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20–612 PDF 2005

S. HRG. 109–089

TO CONSIDER THE REAUTHORIZATION OF THE

COMMODITY FUTURES TRADING COMMISSION

HEARING

BEFORE THE

COMMITTEE ON AGRICULTURE, 

NUTRITION, AND FORESTRY

UNITED STATES SENATE

ONE HUNDRED NINTH CONGRESS

FIRST SESSION

MARCH 8 & 10, 2005

Printed for the use of the 

Committee on Agriculture, Nutrition, and Forestry

(

Available via the World Wide Web: http://www.agriculture.senate.gov 

COMMITTEE ON AGRICULTURE, NUTRITION, AND FORESTRY

SAXBY CHAMBLISS, Georgia, Chairman 

RICHARD G. LUGAR, Indiana 

THAD COCHRAN, Mississippi 

MITCH MCCONNELL, Kentucky 

PAT ROBERTS, Kansas 

JAMES M. TALENT, Missouri 

CRAIG THOMAS, Wyoming 

RICK SANTORUM, Pennsylvania 

NORM COLEMAN, Minnesota 

MICHEAL D. CRAPO, Idaho 

CHARLES E. GRASSLEY, Iowa 

TOM HARKIN, Iowa 

PATRICK J. LEAHY, Vermont 

KENT CONRAD, North Dakota 

MAX BAUCUS, Montana 

BLANCHE L. LINCOLN, Arkansas 

DEBBIE A. STABENOW, Michigan 

E. BENJAMIN NELSON, Nebraska 

MARK DAYTON, Minnesota 

KEN SALAZAR, Colorado

MARTHA SCOTT POINDEXTER, Majority Staff Director 

DAVID L. JOHNSON, Majority Chief Counsel 

STEVEN MEEKS, Majority Legislative Director 

ROBERT E. STURM, Chief Clerk 

MARK HALVERSON, Minority Staff Director 

(II) 

(III)

C O N T E N T S 

Page

HEARING(S):

To Consider the Reauthorization of the Commodity Futures Trading

Commission ........................................................................................................... 01

Tuesday, March 8, 2005

STATEMENTS PRESENTED BY SENATORS 

Chambliss, Hon. Saxby, a U.S. Senator from Georgia, Chairman, Committee 

on Agriculture, Nutrition, and Forestry ............................................................. 01

Harkin, Hon. Tom, a U.S. Senator from Iowa, Ranking Member, Committee 

on Agriculture, Nutrition, and Forestry ............................................................. 11

Conrad, Hon. Kent, a U.S. Senator from North Dakota ...................................... 17

Leahy, Hon. Patrick, a U.S. Senator from Vermont ............................................. 20

Lugar, Hon. Richard G., a U.S. Senator from Indiana ......................................... 07

Salazar, Hon. Ken, a U.S. Senator from Colorado ................................................ 17

WITNESSES 

Brown-Hruska, Sharon, Chairman, Commodity Futures Trading Commission, 

Washington, DC ................................................................................................... 02

Panel I 

Carey, Charles P., Chairman, Chicago Board of Trade, Chicago, Illinois ........... 22

Damgard, John M., President, Futures Industry Association, Washington, 

DC .......................................................................................................................... 31

Duffy, Terrence A., Chairman, Chicago Mercantile Exchange, Chicago,

Illinois ................................................................................................................... 24

Nandapurkar, Satish, Chief Executive Officer, Eurex US, Chicago, Illinois ...... 29

Newsome, James, President, New York Mercantile Exchange, Inc., New York, 

New York .............................................................................................................. 26

Schoenhut, Frederick W., Chairman, New York Board of Trade, New York, 

New York .............................................................................................................. 28

APPENDIX 

PREPARED STATEMENTS: 

Harkin, Hon. Tom ............................................................................................ 42

Brown-Hruska, Sharon .................................................................................... 46

Carey, Charles P. .............................................................................................. 51

Damgard, John M. ............................................................................................ 93

Duffy, Terrence ................................................................................................. 60

Leahy, Hon. Patrick ......................................................................................... 44

Newsome, James .............................................................................................. 69

Shoenhut, Frederick W. ................................................................................... 82

Nandapurkar, Satish ........................................................................................ 88

DOCUMENT(S) SUBMITTED FOR THE RECORD: 

A Review of Recent Hedge Fund Participation in NYMEX Natural Gas 

and Crude Oil Futures Markets, submitted by James Newsome ............. 106

Page

IV

DOCUMENT(S) SUBMITTED FOR THE RECORD—Continued

The Governance of Self Regulatory Organizations 69 Fed. Reg. 32326 

(June 9, 2004), submitted by John Damgard ............................................. 119

QUESTIONS AND ANSWERS SUBMITTED FOR THE RECORD: 

Chambliss, Hon. Saxby .................................................................................... 139

Harkin, Hon. Tom ............................................................................................ 148 

Santorum, Hon. Rick (answers not provided: questions to Mr. Terence 

Duffy) ............................................................................................................. 158

Thursday, March 10, 2005

STATEMENTS PRESENTED BY SENATORS 

Chambliss, Hon. Saxby, a U.S. Senator from Georgia, Chairman, Committee 

on Agriculture, Nutrition, and Forestry ............................................................. 163

Salazar, Hon. Ken, a U.S. Senator from Colorado ................................................ 173

WITNESSES 

Panel I 

Ireland, Oliver I., Partner, Morrison & Foerster, LLP, Washington, DC, on 

behalf of Huntsman Corporation and Industrial Energy Consumers of 

America ................................................................................................................. 167

Pickel, Robert G., Executive Director and Chief Executive Officer,

International Swaps and Derivatives Association, Inc., New York, NY .......... 165

Sprecher, Jeffrey C., Chairman and Chief Executive Officer, 

InterContinentalExchange, Atlanta, GA ............................................................ 164

Panel II 

Gaine, John G., President and Chief Executive Officer, National Futures 

Association, Chicago, IL ...................................................................................... 178

Green, Micah S., President, The Bond Market Association, Washington, DC ... 180

Roth, Daniel J., President and Chief Executive Officer, National Futures 

Association, Chicago, IL ...................................................................................... 176

APPENDIX 

PREPARED STATEMENTS: 

Gaine, John G. .................................................................................................. 224

Green, Micah S. ................................................................................................ 231

Ireland, Oliver I. ............................................................................................... 213

Pickel, Robert G. ............................................................................................... 199

Roth, Daniel J. .................................................................................................. 218

Sprecher, Jeffrey ............................................................................................... 188

DOCUMENT(S) SUBMITTED FOR THE RECORD: 

Cochran, Hon. Thad ......................................................................................... 238

Martin Doyle, President, OneChicago, LLC ................................................... 245

National Grain and Feed Association ............................................................. 254

The National Grain Trade Council on Reauthorization of the Commodity 

Futures Trading Commission ...................................................................... 240

(1)

TO CONSIDER THE REAUTHORIZATION OF 

THE COMMODITY FUTURES TRADING 

COMMISSION 

TUESDAY, MARCH 8, 2005, 

U.S. SENATE,, 

COMMITTEE ON AGRICULTURE, NUTRITION, AND FORESTRY,, 

Washington, DC 

The Committee met, pursuant to notice, at 10:02 a.m., in room 

SD–106, Dirksen Senate Office Building, Hon. Saxby Chambliss, 

[Chairman of the Committee], presiding. 

Present or submitting a statement: Senators Chambliss, Lugar, 

Harkin, Leahy, Conrad, and Salazar. 

STATEMENT OF HON. SAXBY CHAMBLISS, A U.S. SENATOR 

FROM GEORGIA, CHAIRMAN, COMMITTEE ON AGRICULTURE, 

NUTRITION, AND FORESTRY 

The CHAIRMAN. The committee will come to order. Good morning. 

The authorization of the Commodity Futures Trading Commission, the Federal agency responsible for overseeing the trading of 

commodity futures contracts, will expire on September 30, 2005. 

Commodity futures contracts are traded on agricultural, energy, 

and metal commodities and increasingly on financial instruments, 

such as instrument rates and foreign currencies. Reauthorizing the 

CFTC is an important task before the committee this year. 

The Commodity Exchange Act is the basic law that empowers 

CFTC to oversee commodity futures markets. In 2000, as part of 

the last CFTC reauthorization, the Congress made what most experts agree were landmark reforms in the Commodity Exchange 

Act by passing the Commodities Futures Modernization Act. The 

CFMA provided legal certainty for the over-the-counter swaps market and also streamlined the regulatory process for exchange traded futures markets. The CFMA shifted the CFTC away from a prescriptive, rules-based regulatory approach to a more flexible market-oriented approach based on broad core principles. 

Since the passage of the CFMA, the industry has seen tremendous growth in trading volume on both the exchange traded futures 

markets and over-the-counter derivatives markets. This year, as 

part of the reauthorization process, the committee will review the 

Commodity Exchange Act, as amended by CFMA, to determine 

whether additional changes in the law are needed to help CFTC 

continue to foster open, competitive, and financially sound commodity futures markets and to protect the market users and the 

public from fraud and manipulation. 

2

Most of the folks I have met with are generally pleased with the 

Commodity Exchange Act, as amended by the CFMA Act of 2000 

and are not seeking many, if any, changes in the legislation this 

year. We will take in thoughts and suggestions on this important 

question from a wide array of witnesses over the course of two 

hearings the committee is holding on CFTC reauthorization this 

week. 

Today, I am pleased to welcome Commodity Futures Trading 

Commission Acting Chairman Sharon Brown-Hruska and a group 

of outstanding people from the private sector representing U.S. futures exchanges and the futures industry. I look forward to hearing 

your testimony. 

Senator Harkin has let us know that he will be here. He is running behind, and we have a number of other Senators who have 

indicated their intention to attend. They will likely arrive as we 

proceed through the course of this hearing. 

Madam Chairman, it is again a pleasure to have you with us this 

morning. We look forward to your comments and we will take those 

comments at this time. Thank you. 

STATEMENT OF SHARON BROWN-HRUSKA, ACTING

CHAIRMAN, COMMODITY FUTURES TRADING COMMISSION, 

WASHINGTON, DC 

Ms. BROWN-HRUSKA. Thank you, Chairman Chambliss. Good 

morning. I am pleased to be here to appear on behalf of the Commodity Futures Trading Commission to discuss the important 

issues surrounding the reauthorization of the Commission. 

Before I begin my testimony, I would like to recognize and introduce my fellow colleagues on the Commission who join me here 

today. First is Commissioner Walt Lukken, who is certainly no 

stranger to many of you on the Hill because of his years of experience working for Senator Lugar and the Agriculture Committee. I 

would also like to introduce the two newest members of the Commission, Commissioner Fred Hatfield and Commissioner Mike 

Dunn, both of whom I had the honor of swearing in this past December. I look forward to continuing to work with them and drawing on their considerable insights and experiences. I have solicited 

input from all the Commissioners in preparing this testimony. 

Finally, I would like to recognize and commend the staff of the 

CFTC. Many of them are behind me. Without their energy and 

dedication, much of the innovation that the Commodity Futures 

Modernization Act of 2000 enabled would not have been possible. 

Well, it has been just over 4 years since Congress passed the 

CFMA. While this may seem like a short time, the amount of 

change that has occurred in the futures and derivatives industry 

over that period has been extraordinary, and much of that change 

has been facilitated by the flexibility and innovative foresight of 

that legislation and Congress for passing that legislation. 

Overall, the Act, as amended by the CFMA, functions exceptionally well. The CFMA has provided flexibility to the derivatives industry and legal certainty to much of the over-the-counter derivatives market. This flexibility has allowed the industry to innovate 

with respect to the design of contracts, the formation of trading 

platforms, and the clearing of both on-exchange and off-exchange 

3

products. The industry is no longer over-burdened with prescriptive 

legal requirements and it is able to operate using its best business 

judgment rather than that of its regulator. At the same time, economic and financial integrity have been safeguarded and the Commission has been able to maintain its ability to take action against 

fraud and abuse in the markets it oversees. 

When Congress adopted the CFMA, it put in place a practical 

principles-based model and gave the CFTC the tools to regulate 

markets that were challenged by competition, brought about by 

technology and an increasingly global marketplace. Since that time 

when the CFMA was passed, the futures industry, as you noted, 

has experienced phenomenal growth and innovation. The markets 

have also become more global. There is more access than ever for 

U.S. customers wanting to trade on foreign exchanges, as well as 

for foreign customers wanting to trade on U.S. markets. 

One of the benefits that has come from all this innovation and 

globalization has been increased competition and a lowering of 

trading costs and an increase in the market quality overall. In addition, new products and new amendment certification procedures 

in the CFMA have also lowered regulatory barriers and fostered innovation by providing exchanges greater flexibility in listing contracting and in providing them with an ability to react to developments in the cash markets and the competitive markets in which 

they operate. 

We at the Commission are committed to ensuring that our regulatory policies are similarly responsive and that the implementation of the CFMA fulfills the intent of Congress. Competition and 

innovation must be realized in such a way that customer protection 

is not compromised and that the financial and economic integrity 

of our markets is preserved. In that regard, there remains more 

that we can do as a regulatory agency to move the ball forward 

even within the current statutory model. 

As we begin the reauthorization process, any change should come 

with careful consideration of potential outcomes as well as unintended consequences that may present themselves. With that in 

mind, let me highlight three areas of concern on which Congress 

may wish to focus as it deliberates during the reauthorization process. 

First, Congress may wish to evaluate whether clarifications are 

necessary to the legal framework provided for exempt markets. 

Second, Congress may wish to suggest ways that we can more effectively avoid duplicative burdens on the markets and, going forward, provide us with guidance and support as we seek to work 

with other agencies and with other jurisdictions. 

Finally, we at the Commission are cognizant of Congress’s firm 

commitment to ensuring that customers are protected from fraud 

and manipulation, and to that end, Congress may wish to review 

whether the CFTC has clear and adequate authority to police retail 

fraud, particularly in the foreign exchange markets. 

In the wake of the Enron collapse and in response to recent runups in prices of natural gas and crude oil, there have been calls to 

increase the CFTC’s regulatory authority in the energy sector. 

Some have called for retrenchment and a return to the prescriptive 

forms of regulation, like adoptions of federally determined price 

4

limits and position limits. Others have called for more sweeping 

legislative changes that would give the Commission greater reach 

into the proprietary and bilateral markets. 

As you consider the appropriateness of such proposals, I would 

ask that you keep in mind that the CFTC has responded decisively 

to prosecute wrongdoing in the energy markets. The Commission 

has acted resolutely in the energy markets, demonstrating that its 

authority is significant and that it intends to use it. The CFTC successfully pursued a complaint against Enron for manipulation of 

the natural gas markets. In addition, the Commission has filed and 

continues to pursue various actions and investigations in the energy sector against both companies and individuals. 

In addition, the CFTC has recently promulgated regulations 

clarifying and detailing its authority regarding exempt markets, including certain energy transactions, to better ensure that these 

markets remain free from fraud and manipulation. 

We are aware that last year’s energy bill contained several provisions that would directly affect the CFTC’s oversight responsibilities and we believe that it is appropriate and timely for our authorizing committee in Congress to consider and weigh in on those 

proposed changes. 

In the security future products area, as you know, the CFMA 

was noteworthy, in part because of Congress’s decision to permit 

the trading of futures on single securities under the joint jurisdiction of the CFTC and the SEC. However, more than 4 years after 

the CFMA’s passage, the growth of single-stock futures trading 

continues to be modest, at best. In December, the NQLX exchange, 

one of the two exchanges that had been offering single-stock futures, suspended trading. 

Now, it has been a source of some concern that this sector has 

not been more successful, and despite the best efforts of the Commission, the CFTC, and the SEC, has not really fully achieved the 

goals of the CFMA. In many areas, however, I am pleased to say 

that the two agencies continue to work together to establish regulatory approaches that avoid duplicative regulation and registration. 

The CFMA also clarified that the CFTC has jurisdiction over retail foreign currency futures and options contracts, whether transacted on-exchange or over-the-counter, as long as they are not otherwise regulated by another agency. However, as demonstrated in 

the recent adverse Zelener decision, a case litigated by the Commission, the CFTC continues to face challenges to its jurisdiction based 

on how retail forex transactions are characterized. 

We at the Commission have been and remain committed to protecting retail customers against the kind of egregious fraud we see 

in the forex area. Our track record in the forex area is favorable. 

Of the 70 cases that we filed thus far, the Commission has lost 

only three. 

As noted, it has only been just 4 years since Congress enacted 

and the Commission began implementing the CFMA. Given the 

progress made and the lessons learned, Congress may determine 

that it is premature to open the Act to significant changes. The 

Commission has been able to effectively work within the current 

structure of the Act to police markets, to ensure the integrity of the 

5

price discovery mechanism, and to maintain the financial integrity 

of the markets and to protect customers. 

The Commission stands ready to offer its assistance as Congress 

moves through the reauthorization process and considers the range 

of potential options. 

In conclusion, let me say that my fellow Commissioners and I 

welcome this opportunity to work with you on the reauthorization 

of the CFTC. I greatly appreciate the opportunity to testify before 

you today on this important matter, and I would be pleased to answer any questions that the Commission may have. Thank you, sir. 

The CHAIRMAN. Thank you very much, Madam Chairman. 

[The prepared statement of Ms. Brown-Hruska can be found in 

the appendix on page 46.] 

The CHAIRMAN. You detailed several areas of concern that exist 

between the jurisdiction of CFTC and the SEC. How big is this 

problem and is it appropriate to try to legislatively resolve these 

areas of concern? Do you have an ongoing dialog with the SEC to 

such an extent that you think that is the best way to resolve these 

concerns? 

Ms. BROWN-HRUSKA. Thank you for that question, sir. Actually, 

in many respects, we have attempted to work within the CFMA to 

resolve a number of outstanding issues. The SEC and the CFTC 

fundamentally disagree on some sections of the Act in terms of 

what is required of us. For example, on foreign security indices and 

allowing them to be offered to U.S. customers, and what constitutes 

a narrow-based versus a broad index, the SEC has basically come 

to a position that they want a very high level of scrutiny. They 

have to be a certain liquidity and a certain size, and ultimately, 

what that means is there are a number of market participants who 

are unwilling under those conditions to offer those foreign security 

indices. 

On other areas, we have, in many cases, been limited. In many 

cases, the SEC and the CFTC have done the best they can to come 

to agreement on some difficult issues. Some of it is fundamental 

differences between the way futures markets and security markets 

are regulated and are in many ways the systems that we use to 

ensure performance and operational efficiency in the market. 

One of those areas is in margins. We looked at the CFMA. If you 

look at certain sections where SFPs are discussed, it says that margins in security futures have to be consistent with those in the security options market. Certainly, that is fine. I understand that 

that would help to avoid any kind of regulatory arbitrage. In another section of the SEA, it says that margins are supposed to be 

no lower than the lowest level for security options. 

Well, security options, if you sell an option, there is nothing but 

downside risk on that position. The margin level is set at a fixed 

rate—it is a floor. If you look at a position in a security futures 

product, it has both down-side and up-side risk. From a risk perspective, you look at the risk that that position poses to the marketplace, it is much lower than, say, an option—the option position 

that I described, the short option. 

Our problem is that in the futures area, we usually use risk as 

a basis for determining what margins are. It has been very successful and we have had very few problems in the area of futures beVerDate 0ct 09 2002 11:31 Aug 12, 2005 Jkt 020612 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 C:\DOCS\20612.TXT TOSHD PsN: TOSH
6

cause, in general, the margin levels are set to ensure contract performance and that the individuals who make these contracts will, 

in fat, follow through. The financial integrity has been protected 

and we have had a lot of success. 

In the securities market, they have yet to come around to the 

risk-based margining system. They have yet to adopt and embrace 

portfolio margining as we have in the futures area. 

I guess I gave you a very detailed answer, but I would say that 

there is some language in the CFMA that drove us to not adopt the 

more risk-based approach that I believe is more sophisticated, it is 

a proven methodology for determining margins, and we have a lot 

of confidence in it at the CFTC. There may be some areas within 

the CFMA where we could tweak that language that would provide 

some guidance or some movement on the part of the SEC and the 

CFTC to get to a more sophisticated risk-based margining approach. 

The CHAIRMAN. Have you had any dialog with the SEC about 

any proposed changes of that nature? 

Ms. BROWN-HRUSKA. We haven’t specifically. I have had a very 

good conversation with Chairman Donaldson about security futures 

and about commodity pools that are registered with the CFTC, and 

many of them would also fall under the recent hedge fund registration requirement that the SEC has promulgated. We have talked 

about security futures products and I have talked with him about 

margining and portfolio margining. They have some very competent people over there that they have recently hired that are 

very interested in portfolio margining. 

Fundamentally, Chairman Donaldson is very concerned about 

ensuring that his markets and our markets are free from fraud and 

manipulation, are full of financial integrity, and my gut feeling is 

that he would be very open to a discussion and a dialog going forward to make it possible that we can get the regulatory model for 

SFPs into a better place. 

