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90–742 PDF 2003

THE APPLICATION FOR CONTRACT

MARKET DESIGNATION OF THE U.S.

FUTURE EXCHANGE, LLC BEFORE

THE COMMODITY FUTURES TRADING

COMMISSION

HEARING

BEFORE THE

COMMITTEE ON AGRICULTURE

HOUSE OF REPRESENTATIVES

ONE HUNDRED EIGHTH CONGRESS

FIRST SESSION

NOVEMBER 6, 2003

Serial No. 108–21

(

Printed for the use of the Committee on Agriculture

www.agriculture.house.gov

COMMITTEE ON AGRICULTURE

BOB GOODLATTE, Virginia, Chairman

JOHN A. BOEHNER, Ohio

Vice Chairman

RICHARD W. POMBO, California

NICK SMITH, Michigan

TERRY EVERETT, Alabama

FRANK D. LUCAS, Oklahoma

JERRY MORAN, Kansas

WILLIAM L. JENKINS, Tennessee

GIL GUTKNECHT, Minnesota

DOUG OSE, California

ROBIN HAYES, North Carolina

CHARLES W. ‘‘CHIP’’ PICKERING,

Mississippi

TIMOTHY V. JOHNSON, Illinois

TOM OSBORNE, Nebraska

MIKE PENCE, Indiana

DENNIS R. REHBERG, Montana

SAM GRAVES, Missouri

ADAM H. PUTNAM, Florida

WILLIAM J. JANKLOW, South Dakota

MAX BURNS, Georgia

JO BONNER, Alabama

MIKE ROGERS, Alabama

STEVE KING, Iowa

CHRIS CHOCOLA, Indiana

MARILYN N. MUSGRAVE, Colorado

DEVIN NUNES, California

RANDY NEUGEBAUER, Texas

CHARLES W. STENHOLM, Texas,

Ranking Minority Member

COLLIN C. PETERSON, Minnesota

CALVIN M. DOOLEY, California

TIM HOLDEN, Pennsylvania

BENNIE G. THOMPSON, Mississippi

MIKE MCINTYRE, North Carolina

BOB ETHERIDGE, North Carolina

BARON P. HILL, Indiana

JOE BACA, California

RICK LARSEN, Washington

MIKE ROSS, Arkansas

ANI ́BAL ACEVEDO-VILA ́ , Puerto Rico

ED CASE, Hawaii

RODNEY ALEXANDER, Louisiana

FRANK W. BALLANCE, JR., NORTH

CAROLINA

DENNIS A. CARDOZA, California

DAVID SCOTT, Georgia

JIM MARSHALL, Georgia

EARL POMEROY, North Dakota

LEONARD L. BOSWELL, Iowa

KEN LUCAS, Kentucky

MIKE THOMPSON, California

MARK UDALL, Colorado

RICK LARSEN, Washington

LINCOLN DAVIS, Tennessee

PROFESSIONAL STAFF

WILLIAM E. O’CONNER, JR., Staff Director

KEVIN KRAMP, Chief Counsel

STEPHEN HATERIUS, Minority Staff Director

ELYSE BAUER, Communications Director

(II)

(III)

C O N T E N T S

Page

Boehner, Hon. John A., a Representative in Congress from the State of

Ohio, prepared statement .................................................................................... 4

Goodlatte, Hon. Bob, a Representative in Congress from the Commonwealth

of Virginia, opening statement ............................................................................ 1

Moran, Hon. Jerry, a Representative in Congress from the State of Kansas,

opening statement ................................................................................................ 3

Smith, Hon. Nick, a Representative in Congress from the State of Michigan,

prepared statement .............................................................................................. 5

Stenholm, Hon. Charles w., a Representative in Congress from the State

of Texas, opening statement ................................................................................ 2

WITNESSES

Carey, Charles P., chairman, Chicago Board of Trade, Chicago, IL ................... 32

Prepared statement .......................................................................................... 91

Damgard, John, president, Futures Industry Association, Washington, DC ...... 35

Prepared statement .......................................................................................... 100

Answers to submitted questions ...................................................................... 103

Duffy, Terry, chairman, Chicago Mercantile Exchange, Chicago, IL .................. 37

Prepared statement .......................................................................................... 113

Green, Micah S., president, the Bond Market Association, New York, NY ........ 40

Prepared statement .......................................................................................... 94

McErlean, Michael, managing director, Eurex US, Chicago, IL .......................... 42

Prepared statement .......................................................................................... 83

Answers to submitted questions ...................................................................... 111

Newsome, James E., Chairman, Commodity Futures Trading Commission,

Washington, DC ................................................................................................... 5

Prepared statement .......................................................................................... 65

Answers to submitted questions ...................................................................... 71

Roth, Dan., president, National Futures Association, Chicago, IL ...................... 44

Prepared statement .......................................................................................... 96

SUBMITTED MATERIAL

American Bankers Association, et al., statement ................................................. 138

Gaine, John G., Managed Funds Association, statement ..................................... 139

Magold, Rainer, Baker & McKenzie, Frankfort, Germany, letter of October

2, 2003 to Terrance Livingston, Chicago Board of Trade ................................. 131

Wilson, Donald L., Jr., chief executive officer and founder, DRW Holdings,

LLC, statement .................................................................................................... 133

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THE APPLICATION FOR CONTRACT MARKET

DESIGNATION OF THE U.S. FUTURE EXCHANGE, LLC BEFORE THE COMMODITY

FUTURES TRADING COMMISSION

THURSDAY, NOVEMBER 6, 2003

HOUSE OF REPRESENTATIVES,

COMMITTEE ON AGRICULTURE,

Washington, DC.

The committee met, pursuant to call, at 10:10 a.m., in room

1300, Longworth House Office Building, Hon. Bob Goodlatte (chairman of the committee) presiding.

Present: Representatives Boehner, Pombo, Smith, Lucas of Oklahoma, Moran, Jenkins, Gutknecht, Ose, Johnson, Osborne,

Rehberg, Janklow, Burns, Rogers, Neugebauer, Stenholm, Peterson, Dooley, Etheridge, Hill, Baca, Alexander, Ballance, Scott, Marshall, Pomeroy, Boswell, Lucas of Kentucky, Udall and Larsen.

Staff present: Dave Ebersole, senior professional staff; Brent

Gattis, Ryan Weston, Callista Gingrich, clerk; Kelli Ludlum, Teresa

Thompson, and John Riley.

OPENING STATEMENT OF HON. BOB GOODLATTE, A REPRESENTATIVE IN CONGRESS FROM THE COMMONWEALTH

OF VIRGINIA

The CHAIRMAN. Good morning. This hearing of the House Committee on Agriculture to review the application for contract market

designation of the United States Futures Exchange LLC before the

Commodity Futures Trading Commission will come to order.

The committee meets this morning to review the substance and

process of the pending application of U.S. Futures Exchange, also

known as Eurex U.S., to operate a futures exchange in Chicago.

Since Eurex U.S. filed this application with the Commodity Futures Trading Commission in mid-September, it has generated a

great deal of controversy. The application also has generated legitimate questions about public policy in the area of derivatives regulation, and this comes just 3 years after the President signed the

Commodity Futures Modernization Act on December 21, 2000. At

that time, the CFMA was widely described as a milestone in sensible deregulation. I hope this hearing is not building the foundation for reregulating the derivatives market in this country.

This proposal has stirred a pot of legitimate concerns and questions about the CFTC’s due diligence concerning the application

and public interest in keeping the process fair and open and our

markets orderly.

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Among those questions are the following: Is the application incomplete because it does not reveal, at least not publicly, the contracts Eurex U.S. will trade if the CFTC designates the exchange

as a contracted market?

If approved, will Eurex U.S. offer cross-border clearing and settlement procedures that could potentially harm the public interest?

And, though apparently not contained within the original application, what is the process for offering such services in the future?

Does the National Futures Association, a CFTC-regulated futures

association, have the capability to carry out regulatory services for

Eurex U.S., and what is the standard the CFTC uses to make that

determination?

Has the CFTC informed the Department of the Treasury and the

Federal Reserve that Eurex U.S. plans to offer U.S. Government

securities as a part of the contract market designation application

process required by the Commodity Exchange Act? And, more basic

to that question is the one asked a moment ago: Is Eurex

U.S.required to list futures and option contracts it will trade prior

to designation as a contract market?

Who runs Eurex U.S., and who is responsible for its operation?

And, finally, to satisfy my own curiosity, does the German Government reciprocate by offering a licensing process similar to that

availability through the CFTC under the Commodity Exchange

Act? And is that process easily implementable?

Some of the questions have been answered in a letter Chairman

Newsome sent to me on October 27, 2003, in response to a set of

questions I asked the CFTC.

From a reading of the testimony the committee will hear this

morning and the comment letters the Chicago exchanges submitted

during the CFTC’s notice and comment period on the Eurex U.S.

application, I think there are many questions that remain to be answered. I hope we are able to answer most of them today.

It is now my pleasure to recognize the gentleman from Texas, the

ranking Democrat, Mr. Stenholm.

OPENING STATEMENT OF HON. CHARLES W. STENHOLM, A

REPRESENTATIVE IN CONGRESS FROM THE STATE OF TEXAS

Mr. STENHOLM. Thank you, Mr. Chairman. Thank you for holding this timely hearing. It is an exciting day here at the Agriculture Committee, and the issue before us promises to be a lively

one.

Mr. Chairman, last year the world’s futures and options exchanges traded nearly 6 billion contracts. Over 500 million of those

were traded at the Chicago Mercantile Exchange, over 300 million

at the Chicago Board of Trade and just over 801 million on Eurex.

We have before our committee today the worldwide heavy hitters

of exchange-traded derivatives.

Our gain today is Chicago’s loss, by the way. Dow Jones reports

that this hearing has stolen just a little of the thunder from the

Annual Future Industries Association Expo, which is going on in

the Windy City right now. That story describes Eurex as the elephant in the corner, but the Chicago story we hear today may be

that Eurex is really the Trojan horse, a gift of liquidity, fairness,

open access and modern efficiency that disguises a hidden attack

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on integrity and fair pricing. In the Eurex story all they want to

do is to bring low-cost trading to an American market. Some may

even suggest that there is an element of competition involved in

the discussion we are hearing today.

We also have the Commodity Futures Trading Commission,

which for the moment at least is the gold standard of the financial

market regulation throughout the world for sure, but especially

here in the United States where its sister agencies are consumed

with governance and accounting crises, not true today in the Commodity Futures Trading Commission. Through its active involvement with the International Organization of Securities Commissions, the CFTC continues to lead an international cooperation in

regulatory innovation.

Mr. Chairman, this hearing provides us the opportunity to witness the task faced by the Commission in a debate that calls on

it to define and refine, as you have stated in your opening comments, Mr. Chairman, define and refine key aspects of the Commodity Futures Modernization Act which was enacted nearly 3

years ago.

Clearly, one goal of the Act was to allow exchanges, new and old,

to bring innovative ideas to the marketplace by allowing for more

flexibility for market participants to innovate. The Act also necessarily compels the Commission to define anew its charge to preserve the integrity of markets, and our sister agencies today now

are under fire because of their lack of doing that.

Mr. Chairman, the CFTC has a difficult task, given the issues

brought before it by the Eurex U.S. application, and it will be important for us to pay close attention to its deliberations. The hearing today and our excellent panel of witnesses will certainly help

us to see more clearly what the real-world impact of the CFMA is

going to be. The entire situation is as much a test of the Act as

it is of the CFTC.

Again, thank you, Mr. Chairman, for convening this important

meeting of the committee.

Mr. MORAN [presiding]. Thank you very much, Mr. Stenholm.

Mr. Goodlatte, I understand you have duties on the House floor.

We welcome you back at your earliest opportunity.

I would like to take a moment to make a brief opening statement.

OPENING STATEMENT OF HON JERRY MORAN, A REPRESENTATIVE IN CONGRESS FROM THE STATE OF KANSAS

Mr. MORAN. First of all, thank all the witnesses for their appearance before our committee today.

The Commodity Futures Trading Commission and the futures industry are an important part of the oversight of this Agriculture

Committee and specifically the subcommittee that I am honored to

chair. In June, our General Farm Commodities and Risk Management Subcommittee held a series of hearings on the implementation of CFMA. I think we heard a number of topics and discussion

about current issues from the regulatory perspective, as well as the

views of the industry as far as tact and overall competitiveness in

the industry. I think at an initial glance during that series of hearings it appeared that CFMA had accomplished much of its intended

4

purpose, regulatory relief to foster industry growth, while still protecting market integrity for all participants.

In the 3 years since the passage of CFMA, the futures markets

have developed and traded more than 790 million contracts last

year. Yet despite the successes of CFMA, there are concerns that

remain about fairness of the global playing field among U.S. exchanges, electronic markets, over-the-counter markets and international firms.

Today we have the opportunity to more closely examine another

particular facet of CFMA, the process for designation of new contract markets. The Eurex U.S. application provides an opportunity

for members to become more familiar with the new regulatory approval process by reviewing the status of this particular application

now pending at CFTC.

With regard to contract market designation, it is my hope that

this hearing will help clarify whether we have in fact achieved the

right balance of self-regulation and minimal Government oversight

or whether additional steps are needed to ensure market integrity

of the competitiveness of the U.S. futures industry.

Other members of the committee, you are welcome to make opening statements as part of the record.

[The prepared statements follow:]

PREPARED STATEMENT OF HON. JOHN A. BOEHNER, A REPRESENTATIVE IN CONGRESS

FROM THE STATE OF OHIO

Thank you, Mr. Chairman. As long as I have been a member of this committee,

I have diligently championed and defended a free-market, free-enterprise approach

to the policy discussions this committee has engaged in including farm bill rewrites

and the sweeping regulatory changes made by the Commodity Futures Modernization Act.

I strongly supported the CFMA and I continue to support its merits. The Commodity Futures Trading Commission is stocked with talented people who are extremely capable of overseeing the self-policing and self-regulatory futures industry

features that made CFMA a model of market regulatory law which was designed

to allow competition to flourish.

The purpose of this hearing today is not to undermine the tenets of CFMA or to

begin backtracking on the promises made by that landmark legislation. The purpose

of this hearing is to fulfill our Congressional oversight responsibility to make certain

that the designated contract market application submitted by Eurex U.S. for the

U.S. Futures Exchange satisfies all of the designation criteria, the CFTC’s core principles and our expectations for market transparency and integrity.

Eurex is one of the world’s leading futures exchange and I would suggest that its

application to do business here in the U.S. is itself a novel issue. However, with passage of CFMA we recognized that global competition is good for all stakeholders and

especially customers and therefore we welcomed it.

Now, without standing in the way, we must ensure that global competition is fair

and that all customers are adequately protected in an industry that prides itself on

innovative products and innovative ways to trade those products.

Before and after many of the well-publicized corporate financial collapses of recent

years, the House Education and Workforce Committee, which I chair, has invested

considerable time in examining customer protections and conflict of interest in the

business models of investment advice companies to ensure investment integrity for

our Nation’s workforce. Similarly, I believe this committee and this hearing can provide further examination of the Eurex business model so that Eurex can discuss

their business plans and so that all stakeholders can publicly air their concerns to

ultimately preserve the market integrity of the futures industry.

CFMA gave unprecedented latitude and flexibility to the futures industry and to

futures regulators and I believe it has succeeded. But to continue that success, when

new issues arise, Congress and the CFTC must take the opportunity to do our jobs

by ensuring customer protection and market integrity without hindering global competition.

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PREPARED STATEMENT OF HON. NICK SMITH, A REPRESENTATIVE IN CONGRESS FROM

THE STATE OF MICHIGAN

Thank you Mr. Chairman for holding this hearing to review the issues surrounding the Eurex application that is currently under CFTC consideration.

The Commodity Futures Modernization Act of 2000 significantly altered the regulatory framework for U.S. futures markets. One of the primary goals of the CFMA

was to provide an efficient and effective regulatory structure that combines necessary Government oversight and aggressive private industry self-regulation. It is

now the charge of the Commodity Futures Trading Commission to provide effective

oversight and allow markets to serve the vital economic functions of providing a

means for offsetting price risk and providing a mechanism for price discovery. This

requires the CFTC to make certain that potential exchanges meet standards that

allow for fair and open competition. Competition within our markets is necessary

to promote better products and more efficient operations.

The question before us today is not whether or not allowing Eurex to establish

a U.S. exchange would increase the competition in the U.S. futures industry, but

rather to make certain that this is done in a fair and open manner. The CFTC will

work hard on this application and their decision to take the application off the 60-

day fast track approval process in order to more thoroughly evaluate the application

is appropriate. It would be far better to address some of the complicated and unique

issues presented by this application up front as opposed to trying to backtrack and

deal with them later. As a committee, I believe it is our responsibility to make sure

that the CFTC has the statutory authority and exercises that authority to thoroughly handle the complex issues involved in a foreign owned entity seeking to become a designated futures exchange in the United States.

Mr. MORAN. We will turn to our first witness, which I welcome,

my friend and the chairman of the CFTC, Mr. Jim Newsome.

Chairman Newsome, you may proceed.

STATEMENT OF JAMES E. NEWSOME, CHAIRMAN, COMMODITY

FUTURES TRADING COMMISSION, WASHINGTON, DC

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

Mr. Chairman, members of the committee, I appreciate the opportunity to testify before you today on behalf of the Commission

regarding the application filed by U.S. Futures Exchange to become

a designated contract market, which is more commonly referred to

as a futures exchange.

As you know, through the Commodity Futures Modernization Act

of 2000, this committee and then the full Congress profoundly altered the manner in which derivatives markets are regulated in

the United States by replacing the one-size-fits-all prescriptive

rules of the past with broad core principles aimed at promoting responsible innovation and fair competition among exchanges and

other market participants. A portion of the flexibility provided by

the CFMA allows for the self-certification of certain contracts and

rules. This provision was widely supported by industry, including

many of those represented here today.

This is an exciting time for the futures business. Due to a number of factors, the industry that we regulate has grown significantly

over the past few years. We believe that a primary contributing

factor is the modernized regulatory structure established by Congress through the Commodity Futures Modernization Act. This new

flexible approach to regulation has encouraged innovation in the

use of cutting-edge technology and has allowed market participants

to implement business plans with much greater ease. It has also

resulted in an unprecedented number of new entrants into the

marketplace.

6

One thing that the CFMA did not do, however, was limit the

Commission’s oversight. We continue to have the authority to review and deny, if needed, any rule or contract that we believe falls

short of the Act’s core principles, whether it is self-certified or not.

Since December of 2000 when the CFMA was signed into law,

the CFTC has designated four new exchanges as contract markets

and has received three additional applications, including the application filed by U.S. Futures Exchange. Throughout this time, the

Commission has been committed to providing a level regulatory

playing field for all existing and potential market participants,

while being vigilant in its mission to foster markets free of fraud

and manipulation, and it is evaluating U.S. Futures Exchange’s application accordingly.

To become a designated contract market, an applicant must demonstrate to the Commission that it will comply with the conditions

set forth in the Act, which consist of eight designation criteria and

18 core principles. It must also provide sufficient assurance that it

will continue to comply with those conditions. If these criteria are

not met to the satisfaction of the Commission, designation simply

will not be granted.

By statute, the Commission must approve or deny an application

for designation within 180 days of its submission, unless the application is materially complete, in which case the 180-day period may

be stayed.

By regulation, an application may be considered under a 60-day

procedure in appropriate circumstances. Although originally slated

for 60-day review, the Commission decided to remove the application from the expedited procedure. It is now reviewing it under the

180-day statutory time frame to ensure that we have an adequate

opportunity to fully consider all the issues.

U.S. Futures Exchange formally applied for designation as a contract market on September 16th, 2003. The application includes all

general information required by our rules to be considered complete. I have outlined those requirements in my written testimony,

Mr. Chairman.

However, the staff is currently reviewing the application and is

not ready to submit it to the Commission for approval. According

to the application, all trading on the exchange will be done electronically through a version of the trading system that Eurex

Frankfurt has operated in the U.S. since the year 2000 in a joint

venture with the Chicago Board of Trade.

The trading system will provide a full audit trail of orders, bids

and transactions. Audit trail information will be submitted directly

to the National Futures Association, a Commission-registered futures association which will provide certain regulatory services for

the exchange, such as conducting surveillance for trade practice

violations, market manipulation, price distortions and market congestion.

U.S. Futures Exchange staff in Chicago will conduct real-time

monitoring of exchange trading activity. Clearing and settlement

services will be provided by The Clearing Corporation, a derivatives clearing organization registered with the Commission based

in Chicago.

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The Commission has published for public comment all portions

of the application except for those containing trade secrets or commercial or financial information subject to confidential treatment

under the law. In considering whether to approve the application,

the Commission will carefully consider all comments received.

As with all applications for contract market designation, Commission staff is currently reviewing the information submitted by

the U.S. Futures Exchange to determine whether the operations

described in the supporting technical and regulatory services agreements demonstrate that it meets the eight criteria for designation

and the 18 core principles.

In the process of reviewing such submissions, particular questions arise on various aspects of almost any application. This leads

to an ongoing dialog between Commission staff and the applicant

until all questions have been answered and the staff is satisfied

that no outstanding issues remain.

The Commission received answers to these questions from U.S.

Futures Exchange just yesterday, and we are currently reviewing

them to determine whether the responses are satisfactory or

whether we will need to ask additional questions.

There are at least two issues that have been raised in various

forums, including questions from this committee that the current

application before the Commission does not address: a proposed

clearing link with Eurex Clearing, which is the clearing and settlement arm of Eurex Frankfurt; and, two, proposed incentive programs for attracting business to the Exchange. Again, I have addressed in detail both of these issues in the written testimony.

In closing, I would like to emphasize that U.S. Futures Exchange

has applied to become a U.S. exchange that will be subject to the

CFTC’s direct regulatory authority. The Commission takes its responsibilities in reviewing applications for contract market designation seriously and is applying the highest standards of regulatory

review to the application made by U.S. Futures Exchange. We

pledge to this committee that we will review the application, mindful of all comments received, with an eye toward ensuring all necessary standards are met and that only sound ethical business

practices are allowed to exist in the U.S. marketplace.

Mr. Chairman, I appreciate the invitation to appear before this

committee today and certainly will be happy to answer any questions that you might have.

[The prepared statement of Mr. Newsome appears at the conclusion of the hearing.]

Mr. MORAN. Mr. Chairman, thank you for your testimony.

I recognize the gentleman from Ohio, Mr. Boehner.

Mr. BOEHNER. I want to thank the chairman and welcome Mr.

Newsome and all of our guests today.

As most of you know in this room, I have long championed a free

market, free enterprise approach to the policy discussions that we

have had in this room; and I strongly supported the CFMA, as I

continue to support the bill and the work of the Commission.

The purpose of this hearing today is not to undermine the tenets

of CFMA or to begin, I don’t believe, backtracking on their promises made under that landmark legislation, but the fact is that as

we have more competition here in the U.S. we want to make sure

8

that we have an apples-to-apples comparison, and I do have several

questions.

Although EurexEurope is an electronic exchange, as they hope to

establish here in our country, it is my understanding that really

only a small percentage of the European Government bond options

trade electronically. In fact, in the first 9 months of 2003, only 10

percent of these bond options traded electronically. The other 90

percent of the options traded as block transactions, either in the

call-around market or through internalization of orders by brokers

in which the broker takes the position opposite of his customer.

Consequently, there is no centralized price discovery mechanism,

and I think the result can often be a fragmented market that is not

as transparent as what we see here.

So, Mr. Chairman, I guess the question is, has the CFTC examined the possibility of this type of trading system taking root here

in the United States?

Mr. NEWSOME. Thank you, Mr. Chairman.

Both of those things—and you mentioned two, block trading and

then the call-around activity—and I will try to address those separately. Certainly with respect to the regulatory system of the futures industry, the regulatory system, we are all in favor of having

markets that are as open and as transparent as we can absolutely

operate them.

With regard to block trading, that is an issue that the Commission discussed in great detail several years ago, and I have to

admit to you that initially upon my tenure at the Commission I

was opposed to block trading rules, because I thought it was most

beneficial for all trades to take place in a very transparent marketplace.

However, as the discussion progressed and with competition from

the over-the-counter marketplace, it became apparent to me that

block trading and rules allowed by the Commission to allow block

trading offered the exchanges an opportunity to compete in the

over-the-counter marketplace or against the over-the-counter marketplace. Because, obviously, if you have got a large block of trades

and you try to do those on the floor in what could be an illiquid

market, even if it is not, you could get taken advantage of from

both a price and a time standpoint; and being able to offer that as

a block away from the pit allowed, under the rules that we approved, a fair price for that large block. So, ultimately, I ended up

approving block trading rules because I did think it offered an avenue to compete against the over-the-counter marketplace.

I would say that nine exchanges here in the U.S. currently have

block trading rules on their books. From a volume standpoint, the

percentage of block trading in the U.S., even though they are allowed to do so and have rules to that effect, are much smaller than

many of the exchanges in Europe.

With respect to the call-around market, that is a concept that is

relatively new to me. In fact, I have just heard that terminology

over the last couple days. I am going to give an analogy that compares what I understand the call-around market to be to something

that we have allowed, that the CFMA allowed in the U.S., and that

is the clearing of over-the-counter contracts. As I have reviewed

what the call-around market is, it appears to me that, at the very

9

least, it is similar to what the CFMA allowed, which was a visionary approach in the CFMA that would allow in some circumstances

a designated clearing organization the opportunity to clear overthe-counter contracts.

Since the CFMA was passed, we have allowed I think at least

two exchanges the opportunity to clear such contracts, and I think

the majority of those are being cleared by the NYMEX Clearing

House.

So that is something that we are going to dig into more to find

out if that analogy that I just gave you is in fact accurate, but to

the best of my ability right now, it would be at least similar.

Mr. BOEHNER. Mr. Chairman I see those red lights flashing. I

have some additional questions, and I am sure you wouldn’t mind

if I submitted those questions in writing to you.

Mr. NEWSOME. Absolutely.

Mr. BOEHNER. Thank you.

Mr. MORAN. The gentleman from Minnesota, Mr. Peterson.

Mr. PETERSON. Thank you, Mr. Chairman.

Mr. Newsome, thank you for being here, and we had a good discussion yesterday. To just summarize the discussion I had with you

yesterday, as I understand what is going on here, that if at the end

of this process if you prove this, this exchange is going to have to

comply with everything, all the laws that the exchanges here in the

United States comply with. Is that correct?

Mr. NEWSOME. Yes, sir, that is correct.

Mr. PETERSON. On this issue of surveillance that apparently is

going to be going on in Eurex Frankfurt, there is a question, that

if they are going to use that for surveillance, how does that work

if that exchange is not approved as a self-regulatory organization

under the Commodity Exchange Act? Is that accurate, or if this

goes ahead, are you going to approve that as a self-regulatory agency?

Mr. NEWSOME. Well, I think there are a couple aspects of that

question. One is delegation of responsibilities, and in order for a

contract market to delegate core responsibilities it has to delegate

those to a registered entity. However, there is another scenario

which involves contractual services; and under a contractual services agreement, which doesn’t necessarily mean you are providing

an agreement or services for a core principle, you are allowed to

delegate those to nonregistered entities.

Now it is my understanding that all of the core functions in

terms of meeting the Act will either be supplied by U.S. Futures

Exchange itself or to regulated entities such as the National Futures Association or The Clearing Corporation.

It is my understanding that there are contractual services agreement with nonregistered entities to supply some marketing assistance, some backup, data assistance, and that would be allowed

under the Commission rules. I mean, it would be very similar to

a situation that exists today in which the Board of Trade has a contractual services agreement with Eurex to supply the electronic

trading system that they have been using; and as that agreement

is terminated, they have entered into another agreement with a

nonregistered entity, LIFFE, to supply.

10

So that is not necessarily a unique scenario, but there is a difference between delegated responsibilities and contractual services.

Mr. PETERSON. So what Eurex Frankfurt is going to be doing

would be not a primary, whatever you call it, the terminology?

Mr. NEWSOME. Not a core function. But I would add that we are

continuing the look at that. We will make sure that that is the

case; and unless we are satisfied, we will not approve the application designation.

Mr. PETERSON. Now, this outsourcing to the national futures

agency or whatever it is, it has been questioned by some that the

amount that is being talked about here, I guess that $600,000,

which is substantially less than is being spent by the Board of

Trade, for example, and I guess other exchanges here in the United

States, could you comment on that, according to my information,

the Board of Trade spends like $19 million, and they are going to

outsource this for only $600,000. How does that square?

Mr. NEWSOME. Yes, sir, I will be glad to.

A couple of things. One, I want to comment about the National

Futures Association, and then there is another industry group

called the Futures Industry Association, both of which you are

going to hear from later today.

The Futures Industry Association is the more typical industry organization that develops policy, lobbies on behalf of its membership, which is primarily the firms.

The National Futures Association is not a traditional association

that represents its members in a lobbying-type capacity. The National Futures Association was created in 1981 under the umbrella

of the Commodity Exchange Act to assist the CFTC in providing

regulatory functions. We have relied on the NFA through designation of functions now for over 20 years, such as registering intermediaries, conducting audits of intermediaries, just very numerous

functions that we have asked them to provide; and they have done

so very, very successfully over this time period.

With regard to the amount of resources that they have and the

amount that is going to be spent initially on this oversight activity

versus what the Chicago exchanges have spent is not an apples-toapples comparison. I would state, first of all, that the Chicago Mercantile Exchange and the Chicago Board of Trade both do an outstanding job of monitoring their marketplace; and I would also say

that they go above and beyond what is required in the Commodity

Futures Modernization Act to do so. But we measure by the legal

standard in the CFMA of what is required; and based upon the application that has been sent to us, it appears that the NFA is more

than capable of meeting those responsibilities. Now, again, when you look at the money, the $600,000 versus the $19 million, I think you have to keep in mind that on one hand

you have got two exchanges that are trading hundreds and millions

of contracts, and on the other hand you have got a start-up exchange that has not traded a single contract yet, and there are escalating clauses built in to their agreement. So as volume increases

and the responsibilities of NFA increase, they are paid more and

have the ability to bring on more staff. So at least at this point that

is a concept that we seem to be comfortable with.

Mr. PETERSON. Thank you.

11

Thank you, Mr. Chairman.

Mr. MORAN. Thank you, Mr. Peterson.

The gentleman from Oklahoma.

Mr. LUCAS of Oklahoma. Thank you, Mr. Chairman; and thank

you, Chairman Newsome. You have done a good job in your written

testimony, your comments so far today.

If I could work through a few of these points, and I agree with

the logic of moving the application from the 60-day fast track review process over to the 180-day fast track.

It appears to me the way the law is structured, Mr. Chairman,

that if CFTC determines along with the applicant that more time

is needed, together all of the pertinent information necessary to

make a final decision, one way or the other, that that is possible.

Is that the way you would interpret it? It is possible to go past this

180-day mark if the applicant and CFTC agree that it is necessary?

Mr. NEWSOME. Well, I would go one step further. I wouldn’t even

say that the applicant has to agree. If the Commission determines

that the application is not complete, it is my belief that the Commission alone could stay that 180-day time period.

Mr. LUCAS of Oklahoma. Good. I would agree with that logic.

Do you believe at the point in time you are at at present, looking

at your staff resources and the way the process has gone, the information made available to you, will it be possible to make a decision

within that 180-day time frame from your vantage point at this

moment?

Mr. NEWSOME. I think it is difficult to say right now, Congressman. I mean, we have just gotten responses to their questions.

I would say, unless issues are raised that we are not aware of,

it is certainly possible that it could be completed within that 180

days, but if, as typical, the answers to these questions will probably

raise more questions that we will want to ask. I would say with

regard to the time frame, whether it is 180 days or whether it is

stayed, we won’t designate until we are fully satisfied that they

meet the core principles of the Act.

Mr. LUCAS of Oklahoma. Along that line of logic—and I realize

CFTC is reviewing the application in the terms that it is presented

where the applicant specifically describes what they propose to do.

