[House Hearing, 115 Congress]
[From the U.S. Government Publishing Office]





                         LEGISLATIVE PROPOSALS
                         REGARDING DERIVATIVES

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

                                HEARING

                               BEFORE THE

                    SUBCOMMITTEE ON CAPITAL MARKETS,
                       SECURITIES, AND INVESTMENT

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                     ONE HUNDRED FIFTEENTH CONGRESS

                             SECOND SESSION

                               __________

                           FEBRUARY 14, 2018

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 115-74

















[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]









                                   ______
		 
                     U.S. GOVERNMENT PUBLISHING OFFICE 
		 
31-347 PDF                WASHINGTON : 2018                 































                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                    JEB HENSARLING, Texas, Chairman

PATRICK T. McHENRY, North Carolina,  MAXINE WATERS, California, Ranking 
    Vice Chairman                        Member
PETER T. KING, New York              CAROLYN B. MALONEY, New York
EDWARD R. ROYCE, California          NYDIA M. VELAZQUEZ, New York
FRANK D. LUCAS, Oklahoma             BRAD SHERMAN, California
STEVAN PEARCE, New Mexico            GREGORY W. MEEKS, New York
BILL POSEY, Florida                  MICHAEL E. CAPUANO, Massachusetts
BLAINE LUETKEMEYER, Missouri         WM. LACY CLAY, Missouri
BILL HUIZENGA, Michigan              STEPHEN F. LYNCH, Massachusetts
SEAN P. DUFFY, Wisconsin             DAVID SCOTT, Georgia
STEVE STIVERS, Ohio                  AL GREEN, Texas
RANDY HULTGREN, Illinois             EMANUEL CLEAVER, Missouri
DENNIS A. ROSS, Florida              GWEN MOORE, Wisconsin
ROBERT PITTENGER, North Carolina     KEITH ELLISON, Minnesota
ANN WAGNER, Missouri                 ED PERLMUTTER, Colorado
ANDY BARR, Kentucky                  JAMES A. HIMES, Connecticut
KEITH J. ROTHFUS, Pennsylvania       BILL FOSTER, Illinois
LUKE MESSER, Indiana                 DANIEL T. KILDEE, Michigan
SCOTT TIPTON, Colorado               JOHN K. DELANEY, Maryland
ROGER WILLIAMS, Texas                KYRSTEN SINEMA, Arizona
BRUCE POLIQUIN, Maine                JOYCE BEATTY, Ohio
MIA LOVE, Utah                       DENNY HECK, Washington
FRENCH HILL, Arkansas                JUAN VARGAS, California
TOM EMMER, Minnesota                 JOSH GOTTHEIMER, New Jersey
LEE M. ZELDIN, New York              VICENTE GONZALEZ, Texas
DAVID A. TROTT, Michigan             CHARLIE CRIST, Florida
BARRY LOUDERMILK, Georgia            RUBEN KIHUEN, Nevada
ALEXANDER X. MOONEY, West Virginia
THOMAS MacARTHUR, New Jersey
WARREN DAVIDSON, Ohio
TED BUDD, North Carolina
DAVID KUSTOFF, Tennessee
CLAUDIA TENNEY, New York
TREY HOLLINGSWORTH, Indiana

                     Shannon McGahn, Staff Director
      Subcommittee on Capital Markets, Securities, and Investment

                   BILL HUIZENGA, Michigan, Chairman

RANDY HULTGREN, Illinois, Vice       CAROLYN B. MALONEY, New York, 
    Chairman                             Ranking Member
PETER T. KING, New York              BRAD SHERMAN, California
PATRICK T. McHENRY, North Carolina   STEPHEN F. LYNCH, Massachusetts
SEAN P. DUFFY, Wisconsin             DAVID SCOTT, Georgia
STEVE STIVERS, Ohio                  JAMES A. HIMES, Connecticut
ANN WAGNER, Missouri                 KEITH ELLISON, Minnesota
LUKE MESSER, Indiana                 BILL FOSTER, Illinois
BRUCE POLIQUIN, Maine                GREGORY W. MEEKS, New York
FRENCH HILL, Arkansas                KYRSTEN SINEMA, Arizona
TOM EMMER, Minnesota                 JUAN VARGAS, California
ALEXANDER X. MOONEY, West Virginia   JOSH GOTTHEIMER, New Jersey
THOMAS MacARTHUR, New Jersey         VICENTE GONZALEZ, Texas
WARREN DAVIDSON, Ohio
TED BUDD, North Carolina
TREY HOLLINGSWORTH, Indiana







































                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    February 14, 2018............................................     1
Appendix:
    February 14, 2018............................................    35

                               WITNESSES
                      Wednesday, February 14, 2018

Bentsen, Jr., Hon. Kenneth E., President and Chief Executive 
  Officer, Securities Industry and Financial Markets Association.     5
Deas, Thomas C., Chairman, National Association of Corporate 
  Treasurers, on behalf of the Coalition for Derivatives End-
  Users..........................................................     7
Green, Andy, Managing Director of Economic Policy, Center for 
  American Progress..............................................     9
O'Malia, Scott, Chief Executive Officer, International Swaps and 
  Derivatives Association, Inc...................................    10

                                APPENDIX

Prepared Statements:
    Bentsen, Jr., Hon. Kenneth E.................................    36
    Deas, Thomas C...............................................    43
    Green, Andy..................................................    50
    O'Malia, Scott...............................................    78

              Additional Material Submitted for the Record

Huizenga, Hon. Bill:
    Statement for the record from Cboe Global Markets, Inc.......    89
    Statement for the record from Walter L. Lukken, President and 
      Chief Executive Officer, Futures Industry Association (FIA)    91
    Statement for the record from Futures Industry Association 
      (FIA), Commodity Markets Council (CMC), CME Clearing (CME), 
      and Intercontinental Exchange (ICE)........................    99
    Statement for the record from The Investment Company 
      Institute..................................................   103
    Statement for the record from Mastercard.....................   107
    Statement for the record from Managed Funds Association......   109
    Statement for the record from Western Union..................   115

