U.S. GOVERNMENT PRINTING OFFICE

69–315 CC WASHINGTON : 2001

S. HRG. 106–907

CFTC REPORT ENTITLED ‘‘A NEW REGULATORY

FRAMEWORK’’

HEARING

BEFORE THE

COMMITTEE ON AGRICULTURE,

NUTRITION, AND FORESTRY

UNITED STATES SENATE

SUBCOMMITTEE ON RESEARCH,

NUTRITION AND GENERAL LEGISLATION

ONE HUNDRED SIXTH CONGRESS

SECOND SESSION

ON

CFTC REPORT ENTITLED ‘‘A NEW REGULATORY FRAMEWORK’’

MARCH 20, 2000

Printed for the use of the

Committee on Agriculture, Nutrition, and Forestry

(

For sale by the U.S. Government Printing Office

Superintendent of Documents, Congressional Sales Office, Washington, DC 20402
COMMITTEE ON AGRICULTURE, NUTRITION, AND FORESTRY

RICHARD G. LUGAR, Indiana, Chairman

JESSE HELMS, North Carolina

THAD COCHRAN, Mississippi

MITCH MCCONNELL, Kentucky

PAUL COVERDELL, Georgia

PAT ROBERTS, Kansas

PETER G. FITZGERALD, Illinois

CHARLES E. GRASSLEY, Iowa

LARRY E. CRAIG, Idaho

RICK SANTORUM, Pennsylvania

TOM HARKIN, Iowa

PATRICK J. LEAHY, Vermont

KENT CONRAD, North Dakota

THOMAS A. DASCHLE, South Dakota

MAX BAUCUS, Montana

J. ROBERT KERREY, Nebraska

TIM JOHNSON, South Dakota

BLANCHE L. LINCOLN, Arkansas

KEITH LUSE, Staff Director

DAVID L. JOHNSON, Chief Counsel

ROBERT E. STURM, Chief Clerk

MARK HALVERSON, Staff Director for the Minority

(II)
(III)

C O N T E N T S

Page

HEARING:

Monday, March 20, 2000, CFTC Report Entitled ‘‘A New Regulatory Framework’’ ..................................................................................................................... 1

APPENDIX:

Monday, March 20, 2000 ......................................................................................... 41

DOCUMENT(S) SUBMITTED FOR THE RECORD:

Monday, March 20, 2000 ......................................................................................... 103

Monday, March 20, 2000

STATEMENTS PRESENTED BY SENATORS

Fitzgerald, Hon. Peter G., a U.S. Senator from Illinois, Chairman, Subcommittee on Research, Nutrition and General Legislation, Committee on

Agriculture, Nutrition and Forestry ................................................................... 1

WITNESSES

PANEL I

Paul, Robert C., General Counsel, Commodity Futures Trading Commission,

Washington, DC ................................................................................................... 2

PANEL II

Brennan, David P., Chairman, Chicago Board of Trade, Chicago, Illinois,

accompanied by Thomas Donovan, President and Chief Executive Officer,

Chicago Board of Trade, Chicago, Illinois .......................................................... 14

Crapple, George, President, Managed Funds Association, New York, New

York ....................................................................................................................... 29

Downey, David, Executive Vice President, Interactive Brokers LLC, Chicago,

Illinois ................................................................................................................... 32

Lind, Barry, Chairman, Lind-Waldock & Company, Chicago, Illinois ................ 23

McNulty, James J, President and Chief Executive Officer, Chicago Mecantile

Exchange, Chicago, Illinois ................................................................................. 15

Wilmouth, Robert K., President, National Futures Association, Chicago, Illinois ........................................................................................................................ 11

Waye, Jan R., Senior Vice President, Cargill Investor Services, Inc., Chicago,

Illinois ................................................................................................................... 26

APPENDIX

PREPARED STATEMENTS:

Fitzgerald Hon. Peter G. .................................................................................. 42

Brennan, David P ............................................................................................. 60

Crapple, George ................................................................................................ 77

Downey, David .................................................................................................. 87

Lee, Peter .......................................................................................................... 82

Lind, Barry ........................................................................................................ 95

Paul, Robert C. ................................................................................................. 46
Page

IV

PREPARED STATEMENTS—CONTINUED

McNulty, James J. ............................................................................................ 51

Waye, Jan R. ..................................................................................................... 74

Wilmouth, Robert K ......................................................................................... 67

DOCUMENT(S) SUBMITTED FOR THE RECORD:

CFTC (report) A New Regulatory Framework, submitted by Jan R. Waye 104
(1)

CFTC REPORT ENTITLED ‘‘A NEW

REGULATORY FRAMEWORK’’

MONDAY, MARCH 20, 2000

U.S. SENATE,

SUBCOMMITTEE ON RESEARCH, NUTRITION, AND GENERAL

LEGISLATION, OF THE COMMITTEE ON AGRICULTURE,

NUTRITION, AND FORESTRY,

Washington, DC.

The Subcommittee met, pursuant to notice, at 10:05 a.m., in

room 2525, Dirksen Federal Building, 219 South Dearborn Street,

Chicago, Illinois, Hon. Peter G. Fitzgerald, Chairman of the Subcommittee,) presiding.

Present or submitting a statement: Senator Fitzgerald.

OPENING STATEMENT OF HON. PETER G. FITZGERALD, A. U.S.

SENATOR FROM ILLINOIS, CHAIRMAN, SUBCOMMITTEE ON

RESEARCH, NUTRITION, AND GENERAL LEGISLATION, OF

THE COMMITTEE ON AGRICULTURE, NUTRITION AND FORESTRY

The CHAIRMAN. This hearing will come to order. This is a hearing on the Subcommittee on Research, Nutrition and General Legislation of the U.S. Senate Committee on Agriculture, Nutrition

and Forestry.

The purpose of the hearing is to examine proposed regulations

that may be coming forth from the Commodity Futures Trading

Commission. CFTC has suggested that it is willing to grant broad

regulatory relief to futures exchanges and create a new regulatory—framework.

I’ve asked each panelist, instead of reading the prepared remarks, to instead summarize their remarks as best they can. I’m

going to set a good example by sparing you the reading of my opening statement which I am now going to ask myself for permission

to submit for the record.

And with that, Mr. Paul, welcome to Chicago and please, why

don’t you begin.

[The prepared statement of Senator Fitzgerald can be found in

the appendix on page 42.]
2

STATEMENT OF C. ROBERT PAUL, GENERAL COUNSEL, COMMODITY FUTURES TRADING COMMISSION, WASHINGTON,

DC., ACCOMPANIED BY PAUL ARCHITZEL, DIVISION OF ECONOMIC ANALYSIS

Mr. PAUL. Thank you Mr. Chairman. I’m pleased to be here to

testify before you on behalf of Chairman Rainer and appreciate the

opportunity to discuss recent efforts at regulatory reform.

I also want to introduce you to my left, Paul Architzel from our

Division of Economic Analysis who headed up the task force that

prepared this regulatory framework that we are discussing today.

I will try to summarize my written remarks as briefly as possible

but I am sure, Mr. Chairman, that you can feel free to interrupt

me as I go through this with any questions you may have and I’ll

leave time at the end to answer any questions you might have.

Chairman Rainer has identified three public policy goals on

which the CFTC should focus in regulating derivatives markets:

first, creating a comfortable climate for competition in all sectors

of the industry; second, removing any regulatory barriers that

hamper these markets from fully exploiting innovations in technology; and third, decreasing the level of systemic risk in domestic

and international derivatives trading. To achieve these goals it is

imperative to modernize the way we regulate futures markets.

Accordingly, a staff task force of the Commission has developed

a new regulatory framework that would change the regulatory

structure for derivatives. The proposed framework is intended to

promote innovation, maintain U.S. competitiveness, reduce systemic risk, and protect derivatives customers.

The new frame work is a work in progress; it is a staff document

on which there has been no Commission action to date. The CFTC

intends to hold at least one public hearing on this proposal to get

as much input as possible from the markets and participants. We

want to find solutions that serve the public interest. But we also

recognize that time is not our ally. In spite of the difficulty of developing answers to questions of regulatory architecture, we must

work together to expeditiously reach conclusions suitable for these

markets and the public interest.

Technology offers us tangible benefits that are either immediate

or imminent, including faster and better execution; significantly

lower transaction costs; cross-market clearing, netting and offsetting systems; and increased liquidity. The U.S. futures industry

must embrace technology without reservation to build stronger

markets if it expects to remain competitive.

Flexibility is the hallmark of the new framework. The staff’s proposal recommends that the Commission replace the current onesize-fits-all regulation for futures markets with a structure that

would instead apply broad, flexible ‘‘core principles,’’ which are tailored to match the degree and manner of regulation to a variety of

market structures and participants. Under this proposal, multilateral trade execution facilities will operate in one of three categories, taking into account the nature of the underlying commodities and the sophistication of the customers. While the framework

invites changes, it does not impose it on established futures exchanges. Existing exchanges operating as contract markets may re-
3

organize under the terms of the framework, but they are not compelled to do so.

The framework offers the following three basic categories of exchanges or trading facilities correlating to a spectrum of regulation:

recognized futures exchanges, recognized derivative transaction facilities and exempt multilateral trading facilities. And I want to

compliment the Chairman on getting those rather accurately in his

introduction.

The category recognized futures exchange [RFE], or an RFE,

would include multilateral transaction execution facilities that permit access to any type of customer, institutional or retail, and that

trade any type of contract, including those that are based on commodities that have finite deliverable supplies or cash markets with

limited liquidity. Because these markets trade markets that may

have a greater susceptibility to price manipulation and because the

presence of non-institutional traders participating here raise deeper concerns for customer protection, RFEs would be subject to a

higher level of Commission oversight than market in either of the

other two categories.

Nonetheless, the proposed RFE offers significant regulatory relief

compared to the current requirements applicable to designated contract markets. Detailed prescriptive rules would be replaced with

15 broad ‘‘core principles.’’ These include principles relating to market surveillance, position reporting, transparency, fair trading and

customer protection. Any board of trade, facility, or entity that is

currently required to be designated as a contract market would be

eligible to qualify as an RFE.

The second category, the derivatives transaction facility [DTF],

would be subject to a lesser degree of Commission oversight. A facility would be eligible to become a DTF if: (i) the contracts traded

on the facility are for commodities that have nearly inexhaustible

supplies or for which there is no underlying cash markets (e.g.,

weather derivatives); (ii) the Commission determines on a case-bycase basis that the contract would be appropriate for this level of

regulation; or (iii) the facility limits access to commercial traders

only.

A DTF would be required to adhere to only seven core principles,

including those relating to market oversight, transparency, and recordkeeping. Because a DTF either would be limited to commodities

that are not susceptible to manipulation or would limit access to

institutional or commercial participants, a DTF would not be required to adhere to certain other core principles applicable to an

RFE such as those relating to position monitoring, customer protection or dispute resolution.

Finally, the third category, the exempt multilateral transaction

execution facility [MTEF], or exempt MTEF, would operate on an

unregulated basis. This would be a self-effectuating exemption for

transactions among institutional traders in commodities that are

unlikely to be susceptible to manipulation.

These markets would be exempt from all requirements of the

Commodity Exchange Act and Commission regulations, except for

anti-fraud and anti-manipulation. Moreover, if a designated contract market elects to trade an eligible contract that serves as a

sort of price discovery on an exempt MTEF, the MTEF would be
4

required to continue to provide pricing information to the public.

Exempt MTEFs would not, however, be permitted to hold themselves out to the public as being regulated by the Commission.

That is a brief overview of the staff’s regulatory proposal, and I

would be happy to answer any questions. Thank you again for the

opportunity to testify before you today.

[The prepared statement of Mr. Paul can be found in the appendix on page 46.]

The CHAIRMAN. Mr. Paul, thank you, and I think you gave a very

good, concise explanation of the three different categories that

would be available.

Let me ask you the threshold question. I believe in the CFTC’s

report to Congress about these proposals that you suggested that

you have the ability to implement it through your own regulatory

powers without any help from Congress. Does the CFTC believe

that this proposal should or should not be codified by Congress?

Mr. PAUL. Well, although we believe that we have proper statutory authority under Section 4(c) to adopt these regulations without

legislation, we do see a benefit in working with your Subcommittee

and Chairman Lugar’s Parent Committee in codifying some of the

structure. We think that it would perhaps enhance the ability to

get meaningful legislation adopted that would greater legal certainty to the markets.

The CHAIRMAN. If Congress decides to, as we rewrite the CEA,

codifying the core principles and having three different layers?

Mr. PAUL. I am not sure that we would go as far as codifying,

suggesting that you codify the core principles, only because that

might detract from the kind of flexibility that we hope to achieve

through this regulatory framework. But I think what we had discussed internally, and I think already discussing with Congressional staff, is codifying the categories and maybe some of the overarching concepts without necessarily delving into the kind of detail

that you would find at the 15 core principles for the RFE, or the

seven core principles for the DTF.

