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



 
             THE FUTURE OF THE CFTC: END-USER PERSPECTIVES 

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

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                        GENERAL FARM COMMODITIES
                          AND RISK MANAGEMENT

                                 OF THE

                        COMMITTEE ON AGRICULTURE
                        HOUSE OF REPRESENTATIVES

                    ONE HUNDRED THIRTEENTH CONGRESS

                             FIRST SESSION

                               __________

                             JULY 24, 2013

                               __________

                            Serial No. 113-7


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

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

82-369 PDF                       WASHINGTON : 2013 
-----------------------------------------------------------------------
  For sale by the Superintendent of Documents, U.S. Government Printing 
   Office Internet: bookstore.gpo.gov Phone: toll free (800) 512-1800; 
          DC area (202) 512-1800 Fax: (202) 512-214 Mail: Stop IDCC, 
                      Washington, DC 20402-0001



                        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

                                 ______

      Subcommittee on General Farm Commodities and Risk Management

                  K. MICHAEL CONAWAY, Texas, Chairman

RANDY NEUGEBAUER, Texas              DAVID SCOTT, Georgia, Ranking 
MIKE ROGERS, Alabama                 Minority Member
BOB GIBBS, Ohio                      FILEMON VELA, Texas
AUSTIN SCOTT, Georgia                PETE P. GALLEGO, Texas
ERIC A. ``RICK'' CRAWFORD, Arkansas  WILLIAM L. ENYART, Illinois
MARTHA ROBY, Alabama                 JUAN VARGAS, California
CHRISTOPHER P. GIBSON, New York      CHERI BUSTOS, Illinois
VICKY HARTZLER, Missouri             SEAN PATRICK MALONEY, New York
KRISTI L. NOEM, South Dakota         TIMOTHY J. WALZ, Minnesota
DAN BENISHEK, Michigan               GLORIA NEGRETE McLEOD, California
DOUG LaMALFA, California             JIM COSTA, California
RICHARD HUDSON, North Carolina       JOHN GARAMENDI, California
RODNEY DAVIS, Illinois               ----
CHRIS COLLINS, New York

                                  (ii)



                             C O N T E N T S

                              ----------                              
                                                                   Page
Conaway, Hon. K. Michael, a Representative in Congress from 
  Texas, opening statement.......................................     1
    Submitted letters............................................    87
Scott, Hon. David, a Representative in Congress from Georgia, 
  opening statement..............................................     2

                               Witnesses

Cordes, Scott, President, CHS Hedging, Inc., St. Paul, MN; on 
  behalf of National Council of Farmer Cooperatives..............     3
    Prepared statement...........................................     5
    Submitted questions..........................................    94
Kotschwar, Lance, Senior Compliance Attorney, Gavilon Group, LLC, 
  Omaha, NE; on behalf of Commodity Markets Council..............     9
    Prepared statement...........................................    11
    Submitted questions..........................................    95
McMahon, Jr., Richard F., Vice President of Energy Supply and 
  Finance, Edison Electric Institute, Washington, D.C............    16
    Prepared statement...........................................    17
    Submitted questions..........................................    96
Monroe, Chris, Treasurer, Southwest Airlines Co., Dallas, TX.....    20
    Prepared statement...........................................    21
    Submitted questions..........................................    98
Soto, Andrew K., Senior Managing Counsel, Regulatory Affairs, 
  American Gas Association, Washington, D.C......................    23
    Prepared statement...........................................    25
    Submitted questions..........................................    98
Guilford, Gene A., National & Regional Policy Counsel, 
  Connecticut Energy Marketers Association, Cromwell, CT; on 
  behalf of Commodity Markets Oversight Coalition................    29
    Prepared statement...........................................    31
    Submitted question...........................................    96

                           Submitted Material

Auer, Kenneth E., President and CEO, Farm Credit Council, 
  submitted letter...............................................    92


             THE FUTURE OF THE CFTC: END-USER PERSPECTIVES

                              ----------                              


                        WEDNESDAY, JULY 24, 2013

                  House of Representatives,
         Subcommittee on General Farm Commodities and Risk 
                                                Management,
                                  Committee on Agriculture,
                                                   Washington, D.C.
    The Subcommittee met, pursuant to call, at 10:01 a.m., in 
Room 1300 of the Longworth House Office Building, Hon. K. 
Michael Conaway [Chairman of the Subcommittee] presiding.
    Members present: Representatives Conaway, Neugebauer, 
Austin Scott of Georgia, Crawford, Gibson, Hartzler, Noem, 
Benishek, LaMalfa, Hudson, Davis, Collins, David Scott of 
Georgia, Vela, Gallego, Enyart, Vargas, Maloney, Walz, Negrete 
McLeod, Costa, Garamendi, Peterson (ex officio), and McIntyre.
    Staff present: Caleb Crosswhite, Jason Goggins, Kevin 
Kramp, Pete Thomson, Suzanne Watson, Tamara Hinton, John Konya, 
C. Clark Ogilvie, Liz Friedlander, and Riley Pagett.

OPENING STATEMENT OF HON. K. MICHAEL CONAWAY, A REPRESENTATIVE 
                     IN CONGRESS FROM TEXAS

    The Chairman. This hearing of the Subcommittee on General 
Farm Commodities and Risk Management entitled, The Future of 
CFTC: End-User Perspectives, will come to order.
    This morning I would like to welcome everyone to the third 
in a series of hearings to examine the CFTC's reauthorization 
in advance of writing legislation. Yesterday the Committee 
heard from CFTC Commissioners Scott O'Malia and Mark Wetjen. It 
proved to be a productive and insightful conversation that I 
hope will continue today.
    Today we are joined by a diverse group of representatives 
from across the spectrum of end-users. Today's panelists will 
share the perspectives of the farmers, manufacturers, 
transportation firms, utility companies and others who produce 
the goods and services that every American consumes each day. 
Well-functioning markets are essential to help grow the economy 
and one needs to look no further than our witnesses here today 
to understand how important it is for the CFTC to get its 
regulations right.
    I thank each of our witnesses for appearing here today to 
share your thoughts about how to improve both the operations 
and the regulations of the Commodity Futures Trading 
Commission. It is important for the Committee to hear your 
views, because ultimately, derivatives markets exist to support 
end-users, not financial firms. Although derivatives markets 
have been broadly mischaracterized as opaque, risky and exotic, 
the reality for end-users is far more mundane. Derivatives 
contracts are a part of everyday life for thousands of 
businesses. They enable risks to be transferred from those who 
are willing to pay to avoid it so that manufacturing, energy 
production and operations costs can all be predicted to a 
reasonable degree of certainty.
    As a result, the price of buying a box of cereal, paying 
your power or gas bill, or buying an airline ticket home for 
Thanksgiving will hopefully remain relatively stable. This 
transfer of risk allows businesses to free up productive 
capital, to invest in new products, to build new facilities and 
to hire new employees. Unfortunately, despite Congress' clear 
intent to exempt end-users from the brunt of Dodd-Frank, the 
past few years have been a regulatory roller coaster for them.
    As I mentioned in yesterday's hearing, I am concerned about 
the impact that delays and last-minute no-action letters are 
having on how market participants manage their businesses. The 
lack of business certainty has no doubt cost many companies 
valuable capital and changed their strategic thinking. 
Regulations should be created and exist to protect markets, not 
to destroy them.
    I look forward to hearing the comments of our witnesses on 
the rule-making processes and how the CFTC will work to address 
the concerns they raise throughout. The perspective of today's 
witnesses are essential to crafting a forward-looking 
reauthorization bill, and I want to thank them again for taking 
the time to visit with us today.
    With that, I'd like to turn to my colleague from Georgia, 
the Ranking Member, David Scott, for his opening remarks. 
David?

  OPENING STATEMENT OF HON. DAVID SCOTT, A REPRESENTATIVE IN 
                     CONGRESS FROM GEORGIA

    Mr. David Scott of Georgia. Thank you very much, Mr. 
Chairman, and I join you in welcoming our distinguished 
witnesses. We are certainly looking forward to their important 
testimony.
    Today's hearing is vitally important as it reminds us of 
why the markets regulated by the CFTC exist in the first place 
which is to serve companies both large and small, as well as 
individuals, small businesses, like farmers and their co-ops in 
managing their business risk. It is important to ensure that 
our markets function as they are intended and as end-users need 
them, too, in order that they can engage in the legitimate 
hedging activities necessary for their business operations.
    However, I must say that right now, it is perhaps the case 
that things are not quite operating as they should. We do have 
an issue that is bubbling its head up that we need to watch 
very carefully at this point and that is whether banks should 
own and control vast storages or warehouses and oil tankers, 
pipelines and shipments, distribution of commodities, like 
aluminum, like gasoline. Is that fair, with the delays and 
timing of getting these commodities like aluminum, gasoline, to 
manufacturers and end-users. And the fundamental question is if 
these activities could pose another risk or a crisis to our 
nation's financial system, so as our Committee is charged with 
management, risk and commodities, we have to keep a very 
jaundiced eye on this as to whether or not this results in mass 
inflated pricing.
    And it is very important to note that with this we must 
know that banks, holding companies, are allowed certain 
commodity activities that are complimentary to financial 
activities, and they are permissible for bank-holding 
companies. But it is something that is there, and of course 
Members of this body as well as my constituents, have concerns 
about that and the oil markets as well.
    So a careful examination of how commodity markets are 
functioning currently with the perspective of those using them 
to hedge commodity risk is vitally important as we continue 
discussions about the future of the CFTC and the stability and 
yes, the even playing field for all of our end-users so that we 
protect our banking system, we protect our end-users, we 
protect our financial system, and in fact the world economy and 
be careful not to ease into another crisis unintentionally.
    With that, Mr. Chairman, I yield back.
    The Chairman. I thank the gentleman. I would now like to 
welcome our panel of witnesses this morning. We have Mr. Scott 
Cordes, President, CHS Hedging, Inc., St. Paul, Minnesota, on 
behalf of the National Council of Farmer Cooperatives. We have 
Mr. Lance Kotschwar. Is that close, Lance?
    Mr. Kotschwar. Close.
    The Chairman. Okay. Will Lance be okay? Senior Compliance 
Attorney, the Gavilon Group, LLC, Omaha, Nebraska, on behalf of 
the Commodity Markets Council. We have Mr. Richard F. McMahon, 
Vice President, Edison Electric, here in Washington, D.C. We 
have Chris Monroe, Treasurer, from Southwest Airlines in 
Dallas. We have Andrew Soto, Senior Managing Counsel, 
Regulatory Affairs, American Gas Association here in D.C. We 
have Mr. Gene Guilford, National & Regional Policy Counsel, 
Connecticut Energy Marketers Association, Cromwell, 
Connecticut, on behalf of the Commodity Markets Oversight 
Coalition.
    Mr. Cordes, you are ready to begin, and you have about 5 
minutes, if you can hold to the time.

 STATEMENT OF SCOTT CORDES, PRESIDENT, CHS HEDGING, INC., ST. 
 PAUL, MN; ON BEHALF OF NATIONAL COUNCIL OF FARMER COOPERATIVES

    Mr. Cordes. Thank you, Chairman. Chairman Conaway, Ranking 
Member Scott, and Members of the Committee, thank you for 
holding this hearing to review key issues to end-users as you 
prepare for CFTC reauthorization. I am Scott Cordes, President 
of CHS Hedging, a commodity brokerage subsidiary of CHS Inc. 
CHS is a proud member of the National Council of Farmer 
Cooperatives, and I appear here today on behalf of NCFC.
    Farmer cooperatives are an important part of the success of 
American agriculture. In particular, by providing commodity 
price risk management tools to their member-owners, farmer 
cooperatives help mitigate commercial risk in the production, 
processing and selling of a broad range of agricultural, energy 
and food products.
    As you know, co-ops have long used exchanged-traded futures 
and options to hedge the price risk of commodities they 
purchase, supply, process or handle for their members. In 
recent years, over-the-counter derivatives or swaps have also 
become increasingly important to hedge price risk. In fact, 
swaps play a critical role in the ability of cooperatives to 
provide forward contracts especially in volatile markets.
    Therefore, the Committee oversight of CFTC during the Dodd-
Frank rule-making process has been instrumental in ensuring 
that co-ops and farmers continue to have access to needed risk 
management tools. Continued oversight is important as the 
process turns from one of rule-making to one of compliance. 
This shift is something that NCFC members are now grappling 
with. They must clearly understand the provisions of the 
regulations while also figuring out how different regulations 
will fit together in a coherent framework. In some instances, 
co-ops are finding it challenging to understand how to be 
compliant, even as they spend a significant amount of resources 
to address the new regulations.
    Part of the concern also lies with CFTC's eventual 
enforcement of the new regulations. As we have throughout the 
process, we urge CFTC to continue to work closely with the 
industry and take a collaborative approach to the compliance. 
This would be a continuation of the willingness that CFTC has 
shown to listen to our concerns during the rule-making process. 
Other rules that have not yet been finalized continue to cause 
uncertainty over the new costs that will be imposed on the 
agriculture industry. For instance, swap dealers, who co-ops 
often use to lay off risk, must comply with capital and margin 
requirements that are still unknown. What these costs will be 
and how they will be processed and passed on to end-users 
remains to be seen and could dramatically impact the cost 
effectiveness of hedging in the OTC market.
    There still is the question of whether the so-called 
Prudential Regulators will require bank swap dealers to collect 
margin from end-users. We appreciate this Committee's work on 
the issue and House passage of the Business Risk Mitigation and 
Price Stabilization Act. Clearly, mandatory margin would 
increase cost to hedgers, operations and ultimately discourage 
prudent hedging practices.
    Similarly we are waiting to see what will be contained in 
the revised position limits rule. As explained further in my 
written statement, two key areas of that rule we ask this 
Committee to focus on closely are the definition of bona fide 
hedge and the reporting of aggregated positions. The commercial 
hedgers could be adversely affected if those issues are not 
properly addressed.
    In other instances, rules have been finalized and we are 
just now finding where it would be difficult or impossible to 
comply. In these instances we have to request no-action relief 
to the regulation from CFTC. For example, one CFTC regulation 
imposes phone recording requirements on some entities, such as 
grain elevators, who provide brokerage services so their farmer 
customers can hedge on exchanges. Because those elevators are 
technically branch offices associated with a futures commission 
merchant, they are bound by the same recording requirements as 
required as the FCM.
    However, given the infrequent and low volume of futures 
transaction handled by those branches, complying with the phone 
recording requirements under this regulation would not be 
economically feasible. The cost to comply with this regulation 
would in many cases exceed the total revenues of those FCM 
branches. In addition, the recording and indexing of cell phone 
conversations pose a huge challenge. If enforced, this 
regulation would mean that many local branches would no longer 
be able to offer these risk management options. We hope you 
will support us in this effort.
    Last, I would like to highlight an issue that has generated 
a lot of attention with the industry right now, additional 
protection for futures customers. NCFC supports much of what 
CFTC has proposed in the wake of MF Global and Peregrine's 
failures to protect customers. However, we are concerned with 
the potential unintended consequences that a one-size-fits-all 
regulation may have on hedgers and smaller FCMs. In addition to 
increased costs for hedgers, this proposed rule would be more 
financially and operationally burdensome to firms like farmer 
cooperative owned FCMs which work with hedgers. We are 
concerned with several aspects of the proposed regulations 
including changes around capital charges, residual interests, 
and establishment of risk management systems. Especially 
concerning is the requirement that an FCM's residual interest 
in customer-segregated account must at all times be sufficient 
to exceed the sum of potential margin calls. This is counter to 
the historical interpretation and would actually require 
customers as farmers to front additional dollars to fund their 
hedge accounts while providing little in the way of additional 
protection.
    While my written testimony delves deeper into those 
concerns, I would be pleased to elaborate on the issue or 
answer any other questions you may have. Thank you again for 
the opportunity to testify today. Thank you, Mr. Chairman.
    [The prepared statement of Mr. Cordes follows:]

 Prepared Statement of Scott Cordes, President, CHS Hedging, Inc., St. 
     Paul, MN; on Behalf of National Council of Farmer Cooperatives
    Chairman Conaway, Ranking Member Scott, and Members of the 
Committee, thank you for the invitation to testify today on 
reauthorization of the Commodity Futures Trading Commission (CFTC) and 
key issues concerning the agriculture industry's ability to use and 
offer risk management tools.
    I am Scott Cordes, President of CHS Hedging, a commodity brokerage 
subsidiary of CHS Inc. CHS is a farmer-owned cooperative and a grain, 
energy and foods company. We are owned by approximately 55,000 
individual farmers and ranchers, in addition to about 1,000 local 
cooperatives who represent another 350,000 producers. You might also be 
interested to know I grew up on a grain and dairy farm in Southeastern 
Minnesota that my brother still operates today.
    Today, I am testifying on behalf of the National Council of Farmer 
Cooperatives (NCFC). NCFC represents the nearly 3,000 farmer-owned 
cooperatives across the country whose members include a majority of our 
nation's more than two million farmers.
    Farmer cooperatives--businesses owned, governed and controlled by 
farmers and ranchers--are an important part of the success of American 
agriculture. They are a proven tool to help individual family farmers 
and ranchers through the ups and downs of weather, commodity markets, 
and technological change. Through their cooperatives, producers are 
able to improve their income from the marketplace, manage risk, and 
strengthen their bargaining power, allowing them to compete globally in 
a way that would be impossible to do individually.
    In particular, by providing commodity price risk management tools 
to their member-owners, farmer cooperatives help mitigate commercial 
risk in the production, processing and selling of a broad range of 
agricultural, energy and food products. America's farmers and ranchers 
must continue to have access to new and relevant risk management 
products that enable them to feed, clothe and provide fuel to consumers 
here at home and around the world. Last year's drought across much of 
the country, which impacted so many producers so severely, once again 
illustrates the need for a multilayered risk management strategy in 
agriculture.
Cooperatives' Use of Derivative Markets
    As processors and handlers of commodities and suppliers of farm 
inputs, farmer cooperatives are commercial end-users of the futures 
exchanges, as well as the over-the-counter (OTC) derivatives markets. 
They use exchange traded futures and options and OTC derivatives to 
hedge the price risk of commodities they purchase, supply, process or 
handle for their members.
    In addition to the exchange-traded contracts, OTC derivatives have 
become increasingly important to hedge price risks. Due to market 
volatility in recent years, cooperatives are increasingly using these 
products to better manage their exposure by customizing their hedges. 
This practice increases the effectiveness of risk mitigation and 
reduces costs to the cooperatives and their farmer-owners. Swaps also 
play a critical role in the ability of cooperatives to provide forward 
contracts, especially in times of volatile markets. Because commodity 
swaps are not currently subject to the same margin requirements as the 
exchanges, cooperatives can use them to free up working capital.
    OTC derivatives are not just used for risk management at the 
cooperative level, however. They also give the cooperative the ability 
to provide customized products to farmers and ranchers to help them 
better manage their risk and returns. Much like a supply cooperative 
leverages the purchasing power of many individual producers, or a 
marketing cooperative pools the production volume of hundreds or 
thousands of growers, a cooperative can aggregate its owner-members' 
small volume hedges or forward contracts. It can then offset that risk 
by entering into another customized hedge via the swap markets.
    In addition, there are farmer-owned cooperative futures commission 
merchants (FCM), such as CHS Hedging, that provide brokerage services 
to farmers, ranchers, and commercial agribusiness. These operations 
perform a critical service of providing price risk management to a 
customer base comprised largely of physical commodity hedgers.
The Dodd-Frank Act
    We greatly appreciate the ongoing oversight the House Agriculture 
Committee has provided as the Dodd-Frank rules have been written. Your 
work in encouraging the CFTC to ensure that the agriculture industry 
has affordable access to innovative risk management tools once the Act 
is implemented is commendable. With your continued leadership, we are 
hopeful that the agriculture industry will avoid being subject to a 
``one-size-fits-all'' type of regulation intended for Wall Street.
    As such, we have been working to ensure that the implementation of 
the Dodd-Frank Act preserves risk management tools for farmers, their 
cooperatives and others involved in the agriculture industry.
    During the rulemaking process, NCFC has advocated for the 
following:

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

   Exclude agricultural cooperatives from the definition of a 
        swap dealer;

   Acknowledge that forward contracts continue to be excluded 
        from CFTC swap regulation;

   Maintain a bona fide hedge definition that includes common 
        commercial hedging practices; and

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

    We recognize the complexity in crafting rules for the 
implementation of Dodd-Frank that best fit cooperatives, and appreciate 
the work of the Commission in addressing many of our concerns in the 
rule-writing process. While we now know farmer cooperatives will be 
treated as end-users and not swap dealers, there are additional 
questions and concerns that have arisen since many rules have been 
finalized and NCFC members have turned their attention to compliance.
    As such, we are doing our best to put into place policies and 
procedures, but often find it a challenge to understand what exactly 
needs to be done to address the complex regulations. Given this 
situation, we also have concerns regarding how CFTC will enforce the 
regulations. We urge the Committee to encourage CFTC to work closely 
with industry to ensure clear understanding by all parties before 
beginning any enforcement actions.
Costs to End-Users
    Uncertainty over ultimate costs and market liquidity is an ongoing 
concern for farmers and their cooperatives. Agriculture is a high-
volume, low-margin industry, and incremental increases in costs, 
whether passed on from a swap dealer or imposed directly on a 
cooperative will trickle down and impact farmers. Taken one rule at a 
time, the costs may not seem unreasonable, but to those who have to 
absorb or pass on the collective costs of numerous regulations it is 
evident. Even as end-users, significant resources must be used just to 
comply with the additional paperwork requirements. In fact, a number of 
NCFC members have had to greatly increase the amounts they have spent 
on compliance in the last 2 years on additional staff, outside 
assistance, and investments in technology.
    It is also unclear how other costs will be forced down to end-users 
and impact their ability to hedge. We fear an increased cost structure 
due to higher transaction costs (or because certain risk management 
tools cease to exist altogether) may discourage prudent hedging 
practices. For example, cooperatives often use swap dealers in 
utilizing the OTC market to lay off the risk of offering forward 
contracts to producers and customers. However, the costs associated 
with dealers' compliance with capital, margin and other regulatory 
requirements remain unclear.
    Additionally, we are concerned with the so-called ``Prudential 
Regulators'' margin proposal requiring bank swap dealers to collect 
margin from end-users. As end-users, cooperatives use swaps to hedge 
interest rates, foreign exchange, and energy in addition to 
agricultural commodities. Often, cooperatives look to their lenders to 
provide those swaps. Under the proposed rule requiring end-users to 
post margin, costs to businesses will increase as more cash is tied up 
to maintain those hedges. The additional capital requirements will 
siphon away resources from activities and investment in cooperatives' 
primary business operations.
    Congressional intent was clear on this point--end-users were not to 
be required to post margin. We appreciate the House of Representatives 
reaffirming this just last month by passing the Business Risk 
Mitigation and Price Stabilization Act.
Part 1.35 record-keeping Requirements
    As a service to their customers, farmer-owned cooperative FCMs have 
a network of branch operations embedded in locations such as grain 
elevators, whose primary business is handling the cash grain volume of 
their producer customers. As a branch office of a cooperatively-owned 
FCM, these commercial grain elevators have chosen to provide brokerage 
services as a means of providing access to risk management tools for 
their farmer customers who want to hedge their production volume 
through futures and/or options.
    Given the infrequent and low volume of futures/options transactions 
handled by ``branches'' associated with those FCMs, complying with the 
oral recording requirements (recording of all phone calls) under this 
regulation would not be economically feasible. The necessary investment 
to put in place and maintain a system to comply with the regulations 
would exceed not only any profits, but in many cases the total revenues 
of those FCM branches--to the point that those local branches could no 
longer provide brokerage services. The effect would be reduced risk 
management options, and their use, by farmers and ranchers.
    Moving forward, we intend to ask CFTC for a no-action relief to 
this regulation, well before the compliance deadline of December, on 
the basis that CFTC recognized the burden that the oral communications 
record-keeping requirement would have on other smaller futures brokers. 
We hope that you will support our efforts in gaining this relief.
The Position Limits Rule
    While the rule imposing position limits for swaps and futures was 
vacated by a court decision in September 2012, it is our understanding 
that CFTC is redrafting a new proposal. We continue to advocate that 
CFTC recognize common commercial hedging practices, such as 
anticipatory hedging and cross hedging, as bona fide hedges in that 
rule, and look forward to providing input when the proposal is made 
available for public comment. We would also encourage this Subcommittee 
to keep a close eye on that definition as the rule is rewritten.
    Other aspects of this rule have also caused some confusion among 
NCFC's members. One example is the section that addresses aggregation 
of positions for the purposes of hedge limits for entities in which 
ownership of another is ten percent or greater (under the original 
rule), or 50 percent under CFTC's earlier re-proposal of the rule. 
Given the nature of independent risk management functions of 
subsidiaries or joint ventures of some of our cooperatives, it has 
caused further confusion over how each partner would communicate and 
share that information and/or account for each other's positions on a 
day-to-day basis.
The Forward Exclusion
    Forward contracting allows farmers, cooperatives, and other 
businesses to price their product into the future, take positions to 
try to maintain a profit margin, and protect against unknown but 
potentially adverse price fluctuations. Therefore, understanding what 
constitutes an excluded forward contract is critical in order for 
businesses to continue their commercial supply and sales contracts.
    We appreciate the guidance set forth regarding the forward 
exclusion in the product definitions rule. That guidance provided 
certainty about what constitutes an excluded forward contract, as 
forward contracts in non-financial commodities that contain embedded 
price options would be excluded forward contracts and not considered to 
be ``swaps.''
    Recently, however, in light of the CFTC's seven-part interpretation 
in the rule, some NCFC members have raised concerns over the 
appropriate treatment of forward contracts commonly used in physical 
supply arrangements that contain volumetric optionality. If the CFTC 
were to take a narrow view of the seven-part interpretation, it may 
view as options many other routine physical supply contracts in which 
the predominant feature is delivery.\1\ Such an interpretation would 
require those common commercial forward contracts to come under the 
regulations intended for swaps such as reporting and position limits.
---------------------------------------------------------------------------
    \1\ Many commercial parties, including cooperatives, include some 
volumetric flexibility in physical supply agreements for both 
commercial and operational reasons. This allows them to address the 
uncertainty caused by likely changes in supply and demand fundamentals, 
including, for example, changes in suppliers and customers, 
transportation/vessel availability and capacity, operation and 
maintenance of a facility, and other commercial considerations that 
arise in the normal course of managing a physical commodity business. 
For example, some dairy cooperatives utilize volumetric flexibility in 
the sale of milk, both to minimize marketing costs and to balance 
supply and demand. It is not unusual for milk sales contracts to 
require a monthly range in deliverable volume. This is done to address 
the unknown supply and demand dynamics that will occur between seasons 
of the year (more milk is produced in the spring time than in the fall, 
while plant-level demand is greater in the fall as product is made for 
the holiday season). Additionally, dairy cooperatives that supply 
beverage milk plants need to have flexibility to divert deliveries to 
beverage plants during high demand parts of the week (beverage bottlers 
have their greatest demand on a Thursday to meet supermarket customers' 
heaviest grocery shopping period over the weekend).
---------------------------------------------------------------------------
    The uncertainty of the CFTC interpretation of these types of 
contracts, all previously covered under the forward contracting 
exclusion, will require NCFC members to expend significant labor and 
costs to review hundreds of sales transactions to determine if they 
continue to meet the forward contract exclusion. Again, this is an 
unnecessary resource and cost burden on end-users that should be 
avoided. We hope CFTC will interpret this exclusion consistently with 
its historical understanding and prior guidance.
Customer Protection
    NCFC supports strengthening protections for futures customers. We 
appreciate the House Agriculture Committee's hearings on this issue and 
the work CFTC has done in proposing new rules in this area subsequent 
to the failure of MF Global and Peregrine Financial Group. However, we 
are concerned with the potential unintended consequences that a ``one-
size-fits-all'' regulation may have on hedgers and smaller FCMs. The 
proposed rules do not take into account the type of FCM--by size, the 
risk profile of their customers, or whether or not the FCM also has 
proprietary trading or is a broker-dealer. In addition to increased 
costs for hedgers, this proposed rule would be more burdensome to 
smaller firms like farmer cooperative-owned FCMs, which largely deal 
only with hedgers.
    Regulations that would accelerate a further consolidation in the 
FCM industry would have the adverse effect of leaving commodity hedgers 
with fewer options, while concentrating risk among fewer FCM entities. 
While the issues behind the decreasing numbers of FCMs are more complex 
than just regulatory burden, we are concerned with several aspects of 
the proposed regulations, including changes around capital charges, 
residual interest, and establishment of risk management systems under 
Rule 1.11, which will be financially and operationally burdensome for 
smaller FCMs.
    One provision would require an FCM to take a capital charge with 
respect to any margin call that is outstanding for more than one 
business day, as opposed to the current practice of 3 business days. 
This proposed rule would clearly disadvantage smaller FCMs and many 
retail customers. Many smaller hedgers do not transfer funds by wire, 
but rather write checks. As such, it is common practice for farmer 
cooperative-owned FCMs to pay the clearing houses or the clearing FCMs 
in advance of receiving customer funds. By adding the additional 
capital charge after just one day, FCMs will possibly be forced to 
require their customers to wire transfer/ACH funds or maintain 
excessive funds in their account. The costs associated with either 
option would disproportionately affect smaller hedgers, while adding 
little in the way of added customer protection.
    Another provision would require that an FCM's residual interest in 
the customer-segregated account must at all times be sufficient to 
exceed the sum of the margin deficits that the FCM's customers have in 
their accounts. This requirement is counter to the historical 
interpretation, which requires an FCM to maintain residual interest to 
cover customer-segregated accounts with negative net liquidating 
balances (debit equity). This gives an FCM time to collect customer 
funds prior to the time a payment must be made to the clearing house.
    In addition to increased costs for hedgers, this proposed rule 
would be more burdensome to firms like farmer cooperative-owned FCMs, 
which largely deal only with hedgers. Although the risk profile of the 
customer base is very low, customers are predominantly on one side of 
the market and therefore more susceptible to big swings in the market. 
To require all deficits to be covered immediately would be overly 
burdensome on these FCMs given the low-risk profile of their customers 
as hedgers. We encourage Members of this Subcommittee to express 
concerns over this proposal to CFTC.
    Thank you again for the opportunity to testify today before the 
Committee on behalf of farmer-owned cooperatives. We appreciate your 
role in ensuring that farmer cooperatives will continue to be able to 
effectively hedge commercial risk and support the viability of their 
members' farms and cooperatively owned facilities. I look forward to 
answering any questions you may have.
    Thank you.

    The Chairman. Thank you. Lance, 5 minutes.

   STATEMENT OF LANCE KOTSCHWAR, SENIOR COMPLIANCE ATTORNEY, 
 GAVILON GROUP, LLC, OMAHA, NE; ON BEHALF OF COMMODITY MARKETS 
                            COUNCIL

    Mr. Kotschwar. Thank you, Chairman Conaway, Ranking Member 
Scott, and Members of the Subcommittee. Thank you for the 
invitation today. My name is Lance Kotschwar. I work for 
Gavilon in Omaha, Nebraska, and I am a senior compliance 
attorney. I am testifying today on behalf of the Commodity 
Markets Council.
    CMC is a trade association comprised of exchanges and their 
industry counterparts. Our activities include the complete 
spectrum of commercial end-users including all the futures 
markets and all of energy and agriculture products. We are 
well-positioned to provide the consensus views of commercial 
end-users of derivatives, and my views today represent the 
collective view of the CMC membership.
    Our members depend on efficient and competitive functioning 
of U.S. futures exchanges, and we support well-regulated 
markets as long as the regulations are reasonable. As you seek 
to reauthorize to CFTC, we would like to emphasize several 
points starting with this. Any time that we change regulations 
that affect the hedging mechanism, that is going to introduce 
risk into the system that is going to have to be priced, and 
that is going to be a negative impact on both producers and 
consumers and everything in between. So to help inform you as 
you reauthorize, I want to offer a few thoughts and comments 
about our end-user concerns. My written statement goes into a 
lot of details about protection of customer collateral, but I 
want to spend my time focusing on our end-user concerns.
    As Mr. Cordes said, we have a lot of concerns about this 
Part 1.35 record-keeping requirements. As the CFTC was going 
through the rule-making process, CMC was very engaged on it. We 
wanted to make sure that this expansion would not require non-
clearing members of a DCM to have to record phone calls related 
to physical commodity purchases and sales. Just going to a 
straight example, we didn't want grain companies that have 
exchange memberships to have to record phone calls to farmers.
    Well, we won that battle, but we lost the bigger war 
because we weren't paying close attention to the fine print. 
The CFTC final rule quietly inserted some additional language 
that previously existed only in a guidance document that 
significantly expanded the scope of what they consider to be an 
electronic document, and they basically expanded to cover 
everything except oral conversations. It includes text 
messaging, instant messaging, e-mail and any other electronic 
communication. The cost of maintaining all this stuff is quite 
substantial and particularly you are trying to doing in a 
searchable format as the CFTC has requested, to the extent that 
is even technically feasible. In our case, we have totally 
instructed all of our grain locations they are not to use any 
kind of instant messaging at all right now. We have forced them 
back to the phones. So that is probably the exact opposite of 
what this rule is supposed to do.
    Let me just to expand on what Mr. Cordes said. If you have 
a grain elevator with 100 locations, on any given day they are 
buying and selling grain all over the country. They are not 
doing futures for each individual sale. They look at their net 
exposure, and then that is what they go to the exchange with. 
So under the CFTC's rule, are we going to record all those 
phone calls when you have to get a tenuous connection to what 
the futures layoff is anyway? It doesn't seem to be a very good 
public policy process, especially since they are telling us we 
don't have to record phone calls but you have to do everything 
else. Let us face it. Text messaging and other kinds of 
electronic communications have largely replaced phone calls 
today in the 21st century. So if the policy is not to record 
phone calls, we need to be a little more logical about it.
    Another area that we have some concerns about is bona fide 
hedging. Congress provided a definition of bona fide hedging 
within Dodd-Frank that the CFTC has unnecessarily narrowed. 
They have come up with at least five different definitions in 
various rules, and that creates a lot of confusion and could 
disrupt legitimate risk mitigation practices. We certainly are 
very interested in working with you to try to get this whole 
notion of bona fide hedging steered back in the right 
direction.
    As Mr. Cordes has also said, we also have concerns about 
the scope of the swap dealer definition. We believe that the 
final rule defining who must register was--the Dodd-Frank Act, 
that was largely a category that was designed for large 
financial institutions. But we believe the way it has been 
implemented, it is altering trading activity between commercial 
market participants, and it is pushing more swap activity into 
the large dealer banks which is exactly the opposite of what 
Dodd-Frank wanted to do. Commercial participants are curtailing 
their trading activities for fear of having to get caught up in 
that definition of what a swap dealer is because they can't 
comply with the requirements.
    We have some other concerns, too. I will just briefly 
mention them. We have some concerns about historical swap 
reporting, the real-time reporting rule as it relates to 
especially trading in illiquid months, position limits, 
particularly aggregation, and last, residual interest which was 
written under the heading of customer protection but as written 
will have a costly and negative impact for our members and the 
FCMs that we use.
    And with that, I yield back the rest of my time.
    [The prepared statement of Mr. Kotschwar follows:]

  Prepared Statement of Lance Kotschwar, Senior Compliance Attorney, 
 Gavilon Group, LLC, Omaha, NE; on Behalf of Commodity Markets Council
    Chairman Conaway, Ranking Member Scott, and Members of the 
Subcommittee: thank you for holding this hearing to review the 
reauthorization of the Commodity Futures Trading Commission (``CFTC''). 
My name is Lance Kotschwar, Senior Compliance Attorney for Gavilon 
Group, LLC. I am testifying today on behalf of the Commodity Markets 
Council (``CMC'').
    CMC is a trade association that brings together commodity exchanges 
and their industry counterparts. The activities of CMC members include 
the complete spectrum of commercial end-users of all futures markets 
including energy and agriculture. Specifically, our industry member 
firms are regular users of the Chicago Board of Trade, Chicago 
Mercantile Exchange, ICE Futures U.S., Kansas City Board of Trade, 
Minneapolis Grain Exchange and the New York Mercantile Exchange. CMC is 
well-positioned to provide the consensus views of commercial end-users 
of derivatives. My comments represent the collective view of the CMC 
membership.
    All CMC member firms depend upon the efficient and competitive 
functioning of the risk management products traded on U.S. futures 
exchanges. CMC and its members support well-regulated markets, and 
while the financial crisis of 2008 had nothing to do with commodity 
markets, we recognize the need for the Dodd-Frank Act and support its 
goals. In turn, that regulation should be efficient and reasonable 
rather than overly prescriptive and complex.
    Regulatory initiatives that lack clarity or evolve to be at cross-
purposes with the core principles on which the Commission was founded 
are concerning to CMC members. Such regulatory disparities generate 
market inefficiencies and costs, which widen price margins between 
producers and consumers of energy and agricultural commodities, as well 
as those finished food, energy, and consumer products that derive from 
the underlying commodities.
    Most agricultural commodities are produced seasonally yet consumed 
continuously, whereas energy commodities are produced continuously and 
consumed seasonally. We manage that flow of physical commodity and 
dynamically hedge it, allowing us to offer higher prices to producers 
and lower prices to consumers. As Congress seeks to once again 
reauthorize the CFTC, we would like to emphasize several points 
starting with this: undue regulatory interference with the hedging 
mechanism introduces risk that must be priced into the chain, 
negatively affecting both ends and everything in between.
    At this critical juncture in Dodd-Frank rule writing and 
implementation, CMC members are concerned that the CFTC's efforts to 
implement new swap regulatory rules has now morphed into a crusade of 
rewriting many long-standing futures market regulations that Congress, 
via Dodd-Frank, never contemplated. Even more problematic is that this 
regulatory barrage is occurring almost entirely without consideration 
of real costs on commodity producers or consumers. The additional 
regulatory costs that the CFTC is forcing upon end-users and commercial 
participants will ultimately be passed on to the consumers of commodity 
products and will also reduce market liquidity, further raising the 
costs of risk management, and ultimately the cost of finished 
agricultural and energy goods.
Issues of Concern
    Generally our ideas for legislative changes fall into two main 
categories: improvements to the protection of customer collateral in 
derivatives markets and concerns related to the implementation of 
various provisions of the Dodd-Frank Act with respect to the impacts on 
commercial end-users.
Protection of Customer Collateral
    Given recent events surrounding the collapse of two Futures 
Commission Merchants (``FCMs'') and the mismanagement and disappearance 
of customer collateral, we request that the Committee consider the 
various market driven proposals to further protect these assets, as 
they are vital to our member companies and all other market 
participants seeking to manage risk in the derivatives markets. Ideas 
of alternative collateral segregation regimes and insurance programs 
have been floated, and we encourage both this Committee and other 
relevant Congressional committees to fully examine and vet these 
proposals to allow for further protection of customer collateral.
CFTC Customer Protection Proposal
    CMC commends the efforts of the National Futures Association 
(``NFA'') and the CFTC to improve certain aspects of how customer 
collateral is treated, although there is one particular issue raised by 
the CFTC in a recent proposed rule that has generated serious concern 
among our members. Specifically, CMC strongly believes that the 
proposed requirement that FCMs maintain a residual amount sufficient to 
cover on a constant basis the aggregate of customer margin deficits 
could create considerable liquidity issues and increase costs for FCMs, 
producers, and end-users. Such a decrease in liquidity could be 
substantial and limit the number and type of transactions FCMs clear, 
the number of customers they service, and the amount of financing they 
provide. The proposal would require FCMs to fund accounts holding their 
customers' collateral with proprietary assets in excess of the 
aggregated margin deficiencies of all its clients on a continuous 
basis. The proposal also appears to require executing FCMs to collect 
collateral for give-ups so that customer positions are fully margined 
in the event a clearing FCM rejects a trade. If the proposed residual 
interest provision were to be finalized, FCMs may be forced to take 
steps such as over-margining clients, requiring clients to pre-fund 
their margin accounts, imposing punitive interest rate charges on 
margin deficit balances, and introducing intra-day margin calls. Such 
steps would dramatically increase the cost of using futures markets and 
may force many end-users to decrease or discontinue hedging and risk 
management practices, which is the reason these markets were created.
    Market participants are active in developing methods of early 
detection of any improper transfer of customer funds due to errors or 
theft. For example the Chicago Mercantile Exchange (``CME'') and the 
NFA have implemented various protective measures, including: (1) 
requirements regarding an FCM's residual financial interest in customer 
accounts, (2) restrictions on an FCM's disbursements from customer 
accounts, and (3) procedures that will facilitate monitoring of 
customer funds.
    In order to detect an improper reporting of asset balances, CME and 
NFA have implemented a number of measures, most of which relate to 
confirmation of balances and review of bank statements and certain FCM 
information. Both designated self-regulatory organizations are using an 
aggregator to get bank balances reported to them electronically on a 
daily basis.
    CME and NFA also perform limited reviews of the customer 
investments reported on the Segregated Investment Detail Reports to 
ensure compliance with the requirements of CFTC rules. CME performs 
detailed audit work on risk-based examinations, including a review of 
qualified depositories, third-party statements, reconciliations, mark-
to-market schedules, valuation (readily marketable and highly liquid), 
obtaining confirmations, etc. Additionally, in April 2012, CME started 
performing limited reviews of customer segregated, secured, and 
sequestered statements on a surprise basis outside of the regular risk-
based examination.
End-User Concerns
    The CFTC has been working diligently since the passage of Dodd-
Frank in July of 2010 and should be commended for the progress they 
have made thus far. CMC recognized and supported the need for reform in 
the over-the-counter (OTC) swaps market and believes that Dodd-Frank 
provided a foundation for an effective overhaul of this important risk-
management market. However, there are various issues that have arisen 
as part of the implementation process which we believe the Committee 
should revisit going forward.
Part 1.35 record-keeping Requirements
    A significant and concerning expansion of current data requirements 
beyond the scope of Dodd-Frank is related to record-keeping 
requirements in Part 1 of Commission regulations. In accordance with 
Dodd-Frank, the CFTC expanded the futures record-keeping requirements 
that existed for certain markets participants to swaps. However, they 
also significantly expanded the written requirements, as well as 
created a new requirement to record oral conversations.
    Compliance costs have already been incredibly substantial now that 
compliance with the written requirements is mandatory and will only 
increase once compliance with the oral recording requirement comes into 
effect later this year. Again, the market is searching for a reason for 
and measurable benefit of all of this new information that must be 
maintained and archived in a particular way.
    In addition, the rule is vague as to which communications must be 
retained, so in an abundance of caution, market participants are 
effectively saving every e-mail, news article, or any other piece of 
information that might ``lead to the execution of a transaction'' and 
soon will have to begin recording every phone call that might ``lead to 
the execution of a transaction.'' This vague ``lead to . . .'' language 
appears nowhere in any prior iteration of Rule 1.35 or in any prior 
CFTC Advisory relating to the rule, and operates to expand 
substantially the scope and burdens of the rule. Also, the application 
of the requirements to members of an exchange seems to have no 
regulatory rationale and only serves as a disincentive to be an 
exchange member.
    Finally, the cost figures contained in the cost-benefit analysis in 
the final rule are not justified. Compliance costs are exponentially 
higher than they estimate, and in some cases the technology is not even 
available to market participants. Requests for clarification have not 
yet been answered, and CMC will be submitting a written request soon in 
a continued effort to clarify and hopefully narrow the scope of what 
must be retained and, therefore, reduce what we view as unnecessary 
compliance costs.
Scope of Swap Dealer Definition
    The Commission's final rule defining who must register as a swap 
dealer, a regulatory category that carries an immense regulatory burden 
and was designed for large financial institutions, is altering trading 
activity between commercial market participants and pushing more swap 
activity into the large dealer banks. This is directly counter to the 
goal of Dodd-Frank to increase competition and reduce the concentration 
of risk in a few large financial firms. We do not believe that Congress 
intended to capture commercial end-users as swap dealers for swap 
activity that is ancillary to their physical commodity business, but 
that is exactly what the final CFTC rule accomplishes.
    Many commercial market participants are curtailing trading 
activities with other end-users for fear of being captured by a 
complicated, capital-based regulatory regime designed for large 
financial institutions with which most end-users are incapable of 
complying. We do not believe this was the intent of Congress, and in 
fact seems to be the complete opposite outcome by further consolidating 
trading activity in a few large financial institutions. We urge the 
Committee to revisit this very important issue.
    Current regulations have arbitrarily established a de minimis 
level, the breach of which requires registration as a swap dealer, at 
$8 billion with a drop to $3 billion following an unpredictable CFTC 
decision making process. The only certainty in the process is that a 
lack of action will result in the de minimis level declining in 5 
years. This $3 billion level is also arbitrary and would significantly 
affect the number of firms defined and regulated as swap dealers. 
Changes should not be made through such a long and ill-defined process, 
which includes several unpredictable and difficult to follow steps for 
market participants. We need a more predictable process.
Reporting and record-keeping under Part 46
    Part 46 of the Commission's regulations requires market 
participants to report swap trades entered into from July 21, 2010, 
when the Congress passed Dodd-Frank, until April 10, 2013. Included in 
the transactions subject to this requirement are energy swaps as well 
as cleared Exchange of Futures for Related Positions (``EFRP'') trades, 
which were centrally cleared by the CME Group and Intercontinental 
Exchange. In these transactions, the original trade only occurs if it 
is accepted for clearing, and once it is, the original trade is 
terminated and replaced with two new trades with each of the original 
executing counterparties facing the clearinghouse. The original trade 
creates zero risk, and the reporting of the trade serves no regulatory 
purpose that we can discern. The reporting requirement does, however, 
create a significant compliance burden on end-users. Given that the 
data is available to regulators from the clearinghouses and the 
clearinghouses have reported the trades on the market's behalf, the 
CFTC should grant the multiple requests from market participants to 
waive the historical reporting requirement for end-users.
Real-Time Reporting
    Under the real-time reporting rule, end-users have a longer time in 
which to report trades with other end-users. However, trades that 
involve a swap dealer or major swap participant must be reported in a 
much shorter time after execution. Because the rule requires trades 
between a non-dealer and a swap dealer be reported within the dealer's 
time limit, swap dealers and major swap participants have limited time 
to lay off risk before the trade is made public. While the delay may be 
sufficient for liquid markets, they are not sufficient for illiquid 
markets and time frames. When a dealer has to report such illiquid 
trades to the market quickly and the dealer may not be able to lay off 
the risk of that trade in the prescribed time, the dealer is taking a 
risk and will charge the counterparty (here, the commercial end-user) 
for that increased risk if they are willing to execute the trade at 
all. This increased cost and possible inability to trade in illiquid 
markets will hurt commercial end-users' ability to efficiently hedge.
Inter-Affiliate Transactions
    Inter-affiliate trades are subject to record-keeping requirements 
under Part 45, requiring that the records of inter-affiliate swaps are 
``full, complete, and systematic.'' We view this requirement as 
burdensome and providing very little benefit relative to the increased 
cost to our members. The information that the Commission is seeking is 
available through the visibility of market-facing swaps, as they are 
largely identical. Additionally, these inter-affiliate and market-
facing trades are for the purpose of hedging or mitigating commercial 
risk and are documented pursuant to inter-affiliate agreements such 
that both parties must make payments and deliveries specified, although 
the transactions may be settled by an intercompany transfer or 
allocation. The internal documentation is done as necessary for 
internal purposes, but may not contain all information required or in 
the format required under Part 45.
    With respect to mandatory clearing and the end-user exception, we 
appreciate the Commission's recent relief providing an exemption for 
swaps between commonly owned affiliates. The Commission still needs to 
clarify that swaps entered into by a centralized hedge function of a 
commercial entity are eligible for the end-user clearing exception when 
hedging on behalf of the commercial company, whether or not the entity 
housing the hedge function for the company is by definition a financial 
entity.
Position Limits Aggregation and Reporting of Daily Physical Positions
    The CFTC's rule imposing position limits for swaps and futures was 
vacated in September 2012 [shortly before compliance became mandatory]. 
The part of the rule that addressed aggregation of entities for 
purposes of position limits was re-proposed but not finalized before 
the rule was vacated. That re-proposal required aggregation of entities 
in which one has ownership of the other of 50% or greater, and provided 
an exception from aggregation at 10% or lower ownership level. Between 
10-50%, there is a multi-factor test to determine if aggregation of 
required, with a presumption of control.
    Although the rule has been vacated, the CFTC has both appealed the 
court's ruling and is drafting a new proposal. We urge the CFTC to 
adopt a rule that requires aggregation based on control, rather than 
percent ownership and not to include any presumption of control. 
Aggregation is appropriate only when one entity controls the trading 
activity of another entity or has unfettered access to trading 
information of such other entity that could be used to facilitate its 
own trading. Absent such control and access to information, aggregation 
should not be required, regardless of the percent ownership or equity 
interest in the owned entity. For example, in the context of a limited 
partnership, a limited partner may own a majority of the partnership 
and be entitled to the majority of its profits, although day-to-day 
control of the partnership actually vests with the general partner. 
Further, it is particularly true in connection with joint ventures that 
majority ownership does not necessarily equate to the majority owner's 
control of the owned entity's trading activity.
    The automatic application of the aggregation requirement to persons 
holding in excess of 50% ownership or equity interest would force 
market participants to share information and coordinate trading, which 
is exactly what the CFTC seeks to prevent. Such sharing of information 
may also raise antitrust concerns, notwithstanding the Commission's 
clarification that an information sharing exemption will be granted 
provided such initial sharing of information does not give rise to a 
``reasonable risk'' of violating Federal laws. Under the final position 
limits rule, affiliated entities will be required to assign position 
limits among several accounts that are presently traded independently 
of, and in competition with, each other. CMC is concerned that 
continuous correspondence and negotiations between affiliated entities 
will expose them to charges of collusive and anticompetitive behavior. 
Given the nature of trading, it is highly impractical to ask the 
opinion of counsel as to whether information sharing at any point 
during intra-day trading gives rise to a ``reasonable risk'' of Federal 
antitrust laws being violated. As such, in practice, affiliated 
entities will be unable to avail themselves of the protection seemingly 
afforded by the information sharing exemption currently constructed in 
Part 151.7(i).
    The vacated position limits rule also required the reporting of 
daily physical positions to justify hedge exemptions, which under the 
rule were only available to commercial market participants, rather than 
the historical requirement of monthly physical position reporting. The 
change would be virtually impossible for a global commodities firm to 
comply with. The industry viewed the change as unnecessary and overly 
burdensome, given that the Commission has always had the ability to ask 
for data to justify a hedge exemption. We do not believe it is an 
efficient or productive use of resources to devote the time that would 
be required to review all of the new data and, if those resources are 
not devoted to review all of the data, it is inefficient to constantly 
collect given that the CFTC may at any time ask for the data. We 
believe the CFTC should retain the historical requirement to report 
monthly positions in any new position limits proposal.
Bona Fide Hedging
    Congress provided a definition of a bona fide hedge within Dodd-
Frank that the CFTC has unnecessarily narrowed, including related to 
anticipatory hedging, and has created at least five different 
definitions in various rules of what constitutes a bona fide hedge. 
This is nonsensical and creates unnecessary confusion, while disrupting 
legitimate risk mitigation practices. We are committed to working with 
Congress to set clearer direction on bona fide hedges so that 
transactions that limit economic risks are viewed as bona fide hedges 
by the CFTC.
Summary
    Commodity derivatives markets continue to grow and prosper. They 
have become deeper and more liquid, narrowing bid/ask spreads, and 
improving hedging effectiveness and price discovery. All of these 
developments serve the interests of the trade as well as the public. 
The regulation of swaps has also motivated a general industry move 
toward the futures market, which has been termed ``futurization.'' 
While we will continue to transact swaps especially for more tailored 
transactions, we support the transition to futures.
    The swap reforms in Dodd-Frank were not necessary because of 
problems in physical commodity markets. Commercial end-users of 
agricultural and energy futures had no role in creating the financial 
crisis. In fact, the regulated futures market fared well throughout the 
financial crisis and futures markets generally provide greater 
regulatory certainty for our members than evolving swaps regulations.
    We believe that as Congress considers how the CFTC is to regulate 
in the future, it should use the core principles on which the CFTC was 
created as its guide. A balance must be maintained between regulatory 
zeal and consideration as to how regulatory changes could result in 
negative consequences to not just CMC members in the middle of the food 
and energy chain, but also to the producers and consumers on each side 
of the chain. Given this, we strongly believe that the CFTC's current 
trend toward very prescriptive changes to futures market regulation 
will hinder rather than improve our economy's ability to manage 
commodity market risks.
    While the independent regulatory agency that this Committee has 
oversight responsibilities over must continue to evolve in order to 
adequately regulate increasingly complex derivatives markets, many of 
these pending changes also introduce the potential for regulators to 
create risk and increase costs by going beyond their purview. Doing so 
without consideration of the consequences is dangerous and violates 
both the ``do no harm'' principle of being a regulator as well as the 
CFTC's core principles regulatory methodology.
    At present, this barrage of new CFTC rules is causing compliance 
costs to skyrocket. In addition, significant regulatory uncertainty 
continues to exist, and despite the approximately 100 various letters 
issued by the Commission to clarify rule language or extend compliance 
dates, many compliance questions remain.
    The objective of the Commodity Exchange Act has never been to 
discourage hedging, but rather to create a market and regulatory 
environment that maintains market integrity while promoting the 
economic benefits of risk management. Purposely adding complexity and 
regulatory uncertainty to the marketplace only adds unnecessary costs. 
Uncertainty, via additional regulation of the risk management tools 
that commodity market participants utilize, actually creates risk where 
it didn't previously exist.
    Thank you for this opportunity to testify. We look forward to 
continuing to work with this Committee to strike the right balance.
    I look forward to your questions.