The CHAIRMAN. You made a very correct statement when you 

said that we want to make sure that there are no unintended consequences that come out of this legislation, particularly any 

changes that might be made to the existing legislation. That is always a concern and is a real problem, unfortunately, with a lot of 

legislation that comes off the Hill. Can you think of any unintended 

consequences that came out of the CFMA that you are having to 

deal with now? 

Ms. BROWN-HRUSKA. That is a very good question. You know, I 

would say I can’t think of any in general. The CFMA has performed extremely well. Usually, when we think of unintended consequences, we think of negative impacts on the market, and I can 

generally think of only positive impacts. The CFMA did enable innovation and it did give the CFTC significant authority to go after 

fraud and manipulation. We have done so. Even when we have 

seen some problems in the marketplace, some bad actors who are 

intent upon breaking the law, that is what they did. They broke 

the law. The law as enumerated in the CFMA, we were able to go 

after those individuals and entities and have had a very successful 

enforcement record in that area. 

7

The CHAIRMAN. I have some other questions, but I want to give 

Senator Lugar an opportunity to proceed, so Senator Lugar. 

STATEMENT OF HON. RICHARD LUGAR, A U.S. SENATOR FROM 

INDIANA 

Senator LUGAR. Thank you very much, Mr. Chairman. I appreciate your testimony. I would just say, as an historical anecdote, 

that when I came on the committee in 1977, Senator Herman Talmadge, who was our chairman, another distinguished Georgian, 

pointed to Senator Leahy of Vermont and to me to shepherd CFTC 

and FIFRA, the Fungicide, Insecticide, Rodenticide Act. These were 

the areas in which no other member of the committee had particular interest, nor did, the Chairman. 

[Laughter.] 

Senator LUGAR. In any event, in these uncertain fledgling hands, 

all this came, and so I appreciate especially your tracing the history and, of course, what I think of as the culmination of this in 

the Act that was passed 4 years ago. Around this table, many 

members of the industry came a year before that just simply to 

philosophize about, in the best of all worlds, what the regulatory 

act and its reauthorization should look like. Members devoted a lot 

of time to it, as did members of the Banking Committee, and there 

was active consideration, as you recall, with the SEC and their interest. 

When the Chairman asked, were there unintended consequences, 

and you pondered and could not think of any, this is reassuring 4 

years down the trail. 

I pay tribute to one of your colleagues, Walt Lukken, who was 

a member of our staff and certainly a vital factor in that legislation 

and I appreciate his presence this morning. 

Let me return to a point that you took up because it has been 

a source of comment in various post-mortems of the Act and that 

is the whole area of energy regulation. Fairly early in the game, 

energy was taken off the table, at least in terms of CFTC jurisdiction, and has, by and large, not remained that way. You pointed 

out that there are powers under the Act now and you have successfully prosecuted a large number of individuals. You have taken a 

look at the Enron company specifically, as you mentioned. 

Energy, obviously, in all of its aspects, is different from corn and 

soybeans or various other things with which you have dealt successfully. I have always continued to be one to raise the issue of 

energy because prior to Enron, it appeared to me, at least from testimony that we were getting, that the potentialities for severe damage to the American economy were there. Perhaps CFTC was not 

responsible and should not be. Others might have taken this up, 

but others didn’t. As you read the 20th book on Enron and all of 

the lack of regulatory responsibility, this is a severe indictment of 

government generally that cost a lot of people their jobs and their 

capital, leaving aside prosecutions that are still underway. 

I hope you will continue. I am not going to make a suggestion 

for amendment of the Act because the complexities technically of 

doing this, I understand, having heard a lot of testimony on it. At 

the same time, I would just simply be remiss not to echo that concern that we have suggested in the past, because I am not certain 

8

that area is quite tied and bolted down in a way that is satisfying. 

By that, I don’t mean in a way that stultifies in any way the energy markets, entrepreneurship, careful of resources, but those considerations are there for every commodity that you are dealing 

with. Energy commodities are likely to be an increasingly competitive and difficult area. 

In my Foreign Relations Committee work, we are hearing testimony, for example—these are not unique situations—of China and 

India seeking almost every last Btu of reserves anywhere in the 

world for dynamic economies that are going to have huge demands, 

with a third of the world’s population heating homes sometimes for 

the first time and driving cars, quite apart from manufacturing. 

These are other alternative energy sources than the ones that you 

might be regulating, but I just sense that this is going to become 

a much more competitive situation, politically more volatile as the 

prices rise. Then there are charges of spiking or that people are 

speculating on political unrest or suppositions. This may be an area 

that is within your purview and maybe not, but I simply, as a 

friend of CFTC, mention that I hope that you will be observant, 

along with the Commissioners, of this particular area. 

Let me just ask as a housekeeping question, is your budget OK? 

Do you have enough money to run the agency? Are you employing 

successfully and finding the people that you need for this increasingly sophisticated work, because the industries involved want to 

have confidence that in your hands, you have the best people and 

that they are adequately taken care of. 

Ms. BROWN-HRUSKA. Thank you so much for your comments, 

Senator Lugar. I also appreciate having Commission Walt Lukken 

now in my camp. He is tremendous good help and a great colleague. 

In response to your question, I would say that on the budgetary 

front, we had some problems retaining and keeping good staff. One 

thing about derivatives, futures, and options markets, it is a complex business and there are lots of different types of markets and 

some of them are based on interest rate products. It is a sophisticated pricing mechanism, and some are based on currencies, and 

then we have pork bellies and the whole gamut. 

It has been the case that we would sometimes train and bring 

along very good, qualified people and they would go and leave and 

go to other agencies. As a way to stem that loss of good people to 

other financial agencies, we implemented pay parity and that is in 

thanks to Congress for providing us with our authority to do that. 

We are able to raise the pay levels to that of the other FIRREA 

agencies. That is, to raise salary levels to the other financial regulators, even though we are still somewhat behind the Fed and 

Treasury and the other agencies. We have caught up enough where 

we have stemmed that loss, of individuals. 

Well, when we implemented that, that cost money, and so we 

have had to really tighten up on our use of resources. We have become extremely efficient to ensure that we maximize our resources. 

That said, Congress has been very supportive. The President’s 

budget has delivered for us some sensible numbers that will enable 

us to operate next year, again in a very tight, efficient way. We appreciate your support and your interest and we thank you for your 

9

continued support as we work to try to get the level that the President has requested, because we feel that that will enable us to perform successfully in the future. 

Senator LUGAR. Just one more question that goes back also historically to a trauma in the financial community, the long-term 

capital management difficulties, as you have mentioned, derivatives. All of us around the Agriculture Committee table got an education in derivatives in a hurry. We had regular appearances by 

Alan Greenspan and other persons who are not usually a part of 

the agricultural community or even the CFTC community trying to 

explain how this could happen and how we tried as a world to unravel it once it did without grievous harm. 

You have confidence that a long-term capital management 

scheme, granted, if it is the first time through, always difficult say, 

well, historically we know what we are doing, but are the controls 

that you have now, the people that cite these situations, you believe adequate to give assurances? I ask this because rumor mongers last year getting worried about hedge fund operations of all 

sorts felt maybe bubbles, as they were terming it, might be happening in various places, nothing of the scale of long-term capital 

management, which we were advised that Nobel Prize winners 

were busy working on mathematical models that were absolutely 

certain to work, until they didn’t. 

I just wonder, what is your confidence level with regard to derivatives, at least on the grand scale of that entire economies? 

Ms. BROWN-HRUSKA. Well, I would say that Long-Term Capital 

Management did speculate in some very illiquid assets globally. 

They were very aggressive. The problem—and much of this doesn’t 

really fall within the CFTC’s purview. Just looking at it—having 

been one of those rocket scientists myself as a professor—I would 

look at this and what was going on, and part of the problem, was 

that the banking institutions were extending a significant amount 

of credit. 

Senator LEAHY. There were several misjudgments here. 

Ms. BROWN-HRUSKA In looking at it, that a lot of the over-leverage that was in Long-Term Capital Management—at least I have 

it on fairly good authority from, as you mentioned, Chairman 

Greenspan and others—that that now is not the case. Banking institutions have greater controls to ensure that the credit quality 

and the credit offered to these types of funds is well within their 

tolerance level and that the risks that are being taken are monitored and that they have controls, risk-management controls. 

From the CFTC’s perspective, we do regulate Commodity Pool 

Operators and Commodity Trading Advisors, and have since 1974. 

They started as basically futures funds that came together to combine investors’ money, and institutions who are usually sophisticated, usually wealthy who take these kinds of risks. These investors and institutions are usually what we call credited investors or 

qualified purchasers that meet high standards set by the Securities 

and Exchange Commission. What we have seen is that those CPOs 

and CTAs have generally performed well. They are subject to the 

NFA, National Futures Association, and the CFTC’s recordkeeping 

requirements, reporting requirements, and they must have internal 

controls in place. 

10

From our perspective, looking at our experience with regulating 

Commodity Pool Operators and Commodity Trading Advisors, 

which are constituted usually as limited partnerships, that would 

fall under the SEC’s definition of a hedge fund—our experience has 

been that the type of oversight that we have has been successful 

and has been able to help uncover wrongdoing and misrepresentations. Our experience has been very good and I would suggest that 

when Dan Roth of the NFA testifies, he will probably also talk 

about that. 

From our perspective, at least that piece of it which are, at least, 

defined as hedge funds by the SEC, we feel we have a good regulatory program and we feel it has been effective. Our only issue 

there is that we would try to avoid duplicating our regulatory program over at the SEC. In general, that they have a similar program in mind for hedge funds and it is something that should be 

considered carefully and we are in discussions. 

Senator LUGAR. I thank you for recognizing the alliances you 

have. NFA, of course, is very important within the industry, but 

likewise, good friends on the Senate Banking Committee working 

with this committee. The SEC and the CFTC are not adversaries. 

When it comes to these global situations, the importance of that 

communication and common work is so important. I thank you very 

much. 

Thank you, Mr. Chairman. 

The CHAIRMAN. Thank you, Senator Lugar. Once again, I have 

always been impressed with the intellect and the public commitment of Senator Lugar, but now that I know that as a young Senator you were given the issue of swaps and derivatives and FIFRA 

to deal with, I am impressed that you ran for reelection——

[Laughter.] 

The CHAIRMAN [continuing]. and stayed on the Agriculture Committee, too, Dick. 

You mentioned the budget issue. I know one thing we talked 

about with your predecessor, Chairman Newsome, who obviously 

happens to be here today, was the issue of pay parity. I understood 

from Jim, and I would just like your comments very quickly on how 

you think that has affected your ability to recruit and retain some 

of the top people, which you obviously need, dealing with the very 

complex issues that you do. 

Ms. BROWN-HRUSKA. Well, thank you very much, Chairman. It 

was critical to stop the bleeding, in many respects, at the CFTC 

and to help us get young, well-trained, or older, well-trained, vibrant individuals to come to work at the CFTC, to come to Washington. It has been very successful in many respects and I am delighted to say that we are very close to a point where we can actually go out and hire some new people, and I suspect that where we 

are right now, we will have a greater pool of talent to draw from. 

That it has worked very well. 

Again, we have to be very efficient in the use of our resources 

to ensure that we can continue to keep up with the pay levels that 

we see in other financial regulatory agencies, but by and large, it 

is working very well. Again, I would thank Congress for their support on this issue and it has been very successful. 

The CHAIRMAN. Thank you. 

11

Senator Harkin. 

STATEMENT OF HON. TOM HARKIN, A U.S. SENATOR FROM 

IOWA, RANKING MEMBER, COMMITTEE ON AGRICULTURE, 

NUTRITION, AND FORESTRY 

Senator HARKIN. Thank you very much, Mr. Chairman. I apologize for being late. I don’t know if you have seen the weather out 

there lately, but it took me an hour and a half to go 12 miles this 

morning. If someone would run for President of the United States 

on a platform of getting rid of traffic jams, you would win handsdown. I don’t care what party they are in. I would vote for them. 

[Laughter.] 

Senator HARKIN. Thank you, Mr. Chairman. 

In the 4 years since the passage of the Commodity Futures Modernization Act, the options and derivatives industry has seen record 

volumes and unprecedented competition, leading to new products 

and lower prices for users of these markets. I want to welcome 

Chairman Sharon Brown-Hruska, Commissioner Walt Lukken, and 

our two newest Commissioners, Mike Dunn and Fred Hatfield. Of 

course, I have to mention that Mike is from Keokuk, Iowa, and has 

had a long record of service in agriculture and, of course, worked 

a long time with Fred Hatfield here on the Hill, both when he was 

here on the Hill and off the Hill, and then with some California agriculture and things like that, so it is good to see you, also, Fred. 

Anyway, I look forward to working with all of you on the reauthorization of the CEA. I want to commend you, Chairman BrownHruska, for the CFTC’s work in implementing and enforcing the 

CFMA. It addressed some of the critical issues that faced the futures and derivatives markets in the 1990’s. We sought to improve 

the competitive footing of our futures and derivatives industry by 

reducing regulatory burdens. We clarified some of the legal status 

of our over-the-counter derivatives transactions, reforming ShaddJohnson, and some other things. 

It has been largely successful in achieving these objectives. However, there are a few areas noted in some of the witnesses that will 

be here in the next panel, some of their testimony, and some of my 

own observations. 

This country has been rocked by several serious financial scandals the past few years. These scandals have shown that perhaps 

no segment of the futures and derivatives markets are safe from 

manipulation. Additionally, with the large expansion in futures and 

derivatives volume, we need to consider whether the CFTC needs 

additional tools to keep tabs on the over-the-counter trade in derivatives. 

Given the impact that large pension funds, banks, and other financial institutions have on our economy, we should consider 

whether the CFTC should have the authority to ask for information 

from those institutions even regarding over-the-counter activities if 

it might help prevent a financial calamity down the road. 

I continue to be particularly concerned whether the CFTC has 

adequate authority to oversee energy markets. Energy swaps and 

derivatives have a far more direct linkage to consumers’ pocketbooks than other exempt commodities, such as the metals, for example. The 46 energy enforcement cases settled by the CFTC so far 

12

for over $300 million in fines demonstrates that the CFTC has the 

authority to punish wrongdoing, which you have done, and that the 

Commission is using that authority. I congratulate you for that. 

Still, we need to make sure that Federal agencies have the authority and tools needed to detect and prevent these abuses from 

occurring in the first place, especially given the fallout they can 

have for consumers. We need to review the Commission’s antifraud and anti-manipulation authorities, as well as its enforcement 

resources, to make sure they are up to the challenge of regulating 

existing markets. Particularly, I believe we need to consider whether anti-fraud and anti-manipulation authority should be applied to 

principal-to-principal trades. 

Now, in the past, I have said no. I have been on the side of those 

that said no because these are principal-to-principal. These are, as 

we said in the past, these are big boys and girls. They know what 

is going on, and it affects a small segment, large deals. Then again, 

some of those affect consumers directly in the fallout of those. 

Again, we need to consider that again. We had in the past. We 

didn’t, but now, maybe we should, especially since we are having 

so many dealings taking place on the electronics markets now, as 

well as broker trades. We have these going on in the electronics 

markets. 

It seems to me that all similar markets, whether they are brokered, electronic, or what, should be held to the same standards of 

transparency and openness, and so this is what I am going to be 

looking at as we look ahead on the CEA reauthorization. We would 

like to have—I would hope that we could have your input on that. 

I did read your testimony. I had a lot of time this morning, driving in——

[Laughter.] 

Senator HARKIN [continuing]. I did read your testimony. I am 

just wondering why you aren’t yet making any recommendations to 

us about what changes in the law or tools that the CFTC needs to 

make sure that it can do its job as effectively as possible. You are 

the experts, not us. You have the firsthand knowledge, based on experience. As I said, you have already levied over $300 million in 

fines, so you have a good insight as to what is happening out there. 

Where is the CEA falling short? 

I guess I would just ask, will the Commission be providing this 

committee with any specific recommendations for CEA reauthorization this year? Will you be providing us with some recommendations? 

Ms. BROWN-HRUSKA. We would be delighted to do so. What I 

wanted to outline in my testimony were the areas of concern that 

we had, and I am sure that they are the same areas of concern that 

you have. We have in the past—for example in the energy area—

reached out to this committee to try to provide it with a number 

of briefings and background on how our cases are going and where 

we have had difficulties in bringing those cases. I really appreciate 

the fact that this committee has been so open to our views and I 

appreciate your mentioning our expertise in this area. 

The reason that I didn’t come out of the blocks bringing specific 

recommendations is that I thought it would be of value to hear 

from the industry. In terms of for example, you mentioned prinVerDate 0ct 09 2002 11:31 Aug 12, 2005 Jkt 020612 PO 00000 Frm 00016 Fmt 6633 Sfmt 6633 C:\DOCS\20612.TXT TOSHD PsN: TOSH
13

cipal-to-principal energy transactions—ultimately, it is Congress 

that needs to decide whether or not the CFTC should be in the 

middle of a dispute between Royal Dutch Shell and Goldman 

Sachs. When you have the big boys that are doing these large 

transactions, that they have a lot of facility and a lot of ability to 

protect themselves against each other. They wouldn’t agree to do 

the transaction if they didn’t think that the price was a fair one. 

They wouldn’t transact with each other if they didn’t know what 

they were getting into. 

In many respects, the reason that the Commission hasn’t brought 

to you a specific recommendation in this regard is we think that 

this is an area that Congress should provide us with guidance. 

Now, we can give you some language. In fact, the energy bill, as 

I mentioned before, had some language that we felt, by and large, 

provided some clarification that would on a marginal basis help us 

ensure that we can succeed in court if we should bring a case. For 

the 2(h) markets specifically, which are not intermediated, if you 

will look at our fraud authority in the 4b area, it says fairly clearly 

that our fraud authority applies to intermediated transactions. 

We thought there is a question of whether it is clear that Congress reserved fraud authority for the Commission in the energy 

markets in the 2(h) language. Those markets are multilateral, or 

bilateral markets, and as you mentioned, electronic. They are not 

intermediated. The 4b fraud statute applies to intermediated transactions. We wanted to lay it out and provide you with our views 

and we will be glad to circle back to you and to this committee with 

our assessment of those changes. 

Senator HARKIN. I look forward to getting that and looking at it 

and discussing with you and other Commissioners as we proceed 

on this reauthorization. 

Like I said, I don’t know myself. I am still a little uncertain 

about this myself. I thought I knew where I was before, but I am 

not certain about it right now with some of the fallout on some of 

these things as it affects consumers, which brings me to my next 

question. 

We are very sensitive in the Midwest about natural gas prices, 

both in terms of heating in the winter, but also for fertilizer production, and there has been great volatility in the natural gas markets recently. I have heard a lot of complaints from our fertilizer 

industry, especially, on this. 

I don’t know what has caused all this. It seems to me that information regarding supplies are inadequate, that for some reason, 

the natural gas industry is not as openly transparent, perhaps, 

maybe even as the oil industry is as far as the different sources of 

supply and things like that. 

It just seems to me that we have a situation here where the 

CFTC might want to look at some of the limits on trading on natural gas, whether they are set too high. I am told the price limit 

is now $3 per day. Actually, I am told it is more than just per day. 

It is just for a few minutes or something like that, like 15 minutes. 

In other words, if the limit was reached, unlike commodities, some 

other commodities, which close it for the day, this only does it for 

a short amount of time. I could be wrong on that, but that is what 

I am informed, anyway. That limit has never been reached on that. 

14

I am just wondering if we need better limits and if this is some 

area where the CFTC should be paying some more attention, I 

guess, on the volatility, what is happening in the natural gas markets. 

Ms. BROWN-HRUSKA. That price limits are an imperfect way of 

controlling volatility. That is one of——

Senator HARKIN. It is just for cooling. It is just to let things cool 

off a little bit, right? 

Ms. BROWN-HRUSKA. Yes. I guess that that is the theory. 

Senator HARKIN. That is the theory. 

Ms. BROWN-HRUSKA. What it does is if you shut down trading, 

if you have a price limit that is extraordinarily tight, if you make 

them tighter such that they are constantly—or if it is such that 

they are being kicked in frequently, it does have the effect of stopping trading in just the regulated futures markets rather than in, 

say, the over-the-counter markets and in the cash markets. A lot 

of the trading will continue to take place, in many cases, in those 

other markets and the markets get disconnected. It actually creates 

some underlying inefficiencies in the regulated market, which are 

very transparent in their publication of the prices on an interminute basis. You can see streaming quotes of prices in natural gas 

on your computer at any given time. 

I would say that—generally, you mentioned about volatility and 

high prices, and I agree completely with you that nobody is enjoying the high prices that we have been seeing in the natural gas 

area because it does cost important segments of our economy greater—it raises their cost and then it makes it not feasible to do some 

of their activity and so it does have a negative effect. 

Senator HARKIN. It is not just the high price, it is the volatility 

of those prices that causes so much uncertainty in the industry out 

there, even for any kind of forward contracting or anything. There 

is just this huge volatility. 

