[House Hearing, 114 Congress]
[From the U.S. Government Publishing Office]


    HEARING TO REVIEW THE IMPACT OF G20 CLEARING AND TRADE EXECUTION
                              REQUIREMENTS

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

                                HEARING

                               BEFORE THE

        SUBCOMMITTEE ON COMMODITY EXCHANGES, ENERGY, AND CREDIT

                                 OF THE

                        COMMITTEE ON AGRICULTURE
                        HOUSE OF REPRESENTATIVES

                    ONE HUNDRED FOURTEENTH CONGRESS

                             SECOND SESSION

                               __________

                             JUNE 14, 2016

                               __________

                           Serial No. 114-53
                           
                           
[GRAPHIC NOT AVAILABLE IN TIFF FORMAT]                           


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


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                        COMMITTEE ON AGRICULTURE

                  K. MICHAEL CONAWAY, Texas, Chairman

RANDY NEUGEBAUER, Texas,             COLLIN C. PETERSON, Minnesota, 
    Vice Chairman                    Ranking Minority Member
BOB GOODLATTE, Virginia              DAVID SCOTT, Georgia
FRANK D. LUCAS, Oklahoma             JIM COSTA, California
STEVE KING, Iowa                     TIMOTHY J. WALZ, Minnesota
MIKE ROGERS, Alabama                 MARCIA L. FUDGE, Ohio
GLENN THOMPSON, Pennsylvania         JAMES P. McGOVERN, Massachusetts
BOB GIBBS, Ohio                      SUZAN K. DelBENE, Washington
AUSTIN SCOTT, Georgia                FILEMON VELA, Texas
ERIC A. ``RICK'' CRAWFORD, Arkansas  MICHELLE LUJAN GRISHAM, New Mexico
SCOTT DesJARLAIS, Tennessee          ANN M. KUSTER, New Hampshire
CHRISTOPHER P. GIBSON, New York      RICHARD M. NOLAN, Minnesota
VICKY HARTZLER, Missouri             CHERI BUSTOS, Illinois
DAN BENISHEK, Michigan               SEAN PATRICK MALONEY, New York
JEFF DENHAM, California              ANN KIRKPATRICK, Arizona
DOUG LaMALFA, California             PETE AGUILAR, California
RODNEY DAVIS, Illinois               STACEY E. PLASKETT, Virgin Islands
TED S. YOHO, Florida                 ALMA S. ADAMS, North Carolina
JACKIE WALORSKI, Indiana             GWEN GRAHAM, Florida
RICK W. ALLEN, Georgia               BRAD ASHFORD, Nebraska
MIKE BOST, Illinois
DAVID ROUZER, North Carolina
RALPH LEE ABRAHAM, Louisiana
JOHN R. MOOLENAAR, Michigan
DAN NEWHOUSE, Washington
TRENT KELLY, Mississippi

                                 ______

                    Scott C. Graves, Staff Director

                Robert L. Larew, Minority Staff Director

                                 ______

        Subcommittee on Commodity Exchanges, Energy, and Credit

                    AUSTIN SCOTT, Georgia, Chairman

BOB GOODLATTE, Virginia              DAVID SCOTT, Georgia, Ranking 
FRANK D. LUCAS, Oklahoma             Minority Member
RANDY NEUGEBAUER, Texas              FILEMON VELA, Texas
MIKE ROGERS, Alabama                 SEAN PATRICK MALONEY, New York
DOUG LaMALFA, California             ANN KIRKPATRICK, Arizona
RODNEY DAVIS, Illinois               PETE AGUILAR, California
TRENT KELLY, Mississippi

                                  (ii)
                             
                             
                             C O N T E N T S

                              ----------                              
                                                                   Page
Conaway, Hon. K. Michael, a Representative in Congress from 
  Texas, opening statement.......................................    73
Peterson, Hon. Collin C., a Representative in Congress from 
  Minnesota, opening statement...................................     5
Scott, Hon. Austin, a Representative in Congress from Georgia, 
  opening statement..............................................     1
    Prepared statement...........................................     2
Scott, Hon. David, a Representative in Congress from Georgia, 
  opening statement..............................................     3

                               Witnesses

Duffy, Hon. Terrence A., Executive Chairman and President, CME 
  Group Inc., Chicago, IL........................................     5
    Prepared statement...........................................     7
    Submitted questions..........................................    79
Edmonds, Christopher S., Senior Vice President, Financial 
  Markets, Intercontinental Exchange, Inc., Chicago, IL..........     9
    Prepared statement...........................................    11
    Submitted questions..........................................    80
Rosenberg, Marnie J., Global Head, Clearinghouse Risk and 
  Strategy, JPMorgan Chase & Co., New York, NY...................    13
    Prepared statement...........................................    15
    Submitted questions..........................................    80
Merkel, J.D., Stephen M., Executive Vice President, General 
  Counsel and Secretary, BGC Partners, Inc.; Director, Wholesale 
  Markets Brokers' Association, Americas, New York, NY...........    25
    Prepared statement...........................................    27
    Submitted questions..........................................    82
Berger, Stephen John, Director, Government and Regulatory Policy, 
  Citadel, LLC, New York, NY; on behalf of Managed Funds 
  Association....................................................    45
    Prepared statement...........................................    46
    Submitted questions..........................................    84
Zubrod, Luke D., Director, Risk and Regulatory Advisory Services, 
  Chatham Financial, Kenneth Square, PA..........................    57
    Prepared statement...........................................    59
    Submitted questions..........................................    87

 
    HEARING TO REVIEW THE IMPACT OF G20 CLEARING AND TRADE EXECUTION
                              REQUIREMENTS

                              ----------                              


                         TUESDAY, JUNE 14, 2016

                  House of Representatives,
   Subcommittee on Commodity Exchanges, Energy, and Credit,
                                  Committee on Agriculture,
                                                   Washington, D.C.
    The Subcommittee met, pursuant to call, at 10:00 a.m., in 
Room 1300 of the Longworth House Office Building, Hon. Austin 
Scott of Georgia [Chairman of the Subcommittee] presiding.
    Members present: Representatives Austin Scott of Georgia, 
Lucas, Neugebauer, Rogers, LaMalfa, Davis, Kelly, Conaway (ex 
officio), David Scott of Georgia, Vela, Kirkpatrick, Aguilar, 
and Peterson (ex officio).
    Staff present: Caleb Crosswhite, Darryl Blakey, Kevin Webb, 
Paul Balzano, Stephanie Addison, Faisal Siddiqui, John Konya, 
Liz Friedlander, Matthew MacKenzie, Nicole Scott, and Carly 
Reedholm.

 STATEMENT OF HON. AUSTIN SCOTT, A REPRESENTATIVE IN CONGRESS 
                   FROM THE STATE OF GEORGIA

    The Chairman. Good morning. This hearing of the Committee 
on Agriculture, to review the impact of G20 clearing and trade 
execution requirements, will come to order.
    Good morning. Thank you for joining the Commodity 
Exchanges, Energy, and Credit Subcommittee for our last 
installment of our three-part hearing series examining the 
implementation of the derivatives market reforms envisioned by 
world leaders following the 2008 global financial crisis. 
Today, we will wrap up the series with a focus on clearing and 
trade execution requirements.
    Throughout this series, we have reiterated many times that 
our goal is not an indictment of the reform objectives, but 
rather an analysis of its implementation by United States 
regulators and the interaction of the U.S. regulatory regime 
with that of other global jurisdictions. A vibrant and 
resilient derivatives marketplace is crucial for the market 
participants and end-users who rely on it to manage their 
diverse business risks. It is also critical for the consumers, 
Americans in the Eighth District of Georgia and across the 
nation, who rely on the price stability afforded by these risk 
management practices.
    Crucially, the global nature of this marketplace cannot be 
taken for granted. Regulations must not unnecessarily fragment 
the market, defining liquidity pools by borders instead of 
market needs. We have already had many conversations on cross-
border equivalence and recognition in the clearing space.
    While we are encouraged by recent steps toward U.S.-EU 
regulatory harmonization of clearinghouses, applications to 
European Securities and Market Authority for U.S. 
clearinghouses to be recognized remain outstanding with a 
quickly approaching deadline. I am told this will be done soon, 
but this process has taken far too long.
    Equivalence recognition and substituted compliance 
decisions must be resolved more quickly. Regulators need to be 
working now to prevent similar protracted negotiations for 
trade execution facilities in the future.
    We are glad to have witnesses before us today who can 
expound on the changes to the clearing ecosystem. While 
transaction clearing has long played a role in the marketplace, 
Dodd-Frank swaps clearing mandate has significantly expanded 
the volume of cleared transactions. I am sure that the insights 
and perspectives offered today will be vital as we think 
through the related implications of resilience and recovery of 
clearinghouses in times of market stress. Many questions have 
been raised about the workability of the CFTC's trade execution 
rules. Do they accurately reflect Congressional intent, and 
sufficiently take into account the intricacies of the 
marketplace they regulate, do they restrict market access for 
the end-users who need to meet specific and custom hedging 
needs, and perhaps most importantly, do they impose arbitrary 
barriers to trading that diminishes liquidity? We look forward 
to exploring these and other issues more deeply today.
    In developing their market reform framework, G20 leaders 
were clear about the need for global regulators to collaborate 
and coordinate on these rules. They saw consistent 
implementation of reforms as preventing regulatory arbitrage, 
protecting financial stability, and promoting competition and 
innovation. This too is the standard by which we measure our 
regulatory progress.
    With that, I want to welcome our panel of accomplished 
witnesses who bring their diverse viewpoints on clearing and 
trade execution. Thank you each for the time and effort you put 
into being here today. We look forward to leaving here with a 
deeper understanding of the issues at hand.
    [The prepared statement of Mr. Austin Scott follows:]

 Prepared Statement of Hon. Austin Scott, a Representative in Congress 
                              from Georgia
    Good morning. Thank you for joining the Commodity Exchanges, 
Energy, and Credit Subcommittee for our last installment of our three-
part hearing series examining the implementation of the derivatives 
market reforms envisioned by world leaders following the 2008 global 
financial crisis. Today, we will wrap up the series with a focus on 
clearing and trade execution requirements.
    Throughout this series, we've reiterated many times that our goal 
is not an indictment of the reform objectives, but rather an analysis 
of their implementation by United States regulators and the interaction 
of the U.S. regulatory regime with that of other global jurisdictions.
    A vibrant and resilient derivatives marketplace is crucial for the 
market participants and end-users who rely on it to manage their 
diverse business risks. It is also critical for the consumers, 
Americans in the Eighth District of Georgia and across the nation, who 
rely on the price stability afforded by these risk management 
practices.
    Crucially, the global nature of this marketplace cannot be taken 
for granted. Regulations must not unnecessarily fragment the market, 
defining liquidity pools by borders instead of market needs. We have 
already had many conversations on cross-border equivalence and 
recognition in the clearing space.
    While we are encouraged by recent steps toward U.S.-EU regulatory 
harmonization for clearinghouses, applications to the European 
Securities and Markets Authority for U.S. clearinghouses to be 
recognized remain outstanding with a quickly approaching deadline. I'm 
told this will be done soon, but this process has taken far too long. 
Equivalence, recognition, and substituted compliance decisions must be 
resolved more quickly. Regulators need to be working now to prevent 
similar protracted negotiations for trade execution facilities in the 
future.
    We are glad to have witnesses before us today who can expound on 
the changes to the clearing ecosystem. While transaction clearing has 
long played a role in the marketplace, Dodd-Frank's swaps clearing 
mandate has significantly expanded the volume of cleared transactions.
    I'm sure that the insights and perspectives offered today will be 
vital as we think through the related implications for resilience and 
recovery of clearinghouses in times of market stress.
    Many questions have been raised about the workability of the CFTC's 
trade execution rules.

   Do they accurately reflect Congressional intent and 
        sufficiently take into account the intricacies of the 
        marketplace they regulate?

   Do they restrict market access for the end-users who need to 
        meet specific and custom hedging needs?

   And perhaps most importantly, do they impose arbitrary 
        barriers to trading that diminishes liquidity? We look forward 
        to exploring these and other issues more deeply today.

    In developing their market reform framework, G20 leaders were clear 
about the need for global regulators to collaborate and coordinate on 
these rules. They saw consistent implementation of reforms as 
preventing regulatory arbitrage, protecting financial stability, and 
promoting competition and innovation. This, too, is the standard by 
which we measure our regulatory progress.
    With that, I want to welcome our panel of accomplished witnesses 
who bring their diverse viewpoints on clearing and trade execution.
    Thank you each for the time and effort you put into being here 
today. We look forward to leaving here with a deeper understanding of 
the issues at hand.
    I'll recognize our Ranking Member, Mr. Scott, for any remarks he'd 
like to make.

    The Chairman. And I will recognize our Ranking Member, Mr. 
Scott, for any remarks he would like to make.

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

    Mr. David Scott of Georgia. Thank you, Chairman Scott. It 
is a pleasure to be here. This is indeed an important and very 
timely hearing.
    As we know, the derivatives and swaps market that we are 
dealing with is an $600+ trillion piece of the world's economy. 
It is very complex, complicated, and oftentimes all too 
confusing. So I thought we might give just a little background 
to sort of set the stage for how we got here.
    As you all remember, after the financial crisis the 
derivatives markets were dramatically transformed by Title VII 
in the Dodd-Frank Act. And Title VII falls directly under the 
purview of this Committee. It is a section relating to 
derivatives, the large swaths of CFTC and SEC mandates. These 
are our regulators in this area. And one of our major concerns 
is to make sure that our two regulatory agencies themselves can 
harmonize and make sure, and that is a very important mandate 
for our Committee to make sure of. This included rulemakings 
pertaining to clearing, trade executions, reporting, and 
transparency obligations.
    Then we come back a little earlier in 2009, the G20 
proposed reforms to the derivatives markets with a particular 
emphasis on making sure a global standard is met so that 
harmonization in our rules could be met. The United States' 
response to this G20 summit was Dodd-Frank, while other 
countries have implemented their own laws with varying 
timelines, which creates another problem. This mismatch in 
timing has led to a slew of equivalency problems, none greater 
than what is happening in the European Union. For example, the 
EU will soon implement a rule that is not, and could not be as 
strong as the United States' rule. And given the global nature 
of our world's derivatives markets, equivalency problems have 
led to many market participants going from one place to 
another.
    And so on Tuesday, May 24, the CFTC issued a final rule 
that applies to the Commission's margin requirements for 
uncleared swaps in the context of cross-border transactions. 
This rule would limit the ability of banks and other traders to 
move swaps businesses abroad to avoid U.S. trading 
requirements. And this is something we need to hear from you, 
how it impacts our industry. The rule requires that offshore 
units of U.S. banks adhere to CFTC margin rules, even in cases 
where the unit's American parents aren't explicitly off the 
hook for trades.
    Now, just to refresh your memory, swaps did get a bad name 
during the financial crisis because of a certain swap called 
the credit default swap. It is a key over-the-counter 
derivative. During that crisis, if you recall, AIG issued a 
huge amount of CDS contracts, paying out similar to an 
insurance contract, when collateralized debt obligations 
collapsed. This was hugely speculative, and has since been 
corrected because a version of it has been targeted by U.S. 
policymakers for greater oversight and transparency because 
they played a central role in the financial crisis.
    So we come to December 2015. Now, CFTC finalized rules to 
set collateral or margin requirements on trade between swap 
dealers and other firms that aren't done through 
clearinghouses. This is what is referred to as uncleared swaps, 
and makes a multi-trillion dollar swaps market that isn't 
backed by a central clearinghouse. However, this December 25 
rule did not set guidelines for cross-border swaps. As written, 
the swaps were guaranteed by the foreign counterparty, the 
swaps were exempt from U.S. margin requirements, and because of 
this, U.S. banks have been restructuring their contracts to de-
guarantee these swap transactions, and any liability for these 
swaps would then lie solely with the offshore operation. Now, 
most of this was moved to London.
    And so now, we are in a situation where we want to hear 
from you pertaining to this rule, and to share with this 
Committee concerns that you in the industry have. Regardless of 
what we do here, it is you, it is the clearinghouses, it is the 
market participants who have to make all of this work.
    So, Mr. Chairman, I look forward to a good hearing, an 
important and timely hearing, and thank you for the time.
    The Chairman. Thank you, Mr. Scott. And I understand Mr. 
Peterson, the Ranking Member of the full Committee, has a 
statement that he would like to be recognized to make.

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

    Mr. Peterson. Thank you, Mr. Chairman. And I will be brief. 
And I want to thank the panel of witnesses for joining us 
today.
    When we wrote Title VII of Dodd-Frank, we incorporated 
goals set by the G20 in response to the market's failure. We 
also took into account the risks posed by an opaque, top-heavy 
swaps market. We required standardized swaps to be cleared and 
to be traded in an environment, with multiple market 
participants making both bids and offers. That clearing 
requirement has now been met and we have brought stability to 
the market.
    I am looking forward to discussing the trade execution 
issue today because I don't believe we have achieved the goal 
that we set in Dodd-Frank in terms of the way that swaps are 
traded. Not much has changed. In some ways, the marketplace is 
worse now than it was before the crisis. The four largest 
dealers control 90 percent of all the swaps traded. The pre-
crisis market structure, where they served clients in one 
market, and deal nearly exclusively with each other in the 
secondary market, still exists. So I hope today's hearing can 
help us understand why this is the case, and I look forward to 
your testimony. I yield back my time.
    The Chairman. The chair would remind other Members to 
submit their opening statements for the record so the witnesses 
may begin their testimony, and to ensure that there is ample 
time for questions.
    I would like to welcome our witnesses to the table. First, 
we have the Honorable Terrence Duffy, Executive Chairman and 
President of the CME Group, from Chicago, Illinois. We have Mr. 
Christopher Edmonds, Senior Vice President, Financial Markets, 
Intercontinental Exchange, Chicago, Illinois; Ms. Marnie 
Rosenberg, Global Head, Clearinghouse Risk and Strategy, 
JPMorgan Chase and Company, New York, New York; Mr. Stephen 
Merkel, Executive Vice President, General Counsel and 
Secretary, BGC Partners, Incorporated, New York, New York, on 
behalf of the Wholesale Markets Brokers' Association; Mr. 
Stephen John Berger, Director, Government and Regulatory 
Policy, Citadel, LLC, New York, New York, on behalf of the 
Managed Funds Association; Mr. Luke Zubrod, Director, Risk and 
Regulatory Advisory Services, Chatham Financial, Kenneth 
Square, Pennsylvania.
    Mr. Duffy, please begin when you are ready.

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

    Mr. Duffy. Thank you, Mr. Chairman. Chairman Scott, and 
Ranking Member Scott, Members of the Subcommittee, I am Terry 
Duffy, the Executive Chairman and President of CME Group, and I 
thank you for the opportunity to testify today regarding the 
G20 clearing and trading commitments.
    These commitments were meant to create a global regulatory 
framework; however, some G20 nations have not implemented core 
elements of the G20 reforms consistently. For example, 
regulatory requirements for clearinghouses have not been 
defined on a coordinated basis. This has the potential to 
create inconsistency, uncertainty, and disruption to the smooth 
functioning of global derivatives markets.
    Fortunately, negotiations between the U.S. and the EU on 
equivalence were successfully resolved in February. That is 
when the European Commission originally granted the CFTC 
equivalent status. The European Securities Market Authority is 
now implementing that agreement. It is ensuring that the CME 
clearing is recognized as equivalent in advance of the June 21 
date for European clearing mandate.
    I want to applaud Chairman Massad and his European 
counterparts for working through their differences and reaching 
a positive outcome. However, the process took too long. This 
created considerable uncertainty for European participants 
wanting to clear products in the United States. We encourage 
global regulators to avoid this kind of potential market 
disruption in the future. They should implement long-term 
solutions. They should not force markets to go through a 
national equivalence and recognition process every few years. 
Otherwise, regulation will artificially influence liquidity, 
price discovery, and risk management. It will disadvantage 
individual markets in an increasingly competitive global 
marketplace.
    Beyond equivalence, the global clearing mandates have also 
led to increased focus on clearinghouses' risk management. In 
2012 and 2013, enhanced risk management standards were adopted 
for clearinghouses. More recently, there has been a focus on 
recovery and resolution. Central clearing increases 
transparency, reduces systemic risk, and strengthens the 
financial system. Clearing members and market participants 
bring risk to the clearinghouse through their trading 
activities. In contrast, a clearinghouse's core function is to 
manage that risk. We don't create the risks.
    Clearinghouses are responsible for ensuring the overall 
safety and soundness of their markets. CME Clearing uses a 
number of tools to monitor and limit the risk it manages. These 
include its safeguards packages and waterfall structure. They 
provide a firewall against a potential systemic impact of a 
failing clearing member. These tools have proven themselves to 
be extremely effective in stressed markets and during the worse 
financial crisis in memory.
    We have long supported first loss contributions to each of 
our financial safeguard packages. This further aligns our 
interests with those of market participants. We are committed 
to ensuring that the capital contributions from clearing 
members, as well as CME, will be sufficient to avoid the 
mutualization of losses in a default situation. As a result, 
when addressing a clearing member failure, CME Clearing has 
never had to access the default fund contribution of a failing 
clearing member, the mutualized capital of its clearing 
members, or the capital that CME has in its default fund.
    Effective risk management must strike a balance between 
initial margins, clearinghouse contribution capital, and 
clearing member guarantee fund contributions. This ensures that 
all market participants have appropriate incentives to manage 
risk across the markets.
    Before closing, I want to mention the leverage ratio rule 
adopted by the Basel Committee and the Federal Reserve. It is 
an example of a regulation that is at odds with the G20 
commitments to clearing. The leverage ratio will make clearing 
more expensive and less accessible. Why? Because it fails to 
recognize how customer collateral, appropriately segregated, 
reduces exposures. The Basel Committee recently proposed 
changes to the rule, but they stopped short of endorsing a 
segregated collateral offset for client-cleared derivatives. 
Customer collateral is legally required to be segregated, 
reduces exposures, and cannot be used to increase a clearing 
member's leverage. Without such an offset, clearing costs will 
increase. Further, moving the clients of defaulted clearing 
members will be much more difficult.
    I thank you for your time and attention this morning, and I 
look forward to answering any questions you may have of me.
    [The prepared statement of Mr. Duffy follows:]

 Prepared Statement of Hon. Terrence A. Duffy, Executive Chairman and 
                President, CME Group, Inc., Chicago, IL
    The G20 commitments were meant to create a global regulatory 
framework. However, some G20 nations have not implemented the core 
elements of the G20 regulatory reforms consistently. This lack of 
coordination has the potential to create inconsistency, uncertainty, 
and potential harm to the efficient functioning of U.S. and global 
derivatives markets.
Equivalency and Recognition
    As one example of this inconsistency, regulatory requirements for 
clearinghouses have not been defined on a coordinated basis. 
Fortunately, the negotiations between the U.S. and EU on equivalence 
were successfully resolved in February, when the European Commission 
officially granted the CFTC ``equivalent'' status. The European 
Securities Markets Authority is now implementing that agreement by 
ensuring that CME Clearing is recognized as equivalent in advance of 
the June 21 start date for the European clearing mandate.
    However, the process for U.S. clearinghouses obtaining equivalence 
and recognition in Europe has taken far too long. While we applaud 
Chairman Massad and his European counterparts for working through their 
differences and reaching a positive outcome, we encourage policymakers 
on both sides of the Atlantic to ensure that market participants do not 
have to deal with the uncertainty created by such long delays in 
reaching a cross-border agreement. This requires agreement among global 
regulators to implement long-term solutions for increasingly global 
markets and not force markets to go through national equivalence and 
recognition processes every few years.
    If this is not the case, then regulation will artificially 
influence liquidity, price discovery and risk management, and 
competitively disadvantage individual markets in an increasingly 
competitive global marketplace.
Risk Management through Central Clearing
    Congress has taken important steps toward strengthening the U.S. 
financial system post financial crisis. By way of example, a clearing 
mandate has been imposed for certain swaps--requiring that they be 
cleared through central clearinghouses like CME Clearing. These reforms 
increase transparency and reduce systemic risk by using the best 
practices of central clearing in the broader financial markets.
    A clearinghouse's core function is risk management--not trading or 
other types of risk creation. Unlike clearing members and market 
participants, clearinghouses do not bring risk to the clearing system. 
Instead, clearinghouses are responsible for ensuring the overall safety 
and soundness of their markets.
    Clearinghouses, like CME Clearing, utilize a number of tools, such 
as the financial safeguards package and waterfall structure, to monitor 
and limit the risks brought by its clearing members and customers and 
to limit the systemic impact of a failing clearing member. These tools 
have been tested in stressed markets and have demonstrated their 
effectiveness against the worst financial crises in memory. CME 
Clearing has never had to access a defaulting clearing member's default 
fund contribution, CME's own contributed capital, or the mutualized 
capital of its clearing members to address a clearing member default. 
At its core, the clearing mandate and other related financial reforms 
were driven by a decision by the G20 that the robust performance by 
clearinghouses during the financial crisis suggested that their market 
structure and risk management should be a template for the financial 
markets, going forward.
    In response to the swaps clearing mandate, some have called for 
greater scrutiny of clearinghouse risk management, including the amount 
of capital that clearinghouses should be required to hold. We support 
best practices in risk management. It is critical, however, to 
recognize that the central clearing mandate was adopted due to 
clearinghouse resiliency during the financial crisis. Furthermore, the 
CFTC and other global regulators have significantly enhanced the risk 
management standards applied to clearinghouses beyond those which 
performed robustly during the financial crisis. The failure to 
recognize the increased resiliency of clearinghouses following these 
changes potentially risks distracting the regulatory focus away from 
less robust areas of the financial markets.
    Unlike the participants in our markets, risk management is the core 
function of CME Clearing and we have strong motivation to ensure 
clearing member contributions and our own capital contributions will be 
sufficient to avoid the mutualization of losses in a default situation. 
Effective risk management must strike the appropriate balance between 
initial margins, clearinghouse contributed capital, and clearing member 
guaranty fund contributions to ensure that all market participants have 
appropriate incentives to manage risk across the market. CME Clearing 
has long advocated for clearinghouses to make meaningful, first-loss 
contributions to their financial safeguards packages. CME Clearing 
makes a sizeable contribution to each of its financial safeguards 
packages, which works to align our interests with those of our market 
participants.
    In addition, CME Clearing regularly publishes public disclosures 
describing its risk management practices and measuring its available 
financial resources in compliance with local and international 
standards and best practices. This provides the market significant 
transparency into our risk management practices.
    Some have also called for the introduction of a framework for 
addressing any losses that exceed the clearinghouse's financial 
resources. CME Group supports U.S. and international efforts to 
introduce robust recovery and resolution regimes for clearinghouses. 
However, we caution that no two clearinghouses are the same and the 
recovery and resolution framework should be tailored to the specific 
characteristics of each clearinghouse while ensuring that the tools 
prescribed are appropriately calibrated.
    Clearinghouses should retain flexibility in designing their 
recovery tools to take into account dynamic market conditions, and the 
specific products and markets they serve. Clearinghouses must also have 
the flexibility and discretion to implement their recovery tools and 
maintain the ability to use all possible tools available to them prior 
to resolution.
    Moreover, clearinghouses have the foremost expertise in managing 
the risks of the markets which they clear; therefore, we believe that a 
clearinghouse should only be put in resolution when the recovery 
process is exhausted. In addition to this expertise, the incentives of 
clearinghouses are aligned with overall market stability making them 
the appropriate pre-resolution decision-maker on the steps needed to 
recover their markets.
    In some jurisdictions it is suggested that initial margin 
collateral provided by market participants should be used other than 
for its sole, intended purpose as collateral for cleared positions, but 
as a means to allocate losses or as a temporary source of liquidity. 
This is commonly referred to as ``haircutting'' initial margin 
collateral. CME Group strongly opposes the haircutting of initial 
margin collateral whether during recovery or resolution, both as 
unlawful in regards to clients under the Commodity Exchange Act and 
Dodd-Frank Act and as a matter of policy, due to its destabilizing 
impact on markets and its negative capital impacts.
    Collateral haircutting directly impacts participants in pension 
funds and other end-users by appropriating their assets which are not 
designed to address mutualized risk and such appropriation is 
prohibited under U.S. law. Effectively, the haircutting of client 
collateral amounts to a taxpayer bailout due to the fact that the 
assets of participants in pension plans, the very people we are trying 
to protect, are put up as client collateral and would be at risk of 
appropriation if the haircutting of client collateral were permitted.
    Haircutting of client collateral also creates a lack of incentive 
for market participants to actively participate in the default 
management process. CME Clearing is a strong supporter of sound risk 
management underpinned by the belief that market participants must be 
incentivized to manage the risks they create.
    We encourage Congress to avoid inappropriate shifts in costs to 
end-users and reduction in clearing member incentives to actively 
manage their risk. The appropriate balance must be struck between 
initial margins, clearinghouse contributed capital, and clearing member 
guaranty fund contributions to ensure that all market participants have 
appropriate incentives to manage risk across the market.
Leverage Ratio
    Finally, highlighting a regulatory inconsistency with regard to the 
G20 commitments, the supplemental leverage ratio rule adopted by the 
Basel Committee and the Federal Reserve is directly at odds with the 
G20 commitment to clearing.
    Plainly speaking, the supplemental leverage ratio will make 
clearing more expensive and less accessible given its failure to 
recognize appropriately segregated client collateral in the centrally 
cleared derivatives markets. Customer collateral is required by law to 
be segregated, reduces exposures, and cannot be used to increase 
leverage. The Basel Committee has recently proposed changes to its 
leverage ratio framework; however it has stopped short of endorsing 
client collateral offsets for client cleared derivatives. Continued 
failure to do so will needlessly make more difficult a clearing firm's 
ability to accept a portfolio of fully margined clients of a defaulted 
clearing member.

    The Chairman. All right, Mr. Edmonds.

  STATEMENT OF CHRISTOPHER S. EDMONDS, SENIOR VICE PRESIDENT, 
              FINANCIAL MARKETS, INTERCONTINENTAL
                  EXCHANGE, INC., CHICAGO, IL

    Mr. Edmonds. Chairman Scott, Ranking Member Scott, I am 
Chris Edmonds, Senior Vice President, Financial Markets, for 
Intercontinental Exchange, or ICE. I appreciate the opportunity 
to appear before you today, and discuss the role of clearing 
and trade execution.
    Since launching an electronic over-the-counter energy 
marketplace in 2000 in Atlanta, Georgia, ICE has expanded both 
in the U.S. and internationally. Over the past 16 years, we 
have acquired or founded derivative exchanges and 
clearinghouses in the U.S., Europe, Singapore, and Canada. ICE 
has a successful and innovative history clearing exchange-
traded derivatives, and OTC derivatives such as energy and 
credit default swaps, or CDS. In 2008, ICE launched the first 
new clearinghouse in the UK in over a century; ICE Clear 
Europe, which clears energy, credit, and interest rate 
derivatives. We launched our CDS clearinghouse; ICE Clear 
Credit, in 2009, and it has since converted to a derivatives 
clearing organization following the implementation of Dodd-
Frank.
    Following the financial crisis in 2008, global financial 
ministers decided, to the extent possible, the OTC derivative 
market should be cleared. Global regulators recognized that a 
clearinghouse, by acting as a central counterparty to 
transactions, minimizes bilateral risk. As a result of 
increased clearing, market participants are realizing that 
moving uncleared positions and clearing creates both 
operational and capital efficiencies. For example, since 2009, 
ICE Clear Credit and ICE Clear Europe have cleared more than 
$78 trillion in CDS notional, but through compression and 
netting, currently maintain a combined open interest of 
approximately $1.5 trillion, significantly reducing the 
bilateral credit exposure among market participants, and 
reducing systemic risk.
    Ironically, despite mandate-driven and natural growth in 
the volume of cleared contracts, the number of futures 
commission merchants, or FCMs, available to provide clearing 
services for end-users has dropped from 190 to 76 in recent 
years. The bulk of derivatives clearing is now concentrated in 
a few bank-owned FCMs. These firms are constrained by the 
proposed requirement under Basel III that banks hold regulatory 
capital against clearing customer margin on their balance 
sheet, even though the customer margin is posted to a 
clearinghouse and held on a segregated basis.
    ICE has joined a group of concerned market participants to 
encourage the Basel Committee to reconsider and refine aspects 
of this rule. We appreciate the several Members of this 
Subcommittee who have helped us raise the issue with banking 
regulators. The Basel Committee recently indicated it may 
rethink its position, and has requested further comment on the 
proposal. ICE and the broader derivatives industry are hopeful 
the Basel Committee will recognize segregated and the risk-
reducing nature of customer funds that are restricted on bank 
balance sheets.
    We are also pleased European and U.S. regulators reached an 
agreement on margin equivalence standards for CCPs in their 
respective jurisdictions. Further coordination between 
regulators is still required to ensure that these standards do 
not create opportunities for regulatory arbitrage or balkanize 
global markets. But this first step brings important regulatory 
certainty to clearing customers.
    We are also hopeful the global regulators will reach 
agreement on equivalence between trade execution platforms 
within a reasonable timeframe. Over the past decade, ICE has 
invested heavily in our clearinghouse technology and risk 
management practices. ICE has kept pace with, and often 
preceded regulatory reforms, new global rules, and 
international standards that have been established with respect 
to risk controls, levels of protection, and proper functioning 
of clearinghouses. We have worked closely with regulators, 
clearing members, and end-users to implement clearing models 
that meet or exceed modern regulatory reforms and international 
standards. The result is an even more robust clearing model 
that includes many ICE-led initiatives such as the introduction 
of skin-in-the-game, or the contribution by clearinghouses of 
designated amounts of their own capital for the default 
waterfall.
    ICE clearinghouses are subject to extensive regulatory 
oversight and strong corporate governance requirements, 
exercised largely through risk and advisory committees, and 
independent boards of directors. Risk committees include 
representatives from our clearing member firms, and in some 
cases, end clients. ICE clearinghouses regularly conduct margin 
back-testing, default fund stress testing, and liquidity stress 
testing, the results of which are reviewed by clearing members 
and regulators. The ICE clearinghouses also provide public 
disclosure of their margin back-testing, default fund stress 
testing, and liquidity stress testing as part of their 
compliance with the CPMI-IOSCO public quantitative disclosure 
standards. The rules, practices, and procedures of ICE's 
clearinghouses are fully transparent and publicly disclosed in 
a consistent manner. Any material change to ICE's clearing 
processes are subject to rigorous internal governance review, 
as well as applicable regulatory review and approval.
    Thank you for the opportunity to share our views with you, 
and I would be happy to answer any questions you and the 
Members of the Subcommittee may have.
    [The prepared statement of Mr. Edmonds follows:]

 Prepared Statement of Christopher S. Edmonds, Senior Vice President, 
    Financial Markets, Intercontinental Exchange, Inc., Chicago, IL
Introduction
    Chairman Scott, Ranking Member Scott, I am Chris Edmonds, Senior 
Vice President, Financial Markets for Intercontinental Exchange, or 
ICE. I appreciate the opportunity to appear before you today to discuss 
the role of clearing and trade execution.
Background
    Since launching an electronic over-the-counter (OTC) energy 
marketplace in 2000 in Atlanta, Georgia, ICE has expanded both in the 
U.S. and internationally. Over the past sixteen years, we have acquired 
or founded derivatives exchanges and clearing houses in the U.S., 
Europe, Singapore and Canada. In 2013, ICE acquired the New York Stock 
Exchange, which added equity and equity options exchanges to our 
business. Through our global operations, ICE's exchanges and clearing 
houses are directly regulated by the U.S. Commodity Futures Trading 
Commission (CFTC), the Securities and Exchange Commission (SEC), the 
Bank of England, the UK Financial Conduct Authority and the Monetary 
Authority of Singapore, among others.
    ICE has a successful and innovative history clearing exchange 
traded derivatives and OTC derivatives such as energy and credit 
default swaps (CDS). ICE Clear Credit (ICC) began operating as a trust 
company in 2009 under the supervision of the Federal Reserve Board and 
the New York State Banking Department and converted to a derivatives 
clearing organization (DCO) following implementation of the Dodd-Frank 
Wall Street Reform and Consumer Protection Act (DFA). In 2008, ICE 
launched ICE Clear Europe (ICEU), the first new clearing house in the 
UK in over a century. ICEU clears derivatives in several asset classes 
including energy, agriculture, interest rates and credit. In total, ICE 
owns and operates six clearing houses in North America, Europe and 
Asia.
Current Clearing Environment
    Observers frequently point to a lack of cleared derivative 
contracts as a significant factor in the broad reach and complexity of 
the 2008 financial crisis. The disciplined and transparent risk 
management practices (including uniform collateral requirements and the 
daily marking-to-market of losses) associated with regulated cleared 
contracts serves to reduce systemic risk. Whereas, opaque bilateral OTC 
derivative transactions result in counterparty exposures that can 
become hard to unwind when the market experiences a period of 
widespread stress. A clearing house, by acting as a central 
counterparty (CCP) to transactions, minimizes bilateral risk by 
compressing derivative exposures. For example, since 2009, ICC and ICEU 
have cleared more than $78 trillion in CDS notional, but through 
compression currently maintain a combined open interest of $1.5 
trillion, significantly reducing bilateral credit exposure among market 
participants and reducing systemic risk.
ICE Global Cleared Activity--Gross Notional vs. Open Interest


    In response to the financial crisis, the G20 finance ministers 
decided that, to the extent possible, the OTC derivative market should 
be cleared. Congress followed suit with the DFA, which created a 
clearing requirement for liquid standardized derivatives. Today, 
certain U.S. and European CDS indices and certain interest rate swaps 
are mandated for clearing by the CFTC. The European Market 
Infrastructure Regulation (EMIR) created a similar clearing mandate for 
Europe. As a result of increased clearing, market participants are 
realizing that moving uncleared positions into clearing results in 
risk, operational and capital efficiencies.
Basel-Fueled Headwinds
    Ironically, despite mandate-driven and natural growth in the volume 
of cleared contracts, the number of futures commission merchants (FCM) 
available to provide clearing services for end-users has dropped 
considerably in recent years. What had been an industry of 190 firms in 
2004 was reduced to 76 firms by 2014, according to the Futures Industry 
Association. The bulk of derivatives clearing is now concentrated in a 
few bank owned global FCMs. These firms are constrained by the proposed 
Basel Committee on Banking Supervision's leverage ratio framework 
(Basel III). Basel III requires a bank to hold regulatory capital 
against clearing customer margin on its balance sheet notwithstanding 
that the customer margin is posted to a clearing house and held at the 
clearing house on a segregated basis. This Basel III capital 
requirement makes it more expensive for banks to offer clearing 
services, at the very time clearing capacity is shrinking and customer 
demand is increasing. Further, Basel III makes the transfer (or 
porting) of client positions much more difficult as banks must perform 
an assessment of their capital costs before accepting a client position 
transfer. This will complicate default resolution as banks will be less 
likely to accept client positions from a defaulting clearing member.
    ICE has joined a group of concerned FCMs, end-users and other 
clearing house operators to encourage the Basel Committee to reconsider 
and refine aspects of the rule which is set to become final at the 
start of 2017. CFTC regulations already prohibit banks from using 
customer margin funds in any way other than to mitigate the risk 
reflected in customer positions. The Basel committee recently indicated 
it may rethink this position and has requested further comment on the 
proposal. ICE and the broader derivatives industry are hopeful the 
Basel Committee will recognize the segregated and risk reducing nature 
of customer funds that are restricted on bank balance sheets.
Regulatory Coordination
    Earlier this year, European and U.S. regulators reached an 
important milestone on margin equivalence standards for CCPs in their 
respective jurisdictions. This determination encourages continued 
cross-border activity and will help prevent a fragmentation of 
liquidity for related contracts. Further coordination between the 
regulators is still required to ensure the standards do not create 
opportunities for regulatory arbitrage or balkanize global markets, but 
this first step brings important regulatory certainty to clearing 
customers. We are also hopeful that global regulators will reach 
agreement on equivalence between trade execution platforms within a 
reasonable timeframe.
    Since the enactment of the DFA, ICE has also worked with the CFTC 
and the SEC to provide CDS market participants the benefits of capital 
efficiency that can come with the portfolio margining of risk off-
setting positions.\1\ The SEC developed a portfolio margining regime 
that requires each clearing member to create its own set of portfolio 
margining standards. Under these rules, there has been some progress in 
single name clearing but uncertainty remains. We look forward to 
working with the SEC to resolve the questions still limiting market 
participants' ability to use these critical risk management tools.
---------------------------------------------------------------------------
    \1\ CDS Index instruments are subject to CFTC regulation, while CDS 
single name instruments are subject to SEC regulation, therefore a 
coordinated effort was required to provide for portfolio margining for 
CDS.
---------------------------------------------------------------------------
CCP Operation and Role in the Financial System
    The central counterparty clearing model is effective and has been 
relied upon in futures markets for more than 100 years. The recent 
introduction of mandatory clearing obligations for certain swaps has 
increased awareness around clearing and the significant benefits it 
brings to the capital markets. Over the past 100 years, clearing house 
risk management practices have been repeatedly tested and have 
performed as designed in resolving clearing member defaults.
    Over the past decade, ICE has invested heavily in our clearing 
house technology and risk management practices. ICE has kept pace with 
and often preceded regulatory reforms, new global rules, and 
international standards \2\ that have been established with respect to 
risk controls, levels of protection and proper functioning of clearing 
houses. We have worked closely with regulators, clearing members and 
end-users to implement clearing models that meet or exceed modern 
regulatory reforms and international standards. The result is an even 
more robust clearing model that includes many ICE-led initiatives, such 
as the introduction of ``skin-in-the-game,'' the clearing house's 
contribution of a designated amount of its own capital to the default 
waterfall.
---------------------------------------------------------------------------
    \2\ Committee on Payment and Settlement Systems, International 
Organization of Securities Commissioners (CPSS-IOSCO), Principles of 
Financial Market Infrastructures (April 2012). http://www.bis.org/publ/
cpss101a.pdf.
---------------------------------------------------------------------------
    ICE clearing houses are subject to extensive regulatory oversight 
and strong corporate governance requirements, exercised largely through 
risk and advisory committees and independent boards of directors.\3\ 
Risk committees include representatives from clearing member firms and, 
in some cases, end clients. ICE clearing houses regularly conduct 
margin back-testing, default fund stress testing, and liquidity stress 
testing, the results of which are reviewed by clearing members and 
regulators. In addition, the clearing houses' margin, guaranty fund and 
liquidity methodologies are independently validated on a routine basis.
---------------------------------------------------------------------------
    \3\ For an overview of the risk governance at ICE clearing houses 
see: ICE Clear Europe--www.theice.com/clear-europe/risk-management; ICE 
Clear U.S.--www.theice.com/clear-us/regulation; ICE Clear Credit:--
www.theice.com/clear-credit/regulation.
---------------------------------------------------------------------------
    The rules, practices and procedures of ICE's clearing houses are 
fully transparent and are publicly disclosed in a consistent manner, as 
set out within the CPMI-IOSCO Principles for Financial Market 
Infrastructures (PFMIs) \4\ and various regulatory requirements. Any 
material changes to ICE's clearing processes are subject to rigorous 
internal governance as well as applicable regulatory review and 
approval.\5\
---------------------------------------------------------------------------
    \4\ Supra, nt. 2.
    \5\ For an overview of ICE central clearing operations and 
governance see: https://www.theice.com/publicdocs/
Central_Clearing_Reducing_Systemic_Risk.pdf.
---------------------------------------------------------------------------
Conclusion
    ICE has always been and continues to be a strong proponent of open 
and competitive markets, and of appropriate regulatory oversight of 
those markets. As an operator of global futures and derivatives 
markets, ICE understands the importance of ensuring the utmost 
confidence in its markets. To that end, we have continuously worked 
with regulatory bodies in the U.S. and abroad to ensure they have 
access to all relevant information available to ICE regarding trade 
execution and clearing activity on our markets. ICE continues to work 
closely with governments and regulators at home and abroad to address 
the evolving regulatory challenges presented by derivatives markets and 
will continue to work cooperatively for solutions that promote the best 
and safest marketplaces.
    Mr. Chairman, thank you for the opportunity to share our views with 
you. I would be happy to answer any questions you and Members of the 
Subcommittee may have.