    The Chairman. Thank you very much. You get extra-credit for 
that later on.
    Mr. Kotschwar. Thank you.
    The Chairman. Mr. McMahon, 5 minutes.

STATEMENT OF RICHARD F. McMAHON, Jr., VICE PRESIDENT OF ENERGY 
              SUPPLY AND FINANCE, EDISON ELECTRIC
                  INSTITUTE, WASHINGTON, D.C.

    Mr. McMahon. Good morning. Chairman Conaway, Ranking Member 
Scott, and Members of the Subcommittee, thank you for the 
opportunity to discuss the perspective of end-users on the 
future of the CFTC.
    I am Richard McMahon, Vice President of Energy Supply and 
Finance for the Edison Electric Institute. EEI is the trade 
association of U.S. shareholder-owned electric utilities. My 
views are also shared by the Electric Power Supply Association, 
which is the national trade association for competitive 
wholesale electric suppliers.
    The electric power industry is the most capital-intensive 
industry in the United States, an $840 billion industry. Our 
members are projected to spend approximately $90 billion per 
year through 2015 on cleaner generating capacity, environmental 
and energy-efficiency upgrades, as well as smart grid and cyber 
security improvements.
    Our members are non-financial entities that primarily 
participate in the physical commodity market and rely on swaps 
and futures contracts primarily to hedge and mitigate their 
commercial risk. The goal of our member companies is to provide 
their customers with reliable electric service at affordable 
and stable rates. Since wholesale electricity and natural gas 
historically have been two of the most volatile wholesale 
commodity groups, our members manage these risks using 
derivatives for the benefit of their customers. In essence, our 
members are the quintessential commercial end-users of swaps.
    Our members support the goals of Dodd-Frank. We believe, 
however, that there are areas where Congress should consider 
minor adjustments.
    A new category of market participants, swap dealers, was 
created by Dodd-Frank. These swap dealers must register with 
the CFTC and are subject to extensive and burdensome regulatory 
requirements. The CFTC was directed to exempt entities that 
engage in a de minimis quantity of swap dealing. The CFTC set 
this threshold at $8 billion. However, it will be reduced 
automatically to $3 billion in 2018 absent CFTC action.
    We oppose such a dramatic reduction in the de minimis 
threshold without deliberative CFTC action including a formal 
rulemaking process that allows stakeholders to provide input on 
what the appropriate threshold should be.
    As I previously mentioned, the electric power industry is 
one of the most capital-intensive industries. Requiring non-
financial end-users to post margin could tie up much-needed 
capital that would otherwise be used to invest in local 
economies and to create jobs. Congress should clarify that it 
did not intend for margin requirements to apply to non-
financial end-users.
    Last year, the U.S. District Court vacated final CFTC rules 
regarding position limits. These vacated rules defined the term 
bona fide hedging in a way that was unnecessarily narrow and 
would have discouraged a significant amount of beneficial risk 
management activity. This restrictive definition of bona fide 
hedging transactions could make hedging more difficult and 
costly and inadvertently increase systemic risk by encouraging 
end-users to leave large portions of their portfolios unhedged. 
Congress should direct CFTC to allow transactions to be 
considered bona fide hedging if they meet general requirements, 
not limited to this enumerated list.
    The Dodd-Frank Act defines the term financial entity as an 
entity that is predominantly engaged in activities that are in 
the business of banking, or in activities that are financial in 
nature. Dodd-Frank allows affiliates or subsidiaries of an end-
user to rely on the end-user exemption when entering into a 
swap on behalf of the end-user. However, swaps entered into by 
end-user hedging affiliates who fall under the definition of 
financial entity cannot take advantage of the end-user 
exemption. Congress should amend the definition of financial 
entity to ensure that commercial end-users are not 
inadvertently regulated as a financial entity.
    Currently, the CFTC's rules generally treat affiliate swaps 
like any other swap. So companies must, under certain 
circumstances, report swaps between majority-owned affiliates 
and must submit such swaps to clearing unless the end-user 
hedging exception applies or a complex criteria for inter-
affiliate clearing exemptions are met.
    The CFTC has provided some relief in the form of no-action 
letters. However, these no-action letters are often 
insufficient and cause uncertainty among end-users. EEI 
supports bipartisan legislation to address the inter-affiliate 
transaction issue.
    In closing, I would like to thank you and your leadership 
and the ongoing interest in the issues surrounding the 
implementation of Dodd-Frank and their impact on commercial 
end-users.
    And again, I appreciate the opportunity to testify and 
would be happy to answer any questions.
    [The prepared statement of Mr. McMahon follows:]

Prepared Statement of Richard F. McMahon, Jr., Vice President of Energy 
    Supply and Finance, Edison Electric Institute, Washington, D.C.
Introduction
    Chairman Conaway, Ranking Member Scott, and Members of the 
Subcommittee, thank you for the opportunity to discuss the perspective 
of end-users on the future of the Commodity Futures Trading Commission 
(CFTC).
    I am Richard McMahon, Vice President of Energy Supply and Finance 
for the Edison Electric Institute (EEI). EEI is the trade association 
of U.S. shareholder-owned electric utilities, with international 
affiliates and industry associates worldwide. EEI's U.S. members serve 
virtually all of the ultimate electricity customers in the shareholder-
owned segment of the industry, and represent approximately 70 percent 
of the total U.S. electric power industry.
    The electric power industry is the most capital-intensive industry 
in the United States--an $840 billion industry representing 
approximately three percent of real gross domestic product. Our 
industry is projected to spend approximately $90 billion a year through 
2015 for major transmission, distribution and smart grid upgrades; 
cybersecurity measures; new, cleaner generating capacity; and 
environmental and energy-efficiency improvements.
    My views are shared by the Electric Power Supply Association 
(EPSA), which is the national trade association for competitive 
wholesale electricity suppliers, including power generators and 
marketers. EPSA members include both independent power producers and 
the wholesale supply businesses of utility holding companies. EPSA 
members supply electricity nationwide with an emphasis on the \2/3\ of 
the country located within a regional transmission organization or 
independent system operator (so-called ``organized markets''). EPSA 
members and other competitive suppliers account for 40 percent of the 
installed electric generating capacity in the United States. These 
suppliers are the primary sources of electricity for most of Maine to 
Virginia, across to Illinois, and in Texas and California.
    Our members are non-financial entities that primarily participate 
in the physical commodity market and rely on swaps and futures 
contracts primarily to hedge and mitigate their commercial risk. The 
goal of our member companies is to provide their customers with 
reliable electric service at affordable and stable rates, which has a 
direct and significant impact on literally every area of the U.S. 
economy. Since wholesale electricity and natural gas historically have 
been two of the most volatile commodity groups, our member companies 
place a strong emphasis on managing the price volatility inherent in 
these wholesale commodity markets to the benefit of their customers. 
The derivatives market has proven to be an extremely effective tool in 
insulating our customers from this risk and price volatility. In sum, 
our members are the quintessential commercial end-users of swaps.
    Title VII of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act of 2010 (the ``Dodd-Frank Act'') provides certain 
exemptions for non-financial end-users, recognizing that they are not 
the entities posing systemic risk to the financial system. Since 
passage of the Dodd-Frank Act, we have been actively working with the 
Federal agencies, including the CFTC, as they work their way through 
the implementation process to ensure that the Congressional intent of 
exempting non-financial end-users remains intact. Even though a 
majority of the rules have been promulgated by these agencies, concerns 
still surround some of the remaining issues important to electric 
companies.
    Our members support the Dodd-Frank Act's primary goals of 
protecting the financial system against systemic risk and increasing 
transparency in derivatives markets. We believe, however, that there 
are areas where Congress should consider minor adjustments to ensure 
the Dodd-Frank Act achieves its purpose while not inadvertently 
impeding end-users' ability to hedge. As Congress examines possible 
modifications to the Commodity Exchange Act, we ask that you consider 
the following issues:
De Minimis Level
    A new category of market participants, swap dealers, was created by 
the Dodd-Frank Act. These swap dealers must register with the CFTC and 
are subject to extensive record-keeping, reporting, business conduct 
standards, clearing, and--in the future--regulatory capital and margin 
requirements. However, the Act directed the CFTC to exempt from 
designation as a swap dealer entities that engage in a de minimis 
quantity of swap dealing. The CFTC issued a proposed rule on the de 
minimis threshold for comment in early 2011. After review of hundreds 
of comments, a series of Congressional hearings and after dozens of 
meetings with market participants, the CFTC set this de minimis 
threshold at $8 billion. However, it will then be reduced automatically 
to $3 billion in 2018 absent CFTC action.
    We oppose such a dramatic reduction in the de minimis threshold 
without deliberate CFTC action. Inaction is always easier than action, 
and inaction should not be the default justification for such a major 
regulatory action. In addition, we believe the CFTC should not have the 
authority to change the de minimis level without a formal rulemaking 
process that allows stakeholders to provide input on what the 
appropriate threshold should be.
    Absent these procedural changes, we are concerned a deep reduction 
in the de minimis level could result in commercial end-users being 
misclassified as swap dealers, hindering end-users' ability to hedge 
market risk while imposing unnecessary costs that eventually will be 
borne by consumers.
Margin Requirements
    As I previously mentioned, the electric power industry is one of 
the most capital-intensive industries in the United States. With our 
industry projected to spend approximately $90 billion a year through 
2015 for major upgrades to the electric system, requiring non-financial 
end-users to post margin could tie up much-needed capital that 
otherwise would be used to invest in local economies. With the lack of 
clarity on whether or not Prudential Regulators and possibly the CFTC 
plan on requiring non-financial end-users to post margin, Congress 
should clarify that it did not intend for margin requirements to apply 
to non-financial end-users.
    In addition, we ask Congress to clarify that it did not intend for 
the CFTC and Prudential Regulators to place limitations on the forms of 
collateral swap dealers and major swap participants can accept from 
non-financial end-users if they agree to collateralize a swap as a 
commercial matter. We support bipartisan legislation that seeks to 
further clarify that end-users are exempt from margin requirements. 
H.R. 634, sponsored by Rep. Michael Grimm (R-NY), passed the House on 
an overwhelmingly bipartisan vote of 411-12. Similar legislation has 
also been introduced in the Senate--S. 888, sponsored by Sen. Mike 
Johanns (R-NE).
Bona Fide Hedging
    On September 28, 2012, the U.S. District Court for the District of 
Columbia vacated final CFTC rules regarding position limits. These 
vacated rules defined the term bona fide hedging. As written in the 
CFTC's rule that was vacated, the definition was unnecessarily narrow 
and would have discouraged a significant amount of important and 
beneficial risk management activity. Specifically, the rule narrowed 
the existing definition considerably by providing that a transaction or 
position that would otherwise qualify as a bona fide hedge also must 
fall within one of eight categories of enumerated hedging transactions, 
a definitional change neither supported in nor required by the Dodd-
Frank Act. This restrictive definition of bona fide hedging 
transactions could disrupt the commodity markets, make hedging more 
difficult and costly, and may increase systemic risk by encouraging 
end-users to leave a relatively large portion of their portfolios un-
hedged.
Financial Entities
    The Dodd-Frank Act defines the term ``financial entity'', in part, 
as an entity that is ``predominantly engaged in activities that are in 
the business of banking, or in activities that are financial in nature, 
as defined in section 4(k) of the Bank Holding Company Act of 1956.'' 
Incorporating banking concepts into a definition that also applies to 
commercial commodity market participants has had unintended 
consequences.
    Unlike our members, banks and bank holding companies generally 
cannot take or make delivery of physical commodities. However, banks 
and bank holding companies can invest and trade in certain commodity 
derivatives. As a result, the definition of ``financial in nature'' 
includes investing and trading in futures and swaps as well as other 
physical transactions that are settled by instantaneous transfer of 
title of the physical commodity. An entity that falls under the 
definition of a ``financial entity'' is generally not entitled to the 
end-user exemption-an exemption that Congress included to benefit 
commercial commodity market participants--and can therefore be subject 
to many of the requirements placed upon swap dealers and major swap 
participants. In addition, the CFTC has used financial entity as a 
material term in numerous rules, no-action relief, and guidance, 
including, most recently, its cross-border guidance. The Dodd-Frank Act 
allows affiliates or subsidiaries of an end-user to rely on the end-
user exception when entering into the swap on behalf of the end-user. 
However, swaps entered into by end-user hedging affiliates who fall 
under the definition of ``financial entity'' cannot take advantage of 
the end-user exemption, despite the fact that the transactions are 
entered into on behalf of the end-user.
    Many energy companies structure their businesses so that a single 
legal entity within the corporate family acts as a central hedging, 
trading and marketing entity--allowing companies to centralize 
functions such as credit and risk management. However, when the banking 
law definitions are applied in this context, these types of central 
entities may be viewed as engaging in activity that is ``financial in 
nature,'' even with respect to physical transactions. Hence, some 
energy companies may be precluded from electing the end-user clearing 
exception for swaps used to hedge their commercial risks and be subject 
to additional regulations applicable to financial entities. 
Importantly, two similar energy companies may be treated differently 
if, for example, one entity uses a central affiliate to conduct these 
activities and another conducts the same activity in an entity that 
also owns physical assets or that has subsidiaries that own physical 
assets. Accordingly, Congress should amend the definition of 
``financial entity'' to ensure that commercial end-users are not 
inadvertently regulated as ``financial entities.''
Inter-Affiliate Transactions
    Currently, the CFTC's rules and proposed rules generally treat 
inter-affiliate swaps like any other swap. Hence, companies must, under 
certain circumstances, report swaps between majority-owned affiliates 
and must submit such swaps to central clearing unless the end-user 
hedging exception applies or complex criteria for the inter-affiliate 
clearing exemption are met. In the absence of a more expansive clearing 
exemption for inter-affiliate trades, the costs of clearing likely 
would deter most market participants from entering into inter-affiliate 
transactions and could create more risk for clearinghouses. For 
example, without an exemption, additional affiliates in a corporate 
family would need to become clearing members or open accounts with a 
Futures Commission Merchant, and all affiliates would need to develop 
and implement redundant risk management procedures and trade processing 
services, such as e-confirm.
    The CFTC has provided some relief in the form of no-action letters. 
However, in many circumstances, these no-action letters do not provide 
adequate relief and frequently cause more confusion and uncertainty 
among end-users. EEI supports bipartisan legislation to clarify the 
requirements placed on inter-affiliate transactions. The Inter-
Affiliate Swap Clarification Act (H.R. 677), which seeks to clarify a 
number of these requirements, has been introduced by Rep. Steve Stivers 
(R-OH) in the House.
    Finally, for the reasons enumerated in the testimony of the 
American Gas Association, we agree that options and forward contracts 
that are intended to be physically settled or contain volumetric 
optionality should be excluded from the definition of a swap.
Conclusion
    Thank you for your leadership and ongoing interest in the issues 
surrounding implementation of the Dodd-Frank Act and their impact on 
commercial end-users. We appreciate your role in helping to ensure that 
electric utilities and energy suppliers can continue to use over-the-
counter derivatives in a cost-effective manner to help protect our 
electricity consumers from volatile wholesale energy commodity prices.
    Again, I appreciate the opportunity to testify and would be happy 
to answer any questions.

    The Chairman. I thank the gentleman. Mr. Monroe for 5 
minutes.

 STATEMENT OF CHRIS MONROE, TREASURER, SOUTHWEST AIRLINES CO., 
                           DALLAS, TX

    Mr. Monroe. Chairman Conaway, Ranking Member Scott, and 
Members of the Subcommittee, thank you for convening this 
hearing. My name is Chris Monroe, and I am the corporate 
Treasurer of Southwest Airlines. I am pleased to be here today 
to explain how the Dodd-Frank Act has caused a major impact to 
a commercial end-user like Southwest Airlines.
    Mr. Chairman, as a Texan, you know we began operating in 
1971 with three planes serving three Texas cities. Back then, 
as now, our purpose was to connect people to what is important 
to their lives with friendly, reliable and affordable air 
transportation. Friendly in this context doesn't just mean 
having nice employees. It means allowing customers to change 
their flights and check a bag without paying a penalty.
    Today, Southwest is the nation's largest domestic airline 
in terms of passengers, and we are the only major airline with 
a truly national route structure that has not gone through 
bankruptcy or imposed mass-employee layoffs or furloughs, or 
reduced workers' wages or benefits.
    One key to our unparalleled success has been our ability to 
hedge fuel through legitimate end-user derivatives purchased in 
the futures markets. Hedging at Southwest is enterprise risk 
management, essential in our view given our $6 billion annual 
fuel bill. To hedge, we commonly enter into transactions many 
months or years in advance of needing the physical product. 
Trading in these illiquid markets allows us to manage our fuel 
costs, which in turn helps us to keep fares low and maintain 
large jet flights in the communities we serve.
    I am here today to highlight a few issues that have begun 
to impact these important markets that companies such as 
Southwest rely on to manage risk. One area we are seeing 
negative commercial impact is the CFTC's Real-Time Reporting 
Rule. That regulation prescribes the maximum time delay before 
swap trade data is publicly disseminated. The prescribed time 
delays may be sufficient for liquid markets, but the timeframes 
are not sufficient for illiquid markets, which, as I said 
before, is where Southwest commonly trades. Only a few market 
participants trade that far out on the curve, which makes 
contracts highly illiquid, even in contracts that may be liquid 
in the front months such as crude oil.
    Additionally, Southwest has a particularly identifiable 
trading strategy, a hedging DNA if you will, which makes us 
quite visible in a market with few participants. This is 
particularly harmful. It is my understanding that Dodd-Frank 
expressly mandated that the identity of legitimate end-users 
like Southwest would be kept confidential and for good reasons 
as will become clear.
    When a dealer has to report illiquid trades to the market 
quickly, the dealer is less likely to be able to lay off the 
risk of that trade in the prescribed time. If the dealer is 
still holding a large amount of risk when the trade is shown to 
the public, the dealer can be front-run and, as a result, take 
a loss on the trade. That increased risk to the dealer will 
either curtail trades or materially increase the costs of the 
trade to the end-users. If an end-user like Southwest can no 
longer access the markets to hedge fuel, it would be contrary 
to the purposes of the legislation and in our view hostile to 
Congressional intent.
    Since the rule became effective, Southwest is already 
seeing changes in market behavior and swap pricing. A recent 
trade cost Southwest an additional 35 basis points in spread. 
Applying that additional 35 basis points in cost to typical 
volumes traded by Southwest in illiquid areas of the crude 
curve and in illiquid products such as jet fuel, will add 
roughly $60 million in annual costs. Following the rule's 
implementation, Southwest heard from dealers who plainly were 
aware of our trades that we had entered into that will settle 
in 2015 and beyond.
    Southwest does not object to real-time reporting of swap 
transactions to the CFTC. We support transparency. However, 
based on the fact that liquidity diminishes further out in 
time, there is a point where the benefits derived from public 
reporting do not outweigh the detriment to those who are 
trading illiquid contracts as the market participants become 
easier to identify, ultimately allowing others to take 
advantage of their market position.
    In conclusion, it would be fair to say that neither the 
drafters of Dodd-Frank nor the CFTC officials intended to 
impede Southwest's ability to hedge our high fuel costs as a 
legitimate end-user, but unfortunately this has been the result 
of the Real-Time Reporting Rule. I look forward to today's 
discussion on this issue as well as other issues affecting 
commercial end-users. We also encourage the Subcommittee to 
consider legislative solutions to address the unintended 
consequences of the Real-Time Reporting Rule.
    Thank you for this opportunity to testify, and I look 
forward to answering your questions.
    [The prepared statement of Mr. Monroe follows:]

Prepared Statement of Chris Monroe, Treasurer, Southwest Airlines Co., 
                               Dallas, TX
    Chairman Conaway, Ranking Member Scott, and Members of the 
Subcommittee, thank you for convening this hearing. My name is Chris 
Monroe and I am the corporate Treasurer of Southwest Airlines. I am 
pleased to be here today to explain how the Dodd-Frank Act has caused a 
major impact to a commercial end-user like Southwest Airlines.
    Mr. Chairman, as a Texan you know we began operating in 1971 with 
three planes serving three Texas cities. Back then, as now, our purpose 
was to connect people with what's important to their lives with 
friendly, reliable, and affordable air transportation. ``Friendly'' in 
this context doesn't just mean having nice Employees. It means allowing 
Customers to change their flights and check a bag without paying a 
penalty.
    Today, Southwest is the nation's largest domestic airline in terms 
of passengers. We are the ONLY major airline with a truly national 
route structure that has not gone through bankruptcy, or imposed mass-
Employee layoffs or furloughs, or reduced workers' wages and benefits. 
One key to our unparalleled success has been our ability to hedge fuel 
through legitimate end-user derivatives purchased in the futures 
markets. Hedging at Southwest is enterprise risk management--essential 
in our view given our $6 billion annual fuel bill. To hedge, we 
commonly enter into transactions many months or years in advance of 
needing the physical product. Trading in these illiquid markets allows 
us to manage our fuel costs, which in turn helps us to keep fares low 
and maintain large jet (Boeing 737) flights in the communities we 
serve.
    I am here today to highlight a few issues that have begun to impact 
these important markets that companies such as Southwest relay on to 
manage risk. One area where we are seeing a negative commercial impact 
is the Commodity Futures Trading Commission's (``CFTC's'') Real-Time 
Public Reporting of Swap Transaction Data Rule (``Real-Time Reporting 
Rule''). That regulation prescribes the maximum time delay before swap 
trade data is publicly disseminated. Under this rule, swap dealers and 
major swap participants (generally referred to as ``dealers'') have a 
much shorter time in which to report trade data after execution than 
trades between two commercial end-users. Importantly, trades between a 
legitimate commercial end-user and a dealer must be reported within the 
dealer's shorter time limit. Given that the vast majority of bilateral 
trades entered into by commercial end-users are transacted with a 
dealer, this means nearly all commercial end-user trades are reported 
on the accelerated time limit.
    The dealer time delays may be sufficient for liquid markets, but 
the timeframes are not sufficient for illiquid markets, which, as I 
said before, is where Southwest commonly trades. Only a few market 
participants trade that far out the curve, which makes the contracts 
highly illiquid, even in contracts that may be liquid in the front 
months such as crude oil. Additionally, Southwest has a particularly 
identifiable trading strategy, a hedging ``DNA'' if you will, which 
makes us quite visible in a market with few participants. This is 
particularly harmful. It is my understanding that Dodd-Frank expressly 
mandated that the identity of legitimate end-users like Southwest would 
be kept confidential--and for good reasons as will become clear.
    When a dealer has to report illiquid trades to the market quickly, 
the dealer is less likely to be able to lay off the risk of that trade 
in the prescribed time. If the dealer is still holding a large amount 
of the risk when the trade is shown to the public, the dealer can be 
front-run and, as a result, take a loss on the trade. That increased 
risk to the dealer will either curtail trades or materially increase 
the costs of the trade to the end-users.) If an end-user like Southwest 
can no longer access the markets to hedge fuel it would be contrary to 
the purposes of the legislation and in our view hostile to 
Congressional intent.
    Since the rule became effective, Southwest is already seeing 
changes in market behavior and swap pricing. A recent trade cost 
Southwest an additional 35 basis points in spread. Applying an 
additional 35 basis points in cost to the typical volumes traded by 
Southwest--in illiquid areas of the crude curve and in illiquid 
products such as jet fuel--will add roughly $60 million in annual 
costs. Following the rule's implementation, Southwest heard from 
dealers who plainly were aware of trades we had entered into that will 
settle in 2015.
    Southwest does not object to real-time reporting of swap 
transactions to the CFTC. We support transparency. However, based on 
the fact that liquidity diminishes further out in time, there is a 
point where the benefits derived from public reporting do not outweigh 
the detriment to those who are trading illiquid contracts as the market 
participants become easier to identify, ultimately allowing others to 
take advantage of their market position.
    Other issues still open for debate at the regulatory level which 
have the potential to completely change how we hedge relate to margin 
for uncleared swaps. Congress clearly intended to exempt commercial 
end-users from mandatory minimum margin requirements to retain the 
flexibility of end-users and their counterparties to avoid 
unnecessarily tying up scarce working capital. In that vein, Congress 
included specific language in Dodd-Frank \1\ to allow non-cash 
collateral to be posted as margin as agreed to by the counterparties. 
This is an important practice to Southwest, as we use unencumbered 
assets such as aircraft to collateralize our hedge positions. This 
allows us to retain cash in the company to invest in our business, grow 
our route network, and create new jobs, and keep our fares low for 
customers. However the proposed rule related to uncleared margin 
requirements from the Prudential Regulators, who regulate nearly all of 
our trading counterparties, seems to both require commercial end-users 
to post margin and explicitly disallows the use of non-cash collateral 
as margin. We believe all involved regulatory bodies should follow the 
intent of Congress and retain the flexibility in counterparty trading 
relationships with respect to margin for commercial end-users.
---------------------------------------------------------------------------
    \1\ Within Section 731 of the Dodd-Frank Act:

      ``(D) Comparability of capital and margin requirements.--

        ``(i) In general.--The prudential regulators, the Commission, 
and the Securities and Ex-
    change Commission shall periodically (but not less frequently than 
annually) consult on
    minimum capital requirements and minimum initial and variation 
margin requirements.
        ``(ii) Comparability.--The entities described in clause (i) 
shall, to the maximum extent
    practicable, establish and maintain comparable minimum capital 
requirements and min-
    imum initial and variation margin requirements, including the use 
of non cash collateral,
    for--

          ``(I) swap dealers; and
          ``(II) major swap participants''
---------------------------------------------------------------------------
    In conclusion, it would be fair to say that neither the drafters of 
Dodd-Frank nor the CFTC officials intended to impede Southwest's 
ability to hedge our high fuel costs as a legitimate end-user, but 
unfortunately that has been the result of the Real-Time Reporting Rule. 
I look forward to today's discussion on this issue as well as other 
issues affecting commercial end-users. We also encourage the 
Subcommittee to consider legislative solutions to address the 
unintended consequences of the Real-Time Reporting Rule.
    Thank you for this opportunity to testify and I look forward to 
answering your questions.

    The Chairman. Thank you, sir. Mr. Soto for 5 minutes.

          STATEMENT OF ANDREW K. SOTO, SENIOR MANAGING
           COUNSEL, REGULATORY AFFAIRS, AMERICAN GAS
                 ASSOCIATION, WASHINGTON, D.C.

    Mr. Soto. Chairman Conaway, Ranking Member Scott, Members 
of the Subcommittee, thank you for inviting me to appear before 
you today. I am here on behalf of the American Gas 
Association's more than 200 local energy companies that deliver 
clean natural gas throughout the United States. As Raking 
Member Scott had indicated earlier at the opening of this 
hearing, we believe that gas utilities, large and small, pose 
little or no systemic risk to the nation's financial system.
    AGA has worked cooperatively with the CFTC and its staff 
throughout the rule-making process to implement the Dodd-Frank 
Act, and we appreciate the magnitude and difficulty of the 
task. However, from a business perspective, regulatory 
certainty is essential for planning and compliance. And let me 
just take the example of the swap definition as an area of 
uncertainty. What is and what isn't a swap is fundamental to 
the whole regulatory regime, and yet throughout the process, 
there has been an evolution of what transactions fall in and 
fall out. There was a three-part test for certain forwards that 
were excluded, and then in the interim final rule, the last 
discussion on the subject, there was a further seven-part test 
and the Commission asked for additional comments. They have not 
yet acted on those comments, and as a result, there is 
tremendous confusion and disagreement in the energy industry as 
to which type of gas supply transactions will be subject to the 
CFTC's regulations.
    Consequently, some industry counterparties have taken the 
view that they will treat all of their energy transactions that 
contain any option or choice for one of the parties as a trade 
option. Other counterparties are insisting on contract 
provisions to be included in their contracts to force agreement 
as to how the transactions should be treated. One of my members 
has told me that they have entered into routine transactions 
with multiple counterparties where the different counterparties 
themselves have conflicting interpretations of what are 
essentially identical contracts.
    Uncertainty is hampering business planning and compliance 
and is disrupting contracting practices in the industry, and it 
also hampers the CFTC's ability to be an effective market 
monitor. Therefore, we believe that the CFTC and the industry 
would benefit greatly from additional administrative processes 
whereby industry participants could obtain in a timely manner 
the kind of regulatory certainty they need for planning and 
compliance and challenge agency action if necessary.
    In particular, we offer the following three 
recommendations. First, AGA recommends that Congress amend the 
Commodity Exchange Act to provide clear and defined procedures 
for challenging CFTC rules and orders in a United States Court 
of Appeals. A broad judicial review provision allowing for the 
direct challenge of CFTC rules and orders would both have a 
rehabilitative effect on problems with the current process and 
a prophylactic effect in strengthening the agency's rule-making 
process.
    Second and relatedly, AGA recommends that Congress provide 
direct judicial review of jurisdictional disputes between the 
Commodity Futures Trading Commission and the Federal Energy 
Regulatory Commission. For energy end-users such as AGA's 
members, the main source of frustration with the CFTC's 
implementation of the Dodd-Frank Act has been a lack of 
regulatory certainty as to whether physical transactions 
traditionally regulated by FERC would now be subject to CFTC 
regulation as swaps. Industry participants would greatly 
benefit by clearly defined scopes of jurisdiction between the 
two agencies.
    Third, AGA recommends that Congress require the CFTC to 
provide better internal administrative processes for interested 
parties to see clarity and guidance on agency issues. Under 
current CFTC rules, there are insufficient avenues available 
for the public to obtain timely definitive guidance in the form 
of a final agency action. As a result, parties have relied on 
staff action in the form of no action or exceptive relief, 
interpretive guidance and/or interpretations by the General 
Counsel to obtain necessary clarification of the agency rules. 
And this is the point I believe that Commissioner O'Malia had 
made at yesterday's hearing.
    AGA believes that the inclusion of administration process 
reforms in the CFTC's governing statutes and rules would have a 
positive impact on the agency's ability to be a responsive and 
effective regulator. And we would be pleased to provide the 
Committee with specific recommendations at your request.
    I thank you for the consideration of this testimony and 
look forward to answering any questions you might have.
    [The prepared statement of Mr. Soto follows:]