 
                         LEGISLATIVE PROPOSALS
                         REGARDING DERIVATIVES

                              ----------                              


                      Wednesday, February 14, 2018

                     U.S. House of Representatives,
                           Subcommittee on Capital Markets,
                                Securities, and Investment,
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to notice, at 2:19 p.m., in 
room 2128, Rayburn House Office Building, Hon. Bill Huizenga 
[chairman of the subcommittee] presiding.
    Present: Representatives Huizenga, Hultgren, Wagner, 
Poliquin, Hill, Mooney, Davidson, Budd, Hollingsworth, Maloney, 
Sherman, Lynch, Scott, Himes, Foster, Sinema, Vargas, 
Gottheimer, and Gonzalez.
    Also present: Representatives Lucas and Luetkemeyer.
    Chairman Huizenga. The committee will come to order. And 
without objection the Chair is authorized to declare a recess 
to the committee at any time.
    This hearing is entitled, ``Legislative Proposals Regarding 
Derivatives.''
    I now recognize myself for 4 minutes to give an opening 
statement.
    Derivatives are financial instruments or contracts with 
prices or terms of payments derived directly from the value or 
performance of another asset or commodity. They are primarily 
used to manage risk. While derivatives have long been used to 
manage risks related to the pricing of goods such as produce 
and livestock, they have become increasingly more complex over 
time.
    Nowadays corporations including industrial and financial 
firms use derivatives to hedge their exposure to risks such as 
the changes in prices of commodities or fluctuations in 
currencies, interest rates, or underlying equity securities.
    As of June 2017, the notional amount of outstanding over-
the-counter (OTC) derivatives contracts were $542 trillion with 
a gross market value of $13 trillion.
    The Securities and Exchange Commission (SEC) and the 
Commodities Futures Trading Commission, CFTC are the regulators 
charged with supervising the trading of derivatives. The 
regulation of the derivatives market changed drastically in 
response to the 2008 financial crisis.
    Title VII of the Dodd-Frank Act restructured the 
derivatives market to more closely resemble the market for 
listed securities and listed futures tradings. The reforms 
included mandatory clearing for certain swaps and increased 
data disclosures meant to promote greater market liquidity and 
transparency. However, despite these well-intentioned reforms 
Title VII of the Dodd-Frank Act has resulted in a fragmented 
regulatory scheme of the derivatives market.
    Perhaps the largest criticism of Title VII is, one outlined 
in the recent Treasury report on Capital Markets, the lack of 
clarity provided to the SEC and the CFTC on how they should 
propose and issue their rules. Title VII bifurcated the 
regulatory jurisdiction over swaps. The CFTC oversees interest 
rate swaps, indexed credit default swaps, foreign exchange 
swaps, certain types of equity swaps, and other commodity 
swaps.
    The SEC oversees the security-based swap market. While the 
CFTC has finalized their swaps rule, the SEC has yet to 
finalize their regulations for registration and regulation of 
security-based swaps, dealers trade reporting, mandatory 
central clearing of standardized security-based swaps, and 
trade execution requirements.
    This incomplete and disjointed regulatory structure has 
resulted in discrepancies between the SEC and the CFTC's 
interpretations of Title VII, making it difficult for market 
participants to comply with these inconsistent regulations.
    One of the proposals before us today would require that the 
CFTC and SEC harmonize their over-the-counter swaps rules to 
provide necessary clarity to the market.
    It is encouraging to hear SEC Chairman Clayton say that the 
SEC and the CFTC are already moving in this direction. In a 
recent speech he said, quote, ``we are seeking to harmonize our 
ultimate securities-based swap rules with the CFTC where 
appropriate, to increase effectiveness as well as reduce 
complexity and cost. This requires deliberate and constructive, 
and current engagement with our CFTC brethren which I am 
pleased to report is well underway,'' close quote.
    The other proposals before us today fix many of the market 
irregularities that exist in today's derivatives markets. I 
would like to thank my friend and chairman of our Financial 
Institutions Subcommittee, Representative Luetkemeyer for 
introducing a bill that would require the appropriate Federal 
banking agencies to recognize initial margin in the firm's 
leverage ratio calculation.
    The other proposals include drafts to help provide relief 
for derivatives end-users, clarify the relief from mandatory 
clearing availability to centralized Treasury units of non-
financial affiliates, and exempt swap transactions between 
affiliated entities from the swaps rules, clarify the 
definition of financial entity, excluding hedging swaps from 
the swap dealer de minimis threshold, provide clarity regarding 
the de minimis exception, annual thresholds for swap dealers 
and security-based swap dealers, clarify the definition of 
financial end-user as it applies to parent and holding 
companies, and exclude non-U.S. regulated funds from the 
definition of, quote, ``a United States person.''
    As we address these current legislative proposals, it is 
important to note that derivates are a vital part of the 
healthy functioning of our global economy. Companies of all 
sizes in Michigan and across the United States use derivatives 
to better manage the risks that they face every day. 
Derivatives help to ensure that prices are stable and that 
customers are not subject to immense market fluctuations.
    We must work to ensure that the derivatives market is 
appropriately regulated and is working efficiently to benefit 
Main Street investors.
    And with that I will yield to the gentlelady from New York 
for her 5 minutes for an opening statement.
    Mrs. Maloney. I thank the Chairman for holding this 
important hearing and welcome all of our guests today, 
particularly my former colleague and friend Ken Bentsen, always 
a pleasure to see you.
    This hearing will examine 11 different derivatives bills. 
While I have never believed that Dodd-Frank was perfect, I 
think it is important to remember why Dodd-Frank created a 
regulatory regime for derivatives in the first place.
    Derivatives played a central role in the financial crisis. 
They turned losses on sub-prime mortgages in the U.S. into a 
global financial crisis, allowed financial institutions to take 
on excessive risks, and created dangerous connections between 
financial institutions that spread and amplified risk across 
the entire financial system.
    It was derivatives that brought down AIG, a 90-year-old 
company that was one of the largest financial institutions in 
the world. Taxpayers were forced to spend $180 billion to bail 
out and restructure AIG which failed because of risky, 
unregulated gambling on credit default swaps.
    This is why Fed Chairman Ben Bernanke testified and I 
quote, ``making derivatives safer is very important, part of 
solving Too Big to Fail and preventing another financial 
crisis.''
    Dodd-Frank created a comprehensive regulatory regime for 
derivatives so that they would never bring down the financial 
system again.
    Under Title VII of Dodd-Frank, over-the-counter derivatives 
are now regulated by the CFTC and the SEC. Standardized 
derivatives have to go through central clearinghouses, trade on 
transparent exchanges, and be reported to regulators.
    Financial institutions have to hold appropriate capital 
against their derivatives, and have to post collateral on their 
derivatives every single day. This is all contributive to a 
derivatives market that is vastly safer than it was before the 
crisis. But Congress did recognize that lots of companies use 
derivatives to hedge their day-to-day risks and not to take 
speculative bets. That is why Dodd-Frank specifically exempted 
these companies which are known as end-users of derivatives 
from many of the new regulations in the bill.
    When sufficient evidence was presented to this committee 
that end-users were being inadvertently swept up in the 
regulatory regime intended for big banks and hedge funds, this 
committee acted on a bipartisan basis to tweak the law to 
protect end-users. That bill ultimately was signed into law. I 
remember it well because it was attached to the Terrorism Risk 
Insurance Act, a bill that was very important for New York 
City, the area I represent.
    Congress also acted on a bipartisan basis to clarify when 
certain derivates trades between affiliates of the same company 
could be exempt from some of the Dodd-Frank rules. And Congress 
made these changes because we wanted to ensure that derivatives 
remained available for the end-user companies that rely on 
derivatives to hedge their day-to-day risks. But these were 
technical fixes that were identified immediately after Dodd-
Frank passed and were intended to help legitimate commercial 
end-users.
    Any additional changes to Dodd-Frank's derivatives rules 
needs to satisfy, in my opinion, a high burden of proof for me 
to support rolling back rules on the derivatives market just 
because they are inconvenient for some institutions. There 
needs to be a real, concrete problem that is both significant 
and unintended in order for me to support further changes to 
Dodd-Frank's derivatives rules.
    I look forward to hearing and learning today from the 
testimony of the board here today and from my colleagues.
    I yield my remaining time to my esteemed colleague from the 
great State of California, Mr. Sherman.
    Mr. Sherman. Thank you.
    Dodd-Frank was written in this room. It did not come down 
to us from Mount Sinai. I am open to changes and at the same 
time we need a secure financial system.
    As the Chairman points out the purpose of derivatives is to 
allow an investor or other end-user to shift risk. Most of the 
time we shift risk, we call that an insurance contract. We need 
to make sure that whenever derivatives are issued, wherever 
someone is assuming risk that they can handle that risk and 
that there is no possibility of a bail-out, or even worse yet a 
telephone call from Wall Street saying we had better bail out 
the issuer of that derivative or the entire economy goes down.
    AIG was in the insurance business and all of their 
subsidiaries seemed to have weathered the crisis except for the 
only one that was not regulated as an insurance company. That 
entity assumed risk, didn't have adequate reserves, and I yield 
back.
    Chairman Huizenga. The gentlelady's time has expired.
    And at this point the Chair now recognizes the gentleman 
from Illinois Mr. Hultgren, the Vice Chairman of the 
subcommittee.
    Mr. Hultgren. Thanks, Chairman Huizenga. Thanks for holding 
this important hearing. It is not often that we get the 
opportunity for an in-depth discussion of derivatives issues 
despite our committee maintaining some jurisdiction over 
derivatives.
    It is important for us to identify opportunities to provide 
relief from Dodd-Frank and Basel regulatory framework, if it 
means lowering cost for companies simply interested in managing 
their market risks.
    As a former member of the House Agriculture Committee under 
Chairman Lucas, we used to have more regular opportunities to 
deal with these issues, but I do know how important it is for 
companies in my district and especially in Chicago to be able 
to effectively manage their market risk.
    We shouldn't have regulator impediments that discourage 
legitimate hedging strategies. We want our markets to function 
in a way that allow for opportunities to lower overall costs.
    I am very encouraged by a number of legislative proposals 
under consideration today, I am a co-sponsor of Chairman 
Luetkemeyer's bill calling for a narrow but practical change in 
the supplementary leverage ratio.
    I have also received positive feedback from my constituents 
on a number of draft bills under consideration, such as relief 
from the credit valuation adjustment, amending the definition 
of financial entity, and relief from mandatory clearing for 
centralized Treasury units that I hope to learn more about 
today.
    Thanks, Chairman. And I yield back.
    Chairman Huizenga. The gentleman yields back.
    I would like to address also the participation in the 
subcommittee hearing today and without objection any member 
from the Financial Services Committee is permitted to 
participate in today's subcommittee hearing.
    Misters Luetkemeyer and Lucas are members of the Financial 
Services Committee and we appreciate their interest in this 
important topic.
    Today we welcome the testimony of Kenneth Bentsen, Jr., 
President and CEO of the Securities Industry and Financial 
Markets Association, also known as SIFMA; Thomas Deas, who is 
Chairman of the National Association of Corporate Treasurers on 
behalf of the Coalition for Derivatives End-Users; Mr. Andy 
Green, Managing Director of Economic Policy for the Center for 
American Progress; and Scott O'Malia, Chief Executive Officer, 
International Swaps and Derivatives Association, ISDA.
    We appreciate your time and attention to this. Each of you 
will be recognized for 5 minutes to give an oral presentation 
of your testimony. Without objection, each of your written 
testimonies will be made part of the permanent record as well.
    So with that, Mr. Bentsen, you are recognized for 5 
minutes.

             STATEMENT OF HON. KENNETH BENTSEN, JR.

    Mr. Bentsen. Thank you, Chairman Huizenga and Ranking 
Member Maloney and members of the committee. I appreciate the 
opportunity to testify on Title VII of Dodd-Frank.
    As was pointed out, Title VII created a new regulatory 
regime for derivatives or swaps. SIFMA believes the key pillars 
of this regime, transparency requirements, central clearing, 
and capital and margin requirements are beneficial to the 
market and should remain in place.
    But we are concerned that some of the regulations go beyond 
what is necessary to achieve Title VII's core objectives and 
may even conflict with other regulations. It is important for 
policymakers to evaluate these issues including Congress.
    I would like to offer SIFMA's view on four pieces of 
legislation being considered by the committee.
    First, inter-affiliate transactions are for centralized 
risk management between affiliated counterparties within a firm 
as they serve their clients. Inter-affiliate transactions don't 
raise system risk concerns because they don't create new 
exposure outside the corporate group or increase 
interconnectedness between third parties.
    We are concerned that U.S. banking regulators have 
incorrectly and uniquely imposed initial margin requirements in 
such transactions, whereas the CFTC and other jurisdictions 
have not. Some SIFMA members report that they are locking up 
more margin for risk reducing inter-affiliate transactions than 
they are collecting from third parties. These requirements 
discourage prudent risk management strategies and make it more 
challenging to provide hedging solutions for end-user 
customers.
    This also locks up capital that firms could allocate to 
invest in the broader economy. We believe that a logical 
solution would be to exempt inter-affiliate swaps from initial 
margin, mandatory clearing, and mandatory trading requirements 
so long as they are part of a centralized risk management 
program and remain subject to variation margin and trade 
reporting requirements.
    SIFMA currently supports legislative measures to fix the 
treatment of inter-affiliate swaps. We believe that any such 
measure should apply consistently across all U.S. regulators.
    Second, Title VII's distinction between swaps and security-
based swaps did not accurately reflect market practice and the 
jurisdictional split between the CFTC and the SEC has posed 
challenges.
    Despite efforts by the agencies to coordinate and harmonize 
the requirements, important differences remain. Some areas 
where more work is needed include reducing conflicts with other 
legal regimes. For example, the SEC has adopted certification 
and legal opinion requirements relating to the SEC's access to 
a non-U.S. dealer's books and records which create conflicts 
with foreign laws that the CFTC has sought to avoid.
    Second, following consistent international standards for 
margin and reporting requirements which helps promote a level 
playing field and efficient coordination among regulators. And 
third, recognizing instances where satisfying another 
regulator's requirements would achieve a comparable outcome 
while avoiding overlapping regulations.
    The SEC and CFTC should look for more opportunities to 
leverage each other's rules for dual registrants.
    We support recent efforts to consider additional 
harmonization, such as indicated in the recent speeches by 
Chairmen Clayton and Giancarlo, and look forward to 
contributing to this dialog.
    We also encourage coordination between market regulators 
and banking regulators especially on capital and margin.
    Third, completely risk-insensitive leverage capital 
measures such as the supplemental leverage ratio are becoming 
binding capital restraints for many banking organizations. As a 
result, the amount of required capital is increasingly 
unrelated to the level of risk taken. This could lead to 
insufficient or excess capital levels depending on the 
prevailing economic conditions.
    One particular problematic area is the SLR's (supplementary 
leverage ratio) treatment of centrally cleared derivatives. 
When a firm clears derivatives for a client, the firm 
guarantees the client's obligations to the clearinghouse, 
collects initial margin from the client to securities 
obligation, and segregates that margin. Although this initial 
margin largely offsets exposure to the client and the clearing 
firm, the clearing firm cannot use the margin to fund its 
business. The SLR does not recognize an offset for the initial 
margin.
    Because the SLR requires clearing firms to hold capital 
against client exposures far in excess of the risk, it 
discourages client clearing. This incentive runs counter to 
Dodd-Frank's mandate to promote clearing.
    SIFMA supports H.R. 4659 as it would deduct client provided 
initial margin on cleared derivatives from the leverage 
exposure for the clearing firm and it requires amendments to 
the capital rules to reflect this change. This is one of 
several changes policymakers should consider with respect to 
the SLR.
    Last, Title VII exempts a person from being deemed a swap 
dealer if the person engages in only a de minimis quantity of 
swaps connected to its dealing activity.
    When the CFTC and the SEC initially adopted rules 
implementing these provisions, they did not have data to 
sufficiently inform the process. They therefore set their de 
minimis thresholds conservatively with automatic reductions 
over a period of time absent a rulemaking.
    We have concerns that decreasing the de minimis threshold 
would reduce the number of market participants willing to deal 
in swaps within commercial end-users. Such an outcome would 
reduce liquidity and concentrate swaps with larger 
institutions.
    We believe that the changes to the de minimis threshold 
must be supported by robust data and we support the CFTC's 
recent order providing for additional time to make informed 
decisions on this issue.
    Thank you for the opportunity to present our views. And I 
look forward to your questions.
    [The prepared statement of Mr. Bentsen can be found on page 
36 of the appendix.]
    Chairman Huizenga. We can tell Mr. Bentsen is an expert 
witness. He is turning back time and the Chairman can't even 
jam it all in, in the time allotted, so way to go.
    With that, Mr. Deas, you are recognized for 5 minutes.