    The Chairman. Thank you, Mr. Edmonds.
    Ms. Rosenberg.

 STATEMENT OF MARNIE J. ROSENBERG, GLOBAL HEAD, CLEARINGHOUSE 
     RISK AND STRATEGY, JPMorgan CHASE & CO., NEW YORK, NY

    Ms. Rosenberg. Thank you for holding this hearing, and 
extending JPMorgan Chase the opportunity to present our views 
on implementation of the G20 derivative reforms.
    My name is Marnie Rosenberg, and I am the Global Head of 
Clearinghouse Risk within JPMorgan Chase's Independent Risk 
Management Function. Our firm is a leading provider of access 
to clearing across the globe.
    The clearing mandate has benefitted the system overall by 
reducing risk and enhancing transparency. On the other hand, it 
has further concentrated risk in a small number of large global 
CCPs, and increased interconnectedness within the system.
    Today, one of the critical public policy issues for 
regulators and policymakers is ensuring that CCP risk 
management and governance frameworks are appropriately aligned 
and effective for the systemic role that CCPs have assumed.
    I lead a team that focuses on identifying, mitigating, and 
reducing our firm's CCP membership risks, and it is from this 
perspective that I raise three key questions for policymakers 
today. First, are CCPs sufficiently resilient to withstand the 
default of one or more clearing members, or a major loss 
arising from an operational failure or a cybersecurity attack? 
Second, do CCPs have adequate plans and resources to recover 
from such a loss to carry on offering critical services? And 
finally, if they can't recover, do they have credible 
resolution plans to continue to provide critical services, and 
ensure a CCP's failure does not cause broader market 
instability or require taxpayer assistant. Regulators, 
including the CFTC, have made significant progress in 
addressing these questions, but there remains widespread 
agreement that there should be more done.
    The starting block for resilient CCPs is a strong, 
effective risk governance framework. Each CCP makes the 
decisions with respect to how they manage risk, including 
setting membership and eligible collateral requirements, 
establishing margin levels and overall financial safeguards, 
and determining the products that they offer for clearing. At 
the same time, clearing members bear the capital consequences 
of loss through the collective funds they provide to the CCP 
for loss mutualization. Therefore, risk governance rules should 
evolve to ensure that those that bear potential losses have a 
meaningful voice with how risk is managed.
    This can be achieved by mandatory and meaningful 
consultation and inclusion of clearing members in the decision-
making process, enhanced and consistent risk committee 
standards, and appropriate levels of a CCP's own resources at 
risk, often referred to as skin-in-the-game.
    Robust and transparent stress testing is critical to 
ensuring a CCP has sufficient resources should a clearing 
member default. CCP-designed stress test frameworks should be 
subject to more prescriptive global standards, and the testing 
methodology should be more transparent to clearing members. 
This is critical for clearing members to identify and manage 
the risk inherent in using a specific CCP. Specifically, 
regulatory-driven stress tests would provide oversight and 
inform supervisory requirements by evaluating the adequacy of 
the CCP's financial safeguards. Results of these tests should 
be disclosed. We look forward to U.S. regulatory support on 
this front as global standards are developed over the next 
year.
    While resiliency is important, it is also crucial to ensure 
collectively that CCPs can recover from a threat to their 
viability in order for them to continue to provide core 
services to the market and avoid systemic contagion. But a 
CCP's ability to allocate losses to clearing members through 
recovery tools, such as cash calls on members, must be very 
limited and subject to predetermined and predictable limits, 
otherwise, they can be pro-cyclical and have a destabilizing 
effect on the broader market. Moreover, bank regulators today 
expect and demand it.
    Last, well-defined plans and pre-established resources to 
resolve systemically important CCPs in the case of an event are 
still needed. If a CCP is no longer a viable entity, it must be 
resolved in a manner that is not disruptive to the marketplace, 
and without public support. An effective resolution plan does 
not result in wind-down or liquidation, it means having tools 
and resources to replenish the default fund and regulatory 
capital, and reopen for business with a recapitalized CCP that 
can continue to provide these critical services to the market.
    Thank you, and I look forward to taking questions.
    [The prepared statement of Ms. Rosenberg follows:]

 Prepared Statement of Marnie J. Rosenberg, Global Head, Clearinghouse 
         Risk and Strategy, JPMorgan Chase & Co., New York, NY
Introduction
    Chairman Scott, Ranking Member Scott, and Members of the 
Subcommittee, thank you for holding this hearing and for extending 
JPMorgan Chase the opportunity to present our views. My name is Marnie 
Rosenberg, and I am the Global Head of Clearinghouse Risk and Strategy 
within JPMorgan Chase's independent Risk Management Function.
    We appreciate the Committee's leadership in holding this series of 
hearings to review implementation of the derivatives reforms agreed by 
the Group of Twenty (G20) in 2009.\1\ It is and will continue to be 
important to ensure the objectives of increased transparency and a 
reduction in systemic risk are being met, while also monitoring the 
impact on the derivatives markets and the ability for businesses to 
access those markets to manage risk.
---------------------------------------------------------------------------
    \1\ http://www.g20.utoronto.ca/2009/2009communique0925.html.
---------------------------------------------------------------------------
    As this Committee knows well, American companies use futures and 
swaps to manage a wide variety of risks they encounter in their day-to-
day business, such as interest rate risk when companies borrow money, 
currency risk when they sell their goods overseas or commodity risk 
posed by fluctuations in prices of raw materials used in production.
    JPMorgan works with companies from all industry sectors who seek to 
hedge their risks in the swaps markets, which allows them to do so in a 
flexible and customized manner that is not possible in the exchange-
traded markets. We serve end-users by providing liquidity, financing 
and customized risk management solutions across markets, including 
energy, metals and agricultural markets.
    In addition, JPMorgan is a leading provider of access to clearing 
across the globe, with fifty-four memberships at forty-two clearing 
houses, or ``CCPs'' that offer futures and/or swaps clearing. In 
addition to its clearing memberships, JPMorgan provides services 
directly to CCPs globally, acting as a liquidity provider, cash 
manager, investment advisor, settlement bank and custodian.
    I lead a team that focuses on understanding current and proposed 
CCP structures and identifying, mitigating and reducing membership risk 
and exposures to enhance how JPMorgan measures and manages our exposure 
to CCPs. We apply this experience and expertise to develop policy 
recommendations on CCP risk issues and to proactively engage in policy 
discussions affecting CCPs to best ensure a safe and sound financial 
system.
    Today, I will focus on the importance of robust risk management 
frameworks at CCPs to the safety and soundness of the financial system.
Overview of State of Reform
    Following the financial crisis, the leaders of the G20 nations 
agreed to a series of measures to increase the transparency of the 
over-the-counter (OTC) derivatives market and to reduce systemic risk. 
The reforms agreed to by the G20 included clearing of standardized OTC 
derivatives through CCPs, trading of standardized OTC derivatives on 
electronic platforms where appropriate, higher capital and minimum 
margin requirements on non-centrally cleared contracts, and requiring 
that all OTC derivatives transactions be reported to trade 
repositories.
    Global initiatives have been underway to implement these changes 
for some time and they are in various states of legislation, 
regulation, and implementation. Many of these reforms have brought 
significant progress in a number of key areas, including: mandatory 
registration and regulation of swap dealers; mandatory clearing of 
standardized contracts between financial firms; greater pre- and post-
trade transparency through public reporting requirements; and execution 
of certain standardized contracts on swap execution facilities (SEFs).
    The Commodity Futures Trading Commission (CFTC) has written and 
adopted the bulk of regulations required to implement swaps market 
reforms under Title VII of the Dodd-Frank Act. These and other reforms, 
taken together, have reduced risk in the system and have facilitated 
greater transparency for regulators and market participants. They have 
also fundamentally altered the market structure of swaps: how and where 
these instruments are traded, the economics of transactions, the nature 
of products available to American companies and the liquidity and 
efficiency of these markets. And as I will discuss later in my 
testimony, mandatory clearing, in particular, has intensified the 
importance among regulators and market participants for CCP risk 
management standards across all clearinghouses, not just those that 
clear derivatives. This development is a positive outcome for overall 
market stability but our work is not yet complete. CCPs have now become 
deeply interconnected and core to our derivatives markets but we have 
yet to fully evolve their risk management and governance models to 
reflect this increasingly critical role.
    This change in market structure is demonstrated by the fact that, 
for the interest rate swap markets as of the first quarter of 2016, 
82.5% of the average daily notional value is now centrally cleared, and 
nearly \1/2\ of the average daily trading activity is executed on a 
swap execution facility.\2\ In contrast, in 2013, only 57.7% of the 
average daily notional value of interest rate swaps market was 
centrally cleared.
---------------------------------------------------------------------------
    \2\ http://www2.isda.org/functional-areas/research/research-notes/.
---------------------------------------------------------------------------
    Now that the rules are largely in place and cleared volumes have 
increased, it is important for the CFTC and other policymakers to: (1) 
consider the implications of the changes to the derivatives markets, 
such as the growing importance of central counterparties to financial 
stability, and fragmentation in swaps markets; (2) review how emerging 
risks might best be managed and mitigated; and (3) determine whether 
adjustments to the rules or additional guidance may be appropriate to 
ensure the markets continue to meet the needs of all market 
participants.
    The following observations and recommendations should be considered 
as the Committee and the CFTC continue their ongoing work in this area:

   Mandatory clearing requirements can reduce risk in the 
        derivatives markets. As the volume of centrally-cleared 
        contracts has increased, however, so has the importance of CCPs 
        as sources of systemic risk. Expectations are that CCPs will 
        only continue to grow in size, importance and inter-
        connectedness.

   Inter-connectedness among systemically-important CCPs and 
        clearing members has increased across jurisdictions. Global 
        CCPs share a common set of large members, raising the 
        likelihood that a default at one CCP will have a cascading 
        effect across the globe. These connections must be mapped and 
        well-understood, and broader industry preparedness is needed to 
        ensure that member default can be contained.

   It is critical for policymakers, regulators and market 
        participants to review the existing CCP risk management, 
        governance and oversight models to ensure they are commensurate 
        with the systemic risk they now pose. Stakeholders need to 
        ensure that sufficient safeguards are in place to promote the 
        resilience of CCPs, and that there are robust plans in place to 
        manage extreme stresses to the financial strength of a CCP 
        without the use of public money. Similarly, operational 
        resiliency is of paramount importance, requiring strong 
        operational risk and cybersecurity risk management. 
        Specifically:

     CCPs should be subject to enhanced resiliency 
            standards.

       Effective risk governance is the fundamental building 
            block for resilient
              CCPs. CCPs should be subject to global minimum governance 
            standards
              and ``skin in the game'' requirements to promote 
            effective alignment of in-
              terests and proper risk management.

       CCPs should be transparent to market participants 
            regarding their risk
              methodologies used to size their aggregate financial 
            safeguards. Higher
              minimum standards are needed for CCP stress testing 
            frameworks, and
              standard regulatory-driven, disclosed stress test 
            frameworks should be im-
              plemented to provide confidence in the adequacy of loss 
            absorbing resources
              held by CCPs.

       Regulators, CCPs and clearing members globally should 
            work together to
              implement and test default management protocols in a 
            coordinated manner
              across CCPs.

     Robust recovery tools should avoid pro-cyclicality and 
            market destabilization.

       A CCP's ability to make cash calls on its members as 
            part of recovery must
              be very limited and subject to a consistent global 
            standard.

       Use of novel recovery tools, such as contract tear-up or 
            gains haircutting,
              have the potential to impose unpredictable losses on 
            participants and
              should be limited in CCP recovery and overseen by an 
            impartial authority.

     Resolution plans should ensure continuity of clearing 
            services while minimizing risks to financial stability and 
            to taxpayers.

   At the same time, new capital requirements under the 
        leverage ratio do not adequately reflect exposure from cleared 
        derivatives and have made it difficult for many clearing member 
        banks to offer clearing services. End-users are beginning to 
        feel the impact of this constraint through reduced access to 
        clearing and increased costs.\3\ This creates a distinct 
        tension between the safety and soundness objectives of 
        prudential regulators and those of market regulators, like the 
        CFTC, responsible for implementing the G20's clearing mandate 
        to reduce risk in the derivatives markets.
---------------------------------------------------------------------------
    \3\ http://www.sifma.org/issues/item.aspx?id=8589958563; http://
www.commoditymkts.org/wpcontent/uploads/2015/11/CMC-MFA-Leverage-Ratio-
Letter-End-User-Impact-Final.pdf.

   The recent agreement between the CFTC and the European 
        Commission with regard to recognition of U.S.-based CCPs by 
        European authorities was a critical development in ensuring a 
        global market for swaps. It also underscores the importance of 
        cross-border coordination on an ongoing basis among regulators 
        around the world, particularly as U.S. and EU authorities begin 
---------------------------------------------------------------------------
        discussions related to trading venue equivalence.

   Finally, the use of SEFs is an important mechanism for 
        enhancing transparency in the swaps markets. Minor adjustments 
        to the CFTC's rules setting out the process for determining 
        swaps mandated to be traded on a SEF and the modes of execution 
        permitted would help to mitigate unnecessary reductions in 
        liquidity that have been widely observed since the SEF rules 
        went into effect.
The New Clearing Ecosystem
I. CCP Resiliency, Recovery and Resolution
    One of the key components of the G20 agenda on derivatives reforms 
was mandating the use of CCPsfor the clearing of all standardized OTC 
derivatives contracts. A CCP interposes itself betweencounterparties to 
a derivatives transaction, whereby the CCP becomes the buyer to every 
seller and theseller to every buyer. The use of CCPs creates numerous 
benefits for market participants and thefinancial system by providing 
for centralized risk management and processing as well as risk 
reductionthrough collateralization of trades and multilateral netting.
    The increased use of CCPs has led to concentration of credit, 
liquidity, operational and legal risk arising from OTC derivatives in a 
small number of the large global CCPs. These risks are now centrally 
managed by CCPs themselves and market participants must rely upon CCPs 
to maintain appropriate membership criteria and risk management 
standards, and conduct ongoing, adequate member due diligence. This 
dependency upon CCPs to maintain strong risk management standards 
existed prior to the introduction of mandatory swaps clearing but has 
now become more pressing as mandatory clearing in multiple 
jurisdictions has led to further concentration of risk while, at the 
same time, market participants no longer have the option to execute and 
clear bilaterally if they become concerned with a CCP's risk management 
protocols. While mandatory clearing has been in effect in the U.S. for 
nearly 3 years, market participants will need to begin complying with 
the European Union's (EU) clearing requirement for OTC derivatives 
products later this month.\4\ Other jurisdictions have also moved 
forward with mandating the use of CCPs for certain standardized OTC 
derivatives. Further, as rules imposing margin requirements on swaps 
that are not cleared are implemented beginning in September 2016, an 
even greater use of CCPs is anticipated from market participants 
seeking to voluntarily clear additional products to benefit from margin 
efficiencies and multilateral netting that can be gained through 
clearing.
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    \4\ https://www.esma.europa.eu/regulation/post-trading/otc-
derivatives-and-clearing-obligation.
---------------------------------------------------------------------------
    Due to JPMorgan's role as a significant clearer in global 
derivatives markets, it is imperative that we understand our own 
exposure and risks to CCPs, and evaluate how and whether the current 
regulatory and legal structures for CCPs are sufficiently suited to 
their growing importance to the financial system. This is why JPMorgan 
published a paper in 2014 called ``What is the Resolution Plan'' for 
CCPs.\5\
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    \5\ https://www.jpmorganchase.com/corporate/About-JPMC/document/
resolution-plan-ccps.pdf.
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    In the current derivatives clearing ``ecosystem'', policymakers and 
market participants need to address some key questions:

   Are CCPs sufficiently resilient that they can withstand a 
        clearing member(s) default or major loss through sufficiently 
        strong first line of defense measures: are membership criteria 
        robust, is eligible collateral limited to the highest quality 
        liquid assets and are products that are cleared sufficiently 
        liquid, standard, and suitable for clearing?

   Do CCPs have adequate plans to recover from such a loss and 
        carry on offering critical services?

   If CCPs can't recover, do they have adequate plans to 
        continue to provide critical services and ensure the failure of 
        a CCP does not cause wider market instability or require 
        taxpayer assistance?

    In response, we have come a long way, but more work is needed.
    Currently, CCPs are expected to meet higher regulatory and risk 
management standards, including internationally agreed to standards 
published by the Committee on Payments and Market Infrastructure (CPMI) 
and the International Organization of Securities Commissions (CPMI-
IOSCO) in 2012, referred to as the Principles for Financial Market 
Infrastructures (PFMIs) \6\ as implemented in the U.S. by CFTC 
rulemakings under authorities in Title VII and Title VIII of the Dodd-
Frank Act. Nevertheless, regulators around the world have acknowledged 
that more work is needed, and CCPs have become a high priority on the 
agenda for global financial regulatory standard-setting bodies, 
including the Financial Stability Board and CPMI-IOSCO and we expect 
this focus to continue. These bodies are largely comprised of 
regulators, central bankers and in some cases, finance ministries from 
the U.S. and around the world.
---------------------------------------------------------------------------
    \6\ http://www.bis.org/cpmi/publ/d101a.pdf.
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CCPs Should be Subject to Enhanced Resiliency Standards
    A resilient CCP should have the ability to withstand severe stress 
events such as clearing member defaults, and this can be achieved by 
having strong membership requirements to ensure the soundness of its 
clearing members while also ensuring fair and open access, robust risk 
management standards and adequate capital and liquidity resources. A 
resilient CCP must also be able to have sufficient controls and 
protections in place to withstand significant losses stemming from non-
default events, such as fraud or a cybersecurity attack.
    There are four key recommendations on how to improve CCP resiliency 
and strengthen the clearing ecosystem:

  (1)  Effective risk governance is the cornerstone of resilient CCPs. 
            CCPs should be subject to global minimum risk governance 
            standards and ``skin in the game'' requirements to promote 
            effective alignment of interests and to incentivize strong 
            risk management.

    Many CCPs have migrated from being utilities owned by members to 
private for-profit institutions. This shift introduces an inherent 
tension and potential conflict of interest between a CCP's role as a 
market utility that can mutualize potential losses among its members 
and its commercial objectives to increase revenues and earnings/
dividends for its shareholders and market share. The fact that its 
members bear the losses also introduces an element of moral hazard.
    CCPs make key decisions impacting the risk profile of the CCP and 
its membership, with respect to the products that can be cleared, the 
members who participate in the CCP, the framework used to mitigate the 
risk brought in by participants, the type of collateral that can be 
posted and the aggregate amount of safeguards to maintain. However, it 
is clearing members of the CCPs that bear the capital consequences of 
any losses, through the collective funds (the ``default fund'') they 
provide to the CCP for loss mutualization. Therefore, CCP risk 
governance structures should evolve to ensure that those that bear 
potential losses and market risk as part of default management have a 
meaningful voice with regard to how risk is brought into the CCPs. 
Governance needs to be commensurate with the changed role of CCPs and 
the new responsibilities that CCPs have within the financial system. 
This can be achieved by mandatory, meaningful consultation and 
inclusion in the decision making process for clearing members, 
availability of appropriate, funded amounts of a CCP's own resources 
(``skin in the game'') and increased capital available at the end of 
the waterfall.
    Governance. Members themselves must have more of a say in material 
risk decisions that are made by the CCP as it impacts their own capital 
contributions through the default fund. Current U.S. regulation does 
not require CCPs to incorporate and demonstrate input from clearing 
members or CCP risk committees early in the process with respect to key 
risk management decisions impacting clearing members' liability. CCPs 
globally should therefore be required to obtain input from their 
clearing members and the CCP's relevant risk committees on all material 
risk matters such as products that can be cleared, changes to loss 
mutualization rules, and post-default risk management decisions. CCPs 
should be required to maintain records and report any conflicts between 
CCP decision, risk committee opinion and clearing member views. In 
addition, consistent global standards are needed with respect to a 
CCP's risk committees. Risk committees should be required to have 
clearly-defined mandates, diverse memberships, and minimum member 
qualifications. The risk committee representatives should provide an 
independent, expert opinion on a CCP's risk management strategy and the 
impact of a CCP's actions on CCP and member stability, market integrity 
and clients.\7\ If the views of a CCP's risk committee are not 
incorporated by the CCP in making key risk management decisions, the 
CCP should be required to document and disclose to regulators how the 
risk committee's views have been addressed.
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    \7\ https://www.theclearinghouse.org/issues/articles/2015/09/
20150918-tch-comments-to-cpmi-iosco-on-ccp-riskgovernance.
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    ``Skin-in-the-game''. CCPs should be subject to a meaningful risk-
based minimum contribution to the guarantee fund ahead of non-
defaulting members called ``skin in the game'' (SITG). While many CCPs 
currently contribute such capital to their overall financial 
safeguards, the current level of CCP contributions, at generally less 
than 5% of the member default fund, are not sufficient. The CFTC 
currently does not require CCPs to have minimum SITG capital 
contributions. CPMI-IOSCO is expected to issue a market consultation 
this year to set global standards, which is a welcome and positive 
development. Having a risk-based, minimum level of SITG would 
appropriately align incentives amongst the CCP and its members and 
ensure proper risk management and governance. Aligning and scaling CCP 
contributions with those of the largest clearing members will also help 
to ensure that membership requirements remain strong and will limit the 
possibility that any single member becomes too large as a proportion of 
total risk.
    CCP Capital. The current minimum CFTC and global capital 
requirements for CCPs should be reviewed. Currently, CCPs are required 
to cover at least 6 months of operating expenses under CPMI-IOSCO 
standards and twelve months under CFTC requirements. This is primarily 
meant to cover business and operating risk and any losses that arise by 
a non-member default event such as cyber risk, technology failure, or 
fraud. However, CCP capital should be available for both default and 
non-default losses. Members should not be responsible for non-default 
losses. This should be the responsibility of the CCP's shareholders. 
The size and impact of such events are untested and the current capital 
levels may be insufficient to cover losses. Sufficient standards are 
needed to address operational risk, and in particular, cyber-risk 
through investments in expertise and ensuring infrastructures to handle 
these risks are adequate. This is front and center on the international 
regulatory agenda and the work done by CPMI-IOSCO and the CFTC to 
address these risks through consultations on cybersecurity and 
operational controls is another welcome and positive development.

  (2)  CCPs should be more transparent to market participants regarding 
            risk methodologies used to size their aggregate financial 
            resources to cover the largest single (or two) member 
            defaults.\8\
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    \8\ http://www.bis.org/cpmi/publ/d101a.pdf.

    Clearing members and their clients must have access to and 
transparency around the methodologies used by CCPs to develop financial 
safeguards in order to identify and manage the risks inherent in using 
a specific CCP. For example, transparency regarding stress scenarios 
used by a CCP to determine the size of financial safeguards is 
necessary to provide clarity to participants on whether the CCP has 
sufficient resources to absorb default losses.
    While the industry has made significant progress on CCP 
transparency over the last 3 years, more must be done. Regulators 
around the world continue to voice support for market participants' 
calls for transparency and now require public disclosures through the 
CPMI-IOSCO quantitative disclosures standard that was published in 
February 2015.\9\ Current, standard disclosures are useful to 
participants on many levels but these disclosures alone are not 
sufficient as they do not permit CCP users to replicate margin models 
and do not provide details of the stress scenarios that a CCP has 
determined it will be able to withstand. The more market participants 
can adequately measure and manage their credit risks to CCPs, the more 
confidence the system will have that CCPs have sufficient resources to 
withstand a crisis.
---------------------------------------------------------------------------
    \9\ http://www.bis.org/cpmi/publ/d125.pdf.

  (3)  More prescriptive, minimum global standards are needed to govern 
            CCP stress testing along with the establishment of standard 
            regulatory-driven, disclosed stress test frameworks to 
            provide confidence in the adequacy of aggregate financial 
---------------------------------------------------------------------------
            safeguards held by CCPs.

    Adequate stress testing of CCP members and their client portfolios 
is key to evaluating whether a CCP has sufficient resources should a 
clearing member(s) default. To ensure this, a CCP's financial 
safeguards should be sized based on CCP-designed stress test frameworks 
that are subject to minimum and more prescriptive standards that are 
transparent to clearing members and other market participants. In 
addition, there should be regulatory-driven stress tests that then 
provide oversight and inform supervisory requirements by evaluating the 
adequacy of the CCP's financial safeguards with appropriate 
consequences should a CCP fail the test.
    There has been significant progress towards enhanced standards for 
stress testing,\10\ and CPMI-IOSCO is expected to issue a consultation 
with additional guidance for CCPs in the third quarter of 2016. In 
addition, European regulators recently conducted stress tests of CCPs 
in Europe, and it is important that such a framework is extended to 
CCPs globally.
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    \10\ In July of 2015, ISDA sent a letter to CPMI-IOSCO setting out 
the industry's principles for CCP stress testing: www.isda.org.

  (4)  Regulators, CCPs and clearing members globally should work 
            together to develop, implement and test standard default 
---------------------------------------------------------------------------
            management protocols in a coordinated manner across CCPs.

    It is important for policymakers to consider that a large clearing 
member default could occur simultaneously at multiple CCPs and that 
CCPs are highly dependent upon non-defaulting members to help manage 
the default, participate in the default management process and absorb 
the defaulter's portfolio with its associated market risks. A CCP's 
dependency upon the resources and expertise of its broader membership 
to achieve a successful default management outcome cannot be 
underestimated, and market and prudential regulators, CCPs and all of 
their participants have a vested interest in making sure this happens. 
Currently, while each CCP tests its default management protocols with 
its members through default management fire drills, these drills are 
done in isolation and not in collaboration with other CCPs. An extreme 
market stress event that occurs across CCPs in multiple jurisdictions 
could severely constrain the ability of non defaulting members to 
respond effectively. In order to ensure market preparedness for such an 
event, a coordinated approach to drills under the joint oversight of 
relevant regulators, and a push for more standardized default 
management protocols among global CCPs is necessary. As an example, a 
recent joint default management exercise run by UK and German 
authorities coordinated across two CCPs, LCH and Eurex, was an 
important step in the right direction. However, more is needed, 
including involvement of U.S. CCPs and authorities in future work. This 
will be a topic at an upcoming Market Risk Advisory Committee meeting 
at the CFTC, for example, which is a very welcome development.
Robust Recovery Tools Should Avoid Pro-Cyclicality and Market 
        Destabilization
    Focusing on CCP resilience is a necessary first step, but it is not 
sufficient on its own. To the extent that resiliency measures are not 
sufficient, CCPs are required to have robust recovery plans that ensure 
continuity. ``Recovery'' refers to the ability of a CCP to recover from 
a threat to its viability so that it can continue providing its 
critical services without entering into resolution or insolvency. While 
efforts are appropriately focused on reducing the likelihood of any CCP 
entering recovery, it is important that CCPs are prepared through 
comprehensive and effective recovery plans that are also transparent, 
measurable and acceptable to members who bear the majority of the risk.
    In 2013, the CFTC adopted rules requiring systemically important 
CCPs to comply with international standards for CCPs, including a 
requirement to maintain viable recovery plans. Since that time, U.S. 
CCPs have been revising their end of waterfall rules to put in place 
robust processes, agreements and defined tools to support recovery.
    Clearly defined, transparent, and robust ex ante CCP recovery plans 
that do not lead to destabilizing and pro-cyclical effects are 
essential. Specifically:

  (1)  A CCP's ability to make cash calls on its members as part of 
            recovery must be very limited and be subject to a 
            consistent global standard.

    Currently, CPMI-IOSCO and the CFTC do not prescribe rules with 
respect to the number of cash calls that a CCP can impose upon its 
members. This has led to CCPs implementing varied rules which make it 
difficult for members to measure and manage their own exposures. The 
interconnectedness among CCPs suggests that there could be multiple, 
simultaneous cash calls on the same clearing members. In the absence of 
limits, the cash calls may not be reliable, particularly in a stressed 
market, and could lead to liquidity and funding issues that would be 
vectors for further financial instability.

  (2)  Use of novel recovery tools, such as contract tear-up or gains 
            haircutting, have the potential to impose unpredictable 
            losses on participants and should be limited in CCP 
            recovery and overseen by an impartial authority.

    Gains haircutting is a tool for allocating losses in recovery that 
is being implemented by CCPs to satisfy their regulatory requirement to 
ensure comprehensive loss allocation. This tool allows CCPs to reduce 
any payments it owes to participants. Most importantly, it could lead 
to disproportionate distribution of losses to certain market 
participants, which could in turn incentivize such participants to take 
actions with respect to their positions that are destabilizing or 
otherwise inhibit the CCP's recovery.
    Similarly, CCPs have proposed partial tear-up as a way to restore 
the CCP to a matched book should default management protocols fail to 
successfully liquidate the defaulter's portfolio. The CCP would tear-up 
positions of the defaulter and those non-defaulting participants that 
hold equal and offsetting positions at a price determined by the CCP. 
Because this tool would be used during a period of illiquidity, 
establishing a fair market price would be quite challenging and 
subjective on the part of the CCP.
    A CCP's decision to use recovery tools like gains haircutting and 
partial tear-up should be overseen by an impartial authority, and 
require compensation to be paid by the CCP to participants who suffer 
losses. While the CPMI-IOSCO recovery report already contemplates 
compensation in particular, U.S. regulators should consider issuing 
guidance in this regard.

    Resolution plans should ensure continuity of clearing services 
while minimizing risks to financial stability and to taxpayers.