The CHAIRMAN. This proposal would really not depend on what

type of physical exchange you are, whether you are a pit based exchange or an electronic exchange. It would go beyond those areas

and an electronic exchange could try to qualify theoretically to be

a recognized futures exchange, I suppose. In addition a pit based

exchange could at least try to be a recognized derivatives transaction facility. And possibly, if they are just institutional traders

trading commodities with inexhaustible supplies and no underlying

cash market, a traditional pit based exchange could try to become

an exempt multilateral transaction facility.

Mr. PAUL. I could not have said it any better myself. That is the

beauty of this proposal. I think the staff, working with Mr.

Architzel, had their different approaches including those that

might be based on what the medium is, but we think that kind of

flexibility that we put into this proposal is of greater benefit to the

markets. We let the markets choose which medium it would like

to trade in, and by gearing the regulation, calibrating it according

to what products and who the participants are, we think we can

achieve regulatory goals without unduly hampering the innovation

on the technology side.
5

The CHAIRMAN. Now, both of the main futures exchanges in Chicago, the Chicago Board of Trade and the Chicago Mercantile Exchange, are now considering proposals to reorganize themselves internally. The Chicago Board of Trade is considering creating two

separate companies, one that would be an on-line company and the

other that would be the traditional pit based exchange.

Would a change in these regulations affect the way those exchanges might want to be organized? If they decided that they

wanted to have an RFE, a DTF and an exempt MTEF, would they

have to have three separate subsidiaries? How would this work?

Would each have to have a separate legal identity?

Mr. PAUL. The framework currently would call for separate entities for different type of structures, but we are discussing that, because our interest is making sure that the participants know exactly what level of regulation that they are engaging in. So therefore, I think the original inclination was to have separate entities.

But I think that we are considering whether or not we want to provide the kind of flexibility that may be able to allow a single entity

to offer different types of markets, as long as it is clear to the participants, to the customers, which entity they are trading and

therefore, what level of protection that they might be protected by.

Mr. ARCHITZEL. Just to clarify. Recognized markets can be traded

under the same legal entity. It is only the exempt MTEF that is

required to be traded through a separate legal entity, because that

level is not regulated. So the exchanges would have the ability to

operate both the RFE and the DTF under the same legal entity.

The CHAIRMAN. OK. So that one legal entity could have the RFE

and the DTF, but if you wanted to have the exempt MTEF you

would have to have a separate subsidiary or a separate company.

Mr. ARCHITZEL. Exactly.

The CHAIRMAN. OK. That clarifies. That is important.

Now, to be a recognized derivatives transaction facility, a recognized DTF, you say that there would be two main requirements:

First, only commodities with, nearly inexhaustible deliverable supplies, no underlying cash market, or contracts that the CFTC allows on an individual case-by-case basis could be traded. Secondly,

commercial traders would be allowed to trade. What do you mean

by commercial traders?

Mr. PAUL. I’ll try to clarify that. That is either/or, Mr. Chairman.

The CHAIRMAN. OK. That is right. So in other words, retail customers and that would not be a problem. If they are dealing with

commodities, such as Euro dollars or foreign currencies, commodities a nearly inexhaustible deliverable supply?

Mr. ARCHITZEL. That is correct. Retail customers are permitted

with special enhanced protection. This DTF is intended to be a

market mainly for institutional customers. But if the market qualifies as a DTF on the basis of the nature of the commodity, then

it is possible for retail customers to access the market if certain

conditions are met. Those conditions are that the customers trade

through a registered FCM, that the FCM be a clearing member of

at least one RFE and that the FCM meet a higher minimum net

capital standard.

The second group of markets that can be a DTF are markets

which are open only to commercial traders. This type of DTEF,
6

which is essentially B–2–B, is only commercial traders is open for

any commodity. So these are two very distinct types of markets.

The CHAIRMAN. OK. So you could envision an agricultural commodity being traded in a DTF provided that only institutional participants are involved?

Mr. ARCHITZEL. At this point we have not limited the types of

commodities that can trade on a DTEF, although the staff report

recommends that the Commission seek comment on whether agricultural commodities in particular should be qualified to belong in

this category. So that is something that we recommend that the

Commission seek comment on. Agricultural commodities have

somewhat different characteristics and in the past were sometimes

treated differently under the regulations. But certainly any physical commodity could belong in the DTF category and qualify for it,

if the market were restricted to commercial traders.

The CHAIRMAN. Now, let me just talk about commodities with a

nearly inexhaustible deliverable supply. Do you fit United States

Treasury Bonds in that category?

Mr. ARCHITZEL. That is a ‘‘moving target’’ right now.

The CHAIRMAN. Because the supply is going down. I mean it is

3.5 trillion outstanding right now, but it is scheduled to go down

to zero by 2015.

Mr. ARCHITZEL. I think that is something that needs to be addressed further. We should have guidelines saying what commodities fit into this category. And as markets change, as commodities

change, we could review and revise the guidelines.

The CHAIRMAN. Now, on the exempt multilateral transaction facilities, would I be correct to surmise that no retail customers

could, under any circumstances, be allowed in that?

Mr. ARCHITZEL. That’s correct.

The CHAIRMAN. That would be totally institutional. Right now

the current sections of the CEA that provide the principle regulatory framework for the CFTC are Section 5 and 6 of the CEA.

How would the new regulatory framework impact those sections?

Mr. ARCHITZEL. The core principles summarize and digest most

of the provisions in Section 5 and 5a, and would serve as a replacement by and large for those individual sections of the Act. In other

words, sections 5 and 5a of the Act, talk about the manipulability

of commodities, and there is a core principle that relates to that.

So the core principle would serve as an alternative to that provision of the Act.

The CHAIRMAN. The report recommends, as you have talked

about, that the current CFTC regulatory framework be replaced

with the derived four principles that are intended to encompass all

technology and business organizations. However, the report does

not address in detail how these principles are to be implemented

or provide guidelines for industry participants to follow.

Who will determine how industry participants will apply these

principles and how they will be accomplished?

Mr. ARCHITZEL. The report envisions that the core principles will

be accompanied by statements of acceptable practices or best practices, and those would be interpretive statements by the Commission, giving guidance to the industry on compliance with the core

principles. We also envision that the interpretive statements would
7

be written in cooperation with the industry and envision that the

National Futures Association will be providing input to us on those

as well.

I think it is important to note, though, because those would be

acceptable practices, they would not be exclusive of other ways that

facilities could come to us and demonstrate that they are in compliance with the core principles. That is what we are trying to achieve

from this framework, as opposed to giving the specific prescription

as to how they should achieve these goals, but leave it open to

them. But we give them the convenience of knowing if they do

things in a certain way that creates a safe harbor.

The CHAIRMAN. OK. According to your report, non-institutional

customers require greater market protection than institutional or

commercial customers. Non-institutional customers may be permitted access on both an RFE, a recognized futures exchange, and

DTF facility, recognized derivatives transaction facility, although

the core principles for an RFE contain provisions for customer protection and dispute resolution for non-institutional customers. The

DTF core principles do not contain such provisions.

Could you explain the absence of the customer protection and

dispute resolution provisions in the DTF core principles?

Mr. PAUL. Well, I will start and Paul can supplement it. We feel

that we can achieve customer protection for the non-institutional

customers trading on DTF by regulating the intermediary. And this

is frankly a concept that we learned by soliciting comments from

the industry. And we think that as long as we have an intermediary that is a registrant of the CFTC, and therefore, is obligated to follow the CFTC rules with respect to risk disclosure, segregation of assets, making sure that they get the information they

need on the markets, that we can protect the customer at that level

as opposed to doing it at the exchange level.

Mr. ARCHITZEL. I think the additional thing to note is that although there is not the dispute resolution provision, there would be

the availability of the CTFC reparation procedures which is like a

small claims court for customers who feel they have been injured

by a violation of the Act or regulations. And those would remain

available to retail customers, because they would be trading

through registrants.

The CHAIRMAN. You have a lot in your report about the segregation of customer funds. If I read it correctly, institutional customers

would be able to opt out of requiring that their funds be segregated; was that how you set this up?

Mr. ARCHITZEL. That is only if the DTF has rules providing for

that. And in doing so, in providing those rules, they would also

have to provide for financial disclosure and other types of disclosures to market participants on what the effects would be by having the opt out allowance.

The CHAIRMAN. If those funds are not segregated and there is a

problem, it really gets hard to trace, does it not? How do you determine whose money was taken, misappropriated or misapplied?

Mr. PAUL. Well, I guess we believe that, that is a risk that we

would allow certain customers to take as long as they are fully informed of what the risks are. And that is also why we are not recommending that, that be permitted at the recognized futures ex-
8

change level. And just parenthetically, when the task force originally put together this proposal, they had another category between the RFE and DTF known as a recognized institutional futures exchange, which would be somewhere in between the regulatory framework on the spectrum of regulation, and that would be

created so that institutional customers could opt out of seg. We

found that there was not a real appetite for that in the market. So

we thought we would simplify it with just the three big markets

we have now.

The CHAIRMAN. You figured that the big boys who are participating in the markets can take care of themselves. That they would

probably demand their funds be segregated or have those kind of

protections that they could handle, is that correct? Whereas, a retail customer might not think of that issue, is that correct?

Mr. ARCHITZEL. This issue has come up over the years. There are

foreign exchanges that operate without segregation of customer

funds, and generally that is available for larger customers as an

option. Over the years our exchanges have said that they would be

able to compete more effectively with foreign markets if they were

able to make adjustments to. So that is something that we are comfortable with for large institutional customers only, provided that

appropriate disclosures are made at the market level.

Mr. PAUL. One of the reasons, just to finish this thought, one of

the reasons why there did not seem to be a keen appetite for the

RFE is because the proposal also recommends that we broaden the

permissible investment of segregated funds. And that is really why

not only customers, but also the intermediaries were reluctant to

extend segregated funds any further than they had to because they

would get low return on those funds that were segregated, to the

extent that we have made it a little broader possibilities as to what

they could invest it in and provide better return, the need to opt

out of seg is not as acute.

The CHAIRMAN. OK. Now, the first page of the report recommends that the Commission propose a quote, ‘‘new regulatory

framework to apply to multilateral execution facilities that trade

derivatives.’’

How does the CFTC define, quote, ‘‘transaction execution facility,’’ and what is the CFTC’s position on the meaning of multilateral? What is the CFTC’s position on the meaning of this term in

the context of the current swaps exemption?

Mr. PAUL. Well, that is actually one of the thorniest concepts

that we are wrestling with right now, Mr. Chairman. And we are

engaged in ongoing discussions both internally and with various

representatives of the industry, to come up with a definition that

we will include in our proposed rule making, that will better define

what a multilateral transaction execution facility is.

Beyond that, I think at this point it is such an inchoate issue

that I think that we probably cannot give you much further guidance at this time.

The CHAIRMAN. So that is a work in progress?

Mr. PAUL. That is where the rubber meets the road on the current proposal.
9

The CHAIRMAN. OK. We are going to have to come up with all

the details to actually get these regulations or statutory things enacted.

The report states that the registration process should be ‘‘streamlined,’’ quote, unquote, for futures commission merchants and introducing brokers; however, it does not state in any detail how this

is to be done.

Would you explain what the report means by streamlining the

registration process?

Mr. ARCHITZEL. The streamlining envisioned there is accepting

various types of accounting reports at various stages during the

year, rather than requiring a certified audit at the time of actual

filing for registration. That is the nature of streamlining envisioned.

The CHAIRMAN. OK. The report provides for an exempt multilateral transaction facility in which a facility could choose to operate

a market exempt from commission regulations except for the antifraud and anti-manipulation provisions. This facility would only be

available to institutional traders who trade commodities with inexhaustible deliverable supplies, or supplies that are otherwise sufficiently large to render a contract traded unlikely to be susceptible

of manipulation.

Doe not this exemption operate to deny retail customers access

to the most liquid markets?

Mr. PAUL. Well, Mr. Chairman, the retail customer currently

does not have access to all markets. We do not think that we are

denying access by virtue of our proposal. In fact, we actually think

that we are providing them with access to certain markets they

might not currently have through some of the flexibility we have

built into the DTF category.

So to the extent that retail customers currently trade in designated contract markets, they will be able to continue to do so

through the recognized futures exchanges. We think they will probably get access to broader markets through the DTF category, but

the exempt MTEF category is really designed to provide a regulatory framework that the over the counter market that currently

exists completely outside of our regulation to operate under.

The CHAIRMAN. They do not have access to that now; namely, the

over the counter market involving private contracts. I notice that

you suggest that you suspect that many over the counter type markets now might want to become DTFs so that they could have that

imprimatur of CFTC regulation. Would you explain your thinking

on that a little bit more? Do you see some positive advantages in

saying that you are regulated. Do you believe people might have

more faith in the integrity of the markets if they know that you

have that regulatory check?