                    STATEMENT OF THOMAS DEAS

    Mr. Deas. Good afternoon, Chairman Huizenga, Ranking Member 
Maloney, and members of the subcommittee, I am Tom Deas, 
Chairman of the National Association of Corporate Treasurers, 
which is a member of the Coalition for Derivatives End-Users. 
Our coalition represents hundreds of end-user companies across 
the country that employ derivatives to manage day-to-day 
business risks.
    I would like to thank you all for doing so much to protect 
Main Street companies from undue burdens of financial 
regulations. We support the transparency that the Dodd-Frank 
Act attempts to achieve in the derivatives market. We also 
believe it is sound policy and consistent with the law to 
exempt end-users from provisions intended to reduce the 
inherent riskiness of swap dealers' activities, but which can 
increase end-users' cost and make our risk management 
activities prohibitively expensive.
    As you consider potential changes to Dodd-Frank and its 
implementing regulations, I want to assure you that end-users 
comprising less than 10 percent of the derivatives market are 
offsetting business risk, and not creating new financial ones.
    We support legislative changes to address, first, bill No. 
2 on the agenda related to capital charges. A bipartisan 
consensus has clarified that commercial end-users are exempted 
from having to post cash to margin their derivatives positions. 
However, U.S. prudential banking regulators are requiring swap 
counter-parties they regulate to hold extra capital against 
end-users on margin trades.
    This effectively negates the exemption with an equivalent 
economic cost that end-users must bear. This credit valuation 
adjustment not only adds costs that can make hedging business 
risk too expensive but places American companies at a 
competitive disadvantage compared to their European and other 
foreign rivals whose regulators have exempted their end-users 
from this burden in recognition that their derivatives are 
reducing overall economic risk.
    Next, bill No. 3 on the agenda, the financial entity 
definition. The coalition believes that end-users employing 
derivatives to reduce their business risk should not be unduly 
burdened with regulations intended for those running open books 
of positions such as swap dealers.
    The unifying characteristic for the end-user exemption 
should be the exact matching of a derivative with an underlying 
business exposure, not whether the end-user is engaged in 
certain activities which might be considered financial in 
nature.
    Take a real estate company which owns and manages factory 
buildings and supporting infrastructure and leases them to 
manufacturers. If this company is organized as a real estate 
fund it is characterized as financial. And under the current 
rules, it cannot hedge its business exposures in the 
derivatives market without being subject to the full range of 
regulations applied to financial counterparties.
    We support proposals that would follow European, Canadian, 
and other foreign regulators that have set thresholds for 
financial activity below which companies would be treated as 
commercial end-users.
    Now finally, relating to bills No. 4 and 5 on the agenda, 
on inter-affiliate exemption and centralized Treasury units, 
end-user treasurers have long widely used the accepted risk 
reduction techniques of netting exposures within our corporate 
group so we can reduce derivatives outstanding with banks.
    We use centralized Treasury units (CTUs) as the hub for 
netting out opposite-way inter-affiliate derivative 
transactions to achieve this reduction in outstanding hedges. 
These CTUs allow us to centralize control and compliance 
supervision across often far-flung corporate groups. However, 
the commercial end-user exemption needs legislative 
clarification to ensure it applies to CTUs and the inter-
affiliate derivatives centralized through them so they are not 
subject to mandatory clearing and the requirement to post 
margin for these internal notional derivative positions.
    In conclusion, end-users employ the OTC derivatives market 
for the efficient transmittal of risk from where they incur it 
to where they can match and offset it with a swap dealer. Undue 
regulatory costs along the way, including those placed on our 
financial intermediaries are ultimately borne by the end-user.
    In our world of finite limits and financial constraints, 
these unintended economic burdens on end-users represent a 
direct dollar for dollar subtraction from funds that we would 
otherwise use to expand our plants, to build inventory, to 
support higher sales, to conduct research and development, and 
ultimately to sustain and we hope grow jobs.
    I noted in my written testimony, specifics of these 
concerns along with suggested remedies and will do my best to 
answer questions you may have.
    Thank you again for your attention to end-user companies.
    [The prepared statement of Mr. Deas can be found on page 43 
of the appendix.]
    Chairman Huizenga. Thank you for your testimony.
    With that, Mr. Green, you are recognized for 5 minutes.

                     STATEMENT OF ANDY GREEN

    Mr. Green. Thank you, Chairman Huizenga, and Ranking Member 
Maloney, for the opportunity to testify in this important 
topic.
    The derivatives market is a vital avenue for financial and 
nonfinancial companies to prudently hedge the risks they face. 
Today's roughly $550 trillion swaps market may not directly 
impact the day-to-day lives of the average American, but a 
severe disruption in the market can have knock-on effects 
impacting the real economy.
    The unregulated swaps market was at the heart of the 2007, 
2008 financial crisis, which cost 8.7 million Americans their 
jobs, 10 million families their homes, and helped eliminate 49 
percent of the average middle-class family's wealth compared to 
2001 levels.
    Thanks in part to the unregulated swaps market, financial 
distress in one company quickly reverberated throughout the 
financial system. AIG is the only most commonly discussed 
example, but every other major Wall Street dealer bank faced 
major threats from margin calls and the risk of knock-on losses 
arising from swaps.
    Nor was the 2008 financial crisis the first time swaps 
markets created major challenges. Long-Term Capital management, 
Enron, Amaranth, Gibson Greeting Cards, Proctor and Gamble, 
Orange County, all got themselves in trouble in one way or 
another from the OTC swaps market, negatively impacting 
investors, market participants, financial stability, and 
taxpayers.
    In the wake of their devastation brought by the financial 
crisis, Title VII of Dodd-Frank sought to bring stability, 
transparency, and competition to the swaps market. Nearly 8 
years since Dodd-Frank was signed into law, with the exception 
of the SEC, the swaps regime is operational and working. And it 
is benefiting the real economy.
    In just one study, the Bank of England found in the U.S. 
total execution costs for day-to-days were reduced by about $7 
million to $13 million a day for SEF-mandated swaps.
    With reform showing positive results in the large 
investment and operations and compliance systems already made 
by firms, any legislative proposal should have to overcome a 
heavy burden in favor of maintaining what is working.
    Financial regulatory changes also need to be considered as 
a whole. For example, FSOC's designation process which helps to 
reduce the risks that non-bank financial firms create knock-on 
effects across markets.
    The Office of Financial Research monitors and investigates 
the risks across the financial system. And other regulatory 
protections such as bank capital, liquidity, and the Volcker 
Rule which properly distribute risk and focus firms' activities 
on the real economy appear under threat. To the extent that 
these tools are dialed back, it places even more strain on any 
weaknesses that may emerge in the derivatives markets.
    Unfortunately, the bills presented today all appear to 
press in the wrong direction. A persistent theme in them is to 
extend the scope of commercial end-user treatment to entities 
and activities that are financial in nature. This violates the 
basic bargain, that strong regulatory protections cover the 
market which is dominated by financial firms, and that special 
treatment can be accorded the relatively small number of 
commercial entities.
    To draw an analogy to public health, a small number of 
people can avoid being immunized and still remain protected by 
the broader use of a vaccine, but if that group becomes too 
large, everyone is put at risk, especially those people who 
actually cannot be immunized.
    To the extent that any of the bills today embody specific 
concerns by market participants, far more needs to be done to 
study specifically identified challenges.
    To facilitate accurate analyses and broad-based consensus 
on these questions, far more market and institutional data, 
including at the subsidiary level, must be made available to, 
and usable by the public.
    Last, policymakers should avoid falling victim to the 
argument that reducing regulation will enhance competition and 
benefit end-users or the real economy. Financial markets have a 
tendency toward rent-seeking behavior which comes at the 
expense of the real economy.
    Regulatory standards are required to ensure transparency 
and competition which benefit those that utilize those markets, 
small and medium-size enterprises, family farmers, 
manufacturers. Energy and commodity companies are far better 
served by a simple, robustly regulated market where prices are 
transparent and competition is meaningful.
    I have addressed the special proposals today in my written 
comments and in the interest of time will stop here. I look 
forward to taking your questions. Thank you.
    [The prepared statement of Mr. Green can be found on page 
50 of the appendix.]
    Chairman Huizenga. Thank you.
    And with that Mr. O'Malia you are recognized for 5 minutes,