    If a CCP is no longer a viable entity for the performance of its 
critical functions, it should be resolved in a manner that is not 
disruptive to the marketplace, is not reliant on taxpayer assistance 
and allows for operational continuity of a newly capitalized entity 
under new ownership that can continue its critical functions.
    The trigger point for resolution should be the point at which the 
exercise of recovery tools becomes too destabilizing for the market, 
threatens the sustainability of the CCP or when the CCP is otherwise 
near or in default. As opposed to recovery, a resolution would be 
managed by resolution authorities, such as the Federal Deposit 
Insurance Corporation (FDIC) in the U.S., and could lead to a change in 
ownership, a write-down of the CCP's equity and the replacement of the 
CCP's management.
    Resolution authorities should develop public sector playbooks or 
action plans that facilitate continuity, are made available to 
participants on a confidential basis, address default and non-default 
losses and provide resolution authorities with appropriate flexibility 
to determine the entity to be put in resolution. In addition, CCP 
resolution plans should not interfere with the resolution plans of 
clearing members, or lead to contagion in other services or segments 
cleared by the CCP, and should minimize risks to market participants 
and the broader financial system. CCP resolution plans should also 
specify ex-ante resources for the recapitalization of the CCP with 
respect to both regulatory capital as well as default fund 
replenishment so that it can re-open for business and provide its 
critical services without taxpayer assistance.\11\
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    \11\ The Clearing House and the International Swaps and Derivatives 
Association recommended in a recent industry paper that authorities 
should consider the ``implementation by CCPs of arrangements to 
maintain replenishment resources that could be used to backstop the 
timely replenishment of the default fund on an interim basis (or any 
failure of a clearing member to perform its replenishment 
obligation).''
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    The resolution regime in the U.S. currently provides for CCPs to be 
resolved under Title II of Dodd-Frank, but it does not provide any 
further framework regarding the tools or resources that can be used to 
resolve CCPs. Further work needs to be done to confirm how a Title II 
resolution would be effectuated for the different ownership and capital 
structures of systemically-important CCPs.
    Recognizing the need for greater prescription, the Financial 
Stability Board (FSB) is expected to consult later this year on further 
guidance on strategies and tools for CCP resolution, such as the 
resources that can be used, the structure to be adopted, the legal 
framework to be applied, the authority responsible for resolution, and 
cross-border coordination issues in the context of a CCP resolution. 
U.S. regulators should issue new guidance in line with the FSB's 
recommendations, which would also support future equivalence 
discussions with various jurisdictions.
II. Capital Constraints are Reducing Access to Clearing for Market 
        Participants
    This Committee and the CFTC should be complimented for their 
leadership in examining the impact of the leverage ratio on the cost of 
clearing for end-users and other market participants. Clearing members 
are fully responsible to the CCP for the performance of the 
transactions they clear for their clients, and clearing members collect 
margin from those clients to offset their exposure to them. The margin 
collected by clearing members is segregated from our own funds as 
required by the Commodity Exchange Act and firms cannot leverage it.
    The Basel Committee's leverage ratio proposal, however, does not 
recognize the exposure reducing effect of the margin collected, and 
does not allow firms to offset off-balance exposure arising from client 
transactions against the value of the margin maintained in segregation.
    This approach creates a disincentive for many clearing member banks 
to offer clearing services due to the higher capital requirements, a 
result at odds with the G20 mandate to move more derivatives into 
central clearing. End-users are already seeing the effects of this 
approach, as there are fewer banks offering clearing services and end-
users are already seeing the price of clearing increase.\12\
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    \12\ http://www.sifma.org/issues/item.aspx?id=8589958563; http://
www.commoditymkts.org/wpcontent/uploads/2015/11/CMC-MFA-Leverage-Ratio-
Letter-End-User-Impact-Final.pdf
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    In its recent consultation regarding revisions to the leverage 
ratio, the Basel Committee did seek input from stakeholders regarding 
the impact of the failure to recognize initial margin as an offset, on 
the cost of clearing. An industry-wide response is being prepared to 
demonstrate the reduction in access to clearing for end-users, and we 
appreciate and look forward to the continued support of this Committee.
III. Mutual Recognition of CCPs is Key to a Global Derivatives Market
    The G20 leaders' 2009 agreement on derivative reform included a 
commitment to undertake reform without causing market fragmentation. 
This is an important goal given the global nature of the derivatives 
market. In practice, despite common objectives, technical and legal 
differences in national rule implementation have led to concerns around 
regulatory conflicts, inconsistencies, arbitrage, gaps and duplicative 
requirements which could undermine this goal. Subsequent G20 
communiques have emphasized the need for regulators to address these 
issues.
    The lengthy negotiation between U.S. and EU authorities on EU 
recognition of U.S.-based CCPs regulated by the CFTC illustrates the 
challenges faced. Policymakers had struggled to reach agreement due in 
part to differences in the applicable initial margin regimes in each 
jurisdiction. Following negotiations lasting over 2 years, in February 
2016, the CFTC and European Commission announced a ``Common Approach'' 
regarding requirements for CCPs.\13\ This was a welcome development, 
alleviating prolonged uncertainty which had been detrimental for market 
participants in the U.S. and EU, as well as in other jurisdictions 
seeking recognition in these markets.
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    \13\ http://www.cftc.gov/PressRoom/PressReleases/
cftc_euapproach021016.
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    The agreement between EU and U.S. authorities is critical to 
mitigating unnecessary reductions in cross-border trading and market 
liquidity by ensuring market participants across both continents have 
continued access to CCPs in each other's markets, and to prevent 
European banks from facing punitive capital requirements for exposures 
to U.S.-based CCPs.
    The process will help to instruct and streamline future equivalence 
and substituted compliance determinations between U.S., EU and other 
authorities, particularly with respect to equivalence for trading 
venues and substituted compliance for clearing, trade execution and 
margin requirements, to ensure that derivative markets remain global, 
liquid and resilient. It is important that regulators focus on thematic 
and outcomes-based determinations, rather than pursuing a granular 
element-by-element approach. It is also important to recognize that 
markets are global and that the global economy benefits most if capital 
is able to freely flow across those markets.
Trade Execution and the Implementation of the SEF Mandate
I. Evolution in Swaps Execution
    Title VII of the Dodd-Frank Act established a comprehensive 
regulatory framework for swap trading platforms with the intent of 
furthering two policy objectives: (1) increasing pre-trade transparency 
to market participants before the point of execution; and (2) promoting 
trading on regulated exchanges. To achieve these objectives, Title VII 
created new types of trading facilities for swap execution known as 
swap execution facilities (``SEFs''), established core principles for 
the orderly and efficient operation of SEFs and introduced a 
requirement that certain swaps subject to the trade execution 
requirement in Section 2(h)(8) of the Commodity Exchange Act (``CEA'') 
be traded on or pursuant to the rules of a SEF or traditional exchanges 
(designated contract market (``DCM'')).
    In June 2013, the CFTC adopted final rules that, among other 
things, defined which trading facilities and platforms must register as 
SEFs, established prescriptive requirements for SEFs to operate in 
accordance with SEF core principles and, although not expressly 
required by Dodd-Frank, created a process for determining which swaps 
are subject to the CFTC's trading mandate (``Mandated Swaps''). That 
process is commonly known as the ``made available to trade'' or ``MAT'' 
process. The CFTC's final rules' further required that all multiple-to-
multiple trading platforms that list swaps to register as SEFs, even if 
those platforms do not offer Mandated Swaps for trading.
    Since the CFTC's final trade execution rules came into force in 
October 2013 and the introduction of SEFs the CFTC's reforms have 
brought greater transparency, better price information and significant 
enhancements to market integrity. Notwithstanding these achievements, 
research shows that global derivatives markets have fragmented along 
geographic lines.\14\
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    \14\ https://www2.isda.org/functional-areas/research/research-
notes/.
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    These rules require all electronic trading platforms that provide 
access to U.S. investors for swap execution to register with the CFTC 
as SEFs. Under the CFTC's final rules, Mandated Swaps must be executed 
on a SEF or DCM through an electronic order book or a request-for-quote 
system that operates in conjunction with an order book.\15\ This 
trading requirement has fundamentally changed the trading protocols and 
widely-accepted trading practices that were in place for market 
participants before the adoption of the CFTC's final rules.
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    \15\ A request-for-quote system is a type of electronic bidding 
solicitation in which a requester (i.e., a client) seeks bids from 
several dealers to provide a price quote for the execution of a 
particular swap.
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    In February 2014, the first series of swaps became subject to the 
CFTC's trading mandate. As of that date, all U.S. persons (and non-U.S. 
persons trading with U.S. persons) had to trade Mandated Swaps on 
registered SEFs or DCMs and all SEFs and DCMs that listed Mandated 
Swaps were required to do so in accordance with the CFTC's final rules.
II. Market Impact of the CFTC's Final Rules
    In effect, since the CFTC's trade execution requirements are 
restrictive and burdensome, non-U.S. market participants are choosing 
not to trade on SEFs. In addition, since the CFTC has not establish a 
process of recognizing non-U.S. trading venues that are subject to 
comparable regulatory oversight, U.S. participants have limited access 
to these non-U.S. based platforms and arguably non-U.S. liquidity 
pools.
    These unintended consequences are most evident in the global 
interest rate swap markets which have inhibited market participants 
from getting better pricing on derivatives resulting from varying 
levels of market fragmentation. This pattern is most persistent in 
euro-denominated interest rate swaps (IRS), where the vast majority of 
trading activity occurs between European dealers. ISDA research finds 
that 91.2% of cleared euro IRS activity in the European interdealer 
market was transacted between European counterparties in December 2015. 
In September 2013, immediately prior to the introduction of the SEF 
rules, this figure stood at 70.7%.\16\
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    \16\ https://www2.isda.org/functional-areas/research/research-
notes/.
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    Although concerns over best pricing have been discussed for almost 
3 years, there are no signs currently that this trend is reversing. 
CFTC Chairman Massad's recent statements that suggest the CFTC is 
planning to make some adjustments to their final trade execution rules 
are welcome and important for promoting market efficiency. In this 
regard, market participants have put forth recommendations to improve 
pricing and restore liquidity in the derivatives markets, while still 
achieving the objectives of the reforms.
III. Market Participants Want Additional Choice in Execution and 
        Greater Flexibility in SEF Rules
    As noted above, the CFTC's final rules require SEFs to provide 
execution methods that may include either an order book (similar to an 
exchange) or a request for quote to a minimum of three participants. 
Many of our U.S. clients want flexible trading requirements and 
protocols that will provide competitive and efficient execution based 
on the unique characteristics of a particular product.
    The Dodd-Frank Act does not require that SEFs only execute 
transactions by means of an order book or a request-for-quote system to 
three. Such a restrictive interpretation contradicts Congressional 
intent to allow swaps to be traded by ``any means of interstate 
commerce,'' discourages trading of swaps on SEFs and hurts pre-trade 
price transparency.\17\ The CFTC's restrictive interpretation makes it 
difficult to achieve the broad goal of global swaps trading envisioned 
by the G20 member countries. In Europe, policymakers and regulators 
intend to allow derivative contracts that are subject to the trading 
obligation to be traded on a number of centralized venues, which offer 
more flexible methods of execution than provided for under the CFTC's 
SEF rules.
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    \17\ 7 U.S.C. 1a(50) (2015).
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    There are achievable ways in which to reduce the undesirable 
regulatory outcomes that threaten the efficient functioning of the 
swaps markets, reduce barriers to market access for U.S. market 
participants looking to trade abroad and for non-U.S. market 
participants wishing to trade efficiently in the United States, and 
minimize roadblocks to an effective cross-border regulatory regime, 
while preserving increased transparency and market integrity.
    The CFTC should consider amending its rules to allow the CFTC, 
under certain circumstances, to approve additional methods of execution 
for Mandated Swaps. In addition, adjusting SEFs' execution models could 
facilitate a path toward achieving a substituted compliance regime for 
derivatives trading.
IV. The MAT Process Should Give the CFTC Decision-Making Authority With 
        Regard to Products Mandated To Be SEF Traded, and Market 
        Participants Should Have the Opportunity To Provide Input
    Under the current MAT process, a SEF or DCM files with the CFTC, 
identifying the swap or swaps that will be subject to the CFTC's 
trading mandate. The only requirements or regulatory standards that the 
SEF's or DCM's analysis must meet are that: (1) the swaps in the 
submission must already be subject to mandatory clearing; and (2) the 
submission must consider one of six factors, broadly defined. Depending 
on the type of submission, in either 10 or 30 days following the 
official filing date, the SEF's MAT determination becomes law and 
applies to all SEFs, DCMs and market participants. SEFs are for-profit 
entities and this framework does not appropriately balance their 
commercial interests with the needs of market participants nor does it 
provide the CFTC with an adequate voice in the approval process. 
Specifically:

   The MAT process should require SEFs to provide a more 
        granular explanation as to why a particular swap contains the 
        requisite trading liquidity for mandatory trading. For example, 
        SEFs should present additional quantitative and qualitative 
        data as part of their MAT determination assessment.

   The public should be given the opportunity to provide 
        comments to a SEF's MAT determination submission through a 
        public consultation process.

   The CFTC and not SEFs should make the final decision as to 
        when a swap should be considered to be a Mandated Swap.

   The CFTC should view a swap's availability for mandatory 
        trading as a fluid determination. The SEF rules do not provide 
        sufficient flexibility to both SEFs and SEF users to remove a 
        certain swap from a MAT determination if the trading 
        characteristics of the swap change such that it is no longer 
        suited for trading through a SEF's order book or through a 
        request for quote to three participants.

    Market participants understand the CFTC is actively evaluating 
reforms to the MAT process and such refinements would be welcome.
IV. Trading Venue Equivalence Will Reduce the Risk of Further Market 
        Fragmentation and Promote Trading Liquidity Between U.S. and 
        Non-U.S. Markets
    Other jurisdictions are at various stages of developing their own 
trade execution regulatory regimes. For example, the EU is in the 
process of developing its trading proposals, and its trading obligation 
is not expected to be implemented until 2018. Notwithstanding that 
foreign regulatory regimes are in their formative stages, it is 
encouraging that the CFTC has begun coordinating with foreign 
regulators to facilitate mutual recognition of trading platforms and 
trading requirements.
    To reduce the risk of market fragmentation and to enhance trading 
liquidity between U.S. and non-U.S. markets, the CFTC should apply the 
principles outlined in the Final Report issued by IOSCO Task Force on 
Cross-Border Regulation and recognize and highlight the broad 
commonalities between the U.S. and foreign regulatory regimes, rather 
than focus on the more technical, line-by-line differences between the 
underlying rules.
    The CFTC should compare its final trading rules with foreign 
regulations designed to achieve corresponding regulatory outcomes. 
Where these requirements are satisfied, the CFTC should provide that 
the foreign trading venues are exempt from SEF registration and 
compliance with the SEF rules, and that where a swap is subject to the 
CFTC's trading mandate, the parties to such a swap may satisfy the 
obligation to comply with the CFTC's trading mandate by executing such 
a swap on a foreign trading venue in accordance with applicable rules, 
regardless of their status as a U.S. person or otherwise.
    Congress directed the CFTC to exempt a trading venue from CFTC 
registration if the CFTC finds that the facility is ``subject to 
comparable, comprehensive supervision and regulation on a consolidated 
basis by . . . the appropriate governmental authorities in the home 
country of the facility.'' This creates concerns about the competitive 
harm to American companies resulting from differences in final 
regulations, the gap in implementation dates in Europe and other 
jurisdictions as well as confusion over the extraterritorial 
application of these provisions. Congress provided the CFTC with broad 
authority to exempt platforms to adopt such a restrictive approach to 
mutual recognition. To that end, market participants see this authority 
as a helpful mechanism by which Congress intended the CFTC to pursue a 
more flexible approach based on global regulatory collaboration.
    The work the CFTC and EU regulators have undertaken to date 
discussing these issues is important. In February 2016, both regulators 
announced the U.S./EU Common Approach, which market participants hope 
will result in greater harmonization of global trade execution 
standards.
Conclusion
    We thank the Committee for the opportunity to share this 
perspective and we offer our assistance to policymakers in addressing 
issues that promote the viability of markets critical to end-users and 
economic growth.
    With the implementation of mandatory central clearing, CCPs have 
become an increasingly important component in the overall safety and 
soundness of the financial system. It is therefore critical that 
policymakers and market participants ensure the risk management 
frameworks in place at CCPs are sufficiently robust to reflect this 
enhanced role, particularly as central clearing is no longer optional 
for many market participants seeking to manage risk.
    Similarly, it is important for regulators to review the various new 
requirements, with regard to both market reforms and new prudential 
standards, to understand any interconnections and ensure objectives are 
aligned. The leverage ratio's failure to recognize the exposure 
reducing effect of initial margin for client clearing is an example 
where regulatory objectives are at odds and it is already manifesting 
in reduced access to clearing services for some market participants.
    Last, minor adjustments to the CFTC's SEF rules would support 
market efficiency, while maintaining the core objectives of enhanced 
transparency and market integrity.

    The Chairman. All right, thank you, Ms. Rosenberg.
    Mr. Merkel.

STATEMENT OF STEPHEN M. MERKEL, J.D., EXECUTIVE VICE PRESIDENT, 
 GENERAL COUNSEL AND SECRETARY, BGC PARTNERS, INC.; DIRECTOR, 
                       WHOLESALE MARKETS
          BROKERS' ASSOCIATION, AMERICAS, NEW YORK, NY

    Mr. Merkel. Thank you, Chairman Scott, Ranking Member 
Scott, and Members of the Subcommittee.
    My name is Stephen Merkel. My company, BGC Partners, is a 
leading global intermediary to the wholesale financial markets. 
I am testifying today as a Director and former Chairman of the 
Wholesale Markets Brokers' Association, Americas, an 
independent industry body, representing the largest interdealer 
brokers. Each of our members has a CFTC-registered swap 
execution facility, or SEF.
    Mr. Chairman, it has been a long, strange trip, from the 
early versions of what would ultimately result in the Dodd-
Frank Act, to the current state of affairs. Generally speaking, 
nothing has gone as planned.
    The SEF rules demonstrate an interpretation inconsistent 
with the new Commodity Exchange Act statutory authority. The 
subsequent SEF registration process highlighted numerous 
defects in the rules. As a result of these detours, we found, 
and find, ourselves in an environment of regulatory 
uncertainty, fragmented liquidity, and a need for course 
corrections by the CFTC.
    Looking forward, and putting it simply, we all need to 
support the CFTC to fine-tune its rules and enjoy harmonious 
relationships around the world.
    I credit highly the dedicated CFTC staff who completed an 
enormous amount of work, designing and implementing the 
architecture for a regulatory regime. CFTC staff has helped us 
through the registration process to become a SEF, accommodated 
us through the issuance of no-action letters, staff guidance, 
and interpretative statements. Unfortunately, this reactive and 
ad hoc process cannot easily cover every problem or need, and 
fails to provide the same regulatory certainty as APA compliant 
rules.
    My written testimony references a series of outstanding 
substantive issues that need to be resolved. We are encouraged 
by Chairman Massad's recent statement that CFTC will seek to 
codify the existing no-action letters under the formal 
rulemaking process, and we urge them to address a wider set of 
issues in that release.
    There have also been pronounced market implications. 
Liquidity has fragment by jurisdiction as non-U.S. participants 
seek to avoid Dodd-Frank.
    My written testimony cites the recent ISDA research and the 
Bank of England staff study on this point. The research warns 
that there is no sign of this trend reversing.
    This arrangement is not sustainable, nor is it consistent 
with the visions set forth in Pittsburgh in 2009. Because this 
is a new regulatory framework, the CFTC should regularly 
analyze market data to study the impact of its rules. If ISDA 
and the Bank of England can do this, the CFTC should too. The 
research should be published, conclusions publicly commented 
on, and the resulting product should inform future policy 
initiatives.
    The path forward for any future mutual recognition process 
will need to resolve the awkward regulatory relationship among 
jurisdictions. Current comparison of Dodd-Frank in MiFID II 
raises questions about whether the two can coexist, including 
the CFTC's past failed attempt to institute a qualified 
multilateral trading facility regime.
    There are also divergent approaches to the permitted 
methods of execution with, for example, MiFID explicitly 
identifying auction protocols. Furthermore, the CFTC's reliance 
on no-action relief is a procedural tool that is not recognized 
in Europe.
    Mr. Chairman, I hope this Subcommittee will encourage the 
CFTC to make mutual recognition and equivalency a high 
priority.
    I would be pleased to answer your questions. Thank you.
    [The prepared statement of Mr. Merkel follows:]

     Prepared Statement of Stephen M. Merkel, J.D., Executive Vice 
President, General Counsel and Secretary, BGC Partners, Inc.; Director, 
     Wholesale Markets Brokers' Association, Americas, New York, NY
Introduction
    Chairman Scott, Ranking Member Scott, and Members of the 
Subcommittee, thank you for providing this opportunity to participate 
in today's hearing.
    My name is Stephen Merkel. I am the Executive Vice President, 
General Counsel and Secretary of BGC Partners, Inc. (``BGC Partners''), 
a leading global intermediary to the wholesale financial markets, 
specializing in the brokering of a broad range of financial products, 
including fixed income, interest rate derivative, foreign exchange, 
equity, equity derivative, credit derivative, listed futures, 
commodity, and structured product markets. BGC Partners was created in 
August 2004, when Cantor Fitzgerald separated its voice and electronic 
interdealer brokerage business from its dealer activities.
    I am testifying today in my capacity as a Director and former 
Chairman of the Wholesale Markets Brokers' Association, Americas (the 
``WMBAA''), which represents BGC Partners, GFI Group, Tradition, and 
Tullett Prebon.\1\ Each of the WMBAA member firms has registered a swap 
execution facility (``SEF'') with the Commodity Futures Trading 
Commission (``CFTC''). For each of the last 7 years, we have 
collectively hosted a 1 day conference in Washington or New York 
appropriately entitled ``SEFCON'' that explores the top issues facing 
our industry and over-the-counter (``OTC'') markets from both a 
domestic and global perspective. The WMBAA extends thanks to the 
Chairman and other Members of the Agriculture Committee who have 
attended and shared their thoughts at this marquee event.
---------------------------------------------------------------------------
    \1\ The WMBAA is an independent industry body representing the 
largest inter-dealer brokers. The founding members of the group--BGC 
Partners, GFI Group, Tradition, and Tullett Prebon--operate globally, 
including in the North American wholesale markets, in a broad range of 
financial products, and have received permanent registration as swap 
execution facilities. The WMBAA membership collectively employs 
approximately 4,000 people in the United States; not only in New York 
City, but in Stamford and Norwalk, Connecticut; Chicago, Illinois; 
Jersey City and Piscataway, New Jersey; Raleigh, North Carolina; Juno 
Beach, Florida; Burlington, Massachusetts; and Dallas, Houston, and 
Sugar Land, Texas. For more information, please see www.wmbaa.com.
---------------------------------------------------------------------------
    Thank you for inviting me to speak with you about the ongoing 
implementation of the September 2009 Pittsburgh G20 commitments to 
improve OTC derivatives markets.\2\ The WMBAA remains supportive of 
coordinated global efforts to promote trading on regulated venues, 
central counterparty clearing, and public reporting of standardized OTC 
derivative contracts in order to ``improve transparency in the 
derivatives markets, mitigate systemic risk, and protect against market 
abuse.'' \3\
---------------------------------------------------------------------------
    \2\ See Leaders' Statement, the Pittsburgh Summit, September 24-25, 
2009, available at
https://www.treasury.gov/resource-center/international/g7-g20/
Documents/pittsburgh_sum
mit_leaders_statement_250909.pdf.
    \3\ Id.
---------------------------------------------------------------------------
    I welcome the chance to update you from the WMBAA's perspective as 
it relates to implementation of trade execution regulations and the 
impact on global market conditions.
    In my written testimony, I will focus on the following points:

   First, the primary driver of the G20 commitments was to 
        address systemic risk to our financial system. Trade execution 
        in and of itself was not and has never been singled out as 
        contributing to the financial crisis.

   Second, while not without challenges or material shifts in 
        pre-existing market structure, markets are gradually adjusting 
        to the new regulatory landscape and the new SEF trading 
        environment. There remain significant efforts to ensure a 
        globally coordinated approach is ultimately put in place. The 
        CFTC should continue to review its rules, analyze their impact 
        on market conditions, with quantifiable metrics, and adjust the 
        regulations as appropriate.

   Third, important lessons should be learned from the 
        prolonged clearinghouse mutual recognition negotiations so that 
        trade execution venues do not have to endure the same 
        experience. With liquidity provision services offered by SEFs 
        in the United States (``U.S.''), multilateral trading 
        facilities (``MTFs''), soon to be recognized organized trading 
        facilities (``OTFs'') in Europe, introducing brokers, 
        traditional broker-dealers, and others, global regulators 
        should more carefully coordinate regulatory efforts so as to 
        not fragment markets, reduce liquidity, and increase costs to 
        users by rupturing the existing methods by which U.S. and non-
        U.S. swap dealers, international banks, global asset managers, 
        and end-users access competitive, transparent OTC markets in 
        the U.S. or in other jurisdictions. We have already witnessed 
        liquidity move across borders. Global regulatory gaps have not 
        only promoted bifurcation of trading patterns but can be 
        exploited to the detriment of investors.

   Finally, while some key implementation issues remain with 
        the CFTC's SEF rules, and I will highlight several today, the 
        WMBAA remains hopeful that many of these outstanding issues can 
        be resolved by the regulatory agencies. I will explain how the 
        CFTC interpreted clear Congressional intent to fashion a 
        flexible swap trading regime into a prescriptive, artificially 
        restrictive rule set and, to date, has not fully evaluated the 
        impact of its rules on market quality. Although continued 
        oversight and vigilance, such as this hearing, remain needed on 
        an ongoing basis, it is also our hope that that Congress will 
        not have to be called upon to reiterate through new legislation 
        its previously stated desire for a flexible, technology-neutral 
        trade execution framework that encourages innovation and 
        fosters liquidity formation.
I. The Transition to OTC Trading on Regulated Platforms Is Proceeding, 
        But Not Without Challenges
    While the CFTC's SEF rules were implemented in 2013, the first 
``made available to trade'' or ``MAT'' determination did not become 
effective until February 2014. That determination, which can only be 
initiated by a SEF petition, is the first step towards requiring that a 
certain swap be traded on a SEF. Currently, the mandatory trade 
execution requirement only applies to certain interest rate and credit 
default swaps. Accordingly, in those markets, we have seen increased 
market reliance on SEFs to facilitate trading in these products.
    Indeed, a recent International Swaps and Derivatives Association 
(``ISDA'') study found that more than \1/2\ of average daily interest 
rate derivatives trading activity was executed on a SEF during the 
first quarter.\4\ For the credit default swap index market, SEF trading 
accounted for 78.8% of average daily trade counts and 78.1% of average 
daily notional volume.\5\
---------------------------------------------------------------------------
    \4\ See ISDA SwapsInfo First Quarter 2016 Review, June 2016 
(stating ``[m]ore than half of average daily IRD trading activity was 
executed on a [SEF] during the first quarter: 52.6% by trade count and 
56.0% by notional volume''), available at http://www2.isda.org/
attachment/ODQxNg==/SwapsInfo%20First%20Quarter%202016%20Review%20.pdf.
    \5\ See id.
---------------------------------------------------------------------------
    These statistics, coupled with statements of support for regulated, 
transparent intermediation of OTC derivatives by the buy-side 
institutions such as mutual funds, pension funds, insurance firms,\6\ 
and other market participants suggest a broad adjustment to rules 
implemented in support of the G20 mandate to promote regulated swap 
trade execution as a replacement for purely bilateral trade activity.
---------------------------------------------------------------------------
    \6\ See Letter from Timothy W. Cameron and Lindsey Weber Keljo, 
Asset Management Group, Securities Industry and Financial Markets 
Association to the CFTC, May 11, 2015, available at http://
www.sifma.org/commentletters/2015/sifma-amg-submits-comments-to-the-
cftc-in-response-to-commissioner-giancarlo-s-white-paper-and-in-
regards-to-the-sef-regulatory-framework/.
---------------------------------------------------------------------------
    However, while the ISDA research indicates that market participants 
have migrated towards regulated intermediation in selected 
marketplaces, there are serious global market structure issues across 
the derivative markets generally that remain unresolved.
    In the U.S., for example, there are now 21-fully registered SEFs, 
one temporarily-registered SEF, and two SEFs with applications still 
pending. This means, just in the U.S. alone, domestic market 
participants must choose among 24 different venues to access liquidity. 
For each SEF, market participants have to review and compare individual 
rule books, analyze different cost structures, and complete the legal 
and technical components of onboarding before executing the first 
trade.
    While the ISDA statistics and large number of recently-registered 
SEFs may suggest a smooth transition to the SEF regime, I will share 
with the Subcommittee some of the troublesome compliance and 
interpretative issues related to swap trading that still remain. Some 
of these issues will likely be dealt with through CFTC staff 
interpretation of existing regulations and others will require changes 
to the rules. Regardless, the complexities of connecting market 
participants--with varying technological sophistication and available 
resources--with SEFs, clearinghouses, credit hubs, swap data 
repositories, and other critical market infrastructure, require 
agreement among these entities about how to best comply with the 
ruleset adopted by the CFTC, as well as those forthcoming rules from 
the Securities and Exchange Commission (``SEC'') for security-based 
swaps and corresponding regulation in Europe and Asia. With more 
clarity from regulators and consensus among market participants, the 
smoother the ongoing transition to the new rules will be.
II. The Global Swap Trading Landscape Requires Global Coordination; Any 
        Other Approach Will Harm Financial Markets
A. SEF Rules Have Fragmented Global Market Liquidity
    As intermediaries of financial products and operators of regulated 
exchange venues around the world, WMBAA members have observed firsthand 
the pronounced fragmentation caused by the CFTC's SEF rules. 
Anecdotally, we have seen market participants refrain from transacting 
with counterparties in certain jurisdictions to avoid the CFTC's 
regulatory burdens.
    For example, rather than submit to U.S. regulation, a wide spectrum 
of non-U.S. entities either withdrew from U.S. trading venues or 
refused to trade with U.S. person counterparties to reduce activity 
that would be attributed towards the ``swap dealer'' or ``major swap 
participant'' thresholds which carry significant and costly 
obligations. As a result, liquidity has been formed by jurisdiction. 
Trading has become more regionalized with, for example, Euro and 
British Pound interest rate swaps traded almost exclusively among non-
U.S. counterparties and away from SEFs, while U.S. Dollar interest rate 
swaps are now almost exclusively traded in the U.S.\7\
---------------------------------------------------------------------------
    \7\ See ISDA Research Note: Cross-Border Fragmentation of Global 
Interest Rate Derivatives: Second Half 2015 Update, May 2016, available 
at http://www2.isda.org/attachment/ODM4NQ==/Fragmentation%20FINAL1.pdf.
---------------------------------------------------------------------------
    Last month, ISDA also published its ``Second Half 2015 Update'' 
analyzing the cross-border fragmentation of global interest rate 
derivatives. ISDA concludes that ``[t]he fracturing of the global 
interest rate swaps market that emerged in the aftermath of U.S. [SEF] 
rules coming into force in October 2013 shows no signs of reversing'' 
and that ``some liquidity pools continue to be split on U.S. and non-
U.S. lines.'' \8\ Specifically, ISDA found that ``91.2% of cleared euro 
interest rate swap (`IRS') activity in the European interdealer market 
was transacted between European counterparties in December 2015,'' 
compared with 70.7% just before the CFTC's SEF rules went into effect 
in September 2013.\9\
---------------------------------------------------------------------------
    \8\ Id.
    \9\ Id.
---------------------------------------------------------------------------
    Other analysis of market data reaches the same conclusion. For 
instance, a recent Bank of England staff working paper found that:

          the introduction of the SEF trading mandate reduced the 
        proportion of trading taking place between U.S. and non-U.S. 
        persons, particularly for EUR denominated swaps. This suggests 
        that some non-U.S. persons became less willing to trade with 
        U.S. persons as this would require them to trade on a SEF. 
        Thus, an effect of the new regulation was increased 
        geographical fragmentation of the global swap market.\10\
---------------------------------------------------------------------------
    \10\ Benos, Evangelos, Richard Payne and Michalis Vasios, Bank of 
England Staff Working Paper No. 580, Centralized trading, transparency 
and interest rate swap market liquidity: evidence from the 
implementation of the Dodd-Frank Act, available at http://
www.bankofengland.co.uk/research/Documents/workingpapers/2016/
swp580.pdf, page 2.

    The Bank of England staff did not just identify fragmented markets. 
The paper also concludes that SEF trading brings benefits to investors. 
Namely, ``as a result of SEF trading, activity increases and liquidity 
improves across the swap market, with the improvement being largest for 
[U.S. Dollar] mandated contracts which are most affected by the 
mandate. The associated reduction in execution costs is economically 
significant.'' \11\
---------------------------------------------------------------------------
    \11\ Id.
---------------------------------------------------------------------------
B. Policymakers Must Improve the Mutual Recognition Process
    While the CFTC SEF registration process may be complete (with the 
SEC's corresponding security-based SEF regime still outstanding), the 
impeding MiFID II January 2018 target compliance date makes it vital 
that any trade execution regulatory gaps among the principal 
jurisdictions be resolved in the coming months.
    This Subcommittee and my fellow witnesses are all familiar with the 
issue of clearinghouse equivalence, having explored the topic in many 
prior hearings.\12\ We were pleased to see the announcement of a common 
approach for central clearing counterparties in February 2016.\13\ 
However, as CFTC Commissioner J. Christopher Giancarlo has noted, the 
equivalence debate for U.S.-registered SEFs/security-based SEFs versus 
MTFs, OTFs, and other versions of registered trading venues outside the 
U.S. could lead to another ``equivalency standoff.'' \14\
---------------------------------------------------------------------------
    \12\ See Testimony of Terrance A. Duffy before the House Committee 
on Agriculture Subcommittee on Commodity Exchanges, Energy, and Credit, 
Hearing on CFTC Reauthorization, March 25, 2015, available at http://
agriculture.house.gov/uploadedfiles/duffy_testimony.pdf; see also 
Testimony of Chairman Timothy G. Massad before the U.S. House Committee 
on Agriculture, February 10, 2016, available at http://
agriculture.house.gov/uploadedfiles/massad_testimony.pdf.
    \13\ The United States Commodity Futures Trading Commission and the 
European Commission: Common approach for transatlantic CCPs, February 
10, 2016, available at http://www.cftc.gov/idc/groups/public/@newsroom/
documents/speechandtestimony/eu_cftcstatement.pdf.
    \14\ See Six Month Progress Report on CFTC Swaps Trading Rules: 
Incomplete Action and Fragmented Markets, August 4, 2015, available at 
http://www.cftc.gov/PressRoom/SpeechesTestimony/
giancarlostatement080415.
---------------------------------------------------------------------------
    Furthermore, the CFTC's past efforts to provide a ``qualified'' MTF 
regime for execution platforms operating within the EU where U.S. 
person entities would be allowed to execute off-SEF \15\ failed 
because, among other reasons, the proposed terms allowed the CFTC to 
unilaterally remove the relief at any time. The proposal also did not 
attract participants because, under the terms of the relief, an MTF 
would be required to comply with the CFTC's SEF regime not just for 
trades involving U.S. counterparties or U.S.-regulated products, but 
even for trades executed between European counterparties on a European-
regulated product through a European trading venue. That expansive 
overreach went too far for already-regulated market participants to 
agree to a second layer of regulatory burdens.
---------------------------------------------------------------------------
    \15\ CFTC No-Action Letter No. 14-46, April 9, 2014, available at 
http://www.cftc.gov/ucm/groups/public/@lrlettergeneral/documents/
letter/14-46.pdf.
---------------------------------------------------------------------------
    Therefore, while multiple EU-based execution venues, including all 
WMBAA member firms, were prepared to meet the necessary qualifications 
for both the CFTC and the UK's Financial Conduct Authority, this 
proposal did not result in any European intermediaries agreeing to 
submit it and its participants to comprehensive CFTC oversight. The 
global derivative markets can ill afford a repeat of this scenario in 
the equivalence negotiations leading up to MiFID II implementation, 
especially because the European regulatory regime does not offer the 
flexibility of no-action relief and, therefore, an avoidable 
polarization of liquidity pools may become permanent if an agreement is 
not reached prior to January 2018. We urge the Subcommittee to 
prioritize execution equivalence as the primary tool to counter the 
increasingly well-entrenched trend for liquidity to be split along 
regional lines.
    As we have seen, the paralyzing impact this delay in coordination 
and overall uncertainty can bring to clearinghouses with the 
accompanying segregation of trading, the same (if not worse) could 
happen if the current opportunity to shape execution equivalence 
between the U.S. and the EU is squandered. Of course, the costs will be 
borne by liquidity providers, asset managers, and end-users who rely on 
intermediaries to provide this vital function, as they will receive 
fragmented, less competitive bids and offers due to barriers erected by 
uncoordinated cross-border rules. All of these artificial blockages to 
natural liquidity formation result in higher costs to investors who are 
meant to be the ultimate beneficiary of the reforms instituted by the 
Dodd-Frank Wall Street Reform and Consumer Protection Act (``Dodd-Frank 
Act'').\16\
---------------------------------------------------------------------------
    \16\ Public Law 111-203, 124 Stat. 1376 (2010).
---------------------------------------------------------------------------
    Subsequent to the G20 summit in Pittsburgh and well before the 
adoption of the Dodd-Frank Act, WMBAA members and other trading firms 
were preparing for what would ultimately result in the current SEF 
regime. There has been nearly a decade of time, energy, and resources 
devoted to post-financial crisis regulatory reform that has been 
replicated in other G20 jurisdictions. These parallel work streams 
should have resulted in a comprehensive, consistent, and coordinated 
global oversight framework that promotes market liquidity and function 
while meeting public policy objectives.
    Yet, to date, that has not occurred. Some global financial services 
companies have created and registered separate entities in various 
jurisdictions purely to avoid being subject to SEF terms and 
conditions. Some intermediaries have submitted their European platforms 
for U.S. oversight in a splintered fashion. And, most recently, the 
CFTC received an application for a jointly-registered SEF and MTF. 
While market participants remain tentative and unsure as to how the G20 
global trade execution implementation permutations will play out, this 
also suggests uncertainty among the trading venues themselves.
III. Examples of Necessary Regulatory Improvements to the CFTC SEF 
        Regime
    The WMBAA has long publicly supported a flexible, principles-based 
approach to the implementation of the Dodd-Frank Act trade execution 
framework. In that light, we continue to harbor reservations about some 
of the technical points related to the CFTC's interpretation of certain 
provisions of the Dodd-Frank Act and the staff's reading of the 
implementing regulations in terms of satisfactory policies and 
procedures. Furthermore, while other global regulatory bodies and 
industry associations, like the Bank of England and ISDA, have engaged 
in an empirically-based evaluation of the swap trading rules on market 
conditions, the CFTC has not yet published any data-driven analysis of 
their own rules. We strongly believe that should be completed, 
published for market feedback, and result in appropriate changes to the 
rules.
    As I said at the outset, we remain hopeful that many of these can 
be resolved at the agency level. But we very much appreciate this 
Subcommittee's interest in these very important issues and its 
continued oversight of the CFTC's work.
    The current mix of statute, rules, no-action letters, staff 
guidance, and interpretive statements does not provide sufficiently 
predictable regulatory certainty for SEFs to plan, invest, and grow 
domestically or to be able to incorporate SEF activity within global 
operations. As long-standing businesses placed under a novel regulatory 
scheme, it is vital to know objectively not just the practical 
implications of rules but how they may be interpreted on a permanent 
basis similar to rules adopted under the Administrative Procedure Act. 
Staff or Division letters and guidance are informative, but can be 
revoked or amended at any time without any due process protections. The 
Subcommittee should remain aware of the Commission's reliance on these 
measures and protect against their overuse.
    Chairman Massad has said, even recently, that the CFTC has ``fine-
tuned'' some of its rules through no-action letter relief and will 
``consider a codification of those adjustments, and potentially other 
changes to enhance SEF trading and participation.'' \17\ The WMBAA 
welcomes this approach as an initial step as the formalization in rule 
text provides additional reliability. However, the WMBAA also believes 
that more substantive, comprehensive changes are likely necessary on a 
wider range of issues than simply codifying a few existing no-action 
letters. We agree with Chairman Massad that the CFTC should work to 
create ``the foundation for the market to thrive'' and ``permit 
innovation, freedom and competition.'' \18\
---------------------------------------------------------------------------
    \17\ Statement of Chairman Timothy Massad before the CFTC's Market 
Risk Advisory Committee, April 26, 2016, available at http://
www.cftc.gov/PressRoom/SpeechesTestimony/massadstatement042616.
    \18\ Remarks of Chairman Timothy Massad before the ISDA 30th Annual 
General Meeting, April 23, 2015, available at http://www.cftc.gov/
PressRoom/SpeechesTestimony/opamassad-17.
---------------------------------------------------------------------------
    To assist the Commission in its review of changes to enhance SEF 
trading and participation, in March of this year, the WMBAA submitted a 
comprehensive list of issues to Chairman Massad. That letter is 
attached to my testimony today. We look forward to participating in a 
productive dialogue with Chairman Massad, his fellow Commissioners, and 
the hard-working CFTC staff.
    Briefly, I would like to highlight a few issues set forth in the 
WMBAA's March 2016 letter.
    Explicit regulatory certainty with respect to flexible modes of 
execution. The SEF definition, as set forth in the Dodd-Frank Act,\19\ 
is intentionally broad, flexible, and contemplates a wide array of 
execution methods. The implementing CFTC regulation artificially 
restricts permitted methods of liquidity formation and execution to an 
order book or request for quote (``RFQ'').\20\ First, this is 
problematic because it is inconsistent with the clear language of the 
statute. Second, this approach may prevent or discourage certain 
technologies from facilitating trading through a registered SEF. 
Finally, and importantly given the ongoing work to achieve global 
harmonization, the restriction on execution methods is narrower than 
those clearly permitted under MiFID II, which may ultimately drive 
derivatives trading away from the U.S.
---------------------------------------------------------------------------
    \19\ See CEA  1a(50) (``a trading system or platform in which 
multiple participants have the ability to execute or trade swaps by 
accepting bids and offers made by multiple participants in the facility 
or system, through any means of interstate commerce, including any 
trading facility, that--(A) facilitates the execution of swaps between 
persons; and (B) is not a designated contract market.'').
    \20\ The traditional RFQ trading protocol, where a single market 
participant solicits a bid or offer from at least three other market 
participants, seems to fall short of the ``multiple to multiple'' 
component of the SEF definition.
---------------------------------------------------------------------------
    The WMBAA urges the CFTC to make clear that SEFs may operate other 
protocols besides order books or RFQs, including Trading Facilities, 
under the Commodity Exchange Act (``CEA''). For example, auction-type 
systems such as BGC Partners' VolumeMatch meet the CEA definition of 
trading facility and, therefore, should be explicitly permitted as an 
acceptable execution method for Required Transactions. It has been our 
experience that these new trading protocols continue to gain favor in 
the marketplace as an alternative to order book and RFQ trading and 
more effectively promote competitive price discovery for interested 
parties.
    Made Available to Trade. The WMBAA believes the MAT process should 
be amended. While SEFs should commence the review through the filing of 
the petition, the petition's approval should not be a ``negative 
consent'' process. The CFTC's Part 40 rules' 10 day negative consent 
process starts with a presumption of approval and removes any real 
discretion or judgment from the CFTC's hands. The MAT determinations 
are important and should benefit from more careful analysis of a wider 
set of information rather than being subject to the single submission 
of an individual SEF.
    Rather, the CFTC should have the responsibility of making the 
determination based on objective criteria and subject to public notice 
and comment on the petition. The factors that the CFTC considers in 
deciding whether to impose a SEF trading mandate should be consistent 
with the process and analysis followed by other global financial market 
regulators in order to prevent any bifurcation of the swap markets and 
regulatory arbitrage.
    SEF Position Limit or Position Accountability Regimes. The Dodd-
Frank Act requires SEFs to ``adopt for each of the contracts of the 
facility, as is necessary and appropriate, position limitations or 
position accountability for speculators'' and then to ``[m]onitor 
positions established on or through the [SEF] for compliance with the 
limit set by the Commission and the limit, if any, set by the [SEF].'' 
\21\ The WMBAA and the broader SEF community, including a SEF chief 
compliance officer working group, have engaged with the CFTC on this 
issue. Both the National Futures Association and the WMBAA have 
authored white papers on the topic.
---------------------------------------------------------------------------
    \21\ CEA  5h(f)(6).
---------------------------------------------------------------------------
    Simply put, SEFs, as competitive trading platforms, do not possess 
information about a trader's overall position in any given swap or its 
underlying instrument or commodity because of the inherently 
competitive nature of swap trading. A SEF is not a centralized 
exchange; each SEF is one of multiple competitive platforms 
facilitating trading activity in fungible financial products that can 
and does move easily from one venue to another. Unlike listed futures 
and options where trading and clearing is vertically integrated and 
each centralized exchange has information about positions in the 
marketplace for any specific contract, each SEF only has information 
about swap transactions that take place on its individual facility and 
has no access to information as to whether a particular trade on the 
facility adds to an existing market-wide position or whether it offsets 
all or part of an existing position in that swap.
    The CFTC should specify that SEFs are not obligated to impose 
position limits or accountability until such time as the CFTC 
determines that such measures are ``necessary and appropriate,'' 
especially because unified position information is available at the 
swap data repository level where all SEF trade data is maintained. 
Further, implementing position limitations or position accountability 
is not necessary and appropriate at this time because, it has not been 
proven that such limits are an effective tool for detecting and 
preventing manipulation and other abuses for swaps.
    SEFs accept and take seriously their obligation as market operators 
to ensure they provide reliable, resilient venues to access competitive 
pricing. This includes monitoring for manipulation and other abusive 
trading activity that takes place on each individual facility which 
will continue in earnest as part of our responsibility to meet existing 
SEF core principles.
    SEF Financial Resource Requirements. The CEA requires all SEFs to 
have ``adequate financial, operational, and managerial resources.'' 
During the SEF registration review process, we learned that CFTC staff 
believe that all SEF employees are considered part of the SEF's 
financial obligation, regardless of the employment arrangement (e.g., 
at-will, contractual, or guaranteed salary). As a result, SEFs with 
voice-based systems face significantly higher financial resources 
commitments than those facilities that only provide electronic trading 
access. The Dodd-Frank Act does not dictate this outcome. From a public 
policy standpoint, it prevents investment and growth if a SEF must 
freeze capital to help pay at-will or contracted staff for a full year 
when, in reality, the SEF does not have that liability to simply 
``discharge each responsibility of the [SEF].''
    We continue to discuss with the CFTC and staff a more realistic, 
flexible interpretation that promotes all types of swap trading and 
only attributes the financial resource requirement to cover the fixed 
costs associated with compliant SEF operation and solely those required 
to ensure compliant operations. We think that is a more appropriate 
approach than factoring in variable costs and costs related to staff 
that are not core to a compliant operating structure and who would not 
be associated with the SEF for the currently-required 12 month 
timeframe in the event of a change to the business. One possible 
solution involves relying on a rule provision that delegates the CFTC's 
authority on this issue to the Director of the Division of Market 
Oversight. We look forward to continued engagement with the CFTC on 
this issue.
IV. Conclusion
    Mr. Chairman, the WMBAA appreciates the opportunity to appear today 
and discuss the ongoing work to implement the G20 mandates. We look 
forward to continued work on these developments with Congress, the 
CFTC, the SEC, and regulatory bodies around the world.
    I would be pleased to answer any questions you may have.
                                Appendix
March 11, 2016

  Hon. Timothy Massad,
  Chairman,
  Commodity Futures Trading Commission,
  Washington, D.C.