While I agree with you that if you set limits too low, that stifles 

the—it stifles all kinds of innovations and everything else. Then if 

you have them too far apart, then you get this huge volatility 

swing all the time. Surely there is some middle ground someplace 

that we could reach on this. I don’t know. 

Ms. BROWN-HRUSKA. Well, there has been a substantial amount 

of research that has looked at this. To see whether price limits do, 

in fact, help control volatility. Sometimes it actually leads to an increase in volatility because traders anticipate that they are getting 

closer to the limit and they will start to trade out more rapidly of 

their position because they don’t want to be caught with an open 

position when that price limit comes in because then they can’t get 

out. They are actually stuck with risk, so it creates risk. It creates 

some systemic risk for the markets. It is not clear that, in some 

cases, the limits, actually increases volatility. 

Senator HARKIN. Good observation. That is why I said we need 

to look at this some more. 

Ms. BROWN-HRUSKA. Well, we are looking at it. 

Senator HARKIN. I haven’t really seen much from CFTC on natural gas, though. I just really haven’t seen a lot. Maybe there is 

and I am just not that aware of it. I am really taking a look at 

some of the——

15

Ms. BROWN-HRUSKA. Well, we certainly have looked at a lot of 

individual episodes of volatility recently where we have seen huge 

run-ups. 

Senator HARKIN. Yes. 

Ms. BROWN-HRUSKA. Then I would say that we do that in a lot 

of markets. We do that in other markets that are important to you 

and your constituents. I know we look at cattle. We look at grains. 

Sometimes we have big run-ups in grains and we have to look at 

those. I would say that a lot of the evidence and what we have seen 

in these markets are consistent with the energy complex, as well. 

We see similar situations where when there is uncertainty about 

supply and demand, that we see greater volatility. Really, in the 

energy space, we have very tight supply and demand conditions. 

We have a problem with not enough supply, and storing natural 

gas is a problem, and providing it in the seasonal way that it is 

demanded has also been an issue, where we see that reflected in 

the prices. We see a lot of market fundamentals creating this volatility. 

Senator HARKIN. You put——

The CHAIRMAN. Senator, can I interject something quickly? This 

is a critical area. Your questions have been right on point, Tom. 

One of the criticisms that has been directed at the Act itself is that 

it allows the natural gas market to be manipulated rather than 

supply and demand forces work their way. I know CFTC did an investigation a year or so ago, or you have been doing it over the last 

year, relative to this issue. Can you give us some of your comments 

regarding manipulation versus supply and demand creating these 

volatile highs and lows that Senator Harkin is talking about? 

Ms. BROWN-HRUSKA. Well, I can speak generally. We have completed our investigations that have looked in those episodes. We 

had one last fall. We had one the year before that. In every case 

we look at, we are grateful that we have, in fact, a significant 

amount of information on the positions of large traders, of energy 

market participants, of users, to determine what their intentions 

are and what their trading activity is. It is our Large Trader Reporting System. We evaluate that trade. We evaluate the audit 

trail and the prices that we see to determine if there was any strategic manipulative behavior. 

In both those investigations, we found a lot of supply and demand-type explanations for the volatility and the prices that we 

saw. For example, we could link it directly to, in some cases, unrest. If you look at crude oil, we could look at situations in the Middle East where we had some concerns about supply there. If we 

look at natural gas, it is the winter heating season. In this last fall, 

uncertainty about what the weather would be like and whether or 

not supplies would be able to keep up with those weather conditions clearly predicted some of the price patterns that we saw. 

We use all the data that we have at our disposal and all the information that we can get, and you mentioned, Senator Harkin, 

over-the-counter market positions. If we suspect that somebody is 

trying to manipulate the futures markets so that they can benefit 

themselves in their over-the-counter market or their cash market 

position, we can get that information. We can do a special call, and 

we do them all the time to get the information that we need to enVerDate 0ct 09 2002 11:31 Aug 12, 2005 Jkt 020612 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 C:\DOCS\20612.TXT TOSHD PsN: TOSH
16

sure that they are not using the concert of two markets to manipulate our markets. 

I would say, by and large, that we have and we will continue to 

investigate unusual price activity. We will tie that in with our significant resources in the enforcement and in the surveillance area 

to ensure that the markets are not manipulated and we do that in 

a very proactive way, I would add. We see it on a day-to-day basis. 

If something is going on in the markets that is a concern to us, we 

immediately start watching those markets. We are in touch with 

the regulatory officials at the exchanges to try to get an understanding of what is going on. We work with them. If they want to 

raise their margin levels due to the increases in volatility and concerns that they have, we support that. We work with them to identify who the traders are and what their intentions are. 

I would say, by and large, we have been very successful, and part 

and parcel to that is because of a good working relationship that 

we have with the markets, with the exchanges, particularly, but 

even in the over-the-counter markets, that we do have special call 

authority and we don’t hesitate to use it. 

Senator HARKIN. Thank you, Mr. Chairman. Thank you for asking that question. You can see that—I was listening to Senator 

Lugar’s questions, also. As we go down this path on the reauthorization of the CEA, energy markets are going to be one big thing 

that we are going to have to wrestle here as to what authority 

CFTC, if any—I am not even certain about that—what additional 

authority you may need to get data. If you say supplies are tight, 

do you really have the tools that you need to get that kind of information to know whether or not the markets are transparent, really 

transparent or not? 

I am not convinced of that right now, and so my questions as we 

go forward are going to be around that area. Of course, I focused 

a little bit on natural gas. I just might focus on other things. It 

seemed that we had great volatility there. The spreads are too 

wide. There is great uncertainty as to what the data shows in 

terms of supplies out there. Again, I just wonder, Mr. Chairman, 

whether or not CFTC might need some additional authorities in 

that area. Like I said, I don’t know the answer to that question, 

but we are going to have to pursue it. 

Thank you, Mr. Chairman. 

[The prepared statement of Senator Harkin can be found in the 

appendix on page 42.] 

The CHAIRMAN. You are absolutely right. As we go through this 

process, we have to wrestle with this issue. Madam Chairman, 

those of us on this committee can pretty easily follow what the 

planting season portends, what the harvest is, and what the 

drought situation is, so we can follow commodities, agricultural 

commodities. Something like natural gas that doesn’t have an annual harvest season, it is obviously much more difficult for us to 

give any oversight. That is why we have CFTC. We would urge you 

to continue to be proactive and to keep us advised and to dialog 

with us as we go through this process to make sure we are doing 

the right thing legislatively. 

Senator Salazar. 

17

STATEMENT OF HON. KEN SALAZAR, A U.S. SENATOR FROM 

COLORADO 

Senator SALAZAR. Thank you, Mr. Chairman, and thank you, 

Senator Harkin. Congratulations to you, Chairman Brown-Hruska, 

on the fine job that you are doing. 

I realize that CFMA has a relatively short life span. You have 

only been working with the reauthorization for the last four or 5 

years. I appreciate the great work that you and the staff and the 

Commissioners have been doing. 

I also am going to be a supporter of the reauthorization, because 

you have been doing a great job. Following along the same lines of 

questions that were being asked by Senator Harkin, it would be a 

good time for you and the Commissioners to look back to see 

whether or not there are lessons to be learned from the last 5 years 

of what has happened with respect to some of the scandals that we 

have seen in other aspects of our financial markets and if there is 

anything that we ought to be doing as a Congress to try to address 

those issues. 

I come from a background, for the last 6 years, I spent my life 

as Attorney General. In that regard, I was very involved in investigations and prosecutions relating to the mutual fund industry as 

well as talking to some of my colleagues about some of the improprieties that occurred on Wall Street. 

You have been doing a very good job with respect to the kind of 

reauthorization and the right kind of enforcement and I very much 

appreciate that. It would be very useful for us as a Congress to 

have your thoughts, as the Chairman of the Commission, on 

whether or not there are any changes that ought to be made to 

avoid the kinds of problems that we saw, for example, in the mutual fund industry. My own view of what happened in the mutual 

fund industry is that we had regulation and we had regulators, but 

we didn’t have the right kind of enforcement so that we ended up 

having the kind of preferential treatment that allowed the market 

timers to come in and to basically take advantage of the ordinary 

mom-and-pop Americans that were investing in their 401(k)s and 

in their mutual funds. 

My own request of you is that you think long and hard, now that 

we are going through this reauthorization process, and use it as an 

opportunity to make sure that among commodities trading, that we 

don’t have the same kinds of problems that we had in other aspects 

of our financial markets here in America. 

Thank you very much. Thank you, Mr. Chairman. 

The CHAIRMAN. Thank you, Senator Salazar. 

Senator Conrad. 

Senator CONRAD. Thank you, Mr. Chairman. Thank you, Ms. 

Chairman. Is that the appropriate appellation, Ms. Chairman? 

Ms. BROWN-HRUSKA. Madam Chairman. 

[Laughter.] 

STATEMENT OF HON. KENT CONRAD, A U.S. SENATOR FROM 

NORTH DAKOTA 

Senator CONRAD. Thank you very much for being here. Let me, 

first of all, associate myself with the questions of Senator Harkin, 

because they were right on target. 

18

Let me just say that I had an opportunity to meet with industry 

experts on natural gas in the last day and a half and they tell me 

they think we are poised to have very substantial upward movements in the natural gas market. We look at what is happening 

with the snowpack out our way. That means—the snowpack is way 

down. That means production from our main stem dams on the reservoirs is going to be down. That means more pressure on natural 

gas. We have, as you know, lots of other pressures on that market. 

Senator Harkin was absolutely right to be focusing on volatility 

in natural gas. I want to make clear that I share his concern. 

I want to turn to another area of concern and that is exchange 

rate contracts and how much risk is being run there. What I am 

most interested in is what would happen, in your judgment, if 

there were a precipitous fall in the dollar? The reason I ask is we 

have already seen the dollar come off the Euro about 30 percent 

in the last 2 years. There seems to be continuing pressure on the 

dollar as we continue to run massive trade deficit. As you know, 

the trade deficit was over $600 billion last year. The operating deficit of the United States was over $600 billion last year. That includes the money that we are borrowing from Social Security and 

have to pay back that is not included in what the press defines as 

the deficit. On an operating deficit, the truth is, we are running 

about a $600 billion shortfall there, as well. 

Much of that is being funded now externally. Over the last 3 

years, our foreign indebtedness has gone up 91 percent, quite stunning. We had, 3 years ago, a trillion dollars of foreign indebtedness. 

Now, we are approaching two trillion of foreign indebtedness. 

We saw 2 weeks ago, South Korea sent shudders through the 

market by announcing they were going to diversify out of dollardenominated debt and dollar-denominated securities, that they 

thought the risk was growing unacceptably given our budget and 

trade deficits. 

We have had Warren Buffet, one of the most successful investors 

in our country, indicate that he is placing major bets against the 

U.S. currency. We have seen others similarly indicate growing concern. I understand there was a delegation from Japan here last 

week warning the United States that we could not continue to run 

these massive deficits. As you know, we have already borrowed 

over $700 billion from Japan alone. 

The vulnerability and the risk here, it strikes me, in these exchange rate contracts is if there were a precipitous fall in the dollar, and many economists are warning us that that could occur. 

What are the protections in place against the chaos that would 

ensue if there were a precipitous fall in the dollar? 

Ms. BROWN-HRUSKA. Well, I would say that the last time I 

taught this—I taught international finance, so I remember the data 

of the last time I looked at it, and your data sounds much more 

up-to-date than mine—but I remember that, in fact, the vast majority of the foreign currency traded in the world used to be about 

$4 trillion a day, in the interbank currency markets and largely 

outside of our jurisdiction. 

A lot of that is hedged in forward and swap transactions. In the 

forex area, the swaps transactions are largely designed to help 

companies manage the mismatch between their foreign currency 

19

cash inflows and their foreign currency cash outflows that they 

have as a part of doing business. 

What typically is the case is that to swing back to your question, 

of the regulated foreign currency transactions that we have oversight of. They are probably on the order of two or 3 percent of the 

total foreign currency transactions that take place. 

I am very confident in our market’s ability to continue to provide 

risk management regardless of the direction of the U.S. dollar. 

That is the key thing. Derivatives provide a way to manage that 

uncertainty about where the dollar is going, and so it is vitally important that they be allowed to function so that businesses, from 

the smallest operation to the largest, be able to rely upon those 

marketplaces to hedge those risks. 

Senator CONRAD. Let me interrupt you there because I am running out of time. In fact, I am out of time, Mr. Chairman. If I could 

just conclude with one question? 

The CHAIRMAN. Sure. Go ahead. 

Senator CONRAD. Let me just—I am told that this recent court 

case, the Zelener case, that the court held that these exchange rate 

contracts are not futures contracts and therefore not subject to 

CFTC regulation. Is that an accurate depiction? 

Ms. BROWN-HRUSKA. That they are not futures contracts? Yes, 

that is accurate. 

Senator CONRAD. Yes, and so not subject to CFTC regulation. 

Ms. BROWN-HRUSKA. Yes. 

Senator CONRAD. Who does regulate them? 

Ms. BROWN-HRUSKA. Well, in fact, we brought a case for fraud 

in that particular case, so obviously we believe that we regulate 

them. 

Senator CONRAD. Yes, but the court says no. 

Ms. BROWN-HRUSKA. Again, yes, this has been a very difficult 

court case. In fact, we appealed it all the way up to the Supreme 

Court. It is one of those situations where they focused on the language of——

Senator CONRAD. I know, but I don’t want to go into the detail. 

I want to know where we are now. What concerns me, and what 

has to concern this committee, I would say to my chairman, is if 

you all don’t regulate these contracts, who does? You say you are 

confident of where we are. Well, I will tell you, if nobody is regulating these things, I am not confident, and there is too much risk 

out there to be confident, it seems to me, if we have a court decision that says you can’t regulate these contracts. 

Ms. BROWN-HRUSKA. Well——

Senator CONRAD. That is the court determination, right? 

Ms. BROWN-HRUSKA. It was one court, yes. We are——

Senator CONRAD. We are stuck with that until some other court 

makes some other determination or, perhaps, until we act. Is there 

any requirement that Congress respond to this, or can you give advice to us? It doesn’t have to be now. Perhaps you need to consult 

with others. 

What I want to make sure we get on the record here, Mr. Chairman, is does Congress need to act in response to this court decision 

to make certain that CFTC has jurisdiction in this area? Do we 

need to do that? 

20

Ms. BROWN-HRUSKA. Well, I would say that yes, we are looking 

at it and our intention is to continue to bring these cases. I just 

signed three of them yesterday, where we were taking action 

against——

Senator CONRAD. I appreciate that, but we have a problem here, 

don’t we? We have a court that said, these are not futures contracts. My time is—I have gone over my time. Let me just conclude 

by saying, Mr. Chairman, we need to really insist that we get a 

recommendation on what action we might need to take in response 

to that court determination. I don’t want to leave you without the 

authority to be examining these contracts. The risk is simply too 

great. 

Ms. BROWN-HRUSKA. Thank you, sir. 

Senator CONRAD. I thank the Chairman. 

The CHAIRMAN. Very good question. Let me just suggest, Madam 

Chairman, that you have your staff put together the issue that now 

you are faced with after the decision in this case and give us your 

recommendation on that issue. 

Ms. BROWN-HRUSKA. Thank you, sir. We would be happy to. 

STATMENT OF HON. PATRICK LEAHY, A U.S. SENATOR FROM 

VERMONT 

The CHAIRMAN. Senator Leahy. 

Senator LEAHY. Thank you, Mr. Chairman. 

The CFTC is one of the few Commissions where I have worked 

with a majority of the Commissioners, most of them former Hill 

staffers. I also want to commend the Acting Chair, Ms. BrownHruska. She has done a great job in her leadership role, and I 

know a number of these issues have been raised already. 

As I look around, I see Mike Dunn, who worked extensively on 

agriculture credit and banking issues when I was chairman. Commissioner Walt Lukken did a fantastic job on the last reauthorization of the Commodity Exchange Act. Fred Hatfield worked with 

Senator Breaux, and Doug Leslie, who was on loan to me and Senator Lugar for around 2 years assisted this committee. 

I know that former Chairman Lugar has talked already about 

when he and I volunteered—that is the day we arrived 1 minute 

late, Dick——

[Laughter.] 

Senator LUGAR Senator Talmadge volunteered us to take on the 

CFTC thing. I ended up learning more in a short time than I ever 

thought I would. 

Senator LEAHY Madam Chairman, I appreciate your effort to 

close down some of these boiler room operations. What they do, and 

usually to the most—what they bilk people out of, and they are 

usually the people who can least afford it. People who deal on a 

professional basis on commodities know the risks. They deal with 

millions of dollars, sometimes hundreds of millions of dollars back 

and forth, but that is a business. They know how to deal with the 

risk. They know how to handle it. 

When you are a person on a fixed income or you are a person 

who gets a call from one of these boiler rooms, it doesn’t work that 

way, and especially if you have a family who is desperate. They 

may have both parents holding down jobs, trying to make ends 

21

meet. They get some of these calls, and you have heard probably 

more of them than I have, but I have listened to some of the recordings and being lured into foreign exchange markets. You and 

I know enough to hang up on it from our own past experience, but 

a lot of people don’t and they just go into ruin. They have to be 

closed down totally. 

I have worked on both the Appropriations Committee and the Judiciary Committee to give funding to the Justice Department for 

people designated to work on specific issues and I am happy to 

work on this. 

Now, there are other areas, the Enron collapse. I am very concerned about energy markets. We see the price of oil going up. This 

could affect, whether it is in a rural area like mine or a major population area, the energy markets make a determination whether 

they are going to make it or not, whether they are going to have 

jobs or not. It is vital to be able to protect us on these markets, 

especially in the anti-fraud, anti-manipulation efforts. 

The CFTC needs a stronger oversight role regarding over-thecounter foreign exchange and options contracts. I know it is a complicated issue. When I came in, somebody mentioned the Seventh 

Circuit case, Zelener. Let us work together. Let us work together 

on this. 

My question would be about the over-the-counter forex, the foreign currency exchange. Are you getting the kind of help you want 

from the Department of Justice in putting these people out of business? 

Ms. BROWN-HRUSKA. Well, thank you for your comments. You 

know, we have a number of open forex investigations with the Department of Justice now and we very much appreciate it. We have 

been very well received by Justice and our cooperative efforts have 

paid off, not only in forex, but in the energy investigations that we 

brought, as well. 

The Division of Enforcement at the CFTC and the Department 

of Justice together brought Operation Wooden Nickel last year, one 

of the largest undercover operations in the history of our agency. 

In that action alone, over 30 people were arrested. In sum, our relations with Justice have been very good and our markets benefit 

from that work. 

You mentioned also, or someone mentioned States’ Attorney Generals. We have also worked with those individuals and their offices 

as well, to bring a lot of our cases in the energy and forex area. 

I said that we might like some clarification in our forex authority, given the Zelener case, the States do also have significant authority, the Attorneys General and so does Justice, so does the Federal Trade Commission, if they want to take up some of these 

cases. In many respects, by cooperative enforcement, we are able 

to ensure that those late-night cold callers and those Internet 

fraudsters are tracked down and put out of business. 

Senator LEAHY. I am sure you agree with me. We want commodities markets to work. Obviously, when you have an economy like 

ours, especially one that uses so much from energy to food and everything in between, we want them to be able to work. Everything 

gets tarnished, at least in the view of the average person, if these 

22

illegal groups are working. I want you to be able to bring the hammer down. 

Incidentally, Senator Feinstein has again introduced a bill to regulate over-the-counter energy trading. Have you had a chance to 

look at that? 

Ms. BROWN-HRUSKA. No, I haven’t seen the specifics. I know that 

it—I have seen her past legislation and some of it was well received in terms of its intent. 

Senator LEAHY. We may want our staffs to talk more on that. It 

is another area, especially after some of the past things, and as energy prices go up, it is something a lot of us here are very concerned about. 

Mr. Chairman, I will have other questions for this and the other 

panel. I will just introduce those for the record. We have a Judiciary meeting going on. I wanted to come down to give my compliments to the Chairman, but also to emphasize, like Senator 

Lugar already has, that a lot of us, and I know this includes the 

two of you, we want commodities trading to work. We also want 

to make sure that those who try to cash in on unsuspecting Americans, that we bring the hammer down pretty hard. 

The CHAIRMAN. Thank you, Senator Leahy. 

[The prepared statement of Senator Leahy can be found in the 

appendix on page 44.] 

TheCHAIRMAN. We have already publicly stated our admiration 

for you and Senator Lugar for taking this on early and staying on 

the committee. 

Madam Chairman, thank you very much. We appreciate your 

testimony and your very frank discussion that we have had here 

today, and we look forward to staying in touch as we move through 

this process. 

Ms. BROWN-HRUSKA. Thank you, Mr. Chairman. 

The CHAIRMAN. Thank you. We will now ask our second panel of 

very distinguished members of the industry to come forward. 