But in the nature of the way the world works, sometimes events,

circumstances, potential business plans develop, courses of unexpected consequences take place. Is it possible under the law the

way it is currently worded—can I feel confident that CFTC has the

ability to prevent in the future any major deviations or events that

would occur that would be different, so to speak, than the application process would imply or discuss?

Mr. NEWSOME. Well, Congressman——

Mr. LUCAS of Oklahoma. That is a western Oklahoma question

coming from constituents that are sensitive about the phrase ‘‘manipulation’’.

Mr. NEWSOME. I certainly believe that to be the case.

One, through meeting core principles, the contract market has

the responsibility to not list contracts that may be susceptible to

manipulation. It is our responsibility as the oversight agency to try

and make sure that that is the case, and we do that to the best

of our ability.

12

However, if any time we become suspicious or concerned that a

contract, even though it might have been self-certified because of

changes in the marketplace or other things outside our control, if

we become concerned that that contract becomes susceptible to manipulation, we can either require the exchange to make changes to

that contract or we can stop in the most extreme cases trading of

the contract. So I believe we have got the authority needed to do

so.

Mr. LUCAS of Oklahoma. That is a very important issue. Because

while perhaps my average constituents back home don’t realize or

appreciate just how much influence the institutions that you have

oversight over influence everything from their monthly mortgage

bill to the price of wheat posted at the local elevator, how critically

important—and that leads me to my next question about the issue

of self-certification in the way that new contract trading started

and that sort of thing. Has CFTC ever stopped an exchange from

trading a self-certified contract?

Mr. NEWSOME. Not formally. If you look at kind of how we do

things and if an exchange intends to self-certify a contract that

they think is either novel or may raise issues, typically they come

in and talk to us in advance. If there are issues that we raise, then

they work with us to solve those issues before it ever formally becomes self-certified. So because of that up-front process, we have

never formally turned down one, but certainly we have had lots of

discussions at the front end before contracts have been certified.

Mr. LUCAS of Oklahoma. If the chairman would indulge me for

one more question, thinking about Mr. Boehner’s observations, the

law requires that the Treasury be consulted on certain contracts

when Treasury products such as bonds are the basis of the contracts. Has the Treasury been consulted on this application since

the U.S. Futures Exchange plans to trade bond futures?

Mr. NEWSOME. The short answer is yes. I personally have had

conversations with officials at both the Fed and the Treasury with

regard to this, and upon receipt of those contracts yesterday they

were forwarded to the Fed and Treasury for their review.

Mr. LUCAS of Oklahoma. Thank you, Mr. Chairman.

Mr. MORAN. Yes, sir. Mr. Lucas, thank you.

The gentleman from California, Mr. Dooley.

Mr. DOOLEY. Thank you, Mr. Chairman.

I will preface my questions with, I am a little bit skeptical about

the motivation for this hearing, and the reason for that. I think if

the Chicago Board of Trade or the Chicago Mercantile Exchange

had submitted a similar application, we wouldn’t be having this

hearing. I think that we ought to consider, that this is really an

issue in terms that there has in fact been a breakdown in terms

of the responsibility of what CFTC has done, which to date there

is absolutely no evidence that Chairman Newsome and his team

are not doing their job in terms of evaluating the Eurex proposal.

I think there are some legitimate questions that are being brought

up here, but I think we ought to understand that when we passed

the reforms our approach here and idea was to give a better environment for the creation of innovation in new products and ensure

that we are having fair competition.

13

I am a little concerned on whether or not what we are doing here

is in some ways stifling what could be a—new products are being

offered that are going to give consumers and people who are participating in that something of greater value, which I think is good.

Because everything we are hearing about now, no one is really giving any attention to the people that would be using the products

that Eurex is offering. We are looking in terms of the only approach to ensure that those consumers are being protected is the

CFTC, when Eurex is going to have to demonstrate that they are

providing something of value.

I am a little bit troubled, and even in some of the testimony that

I have read from—even from the Chicago Board of Trade where

they give some of their concerns that lead up to the foundation for

not even their factual problems with the Eurex application, but

they go through four points.

First, Eurex would have you believe that its new exchange would

bring electronic trading to the United States. They say that is untrue. I mean, I think it is irrelevant. I think it is irrelevant to what

Chairman Newsome is considering.

It says, second, Eurex claims that CBOT is a monopoly. It is not

true. I think it is irrelevant to ask whether or not CBOT is a monopoly, certainly in the context of what Eurex is doing.

Third, they go on to say that Eurex would have you believe that

it will become the low-cost provider of trading services in the

United States. They say that is not true. I think that is irrelevant.

If they can offer a product that is demonstrated to have some value

to people and value to consumers, then we allow them to go forward.

Then they say, fine, the Eurex would have you believe that it will

offer a fully electronic marketplace, and that is more ruse than reality. Why should we care? I mean, we set up a regulatory system

to allow for products to be offered under the oversight and the regulatory approach of the CFTC, and we ought to allow that to move

forward.

I guess one of the specific issues that I would like to address is

there has been some criticism whether or not the incentive plans

that Eurex would be offering, whether or not they have offered

those for consideration; and Chairman Newsome, I would like you

to address that point.

Also, if CBOT or another player on the exchanges were offering

incentive plans, do they have to have those approved if they have

a modification in those in order to attract businesses or new business?

Mr. NEWSOME. Thank you, Congressman.

Certainly the incentive programs have been something that have

widely been discussed in the media and at meetings. I am glad to

hear you use the word ‘‘incentive,’’ because typically ‘‘payment for

order flow’’ is the term that has been used. In a nutshell, that is

what in the futures industry we have traditionally called incentives, and that is what they are, incentives to encourage trading in

volume on your exchange. There are various kinds of incentive programs that are currently used by our domestic exchanges today.

Certainly there are incentive programs that are utilized in other

jurisdictions and marketplaces around the globe.

14

The incentive package—and I think there are two issues here.

One, those are packages that are allowed to be self-certified. Their

incentives have to become rules. Those rules then in turn can be

self-certified. However, I think the bottom line is whether it is selfcertified or whether it is submitted to the Commission for

preapproval, the bottom line is the Commission still has the obligation to review and decide whether or not to accept them. I think,

obviously, if we determine that these incentive packages do not

meet the core principles or they don’t allow the brokers to follow

their proper fiduciary responsibilities, then we are not going to

allow that to be the case.

I would say, as I mentioned earlier, traditionally if anything is

considered controversial or novel, they come to us first to review

it, because the last thing they want is to self-certify it and then

have us pull it back. It is not only embarrassing but it is costly for

them for that to be the case. So that is the incentive for them to

come to the CFTC first, regardless of how they move forward.

But, more specifically, if there are changes to those who have initially been self-certified or preapproved, yes, they would have to go

back and go through either that self-certification or the

preapproval again.

Mr. DOOLEY. Well, thank you very much. I just want you to know

that I personally have a great deal of confidence in your approach

to the consideration of this application, and hopefully this hearing

just doesn’t communicate that there is a broad distrust or concern

of a lack of oversight on your work.

Mr. NEWSOME. Thank you, Congressman.

Mr. MORAN. The gentleman from Georgia, Mr. Scott, asked for

the opportunity to question the witness out of order. The only way

I know how to do that, Mr. Scott, is to yield to you. It is now my

turn to ask questions, and I would yield you a portion of my time.

Mr. SCOTT. Thank you very much, Mr. Chairman, for your generosity. I appreciate it. I have a conflict happening at the same time,

but I did want to ask Chairman Newsome just this line of questioning.

If the Eurex U.S. application included this intention to trade

Treasury futures, would the application review process be different? And specifically, would the Treasury Department involvement be required? Can Eurex U.S. avoid the Treasury Department

involvement by not specifying these contract terms?

Mr. NEWSOME. Yes, sir, it is different in this context for the very

reason that you bring up. Not only does the Act suggest that Treasury and Fed should have the opportunity to review those, I personally feel that that is the case as well. I have had conversation with

officials at both agencies. We have submitted the application and

the contracts to them for their review, and we are waiting to hear

their response.

Mr. SCOTT. Thank you very much.

Mr. MORAN. Yes, sir. Thank you, Mr. Scott.

The gentleman from Indiana, Mr. Hill.

Mr. HILL. Thank you, Mr. Chairman.

Mr. Chairman, you remarked in your opening testimony that the

terminology ‘‘call-around’’ was something that you just learned

about in the last couple of days. Could you tell me what you think

15

call-around means then, since you just learned about it for the last

couple days?

Mr. NEWSOME. Throughout this discussion there have been some

terms that have been utilized that are not what I would say called

traditional futures terms, like payment for order flow, which is

typically more of a securities industries term, versus incentives

that we have used in the futures business. I think call-around is

one of those terms, and it seems to me that it is more of a term

that is used in foreign jurisdictions versus in our U.S. jurisdiction,

and, because of that, it was a term that I was not familiar with.

As best as I understand and as I have looked into it over the last

couple of days, it appears to be similar to a scenario that was created and allowed through the CFMA in which over-the-counter contracts that are traded prior to the CFMA were not allowed to be

cleared on a designated clearing organization, and the CFMA allowed that to happen. The Commission has developed rules, and we

actually have instances where that is the case now, most specifically at the New York Mercantile Exchange clearing over-thecounter energy contracts.

So to my understanding the call-around would be a similar scenario. As we look into it more and if I find out that that is not the

case, I will certainly make sure that this committee is made aware

of that.

Mr. HILL. OK. Do you foresee any problems with surveillance as

it relates to the definition of call-around?

Mr. NEWSOME. No, sir, not at this point. But, again, that is an

area we have just received the answers to these questions. We are

beginning the review. I would only say that if we are not satisfied

with surveillance methods, then we won’t allow the designation

until we are satisfied.

Mr. HILL. In conversations I have had with several people over

the last couple of days, there was a claim that there is a possible

illegality of Eurex self regulatory surveillance being conducted by

the NFA. How do you respond to that kind of charge?

Mr. NEWSOME. To the best of my knowledge, I would disagree

with that. I think it goes back to what I understand to be language

in the bylaws of NFA, and certainly NFA’s representative will be

here in the next panel to discuss that in more detail. But it is my

understanding that there is a difference between delegation of responsibilities, which may be against the by laws of NFA, versus

contractual services, which is not against their by laws; and I believe that in this application there are contractual services agreements that would be allowed.

The difference between the two, if you are delegated to perform

a function, then you fulfill the responsibility of the contract market

or of the exchange all the way from monitoring the market to determining the penalties if they are needed. In a contractual services agreement, you have got the responsibility to monitor the market, but then you pass that information to the exchange, and the

exchange then fulfills the disciplinary function that they are responsible for. Under either scenario, the exchange is ultimately responsible for what happens, whether it is delegated or contracted

out.

Mr. HILL. OK. That is all I have, Mr. Chairman.

16

Mr. MORAN. Thank you, sir.

Thank you, Mr. Hill.

The gentleman from Minnesota, Mr. Gutknecht.

Mr. GUTKNECHT. Thank you, Mr. Chairman.

I just want to disagree slightly with my friend, Mr. Dooley. I

think this is a serious hearing, and I am glad we are having it.

Frankly, I think perhaps we should have more hearings.

I think, if I could use an analogy, let me, first of all, say that

I don’t think that we envision this kind of an application when we

reauthorized the CFTC. Maybe I just asked a short question. Mr.

Newsome, did you envision this kind of an application?

Mr. NEWSOME. Quite honestly, I don’t think anyone envisioned at

that time that this could be the scenario, but I think to me that

was one of the great things about the CFMA, is that it created this

flexibility for both the Commission and market participants. So

while I would have to say honestly I don’t think anyone envisioned

it, I certainly don’t think the CFMA prohibits it.

Mr. GUTKNECHT. Let me say, Mr. Chairman, Mr. Newsome and

members, I certainly didn’t. I do come at this with certain prejudices, and I will use that term intentionally.

First of all, I am an auctioneer, and I believe in markets, but

what we are talking about here is a whole different kind of auction

that they want to come in and do.

With all due respect to Mr. Dooley, if an auction company wanted to come into my territory and provide free auctions to the 10

largest auctions next year, I would have very strong disagreement

with that policy, and I think at some point you have to deal with

that idea of rebating commissions. I mean, I think it certainly

raises ethical questions as to whether or not we should approve

that kind of an application.

Let me give an analogy there. If some large milk importers wanted to come into California or Minnesota and they wanted to provide

milk for free for the first year to the 10 largest consumers, we certainly would raise questions.

Let me also state one of the other prejudices I come at this with.

I am the cochairman of the Congressional Study Group on Germany, and I certainly have a very special affection for Germany

and the German people, but I have to tell you that their view of

fair trade is not exactly our view. If you doubt that, just look at

how they deal with us on bananas and hush kits and GMO beans

and hormone-treated beef and all kinds of other issues. Our view

of that is not their view of that.

I think at the end of the day we have to satisfy ourselves and

certainly you have to satisfy yourself that you have the authority

to deal with entities that may be a long ways away and may be

beyond the long arm of the CFTC to deal with. It seems to me we

need answers to those kinds of questions before the application is

given final approval, not after. Once the horse is out of the barn,

all of a sudden none of this will make much difference.

Can you talk a little bit about this whole idea of rebating commissions for the first year to the 10 largest users? Is that ethical?

Is that approved by you? And what do you think the long-term implications of that are?

17

Mr. NEWSOME. If I might, I would like to comment on a couple

of the points that you brought up.

First of all, as a cattleman, in my activities with the Mississippi

Cattlemen’s Association and working with the National Cattlemen’s Association, I can assure you I understand how completely

frustrating it is to deal with the Europeans on a number of trade

issues, and I know that this Congress is dealing with a lot of that

as we speak.

In my current role in trying to fulfill my responsibilities to the

Commission and to the Commodity Futures Modernization Act and

in whether it was foreseen or not, it seems to me that certainly it

is not prohibited. So we are trying to view this application as we

would any other.

Now there are some novel ideas that it brings up, and you have

mentioned several of them, and those ideas are forcing the Commission to really dig deep in our review.

The incentives is one. First of all, it is difficult for me to comment on the incentive package that Eurex may or may not offer,

because it hasn’t been submitted to us. I know that, apparently in

marketing meetings across Chicago and possibly elsewhere, there

have been incentive packages talked about. We do not have an incentive package in front of us. We will at some point, either for

preapproval or for certification, and we will view that based upon

the criteria that we have looked at other incentive packages. If we

don’t think it is fair, if we don’t think it meets the core principles,

if we think it leads the brokers down a path of not considering

their customers as a priority or that may inhibit their ability to fulfill their fiduciary responsibility, we just won’t allow it.

With regard to the German authority, we have had a long-standing relationship with the German authorities. We have a memorandum of understanding with them that we have had for a number

of years, and we have had several instances to utilize that memorandum of understanding. All I can say, based upon our past experiences, is that they have been very helpful and they have provided

in the past everything that we have requested and everything that

we needed.

In addition to that, through IOSCO, we have just signed, and

Germany has just become one of the signatories as well, to a much

broader international memorandum of understanding that I think

is just as effective as the one that we have between them.

So at this point I am comfortable that we have the authority that

we need. If a situation arises or if we get to a point where we don’t

have the authority that we need, I think we have got the ability

and the wherewithal to make changes, whether that is stopping

trading or removing market participants, to get to a comfortable

point.

Mr. GUTKNECHT. Mr. Newsome, my time is expired, but I do hope

that you accept the admonishment that we expect you to take your

time and get the answers before the application is approved and

not after.

Mr. MORAN. The gentleman from North Carolina.

Mr. ETHERIDGE. Thank you, Mr. Chairman.

18

As CFTC chairman, you are clearly knowledgeable about what

someone must do to establish a futures exchange here in the

United States. Are you as familiar with overseas markets?

Let me ask you a couple more questions, and I will let you put

it all together.

For instance, do you have an idea of how easy it would be and

how long it would take for a U.S. exchange to be licensed for business in, say, Germany or Switzerland or some other country? And

are our regulatory processes in these areas similar? Finally, can a

U.S. exchange be authorized to operate in these countries 6 months

after applying for permission to do so?

Mr. NEWSOME. I will be glad to answer those to the best of my

ability.

With regard to how welcomed a domestic exchange might be for

designation in another country, I think that is impossible to answer, because that hasn’t been the case. I mean, nobody has applied. We have no history to draw from.

I don’t question that there is probably more difficulty in getting

into other jurisdictions than there may be in the United States, I

think particularly since the passage of the CFMA. So generally I

would say it is probably easier to access our markets than elsewhere, but, again, we don’t have anything concrete to base that on.

The only thing we have concrete with regard to the German markets is that the Chicago Board of Trade, the Chicago Mercantile

Exchange, and NYMEX, all applied for the ability to place terminals within the German jurisdiction; and that request was granted.

They currently have terminals operating there giving German citizens access to their marketplace. So, as far as I am aware, that is

the only concrete evidence that we have that they are at least receptive to those cross-jurisdictional issues.

Mr. ETHERIDGE. But terminal is entirely different than opening

an——

Mr. NEWSOME. Absolutely.

Mr. ETHERIDGE. OK. Thank you.

Second, I know that the American exchanges are very concerned

about the fair trade aspects of this application. I think we are all

aware of that. In other words, competitors having a level playing

field and the same line of access to other nations. Does the notion

of fair trade have any consideration under CFTC’s review of the

DCM application sponsored by foreign entities?

Finally, if such reciprocity is not reflected in the CFTC’s DCM

criteria, should we amend the CEA to make it a consideration?

Mr. NEWSOME. To my knowledge, reciprocity is not included in

the CFMA; and because of that, we are not regarding that as an

important part or a part, period, of our review. I certainly understand, particularly given my background, that that is a very emotional issue, but it is not currently a part of our consideration; and

whether or not the Act needs to be reviewed with regard to that,

certainly that is much more up to this body than it is to me.

My only concern is that it could create difficulties with regard to

current trade agreements that we operate under. I know based on

several things that we have done at the Commission we have been

aware of the GATT agreement at times to try and make sure that

19

we didn’t violate that agreement, but, beyond that, I wouldn’t have

much more to offer, Congressman.

Mr. ETHERIDGE. Let me raise one other point, because my time

is running out.

The problem of Enron and long-term capital markets and Arthur

Andersen and other corporate problems over the last 3 years are

largely responsible for much, I think, of the American public’s lack

of confidence and trust in the way corporations and companies are

governed and, at the same time, in the Government agency’s ability

to watch over them.

Now I believe we don’t have—and let me say that we don’t have

an Enron problem in this industry, but here is my question: What

kind of message is the American public going to hear about trust

when someone can submit a DCM application that outlines one

business plan but publicly promotes a very different plan and the

CFTC can then call them on it?

Mr. NEWSOME. Well, I think the bottom line is that they will not

be designated by the CFTC as a contract market to list contracts

until we are comfortable with that board. It is my understanding

that, as part of the questions that were submitted yesterday, that

there is much more detail in terms of how that board is going to

be structured. I haven’t had the opportunity to look at that, so I

don’t know, but I would say that board structure and corporate

governance we consider a very important issue.

In fact, in May of this year I announced and we have since started a review of our self-regulatory organizations, and review of corporate governance is a part of that review that we are currently

undergoing with our existing markets. Certainly somebody that is

coming in for an application we are going to hold to that same

standard.

There have been accusations across this industry that some of

the boards and corporate governance structures are not acceptable.

I don’t know whether that is the case or not, but I do know that

we are reviewing it, and if we find that not to be the case, we are

going to make changes.

Mr. ETHERIDGE. Thank you, Mr. Chairman. I know my time is

expired, but trust and confidence are a critical part of this whole

thing. That is why it makes our systems work well, and I hope you

will keep that in mind.

Mr. MORAN. Thank you, Mr. Etheridge.

The gentleman from Georgia, Mr. Burns.

Mr. BURNS. Thank you, Mr. Chairman, and I appreciate Mr.

Newsome’s input.

I want to follow up on some discussions Mr. Etheridge brought

up at the end.

My question deals with the U.S. Futures Exchange. In your testimony, it is a Delaware limited liability corporation. It is a wholly

owned subsidiary of U.S. Exchange Holdings that is a whollyowned subsidiary of Eurex Frankfurt, it is a wholly-owned subsidiary of Eurex Zurich, which is owned in equal parts by Deutsche

Borse and SWX Swiss Exchange.

Now, that is a bit confusing, and it is a bit confusing considering

the fact that we know who the shareholders are in the Chicago

Board of Trade, and we know who the shareholders are in the MerVerDate 11-SEP-98 10:17 Dec 23, 2003 Jkt 090742 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 F:\DOCS\10821 HAGRI PsN: HAGRI
20

cantile Exchange, and yet there is a board of directors, U.S. Futures Exchange is governed by the board of directors elected each

year at an annual meeting each year by shareholders.

My question is who are the shareholders, who elects the board,

and what role will they play?

Mr. NEWSOME. I would say that those are questions that we are

currently asking.

Mr. BURNS. Those are tough questions.

Mr. NEWSOME. They are tough questions, but in a response from

Chairman Greenspan to a request for information, he brought out

the point that it becomes more and more difficult to tell who the

shareholders are; knowing, now that Chicago Mercantile Exchange

has gone public.

Mr. BURNS. But we know who the shareholders are.

Mr. NEWSOME. Exactly, and we are trying to find out who they

are in this application as well.

Mr. BURNS. It is a very critical point.

Mr. NEWSOME. Well, ultimately, we know that Deutsche Borse

and the Swiss Exchange are in the bottom of that chain that you

just went through.

We do know that over 50 percent of the shareholders of Deutsche

Borse are U.K. And U.S.-based. For example, two different arms of

Fidelity are 10 percent owners in Deutsche Borse, but I understand

your question. We are working to get to the bottom of that. I do

not have the answer to that.

Mr. BURNS. I think that that issue must be resolved before we

can proceed. Another point, and again, Mr. Gutknecht and Mr.

Etheridge alluded to this, we are looking for fair and open markets.

I am certainly an individual that would support that. We welcome all competition, the United States. I am concerned that reciprocity is not being addressed here, certainly not in the statute,

maybe it should be, but just a quick question: With the terminal

access in the European marketplace, was that done on a national

level or was it diluted to where our exchanges had to go on a Stateby-State basis?

Mr. NEWSOME. The way the German regulatory system is set up,

it is both. You have a national regulator and then once you go

through that process, then, you have to go through the State regulator, depending on where you want to be located, so there is no

question it is a more burdensome process from that standpoint

than it is here.

Mr. BURNS. So that, if a hypothetical exchange chose to do the

same type, provide the same type of proposal in the European environment, it would find it much more burdensome to proceed to the

same point that maybe the U.S. Futures Exchange would like to

be provided here.

Mr. NEWSOME. Well, I cannot say that with any certainty, because, to my knowledge, has not been pressed at the designated

contract market level, but I think you could certainly draw that

conclusion.

Mr. BURNS. Final point or two on transparency, and really our

ability to have confidence that this is a free and open and secure

marketplace.

21

I would like to hear your comments about your evaluation of the

current proposal, as relates to self-regulation, self-certification and

transparency.

Mr. NEWSOME. Well, I think those are differing issues, and the

transparency issue has been one of the most emotional, and it always creates a difficult situation for us to be in the middle of what

the public wants to see and what we consider to be confidential information that only we have the opportunity to see.

I mean, there is no doubt that, on behalf of competing exchanges,

you would like to see it all. It is our responsibility to decide where

the line is drawn, because it is exactly like Ford wanted to see the

whole marketing plan for General Motors for the next year. They

would love to have that information. The CFMA clearly draws the

line in terms of trying to decide what is competitive, the information that deals with financial contracts, and just the things that we

should be sensitive about.

What we had tried to do, Congressman, is to follow the same

process and the same guidelines that we have used for everyone

else, and there is a process for appealing, under FOIA, to try to get

more information, and we go through that process regularly. Those

decisions are made through our general counsel’s office, and we are

going through part of that process now. So the only thing I would

say is that we are trying to make sure that we are fair and we

treat everyone the same, with regard to transparency and what we

are putting out to the public.

Mr. BURNS. Let me conclude by thanking the chairman. I have

great confidence in the chairman and great confidence in the CFTC

and I hope we will continue this discussion as we move forward.

The CHAIRMAN. Thank you, the gentleman from North Carolina,

Mr. Ballance.

Mr. BALLANCE. Well, gentlemen, I did not have a question, but

I think I have got one now. Under this new Act, which I am not

very familiar with, I take it CFTC has authority to decide whether

or not to accept an application.

Mr. NEWSOME. Yes, sir.

Mr. BALLANCE. And, if somebody does not like your decision,

where is the Court of Appeals?

Mr. NEWSOME. I do not think there is one.

Mr. BALLANCE. For example, if the applicant is dissatisfied, what

rights would the applicant have to ask for a review and if someone

in this body is not satisfied with your decision?

Mr. NEWSOME. Well, typically, it is not just a black and white

process. We submit this to you and then do you say yea or nay. It

is an ongoing process and it typically starts before they even officially turn in the application. So say an application is turned in to

the Commission. We would review that application and normally

ask an extensive number of questions to get clarification to that.

They would provide those and if there were areas that we disagreed then we would tell them that, in our opinion, this section

does not meet the core principles or the Act or we have issues and

we are not comfortable, so it begins a process where we are backand-forth to work through the issues that are in front of us.

At the end of the day, we are the ultimate decider of whether it

is designated or not and what is included or not, and I cannot reVerDate 11-SEP-98 10:17 Dec 23, 2003 Jkt 090742 PO 00000 Frm 00024 Fmt 6633 Sfmt 6633 F:\DOCS\10821 HAGRI PsN: HAGRI
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member a time when we were unable, with an applicant, to work

that out.

Were they happy?

Probably not, but we have to get to a point that we feel we are

satisfied that the core principles and rules of the CEA and the

CFMA are met, and, ultimately, that is what we try to get.

Mr. MORAN [presiding]. Thank you, Mr. Ballance.

The gentleman from Texas, Mr. Neugebauer.

Mr. NEUGEBAUER. Thank you, Mr. Chairman.

My primary interest is in the end-user, the people that are depending on these exchanges on a daily basis to enhance their business opportunities, and there is a lot of discussion has been about

the incentives or payment for flow.

In the existing exchanges that are in our country today, are you

aware of any practice in any of those exchanges where incentives

or discounts are given to any of the members that are using those

exchanges?

Mr. NEWSOME. First of all, I think that is one of the good things

about incentives, because it makes trading more efficient, and you

would hope ultimately that that efficiency is passed on to the customer.

I believe that if you look at the exchange level, most of the incentives are offered to those who are doing the actual trading, and

then the question becomes: Are those brokers or are those FCM’s,

in turn, passing that efficiency on to their customers.

As competitive as that side of the business is, my assumption

would be yes, but I cannot say that with certainty.

Mr. NEUGEBAUER. But the question was: You believe today that

there are incentives being paid or given by the existing exchanges

to, say, high-volume customers?

Mr. NEWSOME. Oh, absolutely.

Mr. NEUGEBAUER. So this is not a new concept of incentivizing

large customers or trying to attract large customers, saying if you

will bring your business over here, we will clear your transactions

for X number of dollars?

Mr. NEWSOME. No, sir.

There are a number of types of incentives that we see offered

from fee holidays, which are basically not charging fees for a certain period, at the beginning of a new contract, or tiered incentives,

based upon your volume of trading and what you end up paying,

and we see multitudes of those types of incentives.

Mr. NEUGEBAUER. The other thing, and I think the one thing

that all of us have watched in the last year or 2, what we thought

were very open and transparent and very honest systems. We are

finding out that in some of the exchanges or in some of the houses,

for example, we just recently found out that the mutual funds,

there was a little bit of call around trading going on after those

markets were closing.

And I came from the real-estate business, where sometimes there

is a procedure that we do not call it call-around, but property is

moved, based on making some phone calls, and I would tell you

that, in my personal opinion, there is not much transparency in

calling around trading, and I think one of the things I would like

to hear from you is where could you see a place in the market

23

where you could not either in open outcry or in electronic trading

that you would need to do a call-around trade?

Mr. NEWSOME. Well, I think it raises two issues, and I will address it from what we consider the traditional block trade and into

what I understand the call-around to be.

As I commented earlier, when exchanges first started coming to

the Commission to ask for approval of rules to block trade, I was

opposed to that, because, quite frankly, I called it non-competitive

trading, and I happen to think the transparency is a good thing,

and I think, throughout the discussion, the compelling argument to

me that allowed me to vote in favor of the block trading rules was

the opportunity of the exchanges to compete with the over-thecounter marketplace, because, in our block trading rules, the block

trade can occur off the floor, but it has to be within a price range

that is suitable for that number of trades, and then it has to be

announced to the floor within a specific time frame, depending

upon the size of the block, so even though the trade occurs off the

floor, it is expressed to the marketplace at some point, and, in an

over-the-counter trade, that is not the place.

It takes place, we are never aware of it, we do not hear about

it, there is nothing transparent about it, so initial transparency,

the fact that we find out at least a portion of the ability to use that

in competition was an appealing argument for me that I voted for.

In the call-around market, that terminology is somewhat new to

me and so I am trying to learn more about it, but from what I have

been able to find out, the call-around is very similar to an over-thecounter transaction between two sophisticated parties of which we

have no access and it is not transparent, but, because it is between

two sophisticated parties, the decision has been made in the past

that that is acceptable.

It is a business decision between those two, and then clearly—

the ability to clear that either call-around or over-the-counter contract at least brings that portion of it into a regulated system and

information is collected so while, maybe not ideal, I think that they

tend to serve a specific function, and I think it is a legitimate function .

Mr. NEUGEBAUER. The call-around trade then is cleared through

the Exchange and so the terms of that trade then are disclosed at

the clearing, at the end of the marketplace?

Mr. NEWSOME. Yes, sir, through the clearinghouse.

Mr. NEUGEBAUER. It is not my understanding and I would be interested to hear testimony.

Mr. NEWSOME. And as I said earlier, that is new to me and I

may be wrong.

Mr. NEUGEBAUER. I appreciate the chairman seems to be sensitive to making sure and even your thoughts about over-thecounter trades, I just would say I have that same sensitivity and

as you look at that application and as you approve or look at approving that type of trading, I would ask you, on behalf of the people that use those exchanges, to approach that with caution.

Mr. NEWSOME. OK.

Mr. NEUGEBAUER. Thank you, sir.

Mr. MORAN. The gentleman’s time has expired.

The gentleman from Georgia, Mr. Marshall.

24

Mr. MARSHALL. Thank you, Mr. Chairman.

Mr. Newsome, thank you for your testimony, and I must say I

do not know much about your organization, but I have some confidence in it, because you have got a former student of mine,

Marcia Blase, working for you and she is extremely bright and

dedicated, so congratulations on having her working for you and

that comforts me somewhat.

I find myself in agreement with Mr. Dooley’s comments and Mr.

Gutknecht’s comments, and yet the two of them seem to be disagreeing with one another.

On the one hand, we are certainly interested in competition that

enhances the services and prices that individuals who want to take

advantage of the futures market can obtain; on the other hand, we

are not particularly interested in bringing into the United States,

as some mentioned, the Trojan horse, that possibility, Charlie Stenholm, a Trojan horse that could somehow undermine the system

that we have in place at present with competition that may not be

fair, competition that we cannot even anticipate, that might be difficult, and as I sat here listening, I was comforted somewhat by the

thought that the process that you go through, in trying to decide

whether or not to approve the application, is one that is very open,

and then I went, well, I do not know whether it is open or not, and

Mr. Burns asked the question just how transparent is this process?

The reason I am comforted with a very transparent process, a

very open process, is you have got very competent individuals who

know the business cold who are quite interested in avoiding competition from this foreign source that would like to have an opportunity to persuade you that it is not a good idea to approve this

application, and if you are completely open in what they say to you

and what you say to them so that these third parties that are interested in this have an opportunity to look at all of that, then they

will be in a position to encourage you to ask additional questions,

raise red flags with regard to responses, and identify problems that

you cannot deal with.

Mr. Gutknecht’s suggesting that perhaps there are problems you

cannot deal with that you are going to have to come back to us or

somebody else and say a concern has been raised that we cannot

deal with. It is not in our jurisdiction. It is not the sort of thing

we consider.