Re: Swap Execution Facility Regulations, Made Available to Trade 
            Determinations, and Swap Trading Requirements

    Dear Chairman Massad:

    Since the promulgation of the regulations governing swap execution 
facilities (``SEFs'') pursuant to the Dodd-Frank Wall Street Reform and 
Consumer Protection Act (the ``Dodd-Frank Act''), Commissioners of the 
Commodity Futures Trading Commission (``CFTC'' or ``Commission'') have 
discussed the Commission's consideration of potential revisions to 
various aspects of its swap regulations, including those reforms 
related to SEFs and trade execution. For example, you have stated that 
the Commission is ``focused on issues concerning trading on [SEFs],'' 
and that you ``will ask the Commission to consider a number of rule 
changes to enhance SEF trading and participation.'' \1\ Calls for the 
Commission to consider potential revisions to its Dodd-Frank Act 
regulations have also been raised by Commissioner Bowen \2\ and 
Commissioner Giancarlo.\3\ In addition, Commission staff has indicated 
that they are considering potential no-action relief or guidance with 
respect to issues that market participants have identified as 
problematic.
---------------------------------------------------------------------------
    \1\ See Keynote Remarks before the Institute of International 
Bankers Annual Washington Conference (Mar. 7, 2016).
    \2\ See Statement of Commissioner Bowen, Dec. 1, 2014 (stating that 
``the best way of viewing changes to [the CFTC's Dodd-Frank Act 
rulemakings] is not that [the CFTC is] tweaking them, but rather that 
[the CFTC is] enhancing them. Sometimes that may mean making the rules 
more cost-effective and leaner, but at other times that will mean 
making them stronger than before. Enhancing a rule can mean reducing 
burdens to business while strengthening protections for the public''), 
available at http://www.cftc.gov/PressRoom/SpeechesTestimony/
bowenstatement120114.
    \3\ See Commissioner Giancarlo White Paper, ``Pro-Reform 
Reconsideration of the CFTC Swaps Trading Rules: Return to Dodd-Frank'' 
(Jan. 29, 2015), available at http://www.cftc.gov/ucm/groups/public/
@newsroom/documents/file/sefwhitepaper012915.pdf; see also Statement of 
Commissioner Giancarlo, Six Month Progress Report on CFTC Swaps Trading 
Rules: Incomplete Action and Fragmented Markets (Aug. 4, 2015), 
available at http://www.cftc.gov/PressRoom/SpeechesTestimony/
giancarlostatement080415.
---------------------------------------------------------------------------
    The Wholesale Markets Brokers' Association, Americas (``WMBAA'') 
\4\ appreciates the Commission's careful and deliberative approach to 
the regulation of SEFs and extends its appreciation to the Commission 
for granting permanent registration to each of the member firms' SEFs 
earlier this year. This milestone represents a significant step toward 
firmly establishing the regulatory regime for mandatory trade execution 
as envisioned by the Dodd-Frank Act and providing market participants 
with further much-needed regulatory certainty. Against the backdrop of 
permanent SEF registration, the WMBAA looks forward to continuing to 
work with the Commission and its staff on all matters pertaining to 
SEFs, including on any future CFTC rulemakings, amendments, guidance, 
or interpretations related to trade execution and SEFs, to ensure that 
the regulations are implemented in accordance with the underlying 
statutory intent and accomplish the Dodd-Frank Act's goal of 
``promot[ing] the trading of swaps on swap execution facilities.''
---------------------------------------------------------------------------
    \4\ The WMBAA is an independent industry body representing the 
largest inter-dealer brokers. The founding members of the group--BGC 
Partners, GFI Group, Tradition, and Tullett Prebon--operate globally, 
including in the North American wholesale markets, in a broad range of 
financial products, and have received temporary registration as swap 
execution facilities. The WMBAA membership collectively employs 
approximately 4,000 people in the United States; not only in New York 
City, but in Stamford and Norwalk, Connecticut; Chicago, Illinois; 
Jersey City and Piscataway, New Jersey; Raleigh, North Carolina; Juno 
Beach, Florida; Burlington, Massachusetts; and Dallas, Houston, and 
Sugar Land, Texas. For more information, please see www.wmbaa.com.
---------------------------------------------------------------------------
    The WMBAA supports the Commissioners' recognition that the 
regulations should be assessed and reconsidered on an ongoing basis. In 
particular, the WMBAA supports Commission efforts to ``formalize 
through notice-and-comment rulemaking a number of the `no-action' 
positions the staff has taken, such as simplifying the confirmation 
process, streamlining the process for correcting error trades, and 
others.'' \5\ We support the regulatory certainty that formal rule 
changes would provide to issues related to SEF confirmation and 
reporting, trades deemed void ab initio,\6\ and trading of block trades 
``on facility.'' The WMBAA also recognizes that certain reporting 
requirements may merit reconsideration, including the ``embargo rule,'' 
and would welcome the opportunity to discuss such issues further with 
the Commission.
---------------------------------------------------------------------------
    \5\ See Keynote Remarks of Chairman Massad before the Institute of 
International Bankers Annual Washington Conference (Mar. 7, 2016).
    \6\ Revised regulations should permit SEFs to correct clerical or 
operational errors on swaps rejected for clearing. In addition, if a 
swap has been accepted by a DCO for clearing, and a clerical or 
operational error is subsequently identified, the regulations should 
permit a SEF to correct the error in the trade without initiating a 
``new trades, old terms'' offset and resubmission, provided that the 
DCO has the operational capability to permit such a correction.
---------------------------------------------------------------------------
    Further, to assist the Commission and its staff in its assessment 
of the SEF regulations, the WMBAA respectfully offers the attached 
matrix in Appendix A, which we have prepared based on our expertise as 
over-the-counter market operators for over 25 years and a combined 
tenure in the industry of over 100 years, and our experience to date 
with the implementation of the SEF related rules. For each of the 
following topics, the matrix notes the relevant statutory provision, 
describes the implementation issue experienced by market participants, 
references the relevant CFTC rule or staff advisory, and suggests a 
potential recommendation to address the issue. The topics are not 
presented in order of importance, but rather represent the regulatory 
implementation issues that the WMBAA members are addressing:

   Methods of execution;

   Made available to trade process;

   Audit trail requirements for voice-based executions;

   Position limits; \7\
---------------------------------------------------------------------------
    \7\ A WMBAA white paper on position limits, which was submitted to 
the Division of Market Oversight staff, is attached hereto as Appendix 
B.

---------------------------------------------------------------------------
   Financial resource requirements;

   Cross-border issues;

   Margin requirements;

   Embargo rule; and

   SEF record-keeping requirement.

    In addition to the specific issues addressed in the matrix, the 
WMBAA recommends that the Commission examine the commercial impact of 
its SEF regulations and other rules on the swap market. Specifically, 
wherever possible, the Commission should seek to ensure a level playing 
field between the futures and swap markets for commercially-equivalent 
risk management contracts by not permitting any unfair regulatory 
advantage to either market. The WMBAA believes that such regulatory 
instances, in which a swap market requirement that results in 
additional costs or creates disincentives for trading swaps relative to 
the futures market equivalent, should be reconsidered by the 
Commission.
    Last, to the extent that Commission action to modify certain swap-
related regulations are constrained by statutory language under the 
Dodd-Frank Act, the WMBAA would welcome the opportunity to work with 
the Commission to advocate for appropriate legislative changes before 
Congress. However, the attached list includes solely those issues which 
the WMBAA believes can be addressed through regulatory action.
          * * * * *
    We welcome the opportunity to discuss these comments with you at 
your convenience. Please feel free to contact the undersigned with any 
questions you may have on our comments.
            Sincerely,
            
            
William Shields,
Chairman, WMBAA.

cc:

The Honorable Sharon Bowen, Commissioner;
Mr. Vince McGonagle, Director, Division of Market Oversight.

                                             appendix a: cftc part 37 sef regulations: recommended revisions
--------------------------------------------------------------------------------------------------------------------------------------------------------
     Relevant Statutory Provision                      Issue                        CFTC Regulation Proposed                  Solution/Revision
--------------------------------------------------------------------------------------------------------------------------------------------------------
CEA  1(a)(50)
 
    ``The term `swap execution
 facility' means a trading system or
 platform in which multiple
 participants have the ability to
 execute or trade swaps by accepting
 bids and offers made by multiple
 participants in the facility or
 system, through any means of
 interstate commerce, including any
 trading facility, that--
                                       Methods of Execution
                                                                              Rule 37.9(a)(2)
 
                                                                                                                    Add a new clause ``(C)'' to the
--------------------------------------------------------------------------------------------------------------------------------------------------------
CEA  2(h)(8)
 
    ``(A) In general.--With respect
 to transactions involving swaps
 subject to the clearing requirement
 of paragraph (1), counterparties
 shall--
      (i) execute the transaction on
   a board of trade designated as a
   contract mar-
    ket . . .; or
      (ii) execute the transaction on
   a [registered SEF] or a swap
   execution facility that is exempt
   from registration . . .
                                       Made Available to Trade Process        Rule 37.10(a)(1): ``Required          Amend the made available to trade
    (B) Exception.--The requirements
 [above] shall not apply if no board
 of trade or [SEF] makes the swap
 available to trade or for swap
 transactions subject to the clearing
 exception . . . .''
--------------------------------------------------------------------------------------------------------------------------------------------------------
CEA  5h(f)(2)(B)(ii) (Core Principle  Voice Audit Trail                      Rule 37.205                           Revise the rules or provide guidance
 2)                                    CFTC staff has expressed a desire      Commission rule 37.205 sets forth      related to audit trail requirements
                                        that SEFs must be able to store        the audit trail requirement for       for voice-based executions on SEFs
    ``A [SEF] shall . . . establish     recordings of oral communications in   SEFs to ``capture and retain all      to account for the unique
 and enforce trading, trade             a digital database and convert such    audit trail data necessary to         characteristics of voice execution
 processing, and participation rules    recordings into searchable text.       detect, investigate, and prevent      and to recognize the currently
 that will deter abuses and have the   In addition, CFTC staff has explored    customer and market abuses.''         available technologies. Any such
 capacity to detect, investigate, and   the concept of requiring SEFs to      The Commission requires that such      new rules or guidance would
 enforce those rules, including means   record or access not only the          data is ``sufficient to reconstruct   supplement the existing audit trail
 . . . to capture information that      communications between the SEF's       all indications of interest,          requirements that are tailored to
 may be used in establishing whether    employees and their customers, and     requests for quotes, orders, and      electronic execution and should
 rule violations have occurred.''       any communications between             trades within a reasonable period     more accurately reflect a
                                        employees, but also the                of time and to provide evidence of    ``technology-neutral'' approach to
                                        communications of Introducing          any violations of the rules of the    SEF execution.
                                        Brokers. Introducing Brokers already   [SEF].'' Further, an audit trail     In accordance with the preamble
                                        have the obligation under NFA rules    must also permit a SEF to ``track a   discussion to the final rule, the
                                        to record communications and SEFs      customer order from the time of       WMBAA believes that ``the intent of
                                        have access to such information        receipt through fill, allocation,     the final rules is to require that
                                        pursuant to their rulebooks.           or other disposition, and shall       a SEF establish and maintain an
                                                                               include both order and trade          effective audit trail program, not
                                                                               data.''                               to dictate the method or form for
                                                                              The elements of an acceptable audit    maintaining such information.
                                                                               trail program involve (1) original    Importantly, the rule, by not being
                                                                               source documents, (2) electronic      prescriptive, provides SEFs with
                                                                               transaction history database, (3)     flexibility to determine the manner
                                                                               electronic analysis capability, and   and the technology necessary and
                                                                               (4) safe storage capability.          appropriate to meet the
                                                                                                                     requirements'' (emphasis added). 78
                                                                                                                     Fed. Reg. 33,476, 33,518 (June 4,
                                                                                                                     2013).
                                                                                                                    The WMBAA further recommends that
                                                                                                                     the CFTC consider whether the audit
                                                                                                                     trail requirements may be satisfied
                                                                                                                     based on exception or risk-based
                                                                                                                     SEF reviews.
--------------------------------------------------------------------------------------------------------------------------------------------------------
CEA  5h(f)(6) (Core Principle 6)      Position Limits                        Rule 37.600                           Specify that SEFs are not obligated
                                       SEFs do not possess information about  Same as statutory provision            to impose position limits or
    ``(a) . . . a [SEF] that is a       a trader's position in any given                                             accountability until such time as
 trading facility shall adopt for       swap or its underlying instrument or                                         the Commission determines that such
 each of the contracts of the           commodity. Rather, SEFs only have                                            measures are ``necessary and
 facility, as is necessary and          information about swap transactions                                          appropriate.''
 appropriate, position limitations or   that take place on their individual                                         Implementing position limitations or
 position accountability for            facilities and have no way of                                                position accountability is not
 speculators.                           knowing whether a particular trade                                           necessary and appropriate at this
    (b) Position limits. For any        on the facility adds to an existing                                          time because, for example: (1)
 contract that is subject to a          market-wide position or whether it                                           unlike futures and options where
 position limitation established by     offsets all or part of an existing                                           trading and clearing is vertically
 the Commission . . . the [SEF]         position in that swap.                                                       integrated and each DCM has
 shall: (1) Set its position           In addition, if SEFs were required to                                         information about positions in the
 limitation at a level no higher than   adopt position limits, market                                                marketplace for any specific
 the Commission limitation; and (2)     participants might abuse such                                                contract, they are not an effective
 Monitor positions established on or    limits. For example, if five SEFs                                            tool for detecting and preventing
 through the [SEF] for compliance       that offer a particular product set                                          manipulation and other abuses for
 with the limit set by the Commission   their respective limits at a level                                           swaps; and (2) individual SEFs do
 and the limit, if any, set by the      established by the CFTC, the overall                                         not possess information about a
 [SEF].''                               aggregate position available to                                              trader's position in any given swap
                                        market participants via trading on                                           and, therefore, have no basis of
                                        such SEFs would be five times                                                reference as to how and when a
                                        greater than the level set by the                                            position limit should be set.
                                        CFTC. As such, market participants                                          In addition to these comments, the
                                        could take advantage of this                                                 WMBAA has submitted to the Division
                                        structure by spreading their                                                 of Market Oversight (``DMO'') staff
                                        transactions across multiple SEFs                                            a white paper explaining why a SEF
                                        and DCOs when reaching the limit set                                         position limits and position
                                        by each. While staff has                                                     accountability regime is neither
                                        acknowledged that, in lieu of                                                necessary nor appropriate.\8\
                                        position limits, SEFs may establish                                          Rather than imposing a position
                                        accountability provisions related to                                         limits regime, the WMBAA
                                        trades rather than positions, the                                            respectfully reminds the Commission
                                        details of such accountability                                               that a SEF is subject to regulatory
                                        mechanisms and how accountability                                            requirements to provide data to the
                                        levels would be set are yet unclear.                                         Commission, including data related
                                                                                                                     to the trading activity on the SEF,
                                                                                                                     to assist the Commission with
                                                                                                                     monitoring compliance with Federal
                                                                                                                     speculative position limits.\9\
\8\ The WMBAA white paper is attached
 as Appendix B.
\9\ This approach was endorsed by a
 group of SEFs. See SEF CCO Group
 Discussion Document Regarding SEF
 Core Principle 6--Position Limits
 and Position Accountability (May 21,
 2015).
                                                                                                                    A SEF CCO working group, consisting
                                                                                                                     of CCOs of 18 then-provisionally
                                                                                                                     registered SEFs, commissioned the
                                                                                                                     National Futures Association
                                                                                                                     (``NFA'') to conduct a study
                                                                                                                     regarding swap position limits and
                                                                                                                     position accountability. The NFA
                                                                                                                     study suggested that the swap
                                                                                                                     market might not lend itself to
                                                                                                                     notional transaction size position
                                                                                                                     or accountability levels at the SEF
                                                                                                                     level. While this study did not
                                                                                                                     offer an official disposition as to
                                                                                                                     the necessity or appropriateness of
                                                                                                                     position accountability levels at
                                                                                                                     the SEF level, it presented data
                                                                                                                     suggesting that such position
                                                                                                                     limits or accountability levels
                                                                                                                     will do little to ``reduce the
                                                                                                                     potential threat of market
                                                                                                                     manipulation or congestion,'' the
                                                                                                                     stated goal of the Core Principle.
                                                                                                                     The SEF CCO working group provided
                                                                                                                     DMO staff with a synopsis of this
                                                                                                                     study in the form of a discussion
                                                                                                                     document.
                                                                                                                    As an alternative to the above
                                                                                                                     proposed solution, the WMBAA would
                                                                                                                     welcome specific guidance on how
                                                                                                                     SEFs can practically comply with an
                                                                                                                     accountability provision,
                                                                                                                     reflecting that: (1) SEFs do not
                                                                                                                     possess position information; and
                                                                                                                     (2) swaps are fungible in terms of
                                                                                                                     being traded on multiple venues and
                                                                                                                     cleared by multiple DCOs. Any
                                                                                                                     accountability level(s) should be
                                                                                                                     established by the CFTC, taking
                                                                                                                     into account the entirety of market
                                                                                                                     activity in a product (both on and
                                                                                                                     off SEFs), and such established
                                                                                                                     level(s) should be applied
                                                                                                                     uniformly to all SEFs.
--------------------------------------------------------------------------------------------------------------------------------------------------------
CEA  5h(f)(13) (Core Principle 13)    SEF Financial Resources                Rule 37.1300                          Flexibly interpret the SEF financial
                                       CFTC staff has indicated its           Same as statutory provision            resources requirements to reflect
    ``(A) In general.--The [SEF]        preliminary belief that all SEF                                              that SEFs are execution venues only
 shall have adequate financial,         employees are considered part of the                                         and do not ensure contract
 operational, and managerial            financial obligation, regardless of                                          performance, making their
 resources to discharge each            the employment arrangement, e.g., at-                                        commercial viability less relevant
 responsibility of the [SEF].           will, contractual, and guaranteed                                            on a post-transaction basis.
    (B) Determination of resource       salary. As a result, SEFs with voice-                                       As the Commission has delegated
 adequacy.--The financial resources     based systems face significantly                                             authority to the DMO Director on
 of a [SEF] shall be considered to be   higher financial resources                                                   issues pertaining to SEF financial
 adequate if the value of the           commitments than those facilities                                            resources, the WMBAA looks forward
 financial resources exceeds the        that only provide electronic trading                                         to working with Commission staff to
 total amount that would enable the     access.                                                                      appropriately account for the
 [SEF] to cover the operating costs    The Commission's rules do not                                                 following considerations in
 of the [SEF] for a 1 year period, as   recognize that: (1) SEFs do not                                              refining the SEF rules, including
 calculated on a rolling basis.''       possess or maintain client funds or                                          with respect to creating an
                                        open interest; (2) there is no                                               appropriate methodology for
                                        practical need for any individual                                            computing projected operating
                                        SEF to maintain sufficient resources                                         costs. See Rule 37.1307.
                                        for a period of 1 year after an                                             The SEF financial resources
                                        event that results in the closure of                                         requirement should focus on the
                                        a SEF, as a SEF could wind down its                                          fixed costs associated with
                                        operations in a much shorter time                                            compliant SEF operation and solely
                                        period; and (3) for SEFs with voice                                          those required to ensure compliant
                                        brokers, such voice brokers are not                                          operations, rather than the
                                        necessary to ensure operation of a                                           variable costs and costs related to
                                        compliant SEF and could be removed                                           staff that are not core to a
                                        at any point and for any reason                                              compliant operating structure. The
                                        without impacting the SEF's ability                                          WMBAA notes that the costs
                                        to satisfy the Core Principles.                                              associated with employing SEF
                                                                                                                     brokers constitute variable costs
                                                                                                                     and are not core to the compliance
                                                                                                                     regime and the operations of a SEF,
                                                                                                                     or necessary or required to operate
                                                                                                                     a compliant SEF, as is demonstrated
                                                                                                                     by other registered SEFs that do
                                                                                                                     not employ brokers. Therefore,
                                                                                                                     costs related to employing SEF
                                                                                                                     brokers should be excluded from the
                                                                                                                     financial resources calculation.
                                                                                                                     Contrary to DMO letter 15-26, any
                                                                                                                     salary or compensation for SEF
                                                                                                                     employee-brokers should not be
                                                                                                                     included in the calculation of
                                                                                                                     projected operating expenses.
                                                                                                                    In addition, the WMBAA has submitted
                                                                                                                     information to DMO staff regarding
                                                                                                                     liquid assets and would welcome any
                                                                                                                     further communication as needed for
                                                                                                                     a rule revision to reduce the
                                                                                                                     burden from 6 months' liquid assets
                                                                                                                     to 3 months' liquid assets.
                                                                                                                    Any modification of the financial
                                                                                                                     resource rules should take into
                                                                                                                     account the fact that the exit of
                                                                                                                     an individual SEF (or brokers
                                                                                                                     within an operational SEF) would
                                                                                                                     not have broad market-wide or
                                                                                                                     systemic effects on the swap
                                                                                                                     marketplace. This is because the
                                                                                                                     trades previously executed on the
                                                                                                                     SEF would have been fully processed
                                                                                                                     and reported, and the positions
                                                                                                                     resulting from all trades would be
                                                                                                                     unaffected, as they are held either
                                                                                                                     at a DCO for cleared trades or with
                                                                                                                     the counterparties for uncleared
                                                                                                                     trades. Moreover, if a SEF were to
                                                                                                                     experience difficulty or choose to
                                                                                                                     exit the marketplace, the wind-down
                                                                                                                     process would occur quickly. As
                                                                                                                     SEFs do not hold positions, the
                                                                                                                     unwind process would take no longer
                                                                                                                     than a few months.
--------------------------------------------------------------------------------------------------------------------------------------------------------
CEA  2(i)                             Cross-Border Concerns                  DSIO Advisory No. 13-69
                                       The scope of the Commission's cross-
    ``The provisions of this Act        border guidance is far reaching such
 relating to swaps . . . (including     that a permitted transaction
 any rule prescribed or regulation      involving two non-U.S.
 promulgated under that Act), shall     counterparties may be subject to SEF
 not apply to activities outside the    execution under footnote 88.
 United States unless those            This interpretation has had the
 activities--                           practical effect of bifurcating
      (1) have a direct and             markets based on the participants'
   significant connection with          jurisdictions, impeding liquidity
   activities in, or effect on,         and redirecting activity away from
   commerce of the United States; or    SEFs and, as a result, away from
      (2) contravene such rules or      U.S. markets and the oversight of
   regulations as the Commission may    U.S. regulators.
   prescribe or promulgate as are
   necessary or appropriate to
   prevent the evasion of any
   provision of this Act . . . .''
 
                                                                                                                    Address cross-border issues through
 
 
 
                                                                                                                    In addition, while non-U.S. swap
                                                                                                                     dealers located in the U.S. have
                                                                                                                     received no-action relief from the
                                                                                                                     execution mandate, no corresponding
                                                                                                                     relief has been issued with respect
                                                                                                                     to platforms operating in an
                                                                                                                     execution capacity for such non-
                                                                                                                     U.S. swap dealers located in the
                                                                                                                     U.S., adding to the uncertainty
                                                                                                                     around the implementation of rules.
                                                                                                                     In the interest of stability, no-
                                                                                                                     action relief should be equally
                                                                                                                     granted to participants and
                                                                                                                     platforms where applicable.
--------------------------------------------------------------------------------------------------------------------------------------------------------
CEA  5b(c)(2)(D)(iv)                  Margin Requirements                    Rule 39.13(g)(2)(ii):
                                       CFTC rules related to margin provide
    ``Margin requirements.--The         a significant commercial advantage
 margin required from each member and   to futures over swaps. Specifically,
 participant of a derivatives           the CFTC's rules provide a 5 day
 clearing organization shall be         margin liquidation period for
 sufficient to cover potential          financial swaps, while all futures
 exposures in normal market             have a 1 day margin liquidation
 conditions.''                          period.
                                                                                                                    Re-examine the Part 39 margin
                                                                                    (A) A minimum liquidation time
                                                                                 that is 1 day for futures and
                                                                                 options;
                                                                                    (B) A minimum liquidation time
                                                                                 that is 1 day for swaps on
                                                                                 agricultural commodities, energy
                                                                                 commodities, and metals;
                                                                                    (C) A minimum liquidation time
                                                                                 that is 5 days for all other
                                                                                 swaps . . . .'' (emphasis added).
 
--------------------------------------------------------------------------------------------------------------------------------------------------------
CEA  2(a)(13)(D)                      Embargo Rule                           Rule 43.3(b)(3)(i)
                                       As a result of the embargo rule, SEFs
    ``The Commission may require        and DCMs that would like to continue
 registered entities to publicly        to permit work-ups may face workflow
 disseminate the swap transaction and   issues because they cannot share
 pricing data required to be reported   trade information with their
 under this paragraph.''                customers until such information is
                                        transmitted to an SDR. Such delays
                                        can have a material effect on market
                                        liquidity.
                                       To operate efficiently and
                                        competitively, information which
                                        reflects current market activity
                                        must be available to all market
                                        participants without any disruptive
                                        pauses for the occurrence of other
                                        regulatory activities. Every market
                                        participant must have real-time
                                        information on executed trades for
                                        the entire marketplace to ensure
                                        effective price discovery so that
                                        they can make informed trading
                                        decisions. This allows the market to
                                        operate properly as a single
                                        liquidity pool. In addition, those
                                        SEFs that rely on a third party to
                                        transmit information to SDRs are
                                        further hindered by the embargo rule
                                        in their ability to make available
                                        to all market participants current
                                        market information.
 
                                                                                                                    While the WMBAA appreciates the
--------------------------------------------------------------------------------------------------------------------------------------------------------
CEA  5h(f)(10)
 
    ``Recordkeeping and reporting.--
 
                                       SEF record-keeping Requirement         Rule 45.2(c):
                                                                                                                    Provide guidance to SEFs as to what
--------------------------------------------------------------------------------------------------------------------------------------------------------

        appendix b: wmbaa white paper regarding position limits
White Paper: SEF Position Limits and Accountability Regimes are Neither 
        Necessary Nor Appropriate
May 21, 2015
I. Introduction
    The Wholesale Markets Brokers Association, Americas,\1\ the leading 
industry organization representing the interdealer broker industry, 
provides this White Paper to explain why a position limits or position 
accountability regime for swap execution facilities (``SEFs'') is 
neither necessary nor appropriate.
---------------------------------------------------------------------------
    \1\ The WMBAA is an independent industry body representing the 
largest inter-dealer brokers operating in the North American wholesale 
markets across a broad range of financial products. The five founding 
members of the group are: BGC Partners; GFI Group; ICAP; Tradition; and 
Tullett Prebon. The WMBAA membership collectively employs approximately 
4,000 people in the United States; not only in New York City, but in 
Stamford, Connecticut; Chicago, Illinois; Louisville, Kentucky; Jersey 
City, New Jersey; Raleigh, North Carolina; and Houston and Sugar Land, 
Texas. For more information, please see www.wmbaa.org.
---------------------------------------------------------------------------
    Section 5h of the Commodity Exchange Act (``CEA''), as added by the 
2010 Dodd-Frank Wall Street Reform and Consumer Protection Act (``Dodd-
Frank''), includes a series of core principles for SEFs. In the 5 years 
since Dodd-Frank was adopted, the Commodity Futures Trading Commission 
(``CFTC'' or ``Commission'') has worked to implement Section 5h of the 
CEA, adopting final regulations related to the core principles and 
other requirements for SEFs, including core principle number 6--
position limits or accountability. An applicant SEF must comply with 
core principles to receive its permanent registration from the CFTC.
    In practice, as explained in this White Paper, an overly 
prescriptive interpretation of this core principle would be unworkable, 
cost-intensive, and without any readily identifiable public policy 
benefits. While there have been calls for Congressional review of core 
principle 6,\2\ the WMBAA believes, at this point, the Commission 
should consider a regulatory solution.
---------------------------------------------------------------------------
    \2\ See Pro-Reform Reconsideration of the CFTC Swaps Trading Rules: 
Return to Dodd-Frank, CFTC Commissioner J. Christopher Giancarlo White 
Paper (Jan. 29, 2015), at 45, available at http://www.cftc.gov/ucm/
groups/public/@newsroom/documents/file/sefwhitepaper012915.pdf.
---------------------------------------------------------------------------
    The approach described herein has been recently endorsed by a 
coalition of SEFs \3\ and key industry groups.\4\ The WMBAA supports 
such arguments, particularly that:
---------------------------------------------------------------------------
    \3\ See SEF CCO Group Discussion Document Regarding SEF Core 
Principle 6--Position Limits and Position Accountability, May 21, 2015.
    \4\ See Letter from the International Swaps and Derivatives 
Association and the Securities Industry and Financial Markets 
Association to Ms. Melissa Jurgens, Secretary, CFTC (Feb. 10, 2014), 
available at http://www.sifma.org/commentletters/2014/sifma-and-isda-
submit-comments-to-the-cftc-on-position-limits-for-derivatives/.

          The Commission should exempt SEFs from any requirement to 
        enforce compliance with Federal limits or to establish SEF 
        limits for contracts subject to Federal limits. As an 
        alternative to setting position limits, SEFs should only be 
        required to provide data to the Commission to assist it in 
        monitoring compliance with Federal speculative position 
        limits.\5\
---------------------------------------------------------------------------
    \5\ Id. at 35.

    The SEF marketplace is still in its formative years. The CFTC has 
not yet adopted a position limits regime for swaps. The Commission 
should tread carefully to avoid the imposition of a rigid, unworkable 
requirement that, without adequate cost-benefit analysis, may harm the 
development of these markets. Rather, as suggested by Chairman Timothy 
Massad, the CFTC should work to create ``the foundation for the market 
to thrive'' and ``permit innovation, freedom and competition.'' \6\
---------------------------------------------------------------------------
    \6\ Remarks of CFTC Chairman Timothy Massad before the ISDA 30th 
Annual General Meeting (Apr. 23, 2015), available at http://
www.cftc.gov/PressRoom/SpeechesTestimony/opamassad-17.
---------------------------------------------------------------------------
II. Background
A. Position Limits, Position Accountability
    The CFTC glossary defines a position limit as ``[t]he maximum 
position, either net long or net short, in one commodity future (or 
option) or in all futures (or options) of one commodity combined that 
may be held or controlled by one person (other than a person eligible 
for a hedge exemption) as prescribed by an exchange and/or by the 
CFTC.'' Fundamentally, a position limit caps the size of a position 
that a trader may hold or control for speculative purposes in a 
derivatives contract in a particular commodity. There are three 
elements of the regulatory framework for position limits: the levels of 
the limits, the exemptions from the limits (such as for hedging), and 
the policy on aggregating accounts. While the CFTC has set certain 
commodity position limits, it has not yet established position limits 
for swaps.
    By contrast, the CFTC glossary defines position accountability as 
``[a] rule adopted by an exchange in lieu of position limits requiring 
persons holding a certain number of outstanding contracts to report the 
nature of the position, trading strategy, and hedging information of 
the position to the exchange, upon request of the exchange.'' Position 
accountability does not, by definition, impose a hard limitation on 
traders' speculative derivatives positions in a commodity. Instead, 
position accountability provisions grant the exchange additional powers 
to protect its markets, including the ability to obtain additional 
information from the trader and to limit the size of a trader's 
position, when a trader's derivatives position exceeds a specified 
level.
B. SEFs and Position Limits
    Core principle 6--codified as CEA Section 5h(f)(6)--mandates that a 
SEF ``that is a trading facility'' must ``adopt for each of the 
contracts of the facility, as is necessary and appropriate, position 
limitations or position accountability for speculators.'' \7\ 
Furthermore, ``[f]or any contract that is subject to a position 
limitation established by the Commission pursuant to section 4a(a) of 
the [CEA], the [SEF] shall (i) set its position limitation at a level 
no higher than the Commission limitation; and (ii) monitor positions 
established on or through the [SEF] for compliance with the limit set 
by the Commission and the limit, if any, set by the [SEF].'' \8\
---------------------------------------------------------------------------
    \7\ Commodity Exchange Act (``CEA'')  5h(f)(6).
    \8\ Id.
---------------------------------------------------------------------------
    The CFTC promulgated rule 37.600 by codifying the statutory 
language.\9\ In the preamble to the final SEF rule, the CFTC noted that 
``[s]everal commenters stated that SEFs will have difficulty enforcing 
position limitations'' because ``SEFs will lack knowledge of a market 
participant's activity on other venues, and that will prevent a SEF 
from being able to calculate the true position of a market 
participant.'' \10\ Furthermore, the CFTC describes the guidance and 
acceptable practices in appendix B to the part 37 rules as giving 
``reasonable discretion to comply with  37.600.'' \11\
---------------------------------------------------------------------------
    \9\ 17 CFR  37.600.
    \10\ Core Principles and Other Requirements for Swap Execution 
Facilities, 78 Fed. Reg. 33,476, 33533 (June 4, 2013).
    \11\ Id.
---------------------------------------------------------------------------
    With respect to core principle 6, the guidance in Appendix B states 
that:

          For Required Transactions, a SEF may demonstrate compliance 
        by setting and enforcing position limitations or position 
        accountability levels only with respect to trading on the SEF's 
        own market. For example, a SEF could satisfy the position 
        accountability requirement by setting up a compliance program 
        that continuously monitors the trading activity of its market 
        participants and has procedures in place for remedying any 
        violations of position levels.
          For Permitted Transactions, a SEF may demonstrate compliance 
        by setting and enforcing position accountability levels or 
        sending the Commission a list of Permitted Transactions traded 
        on the SEF. Therefore, a SEF is not required to monitor its 
        market participants' activity on other venues with respect to 
        monitoring position limits.\12\
---------------------------------------------------------------------------
    \12\ Id. at 33601.
---------------------------------------------------------------------------
III. Role of Exchange-Set Position Limits and Position Accountability
    In contrast to SEFs and position limits, the CFTC has historically 
adopted position limits for certain agricultural commodities and also 
has required exchanges, as part of their self-regulatory 
responsibilities, to adopt position limits or position accountability 
provisions in their market surveillance programs. Unlike the OTC swap 
market, futures contracts traded on exchange are owned and exclusively 
listed by an exchange. They are unique contracts that are unavailable 
anywhere else.
    When the CFTC first promulgated speculative position limits, it 
noted that ``the capacity of any contract to absorb the establishment 
and liquidation of large speculative positions in an orderly manner is 
related to the relative size of such positions, i.e., the capacity of 
the market is not unlimited.'' \13\ In the early 1990s, the CFTC 
adopted rules allowing exchanges to establish position accountability 
provisions, in lieu of position limits, for contracts that had been 
subject to exchange-set speculative position limits.
---------------------------------------------------------------------------
    \13\ Establishment of Speculative Position Limits, 46 Fed Reg. 
50938 (Oct. 16, 1981).
---------------------------------------------------------------------------
    Exchange-based position limits have been adopted by designated 
contract markets (``DCMs''), or futures exchanges, and the position 
limits (or position accountability) provisions have been enforced 
through exchange rulebooks and their role as a self-regulatory 
organization conducting market surveillance programs. These protections 
serve as a prophylactic tool to reduce the threats of market power and 
to ensure the integrity of and orderly trading in the derivatives 
market. Exchange-set position limit and position accountability rules 
help prevent traders from accumulating concentrated positions that 
could disrupt a market and cause artificial prices and disorderly 
trading, such as purposefully through the exercise of market power by 
the position holder (e.g., actual or attempted manipulation) or to 
prevent one trader from negatively impacting market stability by 
liquidating too large of a position.
    These rules obligate an exchange, as part of its market 
surveillance effort, to take account of large positions in their market 
either by imposing hard limits on traders' speculative positions or, in 
the case of position accountability, by providing exchanges with ways 
to address the market impact of large positions.
IV. SEFs Cannot Adopt an Exchange-Centric Position Limits or 
        Accountability Regime
    Exchange-based surveillance and position limit and position 
accountability regimes focus on market participants' concentrated 
speculative positions. CFTC staff has stated that ``an acceptable 
market surveillance program should regularly collect and evaluate 
market data to determine whether markets are responding to the forces 
of supply and demand. An exchange also should have routine access to 
the positions and trading of its market participants.'' \14\
---------------------------------------------------------------------------
    \14\ See CFTC Division of Market Oversight, Rule Enforcement Review 
of ICE Futures U.S. (July 22, 2014), at 4, available at http://
www.cftc.gov/ucm/groups/public/@otherif/documents/ifdocs/
icemarksurrer072214.pdf.
---------------------------------------------------------------------------
    Exchanges can readily adopt and enforce position limits or position 
accountability provisions for futures and futures options because they 
have the means to carry out this oversight function. As mentioned 
before, exchanges own their contracts, the trading of which is only 
allowed on its respective exchange, and exchanges also own and operate 
the derivatives clearing organizations (``DCOs''), or direct trades to 
specified DCOs, that process and become the counterparty to each 
transaction executed on the exchange. Further, unlike futures on 
physical commodities for which the underlying products are in limited 
supply, the financial instruments underlying swaps subject to the trade 
execution mandate (interest rate and credit default swap indices) 
generally have very large or nearly inexhaustible deliverable supplies 
and a cash market sufficiently liquid to render swaps traded on those 
instruments highly unlikely to be susceptible to the threat of 
manipulation.
    Exchanges also have ``large trader reporting systems'' \15\ 
designed to obtain current information about traders' positions in 
their derivatives markets. Futures exchanges possess data showing the 
positions held by all reportable traders for each trading day based on 
reports from clearing members, futures commission merchants, and 
foreign brokers detailing close-of-business position data. Each futures 
exchange's ``large trader reporting system'' also provides information 
on the account's ownership and control and identifies futures and 
options traders who trade for the account. By assigning unique 
identification numbers to each trader, futures exchanges can aggregate 
traders' positions across different accounts at multiple clearing 
members to include the positions of all related affiliates.
---------------------------------------------------------------------------
    \15\ See Large Trader Reporting Program, http://www.cftc.gov/
IndustryOversight/MarketSurveillance/LargeTraderReportingProgram/ltrp.
---------------------------------------------------------------------------
    By contrast, SEFs are trading platforms that merely foster 
liquidity for swap execution. They do not have any ownership or 
proprietary control over the products bought and sold on their 
platforms. SEFs do not hold customer funds. They do not guarantee 
performance by counterparties. And, most importantly as discussed 
below, SEFs do not possess information about a trader's position in any 
given swap.
A. Position Limits
    Under Section 4a of the CEA, the Commission is required to 
establish position limits only after it determines that such position 
limits are necessary and appropriate. To date, the CFTC has not made 
that determination for financial swaps and, as a result, has not 
established position limits for these products. However, even if such 
limits were put in place, SEFs are limited in their ability to monitor 
for position limits violations. SEFs can only monitor market activity 
for those transactions that take place on its trading system or 
facility. A SEF only has information about trading activity on its 
facility and does not possess, and has limited means to obtain, 
information about its participants' positions in swaps from activity on 
other venues. There are currently 24 applicant SEFs, making it 
impossible for any one SEF to know how its participants may transact on 
the 23 other platforms.
    In practice, while a participant may enter into a transaction of 
size on one SEF, the SEF has no way of knowing if the participant has 
offset (or increased) its position in the swap through trading on other 
platforms. A swap that is listed and traded on one SEF may, unbeknownst 
to that SEF, be traded on other SEFs, DCMs, or bilaterally between 
counterparties away from any SEF or DCM. As a result, SEFs and DCMs 
listing swaps do not possess information about a trader's position in 
any given swap.
    Position limit information is more appropriately collected by other 
segments of the swap market, including market participants, DCOs, and 
swap data repositories (``SDRs''). However, even a DCO or SDR would 
only have information about traders' cleared positions or reported 
positions at its individual organization. Only the participants 
themselves would have information about their overall cleared and 
uncleared swaps position in a market.
    As a result, it is the WMBAA's view that only the CFTC (or a self-
regulatory body possessing position information about swap market 
participants from SDR and DCO reports) can effectively police the swaps 
market to detect position limit violations and have the enforcement 
tools to take meaningful action to deal with violations. Imposing a 
position-based requirement on SEFs would be ineffective and would incur 
significant redundancies, potential miscounting or double counting of 
trades, and significant impediments related to data standards among the 
24 applicant SEFs. In addition, if all of the SEFs set their individual 
position limit thresholds equal to the not-yet adopted CFTC's limits, 
this regime could encourage ``gaming'' by market participants who could 
spread their activity across SEFs to avoid triggering a ``limit check'' 
by any one SEF.
B. Position Accountability
    As the National Futures Association (``NFA'') recently concluded 
after conducting a data-driven analysis, position accountability levels 
will do little to ``reduce the potential threat of market manipulation 
or congestion, the stated goal of the [SEF core principles].'' \16\
---------------------------------------------------------------------------
    \16\ NFA Swap Accountability Levels Study (Apr. 2, 2015).
---------------------------------------------------------------------------
    The WMBAA believes the concept of a SEF position accountability 
regime is flawed. Most importantly, as discussed above, position 
accountability is meaningful as a market surveillance tool only in the 
context of centralized marketplaces such as exchanges, which is due to 
the fact that they own the products traded and possess information 
about traders' actual positions in the relevant derivatives 
marketplace. Because SEFs do not own products, and therefore do not 
possess the same position information, it is not necessary or 
appropriate for SEFs to adopt position accountability.
    Moreover, recognizing the impracticability of SEFs adopting 
position limits or position accountability regimes, there have been 
suggestions that SEFs adopt, in effect, ``trading accountability'' 
provisions as a means of complying with core principle 6 (i.e., SEFs 
would institute enhanced oversight of and data gathering from a trader 
based solely on trading activity or the size of transactions). This 
suggestion is problematic for two reasons. First, the CEA, as amended 
by Dodd-Frank, does not contemplate a trading activity-based 
accountability regime, but rather contemplates a position management-
focused component. Furthermore, there is no clear metric available for 
SEFs to conduct a position accountability framework. As identified by 
the NFA in its recent report, ``[n]otional transaction size alone is a 
misleading measure of risk.'' \17\ The NFA further concluded that ``the 
swap market might not lend itself to notional transaction size 
accountability levels at the SEF level.'' \18\
---------------------------------------------------------------------------
    \17\ Id.
    \18\ Id.
---------------------------------------------------------------------------
V. Conclusions
    The WMBAA has always supported efforts to promote stability, 
efficiency, transparency, and competition in furtherance of Dodd-
Frank's goal to promote the trading of swaps on SEFs. This includes 
taking steps to minimize threats posed to swap markets, including 
market manipulation from concentrated positions in a certain swap.
    For the reasons previously stated, however, the WMBAA does not 
believe that a SEF-based position limit or position accountability 
regime is necessary or appropriate to meet the purposes set forth in 
Dodd-Frank.
    The WMBAA members and other competitor SEFs want to be part of the 
solution. These venues are bound by a series of core principles to 
ensure fair, vibrant markets. They provide daily CFTC Part 16 lists of 
transactions to the CFTC, and they transmit full trade details to SDRs 
pursuant to their Part 43 and Part 45 confirmation and reporting 
obligations. These data transmissions provide the CFTC with the ability 
to combine data across SEFs to monitor large positions and address 
position limit violations should the CFTC determine to establish 
position limits or position accountability provisions for swap 
contracts.
    In considering ways to monitor swap markets for excessive 
positions, only the CFTC, or a CFTC designated neutral third-party 
self-regulatory organization would be in the position to collect, 
maintain, and synthesize the data to perform this function in an 
efficient, cost-sensitive manner. SEFs operating within the unique 
framework of the execution-only, competitive SEF landscape, in contrast 
to the vertically-integrated futures market structure, are ill-suited 
to establish a position limits or accountability regime.

    The Chairman. Thank you, Mr. Merkel.
    Mr. Berger.

          STATEMENT OF STEPHEN JOHN BERGER, DIRECTOR,
 GOVERNMENT AND REGULATORY POLICY, CITADEL, LLC, NEW YORK, NY; 
                   ON BEHALF OF MANAGED FUNDS
                          ASSOCIATION

    Mr. Berger. Thank you. Chairman Scott, Ranking Member 
Scott, Members of the Subcommittee, my name is Stephen Berger, 
and I am the Director of Government and Regulatory Policy at 
Citadel.
    Citadel is a leading global financial institution that 
manages hedge funds and provides capital market services.
    I am here today on behalf of the Managed Funds Association 
and its members, and I am pleased to provide testimony as part 
of the Committee's review of the impact of the G20 clearing and 
trade execution requirements.
    MFA represents the majority of the world's largest hedge 
funds, and is the primary advocate for sound business practices 
and thoughtful regulation of the industry. MFA continues to 
support reforms to the OTC derivatives markets, including 
central clearing and trading on open, transparent venues. These 
reforms have reduced systemic risk, increased protections for 
investors, promoted competition, and strengthened our nation's 
financial markets.
    I would like to highlight a few recommendations from my 
written statement that I believe would further help realize 
these benefits. With respect to clearing, MFA has been a 
consistent advocate for the central clearing of OTC derivatives 
transactions. Clearing replaces the interconnected web of 
counterparty exposures with a safer system where all 
participants face a well-regulated clearinghouse. This reduces 
systemic risk and enhances the stability and efficiency of our 
markets. Clearing also benefits investors by mitigating 
counterparty credit risk, increasing transparency, and 
facilitating greater choice of trading counterparties and 
platforms.
    In the U.S., clearing has been successfully implemented for 
a significant portion of the interest rate swap and index 
credit default swap markets. In the U.S. today, approximately 
75 percent of these swap transactions are cleared, compared to 
only 16 percent in 2007. Notably, over the past several years, 
investors have successfully cleared hundreds of trillions of 
dollars worth of swap transactions. Nevertheless, there are two 
areas where further progress should be made.
    First, customer clearing in the U.S. must remain affordable 
and robust. MFA is concerned that the Basel Committee's 
leverage framework will needlessly, but significantly, increase 
the cost of clearing for customers by failing to recognize the 
exposure-reducing effects of segregated customer initial 
margin. The Basel leverage ratio should be modified so that it 
provides an offset for customer initial margin, posted to a 
clearinghouse or segregated under U.S. rules.
    Second, further work is required from the CFTC and the SEC 
to implement a viable portfolio margining regime for the CDS 
market. The Dodd-Frank Act specifically sought to promote 
portfolio margining, which allows customers to realize margin 
efficiencies by recognizing offsetting risks within their 
portfolios. However, the interim framework that exists today 
falls short of meeting this goal, and has adversely impacted 
customer clearing.
    Looking forward, MFA supports further efforts to expand 
central clearing to interest rate swaps denominated in all of 
the G10 currencies, and to harmonize these requirements 
globally. While the U.S. was the first to implement central 
clearing, many other jurisdictions have made substantial 
progress in their own implementation. Notably, Europe is 
beginning to phase in central clearing this year, and the scope 
of the European clearing obligation is nearly identical to that 
in the U.S.
    Turning now to the implementation of the G20 trade 
execution requirements. MFA continues to support transitioning 
the trading of standardized liquid cleared swaps and to swap 
execution facilities that provide impartial access and 
facilitate straight-through processing to clearing. This 
transition promises to benefit investors by increasing market 
efficiency, competition, transparency, and liquidity. Recent 
research by the Bank of England concluded that the 
implementation of reforms in the U.S. interest rate swaps 
market yielded significant improvements in pricing and 
liquidity.
    Although the SEF market continues to evolve, a two-tier 
structure unfortunately persists, preventing investors from 
fully participating in all of the various SEF liquidity pools. 
This two-tier market, which reserves certain liquidity pools 
for dealers only, and confines investors to others, hinders 
choice and competition, and frustrates the core principle of 
impartial access. A key roadblock perpetuating the two-tier SEF 
marketplace is the practice of post-trade name give-up where 
the identities of counterparties to otherwise anonymous trades 
are revealed or given up post-trade. This is a legacy practice 
that no longer serves any legitimate purpose for cleared swaps 
where counterparties face clearinghouses and not each other. 
However, by systematically revealing private trading 
information, name give-up deters investors from participating 
on those SEFs that employ it, namely, the historically dealer-
to-dealer SEFs. We believe regulatory action is needed to 
remove this impediment to investors and partial access to all 
SEFs.
    We appreciate the Committee's oversight of derivatives 
clearing and trading, and I thank you for the opportunity to 
speak here today. I would be happy to answer any questions.
    [The prepared statement of Mr. Berger follows:]

  Prepared Statement of Stephen John Berger, Director, Government and 
  Regulatory Policy, Citadel, LLC, New York, NY; on Behalf of Managed 
                           Funds Association
    Chairman Scott, Ranking Member Scott, my name is Stephen Berger and 
I am the Director, Government & Regulatory Policy, of Citadel LLC. 
Citadel is a global financial firm built around world-class talent, 
sound risk management, and innovative market-leading technology. For 
more than a quarter of a century, Citadel's hedge funds and capital 
markets platforms have delivered meaningful and measurable results to 
top-tier investors and clients around the world. Citadel operates in 
all major asset classes and financial markets, with offices in the 
world's leading financial centers, including Chicago, New York, San 
Francisco, Boston, London, Hong Kong, and Shanghai.
    I am here today to speak on behalf of Managed Funds Association 
(``MFA'') and its members regarding the impact of the G20 clearing and 
trade execution requirements for OTC derivatives. MFA represents the 
majority of the world's largest hedge funds and is the primary advocate 
for sound business practices for hedge funds, funds of funds, managed 
futures funds, and service providers. MFA's members manage a 
substantial portion of the approximately $3 trillion invested in hedge 
funds around the world. Our members serve pensions, university 
endowments, and other institutions.
    MFA's members are among the most sophisticated investors and play 
an important role in our financial system. They are active participants 
in the commodity and securities markets, including over-the-counter 
(``OTC'') derivatives markets. They provide liquidity and price 
discovery to capital markets, capital to companies seeking to grow or 
improve their businesses, and important investment options to investors 
seeking to increase portfolio returns with less risk, such as pension 
funds trying to meet their future obligations to plan beneficiaries. 
MFA members engage in a variety of investment strategies across many 
different asset classes. As investors, MFA members help dampen market 
volatility by providing liquidity and pricing efficiency across many 
markets. Hedge fund managers are fiduciaries that invest funds on 
behalf of institutional and high-net worth investors. Our members' 
skills help their customers plan for retirement, honor pension 
obligations, and fund scholarships, among other important goals.
    As part of their asset management strategies, MFA members are 
active participants in the derivatives markets, and have consistently 
supported reforms to the OTC derivatives markets in Title VII of the 
Dodd-Frank Wall Street Reform and Consumer Protection Act (``Dodd-Frank 
Act'') that mitigate systemic risk, increase transparency, and promote 
an open, competitive, and level playing field. We welcomed the market's 
transition to central clearing for liquid, standardized swaps that 
occurred over the course of 2013, and actively engaged in the market's 
evolution of trading liquid, standardized, cleared swaps on registered 
swap execution facilities (``SEFs'') that commenced in 2014.
    As a result, MFA has a strong interest in the successful 
implementation of central clearing and organized trade execution in the 
OTC derivatives markets, which further the goals of the G20 and the 
Dodd-Frank Act to mitigate systemic risk and provide open and 
accessible markets for investors. In this respect, we believe there are 
several additional steps that the Commodity Futures Trading Commission 
(``CFTC'') should take to promote further central clearing and the 
market's transition to trading on SEFs. These steps include: (1) 
expanding mandatory central clearing of interest rate swaps (``IRS'') 
to include swaps denominated in all the G10 currencies; (2) further 
working with the Securities and Exchange Commission (``SEC'') to 
develop a viable portfolio margining regime for cleared credit default 
swaps (``CDS'') as mandated by Congress in the Dodd-Frank Act, (3) 
codifying existing CFTC staff guidance addressing impartial access to 
SEFs; (4) clearly prohibiting post-trade name disclosure by SEFs that 
offer anonymous execution of cleared swaps; and (5) making certain 
other targeted amendments to its final SEF rules to improve the overall 
trading regime. In addition, we believe the Basel Committee on Banking 
Supervision (``Basel Committee'') should modify its treatment of 
segregated initial margin for centrally cleared derivatives for 
purposes of the Basel III leverage ratio to ensure that central 
clearing remains affordable for customers.
    On behalf of MFA, I appreciate the Committee's review and oversight 
of the impact of the G20 clearing and trade execution requirements. MFA 
has consistently provided constructive comments and suggestions to 
regulators to help implement these mandates. We believe our comments 
are consistent with the Committee's public policy goals and will 
further enhance the benefits of OTC derivatives markets. As active 
participants in the U.S. markets for OTC derivatives, we would like to 
work with the G20 countries, Congress, the Committee, the CFTC, and all 
other interested parties to further the optimal implementation of the 
clearing and trade execution rules, which will reduce systemic risk, 
ensure affordable and impartial access to our financial markets, and 
strengthen our nation's economy.
Central Clearing and Its U.S. Implementation
    MFA has consistently supported policymakers' efforts to reduce 
systemic risk in the derivatives markets by transitioning standardized 
and liquid OTC derivative contracts into central clearing. The 
implementation of central clearing was a central goal of the 2009 G20 
commitments and the U.S. has been at the forefront of the move to 
central clearing.
    MFA believes that central clearing has reduced systemic risk by 
eliminating the complex, interconnected web of counterparty exposures 
and replacing it with a safer system where all counterparties face a 
single well-regulated central counterparty (``CCP''). Today, the 
prominent CCPs serving the U.S. market are operated by CME Group 
(``CME''), the Intercontinental Exchange, Inc. (``ICE''), and 
LCH.Clearnet (``LCH''). While not all derivatives products have 
sufficient liquidity to merit being made subject to the mandatory 
clearing requirement, in the U.S., we have seen the successful 
implementation of central clearing for a significant portion of the IRS 
and index CDS markets.
    The progress in implementing central clearing in the U.S. has been 
impressive. According to CFTC Chairman Timothy Massad, approximately 
75% of outstanding U.S. swap transactions (measured by notional value) 
are being cleared, as compared to only 16% in 2007.\1\ In particular, 
the progress in implementing central clearing for end-users and other 
customers of OTC derivatives has been notable. LCH has approximately 
$21.3 trillion notional of customer IRS transactions outstanding.\2\ At 
CME, open interest in IRS is approximately $17.7 \3\ trillion notional, 
and predominantly driven by customers. Finally, ICE has cleared 
approximately $20.8 trillion notional of index CDS for customers.\4\
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    \1\ Remarks of Timothy G. Massad before the Swaps Execution 
Facilities Conference (SEFCON V), November 12, 2014, available at: 
http://www.cftc.gov/PressRoom/SpeechesTestimony/opamassad-4.
    \2\ See LCH Daily Volumes--SwapClear Global, available at: http://
www.lch.com/en/asset-classes/otc-interest-rate-derivatives/volumes/
daily-volumes-swapclear-global.
    \3\ See CME Open Volume Tracker, available at: http://
www.cmegroup.com/education/cme-volume-oi-records.html.
    \4\ See https://www.theice.com/clear-credit.
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    As a result, in MFA's view, the implementation of central clearing 
in the U.S., thus far, has been successful and made our financial 
system much safer. In particular, we believe that central clearing has 
greatly benefitted the market by:

   Mitigating systemic risk and reducing the risk of contagion;

   Providing a mechanism for the orderly unwind of the 
        portfolio of a defaulting market participant that is also 
        designed to protect non-defaulting customers from losses;

   Promoting discipline with respect to margin and collateral 
        practices;

   Improving market transparency;

   Increasing competition among potential trading 
        counterparties and liquidity providers; and

   Supporting the migration of trading onto more open, 
        transparent, trading venues.

    In addition, the CFTC has enhanced the integrity of the execution-
to-clearing workflow by implementing straight-through processing 
(``STP'') requirements. The CFTC's STP rules require clearing members 
to conduct pre-execution credit checks in order to pre-empt post-
execution rejections of trades submitted for clearing, and to establish 
strict timeframes around how quickly an executed trade must be 
submitted to, and accepted or rejected by, a CCP. As a result, these 
STP requirements strengthen market resilience, enhance risk management, 
protect investors by reducing counterparty risk, and promote overall 
market transparency and efficiency. Importantly, the CFTC's STP rules 
established a standard that has now been adopted by the European Union 
(``EU'') in the context of implementing the Markets in Financial 
Instruments Directive (``MiFID II'').
    While not all of the G20 countries have implemented mandatory 
clearing requirements, we appreciate the positive steps taken by many 
countries to achieve harmonization and implementation of central 
clearing on a global basis. For example, mandatory central clearing of 
certain OTC derivatives will begin in the EU later this month. In 
addition, central clearing has already begun in Australia and Mexico, 
and is expected to begin soon in other countries, including Canada, 
Hong Kong, Singapore, and Switzerland. Notably, in light of these 
global developments, the CFTC has recently proposed to expand the 
central clearing requirement in the U.S. to harmonize with these 
foreign jurisdictions.\5\ Last, we applaud the CFTC and the European 
Commission for reaching an agreement on a common approach to the 
regulation of CCPs earlier this year.\6\ This agreement will help to 
ensure that the G20 goal of global, harmonized OTC derivatives 
regulation is fully achieved.
---------------------------------------------------------------------------
    \5\ See CFTC notice of proposed rulemaking on ``Clearing 
Requirement Determination under Section 2(h) of the CEA for Interest 
Rate Swaps'' (``CFTC Additional IRS Proposal''), available at: http://
www.cftc.gov/idc/groups/public/@newsroom/documents/file/
federalregister060916.pdf.
    \6\ See The United States Commodity Futures Trading Commission and 
the European Commission: Common approach for transatlantic CCPs, 10 
February 2016, available at: http://www.cftc.gov/idc/groups/public/
@newsroom/documents/speechandtestimony/eu_cftcstate
ment.pdf.
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Expanding Central Clearing of IRS to Other Currencies
    Consistent with the CFTC Additional IRS Proposal, MFA supports the 
expansion of central clearing to IRS denominated in additional 
currencies.
    Under current CFTC rules, the clearing requirement applies only to 
IRS denominated in the G4 currencies, which include U.S. Dollars, 
Euros, Japanese Yen, and British Pound Sterling. MFA believes that the 
clearing mandate should be expanded to include IRS denominated in all 
of the G10 currencies \7\ because those additional IRS classes are 
traded in significant volumes globally.
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    \7\ The G10 currencies are the U.S. Dollar (USD), Euro (EUR), 
Japanese Yen (JPY), British Pound (GBP), Swiss Franc (CHF), Australian 
Dollar (AUD), New Zealand Dollar (NZD), Canadian Dollar (CAD), Swedish 
Krona (SEK), and Norwegian Krone (NOK).
---------------------------------------------------------------------------
    The CFTC Additional IRS Proposal to expand the clearing mandate 
would apply to IRS denominated in Australian dollars, Swiss francs, 
Canadian dollars, Mexican pesos, Polish zloty, Swedish Krona, Norwegian 
Krone, Hong Kong dollars, and Singapore dollars. The European 
Commission has also recently adopted final regulatory technical 
standards that expand the EU clearing mandate to IRS denominated in 
Polish zloty, Swedish Krona, and Norwegian Krone.\8\ The CME and LCH 
already clear IRS denominated in these currencies and market 
participants already voluntarily clear a significant amount of these 
instruments.
---------------------------------------------------------------------------
    \8\ See European Commission Delegated Regulation (EU) . . ./. . . 
of 10.6.2016 supplementing Regulation (EU) No 648/2012 of the European 
Parliament and of the Council with regard to regulatory technical 
standards on the clearing obligation, 10 June 2016, available at: 
http://ec.europa.eu/finance/financial-markets/docs/derivatives/160610-
delegated-regulation_en.pdf.
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    Consistent with the goal of reducing systemic risk through the 
international convergence of central clearing, MFA believes that 
transitioning IRS denominated in the G10 currencies to the clearing 
requirement is appropriate and timely.
Ensuring the Affordability of Customer Clearing
    Customers are a vital part of the derivatives markets and have been 
critical to the success of central clearing in the U.S. While some 
clearing of swaps between dealers existed prior to enactment of the 
Dodd-Frank Act, artificial barriers to entry prevented customers from 
similarly participating in the cleared swaps market. Implementation of 
the central clearing requirement eliminated many of those artificial 
barriers and resulted in substantial customer clearing.
    However, at present, swaps customers exclusively access CCPs 
indirectly through clearing members, rather than becoming direct 
members of CCPs, for a variety of reasons, both financial and 
operational. MFA expects the demand for clearing services to increase 
as regulators in different jurisdictions fully implement their 
respective mandatory clearing initiatives. As a result, it is critical 
that customer clearing services remain available at an affordable price 
to ensure that customers have fair and equal access to CCPs.
    MFA has strong concerns about the Basel Committee's treatment of 
segregated initial margin for centrally cleared derivatives exposure 
under the Basel III leverage ratio (``Leverage Ratio'') because it 
threatens the ability of customers to use centrally cleared derivatives 
and could limit the ability of end-users to hedge their risks.
    CCPs' risk management methodologies are predicated on the 
collection of initial margin and variation margin from clearing members 
and customers in order to collateralize potential exposure. In 
addition, direct clearing members guarantee payment of their customers' 
obligations to the CCP. Because the initial margin is the customer's 
money,\9\ CFTC rules require clearing members to segregate customer 
funds from the clearing member's own assets.
---------------------------------------------------------------------------
    \9\ Under CFTC rules, a clearing member must separately account 
for, and segregate as belonging to the customer, all money, securities 
and property it receives from a customer as margin. See 17 CFR  1.20-
1.30; 17 CFR  22.2-22.7; see also CFTC Chairman Timothy Massad, 
Testimony before the U.S. House Committee on Agriculture (Feb. 12, 
2015).
---------------------------------------------------------------------------
    While the Basel Committee's framework captures a clearing member's 
guarantee to the CCP as an off-balance sheet exposure, the Leverage 
Ratio fails to provide an offset that recognizes the exposure-reducing 
effect of customers' segregated initial margin. According to the Basel 
Committee, the reason for the lack of an offset for customer initial 
margin is that segregated customer initial margin not only offsets 
exposures, but also can be used by the clearing member for further 
leverage. In the U.S., segregation rules severely restrict the ability 
of initial margin to be held in anything other than extremely low-risk 
and extremely liquid assets, assuring that it is always available to 
absorb losses ahead of the bank.\10\ Moreover, the substantial majority 
of segregated initial margin is posted to the CCP, and therefore, is 
entirely outside the control of the clearing member.\11\
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    \10\ In the United States, segregated margin cannot be reinvested 
except for investments in low-risk and highly liquid assets, such as 
U.S. government securities, managed ``with the objectives of preserving 
principal and maintaining liquidity''. See 17 CFR  1.25(b).
    \11\ Applicable U.S. margin and CCP regulations result in a 
significant majority of margin being passed onto the CCP. Although 
margin rules vary across jurisdictions outside of the U.S., non-U.S. 
margin frameworks for centrally cleared derivatives generally result in 
a substantial portion of margin held at the CCP rather than the 
clearing member.
---------------------------------------------------------------------------
    The Leverage Ratio's failure to recognize the purpose of segregated 
initial margin is a threat to the use of cleared derivatives by 
customers. Because of the lack of offset, clearing members will incur 
large Leverage Ratio exposures, which will likely raise prices for 
customer clearing significantly. The Leverage Ratio, as currently 
structured, is estimated to increase significantly the cost of using 
cleared derivatives.\12\ This substantial cost increase may cause 
customers to reduce their hedging activities to levels that are 
inadequate to manage their risk, which could result in price increases 
and volatility for food, gasoline, and other consumer goods.
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    \12\ The Commodity Markets Council (``CMC'') estimates that the 
Leverage Ratio, as currently structured, would increase the cost of 
using cleared derivatives by more than five times current levels. This 
estimate is based on conversations by CMC members with clearing 
members. The increase in costs would be due to increased fees for 
cleared derivatives. CMC and MFA members also anticipate incurring 
business costs due to their diminished ability to hedge commercial and 
financial risks. See also, Fiona Maxwell, Non-bank FCMs unlikely to 
fill OTC gap, Risk, Oct. 7, 2015, available at: http://www.risk.net/
risk-magazine/news/2429225/non-bank-fcms-unlikely-to-fill-otc-gap#.
---------------------------------------------------------------------------
    Therefore, to ensure the continued affordability and robustness of 
customer clearing in the U.S., we respectfully request that the 
Committee encourage the Basel Committee to modify the Leverage Ratio by 
providing an offset for clearing members to the extent that customer 
initial margin is posted to the CCP, or is segregated under the U.S. 
regulatory regime.
Ensuring a Viable Portfolio Margining Regime
    The Dodd-Frank Act divided jurisdiction over OTC derivatives 
between the CFTC and the SEC. For CDS, the CFTC has jurisdiction over 
most CDS indices, while the SEC has jurisdiction over single-name CDS. 
The CFTC has mandated clearing of certain CDS indices, but the SEC has 
not yet issued a clearing mandate for single-name CDS. However, a 
number of MFA members would like to voluntarily clear single-name CDS 
in order to take advantage of the portfolio margining benefits arising 
from offsetting positions in cleared index CDS and single-name CDS.
    Portfolio margining simply means recognizing the offsetting 
positions within a cleared OTC derivatives portfolio, resulting in 
margin efficiencies. Section 713 of the Dodd-Frank Act specifically 
encouraged the SEC and the CFTC to work together to implement a 
regulatory framework that facilitates portfolio margining.
    ICE has an offering that enables market participants to clear both 
index CDS and single-name CDS in a CFTC-regulated account under the 
Commodity Exchange Act, as amended (``CEA''). In 2011, both agencies 
issued orders approving ICE's portfolio margining regime for dealers' 
proprietary CDS positions. Over a year later, both agencies approved 
ICE's portfolio margining regime for customers. However, the SEC's 
approval order imposed a number of conditions on ICE and clearing 
member firms seeking to offer a CDS customer portfolio margining 
program.
    Notably, each clearing member firm is required to establish its own 
margin methodology that is different from the margin methodology of the 
CCP and must submit its margin methodology to the SEC for review and 
approval. The requirement for each clearing member to have its own 
margin methodology undermines one of the fundamental benefits of 
central clearing, which is the ability for all market participants to 
rely on the same, fully vetted and approved margin methodology 
maintained by the CCP. In addition, it reduces transparency for 
clearing customers, as it is difficult to evaluate and compare the 
different margin methodologies separately established by each clearing 
member.
    In our view, the requirements imposed by the SEC have delayed 
voluntary buy-side clearing of single-name CDS, with resulting adverse 
effects on trading volume and liquidity. We urge the SEC to use the 
CCP's vetted and approved margin methodology as the baseline, with 
clearing members able to collect additional margin as they deem 
appropriate according to their assessment of a clearing customer's 
credit risk. This approach will enable a viable portfolio margining 
regime for cleared CDS as mandated by Congress in the Dodd-Frank Act.
Swap Execution Facilities and the Trade Execution Requirement
    MFA continues to support the Dodd-Frank Act's goal of transitioning 
the trading of standardized, liquid, cleared swaps onto SEFs that 
provide open and impartial access and enable the emergence of an ``all-
to-all'' market (where multiple market participants are able to meet 
and transact). MFA believes the CFTC SEF framework benefits the swaps 
market and its participants by increasing market efficiency, 
competition, transparency and liquidity. In fact, according to recent 
Bank of England research, the implementation of the clearing and 
trading reforms in the U.S. interest rate swaps market has already 
yielded significant improvements in pricing and liquidity, with market 
participants saving as much as $20-$40 million per day, of which $7-$13 
million is being saved by market end-users alone per day.\13\
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    \13\ See Staff Working Paper No. 580 ``Centralized trading, 
transparency and interest rate swap market liquidity: evidence from the 
implementation of the Dodd-Frank Act'', Bank of England (January 2016), 
available at: http://www.bankofengland.co.uk/research/Documents/
workingpapers/2016/swp580.pdf.
---------------------------------------------------------------------------
    While the SEF market continues to evolve, MFA believes the current 
SEF regime can be enhanced by the CFTC taking certain additional steps 
to address the current two-tier market structure and the legacy 
practice of post-trade name disclosure on SEFs that offer anonymous 
execution of cleared swaps.
Two-Tier Market
    Nearly 3 years after the launch of the SEF marketplace, MFA is 
concerned that the swaps market remains bifurcated between ``dealer-to-
dealer'' or inter-dealer broker (``IDB'') SEFs that exclude most buy-
side firms and ``dealer-to-customer'' (or ``D2C'') SEFs.

   IDB SEFs: In one tier, the IDB SEFs offer central limit 
        order books (``CLOBs'') and voice-brokered request-for-quote 
        (``RFQ'') models, among others, with trading on an anonymous 
        basis but the identities of counterparties revealed post-trade. 
        While IDB SEFs may have onboarded a number of buy-side firms, 
        there is no meaningful buy-side trade execution and 
        participation on IDB SEFs.

   D2C SEFs: In the second tier, D2C SEFs offer electronic RFQ 
        systems, which effectively require the buy-side to trade with 
        dealers by requesting quotes on a name-disclosed basis. 
        Although D2C SEFs provide order books, there is more limited 
        liquidity available. Nearly all SEF trading volume by the buy-
        side occurs on two dominant D2C SEFs via name-disclosed RFQ.

    This two-tier market structure prevents the buy-side from accessing 
important pools of liquidity for cleared swaps, including the liquid 
order books. This market structure also confines the buy-side to a 
``price-taker'' role, rather than providing the opportunity to become a 
``price-maker'' as well.
    MFA believes that the persistence of the two-tier swaps trading 
market structure ``status quo'' is contrary to Congress's reform goals. 
It is inconsistent with the Dodd-Frank Act's express impartial access 
requirement for SEFs.\14\ In our view, the status quo needs to change 
to improve competition and market liquidity.
---------------------------------------------------------------------------
    \14\ Pub. L. 111-203, 124 Stat. 1376 (2010). Section 733 of the 
Dodd-Frank Act amends the CEA to require, in pertinent part, that SEFs 
both establish and enforce participation rules and have the capacity to 
enforce those rules, including the means to provide market participants 
with impartial access to the market. See also CFTC rule 37.202 in the 
CFTC final rule on ``Core Principles and Other Requirements for Swap 
Execution Facilities'', 78 Fed. Reg. 33476, 33587 (June 4, 2013), 
available at: https://www.gpo.gov/fdsys/pkg/FR-2013-06-04/pdf/2013-
12242.pdf.
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    Impartial access has contributed to the health and vitality of 
several other significant markets (such as equities and futures 
markets, where any participant can ``make'' or ``take'' prices). By 
contrast, the two-tier swaps market structure perpetuates traditional 
dealers' control of liquidity and protects their role as exclusive 
``price makers''. It also limits the manner and extent to which buy-
side participants may interact in the swaps market. Such structural 
limitations on liquidity provision and risk transfer may increase the 
likelihood of market volatility and instability over the long term. The 
willingness and capacity of traditional dealers to allocate balance 
sheet (i.e., for dealers to use their own funds) to swaps market-making 
activities appears to be diminishing in certain respects. This trend 
will likely continue over time as traditional dealers continue to 
restructure their businesses post-financial crisis and adapt to new 
capital, leverage, and liquidity requirements under Basel III and 
similar rules. Without swaps market reforms that facilitate impartial 
access to all SEFs and encourage alternative forms of price formation 
and liquidity provision and greater diversity of participation (among 
participants and modes of interaction), MFA fears that the U.S. swaps 
market could risk greater volatility and dislocation in times of market 
stress.
    Congress designed the swaps market reforms under Title VII of the 
Dodd-Frank Act to produce a more competitive and transparent swaps 
market structure. Based on the examples set by other significant 
trading markets noted above, MFA believes that true impartial access, 
once implemented and enforced, will provide a stronger foundation for 
U.S. swaps market liquidity and enhance price transparency in the U.S. 
swaps market. This outcome will contribute beneficial effects to the 
nation's economy.
Post-Trade Name Give-Up
    A key mechanism suppressing buy-side trading on IDB SEFs and 
directly contributing to the current two-tier market structure in the 
U.S. is the legacy practice of post-trade name disclosure (or ``give 
up''). We believe that a SEF that imposes access limitations that deter 
buy-side participation in its market contravenes the impartial access 
requirement. Even though otherwise eligible buy-side participants have 
access to all SEFs in theory, the loss of anonymity caused by the 
continuation of post-trade name disclosure is a strong disincentive to 
buy-side participation in IDB SEFs in practice.
    The practice of post-trade name give-up originates in anonymous 
markets for uncleared swaps. Participants in the uncleared swaps market 
reasonably need to limit the firms with which they may trade in order 
to manage counterparty credit risk. Further, to record each new 
bilateral swap with a given counterparty on their books, participants 
need to learn the identity of the counterparty with whom they were 
matched. Thus, post-trade name disclosure and the attendant limitations 
on interactions among market participants are justified in the 
uncleared swaps markets where counterparties have credit exposure to 
each other.
    While the practice may have served a purpose prior to the 
implementation of the current swaps trading and clearing regime, today 
it needlessly reveals the identities of counterparties to otherwise 
anonymous cleared trades. In the early days of the cleared swaps 
market, counterparties used post-trade name disclosure to coordinate 
submission of trades to clearing after trade execution. However, the 
successful implementation of STP for SEF-executed trades, including the 
pre-trade credit check process, has eliminated any need to use post-
trade name disclosure to either manage counterparty credit risk or 
facilitate clearing submission. Post-trade name disclosure nevertheless 
continues to occur as a routine practice on IDB SEFs.
    MFA strongly believes that for swaps that are anonymously executed 
and then immediately cleared, there is no legitimate reason for a party 
to the cleared swap to know the identity of its original executing 
counterparty. Once the CCP accepts the trade for clearing, the trade 
exists only as a cleared trade. The obligations to perform on a cleared 
trade run only between the CCP and the party to the trade (and, where 
applicable, its agent clearing member). In a cleared trade, the CCP is 
the sole counterparty to each of the original transacting parties, and, 
again, the original transacting parties have no rights or 
responsibilities with respect to each other.
    As a result, we firmly believe that the legacy practice of post-
trade name disclosure no longer has a legitimate commercial, 
operational, credit or legal justification in cleared swap markets 
where transacting parties face the clearinghouse and are not exposed to 
each other's credit risk following trade execution.
Adverse Effects of Post-Trade Name Disclosure in the Current Swaps 
        Trading and Clearing Regime
    Among its other adverse effects, post-trade name disclosure is a 
source of random and uncontrolled ``information leakage'' of private 
information on SEFs that offer anonymous execution of cleared swaps. It 
deters buy-side firms from trading on IDB SEFs because it reveals a 
firm's private trading positions and trading strategies to competitors 
or dealers. By doing so, post-trade name disclosure appears 
inconsistent with CFTC rules prohibiting access to private trading 
information. In contrast, when a buy-side firm discloses its identity 
and trading interests in the RFQ market, a buy-side firm has control of 
the associated ``information leakage'' because it can choose to whom it 
sends an RFQ.
    Prohibiting post-trade name disclosure on SEFs would protect the 
privacy of an original counterparty's identifying information as 
required by CFTC rule 49.17(f)(2), as amended. In response to concerns 
that MFA and other market participants raised that the identity of 
counterparties to anonymously executed swap trades could be 
inadvertently revealed post-trade by a swap data repository (``SDR''), 
the CFTC voted unanimously to adopt an interim final rule that amended 
the scope of CFTC rule 49.17(f)(2) by making explicit the limitation on 
counterparty access to data and information related to an anonymously 
executed, cleared swap that applies to SDRs by virtue of the privacy 
requirements of CEA section 21(c)(6). Without further regulatory action 
to prohibit the practice of post-trade name disclosure, a counterparty 
can continue to obtain the identities of its original transacting 
parties from the SEF or from the affirmation hub that processes the 
SEF's trades, even though the SDR is required to protect the privacy of 
such information. Because section 21(c)(6) of the CEA mandates the 
privacy requirement imposed under CFTC rule 49.17(f)(2), MFA believes 
that allowing a SEF to facilitate or permit post-trade name disclosure 
frustrates clear Congressional intent.
    Post-trade name disclosure also perpetuates informational and 
trading advantages for traditional dealers that benefit from their 
ability to access and achieve full visibility into both the inter-
dealer and dealer-to-customer markets. Buy-side firms do not have true 
impartial access to the IDB SEFs that offer anonymous execution through 
CLOBs and other execution models due to the continued practice of post-
trade name disclosure. MFA believes that the continuation of this 
practice creates an uneven playing field and impairs competition, as it 
reduces pre-trade price transparency for otherwise qualified buy-side 
market participants and restricts their ability to trade certain swap 
products anonymously.
    Due to the nature of liquidity in swap markets, it is unlikely that 
the market will resolve this artificial barrier to buy-side 
participation on IDB SEFs on its own. Post-trade name disclosure 
appears inconsistent with the letter and intent of the Dodd-Frank Act's 
swaps market reforms and CFTC rules, and in our view the CFTC has ample 
authority to prohibit this practice. MFA believes that regulatory 
action to prohibit post-trade name disclosure would increase the volume 
of buy-side trading on SEFs as it would attract more users and thus 
more trading volume to these platforms, and allow more flexible and 
efficient execution of both outright swaps and package transactions.
    While some argue that market dynamics will address post-trade name 
disclosure and its adverse effects, we respectfully disagree. 
Commercial and competitive dynamics make it difficult for any one IDB 
SEF to disable post-trade name disclosure unilaterally, as traditional 
dealers that opposed such a change might easily shift their trading to 
other IDB SEFs. This is a classic case where only the regulator can 
readily bring competition and fairness to the market by eliminating 
post-trade name disclosure on any SEF that offers anonymous execution 
of cleared swaps. Doing so will increase the diversity, breadth, and 
depth of liquidity on SEFs and thereby reduce the potential for market 
volatility and disruptions.
    MFA is aware of several arguments to preserve the practice of post-
trade name disclosure on IDB SEFs. We summarize below our counter-
arguments based on the extensive swaps trading experience of many MFA 
members.

