting of the exact same 
commodity, month, strike, and put/call, (iii) the standardized 
measurement method with offsetting in the same expiry, (iv) the 
maturity ladder approach with offsetting in the same expiry, and (v) 
the internal models based approach.
    For purposes of illustrating the impact of these alternative 
approaches, we have set a hypothetical baseline of $20 Million (the 
minimum capital requirement) as the standardized approach with 
offsetting by commodity and expiry. The percentages in the illustration 
below are representative of the actual percentage differences seen in 
our portfolio in applying the different calculation methods. However, 
as noted, the dollar amounts are for illustration purposes only.
    The only variable changed between Rows 1-3 is the offsetting used 
with the calculation of the 3% supplemental charge. Row 4 uses 
paragraphs 7 through 11 of the Market Risk Amendment of which 
paragraphs 8 through 10 prescribe application of the Maturity Ladder 
Approach. Row 5 represents an internal models approach using Historical 
Value at Risk with a 99% confidence interval, 3 year look-back and a 10 
day time horizon.

------------------------------------------------------------------------
                                                           Percent as
                                                        compared to the
    Row       Market Risk Capital   Total Market Risk        Row 3
             Calculation Approach     Capital Charge     ``Standardized
                                                           Approach''
------------------------------------------------------------------------
1           ``Standardized            $536,688,787.53             2,683%
             Approach'' (Gross
             Calculation with
             absolutely no
             offsets)
2           ``Standardized            $112,939,994.78               565%
             Approach''
             (offsetting exact
             same (commodity,
             month, strike, put/
             call))
3           ``Standardized             $20,000,000.00               100%
             Approach''
             (offsetting within
             same commodity and
             expiry)
4           Total for Maturity         $17,738,970.37                89%
             Ladder Approach with
             offsetting in same
             expiry
5           Internal Models-Based       $3,863,209.48                19%
             Approach (HVaR, 99%
             CI, 3 year Lookback,
             10 day time horizon)
------------------------------------------------------------------------

    As depicted in the table above, the differences between the capital 
costs associated with the various approaches are astronomical and, 
unless the Proposed Capital Rule is clarified/revised, the effects on 
the competitive balance between Commodity Swap Dealers and all other 
swap dealers would be substantial. While the Internal-Based Models 
Approach best corresponds an entity's capital charge to its market 
risk, in the event that an internal model is not appropriate for a 
given entity, interpreting or modifying the standardized approach under 
the Proposed Capital Rule to permit netting by commodity and expiry or, 
alternatively, through application of the Maturity Ladder approach, is 
a much better alternative and will allow the market to maintain some 
semblance of competitive balance.
    Additionally, the table depicts the sizeable differences between 
approaches permitting different types of offsets. The approaches using 
offsets that more accurately gauge an entity's market risk result in 
capital charges that are more reasonable and are closer to the capital 
charges that result from using a models-based approach. See Appendix A 
for an illustration of the differences in the calculations used above.
                               Appendix A
    The purpose of this Appendix is to provide a detailed illustration 
of the netting of offsetting exposures described in the comment letter. 
For the sole purpose of this illustration, we have put together the 
below hypothetical portfolio which contains both OTC and centrally-
cleared corn swaps, swaptions, futures and futures options. This is not 
the same portfolio used for the calculations noted in the comment 
letter, but rather a much smaller and single commodity portfolio.
    For simplicity, this illustration only covers the market risk 
charges applicable to 15% directional risk on the net position and the 
3% of ``gross'' to cover forward gap, interest rate and basis risk. The 
Maturity Ladder Approach (iv) and Internal Models (VaR) (v) are 
excluded from this illustration. The initial offsetting allowed under 
the Maturity Ladder Approach is the same as reflected in (iii) below 
although the resulting charges would be slightly less due to lower 
charges (1.5%) for offsetting exposures within a broader ``Time Band''.

                                  Corn


------------------------------------------------------------------------
Position                    OTC                                    Delta
------------------------------------------------------------------------
A                           Long 50 December 2013 swaps          250,000
B                           Long 100 December 2013 5.50        (164,379)
                             puts
C                           Long 250 December 2013 6.50          518,800
                             calls
------------------------------------------------------------------------
Position                    Central Clearing Counterparty          Delta
------------------------------------------------------------------------
D                           Short 150 December 2013 futures    (750,000)
E                           Short 100 December 2013 5.50       (164,384)
                             puts
F                           Short 25 March 2013 6.91 puts         59,762
G                           Short 25 March 2013 6.91 calls      (65,199)
H                           Short 25 July 2013 6.92 puts          57,717
I                           Short 25 July 2013 6.92 calls       (65,199)
------------------------------------------------------------------------

    Definitions of fields used in the below illustrations:
    Underlying Group--the underlying commodity upon which the position 
is based.
    Positions Included--the positions from the above portfolio that are 
included in each line. This really helps to illustrate how the netting 
described is working.
    Contract Month--the delivery month of the underlying on which the 
position is based.
    Option Type--Call, Put or, in the case of swaps and futures, N/A 
for the position shown.
    Strike--The strike price for the position shown.
    Delta--the underlying equivalent size of the position expressed 
here, not as futures equivalents, but notional quantity (i.e., Notional 
Delta). In this illustration using corn, the delta is expressed in 
bushels. To derive the futures contract equivalent size, simply divide 
the number shown by 5000.
    Spot Price--in this case, the spot price of corn used in the 
calculations as prescribed by the proposed rules.
    Delta Notional--derived by multiplying Delta * Spot Price. This is 
the notional value of the based upon the delta as prescribed to do in 
the Amendment to the Capital Accord to incorporate market risks page 31 
under Delta-plus method.
    15% Net Charge--this calculation only applies to the net remaining 
position and is the capital charge for directional risk. It is derived 
by multiplying to total net Delta Notional by 15%.
    3% Gross Charge--this value is derived by multiplying the absolute 
value of Delta Notional by 3% per line item. This is the only charge 
which will vary between the examples below and is dependent upon what 
is allowed to offset/net.




    (i) Standardized Approach with no offsetting--Same methodology used in Row 1 of the comment letter.



--------------------------------------------------------------------------------------------------------------------------------------------------------
                         Positions                                                                    Spot                     15% Net
   Underlying Group      included     Contract Month (MMM-YY)   Option Type   Strike      Delta      Price    Delta Notional    Charge   3% Gross Charge
--------------------------------------------------------------------------------------------------------------------------------------------------------
Corn
                                 A                    Dec-13           N/A         0    250,000.00   5.9975    $1,499,375.00                  $44,831.35
                                 C                    Dec-13          Call       6.5    518,800.17   5.9975    $3,111,504.00                  $93,345.12
                                 B                    Dec-13           Put       5.5   ^164,379.00   5.9975    $(985,863.08)                  $29,575.89
                                 D                    Dec-13           N/A         0   ^750,000.00   5.9975  $(4,498,125.00)                 $134,943.75
                                 E                    Dec-13           Put       5.5    164,383.79   5.9975      $985,891.79                  $29,576.75
                                 F                    Mar-13           Put      6.91     59,761.61   5.9975      $358,420.27                  $10,752.61
                                 G                    Mar-13          Call      6.91    ^65,198.86   5.9975    $(391,030.18)                  $11,730.91
                                 I                    Jul-13          Call      6.92    ^67,119.50   5.9975    $(402,549.20)                  $12,076.48
                                 H                    Jul-13           Put      6.92     57,716.57   5.9975      $346,155.12                  $10,384.65
                                                              ------------------------------------------------------------------------------------------
  Corn Total                                                         Net Total            3,131.62   5.9975       $18,781.89  $2,817.28      $377,217.50
--------------------------------------------------------------------------------------------------------------------------------------------------------





    (ii) Standardized Approach offsetting exact same Commodity, Month, Strike, Put/Call--Same methodology used in Row 2 of the comment letter.



--------------------------------------------------------------------------------------------------------------------------------------------------------
                         Positions                                                                    Spot                     15% Net
   Underlying Group      included     Contract Month (MMM-YY)   Option Type   Strike      Delta      Price    Delta Notional    Charge   3% Gross Charge
--------------------------------------------------------------------------------------------------------------------------------------------------------
Corn
                                 F                    Mar-13           Put      6.91     59,761.61   5.9975      $358,420.27                  $10,752.61
                                 G                                    Call      6.91    ^65,198.86   5.9975    $(391,030.18)                  $11,730.91
                                 H                    Jul-13           Put      6.92     57,716.57   5.9975      $346,155.12                  $10,384.65
                                 I                                    Call      6.92    ^67,119.50   5.9975    $(402,549.20)                  $12,076.48
                              A, D                    Dec-13           N/A         0   ^500,833.15   5.9975  $(3,003,746.82)                  $90,112.40
                                 B                                     Put       5.5          4.79   5.9975           $28.71                       $0.86
                                 C                                    Call       6.5    518,800.17   5.9975    $3,111,504.00                  $93,345.12
                                                              ------------------------------------------------------------------------------------------
  Corn Total                                                         Net Total            3,131.62   5.9975       $18,781.89  $2,817.28      $228,403.03
--------------------------------------------------------------------------------------------------------------------------------------------------------





    (iii) Standardized Approach offsetting within same commodity and expiry--Same methodology used in Row 3 of the comment letter



--------------------------------------------------------------------------------------------------------------------------------------------------------
                       Positions                                                                      Spot                     15% Net
 Underlying Group       included      Contract Month (MMM-YY)   Option Type   Strike      Delta      Price    Delta Notional    Charge   3% Gross Charge
--------------------------------------------------------------------------------------------------------------------------------------------------------
Corn
                              F, G                    Mar-13                             ^5,437.25   5.9975     $(32,609.91)                     $978.30
                              H, I                    Jul-13                             ^9,402.93   5.9975     $(56,394.09)                   $1,691.82
                     A, B, C, D, E                    Dec-13                             17,971.80   5.9975      $107,785.89                   $3,233.58
                                                              ------------------------------------------------------------------------------------------
  Corn Total                                                         Net Total            3,131.62   5.9975       $18,781.89  $2,817.28        $5,903.70
--------------------------------------------------------------------------------------------------------------------------------------------------------