I am a little worried about that. I guess I find myself wondering

how would somebody like me who does not have a great deal of expertise in this particular area, how would somebody like me get

comfortable with there is a process that is going to permit a reasonable opportunity for those individuals who do have great expertise and interest in questioning this application to thoroughly question it in time for both you and us, if need be, to take action?

Mr. NEWSOME. Thank you, sir.

Well, I would say, first of all, that there are very large portions

of the application that have been put out for comment and that we

have received and still are receiving comment on, and obviously we

will go through those comments with a very fine-toothed comb,

and, as usual, I would expect those comments to raise questions

that we will need answers to from the applicant.

25

I think we are also very fortunate on the Commission that we

have a very professional and qualified staff who have been through

these kinds of reviews numerous times, who, quite frankly, I think

do a very good job.

Obviously, the public comment, the comment from other experts,

is very valuable to us, but we include all aspects of the Commission

in these reviews, not just the market oversight group that has the

ultimate responsibility of making the recommendation to the commission, but we include those who are actually surveying markets

to protect against manipulation and we include our enforcement division. It is a commission wide effort to look at, raise issues, ask

questions before the staff gets to a point of comfort where they are

making a recommendation to us.

I think, without question, I have got the complete confidence in

this oversight committee, and, if there are any issues that are

raised through our review that are concerns that we cannot address through our rules in the current act, I will personally come

to this committee to raise those issues and to start a dialogue of

how we address them.

Mr. MARSHALL. That sounds fair enough.

Thank you, sir.

Thank you, Mr. Chairman.

Mr. MORAN. Thank you.

The gentleman from Michigan, Mr. Smith.

Mr. SMITH. Thank you, chairman.

Chairman Newsome, thank you for all your work and for being

here.

Mr. NEWSOME. Yes, sir.

Mr. SMITH. What was the key reason that you took the application off of fast track? Was it a lack of information or was it that

it looked like the application might not meet the core principles?

Mr. NEWSOME. Let me say, and I appreciate you asking that

question, because I haven’t gotten that, and it gives me the opportunity to give a real quick background, if that is OK with you.

The statutory language is 180 days. Says nothing about 60 days.

The Commission rule, in trying to further the intent of the Act

said there are some rules, possibly some contracts, that we do not

need 180 days on, so we developed the 60-day fast track, and I can

say from many rule submissions and rule amendments, that process works very well.

From the contract designation standpoint of which we had designated 4, none have been designated within that 60-day period, so

I think we need to go back and review whether or not we want to

continue to offer that 60-day fast track——

Mr. SMITH. I am hearing you say it is pretty much automatic. If

there is any question then you take it off of——

Mr. NEWSOME. Well, I hate to think it is automatic, because we

make an attempt to look at things and review things as quickly as

possible.

Within a contract market designation, particularly with one as

large and as extensive as Eurex, it is just very difficult to get to

a point where we are comfortable within that time frame and for

that reason we took it off.

26

Mr. SMITH. The CFMA took away some of your oversight authority. Does CFTC have adequate statute authority to thoroughly

evaluate such applications to adequately know the consequences of

an approval?

Mr. NEWSOME. Well, I think when an application comes in, it

comes in for designation as a contract market. The contracts themselves do not have to be included as part of that application, but,

however, they are not allowed to trade contracts until after they

have become designated.

Now, as part of that, obviously, they can self-certify those contracts and some of their rules.

While we have given up that up-front or that prior approval, I

do not believe we have given up any of our responsibility, because

we could always after the fact, if we do not feel that it meets the

core principles of the Act, we can pull it.

Mr. SMITH. But you do have, as far as you are concerned, you do

have all the statutory authority you need to dig in to thoroughly

evaluate, discover, or lock in the clearing procedures that your

recollection is suggesting?

Mr. NEWSOME. Yes, sir.

Mr. SMITH. Let me ask you the question of what would be the

consequences of an approved application. Do we look at that? Is

there a possibility it might put some of our current exchanges out

of business? Would it bring down the price to the customers? Does

CFTC look at the consequences of an approval?

Mr. NEWSOME. Not from the standpoint of who may win or lose

at the end of the competition.

Certainly, I am a strong believer in competition. I think that the

CFMA created a very competitive playing field, without regard to

open outcry or electronic trading, and it is our responsibility, as the

regulator and overseer, to make sure that, if you are going to have

competitive markets, you have got to have level playing fields for

them to be truly competitive. That is our responsibility, we take it

very seriously, and that is the way we approach the review of the

contract, this one or any other.

Mr. SMITH. Eurex has said, it’s been the least quoted as saying

that they might look to a foreign clearing link in the future, but

am I correct that this isn’t in the application, or is somehow it is

locked in that they are going to use the same clearing that we use

for the rest of the U.S. exchanges?

Mr. NEWSOME. The application that is in front of us includes a

very traditional exchange clearinghouse link.

Now, I understand that, in some of these marketing meetings,

there has been discussion about a clearing link with yourself. I

would say this: Before trades traded on a contract market in the

U.S. could be cleared at a non-domestic exchange, we would require

that that non-domestic clearinghouse come in and register as a designated clearing organization.

Mr. SMITH. Do I understand that you do not know through the

application process or down by hearings or interviews exactly what

products this U.S. Eurex is going to offer?

Mr. NEWSOME. I think we received contracts yesterday. We received the U.S. Treasury complex yesterday, so that is the only

27

thing that has been sent into us. Beyond that, we do not have

those yet.

Mr. SMITH. Mr. Chairman, the red light is blinking.

Mr. MORAN. I had noticed the same thing, Mr. Smith.

Thank you for your attention.

The gentleman from Washington, Mr. Larsen.

Mr. LARSEN. Thank you, Mr. Chairman, and Chairman

Newsome, for your thankless job, I want to say thank you to you

and your staff, the great work you do.

I want to relate these questions to the criteria that you have to

follow. A couple of them prevent market manipulation, fair and equitable treatment, financial integrity of transactions. Those have to

do with a fundamental precept of the free market we like to

espouse and that is perfect information that really does not exist,

but the principle is that most everyone has access to most of the

information at relatively the same time, so you can compete fairly

and trade information and benefit from that, from that trade so in

looking at my colleague’s question, my colleague from Georgia’s

question, Mr. Burns’ question, looking at U.S. Futures is structured

as subsidiary of a subsidiary of a subsidiary, is there anything in

how U.S. Futures is structured that causes problems for you to do

your job on the enforcement side?

And let me relate my second question: In your testimony on page

5, you talk about your MOU with BaFin.

The fair and level playing field should not only exist for people

to compete, but it should exist for you to have the ability to enforce,

as well, so does the MOU with BaFin cover the particular circumstances under which U.S. Futures is organized?

The way it is structured, would you have the ability to do what

you need to do to enforce, enforce CFTC rules and regulations?

Mr. NEWSOME. Yes, sir. We feel that we do.

The MOU’s are not just a pie in the sky. We have had opportunity in the past to utilize the agreements as part of those MOU’s,

and we have been successful in doing so.

Will that continue from here out? It is impossible to say, but we

have to get to a point where we are confident that that is the case

and that we can, in fact, reach those who need to be reached.

There is one scenario that some have called a loophole; I do not

know whether it is a loophole or not, but it is a loop hole that exists for everyone, and that is a controlling person who is in a foreign jurisdiction, and if they take non-public information and trade

on that information, could we reach them, and the answer is it may

be very difficult to do so, but that exists in the structure of our domestic exchanges today, as well as it will exist on the Eurex structure, and the only way that I know to be sure that that will not

happen is to not allow foreign participation in our markets, and I

do not think that is a viable option, so that is somewhat of an

issue. It has never been something that we have had to deal with,

but we understand that could be the case, and we are aware of it.

Mr. LARSEN. OK. All right.

Second set of questions has to do with you addressed it a little

bit, about the Freedom of Information Act and what information

you can release, the judgment that you have to make about what

28

you should release and what you shouldn’t release because of proprietary information.

Do you expect there will be any additional portions of the U.S.

Futures application released publicly for further comment or are

you at the end of the line in that regard?

Mr. NEWSOME. Well, no. I envision that there could be more released, because it depends upon the answers to the questions that

we have just gotten.

If those answers raise material issues in portions of the application that we can make public, well, so, I would say typically that

is the case, and my expectation is that there will be more made

available for comment.

Mr. LARSEN. Sure.

Thank you, Mr. Chairman. Mr. Chairman, I would like to yield

back about 10 seconds of my time.

Mr. MORAN. I am very grateful for your contribution.

The gentleman from California.

Mr. OSE. Thank you, Mr. Chairman.

Mr. Newsome, the regulatory regimes that CFTC operates under,

are they similar to, say, the regulatory regimes that the SEC applies to securities exchange?

Mr. NEWSOME. They are similar in a very general nature, but because of the differences in the market places, the differences in the

products traded, there are some real underlying differences as well,

such as fungibility. Fungibility in the securities market, that is not

the case here, so I would say, generally, yes, while there are lots

of specific differences.

Mr. OSE. So within those four existing contract designated market places, because of the manner in which the underlying contracts are traded in those markets might vary, there is slightly different means of interpreting the regulatory regime?

Mr. NEWSOME. Well, I think the regulatory regime between the

two agencies is quite different and over the last 20 years, the two

agencies have taken differing approaches to their regulatory regimes.

Mr. OSE. Well, I want to be clear. I am probably favorably disposed to anything that would create an ability to increase liquidity

in these market places, given that we might have some sort of catastrophe in the future.

I will tell you, having served over on financial services, as Mr.

Lucas does, as Mr. Baca does, and Mr. Hill, a lot of the things that

you are talking about within the market places that you regulate,

self-certification, payment for overflow and the like, have arisen in

the securities side, and we are having nothing but trouble; in fact,

just as an aside, there is a hearing I am missing, right now, over

in Financial Services, having to do with mutual fund regulation,

and I am trying to figure out why CFTC would not require the

same level of disclosure, same principles, same transparency for

protection of the investor as, say, the SEC would.

Mr. NEWSOME. Well, a lot of these things have taken place over

history and which I was not involved in and am not aware of.

The only thing that I guess I could say is that, even though different approaches have been taken, the results have been good. I

think a lot of it goes back to differing market places and particuVerDate 11-SEP-98 10:17 Dec 23, 2003 Jkt 090742 PO 00000 Frm 00031 Fmt 6633 Sfmt 6633 F:\DOCS\10821 HAGRI PsN: HAGRI
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larly differing contracts. Stock on IBM is stock on IBM and within

futures markets, you develop a specific contract, and that is your

contract to trade.

Obviously, someone can mirror it, but for that reason, we haven’t

had fungibility, and for that reason, payment for order flow has not

been an issue here, where you have got fungible contracts, and

there is incentive to try to pull one away from the other, as has

been the issues raised in the securities side. So I mean, I think it

is, while the general oversight may be the same.

I think, as you look under the surface, it is an apples-and-oranges comparison.

Mr. OSE. The reason I am bringing it up is that we have struggled, since just prior to September 11, trying to get NASDAQ designated as an exchange, and every time one question gets answered, another question arises, and I cannot help but think that

this path for Eurex is going to be similarly littered with potholes

for whatever reason.

My concern here, Mr. Chairman Moran, is that whatever we do,

that we exercise our oversight so that our investors, whether they

be domestic and international in nature, know that the front running that might occur elsewhere, or the inappropriate behavior

that we are seeing some of elsewhere in other markets is being

properly constrained and eliminated at CFTC’s markets; I mean,

this is a serious issue. I think you talked about trust, or maybe it

was Mr. Etheridge; I mean, the same concept holds, and it gets

down to balancing our needs for liquidity with our needs for transparency.

My attitude, frankly, is that if you have a public market, you

make some nominal adjustments for the different instruments in

each market, but the basic regulatory structure should be the same

from A to B to C, because then you have a level playing field, and

we aren’t picking the winners and losers.

I yield back.

Mr. MORAN. I thank the gentleman.

The gentleman from North Dakota.

Mr. POMEROY. I thank the chairman.

I enjoyed my colleague’s comments on it and I am inclined to

agree with your analysis.

Mr. Chairman, it is good to see you again.

Mr. NEWSOME. Good to see you.

I was almost disappointed when I thought you weren’t going to

make it.

Mr. POMEROY. No, no.

I’ve enjoyed your service, think you have done a good job, and

also a pleasure to have you here at the Agriculture Committee.

First of all, my thoughts on fast track versus non-fast track.

Back when we put that in place, I guess I could irreverently refer

to it as the Brooks Leeborn Relief Act. We had a backlog that needed to be dealt with and we needed to free our market participants,

and so we put together an expedited review process, but I will tell

you what was, in my mind, was products, it wasn’t though we

scrapped all of the other approval time lines.

Mr. NEWSOME. Right.

Mr. POMEROY. But we had an expedited one.

30

Simple things ought to be done quickly. That was basically my

thinking on it.

This isn’t simple, so I am glad you did pull it off of fast track

because I do not think it was appropriate for fast track, at least

when I voted for it.

I used to be a regulator and that kind of hinders me because I

look at the world through the tortured prism of a former insurance

commissioner, and I know things there may or may not have any

relevance to your job, at all, but on this longer time frame, getting

to the issue of disclosure that has been discussed a bit, I think it

is important and part of the public purpose served by this longer,

more thorough review process, to have all of the information in the

public domain that can possibly be there, full immediate disclosure

of everything that—but for proprietary reason, should not be placed

in the public domain, because you got two groups reviewing this

application.

Obviously, the talented and deep staff that you command and

then competitors will also be fly speck in this thing, and ultimately

it will be your judgment, but their own due diligence review is

going to be helpful and bring more resources to bear ultimately for

the Commissioner’s assistance, and so that is the rule of disclosure

and I hope you will put it into the public domain anything that can

go there.

Mr. NEWSOME. Can I make a quick comment on that?

Mr. POMEROY. Sure.

Mr. NEWSOME. I agree with you completely and certainly everything that we believe we can put out for public comment, without

creating proprietary concerns or trade secrets or financial arrangements, we do so. It has become a more difficult process since the

passage of the CFMA, and I will tell you: It is something that we

deal with on a very constant basis, and the reason for the difficulty

is self certification, if we require contracts to be prior approved,

they are put out for comment, then, as a competitor, I can say,

well, that is a great contract, I will self-certify it and list it in front

of the guy who developed it, so we try to be very cognizant of that,

in terms of the competitive nature of the scenario and what is proprietary, but we do work very hard on that.

Mr. POMEROY. I just sensed in your answer to Mr. Larsen that

there maybe were some materials that maybe could go into the

public domain and haven’t?

Mr. NEWSOME. Well, it is based on the questions and we just got

the answers to our initial round of questions yesterday, we are reviewing those, and if that raises material issues that we can put

out, then we will resubmit that out for comment again.

Mr. POMEROY. Good. The other issue is the one that you referenced, that you really do not have a mechanism to respond or

deal with, and that is your realm of regulatory control only goes

so far when you look at some of these new global intermingled relationships, and those relationships to, if not squarely part of this application, certainly are kind of in the air around this application.

I think that we need to hear more from you about the response.

I do note that you acknowledged some of this is inevitable, some

of this has to happen, it is a global economy, global markets, global

business, and faster than ever with the electronic format, I agree

31

with that, but I cannot abide by, so there is only so much we can

regulate anymore, there is only so much protection we can offer the

American interests, as we have global participation in an exchange

of this nature.

We got to do better than that. We really, I think, need to bear

down on that one and come up with some strategies that do allow

us to preserve and protect the public interest and just I am wrapping up, this is an important point: If we have got our regulatory

control here but we have got an entity that is basically foreignowned, foreign placed and dealing with its counterparts abroad,

even on material sometimes, it could be, I think, adverse to U.S.

currency interests or something like that, we got to have a way of

protecting this violation information.

And so I do not know whether it needs to be dealt with as part

of this application, but it certainly needs to be in this brave new

world part of the planning for the CFTC, and I would like the Commissioner’s response.

Thank you, Mr. Chairman. I yield back the balance of my time.

Mr. MORAN. I have heard you wrap-up before, and that is what

I was concerned about.

Mr. NEWSOME. If I could make a suggestion, Congressman, Mr.

Chairman, without the proper legal background, I am sure that I

have done a very poor job this morning of explaining exactly what

our enforcement authorities are within this global marketplace,

through our MOU’s. So with your permission and the chairman’s

permission, I would love to be able to go back and in much greater

detail, provide that information to you and submit it as part of this

record.

Mr. POMEROY. Good. Thank you.

It is a nice way of getting out of answering a tough question.

Mr. MORAN. I would recognize the gentleman from Texas.

Before I do so, I think I will lose my gavel. I would like to take

just a moment to acknowledge the passing of a Kansan whose funeral is later today, a former CFTC member, Kalo Hineman, and

Mr. Hineman was the chairman of the CFTC and he served there

from 1981 to 1991, and a very outstanding Kansan and a distinguished constituent of mine, and I express my condolences to his

family, but also to the CFTC community upon his passing. And I

now would recognize the gentleman from Texas.

Mr. STENHOLM. Thank you, Mr. Chairman.

Welcome, Chairman Newsome.

Mr. NEWSOME. Yes, sir.

Mr. STENHOLM. Exchange governance is a hot topic.

I would like for you and maybe this fits in the same category you

just answered Mr. Pomeroy, but, if you can, please describe for the

committee your understanding of the governance structure described in the U.S. Eurex application, in terms of its board, its executives, how will U.S. Eurex structure compare to other Government structures at U.S. Futures Exchange?

Mr. NEWSOME. What I will have to do—that was a question that

we ask as part of these rounds of questions we got from the initial

application.

It is my understanding the response was much more detailed

than what we initially had access to. So Congressman, what I

32

would love to do is go back and look at that in more detail. I think

that that would be ever more accurately than I am able to do this

morning.

The CHAIRMAN. Mr. Chairman, we apologize for missing what I

understand was a very good discussion. We had to manage a very

important piece of legislation on the floor, and I understand that

the questions have been very thorough and you covered every topic

that I raised in my opening statement, and I will look forward to

hearing the details, but I want to thank you for your donation of

2 hours of your time, and I think this is reflected very, very well

on the CFTC, and we thank you for your leadership, so let me

thank you and excuse you and we will move to the next panel.

Mr. NEWSOME. Thank you, Mr. Chairman.

The CHAIRMAN. We now invite our second panel to the table.

Mr. Charles Carey, chairman of the Chicago Board of Trade, Chicago, IL, who is accompanied by Mr. Mark Young, an attorney-atlaw with Kirkland & Ellis of Washington, DC; Mr. John Damgard,

president of the Futures Industry Association of Washington, DC;

Mr. Terrence Duffy, chairman of the Chicago Mercantile Exchange

of Chicago, IL, who is accompanied by Mr. Craig Donohue, incoming chief executive officer of the Chicago Mercantile Exchange of

Chicago, IL; Mr. Micah Green, president of the Bond Market Association of New York, NY, who is accompanied by Mr. Michael Decker, senior vice president of research and policy Analysis of the Bond

Market Association of New York; Mr. Michael McErlean, director

of the United States Futures Exchange of Chicago, Il, who is accompanied by Mr. Ed Rosen, an attorney-at-law with Cleary, Gottlieb, Steen and Hamilton of New York; and Mr. Daniel Roth, president and chief executive officer of the National Futures Association

of Chicago, Illinois.

Gentlemen, we are pleased to have all of you here today.

We remind you that your complete statement will be made part

of the record and ask that you limit your remarks to 5 minutes.

We will begin with Mr. Carey.

Welcome

STATEMENT OF CHARLES P. CAREY, CHAIRMAN, CHICAGO

BOARD OF TRADE, CHICAGO, IL, ACCOMPANIED BY BERNARD W. DAN, PRESIDENT AND CHIEF EXECUTIVE OFFICER,

CHICAGO BOARD OF TRADE

Mr. CAREY. Thank you, Mr. Chairman and members of the committee.

I am Charlie Carey, chairman of the Chicago Board of Trade. On

September 16, Eurex U.S. filed its contract market designation application with the CFTC. U.S. Eurex is a subsidiary of Eurex

Frankfurt, an affiliate of Eurex Deutschland, the only futures and

options exchange in Germany. The issues raised by this application

are profound and far-reaching. This hearing will promote a serious

public debate on those issues. We commend you for your leadership

in calling this hearing.

I would like to cover a couple things that really go to the trust

and confidence of the application. I think they were referred to or

addressed by Congressman Dooley, but I would like to correct the

record on a number of key points.

33

First, Eurex would have you believe that its new exchange would

bring electronic trading to the United States. That is not true.

Chicago Board of Trade now offers vibrant and liquid electronic

trading markets. Today over 80 percent of our volume in the U.S.

Treasury complex is electronically traded.

Second, Eurex claims that the Board of Trade is a monopoly.

That is not true. Even Eurex’s counsel conceded last Friday to the

CFTC it is beyond dispute that there is vigorous competition between U.S. exchanges.

Third, Eurex claims that it will offer a fully electronic marketplace. Again, not true.

The written testimony of Mr. Don Wilson, a major trader on

Eurex, the Chicago Board of Trade, and the Chicago Mercantile Exchange, dispels this myth.

Eurex does not trade electronically, options but in a call around

market. I mention those mischaracterizations because they bear directly on Eurex’s credibility, and credibility is the essence of effective self-regulation.

We have three basic points about the Eurex U.S. application. The

application should be considered fully and carefully by the CFTC;

second, the application should be considered only when it is complete, and right now it is materially incomplete; third, the application should be granted only if it meets the statutes of specific criteria for registration of an exchange. Point 1, the application review process should be thorough. The Eurex application is too important and raises too many novel issues for consideration under

any form of quick fix process. Allowing a foreign board of trade to

be the owner/operator U.S. exchange is only one of the many challenging issues the U.S. business plan presents. Some of those

issues go directly to preventing manipulation, protecting customers,

providing financial integrity and promoting market transparency.

We know that the CFTC is as concerned about these public policy goals as we are. Point 2, the CFTC should have the opportunity

to consider the real business plan Eurex proposes to adopt. The

U.S. Eurex application however is very different from the business

plan Eurex has trumpeted for months in their press statements,

Web site, and marketing materials. Just like a consumer should

not be subject to bait-and-switch tactics, the CFTC should not be

asked to approve one model while the applicant is touting a different business plan. The CFTC should consider the application

only when it is complete and accurate.

Point 3, the application should be approved only if it meets the

high standards for a new high registered exchange. The decision

whether to approve a new exchange is among the most significant

decisions the Commission is called upon to make, especially since

Congress has recognized that effective self-regulation is what allows our markets to serve the national public interest. That decision should be based on the merits of the complete application and

the CFTC’s informed judgment, whether the application satisfies

the statute.

My written testimony provides specific details on the many

issues raised by this application. The bottom line is that we believe

the information is materially incomplete now and that the CommisVerDate 11-SEP-98 10:17 Dec 23, 2003 Jkt 090742 PO 00000 Frm 00036 Fmt 6633 Sfmt 6633 F:\DOCS\10821 HAGRI PsN: HAGRI
34

sion should suspend its process until the application is complete,

and here is why.

The Eurex application is significant for how little it reveals and

how much it conceals.

What does it reveal?

It reveals that Eurex intends to trade undisclosed futures and

options, using the same electronic system and clearing entity that

the Chicago Board of Trade uses right now.

It reveals that Eurex will rely in some way on NFA for market

surveillance. That is about it.

What does the application conceal?

The list is long. For example, we do not know what resources

NFA has or will use to conduct market surveillance for Eurex. We

do not know how NFA or Eurex for that matter intends to police

the Eurex over-the-counter caller on market options. We do not

know what role Eurex Frankfurt and Eurex Deutschland will play

in preventing manipulation on Eurex U.S., how they will avoid the

acknowledged squeezes they have in their home markets and by

what statutory authority they can avoid for a U.S. designated contract market since they were not registered under U.S. law.

We do not know what clearing systems they will use, we do not

know how much of the trading will be cleared in Germany, or how

much publicized Eurex Clearing Corporation global clearing link

would work or how the CFTC would oversee that activity. We do

not know much about this link, other than Eurex and The Clearing

Corporation promised that the link would be operational on February 1 or shortly thereafter, and that representation was specifically made to those shareholders who voted to approve the U.S.

Clearing Corporation reorganization.

We do not know these things because the application does not

address these questions. The statute says when an applicant files

its application, the Commission shall have 180 days to review it,

but that applies only to complete applications.

In our view and on this record of unanswered questions, the U.S.

Eurex, application is very much materially incomplete and the

CFTC should suspend its review until it receives a complete application.

The CFTC is a fair agency ably led by Chairman Newsome and

his fellow commissioners. We know it is dedicated to serving the

public entity and the national interest. All we ask is the CFTC

make sure they get a complete and accurate picture of the Eurex

application, obtain fully informed public comment and then apply

the statute and regulations.

The Eurex application ultimately may be approved, fully or conditionally, or denied. That is an issue for another day.

What we are concerned about today is the process and making

sure that all of the issues raised, are made fully by the Commission

with due deliberation based on a complete record.

Thank you for your time and attention. I would be happy to answer any questions. Thank you.

[The prepared statement of Mr. Carey appears at the conclusion

of the hearing.]

The CHAIRMAN. Thank you, Mr. Carey.

35

Mr. Damgard, we are pleased to have you with us, representing

your organization.

STATEMENT OF JOHN M. DAMGARD, PRESIDENT, FUTURES

INDUSTRY ASSOCIATION

Mr. DAMGARD. Thank you, Mr. Chairman, and members of the

committee.

On behalf of the Futures Industry Association, I want to thank

you for the opportunity to appear before you today to discuss the

application of the U.S. Futures Exchange, LLC, for designation as

a contract market. When Congress amended the Commodity Exchange Act through the Commodity Futures Modernization Act of

2000, an underlying purpose was to promote responsible innovation

and fair competition among boards of trade, other markets and

market participants. The application of the U.S. Futures Exchange,

an indirect subsidiary of Eurex, marks an important step in realizing the vigorous competition among markets that Congress anticipated in the CFMA.

Attached to my statement is a copy of the comment letters that

the FIA has filed with the Commission, which I request be made

part of the record and my comments today will focus on the two

issues that the committee indicated particular interest in.

The designation process: The CFMA signified a radical new approach to the revelation of derivative markets. Prior to the enactment of the CFMA, the prescriptive regulations had unnecessarily

delayed the approval of invasive trading procedures.

To replace these regulations, Congress set out a limited number

of broad criteria that an applicant would have to meet in order to

be approved as an exchange and certain core principles with which

the exchange would have to continue to apply in order to maintain

its designation.

Consistent with its goal of promoting responsible innovation,

Congress further provided that the exchange will have responsible

discretion in establishing the manner in which it complies with

these principles.

Congress also specifically removed the statutory requirement

that effectively required the Commission to publish applications for

designation for comment in the Federal Register. This change in

the law promised to expedite the review and approval of new exchanges.

More important, it confirmed that the Commission, as the expert

agency responsible for the regulation of derivative markets, is best

suited to determine whether an applicant meets the statutory criteria and is able to comply with the core principles that Congress

established.

Since the enactment of the CFMA, the Commission has designated four new contract markets, OneChicago, NASDAQ Life, Island Futures Exchange, and the CBOE Futures Exchange.

In each instance, the Commission approved the application without requesting comment from the public. In providing a 30-day period for public comment on the U.S. Futures Exchange application,

the Commission presumably determined that its review could benefit from receiving the views of the industry.

36

Nevertheless, we caution that the Commission must take care

not to adopt different procedures for certain applicants that may

appear to be designed solely to prevent new entrants from establishing their business in a timely manner. Such actions would

clearly be contrary to Congressional intent in enacting the CFMA.

We also want to emphasize that the lack of public comment period has not denied the FIA the opportunity to express its views,

with respect to the organization, operation, and rules of exchange

applicants.

Rather than dealing indirectly through the Commission, however, we now work directly with the relevant exchange or clearing

organization, a change in procedure that has proved to be more efficient or more productive; for example, the Security Futures Committee composed of representatives of the FIA member firms and

member firms of the Securities Industry Association met often with

the staffs of OneChicago LLC and NQLX and provided both with

written and oral comments.

Second, FIA has worked with the Chicago Mercantile Exchange

and the Chicago Board of Trade to resolve the numerous operational issues that have arisen in connection with the implementation of their common clearing link.

Third, as with OneChicago, and NQLX, representatives and

member of FIA firms have held a number of meetings with the

staff of the U.S. Futures staff. In particular, we have recommended

several changes to their trading procedures which the exchange

has agreed to consider.

Finally, we recently formed an ad hoc group to work with the

U.S. Futures Exchange and The Clearing Corporation to resolve

operational issues as they develop their clearing link.

Self Regulatory Program—which I will just submit for the record

in order to stay with my 1-minute time period, and I will move to

my conclusion.

We do not know if the U.S. Futures Exchange will succeed, assuming its application is approved. However, we do know that competition invariably improves markets. In fact, in recent months, we

have seen reductions in fees and welcome changes in trading rules

that we believe have been adopted in anticipation of the U.S. Futures Exchange application. These changes benefit both customers

and intermediaries by reducing costs and facilitating the execution

of certain transactions.

We support competition across all markets and all products. Our

members compete on a product-by-product basis daily. We see no

reason why exchanges should not be subject to similar competitive

pressures.

We also see no obstacles that would prevent the Chicago Mercantile Exchange and the Chicago Board of Trade, in particular,

from taking the fight to the U.S. Futures Exchange. CME and

CBT, in the aggregate, account for approximately 85 percent of the

U.S. Futures Exchange volume. In achieving this position, they

have demonstrated that they are both fierce and able competitors.

As I noted when I began my remarks, an underlying purpose of

the CFMA is ‘‘to promote responsible innovation and fair competition.’’ provided an applicant meets the criteria specified in the act

and the Commission’s regulations, an exchange should be desVerDate 11-SEP-98 10:17 Dec 23, 2003 Jkt 090742 PO 00000 Frm 00039 Fmt 6633 Sfmt 6633 F:\DOCS\10821 HAGRI PsN: HAGRI
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ignated as a contract market upon the same terms and conditions—and pursuant to the same procedures—to which all other

applicants are subject.

For example, it is worth remembering that when foreign exchanges first applied to the Commission for authority to place their

terminals in the United States, many U.S. exchanges, including

those represented here today, argued that the foreign exchanges

should be required to come to the U.S., apply for designation as

contract markets and compete with U.S. exchanges on a level playing field.

Eurex has agreed to meet this challenge, establishing a subsidiary here to compete with other U.S. exchanges on the same terms

and conditions, and subject to the same laws and regulations, to

which all U.S. exchanges are subject. FIA would be greatly troubled if the world’s largest futures exchange or other entrants that

are willing and able to comply with U.S. laws and regulations were

unfairly denied this opportunity.

Thank you again for this opportunity to appear before you, and

I would be pleased to answer any questions.

[The prepared statement of Mr. Damgard appears at teh conclusion of the hearing.]

The CHAIRMAN. Thank you, Mr. Damgard.

Mr. Duffy, welcome. We are pleased to have you with us today.

STATEMENT OF TERRENCE A. DUFFY, CHAIRMAN, CHICAGO

MERCANTILE EXCHANGE, ACCOMPANIED BY CRAIG S.

DONOHUE, INCOMING CHIEF EXECUTIVE OFFICER, CHICAGO MERCANTILE EXCHANGE

Mr. DUFFY. Thank you. It is a pleasure to be here, and I want

to thank Chairman Goodlatte and members of the Agriculture

Committee.

As he said, I am Terry Duffy. I am the chairman of the board

of the Chicago Mercantile Exchange. I want to thank you, Mr.

Chairman, for this hearing, and I think it is interesting that we are

starting to hear a few issues that came forward this morning from

Eurex, I think only because of this hearing; and I would like to tick

off a few of those I was writing down prior to the first panel.

