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HEARING TO REVIEW REAUTHORIZATION OF 

THE COMMODITY EXCHANGE ACT

HEARING

BEFORE THE

SUBCOMMITTEE ON 

GENERAL FARM COMMODITIES AND RISK 

MANAGEMENT

OF THE

COMMITTEE ON AGRICULTURE 

HOUSE OF REPRESENTATIVES

ONE HUNDRED TENTH CONGRESS

FIRST SESSION

WEDNESDAY, SEPTEMBER 26, 2007

Serial No. 110–27

(

Printed for the use of the Committee on Agriculture 

agriculture.house.gov 

COMMITTEE ON AGRICULTURE 

COLLIN C. PETERSON, Minnesota, Chairman 

TIM HOLDEN, Pennsylvania, 

Vice Chairman 

MIKE MCINTYRE, North Carolina 

BOB ETHERIDGE, North Carolina 

LEONARD L. BOSWELL, Iowa 

JOE BACA, California 

DENNIS A. CARDOZA, California 

DAVID SCOTT, Georgia 

JIM MARSHALL, Georgia 

STEPHANIE HERSETH SANDLIN, South 

Dakota 

HENRY CUELLAR, Texas 

JIM COSTA, California 

JOHN T. SALAZAR, Colorado 

BRAD ELLSWORTH, Indiana 

NANCY E. BOYDA, Kansas 

ZACHARY T. SPACE, Ohio 

TIMOTHY J. WALZ, Minnesota 

KIRSTEN E. GILLIBRAND, New York 

STEVE KAGEN, Wisconsin 

EARL POMEROY, North Dakota 

LINCOLN DAVIS, Tennessee 

JOHN BARROW, Georgia 

NICK LAMPSON, Texas 

JOE DONNELLY, Indiana 

TIM MAHONEY, Florida 

BOB GOODLATTE, Virginia, Ranking 

Minority Member 

TERRY EVERETT, Alabama 

FRANK D. LUCAS, Oklahoma 

JERRY MORAN, Kansas 

ROBIN HAYES, North Carolina 

TIMOTHY V. JOHNSON, Illinois 

SAM GRAVES, Missouri 

JO BONNER, Alabama 

MIKE ROGERS, Alabama 

STEVE KING, Iowa 

MARILYN N. MUSGRAVE, Colorado 

RANDY NEUGEBAUER, Texas 

CHARLES W. BOUSTANY, JR., Louisiana 

JOHN R. ‘‘RANDY’’ KUHL, JR., New York 

VIRGINIA FOXX, North Carolina 

K. MICHAEL CONAWAY, Texas 

JEFF FORTENBERRY, Nebraska 

JEAN SCHMIDT, Ohio 

ADRIAN SMITH, Nebraska 

KEVIN MCCARTHY, California 

TIM WALBERG, Michigan 

PROFESSIONAL STAFF

ROBERT L. LAREW, Chief of Staff 

ANDREW W. BAKER, Chief Counsel 

APRIL SLAYTON, Communications Director 

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

SUBCOMMITTEE ON GENERAL FARM COMMODITIES AND RISK MANAGEMENT

BOB ETHERIDGE, North Carolina, Chairman 

DAVID SCOTT, Georgia 

JIM MARSHALL, Georgia 

JOHN T. SALAZAR, Colorado 

NANCY E. BOYDA, Kansas 

STEPHANIE HERSETH SANDLIN, South 

Dakota 

BRAD ELLSWORTH, Indiana 

ZACHARY T. SPACE, Ohio 

TIMOTHY J. WALZ, Minnesota 

EARL POMEROY, North Dakota 

JERRY MORAN, Kansas, Ranking Minority 

Member 

TIMOTHY V. JOHNSON, Illinois 

SAM GRAVES, Missouri 

CHARLES W. BOUSTANY, JR., Louisiana 

K. MICHAEL CONAWAY, Texas 

FRANK D. LUCAS, Oklahoma 

RANDY NEUGEBAUER, Texas 

KEVIN MCCARTHY, California 

CLARK OGILVIE, Subcommittee Staff Director

(II) 

(III)

C O N T E N T S 

Page 

Etheridge, Hon. Bob, a Representative in Congress from North Carolina, 

opening statement ................................................................................................ 1

Goodlatte, Hon. Bob, a Representative in Congress from Virginia, opening 

statment ................................................................................................................ 15

Prepared statement .......................................................................................... 4

Graves, Hon. Sam, a Representative in Congress from Missouri, prepared 

statement .............................................................................................................. 4

Moran, Hon. Jerry, a Representative in Congress from Kansas, opening statement ...................................................................................................................... 2

Prepared statement .......................................................................................... 3

Peterson, Hon. Collin C., a Representative in Congress from Minnesota, prepared statement ................................................................................................... 3

Salazar, Hon. John T., a Representative in Congress from Colorado, prepared 

statement .............................................................................................................. 5

WITNESSES

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

Group, Inc., Chicago, IL ....................................................................................... 5

Prepared statement .......................................................................................... 8

Newsome, Ph.D., James E., President, CEO, and Member, Board of Directors, 

New York Mercantile Exchange, Inc., New York, NY ...................................... 15

Prepared statement .......................................................................................... 17

Carlson, Layne G., Corporate Secretary and Treasurer, Minneapolis Grain 

Exchange, Minneapolis, MN ............................................................................... 24

Prepared statement .......................................................................................... 25

Sprecher, Jeffrey C., Founder, Chairman, and CEO, 

IntercontinentalExchange, Inc., Atlanta, GA .................................................... 27

Prepared statement .......................................................................................... 29

Walsh, Ph.D., Michael J., Executive Vice President, Chicago Climate Exchange, Chicago, IL .............................................................................................. 32

Prepared statement .......................................................................................... 34

Roth, Daniel J., President and CEO, National Futures Association, Chicago, 

IL ........................................................................................................................... 49

Prepared statement .......................................................................................... 50

Zerzan, Gregory P.J., Counsel and Head, Global Public Policy, International 

Swaps and Derivatives Association, Washington, D.C.; on behalf of Securities Industry and Financial Markets Association ............................................. 53

Prepared statement .......................................................................................... 55

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

D.C. ........................................................................................................................ 59

Prepared statement .......................................................................................... 61

Becks, Theresa D., Member, Managed Funds Association; President and CEO, 

Campbell and Company, Inc., Towson, MD ....................................................... 67

Prepared statement .......................................................................................... 69

Brodsky, William J., Chairman and CEO, Chicago Board Options Exchange, 

Chicago, IL; on behalf of U.S. Options Exchange Coalition ............................. 72

Prepared statement .......................................................................................... 75

SUBMITTED STATEMENTS

Lukken, Walter L., Acting Chairman, U.S. Commodity Futures Trading Commission, Washington, D.C., letter and response to questions .......................... 89

Newsome, Ph.D., James E., President, CEO, and Member, Board of Directors, 

New York Mercantile Exchange, Inc., New York, NY, response to questions 101

Page

IV

Niv, Drew, President and CEO, Forex Capital Markets LLC, New York, 

NY, prepared statement ...................................................................................... 85 

(1)

HEARING TO REVIEW REAUTHORIZATION OF 

THE COMMODITY EXCHANGE ACT 

WEDNESDAY, SEPTEMBER 26, 2007

HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON GENERAL FARM COMMODITIES AND

RISK MANAGEMENT, COMMITTEE ON AGRICULTURE, Washington, D.C. 

The Subcommittee met, pursuant to call, at 10 a.m., in Room 

1300 of the Longworth House Office Building, Hon. Bob Etheridge 

[Chairman of the Subcommittee] presiding. 

Members present: Representatives Etheridge, Marshall, Boyda, 

Peterson [ex officio], Moran, Conaway and Goodlatte [ex officio]. 

Staff present: Andy Baker, Adam Durand, Alejandra GonzalezArias, Scott Kuschmider, Clark Ogilvie, John Riley, Sharon 

Rusnak, Kristin Sosanie, Bryan Dierlam, Kevin Kramp, and Jamie 

Weyer. 

OPENING STATEMENT OF HON. BOB ETHERIDGE, A 

REPRESENTATIVE IN CONGRESS FROM NORTH CAROLINA 

Mr. ETHERIDGE. This hearing of the Subcommittee on General 

Farm Commodities and Risk Management to review the reauthorization of the Commodity Exchange Act will come to order. To 

begin with, I ask unanimous consent that Mr. Barrow may sit with 

the Committee, without objection. 

Most Americans by now know that Congress needs to pass a new 

farm bill this year. Fewer Americans probably know that we also 

need to reauthorize the Commodity Futures Trading Commission. 

The futures industry impacts our lives every single day. Derivatives trading provides customers with fora for price discovery and 

price hedging for a wide variety of commodities and financial instruments. As the oversight agency for derivatives, the CFTC keeps 

watch over a trillion dollar industry that affects almost everything, 

from the price of corn, wheat and soybeans that goes into our food 

products, to the interest you pay on mortgages. It is the CFTC’s 

mission to foster the economic utility of the futures markets by encouraging their competitiveness and effectiveness, ensuring their 

integrity and protecting market participation against manipulation, 

abusive trading practices and fraud. 

In 2000, Congress took a bold step in dramatically changing how 

the CFTC oversees derivatives markets by moving from a regulatory regime to a principles-based structure. We removed the 

shackles that restrained an industry and we have seen the good results of Congress’s work. Now, here we are, almost 7 years removed 

2

from that point and people are asking questions, whether the regulatory regime we created in 2000 is appropriate for every commodity, whether we should increase the Commodity Futures Trading Commission’s authority in some areas. Therefore, as this Subcommittee moves forward with reauthorization, it is an appropriate 

time for us to review what Congress accomplished with the Commodity Futures Modernization Act of 2000 and the CFTC’s oversight of these markets. 

Today we will hear from a variety of participants in the futures 

industry. I hope my colleagues will find this hearing informative. 

I know I am looking forward to hearing today’s testimony from our 

witnesses. One of the messages we will hear from most of the witnesses today concerns enforcement actions taken by the CFTC and 

the Federal Energy Regulatory Commission. There is a growing 

fear that recent FERC action may be encroaching upon the CFTC’s 

exclusive jurisdiction over the futures markets. The CFTC and 

FERC have a good working relationship and they have been working cooperatively since enactment of the Energy Policy Act of 2005. 

However, when Congress passed the Energy Policy Act, nowhere 

did it repeal or limit the Commodity Exchange Act’s explicit grant 

to the CFTC of exclusive jurisdiction over the futures market. 

I do not know why the FERC chose to take an enforcement action, which has called its own authority into question. I do not 

know that it was Congress’s intent that the CFTC should have exclusive jurisdiction over futures markets. For the CFTC to fail to 

assert its exclusive jurisdiction, when appropriate, would equal a 

failure to uphold the will of Congress. But we will have more opportunity to discuss this with our witnesses. I want to welcome 

each of you here today and thank you for testifying. 

With that, I now turn to the gentleman from Kansas, my good 

friend, Mr. Moran, for his opening statement. 

OPENING STATEMENT OF HON. JERRY MORAN, A 

REPRESENTATIVE IN CONGRESS FROM KANSAS 

Mr. MORAN. Mr. Chairman, thank you very much. We gather 

here today to determine information about the commodities futures 

markets of the United States in preparation for reauthorization of 

the Commodity Exchange Act. As I said earlier, the family has 

gathered once again. Perhaps this time we can have an end result 

with a bill that becomes law. We do have a diverse group of witnesses with us today from different sectors within the industry and 

I pledge that I will pay close attention to what these individuals 

have to say. 

Since the passage of the Commodity Futures Modernization Act 

of 2000, this industry has experienced record growth. Growth in 

the commodities future industry has provided new ways for businesses to manage risk and has substantially benefited the U.S. 

economy. With growth, however, comes new challenges. Recently, 

the natural gas derivatives market has become the center of public 

attention and in July, this Subcommittee held a hearing on natural 

gas markets. As I stated then, it is the duty of the Subcommittee 

to examine how markets, like exempt commercial markets, have 

evolved and decide whether regulatory changes should be made. In 

3

doing so, the Subcommittee should be adequately informed and 

only proceed in a deliberative manner. 

As I have said in the past, we should be cautious in making 

sweeping changes to a system that has brought new investment 

and growth to the U.S. economy. Any changes to the Commodity 

Futures Modernization Act by this Subcommittee must take into 

account any possible adverse effects new regulatory burdens on the 

market would have. We should be wary of actions that might stifle 

market growth, drive markets overseas or discourage entrepreneurs from developing new and legitimate markets. 

I thank the witnesses for their testimony today and I thank 

Chairman Etheridge for holding this hearing. I look forward to 

working with you, Mr. Etheridge, to see that we reauthorize the 

Commodity Exchange Act in a conscious, yet expeditious manner. 

Thank you, Mr. Chairman. 

[The prepared statement of Mr. Moran follows:]

PREPARED STATEMENT OF HON. JERRY MORAN, A REPRESENTATIVE IN CONGRESS

FROM KANSAS

Thank you, Mr. Chairman. We are here today to gather information on the commodity futures markets in the United States in preparation for the reauthorization 

of the Commodity Exchange Act. To that end we have before us a diverse group of 

witnesses from many different sectors of the industry. Each witness is an important 

player in the commodity futures industry and it is incumbent upon this Subcommittee to listen closely to what these individuals have to say. In the end, it is 

they who will have to contend with any new regulations that we create during reauthorization. 

Since passage of the Commodity Futures Modernization Act in 2000, this industry 

has experienced record growth. Growth in the commodity futures industry has provided new ways for businesses to manage risk and has substantially benefited the 

U.S. economy. With growth, however, come new challenges. Recently, the natural 

gas derivatives market has become the center of public attention and on July 12, 

2007, this Subcommittee held a hearing on the natural gas markets. 

As I stated then, it is the duty of this Subcommittee to examine how markets, 

like exempt commercial markets (ECMs), have evolved and decide whether a regulatory change should be made. In doing so the Subcommittee should be adequately 

informed and only proceed in a deliberate manner. As I have said in the past, we 

should be cautious in making sweeping changes to a system that has brought new 

investment and growth to the U.S. economy. Any changes to the Commodity Futures Exchange Act by this Subcommittee must take into account any possible adverse effects new regulatory burden will have on the market. We should be wary 

of actions that might stifle market growth, drive markets overseas, or discourage 

entrepreneurs from developing new and legitimate markets. 

I want to thank all the witnesses for your testimony today. I also want to thank 

Chairman Etheridge for holding this hearing. I hope we can work to together to reauthorize the Commodity Exchange Act in a conscious, yet expeditious manner.

Mr. ETHERIDGE. I thank the gentleman and appreciate his comments. The chair would request that other Members submit their 

opening statements for the record so that the witnesses may begin 

their testimony and we ensure that there is ample time for questions. 

[The prepared statements of Messrs. Peterson, Goodlatte, 

Graves, and Salazar follow:]

PREPARED STATEMENT OF HON. COLLIN C. PETERSON, A REPRESENTATIVE IN

CONGRESS FROM MINNESOTA

Thank you, Chairman Etheridge, for calling this hearing today, and for all the important work you have done on this issue in preparation of reauthorizing the Commodity Exchange Act. 

4

We have spent the better part of the year preparing and passing a farm bill here 

in the House, but today we renew examination of another area of interest in this 

Committee that affects every producer and consumer in America: the derivatives 

markets. Everyone who pays a grocery bill or gas bill, or who applies for a loan or 

has a mortgage, is affected by these markets. 

Congress last reauthorized the Commodity Exchange Act in 2000, making what 

at that time were the most significant changes in the law since the Commodity Futures Trading Commission was created in 1974. When the CFTC was established, 

the majority of futures trading took place in the agricultural sector. Even today, 

most people probably associate futures trading with people in pits in Chicago or 

New York, loudly haggling over contracts for orange juice or porkbellies. The reality 

is that derivatives have become increasingly varied over time and today encompass 

a wide selection of highly complex financial products and indicators like bonds, currencies, interest rates and stock indexes. 

Congress allowed for various levels of regulation of futures contracts in the 2000 

reauthorization, in part to handle the demand for these products. Both the CFTCregulated exchanges and the over-the-counter exchanges have experienced strong 

annual growth in trading volumes since then, along with the proliferation of new 

trading products and participation of more investors of all classes than ever before. 

Every farmer, producer, processor and consumer benefits from open, transparent 

derivatives markets. Consequently, every one of us pays the price if these markets 

are manipulated or distorted. Because futures prices are used as points of reference 

for many physical transactions, manipulation in the futures markets can have a significant effect on what consumers pay and what farmers and producers receive. 

That makes the activities of the derivatives markets very much in the public interest. 

It is my hope that today’s hearing will give us a good understanding of what 

needs to be done in this reauthorization given the changes in derivatives markets 

since the last reauthorization was passed. 

I welcome today’s witnesses and I yield back my time. 

PREPARED STATEMENT OF HON. BOB GOODLATTE, A REPRESENTATIVE IN CONGRESS

FROM VIRGINIA

Thank you Mr. Chairman, and thank you for holding this hearing. I believe it is 

essential to reauthorize the Commodity Futures Trading Commission, which was 

last reauthorized by the Commodity Futures Modernization Act (CFMA) and expired 

in 2005. 

The CFMA has been lauded by many as the most significant amendments to the 

Commodity Exchange Act since the CFTC was created in 1974. The CFMA provided 

for the creation of unregulated futures exchanges, where all trading involved sophisticated or professional investors. Both the exchanges and the OTC markets have experienced strong growth in trading volumes since 2000. More recently both have experienced increased volatility. I am anxious to hear what our witnesses think causes 

this volatility and if it, in anyway, degrades the price discovery function of the futures markets. 

I’ve watched the CFTC’s response to the market volatility and I have been impressed with its efforts and achievements. That does not mean that all should be 

left as is. I think the CFTC takes very seriously its primary responsibility as the 

exclusive regulator of the futures markets. I know the Commission would like and 

believe it needs more resources. I am interested to learn that the Commission now 

also believes it needs more enforcement tools. What government agency or regulator 

doesn’t? 

I am more interested to learn what the regulated community believes. Has the 

CFTC done an effective job of regulating the futures markets? Does it need more 

enforcement tools or oversight capability? Does it need more regulatory authority? 

Is it under-funded? 

These are all questions that need to be answered before we can craft the next reauthorization effort. The witnesses that are assembled today will be able to provide 

this Committee with that insight. I doubt we need to craft changes as significant 

as those in 2000, but I know we need to adequately address the concerns of our witnesses today. 

Thank you Mr. Chairman. 

5

PREPARED STATEMENT OF HON. SAM GRAVES, A REPRESENTATIVE IN CONGRESS FROM

MISSOURI

I want to thank the Chairman and Ranking Member for having this hearing 

today. I appreciate the opportunity to submit remarks to the record. 

As most of my colleagues on this panel know, the reauthorization of the Commodity Exchange Act is very important to me and my constituents. It is my full intention to work with all parties involved to reach a deal that is amicable to everyone 

and I am hopeful that we can reauthorizes this program with everyone’s support. 

We can all agree that the quicker we reauthorize the Commodity Exchange Act 

the sooner everyone can get back to business, and I think that is in the best interest 

of everyone here today. 

I look forward to listening to the panelists today and moving forward with this 

reauthorization. 

PREPARED STATEMENT OF HON. JOHN T. SALAZAR, A REPRESENTATIVE IN CONGRESS

FROM COLORADO

Good morning. I first want to thank Chairman Etheridge and Ranking Member 

Moran for holding this important hearing today. 

As relieved as I am for completing our portion of the 2007 Farm Bill, I know there 

is still work to be done. 

With that said, I want to thank all of the witnesses for coming in today to discuss 

such a vital issue for farmers today. 

I can only imagine how busy all of you have been with the record harvests taking 

place. 

Over the last few weeks Colorado has had a record wheat harvest and corn is soon 

to come. 

As you know, this Act has been around for over 70 years with just a few changes 

taking place since the original Act in 1936. 

I want to reiterate something I stated many times during the farm bill hearings. 

Our average age of U.S. farmers is 55 years old, and I blame it on one reason—

there is not enough profitability in agriculture. 

I think the 2007 Farm Bill has been written to benefit the producer and not the 

consumer like many farm bills in the past. 

As we move forward reviewing the Commodity Exchange Act, I want to make sure 

we do what we can do take care of our farmers. 

Thanks again to the leadership of the Committee for their hard work and I look 

forward to hearing the testimony.

Mr. ETHERIDGE. I would like to begin to welcome each of you 

panelists to the table this morning. Thank you for coming and 

being with us. 

Our first witness is Mr. Duffy, who is the Executive Chairman 

of the Chicago Mercantile Exchange Group in Chicago; second witness is Dr. Newsome, President and CEO of the New York Mercantile Exchange in New York; Mr. Carlson, who is the Corporate 

Secretary and Treasurer of Minneapolis Grain Exchange in Minneapolis, Minnesota; Mr. Sprecher, who is Chairman and CEO of 

the IntercontinentalExchange in Atlanta, Georgia; and Dr. Walsh, 

who is Executive Vice President, Chicago Climate Exchange in Chicago, Illinois. 

Mr. Duffy, please begin when you are ready. I would ask if you 

would, please, to the extent possible, to summarize your statements 

in 5 minutes and your total statement will be included in the 

record. Thank you. If you will please begin. 

STATEMENT OF TERRENCE A. DUFFY, EXECUTIVE CHAIRMAN, 

CHICAGO MERCANTILE EXCHANGE GROUP, INC., CHICAGO, IL 

Mr. DUFFY. Thank you, Mr. Chairman. I am Terry Duffy. I am 

the Executive Chairman of the Chicago Mercantile Exchange 

Group. I want to thank you, Chairman Etheridge, and Members of 

6

the Subcommittee for this opportunity to appear here today to 

present our views on some of the issues facing Congress as it continues the reauthorization process. CME Group was formed by the 

merger of Chicago Mercantile Exchange Holdings and Chicago 

Board of Trade Holdings. CME Group is the parent of CMS and the 

Board of Trade. CME Group also owns Swapstream Operating 

Services Limited, an OTC trading facility, and owns an interest in 

FXMarketspace Limited, an FX trading platform. We serve the 

global risk management needs of our customers and those who rely 

on price discovery formed by our competitive markets. 

We offer a comprehensive selection of benchmark products, including most major asset classes, including futures and options 

based on interest rates, equity indexes, foreign exchange, agricultural commodities, energy and alternative investment products, 

such as weather and real estate. I submitted my full testimony for 

the record and will summarize our major points here first. 

The CFTC’s implementation of the CFMA: The CFTC’s administration of the Commodity Futures Modernization Act of 2000 has 

been a tremendously positive force for the derivatives industry. We 

think that the success of the U.S. derivatives industry under the 

regulatory regime created by the CFMA provides a compelling example for the securities industry. The reduction of barriers to new 

and cross-border entry into the global futures and options industry 

has spurred growth and innovation. U.S. investors can directly 

trade foreign futures and options contracts from the United States. 

Also, European and Asian investors can directly trade products listed by CME Group and other U.S. futures and options exchanges 

from abroad. 

U.S. capital markets have not had the same advantage. The 

overly prescriptive regulation imposed on U.S. securities exchanges 

and issuers is blamed, in part, for the success of foreign securities 

exchanges and the gravitation of major IPOs to offshore markets. 

The problems with the securities regulation have been cited to revive a call for merging the CFTC and the SEC. The inadequacies 

of security markets regulation need to be resolved by reform of that 

regulatory regime. It cannot be resolved by subjecting derivative 

markets to a system that is not credible in a global economy. Minor 

jurisdictional disputes have no bearing on effective regulation of 

derivatives or securities. Moreover, the CFTC has done its best to 

find a solution that permits questioned products to trade under 

both regimes and permits the marketplace to choose. 

Second, CME’s recommendation for reauthorization: We enthusiastically applaud the success of the CFMA and urge the CFTC be 

reauthorized. The U.S. futures industry kept its place as a world 

leader and innovator because CFMA adopted a principles-based 

regulatory regime and the CFTC fostered the concept. Reauthorization offers a valuable opportunity to fine tune CFMA based on experienced gained since 2000. CME offers two recommendations. 

Off-exchange retail FX futures trading: The fact that the CFTC 

and NFA are compelled to devote a large share of their resources 

to protecting retail customers from widespread fraud in OTC FX 

markets is evidence that a serious problem exists. We have lost 

track of the number of CFTC and NFA enforcement actions since 

we first urged elimination of the exemption that permitted off-exVerDate 0ct 09 2002 11:27 Apr 02, 2009 Jkt 041481 PO 00000 Frm 00010 Fmt 6633 Sfmt 6601 I:\DOCS\110-27\48374.TXT SOLEM PsN: REBEKA
7

change trading of retail foreign exchange contracts. As expected, 

there have been hundreds of enforcement actions, hundreds of millions of dollars in fraudulent losses to small traders and each day 

brings new examples. 

At a minimum, we need an amendment that will clarify the retail FX system that do not regularly settle contracts by delivery are 

subject to CFTC registration requirements; that is, unless they are 

operated by banks or other financial institutions. Further, it should 

be specified that such systems may only be operated by Designated 

Contract Markets or well-capitalized and fully regulated futures 

commodity merchants. In addition, all intermediaries who serve 

the same function as commodity pool operators, commodity trading 

advisors and introducing brokers, should register as such and be 

subject to comparable regulation. 

Exempt commodity markets: Section 5(b) of the Commodity Exchange Act charges the Commission with the duty to oversee the 

system of effective self-regulation of trading facilities, clearing systems, market participants and market professionals. It is the Commission’s responsibility to deter and prevent price manipulation or 

any other disruptions to market integrity, to ensure the financial 

integrity of all transactions subject to this chapter and the avoidance of systemic risk and to protect all market participants from 

fraudulent or other abusive sales practices. These purposes, in the 

statutory exemption for commercial markets found in Section 

2(h)(3) are in conflict. 

The key purpose mandated by Congress in Section 5(b) is jeopardized if trading facilities for contracts in exempt commodities are 

permitted to coexist with regulated futures exchanges that list 

those same commodities. Exempt commercial markets do not have 

any system to effectively self-regulate their facilities or their market participants. Their contracts are traded based on the price of 

commodities that have limited supplies and that have often been 

the subject of manipulative activity and disruptive market behavior. 

There is no mechanism in place to deter or prevent price manipulation or any other disruptions to market integrity. The Commission cannot track the buildup of dominant positions. At best, the 

Commission has the power to punish such conduct only after the 

fact. We find this to be a serious problem that is at odds with 

Congress’s intent behind CFMA. If left unaddressed, the situation 

jeopardizes the public’s confidence and the CFTC’s ability to do its 

job. 

The Section 2(h)(3) exemption for unregulated commercial markets should be eliminated. You can’t fix the problem by merely 

changing reporting requirements. In order to secure accurate reports, a market needs an effective surveillance and compliance system. This requires that an effective system of self-regulation must 

be put in place. The logical conclusion is that you must implement 

at least the core principles required of derivative transaction execution facilities to get a useful result. 

Before I conclude, I want to make mention of the periodic attempts to impose transaction tax on exchange traded futures contracts. That effort is utterly misguided. First, the tax will fall on 

liquidity providers who will simply be driven offshore to untaxed 

8

exchanges. Second, the regulated exchanges already pay for the 

Commission’s direct oversight and their customers pay a fee to the 

National Futures Association for the services it performs, many of 

which have been off-loaded from the CFTC. 

Finally, the CFTC’s expenses and need for additional staff are attributed to off-exchange frauds and manipulations, not self-regulated trading. To close, CME Group, its members and their customers and the Nation’s market-based economy have prospered 

under CFMA. The CFTC deserves commendation and should be reauthorized. The principles of CFMA should be reaffirmed. Mr. 

Chairman, I thank you very much for your time this morning. 

[The prepared statement of Mr. Duffy follows:]

PREPARED STATEMENT OF TERRENCE A. DUFFY, EXECUTIVE CHAIRMAN, CHICAGO

MERCANTILE EXCHANGE GROUP, INC., CHICAGO, IL 

I am Terrence Duffy, Executive Chairman of Chicago Mercantile Exchange Group, 

Inc., (‘‘CME Group’’ or ‘‘CME’’). Thank you Chairman Etheridge and Members of the 

Subcommittee for this opportunity to appear here today to present our views on 

some of the issues facing Congress as it continues the reauthorization process. CME 

Group was formed by the merger this year of Chicago Mercantile Exchange Holdings Inc. and CBOT Holdings Inc. CME Group is the parent of CME Inc. and The 

Board of Trade of the City of Chicago Inc. (the ‘‘CME Group Exchanges’’). CME 

Group also owns Swapstream Operating Services Limited, an OTC trading facility, 

and owns an interest in FXMarketspace Limited, an FX trading platform that is authorized and regulated by the Financial Services Authority. The CME Group Exchanges serve the global risk management needs of our customers and those who 

rely on the price discovery provided by the competitive markets maintained by the 

Exchanges. The CME Group Exchanges offer a comprehensive selection of benchmark products in most major asset classes, including futures and options based on 

interest rates, equity indexes, foreign exchange, agricultural commodities, energy, 

and alternative investment products such as weather and real estate. Additionally, 

we offer order routing, execution and clearing services to other exchanges by means 

of our Globex® electronic trading platform and our clearing house. CME Group is 

traded on the New York Stock Exchange and NASDAQ under the symbol ‘‘CME.’’ 

I. The CFTC’S Implementation of CFMA 

I am pleased to give our view of the achievements of the Commodity Futures 

Trading Commission and the successes of our industry made possible by the Commodity Futures Modernization Act of 2000 (‘‘CFMA’’). The CME Group commends 

Congress, and the agriculture committees, for the foresight in 2000 to enact a principles-based regulatory regime for our industry. 

The success of the derivatives industry sharply contrasts with developments in 

U.S. capital markets. Foreign exchanges have been attracting new listings to the apparent detriment of U.S. markets—thereby focusing negative attention on the U.S. 

regulatory system for securities exchanges and issuers. There is concern that U.S. 

security markets have been hamstrung in meeting international competition by 

overly-prescriptive regulation. A strong case has been made that innovation is 

slowed and U.S. markets cannot attain a first mover advantage because of the lag 

between idea and implementation imposed by the regulatory regime. 

We think that the marked success of the U.S. derivatives industry under the regulatory regime created by the CFMA provides a compelling example for the securities 

industry. In our view, reducing or limiting barriers to entry in the global futures 

and options industry has strongly contributed to business growth. For example, the 

compounded annual growth rate of the global futures and options industry from 

2000 through 2006 was 28% compared to only 4% for equity securities markets. This 

is due, at least in part, to the fact that U.S. investors can directly and electronically 

trade foreign futures and options contracts from the U.S. Correspondingly, European and Asian investors can directly and electronically trade products listed by 

CME and other U.S. futures and options exchanges. Moreover, foreign boards of 

trade can efficiently offer U.S. customers access to products also traded on U.S. exchanges, thereby increasing global competition in these markets. In contrast, under 

current SEC rules, U.S. investors cannot directly and electronically trade foreign equity securities of foreign issuers that do not comply with SEC disclosure standards 

or U.S. GAAP accounting standards. The CFTC has wisely promoted global growth 

9

and competition while recognizing that comparability in regulatory standards is superior to insisting upon additional, but not necessarily better, regulatory requirements. 

Despite this record, we are concerned that most discussions of regulatory shortcomings in the U.S. lump derivative and security markets together and treat the 

regulatory problem as if it were caused by separate regulation of those two sectors. 

We have not discovered a single, considered explanation of why separate regulation 

of futures and securities has adversely impacted securities markets. 

The U.S. futures industry kept its place as a world leader and innovator because 

CFMA adopted a principles-based regulatory regime and the Commission embraced 

and fostered the concept. CFMA set the stage for innovation and international expansion of U.S. futures markets. 

Some observers argue that the occasional jurisdictional ‘‘overlap’’ between the 

CFTC and SEC with respect to some innovative new products demonstrates a dysfunctional system that must be changed. Those ‘‘border disputes’’ certainly exist and 

are unfortunate, but they have no bearing on the effective and efficient regulation 

of the great mass of futures products that lie solely within CFTC’s jurisdictional 

purview. The proper resolution is the course that the CFTC pioneered, i.e., finding 

a solution that permits the new products to trade under both regimes and permitting the ‘‘market’’ to choose. 

The continuing call for merging the CFTC and the SEC is sometimes justified as 

a means to resolve these minor conflicts. Such a merger has no value for futures 

markets which already enjoy principal-based regulation. There is no benefit to the 

customers, since the most likely outcome will be the elimination of the better regulatory system. The inadequacies of securities market regulation cited by critics need 

to be resolved by reform of that regulatory regime, not by subjecting derivative markets to a system that is not credible in a global economy. 

Perhaps it is premature to comment, but there appears to be a serious jurisdictional conflict between the CFTC and the Federal Energy Regulatory Commission 

(‘‘FERC’’), arising out of FERC’s prosecution of Amaranth in connection with its 

trading of natural gas on NYMEX, a designated contract market subject to the exclusive jurisdiction of the CFTC. Section 2(a)(1)(A) of the CEA provides: ‘‘The Commission shall have exclusive jurisdiction, except to the extent otherwise provided in 

subparagraphs (C) and (D) of this paragraph and subsections (c) through (i) of this 

section, with respect to accounts, agreements . . . and transactions involving contracts of sale of a commodity for future delivery, traded or executed on a contract 

market designated or derivatives transaction execution facility registered pursuant 

to section 7 or 7a of this title or any other board of trade, exchange, or market . . . .’’ The CFTC investigated Amaranth’s conduct and charged it with an attempted manipulation under the CEA. FERC investigated the same conduct and 

charged Amaranth with manipulative conduct under the different standard applicable in its statute. FERC is taking the position that it has jurisdiction over conduct 

on a futures exchange if that conduct impacts cash markets under its jurisdiction. 

In effect, FERC reads the CFTC’s exclusive jurisdiction out of existence. The prosecution of the same conduct by separate Federal agencies under differing standards 

creates exactly the sort of conflict that Congress sought to avoid by limiting the 

reach of FERC jurisdiction. 

II. CME’s Recommendations for Reauthorization 

We urge that the CFTC be reauthorized. Generally we agree that CFMA has been 

a resounding success, but we also believe that reauthorization offers a valuable opportunity to fine tune that statute based on industry experience gained in the 7 

years since the CFMA’s enactment. In that regard, CME offers three recommendations for consideration. We also wish to comment on the recurring efforts to impose 

a transaction tax on exchange traded futures to fund the Commission. 

Off-Exchange Retail FX Futures Trading 

The first area in need of fine tuning involves retail, off-exchange trading of foreign 

exchange derivatives. We have lost track of the number of CFTC and NFA enforcement actions since we first urged elimination of the exemption that permitted offexchange trading of retail foreign exchange contracts. As we predicted, there have 

been hundreds of enforcement actions, hundreds of millions in fraudulent losses to 

small traders, and each day brings new cases and more losses. The confluence of 

the massive continuing frauds committed against retail customers by fly-by-night 

foreign exchange dealers, and the unfortunate decision of the 7th Circuit Court of 

Appeals in CFTC v. Zelener, compel this industry to reexamine the public policy implications of how the CFMA addresses off-exchange retail foreign exchange futures 

10

and the threshold definition of what transactions should be subject to CFTC jurisdiction. 

The fact that the CFTC and NFA are compelled to devote such substantial resources to protecting retail customers from widespread fraud in the off-exchange FX 

market is evidence enough that a serious problem exists with the CFMA that cries 

out for reform. In the aftermath of the Zelener decision, FX dealers can structure 

a margined currency contract for speculative use by retail customers and assert that 

is beyond the reach of the CFTC’s jurisdiction. I don’t believe that there is a single 

person in this room who would not agree that such contracts are futures contracts 

that deserve the protection of the CFTC. Under the Zelener case, it does not matter 

what the dealer actually does or what the customer actually expects—a single sentence in the small print of the customer agreement denies the CFTC jurisdiction. 

The sharp operators and bucket shops have already figured out that the rationale 

of the Zelener opinion can apply to commodities other than FX. If we only fix the 

FX problem, those operators will simply transfer their scams to orange juice, gold 

and heating oil. The CFTC’s jurisdiction and its retail consumer protections will be 

reduced to irrelevance. 

At a minimum, we need an amendment that will clarify that retail FX derivative 

trading systems that do not regularly settle contracts by delivery are subject to 

CFTC registration requirements, unless operated by banks or other financial institutions. To the extent that such systems are regulated by the CFTC, they should 

only be operated by designated contract markets or well capitalized and fully regulated FCMs. All intermediaries who serve the same function as CPOs, CTAs and 

IBs and who deal with retail customers of off-exchange FX trading systems, regardless of the identity of the operator or the platform, must be required to register in 

the appropriate capacity and be subject to comparable regulation. 

Exempt Commodity Markets 

Our perspective is based on ‘‘first principles,’’ which means we look to the findings 

and purposes adopted by Congress to guide the Commission’s exercise of its jurisdiction. Section 5(b) of the Commodity Exchange Act charged the Commission with a 

duty to oversee ‘‘a system of effective self-regulation of trading facilities, clearing 

systems, market participants and market professionals’’ and to ‘‘to deter and prevent price manipulation or any other disruptions to market integrity; to ensure the 

financial integrity of all transactions subject to this chapter and the avoidance of 

systemic risk; to protect all market participants from fraudulent or other abusive 

sales practices.’’ 

There is a growing conflict between these ‘‘purposes’’ and the statutory exemption 

for Commercial Markets found in Section 2(h)(3), which is the basis for the Exempt 

Commercial Market (‘‘ECM’’) category. It is clear that all of the key purposes mandated by Congress in Section 5(b) are jeopardized if trading facilities for contracts 

in exempt commodities are permitted to coexist with regulated futures exchanges 

that list those same commodities. The Exempt Commercial Markets authorized by 

Section 2(h)(3), do not have any system of ‘‘effective self regulation’’ of their facilities 

or of their market participants. Their contracts are traded based on the prices of 

commodities that have limited supplies and that have often been the subject of manipulative activity and disruptive market behavior. There is no mechanism in place 

‘‘to deter and prevent price manipulation or any other disruptions to market integrity.’’ The Commission cannot track the build-up of dominant positions. The ECM 

has no real power over its users. At best, the Commission has power to punish such 

conduct after the fact. We find this to be a serious problem, as explained in detail 

below, that is at odds with Congress’s intent behind the CFMA and which, if left 

unaddressed, is likely to jeopardize the public’s confidence in the CFTC’s ability to 

do its job.

A. Trading standardized, cash settled, fungible commodity contracts on 

a multilateral execution facility is indistinguishable from futures trading.

