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70–998 PDF 2011

HEARING TO REVIEW LEGISLATIVE

PROPOSALS AMENDING TITLE VII OF 

THE DODD-FRANK WALL STREET REFORM 

AND CONSUMER PROTECTION ACT

HEARING

BEFORE THE

COMMITTEE ON AGRICULTURE 

HOUSE OF REPRESENTATIVES

ONE HUNDRED TWELFTH CONGRESS

FIRST SESSION

OCTOBER 12, 2011

Serial No. 112–25

(

Printed for the use of the Committee on Agriculture 

agriculture.house.gov 

COMMITTEE ON AGRICULTURE 

FRANK D. LUCAS, Oklahoma, Chairman 

BOB GOODLATTE, Virginia, 

Vice Chairman 

TIMOTHY V. JOHNSON, Illinois 

STEVE KING, Iowa 

RANDY NEUGEBAUER, Texas 

K. MICHAEL CONAWAY, Texas 

JEFF FORTENBERRY, Nebraska 

JEAN SCHMIDT, Ohio 

GLENN THOMPSON, Pennsylvania 

THOMAS J. ROONEY, Florida 

MARLIN A. STUTZMAN, Indiana 

BOB GIBBS, Ohio 

AUSTIN SCOTT, Georgia 

SCOTT R. TIPTON, Colorado 

STEVE SOUTHERLAND II, Florida 

ERIC A. ‘‘RICK’’ CRAWFORD, Arkansas 

MARTHA ROBY, Alabama 

TIM HUELSKAMP, Kansas 

SCOTT DESJARLAIS, Tennessee 

RENEE L. ELLMERS, North Carolina 

CHRISTOPHER P. GIBSON, New York 

RANDY HULTGREN, Illinois 

VICKY HARTZLER, Missouri 

ROBERT T. SCHILLING, Illinois 

REID J. RIBBLE, Wisconsin 

KRISTI L. NOEM, South Dakota 

COLLIN C. PETERSON, Minnesota, Ranking 

Minority Member 

TIM HOLDEN, Pennsylvania 

MIKE MCINTYRE, North Carolina 

LEONARD L. BOSWELL, Iowa 

JOE BACA, California 

DENNIS A. CARDOZA, California 

DAVID SCOTT, Georgia 

HENRY CUELLAR, Texas 

JIM COSTA, California 

TIMOTHY J. WALZ, Minnesota 

KURT SCHRADER, Oregon 

LARRY KISSELL, North Carolina 

WILLIAM L. OWENS, New York 

CHELLIE PINGREE, Maine 

JOE COURTNEY, Connecticut 

PETER WELCH, Vermont 

MARCIA L. FUDGE, Ohio 

GREGORIO KILILI CAMACHO SABLAN, 

Northern Mariana Islands 

TERRI A. SEWELL, Alabama 

JAMES P. MCGOVERN, Massachusetts 

PROFESSIONAL STAFF

NICOLE SCOTT, Staff Director 

KEVIN J. KRAMP, Chief Counsel 

TAMARA HINTON, Communications Director 

ROBERT L. LAREW, Minority Staff Director 

(II) 

(III)

C O N T E N T S 

Page 

Conaway, Hon. K. Michael, a Representative in Congress from Texas, submitted statement on behalf of Hon. Glenn English, CEO, National Rural 

Electric Cooperatives Association ....................................................................... 111

Lucas, Hon. Frank D., a Representative in Congress from Oklahoma, opening 

statement .............................................................................................................. 1

Prepared statement .......................................................................................... 2

Submitted legislation ....................................................................................... 4

Owens, Hon. William L., a Representative in Congress from New York, prepared statement ................................................................................................... 31

Peterson, Hon. Collin C., a Representative in Congress from Minnesota, opening statement ........................................................................................................ 29

Prepared statement .......................................................................................... 30

Stivers, Hon. Steve, a Representative in Congress from Ohio, submitted letter .......................................................................................................................... 32

WITNESSES

Cordes, Scott, President, Country Hedging, Inc., Inver Grove Heights, MN; 

on behalf of National Council of Farmer Cooperatives ..................................... 33

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

Williams, Douglas L., President and Chief Executive Officer, Atlantic Capital 

Bank, Atlanta, GA ............................................................................................... 39

Prepared statement .......................................................................................... 40

Sanevich, Bella L.F., General Counsel, NISA Investment Advisors, L.L.C., 

St. Louis, MO; on behalf of American Benefits Council; Committee on 

Investment of Employee Benefit Assets ............................................................. 44

Prepared statement .......................................................................................... 45

Giancarlo, J.D., J. Christopher, Executive Vice President—Corporate Development, GFI Group Inc.; Board Member, Wholesale Markets Brokers Association, Americas, New York, NY ............................................................................ 51

Prepared statement .......................................................................................... 53

Boultwood, Brenda L., Chief Risk Officer and Senior Vice President, Constellation Energy, Baltimore, MD; on behalf of Coalition for Derivatives 

End-Users ............................................................................................................. 67

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

Thul, Todd, Risk Manager, Cargill AgHorizons, Minneapolis, MN; on behalf 

of Commodity Markets Council ........................................................................... 72

Prepared statement .......................................................................................... 73

SUBMITTED MATERIAL

American Bankers Association, submitted statement .......................................... 113

Independent Community Bankers of America, submitted statement ................. 117

(1)

HEARING TO REVIEW LEGISLATIVE

PROPOSALS AMENDING TITLE VII OF 

THE DODD-FRANK WALL STREET REFORM 

AND CONSUMER PROTECTION ACT 

WEDNESDAY, OCTOBER 12, 2011

HOUSE OF REPRESENTATIVES, 

COMMITTEE ON AGRICULTURE, 

Washington, D.C. 

The Committee met, pursuant to call, at 10:08 a.m., in Room 

1300 of the Longworth House Office Building, Hon. Frank D. Lucas 

[Chairman of the Committee] presiding. 

Members present: Representatives Lucas, Goodlatte, Johnson, 

Neugebauer, Conaway, Schmidt, Stutzman, Gibbs, Austin Scott of 

Georgia, Tipton, Crawford, Gibson, Hultgren, Hartzler, Schilling, 

Ribble, Noem, Peterson, Holden, McIntyre, Boswell, Baca, David 

Scott of Georgia, Costa, Schrader, Owens, Courtney, Fudge, Sewell 

and McGovern. 

Staff present: Tamara Hinton, Kevin Kramp, Josh Mathis, Ryan 

McKee, Nicole Scott, Debbie Smith, Heather Vaughan, Suzanne 

Watson, Liz Friedlander, C. Clark Ogilvie, Anne Simmons, John 

Konya, and Caleb Crosswhite. 

OPENING STATEMENT OF HON. FRANK D. LUCAS, A 

REPRESENTATIVE IN CONGRESS FROM OKLAHOMA 

The CHAIRMAN. This hearing of the Committee on Agriculture to 

review legislative proposals amending Title VII of the Dodd-Frank 

Wall Street Reform and Consumer Protection Act will come to 

order. 

I want to thank all of you for joining us today and to our witnesses, each of whom traveled to appear before our Committee, and 

I would like to thank the many Members of this Committee on both 

sides of the aisle who have worked so hard in preparing legislation 

for us to consider today. 

This is the seventh hearing we have had regarding Title VII of 

the Dodd-Frank Wall Street Reform and Consumer Protection Act. 

We have heard from over 30 market participants from a wide range 

of organizations. In the course of those seven hearings, we have 

gathered a good deal of information on how the implementation of 

Dodd-Frank is affecting businesses across the country. We have 

heard that some regulations may impose significant costs that 

aren’t being accounted for by the CFTC. We have heard that Congressional intent on many proposals including margin exemptions 

for end-users has not been adhered to. We have heard confusion 

2

about the order of regulations being proposed and concern about 

the scope of the regulatory definitions, and most importantly, we 

have heard from businesses that are concerned that some DoddFrank regulations will actually inhibit their ability to manage risk. 

That runs contrary to the purpose of Dodd-Frank, which was to increase stability and transparency in our financial markets. So 

today we will consider seven legislative proposals aimed at fixing 

some important areas in implementation where the regulators, my 

friends at CFTC in particular, simply haven’t gotten it right. 

Now, none of these bills propose dramatic changes to DoddFrank. They are aimed at ensuring that the regulators don’t implement rules that conflict with, or are contrary, to what Congress intended. They do not undermine reform and they are not efforts to 

repeal Dodd-Frank. They are intended to restore the balance that 

I believe can exist between sound regulation and a healthy economy. 

Some may say that looking at legislative remedies is premature, 

that we should wait until the rules are finalized and let the regulators improve upon the proposed rules. It is my sincere hope that 

the rules improve. It is my hope that the agencies will listen to the 

comments that have been filed and to the feedback they have gotten from market participants and from Congress. But with unemployment stuck at nine percent, I am not willing to just stand by 

and keep my fingers crossed, so to speak, that the flaws in the proposed rules will be fixed. We are facing widespread and potentially 

severe unintended consequences from these regulations, and that 

will potentially have a dire effect on our economic recovery. When 

the rules are final, let us face it, they are final, and businesses 

across the country including farmers and ranchers need to prepare 

for the new regulations and related costs now. They will not be 

able to wait for Congress to act. 

I would also note that we will consider three discussion drafts 

today. I welcome and encourage feedback from our witnesses and 

Members on this Committee about ways in which we can and 

should improve upon these proposals. They are aimed at making 

sure that an overly broad swap dealer definition doesn’t encumber 

our energy and ag sectors, that our pensions and government entities do not face prohibitive burdens when accessing swap markets, 

and that small financial institutions and farm credit banks can 

continue to pair credit with risk-mitigating tools. All of these proposals aim to keep capital in the hands of businesses that we need 

to lead our economic recovery. 

Thank you again for coming here today. I look forward to hearing 

from our witnesses. 

[The prepared statement of Mr. Lucas follows:]

PREPARED STATEMENT OF HON. FRANK D. LUCAS, A REPRESENTATIVE IN CONGRESS

FROM OKLAHOMA

Thank you for joining us today, and to our witnesses, each of whom traveled to 

appear before our Committee. 

I’d also like to thank the many Members of this Committee—on both sides of the 

aisle—who have worked so hard in preparing legislation for us to consider today. 

This is the seventh hearing we’ve had regarding Title VII of the Dodd-Frank Wall 

Street Reform and Consumer Protection Act. We’ve heard from over 30 market participants, from a wide range of organizations. 

3

In the course of those seven hearings, we’ve gathered a good deal of information 

on how the implementation of the Dodd-Frank Act is affecting businesses across the 

country. 

We’ve heard that some regulations may impose significant costs that aren’t being 

accounted for by the CFTC. 

We’ve heard that Congressional intent on many proposals, including a margin exemption for end-users, has not been adhered to. 

We’ve heard confusion about the order of regulations being proposed and concern 

about the scope of regulatory definitions. 

And most importantly, we’ve heard from businesses that are concerned that some 

Dodd-Frank regulations will actually inhibit their ability to manage risk. 

That runs counter to the purpose of Dodd-Frank, which was to increase stability 

and transparency in our financial markets. 

So today, we will consider seven legislative proposals aimed at fixing some important areas in implementation where the regulators—the CFTC in particular—simply 

haven’t gotten it right. 

None of these bills propose dramatic changes to Dodd-Frank. They are aimed at 

ensuring that the regulators don’t implement rules that conflict with, or are contrary to, what Congress intended. 

They do not undermine reform, and they are not efforts to repeal Dodd-Frank. 

They are intended to restore the balance that I believe can exist between sound 

regulation and a healthy economy. 

Some may say that looking at legislative remedies is premature—that we ought 

to wait until the rules are finalized and let the regulators improve upon the proposed rules. 

It is my sincere hope the rules improve. It is my hope that the agencies will listen 

to the comments that have been filed, and to the feedback they’ve gotten from market participants and from Congress. 

But with unemployment stuck at nine percent, I’m not willing to just stand by 

and keep my fingers crossed that the flaws in the proposed rules will be fixed. 

We are facing widespread and potentially severe unintended consequences from 

these regulations, that will have a direct effect on our economic recovery. 

When the rules are final, they’re final. And businesses across the country, including our farmers and ranchers, need to prepare for the new regulations and related 

costs now. They will not be able to wait for Congress to act. 

I’d also note that we will consider three discussion drafts today. I welcome and 

encourage feedback from our witnesses and the Members on this Committee about 

ways in which we can and should improve upon these proposals. 

They are aimed at making sure that an overly broad swap dealer definition 

doesn’t encumber our energy and agriculture sectors, that our pensions and government entities do not face prohibitive burdens when accessing swaps markets, and 

that small financial institutions and farm credit banks can continue to pair credit 

with risk mitigating tools. 