Gentlemen, welcome this morning. We are very pleased to have 

with us Mr. Charles P. Carey, Chairman of the Board, Chicago 

Board of Trade, from Chicago; Mr. Terrence A. Duffy, Chairman of 

the Board, Chicago Mercantile Exchange, also Chicago; Dr. James 

Newsome, President, New York Mercantile Exchange, New York, 

and obviously the former Chairman of the CFTC; Mr. Frederick W. 

Schoenhut, Chairman of the Board, New York Board of Trade, of 

course, New York; Mr. Satish Nandapurkar, President and CEO of 

Eurex US, Chicago; and Mr. John Damgard, President, Futures Industry Association, located here in Washington. 

Gentlemen, we welcome you here this morning. We look forward 

to your testimony and to your dialog. Mr. Carey, we will start with 

you. I would encourage all of you to submit your statements for the 

record. Limit your comments to 5 minutes. Thank you. 

STATEMENT OF CHARLES P. CAREY, CHAIRMAN, CHICAGO 

BOARD OF TRADE, CHICAGO, ILLINOIS 

Mr. CAREY. Thank you, Mr. Chairman and members of the committee. My name is Charles Carey. I am Chairman of the Chicago 

Board of Trade. It is an honor for me to be here today to present 

23

the Board of Trade’s views. As you have requested, we have submitted our written testimony for the record. 

We commend Congress for passing the Commodity Futures Modernization Act and the careful and thoughtful way in which the 

Commodity Futures Trading Commission has implemented its provisions. The CFMA gave the Commission needed flexibility to deal 

with innovation and brought legal certainty to many products while 

preserving regulatory concepts that are essential to our industry. 

The Commission and its staff have shown great insight in using 

this authority to reduce regulatory burdens without sacrificing vital 

customer protections. 

In my written testimony, I call attention to several issues that 

deserve discussion, but major changes to the law appear unnecessary at this time. 

For example, security futures, which were allowed for the first 

time by the 2000 Act, have yet to reach their potential. Dual regulation by the CFTC and the Securities and Exchange Commission 

has created challenges. We hope the two Commissions work together to relieve these, such as the unfair and unnecessary margin 

in equities that inhibit the growth of stock futures and their usefulness as risk management tools. 

A Federal court decision holding that the CFTC has no antifraud jurisdiction over retail foreign currency transactions could 

lead to increased opportunities for fraud. The potential impact of 

this decision is a matter of concern across the futures industry. 

Congress may find that this issue warrants a legislative response. 

If that is the case, the CBOT will, as always, be happy to work 

with the committee, the Commission, and other industry representatives in creating a solution. 

Since the CFMA, a major trend in the industry has emerged toward international expansion and cross-border business arrangements. This trend presents interesting challenges for regulators 

both at home and abroad. 

In one such initiative, Eurex soon will ask the CFTC to approve 

a plan to approve trades on its U.S. subsidiary contract market 

through a clearinghouse located in Frankfurt, beyond the regulatory control of the CFTC. The prior Chairman of the Commission 

told the House Agriculture Committee that such a non-domestic 

clearinghouse must register with the CFTC as a designated clearing organization. The CBOT believes this is good regulatory policy 

and will preserve for U.S. citizens trading on Eurex US the protections available under U.S. regulation and bankruptcy law in the 

event of a default or insolvency. 

Recent actions of a handful of traders in London selling and buying bonds through a European electronic trading system are being 

investigated by four European governments for possible price manipulation. This incident illustrates the potentially destabilizing effect that market behavior can have across borders and between exchanges and marketplaces. Comparable regulation and information 

collection among regulators of different countries is essential to 

help detect and prevent systemic harm from such activities. 

The Chicago Board of Trade is pleased that the CFTC recently 

began discussions with the Committee of European Securities Regulators and hopes those discussions will be productive in resolving 

24

issues of regulatory disparities and gaps in a manner consistent 

with the CFMA. 

In addition to customer protection issues, unequal regulatory 

treatment can also result in uneven regulatory costs, thereby creating unfair competitive advantages. Decisions being made now 

with regard to policies and protocols for cross-border business are 

setting critically important precedents that will impact the global 

derivatives industry for years to come. 

The Chicago Board of Trade, the oldest and one of the largest futures exchanges in the world, had its best year ever, trading over 

600 million contracts last year, a volume increase of over 31 percent over the prior year. The success of the Chicago Board of Trade 

over the years reflects the confidence that market participants 

around the globe have in our commitment to vigorous, even-handed 

self-regulation. 

Self-regulation with Commission oversight continues to work 

well. There have been questions raised concerning the move by exchanges to become for-profit organizations and whether they can 

avoid conflicts of interest. A for-profit exchange has an even greater incentive to maintain and increase public confidence. Experience 

has shown that investors prefer markets that have demonstrated 

integrity through self-regulation. 

The Chicago Board of Trade is presently going through the process of becoming a for-profit organization. I assure the committee 

that this new status, while enabling us to compete more efficiently 

with other exchanges from around the globe, will not lessen our 

dedication to fair and forceful self-regulation. We hope and expect 

that regulators will keep in mind the advantages of knowledgeable 

and experienced self-regulation and not impose rigid definitions 

that, for example, may preclude a member of an exchange with no 

other ties to the exchange from becoming an independent director 

or committee member. 

Again, thank you for the opportunity to testify today. The Chicago Board of Trade is pleased to respond to questions and provide 

any assistance the committee may deem necessary. Thank you. 

The CHAIRMAN. Thank you very much. 

[The prepared statement of Mr. Carey can be found in the appendix on page 51.] 

The CHAIRMAN. Mr. Duffy. 

STATEMENT OF TERRENCE A. DUFFY, CHAIRMAN, CHICAGO 

MERCANTILE EXCHANGE, CHICAGO, ILLINOIS 

Mr. DUFFY. Thank you very much, Mr. Chairman. I am Terry 

Duffy. I am the Chairman of Chicago Mercantile Exchange Holdings, Incorporated, which owns and operates the largest U.S. futures exchange. I am happy to appear before you, Chairman 

Chambliss, to offer you and the committee the CME’s view as to 

what the committee should be considering as it undertakes reauthorization of the CFTC. 

In the judgment of the CME, the Commodity Futures Modernization Act of 2000 represents successful landmark legislation that 

materially and beneficially transformed the nation’s futures markets. The CFMA’s reduction of high-cost regulation has been an unVerDate 0ct 09 2002 11:31 Aug 12, 2005 Jkt 020612 PO 00000 Frm 00028 Fmt 6633 Sfmt 6633 C:\DOCS\20612.TXT TOSHD PsN: TOSH
25

qualified success, making futures trading more efficient and useful 

to a wide range of customers. 

Throughout its over 100–year history and especially so in the 

past three decades, the CME has earned a reputation as a premier 

innovator and industry pace setter. A very clear demonstration of 

our leadership in the global derivatives industry is the historic 

clearing link between the CME and the Chicago Board of Trade, 

which has delivered on the efficiencies and the $1.8 billion in savings just as promised. 

Within our organization, the initials ‘‘CME’’ stand for Customers 

Mean Everything, and that customer-driven perspective explains 

much in terms of our success since the enactment of the CFMA. 

While the CME enthusiastically applauds the success of the 

CFMA and recommends that we retain this historic statutory 

framework, the upcoming Congressional reauthorization process offers a valuable opportunity to fine-tune that statutory regime based 

on industry experience gained since the CFMA’s enactment in 

2000. 

The first area in need of fine-tuning involves retail foreign exchange futures. There have been massive continuing frauds against 

retail customers in the OTC FX market. A loophole in the Act permits unregistered known offenders to sell foreign currency futures 

to naive retail customers. This loophole can and should be closed. 

Compounding this problem is the recent unfortunate decision of 

the Seventh Circuit Court of Appeals in CFTC v. Zelener, where 

the court adopted an extremely narrow definition of futures contracts. Zelener held that a futures contract stops being a futures 

contract if the seller inserts a meaningless disclaimer. The ruling 

permits OTC dealers to easily offer futures-like contracts to unsophisticated customers without the CFTC’s jurisdiction or registration requirements. As noted in recent testimony by Acting CFTC 

Chairman Brown-Hruska, this retail fraud has spread from foreign 

currency scams to heating oil and orange juice. This can and 

should be stopped by closing the loophole created by Zelener.

Unless the loophole is closed, the committee should be concerned 

with the very real prospect that, before long, the CFTC’s jurisdiction and its retail customer protections may be reduced to irrelevance. The challenge for the committee and the futures industry is 

to find an effective solution that will politically survive the reauthorization process. 

The second area in which the CFMA needs to be modified deals 

with single-stock futures. Inter-exchange competitive concerns combined with regulatory and legislative turf contests ended the hope 

for this product long before it was launched. It is time to let futures 

exchanges trade the product as a pure futures contract and to let 

the security exchanges trade it as a securities contract. Let the relevant exchanges deal solely with the irrespective regulator, whether the CFTC or the SEC, which is what I believe Congress initially 

intended in 2000 in authorizing single-stock futures. I would urge 

the committee to prevail upon the respective regulatory agencies to 

eliminate all undue regulatory impediments. 

Before concluding, Mr. Chairman, I noted that one of the witnesses called for Congress to force exchanges that innovate and 

pioneer new contracts to freely give up their benefits of the investVerDate 0ct 09 2002 11:31 Aug 12, 2005 Jkt 020612 PO 00000 Frm 00029 Fmt 6633 Sfmt 6633 C:\DOCS\20612.TXT TOSHD PsN: TOSH
26

ment and innovation to competitors. That idea is utterly contrary 

to every viable economic principle that has made the U.S. economy 

work. 

A number of other issues have been raised in written testimony. 

I will be pleased to explain why self-regulation in the futures industry works, how our corporate governance meets the highest 

standards, and why the rulemaking process under the CFMA is not 

broken in response to your questions or in supplemental testimony. 

In conclusion, I want to thank you, Mr. Chairman, for allowing 

me to participate in this hearing. The CME, its customers, and the 

industry have benefited greatly under the CFMA. The CME looks 

forward to participating in the reauthorization process, helping the 

committee craft amendments that preserve the original intent of 

the CEA, amendments that protect retail customers and that improve the efficiency, the competitiveness, and the fairness of futures trading for all market participants. 

I would be very pleased to answer any questions the committee 

may have. Thank you, sir. 

The CHAIRMAN. Thank you, Mr. Duffy. 

[The prepared statement of Mr. Duffy can be found in the appendix on page 60.] 

The CHAIRMAN. Dr. Newsome, welcome back. 

STATEMENT OF JAMES NEWSOME, PRESIDENT, NEW YORK 

MERCANTILE EXCHANGE, INC., NEW YORK, NEW YORK 

Mr. NEWSOME. Thank you, Mr. Chairman. 

The CHAIRMAN. This is the first time you have been here in this 

capacity, I believe. 

Mr. NEWSOME. Yes, sir, it is. 

The CHAIRMAN. We congratulate you again and welcome. We look 

forward to your testimony. 

Mr. NEWSOME. Thank you very much. Mr. Chairman, members 

of the committee, it is an honor to be here as President of the New 

York Mercantile Exchange today. It is certainly an honor to see 

friends on this committee and former colleagues at the CFTC, as 

well. 

NYMEX is the world’s largest forum for trading and clearing 

physical commodity-based futures contracts, primarily energy and 

metals. The Commodity Futures Modernization Act of 2000 was 

landmark legislation that provided critically needed legal certainty 

and regulatory flexibility to U.S. futures and derivatives markets. 

It is our view that the current structure is providing a reasonable, 

workable, and effective oversight regime for regulated exchanges. 

Prior to the CFMA, the CFTC operated under a one-size-fits-all 

regulatory approach. Regulatory inequities, particularly prior approval requirements for rule and contract changes, imposed unreasonable constraints on domestic exchanges competing with international and unregulated exchanges. This committee and the Congress agreed that the orientation of the CFTC should be shifted to 

a more flexible oversight role. 

To address these issues, Congress established market tiers so 

that a marketplace could now select a level of regulation according 

to the product types offered, and even more importantly, eligible 

participants for the facility. 

27

NYMEX operates by choice at the highest level of regulation by 

the CFTC. It has consistently been deemed by the CFTC staff reviews to have maintained adequate regulatory oversight and programs. As a result of Congress’s foresight and innovation, NYMEX, 

acting subject to CFTC review and oversight, can now bring new 

products and services to market promptly to meet customer needs. 

Although NYMEX is largely a marketplace used by commercial 

participants for hedging, the benefits also accrue more broadly to 

consumers, who receive prices based on open and fair competition. 

Prices for the commodities traded in U.S. futures markets are vital 

to our national economy and are recognized as reliable, global 

benchmarks. 

As a note, the CFMA maintained the CFTC’s exclusive jurisdiction over futures and options on futures. NYMEX supported and 

continues to support this approach, which would be maintained by 

several savings clauses contained in last year’s energy bill. 

It is important to point out that contrary to what some have suggested, the CFMA did not diminish the regulatory oversight responsibilities of the CFTC. Although regulated exchanges may selfcertify new contracts and rule changes, the CFTC retains the responsibility to assure that all changes are in accordance with the 

guidelines of the Act. In practice, there is always prior discussion 

with the CFTC on any substantive change. 

Regulatory flexibility was vital in responding to the financial failure of Enron. In the aftermath, other energy trading companies 

lost credit ratings. Stock prices plummeted, and liquidity crises 

began to develop because market participants lacked confidence in 

each other’s abilities to perform transactions. 

In response, NYMEX addressed these issues by rapidly implementing a number of important measures to migrate positions from 

the over-the-counter marketplace to NYMEX and the protections 

provided by its AA-Plus rated clearinghouse. NYMEX also began 

launching a slate of products appealing to OTC participants which 

are executed off the exchange but brought to NYMEX for clearing. 

In doing so, 130 products that are traditionally traded OTC have 

been brought under the umbrella of a regulated exchange, which 

establishes the identity of participants, a transaction audit trail, 

daily position surveillance, and credit security, none of which would 

have been available prior to the CFMA. 

NYMEX’s safeguards allowed us to maintain solid footing during 

this challenging time, and thanks to the flexibility permitted under 

the CFMA, NYMEX adapted and provided the necessary tools to 

help stabilize impacted businesses. 

We recently completed an analysis of hedge fund participation in 

several NYMEX markets during 2004, which is being submitted to 

the committee, Mr. Chairman, for the record. As you review this 

report, I believe you will agree, as our research suggests, that 

hedge funds serve an overall constructive role in our markets. 

While hedge fund participation has not made up a large portion of 

our markets to date, we continue to monitor this market segment 

closely. 

Market integrity continues to be effectively safeguarded on the 

regulated exchanges through stringent adherence to the CFMA 

28

core principles. As a self-regulatory organization, NYMEX devotes 

significant resources to the oversight of all of its markets. 

With regard to CFTC oversight responsibilities, the agency has 

been, by all accounts, quite vigorous in exercising the scope of its 

current authority to police abuses in OTC markets, including energy markets. Nonetheless, there remain open questions respecting 

CFTC anti-fraud authority over principal-to-principal transactions 

involving exempt commodities executed bilaterally or on electronic 

platform. Congress may wish to consider whether clarification or 

guidance in this area is needed. 

As my time is out, Mr. Chairman, I would just say that I appreciate having the opportunity to be here today and I look forward 

to answering any questions that the committee might have. 

The CHAIRMAN. Thank you, Dr. Newsome. 

[The prepared statement of Mr. Newsome can be found in the appendix on page 69.] 

The CHAIRMAN. Mr. Schoenhut, we are pleased to have you with 

us. 

STATEMENT OF FREDERICK W. SCHOENHUT, CHAIRMAN, NEW 

YORK BOARD OF TRADE, NEW YORK, NEW YORK 

Mr. SCHOENHUT. Mr. Chairman and members of the committee, 

thank you for this opportunity to testify on behalf of the New York 

Board of Trade regarding the reauthorization of the Commodity 

Futures Trading Commission. My name is Fred Schoenhut and I 

am Chairman of the Board of the New York Board of Trade. 

In 2004, the Coffee, Sugar, and Cocoa Exchange, founded in 

1882, and the New York Cotton Exchange, founded in 1870, formally became one exchange, the New York Board of Trade. Like its 

predecessor exchanges, NYBOT is a not-for-profit membership organization established under New York law. NYBOT is the premier 

world market for futures and options in cocoa, coffee, cotton, orange 

juice, and sugar. The exchange also has markets in currency rates 

and equity indexes. While the financial markets exhibit different 

underlying characteristics than the agricultural commodities that 

dominate the exchange, they all provide reliable tools for price discovery, price risk management and investment. 

In 1994, NYBOT established a trading floor in Dublin, which is 

the first open outcry trading facility in Europe owned by a U.S. exchange. 

The concept of self-regulation long embodied in the CEA was 

strongly reinforced and expanded by the Commodity Futures Modernization Act of 2000. The CFMA was the culmination of 4 years 

of work by the Congress. It provided the flexibility for exchanges 

to decide how best to structure their businesses around a set of 

core principles. 

The CFTC provides oversight rather than promulgating prescriptive regulations and second-guessing exchange decisions. 

We believe the CFMA is working as intended, allowing markets 

to be competitive by modernization and streamlining the regulatory 

system. We, therefore, support a reauthorization bill that continues 

this current regulatory structure. In this regard, we wish to point 

out three areas of the exchange self-regulatory structure that are 

important to maintain. 

29

First, each exchange should continue to be allowed to determine 

the composition of its governing board. NYBOT finds that diversification of board membership is beneficial to protect the public interest and the economic self-interest of the markets. It allows each 

exchange to have a range of expertise on its board, including people 

who are actively engaged in the trading of exchange products. How 

board members are chosen and how representation of various exchange communities should be allocated are matters for each exchange to determine for itself in light of its own particular circumstances. 

Second, the structure for exchange compliance and disciplinary 

functions should also remain unchanged. Currently, each exchange 

is required to have procedures in place for monitoring and enforcing contract market rules. The CFTC conducts regular rule enforcement reviews to determine whether an exchange is meeting this requirement. We believe this current system works well and additional requirements regarding the makeup or functions of the disciplinary committees are not needed. 

Third, exchanges are required to establish and to enforce rules 

that minimize conflicts of interest in the decision-making process. 

There is a flexibility for each exchange to determine how to meet 

this requirement, recognizing that each exchange has a different 

governing structure. At NYBOT, we disqualify board members from 

participating in a decision if they have potential conflicts. However, 

if a person with a potential conflict has a useful expertise, we may 

ask that that person provide information to the board to inform our 

deliberations. 

In closing, on behalf of the exchange, its trading community, and 

users, I would like to thank the CFTC, this committee, and the 

Congress for the support they gave NYBOT after 9/11. NYBOT was 

the only exchange completely destroyed in the World Trade Center 

terrorist attack. Fortunately, we had a backup trading floor facility 

in Long Island City, and using this site, we opened up 6 days later. 

Thanks to the assistance Congress provided, we were able to rebuild in lower Manhattan and move into our new facilities in September of 2003. In 2004, we hit a record trading volume of approximately 32 million contracts, representing a 32 percent increase 

over the 2003 volume. 

Mr. Chairman, I would be happy to answer any questions you or 

the committee members may have. Thank you. 

The CHAIRMAN. Thank you very much. 

[The prepared statement of Mr. Schoenhut can be found in the 

appendix on page 82.] 

The CHAIRMAN. Mr. Nandapurkar. 

STATEMENT OF SATISH NANDAPURKAR, CHIEF EXECUTIVE 

OFFICER, EUREX US, CHICAGO, ILLINOIS 

Mr. NANDAPURKAR. Thank you. Chairman Chambliss, Senator 

Lugar, thank you for the opportunity to testify. I am Satish 

Nandapurkar, CEO of Eurex US. Eurex US is grateful today to be 

invited to participate in these hearings and to be able to present 

our views as a relative new entrant in these markets. 

I am in agreement with the others on this panel that, in our 

opinion, the CFMA has been a tremendous success. It is working 

30

as Congress intended, namely by giving exchanges more freedom to 

innovate and by making it more attractive to operate in the U.S. 

as a U.S. registered and regulated futures exchange. 

The CFMA has facilitated an unprecedented level of competition 

in the United States, resulting in greater innovation, greater efficiency, and greater choice for market participants. The numbers 

speak for themselves. In 2000, total volume on U.S. futures exchanges was 600 million contracts. Last year, total volume 

ballooned to 1.6 billion. 

We are also of the opinion that the CFTC has done an outstanding job in putting into practice this groundbreaking legislation, starting with former Chairman Newsome and now continuing 

with Acting Chairman Brown-Hruska. The CFTC has moved expeditiously, yet prudently, in implementing the new streamlined regulatory structure while ensuring that participants are adequately 

protected. 