Mr. PAUL. Absolutely. And we believe that there is interest

amongst certain types of markets and certain market participants

to trade in a regulatory environment. All regulation is not bad.

Many market participants seek the U.S. markets because of its

high regulatory integrity, because of the sense that the markets

and the participants are being looked after. So for those types of

markets we certainly don’t want to deny them a home if they are
10

looking for some place that they can provide greater comfort to

their participants and for their products.

Mr. ARCHITZEL. It is also noteworthy that the recognition that

the Commission bestows on markets, either the RFE or the recognized DTF, corresponds to those minimum regulatory standards

that other regulators internationally subscribe to, so that recognition as a DTF carries with it an acknowledgement that, that market meets the minimum international standards. It may therefore

make it easier for a market which intends to do business globally

to get approved by regulators in foreign countries as well.

The CHAIRMAN. I see. What would you say are minimum standards internationally, though? What basis is there for saying there

are minimum standards internationally?

Mr. ARCHITZEL. The staff spent a lot of time looking at guidance

put out by various organizations of international regulators such as

IOSCO, which is an international securities regulatory body. Over

the years we have cooperated with those groups to harmonize our

rules and regulations. So at this point there is a great deal of guidance put out by these international groups that most international

regulators subscribe to. And our core principles correspond with

that guidance very closely.

The CHAIRMAN. Finally, I want to ask you a couple other questions. This is a little bit off the main subject of our hearing, which

is your proposed new regulations. Many of the Chicago participants

are interested in allowing futures on individual stocks. I know that,

that will probably be the subject of several other separate hearings.

But I was interested in how the margins are now set on stock index

futures. Reading the CEA, it looks like it is really up to the Federal

Reserve, but if the Federal Reserve declines to set up margin requirement, the CFTC steps in and sets a margin requirement.

What is the margin requirement now on stock index futures and

who has set that?

Mr. ARCHITZEL. The exchanges in the first instance set the margin requirements, and report to us for approval of those. They are

currently set at levels which cover very high confidence numbers

above 99-percent for market movements on a daily basis in the

market.

The CHAIRMAN. What is the margin requirement? Do you know?

Mr. ARCHITZEL. I would have to provide that data for you for the

record in a written statement.

The CHAIRMAN. OK.

Mr. PAUL. And one of the things that we have discussed with the

SEC in our negotiations on Shad–Johnson is coming up with some

sort of harmonized margin requirement for single stock futures regardless of where they trade. And we have discussed various approaches. The SEC has its own opinion on the subject. I do not

want to speak on their behalf, but it seems like I think we are moving toward meeting in the middle on margin requirements that

may begin to equity options as being really the closest parallel, but

preferably something that is based on—— The CHAIRMAN. Are those margin requirements about 50-percent?

Mr. PAUL. Fifty-percent, Mr. Chairman, is for the actual stock.

The equity options, and similar to what the futures exchanges do
11

on index contracts is it is risk based and the span margining system that the Chicago Mercantile Exchange has developed which is

probably the best at trying to calibrate, or at least take into account, the volatility of the instrument. And we think that is probably the approach that we should agree on with the SEC on a consistent margin framework for single stock futures, and whether

that is done under the auspices of the Fed or done through an

memorandum of understanding between the SEC and the CFTC

and through the review process of the exchange margins. Those are

the kinds of issues that we are trying to hammer out right now.

The CHAIRMAN. OK. My final question is how long did it take you

to come up with this new proposal? I saw you had a task force that

put this together. How long have they been working on this?

Mr. ARCHITZEL. We started in October.

The CHAIRMAN. And you got it done that rapidly?

Mr. ARCHITZEL. Yes.

The CHAIRMAN. That is very good work. I want to compliment

the CFTC on their proposals here. They seem to me, at least at

first blush, to make a lot of sense. I have heard a lot of positive

comment. I look forward to hearing in more detail what some of the

others have to say today. But I want to compliment Chairman

Rainer on moving the CFTC in this direction, and with the speed

with which you acted. I think you have a pretty solid framework

for us to work on. So thank you all very much.

Mr. PAUL. Thank you, Mr. Chairman.

The CHAIRMAN. Now, we can move to the second panel. On the

second panel we have James J. McNulty, President and Chief Executive Officer, Chicago Mercantile Exchange; Mr. David P. Brennan,

Chairman, Chicago Board of Trade; Mr. Thomas R. Donovan, President and Chief Executive Officer, Chicago Board of Trade; and Mr.

Robert K. Wilmouth, President of the National Futures Association.

And again, if I could ask each of you to summarize your thoughts

rather than reading the prepared remarks, I would appreciate that.

We will submit your prepared remarks for the record. Also, I notice

some of you, in your prepared remarks, had a lot about the possibility of futures on individual stocks. That is a little bit beyond the

scope of today’s hearing. While that is a great topic, I would probably hear from Bill Brodsky over at the CBOT real quick if we get

too far down that road. So I want to keep it pretty much on target,

on the proposed new regulations that the CFTC has come up with.

I would also like to hear from the two exchanges on how these

new proposals might affect your own plans for reorganization, both

of which you both have underway already. If these regulations

came into effect, would you want to rethink in any way your proposals for reorganizing, so that you could take advantage of these

separate possible regulatory schemes.

I do not know if we have a volunteer to go first. Would Mr.

Wilmouth like to go first? Thank you for coming here.

STATEMENT OF ROBERT K. WILMOUTH, PRESIDENT AND

CHIEF EXECUTIVE OFFICER, NATIONAL FUTURES ASSOCIATION

Mr. WILMOUTH. Thank you very much, Mr. Chairman. I appreciate the opportunity to present the views of the National Futures
12

Association on the CFTC’s proposed new regulatory framework

which we think is one of the most important developments in the

futures industry since the creation of the Commission itself. And

I will confine my remarks specifically to the CFTC’s proposed new

regulatory framework.

We all know that we are facing great competition, both from off

shore markets and over the counter markets, and the regulation of

the industry must be overhauled and streamlined if regulated markets are going to remain competitive and be attractive. In short, we

have to find new ways to reduce regulatory burdens without reducing regulatory protections.

One way to achieve that goal is to maximize the use of self-regulation, while returning the Commission to its intended role of overseer of the self-regulatory process rather than as a micro manager.

The Commission’s proposed framework is dramatic and it is a bold

step.

The focus on core principles for both exchanges and intermediaries is exactly the right approach. The Commission should

tell those that it regulates what they have to do, not how to do it.

The answer to the how question changes with every new development in technology. That is why the role of self-regulation will be

even greater in the markets of tomorrow.

Technology is really tearing down the barrier of entry faster than

any government policy ever could. From 1977 to 1999 there were

no new futures exchanges formed. In the last 6-months, at least six

different enterprises have stated their interest in creating new

electronic futures exchanges. All of them are dedicated to using effective self-regulation to insure the integrity of the marketplace,

and the public’s confidence in those markets. But none of these

new exchanges that are in the formation stages are really shackled

by the past. Every one of them is looking for more efficient ways

to perform their self-regulatory functions, and every one of them

has contacted NFA to discuss outsourcing that function to us.

My point is simply not that NFA is going to play an even greater

role in the years ahead, but that the flourishing number of exchanges and the corresponding changes to the entire industry, including its self-regulatory functions need action now, today. Time

is of the essence. And we would urge both the Commission and

Congress, Mr. Chairman, to move ahead as aggressively as possible.

We certainly recognize that difficult work lies ahead. The comments of Paul Architzel and Robert Paul earlier indicate that. The

proposed framework is just that, it is simply a framework. It does

not address the details which will have to be resolved to move the

proposal from the paper world to the real world. Some of these details should be readily solvable, but those core principles need to

be supplemented with interpretive guidelines on which the entire

industry can rely.

But we suggest first of all how that guidance should not be provided. If we revert to having regulators in Washington dictating to

the industry how the core principles have to be followed, we will

end up right back where we are now. In addition, NFA is currently

involved with the Futures Industry Institute on a best practices

study on order transmission and entry, a study directed by the
13

Commission and funded by a portion of the fine that they imposed

in a CFTC enforcement action. We are convinced that a best practices approach is an excellent way to supplement the Commission’s

proposed core principles and provide the guidance that we think is

necessary to the industry.

Two basic points. When we talk about best practices, we have to

consider the basic question of best practices from whose perspective. Best practices in our mind have to be considered from the perspective of the customer. We spent a good deal of time in our current study talking to end users and customers and what they want

from best practices is very clear. They want procedures that insure

fair treatment and quick execution at the best price.

Second point. By definition, best practices have to be developed

through direct and active involvement through the industry. The

Commission should specify that the core principles will be supplemented with best practices guidance, developed through the industry’s self-regulatory process, which includes NFA and of course, the

exchanges.

Another detail which can be resolved quickly involves the registration process, and you asked a question about that earlier. The

Commission’s proposal, as you stated, states that the registration

process should be streamlined but does not necessarily address how

in any great detail. Over the past several years, NFA has made a

number of proposals to simplify the registration process, and we

have recently updated those suggestions and submitted them to the

Commission’s staff.

If a firm or an individual has gone through a screening process

in the securities industry, conducting another background check for

registration in the futures industry is clearly a wasted effort. And

we agreed with the Commission’s proposal, in effect, to passport

those firms and individuals into registration. Those passported

firms would still, however, be registered and subject to the same

core principles as other firms. And there needs to be some mechanism to monitor their compliance with those principles, even if

those firms are dealing with institutional customers.

The answer again is self-regulation subject to Commission oversight. The Commission’s proposal would not require those

passported firms to be members of a futures industry SRO. We believe that this is an oversight which needs to be corrected.

One of the major questions unanswered also in the current proposal, and you asked this question, is exactly what the Commission

means by the term institutional customer. There are at least to my

knowledge six different definitions of sophisticated customer in the

Commission’s rules. NFA proposed a uniform definition of sophisticated customer several years ago that was modeled very closely on

the Commission’s definition of eligible swaps participant. That definition has served very well for many, many years and should be

the basis for the definition of institutional customer in this context.

We would recommend that the threshold test for that term be no

higher than those currently in place.

Another key under the proposal will be the types of commodities

which are not readily susceptible to manipulation, and should

therefore be subject to less regulation. The answer must be a practical one, dictated by the realities of the marketplace, rather than
14

theories of the classroom. The end users of the markets for petroleum products, for example, may very well have the best perspective on this issue and their views should be accorded great weight

by the Commission.

And finally, Mr. Chairman, let me reiterate our enthusiastic support for the Commission’s overall approach, but let me also note

that this exercise of the Commission’s exemptive authority does not

obviate the need for legislative action. We urge the Commission to

move as quickly as possible to resolve the remaining issues and to

enact its proposal. And we also urge Congress to support that effort

and adopt legislation to codify, as you suggested, the Commission’s

approach. Thank you very much.

[The prepared statement of Mr. Wilmouth can be found in the

appendix on page 67.]

The CHAIRMAN. Thank you, Mr. Wilmouth. Mr. Brennan. Thank

you.

STATEMENT OF DAVID P. BRENNAN, CHAIRMAN, CHICAGO

BOARD OF TRADE, ACCOMPANIED BY THOMAS DONOVAN,

PRESIDENT AND CHIEF EXECUTIVE OFFICER, CHICAGO

BOARD OF TRADE, CHICAGO, ILLINOIS

Mr. BRENNAN. Good morning, Mr. Chairman. I am David Brennan, Chairman of the Chicago Board of Trade. With me today is

Tom Donovan, our CEO and President. We want to thank you for

holding this hearing in the City of Chicago, the derivatives capital

of the world. Our theme today is that we want Chicago to retain

the title as the derivatives capital of the world. To do that, we have

to change our way of doing business. And we are. But we also need

to change the way Washington looks at our business. To do that

we need to modernize the Commodity Exchange Act and tear down

the existing barriers to competition.

Mr. Chairman you have been a true leader on these important

issues in Congress, and we thank you for your insights and your

intellect and your leadership. In quite a short time you have proven that you are knowledgeable about our issues and committed to

our mutual goals of fair competition and even-handed government

oversight. We thank you for your efforts.

Another new leader in our industry also deserves praise. CFTC

Chairman Bill Rainer is fully committed to rationalizing regulation

of exchanges and the industry as a whole. He has brought market

experience and creativity to the Agency. We applaud the Chairman’s efforts and look forward to working with him on the finishing touches to his new regulatory blueprint.

We have submitted a written statement that describes in detail

our reaction to the CFTC’s New Regulatory Framework. In summary, the Chicago Board of Trade endorses the CFTC’s new regulatory approach. We believe the CFTC’s proposal will add up to better markets, better competition and better service for the thousands that use our markets.