First is the NFA agreement which was supposedly signed last

night. Two is, Eurex has a new board. It went from 1 to 12, kind

of interesting. Third is filing of the contract specs. Fourth, withdrawal of payment for order flow. All of this happened yesterday

and likely only because of this hearing. That should concern us

about this process.

With that being said, CME today is the largest futures exchange

in the United States and the largest futures clearing organization

in the world. We fully comply with the Commodity Exchange Act

and all relevant CFTC regulations. We are also the only

demutualized and publicly traded financial exchange in the United

States. Our organizational structure, our governance standards,

our compensation practices, our business model and our market

practices are all publicly disclosed.

The CME, along with the Chicago Board of Trade, accounts for

approximately 150,000 jobs in the United States. We offer trading

38

via both our open outcry and our GLOBEX electronic trading platforms.

During my testimony today I want to make it clear that this is

not about open outcry versus electronic trading. Today, nearly onehalf of all trading on the CME is fully automated, reflecting the extraordinary growth rate of our GLOBEX system. Also the Chicago

Board of Trade’s Treasury bond futures contracts, which Eurex

plans to compete with, are now more than 80 percent electronic.

CME’s concerns with the Eurex U.S. application are simple. The

application is defective. Eurex’s recent application omits any information regarding its planned means and methods of operation in

the hopes of appearing to qualify as a plain vanilla exchange, eligible for fast track treatment. Not surprisingly, the application is so

devoid of real information, it fails even to specify the contracts that

will be traded. We welcome the news that the Commission shares

our conviction that the application require much more vigilant review.

Now that the time pressures of the fast track have been removed, we believe that critical examination of the following four aspects of Eurex’s proposed plans is in order.

First, the structure of Eurex U.S.: I find it ironic that Eurex U.S.

has claimed a connection with its German parents in order to limit

the scope of the CFTC review, but it is quick to enlist German Finance Minister Hans Eichel to plead its case with U.S. Treasury

Secretary John Snow and the international press. It will be organized as a wholly owned subsidiary of U.S. Exchange Holdings,

Inc..

We have gone through this before, but I will say it again. This

entity is a wholly owned subsidiary of Eurex Frankfurt, which is

a wholly owned subsidiary of Eurex Zurich, which is, in turn,

owned in equal parts by Deutsche Borse and the SWX Swiss Exchange. This is a very complicated picture that presents compelling

jurisdictional questions when it comes to holding a real party responsible.

Eurex U.S. is effectively a branch office of the German exchange

Eurex Frankfurt. All of Eurex’s critical clearing, operational and

regulatory functions will be outsourced to third parties; one is

Eurex’s ultimate parent, based in Germany and not subject to the

Commodity Exchange Act. Another major outsourced provider, the

NFA, lacks sufficient experience, resources and authority to provide

such services.

Eurex must demonstrate that it will prevent market manipulations through market surveillance, compliance and enforcement

practices and procedures. It must demonstrate that it meets its obligation to ensure fair and equitable trading through the facilities

of the contract market and the capacity to detect, investigate and

discipline any person who violates the rules. Accordingly, Eurex

should be required to offer sound reasons why the various parties

to whom it plans to delegate its responsibilities can meet the

CFTC’s own essential criteria for designation.

Payment for order flow and internalization. The application

omits all information with respect to Eurex’s actual business. However, Eurex has publicized it has big plans to capture market

share. Eurex intends to buy liquidity. It offered to run a $40 milVerDate 11-SEP-98 10:17 Dec 23, 2003 Jkt 090742 PO 00000 Frm 00041 Fmt 6633 Sfmt 6633 F:\DOCS\10821 HAGRI PsN: HAGRI
39

lion survival-of-the-fittest game that rewards fiduciaries who direct

their customer trades to the Eurex platform even when U.S. customers might be far better off trading in more liquid, efficient and

transparent markets.

Eurex now claims to have withdrawn its offer of payment for

order flow. It is obvious they got caught with their hand in the

cookie jar when they shouldn’t have even been in the kitchen. Here

is Eurex with an application on file, actively marketing to its customers, listing the alleged advantages of their Treasury bond futures contracts over the Chicago Board of Trade’s products and discussing payment for order flow, and yet none of this has been submitted to or approved by the Commodity Futures Trading Commission.

I would like to read a quick quote from Chairman Donaldson:

‘‘Like payment for order flow, internalization can discourage markets from competing on the basis of price and pose a conflict of interest for broker-dealers’’.

Additionally, Eurex will allow firms to cross or take the opposite

sides of their own customer orders to an extent never permitted in

the U.S. marketplace. Eurex’s application fails to explain and justify these plans.

Third is fair competition. Eurex, with the FIA, has been running

a publicity campaign alleging that the Chicago exchanges fear competition. Given Eurex’s history, this contradicts reality. Eurex

pulled out all the stops to prevent the CME from locating a single

GLOBEX terminal in its home territory. Our German lawyers advised us in writing that Eurex interfered, delaying for more than

a year. I would be happy to release the documentation for the

members of this committee, which I have right in front of me.

The CME’s track record for responding to competition has been

affirmative and consistent. Let me give you two examples. When

BrokerTec applied for contract market designation, the CME sent

a three-page letter to the CFTC, which noted a defect in one rule;

otherwise, we didn’t object. When the Canada futures exchange applied, the CME placed no obstacles in its path. Our comments to

the CFTC have always been in pursuit of assuring competition on

a level playing field.

Fourth, manipulation and compliance. The ownership structure

of Eurex U.S. is particularly troublesome in light of financial press

reports about Eurex’s lack of enforcement of regulations. It is reported that Eurex has been used for several squeezes involving

German debt. The most widely reported large-scale squeeze allegedly occurred in March 2001. Deutsche Bank reportedly cornered

the cheapest in a delivery note for the BOBL, the midterm contracting—maturing in March 2001. This resulted in a significant

gain to Deutsche Bank, but large losses to individual traders with

short positions.

Eurex’s response was muted. The allegation concerned market

manipulation, yet Eurex issued only a private reprimand to Deutsche Bank. It also appears that the German Government took no

action against Deutsche Bank nor in favor of the traders who lost

money. This resulted in public criticism of Eurex’s approach to regulation was inappropriate and wanting.

40

Squeezes also have allegedly occurred with respect to the Bund

and Schatz contracts. Eurex intends to operate an international

linkage that will permit trading in the same contract in two jurisdictions with different regulatory requirements. The Commission

needs evidence that wash trades and abusive trading practices allegedly permitted in Germany will not impair the fair operation of

our regulated U.S. market. Such arrangements present significant

potential cross-border bankruptcy and other legal risks, none of

which have been clearly delineated for market users and regulators.

Many of the most important rules respecting the fairness of markets to customers are facially inadequate, incomplete or ambiguous.

The application includes no explanation as to how those rules can

possibly comply with the key designation criteria.

In conclusion, the Chicago Mercantile Exchange does welcome

Eurex. We expect that upon full examination and careful adjustments to its regulatory and compliance systems, it will prove a valuable addition to the lineup of the world’s greatest futures exchanges in Chicago. It is clear, however, that the 60-day fast track

process was not the correct path. We hope that Eurex will complete

its application, and that its business plans will be fairly assessed.

Where the integrity, safety and soundness of our financial markets

are involved, judicious public policy compels careful and thorough

scrutiny, not a rush to judgment.

In the end, the real winners will be our U.S. investors who will

be protected by the American standard of a sound regulatory environment.

I thank the chairman.

[The prepared statement of Mr. Duffy appears at the conclusion

of the hearing.]

The CHAIRMAN. Thank you, Mr. Duffy.

Mr. Green, welcome.

STATEMENT OF MICAH S. GREEN, PRESIDENT, THE BOND

MARKET ASSOCIATION, ACCOMPANIED BY MICHAEL DECKER, SENIOR VICE PRESIDENT, RESEARCH AND POLICY

ANALYSIS

Mr. GREEN. Thank you, Mr. Chairman, and members of the committee; thank you for the opportunity to testify today on this important issue. My name is Micah Green, and I am president of The

Bond Market Association, which represents firms and banks that

underwrite, trade and sell debt securities and, in particular in the

case of this issue today, the U.S. Treasury market. And as I look

to my right and see our friends at the CBOT and the CME and I

look to my left and I see our friends from Eurex, I realize I am

aptly placed in the middle because we are the customer. We are the

customer of the futures market.

In fact, the financial futures market is critical to an efficient

bond market, a point that I will discuss in further detail later.

Every day tens of thousands of Treasury futures contracts change

hands to help facilitate the $400 billion daily market in Treasury

securities.

The Chicago Board of Trade, which lists Treasury contracts, has

for many years provided a crucially important service to the marVerDate 11-SEP-98 10:17 Dec 23, 2003 Jkt 090742 PO 00000 Frm 00043 Fmt 6633 Sfmt 6633 F:\DOCS\10821 HAGRI PsN: HAGRI
41

ketplace. The Bond Market Association has a long working relationship with the Board of Trade and the CME on market trading

hours and many other issues. In fact, we worked as close working

partners on getting the bond markets reopened in an orderly way

immediately following the tragedy of 9/11 and, more recently, after

the blackout this summer.

The Association does not come here today to take a specific position with respect to the details and merits of Eurex’s application

to open a U.S.-based futures exchange. However, it is our view that

Eurex’s application should be given full and fair consideration by

the CFTC and evaluated solely on Eurex’s ability to satisfy established legal and regulatory requirements. We do not believe an exchange’s country of origin should be a factor in determining compliance with local statutes and regulations.

Indeed, one of the principal goals of the Commodities Futures

Modernization Act of 2000 was to promote that very competition

among exchanges and to recognize the role that technology has

played in the evolution of the markets. The approval of new exchanges, regardless of where their owner is based, is certainly consistent with such a goal. Competition helps ensure that issuers of

fixed-income securities are able to borrow at the lowest interest

rates possible.

The same holds true for competition among exchanges that facilitate trading in financial products. Fair competition leads to greater

efficiencies that are realized by market participants in the form of

lower costs and lower risks. Financial futures are an integral part

of the financial markets that play a sometimes unnoticed, but critically important role in the global economy. Any development that

brings users of financial futures greater choice and therefore the

potential of better pricing and efficiency will have a positive effect

on the overall economy.

I would like to offer a brief example of how this can be so.

Bond dealers access the future markets to hedge and protect the

value of their bond inventories from market swings. Those market

swings happen continuously throughout the day and the evening.

Hedging involves taking a trading position that offsets another position so that when one position falls in value, the other rises to

countervail the loss.

Take the example of a dealer who purchases a million dollars in

10-year Treasury notes. If market interest rates should rise after

the dealer makes the initial purchase, the face value of the bonds

in inventory will fall, and the dealer will realize the loss. To hedge

this position, the dealer would lock in the initial price they paid for

the notes by purchasing Government bond futures contracts to sell

the same amount of securities. This essentially eliminates the risk

of loss, while preserving any upside gain.

For such a strategy to work, it is critical the dealer has the ability to easily purchase and sell the futures contracts at fair prices

and low costs. The deeper and more liquid the futures market, the

easier and more economically dealers can hedge their positions.

But why is the ability of a bond dealer to trade efficiently good

for the economy? Very simply, the easier and cheaper it is for dealers to hedge their trading positions using futures, the more liquid

is the cash market for the underlying bond or other financial prodVerDate 11-SEP-98 10:17 Dec 23, 2003 Jkt 090742 PO 00000 Frm 00044 Fmt 6633 Sfmt 6633 F:\DOCS\10821 HAGRI PsN: HAGRI
42

ucts being hedged. The more liquid a market is, the less risky it

is for investors to hold securities in that market. The less risk investors face, the lower return they will demand when initially buying securities from issuers.

Bond issuers, therefore, benefit from a more liquid market, as it

generally means investors will demand lower interest rates on the

issuer’s bonds. Fostering competition among futures exchanges

will, in the end, make it less costly for the Federal Government,

States and localities, corporations and individual families to borrow.

Again, Mr. Chairman, I would like to stress that Congress intended to promote this very competition among futures exchanges

when it passed the CFMA in 2000; and the CFTC, of course, has

long recognized that promoting efficient markets is good public policy. We are confident the CFTC will consider Eurex’s application as

it would any other submission and make its decision based on the

merits of the application.

We urge the committee to encourage the CFTC to act expeditiously and fairly in evaluating Eurex’s application. I thank you for

the opportunity to present our views.

[The prepared statement of Mr. Green appears at the conclusion

of the hearing.]

The CHAIRMAN. Thank you, Mr. Green.

Mr. McErlean, welcome

STATEMENT OF MICHAEL McERLEAN, DIRECTOR, U.S. FUTURES EXCHANGE, LLC, ACCOMPANIED BY ED ROSEN, ATTORNEY-AT-LAW, CLEARY GOTTLIEB, STEEN & HAMILTON

Mr. MCERLEAN. Mr. Chairman and members of the committee,

thank you for the opportunity to testify today. I am Mike

McErlean, president and chief executive of U.S. Futures Exchange

LLC. U.S. Futures Exchange is a U.S. company that is 100 percent

owned by Eurex Frankfurt AG. That, in turn, is owned by Deutsche Boerse and the Swiss Exchange. Deutsche Boerse is a publicly

traded company with 36,000 shareholders. A majority of the shares

are owned by U.S. and U.K. institutional investors.

U.S. Futures Exchange filed an application for contract market

designation with the CFTC on September 16. Before speaking

about our application, I would like to tell you a little bit about myself, because I think my career really reflects the growth of electronic trading in the futures markets.

I was born and raised in the city of Chicago, and after graduating with a business degree at Illinois State University in 1982, I

went to work in the bond pits of the Chicago Board of Trade. Over

the next 10 years I rose to manager of the CBOT’s 30-year bond

futures pit, trading for Goldman Sachs. My clients were the biggest

players and the biggest contract at the biggest exchange in the

world.

In 1992, Goldman Sachs transferred me to Asia, where an interesting development began to gain acceptance in the world of futures trading, trading electronically. Exchanges in the U.S., Europe

and Asia began to recognize the advantages of using technology to

offer a service that was less expensive to deliver than the traditional business model of open outcry trading. Markets in Hong

43

Kong, Sydney and Tokyo were among the first in the world to fully

embrace the advantages of electronic trading.

In 1996, Goldman asked me to manage how the firm serviced clients on electronic exchanges. In 1997, I moved to London where I

experienced first hand the changeover from open outcry trading to

electronic trading, as the Paris futures exchange shut its floor, followed closely by the London futures exchange known as LIFFE. I

led my firm’s transition to electronic trading and successfully used

technology to improve efficiencies and execution services for ourselves and for our customers.

My impression from my work at Goldman and from serving on

the boards of various exchanges in three different time zones is

that electronic trading, by increasing competition and lowering

costs, actually causes the markets to grow faster.

I look at my current assignment at Eurex as bringing the benefits of electronic trading to the U.S. markets and being an agent

for change, positive change in client service, fees and pricing, transparency and dynamic growth for the markets in the United States.

We believe that there is a significant demand for our model, and

that U.S. market participants would welcome the opportunity to

trade U.S. and European contracts on a designated contract market

with our characteristics.

I would like to summarize briefly some of the features of the exchange. We will operate as a U.S. company, based in Chicago, with

all operations conducted out of our headquarters now under construction at Sears Tower. The exchange will be staffed by U.S. employees, acquire services from U.S. service providers and be subject

in all respects to the same U.S. regulatory oversight by the CFTC

that applies to all U.S. futures exchanges.

I assure you we will establish a representative governance structure that will reflect a diverse cross-section of market users. The

board of the exchange will be comprised of 12 members, six of

whom will represent different market user groups. Access to the

exchange will be available to all market participants, not artificially restricted to a limited membership. All investors will have

the same rights in executing their trades with no trading or information advantages to a restricted group of insiders.

Investors will be able to trade at a cost significantly lower than

the current cost on the major U.S. futures exchanges. I believe that

all U.S. investors, not just our customers, will ultimately benefit

from lower trading costs as a result of our entry into the U.S. market.

The CFTC has published our application for public comment.

This is an important part of the regulatory framework, and I

pledge that we will respond promptly to all legitimate concerns

that may be raised.

I would like to conclude by saying that our entry into the U.S.

market will bring greater competition to the U.S. futures industry,

benefiting all investors and the U.S. futures industry itself. This

will help to achieve the goals of the Commodity Futures Modernization Act.

I am happy to answer any questions that the members of this

committee may have. Thank you.

44

[The prepared statement of Mr. McErlean appears at the conclusion of the hearing.]

The CHAIRMAN. Thank you, Mr. McErlean.

Mr. Roth, welcome.

STATEMENT OF DANIEL J. ROTH, PRESIDENT AND CHIEF

EXECUTIVE OFFICER, NATIONAL FUTURES ASSOCIATION

Mr. ROTH. Thank you, Mr. Chairman. My name is Dan Roth, and

I am the president of National Futures Association. I very much

welcome the opportunity to testify today and to describe for you the

types of regulatory services that NFA is prepared to perform for

USFE if, in fact, it is designated as a contract market.

By way of background for those of you not familiar with NFA,

I should mention that NFA is the industry-wide self-regulatory

body for the U.S. futures industry. We do not operate a marketplace. We never have. Our sole function over the last 21 years has

been regulation and the protection of customers. We see our basic

mission as working in close partnership with the CFTC to provide

this industry with the most effective and efficient regulation possible. And I would like to note for you that over the last 21 years,

while trading volume on U.S. futures exchanges has increased by

over 400 percent, customer complaints during that same time period have dropped by over 70 percent, and we are very proud of

that accomplishment, proud to have been part of the regulatory

process which produced those results.

Like any organization, like any regulatory body, we know that

we have to keep pace with changes that are occurring in the futures industry; and it was in the spring of 1999 that our board of

directors first discussed and approved the first of several strategic

planning reports. One key initiative in the 1999 report focused on

NFA adding value to the industry by offering to perform self-regulatory services and functions on behalf of electronic futures exchanges.

In February 2001, the board again discussed and reviewed our

strategic plan and unanimously approved an amendment to our articles of incorporation to provide and make clear that providing regulatory services to markets that the board approves is one of NFA’s

fundamental purposes. Because there was some question on this

point, let me also point out that the articles do provide and have

always provided that NFA shall not adopt or enforce or administer

any of its rules against any of its members or associates in any way

to interfere with the contract market’s jurisdiction.

The type of regulatory agreement that we have with Eurex does

not in any way involve the application or enforcement or administration of NFA rules against any NFA member, and in fact, we

don’t even adopt or administer Eurex rules or USFE rules. To the

contrary, we provide certain regulatory services, prepare reports

and turn those over to USFE for its ultimate determination as to

whether disciplinary sanctions are warranted.

To date, our executive committee, acting on behalf of our board,

has unanimously approved and authorized staff to execute regulatory service agreements with four different exchanges, all of

which have been approved by the CFTC, that is, BrokerTec, Merchants Exchange, Island Futures Exchange and OnExchange. We

45

currently provide services for two of those exchanges, BrokerTec

and Merchants, both of which operate at low-volume levels.

I would note also that our senior management and our board of

directors recognized that NFA would need to obtain special expertise to perform the practice and market surveillance functions that

were contemplated. Our first step in implementing the board’s strategic plan was to hire Yvonne Downs in early 2000. Prior to joining

NFA Ms. Downs worked at the Chicago Board of Trade for almost

20 years. In 1995, the Board of Trade promoted her to senior vice

president and administrator of the office of investigations and audits. In that position her responsibilities included the supervision

of five regulatory divisions including surveillance and investigations.

Under Ms. Downs’s direction, we developed our own market surveillance and trade practice program, which we call TAPS, the

Trade Analysis and Profiling System. Ms. Downs has also hired a

number of individuals with extensive experience at the Board of

Trade to help her in that effort; and more importantly, we have a

compliance staff of about 100 people.

Over the last 3 years we have cross-trained up to 12 of those individuals in market surveillance and trade practice functions so

that they are there if need be, as circumstances warrant, to supply

our forces to perform these functions; and obviously we will not

hesitate to hire outside of NFA just as we have in the past.

I would also like to point out that with respect to the Eurex or

the USFE application, we have tried to treat that like we have any

other application, each of the four that I have already alluded to.

Each of the four were presented to our executive committee for

their approval. The executive committee voted in October to approve this contract by a vote of 7 to 1; and as in every other instance where we have entered into one of these agreements, we

have always informed the board at its next meeting. We intend to

do that at the November 20 board meeting. As with any decision

by our executive committee, the board always has the implicit authority, if it chooses to, to review and possibly reverse that decision.

There is a detailed report or description of our trade practice and

market surveillance program, and I will spare you a dramatic reading of that, but I would like to let you know that over the last 21

years we have built a reputation as an effective and efficient regulator, and we have done it in the face of getting additional responsibility over and over from the CFTC. In every instance, we have

taken the approach to just do the job right, and we won’t hesitate

to use that same approach here.

We will devote whatever resources it takes to do the job right;

and if we find that the contractual agreement does not provide for

us to recover our resources, Mr. McErlean is going to hear about

it in a hurry, and he can either renegotiate those fees so that we

do recover the cost, or he can find another regulator.

With that, Mr. Chairman, I am over my time, and I would be

happy to answer any questions.

[The statement of Mr. Roth appears at the conclusion of the

hearing.]

Mr. MORAN [presiding]. Mr. Roth, thank you very much.

46

Mr. Boehner.

Mr. BOEHNER. Thank you, Mr. Chairman.

Let me welcome all of our witnesses on the panel. And I want

to especially welcome Mr. Green, who we haven’t seen much of

since he became the president.

Sorry to see that your hair is becoming a lot more gray than it

was when you ran your Washington office.

I find myself in full agreement, Mr. Green, with your analogy

that competition makes all of us better. As I said earlier, I am a

big believer in competition. Having grown up with 11 brothers and

sisters, you learn to compete rather quickly, and during my years

in my own business, you see the benefits that competition brings

to the marketplace, as much as I hated having more competitors.

I understand where the Chicago exchanges are coming from, but

Mr. McErlean, you have been beaten up here pretty good this

morning. I thought I would give you an opportunity to respond to

the charges that your application was incomplete. Let me ask this

first question that was raised by Mr. Duffy’s testimony, when apparently on your application there was listed one board member,

and in the submission last night to the questions from the CFTC,

we now have 12 board members.

Mr. MCERLEAN. Well, Congressman, we submitted the application in back on September 16 you have to understand we are a

start-up company, we are a new organization. There are many

things that we would like to do in the future that we haven’t necessarily thought out yet or brought to the market, because we are

still in consultation with market participants that would benefit

from any services that we may offer.

So that is, my answer for going from one director to 12. It was

never our intention to start a futures exchange with one director.

We will have the same governance structure that is widely accepted here in the United States.

In regard to the incomplete application, I would say the fact that

the public does not know everything about the application does not

mean it is not complete. Our application is over 2,000 pages that

we submited to the CFTC. And we understand the competing exchanges’ desire, as a competitor, to know as much as possible about

what is inside those applications; however, competitively sensitive

information is precisely what the law, and for good reason, protects

from disclosure. Other information like regulatory services agreements are not disclosed because disclosure would compromise the

market surveillance to be performed under that agreement.

The Commission is perfectly competent to review the entire application, including the competitively sensitive portions that are

not made public.

Mr. BOEHNER. Mr. McErlean, you heard the discussion that went

on earlier about the call-around practice that is apparently prevalent in Europe, where some 90 percent of the trades ever really go

through the exchange and that this practice does not occur here.

Do you expect that this call-around practice will be brought to

the States?

Mr. MCERLEAN. I will tell you that U.S. Futures Exchange is

committed to developing a liquid and successful screen-based options marketplace. We have made significant technology investVerDate 11-SEP-98 10:17 Dec 23, 2003 Jkt 090742 PO 00000 Frm 00049 Fmt 6633 Sfmt 6633 F:\DOCS\10821 HAGRI PsN: HAGRI
47

ments so that we can provide new functionality in our electronic

system that we will be introducing with the rollout of the new exchange. We have things like a strategy builder——

Mr. BOEHNER. So we are not going to have call-around activities

in the United States?

Mr. MCERLEAN. I would say that we are committed to a fully

electronic market for trading options here in the United States.

Mr. BOEHNER. Let me ask the question about incentives that—

at least Chairman Newsome referred to them as incentives—in

your marketing materials you committed to refund up to half the

fees to the top 10 producers in terms of those who bring volume

to your exchange.

Is this in the best interest of the customer or those who bring

the business to you?

Mr. MCERLEAN. It is in the best interest of the customer if we

create a vibrant, liquid marketplace. We are confident that the people that received our marketing material received it in the manner

in which it was intended, as a discussion piece.

Mr. BOEHNER. Do you or do you not intend to offer the 10 largest

companies who bring you business an incentive or discount?

Mr. MCERLEAN. We are in discussions with our market participants regarding what would incentivize them to trade on our exchange, but I assure you we will not produce any type of incentive

program that is not condoned under CFTC law.

Mr. BOEHNER. Thank you, Mr. Chairman.

Mr. MORAN. Mr. Stenholm.

Mr. STENHOLM. I like the answer to the last question Mr.

Boehner asked, because what was being proposed was getting on

awfully thin ice for someone that was purporting to be interested

in setting markets and trading customers in a fair way. I think

your answer is a good one, and I think CFTC will be very interested in that.

The primary purpose of the Commodity Futures Modernization

Act was to transform the Commodity Futures Trading Commission

from a front line regulator into an oversight agency. U.S. futures

exchanges sought the opportunity to self-certify rules and contracts

for a number of reasons, including having the opportunity to shield

new products from competition. The act was designed to give the

futures business greater flexibility to offer useful and innovative

products.

How does the Eurex U.S. application fit in with the purposes and

spirit of the Commodity Exchange Act, as modified by CFMA? Is

this application not an example of the type of innovation that was

sought from this committee and granted?

Mr. Duffy, Mr. Carey, I think would be appropriate ones; or any

of you other than Mr. McErlean.

Mr. CAREY. As I stated in my testimony, we think the application

is materially incomplete. They must believe that it was materially

incomplete, because they have changed it or they have brought in

more information. And we think that this hearing has probably

generated that information.

So I think it really will allow the CFTC to do a better job in reviewing these practices that are called into question, and we think

48

our questions were regarding inadequate information on market

surveillance programs.

Again, you cite the call-around market. You cite Don Wilson’s

testimony, which was presented to the committee in written form,

where he cited the fact that there is indeed payment for order flow

and there is indeed the ability to internalize flow. And these are

practices that could basically be brought into this country unless

we we don’t have to know, but the CFTC has to know about the

electronic systems and their capabilities and how exactly these

markets will be conducted in light of the fact that today 90 percent

of the volume on the option market is done at a call-around, voicebrokered. And it is merely posted to the electronic match; it is not

really traded electronically.

So from that standpoint, these are some of the concerns. Obviously, no terms and conditions of the contracts to be traded have

been disclosed. I guess they have changed that in the last 24 hours,

if I understand the testimony correctly. And I think that another

issue for the CFTC that they will have to deal with is, obviously

if they are changing the technology that the Board of Trade has

been trading on, and they are going to provide new technology,

then I think it probably should have to come under some sort of

review process with the CFTC.

So while the modernization act does provide the CFTC with flexibility, they also have the flexibility to require Eurex to file its real

business plan in a complete application.

Mr. DUFFY. Mr. Chairman, if I may respond to that also, I think

Charlie said it correctly that we have just now received, and Chairman Newsome said he received, these contracts last night. I think

that is exactly what happened. This hearing has brought that to

the front, and for several reasons. I think that the contracts have

been out there.

We talk a lot about these marketing materials, about payment

for order flow and things of that nature that the people from Eurex

have been promoting, but now they want to decline it and say it

was just a discussion document. I don’t know how you go to clients

and say this was what you were promoting, but now you are not

going to follow through with it.

That being the point, when you have contracts—and they have

come out right from the beginning, regardless of the Commodity

Futures Modernization Act, that they were going to list U.S. debt,

U.S. Treasuries cloning the Chicago Board of Trade’s contracts.

Once that information is made available, they are supposed to submit it to the CFTC. The reason they did not is so they could circumvent the Treasury to the last minute and self-certify. I mean,

it is quite obvious why they did what they did.

Mr. DAMGARD. Can I help out Mr. McErlean on this one?

I believe that the answer to this one is a simple yes. My members probably transact somewhere around 90 percent of the business on both of these exchanges, these two great exchanges on either side, who do a fantastic job.

They also have an awful lot of business on Eurex, but Eurex has

gone from zero to the largest in the world in 10 years, not because

they haven’t won the confidence of these traders or these firms.

They also have done an excellent job.

49

And the fact that they are willing to close their market 2 hours

early in Frankfurt and open in Chicago to accommodate American

traders, and American traders who are now electronically accessing

their market subject to German law, that is going to change if and

when they are approved. And that means American traders, many

of them members of these two exchanges, will be trading in the

United States subject to CFTC regulations. Revenues will be coming out of Frankfurt into Chicago; and it seems to me that that is

good.

Competition is very healthy, and let the competition begin.

Mr. MCERLEAN. I would like to add that the CFMA does work

in that when we put our application in, the CFTC came back to us

with questions. We answered those questions. Those generated

more questions.

We have come back and answered the questions that they have

had. We have not tried to hide anything about what we plan to do

in the United States. We want to become a U.S.-regulated exchange under the same oversight that the exchanges at this table

are under, and we don’t expect any special treatment at all.

So I would just submit that the system works.

Mr. GREEN. Congressman Stenholm, to give the Bond Market Association’s perspective, the genius of the CFMA that emanated

from this committee is that it didn’t create a box in which to regulate. It created a framework that had flexibility to grow and change

with the times, and I think the reason we are sitting here is because the times are changing and the CFMA is working.

So I would say the answer, just as Mr. Damgard said, to your

question is a resounding yes.

Mr. MCERLEAN. If I may yield the microphone to my colleague.

Mr. ROSEN. Forgive me. I just want to clarify. As Mr. McErlean

said, the responses that were given yesterday were not given as a

result of the hearing. They were given in response to questions that

were provided by the CFTC before a hearing was ever scheduled.

I would like also to respond a little bit to the discussion on internalization in the call-around market, because I think there is some

confusion about that and confusion about the roles that exchanges

play in it.

I would start by observing that no exchange—no exchange; I will

repeat that—no exchange benefits from vibrant off-exchange markets, because off-exchange markets compete with exchange markets. The exchanges don’t create these call-around markets.

Eurex in Europe is not thrilled with the notion that most of this

business is conducted other than on the exchange, but we must understand this market exists in the United States as well. The only

reason the Chicago Board of Trade isn’t here talking about what

its percentage is in the relationship between those trades in the exchange-traded markets is because it doesn’t see that, because it

hasn’t made the choice that Eurex made that there is an incremental public benefit in allowing those transactions, once they have

been executed, to be submitted to a regulated clearing facility to

mitigate the credit that is associated with those transactions and

to build up the open interest that provides more opportunity for liquidity through the liquidation of trades that are executed on the

exchange.

50

So Eurex is committed—USFE is committed in the United States

to having as robust, deep and liquid an exchange-traded market

through the screen-based trading system and is not incentivized in

any way to promote off-exchange trading.

Mr. STENHOLM. Would you identify yourself for the record, sir.

Mr. ROSEN. Yes. I am Ed Rosen, R-O-S-E-N.

Mr. STENHOLM. Mr. Duffy.

Mr. DUFFY. Mr. Chairman, if I could make one comment on the

call-around market, which Mr. Rosen just explained very well; and

I am sure he has traded a lot of markets on the call-around, but

someone who is very knowledgable about the call-around market is

John Gilmore, who is the former head of global futures at Goldman

Sachs.

I quote from Mr. Gilmore: ‘‘It is a very opaque marketplace that

favors only the people that it decides to favor.’’ That is a quote from

Goldman Sachs, the former head of global futures, not from me.

The CHAIRMAN [presiding]. I thank the gentleman.

Mr. McErlean, I understand you are the sole administrative officer of Eurex U.S.?

Mr. MCERLEAN. That is correct.

The CHAIRMAN. And who do you report to?

Mr. MCERLEAN. I am the president and CEO, and I am responsible for the operations of U.S. Futures Exchange here in the

United States.