    Prepared Statement of Andrew K. Soto, Senior Managing Counsel, 
     Regulatory Affairs, American Gas Association, Washington, D.C.
    Chairman Conaway, Ranking Member Scott, and Members of the 
Committee, I am Andrew K. Soto, Senior Managing Counsel for Regulatory 
Affairs at the American Gas Association (AGA). Founded in 1918, AGA 
represents more than 200 local energy companies that deliver clean 
natural gas throughout the United States. More than 65 million 
residential, commercial and industrial natural gas customers, or more 
than 175 million Americans, receive their gas from AGA members. In my 
role at AGA, I represent the interests of AGA's members before a 
variety of Federal agencies, including the Commodity Futures Trading 
Commission (CFTC).
    Thank you for inviting me to appear before you today on the issue 
of the impact of the CFTC's implementation of the Dodd-Frank Wall 
Street Reform and Consumer Protection Act on non-financial entities or 
end-users. AGA member companies are end-users of futures and swaps in 
that they use such financial instruments to hedge and mitigate their 
commercial risks, in particular price volatility associated with 
procuring natural gas commodity supplies for their customers. AGA 
members have an interest in transparent and efficient financial markets 
for energy commodities, so that they can engage in risk management 
activities at reasonable cost for the benefit of America's natural gas 
consumers. We believe Congress intended in the Dodd-Frank Act to 
protect end-users' ability to use financial transactions to hedge and 
mitigate commercial risk in recognition of the fact that non-financial 
end-users did not cause the financial crisis that led to the passage of 
the Dodd-Frank Act and pose little or no systemic risk to the financial 
system.
    My testimony will address three areas. First, I will explain the 
importance of transparent and efficient financial markets to gas 
utilities that procure and deliver clean, affordable natural gas to 
their customers. Second, I will address the impact of the CFTC's 
implementation of the Dodd-Frank Act on gas utilities' ability to enter 
into financial and physical contracts to manage commercial risks 
associated with the business of procuring natural gas. Third, I will 
recommend administrative process reforms, which we believe will help 
make the CFTC a more responsive regulator and provide additional 
avenues to obtain regulatory certainty, which is essential for business 
planning and compliance.
Gas Utility Reliance on Financial Markets
    AGA member companies provide natural gas service to retail 
customers under rates, terms and conditions that are regulated at the 
local level by a state commission or other regulatory authority with 
jurisdiction. Each year, natural gas utilities develop seasonal plans 
to reliably meet the gas supply needs of their retail customers. Gas 
utilities build and manage a portfolio of physical gas supplies and 
services in order to meet anticipated demand. A portfolio of assets and 
contracts may include natural gas supply contracts, pipeline 
transportation storage and no-notice services, and on-system assets 
such as natural gas storage, liquefied natural gas storage, and propane 
air storage. Because a significant portion of customer demand is 
weather driven, gas utilities cannot know with certainty when, or even 
if, a certain amount of the gas supplies they make plans to have access 
to will be needed. Gas utilities, therefore, typically enter into 
certain gas supply contracts with flexible delivery terms as part of 
their supply portfolios in order to meet demand swings driven by 
variable customer loads throughout the season or year. Factors 
affecting variable loads include expected and unexpected volatility in 
customer demand, weather events, constraints or disruptions to 
alternative sources of supply, and heightened seasonal (winter) demand 
fluctuations. Flexible delivery terms are an essential element of some 
of the gas supply contracts used to meet variable system load 
requirements.
    Gas utilities have a strong interest in managing their supply 
portfolios to ensure that the overall cost for natural gas service 
remains stable and at a reasonable cost to their customers. Gas 
utilities are commercial entities exposed to commodity risks, most 
especially the price of natural gas commodities. In addition to their 
physical transaction activities, many gas utilities use a variety of 
financial tools such as futures and financial derivatives or ``swaps'' 
to hedge against volatility in natural gas commodity costs. In general, 
gas utilities forecast the anticipated demand on their systems and 
assess the underlying physical exposure associated with that demand. 
Many gas utilities then determine if financial instruments are 
appropriate to mitigate all or a portion of that exposure. Some gas 
utilities are required by state regulatory agencies to hedge a portion 
of forecasted demand to manage potential price volatility. These 
activities are not speculative in nature; rather, gas utilities enter 
into financial transactions to hedge or mitigate commercial risk 
associated with forecasted demand. As such, the financial transactions 
of gas utilities pose little or no systemic risk to the financial 
markets.
End-User Issues with CFTC Implementation of the Dodd-Frank Act
    As noted above, regulatory certainty is essential for business 
planning and compliance. To illustrate the difficulty energy end-users 
like gas utilities have encountered in preparing to comply with the 
CFTC's regulations implementing the Dodd-Frank Act, let me use the 
agency's definition of a ``swap'' as an example. At the outset, it is 
important to note that the entire foundation of the CFTC's regulation 
of the financial derivatives market rests on what is or is not 
considered a ``swap.'' Who is or is not a swap dealer or major swap 
participant, what transactions are required to be cleared, what 
transactions are required to be reported, what transactions are subject 
to position limits, etc., all rest on the definition of a ``swap.'' 
Many parties, including AGA, initially suggested that the CFTC define 
``swap'' at the beginning of its implementation of the Dodd-Frank Act, 
so that market participants would have a clear understanding of the 
scope of the regulations as the whole regulatory framework was being 
developed. Instead, the CFTC did not issue a final rule defining 
``swap'' until August 2012, more than 2 years after the Act was passed, 
and issued only an ``interim'' final rule at that. Even now, toward the 
end of its process, the CFTC has yet to define the parameters of its 
``swap'' definition in a manner that can be clearly and consistently 
applied within the gas industry.
    To give you a better sense of what is at stake, let me walk through 
the development of the ``swap'' definition as it relates to natural gas 
market participants. In August 2010, the CFTC issued an Advance Notice 
of Proposed Rulemaking,\1\ requesting public comment on the key 
definitions that would be used to establish the framework for 
regulating swaps. The proposal did little more than reference the 
statutory definition of ``swap,'' providing no views on what the agency 
considered the scope of the definition to be. After a round of public 
comment, in May 2011, the CFTC issued a Proposed Rule and Proposed 
Interpretations regarding the ``swap'' definition.\2\ There, the CFTC 
proposed to exclude forward contracts in non-financial commodities from 
the definition of a ``swap'' under the Dodd-Frank Act, consistent with 
its historical interpretation of the forward contract exclusion under 
the Commodity Exchange Act. The CFTC explained that forward contracts 
with respect to non-financial commodities were commercial merchandising 
transactions where the primary purpose is to transfer ownership of the 
commodity and not to transfer solely the price risk. The CFTC noted 
that it had previously established an Energy Exemption for certain 
types of transactions that were not considered futures. The CFTC then 
proposed an interpretation to withdraw as unnecessary this Energy 
Exemption.
---------------------------------------------------------------------------
    \1\ Definitions Contained in Title VII of Dodd-Frank Wall Street 
Reform and Consumer Protection Act, 75 Fed. Reg. 51429 (Aug. 20, 2010).
    \2\ Further Definition of ``Swap,'' ``Security-Based Swap,'' and 
``Security-Based Swap Agreement,''; ``Mixed Swaps; Security-Based Swap 
Agreement record-keeping,'' 76 Fed. Reg. 29818 (May 23, 2011).
---------------------------------------------------------------------------
    The CFTC believed that the statutory definition of ``swap'' 
explicitly provided that commodity options are ``swaps.'' Thus, for 
non-financial commodity options embedded in forward contracts, the CFTC 
established a three-part test. The CFTC explained that a transaction 
will be considered an excluded forward contract (and not a swap) where 
the non-financial embedded option: (1) may be used to adjust the 
forward contract price, but does not undermine the overall nature of 
the contract as a forward contract; (2) does not target the delivery 
term, so that the predominant feature of the contract is actual 
delivery; and (3) cannot be severed and marketed separately from the 
overall forward contract in which it is embedded. The CFTC added that 
conversely, where the embedded option renders delivery optional, the 
predominant feature of the contract cannot be actual delivery, and the 
embedded option to not deliver precludes treatment of the contract as a 
forward contract. The CFTC then sought public comment on all aspects of 
its proposed definitions and interpretations.
    The CFTC's proposed rule generated considerable confusion in the 
natural gas industry as market participants began to wonder whether 
their commercial merchandising transactions, particularly those with 
flexible delivery terms, would be considered ``swaps'' under the CFTC's 
proposed interpretation. Numerous comments were filed seeking 
clarification as to whether particular types of transactions would be 
considered ``swaps.'' AGA, for its part, filed comments explaining that 
gas utilities enter into physical gas supply transactions with flexible 
delivery terms as important elements of their ability to meet their 
customers' needs at a reasonable cost. Because gas consumption to 
residential and commercial customers is largely weather-driven 
(consumption increases as the weather gets colder) and predicting the 
weather is not an exact science, gas supply contracts with delivery 
flexibility help AGA members make sure gas supplies are, or can be 
made, available when the customers actually need the gas without having 
to pay excessively higher prices at the actual time of need and/or 
other fees associated with pipeline imbalance penalties.
    In August 2012, almost 2 years later, the CFTC issued an interim 
final rule, further interpretations, and a request for comment on the 
interpretations.\3\ The CFTC provided additional guidance on the scope 
of its forward contract exclusion. In particular, the CFTC established 
a seven-part test that it would apply in determining whether a contract 
with flexible delivery terms would be regulated as a ``swap'' or 
excluded as a forward contract. The CFTC then provided further 
interpretations responding to the requests to clarify whether certain 
types of transactions would be considered, and regulated as, ``swaps.'' 
Notably, the CFTC sought to clarify that certain physical commercial 
transactions for natural gas pipeline transportation and storage 
service agreements would not be considered options, and thus would not 
be regulated as ``swaps,'' if they met a three-part test. However, the 
CFTC added that if such transportation and storage agreements employed 
a certain two-part rate structure, such agreements would be considered 
options subject to swap regulation. The CFTC then believed that these 
interpretations would benefit from further public input and requested 
additional comments.
---------------------------------------------------------------------------
    \3\ Further Definition of ``Swap,'' ``Security-Based Swap,'' and 
``Security-Based Swap Agreement''; ``Mixed Swaps''; ``Security-Based 
Swap Agreement record-keeping,'' 77 Fed. Reg. 48208 (Aug. 13, 2012).
---------------------------------------------------------------------------
    More confusion reigned. Was the rule final or only interim? How 
should the seven-part test be applied? What do some of the elements 
mean? Did the CFTC really intend to regulate as ``swaps'' all natural 
gas pipeline transportation and storage agreements with two-part rates? 
Again, numerous comments were filed seeking clarification of the CFTC's 
rules and interpretations. Many comments focused on whether pipeline 
transportation and storage agreements, long regulated exclusively by 
the Federal Energy Regulatory Commission (FERC) under the Natural Gas 
Act, would be considered options and subject to the CFTC's swap 
regulations. In November 2012, the CFTC's Office of General Counsel 
(OGC) issued a Response to Frequently Asked Questions Regarding Certain 
Physical Commercial Agreements for the Supply and Consumption of 
Energy. In essence, OGC staff stated that if a pipeline transportation 
or storage agreement with a two-part rate structure met an additional 
five-part test, the transaction would not be considered an option and 
thus not subject to regulation as a ``swap.'' Apart from this staff 
action aimed solely at clarifying the two-part rate issue for pipeline 
transportation and storage contracts, the CFTC has not acted on the 
comments it received in response to its request for further public 
input on the ``swap'' definition and interpretations.
    Relatedly, in April 2012, the CFTC issued an interim final rule 
holding that certain commodity options would be considered ``trade 
options'' if they met a three-part test. Trade options, while regulated 
by the CFTC, would not be subject to the full panoply of regulations 
established for ``swaps.'' Notably, trade options would be subject to 
significantly less intense reporting requirements for counterparties 
that are not already required to report their swaps. Once again, 
several comments were filed in response to the interim final rule, yet 
the CFTC has not issued any further interpretations or clarifications 
regarding trade options, although the CFTC's staff has issued no-action 
relief regarding trade option reporting.
    In the absence of clear guidance from the CFTC, numerous parties, 
including AGA, have filed requests for interpretive guidance and/or no-
action relief from CFTC staff as deadlines for reporting and other 
compliance obligations have approached. Many of these requests remain 
outstanding and have not been acted upon by the CFTC or its staff.
    Where does that leave us? There remain disagreements and confusion 
within the natural gas industry as to which types of gas supply 
transactions, if any, will be subject to CFTC regulation. These 
transactions are normal commercial merchandising transactions that 
parties use to buy and sell natural gas for ultimate delivery to end-
use customers. They would not normally be considered speculative, 
financial transactions as the parties contemplate physical delivery of 
the commodity. Nevertheless, transactions that contain some option or 
choice for one or the other counterparty, raise questions for some as 
to whether they would be considered commodity options regulated as 
swaps, meet a three part test and a seven-part test to be excluded as 
options embedded in forward contracts, be viewed as trade options 
subject to a lessened reporting burden, or be considered facility use 
agreements that meet a three-part test and then a five-part test and 
not subject to regulation at all. Some counterparties in the industry 
have taken the view that regardless of whether a transaction would 
satisfy the seven-part test for options embedded in forward contracts, 
they will report all such transactions as trade options out of an 
abundance of caution to avoid the risk of a violation of the CFTC's 
rules. Other counterparties have insisted upon contract provisions to 
force agreement as to the regulatory treatment of the transaction. Some 
AGA member companies, in the normal course of business, have entered 
into routine transactions with multiple counterparties where the 
different counterparties have conflicting regulatory interpretations of 
what are essentially identical contracts. Thus, normal contracting 
practices in the natural gas industry have been seriously disrupted.
    Until the CFTC provides definitive rules clarifying the regulatory 
treatment of these transactions, turmoil in the industry will continue. 
Moreover, the different interpretations and understandings of the 
CFTC's scope of the ``swap'' definition is, and will continue to, lead 
to inconsistent reporting of swap transactions to swap data 
repositories and to the CFTC.
Administrative Process Reforms
    AGA and its members have been frustrated in their efforts to obtain 
regulatory certainty from the CFTC in its implementation of the Dodd-
Frank Act. Uncertainty with regard to something so fundamental to 
derivatives regulation as what is and what is not a ``swap,'' is 
hampering business planning and compliance and disrupting contracting 
practices in the industry. It also hampers the CFTC's ability to be an 
effective market monitor and regulator. AGA believes that the CFTC and 
the industry would benefit greatly from additional administrative 
processes whereby industry participants could obtain in a timely manner 
the kind of regulatory certainty they need for business planning and 
compliance, and could challenge agency action if necessary. In 
particular, we offer the following recommendations:
    First, AGA recommends that Congress amend the Commodity Exchange 
Act (CEA) to provide clear and defined procedures for challenging CFTC 
rules and orders in court. Although the CEA currently contains 
provisions allowing for judicial review by a U.S. Court of Appeals of 
certain agency actions, the provisions are very limited and provide no 
defined avenue for challenging CFTC rules and orders generally. A broad 
judicial review provision allowing for the direct challenge of CFTC 
rules and orders would have both a rehabilitative effect on the current 
process and a prophylactic effect on future agency action. Specific 
judicial review provisions would allow interested parties to challenge 
particular agency actions that are unreasonable and hold the CFTC 
accountable for its decisions. In addition, judicial review would have 
an important prophylactic effect by requiring the agency to think 
through its decisions before they are made to ensure that they are 
sustainable in court, thus enabling the agency to be a more 
conscientious and prudent regulator. In the absence of specific 
judicial review provisions, the general review provisions of the 
Administrative Procedure Act (APA) would apply, requiring parties 
seeking to challenge CFTC rules to file a claim before a U.S. District 
Court, move for summary judgment (as a hearing would likely be 
unnecessary), obtain a ruling and then, if necessary, seek further 
judicial review before a U.S. Court of Appeals. In the recent 
litigation over the CFTC's position limits rule, which followed the 
review provisions of the APA, the CFTC's General Counsel acknowledged 
the efficiency and desirability of direct review by the U.S. Court of 
Appeals of agency rules, and stated that the agency would have no 
objection to such direct review assuming Congress were to authorize 
it.\4\ Accordingly, provisions allowing for direct review by a U.S. 
Court of Appeals of rules and orders of the CFTC would enable both the 
industry and the agency to benefit from the administrative economy, 
procedural efficiency and certainty of having a dedicated forum in 
which agency decisions are reviewed.
---------------------------------------------------------------------------
    \4\ See Motion of Respondent to Dismiss for Lack of Subject Matter 
Jurisdiction, Doc. #1350987 at pp. 2, 4, International Swaps and 
Derivatives Ass'n et al. v. CFTC, No. 11-1469 (D.C. Cir. 2012) (stating 
that ``direct review in [the U.S. Court of Appeals] would serve the 
interests of judicial economy'' and that ``the Commission recognizes 
the benefits of direct appellate review in these circumstances and 
would have no objection to such review.''); Reply of Respondent in 
Further Support of Motion to Dismiss, Doc. #1353103 at pp. 2 n. 1, 
International Swaps and Derivatives Ass'n et al. v. CFTC, No. 11-1469 
(D.C. Cir. 2012).
---------------------------------------------------------------------------
    Second, and relatedly, AGA recommends that Congress provide direct 
judicial review of jurisdictional disputes between the CFTC and the 
FERC. In the Dodd-Frank Act, Congress directed the two agencies to 
enter into a Memorandum of Understanding within 180 days of enactment 
of the legislation, in order to resolve conflicts concerning 
overlapping jurisdiction and to avoid, to the extent possible, 
conflicting or duplicative regulations.\5\ More than 3 years has 
passed, and no such memorandum has been negotiated by the two agencies. 
For energy end-users such as AGA's member gas utilities, the main 
source of frustration with the CFTC's implementation of the Dodd-Frank 
Act has been the lack of regulatory certainty as to whether physical 
transactions traditionally regulated by FERC would now be subject to 
CFTC regulation as ``swaps.'' Industry participants would benefit 
greatly by clearly defined scopes of jurisdiction as between the two 
agencies. Congress has already provided mechanisms for the judicial 
review of disputes between the CFTC and the SEC regarding swaps and 
security-based swaps (Section 712(c)) \6\ and novel derivative products 
that may have elements of both securities and futures (Section 718).\7\ 
We encourage Congress to provide similar mechanisms with regard to 
jurisdictional issues as between the CFTC and the FERC.
---------------------------------------------------------------------------
    \5\ Dodd-Frank Wall Street Reform and Consumer Protection Act, P.L. 
No. 111-203,  720 (2010).
    \6\ Dodd-Frank Wall Street Reform and Consumer Protection Act, P.L. 
No. 111-203,  712 (2010).
    \7\ Dodd-Frank Wall Street Reform and Consumer Protection Act, P.L. 
No. 111-203,  718 (2010).
---------------------------------------------------------------------------
    Third, AGA recommends that Congress require the CFTC to provide 
better administrative processes for interested parties to seek clarity 
and guidance on agency issues. Under current CFTC rules, there are 
insufficient avenues available for the public to obtain timely, 
definitive guidance in the form of final agency action, particularly as 
to the impacts of the CFTC's regulations on commercial end-users. As a 
result, parties have relied on staff action in the form of no-action or 
exemptive relief, interpretive guidance, and/or interpretations by the 
General Counsel to obtain necessary clarifications of the agency's 
rules. These avenues are less than satisfying in that they reflect only 
the views of staff and not those of the Commissioners themselves. The 
CFTC should provide commercial market participants with specified 
administrative processes in which to obtain definitive guidance from 
the agency on a timely basis.
    AGA believes that the inclusion of administrative process reforms 
in the CFTC's governing statutes and rules would have a positive impact 
on the agency's ability to be a responsive and effective regulator. AGA 
would be pleased to provide the Committee with supplemental information 
on specific mechanisms to achieve these goals.
    Thank you for your consideration of these comments.

    The Chairman. Thank you, Mr. Soto. Mr. Guilford?

   STATEMENT OF GENE A. GUILFORD, NATIONAL & REGIONAL POLICY 
             COUNSEL, CONNECTICUT ENERGY MARKETERS
   ASSOCIATION, CROMWELL, CT; ON BEHALF OF COMMODITY MARKETS 
                      OVERSIGHT COALITION

    Mr. Guilford. Honorable Chairman Conaway, Ranking Member 
Scott, and distinguished Members of the Subcommittee, on behalf 
of the Commodity Market Oversight Coalition, CMOC, we wish to 
thank you for the opportunity to appear before you today on the 
matter of the Commodity Futures Trading Commission and to 
address matters relating to the CFTC's authorities regulating 
the activities in the commodity markets and the impact of those 
activities on end-users.
    The Commodity Market Oversight Coalition, CMOC, is a non-
partisan alliance of organizations that represent commodity-
dependent American industries, businesses, end-users and 
consumers. We are the farmers, truckers, heating oil retailers, 
Mom and Pop gas station operators, airlines and others who rely 
on transparent, functional and stable commodity markets in 
which to hedge our operations for the mutual benefits of those 
who deliver tangible goods to markets and from which we take 
delivery of tangible goods, as well as for the benefit of the 
millions of consumers that we serve. Our members rely on 
functional transparent and competitive commodity derivatives 
markets as a hedging and price discovery tool. As a coalition, 
we favor government policies that promote stability and 
confidence in the commodity markets, seek to prevent fraud, 
manipulation and excessive speculation and preserve the 
interests of bona fide hedgers and American consumers. Since 
its inception in 2007, our coalition and its member 
organizations have delivered testimony and written 
Congressional leaders in support of many of the reforms in 
Dodd-Frank and in legislation prior to Dodd-Frank's enactment. 
And though while Dodd-Frank was indeed historic legislation, it 
was not perfect, and Title VII reforms in which we spent the 
majority of our time were no exception.
    Even with its imperfections, one cannot say that Dodd-Frank 
was unnecessary or that that new authorities granted to the 
CFTC under the Act were inappropriate. In the mid-1990s, the 
over-the-counter derivatives market had a notional value of 
between $20 trillion and $25 trillion. Today the derivatives 
markets notional value exceeds $600 trillion. But even in the 
early 1990s, there had been episodes of fraud, Bankers Trust, 
Procter & Gamble, Gibson Greeting Cards. Bankers Trust had 
defrauded some of its derivatives customers, and second, there 
was evidence of manipulation in the markets. Sumitomo 
Corporation had managed to manipulate the world market in 
copper in part using the over-the-counter derivatives markets 
to disguise its operation and fund them. Later and after the 
fact there were other incidents of market manipulation 
discovered involving Enron and the electricity markets, 
Amaranth and natural gas, BP and propane, and crude oil.
    When accepting the John F. Kennedy Profiles of Courage 
Award in 2009, former CFTC chair, Brooksley Born, stated, 
``Special interest in the financial services industry are 
beginning to advocate a return to business as usual and to 
argue against the need for any serious reform. We have to 
muster the political will to overcome these special interests. 
If we fail now to take the remedial steps to close the 
regulatory gaps, we will be haunted by our failure for years to 
come.''
    We, too, express concerns about what Dodd-Frank has done in 
our markets and certainly what it has had for impacts on our 
companies and our customers. That, however, doesn't mean we 
should do nothing, but it does mean that there are things that 
we should address. And we look forward to working with the 
Committee in the following areas that we would recommend 
specific attention be given. Number one is manipulation and 
excessive speculation. The Subcommittee should examine the 
efficacy of the October 18, 2011, position limits rule. As we 
all know, the Federal court remanded that back to the agency 
last year because there was a conflict between two different 
parts of the statute with regard to whether or not position 
limits could be in effect immediately or whether position 
limits were subject to an appropriate and necessary clause. The 
Federal court remanded it back to the agency in order to go 
back and touchstone. We need to clarify that.
    Number two, our index funds. The Subcommittee should 
inquire within the CFTC of its progress in implementing the 
recommendations of the bipartisan PSI staff report in 
addressing end-user concerns over index fund speculation.
    High-frequency trading. We urge the Committee to 
investigate the role of high-frequency trading and other 
potentially harmful or disruptive new trends in commodity 
markets and determine whether or not additional CFTC authority 
is required to deal with the potential impacts of high-
frequency trading.
    Penalties. We believe the Subcommittee should consider 
extending the statute of limitations for the CFTC from its 
present 5 years to a minimum of 10 years for its 
investigations.
    Bankruptcy protections. In light of MF Global and 
Peregrine, we recommend the Committee--we would like to work 
with the Committee rather on the extension of the Securities 
Investor Protection Act to clients.
    The trade option exemption is one that impacts a number of 
our members because it has a limitation of a $10 million net 
worth requirement with a separate $1 million net worth 
requirement for bona fide hedgers, and frequently our companies 
are small enough so they fall below that threshold. We would 
like to see that changed so that we continue to have access to 
engage in trades.
    The Energy and Environmental Markets Advisory Committee was 
created in 2008, yet it hasn't met since 2009. We think the 
CFTC would benefit greatly by the advice of those who were 
actually in the industry.
    And with that, I would like to thank you for your time and 
attention and I would be happy to answer any questions you may 
have, Mr. Chairman.
    [The prepared statement of Mr. Guilford follows:]

   Prepared Statement of Gene A. Guilford, National & Regional Policy
  Counsel, Connecticut Energy Marketers Association, Cromwell, CT; on 
            Behalf of Commodity Markets Oversight Coalition
    Honorable Chairman Conaway, Ranking Member Scott, and distinguished 
Members of the Committee, on behalf of the Commodity Market Oversight 
Coalition [CMOC] we wish to thank you for the opportunity to appear 
before you today on the matter of the future of the Commodity Futures 
Trading Commission [CFTC] and to address matters relating to the CFTC's 
authorities regulating the activities in the commodity markets and the 
perspectives of end-users.
About CMOC
    The Commodity Markets Oversight Coalition (CMOC) is a non-partisan 
alliance of organizations that represent commodity-dependent American 
industries, businesses, end-users and consumers. We are the farmers, 
truckers, heating oil retailers, mom and pop gasoline station 
operators, airlines and others who rely on transparent, functional and 
stable commodity markets in which to hedge our operations for the 
mutual benefit of those who deliver tangible goods to markets and from 
which we take delivery of tangible goods, as well as for the benefit of 
the millions of consumers we serve. Our members rely on functional, 
transparent and competitive commodity derivatives markets as a hedging 
and price discovery tool. As a coalition, we favor government policies 
that promote stability and confidence in the commodities markets; seek 
to prevent fraud, manipulation and excessive speculation; and preserve 
the interests of bona fide hedgers, commodity-dependent industries and 
ordinary American consumers. Since its inception in August of 2007, our 
coalition and its member organizations have delivered testimony and 
written Congressional leaders in support of these reforms. While the 
Dodd-Frank Act was indeed historic legislation, it was not perfect 
legislation and Title VII reforms are no exception.
    We continue to remind the Congress to be mindful of the need for 
stable, transparent and accountable futures, options and swaps markets 
and the effect on the confidence of consumers, commodity end-users, 
bona fide hedgers and other stakeholders.
Why is an active, adequately funded and fully authorized CFTC 
        necessary?
    At the urging of our coalition and in response to dramatic changes 
in the marketplace, Congress expanded CFTC authority over the futures, 
options and swaps markets during its 2008 reauthorization. This 
included language from the bipartisan ``Close the Enron Loophole Act'' 
expanding oversight to ``price discovery contracts'' on previously 
unregulated electronic trading platforms.\1\ The 2008 bill also 
strengthened anti-fraud provisions and increased civil monetary 
penalties for manipulation and attempted manipulation from $500,000 to 
$1 million per violation.
---------------------------------------------------------------------------
    \1\ The Close the Enron Loophole Act was introduced in the Senate 
(S. 2058) by Sen. Carl Levin (D-MI) on September 17, 2007 and in the 
House (H.R. 4066) by Rep. Peter Welch D-VT). The House bill had three 
Republican cosponsors, including Reps. Chris Shays of Connecticut, Jeff 
Fortenberry of Nebraska and Todd Platts of Pennsylvania.
---------------------------------------------------------------------------
    However, much of the deregulation of the derivatives markets under 
the Commodity Futures Modernization Act of 2000 (Pub. L. 106-554) 
remained unaddressed until the enactment of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act of 2010,\2\ simply referred to as 
the ``Dodd-Frank Act.'' Building on the reforms included in the 2008 
Farm Bill, Congress used the Dodd-Frank Act as a means to further 
address the crisis of opacity, instability and diminished confidence in 
the derivatives markets and to address factors that lead to the 2007-
2008 bubble in commodity prices.
---------------------------------------------------------------------------
    \2\ Pub. L. 111-203.
---------------------------------------------------------------------------
    Even with its imperfections, one cannot say that Dodd-Frank was 
unnecessary or that the new authorities granted to the CFTC under the 
Act were inappropriate.
    In the mid-1990s the over-the-counter derivatives market had a 
notional value of between $20-$25 trillion. Today the derivatives 
market's notional value exceeds $600 trillion. Even then, there had 
been episodes of fraud. Bankers Trust was a large over-the-counter 
derivatives dealer, and it became clear, through suits brought by some 
of its customers--primarily Procter & Gamble and Gibson Greeting 
Cards--that Bankers Trust had defrauded some of its derivatives 
customers. Second, there was evidence of manipulation in the markets. 
Sumitomo Corporation had managed to manipulate the world market in 
copper, in part using over-the-counter derivatives to disguise its 
operations and fund them. Later, and after the fact, there were other 
incidents of market manipulation discovered involving Enron and 
electricity markets, Amaranth and natural gas markets,\3\ BP/Propane 
and the propane markets,\4\ as well as crude oil.\5\
---------------------------------------------------------------------------
    \3\ http://www.hsgac.senate.gov//imo/media/doc/
REPORTExcessiveSpeculationinthe
NaturalGasMarket.pdf
    \4\ http://www.cftc.gov/PressRoom/PressReleases/pr5405-07.
    \5\ http://www.crai.com/uploadedFiles/Publications/FM-Insights-
Commodity-Price-Manipulation.pdf.
---------------------------------------------------------------------------
    Just last week it was reported that the Federal Energy Regulatory 
Commission is in discussions with JP Morgan Chase regarding an alleged 
manipulation of electricity markets that could cost the bank $500 
million.\6\
---------------------------------------------------------------------------
    \6\ http://dealbook.nytimes.com/2013/07/17/jpmorgan-in-talks-to-
settle-energy-manipulation-case-for-500-million/.
---------------------------------------------------------------------------
    We can never forget that concerns were raised about these 
unregulated, rapidly growing markets that were characterized by a lack 
of transparency, unlimited leverage, and interconnections between large 
institutions through counterparty credit risk. Those features of the 
market appeared to create the potential of systemic risk, as was later 
confirmed in the financial crisis of 2008.
    However, much of the deregulation of the derivatives markets under 
the Commodity Futures Modernization Act of 2000 (Pub. L. 106-554) 
remained unaddressed until the enactment of the Dodd- Frank Wall Street 
Reform and Consumer Protection Act of 2010, simply referred to as the 
``Dodd-Frank Act.'' Building on the reforms included in the 2008 Farm 
Bill, Congress used the Dodd-Frank Act as a means to further address 
the crisis of opacity, instability and diminished confidence in the 
derivatives markets and to address factors that led to the 2007-2008 
bubble in commodity prices.
    The financial crisis that began with the fall of Lehman and a 
cascade of other powerful financial institutions, leading ultimately to 
the loss of more than $12 trillion of national wealth, the loss of 
millions of American jobs, the loss of value of millions of American 
homes, 401(k) plans and pensions is why we need the Commodity Futures 
Trading Commission. The nation needs commodity markets that are fully 
transparent and free of manipulation, excessive speculation and other 
disruptive trading activity. We need markets with participants that are 
accountable for their actions and properly overseen for the benefit and 
protection of consumers and taxpayers. Hopefully, we have not forgotten 
what the absence of effective oversight and regulation has wrought upon 
the nation as we continue to struggle to recover from the greatest 
threat to the nation's economy since the Great Depression.
    When accepting the John F. Kennedy Profiles in Courage Award in 
2009, former CFTC Chair Brooksley Born stated, ``Special interests in 
the financial services industry are beginning to advocate a return to 
`business as usual' and to argue against the need for any serious 
reform. We have to muster the political will to overcome these special 
interests. If we fail now to take the remedial steps to close the 
regulatory gap, we will be haunted by our failure for years to come.''
Manipulation and Excessive Speculation
    Speculative position limits are important in preserving the 
integrity of the commodity markets and the needs of bona fide hedgers. 
Such limits serve to prevent market manipulation (such as corners and 
squeezes) and unwarranted price swings associated with excessive 
speculation. Therefore, our coalition strongly supports the decision of 
Congress to mandate speculative position limits under Section 737 of 
the Dodd-Frank Act.
    Excessive Speculation is defined as that which drives prices higher 
in apparent defiance of supply and demand fundamentals. We contend that 
recent events point to just such a dislocation in the energy commodity 
markets, as follows:

------------------------------------------------------------------------
                                      2007                  2012
------------------------------------------------------------------------
Unemployment                  4.6%                  7.6%
U.S. crude oil consumption    20 mmbls @ day        18.5 mmbls @ day
U.S. domestic crude           5 mmbls @ day         6.5 mmbls @ day
 production
U.S. WTI crude oil price      $72 @ bbl             $94 @ bbl
U.S. gasoline consumption     9.3 mmbls @ day       8.7 mmbls @ day
U.S. gasoline prices [ave]    $2.84 @ gal           $3.68 @ gal
------------------------------------------------------------------------

    In just the last 4 weeks we have seen U.S. WTI prices increase from 
$94 @ bbl on the NYMEX [August contract] to over $108 @ bbl--adding $14 
@ bbl. At the same time, we have seen U.S. RBOB gasoline on the NYMEX 
[August 2013 contract] increase from $2.67 @ gal to $3.13 @ gal, adding 
46 @ gallon.
    As America consumes 360 million gallons of gasoline a day, NYMEX 
driven RBOB contract increases of 46 @ gallon will cost Americans an 
additional $165 million per day, $1.1 billion per week, $4.6 billion 
per month.
    These market activities are occurring while, according to our 
Department of Energy's Energy Information Agency, WTI crude stocks at 
Cushing, Oklahoma have been at their highest levels ever recorded. In 
addition, in 2012 the U.S. saw the largest increase in daily crude oil 
production since commercial production began in 1859. Between 2007 and 
2012 we saw not only the extraordinary demand destruction of 1.5 mmbls 
of daily crude oil demand, but at the same time saw a 1.5 mmbls @ day 
of increased domestic crude oil production--a swing of 3 mmbls. Yet, 
WTI crude prices increased more than 30%.
    Further, in 2011 the U.S. became a net exporter of refined 
distillates for the first time since 1948 and in 2012 became a net 
exporter of gasoline for the first time since 1960. RBOB gasoline 
contract increases of 46 @ gal are with the backdrop of having seen a 
domestic demand destruction of 600,000 bbls @ day.
October 2011 Position Limits Rule
    The CFTC approved a final rule establishing mandatory position 
limits on October 18, 2011. This rule was to go into effect on October 
12, 2012. However, the rule was vacated by a District Court Judge on 
September 28, 2012 and the decision is currently under appeal. Our 
coalition strongly supports the immediate implementation of mandatory 
position limits and believes that the intent of the Congress was clear 
and unambiguous in this regard. On April 22, 2013, we filed an amicus 
curiae brief with the Court of Appeals and we are confident that the 
District Court's decision to vacate the position limits rule will be 
swiftly reversed.
    Still, the Committee should examine the efficacy of the October 18, 
2011 position limits rule, as well as the underlying statutory 
authorities of the CFTC, in preventing market manipulation and the 
harmful effects of excessive speculation.\7\ Specifically, members of 
our coalition have expressed concerns to regulators that individual 
position limits set forth by the rule are too high, and that the rule 
only requires periodic review of established limits (annually for 
agricultural contracts and biennially for energy contracts).
---------------------------------------------------------------------------
    \7\ 7 U.S.C. Section 6(a)(1).
---------------------------------------------------------------------------
    In addition to individual speculative position limits as set forth 
by the rule, an effective way to prevent excessive speculation from 
distorting commodity prices and to restore the balance between 
commercial hedgers and financial investors is to require aggregate 
limits on all speculation as a class of trader. In the forthcoming CFTC 
Reauthorization Act, the Committee should expand upon the existing 
Dodd-Frank Act position limits mandate to require the CFTC to establish 
class specific limits on speculation.\8\ We attach as Appendix ``A'' 
the list of more than 100 independent studies that point to the role 
excessive speculation plays in the artificial inflation of commodity 
prices that is the focus of the position limits rule.
---------------------------------------------------------------------------
    \8\ See comments by Delta Airlines, the Air Transport Association 
(now Airlines for America) and the Petroleum Marketers Association of 
America and New England Fuel Institute Comment letters on the 
``Position Limits for Derivatives,'' 76 FR 4752 (Jan. 26, 2011), 
submitted to the CFTC on March 28, 2011.
---------------------------------------------------------------------------
The U.S. Tax Code and Energy Market Speculation
    Futures contracts, as prescribed by 26 U.S.C.  1256 of the tax 
code, are taxed with a blended rate of long and short-term gains: 60% 
long-term capital gains and 40% short-term. Whether one agrees or 
disagrees with speculation being a factor in commodity markets, most 
should agree that we should examine why this activity is subsidized by 
the Tax Code. The Tax Code incentivizes speculation in commodities over 
speculation in any other market. Even more, speculation in commodities 
is a great way to guarantee a lower tax rate than the general income 
tax, when compared to any other profession in America.
    In essence, the Tax Code promotes speculation in commodities 
markets, and it does so in several ways. People who are speculating in 
commodity future markets are inherently short-run, and care far more 
about the discount on the short term capital gains tax rate than they 
do the increased cost of long-term commodity ownership. Whereas a 
short-term equity speculator is taxed at the general income rate, a 
commodities/futures speculator is taxed at 23%. The consequences of 
this are two-fold: first, there is an economic incentive for 
speculators to ply their craft in commodities markets as opposed to 
equity markets, and second, speculators desire volatility in the short-
run in order to maximize their capacity to make money, such that there 
is a serious misalignment of incentives between speculative market 
participants and the purpose of commodity markets. [commercial/bona 
fide hedgers versus non-commercial financial speculators]
    Meanwhile, short-term transactions that result in realized gains in 
commodity markets are not done with the intention ever taking or giving 
delivery of the underlying goods themselves. Rather, these transactions 
are done for the purpose of realizing a gain off of changes in price. 
These transactions require inefficiencies between supplier and buyer 
PLUS volatility in order to generate a profit. In seeking volatility, 
such transactions promote yet further volatility. Because of this fact, 
volatility and market dislocations lead directly to more opportunities 
for speculative gains. Pushing such actors into commodity markets 
creates a situation where volatility becomes a self-fulfilling prophecy 
for the benefit of a significant portion of market participants, but a 
detriment to society at large.
    In examining the authorities of the CFTC one might examine why one 
body of Federal law seems to encourage energy market speculation [the 
Tax Code] while another body of Federal law seems to discourage energy 
market speculation [Dodd-Frank].
Index Funds
    Congress and the CFTC have yet to adequately address the well-
documented harm caused by index fund speculation in the commodity 
markets. In June of 2009, the Senate Permanent Subcommittee for 
Investigation (PSI) published a bipartisan report by Chairman Carl 
Levin of Michigan and ranking Member Tom Coburn of Oklahoma entitled 
Excessive Speculation in the Wheat Market.\9\
---------------------------------------------------------------------------
    \9\ Link to the Senate PSI Wheat Report: http://bit.ly/WheatRpt 
(Accessed May 1, 2013). Editor's note: the referenced link goes through 
a third party server, the official Senate link is http://
www.hsgac.senate.gov/imo/media/doc/
REPORTExcessiveSpecullationintheWheat
MarketwoexhibitschartsJune2409.pdf.
---------------------------------------------------------------------------
    The report concludes that the ``activities of commodity index 
traders, in the aggregate, constituted `excessive speculation,' '' and 
that index funds have caused ``unwarranted price changes'' and 
constitute an ``unwarranted burden on commerce.'' The PSI report urged 
legislative and regulatory measures to limit the impact of index fund 
investments in commodities.
    These recommendations include the phasing-out of CFTC no-action 
letters that essentially classified index funds as bona fide hedgers 
and exempted them from speculative position limits. The report also 
urges the CFTC to collect more data and evaluate the extent to which 
index funds affect prices for non-agricultural commodities including 
crude oil. While the CFTC has made considerable effort to improve data 
collection, regulators have not yet published any sort of comprehensive 
evaluation on the role index funds as recommended by the bipartisan PSI 
report. The Committee should inquire with the CFTC on its progress in 
implementing the recommendations of the bipartisan PSI staff report and 
addressing end-user concerns over index fund speculation.
    Of note, our coalition has supported legislation in Congress that 
would limit the ability of index funds to speculate in commodities. In 
the House of Representatives, then Congressman Ed Markey of 
Massachusetts introduced the Halt Index Trading of Energy Commodities 
(HITEC) Act (H.R.785) on March 13, 2013. It currently enjoys 21 
cosponsors. The bill would prohibit new investments in commodities by 
index funds and give existing index funds 2 years to wind down their 
positions.
    The Congress has to look no further than the way Wall Street 
markets participation in index funds for the reason why and how index 
funds adversely affect the orderly operation of these markets and 
artificially inflate commodity prices, as follows:

          ``How do I sell something that I don't own, or why would I 
        buy something I don't need''. The answer is simple. When 
        trading futures, you never actually buy or sell anything 
        tangible; you are just contracting to do so at a future date. 
        You are merely taking a buying or selling position as a 
        speculator, expecting to profit from rising or falling prices. 
        You have no intention of making or taking delivery of the 
        commodity you are trading, your only goal is to buy low and 
        sell high, or vice-versa. Before the contract expires you will 
        need to relieve your contractual obligation to take or make 
        delivery by offsetting (also known as unwind, or liquidate) 
        your initial position. Therefore, if you originally entered a 
        short position, to exit you would buy, and if you had 
        originally entered a long position, to exit you would sell.'' 
        \10\
---------------------------------------------------------------------------
    \10\ http://www.altavest.com/education/default.aspx.

    Had it not been for the unfortunate 2003 decision of the Federal 
Reserve that allowed regulated banks to trade in physical commodity 
markets, much of the artificial inflation of commodity prices we have 
seen since would not have occurred. Last week the Federal Reserve 
announced its intention to ``review'' its 2003 decision \11\ and we 
encourage the Congress to make it known to the Fed that reversing that 
decision should be a priority at the earliest possible opportunity.
---------------------------------------------------------------------------
    \11\ http://www.federalreserve.gov/boarddocs/press/orders/2003/
20031002/attachment.pdf.
---------------------------------------------------------------------------
    Figure One graphically illustrates the recent history of the energy 
commodity markets, deregulation, Federal Reserve decisions and then the 
results for energy prices when the investment banking community began 
to play a disproportionate role in those markets.

    The Committee should consider proposals to limit the role of index 
funds in commodities.
Figure One
Cushing, OK Crude Oil Future Contract 1

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

        Crude Oil price data from U.S. DOE/EIA.
High Frequency Trading
    In order for commodity prices to accurately reflect real-world 
supply and demand, futures, options and swaps markets must be driven by 
educated traders that are responding objectively to market 
fundamentals. Our coalition grows increasingly concerned over the 
impact of high-speed automated trading by means of computer 
algorithms--also known as algo-trading or High-frequency Trading 
(HFT)--on the commodities markets. HFT has already become a dominant 
force in the securities markets and many allege it has been responsible 
for a series of disruptive market events, including the Flash Crash 
that caused the Dow Jones Industrial Average to plunge 1,000 points 
(nine percent) on May 6, 2010.
    In response to the 2010 ``Flash Crash,'' on November 2, 2011, Sen. 
Tom Harkin (D-IA) and Rep. Peter DeFazio (D-OR) introduced the Wall 
Street Trading and Speculators Tax Act, which would impose a .03 
percent excise tax on all trades of securities. Sen. Harkin and Rep. 
DeFazio said an analysis by the Joint Committee on Taxation estimated 
the tax would generate $352 billion in revenue from January 2013 
through 2021, if enacted. The tax was designed to disproportionately 
affect HFTs, who place thousands of trades in a matter of minutes. 
While this effort failed in 2011, on February 28, 2013, Sen. Harkin and 
Rep. DeFazio reintroduced a financial transaction tax bill, which was 
then referred again to the House Ways and Means and Senate Finance 
Committees. CMOC looks forward to working with the Congress as it 
considers these important measures.
    More recently, some have accused algo-trading as responsible for a 
145-point market drop in response to a false tweet about a terrorist 
attack on the White House that was posted on a hacked Associated Press 
Twitter feed on April 23, 2013.
    A May 1, 2013 Wall Street Journal expose further charges that 
``High-speed traders are using a hidden facet of the Chicago Mercantile 
Exchange's computer system to trade on the direction of the futures 
market before other investors get the same information.'' According to 
the Journal, such trades are conducted by computers that have an 
advantage of just ``one to 10 milliseconds'' and allow the structure of 
orders ``so that the confirmations tip which direction prices for crude 
oil, corn or other commodities are moving.'' The influence of HFT in 
commodities continues to grow. The article cites a Tabb Group estimate 
that HFT now comprises ``about 61 percent of all futures market volume, 
up from 47 percent in 2008.'' Some market experts told the Journal that 
a failure to address this issue could result in market distortions, 
increased risks and the loss of liquidity.\12\ Thankfully, the CFTC has 
announced that it will investigate the role of High-Frequency trading 
in the commodity markets and evaluate the need for new regulations to 
protect market participants and preserve market integrity.\13\ They are 
not alone. Lawmakers in Europe have become so concerned about this 
issue they have even proposed limiting or banning HFT in commodities 
markets altogether.\14\
---------------------------------------------------------------------------
    \12\ ``High-speed Traders Exploit Loophole,'' The Wall Street 
Journal, May 1, 2003. Link: 
http://on.wsj.com/15a3uVS (Accessed May 1, 2013)
    \13\ ``Statement of Chairman Gary Gensler before the CFTC 
Technology Advisory Committee,'' April 30, 2013.
    \14\ ``Europe to ban high-frequency trading in commodities,'' 
BullionStreet (blog), October 29, 2012. Link: http://bit.ly/15a3mG7 
(Accessed May 1, 2013)
---------------------------------------------------------------------------
    As a corollary to these concerns is the practice of market 
information gathering organizations to release data to certain paying 
customers minutes prior to the same information being release to the 
general public. A June 12, 2013 CNBC report cites that ``contract 
signed by Thomson Reuters, the news agency and data provider, and the 
University of Michigan, which produces the widely cited economic 
statistic, stipulates that the data will be posted on the web for the 
general public at 10 a.m. on the days it is released. Five minutes 
before that, at 9:55 a.m., the data is distributed on a conference call 
for Thomson Reuters' paying clients, who are given certain headline 
numbers. But the contract carves out an even more elite group of 
clients, who subscribe to the `ultra-low latency distribution 
platform,' or high-speed data feed, offered by Thomson Reuters. Those 
most elite clients receive the information in a specialized format 
tailor-made for computer-driven algorithmic trading at 9:54:58.000, 
according to the terms of the contract. On occasion, they could get the 
data even earlier-the contract allows for a plus or minus 500 
milliseconds margin of error.''
    ``In the ultra-fast world of high-speed computerized markets, 500 
milliseconds is more than enough time to execute trades in stocks and 
futures that would be affected by the soon-to-be-public news. Two 
seconds, the amount promised to `low latency' customers, is an 
eternity.''
    ``For exclusive access to the data, Thomson Reuters pays the 
University of Michigan $1 million per year, according to the contract, 
in addition to a `contingent fee' based on the revenue generated by 
Thomson Reuters. The contract reviewed by CNBC was signed in September 
2009. It expired a year later. Thomson Reuters and the University 
Michigan confirmed that the relationship still exists.'' \15\
---------------------------------------------------------------------------
    \15\ June 12, 2013 http://www.cnbc.com/id/100809395.

    We urge the Committee to investigate the role of HFT and other 
potentially harmful or disruptive new trends in the commodity markets 
and determine whether or not additional CFTC authority is required to 
address these concerns. We attached as Appendix ``B'' the listing of 
independent studies showing the harmful effects of high speed trading 
on the orderly operation of commodity markets.
Penalties
    Current law allows fines of up to $1 million per violation for 
manipulation or attempted manipulation and $140,000 for other 
violations of the CEA.\16\ In practice, while the amount of these fines 
vary, they are often insignificant when compared to the overall profits 
of many market participants such as financial institutions and may be 
doing little to deter violations of the law. In effect, for many large 
firms, these relatively minuscule fines just become part of the cost of 
doing business. Given this, the Committee should increase fines and 
penalties as appropriate in order to more effectively deter 
manipulation and other unlawful behavior.
---------------------------------------------------------------------------
    \16\ 7 U.S.C.  13.
---------------------------------------------------------------------------
    Additionally, the CFTC is restrained by the blanket 5 year Statute 
of Limitations. This restricts the ability of Commissioners to 
prosecute violations of the CEA, including cases of fraud and 
manipulation. The existing 5 year Statute of Limitations challenges the 
CFTC to prosecute cases despite a limited budget and personnel, the 
increasing complexity of the markets it regulates and the volume of 
data that must be collected and analyzed. Therefore, the Committee 
should extend the Statute of Limitations for the CFTC to a minimum of 
10 years.
Bankruptcy Protections
    Following a series of brokerage-house bankruptcies in the late 
1960s, Congress enacted the Securities Investor Protection Act (SIPA) 
of 1970 in order to extend FDIC-like protections to brokerage clients 
and to restore investor confidence.\17\ The Act established the 
Securities Investor Protection Corporation (SIPC) to oversee the 
protection of customer funds and investments in the event of a broker-
dealer failure and provide insurance coverage of up to $500,000 for the 
value of a customer's net equity, including up to $250,000 for cash 
accounts.
---------------------------------------------------------------------------
    \17\ Pub. L. 91-598.
---------------------------------------------------------------------------
    Unfortunately, Congress failed to extend SIPA protections to 
commodity brokerage clients, including commodity hedgers. It is likely 
that lawmakers simply did not foresee that commodity hedging would 
become such a widespread and vital component of the American economy as 
it is today. As a result, when the brokerage firm MF Global filed for 
bankruptcy over 18 months ago, its clients lacked adequate Federal 
protections for their funds, accounts and positions. They were thrown 
into the chaos and uncertainty of recovering their funds, a problem 
that could have been alleviated if SIPA-style protections existed for 
these customers.
    Therefore, we believe the Committee should enhance protections for 
commodity brokerage clients, including:

   The prioritization of commodity brokerage clients' claims 
        filed with bankruptcy Trustees;

   The creation of a new insurance fund for the protection of 
        commodity brokerage clients that would provide similar 
        protections as the SIPA-created securities investor insurance 
        fund;

   The creation of a nonprofit Commodity Futures Protection 
        Corporation (CFPC) that will be separate from the Securities 
        Investor Protection Corporation and oversee the remediation of 
        customer funds in the event of a commodity broker-dealer 
        failure and to manage the insurance fund associated with the 
        new law; and

   A requirement that in the event of a bankruptcy, the CFPC 
        work with the CFTC, self regulatory organizations and the 
        courts in carrying out its mission, especially the restoration 
        of client funds and the liquidation or transference of 
        commodity positions.