Since enactment of the CFMA, the CFTC has designated eight 

new futures markets and eight new clearinghouses. Not surprisingly, the increase in competition has been accompanied by new 

products, new services, lower costs, and increased efficiency. Six 

hundred new products have been filed since enactment of the 

CFTC, and as exchanges compete, fees drop, and sometimes dramatically. When we came into the market for Treasury futures 

products, the incumbent exchange, the CBOT, dropped their fees 

80 percent, in some cases dropped their fees to zero. That resulted 

in substantial savings for end users. 

Competition has also forced exchanges to finally respond to customers’ preferences for the transparency, immediacy, and efficiency 

of electronic trading. The majority of futures traded in the United 

States are now traded electronic. That was certainly not the case 

in 2000. Thanks to electronic trading, a trader in Georgia or a trader in Indiana has the access to the same information, is on the 

same playing field that was once reserved for exchange members 

that stood in the pits in Chicago. 

We at Eurex US are particularly indebted to the committee, for 

without the committee and without the CFMA, there would be no 

Eurex US. If I may, I would like to tell you a little bit about my 

exchange. 

We are a new futures exchange registered with the CFTC and 

regulated fully by the CFTC. We are headquartered in Chicago 

with a U.S. management team based in Chicago. Our clearing is 

handled by the Clearing Corporation, a 70–year-plus institution 

based in Chicago. All our market surveillance and trade practice 

surveillance is provided by the not-for-profit National Futures Association, also based in Chicago. 

We launched last February with futures and options on two-, 

five-, 10-year Treasury Notes and 30-year Treasury Bonds. We 

have expanded our product line this year to include equity indexed 

products, namely the Russell 1000 and 2000 futures. 

Our approach to derivative markets is quite straightforward. We 

believe that all customers should get the benefit of a fully electronic trading system, equal access to information on a level playing field, and low fees for everyone. We believe that no one should 

have to pay for a membership to be able to get these benefits. 

31

Our goal here is not just to compete in the United States, but 

to expand the market in doing so. As markets continue to globalize, 

we plan to be on the forefront of facilitating cross-border trade, 

making it easier for European participants to access U.S. markets 

and U.S. participants to access European markets. We have had 

extensive discussions with the CFTC on the implementation of the 

next phases of our global business plans. 

In enacting the CFMA, Congress placed great faith in competition and that faith has been rewarded. Greater innovation and 

greater efficiency has been the engine of growth in the futures industry over the past few years. In our way, we are trying to realize 

the potential created by the CFMA. We offer the U.S. marketplace 

open and equal access, an all-electronic venue, competitive trading 

in existing products, new products, and low fees for everyone. Our 

course forward is to build on this foundation, to bring greater business into the United States. 

The CFMA has greatly facilitated our ability to do this. We urge 

Congress to stay the course. You have done your part. Now it is 

our turn to do our part. Continued reliance on the benefits of competition will transform this industry even further for the benefit of 

everyone and preserve the U.S.’s leadership role in the global futures markets. Thank you. 

The CHAIRMAN. Thank you, Mr. Nandapurkar. 

[The prepared statement of Mr. Nandapurkar can be found in 

the appendix on page 88.] 

The CHAIRMAN. Mr. Damgard. 

STATEMENT OF JOHN M. DAMGARD, PRESIDENT, FUTURES 

INDUSTRY ASSOCIATION, WASHINGTON, DC 

Mr. DAMGARD. Thank you very much, Chairman Chambliss, Senator Lugar. I am pleased to appear with my friends from the exchange community. On behalf of the Futures Industry Association, 

I want to thank you very much for appearing here today. 

I have one advantage over the others at the table, if it is an advantage, and that is that I have been involved in every CFTC reauthorization since the agency was created in 1974. I remember well, 

Senator Lugar, those discussions in 1978 at the first reauthorization. Along with Leo Melomed, who is here and needs no introduction, we were the only ones that go back quite that far. 

I know firsthand the historic and vital role this committee has 

played in periodically reviewing the CFTC’s operations and reforming the Commodity Exchange Act when warranted. This committee’s work on the Commodity Futures Modernization Act of 2000 is 

only the latest example of your significant contribution to our mutual goals of strong, competitive, innovative, and honest futures 

and options markets. Your longstanding commitment is greatly appreciated by this industry. 

In light of that expertise, we would make a specific recommendation to this committee. As you know, last year’s energy bill contained amendments to the Commodity Exchange Act. If similar efforts to amend the Act are made this year, we believe they should 

be part of this committee’s consideration of CFTC reauthorization 

instead of in the energy bill. 

32

The CFMA was a piece of landmark legislation which left the 

Commission with a very ambitious agenda. Under strong leadership, the Commission has implemented the new regulatory design 

authored by this committee. They are to be commended for their 

efforts. 

CFTC reauthorization provides an opportunity to reconsider the 

regulatory program for the futures markets to see what is working 

and what is not. In FIA’s view, the list of what is working is long 

and the list of what is not is quite short. My written testimony goes 

over those lists in more detail, but let me just summarize some of 

the high points. 

The fundamental changes enacted in the CFMA have worked 

well. We are not in favor of any change to the basic statutory design. In particular, FIA would be concerned with any plan to expand dramatically the jurisdiction of the CFTC. In our view, when 

the CFTC’s mission strays from its oversight of exchange traded futures and options, it distracts from the Commission’s ability to 

achieve the Act’s essential regulatory purposes. 

That is why we have concerns about any proposal to expand the 

CFTC’s jurisdiction as a response to the ongoing problem of fraud 

against retail customers in OTC FX transactions. The CFTC was 

not set up to become a national consumer protection agency for 

commodity transactions, a fact that this committee recognized in 

1982 when it wrote, quote, ‘‘The Commission by itself cannot be 

primarily responsible for policing every enterprise operating under 

a commodity theme.’’

Consistent with this committee’s reasoning, our approach to retail FX fraud would be twofold. First, give the CFTC specific targeted authority to pursue fraud claims against otherwise unregulated persons, and second, encourage law enforcement officials to 

take action against, and if need be, put behind bars, those who con 

retail customers in FX transactions. The only proven way to deter 

and end retail FX fraud is a strong, cooperative, Federal, State, 

and local law enforcement campaign to lock up those responsible 

and keep them from bouncing from one jurisdiction to another 

when they get caught. 

Fair competition, transparency in exchange rulemaking, and true 

SRO independence continue to be areas where the FIA would support improvements. The CFMA has sparked efforts to introduce 

more direct competition among exchanges, as we had hoped. Thus 

far, the challenger markets have not been successful in doing more 

than chipping away at the entrenched markets’ dominance. Further action by Congress and/or the Commission may be needed to 

accomplish the real purpose and the real promise of competition by 

affording our customers a choice of efficient, low-cost market platforms from which to select the best price available for any trade. 

No one wants to go back to the days when all exchange rules required costly and time consuming CFTC approval. Our concern is 

that the current regime works to shut out our members and their 

customers from both the exchange internal approval process and 

any subsequent CFTC review. For example, a 3-day private comment period on whether the Commission should approve an important exchange rule is no substitute for the kind of due process anyone would expect from a fully informed agency deliberation. We 

33

look forward to working with this committee, the Commission, and 

the exchanges to make exchange rule makings more open to public 

comment and input. 

SROs have an important job to do, making sure that the public 

has confidence in our markets. Independent directors signal to 

market users around the world that our SROs are serious about 

self-policing and put the public interest above their business interest. While some exchanges, notably the Chicago Mercantile Exchange, have made real strides in this area, others have not. We 

want to work with all interested parties to strengthen this aspect 

of SRO operations. 

Our last concern is product availability. Our members serve a sophisticated customer base that use futures markets all over the 

world to manage price risks in their business or investment activity. When U.S. law or regulation prevents our customers from obtaining access to exchange-traded products either in this country or 

overseas, it has the perverse effect of forcing our customers to use 

other less transparently priced instruments to manage those risks, 

often without the clearing protection exchange trading affords. 

While those anomalies do not occur often, where they do, we ask 

this committee’s help in removing them. 

In conclusion, Mr. Chairman, FIA looks forward to working with 

this committee and its staff and the rest of the industry. We believe that with a handful of changes, we can make an excellent regulatory system even better. Thank you very much, and I am 

pleased to answer any questions. 

The CHAIRMAN. Thank you, Mr. Damgard. 

[The prepared statement of Mr. Damgard can be found in the appendix on page 93.] 

The CHAIRMAN. Let me just say to all of you, as we did with the 

Chairman of CFTC, we would like to request that you give us any 

recommendations for proposed changes that you might have in 

writing so that all members of the committee can review any suggestions that you have as we move forward with this reauthorization. 

Mr. Nandapurkar, your testimony mentions the proposed Global 

Clearing Link. Could you explain in a little more detail what this 

is, how it works, and its effect—what effects it might have on the 

markets? 

Mr. NANDAPURKAR. Mr. Chairman, I would be glad to. The Global Clearing Link is a mechanism that links our clearinghouse, the 

Clearing Corp. in Chicago, with the clearinghouse of Eurex in 

Frankfort, Eurex Clearing. We believe it is similar to other clearing 

arrangements that have been in place before, namely the CME link 

with Singapore, their MOS link, and the CME link with MEFF. We 

are trying to provide benefits to members and benefits to customers 

where we can lower their costs and provide greater efficiencies in 

them doing cross-border trades. 

We have already gotten phase one of the Global Clearing Link 

approved, and in phase one of the Global Clearing Link, the real 

benefit is that it allows U.S. customers to repatriate their funds 

from overseas back into the U.S. What happens today when people 

trade or when traders trade, they can trade all over the world, as 

34

Mr. Damgard just said. There are traders here in the U.S. that 

trade in Europe. There are traders in Europe that trade in the U.S. 

For Eurex, about 20 percent of Eurex’s business comes from the 

U.S., and when a trader in the U.S. trades on Eurex, they trade 

on the exchange, they leave their funds at Eurex Clearing, and 

that is where they put their margin. Thanks to the first phase of 

the Global Clearing Link and the link between the Clearing Corp. 

and Eurex Clearing, now those same U.S. traders can repatriate 

their funds out of Europe and back into the U.S. and hold their 

margins and hold their positions back with their clearing firm here 

in the United States. We can get the money out of Europe and back 

here and it gives them the opportunity to do that with their U.S. 

relationship. 

The second phase of the Clearing Link is a phase where new European customers—what we hope we can do with the second phase 

is to allow a new set of market users in Europe, namely small and 

mid-sized European customers, to have better access to U.S. products. What we are going to hope to allow them to do is to trade 

U.S. products, but use their existing clearing relationships in Europe to be able to clear those products. By doing that, we hope to 

bring a lot of new business into the U.S., and that is probably the 

biggest benefit, is the type of business that we are going to get and 

the new business that is going to come in. 

We are working with the CFTC. We have had extensive discussions with the CFTC. One of the things I should mention is we 

have committed in our exchange application and our approval that 

we will not go forward with the Global Clearing Link in any way 

without full approval of the CFTC of that Global Clearing Link. We 

expect to be filing how we plan to do this fairly soon and we also 

expect that there will be a public comment period in terms of the 

details of the Global Clearing Link. 

The CHAIRMAN. Mr. Carey, in your written testimony, you seem 

to have some concerns relative to the Global Clearing Link. Do you 

care to comment? 

Mr. CAREY. Yes. Thank you, Mr. Chairman. We believe if they 

go forward, the Frankfurt Clearing House should register as a 

DCO. It is the best way to ensure consistent protection for U.S. 

customers. We haven’t seen the application for the Link itself, so 

we are not sure how it is going to function. 

The CHAIRMAN. Mr. Duffy, in his written testimony, and Mr. 

Damgard referred to it somewhat, the FIA appears to raise some 

concerns of possible problems with regard to the SRO structures of 

the exchanges that may create conflicts of interest for the exchanges and allow them to impose rules which benefit themselves 

but have anti-competitive consequences for competing exchanges 

and the users of exchanges. Would you care to give me your response to this concern, please, sir? 

Mr. DUFFY. Well, the Chicago Mercantile Exchange today has 

rules on its book that have been approved by the CFTC for many 

years and we just are upholding all of our rules to make sure that 

the centralized marketplace is not fractured. What we are doing is 

making certain that wash trades, which already are prohibited 

trades under the Commission’s rules, don’t happen at our institution. I believe that is what Mr. Damgard is referring to. 

35

The CHAIRMAN. Mr. Damgard, any comment you wish to make? 

Mr. DAMGARD. We have watched carefully what has gone on in 

the securities industry and we are certainly not sold on the idea 

that the New York Stock Exchange has the right model, where 100 

percent of the directors have to be independent. Our members believe that at least 50 percent of the members of a board ought to 

be independent directors, and that leaves plenty of people left on 

their board who would have industry knowledge. It comes down to 

a definition of what is independent. 

We would argue that floor traders subject to the regulatory authority of their SRO’s, who can be disciplined, by those SRO’s, do 

not qualify as independent. To say otherwise, simply doesn’t meet 

the laugh test. The Chicago exchanges have had many, many qualified independent directors, such as Dan Glickman and Myron 

Scholes. Floor traders who historically looked out only for the interest of the floor, should not qualify as independent. In the old days, 

when there was no competition among the exchanges, the floor 

traders didn’t really have to be concerned about what the customer 

thought because there was only one place to go with the trade. I 

believe such a policy of drawing independent directions from the 

ranks of the floor trading population would hurt the reputation of 

our industry. We need to make sure that customer confidence in 

these exchanges remains very, very high. 

Mr. DUFFY. Mr. Chairman, if I may respond, I thought you were 

referring to some rules that we have enforced at our institution. As 

far as the independence issue related to the governance of the SRO, 

the Chicago Mercantile Exchange is a publicly traded entity and 

our board and all of its members do comply with the listing standards of the New York Stock Exchange and the SEC. We have an 

independent board, which we are required to have by law, with a 

majority made up of independent directors. We do comply with all 

NYSE and all SEC requirements as far as our independence. 

Mr. DAMGARD. I would only respond by saying the New York 

Stock Exchange does not consider local market makers as independent. 

The CHAIRMAN. Mr. Schoenhut, what are your views of the current structure of CFTC oversight of exchange governing bodies and 

disciplinary committees? 

Mr. SCHOENHUT. Thank you, Mr. Chairman, for that question. 

NYBOT is quite satisfied with the CFTC oversight functionality. In 

our experience with the CFTC with respect to our board, I should 

point out that we have five independent or public directors and 

then people of expertise from several trade areas, futures commission merchants both large and small, as well as floor traders comprising the balance of our board. We feel that this system has 

worked successfully for years, as is evidenced by the fact that the 

New York Board of Trade has received many favorable commentaries by the CFTC. We feel that our board and the issues that 

come to our board at times can be very technical in nature, and to 

have expertises such as what we have is very important to our 

business. 

The CHAIRMAN. Thank you. Senator Lugar. 

Senator LUGAR. Mr. Chairman, in carrying on a little further this 

current inquiry, certainly, an enormous amount has been written 

36

in the financial press about boards of directors. Both Fortune and 

Business Week, as I recall, in recent issues have surveyed Sarbanes-Oxley and what it has meant to many corporations, and still, 

a minority of New York Stock Exchange listed stocks seem to have 

something that appears to meet the standards of Sarbanes-Oxley, 

although there are a good number of rationalizations why this is 

not so. 

It is important, and each one of you have said it in your own 

way, that this industry really exemplify confidence levels with regards to the directors. This is a serious issue, but a difficult political issue within each company, or maybe even within each exchange. Really, it is beyond our—well, we are not going to get into 

it exchange by exchange today as to what these circumstances have 

been and how reforms have been made, but I would just say that 

at a time when things are moving well, and each of you are testifying that way and we feel that way, this is a time to make certain 

we are in consonance with the general business community, and it 

is still one of reform. A good number of corporations in America, 

not hopefully any here today, are resisting that reform. They are 

hoping it will blow over as an enthusiasm that came after the stock 

market bubble and what have you. 

I am hopeful that you will work with us as we try to boost you. 

This is not a mutual admiration society, but nevertheless, this committee has taken a strong interest in the strengthening of the industry and in ensuring people of the integrity of it, both at home 

and abroad, and so have you. I simply see something here that is 

important to maybe examine more carefully. I really have not, and 

so I am intrigued, really, by the discussion. 

Let me just ask you, Dr. Newsome, because you have seen historical memory from your own standpoint as Chairman, why do you 

believe the volume of transactions has risen so dramatically on 

some of the exchanges that have been testifying here today? What 

is happening in our economy or in the world or maybe in the structure of these markets and trading practices that would lead to that 

kind of dynamic increase? 

Mr. NEWSOME. Thank you, Senator Lugar. I would respond in a 

couple of ways. One goes directly to the flexibility afforded by the 

Commodity Futures Modernization Act and that leads to part of 

the discussion we are having here about corporate structure. 

Senator LUGAR. Yes. 

Mr. NEWSOME. One of the things that the Act did that was most 

important from this committee and the Congress was to allow the 

exchanges to all get outside of the box that they were required to 

serve in prior to the passage of the CFMA. With that new flexibility, we have seen exchanges go in different directions in terms 

of the types of products they offer, the types of services that they 

offer to their members and to their customers, and differences in 

corporate governance structure, as well. We all have rules and regulations, some just by the CFTC, others, as NYMEX and the CME, 

with regard to the SEC. Even though we are not a publicly traded 

company, we are an SEC registered company and have to abide by 

all of the Sarbanes-Oxley rules, which we have implemented over 

the past year. 

37

While there certainly are some constants, the flexibility to come 

up with differing products and differing services to customers was 

certainly a key component of this increase in volume. I don’t think 

it is a coincidence that it all happened at the same time. 

The second component of that, I believe, is really a maturing of 

the futures industry. If you look at futures on agricultural products, obviously, that goes back many, many years. Over the last 25 

years, there has been an explosion in the development of new products within the futures industry to allow customers in other service 

areas to manage their risk, from the financial products very successfully offered by both the Chicago exchanges to the energy contracts that NYMEX and other products in all the exchanges. 

Customers, end users, have developed more and more comfort 

with how to utilize these products to manage risk. As the banks 

have expanded, as the companies, the underlying producers or 

processors of these products have matured and developed more of 

a comfort level, they have realized the opportunities to utilize futures products to manage risk and therefore, the explosion that we 

have seen over the last few years. 

Senator LUGAR. No one could——

Mr. DAMGARD. May I add a word? 

Senator LUGAR. Yes, Mr. Damgard. 

Mr. DAMGARD. I also think it is competition. The competition has 

caused the existing exchanges to reduce their fees. We all knew 

that they knew how to compete, and they certainly have done so. 

The explosion in volume is clearly a result of more and more people 

utilizing these risk management devices. There is no question in 

my mind but what, even though it was resisted by some 4 years 

ago, this committee deserves an awful lot of credit for making sure 

that competition now exists in our markets. 

Senator LUGAR. I appreciate that comment, especially from the 

standpoint of farmers in the country. The committee maybe is an 

improbable committee to be regulating all of this, although it grew 

from our interest in the agriculture commodities some time ago. 

The same principles have worked, as you all have illustrated, for 

a lot of different situations, different markets. 

One of the problems of testimony of farmers and farm groups 

over the years has been how few farmers either understood these 

markets and their importance, and sadly, how few really took advantage of those opportunities. It appears to me that there probably is a greater participation by people in the agriculture community, producers, in these markets. In part, we have had long discussions of crop insurance at various levels, tried to think through 

with farmers who, at a typical meeting, say in my State would 

have said, we plant the crop, we harvest the crop and take the 

price that you get. God willing, we survive. 

Unfortunately, this kind of faith did not lead to survival. The 

need to have crop insurance against catastrophe, but even more, to 

be thinking in terms of forward contracts, to be making some disciplined sales, is all the difference in a very low-margin business, 

and for many farmers, the only difference between a loss that is 

very severe and the possibilities of staying alive. 

The educational process still is an important one, and although 

many of the farmers now are larger, perhaps, a lot of younger 

38

farmers have come along who do not see what you are doing today 

as gambling, and that used to be the charge, that you folks are 

simply countenancing almost a vast casino situation, many younger 

farmers coming through their own educational process financially 

have seen the value and, in fact, the importance of what is occurring here, quite apart from all sorts of other users in industry or 

other people throughout the world may see this, and I hope that 

will continue. 

It may be a small part of the picture in terms of volume as we 

now look at what was surveyed today, but it is very important to 

this committee. It is very important to our country that our farmers be successful and that they have these opportunities, they have 

confidence in these markets. To the extent that you have enhanced 

that, we really appreciate it very much. 

Mr. Chairman, I would just ask a final request that I put a short 

opening statement I had that I did not deliver in the record. I appreciate your indulgence in that. 

The CHAIRMAN. Certainly. Without objection, that will be done. 

Senator LUGAR. Thank you, sir. 

The CHAIRMAN. You are absolutely right. Mr. Damgard made a 

very good point, that it is critically important that the integrity of 

the markets be maintained. Otherwise, that confidence will not be 

there. While you might still be somewhat identified as solely a part 

of the agriculture community, we know otherwise. The agriculture 

part of it is so vitally important. You don’t find a successful farmer 

today who doesn’t have a computer sitting on his desk, and they 

utilize those computers on a daily basis to bring up the markets 

relative to their particular products that each of you deal with. 