Bilateral swaps, including swaps respecting energy, metals and other non-agricultural products, as defined at section 2(g) of the CEA, were excluded from the exchange trading requirement of the CEA because they had developed into an important product and a formal confirmation of their excluded status was desirable. The 

Commission’s Policy Statement Concerning Swap Transactions, 54 Fed. Reg. 30,694 

(July 21, 1989) was the first step in the direction of excluding financial product 

swaps. The Futures Trading Practices Act of 1992, P.L. No. 102–546, 106 Stat. 3590, 

amended the CEA and clarified the Commission’s authority to exempt certain transactions from the exchange trading requirement. The Commission adopted such reguVerDate 0ct 09 2002 11:27 Apr 02, 2009 Jkt 041481 PO 00000 Frm 00014 Fmt 6633 Sfmt 6621 I:\DOCS\110-27\48374.TXT SOLEM PsN: REBEKA
11

1 (g) Excluded swap transactions

No provision of this chapter (other than section 7a (to the extent provided in section 7a(g)

of this title), 7a–1, 7a–3, or 16(e)(2) of this title) shall apply to or govern any agreement,

contract, or transaction in a commodity other than an agricultural commodity if the agreement, contract, or transaction is—

(1) entered into only between persons that are eligible contract participants at the time

they enter into the agreement, contract, or transaction; 

(2) subject to individual negotiation by the parties; and 

(3) not executed or traded on a trading facility.

lations in 1992, e.g., 17 C.F.R. 35. An excluded bilateral swap must be ‘‘subject to 

individual negotiation by the parties and not executed on a trading facility.’’ 1

CEA Section 2(d)(2) excluded electronically traded contracts based on certain financial measures that were deemed unlikely to be subject to manipulative activity 

(an ‘‘excluded commodity’’) if the contract is entered into on a principal-to-principal 

basis between eligible contract participants. This exclusion is based on the recommendations of the President’s Working Group (‘‘PWG’’). The PWG carefully limited its recommendation for an excluded electronic trading platform to a class of 

commodities that did not include the types of commodities traded on an ECM:

‘‘Accordingly, the Working Group unanimously recommends that Congress 

amend the CEA to clarify that entering into or trading excluded swap agreements (i.e., agreements between eligible swap participants that do not involve 

non-financial commodities with finite supplies) through electronic trading systems with certain characteristics does not affect the status of the agreements 

traded through the system and does not provide a basis for regulation of the 

system. Over-the-Counter Derivatives Markets and the Commodity Exchange 

Act, Report of The President’s Working Group on Financial Markets, at 18–19 

(November 1999) (emphasis supplied)

CME supported and continues to support those portions of the CFMA that exclude 

bilateral swaps in financial commodities. We also support the electronic trading of 

financial derivatives on Exempt Boards of Trade as provided in CFMA. But, the contracts traded on ECMs are not such bilateral swaps. They are standardized derivatives whose terms are set by the operator of the trading platform. Identical contracts become fungible if the platform provides central counterparty clearing. Consequently a buyer can offset his position by selling an equal and opposite contract. 

The price of the transaction is set at the time of the transaction but delivery is deferred. We do not consider these to be forward cash contracts because they are not 

regularly settled by the delivery of a specific cash instrument; rather they are cash 

settled like many financial futures contracts. 

The only significant differences between traditional DCMs and ECMs is the ‘‘eligible contract participant’’ (‘‘ECP’’) qualification of the ECM’s customers and the requirement that ECM customers execute transactions without a broker or other 

intermediary. However, it is only those traders that are large enough to satisfy the 

ECP requirements who are likely to be involved in manipulative activity. Of course, 

CME Group Exchange customers can also directly enter their orders into the 

GLOBEX trading system and most customers do qualify as eligible contract participants. That difference may justify a different set of customer protection rules for 

ECMs, but it does not justify the lack of a self-regulatory system, large trader reporting or information sharing with other exchanges.

B. Coexisting regulated and unregulated markets for economically 

equivalent commodity contracts impair information flows necessary to 

prevent misconduct.

Large trader reports are the key element of Commission and self-regulatory organization surveillance programs to prevent disruptive market activities. ECMs do not 

require large trader reports and do not participate in the Intermarket Surveillance 

Group, which shares information across exchanges. There is no logical basis for this 

distinction. If the prevention of disruptive market behavior is to remain a goal of 

derivatives regulation, information collection and sharing is essential. 

The intensity of concern respecting this lack of information depends on the likelihood of manipulation or other market disruptions that may be caused by trading 

particular underlying products, i.e. excluded versus exempted commodities. Again, 

the 1999 PWG report is instructive. The PWG’s recommendations for eliminating 

the exchange trading requirement and easing regulatory burdens on electronic trading facilities, which host transactions involving derivatives based on excluded commodities, were premised on its considered judgment respecting the risks of manipulative and market distorting activity in the excluded commodities:

12

2Testimony of Jeffrey C. Sprecher, Chairman and Chief Executive Officer, 

IntercontinentalExchange, Inc., Before the House Agriculture Subcommittee on General Farm 

Commodities and Risk Management Committee on Agriculture, page eight (July 12, 2007). 3 CEA Section 5a(c)(2) provides as follows:

Deterrence of abuses.—

‘‘Where regulation exists, it should serve valid public policy goals. The justifications generally cited for regulation of the futures markets include the goals of 

protecting retail customers from unfair practices, protecting the price discovery 

function, and guarding against manipulation. With similar policy goals in mind, 

the Working Group has recommended limiting the proposed exclusion for swap 

agreements to eligible swap participants trading for their own account . . . . It 

has also recommended limiting proposed exclusions to markets that are not readily susceptible to manipulation and that do not currently serve a significant price 

discovery function.’’ Over-the-Counter Derivatives Markets and the Commodity 

Exchange Act, Report of The President’s Working Group on Financial Markets, 

at 22 (November 1999) (emphasis supplied)

The PWG made it abundantly clear that trading facilities for energy and metals 

products should not be exempted:

‘‘Due to the characteristics of markets for non-financial commodities with finite 

supplies, however, the Working Group is unanimously recommending that the 

exclusion not be extended to agreements involving such commodities. For example, in the case of agricultural commodities, production is seasonal and volatile, 

and the underlying commodity is perishable, factors that make the markets for 

these products susceptible to supply and pricing distortions and to manipulation. There have also been several well-known efforts to manipulate the prices 

of certain metals by attempting to corner the cash or futures markets. Moreover, the cash market for many non-financial commodities is dependent on the 

futures market for price discovery.’’ Id. at 16 (emphasis supplied)

The testimony adduced at the recent Congressional hearings on the Amaranth 

episode and energy trading issues confirms the validity of the PWG’s concerns about 

an exclusion for energy trading facilities.

C. The Remedy: The Section 2(h)(3) exemption for unregulated commercial markets should be eliminated.

Potential disruption of regulated markets and the cash market for certain exempted commodities justifies an increase in the flow of current information from organized OTC markets to the Commission. One seemingly simple solution is to change 

reporting requirements. Our experience suggests that this will be a failure. In order 

to provide accurate reports, a market needs an effective surveillance and compliance 

system. This implies that an effective system of self regulation must be put in place. 

The logical conclusion is you must implement at least the core principles required 

of a Designated Transaction Execution Facility (‘‘DTEF’’) to get a useful result. 

The 2(h)(3) special exemption for commercial markets trading commodity futures 

contracts based on energy, metals and other non-enumerated commodities is directly 

contrary to the recommendations of the President’s Working Group on which CFMA 

was based. The PWG expressly found that an exemption for exchange-like trading 

of derivatives based on underlying commodities that were not immune from manipulation was not appropriate. The legislative history of the CFMA provides no explanation for why Congress deviated from the PWG recommendations. 

If Congress needs any further justification for taking action to reverse this hole 

in the CEA’s regulatory safety net, Intercontinental Exchange’s Jeffrey Sprecher’s 

recent testimony before Congress adequately confirms that there is ample need for 

it now. He conceded that it is essential to the performance of the CFTC’s oversight 

function that there be enhancements ‘‘to the quality and quantity of information 

currently available to the CFTC and, in particular, its ability to integrate data from 

ICE and NYMEX.’’ 2 Additionally, our sense is that the CFTC devotes an outsized 

proportion of its human and financial resources to trying to stay abreast of problems 

in the ECM market and dealing with other off-exchange trading. Eliminating the 

2(h)(3) category would produce significant efficiencies of administration and more effective regulatory oversight without any adverse implications for innovation, competition or market flexibility. Any trading facility that is now successfully operating 

as an ECM can easily and inexpensively convert to a DTEF or DCM. Beyond the 

market protections reflected in a DTEF’s core principles, a DTEF has an affirmative 

obligation to deter market abuses and to implement systems and procedures to comply with that obligation.3 The Commission has oversight powers to insure that the 

13

The board of trade shall establish and enforce trading and participation rules that will

deter abuses and has the capacity to detect, investigate, and enforce those rules,

including means to—

(A) obtain information necessary to perform the functions required under this section;

or 

(B) use technological means to—

(i) provide market participants with impartial access to the market; and 

(ii) capture information that may be used in establishing whether rule violations have

occurred. 4 In their letter to Congressional leaders dated November 3, 2005, the PWG principals stated 

inter alia that: ‘‘In addition to retail foreign currency fraud issues, the PWG members have discussed the complex issues related to . . . the implementation of risk-based portfolio margining 

systems for security futures products and security options . . . As part of these discussions, the 

PWG is committed to resolving the portfolio margining system and narrow-based index issues 

within the time frames set forth below:

With regard to portfolio margining, the SEC has committed to approving self regulatory organization (SRO) rules that permit the use of risk-based portfolio margining methodology to

determine margin requirements for portfolios that include security futures products and for

security options by June 30, 2006. In the event that the SEC does not approve such SRO

rules, the SEC will promulgate rules to permit risk-based portfolio margining for security options by September 30, 2006, and the SEC and CFTC will do so jointly for security futures

products by the same date.’’

obligation is met. The existing DTEF regulatory scheme would appear to provide an 

effective remedy to the problems identified with ECMs without the need to invent 

something new. 

The Commission’s published list of ECMs confirms our belief that there appears 

to be no barrier for ECMs to convert to DTEFs or DCMs. There are numerous providers to whom any servicing needs, such as clearing and/or compliance, can be 

outsourced efficiently. The significant entrants, such as ICE, ChemConnect, Inc., 

Chicago Climate Exchange, Inc., and TradeSpark have affiliates that are already 

regulated by the Commission and can provide such services in house. HoustonStreet 

seems to be a marketplace for physical crude oil and other refined products that 

makes certain NYMEX ClearPort products available in a linkage arrangement. 

NetThruPut Inc. appears to be a cash crude oil trading system. It is unclear, from 

its websites, what ICAP is actually doing as an ECM. Some, such as Optionable, 

Inc. and Commodities Derivative Exchange, Inc., are out of business. Others appear 

to be trading agricultural commodities like pulp and salmon, which, not being exempt commodities, are not within the purview of ECMs. 

Security Futures Products 

In my Congressional testimony of June of 2003, I characterized single stock futures as ‘‘the CFMA’s unfulfilled promise’’. I am sad to say what was true then remains so even today. As evidenced by the success and acceptance of the contract 

in European markets, single stock futures can be a great product with enormous 

benefits to market users. The regulatory system that has slowly evolved between 

CFTC and SEC has yet to address various key issues and several of the regulations 

that have been produced thus far are overly burdensome and inflexible, frustrating 

development of products that would be both useful and desirable to market participants. 

It is time to let futures exchanges trade the product as a pure futures contract 

and to let securities exchanges trade it as a securities product. Let the relevant exchanges deal solely with their respective regulator, the CFTC or the SEC, which is 

what I believe the Congress intended in 2000 in authorizing single stock futures. 

We want competitive forces to determine the outcome—not government. Fulfilling 

that promise made in 2000 will advance the customers’ interest substantially. We 

would encourage the Subcommittee to use its oversight jurisdiction to insist that the 

respective regulatory agencies eliminate undue regulatory impediments that have 

been erected to frustrate the introduction of security futures products.4

Transaction Tax 

The periodic attempts to impose a transaction tax on exchange traded futures contracts are misguided. First, the tax will fall on liquidity providers who will simply 

be driven off shore to untaxed exchanges. Second, the regulated exchanges already 

pay for the Commission’s direct oversight and their customers pay a fee to the National Futures Association for the services it performs, many of which have been 

offloaded from the CFTC. Finally, the CFTC’s expenses and need for additional staff 

is attributable to off-exchange frauds and manipulations, not self-regulated exchange trading. 

14

5 In its March 1, 2007 budget recommendation letter, the bi-partisan leadership of the House 

Agriculture Committee stated: ‘‘The Administration has also proposed the enactment of new 

user fees to be charged by a number of different agencies under the jurisdiction of the Committee on Agriculture. Some of these fees have been proposed before, and it has been the consistent judgment of our Committee that the widespread benefits of the activities involved justify 

the use of the general treasury.’’ 

Each year we are faced with a proposal to fund the Commodity Futures Trading 

Commission’s budget with a ‘‘transaction tax’’ levied on U.S. futures exchange trading. This tax will: (1) impair liquidity of U.S. futures markets; (2) change the competitive balance in favor of foreign and OTC markets; (3) unfairly burden U.S. futures exchanges with the costs of policing OTC fraud; (4) hurt the local economies 

in the cities and states where futures exchanges create great employment opportunities; (5) lessen the value of the information provided to farmers and the financial 

services industry by means of the price discovery that takes place in liquid, transparent futures markets; (6) adversely impact the cost of financing the national debt; 

and, ironically, (7) fail to increase the taxes actually collected. Fortunately, with the 

Agriculture Committee’s leadership, Congress has consistently rejected this ill-conceived tax proposal.5 A transaction tax is ill-conceived and counter-productive and 

should be rejected for all of the reasons listed, as explained in more detail below: 

1. Adversely Impacting Liquidity: We estimate that the transaction tax will add 

significantly to the execution costs of the significant liquidity providers on U.S. futures exchanges. These market makers whose constant participation and rapid turnover is the major source of market liquidity operate on razor thin margins. Every 

market maker would pay an additional tax on top of his existing Federal, state and 

local taxes. A transaction tax to fund the CFTC imposes millions per year in tax 

on market makers in addition to the tax they already pay on any profits they 

achieve. The transaction tax is imposed whether or not they actually profit. Many 

of these market makers are at the margin of profitability. This significant tax will 

expose them to the choice of continuing at a profit level unjustified by the risks assumed or exiting the business. The exit of liquidity providers means decreased efficiency of the futures markets, more volatility and less facility for other market participants to make effective use of futures markets. We are also concerned that the 

discipline exerted on the agency’s budget by the appropriations process will evaporate under a regime where the costs are allocated to certain market users. 

2. Upsetting the Competitive Balance: The transaction tax only applies to domestic futures exchange trading: competing over-the-counter markets, including the 

ECMs that are discussed above, and foreign futures exchanges are not covered. This 

feature grants those venues substantial, unearned competitive advantages over U.S. 

regulated futures exchanges. Users of U.S. futures markets can and do readily shift 

their business off-exchange or overseas if U.S. futures markets are too costly. In this 

era of electronic trading, market participants can transfer their business to trading 

platforms that offer the most competitive transactional pricing. It is as easy for an 

exchange to claim a foreign venue and avoid costly U.S. regulation or taxes. This 

is not a remote possibility, it is happening now in connection with the major competitive battle between a U.S. and U.K. energy futures market. 

3. Taxing the Wrong Parties: Futures exchanges already pay for direct supervision 

by the CFTC. Customers trading on U.S. futures exchanges pay a fee to cover the 

regulation of intermediaries provided by the National Futures Association, which 

has taken over many of the responsibilities of the CFTC. A significant and increasing amount of CFTC’s enforcement and surveillance budget is dedicated to detecting 

and prosecuting fraud in OTC trading (for example, OTC currency and energy trading), yet this transaction tax proposal would have exchange traders foot the bill for 

CFTC’s OTC-related surveillance and enforcement activities. So too, trading done 

through foreign exchange affiliates of U.S.-based OTC entities would similarly escape the ambit of the transaction tax even while CFTC would be dedicating its staff 

resources to surveillance and enforcement activities related to those markets. 

4. Hurting Local Economies: Harming the U.S. futures industry will affect both 

the U.S. and local economies. In Chicago, the exchange industry provides more than 

100,000 direct and indirect jobs; more than $48 billion are on overnight deposit in 

Chicago and New York banks as a result of the exchanges. The exchanges and those 

who depend on them for their livelihoods are the source of millions of dollars in Federal, state and local tax revenues. New York benefits just as directly from its three 

futures exchanges, with billions contributed to NYC’s economy and hundreds of millions in Federal state and local taxes. 

5. Impairing Price Discovery: Futures markets provide significant benefits to market users and to persons seeking good information on future pricing in order to 

guide their decision making on investment, planting, herd management, etc. The 

15

deeper and more liquid the market, the better the price discovery and information 

provided. Any impairment of liquidity lessens the value of the information and the 

functioning of our market based economy. 

6. Increasing the Cost of Financing the National Debt: The value to the Federal 

Government of liquid, efficient domestic futures markets far exceeds the revenue 

that might be generated by the transaction tax. Liquid futures markets save the 

Treasury and taxpayers millions of dollars by allowing government securities dealers effectively to hedge their risks and to bid more aggressively at auctions for 

Treasury securities. The savings to the Treasury in interest rate payments are 

worth far more than the $127 million the transaction tax is expected to raise. If a 

government-imposed transaction tax diminishes liquidity in futures markets, thereby increasing government borrowing costs by even one basis point, that tax would 

increase the Federal deficit by at least $474,543,158.71 million per year. 

7. Securing No Real Gain in Revenues: In every instance when a government imposed a transaction tax on futures trading, the loss of business to foreign exchanges 

forced a reversal. In some cases it came too late and the industry was lost. If the 

proposed transaction tax forces the U.S. futures business overseas or to untaxed 

substitute markets, the anticipated revenue will be an illusion. Diminished futures 

industry business and employment will also result in reduced corporate and personal income taxes in this country. Not only will the proposed transaction tax fail 

to produce enough ongoing revenue to fund the CFTC, but it will reduce government 

revenues generally. 

V. Conclusion 

The CME, its members and their customers, and the nation’s market based economy have prospered under the CFMA. The CFTC should be reauthorized and the 

principles of CFMA should be reaffirmed. The CME looks forward to engaging significantly in the reauthorization process and to achieving legislation that maintains 

the significant successes of the CFMA while making discreet corrections designed 

to materially improves the utility, efficiency, competitiveness and fairness of our futures markets for our customers and all market participants.

Mr. ETHERIDGE. Thank you, Mr. Duffy. And if the other Members 

would suspend for just a minute. We have been joined by the Ranking Member of the full Committee, if he has comments for an opening statement. 

Mr. GOODLATTE. Thank you, Mr. Chairman. 

Mr. ETHERIDGE. We would gladly recognize you this morning. 

OPENING STATEMENT OF HON. BOB GOODLATTE, A 

REPRESENTATIVE IN CONGRESS FROM VIRGINIA 

Mr. GOODLATTE. The only thing I will say is that I very much 

appreciate your holding this hearing, that we have been long working on the effort to reauthorize this important legislation, so I am 

pleased to be here to hear the testimony of the witnesses and have 

them help us find a way forward. I welcome all members of this 

panel. 

Mr. ETHERIDGE. Thank you, sir. Dr. Newsome. 

STATEMENT OF JAMES E. NEWSOME, PH.D., PRESIDENT, CEO, 

AND MEMBER, BOARD OF DIRECTORS, NEW YORK

MERCANTILE EXCHANGE, INC., NEW YORK, NY 

Dr. NEWSOME. Thank you, Mr. Chairman. Mr. Chairman, Mr. 

Moran, Members of the Committee, as President and CEO of the 

New York Mercantile Exchange, I appreciate the opportunity and 

the invitation to share our views today. The CFMA has provided 

critically needed legal certainly and modernization to U.S. futures 

and derivatives markets. The CFMA also provides a well-considered oversight framework for futures markets that has enhanced 

the abilities of NYMEX and the other regulated exchanges to operate in a rapidly changing business environment. 

16

The CFMA shifted away from a ‘‘one-size-fits-all’’ prescriptive approach to a more flexible approach that included the use of core 

principles for DCMs or Designated Contract Markets. In today’s 

competitive global environment, this shift is more important now 

than ever before. In addition, the CFMA strengthened the CFTC’s 

role as an oversight regulator. The CFMA’s flexible regulatory 

framework provides benefits to the marketplace while continuing to 

ensure confidence in the integrity of futures markets. 

However, with an ever evolving marketplace, some markets differ dramatically now than just 7 years ago, causing the need for 

this Committee’s reevaluation of certain aspects of the CFMA. The 

CFMA established an unregulated market category, the exempt 

commercial market, and due to evolution of some markets, non-regulation of certain ECM markets can no longer be justified. Over the 

last several months, the role of ECMs has received a great deal of 

scrutiny in Congress and elsewhere. Prior to and during this period, NYMEX has observed and voiced a broad and growing consensus that certain products traded on ECMs and DCMs are tightly linked and effectively comprise one broader market. 

Consequently, NYMEX, along with others, have concluded that 

there is a need for appropriate statutory change to provide effective 

regulatory oversight of markets that are of critical importance to 

U.S. consumers and to the overall economy. The debate over the 

changes in the marketplace is now largely settled. The real question becomes the appropriate statutory response. Mr. Chairman, today’s timely hearings provides an opportunity for the Congress, the 

CFTC and the industry to begin to work together constructively on 

developing a solution. 

It has become apparent to me that the structural issues raised 

by changes in the marketplace cannot be addressed effectively at 

the level of individual exchanges. NYMEX believes that a targeted 

approach that directly addresses the specific issues raised by these 

industry changes would be the most effective policy response and 

would provide the greatest assurance of limiting the unintended 

consequences of broader changes. 

NYMEX believes that a heightened level of CFTC oversight 

should be mandated for certain products listed on ECMs whose 

products are directly linked to regulated markets. However, 

NYMEX does not believe that the case has been made for extending such heightened regulation to other products listed on such an 

ECM to other ECMs that have not triggered these policy interest 

and concerns or the traditional bilateral OTC marketplace. 

Specifically, for those products trading on ECMs that have triggered public policy interest and concerns, NYMEX believes that the 

CEA should be amended to mandate routine large trader reporting 

and position accountability requirements for financially settled 

ECM contracts that are highly linked and functionally equivalent 

to regulated DCM contracts. Such ECMs must also be assigned 

self-regulatory responsibilities to police their own markets and to 

submit applicable rule changes to the CFTC. 

Finally, over 30 years ago, Congress very wisely gave the CFTC 

exclusive statutory authority over the regulation of futures transactions. This exclusive authority has been reaffirmed by Congress 

in every subsequent reauthorization of the CEA. It has also estabVerDate 0ct 09 2002 11:27 Apr 02, 2009 Jkt 041481 PO 00000 Frm 00020 Fmt 6633 Sfmt 6601 I:\DOCS\110-27\48374.TXT SOLEM PsN: REBEKA
17

lished case law in the Federal courts. NYMEX believes strongly 

that the CFTC currently has and should continue to have exclusive 

authority and jurisdiction over futures transactions and futures 

markets. To vary from this prudent regulatory structure would create confusion, inconsistency and uncertainty, ultimately harming 

the vitality and effectiveness of derivatives markets, as well as the 

broader economy relying upon such markets for both price discovery and the hedging of risk. Thank you, Mr. Chairman. 

[The prepared statement of Dr. Newsome follows:]

PREPARED STATEMENT OF JAMES E. NEWSOME, PH.D., PRESIDENT, CEO, AND MEM- BER, BOARD OF DIRECTORS, NEW YORK MERCANTILE EXCHANGE, INC., NEW YORK, NY 

Mr. Chairman and Members of the Committee, my name is Jim Newsome and I 

am the President and Chief Executive Officer of the New York Mercantile Exchange, Inc. (NYMEX or Exchange). NYMEX is the world’s largest forum for trading 

and clearing physical-commodity based futures contracts, including energy and metals products, and has been in the business for more than 135 years. NYMEX is a 

federally chartered marketplace, fully regulated by the Commodity Futures Trading 

Commission (CFTC) both as a ‘‘derivatives clearing organization’’ (DCO) and as a 

‘‘designated contract market’’ (DCM). 

These categories of regulated entities were established by the Commodity Futures 

Modernization Act of 2000 (CFMA), which amended the Commodity Exchange Act 

(CEA or the Act). The CFMA provided greater legal certainty for over-the-counter 

(OTC) derivatives transactions and established a number of other new statutory categories for trading facilities. On behalf of the Exchange, its Board of Directors and 

shareholders, I want to express our appreciation to the Committee for holding today’s hearing on the reauthorization of the CFTC. 

Overview 

The CFMA is a landmark piece of Federal legislation that has provided critically 

needed legal certainty and regulatory streamlining and modernization to U.S. futures and derivatives markets. The CFMA provides a well-considered oversight 

framework for futures markets that has enhanced the abilities of NYMEX and the 

other regulated exchanges to operate in a rapidly changing business environment. 

The CFMA’s flexible regulatory framework also provides competitive benefits to the 

marketplace while continuing to ensure confidence in the integrity of our markets. 

The Exchange further believes that the tiered statutory structure for trading facilities has been effective in many respects. 

However, with an ever-evolving market place, today’s markets differ dramatically 

from only 7 years ago, causing the need for this Committee’s reevaluation of certain 

aspects of the CFMA. The CFMA established an unregulated market category, the 

exempt commercial market (ECM), and due to the changes in the market place, nonregulation of certain ECMs can no longer be justified. 

Over the last several months, the role of ECMs has received a great deal of scrutiny in Congress and elsewhere. During this period, NYMEX has observed a broad 

and growing consensus that certain products traded on ECMs and DCMs are tightly 

linked and effectively comprise one broader market. Consequently, NYMEX, along 

with some legislators and regulators, have concluded that there is a need for appropriate statutory change to provide effective regulatory oversight of markets that are 

of critical importance to U.S. consumers and to the overall economy. The debate 

over the changes in the marketplace is now largely settled. The real question becomes the appropriate statutory response. Today’s timely hearing provides an opportunity for Congress, the CFTC and the industry to begin to work together constructively on developing a solution. 

Finally, over thirty years ago, Congress unambiguously gave the CFTC exclusive 

statutory authority over the regulation of futures transactions. This exclusive authority has been continually reaffirmed by Congress in every subsequent reauthorization of the CEA and is also established case law in the Federal courts. NYMEX 

believes strongly that the CFTC currently has and should continue to have exclusive 

authority and jurisdiction over futures transactions and markets. To vary from this 

prudent regulatory structure would only create confusion, inconsistency and uncertainty, ultimately harming the vitality and effectiveness of derivatives markets as 

well as the broader economy relying upon such markets for price discovery and 

hedging of risk.

18

I. The CFMA, by all indicators, is providing a reasonable, workable, and 

effective oversight regime for the regulated exchanges.

The CFMA provides a well-considered, flexible regulatory framework that has enhanced the abilities of NYMEX and the other regulated exchanges to operate in a 

rapidly changing business environment and that has provided competitive benefits 

to the marketplace while continuing to ensure confidence in the integrity of our 

markets. 

Prior to the CFMA, the CFTC operated under a ‘‘one-size-fits-all’’ regulatory approach. Regulatory inequities imposed severe and unreasonable constraints on the 

abilities of domestic exchanges to compete with foreign exchanges operating in the 

U.S. and abroad and with unregulated over-the-counter markets. In particular, prior 

approval requirements for rule and contract changes, especially where few or no 

substantive regulatory concerns were present, further exacerbated an uneven playing field and disadvantaged U.S. regulated markets. 

The CFMA shifted away from a ‘‘one-size-fits-all’’ prescriptive approach to futures 

exchange regulation to a more flexible approach that included the use of ‘‘Core Principles’’ for DCMs. In addition, the CFMA confirmed the CFTC’s role as an oversight 

agency (rather than a ‘‘command and control’’ agency that must issue affirmative 

approval before any new innovations could be introduced to the market). Congress 

largely replaced extremely detailed, prescriptive regulation with more broadly structured ‘‘Core Principles’’ for regulated markets. Under the Core Principles approach, 

Congress sets broad performance standards that must be met by the regulated entity, while enabling the entity to have flexibility with regard to how it complies with 

these standards. Thus, the CFMA made clear that regulated DCMs shall have reasonable discretion as to the manner in which they comply with the applicable Core 

Principles set forth in regulation. 

As a result of the flexible Core Principles approach to regulation, the Exchange 

can respond rapidly to changing markets by introducing new risk management 

products, which benefit a broad spectrum of market participants. Market participants have also benefited from recent increased volume levels at all exchanges, 

which further emphasizes the exchanges’ need to be able to respond quickly to market participants’ risk management needs. As a result of Congress’ foresight and innovation, such improvements can be implemented, subject to CFTC review and oversight, without protracted approval processes. CFTC staff periodically undertakes reviews to assess the adequacy of self-regulatory programs and NYMEX has consistently been deemed to have maintained adequate regulatory programs in compliance 

with its obligations as a self-regulatory organization (SRO) under the CEA. 

The CFMA also created several new market tiers. The tiered structure was intended to impose a degree of regulation necessary to the market place based on the 

product traded and the market participants. Thus, at the highest tier of regulation, 

the DCM category, 18 core principles apply on an ongoing basis and the market is 

open to all products and all market participants and trades are or can be intermediated. 

The derivatives transaction execution facility (DTEF) is at the second tier of regulation and is subject to nine core principles. The market generally can trade products that are highly unlikely to be susceptible to manipulation, and it is not open 

to all market participants. Under one version of the DTEF, market participants 

must be eligible contract participants or trade through a registered FCM with net 

capital of at least $20,000,000. Under the other version of DTEF, participants are 

limited to eligible commercial entities. The DTEF category to date has not been utilized by the derivatives industry. 

The third market tier, for exempt markets, includes ECMs and Exempt Boards 

of Trade (EBOT). EBOTs generally are limited to excluded commodities and are unregulated. The ECM tier is open only to eligible commercial entities, trades products 

other than financial derivatives and agricultural commodities and also, as a facility, 

is completely unregulated. Transactions on the ECM are subject only to the CFTC’s 

antifraud and anti-manipulation authority. To date, 20 entities have filed notification with the CFTC of their intention to operate as an ECM, and approximately six 

companies have filed notification of their intention to operate as an EBOT.

II. The current statutory structure no longer works for certain markets 

operating as ECMs.

The CFMA was enacted following the issuance of a report by the President’s 

Working Group on Financial Markets (PWG) that was undertaken at the direction 

of Congress to examine OTC derivatives markets and to provide legislative recommendations to Congress. The PWG Report, entitled ‘‘Over-the-Counter Derivatives Markets and the Commodity Exchange Act,’’ was issued in 1999 and focused 

19

primarily on swaps and other OTC derivatives transactions executed between eligible participants. Among other things, the PWG Report recommended exclusion from 

the CEA for swap transactions in financial products between eligible swap participants. Yet, the PWG Report explicitly noted that ‘‘[t]he exclusion should not extend 

to any swap agreement that involved a non-financial commodity with a finite supply.’’ (Report of the PWG, ‘‘Over-the-Counter Derivatives Markets and the Commodity Exchange Act’’ (November 1999) at p. 17.). However, in a footnote, the PWG 

stated that ‘‘[t]he CFTC would retain its current exemptive authority for swap 

agreements that involve a non-financial commodity with a finite supply.’’ (Id.). 

The CFMA added new section 2(h) to the CEA, which exempted energy commodities from CFTC regulation and allowed the trading of energy swaps on an electronic 

trading platform. Section 2(h) was intended to provide legal certainty to energy 

swaps traded on or off a trading facility by clarifying that bilateral contracts, agreements or transactions in exempt commodities between eligible commercial entities 

were not subject to CFTC regulation, even if the contracts were cleared, but remained subject to the CFTC’s anti fraud and anti manipulation provisions. The 

CFTC implemented Section 2(h)(3) in Part 36 of its regulations by creating the category of markets known as ECMs. While transactions executed on an ECM generally are subject to anti-fraud and anti-manipulation authority, the ECM itself is 

essentially exempt from all substantive CFTC regulation and oversight. In addition, 

the ECM by statute has no affirmative requirements to engage in any self-regulatory activities to monitor its markets or otherwise seek to prevent any manner of 

market abuses. 

The ECM category was designed for commercial market participants who were in 

the business of making and taking delivery of the physical product, and who would 

be limited to engaging in principal-to-principal trading with each other. The exemption from effective CFTC oversight and regulation of the ECM trading facility built 

on the CFTC’s existing 1993 Energy Exemption for OTC bilateral energy swaps between commercial entities. There was a view at the time that there was not a public 

policy need to protect large commercial participants from transactions with other 

large and similarly situated commercial entities. However, the large-scale exemption 

of ECMs from effective CFTC oversight did not contemplate that the trading activities of commercial players on such trading facilities eventually would have spill-over 

or ripple effects on the broader regulated energy markets and ultimately affect consumers. 

A series of profound changes have occurred in various OTC markets since the passage of the CFMA, including technological advances in trading, such that NYMEX, 

the regulated DCM, and the IntercontinentalExchange (ICE), an unregulated ECM, 

have become highly linked trading venues. As a result of this phenomenon, which 

could not have been reasonably predicted only a few short years ago, the current 

statutory structure no longer works for certain markets now operating as ECMs. 

Specifically, the regulatory disparity between the NYMEX and the ICE, which are 

functionally equivalent, has created serious challenges for the CFTC and for 

NYMEX in its capacity as a self-regulatory organization. NYMEX also has concluded that ECMs, such as ICE, which function more like a traditional exchange 

and which are linked to an established exchange, should be subject to regulation 

of the CFTC for certain products in the form of large trader reporting, position limits/accountability levels and self-regulatory responsibilities. 

In addition, the continuing exchange-like aggregation and mutualization of risk 

at the clearinghouse level from trading on active ECMs, such as ICE, where large 

positions are not monitored, raise concerns about spill-over or ripple implications for 

other clearing members and for various clearing organizations that share common 

clearing members. Consequently, legislative change is necessary to address the real 

public interest concerns created by the current structure of the OTC electronicallytraded natural gas market and the potential for systemic financial risk from a market crisis involving significant activity occurring on the unregulated trading venue. 

Subsequent to the passage of the CFMA in late 2000, derivatives markets, especially natural gas derivatives markets, evolved in just a few short years to an extent 

and at a rate that would have been very difficult to predict in 2000. For example, 

when the CFTC was in the midst of proposing and finalizing implementing regulations and interpretations for the CFMA in 2001, even shortly following the wake of 

the Enron meltdown in late 2001, the natural gas market continued to be largely 

focused upon open outcry trading executed on the regulated NYMEX trading venue. 

At that time, NYMEX offered electronic trading on an ‘‘after-hours’’ basis, which 

contributed to only approximately 7–10% of overall trading volume at the Exchange. 

Electronic trading (of standardized products based upon NYMEX’s natural gas contracts) was at best a modest proportion of the overall market. Moreover, it was more 

20

than 6 months following the Enron meltdown before the industry began to offer 

clearing services for OTC natural gas transactions. 

However, in determining to compete with NYMEX, ICE, which as previously 

noted operates as an ECM, not only copied all of the relevant product terms of 

NYMEX’s core or flagship natural gas futures contract, but also misappropriated the 

NYMEX settlement price for daily and final settlement of its own contracts. As 

things stand today, natural gas market participants have the assurance that they 

can receive the benefits of obtaining NYMEX’s settlement price, which is now the 

established industry pricing benchmark, by engaging in trading either on the regulated NYMEX or on the unregulated ICE. 

For some period of time following the launch of ICE as a market, ICE was the 

only trading platform that offered active electronic trading during daytime trading 

hours. In September of 2006, NYMEX began providing ‘‘side-by-side’’ trading of its 

products—listing products for trading simultaneously on the trading floor and on 

the electronic screen. Since that time, there has been active daytime electronic trading of natural gas on both NYMEX and ICE. The share of electronic trading at 

NYMEX as a percentage of overall transaction volume has shifted dramatically to 

the extent that electronic trading now accounts for 80–85% of overall trading volume at the Exchange. 

The existence of daytime electronic trading on both NYMEX and ICE has fueled 

the growth of arbitrage trading between the two markets. Thus, for example, a 

number of market participants that specialize in arbitrage activity have established 

computer programs that automatically trade the spread between the two markets 

and that transmit orders to one market when there is an apparent price imbalance 

with the other market. As a result, there is now a relatively consistent and tight 

spread in the prices of the competing natural gas products. Hence, the two competing trading venues are now tightly linked and highly interactive and in essence 

are simply two components of a broader derivatives market. As the CFTC itself acknowledged in its recent proposed rule-making, there is now ‘‘a close relationship 

among transactions conducted on reporting markets and non-reporting transactions.’’ (72 Fed. Reg. 34,413, at 34,414 (2007) (proposed June 22, 2007.) 

Because ICE price data are available only to its market participants, NYMEX 

does not have the means to establish conclusively the extent to which trading of ICE 

natural gas swaps contributes to, influences or affects the price of the related natural gas contracts on NYMEX. However, a recent CFTC staff study provided confirmation that price discovery is occurring on both the ICE and the NYMEX trading 

venues. It is also clear that, as a consequence of the extensive arbitrage activity between the two platforms and ICE’s use of NYMEX’s settlement price, as well as 

other factors, the two natural gas trading venues are now tightly linked and highly 

interactive. These two trading venues serve the same economic functions and are 

now functionally equivalent. 

NYMEX staff has been advised that, during most of the trading cycle of a listed 

futures contract month, there is a range of perhaps only five to twelve ticks separating the competing NYMEX and ICE products. (The NYMEX NG contract has a 

minimum price fluctuation or trading tick of $.001, or .01¢ per mmBtu.) NYMEX 

staff has also been advised by market participants who trade on both markets that 

a rise (fall) in price on one trading venue will be followed almost immediately by 

a rise (fall) in price on the other trading venue, whether the change in price be initiated on either NYMEX or ICE. These observations of real-world market activity 

along with the recent CFTC staff study support the conclusion that trading of ICE 

natural gas swaps do in fact contribute to, influence and affect the price of the related natural gas contracts on NYMEX. No one could have predicted in 2000, when 

the exemption was crafted for energy swaps, how this market would evolve. 

The ICE market now holds a significant market share of natural gas trading, and 

a number of observers have suggested that most of the natural gas trading in the 

ICE Henry Hub swap is subsequently cleared by the London Clearing House, the 

clearing organization contracted by ICE to provide clearing services. Thus, there is 

now a concentration of market activity and positions occurring on the ICE market, 

as well as the exchange-like concentration and mutualization of financial risk at the 

clearing house level from that activity. 