    When combined with enhanced customer protections currently being 
considered by the Commodity Futures Trading Commission, self-regulatory 
organizations, futures exchanges and brokerage firms, we believe that a 
futures insurance program will go a long way to restoring confidence in 
these markets. This is especially true for Main Street businesses, 
farmers and ranchers, and other industries that utilize futures, 
options and swaps to mitigate price risks and to help insulate their 
companies and their consumers from volatility and uncertainty.
Trade Options Exemption
    The Dodd-Frank Act made it unlawful for anyone that is not an 
Eligible Contract Participant (ECP) to enter into an over-the-counter 
or off-exchange swap. In order to qualify as an ECP, an entity has to 
meet a $10 million net worth requirement, with a separate $1 million 
net worth requirement for bona fide hedgers. Although many small 
businesses, farmers and other end-users may qualify as an ECP, their 
net worth can often fluctuate, causing them to be unsure from time-to-
time whether they satisfy the $1 million net worth requirement for 
hedgers. Moreover, an entity's net worth may have an inverse 
relationship with its liabilities; that is, as liabilities increase and 
the business finds itself with an urgent need to hedge, its net worth 
may decrease.
    For businesses that do not qualify as ECPs and that hedge commodity 
prices through physically settled bilateral options, the CFTC has 
proposed a ``trade options exemption'' in order to extend measured 
regulatory relief. However, some CMOC members have recommended that the 
CFTC extend the trade options exemption to small hedgers that engage in 
``financially-settled,'' not just physically-settled, options. 
Financially-settled options allow some third-party hedging firms 
serving small businesses to aggregate a collection of less-than-
standard contract volumes into a single financially-settled option. The 
CFTC has not yet finalized the Trade Options rule. We encourage the 
Committee to consult with the CFTC on the status of the trade options 
exemption and, if necessary, take action to codify regulatory relief 
for small hedgers.
Energy & Environmental Markets Advisory Committee
    In response to unprecedented volatility in the energy markets and 
at the urging of members of this coalition, the CFTC established the 
Energy Markets Advisory Committee in June of 2008. The purpose of this 
advisory committee, according to then-Acting CFTC Chairman Walt Lukken, 
was to assemble representatives from the energy industry, end-user 
groups and other market stakeholders to ``ensur[e] that the Commission 
is fully informed of industry developments and innovations so that the 
Commission can rapidly respond to changing market conditions and ensure 
that these markets are not subject to foul play.'' In 2009 the 
committee's charter was revised to include emerging environmental 
markets such as carbon trading markets and renamed the ``Energy & 
Environmental Markets Advisory Committee'' (EEMAC).
    Congress clearly felt the EEMAC was important enough to make it 
permanent under Section 751 of the Dodd-Frank Act. Despite this, the 
advisory committee has only met three times since it was formed in 
2008. Not a single meeting has been held since the EEMAC was made 
permanent in 2010. Meanwhile, the CFTC's Agriculture Advisory 
Committee, Global Markets Advisory Committee and the Technology 
Advisory Committee have met over 20 times. The Committee should require 
the CFTC to establish a charter for the EEMAC by a date certain and 
require at least annual meetings to receive input from energy market 
stakeholders.
CFTC Resources
    In retrospect, not to criticize but to make an observation with the 
benefit of hindsight, in establishing deadlines for the completion of 
regulatory proceedings within 365 days of the enactment of Dodd-Frank 
was an error. The hundreds of complex issues that needed to be 
addressed, most with the coordination of other agencies, was a recipe 
for putting the CFTC severely behind in meeting their statutory 
deadlines.
    Today CFTC staff is at 689 people, only nine percent bigger than 20 
years ago. At minimum CFTC needs 1,015 people in addition to new 
technology investments. CFTC collected $2 billion in fines last year 
(benefitting the Treasury, not CFTC budget)--that is CFTC 
appropriations funding for 22 prior fiscal years. This year the size of 
the CFTC actually contracted because of sequestration and cut 20-30 
people from the staff. The CFTC hasn't been able to hire experts on 
swaps markets, which is needed. The CFTC needs new technology in order 
to even try to keep up with the $600 trillion derivatives market and 
the private sector technology advancements that the agency is 
responsible for overseeing. If flat funding is provided, CFTC would 
have to cut another 50 people (about eight or nine percent) despite the 
responsibility to cover the swaps market. Therefore, we continue to 
urge Congress to fully fund the CFTC at the levels requested by the 
Administration.
Conclusion
    In this reauthorization effort we need to not only examine the 
necessary corrections for the imperfections in Dodd-Frank that we have 
cited, but also the magnitude of the new authorities the CFTC was given 
to protect the sanctity of the commodity markets and the pocketbooks of 
American taxpayers and the diminished resources with which this agency 
has had to operate under extraordinarily difficult circumstances.
    Thank you for the opportunity to appear with you today and I would 
be happy to answer any questions you may have.




                                                                       Appendix A
                                          Independent Studies on the Negative Effects of Commodity Speculation
                         Evidence on the Negative Impact of Commodity Speculation by Academics, Analysts and Public Institutions
                                                                       21 May 2013
 Note: This list is constantly being updated and revised. It only collects evidence that supports a critical view of commodity speculation in general or
                                                                 certain elements of it.

                                             Compiled by Markus Henn, WEED, [Redacted], www.weed-online.org






                                                       (A) Academic peer reviewed journal articles
(1) Baffes, John (The World Bank) (2011): The long term implications of the 2007-08 commodity-price boom. Development in Practice, Vol. 21, Issue 4-5,
 pages 517-525: ``Demand by emerging economies is unlikely to put additional pressure on the prices of food commodities, although it may create such
 pressure indirectly through energy prices. The effect of biofuels on food prices has not been as great as originally thought, but the use of
 commodities by investment funds may have been partly responsible for the 2007-08 spike.'' [http://www.tandfonline.com/doi/abs/10.1080/
 09614524.2011.562488]
(2) Belke, Ansgar (IZA/University Duisburg-Essen)/Bordon, Ingo G. (University Duisburg-Essen)/Volz, Ulrich (German Development Institute) (2012):
 Effects of Global Liquidity on Commodity and Food Prices. World Development, in press: ``Over the period that we observed, 1980-2011, food and
 commodity price inflation were apparently driven by monetary expansion in the world's major economies. By examining the pertinence of monetary
 liquidity, our results add to the discussion on a financialization of commodities, that stresses the aspect of financial liquidity, where food and
 commodity prices are driven to a large extent by flows of portfolio investment seeking return in commodity markets and not merely by demand from the
 real economy. Policymakers should care about the negative side-effects of loose monetary policy and consider stricter regulation of food and commodity
 markets--such as the imposition of tighter limits on speculative positions in food commodities--to prevent a further flow of liquidity into these
 markets.'' [http://www.sciencedirect.com/science/article/pii/S0305750X12003038]
(3) Chevallier, Julien (University of Paris) (2012): Price relationships in crude oil futures: new evidence from CFTC disaggregated data. Environmental
 Economics and Policy Studies, August 2012: ``we are able to highlight the influence of the CFTC `Money Managers' net position category (as a proxy of
 speculative trading) on the oil price at reasonable statistical confidence levels. (. . .) The policies being considered by the CFTC to put aggregate
 position limits on futures contracts and to increase the transparency of futures markets are moves in the right direction.'' [http://
 www.springerlink.com/content/41485582m36k3841/?MUD=MP]
(4) Cifarelli, Giulio (University of Florenz)/Paladino, Giovanna (LUISS University/BIS) (2010): Oil price dynamics and speculation: A multivariate
 financial approach. Energy Economics, Vol. 32, Issue 2, March 2010, pages 363-372: ``Despite the difficulties, we identify a significant role played by
 speculation in the oil market, which is consistent with the observed large daily upward and downward shifts in prices--a clear evidence that it is not
 a fundamental-driven market.'' [http://www.sciencedirect.com/science/article/pii/S0301421511000590%20]
(5) Czudaj, Robert/Beckmann, Joscha (Duisburg University) (2012): Spot and futures commodity markets and the unbiasedness hypothesis--evidence from a
 novel panel unit root test. Economics Bulletin, 2012, vol. 32, issue 2, pages 1695-1707: ``Our findings show that most spot and futures markets for
 commodities were efficient until the turn of the millennium, but appear to be inefficient thereafter owing to an increase in volatility, which might be
 attributed to the intense engagement of speculation in commodity markets.'' [http://econpapers.repec.org/article/eblecbull/eb-12-00122.htm]
(6) Du, Xiaodong/Yu, Cindy L./Hayes, Dermott J. (Iowa State University) (2011): Speculation and Volatility Spillover in the Crude Oil and Agricultural
 Commodity Markets: A Bayesian Analysis. Energy Economics, Vol. 33, Issue 3, May 2011, pages 497-503: ``Speculation, scalping, and petroleum inventories
 are found to be important in explaining oil price variation.'' [http://www.sciencedirect.com/science/article/pii/S014098831100017X%20]
(7) Fan, Ying (Chinese Academy of Sciences)/Xu, Jin-Hua (Hefei University) (2011): What has driven oil prices since 2000? A structural change
 perspective: ``Through establishing a comparative model, we quantitatively measure the effects of speculation and episodic events such as wars on oil
 price changes. We find that the explanatory power of the models is obviously improved after allowing for the two factors. In particular, during the
 `Relatively calm market' period (January, 2000 to March, 2004) and `Bubble accumulation' period (March, 2004, to June, 2008), when the speculation
 variables are considered, not only they are significant, but also the explanatory ability greatly rises and various diagnostic tests are improved,
 indicating that speculation is a highly influential factor on oil price changes in these periods.'' [http://www.sciencedirect.com/science/article/pii/
 S0140988311001228]
(8) Gilbert, Christopher (Trento University) (2010): How to understand high food prices. Journal of Agricultural Economics. Vol. 61, Issue 2, pages 398-
 425: ``By investing across the entire range of commodity futures, index-based investors appear to have inflated food commodity prices.'' [http://
 onlinelibrary.wiley.com/doi/10.1111/j.1477-9552.2010.00248.x/abstract]
(9) Gutierrez, Luciano (University of Sassari) (2012): Speculative bubbles in agricultural commodity markets. European Review of Agricultural Economics,
 2012, pages 1-22: ``We investigate whether commodity prices during the spike of 2007-2008 might have deviated from their intrinsic values based on
 market fundamentals. To do this, we use a bootstrap methodology to compute the finite sample distributions of recently proposed tests. Monte-Carlo
 simulations show that the bootstrap methodology works well, and allows us to identify explosive processes and collapsing bubbles for wheat, corn and
 rough rice. There was less evidence of exuberance in soya bean prices.'' [http://erae.oxfordjournals.org/content/early/2012/06/27/
 erae.jbs017.short?rss=1%20]
(10) Hache, Emmanuel/Lantz, Frederic (IFPEnergies Nouvelles, Paris) (2012): Speculative Trading & Oil Price Dynamic: A study of the WTI market, Energy
 Economics (Accepted Manuscript, 3 September 2012): ``We conclude that the hypothesis of an influence of noncommercial players on the probability for
 being in the crisis state cannot be rejected. In addition, we show that the rise in liquidity of the first financial contracts, as measured by the
 volume of open interest, is a key element to understand the dynamics in market prices.'' [http://www.sciencedirect.com/science/article/pii/
 S0140988312002162]
(11) Kaufmann, Robert K./Ullman, Ben (Boston University) (2009): Oil prices, speculation, and fundamentals: Interpreting causal relations among spot and
 futures prices: ``Together, these results suggest that market fundamentals initiated a long-term increase in oil prices that was exacerbated by
 speculators, who recognized an increase in the probability that oil prices would rise over time.'' [http://www.sciencedirect.com/science/article/pii/
 S0140988309000243]
(12) Kaufmann, Robert K. (Boston University ) (2011): The role of market fundamentals and speculation in recent price changes for crude oil. Energy
 Policy, Volume 39, Issue 1, January 2011, Pages 105-115: ``Although difficult to measure directly, I argue for the role of speculation based on the
 following: (1) a significant increase in private U.S. crude oil inventories since 2004; (2) repeated and extended breakdowns (starting in 2004) in the
 cointegrating relationship between spot and far month future prices that are inconsistent with the law of one price and arbitrage opportunities; and
 (3) statistical and predictive failures by an econometric model of oil prices that is based on market fundamentals. These changes are related to the
 behavior and impact of noise traders on asset prices to sketch mechanisms by which speculative expectations can affect crude oil prices.'' [http://
 www.sciencedirect.com/science/article/pii/S0301421510007044]
(13) Mayer, Jorg (UNCTAD) (2012): The Growing Financialisation of Commodity Markets: Divergences between Index Investors and Money Managers. Journal of
 Development Studies, Vol. 48, Issue 6, pages 751-767: ``During 2006-2009, index trader positions had a price impact for some agricultural commodities,
 as well as oil. During 2007-2008, money managers impacted prices for nonagricultural commodities, especially copper and oil.'' [http://
 www.tandfonline.com/doi/abs/10.1080/00220388.2011.649261]
(14) Newman, Susan A. (University of the Witwatersand) (2009): Financialization and Changes in the Social Relations along Commodity Chains: The Case of
 Coffee. Review of Radical Political Economics. Vol. 41, No. 4, pages 539-559: ``It is argued that increased financial investment on international
 commodity exchanges, together with market liberalization, have given rise to opportunities and challenges for actors in the coffee industry. Given the
 heterogeneity of market actors, these tend to exacerbate inequalities already present in the structure of production and marketing of coffee.'' [http://
 rrp.sagepub.com/content/41/4/539.abstract]
(15) Nissanke, Machiko (University of London) (2012): Commodity Market Linkages in the Global Financial Crisis: Excess Volatility and Development
 Impacts. Journal of Development Studies, Vol. 48, Issue 6, pages 732-750: ``This article (. . .) suggests that a significant portion of the closely
 synchronised price dynamics in commodity and financial markets is explained by market liquidity cycles in global finance, as financial investors manage
 their portfolio at ease through `virtual' stock holdings of commodities in derivatives dealings and markets.'' [http://www.tandfonline.com/doi/abs/
 10.1080/00220388.2011.649259]
(16) Morana, Claudio (University of Milano, Bicocca) (2012): Oil price dynamics, macro-finance interactions and the role of financial speculation.
 Journal of Banking & Finance, in press: ``While we then find support to the demand side view of real oil price determination, we however also find a
 much larger role for financial shocks than previously noted in the literature.'' [http://www.sciencedirect.com/science/article/pii/S037842661200266X]
(17) Sigl-Grub, Christoph/Schiereck, Dirk (Technical University Darmstadt) (2010): Speculation and nonlinear price dynamics in commodity futures
 markets. Investment Management and Financial Innovations, Vol. 7, Issue 1, pages 59-73: ``In this article we present theoretical considerations and
 empirical evidence that the short-run autoregressive behavior of commodity markets is not only driven by market fundamentals but also by the trading of
 speculators.'' [http://businessperspectives.org/journals_free/imfi/2010/imfi_en_2010_01_Sigl.pdf]
(18) Silvennoinen Annastiina (Queensland University)/Thorp, Susan (Sydney University) (2013): Financialization, crisis and commodity correlation
 dynamics. Journal of International Financial Markets, Institutions and Money, Vol. 24, April 2013, Pages 42-65: ``Stronger investor interest in
 commodities may create closer integration with conventional asset markets. We estimate sudden and gradual changes in correlation between stocks, bonds
 and commodity futures returns driven by observable financial variables and time (. . .). Most correlations begin the 1990s near zero but closer
 integration emerges around the early 2000s and reaches peaks during the recent crisis. (. . .) Increases in VIX and financial traders' short open
 interest raise futures returns volatility for many commodities. Higher VIX also increases commodity returns correlation with equity returns for about
 half the pairs, indicating closer integration.'' [http://www.sciencedirect.com/science/article/pii/S1042443112001059]
(19) Tang, Ke (Princeton University)/Xiong, Wei (Renmin University) (2012): Index Investment and the Financialization of Commodities. Financial Analyst
 Journal, Vol. 68, Number 6, pages 54-74: ``concurrent with the rapid growth of index investment in commodity markets, prices of non-energy commodities
 have become increasingly correlated with oil prices. This trend is significantly more pronounced for commodities in two popular indices: the S&P GSCI
 and the DJ-UBSCI. Our findings reflect a fundamental process of financialization among commodity markets, through which commodity prices have become
 more correlated with each other. As a result of the financialization process, the price of an individual commodity is no longer determined solely by
 its supply and demand. Instead, prices are also determined by the aggregate risk appetite for financial assets and the investment behavior of
 diversified commodity index investors.'' [http://www.princeton.edu/wxiong/papers/commodity.pdf]
(20) Tokis, Damir (ESC Rennes) (2011): Rational destabilizing speculation, positive feedback trading, and the oil bubble of 2008. Energy Economics, Vol.
 39, Issue 4, April 2011, pages 2051-2061: ``institutional investors that invest in crude oil to diversify their portfolios and/or hedge inflation can
 destabilize the interaction among commercial participants and liquidity-providing speculators.'' [http://www.sciencedirect.com/science/article/pii/
 S0301421511000590]
                                          (B) Research papers published by universities and public institutions
(1) Adammer, Philipp/Bohl, Martin T./Stephan, Patrick M. (University of Munster) (2011): Speculative Bubbles in Agricultural Prices: ``The empirical
 evidence is favorable for speculative bubbles in the corn and wheat price over the last decade.'' [http://papers.ssrn.com/sol3/
 papers.cfm?abstract_id=1979521]
(2) Algieri, Bernardina (Bonn University) (2012): Price Volatility, Speculation and Excessive Speculation in Commodity Markets: Sheep or Shepherd
 Behaviour?: ``. . . this study shows that excessive speculation drives price volatility, and that often bilateral relationships exist between price
 volatility and speculation. (. . .) excessive speculation has driven price volatility for maize, rice, soybeans, and wheat in particular time frames,
 but the relationships are not always overlapping for all the considered commodities.'' [http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2075579]
(3) Algieri, Bernardina (Bonn University) (2013): A Roller Coaster Ride: an empirical investigation of the main drivers of wheat price: ``The variables
 with the largest effects on price movements over the period 1995-2012 are the global demand, speculation, and the real effective exchange rate. This
 testifies that the financial 25 and wheat markets have become more and more interwoven, and `speculation' based on investing in futures contracts on
 commodity markets, to profit from price fluctuations, is an important determinant of price dynamics.'' [http://www.zef.de/fileadmin/webfiles/downloads/
 zef_dp/zef_dp_176.pdf]
(4) Anderson, David et al. (Texas University) (2008): The effects of ethanol on Texas food and feed: ``Speculative fund activities in futures markets
 have led to more money in the markets and more volatility. Increased price volatility has encouraged wider trading limits. The end result has been the
 loss of the ability to use futures markets for price risk management due to the inability to finance margin requirements.'' [http://www.afpc.tamu.edu/
 pubs/2/515/RR-08-01.pdf]
(5) Baffes, John (The World Bank)/Haniotis, Tassos (European Commission) (2010): Placing the 2006/08 Commodities Boom into Perspective. World Bank
 Research Working Paper 5371: ``We conjecture that index fund activity (one type of `speculative' activity among the many that the literature refers to)
 played a key role during the 2008 price spike. Biofuels played some role too, but much less than initially thought. And we find no evidence that
 alleged stronger demand by emerging economies had any effect on world prices.'' [http://www-wds.worldbank.org/external/default/WDSContentServer/IW3P/IB/
 2010/07/21/000158349_20100721110120/Rendered/PDF/WPS5371.pdf]
(6) Baldi, Lucia/Peri, Massimo, Vandone, Daniela (Universita degli Studi di Milano) (2011): Price discovery in agricultural commodities: the shifting
 relationship between spot and futures prices: ``Last but not least, financial speculation, which caused considerable price volatility and prevented the
 planning of supply in many countries, contributed to creating a situation of market instability.''
(7) Bass, Hans H. (University of Bremen) (2011): Finanzmarkte als Hungerverursacher? Studie fur Welthungerhilfe e.V.: ``Das Engagement der
 Kapitalanleger auf den Getreidemarkten fuhrte nach unseren Berechnungen in den Jahren 2007 bis 2009 im Jahresdurchschnitt zu einem Spielraum fur
 Preisniveauerhohungen von bis zu 15 Prozent.'' [http://www.zukunftderernaehrung.org/images/stories/pdf/materialien.texte/
 whh_studie_bass_finanzmrkte_hungerverursacher.pdf]
(8) Basak, Suleyman/Pavlova, Anna (London Business School/Centre for Economic Policy Research) (2013): We find that in the presence of institutions the
 prices of all commodity futures go up. The price rise is higher for futures belonging to the index than for nonindex ones. If a commodity futures is
 included in the index, supply and demand shocks specific to that commodity spill over to all other commodity futures markets. In contrast, supply and
 demand shocks to a nonindex commodity affect just that commodity market alone. In the presence of institutions the volatilities of both index and
 nonindex futures go up, but those of index futures increase by more. Furthermore, financialization leads to an increase in the correlations amongst
 commodity futures as well as in equity-commodity correlations. Increases in the correlations between index commodities exceed those for nonindex ones.
 We model explicitly demand shocks which allows us to disentangle the effects of financialization from the effects of rising demand for commodities, and
 find that in the presence of demand shocks the impact of institutions on futures prices becomes considerably stronger.'' [http://papers.ssrn.com/sol3/
 papers.cfm?abstract_id=2201600]
(9) Basu, Parantap/Gavin, William T. (Federal Reserve Bank of St. Louis) (2011): What explains the Growth in Commodity Derivatives?: ``Banks argue that
 they need to use commodity derivatives to help customers manage risks. This may be true, but the recent experience in commodity futures did not reduce
 risks but exacerbated them just at the wrong time.'' [http://research.stlouisfed.org/publications/review/11/01/37-48Basu.pdf]
(10) Bicchetti, David/Maystre, Nicolas (UNCTAD) (2012): The synchronized and long-lasting structural change on commodity markets: evidence from high
 frequency data: ``we document a synchronized structural break, characterized by a departure from zero, which starts in the course of 2008 and continues
 thereafter. This is consistent with the idea that recent financial innovations on commodity futures exchanges, in particular the high frequency trading
 activities and algorithm strategies have an impact on these correlations.'' [http://mpra.ub.uni-muenchen.de/37486/1/MPRA_paper_37486.pdf]
(11) Boos, Jaap W.B. (Universitat Maastricht, School of Business and Economics)/van der Moolen, Maarten (Rabobank) (2012): A Bitter Brew? Futures
 Speculation and Commodity Prices: ``speculation is an important part of the coffee price generation process.'' [http://edocs.ub.unimaas.nl/loader/
 file.asp?ID=1709%20]
(12) Borin, Alessandro/Di Nino, Virginia (Bank of Italy) (2012): The role of financial investments in agricultural commodity derivatives markets: ``this
 result gives some support to the idea that swap dealers, whose growing weight in the regulated exchanges tends to reflect the large exposures of
 `commodity index investors' in the OTC markets, may have a destabilizing impact on futures prices, at least in the short run. On the contrary, the
 activity of more traditional speculators seems to favour price stability, probably enhancing market liquidity.'' [http://www.bancaditalia.it/
 pubblicazioni/econo/temidi/td12/td849_12/en_td849/en_tema_849.pdf]
(13) Buyuksahin, Bahattin (International Energy Agency)/Robe, Michel A. (American University) (2010): Speculators, Commodities and Cross-Market
 Linkages: ``We then show that the correlations between the returns on investable commodity and equity indices increase amid greater participation by
 speculators generally and hedge funds especially.'' [http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1707103]
(14) Cheng, Ing-Haw (University of Michigan)/Kirilenko, Andrei (CFTC)/ Xiong, Wei (Princeton University) (2012): Convective Risk Flows in Commodity
 Futures Markets: ``We find that CITs and hedge fund positions reacted negatively to the VIX during the recent financial crisis . . . Consistent with
 theories suggesting this is related to the distress of financial institutions, we find that CITs with high CDS spreads are more sensitive to movements
 in the VIX. Contrary to the hedging pressure hypothesis, we do not find that hedgers increased their hedges as the VIX rose. Finally, the findings show
 that the reactions of all trader groups were persistent over time. This evidence suggests that during times of distress, there was a flow of risk away
 from financial institutions back towards commercial hedgers.'' [http://www.princeton.edu/wxiong/papers/RiskConvection.pdf]
(15) Coleman, Les/Dark, Jonathan (University of Melbourne) (2012): Economic Significance of Non-Hedger Investment in Commodity Markets: ``We find a
 cointegrating relationship in larger markets between scaled open interest and real spot price, where it is usually the price that adjusts to deviations
 from long run equilibrium.'' [http://papers.ssrn.com/sol3/Delivery.cfm/SSRN_tID2021919_tcode373191.pdf?abstractid=2021919&mirid=1]
(16) Cooke, Bryce/Robles, Miguel (IFPRI) (2009): Recent Food Prices Movements. A Time Series Analysis: ``Overall, our empirical analysis mainly provides
 evidence that financial activity in futures markets and proxies for speculation can help explain the observed change in food prices; any other
 explanation is not well supported by our time series analysis.'' [http://www.ifpri.org/sites/default/files/publications/ifpridp00942.pdf]
(17) Creti, Anna/Joets, Marc/Mignon, Valerie (CEPII, Paris) (2012): On the links between stock and commodity markets' volatility: ``Our results show
 that correlations between commodity and stock markets are time-varying and highly volatile. The impact of the 2007-2008 financial crisis is noticeable,
 emphasizing the links between commodity and stock markets, and highlighting the financialization of commodity markets. We also show that, while sharing
 some common features, commodities cannot be considered a homogeneous asset class: a speculation phenomenon is for instance highlighted for oil, coffee
 and cocoa, while the safe-haven role of gold is evidenced.''
  [http://www.cepii.fr/anglaisgraph/workpap/pdf/2012/wp2012-20.pdf]
(18) Dicembrino, Claudio/Scandizzo, Pasquale L. (University of Rome) (2012): The Fundamental and Speculative Components of the Oil Spot Price: ``Our
 results show that speculative components, measured according to mathematical option theory, may be at the origin of significant and sizable effects on
 oil prices, specially for what concerns the episodes of extreme variations. The speculation issue, however, suggests that further investigation may be
 conducted in order to identify the factors affecting the speculation itself.'' [http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2043158]
(19) Dorfman, Jeffrey H./Karali, Berna (University of Georgia) (2012): Have Commodity Index Funds Increased Price linkages between Commodities?: ``In
 combination with our results on correlation coefficients and non-stationarity, these empirical results are indicative, but not fully convincing, of the
 growth of commodity index funds impacting commodity futures market linkages over the last 8 years.'' [http://www.farmdoc.illinois.edu/nccc134/conf_2012/
 pdf/confp01-12.pdf]
(20) Doroudian, Ali/Vercammen, James (University of British Columbia) (2012): First and Second Order Impacts of Speculation and Commodity Price
 Volatility: ``Both of these results are consistent with the theoretical arguments that speculation which involves large-scale institutional investment
 can have first and second order impacts on commodity price volatility.'' [http://ageconsearch.umn.edu/bitstream/126947/2/
 Speculation%20SPAA%20Jan%202012wCover.pdf]
(21) Eckaus, R.S. (MIT) (2008): The Oil Price Really Is A Speculative Bubble: ``Since there is no reason based on current and expected supply and demand
 that justifies the current price of oil, what is left? The oil price is a speculative bubble.'' [http://www.cii.org/UserFiles/file/
 oil%20prie%20is%20spec%20bubble%20-%20MIT%20study%20-%20June%202008.pdf]
(22) Einloth, James T. (FDIC) (2009): Speculation and Recent Volatility in the Price of Oil: ``The paper finds the evidence inconsistent with
 speculation having played a major role in the rise of price to $100 per barrel in March 2008. However, the evidence suggests that speculation did play
 a role in its subsequent rise to $140.'' [http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1488792]
(23) Frankel, Jeffrey (Harvard Kennedy School)/Rose, Andrew K. (Haas School of Business, UC Berkeley) (2010): Determinants of Agricultural and Mineral
 Commodity Prices: ``Our annual empirical results show support for the influence of economic activity, inventories, uncertainty in the spread and recent
 spot price changes.'' [http://faculty.haas.berkeley.edu/arose/Commod.pdf]
(24) Gilbert, Christopher (Trento University) (2010): Speculative Influences on Commodity Futures Prices: ``The results . . . indicate that index-based
 investment in commodity futures may have been responsible for a significant and bubble-like increase of energy and nonferrous metals prices, although
 the estimated impact on agricultural prices is smaller.'' [http://www.unctad.org/en/docs/osgdp20101_en.pdf]
(25) Gilbert, Christopher/Pfuderer, Simone (University of Trento) (2012): Index Funds Do Impact Agricultural Prices: ``We use Granger-causality methods
 to re-examine the data analyzed in Sanders and Irwin (2011a). Our analysis supports their conclusion that mo impacts are discernible for the four
 grains markets they consider. However, Granger-causality is established in the less liquid soybean oil and livestock markets. We conjecture that index
 investment does also have price impact in liquid markets but that market efficiency prevents the detection of this impact using Granger-causality
 tests.'' [http://www.york.ac.uk/res/mmf/documents/SI_5.pdf]
(26) Girardi, Daniele (University of Siena) (2011): Do financial investors affect commodity prices? The case of Hard Red Winter Wheat: ``Our empirical
 analysis suggests that financial investors played an important role in affecting wheat price fluctuations in recent years. In particular they seem to
 have linked wheat price dynamics to U.S. equity market returns and to oil price movements.'' [http://mpra.ub.uni-muenchen.de/35670/1/
 MPRA_paper_35670.pdf]
(27) Ghosh, Jayati (Jawaharlal Nehru University) (2010): Commodity speculation and the food crisis: ``Thus international commodity markets increasingly
 began to develop many of the features of financial markets, in that they became prone to information asymmetries and associated tendencies to be led by
 a small number of large players. Far from being `efficient markets' in the sense hoped for by mainstream theory, they allowed for inherently `wrong'
 signalling devices to become very effective in determining and manipulating market behaviour. The result was the excessive price volatility that has
 been displayed by important commodities over the recent period--not only the food grains and crops mentioned here, but also minerals and oil.'' [http://
 www.wdm.org.uk/sites/default/files/Commodity%20speculation%20and%20food%20crisis.pdf]
(28) Goyal, Ashima/Tripathi, Shruti (Indira Gandhi Institute of Development Research) (2012): Regulations and price discovery: oil spot and futures
 markets: ``The results show expectations mediated through financial markets did not lead to persistent deviations from fundamentals. (. . .) But there
 is stronger evidence of short-term or collapsing bubbles in mature market futures compared to Indian, although mature markets have a higher share of
 hedging. Indian regulations such as position limits may have mitigated short duration bubbles. It follows leverage due to lax regulation may be
 responsible for excess volatility.'' [http://www.igidr.ac.in/pdf/publication/WP-2012-016.pdf]
(29) Greenberger, Michael (University of Maryland) (2010): The Relationship of Unregulated Excessive Speculation to Oil Market Price Volatility: ``When
 speculators make up too large a share of the futures market, they have the potential to upset the healthy tension between consumers and producers and
 resulting adherence of prices to market fundamentals. The resulting volatility makes it more difficult for commercial consumers and producers to
 successfully hedge risk, because prices do not reflect market fundamentals, and so they abandon the futures market and risk shifting--thereby further
 destabilizing the price discovery influence of these markets.'' [http://www.michaelgreenberger.com/files/IEF-Greenberger-AppendixVII.pdf]
(30) Halova, Marketa W. (Washington State University) (2012): The Intraday Volatility--Volume Relationship in Oil and Gas Futures: ``For the nearby
 contract, Granger-causality tests show that past values of volume help explain volatility which agrees with the Sequential Information Arrival
 Hypothesis. Past values of volatility have explanatory power for volume only when absolute return is used as the volatility measure; when the
 conditional variance from GARCH models is used as the volatility measure, the causality in this direction disappears. These results change when low-
 frequency daily data is applied. (. . .) if past volume can be used to forecast volatility, markets are not efficient. Therefore, the lagged volume
 having explanatory power for volatility indicates some market inefficiency, at least at the 10-minute interval frequency.'' [http://cahnrs-cms.wsu.edu/
 ses/people/marketa_halova/Documents/oilVolumeVolatility_v25_paper.pdf]
(31) Hamilton, James (University of California) (2009): Causes and Consequences of the Oil Shock of 2007-08: ``With hindsight, it is hard to deny that
 the price rose too high in July 2008, and that this miscalculation was influenced in part by the flow of investment dollars into commodity futures
 contracts.'' [http://www.brookings.edu//media/Files/Programs/ES/BPEA/2009_spring_bpea_papers/2009a_bpea_hamilton.pdf]
(32) Hamilton, James D. (University of California)/Wu, Cynthia (University of Chicago) (2011): Risk Premia in Crude Oil Futures Prices: ``We document
 significant changes in oil futures risk premia since 2005, with the compensation to the long position smaller on average but more volatile in more
 recent data. This observation is consistent with the claim that index-fund investing has become more important relative to commercial hedging in
 determining the structure of crude oil futures risk premia over time.'' [http://dss.ucsd.edu/jhamilto/hw4.pdf]
(33) Henderson, Brian J. (George Washington University)/Pearson, Neil D./Wang, Li (University of Illinois at Urbana-Champaign) (2012): New Evidence on
 the Financialization of Commodity Markets: ``Commodity-Linked Notes (CLNs) . . . issuers hedge their liabilities by taking long positions in the
 underlying commodity futures on the pricing dates. These hedging trades are plausibly exogenous to the contemporaneous and subsequent price movements,
 allowing us to identify the price impact of the hedging trades. We find that these hedging trades cause significant price changes in the underlying
 futures markets, and therefore provide direct evidence of the impact of `financial' trades on commodity futures prices.'' [http://www.ccfr.org.cn/
 cicf2012/papers/20120525010717.pdf]
(34) Hong, Harrison (Princeton University)/Yogo, Motohiro (University of Pennsylvania) (2009): Digging into Commodities: ``Since 2004 . . . commodity
 prices have appreciated considerably, and aggregate basis has fallen (if anything), suggesting that futures prices have responded at least (if not more
 than) one-for-one with spot-price shocks. This could reflect the belief among investors that these price shocks are permanent or highly persistent.
 This is however unprecedented since even during the energy crisis of the seventies, one did not see such a striking movement in futures prices. This
 finding could instead reflect the conventional wisdom that lots of new indexed money flowed into commodity futures (as opposed to the spot market),
 chasing returns during this period.'' [http://www.usc.edu/schools/business/FBE/seminars/papers/F_9-25-09_MOTOHIRO.pdf]
(35) Inamura, Yasunari/Kimata, Tomonori/Takeshi, Kimura/Muto, Takashi (Bank of Japan) (2011): Recent Surge in Global Commodity Prices--Impact of
 financialization of commodities and globally accommodative monetary conditions: ``While the strong increase in commodity prices has been driven by
 global economic growth propelled by emerging economies, speculative investment flows into commodity markets have amplified the intensity of the price
 surge. (. . .) global commodity markets have become more sensitive to portfolio rebalancing by financial investors, which has made commodity markets
 more correlated with other asset markets, including major equity markets.'' [http://www.boj.or.jp/en/research/wps_rev/rev_2011/rev11e02.htm/]
(36) Jickling, Mark/Austin, Andrew D. (Congressional Research Service) (2011): Hedge Funds Speculation and Oil Prices: ``A statistically significant
 correlation is evident between changes in positions held by `money managers' (a category of speculators that includes hedge funds) and the price of
 oil. In other words, during weeks when money managers have been net buyers of oil futures and options (or increased the size of their long positions),
 the price has tended to rise. Price falls, conversely, have tended to coincide with reductions in money managers' long positions.'' [http://www.fas.org/
 sgp/crs/misc/R41902.pdf]
(37) Juvenal, Luciana/Ivan, Petrella (Federal Reserve Bank of St. Louis) (2011): Speculation in the Oil Market: ``We find that the increase in oil
 prices in the last decade is mainly due to the strength of global demand, consistent with previous studies. However, financial speculation
 significantly contributed to the oil price increase between 2004 and 2008.'' [http://research.stlouisfed.org/wp/2011/2011-027.pdf]
(38) Kawamoto, Takuji/Kimura, Takeshi/Morishita, Kentaro/Higashi, Masato (Bank of Japan) (2011): What has caused the surge in global commodity prices
 and strengthened cross-market linkage?: ``Moreover, we find quantitative evidence that an increase in cross-market linkage between commodity and stock
 markets was caused by the markets' increased comovements due to large fluctuations in the global economy during the financial crisis as well as by the
 `financialization of commodities,' that is, financial investors are increasingly treating commodities as an investment asset class.'' [http://
 www.boj.or.jp/en/research/wps_rev/wps_2011/data/wp11e03.pdf]
(39) Khan, Mohsin S. (Petersen Institute) (2009): The 2008 Oil Price `Bubble': ``While market fundamentals obviously played a role in the general run-up
 in the oil prices from 2003 on, it is fair to conclude by looking at a variety of indicators that speculation drove an oil price bubble in the first
 half of 2008. Absent speculative activities, the oil price would probably have been in the $80 to $90 a barrel range.'' [http://www.piie.com/
 publications/pb/pb09-19.pdf]
(40) Lagi, Marco/Bar-Yam, Yavni/Bertrand, Karla Z./Bar-Yam, Yaneer (New England Complex Systems Institute, Cambridge MA) (2011): The Food Crises A
 Quantitative Model of Food Prices Including Speculators and Ethanol Conversion: ``The two sharp peaks in 2007/2008 and 2010/2011 are specifically due
 to investor speculation, while an underlying upward trend is due to increasing demand from ethanol conversion. The model includes investor trend
 following as well as shifting between commodities, equities and bonds to take advantage of increased expected returns. Claims that speculators cannot
 influence grain prices are shown to be invalid by direct analysis of price setting practices of granaries.'' Update (2012): ``we extend the food prices
 model to January 2012, without modifying the model but simply continuing its dynamics. The agreement is still precise, validating both the descriptive
 and predictive abilities of the analysis.'' [http://necsi.edu/research/social/food_prices.pdf] [http://necsi.edu/research/social/foodprices/update/
 food_prices_update.pdf]
(41) Lammerding, Marc/Stephan, Patrick/Trede, Mark/Wilfling, Bernd (University of Munster): Speculative bubbles in recent oil price dynamics: Evidence
 from a Bayesian Markov-switching state-space approach: ``we find robust evidence for the existence of speculative bubbles in recent oil price
 dynamics.'' [http://www1.wiwi.uni-muenster.de/cqe/forschung/publikationen/cqe-working-papers/CQE_WP_23_2012.pdf]
(42) Le Pen, Yannick (Universite Paris-Dauphine)/Sevi, Benoit (Aix-Marseille University) (2012): Futures Trading and the Excess Comovement of Commodity
 Prices: ``Our estimates provide evidence of a time-varying excess comovement which is only occasionally significant, even after controlling for
 heteroscedasticity. Interestingly, excess comovement is mostly significant in recent years when a large increase in the trading of commodities is
 observed. However, we show that this increase in trading activity alone has no explanatory power for the excess comovement. Conversely, measures of
 hedging and speculative pressure explain around 60% of the estimated excess comovement thereby showing the strong impact of the financialization on the
 price of commodities and the fact that demand and supply variables are not the sole factors in determining equilibrium prices.'' [http://
 papers.ssrn.com/sol3/papers.cfm?abstract_id=2191659]
(43) Liu, Peng (Cornell University)/Zhigang, Qui/Tang, Ke (Renmin University of China) (2011) Financial-Demand Based Commodity Pricing: A Theoretical
 Model for Financialization of Commodities: ``In this paper, we develop an equilibrium model that shows that financial investment does influence
 commodity prices and volatilities. Furthermore, financial investments dilute the relationship between convenience yields (a proxy for the fundamentals)
 and commodity prices.'' [http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1946197]
(44) Lombardi, Marco J./Van Robays, Ine (European Central Bank) (2011): Do financial investors destablize the oil price?: ``We find that financial
 investors in the futures market can destabilize oil spot prices, although only in the short run. Moreover, financial activity appears to have
 exacerbated the volatility in the oil market over the past decade, particularly in 2007-2008. However, shocks to oil demand and supply. remain the main
 drivers of oil price swings.'' [http://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1346.pdf]
(45) Luciani, Giacomo (Gulf Research Center Foundation) (2009): From Price Taker to Price Maker? Saudi Arabia and the World Oil Market: ``The inflow of
 liquidity, the increasing role played by the futures market (paper barrels) over the spot (wet barrels), and the proliferation of derivatives which
 encourage betting on price changes rather than on the absolute level of prices all contribute to worsen the situation, amplifying price oscillations.''
 [http://www.princeton.edu/gluciani/pdfs/Saudi%20Arabia%20and%20the%20World%20Oil%20Market.pdf]
(46) Mayer, Jorg (UNCTAD) (2009): The Growing Interdependence between Financial and Commodity Markets: ``The increasing importance of financial
 investment in commodity trading appears to have caused commodity futures exchanges to function in such a way that prices may deviate, at least in the
 short run, quite far from levels that would reliably reflect fundamental supply and demand factors. Financial investment weakens the traditional
 mechanisms that would prevent prices from moving away from levels determined by fundamental supply and demand factors--efficient absorption of
 information and physical adjustment of markets. This weakening increases the proneness of commodity prices to overshooting and heightens the risk of
 speculative bubbles occurring.'' [http://www.unctad.org/en/docs/osgdp20093_en.pdf]
(47) Medlock, Kenneth B./Jaffe, Amy M. (Rice University) (2009): Who is in the Oil Futures Market and How Has It Changed?: ``. . . trading strategies of
 some financial players in oil appears to be influencing the correlation between the value of the U.S. dollar and the price of oil. (. . .) We also find
 that the correlation between movements in oil prices and the value of the dollar against the trade-weighted index of the currencies of foreign
 countries has increased to 0.82 (a significant measure) for the period between 2001 and the present day, compared to a previously insignificant
 correlation of only 0.08 between 1986 and 2000.'' [http://www.bakerinstitute.org/publications/EF-pub-MedlockJaffeOilFuturesMarket-082609.pdf]
(48) Mou, Yiqun (Columbia University) (2010): Limits to Arbitrage and Commodity Index Investment: Frontrunning the Goldman Roll: ``This paper focuses on
 the unique rolling activity of commodity index investors in the commodity futures markets and shows that the price impact due to this rolling activity
 is both statistically and economically significant.'' [http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1716841]
(49) Naylor, Rosamund L./Falcon, Walter P. (Stanford University) (2010): Food Security in an Era of Economic Volatility: ``Uncertainty surrounding
 exchange rates and macro policies added to price misperceptions, as did flurries of speculative activity in organized futures markets. Events since
 2005--including the most recent period of price variability in 2010--underscore the point that uncertainty and expectations can be as important as or
 even more important than actual changes in grain demand and supply in driving price variability.'' [http://www.ncbi.nlm.nih.gov/pubmed/21174866]
(50) Nissanke, Machiko (University of London) (2011): Commodity Markets and Excess Volatility. Sources and Strategies to Reduce Adverse Development
 Impacts: ``Thus, commodity prices, as prices of any assets traded globally, can be largely influenced by market liquidity cycles in global finance.
 From this particular perspective, we can have a plausible narrative of the recent episode of commodity price cycle. (. . .) Clearly, trading activities
 in world commodity markets have undergone some fundamental change, as the links between activities in commodity and financial markets has further
 intensified.'' [http://common-fund.org/uploads/tx_cfc/CFC_report_Nissanke_Volatility_Development_Impact_2010_02.pdf]
(51) Peri, Massimo/Vandone, Daniela/Baldi, Luca (Universita degli studi di Milano) (2012): Internet, Noise Trading and Commodity Prices: ``Moreover,
 results show that variations in information demand have a significant effect on corn futures volatility, and this effect is robust even when
 controlling for variations in the supply of information. This result is relevant since it can be interpreted in light of behavioural finance, where
 studies consider information demand as an expression of noise trading: the search of information on commodity prices through Internet by noise traders
 can amplify volatility especially in case of negative shock, when investment decisions are more easily influenced by panic or irrational behavior.''
 [http://www.economia.unimi.it/uploads/wp/DEAS-2012_07wp.pdf]
(52) Phillips, Peter C.B. (Yale University)/Yu, Jun (Singapore University) (2010): Dating the Timeline of Financial Bubbles During the Subprime Crisis:
 ``a bubble first emerged in the equity market during mid-1995 lasting to the end of 2000, followed by a bubble in the real estate market between
 September 2000 and June 2007 and in the mortgage market between August 2005 and July 2007. After the subprime crisis erupted, the phenomenon migrated
 selectively into the commodity market and the foreign exchange market, creating bubbles which subsequently burst at the end of 2008, just as the
 effects on the real economy and economic growth became manifest.'' [http://cowles.econ.yale.edu/P/cd/d17b/d1770.pdf ]
(53) Pollin, Robert/Heintz, James (University of Massachusetts) (2011): How Wall Street Speculation is Driving Up Gasoline Prices Today: ``A major
 additional factor is the rapid growth in large-scale speculative trading around oil prices through the oil commodities futures market. Indeed, we
 estimate that, without the influence of large-scale speculative trading on oil in the commodities futures market, the average price of gasoline at the
 pump in May would have been $3.13 rather than $3.96.'' [http://www.nefiactioncenter.com/PDF/umass_study.pdf]
(54) Ray, Darryl E./Schaffer, Harwood D. (University of Tennessee) (2010): Index funds and the 2006-2008 run-up in agricultural commodity prices: ``the
 fundamentals and/or expectations in the energy and mineral markets rein supreme--grains are along for the ride with little-to-no regard to what is
 happening in the grain sector. Worries during the period about the availability of oil drove up the price of crude, which caused index funds to
 rebalance their portfolios by making additional purchases of the other commodities to maintain the specified balance. Since the resulting price
 increases in agricultural commodities had virtually nothing to do with their market conditions, the record level of activity in the futures market by
 index funds would seem to make index funds a logical source of possible price overshooting.'' [http://www.agpolicy.org/weekpdf/545.pdf]
(55) Robles, Miguel/Torero, Maximo/Braun, Joachim von (IFPRI) (2009): When speculation matters: ``Changes in supply and demand fundamentals cannot fully
 explain the recent drastic increase in food prices. Rising expectations, speculation, hoarding, and hysteria also played a role in the increasing level
 and volatility of food prices.'' [http://www.ifpri.org/sites/default/files/publications/ib57.pdf]
(56) Schulmeister, Stephan (Vienna University) (2009): Trading Practices and Price Dynamics in Commodity Markets: ``Based on the `bullishness' in
 commodity derivatives markets, short-term oriented speculators reacted much stronger to news in line with the expectation of rising prices than to news
 which contradicted the `market mood'. Hence, they put more money into long positions than into short positions and held long positions longer than
 short positions. Due to this trading behavior, upward commodity price runs lasted longer in recent years than downward runs causing prices to rise in a
 stepwise process. Commodity price runs were lengthened by the use of trend-following trading systems of technical analysis. These systems try to
 exploit price runs by producing buy (sell) signals in the early stage of an upward (downward) run. The aggregate trading signals then feed back upon
 commodity prices.'' [http://www.wifo.ac.at/wwa/downloadController/displayDbDoc.htm?item=S_2009_TRANSACTION_TAX_34919$.PDF]
(57) Schulmeister, Stephan (Vienna University) (2012): Technical Trading and Commodity Price Fluctuations: ``If one aggregates over the transactions and
 open positions of the 1,092 technical models, it turns out that technical commodity futures trading exerts an excessive demand (supply) pressure on
 commodity markets.'' [http://www.wifo.ac.at/wwa/downloadController/displayDbDoc.htm?item=S_2012_COMMODITY_PRICE_FLUCTUATIONS_ 45238$.PDF]
(58) Singleton, Kenneth J. (Stanford University) (2010): The 2008 Boom/Bust in Oil Prices: ``In my view, while spot-market supply and demand pressures
 were influential factors in the behavior of oil prices, so were participation in oil futures markets by hedge funds, long-term passive investors, and
 other traders in energy derivatives.'' [http://www.cftc.gov/ucm/groups/public/@swaps/documents/dfsubmission/dfsubmission26_091410-ata.pdf]
(59) Singleton, Kenneth J. (Stanford University) (2011): Investor Flows And The 2008 Boom/Bust in Oil Prices: ``there was an economically and
 statistically significant effect of investor flows on futures prices . . . The intermediate-term growth rates of index positions and managed-money
 spread positions had the largest impacts on futures prices.'' [http://www.stanford.edu/kenneths/OilPub.pdf]
(60) Sockin, Michael/Xiong, Wei (Princeton University) (2012): Feedback Effects of Commodity Futures Prices: ``As a result of information frictions and
 production complementarity, increases in the futures prices, even if driven by non-fundamental reasons, can lead to increased, rather than decreased,
 commodity demand and thus spot prices. This outcome contradicts two widely held arguments that speculators who trade only in futures markets cannot
 aect spot prices and that commodity price increases driven by non-fundamental reasons must be accompanied by inventory spikes.'' [http://
 www.princeton.edu/wxiong/papers/feedback.pdf]
(61) Timmer, C. Peter (Center for Global Development, Washington) (2009): Peter Timmer: Peter Timmer: Did Speculation Affect World Rice Prices?:
 ``Speculative money seems to surge in and out of commodity markets, strongly linking financial variables with commodity prices during some time
 periods. But these periods are often short and the relationships disappear entirely for long periods of time.'' [ftp://ftp.fao.org/docrep/fao/011/
 ak232e/ak232e00.pdf]
(62) Tse, Yiuman/Williams, Michael (University of Texas at San Antonio) (2011): Does Index Speculation Impact Commodity Prices?: ``We conclude that
 speculative pressures exerted by commodity index investors can impact non-index commodities. These results are likely not due to speculative pressure
 itself, but rather the subsequent price destabilizing trades of uninformed, positive feedback traders.'' [http://business.utsa.edu/wps/fin/0007FIN-257-
 2011.pdf]
(63) Tse, Yiuman (University of Texas at San Antonio) (2012): The Relationship Among Agricultural Futures, ETFs, and the U.S. Stock Market: ``I find
 that Granger-causality in returns primarily runs from individual futures to the agriculture ETFs. However, DBA and RJA returns are also significantly
 caused by S&P 500 index returns, showing that stock market sentiment influences pricing behavior. The results are also consistent with the impact of
 financialization of commodities on agriculture prices.'' [http://business.umsl.edu/seminar_series/Spring2012/DBA20.pdf]
(64) Van der Molen, Maarten (University of Utrecht) (2009): Speculators invading the commodity markets: a case study of coffee: ``The results indicate
 that index speculators frustrated the futures market in the period between 2005 and 2008. This conclusion is based on the following indications:
 fundamentals have a lower impact on the price, the volume of index speculators has increased and their ability to influence the futures market has
 increased.'' [http://library.wur.nl/WebQuery/clc/1934340]
(65) Vansteenkiste, Isabel (European Central Bank) (2011): What is driving oil price futures? Fundamentals versus Speculation: ``We find that for the
 earlier part of our sample (up to 2004) that fundamentals have been the key driving force behind oil price movements. Thereafter, trend chasing
 patterns appear to be better in capturing the developments in oil futures markets.'' [http://www.ecb.int/pub/pdf/scpwps/ecbwp1371.pdf]
(66) Varadi, Vijay Kumar (ICRIER) (2012): An evidence of speculation in Indian commodity markets: ``results exhibit that speculation has played decisive
 role in the commodity price bubble during the global crisis in India.'' [http://mpra.ub.uni-muenchen.de/38337/1/MPRA_paper_38337.pdf]
(67) Von Braun, Joachim (Bonn University), Tadesse, Getaw (IFPRI) (2012): Global Food Price Volatility and Spikes: An Overview of Costs, Causes and
 Solutions: ``The general conclusion on price spikes is that they were driven by excessive volumes of futures trading more than by demand side (oil
 price) and supply side shocks.'' [http://www.zef.de/fileadmin/webfiles/downloads/zef_dp/zef_dp_161.pdf]
(68) Windawi, A. Jason (Columbia University) (2012): Speculation, Embedding, and Food Prices. A Cointegration Analysis: ``The Wheat Granger test results
 show a clustering of speculative financial influences on wheat prices in the period from early 2006 through June of 2010, with a particularly strong
 increase in the four subperiods beginning with the first drop in prices. (. . .) Like the wheat tests, the Granger results for Corn . . . were
 clustered around the first wave of the food crisis . . .'' [http://academiccommons.columbia.edu/item/ac:146501]
(69) Wray, Randall L. (University of Missouri-Kansas City) (2008): The Commodities Market Bubble--Money Manager Capitalism and the Financialization of
 Commodities: ``There is adequate evidence that financialization is a big part of the problem, and there is sufficient cause for policymakers to
 intervene with sensible constraints and oversight to reduce the influence of managed money in these markets.'' [http://www.levyinstitute.org/pubs/
 ppb_96.pdf]
                                               (C) Research papers and testimonies by analysts and traders
(1) Berg, Ann (former CBoT trader and director, now FAO advisor) (2011): The rise of commodity speculation: from villainous to venerable: ``Structural
 changes in global commodity markets have greatly contributed to rising prices and increased price variability. These fundamental trends toward higher
 prices have been a key lure for increased speculative activity on the major futures exchanges.'' [http://www.nefiactioncenter.com/PDF/
 theriseofcommodityspeculation.pdf]
(2) Bukold, Steffen (2010) (Energycomment): Olpreisspekulation und Benzinpreise in Deutschland: ``Traditionelle Erklarungen, die nur auf den physischen
 Olmarkt schauen, sind nicht hilfreich: Ein Uberangebot an Rohol, schwache Nachfrage und uberquellende Lager hatten zu sinkenden, bestenfalls
 stagnierenden Roholpreisen fuhren mussen. Die Erklarung liegt im starken Engagement von Finanzinvestoren, die Ol (genauer: Ollieferkontrakte) aus
 spekulativen Grunden kaufen, d.h. auf hohere Olpreise wetten. Der Roholmarkt ist dadurch noch starker als bisher zu einem Hybridmarkt geworden, also
 einer Mischung aus Rohstoffmarkt und Finanzmarkt.'' [http://www.energiepolitik.de/oelpreisspekulation/]
(3) Cooper, Marc (Consumer Federation of America) (2011): Excessive Speculation and Oil Price Shock Recessions: A Case of Wall Street ``Deja vu all over
 again'': ``the paper shows that excessive speculation, not market fundamentals caused the spike in oil prices. The movement of trading and prices in
 the 3 years since the speculative bubble in oil burst in 2008 provides even stronger evidence that excessive speculation is a major problem that
 afflicts the oil market and the economy.'' [http://www.consumerfed.org/pdfs/SpeculationReportOctober13.pdf]
(4) Deutsche Bank Research (2009): Do speculators drive crude oil prices? Dispersion in beliefs as price determinants: ``The econometric estimates can
 reject the null hypotheses that the dispersion in beliefs of speculators has no influence on the crude oil price and its volatility. Both the Granger
 causality tests and the distributed lag models, which also include lagged regressors that measure the dispersion in beliefs of speculators, confirm
 moreover the role of speculation as a precursor to price movements . . .'' [http://www.dbresearch.com/servlet/reweb2.ReWEB?
 ColumnView=0&Function=showPeriOverview(NERESNOT;noTopic;noRegion) &Submit=ShowPdf&rwnode=DBR_INTERNET_EN-PROD$RSNN000000000013
 6534&rwobj=ReFIND.ReFindSearch.class&rwsite=DBR_INTERNET_EN-PROD& type=callFunction]
(5) Dicker, Dan (former NYMEX trader) (2011): ``I wrote Oil's Endless Bid to show how the treatment of oil as a stock by investors, far more than any
 number of globally significant competing factors, causes the dramatically higher prices that we've seen in recent years. I've witnessed seismic changes
 to the oil markets during my many years as a trader, and it's the everyday consumer who shoulders the burden.'' [http://www.marketwire.com/press-
 release/oils-endless-bid-taming-unreliable-price-oil-secure-our-economy-dan-dicker-published-1503559.htm]
(6) Goldman Sachs (2011): Global Energy Weekly, March 2011: ``We estimate that each million barrels of net speculative length tends to add 8-10 to the
 price of a barrel of oil.'' [http://www.energianews.com/newsletter/files/80e9ebe0ff67bd94432a4031ee17c2b9.pdf]
(7) Evans, Tim (Citigroup energy analyst) (2008): The Official Demise of the Oil Bubble (Wall Street Journal article): ``This is a market that is
 basically returning to the price level of a year ago which it arguably should never have left. (. . .) We pumped up a big bubble, expanded it to an
 impressive dimension, and now it is popped and we have bubble gum in our hair.'' [http://blogs.wsj.com/marketbeat/2008/10/10/the-official-demise-of-the-
 oil-bubble/]
(8) Frenk, David (Better Markets) (2010): Review of Irwin and Sanders 2010 OECD report: ``1) The statistical methods applied are completely
 inappropriate for the data used. 2) The study is contradicted by the findings of other studies that apply more appropriate statistical methods to the
 same data. 3) The overall analysis is superficial and easily refuted by looking at some basic facts.'' [http://blog.newconstructs.com/wp-content/
 uploads/2010/10/FrenkPaperReutingOECDStudy_IrwinAndSanders.pdf]
(9) Frenk, David/Turbeville, Wallace C. (Better Markets) (2011): Commodity Index Traders and the Boom/Bust Cycle in Commodities Prices: ``We find strong
 evidence that the CIT Roll Cycle systematically distorts forward commodities futures price curves towards a contango state, which is likely to
 contribute to speculative `boom/bust' cycles by changing the incentives of producers and consumers of storable commodities, and also by sending
 misleading and non-fundamental, price signals to the market.'' [http://papers.ssrn.com/Sol3/papers.cfm?abstract_id=1945570]
(10) Gheit, Fadel/Katzenberg, Daniel (2008) (Oppenheimer & Co.): Surviving lower oil prices: ``The investment banks that hyped oil prices using voodoo
 economics have suddenly reversed their position and now expect much lower oil prices. They helped cause excessive speculation, create the oil bubble,
 and contributed to the global financial crisis. They have changed their tune in exchange for a government bailout, not because of changes in market
 fundamentals.'' [http://www.nakedcapitalism.com/2008/10/commodities-continue-to-tank.html]
(11) Hunt, Simon (Simon Hunt Strategic Services) (2011): ``Slowly, the truth on whether the global copper market is really tight is coming out. It
 illustrates just how large an involvement the financial institutions have become to the copper industry. It shows, too, that by throwing money at a
 market, prices can be driven higher. In the process, however, the delicate balance between supply and the industry's requirements for a basic material
 used to produce a range of essential products is destroyed. In short, copper is becoming a financial asset in place of its historic role as an
 industrial metal.'' [http://traderightuk.wordpress.com/2011/09/07/guest-blog-simon-hunt-on-copper/]
(12) Kemp, John (Reuters) (2008): Crisis remakes the commodity business: ``It does not alter the fact most of the upsurge in futures and options
 turnover on commodity exchanges and in OTC markets over the last 5 years has come from investment-related rather than trade-related business.'' [http://
 www.reuters.com/article/2008/10/29/column-kemp-idUSLT9693720081029]
(13) Korzenik, Jeffrey (CIO, Caturano Wealth Management) (2009): Fundamental Misconceptions in the Speculation Debate: `` `Overspeculation' or
 `excessive speculation' exists when speculators become primary drivers of price. When this happens, commodities are no longer efficiently allocated--if
 prices are driven below the point where commercial supply and demand meet, shortages result.'' [http://inefficientfrontiers.wordpress.com/2009/07/29/
 fundamental-misconceptions-in-the-speculation-debate/]
(14) Lake Hill Capital Management (2013): Investable indices are distorting commodities and futures: ``. . . it is important to recognize that
 institutional and retail indexing demand can create price distortions that cloud the fundamental picture. Increased indexing leads to steeper futures
 term structures, and this results in more costly exposure.'' [http://www.hedgefundintelligence.com/Article/3202027/AbsoluteReturn-Opinion/Investable-
 indices-are-distorting-commodities-and-futures.html?LS=Twitter]
(15) Lines, Thomas (commodity consultant) (2010): Speculation in food commodity markets: ``These are the main problems that are caused by long-only
 index trading: It pushes prices up, irrespective of the market situation. It disrupts the rolling over of futures contracts when the nearest month
 expires.'' [http://www.eurodad.org/uploadedFiles/Whats_New/News/Speculation%20in%20Food%20commodity%20markets.pdf]
(16) Masters, Michael W. (Masters Capital)/White, Adam K. (White Knight Research) (2008): The Accidental Hunt Brothers: ``Index Speculators have bought
 more commodities futures contracts in the last 5 years than any other group of market participant. They are now the single most dominant force in the
 commodities futures markets. And most importantly, their buying and trading has nothing to do with the supply and demand fundamentals of any single
 commodity. They pour money into commodities futures to diversify their portfolios, hedge against inflation or bet against the dollar.'' [http://
 www.loe.org/images/content/080919/Act1.pdf]
(17) Morse, E. (former Lehman Brothers chief energy economist) (2008): Oil Dotcom, Research Note: ``Fundamental changes cannot explain sudden, severe
 price or curve movements. (. . .) Our conclusion from this study is that we are seeing the classic ingredients of an asset bubble.''
(18) Newell, J. (Probability Analytics Research) (2008): Commodity Speculation's ``Smoking Gun'': ``Real market forces in these diverse markets are
 largely independent of one another, and therefore price changes should be essentially uncorrelated. This was clearly true historically; from 1984
 through 1999 average correlation between all commodities was only 7%. In the last 12 months this average rose to 64%. Correlation with the GSCI was 23%
 historically, and rose to 76% in the last year. Index speculation has swamped real market forces.'' [http://accidentalhuntbrothers.com/wp-content/
 uploads/2008/11/probalytics-081117.pdf]
(19) Petzel, Todd E. (Offit Capital Advisors) (2009): Testimony before the CFTC: ``I believe these investors in aggregate have had a material impact on
 price levels, price spreads and the level of inventories being held.'' [http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/
 hearing072809_petzel2.pdf]
(20) Soros, George (2008): Interview with Stern: ``Speculators create the bubble that lies above everything. Their expectations, their gambling on
 futures help drive up prices, and their business distorts prices, which is especially true for commodities. It is like hoarding food in the midst of a
 famine, only to make profits on rising prices. That should not be possible.'' [http://www.stern.de/wirtschaft/news/maerkte/george-soros-we-are-in-the-
 midst-of-the-worst-financial-crisis-in-30-years-625954.html]
(21) Tudor Jones, Paul (Tudor Investment Corporation) (2010): Price Limits: A Return to Patience and Rationality in U.S. Markets. Speech to the CME
 Global Financial Leadership: ``Every exchange traded instrument including all securities, futures, options and any other form of derivatives should
 have some form of a price limit. And this is all the more urgently needed now that electronic execution dominates trading.'' [http://media.ft.com/cms/
 834d6096-de23-11df-9364-00144feabdc0.pdf]
(22) Urbanchuk, John M. (Cardno ENTRIX) (2011): Speculation and the Commodity Markets: ``A careful examination of activity by non-commercial and index
 traders (i.e., speculators) in the corn futures market in the context of supply and demand fundamentals strongly suggests that speculation is a major
 factor behind the sharp increase in both the level and volatility of corn prices this year.''  [http://ethanolrfa.org/page/-/
 ENTRIX%20Speculation%20Paper.pdf?nocdn=1&utm _medium=email&utm_campaign= New+Reports+Fault+Speculation+for+Volatile+Commodity+ Food+Prices&utm_content=
 New+Reports+Fault+Speculation+for+Volatile+Commodity+Food+Prices+ CID_284b92e095cb531b6481bde94e6c788a&utm_
 source=Email+marketing+software&utm_term=Cardno+Entrix]
(23) Woolley, Paul (former fund manager, York University/London School of Economics) (2010): Why are financial markets so inefficient and exploitative--
 and a suggested remedy: ``With the flood of passive and active investment funds going into commodities from 2005 onwards, prices have been increasingly
 driven by fund inflows rather than fundamental factors. Prices no longer provide a reliable signal to producers or consumers.'' [http://
 harr123et.files.wordpress.com/2010/07/futureoffinance-chapter31.pdf]
                                                           (D) Reports by public institutions
(1) Chevalier, Jean-Marie (ed.) (Ministere de l'Economie, de l'Industrie et de l'Emploi) (2010): Rapport du groupe de travail sur la volatilite des prix
 du petrole: ``On peut raisonnablement avancer en conclusion que le jeu de certains acteurs financiers a pu amplifier les mouvements a la hausse ou a la
 baisse des cours, augmentant la volatilite naturelle des prix du petrole . . .'' [http://www.minefe.gouv.fr/services/rap10/100211rapchevalier.pdf]
(2) House of Commons Select Committee on Science & Technology of the United Kingdom (2011): ``While the debate on the relative importance of the
 multiple factors influencing commodities prices is still open, it is clear that price movements across different commodity markets have become more
 closely related and that commodities markets have become more closely linked to financial markets.'' [http://www.publications.parliament.uk/pa/cm201012/
 cmselect/cmsctech/726/72606.htm]
(3) Jouyet, Jean-Pierre (President de l'Autorite des marches financiers)/de Boissieu, Christian (President du Conseil d'analyse economique)/Guillon,
 Serge (Controleur general economique et financier) (2010): Rapport d'etape--Prevenir et gerer l'instabilite des marches agricoles: ``Les marches
 agricoles sont confrontes a une mondialisation et a une financiarisation qui influencent leur fonctionnement. La volatilite naturelles des prix qui
 caracterise ces marches est amplifiee par de nouveaux facteurs et notamment par une speculation excessive.'' [http://agriculture.gouv.fr/IMG/pdf/
 Nouveau_rapport_etape_Jouyet_Boissieu_Guillon.pdf]
(4) Schutter, Olivier de (UN Special Rapporteur on the Right to Food) (2010): Food commodities speculation and food price crises: Regulation to reduce
 the risks of financial volatility: ``The global food price crisis that occurred between 2007 and 2008 . . . had a number of causes. The initial causes
 related to market fundamentals, including the supply and demand for food commodities, transportation and storage costs, and an increase in the price of
 agricultural inputs. However, a significant portion of the increases in price and volatility of essential food commodities can only be explained by the
 emergence of a speculative bubble.'' [http://www.theaahm.org/fileadmin/user_upload/aahm/docs/20102309_briefing_note_02_en.pdf]
(5) Tanaka, Nobuo (head International Energy Agency) (2009): IEA says speculation amplifying oil prices moves (Reuters article): ``Our analysis shows
 that the fundamentals are deciding the direction of the price while these funds or speculations . . . are amplifying the movement.'' [http://
 uk.reuters.com/article/2009/06/30/iea-oil-idUKNWNA801920090630]
(6) United Nations Conference on Trade and Development (UNCTAD) (2009): Trade and Development Report, Chapter II--The Financialization of Commodity
 Markets: ``The financialization of commodity futures trading has made commodity markets even more prone to behavioural overshooting. There are an
 increasing number of market participants, sometimes with very large positions, that do not trade based on fundamental supply and demand relationships
 in commodity markets, but, who nonetheless, influence commodity price developments.'' [http://www.unctad.org/en/docs/tdr2009ch2_en.pdf]
(7) United Nations Conference on Trade and Development (UNCTAD) (2009): The global economic crisis: Systemic failures and multilateral remedies: ``The
 evidence to support the view that the recent wide fluctuations of commodity prices have been driven by the financialization of commodity markets far
 beyond the equilibrium prices is credible. Various studies find that financial investors have accelerated and amplified price movements at least for
 some commodities and some periods of time. (. . .) The strongest evidence is found in the high correlation between commodity prices and the prices on
 other markets that are clearly dominated by speculative activity.'' [http://www.unctad.org/en/docs/gds20091_en.pdf]
(8) United Nations Conference on Trade and Development (UNCTAD) (2011): Price Formation in Financialized Commodity Markets: the Role of Information:
 ``Due to the increased participation of financial players in those markets, the nature of information that drives commodity price formation has
 changed. Contrary to the assumptions of the efficient market hypothesis (EMH), the majority of market participants do not base their trading decisions
 purely on the fundamentals of supply and demand; they also consider aspects which are related to other markets or to portfolio diversification. This
 introduces spurious price signals to the market.'' [http://www.unctad.org/en/docs/gds20111_en.pdf]
(9) United Nations Commission of Experts on Reforms of the International and Monetary System (2009): Report: ``In the period before the outbreak of the
 crisis, inflation spread from financial asset prices to petroleum, food, and other commodities, partly as a result of their becoming financial asset
 classes subject to financial investment and speculation.'' [http://www.un.org/ga/president/63/interactive/financialcrisis/PreliminaryReport210509.pdf]
(10) United Nations Food and Agricultural Organisation (FAO) (2010): Final report of the committee on commodity problems: Extraordinary joint
 intersessional meeting of the intergovernmental group (IGG) on grains and the intergovernmental group on rice: ``Unexpected crop failure in some major
 exporting countries followed by national responses and speculative behaviour rather than global market fundamentals, have been amongst the main factors
 behind the recent escalation of world prices and the prevailing high price volatility.'' [http://www.fao.org/fileadmin/templates/est/
 COMM_MARKETS_MONITORING/Grains/Documents/FINAL_REPORT.pdf]
(11) United Nations Food and Agricultural Organisation (FAO) (2010). Price Volatility in Agricultural Markets. Economic and Social Perspectives Policy
 Brief 12: ``Financial firms are progressively investing in commodity derivatives as a portfolio hedge since returns in the commodity sector seem
 uncorrelated with returns to other assets. While this `financialisation of commodities' is generally not viewed as the source of price turbulence,
 evidence suggests that trading in futures markets may have amplified volatility in the short term.'' [http://www.fao.org/docrep/013/am053e/
 am053e00.pdf]
(12) United Nations Food and Agricultural Organisation (FAO), IFAD, IMF, OECD, UNCTAD, WFP, The World Bank, The WTO, IFPRI, UN HLTF (2011): Price
 Volatility in Food and Agricultural Markets: Policy Responses: ``While analysts argue about whether financial speculation has been a major factor, most
 agree that increased participation by noncommercial actors such as index funds, swap dealers and money managers in financial markets probably acted to
 amplify short term price swings and could have contributed to the formation of price bubbles in some situations.'' [http://www.fao.org/fileadmin/
 templates/est/Volatility/Interagency_Report_to_the_G20_on_Food_Price_Volatility.pdf]
(13) United States Senate, Permanent Subcommittee on Investigations (2007): Excessive Speculation in the Natural Gas Market: ``Amaranth's 2006 positions
 in the natural gas market constituted excessive speculation. (. . .) Purchasers of natural gas during the summer of 2006 for delivery in the following
 winter months paid inflated prices due to Amaranth's speculative trading.'' [http://hsgac.senate.gov/public/_files/
 REPORTExcessiveSpeculationintheNaturalGasMarket.pdf]
(14) United States Senate, Permanent Subcommittee on Investigations (2009): Excessive Speculation in the Wheat Market: ``This Report concludes there is
 significant and persuasive evidence that one of the major reasons for the recent market problems is the unusually high level of speculation in the
 Chicago wheat futures market due to purchases of futures contracts by index traders offsetting sales of commodity index instruments.'' [http://
 hsgac.senate.gov/public/_files/REPORTExcessiveSpecullationintheWheatMarketwoexhibitschartsJune2409.pdf]
(15) United States Senate, Permanent Subcommittee on Investigations (2006): The Role of Market Speculation in Rising Oil and Gas Prices: ``The large
 purchases of crude oil futures contracts by speculators have, in effect, created an additional demand for oil, driving up the price of oil to be
 delivered in the future in the same manner that additional demand for the immediate delivery of a physical barrel of oil drives up the price on the
 spot market.'' [http//www.hsgac.senate.gov/public/_files/SenatePrint10965MarketSpecReportFINAL.pdf]