All of these proposals aim to keep capital in the hands of the businesses we need 

to lead our economic recovery. 

Thank you again for being here today, and I look forward to hearing from our witnesses.

4

LEGISLATION

H.R. 1840, To improve consideration by the Commodity Futures Trading 

Commission of the costs and benefits of its regulations and orders.


11225001.eps
5


11225002.eps
6


11225003.eps
7

H.R. 2586, Swap Execution Facility Clarification Act


11225004.eps
8


11225005.eps
9


11225006.eps
10


11225007.eps
11

H.R. 2682, Business Risk Mitigation and Price Stabilization Act of 2011


11225008.eps
12


11225009.eps
13


11225010.eps
14

H.R. 2779, To exempt inter-affiliate swaps from certain regulatory requirements put in place by the Dodd-Frank Wall Street Reform and Consumer Protection Act.


11225011.eps
15


11225012.eps
16


11225013.eps
17

DRAFT LEGISLATION

H.R. ll, Pension Plan Risk Reduction Act of 2011


11225014.eps
18


11225015.eps
19


11225016.eps
20


11225017.eps
21


11225018.eps
22


11225019.eps
23

H.R. ll, Small Business Credit Availability Act


11225020.eps
24


11225021.eps
25


11225022.eps
26

H.R. ll, To amend the Commodity Exchange Act to clarify the definition 

of swap dealer.


11225023.eps
27


11225024.eps
28


11225025.eps
29

The CHAIRMAN. And now I turn to the Ranking Member, the outstanding gentleman from Minnesota, for any comments he may 

have. 

OPENING STATEMENT OF HON. COLLIN C. PETERSON, A 

REPRESENTATIVE IN CONGRESS FROM MINNESOTA 

Mr. PETERSON. Thank you, Mr. Chairman, and thank you for 

calling this hearing. 

You know, we hear a lot of talk about concern that we need to 

see the big picture and we need to have certainty with these regulations and so forth. But, I would argue that what we are doing 

here to some extent is actually adding to the uncertainty and not 

necessarily focusing on what the real problems are. I understand 

that the House needs to move but the reality is that these bills are 

not going anyplace in the Senate. I think they just muddy the 

water, and frankly, some of the bills don’t fix the problems that are 

some of the most significant problems that are not being caused by 

the CFTC, they are actually being caused by the Prudential Regulators. For example, the end-user issue which we tried to address 

in the bill and tried to make sure that end-users were not going 

to be subject to cash margins, the reason there is a cash margin 

issue is not because of the CFTC, it is because of the Prudential 

Regulators who are requiring their banks to have cash margins in 

the rules that they have adopted, which this Committee has no jurisdiction over. I am also told that apparently the Prudential Regulators have the authority to do this and had the authority prior to 

the passage of Dodd-Frank. So even if we repeal Dodd-Frank, the 

Prudential Regulators would have the authority to require the 

banks to have cash margin requirements on their counterparties. 

So one of the questions I have is, we have had seven hearings 

but we have not had the Prudential Regulators in and we have not 

had the SEC in in those seven hearings. Now, when I was Chairman, we had them in because they are part of the issue here. You 

know, the other thing that happened in Dodd-Frank is there was 

an agreement that they were going to work together, and I would 

argue that part of the challenge that they are having at the CFTC 

is trying to work in conjunction with the SEC. The SEC is still 

largely a dysfunctional agency that is operating 50 years ago with 

a rules-based regulatory system that is never going to keep pace 

with what is going on today in the financial community. 

So I would ask you, Mr. Chairman, to consider holding a hearing 

where we get the Prudential Regulators in and the SEC and the 

CFTC so we can talk about the problems that are being caused by 

trying to harmonize these rules. Now, we also have a situation 

where they are trying to harmonize these rules with Europe, which 

is an even bigger challenge, and that is entering into all of this 

stuff. 

Some of these bills are focused on issues that I am concerned 

about. I am not sure they are going to fix the problem. You know, 

we have problems being put on this country by what is going on 

in Europe, which is a mystery to me. It looks like a setup deal 

going on there. The entire economy of Greece is $260 billion. There 

is no way that the economy of Greece is going to take down this 

financial market by itself. And now, where we have had these dire 

30

warnings that the whole world is going to collapse because of 

Greece, it looks to me like they are trying to force Europe into a 

TARP kind of a deal, a panic kind of a deal similar to what happened in the United States. Yesterday when probably the most significant item that happened was when Slovakia voted down the 

deal in Europe—where is it? On the Internet this morning it is in 

the business section, the third one down. So why is it that Greece 

is the lead story every time but all of a sudden we are going to 

bury the thing that is actually the problem? I mean, I just wonder 

what the heck is going on here. 

So these bills, the first bill that is here, this cost-benefit analysis 

by Mr. Conaway, I think it is a good bill. It codifies the Executive 

Order. But I have a bill, H.R. 3010, that I am a cosponsor of that 

actually goes much further, that is comprehensive, that doesn’t just 

do it in the CFTC but does it in the whole government. We have 

other bills here that are trying to fix some of these definitions that 

are not finalized at this point. We have a bill on inter-affiliate 

swaps that appears to me would give the Wall Street guys a way 

to set up subsidiaries to get around these rules. 

So my point is, we just have to be careful about what we are 

doing here. I think we are sending signals out there—I have had 

people in my office that think that somehow or another this is all 

going to happen. I don’t think any of this stuff is going to happen 

in the Senate. 

So I would just encourage this Committee to take a step back, 

take a look at the big picture, get the folks, everybody in the room 

here that is involved in this. As I have said from the start, if there 

is a way to fix some of these problems that is within our jurisdiction and we can actually get done, I am all for it, but frankly, in 

a lot of cases, some of these bills will do more harm than good. 

So with that tirade, I will yield back. 

[The prepared statement of Mr. Peterson follows:]

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

CONGRESS FROM MINNESOTA

Thank you Mr. Chairman. This is the seventh hearing this Committee has held 

concerning the Dodd-Frank Act. Today, we are hearing from witnesses regarding 

several bills that have been introduced or may be introduced or considered by this 

Committee to amend that law. 

As I have said at previous hearings, I believe amending Dodd-Frank is premature. 

The Commodity Futures Trading Commission has not finalized many of the rules 

that concern the issues we are discussing today. We should wait to see the final 

rules and if the CFTC gets them right or wrong before acting. If regulators don’t 

implement the law as we intended, if they screw things up, I stand ready to help 

with legislative fixes. However, we need to give the regulators the opportunity to 

get things right. 

The Committee risks jeopardizing our credibility if we take a ‘Chicken Little’ approach and pass legislation to fix problems that fail to materialize. 

That being said the Commission is on tap to vote on many of its proposed rules 

in the coming months. Therefore, I believe today’s hearing is appropriate so the 

Committee may respond quickly should the CFTC ignore common sense and finalize 

a faulty rule. 

The legislative proposals under discussion this morning attempt to address a wide 

range of fears expressed by market participants at our earlier hearings. Some of 

these legislative proposals might work, others may not fix the problem at all and 

still others would create regulatory loopholes for the Wall Street banks so large you 

could drive a combine through them. 

I sympathize with the concerns we have already heard, and will hear yet again 

today, from our witnesses. These are not the folks who caused the 2008 financial 

31

collapse and subsequent recession. However, if the so-called solutions to their concerns weaken the law to permit another financial catastrophe, they will not get my 

support. 

Many of these legislative proposals attempt to address concerns that involve other 

regulators. For some reason, however, the Committee refuses to bring them in to 

testify. Our witnesses today will address the proposed margin rules by the Prudential Regulators, such as the Federal Reserve, but why haven’t these regulators been 

brought before the Committee to answer our questions? 

We will also hear concerns regarding the consistency of rules between regulators, 

particularly the CFTC and the SEC, and the definitions which must be developed 

jointly by the CFTC and the SEC. When is Mary Schapiro, the SEC Chairman, 

scheduled to testify about these matters? 

In previous Congresses, we brought all the regulators before the Committee prior 

to moving on legislation that involved them. Why has the majority abandoned this 

practice? 

I believe it is imperative that the Committee’s next hearing on this topic bring 

together the CFTC, SEC and Prudential Regulators to testify and answer our questions before the Committee moves forward on these legislative proposals. To do otherwise would be legislative malpractice and a disservice not only to ourselves, but 

to the witnesses here today and from previous hearings who have understandable, 

if premature, concerns 

Ultimately, I believe the CFTC is taking its time to get this right. And perhaps 

that is what some people are afraid of—that a regulator can listen to the public and 

respond appropriately. Maybe that is why many in the Republican Congressional 

leadership still seem dedicated to a total repeal of Dodd-Frank. They are afraid the 

law could succeed. Time will ultimately tell, but I’m holding out hope. 

I want to welcome our witnesses here today and with that Mr. Chairman, I yield 

back.

The CHAIRMAN. The Ranking Member yields back, and the chair 

has always appreciated the Ranking Member’s insights. 

With that, I would request that other Members submit their 

opening statements for the record so the witnesses may begin their 

testimony and to ensure that there is ample time for questions. 

[The prepared statement of Mr. Owens and submitted letter of 

Mr. Stivers follow:]

PREPARED STATEMENT OF HON. WILLIAM L. OWENS, A REPRESENTATIVE IN CONGRESS

FROM NEW YORK

I would like to thank Chairman Lucas and Ranking Member Peterson for their 

hard work on this issue. Over the last year, I have heard from many groups in my 

district that are concerned that the CFTC’s proposed ‘‘swap dealer’’ definition would 

unfairly capture commercial energy companies, agricultural cooperatives and community banks, electric cooperatives and farm credit system institutions. 

Congress included two exceptions from the ‘‘swap dealer’’ definition in Dodd-Frank 

that were intended to exclude these entities from falling into this regulatory category. The first exception relates to the entity’s transacting in a dealing capacity 

‘‘as a part of a regular business.’’ In other words, because none of the witnesses here 

represent companies that engage in swap activity as their main or usual business, 

but rather use swaps to hedge their business risk, Congressional intent is clear—

they should be exempt from these regulations. The second exception is the de minimis exception, which gives the CFTC broad discretion in determining which entities 

are exempt. Very few entities would qualify for the very low threshold in the proposal, which only exempts entities that engage in fewer than twenty swaps a year. 

In July, 71 of my colleagues joined Congressman Conaway and me in sending a 

letter to Chairman Gensler asking for clarification of the Commission’s proposal. 

The Chairman’s response indicated that the Commission is ‘‘committed to implementing the statutory definition and closely following Congressional intent,’’ but 

there was little explanation given regarding the discrepancies between the proposal 

and Congressional intent. 

As a cosponsor of H.R. 2682, I believe this legislation is necessary to ensure that 

the CFTC implements the intent of Congress in exempting true end-users from derivatives regulations. If forced to comply with the increased requirements for posting capital and margin, reporting requirements, record keeping and other regulations, the services currently offered by end-users could become cost prohibitive, imVerDate 0ct 09 2002 15:26 Nov 29, 2011 Jkt 041481 PO 00000 Frm 00035 Fmt 6633 Sfmt 6621 I:\DOCS\112-25\70998.TXT BRIAN
32

peding their ability to conduct business, resulting in higher prices for my constituents, and diverting of capital that could otherwise be invested in their business and 

used to help create jobs. 

These financial instruments are particularly important for dairy farmers in my 

district, who depend on their cooperatives for tools to manage price risk and lock 

in margins. For example, a dairy farmer might want to get a guaranteed price on 

future deliveries of milk from his co-op, but might be concerned that input costs for 

corn and soybean meal will fluctuate, cutting into expected returns. By purchasing 

a financially settled swap from their co-op, the dairy farmer can hedge his or her 

input costs, while receiving a guaranteed price for their milk. Without the co-op, the 

farmer would have to go to a futures exchange to hedge their input costs. The farmer would have to post margin and buy contracts that are larger than the volume 

of his feed needs and don’t necessarily correspond with the farmer’s monthly purchases. The co-op is able to aggregate the small contracts with its dairy farmers and 

then offset its exposure either in the futures market or with a more customized 

product in the swaps market. 

The derivatives market needs to be better regulated and certain participants need 

to post margin to cover these trades. However, this legislation is needed to ensure 

that community banks, agricultural coops, energy utilities, community banks and 

other end-users can continue to hedge against risk. It is imperative that we move 

forward with this legislation and I respectfully request that the other Members of 

this Committee support this bipartisan effort. 

SUBMITTED LETTER BY HON. STEVE STIVERS, A REPRESENTATIVE IN CONGRESS FROM

OHIO

Dear Mr. Chairman:

I have introduced, along with our colleague Ms. Fudge, H.R. 2779, which is set 

for a legislative hearing in your Committee today. The purpose of this legislation 

is simple and straightforward. The Federal Government should not penalize companies of any size by over-charging them for the way in which they do business. 