    Mr. Conaway. I thank the witnesses, and recognize Mr. 
Neugebauer, for 5 minutes.
    Mr. Neugebauer. Thank you, Mr. Chairman.
    Mr. Duffy, you mentioned that industry had taken a lot of 
steps to make sure that customers' segregated funds were 
protected, and could you kind of just elaborate on how you 
think we are today versus where we were, say, 2 years ago prior 
to MF Global and----
    Mr. Duffy. Sure, I would be happy to. Mr. Roth elaborated 
on a couple of the new methodologies that we are deploying to 
shore up the system, but where we are at is whether we are 
asking the CEO or the CFO to sign off on the movement of 
certain segregated funds, a couple of things that Mr. Roth 
highlighted, but what is still missing and what is missing in a 
lot of things in legislation is teeth in anything. I am a 
proponent of regulation to an extent. I am a proponent of 
regulation that makes sense on a global basis. What I think we 
are also missing is the deterrent for people not to go down the 
paths that someone did like at MF Global. I think that we have 
shored up the system. People have said to me is there a crisis 
of confidence in your market participants? I spoke at the 
Kansas Grain and Feed Association. There wasn't a crisis of 
confidence in the market, there was a crisis of confidence in 
what was the lack of not being done to a certain individual 
that went in and used their money for their own purposes.
    This is where the problems lie, sir. I think that the old 
saying is ``Don't throw the baby out with the bath water.'' We 
have good systems in place in our industry. We have added three 
or four more to shore that up. What we need to do is put teeth 
into these things and make people make certain they don't go 
down this path.
    Mr. Neugebauer. Just to kind of move forward on that, in 
one of the proposals that is out there is an insurance program, 
and I was thinking this morning--and also looking at your 
testimony, and you mentioned that you were opposed to the user 
fees that the--or the fee that the President proposed in his 
budget. Do you worry that if you put these user fees on and you 
implement an insurance program, that you drive the 
transactional cost up for some of the end-users? And we have 
already seen a decline in activity. Are we driving some 
additional people out of the markets?
    Mr. Duffy. I think there is no question that is true. I am 
not a proponent of insurance. I supported the study to Mr. 
Roth's comments. I think it is the right thing to do. We should 
never make a knee-jerk reaction when it comes to something like 
this, so the study was a good idea. The problem is it should be 
voluntary, not mandatory. I think if people want to have their 
costs go up, which they will--you have to realize, sir, we put 
$100 million fund in place at CME. I couldn't get it insured. I 
had to self-insure that fund because the cost of the insurance 
would be a lot more than it is worth, so can you imagine trying 
to insure $158 billions of customer segregated funds, what that 
would do to the consumer or to the risk offsets that people are 
trying to do at FCStone or places? They wouldn't be able to 
afford it. So I don't think Congress should mandate it. I think 
we have good rules in place, and I don't think insurance is a 
bad idea, but it is up for the individual if they want to 
acquire it to acquire it, and Congress should not mandatorily 
put it in place.
    Mr. Neugebauer. Thank you.
    Mr. Sprecher, I understand that the EU could, as early as 
June, make a determination whether or not the U.S. regulatory 
standards are equivalent to theirs. Should that determination 
be not equivalent, what would be the ramifications on EU 
clients doing business regularly in the U.S. markets, and vice 
versa?
    Mr. Sprecher. Thank you for the question. The concern that 
I have is that if the EU were to make such a determination, and 
you rightfully pointed out that they may do that as soon as 
June, they would deny access for European customers to U.S. 
markets. As a market operator and sitting next to another great 
market operator, we enjoy sitting in the United States and 
having the world come to us. We enjoy having the world's 
agricultural markets in the United States. My company has a 
contract called World Sugar, which is largely produced outside 
the U.S. and largely consumed outside the U.S., but yet trades 
in U.S. markets. I think if we start denying access or if other 
countries decide to deny access of global market participants 
to the U.S., it will have broad repercussions on keeping these 
markets here and regulated in the U.S.
    Mr. Neugebauer. Well, the--issue is extremely important to 
our--isn't it?
    Mr. Sprecher. Absolutely important to our market and our 
domestic market participants. We know--and the United States 
has benefitted from the globalization of commodities. We are at 
the center of that, and it would be sad to see the world get 
balkanized as the result of the lack of regulatory 
harmonization.
    Mr. Neugebauer. Thank you, Mr. Chairman. I yield back.
    Mr. Conaway. Thank you, Mr. Neugebauer.
    The Ranking Member for 5 minutes.
    Mr. Peterson. Thank you, Mr. Chairman.
    Mr. Dunaway, I was reading your testimony here, and I guess 
I need more clarification or information here about this issue 
with the capital margin requirements. I don't understand what 
is going on here, why it is the businesses under the bank, the 
capital margin requirements are less than they are if they are 
not, and that is one issue. And then is this why people are 
pushing this swap push-out bill, because the more they can get 
under the bank, the less capital they have to come up with? Is 
that--I have been kind of mystified why there has been all this 
push for this swap push-out bill.
    Mr. Dunaway. Well, I can certainly address the first part 
of your question. I am not quite as familiar with the second 
half, but with regards to the regulatory capital requirement 
for a non-bank swap dealer, it really comes down to the fact 
that the banks already have internal models that have been 
approved by the regulators and the CFTC is willing to rely on--
--
    Mr. Peterson. What regulator?
    Mr. Dunaway. Either the SEC or the Prudential Regulators 
have approved their models.
    Mr. Peterson. And so the CFTC has gone along with that?
    Mr. Dunaway. They have accepted the internal models that 
those banks, but however----
    Mr. Peterson. But they are trying to put a different model 
on people that are outside?
    Mr. Dunaway. They are not accepting--at this point, they 
are not approving any other internal model, so they are taking 
a standardized----
    Mr. Peterson. So you don't know what they are doing, or 
what?
    Mr. Dunaway. I do know what they are doing, and it is laid 
out in our comment letter that we made to the CFTC. They are 
taking a page out of the Basel II regulations and creating a 
standardized approach, but the real downfall of that is it 
takes a complete gross position for non-bank affiliates. We are 
taking a market risk, even if we have economically offsetting 
positions.
    Mr. Peterson. So you have had discussions, obviously, with 
the CFTC staff, I guess?
    Mr. Dunaway. Yes, we have.
    Mr. Peterson. What is their explanation for this? I mean, 
it doesn't seem to make any sense. Why are they doing this?
    Mr. Dunaway. We have--the beginning of January, we 
submitted our comment letter, which I believe has been provided 
to the Committee, with the calculations, and we followed that 
up with discussions with both CFTC staff and some of the 
Commissioners. I don't have a good answer as to why they are 
doing it. I know that we have not received any direct feedback 
addressing our concerns, other than that they understand the 
concern, but we haven't seen any tangible evidence of rule 
changes being proposed.
    Mr. Peterson. Okay. But they have not actually finalized 
this, and so if nothing changes, you are going to have to put 
up significantly more capital than the banks.
    Mr. Dunaway. If the rules are incorporated, yes, as they 
are currently stated.
    Mr. Peterson. I guess the way this was proposed, 90 percent 
of the swaps that are out there are going to be allowed to 
remain under the banks, and about ten percent would have been 
pushed out into a separate entity, the reason being that the 
banks have government money, taxpayer money behind them and 
these swaps that we are pushing out have nothing to do with the 
banking activity. They are different. So there is a bill to 
allow 99 percent of the swaps to be pushed out, so there will 
be hardly anything left in the bank. I was trying to figure out 
why they were doing this. Well maybe it is because of this, 
that they are going to have to--if they don't allow it under 
the banks, they are going to have to put up significantly more 
capital in this new entity that they create to hold those ten 
percent swaps that are pushed out. But you haven't run into 
that or nobody----
    Mr. Dunaway. I am not familiar if they push it out, if they 
can still use the internal model or not, but I would assume 
that they would still have the benefit of utilizing the 
internal model, otherwise I am not sure. You can see the 
dramatic effect it has on our capital requirements. Even the 
large banks, I don't think that they could economically handle 
or----
    Mr. Peterson. I mean, that would be even more questionable 
that they would allow--if they did have to set up the separate 
entities and ten percent of the swaps were pushed out, if they 
allowed the banks to use that other definition and not you, 
that would be even worse.
    Mr. Dunaway. I would agree.
    Mr. Peterson. You know, it doesn't make any sense. So I 
guess my staff would like to follow up with you and also with 
the Commission and try to figure out what is going on here.
    Mr. Dunaway. Certainly. I would appreciate that. Thank you.
    Mr. Peterson. It doesn't seem to make any sense to me.
    I yield back.
    Mr. Conaway. The gentleman yields back.
    I recognize myself for 5 minutes.
    The Committee last Congress, and this Congress, have passed 
a cost-benefit bill that would basically encapsulate what the 
President asked all agencies to do with respect to determining 
what the costs are of a particular proposed rule. We have been 
particularly disappointed in the way the CFTC has done that. 
Can you give us some real world examples, anybody on the panel, 
of where the CFTC did do a cost-benefit analysis and either got 
it right or got it wrong with respect to the implementation 
that you are now going through? So Mr. Sprecher, Mr. Duffy, any 
of you can give us some examples of where that is--either lined 
up with what the CFTC said, or is out of line?
    Mr. Sprecher. Well, the most obvious example that affects 
both the CME Group and ICE has been the position limit rules 
which came out and ultimately are the subject of court matter 
over this very issue. Our customers every day want certainty 
about position limits. People are--as you well know, our mutual 
constituents want certainty so that they can make informed 
decisions, going forward, as part of reinvigorating the economy 
is making forward decisions, and unfortunately, this whole 
position limit area is tied up in courts over this very issue, 
and we are in the unfortunate position of not being able to 
help our customers with any kind of guidance on how they might 
want to hedge their future risks.
    Mr. Conaway. So Mr. Duffy?
    Mr. Duffy. Yes, if I could add, I was going to mention 
position limits but I am glad Jeff did, because we are both 
affected by it. But one of the things--I will try to give you 
the other side of the equation of what I think they got right, 
and that is on the margin issue as it relates to futures versus 
swaps, 1 day versus 5 days. They have historical backgrounds 
and data to show that futures should be margin 1 day. They also 
have historical data to show that swaps have been margin 5 
days, hence Mr. Sprecher's clearinghouse in London at ICE Trust 
for credit default swaps. So to say that a swap is identical to 
a future is just flat wrong, and it should not be margin in the 
same respect because there are certain participants who can 
participate in the default. There are certain ones who can't. 
There are 12\1/2\ to 20 million contracts a day traded in the 
regulated futures market where people can participate in 
default. There are 2,000 transactions a day in the over-the-
counter swaps market where a handful of participants can 
participate. I think that is where they got it right, if you 
want to look at where they got it right.