The CHAIRMAN. And who do you report to?

Mr. MCERLEAN. I have reporting lines through to Frankfurt if I

need help to make a decision. I also speak to my colleagues in Chicago. I also speak to market participants and people I know within

the industry.

The CHAIRMAN. And I understand from your testimony and what

we heard earlier that you plan to have and may now have a 12-

member board of directors. Have you appointed those members?

Mr. MCERLEAN. We have not done so yet.

The CHAIRMAN. All right.

Mr. MCERLEAN. But it will be done before we start operations as

an exchange.

The CHAIRMAN. How will that board of directors be selected? Will

any of the members be officers or employees of Deutsche Boerse or

Swiss Exchange?

Mr. MCERLEAN. Well, we have contemplated and are discussing

having U.S. investors invest in the U.S. Futures Exchange, and at

least six of them will come from those market investors.

The other six will could be European or foreign ownership, but

the majority will be U.S. participants.

The CHAIRMAN. How will those directors be compensated?

Mr. MCERLEAN. I am not aware that there will be a compensation for the directors as yet, as these issues are still being discussed.

The CHAIRMAN. These are not resolved?

Mr. MCERLEAN. Right.

The CHAIRMAN. Well, let me just ask you this. As you know, corporate governance has been a grave concern of the Securities and

Exchange Commission and other regulators and the Congress over

51

the last years. Do you expect to have a working board of directors

prior to beginning Eurex U.S. operations?

Mr. MCERLEAN. Yes, we do.

The CHAIRMAN. And should the board be in place prior to the

CFTC’s approval of your application?

Mr. MCERLEAN. If it is not, when we appoint the board, we will

certainly let the CFTC know who the management structure is.

The CHAIRMAN. Mr. Damgard, or Mr. Green for that matter, your

testimony indicates your association favors competition among exchanges. As you know, there was some controversy around the vote

of the former Board of Trade Clearing Corporation to allow Eurex

U.S. to clear trades at the clearinghouse.

Do you have any thoughts about competition among clearinghouses, and do you believe the Commodity Futures Modernization

Act envisioned competition among clearinghouses?

Mr. DAMGARD. I think competition is healthy. I think that the

model in the futures industry is working rather well. We have had

concerns in the past over the governance of the clearinghouses.

We also admire the model in the options industry where there

is one central clearinghouse that is run as a utility, where each

and every new exchange that is designated by the SEC has access

to the same pool of liquidity. It certainly has benefited the investor,

but obviously in a competitive environment like that, there are

winners and losers.

Some of the start-up exchanges, the all-electronic exchanges,

have done extremely well in taking market share away from established exchanges like the Chicago Board Options Exchange, and

the result has been that the Chicago Board Options Exchange has

been very aggressive in playing catch-up ball. And all of that benefits the investor. That is called fungibility, and we have talked

about that in the past.

The fact that the Board of Trade and the Mercantile have combined their clearing operations and reduced the costs of running

two clearinghouses, all those trades, 85 percent of them now, all

being processed by a very, very fine clearinghouse is something

that will save the firms a lot of money.

The issues that we have so far are, since all the money, or virtually all the money, in that clearinghouse is put up by the clearing members, we are concerned that there is not representation on

the board of the Mercantile that oversees the decision-making with

respect to that clearinghouse. And the fee structure at the clearinghouse is subject to the board of the Mercantile, and the Mercantile,

as you know, is now a for-profit entity.

That clearinghouse captures all the trades. There is no way that

those trades can go anywhere else, because the Mercantile’s rules

require those trades to go to that one clearinghouse, and that clearinghouse has really no constraints other than its own board in

terms of raising the fees.

The CHAIRMAN. Mr. Green.

Mr. GREEN. Mr. Chairman, I have no crystal ball, so I can’t predict exactly what the outcome would be, but my gut tells me philosophically that we would believe that competition would lead to a

better marketplace.

52

In the cash market for Treasury securities, there are two principal clearance banks, Bank of New York and JP Morgan Chase.

And in fact the Federal Reserve has looked at whether or not two

is enough. We happen to believe that the dynamic of the two creates a kind of competitive environment to ensure sufficient redundancy, to ensure efficiency and use of technology.

But competition is good there. Competition is a good element. So

just philosophically, from where we sit, we can only believe that

the infusion of competition would be a good thing.

The CHAIRMAN. Mr. Damgard, what business advantage does

Eurex gain by establishing a physical presence in this country? Is

there some opportunity available to Eurex that it cannot obtain operating its electronic system from Europe?

And is that opportunity more about a clearing and settlement operation than a trade execution operation?

Mr. DAMGARD. That question probably is best put to Eurex. I

don’t know. I mean, I am welcoming Eurex and any other exchange

that wants to come in and compete on a product-by-product basis.

I would be here cheering just as loud for the two Chicago exchanges if they were to list Eurex’s products.

What this industry needs and has needed for a long time is direct competition on a product-by-product basis. I would love to ask

my two pals here, Why haven’t you listed the other guy’s signature

product?

The CHAIRMAN. Well, let’s let Mr. McErlean answer the question

you didn’t answer.

Mr. MCERLEAN. We have screens here in the U.S. already, and

we could list the U.S. products on those screens and trade them

and clear them in Europe.

But we feel that there is an advantage to starting a U.S.-regulated exchange under the scope of the CFTC and to clear those

products here in the United States and give our clients, the end clients, choice of where they, A, want to trade those products and, B,

where they want to clear those products.

Our clients have told us that they think it would be advantageous for them to be able to clear some of these products, both

European products and the U.S. products, under one regulatory infrastructure in one clearinghouse. It gives them ability to manage

their collateral more efficiently. And so we are trying to respond to

the market and what the market is asking us for in terms of valueadded services.

And we would like to be able to deliver those value-added services to the market. And that is why we have been discussing our

clearing link with market participants; and when our clearing link

is established, we will be going to the CFTC to get their OK regarding the parameters of that clearing link.

The CHAIRMAN. Let me ask if Mr. Duffy or Mr. Carey want to

respond to any of what——

Mr. DUFFY. If I may, I would like to respond to a couple things.

And I think I heard a few things—I don’t know if Mr. Damgard

is trying to start a debate, but I would love to do it with Mr.

Damgard on competition, because the Chicago Mercantile Exchange has had competition since its existence, for 105 years.

53

I have something in front of me that shows over 100 different examples since 1858 where the Chicago exchanges have had competing product. So I don’t know what we get about competition.

We have traveled the world around. The people sitting behind

me, Mr. Melamed and Mr. Sandner, have traveled the world

around helping foreign exchanges open up their contract markets

so that we could compete.

This is not a hearing about competition. If this was strictly a

hearing about competition, I would fly to Frankfurt, pack Rudy’s

bag and help him move over here. That is not the case. This is a

case about regulatory framework. That is our concern.

So we have no issues with competition. We welcome the competition. We thrive on it. We have done it for 105 years. We will for

another 105 years.

We talk about the extraordinary growth rate that has happened

with Eurex. Well, if you look over the last 3 years, the growth rate

of the Chicago Mercantile Exchange has exceeded that of Eurex.

We have come to the forefront in competition. We are not concerned about it, sir.

So again, I think that this is something that we are concerned

about, the regulatory framework issues, the payment for order flow

issues, manipulation and things of that nature. It is not about competition.

The CHAIRMAN. Thank you.

Mr. CAREY. I would just echo that. There has been competition

on occasion going back, but it seems that liquidity is the measure

of cheapest costs, and whoever achieves the liquidity provides the

tightest market.

But going back to regulatory framework, we appreciate the ability to be here today and comment, because as we have noted, the

story tends to change; and we think that Congress intended the applicant for registration to file at the CFTC the same business plan

that it is offering to the public.

The CHAIRMAN. Thank you.

Mr. McErlean.

Mr. MCERLEAN. I guess in terms of electronic trading and the

growth of electronic trading here in the United States, it has been

dynamic over the last 3 years. In fact, the Chicago Board of Trade

open outcry volumes peaked in 1998 and have been going down

ever since.

I would like to think that their growth in the last 3 years is because they have been trading on the Eurex trading system since

August 2000, and their volumes have gone from 8 million to 52 million to 126 million in a 3-year period.

But what our clients are telling us is they would like us to come

to this market and compete, because they know that while we

trade electronically and these other exchanges trade electronically

also, the fees and pricing structure that we have is a lot more advantageous to the end client.

Now by us coming here, miraculously some of the fees and pricing at the Chicago exchanges are coming down, and I think that

is exactly what the CFMA intended when it was passed several

years ago. I think the system works, and competition is good.

The CHAIRMAN. Thank you very much.

54

The gentleman from California, Mr. Dooley.

Mr. DOOLEY. Thank you, Mr. Chairman, and I came back in part

to give anyone that wanted to comment on some of my earlier comments a chance to either object or raise questions. But guess I am

coming at this from the standpoint that I think, in some ways,

Eurex’s application is a validation of the Commodities Futures

Modernization Act. I thought that is what we had in mind, that we

had no idea as policymakers what products would be offered and

developed out there. Our challenge was, how do you create a regulatory environment that is going to allow for innovation and creativity, the development of products and can respond to a market

demand?

So that is kind of the way I look at this, and I guess on the issue

that this is not about competition, when we are talking about a

regulatory framework, I think that would have greater merit if

there was a clear demonstration that the regulatory framework is

broken down.

But the Commodity Futures Trading Commission has not even

finished their consideration of the application that has been submitted. You cannot even point to, now that there is cause for us

to as policymakers to say that there has been an abrogation of the

responsibility that we have endowed in the Commodity Futures

Trading Commission.

They have requested additional information from Mr. McErlean’s

group, and they have responded to that. I have a hard time really

understanding is that it looks like this hearing in part is motivated—from my perspective is that there is some real concerns

about a competitive model coming in.

Even the comment, Mr. Carey, you made about new technology,

I mean, as one member who really has felt very strongly that there

was a need for new technology, I look at what they are doing as

again bringing in a new competitive model, that maybe the technology that they are using is going to give some efficiencies that

provide a benefit to Mr. Damgard’s constituencies and Mr. Green’s.

And I just make those statements and just give any of you an

opportunity to respond to them.

Mr. DUFFY. Well, I will be happy to take that for one second.

I mean, I think Congressman Gutknecht put it very appropriately. He said the horse is out of the barn. We did not want to

be at this hearing today, Congressman. This isn’t something that

we all relished flying in the weather last night to come here for

this hearing. This is not something we wanted. We want to comment on a complete application; that is all we wanted from the

start.

Mr. DOOLEY. Just a second. Is the application process that Eurex

is currently involved in, does it differ markedly from any other application in the way the CFTC has considered it? And the further

requests for information by CFTC on a prior application, is there

a clear difference in the terms of the approach?

Mr. DUFFY. It differs dramatically. When you are out marketing,

as I said earlier, a certain way that you are going to conduct business to your clients, your clients expect you to do that. You don’t

go out and market something and then give them a wink and a nod

55

and say, We are not going to do it. So those are big concerns that

we have.

When you put out a $40 million payment for order flow to your

top 10 fiduciaries, when you put out that you are not going to say

what products you are going to trade, but we all know what products we are going to trade. There are a lot of things there. When

you talk about a cross-border clearing arrangement, OK, we are not

going to put it in, we will self-certify later. We don’t want to talk

to the Treasury right now.

These are serious issues. These aren’t something that the Chicago Mercantile Exchange brought to this committee hearing. We

want an answer. That is all. It is not a big deal.

Mr. DOOLEY. If I can just respond, though, has CFTC passed

judgment? Do they not still have the opportunity before they approve those products? Don’t they still have to make a determination?

Mr. DUFFY. There is no question about it. Unfortunately, this

was on a fast track, Congressman, as you are well aware, which

would have been up November 16. So they could still have approved the application which——

Mr. DOOLEY. Didn’t Mr. Newsome say that they could stay the

180 days if they didn’t feel they had adequate information——

Mr. DUFFY. I don’t have all the confidence in the world that—

I don’t work for the CFTC. I don’t know what they are going to do.

So that 180-day statute, I don’t know what is going to happen. I

think these issues are relevant and need to be raised.

Mr. CAREY. I would like to make a point. In the 2000 act, Congress set up a structure to expedite approvals for registered exchanges for rules and new contracts, but the special standards to

become a registered exchange were intended to be rigorous and

must be met first. We have been assured today, thanks to this

hearing, that the highest standards of regulatory review will be applied to this Eurex U.S. application.

We also think the statute allows the CFTC to consider fair trade

issues, which Chairman Duffy just mentioned, the fact that this

was proposed in the public domain but not with the CFTC.

So we are grateful that they are going through this review process, but when they are stating that they are going to spend $40

million on an incentive program, or we have heard rumors of no

charges for 2 years, or the fact that they will spend $100 million

to gain steal this liquidity, as Werner Siefert has been quoted as

saying, we think the statute allows the CFTC to consider fair trade

issues. If Congress wants to make that explicit, we would support

such a statutory amendment.

Mr. DAMGARD. Mr. Dooley, I would just like to say I agree with

you, and I have great faith in the CFTC. I think Jim Newsome is

an extremely competent, qualified public servant, and I believe that

Jim Newsome knows more about this than perhaps anyone else.

I also think it is instructive to note that all the customers and

everyone else believe that this application ought to be considered

fairly and not with respect to anything other than what the experts

believe is right or wrong, except the two Chicago exchanges who

see them as a competitive threat. So I believe that you are right

on target.

56

Mr. MCERLEAN. Congressman Dooley, I would like to say that

our so-called ‘‘market materials’’ were materials that we used in bilateral meetings with some of our prospective clients. We have had

no complaints from those clients regarding the discussions that we

had. The only complaints have come from the exchanges that we

plan to compete with in the future with.

Mr. MORAN [presiding]. Mr. Dooley, thank you very much.

I would like to indicate I think that this hearing is important,

and appropriate. I think it is of great value to this committee, to

Congress, to the American people, to investors.

I understand for the first time, when an application is being filed

with CFTC under a new law, that we have every right and obligation to explore how that process works or doesn’t work. I don’t

think it is the prerogative of this committee to make a decision as

to whether or not CFTC should grant that application, but I think

there is nothing wrong with the Members of Congress examining

the effects of their legislative efforts.

This committee spent a lot of time and effort on a very difficult

subject over many months, many years, in fact—trying to figure

out what it is that we could do to improve the regulatory environment, create greater opportunities for investors as well as the exchanges to compete in a worldwide market.

And so I am delighted to have the opportunity to have the hearing and to see what is occurring in the markets and to examine

how CFTC is performing their role.

I am delighted to have the opportunity to have the hearing and

see what is occurring in the markets and to examine how CFTC

is performing their role.

Mr. McErlean, I was not terribly interested in this question,

until Chairman Goodlatte asked it, and I was not sure about the

kind of reluctance or inability to answer the question, which was:

Who do you report to and how are your board of directors selected?

Mr. MCERLEAN. The board will be selected, again, from investors.

We are seeking investors in the Exchange. We announced that we

are setting aside up to 20 percent of the Exchange ownership for

U.S. investors. We will put together a board of 12, six of whom will

come from a cross-section of the market; the other six will be some

independent, some from the Eurex organization within Chicago.

Mr. MORAN. Those board members will initially invest in the

U.S. company?

Mr. MCERLEAN. The organizations that the board members will

represent may be investors.

Mr. MORAN. And then the question, again, about who you report

to; in kind of the Kansas vernacular, who is your boss?

Mr. MCERLEAN. Here in the United States, I am the president

and CEO, and if there is any legal or regulatory issue to address,

I am the person that will address it. But Eurex U.S. is a U.S. company that is owned by U.S. Futures Exchange holdings, which is

owned by Deutsche Boerse, and so I will report to someone in

Frankfurt.

Mr. MORAN. You have stockholders now and the chairman on the

board?

57

Mr. MCERLEAN. Right now we do have a stockholder. It is wholly

owned by U.S. Futures Holdings, and that particular company does

have a board or an ownership structure.

Mr. MORAN. The discussion about the clearing link back with Europe, as I understand it, that is an application you intend to file

later.

Would you explain what you mean to the committee about the

plans for the clearing link back with Europe?

Mr. MCERLEAN. Yes, sir. We are speaking to our vendors, our

market participants, our clients, as well as our market partners,

The Clearing Corporation in Chicago, and Eurex Clearing AG in

Frankfurt about the parameters of how this clearing link will work.

When we are ready with the clearing link we think we have answered all the questions, we will come to the CFTC for approval.

We thought that the process of this application would be going a

lot quicker than we are experiencing, and so we have been put off

track a little bit from that schedule.

Mr. MORAN. And the reason that that is a separate application

as compared to part of the application now pending is?

Mr. MCERLEAN. That is regulatory approval that our DCO, that

the clearing organization in Chicago will have to seek. That is not

something we will seek.

Mr. MORAN. And can you describe the clearing relationship in

Chicago and the clearing in Europe?

Mr. MCERLEAN. They would clear each other’s products. From

my understanding, the clearing organization in Europe, Eurex AG,

would also have to register here in the United States to be a DCO,

and there would be contractual relationships between the two.

Again, we would not do anything unless it was okayed under

U.S. law and the oversight of the CFTC. And I would add that our

marketing of a clearing link is not unusual. The CME and the

CBOT announced the clearing link before they had CFTC approval.

We are getting feedback from the market participants that there

is value to be gained from a clearing link and trying to deliver the

products that they would like to use in the future.

Mr. MORAN. My time has expired. Thank you very much, Mr.

McErlean.

Mr. Etheridge.

Mr. ETHERIDGE. Thank you, Mr. Chairman.

I guess this will be for Mr. Carey and Mr. Duffy, if you would.

Can you tell me what your experience has been in regard to efforts that you have made to do business in Germany, as one example, and do you view the offers or the opportunities to do business

there as having the same kind of expeditious licensure opportunities as we have here in this country?

Mr. DUFFY. I will tell you from experience that we have at the

Chicago Mercantile Exchange, we tried to put a single trading terminal, one——

Mr. ETHERIDGE. Would you tell us what a trading terminal is?

Mr. DUFFY. It is our own terminal that gives access back to our

own markets in Chicago. When we tried to put the terminal in, we

were put at bay for over a year’s time, and Eurex really flexed its

political muscle; and, as I stated, I have a copy actually from our

German lawyers, which I am willing to submit so the Members of

58

Congress can see the efforts we had to go through to try to put one

single terminal in Germany, over a year, sir.

Mr. CAREY. Briefly, I would like to say that our counsel’s opinion,

which we have submitted for the record, indicates that we may not

receive fair trade treatment if we sought to compete in Germany.

Also I would like to address an earlier question to Mr. McErlean.

It said in the question-and-answer materials that were provided for

the proxy for the shareholders at the clearing corporation, it says:

Will the link be operational when Eurex launches Eurex-U.S?

The answer of the clearing corporation and Eurex is that they

process of finalized the details of the link which is expected to become operational February 1, 2004, or shortly thereafter; so, again,

that is why we appreciate this hearing. That is why this hearing

was necessary, to comment on these inconsistencies.

Mr. ETHERIDGE. Thank you.

Mr. MCERLEAN. May I comment?

Mr. ETHERIDGE. Sure.

Mr. MCERLEAN. My first comment is if, when we started down

that road, our application had gone through as quickly as we had

planned, we would not have to be contemplating the timing of our

clearing link.

My second comment is regarding reciprocity and bringing trading

terminals either from the U.S. or Germany or Germany into the

U.S., Eurex had a similar experience where it took about a year to

get approval to put clearing or trading terminals——

Mr. DUFFY. I do not mean to interrupt, Mr. McErlean, but the

correct number is 3 months.

Mr. MCERLEAN. But the process had started 10 months earlier.

May I comment on reciprocity, if you don’t mind? We have identified no provision of German law that would preclude a U.S. or

other non-German person from opening an exchange in Germany

or impose special obstacles requirements on U.S. or other foreign

persons. We have not seen any provision cited. It has been suggested that the German authorities would or could prevent a new

exchange competitor.

However, we are aware of no such denials. None have been cited

to us and the only known case is squarely to the contrary.

NASDAQ Deutschland—and I would note that Cantor Futures

Exchange have put their terminals into Germany. Contrary to suggestion, in Germany, as in the U.S., an abuse of discretion by regulatory authority in applying the law may be challenged in court;

and furthermore, you can go to any European country and you can

pick the easiest one if you like, and register and passport automatically into Germany.

We have and would like to submit for the record an agreed list

of criteria for the approval of a new exchange, a list that has been

agreed by all exchange supervisory authorities and that does not

include application of any exclusionary criteria of the type that has

been suggested.

Mr. ETHERIDGE. Thank you.

When we are talking about these changes, we are talking about

bonds and commodities, but you are also talking a lot about moving

of monetary issues and how it has impacted on U.S. funds, et

cetera.

59

Would you have any objection to your open case being reviewed

by the U.S. Treasury Department and the Federal Reserve?

Mr. MCERLEAN. No, sir.

Mr. ETHERIDGE. If not, if the answer is you have no objection,

then put this issue to rest. Would you consider asking the CFTC

to submit your application for review? If the Treasury or the Fed

requested information about the products you plan to offer, would

you provide it?

Mr. MCERLEAN. Sir, we have given our application to the CFTC,

and if they would like to have it reviewed by the Treasury or the

Fed, that is their prerogative and we would not object.

Mr. ETHERIDGE. OK, but that was not my question.

Mr. MCERLEAN. Then could you repeat your question, please, sir?

Mr. ETHERIDGE. My question was if you have no objection, would

you submit it to the Treasury or to the Federal Reserve for review?

Mr. MCERLEAN. If we had an objection of how the CFTC was——

Mr. ETHERIDGE. No, that was not my question. Let me repeat it,

if I may, Mr. Chairman. I realize my time has run out.

Would you have any objection to your application being reviewed

by the U.S. Trade and Treasury and Federal Reserve?

Mr. MCERLEAN. Thank you.

Mr. ETHERIDGE. And I said if not, to put it to rest, would you

consider asking the CFTC to submit your application for review by

them?

Mr. MCERLEAN. We would have no objection, sir.

Mr. ETHERIDGE. So then you will ask them to submit it for review?

Mr. ROSEN. At the request of the CFTC, because he wanted to

expedite that process, we yesterday provided them the contract

specs specifically to facilitate the discussion of those terms with the

Fed and the Treasury because we had no objections whatsoever

to——

Mr. ETHERIDGE. So you have already moved in that area?

Mr. ROSEN. Yes, sir.

Mr. ETHERIDGE. OK. Thank you.

Mr. MORAN. Mr. Burns.

Mr. BURNS. Thank you, Mr. Chairman. I appreciate the time and

the expertise. The panel has been very enlightening.

Mr. McErlean, I have been very concerned that the committee

chairman asked a question and the subcommittee chairman asked

a question about who you report to. This is not a sole proprietorship, this is not a situation where you are the sole owner of an enterprise. You report to somebody. And either you are unwilling or

unable to respond; is that correct?

Mr. ROSEN. No, he is not unwilling to respond.

Mr. McErlean, because he is the chief executive officer——

Mr. BURNS. Can he speak for himself?

Mr. MCERLEAN. As the chief executive and president of the Exchange, I am responsible for all that goes on.

Mr. BURNS. I understand.

Are you the sole proprietorship of the Exchange?

Mr. MCERLEAN. And I would report to the organization in Frankfurt.

Mr. BURNS. And their name is?

60

Mr. MCERLEAN. Mr. Rudi Ferscha.

Mr. BURNS. Thank you. And he is?

Mr. MCERLEAN. He is CEO of Eurex AG.

Mr. BURNS. Thank you. I appreciate that.

Mr. Duffy, you discussed the potential for market squeeze and

the potential problems with that for a layman. Would you please

explain market squeeze?

Mr. DUFFY. I would be happy to, but I am citing from a 2001 Financial Times article related to the Bobl market squeeze that allegedly occurred, just so we understand that. But a market squeeze

would be where a significant player would be able to buy enough

of futures contract to manipulate the price to a certain level, especially when it goes unregulated, and the regulator is obviously

charged with making certain that those positions are not to a point

where no one can. On the opposite side, does not matter what the

fundamentals are, if they just do not move, they can make the

price do whatever they want. So that is up to the regulator to make

that decision. And when I cited the Financial Times article, Eurex

only reprimanded Deutsche Bank and the German Government did

nothing in relation to it.

Mr. BURNS. Who are winners and losers in that situation?

Mr. DUFFY. The losers of that particular situation, sir, were the

short position of individual investors who were hedging their portfolios in German debt.

Mr. BURNS. Is there any risk of similar type of concerns in the

U.S. market?

Mr. DUFFY. I think there is always that problem. Because of the

regulation we have in the U.S., we feel very well protected.

Mr. BURNS. OK.

Mr. McErlean, you care to respond to the concept of market

squeeze?

Mr. MCERLEAN. I am not an employee of the Eurex Exchange in

Europe, but from what I understand regarding the situation where

there was a market squeeze, that the Eurex immediately addressed

the problem by changing some of their delivery rules, and there

has not been any such problems since.

Mr. BURNS. I want to shift gears and talk about surveillance.

I would like for Mr. Carey and Mr. Duffy and Mr. McErlean all

to respond with your quick summaries of your surveillance and the

extent to which you deal with your market surveillance; specifically, your allocation of resources, how many dollars it takes to do

that, and how many staff that you think is appropriate, given the

volume and the complexity of your markets.

Mr. Carey.

Mr. CAREY. Well, I would say the last numbers I have seen are

that we have 85 employees and we allocate $19 million a year to

market oversight, and that includes trade practices, avoiding anything like these squeezes and overall surveillance of our electronic

markets and open outcry markets.

Mr. BURNS. Mr. Duffy.

Mr. DUFFY. We have at Chicago Mercantile 120 people in our

regulatory department that are completely dedicated toward market surveillance. We have an annual budget of $20 million associVerDate 11-SEP-98 10:17 Dec 23, 2003 Jkt 090742 PO 00000 Frm 00063 Fmt 6633 Sfmt 6633 F:\DOCS\10821 HAGRI PsN: HAGRI
61

ated with that budget, to protect the safeguards of our institution

and our customers.

Mr. BURNS. Mr. McErlean.

Mr. MCERLEAN. We have outsourced our market surveillance and

that will be performed by the National Futures Association. We

have every confidence in the NFA to be able to perform that function, as does the CFTC.

Mr. BURNS. And your budget?

Mr. MCERLEAN. We have one person on our staff right now that

will be in charge of regulatory oversight and who will——

Mr. BURNS. One person to——

Mr. MCERLEAN. One person that will liaise with the NFA in

terms of regulatory oversight.

Mr. BURNS. And your anticipated budget for regulatory oversight?

Mr. MCERLEAN. We are still developing a budget, sir. I do not

have that answer for you. I would love to give that to you.

Mr. BURNS. I would appreciate it.

Mr. Roth, as the NFA and as the individual who will be providing the regulatory service agreements to U.S. Futures Exchange, I

understand from your testimony that you have experience with,

what, four different exchanges; is that correct?

Mr. ROTH. Well, we signed regulatory service agreements with

four different exchanges but, Congressman, two of those have never

traded.

Mr. BURNS. And consequently you said you have 100 on compliance staff.

What is your level of confidence that you have—for example, my

question really is the current volume of surveillance you support

versus the potential future volume of surveillance that you must

support.

Mr. ROTH. Right. And it could very well be that USFE has greater volume than the exchanges that we provided services for in the

past.

Mr. BURNS. Is that a likelihood?

Mr. ROTH. Well, I will tell you, Congressman, BrokerTec thought

they were going to do pretty big volume, too. We have not talked

with the Futures Exchange yet that has intended to have small

volume, so I do not know whether that volume will be there or not.

What I do know is in making comparisons of this sort, it is very

important that—I think the expression has been used several times

today that we do an apples-to-apples comparison.

With respect to our services agreement with the USFE, plus the

services that we are talking about, they do not include the market

supervision function. They do not include performing audits of their

members. They do not include financial analysis. All of that is

something that NFA may be willing to do for them and may be

willing to do, but there would be charges for all of those types of

functions.

Also, our surveillance would not have to include personnel for

any of these sorts of surveillance issues that are unique to open

outcry issues.

With respect to the contract, the contract provides that if USFE

never trades a single contract, they are obligated to pay approxiVerDate 11-SEP-98 10:17 Dec 23, 2003 Jkt 090742 PO 00000 Frm 00064 Fmt 6633 Sfmt 6633 F:\DOCS\10821 HAGRI PsN: HAGRI
62

mately $600,000 a year, but as their volume goes up—that is just

a minimum level, and as their volume goes up, the revenue that

would be paid to NFA would go up. And we are confident that we

can support an adequate staff to do the job.

The CFTC has reviewed our surveillance program on no fewer

than five occasions. They have reviewed it with respect to each of

the four previous applications for contract market designation.

They have also reviewed it in the context of a rule enforcement review, and in each instance they found that NFA’s programs met all

of the statutory and regulatory requirements.

And the point I made in my testimony is the point I reiterate

here: We made our estimates as to the type of staffing that would

be appropriate, but if at any point—we have not made our reputation over the last 20 years by trying to scrimp on resources. We

will do the job and we will do it right, and if that requires that

USFE pay higher fees, then we will talk to them exactly about

that.

Mr. DUFFY. Congressman Burns, you asked the rest of us to state

on the record what we paid in annual budgets for our compliance

regulatory framework. Mr. Roth has stated in his testimony that

he is going to do these functions.

I believe it would only be fair that he states on the record what

his first-year agreement would be, understanding that it is an upstart company with a $6 billion market cap company behind it. I

understand it is an upstart, but I would like to know if there are

caps involved in this agreement or what the first annual year

would be of revenue.

Mr. ROTH. There are caps involved. The amount to be paid by

USFE depends on volume. There is a minimum for the narrow

services that I described of approximately $600,000 in the first

year. It could be as high as approximately $3 million in the first

year.

Mr. BURNS. For an estimated volume?

Mr. ROTH. For instance, if their volume gets up to 25 percent of

the Chicago Board of Trade’s volume, we would have staffing and

funding to provide funding for approximately 25 staff people, which

we think is adequate.

If that is not adequate, if we are wrong, we will devote the staff

necessary to do that, and we will turn to USFE and suggest that

either they renegotiate the fees to ensure that we are recovering

our cost or they search around for another regulator.

Mr. BURNS. Thank you, Mr. Chairman.

Mr. MORAN. Both Mr. Burns’ and Mr. Duffy’s time has expired.

Mr. DUFFY. Come on; could I have some of Mr. Damgard’s?

Mr. MORAN. The gentleman from Georgia, Mr. Marshall.

Mr. MARSHALL. Thank you, Mr. Chairman.

Mr. McErlean, were you here earlier when Mr. Newsome testified?

Mr. MCERLEAN. Yes, sir, I was.

Mr. MARSHALL. Then you heard the nature of my questions,

then, and you may not recall them, but I am interested in transparency of the process. I trust that as long as everybody sees what

is on the table, then the right questions will be asked, the right inquiries made, and proper decision will be made by CFTC.

63

In response to my question, Mr. Newsome said: Well, some of the

stuff that we are given by United States Futures Exchange is proprietary and we do not reveal it. We reveal as much as we think

we possibly can.

What is it in your application, 2,000 pages long, that you consider to be proprietary that somehow these folks will not be able

to figure out; I mean, it does not seem to me—well, actually, from

my perspective, it does sound a bit like alchemy, but I doubt from

the perspective of anybody in the room it is.

I doubt that there are too many things that are truly major secrets that you need to worry about; and as far as this committee

is concerned, certainly this member is concerned, your willingness

to be very public with as much of your application that you possibly

can brings me comfort that the process of oversight and regulation

that CFTC must go through is one that will work, because it is

open, it is not behind closed doors. It is not something that the

public would really worry about as long as those who are concerned, who are here as experts, have a fair shot of saying hey, this

does not comply with one of the 18 requirements, that sort of thing.

So what are you trying to hide that you are not willing to make

public?

Mr. MCERLEAN. Well, sir, thank you very much for that question.