Regulators under Dodd-Frank were given broad authority to issue rules and regulations for reforming our nation’s financial system, and there is a fear that those 

regulators will draft proposals that will decentralize the financial business model 

used by American corporations across the country and around the world. 

Inter-affiliate swap contracts are an accounting method used to assign ownership 

to a contract which has been collateralized by another corporate affiliate which aggregates risk across multiple companies, thus providing a method for managing that 

risk more efficiently. Companies that establish financial service corporations for the 

purposes of aggregating risk do so because it allows them to centralize financial 

transactions and utilize the skills and knowledge of financial experts who manage 

complicated financial transactions every day. 

Without this bill, the government could intrude into how businesses manage their 

finances by regulating even internal swaps transactions that do not create systemic 

risk. The legislation your Committee is discussing today provides an exemption for 

any swap contracts between two companies that are either in a parent-subsidiary 

relationship, or are under common control. In no way does it preclude the oversight 

or regulation of transactions between the parent company and the marketplace. 

This bill would simply prevent those companies employing a business structure, 

which allows it to manage risk more efficiently, from being charged twice or three 

times as much. 

I look forward to continuing to work with you and our fellow colleagues on this 

important issue.

I would like to welcome our panel of witnesses to the table: Mr. 

Scott Cordes, President, Country Hedging, for the National Council 

of Farmer Cooperatives; Mr. Douglas Williams, President and Chief 

Executive Officer, Atlantic Capital Bank; Bella Sanevich, General 

Counsel, NISA Investment Advisors, for the American Benefits 

Council; Mr. Chris Giancarlo, Executive Vice President, GFI Group, 

for the Wholesale Markets Brokers Association, Americas; Brenda 

Boultwood, Chief Risk Officer and Senior Vice President, Constellation Energy for the Coalition for Derivatives End-Users; and Todd 

33

Thul, Risk Manager, Cargill AgHorizons for the Commodity Market 

Council. 

Mr. Cordes, please begin when you are ready, sir. 

STATEMENT OF SCOTT CORDES, PRESIDENT, COUNTRY

HEDGING, INC., INVER GROVE HEIGHTS, MN; ON BEHALF OF 

NATIONAL COUNCIL OF FARMER COOPERATIVES 

Mr. CORDES. Chairman Lucas, Ranking Member Peterson and 

Members of the Committee, thank you for holding this hearing on 

proposed legislation to amend the Dodd-Frank Act. 

I am Scott Cordes, President of Country Hedging, a commodity 

brokerage subsidiary of CHS Inc. CHS is an energy, grains and 

food cooperative owned by approximately 55,000 individual farmers 

and ranchers and approximately 1,000 local cooperatives. CHS is 

proud to be a member of the National Council of Farmer Cooperatives, and I am here today to testify on behalf of NCFC. 

Farmer cooperatives are an important part of success of American agriculture. By providing commodity price risk management 

tools to their member-owners, farmer co-ops help mitigate commercial risk in the production, processing and marketing of a broad 

range of agriculture, food and energy products. 

Please refer to my written statement for the record for greater 

details but at this time I would provide comment on four key provisions NCFC believes are critical to preserving risk management 

tools for farmers and their cooperatives. 

We ask for your support of the following. One, treat agriculture 

cooperatives as end-users. Two, exclude agriculture cooperatives 

from the definition of swap dealer. Three, consider the aggregate 

costs associated with new regulations that impact agriculture. And 

four, maintain a bona fide hedge definition that includes common 

commercial hedging practices. 

The end-user exemption: First and foremost, agriculture cooperatives should be treated as end-users because they aggregate the 

commercial risk of their individual farmer-members. Due to market 

volatility in recent years, cooperatives are increasingly using swaps 

to better managing their exposure by customizing their hedges. The 

practice increases the effectiveness of risk mitigation and reduces 

cost to cooperatives, their farmer owners and customers. At CHS, 

entering into commodity swaps frees up working capital. This allows us to continue forward contracting grain from farmers. Therefore, we are concerned with the so-called Prudential Regulators 

market proposal that requires bank swap dealers to collect margin 

from end-users. We fear this would negatively affect our ability to 

continue offering forward contracts. We also fear mandatory margin would increase costs to hedging operations and ultimately discourage prudent hedge operations and practices. Congressional intent was clear on this point. End-users were not to be required to 

post margin. We support legislation that would reaffirm this intent. 

Swap dealer definition: The uncertainty created by the entity 

definition rules is NCFC’s greatest concern as implementation continues. Specifically, we believe agriculture cooperatives should not 

be defined as swap dealers, and we support legislation to further 

clarify what entities would be classified and regulated as such. The 

proposed legislation clarifies swap dealers do not include those 

34

using swaps to hedge or which enter into swaps ancillary to one’s 

business. It also provides for a commercially meaningful threshold 

under the de minimis exception. This would ensure there are options for hedgers to find commercial swap counterparties. However, 

some cooperatives are at risk of being designated as a swap dealer 

due to their unique structure. Unlike a traditional corporation 

structure, cooperatives look to transfer risk from the local level to 

the federated affiliated cooperative. Using swaps as a tool to transfer risk should not lead them to be defined as dealers. We are very 

interested in having those transactions addressed in the proposed 

inter-affiliate legislation. 

Regulatory costs to agriculture: As you know, agriculture is a 

high-volume, low-margin industry. Incremental increases in cost 

will trickle down and affect producers. Taken one rule at a time, 

the cost may not seem unreasonable, but to those who have to absorb or pass on collective costs of numerous regulations, it is evident those costs are significant. We encourage this Committee to 

seek a more thorough analysis to consider the aggregate affect of 

these regulatory actions. 

Bona fide hedge definition: Finally, we advocate maintaining a 

bona fide hedge definition that includes common commercial hedging practices. I bring this issue to your attention as the Commission is scheduled to vote on this rule in the near future. I would 

encourage the Committee to take a close look at the definition 

when the final rule is issued. 

In conclusion, we ask that you consider those four points I outlined above. Thank you again for the opportunity to testify today 

before the Committee on behalf of farmer-owned cooperatives. I 

look forward to answering any questions you may have. Thank you. 

[The prepared statement of Mr. Cordes follows:]

PREPARED STATEMENT OF SCOTT CORDES, PRESIDENT, COUNTRY HEDGING, INC., 

INVER GROVE HEIGHTS, MN; ON BEHALF OF NATIONAL COUNCIL OF FARMER

COOPERATIVES

Chairman Lucas, Ranking Member Peterson, and Members of the Committee, 

thank you for the opportunity today to discuss the role of the over-the-counter 

(OTC) derivatives market in helping farmers and farmer-owned cooperatives manage commodity price risks. I am pleased to be here representing the National Council of Farmer Cooperatives (NCFC) and provide input on the key issues concerning 

implementation of the Dodd-Frank Wall Street Reform and Consumer Protection 

Act (Dodd-Frank Act) as well as potential legislative reforms this Committee may 

take under consideration in the near future. 

I am Scott Cordes, President of Country Hedging, a commodity brokerage subsidiary of CHS Inc. CHS is a farmer-owned energy, grains and foods cooperative 

committed to providing essential resources that enrich lives around the world. CHS 

is owned by approximately 55,000 individual farmers and ranchers who own shares 

by selling us grain directly or as customer-owners of one of five dozen CHS Country 

Operations retail units. We are also owned by about 1,000 local cooperatives who 

represent another 350,000 producers. You might also be interested to know I grew 

up on a grain and dairy farm in Southeastern MN that my brother still operates 

today. 

I also serve on NCFC’s Commodity Futures Trading Commission (CFTC) working 

group, which was formed to provide technical assistance to NCFC on commodity 

markets, including implementation of Title VII of the Dodd-Frank Act. On behalf 

of the CHS farmer-owners, and more broadly the more than two million farmers and 

ranchers who belong to farmer cooperatives, I thank the Committee for holding this 

hearing to discuss proposed legislation to amend the Dodd-Frank Act. 

Farmer cooperatives—businesses owned, governed and controlled by farmers and 

ranchers—are an important part of the success of American agriculture. This ownerVerDate 0ct 09 2002 15:26 Nov 29, 2011 Jkt 041481 PO 00000 Frm 00038 Fmt 6633 Sfmt 6621 I:\DOCS\112-25\70998.TXT BRIAN
35

ship structure that has served CHS owners well for 80 years helps individual family 

farmers and ranchers thrive despite the ups and downs of weather, commodity markets, and technological change. Through their cooperatives, producers are able to 

improve their income from the marketplace, manage risk, and strengthen their bargaining power, allowing farmers to compete globally in a way that would be impossible to replicate as individual producers. In all cases farmers are empowered, as 

elected board members, to make decisions affecting the current and future activities 

of their cooperative. Earnings derived from these activities are returned by cooperatives to their farmer-members on a patronage basis, thereby enhancing their overall 

farm income and improving rural economies. 

In particular, by providing commodity price risk management tools to their member-owners, farmer cooperatives help mitigate commercial risk in the production, 

processing and selling of a broad range of agricultural and food products. America’s 

farmers and ranchers must continue to have access to new and innovative risk management products that enable them to feed, clothe and provide fuel to consumers 

here at home and around the world. Any regulatory action that could jeopardize access to these tools should be avoided. 

As such, we have been working to ensure that the implementation of the DoddFrank Act preserves risk management tools for farmers and their cooperatives. 

During the rulemaking process, NCFC has advocated for the following:

• Treat agricultural cooperatives as end-users because they aggregate the commercial risk of individual farmer-members and are currently treated as such by 

the CFTC;

• Exclude agricultural cooperatives from the definition of a swap dealer;

• Consider aggregate costs associated with the new regulations and the impact 

on the agriculture sector; and

• Maintain a bona fide hedge definition that includes common commercial hedging practices.

Even though it has been more than a year since the Dodd-Frank Act was signed 

into law, we are still uncertain as to how farmer cooperatives will be classified and 

what regulations they will be subject to. The resulting uncertainty has put business 

plans on hold and has delayed investment to increase the capacity for cooperatives 

to expand their risk mitigation services. 

Cooperatives’ Use of the OTC Market 

As processors and handlers of commodities and suppliers of farm inputs, farmer 

cooperatives are commercial end-users of the futures exchanges, as well as the OTC 

derivatives markets. Due to market volatility in recent years, cooperatives are increasingly using OTC products to better manage their exposure by customizing their 

hedges. This practice increases the effectiveness of risk mitigation and reduces costs 

to the cooperatives and their farmer-owners. 

OTC derivatives are not just used for risk management at the cooperative level. 

They also give the cooperative the ability to provide customized products to smaller 

local cooperatives and individual farmer-members to help them better manage their 

risk and returns. Much like a supply cooperative leverages the purchasing power 

of many individual producers, or a marketing cooperative pools the production volume of hundreds or thousands of growers, a cooperative can aggregate its membersowners’ commodity price risk. It can then offset that risk with a futures contract 

or by entering into another customized hedge via the swap markets. 

Some examples include:

• Local grain cooperatives offer farmers a minimum price for future delivery of 

a specific volume of grain. The local elevator then offsets that risk by entering 

into a customized swap with an affiliated cooperative in a regional or federated 

system.

• Since most individual farmers do not have the demand necessary to warrant a 

standard 42,000 gallon monthly NYMEX contract, individual farmers can hedge 

their fuel costs by entering into swaps in 1,000 gallon increments through the 

co-op.

• Local supply cooperatives use swaps to mitigate their price risk in both crop nutrients and propane.

• Cooperatives facilitate hedging for dairy farmers by offering a fixed price for 

their milk and a swap to hedge their feed purchases. Dairy cooperatives also 

use swaps to offset the risk of offering forward contracts to their farmers, as 

well as to hedge the risk of offering forward price sales contracts to their customers.

36

• Cooperatives offer livestock producers customized contracts at non-exchange 

traded weights to better match the corresponding number of animal units they 

have while also reducing producers’ financial exposure to daily margin calls.

While my colleagues from dairy or livestock cooperatives could provide greater details on how the above programs work for those sectors, they are all similar in concept and purpose to the risk management programs we provide to our CHS memberowners. We enter into OTC derivatives to hedge the price risk of commodities that 

we purchase, supply, process or handle for our members. 

Swaps also play a critical role in the ability of cooperatives to provide forward 

contracts, especially in times of volatile markets. Because commodity swaps are not 

currently subject to the same margin requirements as the exchanges, cooperatives 

can use them to free up working capital. 

For example, considerable amounts of working capital have been tied up to cover 

daily margin calls as a result of increased volatility in grain and oilseed markets. 