                   STATEMENT OF SCOTT O'MALIA

    Mr. O'Malia. Chairman Huizenga, Ranking Member Maloney, and 
members of the committee on behalf of the International Swaps 
and Derivatives Association and its 900 member firms, I would 
like to thank the committee for holding this timely hearing to 
discuss potential adjustments to the regulatory regime of the 
derivatives market.
    I am pleased to offer my written testimony where I have 
addressed in great detail my observations regarding the 
progress that has been made to implement Dodd-Frank, the 
important initiatives taken by ISDA and its membership to 
develop mutualized solutions to optimize implementation of the 
rules, and then more specific recommendations on the 
legislation before this subcommittee.
    The implementation of Dodd-Frank and the related margin in 
capital rules have made the financial market more transparent, 
more resilient and have reduced systemic risk.
    Over the past 7 years, ISDA and our members have made 
significant progress in implementing the regulatory agenda. 
Today trade data on derivatives is now required to be reported 
to SDRs and fully accessible to regulators. Nearly 88 percent 
of interest rate derivatives and 80 percent of CDS Index 
notional trade in 2017 is centrally cleared. More than half of 
all interest rate derivatives in the U.S. were traded on an 
electronic platform in 2017.
    Globally significant banks have added $1.77 trillion in 
Tier 1 capital to their balance sheets since 2009 and further 
increases are contemplated.
    Nearly $1 trillion of collateral has been posted by 
counterparties with the 20 largest market participants to back 
the risk of the non-cleared swaps and we are only halfway 
through that process.
    It is important to stress that we are in no way advocating 
for a roll-back of this progress. However, with any regulatory 
reform of this size and this scope we are bound to find areas 
where anticipated outcomes and the actual results don't align, 
creating redundancies, higher costs or areas for improvement. 
And we believe these improvements could be made to the current 
regulatory regime by focusing on three broad areas.
    First, harmonizing regulatory requirements; second, 
reducing operational complexity and cost; and third, providing 
regulatory relief to market participants, small market 
participants and end-users.
    Let me begin by discussing the need for greater regulatory 
alignment.
    As we all know, both the CFTC and the SEC have oversight 
over parts of the swap market. Ideally we would have an 
effective identical requirement for the market segments the two 
agencies oversee. However, such an outcome has proven to be 
difficult to achieve in practice. As a result, ISDA recommends 
that the CFTC and the SEC develop a more holistic solution, a 
safe harbor approach to address these issues.
    Under such an approach, market participants in compliance 
with the CFTC rule sets for swaps including business conduct, 
capital and margin would be granted a safe harbor from the same 
rules sets issued by the SEC and vice versa. To be clear, in 
either case the derivative activity would be thoroughly 
regulated.
    Most importantly, the safe harbor approach does not 
contemplate the relinquishment of the agencies' respective 
authorities or jurisdiction. Both commissions would retain 
anti-fraud and anti-manipulation enforcement authority and the 
respective Congressional committees would retain their 
legislative and regulatory oversight.
    One final word on this matter, while it has taken 
significant work between the U.S. and Europe to find a solution 
to recognize one another's clearing and trading rules, it would 
be quite remarkable if we were able to achieve a determination 
with a foreign government but not within our own.
    Turning now to a second area where greater global 
regulatory harmonization is needed and that is the treatment of 
inter-affiliate transactions under the margin rule.
    My former colleague, Chairman Gary Gensler, explicitly 
recognized the benefits of such transactions when providing an 
exception from the clearing requirements. This position enjoyed 
bipartisan support on the commission. His successor, Tim 
Massad, further memorialized the CFTC position by providing an 
exemption from the initial margin requirements which are 
consistent with policies in the EU and Japan.
    Now the rules promulgated by the U.S. prudential regulators 
however do not provide such an exemption and disadvantage 
certain firms doing business in the U.S. and abroad. The 
legislation being discussed today would remedy this disparity.
    Moving on to my second theme is reducing operational 
complexity and cost. I can think of no better example than the 
treatment of margin under the supplemental leverage ratio 
requirements. In its current form the leverage ratio acts to 
dis-incentivize central clearing adding to cost of banks to 
provide this service. This perverse impact has been highlighted 
by numerous policymakers over the past several years.
    This is not a partisan issue. CFTC chairmen under two 
separate administrations have raised these concerns. It runs 
counter to the objectives of the G20 as implemented by Congress 
in Dodd-Frank and to encourage centralized clearing.
    Now the final broad area which I will discuss is providing 
relief to small market participants and end-users.
    ISDA believes that Congress can have an immediate impact on 
this. We applaud the committee's focus to address the un-level 
playing field created the Credit Value Adjustment providing a 
technical fix to the exemption of centralized Treasury units 
and ending the uncertainty over the CFTC's swap dealer de 
minimis threshold.
    As noted earlier, ISDA and its members support a safe and 
efficient market and we have worked hard to implement the 
regulatory reforms to increase transparency and mitigate 
systemic risk.
    ISDA looks forward to working with Congress, the U.S., and 
international regulators to develop solutions to further 
strengthen, simplify, and harmonize the regulatory framework.
    Thank you very much.
    [The prepared statement of Mr. O'Malia can be found on page 
78 of the appendix.]
    Chairman Huizenga. Thank you.
    At this time I would like to recognize myself for 5 
minutes.
    Real quickly and this wasn't in the oral testimony but in 
written testimony. We saw Mr. Green compare the different rules 
from different agencies as different types of transportation 
modes having different types of safety rules. It seems to me 
that it might be the same highway but we now have the State 
police setting truck speeds and safety rules, and while the 
county sheriff is setting vehicle speeds, private vehicles 
speeds on those same highways and roadways.
    Mr. Bentsen and Mr. Deas, and maybe Mr. Deas first, how are 
these end-users generally different from other participants in 
the OTC derivatives markets and did the derivatives activity by 
end-users contribute to this financial crisis that we had seen 
previously?
    Mr. Deas. Thank you, Mr. Chairman. The fundamental 
difference between end-users and the other participants in the 
market is that to qualify as an end-user you must be matching a 
derivative exactly as to timing, amount, currency, whatever the 
characteristics may be with an underlying business exposure.
    So the exposure of the day-to-day business risk and the 
derivative are matched and they offset each other exactly. 
Whereas swap dealers are maintaining an open book, at times 
that book doesn't balance and positions going one way may 
exceed those going another way, and so, that they incur through 
that imbalance a risk, and it is proper we think that there be 
appropriate capital and other charges related to those risks.
    End-users comprise less than 10 percent of the derivatives 
market and did not contribute to systemic risk.
    Mr. Bentsen. I guess I would just add, this is a little bit 
of a dilemma inherent in the U.S. regulatory framework that 
this committee and its predecessor committees have dealt with 
over the years where you have products that are providing the 
same function but are differentiated by legal definition, and 
you run into a situation of functional regulation which is the 
U.S. framework that we have in place.
    In our mind it doesn't make a lot of sense for regulators 
to have differing regulation for the same product just because 
of the legal definition. It actually seems, in our mind, to run 
counter to what has been at the top of the house at the U.S. in 
multiple administrations, in the agreements that are worked out 
amongst the G20 and the Pittsburgh Principals of having 
harmonization across jurisdictions, particularly in what is a 
global marketplace.
    So I think those different enforcement schemes are not 
necessarily the best approach.
    Chairman Huizenga. So ultimately you believe the 
inconsistencies have affected compliance and--
    Mr. Bentsen. It creates fragmentation--
    Chairman Huizenga. Fragmentation--
    Mr. Bentsen. Yes, it creates fragmentation in what is a 
global market and it affects everything from execution, price, 
and availability.
    Chairman Huizenga. And not in a beneficial way I think is--
    Mr. Bentsen. No, we have seen that some of our buy-side 
members have done surveys where they have seen cost and 
execution go up, the number of entities who are willing to 
provide clearing services go down. And then even in the cross-
border realm where we have seen fragmentation in markets which 
reduces liquidity, which we don't think is a good thing.
    Chairman Huizenga. Ultimately do you believe the CFTC 
should be granted the authority to issue the fees on 
derivatives? That is something that has been proposed in the 
budget by the White House, and I am curious how it would affect 
market participants and liquidity in the marketplace, maybe 
have you address that, Mr. O'Malia? Mr. O'Malia, if you want to 
go first?
    Mr. O'Malia. Thank you. This proposal has come up time and 
time again in different forms and in different administrations. 
And each time it has been rejected because it adds to the cost 
of risk management. We don't support the fees that are proposed 
in the budget.
    Chairman Huizenga. Neither does Mr. Giancarlo.
    I don't know if Mr. Bentsen--
    Mr. Bentsen. I think Scott makes a fair point. I think what 
is in--and Chairman Giancarlo did come out against this the 
other day. And there's the question of how you would let--in 
some cases you could have a fee that exceeds the spread on the 
product, and so, you have to take that into consideration as 
well.
    Chairman Huizenga. With that I will yield back my time and 
recognize the gentlelady who has freshly returned from the 
floor as we are debating some Financial Services bills down 
there.
    The gentlelady from New York is recognized for 5 minutes.
    Mrs. Maloney. Thank you. Thank you. Thank you. I thank the 
gentleman for recognizing me.
    First of all I would like to ask Mr. Green. As I mentioned 
in my opening statement I think that there should be a very 
high burden of proof for any bill that makes additional changes 
to Dodd-Frank's derivatives rules.
    There needs to be a real concrete problem that is both 
significant and unintended before I am willing to support 
legislative change for derivatives rules.
    In your view, Mr. Green, do any of these bills meet this 
high standard of proof or any or the problems that the bills 
are addressing significant enough to warrant legislative 
action?
    Mr. Green. Thank you. No, they do not on both questions.
    Mrs. Maloney. Mr. Green, as you know, Dodd-Frank excluded 
legitimate commercial end-users from many of the derivatives 
rules that were intended for banks and hedge funds. One of 
these bills would extend the end-user exemption to commodity 
pools and even to private funds. Are these legitimate 
commercial end-users or are they more like financial 
institutions? And do you think it is appropriate to treat these 
entities like end-users?
    Mr. Green. Thank you. Absolutely not. Despite the name 
``commodity pool,'' this is not some place that drained the 
water in their backyard pool and has filled it now with corn 
and wheat. These are basically mutual funds or private funds 
that are offered to investors or other market participants for 
the purpose of investing and I use that term with a little bit 
of quotes because the commodities markets and the comodities 
derivatives markets are different from normal SEC investment 
markets.
    They are for the purpose of investment they are financial 
activities, they are not owning commodities or engage in those 
types of activities. It is really quite inappropriate to extend 
end-user treatment to them. And I would even argue that the 
real estate funds we have seen from the financial crisis, and 
in other cases, that real estate can be a major source of 
speculative bubbles and that prudent risk management of a 
financial nature is essential when you are engaged in these 
types of financial activities.
    Mrs. Maloney. Mr. Green, one of these bills would reduce 
the capital requirement for banks that are trading derivatives 
with end-users. How would giving relief to banks on their 
derivatives trade help end-users?
    Mr. Green. I don't believe that it would, and I believe the 
evidence of what we have seen with respect to capital and the 
approaches to capital overall suggest that it does not 
historically.
    It is important to remember that it is frequently 
understood that capital is something that people talk about as 
being held by a company. It is a form of funding. It is there 
so that firms can withstand losses and be flexible with 
response to changing market conditions.
    In this particular bill you are referencing, it is very 
essential that fair value risks are of credit, as they change, 
are appropriately included within capital. And we are ready, we 
are looking at banks overall, very, very much at the bare 
minimum in terms of a socially responsible level in equity 
capital buffer, any steps taken to reduce that would be very 
unwise.
    Mrs. Maloney. Do you think banks would pass on this relief 
to end-users in the form of lower trading costs?
    Mr. Green. No. I don't believe the evidence is that would 
be the case. I believe the trading costs are lowered when you 
have competition, and real transparency in the market and that 
is why those types of parts the reforms are essential and need 
to be advanced further.
    Mrs. Maloney. Or would this simply make trading derivatives 
more profitable for banks?
    Mr. Green. It would certainly be more profitable. It would 
certainly make it more profitable, but really what it does is 
it creates more of a risk that is being borne by the taxpayer 
and the resolution regime that would have to step in if the 
equity was not there to absorb the risks of losses.
    It is important to remember that capital and even margin 