Restructuring Federal regulation and restructuring our business

go hand in hand. The CFTC’s plan responds to the same market

forces—technology, globalization, innovation, and competition—

which have also caused the exchanges to restructure.
15

The Board of Trade is no exception. Our plan would take our existing pit trading and electronic trading business lines and restructure them into two independent for-profit companies.

Both will try to attract business by providing liquid trading markets. Both will innovate and invest in technology to provide customers the best service. Both will make every effort to provide customers with a market that they can trust, and both markets will

compete.

Our plan is designed to give each company and each trading

platform a fair chance to succeed. No business could really ask for

more than that.

Federal regulation is part of that ‘‘fair chance.’’ We believe in

open markets and fair competition. To us, similar products, traded

in similar circumstances should have similar government oversight.

That means privately negotiated transactions may be excluded, but

all public execution facilities should be treated the same. That is

our ‘‘golden rule’’ of fair competition.

Today that rule is not being met. After almost 80-years, the Commodity Exchange Act has become unworkable. Over-the-counter derivatives, especially in the area of equity swaps, are plagued by

legal uncertainty. Exchange markets suffer from extreme regulatory arbitrage, which the CFTC’s proposal tries to remedy. For

single stock futures, it is even worse. We are barred from competing at all under a law that we were told 18-years-ago would be

‘‘temporary,’’ until a regulatory impasse could be resolved.

Mr. Chairman, reform of the Commodity Exchange Act must

cover each of these three areas. All we have ever asked for is a fair

chance to compete. This year’s CFTC Reauthorization offers us a

real opportunity to reach that goal. With your leadership, we are

more encouraged than ever before that we might finally get a fair

chance to compete. Again, thank you for the opportunity to be here,

and we appreciate your efforts. Thank you.

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

The CHAIRMAN. Thank you very much, Mr. Brennan. Mr. McNulty, would you like to proceed?

STATEMENT OF JAMES J. MCNULTY, PRESIDENT AND CHIEF

EXECUTIVE OFFICER, CHICAGO MERCANTILE EXCHANGE,

CHICAGO, ILLINOIS

Mr. MCNULTY. Yes. Thank you, Mr. Chairman, and committee

members, ladies and gentlemen. I am James J. McNulty. I am the

President and Chief Executive Officer of the Chicago Mercantile

Exchange, and I have held this post since February 7th of the year

2000.

The CHAIRMAN. This is a baptism by fire, your first Congressional hearing. You will have many more over the years.

Mr. MCNULTY. Thank you. Obviously I come to this hearing

short of experience in the history of the exchange; however, I have

had 25-years of experience in the full range of financial markets.

I have traded and supervised trading in all financial futures and

options and I am sensitive to the needs and expectations of the

over the counter markets, having trading in the bank, investment

bank market for the past 25-years.
16

I also appreciate the impact of technology on the future of the financial services industry and I hope that this testimony reflects

that sensitivity.

The CME is exceptionally encouraged by the CFTC staff task

force report, A New Regulatory Framework. The Commission has

been both responsible and responsive to the concerns of all elements in the financial services industry. We are pleased by the

tone of the proposal, which is consistent with the progressive regulatory philosophy that depends on oversight and competition among

markets, rather than prescriptive regulation and protected market

spaces.

The CFTC staff under Chairman Rainer has demonstrated a

deepening understanding of the complex technological and competitive issues facing our markets, and the commitment to providing

much needed regulatory relief. I will discuss our view of the details

of the report and suggestions for implementing it below.

The task force recommends that the Commission convert its proposal into proposed rule making, subject to a 60-day-comment-period and public hearings to provide a full public airing of the important public policy issues. If those recommendations are followed,

final rules implementing the proposal are likely to be adopted sooner than 6-months. Senator Lugar has indicated that the Commission’s recommendations may provide a basis for drafting amendments to the CEA. We agree that the time is right to act and that

legislation, based on the principles of the report, is better than rule

making.

We are less sanguine about reform of the Shad-Johnson Accord.

Eighteen-years ago the Shad-Johnson Accord divided jurisdiction

between the SEC and the CFTC and included a temporary ban on

most equity futures contracts. That temporary ban lasted 18-years,

during which the single stock futures have thrived in the OTC

market in the form of equity swaps and on options exchanges in

the form of synthetic futures. Recently the President’s working

group and Congressional leaders have called for an end to the ban.

Of course, we are pleased that the agencies have agreed that this

is appropriate and that U.S. exchanges would be permitted to compete in world markets and to offer U.S. customers the opportunity

to manage their risk by means of equity futures contracts. We are

also pleased that they have found a way to accommodate their jurisdictional and regulatory concerns on several important issues.

But it is too late in the game to be satisfied with signs of progress.

We share Senator Lugar’s disappointment that the agencies were

unable to resolve all of the jurisdictional concerns within the time

frame requested.

Our goal is freedom to give our customers what they want and

need. Remember, we created tremendously useful products, equity

indices, for example, in the face of overwhelming opposition. The

SEC and its client exchanges opposed futures on indices with all

of the same arguments that they now raise against futures on individual securities. Nonetheless, equity indices are among the most

popular contracts on securities exchanges, as well as on futures exchanges.
17

Futures trading of equity indices has enhanced customer opportunity with none of the ill consequences predicted by the SEC or

securities exchanges. In fact, their business has directly benefitted.

One-year ago the Chicago Mercantile Exchange, with the Chicago

Board of Trade and NYMEX, undertook to craft amendments to the

Commodity Exchange Act that would enhance competition and customer opportunity. We continue to believe that the joint exchange

proposal is the best formation for regulatory relief. However, we

are well aware that the legislative and industry consensus in favor

of a good plan, trumps our theoretically better plan. We are prepared to join the consensus and to give up our plan in favor of the

CFTC staff proposal, if we can assure Shad-Johnson relief and fix

some of the minor flaws in the CFTC plan.

Our goal was and remains equivalent regulatory treatment for

functionally equivalent execution facilities, clearing houses and

intermediaries. If we can get to that goal by the path of the CFTC’s

proposal, then let us proceed with reasonable haste. Thank you

very much for the opportunity to give testimony today.

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

The CHAIRMAN. Thank you very much, Mr. McNulty. Mr. Donovan, did you want to add anything?

Mr. DONOVAN. David Brennan presented our testimony. What I

would like to do, though, is thank you for having this hearing

today, because this is a process that we have been engaged in for

a number of years. The clock is ticking, and we have a short year.

We know the members of Congress are going to want to get out as

early as possible this year, and quite honestly, I am afraid if we

do not complete the process this year, that Congress will grow

weary of this issue. So I harken to Senator Lugar’s admonition at

the last hearing, that we had better resolve this and work closely

with all segments of the financial services sector to move this

along. I do think that there are some things that we have to have

from this legislation. Namely, a codification of what the CFTC has

put forward, because having lived with the CFTC for the past 20-

years and a number of chairmen, commissioners and staff, it is

very important for us to put something in place that also provides

legal certainty for the futures industry so that we can deal with the

future.

The CHAIRMAN. Well, thank you. Let me just pick up on your remarks, Mr. Donovan. Right now, the CEA is being rewritten, we

have not come forward with a proposal. We have not even passed

a proposal out of the Committee. At the same time, the CFTC is

proposing new regulations. Meanwhile every day you have all sorts

of new types of competition. You are looking at reorganizing yourselves to better address the future competition and the competition

that you have out there now. You are being hurt by the lack of

legal uncertainty in that you do not know what the new CEA is

going to look like. You do not know what the new regulations are

going to look like.

How is this uncertainty impacting the Chicago Board of Trade’s

plans for reorganizing itself?

Mr. DONOVAN. I think, first of all, we are moving ahead at full

speed because we really believe that we have to restructure the ex-
18

change. Chairman Brennan has taken on the initiative, and he has

done a tremendous job of moving it along under very difficult circumstances. It is difficult to change a membership organization

when you are having success. But we realize that the future is

moving at Internet speed and we have to make plans for our restructuring as though Congress will address that legislatively and

will give us the regulatory framework and flexibility to do what we

propose in our plan.

If you saw today’s issue of ‘‘Crain’s’’. The CHAIRMAN. I read it, yes.

Mr. DONOVAN. There is a piece in there from Chairman Brennan

where he talks about the blueprint that we have. Well, we are moving very quickly to separate two companies. Each of them will have

different needs, and each of these companies will have to find a

regulatory framework with which to function and one that, once a

law is passed, will not be so rigid that the day after the bill is

signed that new technology will not dictate that it be changed, because Congress is not going to come back to this again in the near

future. So it is our hope that we will have enough flexibility and

have a performance standard, rather than a design standard, that

we can look to for guidance as the goals that we have to achieve

after this legislation is passed.

The CHAIRMAN. When do you hope to accomplish your proposed

reorganization? Would you want to address that?

Mr. BRENNAN. Mr. Chairman, for my purposes I wish it was yesterday. But, we are waiting for about two more pieces of the plan

before we can go to a membership vote. As soon as I can get those,

I am planning on scheduling a special Board meeting, and the vote

will be 30-days after that special Board meeting. Right now, I am

waiting to hear from an independent allocation committee which is

made up of our five individual directors. Their job is to determine

the allocation of stock, because we have five different classes of

membership. That is pretty much dictated by law.

The CHAIRMAN. Ultimately you would have two separate companies, one which would be the pit based exchanges, and the other

which would be the electronic exchange.

Mr. BRENNAN. That is correct.

The CHAIRMAN. Now, just looking at these new regulations, and

maybe I am premature in asking this, but would you be trying to

become an exempt multilateral transaction facility for the electronic exchange and remain a recognized future exchange for your

pit based? Do you have any ideas on this?

Mr. BRENNAN. We have not gotten into that kind of detail yet,

but I think we are going to analyze our business by product and

we expect to be trading the same products in both places. To the

extent that we can reach the flexibility we need with both, we will

approach it on a product basis I would expect.

The CHAIRMAN. But these proposed changes, once they occur,

could have a huge impact on your reorganization, could they not?

Mr. BRENNAN. Yes.

The CHAIRMAN. Yes. Mr. McNulty, how would these proposed

changes affect the Mercantile Exchange’s proposed reorganization?

Mr. MCNULTY. Well, Mr. Chairman, having advised some airlines

and utilities and banks even in their recent deregulation and
19

changes of technology, one of the things that we found is that you

need to be a speedy decision maker and you need to be able to

make the right kinds of investment. So the Chicago Mercantile Exchange has filed an S–4 with the SEC in order to demutualize the

exchange. And what we hope to gain by that, of course, is the ability to work more flexibly with the capital structure and also the

ability to have a corporate governance that is streamlined and allows us to make those speedy decisions.

This change in regulation will cause us to make some legal steps,

undoubtedly. So we would imagine, for example, that the recognized futures exchange and the derivatives transaction facility

would be essentially in the parent firm, following demutualization.

And then we could imagine that the exempt multilateral transaction facility would be a subsidiary of the parent firm.

The CHAIRMAN. As Mr. Paul pointed out, they would envision

that the exempt multilateral transaction facility would have to be

a separate corporation, a separate legal entity.

Mr. Wilmouth, how do the proposed regulations change or expand the role of the NFA as a self-regulating body for the industry?

Mr. WILMOUTH. It is rather difficult to tell at this stage of the

game exactly what role we are going to be taking by intermediaries

and the exchanges. We made a basic decision 2-years ago to put

ourselves forward as an outsourcing facility for self-regulatory functions that have to be performed by the industry. Over the past 2-

years I have made proposals to both Chicago Board of Trade and

the Chicago Mercantile Exchange to outsource their self-regulatory

responsibilities to us. At the present time they have decided to

maintain that in house, but as they come forward and become electronic exchanges, then we certainly are going to revisit that proposition.

The other thing that we have done, we are, as I said in my prepared testimony, talked to six different electronic, seven different

electronic exchanges recently who are just coming to the forefront

with all different types of new products and wanting to become futures exchanges. We are discussing with them each of the possibility of outsourcing their self-regulatory functions to us. So we think

this is a broad step forward for us. We think it has great opportunities for us in the future and we are gearing ourselves toward that

line.

The CHAIRMAN. Would the Board of Trade and Mercantile Exchange, care to comment on what you might do in terms of taking

advantage of the option of having self-regulatory functions that

would obviate the need for greater CFTC supervision. I do not

mean to be putting you on the spot. How does all this strike you?

To be a DTF you would have to have a self-regulatory body. I

would imagine your internal self-regulation would fit the bill or you

could outsource it. How do you see whether it will be internal or

whether you will contract it out to the NFA? How do you see the

self-regulatory function being changed by the CFTC’s proposed regulations?