We were not trying to hide anything that would damage our competitive position or reveal to the market what some of the commercial contracts that we have in place with some of our service providers are, for competitive reasons and for reasons I think that the

Exchange or the CFTC intended; that you do not necessarily want

to make public to the markets specific things in terms of how you

are going to conduct market oversight in your markets, because

then you are giving the keys of the hen house to the fox. Everyone

would have that information and know how to circumvent those

rules.

Mr. MARSHALL. The market oversight, those being provided by

Mr. Roth; is that correct?

Mr. MCERLEAN. Correct.

Mr. MARSHALL. But pursuant to rules that you are establishing?

Mr. MCERLEAN. We have a contractual relationship with the

NFA as well as with The Clearing Corporation in Chicago, as well

as with Deutsche Boerse Systems, Incorporated, to provide us with

the——

Mr. MARSHALL. Are you familiar with the market oversight rules,

whatever process is followed by the board and the Exchange? Are

you familiar with what they do with their $19 million and $20 million?

Mr. MCERLEAN. Yes. But because we do not have to support a

trading floor, that our budget will be able to be a lot less.

Mr. MARSHALL. I fully accept that. That is obvious. But will you

be doing the same things?

Mr. MCERLEAN. Yes, we will.

Mr. MARSHALL. So what is the secret?

Mr. MCERLEAN. We will have large trader reports and we will

make those available to both the NFA and the CFTC.

Mr. MARSHALL. I take it that neither of the other two exchanges

makes this information public?

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Mr. ROTH. Congressman, with respect to the regulatory services

agreement between NFA and USFE, the portion that is sensitive

to us is that schedule which details how we will conduct surveillance. And we would not want that to be made public, so as to give

anyone a road map to avoid that surveillance or circumvent that

surveillance. That is the only part of the regulatory agreement that

we find sensitive.

Mr. MARSHALL. What other proprietary information is included

in your application, despite this concern about the regulatory process?

Mr. MCERLEAN. Just the commercial aspects that deal with our

relationships with our service providers.

Mr. MARSHALL. And nothing other than that? Are those the only

things that have not been made public thus far?

Mr. MCERLEAN. That is correct.

Mr. MARSHALL. So you are familiar with——

Mr. MCERLEAN. The contract specifications.

Mr. MARSHALL. What contract?

Mr. MCERLEAN. The contract that we will trade on this new exchange.

Mr. MARSHALL. They have not been released?

Mr. MCERLEAN. They have been provided to the CFTC yesterday.

Mr. MARSHALL. And are these the contracts that you have been

floating with possible large traders?

Mr. MCERLEAN. These are the contracts that we originally announced back in September when we submitted our application,

but we were still discussing the contract specifications of them

until recently.

Mr. MARSHALL. I see my time has expired, Mr. Chairman.

I would simply encourage you to reveal absolutely as much as

you possibly can as part of this process, because you are going to

hear from this committee, and others, repeated complaints about

transparency and the need for transparency.

Mr. MORAN. Thank you, Mr. Marshall.

Mr. Stenholm.

Mr. STENHOLM. No additional questions.

It just seems to me that having listened to much of the testimony

today, reading and visiting, that the process is working as was intended. CSMA was designed to deal with just a situation like we

are now watching CFTC deal with, and it is being done in a way

that I think everyone intended that it should be done.

I was asked just a moment ago that question and I thought I

would respond on the record. The gentleman from Georgia, Mr.

Marshall, asked it, talking about the question we are talking

about, transparency. That is something that customers—in this

case today, we are not talking about cotton farmers and the wheat

farmers as far as we are talking about the citizens of the United

States, I guess the customers of the tremendous job that the America and the Chicago Board have done and are doing and Eurex

wishes to do in the United States, that which they have been doing

worldwide.

We all want a level playing field. We all want the rules to be followed. And with some of the public not only concerns, but the exposure now of wrongdoing that SEC and others have been coming up

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with, the latest being something that just shocked everyone, that

the mutual fund industry was in fact playing hanky-panky with

doing the things. When you are talking about trading around, that

sounds like somebody is going around the rules. Well, that is not

really what it is, but it could be, and CFTC, that is what they are

here for.

When we start talking about self-regulation, that always makes

me a little bit nervous, but I do not get near as nervous about selfregulation if somebody is standing by with a good tree and a rope,

appropriate horse, prepared to deal with the problem. And if there

is anybody trading around and making money and putting it in

their own pocket as a result of the rules and regulations that we

think we have played that would protect them through transparency—just want you to know, Kansas and Texas got a pretty

good reputation for ropes and trees. The chairman says Kansas has

got a better reputation. Georgia would probably be right there with

us.

And this hearing today, I think, is a perfect example of what this

committee is all about. I think everyone at the table, there is some

differences—well, probably not differences of opinion as much as

concerns about the process working in the way in which it was intended, and I think this hearing has been very complimentary to

that process.

We will continue to exercise our oversight, oversee FTC, and continue to be very concerned about the point that Mr. Marshall

raised in his last question.

So, Mr. Chairman, I thank you for providing for this hearing.

Mr. MORAN. Mr. Stenholm, thank you very much.

Mr. Stenholm gave me the opportunity to speak about trees and

horses and ropes, and I concluded that no one could deliver that

scenario better than Mr. Stenholm.

It is, I think, as I said earlier, a very useful hearing. I appreciate

the patience of our witnesses. It has been a long morning, into the

afternoon.

I appreciate the long time that Chairman Newsome spent with

us, and I am always pleased by the expertise that he demonstrates.

We recognize that there are significant issues that are presented

at the table here in this panel, and our committee is very interested in playing our role as oversight at CFTC.

Without objection, the record of today’s hearing will remain open

for 10 days to receive additional material and supplementary written responses from witnesses to any question posed to them by a

member of this panel.

This hearing of the House Committee on Agriculture is now adjourned.

[Whereupon, at 1:40 p.m., the committee was adjourned.]

[Material submitted for inclusion in the record follows:]

STATEMENT OF JAMES E. NEWSOME

Thank you Chairman Goodlatte and members of the committee. I appreciate the

opportunity to testify before you today on behalf of the Commission regarding the

application filed by U.S. Futures Exchange, L.L.C. (U.S. Futures Exchange or Exchange) to become a designated contract market, which is commonly referred to as

a futures exchange.

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As you know, through the Commodity Futures Modernization Act of 2000

(CFMA), Congress profoundly altered the manner in which derivatives markets are

regulated in the United States by replacing the one-size-fits-all prescriptive rules of

the past with broad core principles aimed at promoting responsible innovation and

fair competition among exchanges and other market participants. This is an exciting

time for the futures business. Due to a number of factors, the industry that we regulate has grown significantly over the past few years. We believe that a primary contributing factor is the modernized regulatory structure established by Congress in

the CFMA. This new, flexible approach to regulation has encouraged innovation and

the use of cutting-edge technology, and has allowed market participants to implement business plans with much greater ease. It has also resulted in an unprecedented number of new entrants into the marketplace. Since December 2000, when

the CFMA was signed into law, the Commodity Futures Trading Commission has

designated four new exchanges as contract markets and has received three additional applications, including the application filed by U.S. Futures Exchange.

Throughout this time the CFTC has been committed to providing a level regulatory

playing field for all existing and potential market participants, while being vigilant

in its mission to foster markets free of fraud and manipulation, and it will evaluate

U.S. Futures Exchange’s application accordingly.

To put things into context, I would first like to outline the legal requirements for

contract market designation set forth in the Commodity Exchange Act (Act), as

amended by the CFMA, and in the Commission’s regulations. I will also outline the

substance of U.S. Futures Exchange’s application, including a description of its proposed clearing plans and how it intends to fulfill its self-regulatory responsibilities,

and describe the process by which the Commission is evaluating the application. Finally, because questions have been raised concerning the Commission’s authority to

address activity occurring abroad that may relate to the Exchange’s operations, I

will comment on the Commission’s authority to reach extraterritorial conduct.Legal

Requirements for Contract Market Designation

To become a designated contract market (DCM), an applicant must demonstrate

to the Commission that it will comply with the conditions set forth in the Act, which

consist of eight designation criteria and eighteen core principles, and must provide

sufficient assurance that it will continue to comply with those conditions. (The details of the designation criteria and the core principles are attached as an appendix).

By statute, the Commission must approve or deny an application for designation

within 180 days of its submission, unless the application is materially incomplete,

in which case the 180-day period may be stayed. See section 6(a) of the Act.

By regulation, an application may be considered under a 60-day procedure in appropriate circumstances. See Commission Rule 38.3. Although originally slated for

60-day review, the Commission decided to remove the application from the expedited procedure and is now reviewing it under the 180-day statutory timeframe to

ensure that we have an adequate opportunity to fully consider all of the issues.

In order to be complete, an application must include: (1) a copy of the applicant’s

rules and any technical manuals, guides, or instructions for users of the market; (2)

descriptions of the trading system, test procedures and results, and contingency or

disaster recovery plans; (3) descriptions of the applicant’s legal status and governance structure; (4) copies of agreements, including third-party regulatory service

agreements, that will enable the applicant to meet the conditions for designation;

and (5) to the extent that it is not self-evident, an explanation as to how the application satisfies the conditions for designation.

The Act provides further that an exchange shall have reasonable discretion in establishing the manner in which it achieves compliance with the core principles, and

may do so by delegating relevant functions to a registered futures association or another registered entity. In adopting rules implementing the Act, the Commission

recognized that some existing exchanges had outsourced certain of these functions

to non-registered entities, and determined that such outsourcing is permissible. See

66 Fed. Reg. 42256, 42266 (Aug. 10, 2001). In either case, however, the exchange

remains ultimately responsible for assuring compliance.

U.S. FUTURES EXCHANGE’S APPLICATION

U.S. Futures Exchange formally applied for designation as a contract market on

September 16, 2003. According to its application, U.S. Futures Exchange is a Delaware limited liability company headquartered in Chicago, and is a wholly owned

subsidiary of U.S. Exchange Holdings, Inc., a separately capitalized, wholly owned

subsidiary of Eurex Frankfurt A.G. (Eurex Frankfurt). Eurex Frankfurt is a wholly

owned subsidiary of Eurex Zurich A.G., which is owned in equal parts by Deutsche

Borse A.G. and SWX Swiss Exchange. U.S. Futures Exchange will be governed by

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a Board of Directors elected each year at its annual meeting of shareholders. The

Board will appoint a Chairman, and the Chairman may appoint a President, who

will serve as Chief Executive Officer of the U.S. DCM.

All trading on the Exchange will be done electronically, through a version of the

trading system that Eurex Frankfurt has operated in the U.S. since the year 2000

in a joint venture with the Chicago Board of Trade. The trading system will provide

a full audit trail of orders, bids and transactions. Audit trail information will be submitted directly to the National Futures Association (NFA), a Commission-registered

futures association, which will provide certain self-regulatory services for the Exchange such as conducting surveillance for trade practice violations, market manipulation, price distortions and market congestion. U.S. Futures Exchange staff in

Chicago will conduct real-time monitoring of Exchange trading activity. Clearing

and settlement services will be provided by The Clearing Corporation (formerly the

Board of Trade Clearing Corporation), a derivatives clearing organization (DCO)

registered with the Commission.

As with all applications for contract market designation, Commission staff is currently reviewing U.S. Futures Exchange’s application to determine whether the operations described and the supporting technical and regulatory services agreements

demonstrate that the Exchange meets the eight criteria for designation and the

eighteen core principles. With respect to the proposed outsourcing of self-regulatory

functions to NFA, in addition to reviewing the terms of the services agreement,

prior to designation Commission staff will, among other things, conduct on-site examinations to determine whether appropriate surveillance systems are in place and

functional. In the event that the Commission approves the provision of regulatory

services by NFA, the Commission will monitor NFA’s performance on an ongoing

basis through rule enforcement reviews, as it does for all self-regulatory organizations.

The Commission has published for public comment all portions of the application

except for those containing trade secrets or commercial or financial information subject to confidential treatment under the law. In considering whether to approve the

application, the Commission will carefully consider all comments received.

ISSUES RAISED

There are two issues that have been raised in various forums, including questions

from this committee, that the current application before the Commission does not

address: (1) a proposed clearing link with Eurex Clearing A.G. (Eurex Clearing),

which is the clearing and settlement arm of Eurex Frankfurt; and (2) proposed incentive programs for attracting business to the Exchange.

CLEARING LINK

The application currently pending before the Commission does not request approval of trade clearing or settlement arrangements outside the U.S. As mentioned

earlier, the clearing component of the application is based upon the proposed clearing services agreement with The Clearing Corporation. Although U.S. Futures Exchange has publicly announced that it intends to offer a clearing link with Eurex

Clearing at some point in time, it has not presented the Commission with any crossborder clearing plans. Neither the Act nor the Commission’s regulations require that

an application for designation as a contract market include all future clearing plans

that may be contemplated, or future plans in general. The application need only include information demonstrating an ability to satisfy the conditions for designation

based upon a current business plan. Because we can consider only the proposal contained in the application, the Commission’s review of the clearing component of the

application is currently proceeding strictly on the basis of the proposed clearing

services agreement with The Clearing Corporation.

Although the Commission does not know the particulars of the Exchange’s future

plans for a cross-border clearing link, the Commission can assure the committee

that any proposal that would permit the clearing of U.S. Futures Exchange positions

by Eurex Clearing would require that Eurex Clearing first become a U.S. DCO. See

sections 5(b)(5) and 5(d)(11) of the Act and applicable part 38 Guidance. In accordance with Commission policy, those portions of any application filed by Eurex Clearing to become a DCO that are not subject to a request for confidential treatment

under the Freedom of Information Act or Commission regulations would be released

to the public for comment.

It is conceivable that a proposal to enable Eurex Clearing to clear U.S. Futures

Exchange positions could be considered under other provisions of the Act or regulations, but any such proposal would require affirmative Commission action, which

would not be taken without the opportunity for public comment.

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INCENTIVE SCHEMES

U.S. Futures Exchange has not presented the Commission with any plans for generating volume on the Exchange. Incentives aimed at generating trading volume on

futures exchanges, such as ‘‘fee holidays’’ for new products and reduced fees for market makers, have long been viewed as acceptable by the Commission. Most U.S. exchanges offer such incentives in the normal course of business. Commission staff

analysis of these programs focuses primarily on whether the incentive will distort

open, competitive and efficient trading in the product by making abusive practices,

such as wash trading, economically attractive. In addition to the foregoing review,

the Commission would review any marketing plan offered by U.S. Futures Exchange, as it would from any other applicant or registrant, to determine whether

its implementation would pose an impermissible conflict of interest between brokers

and the fiduciary duties owed to customers. I would like to emphasize that the Commission will not allow U.S. Futures Exchange to offer any incentive program that

other U.S. contract markets would not be permitted to offer.

THE COMMISSION’S EXTRATERRITORIAL ENFORCEMENT AUTHORITY

The fact that U.S. Futures Exchange is owned by a German company has led to

questions concerning the CFTC’s authority to prosecute foreign individuals. In recognition of the international nature of commodity futures and option trading, Congress has given the Commission broad powers to take actions against persons suspected of violating the Act wherever such persons may be located, and to serve subpoenas seeking the production of witnesses and documents wherever they may be

located. See, e.g., sections 6(c), 6b and 6c(a) of the Act. In addition, the Commission

may prosecute any person located abroad who, directly or indirectly, controls a person who commits a violation of the Act. See section 13(b) of the Act.

To enhance its extraterritorial enforcement powers, the Commission has entered

into numerous bilateral information-sharing arrangements (also known as Memorandums of Understanding or MOUs) with foreign regulators. With respect to Germany in particular, the Commission has enjoyed a long-standing and extensive cooperative relationship with the Bundesanstalt fur Finanzdienstleistungsaufsicht

(BaFin), our German counterpart, and its predecessor agency. The BaFin’s cooperation has been critical to the Commission’s ability to combat violations in a number

of instances, by assisting our Division of Enforcement in obtaining trading and bank

records, registration histories, complaint and investigation files, and most recently,

obtaining the statement of a witness. The Commission fully expects, based upon its

past experience with the BaFin, that should circumstances require assistance from

Germany in connection with U.S. Futures Exchange’s operations, such assistance

will be forthcoming in accordance with the provisions of the MOU.

It should be noted that, to the extent the Commission may encounter difficulty

in pursuing violations of the Act or regulations committed by persons who are located abroad, that issue exists today with respect to activity conducted by foreign

persons on existing U.S. exchanges. Furthermore, there is no prohibition on foreign

persons serving as senior executives or board members of U.S. exchanges, and a

number of non-U.S. citizens have done so.

In closing, I would like to emphasize that U.S. Futures Exchange has applied to

become a U.S. exchange that will be subject to the CFTC’s direct regulatory authority. The Commission takes its responsibilities in reviewing applications for contract

market designation seriously, and will apply the highest standards of regulatory review prior to approving the application made by U.S. Futures Exchange. We pledge

to you that we will review the application, mindful of all comments received, with

an eye toward ensuring that all necessary standards are met, and that only sound,

ethical business practices are allowed to exist in the U.S. marketplace. I thank you

for the invitation to appear today, and will be happy to answer any questions you

may have.

APPENDIX

CRITERIA FOR DESIGNATION

The eight criteria for designation as a contract market are as follows:

(1) IN GENERAL—To be designated as a contract market, the board of trade

shall demonstrate to the Commission that the board of trade meets the criteria specified in [the Act].

(2) PREVENTION OF MARKET MANIPULATION—The board of trade shall

have the capacity to prevent market manipulation through market surveillance,

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ducting real-time monitoring of trading and comprehensive and accurate trade reconstructions.

(3) FAIR AND EQUITABLE TRADING—The board of trade shall establish and

enforce trading rules to ensure fair and equitable trading through the facilities of

the contract market, and the capacity to detect, investigate, and discipline any person that violates the rules. The rules may authorize:

(A) transfer trades or office trades;

(B) an exchange of:

(i) futures in connection with a cash commodity transaction;

(ii) futures for cash commodities; or

(iii) futures for swaps; or

(C) a futures commission merchant, acting as principle or agent, to enter into or

confirm the execution of a contract for the purchase or sale of a commodity for future delivery if the contract is reported, recorded, or cleared in accordance with the

rules of the contract market or a derivatives clearing organization.

(4) TRADE EXECUTION FACILITY—The board of trade shall:

(A) establish and enforce rules defining, or specifications detailing, the manner of

operation of the trade execution facility maintained by the board of trade, including

rules or specifications describing the operation of any electronic matching platform;

and

(B) demonstrate that the trade execution facility operates in accordance with the

rules or specifications.

(5) FINANCIAL INTEGRITY OF TRANSACTIONS—The board of trade shall establish and enforce rules and procedures for ensuring the financial integrity of

transactions entered into by or through the facilities of the contract market, including the clearance and settlement of the transactions with a derivatives clearing organization.

(6) DISCIPLINARY PROCEDURES—The board of trade shall establish and enforce disciplinary procedures that authorize the board of trade to discipline, suspend, or expel members or market participants that violate the rules of the board

of trade, or similar methods for performing the same functions, including delegation

of the functions to third parties.

(7) PUBLIC ACCESS—The board of trade shall provide the public with access to

the rules, regulations, and contract specifications of the board of trade.

(8) ABILITY TO OBTAIN INFORMATION—The board of trade shall establish

and enforce rules that will allow the board of trade to obtain any necessary information to perform any of the functions describe in the [criteria for designation], including the capacity to carry out such international information-sharing agreements as

the Commission may require.

7 U.S.C. § 5(b).

CORE PRINCIPLES

The thirteen core principles for contract markets are as follows:

(1) IN GENERAL—To maintain the designation of a board of trade as a contract

market, the board of trade shall comply with the core principles specified in [the

Act]. The board of trade shall have reasonable discretion in establishing the manner

in which it complies with the core principles.

(2) COMPLIANCE WITH RULES—The board of trade shall monitor and enforce

compliance with the rules of the contract market, including the terms and conditions of any contracts to be traded and any limitations on access to the contract

market.

(3) CONTRACTS NOT READILY SUBJECT TO MANIPULATION—The board of

trade shall list on the contract market only contracts that are not readily susceptible to manipulation.

(4) MONITORING OF TRADING—The board of trade shall monitor trading to

prevent manipulation, price distortion, and disruptions of the delivery or cash-settlement process.

(5) POSITION LIMITATIONS OR ACCOUNTABILITY—To reduce the potential

threat of market manipulation or congestion, especially during trading in the delivery month, the board of trade shall adopt position limitations or position accountability for speculators where necessary and appropriate.

(6) EMERGENCY AUTHORITY—The board of trade shall adopt rules to provide

for the exercise of emergency authority, in consultation or cooperation with the

Commission, where necessary and appropriate, including the authority to——

(A) liquidate or transfer open positions in any contracts;

(B) suspend or curtail trading in any contracts; and

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(C) require market participants in any contract to meet special margin requirements.

(7) AVAILABILITY OF GENERAL INFORMATION—The board of trade shall

make available to market authorities, market participants, and the public information concerning——

(A) the terms and conditions of the contracts of the contract market; and

(B) the mechanisms for executing transactions on or through the facilities of the

contract market.

(8) DAILY PUBLICATION OF TRADING INFORMATION—The board of trade

shall make public daily information on settlement prices, volume, open interest, and

opening and closing ranges for actively traded contracts on the contract market.

(9) EXECUTION OF TRANSACTIONS—The board of trade shall provide a competitive, open, and efficient market and mechanism for executing transactions.

(10) TRADE INFORMATION—The board of trade shall maintain rules and procedures to provide for the recording and safe storage of all identifying trade information in a manner that enables the contract market to use the information for purposes of assisting in the prevention of customer and market abuses and providing

evidence of any violations of the rules of the contract market.

(11) FINANCIAL INTEGRITY OF CONTRACTS—The board of trade shall establish and enforce rules providing for the financial integrity of any contracts traded

on the contract market (including the clearance and settlement of the transactions

with a derivatives clearing organization), and rules to ensure the financial integrity

of any futures commission merchants and introducing brokers and the protection of

customer funds.

(12) PROTECTION OF MARKET PARTICIPANTS—The board of trade shall establish and enforce rules to protect market participants from abusive trading practices committed by any party acting as an agent for the participants.

(13) DISPUTE RESOLUTION—The board of trade shall establish and enforce

rules regarding and provide facilities for alternative dispute resolution as appropriate for market participants and any market intermediaries.

(14) GOVERNANCE FITNESS STANDARDS—The board of trade shall establish

and enforce appropriate fitness standards for directors, members of any disciplinary

committee, members of the contract market, and any other persons with direct access to the facility.

(15) CONFLICTS OF INTEREST—The board of trade shall establish and enforce

rules to minimize conflicts of interest in the decisionmaking process of the contract

market and establish a process for resolving such conflicts of interest.

(16) COMPOSITION OF BOARDS OF MUTUALLY OWNED CONTRACT MARKETS—In the case of a mutually owned contract market, the board of trade shall

ensure that the composition of the governing board reflects market participants.

(17) RECORDKEEPING—The board of trade shall maintain records of all activities related to the business of the contract market in a form and manner acceptable

to the Commission for a period of 5 years.

(18) ANTITRUST CONSIDERATIONS—Unless necessary or appropriate to

achieve the purposes of this Act, the board of trade shall endeavor to avoid——

(A) adopting any rules or taking any actions that result in any unreasonable restraints of trade; or

(B) imposing any material anticompetitive burden on trading on the contract market.

7 U.S.C. § 5(d).

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STATEMENT OF CHARLES P. CAREY

Mr. Chairman and members of the committee, I am Charlie Carey, the chairman

of the Chicago Board of Trade. I am pleased to appear before this committee to discuss our concerns about the application filed by Eurex U.S. to become a registered

futures exchange, what the statute calls a designated contract market.

Mr. Chairman, the Board of Trade commends you for your leadership in calling

this hearing. The issues raised by the Eurex application are profound and far-reaching. This hearing will promote a serious public debate on those issues.

To give that debate a proper framework, the committee should be aware of a number of basic facts at the outset. First, Eurex would have you believe that its new

exchange would bring electronic trading to the U.S. The truth is that the Board of

Trade, along with other U.S. exchanges, now offers vibrant and liquid electronic

trading markets. For us, over 80 percent of our popular U.S. Treasury Futures complex futures contracts are executed electronically. Our electronic trading markets

are growing rapidly every day. And we hope to increase that growth starting next

year once we replace the trading system offered by Eurex with what the industry

recognizes and we believe to be a more attractive, technologically sophisticated trading platform offered by Euronext-Liffe. At the same time and recognizing the current limitations of technology, we continue to—offer our customers the opportunity

to execute futures and options transactions in our trading pits in order to provide

an open and transparent marketplace for all orders regardless of complexity— At

the CBOT we continue to make the necessary investments in both trading platforms

to give our customers a choice of two markets that provide integrity, fairness and

transparency.

Second, Eurex claims the CBOT is a monopoly. Not true. As even Eurex’s counsel

has conceded to the CFTC, that ‘‘there is vigorous competition between U.S. exchanges is beyond dispute.’’ The Board of Trade competes daily for interest rate derivatives and risk management business with some of the best capitalized firms in

the world. Some of those entities also own an existing U.S. exchange that competes

directly with the Board of Trade by cloning its products in an electronic trading

market.

Third, Eurex would have you believe that it will become the low-cost provider of

trading services in the U.S. Not true. Liquidity is the key for any trader. Participants come to the CBOT’s centralized pool of liquidity to assess the market and determine the best price, based on bids and offers that are posted for all to see— That

kind of clear market transparency makes price discovery faster and more efficient.

Cost is a function of the bid-ask spread, the time to execute a transaction and the

exchange transaction fees— CBOT remains the leader and offers the best value for

market participants in terms of market transparency and liquidity.

Finally, Eurex would have you believe that it will offer a fully electronic marketplace. That is more ruse than reality. The fact is that the Eurex trading software

is not capable of accommodating liquid and transparent options trading, complex futures trading or combination orders involving both futures and options. These types

of orders are prevalent in the U.S. Treasury markets. That is one of the reasons

we choose what we thought was a more technologically sophisticated alternative in

the trading system developed by Euronext-Liffe. Instead, Eurex will rely upon a

call-around telephone dealer market for options and other complex trading, one that

allows dealers to quote opaque prices to customers and to internalize order flow.

Then the Eurex system will be used just to record the trade. That is not the kind

of open and competitive market transparency the Board of Trade offers through

both its trading pits and electronic trading systems. We believe the more market

transparency the better price the customer receives. (As this committee will recall,

the energy market pricing difficulties of a few years ago confirm the public interest

in and value of market transparency.) Those are business considerations; this hearing has been called to discuss the regulatory implications of the Eurex U.S. application. We have three essential points about the application. • It should be considered fully and carefully by the Commodity Futures Trading

Commission. • It should be considered only when the application is complete; right now it is

not. • It should be granted only if the application meets the statute’s specific criteria

for registration of an exchange.

The application review process should be thorough. The Eurex application is too

important and raises too many novel issues for consideration under any form of

quick fix process. I am pleased the CFTC has agreed and decided to disallow fast

track treatment of the application. Allowing a foreign board of trade to own and operate a U.S. exchange as a subsidiary is only one of many challenging issues the

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Eurex business plan presents. Some of those issues go directly to preventing manipulation, protecting customers, providing financial integrity and promoting market

transparency. We know that the CFTC is as concerned about these public policy

goals as we are. We agree with the CFTC that the public interest compels the agency to be as informed and deliberative as they can be when addressing those types

of considerations in the context of designating a contract market.

The application must be complete and accurate. The CFTC should have the opportunity to consider the real business plan Eurex proposes to adopt. Eurex’s application, however, is very different from the business plan Eurex portrays in their press

statements, website and marketing materials. Just like a consumer should not be

subject to bait and switch sales tactics, the CFTC should not be asked to approve

one business model while the applicant is touting a different business plan it intends to implement once the CFTC process runs its course. The CFTC should consider the application only when it is complete and accurate.

The application should be approved if it meets the high statutory standards for

a new contract market. We have no quarrel with the CFTC’s rules or the statute’s

terms governing the process for CFTC consideration of contract market designation

applications. The decision whether to grant contract market status to any applicant

is among the most significant decisions the Commission is called upon to make, especially since Congress has recognized that ‘‘effective self-regulation’’ is what allows

our markets to serve the ‘‘national public interest.’’ That decision should be based

on the merits of all aspects of the application and the CFTC’s informed judgment

whether the application satisfies the statute.

Here is the background that leads me to these conclusions.

On September 16, 2003, Eurex U.S. filed its contract market designation application with the CFTC. Eurex U.S. is a subsidiary of Eurex Frankfurt and an affiliate

of Eurex Deutschland, the only futures and options exchange in Germany. The application consisted of 20 parts, 16 of which Eurex insisted were entitled to confidential treatment. While Eurex later reduced that confidentiality request to nine parts

of its application, the missing parts are still the meat of the application. The Board

of Trade and others have contested treating those materials as confidential under

the Freedom of Information Act. That matter is still pending before the Commission

and should be resolved before any further action is taken on this application.

The Commission requested public comment on those portions of the Eurex application for which Eurex has not sought confidential treatment. Comments were due

on October 16. The Board of Trade submitted its comment letter to the Commission

on that date and asks that a copy of that letter be included in the record of this

hearing.

On October 14, the CFTC informed Eurex that its application did not qualify for

fast track consideration. Instead, the application would be considered under the

statutory process, which contemplates action within 180 days on any application

that is materially complete. We believe that the 180 day time frame should be

ample time to consider the Eurex application if it is materially complete.

In our view, however, the Eurex application is materially incomplete right now.

Here is why.

The Eurex application is significant for how little it reveals and how much it conceals.

It reveals that Eurex intends to use the same electronic trading system it developed with the Board of Trade and which the Board of Trade uses now for its evergrowing electronic futures trading platform, called the a/c/e system. It reveals that

Eurex will rely in some way on National Futures Association for market surveillance along with Eurex Frankfurt and Eurex Deutschland. It also reveals that

Eurex will use The Clearing Corporation (formerly known as the Board of Trade

Clearing Corporation), a clearing organization in which Eurex now owns a large

stake. It reveals that Eurex intends to trade futures and options on futures contracts.

What does the application conceal? The list is long. Very long. We don’t know if

the NFA can legally conduct market surveillance for Eurex, how NFA will conduct

market surveillance, what resources it will employ, what fees it would receive, what

experience and jurisdiction it has in policing foreign traders in what aspires to be

an international market and how it would propose to overcome any CFTC-cited

shortcomings in the delegated functions it already performs for other selected and

far smaller markets. We don’t know how NFA, or Eurex for that matter, intends

to police the over-the-counter call around market in options on futures Eurex apparently must offer as the only way it trades options.

We don’t know what role Eurex Frankfurt and Eurex Deutschland will play in

preventing manipulation on Eurex U.S., how they will avoid the acknowledged

squeezes they have experienced in their home markets in recent years, and by what

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statutory authority they can perform any delegated functions for a US designated

contract market since they are not registered under U.S. law. We don’t know what

SRO function Eurex U.S. will actually perform, what resources and capabilities it

has to do so or how it can discharge its statutory obligation to be sure its delegates

will perform their statutory and contract functions as required. We don’t even know

the terms and conditions of the futures and options contracts that Eurex U.S. intends to trade and whether those terms and conditions will make trading more or

less susceptible to manipulation.

We don’t know what clearing arrangements or clearing system Eurex will actually

use. We don’t know how much of the trading in the US will be cleared in Germany,

how the much ballyhooed Eurex-TCC global clearing link would work, how the

CFTC will oversee that activity, how Eurex in Germany can legally clear trades on

a U.S. contract market without becoming a CFTC-registrant, or how fairness and

avoidance of conflicts of interest can be achieved for US customers and firms once

the link is implemented if the German clearing entity dictates clearing practices.