only cover a small portion of the estimated risks that are 
created by these exposures. When models fail and other problems 
emerge, we need a sufficient buffer to be able to withstand 
what happens in the markets. And those benefits would not go on 
to the end-users.
    Mrs. Maloney. Thank you very much. My time has expired. 
Thank you.
    Chairman Huizenga. The gentlelady yields back.
    With that, the Chair recognizes the Vice Chairman, Mr. 
Hultgren, for 5 minutes.
    Mr. Hultgren. Thanks, Chairman. Thank you all, so much for 
being here. I want to address my first question to Mr. O'Malia 
if that is all right. It is a multi-part question.
    Is it practical for the credit valuation adjustment (CVA) 
to apply to derivatives transactions with end-users that are 
designed for hedging purposes? And do you believe U.S. bank 
regulators were attempting to address an issue or was this 
simply an oversight? And why would the EU's implementation of 
the Basel framework exclude hedging transactions with end-users 
from the CVA calculation?
    Mr. O'Malia. Thank you very much. The capital rules are 
really developed as global rules and through the Basel 
committee, they are trying to establish a consistent regulatory 
framework. That is very important because as was noted earlier, 
these are global markets and so you are dealing with global 
banks with end-users that can trade in different areas and 
access liquidity. And it is very important that we align those 
rules in a very comprehensive and consistent fashion.
    As you quite rightly pointed out, the European Commission 
did not impose a CVA charge, chose not to do that. Right now, 
we are trying to assess what the new Basel requirements would 
do to impact U.S. traders. And it is very important we do the 
economic analysis. I don't think the data will hide the fact 
that this is more expensive for end-users if you have these in 
place. And then you have to reconcile the international 
standards and balance and what that does for you as 
competitiveness.
    Mr. Hultgren. I wonder if you could maybe detail even a 
little bit more some of the unintended consequences of the 
current CVA treatment. For example, does the current CVA 
treatment disincentivize hedging by institutions, instituting a 
punitive capital framework on banks for engaging in hedging 
transactions with end-users, and are U.S. banks and end-users 
at a disadvantage to their European competitors?
    Mr. O'Malia. I believe they are. And there are several of 
these capital rules whether it is the leverage ratio that adds 
cost while you are including initial market (IM) for cleared 
risk, that doesn't take that into consideration. There are a 
number of different capital rules that are just going to 
increase the cost to end-users in these positions making it 
more expensive to either access capital and/or access clearing 
which is clearly a mandate and a goal of Dodd-Frank.
    Mr. Hultgren. Yes. Thanks, Mr. O'Malia.
    Mr. Deas, if I could address to you, your testimony 
underscores what I think is a widely recognized concern when a 
company falls under Dodd-Frank's definition of financial 
entity, it is automatically precluded from qualifying for or 
otherwise electing any of the exceptions or exemptions for 
uncleared derivatives. Do you know the justification for why 
the law was written this way if any?
    Mr. Deas. Congressman, no. We feel that the relevant 
distinction should be an end-user should be using derivatives 
to hedge underlying business risk rather than maintaining an 
open book as a swap dealer would do. If that entity as in my 
example a real estate fund that owns factories and leases those 
to manufacturing companies, we would think that that should be 
exempt from these extra requirements, and failure to exempt 
such entities would ultimately result in costs being passed on 
to manufacturers.
    Mr. Hultgren. Yes. Do you believe the draft bill under 
consideration today named Derivative 03 would address this 
issue and bring parity for these companies deemed as financial 
entities that use derivatives for hedging?
    Mr. Deas. Our coalition does support the bill scheduled as 
agenda item 3 and that it would not only do that, but it would 
bring the U.S. in line with Europe, Canada, Singapore, 
Australia, and other of our foreign competitors.
    Mr. Hultgren. Thanks.
    Mr. Bentsen, my last minute here, CFTC Commissioner 
Quintenz recently spoke at the conference in D.C. hosted by the 
Mercatus Center and the Institute for Financial Markets where 
he focused on the need for updating the de minimis exemption 
for swap dealers and security-based swap dealers, noting and I 
quote, ``the threshold's reduction to $3 billion would create a 
`black hole,' sucking in community banks and end-users who pose 
zero systemic risk. At the center of that `black hole' lies an 
enormous set of costs.''
    Do you believe that legislation proposing to exclude all 
hedging from the swap dealer de minimis threshold would provide 
relief to those dealers concerned with exceeding the threshold?
    Mr. Bentsen. That is a good question. First of all, to your 
first point and what the Commissioner was talking about is a 
concern that if you--and as I said in my testimony, we really 
need more data to see who is subject to the de minimis 
threshold.
    All the larger banks are obviously well beyond the 
threshold and whatever you are going to set it at. But there 
are a lot smaller dealers who are not subject to it, and our 
concern is that many of those smaller dealers, while they pose 
no systemic risk, might not be willing to stay in the business 
if they are going to be subject to that compliance to serve 
their clients so this is traded away to others.
    You will create more concentration in the market and you 
will take more players out of the market. We think that the 
commission needs to be very cautious in their approach here. 
They now are getting more data since these rules have come into 
place. Let us look at the data and see what it says.
    Mr. Hultgren. Thanks.
    My time has expired. I yield back. Thanks, chairman.
    Chairman Huizenga. The gentleman's time has expired.
    The gentleman from California is recognized for 5 minutes.
    Mr. Sherman. Mr. Bentsen, welcome back. As market 
participants work to comply with U.S. derivative rules, do you 
have any suggestions for how U.S. regulators like the SEC, the 
CFTC can achieve their regulatory objectives in situations 
where there are conflicts with international data privacy, 
blocking, secrecy laws, and other jurisdictions?
    Mr. Bentsen. It is a very good question. It is something 
that, obviously, national regulators have not only their legal 
mandate that the Congress provides, puts forth for them but 
when you are dealing with global markets you have to deal with 
other national laws and cross border.
    In the case of the data reporting, the ability to look at 
books and records is a problem that both the SEC and CFTC are 
confronting. The CFTC, I think, is trying to be more 
accommodative where they conflict with the national law, 
privacy laws that are in place. The SEC, I think, is still 
struggling with that and we think that they need to do more 
work in that area.
    And it is something that I think the U.S. needs to be very 
cognizant of because this can cut both ways. We have been 
through this process of trying to get equivalency regimes put 
in place for trading and clearing, where we have had foreign 
regulators who want to have access to books and record and the 
like in the U.S.
    And we have had to work through the process. I think any 
time we are negotiating and trying to accomplish our goals in 
negotiating with a foreign entity, we need to consider the two-
way street approach. And I think this is only going to get more 
complicated as we go through the Brexit regime.
    Mr. Sherman. One reference from outside this room is the 
exchange of information provisions that we have in our tax 
treaties where we also have regulators, in this case tax 
authorities, looking at the same regulation.
    Mr. Deas, you are here for the end-users. A certain amount 
of capital is posted at various times with the exchanges. 
Question is whether this is adequate enough for you to assure 
me that none of these end-users that you represent are ever 
going to come to Congress and say, they didn't post enough 
capital so they are now liable to us, we sue them, they are 
bankrupt, you will have to bail us out. Is there enough capital 
being posted so that none of your members will ever say such 
and such a derivative issuer went under and Uncle Sam has got 
to write a check?
    Mr. Deas. Congressman, thank you for that question. Just to 
address an answer Mr. Green just gave, I can't tell you that 
the vaccination regime we have guarantees that nobody will get 
sick. What I can tell you is that end-users comprise less than 
10 percent of the derivatives market by notional amount 
outstanding and during the financial crisis, represented a far 
lower percentage than that of defaulting parties.
    Mr. Sherman. But we may be in a circumstance where we need, 
if we just required higher capital, we might be OK, but because 
we didn't, Uncle Sam has to write a check.
    Mr. Deas. Sir--
    Mr. Sherman. Before the entire economy falls apart.
    Mr. Deas. End-users seek to do their derivative 
transactions in the majority with Fed-member banks or other 
regulated financial institutions of that type and in our case, 
the Federal Reserve does stress tests and conducts other 
examinations.
    Mr. Sherman. The higher standards that there are imposed on 
those you are buying derivatives from, the less likely it is 
that they will default, the less likely that either you or I 
will be holding the bag.
    Mr. Deas. We believe that there is an adequate capital 
cushion to guard against these kinds of outlier events.
    Mr. Sherman. OK.
    Let me just ask Mr. Green, this is insurance, I have got a 
comprehensive auto insurance. If my car is stolen, I give the 
pink slip which is what we call the title to the insurance 
company and they write me a check for 20 grand.
    If instead we structured that as a credit de-car swap and 
we would say under certain circumstances I give them the pink 
slip and they give me $20,000 worth of U.S. treasuries, that 
would just be the trade of one piece of paper for another piece 
of paper. I guess it would not be regulated as insurance.
    Why and I realize this is national or international so you 
might need a national regulator but why don't we regulate this 
like insurance?
    Chairman Huizenga. Quickly answer.
    Mr. Sherman. Very quick answer.
    Mr. Green. You make some very important conceptual points. 
We have not historically done that, but there are some very 
strong arguments why particularly certain parts of the market 
ought to be treated like that, particularly credit markets and 
certain parts of Dodd-Frank do start to push in that direction 
such as prohibiting a firm from betting against a 
securitization product that they issue. I think there is a lot 
of conceptual backing to the argument you are making and ought 
to be supported further.
    Chairman Huizenga. The gentleman's time has expired.
    With that, the gentlelady from Missouri is recognized for 5 
minutes.
    Mrs. Wagner. Thank you, Chairman Huizenga.
    And thanks to all of our witnesses for being here today; 
many of you are repeat customers.
    The 2017 Treasury report on capital markets contains 
recommendations for the CFTC and the SEC to undertake a joint 
effort to review their respective rulemakings in order to 
eliminate redundancies.
    Mr. Bentsen, in your testimony, you also note and I quote, 
``the regulatory distinctions between swaps and security-based 
swaps as defined under Title VII did not accurately reflect 
market practice and the resulting jurisdictional split between 
the CFTC and SEC has posed challenges for market 
participation.''
    Mr. Bentsen, can you please briefly explain how the 
different regulatory timelines and approaches under both the 
SEC and CFTC have created these inconsistencies and 
redundancies?
    Mr. Bentsen. I think what we are finding is, a lot of it is 
in my testimony but the treatment of rules in terms of how you 
define a U.S. person and, a lot of the rules the SEC has not 
finished yet so they are still in the promulgation period.
    Mrs. Wagner. Yes.
    Mr. Bentsen. But it moved and not clearly been moving in 
the same direction. We think where we are now is an opportunity 
with the Treasury recommendations, with the two new leaders of 
the two commissions to try and create either harmonization or 
as one of the other witnesses testified, a safe harbor approach 
or a substituted compliance approach between the two regimes.
    Mrs. Wagner. Thank you.
    Mr. O'Malia, you also talked about duplicative requirements 
in your testimony and for a need to level that playing field. 
For some market participants who must adhere to both sets of 
rules, how do these different approaches for many of the 
similar activities and products create compliance concerns and 
additional costs?
    Mr. O'Malia. The operational challenges of implementing 
dual sets of regulation and we have examples on a global level, 
in particular the data rules, each jurisdiction requires a 
different data reporting regime. I think we have to look at 
this in a very practical approach and then also look at it in 
what results do you want to achieve.
    Now, the CFTC and the SEC have largely well-aligned swap 
dealer definitions and rules. They are being implemented on a 
different timeframe, so the results you are going to get if you 
deal with the safe harbor approach, basically saying to the 
extent you have complied fully with the CFTC rules for swap 
dealer registration and meet all those, you are compliant with 
the SEC or vice versa if you chose to start with the SEC.
    Now, the two agencies could work together to figure this 
thing out.
    Mrs. Wagner. How about a holistic approach, what about 
that?
    Mr. O'Malia. We would like a safe harbor approach. You 
comply with one or the other. And there are examples of this 
that we achieved at the CFTC back in 2013 with FERC (Federal 
Energy Regulatory Commission). We were not the FERC tariff 
rate-setter, but yet we had jurisdiction over some of those 
commodity markets. We deferred to the FERC to make those 
decisions.
    These are workable solutions. We also worked with other 
SROs to defer some of that regulatory oversight. It is 
imminently possible and available to us. It is letting the 
chairman sort this out given the strong direction from the 
committee and others to get those results and then I think you 
will have an operational solution.
    Mrs. Wagner. I appreciate your elaborating especially on 
the regulatory safe harbor testimony that you have given.
    Mr. Bentsen, since the U.S. and EU have been able to 