    Mr. Conaway. Okay. Mr. O'Connor, can you give us your 
thoughts on the importance of harmonization with respect to the 
SEC and the CFTC, as well as the world regulatory scheme?
    Mr. O'Connor. Yes. I think a useful example might be the 
impact of the CFTC's reach outside of the U.S. jurisdiction, so 
the CFTC is fairly unique in that it requires swaps dealers to 
register and there is a reluctance on the part of overseas 
banks to register with the CFTC, and in fact, on the part of 
their own regulators as well to have that happen. So what has 
happened is that many, many international banks have now 
stopped trading with U.S. banks in the swap markets, since to 
do so would trigger a requirement for them to register with the 
CFTC, and there might be some perceived actual burden 
associated with such registration.
    So what that means is that liquidity has been harmed in 
that U.S. banks can no longer access liquidity provided by the 
overseas banks and vice versa, and the overseas banks, in 
addition to not trading with U.S. banks, are not trading with 
their U.S. clients either, so U.S. corporations and investment 
firms that used to trade with offshore banks now have seen that 
liquidity dry up as well, so that is an example.
    Mr. Conaway. Is there a way to quantify that in terms of--I 
understand the overall concepts, but is there a way to quantify 
the lack of liquidity or the increase in costs as a result of 
lack of liquidity that we can point to specifically with hard 
data?
    Mr. O'Connor. Not one that springs to mind immediately, but 
certainly we can try to do some work and get that to you.
    Mr. Conaway. All right. Mr. Roth, you mentioned the study 
that some of you are conducting. What is the timing for when 
that is supposed to be done? I think Mr. Lukken said this 
summer, but is that what your expectations are?
    Mr. Roth. Yes, I am always more optimistic. We are in the 
process of--the consultant has all the data that he needs. He 
needs to provide that data to the insurance companies and then 
get responses back from insurance companies to his requests for 
estimates for cost. So it is going to be a little bit out of 
his control. It is going to depend on how long those insurance 
companies take to get back to him, but we were hoping within 
the next 6 weeks we would have a response.
    Mr. Conaway. All right, thank you. I will yield back.
    Mr. Scott for 5 minutes.
    Mr. David Scott of Georgia. Thank you, Mr. Chairman. It is 
good to have all of you here and Mr. Sprecher, good to have you 
here up from Atlanta, Georgia.
    Mr. Sprecher, let me start with you. You have been working 
with the CFTC and the SEC for quite some time on what we call 
portfolio margining regime for credit default swaps. Can you 
give us a brief update on the progress of that?
    Mr. Sprecher. Sure. Thank you for the question.
    First, let me say that I think it is the nature of my 
testimony and hearings like this in general to point out 
failings of the agencies because we want to correct them, but 
we very much appreciate that both SEC and CFTC have been given 
a tall mandate to implement Dodd-Frank in a short period of 
time. And one of the areas that is a tall mandate is how to 
cooperate on this so-called portfolio margining. The CFTC 
largely has its work done and we thank them for that. We have 
now turned to the SEC and are trying to work through their 
process. They obviously have a different priority set, 
different time table on the things they are working on on Dodd-
Frank, so we have tried to raise the priority level of this 
issue with them. We have also asked many of you to help us 
raise that priority issue.
    There is a critical deadline coming up in June 10 where 
more of our mutual constituents are going to be required to do 
clearing, and we are advocating very hard and strongly with the 
SEC that they finish their work in this area by June 10, or if 
they cannot finish their work, at least provide some kind of 
interim relief that would not make it expensive for end-users 
to start clearing, which they are going to be required to do by 
law. I have some hope from our recent conversations, including 
in the past 24 hours, that the SEC understands that deadline 
and is making efforts to try to make sure that our mutual 
constituents will see some relief.
    Mr. David Scott of Georgia. That June deadline is very 
important for that as well for the joint rulemaking, which is 
what I would like to talk to you for a minute now. You are 
somewhat caught in the middle of that between the CFTC and the 
SEC. Can you tell us, is that harmonization possible? Where 
could you pinpoint the problem as to why we can't get the SEC 
and the CFTC to harmonize? That is critical, and like you said, 
June is just a few days away when Europe will be making their 
decisions.
    Mr. Sprecher. Yes. Both agencies come from two different 
perspectives. One, an agency that is very used to overseeing 
farmers and ranchers and commodity traders, and another that is 
overseeing individual shareholders and securities investors. 
They have had different regimes, as many of you know, and a lot 
of history with their regimes and they both bring their own 
biases and backgrounds to the discussion on how to harmonize. 
Frankly, they are trying to find the best of both worlds. 
Securities law and just the size and breadth of the SEC is 
large and complicated, and so it was not surprising to us to 
see the CFTC be able to get its work done quickly. But the SEC 
is a very complicated process that is embedded in past history. 
I am hopeful that they understand the issue. A lot of end-users 
and our mutual constituents have been in to inform them how 
important getting this right is, and I do think that that has 
had an impact on them to raise the priority on this issue.
    Mr. David Scott of Georgia. In your estimation, do you 
think it is possible that they can come together and coordinate 
and harmonize?
    Mr. Sprecher. I think it is a minimum they will provide 
some interim ability is my hope. I think the process of 
harmonizing is going to take significantly more time, however.
    Mr. David Scott of Georgia. And I want to ask you one more 
quick question.
    You mentioned the importance, in your estimation, of what 
you referred to as bona fide hedging.
    Mr. Sprecher. Yes.
    Mr. David Scott of Georgia. And how that would hurt 
commercial end-users. Could you tell us how that would be the 
case?
    Mr. Sprecher. Sure. You know, in custom and practice over 
the last many years, we have had at the Exchange many bona fide 
hedgers. These are farmers, ranchers, industrial companies that 
are looking to specifically hedge risk. The definition--some of 
the definitions that have been proposed are very, very specific 
on how one would consider a hedge and go way beyond the history 
of how we have been looking at this in the past. For example, 
my father-in-law, who is a farmer, is right now planting his 
corn. He is going to hedge his corn risk in some way on CME 
markets. He has no idea exactly how much corn he is going to 
end up with at the end of the year. His hedge will not be a 
perfect hedge. It will, by nature, be an imperfect hedge. He 
has to make a guesstimate as to how many sunshine days they are 
going to have, how his crop might do, how the yields will be 
this year. If we hold him to a standard where he has to be 
specific up front, it is almost an impossibility and if you go 
to very complex industrial companies that are hedging foreign 
exchange risks because they are global, they are hedging 
interest rate risk because they borrow, they are hedging 
commodity risk because of the inputs, they don't have perfect 
information and they often buy more contracts than they need or 
less contracts than they need and we understand that at the 
exchange level. We work with these people day in and day out. 
We challenge them on what they do and we think that process 
historically has worked very well.
    Mr. David Scott of Georgia. Thank you, Mr. Sprecher.
    Mr. Sprecher. Thank you.
    Mr. Conaway. Mr. Scott for 5 minutes.
    Mr. Austin Scott of Georgia. Thank you, Mr. Chairman, and 
the gentleman Mr. Neugebauer asked most of my questions about 
the European Union, which is what I wanted to concentrate on, 
and the potential for two different sets of rules.
    One of my primary concerns with what I see coming out is 
the effect on liquidity, whether it is an increased transaction 
cost, which means you have fewer transactions, or one set of 
rules for the U.S. and one set of rules for the European Union. 
If the European Union is going to give us an answer in June, 
which is 1 month from now, what do you expect to happen between 
now and the end of June from U.S. regulatory agencies, and what 
do you anticipate the liquidity challenges, not only for the 
U.S. but for the world, would be if we end up with the EU 
saying we will not accept the rules from the U.S.?
    Mr. Sprecher. Thank you for the question, Congressman 
Scott.
    We hope that, given the short time that you indicate, the 
CFTC engages on this on a meaningful level, and if it cannot 
work with the EU in such a short period of time, that the two 
of them agree to come up with a different deadline.
    I think all of us in the room have seen our end-users have 
to make last minute decisions or seek last minute relief, and 
it is agonizing and it is imperfect. For my own company, we are 
having to make decisions do we break apart the liquidity and 
contracts and launch U.S. versions and separate European 
versions, because the two regulatory regimes may not come 
together. We can't do that overnight. We would have to give a 
lot of conversation with the global market participants on why 
we would be looking at splitting markets and how it is going to 
impact them, and if that is what regulators are asking us to 
do, we ourselves need a lot of time. So the deadlines are 
frightening in their immediacy, and we really hope that the 
CFTC will engage at a very meaningful level with Europe. The 
relationship between the U.S. and Europe is one that you would 
hope that we would be able to come to much commonality.
    Mr. Duffy. If I could add a little bit. We are obviously 
concerned about the overreaching potential of what the U.S. 
Government and what is going to be retaliated back on U.S. 
participants in foreign markets. You know, one of the examples 
is right now Europe is proposing a 2 day margin for their 
products and then there is--so people are saying well what does 
that mean? If we don't accept that here in the U.S., will they 
start to put different restrictions on U.S. participants in 
foreign markets? Well, what they fail to recognize is in the 
United States, we do interday margin, so we do margin on a real 
time basis every--we don't do it once a day. We do it twice a 
day, sometimes three times a day because we do mark to market 
every 12 hours, and more if needed. They don't do that in 
Europe. What they do is they only do it on a basis of what 
market conditions predict. So they are trying to get 
commonality across the platforms, and this is one of the 
reasons how they are going to bring it out. Well we already 
have an answer for that. We do it and we do it even more than 
you do it today.
    The other issue on the tax, which is something you raised 
which is a concern of mine. First of all, Great Britain, to 
their credit, have already said they will not accept a Tobin 
Tax on users fees as the rest of the European Union is 
proposing it. What they also failed to admit is they are going 
to have another vote after the elections in November and codify 
that at the end of the year. So we will see how that vote goes 
first. So the worst thing this Congress could do is react on a 
knee-jerk reaction to compare what Europe is going to do prior 
to us and then us doing it first. So that is a big concern we 
have in our industry.
    Mr. Austin Scott of Georgia. I don't believe it will be the 
Congress that has a knee-jerk reaction. It might be an agency 
or an Administration.
    Just real quick--I am almost out of time. What percentage 
of the global markets trade through our U.S. entities?
    Mr. Sprecher. Well, my company, which as you know is based 
in Atlanta, Georgia, has more than 50 percent of our revenues 
come from entities outside the United States.
    Mr. Austin Scott of Georgia. I think that, again, gets back 
to one of our primary concerns in that we want those foreign 
businesses doing business in the United States. It is good for 
the United States and it is good for our economy.
    With that, Mr. Chairman, I am down to about 20 seconds 