Dr. Newsome, in your testimony, you made reference to a new 

NYMEX study of hedge fund participation in NYMEX natural gas 

and crude oil futures markets. Would you very quickly summarize 

that study’s findings for us, please? 

Mr. NEWSOME. Yes, sir, Mr. Chairman. Not long after coming to 

NYMEX, we experienced some pretty drastic volatility in energy 

markets. The press and many others were quick to point the finger 

at speculators, particularly hedge funds and their involvement in 

the markets. As an exchange with access to the actual data of who 

was trading, I felt that it was very important for us to look at that 

data and actually analyze the role of hedge funds with regard to 

some of our key markets because no one else had that data, and 

even though we had it, we didn’t know the answer to the question. 

In the beginning of August, we undertook a study. We actually 

expanded that study a couple of times to include the whole year 

from January through December of 2004, specifically looking at the 

level of activity of hedge funds in natural gas and crude oil contracts in NYMEX. 

The findings would be somewhat surprising to a number of people, particularly the low level of activity in hedge funds in those 

two markets. With regard to the crude oil market, hedge fund trading was less than 3 percent. In crude oil, hedge fund trading was 

just a hair over 9 percent. Those indicate relatively low levels of 

trading activity, certainly from our standpoint, not large enough 

levels of trading in which they could potentially move the marketplace. 

39

The second thing that we found is that the open interest in both 

of those contracts by hedge funds was quite a bit larger than most 

market participants, indicating that hedge funds tend to hold on to 

their positions for a longer period of time as regard to other market 

participants, therefore actually decreasing volatility because of 

holding onto those positions. 

We go into detail, Mr. Chairman, in terms of that report. The 

fact that we are making it available to this committee today as 

part of the record is actually the first time that anyone has seen 

that report, as we just finished it. I am sure that as you read it, 

there may be other questions that arise and certainly we look forward to working with you to explain our findings in the report. 

The CHAIRMAN. Thank you very much. 

Let me say to each of you, as well as to Chairman BrownHruska, we appreciate your being here to give us your views on 

where we are with respect to the reauthorization of CFTC and 

what changes we should consider relative to the CFMA. Again, I 

will just ask each of you to give us in writing any suggested 

changes and your reasoning therefore. We will look forward to continuing a dialog with you. 

It is truly amazing to sit on the outside of your markets and see 

the true growth and the competition. You are right, Mr. Damgard, 

has probably expanded this, but the sophistication of the investor 

because of the education of your particular institutions has contributed greatly to that, also. We appreciate your continuing work with 

this committee as well as your continuing cooperation with the 

CFTC. 

We will leave the record open for an additional 5 days for written 

questions to be submitted to any of you and we would hope that 

you would immediately get those responses back to us. 

We have another hearing set on Thursday, after which we will 

begin our deliberations as to what direction we are heading. 

Again, gentlemen, thank you very much, and this hearing is concluded. 

[Whereupon, at 12:22 p.m., the committee was adjourned.] 

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(163)

TO CONSIDER THE REAUTHORIZATION OF 

THE COMMODITY FUTURES TRADING 

COMMISSION 

THURSDAY, MARCH 10, 2005, 

U.S. SENATE,, 

COMMITTEE ON AGRICULTURE, NUTRITION, AND FORESTRY,, 

Washington, DC. 

The committee met, pursuant to notice, at 10:08 a.m., in room 

SR–328A, Russell Senate Office Building, Hon. Saxby Chambliss, 

chairman of the committee, presiding. 

Present or submitting a statement: Senators Chambliss and 

Salazar. 

STATEMENT OF SAXBY CHAMBLISS, A U.S. SENATOR FROM 

GEORGIA, CHAIRMAN, COMMITTEE ON AGRICULTURE,

NUTRITION, AND FORESTRY 

The CHAIRMAN. This hearing will come to order, and good morning. 

We are here today to discuss the reauthorization of the Commodity Futures Trading Commission, which is set to expire in September of this year. CFTC is charged with the responsibility of 

overseeing the trading of commodities futures contracts, and the 

Commodity Exchange Act is the basic law that empowers CFTC to 

carry out this responsibility. 

As part of the last CFTC reauthorization in 2000 Congress 

passed the Commodity Futures Modernization Act, making some 

substantial changes in the Commodities Exchange Act. The CFMA 

provided legal certainty for the over-the-counter swaps market and 

also streamlined the regulatory process for exchange, traded futures markets. 

As we proceed into this reauthorization of the CFTC, the committee is hoping to learn not only how people view the changes 

made in 2000, but also what changes, if any, need to be made in 

future legislation. 

This is the second hearing held by the committee on the subject 

of CFTC reauthorization, and I thank all the witnesses for appearing today to discuss this very important topic. We have already 

heard from the acting chairman of the CFTC as well as a group 

of people representing U.S. futures exchanges and the futures industry. 

Today I would like to welcome representatives from the over-thecounter markets and others from across the industry. The committee looks forward to hearing your views on this reauthorization 

164

process. We have with us today Mr. Jeffrey Sprecher, the CEO of 

InterContinentalExchange in Atlanta, Georgia; Mr. Robert Pickel, 

Executive Director and CEO of the International Swaps and Derivatives Association from New York; and Mr. Oliver Ireland, Partner with Morrison & Foerster here in Washington, DC, on behalf 

of Huntsman Chemical, a member of the Industrial Energy Consumers of America. 

This will be our first panel, and gentlemen, we welcome you this 

morning. We have a number of other hearings that are ongoing 

this morning, including a very important hearing that affects this 

committee and that is the markup on the budget for fiscal year 

2006, so we have a number of members who are absent as a result 

of that hearing and others. 

I am advised that Senator Harkin will be running a little late 

getting here, but he will be here shortly. We are going to go ahead 

and proceed with opening statements from this first panel. Mr. 

Sprecher, we will start with you, then Mr. Pickel and then Mr. Ireland. We welcome you again. Thank you for being here. We look 

forward to your comments. 

Mr. Sprecher. 

STATEMENT OF JEFFREY C. SPRECHER, CHAIRMAN 

AND CHIEF EXECUTIVE OFFICER, 

INTERCONTINENTALEXCHANGE, ATLANTA, GEORGIA 

Mr. SPRECHER. Thank you, Mr. Chairman. 

My name is Jeff Sprecher, and I am the founder, the Chief Executive Officer and the Chairman of InterContinentalExchange, 

which in our industry is also known as ICE. ICE operates the leading global electronic over-the-counter marketplace for trading energy commodities and derivative contracts that are based on energy 

commodities. Energy commodities that are traded on our platform 

include oil, natural gas and power. ICE also operates an energy 

commodities futures exchange through a wholly owned Londonbased subsidiary called the International Petroleum Exchange of 

London, which is also known in the industry as the IPE. 

I would like to thank the committee for its effective and farsighted work in developing and adopting the CFMA. The CFMA 

has been critical to my company’s success for three reasons. First, 

the CFMA provided legal certainty for OTC derivative contracts. 

Second, the CFMA created a new category of trading facility called 

the exempt commercial market. This committee recognized that 

electronic marketplaces whose participants are limited to eligible 

commercial entities, or ECMs, trading on a principal-to-principal 

basis do not require the same level of Federal oversight as futures 

exchanges that are accessed by the retail public. The CFMA also 

permitted the clearing of OTC transactions. Today ICE provides 

clearing for a variety of its OTC contracts, reducing unwanted credit exposure and increasing market liquidity. 

As you mentioned, we are headquartered in Atlanta, Georgia and 

we operate a many-to-many electronic platform that allows buyers 

and sellers of physical commodities and derivative contracts to view 

and act on each other’s bids and offers. ICE, unlike Enron with its 

EnronOnline, is not a party to any of the transactions on our platform. ICE’s electronic platform is designed to enhance the transVerDate 0ct 09 2002 11:31 Aug 12, 2005 Jkt 020612 PO 00000 Frm 00168 Fmt 6601 Sfmt 6601 C:\DOCS\20612.TXT TOSHD PsN: TOSH
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parency, the speed and the quality of trade execution. In addition 

our platform offers a comprehensive suite of trading-related services including OTC electronic trade confirmation, access to clearing 

services and the publication and dissemination of market data and 

information. 

As I stated earlier, ICE operates as an ECM under the jurisdiction of the CFTC. As an ECM ICE is required to comply with access, with reporting and recordkeeping requirements. ICE has 

worked closely with the CFTC since our inception and we look forward to continuing a cooperative relationship. We also look forward 

to working with this committee as it considers the many issues facing the CFTC during its reauthorization. 

With respect to issues affecting ECMs in particular, ICE is of the 

view that the CFMA and the rules adopted by the CFTC provide 

for an effective framework for oversight of commercial marketplaces. There is no need to amend the Commodity Exchange Act in 

this area. The CFTC has promoted open, freely accessible and 

transparent markets including permitting the creation of ECMs. I 

believe that restricting trading activity through additional regulation would only adversely affect the market liquidity and price 

transparency and would not reduce price volatility that we have 

been seeing recently in energy. 

On behalf of ICE I would again like to thank the committee for 

its excellent work in enacting the CFMA. It’s been a clear benefit 

to my company, and I would submit, to the producers and the users 

of energy commodities around the world. 

ICE looks forward to working with the committee during the reauthorization process, and at the appropriate time I will be happy 

to take your questions. Thank you. 

[The prepared statement of Mr. Sprecher can be found the appendix on page 188.] 

The CHAIRMAN. Great. Thank you. 

Mr. Pickel. 

STATEMENT OF ROBERT G. PICKEL, EXECUTIVE DIRECTOR 

AND CHIEF EXECUTIVE OFFICER, INTERNATIONAL SWAPS 

AND DERIVATIVES ASSOCIATION, INC., NEW YORK, NEW 

YORK 

Mr. PICKEL. Mr. Chairman and members of the committee, I appreciate your invitation to testify today on behalf of ISDA. ISDA 

has appeared frequently before the committee in prior years and 

we welcome the opportunity to be with you today as you continue 

your important hearings with respect to legislation to reauthorize 

the Commodity Futures Trading Commission. 

ISDA is an international organization, and its more than 600 

members include the world’s leading dealers in swaps and other 

off-exchanged derivative transactions commonly referred to as OTC 

derivatives. ISDA’s membership also includes many of the businesses, financial institutions, governmental entities and other end 

users that rely on OTC derivatives to manage risk inherent in their 

core economic activities effectively and efficiently. I am also happy 

to say that my two fellow panelists, their firms are also members 

of our organization. 

166

The Commodity Futures Modernization Act was adopted by Congress with broad bipartisan support after careful consideration over 

several years by four congressional committees and with the support of the President’s working group. The CFMA extended much 

needed regulatory relief for the futures exchanges, provided legal 

certainty and regulatory clarify for OTC derivatives, and removed 

the ban on the trading of single stock futures. 

ISDA’s principal interest in the CFMA was and remains with 

those provisions intended to provide legal certainty for OTC derivatives. The phrase ‘‘legal certainty’’ means simply that the parties 

to an OTC derivatives transaction must be certain that their contracts will be enforceable in accordance with their terms. The 

CFMA framework for providing legal certainty is based on a longstanding consensus among Congress, the CFTC and others that 

OTC derivative transactions are not appropriately regulated as futures under the CEA. 

The legal certainty provisions of the CFMA were intended by 

Congress to reduce a systemic risk and promote financial innovation. Our experience since 2000 confirms that both of these objectives have been achieved. The use of OTC derivatives for risk management purposes has continue to grow both in periods of economic 

downturn and uncertainty and in times of economic expansion. 

The reductions in systemic risk resulting from enactment of the 

legal certainty provisions of the CFMA have not come at the expense of financial innovation. New types of OTC derivatives have 

gained increased market acceptance since enactment of the CFMA. 

For example, the significant growth in credit default swaps to manage credit risk in times of volatility and uncertainty has been 

greatly enhanced by the legal certainty provisions of the CFMA. 

Similarly, the legal certainty provisions have encouraged dealers to 

develop and businesses to use an increasing range of new kinds of 

OTC derivatives such as weather derivatives to manage additional 

types of risk. Finally, the CFMA removed the regulatory barriers 

to clearing of OTC derivatives, and while collateralized transactions remain more prevalent, the emergence of alternative clearing proposals attests to the positive effects of the CFMA on financial innovation. 

For these reasons ISDA shares the view expressed by Acting 

CFTC Chair Sharon Brown-Hruska that the CFMA functions extremely well. In our view this is attributable to the care with which 

Congress constructed the legislation, to the even-handed manner in 

which the CFTC has interpreted and administered the CFMA in 

accordance with congressional intent, and to the CFTC’s vigorous 

enforcement program following the collapse of Enron and the California energy situation. 

ISDA believes that the experience that its members and others 

have had under the CFMA demonstrates that there is no fundamental need for Congress to make substantive changes to those 

portions of the legislation governing OTC derivatives. ISDA is of 

course aware that others have advocated substantive changes to 

the legislation, including changes with respect to OTC derivatives. 

In our view, however, the case for such changes simply has not 

been made. 

167

We understand that you and your colleagues will want to have 

the benefit of a full range of views concerning the CFMA. We think 

this is highly desirable and welcome the opportunity to participate 

constructively in the debate and discussion of possible changes. We 

do, however, urge you and your colleagues to proceed cautiously in 

reopening the CFMA. The legislation, although carefully crafted, is 

complex and the potential for unintended and undesirable consequences from selective changes is great. 

We also urge you and your colleagues to ensure that your committee asserts fully its right and responsibility to review and approve any substantive changes to the CEA. Our experience in recent years has confirmed that the use of freestanding amendments 

offered to separate legislation without your committee’s review, 

scrutiny and public comment is an undesirable method of considering changes to legislation as complex and important as the CEA. 

Let me conclude, Mr. Chairman, with three observations. First, 

by providing legal certainty and regulatory clarity for OTC derivatives in a manner consistent with the longstanding policies and the 

CFTC, the CFMA materially reduced systemic risk and encouraged 

financial innovation. Second, the regulatory relief provided to the 

futures exchanges has likewise provided substantial benefits to the 

capital markets. Together these two factors confirm that the policy 

judgments made in 2000 were sound then and remain so today. 

Finally, ISDA remains available and is looking forward to working cooperatively and constructively with your committee, and we 

look forward to the opportunity to do so in the coming months. 

I look forward to any questions you may have. Thank you. 

[The prepared statement of Mr. Pickel can be found in the appendix on page 199.] 

The CHAIRMAN. Thank you very much. 

Mr. Ireland. 

STATEMENT OF OLIVER I. IRELAND, PARTNER, MORRISON & 

FOERSTER, LLP, WASHINGTON, DC, ON BEHALF OF

HUNTSMAN CORPORATION AND INDUSTRIAL ENERGY

CONSUMERS OF AMERICA 

Mr. IRELAND. Thank you, Mr. Chairman and members of the 

committee. 

I am a partner in the D.C. office of Morrison & Foerster. I previously served as Associate General Counsel to the Board of Governors of the Federal Reserve System, and there advised the Board 

on matters relating to derivative transactions. I am here on behalf 

of the Huntsman Corporation, a member of the Industrial Energy 

Consumers of America. I thank you and the members of the committee for the opportunity to participate in today’s hearing on 

CFTC reauthorization legislation. 

Huntsman is a global leader in the chemical manufacturing business. Global manufacturing companies like Huntsman depend on 

the commodities markets for their materials and rely on fair pricing in those markets. A key commodity for Huntsman, as well as 

thousands of other domestic businesses and millions of farmers and 

consumers is natural gas. 

While we generally believe that the Commodity Exchange Act as 

amended by the Commodity Futures Modernization Act of 2000 

168

functions exceptionally well, price volatility in the natural gas contracts since mid 2000 suggest that the market for natural gas futures may not be operating efficiently, and that the regulatory 

framework for these contracts should be reviewed. 

A price of natural gas that is shaped by fundamental forces of 

supply and demand will allocate the supplies of gas within the 

economy most effectively. Facilitating this pricing function is one of 

the key purposes of the Commodity Exchange Act. However, if this 

pricing process breaks down, that breakdown can result in inappropriate pricing and inefficient allocation of natural gas in the economy. 

We believe that there is evidence that the level of price volatility 

in the futures market for natural gas is impairing, rather than promoting, pricing in the natural gas market. Since 2000 day-to-day 

price volatility in the natural gas futures contract traded on the 

NYMEX has increased substantially, even after taking into account 

the higher prices for natural gas during this period. By some measures price volatility in the natural gas contracts traded on the 

NYMEX has increased by 60 percent. During the same period commercial trading participants on the NYMEX have declined to a relatively small percentage of the market participants. We believe 

that this price volatility raises questions as to whether the trading 

in natural gas may be subject to inappropriate practices. 

While the CFTC has responded to a number of unlawful acts in 

the markets for natural gas, we believe that the committee should 

consider four changes to the Commodity Exchange Act to augment 

the authority of the CFTC to address natural gas contracts. 

First, we think that the committee should consider regulating 

natural gas under the Commodity Exchange Act under the same 

framework applicable to agricultural commodities. 

Second, we believe that the committee should consider requiring 

the CFTC to review and seek public comment on and approve existing and new rules for natural gas contracts based on consistency 

with the core principles established in the Commodity Exchange 

Act. We believe that this process should focus particular attention 

on price fluctuation limits or circuit breakers. Circuit breakers can 

provide time for markets to evaluate new information and to act 

appropriately, therefore promoting price discovery. We believe that 

a circuit breaker more on the order of the 8 percent that was in 

effect prior to the year 2000 should be the benchmark and that circuit breakers above that level should be scrutinized carefully. 

Third, we believe that the committee should consider giving the 

CFTC backup authority to require large position reporting where 

such reports are not otherwise being made. The CFTC should also 

be authorized to require recordkeeping to help police the reporting 

requirement. We recognize that these authorities should be used 

sparingly, taking into consideration the burden that they may impose as well as their utility in detecting or deterring inappropriate 

market practices. 

Finally, we believe that the committee should consider giving 

special authority to the CFTC to address rules for settlement in the 

natural gas futures contracts, allowing for cash settlement where 

market manipulation is suspected, and thereby making short 

squeezes in the futures market more difficult. 

169

Thank you for the opportunity to be here today, and I would be 

happy to address any comments or questions the committee may 

have. 

[The prepared statement of Mr. Ireland can be found in the appendix on page 213.] 

The CHAIRMAN. Thank you very much. Thanks to all of you. 

Mr. Ireland, I will let you back up a minute and explain to my 

limited brain capacity this circuit breaker. Would you run through 

that one more time? I am not sure I followed you. 

Mr. IRELAND. Many markets, including the futures markets, have 

what I refer to as a circuit breaker which when the price of trading 

reaches a certain level at variance with the previous trade’s close, 

trading stops either for the day or for some period of time. For example, in the natural gas contract on the NYMEX up until early 

the year 2000 if the price moved 15 cents they stopped trading 

until the next day. That gives——

The CHAIRMAN. Which is what we refer to as limit up or limit 

down? 

Mr. IRELAND. Limit up or limit down, the same thing. Similar 

provisions are in place in the equities market and were recommended by the President’s working group on financial markets 

following the 1987 stock market break. 

The CHAIRMAN. There is no such provision for natural gas is 

what you are saying? 

Mr. IRELAND. Well, there is a provision today, but the dollar limit 

is I believe on the NYMEX $3, and that stops trading for 5 minutes, and then it resumes, and then it stops if it moves another $3. 

With the prevailing price of natural gas of about $6, that $3 trading limit, which restarts again so quickly, I do not think imposes 

any meaningful time for the market to catch up with new information. 

The CHAIRMAN. Explain to me again what your thought is relative to what sort of regulatory measure ought to be established to 

control that. 

Mr. IRELAND. We think that the CFTC should review each natural gas contract provision or exchange rule applicable to natural 

gas for consistency with the core principles. We believe that when 

the CFTC reviews those rules, as the current gas contract does provide for a trading limit greater than the pre-early 2000 number, 

which was about 8 percent, that that number ought to receive particular scrutiny and the Commission ought to affirmatively find, 

based on substantial evidence, that that number is not going to facilitate manipulation in the markets, and that that is consistent 

with the price discovery function of the exchange. 

The CHAIRMAN. OK. Mr. Sprecher, we understand that ICE is an 

exempt commercial market under the CEA, and why are you not 

regulated in the same way as NYMEX? 

Mr. SPRECHER. Thank you for your question. As an exempt commercial market, ICE is limited as to the participants that we can 

allow to use our system, and under the CFMA those participants 

are called ECEs, I believe, exempt commercial entities, but they essentially are companies with substantial knowledge and a substantial asset base. I believe a company must have at least $100 million 

170

worth of assets, $10 million in net worth, and a substantial business in the industry to participate on ICE. 