determine regulatory equivalence in terms of clearing and trade 
execution rules, does it make sense for the SEC and CFTC to do 
the same within the U.S. regulatory framework?
    Mr. Bentsen. Yes, I think so. Yes, absolutely, I think that 
we have functional regulation in the U.S. that sometimes is 
defined by legal definition but we are talking about similar 
products. I think that we should certainly domestically try and 
have similar coordination that we are trying to do cross 
border.
    Mrs. Wagner. Many requirements in the Title VII of Dodd-
Frank tasked the SEC and CFTC with virtually identical 
rulemakings. One would think that requirements for swaps and 
security-based swaps would be very similar if not identical. 
Has this been the case, Mr. Bentsen?
    Mr. Bentsen. I think as we have gone through the rulemaking 
process, we have seen that there have been differences in 
interpretation of Title VII between the two regulators. I don't 
want to say that it is necessarily one regulator versus 
another. And to be fair, they have come at it from their legacy 
focus.
    The CFTC was much a futures regulator; the SEC obviously a 
securities regulator. But as we have had some experience now, 
7, 8 years of experience, this is really something where we 
should be able to converge or just, as Scott said, employ a 
safe harbor approach.
    Mrs. Wagner. I appreciate that. My time has expired. I have 
some other questions, Mr. Chairman, I will submit for the 
record. I thank the witnesses and I yield back.
    Chairman Huizenga. The gentlelady's time has expired.
    The gentleman from Massachusetts, Mr. Lynch, is recognized 
for 5 minutes.
    Mr. Lynch. Thank you, Mr. Chairman.
    I want to thank the witnesses for your help on this matter. 
First of all, this grouping the bills, the 11 bills that are 
presented, they are not actually bills, they don't have bill 
numbers. But I guess they call them proposals, taken in the 
aggregate would wipe out much of the taxpayer protections that 
were put in place by Dodd-Frank after the crisis back in 2008.
    In particular, one of the bills before us today H.R. blank 
number 6, I guess at least that is in the memo, creates a large 
exemption for swaps between quote, ``affiliated entities.'' 
They would be exempt from CFTC and SEC regulations. We have 
addressed before, during Dodd-Frank, and subsequent to that.
    We have previously considered this matter with input from 
both Treasury and the FDIC (Federal Deposit Insurance 
Corporation). And we have some pertinent communications 
specifically from Vice Chairman Tom Hoenig of the FDIC. And I 
think it is instructive that he says inter-affiliate margin 
ensures that there is sufficient capital and liquidity to the 
financial firm in the market should any unit of a consolidated 
bank company find itself in a position where it cannot serve 
end-users or where its failure becomes a threat to the broader 
economy and the taxpayer.
    Chairman Hoenig then pointed out that affiliates are 
incentivized to transfer their risks through uncleared swaps to 
U.S. banks who have valuable subsidies including importantly 
the implicit presumption that they will be bailed out by the 
U.S. taxpayer.
    If the banks don't collect margin from their affiliates on 
these trades, the bank effectively takes on the affiliate's 
risks which are subsidized by the taxpayer. Mr. Hoenig also 
wrote that requiring JPMorgan's affiliate operating in London 
to post margin to JPMorgan's U.S. bank, that would have helped 
keep the $2 billion London Whale losses outside of the 
federally insured bank. I think it is a great example in what 
we are talking about here today.
    The bill would also eliminate the CFTC's initial margin 
requirement for swaps with foreign affiliates that are not 
subject to comparable regulatory regime, exposing us to 
considerable risk.
    Mr. Green, are we seeing here a case of a purported 
exception actually swallowing the rule? If an affiliate is 
described too broadly, couldn't companies simply funnel their 
derivative trades through a so-called affiliate to evade U.S. 
requirements?
    Mr. Green. Yes, I agree with that. I think this is an area 
that is extremely dangerous. It is extremely broad, some 
estimates are at the inter-affiliate swaps are half the swaps 
that are out there. The large financial firms have thousands of 
affiliates, the most important affiliates are a smaller number 
of that.
    But given the interactions between resolution and also 
cross border where a lot of the conversation about 
inconsistency in CTFC versus SEC regulation that was just noted 
a couple of minutes ago, are actually about the extent to which 
foreign affiliates that are foreign affiliates of U.S. firms 
where the risk will come back to the U.S. are subject to the 
basic protections that we set in place for the U.S. taxpayer.
    If you start to undermine those, you have major, major 
challenges. Now, as Commissioner O'Malia has noted, Chairman 
Gensler and others have noted, there are distinct differences 
that require these swaps to be tailored slightly and we can 
discuss and debate particularities but the bill that is 
presented today is a broad base exemption that is not 
acceptable.
    Mr. Lynch. Right. What does this bill do to the 
requirements for posting margin with foreign affiliates that 
are not subject to overseas regulatory regimes, that are 
comparable to our own? You touched on that a little bit but I 
am just concerned that aren't we just creating a loophole to 
allow foreign-funnelled trades to have an advantage over U.S. 
banks that don't operate through a foreign affiliate?
    Mr. Green. Absolutely. This is, any time where you are 
getting into a description like you mentioned, I think that is 
a very real risk. This is the Export U.S. Financial Service 
Jobs Abroad Act. This is import foreign risk into the U.S. 
because the U.S. taxpayer, for a variety of reasons, has been 
the one that has had to step up and make sure that U.S. 
financial institutions are there when need be.
    And a far more appropriate approach is to ensure a broad, 
consistent using substitute compliance comparability regime so 
that there are good regulatory approaches around the world and 
where there are not, we need to make sure that the U.S. 
regulatory regime is the floor and then no one can evade it 
with a large exemption like the one that is being proposed in 
the bill today.
    Mr. Lynch. Thank you, Mr. Chairman. I yield back.
    Chairman Huizenga. The gentleman's time has expired.
    The gentleman from Maine is recognized for 5 minutes.
    Mr. Poliquin. Thank you, Mr. Chairman. I appreciate it very 
much.
    And thank you, gentlemen, for all being here today.
    One of the roles of Government as I see it is to make sure 
that we create laws and rules are made such that our families 
are helped in such they live better lives with more 
opportunities and more freedom. That is why I have been a very 
big proponent and continue to about reducing or limiting the 
regulatory environment that is redundant and unnecessary and 
harmful.
    Second of all, I have been a big supporter of our tax 
reform package which is being quite successful as far as 
stimulating economic growth and job creation here in this 
country and my State of Maine.
    The State of Maine, gentlemen, has world-class fisheries 
and agriculture and also wood products. We have tremendous 
resources, natural resources with our sustainable forests and 
what have you. I am really concerned about some of the folks on 
the other side of the aisle today saying something to this and 
I will paraphrase, I hope I get it right that they are 
concerned about any adjustments to Dodd-Frank when it comes to 
derivatives because they believe that doing so will represent 
or cause potentially systemic risk to our economy.
    Now, what would be helpful to me, Mr. Deas, if I am 
pronouncing it correctly.
    Mr. Deas. Deas, sir.
    Mr. Poliquin. Deas, thank you sir, could you use a specific 
example of an end-user, say, a potato farmer in Aroosta county, 
how such an end-user might us such a derivative, such a 
financial instrument to help that farm conduct his business to 
lower its risk so it can grow, be more successful and also 
offer more price stability to the consumer. And explain to us 
clearly, sir, how that does not represent a systemic risk to 
the U.S. economy.
    Mr. Deas. Yes, sir. I am privileged to have served 18 years 
in the treasury and corporate finance function at Scott Paper 
Company which as you know--
    Mr. Poliquin. When I was a kid growing up in Central Maine, 
Scott Paper was a great employer right across the river in 
Winslow, Maine and we appreciated those jobs. My best buddy 
across the street, his dad was a machinist at Scott Paper, 
thank you for that job.
    Mr. Deas. Thank you, sir. And it was my privilege to 
finance the construction of those operations. And I can tell 
you for example at the Winslow mill where there are, quite a 
bit of energy is consumed in the transformation of wood pulp 
into paper, those energy exposures to the extent they are 
variable represent a risk to the business and to the extent 
that Scott Paper Company's treasury were able to hedge those 
energy purchases forward in the over-the-counter derivatives 
market matching up exactly the exposure of when we are buying 
the energy against the derivative, it helped stabilize the 
business, maintain level cost base and ultimately support those 
jobs in Winslow.
    Mr. Poliquin. That in your opinion, sir, represented no 
potential systemic risk to the U.S. economy?
    Mr. Deas. We think it is risk-reducing and the Europeans 
have taken the same view and exempted their end-user companies 
from many of these regulations we are advocating be adopted in 
the U.S.
    Mr. Poliquin. Mr. Bentsen, do you have a further experience 
that could shed light on this issue where the end-user is 
representing no risk to the U.S. economy?
    Mr. Bentsen. I think Mr. Deas has laid it out well. The 
end-user is effectively buying the product to mitigate their 
risk or to hedge their risk activity. They are really in a 
different function than in a financial risk.
    Mr. Poliquin. Explain to us if a paper company like Scott 
might not have the ability to hedge its risk, how that might be 
more risky to the economy and to the families that depend on 
those jobs.
    Mr. Bentsen. And, again, Mr. Deas is probably better to 
speak to this fact, to talk about having to mitigate your risk 
to fluctuations and the cost of fuel or feedstock for your 
plants or fluctuations for a global company, fluctuation in 
currency prices.
    Mr. Poliquin. How might there be some confusion, gentlemen, 
either one of you, between this issue that we are talking about 
in the use of derivatives in other parts of the economy that 
could have and did in some parts cause problems in 2008.
    Mr. Bentsen. I think, first of all, we have to step back 
and look at where we are today compared to where we were in 
2007-2008. We have a very robust new architectural regime that 
has been put in place for the derivatives markets in the U.S. 
and across the globe. And much of what we are talking about 
today is how do we, in what is truly a global marketplace, how 
do we make sure that the plumbing is the same across the 
organization. We don't create fragmentation or diminish 
liquidity in different market sectors so companies like Scott 
Paper or a global company can function globally as well.
    Here we are talking about do we have the calibration right 
after 7 years of imposing a dramatic series of rules, many of 
which the industry supports. But the time is now to see what 
works, what does not work and are we accomplishing the policy 
goals.
    Mr. Poliquin. Thank you, gentlemen, very much. Appreciate 
your time.
    Thank you, Mr. Chairman.
    Chairman Huizenga. The gentleman's time has expired.
    The Chair at this time recognizes the gentleman from 
Georgia, Mr. Scott, for 5 minutes.
    Mr. Scott. Thank you very much, Mr. Chairman. This is a 
very interesting and very important hearing dealing with a very 
important matter. But first, I want to thank Mr. Luetkemeyer 
for, again, partnering with me on some common sense 
legislation. And I want to devote that to our legislation that 
Mr. Luetkemeyer working with H.R. 4659 of which I am the 
Democratic lead on.
    It forces banking regulators to recognize the exposure-
reducing nature of client margin for cleared derivatives. Now, 
first of all, I have recognized the importance of client 
margins and I believe that client margin should be excluded 
from what we refer to as supplemental leverage ratio 
calculations, but more importantly, if we were to include 
client margin in supplemental leverage ratio calculation, it 
would put our clearinghouses at a very distinct disadvantage.
    And a major thing we wanted to do in Dodd-Frank was bring 
transparency to this over-the-counter market that previously 
operated in the shadows of our financial system. But we made a 
decision as a Nation to expand the use of central clearing.
    That is why I struggle to understand why anyone could not 
be supportive of putting together regulations that incentivize 
more companies to clear derivatives. That is what our bill, Mr. 
Luetkemeyer and I, our bill 4659 does. It makes clearing more 
attractive to our country's biggest institutions.
    Mr. Bentsen, you and Mr. O'Malia, I would like for you to 
comment and explain, am I going wrong? Am I right? And does not 
our bill help in this matter?
    Mr. Bentsen. Mr. Scott, I think you are right on point. 
This is counterintuitive and goes against what really was 
official policy of trying to drive more product that could be 
driven to central clearing and now you are being penalized for 
doing this. It is one of the problems in the construct of the 
SLR and we think needs to be approached. We think you all are 
right on target.
    Mr. Scott. Now, let me ask you this and Mr. O'Malia you 
comment, too, because this could get into record questions I 
always try to be able to not just look down the road but look 
down the road and around corners to see what might be coming. 
And I think as we get further in this bill, a question might be 
raised that what we are trying to do with 4659, somebody could 
say what Mr. Scott and Mr. Luetkemeyer are doing could make our 
financial system riskier.
    Do you, anybody agree with that we want to make sure that 
what we are doing is making our system stronger. I don't want 
anybody arguing later on as we get to moving this bill that 
there is any risk involved. Would you all comment on that? 
Anybody, Mr. O'Malia?
    Mr. O'Malia. Sir, ISDA supports the legislation and the 
lead--
    Mr. Scott. Pardon me. Repeat that again.
    Mr. O'Malia. ISDA supports the legislation.
    Mr. Scott. Thank you, sir.
    Mr. O'Malia. We are pleased to support it because we think 