   Post-Trade Name Disclosure is Not Necessary to Deter 
        ``Gaming''. Some have argued that the practice of post-trade 
        name disclosure should be preserved to prevent buy-side firms 
        from ``gaming'' the market. Proponents of this view claim that 
        buy-side firms could post a low resting bid (or high resting 
        offer) in an anonymous CLOB, and then solicit a dealer through 
        an RFQ to motivate the dealer to lower its price in reliance 
        upon the price level posted in the CLOB. This theoretical risk 
        exists in any market that employs both anonymous and disclosed 
        trading protocols and historically, has not risen to a level of 
        serious concern. The Treasury securities and foreign exchange 
        markets, for example, have operated for years with both 
        anonymous and disclosed execution channels, and participants 
        have been able to trade across both without concerns of gaming. 
        Nothing about the swaps market necessitates a different 
        policing paradigm from other markets. Further, SEF CLOBs 
        require market participants to post firm resting bids/offers. 
        SEF participants that attempt to ``game'' dealers on pricing 
        would be at risk of their firm offers being matched, resulting 
        in potentially unfavorable positions. The likelihood of 
        detection for engaging in any gaming behavior, regardless of 
        whether or not a SEF uses post-trade name disclosure in its 
        market, also serves as a strong deterrent. Such actions carry 
        serious reputational and enforcement risks that buy-side market 
        participants naturally avoid.

   Post-Trade Name Disclosure Does Not Facilitate Dealer 
        Capital Allocation. Contrary to some claims, MFA believes that 
        post-trade name disclosure does not help dealers in allocating 
        their capital among their customer base. In an anonymously 
        executed market, there is no affirmative decision by a dealer 
        to direct business to a particular counterparty based on a pre-
        existing relationship, or to reward loyal customers with better 
        prices--the parties are transacting only on the basis of 
        anonymously posted bids and offers. The pricing for a 
        particular swap does not change when the parties' identities 
        are disclosed to each other post-execution. MFA does not expect 
        that the elimination of post-trade name disclosure will have 
        any impact on future pricing of such swap trades, because 
        trading decisions are not based on the identity of the 
        counterparty to begin with.

   Concerns that Dealers Will Provide Less Liquidity to Markets 
        Without Post-Trade Name Disclosure Lack Precedent in Similar 
        Markets. In electronic order-driven trading markets, it should 
        not matter whether a dealer's counterparty is another dealer or 
        a buy-side firm. Thus, these markets should remain anonymous to 
        create a level playing field for all participants. Further, as 
        the willingness and capacity of traditional dealers to allocate 
        balance sheet to swaps market-making activities appears to be 
        diminishing in certain respects due to Basel III's higher 
        capital requirements, regulatory steps that promote impartial 
        access to all SEFs encourage alternative forms of price 
        formation and liquidity provision and greater diversity of 
        participation (among participants and modes of interaction). 
        These steps are essential investments for building a more 
        robust and competitive swaps market in our country.

    In MFA's view, the unintended consequence of regulatory inaction 
may be increased volatility in the U.S. swaps market. It is time for 
the CFTC to exercise its regulatory authority to prohibit post-trade 
name disclosure for anonymously executed, cleared swaps. By doing so, 
the CFTC will promote the transition to SEFs that operate in accordance 
with Dodd-Frank's contemplated reforms for the U.S. swaps market. We 
anticipate that regulatory prohibition of this practice will encourage 
greater voluntary trading by buy-side firms on IDB SEFs and make the 
SEF regime more attractive internationally, as a result of the true 
impartial access to these markets.
    MFA petitioned the CFTC for this rule change as well as other rule 
changes to improve the SEF regime, as discussed below. We respectfully 
urge the Committee to support such changes at the CFTC.
Proposed SEF-Related Rule Amendments
    MFA urges the CFTC to modify and update its SEF-related rules in 
light of experience with SEF trading. In October 2015, MFA submitted a 
petition to the CFTC to amend certain provisions of its regulations 
related to OTC derivatives trading on SEFs, based on MFA members' 
experiences to date and the ``lessons learned'' through the 
implementation process.\15\ MFA's proposed amendments would: (1) codify 
existing CFTC staff guidance around the implementation of the CFTC's 
impartial access requirements; (2) codify existing CFTC staff guidance 
around the implementation of the CFTC's STP requirements; (3) clearly 
prohibit post-trade name disclosure by SEFs for swaps that are executed 
anonymously; (4) facilitate SEF execution of package transactions by 
requiring the package transaction as a whole to become ``made available 
to trade'' in order to be subject to the CFTC's trade execution 
requirement; (5) provide a mandatory public comment period for every 
``made available to trade'' (``MAT'') determination submission by a SEF 
under Part 40 of the CFTC's regulations; (6) establish a clear process 
for determining when a swap product should no longer be considered 
available to trade on a SEF; (7) codify existing CFTC staff guidance 
and no-action relief around rejection of swaps from clearing and 
resubmission for operational and clerical errors; (8) clarify the order 
interaction requirements between different SEF trading protocols; and 
(9) modify the definition of ``block trade'' in Part 43 of the CFTC's 
regulations to authorize on-SEF execution of a block trade as a 
``permitted transaction'' as defined in section 37.9(c) in order to 
facilitate pre-execution credit checks of block trades that are 
intended to be cleared.
---------------------------------------------------------------------------
    \15\ See MFA Petition for Rulemaking to Amend Certain CFTC 
Regulations in Parts 1 (General Regulations under the Commodity 
Exchange Act), 39 (Derivatives Clearing Organizations, Subpart B--
Compliance with Core Principles) and 43 (Real-Time Public Reporting), 
submitted to Mr. Christopher Kirkpatrick, Secretary of the Commission, 
on October 22, 2105, available at: https://www.managedfunds.org/wp-
content/uploads/2015/10/CFTC-Petition-for-SEF-Rules-Amendments-MFA-
Final-Letter-with-Appendix-A-Oct-22-2015.pdf.
---------------------------------------------------------------------------
    In addition, in subsequent discussions with the CFTC, the MFA also 
advocated for increased mandatory disclosure from SEFs regarding 
trading protocols, fees, and governance.
    I will review MFA's supporting arguments for each of MFA's proposed 
amendments, other than our rationales for the requested rule to 
prohibit post-trade name give-up discussed above.
Codify Existing CFTC Staff Guidance: Impartial Access
    MFA's proposed amendments to section 37.202(c) would codify 
existing staff guidance to prohibit the use of enablement mechanisms 
and breakage agreements for swaps that are intended to be cleared on 
SEFs. A SEF that requires or permits such arrangements imposes barriers 
to the buy-side's access to that SEF and contravenes the CFTC's 
impartial access requirements. In addition, our proposed amendments 
prohibit a SEF from limiting access to certain types of eligible 
contract participants in a discriminatory manner. Such access 
limitations could be based on the manner in which certain types of 
eligible contract participants typically interact in the market, 
anticipated levels of trading activity, or entity registration status. 
These and other status-based access criteria also act as artificial 
barriers to the buy-side's access to SEFs.
Codify Existing CFTC Staff Guidance: STP
    MFA's proposed amendments to section 1.73 would codify existing 
CFTC staff guidance clarifying the pre-execution risk management 
requirements for clearing futures commission merchants (``FCM'') and 
the obligation for SEFs to facilitate compliance with these 
requirements.
    Consistent with current CFTC staff guidance, MFA's proposed 
amendments to section 1.74 would establish an outer boundary of 60 
seconds after submission of a trade to the clearing FCM for acceptance 
for clearing. Our proposed amendments would retain the current timing 
standard of ``as quickly as technologically practicable if fully 
automated systems were used'' (``ASATP'') to require timing reductions 
for clearing acceptance from the 60 second outer boundary that 
continuing improvements in technology will enable.
    Finally, consistent with current CFTC staff guidance, MFA's 
proposed amendments to section 39.12(b)(7) would establish an outer 
boundary of 10 seconds after submission of any trade for clearing to a 
CCP for the CCP to accept or reject a trade for clearing. Our proposed 
amendments would retain the ASATP standard to require timing reductions 
for clearing acceptance from the 10 second outer boundary that 
continuing technology improvements will enable.
More Clearly Address Package Transactions in MAT Determination Process
    MFA's proposed amendments to section 37.9 would revise the 
definition of a ``required transaction'' to include ``any transaction 
involving a stand-alone swap or any package transaction that is subject 
to the trade execution requirement in section 2(h)(8) of the [CEA]''. 
We would also define a ``package transaction'' as follows:

          Package transaction means a transaction involving two or more 
        instruments: (1) that is executed between two or more 
        counterparties; (2) that is priced or quoted as one economic 
        transaction with simultaneous or near simultaneous execution of 
        all components; (3) where the execution of each component is 
        contingent upon the execution of all other components; and (4) 
        where the risk of the offsetting components is reasonably 
        equivalent.

A transaction meeting this definition would not be deemed a required 
transaction, unless the package transaction as a whole has become 
subject to the CFTC's trade execution requirement in section 2(h)(8) of 
the CEA.
    Based on the implementation experiences of MFA members, we believe 
a determination should be made regarding the liquidity characteristics 
of the package transaction as a whole. This approach would avoid the 
need for CFTC staff to resort to issuing serial no-action relief as the 
industry continues to work on the remaining execution challenges and 
infrastructure solutions for certain types of package transactions.
    This approach differs from the current process, where a MAT 
determination has implications not only for the execution of a given 
swap on a stand-alone basis, but also for all package transactions that 
include such a swap. Both the liquidity profile and the ability of 
market infrastructure to facilitate trading of swaps executed on a 
stand-alone basis versus as part of a package transaction can vary 
widely. Therefore, our changes to section 37.10 would require SEFs to 
apply the CFTC's MAT criteria separately at the package level to avoid 
execution challenges and the need for extended or permanent staff no-
action relief from the trade execution requirement for certain types of 
package transactions.
Provide Public Comment Period for MAT Determinations
    MFA's proposed amendments would require a public comment period 
with respect to each MAT determination submission by a SEF. We believe 
a mandatory public comment period would provide market participants 
with a critical opportunity to inform the CFTC as to a swap product's 
suitability and the industry's technological and operational readiness 
to move the product from the OTC market to SEF trading. We also believe 
that our proposed amendments would enable the CFTC to perform a more 
meaningful oversight role, furthering international harmonization.
Establish a Process for de-MAT Determinations
    MFA's proposed amendments would establish a clear process for 
determining when a stand-alone swap or package transaction is no longer 
available to trade on a SEF (a ``de-MAT determination''), based on the 
CFTC's current six MAT factors. We believe the CFTC should administer 
this process by retaining its authority to make such a determination on 
an annual basis or if the CFTC receives notice of de-listing 
submissions from at least two SEFs for a particular swap. Consistent 
with our request for MAT determinations, our proposed amendments would 
also require a public comment period to further inform the CFTC's 
consideration of any de-MAT determination.
    We believe that a separate de-MAT determination process would serve 
as an important check-and-balance mechanism, rather than a process that 
relies exclusively on determinations of SEFs. If none of the six MAT 
factors support a determination that a stand-alone swap or a package 
transaction is made available to trade, as confirmed objectively by the 
CFTC's broader view of market trading data for the product in question, 
the CFTC should issue a public de-MAT determination order that will 
suspend the trade execution requirement for that product. That 
suspension would apply universally to all SEFs.
Codify Existing CFTC Staff Guidance and No-Action Relief: Rejection 
        from Clearing and Resubmission
    MFA's proposed amendments would codify, with clarifying 
modifications, existing CFTC staff no-action letter 15-24 that 
facilitates the correction of operational or clerical errors made in 
the submission of a swap to clearing. Specifically, the current no-
action letter authorizes the resubmission of a corrected trade that 
matches the terms and conditions of the erroneous trade, other than the 
relevant operational or clerical error and the time of execution. MFA's 
proposed amendments would also further codify the treatment of an 
intended-to-be-cleared swap that is rejected from clearing (i.e., void 
ab initio), which MFA strongly supports.
    We note that ESMA included both void ab initio and a resubmission 
procedure in its published regulatory technical standards under MiFID 
II. As a result, codifying these points would further harmonization 
between SEFs and MiFID II trading venues.
Clarify RFQ and Order Interaction
    MFA's proposed amendments to section 37.9(a)(3)(i) involve the 
CFTC's requirement that firm bids and offers must be taken into account 
and communicated to an RFQ requester along with the RFQ responses. 
These amendments would further clarify that any firm bid or offer that 
is communicated to an RFQ requester in this situation must be provided 
in an executable form so that the RFQ requester can easily access such 
price if so desired. In addition, as SEFs continue to make innovations 
in trading protocols, it is important that the order interaction 
requirement not be construed so narrowly as to render it inapplicable 
for these new trading protocols. As a result, these amendments would 
clarify that a SEF must communicate to an RFQ requester any firm bid or 
offer pertaining to the same instrument resting on any of the SEF's 
markets, trading systems or platforms. We believe these amendments 
promote pre-trade price transparency by ensuring the RFQ requester has 
the ability to view and access competitive firm quotes anywhere on the 
SEF.
Codify Existing CFTC Staff No-Action Relief: Eliminate ``Occurs Away'' 
        Requirement for Authorized On-SEF Execution of Block Trades
    MFA's proposed amendments would codify, with modification, existing 
CFTC staff no-action letter 14-118 by eliminating the ``occurs away'' 
requirement for block trades. More specifically, our proposed 
amendments would expressly authorize on-SEF execution of any block 
trade as a permitted transaction. By doing so, a block trade can be 
executed by RFQ to 1 or by voice to facilitate the requisite pre-
execution credit checks of block trades that are intended to be 
cleared.
Increased Mandatory Disclosure from SEFs regarding Trading Protocols, 
        Fees, and Governance
    In November 2015, the CFTC issued a notice of proposed rulemaking 
regarding ``Regulation Automated Trading'', which included a provision 
requiring a designated contract market (``DCM'') to provide additional 
public information regarding its market maker and trading incentive 
programs. MFA supported such requirement and, in addition, recommended 
that the CFTC require SEFs to make similar types of market maker and 
trading incentive program disclosures. Applying these transparency 
requirements to SEFs would level the playing field with DCMs, as DCMs 
may directly compete with SEFs by listing swaps or economically similar 
contracts. MFA believes that such disclosure requirements will provide 
investors and the broader public with more information and transparency 
into DCM and SEF market maker and trading incentive programs, and we 
agree with the CFTC that such disclosure will enhance market integrity.
    Further, it is our view that market participants can benefit from 
greater transparency from SEFs regarding other important aspects of 
their offering, including trading protocols, fees, and governance. 
Ensuring that this type of information is consistently provided to 
market participants, will level the playing field and ensure that all 
investors can make informed decisions regarding whether to join a 
particular platform.
Conclusion
    On behalf of MFA, I appreciate the Committee's review of the impact 
of the G20 clearing and trade execution requirements. As discussed, we 
believe that the CFTC should expand mandatory central clearing to IRS 
denominated in all G10 currencies. We also believe that the CFTC should 
engage in further rulemaking to ensure anonymous and impartial access 
to SEFs so as to promote an open, competitive, and level playing field. 
In addition, we respectfully ask Congress to encourage the Basel 
Committee to modify the Basel III leverage ratio to ensure that central 
clearing remains affordable for customers. We believe that, by 
promoting central clearing and organized trade execution in the OTC 
derivatives markets, these measures will advance the G20's and 
Congress's goal of reducing systemic risk.
    MFA is committed to working with Members and staff of Congress, the 
Committee, and regulators to reduce systemic risk, ensure affordable 
and impartial access to our financial markets, and strengthen our 
nation's economy. Thank you for the opportunity to appear before you 
today. I would be happy to answer any questions that you may have.

    The Chairman. Thank you, Mr. Berger.
    Mr. Zubrod.

        STATEMENT OF LUKE D. ZUBROD, DIRECTOR, RISK AND
   REGULATORY ADVISORY SERVICES, CHATHAM FINANCIAL, KENNETH 
                           SQUARE, PA

    Mr. Zubrod. Good morning, Chairman Scott, Ranking Member 
Scott, and Members of the Subcommittee. I thank you for the 
opportunity to testify today regarding certain derivatives-
related aspects of Dodd-Frank.
    My name is Luke Zubrod, and I am a Director at Chatham 
Financial. Chatham is an independent firm providing advice and 
services to businesses that use derivatives to reduce their 
interest rate, foreign currency, and commodity price risks. 
Based in Pennsylvania, we serve 1,800 firms globally, including 
clients in every state represented by Members of this 
Subcommittee.
    Our clients' risk reduction activity benefits the global 
economy by allowing a range of businesses, from manufacturing 
to agriculture, to real estate to financial services, to 
improve planning and forecasting, and offer more stable prices 
to consumers and a more stable contribution to economic growth.
    Chatham appreciates this body's bipartisan efforts to 
address key concerns of non-financial end-users following the 
passage of Dodd-Frank, including efforts to clarify that margin 
and clearing requirements should not apply to nonfinancial end-
users and their centralized treasury units. These efforts were 
instrumental in eliminating key barriers to efficient access of 
the derivatives market.
    Today, I will identify two similar barriers affecting a 
range of financial end-users that use low volumes of 
derivatives to reduce risk. In particular, clearing and margin 
requirements when applied to those transacting low volumes of 
OTC derivatives deter such end-users from managing their risks, 
cause them to manage their risks poorly, or dictate that they 
do so at significant expense.
    Chatham's clients facing unwarranted burdens due to 
clearing and/or margin requirements touch a wide variety of 
industries, including corporates deemed to be financial in 
nature, real estate and infrastructure funds that make cross-
border investments in buildings, railroads, ports, et cetera, 
regional banks that are contemplating using derivatives to 
serve their customers, reduce risk, or compete with larger 
banks in their footprints, microfinance funds whose capital is 
directed toward enabling the world's poor to lift themselves 
and their families from poverty in developing countries.
    The first burden such firms face relates to the cost of 
clearing for such low volume users. Clearing members typically 
charge minimum monthly fees to establish a relationship that 
would enable a customer to comply with the clearing mandate. 
These fees vary by firm and customer, but typical fees amount 
to $100,000 per year or more. A firm hedging interest rate 
risks for a single 5 year bank loan will thus obligate itself 
to $\1/2\ million in fees over that period, just to have the 
privilege of hedging in the OTC markets.
    The second burden relates to risk imposed by the margin 
requirements which expose a company to liquidity risk that many 
firms are unwilling to take on. Liquidity risk is the risk that 
a sudden sharp movement in market conditions could force a 
company to come up with sums of cash that are significant to 
the company on short notice. In an extreme case, such margin 
calls could cause a firm to default on an obligation.
    Consider a firm with a 5 year interest rate risk, concerned 
that in today's historically low interest rate environment, 
increasing rates could adversely affect their ability to make 
payroll. Such a firm could fully eliminate such risk by 
entering into a 5 year interest rate swap to lock in a fixed 
interest rate. On $100 million, 5 year swap, subject to 
clearing or margin requirements, a firm would need to post 
approximately $2 million at inception, which could grow to as 
much as $12 million in a normally stressed market, and $25 
million in an extremely stressed market, such as was seen 
during the financial crisis. These costs and risks create 
unintended consequences by negatively impacting the risk 
management decisions many firms make, causing them to stop 
hedging and retain risks that may harm business performance or 
even firm viability, hedge poorly in ways that cause them to 
retain risk, or hedge at significant expense and attempt to 
pass on cost to customers.
    While the benefits of clearing were widely understood when 
Congress enacted the clearing mandate, the costs were not. We 
now understand clearing to be a system that simply does not 
accommodate small and low-volume users. The consequence is that 
entities whose derivatives use has no ability to undermine 
financial stability are cut off from properly or effectively 
managing their risks. Small financial end-users are essentially 
thrown into a raging sea of market volatility without a 
dependable life preserver.
    These concerns could easily be addressed if Congress 
exempted low-volume users from clearing and margin requirements 
via a financial entities de minimis exception. Such an 
exception could be narrowly tailored to ensure that firms that 
meaningfully contribute to systemic risk would not be eligible. 
Such an approach is consistent with approaches adopted or 
proposed by Australia, Canada, Japan, and Singapore.
    Thank you for the opportunity to testify today, and I am 
happy to address any questions you may have.
    [The prepared statement of Mr. Zubrod follows:]

  Prepared Statement of Luke D. Zubrod, Director, Risk and Regulatory 
        Advisory Services, Chatham Financial, Kenneth Square, PA
    Good afternoon, Chairman Scott, Ranking Member Scott, and Members 
of the Subcommittee. I thank you for the opportunity to testify today 
regarding aspects of the Dodd-Frank Act that emanated from the G20 
agenda for OTC derivatives. My name is Luke Zubrod and I am a Director 
at Chatham Financial (``Chatham''). Chatham is an independent advisory 
and technology firm providing services to businesses that use 
derivatives to reduce their interest rate, foreign currency and 
commodity price risks (``end-users''). A global firm based in 
Pennsylvania, Chatham serves as a trusted advisor to over 1,800 end-
user clients annually ranging from Fortune 100 companies to small 
businesses, including clients headquartered or doing business in every 
state represented by Members of this Subcommittee. Since our founding 
in 1991, we have advised clients on nearly $4 trillion in hedging 
transactions.
    Chatham's clients rely on derivatives to reduce business risks, not 
for trading or speculative purposes. This risk reduction activity 
benefits the global economy, by allowing a range of businesses--from 
manufacturing to agriculture to real estate to financial services--to 
improve planning and forecasting, and offer more stable prices to 
consumers and a more stable contribution to economic growth.
    Chatham supports the Dodd-Frank Act's aims of reducing systemic 
risk and increasing transparency in the derivatives market. We also 
appreciate the bipartisan efforts of this body to ensure that 
regulatory burdens are proportionately applied, taking into account an 
entity's potential ability to jeopardize financial stability. In 
particular, we appreciate efforts to address key concerns of 
nonfinancial end-users following the passage of Dodd-Frank, including 
efforts to clarify that margin and clearing requirements should not 
apply to such end-users and their centralized treasury units. These 
efforts were instrumental in eliminating key barriers to efficient 
access of the derivatives market.
    Today, I will identify two similar barriers affecting a range of 
financial end-users that use low volumes of derivatives to reduce risk. 
In particular, clearing and margin requirements, when applied to those 
transacting low volumes of OTC derivatives, deter such end-users from 
managing their risks, cause them to manage their risks poorly or 
dictate that they manage such risks at significant expense. Indeed, per 
transaction costs for low-volume users are especially high when 
compared to the costs applicable to larger users--a fact that is at 
odds with their relative contributions to systemic risk.
    Chatham's clients facing unwarranted burdens due to clearing and/or 
margin requirements touch a wide variety of industries, including the 
following:

   Corporates deemed to be financial in nature under Title VII 
        (e.g., technology companies that process certain types of 
        payments);

   Real estate and infrastructure funds that make cross-border 
        investments in buildings, railroads, ports and other such 
        physical assets;

   Regional banks that use limited quantities of derivatives 
        products or are contemplating using such products to serve 
        their customers, reduce risk or compete with larger banks in 
        their footprints, and that do not otherwise qualify for the 
        small bank exemption; [and]

   Microfinance funds whose capital is directed toward enabling 
        the world's poor to lift themselves and their families from 
        poverty in developing countries.

    While the businesses in which these firms engage vary widely, such 
firms share at least two characteristics: they (1) use derivatives to 
manage and reduce risk and (2) do not use quantities of derivatives 
that are sufficient to jeopardize financial market stability.
    Let's consider the burdens such firms face, assess whether such 
burdens are necessary for the mitigation of systemic risk and consider 
what actions might alleviate unnecessary burdens.
    The first burden relates to the cost of clearing for low-volume 
users. Clearing members typically charge minimum monthly fees to 
establish a relationship that would enable a customer to comply with 
the clearing mandate. These fees vary by firm and customer but typical 
fees amount to $100,000 per year or more. Consider a firm that does not 
qualify for the end-user exception and needs to hedge a single interest 
rate risk over a 5 year period, as might be the case for a firm 
entering into a variable rate bank loan. That firm will obligate itself 
to $\1/2\ million in fees over that period just to have the privilege 
of hedging in the OTC derivatives market.
    The second burden relates to risk imposed by the margin 
requirements applicable to cleared swaps and soon to be applicable to 
swaps that are not centrally cleared. Margin requirements expose a 
company to new risks that many firms are unwilling to take on--
especially liquidity risk. Liquidity risk is the risk that a sudden 
sharp movement in market conditions could cause a company, via a margin 
call, to come up with sums of cash that are significant to the company 
on short notice. In an extreme case, such a margin call could cause a 
firm to default on an obligation. At a minimum, a firm will need to 
hold back funds that it might otherwise invest in its business to 
ensure it has enough cash on hand to meet margin calls.
    Consider the aforementioned firm with a 5 year interest rate risk. 
Such a firm might be concerned that in today's historically low 
interest rate environment, increasing rates could adversely affect 
their ability to make payroll. In the OTC derivatives market, such a 
firm could fully eliminate such risk by entering into a 5 year interest 
rate swap to lock in a fixed interest rate. Prior to the clearing 
mandate, such a firm might have been able to negotiate a credit 
arrangement that did not require it to post cash margin. Rather, banks 
were able to manage credit risk to such borrowers through a variety of 
other means. The borrower was able to enter into the swap without any 
up-front fees--all costs associated with the swap were included in the 
fixed interest rate paid to the bank. On a $100 million swap, a firm 
would need to post approximately $2 million at inception, which could 
grow to as much as $25 million in a stressed market such as was seen 
during the financial crisis (or approximately $12 million in normalized 
market conditions). These amounts are illustrative of liquidity risks 
and would not need to be diverted from productive use if a firm were 
exempt from the clearing and margin requirements.
    These costs and risks create unintended consequences by negatively 
impacting the risk management decisions many firms make. In particular, 
a firm's risk management behavior may change in three ways: the firm 
may (1) stop hedging, (2) hedge poorly or (3) hedge expensively.

  1.  Stop Hedging: Some firms respond to the high cost of clearing and 
            margining by choosing not to hedge, retaining risk in their 
            businesses that could unnecessarily jeopardize business 
            performance or, in extreme cases, even a firm's viability.

  2.  Hedge Poorly: Some firms enter into risk management products that 
            force them to retain some risks. For example, some firms 
            avoid the liquidity risk associated with cleared and 
            margined swaps by managing their risks with products like 
            options that do not create uncertain demands on a company's 
            cash. While this may satisfy a firm's risk management 
            objective in the short term, option products generally 
            become very expensive when hedging for longer periods, and 
            so companies often buy less protection, increasing their 
            exposure to financial market gyrations over the long-term.

  2.  Hedge Expensively: Some firms may proceed with entering into 
            cleared swaps, but incur the substantial costs to do so. 
            This in turn increases the cost of their services and/or 
            dampens their ability to deliver returns to investors like 
            pension funds.

    While the benefits of clearing were widely understood when Congress 
enacted the clearing mandate, the costs were not. We now understand 
central clearing to be a system that simply does not accommodate small 
and low-volume users. The consequence is that entities whose 
derivatives use has no ability to undermine financial stability are cut 
off from properly or effectively managing their risks. Small financial 
end-users are essentially thrown into a raging see of market volatility 
without a dependable life preserver.
    These concerns could easily be addressed if Congress exempted low-
volume users from clearing and margin requirements via a financial 
entities de minimis exception. Such an exception could be narrowly 
tailored to ensure that firms that meaningfully contribute to systemic 
risk would not be eligible. Congress has already recognized the 
principle underlying such an exception in Title VII of Dodd-Frank. 
However, that principle was narrowly applied to small banks and credit 
unions (i.e., those with less than $10 billion in assets) and does not 
include the various types of market participants identified in this 
testimony.
    Numerous foreign governments, including Australia, Canada, Japan 
and Singapore, have exempted or proposed to exempt a range of financial 
entities whose transaction volumes are relatively small from their 
clearing and/or margining rules, effectively acknowledging the burdens 
such requirements create for smaller entities and the limited public 
policy benefits of encompassing such entities within the requirements' 
scope.
    On the basis of the evidence now available on the cost of clearing 
and margin, the extent to which such costs adversely affect low-volume 
users, the recognition that such entities have limited ability to 
undermine financial stability, and the extent to which foreign 
governments have similarly exempted low-volume users, we urge 
policymakers to enact a financial entities de minimis exception from 
clearing and margin requirements. We believe such a policy would 
provide needed relief without increasing systemic risk.
    We appreciate your attention to these concerns and look forward to 
supporting the Subcommittee's efforts to ensure that derivatives 
regulations, while fully reflecting the policy objectives of Dodd-
Frank, do not unnecessarily burden American businesses, jeopardize 
economic growth, or harm job creation by creating barriers to tools 
used to reduce the risk of investing in the economy.
    Thank you for the opportunity to testify today and I am happy to 
address any questions you may have.