We are not allowed access—to allow participants to access our 

platform who are retail customers, unknowledgeable or small net 

worth companies, which is allowed in the futures industry, and we 

think the Modernization Act was very well crafted in recognizing 

that the Government does not need the same level of scrutiny to 

two large international oil companies doing business with one another as opposed to the broad access consumer-base marketplaces 

that are a part of the futures business. 

The CHAIRMAN. Let me ask you about the comments of Mr. Ireland relative to this circuit breaker issue. You of course trade in 

energy contracts. 

Mr. SPRECHER. Yes. 

The CHAIRMAN. While you have this exempt status, I am certain 

that there obviously are times when you have interaction with 

CFTC relative to the contracts you utilize. Would you comment on 

his statement relative to this proposed control of the volatility, and 

also how you interact with CFTC relative to energy contracts that 

you have. 

Mr. SPRECHER. Sure. I have a number of thoughts. First of all 

with respect to reauthorization, I have the view that the CFTC has 

a lot of tools in its capacity to make sure that markets run orderly 

and to make sure that there is no fraud or manipulation, and while 

I do not have a specific stake in the New York Mercantile Exchange, I am aware that exchanges in general have anti-fraud, 

anti-manipulation, and free and orderly market responsibilities as 

part of their charter and mandate to the CFTC. I do not know that 

the reauthorization needs to specifically address new language. 

Now that being said, there is no question that natural gas has 

become a preferred fuel in our country because of its clean-burning 

efficiency and wide accessibility, and as such the market has become incredibly complicated with many users and gas moving 

around the country. The New York Mercantile Exchange trades a 

single contract that is delivered at the Henry hub in Louisiana. On 

the over-the-counter market, or in layman’s terms, the non-exchange market, there are over 200 different delivery points for natural gas, and they are all woven together in a complex marketplace, and so while it might be beneficial to halt trading in one 

market to allow an orderly process, I think the reality is that there 

are these other markets that would continue to trade unabated, 

and you run the risk of essentially allowing sophisticated market 

participants or these ECEs that trade in the over-the-counter market to continue to trade and hedge during high volatility while the 

retail customer and the smaller participant who do not access these 

markets would essentially be trapped by an artificial price cap for 

a moment in time. I am not sure it is ultimately a workable solution given the complexity of our markets today. 

The CHAIRMAN. Mr. Pickel, do you have a comment relative to 

that issue? 

Mr. PICKEL. Not specifically on the recommendations that Mr. 

Ireland made. I would say that you have here represented on the 

panel the range of activity. You have comments regarding an actual exchange, the NYMEX. You have the perspective of the ECM 

171

in ICE. Then you have the perspective that ISDA brings to the 

issues, which is the privately negotiated sector where parties will 

enter into a transaction on a bilateral basis typically governed by 

a contract that we have published and developed over the years, 

and again, under the CFMA those transactions are excluded from 

the CEA in recognition that those transactions are typically done 

between sophisticated parties. They negotiate a contract and agree 

to their own protections in that contract, and it is really only those 

two parties who are aware of the terms of that particular contract, 

as distinct from an exchange where that price gets published and 

is available on screens on a running basis, and also information regarding the trading on ICE that can also be obtained by those people who are participating in that marketplace. 

The CHAIRMAN. Would your customers’ transactions not have an 

influence on the price of natural gas on NYMEX, for example? 

Mr. PICKEL. The transaction itself, no, I do not think those would 

serve that price discovery function. Now, the parties may in turn 

go and look to lay off some of their exposure either on the NYMEX 

or on ICE or some other market that might be available, and to the 

extent that those activities trigger concerns from a manipulation 

standpoint, the protections and the authorities that the CFTC has 

would apply, but with respect to those activities, not with respect 

to the bilateral contract. 

The CHAIRMAN. Mr. Ireland, is it your thought that regulation 

ought to extend to those private contracts as well? 

Mr. IRELAND. My thought is that we ought to treat natural gas 

more as an agricultural commodity, and agricultural commodities 

were excluded from many of the exemptions created in the Commodity Exchange Act and the Commodity Futures Modernization 

Act. To a certain extent, yes, we would restore some of the CFTC 

provisions applicable to the natural gas contract that do not apply 

now to over-the-counter transactions. 

The CHAIRMAN. Before I forget, Mr. Pickel, you mentioned weather derivatives. Again, explain that to me if you will. Give me your 

definition again of a weather derivative and what we are talking 

about here. 

Mr. PICKEL. It is a transaction typically entered into again on a 

bilateral basis using ISDA documentation, where a party may look 

to hedge his exposure that he might have as a result of weather 

activity, for instance, rainfall is typical, heating degree days, there 

are often contracts done on that. This is a growing, this is a newer 

product, but it allows, for instance, an ice cream manufacturer who 

thinks it is going to be—whose profits depend on it being a very 

hot summer, buying some protection in the event that the summer 

ends up being cooler than expected. This allows them through a bilateral contract to obtain some financial protection against the exposure that it might have to a cooler than normal summer. 

The CHAIRMAN. Again, that would be an exempt transaction. 

Mr. PICKEL. Again, done pursuant to the requirements of typically Section 2(g) of the CFMA. It is between parties that satisfy 

the requirements for eligible contract participants, and if it is individually negotiated as described in that particular clause, then yes, 

and I mean weather derivatives in particular are very much taiVerDate 0ct 09 2002 11:31 Aug 12, 2005 Jkt 020612 PO 00000 Frm 00175 Fmt 6601 Sfmt 6601 C:\DOCS\20612.TXT TOSHD PsN: TOSH
172

lored to the specific needs of the parties, so virtually all of those 

would satisfy the individual negotiation requirement there. 

The CHAIRMAN. Mr. Sprecher, one issue that keeps arising is the 

situation involving Enron and the collapse of that company and the 

obvious financial effect on not just employees but investors. How is 

ICE different from EnronOnline and what protections are in place 

in your opinion that really will not allow another situation involving Enron in the industry to occur? 

Mr. SPRECHER. First of all, probably the main difference between 

ICE and Enron is that Enron was a party to every buy and sell 

transaction on its EnronOnline, whereas we simply are operating 

a neutral marketplace. We are more like an eBay, running the 

eBay site where buyers and sellers come together, and we are not 

a party to the transactions. 

I am sure of most interest to you in your unique role is that my 

understanding is that Enron received an exemption from oversight 

by the CFTC, and thanks to the foresight I guess of the committee 

in putting in the CFMA, companies like mine are actually in this 

unique category called ECMs where the CFTC does have oversight 

on my company and where we are tasked with anti-fraud and antimanipulation responsibilities and accountable to the CFTC. 

The CHAIRMAN. Does the CFTC ever come to you and say: We are 

doing some oversight on natural gas; we want to see some of your 

contracts? 

Mr. SPRECHER. Yes, actually quite often. It is obvious that there 

was a fair amount of nonsense that went on in the energy markets 

early in this decade, and in trying to build an enforcement record 

and hold people accountable for their actions we have become a 

data repository for transactions that were done, and we often provide that information to the CFTC so that they can recompile trading. One of the luxuries of electronic trading is that it is saved in 

a data base and the CFTC has tasked us with the responsibility 

to keep those records intact and to be able to provide them to them. 

I would also mention to you that we have a similar relationship 

with the Federal Energy Regulatory Committee and work closely 

with them in the same vein. 

The CHAIRMAN. Is there any pattern that has developed that 

would indicate that when certain things happen that that triggers 

CFTC coming to you, for example, a spike or increase in oil prices, 

or is there a pattern that dictates when they are going to come ask 

you for those contracts, or they do it just at random? 

Mr. SPRECHER. It is a bit of actually a two-way street. A unique 

spike price is very often an example of when they would come to 

us, also a specific investigation that may be underway against either an unexplainable market activity or an individual company or 

a trader. Similarly, we have adopted with the CFTC a mechanism 

where if we ourselves see something in the market that we cannot 

explain, we report it to the CFTC so that they are aware of it, and 

between us work out some kind of data coordination. 

The CHAIRMAN. Senator Salazar. 

173

STATEMENT OF HON. KEN SALAZAR, A U.S. SENATOR FROM 

COLORADO 

Senator SALAZAR. Thank you very much, Chairman Chambliss, 

and thank you members of the committee for spending some time 

with us here this morning. 

My own view is that CFMA and the CFTC have been working 

well, but this is an opportunity, as you go through the needle of 

reauthorization, to figure out how we might be able to improve the 

law. 

My distinguished colleagues Senator Leahy and Senator Feinstein have talked about the need for additional oversight of overthe-counter energy markets and many of them have talked to me 

about the need to move forward, and in that direction, Senator 

Feinstein has legislation that would modernize the act from her 

point of view and would give additional authority to prevent fraud 

and manipulation in the energy markets. 

I was wondering whether you might share with me your perspectives on Senator Feinstein’s legislation and whether or not that is 

a direction that we should be encouraged to head in as we review 

the reauthorization of CFMA? 

Mr. PICKEL. Perhaps I will start on that, and obviously we have 

been active in the past 5 years as we have seen Senator Feinstein’s 

proposal come up for consideration on the floor of the Senate and 

reacting to that. 

As we have all said, the CFMA was a great advance forward. 

One of the ways it was was recognizing that there really are several different ways in which products are transacted and entered 

into so that you have a provision that is very much consistent with 

the longstanding policy of Congress and the CFTC, that the types 

of bilateral contracts that people enter into privately negotiate, tailor the terms specifically to their needs, and also typically entered 

into using an ISDA contract, are the types of private activity that 

are not subject to and should not be subject to regulation by the 

CFTC. 

Mr. Ireland mentioned the agricultural commodities which were 

very consciously recognized as being something separate. There are 

a number of provisions in the CFMA that recognize that energy 

may have some different features, and depending on the type of activity and the level of interaction between parties and their effect 

on the marketplace, there are provisions in there that put in a different layer of regulation, if you will, including anti-fraud and antimanipulation authority, so those protections are in there. In fact, 

the CFTC since the CFMA was enacted has had a vigorous enforcement program in light of the California energy situation in light of 

some of the effects on the energy marketplace, and they should be 

applauded for that activity, and they have confirmed that they feel, 

and they have repeated this several times over the last several 

years, that they have sufficient authority to take action against 

fraud that happened in those marketplaces, and I am sure that 

they will continue to do that and protect consumers in the energy 

area. 

Mr. SPRECHER. I guess I would echo Mr. Pickel’s thoughts in that 

my company is of the opinion that the CFMA and the statutory 

oversight of the CFTC has the provisions that they need to run efVerDate 0ct 09 2002 11:31 Aug 12, 2005 Jkt 020612 PO 00000 Frm 00177 Fmt 6601 Sfmt 6601 C:\DOCS\20612.TXT TOSHD PsN: TOSH
174

fective markets. In our dialog with the Commission they too have 

said to us that they believe they have all the tools that they need. 

I understand the frustration in the West and am sympathetic to 

it. We as a marketplace want there to be fair and orderly markets. 

My company charges a commission on every trade, so the more 

trades that are done, the more money we make, and the only way 

you can bring more participants into a market is if they feel that 

it is fair and orderly. 

With respect to the specific Feinstein legislation, we think that 

it is a bit redundant from what is already available to the CFTC. 

Senator SALAZAR. Mr. Ireland. 

Mr. IRELAND. Senator Salazar, our particular concern is the natural gas contract, and more particularly, volatility in the natural 

gas contract. As I understand Senator Feinstein’s legislation it is 

substantially broader than that. Like my colleagues on the panel 

we generally think that the CFMA has worked well and that the 

Commodity Exchange Act has worked well as amended by the 

CFMA, and we have a much narrower issue than is addressed by 

the Feinstein bill. 

We also think that there are particular characteristics in the gas 

contract that are different than other energy contracts. 

Senator SALAZAR. I am interested also to find out a little bit more 

about these weather derivatives. My wife is the proud owner and 

operator of a Dairy Queen and——

[Laughter.] 

Senator SALAZAR. [continuing] is very acutely aware of what happens when you have a cold day and you are trying to sell ice cream. 

I am wondering if you could just tell us a little bit more about how 

weather derivatives do actually work and is it an emerging part of 

what is happening with commodity trading? It is a concept that I 

had not heard about until this morning. 

Mr. PICKEL. Perhaps Mr. Sprecher can indicate whether he is developing a contract on ICE for weather derivatives. I really cited 

that example in my testimony as indication of innovation. New 

products, new ways of looking at risk, developing new tools to help 

companies manage the risks that they have. The traditional OTC 

derivative had been developed in the interest rate world, the FX 

world. Once that was developed people said, well are there not 

other types of risks we can apply this same technology, if you will, 

to manage risk? 

Weather is one of the next steps. I do not know that people 

would say that it is going to grow into the size of business that that 

interest rate and currency or the credit derivative business is, but 

nevertheless, it is an indication that by having the right regulatory 

framework you encourage innovation, people are developing new 

tools. 

As far as the specifics of the trade, it is really very much dependent upon where somebody works or has their Dairy Queen or has 

their factory, where they have their market, what the particular 

historical weather trends are, because it is very much—the pricing 

of it, the level at which you are willing to buy or sell protection is 

very much dependent upon what the historical experience is, and 

fortunately here in the United States we have a very deep and rich 

history of collecting rainfall data, temperature data, so it provides 

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a very conducive environment for developing that. Other countries 

do not have that same rich history in terms of collecting that information, so it is a product that has potential, has application, but 

it is really cited by me more as an example of innovation than in 

terms of the next big thing. 

Senator SALAZAR. I have to go to a meeting with the Secretary 

of Interior but I wanted to thank the panel for participating here 

with us this morning, and I applaud and appreciate the leadership 

of Chairman Chambliss on this important issue and look forward 

to the reauthorization of CFMA. 

Thank you very much. 

The CHAIRMAN. Thank you very much, Senator Salazar. 

Mr. Sprecher, the acronym of ICE may be an appropriate acronym to initiate these weather contracts. 

[Laughter.] 

The CHAIRMAN. I want to be a little bit informal because I have 

been informed that Senator Harkin is now not going to be able to 

make it, and I do not want to have all this expertise here and not 

take full advantage of it. Just before we close, if any of the three 

of you have any comments that you feel need to be made relative 

to any further explanation of anything you have said or anything 

we have not asked about, I want to give you an opportunity for 

that. Does anybody want to make any additional comments? 

Mr. PICKEL. Mr. Chairman, I might just reemphasize something 

that I mentioned in my testimony. I am sure you are well aware 

of these provisions, principally in the energy bill in the past Congress that were amending provisions of the Commodity Exchange 

Act, and it is important for you and for your committee to work 

with the Energy Committee to let them know that you have a process this year in reauthorization, you are going to be looking at various aspects of the CEA and that it is really appropriate for those 

issues to be considered through your committee and not through 

other processes. I would just reemphasize that. 

The CHAIRMAN. Thank you. That will be done. When we went 

through the reauthorization back in 2000 I was on the subcommittee that Congressman Tom Ewing chaired over on the 

House side, and of course, Tom led the way on our side on that, 

and basically it was two of us that worked on that side. The one 

thing that I walked away from that process with was an understanding that this was a highly complex area of the financial community that unsophisticated people needed to stay away from. I am 

not just sure how much Government involvement ought to be relative to the ability of individuals to enter into contracts. 

By the same token I am sensitive to what you said, Mr. Ireland, 

relative to outside transactions having an influence on market 

transactions. I do want to make sure that as we go through this 

process we thoroughly vet that and make sure that we give it every 

due consideration as to whether or not there should be some regulation. 

In that vein, let me just close with you by saying, as I am going 

to tell the other panel, as I told the folks on Tuesday, we are not 

asking for any additional comments. We have your statements. We 

know where your positions are. If you want to provide any comments, suggestions, recommendations to us in writing in addition 

176

to what you have done already as a result of this hearing and the 

hearing on Tuesday, please feel free to do so. 

We do not have a timeline set. Senator Harkin and I have talked 

about the fact that we are going to complete this hearing, analyze 

the information that we have received, and then we will move 

ahead. I just want to make sure that we let everybody who has a 

stake in this complex issue to feel like they have had full opportunity to provide us information. 

Again, thank you all very much for being here. We appreciate 

your testimony and participation. 

We will move to the next panel which will be Mr. Daniel J. Roth, 

President of the National Futures Association of Chicago; Mr. John 

G. Gaine, President, Managed Funds Association here in Washington, DC, and Micah S. Green, President of the Bond Market Association here in Washington, DC. 

Gentlemen, thank you very much for being here today. We appreciate your participation in this process as we move forward with reauthorization of CFTC, and we will again go down the line, starting with you, Mr. Roth. Thank you, and we look forward to your 

testimony. 

STATEMENT OF DANIEL J. ROTH, PRESIDENT AND CHIEF

EXECUTIVE OFFICER, NATIONAL FUTURES ASSOCIATION, 

CHICAGO, ILLINOIS 

Mr. ROTH. Thank you, Mr. Chairman. 

National Futures Association is the industry-wide self-regulatory 

body for the futures industry, and I know that the process of selfregulation has come under a fair amount of criticism over the last 

couple of years, and the problems that have been encountered over 

in the securities industry have been very well publicized. 

What has not been very well publicized is the success that selfregulation has had in the futures industry, and what I would point 

out to you is that since 1982, which is when NFA began operation, 

since the date that NFA began operation——

The CHAIRMAN. What was that, 1982? 

Mr. ROTH. 1982. Since that time volume on U.S. futures exchanges has increased by over 1,200 percent. During that same period of time customer complaints have actually dropped by 74 percent, and that is a fairly significant and dramatic achievement, and 

it is an achievement that was not an accident. It was the result of 

a lot of hard work. It was the result of a very close working partnership between the CFTC and NFA to close down the boiler rooms 

and the bucket shops that generated so many of those complaints. 

Today though I am concerned that all the progress that we made 

in shutting down those types of firms, all that progress may be in 

jeopardy, and it may be in jeopardy because the CFMA, for all of 

its success, failed to achieve one of its customer protection objectives. In the CFMA Congress tried to clarify once and for all the 

CFTC’s authority to protect retail customers that were investing in 

foreign currency futures. As we sit here today, the Commission’s 

authority to protect retain customers may be more uncertain now 

than it was then, and the main problem is the Zelener decision 

from the 7th Circuit that you have heard about and that we talked 

177

about at some length in the last hearing. That decision, in my 

view, really did three things. 

No. 1, it made it a lot harder for the Commission to prove that 

these leveraged contracts marketed to retail customers to speculate 

in commodity prices made it much harder to prove that those contracts are in fact futures. No. 2, the decision made it much easier 

for the unscrupulous, for the fraud guys to set up their operations 

in such a way that they can place themselves beyond the reach of 

the CFTC. No. 3, by doing those two things, that decision, in my 

view, created an honest to God real live customer protection issue. 

To make matters worse, the committee should be aware that this 

is not a foreign currency problem, per se. There was nothing in 

that Zelener decision that limited its rationale to that particular 

product, to foreign currency products. The scammers that are setting up boiler rooms to sell foreign currency products under the 

Zelener decision could just as easily sell heating oil products, unleaded gas, natural gas, ag products, metal products, anything. 

In the view of National Futures Association, this decision has 

created a real customer protection issue, and we feel that it is an 

issue that Congress has really got to tackle head on. 

In all the discussions I have heard four different reasons why 

Congress should not reopen the Act, why Congress should not address this issue, and frankly, I do not find any of them particularly 

persuasive. 

No. 1. I have heard some argue that there is no need to clarify 

the CFTC’s authority to protect retail customers because the State 

regulators have all the authority necessary to go after these firms. 

I have spent over 20 years working with State regulators, and I 

can tell you firsthand that I know that they are dedicated and they 

are committed and they are intelligent and they are overwhelmed. 

If anybody thinks that the State regulators have both the resources 

and the expertise to protect retail customers from these futures 

look-alike scams, well, they are just dreaming. 

No. 2. I have heard people say that there is no need for Congress 

to act here because the CFTC may be able to litigate its way out 

of the Zelener problem, that the CFTC can just bring different 

types of cases with different types of evidence, and deal with the 

problem that way. 

Mr. Chairman, I have explained in my written testimony why 

that is nowhere near as easy as it sounds, and that really to try 

to rely on litigating our way out of the Zelener problem places an 

awful lot of chips on a bet that is no sure thing. 

No. 3. I have heard that it is just premature. You know, the 

Zelener decision was handed down by the 7th Circuit last August. 

The CFMA itself is relatively new and it is just premature to be 

doing anything at this point and we should wait and let events 

unfurl. Well, realistically, if we talk about waiting, or waiting till 

the next reauthorization, and we all know that an awful lot of people can get hurt in 5 years, and I just do not think that that is 

an acceptable approach. 

The final thing that I have heard, Mr. Chairman, is that if Congress does act in this area, whatever we do should be limited to 

deal with just Forex products and not go beyond foreign currency 

products. Well, as I explained earlier, I do not think the problem 

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is limited to foreign currency products, and I do not think the solution can be limited to foreign currency products either. 