As previously noted, at the time that the CFMA was being formulated in Congress, the presumption was that larger, sophisticated market participants did not 

need a regulatory agency to protect them from trading with each other. Also, there 

were no perceived concerns at that time about potential impact on the public interest implicated by trading on ECMs. Yet, what has become clear in the last several 

years is that the changing nature and role of ECM venues, such as ICE, do now 

trigger public interest concerns in several ways, including with respect to the mulVerDate 0ct 09 2002 11:27 Apr 02, 2009 Jkt 041481 PO 00000 Frm 00024 Fmt 6633 Sfmt 6621 I:\DOCS\110-27\48374.TXT SOLEM PsN: REBEKA
21

tiple impacts on other trading venues that are regulated, as well as through the exchange-like aggregation of financial risk. 

The CFMA, however, did contemplate the possibility of ECMs becoming price discovery markets and, accordingly gave the CFTC authority to make the determination that an ECM performed a significant price discovery function and to require 

the dissemination of prices, trading volume and other trading data. This authority 

has never been exercised despite the tremendous growth in the volume of trading 

in the natural gas contract on ICE and the clear linkage between that market and 

the NYMEX. In recent public statements at both the staff and the Commission level, 

there have been indications from the CFTC that the price discovery criteria initially 

established by CFTC rules in 2004 may have become outdated. Consequently, CFTC 

staff is now reviewing those standards and considering whether to replace them 

with newer criteria that more appropriately capture the current marketplace reality. 

NYMEX does not have any ongoing formal relationship with ICE. In particular, 

as ICE and NYMEX are in competition with each other, there are currently no arrangements in place, such as information-sharing, to address market integrity 

issues. NYMEX as a DCM does have affirmative self-regulatory obligations; ICE as 

an ECM has no such duties. Yet, from a markets perspective, the ICE and NYMEX 

trading venues for natural gas are tightly linked and highly interactive; trading activity and price movement on one venue can quickly affect and influence price movement on the other venue. 

As one case example of concerns created for NYMEX as a DCM because of the 

differences in the level of regulation, NYMEX staff was aware of and monitored all 

open positions that Amaranth maintained in NYMEX trading venues, including the 

physically delivered NG natural gas futures contract. NYMEX conducted regular reviews of Amaranth’s open positions in excess of position accountability levels prescribed by NYMEX rule. NYMEX staff members directed Amaranth in early August 

2006 to reduce its open positions in the first two nearby contract months based upon 

what they believed to be a significant concentration in NYMEX markets in Natural 

Gas (relying upon an NG ‘‘futures only’’ approach). NYMEX believes that such a directive was prudent and also was effective with respect to reducing positions carried 

on our platform. 

As noted, NYMEX maintains no information sharing agreement of any kind with 

ICE; the Exchange also observes that, during the period in question, the CFTC was 

not receiving any regular information from ICE as to positions on its platform. 

Thus, a shift of positions by Amaranth from NYMEX to ICE was undetectable at 

that time both by NYMEX and the CFTC. NYMEX believes that the outdated provisions of the CEA concerning ECMs do raise concerns not only for DCMS and for 

regulators but also for market participants and indeed for the general public as a 

whole. 

While the dissemination of market data from ICE would be useful, the CFTC’s 

existing statutory authority does not go far enough in order to address the significant regulatory problems identified by the Amaranth case. Thus, a legislative 

change is required to give the CFTC a certain level of authority over these markets 

as needed to address the identified public interest concerns. 

It has become apparent to NYMEX that the broad structural issues raised by 

changes in the marketplace cannot be addressed effectively at the level of individual 

exchanges. For example, earlier this year, in an effort to cooperate with the Federal 

Energy Regulatory Commission (FERC) and following consultation with CFTC staff, 

NYMEX issued a compliance advisory in the form of a policy statement related to 

exemptions from position limits in NYMEX Natural Gas (NG) futures contracts. 

NYMEX adopted this new policy on an interim basis in a good faith effort to carry 

out its self-regulatory responsibilities and to address on an individual exchange 

level the market reality demonstrated by Amaranth’s trading on both regulated and 

unregulated markets. 

However, this experience has had an adverse impact on NYMEX’s trading venues 

and is seemingly creating the result of shifting trading volume (during the critically 

important NG closing range period at NYMEX on the final day of trading) from our 

regulated trading venue to unregulated trading venues. Specifically, the new interim policy implemented by NYMEX on a good-faith basis has: (1) reduced volume 

on NYMEX during the critical 30 minute closing range period; (2) presumably shifted volume from the regulated to the unregulated trading venues; and (3) failed to 

solve the structural imbalances brought to light by Amaranth’s trading. In addition, 

this policy could create new problems by diminishing the vitality of the natural gas 

industry’s pricing benchmark. Consequently, NYMEX now believes strongly that 

legislative change is both necessary and appropriate. 

NYMEX believes that a targeted approach that directly addresses the specific 

issues raised by these industry changes would be the most effective policy response 

22

and would provide the greatest assurance of limiting the unintended consequences 

of more sweeping or draconian changes. Thus, NYMEX believes that a heightened 

level of CFTC regulation and oversight should be mandated for certain products listed on a particular ECM triggering the public policy concerns noted above. NYMEX 

does not believe that the case has been made for extending such heightened regulation to other products listed on such an ECM, to other ECMs that have not triggered these policy interests and concerns, or to the traditional bilateral OTC market. 

In particular, for those products trading on ECMs that have triggered public policy interests and concerns, NYMEX believes that the CEA should be amended to require routine mandated large trader reporting and position accountability requirements for financially settled ECM contracts that are highly linked to and functionally equivalent with regulated DCM contracts. Such ECMs also must be assigned 

self-regulatory organization duties to police their own markets and to submit applicable rule changes to the CFTC in a manner similar to other regulated entities; the 

CFTC also should have clear authority to address any failures by the ECM to comply with such requirements. NYMEX believes strongly that such statutory changes 

are necessary and appropriate and would not negatively impact the core price discovery and hedging functions provided by derivatives markets. 

At present, the greatest attention has been focused upon energy products listed 

by ECMs. NYMEX does not believe it would be appropriate to exclude products by 

category from heightened regulation, as markets may evolve for other products, such 

as metals, biofuel or weather derivatives, in a manner similar to the evolution of 

energy markets. 

The targeted approach that NYMEX recommends should not unduly affect the 

ability of ECMs to be sources of innovation, including with respect to the adoption 

of new trading technologies. This targeted approach may result in an ECM needing 

to distinguish on its electronic trading system those products that are subject to 

CFTC oversight from those products that remain exempt from CFTC regulation. 

However, more generally, NYMEX’s recommended approach would not appear to require whole-sale changes in an ECM’s business model. 

It has been suggested that any manner of regulation of an ECM would lead immediately to the shift of trading elsewhere, either to the traditional bilateral OTC market or to less-regulated foreign boards of trade. NYMEX believes that this prospect 

is improbable for several reasons: (1) market participants will continue to be attracted to markets that offer pools of liquidity for trading in their products; (2) market participants appear to have a preference for the speed and efficiency of electronic trading as compared to the traditional phone bilateral market; and (3) electronic trading systems facilitate the clearing of traded products, which also seems 

to be the growing preference for OTC participants in a variety of products. Consequently, NYMEX believes that the hypothetical prospect of a worst-case scenario 

should not be misused to dissuade Congress or the CFTC from undertaking carefully considered and targeted solutions that can effectively fix the current shortcomings of the existing statutory structure.

III. The CFTC has exclusive jurisdiction over futures transactions and 

markets.

Since the original passage of the CEA, the CFTC has had clear and unambiguous 

exclusive authority over futures transactions and markets. When the CEA was first 

enacted, Congress provided that the CFTC have ‘‘exclusive jurisdiction. . . . with 

respect to accounts, agreements and transactions involving contracts of sale of a 

commodity for future delivery.’’ 7 U.S.C. § 2(a)(1)(A) (emphasis added.) Moreover, the 

legislative history is quite clear as to Congress’ legislative intent: ‘‘(a) the Commission’s jurisdiction over futures markets or other exchanges is exclusive and includes 

the regulation of commodity accounts, commodity trading agreements, and commodity options; (b) the Commission’s jurisdiction, where applicable, supersedes state 

as well as Federal agencies. . . .’’ Sen. Rep. No. 93–1131, 93rd Cong., 2d Sess., 

(1974) U.S.C.A.N. p. 48. In particular, Congress expressly made clear that the 

CFTC’s jurisdiction over futures transactions and markets was to ‘‘avoid unnecessary, overlapping and duplicative regulation.’’ 120 Cong. Rec. H34, 736 (Oct. 9, 

1974). 

The Federal courts have consistently upheld and affirmed this exclusive jurisdiction. Thus, for example, the U.S. Seventh Circuit Court of Appeals observed that 

the purpose of the CEA was to place the futures markets ‘‘under a uniform set of 

regulations.’’ Am. Agric. Movement, Inc. v. Board of Trade of the City of Chicago, 

977 F. 2d 1147, 1155–57 (7th Cir. 1992). 

The Energy Policy Act of 2005 (EPAct) provided the FERC for the first time with 

enforcement powers in the form of anti-manipulation authority over transactions in 

23

connection with its jurisdictional entities. In addition, the EPAct directed that 

FERC establish a memorandum of understanding with the CFTC to work together 

cooperatively and to share information. It is interesting to note that, in that memorandum of understanding, the FERC specifically acknowledged that the CFTC: ‘‘has 

exclusive jurisdiction with respect to accounts, agreements, and transactions involving contracts of sale of a commodity for future delivery. . . .’’ (emphasis added.) 

More recently, FERC appears to have interpreted its new found authority expansively in a manner that encroaches upon the CFTC’s exclusive authority over transactions executed on futures exchanges. FERC argues that its jurisdiction includes 

authority over futures contracts that serve as a price reference for cash transactions 

which are entered into by its jurisdictional entities. The effect of this broad construction (of the language in EPAct granting FERC anti-manipulation authority 

over cash market transactions) is the elimination of the CFTC’s exclusive jurisdiction over futures market transactions. Thus, the latest FERC position is clearly inconsistent with the plain meaning of the CEA’s exclusivity provisions. It is also inconsistent with the general understanding of the terms of the memorandum of understanding that FERC negotiated and ultimately executed with the CFTC. 

NYMEX believes strongly that Congress was correct when it established the 

CEA’s statutory framework to provide for uniform regulation of futures transactions 

and markets. The Exchange also believes that it is clear that the CFTC currently 

has and should continue to have exclusive authority and jurisdiction over futures 

transactions and markets. This is imperative to avoid duplicative and conflicting 

regulation. To vary from this prudent regulatory structure would only create confusion, inconsistency and uncertainty, ultimately harming the vitality and effectiveness of derivatives markets as well as the broader economy relying upon such markets for price discovery and hedging of risk. 

Conclusion 

The CFMA is a landmark piece of Federal legislation that has provided critically 

needed legal certainty and regulatory streamlining and modernization to U.S. futures and derivatives markets. The CFMA provides a well-considered oversight 

framework for futures markets that has enhanced the abilities of NYMEX and the 

other regulated exchanges to operate in a rapidly changing business environment. 

The Exchange further believes that the tiered statutory structure for trading facilities has been effective in many respects. However, a series of profound changes have 

occurred in various OTC markets since the passage of the CFMA, including technological advances in trading, such that the regulated DCM, NYMEX, and the unregulated ECM, IntercontinentalExchange, have become highly linked trading venues. 

As a result of this phenomenon, which could not have been reasonably predicted 

only a few short years ago, the current statutory structure no longer works for certain markets now operating as ECMs. 

Specifically, the regulatory disparity between the NYMEX and certain ECMs, particularly the ICE, which are functionally equivalent, has created serious challenges 

for the CFTC and for NYMEX in its capacity as an SRO. NYMEX has also concluded that ECMs such as ICE, which function more like a traditional exchange and 

which are linked to an established exchange, should be subject to regulation of the 

CFTC for certain products in the form of large trader reporting, position limits/accountability levels and self-regulatory responsibilities. In addition, the continuing 

exchange-like aggregation and mutualization of risk at the clearinghouse level from 

trading on active ECMs such as ICE, where large positions are not monitored, raise 

concerns about spill-over or ripple implications for other clearing members and for 

various clearing organizations that share common clearing members. Consequently, 

legislative change is necessary to address the real public interest concerns created 

by the current structure of the OTC electronic trading market and the potential for 

systemic financial risk from a market crisis involving significant activity occurring 

on the unregulated trading venue. 

Finally, over thirty years ago, Congress unambiguously gave the CFTC exclusive 

statutory authority over the regulation of futures transactions. This exclusive authority has been reaffirmed by Congress in every subsequent reauthorization of the 

CEA and is also established case law in the Federal courts. NYMEX believes strongly that the CFTC currently has and should continue to have exclusive authority and 

jurisdiction over futures transactions and markets. To vary from this prudent structure would only create confusion, inconsistency and uncertainty, ultimately harming 

the vitality and effectiveness of derivatives markets as well as the broader economy 

relying upon such markets for price discovery and hedging of risk. 

I thank you for the opportunity to share the viewpoint of the New York Mercantile Exchange with you today. I will be happy to answer any questions that any 

Members of the Committee may have.

24

Mr. ETHERIDGE. Thank you, sir. Mr. Carlson. 

STATEMENT OF LAYNE G. CARLSON, CORPORATE SECRETARY 

AND TREASURER, MINNEAPOLIS GRAIN EXCHANGE,

MINNEAPOLIS, MN 

Mr. CARLSON. Good morning. My name is Layne Carlson and I 

am an officer of the Minneapolis Grain Exchange. It is a great 

pleasure to be here before the Subcommittee and speak on matters 

important to us. The Minneapolis Grain Exchange is both a Designated Contract Market for trading futures and a Derivatives 

Clearing Organization, which means we clear all trades executed 

on our market and assume all counterparty risk that the buyers 

and sellers will make payment for the contracts traded. As a Designated Contract Market and a Derivatives Clearing Organization, 

the MGEX is subject to CFTC oversight of our trading markets and 

our clearing operations. 

The Grain Exchange was first established in 1881 and is the only 

futures and options market for hard red spring wheat and five 

index contracts based on wheat, corn and soybeans. Clearly, our 

current focus on agricultural based contracts and being located in 

the Midwest these past 126 years, we are part of that bread basket 

of America. However, traders from around the world now trade our 

contracts and that trend is expected to continue. Trade volume and 

open interest records are becoming routine at the Grain Exchange. 

In short, the Grain Exchange provides a demonstrated and valuable service to the public for price discovery and risk control that 

goes beyond just agriculture, merchandising and food product sectors. 

While the Grain Exchange is not the size of the better known 

contract markets in Chicago and New York, we can be and are affected by global events, domestic and international policies, Federal 

laws and CFTC rules and regulations. Events and rules that may 

affect large markets nominally may be significant to the MGEX, 

our clearing members, our market participants and our membership. Consequently, what is put into or left out of the bill reauthorizing the CFTC can be positive or detrimental to us as a viable 

market. 

One item that is debated from time to time is folding the CFTC 

into the Securities and Exchange Commission. From the viewpoint 

of the Grain Exchange, we believe that would be detrimental. 

While the CFTC and the SEC share some common goals, such as 

protecting the marketplace from fraud, we also have unique and 

competing purposes. No more so was this in evidence than the recent events surround Sentinel Management Group. Sentinel was a 

specialized firm investing funds on behalf of other firms, many of 

whom were small clearing members at the Grain Exchange. When 

Sentinel froze the release of customer funds, it put a severe strain 

on them and had the potential to materially affect the operations 

of the Grain Exchange. 

The CFTC recognized the risk to the futures industry and 

worked with the exchanges and the clearinghouse on behalf of the 

FCMs to get some of those funds released so that certain FCMs 

could remain a going concern. The SEC, on the other hand, initially 

tried to prevent the release of the funds. The point being, a Federal 

25

regulator that is more closely attuned to the needs of those it is 

regulating is preferable to a regulator that is monitoring multiple 

industries. 

As mentioned earlier, the MGEX is not the size of our larger contract markets. As such, when laws and rules focus on addressing 

issues deemed important to them or the futures industry it can 

have a material and unintended spillover effect to the Grain Exchange. In other words, in this instance, a one-size-fits-all approach 

regulatory law may not—may be easier to draft and implement, 

but it often creates unnecessary cost for the Grain Exchange, which 

is forced to address compliance issues not present in our size market. A perfect example was the perceived conflict of interest within 

large for-profit entities. At no time did those allegations of problems within the governance or regulatory structure extend to mutual or not-for-profit entities, such as the Grain Exchange. 

Nonetheless, the Grain Exchange was required to meet new regulations mandating a minimum percentage of narrowly defined 

public directors be placed on our Board and even the establishment 

of a regulatory oversight committee. The regulatory oversight committee has a requirement of at least three public directors, which 

is puzzling to the Grain Exchange, since we only have three staff 

members in our regulatory department. Further, finding qualified 

individuals to serve in that capacity is not easy and it is going to 

likely require funding. In short the MGEX gets penalized for something perceived happening elsewhere in the industry. 

An annual budget topic that won’t go away is the transaction fee 

for commodities trades that are executed. While a source of revenue for the government, it is essentially another layer of taxation 

on the futures industry. The industry in which we operate is extremely price competitive and worldwide the focus, again, is on reducing costs and fees to be competitive. The MGEX is no different. 

We have to look at our trading costs, as well. A Federal transaction 

fee can only hinder our ability to be competitive on cost. Further, 

the regulatory burden should not be placed just on market participants since all taxpayers benefit from that. 

The MGEX is very supportive and thankful for the regulatory 

changes Congress was able to initiate by passing the CFMA of 

2000. We view the Act as a welcome potential to reduce the regulatory burden experienced by traditional and domestic markets, 

compared to foreign. The MGEX believes there has been an improvement in the area and we would like to thank the CFTC, as 

well, for moving from a very prescriptive regulatory policy to a 

more flexible approach with the introduction of core principles. In 

short, we support the reauthorization of the CFTC. 

The MGEX again thanks the Subcommittee for this opportunity 

to express our views. 

[The prepared statement of Mr. Carlson follows:]

PREPARED STATEMENT OF LAYNE G. CARLSON, CORPORATE SECRETARY AND

TREASURER, MINNEAPOLIS GRAIN EXCHANGE, MINNEAPOLIS, MN 

Good morning, my name is Layne G. Carlson and I am an officer of the Minneapolis Grain Exchange (MGEX). It is a great pleasure to be here before the Subcommittee on General Farm Commodities and Risk Management, and speak on 

matters important to us. 

26

The Minneapolis Grain Exchange is both a Designated Contract Market (DCM) 

for trading futures and a Derivatives Clearing Organization (DCO) which means we 

clear all trades executed on our market and assume the counterparty risk that the 

buyers and sellers will make payment for the contracts traded. As a DCM and DCO, 

the MGEX is subject to CFTC oversight of our trading markets and clearing operations. 

The Minneapolis Grain Exchange was first established in 1881, and is the only 

futures and options market for Hard Red Spring Wheat, and five Index contracts 

based on wheat, corn and soybeans. Clearly, our current focus is on agriculture 

based contracts. Being located in the Midwest these past 126 years, we are part of 

the bread basket of America. However, traders from around the world trade our contracts and that trend is expected to continue. Trade volume and open interest 

records are becoming routine at the MGEX. In short, the MGEX provides a demonstrated and valuable service to the public for price discovery and risk control that 

goes beyond just the agriculture, merchandising, and food product sectors. 

While the MGEX is not the size of the better known contract markets in Chicago 

and New York, we can be and are affected by global events, domestic and international policies, Federal laws, and CFTC rules and regulations. Events and rules 

that may affect large markets nominally may be significant to the MGEX, our clearing members, market participants and membership. Consequently, what is put into 

or left out of any bill reauthorizing the CFTC can be positive or detrimental to the 

MGEX’ future as a viable market. 

One item that is debated from time to time, is folding the CFTC into the Securities and Exchange Commission (SEC). From the viewpoint of the MGEX, we believe 

that would be detrimental. While the CFTC and SEC share some common goals, 

such as protecting the marketplace from fraud, each also have unique and competing purposes. No more so was this in evidence than with the recent events surrounding Sentinel Management Group, Inc. (Sentinel). Sentinel was a specialized 

firm investing funds on behalf of other firms, many of whom were small clearing 

members investing customer funds. Some of these firms were clearing members and 

futures commission merchants (FCMs) at the MGEX. When Sentinel froze the release of customer funds, it put a severe strain on them and had the potential to 

materially affect the MGEX. The CFTC recognized the risks to the futures industry 

and worked with the exchanges and clearing houses on behalf of FCMs to get some 

of the funds released so that certain FCMs could remain a going concern. The SEC, 

on the other hand, initially tried to prevent the release of the funds. The point 

being, a Federal regulator that is more closely attuned to the needs of those it is 

regulating is preferable to a regulator that is monitoring multiple industries. 

As mentioned earlier, the MGEX is not the size of the larger contract markets. 

As such, when laws and rules focus on addressing issues deemed important to them 

or the futures industry, it can have a material and unintended spillover effect to 

the MGEX. In other words, a one-size-fits-all approach to regulatory laws and rules 

may be easier to draft and implement, but it often creates unnecessary costs for the 

MGEX which is forced to address compliance issues not present in our size market. 

A perfect example was the perceived conflicts of interest within the large for profit 

entities. At no time did the allegations of problems within the governance or regulatory structures extend to the mutual or not for profit entities such as the MGEX. 

Nonetheless, the MGEX was required to meet the new regulations mandating a 

minimum percentage of narrowly defined public directors be placed on our board 

and the establishment of a Regulatory Oversight Committee (ROC). The CFTC requirement that the MGEX create a ROC consisting of at least three public directors 

to monitor the MGEX regulatory department consisting of three staff employees is 

entirely puzzling. Further, finding qualified individuals to serve in that capacity is 

not easy and will likely require funding. In short, the MGEX gets penalized for 

something perceived happening elsewhere in the industry. 

An annual budget topic that won’t go away is the transaction fee for each commodities trade executed. While a source of revenue for the government, it essentially 

is another layer of taxation to the futures industry. The industry in which we operate is extremely price competitive. Worldwide, the focus is on reducing costs and 

fees to remain competitive. The MGEX is no different; we have to look at our trading and clearing costs as well. A Federal transaction fee can only hinder the ability 

to be competitive on cost. Further, the regulatory burden should not be placed on 

just market participants since all taxpayers benefit from government oversight. 

The MGEX was supportive of and thankful for the regulatory changes Congress 

was able to initiate by passing the Commodity Futures Modernization Act of 2000. 

The MGEX viewed the Act as a welcome potential to reduce the regulatory burden 

experienced by traditional domestic contract markets compared to foreign markets. 

The MGEX believes there has been an improvement in that area. The MGEX exVerDate 0ct 09 2002 11:27 Apr 02, 2009 Jkt 041481 PO 00000 Frm 00030 Fmt 6633 Sfmt 6621 I:\DOCS\110-27\48374.TXT SOLEM PsN: REBEKA
27

presses its thanks to the CFTC as well for moving from a very prescriptive regulatory policy to a more flexible approach with the introduction of core principles. 

However, the MGEX would like to see Congress’ original intention for a flexible regulatory environment extended further to specifically account for small contract markets or not for profit entities. The MGEX looks forward to working with CFTC Acting Chairman Lukken and the other Commissioners in applying that flexibility. 

The Act also opened up the domestic market to non-traditional trading markets 

such as DTEFs and ECMs. These new markets were, for the most part, excluded 

or exempt from much of the regulatory burdens still imposed on the traditional contract markets such as the MGEX. While the new markets provide many beneficial 

trading products, the traditional small markets remain under a regulatory oversight 

that even with the changes noted earlier has not moved far enough from its preAct days to account for small contract markets. The MGEX is simply looking for 

that level playing field so that we can compete in areas such as new trade products. 

The MGEX again thanks the Subcommittee for this opportunity to express our 

views. That concludes my testimony.

Mr. ETHERIDGE. Thank you, sir. Mr. Sprecher. 

STATEMENT OF JEFFREY C. SPRECHER, FOUNDER,

CHAIRMAN, AND CEO, INTERCONTINENTALEXCHANGE, INC.,

ATLANTA, GA 

Mr. SPRECHER. Mr. Chairman and Members, my name is Jeff 

Sprecher. I am the Chairman and Chief Executive Officer of 

IntercontinentalExchange, which is also known in the industry as 

ICE. We very much appreciate the opportunity to appear before 

you today to discuss our views on the reauthorization. ICE was established in the year 2000 as an over-the-counter energy market 

and since that time, ICE has grown significantly through both innovation and acquisition. It is now a diversified global marketplace 

in futures and over-the-counter derivatives across a variety of product classes, including agriculture and energy commodities, foreign 

exchange and equity indices. 

Headquartered in Atlanta, ICE now has offices in New York, 

Chicago, Houston, London, Singapore, Winnipeg and Calgary. ICE 

hosts three separate markets on our electronic platform. First, 

there is ICE’s over-the-counter energy market, which operates 

under the CEA as an exempt commercial market. Second is a British subsidiary, ICE Futures Europe, which was formerly known at 

the International Petroleum Exchange of London, and that is regulated by the UKFSA. Third is an American subsidiary, ICE Futures 

U.S., which was formerly known as the New York Board of Trade, 

which is a Designated Contract Market under the CEA. ICE recently also acquired the Winnipeg Commodity Exchange, a regulated futures exchange in Canada, which will also be migrated to 

the ICE electronic platform shortly. 

ICE Futures U.S. offers both traditional open-outcry trading, as 

well as electronic trading in futures and options on soft commodities like coffee, sugar and cotton, and financial indices and currencies. ICE Futures U.S. is headquartered in New York City. Adding electronic trading to these markets, beginning just this past 

February, gave market users greater flexibility in trade execution 

with availability via the Internet or dedicated lines anywhere in 

the world. As a result, ICE Futures U.S. became more competitive 

in the global marketplace, as evidenced by a rapid increase in trading volume in excess of 35 percent. ICE also acquired a U.S. clearinghouse which is now called ICE Clear U.S. and it continues to 

28

be operated as a registered Derivatives Clearing Organization 

under the CEA. 

As the Subcommittee considers the reauthorization of the CEA, 

we urge you to maintain the principles-based regulatory structure 

and flexibility that is embodied in the landmark Commodity Futures Modernization Act of 2000. In particular, the tiered system 

of regulation provides regulatory certainty and has placed the 

United States in a better position to attract business and maintain 

its competitive position in a global marketplace. ICE and it market 

participants, including energy producers, distributors and users 

have benefited significantly from regulatory flexibility that is embodied in the CFMA through the ECM structure established under 

Section 2(h)(3) of the Act. 

At the time of ICE’s formation, commercial hedgers had only two 

options if they wished to hedge energy price risk. They could seek 

to hedge their risks through one of a limited number of futures contracts that were traded on a regulated exchange, such as NYMEX, 

which offered liquidity, however, the terms of which were often an 

imperfect match for the hedging needs of commercial users. Or 

they could work with an investment bank or so-called voice broker, 

to negotiate a bilateral swap contract to address their specific hedging needs in a more tailored fashion. The bilateral swap markets 

were less than transparent and the commercial hedger often had 

little sense of where the true market was and whether it was being 

charged a fair price by the dealer or the voice broker. 

I formed ICE to bridge the gap between the existing futures market and voice brokered swaps market. Fundamentally, ICE’s overthe-counter functionality serves as an electronic voice broker, offering its services to institutional and commercial entities that participate in the over-the-counter markets, but allowing them to trade 

in a more transparent and much more cost-effective manner. ICE 

offers some bilateral swaps that are financially settled based on a 

futures contract price. We also offer a large number of customized 

swaps that are tailored to delivery locations of users around the 

country, and thus, are better able to meet the specific hedging 

needs of the end-user. 

Importantly, we offer all of these contracts through a transparent 

electronic marketplace that does not discriminate between market 

users, including the small utility, who gets the same treatment as 

a large investment bank. Furthermore, viewers and users can see 

the entire bid/offer stack, giving them access to the depth of market 

and the liquidity in the market. These tangible benefits from ICE’s 

commercial markets include more efficient hedging of price risk, 

greater transparency in all parts of the market, not just the benchmark futures hubs, and vastly improved liquidity through the introduction of more market participants. 

These benefits were brought about by ICE’s innovative business 

model, its product offerings and other changes to markets that 

were stimulated by our competitive challenge. As markets have 

grown and developed since the passage of the CFMA, so have new 

regulatory challenges. ICE advocates a targeted approach to any 

reform of the CEA, recognizing unique characteristics of many customized markets that have evolved and the importance of continuing to encourage market innovation. 

29

In this regard, some level of additional reporting and a system 

of position accountability may be appropriate for certain ECM contracts, specifically, those that settle on futures market contract 

prices and that are the true equivalent of regulated futures. However, most of the energy swap contracts traded on ICE are niche 

products that are over-the-counter markets, that are illiquid and 

they are not amenable to the application of such requirements. ICE 

therefore urges the Subcommittee to stay within the current regulatory framework and allow the CFTC to make adjustments that 

may be appropriate for particular products. 

Mr. Chairman, my complete statement has been submitted for 

the record and I look forward to answering your questions. 

[The prepared statement of Mr. Sprecher follows:]

PREPARED STATEMENT OF JEFFREY C. SPRECHER, FOUNDER, CHAIRMAN, AND CEO, 

INTERCONTINENTALEXCHANGE, INC., ATLANTA, GA 

Mr. Chairman, I am Jeff Sprecher, Chairman and Chief Executive Officer of 

IntercontinentalExchange, Inc., or ‘‘ICE.’’ We very much appreciate the opportunity 

to appear before you today to discuss our views on the reauthorization of the Commodity Exchange Act (the ‘‘Act’’ or ‘‘CEA’’). 

ICE was established in 2000 as an over-the-counter (OTC) market. Since that 

time, ICE has grown significantly, both through its own market growth fostered by 

ICE’s product, technology and trading innovations, as well as by acquisition of other 

markets to broaden its product offerings. 

Today, ICE operates a leading global marketplace in futures and OTC derivatives 

across a variety of product classes, including agricultural and energy commodities, 

foreign exchange and equity indexes. Commercial hedgers use our products to manage risk and investors provide necessary liquidity to the markets. Headquartered in 

Atlanta, ICE has offices in New York, Chicago, Houston, London, Singapore, and 

Calgary. 

ICE hosts three separate markets on our electronic trading platform—ICE’s OTC 

energy market, which operates under the CEA as an ‘‘exempt commercial market,’’ 

or ECM, and two subsidiaries: ICE Futures Europe, formerly known as the ‘‘International Petroleum Exchange,’’ which is regulated by the UK Futures and Securities 

Authority and ICE Futures U.S., formerly known as ‘‘The Board of Trade of the City 

of New York (NYBOT),’’ which is a regulated Designated Contract Market (DCM) 

under the CEA. 

ICE Futures U.S. offers traditional open-outcry trading in futures and options on 

soft commodities (coffee, sugar, cocoa, cotton, and orange juice), financial indexes 

and currencies through trading floors located in New York City and in Dublin, Ireland. In February 2007, ICE Futures U.S. started trading its core agricultural futures on the ICE electronic platform, side-by-side with open outcry and we are in 

the process of introducing electronic trading of futures and options in our equity 

index and foreign currency products. Adding the electronic platform gave market 

users greater flexibility in trade execution, with availability via Internet or dedicated lines anywhere in the world. As a result, ICE Futures U.S. became more competitive in the global marketplace, as evidenced by a 36% increase in volume in soft 

commodity futures during the first 6 months following initiation of electronic trading, compared to the same 6 month period in 2006. 

ICE also acquired NYBOT’s clearinghouse, which is now called ‘‘ICE Clear U.S.’’ 

and continues to be operated as a registered Derivatives Clearing Organization 

(DCO) under the CEA. Currently, it only clears trades transacted on ICE Futures 

U.S.. ICE’s other contracts are cleared through LCH.Clearnet Ltd. in the United 

Kingdom, but plans are underway to transition ICE’s other contracts to our own, 

newly-formed UK clearinghouse. 

As the Subcommittee considers reauthorization of the CEA, we urge you to maintain the principles-based regulatory structure and flexibility embodied in the landmark Commodity Futures Modernization Act of 2000 (CFMA). In particular, the 

tiered system of regulation provides regulatory certainty and has placed the United 

States in a better position to attract business and maintain competitiveness in the 

global marketplace. U.S. futures and derivatives markets flourished, while new 

technologies and products tailored to meet the changing needs of commercial customers and investors were given the opportunity to develop. 

30

ICE and its market participants, including energy producers, distributors and 

users, benefited significantly from the regulatory flexibility embodied in the CFMA 

through the ECM structure established under section 2(h)(3) of the Act. It allowed 

the development of a transparent electronic trading system for commercial and professional market users, allowing them to hedge risk in a more efficient and effective 

manner. 

As these markets have grown and developed since passage of the CFMA, new regulatory challenges have emerged. ICE advocates a targeted approach to any reform 

of the CEA. Such an approach recognizes the unique characteristics of the many 

customized markets that have evolved and the importance of continuing to encourage market innovation. 

In this regard, some level of additional reporting and a system of position accountability may be appropriate for certain ECM contracts—specifically, those that settle 

on a futures market contract price and that are the true economic equivalent of a 

contract actively traded on a regulated futures market. However, most of the energy 

swap contracts traded on ICE are niche OTC products that are not amenable to the 

application of such requirements. ICE therefore urges the Subcommittee to stay 

within the current regulatory framework and to allow the CFTC to make adjustments that may be appropriate for a few particular products. 

Background and History 

At the time of CFMA’s passage and ICE’s formation, commercial hedgers had two 

primary options if they wished to hedge energy price risk—they could seek to hedge 

their risk through one of the limited number of futures contracts traded on an exchange, such as NYMEX, or they could work with an investment bank or so-called 

‘‘voice broker’’ to negotiate a bilateral swap contract to address their hedging needs 

in a more tailored fashion. Each of these markets had its benefits and drawbacks. 

Futures exchanges such as NYMEX offered a limited number of highly liquid 

benchmark contracts. While these pricing benchmarks offered deep liquidity (and 

hence a better view of true market price at a given location), they usually did not 

address the precise hedging needs of the commercial user due to the limited number 

of contracts traded and the limited number of delivery points of those contracts. For 

example, a NYMEX Henry Hub natural gas futures contract is tied to the price of 

natural gas delivered at the Henry Hub in Tailgate, Louisiana. While relevant, the 

price of natural gas at the Henry Hub does not define the price of natural gas at 

all locations around the country for a large number of reasons, ranging from the 

influence of transportation and storage costs to local supply and demand dynamics. 

For this reason, futures contracts did not provide a complete hedge of the commercial user’s ultimate price risk. In addition, a physically delivered futures contract 

had the added problem that if held to expiration (the time through which a commercial user might need to hedge price risk), the holder of the contract could be forced 

to make or take delivery of the underlying commodity. 

Furthermore, NYMEX was, until the introduction of meaningful competition by 

ICE, overwhelmingly an open outcry trading market. The hedger or customer wishing to execute business would call its broker and typically be quoted a wide ‘‘bid/

ask spread’’. Customers often did not even get executed in the quoted range due to 

the time delay inherent in the process and the absence of firm, executable prices 

resulted in customers paying more to hedge their price risk—making their businesses more expensive to operate, with costs ultimately either being born by the 

business itself (resulting in lower operating margins) or by its customers (higher 

prices being charged to customers). Finally, open outcry gave floor traders who were 

trading for their own account an important time and information advantage in the 

market. 

Alternatively, if the hedger sought to hedge its price risk through use of a bilateral swap contract executed with a dealer (such as an investment bank) or through 

the services of a voice broker, the hedger faced a number of different trade-offs. On 

the one hand, the hedger could better tailor the product to its specific hedging 

needs, for example, by entering into a swap contract that was tied to a delivery 

point closer to where the commodity would be used. On the other hand, bilateral 

swap markets tended to be opaque and the commercial hedger often had little sense 

of where the true market was and whether it was being charged a fair premium 

by the dealer or voice broker for shifting the risk in question. Finally, there was 

no guarantee of fairness in pricing—different fees and better terms could be charged 

to different customers—meaning the small commercial player with limited hedging 

needs might not be offered the same opportunity as another market participant that 

transacted a significant volume of business with the investment bank or voice 

broker. As a result, spreads might be even wider than in the futures market. 

31

I formed ICE to bridge the gap between the existing futures market and the voice 

brokered swaps market. In addition to offering bilateral swaps tied to individual futures contracts (swaps that were financially settled and could be held to contract 

expiry), ICE also offered a large number of tailored swap contracts that, like those 

being offered in the broader OTC swaps market, were better tailored to the delivery 

locations of users around the country and thus better tailored to the specific hedging 

needs of the end user. Importantly, ICE offered all of these contracts through a 

transparent electronic marketplace offering firm, executable prices and employing a 

strict best bid/best offer trading protocol that did not discriminate between market 

users (the smallest utility would get the same treatment as the largest investment 

bank). Furthermore, ICE offered users a view into the ‘‘bid/offer’’ stack so that market participants could for the first time assess the depth of liquidity in a market. 

In summary, ICE provided market participants a compelling alternative to the 

hedging opportunities then being offered by the futures market or by the voice-brokered swaps market. Fundamentally, however, ICE served as an ‘‘electronic voice 

broker,’’ offering its services to the same institutional and commercial entities participating in the OTC market, but allowing them to trade in a more efficient and 

cost effective manner. 

Responding to the needs presented by the downturn in the merchant energy markets in 2002, ICE continued to innovate through its subsequent introduction of 

‘‘cleared’’ OTC swap contracts. Following its acquisition of ICE Futures Europe (formerly the International Petroleum Exchange), ICE for the first time had the infrastructure to offer the option of credit intermediation in a swap contract to better 

provide liquidity to the marketplace. The elimination of bilateral counterparty credit 

risk was an important innovation facilitated by the CFMA, which allowing contracts 

to be cleared through third party clearing arrangements such as the one ICE entered by ICE with a third party clearing house. 

Benefits to the Marketplace 

Ultimately, the tangible benefits to the marketplace included more efficient hedging of energy price risk (tighter markets), greater price transparency in all parts of 

the marketplace (not just at benchmark hubs tied to futures contracts), and vastly 

improved liquidity through the introduction of more participants (and thus greater 

price competition) in the markets. These benefits have not been limited to those 

brought about directly by ICE’s business and its product offerings, but include those 

resulting from changes to the business models and product offerings of other market 

participants that responded to the competitive challenge presented by ICE’s business. It is ultimately for others to determine cause and effect, but one cannot ignore 

the question of whether and how quickly other parts of the market, in some cases 

dominated by member interests, would have adopted electronic trading and pursued 

product innovation in the absence of the competition presented by ICE’s markets. 