it is prudent and recognizes that clearing has put IM aside and 
that is a very important risk-reducing measure. And to add an 
SLR component on it or not to recognize the fact that you have 
got risk-reducing IM associated with it just makes it more 
costly.
    Mr. Scott. Thank you very much.
    Mr. Chairman, I think I would be derelict in my duty if I 
not mention that I am the ranking democrat on the derivatives 
committee in agriculture and when my staff alerted me that we 
would be having an 11-bill legislative hearing on derivatives, 
I absolutely thought right then that they would give our little 
subcommittee in agriculture that I am head of where Dodd-Frank 
exclusively gave our subcommittee on commodities markets 
interchange and on derivatives a little bit of a warning and 
say can you work with us on that.
    And I see my former chairman Mr. Lucas there and I know he 
would be proud of me for getting respect for our agriculture 
committee on this, and perhaps you might pass that along to the 
chairman. We hope that it wasn't a disrespect but we work hard 
there, Austin Scott and I and we would have loved to have a 
little part in this.
    Thank you, sir.
    Chairman Huizenga. The gentleman's time has expired but it 
is my understanding that there has been communication between 
our committee and the agricultural committee and Dodd-Frank as 
you pointed out did put CFTC in charge of certain aspects but 
it also created bifurcated authority under which the SEC is 
also a part of that.
    That is the reason--
    Mr. Scott. I don't argue any exclusivity. I just as the 
ranking member, I certainly was not informed and thought I 
would bring that out. I look forward to going forward, however.
    Chairman Huizenga. Fair enough.
    All right. With that, the Chair recognizes the gentleman 
from Ohio, Mr. Davidson, for 5 minutes.
    Mr. Davidson. Thank you, chairman.
    I really thank our witnesses and as Mr. Scott alluded about 
the intersection with agriculture, that will highlight one of 
the many reasons the topic of derivatives is so important to 
Ohio's 8th district, agriculture being very critical to our 
district but manufacturing companies like AK Steel, retail 
companies like Speedway in Enon, Ohio who are purchasing fuel 
and so many others, in the insurance markets, derivatives are a 
massive part of global trade.
    They are a massive part of risk management. And before 
coming to Congress, I spent the past 15 years starting and 
growing manufacturing companies. I know firsthand the effect 
Basel III has had and those international standards on the 
regulatory overreach that has been happening across our whole 
economy, particularly with the need for small companies to 
access capital that they need to grow.
    But in 2014, European regulators exempted risk-weighted 
assets held by European banks from the Basel imposed capital 
variation adjustment requirement also known as CVA. This 
exemption has provided a business advantage to European banks, 
European customers, and European end-users at the expense of 
American businesses, banks, and end-users.
    Mr. Deas, you addressed this exact concern in your opening 
testimony and I wonder in regards to the U.S. markets, what 
consequences you have seen as a result of the European 
exemption.
    Mr. Deas. Congressman, thank you for that question. I am 
also privileged to represent U.S. treasurers at the 
international group of treasury associations and our colleagues 
in Europe calculated that that difference was about 5 basis 
points on an average swap. If you take--I don't have my 
calculator with all the zeros in it--but if you take the $500 
trillion number that the Chairman mentioned of derivatives and 
take 10 percent as the estimate for end-users and then take 5 
basis points of that, that is real money.
    And we would propose to be exempted from that and keep us 
in line with our European competitors.
    Mr. Davidson. That is terrific. I think anyone would have a 
hard time calling that crumbs but I have been surprised by the 
use of the term lately. Do you believe this exemption only has 
hurt U.S. financial institutions or does it go through the rest 
of the economy and affect end-users?
    Mr. Deas. Absolutely, I can tell you that we prefer to 
trade in general. I am speaking now on behalf of corporate 
treasurers with member banks regulated by the prudential 
banking regulators as our swap counterparties and I can tell 
you that they have to cover their cost and to the extent they 
have to hold aside capital for transactions with us, they 
absolutely price that in. And we ultimately bear the cost as 
end-users and that is passed on to our customers.
    Mr. Davidson. Thank you for that.
    Mr. Bentsen, in their capital markets report last year, the 
Treasury Department expressed U.S. derivatives market 
participants were at a disadvantage when compared to their 
international counterparts. Does the EU CVA exemption play a 
role in fostering this competitive disadvantage and have other 
nations taken any action in response to this?
    Mr. Bentsen. I think it was $25 billion maybe but I think 
the EU CVA decision was a diversion from what Basel was trying 
to get to having a uniform approach but it also underscored 
problems in the Basel approach to CVA and more inherently. And 
it was a problem for the U.S. I know it was a problem for the--
the Canadians had raised concerns about it as well and other 
jurisdictions also.
    Basel as I understand it is now I think starting to take a 
look at going back and looking at CVA. It is not helpful to 
have diversions within jurisdictions on global marketplaces, 
number one, but even before that is the calculation, the right 
calculation. We hope that this can be resolved and we can get 
back to a uniform standard globally.
    Mr. Davidson. In the interim, do you feel that the CVA 
requirements for U.S. over-the-counter derivatives could be 
exempted so that the U.S. would be in that level playing field?
    Mr. Bentsen. Yes. That is an issue I know that Mr. Deas' 
group has weighed in more than ours. It is an issue that needs 
to be resolved for sure one way or the other.
    Mr. Davidson. Mr. Deas, do you feel like Congress providing 
that exemption would level the playing field?
    Mr. Deas. Yes, sir. That would be important and so we fully 
support, the coalition does, bill No. 2 on the agenda that 
would achieve that for us.
    Mr. Davidson. Would the net effect of such an exemption be 
felt in sectors such as agriculture and really across the U.S. 
economy?
    Mr. Deas. Absolutely. I was privileged to serve as 
treasurer of FMC Corporation which is a leading supplier of 
agricultural chemicals and I can tell you that to the extent 
that that company is hedging its risks with bank counterparties 
in the derivatives market, it bears the cost of the CVA charge 
they have to incur.
    Mr. Davidson. Thank you.
    My time has expired. Mr. Chairman, I yield.
    Chairman Huizenga. Not seeing anybody on the other side of 
the aisle, gentleman from North Carolina, Mr. Budd, is 
recognized for 5 minutes.
    Mr. Budd. Thank you, Mr. Chairman.
    Again, thank you to our witnesses for your being here 
today.
    We have some exciting proposals that would impact the 
derivatives market and we have actual legislation like Mr. 
Luetkemeyer's bill here 4659 which if enacted would rightfully 
ensure that the SLR recognizes the exposure of reducing nature 
if initial client margin in cleared derivative transactions.
    My questions have to do with proposal No. 1 which would 
direct the SEC and CFTC to harmonize rules overseeing the over-
the-counter swaps. The different regulatory timelines and 
approaches under SEC and CFTC create inconsistencies and 
sometimes redundancies which we can fix with this proposal.
    My first question is, and this is an open question, for 
some market participants who have to adhere to both sets of 
rules, how do these different approaches for many similar 
activities and products create compliance concerns and 
additional costs?
    Again, for any of you.
    We can start with you, Mr. Bentsen, if you like.
    Mr. Bentsen. Again, as I pointed out, we are still getting 
the SEC rules so they are lagging a little behind so firms have 
been focusing more on their compliance with the CFTC rules. But 
as we're seeing where the SEC has been headed, it is raising 
the concerns that you would have conflicting compliance regimes 
that you would have to apply for different products.
    We do know as I pointed out how you define U.S. person and, 
again, both agencies maybe have some things that are good, some 
things that are not so good. The idea of while we are still in 
this process of creating, mandating harmonization, driving 
harmonization would be a good thing.
    Mr. Budd. Mr. Deas or anyone else?
    Mr. O'Malia. If I may, the significant implication of just 
filing and complying with the swap data or the swap dealer 
rules themselves is massive. It is thousands of pages, a lot of 
compliance back and forth working with the staff and the 
agencies to develop the right compliance regimes.
    In fact, I don't think the CFTC has officially and 
finalized the swap dealer checklist yet for anybody to be in an 
official--they are on their temporary registration. It is a 
massive challenge today and to double that with different rules 
with the SEC, different rules from the CFTC, different guidance 
you may receive from the staff will just make that operation 
that much more difficult.
    I think a safe harbor when you complied eventually with the 
SEC or the CFTC rules, either one, then you have met that 
mandate. Then, you think about some of the capital requirements 
and other requirements that will pass on as a result of that. 
From a practical standpoint, it is an operational challenge of 
enormous consequence.
    Mr. Budd. Thank you. Mr. Green?
    Mr. Green. Just a couple of thoughts. One is, these are 
very different markets. Credit default swaps look to bonds, 
foreign exchange look to currencies, commodities, very 
different from interest rates, et cetera, and total return 
swaps are in the equities market. There are legitimate 
differences that can and should emerge based on these different 
markets. Everybody wants as much similarity as possible. I do 
think we are seeing that. But one of, the U.S. person 
definition, frankly, the SEC has taken a weaker approach, in 
part due to massive lobbying to try to dial back jurisdiction 
toward being only the U.S., whereas the CFTC took an approach 
as mandated in Dodd-Frank that said if the risk is going to 
come back to the U.S., we are going to capture that. So I think 
there are tensions and things going on that we need to think 
about.
    Mr. Budd. Thank you, Mr. Green. I want to go ahead and jump 
to the second question while we have some time. Besides this 
proposal which I support, are there any other approaches to 
this body we should consider, such as a regulatory safe harbor?
    Mr. Bentsen. Yes, a safe harbor would be a good idea. And I 
think the other thing to keep in mind is where we are today 
versus where we were a year ago, or certainly 8 years ago, a 
lot has already been done. I would caution mandating starting 
all over again. Let us start with the framework that we are in, 
and let us figure out how we can make it work, and a safe 
harbor is a good example of that.
    Mr. O'Malia. I think to Mr. Green's point, if you do 
believe that the SEC should have different rules, a safe harbor 
works nicely. Because then it respects the SEC's differences to 
whatever extent there are, and then you can say, if you have 
complied with one, you have complied with the other. A safe 
harbor also protects this committee's jurisdiction. And when 
you think about, as Mr. Green pointed out, the difficulty 
around products, the difficulty around jurisdictions, there is 
no way to neatly divide this up, and to protect everybody's 
current jurisdiction, as Mr. Scott pointed out, it is important 
that agriculture have its oversight. This is the easiest way in 
our opinion to make sure that everybody still controls their 
piece of the pie.
    Mr. Budd. Thank you for that, and I want to go ahead and 
yield back since I am out of time.
    Chairman Huizenga. The gentleman's time has expired. And 
with that, we welcome our guest, the gentleman from Oklahoma, 
Mr. Lucas for 5 minutes.
    Mr. Lucas. Thank you, Mr. Chairman, and I appreciate the 
opportunity to join this subcommittee today. Not necessarily 
being a member of the subcommittee, but a member of the full 
committee, and as was noted by my colleague off the Ag 
committee and fellow member here, Mr. Scott, an old Ag 
committee chairman, and ranking member at the time Dodd-Frank 
was put together, I am very sensitive about this issue, and in 
fact it is a topic that matters to my farmers, my ranchers, all 
my end-users in the district who use these derivative products 
to hedge their positions in the market.
    And I would note, as has been discussed by a variety of 
members, I am also particularly pleased to note the two 
proposals under consideration today, and very happy to be one 
of the original co-sponsors of Mr. Luetkemeyer's bill 4659 to 
support the initial, offsetting the initial margin for SLR 
calculations, and the second of this proposal regarding margin 
requirements for inter-affiliated transactions which mirrors my 
amendments to the CFTC reauthorization bill that was passed out 
of the full House last year.
    But first, turning to Mr. O'Malia and the SLR issue, this 
issue is not immediately obvious to people that don't interact 
a lot with derivatives markets. But could you briefly explain 
the rules that ensure that posted customer margin cannot be 
used to fund a bank's own operation? Let us get to the core of 
the issue here.
    Mr. O'Malia. Yes, that is an important point, because that 
just shows that the IM or the initial margin is reserved and 
protected, not on the bank's balance sheet. It is with a 
clearinghouse, for example, or it could be possibly with a U.S. 
Federal Reserve account where they have put the cash as well. 
These are in very safe and secure spots and are truly reserved 
for risk reduction, they are also the property of the customer.
    Mr. Lucas. One more time, let us make it very clear. So 
there is no real threat that money can be misappropriated by a 
bank when it is placed in one of these accounts.
    Mr. O'Malia. Correct. In the secured third-party accounts, 
there is--
    Mr. Lucas. Because that is one of the concerns of my 
colleagues is that this money that is in secured third-party 
accounts might be manipulated by the banking institution. But 
that is not going to happen. Let us assume this bill were to be 
passed into law and CFTC Chairman Giancarlo has estimated that 
enacting this simple change would reduce leverage exposure by a 
mere 0.22 percent nationwide. That is about a quarter of a 
percentage point nationwide. Do you have any sense as to how 