For farmers to continue to take advantage of selling grain forward during price rallies, cooperatives have to either increase borrowing or look for alternative ways to 

manage such risk. Using the OTC market has become that alternative. In 2008, 

multinational grain companies were running out working capital due to extreme 

grain volatility. CHS was able to enter into swaps to free up working capital so that 

it could continue to contract and forward price grain with its members. As was the 

case during the volatile markets in 2008, swaps today allow cooperatives to free up 

working capital and continue to forward contract with farmers. 

Definition of Swap Dealer 

The uncertainty created by the ‘‘definitions’’ rules is NCFC’s greatest concern as 

implementation continues. While the CFTC has proposed regulations for swaps and 

swap dealers, it is unclear to us who, or what transactions, will be subjected to 

those additional regulations. As the rule was proposed, some activities of cooperatives such as those previously mentioned would appear to push cooperatives into the 

‘‘swap dealer’’ category. 

Regulating farmer cooperatives as dealers would increase requirements for posting capital and margin on swaps it uses with other dealers to offset the risk of providing risk management products and services to its members and customers. This 

requirement, combined with the cost of complying with other regulatory requirements intended for large financial institutions, could make providing those services 

to a cooperative’s member-owners uneconomical. Such action would result in the unintended consequence of increasing risk in the agricultural sector. In addition, it 

would severely limit the number of non-financial entities that could provide risk 

management tools in the form of financially settled instruments (swaps). 

The two main issues in the proposed rule are the application of the ‘‘interpretive 

approach for identifying whether a person is a swap dealer,’’ and the very low 

thresholds on the ‘‘de minimis exception.’’ As such CFTC would likely capture a 

number of entities, including farmer cooperatives, which were never intended to be 

regulated as swap dealers. Yet farmer cooperatives do not resemble what is generally and commonly known in the trade as a swap dealer—ones that profit from 

the spread between the buying and selling of swaps. Cooperatives are not driven 

by that profit motive, but rather are hedging, or assisting their members and customers in hedging the price risks inherent to the agriculture industry. Farmer cooperatives mitigate risk as opposed to others in the marketplace who take on risk 

for profit. 

Therefore, we support legislation to clarify what entities would be classified and 

regulated as swap dealers. The proposed legislation clarifies that swap dealers do 

not include those using swaps to hedge, or which enter into swaps ancillary to one’s 

business as a producer, processor, or commercial user of a commodity. Both of those 

‘‘prongs’’ capture the essence of farmer cooperatives’ and their members’ utilization 

of swaps. By providing for a commercially meaningful threshold under the ‘‘de minimis exception,’’ the bill would ensure there are options for hedgers to find commercial swap counterparties other than just financial entities. 

Further, some cooperatives, such as CHS, are currently at risk of being designated as swap dealers due to their unique structure. For example, a federated 

grain or farm supply cooperative is owned by many local cooperatives which are separate business entities. Unlike a traditional corporate structure where risk can be 

transferred internally, the ability to transfer risk from the local level to the federated cooperative—in this case in the form of a swap—is treated as an external 

transaction under the draft rules. Thus we are very interested in having those 

transactions addressed in the ‘‘inter-affiliate’’ legislation introduced by Representatives Marcia Fudge and Steve Stivers. While their legislation as introduced is specific to affiliate transactions between parties under common control, the same jusVerDate 0ct 09 2002 15:26 Nov 29, 2011 Jkt 041481 PO 00000 Frm 00040 Fmt 6633 Sfmt 6621 I:\DOCS\112-25\70998.TXT BRIAN
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tification can be made for similar transactions between affiliated cooperatives and 

their affiliated member-owners. Because of the bottom-up ownership structure of a 

cooperative, the affiliates are not under ‘‘common control’’ of the larger cooperative. 

Therefore, we would like to see an additional provision included in this legislation 

to include transactions between a cooperative and its member-affiliates, taking into 

account the differing structure of cooperative ownership from that of a traditional 

corporate entity. 

Many agricultural cooperatives, like CHS, borrow from CoBank, which is also a 

cooperative. We are concerned that CFTC would classify CoBank as a swap dealer 

because CoBank sells swaps to its customers in conjunction with providing loans. 

Congress specifically exempted these types of swaps from qualifying a commercial 

bank as a swap dealer. The exemption, however, was inadvertently limited only to 

‘‘insured depository institutions,’’ and as a Farm Credit System institution, CoBank 

is not an insured depository institution. We urge CFTC to ensure CoBank’s swaps 

are treated the same as other regulated lenders and do not qualify the bank as a 

swap dealer. Otherwise, our co-op, as well as others like us who borrow from 

CoBank, will be penalized. 

Cost-Benefit Analysis 

Agriculture is a high-volume, low-margin industry. Incremental increases in costs, 

whether passed on from a swap dealer or imposed directly on a cooperative, will 

trickle down and affect producers. It is important to keep in mind the aggregate 

costs associated with the many new regulations and the implications it will have 

for the agriculture sector. Taken one rule at a time, the costs may not seem unreasonable to those who are writing the rules. But to those who have to absorb or pass 

on the collective costs of numerous regulations, it is clearly evident those costs are 

significant. While the Commission believes it is doing its due diligence in providing 

cost-benefit analyses of the regulations it is proposing, we think better analysis is 

called for to consider their aggregate effect. 

For example, one so-called ‘‘small’’ change in the regulations is contained in the 

conforming amendments proposed rule and has to do with additional recording requirements. We are concerned this proposal would not only add swaps to the new 

recordkeeping requirements, but also extend the new requirements to cash purchase 

and forward cash contracts entered into by any member of a designated contract 

market (DCM). 

As a result, all farmer cooperatives that are members of DCMs (Chicago Mercantile Exchange, Kansas City Board of Trade, Minneapolis Grain Exchange, etc.), 

and by extension every one of their local facilities, to be bound by this regulation. 

Farmer cooperatives that are members of DCMs have an integrated network of 

grain elevators to originate and store grain purchased from farmers. The proposed 

change would require those elevators to record, among other things, all oral communications (telephone, voicemail, facsimile, instant messaging, chat rooms, electronic 

mail, mobile device or other digital or electronic media) that lead to execution of 

cash transactions with farmers. In addition, each transaction record must be maintained as a separate electronic file identifiable by transaction and counterparty and 

kept for 5 years. 

While some traders now record certain conversations in order to provide a record 

of order execution, the CFTC’s proposal would require employees at hundreds of operations to record all face-to-face and phone conversations with farmers, even when 

tape recording has never been their practice in the past. Such a requirement would 

impose huge regulatory burdens and costs on cooperatives and other businesses and 

farmers in rural America. For example, CHS buys grain at over 350 grain elevators 

across the United States. To install and maintain such recordkeeping systems would 

cost us over $6 million. In fact, the necessary investment to put in place and maintain such a system would not only greatly add to the cost of doing business, but 

would be an extreme compliance burden for the cash grain community. Since farmers would not be too keen having all their marketing conversations recorded and 

kept for 5 years, this would penalize those who are members of DCMs relative to 

other facilities. For those reasons, we believe this will have a net effect of driving 

grain industry participants to drop their membership in the exchanges. Further, we 

do not believe this regulatory burden is necessary to achieve the stated goals in the 

cash commodity markets. I would note that this ‘‘small’’ change tucked into one of 

the thousands of pages of proposed rules was not called for under the Dodd-Frank 

Act but rather has been initiated by the CFTC. 

End-User Exemption From Margin Requirements 

Consistent with Congressional intent, NCFC supports the CFTC’s proposed rules 

to clarify that it ‘‘would not impose margin requirements on non-financial entities,’’ 

38

and that ‘‘parties would be free to set initial and variation margin requirements in 

their discretion and any thresholds agreed upon by the parties would be permitted.’’ 

Farmer cooperatives are an extension of their members who are end-users. By extension, a farmer cooperative should also be an end-user. 

However, we are concerned the so-called ‘‘Prudential Regulators’’ margin proposal 

requires bank swap dealers to collect margin from end-users. As I noted earlier, 

swaps play a critical role in the ability of cooperatives to provide forward contracts, 

especially in times of volatile markets. This is because commodity swaps are not 

currently subject to margin requirements such as contracts on the exchanges and 

t can be used to free up working capital. 

As end-users, cooperatives use swaps to hedge interest rates, foreign exchange, 

and energy in addition to agricultural commodities. Often, cooperatives look to their 

lender to provide those swaps. Under the proposed rule requiring end-users to post 

margin, costs to businesses will increase as more cash is tied up to maintain those 

hedges. The additional capital requirements will be siphoned away from activities 

and investment in cooperatives’ primary business ventures. Furthermore, cash for 

margin is often borrowed from lenders through the use of credit lines. As a result, 

we could see a situation where a commercial end-user would have to borrow cash 

from its lender, and pay interest on it, just to give it back to the same lender to 

hold as margin. Congressional intent was clear on this point—end-users were not 

to be required to post margin. We support legislation that would reaffirm this intent. 

Bona Fide Hedge Definition 

Although legislation has not yet been introduced to address the bona fide hedge 

definition in the position limits rule, I bring this issue to your attention as the Commission is scheduled to vote on that rule in the near future. Once again, it appears 

the Commission may be going well beyond what Congress intended in the DoddFrank Act. In the draft rule, CFTC has classified common commercial hedging practices as speculative in nature. These include such practices as anticipatory hedging 

and cross hedging. For example, an anticipatory hedge could involve selling a corn 

future Friday afternoon, knowing that grain will be bought throughout the weekend. 

Common cross hedges would include hedging a dried distillers grain position with 

corn or hedging a cheese position with Class III milk, butter and whey. 

For NCFC’s dairy cooperative members, the ‘‘5 day rule’’ poses a significant problem. Six of the seven dairy futures contracts, and the swaps that use these futures 

for settlements, are cash-settled instruments. Five of the six cash-settled futures 

contracts have open interest of less than 5,000—spread across 24 months of futures 

contracts. One of the dairy contracts that has physical delivery currently has zero 

open interest. 

Due to these instruments settling against U.S. Department of Agriculture determined cash prices, there is perfect convergence of futures to cash. There are not any 

issues associated with deliverable contracts held during the last few days prior to 

settlement. Since this is the case, the dairy industry users hold these instruments 

until their positions close out on the settlement date. If these instruments were required to close out prior to settlement date, it would result in unusual price changes 

in the last few days—especially for the contracts that have very low open interest. 

Imposing the 5 day rule in the dairy sector would reduce the effectiveness of hedges 

and possibly reduce the use of these instruments by dairy farmers and their cooperatives, resulting in increased risk. 

I would encourage this Committee to take a close look at this definition when the 

final rule is issued. The implications are not only contained to the position limits 

themselves, but also other rules, such as what will be considered hedging or mitigating commercial risk for the purposes of commercial end-users being able to access 

the end-user exception to the clearing requirement. 

In summary, we hope you will give consideration to the following: treating agricultural cooperatives as end-users; excluding agricultural cooperatives from the definition of a swap dealer; consider the aggregate costs associated with the new regulations that impact agriculture; and, maintain a bona fide hedge definition that includes common commercial hedging practices. 

Thank you again for the opportunity to testify today before the Committee on behalf of farmer-owned cooperatives. Your leadership and oversight in the implementation of the Dodd-Frank Act is to be commended. We especially appreciate your role 

in ensuring that farmer cooperatives will continue to be able to effectively hedge 

commercial risk and support the viability of their members’ farms and cooperatively 

owned facilities. I look forward to answering any questions you may have. 

Thank you.

39

The CHAIRMAN. Thank you. 

Mr. Williams, when you are ready. 

STATEMENT OF DOUGLAS L. WILLIAMS, PRESIDENT AND 

CHIEF EXECUTIVE OFFICER, ATLANTIC CAPITAL BANK,

ATLANTA, GA 

Mr. WILLIAMS. Chairman Lucas, Ranking Member Peterson, and 

Members of the Committee, I appreciate the opportunity to testify 

today regarding the impact of derivatives regulation on community 

banks and to add my support for legislation under consideration by 

the Committee. 

My name is Douglas Williams and I am the President and Chief 

Executive Officer of Atlantic Capital Bank. Located in Atlanta, 

Georgia, Atlantic Capital is a commercial bank with assets of approximately $870 million. We focus primarily on serving the banking needs of small- to mid-sized enterprises across Georgia. These 

enterprises are the engine of economic recovery and job creation in 

our region. 

Since opening in 2007, we have provided our customers with superior levels of service and local knowledge of a community bank 

by offering access to the expertise and capital typically found at 

larger banks. In 4 short years, we have created a better banking 

experience for over 350 companies and are proud of the relationships we have built with them. 