One Size of Regulation Does Not Fit All Markets or Contracts 

As these markets have grown and developed, new regulatory challenges have 

emerged, requiring a thorough and careful review by Congress and the CFTC during 

the CEA reauthorization process. As we have stated previously before this Subcommittee, ICE advocates a targeted approach to any reform of the CEA. This approach recognizes the unique characteristics of the many customized markets that 

have evolved under the CFMA. Unfortunately, some in Congress are suggesting a 

uniform approach to regulating these markets. This would be a great mistake. 

The problem with ‘‘one-size-fits-all’’ regulation can best be illustrated by contrasting the historic nature of futures markets (limited number of actively traded 

benchmark contracts, all transactions executed through a broker who can trade for 

its own account or that of a retail customer) with the ECM OTC swaps markets 

(large number of niche products, many illiquid and thinly traded, principals only 

trading). Recognizing the importance of futures pricing benchmarks to the general 

public (a DCM is obligated to publish its prices to be used by the broader market), 

and in recognition of the potential for conflicts of interest due to members trading 

for their own accounts alongside business transacted on behalf of customers, some 

of whom were retail customers, DCM core principles were developed to facilitate 

regulation of the markets by the DCM, which acted as a self regulatory organization. The typical high level of liquidity in benchmark contracts make application of 

core principles such as market monitoring and position accountability and limits 

feasible and appropriate. 

Suggesting that these same DCM core principles, which were developed with the 

futures exchange model in mind, should apply to all OTC swap contracts traded on 

an ECM market is attempting to fit the proverbial square peg in a round hole. 

While some level of additional reporting and a system of position accountability may 

32

be appropriate for certain contracts—specifically, those that settle on a futures market contract price and that are the true economic equivalent of a contract actively 

traded on a regulated futures market—most of the energy swap contracts traded on 

ICE are niche OTC products that trade in illiquid markets that are not amenable 

to the application of DCM core principles. For example, how would an ECM actively 

monitor an illiquid swaps market in an attempt to ‘‘prevent manipulation’’ where 

price changes can be abrupt due to the limited liquidity in the market? How would 

an ECM swaps market administer accountability limits in a market that has only 

a handful of market participants? Should the ECM question when a single market 

participant holds 50% of the liquidity in an illiquid market when the market participant is one of the few providers of liquidity in the market? 

It is important to analyze these questions not in isolation, but in the context of 

market participants having alternatives such as OTC voice brokers through which 

they can conduct their business. Importantly, such OTC voice brokers can even offer 

their customers the benefits of clearing through use of block clearing facilities offered by NYMEX (and also by ICE). Faced with constant inquiries or regular reporting by the ECM related to legitimate market activity, and facing no such monitoring 

when it transacts through a voice broker, market participants might choose to conduct their business elsewhere. It is for these and other reasons that Congress and 

the Commission have developed the carefully calibrated two-tier regulatory structure applicable to DCMs and ECMs. We believe that the judgments made by Congress and the Commission thus far have been prudent and should generally be 

maintained. 

Conclusion 

ICE has always been and continues to be a strong proponent of open and competitive markets in energy commodities and other derivatives, and of appropriate regulatory oversight of those markets. As an operator of global futures and OTC markets, and as a publicly-held company, ICE understands the importance of ensuring 

the utmost confidence in its markets. To that end, we have continuously worked 

with the CFTC and other regulatory agencies in the U.S. and abroad in order to 

ensure that they have access to all relevant information available to ICE regarding 

trading activity on our markets. We have also worked closely with Congress to address the regulatory challenges presented by emerging markets and will continue 

to work cooperatively for solutions that promote the best marketplace possible. 

However, in prescribing regulation, it is important to consider the fundamental 

nature of the market in question and avoid engaging in a superficial, ‘‘one-size-fitsall’’ analysis that would unduly burden the efficient operation of markets and potentially stifle innovation. In short, the level of regulation should fit the market in 

question both in terms of the users who can access the market as well as the amenability of the market to active monitoring and the prevention of manipulative activity. 

The goal of regulation fitting the characteristics of the market in question has 

been ably achieved under the principles-based regulation embodied in the CFMA, 

and calls to apply DCM core principles to illiquid markets, to replace the ECM category of marketplace with a more regimented level of oversight, or to eliminate the 

ECM category entirely, are misguided and counterproductive. The CFMA has allowed for greater competition and heightened transparency and provided the CFTC 

with a deeper view of the OTC markets than they would have otherwise had. 

Mr. Chairman, thank you for the opportunity to share our views with you on reauthorization of the CEA. We look forward to continuing to work with the Subcommittee and your staff as you address this critical reauthorization. I would be 

happy to answer any questions you may have.

Mr. ETHERIDGE. Thank you, sir. Dr. Walsh. 

STATEMENT OF MICHAEL J. WALSH, PH.D., EXECUTIVE VICE 

PRESIDENT, CHICAGO CLIMATE EXCHANGE, CHICAGO, IL 

Dr. WALSH. Good morning, Mr. Chairman and Committee Members. Thank you for the chance to be here. I am a last minute substitute for Dr. Richard Sander, who, under doctor’s orders was told 

to stay in bed for a day or two and I appreciate the opportunity 

to brief you. The Chicago Climate Exchange is a real life example 

how the vision that under-lied the establishment of the Exempt 

Commercial Market structure has led to significant economic and 

social benefits for American businesses and farmers and foresters, 

33

because we were able to build an exchange rapidly and in an environment that fostered innovation and led to these benefits. 

The Chicago Climate Exchange operates a voluntary but legally 

binding greenhouse gas emission reduction and trading program. 

As you know, there is no such regulatory requirement for management of greenhouse gases in North America at this time, but many 

American businesses and businesses throughout the Western 

Hemisphere wanted to prepare and build their abilities to operate 

under market-based carbon constraints they are facing internationally. And more importantly, the Chicago Climate Exchange wanted 

to demonstrate firmly how U.S. farmers and foresters can be a core 

part of the solution set in market-based mechanisms to reduce 

greenhouse gas emissions and global warming. 

The Commodity Futures Modernization Act and its Exempt Commercial Market structure were critical in facilitating the implementation of Chicago Climate Exchange. It fostered innovation, speed 

to market and allowed us to be competitive on a global basis, as 

I will briefly explain in a moment. Chicago Climate Exchange also 

made the very important decision to develop a self-regulatory structure. We did this by establishing a detailed rule book for the capand-trade mechanism that governed the environmental aspects of 

the program, providing a transparent market, and by contracting 

with the NASD, now known as the Financial Industry Regulatory 

Authority, or FINRA, to provide regulatory services. 

Now, this is a market mechanism for environmental improvement that is modeled on the law that the U.S. Congress passed in 

1990, establishing a sulfur dioxide reduction cap and trade program. The members of the Exchange execute a legally binding contract to annually reduce their greenhouse gas emissions, have them 

independently audited—and every member of the Exchange has its 

emissions independently audited. All of the mitigation projects, 

such as agricultural soils, methane capture, reforestation, such as 

Senator Lucas’ farm, are subject to independent verification by 

qualified experts. 

So in achieving the annual emission reduction goals, there are 

options, there is flexibility. The members can either internally reduce their emissions or they can partner with other members of the 

Exchange, such as those industrial or governmental enterprises 

that beat the emission reduction goal and they can make a trade 

so they can combine to achieve the goals, or they can partner with 

the U.S. farmers and foresters who do qualified and verified mitigation practices on farms, livestock operations and forests. It has 

become a significant enterprise and there is lots of learning going 

on, lots of business opportunity being developed. 

The members of the Exchange, almost 350 members now, include 

agricultural businesses such Cargill and Smithfield Foods, Ford 

Motor Company, Temple Inland, Waste Management, Dupont, 

Bayer, universities, Bank of America. We have got a couple of 

states, several cities, even the United States House of Representatives has decided that it wants to, in part, address its greenhouse 

gas mitigation through participation in the Exchange. We are very 

happy to see engagement and participation around the world. It is 

critical to engage our partners in building these solutions wherever 

we can, including China and India. 

34

Now, it turns out that the members of the Exchange have found 

amazing internal efficiencies, business opportunities in developing 

new renewable energy and energy management systems, and they 

have a price of carbon to work towards and to manage towards. 

Many of the members joined the Exchange for lots of reasons, to 

better manage their emissions and energy consumption, but we 

would not have been able to establish this mechanism, this organized rules-based self-regulatory structure without the ECM structure, without the rule that facilitates and fosters innovation. 

Let me spend a short moment—I would love to spend a lot more 

time on this, my favorite topic, of how farmers and foresters are 

finding new income opportunities around the country in providing 

a global environmental service. The Iowa Farm Bureau, the North 

Dakota Farmers Union, farmers and foresters throughout the country are doing greenhouse gas mitigation services and being paid for 

it, right now. We would not be here if we were not able to expeditiously build the start-up mechanism and get it going. I should note 

that the Chicago Climate Exchange has been able to implement, in 

the field, some of these agricultural and forestry practices and 

verify those under a grant from the USDA, full disclosure. 

So we are demonstrating, on a daily basis, a globally significant 

piece of progress for environmental improvement and a cost-efficient rules-based structure. Had we faced a significantly higher 

cost structure due to institutional regulatory requirements, we 

would not have been able to get off the ground. It is as simple as 

that. We do think that having a self-regulatory service, having 

transparent rules-based markets, is absolutely critical to making 

sure that the environmental commodity is being exchanged in an 

area of integrity, but we are seeing, right now, that U.S. businesses, governments, educational institutions, farmers and foresters are enjoying benefits from the ability to quickly implement 

an innovative new structure. 

We would not have been able to realize the significant progress, 

demonstrating how to do this on the ground, demonstrating the full 

role that farmers and foresters should be able to participate in a 

market-based solution had we not been able to operate quickly and 

under the low-cost structure that the Exempt Commercial Market 

structure provided. We think it is an important opportunity to foster innovation. We have exported some of our skills sets internationally and now globally and we think this is a very critical innovation fostering element of the CFMA and we look forward to the 

open discussion. Thank you, Mr. Chairman. 

[The prepared statement of Dr. Walsh follows:]

PREPARED STATEMENT OF MICHAEL J. WALSH, PH.D., EXECUTIVE VICE PRESIDENT, 

CHICAGO CLIMATE EXCHANGE, CHICAGO, IL 

Chairman Etheridge, Congressman Moran and Members of the Subcommittee. I 

want to thank you for your invitation to be with you today. In the context of the 

discussions regarding Section 2(h)3 of the Commodity Exchange Act, I would like 

to share with the Subcommittee the experience of developing, launching and implementing the Chicago Climate Exchange (‘‘CCX’’), which is a cap-and-trade system 

that has been trading emissions allowances derived from real emissions reductions 

and offset projects in the United States since 2003, and the context in which it was 

created. 

As you know, the United States does not require emissions reductions of greenhouse gases and therefore most elements of the U.S. economy have not been able 

35

to access what has become known as the ‘‘carbon market.’’ However, the successful 

innovation, design and operation of CCX has enabled key members of the U.S. economy, including the agriculture sector, to realize the significant economic, financial, 

social and operational benefits associated with the reduction of greenhouse gas 

emissions and emissions trading, which was pioneered in the United States as part 

of the Clean Air Act. 

The Commodity Futures Modernization Act (‘‘CFMA’’) and the implementation of 

the Exempt Commercial Market (‘‘ECM’’) status were critical to facilitating the creation of the Chicago Climate Exchange. The intentions of the CFMA in terms of enabling legislation to foster innovation, ‘‘speed to market’’ and to enhance the competitiveness of U.S. commodities markets were fundamental in the development of 

CCX. At the same time, CCX’s decision to develop a self-regulatory structure was 

fundamental in ensuring the credibility and integrity of this nascent market. CCX 

did this by developing a rulebook for its cap-and-trade system, providing a transparent market and by contracting with the NASD, now FINRA, to provide regulatory services to CCX. 

CCX is a financial institution that exists to advance economic, environmental and 

social goals. We are the world’s first, and North America’s only, voluntary but legally binding rules-based greenhouse gas emission reduction and trading program, 

as well as the only global emissions trading system handling all six greenhouse 

gases with a multi-sector emissions reduction requirement. Designed in 1999 and 

2000 as a pilot project based in the Midwest, CCX began trading in 2003, and its 

membership has grown to almost 350 diverse entities including some of the most 

significant names in the American economy. 

Emissions of CCX Members represent 14% of stationary emission sources in the 

United States. CCX members execute legally binding commitments to meet annual 

emission reduction goals of 4% below baseline for 2006 and 6% below by 2010, at 

a minimum. Members who exceed their reduction commitments may sell allowances; 

those who do not make the required cuts must buy allowances to come into compliance. CCX Rules require that all emission baselines, annual reduction commitments 

and offset projects are subject to a standardized third party verification by FINRA. 

As an ECM, screen trading is principal-to-principal trading. FINRA conducts market surveillance to monitor trading activity on the CCX trading platform for market 

manipulation and fraud. 

CCX Membership includes representatives from a diverse array of economic sectors, both domestically and abroad, including nearly every state represented on this 

Committee. Among these sectors, CCX membership includes agricultural entities 

(Cargill and Smithfield Foods), automotive (Ford Motor Co.), utilities (American 

Electric Power and American Municipal Power), chemicals (DuPont, Bayer and Dow 

Corning), forestry (International Paper and MeadWestvaco), academic institutions 

(Michigan State, Iowa, Minnesota and Oklahoma) and financial institutions (Bank 

of America), and public sector entities such as the States of New Mexico and Illinois, 

seven municipalities and three counties (King County, County of Sacramento and 

Miami-Dade County). Approximately 25 million people live and work in the cities, 

counties and states which are members of CCX and another 2 million are employed 

by its corporate members. In addition, I am proud to note that the U.S. House of 

Representatives itself is in the process of becoming an Exchange Participant on the 

Chicago Climate Exchange as part of its efforts to address the greenhouse gases derived from operating this building and its offices. 

CCX international membership includes a city and a utility in Australia (Melbourne and AGL), and eight companies in South America which have taken on a 

legally-binding commitment to reduce their emissions even though they are not yet 

required to do so. We have also engaged the interest of both Chinese and Indian 

policy leaders on the issue of market-based initiatives to address environmental concerns. We have approved and registered offset projects from both China and India, 

as well as Costa Rica and Brazil. 

Members report that the baselines, audits and annual commitments represent 

concrete goals that help them focus on internal efficiencies and attendant financial 

opportunities. They reduced their emissions through increased energy efficiency, expanded use of renewable fuels, and realized low-cost reductions in non-CO2 greenhouse gases through use of direct abatement equipment. Many members have exceeded their reduction targets. As an important aside, another benefit of the price 

discovery mechanism provided by an organized market is the ability to spur innovations. Now that the price of carbon is more transparent, entrepreneurs in areas related to clean energy have been able to raise capital from both fixed income and 

equity investors after factoring in CCX prices in their business plans. 

Members join CCX for various reasons, but all for at least these reasons: to better 

master their emissions data and to gain early adopter benefits with price discovery 

36

for carbon and all aspects of risk mitigation, including financial, operational, and 

reputational. To date, CCX Members as a group have reduced their emissions by 

almost 11% beyond their annual commitments, representing 90 million tons of reduction of CO2 in the first three compliance years. These activities have placed CCX 

members in the United States at the forefront of a major economic opportunity. Had 

CCX not been able to form as an ECM, these benefits would have been lost, along 

with the vital time needed to build our infrastructure in order to address these important environmental and economic challenges. 

In addition, the CCX Offsets Program is proving successful at rewarding emissions mitigation through sustainable farming and forestry, while also providing a 

new income source for U.S. agriculture. Entities such as the Iowa Farm Bureau and 

the National Farmers Union are leading the way in building the infrastructure for 

the agricultural offsets program. To date, projects representing more than 2 million 

acres of conservation tillage and grassland in multiple U.S. States have been registered, verified and sold through the Exchange. In 2005 and 2006, over 1.2 million 

acres in the U.S. have been enrolled, with producers earning over $3 million from 

the sale of CCX Carbon Financial Instrument contracts. The same growth was experienced in the tonnage enrolled under the agricultural methane program, which 

went from 24,100 tons to 207,200 tons during the same period. These offsets provide 

a least-cost avenue for society to reduce greenhouse gas emissions in addition to enhancing farm profitability and income diversification. 

American agricultural producers are taking a leadership role in promoting long 

term sustainability of U.S. agricultural soils through the CCX. The CCX Offsets 

Committee has recently approved protocols for rangeland management soil carbon 

offsets projects, which will soon be registered in the Exchange. A Member of this 

Congress, Senator Richard Lugar, has registered reforestation credits from trees 

planted at his Indiana family farm, which is helping set the example for many other 

farmers. CCX is also pleased to inform the Committee that it is received a grant 

supported by the U.S. Department of Agriculture to further the goals and objectives 

of the CCX agricultural offset program. Expansion of this program can help minimize the need for additional subsidies, lower the tax burden required to finance 

them while encouraging behavioral change and innovative practices. It is also important to note that the potential for offsets coming from coal mine/coal bed methane is substantial, and protocols have been approved and projects will soon be registered. 

CCX has also created a futures exchange for trading futures contracts based on 

U.S. SO2 and NOX emission allowances—the Chicago Climate Futures Exchange—

which is a designated contract market regulated by the Commodity Futures Trading 

Commission; and the European Climate Exchange, the leading marketplace for carbon emissions in Europe, regulated by the United Kingdom’s Financial Services Authority. In a note of irony, we have American ingenuity and financial know-how 

being exported to Europe. Jobs are being created and an entire new field of specialization is being developed in both the U.S. and around the world. These financial 

institutions advance social objectives and economically efficient environmental protection by providing rules-based markets with low transaction costs and transparent 

prices. 

The effectiveness of a cap-and-trade system with the above design features is now 

being demonstrated every day by CCX members across the globe. The environmental and economic benefits being generated are of national and global significance. The innovative approach taken by CCX benefited greatly from its ability to 

establish and function as an Exempt Commercial Market. The costs of establishing 

an exchange such as ours from an institutional and regulatory standpoint would 

have been prohibitive had we not had this opportunity. At the same time, the importance of the regulatory services provided by FINRA in the case of CCX is critical. 

In a cap-and-trade system the ability to ascertain the quality of the commodity 

being traded is fundamental for market participants and the integrity of the program. 

As you can see from our experience, CCX’s objective is to provide a social benefit 

through the reduction of greenhouse gases in the atmosphere. For that to have happened, proper measurement, monitoring and verification were necessary and, in our 

case, has enabled thousands of U.S. farmers and foresters to provide an environmental service in a credible and transparent way. We are happy to announce that 

the world’s largest market in terms of emissions under management now operates 

out of Chicago, and its birth and ability to stay competitive have benefited tremendously from the provisions of the CFMA and the Exempt Commercial Market category. 

We hope that our experience in CCX can help inform this important discussion. 

Thank you again for your interest.

37

Mr. ETHERIDGE. Thank you, Dr. Walsh. Just so that everyone 

will know, it looks like we are going to have a vote call somewhere 

between maybe 11:20 and 11:45, so probably within the next hour. 

And we will ask each Member, to the extent possible, to constrain 

yourself to the 5 minutes that will be allocated. The chair will now 

recognize himself for 5 minutes and I will try to restrain myself 

within the 5 minute time limit. 

Dr. Newsome and Mr. Sprecher, both of you appear to be circling 

around the same idea that some heightened oversight might be 

necessary for certain products listed on the ECM. You may differ 

on the amount and scope of oversight and regulation, you may differ on whether a change in law is necessary to achieve greater 

oversight, but in principle, you don’t seem to be quite that far 

apart. My question is what is the trigger? 

If Congress is to act in this area, we could write a change application just to the contract or the commodity in question, but this 

would fail to address the next problem that might come along. We 

could give the CFTC some broader authority, but that might just 

stifle the innovation. What, in the EMC, should trigger greater 

oversight? Both of you have touched upon it, to some extent, so 

please expand upon your own comments on each other’s ideas of 

what should trigger oversight of the EMC traded contract. Whichever wants to begin first. 

Dr. NEWSOME. Thank you, Mr. Chairman. I think we have got a 

real live example to use and we don’t just have to talk in theory 

about what an appropriate trigger might be, and that goes back to 

the situation with Amaranth and the collapse. This Subcommittee 

held a hearing about that earlier in the summer, and we talked 

through it in detail. But I think, in looking back at that situation, 

there are a couple of things that strike us in terms of the linkage 

of the ECM contract and natural gas directly to the regulated futures contract. The fact that the ECM natural gas contract served 

as an effective substitute for the exchange contract and even based 

upon the CFTC staff comments last week that, in fact, that contract served a price discovery role on a certain percentage of the 

days that the trading community used it. 

So we think those are the key components that can be used as 

a trigger to create more effective oversight from the CFTC in terms 

of submission of the large trader reports, position accountability 

and the self-regulatory oversight functions. We have talked about 

that contract specifically, but we also believe that other contracts 

may develop in the same manner as natural gas and that the 

CFTC should have flexibility to continue to evaluate other contracts and if other contracts, in fact, meet those same triggers that 

natural gas has met, then that oversight would be accepted, as 

well. 

Mr. ETHERIDGE. Thank you, sir. Mr. Sprecher, anything you 

want to add to that? 

Mr. SPRECHER. No, I think he framed the question, actually, 

quite eloquently, which is we are definitely in broad agreement and 

there are some nuance differences Dr. Newsome and I have. Generally speaking, when a contract that is less regulated or unregulated becomes the functional equivalent of a regulated contract, it 

only makes sense that we should close that gap. I mean, we 

38

shouldn’t create a regulatory arbitrage opportunity within our 

country. 

So the question is how do we do that? I am cognizant that the 

CFTC has testified here, that they believe they have what they 

need to handle that and but also, I believe it was at the last hearing on natural gas that Acting Chairman Lukken said he may be 

at the outer limits of his view on that and so to the extent that 

the CFTC needs to define that outer limit, needs to push the outer 

limit a little further, we would certainly support some modification. 

But generally speaking, I believe that they have the authority and 

we continue, at ICE, to work with the CFTC to provide more information, more systems, more visibility to help them bridge that gap 

between ICE and NYMEX. 

Mr. ETHERIDGE. Thank you. Let me quickly try to get one other. 

Mr. Duffy, Dr. Newsome, in each of your written statements, you 

mention the jurisdictional conflict between FERC and CFTC. Both 

of you fear FERC’s potential encroachment upon the CFTC’s exclusive jurisdiction over futures markets. Can either of you give the 

Subcommittee some practical, real world implications of what could 

happen to your exchanges and the people who use them if FERC’s 

action does constitute an encroachment in the CFTC’s jurisdiction, 

because some might say, as a question, why shouldn’t we have another cop on the beat and what can you tell them? 

Dr. NEWSOME. Mr. Chairman, we view this as a very serious 

issue and one that could go to the core of tearing down the very 

structure of the Commodity Exchange Act and the jurisdiction of 

the CFTC. I think FERC is but the example that is in front of us 

today. If that is allowed to happen, then you are looking at USDA 

coming in on other contracts, the Treasury on financial contracts 

and I think the exclusive jurisdiction of the CFTC is what sets us 

apart from other jurisdictions from around the globe that have allowed the growth and effectiveness of our markets. 

We have a specific example regarding FERC and the CFTC with 

FERC coming in, requesting—probably requesting is not quite 

strong enough, but almost demanding that we make changes to 

certain settlements that the CFTC had long approved and was 

comfortable with and as the Exchange, we are caught in the middle 

between the views of two Federal regulatory agencies and that is 

not useful to our market. 

Mr. ETHERIDGE. Thank you. 

Mr. DUFFY. You know, Mr. Chairman, it would be—I am not 

even going to try to add to that because I think Dr. Newsome 

summed it up quite well on all products. 

Mr. ETHERIDGE. Thank you, sir. Before we move to my good 

friend, Mr. Moran, we have been joined by the Chairman of the full 

Committee, Mr. Peterson. With that, I will move to Mr. Moran and 

recognize him for 5 minutes. 

Mr. MORAN. Mr. Chairman, thank you very much. I am anxious 

for the day in which the gentleman from Virginia’s portrait is 

hanging in this room. My failure to attend the reception last night 

is—perhaps you didn’t even notice I wasn’t there, but now that——

Mr. ETHERIDGE. Now that you have since raised the issue, it is 

a serious issue. 

39

Mr. MORAN. And as a result of feeling badly about my absence, 

I would yield my time to the gentleman from Virginia. 

Mr. GOODLATTE. Well, the cat is out of the bag now. I thank the 

gentleman. That day is well nigh and I thank him for his gracious—I want to join the Chairman in expressing my concern about 

the question of the exclusive jurisdiction of the CFTC over futures 

contracts. I have had many discussions with a number of you over 

time about this issue and the various ramifications of it, but I just 

want to be on the record as saying that I think that if that jurisdiction were to somehow be narrowed, the consequences for your industry and playing in a different arena, if you will, would be significant in the conflict between these two different Federal regulatory agencies. It is not going to be well for the openness and 

transparency of these markets that I think the CFTC has done a 

generally good job of protecting. 

Let me ask you, in following up on that, if you might just comment on some of the operations of the CFTC. Do you think it is 

adequately funded? I will start with Mr. Duffy. 

Mr. DUFFY. Well, I think the funding would be a budget of 

around $87 million to $93 million over the last couple years and 

they were asking for $120 million annually. One of the things that 

I said in my testimony, a big part of the CFTC’s budget goes to 

chasing off-exchange unregulated platforms and there are hundreds of millions of dollars being lost by people that are soliciting 

retail people to trade foreign exchange products, promising them 

great returns that are just literally impossible and we all know it, 

so the CFTC is chasing these folks. Unfortunately, the way the 

statute reads, they are chasing them after the crime has been committed, so that is very difficult. 

So that is another reason why we need a fix for this retail FX 

platform, so again, we are very supportive of the Commission getting all the resources it needs. I think I echo your comments, Congressman, that you know, we need to have this single regulator. 

We do compete globally and for us to have multiple regulators in 

the U.S., it would cripple us in a global marketplace and again, 

that is where we do compete. We don’t compete so much 

centrically, we compete globally and again, that is another thing I 

cited in my testimony that is a problem with the securities industry and why I think that it has been crippled, and IPOs are going 

to foreign lands versus staying here in the U.S., so that would be 

my view on the funding of the CFTC. 

Mr. GOODLATTE. Dr. Newsome. 

Dr. NEWSOME. Mr. Goodlatte, I admit up front that I may be 

somewhat biased as a former Chairman of that agency in my response, but I do believe that the CFTC is under-funded. They have 

got the lowest level of staff in over 20 years at a time when they 

are regulating more markets, more contracts. We all know and are 

aware of the explosion in growth of this business, so I think I 

would agree with my friend, Mr. Duffy, that we are asking them 

to do something in a much larger space that has become very, very 

difficult for them to do. In addition to increasing the funding and 

staff size, I also think we should increase the penalties in which 

they have the authority to place upon these wrongdoers that Mr. 

Duffy mentioned. I think if we increase the penalties as we were 

40

all in agreement in reauthorization hearings last year, that, too, 

would help with some of the jurisdictional issues and penalties that 

other agencies have. 

Mr. GOODLATTE. Let me ask, has it been your experience that the 

Presidential Working Group responds quickly to matters put before 

it? 

Dr. NEWSOME. In my experience, yes. The PWG has responded 

very quickly, particularly in issues not only that are significant to 

the industry, but the Congress is attempting to address, as well. 

Mr. GOODLATTE. Mr. Carlson, do you have a view on that? 

Mr. CARLSON. We very much have kept up with the Presidential 

Working Group and we appreciate the work that they have done. 

Stepping back to the budget size of the CFTC, we believe, from a 

small exchange standpoint, we have been adequately regulated, so 

the effect that we see on their budget is nominal, in some respects, 

but we also notice that they are also chasing off-exchange regulatory matters. 

Mr. GOODLATTE. Thank you. And Mr. Duffy, you commented 

about our ability to remain competitive in the international marketplace and I wonder if you could compare our regulatory regime 

with that of the Europeans? 

Mr. DUFFY. Well, I mean, Jim might be better suited for this 

question, since he was a big part of the regulatory regime as it was 

being harmonized throughout the country, especially in Europe, 

when he was Chairman of the CFTC, but right now, it appears that 

we are on much more of a level playing field, especially dealing 

with the European countries, by having our products in there. The 

CME Group now is in 83 countries throughout the world with our 

product and we are executing business globally, so as far as the 

regulatory regime goes, I mean, I think it suits us quite well right 

now. 

Mr. GOODLATTE. Thank you. And that was a handoff to Dr. 

Newsome, so——

Dr. NEWSOME. I think we have made a lot of progress in leveling 

the playing field globally. Still, there are some differences that 

exist. If you look at the Financial Services Authority in the UK recognized as a comparable regulator to the CFTC within the derivatives space, but I think there are some real differences, as well. 

They have roughly 20 to 30 people that are dedicated solely to the 

derivatives space, where the CFTC has over 400. If you look at the 

number of enforcement cases that have been brought by the CFTC, 

which I think their record is very, very good and aggressive in policing wrongdoing, much, much fewer cases are brought within the 

European community. 

Mr. GOODLATTE. Thank you. Mr. Chairman, I know my time has 

expired. I wonder if I might direct one question to Dr. Walsh, because I am interested in this new area. 

Mr. ETHERIDGE. Proceed. 

Mr. GOODLATTE. Can you tell us a little bit about how you determine what various agricultural activities are—is there a schedule, 

for example, in terms of evaluating that for carbon sequestration? 

Dr. WALSH. Yes, Congressman. We have got a variety of tools 

that have been developed with, really, some of the top experts in 

the world on these issues from Kansas State University, Virginia 

41

Tech, Ohio State and so on. We have established a schedule of 

standardized crediting for certain conservation tillage practices 

when done on a continuous basis, depending on the part of the 

country that you are located in, which is the function of crop 

growth, soil types and so forth in the area of methane capture. 

There are standard measurement methodologies that have been 

developed, a little bit of trial and error there, but an important 

mitigation and clean energy source in the area of rangeland management, we are currently piloting some field tests to confirm our 

ability to quantify acreage and apply the standard factors on a per 

acre, per year crediting basis. And in the space of forestation, we 

use some of the direct measurement and standardized lookup tables that have been established by the Forest Service. 

Mr. GOODLATTE. I recognize that we don’t have these requirements to reduce greenhouse gases in the U.S. at this time. In light 

of that, in light of what is going on elsewhere in the world, what 

is your volume of business and who are your competitors? 

Dr. WALSH. Well, Congressman, we operate three separate exchanges. One is an Exempt Commercial Market, which, of course, 

involves screen trading on a principle-to-principle basis and the 

trading in that market, spot market trading, is monitored for market manipulation and fraud by FNRA. The volumes in our North 

America based market are approximately 1⁄100 of the volumes in 

our European market we established and we sort of exported an 

American financial know-how and established the European Climate Exchange. We are transacting in the range of about $100 million a day at our London operation. We transact a half a million 

to a million dollars a day in our U.S. operation. 

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

Mr. ETHERIDGE. Thank you, sir. The gentlelady from Kansas, 

Mrs. Boyda. 

Mrs. BOYDA. Thank you, Mr. Chairman. Dr. Walsh, I would just 

like to say thank you for what you are doing and the work that is 

going on in Kansas. It is growing. I think we are looking at what 

is going on around some of our neighboring states and so there is 

growing appreciation of what you have been trying to do. 

Mr. Duffy, if I could—I am new to this. I am one of the new kids 

in Congress and your initial testimony kind of did this. You seem 

to be concerned about something and I am not quite sure and if 

you could just step back and help me understand what your concern was and as it went down the line. I just couldn’t figure out 

where that concern, as such, was coming from. 

Mr. DUFFY. The concern is a couple different things, Congresswoman, and the first was on the elimination of 2(h)(3). They have 

had a bit of a debate about it here. 

Mrs. BOYDA. Help me with what 2(h)(3) is. 

Mr. DUFFY. 2(h)(3) is the exempt commodity code of the 2000 Act 

and it gives people an opportunity to trade principle-to-principle 

with exempt products, so basically, not being regulated and our 

concern is that some of these products are being competitively traded on an exchange. And Dr. Newsome could talk to this more because he lists these contracts at the NYMEX. We do process them 

at the CME, because we are their electronic provider for all 

NYMEX’s products, so we are trading these on a regulated platVerDate 0ct 09 2002 11:27 Apr 02, 2009 Jkt 041481 PO 00000 Frm 00045 Fmt 6633 Sfmt 6601 I:\DOCS\110-27\48374.TXT SOLEM PsN: REBEKA
42

form and they are competed with an unregulated platform, so there 

are position limits that the CFTC has on a regulated exchange, 

where on an unregulated platform, they don’t have these limits, so 

there can be manipulation in products. 

That concerns us. There is reputational harm if there is manipulation in energy or any other product that harms the entire industry. So even thought the CME doesn’t list, as its core products, energy, we do it for the NYMEX. It is still reputational risk to the 

industry and that concerns us, so again, that is why we believe 

2(h)(3) should be eliminated, because there are competing products 

being traded on regulated platforms that are identical. Second, on 

our——

Mrs. BOYDA. And again, who would that impact the most here? 

If it was eliminated? 

Mr. DUFFY. I don’t know if it would impact anybody, because we 

have, in my testimony, said that we believe that there is a DTEF 

solution, which is a Derivatives Transaction Execution Facility, and 

this has standards that they would have to adhere to, nine core 

standards which are fairly benign standards, including daily publication of trading information, fitness standards, conflicts of interest, recordkeeping and antitrust consideration, so most exchanges 

today, the IntercontinentalExchange operates a futures exchange. 

They already have an SRO. 

The Climate Exchange has a futures exchange, as Dr. Walsh has 

cited, so they already fit under this. We don’t believe that innovation would be harmed any way. We, at the CME Group, have been 

around for 150 years as a regulated institution and we have been 

able to innovate through that entire time without any problems, so 

we don’t see where there has been any arguments being made that 

innovation would be stymied, for lack of a better term, so again, 

we don’t see how this impacts anybody if it was to go into a DTEF. 

Mrs. BOYDA. Is there agreement or disagreement? 

Dr. NEWSOME. From the New York Mercantile Exchange, of 

course, we operate as a regulated marketplace, just as our colleagues in Chicago. I think the most important concept is the fact 

that we are in complete agreement with our friends in Chicago that 

something needs to be done. We are taking a slightly different approach on how you address that. 

The CME Group is recommending to repeal the 2(h)(3) and I 

think it makes some valid arguments. Our approach has been 

based upon the situation with Amaranth, to take a more targeted 

approach and address specifically the contracts that are linked to 

an exchange contract, that serve as an effective substitute, while 

maintaining the structure of the CFMA as it has been since 2000. 

Mr. SPRECHER. We operate both, as Chairman Duffy mentioned, 

we operate both regulated futures exchanges and Exempt Commercial Markets. I started ICE as the founder, as an Exempt Commercial Market. In other words, I was able to just find two people that 

were willing to trade with each other across a relatively crude network and from that, build a company. The same thing has happened with Dr. Sander, who started the Chicago Climate Exchange, 

which we operate for him under an outsourcing relationship, did 

the same thing. 

43

So the innovation that we are talking about is the ability of entrepreneurs to come in and create new market structures at low 

cost and to start a self-regulated futures exchange from scratch 

would be a daunting task. I am not sure it can really be done. And 

certainly, I couldn’t have done it, I will say that. So where Dr. 

Newsome and Chairman Duffy and I do agree is that at times, if 

a contract becomes the functional equivalent of a future and has 

a different regulatory regime, we should take away that regulatory 

arbitrage. 

Nobody is looking to, nobody that I have heard on this panel is 

looking to take regulated futures into an unregulated environment. 

That, I don’t think, is actually helpful for a market, but to allow 

entrepreneurs to start new markets at low barriers to entry, which 

they can do in every other country, I would remind you, I don’t 

think we should preclude that in this country. 

Mrs. BOYDA. All right. Thank you very much. Yes? 

Dr. WALSH. Congresswoman, first thank you for your kind remarks. We are working hard to grow opportunities in Kansas, in 

these emerging markets. I would note that it is not just the cost 

of activating the exchange that would become prohibitive if the designated contract market rules were applied to a lot of these innovative upstarts, not just CCX, but others that are emerging with 

some promising new opportunities for American businesses, but the 

cost of participation. Many of the members of Chicago Climate Exchange, take the City of Melbourne, Australia, the University of 

Minnesota, other governments and small businesses, are not necessarily involved in the Chicago Climate Exchange because they 

are eager to do so much trading. 

They want to learn how to manage their energy and emissions 

flow, they want to understand the policy implications. They want 

to prepare for a carbon constrained future. So if we put up the 

sorts of hurdles that the entities would have to face under a DCM 

and under a futures market regulatory structure, we might not 

only kill off the sort of the potential golden goose of the exchange 

itself, but kill off the possibility for lots of businesses and farmers 

and foresters to learn how to work in these markets. So it is the 

exchange and the participation that would become more difficult 

and costly if we ditch this really innovative provision to foster new 

market mechanisms. 

Mr. ETHERIDGE. Thank you very much. Thank you very much. 

The gentleman from Texas is recognized for 5 minutes. Just so you 

know, a vote has been called. This will probably be the last question we are able to get in before we have to take a break. Probably 

we will be gone anywhere from 15 to 20 minutes and then we will 

come back and continue. It is two votes. 

Mr. CONAWAY. Thank you, Mr. Chairman. Dr. Walsh, a couple of 

things. What are those hurdles that you say this would put in place 

that would prevent participants like Melbourne, Australia? Give us 

a sense of what that hurdle is. 

Dr. WALSH. Well, anybody who wants to trade in a futures market has a significant set of procedures to go through to demonstrate 

wherewithal, to demonstrate understanding and familiarity and 

these are steps that are absolutely appropriate for the large, economically important commodity futures and financial futures marVerDate 0ct 09 2002 11:27 Apr 02, 2009 Jkt 041481 PO 00000 Frm 00047 Fmt 6633 Sfmt 6601 I:\DOCS\110-27\48374.TXT SOLEM PsN: REBEKA
44

kets, but is this at all necessary? And I think the wisdom of the 

Congress, in establishing the Exempt Commercial Market structure, said no, that is not necessary, a costly regulatory and reporting set of procedures for these new upstart markets that are indeed, not even a futures market, in our case. This is a spot market. 

Mr. CONAWAY. Did I hear you say the participant does not need 

to demonstrate knowledge and understanding of what he or she 

might be doing? Does Orange County, California, come to mind? 