much clearing activity would be increased by such a bill?
    Mr. O'Malia. We do not, sir, offhand.
    Mr. Lucas. But it is a fair statement to say there would 
indeed be an increase.
    Mr. O'Malia. It certainly reduces the cost of not paying 
two insurance protection items. One, IM, which is significant, 
and then the other is any charge you have had to pay for 
dealing with a bank that it will charge you an SLR.
    Mr. Lucas. With, as Mr. Giancarlo noted, an increase of 22 
hundredths of a percentage point nationwide in exposure. That 
is a pretty cost-effective balance out, I would think.
    Mr. Bentsen, turning to the inter-affiliate margin 
requirements, could you give us some reasons why affiliates 
might want to enter into these transactions? We are a body 
where you need to reinforce the important points.
    Mr. Bentsen. Banks will enter into inter-affiliate 
transactions when they have got an outbound transaction and 
then they will do swaps to better manage and mitigate their 
risks as an organization. And so they are not taking on more 
risk, they have already collected margin where they need to. It 
is really in effect collecting margin again. And that ends up 
trapping, and to your point that you were just making with 
respect to central clearing and the SLR, that ends up trapping 
assets which are not actually available to the bank in that 
instance as well. In fact, the prudential regulators, who are 
different from the CFTC, different from Japan and Europe and 
other Basel entities, the prudential regulators do not count 
this margin in the bank's resolution plans. It is not viewed as 
available for single point of entry in the resolution plans.
    In effect, it is not really adding value from a safety and 
soundness or a systemic aspect, but it is trapping capital that 
could be allocated elsewhere.
    Mr. Lucas. Which is a cost to the economy as a whole when 
you put that weight out there.
    Mr. Chairman, in a final observation, I would simply note 
to my colleagues, a handful of us only anymore it seems like 
were here for the Dodd-Frank process and all the things we went 
through in that bill. I would note to my colleagues that the 
document that dealt with derivatives that came out of the Ag 
committee was done in a very bipartisan way, 8, 9 years ago. 
And the work that was done in this committee was done in a 
relatively bipartisan way. It is when we got to conference that 
the bill that came out of there was not a bipartisan document. 
I always note to my friend, when the primary authors of 
legislation retire shortly after it is signed into law, that is 
an indication. Yield back, Mr. Chairman.
    Chairman Huizenga. That is an interesting observation. With 
that, we would like to welcome our other guest, Chairman of 
Financial Institutions, Mr. Luetkemeyer for 5 minutes.
    Mr. Luetkemeyer. Thank you, Chairman Huizenga, I appreciate 
the opportunity to be in your committee this afternoon and 
listen to some of the testimony and the questions. As I have 
been listening here, they have been discussing H.R. 4659, and 
have thoroughly discussed it in my mind, a lot of the ins and 
outs, and I don't know that I have got a whole lot of questions 
left here. But let me just thank Congressman Scott for his hard 
work on the bill, I know Congressman Lucas who just asked some 
questions did a very good job of framing some of the concerns 
that we had, that we tried to address with supplemental ratio, 
leverage ratios here.
    Let me just ask a couple of quick questions here with 
regards to, I am a firm believer that banks need to hold 
adequate capital to protect themselves and their customers and 
the financial system. That is one thing that both Republicans 
and Democrats agreed upon coming out of the financial crisis as 
Chairman Lucas just indicated. With respect to supplemental 
leverage ratio, do you believe the current treatment of client 
margin is appropriate?
    Mr. O'Malia?
    Mr. O'Malia. We do.
    Mr. Luetkemeyer. Very good. Do you want to elaborate more 
than just yes?
    Mr. O'Malia. Yes. This has gone back years and years that 
so many things around client protection of margin and, goes 
back all the way to the early futures markets, and we built 
those solutions on those, and those have been robust, they have 
not changed, they are protective. They are resilient, we have 
found with different FCM failures that there is a way to 
protect the client margin here. And it is very important as we 
think about what we are going to do with raising the standards 
around CCPs (central counterparty clearinghouses) going 
forward, because the resolution and recovery tools around CCPs 
we think can be increased, you have better protection around 
protecting IM and customer margin that has been given to a CCP. 
We want to make sure that the waterfall events do protect that 
customer money going forward. It is the foundation of this very 
safe system.
    Mr. Luetkemeyer. Perfect. With respect to the impact of 
H.R. 4659, the CFTC has calculated that an offset for initial 
client margin will result in a less than 1 percent decrease in 
overall capital reserves. Do you agree with the financial--do 
you agree that the financial system could withstand a capital 
reduction to less than a penny on a dollar in exchange for both 
significantly reduced costs on agricultural producers and 
encouraging more clearing in the derivatives market?
    Mr. O'Malia. We do, we do believe that it could withstand 
that and the system will be safe.
    Mr. Luetkemeyer. Anybody else?
    Mr. Green. The supplementary leverage ratio is based on the 
idea that we want a risk-neutral way of evaluating the capital, 
the equity that is in the system. And the more you start 
adjusting things based on the, how people view the riskiness or 
the usability, et cetera, of a particular asset, the less value 
it is overall of being risk-blind. And it is important I think 
to remember that this is, the supplementary leverage ratio is 
calculating, tending to calculate a broader overall exposure. 
The margin, or even the capital against the swap is only a 
portion of the overall risk that could come back to the firm. 
The firm stands in with a full guarantee to the counterparty. 
And so the SLR attempts to calculate that. And as folks like 
Sheila Bair and other respected regulators, Tom Hoenig at the 
FDIC have noted that it is the simplicity of the leverage ratio 
that gives us its value. We ought to try to retain that as much 
as possible.
    Mr. Luetkemeyer. Mr. Bentsen, are you going to come in on 
that?
    Mr. Bentsen. Sure. First of all, again, it contravenes 
official policy going back to the Obama Administration to drive 
more of the swap business to central clearing. And not just 
Chairman Giancarlo but Chairman Massad had come out and said 
that this should be changed. The second thing is, the SLR which 
is gold-plated in the U.S., we have had a leverage ratio In the 
U.S. since the Great Depression. We took it from 3 percent to 5 
percent and 6 percent. And it has become the binding constraint 
on top of what is an extremely robust capital regime that has 
been put in place since the financial crisis, which can exceed 
to high double digits for many firms. The idea of making this 
one change that is counter-intuitive to what the policy is to 
drive, really, the benefits or the cost in this instance far 
outweigh the benefits as to what policy has been.
    Mr. Luetkemeyer. You have a comment you are going to make, 
sir?
    Mr. Deas. Sir, just speaking as a corporate treasurer, I 
can tell you that if ultimately the initial margin and capital 
through CBA and other requirements are intended to offset risk, 
and yet if initial margin is not calculated in the 
determination of risk for capital purposes, it seems to be out 
of sync with the economic realities, and ultimately, that will 
get us off-track.
    Mr. Luetkemeyer. Appreciate your comments, I see I am out 
of time. I yield back. Thank you, Mr. Chairman, for your 
diligence today.
    Chairman Huizenga. No problem, gentleman's time has 
expired. With that, Mr. Hollingsworth from Indiana is 
recognized for 5 minutes.
    Mr. Hollingsworth. If nobody has told you yet, Happy 
Valentine's Day. I actually live in the very southern part of 
my district in Indiana, and I live just literally two or three 
miles from the Kentucky border. And sometimes, I run into 
businesses based in Indiana that say, I have a location in 
Kentucky and a location in Indiana. And I am literally required 
to do something in Indiana and I am barred from doing that same 
thing in Kentucky. And they are trying to work across those two 
jurisdictions. Now, that is a really small problem for a lot of 
small businesses, but it could be a really big problem, and I 
think it was addressed in the Treasury report, for large 
multinationals trying to comply with U.S. rules, but might find 
themselves in a situation where non-U.S. jurisdictions bar them 
from certain activities.
    So this is coming to Mr. Bentsen and Mr. O'Malia. I wanted 
to really address this. I think both of you alluded to this in 
your testimony earlier, but I want to draw your attention to 
pages 133 and 135 of the Treasury report, quote, ``market 
participants have raised concerns with aspects of the SEC's 
cross border rules and have highlighted those that conflict 
with privacy, blocking and secrecy laws in non-U.S. 
jurisdictions.''
    A company is here, trying to comply with rules here but 
maybe see cross currents of rules elsewhere preventing them 
from full compliance here. And I think this has a long history 
of us trying to work these things out; task force getting 
together, signing MOUs, forbearance, et cetera.
    I guess I really wanted to get at what do you think that 
those trying to comply with U.S. derivatives rules, what 
suggestions of how U.S. regulators including the SEC and the 
CFTC should work to help ensure there is harmony between these 
two or ensure there are opportunities for cross national 
companies to be able to operate in both jurisdictions, meet the 
rules of both jurisdictions?
    Are there any suggestions you have for the SEC or CFTC on 
how we could best work through that process as quickly as 
possible to ensure that these companies that want to do the 
right thing can quickly do the right thing for both the 
jurisdictions they operate in?
    Mr. Bentsen. I guess I will start. I think this is an issue 
that it is hard to believe why this can't be worked out. And I 
think if you read the other parts of the Treasury report 
particularly the first Treasury report, it makes a very 
important point that is indicative of the U.S. financial 
markets because we have a very open market system here where we 
have both U.S. and non-U.S. domiciled firms that invest in our 
markets and provide capital credit and liquidity to our markets 
to the betterment of the country as a whole.
    And one of things it points out is that non-U.S. domiciled 
financial institutions provide a tremendous amount of credit 
and capital to the U.S. markets including to areas like Indiana 
in the agricultural space and elsewhere. That is important and 
we should value that.
    The problem is where we have rules that conflict and we 
have this inbound also from other jurisdictions sometimes in 
the U.S., rules that conflict with a domestic rule that could 
preclude an entity from actually providing the services in the 
U.S. and that would create a cost to the system here.
    To us it seems in the case where a European-based swap 
dealer cannot comply with the rule as defined by the SEC and, 
therefore, can't be a registered swap dealer does not seem to--
there has got to be a way to work through that.
    Mr. Hollingsworth. It doesn't benefit us, right?
    Mr. Bentsen. It doesn't benefit us.
    Mr. Hollingsworth. For those that might say, we want to 
keep foreign firms out, that is not true of the financial 
services industry, it is not true generally. Everybody 
participates.
    Mr. Bentsen. It would be a disadvantage to the U.S.
    Mr. Hollingsworth. That's exactly right. Well said.
    Mr. O'Malia. There a number of examples and I know each of 
the chairmen of the respective agencies have worked very hard 
to build the international bridges I would have to say that the 
relationship among this Administration and internationally has 
been quite strong. Time has passed since some of the earlier 
rules, the exporting of U.S. regulation has dissipated a little 
bit and the conversation has probably moved on.
    But there are always going to be these little issues where 
there is a misunderstanding or you just simply can't deliver 
the rules. There are plenty of data rules globally that privacy 
functions prevent entities from reporting. Asia in particular 
has a number of these things.
    To Ken's point, you certainly don't want to put the U.S. at 
a disadvantage in terms of attracting capital or business.
    Mr. Hollingsworth. Yes. I am a big believer that frankly 
the more participants we have, more varied participants that we 
have, the better and stronger, more resilient the ecosystem is 
overall. That resiliency is a more emergent quality than a 
dictated quality.
    We need to welcome foreign firms operating here. Rising 
tide lifts all boats but we have to figure out a way to get 
through some of these gaps and make sure that across 
jurisdictions they can comply with both sides at the same time 
to better empower them which ultimately empower Americans 
better and that is what I am really excited about.
    And with that, Mr. Chairman, I yield back.
    Chairman Huizenga. The gentleman yields back.
    I would like to thank our witnesses for their testimony 
today. I think this was very illuminating and helpful as we are 
having this. Without objection, I would like to submit the 
following statements for the record. First, the statement from 
Richard Baker, President and CEO of Managed Funds Association 
and without objection and a letter of support from FIA, 
Commodity Markets Council, CME Group and the Intercontinental 
Exchange and without objection.
    The Chair notes that some Members may have additional 
questions for this panel, which they may wish to submit in 
writing. Without objection, the hearing record will remain open 
for 5 legislative days for Members to submit written questions 
to these witnesses and to place their responses in the record. 
Also, without objection, Members will have 5 legislative days 
to submit extraneous materials to the Chair for inclusion in 
the record.
    Once again, I appreciate your time and expertise in this 
very complicated space and we look forward to continuing this 
conversation. With that, this hearing is adjourned.
    [Whereupon, at 4:03 p.m., the subcommittee was adjourned.]

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                           February 14, 2018







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