Atlantic Capital uses interest rate derivatives to manage risks 

that are inherent in banking and to help our customers manage 

their risks. We do not enter into credit default swaps or speculate 

with derivatives. Neither our use, nor our customers’ use, of derivatives poses systemic risk. Systemic risk in the derivatives market 

is concentrated among a few large financial institutions. Just 25 

banks hold 99.86 percent of the total notional volume. The remaining banks together comprise just .14 percent of the notional volume 

held at all U.S. banks. Certain proposed rules released by the 

CFTC could unnecessarily jeopardize our ability to manage risk, 

provide the services our clients need and remain competitive 

against larger institutions. I will focus on two issues: the swap 

dealer definition and the potential exemption from the financial entity definition for small banks. 

Community and regional banks are concerned that the swap 

dealer definition in the CFTC’s proposed rule could capture hundreds of smaller banks that offer risk management products to 

commercial customers. Title VII provided an exemption from this 

definition for any swap offered by a bank to a customer in connection with originating a loan with that customer. However, the 

CFTC’s proposed rule interpreting this exemption is unnecessarily 

narrow. In my written testimony, I elaborate on the specific ways 

in which this rule could hurt small banks. 

The Small Business Credit Availability Act clarifies that swaps 

offered by a bank in connection with an extension of credit that the 

bank has facilitated should be excluded from the definition of swap 

dealer. This bill will decrease the likelihood that many smaller 

banks will be forced to choose between limiting the services they 

offer to customers and complying with the same substantial regulatory burdens imposed on Wall Street dealers. Additionally, we 

40

are concerned that the CFTC’s proposed thresholds for the de minimis exception are extremely low. Absent an increase in these 

thresholds, many small banks will be forced to cease offering these 

services to customers to avoid facing the regulatory burden applicable to swap dealers. The bill to amend the Commodity Exchange 

Act to clarify the definition of swap dealer modifies the de minimis

exception to the swap dealer definition to alleviate this unnecessary 

burden for small banks. 

Additionally, many community banks are concerned that the 

clearing and trading requirements attendant to classification as financial entities could have the effect of shutting them out of the 

derivatives market. Initial estimates suggest that a community 

bank may have to pay a clearing member over $100,000 per year 

just to maintain the ability to clear swaps. While large buy-side 

firms and hedge funds may do enough trading per year to justify 

these costs, smaller banks may have no choice but to stop using derivatives. These banks would no longer be able to offer customers 

the risk management products they need and would have a more 

difficult time managing basic risks that are inherent in banking. 

We urge the Committee to pass the Small Business Credit Availability Act, which would provide an explicit exemption for the financial entity definition for small banks and smaller institutions 

that have $30 billion or less in assets or whose swaps exposure is 

no greater than $1 billion. Notably, the notional amount held at 

U.S. banks with $30 billion or less in assets comprises just .09 percent of the total notional amount held by all U.S. banks. 

We applaud the work of the Committee and the regulators to 

strengthen the OTC derivatives market, and we appreciate the 

Committee’s consideration of these important pieces of legislation 

to address the specific concerns of small banks. I thank you for opportunity to testify today and I am happy to answer any questions. 

[The prepared statement of Mr. Williams follows:]

PREPARED STATEMENT OF DOUGLAS L. WILLIAMS, PRESIDENT AND CHIEF EXECUTIVE

OFFICER, ATLANTIC CAPITAL BANK, ATLANTA, GA 

Chairman Lucas, Ranking Member Peterson, and Members of the Committee, I 

appreciate the opportunity to testify today regarding the impact of derivatives regulation on community banks, and to add my support for three pieces of legislation 

under consideration by the Committee. My name is Douglas Williams, and I am the 

President and Chief Executive Officer of Atlantic Capital Bank (‘‘Atlantic Capital’’). 

Located in Atlanta, GA, Atlantic Capital is a commercial bank with assets of approximately $870 million and deposits of more than $720 million. We focus primarily on serving the banking needs of small to mid-sized enterprises in metropolitan Atlanta and across Georgia. These enterprises are the engine of economic recovery and job creation in our region. 

Since opening our doors in 2007 we have provided our customers with the superior levels of service and local market knowledge often associated with smaller community banks while offering access to the banking expertise and capital typically 

found at larger money center banks. At Atlantic Capital Bank, our bankers have, 

on average, more than twenty-five years of banking experience. 

We take a relationship approach—rather than a transactional approach—to banking. In 4 short years we have created a better banking experience for over 350 

emerging growth companies, small businesses and mid-market enterprises, and we 

are proud of the relationships we have built with them. 

As is the case with hundreds of community and regional banks, Atlantic Capital 

uses interest rate derivatives to prudently manage risks that are inherent in the 

business of commercial banking and to help our customers meet their risk management needs. We do not enter into credit default swaps or use derivatives for speculaVerDate 0ct 09 2002 15:26 Nov 29, 2011 Jkt 041481 PO 00000 Frm 00044 Fmt 6633 Sfmt 6621 I:\DOCS\112-25\70998.TXT BRIAN
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1Please see the attached † and refer to page 1 of the report at: http://www.occ.treas.gov/topics/capital-markets/financial-markets/trading/derivatives/dq211.pdf. 

† [This document is retained in Committee files.] 2 Based on publicly available call report data on the website of the Federal Deposit Insurance 

Corporation. 

tion, trading or proprietary investment. At Atlantic Capital, we use derivatives to 

hedge the interest rate risk associated with financing we provide to our clients. 

Here are three brief examples:

(1) We offered a borrower a competitive construction financing that upon completion converted to a long-term financing. This allowed our customer to meet 

its objective of locking in its future interest expense on the long-term financing, 

while also allowing the bank to avoid taking on any incremental interest rate 

risk. Importantly, we could not have assisted this customer without interest 

rate swaps.

(2) Atlantic Capital provided financing to a small developer in a low-income 

area of downtown Atlanta that was leased to a commercial user. Our interest 

rate swap fixed the rate so that the lease payments exceed the cost of debt in 

any interest rate environment.

(3) Atlantic Capital financed a Georgia-based exporter of agricultural products 

and helped them lock in their interest expense with an interest rate swap, allowing them to reduce uncertainty in their business.

Neither our use nor our customers’ use of derivatives poses systemic risk. As was 

shown during the financial crisis, systemic risk in the derivatives market is concentrated among a few very large and interconnected financial institutions. According to the Office of the Comptroller of the Currency’s (OCC’s) Quarterly Report on 

Bank Trading and Derivatives Activities, the derivatives market is ‘‘dominated by 

a small group of large financial institutions.’’ While 1,071 banks and trust companies in the U.S. use derivatives, five banks hold 96% of the total notional volume 

and 86% of the total credit exposure. Looking beyond the top five, just 25 banks 

hold 99.86% of the total notional volume, and the remaining 1,046 banks together 

comprise just 0.14% of the entire notional volume held at all U.S. banks.1

In addition to the vast differences in the size and volume of trades done by small 

banks as compared to the largest financial institutions, there are important differences in the types of derivatives used by smaller banks and their purposes. Small 

banks typically use derivatives to hedge their own balance sheet risk or to facilitate 

the risk management needs of their customers. Small banks generally use interest 

rate, foreign exchange and, to a lesser extent, commodity derivatives. Use of credit 

derivatives among small banks is rare. Indeed, only 18 commercial banks in the 

U.S. currently use the credit default swaps made infamous by AIG Financial Products.2

My comments today reflect concern that certain proposed rules released by the 

Commodity Futures Trading Commission (‘‘CFTC’’)—including those relating to the 

key definitions in Title VII—could unnecessarily jeopardize our ability to manage 

risk, provide the services our clients need and remain competitive against much 

larger financial institutions. Indeed, this Committee has heard the testimony of representatives from two other community banks, Susquehanna Bank and Webster 

Bank, regarding the potential consequences of being swept into the ‘‘financial entity’’—or worse—‘‘swap dealer’’ definition in Title VII of Dodd-Frank. We share those 

concerns and strongly support the common-sense legislation recently introduced in 

the House that seeks to protect smaller banks from the substantial and unnecessary 

regulatory burden associated with the financial entity and swap dealer classifications. This legislation does not dilute or detract from the important features of Title 

VII designed to protect against systemic risk and promote transparency in the OTC 

derivatives market; rather, these bills strengthen the framework established in Title 

VII. 

I would like to focus today on two key issues: the swap dealer definition and the 

potential exemption from the financial entity definition for small banks. 

(1) Swap Dealer Definition 

Several community and regional banks have expressed concern that the swap 

dealer definition in the CFTC’s proposed rule could capture hundreds of community 

and regional banks that offer risk management products to commercial customers. 

One only need look at the comment file on the CFTC’s website for the entity definitions rule to get a sense for the concerns that numerous smaller banks have regardVerDate 0ct 09 2002 15:26 Nov 29, 2011 Jkt 041481 PO 00000 Frm 00045 Fmt 6633 Sfmt 6621 I:\DOCS\112-25\70998.TXT BRIAN
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3Please see comment file here: http://comments.cftc.gov/PublicComments/

CommentList.aspx?id=933. 4Please refer to pages 2–3 of the comment letter submitted by Atlantic Capital and 18 other 

community and regional banks to the CFTC for examples. 5Please refer to pages 5–6 of the comment letter submitted by Atlantic Capital and 18 other 

community and regional banks to the CFTC for additional comparative data: http://

www.chathamfinancial.com/wp-content/uploads/2011/02/Coalition-Comments-SmallBanks.pdf. 

ing an overly broad swap dealer definition.3 A broad definition would hamper the 

ability for many smaller banks to compete with larger financial institutions without 

any appreciable benefit in terms of enhanced market oversight or reduction in systemic risk. 

Title VII provided an exemption from the swap dealer definition for any swap offered by a bank to a customer in connection with originating a loan with that customer; however, the CFTC’s proposed rule interpreting this exemption is unnecessarily narrow. While not required by Title VII, the CFTC is considering whether to 

limit the exemption to swaps offered ‘‘contemporaneously’’ with origination of the 

loan. It is important to stress that the word ‘‘contemporaneously’’ is not found in 

the statute. As it is common for a borrower to enter into an interest rate swap before or after origination of the corresponding loan, the exemption should not be limited to any swap entered into contemporaneously with a loan. In addition, we would 

urge the CFTC to consider excluding from the swap dealer definition swaps offered 

by a bank in connection with syndicated loans, loan participations and bond 

issuances that are facilitated by the bank, as bank customers that benefit from 

these financings often use derivatives to hedge the associated interest rate risk.4

The Small Business Credit Availability Act modifies the swap dealer definition to 

clarify that swaps offered by a bank in connection with an ‘‘extension of credit’’ that 

the bank has facilitated should be excluded from the definition of swap dealer. This 

language is intended to clarify that the CFTC should not take an overly narrow 

read of the exclusion for these important transactions. This bill will decrease the 

likelihood that many smaller banks will be forced to choose between limiting the 

services they offer to customers and complying with the same substantial regulatory 

burdens imposed on the big Wall Street dealers. 

Additionally, we are concerned that the CFTC’s proposed thresholds for the socalled ‘‘de minimis exception’’ from the swap dealer definition are extremely low and 

should be increased. For example, if a bank were to offer just 21 hedges to customers in one year, it could be subject to the full panoply of regulation applicable 

to swap dealers, depending on the CFTC’s interpretation of the swap dealer definition. Atlantic Capital has been offering interest rate risk management products to 

our customers for only 18 months, and we currently have 21 swaps with an aggregate notional amount of $88 million on our books. We fear that many small banks, 

including Atlantic Capital, would simply be forced to cease offering these risk management services to customers to avoid facing the costly regulatory burden associated with registration as a swap dealer. 

We urge regulators to compare the thresholds for the de minimis exception 

against the volume of dealing done by the large financial institutions that control 

the vast majority of the OTC derivatives market. Available data 5 suggest that the 

CFTC could substantially increase the thresholds without running afoul of Congressional intent. For example, at number one on the OCC’s list of banks with the largest derivatives books, J.P. Morgan has more than $78 trillion in notional volume of 

active trades in place. The number ten firm on the OCC’s list, PNC Bank, has 0.43% 

of J.P. Morgan’s book, at around $337 billion in notional volume. Assuming that just 

10%, or $33 billion, of PNC’s total book was done with customers and that these 

trades were spread over 10 years would give you $3.3 billion per year—33 times the 

threshold above which a firm would be deemed a swap dealer under the current de 

minimis threshold of $100 million. Given the relatively infinitesimal level of activity 

by small financial institutions and the substantial regulatory burden that would be 

imposed if these institutions were deemed swap dealers, we believe the cost of additional oversight over smaller financial institutions would substantially outweigh any 

benefits to the financial system. 

The discussion draft that amends the Commodity Exchange Act to clarify the definition of swap dealer modifies the de minimis exception to the swap dealer definition to exempt entities from registering as a swap dealer if the average aggregate 

gross notional volume of its outstanding swaps over the preceding 12 months does 

not exceed $3 billion as adjusted by the Consumer Price Index for the 12 month period ending the preceding April 30. The bill’s modifications to the swap dealer definition and the inclusion of a specific threshold for the de minimis exception would 

43

6 Any exempt small financial institution still would have to meet the conditions required for 

the end-user exception to mandatory clearing and trading. 

result in the regulatory capture of firms which dominate the derivatives market 

while alleviating the burden for small banks which collectively comprise a fraction 

of the derivatives market. 