here. I yield the remainder of my time to you.
    Mr. Conaway. The gentleman yields back. Thank you very 
much.
    Mr. Costa for 5 minutes.
    Mr. Costa. Thank you very much, Mr. Chairman.
    Mr. O'Connor, your testimony was somewhat critical on 
business conduct standards in Dodd-Frank, which were designed 
to provide customer protection in the swap market. Do you 
believe that we should have some sort of customer protection, 
or should we go back to pre-2008?
    Mr. O'Connor. I absolutely believe there should be customer 
protection. I think the main point that I was attempting to 
make was that the approach has been ultra prescriptive rather 
than principle-based, and that has led to an enormous challenge 
from an implementation perspective.
    Mr. Costa. I think you also have to remember, we were 
reacting to a crisis. We had a meltdown. I mean, some argue 
that, economists, we were this close to a worldwide depression.
    Your testimony also bemoans the possibility of multiple 
swap data repositories, and we had a lot of debate, as you 
know, on Dodd-Frank. The Committee heard similar complaints 
from other organizations like yours and private companies that 
sought a government mandate to a single swap data repository, 
always for the benefit of, one would argue, the regulators. 
This Committee rejected that approach in letting the market 
decide whether or not a single or multiple repositories would 
be best. Well the single repository is such a great idea and 
multiple repositories are so bad, why are you seemingly afraid 
of letting the market come to the conclusion by itself?
    Mr. O'Connor. My point--and I am almost wearing a regulator 
hat here, is that the idea behind the data repositories is to 
provide one database where regulators can go to look at 
behavior in the market and all transactions from all market 
participants, and I think that, as I said in my written 
testimony, that would give regulators an unprecedented tool in 
global markets, and no other market anywhere in the world has 
there been the chance to create something that would give 
regulators tools to see what every counterparty was doing in 
every market. And as a single model, if that is split up into 
ten repositories, then that is an opportunity lost is the point 
I am trying to make.
    Mr. Costa. All right, before my time expires, Mr. Duffy and 
Mr. Sprecher, in your testimony--or in the testimony, Mr. 
O'Connor expressed worries about fragmentation of derivatives 
trade reporting. Each of your companies, I am told, has your 
own swap data repository, and the CFTC has been sued by another 
swap data repository for approving rules governing each of your 
SDRs. Do you agree with Mr. O'Connor's view that 
fragmentation--on the fragmentation of swap reporting?
    Mr. Duffy. I will say this, that if the swap is being 
cleared at Mr. Sprecher's clearinghouse or mine, the cost to 
the participants are a lot less. If you have--and second of 
all, the regulator already gets a copy of each and every swap, 
so he doesn't have to worry about going to one place. He gets a 
copy of the swap transaction from the SDRs.
    Second, the costs associated with duplication of having a 
swap cleared at IntercontinentalExchange or at CME Group and 
then sent to one central swap depository is going to cost the 
participants multiples of that. So we are already doing that.
    Mr. Costa. Mr. Sprecher, quickly before my time expires.
    Mr. Sprecher. Yes, and in fact, CME Group and ICE every day 
arrange for Large Trader Reports to go to the CFTC to show the 
entire positions in our clearinghouse, and so this is really 
just an augmentation of what exists today.
    Mr. Costa. Let me ask you my final question here. You have 
all kind of expressed your concerns about what is going on here 
with the implementation of the regulatory scheme of Dodd-Frank. 
I don't know that I have really clearly heard you say what 
concerns you about what the Europeans are doing right now 
because I have some interaction with my colleagues there and 
what are your concerns about what is going on there?
    Mr. Lukken. Just quickly, one of the issues that we are 
dealing with that has been resolved in the United States is how 
swaps are segregated here in the United States using the LSOC 
methodology. In Europe, that is exponentially more complex, 
given that Europeans through a mirror have to give a choice of 
both omnibus segregation for swaps and individually segregated 
accounts for swaps. That is being interpreted by several 
jurisdictions within Europe differently, so companies that we 
represent have to come in and build multiple systems in order 
to account for each of those different interpretations. We are 
working with ESMA in Paris to help to consolidate that, to make 
it one comprehensive guidance on how that is going to be built 
for the Europeans, and that is just beginning. We are about a 
year behind where we are with Dodd-Frank in Europe, but we are 
starting to focus our attention----
    Mr. Costa. How would you describe the--well----
    Mr. Conaway. Nice try, Mr. Costa. The gentleman's time has 
expired.
    Mr. Costa. Thank you, Mr. Chairman.
    Mr. Conaway. Mr. Fincher for 5 minutes.
    Mr. Fincher. Thank you, Mr. Chairman, and I thank the panel 
for being here today.
    Listening to the comments from you all and then some of my 
colleagues on the--here today, just thinking about who is going 
to regulate the regulators, who is going to oversee the 
overseers. You know, how big can it get? How out of control can 
it get? I was listening to the Ranking Member, my friend who is 
very knowledgeable about these issues, and him being reluctant 
from Mr. Dunaway's testimony about how cloudy a lot of these 
rules still are.
    I guess my point--and Mr. Duffy, I am going to let you 
comment on this--we are going to be placed at a terrible 
disadvantage. We are seventh generation farmers. I come from a 
family farm background. We farm about 12,000 acres of corn and 
cotton, soybeans, and wheat. I know firsthand, from having to 
deal with Cargill Bungees selling your product and then them 
having to go in the market and take a position on that market 
that I may deliver in September, December, March, June, 
whatever the month may be. When you start really pressing down 
on them with more regulations, more margin requirements, then 
they come back to me and say Mr. Fincher, we need more capital. 
We need a higher risk protection, and my bottom line starts to 
decrease. Mr. Scott and I have a credit valuation adjustment 
bill that is a study, and my fear is we are going to open the 
door to the European institutions on having the advantage over 
us because just the credit valuation is a prime example. They 
are delaying or not going to enforce it and we are.
    Mr. Duffy, would you comment on some of that?
    Mr. Duffy. I would be happy to try to comment on that. I 
think you are absolutely right. I think that especially when 
you look at London, London is truly a one-trick financial 
institution. That is what it does. It is going to do everything 
in its power to capture financial services business, and if 
anybody thinks that excludes agricultural derivative trading or 
anything else of that nature, they are sadly mistaken. They 
already trade those products throughout Europe today. I said 
this before and I will say it again. If we become an importer 
of those types of goods and services in this country it will be 
a shame, because what will happen when you become an importer 
of those products, you become an importer of that price and you 
will be determining what they do.
    Mr. Sprecher gave a great example about World Sugar. It 
trades here in the United States. We set it, we don't even use 
it. That is a huge advantage that we have and we should never 
want to give that up, sir. I think that our financial markets, 
as long as they have the proper oversight, should be free to 
operate in the global capacity that we do, and that is 
critically important for you as a farmer, or a banker, or any 
other--mortgage or reinsurer.
    Mr. Fincher. We are so fortunate. I mean, money loves a 
safe place and capital, it loves a safe place. And thinking 
about MF Global, Mr. Corzine, and the things that happened 
there and farmers and ranchers losing money all across the 
country, I have a news flash for everybody. I don't care how 
many laws you pass in Congress, bad actors are still going to 
go bad things, and you are going to tighten down the market to 
the point that no one can do business and we have no room for 
opportunity, and we are going to lose the market share. I feel 
that is what is going to happen from my small perspective.
    One last question. I have a minute left. Explain why moving 
to a 1 day margin is so unreasonable for many customers, Mr. 
Duffy.
    Mr. Duffy. Moving to a 1 day margin? You know, again, 
margin at the CME Group is based on the evaluation of the risk 
of the portfolio, so we really don't measure it. Our risk 
department is taught not to measure it in days, it is taught to 
measure in risk. What is the cost of the position, and that is 
the way we do things to protect the system. Fortunately, the 
government has come up with a system that either 1 day, 2 days, 
5 days or 10 days on how they decide the collection for the 
regulatory floor. I think that is important, because whether 
you are a farmer, rancher, or a reinsurer, capital is tight but 
yet you still need to risk your portfolio. I don't care that 
insurance rates are next to zero. What happens if they go to 
five percent overnight and you don't have your portfolio risk 
and you are stuck with a bunch of mortgages at zero? You are 
going to have a real big problem. So people have to make sure 
they have the ability to do risk management, and at the same 
time, they can't tie all their capital up in margin, which is 
completely unnecessary to the system.
    Mr. Fincher. Absolutely. Well my time is almost up. I 
appreciate the comments. Thank you. I yield back.
    Mr. Conaway. The gentleman yields back.
    Mr. Davis for 5 minutes.
    Mr. Davis. First of all, thank you, Mr. Chairman, and thank 
you to each and every one of you. I apologize, I had to leave 
and I am coming back, so if there is anything redundant, please 
forgive us.
    I would like to ask you kind of an open-ended question, 
starting with Mr. Duffy. Is there anything that--any questions 
that you haven't had asked yet that you think are very 
imperative that this Committee needs to understand so that we 
can move forward in ensuring that this regulatory environment 
does not stop what you guys are doing on a regular basis?
    Mr. Duffy. I don't know if there has been not a question 
asked, Mr. Davis, but what is important for this Committee that 
oversees the regulator is to make sure that they are enacting 
what was in the spirit of the Dodd-Frank law, and not to come 
up with some interpretations that had nothing to do with the 
law that puts us at what Mr. Fincher said is a complete 
competitive disadvantage, because that is exactly the path we 
are going to go down if we continue to have the law interpreted 
by the regulator that was not voted on by the Congress.
    Mr. Davis. Thank you, Mr. Duffy. I appreciate your comments 
and I could not agree more. Is there anybody else on the panel 
that would like to address this issue?
    Mr. Lukken. I would just mention--and we would like to 
leave this thought for the Committee is the amount of work that 
has gone on since MF Global and since Peregrine to try to 
restore customer confidence. Many of these panelists have 
talked about this today, all of the different changes that have 
gone on, whether it is the automatic verification system that 
Mr. Roth has talked about where we are getting daily 
confirmations directly with the bank to verify that the money 
is there that the FCMs are holding, that is huge. That is 
unprecedented, and these guys are way ahead of the curve with 
other industries in this area. Whether it is all the changes, 
the Corzine rule that the CME and the NFA have adopted where if 
a firm is going to move customer money, anything above 25 
percent, that they have to get the CFO or the CEO to sign off 
on that, I mean, that is accountability, the controls that have 
been put into place. So I just wanted to make sure this 
Committee understand the enormous amount of work that the self-
regulatory organizations and the industry and the CFTC and the 
rulemaking it is currently contemplating are doing to restore 
customer confidence, and we just want to make sure that the 
Committee understands that fully.
    Mr. Davis. Thank you, sir.