Dr. WALSH. Well, in the case of financial derivatives and 

large——

Mr. CONAWAY. We were talking about your—but it is odd that 

you would say you don’t want informed participants. 

Dr. WALSH. Oh, no, sir. That is not at all what we are saying. 

We absolutely have an extensive preparation and briefing before 

the members of the Exchange execute the contract to commit to the 

terms of the Exchange. We facilitate their participation and reporting and annual compliance and it is really a facilitative audit, in 

fact, to help them get their numbers and data in order. But many 

of the members of the Exchange choose not to, because they don’t 

need to, participate in the trading part. 

Mr. CONAWAY. Okay. 

Dr. WALSH. And they have that as an option. And to say you are 

going to be trading some sophisticated, high-value commodity, your 

financial instruments—is not the correct assessment in this particular case. 

Mr. CONAWAY. Okay. How do you settle arguments between your 

participants? 

Dr. WALSH. We generally don’t have many arguments. We have 

an overnight payment and delivery process. Nobody has failed on 

the payment and delivery terms and we do have a committee structure that is the governance process. Members of the Exchange participate in a self-regulatory structure, sir. 

Mr. CONAWAY. And on your disclosure sheet, you got contracts of 

some sort with USDA? What are those contracts? 

Dr. WALSH. I am sorry, sir?. 

Mr. CONAWAY. On your disclosure page you have contracts with 

the USDA. 

Dr. WALSH. Oh, yes, sir. The USDA has provided, through NRCS, 

first, a small grant and then a little bit bigger one, to help us to 

engage expert verifiers to do field inspections, in particular, on conservation tillage plots, on grass planting plots and now on rangeland management fields. It is a fairly expensive initial cost and we 

are trying to build up the capacities, bringing in folks like SES, out 

of Lenexa, Kansas, bringing in forestry and farm experts to do infield inspections, so we have integrity underlying the product. 

Mr. CONAWAY. Why would the participants not pay for that? 

Dr. WALSH. Well, I think we are going to move to that sort of 

model, but my sense is the good folks at USDA thought that this 

was a public benefit to test out these ideas and to form and revise 

the protocols and to get that talent base built up. We do envision 

a self-funding model in the not-too-distant future. 

Mr. CONAWAY. Okay. Thank you, Mr. Chairman, I yield back. 

Mr. ETHERIDGE. I thank the gentleman. The gentleman from 

Georgia, Mr. Marshall, for 5 minutes. 

45

Mr. MARSHALL. Thank you, Mr. Chairman. I guess I am pleased 

to see the sensitivity of our staff in putting Mr. Carlson between 

Mr. Sprecher and Dr. Newsome and Mr. Duffy. We appreciate the 

service that you are providing us, sir. 

Just real briefly, Mr. Sprecher, following up on Mrs. Boyda’s 

question. How do we keep the baby and toss the bathwater with 

regard to this exempt market issue, the 2(h)(3) issue? Real briefly. 

Mr. SPRECHER. Sure. I think the CFTC is, itself, trying to do 

that, but if Congress wants to play a role, I think it can help codify 

some of the things that they are doing, which is continued reporting. The area where I think there is some vagary that could use 

some direction from Congress is that if a problem is seen, what action should be taken and who should take. For example, should 

ICE become a self-regulated type organization where it can direct 

market participants or should the CFTC, itself, direct market participants? We have told the CFTC we are happy to play either role. 

Mr. MARSHALL. In trying to figure out what direction we should 

take, perhaps we should take some guidance from the CFTC. If the 

CFTC feels that it is able to deal with the worries about inappropriate manipulation, et cetera, with the tools that it has at the moment, then perhaps the CFTC might tell us that it doesn’t need additional legislation from Congress. Contrariwise, if it doesn’t, would 

that be where we should seek our guidance? 

Mr. SPRECHER. I hesitate in telling somebody like you what to do, 

but I do think that the——

Mr. MARSHALL. I need lots of advice on this issue. 

Mr. SPRECHER. I do think, as some of my colleagues have pointed 

out, there is a general awareness, in our industry, in Congress and 

the CFTC, a potential for problems that need to be corrected and 

I am cognizant of the fact that the acting Chairman said he is at 

the outer limits of what he can do, so I suspect that is a signal to 

Congress that he could potentially use some help. 

Mr. MARSHALL. CFTC funding, I think everybody agrees that it 

is a challenge, simply to keep the kind of good folks working for 

the CFTC that we really need to have. In order for them to be competent, to appropriately regulate, we have got to increase their salaries substantially and if the budget doesn’t grow substantially in 

order to do that, then the staffing has to diminish dramatically and 

when you diminish the staffing, you have a quantity problem. It is 

just simply not enough people. 

And a number of people have suggested that the industry should 

be bearing the cost of this. It is the way the SEC works. Just brief 

comments about that. I want to talk about energy and Graves-Barrow here if we have an opportunity, so very brief comments about 

where should the funding come from? It seems to me to be a fairly 

minor expense compared to the size of the industry and that the 

industry ought to step up and offer to carry some of this cost. And 

I guess this is principally directed to the exchanges. 

Mr. DUFFY. Yes. If I may, Mr. Chairman, answer that question? 

Mr. MARSHALL. I appreciate the promotion, thank you. 

Mr. DUFFY. No. Congressman, thank you. We have a big difference in this because the budget for the CFTC, as I have outlined 

in my testimony, a lot of budgetary needs go to trading or chasing 

46

off-exchange, unregulated activity and that is a big concern for us, 

that the regulated exchanges should bear that cost. Also——

Mr. MARSHALL. Can I interrupt? 

Mr. DUFFY. Yes, sir. 

Mr. MARSHALL. So if we—I suspect your view is that somehow 

we ought to make some adjustments legislatively that limits the 

extent to which this kind of thing can go on off-exchange, which 

means it would come on to exchange, so at that point, you would 

be willing to carry all the costs? 

Mr. DUFFY. Well, again, that is not—what we are saying is when 

there are hundreds of millions of dollars being lost and fines being 

levied after the horse has been out of the barn, it is a little difficult 

to collect those fees because the people are gone. Again, our people 

do pay a fee to the National Futures Association for regulation, 

which a lot of that CFTC regulation has been off-loaded to the 

NFA, so we already do participate, our clients do, in paying for regulation to the agency. 

Second, we are talking about an industry that has got half a million in commodity accounts in the U.S. versus several millions of 

contracts of equities and we have only a handful of people providing deep pools of liquidity that benefit multiple constituencies, 

that that would not happen if they had to pay a user fee on top 

of that. We are talking about a fee or a tax before they even made 

or lost a profit on each and every one of their transactions and 

these folks can go overseas quite quickly. 

Mr. MARSHALL. I apologize for interrupting. My time is about to 

expire. We have votes coming up. It would be very helpful to us, 

for all of you, and I am sure you will be doing so, but if you could 

comment in writing about the proposed Graves-Barrow legislation 

and assuming that there is a problem here, what sort of solution 

is appropriate, in your views. Thank you, Mr. Chairman. 

Mr. ETHERIDGE. I thank the gentleman and if you would submit 

that in writing, it would be helpful. We will stand in recess probably for about 15 minutes, soon as we get these two votes. We are 

in the last 3 or 4 minutes of one vote and we have one 5 minute 

vote and then we will back. Thank you. 

[Recess] 

Mr. ETHERIDGE. We thank you very much for waiting on us. I 

recognize the gentleman from Kansas for 5 minutes. 

Mr. MORAN. Mr. Chairman, thank you very much. A number of 

our colleagues on this Committee have zeroed in on issues related 

to the regulation of ECMs and on the testimony of Mr. Sprecher, 

he indicates that most energy swap contracts traded on ICE are 

niche OTC products that are not amenable to the application of 

such requirements, urges the Subcommittee to stay within the current regulatory framework and allow CFTC to make adjustments 

that may be appropriate for a few particular products. Is the division between you and your colleagues, to whatever side of the room 

that is, is this the issue about the few regulated products, is that 

the distinction that we are having a discussion about? 

Mr. SPRECHER. Well, I think Dr. Newsome and I could actually 

probably even agree on what the products are and I think the industry, generally, the energy industry would generally support us 

in our views, given all the conversations we have had. I think what 

47

we are talking about now are okay, having figured out the specific 

products should have more, let us call it, oversight, what form and 

how should——

Mr. MORAN. It is not the products. It is the level of regulation, 

the level of oversight? 

Mr. SPRECHER. Correct. And its nuance diversions of that, not 

whether or not it should exist at all. 

Mr. MORAN. Mr. Carlson, the CFTC made some changes in their 

rules and regulations in regard to outside directors, I would guess, 

6 months ago. Are you able to easily comply with those new rules 

and regulations? And do you have a sense, that with a new Chairman of the CFTC, there is flexibility there in meeting the criteria 

that was established for outside directors? 

Mr. CARLSON. Well, we are complying with the Safe Harbor provisions under the core principles that they provided us. We are not 

necessarily in favor of it coming from the top down, forcing us to 

make these changes, but I think we are trying to put the best face 

on it as possible and use this as an opportunity for us to try to 

make some changes that we wanted to make internally. So in some 

respects, we are not necessarily that opposed to what happened, 

but we did not like the fact that it was coming down, forcing us 

to make those changes, as opposed to us moving on our own. 

Mr. MORAN. So you would have no suggestions to this Subcommittee in regard to legislative changes as we discuss reauthorization about those rules? 

Mr. CARLSON. Well, what we have proposed, as I put in my testimony, was the fact that there are little nuances here and there, 

and one particular one that kind of bothers is, as a small exchange, 

is that there is a regulatory oversight Committee consisting of 

these three public directors and that is under the Safe Harbor provision. It seems silly, in our respect, to have to have that because 

we don’t have some of the underlying problems that were perceived 

at the other exchanges from a regulatory side. And we only have 

three staff individuals that will be supervised under the three public directors, so again, it is a little bit top-heavy, to say the least. 

Mr. MORAN. Do you have any sense that the CFTC, with new 

leadership, new Commissioners, has a different approach to this 

topic? 

Mr. CARLSON. I think we are very pleased with Acting Chairman 

Lukken and we are in contact with them and we are hoping there 

may be some changes yet to come, prior to——

Mr. MORAN. From my perspective, that would be a good thing 

and much less cumbersome and more timely than what this Committee might be able to do, based upon our history with reauthorization. 

Mr. CARLSON. I agree. Thank you. 

Mr. MORAN. Thank you. Let me ask one other question, just a 

broader question is that much of the testimony has been about examples of things that have occurred in the markets that perhaps 

suggest the need for additional regulation. We look, retrospectively, 

back and make suggestions for what we ought to do with reauthorization. Do any of you see future trends in the futures industry 

that we need to be made aware of so that we are legislating 

proactively, as compared to responding to issues that have arisen 

48

in the past that perhaps need our attention now? Anything out 

there in the industry that we ought to be aware of? 

Dr. NEWSOME. Congressman, I think the issue that we are talking about with regard to ECMs and triggers for more regulation 

certainly could be a trend. Right now, it is contained to one marketplace and we are trying to address it specifically. I think if Congress takes the targeted approach that we recommended, I agree 

with Mr. Sprecher, that we have the exact idea of what product 

would, at least initially, be encompassed. 

I think one area that I would slightly disagree with Mr. Sprecher 

on is the authority that the CFTC currently has. The CFTC currently has special call authority to collect information. That information is collected after the fact and we are looking at a preventative solution here with regard to these recommendations, so I think 

the mandated large trader reports needs to be one of the components. Second, with regard to position accountability or the self-regulatory organization, the CFTC does not have the authority to oppose those requirements on EMCs today. 

Mr. MORAN. Dr. Newsome, thank you. I am pleased to have 

asked an open-ended question to give you the opportunity to answer the question that you would like to answer. Mr. Chairman, 

thank you for the time and my time is expired. 

Mr. ETHERIDGE. I thank my friend for his comments and I would 

say, before we dismiss this panel, there may be additional questions by Members to you and we would ask that you respond to 

those as quickly as possible for the Committee. And with that, if 

the gentleman from Kansas has a closing comment? 

Mr. MORAN. Mr. Chairman, no. I would like to proceed with the 

next panel. I appreciate the testimony we have heard today and 

again, hope that we have some results from these continual discussions about reauthorization. 

Mr. ETHERIDGE. I thank the gentleman. Let me thank each of 

our panelists. You have been most helpful this morning in your 

comments and I can assure you that we will be in touch with you, 

other Members may, for information as we move forward with this 

reauthorization. Thank you very much and we will now welcome 

the second panel. 

Let me welcome our second panel to the table and thank you for 

coming. First is Mr. Roth, who is President and CEO of National 

Futures Association in Chicago. Second is Mr. Zerzan, Counsel and 

Head of Global Public Policy, International Swaps and Derivatives 

Association on behalf of ISDA and the Securities Industry and Financial Markets Association here in D.C.; Mr. Damgard, President 

of Futures Industry Association here in D.C.; Ms. Becks, President 

and CEO of Campbell & Campbell, Incorporated, on behalf of the 

Managed Funds Association in Baltimore; and Mr. Brodsky, Chairman and CEO of Chicago Board Options Exchange on behalf of the 

U.S. Options Exchange Coalition out of Chicago. 

Let me thank each of you and Mr. Roth, if you would, begin 

when you are ready and I would ask all the witnesses, if you 

would, try to limit your time to 5 minutes. It looks like we could 

have another vote somewhere around noon or shortly thereafter, 

which hopefully will give us time to get most of our stuff in if we 

49

move and we aren’t joined by others, we may get it all in. So Mr. 

Roth, we will begin with you, please, sir. 

STATEMENT OF DANIEL J. ROTH, PRESIDENT AND CEO, 

NATIONAL FUTURES ASSOCIATION, CHICAGO, IL 

Mr. ROTH. Thank you, Mr. Chairman. My name is Dan Roth and 

I am the President of National Futures Association, which is the 

industry-wide self-regulatory body for the futures industry. The 

first panel this morning touched on a number of really crucial 

issues, whether it is 2(h)(3) or the CFTC’s exclusive jurisdiction. 

Those are all important issues and we are glad that they are being 

debated here. 

If I could this morning, though, I just wanted to remind the Committee that we have some unfinished business related to customer 

protection issues in the off-exchange retail forex space. I testified 

in both 2003 and 2005 that I felt that certain provisions of the 

CFMA, along with subsequent case law, had created situations 

where unsophisticated retail customers were particularly vulnerable in the off-exchange forex area. If I could, I would like to take 

a couple of minutes and describe the context of those issues, describe in greater detail some of the problems we have seen and 

some possible solutions. 

First of all, when I testified in 2003, I told the Committee that 

the forex dealer/members of NFA at that time held about $170 million in customer funds. Today, 4 years later, that number has 

grown to over $1 billion in customer funds. So that is pretty dramatic growth and it has been accompanied by some pretty dramatic 

problems. Our forex dealer/members at NFA constitute less than 1 

percent of our overall membership, but those members account for 

over 20 percent of the customer complaints that are filed in our arbitration program; they account for 50 percent of NFA’s enforcement docket; they account for 50 percent of the emergency actions 

that we have had to take this year. 

I think there are a number of provisions in the Act that have 

contributed to those problems and I would like to discuss them 

briefly, if I could. If you look at the firms that have created most 

of the problems, they share a couple of traits. First of all, most of 

these firms, although registered as FCMs, aren’t really FCMs, at 

all, at least, not as the way that term in defined in Section 1(a)(20) 

of the Act. These firms don’t do any exchange traded futures business, at all. They get registered as FCMs for the sole purpose of 

qualifying, under the Act, to do off-exchange retail forex. So in that 

sense, they are not really FCMs, at all. 

The second trait that these firms often share, not always, but 

very often, is that they tend to be thinly capitalized, which is of 

particular concern because frankly, the risks that operating a dealer market include are substantially different than the risks involved in a traditional FCM business, where you are acting as an 

agent for your customer. And second, there is no clearing organization standing behind these off-exchange products, so that the forex 

dealer is really the sole source to ensure the fulfillment of financial 

obligations to customers. 

So for those two reasons, I think that there needs to be a substantially higher capital requirement for forex dealers than for traVerDate 0ct 09 2002 11:27 Apr 02, 2009 Jkt 041481 PO 00000 Frm 00053 Fmt 6633 Sfmt 6601 I:\DOCS\110-27\48374.TXT SOLEM PsN: REBEKA
50

ditional FCMs. So really with respect to those two problems, I 

think we would urge Congress to limit the FCMs that can act as 

counterparties to retail forex transactions to those FCMs that are 

real FCMs, that are actively engaged in the activities described in 

Section 1(a)(20) of the Act and to those firms that have at least $20 

million in capital. 

The next problem I just wanted to discuss is one that this Committee dealt with in H.R. 4473 and I applaud you for doing that, 

and it is the solicitor issue, what we have referred to as the solicitor issue. The CFMA provides that if a counterparty to the retail 

forex transaction is an FCM, then that whole transaction is outside 

the regulatory authority of the Act, which means that the person 

soliciting the customers, the person actually working the phones 

and selling the product to the retail customers, is not required to 

be registered, not required to be regulated at all and H.R. 4473 addressed that issue and that is good. 

What I am telling you is that in the last couple of years we have 

seen a slight variation on that theme where now we have firms 

that become active as the equivalent of commodity pool operators 

or commodity trading advisers, but again, they limit themselves to 

off-exchange retail forex transactions with the result that those 

pool operators and trading advisers aren’t required to be registered. 

They are not regulated and those customers don’t receive the same 

regulatory protections as regular CPO/CTA customers. I think the 

H.R. 4473 approach on the solicitor just needs to be modified 

slightly to capture the CPO/CTA elements, as well. 

And finally, Mr. Chairman, let me just conclude by just mentioning again, briefly, the Zelener case. As I mentioned before in 

my testimony, in our view, the problem with the Zelener case is 

that it gives the scammers a blueprint, directions on how to write 

their contracts to avoid CFTC jurisdiction. In that sense, the problem with Zelener, it is not a forex problem, per se, it is a problem 

with unregulated retail futures markets. That is why we supported, 

last time, a broad Zelener fix rather than the narrow fix that was 

in H.R. 4473. We continue to think that the broad fix is the better 

fix, but in light of all the problems we have had, we also believe 

that a fix now is infinitely better than a fix later. And we continue 

to support a broader fix, but what we urge most is a prompt resolution of these issues and prompt reauthorization of the CFTC and 

we will support any sort of proceeding or any sort of proposal that 

helps us achieve those ends. 

So Mr. Chairman, thank you very much and I would be happy 

to answer any questions. 

[The prepared statement of Mr. Roth follows:]

PREPARED STATEMENT OF DANIEL J. ROTH, PRESIDENT AND CEO, NATIONAL

FUTURES ASSOCIATION, CHICAGO, IL 

My name is Daniel Roth, and I am President and Chief Executive Officer of National Futures Association. Thank you Chairman Etheridge and Members of the 

Subcommittee for this opportunity to appear here today to present our views on 

some of the issues facing Congress as it continues the reauthorization process. NFA 

is the industry-wide self-regulatory organization for the U.S. futures industry. As 

a regulator, NFA is first and foremost a customer protection organization. 

I testified before this Subcommittee in 2003 and in 2005 about off-exchange forex 

futures that were being sold to retail customers. I stated then and believe now that 

certain provisions of the Commodity Futures Modernization Act of 2000 and subseVerDate 0ct 09 2002 11:27 Apr 02, 2009 Jkt 041481 PO 00000 Frm 00054 Fmt 6633 Sfmt 6621 I:\DOCS\110-27\48374.TXT SOLEM PsN: REBEKA
51

quent case law had the unintended consequence of making unsophisticated, retail 

customers the prey of fly-by-night operators. Let me put these issues in some overall 

context, describe in detail the problems we have seen in the statute and share with 

you some proposed solutions. 

In the CFMA Congress attempted to resolve the so-called Treasury Amendment 

issue once and for all by clarifying that the CFTC does, in fact, have jurisdiction 

to protect retail customers investing in foreign currency futures. The basic thrust 

of the CFMA in this area was that foreign currency futures with retail customers 

were covered by the Commodity Exchange Act (‘‘Act’’) unless the counterparty was 

an ‘‘otherwise regulated entity,’’ such as a bank, a broker-dealer or an FCM. When 

I testified here in 2003, I told you that NFA Member FCMs held $170 million in 

retail customer funds trading off-exchange forex. Four years later, that number is 

now over $1 billion. With this dramatic growth there have been some pretty dramatic problems. 

Members acting as counterparties to retail forex transactions account for less that 

1% of NFA’s membership. Unfortunately, they also account for over 20% of the customer complaints filed with our arbitration program, over 50% of NFA’s current enforcement docket and over 50% of the emergency enforcement actions NFA has 

taken over the last year. 

There a number of problems in the current statute that have contributed to these 

problems. If you look at the firms that have caused virtually all of the customer protection problems in retail forex, they share a couple of traits. First of all, they are 

not really FCMs at all. Congress intended to allow FCMs, along with banks, brokerdealers and insurance companies, to act as counterparties to retail forex transactions because they are all ‘‘otherwise regulated entities.’’ The wording of the statute, though, opened the door for firms that are not really FCMs to take advantage 

of the FCM exemption. Firms became registered as FCMs that are FCMs in name 

only—they do no exchange-traded futures. They are registered as FCMs solely to 

qualify to do retail forex business. To make matters worse, due to a further anomaly 

in the statute, the Act currently does not provide the CFTC with any rulemaking 

authority over these firms at all. Clearly, Congress did not intend to allow firms 

that are FCMs in name only to act as counterparties to retail forex futures. Congress should fix this problem by limiting the FCMs that can act as counterparties 

to those that are primarily and substantially engaged in the activities described in 

Section 1(a)(20) of the Act. 

The second trait that marks the problem firms in retail forex is that most, though 

not all, have been thinly capitalized. Congress long ago recognized that acting as 

a dealer involves greater risk than acting as an agent in futures trading, the way 

a traditional FCM does. That is why Congress in 1978 imposed a $5 million net 

worth requirement for firms granting dealer options and why the CFTC created a 

$2.5 million capital requirement for leverage transaction merchants in 1984. Congress should amend Section 2(c) of the Act to require FCMs acting as counterparties 

to retail forex transactions to maintain minimum capital of at least $20 million. 

NFA has raised the capital requirements for forex dealers several times but this 

congressional action could ensure that firms can meet their obligations to their customers and have a significant financial stake in their business. 

NFA is strongly supportive of both of these solutions to the customer protection 

problems we have experienced with retail forex. We are also strongly supportive of 

giving the CFTC rulemaking authority over FCM only firms (i.e. those that are not 

otherwise enumerated in Section 2(c) of the Act to act as retail forex counterparties). 

It is simply paradoxical to call these FCMs ‘‘otherwise regulated’’ when, other than 

anti-fraud jurisdiction, there is no Federal regulatory oversight of these firms’ activities. 

There’s one more forex problem I should mention that poses significant customer 

protection issues based upon the wording of the CFMA. Specifically, the wording of 

the statute currently only requires the counterparty to these transactions to be an 

otherwise regulated entity. This creates the possibility that an FCM, for example, 

might be the counterparty but the firm that actually does the telemarketing for 

these products is completely unregistered and unregulated. There are literally hundreds of these unregulated firms selling off-exchange forex transactions to retail customers and in some instances the people making the sales pitches have been barred 

from the futures industry for sales practice fraud. I do not think that’s what Congress intended at all, and H.R. 4473 passed by the House in 2005 contained an 

amendment to Section 2(c) of the Act to make clear that not only the counterparties 

but also the persons actually selling these products to retail customers must be registered with the CFTC and subject to its jurisdiction. We, of course, support this 

amendment. 

52

In the last few years we have also seen a growing number of firms acting as trading advisors and pool operators that trade exclusively off-exchange forex. Under the 

current statute, these firms are not required to be registered and their customers 

do not receive the same regulatory protections as customers of CPOs and CTAs that 

trade on-exchange. Some of these unregistered firms tout outlandish performance 

claims that cannot be substantiated. We believe that H.R. 4473’s amendment should 

be extended to require those persons that manage accounts or pooled investment vehicles on behalf of retail customers to register and be subject to the CFTC’s jurisdiction. 

The last issue I wanted to discuss brings us back to the Zelener case. As you may 

recall, in the Zelener case the CFTC attempted to close down a boiler room selling 

off-exchange forex trades to retail customers. The District Court found that retail 

customers had, in fact, been defrauded but that the CFTC had no jurisdiction because the contracts at issue were not futures. The Seventh Circuit affirmed that decision. The ‘‘rolling spot’’ contracts in Zelener were marketed to retail customers for 

purposes of speculation; they were sold on margin; they were routinely rolled over 

and over and held for long periods of time; and they were regularly offset so that 

delivery rarely, if ever, occurred. In Zelener, though, the Seventh Circuit based its 

decision that these were not futures contracts exclusively on the terms of the written contract itself. Because the written contract in Zelener did not include a guaranteed right of offset, the Seventh Circuit ruled that the contracts at issue were not 

futures. 

For a short period of time, Zelener was just a single case addressing this issue. 

However, time has proven that the CFTC cannot litigate itself out of the Zelener

problem. Since 2004, various Courts have continued to follow the Seventh Circuit’s 

approach in Zelener causing the CFTC to lose enforcement cases relating to forex 

fraud. Therefore, Zelener allows completely unregulated firms and individuals 

through clever draftsmanship to sell to retail customers contracts that look like futures and act like futures outside the CFTC’s jurisdiction. The bottom line is that 

these Court decisions make it much harder for the Commission to prove that contracts sold to retail customers to speculate in commodity prices are futures, makes 

it easier for the unscrupulous to avoid CFTC regulation and creates a real, live customer protection issue. Unsophisticated retail customers are being victimized by 

high-pressured sales pitches for foreign currency futures look-alike products. These 

retail customers are the ones who most need regulatory protection, and that protection should not be stripped from them because a clever lawyer finds a loophole in 

the law. 

NFA recognizes that H.R. 4473 addressed the Zelener problem with regard to retail forex. NFA applauds those efforts in addressing the current scam of choice—

forex—among fraudsters and believes that any future reauthorization legislation 

should at the very least incorporate H.R. 4473’s approach to this issue. However, 

NFA remains concerned that the rationale of the Zelener decision and its progeny 

is not limited to foreign currency products. Similar contracts for unleaded gas, heating oil, agricultural products or virtually any other commodity could be sold to the 

public in an unregulated environment. 

NFA and the exchanges have developed a fix to Zelener that goes beyond forex 

and does not have unintended consequences. Our approach codifies the approach the 

Ninth Circuit took in CFTC v. Co Petro—which was the accepted and workable state 

of the law until Zelener—without changing the jurisdictional exemptions in Section 

2(c) of the Act. In particular, our approach would create a statutory presumption 

that leveraged or margined transactions offered to retail customers are futures contracts if the retail customer does not have a commercial use for the commodity or 

the ability to make or take delivery. This presumption is flexible and could be overcome by showing that the transactions were not primarily marketed to retail customers or were not marketed to those customers as a way to speculate on price 

movements in the underlying commodity. 

This statutory presumption would not affect either the interbank currency market 

or already regulated instruments like securities and banking products. It would, 

however, ensure that scammers cannot tailor their written agreements to sell leveraged commodity products to retail customers for speculative purposes in a completely unregulated environment. Moreover, it protects retail customers by giving 

the CFTC the power to shut down unregulated boiler rooms and freeze their funds. 

While NFA continues to believe that the solution to Zelener should go beyond 

forex, we recognize that H.R. 4473’s narrow Zelener fix would be a marked improvement over the current state of the law. If Congress adopts only a narrow Zelener

fix and boiler rooms move to other commodities using Zelener-type contracts, then 

Congress must be willing to re-open the Act before the next reauthorization to consider resolving this issue completely. 

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In closing, let me state that NFA believes the industry and the public have benefited greatly from the enlightened regulatory approach that Congress adopted in the 

CFMA and from the CFTC’s role in implementing the Act. We look forward to working with this Subcommittee, other Congressional committees, the CFTC, and the industry to address the important customer protection issues outlined above.

Mr. ETHERIDGE. Thank you, Mr. Roth. Mr. Zerzan. 

STATEMENT OF GREGORY P.J. ZERZAN, COUNSEL AND HEAD, 

GLOBAL PUBLIC POLICY, INTERNATIONAL SWAPS AND

DERIVATIVES ASSOCIATION, WASHINGTON, D.C.; ON BEHALF 

OF SECURITIES INDUSTRY AND FINANCIAL MARKETS

ASSOCIATION 

Mr. ZERZAN. Thank you, Mr. Chairman and Ranking Member, 

for inviting ISDA and SIFMA to testify today. Collectively, ISDA 

and SIFMA represent over a thousand entities that participate in 

both the on-exchange and over-the-counter markets. These entities 

range from financial services companies to manufacturers to insurance companies to parties that participate both as market makers 

as well as end-users of these products. 

At a time when commentators are increasingly calling for the 

adoption of a principles-based approach to financial services regulation, it is important to remember that this Committee got there 

first and the adoption of the Commodity Futures Modernization Act 

of 2000 represented a momentous achievement in terms of financial 

services legislation. The financial service industry, as a whole is 

tremendously important to our economy. It is the third largest contributor to GDP and one in every 19 jobs in this country is in the 

financial services sector. 

The Commodity Futures Modernization Act has allowed both onexchange and over-the-counter derivatives business to explode in 

the United States and it is the leadership of this Committee which 

played a leading role in ensuring that that would happen. Nevertheless, in the time since the passage of the CFMA, the rest of the 

world has caught up to the fact that the financial services sector 

is a tremendous generator of economic growth. As several reports 

this year have already noted, the United States leadership, as the 

premiere center for financial services, is increasingly under assault. 

The world’s largest derivatives exchange, the Chicago Mercantile 

Exchange, is in the United States, but it is followed closely by two 

European-based entities. In the over-the-counter markets, United 

States leadership has actually succumbed to that of the UK: 43 

percent of the over-the-counter derivatives business is done in the 

United Kingdom, compared to 24 percent in the United States. 

So what we have seen is an issue arise around the question of 

what can the United States do to increase its competitiveness in 

this area. The prudent leadership of the Commodity Futures Trading Commission ensures that the U.S. remains a very attractive 

market for over-the-counter derivatives, but regulatory uncertainty 

has been cited as a reason why some market participants choose 

to go overseas. In that vein, with the recent actions of the Federal 

Energy Regulatory Commission, we see some of the uncertainty 

that market participants are wary of. With respect to reauthorization, then, ISDA and SIFMA have the following recommendations. 

First, we think Congress should provide CFTC with the resources necessary to meet its staffing and IT procurement needs. 

54

Second, the Congress should consult with the President’s Working 

Group to determine if a definable market problem in need of a legislative solution exists. To the extent that the President’s Working 

Group and Congress are able to identify a problem, then any such 

solution should be narrowly tailored to address that problem in a 

way that imposes the least cost on market participants. Last, we 

would urge that Congress reaffirm the exclusive jurisdiction of the 

Commodity Futures Trading Commission with respect to transactions on a registered exchange involving energy commodity derivatives. 

We thank the Committee for its continued leadership and we are 

happy to answer any questions. 

[The prepared statement of Mr. Zerzan follows:]

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PREPARED STATEMENT OF GREGORY P.J. ZERZAN, COUNSEL AND HEAD, GLOBAL

PUBLIC POLICY, INTERNATIONAL SWAPS AND DERIVATIVES ASSOCIATION,

WASHINGTON, D.C.; ON BEHALF OF SECURITIES INDUSTRY AND FINANCIAL MARKETS

ASSOCIATION


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Mr. ETHERIDGE. Thank you. Mr. Damgard. 

STATEMENT OF JOHN M. DAMGARD, PRESIDENT, FUTURES 

INDUSTRY ASSOCIATION, WASHINGTON, D.C. 

Mr. DAMGARD. Chairman Etheridge, Ranking Member Moran 

and Members of the Subcommittee, I am John Damgard, President 

of the Futures Industry Association and thank you very much for 

the opportunity to appear today. 

FIA has three general points to make. Number one, we endorse 

CFTC reauthorization. We support CFTC exclusive jurisdiction and 

we oppose any major changes to the CFMA. FIA believes that the 

CFTC is an excellent agency that fulfills its statutory mission in 

an efficient and effective manner. CFTC’s past and present leaderVerDate 0ct 09 2002 11:27 Apr 02, 2009 Jkt 041481 PO 00000 Frm 00063 Fmt 6633 Sfmt 6601 I:\DOCS\110-27\48374.TXT SOLEM PsN: REBEKA

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ship is to be commended for this record. The CFTC does, indeed, 

deserve to be reauthorized. Recently, a controversy has arisen concerning the scope of the Commission’s exclusive jurisdiction. There 

should be no controversy. In 1974, the House Ag Committee created both the CFTC and its exclusive jurisdiction to make sure that 

only an expert, specialized agency would regulate futures trading. 

Congress knew that exposing futures exchanges, intermediaries 

and market participants to duplicative or conflicting regulation 

from other agencies with no expertise in futures markets would be 

a recipe for disaster. That is why Congress has made crystal clear 

that the CFTC’s exclusive jurisdiction, where applicable, supersedes that of any other agency. As the courts have held, that 

means no other agency, whether it is the SEC, the FERC, the 

USDA or the states may police the futures markets. Any other result would threaten the competitiveness of U.S. futures markets. 

This Subcommittee was the birthplace of the CFMA. That landmark legislation has allowed our markets to prosper and grow and 

even though FIA does not believe its full competitive promise has 

been realized, we would oppose major changes to the CFMA’s 

framework. There are four specific substantive areas we expect the 

Subcommittee will consider in it deliberation and let me offer our 

views. 

SRO reform: FIA supports the important role the exchanges, 

clearing organizations and NFA perform as self-regulatory organizations. Their expert market knowledge and close proximity to the 

trading markets is vital to its effective oversight. However, as exchanges are moved successfully into the for-profit world, their public interest duties have come into conflict with their private interests. That has affected public confidence in self-regulation. To address this concern, the CFTC has proposed a series of best practice 

reforms for SROs, including a Safe Harbor for an exchange when 

35 percent of its Board of Directors are independent public directors. The CFTC has proposed some modest revisions to its new 

guidelines. FIA strongly supports these SRO reforms and urges the 

Commission to implement them as soon as possible. 

Competition: Promoting fair competition was a goal of the 

CFMA. Although it has led to the creation of more new exchanges, 

it has not stimulated the kind of direct product competition that 

the CFMA envisioned and this is very disappointing. Competition 

leads to reduced costs, higher volumes, narrower spreads and 

greater innovation. Competition also is the best system for serving 

the interests of our customers. Exempt commercial markets, ECMs, 

in the energy space have been the one area of direct product competition under CFMA. ECM trades are principle-to-principle, not 

brokered, and my member firms are largely brokers, so you might 

expect me to oppose ECMs. We do not. We support them because 

ECMs serve as incubators for the successful training platforms of 

tomorrow. If you cut out ECMs, you cut out the competitive, innovative heart of the CFMA. With the merger of the Chicago Merc 

and the Board of Trade, some might argue that futures exchanges 

have become more concentrated than competitive and if this true, 

it is unfortunate because real competition leads to better service, 

lower fees for the customers. 

61

Recently we have seen clearing fees reduced for some financial 

markets, but not on U.S. futures exchanges. With the explosive 

growth in futures trading volume, my members have asked me why 

they have not enjoyed similar clearing fees reductions and I do not 

have a good answer. I do know that competition and market structures are critical issues for customer service. Unless competitive 

forces materialize in our markets, FIA believes the CFTC should 

study the state of competition in our industry to make sure that 

we have the best market structure in place for serving our customers. 

Energy: Everyone agrees that the price of energy is a critical element of our national economy. As a result of CFMA, our energy 

markets have experienced considerable innovation and increased 

competition without compromising the public interest. There is no 

regulatory gap for futures manipulation. The Commission uses a 

wealth of market surveillance techniques and an arsenal of enforcement weapons in its pursuit of what Chairman Lukken has labeled 

the agency’s zero tolerance for price manipulation. FIA agrees with 

this emphasis. Price manipulation should be prevented whenever 

possible and never tolerated. 

Some have questioned how well existing anti-manipulation defenses work when more than one energy market exists. Multiple 

trading facilities, like NYMEX and ICE only enhance the need for 

strong CFTC oversight. When two markets are competing directly, 

the CFTC’s market surveillance staff must have ready access to all 

relevant large trader reporting. At the same time, FIA believes 

price manipulation is of little concern in one-off, non-standardized 

transactions between two eligible contract participants where the 

price affects the individual transaction, not a wider market. Those 

transactions should remain outside the CFTC’s price manipulation 

authority. 

Retail FX: FIA continues to support the legislation offered by the 

President’s Working Group in 2005 to enhance the CFTC’s power 

over retail FX transactions. This targeted, focused approach makes 

sense and should help the Commission to combat the boiler rooms 

and bucket shops that abuse customers. 

And in conclusion, our last part is a familiar one and a critical 

one. FIA opposes the funding of the CFTC through a transaction 

tax. All taxpayers benefit from CFTC market oversight, therefore 

all taxpayers should pay for it. If the CFTC needs additional resources, and we believe they do, the Administration should request 

and Congress should appropriate the necessary funds, but a transaction tax would hit hardest those traders that provide essential 

market liquidity. It is therefore a bad idea whose time should never 

come. 

Thank you for holding this hearing and I am happy to answer 

any questions. 

[The prepared statement of Mr. Damgard follows:]

PREPARED STATEMENT OF JOHN M. DAMGARD, PRESIDENT, FUTURES INDUSTRY

ASSOCIATION, WASHINGTON, D.C. 

Chairman Etheridge, Ranking Member Moran, Members of the Subcommittee, I 

am John Damgard, president of the Futures Industry Association (FIA). On behalf 

of FIA, I want to thank you for the opportunity to appear before you today. FIA 

is a principal spokesman for the commodity futures and options industry. Our regVerDate 0ct 09 2002 11:27 Apr 02, 2009 Jkt 041481 PO 00000 Frm 00065 Fmt 6633 Sfmt 6621 I:\DOCS\110-27\48374.TXT SOLEM PsN: REBEKA
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ular membership is comprised of 35 of the largest futures commission merchants 

(FCMs) in the United States. Among our 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 serve as brokers for more than ninety percent of all customer transactions executed on United States contract markets. 

As these statistics indicate, the clearing firms are the backbone of FIA’s membership. Not surprisingly, the clearing firms are also the backbone of the futures industry. These firms underwrite the financial performance of their customers and provide the billions of dollars in capital that makes the U.S. futures clearing system 

widely respected as the world-wide hallmark of financial integrity. The U.S. futures 

exchanges are remarkably successful and profitable enterprises, as the price of their 

stock reflects. The futures clearing firms are a big part of that success story, a part 

often overlooked and sometimes underappreciated. 