I recognize very well that there are very legitimate concerns 

about a legislative fix to this problem. I know that all of us are 

fearful of unintended consequences, and my goal here is to restore 

the CFTC’s jurisdiction, not to expand the CFTC’s jurisdiction, and 

my goal here is to protect retail customers and not to in any way 

interfere with institutional business. I know there is always a 

threat of unintended consequences, but all that means is that it is 

a hard problem to solve, and just because it is hard does not mean 

it cannot be done. 

We feel that legislative action here is mandatory. We have to 

come up with the right solution, and NFA is very much dedicated 

to working with this committee, to working with the industry, to 

working with the Commission, and to work with anybody else that 

can help us find a solution that is practical, that is politically acceptable, and that actually achieves the goal of customer protection. 

Thank you, Mr. Chairman. 

[The prepared statement of Mr. Roth can be found in the appendix on page 218.] 

The CHAIRMAN. Thank you. 

Mr. Gaine. 

STATEMENT OF JOHN G. GAINE, PRESIDENT, MANAGED 

FUNDS ASSOCIATION, WASHINGTON, DC 

Mr. GAINE. Chairman Chambliss and members of the committee, 

my name is Jack Gaine. I am President of Managed Funds Association, and I thank you for the opportunity to share our views with 

you today about the CFTC’s reauthorization. 

I will be very brief in my oral comments but would ask that my 

written statement be included in the record. 

We commend the committee for this timely hearing and we commend the CFTC for their steady, sensible hand in implementing 

the CFMA over the last 4 years. We are not advocating any statutory change at this time, but I will put a footnote on that and say 

that with regard to Mr. Roth’s concern about a gap in the antifraud provisions, we certainly are, as NFA is willing to, willing to 

work with him, the committee, et cetera, to close any real gaps that 

exist in order to provide full public protection against fraudulent 

activities. 

MFA is the primary trade association representing professionals 

who specialize in the alternative investment industry which consists of funds of funds, futures funds and hedge funds. We have 

over 850 members including representatives of 35 of the 50 largest 

hedge fund groups in the world. Our members, many of whom represent firms that are registered with the CFTC as commodity trading advisers and commodity pool operators, manage a substantial 

portion of the over one trillion dollars invested in alternative investment products globally. We are major users of the futures markets and many of us are regulated by the National Futures Association as well. 

Since the last reauthorization we have worked extensively with 

the CFTC on a number of important rule-making projects as well 

179

as private sector initiatives which I have detailed in my written 

statement. 

We are different from most of the witnesses who will appear before you because we are the user of a lot of the facilities and the 

services that are provided by the exchanges and other witnesses. 

Increased interest in and use of alternative investments is a direct 

result of the growing demand from institutional and other sophisticated investors, for investment vehicles that deliver true diversification and help them meet their future funding obligations and 

other investment objectives. 

Our members’ funds perform a number of important roles in the 

global marketplace, including contributing to a decrease in overall 

market volatility, acting as shock absorbers and liquidity providers 

by standing ready to take positions in volatile markets when other 

investors choose to remain on the sidelines. Moreover, our funds 

utilize state-of-the-art trading and risk management techniques 

that foster financial innovation and risk sophistication among market participants. 

Let me turn briefly to just two or three specific issues. Hedge 

funds’ effect on the energy markets, and I will put a footnote to 

this as well, that at Tuesday’s hearing, President Newsome released a study that the NYMEX had done on the role of hedge 

funds in natural gas and crude oil futures. I have read the report. 

It is very comprehensive and it has a lot of data and makes a very 

strong case that there is no adverse effect on the energy markets 

by virtue of hedge fund activities. 

Energy markets enjoy all of the described benefits provided by 

the alternative investment industry. Recently, there has been increased discussion about hedge funds’ impact on energy. Some participants have argued that price swings and volatility are a result 

of the impact of speculative futures trading by hedge funds. 

Recently both the CFTC, and the Federal Energy Regulatory 

Commission concluded that hedge funds really were not the cause 

of the volatility. We also believe that the CFTC is doing an excellent job in overseeing the energy trading market. They have assessed penalties of approximately $300 million in recent years. The 

industry, including MFA members who trade in these markets, 

benefit from appropriate regulatory actions since these actions promote fair and efficient pricing in the marketplace. 

We are comfortable that the CFTC, the FERC and the New York 

Mercantile Exchange each have correctly recognized that hedge 

funds are not dominating energy trading, and that the current system in place is adequate to provide public protection. 

We would ask this committee, in its oversight function, to urge 

the SEC and CFTC to work cooperatively to avoid duplicative regulation. I have gone into more detail in my written testimony. We 

would ask also that the committee, in its oversight function, urge 

the CFTC to act on the petitions of the various exchanges—Chicago, Minneapolis and Kansas City—to liberalize or relax the speculative position limits on a number of agricultural contracts. 

In conclusion we think the CFMA was a masterful piece of work. 

We think the implementation has been excellent. We stand ready 

to assist the committee, answer any questions and work with Mr. 

180

Roth, because he seemed to include the world in the people he is 

willing to work with, in solving any of his problems. 

Thank you, Mr. Chairman. 

[The prepared statement of Mr. Gaine can be found in the appendix on page 224.] 

The CHAIRMAN. Thank you very much, Mr. Gaine. 

Mr. Green. 

STATEMENT OF MICAH S. GREEN, PRESIDENT, THE BOND 

MARKET ASSOCIATION, WASHINGTON, DC 

Mr. GREEN. Good morning, Mr. Chairman. Thank you very much 

for allowing the Bond Market Association to participate in this 

hearing on the reauthorization of the CEA and in particular the 

changes made in 2000 under the CFMA, a law which, by the way, 

we believe was an outstanding achievement of the Congress. 

Through our offices in New York, Washington, and London, the Association represents the $44 trillion global bond markets. Our 

members include all major dealers in Federal agency bonds, as well 

as the securitization market, corporate and municipal securities, in 

addition to all of the primary dealers of U.S. Treasury securities as 

recognized by the Federal Reserve Bank of New York. Our members are also active in the markets for over-the-counter financial 

products and contracts involving forward payments or deliveries relating to a variety of fixed income securities, interest rates and 

credit products. 

The Bond Market Association participated actively in the debate 

that led to the enactment of the CFMA. At that time we advocated 

changes to the CEA that were viewed as critical to vibrant markets 

in OTC securities, derivatives and foreign exchange. The CFMA 

has proved to be extremely successful in that regard because it 

clarified the exclusion from the CEA and the jurisdiction of the 

CFTC of OTC derivatives, swaps and foreign exchange transactions. The much-needed legal certainty the Treasury amendment 

in the CEA continues to bring these important sectors of the capital markets, enables markets for U.S. Treasury securities in particular, which allows the Government to borrow at a lower cost and 

save U.S. taxpayers real money. 

I want to congratulate this committee and your counterparts in 

the House, as well as past and current leadership and members of 

the CFTC for your foresight in enacting the CFMA nearly 5 years 

ago. You clearly anticipated the expansion of the markets around 

the globe and the need to facilitate liquid and efficient markets 

wherever they may exist, and to particularly ensure that U.S. markets are not at a disadvantage. You clearly sensed that prescriptive 

rules and regulations in an economy that require nimbleness and 

flexibility would make it more difficult for markets to adjust to 

changing conditions, and that sound principles-based rules ensured 

that markets function smoothly even in times of stress. 

Finally, you clearly foresaw the development of sophisticated risk 

management techniques that permit institutional market participants to manage risk in an increasingly precise manner. Market 

participants can retain the risk they wish to retain, and for a fee 

transfer those risks they do not wish to retain to other market participants. These improvements in risk management facilitated by 

181

the OTC derivatives market have helped the U.S. and global economies weather recessions and interest rate volatility. In other words, 

the leadership you provided nearly 5 years ago when you were in 

the House and now in the Senate, was really quite extraordinary 

and has provided tangible benefits to the economy. 

The Bond Market Association set out three fundamental policy 

goals during the last reauthorization process. We called for maintaining the OTC markets as a viable alternative to traditional organized exchanges, preserving the enforceability of contracts freely 

negotiated between market participants, and avoiding duplicative 

regulation. 

I am happy to report for the benefit of the broader national and 

global economies the CFMA did in fact meet those goals. Clarifying 

the exclusions for commodities and swaps from the CFTC’s jurisdiction and assuring contract enforceability as the CFMA does, have 

brought the OTC derivatives market the legal certainty it needed 

to thrive. 

In closing, Mr. Chairman, I would like to reiterate our support 

for the CFMA. The law strikes a delicate balance between regulating a rapidly changing market and encouraging innovation and 

diversity. Prior to the CFMA, the OTC derivatives market was restrained by legal uncertainty. Again, thanks to the foresight of the 

Congress and particularly this committee, this market is now thriving and helping to save taxpayers money by lowering the cost of 

borrowing for the Federal Government. Improved risk management 

and lower capital costs also help to stimulate the broader economy. 

In the context of the reauthorization process, the Association 

strongly urges this committee and Congress not to alter any of the 

fundamental elements of the CFMA that encourage and orderly 

and innovative OTC derivatives market. 

Thank you very much for the opportunity to testify. 

[The prepared statement of Mr. Green can be found in the appendix on page 231.] 

The CHAIRMAN. Thank you very much, Mr. Green. In your written testimony you mention a 2002 observation by Federal Reserve 

Board Chairman Alan Greenspan, that complex financial instruments developed to manage risk have made the global economy, 

and a I quote, ‘‘a far more flexible, efficient and resilient financial 

system that existed just a quarter-century ago.’’

Would you elaborate on that a little bit, and what is the role of 

the over-the-counter derivatives such as swaps in this development? 

Mr. GREEN. If you think about risks in the marketplace you have 

interest rate risks and the movement of the markets, and you have 

credit risk, if you have credit exposure. As Mr. Pickel described 

earlier, you can now look at other risks that are out there, catastrophic events. You can look at weather-related issues, virtually—

any risk that right now is manageable that many years ago was 

not manageable—and in an economy where you cannot necessarily 

predict what is going to happen as it relates to interest rates, as 

it relates to credit quality, as it relates to weather and other potentially uncontrollable events. The ability to manage that risk allows 

you to absorb changes in a much more measured and much more 

organized way. In fact, there was a time about a summer and a 

182

half ago, interest rates spiked up tremendously at a time when interest rates were at record lows. In previous years when that happened in 1998 or 1994 you would have seen a particular catastrophic event in the marketplace, and I am not saying for a second 

that there will not be future catastrophic events in marketplaces, 

but it is instructive to see that that happened post-CFMA, and you 

saw the marketplace absorb it. 

Now, obviously, when there are losses in the market, the losses 

find themselves somewhere, but they are less concentrated now because people have been able to use the financial products, again, 

that the CFMA has allowed for privately negotiated and very specialized and precise contracts to allow for that very knowledgeable 

management of that risk and absorb the changes in the economy. 

The CHAIRMAN. Did that flexibility exist prior to the Modernization Act in 2002? 

Mr. GREEN. Not to the degree it does now. There was uncertainty, and every bit of uncertainty, no matter how minute it is, 

carries with it a cost and a burden to the free flow of the economy. 

There is no question that the CFMA has contributed greatly to 

dealing with that legal uncertainty. 

The CHAIRMAN. Who is the beneficiary of that flexibility? Is it 

more the market or the customer? 

Mr. GREEN. Everyone. The fact is that when the marketplace can 

absorb sudden changes in interest rates or credit quality or virtually any other thing, everyone—and frankly not just in the 

United States but around the globe—benefits and it allows for the 

absorption factor. It is like driving a car without shock absorbers. 

You need those shock absorbers, and that is all about risk management, and certainly the parties involved in the transactions benefit 

from that, but the customers of those people and the beneficiaries 

of the products and the economy generally benefits. 

The CHAIRMAN. What if any effect would the Feinstein legislation, in your opinion, have on that flexibility? 

Mr. GREEN. Well, I share the views that were expressed by the 

prior panel. We believe that the CFTC has the authority, and they 

have exercised that authority, to their credit. What we worry about 

is imprecision and building of more uncertainty, and that is why 

we join in calling that this committee particularly, with its expertise in the CEA and the CFMA, needs to make sure that it carries 

out its will in this process as opposed to writing this sort of legislation on the floor, because it is a very delicate piece of legislation. 

You remember from the House how really masterfully, you all put 

it together in a way that made sense for the market and the market participants, and if any changes were to lead to uncertainty, 

you would basically be turning back the hands of time. We are worried that the Feinstein amendment, No. 1, is not needed; No. 2 was 

overly broad, leading to more uncertainty. We would join certainly 

with Mr. Pickel, and the Bond Market Association has worked very 

closely with ISDA on that issue in opposing such an amendment. 

The CHAIRMAN. Before I leave that particular issue, let me ask 

Mr. Gaine and Mr. Roth for your reaction to the Feinstein proposal. 

Mr. GAINE. I really would only echo Mr. Green and the earlier 

panelists and my own testimony here, that the existing statutory 

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and regulatory framework that is in place has been shown to be 

adequate to address the issues. 

I do feel Mr. Ireland’s pain. We all would like lower energy 

prices, but the volatile supply and demand domestically and internationally, factors that are at play now, unfortunately do not give 

us that luxury. Having markets that can adapt nimbly and quickly, 

are very important, and the cause of any volatility, are the fundamental supply and demand factors. 

The CHAIRMAN. Mr. Roth. 

Mr. ROTH. Mr. Chairman, I would just point out that from a regulatory point of view, every time you run into an issue what you 

are really trying to do is the most efficient to deal with any regulatory issue is to provide the least degree of regulation that you 

need to do to accomplish the results and generally let the markets 

work out the rest. 

We always, in any issue that we encounter, try to figure out 

what is the least burdensome method to achieve the desired result. 

That is always what you are striving to do because that is what 

avoids the unintended consequences that I was referring to earlier. 

Without getting specific as to the Feinstein amendment, all the 

comments from the other panelists are really attuned to that same 

basic philosophy to make sure that the regulations that you do impose are sufficient to achieve the desired objective without being 

too burdensome and having those unintended consequences. Everything that Mr. Pickel and Mr. Green and Mr. Gaine have said, are 

certainly things that philosophically NFA would agree with. 

The CHAIRMAN. Mr. Roth, you talked about the amount of increase in contracts since 1982, and the correlating decrease in complaints. I notice in your testimony, I believe, you had, what, 93 

complaints in the last year, which does seem like a fairly minimal 

number. What kind of increase have you seen since the CFMA relative to the increase in contracts and decrease in complaints? 

Mr. ROTH. Let me just put in context the statistic that you cited 

from my testimony. One of the points we make in our written testimony was that Congress may want to reconsider whether it should 

continue to require the CFTC to operate a reparations program, 

which is a dispute resolution program for customers, and it is a 

program that has been in place for a very long time, since back in 

the 1970’s. What we pointed out was that back when the program 

was instituted the world was a much different place. For one thing 

the boiler rooms were really a problem of much greater scope than 

they are right now, generating a lot more customer complaints 

than we have now. No. 2, NFA had not even begun operations yet, 

and our arbitration program that we offer customers had not been 

in place yet. 

What we point out in our testimony was that back in 1982 when 

NFA began operations the CFTC used to get a thousand complaints 

a year in the reparations program, and last year they had 93. 

Our point is that we think maybe that is a program that was valuable at its time but maybe has outlived its usefulness and maybe 

the Commission could redeploy its resources elsewhere, and maybe 

it is time to get rid of the reparations program. That is the specific 

point about this statistic. 

184

With respect to the CFMA and its impact on customer complaints, I can tell you that for the most part we have been able to 

keep the level of customer complaints at near record level lows. 

What is of concern to me is that with respect to, again, retail Forex 

problems, completely apart from the Zelener decision. You know, 

we have members that are Forex dealer members of NFA that we 

regulate and we have about 27 members that are active in that 

area right now, and though few in number, those retail Forex accounted for about over 20 percent of the customer complaints we 

received in arbitration last year at NFA. That even apart from 

Zelener there have been regulatory problems with respect to retail 

Forex. It is a disproportionate share of our customer complaint 

docket and it is something that we are going to continue to work 

on and struggle with. 

Where we have the authority to act, at least we can act. The 

Zelener problem creates issues where neither the CFTC nor NFA 

would really have the authority to regulate that activity. 

The CHAIRMAN. I want to make sure you have answered my next 

follow-on thought process, and that is I hear what you are saying 

when you say that the Zelener decision has brought on some problems, some of those unintended consequences almost that we did 

not anticipate with the legislation. I noted your suggestions and 

comments relative to the reasons why, and your response is too 

there should be no changes in the Act. By the same token what I 

am hearing from you is that you like the idea of self-regulation, 

that you do not want any more Government involvement than you 

have to have. The same token you want to make sure that you 

have the ability I guess to put some teeth into the self-regulatory 

process that maybe you do not have now. By the same token you 

are saying that you have had a tremendous increase in the volume 

of contracts and a collateral declining decrease in the number of 

complaints. 

I am just wondering why we really ought to think about making 

changes when that scenario is in place. 

Mr. ROTH. Mr. Chairman, the reason we have to make a change 

is that the reason that we have been able to achieve a dramatic 

drop in customer complaints is that there was a regulatory presence and a strong regulatory presence where these types of products were being marketed to retain customers. That is how we got 

to where we are. The problem with the Zelener decision is that it 

creates the exact opposite environment, where that marketing activity can go on with retail customers in a completely unregulated 

environment. The format, the way we got to where we are is by 

having a regulatory presence with respect to the protection of retail 

customers. The Zelener decision threatens to undo that and that is 

why I am concerned about it. 

The CHAIRMAN. Mr. Gaine, you heard the previous panel talk a 

lot about the energy market and in particular the natural gas market. Can you explain how hedge funds increase liquidity with respect to the energy market and how this benefits the market? 

Mr. GAINE. Yes. This was probably discussed in some detail. 

First, I am just a lawyer, not an economist. Maybe that is a plus. 

It is discussed in some detail in the NYMEX study that I referenced that was released several days ago. In their analysis they 

185

did a study of trading activity over certain periods of time, and actually found that hedge fund activity decreased the volatility, and 

they did it by using mathematics and looking at the trading 

records over a considerable period of time, both in natural gas and 

crude oil futures. The increase in liquidity would as a general proposition serve to be neutral or favorable toward reducing volatility, 

and we certainly do provide that to these markets. 

As I said, hedge funds have to come in to the market and have 

to get out of the market. They are not going to stand for delivery. 

They do not take a position in crude oil and then put it in the tanker and put it offshore. They are going to liquidate that, so they are 

going to be both a buyer and seller in most instances. As I say, 

they are expanding the pool, the liquidity pool. That coupled with 

the findings of the study that I referred to make a fairly firm case 

that they are a plus to the pricing discovery and other functions 

of the futures markets. 

The CHAIRMAN. Gentlemen, again, we have had a vote that was 

just called, so we are going to have to conclude anyway. We do 

have a few minutes, and I want to give you the same opportunity 

that I gave the last panel. We are in a little more of an informal 

situation here. If anybody has any additional comments you want 

to make relative to anything you said or any other issue that has 

been brought up, I want to make sure that we get all of the input 

from you we can. I will give each of the three of you that opportunity if you would like to. 

Mr. GAINE. Mr. Chairman, if I might just say I would like to associate particularly with Mr. Green’s comments about the pocket of 

expertise that resides in 328 Russell with respect to many of these 

issues, and it is a problem on this side, but even a greater problem 

in the other body. It is very important that any crafting or any considerations of changes to these highly complex issues be really 

managed by those who are in the know, which is this committee 

and its members and its staff. 

The CHAIRMAN. I appreciate that compliment, particularly as a 

recovering lawyer myself, Mr. Gaine. 

[Laughter.] 

The CHAIRMAN. As we move through this, it is a very complicated 

issue, as all of you have explained and as we know. We would appreciate a continuing dialog with you because that is the way the 

best legislation is ultimately produced. 

While we have your written testimony, while we have your comments today, if there is any other written suggestions or comments, 

not just on what may have been said over the last couple of days, 

but there are going to be other developments. We do not know 

where the Zelener decision is going, Mr. Roth. I agree with you that 

may present a whole new factual set of circumstances to us that 

may evolve even further between now and the time legislation is 

crafted. 

We would appreciate your input and appreciate your comments 

and your continuing dialog with staff and with our offices also. 

Thank you very much for being here. We are going to leave the 

record open for 5 days. I feel certain that Mr. Harkin probably will 

have some questions to ask one or both panels. We would ask that 

you get those responses to us as soon as possible. 

186

There are many groups that have an interest in the reauthorization process, and without objection written testimony submitted 

today may be included in the record. 

Thank you very much for being here and for your participation. 

This hearing is concluded. 

(187)

A P P E N D I X

MARCH 10, 2005

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(237)

DOCUMENTS SUBMITTED FOR THE RECORD

MARCH 10, 2005

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Æ


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