Mr. DONOVAN. Well, I think that looking to a restructured Chicago Board of Trade, our new ECBOT, so to speak, our electronic

company would be looking to find its way into the least regulated

areas and require less regulation. Just by virtue of the electronic
20

trading, you have more information electronically and the markets

may require a lesser level of regulation. As far as the CBOT, the

open outcry portion of that, we feel that right now our self-regulatory front line function is far and away the best anyway. We

think that the CFTC strictly should be an oversight agency, one

that provides the flexibility for us to use our self-the regulatory

structure as a marketing tool, for people to want to come and trade

at the Chicago Board of Trade.

I have a great deal of respect for Bob Wilmouth and NFA. I

served on the Board from the very beginning, but I really feel that

the regulation that an exchange provides is a front line regulation

and serves as a marketing tool, something that you can do better

than anyone else, that people feel comfortable trading in your exchange.

Mr. MCNULTY. I can only echo Mr. Donovan’s comments. We

have spent years building a highly disciplined self-regulatory body

in the CME, and we think that is one of the reasons people come

to work on our exchange.

The CHAIRMAN. OK. Let me shift gears just a little bit and ask

the Chicago Board of Trade a question specifically. Although the

basis for eligibility as a DTF applies to all commodities, the report

states that domestic agricultural commodities may constitute a

unique category because the current futures markets tend to be the

primary, if not the only, centralized source of price basing for those

commodities.

In your submitted testimony, you recommend that trading in

physical commodities, including agricultural futures, qualify for

DTF treatment. Would you please comment further on the reasons

for your recommendations here?

Mr. BRENNAN. I will begin. I think rather simply, Mr. Chairman,

we believe markets are markets. And to the extent that you can

provide liquid markets, the less regulatory burdens you have, the

more market players you will have, and the more people that will

come and provide liquidity. Any time you have any kind of barriers

to entry or any kind of restrictions, it may keep participants away.

That ultimately affects the end users. So very simply, we believe

that markets are markets and if you have the right regulatory

structure, a concern about, whether it be cornering or those issues,

I think that those are handled through the regulatory requirements.

The CHAIRMAN. Let me ask Mr. McNulty about clearing facilities.

The report recommends the expansion of clearing facilities in the

United States. Do you support this recommendation?

Mr. MCNULTY. Well, I think that clearing facilities, in the case

of the CME, would be one of the major assets of the exchange. And

we could foresee a time when not only do we have further cooperation than we already have with many of the global clearing houses,

but we also could foresee a time where we use this as a new source

of revenue, where with many of the new exchanges that are opening up, we could provide them with back office services, clearing

services, settlement, even dispute resolution as part of a revenue

stream for the exchange.

The CHAIRMAN. Mr. Wilmouth, let us return to the best practices

issue. In your testimony, you recommended that the core principles
21

should be supplemented with best practices guidelines developed

through the industry self-regulatory process. Would you want to

comment further on this recommendation. Specifically, would you

imagine some of the best practices would be written up in the regulations that the CFTC promulgates pursuant to whatever changes

we make in the statute itself, or would you imagine that the CFTC

would just have papers on file that people could ask for their best

practices, manuals? How would you envision that would work?

Mr. WILMOUTH. Let me, first of all, say that I look best practices

as kind of like a safe harbor, and this is a constantly changing

thing. So I am not certain that I would want to codify it specifically

by the CFTC, because they would be constantly changing. Let me

give you an example of what we are doing right now, if I may.

With the Futures Industry Association, funded by the CFTC, we

have initiated a best practices study focusing on order entry and

transmission procedures in the futures industry. What we did is we

formed, and this is part of the self-regulatory process from gathering all the ideas of the best minds in the industry, we have formed

four separate committees to take a look at the best practices in

that specific area. We formed an operations committee, a technology committee, a compliance committee and a legal committee,

made up of industry practitioners. Together with some outside consultants, we are visiting with all of the exchanges, a significant

number of the FCMs. We are even sending some of our consultants

abroad to talk to some of the exchanges over there. We hope to

come out with a best practices in that specific area, through the cooperation of the entire industry.

I would envision that same practice applying across the board to

all the best practices that we would envision coming out of the

CFTC regulatory reform measure. We think that makes good sense

because it draws on the talent, the wealth of talent that exists in

the industry.

The CHAIRMAN. So as these best practices guidelines are developed, and if there is a market participant who is complying with

those best practices, you would see that as a safe harbor. If they

have been following these types of practices, they would presumably be safe from getting in trouble.

Mr. WILMOUTH. They would be a safe harbor, that is right. And

I do not think that we want those specified specifically, because

they are going to change over a period of time. They will constantly

be changing.

The CHAIRMAN. So we would just maybe refer to a best practices

policy which itself could be ever changing.

Finally, I have a question for all the panelists. You all agree that

we should codify these regulatory changes? Is there an agreement

on that.

With respect to intermediaries, the report recommends relaxed

standards as to risk, disclosure, registration, financial requirements and the treatment of customer segregated funds. What do

you think of these recommendations?

Mr. DONOVAN. We are supportive of the recommendations. We

are supportive of a bill that will allow the flexibility to allow this

industry to address the technology, the globalization and innova-
22

tion of our competitors. And if we are unable to do that when this

legislation is passed, the business will not be in the United States.

The CHAIRMAN. OK.

Mr. MCNULTY. I would like to echo Mr. Donovan’s comments,

and I can tell you, having been in the OTC markets for 25-years,

it would normally take us 24-hours to turn around a contract,

whether the request came from Hong Kong, Latin America, Europe, we could turn around and launch a contract in Switzerland

within 24-hours. We are not close to that yet in the United States,

and I think this legislation would lead us to that point. And I think

it would also loosen some of the restrictions on the intermediaries

which would also allow this market to grow at a faster rate than

it has in the past 10-years.

The CHAIRMAN. You really like the idea of being able to come out

with a new contract without getting prior approval; that is very important to you.

Let me just sum up here. Do you think that this proposal gives

you the type of regulatory relief that you need in the 21st Century,

leaving aside the issue of the Shad-Johnson. Which I am going to

try and address Shad-Johnson at an upcoming hearing and will

certainly be something that we will continue to talk about and be

working on.

Mr. DONOVAN. It is a step in the right direction. It will definitely

depend on how rigid the rules are applied to core principles. If they

take away the flexibility that you need, it will miss its purpose.

The CHAIRMAN. The devil is going to be in the details here, how

we actually put this in the law.

Mr. DONOVAN. Right.

The CHAIRMAN. But you agree with the principles, and you think

it gives you pretty good flexibility and will help you compete, is

that correct?

Mr. DONOVAN. Yes.

The CHAIRMAN. That is good. I am very happy to hear that. I

want to thank you all for testifying today. We will later take up

the issue of futures on individual stocks and Shad-Johnson. If you

read the CEA, and I have it right here, I am struck first by the

many pages that deal with this complicated Shad-Johnson agreement. It is one of the first things that is addressed in the CEA. I

think we are going to have to work on that. To be fair, we will have

to have other hearings and receive input from people who might

have a different opinion than yours. We will do that at the time.

I remain committed toward making sure that our Chicago markets, not only survive, but succeed and flourish in the 21st Century, and I look forward to working with you all toward that end.

Thank you all very much.

I would now like to take about a 5-minute break before we bring

in the final panel of market participants.

[Recess.]

Could we bring this hearing back to order.

On our third panel of market participants and intermediaries we

have several distinguished panelists. Mr. Barry Lind, who is from

Lind-Waldock & Company, has one of the largest retail customer

bases, as I understand it, in the country; Mr. Jan R. Waye, Senior

Vice President of Cargill Investor Services; Mr. George Crapple,
23

President of the Managed Funds Association; and also Mr. David

Downey, Executive Vice President of Interactive Brokers LLC.

Mr. Peter Lee, who is the Managing Director of Merrill Lynch

Futures, has had a family emergency and was supposed to be here

today, but could not be here due to that emergency. I am going to

ask unanimous consent that his testimony be included in the

record. Since there is nobody else here to object, I will give that

consent.

[The prepared statement of Mr. Lee can be found in the appendix

on page 82.]

We will begin with Mr. Lind, the Chairman of Lind-Waldock &

Company. Would you summarize what your company does. And

what its role in the market is. As I mentioned, you have a large

customer base. Could you first describe the manner in which you

participate in the market. If you could stick to the topic of how

these new regulations would affect your company in the futures

market, and stick to that main issue, we would appreciate it.

Thank you.

STATEMENT OF BARRY J. LIND, CHAIRMAN, LIND-WALDOCK &

CO., LLC, CHICAGO, ILLINOIS

Mr. LIND. Thank you, Mr. Chairman, and thank you for the opportunity to be here. Lind-Waldock is best known for having the

largest retail customer base in the industry. We do a lot of institutional business and commercial business, but our primary focus

here is on the retail. We are members of almost all the major exchanges in the U.S. We do a lot of our business on-line. Over half

our orders come in on-line, as the industry is changing.

The CHAIRMAN. From retail customers?

Mr. LIND. From retail customers. We are probably as well electronically committed and situated as any firm in the industry. And

today I would like to address you in regard to the retail aspect of

things, because I knew there would be a lot of other people covering the other aspects.

First, let me say that I am very impressed and very happy that

the CFTC and Chairman Rainer are looking to modernize and rationalize the regulatory framework of the futures market. Even

though this is a work in progress, I would like to commend him for

his good work in harmonizing the interests of the industry and the

market participants. And I think that the work that he has done

has assured us that everybody has gotten a fair hearing. He is certainly very qualified and he is a knowledgeable listener. And that

is what has resulted in I think this overall position that we have

today of re-engineering the regulation which I agree with.

In general, I agree with the approach. The regulation needs to

have flexibility that is based on the type of market that is being

regulated, the kind of instruments and the sophistication of the

participants. This allows some markets to operate with less regulation, an outcome that I think is a good one. However, there seems

to be a consensus that less regulated markets are appropriate for

institutional and for qualified investors. There is more hesitation

to allow individual investors the advantages that may exist in less

regulated areas.
24

My own position is that individual investors should be allowed

access to less regulated markets in order to have the advantages

of increased competition that a less regulated market will bring. I

believe that with the appropriate framework individuals can enjoy

this access with substantially the same protections as the current

regulatory environment has.

One of my fundamental convictions is that my customer, in addition to regulatory protection, should be able to have the benefit of

the best price available, even if it occurs outside a market that is

the most protective of the customer. Any regulatory scheme that

has the effect of keeping my customers from less regulated markets

will be a costly victory for my customers. They will have all the

benefits of protection from fraud and market manipulation but they

will be limited to markets where largest liquidity providers may

have vanished and it is from this perspective that I offer my comments.

The bedrock of customer protection in current regulations is the

requirement that customers’ funds be segregated. And I commend

the CFTC for keeping this requirement as an important part of the

customer protections in any market where an individual investor is

permitted to conduct transactions. I fully endorse the report’s additional recommendation that non-institutional traders be allowed to

access a derivatives transaction facility only through a registered

futures broker that is a clearing member of at least one recognized

futures exchange, and has a minimum net capital of $20 million.

The benefit of this is twofold. It provides discipline for the carrying firm by requiring that they have capital at risk, and it offers

the benefit of regular periodic inspections by an external monitor.

And let me say this about the level of capital requirement. I think

that this will tend to exclude less responsible parties who may be

looking to make a quick buck in these less regulated markets. 20-

million will suffice to keep most of these people, if not all of them,

out.

I am pleased that the report calls for changing the net capital

rules to base them on risk. I have been asking for this for years

and years. The current capital rule is an old, old banking rule and

makes no sense in derivative markets. Right now, as an example,

if I have a customer with $100,000 in cash and no position, I have

to put up $7,000 in capital. If, however, he has 100,000-bushels-ofbeans on with no money, and therefore, I have substantial risk.

Today I have no capital charge for him. So a risk based capital rule

would be a move in the direction of rationality.

Most observers, including myself, expect the deregulated environment resulting in increased competition. Even though competition

may tighten market spreads in other markets, I think it will take

liquidity away from the recognized futures exchanges. If this result

occurs, the ability to enter into a transaction in one arena and to

offset it in another would benefit all parties, except possibly the

market maker. In my written testimony I have termed this the universal transfer mechanism, if you care to look at that.

In a multiple market maker market, I didn’t think I would get

through that, there will be multiple platforms on which trades can

be made. In this kind of environment the challenge is to provide

a level of transparency to the price discovery process. We believe
25

in the not too distant future all trades will be conducted on electronic trading platform, where our customers will receive the best

bid and offer from the recognized futures exchanges and the

counter parties with whom we are dealing with. In this environment our customers will simply point and click on the best market

available. However, we are not there yet.

In the interim we propose that brokers who allow retail customers to deal in less regulated markets be obligated to display

multiple bids, offers and last sales. These would come from the

market makers with whom the retail customer’s broker is dealing,

along with appropriate recognized futures exchanges. The customer

would then simply choose what he believes to be the best priced

market. These multiple prices should be recorded along with the

customer’s transaction.