                                                                       Appendix B



                                38 Independent Studies on the Negative Effects of High Speed Trading on Commodity Markets
--------------------------------------------------------------------------------------------------------------------------------------------------------
         Author(s), Title, Year                           Data                                              Relevant findings
--------------------------------------------------------------------------------------------------------------------------------------------------------
Anand, Tanggaard, Weaver, ``Paying for   Swedish equities, 2002-2004             Designated market makers with affirmative obligations improve market
 Market Quality'' (2009)                                                          quality, increase market valuation.
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://journals.cambridge.org/action/displayAbstract?fromPage=online&aid=7077684&fulltextType=RA&fileId=S0022109009990421]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Bank for International Settlements,      Foreign exchange, 2010 and 2011         ``HFT has had a marked impact on the functioning of the FX market in
 ``High frequency trading in the                                                  ways that could be seen as beneficial in normal times, but also in
 foreign exchange market'' (2011)                                                 ways that may be harmful to market functioning, particularly in times
                                                                                  of market stress.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.bis.org/publ/mktc05.pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Bichetti, Maystre, ``The synchronized    U.S. futures and equities, 1997-2011    ``This paper documented striking similarities in the evolution of the
 and longlasting structural change on                                             rolling correlations between the returns on several commodity futures
 commodity markets: evidence from high                                            and the ones on the U.S. stock market, computed at high frequencies .
 frequency data'' (2012) (Added 3/2012)                                           . . we think that HFT strategies, in particular the trend-following
                                                                                  ones, are playing a key role . . . commodity markets are more and more
                                                                                  prone to events in global financial markets and likely to deviate from
                                                                                  their fundamentals.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://mpra.ub.uni-muenchen.de/37486/1/MPRA_paper_37486.pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Boehmer, Fong, Wu, ``International       Equities in 37 countries (excluding     ``Overall, our results show that algorithmic trading often improves
 Evidence on Algorithmic Trading''        U.S.), 2001-2009                        liquidity, but this effect is smaller when market making is difficult
 (2012) (Added 3/2012)                                                            and for low-priced or high-volatility stocks. It reverses for small
                                                                                  cap stocks, where AT is associated with a decrease in liquidity. AT
                                                                                  usually improves efficiency. The main costs associated with AT appear
                                                                                  to be elevated levels of volatility. This effect prevails even for
                                                                                  large market cap, high price, or low volatility stocks, but it is more
                                                                                  pronounced in smaller, low price, or high volatility stocks.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2022034]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Chae, Wang, ``Determinants of Trading    Taiwanese equities, 1997-2002           Absent mandatory obligations, market maker privileges don't induce
 Profits: The Liquidity Provision                                                 market makers to provide liquidity; privileged but unconstrained
 Decision'' (2009)                                                                market makers make profits when demanding liquidity in their own
                                                                                  informed trades; unconstrained market makers are informed traders
                                                                                  rather than liquidity providers in most scenarios.
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://mesharpe.metapress.com/link.asp?target=contribution&id=HJV244322G246764]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Easley, Lopez del Prado, O'Hara, ``The   U.S. futures, 2010                      Unregulated or unconstrained HFT market makers can exacerbate price
 Microstructure of the Flash Crash''                                              volatility when they dump inventory and withdraw, flash crashes will
 (2011)                                                                           recur because of structural issues.
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1695041]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Egginton, Van Ness, Van Ness, ``Quote    U.S. equities, 2010                     ``We find that quote stuffing is pervasive with several hundred events
 Stuffing'' (2012) (Added 3/2012)                                                 occurring each trading day and that quote stuffing impacts over 74% of
                                                                                  U.S. listed equities during our sample period. Our results show that,
                                                                                  in periods of intense quoting activity, stocks experience decreased
                                                                                  liquidity, higher trading costs, and increased short-term volatility.
                                                                                  Our results suggest that the HFT strategy of quote stuffing may
                                                                                  exhibit some features that are criticized in the media.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1958281]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Ferguson, Mann, ``Execution Costs and    U.S. futures, 1992                      Unregulated or unconstrained market makers in the futures market have
 Their Intraday Variation in Futures                                              much more rapid inventory cycles than (regulated) equity market
 Markets'' (2001)                                                                 makers, are active rather than passive traders, and ``actively trade
                                                                                  for their own accounts, profiting from their privileged access . . .''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.jstor.org/stable/10.1086/209666]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Frino, Forrest, Duffy, ``Life in the     Australian futures, 1997                Unregulated or unconstrained market makers are not passive liquidity
 pits: competitive market making and                                              providers, they behave aggressively like informed traders.
 inventory control--further Australian
 evidence'' (1999)
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.sciencedirect.com/science/article/pii/S1042444X99000134]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Frino, Jarnecic, ``An empirical          Australian futures, 1997                Unregulated or unconstrained market makers demand liquidity to profit
 analysis of the supply of liquidity by                                           from information advantages of privileged access, less likely to
 locals in futures markets: Evidence                                              supply liquidity in volatile markets, almost as likely to demand as to
 from the Sydney Futures Exchange''                                               supply liquidity.
 (2000)
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.sciencedirect.com/science/article/pii/S0927538X00000238]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Frino, Jarnecic, Feletto, ``Local        Australian futures, 1997                Unregulated or unconstrained market makers are active and informed
 Trader Profitability in Futures                                                  traders.
 Markets: Liquidity and Position Taking
 Profits'' (2009)
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://onlinelibrary.wiley.com/doi/10.1002/fut.20393/abstract]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Golub, Keane, ``Mini Flash Crashes''     U.S. equities, 2006-2010                ``As soon as the [HFT] market maker's risk management limits are
 (2011) (Added 3/2012)                                                            breached . . . the market maker has to stop providing liquidity and
                                                                                  start to aggressively take liquidity, by selling back the shares
                                                                                  bought moments earlier. This way they push the price further down and
                                                                                  thus exaggerate the downward movement.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://fp7.portals.mbs.ac.uk/Portals/59/docs/MC%20deliverables/WP27%20A%20Golub%20paper%202_ReportMiniFlashCrash.pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Hautsch, Huang, ``On the Dark Side of    U.S. equities, 2010                     ``Using data from the NASDAQ TotalView message stream allows us to
 the Market: Identifying and Analyzing                                            retrieve information on hidden depth from one of the largest equity
 Hidden Order Placements'' (2012)                                                 markets in the world.''
 (Added 3/2012)
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2004231]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Hirschey, ``Do High-Frequency Traders    U.S. equities, 2009                     ``HFTs' aggressive purchases predict future aggressive buying by non-
 Anticipate Buying and Selling                                                    HFTs, and their aggressive sales predict future aggressive selling by
 Pressure?'' (2011) (Added 3/2012)                                                non-HFTs''; ``These findings suggest HFTs trade on forecasted price
                                                                                  changes caused by buying and selling pressure from traditional asset
                                                                                  managers.''
                                                                                 The author writes that ``On net, it is probable HFTs have a positive
                                                                                  impact on market quality'' because of tighter spreads; investment
                                                                                  managers might disagree.
--------------------------------------------------------------------------------------------------------------------------------------------------------
[https://www2.bc.edu/taillard/Seminar_spring_2012_files/Hirschey.pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Johnson, Zhao, Hunsader, Meng,           U.S. equities, 2006-2011                The authors study ``18,520 ultrafast black swan events that we have
 Ravindar, Carran, Tivnan, ``Financial                                            uncovered in stock-price movements between 2006 and 2011'' and find
 black swans driven by ultrafast                                                  ``an abrupt systemwide transition from a mixed human-machine phase to
 machine ecology'' (2012) (Added 3/                                               a new all-machine phase characterized by frequent black swan events
 2012)                                                                            with ultrafast durations.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://arxiv.org/ftp/arxiv/papers/1202/1202.1448.pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Joint CFTC-SEC Advisory Committee on     U.S. futures and equities, 2010         ``In the present environment, where high frequency and algorithmic
 Emerging Regulatory Issues,                                                      trading predominate and where exchange competition has essentially
 ``Recommendations Regarding Regulatory                                           eliminated rule-based market maker obligations, liquidity problems are
 Responses to the Market Events of May                                            an inherent difficulty that must be addressed. Indeed, even in the
 6, 2010'' (2011)                                                                 absence of extraordinary market events, limit order books can quickly
                                                                                  empty and prices can crash simply due to the speed and numbers of
                                                                                  orders flowing into the market and due to the ability to instantly
                                                                                  cancel orders.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.sec.gov/spotlight/sec-cftcjointcommittee/021811-report.pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Kim, Murphy, ``The Impact of High-       U.S. equities, 1997-2009                Traditional market microstructure models have significantly
 Frequency Trading on Stock Market                                                underestimated market spreads in recent years. This is because of how
 Liquidity Measures'' (2011) (Added 3/                                            trade sizes have decreased with the recent dominance of high frequency
 2012)                                                                            trading. When the authors correct for this they find that spreads have
                                                                                  not decreased as much as HFT proponents believe.
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.kellogg.northwestern.edu/faculty/murphy_d/murphy_kim_spread.pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Kirilenko, Samadi, Kyle, Tuzun, ``The    U.S. futures, 2010                      Unregulated or unconstrained HFT market makers exacerbated price
 Flash Crash: The Impact of High                                                  volatility in the Flash Crash, hot potato trading, 2 minute market
 Frequency Trading on an Electronic                                               maker inventory half-life; ``. . . High Frequency Traders exhibit
 Market'' (2010)                                                                  trading patterns inconsistent with the traditional definition of
                                                                                  market making. Specifically, High Frequency Traders aggressively trade
                                                                                  in the direction of price changes . . . when rebalancing their
                                                                                  positions, High Frequency Traders may compete for liquidity and
                                                                                  amplify price volatility.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1686004]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Kurov, Lasser, ``Price Dynamics in the   U.S. futures, 2001                      Unregulated or unconstrained market makers demand liquidity to profit
 Regular and E-Mini Futures Markets''                                             from information advantages of privileged access.
 (2004)
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.jstor.org/stable/30031860]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Linton, O'Hara, ``The impact of          Literature review and survey            ``The nature of market making has changed, shifting from designated
 computer trading on liquidity, price                                             providers to opportunistic traders. High frequency traders now provide
 efficiency/discovery and transaction                                             the bulk of liquidity, but their use of limited capital combined with
 costs'' (2011)                                                                   ultrafast speed creates the potential for periodic illiquidity''; in
                                                                                  ``regular market conditions,'' liquidity has improved and transaction
                                                                                  costs are lower.
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.bis.gov.uk/assets/bispartners/foresight/docs/computer-trading/11-1276-the-future-of-computer-trading-in-financial-markets.pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Locke, Sarajoti, ``Interdealer Trading   U.S. futures, 1995                      Unregulated or unconstrained market makers demand liquidity to manage
 in Futures Markets'' (2004)                                                      inventories.
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://papers.ssrn.com/sol3/papers.cfm?abstract_id=265932]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Lyons, ``A Simultaneous Trade Model of   Model derived from empirical studies    Demonstrates hot potato trading among unregulated or unconstrained
 the Foreign Exchange Hot Potato''        of 1992 U.S. foreign exchange market.   market makers. ``Hot potato trading'' means cascading inventory
 (1997)                                                                           imbalances from market maker to market maker in response to a large
                                                                                  order. Hot potato trading explains most of the volume in foreign
                                                                                  exchange markets. Hot potato trading is not innocuous--it makes prices
                                                                                  less informative.
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://linkinghub.elsevier.com/retrieve/pii/S0022199696014717]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Lyons, ``Foreign exchange volume: Sound  U.S. foreign exchange, 1992             Unregulated or unconstrained market makers cascade inventory imbalances
 and fury signifying nothing?'' (1996)                                            from one to another, as ``. . . trading begets trading. The trading
                                                                                  begotten is relatively uninformative, arising from repeated passage of
                                                                                  inventory imbalances among dealers . . . this could not arise under a
                                                                                  specialist microstructure.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.nber.org/chapters/c11365.pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Manaster, Mann, ``Life in the pits:      U.S. futures, 1992                      Unregulated or unconstrained market makers aggressively manage
 competitive market making and                                                    inventory, are ``active profit-seeking,'' have much shorter inventory
 inventory control'' (1996)                                                       cycles than equities market makers.
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.jstor.org/stable/2962316]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Manaster, Mann, ``Sources of Market      U.S. futures, 1992                      Unregulated or unconstrained market makers demand liquidity to profit
 Making Profits: Man Does Not Live by                                             from information advantages of privileged access, are ``predominant''
 Spread Alone'' (1999)                                                            informed traders.
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.23.6354&rep=rep1&type=pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------
McInish, Upson ``Strategic Liquidity     U.S. equities, 2008                     ``We model and show empirically that latency differences allow fast
 Supply in a Market with Fast and Slow                                            liquidity suppliers to pick off slow liquidity demanders at prices
 Traders'' (2012) (Added 3/2012)                                                  inferior to the NBBO. This trading strategy is highly profitable for
                                                                                  the fast traders.''; ``[O]ur research focuses on the ability of fast
                                                                                  liquidity suppliers to use their speed advantage to the detriment of
                                                                                  slow liquidity demanders, which we believe unambiguously lowers market
                                                                                  quality. The ability of fast traders to take advantage of slow traders
                                                                                  is exacerbated in the U.S. by the regulatory and market environment
                                                                                  that we describe below.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1924991]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Panayides, ``Affirmative obligations     U.S. equities, 1991 and 2001            Mandatory market maker obligations reduce volatility.
 and market making with inventory''
 (2007)
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.sciencedirect.com/science/article/pii/S0304405X0700133X]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Silber, ``Marketmaker Behavior in an     U.S. futures, 1982-1983                 Unregulated or unconstrained market makers profit from the information
 Auction Market: An Analysis of                                                   advantages of privileged access, 2 minute inventory cycles.
 Scalpers in Futures Markets'', (1984)
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.jstor.org/stable/2327606]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Smidt, ``Trading Floor Practices on      Literature review and survey            On futures exchanges, inventory imbalances among unregulated or
 Futures and Securities Exchanges:                                                unconstrained market makers create ``potentially unstable'' markets
 Economics, Regulation, and Policy                                                and price overreactions during ``scalper inventory liquidation.''
 Issues'' (1985)
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.farmdoc.illinois.edu/irwin/archive/books/Futures-Regulatory/Futures-Regulatory_chapter2.pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------
United States Commodity Futures Trading  U.S. futures and equities, 2010         Unregulated or unconstrained HFT market makers exacerbated price
 Commission and Securities and Exchange                                           volatility in the Flash Crash, hot potato trading.
 Commission, ``Findings Regarding the
 Market Events of May 6, 2010'' (2010)
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.sec.gov/news/studies/2010/marketevents-report.pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------
United States Federal Trade Commission,  U.S. futures, 1915-1922                 Unregulated or unconstrained market makers both cause and exacerbate
 ``Report of the Federal Trade                                                    price volatility; ``The scalpers who operate with reference to
 Commission on the Grain Trade,''                                                 fractional changes within the day may have a stabilizing effect on
 Volume 7 (1926)                                                                  prices so far as such changes with the day are concerned, but when the
                                                                                  market turns they run with it, and they may accentuate an upward or
                                                                                  downward movement that is already considerable.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
Van der Wel, Menkveld, Sarkar, ``Are     U.S. futures, 1994-1997                 Unregulated or unconstrained market makers demand liquidity for a
 Market Makers Uninformed and Passive?                                            substantial part of the day and are active and informed speculators.
 Signing Trades in the Absence of
 Quotes'' (2009)
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.newyorkfed.org/research/staff_reports/sr395.html]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Van Kervel, ``Liquidity: What You See    U.K. equities, 2009                     ``We show that a specific type of highfrequency traders, those who
 is What You Get?'' (2012) (Added 3/                                              operate like modern day market makers, might in fact cause a strong
 2012)                                                                            overestimation of liquidity aggregated across trading venues. The
                                                                                  reason is that these market makers place duplicate limit orders on
                                                                                  several venues, and after execution of one limit order they quickly
                                                                                  cancel their outstanding limit orders on competing venues. As a
                                                                                  result, a single trade on one venue is followed by reductions in
                                                                                  liquidity on all other venues.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2021988]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Venkataraman, Waisburd, ``The Value of   French equities, 1995-1998              Designated market makers with affirmative obligations improve market
 the Designated Market Maker'' (2006)                                             quality, increase market valuation.
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://papers.ssrn.com/sol3/papers.cfm?abstract_id=881585]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Wang, Chae, ``Who Makes Markets? Do      Taiwanese equities, 1997-2002           Absent mandatory obligations, market maker privileges don't induce
 Dealers Provide or Take Liquidity?''                                             market makers to provide liquidity; they derive profits from their own
 (2003)                                                                           informed trades; ``While dealers may be meant to perform the socially
                                                                                  beneficial function of liquidity provision, the institutional
                                                                                  advantages granted to them also give the ability to act as super-
                                                                                  efficient proprietary traders if they choose to.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://web.mit.edu/finlunch/Fall03/AlbertWang.pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Working, ``Tests of a Theory Concerning  U.S. futures, 1952                      Unregulated or unconstrained market makers are also trend traders,
 Floor Trading on Commodity Exchanges''                                           profiting from the information advantages of privileged access; they
 (1967)                                                                           can trade aggressively, especially when the market goes against the
                                                                                  firm; inventory cycles of ``minutes''; trend trading accelerates price
                                                                                  changes (but may moderate extremes).
--------------------------------------------------------------------------------------------------------------------------------------------------------
Zhang, ``High-Frequency Trading, Stock   U.S. equities, 1985-2009                ``[H]igh-frequency trading may potentially have some harmful effects''
 Volatility, and Price Discovery''                                                because ``highfrequency trading is positively correlated with stock
 (2010) (Added 3/2012)                                                            price volatility.''
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1691679]
--------------------------------------------------------------------------------------------------------------------------------------------------------
Zigrand, Cliff, Hendershott,             Literature review and survey            Self-reinforcing feedback loops in computerbased trading can lead to
 ``Financial stability and computer                                               significant instability in financial markets; market participants
 based trading'' (2011)                                                           become inured to excessive volatility in a cultural ``normalization of
                                                                                  deviance'' until a large-scale failure occurs; research to date has
                                                                                  not shown a persistent increase in market volatility, but HFT research
                                                                                  is nascent.
--------------------------------------------------------------------------------------------------------------------------------------------------------
[http://www.bis.gov.uk/assets/bispartners/foresight/docs/computer-trading/11-1276-the-future-of-computer-trading-in-financial-markets.pdf]
--------------------------------------------------------------------------------------------------------------------------------------------------------