    The Chairman. Thank you. Thank you all for your testimony.
    The chair would like to 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.
    I now recognize myself for 5 minutes.
    Mr. Edmonds, as we start this hearing, I want to put part 
of today's conversation about recovery and resolution in 
context. U.S. clearinghouses are robust financial institutions 
with significant financial resources at their disposal. The 
recovery or resolution of a clearinghouse like ICE or CME would 
be unprecedented. Can you describe what would have to happen to 
exhaust the resources of a major clearinghouse like ICE?
    Mr. Edmonds. So let's back up and remember that we all 
serve international customers, and given the European 
regulation around qualified CCPs coming out of the European 
equivalence debate that we have had, means that if you are 
deemed systemically important, either you have to meet that if 
you are a European clearinghouse, or you are going to 
voluntarily subscribe to those types of robust structures. So 
that means that simultaneously two of your largest members are 
defaulting on exactly the same day, at the same time. And your 
model right now has to be able to support enough collateral to 
hold against that happening.
    So if you ask me what happens if we are not going to be 
able to survive that, it is going to be more than what those 
standards are, obviously, to get to that point. And that means 
you are going to be in a very stressed market situation, one 
that is likely unprecedented. If you look back at the history 
of the 2008 crisis, you are going to find yourself in a 
position where we all stress test to what those events were, 
the price shocks that we saw to the marketplace and the 
instruments that we held or we do hold now, based on a 
historical look back to that. So we know we can sustain two. We 
know we can sustain likely more than that, but we have to prove 
every day that we have tool sets in order to survive that.
    If you ask me what happens if it is five or six, I am not 
sure you are worried about us at that point in time. There is a 
bigger problem going on in the global financial markets at that 
point in time. But the short answer is you have to be able to 
cover at least more than two going down at the same time.
    The Chairman. Ms. Rosenberg, clearinghouses are bigger 
today, but as we talked about at our last hearing, clearing 
members are also required to hold more capital than they did 
before the crisis. How has this changed your concerns about 
clearinghouse risk?
    Ms. Rosenberg. Thank you for the question. I would just 
reiterate one point that my colleagues here at the table also 
made, is that in terms of capital that we have to hold against 
the guarantee that we provide on behalf of our customers to the 
clearinghouse. We are currently facing a situation with the 
leverage ratio where the cash that we receive from our 
customers is actually risk-reducing because it offsets the 
exposure that we have to the clearinghouse. And so that has 
been an impact from our standpoint in terms of the capital that 
we need to hold, and as a result, we are seeing a contraction 
with several other clearing members actually exiting the 
market, and there is greater concentration with respect to the 
market, which is not a good thing for end-users.
    The Chairman. Mr. Duffy, in a speech last year, Chairman 
Massad noted that clearinghouse risk couldn't just be 
understood in terms of skin-in-the-game, and that you also had 
to look at the full picture of policies and practices that 
mitigate risk. What policies and practices have changed over 
the last 6 years to better manage risk within your 
clearinghouse?
    Mr. Duffy. Well, there have been a number of different 
situations that we have done, and Mr. Edmonds outlined them, 
but we are all new to OTC clearing, which is what we are 
talking about today. Historically, when you look at CME Group 
and our base businesses, which is futures, we have never had a 
default to date due to a customer loss. So that is one of the 
biggest issues.
    When you look at the way things are margined today, since 
Dodd-Frank was put into place, we mark-to-market every day, and 
we can mark-to-market every hour. The capital that we accept 
today is different than it was as little as 5 or 10 years ago, 
so it is much more liquid than it was before.
    Those are a couple of the different issues that we have 
done to bolster our clearinghouse. And we have, again, the risk 
management associated with the clearinghouse is critically 
important to us. The governance that is associated with our 
clearinghouse is important. We are working with agencies 
constantly. We are deemed a systemically important financial 
market, so these are all different things that we have to 
cooperate with and we have done a good job at it.
    The Chairman. Thank you. I have a couple of other questions 
but I am going to try to hold to the 5 minute rule and come 
back for a second round of questions, and try to hold every 
Member to that as close as we can.
    I will now recognize the Ranking Member, Mr. Scott, for 5 
minutes.
    Mr. David Scott of Georgia. Thank you, Chairman Scott.
    My concern in this entire harmonization cross-border 
equivalency issue has been to make sure that our financial 
firms, our clearinghouses, our market participants, are not put 
in a competitive disadvantage in the global marketplace. Mr. 
Duffy, from your testimony I get a sense of rising concern, 
even though we have had the December 2015 moved by the CFTC, 
and now we have the May 24 rule, but you still have some great 
concerns. And from your testimony, as I was reading it, you 
said, ``that if this is not the case, then regulation will 
artificially influence liquidity, price discovery, risk 
management, and competitively disadvantage our market 
participants in an increasingly competitive global 
marketplace'', which goes to my concern.
    So you are telling me that instead of let my heart not be 
troubled, you are saying let our hearts be troubled. Could you 
tell us why you feel, even in the midst of the great work, and 
I tip my hat, that Chairman Massad has done, that you still 
have some indigestion on this issue, that you and I both are 
very much concerned about.
    Mr. Duffy. Thank you, sir. One of the things that I have 
noticed in my 36 year career at the CME, and trading for 23 of 
those, and then being in management for the last 15, and 
especially going through regulation, is uncertainty from market 
participants. It is the worst thing you could possibly have is 
not knowing what the rules of the road are. So when we talk 
about the equivalence equation that was originally done in 
February, what happens is they keep bumping up against the 
dates, the market participants aren't certain what the rules or 
the regs are going to be, what jurisdiction they can 
participate in. And that is exactly what happened again under 
the equivalence.
    Mr. David Scott of Georgia. Yes.
    Mr. Duffy. And as you know, we are waiting for the ESMA 
recognition, which I referenced in my testimony, which 
hopefully we were getting today or tomorrow. But we need to 
have that by June 21. So we are trying to keep participants 
knowing what their capital costs are going to be, if they are 
going to clear at a U.S. entity or not, because they are going 
to be completely different if we are not recognized. And we 
can't continue to bump up against these dates. Certainty is the 
clearest thing I can say to that, sir.
    Mr. David Scott of Georgia. All right. And, Mr. Edmonds, 
let me ask you, first of all I want you to give me an update on 
where we are with equivalence for clearinghouses.
    Mr. Edmonds. Well, as Mr. Duffy said, we still have these 
dates. So we know where we are going to land the airplane. We 
may not know when we are going to land that airplane, is the 
easiest way I could give you that analogy.
    Mr. David Scott of Georgia. Yes. Okay.
    Mr. Edmonds. So the conceptual agreement that the global 
regulators have on the equivalence is well understood. It is 
still the details in that concept that are causing some people 
angst, as you articulated in previous comments on that. Things 
like anti-pro-cyclicality measures, you have three different 
options that you can use in order to meet the global benchmark. 
Well, no one yet knows which of those three everyone is going 
to use at a given time. So we know we have to get to that 
endpoint, but that endpoint is not there yet, and then while 
that endpoint is well defined, the path there is not yet well 
defined. That is where we are going to----
    Mr. David Scott of Georgia. All right. And, Ms. Rosenberg, 
let me ask you, do you think that the clearing mandate that we 
have has been a positive development, and if not, or even if 
so, what more do you specifically think the CFTC should do?
    Ms. Rosenberg. Thank you for the question. I think that the 
G20 global derivatives reforms overall have made the system 
safer and more resilient and increased transparency.
    It has been several years now since global standards have 
been developed for clearinghouses. They were set in 2012 by the 
global standard setter, CPMI-IOSCO. We believe it is time, and 
it has been, and regulators have been taking a step back over 
the last 18 months to revisit those standards, as market 
participants have raised concerns about different areas. I 
spoke about this in my oral remarks, which is CCP risk 
governance and capital contributions, stress testing, 
specifically setting minimum prescriptive standards for 
clearinghouse stress testing, as well as with respect to stress 
testing, ensuring that there is a supervisory regulatory-driven 
stress test that reviews those financial safeguards to ensure 
that they are adequate.
    CPMI-IOSCO has taken that feedback onboard from market 
participants and is in the process of developing a market 
consultation to cover all of these areas; capital, skin-in-the-
game, governance, margin, as well as stress testing. And we 
look forward to U.S. regulatory participation and support, 
including the CFTC, in those discussions.
    Mr. David Scott of Georgia. Thank you very much, Mr. 
Chairman.
    The Chairman. I now recognize Mr. Lucas.
    Mr. Lucas. Thank you, Mr. Chairman. And I appreciate you 
holding this hearing. These, obviously, are complex issues, and 
it is an example of why it is so important that we hear 
directly from the financial sector that is impacted by the 
reforms that have taken place in our markets and our market 
participants.
    I would like to continue the discussion that has been going 
on about the CCP risk management and the equivalency, and my 
first question I will throw out to the crowd, it becomes quite 
clear there is an agreement with the panel that significant 
progress has been made in enhancing the standards for risk 
management at CCPs, and that global coordination among 
regulators in developing those standards. And obviously, the 
European Commission is preparing legislation to address CCP 
recovery and resolution.
    Would the group, and whoever would prefer to go, in what 
order I don't care, would you expand for a bit about the 
various challenges that the CCP equivalency agreement, that was 
just reached between CFTC and European Commission, represent to 
your industry and ultimately to your consumers or customers?
    Mr. Duffy. I will start. I think that the agreement that we 
reached is one of those agreements that, as I said earlier, 
took way too long, which could affect the consumers because of 
the uncertainty of it. I think that we had to bend it a little 
bit here in the United States in order to get deemed 
equivalent, which concerns us a little bit. We want to make 
certain that our regulators are regulating the U.S. markets, 
and not a foreign regulator regulating the U.S. markets. That 
is the way I look at it. So I don't want them being our 
Prudential Regulator.
    There was a lot of back and forth, and hopefully we are in 
a place right now, Mr. Edmonds mentioned pro-cyclicality, there 
has been a lot of pro-cyclicality back and forth on these 
agreements that we never had to adhere to before as a U.S. 
entity, that we are adhering to today, in order to be deemed 
equivalent in the European Union.
    Maybe that is just progress, the way it goes back and 
forth; but, overall, it should not hurt the business here in 
the United States now that we have gotten to this certain 
point.
    Mr. Lucas. Absolutely. And that makes me think of Mr. 
Scott, the Ranking Member's comment about the disadvantage. I 
don't think anyone in this Committee wants the industry and the 
United States or the participants here to be put at a 
disadvantage. And where are we in those circumstances? And I 
throw that again to the rest of the panel.
    Ms. Rosenberg. So one of the things going on in Europe 
right now is that we expect the European Commission to be 
drafting legislation on CCP recovery and resolution. We expect 
that to come out close to the end of the year. I suspect it 
could go into next year.
    In any case, in the U.S. market, we don't require any 
specific legislation to implement recovery and resolution 
standards. Okay. What we want to make sure about also is that 
any legislation that is developed in Europe does not cause 
differences with the U.S. rules and legal environment. The 
Financial Stability Board is in the process of developing 
global standards with respect to resolution planning for 
clearinghouses, what the plans, what the guidance should be 
around developing those plans for resolution authorities with 
respect to CCPs. We would encourage the Europeans and Chairman 
Massad, through his discussions with the European Commission, 
to ensure that those standards that are developed are 
consistent across Europe and U.S. We wouldn't want any 
differences and go through another equivalence type of 
discussion that we have had, and Mr. Duffy elaborated on.
    Mr. Lucas. Mr. Duffy.
    Mr. Duffy. Yes, what I think is important is we do have a 
resolution recovery and stress testing here on U.S. CCPs that 
is overseen by our regulator. I don't disagree with my 
colleague, it would be nice to have a uniform approach across 
the globe, but what is important to us is that we do have that 
within our U.S. regulator right now.
    Mr. Lucas. Ms. Rosenberg, let's continue along this vein. 
Could you discuss with us for a moment the current models for 
stress testing, what weaknesses that might exist, how those 
could be addressed, because it seems, and Mr. Edmonds too, for 
that matter, it seems that the stress testing process modeling 
is absolutely important?
    Ms. Rosenberg. Yes, it absolutely is important. And I just 
want to mention my partners over here, Mr. Edmonds and Mr. 
Duffy, I don't want there to be any perception that the 
companies they work for, the stress testing models are not 
robust, or anything like that. What I am talking about is, I 
have responsibility for overseeing JPMorgan's 50 derivative 
clearinghouse memberships globally, and from that perspective, 
I will say that the current global standards rules that govern 
clearinghouses on stress testing are very light. They 
effectively say that clearinghouses should stress test their 
portfolios and use scenarios that are extreme but plausible. It 
is very light on the prescriptive standards. And so what we 
have raised, JPMorgan, other clearing members, as well as end-
users, to the global standard setters, that there needs to be 
more prescriptive standards. And that would cover those kinds 
of assumptions and basic parameters about how that work should 
be done.
    Separate from that, we do believe that there should be, 
like ESMA has just completed, ESMA is the European regulator 
that oversees CCPs in Europe, they just completed a stress 
test, overseen by the regulator, across 17 European CCPs. We 
believe, and the results were transparent to the market, and we 
believe something like that would provide more confidence in 
CCP structures.
    Mr. Lucas. Mr. Chairman, my time has expired, but if there 
is another round, we may continue along this vein.
    The Chairman. Yes, sir, and it expired a minute ago.
    The chair now recognizes the gentleman from California, Mr. 
Aguilar.
    Mr. Aguilar. Thank you, Chairman Scott. And I don't want to 
be admonished so I will make sure I stick to my time.
    Some of my colleagues have gone down this road. And, Mr. 
Edmonds, you talked about the global nature of this market, 
and, Ms. Rosenberg, you just commented on the same from the 
regulatory framework abroad. So I will make this to Mr. Berger, 
Mr. Merkel, Ms. Rosenberg, and Mr. Zubrod.
    Can we go down that path a little further? I am interested 
to know about the financial regulatory structure in other 
countries and how that is going to impact the swaps market.
    Ms. Rosenberg, you just talked about the European 
discussion moving forward, and earlier you talked about 
continued discussions in the regulatory structure abroad. Can 
we talk about the impact that will have on the U.S. swaps 
market?
    Ms. Rosenberg. Sure. I am happy to start. Thank you for 
that question. That is a very important question.
    One of the things we have seen with respect to SEFs and 
market liquidity is that there could be certain enhancements 
made in the U.S. CFTC rules to curtail the current market 
fragmentation that we have seen between Europe and the U.S. We 
expect the European regulators to develop specific rules around 
SEFs going into next year. And currently, the U.S. rules are 
very prescriptive with respect to how swap dealers can execute 
trades, and we do believe that there needs to be more 
flexibility on that front because we expect that is where the 
Europeans are going. And that is very important. And I do 
believe that the CFTC and Chairman Massad are very supportive 
of this.
    Mr. Aguilar. Mr. Merkel?
    Mr. Merkel. I would agree with that. What we have seen is 
that there were good intentions on the part of the CFTC to try 
to lead and try to get other jurisdictions to harmonize forms 
of execution. It just didn't work. What ultimately ended up 
happening was it chased away non-U.S. participants, and led to 
markets developing outside the United States, which did 
fragment liquidity. It is not a crisis, just unfortunate, and 
doesn't really benefit anyone. From our perspective, we will do 
the business wherever it is. We will do it in New York, we will 
do it in London. And we will have to see what happens with 
MiFID II and how the U.S. agency approaches it. I do think that 
one should be realistic and be somewhat courteous of what is 
going on in Europe, and understand that they don't have to come 
here. And it may well be that we may face a situation in which 
at some point U.S. firms aren't going to be able to do business 
in Europe as easily, and that would be unfortunate for a number 
of reasons. And the best way to do this is to encourage what we 
think is starting to occur, which is a different approach that 
Chairman Massad is taking, and see what develops.
    We are in a cautiously optimistic mode, provided something 
happens. If nothing occurs, we are going to have a problem. I 
just don't, at the moment, think I might be optimistic, but 
that is not likely.
    Mr. Aguilar. Thank you. Mr. Berger?
    Mr. Berger. We are likewise optimistic that a harmonized 
and mutually recognized regime can be put in place for both 
clearing and trading. On the clearing front, as I noted in my 
opening remarks, the scope of the clearing obligation that is 
going to be phased in in Europe beginning this year is 
identical in scope to what has been already put in place in the 
U.S.
    On the execution side, the good news is there is common 
architecture that has been developed. Europe has adopted the 
same execution of clearing workflow and straight through 
processing rules that the CFTC has put in place. And there is a 
commitment in both regimes that trading venues should provide 
impartial and nondiscriminatory access to all market 
participants.
    There is a path forward. Obviously, the European regime is 
a few years being. Clearing is just being phased in there this 
year, and we phased clearing in in 2013. And as other 
commenters have noted, the MiFID II reforms, which will affect 
trading in Europe, come into effect in 2018. So there is a 
timing differential, but the objectives and the end state is 
consistent across both.
    Mr. Aguilar. Thank you. Mr. Zubrod, real briefly.
    Mr. Zubrod. Yes, I will note with respect to my testimony 
the comparison with Singapore, Australia, Japan, and Canada, 
these are governments who have enacted what amounts to 
exceptions to clearing and/or margin in their regimes, and the 
implication for them is that such market participants will not 
be unnecessarily burdened, whereas those here in U.S. markets 
will be by these requirements.
    Mr. Aguilar. Thank you. Thank you, Mr. Chairman.
    The Chairman. The chair now recognizes Mr. Neugebauer, for 
5 minutes.
    Mr. Neugebauer. Thank you, Mr. Chairman.
    Mr. Duffy and Mr. Edmonds, we have talked a lot about 
clearinghouse governance, and so how do you determine what 
level of risk a clearinghouse takes on, and then what are your 
primary tools that you use to manage that risk?
    Mr. Edmonds. Those decisions are made at a risk committee 
level, which is part of the defined part of the governance 
structure. A recommendation is made, whether it is a new 
product, a new member coming into the clearinghouse that is 
going to bring their own level of customer flow into the 
clearinghouse at the time. And once that decision is made to 
launch those new products or to add on that new member, we are 
constantly looking at the entire book, the match book. At no 
point in time do we run an unmatched book. The only time that 
ever happens is if one of the members is defaulting, and our 
job at that moment in time is to bring it back to match book as 
quickly and as efficiently as possible, with as little 
disruption to the marketplace as possible.
    Making certain that all of the members that we govern 
through the clearinghouse structure and the way it is set up 
under the CFTC, that we understand the risks they are bringing, 
and the collateral they bring to support that risk on a daily 
basis is the function of the clearinghouse, and continues to be 
the primary responsibility that we have to the marketplace.
    From a tools perspective, this is everything in the 
waterfall. Membership, not everyone qualifies. If I have $5 and 
you have $5 million, chances are you are a better member than I 
am at that day.
    Mr. Neugebauer. Yes.
    Mr. Edmonds. Okay. Making sure that the qualified members 
are there, and making sure there are operational risk controls 
there so they can process the customer flow. Our members, who 
are very important partners with us, ultimately make the 
decision of who gets access to our clearinghouse services. If 
they have done a poor job, we need to be able to spot that, and 
we need to be able to have a consultation with them. We don't 
like this position, it is too concentrated. If it is too 
concentrated, there are other premiums of collateral we bring 
in there. You may want to hold a very concentrated position, 
and we may be able to get comfortable with that, but you might 
be collateralizing that more than 100 percent of the risk that 
we hold. If that is something you are willing to pay, we will 
take that at the end of the day. And then making sure that we 
get all the way down through, okay, what happens if it goes the 
wrong way. What happens if the collateral wasn't what we 
thought it was going to be? How do we manage that process all 
through again? Membership committee: It is the same for every 
single person. No one is making a bilateral decision. Clearing 
member A gets this function. Clearing member B gets a separate 
function. Everyone is managed to absolutely the same standard 
at all times.
    Mr. Duffy. I would just add, I agree with Mr. Edmonds 
completely on everything he said there, but I would just add 
that one of the things that we have the ability to do under the 
Dodd-Frank Act, which was critically important when we are 
talking about swaps, is the ability to reject a swap at the 
clearinghouse CCP level if we are not comfortable with the risk 
that it is bringing into our institution. I think that is 
something we use, and margin is another tool that Mr. Edmonds 
also referenced. Margin is something that is important for the 
CCPs always to have the ability to set. We are not interested 
in if the price goes up or down, we are interested in managing 
the risk. These are the tools that we have put in place today, 
and I am only outlining a couple of them, Mr. Edmonds did a 
good job outlining the others, but these are critically 
important tools. When you don't have an interest in the market 
going up or down, that is who should be setting the margin, and 
the ability to reject something that you are not quite sure how 
to risk manage is also critically important.
    Mr. Neugebauer. The leverage ratio as several of you 
alluded to that, and so the question I have is: leverage ratio, 
has it caused margins to go up. So, in order to adhere to 
whatever the leverage ratio is pegged at, would you get credit 
for additional margin that you request from your members?
    Mr. Edmonds. Now, that is a bit of the perplexing piece 
because the more margin our members collect on their client 
positions and post to us, the way the rules currently stand 
today, the more capital they have to hold against it. So at a 
time where we are trying to encourage more and more individuals 
to use clearing services because of the risk-reducing nature of 
it, we are adding to that cost. The more collateral we get, the 
more the bank clearing members are having to hold against that. 
Well, they have to then charge for holding that capital against 
that, from a regulatory capital perspective. That increases the 
cost to your end-clients. And that is where this thing begins 
to spiral out and more people are making the decision today, if 
they possibly can, to choose not to be in that situation.
    Mr. Neugebauer. That is counterintuitive. In other words, 
what you are saying is the less risky you make that position, 
the more capital that you have to keep. Do I understand that 
correctly?
    Mr. Edmonds. You do. And yes, it sounds illogical, and we 
are trying to have a logical conversation.
    Mr. Neugebauer. Mr. Duffy?
    Mr. Duffy. May I just jump in real quick? What I think is 
critically important, and Ms. Rosenberg can answer this better 
than any of us because this affects her more than anybody, but 
what is important is her bank, or any other bank, cannot touch 
that collateral that is in the clearinghouse because it is 
segregated. There is no reason to have the leverage ratio 
charge put up against it. They have no access to that capital 
or collateral.
    The Chairman. The chair now recognizes Mr. Davis, from 
Illinois, for 5 minutes.
    Mr. Davis. Thank you. Thank you, Mr. Chairman. And thank 
you to everyone for coming here today to talk about this 
important issue. A lot of the questions that I had planned to 
ask have been asked by my colleagues. And that is the benefit 
of being a little further down the seniority ladder, like we 
are.
    Let me start with you, Mr. Zubrod. Can you go into a little 
more detail on the impact to agricultural and energy firms 
moving away from the swaps market to the futures market to 
possibly hedge their risks?
    Mr. Zubrod. It is a good question, and I appreciate its 
premise. If I can discern correctly, the premise is that we 
should really give due consideration to players who are 
involved in helping to provide price stability to the kitchen 
table, to energy bills that consumers pay at home. My view on 
the key obstacles to smaller players like that in accessing the 
markets tends to be focused, again, on the issue of clearing 
and margin costs for those smaller players, not necessarily the 
obstacles, for example, created by SEFs or other things. There 
are legitimate debates about whether or not one needs to be 
prescriptive in defining all aspects of how SEFs need to 
operate, but that being said, I think that is not the key 
obstacle for a lot of the clients that we work with in 
accessing the markets. It is the significant costs associated 
with clearing and margin.
    Mr. Davis. Okay. Do you have any suggestions to address 
some of these obstacles?
    Mr. Zubrod. Yes, again, for the clearing and margin 
requirements, it could be addressed very simply, and the 
simplistic solution is to exempt small, low-volume players from 
the clearing and margin requirements.
    Mr. Davis. Okay. Mr. Duffy. How are you, sir?
    Mr. Duffy. I am good, sir. How are you?
    Mr. Davis. Good. Nice to see you are on your wing again 
here. As many of you know, it was named the Terry Duffy Wing, 
one of the last Subcommittee hearings that I had. It was just 
me that named it, so sorry, Terry. We don't have a plaque up 
yet. Can you fix that, Chairman Scott?
    Mr. Duffy, how does the CME strike the appropriate balance 
between profits and risk management?
    Mr. Duffy. How do they--between what, profits and risk 
management?
    Mr. Davis. Yes. How does your company strike the balance 
between profits and risk management?
    Mr. Duffy. Risk management comes first, sir. Without risk 
management, we don't have profits. I have said this a million 
times over, the credibility of our marketplace is of the utmost 
importance to CME Group. We cannot shortcut any of the risk 
management tools or protocols that we put into place, or 
continue to put into place, or we will not have shareholders. 
We do not put profits in front of risk management. Again, this 
is something that is near and dear to my heart, and near and 
dear to everybody in the organization, because we will not 
shortcut that process one cent.
    Mr. Davis. And we appreciate that.
    And I will yield back the balance of my time, Mr. Chairman.
    The Chairman. Thank you, Mr. Davis. I now recognize Mr. 
Kelly, from Mississippi, for 5 minutes.
    Mr. Kelly. Thank you, Mr. Chairman and Ranking Member 
Scott, for having this hearing. And thank you, witnesses, for 
being here.
    I have been in and out so if I ask you something that has 
already been asked, I apologize.
    Mr. Davis talks funny beside me, so I know that you guys 
can understand my accent much better than his.
    Ms. Rosenberg, you were partially answering this when I 
walked back in, but if you want to add anything, has the 
clearing mandate been a positive development for the market?
    Ms. Rosenberg. Thank you for the question. Yes, we believe 
it has been a positive development for the market. The G20 
reforms have made the system safer and more transparent. And 
what we are collectively doing now, market participants as well 
as regulators and clearinghouses, are reviewing current 
standards. We do expect market consultation at the global level 
to come out over the next couple of months to cover many of 
these standards that are being revisited, and they include 
stress testing, initial margin, governance, as well as recovery 
tools. And we look forward to providing that input into that 
process.
    Mr. Kelly. And kind of as an unintended follow up, I guess, 
as a member of many clearinghouses, does your firm have any say 
in the products that are cleared in each venue, and do you have 
any concerns about the products that might be cleared in the 
central clearing counterparties JPMorgan is a member of. 
Further, do you think the capital and margin rules are 
incentivizing products to be cleared that perhaps shouldn't be?
    Ms. Rosenberg. That is near and dear to our firm's heart, 
as well as other clearing firms. What I haven't said in my 
testimony is that JPMorgan, as a firm, there are employees at 
JPMorgan that do sit on clearinghouse risk committees, but that 
role that we participate in is as a fiduciary on behalf of the 
clearinghouse, or as a market expert. It is not representing us 
as a clearing firm. What we have seen, and we think we expect 
it to continue to go in this direction, particularly with the 
non-cleared margin rules coming out, starting in September, 
there is an interest by participants and CCPs to clear more 
products. There is going to be a demand to clear more products, 
even if they are not mandated, more complex products. And we do 
think there needs to be more involvement with key stakeholders, 
like members, through a mandatory consultation process early in 
determining whether a product is suitable to clearing because 
the impact of clearing more complex products could impact our 
capital that we contribute through the loss mutualization 
process.
    Mr. Kelly. Mr. Berger, I am talking about swaps execution 
facility, the SEF, can market participants limit themselves to 
using only one SEF, or do they need to use multiple SEFs? And 
if the latter, if they need to use multiple SEFs, what problems 
does that pose?
    Mr. Berger. Market participants are free to use one or 
multiple SEFs. Many buy-side market participants use the two 
SEFs that serve the buy-side community: Bloomberg or Tradeweb, 
so many buy-side market participants will use one or both of 
those venues. There are probably, serving the interest rate 
swap market and the credit default swap market, eight or nine 
SEFs that have a decent amount of liquidity. One of the 
concerns that the Managed Funds Association has, however, is 
that there are really only two SEFs that are truly open and 
accessible to customers in the market, and five or six of the 
other SEFs that have liquidity have to maintain certain 
barriers. So it would be beneficial if investors could access 
the full array of swap execution facilities that have 
liquidity.
    Mr. Kelly. Thank you. And, Mr. Edmonds, we talk a lot about 
models and stress testing, but how good are the models and how 
do we know that the models developed will work in a time of 
stress?
    Mr. Edmonds. We have to use the best information available 
to us at the time. I will tell you, spending time, in my 
previous role at ICE, running the CDS Clearinghouse, we went 
back and we continued to look back at the 2008 crisis, and we 
looked at that and we said what if it was two times as big, 
what if the price differential from the Lehman Brothers' 
default and its impact on credit default swaps was 200 percent 
of what we witnessed that day. And we still hold enough capital 
against that today. If it is 400 percent, we might have a 
different conversation, but as I said earlier in one of my 
remarks, I might not be the thing you are looking at that day, 
it might be a much bigger piece.
    Mr. Kelly. And thank you, Mr. Chairman. I yield back.
    The Chairman. We are going to go on to our second round of 
questioning now. And I yield myself for 5 minutes.
    Mr. Berger, members of your firm have been enthusiastic 
about the impact of Dodd-Frank on cleared derivatives 
transactions, and have worked hard to build a business as a 
nontraditional liquidity provider in certain swaps. Do you see 
the success of Citadel as the new model for swaps liquidity as 
banks retreat from their traditional role in these markets?
    Mr. Berger. Just one note up-front, I am here today 
representing Citadel's hedge funds businesses, speaking on 
behalf of the Managed Funds Association and Citadel Securities, 
which conducts swap market-making activities operates 
independent of Citadel's hedge funds. That said, a central goal 
of the swaps markets reforms was to lower barriers to entry and 
increase competition, and that does directly benefit investors 
by providing more competitive pricing and more diverse sources 
of liquidity beyond the historical incumbent intermediaries in 
the marketplace.
    The Chairman. Do you think that all swaps markets are 
suitable for electronic market-making, and are there any 
liquidity challenges created by Dodd-Frank, despite the success 
you have seen at Citadel?
    Mr. Berger. I don't think all swap markets are suitable for 
electronic trading. There are portions of the swap market that 
remain uncleared, for example, but the portions of the swap 
market that are cleared and that are highly liquid and 
transparent, are standardized, liquid, and transparent, are 
appropriate to trade on swap execution facilities through 
electronic RFQ and order books as well. Research that has 
looked at the impact of the migration to SEF trading has shown 
that it has improved pricing and liquidity. We have heard 
referenced today already to the Bank of England research that 
was released earlier this year or, sorry, at the end of last 
year, that reached that conclusion, and that research has been 
independently validated by some other market researchers, 
including Claris. There are tangible benefits that market 
participants are realizing from these reforms.
    The Chairman. So you think it has improved liquidity, and 
you don't see any challenges with liquidity because of it?
    Mr. Berger. I think that it has improved pricing and 
liquidity, and the challenges that exist with respect to 
liquidity in the marketplace are best addressed by ensuring 
that more market participants can join all the venues that are 
available, and that there are more diverse means of risk 
transfer and price discovery. So that a broader array of market 
participants who can be both price makers and price takers, and 
a more kind of diverse marketplace is the long-term solution to 
any liquidity challenges we face today.
    The Chairman. All right. Ms. Rosenberg, late last week the 
European Union announced that it was delaying its margin for 
uncleared swaps rules. Chairman Conaway stated that this is yet 
another failure of international cooperation which will have 
real consequences for U.S. market participants. How does this 
sudden shift in coordination impact a bank like JPMorgan, and 
what other potential failures of cooperation are you worried 
about?
    Ms. Rosenberg. This is a really--pressed the wrong button, 
sorry.
    The Chairman. That is all right.
    Ms. Rosenberg. This is a really important question, and it 
is something that policymakers and regulators need to be 
focused on. As you mentioned, it is a recent announcement, it 
just happened on Friday, and we are still considering the 
implications for JPMorgan, but our initial concern is that it 
may create disadvantage for U.S. banks. A primary priority for 
the industry throughout the development of these margin rules 
has been consistency and content and timing. So we don't want a 
delay in timing in one jurisdiction that could create undue 
burden or lack of competitiveness for U.S. firms.
    The Chairman. Mr. Zubrod, if U.S. regulators go it alone 
with the uncleared margin rule because the European Union 
failed to follow through with its commitments, what will be the 
impact of end-users like your clients?
    Mr. Zubrod. Sure. Thanks for the question. I would say 
global margin rules really reflected the most careful and 
deliberate process across all of derivatives regulation to 
reach a globally coordinated outcome, and to line up the start 
dates globally as well. And it would be valuable to endeavor to 
retain a key benefit of that coordination by maintaining those 
aligned start dates. Failures to do so will drive imbalances in 
counterparty selection that have competitive implications. For 
example, if I were a European entity, and I had the choice of 
facing a European bank or a U.S. bank, one who was subject to 
U.S. margin rules that started earlier, and another who was 
subject to European rules that had not yet taken effect, if 
those start dates didn't match, I would have the incentive to 
transact with the European bank. So that is certainly a real-
world implication of becoming misaligned on those dates, and we 
should endeavor to move forward in lockstep with Europe.
    The Chairman. Yes. Thank you. I would now recognize Mr. 
Conaway, the Chairman of the full Committee.

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

    Mr. Conaway. Thank you, Mr. Chairman.
    I apologize for popping in and out, but thank you all for 
being here.
    In Chris Giancarlo's white paper in 2015, he was critical 
of the limitation on methods of execution available for swap 
SEFs which was needed in the G20 rules and/or Dodd-Frank, but 
it was a part of the Gensler regime. Can any of you comment on 
the impact that that limitation has on the way you do your 
business, good or bad? Yes, Mr. Merkel?
    Mr. Merkel. Thank you, Mr. Chairman. We would agree with 
Commissioner Giancarlo in that respect. We faced at the WMBAA 
early on, there had been a bias towards exchanges and towards 
electronic marketplaces, and we worked hard to make sure that 
Dodd-Frank ultimately provided a technology-neutral approach 
with respect to marketplaces that used any means of interstate 
commerce. And we thought at that point that the debate was 
over, but it turned out it was just beginning. When the 
proposed rules came out, they were constrained. They really 
were.
    They continued to have issues with voice brokerage, there 
were issues with respect to trying to put in and prevent 
certain matching protocols that otherwise should have been 
permitted, and were successful all over the world, but the 
agency didn't want. Over time, we were able to work with the 
staff to get to a better place, but we continued to have some 
regulatory uncertainty. Letters for relief or guidance have 
been unanswered. Other areas we are in a tacit form. And you 
see that MiFID II has a much more expansive and flexible 
approach to execution than you see here. Again, while I am 
optimistic that it will all be harmonized, we have noticed that 
it has taken time and it has been difficult to get to where we 
have finally gotten to with respect to most, but not all, of 
the auction protocols. Some of the issue may be that, for the 
most part, the agency was used to futures exchanges but not 
necessarily over-the-counter markets. And what you see in the 
over-the-counter markets are a much broader range of methods of 
execution, levels of opacity versus transparency. And what we 
see with the swaps markets has been most successful, and 
derivatives are most robustly traded, is where you don't limit 
the means of execution.
    Mr. Conaway. Right. Mr. Edmonds?
    Mr. Edmonds. I would echo that point. From a clearinghouse 
perspective, certainly, we run exchange businesses and we have 
execution protocols, but the goal of the G20 was to reduce the 
risk. And the only way you are going to achieve that goal at 
the end of the day is to be as open and agnostic as possible of 
how that trade is executed. But once it is executed, it goes 
into a system that is very regulated, very transparent, and 
understood about how the risk is going to be managed. And if we 
are going to do things that take us down a path different than 
that, we are not going to achieve the ultimate efficiency of 
that goal.
    Mr. Conaway. The Chairman has asked about the delay by the 
Europeans on their uncleared swaps margin. Is there an argument 
to be made that the U.S. and the Asian markets should continue 
with that implementation date, because these are simply the 
biggest banks, dealer-to-dealer, and it really won't have any 
real impact? Is there an argument to be made about that as to 
why it would not be necessarily a competitive disadvantage to 
all the rest of the markets in the world if Europe delays it by 
a year? Anybody?
    Mr. Duffy. I am sure Ms. Rosenberg can speak as well as 
anybody on this issue, but this puts the U.S. banks at a huge 
disadvantage to the European banks, just for the example that 
was laid out at the end of the table here. I am hopeful that 
this implementation date that the U.S. and other countries 
around the world are looking at can be postponed in 
coordination with the European date. I just think it puts the 
U.S. banks at a huge disadvantage.
    Mr. Conaway. How would the argument go as to say that if we 
make international agreements, and we all agree to a date, and 
then when we get right here at the last minute we let the 
lowest common denominator drop out, and then we are going to 
reward that bad behavior by delaying everybody else. Is there 
an argument that way to say, ``Look, we are going to stick with 
it, and you guys are going to have to come to the table and get 
your job done the way that you should have done it the way we 
agreed to a year ago?'' Ms. Rosenberg, or anybody?
    Ms. Rosenberg. I was just going to say that the date that 
is going to be the most impactful from a U.S. bank perspective 
is the phase two when the customers start having to post 
noncleared margin. That is later on to next year. As I said, we 
haven't looked at the full implications for JPMorgan as a firm 
in terms of the impacts, whether it be 6 or 9 months, and we 
are happy to provide more feedback on that.
    Mr. Conaway. Well, obviously, this just happened Friday, 
and there are a lot of folks trying to figure out what we did 
to whom on that.
    Thank you very much. I appreciate it. Mr. Merkel, did you 
have a comment?
    Mr. Merkel. It may be obvious, but I did want to make the 
point that there is always a trade-off between U.S. regulators 
wanting to insist on certain safety prudential or fairness 
issues to govern its participants against what the effect would 
be on a global basis. And they have to make a judgment at what 
point they need to insist upon the virtues and understand what 
the negative consequences would be, but it does seem as though 
this particular area is one in which one would expect there 
should be some flexibility as to the date of implementation. 
There does not seem to be a great urgency about it, and there 
would seem to be some benefit in trying to see whether or not 
there can be coordination globally.
    Mr. Conaway. Yes. Mr. Berger, you had a comment?
    Mr. Berger. Thank you. I was just going to add that the 
timeline in both the U.S. and Europe for the implementation of 
these rules is phased in from 2016 to 2020 as originally 
envisioned, and the new uncleared margin rules don't hit the 
end-user or buy-side community until 2019, based on the 
different thresholds they have set. The September 2016 date 
that is being discussed now is relevant for counterparties with 
above $3 trillion notional in uncleared derivatives 
outstanding. That is really a handful of the biggest banks, but 
there is not a direct impact at least on the end-user in the 
current community.
    Mr. Conaway. Yes. Okay. Mr. Chairman, thank you for your 
indulgence. I yield back.
    The Chairman. Thank you. The chair will now recognize Mr. 
Scott.
    Mr. David Scott of Georgia. Yes. I want to get clarity now. 
The date of implementation is September what did you say?
    Mr. Berger. September 1, 2016, is the first implementation 
date.
    Mr. David Scott of Georgia. Yes. And so, Mr. Duffy, you are 
saying that that date puts our U.S. businesses at a competitive 
disadvantage if we don't move it back?
    Mr. Duffy. It certainly could. Ms. Rosenberg, obviously, 
works for a very global bank, and maybe it won't affect their 
European business, I am not sure, but the banks that are 
primarily U.S. banks, U.S.-regulated banks, it will affect 
them. But, the point is, and it is a good point, and the 
Chairman raised it, this just came out Friday, details are a 
little sketchy, and the implementation date of 2016 and then 
followed on by 2017. It goes back to my further point, Mr. 
Scott, and this is just another example of how we are going to 
have uncertainty in the marketplace where the market does not 
need uncertainty, it needs clarity. And one of the things that 
I have heard here amongst this panel, which, on a whole host of 
issues, is we need to have continuity within our European and 
Asian counterparts, so we can have one set of rules.
    Mr. David Scott of Georgia. I see. And you say, Ms. 
Rosenberg?
    Ms. Rosenberg. I would just add to what Mr. Duffy just 
said, which is, it is very complex. We are looking at our legal 
entities, we are looking at our counterparties, we are looking 
at where we do swaps and who we do swaps with. In September, it 
will impact U.S. banks, which means any counterparty that we do 
business with will have to post noncleared margin to us. In 
that instance, if our counterparties can operate or trade and 
execute with non-U.S. counterparties, where they don't have to 
post margin, then they may choose to do so. That is what we are 
evaluating right now, what that impact could be.
    Mr. David Scott of Georgia. When should we do it? As the 
Chairman has said, we have been kicking the can down the road, 
kicking the can down the road, kicking the can down the road 3 
years, 2 years, I don't know. This Committee does not want to 
move in any way, we are very, very, very cautious about putting 
our United States companies in at a competitive disadvantage. 
And if you all, the banks, the clearinghouses, are agreeing 
that this does, let me ask you to describe that competitive 
disadvantage if we don't do it. What would that cause you to 
do?
    Ms. Rosenberg. In terms of how it would impact us, 
counterparties could choose to execute a swap and clear a swap 
bilaterally with a European counterparty that is not yet 
subject to these uncleared margin rules.
    Mr. David Scott of Georgia. Okay.
    Ms. Rosenberg. I mean that is the base of it. I would say 
that our folks internally at JPMorgan, are looking to see how 
much of an impact that could be. But, it gets back to the 
timing and the differences in timing and there was a real 
effort that was put forth to have consistent standards and 
consistent timing of implementation to avoid things like this.
    Mr. David Scott of Georgia. Yes.
    Ms. Rosenberg. So, as I said, we are looking at this, and 
we can come back to you with more information once we have done 
the full evaluation.
    Mr. David Scott of Georgia. Is there a dollar figure, is 
there something that is tangible that the regulators, the CFTC 
or whoever we would need to talk to about this date, that we 
could say X amount of money would be lost? Is there something 
we could put our hands around to really show how large and how 
significant an impact this would be on our American businesses 
if we do not adjust this September date?
    Mr. Edmonds. I don't know that we could say a dollar 
amount, but you could say that there is a limitation in choice 
because if you are going deal, assuming the date doesn't move, 
you are going to deal with a U.S. counterparty that is going to 
have to charge you some number. You may have the option to deal 
with a European entity that is not required to charge you some 
number.
    Mr. David Scott of Georgia. Yes.
    Mr. Edmonds. If you decide that, all things else being 
equal, you are just going to take the path of least resistance 
as long as you can, that may be fine, but you also may have 
much, much less choice as to the number of counterparties that 
you can deal with. And the European counterparties realizing 
that you have less choice, might have the ability to increase 
that cost, for their benefit, to you.
    Mr. David Scott of Georgia. I see. Thank you, Mr. Chairman.
    The Chairman. The chair now recognizes Mr. Lucas, for 5 
minutes.
    Mr. Lucas. Thank you, Mr. Chairman. Just in a way of a 
follow-up, Mr. Duffy, any more observations about stress test 
issues, weaknesses, overcoming those? The earlier discussion we 
had, you seemed to have an observation.
    Mr. Duffy. On the stress test? The only thing I was 
pointing out was that I didn't want to have the perception that 
CCPs in the United States don't have stress tests under its 
U.S. regulator, which we do. I do agree with Ms. Rosenberg, we 
need to have coordination with our European counterparts on 
this because of the businesses that they run. JPMorgan, you 
said, has 71 different clearing entities that they are 
associated with. I understand that part, but the only thing I 
was trying to stress was that we do have very rigorous stress 
tests that are overseen by our U.S. regulator today, there is 
just not a global standard, to Ms. Rosenberg's point.
    Mr. Lucas. So it is an ongoing, evolving process you all 
are completely engaged in?
    Mr. Duffy. It is always going to be ongoing. Absolutely.
    Mr. Lucas. With that, Mr. Chairman, I yield back. Thank 
you.
    The Chairman. Mr. Conaway, do you have any thoughts?
    Mr. Conaway. No.
    The Chairman. Mr. Scott, I now recognize the Ranking Member 
to make any closing remarks he has.
    Mr. David Scott of Georgia. Well, again, Mr. Chairman, this 
has been a very timely and, quite honestly, necessary hearing. 
It has been very revealing. We do have some issues and concerns 
here. I do think we need to take under consideration the 
concerns that several of the panelists have raised, 
particularly, regarding taking a good jaundiced eye look at 
this date. We certainly don't want to put our businesses at a 
disadvantage. This is an evolving issue, it is complicated, it 
is confusing. You are trying to get 20 nations to harmonize, 
and do it on a timely basis. We do not want to do anything that 
would hurt American businesses. That is just my concern.
    I am also concerned about this Basel III situation and the 
leverage ratio. I think that that is a serious issue too.
    So I come away from this hearing with a heightened sense of 
concern. Our Committee needs to make sure we address all these 
issues, and make sure we move, communicate with the CFTC and 
continue to soldier on. And we hope we can move forward and get 
an execution date, but I certainly want to see some of these 
issues examined and cleared.
    Thank you, Mr. Chairman.
    The Chairman. Thank you, Mr. Scott.
    Ma'am, gentlemen, thank you for being here and 
participating in this hearing.
    Under the Rules of the Committee, the record of today's 
hearing will remain open for 10 calendar days to receive 
additional material and supplementary written responses from 
the witnesses to any questions posed by Members.
    This hearing of the Subcommittee on Commodity Exchanges, 
Energy, and Credit is adjourned.
    [Whereupon, at 11:40 a.m., the Subcommittee was adjourned.]
    [Material submitted for inclusion in the record follows:]
                          Submitted Questions
Response from Hon. Terrence A. Duffy, Executive Chairman and President, 
        CME Group Inc.
Questions Submitted by Hon. Collin C. Peterson, a Representative in 
        Congress from Minnesota
    Question 1. At a recent CFTC Market Risk Advisory Committee meeting 
a number of buy-side witnesses testified that the practice of post-
trade name-give up--that is: the removal of anonymity from the market 
after execution, has prevented them from participating in the SEFs 
offered by the Inter-Dealer Brokers. Further, two class-action lawsuits 
alleging anti-trust violations against the largest dealers and several 
of the interdealer brokers have been filed in the credit default swap 
and interest rate markets respectively. These suits both allege that 
the practice of post-trade name give-up has been planned by the largest 
participants and forced on to the inter-dealer brokers in restraint of 
trade. One of them settled late last year for $2bn.
    The SEF Core principles in Dodd Frank require impartial access for 
all eligible market participants. The CFTC's SEF Rule mandates that a 
SEF must ensure ``impartial access to its markets and market services'' 
for eligible participants--and that eligibility itself must be set in 
an impartial, transparent, fair and non-discriminatory manner.
    Do all eligible market participants have impartial access to each 
and every SEF? If not, why not?
    Answer. We are not familiar with the practices of other SEFs. 
However, CME Group's SEF operates in strict accord with the SEF Core 
principles, including supporting CFTC rules and interpretations 
respecting impartial access for all eligible market participants. Our 
SEF access rules are transparent and readily available in chapter I of 
the SEF rulebook (http://www.cmegroup.com/rulebook/SEF/cme-sef-
rulebook.pdf).