    Mr. Roth. Congressman, if I could--I am sorry. Just one 
comment I would make as far as an issue that we haven't talked 
about. Our goal is obviously to prevent FCM insolvencies. When 
they do happen, at some point we need to look at the experience 
with MF Global and with Peregrine and identify changes 
regarding the bankruptcy proceedings to make sure that 
customers receive the priority that Congress intended. I know 
that is a very complicated question. We have ongoing 
discussions with basically everybody here at the table, trying 
to make sure we come up with a solution to those issues. I 
think we have to look at the bankruptcy proceedings themselves. 
There may be a way to do this without--by just amending the 
Commodity Exchange Act. We need to explore that. I think 
bankruptcy issues, at some point we have to get our arms around 
that a little bit better.
    Mr. Davis. Thank you, Mr. Roth.
    Mr. O'Connor?
    Mr. O'Connor. Thank you. I wanted to sort of drill into a 
little bit on the international aspect here. I think that is 
one thing that has been consistent in all of the testimonies, 
and the point I would like to make is while the CFTC has a tool 
through the no action letter to make changes and--relief, and 
ISDA knows this, because we submitted 17 no action letters 
which were almost entirely granted, and by the way, we 
appreciate the work of the CFTC staff in granting that, but it 
does tax resources both at the regulator and the industry to 
have to go through that motion. The point, though, is that the 
Europeans don't have such a mechanism and they have a very, 
very rigid process for--to get to regulation that to change is 
like turning around an oil tanker. So, people shouldn't 
underestimate the seriousness of potential conflict that might 
be out there.
    Mr. Davis. Thank you, Mr. O'Connor. Anybody else? Mr. 
Dunaway?
    Mr. Dunaway. Sure, I will just add one thing real quick. 
One thing I want to make sure the Committee understands is just 
the sheer burden that is being placed on smaller OTC 
participants, the smaller farmers, small commercial entities 
that are really being pushed out of the OTC markets. You know, 
we are fully supportive of clearing of swaps on the very 
clearinghouses, but the sheer burden of the paperwork and the 
disclosures and the hoops that we are making the smaller 
participant jump through really ends up pushing them to 
products that don't fully hedge their risks. They are going to 
exchange rate of product which we are fully happy to offer 
them, but it won't particularly hedge their individual 
commodities. There is an extreme burden that is pushing a lot 
of the smaller farmers, a lot of the smaller commercial 
companies to really hedge themselves ineffectively or not at 
all.
    Mr. Davis. Thank you, Mr. Dunaway, and thank you all very 
much for your time today, and your insight. I yield back.
    Mr. Conaway. The gentleman yields back.
    Mr. LaMalfa for 5 minutes.
    Mr. LaMalfa. Thank you, Mr. Chairman. I apologize. I had to 
step out of the room for a few minutes here. Some of our 
western folks are with us today. Did we get a chance to talk a 
little bit about the no action letters in any of our questions 
from the Committee here? I had one directed for Mr. Duffy here, 
if we--if that hasn't been covered. I don't want to be 
redundant here.
    The point about numerous no action letters being issued at 
last moments for market participants in having to comply with 
the new regulation, many of them having been done just since 
last summer on the ones that we know about that are public. 
Would you be able to elaborate a little bit on how these last 
minute no action letters are being a barrier or very harmful to 
what you are trying to do as you make business decisions as 
well as in the marketplace?
    Mr. Duffy. The best thing I could say to that, Congressman, 
is being around the markets for 33 years like I have, the worst 
thing you could ever have--there is enough uncertainty that you 
have in your everyday business, but when you have uncertainty 
in the way the rules are, how you are supposed to comply, you 
absolutely have no chance to do your risk management business. 
And when we are going to the final hour of the deadline without 
the rules being understood or disseminated properly and then a 
no action letter comes out at the 11th hour, these are harmful 
for risk management, for farmers, for bankers, for reinsurers 
as I have said earlier, across the board no matter what it 
applies to. So these no action letters, which have been 
numerous, are actually coming out at the 11th hour, as I said, 
and it is the worst thing that could happen is uncertainty, 
because uncertainty will chase people away from the marketplace 
and it will do what your colleague said. They will go to other 
markets in different jurisdictions that don't present this type 
of uncertainty. This is critically important. So whatever the 
rules are, I am a big believer--when I saw Sarbanes-Oxley and a 
lot of people said they couldn't comply with 404, well now they 
are complying with 404, but you have to give people time to 
understand the rules and to comply with them. You cannot issue 
a no action letter at the 11th hour.
    Mr. LaMalfa. How do you think that this is a justified way 
of doing business, and why do you think this is this way and it 
continues to be that pattern?
    Mr. Duffy. If I ran the CME Group like that, we wouldn't be 
in business.
    Mr. LaMalfa. Thank you very much. Yes, that is the thing. 
Anybody in business has to make a commitment one way or the 
other with their time, their resources, making long-term 
commitments. You have to have predictability. You have to know 
ahead of time what the ground rules are going to be on 
taxation, anything else, otherwise you are on an incomplete 
playing field that there is no way to know if the bottom line 
is going to be met with the rules that are coming at you at the 
last minute.
    So I thank the entire panel for your testimony here today, 
and hopefully we can make better policy out of this through 
this Committee. So thank you so much.
    I yield back, Mr. Chairman.
    Mr. Conaway. The gentleman yields back.
    Mr. Gibbs for 5 minutes.
    Mr. Gibbs. Thank you, Mr. Chairman. I just wanted to 
mention on the no action letters it is kind of what the EPA 
does with guidance letters.
    First of all, I want to thank you all for being here. I am 
going to kind of pick off Mr. Fincher a little bit, because I 
am a farmer/producer too, and I am really concerned. Sitting 
here listening to your testimony, there is kind of a common 
theme with all these new regulations and more regulatory 
enhancement, concern about liquidity in the market, confidence 
in the market for price discovery, and if people don't have 
confidence, we lose liquidity and we lose price discovery and 
we lose a risk management tool for our farmers out there, and 
that is my top concern.
    So going on that a little bit, it seems to me that we look 
to MF Global and some other things that--moving forward on 
segregation of funds, keeping that separate in your daily 
reporting, that is an area that I believe it looks like to me 
that CFTC should really be focused on to make sure that there 
is a firewall there and there is accountability. Some of these 
other things, the transaction tax and increased margin that 
would put a lot of producers out of the market, am I correct in 
my hypothesis, I guess, on this? You are all shaking your 
heads, so I guess I am.
    Mr. Duffy. Good comment, sir. I think you are absolutely 
spot on. You have basically touched on everything that you are 
talking about. Confidence is of extreme importance, whether you 
are referring to MF Global or anything else. If the 
participants don't have confidence in the system or the 
marketplace, they won't participate, so at the CME Group, we 
spend over $40 million a year--and I don't think there is 
anybody else in our industry that can even match that number--
on just regulatory issues to show that we have compliance. I 
just spent the last 14 to 16 months on the road in the middle 
of the country talking to farmers and ranchers and others about 
the confidence in the marketplace, the tools that we put into 
place. I think that is one of the things that they want to see. 
So we are actually showing them what we are doing.
    Mr. Gibbs. Just, Mr. Duffy, to go on with that, since we 
have had the crisis of MF Global and others, what are you 
seeing with customer funds coming back, participation in the 
market----
    Mr. Duffy. Yes, we are up a couple percent year over year, 
and our overall volume, our agricultural products are actually 
doing quite well, so I am seeing the farmer come back and 
hedging in their products again. And again, as I said earlier, 
I don't believe it was a crisis in the CME Group or anything 
else. I think it was a crisis in the system how it failed them 
and allowed somebody to touch their customer segregated 
property, which they did not believe could ever possibly 
happen. So, now that we have hopefully shored that up a little 
bit, the participants are back in the marketplace, sir.
    Mr. Gibbs. That is good. Do you want to add Mr. Roth?
    Mr. Roth. Congressman, I just wanted to add that since we 
have implemented this system for the daily confirmation of seg 
balances, it officially became active February 15. I should 
also mention that all of the data that we receive is always 
available to the CFTC as well, so that we can have a third set 
of eyes looking at that. We always make all of our data, 
regulatory data immediately available to the CFTC, and so they 
can see the same stuff that we see and I think it is a huge 
improvement from where we were just a year ago.
    Mr. Gibbs. Just to follow up, another question about the 
Bankruptcy Code. You know, the first in line if there is a 
bankruptcy, we see funds that people from the segregated firms 
fail, segregated accounts. Specifically can you provide any 
insight how that Code should be amended to make sure that our 
producers are protected?
    Mr. Roth. Yes, I can just mention an issue that the CFTC 
has always defined customer property under the bankruptcy 
rules--under its bankruptcy rules, it has defined customer 
property and in the event of a shortfall in seg funds, customer 
property has always been defined to include all of the assets 
of the FCM until the customers have been made whole. That is a 
great definition. That is exactly the way it should be. It is 
the way it has been for a long time. There was in a proceeding 
maybe 10 years ago a district court opinion which was 
ultimately rendered moot because the matter was settled, but 
that court decision rendered--created some doubt as to the 
validity of the CFTC's definition, and that is a doubt I don't 
think we should have to live with. I think that cloud should be 
removed and we should figure out a way to make very clear----
    Mr. Gibbs. I am just about out of time. Just a quick 
question. MF Global, our producers out there and getting 
reimbursed, what is the status, Mr. Duffy?
    Mr. Duffy. I will be happy to take shot. Right now, the 
best estimates are that 4D, which are U.S. clients trading on 
U.S. markets, have roughly 99 on the dollar back, and then 
there is another, what are called 30.7, which are U.S. clients 
trading on foreign markets, which have around 97 on the dollar 
back, so we are seeing most of the property returned to the 
participants that it was taken from. Now obviously there are 
shortfalls on the broker/dealer side, but again, in our world, 
because of some of the steps that we were able to take, along 
with our colleagues down the line here, we were able to get the 
money back.
    Mr. Gibbs. Thank you very much. Thank you, Mr. Chairman.
    Mr. Conaway. The gentleman's time has expired.
    Gentlemen, I appreciate each of you coming today and 
helping us with your perspectives on how well the CFTC is doing 
and not doing, both the good and the bad. We have several 
hearings yet to be held with the Subcommittee, and we will look 
forward to additional comments.
    I ask unanimous consent to enter into the record letters 
from the Institute of International Bankers, from SIFMA, and 
the American Bankers Association on this issue.
    [The information referred to is located on p. 59.]
    Mr. Conaway. Again, thank you, gentlemen, for your time 
this morning, and we are adjourned.
    [Whereupon, at 11:49 a.m., the Committee was adjourned.]
    [Material submitted for inclusion in the record follows:]
   Submitted Letters by Hon. K. Michael Conaway, a Representative in 
                          Congress from Texas
May 21, 2013