    The Chairman. All right. Thank you, sir. The chair would 
remind Members that they will be recognized for questioning in 
order of seniority for Members who were here at the start of 
the hearing. After that, Members will be recognized in order of 
arrival. I appreciate Members' understanding. We have six panel 
members. We will do a second round of questioning if possible, 
and I would ask the Members' indulgence that if you ask a 
question with precious little time on the clock, you are not 
going to get all six members of the panel to answer your 
question. So we will probably give you one panel member and 
then if that issue is important to you, you will stick around 
for a second round and go back to that point in time. So with 
that, I will recognize myself for 5 minutes.
    Gentlemen, thank you for coming here today and presenting 
this to us. As I mentioned to a couple earlier, this is the 
detail phase of what we need to be doing. Most of the time 
Members of Congress in these hearings stick to the 10,000 foot 
level, but we need to get into the weeds with respect to this 
reauthorization, and if there are specific details with respect 
to the law itself, now is the time to get those in front of us 
as a part of that.
    Mr. Cordes, regarding the proposed rules on residual 
interest and increased margin accounts for FCMs, I know the 
CFTC is relooking at that, but it seems to me that the SRO has 
done a pretty good job of setting up a daily confirmation 
process for cash balances, for segregated accounts. Is there 
additional regulation needed or would that be enough in this 
regard to protect and avoid forcing your members to put more 
money up and more money at risk, quite frankly, in those 
segregated accounts, or is the current SRO process adequate to 
protect in this regard?
    Mr. Cordes. Thank you, Mr. Chairman. The current 
legislation that is put in place or I should say the rules that 
are there, currently today we have to track and report all of 
our segregated funds and report that in. But then it is also--
the SRO has the ability to electronically look at where all 
those accounts are. So that is full transparency where that is 
today, and that is a big change from where it was probably 
about a year ago. They have access to real-time reporting on 
knowing what that balance is.
    If the change on a residual interest doesn't come to be, 
probably what we are going to see is either the FCMs are going 
to have to put up additional capital on the balance sheet or 
more likely we are going to ask our customers to pre-fund their 
margin accounts additionally. It could increase their margin 
requirements by almost double if that happens.
    The Chairman. I guess the question was, though, is that 
enough control already? Let me ask Mr. Monroe. Mr. Monroe, 
thank you for quantifying, specifically, an impact. One of the 
things that we do on the front end of these regulatory 
processes is predict bad things are going to happen, and it is 
hard to quantify. Now that we have something in place where you 
guys have experienced your costs actually increasing, being 
easily identified within the market as to who you were, was 
that a one-time occurrence, or you are seeing it regularly now?
    Mr. Monroe. No, Mr. Chairman, that actually has continued 
to happen and in fact happened again in a trade that we did 
last week that was for a contract that would settle in 2014. So 
our concern was these low liquidity areas of the market, 2015, 
2016 and beyond, and we actually were identified in a 2014 
trade.
    The Chairman. And the $60 million that you mentioned, was 
that an annualized cost or was that on that one trade?
    Mr. Monroe. No, that would be an annualized cost looking at 
the volume that we typically do in those illiquid areas that 
occurred.
    The Chairman. All right. Can the regulatory scheme be such 
as to bifurcate the real-time reporting to where if you have a 
certain number, beyond a certain number of months on the 
contract it would fall under one set of rules, while near-term 
contracts fall under a different set? Is that too complex to 
regulate or what is the solution for your marked out out-month 
trades that you are being identified on?
    Mr. Monroe. I think there really needs to be a liquidity 
test, and we are working with staff at the CFTC. And we have 
had numerous meetings with them on this issue, trying to get 
some interpretive guidance to come from CFTC on this issue. And 
we feel like there is a solution that recognizes that liquidity 
narrows as you go out on the curve, and it may be on an early 
month in something like jet fuel. And there is some public 
benefit or certainly public benefit in the early months where 
price discovery is critical. But out in 2017, there is no 
public benefit and in fact, we are basically handing inside 
information to nefarious folks.
    The Chairman. I got you. Mr. Soto, with the time left, you 
mentioned judicial review of CFTC. Would you flesh that out a 
little bit for us?
    Mr. Soto. Currently the Commodity Exchange Act enables 
judicial review, direct judicial review, into U.S. Court of 
Appeals for very limited provisions, certain transactions and 
approvals. What we are seeking is a broad ability to go before 
a U.S. Court of Appeals for any rule-making or order issued by 
the Commission. At present you have to first go to Federal 
District Court, seek a summary judgment, and then appeal that 
to the U.S. Court of Appeals to get an answer on the rule-
making, and that is a cumbersome and wasteful process.
    The Chairman. All right. Thank you. Mr. Scott for 5 
minutes?
    Mr. David Scott of Georgia. Thank you, Mr. Chairman. I 
would like to ask this question, get a response from each of 
you on the panel for this. It has been since 2008 since CFTC 
has had reauthorization, budget appropriations. That was before 
the financial crisis, that was before the Wall Street meltdown, 
before the derivatives regulations, increased responsibilities. 
But recently the House Appropriations Committee reported in an 
appropriations bill that reduced the funding of the CFTC by 
more than $10 million, even though Chairman Gensler warned in 
his testimony to the Committee that even at the current 
spending levels with sequestration, the Commission would face 
furloughs and staff losses.
    So I would like to get each of you to respond to three 
questions, yes or no basically. Do you believe that the funds 
of the CFTC as proposed by the House Appropriations Committee 
are at an adequate level? Starting here, basically yes or no. 
The Chairman will knock me down if I don't get all these in in 
5 minutes.
    Mr. Cordes. I would say from our perspective we only see 
one piece of what they are doing. I think they could prioritize 
what they do. I am not sure if I know that is a yes or a no 
without having more details.
    Mr. David Scott of Georgia. Mr. Kotschwar?
    Mr. Kotschwar. I will give you the same answer as Mr. 
Cordes. Without more details, I can't tell you whether that is 
going to be enough or not.
    Mr. McMahon. I would have to say the same. I really have 
not looked at the global issues around budget. So I can't give 
you a good answer to that. I apologize.
    Mr. David Scott of Georgia. But given the fact that the 
CFTC and much of your testimony, you are asking them to do 
more. They are faced with a budget crunch. They are losing 
staff, furloughs. They have Dodd-Frank Title VII to implement. 
You are there. Their workload has been increased by over 400 
percent. Is that not enough information for you? Can we go on? 
Mr. Monroe, what do you think?
    Mr. Monroe. I am not in a position to comment on that, 
either.
    Mr. David Scott of Georgia. Okay. Mr. Soto?
    Mr. Soto. Let me say I don't think the amount is as 
important as what the agency does with the funds that they are 
given. We hope that they would become a more effective and 
responsive regulator with the funds that they have.
    Mr. David Scott of Georgia. Mr. Guilford?
    Mr. Guilford. Thank you for the question. CFTC staff today 
is approximately nine percent larger than it was 20 years ago, 
even though the notional value of the derivatives market over 
which it has jurisdiction has increased by over 30 times.
    Mr. David Scott of Georgia. But could you give me a yes or 
no?
    Mr. Guilford. And the question was, is the House 
Appropriations mark sufficient----
    Mr. David Scott of Georgia. Yes.
    Mr. Guilford.--in order to fund the agency? The answer is 
no.
    Mr. David Scott of Georgia. Good. Okay. Now, second, do you 
believe that the reduced funding that they have from the 
Appropriations Committee hurts the Commission's ability to 
listen, to evaluate and to do all the matters, to regulate, to 
give guidance on all of the range that they are doing regarding 
its rule-making? Yes or no.
    Mr. Guilford. And even in some instances not being able to 
hire experts in order to carry out its responsibilities.
    Mr. David Scott of Georgia. Precisely. Thank you. Yes or 
no?
    Mr. Soto. Again, it is what they do with the money that 
they have, and we hope they become more efficient.
    Mr. David Scott of Georgia. All right. Yes?
    Mr. Monroe. I would echo Mr. Soto on that.
    Mr. David Scott of Georgia. Same thing?
    Mr. McMahon. We have always been able to meet with the 
staff and Commissioners and had no issue with difficulty there.
    Mr. David Scott of Georgia. Yes, sir?
    Mr. Kotschwar. I would echo that response. We don't have 
any trouble getting audience with the Commission when we need 
to, and also point out that----
    Mr. David Scott of Georgia. All right.
    Mr. Kotschwar.--House Appropriations reported level is one 
step in the process. That isn't the amount that is actually 
going to be ultimately decided on.
    Mr. David Scott of Georgia. Even with an increase in the 
workload? Yes, sir, your point, Mr. Cordes, on that question?
    Mr. Cordes. I would say from our perspective the part of 
the industry we operate in and, I mean, we have had access to 
what we need. I would say it is a matter of what you do with 
those resources, how you prioritize.
    Mr. David Scott of Georgia. All right, finally my final 
point on yes or no here is do you believe, given the agency's 
responsibilities are growing, that they need resources in an 
amount that is greater than the $205 million it received in 
2013? In other words, do you think they need more money to cut 
the furloughs, to do the staff, to be able to listen, to be 
able to do the job that they need to do with the increased 
workload that they have in this very complex area?
    Mr. Cordes. Once again, I am not an expert in knowing what 
that whole budget is. I would just say look at what the 
priorities are.
    Mr. David Scott of Georgia. All right. Mr.----
    Mr. Kotschwar. I would echo that response, but I want to go 
just one level deeper. One thing you said earlier is that you 
heard a lot of testimony today about us asking them to do more. 
I actually--we have a lot of areas where we would like them to 
do less. We believe Dodd-Frank was about swaps regulation, and 
they are creating a lot of solutions that are in search of 
problems in the futures space. We think that they could do some 
prioritizing.
    Mr. David Scott of Georgia. Go right down very quickly, 
please, yes or no.
    Mr. McMahon. From the end-user perspective, I think we 
would hope for less regulation of the end-user side.
    Mr. David Scott of Georgia. Okay.
    Mr. Monroe. I think we are fine with----
    Mr. David Scott of Georgia. All right. Mr. Guilford? I 
mean, Mr. Soto?
    Mr. Soto. Commissioner O'Malia yesterday talked about 
information resources that he needs. Our point is that the data 
that is being developed right now, given the uncertainty in the 
market, is inconsistent, it is incomplete. So those technology 
resources are not----
    Mr. David Scott of Georgia. Thank you.
    Mr. Soto.--put to the most effective use, given where the 
regulatory regime is right now.
    Mr. David Scott of Georgia. I just want to know if you 
think they need to get more money to hire the staff that they 
need to do the job.
    Mr. Soto. If they got more money----
    Mr. David Scott of Georgia. That is all.
    Mr. Soto.--the data there is incomplete and inconsistent, 
and it would be wasteful.
    Mr. David Scott of Georgia. Mr. Guilford? Thank you, Mr. 
Chairman.
    Mr. Guilford. Yes.
    Mr. David Scott of Georgia. Thank you so much. I got one 
yes.
    The Chairman. The gentleman yields back. Mr. Austin Scott.
    Mr. Austin Scott of Georgia. Thank you, Mr. Chairman.
    The Chairman. Five minutes.
    Mr. Austin Scott of Georgia. Gentlemen, thank you for being 
here today and helping us with this issue. I actually majored 
in risk management and have my Series 7, so I feel some of your 
pain. And I listened yesterday as the gentleman with the CFTC 
talked about their difficulty and even getting to a common 
definition with the SEC over the word person. And it seems to 
me that when we have two regulatory agencies essentially 
regulating the same field, that when they can't agree on what 
the definition of the word person is, then we are creating a 
situation where you may be in compliance with one regulatory 
agency and out of compliance of another, and it simply depends 
on which one may be auditing you at the time as to whether or 
not you are in compliance or out of compliance.
    You talked about pricing. Most of you talked about pricing, 
and you talked about compliance and I know, Mr. Monroe, you 
talked about the $60 million in additional costs. I assume that 
that cost will either be reflected on your bottom line as a 
reduction in profits or it will be reflected in the price of a 
ticket to travel on Southwest Airlines. And that is one of the 
things that I think sometimes gets lost in this debate as we 
talk about complex financial issues is that the more we raise 
the cost to the end-user, and in my situation, I am talking 
about farmers in particular, you increase the cost to the grain 
farmer, the price, the cost is born by the person every time 
they buy a box of cereal. In the end it goes down to the 
consumer that purchases the last product.
    So Mr. Cordes, you outlined some of the costs that are 
being incurred by end-users in complying with the new Dodd-
Frank Act. Could you be more specific in some of the measures 
that the co-ops generally are having to take to address the new 
rules?
    Mr. Cordes. Yes. Thank you, Congressman. In our particular 
situation, I am just talking for our license FCM group, we have 
a staff of roughly about 40 individuals. We have had one person 
that has been primarily on compliance. We have now ramped that 
up where it is taking two body full equivalents to do those 
kind of things, so it is those areas. It has increased 
compliance around record-keeping, record retention, auditing 
amongst our individuals, training, that kind of thing. I would 
also say though that under Dodd-Frank now, it has even rolled 
out further into the parent company, into the cash and physical 
transactions. We are now having to build out a full compliance 
group that not only looks at all the other compliance issues 
but now things that spill over from Dodd-Frank that start to 
affect the end-user that normally they would look at as normal 
transactions and commerce around cash and physical transactions 
are wondering, does this fit into the scope of new regulation.
    Mr. Austin Scott of Georgia. And would you agree that that 
increased cost in the end is born by the consumer that 
purchases the product?
    Mr. Cordes. Yes, ultimately in the end as the market 
equalizes itself out, those costs will be passed on at some 
point.
    Mr. Austin Scott of Georgia. Mr. Soto, you are in the 
energy business, is that correct?
    Mr. Soto. Yes.
    Mr. Austin Scott of Georgia. And the cost of energy is 
reflected in everything we purchase in this country. The cost 
of manufacturing, energy costs being too high, can send 
manufacturing jobs overseas and the cost of transporting a 
product. Virtually everything that we purchase at some point or 
another gets to the store by a truck. So the cost of that 
energy is obviously reflected in the price.
    Could you speak to the potential increase in costs to the 
energy consumer with the increased rules and regulations based 
on the end-users in your industry?
    Mr. Soto. Thank you, Congressman. To be honest, many 
factors can affect the price of natural gas. Right now natural 
gas consumers are enjoying the benefits of tremendously 
abundant natural gas resources in this country that is 
producing relatively low and stable natural gas prices for 
consumers. But having said that, and the concern that I would 
raise is that through the increased transaction costs 
associated with the hedging programs, the resources that 
utilities have to develop to manage these hedging costs, that 
all makes it more expensive to manage the price volatility for 
consumers, and that gets passed on to consumers. But more 
importantly, the wholesale natural gas market in this country 
has been tremendously competitive, innovative, creative, all 
redounding to the benefit of the customers, prices of the last 
decade notwithstanding, it is really a treasure of this nation. 
And the problem that I would see is if that market becomes less 
efficient, less competitive, because the transacting parties 
are concerned that their physical transaction might be 
considered a swap, we lose something tremendously.
    Mr. Austin Scott of Georgia. Mr. Chairman, I am out of 
time, but gentlemen, thank you for your testimony.
    The Chairman. The gentleman yields back. Thank you. Mrs. 
Negrete McLeod? Mr. Gallego for 5 minutes.
    Mr. Gallego. Thank you. With respect to the issue of what 
is or is not in a price, is there a way to break that down? I 
mean, as you indicated, Mr. Soto, there are a number of factors 
that go into any particular price. I am sure that is true in 
any industry, whether you are talking about giving somebody a 
raise, whether it is a line employee or whether it is an 
executive, the market prices for so many things. I mean, all 
that impacts--and ultimately the consumer pays for all of that, 
is that not accurate?
    Mr. Soto. That is correct, and if there are fewer 
counterparties willing to trade and if the markets become less 
liquid, the product offerings are less innovative, less 
creative, then that just costs more to the consumer.
    Mr. Gallego. I am curious though as to in terms of--is 
there way to allocate costs per factor? I mean, you decided to 
give people X rate of return on their investment, so that is 
passed on or you decided to, or the price of one thing or 
another. I am just talking about the industry. I mean, for the 
airlines, it would be the same. I mean every cost--ultimately, 
as a businessman, I mean, I was in the restaurant business. My 
family was in the restaurant business for a long time, and 
ultimately your costs are always passed on. I mean, when the 
price of any of the food that you are serving goes up, that 
price is ultimately reflected on the prices on your menu.
    Mr. Soto. The transaction costs associated with the 
uncertainty in the contracting market, that is probably more 
easy to quantify and to track. The impacts of illiquidity and 
the less innovative product offerings, that is probably much 
more difficult to quantify.
    Mr. Gallego. So in terms of whether there are more rules 
and regulations or those kinds of things, is there a way to 
allocate how much that is costing you? Do the industries 
specifically break that down by that particular--is there a 
code? I mean, in government apparently everybody talks about it 
has to be coded right. Is there a code for this, because of 
these rules we have to code this differently and so we can 
track how much the cost is?
    Mr. Soto. We have not made that analysis, no.
    Mr. Gallego. Do any of you do that? Can any of you break 
that down, any of the industries, break that down and code it 
differently so you can tell what is allocated to any change in 
the regulations?
    Mr. Monroe. I don't know that we necessarily code an 
expense in a certain way because of an additional regulation, 
but I would say as I spoke to in my testimony that we view it 
as enterprise risk management, and if the markets literally are 
taken away from us, then there is risk to the enterprise. Not 
to overstate that issue, but a fuel price spike has been the 
undoing----
    Mr. Gallego. Right.
    Mr. Monroe.--numerous airlines.
    Mr. Gallego. Yes, right. So with respect to the issue of 
agencies, one of the interesting things to me is when an agency 
in limited--granted, it probably doesn't happen that often, but 
when there is a rule that either is repealed or is changed so 
that it becomes more efficient. I find it interesting, for 
example, that we always talk about how this stuff costs more 
and costs more and costs more, and it raises the price, but it 
doesn't necessarily ever lower prices. And I mean, I know in 
the restaurant business, as an example, that when the price of 
a staple went up and your price went up and then when people 
got used to paying the higher price and then the price went 
back down again, the lower price wasn't always necessarily 
reflected in your menu prices. And how do you balance that with 
respect to allocating, giving credit where credit is due? Is 
there an opportunity to do that, if they make good decisions? 
Yes, sir?
    Mr. McMahon. Well, the utility industry is a little bit 
different than that. It is a cost-of-service industry. It is 
regulated at the retail level, and compliance costs are 
something that is part of rate. So that is passed through to 
customers.
    Mr. Gallego. Right.
    Mr. McMahon. We have not seen so far any example of the 
Dodd-Frank Act as actually----
    Mr. Gallego. Lowering, right.
    Mr. McMahon.--lower costs or seeing any of the costs 
lowered, and our hope going in was that the end-user exemption 
was going to be a relatively clean and broad exemption that 
would really relieve us from a lot of the regulatory burden, 
but that is not the case. And there is a lot of uncertainty 
around things such as posting margin, for example. You know, 
utilities are very credit-worthy, and therefore, they don't, on 
many of their swaps, don't need to post margin. Having to do 
that would tie up a lot of capital, and there would be a lot of 
costs associated with that.
    So that kind of uncertainty hasn't really been fully 
quantified yet, but ultimately those costs are born by the rate 
payers.
    Mr. Gallego. Thank you.
    Mr. Monroe. And I would just point out, we are particularly 
proud to pass through lower costs to our customers and in 
market shares. We are happy to do that.
    Mr. Gallego. I fly it regularly, so absolutely.
    Mr. Monroe. Thank you.
    The Chairman. The gentleman's time has expired. Mr. 
Benishek, 5 minutes.
    Mr. Benishek. Thank you, Mr. Chairman. Thank you all so 
much for coming here this morning. I am a surgeon so I don't 
pretend to have a lot of knowledge about the commodities 
market, but I am learning fast since I got on this Committee. 
But I have a couple of questions on some of the things here.
    Mr. Cordes, can you explain to me more about these no-
action letters that the CFTC puts out? And apparently there is 
some ambiguity if these letters have any basis in law and it 
may create uncertainty. Can you just go through that a little 
bit for me, please?
    Mr. Cordes. Yes, the simplest way I can explain that for 
you, Congressman, is typically there are rules and regulations, 
and if you can state your case that it is economically not 
feasible or physically impossible to perform under those 
things, you can petition the CFTC and say here is the 
situation. Can we get some relief? And depending upon the 
situation, they might issue a no-action letter or they may not. 
If they do issue a no-action letter, then basically it is 
giving you relief from having to comply with that particular 
regulation in your situation.
    Mr. Benishek. Does that ever get overturned then that you 
can have like a none other jeopardy once the deadline has been 
passed?
    Mr. Cordes. I am not aware of that because typically the 
CFTC follows through with that, but in my testimony I gave the 
example around this phone recording, and there are some issues 
there that we will be talking to the Commission about.
    Mr. Benishek. Another question I have----
    Mr. Guilford. Congressman? May I answer that question?
    Mr. Benishek. Sure.
    Mr. Guilford. Mr. O'Malia yesterday in his testimony said 
that there were just over 100 no-action letters currently 
issued by the CFTC in exactly the way the previous speaker just 
addressed. However, 24 of those have no expiration date. So our 
concern about those would be with regard to the fact that it 
isn't only a situation where the agency may not have fully 
formulated a policy with an issue, may not have finished a 
rule-making may not have extended rule-making far enough or 
collected enough public comment. But it is the extent to which 
the CFTC relies on no-action letters simply because it hasn't 
been able to complete its work.
    Mr. Benishek. All right. I have another question about the 
record-keeping. I thought it was pretty amazing the way you 
described the fact that every message would have to be somehow 
documented and searchable and you have relied now on basically 
making phone calls to deal with this. Can you recommend some 
way for the CFTC to do this in a better way? I mean, obviously 
you have some pretty strong feelings about it.
    Mr. Kotschwar. Our recommendation would be let us not 
extend the notion of what needs to be recorded this far.
    Mr. Benishek. What is the object of all that recording? 
What is----
    Mr. Kotschwar. I don't know what the object of that 
recording is. That is our point. We don't see any real good 
public policy value of recording.
    Mr. Benishek. Is there value in oversight by collecting all 
that data? I mean, the way you described it: hundreds of 
transactions going on during a day and you have to maybe make a 
hedge position on some of your transactions. It seems like it 
is----
    Mr. Kotschwar. From a commercial perspective, we don't see 
any value in it. I mean, when we do a purchase or a sale with 
the producer or a customer, we do it with a contract, and we 
maintain all the records necessary to memorialize that 
transaction. And we don't feel the need to go as far as 
recording the phone call where we agreed with the farmer to buy 
his grain. That seems a little excessive. You know, we keep the 
records necessary for that. So going beyond that seems----
    Mr. Benishek. Mr. Guilford, do you have a comment on that 
answer? I mean, I am trying to figure out why they have this 
requirement. Do you have an answer?
    Mr. Guilford. I do, and if I could just follow on the 
previous answer I gave you just for a second. Three years ago 
we recommended to Congress that----
    Mr. Benishek. Well, I would like to stay on the--I have 
only got a certain amount of time.
    Mr. Guilford. Okay.
    Mr. Benishek. So could you answer the question I asked you?
    Mr. Guilford. Yes.
    Mr. Benishek. What is your opinion?
    Mr. Guilford. Of course. We worked a very long time in 
Title VII trying to draw distinctions between legitimate 
hedgers and non-legitimate hedgers, commercial versus non-
commercial market participants. What we attempted to do in 
carrying out that work, Congressman, was to make sure, as much 
as we could, and we may not have been perfect in doing it, that 
all of the industries and more that are represented on this 
panel today----
    Mr. Benishek. Well, I am trying to find out the value of 
the----
    Mr. Guilford. I am getting to that.
    Mr. Benishek. Getting. Yes, but I don't have much time.
    Mr. Guilford. We had nothing to do with the financial 
crisis. So what the agency has done has cast a very wide net 
that encompasses everyone, even though we had nothing to do 
with the financial crisis, in an attempt to determine the 
extent to which there may be systemic risk or other threats 
posed to the financial system, none of which arised from the 
people you are looking at today.
    So in point of fact, a lot of the information may not be 
useful.
    Mr. Benishek. Unfortunately, you talked for about a minute 
but didn't answer the question.
    Mr. Neugebauer [presiding.] Gentlemen, we have been joined 
by the Ranking Member, Mr. Peterson. Mr. Maloney, you are 
recognized for 5 minutes.
    Mr. Maloney. Thank you. Thank you all. My question relates 
to the CFTC's $8 billion de minimis level. I would like to get 
your thoughts on that, to anyone who wants to answer.
    Mr. McMahon. Well, when the de minimis level was 
established, the CFTC initially set it very low in their 
proposed rule. There were hundreds of comments sent into the 
CFTC, several oversight hearings and ultimately they settled on 
the $8 billion number. We felt that was a good number given the 
size of the market, and the fact from the energy perspective, 
we enter into oftentimes large volumetric trades. And so to 
hedge against some of the risks that we need to hedge on fuel 
and also on power supply, that isn't necessarily a very big 
number, even though it seems like a large number.
    We are concerned that if it falls back to $3 billion 
without any kind of process associated with it, that would come 
at the wrong time because we are at a trough of the commodities 
cycle right now, and as Andrew mentioned, we are benefitting 
from low natural gas prices and the $2 to $3 per mmBtu range, 
for example. But we have seen in the last 4 or 5 years when it 
has been as high as $10 per mmBtu. So having that level set at 
an appropriate level high enough will ensure that end-users 
aren't pulled in and regulated as large banks as swap dealers. 
So that is why it was important.
    Mr. Maloney. Yes, thank you. And I am interested in hearing 
from the rest of the panel. But is it fair to say, Mr. McMahon, 
that you are comfortable then with the $8 billion level on an 
ongoing basis?
    Mr. McMahon. We feel the $8 billion for now is a good 
level, and going forward it should be looked at in terms of 
where the overall commodity market is. But that is a good floor 
and a good level for where it should be.
    Mr. Maloney. Is there someone who disagrees with that? 
Would anyone like to comment on the--Mr. Guilford, I will give 
you an opportunity to comment on the idea of it dropping to $3 
billion.
    Mr. Guilford. I agree with the others on the panel who have 
said that it is a number that needs to be flexible with where 
the energy markets are. So a fixed number in time doesn't allow 
that to happen, and it can disadvantage us as competitors.
    Mr. Maloney. How would you best accomplish that, sir?
    Mr. Guilford. That is a great question. You are going to 
have to give us a minute to think.
    Mr. Maloney. You and I are going to get along great. You 
just keep saying that. We are going to get along great. What 
would you prefer as a mechanism there? Would you leave it to--
--
    Mr. Guilford. Well, the mechanism, as the previous speaker 
indicated, there have been times when energy markets have been 
very high with the $8 billion going to go up----
    Mr. Maloney. Well, right, it is not the same in all 
markets.
    Mr. Guilford. Obviously it needs to be able to move with 
the markets. If it is a fixed number in time, then it is going 
to put us at a disadvantage unnecessarily so.
    Mr. Maloney. Correct, simply because the underlying 
commodity price.
    Mr. Guilford. So we need to fashion a way to be able to 
allow that number to move along with energy markets. Now, I am 
not smart enough here today, Congressman, in order to give you 
an answer to exactly how we may be able to fashion a solution 
to that, but I am confident we can find one.
    Mr. Maloney. Got it. And in the 2 minutes I have remaining, 
I would like to give the panel an opportunity to comment on the 
definition of bona fide hedging and where it ended up. You 
touched on this, Mr. Guilford, so we can start with you if you 
want. Part of the problem here is that people don't understand 
that a certain level of speculation does create liquidity in 
the markets and is actually a very healthy thing. Obviously it 
is a Goldilocks problem, and I am curious whether those on the 
panel view excessive speculation currently as being damaging to 
the end-users and where you see that balance being struck.
    Mr. Guilford. Well, 10 years ago when the markets were 
dominated 70 percent by legitimate market participants and 30 
percent by speculation, we had far less difficulties than today 
where that has been flipped. Now it is about 70 percent 
speculation and 30 percent legitimate market participants.
    So first, we share a concern with the rest of the panel 
with regard to the multiplicity of definitions of bona fide 
hedgers. That needs to be clarified, and we need to get all on 
the same page. Second, we do believe there is speculation in 
some cases and we would argue that those may have been evident 
in the past few years, damages our ability to be competitors in 
the marketplace and artificially inflates prices to consumers.
    Mr. Maloney. Mr. Soto?
    Mr. Soto. As the Commissioners mentioned yesterday, there 
are several definitions of the bona fide hedge exemption. We 
were fine with the definition as it was applied in the end-user 
exception. We were fine with it as part of the major swap 
participant definition. We have concerns about a much narrower 
definition as it applies to the position limits rule, and we 
think when the CFTC does come back on the position limits, they 
really need to fix that.
    Mr. Monroe. I would just say that the markets seem to be 
running very efficiently now, and we are generally comfortable 
with what you are describing as a Goldilocks scenario. And we 
are always concerned about anything that threatens liquidity.
    Mr. McMahon. From the utility perspective, again, we have 
large and oftentimes customized transactions. So this narrow 
enumerated list is very limiting.
    Mr. Maloney. Thank you. Thank you, Mr. Chairman.
    The Chairman [presiding.] The gentleman yields back. Thank 
you. Mr. Collins for 5 minutes.
    Mr. Collins. Thank you, Mr. Chairman. I want to thank all 
of the participants today, and I am really interested in 
following up a little bit on the end-user exception, certainly 
to the clearing requirements, and I guess would ask each of 
you, is the definition clear enough? You think it would be 
black and white if you are an end-user or you are not, are you 
finding situations where there is a gray area? How are you 
treating that gray area to know whether a particular company 
might be considered an end-user for the exceptions or not?
    Mr. Cordes. I would say from our perspective, from NCFC is 
we are working with the Commission to get better clarity on 
that. I think we are getting much better facts on that. There 
is still some confusion out in the marketplace on how that 
should be treated on different swap dealers that you might work 
with to lay off some of that risk as an end-user. It has a ways 
to go, but we are getting better.
    Mr. Kotschwar. Ditto his answer. That is exactly where we 
are.
    Mr. McMahon. I think Chairman Gensler described the Title 
VII and Dodd-Frank as a mosaic, and indeed it is. There are a 
lot of overlapping rules and requirements. It is very, very 
intricate, and our concern again on things such as the margin 
requirement, I mean one of the advantages of being an end-user 
is that you are exempt from margin, or you should be, but there 
is a possibility as to the way the rules interact that you 
could be subject to margin.
    It is those sorts of issues that need to be clarified to 
make sure that it is a robust end-user exemption.
    Mr. Monroe. Yes, I would echo that concern, and we also 
have a concern about being able to post non-cash collateral. We 
are unique in the fact that we post aircraft as collateral for 
our hedges. And so we want to be able to continue to do that as 
well, and that is potentially threatened.
    Mr. Soto. Same, from Richard and Mr. Monroe, that non-cash 
collateral, margin and capital requirements for uncleared 
swaps, that is something that not only the CFTC but the other 
Prudential Regulators need to work out.
    Mr. Guilford. We currently don't have an issue with the 
end-user definition.
    Mr. Collins. Thank you. Now, as you have moved forward and 
clearly you are looking for clarification from the CFTC, have 
any of you experienced the frustration of the no-action letters 
and are those shared amongst all of you where at least you are 
getting input from each other's questions?
    Mr. Cordes. We have not requested one yet specifically for 
ourselves going through, so we will learn more of the process 
as we go along. I know they are public information after they 
are issued. How much collaborative effort going in up front, I 
am not aware of.
    Mr. Kotschwar. From CMC's perspective, we have asked for 
relief in several instances, but no, generally, overall it is 
very frustrating. We have a lot of final rules out there and a 
no-action letter is really basically an acknowledgment that no 
one can comply with the rule, either because of timelines or 
because of other substantive issues. So it is very hard to keep 
track of. You have the Code of Federal Regulations that says 
one thing, and then you have a stack of letters that tell you, 
never mind. But very difficult to keep on top of.
    Mr. McMahon. I would agree that conflicting and overlapping 
issue is very important, and I would also say that in some 
cases, for example, under inter-affiliate transactions, there 
are no action letters out there but sometimes the guidance is 
either insufficient or the facts don't line up exactly with the 
particular cases. So it is difficult.
    Mr. Monroe. We have not had any experience with a no-action 
letter, but we have not found relief from this real-time 
reporting rule after several visits and lots of positive 
feedback, and yet we still have not seen any interpretive 
guidance that would fix that issue.
    Mr. Soto. There is a part of the agency's administrative 
process that really needs to be strengthened and that is the 
finalization of clear, definitive rules that the industry 
understands and how to comply with them. And that has to come 
at the Commissioner level, but there has to be final agency 
actions that everyone understands in the industry what their 
compliance obligations are. In the absence of that, we have no 
choice but to go to the staff and say don't enforce these rules 
that are uncertain in a way that we don't know how to comply 
with them. Working with staff has been, I mean, they have been 
helpful in trying to understand the industry concerns and 
providing the relief that they think is necessary, but it is 
indicative of a process where the Commissioners themselves are 
not making the decisions they need to make to give the industry 
certainty.
    Mr. Guilford. We recommended to Congress 3 years ago that 
the Congress codify the process of the issuance of no-action 
letters. We recommend that to you again in this reauthorization 
process. I would be happy to work with you on that.
    Mr. Collins. Well, thank you all for your comments. The 
time has run out. Mr. Chairman, I yield back.
    The Chairman. The gentleman yields back. Mr. Costa for 5 
minutes.
    Mr. Costa. Thank you very much. Mr. Chairman, I have a 
number of questions specifically and generally. Let me begin 
quickly. Mr. McMahon and Mr. Kotschwar, in your testimony you 
talked about your concerns about the de minimis exemption on 
swap dealer registration. Do you envision more companies having 
to register under the current $8 billion level? Do you think 
that the current de minimis level of $8 billion is appropriate 
or do you think that Cargill and BP's dealing activity doesn't 
warrant registration or increased oversight?
    Mr. McMahon. Well, I think from the utility perspective, as 
I said earlier, the $8 billion is appropriate, and that was 
recognizing, too, that that number was formulated when we were 
in the midst of a trough in the commodity cycle, very low 
commodity prices. That number should be a reflection of where 
the commodity prices are, where the overall scale and size of 
the derivatives and swaps market is, and we think the number is 
appropriate. If the number went down, yes, you would see, 
unintentionally, end-users who use these products to hedge 
commercial risk being pulled in and regulated like banks.
    Mr. Costa. And I don't know, Mr. Kotschwar, if you want to 
speak. Can you give us a sense how many more non-financial 
companies would have to register as swap dealers? As you may 
know, I was involved in that effort last year with public 
utilities in California that were included under this and I 
felt was unfairly impacted. Can you comment?
    Mr. Kotschwar. And thank you for your efforts, Congressman. 
Yes, I think that we had not done sort of a sensitivity 
analysis looking at the different levels and how many companies 
would be brought in. But I can tell you that there are lots of 
examples where we are using swaps and commodities to hedge 
significant volumetric risk. For example, the provider of last 
resort obligation that many utilities have in competitive 
markets, and they need to hedge that risk in the event that it 
needs to be covered. You know, and these are large numbers. I 
think that setting it at an appropriate level, $8 billion is 
that level.
    Mr. Costa. And you also said in your testimony about 
amending the definition of financial entity or financial 
entities that are not inadvertently regulated. As we know, we 
have a number of financial institutions that can and often do 
own warehouses and other facilities. They store physical 
commodities. How would you talk about changing the definition 
in Dodd-Frank under that definitional category?
    Mr. McMahon. Well, we want to make sure that commercial 
end-users or affiliates of commercial end-users are 
specifically excluded from that definition. In many cases 
because of codes of conduct and regulatory contracts, again, 
our industry is heavily regulated already at the Federal and 
state level----
    Mr. Costa. How do you do that relief without opening up a 
loophole that you can drive a Mack truck through?
    Mr. McMahon. I think you just limit the exception to 
commercial end-users, those that are using these products to 
hedge commercial risk and specifically exclude banks, hedge 
funds and everybody of that ilk. So I mean that is what our 
argument is because oftentimes we have these subsidiaries set 
up within holding companies to do the financial trading for the 
rest of the family.
    Mr. Costa. Mr. Kotschwar, do you have any different 
comments about this quickly? Because I want to move onto 
another question.
    Mr. Kotschwar. Just to add a little bit to what he said 
about owning the stuff. You know, we acknowledge that the issue 
is out there, and it is something for the Prudential 
Regulators. The Federal Reserve it looking at it closely 
whether banks can own this stuff.
    Mr. Costa. Right.
    Mr. Kotschwar. But you know one of the things the CMC would 
observe is that regardless of what the Fed does in terms of 
allowing banks in or out of this stuff. If there is a demand 
for exposure to commodities, that demand----
    Mr. Costa. No, I have no doubt. The creativity of folks out 
there is boundless it seems to me----
    Mr. Kotschwar. Yes.
    Mr. Costa.--which is part of the problem. Mr. Guilford, 
your testimony comments about how the Federal Reserve is 
reportedly reconsidering its decision to allow banks to play 
heavily in the physical commodity markets. I mean, 
traditionally, we know what that role has been played. Can you 
expand on what role you think the banks may play in these 
markets?
    Mr. Guilford. I don't think they should be allowed to play 
in these markets.
    Mr. Costa. At all?
    Mr. Guilford. No, I don't.
    Mr. Costa. Okay. I am not so sure I don't agree with you. 
The whole panel, you may know, that Germany unilaterally 
imposed new rules over high-frequency traders including 
registration requirements. I hope you are aware of that. We are 
working with them on a host of efforts on a new trade deal on 
financial regulatory non-tariff area efforts. What are your 
thoughts about what the Commission should be doing in this 
area? They are looking at greater oversight on these traders. 
Should Congress include something about high-frequency traders? 
Quickly.
    Mr. Kotschwar. From CMC's perspective, I don't know that 
Congress needs to do anything about it. It is high-frequency 
trading. I think we need to make sure we distinguish between 
looking at the technology because technology is a good thing. 
It is the trading strategies. I mean, if you are not supposed 
to be able to spoof. If you are doing manual trading, you 
shouldn't be able to spoof, if you are electronically trading 
or high-frequency trading, either.
    The Chairman. The gentleman's time has expired. Mr. 
Neugebauer for 5 minutes.
    Mr. Neugebauer. Thank you, Mr. Chairman. Thank you for 
having this important hearing. Mr. Monroe, you mentioned in 
your testimony that the specific trades you talked about where 
you were in the marketplace and market participants could have 
said, ``Oh, Southwest is in the market today.'' Was that a one-
time occurrence or has your DNA been kind of discovered out 
there so on a regular basis that people know that is a 
Southwest transaction and they are trying to hedge or----
    Mr. Monroe. Yes. Well, thank you for that question, 
Congressman. Well, it happened the day--we had a trade the day 
before the database, the website came up, in a trade the day 
after. And the e-mails came and the phone calls came 
immediately. And then we were quiet for trading for a while. We 
don't trade every day. We are an end-user. We are hedging our 
risk. And then when we came back into the market again, we were 
discovered again.
    So we have a specific footprint that we leave. We trade in 
high volume, we trade in certain ways and especially those who 
have traded with us before, and if we are not trading with them 
on that particular day, they know that that is us.
    Mr. Neugebauer. So you think the fact that that is 
occurring, is that negatively impacting Southwest Airlines do 
you think?
    Mr. Monroe. Certainly it is a competitive issue. Typically 
we wouldn't have to disclose our hedging positions until the 
SEC required it at the end of a quarter, which is fine. But to 
have to have that reported the moment that it happens is a 
competitive issue, and then there is the concern about the 
actual swap price rising or the spread rising on us.
    Mr. Neugebauer. So is there anything that could be done to 
give you that anonymity that you need? I mean, what would be 
the fix for that?
    Mr. Monroe. There is a liquidity test that is needed, and 
we feel like that liquidity test probably prescribes that the 
real-time reporting still continues, needs to be done to the 
public in the near close-end months where price discovery is 
important. But in these illiquid areas, the delay can be as 
much as 30 days. At least that 30 days gives our counterparty 
the opportunity to come out of those positions. And we do 
believe in real-time reporting to the CFTC. That should happen. 
It is just to the public. There is no public benefit to a 2017 
crude oil trade being posted within 15 minutes.
    Mr. Neugebauer. So you are saying that those far out 
contracts really don't affect the near-term cash markets?
    Mr. Monroe. Yes, and that is typically, just to your 
earlier question, that is typically where we are seen, where we 
are recognized as hedging. If I am hedging in the next few 
months, they wouldn't see me there. There is too much 
liquidity. It is where there is not enough liquidity and there 
is clearly a large animal in the room. That is us and they know 
it is us.
    Mr. Neugebauer. What would the disallowance of non-cash 
collateral as margin, how would that impact Southwest Airlines?
    Mr. Monroe. Well, that would impact us very negatively. 
Again I mentioned earlier, we use aircraft for collateral, and 
that helps us to lower our cost of capital rather than to have 
to go out and borrow cash to post it as collateral. And we have 
billions of dollars' worth of unencumbered aircraft that we are 
very proud of, and we use those in these markets.
    Mr. Neugebauer. Thank you. I appreciate that. You know, one 
of the things I think that we keep hearing, and whether it is 
this panel of end-users or when I am in the 19th Congressional 
District of Texas, is that people that are using financial 
services, whether it is hedging or other financial services, 
with Dodd-Frank and CFTC rules and all of these things, is that 
it is creating a huge amount of uncertainty, and that 
uncertainty is playing out in how companies are conducting 
their businesses.
    Mr. Cordes, would you say that that is impacting--I think 
about grain dealers or grain elevators in Texas. We may make it 
difficult where they just quit providing hedging opportunities. 
What would that do to the--where would their customers then go 
for that service?
    Mr. Cordes. Yes, I can provide you a little bit of an 
example. If you think back to 2008 when the grain markets were 
moving quite a bit higher, we had increased margin requirements 
that come into the marketplace, started putting a lot of stress 
on the working capital that a lot of these grain dealers had. 
Some of them got stretched to the point where they just had to 
quit buying grain. They said I cannot physically handle this 
anymore. So what happens then is the farmer is faced with where 
is an outlet? I like these prices but how can I lock it in? 
One, they would have to start financing themselves to do that, 
or two, they would just have to wait. And we saw some of them 
waited. So there is some opportunity that is missed there.
    So that furthers into today's discussion around some of 
these potential changes around residual interests. Some of 
these things, if we are going to increase the working capital 
needs, you are probably going to see some of these firms that 
will be stretched to the point where they are saying I can't 
continue to buy grain or maybe I need to get out of business 
and merge with somebody else. So then it limits the choices 
that the farmer ultimately sees.
    Mr. Neugebauer. Thank you, sir. Thank you, Mr. Chairman.
    The Chairman. The gentleman's time has expired. Mr. Vargas 
for 5 minutes?
    Mr. Vargas. Thank you very much, Mr. Chairman. Again, thank 
you for the opportunity to ask some questions. I, too, would 
like to thank all the witnesses for being here. It sounded like 
some of you, that you listened to the testimony yesterday from 
the two Commissioners. So a question was asked of them in two 
different ways. What is the thing that keeps you up at night or 
what is the thing--and you can't say my 3 year old. That has 
been used. That was yours, that is true. But what is the thing 
that worries you the most? We would all agree with the primary 
goals of Dodd-Frank, protecting the financial system against 
systemic risk and increasing transparency in the derivatives 
market. But what is it that worries you the most? Yes, sir, Mr. 
Soto, since my mother's maiden name is Ms. Soto. Why don't we 
go to you first, sir?
    Mr. Soto. What worries my members is getting that phone 
call from CFTC enforcement staff that they have done something 
wrong, despite their best efforts in trying to comply with 
difficult-to-understand rules, they still, the staff, thinks 
that they have done something wrong. And I have seen Federal 
agencies, not the CFTC, penalize industry participants millions 
of dollars for misclassifying their transactions in a way that 
results in a reporting violation.
    And so I mean, those concerns are real. So when they come 
to their association, their national trade association, and say 
what can be done, what keeps me up at night is how do I get a 
straight answer from the agency? How do I get a final rule that 
is well-defined, clearly sets out what the compliance 
obligation is so our members know how to do business planning 
and compliance? And that is the source of my frustration. That 
is what keeps me up at night.
    Mr. Vargas. Well, Mr. Kotschwar, in reviewing your 
comments, I think you were saying that it has become--some of 
these rules--let me see if I can find exactly. Given that we 
strongly believe that the CFTC's current trend toward very 
prescriptive changes is a bad thing. So you almost argue the 
other way, that there should be some flexibility, that 
compliance is very costly. But I mean, I have been trying to 
listen to understand because you want some clear rules, but at 
the same time, if it is too prescriptive, then the compliance 
costs go way up and compliance attorneys like you like that, 
but it is not a good thing necessarily for the system.
    Mr. Kotschwar. Well, certainty is a good thing, but you 
know, over-prescriptiveness is not a good thing, I guess. I 
don't know where the fine line is between certainty and being 
over-prescriptive. One of the things that CMC members worry 
about a lot is where certainty in this area of bona fide 
hedging. You have heard the testimony, a lot of different 
definitions of it. This is the one where we really see a 
situation of this is very ancillary to what Dodd-Frank was 
trying to do. You know, we are trying to set up a framework for 
swaps. What was going on in the hedging in the grain industry, 
in the electricity industry, that requires the regulator to 
come in and topple everything we know about bona fide hedging 
on its head and start over? This is very destabilizing, and it 
worries us.
    Mr. Vargas. Anybody else? Mr. McMahon, sir?
    Mr. McMahon. Yes, I would just add that I think not falling 
over one of the trip wires that would have you miscast as a 
swap dealer. I think that there is so much overlapping and 
interwovenness between these regulations that there is really a 
concern that inadvertently somehow you will hit one of these 
trip wires and be miscast as a dealer and regulated to the 
extent that banks are and ultimately, in order to avoid that, 
anecdotally we are hearing there are fewer counterparties in 
the market and companies are going more physical which, in a 
lot of cases, is a more costly way to hedge.
    Mr. Vargas. Mr. Cordes?
    Mr. Cordes. I would say from our perspective what keeps us 
up at night is this potential one-size-fits-all. You have 
different sized firms. It used to be you had guidance from the 
CFTC. Now it is pretty much you must follow this path, this 
rule, the prescriptive down. So what gets us worried at night 
is, okay, what have we overlooked? What are we missing and what 
is it going to cost us to comply with doing all that stuff 
which in a lot of times a smaller firm, you have a much better 
view. You see a lot of the things. You don't have layers that 
things get missed. It is like we can do that guidance, but to 
go through all that other stuff just gets to be a lot of 
formality that just adds cost.
    Mr. Vargas. Thank you. Thank you, Mr. Chairman. I yield 
back. Thank you, sir.
    The Chairman. The gentleman yields back. Mr. Hudson for 5 
minutes.
    Mr. Hudson. Thank you, Mr. Chairman. I thank the witnesses 
for being here today.
    Mr. McMahon, I enjoyed visiting with your folks last week 
and appreciate in your testimony where you discuss the 
implications of reducing the de minimis threshold with 
deliberate CFTC action. I am glad you raised this point because 
it is something I am very concerned about, something I am 
working with this Committee on.
    As I talked to Commissioner O'Malia yesterday, I understand 
that the de minimis level is based on a notional value. From 
his testimony I gather that works for interest rates lops but 
in commodities markets, rising energy prices can push entities 
over the threshold by giving them changes in their trading. 
This seems like a real problem to me. How would you suggest the 
CFTC address this clearing problem?
    Mr. McMahon. And thank you for all your support and efforts 
on behalf of the industry, Mr. Congressman. At the end of the 
day, our hope is that this level, to the extent that they go 
for a look-back, that there is a process put in place where all 
the stakeholders can come in. I think it should look at the 
overall scale and scope of the market but also recognize that 
it is a very volatile market, particularly with respect to our 
fuels. Historically it has been. Our hope is that it is a 
deliberative process. It involves rule-making, that all the 
stakeholders have an opportunity to participate and obviously 
with the guidance and oversight of the Congressional 
committees. I think that is the best way to get a result that 
will ultimately preclude commercial end-users, such as the 
folks represented on this panel, from being inadvertently being 
cast as swap dealers.
    Mr. Hudson. Thank you for that. You touched on this a 
little bit but has the CFTC's approach to rule-making and the 
resulting rules caused any of your members to restructure or 
reduce hedging, trade less officially? Could you maybe explain 
that in a little more detail?
    Mr. McMahon. Thank you. Our industry is heavily regulated 
at both the state and Federal level. In some cases there are 
overlaps between the regulation. The Dodd-Frank Act did call 
for the FERC and the CFTC to put in place an MOU. That 
Memorandum of Understanding was really never put in place. I 
think that is an issue of some concern for our industry. But in 
many cases, one of the things that many of our companies are 
set up as holding companies, and in order to be efficient about 
how they trade and to separate the regulated businesses from 
the non-regulated businesses, they have trading entities within 
there and a real concern. We felt that that was an appropriate 
way to make sure that the overall entity would be able to 
maintain its end-user status since the purpose of that trading 
entity was to trade on behalf of the end-user. Because of this 
financial entity concern that I put in my statement, that is 
something that that end-user status could be lost from that 
advantage overall.
    So I think that is an example of a real concern with the 
way that the rules are coming out, also the interaction between 
the other Prudential Regulators and the CFTC, and that is 
something that we hope can be resolved.
    Mr. Hudson. I appreciate that. Mr. Soto, in your position, 
your primary focus as I understand is to inform your members of 
the regulations they must adhere to and a system of staying 
between the lines, so to speak. Can you explain to the 
Committee why regulatory certainty is so critical to what you 
do and elaborate some more on specifically what that means for 
business planning?
    Mr. Soto. Thank you. Our industry, the natural gas 
industry, is heavily regulated. There are several Federal and 
state agencies that have some oversight over the actions and 
activities and operations of the utilities. So our members are 
used to compliance, and they build sophisticated programs to 
make sure that they understand each of the regulatory 
obligations, chart them out, make sure all their transactions 
and operations are consistent with those obligations. And the 
difficulty comes in if they don't understand what those 
obligations are requesting them, whether a particular 
transaction would be subject to a specific set of regulations 
or overlapping or conflicting regulations with another agency 
or whether a particular operation has to be done in a certain 
way. IT systems, resources have to be devoted in order to 
comply with record-keeping or reporting requirements. Whenever 
those regulations are unclear, those operations are disrupted.
    And so we are hoping that, again, the theme that I have 
been trying to express today is the notion that we need to get 
answers from the agency in defining all of their regulatory 
obligations, very clearly, very definitively, from the 
Commissioners themselves and not necessarily from staff actions 
and no-action letters and interpretive guidance. It has to be 
the agency through the process. We file comments, answer the 
comments. That is what we are really seeking.
    Mr. Hudson. Thank you, and Mr. Chairman, I yield back the 
seconds I owe you from yesterday.
    The Chairman. All right. Let the record reflect that. I 
appreciate that. The gentleman yields back. Mr. Scott for a 
second round, 5 minutes.
    Mr. David Scott of Georgia. Thank you, Mr. Chairman. Mr. 
Guilford, let me go back to you. You know, in my opening 
statement I remarked about my concern about the banks 
purchasing these warehouses and holding onto these tons of 
aluminum and other commodities, oil takers, all that. Tell me 
why you feel, where is the danger there? What do we have to 
look forward to? And can you explain for us why your position 
is that this should not be?
    Mr. Guilford. It is almost as though the country is being 
turned back about 100 years to the turn of the 20th century 
when Teddy Roosevelt first broke up the great trusts, and it is 
based on the very same reason, the concentration of power in 
one place of an entity that controls the physical market to an 
extent that it has the ability perhaps to manipulate prices. It 
takes vast positions in paper markets, so it is dealing with 
both sides of the energy marketplace, and at the very same 
time, it is selling us our fuel as a wholesale supplier. It has 
another division that is helping us hedge those purchases 
because we are literally tens of thousands of businesses whose 
responsibility it is to try to provide consistent and stable 
prices for consumers. And then on top of that, we can open an 
investment account and a 401(k) plan. It seems like it is 
becoming just an extraordinary concentration of power in one 
place, and we think that there may be great danger in that. And 
I think that is where we have to be very cautious. This didn't 
start until 2003.
    I would only tell you, Mr. Scott, that most of these 
contracts went on the markets at the end of the 1970s and the 
beginning of the 1980s. We functioned for over 20 years without 
the financial services' industry's deep penetration into these 
markets. But since that has occurred, our concern has grown 
about the nature and extent to which we have distortions in the 
markets because of it.
    Mr. David Scott of Georgia. Do you see a threat to a 
possible crisis in any way, financial instability, inflated 
pricing or any of those things? Because it is clear from the 
ruling of the Federal Reserve that the banks are operating 
basically within the regulations they have, and they have up to 
10 years to dispose of these ownerships.
    Mr. Guilford. We are grateful for the fact the Federal 
Reserve is reviewing that decision with the potential toward it 
being overturned in September. And we would encourage the 
Congress to communicate with the Federal Reserve, the very 
important nature of their doing that and doing it thoroughly.
    Mr. David Scott of Georgia. You definitely see a danger 
to----
    Mr. Guilford. Yes.
    Mr. David Scott of Georgia.--financial stability with that?
    Mr. Guilford. Yes.
    Mr. David Scott of Georgia. All right. Now, back to the 
whole panel, I hope I get a better yes or no ratio here. And 
this is just the basic yes or no. But some of my Republican 
friends--and I do have Republican friends. I work with them 
very closely. But they are both in the House and the Senate 
supporting legislation that totally would repeal Dodd-Frank. 
And with regard to Title VII of which we are all involved in in 
the commodities, the derivatives and so forth, do you agree 
with my Republican friends that it should be repealed entirely 
and that the regulation or lack thereof that existed prior to 
the law is the appropriate regulatory regime? Yes or no.
    Mr. Cordes. That is a pretty full question. You know, 
certainly some of the new things that have come in around 
transparency have been helpful. There are some other things 
that have been hurtful. I am not sure I can give you a full 
answer on a full repeal or not.
    Mr. David Scott of Georgia. All right. Good. Yes, sir?
    Mr. Kotschwar. I think generally the CMC position on that 
would be no because the CMC was supportive of the goals of 
Dodd-Frank which was to bring swaps into a regulatory arena 
that was somewhat comparable to what existed for futures.
    Mr. David Scott of Georgia. So you don't support repeal? 
Yes, sir, Mr. McMahon?
    Mr. McMahon. As I said in my statement, we support the 
goals of Dodd-Frank. We just need to get these issues correct.
    Mr. David Scott of Georgia. All right. Mr. Monroe?
    Mr. Monroe. We would not.
    Mr. David Scott of Georgia. All right. Mr. Soto?
    Mr. Soto. I am here on behalf of my members, and my members 
have not told me one way or another whether they support repeal 
or not. So I can't give you a definitive yes or no answer. I am 
here to tell you we want the regulatory regime to be as clearly 
defined and understood as possible.
    Mr. David Scott of Georgia. All right. And Mr. Guilford?
    Mr. Guilford. No, we are not in favor of total repeal.
    Mr. David Scott of Georgia. All right. Thank you very much, 
Mr. Chairman.
    The Chairman. The gentleman yields back. Mr. LaMalfa for 5 
minutes?
    Mr. LaMalfa. Thank you, Mr. Chairman. Maybe I ought to ask, 
would you be in favor of partial repeal which kind of sounds 
like that because all or nothing is probably something you 
can't say or maybe completely before with a little more clarity 
probably being reasonable. So maybe I could just get you all to 
nod your heads yes or no. Would you like to see partial repeal? 
I am seeing some nods. Okay. All right.
    We have some cleaning up to do, a lot of it, and I hear a 
lot of complaints in general about the far reach of the law. 
When some things went wrong with finance markets recently, some 
effort was needed. But as happens around here, we swing the 
pendulum not just a little bit, we swing it all the way.
    So let me ask Mr. McMahon just a couple, following up on--
you are probably aware of my bill, H.R. 1038. If that was put 
into law, having to deal with the threshold for swap dealers 
from $25 million to the $8 billion for taxpayer-owned 
utilities, if we don't get this, or if CFTC does not act in 
this manner as they alluded to at yesterday's hearing, do you 
think the effect on rate-payers is going to be detrimental 
without this fix?
    Mr. McMahon. Ultimately, utilities, our members, can go two 
different courses. I think that if the threshold for the de 
minimis level went down, you would find people not doing a lot 
of the hedging and the activities that would cause them to 
cross that threshold. So what that would mean at the end of the 
day, again, our goal is to deliver affordable, reliable, stable 
rates to our members. So what that would do is basically cause 
us to do less hedging which would probably cause more 
volatility in rates because of the inherent nature of the fuels 
and feed stocks that we use to generate electricity.
    You would just see a movement toward more physical sites 
with transactions which can be extensive, and you would see a 
movement so that you wouldn't become regulated like a bank and 
a swap dealer. So we think this is very, very important to get 
this right because at the end of the day, there was a 
recognition that the activities that the companies and 
industries do on this table do not create systemic risk which 
was ultimately the objective of Title VII to address systemic 
risk and Dodd-Frank. And so we think that getting the level 
right is very important.
    Mr. LaMalfa. You kind of answered my second follow-up and 
that is the whole thrust of our legislation is what did tax-
payer owned utilities have to do with the financial crisis 
anyway? You know, so we think it was maybe an oversight or a 
little lack of common sense on that.
    For Mr. Soto, I am interested in the problems we keep 
hearing about the no-action letters. Can you provide an example 
of a time that you really had to rely on the relief of a no-
action letter or get regulation clarification from CFTC on 
that?
    Mr. Soto. As I described earlier today and in my testimony, 
there is uncertainty and confusion in the industry as to how 
certain gas supply transactions would be treated, whether they 
would be treated as exempted or excluded forward contracts, or 
whether they should be treated as trade options or whether they 
should be treated wholly as swaps. And part of that confusion 
was resolved a bit in the CFTC's proposed rule to treat trade 
options with a lesser regulatory reporting requirement. But as 
that reporting requirement deadline came nearer and nearer and 
people were still confused as to what transactions would be--
could we report these as trade options or would they still be 
excluded? The CFTC granted no-action relief as to how to report 
trade options which gave the industry a little bit of a 
breathing room, knowing that in case they had to report these 
transactions, at least they could report them under a lower 
reporting burden as trade options. And so people breathed 
easier a little bit. But the fundamental question of what 
transaction is a swap, what transaction is excluded as a 
forward, what transaction is a trade option, that is still very 
unclear.
    Mr. LaMalfa. And the last-minute nature of those 
clarifications made it probably even more difficult to----
    Mr. Soto. Indeed.
    Mr. LaMalfa.--running down two different tracks, et cetera.
    Mr. Soto. I think the relief was granted within a week when 
the deadline came due.
    Mr. LaMalfa. Yes. All right. I yield back, Mr. Chairman.
    The Chairman. The gentleman yields back. Mrs. Hartzler for 
5 minutes.
    Mrs. Hartzler. Thank you, Mr. Chairman. Thank you, 
gentlemen, for being here today to let us know how the 
implementation of the Dodd-Frank is impacting each of you.
    Earlier this year I introduced H.R. 2136, the Small 
Business Credit Availability Act, and that would exempt certain 
end-users such as farm credit lenders and nonprofit electric 
cooperatives from the financial entity definition in Dodd-Frank 
if their outward swaps exposure does not exceed $1 billion. And 
I have since worked with Representative Michael Grimm from New 
York to ensure a comparable exemption was included in his bill, 
H.R. 634 which passed overwhelmingly in the House earlier this 
summer, and that excludes these end-users from costly capital 
and margin requirements.
    So I was wondering, Mr. McMahon, can you elaborate on the 
effects of including end-users like electric companies and 
rural electric cooperatives in the financial entity definition?
    Mr. McMahon. Well, again, going back to the question, I 
think it would have a very detrimental effect of being 
classified as a financial entity because you would lose your 
end-user status. Even if one entity within a holding company 
was classified that way, they would not be able to trade on 
behalf of the regulated entity who is the end-user. So I think 
that would be very detrimental.
    I think generally we have looked at this issue more broadly 
in terms of: if the end-user status was taken away and all of 
the swaps and derivatives transactions had to be transacted on 
exchange or with margin posted, what the impact would be on our 
companies, and we have estimated the impact from a cash flow 
standpoint of between $200 and $400 million per year, and that 
would have a significant impact because again, we are in the 
midst of a major capital expansion, and in some cases, that is 
\1/2\ of your capital budget for the year. So it is a 
significant number, and again, I think that companies, if they 
were subject to those sorts of margin requirements, they would 
back off of their hedging, most likely, and to some degree 
redirect money toward other things that were in capital spend 
programs and so on.
    So it would have a negative effect, and that is why it is 
so important that our companies are not in any way classified 
as financial entities and that the end-user status is robust.
    Mrs. Hartzler. Would it have an impact on the rates of your 
rate payers if they have $200, $400 million more in capital 
needed, I assume you would pass those on?
    Mr. McMahon. Yes, absolutely. I mean there is absolutely an 
impact because at the end of the day, we are a rate-regulated 
industry. We are in the middle of this, in the midst of this on 
an industry basis about a $90 billion per year capital spend, 
and your average company's capital budget may be in the range 
of about $1 billion. So having the ability to manage that price 
risk as we do right now where we don't need to post margin, 
where we are end-users, it is very cost effective. And our 
customers get the advantage of the fact that we are very 
creditworthy. So our counterparties don't ask us to post 
margin. But as Mr. Monroe said, in some cases, if we do post 
margin, we want to do something like use a power plant or use a 
physical asset. And having that flexibility is very important.
    So these issues all kind of tie together, but at the end of 
the day, it is about delivering affordable rates, reliable 
rates to our customers.
    Mrs. Hartzler. Exactly, and stable, like you mentioned 
earlier.
    Mr. McMahon. Absolutely.
    Mrs. Hartzler. Affordable, reliable and stable. I thought 
that was very good. In your opinion, how should the definition 
of financial entity be changed to ensure the commercial end-
users are not inadvertently regulated as a financial----
    Mr. McMahon. Well, from our perspective, and thank you for 
the question, our perspective is commercial end-users should be 
explicitly excluded from that definition so that we will not be 
sort of brought in through the actions of Prudential Regulators 
or the CFTC into that definition. We should be explicitly 
excluded.
    Mrs. Hartzler. Okay. Well, we are going to keep trying to 
work, help that happen.
    Mr. McMahon. Thank you so much.
    Mrs. Hartzler. You bet. And I wanted to ask Mr. Cordes a 
question here because yesterday I asked Commissioner O'Malia 
and Wetjen about the damaging proposed rule on residual 
interest in same-day margin calls for farmers and ranchers. And 
I am cautiously optimistic from their answers. I don't know if 
you had an opportunity to hear that but that changes will be 
made, and they feel like there is staff drafting such as we 
speak. But for the record, can you please elaborate on why the 
proposed rule could harm farmers and ranchers?
    Mr. McMahon. Yes. I did catch part of that testimony, and 
it is good to hear that some things are being redrafted and 
looked at. I would say from our perspective, if it is not, here 
is what is going to happen. Going forward, you will have to be 
ready for that one-day event that might happen once or twice a 
year, and for a firm like ours or in our industry where you are 
normally hedgers, and if you get a big market move-up, you have 
to be prepared to have that money on your balance sheet at that 
time, not when the margin call shows up at the end of the day 
or later, at that time. There are periods in our system in the 
last few years, and some of these days, it might be $100 
million a day needs to be--you would have to throw on your 
balance sheet just to be ready for that one-day event. Firms 
are not going to do that. What you are going to do is you are 
going to say, ``Okay, customer, we are going to have you put 
some skin on this game, and by that, you are going to have to 
increase your margin requirement that is on deposit with us.'' 
That is going to affect their working capital, and as I think 
we have heard on some of the other ones, working capital is 
precious, and that costs resources and ultimately hits the 
bottom line.
    Mrs. Hartzler. Absolutely, as----
    The Chairman. The gentlelady----
    Mrs. Hartzler.--the farmer who--yes, okay.
    The Chairman. The gentlelady's time has expired.
    Mrs. Hartzler. Thank you.
    The Chairman. Mr. Davis for 5 minutes.
    Mr. Davis. Thank you, Chairman Conaway and as it always is 
on these Committee hearings, when you are one of the last to 
ask questions, I had a lot of great questions to ask you, but 
almost all of them have already been asked. Mr. Chairman, am I 
the last questioner?
    The Chairman. In this round.
    Mr. Davis. In this round? Oh, another round. Okay. Well, 
then I will keep going. I was going to yield back. I had some 
discussion questions, especially from Mr. Cordes and Mr. 
Monroe, but again, they have already been asked. What we have 
seen here today and what we continue to see is laws like Dodd-
Frank, that have great intentions, have consequences. And from 
the testimony that all of you have given us is the consequences 
are going to be passed on to the consumers. The flight I take 
on Southwest Airlines from Reagan National to St. Louis, to 
comply with these rules, the cost that I and so many different 
consumers in this country will pay will go up. The cost to 
provide electricity will go up. The cost to provide our 
agricultural products in central and southwestern Illinois to 
our local grain elevators will go up, the law of unintended 
consequences when it comes to Dodd-Frank.
    And I know there are concerns. We have agreements, and 
there are those who disagree with the effectiveness of this 
piece of legislation. And with that in mind, you have all been 
asked specific questions by different Members of this 
Committee. I want to know from each of you, if you decide, is 
there any question that we haven't asked you and is there an 
issue when it comes to Dodd-Frank that we have not addressed 
that you would like to let the Committee know is a concern with 
your industry and with your particular business? So with that, 
I will start with Mr. Cordes. If you have any issues?
    Mr. Cordes. Not specifically an issue, but it gets back to 
what we talked about this one-size-fits-all, and your original 
comments about--and I hear this a lot from our customers in the 
industry saying okay, what did we do? Why are we subject to 
this stuff? We were not the cause of all this. We understand 
there is Dodd-Frank legislation, but why are we being asked to 
do these kind of things and why are my costs going up and what 
can we do about it, seems to be kind of the general comments 
that I hear back.
    Mr. Davis. Thank you. I hear that from many of my farmers.
    Mr. Kotschwar. I will get a little more granular with you. 
One of the things that hasn't been talked about today but is on 
CMC's list of things we are concerned about is it was part of 
the position limits rule that got tied up in court. We are 
going to be soon, if they resurrect it the way it was in the 
proposed rule, we are going to be doing daily reporting of 
physical positions. Currently it is agricultural commodities 
only, and they are reported to the Commission on a monthly 
basis. And we went round and round with the Commission on that 
as they were developing this particular part of the rule. We 
thought we had won that particular battle, too, and they said, 
okay, you are right. We will continue to allow you to do 
monthly reports. However, when we looked at the fine print it 
is monthly reports of daily positions. If you look at the 
history of the CFTC on these physical reports, at one time they 
were doing them on a weekly basis, but that was just way too 
much information for CFTC. So they pushed it back to a monthly 
basis. So that is something else. This is something they were 
getting ready to have the industry start doing for from our 
perspective very little benefit, and it is still percolating 
out there.
    Mr. Davis. Okay.
    Mr. McMahon. I think from the electric utility perspective, 
the one issue that would be very helpful would be to have, that 
we haven't discussed already, is to have that Memorandum of 
Understanding between FERC and the CFTC that was mandated under 
the Dodd-Frank Act, to actually have it hammered out, put in 
place, because I think that would help to address some of the 
regulatory uncertainty that some of the other panelists have 
alluded to with respect to jurisdiction and some of the issues 
between the cash market, the futures forwards and derivatives 
markets. So I think that would be very helpful.
    Mr. Monroe. I would just want to make it crystal clear that 
the additional $60 million that we talk about in terms of cost 
to Southwest from the real-time reporting rule is not some sort 
of $60 million that is going to the government in a new tax or 
to some regulative group. This is a group of hedge funds that 
have written specific--they have technology that they have 
built that has been handed to them by our government to have 
free information that they then use to trade against our 
counterparties, and it costs us more. And so that is money 
going from Southwest to hedge funds, just to be very clear 
about that.
    Mr. Davis. Thank you.
    Mr. Soto. To echo remarks from Mr. McMahon, I have talked a 
lot about uncertainty and regulatory uncertainty today, and a 
lot of that derives from transactions that have traditionally 
been regulated by FERC that are now being regulated by the CFTC 
or trying to be regulated or questioned to be regulated by the 
CFTC as swaps. What we really would like is for Congress to 
sort out and say, look, FERC, you take care of these 
transactions and the CFTC, you take care of these transactions. 
Right now we have this crazy Venn diagram of overlapping 
jurisdictions, and it is causing disruptions in the industry. 
The Dodd-Frank Act, Congress has already included provisions to 
sort out the jurisdiction between the CFTC and the SEC. Is 
there something that can be done between FERC and the CFTC?
    Mr. Davis. Mr. Guilford for a couple seconds?
    Mr. Guilford. Yes. I would ask who has the big picture? In 
Congress for example you have division of responsibilities 
between agriculture, financial services and banking. Who has 
the big picture between all three? We created a massive piece 
of legislation that ostensibly gives responsibilities to four 
different agencies, each of which overlap, some of which don't 
necessarily overlap but could. Who has the big picture over all 
of those things? Because what we did, while it may have been 
important in many instances, has created an enormous amount of 
not only uncertainty but additional cost and a very time trying 
to sort out what to do next.
    Mr. Davis. All right. Thank you. If I had time, I would 
yield it back, sir.
    The Chairman. Well, the record reflects that you are over 
about a minute or 2, and we will take that into consideration 
at the next hearing.
    I recognize myself for 5 minutes, second round. Mr. Soto, 
on the delay of the historical reporting requirements back in 
April, what impact is that having on your membership in terms 
of challenges in reporting and what impact would a second no-
action letter have on your membership?
    Mr. Soto. The no-action relief is actually giving the 
industry a little bit of a breathing room and understanding 
what their compliance obligations are. So in that respect, it 
was helpful that the agency provided some relief, but it really 
recognizes that the process for defining the regulatory 
obligations is not strong enough. So if it comes to the next 
deadline, either additional no-action relief is required, but 
really what is required is for the agency to issue final rules 
that are clear, and it is strengthening that agency rule-making 
process that is important.
    The Chairman. All right. One of the things we have talked 
about is the cost-benefit analysis and how we are going to try 
to strengthen those provisions in the bill. Looking back at 
Dodd-Frank and the estimates of what the cost and benefits were 
going to be to the system, can any of you or would any of you 
be willing to quantify the differential if any between what the 
Commission said was going to be the costs of compliance with 
all of these new regulations in various areas and what your 
personal experience or your members' experience has been in 
actual costs of compliance and if you have been able to 
quantify that for the Committee? Mr. Cordes?
    Mr. Cordes. I don't remember exactly what was stated in the 
bill, but I would tell you from our perspective, whether it is 
ourselves as CHS or other members within NCFC, pretty much 
everyone would give you the response that their costs and 
compliance are probably double what they were 3, 4 years ago.
    The Chairman. Yes, thank you for that. I was trying to get 
a differential between what the CFTC said were going to be your 
costs and what has been the actual experience. And some of that 
may be proprietary that you don't want to fess up to. Does 
anyone have a number? Well, if you think of a number or if it 
comes to you, we are going to try to defend strengthening the 
cost-benefit analysis in the bill, so we will be working 
through those provisions.
    I want to thank our panel for being here today. I also want 
to ask unanimous consent to include in the written record the 
comments from the Coalition for Derivatives End-Users and the 
comment from ICI and ABA.
    [The information referred to is located on p. 87.]
    The Chairman. Before we adjourn, I would now like to turn 
to the Ranking Member for a closing statement.
    Mr. David Scott of Georgia. Well, thank you very much, Mr. 
Chairman. Let me just extend my great appreciation to each of 
you for coming, taking the time out of your busy schedule to 
come. Your viewpoints have been well-appreciated. We have a 
number of challenges before us, and we are going to get there 
and we are going to avoid another financial crisis for sure. So 
thank you very much for coming.
    The Chairman. I also want to thank our Members. Clearly the 
Dodd-Frank law itself as well as the regulations that have been 
put in place to try to implement it and grant guidance to the 
system are going to cost the industry and ultimately customers 
more money. The offset to that should be that there are 
benefits to the markets, that the markets are better protected, 
that there is less systemic risk in what is going on. What my 
relatively naive view is that we are going to spend an awful 
lot of time on risks that can never reach the systemic level 
and the costs associated with all of those compliance costs on 
risks that really, at the end of the day, don't make a big 
deal, and that we have lost sight of the bigger issue.
    Dodd-Frank, in my view, was intended to prevent a systemic 
meltdown. I am hard pressed to gather up many, or all, of your 
users at any one point in time and have them do something 
stupid that would systemically put risks to the overall 
financial market, and yet, we have burdened them immensely with 
additional regulations.
    And so one of the things we will try to do with the 
reauthorization is not repeal Dodd-Frank, not undo it, but look 
at it particularly from a common-sense standpoint and say do we 
really need that information every single day in order to 
regulate what we need to regulate? There are risks in every 
market. There are risks in every transaction that you take. 
That is why people make money and lose money. But it is the 
systemic protection of the markets and the fairness of those 
markets that ought to be the deal. And we see an awful lot of 
this regulation that at the end of the day does not protect 
from a systemic meltdown; particularly that meltdown that drove 
Dodd-Frank.
    I thank each one of you for coming here, the preparation 
that you did, the money that you spent getting here and all 
that team behind you that put together your very informative 
written comments. Those will of course go into the record, and 
I have an announcement. Under the rules of the Committee, the 
record of today's hearing will be held open for 10 calendar 
days to receive additional material and supplemental written 
responses from the witnesses to any questions posed by a 
Member. This hearing of the Subcommittee on General Farm 
Commodities and Risk Management is adjourned.
    [Whereupon, at 12:04 p.m., the Subcommittee was adjourned.]
    [Material submitted for inclusion in the record follows:]
   Submitted Letters by Hon. K. Michael Conaway, a Representative in 
                          Congress from Texas
July 23, 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.