(2) Potential Exemption for Small Banks 

Congress provided the regulators with the authority to exempt small banks from 

the financial entity definition. If such an exemption were granted, these small banks 

would only be exempt from the clearing and trading requirements if they are hedging commercial risk and report certain information to the regulators.6 Moreover, 

small banks already are subject to existing regulations and supervisory guidance 

aimed at protecting against counterparty credit risks, including rules that require 

adequate capital to be held against all assets, including derivatives, and that dictate 

the maximum exposures a bank could take to one customer or counterparty. Furthermore, existing regulations allow examiners to take certain actions to prevent default, or to limit bank losses in the event of default. Atlantic Capital and other small 

banks employ sound risk management practices to manage our exposures to bank 

counterparties to a modest level including the use of collateral agreements with 

these counterparties which require them to post liquid collateral for our benefit as 

exposure is created. These protections adequately mitigate risks associated with an 

exception for small banks. 

Many community banks are concerned that the clearing and trading requirements 

attendant to classification as ‘‘financial entities’’ could have the effect of shutting 

them out of the derivatives market altogether. Initial estimates of clearing costs 

suggest that a community bank may have to pay a clearing member—in most cases 

an affiliate of a large Wall St. bank—over $100,000 per year just to maintain the 

ability to clear swaps. Additional fees would be charged by the clearinghouses and 

trading platforms, and legal counsel may be required to negotiate clearing-related 

documentation. 

While large buy-side firms and hedge funds may do enough trading per year to 

justify these costs, smaller banks may have no choice but to stop using derivatives. 

If so, these banks would no longer be able to offer customers the risk management 

products they need and would have a more difficult time managing basic risks that 

are inherent in banking. These would be unfortunate and entirely avoidable outcomes that would have the effect of weakening the banking system and the economy. 

We urge the Committee to prevent such outcomes by passing the Small Business 

Credit Availability Act which would provide a targeted exemption for smaller banks 

from the financial entity definition. The bill would modify Title VII and provide an 

explicit exemption from the financial entity definition for small banks, savings associations, credit unions and farm credit system institutions that have $30 billion or 

less in assets or whose current and potential future exposure for swaps is no greater 

than $1 billion. It should be noted that this $1 billion exposure threshold is just 1⁄8

the exposure threshold proposed by the CFTC in its definition for so-called ‘‘major 

swap participants’’ that have derivatives exposures large enough to pose a threat 

to the financial system. In addition, the OCC’s stats show that the notional amount 

held at U.S. banks and trust companies with $30 billion or less in assets comprises 

just 0.09% of the total notional amount held by all U.S. banks and trust companies. 

We recognize that it is important to resist legislative changes that run counter 

to the core objectives of Dodd-Frank by creating loopholes that would permit firms 

or activities that pose a risk to our financial system to escape regulatory capture; 

however, neither of these bills would have such an effect. Indeed, the targeted application and careful wording of these bills would strengthen Dodd-Frank by limiting 

unintended harm to smaller banks. The large dealers and major market players 

would still be subject to registration, supervision and substantial regulations aimed 

at reducing systemic risk and promoting transparency in the derivatives market. In 

addition, any market participant using derivatives for speculating, trading or investing still would be subject to the clearing, trading and margin requirements. 

I also wish to show support for H.R. 1840, an extremely important piece of legislation that enhances Title VII for the benefit of all market participants, including 

small banks. H.R. 1840 requires the CFTC to perform a qualitative and quantitative 

cost-benefit analysis and to make a reasoned determination that the benefits of new 

regulatory requirements justify the costs. H.R. 1840 lists specific factors, including 

available alternatives to regulation, that the CFTC must consider as part of its costbenefit analysis. We urge the Committee to pass H.R. 1840 and to take steps to enVerDate 0ct 09 2002 15:26 Nov 29, 2011 Jkt 041481 PO 00000 Frm 00047 Fmt 6633 Sfmt 6621 I:\DOCS\112-25\70998.TXT BRIAN
44

sure that the regulators prioritize quality over expedience in their rulemaking effort. 

Conclusion 

It is essential that small banks have continued access to interest rate risk management tools to support recovery and job creation at the small and middle-market 

businesses that form the foundation of the U.S. economy. We applaud the work of 

the Committee and the regulators to strengthen the OTC derivatives market, but 

we urge caution against finalizing rules that would place undue burdens on small 

banks that are incapable of posing future systemic risk and collectively engage in 

a fraction of the derivatives traded by the large dealers. We urge this Committee 

to address the specific concerns of small banks by passing the Small Business Credit 

Availability Act and the bill that would amend the Commodity Exchange Act to clarify the definition of swap dealer. 

I thank you for the opportunity to testify today, and I am happy to answer any 

questions that you may have.

The CHAIRMAN. Thank you. 

And Ms. Sanevich, whenever you are ready. 

STATEMENT OF BELLA L.F. SANEVICH, GENERAL COUNSEL, 

NISA INVESTMENT ADVISORS, L.L.C., ST. LOUIS, MO; ON

BEHALF OF AMERICAN BENEFITS COUNCIL; COMMITTEE ON 

INVESTMENT OF EMPLOYEE BENEFIT ASSETS 

Ms. SANEVICH. Good morning. Thank you for holding this hearing. My name is Bella Sanevich, and I am the General Counsel of 

NISA Investment Advisors. NISA is an investment advisor with 

over $75 billion under management for over 130 clients including 

private and public plans. I am testifying today on behalf of the 

American Benefits Council and the Committee on Investment of 

Employee Benefits Assets. These two organizations represent the 

vast majority of the nation’s private pension plans. Thank you for 

the opportunity to testify on the issues raised for ERISA plans by 

the proposed swap regulations. 

We very much appreciate the open and frank dialogue we have 

had with the agencies to date. The agencies have been very open 

to hearing our concerns. However, a number of issues remain, and 

I will focus on two critical issues for ERISA pension plans under 

the proposed business conduct standards and the need to modify 

the anomalous treatment of ERISA plans under the proposed margin regulations. 

ERISA pension plans use swaps to manage risk inherent in a 

pension plan’s liability and to manage plan funding obligations. If 

swaps are less available or more costly to pension plans, funding 

volatility and cost would increase substantially. This would put 

Americans’ retirement security at very great risk. It would also 

force companies to reserve billions of additional dollars to satisfy 

possible funding obligations, thus diverting those assets from job 

creation and economic growth. 

With respect to the business conduct standards, there are three 

main issues: the fiduciary issue, the advisor issue and the dealer 

retail issue. On the fiduciary issue, the rules proposed by the CFTC 

and the SEC would require swap dealers to review the qualification 

of an ERISA plan’s advisor. Such a review would make the dealer 

a fiduciary under current ERISA rules. Under ERISA, a fiduciary 

to a plan is not permitted to enter into a transaction with the plan, 

so if the swap dealer is a plan fiduciary, then any swap entered 

into with an ERISA is an illegal prohibited transaction. The soluVerDate 0ct 09 2002 15:26 Nov 29, 2011 Jkt 041481 PO 00000 Frm 00048 Fmt 6633 Sfmt 6601 I:\DOCS\112-25\70998.TXT BRIAN
45

tion is clear: No action required by the business conducts standards 

should cause a swap dealer to be treated as a fiduciary. This would 

simply be a clarification that there is not an irreconcilable conflict 

between two sets of regulations. The legislative discussion draft 

does exactly this and should be enacted. 

With respect to the advisor issue, under the Dodd-Frank Act, if 

a swap dealer acts as an advisor to a plan, then the swap dealer 

must act in the best interests of the plan. Unfortunately, the 

CFTC’s proposed rules interpret acting as an advisor so broadly 

that virtually every dealer would be treated as an advisor. This is 

an unworkable conflict of interest that would render swaps unavailable to plans. The reality is that contrary to the CFTC’s apparent assumptions, ERISA plans are prohibited by law from relying on their counterparty for advice. The business conduct standards should state that a dealer is not an advisor to a plan if the 

dealer represents that it is functioning as a counterparty and not 

as an advisor and the plan represents that it has its own internal 

or external advisor. In general, this is a structure adopted by the 

SEC in its proposed rules and by the legislative discussion draft. 

We strongly support these solutions. 

On the dealer veto issue, under the proposed CFTC and SEC 

rules, dealers have significant leverage over plans, contrary to Congressional intent. Congress’s intent to ensure that special entities 

are advised by a qualified advisor is satisfied by current ERISA 

law. This must be reflected in the business conduct rules, and the 

legislative discussion draft would do this with respect to ERISA 

plans. 

Last, the proposed margin regulations issued by the CFTC and 

the Prudential Regulators would, without consideration of the 

unique nature of ERISA plans, treat plans as high-risk financial 

end-users and impose the same burdensome margin requirements 

as are imposed on, for example, hedge funds. This classification is 

inconsistent with Congressional intent because ERISA plans are 

among the lowest risk end-users. They are highly regulated, subject 

to mandatory funding requirements and cannot file for bankruptcy. 

Treating ERISA plans as high-risk financial end-users will actually 

create an increased risk by significantly reducing or eliminating 

the use of a very powerful risk mitigation tool. This would have significant adverse consequences on the retirement security of millions of Americans and divert assets from job creation. As one of 

the safest counterparties, no mandated margin requirements 

should apply to ERISA plans on cleared swaps. 

We thank the Committee for holding this hearing and for the opportunity to testify. I will be happy to answer any questions. 

[The prepared statement of Ms. Sanevich follows:]

PREPARED STATEMENT OF BELLA L.F. SANEVICH, GENERAL COUNSEL, NISA

INVESTMENT ADVISORS, L.L.C., ST. LOUIS, MO; ON BEHALF OF AMERICAN BENEFITS

COUNCIL; COMMITTEE ON INVESTMENT OF EMPLOYEE BENEFIT ASSETS

My name is Bella Sanevich and I am the General Counsel of NISA Investment 

Advisors, L.L.C. NISA is an investment advisor with over $75 billion under management for over 130 clients, including private and public retirement plans. I am testifying today on behalf of the American Benefits Council (the ‘‘Council’’), with respect 

to which NISA is a member, and the Committee on Investment of Employee Benefit 

Assets (‘‘CIEBA’’). 

46

1For convenience of presentation, the references in this testimony to swaps, swap dealers, and 

major swap participants include security-based swaps, security-based swap dealers, and major 

security-based swap participants, respectively. 

The Council is a public policy organization representing principally Fortune 500 

companies and other organizations that assist employers of all sizes in providing 

benefits to employees. Collectively, the Council’s members either sponsor directly or 

provide services to retirement and health plans that cover more than 100 million 

Americans. 

CIEBA represents more than 100 of the country’s largest corporate sponsored pen- sion funds. Its members manage more than $1 trillion of defined benefit and defined 

contribution plan assets, on behalf of 15 million plan participants and beneficiaries. 

CIEBA members are the senior corporate financial officers who individually manage 

and administer ERISA-governed corporate retirement plan assets. 

We very much appreciate the opportunity to address the swap-related issues 

raised by the Dodd-Frank Wall Street Reform and Consumer Protection Act (the 

‘‘Dodd-Frank Act’’) for private retirement plans governed by the Employee Retirement Income Security Act of 1974 (‘‘ERISA’’) 1. And we applaud the Committee for 

holding a hearing on this critical set of issues. 

We believe that the agencies—the Commodity Futures Trading Commission 

(‘‘CFTC’’), which has jurisdiction over the types of swaps most important to plans, 

the Securities and Exchange Commission (‘‘SEC’’), and the Prudential Regulators—

have been working extremely hard to provide needed guidance. Also, the agencies 

have been very open to input on the swap issues from the ERISA plan community. 

We very much appreciate the open and frank dialogue we have had with the agencies to date. 

However, certain proposed regulations affecting ERISA plans could have very adverse effects on plans, none of which were intended by Congress. Accordingly, for 

reasons discussed in more detail below, we testify today in support of:

• This hearing’s legislative discussion draft that would address critical issues 

arising under the proposed business conduct standards;

• Needed legislation that would modify the anomalous treatment of ERISA plans 

under proposed regulations addressing margin requirements; and

• H.R. 1840, which would set forth specific factors that must be considered by the 

CFTC in connection with a cost-benefit analysis of any regulation or proposed 

regulation. 

Importance of Swaps to ERISA Plans 

At the outset, it is important to discuss why the use of swaps is so important to 

ERISA pension plans and why any material disruption of that use could have significant adverse effects on plans, the companies sponsoring plans, and the participants whose retirement security depends in large part on plans. 