In 2000, Congress passed and President Clinton signed into law the Commodity 

Futures Modernization Act (CFMA). With the goal of promoting ‘‘responsible innovation and fair competition among boards of trade, other markets and market participants,’’ the CFMA amended the Commodity Exchange Act to:

• Authorize the Commission to develop a regulatory program for markets that 

would be ‘‘tailored to match the degree and manner of regulation to the varying 

nature of the products traded thereon, and to the sophistication of the customer;’’

• Remove the 20 year prohibition on futures on individual securities and narrowbased securities index contracts and, in another radical departure, provide for 

the joint regulation of these products by the Commission and the Securities and 

Exchange Commission; and

• Assure legal certainty for over-the-counter derivatives.

The CFMA signaled a dramatic, new approach to the regulation of the derivatives 

markets and, as such, placed enormous demands on the Commission and its staff 

as they developed the regulations necessary to implement its myriad provisions. The 

CFTC has done, and continues to do, an admirable job administering the provisions 

of the CFMA and the Commodity Exchange Act as a whole, adapting its regulatory 

authority to the dynamics of an ever-changing and ever-challenging market place. 

FIA wholeheartedly endorses the reauthorization of the CFTC. While FIA and the 

CFTC do not see eye to eye on every issue, we believe the CFTC is an excellent 

Federal agency that discharges its statutory obligations in an efficient and effective 

manner. The CFTC’s past and present leadership is to be commended for this 

record. The CFTC deserves to be reauthorized. 

Recently, a controversy has arisen concerning the scope of the Commission’s exclusive jurisdiction. There should be no controversy. Exclusive jurisdiction was created in the House Agriculture Committee in 1974 to make sure that only the CFTC 

would regulate futures trading activity and conduct by futures exchanges, futures 

professionals and futures market participants. Congress made crystal clear in 1974 

that the CFTC’s jurisdiction, where applicable, supersedes the authority of other 

Federal agencies. 

Congress actually anticipated the seeds of the current controversy when it enacted 

exclusive jurisdiction. The Federal Energy Regulatory Commission claims its cash 

transaction anti-manipulation authority allows it to police the futures markets 

themselves because futures prices are used in entering into cash transactions. But 

Congress knew that one purpose of futures trading is to provide pricing information 

that non-futures market participants can rely upon in their commercial dealings. To 

this day, futures price dissemination is one of the Congressionally-recognized public 

interests served by futures markets. 7 U.S.C. § 5(a). Given that economic reality, 

Congress knew that if cash market regulators, like FERC, could stretch their policing arm into the futures markets, futures exchanges, professionals and market participants would be subjected to regulation from multiple Federal regulators, including the Securities and Exchange Commission, Bureau of Mines, the Department of 

Agriculture, the Department of the Treasury, the Board of Governors of the Federal 

Reserve System as well as FERC. 

Congress made a choice. In our view, the right choice. It said CFTC jurisdiction 

over futures was exclusive. The dictionary defines exclusive as ‘‘not shared with others.’’ Congress adopted CFTC exclusive jurisdiction because it wanted the CFTC’s 

jurisdiction not to be shared with others in order to prevent U.S. futures markets, 

professionals and market participants from bearing the cost of ‘‘duplicative or conflicting’’ regulation. And it wanted to entrust the nationally important economic activity in futures markets to the oversight of one expert regulator, the CFTC. 

63

For over thirty years, CFTC exclusive jurisdiction has achieved Congress’ objective because courts have uniformly accepted that Congress used the word ‘‘exclusive’’ so that the CFTC’s jurisdiction would not be shared with other agencies. For 

over thirty years, these exclusive jurisdiction cases have arisen in two contexts: (1) 

where a Federal or state regulator sought to punish alleged misconduct arising out 

of transactions within the CFTC’s jurisdiction or (2) where a Federal agency, like 

the SEC, had approved options or futures products under its regulatory regime that 

were really subject to the CFTC’s authority. 

The FERC’s recent attempt to change the meaning of ‘‘exclusive’’ to ‘‘non-exclusive’’ falls into the first category. No court has ever accepted the position advanced 

by FERC. And no court should. Exclusive jurisdiction is vitally important to the 

proper functioning of the futures markets. It must be preserved. 

FERC’s latest assertion is that there is a regulatory gap in policing futures market manipulation. Nothing could be further from the truth. The CFTC has comprehensive, time-tested futures price anti-manipulation authority. It vigorously enforces the law. FERC and the CFTC should work together. Each has enormous and 

important responsibilities. By double-teaming futures trading, however, FERC is actually diverting resources from those duties. Exclusive means just what it says. It 

was sound policy in 1974 and remains sound policy today. 

In terms of specific areas for reform of the existing regulatory structure, FIA is 

considering a few proposed areas of technical improvement. Rather than discuss 

them in detail at this time, FIA would prefer to focus on bigger picture issues and 

continue its dialogue with the Commission and others in the futures industry on the 

areas where modest reform would be helpful. Perhaps, in some areas, an administrative solution can be found and no statutory amendments will be necessary. In 

light of the Subcommittee’s interest in moving a reauthorization bill, FIA will expedite this process so that the Subcommittee may give timely consideration to any 

amendments the Commission might recommend. 

At this stage of the process, we want to let you know the views of our members 

in four areas: (a) SRO Reform; (b) Competition; (c) Energy; and (d) Retail FX Transactions. 

SRO Governance and Rule Approvals 

FIA supports the important role that the exchanges, clearing organizations and 

the National Futures Association (NFA) perform as self-regulatory organizations 

(SROs). Given their expert market knowledge and close proximity to the trading 

markets, they provide the best vantage point for addressing many of the futures 

markets’ oversight functions. However, to be fully effective, there must be an increased degree of public confidence in the integrity and objectivity of SROs. 

The Commission, to its great credit, has conducted a comprehensive study of 

SROs in the futures industry, resulting in the promulgation last February of rules 

designed to reform SRO governance in many respects. FIA strongly supported the 

CFTC’s efforts to get ahead of the curve on this issue and devoted considerable time 

and resources to answering the Commission’s many inquiries on this subject over 

the years. 

The Commission’s newly adopted ‘‘best practices’’ are a balanced and sensible 

work product that resulted from its careful study. In the context of a Safe Harbor 

for compliance with applicable core principles for Designated Contract Markets, the 

Commission has identified sound and constructive ‘‘best practice’’ guidelines for 

DCM Board composition, the development of independent Regulatory Oversight 

Committees and improvements in the DCM disciplinary process. Most significantly, 

the safe harbor would be available to any DCM with a Board of Directors comprised 

of at least 35% public (independent, non-industry) board members. 

FIA believes the Commission’s best practices constitute a major step toward addressing the conflicts of interest inherent in for-profit self-regulatory bodies. SROs 

that serve both the public interest and private interests necessarily serve masters 

that at least sometimes conflict. Adding public directors to the board of these SROs 

brings balance to the resolution of those conflicts, and avoids the public perception 

that DCMs will sacrifice public interest responsibilities for the commercial interests 

of their shareholder and members. 

The Commission published its final rules in this area in February and then proposed clarifying and technical amendments to the ‘‘public director’’ definition of its 

safe harbor. FIA strongly encourages the Commission to act as soon as possible on 

its proposed amendments and then implement fully its SRO reforms. FIA is confident these measures will increase public confidence in the self-regulatory protections afforded by DCMs under the CFTC’s enlightened oversight. 

The Commission’s SRO study and safe harbor do not directly address one other 

area where FIA has expressed concerns—self-certification of DCM rules. As the SubVerDate 0ct 09 2002 11:27 Apr 02, 2009 Jkt 041481 PO 00000 Frm 00067 Fmt 6633 Sfmt 6621 I:\DOCS\110-27\48374.TXT SOLEM PsN: REBEKA
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committee no doubt appreciates, DCM rules impose important and sometimes costly 

mandates on intermediaries and market participants alike. Often they can be as important as Commission rules which are adopted after full compliance with the Administrative Procedure Act with its notice and comment requirements. 

DCMs do not operate under any restrictions even approaching the APA. Their 

rule making procedures are often opaque to market participants and the public at 

large. Yet the CEA now allows SROs, primarily DCMs, to self-certify virtually all 

rule changes and make them effective immediately. (The only exception is for 

changes to terms and conditions of agricultural commodity futures contracts with 

open interest.) Commission prior approval of DCM rule changes is limited to those 

situations where a DCM affirmatively requests Commission approval. 

FIA generally does not quarrel with the decision to grant DCMs self-certification 

powers. We do have considerable concern, however, that in some cases virtually industry-wide trading rules and other important mandates, including fee changes, are 

being imposed on market participants and intermediaries, including clearing firms, 

without any Commission prior review and certainly without any form of APA notice 

and public comment. We would urge the Commission, when it is requested, or decides, to review any rule submission from any registered entity to publish the rule 

submission for notice and comment under the APA. The law is clear that Commission action on registered entity rules is agency action under the APA. FIA believes 

the CFTC must therefore follow the APA’s requirements when it considers both new 

registered entity rules and changes to existing rules. Adding this level of transparency to the Commission’s review process will further enhance public confidence 

in our markets. 

In some cases, the power to self-certify a rule change may be misread to override 

other powers and policies under the Act, especially when changes are made that affect trading in contracts with considerable open interest. Those changes have real 

financial consequences and should be subject to prior Commission approval. For 

years, the Commission has reviewed DCM emergency orders—applied by definition 

to trading in contracts with open interest—for many public policy reasons. Allowing 

the DCM’s self-certification powers to circumvent these emergency procedures would 

seem to be counter-productive. This is another area we wish to discuss with the new 

leadership at the Commission and the DCMs themselves to see if we can reach 

agreement on a workable resolution. 

Competition 

Promoting fair competition should be the goal of any sound regulatory program. 

Our strong support for the CFMA in 2000 was based in substantial part on our belief that competition, rather than a prescriptive regulatory structure that established high barriers to entry, would be the best regulator. We fully anticipated that 

the CFMA’s regulatory reforms would encourage new entrants to apply for designation with the Commission as contract markets or clearing organizations. These new 

SROs would compete among themselves and with the existing exchanges for customer business based on products, quality of execution and cost. 

The CFMA has sparked innovation and more new exchange applicants. But, except in the energy area, the direct product competition the CFMA had envisioned 

has not materialized. This is disappointing. Robust competition facilitates the ability 

of U.S. futures markets to serve the public interest. Competition leads to reduced 

costs, higher volumes, narrower spreads and greater innovation. Competition also 

is the best system yet devised for serving the interests of our customers. That 

should be the touchstone of our competitive goals. 

Promoting competition and innovation are the twin reasons FIA urges this Subcommittee to reject calls to eliminate the Exempt Commercial Market category in 

Section 2(h) of the CEA. The ECM category has stimulated most of the innovation 

in trading and clearing under the CFMA. ECMs are electronic trading markets for 

principal-to-principal trading in non-agricultural, non-financial commodities. While 

some ECM trades are cleared, they are not intermediated (brokered) in the traditional sense. My member firms are largely in the intermediation business and their 

bottom line is not necessarily well-served by non-intermediated trading. Nonetheless, FIA still supports retention of the ECM category because it serves as an incubator for the successful trading platforms of tomorrow. Entrepreneurs and other 

challengers of established exchanges should be able to choose how they want to 

begin their business and what level of regulation is compatible short term and long 

term with their business objectives. If you cut ECMs out of the CFMA, you cut out 

the competitive, innovative heart of the CFMA. 

With the merger of the Chicago Mercantile Exchange and Chicago Board of Trade, 

some might argue that the futures industry has moved more toward concentration 

than competition. If that is true, FIA believes it would be very unfortunate. We 

65

know the new CME Group believes it faces real competition every day and we trust 

their apparent domination today will not stop them from innovating tomorrow. 

FIA is still hopeful that the CFMA formula of low regulatory barriers to entry 

through principles-based oversight will stimulate new trading platforms to compete 

with the traditional exchanges. Technological advances and globalization may inspire competition in areas we can’t even predict today. After all, in 2000 who would 

have predicted that the ‘‘winner takes all’’ natural monopoly model for futures trading would be so discredited in the energy area today where the New York Mercantile Exchange and IntercontinentalExchange leadership match wits daily to try 

to gain a market advantage. Perhaps 8 years from now or less, this form of vigorous 

direct competition will expand to other commodity areas beyond energy. 

If not, it may be appropriate to reconsider various market structure issues. Other 

competitive models exist in other financial trading markets, like the securities options world, which might have elements that could be adapted to the futures markets. For example, I have been asked by my members why the Options Clearing 

Corporation has been able to reduce its clearing fees in light of extraordinary trading volume, while the futures clearing fees have not experienced a similar reduction 

despite record futures volume. Is this difference because of administrative efficiencies, technology, ownership structure, governance or some other factor? At this 

point, I have to admit, I don’t know the answer. 

What I do know is that competition and market structure are critical issues for 

customer service. We would urge this Subcommittee to ask the CFTC to study the 

state of competition among centralized trading platforms and clearing entities for 

derivatives products with an eye toward making sure the existing futures market 

structure is the best for serving our customers. 

Energy 

Everyone agrees that the price of energy is a critical element of our national economy. For decades, energy futures have served our national interest by providing a 

means for efficiently managing and reliably discovering energy prices. The Commission should take pride in its effective oversight and stewardship of these markets. 

In recent years, energy markets have experienced considerable innovation and increasing competition, largely as a result of the CFMA. The CFMA has made it possible for new markets to compete with established exchanges. That competition has 

caused traditional exchanges to modernize through electronic trading or at least increase their pace of modernization. The CFMA has also encouraged innovative 

thinking by established exchanges and new trading platforms. The result is that 

those trying to manage energy price risks and those willing to assume those risks 

now have more choices than ever before. Indeed, one of the most popular recent innovations in energy—the ability to submit certain private bilateral energy transactions to regulated clearing entities—flowed directly from the CFMA’s provisions. 

The importance of this innovation cannot be overstated. Those bilateral, but cleared, 

transactions on the New York Mercantile Exchange’s ClearPort facility now comprise approximately 20–25% of that exchange’s monthly volume. 

In our view, the CFMA has sparked these positive developments without compromising the public interest, including the vital interest in preventing price manipulation. The Commission continues to deploy a wealth of market surveillance techniques and an arsenal of enforcement weapons in its pursuit of what Chairman 

Lukken has labeled the agency’s zero tolerance of price manipulation. These Commission tools include large trader reports, special calls, position limits, price manipulation enforcement actions and even sweeping, perhaps unprecedented market 

emergency powers. Clearly, the Commodity Exchange Act and the Commission’s regulatory apparatus continue to target price manipulation as public enemy #1. 

FIA agrees with this emphasis. Price manipulation should be prevented whenever 

possible and never tolerated. The best defense against price manipulation is effective CFTC market surveillance based on all relevant large trader information. The 

Commission’s recent proposal to confirm under its special call authority that large 

traders must maintain books and records for related non-reportable transactions is 

fully consistent with this philosophy. The Commission’s proposal would even include 

trades on foreign boards of trade within this special call authority so that the Commission could obtain access to surveillance data from a large futures trader on both 

a U.S. exchange and a foreign exchange in the same commodity. The Commission’s 

proposal illustrates that the agency’s existing authority is substantial and adaptable 

to current market needs and conditions. 

Some have questioned how well the existing anti-manipulation defenses work 

when more than one energy derivative market exists. In FIA’s view, multiple trading facilities, like NYMEX and the IntercontinentalExchange today in energy, only 

enhance the need for vigorous CFTC oversight. When two markets are largely comVerDate 0ct 09 2002 11:27 Apr 02, 2009 Jkt 041481 PO 00000 Frm 00069 Fmt 6633 Sfmt 6621 I:\DOCS\110-27\48374.TXT SOLEM PsN: REBEKA
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peting directly, it is most important that CFTC market surveillance have ready access to all relevant large trader information. 

If we are to have same commodity competition among trading facilities, as the 

CFMA contemplated and FIA has espoused, then the Commission must conduct this 

kind of multiple market surveillance. This is perfectly consistent with the statute. 

In the CFMA itself, Congress signaled that promoting multiple trading platforms in 

energy derivatives did not mean that price manipulation prevention should be shortchanged. Instead, Congress made clear in the statute that for any energy or other 

‘‘exempt commodity’’ transactions conducted on a ‘‘many to many’’ trading facility—

whether that facility was a DCM, DTEF, or ECM—the Commission was empowered 

to enforce the statute’s prohibition against price manipulation. 

In contrast, Congress did not extend manipulation protections to bilateral, nontrading facility transactions in excluded or exempt commodities. FIA agrees with 

that congressional judgment, embodied in sections 2(d) and 2(g) of the CEA. Price 

manipulation is of little concern in one-off, non-standardized transactions between 

two eligible contract participants where the price affects the individual transaction, 

not a wider market. But where the pricing of trades would affect the interests of 

other market participants, or even others that base commercial transactions on futures market prices, the CFTC has an interest in preventing futures price manipulation. In those circumstances, the CFTC must be the cop on the beat. 

The Commission’s traditional role as the exclusive regulator of futures transactions and markets actually compels this kind of comprehensive and vigilant multimarket surveillance approach. Multiple markets combined with multiple regulators 

would be a recipe for disaster. The slow growth of single stock futures in the U.S., 

relative to other countries, indicates that shared jurisdiction regimes may at least 

inhibit the development of viable trading markets. 

The Commission has in the past made its preeminence in U.S. futures market 

surveillance known to its sister regulatory agencies overseas. If a DCM and a foreign board of trade list for trading essentially the same contract, the Commission 

understandably coordinates its surveillance activities with foreign regulators. The 

Commission’s experience with the Financial Services Authority and ICE Futures 

Europe illustrates how well this kind of cooperative information sharing approach 

can work in practice. The Commission is to be commended for establishing the necessary arrangements without overburdening market participants or sacrificing its 

legitimate surveillance needs. 

FIA recognizes that Congress is not clairvoyant and that market conditions 

change, especially in a world driven by changes in technology that come at us faster 

every day. We know the Commission will take whatever steps it determines to be 

appropriate to update its regulatory approaches consistent with its statutory authority. FIA understands it is possible that the Commission may decide that it lacks 

some needed authority in some areas and may therefore want to recommend to this 

Subcommittee some changes in those areas. Perhaps, as one major ECM has observed in a Congressional hearing, limited changes might be called for in the ECM 

area for some commodities in some circumstances where multiple markets exist. But 

the tests for any of these changes should be: are they essential for the performance 

of the CFTC’s market surveillance function and are they the least intrusive means 

for achieving the required outcome? 

FIA does not believe that any statutory change should be a basis for leveling the 

so-called competitive playing field in energy or any other area. Congress has appropriately allocated regulatory oversight in the CEA based on differences in market 

participants, commodities traded, means of trading, intermediation and even impact 

on cash markets. FIA would not support any fundamental change to that regulatory 

alignment. 

Retail OTC Foreign Currency Transactions. 

As the Subcommittee will recall, the CFMA amended the so-called Treasury 

Amendment based on a two-fold recommendation of the President’s Working Group 

on Financial Markets. First, the CFTC would continue to have no jurisdiction over 

OTC foreign currency futures and options transactions effected between eligible contract participants, as defined in the Act (large, financially-sophisticated, well-capitalized, or otherwise regulated market participants). Second, retail customers could 

effect OTC foreign currency futures and options transactions only if the customer’s 

counterparty for those transactions was among a group of otherwise regulated entities, including banks, broker-dealers and futures commission merchants. Although 

not expressly stated in the amendments, OTC futures and options transactions effected between retail customers and counterparties that were not among the group 

of otherwise regulated entities would be subject to the exchange-traded requirements of section 4(a) of the Act and, therefore, illegal. In order to enforce that ban, 

67

the CFTC would have to prove in court that the offending transactions were futures 

or options. 

It is important to stop here to emphasize that the CFMA provided the CFTC with 

these enforcement powers solely with respect to transactions that are futures or options on foreign currency. The amendments did not purport to grant the Commission 

jurisdiction over cash and forward contracts. Under the CFMA, the active cash and 

forward markets in foreign currency would continue to fall outside of the Commission’s jurisdiction. (Historically, of course, cash and forward transactions on all commodities have been excluded from the Commission’s jurisdiction.) 

In the past 7 years, many unregistered and unregulated entities have engaged in 

widespread sales practice and financial fraud in connection with off-exchange foreign currency transactions with retail customers. Some of these entities have attempted to avoid CFTC prosecution by claiming not to be offering futures on foreign 

currency. To the contrary, the agreements between these entities and their customers stated that these transactions would be conducted on the spot market. Nonetheless, applying a multi-factor approach first blessed by the 9th Circuit in CFTC v. Co-Petro Marketing Group, Inc., the Commission has taken the position that these 

transactions are futures transactions and, therefore, illegal. 

Some years ago the 7th Circuit’s decision in CFTC v. Zelener concerning the legal 

tests for proving that a transaction is a futures contract called into question the 

Commission’s jurisdiction. In that case, the court rejected the multi-factor futures 

definitional approach and, focusing solely on the terms of the customer agreement, 

held that the so-called ‘‘rolling spot’’ contracts offered by the defendants were, in 

fact, spot contracts and not futures contracts. Some claim this decision has created 

enforcement problems for the Commission. 

As FIA told this Subcommittee in 2005, we agree the CFMA’s approach to granting the Commission enforcement jurisdiction over retail fraud in foreign currency 

(FX) transactions was imperfect. That is why we were pleased when the PWG came 

forwarded with a targeted solution to this problem in 2005, and we endorsed the 

PWG’s proposal. While we have some technical suggestions for that legislative proposal, FIA continues to support the PWG’s approach. It would expand the CFTC’s 

enforcement powers to apply its antifraud authority to the offer and sale of Zelenerlike FX contracts. And it would require those that solicit customer business in the 

retail FX area to be registered. 

FIA does not believe that further regulatory authority is needed at this time, but 

we understand that National Futures Association may offer some further refinements to shore up the PWG’s language in some respects. We look forward to reviewing the NFA proposals in the retail FX area. 

Conclusion 

Our last point is a familiar one and a critical one. Price manipulation is public 

enemy #1 because it affects both market participants and the public at large. Price 

manipulation can have a serious ripple effect in our economy and can hurt many 

innocent bystanders. That is why continued CFTC vigilance is so important. 

It is also why Commission regulation benefits not just market participants, but 

just as profoundly non-market participants. For that reason, FIA continues to be vehemently opposed to funding the CFTC through a transaction tax. In our view, all 

taxpayers benefit from CFTC market oversight. Therefore all taxpayers should pay 

for it. If the CFTC needs additional resources, the Administration should request 

and Congress should appropriate the necessary funds. But imposing an arbitrary 

and egregious tax that would be borne most by those that provide the liquidity that 

allows futures markets to serve so many public interests is a bad idea whose time 

should never come. 

Thank you for holding this hearing and for considering our views. I would be 

happy to answer any questions you might have.

Mr. ETHERIDGE. Thank you, sir. Ms. Becks. 

STATEMENT OF THERESA D. BECKS, MEMBER, MANAGED 

FUNDS ASSOCIATION; PRESIDENT AND CEO, CAMPBELL AND 

COMPANY, INC., TOWSON, MD 

Ms. BECKS. Chairman Etheridge and Members of the Subcommittee, thank you for inviting me to testify today. My name is 

Terri Becks. I am appearing today in my capacity as a Member of 

the Managed Funds Association, the MFA, of which I recently 

served on the Board of Directors. I am involved in MFA through 

68

my role as President and CEO of Campbell and Company, Inc. We 

are one of the oldest and largest futures trading advisers in the 

world. 

A little bit about MFA. It is the primary trade association representing professionals who specialize in the management of alternative investments. MFA members offer investment products that 

are not generally correlated to the performance of traditional stock 

and bond investments. These alternative investments help public 

investors, as well as more sophisticated investors diversify their 

portfolio. By taking speculative positions in alternative markets, 

these investments serve the markets as a whole by adding liquidity 

and acting as shock absorbers. 

MFA members have no competitive agenda. We simply want access to efficient, transparent, fair and financially secure markets. 

In that sense, the interests of MFA members have been well-served 

by the excellent work the CFTC and its staff have performed for 

many years. In order to continue to fulfill its unique role and important responsibilities, the CFTC must have sufficient funding to 

support a full and competent staff. Accordingly, MFA strongly supports reauthorizing the CFTC and providing the CFTC with additional resources. 

MFA members’ interests have also been very well served by the 

Commodity Futures Modernization Act, landmark legislation that 

was authorized by this Subcommittee. MFA does not see a need for 

major changes to the CFMA. No case has been made to turn back 

the clock by re-regulating Exempt Commercial Markets that have 

served as an incubator for derivatives trading innovation. Although 

where the markets are linked, the CFTC should have authority to 

obtain large trader reports. We do agree with that suggested 

change. 

When creating the CFTC in 1974, Congress entrusted it with exclusive jurisdiction over futures markets to ensure that no other 

agency would look over its shoulder and second guess its regulatory 

judgments. If jurisdiction is shared either at the Federal or state 

level, market participants will find themselves facing, at worse, 

conflicting, and at best, duplicative government regulations. For 

this reason, MFA encourages the CFTC to assert vigorously its exclusive jurisdiction as Congress intended and the courts have interpreted. MFA members are acutely aware of the unwarranted cost 

and burden multiple regulators impose. 

One of the best examples of how multiple sources of regulation 

squelch innovation is the public commodity pool business. I am 

very familiar with that, as we sponsor our own public funds. Public 

commodity pools are the best vehicle through which retail investors 

can access the futures markets. These pools are managed professionally, allow investors to diversify their risks and provide an affordable futures-based product with a limited liability structure. 

Besides the CFTC, the SEC, the NFA, FINRA and each of the 50 

states all regulate commodity pools. Multiple regulators impose a 

great cost upon commodity pools that is often not warranted by a 

cost benefited analysis. 

In addition to that, in all honesty, I find, in dealing with all the 

various regulators, there is a little bit of teaching that we have to 

do with those that are not familiar with things like the CFTC is 

69

on our specific investment vehicles. Another thing, for example, 

commodity pools are subject to the same record maintenance and 

Sarbanes-Oxley reporting requirements as Fortune 500 companies. 

SOX was not designed with passive investment pools in mind and 

its application to commodity pools is unwarranted. MFA recommends that public commodity pools be treated like investment 

companies for purposes of SOX under the same applicable exemption. 

Another example of over-regulation is FINRA RULE 2810. Prior 

to approving a public offering of commodity pools, FINRA calculates the underwriting compensation. It imposes a 10 percent cap 

on such compensation. Previously, FINRA exempted from this calculation the payment trails for public commodity pools. That exemption reflected the additional service an associated person would 

provide to a pool investor due to the esoteric nature of commodity 

pools and market. In 2004 FINRA ended the exemption for pool 

trail commissions. FINRA believed that its action would not stop 

the offering of commodity pools to the public. 

However, since its action, we have seen fewer public commodity 

pools offered. As a practical matter, FINRA’s actions have forced 

new commodity pools that would have been offered publicly to become private or not offered at all. In effect FINRA’s actions deny 

public investors access to an attractive diversification in their investment alternatives. MFA believes that the trail commission experience and the duplicative filing requirements illustrate well the 

dangers of multiple regulators and the costs it imposes on market 

innovation. In your deliberations, MFA asks the Subcommittee to 

take these concerns into account and to consider any appropriate 

measures to help revive the public commodity pool business. 

Again, thank you for this opportunity to appear today and I 

would be happy to answer any questions that you have. 

[The prepared statement of Ms. Becks follows:]

PREPARED STATEMENT OF THERESA D. BECKS, MEMBER, MANAGED FUNDS

ASSOCIATION; PRESIDENT AND CEO, CAMPBELL AND COMPANY, INC., TOWSON, MD 

Chairman Etheridge and Members of this Subcommittee, thank you for inviting 

me to testify today. My name is Terri Becks. I am appearing today in my capacity 

as a Member of the Managed Funds Association (the ‘‘MFA’’), for which I recently 

served on the Board of Directors. I am involved in MFA through my role as President and CEO of Campbell & Company, Inc.—one of the oldest and largest futures 

trading advisors in the world. 

About MFA 

MFA is the primary trade association representing professionals who specialize in 

the management of alternative investments, including hedge funds, funds of funds 

and managed futures funds. MFA has over 1,400 members, including the vast majority of the largest hedge fund groups in the world who manage a substantial portion of the over $1.67 trillion invested in absolute return strategies. Many MFA 

members are registered with the Commodity Futures Trading Commission (the 

‘‘CFTC’’) as commodity trading advisors (‘‘CTAs’’) and commodity pool operators 

(‘‘CPOs’’). 

MFA has been a vocal advocate for sound and sensible public policy in this important sector of the financial world—a sector that provides many benefits to the global 

marketplace. Funds sponsored by MFA members offer investors the ability to diversify their portfolios in a meaningful way by providing investment products that perform in a manner that is not generally correlated to the performance of traditional 

stock and bond investments. Increased interest in and use of alternative investments is a direct result of the growing demand from institutional and other sophisticated investors for investment vehicles that deliver true diversification. These inVerDate 0ct 09 2002 11:27 Apr 02, 2009 Jkt 041481 PO 00000 Frm 00073 Fmt 6633 Sfmt 6621 I:\DOCS\110-27\48374.TXT SOLEM PsN: REBEKA
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vestments also help them meet their future funding obligations and other investment objectives. MFA members’ funds perform a number of important roles in the 

global marketplace, including contributing to a decrease in overall market volatility, 

acting as ‘‘shock absorbers’’ and liquidity providers by standing ready to take positions in volatile markets when other investors remain on the sidelines. Fund trading 

activity also provides markets with price information, which translates into pricing 

efficiencies, and assists in identifying pricing inefficiencies or trouble spots in markets. Moreover, these funds utilize state-of-the-art trading and risk management 

techniques that foster financial innovation and risk sophistication among market 

participants. 

As major customers of futures exchanges and futures commission merchants 

(‘‘FCMs’’) as well as purchasers of other futures industry services, many of MFA’s 

members directly benefit from the provisions of the Commodity Exchange Act (the 

‘‘CEA’’ or the ‘‘Act’’) and in particular, the reforms brought about by the Commodity 

Futures Modernization Act of 2000 (the ‘‘CFMA’’). The CFTC’s oversight of the U.S. 

futures markets has an important impact on CPOs, CTAs and their clients. Furthermore, many aspects of MFA members’ business operations (such as sales, promotional, registration and operational activities) are also subject to regulation by 

the National Futures Association (the ‘‘NFA’’)—the industry’s self-regulatory organization. The CFTC and the NFA oversee the business activities of CPOs and CTAs 

through registration, disclosure, anti-fraud, recordkeeping and reporting requirements, and periodic audits. Each of the futures exchanges also monitors trading activities of MFA members in their respective markets. 

Many of MFA’s members are subject to regulation under other Federal statutes 

in addition to the CEA. The public offer and sale of interests in commodity funds 

are subject to the Securities Act of 1933 (the ‘‘1933 Act’’), which requires registration 

of these interests and mandates certain disclosure obligations. Commodity funds are 

also subject to the Securities Exchange Act of 1934, which requires the filing of certain publicly-available reports as well as to the individual securities laws of each 

of the 50 states. Many of MFA’s members are also subject to the anti-money laundering requirements of the USA PATRIOT Act of 2001. Unlike investment companies, many MFA members are also subject to all of the records maintenance requirements of the Sarbanes-Oxley Act of 2002 (‘‘SOX’’). 

MFA has a strong interest in the issues you are discussing today. MFA members 

trade on exchange and off exchange. We are neutral in any competitive battles that 

pit traditional exchanges against new trading platforms, or multi-lateral systems 

against bilateral dealer operations. Our members simply want access to efficient, 

transparent, fair and financially secure markets. In that sense, the interests of MFA 

members have been well served by the excellent work the CFTC and its staff have 

performed for many years. 

MFA members’ interests have also been well served by the CFMA, landmark legislation that was authored in this Subcommittee. In that statute, Congress adopted 

a cascading regulatory approach with different levels of oversight assigned to trading in different categories of commodities, market participants and order execution 

facilities. The CFTC has been masterful in applying these new statutory provisions 

to allow new market forces to compete with traditional exchanges in a host of areas, 

especially in energy. MFA members have benefited from these CFMA-inspired innovations. Since the CFMA was passed, MFA has worked together with the CFTC on 

a number of important rulemaking projects. We believe the CFTC’s efforts at reducing unnecessarily burdensome regulations, also a direct result of the CFMA, will 

continue to encourage greater use of futures products in the financial marketplace. 

Accordingly, we are delighted to be here today to discuss the importance of the 

CFTC to our industry and the statutory framework under which it operates. MFA 

strongly supports reauthorizing the CFTC. 

Importance of the CFTC and the CFMA 

In order to continue effectively fulfilling the CFTC’s unique role and important 

responsibilities, the CFTC must have sufficient funding to support a full, competent 

staff. Accordingly, MFA supports the CFTC’s requests for additional resources. 

MFA does not see a need for major changes to the CFMA. No case has been made 

to turn back the clock by re-regulating new trading platforms, known as Exempt 

Commercial Markets (‘‘ECMs’’), that have served an incubator function for derivatives trading innovation. MFA understands that the CFTC’s website has listed 19 

ECMs that have been created since the CFMA was passed. Those markets operate 

as principals only, electronic trading venues for sophisticated well-capitalized market participants. MFA believes it is both appropriate and important to cultivate 

those innovative enterprises. 

71

1The Financial Industry Regulatory Authority is a self-regulatory organization created in July 

2007 through the consolidation of the National Association of Securities Dealers and the member regulation, enforcement and arbitration functions of the New York Stock Exchange. 

Exclusive Jurisdiction and the Avoidance of Duplicative Regulation 

When the CFTC was created in 1974, Congress entrusted it with exclusive jurisdiction over futures markets to ensure that no other agency—whether it be the SEC, 

USDA or the Bureau of Mines—would look over its shoulder and second-guess its 

regulatory judgments. Congress wanted an agency expert in futures markets to determine whether a threat of manipulation existed or some other major market disturbance caused futures market prices not to reflect accurately the forces of supply 

and demand. In short, Congress wanted the CFTC to be able to take appropriate 

action if it sniffed the possibility of manipulation in the air. 

Congress vested extraordinary emergency powers in the CFTC to address any 

such threat, powers the CFTC once called the linchpin of the Act. The CFTC has 

correctly used those powers very sparingly, but their existence serves a very important purpose. Exchanges and market participants alike know that the CFTC alone 

is ready to act when in its informed, expert judgment, action is warranted. That 

power can not work if it is shared with other regulatory bodies, either at the Federal level or the state level; nor can more than one agency police price manipulation 

in futures markets themselves. 

Otherwise exchanges, intermediaries, advisors, funds and other market participants will find themselves facing at worst conflicting, and at best, duplicative, government regulation, the very ills Congress sought to cure with exclusive jurisdiction. 

Multiple regulators sharing concurrent jurisdiction will not strengthen regulation. 

They will just water down regulation at a considerable cost to market participants. 

MFA encourages the CFTC to assert vigorously its exclusive jurisdiction as Congress intended and the courts have interpreted. 

Public Offerings of Commodity Pools 

One of the best examples of how multiple sources of regulation squelch innovation 

is the public commodity pool business. 

Public commodity pools are the best vehicle through which retail investors can access the futures markets because these funds are offered through a full risk disclosure regime and provide an affordable futures-based product with a limited liability 

structure. Public commodity funds are one of the only alternative investment products available to public investors to diversify a traditional stock and bond portfolio. 

Public commodity pools are managed professionally and typically offer liquidity 

monthly—much more frequently than many other forms of alternative investments. 

The CFTC, of course, exercises regulatory jurisdiction over commodity pools. But 

its jurisdiction is far from exclusive. Commodity pools are also regulated by the 

SEC, NFA, the Financial Industry Regulatory Authority 1 (the ‘‘FINRA’’) as well as 

state blue sky regulators. 

MFA believes that multiple sources of regulation have contributed directly to severe contraction of the public commodity pool offering market. Why? Regulation and 

over-regulation bear at least some of the responsibility. For example, unlike investment companies, commodity pools are subject to the same records maintenance and 

SOX reporting requirements as Fortune 500 companies. It is worth noting that public commodity pools have been subject to substantively similar oaths, recordkeeping 

and reporting requirements for more than 2 decades prior to the enactment of SOX. 

Unlike these requirements which were tailored specifically for public commodity 

pools, SOX applies broadly to operating companies. The unnecessarily complicated 

and duplicative requirements of SOX impose real costs to those that may want to 

offer new public commodity pools as variations exist between the SOX requirements 

and those requirements tailored for public commodity pools. MFA supports and encourages the treatment of publicly offered commodity pools like investment companies for purposes of SOX, providing exemptive relief that would promote competition. 

Moreover, public commodity pools are subject to both registration with and regulation by each of the 50 states which are often referred to as Blue Sky laws. Blue 

Sky registration and regulation impose a great cost that is often not warranted by 

a cost-benefit analysis. Blue Sky laws from one state sometimes contradict those 

from another state. Certain Blue Sky laws even conflict with Federal regulation. 

Blue Sky compliance therefore is an extra cost imposed on commodity pool offerings. 

FINRA RULE 2810 (also commonly referred to as ‘‘Direct Participation Programs’’ 

or ‘‘DPP Rule’’) is another example. It requires that, prior to the public offering of 

commodity pool securities, information must be filed with FINRA’s Corporate Financing Department, who must then provide a ‘‘no objections’’ opinion. Before 

72

issuing this opinion, FINRA takes into account the proposed terms and arrangements of the DPP offering, including the level of underwriting compensation which 

may not exceed 10 percent of the gross proceeds of the offering. 

Prior to October 12, 2004, FINRA staff excluded the payment of trail commissions 

for commodity pool direct participation programs from the underwriting compensation limits of the DPP Rule if: (a) the member was registered as a FCM with the 

CFTC; (b) the associated person receiving the trail commissions passed one of two 

exams (the National Commodity Futures Examination (‘‘Series 3’’) or Futures Managed Funds Examination (‘‘Series 31’’)); and (c) the associated person receiving the 

trail commissions provided ongoing investor relations services to its investors. Trail 

commissions for public commodity pools were not included within the underwriting 

compensation because this money was seen as a service fee the investor paid to a 

qualified associated person in exchange for ongoing advice. This policy of excluding 

public commodity pools from the DPP Rule was based on the continuing and regular 

service the associated person would provide to keep the investor informed about the 

status of the investment due to the esoteric and complex nature of commodity pools 

and markets. In addition to encouraging associated persons to obtain Series 3 or Series 31 certification, this treatment provided an incentive for associated persons to 

recommend public commodity pools to investors where appropriate as the trail commissions compensated him or her for the additional servicing required due in part 

to the nature of regular and frequent redemption opportunities. 