Re: End-User Support for Adding H.R. 634 and H.R. 677 to Legislation 
            Reauthorizing the Commodity Futures Trading Commission

    Dear Chairman Lucas and Ranking Member Peterson:

    The Coalition for Derivatives End-Users, representing hundreds of 
end-user companies that employ derivatives to manage risk, write in 
strong support of adding H.R. 634, the Business Risk Mitigation and 
Price Stabilization Act of 2013 and H.R. 677, the Inter-Affiliate Swap 
Clarification Act, to legislation reauthorizing the Commodity Futures 
Trading Commission (the ``CFTC''). These two vital bills would help 
prevent unnecessary and harmful regulation of derivatives end-users and 
preserve jobs. We have attached our June 11, 2013 letter to the U.S. 
House of Representatives in support of the two bills. The letter 
provides a sense of the range of end-user companies that stand behind 
these important bills.
    This Committee, of course, is well aware of these two end-user 
bills, and the Coalition commends your efforts in moving the 
legislation toward enactment. On March 20, 2013, this Committee ordered 
both bills reported by unanimous voice votes. H.R. 634 passed the House 
last month by a vote of 411-12 and we are optimistic that passage of 
H.R. 677 will soon follow. These are commonsense bills that assist non-
financial end-users in targeted, narrow ways that are consistent with 
the intent of Congress in passing the Dodd-Frank Act and that address 
problems not solved by regulatory action.
    Both bills are urgently needed due to the impending application of 
regulatory requirements on end-users. H.R. 634 is needed because 
regulations proposed by the Prudential Banking Regulators have 
interpreted the Dodd-Frank Act as mandating that margin requirements be 
imposed on all swaps, including those entered into by non-financial 
end-users. The CFTC's proposed regulations, while preferable to those 
proposed by the Prudential Banking Regulators, do not provide end-users 
with the predictability and assurance that H.R. 634 provides. As noted 
in the attached letter, a 3% initial margin requirement applied to end-
user transactions could cost more than 100,000 jobs.
    H.R. 677 is urgently needed as well. Under CFTC rules, clearing 
requirements will apply to all swap market participants beginning this 
coming September. H.R. 677 would prevent regulators from denying non-
financial companies the use of the end-user clearing exception because 
they have chosen to hedge their risk in an efficient, highly-effective 
and risk-reducing way--through the use of a centralized treasury unit 
(``CTU''). The CTU provision of H.R. 677 is especially important, as it 
makes clear that non-financial end-user companies that are using swaps 
to hedge or mitigate non-financial risks will not be disparately 
treated based on corporate structure and will not be subject to 
regulation that disadvantages them for employing what is a best 
practice among corporate treasurers.
    To ensure timely consideration of these bills and to prevent 
unnecessary and harmful regulation of derivatives end-users, we request 
that both bills be included in legislation to reauthorize the CFTC if 
they have not already been enacted by the time that your Committee 
reports out the reauthorization.
    Throughout the legislative and regulatory processes surrounding the 
Dodd-Frank Act, the Coalition has advocated for strong regulation that 
brings transparency to the derivatives market and imposes thoughtful 
new regulatory standards that enhance financial stability while 
avoiding needless costs. The Coalition appreciates very much your 
bipartisan legislative efforts to focus regulation where it is needed 
most by removing the burden where it will cause harm and provide no 
benefit.
            Sincerely,

  Coalition for Derivatives End-Users.
                               attachment
June 11, 2013

U.S. House of Representatives,
Washington, D.C.

Re: End-User Support for H.R. 634 to Protect Derivatives End-Users from 
            Unnecessary Margin Requirements and for H.R. 677 to 
            Preserve Central Hedging and Prevent Unnecessary Regulation 
            of Inter-Affiliate Swaps

    Dear Representative:

    The undersigned companies and organizations that employ derivatives 
to manage risk--write in strong support of H.R. 634, the Business Risk 
Mitigation and Price Stabilization Act of 2013, and H.R. 677, the 
Inter-Affiliate Swap Clarification Act. These two vital bills would 
help prevent unnecessary and harmful regulation of derivatives end-
users and preserve jobs.
    H.R. 634 would ensure that regulators would not impose unnecessary 
margin requirements on many end-users. In approving the Dodd-Frank Act, 
Congress made clear that end-users were not to be subject to margin 
requirements. Nonetheless, regulations proposed by the Prudential 
Banking Regulators could require end-users to post margin. While the 
regulations proposed by the Commodity Futures Trading Commission (the 
``Commission'') are preferable to the regulations proposed by the 
Prudential Banking Regulators, the Commission's regulations do not 
provide end-users with the predictability and assurance that H.R. 634 
provides. According to a Coalition survey, a 3% initial margin 
requirement could reduce capital spending by as much as $5.1 to $6.7 
billion among S&P 500 companies alone and cost 100,000 to 120,000 jobs. 
We need Congress to step in and clarify that end-users will continue to 
have the ability to manage risk without the threat of having 
unnecessary initial and variation margin requirements imposed on them. 
In short, we need this bill. In the 112th Congress, an identical bill 
(H.R. 2682) received overwhelming bipartisan support when it passed the 
House on March 26, 2012. This year's version of the bill was ordered 
reported by the House Agriculture Committee by unanimous voice vote and 
by the House Committee on Financial Services by a vote of 59-0.
    H.R. 677 would prevent certain internal, inter-affiliate trades 
from being subject to regulatory burdens that were designed to be 
applied only to certain street-facing swaps. It also would prevent 
regulators from denying non-financial companies use of the end-user 
clearing exception because they have chosen to hedge their risk in an 
efficient, highly-effective and risk-reducing way--through the use of 
centralized treasury units. Regulators have proposed a clearing 
exemption for inter-affiliate trades, but it would impose unreasonable 
conditions on financial end-users and would not address the centralized 
hedging unit problem. The Coalition believes that regulation of inter-
affiliate trades should square with a simple economic reality: internal 
trades do not increase systemic risk. Thus, imposing requirements that 
are designed to address systemic risk on inter-affiliate trades would 
create costs without a corresponding benefit, placing substantial 
burdens on end-users and consumers and increasing costs to the economy. 
H.R. 677 also includes language that ensures bank swap dealers and 
major swap participants would not be able to take advantage of the 
clearing exemption in the bill that is intended for end-users only. The 
House Committee on Agriculture ordered the bill reported by unanimous 
voice vote and the House Committee on Financial Services approved the 
measure by a vote of 50-10. Last year's version of the bill received 
overwhelming bipartisan support when it passed the House on March 26, 
2012.
    Throughout the legislative and regulatory processes surrounding the 
Dodd-Frank Act, the Coalition has advocated for strong regulation that 
brings transparency to the derivatives market and imposes thoughtful 
new regulatory standards that enhance financial stability while 
avoiding needless costs. The Coalition encourages you to support these 
bipartisan bills when they are voted on in the U.S. House of 
Representatives and ensure that new regulations do not impede 
innovation, U.S. competitiveness or job growth.
            Sincerely,

  Air Products & Chemicals, Inc., Allentown, PA
  Ameren Corporation, St. Louis, MO
  American Honda Finance Corporation, Torrance, CA
  Apache Corporation, Houston, TX
  Bayer Corporation, Pittsburgh, PA
  Blyth, Inc., Greenwich, CT
  BP America Inc., Houston, TX
  Business Roundtable, Washington, D.C.
  Cargill, Minneapolis, MN
  Caterpillar, Inc. Peoria, IL
  Daimler North America Corporation, Montvale, NJ
  Deere & Company, Moline, IL
  DuPont Co., Wilmington, DE
  DuPont Fabros Technology, Washington, D.C.
  Eaton, Cleveland, OH
  Edison Electric Institute, Washington, D.C.
  Eli Lilly and Company, Indianapolis, IN
  EnerVest, Ltd., Houston, TX
  EV Energy Partners, Houston, TX
  Exelon Corporation, Chicago, IL
  Financial Executives International, Morristown, NJ
  FMC Corporation, Philadelphia, PA
  Ford Motor Company, Dearborn, MI
  GE, Fairfield, CT
  General Motors Company, Detroit, MI
  Hallmark Cards, Inc., Kansas City, MO
  Hardinge Inc., Elmira, NY
  HCA, Nashville, TN
  Health Care REIT, Toledo, OH
  Helen of Troy, L.P., El Paso, TX
  Hercules Offshore Inc., Houston, TX
  Hersha Hospitality Trust, Harrisburg, PA
  Honeywell International, Morristown, NJ
  IBM Corporation, Armonk, NY
  Independent Petroleum Association of America, Washington, D.C.
  Johnson Controls, Inc., Milwaukee, WI
  Lockheed Martin Corporation, Bethesda, MD
  MAHLE Industries, Incorporated, Farmington Hills, MI
  Mars, Incorporated, McLean, VA
  McDonald's, Oak Brook, IL
  Medtronic, Inc., Minneapolis, MN
  Merck, Whitehouse Station, NJ
  MillerCoors, Chicago, IL
  Motor & Equipment Manufacturers Association, Washington, D.C.
  National Association of Corporate Treasurers, Reston, VA
  National Association of Manufacturers, Washington, D.C.
  National Gypsum Company, Charlotte, NC
  Nielsen, Wilton, CT
  Peabody Energy, St. Louis, MO
  Sealed Air Corporation, Elmwood Park, NJ
  Siemens Capital Company LLC, Iselin, NJ
  Simon Property Group, Indianapolis, IN
  The Boeing Company, Chicago, IL
  The Coca-Cola Company, Atlanta, GA
  The Dow Chemical Company, Midland, MI
  The JBG Companies, Chevy Chase, MD
  The Procter & Gamble Company, Cincinnati, OH
  Time Warner Inc., New York, NY
  U.S. Chamber of Commerce, Washington, D.C.
  United Launch Alliance, Centennial, CO
  United Technologies Corporation, Hartford, CT
  Volvo Group North America, Greensboro, NC
  Whirlpool Corporation, Benton Harbor, MI
  Zimmer, Inc., Warsaw, IN
                                 ______
                                 
July 24, 2013

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

    Dear Mr. Chairman:

    On behalf of the Investment Company Institute, ICI Global, The ABA 
Securities Association, and the American Bankers Association, we 
respectfully submit the enclosed statement for the record for the July 
24, 2013, hearing of the Committee on the reauthorization of the 
Commodity Futures Trading Commission. This statement is in regard to 
the need to amend the definition of ``foreign exchange forward'' in the 
Commodity Exchange Act to include non-deliverable forwards.
    If you or your staff have any questions, please call Karrie 
McMillan [Redacted] at the ICI, Dan Waters [Redacted] at ICI Global or 
Timothy Keehan [Redacted] at the ABA.
            Sincerely,




Karrie McMillan,   Dan Waters,        Cecelia Calaby,   Timothy E.
                                                         Keehan,
General Counsel,   Managing           Executive         Vice President
Investment          Director,          Director and      and Senior
 Company           ICI Global;         General           Counsel,
  Institute;                           Counsel,         American Bankers
                                      ABA Securities      Association.
                                       Association;


                               attachment
July 24, 2013
Statement for the Record for the House Agriculture Committee Hearing on 
        July 10, 2013, on CFTC Reauthorization
    The Investment Company Institute (``ICI''),\1\ ICI Global,\2\ the 
American Bankers Association (``ABA''),\3\ and the ABA Securities 
Association \4\ appreciate this opportunity to submit this statement 
for the record for the July 10, 2013, hearing of the House Agriculture 
Committee. We wish to bring to your attention an important issue 
concerning the fact that one type of foreign exchange forward--non-
deliverable forwards (``NDFs'')--has not been included in the exemption 
for foreign exchange forwards granted by the Secretary of the Treasury 
under the Dodd-Frank Wall Street Reform and Consumer Protection Act 
(``Dodd-Frank Act''). As a result, NDFs are being subject to 
unnecessary and costly regulation, creating problems for both the 
providers and users of NDFs. These users include U.S. investors and 
businesses, such as exporters of agriculture and agriculture-related 
products, engaged in international trade.
---------------------------------------------------------------------------
    \1\ The Investment Company Institute is the national association of 
U.S. investment companies, including mutual funds, closed-end funds, 
exchange-traded funds and unit investment trusts. ICI seeks to 
encourage adherence to high ethical standards, promote public 
understanding and otherwise advance the interest of funds, their 
shareholders, directors and advisers. Members of ICI manage total 
assets of $15.3 trillion and serve over 90 million shareholders
    \2\ ICI Global is the global association of regulated funds 
publicly offered to investors in leading jurisdictions worldwide. ICI 
Global seeks to advance the common interests and promote public 
understanding of global investment funds, their managers, and 
investors. Members of ICI Global manage total assets in excess of U.S. 
$1 trillion.
    \3\ The American Bankers Association represents banks of all sizes 
and charters and is the voice for the nation's $14 trillion banking 
industry and its two million employees.
    \4\ The ABA Securities Association is a separately chartered 
affiliate of the ABA, representing those holding company members of ABA 
that are actively engaged in capital markets, investment banking, and 
broker-dealer activities.
---------------------------------------------------------------------------
    The problem arises because of the definition of ``foreign exchange 
forward'' found in Section 1a(24) of the CEA (7 U.S.C.  1a(24)). That 
definition, as amended by the Dodd-Frank Act, has been interpreted as 
excluding NDFs. This differential treatment of NDFs, we strongly 
believe, was not intended by Congress.
    An NDF is a type of foreign exchange forward that is used when it 
is impractical or impossible for one of the currencies involved to be 
physically delivered outside the home country of that currency due to 
local law or other requirements. Because one of the currencies involved 
cannot be physically delivered, NDFs are settled in a single currency--
usually U.S. dollars--in an amount that reflects the movement in the 
value of the underlying currencies.
    The CEA, as amended by the Dodd-Frank Act, defines a foreign 
exchange forward as follows:

          The term `foreign exchange forward' means a transaction that 
        solely involves the exchange of two different currencies on a 
        specific future date at a fixed rate agreed upon on the 
        inception of the contract covering the exchange.