We don’t know much about this clearing link other than that Eurex and TCC promised the world that the link would be operational on February 1, 2004 or ‘‘shortly

thereafter.’’ And that promise was specifically made to those shareholders who voted

to approve the recent Eurex-TCC reorganization proposal. We don’t know what risk

offsets will be offered for Eurex U.S. and Eurex Deutschland contracts, who will decide on those offsets now that Eurex has become TCC’s largest shareholder, or

whether risk offsets will be uniform or applied in a disparate manner to attract

business.

We don’t know how the trading link that Eurex U.S. and Eurex Deutschland propose to establish will operate other than Eurex proposes to make trading on the two

exchanges fungible. We don’t know how Eurex U.S. and Eurex Deutschland can

hope to offer joint trading ‘‘beginning February 1, 2004,’’ as they claim, when the

application contains none of the details of this trading link.

We don’t know how Eurex will protect against non-competitive trading when it

offers to pay for volume by creating significant, multi-million dollar pay-outs to traders through what is in effect a contest to become one of the top 10 traders on its

markets. We don’t know how Eurex would protect customers when it also offers a

multi-million dollar contest prize for the top 10 brokers on its markets, creating a

significant financial incentive to brokers to put orders through on Eurex even if the

customer could find a better price, transparency, or liquidity somewhere else. We

don’t know how else Eurex is leveraging its power as the only German derivatives

exchange to buy market volume and in its own words ‘‘steal liquidity’’ from U.S. and

other exchanges.

We don’t know to what extent Eurex’s trading will prevent market transparency,

trading that is required by law to be executed openly and competitively. We don’t

know how much private, off-book trading Eurex will tolerate and report belatedly

on its system, falsely claiming it was executed on its market. (That’s what they do

for more than 90 percent of their options trading in Europe according to figures

gleaned from the Eurex website because the Eurex trading software does not accommodate liquid options trading markets or complex futures trading strategies.) We

don’t know what spillover effect these over-the-counter, order internalization practices could have on the pricing in current markets offered by the Board of Trade

and other markets. We don’t even know if Eurex has any meaningful precautions

in place to ensure market transparency or only is focusing on pumping up its potential volume and market share.

While we don’t know the terms and conditions of any of the contracts Eurex will

trade, we do know Eurex says it intends to trade U.S. Treasury Security futures,

among other things. We don’t know how or when Eurex intends to submit those contracts for CFTC review and, as required by law, review by the Department of the

Treasury and Federal Reserve Board. We don’t know what kind of self-regulatory

and governmental coordination trading in these contracts would require. We don’t

know whether market fragmentation of current Treasury Security futures markets

would lead to widening of the bid-ask spreads and increasing the cost to the Treasury of managing the national debt. This is a real cost. Prior to an active Treasury

futures market at the CBOT, the bid-ask spread on Treasury bonds was around

$300. Today, it is $31.25, providing substantial savings to U.S. taxpayers.

We don’t know how Eurex intends to deal with a potential market emergency

caused by trading in U.S. markets by foreign firms or governments, including its

own. We don’t know how Eurex intends to police (or the CFTC intends to police)

the potential misuse of confidential trading and market surveillance data by officials

at the parent company in Germany should they obtain information that employees

at its subsidiary could legitimately decide to share. We don’t know how the CFTC

would exercise legal jurisdiction over the parent company at any time, let alone in

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a market crisis. We don’t know how Eurex would propose to have the CFTC coordinate with EU officials to ensure that there is no conflict of interest that could adversely affect US firms or customers.

We don’t know these things because the application materials available to the

public do not address these questions. Some of them may be in the application, but

shielded from public scrutiny by the requested (and contested) confidential treatment request. And some of them Eurex has said one thing to the CFTC and made

conflicting statements on its website and in its press statements.

On this record, we agree with the Commission’s conclusion that Eurex is not entitled to fast track treatment under CFTC rules. Once complete, the application appropriately should be considered under the statutory 180 day time frame.

But the CFTC should suspend that process too for now since the Eurex application is ‘‘materially incomplete.’’ Until Eurex provides the answers to these questions

and others raised in comment letters filed with the Commission, the 180-day statutory time period should be stopped and restarted only when a complete application

is on file with the CFTC. When the application is complete, we would also urge the

CFTC to request further public comment on the completed application. Our comments filed on October 16 can only be viewed as an interim comment until the application is completed and finalized. We don’t think we should be asked to write a

book review on a book by only being allowed to read 11 of its 20 chapters.

The CFTC is a fair agency, ably led by Jim Newsome and his fellow Commissioners. We know the CFTC is dedicated to serving the public interest and the national interest. All we ask is that the CFTC make sure that they get a complete

picture of the Eurex application, including fully informed public comment, and then

apply the statute and regulations. The Eurex application ultimately may be approved (fully or conditionally) or denied. That is an issue for another day.

What we are most concerned about today is the process and making sure that

substantial and substantive regulatory issues are considered fully with due deliberation based on a complete record. I am sure you share that objective and the CFTC

does as well. I would be happy to answer any questions you might have.

STATEMENT OF MICAH S. GREEN

Good afternoon Chairman Goodlatte and members of the committee. Thank you

for the opportunity to testify today on the important question of Eurex’s application

to become a U.S. futures exchange. My name is Micah Green. I am president of The

Bond Market Association (TBMA), which represents securities firms and banks that

underwrite, trade and sell debt securities. The membership includes all primary

dealers in U.S. Government securities as recognized by the Federal Reserve Bank

of New York and all major dealers of municipal and corporate bonds, Federal agency

securities, mortgage- and asset-backed securities and money market and funding instruments. We have offices in Washington, New York and London.

The Association does not take a position with respect to the merits of Eurex’s application to open a U.S.-based futures exchange. It is our view the Eurex application

should be given full and fair consideration by the Commodity Futures Trading Commission (CFTC) and evaluated solely on Eurex’s ability to satisfy established legal

and regulatory requirements. We do not believe an exchange’s country of origin

should be a factor in determining compliance with statutes and regulations. Indeed,

one of the principal goals of the Commodity Futures Modernization Act of 2000 was

to promote competition among exchanges and to recognize the role that technology

has played in the evolution of the markets.

The Association’s members are firm believers in free and fair financial markets.

Competition helps ensure issuers of fixed-income securities are able to borrow at the

lowest interest rates possible. The same holds true for competition among exchanges

that facilitate trading in financial products. Fair competition leads to greater efficiencies that are realized by market participants in the form of lower costs and risk.

Financial futures are an integral part of the financial markets that play a sometimes unnoticed, but critically important, role in the global economy. Any development that brings users of financial futures greater choice, and therefore better pricing and efficiency, will have a positive effect on the overall economy. More efficient

financial markets mean lower borrowing rates for individuals, corporations and government. Investors benefit with better pricing and liquidity.

THE ROLE OF FINANCIAL FUTURES IN THE BOND MARKETS

Bonds are essentially loans. When investors purchase bonds, they buy the right

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turity. The ‘‘issuer’’ of a bond—the borrower—is obligated to make the interest payments on specified dates. When the bond matures, the issuer must repay the face

value or principal amount of the security.

Investors can choose among bonds issued by a variety of governmental bodies and

corporations. U.S. Government securities are issued by the Treasury Department to

fund the operation of the Government and Federal agencies issue bonds to support

low-cost mortgage loans and other investments. State and local governments issue

municipal bonds to fund schools, roads, drinking water systems, airports and a variety of other public infrastructure. Corporations issue corporate bonds to finance capital investments in new plants, equipment and technology.

There are a number of different participants in the bond market, from underwriters and dealers to issuers and investors—all of whom use and benefit from a

strong and active financial futures market.

ISSUERS

Issuers include any entity with a need for financing and the capacity to attract

investors. For Federal, state and local governments, who are unable to raise equity

capital by issuing stock, bonds are one of the only sources of long-term capital available to finance investment. For corporations, bonds can prove a lower cost source

of capital than bank borrowing, and an attractive solution to the financing of longterm projects.

Issuers sometimes use financial futures to lock in a borrowing rate if present market conditions are favorable but the need to actually issue interest rate-sensitive securities will not occur until a point in the near future.

INVESTORS

Because the investor knows the return on a bond held to maturity, they may consider it a safer investment than a stock. The return on stocks is based on dividends

and capital appreciation. Investors cannot be certain the company will pay a dividend or how the market will value the stock over time. Investors cannot be certain

how the market will value a bond over time either, but they can remain confident

the bond will continue to produce coupon payments and ultimately a principal payment.

Bond portfolios, however, are sensitive to short-term changes in interest rates. An

investor may wish to limit this risk by using financial futures to create a position

that offsets some or all of their bond exposure. Alternatively, investors can use futures contracts to leverage the return—and risk—of their portfolios, since futures

make it possible to control a large volume of securities with a relatively small initial

cash investment.

BROKERS AND DEALERS

Bond dealers are securities firms or departments of commercial banks engaged in

the underwriting, trading and sale of debt securities. Investment bankers work with

the issuer to develop the structure and price of a bond issue. Structure includes elements such as the bond’s maturity and the coupon it will pay. Pricing a bond issue

entails gauging investor interest in the deal and adjusting the yield, so it is attractive for both the issuer and the investor.

Besides using the financial futures markets to hedge interest rate risk in their

securities inventories or other investment positions, brokers and dealers often use

their expertise to speculate on future interest rates or currency movements using

financial futures. This type of trading adds liquidity to the futures markets and increases the likelihood all market participants can find competitively priced futures

contracts.

MARKET MAKING AND THE NEED FOR HEDGING WITH FINANCIAL FUTURES

Bonds generally do not trade on a centralized, organized exchange or trading system like stocks. Rather, the bond market is a decentralized, over-the-counter (OTC)

market. When an investor wants to sell a bond in the secondary market, he or she

usually sells the bond to a dealer. The dealer then attempts to resell the bond to

another investor. This function is known as ‘‘market-making.’’ The time between

when a dealer buys a bond and when the dealer sells the bond, the bond is said

to be in the dealer’s ‘‘inventory.’’ During the time that the bond is in the dealer’s

inventory, the dealer faces a risk the bond’s price will fall before it can be sold to

another investor and that the dealer will incur a loss on the transaction. An active

and liquid market depends on the willingness of bond dealers to put capital at risk

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by buying and selling bonds aggressively. (A liquid market is one in which a given

asset can easily be bought or sold.)

Bond dealers also use a technique known as hedging to protect the value of their

bond inventories from market swings. Hedging is a way to mitigate risk associated

with trading. It involves taking a trading position that offsets another position so

that when one position falls in value, the other rises to countervail the loss. Take

the example of a dealer who purchases $1 million in 10-year Treasury notes in order

to fill the demand of a customer to sell the security. If market interest rates should

rise after the dealer makes the initial purchase, the face value of the bonds in inventory will fall and the dealer will realize a loss. To protect against such a turn

of events, the dealer can hedge the position by buying or selling futures contracts

in order to create an off-setting position. If the dealer wanted to hedge their position, they would purchase Government bond futures contracts to sell the same

amount of 10-year notes. As the dealer sells off the inventory, they can also sell off,

or unwind, the futures contracts that serve as a hedge.

What is most important to the bond dealer in this position is the ability to easily

purchase and sell the futures contracts at fair prices and low costs. This is also important for the bond issuers, investors and the financial system as a whole. The

deeper and more liquid the futures market, the easier and more economically dealers can hedge their position. This, in turn, encourages dealers to commit more capital to making a market in bonds. Increased dealer activity aids liquidity.

Hedging is important to dealers and others who actively trade bonds and other

fixed-income securities. Every day, nearly $800 billion of Treasury, agency,

mortgage- and asset-backed, corporate and municipal bonds change hands. In virtually every transaction, one or more bond dealers put their capital at risk in acting

as a counter-party and market-maker.

A liquid market appeals to investors who are generally more willing to purchase

a bond if they know they can sell it again at a fair market prices should they need

to. In an illiquid market, an investor may find there are so few parties willing to

purchase a given bond that the best market prices do not reflect the bond’s fair

value. The easier and cheaper it is for dealers to hedge their trading positions using

futures, the more liquid is the cash market for the underlying bond or other financial product. The more liquid a market is, the less risky it is for investors to hold

securities in that market. The less risk investors face, the lower return they demand

when initially buying securities from issuers. Bond issuers benefit from a liquid

market as it generally means investors will demand lower interest rates on the

issuer’s bonds. Fostering competition among futures exchanges will, in the end,

make it less costly for the Federal Government, states and localities, corporations

and individual families to borrow.

Our fair and open markets for financial futures ultimately benefit participants at

every level of the financial markets. More efficient financial markets mean lower

borrowing rates for individuals, corporations and government. Investors benefit with

better pricing and liquidity.

The Association believes one of the keys to our fair and open financial futures

markets is competition among the exchanges that facilitate trading in financial futures contracts. Congress has recognized this, most recently in 2000 with the Commodity Futures Modernization Act, as well as the role technology can play in promoting competition.

The CFTC has long recognized that promoting efficient markets is good public policy. We are confident the CFTC will consider Eurex’s application as it would any

other submission and make its decision based on the merits of the application. We

urge the Committee to encourage the CFTC to act expeditiously and fairly in evaluating Eurex’s application. Thank you for the opportunity to present our views.

STATEMENT OF DANIEL ROTH

My name is Daniel Roth, and I am president of National Futures Association.

NFA appreciates this opportunity to appear here today to present our views on some

of the issues arising in connection with Eurex U.S.’s pending application for designation as a U.S. contract market (DCM). At the outset, let me preface my remarks

by stating that I am not here to take a position as to whether the CFTC should

approve or disapprove Eurex U.S.’s application as a DCM or, for that matter, what

the Commission’s timetable for reviewing that application should be. However, I

wish to describe for you how NFA operates as a registered futures association (RFA)

and what regulatory services NFA’s Executive Committee has authorized the organization to provide Eurex U.S. if it is approved as a DCM.

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First, for those of you that may not be familiar with NFA, we are an industrywide

self-regulatory organization occupying a unique position in the futures industry.

Like the exchanges, we are a self-regulatory body, but, unlike the exchanges, NFA

does not operate a marketplace. Self-regulation is not part of what we do—it is all

that we do. Like the trade associations, we are a membership organization, but, unlike those associations, we are not a lobbying organization. We are first, foremost

and only a regulatory body devoted to customer protection.

Our 4,000 Members include futures commission merchants (FCMs), introducing

brokers (IBs), commodity pool operators (CPOs) and commodity trading advisors

(CTAs). We also regulate the activities of approximately 50,000 registered account

executives who work for those Members. NFA’s twenty-five person Board of Directors (Board) has representatives from all our Member firm categories as well as six

futures exchanges and five public directors. Our mission is to work as a partner

with the CFTC to provide the industry with regulation that is both as effective and

as efficient as possible. We think this partnership has been an extraordinary success. In the twenty-one years since NFA began operations, trading volume on U.S.

futures exchanges has increased by over 400 percent. During that same time, customer complaints have actually dropped by over 70 percent.

We all know, though, that a successful past does not ensure a successful future.

The need for regulation that is both effective and efficient has never been greater.

Effective regulation is the best way to assure public confidence, and we have all

seen what happens to markets that lose the public’s confidence. The best way to preserve that confidence is to deserve it—to ensure that the highest levels of integrity

are demanded of all market participants and intermediaries.

Efficient regulation is not just a question of how you write the rules—it also involves making the best use of regulatory resources. For the last 21 years, NFA has

steadily expanded its regulatory role through either delegation of responsibilities

from the CFTC or actively seeking additional regulatory responsibilities. Regardless

of how our role has expanded, we have always made a commitment to retaining any

expertise necessary to perform any additional responsibilities in a high-quality manner. At this time, let me describe each area of our expanded roles.

DELEGATIONS BY THE CFTC

Over the years, the CFTC has entrusted NFA with certain of its frontline regulatory responsibilities to avoid duplication of effort and to direct its own resources

where they are needed most. That trend has continued and accelerated since the

passage of the Commodity Futures Modernization Act of 2000 (CFMA).

For example, last January, the Commission delegated to NFA the authority to review the annual financial reports that CPOs are required to provide to the CFTC

and to their customers. This delegation eliminated the burden of filing those reports

with both the CFTC and NFA. At the same time, NFA collaborated with the CFTC

to implement technology that allows CFTC staff to electronically access and query

information NFA maintains relating to pools in our databases. During the last six

months, NFA’s compliance staff has analyzed over 2,600 pool financial statements

filed by CPOs with NFA.

Additionally, in mid-March, the CFTC authorized NFA to review the prospectustype disclosure document that CPOs provide to customers for publicly-offered commodity pools. In 1997, the CFTC delegated this responsibility to NFA for disclosure

documents for privately offered commodity pools, and managed account programs offered by CTAs. NFA’s team of specialists review about 200 disclosure documents

each month, with an average turnaround time of a few days.

These two delegations are just the latest example of a long list of additional responsibilities that the CFTC has given to NFA over the years. The Commission has

delegated to NFA responsibility for processing registration applications for all categories of registrant; for revoking and denying registrations where appropriate; and

for processing applications for exemptions from registration for foreign firms. To enhance and bring greater efficiency to our registration responsibilities, NFA internally developed an Internet based registration system—NFA’s Online Registration

System. During the Summer of 2002, this system went live and has been met with

virtually unanimous approval by both Members and the CFTC. This system allows

an individual to receive registration instantaneously and allows a firm to easily

monitor its registration activities.

In addition to these formal delegations, NFA constantly works informally with the

CFTC. For example, NFA and the CFTC both take their customer protection mandates very seriously and have always had an excellent relationship working together

on enforcement matters. I should note that last year NFA alone issued over 27 disciplinary complaints against 100 respondents, and issued 35 disciplinary decisions

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that ordered 24 expulsions and 23 suspensions from membership, and assessed over

$650,000 in fines. Additionally, during the last year, NFA has assigned three compliance employees to the CFTC to help the Commission conduct investigations relating to energy and off-exchange foreign currency transactions.

DELEGATIONS BY CONTRACT MARKETS

Section 113 of the CFMA allows, in part, contract markets to comply with their

self-regulatory responsibilities by delegating any relevant function to NFA, an RFA.

If a DCM elects to make such a delegation, the CFMA provides that the DCM shall

remain responsible that the function is carried out. Section 113 essentially codified

a position previously taken by CFTC staff in a 1975 staff advisory.

As early as the Spring of 1999, NFA’s Board discussed and approved the first of

several strategic planning reports. One key initiative of the 1999 report focused on

NFA adding value to the industry by offering to perform self-regulatory functions

on behalf of existing and new electronic futures exchanges. In February 2001, the

Board again discussed and reviewed NFA’s strategic plan and unanimously approved an amendment to Article III of NFA’s Articles of Incorporation to make clear

that the new regulatory services offered by NFA were consistent with NFA’s fundamental purposes. Specifically, NFA’s Articles were amended to state that one of

NFA’s fundamental purposes is to provide such regulatory services to such markets

as the Board may from time-to-time approve. This Articles amendment was subsequently adopted by membership vote and approved by the CFTC.

The strategic plan adopted by the Board allowed staff to offer regulatory services

to both traditional DCMs and to those markets that are not required to perform

self-regulatory responsibilities but voluntarily chose to do so. During the last four

years, staff has worked to implement the Board’s strategic initiatives and has continually kept NFA’s Board advised of its progress.

To date, NFA’s Executive Committee has unanimously authorized staff to execute

Regulatory Services Agreements with four electronic exchanges—BrokerTec, Merchants Exchange, Island Futures Exchange, and OnExchange. Each time this committee authorized staff to enter into one of these agreements, staff informed the entire Board at its next scheduled meeting. At the present time, staff performs services for two markets—Merchants Exchange and BrokerTec, which both currently operate at low volume levels. NFA did not perform regulatory services for these exchanges until the CFTC approved their respective DCM applications. The committee

should also be aware that NFA has previously offered to perform these services for

two other DCMs—OneChicago and NQLX—but these exchanges selected others to

provide these services. For example, OneChicago, owned by the CBOE, CME and

CBOT, contracted with the CME and NQLX, owned by Euronext.liffe, through the

legal entity LIFFE (Holdings) plc, has an agreement with NASDR.

At this time, it is very important for me to note that NFA’s senior management

and Board both recognized that NFA would need to obtain special expertise to perform trade practice and market surveillance functions delegated to NFA by a DCM.

Therefore, our first step in implementing NFA’s strategic plan was to hire Yvonne

Downs in early 2000. Prior to joining NFA, Ms. Downs worked at the CBOT for almost 20 years. In 1995, the CBOT promoted her to Senior Vice-President and Administrator of the Office of Investigations and Audits. In that position, her responsibilities included the supervision of five regulatory divisions: audits, financial surveillance, investigations, market surveillance and regulatory reporting. Under Ms.

Down’s direction, NFA developed its own market surveillance and trade practice

program (TPMS). The principal tool NFA uses for trade practice and market surveillance is the internally developed Trade Analysis and Profiling System (TAPS).

NFA’s market surveillance activities are focused on detecting potential manipulations and price distortions and ensuring the orderly liquidation of expiring contracts. In performing this responsibility, staff uses online quotation systems, computer-generated reports and other tools to conduct daily monitoring of prices, volume, open interest, clearing member and large trader positions, and market news

for all contracts listed on an exchange. Through TAPS, staff has access to a contract’s historical price record and provides exception report alerts whenever upward

or downward price moves exceed preset parameters. Staff can also review the previous day’s trading volume and open interest for each contract. TAPS also enables

staff to view trade and volume information by clearing member or by firm, and to

rank positions in each contract by size. TAPS sends an alert to staff if any trader

has a percentage of either volume or open interest beyond preset parameters.

Obviously, an exchange’s large trader reporting system is an integral function of

TAPS. The system has preset alerts that inform staff whenever a trader has met

the threshold for large trader status. NFA then obtains a large trader report from

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the trader, and enters the information into TAPS’ large traders list, which aggregates all positions held by related parties. Once this information is compiled, staff

monitors large trader positions for concentrations of ownership and potential collusive or concerted activity by market participants. If it appears that any one trader

or account controller has a concentration in a given commodity, staff will contact

the trader or controller to determine the reason for the concentration. TAPS also

enables NFA staff to view complete information regarding each large trader’s trading history at any time.

As contracts approach their expiration dates, staff uses the information in TAPS

about the trading patterns of firms and traders to pay particular attention to large

trader open interest and volume. TAPS also produces exception reports which alert

staff whenever basis relationships do not narrow as expected with the approach of

a contract’s expiration.

TAPS also creates exception reports designed to identify various types of potential

trading abuses and other anomalous trading activity. TPMS staff reviews all of the

exception reports on a daily basis. The types of exceptions include trading ahead of

customers, wash trading, and marking the close. In addition to conducting an exception report review, staff also uses TAPS to conduct customized searches or reviews

of an exchange’s audit trail data. Staff thereby has the flexibility to tailor queries

based on, for example, the time of a transaction, order type, quantity or price.

TAPS also maintains trader profiles, which include average time logged on, average number of trading days per month, frequency of trading, average trade size,

profit and loss history, frequent counterparties, and percentage of total volume in

a given market. The system’s exception reports alert staff to deviations from a trader’s profile, such as those involving unusual profit patterns, significant changes in

volume, and unusual concentrations of trading activity between the same

counterparties.

Obviously, NFA staff works closely to coordinate its market surveillance and trade

practice activities with exchange compliance staff. As previously noted, the exchange

is ultimately responsible for fulfilling its self-regulatory functions. The exchange

staff also has market supervision responsibilities and an obligation to closely monitor the daily activities on its market. If NFA staff determines that trading activity

requires further scrutiny, staff will initiate an investigation and, if in our view the

facts warrant formal disciplinary charges, staff prepares a report that is forwarded

to the exchange. If the exchange’s compliance department concurs with staff’s analysis, then the action will proceed to the exchange’s disciplinary committee for resolution.

For each of the four exchanges that has executed an RSA with NFA, the CFTC

was aware in reviewing each DCM application for approval that NFA had been selected to perform regulatory services for the exchange. Prior to approving each exchange’s application, the CFTC performed an extensive review of NFA’s TPMS program, including TAPS and our staffing levels. Additionally, just earlier this month,

the CFTC completed a rule enforcement review of BrokerTec’s market surveillance,

audit trail, trade practice surveillance and disciplinary programs. In this review, the

Commission found that NFA had adequate programs in place to monitor

BrokerTec’s trading.

Each RSA previously approved by our Executive Committee sought to ensure that

NFA was not exposed to either financial or reputational risk by performing these

regulatory services. We have followed that same course in negotiating an RSA with

Eurex U.S. This RSA’s financial terms are designed to recover NFA’s costs, providing for payment of a fixed monthly fee and a fee that is scalable to volume, allowing

us to add staff to match an increase in activity. Additionally, we realize that NFA’s

reputation could be harmed if Eurex U.S. either imposes barriers that make it difficult for NFA to perform regulatory services and uncover wrongdoing or fails to follow our recommendations in addressing regulatory problems. If either event occurs,

NFA has the right to cancel the RSA with Eurex U.S. and inform the CFTC of our

reasons for doing so.

NFA’s Executive Committee met last month and voted 7–1, with one abstention,

to authorize staff to execute an RSA with Eurex U.S. NFA will inform our Board

of the Executive Committee’s action at the next Board meeting and like any other

Executive Committee action, the Board may elect to review NFA’s agreement with

Eurex U.S.

Although both Congress and the Commission have allowed NFA to expand its

role, our mission today is the same as it was twenty-one years ago. Everything we

do is for a regulatory purpose designed to protect customers, protect market integrity and protect the public’s confidence in these vital markets.

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STATEMENT OF JOHN M. DAMGARD

Mr. Chairman, members of the committee. On behalf of the Futures Industry Association (FIA), I want to thank you for the opportunity to appear before you today

to discuss the application of the U.S. Futures Exchange LLC for designation as a

contract market. FIA is a principal spokesman for the commodity futures and options industry. FIA’s regular membership is comprised of approximately 40 of the

largest futures commission merchants (FCMs) in the United States. Among its associate members are representatives from virtually all other segments of the futures

industry, both national and international. Reflecting the scope and diversity of its

membership, FIA estimates that its members effect more than 90 percent of all customer transactions executed on United States contract markets.

When Congress amended the Commodity Exchange Act through the Commodity

Futures Modernization Act of 2000, an underlying purpose, as expressed in the Act,

was ‘‘to promote responsible innovation and fair competition among boards of trade,

other markets and market participants.’’ The application of the U.S. Futures Exchange, an indirect subsidiary of Eurex, marks an important step in realizing the

vigorous competition among markets that Congress anticipated in the CFMA.

Attached to my statement is a copy of the comment letter that FIA has filed with

the Commission in support of the U.S. Futures Exchange application. I respectfully

request that it be made a part of the record here. I will not repeat the points made

in that letter. Instead, my comments today will focus on two issues with respect to

which the committee indicated particular interest: the process for designation as a

contact market and the U.S. Futures Exchange self-regulatory program.

THE DESIGNATION PROCESS

The CFMA signaled a radical new approach to the regulation of the derivatives

markets. Prior to enactment of the CFMA, the Commission’s prescriptive regulations had unnecessarily delayed the approval of new contracts and the introduction

of innovative trading procedures. To replace these regulations, Congress set out a

limited number of broad criteria that an applicant for designation would have to

meet in order to be approved as an exchange and certain core principles with which

the exchange would have to continue to comply in order to maintain its designation.

Consistent with its goal of promoting responsible innovation, Congress further provided that the exchange ‘‘shall have reasonable discretion in establishing the manner in which it complies with the core principles.’’

Significantly, Congress removed the requirement that an exchange identify the

contracts that it intended to list for trading in connection with its application for

designation as a contract market. As with existing exchanges, therefore, an exchange applicant is permitted to wait until it has been designated as a contract

market and may then list its contracts by certifying to the Commission that the contract complies with the provisions of the Commodity Exchange Act. This provision

of the law assures that new exchanges and existing exchanges are on a level playing

field with respect to the listing of new contracts.

Congress also specifically removed the statutory requirement that effectively required the Commission to publish applications for designation for comment in the

Federal Register. This change in the law promised to expedite the review and approval of new exchanges. More important, it confirmed that the Commission, as the

expert agency responsible for the regulation of derivatives markets, is best suited

to determine whether an applicant meets the statutory criteria and is able to comply

with the core principles that Congress established.

As a result of these amendments to the Act, the Commission is under no obligation to request public comment from interested parties prior to determining whether

an applicant meets the criteria specified in the Act. Congress has left the decision

to seek comment—and the manner in which it seeks comment—to the Commission

to determine in its sole discretion. In this regard, we note that, since the enactment

of the CFMA, the Commission has designated four new contract markets:

OneChicago; Nasdaq-Liffe Markets (NQLX); Island Futures Exchange; and CBOE

Futures Exchange. In each instance, the Commission approved the applications

without requesting comment from the public. Although the industry’s experience

under the CFMA is obviously limited, we have seen nothing to date that would

cause us to recommend a change in the Commission’s authority.

In providing a 30-day period for public comment on the U.S. Futures Exchange

application, the Commission presumably determined that its review could benefit

from receiving the views of the industry, although it did not request comment on

any specific aspect of the exchange application. As discussed above, that is the Commission’s decision to make in its sole discretion. Nonetheless, we caution that the

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Commission must take care not to adopt different procedures for certain applicants

that may appear to be designed solely to prevent new entrants from establishing

their business in a timely manner. Such actions would clearly be contrary to congressional intent in enacting the CFMA.

In this regard, it is important to remember that Eurex is not an unknown entity

to the Commission. To the contrary, over a period of more than seven years, in connection with various requests for regulatory relief from U.S. requirements, the Commission has had several opportunities to review Eurex, its operations and the rules

and regulations to which it is subject. Each time, it has found no reason not to grant

Eurex the same relief that other foreign exchanges were granted.

For example, in 1999, the Commission staff adopted a no-action position, authorizing Eurex, among other foreign markets, to place terminals in its members’ offices

in the U.S. for trading in certain Eurex contracts. Before adopting this position, the

staff conducted a thorough review of Eurex including its operating and trading

rules, its trading system, its settlement and clearing system and its compliance programs. In 2000 and again in 2002, the Commission staff adopted no-action positions

authorizing the offer and sale of certain stock index futures contracts listed for trading on Eurex. More recently, the Commission, pursuant to its rule 30.10, granted

an exemption from registration for firms authorized by Eurex that wish to solicit

orders from U.S. customers trading on that exchange. In granting this latter exemption, the Commission specifically found that Eurex is subject to a regulatory scheme

that is comparable to that to which U.S. exchanges are subject.

We also want to emphasize that the lack of a public comment period has not denied FIA the opportunity to express its views with respect to the organization, operation and rules of exchange applicants. Rather than dealing indirectly through the

Commission, however, we now work directly with the relevant exchange or clearing

organization, a change in procedure that has proved to be both more efficient and

more productive. For example:

• In connection with the applications of OneChicago LLC and NQLX, the Security

Futures Committee, composed of representatives of FIA member firms and member

firms of the Securities Industry Association, met often with the staffs of these exchanges and provided both oral and written comments. Our goal was twofold. First,

we wanted to assure to the extent possible that the exchange rules were designed

to facilitate the efficient execution of transactions in the security futures products

that would be listed on each exchange. Second, we wanted to be certain that any

operational issues our member firms identified were resolved prior to the initiation

of trading.

• Immediately following the announcement of the clearing link between the Chicago Mercantile Exchange (CME) and the Chicago Board of Trade (CBT), FIA advised the leadership of both exchanges that we were ready to work with them to

resolve the numerous questions that were certain to arise as the business and operations details of their arrangement were implemented. To this end, we formed an

ad hoc committee under the leadership of Craig Smithson, Executive Director of

UBS Warburg.

• As with OneChicago and NQLX, representatives of FIA member firms have held

a number of meetings with the staff of the U.S. Futures Exchange to discuss its

rules and operational structure. In particular, we have recommended several

changes to their trading procedures, which the exchange has agreed to consider.

• Finally, we recently formed an ad hoc committee to work with the U.S. Futures

Exchange and The Clearing Corporation to resolve operational issues as they develop their clearing link.