The trail commission is the portion of futures brokerage fee or commission 

charged by the FCM to the pool which is allocated to the associated person. FINRA 

lacks jurisdiction over the level of futures brokerage commissions and cannot regulate either the brokerage fee as a whole or its internal allocation within the brokerage firm. In any event, from the perspective of many public investors, trail commissions would not increase their cost. If trail commissions are unavailable, the FCM 

will simply charge the same brokerage commission to the pool, without allocating 

any portion of it to the associated person who sold the investment. 

In July 2004, FINRA acted on its belief that notwithstanding the limitation of including trail commissions as underwriting compensation, firms and registered representatives would continue to offer and recommend commodity pool DPPs. FINRA 

believed revocation of the trail commission exemption would benefit investors in 

commodity pool DPPs by limiting compensation to the same amounts that already 

applied to all other DPP investments. Thus, effective October 12, 2004, FINRA 

began including trail commissions in calculating whether the level of underwriting 

compensation exceeds the 10% limitation in the DPP Rule. 

Since FINRA began including trail commissions for commodity pools as underwriting compensation, fewer new public commodity pools have been offered. It seems 

clear that—contrary to FINRA’s belief—firms and registered representatives have 

drastically reduced offering public commodity pools and have fewer public commodity pools to recommend where such products meet investors’ financial status and 

investment objectives. As a practical matter, FINRA’s actions have forced new commodity pools that would have been public offerings to become private offerings or 

not be offered at all. Because commodity pools are not available to many public investors when offered privately, many public investors are denied access to an attractive diversification investment alternative. In contrast to more sophisticated investors, the best diversification alternative available to these public investors is to invest directly in the futures market—a far riskier undertaking than public commodity pools. Ironically, public customers also pay full brokerage commissions to 

FCMs for such direct participation in a futures trading account, not the lower rates 

often charged commodity funds. 

MFA makes these observations both as a reminder of the perils of over-regulation 

through multiple regulation and to request the Subcommittee’s consideration of appropriate measures that could be taken to revive the public commodity pool business. 

Again, thank you for this opportunity to appear today. I would be happy to answer any questions you may have.

Mr. ETHERIDGE. Thank you, ma’am. Mr. Brodsky. 

STATEMENT OF WILLIAM J. BRODSKY, CHAIRMAN AND CEO, 

CHICAGO BOARD OPTIONS EXCHANGE, CHICAGO, IL; ON

BEHALF OF U.S. OPTIONS EXCHANGE COALITION 

Mr. BRODSKY. Thank you, Chairman Etheridge and Ranking 

Member Moran. I am William J. Brodsky, Chairman and Chief ExVerDate 0ct 09 2002 11:27 Apr 02, 2009 Jkt 041481 PO 00000 Frm 00076 Fmt 6633 Sfmt 6601 I:\DOCS\110-27\48374.TXT SOLEM PsN: REBEKA
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ecutive Officer of the Chicago Board Options Exchange. Prior to my 

service at the Chicago Board Options Exchange, I was for, almost 

12 years, CEO of the Chicago Mercantile Exchange, where I was 

obviously involved on the futures side of the business. I am also 

currently Chairman of the International Option Market Association, which represents 50 options exchanges around the world. 

I appear today, however, on behalf of the CBOE and the five 

other United States securities options markets, which include the 

American Stock Exchange, the Boston Options Exchange, the International Securities Exchange, the New York Stock Exchange and 

the Philadelphia Stock Exchange, as well as our clearinghouse, the 

Options Clearing Corporation, and together, we comprise the U.S. 

Options Exchange Coalition. 

And just by way of perspective, the U.S. options industry provides an increasingly important role in our economy. Last year the 

exchange listed option business grew at a 35 percent rate, which 

is higher than the stock business, the equity business, at 13 percent, and the futures business at 26 percent. In addition, the volume on all the U.S. options exchanges is approximately the same 

as all the futures exchanges, so it keeps in perspective the size of 

our community, as well. 

In brief, we support reauthorization of the CFTC. We believe the 

CFTC has done a very good job. But we also believe that it is high 

time for a macro review of regulation of financial derivatives that 

recognize the overlapping jurisdiction in financial derivatives. And 

I would point out the fact that the Treasury is now undertaking 

a study which will include some of these issues. 

In addition, I would like to commend the Committee not only on 

CFMA of several years ago, but also your support 2 years ago of 

the vital issues on portfolio margining that helped spur the SEC 

to act on implementing a broad base portfolio margining pilot that 

unequivocally has made our securities markets more competitive. 

However, there are still many issues that Congress can address related to portfolio margining and other important topics. As I sit 

here today, it is clear that despite the best intentions of all the parties, the system of separating the regulation of futures and securities is broken and needs to be fixed. 

This creates regulatory inefficiencies, hampers U.S. competitiveness and impedes innovation. No other country in the developed 

derivative markets applies such a system of two different government agencies regulating equivalent financial products. While a 

merger of the CFTC and the SEC into a combined agency or the 

creation of a newer agency would address these issues, the mechanics and the politics of such a merger would be a long time goal. 

In the meantime, there are concrete steps that can be taken now 

to address the effects of split jurisdiction. 

First, Congress could end the current system of split Congressional oversight of the two agencies. Having both the SEC and the 

CFTC subject to the jurisdiction of a single Congressional Committee would help ensure the consistent oversight of financial regulators. Second, when jurisdictional disputes do arise between the 

SEC and the CFTC, there is currently no mechanism to resolve 

them other than a dialogue between the two agencies or litigation. 

Perhaps, if the SEC and the CFTC, despite their best intentions, 

74

find themselves at an impasse, they should seek the input of other 

members of the Presidential Working Group, specifically, the 

Treasury and the Fed, to resolve these issues promptly. 

But even assuming these steps are taken, the current regulatory 

system is impeding U.S. global competitiveness and innovation in 

several ways. Our major areas of concern are the following: One is 

new product approval process and the lack of legal certainty and 

the other is portfolio margining. The U.S.’s bifurcated regulatory 

system presents significant hurdles that must be overcome in connection with new product approval. When questions arise as to 

whether a particular new product is more properly a security or a 

future, the result can be an interminable delay in bringing that 

product to market while the two agencies try to decide who has the 

jurisdiction over the product. 

Two recent examples are illustrative. The first involves options 

on exchange traded funds that invest and hold gold. In June of 

2005, the CBOE filed a proposal with the SEC to trade options on 

gold ETFs. The gold ETFs themselves have continued to trade as 

securities on securities exchanges. CBOE’s related option proposal 

has not advanced because the SEC and the CFTC are still trying 

to agree, more than 2 years later, on which agency should regulate 

this option product. 

Another example, both the Chicago Mercantile Exchange and the 

CBOE began to trade credit default derivatives this year, but not 

before it took the SEC and the CFTC approximately 9 months to 

determine how to allocate the jurisdiction of these two products between the two agencies and after a similar product began trading 

overseas. The bifurcated system also subjects our clearing agency, 

the Option Clearing Corp, to the jurisdiction of both the SEC and 

the CFTC every time it proposes to clear a new product. This process is time consuming and delays product innovation and effectively gives the CFTC a veto over the introduction of new securities 

products. 

There must be a means to ensure that the proposed new products that raise jurisdictional issues may be introduced to the market more promptly and efficiently. Perhaps other members of the 

Presidential Working Group could broker the jurisdictional issue in 

the case of an impasse. This could also be a recognition by the SEC 

and the CFTC of the circumstances such as where the underlying 

instrument is either a security or a future in which jurisdiction 

should not be a dispute. 

The second example involves portfolio margining. While earlier 

this year the potential availability of portfolio margining became 

greatly expanded, legal impediments to putting those futures positions in securities customers’ accounts for portfolio margining still 

exist. Two important changes must occur in order to permit investors to avail themselves of the full potential of portfolio margining. 

First, Congress needs to amend the Securities Investor Protection 

Act so that futures positions in a customer’s portfolio margining account are protected by SIPA insurance. Without a legislative 

change to SIPA, full evolution to a state-of-the-art portfolio margining system for customers may never occur in the U.S. 

Second, the securities industry and the futures industry have advocated different approaches to the issue of portfolio margining. 

75

Under the security industry’s ‘‘one pot’’ approach, all securities and 

futures positions are maintained in a single portfolio margins securities account for the purpose of maximizing the utility of margin 

collateral in the account. Under the futures industry ‘‘two pot’’ approach, a futures account holds the futures position and the securities account holds the securities position for purposes of maintaining margin collateral. For a host of reasons, the Coalition believes 

that the ‘‘one pot’’ approach is the most efficient means of portfolio 

margining. 

To enable customers to use a single securities account for portfolio margining purposes, however, the CFTC will have to provide 

exemptive relief under the Commodity Exchange Act, yet as another example of the jurisdictional divide between the SEC and the 

CFTC, the two agencies continue to disagree on the most appropriate approach to implementing portfolio margining. If the agencies are unable to agree on the steps necessary to fully implement 

portfolio margining, as its most efficient ‘‘one pot’’ level outlined 

above, Congress or the Presidential Working Group should step in 

to help facilitate a full-course margining for all securities products 

and their related futures. 

The Coalition and I stand ready to work with the Committee and 

its staff as they consider these important issues. I would be happy 

to answer any questions you may have and I would request that 

my full statement be entered into the record. Thank you very 

much. 

[The prepared statement of Mr. Brodsky follows:]

PREPARED STATEMENT OF WILLIAM J. BRODSKY, CHAIRMAN AND CEO, CHICAGO

BOARD OPTIONS EXCHANGE, CHICAGO, IL; ON BEHALF OF U.S. OPTIONS EXCHANGE

COALITION

Mr. Chairman and Members of the Subcommittee, I am William J. Brodsky, 

Chairman and Chief Executive Officer of the Chicago Board Options Exchange 

(‘‘CBOE’’). I appear today on behalf of the CBOE and the five other United States 

options markets: the American Stock Exchange, the Boston Options Exchange, the 

International Securities Exchange, NYSE–ARCA, the Philadelphia Stock Exchange, 

and our clearinghouse, The Options Clearing Corporation (‘‘OCC’’). Together, we 

comprise the U.S. Options Exchange Coalition (‘‘Coalition’’). Our markets trade all 

the exchange-traded security options in the U.S., such as options on individual 

stocks, stock indexes, exchange-traded funds, debt securities, securities volatility, 

and foreign currency. These markets provide the major hedging instruments for the 

U.S. stock market. 

Chairman Etheridge, Ranking Member Moran and Members of the Subcommittee, 

I would first like to thank you for allowing the U.S. Options Exchange Coalition to 

provide its views on reauthorization of the Commodity Exchange Act (‘‘CEA’’). The 

U.S. options industry provides an increasingly important role in our economy. Last 

year exchange-listed options experienced a 35% growth rate, higher than both stock 

(13%) and futures (26%) trading. Additionally, the number of U.S. listed options contracts traded in 2006 approached the number of contracts traded in all U.S. futures 

markets combined. Through August 2007, a record 1.82 billion option contracts 

changed hands in the U.S. options market, a 37.5% increase from the same yearago period, and daily trading volume has averaged 10.8 million contracts up from 

7.9 million contracts at the end of August 2006, with a record 23.7 million options 

contracts being traded on August 16, 2007. 

This unprecedented growth could not have been possible without effective Congressional support and oversight of the U.S. commodity futures and securities markets and their regulators. In particular, I would like to commend this Subcommittee’s exemplary work in the 109th Congress on reauthorization of the Commodity 

Exchange Act. While the reauthorization process was not completed, your support 

2 years ago on vital issues such as portfolio margining helped to spur the U.S. Securities and Exchange Commission (‘‘SEC’’) to act on implementing a broad-based 

76

1See Futures Trading Act of 1982, P.L. No. 97–444, 96 Stat. 2294 (1983); Act of Oct. 13, 1982, 

P.L. No. 97–303, 96 Stat. 1409. 2P.L. No. 106–554, 114 Stat. 2763 (2000). 

3See Grant, J., ‘‘Lack of Consensus Dogs US Regulators,’’ Financial Times (Aug. 26, 2007). 

portfolio margining pilot program that will unequivocally make our securities markets more competitive. However, there are still issues Congress can address related 

to portfolio margining and other important topics, which leads me to comment at 

today’s hearing. 

Above all else, let me stress that it is not our intention to impede, in any way, 

the reauthorization of the CEA. Rather, while you consider the various issues surrounding reauthorization, we urge you to consider our proposals, which we believe 

will benefit all U.S. financial markets and U.S. investors. We believe that actions 

can be taken now that will help to finally resolve issues that have persisted for over 

30 years. 

Since the enactment in 1974 of amendments to the CEA, which gave the CFTC 

jurisdiction over all futures but also provided that the jurisdiction of the SEC was 

not otherwise superseded or limited, there have been conflicts between the two 

agencies as to their respective jurisdiction over novel financial instruments that 

have elements of both securities and futures or commodity contracts. In an attempt 

to resolve those conflicts, the CFTC and SEC agreed, through what became known 

as the Shad-Johnson Accord, to specify which financial instruments fell within each 

agency’s jurisdiction. In 1982 and 1983, Congress codified the Shad-Johnson Accord 

through amendments to the CEA and the Federal securities laws.1 Although that 

legislation helped to provide legal certainty regarding each agency’s jurisdiction in 

certain situations, it did not put an end to the jurisdictional disputes between the 

two agencies in all circumstances. Congress took a step toward this goal when it 

enacted the Commodity Futures Modernization Act of 2000 (‘‘CFMA’’).2 The CFMA 

established a delicate competitive balance between security futures (i.e., single stock 

futures) and security options, but the bifurcated system of regulation between all 

other security-based futures and securities still exists today. 

Competitive forces and the demutualization of exchanges, among other factors, 

have caused the jurisdictional divide between the SEC and CFTC to widen dramatically in recent years. This lack of agreement between the two agencies has recently 

been called a ‘‘jurisdictional balkanization’’ by current SEC Chairman Christopher 

Cox. As I sit here today, it is clear that, despite the best intentions of all parties 

involved, the bifurcated system of regulating futures and securities is broken and 

needs to be fixed. This disjointed structure adversely affects the ability of U.S. exchanges to bring new products to market and to compete. Additional measures can 

and should be taken to streamline the regulation of these similar investment products. 

Competitive forces and the demutualization of exchanges, among other factors, 

have caused the jurisdictional divide between the SEC and CFTC to widen dramatically in recent years. This lack of agreement between the two agencies has recently 

been called a ‘‘jurisdictional balkanization’’ by current SEC Chairman Christopher 

Cox.3 As I sit here today, it is clear that, despite the best intentions of all parties 

involved, the bifurcated system of regulating futures and securities is broken and 

needs to be fixed. This disjointed structure adversely affects the ability of U.S. exchanges to bring new products to market and to compete. Additional measures can 

and should be taken to streamline the regulation of these similar investment products. 

In the view of the U.S. Options Exchange Coalition, competitive fairness requires 

that futures and comparable securities be regulated in a consistent manner. That, 

unfortunately, is not always the case due to the differing missions of the SEC and 

the CFTC. In general, the securities laws are designed to protect investors, provide 

full disclosure of corporate and market information, and prevent fraud, insider trading and market manipulation. By contrast, the commodities laws are designed to facilitate commercial and professional hedging and speculation and to oversee the 

price discovery process. These differing goals may come into conflict when applied 

to a particular situation in which both agencies have an interest. 

A prime example of this occurred recently in connection with the highly publicized 

problems surrounding Sentinel Management Group, Inc. Sentinel is both an investment adviser registered with the SEC and a futures commission merchant registered with the National Futures Association. When questions arose as to the disposition of certain funds held by Sentinel on behalf of various futures commission 

merchants (‘‘FCMs’’) and other clients, the SEC and the CFTC took very different 

positions. While the SEC sought to freeze the proceeds in all Sentinel accounts 

(which it asserted had been improperly commingled) for the ultimate benefit of inVerDate 0ct 09 2002 11:27 Apr 02, 2009 Jkt 041481 PO 00000 Frm 00080 Fmt 6633 Sfmt 6621 I:\DOCS\110-27\48374.TXT SOLEM PsN: REBEKA
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4 Id.

jured investors (including, but not limited to, the affected FCMs), the CFTC sought 

to ensure that the FCMs were given access to their (or their customers’) funds that 

had been in a segregated account in order to preserve the integrity of the futures 

markets and prevent a potentially broader, market-wide collapse. This lack of consensus between the two agencies so exasperated the U.S. District Court judge hearing the matter that he was quoted in the hearing transcript as saying, ‘‘Why doesn’t 

this agency of the government go over and talk to this [other] agency of the government and get your act together, for crying out loud?’’ 4

The current bifurcated regulatory system, under which futures and securities are 

regulated differently, has led to persistent negative consequences for our markets. 

The disjointed structure creates regulatory inefficiencies, hampers competitiveness, 

and impedes innovation. Because of the differing views of the two agencies, questions of jurisdiction with respect to new products—that is, is a new product a security or a future?—are rarely resolved quickly. Split jurisdiction and different governing statutes also lead to legal uncertainties, since a novel aspect of a new securities derivative product could cause the CFTC to claim that the product has elements 

of a futures contract, and a novel aspect of a new futures product could cause the 

SEC to claim that the product is a security. No other country with developed derivative markets applies such a system of two different government agencies regulating 

equivalent financial products. 

While a merger of the CFTC and the SEC, or the creation of one new agency that 

regulates both futures and securities, would address these issues, the mechanics of 

effectuating such a merger or creating a new agency make it a long-term goal. In 

the meantime, there are concrete steps that can be taken now to help bridge the 

sometimes wide divide between the two agencies and streamline the regulatory 

process. The Coalition believes that taking these actions will help to even out the 

competitive landscape, both domestically and between U.S. and foreign competitors, 

as well as provide for a more rapid way of resolving inter-agency disputes. As it considers the issues surrounding reauthorization of the CFTC, the Coalition strongly 

urges Congress to take these recommendations into consideration. 

First, rather than take the laborious step of merging the agencies, Congress could 

more easily end the current system of bifurcated congressional oversight of the two 

agencies. The various committees with jurisdiction over the CFTC and the SEC all 

have legitimate interests in, and concerns about, the operation of the U.S. financial 

markets, but sometimes the interests of one Committee may conflict or compete 

with those of another. Having both the SEC and the CFTC subject to the jurisdiction of a single congressional oversight Committee would go a long way to ensure 

consistent oversight of financial regulators. A single, unified Committee structure 

not only would decrease the likelihood of potentially contradictory direction, but also 

would enable Congress to address issues arising with these financial products more 

quickly and comprehensively. 

Second, when jurisdictional disputes do arise, there is currently no mechanism in 

place to resolve them other than a dialogue between the two agencies. This can lead 

to long delays in the decision-making process, which hinders competitiveness to the 

detriment of investors and our markets. This is not intended to imply that, when 

disputes do arise, either agency is not putting forth a good-faith effort to resolve 

them. Instead, each agency earnestly believes that it is properly applying its statute 

when analyzing a particular jurisdictional issue. The impasses that frequently arise 

may be the natural result of the differing, and sometimes conflicting, philosophies 

of the securities laws and the commodities laws. In such a case, however, a neutral 

arbiter is needed. 

To help the decision-making process move more rapidly, the President’s Working 

Group on Financial Markets (‘‘President’s Working Group’’) could and, we respectfully submit, should take a more affirmative role in resolving jurisdictional issues 

and in brokering disputes between the two agencies. The members of the President’s 

Working Group, comprised of the Secretary of the Treasury (Chairman), the Chairman of the Board of Governors of the Federal Reserve System, and the Chairmen 

of both the SEC and the CFTC, are well-versed in the issues presented in such jurisdictional disputes. If the SEC and CFTC, despite their best intentions, find themselves at an impasse, they could seek input from the other members of the President’s Working Group to resolve the issues promptly. Prompt resolution of jurisdictional disputes is extremely important in order to be able to bring new products to 

market quickly so that the U.S. capital markets can maintain their global competitiveness. 

Even assuming that these overarching steps are taken, the current regulatory system is failing to foster U.S. competitiveness in stocks, futures and security option 

78

5 It should be noted that recently, in connection with a private letter ruling, the Internal Revenue Service agreed that gold ETFs were securities, and were not simply an ownership interest 

in the underlying metal. See Private Letter Ruling 200732036 (August 10, 2007). 

products in several ways. Our major areas of concern today are the new product approval process and lack of legal certainty, jurisdictional issues and dual clearing 

agency regulation, and portfolio margining. 

The Coalition believes that steps can, and must, be taken in each of these areas, 

either by Congress or by the affected agency, that will improve the regulatory system governing stock, futures, and security options and keep our markets competitive 

in the global arena. 

New Products 

The bifurcated regulatory system presents significant hurdles that must be overcome in connection with the new product approval process. When questions arise 

as to whether a particular new product is more properly a security or a future, the 

result can be an interminable delay in bringing that product to market while the 

two agencies try to decide who has jurisdiction over the product. As a result, a comparable product may begin trading overseas, while U.S. agencies are still attempting 

to resolve the jurisdictional issue. 

Two recent examples are illustrative. The first involves options on exchange-traded funds (‘‘ETFs’’) that invest in and hold gold. These ETFs are securities and were 

approved for listing by the SEC on the New York Stock Exchange and the American 

Stock Exchange in October 2004 and January 2005, respectively. Seeking to meet 

customer demand for an option on the gold ETFs, and assuming that an option on 

SEC-approved gold ETFs also would be considered a security, in June 2005, the 

CBOE filed a proposal with the SEC to trade options on gold ETFs. Though the gold 

ETFs have continued to trade as securities on securities exchanges, the related option proposal has not moved forward because the SEC and CFTC are still trying 

to agree, more than 2 years later, on which agency should regulate the product.5

Another problem area has been the introduction of new credit derivative products. 

Both the Chicago Mercantile Exchange and the CBOE began to trade credit default 

products this year, but not before it took the SEC and CFTC approximately 9 

months to determine how to allocate the jurisdiction of these products between the 

two agencies. The compromise reached by the two agencies, however, still did not 

provide legal certainty as to the basis for the allocation. Meanwhile, Eurex, a European Exchange, was able to introduce a competitive product overseas within weeks 

of announcing its intention to do so and before CBOE and CME could obtain the 

requisite approvals. 

There must be a means to ensure that proposed new products that raise jurisdictional issues may be introduced to the market more promptly and efficiently. Possible solutions could include the adoption of a time limit related to new product approvals and/or having the other members of the President’s Working Group broker 

the jurisdictional issue in the case of an impasse after a certain amount of time. 

There also could be a recognition by the two agencies of certain circumstances—such 

as where it is clear that the underlying instrument is either a security or a future 

or a commodity option—in which jurisdiction should not be in dispute. For instance, 

if the SEC has already approved a new product as a security, and that security has 

been registered as such with the SEC, an option on that instrument should also be 

presumed to be a security, barring the opposite conclusion by the SEC after its review. If this presumption would have been applied to options on gold ETFs, those 

option products likely would have been brought to market long ago for the benefit 

of U.S. investors (and others) who had made this ETF a very actively-traded product. 

Jurisdictional Issues and Dual Clearing Agency Regulation 

The options markets’ clearing agency, OCC, clears exchange-traded derivative 

products, and is registered with both the SEC and the CFTC. OCC clears securities 

options, under the jurisdiction of the SEC, security futures, jointly regulated by the 

SEC and CFTC, and futures, under the jurisdiction of the CFTC. OCC is the only 

U.S. clearing organization with the ability to clear all of these products within a single clearing organization, and this provides the opportunity for greatly enhanced efficiency in the clearing process. However, this potential efficiency is seriously diminished by the dual regulatory structure. 

Because of this dual registration, OCC is subject to the jurisdiction of the CFTC, 

as well as that of the SEC, every time it introduces a new securities option product. 

Although the CFTC operates under a self-certification process by which OCC could 

certify that a particular new product does not fall within the jurisdiction of the 

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6See Exchange Act Release No. 34–54919 (Dec. 12, 2006), 71 FR 75781 (Dec. 18, 2006); File 

No. SR–CBOE–2006–14; and Exchange Act Release No. 34–54918 (Dec. 12, 2006), 71 FR 75790 

(Dec. 18, 2006); File No. SR–NYSE–2006–13. The effective date for these rule changes was April 

2, 2007. 

CEA, there are cases where there is genuine ambiguity as to where the jurisdictional line lies. In such cases, OCC has felt compelled to ask for prior approval of 

both agencies in order to avoid the risk of litigation after trading has begun. While 

this may be ultimately effective in limiting that risk, it can also lead to protracted 

discussions between the two agencies. This process is time consuming and can lead 

to compromises that distort product development by forcing product design to be 

driven by jurisdictional considerations instead of economic ones. The lengthy process 

by which credit default options were brought to the market is an example of how 

this process is broken. And if no agreement can be reached at all, the exchanges 

and OCC are forced to either abandon the product—thus effectively allowing the 

CFTC a veto over a product proposed to be traded under the SEC’s jurisdiction—

or to incur the delay and expense of seeking a judicial resolution of the dispute. 

While the dual regulation of OCC may be inefficient, it does not create the jurisdictional conflicts which are inherent in a dual regulatory scheme that attempts to 

divide highly similar economic products between two regulatory agencies under two 

different statutes. If that scheme is perpetuated, then, at the very least, we need 

a single decision-maker who can act as a tie-breaker to bring about prompt and inexpensive resolution of any jurisdictional question. The courts are not an efficient 

vehicle for this purpose. As previously noted, we believe that the President’s Working Group could provide a solution. 

Portfolio Margining 

Earlier this year, the availability of portfolio margining was greatly enhanced for 

securities customers, including those who trade security futures, through expansion 

of an existing portfolio margin pilot program approved by the SEC.6 This expanded 

pilot includes equity options, security futures and individual stocks as instruments 

eligible for portfolio margining. The pilot enhances U.S. competitiveness by bringing 

the benefits of risk-based margining employed in the futures markets, and in most 

non-U.S. securities markets, to U.S. securities customers. The exchange rules approving this pilot also authorized the inclusion of related futures positions in securities customer portfolio margining accounts, often referred to as cross-margining. The 

ability to margin all related instruments in one account would allow customers to 

fully realize the risk management potential of these instruments in a way that is 

operationally efficient. However, legal impediments to putting those futures positions into a securities customer portfolio margining account exist and undercut significantly the ability of customers to fully realize the capital efficiency benefits of 

portfolio margining. 

As discussed below, two important changes must occur in order to permit investors to avail themselves of the full potential of portfolio margining. First, Congress 

needs to amend the Securities Investor Protection Act of 1970’s (‘‘SIPA’’) current 

treatment of futures positions in a customer portfolio margining account. Second, 

the CFTC must provide exemptive relief from the CEA’s requirements regarding 

segregation of customer funds. 

SIPA is the law which governs the activities of the Securities Investor Protection 

Corporation (SIPC). SIPC provides insurance to securities customers to protect them 

from losses caused by the insolvency of their broker-dealer. SIPC insurance does not 

extend to futures positions, other than security futures. Under SIPA, claims of securities customers take priority over claims of general creditors. There is a possibility, 

under current law, that a portfolio margining customer will be treated as a general 

creditor with respect to the proceeds from such customer’s futures positions. The 

possibility of uneven treatment substantially lessens the likelihood that customers 

would want to include related futures products in their portfolio margining securities accounts, and would disincent those customers from taking full advantage of the 

efficiencies created from hedging related positions in a single account. Without a 

legislative solution, full realization of a state-of-the-art portfolio-based margining 

system for customers may never occur in this country. We advocate a targeted 

amendment to SIPA that would extend SIPC insurance to futures positions held in 

a portfolio margining account under a program approved by the SEC. A copy of our 

legislative proposal is attached. We ask the Committee’s help in addressing this 

issue. 

Assuming that SIPC insurance coverage is extended to futures products held in 

a customer’s securities portfolio margining account, a second step is necessary to 

fully implement portfolio margining. Currently, the securities industry and the fuVerDate 0ct 09 2002 11:27 Apr 02, 2009 Jkt 041481 PO 00000 Frm 00083 Fmt 6633 Sfmt 6621 I:\DOCS\110-27\48374.TXT SOLEM PsN: REBEKA
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7The ‘‘two pot’’ approach has been used at the clearing level to permit hedging between positions in Government securities and repurchase agreements in Government securities and various interest rate futures or futures on Government securities, but these arrangements have 

been limited to proprietary positions of member firms of the clearing agencies, not customer accounts. The ‘‘two pot’’ approach has never been developed for customer accounts at the firm, as 

opposed to clearing agency, level. The primary reason for this is that significant legal and regulatory issues would need to be resolved in order to implement a ‘‘two pot’’ approach for customers. See Letter from William H. Navin, Executive Vice President and General Counsel, OCC, 

to Ms. Nancy M. Morris, Secretary, Securities and Exchange Commission, re: Portfolio Margin 

and Cross-Margin Proposals: SR–NYSE–2006–13 and SR–CBOE–2006–14, dated May 19, 2006. 8We note that, even though it has expressed support for a ‘‘two pot’’ approach to portfolio margining, the Chicago Mercantile Exchange also has acknowledged that ‘‘[t]he one pot approach 

generally provides the most optimal level of economic risk offsets . . . .’’ See Letter from Craig 

S. Donohue, President, Chicago Mercantile Exchange, to Mr. Jonathan G. Katz, Secretary, U.S. 

Securities and Exchange Commission, re: SR–CBOE–2006–14; SR–NYSE–2006–13; Portfolio 

Margining and Cross Margining, dated May 9, 2006. 

tures industry are advocating differing approaches to the issue of portfolio margining. Under the securities industry’s ‘‘one pot’’ approach, all securities and futures 

positions are maintained in a single portfolio margin securities account for purposes 

of maximizing the utility of margin collateral in the account. Under the futures industry’s ‘‘two pot’’ approach, a futures account holds the futures positions and a securities account holds the securities positions for purposes of maintaining margin 

collateral. The Coalition believes that the ‘‘one pot,’’ single account approach is the 

most efficient means of portfolio margining for customers and their brokers.7 In 

order for customers to use a single securities account for portfolio margining purposes, however, CFTC action is required. Specifically, the CFTC will need to exempt 

futures products held in a securities portfolio margining account from the operation 

of Section 4d(a)(2) of the CEA. This provision requires that all funds and property 

(including securities held as collateral) in a customer’s futures account must be segregated from all other funds and property, although it may be commingled with the 

property of other futures customers. Consequently, it prohibits the carrying of futures products and related customer property in a portfolio margining account regulated as a securities account and commingled with property other than the segregated funds of other futures customers. In order to facilitate cross-margining in 

securities accounts under the ‘‘one pot’’ approach, the CFTC would therefore need 

to promulgate a rule or issue an order exempting futures products in such accounts 

from the segregation requirements of CEA Section 4d(a)(2) to the extent necessary 

to permit them to be carried in a portfolio margin account and segregated pursuant 

to the SEC’s customer protection rule. Once SIPC insurance is extended to futures 

positions held in a securities customer portfolio margining account, we intend to 

seek such an exemption from the CFTC. 

Highlighting the jurisdictional divide between the SEC and the CFTC, the two 

agencies continue to disagree on the most appropriate approach to implementing 

portfolio margining. In mid-2006, there were plans to establish a working group to 

help the agencies come to a consensus on whether the ‘‘one pot’’ or ‘‘two pot’’ approach should be implemented, but that effort appears to have stalled. Even without 

the input from this proposed industry working group, we strongly believe that the 

‘‘one pot’’ approach is preferable and easier to implement.8 If the agencies are unable to agree on the steps necessary to fully implement portfolio margining at its 

most efficient ‘‘one pot’’ level as outlined above, Congress and/or the President’s 

Working Group should step in to help facilitate full cross margining to all securities 

products and their related futures. 

Portfolio margining is another area where a lack of action here has placed U.S. 

markets at a competitive disadvantage to other markets that do not distinguish between securities and futures products. 

Conclusion 

The U.S. Options Exchange Coalition believes that CFTC reauthorization provides 

an opportunity to bring needed change to the U.S regulatory landscape in order to 

promote the competitiveness of U.S. financial markets. Until major structural 

changes are made, Congress, the CFTC and the SEC should make targeted, discrete 

changes to the ways in which new products are approved for trading in the markets, 

and provide the means by which customers can fully utilize the benefits of portfolio 

margining. Taking these steps will help our markets remain the most competitive 

in the world. 

The Coalition, and I personally, stand ready to work with the Committee and its 

staff as it considers these important issues. 

Thank you again for the opportunity to testify at this important hearing. I would 

be happy to answer any questions that you may have.

81

Mr. ETHERIDGE. Thank you. And I would say to all the panelists, 

your full statement will be entered into the record and thank you. 

We have just a few minutes and I am going to try to limit my time 

to less than 5 minutes. If you will answer very quickly and hopefully, when we conclude here, I would say to you, at this point, that 

we are going to request that any other Members who want to submit questions, we will get them and ask you to respond quickly so 

we can use that testimony. 

Mr. Zerzan, you cited FERC’s action challenging the CFTC’s exclusive jurisdiction as an example of why the United Kingdom is 

beating the U.S. in the world of over-the-counter derivatives. However, from some of the figures you cite in your written testimony, 

the UK’s lead existed long before FERC’s action arose. Given the 

CFMA and its legal certainty with OTC swaps and its hands-off approach for most of the OTC market, what other explanations can 

you give for why the U.S. is losing derivative business and why you 

may be ready to blame Sarbanes-Oxley. I am interested in more derivative specific regulatory problems and the Sarbanes-Oxley is a 

problem that has a greater impact on the securities world. You can 

give me a quick answer. 


11027006
82

Mr. ZERZAN. Yes, Mr. Chairman. I apologize if it appeared that 

I was directly linking FERC to the UK’s lead. In fact, that was 

meant to be an example of the uncertainty that is often cited as 

to why businesses will trade in the UK as opposed to the United 

States. They feel there is a more certain regulatory environment in 

which they know what their potential liabilities are. 

Mr. ETHERIDGE. Okay. You don’t have a specific answer other 

than that? Okay. Let me move to Mr. Brodsky, much of the futures 

industry fears losing all the benefits of a principle-based regulatory 

approach that the CFMA provides the industry. Should the CFTC 

be combined with the SEC, additionally, there are other concerns 

about the SEC like those illustrated in the recent GAO report that 

found that the SEC enforcement division is too slow to take action 

on enforcement cases with 2⁄3 of the investigations pending at the 

end of last year having begun 2 or 3 years earlier. Before we can 

talk merger, shouldn’t Congress focus on improving the SEC first? 

Mr. BRODSKY. You know, I think that this is a smoke screen to 

avoid an honest discussion about whether the agencies should be 

combined. If a division is inefficient, that is a micro problem. I am 

talking about the macro issue that we have virtually economic 

equivalent products being regulated by two agencies and all my colleagues on the panel complain about the concern about duplicative 

regulation and we suffer it right now. And whether I am before 

this Committee or the House Financial Services Committee or the 

comparable committees in the Senate, the issue is there and to pretend that it doesn’t exist is not being fair to the American financial 

system. I think that these issues on principles-based are valid 

issues for discussion, but that is part of the review that I am urging that the Congress do. 

Mr. ETHERIDGE. Thank you, sir. I yield to the gentleman from 

Kansas. 

Mr. MORAN. Mr. Chairman, thank you very much. Much of our 

discussion with the first panel involved ECMs and I wondered if 

any of you would give us your synopsis of the solution to the level 

of regulation, if you believe additional regulation is useful, give us 

the key to what that regulation should be. Mr. Damgard. 

Mr. DAMGARD. I think the CFTC is working pretty closely with 

both NYMEX and ICE right now and it sounded to me, in their testimony, that you had with Mr. Sprecher and Dr. Newsome, very 

close to a solution. And I think, to sum it up, if a product that incubates in an ECM becomes the equivalent of a futures contract, then 

to prevent any kind of disparity in the regulatory system, they 

should still be able to have that choice. I mean, one of our points 

is competition is what is lacking in many of the areas of futures 

with the one exception of energy and we know customers are a 

whole lot better off because we have two viable markets at work. 

One of them is a regulated market and one of them is not. But to 

stamp out ECMs and try to drive everything onto an existing exchange simply would serve the purposes of furthering the lack of 

competition. 

Mr. MORAN. I have additional questions, but due to the time constraints, I will submit them to you in writing and anyone else who 

would like to respond, as Mr. Damgard has, I would appreciate 

that and yield back the balance of my time. 

83

Mr. ETHERIDGE. The gentleman from Georgia. 

Mr. MARSHALL. It looks like we are going to be able to get you 

all out of here and you won’t have to wait for us to come back from 

votes. Thank you all for being here and for your testimony, most 

of which I missed, but I will read. Mr. Zerzan, I would simply remind you that after the last hearing that we had specifically on energy and we adjourned to the meeting room back there, you committed to me, and I hope you can live up to this commitment, that 

you would prepare some notes of the discussion and circulate those 

notes so that everybody would have an opportunity to comment on 

your take on what was said and argued and the positions that were 

taken. And it would certainly be helpful to the Committee to have 

that and is it possible for you to go ahead and do what we agreed 

you were going to do? 

Mr. ZERZAN. I don’t want to get your Chief of Staff in trouble, 

but I actually submitted those——

Mr. MARSHALL. Oh, you did. Great. I appreciate that very much. 

Now, have they been circulated or am I supposed to do that? 

Mr. ZERZAN. I don’t know. 

Mr. MARSHALL. Okay, they haven’t been circulated, so I will circulate to the other folks who were in that meeting. Thank you all. 

Thank you, Mr. Chairman. 

Mr. ETHERIDGE. Thank you. Let me thank each of our panelists 

and I have a couple more questions I withheld and I will submit 

those to you and if you would respond to them. Let me thank you. 

Let me thank the Ranking Member. Each of you, for your testimony, for your help with the witnesses. And before we adjourn, a 

little bit of housekeeping business here. Under the rules of the 

Committee, the record of today’s hearing will remain open for 10 

days to receive additional material and supplemental written responses from witnesses to any question posed by a Member of the 

panel. This hearing of Subcommittee on General Farm Commodities and Risk Management is adjourned. Thank you very much. 

[Whereupon, at 12:17 p.m., the Subcommittee was adjourned.] 