The one thing that the customer’s futures broker cannot totally

control is the price. But if the customer can see all the prices that

we have available we have put him in the best position that he can

possibly be in.

I endorse the report’s provision for streamlining the registration

of FCM’s introducing brokers. I agree that the mandatory disclosures for non-institutional customers should be streamlined and

make use of a single signature format including the freedom to accept electronic signatures. All commission requirements including

documentation and record keeping should be flexible enough to embrace changes in technology without requiring amendment. In

these matters the adoption of core principles that state the goal of

the regulation, rather than prescribe exactly how the goal should

be met, will go a long way in achieving flexibility in dealing with

technical innovation and make us a lot more competitive.

I favor broadening the range of instruments in which segregated

funds can be invested, and removing barriers respecting the secured amount requirements for the funds of customers trading

non–U.S. markets. I am very encouraged by this report. It is a document that recognizes the dual objectives of regulation, fair markets and suitable customer protection. It reflects careful thought

and sensitivity to the needs, both of the industry and the market

participants. It moves away from the traditional inflexible regulatory models. It breaks new ground with its philosophy of core

principles and offers a shining example of both the process that

should be involved in producing regulations and the results that

can be achieved by following this process.

This is a working document that provides a framework to be

fleshed out. Along with everyone affected by this regulation, I am

waiting to see if the final version fulfills the promise of its beginnings. However, this report does make an excellent beginning.

Thank you.

[The prepared statement of Mr. Lind can be found in the appendix on page 95.]

The CHAIRMAN. Thank you very much, Mr. Lind. May we now

hear from Mr. Waye from Cargill Investor Services. Thank you for

being here.
26

STATEMENT OF JAY R. WAYE, SENIOR VICE PRESIDENT,

CARGILL INVESTOR SERVICES, INC., CHICAGO, ILLINOIS

Mr. WAYE. Thank you, Mr. Chairman. Good morning. Cargill Investor Services is A global futures commission merchant operating

in all major futures markets around the world. Our client base can

be broadly categorized between fund clients of which we are going

to hear more of later, large commodity institutions, And large financial institutions. Representing those clients and speaking on behalf of, in addition to Mr. Lind, from the FCM community, I would

say we broadly support the recommendations put forward in the

staff recommendation to the Commission. We believe this is a step

in the right direction, to move from a rules based environment to

one guided by broad principles with specific recommendations for

best practices.

I would, however, like to make four comments and just briefly

summarize on my written remarks which were supplied earlier.

First, and before going into the specific recommendations, one of

the goals of the report was to provide and continue to provide legal

certainty for over the counter derivative contracts. The report said

that is imperative and we agree. But we would take it a step further on behalf of our clients and say that we not only need certainty for OTC financial contracts. We also need legal certainty for

OTC commodity contracts. And by commodity contracts I am including everything, whether we are talking about corn or crude oil

or cotton or electricity. We have seen significant volatility in commodity prices in these contracts, often more so than we have seen

in financial markets in the last several years.

Let me explain why this is important. We believe commercial

parties should be able to enter into over the counter contracts on

commodities without one of the parties later on saying: ‘‘No, I am

going to walk away from that contract, because I entered into an

illegal off exchange futures transaction which was an invalid contract to begin with. We were not allowed to do it.’’ We believe that

legal certainty is essential to prohibit that from happening. We

have seen the volatility that can occur in the electricity markets.

We have seen the volatility that can occur in agricultural markets.

Commercial participants simply need the right to enter into bilateral transactions off exchange and get the same legal certainty that

exists in financial over the counter transactions.

There has been a lot of innovation that has brought to bear in

financial OTC markets. There has been a significant benefit to consumers in terms of risk management. We believe all those same arguments that have been made for financial OTC certainty, equally

apply to commodity OTC certainty.

The CHAIRMAN. Could I stop you for a moment, right now? To

what extent are you able to enter into a private contract right now

with some institutional customer who wants to have a tailor made

contract that will pay his or her institution on the basis of what

happens to the price of an agricultural commodity such as corn?

Can you do that now?

Mr. WAYE. You can do it, Mr. Chairman, but you run the risk

without the legal certainty of the CFTC or the SEC or some other

agency bringing an enforcement action against you later on, that,
27

that was really an off exchange futures contract, even though it

was bilaterally negotiated.

The CHAIRMAN. How much of that are you doing right now? How

much business are you doing that involves private OTC type contracts dealing with underlying agricultural commodity?

Mr. WAYE. Including both agriculture and energy, and this is a

rapidly expanding area. Electricity OTC contracts, we saw the

problems a couple of years ago, when electricity prices spiked to

record highs during the summer. And then we also saw a record

number of defaults. A few years ago we saw a case in Brent crude

oil that’s called the Transinor case, where one of the parties argued

they could walk away from the transaction because it was an off

exchange futures contract. So there is a need to eliminate the uncertainty, to encourage the innovation rather than to have this

cloud hanging over commodity markets.

The CHAIRMAN. It is good you bring up this point, because we

only hear of this legal uncertainty problem in the context of financial over the counter derivatives. That is an area that is growing

rapidly and most of that is really interest rates swaps.

Mr. WAYE. Yes, absolutely. And the final comment I would make

is, whether we like it or not, people that get involved in commodity

markets, tend to be more litigious than institutions trading in financial markets. They tend to walk away from contracts more frequently. The volatility sometimes is much greater. So I guarantee

you that going forward we will continue to see these kind of actions

pop up.

I would like to go to my second point, and that is one already

covered somewhat earlier by the comments you made yourself on

the DTF, the derivatives transaction facility, and how do we determine what commodity contracts can be traded on a DTF. But we

talked about products with inexhaustible supply, and Mr. Chairman, you pointed out that with Treasury securities that is already

a present problem, number one. Number two, one of the few examples of price manipulation did take place with Treasury securities

futures on Treasury bond futures. We support the staff report that

certain markets do need to be held to higher level transparency

and regulation, and we think that is the case, because they perform

an important price discovery function. So our comment here is not

so much to disagree with the staff report, but just to recommend

an alternative definition that contracts were be excluded from the

DTF be those contracts that there is no real price discovery function taking place.

I think a lot of financial market participants today would say the

price discovery for Treasury bonds probably does not take place

anymore in the Chicago Board of Trade, but probably does for corn.

So where the market has a true price discovery function taking

place, that market needs to be held to a higher degree of oversight

and regulation and concern because it is in the public interest. Not

because it is in any particular members’ interests or participant

here this morning, but it is in the public interest. We are trying

to discover a true price. Participants in those markets and markets

themselves need to be held to a higher degree of regulation.

Third, you said not to go here, but I have to, because I made a

comment on stock index products. I will not repeat what was said
28

earlier on Shad-Johnson. But I would say as a global futures commission merchant that our clients outside the U.S. do have access

to a much broader range of equity based products that trade on financial futures exchanges than they do in the U.S.

The CHAIRMAN. Do you trade those stock futures?

Mr. WAYE. On behalf of clients.

The CHAIRMAN. What countries do you do that in? Would you

know off the top of your head?

Mr. WAYE. Absolutely. In fact, I will just combine this with my

last point to save time, because in a lot of these countries we have

seen the equities markets and the futures markets merged into

one. In the cases of Singapore, Sydney, Frankfort and Paris, we

have recently seen a merging, a coming together of the equities exchanges and the futures exchanges under a common platform, a

common clearing house and a common regulator. So our clients in

those markets are clients of our firm, Cargill Investor Services, are

able to trade stock index products, a wide variety of stock index

products or stock index derivatives that trade on the futures exchange because in those countries it is all one exchange. It is moving towards one platform and it is one clearing house.

The CHAIRMAN. Do you have American customers who are using

Cargill to trade futures on individual stocks in foreign countries?

Do you have that at this point?

Mr. WAYE. Yes, but only if those contracts have been approved

by the SEC. If the contracts have not yet been approved by the

SEC, it would be illegal for us to offer them to U.S. domiciled clients.

The CHAIRMAN. OK.

Mr. WAYE. But non-U.S. domiciled clients can have access to

those contracts. I appreciate it is a murky area, but just coming

from a customer side, our non–U.S. clients have access to a much

broader array of stock in equity based futures contracts than those

same customers in the U.S.

Finally, a note on competition. I am glad to see, and the comment was made earlier in the past panel, about the number of new

exchanges that are being proposed in the U.S. Our only concern

here is that the CFTC be prompt and fair in evaluating these new

exchanges and approving them for operation, if they deem so appropriate. I note they did this a couple of weeks ago with a new

exchange in Texas which had been under review I believe for 2- or

3-years. There are six or seven new exchanges in the pipeline. And

we believe that the role of the CFTC is to encourage competition

between exchanges, just as we have significant competition between FCMs and competition exists in other areas of the market,

and we are pleased to see the CFTC take steps and acknowledge

that these new markets are going to be developed, just as we have

seen new markets expand significantly both in equities and in fixed

income securities.

Mr. Chairman, that pretty much summarizes the comments that

I made in our written submission, and I would be very happy to

answer any further questions or be of any further assistance.

Thank you.

[The prepared statement of Mr. Waye can be found in the appendix on page 74.]
29

The CHAIRMAN. Thank you very much, Mr. Waye, for your testimony. And now Mr. Crapple, President of the Managed Funds Association, we appreciate your being here. If you could tell us a little

bit at the start what the Managed Funds Association is and does,

we would appreciate that.

STATEMENT OF GEORGE E. CRAPPLE, CHAIRMAN, MANAGED

FUNDS ASSOCIATION, NEW YORK, NEW YORK

Mr. CRAPPLE. Certainly. A small correction, I am appearing as

Chairman of the Managed Funds Association. Our President Jack

Gaine overcame great transportation obstacles to get here, and he

is also here. But I have the seat at the table.

MFA is a national trade association representing more than 700

participants in the hedge fund and managed funds industry. I

should say I am also the co-Chairman and co-Chief executive of

Millburn Ridgefield which has managed money in the currency and

futures markets since 1971, and also sponsors funds of funds and

equity hedge funds.

MFA appreciates the opportunity to testify before the Subcommittee concerning the CFTC’s New Regulatory Framework Report and issues relating to the reauthorization of the CFTC. Our

association commends the CFTC for its commitment to reinventing

the regulatory program in fundamental ways, an approach designed to attract seemingly intractable regulatory issues that have

been with us for many years, as well as issues that may be critical

in permitting our markets to remain global leaders in the 21st Century.

Members of the MFA in the aggregate manage the vast majority of the over $40 billion invested in managed futures and a significant portion of the nearly $400 billion invested in hedge funds. Our

members are active participants in all derivative markets, on and

off exchanges, foreign and domestic. Accordingly, a regulatory

framework that promotes competition and innovation which results

in liquid, efficient markets is of enormous significance to us. We believe the CFTC’s report and the previously issued President’s

Working Group report on over the counter derivatives identify a

number of important issues deserving priority and attention.

We believe in general that the CFTC’s overall purpose and its

suggested approach are highly constructive. The report significantly advances the debate over the optimal regulatory structure in

the U.S. futures markets and we applaud the development. I would

like to first speak briefly on the new regulatory framework report.

The highly competitive markets in which MFA’s members and

other market participants operate require prompt and creative responses to new market conditions, new technologies, new products

and new trading and clearing mechanisms. The CFTC is to be commended for developing approach to exchange regulation that is designed to expand the ability of U.S. futures exchanges to meet

these challenges through a regulatory framework that affords the

maximum latitude, subject only to constraints reasonably designed

to assure basic customer and market protections.

As we understand it, the report contemplates a regulatory approach under which futures exchanges and the over the counter derivatives trading facilities would operate on an even playing field,
30

one in which appropriate circumstances would be subject to minimal regulatory burdens. We support this concept of a new highly

flexible, largely unregulated marketplace. Now, I think I could echo

really some of the comments that Barry Lind made. We are concerned about the role of our constituents in the new less or nonregulated marketplaces.

Commodity pool operators and commodity trading advisors and

qualified registered professionals acting for pools, hedge funds, and

individual accounts should be able to access all futures markets,

just as today they have access to swaps, over the counter derivatives and foreign futures and options, markets that are not subject

to the highest level of regulation. For CTAs, CPOs and their clients, special conditions or risks in these newly developed markets

should be addressed as they are generally today in the case of foreign futures markets by the use of a standardize risk disclosure

statement.

As is the case with foreign futures, this risk disclosure statement

should be simple and distinct, clearly highlighting the special risks

associated with the particular kind of market, thereby permitting

the customer to make an informed choice whether to assume these

risks. The approach would facilitate the broadest access for CTA

advised futures customers in commodity funds to the greatest possible array of innovative U.S. derivative markets, resulting in the

deepest, most liquid and hence, efficient derivative market, a goal

that we all share.