    Question 2. There was a great deal of testimony regarding 
harmonization with European Rules. However, from published reports a 
number of trade organizations representing incumbent firms with 
significant market power have been arguing to European regulators and 
legislators to make changes to the proposed trade execution regime in 
MiFID II. If that effort is successful, we will be asked to harmonize, 
or to push the CFTC to harmonize, our clear rules on impartial access 
to the SEF marketplace for eligible participants with rules that 
include no such mandate. In that eventuality should harmonization still 
be our top priority?
    Answer. CME Group favors fair and impartial access to U.S. based 
SEFs and DCMs. We favor cross border harmonization to the extent it is 
necessary to permit us to operate for the benefit of customers in other 
jurisdictions. We do not believe that harmonization principles will 
require U.S. law and regulation to permit practices that are 
inconsistent with the existing access standards in this country. It is 
our view that harmonization requires a defined level of protection for 
customers or institutions. It should not be interpreted to require any 
jurisdiction to weaken its market protection standards.

    Question 3. The swaps we discussed at the hearing are not 
customized--they are standardized. Standardized swaps are the only 
swaps that are subject to the trading mandate--they are cleared and are 
subject to the straight-through-processing requirement. And yet, we 
repeatedly hear that the swaps market is fundamentally different than 
other standardized markets: that it is characterized by episodic 
liquidity and that its bifurcated, two-tiered structure is the 
``natural'' evolution of the market. Do you agree or disagree with that 
characterization?
    Answer. We agree that episodic liquidity stemmed from the natural 
evolution of the market.
    While the interest rate swaps that are subject to the trading 
mandate are referred to as ``vanilla'' and are comparatively standard 
in contrast to more highly customized interest rate swaps, most highly 
standardized derivatives products (such as many futures contracts) are 
characterized by an even greater degree of standardization than is 
present in most ``vanilla'' OTC interest rate swaps. In most cases, a 
swap traded today will not be offset by the same swap traded the next 
day. This results in very different liquidity characteristics from 
futures contracts, which have the same expiration and which are 
fungible regardless of the trade date.
    The majority of ``vanilla'' interest rate swaps subject to a 
trading mandate do not have standardized coupons or dates. Products 
with non-standardized coupons and dates can allow market participants 
to achieve specific risk management needs, but will typically have a 
greater number and variety of instruments traded. This results in 
different liquidity formation characteristics than more fully 
standardized products that aggregate liquidity of participants across 
multiple dates and potential coupon rates.
    The emergence of more standardized interest rate swaps, such as MAC 
(Market Agreed Coupon) swaps, and the development of related swap 
futures by multiple global exchanges are likely to have a significant 
impact on the evolution of the swap market toward a more standardized, 
liquid trading venue.
Response from Christopher S. Edmonds, Senior Vice President, Financial 
        Markets, Intercontinental Exchange, Inc.
Questions Submitted by Hon. Collin C. Peterson, a Representative in 
        Congress from Minnesota
    Question 1. At a recent CFTC Market Risk Advisory Committee meeting 
a number of buy-side witnesses testified that the practice of post-
trade name-give up--that is: the removal of anonymity from the market 
after execution, has prevented them from participating in the SEFs 
offered by the Inter-Dealer Brokers. Further, two class-action lawsuits 
alleging anti-trust violations against the largest dealers and several 
of the interdealer brokers have been filed in the credit default swap 
and interest rate markets respectively. These suits both allege that 
the practice of post-trade name give-up has been planned by the largest 
participants and forced on to the inter-dealer brokers in restraint of 
trade. One of them settled late last year for $2bn.
    The SEF Core principles in Dodd Frank require impartial access for 
all eligible market participants. The CFTC's SEF Rule mandates that a 
SEF must ensure ``impartial access to its markets and market services'' 
for eligible participants--and that eligibility itself must be set in 
an impartial, transparent, fair and non-discriminatory manner.
    Do all eligible market participants have impartial access to each 
and every SEF? If not, why not?
    Answer. ICE Swap Trade offers a multitude of methods of access 
related to credit default swaps including an all to all anonymous 
marketplace, broker access and name give ups. By offering various 
methods of access, ICE complies with SEF regulations which are intended 
to promote fair, non-discriminatory and open access. The ICE Swap Trade 
platform will accept a transaction, either cleared or bilateral, as 
long as the transaction meets the SEF requirements.

    Question 2. There was a great deal of testimony regarding 
harmonization with European Rules. However, from published reports a 
number of trade organizations representing incumbent firms with 
significant market power have been arguing to European regulators and 
legislators to make changes to the proposed trade execution regime in 
MiFID II. If that effort is successful, we will be asked to harmonize, 
or to push the CFTC to harmonize, our clear rules on impartial access 
to the SEF marketplace for eligible participants with rules that 
include no such mandate. In that eventuality should harmonization still 
be our top priority?
    Answer. The Rules on access to trading venues under MiFID II were 
agreed to in the Level 1 legislation. The Level 1 legislation requires 
trading venues to have in place transparent and non-discriminatory 
rules based on objective criteria which govern access to their 
facility. These requirements are comparable to the impartial access 
rules for SEFs. ICE believes harmonization between global regulators is 
critical and should be a prioritized accordingly.

    Question 3. The swaps we discussed at the hearing are not 
customized--they are standardized. Standardized swaps are the only 
swaps that are subject to the trading mandate--they are cleared and are 
subject to the straight-through-processing requirement. And yet, we 
repeatedly hear that the swaps market is fundamentally different than 
other standardized markets: that it is characterized by episodic 
liquidity and that its bifurcated, two-tiered structure is the 
``natural'' evolution of the market. Do you agree or disagree with that 
characterization?
    Answer. ICE agrees that although certain interest rate and credit 
default swaps have been standardized and mandated for both execution 
and clearing, current regulations have unintentionally created a 
bifurcation in these swaps markets. New regulations that require fully 
anonymous trading would be necessary to remove this bifurcation.
Response from Marnie J. Rosenberg, Global Head, Clearinghouse Risk and 
        Strategy, JPMorgan Chase & Co.
Questions Submitted by Hon. Collin C. Peterson, a Representative in 
        Congress from Minnesota
    Question 1. At a recent CFTC Market Risk Advisory Committee meeting 
a number of buy-side witnesses testified that the practice of post-
trade name-give up--that is: the removal of anonymity from the market 
after execution, has prevented them from participating in the SEFs 
offered by the Inter-Dealer Brokers. Further, two class-action lawsuits 
alleging anti-trust violations against the largest dealers and several 
of the interdealer brokers have been filed in the credit default swap 
and interest rate markets respectively. These suits both allege that 
the practice of post-trade name give-up has been planned by the largest 
participants and forced on to the inter-dealer brokers in restraint of 
trade. One of them settled late last year for $2bn.
    The SEF Core principles in Dodd Frank require impartial access for 
all eligible market participants. The CFTC's SEF Rule mandates that a 
SEF must ensure ``impartial access to its markets and market services'' 
for eligible participants--and that eligibility itself must be set in 
an impartial, transparent, fair and non-discriminatory manner.
    Do all eligible market participants have impartial access to each 
and every SEF? If not, why not?
    Answer. Yes. All eligible market participants, as defined by each 
SEF, are given the same access. Each SEF is responsible for determining 
its own participation rules, which apply equally to sell-side and buy-
side participants.

    Question 2. There was a great deal of testimony regarding 
harmonization with European Rules. However, from published reports a 
number of trade organizations representing incumbent firms with 
significant market power have been arguing to European regulators and 
legislators to make changes to the proposed trade execution regime in 
MiFID II. If that effort is successful, we will be asked to harmonize, 
or to push the CFTC to harmonize, our clear rules on impartial access 
to the SEF marketplace for eligible participants with rules that 
include no such mandate. In that eventuality should harmonization still 
be our top priority?
    Answer. As a general matter, global harmonization of rules is 
important to ensure well-functioning derivatives markets. We do not 
have a view as to how the Committee should prioritize the hypothetical 
situation identified.

    Question 3. The swaps we discussed at the hearing are not 
customized--they are standardized. Standardized swaps are the only 
swaps that are subject to the trading mandate--they are cleared and are 
subject to the straight-through-processing requirement. And yet, we 
repeatedly hear that the swaps market is fundamentally different than 
other standardized markets: that it is characterized by episodic 
liquidity and that its bifurcated, two-tiered structure is the 
``natural'' evolution of the market. Do you agree or disagree with that 
characterization?
    Answer. There are fundamental differences between the swaps market 
and other standardized markets. For example, liquidity in swaps markets 
tends to be thinner and more episodic compared to the futures and 
equities markets. This episodic liquidity leads to differences in 
market structure and a broader range of methods of execution sought by 
market participants. The CFTC's rules set out minimum liquidation 
periods for initial margin levels that differ between swaps and futures 
(currently five days for most cleared swaps and one day for futures), 
demonstrating their own view that the liquidity profile of the products 
is different.

    Question 4. In your testimony you both described the swaps market 
as being ``fragmented'' as a result of differences in cross-border 
regulatory progress, but you didn't identify who was responsible for 
that fragmentation. The latest OCC report on swaps trading finds that 
the four largest banks control 91% of the notional market. Are trading 
decisions at the firms with that much control of the market responsible 
for fragmentation? If not, who else is fragmenting it?
    Answer. The four largest banks are not responsible for the 
fragmentation, and it would not be accurate to state that those banks 
control 91% of the notional market for swaps trading; the OCC report 
does not reflect the swaps flow executed by the banks. According to the 
latest research from the International Swaps and Derivatives 
Association (ISDA), the global interest rate swaps market has 
fragmented along jurisdictional lines since the US swap execution 
facility rules came into force in October of 2013. This fragmentation 
has been most pronounced in the euro-denominated interest rate swaps 
markets, where 91.2% of cleared euro IRS activity in the European 
interdealer market was transacted between European counterparties in 
December 2015. In September 2013, immediately prior to the introduction 
of the SEF rules, the figure stood at 70.7%.
    This data is an indication that non-U.S. market participants are 
choosing to transact less with U.S. persons, or certain foreign 
subsidiaries or affiliates of U.S. persons, as such transactions would 
be required to be executed on SEF platforms.

    Question 5. The CFTC has required trade data to remain anonymous at 
the SDR level. What do you feel the impact would be if the CFTC imposed 
a requirement that if a trade is entered anonymously it would need to 
stay anonymous throughout its life-cycle?
    Answer. Venues exist today for anonymous trades to remain anonymous 
throughout their life cycle, and therefore there is not a need for the 
CFTC to mandate such a requirement. Markets function best with sound 
regulation, open competition and customer choice.

    Question 6. We have rules in place to ensure a fair, anonymous, 
all-to-all swaps markets where multiple participants can make both bids 
and offers--that type of structure is much more balanced--and 
historically as we've seen with the futures and equity's markets, much 
more resilient in times of stress. Please comment on the structural 
stability that could be supplied if these markets truly operated in the 
anonymous all-to-all manner we intended?
    Answer. We respectfully disagree with the two assumptions that 
underlie this question: (1) anonymous all-to-all swaps markets are 
``much more balanced'' and more resilient in times of stress; and (2) 
swaps are similar to futures and equities (we refer you to our response 
to Question 3).
    Avenues for anonymous all-to-all trading of swaps already exist 
alongside trading through Request-for-Quote (RFQ). Thus, customers have 
a choice between the two execution methods. Efficient and stable 
markets are best achieved through sound regulation and free and open 
competition.

    Question 7. We wrote the SEF Core Principles to require impartial 
access, the CFTC's SEF rule requires impartial access and yet market 
participants don't have impartial access to the full market--what needs 
to change for all eligible market participants to have the kind of 
access we envisioned?
    Answer. We refer you to our response to Question 1.
Response from Stephen M. Merkel, J.D., Executive Vice President, 
        General Counsel and Secretary, BGC Partners, Inc.; Director, 
        Wholesale Markets Brokers' Association, Americas
Questions Submitted by Hon. Collin C. Peterson, a Representative in 
        Congress from Minnesota
    Question 1. At a recent CFTC Market Risk Advisory Committee meeting 
a number of buy-side witnesses testified that the practice of post-
trade name-give up--that is: the removal of anonymity from the market 
after execution, has prevented them from participating in the SEFs 
offered by the Inter-Dealer Brokers. Further, two class-action lawsuits 
alleging anti-trust violations against the largest dealers and several 
of the interdealer brokers have been filed in the credit default swap 
and interest rate markets respectively. These suits both allege that 
the practice of post-trade name give-up has been planned by the largest 
participants and forced on to the inter-dealer brokers in restraint of 
trade. One of them settled late last year for $2bn.
    The SEF Core principles in Dodd Frank require impartial access for 
all eligible market participants. The CFTC's SEF Rule mandates that a 
SEF must ensure ``impartial access to its markets and market services'' 
for eligible participants--and that eligibility itself must be set in 
an impartial, transparent, fair and non-discriminatory manner.
    Do all eligible market participants have impartial access to each 
and every SEF? If not, why not?
    Answer. As envisioned by Congress, the SEF landscape is 
competitive, with over two dozen registered trading venues competing 
for liquidity and trading activity in the over-the-counter marketplace. 
The WMBAA member firms' SEFs are among those platforms. Each of these 
SEFs has demonstrated compliance with CFTC regulation 37.202(a) and has 
set forth clear criteria for market participants who wish to access its 
market and market services.
    With any competitive marketplace, customers have the option to 
conduct business with an array of companies and different types of 
trading platforms. Very few market participants will engage with all 24 
SEFs. For each SEF, eligible market participants have to review and 
compare individual execution models, rule books, analyze different cost 
structures, and consider the legal and technical components of 
onboarding when deciding whether to access a market. As the structure 
of the market evolves in the aftermath of the credit crisis and 
financial regulatory reform implementation, trading methodologies and 
structure will continue to evolve as well. True to the Dodd-Frank 
statutory intent, we look forward to continued competition among 
resilient, innovative trading venues to promote the trading of swaps 
through registered intermediaries.

    Question 2. There was a great deal of testimony regarding 
harmonization with European Rules. However, from published reports a 
number of trade organizations representing incumbent firms with 
significant market power have been arguing to European regulators and 
legislators to make changes to the proposed trade execution regime in 
MiFID II. If that effort is successful, we will be asked to harmonize, 
or to push the CFTC to harmonize, our clear rules on impartial access 
to the SEF marketplace for eligible participants with rules that 
include no such mandate. In that eventuality should harmonization still 
be our top priority?
    Answer. As noted in my testimony, OTC swap markets are global in 
nature. The WMBAA remains supportive of coordinated global efforts to 
promote trading on regulated venues, central counterparty clearing, and 
public reporting of standardized OTC derivative contracts in order to 
``improve transparency in the derivatives markets, mitigate systemic 
risk, and protect against market abuse.'' \1\
---------------------------------------------------------------------------
    \1\ See Leaders' Statement, the Pittsburgh Summit, September 24-25, 
2009, available at 
https://www.treasury.gov/resource-center/international/g7-g20/
Documents/pittsburgh_sum
mit_leaders_statement_250909.pdf.
---------------------------------------------------------------------------
    In just the last few years, we have seen liquidity move across 
borders forming regional liquidity pools. Global regulators should 
carefully coordinate regulatory efforts so as to not fragment markets, 
reduce liquidity, and increase costs to users by rupturing the existing 
methods by which U.S. and non-U.S. swap dealers, international banks, 
global asset managers, and end-users access competitive, transparent 
OTC markets in the U.S. or in other jurisdictions. Global regulatory 
gaps have not only promoted bifurcation of trading patterns but can be 
exploited to the detriment of investors.

    Question 3. The swaps we discussed at the hearing are not 
customized--they are standardized. Standardized swaps are the only 
swaps that are subject to the trading mandate--they are cleared and are 
subject to the straight-through-processing requirement. And yet, we 
repeatedly hear that the swaps market is fundamentally different than 
other standardized markets: that it is characterized by episodic 
liquidity and that its bifurcated, two-tiered structure is the 
``natural'' evolution of the market. Do you agree or disagree with that 
characterization?
    Answer. Yes, the swaps market is fundamentally different than other 
standardized markets. It is a wholesale market where institutional 
market participants can hedge risk exposures. Congress recognized the 
distinctions between exchange-traded financial products like futures 
and equities, on the one hand, and over-the-counter products such as 
swaps. The Dodd-Frank Act provides unique statutory provisions to 
preserve and enhance the unique liquidity characteristics, 
institutional nature of market participants, and bespoke nature of many 
of the instruments.
    As referenced in my testimony, a 2011 Federal Reserve Bank of New 
York (FRBNY) report found that the vast majority of single-name credit 
default swap (CDS) contracts traded less than once per day and index 
CDS contracts traded less than ten times per day, but in very large 
sizes. Similarly, the vast majority of interest rate swap contracts 
traded only once during the 3 month period studied. In comparison, many 
more exchange-traded products tend to have continuous liquidity. 
Certain Eurodollar futures contracts trade on the Chicago Mercantile 
Exchange (CME) over 375,000 times per day.
    The FRBNY study affirms that there are different levels of 
liquidity in the marketplace, even among ``standardized'' products. 
This is why Dodd-Frank correctly ensured flexibility in how market 
participants can meet the trading mandate and transact ``through any 
means of interstate commerce.''
    We support revising the CFTC's swap rules to bring them more in 
line with the statutory intent of Dodd-Frank to ``promote SEF trading'' 
and also to ensure that the global OTC swap market is made more 
competitive and resilient, all while protecting the unique market 
structure that continues to evolve over time.

    Question 4. In your testimony you both described the swaps market 
as being ``fragmented'' as a result of differences in cross-border 
regulatory progress, but you didn't identify who was responsible for 
that fragmentation. The latest OCC report on swaps trading finds that 
the four largest banks control 91% of the notional market. Are trading 
decisions at the firms with that much control of the market responsible 
for fragmentation? If not, who else is fragmenting it?
    Answer. As I noted in my testimony, fragmentation is driven by the 
CFTC's SEF rules and the lack of regulatory harmonization with respect 
to permitted modes of trade execution. Anecdotally, we have seen market 
participants refrain from transacting with counterparties in certain 
jurisdictions to avoid the CFTC's regulatory burdens. As a result, 
liquidity has formed by jurisdiction. Trading has become more 
regionalized with Asian, European and U.S. counterparties trading in 
separate jurisdictions and with a reduced number of potential 
counterparties. My testimony cites to recent ISDA and Bank of England 
research supporting these observations.
    We have concerns that these regulatory gaps will have a more 
pronounced effect as we approach the impending MiFID II January 2018 
target compliance date. These differences must be resolved as soon as 
possible. We urge the Subcommittee to prioritize execution equivalence 
and global coordination as the primary tool to counter the increasingly 
well-entrenched trend for liquidity to be split along regional lines.

    Question 5. The CFTC has required trade data to remain anonymous at 
the SDR level. What do you feel the impact would be if the CFTC imposed 
a requirement that if a trade is entered anonymously it would need to 
stay anonymous throughout its life-cycle?
    Answer. I cannot speculate on the possible market structure impact 
this requirement may have if imposed. However, I strongly encourage the 
CFTC--for this or any other policy proposal--to engage in data-driven 
analysis based on timely, accurate information, to quantify the costs 
and benefits of its proposals. These proposals should be published in 
the Federal Register for an appropriate public notice and comment 
period. These procedural protections will help to produce the soundest 
policy and reflect the input of market participants.
    The CFTC is the beneficiary of several years of comprehensive swap 
market data through SDR reporting. The Commission should closely 
consider the value of this information and perform a rigorous review of 
the information in light of its policy initiatives. As I said at the 
hearing, if ISDA and the Bank of England can conduct research and 
publish their findings for public review, the CFTC should too.

    Question 6. We have rules in place to ensure a fair, anonymous, 
all-to-all swaps markets where multiple participants can make both bids 
and offers--that type of structure is much more balanced--and 
historically as we've seen with the futures and equity's markets, much 
more resilient in times of stress. Please comment on the structural 
stability that could be supplied if these markets truly operated in the 
anonymous all-to-all manner we intended?
    Answer. Please see my response to Question 5.

    Question 7. We wrote the SEF Core Principles to require impartial 
access, the CFTC's SEF rule requires impartial access and yet market 
participants don't have impartial access to the full market--what needs 
to change for all eligible market participants to have the kind of 
access we envisioned?
    Answer. Please see my response to Question 1.
Response from Stephen John Berger, Director, Government and Regulatory 
        Policy, Citadel, LLC; on behalf of Managed Funds Association
Questions Submitted by Hon. Collin C. Peterson, a Representative in 
        Congress from Minnesota
    Question 1. At a recent CFTC Market Risk Advisory Committee meeting 
a number of buy-side witnesses testified that the practice of post-
trade name-give up--that is: the removal of anonymity from the market 
after execution, has prevented them from participating in the SEFs 
offered by the Inter-Dealer Brokers. Further, two class-action lawsuits 
alleging anti-trust violations against the largest dealers and several 
of the interdealer brokers have been filed in the credit default swap 
and interest rate markets respectively. These suits both allege that 
the practice of post-trade name give-up has been planned by the largest 
participants and forced on to the inter-dealer brokers in restraint of 
trade. One of them settled late last year for $2bn.
    The SEF Core principles in Dodd Frank require impartial access for 
all eligible market participants. The CFTC's SEF Rule mandates that a 
SEF must ensure ``impartial access to its markets and market services'' 
for eligible participants--and that eligibility itself must be set in 
an impartial, transparent, fair and non-discriminatory manner.
    Do all eligible market participants have impartial access to each 
and every SEF? If not, why not?
    Answer. The CFTC provided additional clarity regarding the Dodd-
Frank Act's impartial access requirement in the final SEF rules and in 
subsequent impartial access guidance issued in November 2013. This 
additional guidance from the CFTC has been critical in dismantling 
certain barriers that prevented market participants from accessing 
certain trading venues for OTC derivatives, such as restrictive access 
criteria that limited membership only to banks.
    However, we believe that barriers still remain that prevent buy-
side market participants from fully interacting on each and every SEF 
in the market. One such significant barrier is the continued use of 
post-trade name give-up by the legacy interdealer SEFs. By revealing 
counterparty identities post-trade to a swap that was initially 
executed anonymously, these legacy interdealer SEFs inhibit buy-side 
participation even though buy-side participants are now theoretically 
able to join these trading venues.
    The practice of post-trade name give-up originated in uncleared 
markets, where counterparties needed to know each other's identity in 
order to properly book and risk manage the swap. However, for cleared 
swaps that are executed anonymously, we believe that there is no 
legitimate reason that one party needs to find out the identity of the 
other party post-trade, given that both parties immediately face the 
clearinghouse and do not have any bilateral counterparty credit 
exposure to each other. If two parties agree to execute anonymously, 
this choice should be respected throughout the life cycle of the swap.
    Post-trade name give-up inhibits buy-side participation on legacy 
interdealer SEFs in several ways. First, post-trade name give-up is a 
source of random and uncontrolled ``information leakage'' of private 
trading positions and strategies, given that participants are not able 
to control who they may be matched with when executing anonymously on 
the SEF. Second, post-trade name give-up perpetuates the informational 
and trading advantages of traditional dealers that benefit from their 
ability to access and achieve full visibility into both the inter-
dealer and dealer-to-customer markets. In many cases, buy-side 
participants are discouraged from ever even beginning to trade on these 
legacy interdealer SEF platforms as long as the practice continues.
    MFA therefore believes that impartial access to SEFs will only be 
realized once post-trade name gave-up is prohibited for all 
anonymously-executed cleared SEF trades.

    Question 2. There was a great deal of testimony regarding 
harmonization with European Rules. However, from published reports a 
number of trade organizations representing incumbent firms with 
significant market power have been arguing to European regulators and 
legislators to make changes to the proposed trade execution regime in 
MiFID II. If that effort is successful, we will be asked to harmonize, 
or to push the CFTC to harmonize, our clear rules on impartial access 
to the SEF marketplace for eligible participants with rules that 
include no such mandate. In that eventuality should harmonization still 
be our top priority?
    Answer. In MFA's view, ensuring impartial access to trading venues 
is critical in the continued implementation of the G20 reforms for the 
swaps markets. MFA believes that U.S. and European regulators should 
push for harmonization with respect to the implementation of impartial 
access requirements for trading venues and that this is an achievable, 
mutually beneficial priority that will benefit the long-term health and 
vitality of the global swaps markets.
    Similar to the U.S. impartial access requirement, the European 
MiFID II legislation requires trading venues to provide non-
discriminatory access to market participants (see Article 18(3) of the 
MiFID II Directive governing multilateral trading facilities (MTFs) and 
organized trading facilities (OTFs), and Article 53(1) of the MiFID 
Directive \1\ governing regulated markets). As such, there should be no 
difference between the two regimes on this topic, though European 
regulators may be required to issue additional guidance (similar to the 
CFTC's November 2013 impartial access guidance) in order to ensure that 
the non-discriminatory access requirement is properly implemented. We 
believe that ensuring equivalent standards with respect to the 
implementation of impartial access should be a key focus in future 
discussions regarding harmonization and regulatory equivalence.
---------------------------------------------------------------------------
    \1\ Directive 2014/65/EU of The European Parliament and of the 
Council of 15 May 2014 on markets in financial instruments, available 
at http://eur-lex.europa.eu/legal-content/EN/ALL/?uri=CELEX:32014L0065.

    Question 3. The swaps we discussed at the hearing are not 
customized--they are standardized. Standardized swaps are the only 
swaps that are subject to the trading mandate--they are cleared and are 
subject to the straight-through-processing requirement. And yet, we 
repeatedly hear that the swaps market is fundamentally different than 
other standardized markets: that it is characterized by episodic 
liquidity and that its bifurcated, two-tiered structure is the 
``natural'' evolution of the market. Do you agree or disagree with that 
characterization?
    Answer. MFA disagrees with that characterization for standardized 
and liquid cleared swaps. While more bespoke customized swaps may trade 
relatively infrequently, experience with the reforms in the U.S. has 
shown that a great many cleared swaps are standardized and highly 
liquid, and are suitable for SEF trading. In fact, recent Bank of 
England research found that the implementation of the clearing and 
trading reforms in the USD interest rate swaps market has already 
yielded significant improvements in pricing and liquidity for 
investors.\2\
---------------------------------------------------------------------------
    \2\ See Staff Working Paper No. 580 ``Centralized trading, 
transparency and interest rate swap market liquidity: evidence from the 
implementation of the Dodd-Frank Act'', Bank of England (January 2016), 
available at: http://www.bankofengland.co.uk/research/Documents/
workingpapers/2016/swp580.pdf.
---------------------------------------------------------------------------
    As such, MFA does not believe that the current bifurcated, two-
tiered market structure is the ``natural'' evolution of the market. The 
two-tier structure impairs pre-trade transparency for buy-side market 
participants and prevents buy-side market participants from accessing 
important sources of liquidity in the marketplace. This two-tier 
structure also confines the buy-side to a ``price-taker'' role, rather 
than providing the opportunity to become a ``price-maker'' as well, and 
can impair price discovery and competition. In MFA's view, the two-tier 
market needs to evolve in order to improve competition and market 
liquidity, and fully implementing the Dodd-Frank Act's impartial access 
requirement is critical to allowing this evolution to occur.

    Question 4. The CFTC has required trade data to remain anonymous at 
the SDR level. What do you feel the impact would be if the CFTC imposed 
a requirement that if a trade is entered anonymously it would need to 
stay anonymous throughout its life-cycle?
    Answer. In MFA's view, the imposition of such a requirement would 
be consistent with prior CFTC rulemaking to ensure that trade data 
remains anonymous at the SDR level. Currently, this CFTC rule is 
undermined by the continued use of post-trade name give-up, as a 
counterparty can find out the identity of the other party to a trade 
from the SEF even though they are prohibited from doing so at the SDR. 
If two parties agree to execute anonymously, this choice should be 
respected throughout the life cycle of the swap.
    As stated above, MFA believes that ending the practice of post-
trade name give-up for anonymously executed cleared swaps will lead to 
more buy-side participation on legacy interdealer SEFs. In our view, 
impartial access requirements have contributed to healthy liquidity 
conditions in several other significant markets, such as the equities 
and futures markets. Based on these examples, MFA believes that true 
impartial access will provide a stronger foundation for U.S. swaps 
market liquidity and enhance price transparency and competition in the 
U.S. swaps market.

    Question 5. We have rules in place to ensure a fair, anonymous, 
all-to-all swaps markets where multiple participants can make both bids 
and offers--that type of structure is much more balanced--and 
historically as we've seen with the futures and equity's markets, much 
more resilient in times of stress. Please comment on the structural 
stability that could be supplied if these markets truly operated in the 
anonymous all-to-all manner we intended?
    Answer. Fully implementing and enforcing the Dodd-Frank Act's 
impartial access requirement would allow an all-to-all market for 
cleared swaps to emerge (where multiple market participants are able to 
meet and transact). In our view, an all-to-all market has contributed 
to healthy liquidity conditions in several other significant markets, 
such as the equities and futures markets.
    By contrast, the current bifurcated two-tier swaps market structure 
entrenches traditional dealers as exclusive ``price makers''. It also 
limits the manner and extent to which buy-side participants may 
interact in the swaps market. Such structural limitations on liquidity 
provision and risk transfer may increase the likelihood of market 
volatility and instability over the long term. The willingness and 
capacity of traditional dealers to allocate balance sheet to swaps 
market-making activities appears to be diminishing in certain respects. 
This trend will likely continue over time as traditional dealers 
continue to restructure their businesses post-financial crisis and 
adapt to new capital, leverage, and liquidity requirements under Basel 
III and similar rules. Without swaps market reforms that facilitate 
impartial access to all SEFs and encourage alternative forms of price 
formation and liquidity provision and greater diversity of 
participation (among participants and modes of interaction), MFA fears 
that the U.S. swaps market could risk greater volatility and 
dislocation in times of market stress.

    Question 6. We wrote the SEF Core Principles to require impartial 
access, the CFTC's SEF rule requires impartial access and yet market 
participants don't have impartial access to the full market--what needs 
to change for all eligible market participants to have the kind of 
access we envisioned?
    Answer. MFA would encourage the CFTC to take action to prohibit the 
use of post-trade name give-up for cleared swaps executed anonymously 
on SEFs. MFA has submitted a petition to the CFTC in this regard and is 
hopeful this prohibition will be included in any proposed modifications 
to the SEF rules. Without CFTC action, commercial dynamics make it 
difficult for any one legacy interdealer SEF to unilaterally stop using 
post-trade name give-up while others still do.
    In addition, MFA would encourage the CFTC to prioritize the 
enforcement of impartial access. It would be useful for the CFTC to 
actively monitor the progress of trading reforms in the swaps markets, 
and what barriers may continue to affect participation and trading 
activity. We also continue to urge the CFTC to finalize dealer 
ownership and governance restrictions for SEFs, as otherwise potential 
conflicts of interest could arise that inhibit natural market structure 
evolution.
Response from Luke D. Zubrod, Director, Risk and Regulatory Advisory 
        Services, Chatham Financial
Questions Submitted by Hon. Collin C. Peterson, a Representative in 
        Congress from Minnesota
    Question 1. At a recent CFTC Market Risk Advisory Committee meeting 
a number of buy-side witnesses testified that the practice of post-
trade name-give up--that is: the removal of anonymity from the market 
after execution, has prevented them from participating in the SEFs 
offered by the Inter-Dealer Brokers. Further, two class-action lawsuits 
alleging anti-trust violations against the largest dealers and several 
of the interdealer brokers have been filed in the credit default swap 
and interest rate markets respectively. These suits both allege that 
the practice of post-trade name give-up has been planned by the largest 
participants and forced on to the inter-dealer brokers in restraint of 
trade. One of them settled late last year for $2bn.
    The SEF Core principles in Dodd Frank require impartial access for 
all eligible market participants. The CFTC's SEF Rule mandates that a 
SEF must ensure ``impartial access to its markets and market services'' 
for eligible participants--and that eligibility itself must be set in 
an impartial, transparent, fair and non-discriminatory manner.
    Do all eligible market participants have impartial access to each 
and every SEF? If not, why not?
    Answer. The segment of the market Chatham Financial serves has not 
had difficulty accessing SEFs. Chatham's clients are end users, and 
generally use SEFS to hedge interest rate risk. Thus, we are not in a 
position to offer expert insight into the nature of access in the 
credit default swap market. End-users generally use derivatives to 
manage and reduce risk (i.e., to hedge)--not for speculative or trading 
purposes. Those that use derivatives to hedge, generally rely on SEFs 
that price transactions via the request for quote (i.e., RFQ) model 
because it permits greater flexibility to structure a hedge to offset a 
firm-specific risk. While hedgers and those using derivatives for 
investment purposes alike could make use of central limit order books 
(i.e., CLOB)--the pricing model in which Inter-Dealer Brokers excel--
the RFQ model in which Inter-Dealer Brokers do not play a significant 
role is, in our view, best suited for end-user hedgers.
    Buy side asset managers use derivatives for both hedging and 
investment purposes; thus, the optimal execution method--whether RFQ or 
CLOB--may differ from those of other kinds of financial end users, such 
as those whom we advise and on whose behalf we transact. As a general 
principle, Chatham appreciates the value of anonymous trading and we do 
not see a benefit to most end-users of name-disclosed approaches. 
However, our experience does not allow us to offer material input on 
the question of access to the central limit order books offered by 
Inter-Dealer Brokers.

    Question 2. There was a great deal of testimony regarding 
harmonization with European Rules. However, from published reports a 
number of trade organizations representing incumbent firms with 
significant market power have been arguing to European regulators and 
legislators to make changes to the proposed trade execution regime in 
MiFID II. If that effort is successful, we will be asked to harmonize, 
or to push the CFTC to harmonize, our clear rules on impartial access 
to the SEF marketplace for eligible participants with rules that 
include no such mandate. In that eventuality should harmonization still 
be our top priority?
    Answer. Chatham sees growth in electronic trading in the OTC 
derivatives market as a positive development. This growth has been 
spurred both by technological advancement and by regulatory mandates in 
the U.S. and Europe. The principle benefits of electronic trading are 
the ease of facilitating competition and the benefits of straight 
through processing, especially where a party transacts in high volumes. 
These benefits must be set against the costs of evaluating electronic 
marketplaces, reviewing rulebooks of those marketplaces, and setting up 
systems to facilitate straight-through processing. Transaction volumes 
will often dictate whether the benefits of electronic trading outweigh 
the costs. Those that transact in high volumes will generally see 
benefits in adopting electronic trading and will often choose to 
transact electronically whether or not regulation requires them to do 
so.
    Chatham believes it is not necessary to tightly prescribe protocols 
by which electronic marketplaces operate. The U.S. has generally taken 
a more prescriptive approach relative to Europe with respect to trading 
protocols imposed on SEFs. For example, U.S. regulations require that a 
minimum number of dealers participate in swap auctions via electronic 
marketplaces, while requirements on European trading platforms are 
subject to lower requirements. We believe the benefits of competition 
and straight-through processing can accrue under various protocols and 
rule sets, and that the prescriptive approach adopted by the U.S. is 
not necessary to ensure a competitive marketplace.
    As a general principle, we believe it beneficial to market 
participants when regulators globally coordinate and harmonize their 
rules--both with respect to their content and timing--and we believe 
such efforts with respect to trading rules should be given due 
consideration.

    Question 3. The swaps we discussed at the hearing are not 
customized--they are standardized. Standardized swaps are the only 
swaps that are subject to the trading mandate--they are cleared and are 
subject to the straight-through-processing requirement. And yet, we 
repeatedly hear that the swaps market is fundamentally different than 
other standardized markets: that it is characterized by episodic 
liquidity and that its bifurcated, two-tiered structure is the 
``natural'' evolution of the market. Do you agree or disagree with that 
characterization?
    Answer. Yes. Bilateral, uncleared swaps (i.e., typically customized 
swaps) play an important role in allowing market participants to manage 
risk. When risk management is the objective, such swaps are generally 
superior to standardized swaps which cannot be customized to perfectly 
offset idiosyncratic risks. Absent customized swaps, market 
participants would be forced to retain risks that they might otherwise 
have been able to transfer. In addition to the economic benefits of 
customization, market participants who perfectly match their hedge to 
their risk achieve accounting results--via hedge accounting treatment--
that are more consistent with the economic outcome achieved through 
hedging. That is, income statement volatility is reduced or eliminated 
in line with the risk reducing nature of the hedges.
    Additionally, bilateral, uncleared swaps permit customization with 
respect to the credit arrangements used to manage risk associated with 
the swap. Just as banks are able to accept various forms of collateral 
with respect to loans, end-users value their ability with bilateral, 
uncleared swaps to customize the credit support arrangements they enter 
into with swap dealers. For example, centrally cleared swaps are 
secured by initial and variation margin. While bilateral, uncleared 
swaps may be similarly secured, end users may negotiate credit support 
arrangements that are better tailored to their needs. For example, a 
real estate firm may grant a security interest in a real estate asset 
to its swap counterparty, who also may serve as lender on loan that the 
swap hedges. Real estate firms, among others, own physical assets and 
do not carry significant amounts of cash greatly benefit from such 
customizable credit arrangements.
    At the same time, firms that transact in significant volumes, have 
low cost of capital and ready access to liquid resources (e.g., cash 
and certain securities) may find that the centrally cleared market 
meets their risk management needs. Such participants may prefer the 
risk management characteristics of a centralized market.
    Thus, we believe a two-tiered market benefits the market and is not 
inconsistent with public policy objectives related to systemic risk and 
transparency.

    Question 4. The CFTC has required trade data to remain anonymous at 
the SDR level. What do you feel the impact would be if the CFTC imposed 
a requirement that if a trade is entered anonymously it would need to 
stay anonymous throughout its life-cycle?
    Answer. We believe it appropriate that regulators implement rules 
in a manner that prevents market participants from having visibility 
into an individual company's positions. However, we believe it 
appropriate for regulators to have such visibility with respect to all 
positions.

    Question 5. We have rules in place to ensure a fair, anonymous, 
all-to-all swaps markets where multiple participants can make both bids 
and offers--that type of structure is much more balanced--and 
historically as we've seen with the futures and equity's markets, much 
more resilient in times of stress. Please comment on the structural 
stability that could be supplied if these markets truly operated in the 
anonymous all-to-all manner we intended?
    Answer. We believe that structural stability can be supplied to 
these markets without an all-to-all market. Indeed, we believe the 
principle contribution of an all-to-all model in the derivatives market 
relates more to transparency than it does systemic stability, and even 
the transparency benefits can be achieved in ways that are less 
prescriptive than a mandated all-to-all market structure. We believe 
other mechanisms can adequately address systemic stability concerns, 
including clearing, margin and capital requirements. In essence, we 
think while there may be benefits in some cases for all-to-all markets, 
we do not believe there are sufficient benefits to justify that such a 
structure be mandated. Indeed, we believe end-user risk management 
objectives are furthered by way of a variety of means of execution.

    Question 6. We wrote the SEF Core Principles to require impartial 
access, the CFTC's SEF rule requires impartial access and yet market 
participants don't have impartial access to the full market--what needs 
to change for all eligible market participants to have the kind of 
access we envisioned?
    Answer. As noted, Chatham's experience - principally focused on 
interest rate markets and the RFQ model--does not suggest a significant 
concern with impartial access to SEFs. Nonetheless, we think it not 
inappropriate for policy makers to carefully consider the concerns of 
market participants transacting in other asset classes (e.g., credit 
default swaps) and other execution methods (e.g., central limit order 
books).

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