ERISA pension plans use swaps to manage the risk resulting from the volatility 

inherent in determining the present value of a pension plan’s liability, as well as 

to manage plan funding obligations imposed on companies maintaining defined benefit plans. The risk being managed is largely interest rate risk. If swaps were to 

become materially less available or become significantly more costly to pension 

plans, funding volatility and cost could increase substantially. This would put Americans’ retirement assets at greater risk and force companies in the aggregate to reserve billions of additional dollars to satisfy possible funding obligations, most of 

which may never need to be contributed to the plan because the risks being reserved 

against may not materialize. Those greater reserves would have an enormous effect 

on the working capital that would be available to companies to create new jobs and 

for other business activities that promote economic growth. The greater funding volatility could also undermine the security of participants’ benefits. 

Let me explain this volatility issue further. In a defined benefit pension plan, a 

retiree is promised payments in the future. The obligations of a pension plan include 

a wide range of payments, from payments occurring presently to payments to be 

made more than 50 years from now. The present value of those payments varies 

considerably with interest rates. If interest rates fall, the present value of liabilities 

grows. So if interest rates drop, the present value of liabilities can grow, creating 

additional risk for participants and huge economic burdens for the company sponsoring the plan. Swaps are used to address this risk, as illustrated in a very simplified example below. 

Assume that a plan has $15 billion of assets and $15 billion of liabilities so that 

the plan is 100% funded and there is thus no shortfall to fund. Assume that interest 

rates fall by one percentage point. That alone would increase liabilities substanVerDate 0ct 09 2002 15:26 Nov 29, 2011 Jkt 041481 PO 00000 Frm 00050 Fmt 6633 Sfmt 6621 I:\DOCS\112-25\70998.TXT BRIAN
47

tially. Based on a real-life example of a plan whose interest rate sensitivity is somewhat higher than average, we assume a 13% increase in plan liabilities to $16.95 

billion. Based on a realistic example, we assume that assets increase to $15.49 billion. Thus, the decline in interest rates has created a $1.46 billion shortfall. Under 

the general pension funding rules, shortfalls must be amortized over 7 years, so that 

the plan sponsor in this example would suddenly owe annual contributions to the 

plan of approximately $248 million, starting with the current year. A sudden annual 

increase in cash outlays of $248 million can obviously present enormous business 

challenges as well as increased risks for participants. 

Swaps are a very important hedging tool for plan sponsors. Hedging interest rate 

risk with swaps effectively would avoid this result by creating an asset—the swap—

that would rise in value by the same $1.46 billion if interest rates fall by one percentage point. Thus, by using swaps, plan sponsors are able to avoid the risk of sudden increases in cash obligations of hundreds of millions of dollars. If, on the other 

hand, plans’ ability to hedge effectively with swaps is curtailed by the new rules, 

funding obligations will become more volatile, as illustrated above. This will, in 

turn, increase risk for participants and force many employers to reserve large 

amounts of cash to cover possible funding obligations, thus diverting cash from critical job retention, business growth projects, and future pension benefits. 

Without swaps, some companies would attempt to manage pension plan risk in 

other ways, such as through the increased use of bonds with related decreases in 

returns. One company recently estimated that its expected decrease in return that 

would result from using bonds in lieu of interest rate swaps would be approximately 

$100 million. And this pain will be felt acutely by individuals. Companies that lose 

$100 million per year may well need to cut jobs and certainly will have to think 

about reducing pension benefits. 

We also note that the bond market is far too small to replace swaps entirely as 

a means for plans to hedge their risks. There are not nearly enough bonds available, 

especially in the long durations that plans need. Furthermore, a flood of demand 

for bonds would drive yields down, increasing the present value of plan liabilities 

dramatically. In short, a shift from swaps to bonds would be costly, insufficient, and 

potentially harmful for plans, the U.S. markets, and the economy in general. 

Summary of Key Concerns 

We have four main concerns to discuss today. Those concerns are summarized 

below.

• Business conduct standards. The Dodd-Frank Act directed the SEC and the 

CFTC to impose business conduct standards on swap dealers and major swap 

participants (‘‘MSPs’’), with heightened standards applicable when dealers and 

MSPs enter into swaps with a ‘‘Special Entity’’ (which includes ERISA plans). 

These rules were intended to protect ERISA plans that enter into swaps. As 

proposed by the CFTC and, to a lesser extent, the SEC, these standards would 

have very harmful effects on ERISA plans and could operate to eliminate their 

ability to use swaps. The legislative discussion draft raised for discussion in 

connection with this hearing would address this issue very effectively.

• Margin requirements. The CFTC and the Prudential Regulators have proposed margin requirements that would treat ERISA plans as high-risk financial 

end-users (i.e., treating ERISA plans as entities that pose a systemic risk to the 

financial system). Accordingly, the proposed rules would impose very costly 

margin requirements on ERISA plans that enter into swaps. These requirements will create more risk for ERISA plans, and will divert plan assets away 

from more productive uses that could benefit participants. In some cases, the 

requirements could even discourage plans from entering into swaps due to the 

significant increase in opportunity cost as well as actual cost. These results are 

clearly unjustified, since ERISA plans are among the safest counterparties, for 

reasons discussed below. Legislation may well be needed to solve this problem.

• Cost-benefit analysis. We believe that an appropriately thorough cost/benefit 

analysis would clearly reveal that the treatment of ERISA plans in the proposed 

business conduct standards and the margin requirements would have significant costs and no real benefit. We are concerned that the unique nature of 

ERISA plans has not been taken into account in the regulatory process, and a 

more detailed cost-benefit analysis is needed to avoid serious unintended consequences. H.R. 1840, as introduced by Representatives Conaway, Quigley, 

McHenry, Boswell, and Neugebauer, would be very helpful in addressing this 

issue.

• Effective date. The retirement plan community will need substantial time to 

prepare to comply with an entirely new system. Near-term effective dates can 

48

only bring substantial harm by triggering confusion and misunderstandings 

that undermine our country’s retirement security. In this regard, it is essential 

that the rules have sufficiently long implementation dates so that plans and 

their advisors can plan for an orderly transition to the new system without unnecessary, harmful, and costly disruptions. Moreover, plans and their advisors 

will need to establish additional operational and compliance systems, and the 

rules should be sequenced in a manner so that new systems do not have to be 

modified to take into account rules issued subsequently. Of course, it is also 

critical that no rules apply to swaps entered into before the regulatory effective 

date. 

Discussion 

Business Conduct Standards 

Under the proposed business conduct rules, a swap dealer or MSP entering into 

a swap with an ERISA plan is required to provide counsel and assistance to the 

plan. The underlying rationale of these rules was that swap dealers are more knowledgeable than plans and are likely to take advantage of plans unless compelled to 

help them. This rationale has no application to ERISA plans. By law, ERISA plans 

are prohibited from entering into swaps unless they have an advisor with an expertise in swaps. Accordingly, ERISA plans do not have any need for any assistance 

or counsel from dealers. And ERISA plans surely have no interest in counsel from 

their counterparty. So at best, the rules have no effect. Unfortunately, the rules as 

proposed by the CFTC and, to a lesser extent, the SEC would actually have very 

serious adverse effects. Here are just three examples, although there are other 

issues with respect to these proposed rules.

• Requiring actions that would make swaps impossible. The counsel that a 

swap dealer is required to provide to a plan under the rules proposed by the 

CFTC would make the swap dealer a plan fiduciary under ERISA; the SEC’s 

rules may have the same effect. This is the case because the proposed rules 

would require the swap dealers and MSPs to review the qualifications of the 

plan’s advisor. Such a review would make the swap dealer or MSP a fiduciary 

under ERISA. (Under the proposed regulations issued by the Department of 

Labor (‘‘DOL’’) regarding the definition of a ‘‘fiduciary,’’ other actions required 

by the proposed business conduct standards would also convert a swap dealer 

or MSP into a fiduciary. The announcement that the DOL will re-propose the 

fiduciary regulations provides some help on these issues, but does not address 

the present-law problem.)

Pursuant to the DOL’s prohibited transaction rules, a fiduciary to a plan cannot 

enter into a transaction with the plan. So, if the swap dealer or MSP is a plan 

fiduciary, then any swap entered into with an ERISA plan is an illegal prohibited transaction under the DOL rules applicable to plans. Thus, the business 

conduct rules would require a swap dealer or MSP to perform an illegal action 

or refrain from entering into a swap with a plan. Generally, the only way to 

avoid violating the law would be for swaps with plans to cease, with the adverse 

results described above.

Congress clearly never intended to indirectly prohibit plans from utilizing 

swaps. The CFTC, SEC, and DOL should jointly announce that no action required by the business conduct rules will cause a swap dealer or MSP to be 

treated as fiduciary. This would simply be a clarification that there is not an 

irreconcilable conflict between two sets of regulations. If the agencies do not do 

this, Congress needs to step in and enact the legislative discussion draft which 

does exactly this.

• Acting as an advisor. Under the Dodd-Frank Act, if a swap dealer acts as an 

advisor to a Special Entity, such as an ERISA plan, the swap dealer must act 

in the best interests of the Special Entity. Unfortunately, the CFTC’s proposed 

business conduct standards interpret ‘‘acting as an advisor’’ so broadly that all 

swap dealers would be treated as advisors, e.g., by reason of providing information on the risks of the swap. Even if that were not the case, the CFTC’s proposed business conduct standards do not distinguish between selling (e.g., a 

dealer pitching a swap might describe a swap as meeting the objectives of a 

plan) and advising (where a relationship of reliance exists based on shared objectives).

If a dealer is treated as an advisor and thus must act in the best interests of 

its counterparty, this is an unworkable conflict of interest that in virtually 

every circumstance would render swaps unavailable to plans. It is not clear to 

us how a swap dealer that owes a fiduciary duty to its shareholders to obtain 

49

the best possible deal with the plan can simultaneously act in the best interests 

of the plan, which is the dealer’s counterparty. Absent clarification of this issue, 

if the proposed business conduct standards are finalized as proposed, we are 

concerned that virtually all swaps with ERISA plans would likely have to stop, 

due to this conflict.

The core point is that it would be a violation of ERISA for an ERISA plan to 

rely on its counterparty for advice. Based on that point and business common 

sense, our members do not rely on their counterparty for advice. A dealer makes 

its pitch to an ERISA plan. The plan representatives then take the dealer’s 

pitch and fully analyze it with their own advisors. That is how the ERISA plan 

world works. ERISA plans may not, and do not, rely on their counterparties. 

The CFTC needs to revise its regulations to reflect this.

We believe that the business conduct standards should state that a dealer is 

not an ‘‘advisor’’ if (1) the dealer represents in writing that it is functioning as 

a counterparty and not as an advisor, and (2) the Special Entity represents in 

writing that it has its own internal or external advisor. In general, this is the 

structure adopted by the SEC in its proposed business conduct standards and 

by the legislative discussion draft. We believe this provides a very workable 

framework on this issue.

• Dealers’ right to veto plan advisors. Under the proposed CFTC and SEC 

rules, swap dealers and MSPs are required to carefully review the qualifications 

of a plan’s advisor; as noted above, this could effectively preclude swaps with 

plans by making the swap dealer or MSP a fiduciary. In addition, this requirement would give swap dealers and MSPs the ability to veto any advisor advising a plan with respect to a swap. We are not suggesting that a dealer or MSP 

would use this power, but the fear of that result could have a significant effect 

on advisors’ willingness to zealously represent plans’ interests against a dealer 

or MSP. In addition, a dealer or MSP could use this requirement to demand 

information regarding the plan or the advisor, potentially giving the dealer or 

MSP an unfair informational advantage in the swap transaction.

Also, the specter of liability for not vetoing an advisor that subsequently makes 

an error may have an adverse impact on the dealers’ or MSPs’ willingness to 

enter into swaps with plans; this may result in the dealers and MSPs demanding additional concessions from the plans or their advisors, or may cause the 

dealers and MSPs to cease entering into swaps with plans. In all of the above 

cases, the effect on plans’ negotiations with dealers and MSPs would be extremely adverse. This, too, was never intended by Congress.

Congress’ intent in the business conduct standards was to ensure that Special 

Entities are being advised by a qualified advisor. Congress’ objective is by law 

met in the case of an ERISA plan, so there is no need for swap dealers or MSPs 

to be given a counterproductive veto power. By law, ERISA fiduciaries must 

have expertise in the area in which they are advising and must use their expertise prudently. Consistent with the statute, a dealer or MSP should be deemed 

to meet the business conduct standards relating to dealers or MSPs acting as 

counterparties if a plan represents that it is being advised by an ERISA fiduciary. The legislative discussion draft would do exactly this with respect to 

ERISA plans. 