This approach is far superior to limiting eligibility to access a

particular market, to defined group of customers, such as limiting

access to only the institutional clients of a CTA. This would create

significant problems. As the CFTC knows from its recent efforts,

the use of this approach to implement a post trade, order allocation

procedure rendered the rule unworkable. The reporting and record

keeping nightmare is great. In the current case, for example, if the

CTA had 50 clients in a program and only 30 of them qualified for

access to the larger more efficient market, the CTA would be forced

to trade the 30 accounts in one market and the other 20 accounts

in another. As a result, most importantly, the CTA’s performance

results for the 30 accounts could differ substantially from those

with the 20 accounts. Most likely, better results would be gotten

for the 30 supposedly large customers. The fragmentation of liquidity would also adversely affect the efficiency of both markets.

So in summary on this point, MFA strongly suggests that CTAs,

CPOs and all of their clients and investors have access to all futures and derivative markets. I would next like to very briefly address the issue of regulatory relief for commodity pool operators

and commodity trading advisors which is not part of the new regulatory framework report, but is contemplated to be forthcoming.

The CFTC is operating with the MFA, that they will be reviewing the regulatory framework for CPOs and CTAs with the same

objectives, enhancing efficiency and competitiveness, which have

guided its review of exchange regulation. The CFTC staff in cooperation with the MFA is developing draft core principles for

CPOs and CTAs, designed to supplement the report’s recommendations concerning other aspects of regulation. We strongly support

this effort and have so far assisted and stand ready to assist the
31

CFTC and the MFA in any way they consider appropriate. There

are many inefficiencies to be remedied, including for example, putting public and private offerings of pool interests on a level playing

field with public and private offerings of securities and for example,

public offerings of mutual funds. We are under a much more restrictive offering regime for which there is no apparent public interest necessity.

Lastly, I would like to mention legal certainty of OTC derivatives. The CFTC report is not principally designed to address the

issue but the report builds upon and is consistent with the President’s Working Group recommendations for enhanced legal certainty for OTC derivatives, in particular by reinforcing and augmenting the Part 35 swaps exemption, and by providing new exemptions for innovative trading and clearing structures for OTC

derivatives.

MFA strongly supports the objective of enhancing legal certainty

for OTC derivatives including the President’s Working Group recommendations for legislation to exceed OTC financial derivatives

from the CEA, as well as the report’s recommendation for actions

by the CFTC to enhance legal certainty. I would say having listened to Mr. Waye’s remarks, that we would certainly endorse additional legal certainty for OTC commodity contracts as well.

We believe that in defining the statutory exclusion for OTC derivatives and other measures to enhance the legal status of swaps,

the existing criteria defined in eligible swaps participants should

not be further restricted. In fact, they should be expanded to include all clients of CTAs and all commodity pools. The President’s

Working Group suggestion that consideration be given to increasing financial threshold for natural persons engaging in swaps to

$25 million in discretionary investments, in our view, is not warranted by experience or public policy. MFA opposes the creation of

additional restrictions upon access to swaps and other derivatives

transactions. In fact, the real limitation on participation to these

markets is finding a swaps or derivative dealer who has confidence

in accepting the business of a particular customer. And we think

this is the real check on preventing unqualified people from participating in these markets.

In conclusion, MFA fully supports the efforts of this Subcommittee and of the CFTC under Chairman Rainer to make U.S. futures

regulation as innovative as the industry overseas. We look forward

to providing our full assistance and cooperation. Once again, thank

you for the opportunity to present MFA’s views on this important

topic.

[The prepared statement of Mr. Crapple can be found in the appendix on page 77.]

The CHAIRMAN. Thank you very much, Mr. Crapple. We appreciate that. Mr. Downey from Interactive Brokers, LLC, thank you

for being here. I would appreciate if you could describe for the

panel a little bit about what your company does, and then go on

to describe your views on the proposed new regulations.
32

STATEMENT OF DAVID G. DOWNEY, EXECUTIVE VICE

PRESIDENT, INTERACTIVE BROKERS LLC, CHICAGO, ILLINOIS

Mr. DOWNEY. Mr. Chairman, thank you very much for inviting

me to participate. It is an honor and a privilege.

Interactive Brokers is an organization that provides electronic access to the world’s markets, to a variety of customers ranging from

large broker/dealer and FCM trading desks down through some of

Mr. Crapple’s constituents of professional fund managers to individual investors trading out of their kitchens via the use of the

Internet. Our platform provides all of these participants with the

exact same level of access into the marketplace at the exact same

price levels. So they all participate on a level playing field.

We use a network that is connected to over 30 exchanges around

the world. We allow our customers to connect to all 30 of them. Retail, that is our small customers who deserve the highest level of

protection, we only allow them into the electronic marketplaces

where they are protected. They are not allowed into the open outcry markets because of the inefficiencies that occur.

The CHAIRMAN. Is that by your own choice or is that CFTC regulations?

Mr. DOWNEY. No. I have the technology to bring them into the

open outcry using my own people. But I have come to the conclusion recently, within the last 4-months, that there is nothing I can

do to control the risk present in these customers entering the open

outcry. And we are going to develop only from what we believe will

eventually succeed. No one has been able to put forth an argument

that the open outcry will ever overcome the inefficiencies and cost

structures associated with it. They cannot compete on a cheaper,

faster basis with electronic markets.

With that said, Mr. Chairman, I have to join everybody here. I

think this is a tremendous start with what the CFTC has put out,

and it is based on leadership. We are at a moment where we need

absolutely to show, and that includes from Congress. Very briefly,

on the document itself, I have two main topics. One is I do not believe that any customer should be denied access to any facility as

long as they are intermediated and protected. I think that if you

start splitting them up where you have large players creating

prices that are somehow reflected in the retail trading arena, the

retail should have access to both markets. I think that can be

achieved through the intermediaries’ role.

In the absence of that price transparency, if they are trading like

products on different platforms for different people, all prices

should be known to all market participants, whether they are allowed to trade there or not, as long as they have a correlated market elsewhere. They can be influenced by prices being established.

The second issue besides the pricing is that it was very clear

about the codes of conduct for the RFE, the DTF and the intermediary. On the first two, the issue of audit trails and making sure

that there are time stamps that are very clearly spelled out, protecting the customer’s access to the markets on a who knows what

when basis, because that is market manipulation. But there is no

such call on the intermediary’s code of conduct, and that is exactly

where they need it the most. There are three pieces to the interaction between customers and the market.
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There is a collection piece, ruled by the member firms. There is

a distribution piece, ruled by the member firms. And an execution

piece, ruled by the exchanges today. The danger of time stamping

the orders and frontrunning and market manipulation are just as

prevalent upstream as they are at the matching edges. So if I could

make that statement, that the codes of conduct for intermediaries

simply include high resolution audit trails, at least as high as the

exchanges themselves, to make the audit trails meaningful.

With that said, I generally agree with the document. I believe it

is a tremendous start for us, and details need to be worked out.

But the details that need to be worked out are going to be influenced exactly from the leadership from Congress on two very important issues. The first is competition.

Competition is going to be technology based. The exchanges are

rushing towards ownership and they are going to be self-regulated,

and it raises serious questions, are they going to be partisan in deciding whether a certain technology will or will not succeed. This

is no longer an abstraction. We have some exchanges on the securities side who have been faced with issues, should we allow customers to access our markets with the given technology, and they

have taken affirmative steps not to allow customers access, and to

cripple the technology. That simply has to be protected against.

My concerns with the current framework, with the framework

that is being proposed is that the exchange can stop a piece of technology being given to a customer and I need to know who do I

plead to.

The CHAIRMAN. Can you give some examples of what you have

in mind there?

Mr. DOWNEY. Sure. On the options exchanges, the SEC has come

out and said that the member firms have a duty to provide best

execution; that is, deliver their customer orders to the highest bid

or the lowest offer. The broker/dealers have provided this technology that allows a customer in a kitchen in Iowa from observing

the prices on all competing exchanges and pointing and clicking

and sending an order to the appropriate exchange. Last Wednesday

the CBOE effectively terminated the customer’s rights to do the arbitrage if there was a market dislocation between two exchanges or

three exchanges. The customer did not have the right to take advantage of that, given the available technology and they stopped

automatic execution on that exchange with the blessing of the SEC,

a complete contradiction to Congress’ bias toward giving technology

and the SEC’s own statement on broker/dealer’s best execution responsibility.

We have had the experience that while the regulators, acting on

the intent of Congress, have pushed technology and competition.

When push comes to shove, the exchanges step up to the plate and

beg for mercy and the regulators simply back down. The NASD, for

instance, Mr. Chairman, had a recent proposal on order handling.

They received 71 industry comment letters, 59 of them negative in

some regard to its new proposal. The SEC let it stand without comment, no changes. That has to be a Congressional issue.

We demand the regulators, you are to act in the fall on technology, innovation and competition, and you have to make it very
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clear as to the burden of denying technology which will foster competition. That is the first part, leadership.

The second issue is on the clearing house. Competition in the

marketplace in the futures, when I hear that people are going to

create exchanges, I think that is a great idea. Where are they going

to clear it? Where are they going to clear this stuff? If they do not

have a facility to clear, that they have a matching engine means

nothing to me as a participant.

In the futures market today there is no national clearing mechanism. There is no way for an individual with a matching engine

idea to come up and step up and find a place to clear it. They have

to go back. Interesting, Mr. McNulty pointed out that he intends

to make his clearing operation a revenue stream. That means he

is going to use it as a corporate asset, to keep competitors out and

raise the prices. If you really want competitive markets in the futures, by the way, where is the competition between products and

the futures market? There is none. Where is it in the securities

market? Every exchange. Options market? Every exchange. Futures market? They are all based on each other’s exchanges. And

that is because of clearing.

Clearing in the futures market was instituted by Congress in the

1920’s as a result of a default of the Chicago Board of Trade in the

1900’s, early 1900’s. Market participants were unable at that time

to come to an agreement on clearing and Congress had to step in.

In my mind they had a flaw in it. They stepped in and said if you

want to be a contract market, you got to have a clearing house. But

they did not describe how open that clearing house had to be. They

left it to the markets to describe it. The Chicago Board of Trade

has a separate entity. The Chicago Mercantile Exchange has a division. But they are both exclusive to anyone else, and you cannot

get in. When the member firms say we want to compete, they really want to compete on the clearing house. They want people to

allow them to clear. And only Congress is going to allow that to

happen. CFTC cannot push it. This document is not going to help.

We need leadership from Congress. We want competition, and in

order to get competition you need clearing. Clearing structures

should be open to all, along the lines of a national clearing and settlement mechanisms established in the securities market by the

Securities and Exchange Act amendments of 1975. Without that,

we would not have the SEC on the securities side or the OCC on

the options side that allows for competition like the international

securities exchange, the all electronic options exchange which has

driven the options business to incredible competition, lowering and

narrowing of bids and spreads, benefiting the member, benefiting

the customer base. That is what competition is all about, and it is

about clearing.

Mr. Chairman those two issues, a real vision on how we are

going to let technology thrive and the establishment of a national

clearing mechanism for futures is something that we need leadership from Congress on. Thank you.

[The prepared statement of Mr. Downey can be found in the appendix on page 87.]

The CHAIRMAN. Thank you very much for that testimony, Mr.

Downey.
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Would any of the other panelists wish to comment on Mr. Downey’s proposal for a national clearing house? Mr. Lind?

Mr. LIND. I do not know how you would get that to work. I can

say this, that certainly you could not force the Board of Trade

clearing corp. or the Chicago Mercantile Exchange to take on the

clearing of another exchange. First off, at the Mercantile Exchange,

they have a good to the last drop rule. So any funds that we have

up there are one thing, but if there was a big default they could

just keep coming after us on a prescribed rotation until all the

money was gone. No one is going to guarantee a little cattle exchange or some major exchange that may not know what they are

doing. So how you can take that from the level, and certainty you

could not force the Chicago Mercantile Exchange to do that. And

how you can take that on a national realm where you put everybody there, I do not see how the integrity of that would be able to

be set up so that people would be comfortable. Because if you are

going to have DTFs and other exchanges that are coming about,

there would be a lot of reassurance that would be needed to get

people to be willing to guarantee that or put money into that.

The CHAIRMAN. Does anybody else wish to comment? Mr. Waye?

Mr. WAYE. It is difficult to perceive, with all the changes that are

going to be coming up, with electronic markets and the new deregulatory framework, how the clearing house issue is going to unfold. But I think as a clearing firm, we would be willing to put our

capital at risk, if we are satisfied with the organization, with the

rules and the regulations, and if that means new clearing houses

where there are solid financial parties and solid rules and regulations. We would be prepared to put our capital at risk to enable

our clients to participate on new markets. So I cannot guarantee

exactly how it is going to unfold, whether existing clearing houses

will start to clear a broader array of underlying physical products,

for example. Or we may get futures cleared more broadly among

a variety of clearing houses.