[Material submitted for inclusion in the record follows:]

84

85

PREPARED STATEMENT OF DREW NIV, PRESIDENT AND CEO, FOREX CAPITAL

MARKETS LLC, NEW YORK, NY 

We thank the Chairman of the Subcommittee on General Farm Commodities and 

Risk Management, Bob Etheridge, the Ranking Member Jerry Moran, and the Members of the Subcommittee, for this opportunity to submit a statement for the record 

regarding the important issues facing Futures Commission Merchants and the fast 

growing industry of retail foreign exchange trading. My name is Drew Niv. I am 

the President and Chief Executive Officer of Forex Capital Markets LLC (FXCM). 

FXCM is regulated as a Forex Dealer Member by the National Futures Association. 

Forex Dealer Members are U.S. registered Futures Commission Merchants that 

have greater than 35% of revenue from foreign exchange. 

In 2001 retail online currency trading was regulated for the first time with the 

passage of the Commodity Futures Modernization Act of 2000 (‘‘CFMA’’). This law 

required that any non-bank firm making a market in FX be registered and licensed 

by the Commodities Futures Trading Commission. This law was a step in the right 

direction and has greatly facilitated the growth of the retail forex market here in 

the United States. Indeed, FXCM was glad to see the CFMA become law and was 

the very first forex broker to be granted a license under its auspices in early 2001. 

Since then we have strongly supported the NFA and CFTC in their efforts to resolve 

many of the problems confronting the industry, including the ones that NFA President Dan Roth recently brought to the Committee’s attention during his testimony 

on September 26, 2007. 

However, there are two areas the CFMA did not address that are in need of the 

Congress’ immediate attention. The first area is in regard to the absence of customer funds’ segregation in the FX Industry. The second area relates to the continuing problem of unlicensed introducing FX brokers in the United States. 

The absence of customer funds protection in the United States is currently the 

most pressing issue the domestic FX industry faces. This is because the CFMA did 

not make any adjustments to the CFTC’s ‘‘segregation rule’’ when the law was implemented in 2001. The segregation rule stipulates that all client funds deposited 

for trading domestic, on exchange futures or options on futures be kept segregated 

from all company funds and that in the event of bankruptcy the customer’s funds 

are legally segregated from creditors and must be returned to the clients. Because 

the segregation rule does not explicitly state that customer funds that are used to 

trade OTC derivatives, such as foreign exchange contracts, be segregated in the 

same manner these customers are in effect left completely unprotected. This is not 

the case in the other major financial centers where retail forex trading takes place, 

such as the United Kingdom, Canada and Hong Kong. The failure to amend the segregation rule to include CFTC registered Forex Dealer Members places customers 

are at a greater risk in the event of bankruptcy while simultaneously leaving the 

domestic FX retail industry at a severe competitive disadvantage to foreign Forex 

Broker Dealers. 

The issue is of the utmost importance to the forex trading community and as such 

I have included a letter that was submitted to Chairman Peterson earlier this year 

that was signed by some of the largest firms in the industry in support of customer 

funds’ segregation. 

Customers can lose their funds not only when a legitimate firm goes bankrupt but 

when an illegitimate, unlicensed broker encourages naı ̈ve investors into trading 

high risk futures contracts they know nothing about. One of the problems for retail 

foreign exchange trading has been the prevalence of get rich quick scam artists 

promising riches to customers with little knowledge of the market. The CFTC has 

been aggressive in putting such people out of business yet there are still thousands 

of unlicensed firms and individuals who can legally solicit customers to trade foreign 

exchange. Thus this glaring potential for fraud remains a constant in the FX market 

and continues to leave a black mark on industry as a whole. 

The best way to prevent this kind of fraud from happening is to mandate that 

anyone who solicits customers to trade FX be licensed with the CFTC. The CFTC 

already requires any non-bank firm that makes a market in foreign exchange be 

registered (unless they are exempt under the CFMA.) Yet the failure to hold others 

soliciting customers to these same standards is leading to a great deal of inefficiency 

in the industry. By mandating a licensing regime for anyone involved in the business of foreign exchange overnight the industry would be cleaned up as the CFTC 

would have a clear mandate to close down anyone not complying with the CFTC’s 

registration requirement. As it is, the CFTC only acts after fraud has been committed and by then it is too late for customers to ever regain their funds. 

We recommend that the Congress do the following in order to redress the problems described earlier. 

86

(1) Amend the CFTC’s ‘‘segregation rule’’ to include OTC derivatives (such as leveraged foreign exchange contracts) as part of the customer funds that cannot be 

legally co-mingled with company funds. Making this legal distinction will ensure 

that the trading public will not have to endure another RefcoFX bankruptcy debacle. 

Furthermore, it will inspire confidence in U.S. markets and make it easier for American firms to compete with overseas firms where these legal protections are already 

in place. (Please note: making such a legal distinction in no way means that we are 

advocating that the Federal Government should somehow insure the accounts of 

currency traders. The issue is merely about priority in bankruptcy. Right now currency traders have no priority in bankruptcy should their broker go bankrupt because their funds are not segregated by law. Therefore by requiring that brokers 

segregate customer funds we will give currency traders the same priority as do traders in Futures and Equities currently have should a futures or equity broker go 

bankrupt.) 

(2) Mandate that introducing brokers who refer customers to registered commission merchants be licensed by the National Futures Association and regulated by 

the Commodities Futures Trading Commission. Right now it is illegal to solicit 

someone to trade stocks or exchange traded futures contracts without a license. 

These same standards need to be applied to anyone soliciting retail customers to 

trade foreign exchange. This is the next logical regulatory step as the industry 

works towards greater transparency and increased protection of client funds. 

The domestic retail foreign exchange trading industry is one of the fastest growing industries in the nation today (five retail FX brokers made INC. Magazine’s list 

of the fastest growing companies in America in 2006.) As such, it is important that 

the Congress keep pace with the growth of the industry by passing legislation that 

adequately protects the tens of thousands of investors who start trading in this fast 

growing market each year. Taking these actions lays an excellent foundation that 

can lead to the United States taking a position of pre-eminence in this fast growing 

industry. Failure to take action will lead to the United States losing the battle, not 

because of inadequate technology or because of a lack of effort, but because of a regulatory environment deemed backward and unresponsive to the needs of the trading 

public. 

We look forward to working with this Subcommittee, other Congressional committees, the CFTC, the NFA, and the industry to address the important customer protection issues outlined above. 

87

ATTACHMENT


11027007
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11027008
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WALTER LUKKEN, 

Acting Chairman, 

U.S. Commodity Futures Trading Commission, 

Washington, D.C.


11027009
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Questions From Hon. Bob Etheridge, a Representative in Congress From 

North Carolina 

Question 1. Regarding the President’s Working Group (PWG) suggested language 

to correct the ruling in the Zelener case, has the current Commission taken another 

look at the language to determine its adequacy. If not, do each of the current Commissioners believe the proposal is adequate or does any of them believe it should 

be modified in some way; and, if so, how? 

Answer. The Commission believes it is necessary to resolve the Zelener issue. The 

current Commission has not revisited this issue since 2005, when the House approved the PWG proposed Zelener language. The Commission as a whole has never 

opined on the proposed PWG language. As I testified at the September hearing, I 

believe it is critical to resolve the Zelener issue and that the PWG language is an 

appropriate solution. At least two Commissioners now believe that a broader fix 

would be appropriate.

Question 2. As you know, Senator Levin has introduced legislation to amend the 

CEA with regard to regulation of exempt commercial markets (ECMs) that trade energy-based derivatives. I want to hear a comparison between that bill and your recommendations. Please provide a detailed side-by-side comparison. 

Answer. Senator Levin’s bill (S. 2058) and the Commission’s recommendations are 

directed to the same goal, though there are several differences in approach. For example, the triggers in Senator Levin’s bill and the Commission’s recommendations 

are generally similar—each looks to whether a significant price discovery function 

is being performed. But the Commission’s approach keeps the CEA Section 2(h) 

framework for ECMs in place, with targeted add-on provisions for significant price 

discovery contracts in exempt commodities. Senator Levin’s bill, by contrast, would 

establish a new category of registered trading platform for facilities trading pricediscovery energy commodity contracts, which would be separate and apart from the 

ECM trading platform for other exempt commodities. 

The consequences that result from a finding of a significant price discovery function also differ. Under Senator Levin’s bill, trading facilities that meet the price discovery test would be subject to 17 Core Principles. By contrast, the Commission’s 

recommendations focus on four key authorities: (1) large trader position reporting; 

(2) position limits and/or accountability levels; (3) self-regulatory oversight; and (4) 

emergency authority. This measured approach will preserve the role of ECMs as incubators for start-up markets and concepts, which several witnesses at our recent 

hearing said spurs competition and innovation. 

Finally, Senator Levin’s bill calls for recordkeeping and reporting obligations with 

respect to U.S. screen-based trading in energy contracts listed on foreign boards of 

trade. The Commission has not made any similar recommendations, which are problematic in today’s global marketplace. They also are unnecessary given the effectiveness of the Commission’s recently-adopted Policy Statement regarding screen-based 

trading in contracts listed on foreign boards of trade. 

Although these differences in approach make a precise side-by-side analysis difficult, a chart comparing Senator Levin’s bill and the Commission’s recommendations in general terms is attached.

Question 3. Under CFTC Rule 36.3, exempt commercial markets must provide 

price, quantity, and other data on contracts that average five or more trades a day 

over the most recent quarter for which they are relying on the Commodity Exchange 

Act’s exemption for these markets. The GAO report cites CFTC officials who say the 

agency does not actively check to determine whether that five or more trades a day 

threshold is being met on those exchanges that are relying on the CEA exemption 

but not providing information to the CFTC. Why isn’t the CFTC conducting more 

checking to see if contracts on those markets are meeting the five a day threshold? 

Does an ECM have a responsibility in this area? What are the consequences, if any, 

to an ECM that fails to notify the CFTC that a contract has crossed the threshold? 

Answer. GAO is correct. The Commission does not have a regular rule enforcement review program in place to check ECMs for compliance with the five-trade per 

day reporting requirement. However, there are safeguards in place to ensure ECM 

compliance with this provision. First, Regulation 36.3(b)(1)(ii) itself places an affirmative obligation on ECMs to notify the Commission when they have a contract that 

exceeds the threshold. Second, Regulation 36.3(c)(4) requires each ECM to file an 

annual certification with the Commission that it is continuing to operate within the 

conditions of its exemption from having to register as a designated contract market 

(DCM). The terms of the Commission’s ECM annual certification form make clear 

that these conditions include apprising the Commission of those contracts that meet 

the five-trade per day threshold. 

91

Finally, the consequences of failing to properly notify the Commission of a triggering of the reporting requirement are extreme—there is a strong incentive for 

ECMs to honor this provision. ECMs that fail to apprise the Commission that they 

have triggered the reporting requirement run the risk of losing their exemption 

from DCM registration and expose themselves to a Commission enforcement action 

for operating an unregistered exchange pursuant to Section 4(a) of the CEA, for failing to comply with the reporting requirement of Regulation 36.3(b)(1)(ii), and, likely, 

for making a false statement in a filing required under the Commission’s regulations pursuant to CEA Section 9(a)(3).

Question 4. Assuming the PWG Zelener language became law, what specific sections of the Commodity Exchange Act—if any—would prevent someone from using 

the same Zelener-type contract but for natural gas, corn, wheat, or another commodity besides forex? 

Answer. The Commodity Futures Modernization Act of 2000 (CFMA) authorized 

off-exchange trading by retail customers only in foreign currency futures and options. It did not change the law for commodities other than foreign currencies. Thus, 

off-exchange futures trading activity involving retail customers in any other commodity (such as natural gas, metals, corn, or wheat) remains illegal under CEA Section 4(a), which prohibits off-exchange trading in futures. 

Thus far, we have not seen the Zelener contract form, which the 7th Circuit held 

to be a spot contract, utilized for commodities beyond foreign currency. Further, the 

best means to address the Zelener issue—striking the necessary balance between 

cracking down on fraudsters while not interfering with legitimate businesses—may 

vary depending on the commodity involved. Accordingly, I believe that it is best to 

address the problem that is presently before us and that has been before us for the 

past several years—foreign currency.

Question 5. The CFTC Reauthorization bill from last Congress would have required introducing brokers to register with the National Futures Association (NFA). 

In his testimony last month, Mr. Roth, President of the NFA proposed to expand 

this to include commodity trading advisors (CTAs) and commodity pool operators 

(CPOs). Can you talk about whether CTAs and CPOs current are registered with 

any regulatory body and whether the Commission thinks we need to require their 

registration with the NFA? 

Answer. The CFMA specified certain categories of entities that may act as 

counterparties to customers for off-exchange retail forex transactions. However, the 

CFMA was silent with respect to intermediaries for such transactions and provided 

that most of the CEA does not apply to such transactions. Thus, entities that act 

in a manner similar to that of introducing brokers, CPOs or CTAs with respect to 

these forex transactions are not required to register, as would be the case if they 

were intermediating exchange-traded transactions. The registration requirement in 

the proposed forex amendments submitted by the PWG and included in the Reauthorization bill passed by the House of Representatives in December 2005 was not 

limited to introducing brokers. It would require registration of any person who participates in the solicitation or recommendation of off-exchange retail forex transactions.

Question 6. Please provide the Subcommittee with a record of total dollar amount 

of fines levied by the Commission for each year starting with 2000. Please do likewise for the total dollar amount of fines actually collected. 

Answer.

Civil Monetary Penalties FY 2000–2008

Fiscal Year Penalties Imposed Penalties Collected 

2000 $179,811,562 $3,299,362

2001 $16,876,335 $3,170,252

2002 1 $9,942,382 $5,922,387

2003 $110,264,932 $87,699,077

2004 $302,049,939 $122,468,925

2005 2 $76,672,758 $34,237,409

2006 $192,921,794 $12,321,530

2007 $327,378,507 $11,897,033

2008 3 $126,045,682 $4,835

1 Includes $30,005 for civil monetary penalties imposed in prior years. 

2 Includes $617,409 for civil monetary penalties imposed in prior years. 

3Through October 2007. Pending $125,000,000 BP Settlement Collection. 

92

The discrepancy between the amount of civil penalties imposed and the amount 

collected is accounted for by the following factors: (1) when courts order the defendants to pay both restitution to victims and a civil monetary penalty to the Commission, established Commission policy directs available funds to satisfy customer restitution obligations first; (2) in fraud actions, it is not uncommon that the proceeds 

of the fraud have been dissipated and/or that the penalty far exceeds the defendants’ represented financial ability to pay; (3) penalties assessed in default proceedings against respondents who are no longer in business and who cannot be located or are incarcerated; (4) penalties imposed in 1 year may not become due and 

payable until the next year; (5) a penalty may be stayed by appeal; (6) some penalties call for installment payments that may span more than 1 year; (7) penalties 

have been referred to the Attorney General for collection; and (8) collection still in 

process internally.

Question 7. If the Commission were allowed to keep 10% of the fines its actually 

collects to fund IT upgrades, modernization, and improvements, would that make 

a significant difference in improving the CFTC’s IT infrastructure—assuming there 

are no corresponding reductions on the appropriations side? 

Answer. Assuming there were no corresponding reductions on the appropriations 

side, any funds from penalties collected would improve our fiscal situation. In fiscal 

year 2006, we collected over $12 million in penalties, which (assuming the Commission retained 10%) would translate roughly into $1.2 million. This amount would 

not fully fund our IT requirements, but would provide much needed fiscal relief. 

Questions From Hon. Bob Goodlatte, a Representative in Congress From 

Virginia 

Question 1. The CFTC report recommends that if an Exempt Commercial Market 

(ECM) has a significant price discovery function it should have position limits imposed on it. Would the policy on position limits on ECMs be similar to the policy 

on Designated Contract Markets (DCM) with limits on speculative trades, reduced 

limits near expiration and review or exemptions of positions held in excess of the 

limits for legitimate hedges? Would the imposition of position limits on ECMs stifle 

in any way the creativity offered by ECMs? 

Answer. We anticipate that ECMs would be subject to the same type of accountability-level/position-limit regime that is currently required of DCMs under DCM 

Core Principle 5, including the availability of hedge exemptions and spot-month position limits where appropriate. Accordingly, ECM contracts that became subject to 

such an accountability-level/position-limit regime would be treated in a similar manner to comparable DCM contracts under DCM Core Principle 5. 

As with any regulatory restriction, there is a possibility that position limits may 

impact ECM operations. However, the Commission’s recommendation that an accountability-level/position-limit regime be imposed on ECM contracts that perform 

a significant price discovery function is a very discrete measure. This high standard 

has been carefully chosen to ensure that there are minimum safeguards in place to 

prevent the manipulation of contracts that could have a very real impact on the 

prices of commodities in interstate commerce—a goal that underpins the CEA and 

the statutory mandate of the CFTC.

Question 2. If a contract trading on an ECM is deemed to provide a significant 

price discovery function, by what mechanism would the authority you are requesting 

be effectuated? 

Answer. We would anticipate that any amendments to the CEA that require additional obligations of ECMs when they list contracts that become significant sources 

of price discovery would themselves include rulemaking authority for the Commission to establish standards and procedures for making such determinations and for 

effectuating the authorities that result from such a determination. These rules also 

would set forth the specific procedures and guidelines that the Commission would 

follow in making such determinations. The Commission in establishing such standards and procedures would attempt to ensure that they had a high degree of objectivity, thus minimizing any legal uncertainty for ECM operations.

Question 3. Additionally, who would make the determination that a contract trading on an ECM is serving a significant price discovery function? Over what time 

frame would you see the determination being made that a contract trading on an 

ECM is serving a significant price discovery function and that the additional authority needs to be implemented on this contract? 

Answer. We would anticipate that the Commission would be given the authority 

to make determinations as to whether ECM contracts are serving a price discovery 

function. We also anticipate that any price-discovery determination would be based 

upon a contract’s behavior over some reasonable length of time, as the Commission 

93

would want to avoid a situation where contracts are moving in and out of price-discovery status.

Question 4. Last year the Commission testified that the changes proposed in Title 

2 of HR 4473 (the CFTC reauthorization bill in the 109th) specific to natural gas 

price transparency were not necessary. Has the Commission changed its position? 

Answer. We appreciated the bipartisan efforts of this Committee during the 109th 

Congress to address consumer concerns over volatility in the natural gas markets. 

The measures recommended in the Commission’s ECM Report strike an appropriate 

balance in the regulatory approach to these issues. As indicated in the Report, we 

do not see a need to impose added regulatory requirements on over-the-counter 

(OTC) bilateral energy contracts. A targeted approach to ECM significant price discovery contracts will best address the regulatory concerns that have been raised 

while still allowing ECMs to serve as a venue for start-ups where innovative trading 

ideas can incubate and be tested.

Question 5. What type of self-regulatory structure does ICE currently have? 

Answer. Currently, ICE, as an ECM, is not required by the CEA to have any oversight structures commonly associated with a self-regulatory organization such as a 

DCM.

Question 6. If an ECM and the CFTC were provided with emergency authority 

over a contract what could either do if fraud or manipulation were suspected or detected? 

Answer. Historically, the futures exchanges and the Commission have possessed 

broad authority under the CEA to address market emergencies. Under Section 8a(9) 

of the CEA, in an emergency, the Commission can require an exchange ‘‘to take 

such action as in the Commission’s judgment is necessary to maintain or restore orderly trading’’ in a contract. This broad authority would permit the Commission to 

impose trading limits, or even require liquidation, to restore orderly trading conditions in the marketplace. Similarly, Core Principle 6 of the CEA requires that DCMs 

adopt rules to provide for the exercise of emergency authority, in consultation or cooperation with the Commission, including the authority to liquidate positions and 

suspend trading where necessary and appropriate. Having these emergency authorities available often enables Commission and exchange staff to work with market 

participants to prevent emergency situations from arising in the first instance. We 

would anticipate that these same authorities would apply to significant price discovery contracts traded on ECMs.

Question 7. I, too, think the penalties under § 9 should be increased to reflect the 

severity of the crime. Instead of limiting penalties to $1 million, why not make the 

sanction a factor of the illegally obtained profit? Perhaps we should allow for treble 

damages (Three times the amount of damage a judge/jury found the defendant to 

cause) like antitrust law calls for. 

Answer. In addition to CEA Section 9, Sections 6(c) and 6c of the CEA currently 

provide for penalty authority of ‘‘not more than the higher of $100,000 [adjusted to 

$130,000 to account for inflation] or triple the monetary gain,’’ whichever is higher. 

Accordingly, the CEA already contemplates the possibility of penalties based on illegally obtained profits, including treble damages.

Question 8. You have testified, stated in press accounts, and told me in conversation that CFTC staffing levels have hit an all time low. In the 2000 modernization 

effort we authorized pay parity for the CFTC. How has this affected your staffing 

levels? 

Answer. Exempting the CFTC from Title V and authorizing pay parity with the 

FIRREA agencies has been crucial to recruiting and retaining professionals needed 

to oversee the complex futures markets. The Commission has implemented pay parity with funds appropriated by Congress. Since authorization, the Commission has, 

when necessary, sought funds to ensure that our pay structure and pay ranges are 

in line with the FIRREA agencies—and we are satisfied that they are. 

However, presently at the Commission, staffing levels are at an all-time historic 

low, and employee turnover has returned to the double-digit levels we had experienced prior to exemption from Title V. In the last 2 years, the Commission has lost 

over 100 employees, most of which were retirements of senior professionals. We 

need to improve in our ability to recruit, promote, retain, and reward good performers within the existing pay structure—and additional funds have been requested in FY 2009 for this effort.

Question 9. If the Commission does not receive an increase in its appropriation, 

can the Commission augment its budget by imposing/increasing registration fees or 

assessments on trades? 

94

Answer. The Commission has the authority to collect a number of fees related to 

our regulatory functions, such as contract market rule enforcement reviews and contract market designations. We have not interpreted this authority to extend to assessments on trades. The fees that we currently are authorized to collect are deposited in the General Fund of the U.S. Treasury.

Question 10. What happens to the money collected through the Commission’s enforcement activity? 

Answer. Funds collected from civil monetary penalties in CFTC enforcement actions are deposited in the General Fund of the U.S. Treasury. Funds collected from 

orders of restitution and disgorgement are distributed to injured victims.

Question 11. Last month this Subcommittee received testimony that securities 

and futures should be regulated in a consistent manner. Do you care to comment? 

Answer. We support the notion of regulating securities and futures in a consistent 

manner wherever possible, and over the past several years the Commission has 

taken several steps to align our requirements with those of the SEC where that 

makes sense. 

But it must be remembered that these are different markets—the SEC regulates 

markets whose primary function is capital formation, whereas the CFTC regulates 

markets whose primary functions are price discovery and risk management. Sometimes, the different functions of the markets, and the correspondingly different statutory mandates of the SEC and CFTC under the securities laws and the CEA, require different approaches by the two agencies. 

For example, in the securities world, there are extensive disclosures required by 

the issuers of securities, i.e., public companies. In the futures markets, there are 

no ‘‘issuers.’’ The mandated disclosures to retail futures customers thus focus upon 

the risks common to all futures trading.

Question 12. GAO testified that the Commission should more accurately report 

trading data for commercial versus non-commercial trades. The GAO highlights instances where commercial entities may actually place speculative trades but these 

trades are reported as commercial because the entity is a routine commercial trader. 

As a practical matter, can this be done given that entities are organized in any 

number of business units, they place trades in a variety of ways, and often establish 

proprietary methods for managing their company’s risk? This would make standardizing the reporting in the manner recommended by GAO very difficult. What kind 

of problems can this detailed reporting create? What would happen if you reported 

with this type of specificity? 

Answer. Using current reporting methodology, this detailed breakout of speculative positions held by commercials is not possible. To accomplish this, it would probably be necessary to either (1) have every commercial firm set up a separate reporting account for speculative trading; or (2) report its positions directly to the CFTC 

(as opposed to the current large trader reporting system, where futures commission 

merchants report customer positions to the CFTC). Either of these changes would 

entail additional costs to traders. Yet, it is not clear that such a change would substantially improve the commitments of traders (COT) data, as we are not aware that 

there is a substantial amount of speculative trading by commercials. 

The main issue that the CFTC has faced with COT reporting is that commercial 

swap dealers hedge OTC activity (including OTC commodity-index related activity) 

in futures markets. While this trading is hedging (i.e., it is to offset price risk), it 

is different than traditional hedging of underlying physical business.

Question 13. Given the global growth of risk management and the futures industry, what is the CFTC doing with international regulatory bodies to coordinate efforts to prevent fraud and manipulation across the globe? 

Answer. The CFTC has a robust and long-standing international presence. We are 

an active member of the International Organization of Securities Commissions 

(IOSCO), which is a standard-setting body for securities and futures regulators. 

IOSCO coordinates regulators around the world to promote high standards of regulation, including surveillance and enforcement standards. Additionally, the CFTC 

has numerous enforcement arrangements to share information with our overseas 

counterparts and coordinate our enforcement actions as much as possible. In addition to the CFTC’s 24 bilateral enforcement information sharing arrangements with 

foreign regulatory authorities, the CFTC also is a signatory to the IOSCO Multilateral Memorandum of Understanding that provides for the sharing of bank, brokerage, and client identification records among the international regulators. Most recently, the CFTC signed an MOU with the UK Financial Services Authority (FSA) 

in 2006 to share information on an on-going basis to help detect potential market 

abuses where contracts are linked by settlement provisions. Finally, this past October, the CFTC Division of Enforcement convened an international enforcement 

95

meeting with commodity regulators including participants from Europe, Asia, and 

South America. The meeting was focused on detecting and enforcing against antimanipulative conduct, with the goal of enhancing the ability of the CFTC and its 

fellow regulators to detect and deter misconduct affecting commodity prices.

Question 14. GAO has recommended the CFTC develop ‘‘meaningful outcomebased measures’’ to determine the agency’s effectiveness. What type of improved 

measures have you explored? Has GAO provided you detailed suggestions on what 

‘‘meaningful outcome-based measures’’ would be appropriate for an agency like the 

CFTC? 

Answer. GAO’s conclusions were derived primarily from the OMB PART review, 

which recognized that the effectiveness of an enforcement program is not easily 

measured. GAO suggested that ‘‘there are a number of . . . ways to evaluate program effectiveness, such as using expert panel reviews, customer service surveys, 

and process and outcome evaluations.’’ The Commission has requested funding in 

the OMB FY09 budget in order to explore alternate means to evaluate the effectiveness of the program. 

Question From Hon. Nancy E. Boyda, a Representative in Congress From 

Kansas 

Question. In our hearing in late September, Mr. Damgard, President of the Futures Industry Association, in his written testimony asked this Subcommittee and 

the CFTC to study the state of competition among centralized trading platforms and 

clearing entities for derivatives products with an eye toward making sure the existing futures market structure is the best for serving our customers. Does the Commission have any plans to look into this matter? 

Answer. Section 5b(c)(2)(N) of the CEA requires each derivatives clearing organization (DCO), unless appropriate to achieve the purposes of the CEA, to avoid (1) 

adopting any rule or taking any action that results in an unreasonable restraint of 

trade, or (2) imposing any material anti-competitive burden on trading. On an ongoing basis, the Commission reviews DCO rules and other actions for compliance with 

this provision. The Commission notes that this provision directs that competitive 

concerns be weighed in light of the other purposes of the CEA, such as maintaining 

the financial integrity of the markets. To date, the Commission has not identified 

an instance where a DCO has violated this provision. The Commission will continue 

to monitor DCO activity in this area.

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Attachment 

Senator Levin’s ‘‘Close the Enron Loophole Act’’ S. 2058 CFTC Proposal significant price discovery contracts on ECMs 

I. Energy Trading Facilities Analogous Provisions in CFTC Proposal Applicable to Significant Price Discovery Contracts on ECMs.

Section 2(a) of S. 2058 amends Section 1a of the CEA Section 1 of the CFTC proposal amends Section 1a of the CEA. 

A. Adds definition of ‘‘energy commodity’’ as commodity 

1. used as source of energy such as crude oil, gasoline, natural gas, and 

electricity, and 

A. Adds definition of ‘‘significant price discovery contract’’ as agreement, contract, or transaction subject to proposed CEA Section 2(h)(7). 

2. results from burning of fossil fuel 

B. Adds definition of ‘‘energy trading facility’’ Not applicable to CFTC proposal. 

1. not a designated contract market (‘‘DCM’’) 2. facilitates the execution or trading of agreements, contracts, or transactions in an energy commodity AND 

a. facilitates the clearance and settlement of agreements, contracts, or 

transactions in an energy commodity; or 

Not applicable to CFTC proposal. 

b. the Commission determines performs a significant price discovery 

function for energy commodities listed on a trading facility or in the cash market. Factors for the CFTC to consider: 

CFTC to determine whether contract performs a significant price discovery 

function. Proposed CEA Section 2(h)(7)(A)–(B). 

(1) extent to which price of an agreement, contract, or transaction is 

derived from or linked to the price of a futures contract traded on a DCM 

Similar provision in CFTC proposal. Proposed CEA Section 2(h)(7)(B)(i)(I). 

(2) extent to which cash market transactions are directly based on the 

prices in the same energy commodity traded on the energy trading facility 

Similar provision in CFTC proposal. Proposed CEA Section 2(h)(7)(B)(ii). 

(3) the volume of contracts traded on the trading facility Similar provision in CFTC proposal. Proposed Section 2(h)(7)(B)(iii). (4) extent to which data is published after completion of transactions Similar provision in CFTC proposal. Proposed CEA Section 2(h)(7)(B)(ii). (5) extent to which arbitrage market exists between the trading facility and the DCM Similar provision in CFTC proposal. Proposed CEA Section 2(h)(7)(B)(i)(II). (6) other factors Commission deems appropriate Similar provision in CFTC proposal. Proposed CEA Section 2(h)(7)(B)(iv).

II. Section 2(b). Oversight of Energy Trading Facilities Analogous Provisions in CFTC Proposal.

A. Section 2(b)(1) of S. 2058 amends CEA Section 2(h)(3) to exclude Not applicable to CFTC proposal. 

‘‘energy trading facility’’ from qualifying as an exempt commercial market in 

order to make clear that those facilities must comply with new CEA Section 2(j) 

B. Section 2(b)(2) of S. 2058 adds a new Section 2(h)(7) to the CEA. This Not applicable to CFTC proposal. 

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new section provides that notwithstanding any other provision of CEA, an 

energy trading facility and persons trading on an energy trading facility are subject to the new CEA Section 2(j)

III. Section 2(c). Criteria for Trading Facility Registration Analogous Standards for Significant Price Discovery Contracts.

1. New Section 2(j)(4)(A) requires a trading facility to have the capacity to 

prevent price manipulation, excessive speculation, price distortion, and disruption of the delivery or cash-settlement process 

Adds proposed CEA Section 2(h)(7)(C)(ii) Core Principle applicable to significant 

price discovery contracts—ECM must have market surveillance, compliance, and disciplinary practices and procedures. 

2. New Section 2(j)(4)(B) requires a trading facility to monitor trading to 

prevent price manipulation, excessive speculation, price distortion, and disruption of delivery or cash-settlement prices 

Adds proposed CEA Section 2(h)(7)(C)(ii) Core Principle applicable to significant 

price discovery contracts—monitoring of trading to prevent market manipulation, price distortion, and disruptions of the delivery or cash-settlement process. 

3. New Section 2(j)(4)(C) requires a trading facility to list contracts not 

susceptible to manipulation 

Adds proposed CEA Section 2(h)(7)(C)(i) Core Principle applicable to significant 

price discovery contracts—not readily susceptible to manipulation. 

4. New Section 2(j)(4)(D) requires a trading facility that facilitates clearance and settlement by a derivatives clearing organization (‘‘DCO’’) must 

establish and enforce rules requiring financial integrity of contracts 

Not applicable to CFTC proposal. 

5. New Section 2(j)(4)(E) requires a trading facility to establish and enforce rules for obtaining information Adds proposed CEA Section 2(h)(7)(C)(iii) Core Principle—ability to obtain infor- mation. 6. New Section 2(j)(4)(F) requires a trading facility to adopt position limits 

or accountability levels to reduce threat of price manipulation, excessive speculation, price distortion or delivery or cash-settlement process 

Adds proposed CEA Section 2(h)(7)(C)(iv) Core Principle—position limitations or 

accountability. 

7. New Section 2(j)(4)(G) requires a trading facility to adopt rules for 

emergency authority including to (i) liquidate open positions; (ii) suspend or curtail trading; and (iii) require market participants to meet special margin requirements 

Adds proposed CEA Section 2(h)(7)(C)(v) Core Principle—emergency authority, 

including authority to (i) liquidate open positions, and (ii) suspend or curtail trading in contract. 

8. New Section 2(j)(4)(H) requires a trading facility to arrange for daily 

publication of trading information 

Adds proposed CEA Section 2(h)(7)(C)(vi) Core Principle—daily publication of 

trading information. 

9. New Section 2(j)(4)(I) requires a trading facility to establish and enforce 

rules to deter abuse 

Adds proposed CEA Section 2(H)(7)(C)(vii) Core Principle—compliance with 

rules. 

10. New Section 2(j)(4)(J) requires a trading facility to establish rules for 

recording and safe storage of trading information 

Not applicable to CFTC proposal. 

11. New Section 2(j)(4)(K) requires a trading facility to establish rules 

about trading procedures for entering and executing orders 

Not applicable to CFTC proposal. 

12. New Section 2(j)(4)(L) requires a trading facility to insure compliance 

with the rules 

Adds proposed CEA Section 2(h)(7)(C)(vii) Core Principle—compliance with 

rules. 

13. New Section 2(j)(4)(M) requires a trading facility to disclose to the public and the Commission information about contract terms, trading conventions, financial integrity protections, etc. Not applicable to CFTC proposal. 

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Senator Levin’s ‘‘Close the Enron Loophole Act’’ S. 2058 CFTC Proposal significant price discovery contracts on ECMs 

14. New Section 2(j)(4)(N) requires a trading facility to establish fitness 

standards for directors and members of disciplinary committees 

Not applicable to CFTC proposal. 

15. New Section 2(j)(4)(O) requires a trading facility to establish rules governing conflicts of interest in the decision making process Not applicable to CFTC proposal. 16. New Section 2(j)(4)(P) requires a trading facility to maintain all business records for 5 years Not applicable to CFTC proposal. 17. New Section 2(j)(4)(Q) requires a trading facility to avoid adopting 

rules that create an unreasonable restraint of trade or impose anti-competitive burdens on trading on the facility 

Not applicable to CFTC proposal. 

B. Criteria for Energy Trading Facilities—new section 2(j)(5) provides that an 

energy trading facility must continue to comply with all of the criteria in section 2(j)(4) to continue operation, and that violation of any criteria shall constitute a violation of the CEA. 

Core Principles apply to ECMs trading significant price discovery contracts on 

an ongoing basis. Violations of the provisions of proposed CEA Section 2(h)(7) constitute violations of the CEA. 

C. Position Limits and Accountability—new section 2(j)(6) directs the Commission 

1. to ensure that the position limits and accountability levels that are established for energy trading facilities are on a parity with the position 

limits and accountability levels established for similar contracts traded on a DCM and applied in a functionally equivalent manner, 

Adds proposed CEA Section 2(h)(7)(C)(iv) Core Principle—position limitations or 

accountability. Also, amends CEA Sections 4g and 4i regarding recordkeeping and large trader reporting, and Section 8a regarding emergency authority, for significant price discovery contracts. 

2. to take action as necessary to reduce potential threat of price manipulation, excessive speculation, price distortion or disruption of delivery or 

cash-settlement process, and 

3. to obtain information from a trader regarding the trader’s exchange and 

off-exchange positions. 

D. Criteria for Commission Determination—new section 2(j)(6)(D) specifies criteria the Commission or exchange may consider when determining whether 

to require a trader to limit, reduce, or liquidate a position including: 

Not applicable to CFTC proposal. 

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1. person’s open interest relative to the total open interest 2. daily volume of contract 3. person’s overall position in related contracts, including options, and the 

overall open interest or liquidity in the related contracts and options 

4. potential for positions to cause or allow price manipulation, excessive 

speculation, price distortion, or disruption of delivery or cash-settlement process 

5. person’s compliance record 6. any justification provided by person for such position, and 7. other factors as deemed appropriate by Commission 

E. Information for Price Discovery Determination—Section 2(d) amends other 

provisions of the CEA to enable the Commission to obtain information from an electronic trading facility or a derivatives transaction execution facility to evaluate whether the energy trading facility performs a price discovery function 

Conforming amendment (d) amends Section 2(h)(5) to extend CFTC’s special 

call authority for ECMs to obtaining information to make a significant price discovery determination. Also, significant price discovery determination process subject to CFTC rulemaking authority under proposed CEA Section 2(h)(7)(A).

IV. Section 3. Reporting of Energy Trades Analogous Provisions in CFTC Proposal.

A. Section 3 of S. 2058 adds a new CEA section 2(K) which requires U.S. persons who trade certain energy contracts on a foreign board of trade (‘‘FBOT’’) 

to keep records and to report large trades. 

Not applicable CFTC proposal.

V. Antifraud Authority Analogous Provisions in CFTC Proposal. 

A. Section 4 of S. 2058 amends Section 4b of the CEA to clarify the CFTC’s authority to bring fraud actions in off-exchange principal-to-principal futures 

transactions. 

Outside scope of proposal regarding significant price discovery contracts trading 

on ECMs; CFTC supports including this provision as part of CFTC reauthorization.

VI. Commission Rulemaking Analogous Provisions in CFTC Proposal.

A. Section 5 of S. 2058 requires the CFTC to issue proposed rules within 180 

days regarding requirements for an application for registration for an energy trading facility. CFTC must finalize rule within 270 days. 

Adds proposed CEA Section 2(h)(7)(A) requiring CFTC rulemaking to implement 

the provisions of this legislation.

VII. Conforming Amendments Analogous Provisions in CFTC Proposal.

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Attachment—Continued

Senator Levin’s ‘‘Close the Enron Loophole Act’’ S. 2058 CFTC Proposal significant price discovery contracts on ECMs 

A. Section 2 of S. 2058 includes various CEA conforming amendments to provide a comparable degree of CFTC authority over operations of registered 

energy trading facilities as exists with respect to DCMs. 

Adds conforming amendments to : 

CEA Sections (2)(a)(1)(A)—exclusive jurisdiction over significant price discovery contracts on ECMs; CEA Section 2(h)(4)(D)—remove existing significant price discovery function provision applicable to ECMs in light of new Core Principle in CEA Section 2(h)(7)(C)(vi) requiring daily publication of certain trading information; CEA Section 5c—issuance of CFTC interpretations regarding compliance with Core Principles, delegation of functions under Core Principles, violations of Core Principles; CEA Section 8a—authority to alter or supplement rules of the trading facility and to share information with the trading facility. 

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