The differential treatment has resulted from the following language in 
this definition: ``that solely involves the exchange of two different 
currencies.'' Both the Treasury and the CFTC staffs have interpreted 
this language as excluding NDFs from the CEA definition of foreign 
exchange forward. Therefore, when the Treasury, using its authority in 
the Dodd-Frank Act, exempted foreign exchange swaps and forwards from 
the definition of swap, NDFs were not covered by the exemption.\5\
---------------------------------------------------------------------------
    \5\ See ``Determination of Foreign Exchange Swaps and Foreign 
Exchange Forwards'' under the Commodity Exchange Act (Nov. 16, 2012).
---------------------------------------------------------------------------
    There is every reason to believe that this result was unintended by 
Congress when it defined foreign exchange forward. There is nothing in 
the legislative history to indicate that Congress intended to 
differentiate NDFs or, in fact, was even aware of the existence of 
NDFs, which are a very small, though important, part of the foreign 
exchange forward market. Conversations we have had with Congressional 
staff have reinforced that view.
    There is no valid public policy reason for treating NDFs 
differently than other foreign exchange forwards.

   NDFs and other foreign exchange forwards are treated as 
        functional equivalents in the marketplace.

   Standard foreign exchange market documents treat NDFs as a 
        subset of the foreign exchange forward.

   There is nothing in the record to show that NDFs present any 
        material regulatory issues or risks different from other 
        foreign exchange forwards.

   NDFs, like other forwards, functioned smoothly before and 
        during the financial crisis.

    NDFs are used by a variety of end-users and are an important tool 
to facilitate trade and investment between the U.S. and developing 
market countries. For example, asset managers (operating through mutual 
fund structures, private funds, or separately managed accounts) 
routinely use NDFs to hedge currency risks in investments in these 
countries. Likewise, U.S. businesses of all sizes engaged in trade with 
important developing economies such as Brazil, Taiwan, South Korea, 
India, and Indonesia use NDFs to limit currency risk in their 
businesses. These developing economies can be significant markets for 
U.S. agricultural products. Producers of such products often will wish 
to lock in prices and avoid currency fluctuations. Therefore, such 
producers may use NDFs as the only practical way to hedge currency 
risks.
    The importance of this matter to a variety of businesses is evident 
from comment letters submitted to the Treasury and/or the CFTC 
requesting that NDFs, like other foreign exchange forwards, be exempted 
from the definition of swap. Among those submitting such letters, in 
addition to the Investment Company Institute and the ABA Securities 
Association, were the Coalition of Derivatives End-Users and the 
Committee on Investment of Employee Benefit Assets.
    The inability to include NDFs in the Treasury exemption for foreign 
exchange forwards causes a number of problems:

   Because the electronic nature of this trading means it can 
        be moved readily, the jobs and capital associated with NDF 
        trading may easily be relocated to other jurisdictions that 
        will not bifurcate the regulation of their foreign exchange 
        markets or impose unnecessary costs on transacting in NDFs.

   Treasury already has determined that regulation of foreign 
        exchange forwards as swaps is unnecessary and, indeed, counter-
        productive. These findings also should be applicable to NDFs. 
        The additional regulatory costs imposed on NDFs, however, will 
        increase the costs both for U.S. investors and for U.S. 
        companies trading in developing countries.

   U.S. investors and companies seeking to avoid the extra 
        costs imposed on NDFs will either choose not to hedge, thereby 
        increasing their own risk as well as the risk to the U.S. 
        financial system, or they may take the risk of trading NDFs in 
        foreign jurisdictions that may lack U.S. regulatory and 
        judicial protections.

   The differential regulatory treatment creates confusion 
        among market participants and creates legal and operational 
        difficulties for market participants in complying with CFTC 
        rules.

    It should be noted that including NDFs in the Treasury exemption 
would not by any means result in their being unregulated. In 
particular, NDFs would be subject to the same rules governing foreign 
exchange forwards.
    Our associations have recently filed a petition for exemptive 
relief with the CFTC. Unfortunately, it is far from certain if and when 
the CFTC may consider our petition, and the CFTC has no legal 
obligation to consider it. Therefore, we recommend that this issue be 
addressed through a legislative clarification of the definition of 
foreign exchange forward.
    Thank you for the opportunity to provide this recommendation for 
your consideration.
                                 ______
                                 
  Submitted Letter by Kenneth E. Auer, President and CEO, Farm Credit 
                                Council
July 24, 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.


Re: CFTC Reauthorization

    Dear Chairman Lucas and Ranking Member Peterson:

    On behalf of its members, the Farm Credit Council appreciates the 
opportunity to submit this letter concerning the reauthorization of the 
Commodity Futures Trading Commission (``CFTC'').
    The Farm Credit Council is the national trade association for the 
Farm Credit System, a government instrumentality created ``to 
accomplish the objective of improving the income and well-being of 
American farmers and ranchers by furnishing sound, adequate, and 
constructive credit and closely related services to them, their 
cooperatives, and to selected farm-related businesses necessary for 
efficient farm operations.'' \1\ Today, the Farm Credit System 
comprises four banks and 82 associations, which are cooperatively owned 
by their member-borrowers.
---------------------------------------------------------------------------
    \1\ 12 U.S.C.  2001(a).
---------------------------------------------------------------------------
    This year's reauthorization of the CFTC comes at an important time, 
as that agency continues to implement the Dodd-Frank Wall Street Reform 
and Consumer Protection Act (``Dodd-Frank'') and to address rapidly 
evolving market conditions. The Farm Credit Council is interested in 
these developments because Farm Credit System institutions rely on the 
safe use of derivatives to manage interest rate, liquidity, and balance 
sheet risk. The safe use of derivatives allows the Farm Credit System 
to offer reliable, low-cost, and flexible funding to the farmers, 
ranchers, and rural cooperatives that borrow from, and cooperatively 
own, Farm Credit System institutions.
CFTC Cooperative Clearing Exemption
    The Farm Credit Council commends the CFTC for a number of measures 
that the agency has taken to implement Dodd-Frank in a manner that 
mitigates systemic risk and increases transparency, without imposing 
burdensome new costs on cooperative financial institutions like the 
Farm Credit System.
    For example, by a unanimous vote of its Commissioners in July 2012, 
the CFTC proposed a rule providing that an ``exempt cooperative,'' such 
as a Farm Credit System institution, may elect not to clear swaps used 
to hedge or mitigate commercial risk related to loans to its 
members.\2\ In support of its proposal, the CFTC explained that 
cooperatives exist for the benefit of, and cannot be separated from, 
their member owners.\3\ The CFTC recognized that member owners of a 
financial entity could elect the end-user exception if acting alone, 
but could not do so collectively with other member owners at the level 
of a cooperative financial entity with total assets exceeding $10 
billion.\4\ To address this issue, the CFTC proposed exemptive relief 
for cooperative financial institutions, such as a Farm Credit Bank. In 
doing so, the CFTC concluded, among other things, that ``[u]sing the 
substantial, finance-focused resources of the cooperative to undertake 
hedging activities for the numerous members of the cooperative promotes 
greater economic efficiency and lower costs for the members,'' and the 
proposed cooperative exemption therefore ``would promote responsible 
economic and financial innovation and fair competition.'' \5\
---------------------------------------------------------------------------
    \2\ See Clearing Exemption for Certain Swaps Entered Into by 
Cooperatives, 77 Fed. Reg. 41940 (proposed July 17, 2012).
    \3\ See id. at 41943 (``Cooperatives have a member ownership 
structure in which the cooperatives exist to serve their member owners 
and do not act for their own profit. Furthermore, the member owners of 
the cooperative collectively have full control and governance of the 
cooperative. In a real sense, the cooperative is not separable from its 
member owners.'' (footnote omitted)).
    \4\ See id. (``[T]he cooperative members would not benefit from the 
end-user exception if they use their cooperative as the preferred 
vehicle for hedging commercial risks in the greater financial 
marketplace. In light of this, the Commission is exercising its 
authority under Section 4(c) of the CEA to propose  39.6(f) and 
establish the cooperative exemption.'').
    \5\ Id. at 41943-44.
---------------------------------------------------------------------------
    The Farm Credit Council strongly supports the proposed cooperative 
exemption, which has not yet been finalized. Pending the issuance of a 
final rule implementing the cooperative exemption, the CFTC's Division 
of Clearing and Risk has issued several no-action letters stating that 
it will not recommend that the CFTC commence an enforcement action for 
failure to clear a credit default swap or an interest rate swap, 
provided that certain requirements, which are ``essentially the same'' 
as the requirements of the proposed cooperative exemption, are 
satisfied.\6\ The last-issued no-action relief will expire on August 
16, 2013.
---------------------------------------------------------------------------
    \6\ CFTC Letter No. 12-36, Re: Time-Limited No-Action Relief from 
the Clearing Requirement for Swaps Entered Into By Cooperatives (Nov. 
28, 2012), available at http://www.cftc.gov/ucm/groups/public/
@lrlettergeneral/documents/letter/12-36.pdf; CFTC Letter No. 13-24, Re: 
Time-Limited No-Action Relief from the Clearing Requirement for Swaps 
Entered into by Cooperatives (Jun. 7, 2013), available at http://
www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/letter/13-
24.pdf; CFTC Letter No. 13-30, Re: Extension of Time-Limited No-Action 
Relief from the Clearing Requirement for Swaps Entered into by 
Cooperatives (Jun. 21, 2013), available at http://www.cftc.gov/ucm/
groups/public/@lrlettergeneral/documents/letter/13-30.pdf.
---------------------------------------------------------------------------
    It is important for the CFTC to take action to finalize the 
proposed cooperative exemption soon because, under the CFTC's phased 
implementation schedule for compliance with the clearing requirement, 
Farm Credit System institutions will be required to clear interest rate 
swaps when the no-action relief discussed above expires.\7\ As the CFTC 
recognized in proposing the cooperative exemption, mandatory clearing 
will operate to raise the cost of credit for the cooperative members of 
the Farm Credit System--America's farmers, ranchers, and farm-related 
businesses--without reducing systemic risk.
---------------------------------------------------------------------------
    \7\ See Clearing Requirement Determination Under Section 2(h) of 
the CEA, 77 Fed. Reg. 74284, 74289 n. 52, 74320 (Dec. 13, 2012) (to be 
codified at 17 CFR pts. 39 & 50).
---------------------------------------------------------------------------
Application of Margin Requirements to Exempt Cooperatives
    The Farm Credit Council also wants to commend the Committee for its 
continued leadership on the implementation of Dodd-Frank and issues 
facing Farm Credit System institutions. For example, the Committee and 
the House of Representatives recently passed H.R. 634, the Business 
Risk Mitigation and Price Stabilization Act of 2013. H.R. 634 provides, 
among other things, that initial and variation margin requirements 
``shall not apply to a swap in which a counterparty qualifies for . . . 
an exemption issued under section 4(c)(1) from the requirements of 
section 2(h)(1)(A) [the `clearing requirement'] for cooperative 
entities as defined in such exemption.'' \8\ The intent of this 
provision is clear: Margin requirements should not be imposed on Farm 
Credit System institutions, or other qualifying cooperative entities, 
with respect to their uncleared swaps.
---------------------------------------------------------------------------
    \8\ H.R. 634, 113th Cong.  2 (passed the House of Representatives 
June 12, 2013).
---------------------------------------------------------------------------
    The Farm Credit Council strongly supports H.R. 634. The CFTC's 
proposed cooperative clearing exemption would spare cooperative 
entities, like Farm Credit System institutions, the costs of margin 
associated with mandatory clearing. H.R. 634 would similarly spare the 
same entities the costs of margin associated with uncleared swaps. Both 
proposals reflect the sound policy determination that swaps entered 
into by cooperative entities, such as Farm Credit System institutions, 
serve important purposes for members of cooperatives and the larger 
economy, while presenting minimal risk to the U.S. financial system. If 
implemented, both proposals should allow Farm Credit System 
institutions to manage risk by negotiating responsible collateral 
arrangements directly with their swap counterparties.
    Achieving this result depends, however, on the CFTC's final 
implementation of its proposed clearing exemption for cooperatives and 
on the recognition by regulators that Congress intends that margin 
requirements will not be imposed on Farm Credit System institutions. If 
implemented, the CFTC's proposed cooperative exemption would be ``an 
exemption issued under section 4(c)(1) from the requirements of section 
2(h)(1)(A) for cooperative entities'' under H.R. 634. Until the CFTC 
finalizes the exemption, however, the Farm Credit System will not 
secure the relief that H.R. 634 was intended to provide.\9\
---------------------------------------------------------------------------
    \9\ The Farm Credit Council also supports H.R. 2136, the Small 
Business Credit Availability Act, pending before this Committee. By 
excluding a Farm Credit System institution whose aggregate 
uncollateralized outward exposure plus aggregate potential outward 
exposure does not exceed $1 billion from the definition of ``financial 
entity'' in Section 2(h)(7)(C)(ii) of the Commodity Exchange Act, H.R. 
2136 would effectively allow Farm Credit System institutions to qualify 
for the end-user exception to the clearing requirement, under Section 
2(h)(7)(A) of the Commodity Exchange Act, subject to the swap exposure 
threshold. If the Farm Credit System institution qualified for the end-
user exception, H.R. 634 would then operate to prohibit margin 
requirements from being imposed on uncleared swaps entered into by the 
same institution. In conjunction with H.R. 634, H.R. 2136 would make 
clear that margin requirements (imposed either by clearinghouses or by 
regulators on uncleared swaps) should not apply to Farm Credit System 
institutions.
---------------------------------------------------------------------------
    If the CFTC finalizes its proposed cooperative exemption and H.R. 
634 is enacted, H.R. 634 will prohibit the CFTC and the Prudential 
Regulators, including the Farm Credit Administration, from imposing 
margin requirements on cooperative entities under Section 4s(e) of the 
Commodity Exchange Act. This makes sense. Such requirements would 
divert capital otherwise used for loans to farmers, ranchers, and farm-
related businesses into margin payments, diminish the Farm Credit 
System's members' access to credit, and ultimately adversely affect the 
American economy, especially in rural and agricultural communities. The 
Farm Credit Council commends this Committee and the entire House for 
recognizing and addressing this important issue.
    Notwithstanding that the House of Representatives and the CFTC have 
expressed their intent that margin requirements (either associated with 
clearing or with respect to uncleared swaps) should not apply to Farm 
Credit System institutions, the Farm Credit Administration has 
suggested that it has authority--separate from the provisions of the 
Commodity Exchange Act added by Dodd-Frank--to impose ``special'' 
margin requirements on swaps to which a Farm Credit System institution 
is a counterparty.\10\ Pursuant to this authority, the Farm Credit 
Administration has proposed to require Farm Credit System institutions 
to collect initial and variation margin from swap dealer or major swap 
participant (``swap entity'') counterparties.\11\
---------------------------------------------------------------------------
    \10\ See Margin and Capital Requirements for Covered Swap Entities, 
76 Fed. Reg. 27564, 27583 (proposed May 11, 2011) (to be codified at 12 
CFR pt. 624).
    \11\ Id. at 27595 (proposed 12 CFR  624.11).
---------------------------------------------------------------------------
    The Farm Credit Administration's proposal would frustrate the clear 
intent of H.R. 634 and the CFTC's proposed cooperative exemption. The 
requirement to collect margin from swap entity counterparties will, no 
doubt, increase the costs of uncleared swaps. It will likely further 
result in swap entities requiring reciprocal margin obligations from 
Farm Credit System institutions. This result would undo the very relief 
that would be provided by the CFTC's proposed cooperative exemption and 
H.R. 634. The Farm Credit Council believes that this would be contrary 
to the intent of this legislation and the principal regulator charged 
with implementing new derivatives regulation.
          * * * * *
    The Farm Credit Council appreciates the opportunity to submit this 
letter concerning the reauthorization of the CFTC, and thanks the 
Committee for its continued leadership on these important matters.
            Sincerely,
  
            [GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
            
Kenneth E. Auer,
President and CEO,
Farm Credit Council.
                                 ______
                                 
                          Submitted Questions
Response from Scott Cordes, President, CHS Hedging, Inc.; on behalf of 
        National Council of Farmer Cooperatives
Questions Submitted By Hon. K. Michael Conaway, a Representative in 
        Congress from Texas
    Question 1. If the CFTC had published a Dodd-Frank implementation 
timetable and followed it, would that have helped your businesses to 
plan for potential changes in the regulation of the derivatives 
markets?
    Answer. It would have been helpful to have such a timetable, but 
more importantly to have a process that sequenced the rules in a 
logical fashion. Knowing what rules would apply to our company and 
counterparties earlier in the process would have allowed us to focus 
more clearly on preparing for implementation. For instance, as rules 
were being proposed and finalized that would apply to swap dealers, it 
was still unclear as to what transactions, and at what level, would 
determine who would be regulated as swap dealers. The uncertainty from 
that put business plans on hold and customers held back on their risk 
management trading given the uncertainty.

    Question 2. Your testimony notes concerns over market liquidity in 
the over-the-counter derivatives market for hedgers. To date, have you 
seen or experienced any evidence of a lack of liquidity available to 
hedge against risks? What is your plan in the future if you find fewer 
counterparties to hedge your company's risks?
    Answer. Due, in part, to the uncertainly over the regulations, 
we've experienced a general decline of trading in swaps over the past 
three years. In the future, if swaps are not a viable risk management 
option, we would rely on the futures market. However, to the extent the 
futures market did not fit a specific hedging need (or a situation as 
outlined in the next response exists), we would be forced to increase 
our risk exposure, or limit certain business activities.

    Question 3. In your testimony, you state that when a farmer goes to 
lock in a price for his future production of grain or milk by entering 
into a forward contract, someone has to offset that risk in the futures 
market, or potentially with a swap. Obviously, no one would be willing 
to be exposed without hedging their counterparty risk. Can you describe 
what type of financial resources it takes for a local grain elevator to 
hedge its future purchase obligations in the futures market, and how 
have the use of swaps helped ease the financial burdens of hedging 
risks?
    Answer. In recent years, a considerable amount of working capital 
has been tied up to cover daily margin calls as a result of increased 
volatility in grain and oilseed markets. For example, an elevator that 
handles five million bushels of corn in a year may enter into 2,000 
contracts to hedge those purchases. That elevator may have roughly 200 
contracts outstanding at any one time. With initial margin of $2,400 
per contract, $480,000 is required up front. Should the market have a 
limit up move (40/bushel) on a given day, an additional $400,000 is 
needed to cover that hedge. However, most cooperatives operate a number 
of elevators, not just one, so those financial requirements can 
increase significantly. And the need for such resources to hedge 
purchases, particularly during times of market volatility, can put a 
significant strain on working capital.
    Thus, for farmers to continue to take advantage of selling grain 
forward during price rallies, many cooperatives have to either increase 
borrowing or look for alternative ways to manage such risk. Using the 
OTC market has become that alternative because commodity swaps are not 
currently subject to the same margin requirements as contracts on the 
exchanges. For example, in 2008 many grain companies were running out 
of working capital due to extreme volatility in grain prices and 
stopped forward contracting with farmers. CHS was able to enter into 
swaps to free up working capital so that it could continue to contract 
and forward price grain with its members. Today, we continue to use 
swaps to free up working capital so that we can employ it in other 
areas of our business.
Response from Lance Kotschwar, Senior Compliance Attorney, Gavilon 
        Group, LLC; on behalf of Commodity Markets Council
Questions Submitted By Hon. K. Michael Conaway, a Representative in 
        Congress from Texas
    Question 1. If the CFTC had published a Dodd-Frank implementation 
timetable and followed it, would that have helped your businesses to 
plan for potential changes in the regulation of the derivatives 
markets?
    Answer. Yes, that certainly would have been helpful. The haphazard 
finalization of these complex and interconnected rules has created 
extensive confusion for companies that are attempting to comply with a 
new regulatory regime. Couple the lack of any organized approach with 
the flurry of last minute no-action and exemptive relief letters that 
are constantly changing compliance dates and it is nearly impossible to 
feel comfortable that all regulatory obligations are being met.

    Question 2. Do you think the exchanges do a sufficient job of 
setting and policing position limits in the energy markets? Are there 
potential consequences to shutting investment dollars out of the 
derivatives markets?
    Answer. Yes, the exchanges have done a great job in not only 
setting appropriate limits, but also implementing and policing them in 
a sensible way, including how affiliated companies must aggregate 
positions for compliance with the limits. As for the appropriateness 
and/or effectiveness of position limits themselves and the notion of 
placing limits on a class of traders, the government cannot stop 
investor demand for physical commodity exposure. If regulators were to 
limit, for example, an exchange traded fund backed by crude oil 
derivatives in those markets, there is nothing to stop them from 
investing in the underlying physical commodity itself, in this case 
crude oil. These types of entities not only allow these physical market 
investments under their prospectuses, but at times they have shown 
interest in leasing or even owning storage capacity. This is one of 
many factors that must be considered when arbitrarily limiting trading 
activity.

    Question 3. If the CFTC significantly narrows the scope of the bona 
fide hedging exemption from position limits to allow, for example, only 
positions that would be eligible for hedge accounting treatment to 
qualify as a bona fide hedges, how would that impact your business?
    Answer. It would be detrimental. As a commodity merchant, Gavilon 
plays an important role in the physical commodity markets. Most 
agricultural commodities are produced seasonally yet consumed 
continuously, whereas energy commodities are produced continuously and 
consumed seasonally. CMC's members manage that flow of physical 
commodity and dynamically hedge it, which allows us to offer higher 
prices to producers and lower prices to consumers. We look at our net 
exposure to a particular commodity as a combination of physical, 
futures, and swap positions, and we hedge based on that net exposure. 
No one in our business ties a particular derivatives contract to a 
particular bushel of grain or barrel of oil. We are also hedging our 
infrastructure. We have empty grain bins that we know we will fill, 
empty, and refill again. The same is true for oil storage tanks. We are 
constantly looking for a better hedge, a better price, which is why 
these markets are as efficient as they are and we are able to offer the 
favorable forward contracts to farmers that we do. If this dynamic, 
portfolio hedging ability is limited, the result is quite simple: lower 
prices for producers and higher prices for consumers.

    Question 4. It is my understanding that the CFTC already has access 
to your physical positions when you are using a hedge exemption from a 
position limit. Why then, did the Commission finalize a rule that would 
require you to track those positions on a daily basis rather than the 
current monthly requirement?
    Answer. The Commission has the authority to ask us for cash market 
data any time they want it. For an international commodity merchant 
moving grain 24 hours a day, this is an impossible task to achieve on a 
daily basis. If the Commission has questions or concerns with a 
commercial company's ability to justify a hedge exemption, all they 
have to do is ask for more information and they will get it. Daily 
physical position reporting would be an enormous waste of resources for 
commercial end-users, if compliance is even possible at all. Equally as 
important, it is more data than the Commission can process while 
providing little regulatory gain, and therefore a waste of resources 
for them as well.
Response from Richard F. McMahon, Jr., Vice President of Energy Supply 
        and Finance, Edison Electric Institute
Questions Submitted By Hon. K. Michael Conaway, a Representative in 
        Congress from Texas
    Question 1. If the CFTC had published a Dodd-Frank implementation 
timetable and followed it, would that have helped your businesses to 
plan for potential changes in the regulation of the derivatives 
markets?
    Answer. Yes--certainty in the process with a realistic timetable 
for implementation would have helped EEI members during the rulemaking 
and implementation process as EEI members enter into long-term 
commodity contracts, and regulatory certainty is needed. The rulemaking 
process used by the Commission did not provide certainty as to process 
or outcome. For example, key terms, such as the definition of swap, 
were not defined until the end of the rulemaking process. Starting with 
definitions and then moving on to other issues would have allowed EEI 
members to focus on the issues impacting commercial end-users rather 
than focusing on all the issues at once.
    Additionally, a defined rulemaking and rehearing process would have 
promoted certainty in the process. Instead, EEI members were forced to 
rely on Interim Rules and last-minute no-action letters, further 
increasing uncertainty and costs. Unfortunately, there is still lack of 
certainty to the process, and EEI members do not know if or when the 
Commission will respond to comments submitted on interim final rules. 
For example, EEI members began reporting swap transactions to the 
Commission on August 19 but, from July 2010 to the present, have spent 
on average over $1 million per company on hardware, software and 
consulting costs to implement the Commission's recordkeeping and 
reporting rules. Uncertainty still persists as to some of the 
requirements, and different swap data repositories require different 
information to be provided so it is likely that EEI members will 
continue to make system changes going forward, leading to additional 
costs.

    Question 2. How have your members been impacted by the CFTC 
deciding to regulate forward contracts with imbedded ``volumetric 
optionality'' as swaps? What are the future consequences of this 
regulatory over-reach if the CFTC does not change its regulations?
    Answer. Any uncertainty in definitions and implementation increases 
transaction costs for members and ultimately for consumers. In response 
to the Commission request for comment on the seven-factor test for 
imbedded volumetric optionality, EEI and others commented that the test 
was unclear and requested changes. Although the Commission stated that 
it ``would benefit from public comment about [this] interpretation,'' 
to date, the CFTC has not responded to our members' comments. The 
Commission's interpretation is overly narrow, difficult to understand 
and potentially classifies numerous common types of physical forward 
transactions as swaps or trade options. The CFTC's interpretation may 
result in EEI members modifying the structure of some forward contracts 
with volumetric variability or flexibility in ways that are less 
efficient, increase transaction costs and/or create additional risk.
    In addition, due to the lack of clarity in the application of the 
test, there is uncertainty concerning the status of many transactions 
with volumetric optionality. It is possible that, under the test, 
counterparties to a transaction will view the same transaction 
differently, with some viewing it as a forward, some as a trade option 
and some as a swap. These differences all affect recordkeeping, 
reporting and other requirements. The cleanest solution would be for 
the Commission to recognize congressional intent and classify these 
transactions as exempt forwards because the transaction involves the 
sale of a non-financial commodity for deferred delivery that is 
intended to be physically settled. At a minimum, the Commission should 
provide clarification as requested in the filed comments as any 
uncertainty increases costs and decreases the likelihood of end-users 
entering into those transactions.

    Question 3. It appears as though the CFTC, because of the way they 
defined ``swap'', may actually end up subjecting physical forward 
contracts to position limits. What kind of consequences would this have 
for your members?
    Answer. The Commission's vacated Position Limits rule established 
28 referenced contracts--four of which were energy contracts, including 
NYMEX Henry Hub contracts--for position limits. The Dodd-Frank Act 
requires the CFTC to exempt bona fide hedging transactions and 
positions from all position limits. The Commission narrowly defined 
bona fide hedging transactions to eight enumerated transactions unless 
the CFTC gave specific approval to a particular form of transaction. 
The bona fide hedge exemption from position limits is necessary to 
allow end-users of physical commodities to properly hedge their 
commercial risk. However, we fear that the CFTC's limitation of bona 
fide hedges to enumerated transaction types is overly limiting and runs 
counter to Congressional intent to exempt the hedging transactions of 
commercial end-users. A narrow or formula-based definition of what 
constitutes bona fide hedging will place significant limitations on 
many end-users' ability to hedge risk properly and efficiently.
    Further, the Commission's definition of ``swap'' would subject some 
types of physical transactions to position limits, including physical 
forward transactions with volumetric optionality and physical commodity 
options. Examples that are particularly troubling are power 
transactions with volumetric optionality or power transactions 
structured ``heat rate call options'' that are priced using a formula 
that references NYMEX Henry Hub natural gas prices. These transactions 
are for the physical delivery of electricity and the pricing formula 
based upon natural gas prices acts as an embedded hedge to help ensure 
that electric utilities can meet their variable power needs at 
reasonable prices. These transactions are not for the purpose of 
speculating on commodity prices and are not even natural gas 
transactions; but, since they reference NYMEX Henry Hub natural gas 
prices, these physical power transactions would be subject to natural 
gas position limits. Physical transactions with embedded volumetric 
optionality and physical commodity options should not be subject to 
position limits.
Question Submitted By Hon. Doug LaMalfa, a Representative in Congress 
        from California
    Question. Some have suggested that the way to ``fix'' the special 
entity sub-threshold is for the CFTC to lower the de minimis 
registration threshold for the entire energy swaps marketplace to $25 
million. What damage would be done to end-users, consumers, and the 
marketplace by lowering the registration threshold for all energy swaps 
to $25 million?
    Answer. The likely end effect of lowering the threshold for all 
participants to $25 million would either be that (1) almost all users 
of swaps would be classified as swaps dealers, which would subject 
commercial end-users in the energy industry to bank-like regulation, 
including onerous capital and margin requirements, the inability to use 
the end-user clearing exception, and costly and burdensome 
recordkeeping and reporting requirements, or (2) entities would be 
forced to hedge only with banks or through physical forward 
transactions, which will expose hedgers to more risk and higher 
transaction costs. The end result of either option will be increased 
rates for customers. The Commission's rule states that an entity's swap 
dealing activity over the prior 12 months is capped at a gross notional 
value of $8 billion. An entity's aggregate effective notional amount of 
swap dealing reflects both the gross volume of swap activity that the 
entity engages in, and the relative monetary value of that activity, 
which reflects the volatile and non-fixed nature of the commodity 
price. This is different from the notional amount of a swap referencing 
a financial index (e.g., an interest rate swap) which is a set notional 
amount irrespective of whether the swap is 1 month or 20 years. Thus, a 
single relatively small swap contract could exceed the threshold amount 
of $25 million notional value. For example, a single 3 year 50 MW swap 
or a single 3 year 10,000 mmBtu/day swap would likely have a gross 
notional value well in excess of $25 million, based on projected prices 
from the PJM Interconnection, LLC, and Henry Hub. As a result, if the 
de minimis level is reduced to $25 million, one transaction could cause 
an EEI member to be classified as a swap dealer and subject to 
additional registration, capital & margin and reporting requirements. 
The volatility of commodity costs and the large amount of the 
transactions in the energy markets necessitates a higher de minimis 
level to accommodate the volatility in commodity prices and the need to 
accommodate customer usage levels. For these reasons, lowering the de 
minimis registration threshold for the entire energy swaps marketplace 
to $25 million would undermine Congressional intent to exempt 
commercial end-users from the burdensome requirements placed on swap 
dealers, resulting in higher costs of hedging and increased volatility 
for electric utilities and our customers.
Response from Chris Monroe, Treasurer, Southwest Airlines Co.
Questions Submitted By Hon. K. Michael Conaway, a Representative in 
        Congress from Texas
    Question 1. If the CFTC had published a Dodd-Frank implementation 
timetable and followed it, would that have helped your businesses to 
plan for potential changes in the regulation of the derivatives 
markets?
    Answer. Yes. A published implementation timetable that had been 
adhered to would have helped our businesses, as well as the Commission, 
allocate time and resources by focusing on regulatory matters in order 
of their consideration. Additionally we believe that certainty in 
timing likely would have reduced market participants' expenses 
associated with preparation for compliance.

    Question 2. What can Congress do to prevent the prudential banking 
regulators from implementing rules to require commercial end-users to 
post margin while prohibiting the use of non-cash collateral as margin? 
Does H.R. 634 provide the appropriate relief?
    Answer. H.R. 634 provides an exemption for end-users from posting 
margin on uncleared trades and would satisfy Southwest's need for 
relief in terms of margin. It is important to Southwest and other end-
users that any margin that is required to be posted be allowed in the 
form of non-cash collateral, which would allow commercial end-users to 
post as margin the assets that they most frequently hold. Use of non-
cash assets as collateral allows end-users to have much more dynamic 
hedging programs. Southwest takes hedging very seriously not only 
because it is the responsible thing to do given the significant use of 
fuel in our business, but because it is a direct contributor to lower 
costs for our company. Hedging has been a good story for Southwest. 
Lower costs paid for a commodity our company must have in order to 
operate has generally led to healthier, more predictable business, and 
most importantly, lower fares for our customers.
Response from Gene A. Guilford, National & Regional Policy Counsel, 
        Connecticut Energy Marketers Association; on behalf of 
        Commodity Markets Oversight Coalition *
---------------------------------------------------------------------------
    * There was no response from the witness by the time this hearing 
went to press.
---------------------------------------------------------------------------
Questions Submitted By Hon. K. Michael Conaway, a Representative in 
        Congress from Texas
    Question. If the CFTC had published a Dodd-Frank implementation 
timetable and followed it, would that have helped your businesses to 
plan for potential changes in the regulation of the derivatives 
markets?
Response from Andrew K. Soto, Senior Managing Counsel, Regulatory 
        Affairs, American Gas Association
August 28, 2013

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

RE: The Future of the CFTC: End-User Perspectives--Supplemental 
            Questions for the Record

    Dear Chairman Conaway:

    On behalf of the American Gas Association (AGA), I am pleased to 
submit the following responses to the supplemental questions for the 
record regarding my testimony given during the July 24, 2013 public 
hearing of the Subcommittee on General Farm Commodities and Risk 
Management on The Future of the CFTC: End-User Perspectives.
Questions Submitted By Hon. K. Michael Conaway, a Representative in 
        Congress from Texas
    Question 1. If the CFTC had published a Dodd-Frank implementation 
timetable and followed it, would that have helped your businesses to 
plan for potential changes in the regulation of the derivatives 
markets?
    Answer. Yes. As I noted in my testimony, AGA has worked 
cooperatively with the Commodity Futures Trading Commission (CFTC) and 
its staff throughout the rulemaking process to implement the Dodd-Frank 
Wall Street Reform and Consumer Protection Act. We appreciate the 
magnitude and difficulty of the task that faced the CFTC following 
passage of the Act. Nonetheless, if the CFTC had published an 
implementation timetable and followed it, it would have benefitted the 
compliance planning efforts of large end-users such as AGA's member gas 
distribution utilities. In addition, a better sequencing of the CFTC's 
rulemakings would have also been beneficial for compliance planning. 
For example, in our June 3, 2011 comment letter to the CFTC, AGA argued 
that any sequencing of the final rules must begin with the foundational 
definitions of ``swap,'' ``swap dealer,'' and ``major swap 
participant.'' AGA noted in that letter that industry participants need 
to understand whether and to what extent their activities would be 
regulated before they can assess how those activities should be 
regulated. AGA also noted that industry participants need to understand 
whether their activities would be regulated by the CFTC or the Federal 
Energy Regulatory Commission, and urged the CFTC to complete the 
negotiation of the Congressionally mandated Memorandum of Understanding 
with the FERC defining the respective jurisdictions of both agencies. 
As it turned out, the CFTC has only issued an interim final rule 
defining ``swap'' near the end of rulemaking process, and comments 
regarding the definition remain unanswered. Moreover, the CFTC has yet 
to complete negotiations with the FERC regarding jurisdiction.
    Apart from an implementation timetable, business planning requires 
definitive rules clearly setting out the compliance obligations of 
industry participants. AGA believes that the CFTC's rulemaking process 
needs to be strengthened to provide better avenues for the public to 
obtain timely, definitive guidance from the Commission in the form of 
final agency action on the regulatory obligations implementing the 
Dodd-Frank Act. In particular, the public should have a meaningful 
opportunity to comment on the agency's proposals, and the agency should 
consider all relevant comments in fashioning final rules that are well-
reasoned and supported by the record--not interim final rules, and not 
promises to consider issues later which have led to indefinite 
postponements. We are simply asking the agency to adhere to the 
fundamental requirements of the Administrative Procedure Act.

    Question 2. Can you explain why large, end-users such as gas 
utilities, are having a hard time complying with the CFTC's new rules? 
Why is the ``end-user'' exemption from clearing not enough?
    Answer. Large end-users such as AGA's member gas utilities are 
certainly used to regulation. As public utility companies, many aspects 
of their businesses are subject to a variety of regulatory regimes at 
both the state and federal level. The rates they charge for service are 
regulated at the state level by a public utility commission or other 
regulatory body, and their participation in the wholesale natural gas 
markets is regulated by the Federal Energy Regulatory Commission. As a 
result, gas utilities work hard to develop business operations and 
systems to ensure compliance with all applicable Federal, state and 
local regulations and take these compliance measures very seriously. 
Compliance, however, requires certainty. Companies need clear and 
definitive rules in order to understand their compliance obligations 
and develop plans to meet those obligations. That certainty has been 
lacking with regard to many of the CFTC's regulations implementing the 
Dodd-Frank Act.
    The area of uncertainty that has had the most material impact on 
AGA members relates to the CFTC's rulemaking defining ``swap.'' Gas 
utilities are currently entering into what have been traditionally 
considered to be normal commercial merchandising transactions to 
procure natural gas supplies to meet the peak winter time needs of 
their customers. AGA believes that these transactions are excluded from 
the CFTC's definition of a ``swap'' and thus not subject to regulation. 
As I noted during the hearing, however, there is tremendous 
disagreement in the industry as to how these contracts, all of which 
are settled by physical delivery of a commodity, should be treated, 
which has disrupted normal contracting practices. Instead of providing 
clarity for any contract that is intended to settle via physical 
delivery, the CFTC's rules require market participants to apply 
subjective and difficult to understand multi-part tests to these 
transactions to determine whether they fall under the CFTC's definition 
of a ``swap.'' Until the CFTC provides definitive rules clarifying the 
regulatory treatment of these physical commodity transactions, the 
turmoil in the industry will continue. Furthermore, the differing 
interpretations and understandings of the CFTC's ``swap'' definition 
will continue to lead to inconsistent reporting of swap transactions to 
swap data repositories and to the CFTC, thus making the CFTC a less 
effective market monitor and regulator.
    The end-user exemption does indeed lessen the overall financial 
burden, but it does not broadly exempt end-users from the CFTC's 
regulation of the swaps markets. It only applies to the requirement to 
clear swaps on an exchange or other trading platform. Even as to 
uncleared swaps, there are still outstanding rulemakings by the CFTC 
and banking regulators as to the requirement to post margin or retain 
capital for such transactions. Thus, the end-user exemption is fairly 
narrow.
    Further, end-users such as gas utilities are subject to the same 
recordkeeping and reporting requirements associated with their swap 
transactions that are not cleared. End-users are reporting or preparing 
to report uncleared commodity swaps and physical commodity transactions 
that might be considered ``swaps'' under the CFTC's interim final rule 
to swap data repositories. End-users are making significant resource 
investments to properly capture and report their swap transaction data, 
and paying monthly fees to the swap data repositories to ensure that 
their transactions are accurately reported. Even where end-users are 
not designated as ``reporting parties'' under the CFTC's rules, they 
are required to confirm and verify the uncleared swap transaction data 
that is reported on their behalf. Thus, gas utilities must not only 
come to an agreement with their counterparties on what is a reportable 
transaction, they must also verify and confirm that the swap 
transaction data that is reported accurately records the economic terms 
of the transactions. It is in this area that gas utilities and their 
counterparties are trying to sort out their compliance obligations, and 
the area in which current industry confusion and disagreement are 
having the greatest impact.

    Question 3. What kind of internal processes surrounding 
roundtables, ``no action'' letters, and staff guidance would you like 
the CFTC to develop to improve their function as a major market 
regulator?
    Answer. As noted above, AGA believes that the CFTC's rulemaking 
process needs to be strengthened to provide better avenues for the 
public to obtain timely, definitive guidance from the Commission in the 
form of final agency action on the regulatory obligations implementing 
the Dodd-Frank Act. While the CFTC's current regulations provide an 
opportunity to petition for a rule or modification of a rule (CFTC Rule 
13.2), under the regulations there is no obligation on the part of the 
agency to act on such a petition, nor to act within a particular period 
of time. AGA recommends that the CFTC consider a commitment to act on 
petitions for rulemaking or on comments filed in on-going rulemaking 
proceedings within a particular period of time. AGA believes that 
having a defined, workable process for obtaining agency guidance in the 
form of clear, final rules will lessen the need for the industry to 
seek exemptive, or ``no-action'' relief from staff in order to obtain 
the necessary clarifications of the CFTC's rules.
    Further, in April 2013, AGA joined CFTC Commissioner Bart Chilton 
in encouraging the CFTC to develop an End-User Bill of Rights, focused 
on providing reasonable and timely implementation of the Dodd-Frank Act 
as applied to end-users. In particular, Commissioner Chilton called for 
the CFTC to create a venue for end-users to air their concerns, to hold 
regular meetings with end-users, and perhaps establish an End-User 
Advisory Committee. AGA would support all of these proposals. In 
particular, AGA would like to see the CFTC host public roundtables 
focused on implementation challenges for end-users in the energy 
industry, providing sufficient public notice (at least 30 days) in 
order to give the public an opportunity to participate. The CFTC could 
use its authority in section 751 of the Dodd-Frank Act, to have the 
Energy and Environmental Markets Advisory Committee examine end-user 
issues. Alternatively, the CFTC could charter a standing committee 
under the Federal Advisory Committee Act. In addition, AGA would like 
the CFTC to provide public notice on its website or through press 
releases, that a specific division of CFTC staff intends to answer, or 
not answer, requests for no-action relief, interpretative guidance or 
exemptive relief requested by market participants. Currently, market 
participants are unable to track what public filings seeking relief 
have been received by various divisions within the agency, whether and 
when the agency intends to respond to these filings, and which division 
plans to respond.
Question Submitted By Hon. Doug LaMalfa, a Representative in Congress 
        from California
    Question. Some have suggested that the way to ``fix'' the special 
entity sub-threshold is for the CFTC to lower the de minimis 
registration threshold for the entire energy swaps marketplace to $25 
million. What damage would be done to end-users, consumers, and the 
marketplace by lowering the registration threshold for all energy swaps 
to $25 million?
    Answer. On June 7, 2013, AGA joined several other energy trade 
associations in urging CFTC Chairman Gensler not to lower the de 
minimis registration threshold for swap dealers. The associations noted 
that because swap dealers are subject to costly regulatory 
requirements, lowering the de minimis threshold would subject more 
market participants to such requirements and thus increase the costs 
associated with using swaps to hedge and mitigate commercial risk. For 
gas utilities, such cost increases must be borne by the customer, or 
the customer is left exposed to greater price volatility if the gas 
utility chooses to forego entering into swaps to hedge risk. More 
significantly, subjecting additional market participants to the swap 
dealer requirements may result in a reduction in the number of market 
participants willing to engage in swap dealing activity. Fewer swap 
dealers may result in decreased competition, leading to higher costs 
and/or less efficient hedging products, and potentially a greater 
concentration of swap transactions in systemically risky financial 
institutions. Increased transaction costs, decreased competition, and 
less liquidity can all result in consumers paying more.
            Respectfully submitted,

Andrew K. Soto,
Senior Managing Counsel, Regulatory Affairs,
American Gas Association.

                                  