The CFTC staff would allow the non–U.S. clearing house, such

as the London clearing house, to establish a facility or partnership

in the U.S. to clear potentially some of the exempt MTEF trades.

And I am sorry staff is not here today, to just ask the question. I

believe that is the case. So I think we will see more competition

for clearing. I think we will see member firms like ourselves be

willing to clear new exchanges, if we are confident of the financial

strength of those exchanges. So I agree with Mr. Downey, clearing

is really a very, very core critical issue and it is difficult to predict

exactly how it is going to unfold, but I think we will see significant

change coming up in the next year or two.

The CHAIRMAN. Mr. Crapple?

Mr. CRAPPLE. I think it would be highly desirable and it is necessary for effective competition by new exchanges that there be a

clearing mechanism available. I do not really think that a major,

a new exchange is going to have much of a chance getting started

unless it has got the backing of major securities and futures firms

that are clearing members of other exchanges. So I see it more as

a voluntary rather than mandated approach. But there is no doubt

that if it came about through one means or another, that it would

be a great enhancement to competition.
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The CHAIRMAN. Mr. Downey, I want to ask you a question about

access to exempt multilateral transaction facilities, exempt MTEFs.

Would you support access to an exempt MTEF by retail customers

as long as they are represented by intermediaries?

Mr. DOWNEY. Yes. I think that the people that you are discussing

would be exempt and are going to be people who are professionals

who are basically trading a lot of individuals’ money. Those individuals are going to have access to it, but they are trusting some person to actually pull the trigger on their behalf. I think I would like

to say this. The definition of a sophisticated customer is something

that is very difficult to pin down. I know some very sophisticated

customers with $100,000 in capital and I know some very unsophisticated customers with 10-million in capital, and I think one

would be allowed to trade and the other one would not. I think that

it really comes down to do you understand the risks involved here?

Do you understand this trade might have some defaulters to it?

And also again, in trading it comes down to one thing in my

mind. That is the price. Does everybody know what the price is?

Does everybody know what the pressure is going to be? And if you

do not allow individuals to trade in these facilities, as long as they

are trading a product that does have a correlation to a market that

is trading downstream, prices have to be disseminated in a very

timely manner and that means no delay. As soon as they know

about the price, they disseminate it so everybody else can trade on

the knowledge that there is a big transaction that took place and

it is going to affect everybody’s pricing.

The CHAIRMAN. What do the other panelists think about that

issue, whether there should be access to an exempt MTEF by retail

customers as long as they are represented by intermediaries?

Mr. CRAPPLE. I will take a stab at that. I think Mr. Lind would

probably go a step farther than I feel the need to go, because in

his case he is an FCM who would be an intermediary, and in the

case of the Managed Funds Association, our clients, our constituents are the CTAs and CPOs. So in the case of a customer of a

CTA, an individual, regardless of his means, has signed documentation granting discretionary trading authority to a registered

category under the CFTC. So the individual is no longer making

his own trading decisions. He has delegated that, and as long as

the person that it has been delegated to has been invented by the

CFTC and the MFA, we see no good argument for foreclosing that

ultimate customer from any category of the new market frameworks.

Now, I think Mr. Lind referred to a concept of FCMs with $20

million in capital. At least in a case like that, if an FCM is forwarding orders to any level of exchange and something has gone

wrong, you have got a pocket to go to. The customer is not without

recourse. Anyone with capital could actually be an FCM. And it is

possible for any fly-by-night organization. You would not, I do not

think, want to see a blanket rule that any customer of any FCM

could go to any market necessarily. But I have great sympathy for

the concept of limiting it to FCMs that achieve the material capital.

The CHAIRMAN. Mr. Lind?

Mr. LIND. It comes down to two basic situations. One situation,

the more exotic situation might be as an example, something that
37

was offered to me a year ago, which I should have taken. You, as

a customer of mine, on an exempt market, maybe the product that

is going to be offered is something like this. You can get a return

of 1-percent or a return of what the S&P index does over the course

of 2-years. So you put up $100,000 and the worst that you are

going to get back is $102,000 or if the S&P index goes up 20-percent a year, you get back $140,000. They should be able to deal in

that type of product, and they should be able to deal in that type

of product through me. So that is the more exotic type.

But the basic situation that we have is right now a lot of transactions, not anywhere near as many percentage-wise as used to be.

The market has grown and volume is still good at the futures exchanges, but when we get these off exchange products, if the exchange market, for example, right now is two, three, an off exchange you get the inside market is now two and a half, three, but

if the liquidity goes off exchange, like I would suspect a lot of it

is going to happen, then the market might be something more like

one, four on the exchange.

So I want my customer to be able to get at least the two, three,

if not the two and a half, three market. I certainly do not want him

to have to pay four or sell at one, because then, no matter how

much you protect him, then he has been hurt by this. So wherever

the market is, that is what I would like to get for my customer.

The danger that you have in that is if you have some people, because it does not take much to become an introducing broker, and

my fear is that he will go down to this off exchange operation down

the street with his buddy and instead of having a market of two,

three, he will have a market of even to 40 or even to 60. And we

have seen that in the past. And that is why I propose the protection, that the firm has got to be a clearing member, has got to have

enough money at risk so that he is not going to do something

wrong. No member of an exchange that is any kind of substantial

member at all is going to mess around like that. So I think that

the protections are there. And if the protections are there, then I

think that we certainly have to be able to give the best price to the

customer, wherever it exists, whether it exists at the exchange, or

at an exchange or any of the other categories that have been provided.

The CHAIRMAN. Thank you. You do not have anything to add, Mr.

Waye?

Mr. WAYE. I would just go back and support Mr. Crapple’s comment, that I believe individual investors who are having their

funds managed by a third party, and that third party is registered

with the CFTC and the MFA, that third party then should have

the ability to transact in the exempt MTEF market on behalf of its

clients, whether those clients are retail or institutional or commercial. So I would support Mr. Crapple’s comments in that regard.

The CHAIRMAN. So the retail customers get into that MTEF that

way.

Mr. WAYE. Yes.

The CHAIRMAN. Mr. Lind, in your opening statement you talked

a lot about access to markets. You did not use the word, but I think

you were really talking about the bifurcation of the market between retail and institutional customers and you were concerned
38

that retail customers could be denied access to the market with the

greatest liquidity. Do others of you share that concern under this

proposed regulatory scheme? Business could really migrate from

the RFEs. Liquidity could migrate from the RFEs to the less regulated DTFs and exempt MTEFs. If the retail customers do not have

a way of getting in those markets, they are really going to be

locked out of the most liquid markets. That is a real problem, is

it not?

Mr. LIND. That is my problem.

Mr. CRAPPLE. I think that is a good point. I think inevitably

there will be some tendency in that direction. An analogy that was

made by someone used to be if you could trade the same contracts,

certain grain contracts at the Chicago Board of Trade or if you

were a small fry, at the Mid-American Commodity Exchange and

you had to set the positions limits, so actually the big traders used

them all. And they would send orders to the Mid–American Commodity Exchange, and they have a bank of people that the changer

phones and they would just immediately lay this off on the big liquid Board of Trade markets. The problem with that is the toll

charge on it. It was more expensive. I think that we probably

would be faced with something, you would get more customer protection in one sense, but there would be some cost.

The CHAIRMAN. Mr. Downey?

Mr. DOWNEY. Technology today, I think I have demonstrated it

to you in the past, the small retail customers know exactly what

they are getting, as long as they can see the price and watch the

price move and they can see the buy and sell fluctuations by themselves and they can make an informed decision. I do not see the

growth of the market being dominated by the institutions. I see the

growth of this market being dominated by individual investors who

have taken their own decisions into their own hands. And to deny

them access to the liquidity of a marketplace simply because they

are deemed unsophisticated, I think that is unfair. If they can be

delivered, using the technology of a member to protect them and

to make sure that they have all requisite information that they

need for protection, they deserve to be able to participate.

The CHAIRMAN. The problem here is that, in an attempt to help

protect the retail investor, we could in fact deny them the best

prices and thereby hurt them. Far from protecting them, we could

be hurting them. We have got to be very careful here.

To summarize, am I correct in saying that you feel that if the

retail customers would have access to the exempt MTEFs through

other intermediaries, but not directly, they would be protected?

Mr. DOWNEY. I do.

The CHAIRMAN. OK. They would still have access to those most

liquid markets, is that correct?

Mr. DOWNEY. You must remember that the only reason why it

is not clearing houses is because of contract market status. These

would not be contract market status, these entities, these MTEFs,

so they would not need a clearing house. Retail customers should

not be exposed to non-clearing house cleared products. I am trying,

again, to lobby you to create a clearing house.

The CHAIRMAN. Right, right. I hear you. I hear you
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Mr. LIND. Wait a minute. Mr. Chairman, may I comment on

that?

The CHAIRMAN. Yes.

Mr. LIND. The opposite party in this type of transaction, I am

acting as the intermediary for my customer, and maybe the opposite party is Goldman Sachs. Now, in my proposal, all my customers’ funds have to be segregated to begin with. But the responsibility of making that trade good on one side is Goldman Sachs.

Now, if Goldman Sachs defaults, my customers’ monies are still

protected because it is all segregated funds.

Now, if we do not have an arrangement, where we settle every

day and he defaults to me, then my in my opinion that obligation

is mine. The customer gave me the order. I deal with Goldman

Sachs, Goldman Sachs goes out of business, I have to make my customer good. I may have his money in segregated funds, but I may

not have the profit that he had on a position, I have to make that

good myself. But the customer will be totally protected in that regard, whether there is a clearing house with a DTF or not.

The CHAIRMAN. What do you think about the suggestion for the

relaxed standards as to the segregated funds? Does anybody want

to comment any more on that?

Mr. WAYE. Mr. Chairman, I think the recommendations by staff

to allow a somewhat greater degree of flexibility in how segregated

funds are invested and managed by the FCM, as Mr. Lind said, we

would support that.

The CHAIRMAN. What are you allowed to invest them in now?

Mr. WAYE. U.S. Treasury securities.

The CHAIRMAN. And that is pretty much it? What would the proposal be that you can invest them in?

Mr. WAYE. I have not seen it exactly. But I have heard CFTC

staff say you might be able to invest them in similar securities to

what a clearing house accepts today. Or I am not quite sure if their

thought is to lower it like double A or single A or A–1 plus P–1

commercial paper. I am not sure. Just that they would broaden it

beyond treasuries only, which is the current requirement.

The CHAIRMAN. I think they had in mind municipal bonds and

the like. I should not comment on that. I will leave that to the

CFTC.

What do you think about the other suggestions for relaxed standards as to risk disclosure, registration, financial requirements and

the like? What do you all think of these recommendations for the

intermediaries?

Mr. DOWNEY. I personally do not find them to be a burden at all.

They are deliverable. I know a lot of it is the paper, they would

create paper and deliver it and get signed signatures. I think the

CFTC has already moved forward on electronic signatures which

opens up the door for electronic delivery. I do not provide any of

my customers these risk disclosure statements in a paper format.

They capture them electronically. They read them. They take a test

on them. And they acknowledge that they have gotten them. I do

not find them to be a burden. Technology can solve that problem,

and I consider it a good policy to understand that our customer understands the risks involved in the business he is about to undertake.
40

Mr. LIND. First, let me say that the risk disclosure statement for

the retail customer today, I am guessing now but I would have to

say it is probably over 20-years old. And times have changed. The

sophistication of people today, even people who have never traded

before, is so much higher than it was back then, that I think that

risk disclosure today, I think there should be a risk disclosure. I

think it should be for today’s times. I do not think that most of my

customers read it. Certainly I do not give them a test. What do you

do if someone fails the test?

Mr. DOWNEY. Let them take it again.

Mr. LIND. Right. They would check off that they have received

it, but I doubt that very many people read it. Now, I think that

a more appropriate message about the risks of trading could be enclosed in a short enough form that the people probably would read

it. But right now, the whole thing is pretty burdensome, and it is

really out of date, but we can live with that. And I think it should

be there.

Also, going back to the segregated funds, part of the reason why

the relaxation of segregated funds would be, because our competition overseas has a whole relaxed aspect to that. They can invest

in many other things. Some of the customers here would like to direct the firm that they are trading with to take the funds and invest it in something else where they are going to get a better return rather than on treasuries. I, myself, for the retail customer believe the funds should stay segregated but only for the retail customer, and that those funds should be invested only in treasuries

the way they are today.

The CHAIRMAN. Well, thank you very much. I am going to adjourn this Committee meeting now. I appreciate very much the

substantial contribution all of you have made, through your prepared remarks and through your testimony today. Rest assured, I

will take this input back to Washington, as we rewrite the Commodities Exchange Act this year. Let us hope that we get it done

by September, which we have set as an absolute deadline. Thank

you all very much for your help today. Thank you.

[Whereupon, at 12:30 p.m., the hearing was adjourned.]
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