SELF-REGULATORY PROGRAM

As the committee is aware, in connection with its application for designation, the

U.S. Futures Exchange has contracted with the National Futures Association to perform on behalf of the exchange essentially all of the market surveillance and compliance programs that exchanges are required to implement. Although we have every

confidence in NFA’s ability to perform these functions, the Commission ultimately

will determine whether NFA’s programs are properly designed to permit U.S. Futures Exchange to meet its statutory obligations through NFA. As a matter of policy, FIA supports the exchange’s decision to delegate these responsibilities to NFA.

As a matter of law, the CFMA amendments to the Act specifically provide that a

‘‘a contract market . . . may comply with any applicable core principle through delegation of any relevant function to a registered futures association or other registered

entity.’’ NFA, of course, is a registered futures association.

We note that the contract between the U.S. Futures Exchange and NFA is not

unique. NFA currently performs self-regulatory functions for BrokerTec Futures ExVerDate 11-SEP-98 10:17 Dec 23, 2003 Jkt 090742 PO 00000 Frm 00104 Fmt 6633 Sfmt 6633 F:\DOCS\10821 HAGRI PsN: HAGRI
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change and the Merchants Exchange. NFA also has a contract with Island Futures

Exchange to perform services when that exchange begins trading. Similarly,

OneChicago has contracted with CME to perform certain of its self-regulatory functions, while NQLX has a contract with the NASD.

The decision of a new exchange to contract with an established self-regulatory organization should be welcomed, not challenged. In a 2000 White Paper entitled ‘‘Reinventing Self Regulation’’, which was recently updated and reissued, the Securities

Industry Association identified certain guiding principles for securities self-regulatory organizations that are no less applicable to the futures industry. Specifically,

SIA stated that any self-regulatory structure should:

• Foster Investor Protection;

• Preserve Fair Competition;

• Eliminate Inefficiencies;

• Encourage Expert Regulation;

• Promote Reasonable and Fair Costs of Regulation;

• Foster Due Process; and

• Encourage Industry Participation and Self-Regulation.

We submit that the public and the industry can have greater assurance that these

seven purposes will be achieved—and an exchange will be able to perform its statutory responsibilities more effectively—if it retains the services of an experienced

self-regulatory organization rather than attempting to build its own. As an economic

matter, requiring an exchange to maintain its own staff to perform these functions

would likely create an insurmountable barrier to entry that would inhibit any entity

from applying for designation.

We do not know if the U.S. Futures Exchange will succeed, assuming its application is approved. Capturing liquidity from existing exchanges is exceptionally difficult in the best of circumstances. Market participants have demonstrated a wellearned confidence in U.S. exchanges and convincing these participants to trade elsewhere will not be easy. Nor is there any certainty that contracts currently listed

for trading on Eurex will be successful if listed for trading here.

However, we do know that competition invariably improves markets. In fact, in

recent months we have seen reductions in fees and welcome changes in trading

rules that we believe have been adopted in anticipation of the U.S. Futures Exchange application. These changes benefit both customers and intermediaries by reducing costs and facilitating the execution of certain transactions.

FIA wants to emphasize that our support for competition is not limited to foreign

exchanges that may wish to list products currently traded on U.S. markets. We support competition across all markets and all products. In this regard, FIA has consistently pointed favorably to the experience in the equity options markets, where

the ability to list fungible products on multiple markets that then are cleared

through a common clearing organization has led to a dramatic increase in competition among all exchanges. Our members compete on a product-by-product basis

daily. We see no reason why exchanges should not be subject to similar competitive

pressures.

We also see no obstacles that would prevent the Chicago Mercantile Exchange

and the Chicago Board of Trade, in particular, from taking the fight to the U.S. Futures Exchange. CME and CBT, in the aggregate, account for approximately 85 percent of all U.S. futures exchange volume. In achieving this position, they have demonstrated that they are both fierce and able competitors.

As I noted when I began my remarks, an underlying purpose of the CFMA is ‘‘to

promote responsible innovation and fair competition.’’ Provided an applicant meets

the criteria specified in the Act and the Commission’s regulations, an exchange

should be designated as a contract market upon the same terms and conditions—

and pursuant to the same procedures—to which all other applicants are subject.

It is worth remembering that, when foreign exchanges first applied to the Commission for authority to place their terminals in the U.S., many U.S. exchanges, including those represented here today, argued that the foreign exchanges should be

required to come to the U.S., apply for designation as contract markets and compete

with U.S. exchanges on a level playing field. Eurex has agreed to meet this challenge, establishing a subsidiary here to compete with other U.S. exchanges on the

same terms and conditions—and subject to the same laws and regulations—to which

all U.S. exchanges are subject. FIA would be greatly troubled if the world’s largest

futures exchange, or other entrants that are willing and able to comply with U.S.

laws and regulations, were unfairly denied this opportunity.

Thank you again for the opportunity to appear with before you today. I would be

happy to answer any questions you may have about the process at the Commission

or any other areas of interest to you.

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ANSWERS TO SUBMITTED QUESTIONS

You have a long experience of analyzing exchange governing structures.

Are you concerned with regard to any aspect of the governance of Eurex

US? What expectation do you have for the ultimate composition of the

Eurex US Board? Should a greater share of Board sets be dedicated to nonshareholders or others with a stake in the business?

We believe the governance structure of the Eurex US compares favorably with the

governance structures currently in place at other U.S. futures exchanges. The

boards of directors at US futures exchanges remain dominated by representatives

of the floor community with little or not participation from any other industry segments. In contrast, representatives of Eurex US have represented that its board of

directors, which will be comprised of approximately 12 members, will represent all

segments of exchange participants. The exchange has also stated that it will comply

with all corporate governance requirements applicable under U.S. law to U.S. futures exchanges generally.

In this latter regard, the Commodity Futures Trading Commission is currently

conducting a review of the roles, responsibilities, and capabilities of self-regulatory

organizations in the context of the market changes that have taken and are taking

place. We understand that, among other matters, the Commission is reviewing the

governance structures of the exchanges. We would expect that, in connection with

this review, the Commission will examine the changes in governance that the New

York Stock Exchange recently implemented and, in particular, its decision to require

all board members (with the exception of the CEO) to be independent of both exchange members and exchange management. In the event the Commission makes

any recommendations with respect to the structure of exchange boards of directors,

we would encourage all exchanges, including Eurex US, to give them appropriate

consideration. The FIA expects to play an active role in any industry-wide initiative

and we appreciate the foresight of Chairman Newsome in initiating the undertaking.

Are U.S. exchanges able to do in German what Eurex proposed to do

here? Please comment with regard to reciprocity issues. If a US entity applied to open an exchange in Germany tomorrow, could it have a reasonable expectation of getting a decision from German regulators within 6

months?

We will defer to other hearing participants on the question of German law and

policy. However, we would caution that it appears the Commission has had informal

discussions with Eurex for several months before the formal application was filed.

This is the procedure, as we have observed, that all exchange applicants follow in

preparing a final application for submission. Therefore it is difficult to compare the

time it takes to seek designation and commence business as an exchange in each

jurisdiction.

STATEMENT OF MICHAEL MCERLEAN

Chairman Goodlatte, Ranking Member Stenholm, distinguished members of the

committee, thank you for inviting U.S. Futures Exchange here today. U.S. Futures

Exchange is a U.S. company, whose parent company, U.S. Exchange Holdings Inc.,

is a 100 percent subsidiary of Eurex Frankfurt AG, which in turn is owned by Deutsche Boerse and SWX Swiss Exchange. Deutsche Boerse is a publicly traded company listed on the Frankfurt Stock Exchange and is majority owned by UK and U.S.

institutional investors. The company is owned by a total of 36,000 shareholders; the

largest shareholder is a U.S. institutional investor. Only two shareholders hold a

stake larger than five percent; both of these are U.S. entities. SWX Swiss exchange

is owned by 55 financial institutions. We are also in negotiations with a broad range

of market users as potential shareholders of U.S. Futures Exchange.

We welcome this opportunity to submit testimony regarding our application with

the Commodity Futures Trading Commission (CFTC or the Commission) for designation as a new U.S. contract market. We applaud this committee’s continued interest in the integrity and competitiveness of the U.S. futures markets and are

pleased to have the opportunity to share with the committee our plans and to answer any questions that the committee may have regarding our application for contract market designation.

Congress decades ago recognized the global character of the futures markets and

the need for cross-border access to foreign markets, unencumbered by restrictive

regulatory constraints. This principle was codified in the Commodity Exchange Act

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as section 4b(c), which prohibited the CFTC from regulating access by U.S. persons

to foreign markets. This policy proved prescient and has been enormously successful. In this new environment, our U.S. exchange will provide U.S. participants with

the same access to foreign products that they already enjoy through remote access

to foreign exchanges, with the added benefit that they will be trading through an

exchange that wishes to subject itself fully to U.S. regulation, rather than through

a foreign exchange operating abroad.

REGULATORY BACKGROUND

U.S. Futures Exchange filed its application for contract market designation with

the CFTC on September 16th. As the committee is aware, the CFTC published our

application for public comment and subsequently extended the initial 15-day comment period to 30 days. We have made available for public review and comment significant elements of the materials that we filed in support of our application and

have been working cooperatively with the CFTC to provide such additional information as the Commission may request and to resolve issues identified by the Commission. U.S. Futures Exchange endorses the transparency of this process, as it is fully

consistent with Eurex’s own policy of transparency and responsiveness to market

participants. Accordingly, we consider the public comment period to be an extremely

positive and important part of the U.S regulatory framework.

We welcome any comments on our application and intend to respond expeditiously

to any and all legitimate issues that may be raised in the process.

U.S. FUTURES EXCHANGE BUSINESS PLAN

U.S. Futures Exchange will be based in Chicago. All operations of the exchange

will be conducted out of our Chicago headquarters, now under construction, in the

Sears Tower. U.S. Futures Exchange will obtain critical regulatory and clearing

services from the National Futures Association and The Clearing Corporation (formerly, the Board of Trade Clearing Corporation), also located in Chicago.

In short, U.S. Futures Exchange will operate as a U.S. company, located in the

U.S, staffed by U.S. employees, acquiring services from U.S. service providers, and

subject—in all respects—to the same U.S. regulatory framework that is applicable

to all U.S. futures exchanges.

Our business model has been designed to offer U.S. market participants, customers, and end-users a wide variety of benefits, including enhanced market efficiency, greater market transparency, equal market access and lower costs. To this

end, Eurex expects to utilize a modern structure and proven, best of breed, technologies and service providers. Specifically:

Proven market environment. U.S. Futures Exchange will operate a 20 hour/day

all-electronic trading platform utilizing proven, scaleable, state of the art technology

developed by Eurex, our European parent. This platform is currently utilized by the

Chicago Board of Trade under license from Eurex AG and executes more than 80

percent of the volume in the U.S. Treasury Bond futures market through a joint

venture between Eurex and CBOT which ends this year. U.S. Futures Exchange will

provide market participants access to the same trading environment that the Chicago Board of Trade has been using for the past 3 years and is currently utilizing,

under license from Eurex and subject to CFTC oversight, for its a/c/e system.

Open market model. Access to U.S. Futures Exchange will be available to all market participants who satisfy the exchange’s non-discriminatory eligibility requirements. Access will not be artificially restricted to a limited number of market participants who benefit financially and otherwise from restricted membership. All

market participants who wish to do so may have the benefit of direct access to the

exchange and the exchange’s favorable rate structure.

Level playing field; market transparency. All market participants will have equal

access to the market and the same rights in executing their business. There will

be no privileges and no physical environment that segregates the direct and immediate access of members from the indirect access of non-members as is currently the

case on major U.S. futures exchanges. All market participants will have equivalent

access to a competitive and non-discriminatory execution environment. This same

environment provides a level of transparancy that is equal for all market participants and fosters no informational or other trading advantages to a restricted

constitutency of insiders.

Reduced trading costs. The cost of trading on U.S. Futures Exchange will, on average, be significantly lower than the current cost of trading on the major U.S. futures exchanges. Investors, e.g. U.S. pension funds, will pay 30 cents or less per

U.S. Treasury bond futures contract on U.S. Futures Exchange, significantly lower

than the CBOT charges. This will result in significant savings for a wide range of

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market participants. However, as a result of the greater competition that U.S. Futures Exchange will bring to the market, we fully expect that all U.S. market participants—and not just U.S. Futures Exchange’s customers—will ultimately benefit

from lower trading costs as a direct result of U.S. Futures Exchange’s market entrance.

Additional products. U.S. Futures Exchange will list for trading a broad range of

derivatives products including derivatives contracts on U.S. and European interest

rates and indices. Availability of certain products will be subject to an arrangement,

to be finalized, between our U.S. clearing partner, The Clearing Corporation, in Chicago and Eurex Clearing AG in Germany. These European interest rate benchmarks

currently are not traded on any other U.S. contract market. Some of these instruments will, for the first time, offer U.S. market participants and customers the opportunity to manage their European interest rate and equity exposures directly on

a U.S. futures exchange.

Financial integrity. Clearance and settlement services for all trades on U.S. Futures Exchange will be provided by The Clearing Corporation, a registered U.S. derivatives clearing organization, formerly known as the Board of Trade Clearing Corporation, with whom we have entered into a Clearing Services Agreement. The

Clearing Corporation is a venerable financial institution that has been in operation

in Chicago for 78 years, and is widely regarded as the preeminent U.S. provider of

futures clearing services to the financial and agricultural trading communities. The

inability of U.S. Futures Exchange to enter the U.S. market on an expeditious basis

could, as the CBOT has itself noted, lead to the demise and dissolution of The Clearing Corporation. We hope instead that, as our clearing partner, The Clearing Corporation will continue to fulfill its historic role as a leading Chicago financial institution and employer long into the future.

Market integrity. Our customers will enjoy the highest level of market integrity.

Trading on U.S. Futures Exchange will, consistent with customer protection, be

completely anonymous from the time of order entry all the way through contract

settlement and delivery. U.S. Futures Exchange will have a full, immediate, and unalterable audit trail of all activity and transactions that occur on the trading platform. In addition, U.S. Futures Exchange has contracted with the National Futures

Association to conduct market and trade practice surveillance, and to perform other

regulatory duties for the exchange. The National Futures Association is a highly respected CFTC-licensed self-regulatory organization and is widely recognized as the

leading provider of outsourced self regulatory services to U.S. futures exchanges.

Fair governance. U.S. Futures Exchange intends to establish and implement a

representative governance structure that will reflect a diverse cross section of market users. The Board of U.S. Futures Exchange is expected to comprise 12 representatives, including six representatives of the various user groups. U.S. Futures

Exchange also intends to base its corporate governance infrastructure on the principle of responsiveness to the views and concerns of all categories of market participants, without discriminatory bias in the decisionmaking process.

In this connection, U.S. Futures Exchange will comply with all corporate governance requirements applicable under U.S. law to U.S. futures exchanges generally.

As or perhaps even more significant, Eurex’s governance structure will eliminate the

structural factors that lead to significant conflicts of interest and reduce the potential for abusive conduct of the type that afflicts many exchanges in the U.S., including major U.S. futures exchanges. We believe that independent governance, together

with an open market model, is a particularly powerful means of discovering and

meeting customer and market needs, while maximizing fair treatment of market

users and shareholders.

We also intend to broaden our shareholder base through an equity partnership

with U.S. market participants and have reserved a significant stake of the company’s equity for this purpose. We foresee substantial industry participation in the exchange’s governance.

DEMAND FOR AND IMPACT OF COMPETITION

We believe, based on our experience, that U.S. market users are receptive to this

market model. Indeed, we believe that there is significant demand for this model

and that many U.S. market participants would welcome the opportunity to trade

U.S. and European contracts on a designated contract market having the characteristics described above. Moreover, it is widely recognized that the establishment of

U.S. Futures Exchange has the potential, not only to lower trading costs for U.S.

market participants, but also—through competition—to be an engine for overall

growth in the U.S. futures market, to the benefit of all market providers and all

market users.

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This view is supported by a comparison of the trading volumes in the U.S. market

for bond futures and options with the corresponding European market for bond futures and options. The underlying market demand for management of interest rate

risk is about the same in the United States and Europe. Back in 1998, the exchange-traded volume in bond futures and options in the U.S. dollar exchange traded derivatives market was 1.5 times larger than the trading volumes in Euro denominated bond futures and options. Today the exchange traded European derivatives market is significantly larger than the U.S. derivatives market. This demonstrates the dramatic impact that a more democratic market model, effective competition and innovation can have on growth in the market. We hope that by offering

direct access to U.S. dollar denominated products to customers worldwide, U.S. Futures Exchange will both support and expand the growth of the U.S. bond futures

market.

There was a period, not very long ago, when the futures industry effectively began

and ended within the borders of the United States. That was because this was the

only country in the world where the three basic requirements for futures trading

existed in abundance:

• a critical mass of companies and individuals willing and able to use the markets

efficiently;

• a tradition of operating transparent financial markets open to all; and

• a regulatory structure that protected market users without encumbering the operation of markets.

Beginning approximately 20 years ago, with the assistance of both U.S. exchanges

and U.S. market participants, the idea of futures markets spread beyond the borders of this country and new markets began to develop around the world. In many

ways the European exchanges modeled themselves after U.S. markets. Foreign exchanges then began to apply new methods to the trading of these products—the use

of electronic trading systems for example—making it easier for a broader array of

participants to participate directly in the markets. The goal was to make markets

more efficient, more cost effective, more transparent—more responsive to the needs

of the rapidly growing base of market users. And in doing this some European exchanges have succeeded beyond expectations—attracting traders not just from their

European home markets, but from throughout the United States and the rest of the

world as well. U.S. exchanges have themselves recently begun adopting that technology. The a/c/e joint venture between the CBOT and Eurex is a case in point.

U.S. Futures Exchange, as a U.S. designated contract market, is poised to offer

U.S. investors the benefits available in non-U.S. markets, and to do so subject to

the financial safety and customer protections provided by the U.S. regulatory framework. Today, U.S. customers can obtain those benefits only by trading on the global

markets. Only on the global markets do U.S. customers have the opportunity to

trade in a variety of Euro-denominated instruments. U.S. Futures Exchange plans

to offer U.S. market participants access to such products with the support of The

Clearing Corporation, and stands ready to offer U.S. products, on a fully U.S.-regulated domestic contract market, all cleared by a U.S. derivatives clearing organization. In the final analysis, our ability to enter the U.S. market will bring greater

competition to the U.S. futures industry to the benefit of U.S. market participants,

end-users, investors, and the U.S. futures industry itself. This was precisely the goal

Congress had in mind when it enacted the Commodity Futures Modernization Act

of 2000 (CFMA), under the leadership of this committee.

Indeed, this committee is rightly credited for its leadership role in connection with

the legislation ultimately enacted as the CFMA, an act that established a modern

and streamlined framework for the regulation of the U.S. futures markets. The

CFMA is widely heralded as a paradigm for the balancing of private sector autonomy and governmental oversight interests. The premise for that legislation was the

notion that the salutary effect of private sector market discipline would obviate the

need for overly prescriptive governmental intervention, and its attendant inefficiencies. However, that premise depends entirely on the existence of competition. Without competition, or the conditions for competition, there is no market discipline.

Without market discipline there is no market or other mechanism by which exchanges are compelled to be responsive to the needs of market participants. The absence of competition fundamentally undermines Congress’s key objectives in enactment of the CFMA and will perpetuate the imposition of real costs and inefficiencies

on the investors in these markets.

It is equally important to recognize that the benefits of competition are not necessarily limited to consumers. Competition leads to innovation and efficiency. These,

in turn, can be an engine for growth that expands opportunities for all competitors

in the marketplace. This is true across all economic sectors—domestic and foreign.

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We and other observers fully expect that this will be the case in the U.S. futures

markets.

We are pursuing this application precisely because there is an enormous and urgent demand from U.S. market participants, including among constituents of this

committee, for competition, greater efficiencies, greater transparency and lower

costs in the U.S. futures markets. U.S. Futures Exchange is attempting to respond

to this demand by competing in these markets on a level playing field, and subject

to precisely the same regulatory framework as its competitors.

We are confident that this committee will review these issues analytically and

with objectivity. This committee must not be misled by those whose sole motivation

is to prevent the emergence of competition in the U.S. financial futures markets,

to the detriment not only of direct participants in these markets, but ultimately to

all consumers throughout the U.S. economy whose cost of living is affected by the

cost of interest rate products.

We are anxious to respond to any and all questions that this committee or the

CFTC may have and we are confident in our ability to respond to the complete satisfaction of this committee and the CFTC.

We thank the committee for the opportunity to do so.

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ANSWERS TO SUBMITTED QUESTIONS

GOVERNANCE ISSUES

Exchange governance is a hot topic these days. Please describe for the

committee your understanding of the governance structure described in

the Eurex US application. In terms of its Board and its executives, how will

the Eurex US structure compare to other governance structures at U.S. futures exchanges?

In the event of a market emergency, what steps do you expect Eurex US

to follow?

As submitted to the Commission, Eurex US bylaws (in the section titled

‘‘Number of Directors’’) state that the exchange will have only one director

and that the director shall be Mike McErlean. Please describe what you expect the makeup of the Board ultimately to be?

Of its Board members (once more are added), how many will be independent of other ties to the business of the exchange.

What compliance committees will be established by Eurex US and how

will they function? How does this structure in the Eurex US plan compare

to the norm in existing U.S. futures exchange?

The Board of Directors of U.S. Futures Exchange, L.L.C. (USFE) will be constituted in accordance with the Limited Liability Company Agreement and Bylaws

(Bylaws). Pursuant to section 5.2(a) of the Bylaws, there is currently an initial

member of the Board of Directors, Mr. Michael McErlean. Additional Directors will

be appointed prior to the launch of trading.

The Board of Directors of USFE will be selected by its shareholders at a USFE

shareholders meeting. Currently, USFE has one shareholder, U.S. Exchange Holdings, Inc., a Delaware corporation wholly owned by Eurex Frankfurt AG. Before the

USFE shareholders meeting, at which the new USFE Board members will be elected, the Board of Directors of U.S. Exchange Holdings will meet and decide whom

it will elect to the USFE Board of Directors. All of the Directors so elected will meet

the statutory requirements regarding the fitness of directors of exchanges, and a

majority will be U.S. citizens or located in the United States.

When expanded, the Board will be composed of 12 Directors. Of these, at least

six will be drawn from Exchange members and are intended to represent different

general groups of members, such as brokers, arbitrage firms, institutional investors

and independent clearers. The remaining six Directors may include officials, employees or members of the boards of USFE’s parent companies.

USFE’s Compliance Department shall be authorized to conduct and to oversee

surveillance, investigation and rule enforcement activities. The Chief of the Compliance Department shall be in charge of the Compliance Department. The personnel

of the Compliance Department may not operate under the direction or control of a

Member.

The Disciplinary Committee of the exchange shall be authorized to determine

whether violations of the Bylaws or the exchange’s Rules have been committed, to

accept offers of settlement, and to set and impose appropriate penalties. The Disciplinary Committee shall consist of such officers or employees of the exchange appointed to the Disciplinary Committee by the Chief Executive Officer. No employee

of the Compliance Department of the exchange may serve on the Disciplinary Committee.

RECIPROCITY

Are U.S. exchanges able to do in Germany what Eurex proposes to do

here? Please comment with regard to reciprocity issues. If a U.S. entity applied to open an exchange in Germany tomorrow, could it have a reasonable expectation of getting a decision from German regulators within 6

months?

U.S. exchanges are able to do in Germany what Eurex proposes to do here, and

have already done so. There are no restrictions on foreign ownership of exchanges

licensed in Germany. The licensing criteria applied by German regulators make no

distinction based on non-German ownership and are, in fact, quite similar to the

standards applied under U.S. law. German exchange regulators already have permitted Nasdaq to take control of the holding company of the Bremen stock exchange. Nasdaq acquired a 50% plus one ownership stake in the holding company,

which was renamed NASDAQ Deutschland, while the exchange traded securities in

competition with other German exchanges. Even if German exchange regulators

were inclined to delay or deny an application, which we are not aware of, under the

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European Union’s Investment Services Directive a U.S. exchange could operate in

Germany, using a license received from any of the 14 other member states of the

European Union, without the need to obtain any German regulatory approval.

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STATEMENT OF THE AMERICAN BANKERS ASSOCIATION, ET AL.

The Honorable Bob Goodlatte and the Honorable Charles Stenholm

Re: Eurex U.S. Application to become a Designated Contract Market

The undersigned trade associations represent all major participants in the U.S.

capital markets. Our members include banks, securities firms, futures firms, Government securities dealers (including all primary dealers in U.S. Treasury securities

authorized to transact directly with the Federal Reserve Bank of New York) and a

broad range of professional financial intermediaries. Our members include the principal users of financial futures products, including the futures contracts on U.S.

Treasury securities that are currently listed by the Chicago Board of Trade and proposed to be listed by the United States Futures Exchange (Eurex U.S.).

Financial futures contracts represent important risk management tools for our

members, as well as for the thousands of institutions, companies, investors and individual customers our members serve. These products serve a critical role in enabling

our members and others to provide interest rate sensitive products, such as mortgages and commercial loans, to consumers and businesses throughout all sectors of

the United States economy.

We write today to alert the committee to our organizations’ serious concerns regarding possible delay in the Commodity Futures Trading Commissions processing

of the Eurex U.S. application for designation as a contract market. We believe that

the CFTC has the expertise and resources to fully review the Eurex U.S. application

in a timely manner. We urge this committee to encourage the CFTC to proceed expeditiously in acting on the application of Eurex U.S., as it has consistently done

in the processing of other similar applications.

We are familiar with the Eurex U.S. application and have observed the commentary and media coverage attending the application. We wish to emphasize that

we see no significant policy or regulatory issues raised by the application that would

require or justify any legislative changes. Furthermore, we are aware of no issues

that would preclude the prompt processing of the application.

As this committee is aware, the promotion of competition was a principal animating goal of the Commodity Futures Modernization Act of 2000 (CFMA). The CFMA

modernized the regulatory framework for the U.S. futures markets, striking a more

effective balance between Government oversight and private sector discipline. The

CFMA was grounded in the understanding that market discipline can play an important role in protecting investors. Although not a substitute for regulation, the

CFMA recognized that private sector discipline promotes efficiency and mitigates

the need for overly prescriptive regulation. However, market discipline requires vigorous competition of the type that we believe Eurex U.S. is well positioned to potentially provide.

Designation of Eurex U.S. thus offers the potential for greater competition in the

market for U.S. futures products. The entry of Eurex U.S. has the potential to enhance choice, and our members hope and expect that it will lead to increased efficiency, lower costs, a broader range of services and growth in the U.S. futures markets. Any undue delay in consideration of the Eurex U.S. application would put

these important benefits at risk.

As the Committee on Agriculture played a crucial role in drafting the CFMA, our

organizations welcome the committee’s interest in the Eurex U.S. application as well

as in other issues that arise out of enactment of the CFMA. This committee has an

important role to play in ensuring that the promise of the CFMA is realized.

Accordingly, the undersigned organizations urge that this committee strongly encourage the CFTC to implement the CFMA’s objectives by processing the Eurex U.S.

application as expeditiously as possible.

Sincerely,

American Bankers Association, The Bond Market Association, The Financial Services Roundtable, Futures Industry Association, International Swaps and Derivatives

Association, Securities Industry Association

cc: Hon. J. Dennis Hastert, Hon. Nancy Pelosi, Hon. Bill Frist, Hon. Thomas

Daschle, Hon. John W. Snow, Hon. Alan Greenspan, Members of the House Agriculture Committee, Hon. James E. Newsome, Hon. Barbara Holum, Hon. Sharon

Brown-Hruska, Hon. Walt Lukken

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STATEMENT OF JOHN G. GAINE

Thank you Chairman Goodlatte and members of the committee. Managed Funds

Association (MFA) appreciates the opportunity to submit its testimony regarding the

application by U.S. Futures Exchange, L.L.C. (USFE) for designation as a contract

market by the Commodity Futures Trading Commission (CFTC). MFA firmly supports the development of competitive markets and an expeditious, but thorough, review of USFE’s application by the CFTC. The USFE’s application has been strongly

endorsed by the futures commission merchant community. Certain existing domestic

futures exchanges, however, oppose USFE’s request. It is important that the voice

of the end-users of futures markets, contributes to this dialogue, and MFA hopes

that this written testimony accomplishes that goal. Overall, we support the Chairman of the CFTC who stated in his testimony that the CFTC has been ‘‘committed

to providing a level regulatory playing field for all existing and potential market

participants, while being vigilant in its mission to foster markets free of fraud and

manipulation.’’

By way of background, MFA, located in Washington, DC, is the only U.S.-based

global membership organization dedicated to serving the needs of professionals

worldwide that specialize in the alternative investment industry—privately and

publicly managed futures funds, hedge funds, and funds of funds. MFA has approximately 700 members who represent a significant portion of the over $650 billion invested in these types of alternative investment vehicles around the world and who

are, collectively, extremely active participants in the U.S. futures markets. MFA and

its members favor the addition to the marketplace of any qualified contract market

on the basis of fundamental principles of fairness and competition. More specifically,

MFA supports the expeditious review of the USFE’s application without compromising investor protection principles or market stability and surveillance mechanisms.

MFA believes that the designation of additional futures exchanges will foster an

environment of healthy business rivalry, resulting in technological innovation. The

array of products domestically available to U.S. investors is expected to increase significantly with USFE’s introduction of certain European equity index futures and

euro-denominated interest-rate products currently accessible only on overseas exchanges. Additionally, the liquidity of contracts already accessible in the U.S. markets should be enhanced with USFE’s expected inclusion of U.S. interest-rate contracts in its product array.

Furthermore, we believe that the advent of USFE’s involvement in the U.S. futures markets should promote the ‘‘responsible innovation and fair competition’’

among exchanges and market participants that the Commodity Futures Modernization Act of 2000 (the Act) envisioned as critical objectives. MFA believes this involvement would serve the public interest in multiple dimensions by materially improving the liquidity, efficiency, and product diversification of the U.S. futures markets. In addition, MFA views price competition among futures exchanges as a direct

boost to the bottom line of the futures investing public, and allows exactly the sort

of vigorous interplay among market participants and exchanges that the Act was

designed to encourage. We are confident that the CFTC will evaluate U.S. Futures

Exchange’s application with these concepts in mind.

MFA believes these benefits to the investing public come at no cost from the

standpoint of investor protection or the reliability of the operation of our nation’s

markets so long as the CFTC review concludes that adequate investor protection

measures are in place. If approved by the CFTC, USFE will operate in Chicago and

be completely subject to the jurisdiction of the CFTC and the full panoply of relevant U.S. law. USFE trades are to be settled at The Clearing Corporation, a highly

credible domestic clearing organization with historical clearing relationships with

the Chicago Board of Trade (CBOT), while USFE’s execution system is expected to

be an updated version of the trading platform developed by USFE’s parent, Eurex,

and deployed from 2000 to the present by CBOT. Moreover, Eurex itself is a globally

respected exchange—in fact, the largest futures exchange (by volume of contracts)

in the world—already well known to the CFTC in the context of the CFTC’s granting of various forms of regulatory relief. Many U.S. market participants are already

active traders on Eurex.

As the principal representatives of end-users of futures exchanges, MFA believes

there is an overwhelming public policy argument to be made for the CFTC’s expeditious review of the USFE’s application for designation as a contract market. We believe that this will promote market efficiency and depth and avoid disadvantaging

investors if the application process is delayed. MFA respectfully urges the committee to encourage the CFTC to act quickly in its review of the USFE application. We

are confident that the CFTC will fulfill its pledge to ‘‘review the application, mindful

of all the comments received, with an eye toward ensuring that all necessary standVerDate 11-SEP-98 10:17 Dec 23, 2003 Jkt 090742 PO 00000 Frm 00142 Fmt 6633 Sfmt 6633 F:\DOCS\10821 HAGRI PsN: HAGRI
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ards are met, and that only sound, ethical business practices are allowed to exist

in the U.S. marketplace.’’

MFA wishes to thank the committee for the opportunity to submit this testimony.

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