Hon. Frank D. Lucas,
Chairman,
House Committee on Agriculture,
Washington, D.C.;

Hon. Collin C. Peterson,
Ranking Minority Member,
House Committee on Agriculture,
Washington, D.C.

    Dear Chairman Lucas and Ranking Member Peterson:

    In connection with the Agriculture Committee's hearing on ``The 
Future of the CFTC: Market Perspectives'' and given the role of the 
CFTC with respect to swaps regulation under Title VII of the Dodd-Frank 
Wall Street Reform and Consumer Protection Act (DFA), the Institute of 
International Bankers (IIB) would like restate our support for a number 
of important issues. We recognize and applaud the Committee's efforts 
to address these issues in legislation approved by the Committee 
earlier in the year, and in the previous Congress.
    The IIB represents internationally headquartered financial 
institutions from over 35 countries around the world, and its members 
are extensively involved in activities regulated by the CFTC, including 
in particular swaps activities that are subject to the requirements of 
Title VII. Indeed, IIB members constitute approximately \1/2\ of the 
firms that are currently registered as swap dealers under Title VII.
    As the Committee initiates its CFTC reauthorization process, we 
believe whether through standalone legislation or as part of 
reauthorization, that it is important that the Committee provide: (i) 
certainty with respect to the application of the requirements of Title 
VII to cross-border swaps activities, including the effective and 
efficient coordination and harmonization of U.S. rules with those of 
other countries; and (ii) national treatment for the U.S. operations of 
foreign banks vis-a-vis U.S.-headquartered banks in connection with 
their swaps activities in the United States.
Cross-Border Swaps Activities--Certainty in the Coordination of U.S. 
        and International Rules
    (1) A substantial majority of swaps transactions are effected 
        between counterparties in different countries. Ensuring proper 
        alignment of U.S. rules with those of other countries therefore 
        is crucial to maintaining the vitality of the U.S. swaps 
        market.

      Substituted compliance is an important component of harmonizing 
        U.S. swaps rules with the rules of other jurisdictions. 
        Reflecting the strong U.S. commitment to the principles agreed 
        to by the G20 leaders in 2009, DFA Sec. 752 directs the CFTC to 
        consult and coordinate with its regulatory counterparts outside 
        the United States in order to promote effective and consistent 
        global regulation of swaps. The cross-border dimensions of 
        swaps regulation are also addressed in DFA Sec. 722(d), which 
        establishes a general prohibition against the application of 
        Title VII's requirements to swaps activities outside the United 
        States, except with respect to activities that have a ``direct 
        and significant connection with activities in, or effect on, 
        commerce of the United States'' or as may be necessary to avoid 
        evasion of Title VII.
      Unfortunately, efforts to this point to achieve an appropriate 
        cross-border harmonization of Title VII's requirements with 
        those of other countries have born little fruit. As a result, 
        there remains considerable uncertainty regarding the cross-
        border application of Title VII's requirements, which in turn 
        has given rise to significant concerns regarding the prospect 
        of fragmenting and disrupting the international swaps market.
      Mutual recognition of each other's rules through substituted 
        compliance is an important means to accommodate the rules of 
        different countries in a manner that fosters coordination and 
        avoids unnecessary duplication or conflict. Consistent with 
        international comity principles, permitting a financial 
        institution to comply with equivalent rules of another 
        jurisdiction in connection with its cross-border swaps 
        activities best achieves the purposes underlying DFA Sections 
        752 and 722(d).
      At this stage of Title VII's implementation, there exists a very 
        real potential for conflict between U.S. rules and those of 
        other countries. Absent a satisfactory resolution of these 
        conflicts, many global swap dealers will face the untenable 
        position of violating one country's rules or laws in order to 
        comply with another's. We appreciate the Committee's efforts on 
        this issue in approving H.R. 1256, the Swap Jurisdiction 
        Certainty Act. We believe it is essential to make it explicitly 
        clear that reliance on broadly equivalent rules of other 
        countries is an integral part of the cross-border swaps 
        regulatory regime intended under Title VII.
Ensuring National Treatment
    (2) DFA Sec. 716, also known as the ``swap push-out rule'', 
        contains an acknowledged oversight that results in unequal 
        treatment for uninsured U.S. branches and agencies of foreign 
        banks compared to that of U.S. banks. Sec. 716 sets forth a 
        general prohibition against ``Federal assistance'' (including 
        access to the discount window) for swap entities, but includes 
        certain grandfather and transitional provisions that permit the 
        phased-in implementation of the prohibition with respect to 
        insured depository institutions as well as safe harbor 
        provisions that allow insured depository institutions to 
        continue to engage in swap activities related to their bona 
        fide hedging and traditional bank activities. The uninsured 
        branches and agencies of foreign banks are not afforded the 
        benefit of these provisions. Senators Dodd and Lincoln 
        recognized that this exclusion was unintentional and 
        acknowledged that there was a need ``to ensure that uninsured 
        U.S. branches and agencies of foreign banks are treated the 
        same as insured depository institution.'' \1\
---------------------------------------------------------------------------
    \1\ 156 Cong. Rec. S5903-S5904 (daily ed. July 15, 2010) (colloquy 
between Senator Dodd, Chairman of the Senate Banking Committee, and 
Senator Lincoln, Chairman of the Senate Agriculture Committee and 
sponsor of Sec. 716).

      Uninsured U.S. branches and agencies are licensed by a Federal or 
        state banking authority and subject to the same type of safety 
        and soundness examination and oversight as U.S. banks. Based on 
        the policy of national treatment, uninsured branches and 
        agencies are afforded equivalent treatment to U.S. banks, 
        including access to the Federal Reserve's discount window. 
        Access to the discount window is an important tool for 
        maintaining a sound and orderly financial system, and the 
        branches and agencies of U.S. banks are provided access to 
        similar facilities in other countries.
      Based on the disparate treatment to which they are subject under 
        Sec. 716, the uninsured U.S. branches and agencies of foreign 
        banks are facing the prospect of having to ``push-out'' all 
        their existing swap positions and ongoing swap activities to a 
        registered swap affiliate by the July 16, 2013 effective date--
        an impossible compliance task and one that places these 
        uninsured branches and agencies at a substantial competitive 
        disadvantage vis-a-vis insured depository institutions that 
        benefit from the grandfather, transitional and safe harbor 
        provisions. The resulting disparity is wholly at odds with the 
        longstanding U.S. policy of national treatment; the legislation 
        approved by the Committee H.R. 992 would address this 
        unintended oversight.

    (3) The definition of a ``Swap Dealer'' under Sec. 1(a)(49) of the 
        CEA (as modified by the DFA) provides an exclusion for insured 
        depository institutions, specifying that in ``no event shall an 
        insured depository institution be considered to be a swap 
        dealer to the extent it offers to enter into a swap with a 
        customer in connection with originating a loan with that 
        customer.'' Similar to the unintended omission of uninsured 
        U.S. branches and agencies of foreign banks in DFA Sec. 716, 
        this exclusion is provided only for insured depository 
        institutions and results in unequal treatment for those 
        uninsured branches and agencies that generally enter into swaps 
        transactions only in connection with their lending 
        activities.\2\
---------------------------------------------------------------------------
    \2\ For those insured depository institutions that generally enter 
into swaps transactions with customers only in connection with their 
lending activities, the exclusion ensures that such ordinary course 
banking activities will not result in their having to register as a 
swap dealer. At the same time, swap transactions conducted by an 
insured depository institution outside the context of its ordinary 
banking activities may result in it having to register as a swap 
dealer.

      This exclusion permits small U.S. banks the ability to enter into 
        interest rate swaps in connection with their lending activities 
        without having to register as swap dealers, thereby providing 
        them a competitive advantage over the similarly-situated 
        uninsured U.S. branches and agencies of foreign banks, which 
        are denied this parity of treatment. In the last Congress, the 
        Committee approved legislation that addressed this issue. We 
        would urge the Committee to address this important national 
---------------------------------------------------------------------------
        treatment issue as part of the CFTC reauthorization process.

    We thank you for your attention to and efforts on these important 
issues, and are happy to provide additional information at your 
request.
            Sincerely,


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


            
Sarah A. Miller,
Chief Executive Officer,
Institute of International Bankers.
                                 ______
                                 
May 14, 2013

Ananda Radhakrishnan,
Director of Division of Clearing and Risk,
Commodity Futures Trading Commission,
Washington, D.C.

Re: Request for Relief with respect to Rule 39.13(g)(2)(ii)

    Dear Mr. Radhakrishnan:

    The Asset Management Group (the ``AMG'') \1\ of the Securities 
Industry and Financial Markets Association (``SIFMA'') is writing to 
request that the Commodities Futures Trading Commission (the 
``Commission'') take prompt action to provide relief from the terms of 
Rule 39.13(g)(2)(ii). In particular, we are writing to support the 
requests made on behalf of Bloomberg L.P. (``Bloomberg'') in a letter 
dated March 11, 2013, and a Motion for Stay dated April 24, 2013, for 
relief from the 5 day minimum liquidation time required for the 
calculation of initial margin requirements for swaps (other than swaps 
on agricultural commodities, energy commodities and metals) cleared on 
derivatives clearing organizations (``DCOs''). We understand that, 
notwithstanding the related legal actions recently filed on behalf of 
Bloomberg in District Court for the District of Columbia, such requests 
remain pending with the Commission.
---------------------------------------------------------------------------
    \1\ The AMG's members represent U.S. asset management firms whose 
combined assets under management exceed $20 trillion. The clients of 
AMG member firms include, among others, registered investment 
companies, endowments, state and local government pension funds, 
private sector Employee Retirement Income Security Act of 1974 pension 
funds and private funds such as hedge funds and private equity funds. 
In their role as asset managers, AMG member firms, on behalf of their 
clients, engage in transactions that will be classified as ``security-
based swaps'' and ``swaps'' under Title VII of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act (the ``Dodd-Frank Act'').
---------------------------------------------------------------------------
    We are aware of the extensive attention given to this issue by the 
Commission and its staff, including the Commission's consideration of 
comments received on the rule as initially proposed and your 
solicitation of public input through the Public Roundtable on 
Futurization of Swaps (the ``Roundtable'') held on January 31, 2013. We 
take this opportunity to offer the perspective of our buy-side member 
firms and to highlight several important market developments.
Background
    Rule 39.13(g) provides that DCOs shall employ models that will 
generate margin requirements adequate to cover the DCOs' potential 
future exposure to a clearing customer's position based on price 
movements between the last collection of variation margin and the time 
within which the DCO estimates that it would be able to liquidate a 
defaulting clearing member's positions. Under the final rule the models 
must assume, unless an exception is granted, that it will take at least 
1 day to liquidate futures and options (``Futures'') and agricultural 
commodity, energy commodity and metal swaps (``Commodity Swaps'') and 
that it will take at least 5 days to liquidate all other cleared swaps 
(``Non-commodity Swaps''). In the preamble to the final rule, the 
Commission explained that these ``bright-line'' minimum liquidation 
times would provide certainty to the market, ensure that margin 
requirements would be established for the ``thousands of swaps that are 
going to be cleared'' and prevent a potential ``race to the bottom'' by 
competing DCOs.
    AMG believes that the minimum liquidation time of 5 days for Non-
commodity Swaps (a) is arbitrary and overly conservative, (b) is based 
on a fundamentally flawed assumption as to a difference in liquidity 
between futures and swaps, (c) creates an artificial economic incentive 
for market participants to use futures rather than swaps and (d) is 
contrary to Congress's goal of promoting trading of swaps on swap 
execution facilities (``SEFs''). We strongly believe that the minimum 
liquidation time for Noncommodity Swaps should be the same as for 
Futures and Commodity Swaps--i.e., 1 day--with DCOs using their 
reasonable and prudent judgment to set higher liquidation times for 
particular types or classes of transactions where warranted by their 
specific liquidity characteristics as evidenced by quantitative 
analyses derived from sources such as swap data repository data.
The 5 Day Minimum Liquidation Time for Non-Commodity Swaps Is Arbitrary 
        and Overly Conservative
    Nowhere in the adopting release for the final or proposed rules 
does the Commission explain why the minimum liquidation time for Non-
commodity Swaps should be five times that for Commodity Swaps and 
Futures. Initial margin set by a DCO for a particular transaction is 
intended to cover the potential future exposure of the DCO during the 
maximum period between the last collection of variation margin and the 
time within which the DCO estimates that it would be able to liquidate 
a defaulting clearing member's position(s) in such transaction. Thus, 
the appropriate liquidation time for a particular transaction will be 
affected by a number of factors, including: the trading volume, open 
interest, and predictable relationships with highly liquid products of 
such transaction. In adopting a one-size-fits-all 5 day liquidation 
time for Non-commodity Swaps, the Commission relied on a flawed 
assumption, which we discuss below, that Non-commodity Swaps 
categorically take five times longer than Futures and Commodity Swaps 
to liquidate. This belief is not supported and fails to adequately take 
into account the wider range of options available for closing out swap 
transactions as compared to Futures.
    Moreover, a 5 day liquidation time for Non-commodity Swaps is 
overly conservative. The Commission does not provide any data or 
analysis of the liquidity in the interest rate, credit default, foreign 
exchange or equity index swap markets to support the 5 day liquidation 
time for Non-commodity Swaps.
The Commission's Assumption About the Difference in Liquidity Between 
        Futures and Commodity Swaps, on the One Hand, and Non-Commodity 
        Swaps, on the Other Hand, Is Fundamentally Flawed
    The Commission's assumption that Non-commodity Swaps are 
categorically five times less liquid than Futures and Commodity Swaps 
is fundamentally flawed. Many swap contracts have become highly 
standardized and fungible; conversely, new swap futures offerings have 
customized terms. This convergence makes prior distinctions between 
futures and swaps no longer relevant.\2\
---------------------------------------------------------------------------
    \2\ In its Final Rule defining ``swap'' and ``security-based 
swap,'' the Commission described a comment received from the CME that 
the CFTC should ``clarify that nothing in the release was intended to 
limit a DCM's ability to list for trading a futures contract regardless 
of whether it could be viewed as a swap if traded over-the-counter or 
on a SEF, since futures and swaps are indistinguishable in material 
economic effects.'' The Commission declined to provide the requested 
clarification noting that prior distinctions between swaps and futures 
(such as the presence or absence of clearing) may no longer be 
relevant, and as result it is difficult to distinguish between the two 
instruments on a blanket basis. Further Definition of ``Swap,'' 
``Security-Based Swap,'' and ``Security-based Swap Agreement''; Mixed 
Swaps; Security-Based Swap Agreement record-keeping, 77 Fed. Reg. 
48208, 48303 (Aug. 13, 2012).
---------------------------------------------------------------------------
    Standardization of over-the-counter swap terms has been underway 
for some time and is currently accelerating in response to the new 
regulatory developments under the Dodd-Frank Act such as the 
implementation of mandated central clearing and exchange trading. For 
example, the standardization of auction settlement and contract terms 
of credit default swaps began in 2009 under ISDA's ``big bang'' 
protocol. More recently, interest rate swaps (``IRS'') are becoming 
standardized as well. AMG, working in collaboration with ISDA, has 
introduced Market Agreed Coupon Contracts (``MAC Contracts'') which are 
IRS contracts with pre-defined, market-agreed terms, including start 
and end dates and fixed coupon rates.\3\ Similarly, trueEX LLC 
(``trueEX''), a Designated Contract Market (``DCM'') launched in 2012, 
plans to list for trading on its electronic trading platform U.S. 
dollar denominated Standard Coupon & Standard Maturity Interest Rate 
Swap contracts (``SCSM Contracts'') with standardized coupons, 
maturities, roll dates and other terms. In both cases, these 
standardized specifications are intended to create fungible, liquid 
contracts regardless of the date acquired and are highly similar to 
swap futures contracts offered on futures exchanges.
---------------------------------------------------------------------------
    \3\ See SIFMA website: http://www.sifma.org/services/standard-
forms-and-documentation/swaps/.
---------------------------------------------------------------------------
    Despite having highly similar, or in some case indistinguishable, 
trading and liquidity characteristics, the arbitrarily longer 
liquidation time mandated for Non-commodity Swaps by Rule 
39.13(g)(2)(ii) puts them at a significant competitive disadvantage and 
creates an artificial economic incentive for market participants to use 
futures rather than swaps, which could result in unintended and 
unjustifiable regulatory arbitrage. For example, in December 2012, Eris 
Exchange launched ``Eris Standards,'' swap futures contracts with 
quarterly effective dates, pre-determined fixed rates, and cash 
settlement upon maturity, but as described in a press release, these 
swap futures contracts ``are expected to offer margin savings of 40-80% 
compared to cleared OTC interest rate swaps.'' \4\ In contrast, without 
relief from the Commission, the MAC Contracts--which also have 
quarterly effective dates, predetermined fixed rates and more flexible 
means of settlement, including cash unwind--would be required to use a 
5 day liquidation time under Rule 39.13(g)(2)(ii).
---------------------------------------------------------------------------
    \4\ Eris Exchange to Launch New, Margin-Efficient Interest Rate 
Swap Futures (Press Release, Dec. 5, 2012) avail at http://
www.prnewswire.com/news-releases/eris-exchange-to-launch-new-margin-
efficientinterest-rate-swap-futures-182180261.html.
---------------------------------------------------------------------------
    AMG believes that these deliverable swap futures contracts and MAC 
swap contracts are similar instruments and would require substantially 
similar time periods to liquidate in the case of a customer default. 
Accordingly, we strongly believe that the minimum margin requirements 
for these instruments should be the same. Also, we do not believe there 
is any basis whatsoever to increase the margin requirements or minimum 
liquidation times for Futures. As expressed in our prior comment 
letters, we also continue to believe that the Commission should not 
require minimum liquidation times that exceed 1 day for cleared swaps, 
whether Commodity Swaps or Non-commodity Swaps.\5\
---------------------------------------------------------------------------
    \5\ See SIFMA AMG Letter to the Commission on Risk Management 
Requirements for Derivatives Clearing Organizations (Jun. 3, 2011), 
available at http://sifma.org/workarea/downloadasset.aspx?id=25861 
(``In the context of cleared transactions, we believe that a 1 day 
liquidation period for swaps executed on either a DCM or SEF and a 2 
day liquidation period for all other swaps is sufficient for this 
purpose . . .'').
---------------------------------------------------------------------------
Rule 39.13(g)(2)(ii) Is Contrary to Congress's Goal of Promoting 
        Trading of Swaps on SEFs
    By creating incentives favoring futures trading over swap trading, 
Regulation 39.13(g)(2)(ii) runs counter to Congress's explicit goals 
``to promote the trading of swaps on swap execution facilities and to 
promote pre-trade price transparency in the swaps market.'' \6\ A 
nearly identical concern led the Commission to abandon its originally 
proposed bright-line distinction between 1 day and 5 day minimum 
liquidation times for swaps executed on DCMs and SEFs, respectively. In 
the preamble to the final rule, the Commission noted that ``requiring 
different minimum liquidation times for cleared swaps that are executed 
on a DCM and similar cleared swaps that are executed on a SEF could 
have negative consequences.'' \7\ The Commission acknowledged the 
comments of multiple parties that this distinction, among other things, 
would put SEFs at a competitive disadvantage to DCMs, potentially 
create detrimental arbitrage between standardized swaps traded on a SEF 
and contracts with the same terms and conditions traded on a DCM and 
undermine the goal of the Dodd-Frank Act to promote trading of swaps on 
SEFs.\8\ In response to such comments, the Commission determined not to 
mandate different minimum liquidation times for cleared swaps based on 
whether they are executed on a DCM or a SEF.\9\ We believe that the 
same logic should be applied such that minimum liquidation times for 
cleared swaps executed on a DCM or a SEF should be no higher than that 
for exchange-traded futures.
---------------------------------------------------------------------------
    \6\ Commodity Exchange Act  5h(a)(1)(e).
    \7\ Derivatives Clearing Organization General Provisions and Core 
Principles, 76 Fed. Reg. 69334, 69367 (Nov. 8, 2011).
    \8\ Id. at 69366.
    \9\ Id. (``The Commission is persuaded by the views expressed by 
numerous commenters that requiring different minimum liquidation times 
for cleared swaps that are executed on a DCM and equivalent cleared 
swaps that are executed on a SEF could have negative consequences.'')
---------------------------------------------------------------------------
    By arbitrarily setting the liquidation time for Non-commodity Swaps 
at 5 days, as compared to 1 day for Futures, Rule 39.13(g)(2)(ii) 
increases the margin required for Noncommodity Swaps relative to 
Futures and creates an artificial economic incentive for market 
participants to favor Futures, even though the trading and liquidity 
characteristics of the two instruments may be the same. Surely, it 
could not have been Congress' intent in adopting Title VII of the Dodd-
Frank Act for the Commission to create a market structure that would 
move liquidity away from swaps and into Futures.\10\ However, Rule 
39.13(g)(2)(ii) puts SEFs at a competitive disadvantage to DCMs, and 
creates a detrimental arbitrage between Non-commodity Swaps and futures 
contracts with the same terms and conditions. It is critical to our 
members' interests as swap market participants that SEFs be robust and 
vibrant trading platforms and not disadvantaged by external costs that 
arise solely due to regulatory status. However, if the minimum 
liquidation times established by the Commission under Rule 
39.13(g)(2)(ii) remain unchanged, the Congressional goal of promoting 
trading of swaps on SEFS will be undermined.
---------------------------------------------------------------------------
    \10\ Indeed, post-implementation of rules adopted by the Commission 
under the Dodd-Frank Act, the cleared swaps markets may provide more 
protections to participants than the Futures market, For example, the 
Commission's collateral segregation model for cleared swaps (complete 
legal segregation), once implemented, will be more protective than the 
model for Futures, as the MF Global and Peregrine collapses have shown.
---------------------------------------------------------------------------
Relief Requested
    Accordingly, we encourage the Commission to provide relief in the 
form of a stay of Rule 39.13(g)(2)(ii) that would immediately adjust 
the minimum liquidation time for all cleared Non-commodity Swaps, 
whether executed on a SEF or DCM, to a 1 day liquidation time, 
conditioned on the obligation of the relevant DCO to use its reasonable 
and prudent judgment to set higher liquidation times for particular 
types or classes of transactions where warranted by their specific 
liquidity characteristics, as evidenced by quantitative analysis 
derived from sources such as swap data repository data. We respectfully 
request that the Commission act expeditiously to do so, in view of the 
importance of relief before the June 10, 2013 mandatory clearing date 
for category 2 participants, as Bloomberg has explained in its Motion 
for Stay. Relief before June 10 is necessary to give market 
participants more certainty and provide a greater incentive for 
participants to clear their Non-commodity Swap trades.
    Based on the foregoing, we respectfully request that the Commission 
grant the relief described in this letter. We appreciate the 
Commission's consideration of this request, and stand ready to provide 
any additional information or assistance that the Commission might find 
useful. Should you have any questions, please do not hesitate to call 
Tim Cameron at [Redacted] or Matt Nevins at [Redacted].
            Sincerely,


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


            
Timothy W. Cameron, Esq.,
Managing Director, Asset Management Group,
Securities Industry and Financial Markets Association;


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]






Matthew J. Nevins, Esq.,
Managing Director and Associate General Counsel, Asset Management 
    Group,
Securities Industry and Financial Markets Association.

CC:

Hon. Gary Gensler, Chairman, Commodity Futures Trading Commission;
Hon. Jill E. Sommers, Commissioner, Commodity Futures Trading 
    Commission;
Hon. Bart Chilton, Commissioner, Commodity Futures Trading Commission;
Hon. Scott O'Malia, Commissioner, Commodity Futures Trading Commission;
Hon. Mark Wetjen, Commissioner, Commodity Futures Trading Commission.
Certification Pursuant to CFTC Regulation 140.99(c)(3)
    As required by CFTC Regulation 140.99(c)(3), we hereby (i) certify 
that the material facts set forth in the attached letter dated May 14, 
2013 are true and complete to the best of our knowledge; and (ii) 
undertake to advise the CFTC, prior to the issuance of a response 
thereto, if any material representation contained therein ceases to be 
true and complete.
            Sincerely,


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


            
Timothy W. Cameron, Esq.,
Managing Director, Asset Management Group,
Securities Industry and Financial Markets Association;


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]



Matthew J. Nevins, Esq.,
Managing Director and Associate General Counsel, Asset Management 
    Group,
Securities Industry and Financial Markets Association.
                                 ______
                                 
May 21, 2013





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



    Dear Chairman Lucas and Ranking Member Peterson:

    The American Bankers Association (ABA) appreciates the opportunity 
to participate in the comprehensive review of the Commodity Exchange 
Act (CEA) and Commodity Futures Trading Commission (CFTC) regulatory 
oversight. As noted in your request, this reauthorization comes at a 
challenging time. Not only has the CFTC remained responsible for 
oversight of the futures markets, but also it has proposed and 
finalized dozens of rules to implement the new regulatory framework 
required by the Dodd-Frank Act.
    ABA encourages the Committee to address the following issues 
related to the new swaps regulations during the reauthorization: 
implementation transition, cross-border jurisdiction, eligible contract 
participant (ECP) definition, and risk-based measurement for the 
clearing exemption.
Implementation Transition
    New swaps regulations must be implemented carefully so that they do 
not unnecessarily interfere with bank or bank customer risk management. 
The vast majority of banks use swaps to hedge or mitigate risk from 
their ordinary business activities, including lending. Hedging and 
mitigating risk are not only good business practices generally, but are 
important tools that banks use to comply with regulatory requirements 
to prudently manage risks associated with their assets and liabilities.
    Some banks also give customers the option of using swaps to hedge 
and mitigate their loan risk from changes in interest rate or currency 
exchange rates. Farmers and energy companies may want to hedge against 
price changes in commodities. Swaps can be used for all of these 
purposes.
    If banks cannot afford to continue using swaps to hedge risk 
because the regulations are too burdensome or are not implemented in a 
way that ensures a smooth transition, it will affect their ability to 
provide long-term, fixed rate financing. Customers may find long-term 
business planning difficult and may hesitate to borrow if they are only 
able to get short-term loans or loans with variable interest rates. 
They may also defer other business plans if they do not have a cost-
effective way to hedge and mitigate their foreign currency, commodity 
price, or other risks.
    The new regulatory framework for the swaps markets is not yet 
complete. Banks, bank customers, and other market participants need 
clarity as the new regulations are implemented. ABA believes that clear 
rules and interpretive guidance as well as appropriate no-action relief 
will ensure a smooth transition for swaps markets.
Cross-Border Jurisdiction
    Banks operating globally also need clarity about the jurisdictional 
scope of the U.S. regulatory requirements. Although Title VII of the 
Dodd-Frank Act includes provisions that generally limit its 
extraterritorial reach, the language does not clearly delineate a 
standard for determining which cross-border activities should be 
subject to U.S. jurisdiction. Nor does it address the competitive 
imbalances that might arise if swaps regulations apply differently to 
banks depending on the country where they are headquartered.
    The CFTC has issued proposed guidance and an exemptive order to 
address the applicability of Title VII regulations to cross-border 
swaps transactions. The Securities and Exchange Commission (SEC) has 
indicated that it will issue a proposed rule addressing security-based 
swaps transactions. In the meantime, banks operating globally are 
uncertain about which U.S. regulatory requirements may or may not apply 
to some of their derivatives activities and whether the jurisdictional 
scope may differ depending on whether the bank is headquartered in the 
United States or in another country.
    ABA supports the goal of promoting consistency between the cross-
border application of all Title VII rules. Market participants that 
engage in swaps and security-based swaps need clarity and would benefit 
from consistency between CFTC and SEC rules.
Eligible Contract Participant Definition
    ABA has previously asked the CFTC for rulemaking, interpretive 
guidance, or exemptive relief on the eligible contract participant 
(ECP) definition. The ECP definition is a key component of the new 
regulatory framework for the swaps markets, since it will be illegal to 
enter over-the-counter (OTC) swaps with non-ECPs. Many swaps will still 
be OTC transactions because they are exempt from clearing or they are 
customized to meet individual customer needs, so banks and their 
customers need clarity about which individuals or entities will be 
ECPs.
    Following ABA's request, the CFTC staff subsequently issued helpful 
interpretations and no-action relief on some issues related to the ECP 
definition. However the no-action relief only addressed interest rate 
swaps. Furthermore, the Commission has not yet taken formal action and 
the no-action relief will expire no later than June 30, 2013.
    Absent formal Commission action, banks and their customers will be 
left wondering whether they will be able to engage in certain swaps 
transactions or, if they do, whether the swaps will be subject to 
rescission or possibly a private right of action once the no-action 
relief expires. The uncertainty is already having an impact on loan 
negotiations. Since it takes months to negotiate and close a loan, many 
of the loans currently being negotiated will not close until after the 
staff no-action relief expires. As a result, loan officers remain 
uncertain whether many of their customers will be able to use swaps to 
hedge commercial risk. This affects the customers' ability to repay the 
loan and the banks' ability to lend to those customers.
    ABA believes that it is important that the CFTC act expeditiously 
to provide clarity and legal certainty to ensure the transition to the 
new regulatory regime does not unduly disrupt the lending markets. 
Absent clarity, banks will be unnecessarily discouraged from offering 
swaps to customers if it is unclear whether those customers will 
qualify as ECPs. The result will be decreased lending--especially to 
individual entrepreneurs and small and mid-size businesses--at a time 
when our country needs access to credit to ensure sustained economic 
recovery.
Risk-Based Measurement for Clearing Exemption
    Many banks use swaps to hedge or mitigate risk the same way that 
other commercial end-users do, but they were not automatically exempted 
from the swaps clearing requirements even though other end-users were. 
This is incongruous considering that banks are already subject to 
comprehensive regulatory oversight.
    Banks are required to have internal risk management practices and 
are subject to regular supervision by bank regulators. They are also 
subject to legal lending limits that cap the exposure that a bank may 
have to any individual or entity. As a result of the Dodd-Frank Act, 
legal lending limits will now explicitly include swap transactions in 
the measurement of credit exposure to another person.
    The CFTC was required to consider an exemption from swaps clearing 
requirements for certain banks that use swaps to hedge or mitigate 
risk. Even though the CFTC's exemptive authority was not limited to 
institutions of a certain asset size, the Commission adopted a final 
rule exempting banks with total assets of $10 billion or less from the 
clearing requirements.
    ABA asserts that a risk-based measurement for the end-user clearing 
exemption for banks would be more appropriate. For example, even banks 
with $30 billion or less in assets account for only 0.09 percent of the 
notional value of the bank swaps market as of December 2012. Rather 
than a $10 billion asset threshold or any other arbitrary asset 
threshold, a more appropriate measurement for the exemption might be in 
proportion with size of swaps portfolio and risk to the market. Swaps 
activity of this magnitude simply does not pose any significant risk to 
the safety and soundness of swap entities or to U.S. financial 
stability.
Conclusion
    Thank you for your consideration of these issues that the ABA 
believes are essential to successfully functioning swaps markets. 
Please feel free to contact Edwin Elfmann at [Redacted] or Diana 
Preston at [Redacted] if you have any questions or need additional 
information.
            Sincerely,


[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]



James C. Ballentine,
Executive Vice President, Congressional Relations & Political Affairs,
American Bankers Association.

                                  
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