Margin Requirements 

The CFTC and the ‘‘Prudential Regulators’’ (i.e., banking regulators such as the 

Board of the Federal Reserve System and the FDIC) have proposed very burdensome margin requirements on uncleared swaps entered into by ERISA plans. The 

CFTC and Prudential Regulators would treat ERISA plans as ‘‘high-risk financial 

end-users’’ and impose the same margin requirements on ERISA plans as are imposed on, for example, hedge funds. As explained below, this treatment is inappropriate and inconsistent with Congressional intent because ERISA plans are highly 

regulated, and subject to mandatory funding requirements, and cannot file for bankruptcy; thus, they are actually the lowest risk end-users. Treating ERISA plans as 

high-risk financial end-users will actually create risk, rather than reduce it, thereby 

adversely affecting plan participants. We strongly believe that, as one of the safest 

counterparties, no mandated margin requirements should apply to the uncleared 

swaps entered into by ERISA plans. 

Background. The Dodd-Frank Act directed the CFTC, the SEC, and the Prudential Regulators to adopt rules for swap dealers and MSPs that impose margin requirements on uncleared swaps. The Dodd-Frank Act directed the agencies to use 

this authority to protect the financial integrity of the markets by ensuring that the 

50

margin requirements are appropriate in light of the risk associated with an 

uncleared swap. 

The precise nature of the statutory direction to the agencies is not clear. But, as 

described below, the agencies have used this statutory provision to impose margin 

requirements on all end-users, which is hardly consistent with the statute. 

Proposed regulations. The CFTC and the Prudential Regulators have issued 

proposed regulations under the Dodd-Frank provisions described above. The proposed regulations establish three levels of risk, and place all end-users in one of the 

following categories:

• High-risk financial end-users (the riskiest),

• Low-risk financial end-users, and

• Non-financial end-users (the lowest risk).

The ‘‘high-risk financial end-users’’ include, for example, hedge funds and ERISA 

plans. End-users in the ‘‘high-risk’’ category are subject to the most onerous margin 

requirements. The ‘‘low-risk financial end-users’’ are financial entities that are subject to regulatory capital requirements, like insurance companies and banks. Endusers in the ‘‘low-risk’’ category are subject to somewhat less onerous margin requirements. Non-financial end-users are considered the lowest risk group under the 

rules and are subject to the least onerous requirements. 

Our view. The treatment of ERISA plans as high-risk financial end-users does 

not make sense; ERISA plans are at the least some of the lowest risk end-users:

• Unlike almost any other counterparty, ERISA plans cannot avoid their obligations to their counterparties by filing for bankruptcy. If an ERISA plan’s sponsor files for bankruptcy and the plan has outstanding liabilities, the PBGC assumes those liabilities. We are not aware of any instance where the PBGC has 

avoided, or could have avoided, any assumed swap liabilities.

• ERISA plans are subject to stringent funding requirements. In addition to 

ERISA plans having their own assets, plan sponsors are obligated to make contributions to satisfy plan liabilities. Virtually no other counterparty has that 

type of ‘‘credit enhancement’’.

• ERISA plans are not operating entities with the corresponding business risks.

• ERISA plans are tightly regulated by, for example, prudent diversification rules 

and strict fiduciary rules.

• ERISA plan assets must be held in a trust that is not subject to the creditors 

of the plan sponsor.

• Informal surveys indicate that no ERISA plan has ever failed to pay off its swap 

liabilities.

In this context, onerous margin requirements for ERISA plans do not make sense. 

The margin requirements would result in a significant increase in both opportunity 

cost as well as the actual cost of swaps. The proposed margin requirements are so 

onerous that some plans will find it prohibitively expensive to enter into the swaps 

necessary to hedge their risks. This would undermine the retirement security of millions of Americans, and leave plans and plan sponsors exposed to very significant 

market and interest rate risk. To the extent some plans continue to use some swaps, 

the increased costs will result in more potential risk (due to a reduction of a risk 

mitigating strategy, such as interest rate swaps), benefit reductions, and freezes, 

thus hurting the plan participants we are all trying to protect. In light of the absence of risk posed by ERISA plans, we believe that ERISA plans should not be subject to any mandated margin requirements. 

Cost-Benefit Analysis 

ERISA plans are subject to a regulatory regime under ERISA which makes them 

unlike any other counterparty. We are not suggesting that ERISA plans deserve better treatment, but they do deserve the right treatment taking into account their 

unique circumstances. As demonstrated above, the agencies have not recognized 

these unique aspects in their rulemaking. We believe that a requirement that, prior 

to issuing any proposed or final regulation, the agencies must engage in an appropriately thorough cost-benefit analysis might well address this shortcoming. If 

ERISA plans are already required by law to have expert advisors, there is no benefit 

and there is substantial cost to giving dealers and MSPs veto power over plan advisors. Similarly, if it is illegal for an ERISA plan to rely on a dealer to act as its 

advisor, and there is no evidence that this has ever happened, there is no benefit 

attributable to a rule that treats dealers as advisors based on normal selling activiVerDate 0ct 09 2002 15:26 Nov 29, 2011 Jkt 041481 PO 00000 Frm 00054 Fmt 6633 Sfmt 6621 I:\DOCS\112-25\70998.TXT BRIAN
51

ties. In contrast, the cost of effectively precluding ERISA plans from using swaps 

is enormous. 

The agencies need a more effective and more specific means of assessing the costs 

and benefits of their regulations. H.R. 1840 would be a major step forward in that 

regard. 

Effective Date 

A $600 trillion market cannot be restructured overnight without devastating consequences. As discussed above, the use of swaps is critical to the ability of plans 

to manage very significant risks. If a regulatory structure is imposed in haste, the 

possibilities for damage to the retirement system and the retirement security of millions of Americans are very high. In that context, three principles should be followed. 

Time to comply. Plans and their advisors will need substantial time to comply 

with complex and significant new rules. A sufficiently long implementation time is 

essential so that plans and their advisors can plan for an orderly transition to the 

new system without unnecessary, harmful, and costly disruptions. If there is not 

sufficient time to design compliance systems, plans may be unable to enter into 

needed swaps. In other cases, confusion and misunderstandings will lead to unnecessary disputes, which will in turn create costs and disruption. 

Ordering guidance. When an entire market is being restructured, there are substantial interrelationships between the different parts of the restructuring. If one 

set of rules has an earlier effective date, systems will have to be built to accommodate those rules. In building those systems, ERISA plans and others will need to 

make judgments about how to comply with other parts of the Dodd-Frank Act for 

which there is no guidance. When subsequent rules are issued, and those rules inevitably vary in some respect from the systems built by market participants, the 

compliance systems will need to be rebuilt, requiring a whole new transition period. 

This is very costly and disruptive. To avoid this, it is essential that the agencies 

coordinate the timing of guidance on related issues, including providing guidance 

first on definitional issues. 

Prospective effect. It almost goes without saying that no new rules should apply 

directly or indirectly to swaps entered into prior to the effective date of such rules. 

The dollars involved in swap transactions can be enormous, and accordingly, the 

transactions are very carefully negotiated. In that context, it would be fundamentally unfair to impose new rules on prior transactions that were negotiated by the 

parties in good faith based on the law in effect at the time. Moreover, the effect of 

disrupting the financial arrangement of the parties could be extremely adverse for 

one or both of the parties. 

Conclusion 

We thank the Committee for holding this hearing and for the opportunity to testify. Swaps are very important instruments for ERISA plans, giving plans a means 

to manage risks that are potentially very disruptive. We applaud the agencies for 

their hard work and openness to input. However, we remain very concerned that 

certain proposed rules have been issued that are inconsistent with the structure of 

ERISA plans and could cause very significant disruption for ERISA pension plans 

and the participants who rely on those plans for retirement security. We would like 

to continue to work with this Committee, the other Committees of jurisdiction, and 

the agencies to address these concerns so that we have a system that provides the 

important protections intended by the Dodd-Frank Act without unintended adverse 

consequences. 

I would be happy to answer any questions.

The CHAIRMAN. Thank you. 

Mr. Giancarlo, when you are ready. 

STATEMENT OF J. CHRISTOPHER GIANCARLO, J.D.,

EXECUTIVE VICE PRESIDENT—CORPORATE DEVELOPMENT, 

GFI GROUP INC.; BOARD MEMBER, WHOLESALE MARKETS 

BROKERS ASSOCIATION, AMERICAS, NEW YORK, NY 

Mr. GIANCARLO. Thank you, Mr. Chairman, Ranking Member, 

and Members of this Committee. My name is Chris Giancarlo. I am 

Executive Vice President of GFI Group. I testify today on behalf of 

the Wholesale Markets Brokers Association, Americas, the 

WMBAA, representing the largest inter-dealer brokers operating in 

52

wholesale markets across a broad range of swap and other products. Our trading systems are the prototypes for swap execution facilities, or SEFs, under Dodd-Frank. We support H.R. 2586, the 

SEF Clarification Act. 

As we speak this morning, GFI and other WMBAA member firms 

are hard at work employing many thousands of people, executing 

billions of dollars of swaps that account for over 90 percent of brokered swap trades taking place around the globe. The liquidity created by WMBAA members helps to reduce the cost of risk management for American businesses. Before John Deere enters into a 

contract to sell tractors to an Argentinean co-op, it generally finds 

a hedge for the foreign exchange risk. That hedge is often provided 

by a dealer firm or a bank that undertakes the balance sheet knowing it can offset the exposure on one of the hybrid systems that we 

operate for wholesale transactions. 

So how is this done? Imagine a large room filled with long desks, 

not just in New York City but in places like Louisville, Kentucky, 

Jersey City, New Jersey, and Sugarland, Texas. Each desk has a 

group of professional men and women set up with several computer 

screens and telephone squawk boxes that transmit prices to our 

customers. These professionals use sophisticated trading technology 

such as central limit order book, request for quote, or RFQ systems, electronic workup and auction and matching sessions. Each 

method we use is geared to the specific dynamics of the financial 

products we broker. We call this range of trading methods hybrid 

brokerage. It is what CFTC Commissioner Bart Chilton described 

in a press interview after touring our firm as ‘‘big dynamic operations, not just a couple of guys in a back room with a phone.’’

Swap markets are different than futures markets. Participants 

are all institutional, not retail. We deal with an infinitely larger 

number of complex products than in the highly commoditized futures markets. Even in the most liquid swaps products, trading is 

quite variable. The most active single named credit default swap 

contracts trade a little over 20 times a day and the majority trade 

less than once a day. It is because of this trading on liquidity characteristic of swaps that are so unique that our firms have developed the hybrid brokerage methods I have described. Developing 

and operating these hybrid systems creates thousands of well-paying American jobs. 

Turning to the regulatory process, I include in my written testimony a recent comment letter that lays out simple, straightforward 

recommendations for changes to the proposed SEF rules to better 

accord with the law. For example, Congress made very clear in 

Dodd-Frank that SEFs may conduct business using ‘‘any means of 

interstate commerce.’’ Congress’s words are clear. Any means of 

interstate commerce includes the full range of hybrid brokerage 

methods that I have described. 

We are very concerned with the CFTC’s proposed SEF rules restricting trading methods to only electronic central limit order book 

or RFQ systems for non-block cleared swaps. This approach is inconsistent with the plain reading of Dodd-Frank and its legislative 

history. Henry Ford famously told Model T buyers that they could 

have any color they wanted as long as it was black. Here, the 

CFTC is interpreting Dodd-Frank to say that for many trades, 

53

1The WMBAA is an independent industry body representing the largest inter-dealer brokers 

(‘‘IDBs’’) operating in the North American wholesale markets across a broad range of financial 

products. The WMBAA and its member firms have developed a set of Principles for Enhancing 

the Safety and Soundness of the Wholesale, Over-The-Counter Markets. Using these Principles

as a guide, the WMBAA seeks to work with Congress, regulators, and key public policymakers 

on future regulation and oversight of institutional markets and their participants. By working 

with regulators to make wholesale markets more efficient, robust and transparent, the WMBAA 

sees a major opportunity to assist in the monitoring and consequent reduction of systemic risk 

in the country’s capital markets. The five founding members of the WMBAA are BGC Partners; 

GFI Group; ICAP; Tradition and Tullett-Prebon. More about the WMBAA can be found at: 

www.WMBAA.org.

SEFs can use any means of interstate commerce as long as it is 

limited to electronic systems. 

We also question what substantive analysis has been done on the 

economic effect of these restrictions which may diminish trading liquidity and run up transaction costs for American companies and 

businesses. Getting those rules wrong will impact not just banks 

and investment managers but thousands of American companies 

that use swaps to hedge risk and better manage their capital for 

growth and reinvestment into the economy. As Commissioner 

Chilton said in a recent interview, it is important that ‘‘we do not 

mess up platforms that are currently working well. This is a delicate balancing act.’’

Mr. Chairman, consideration and passage of the SEF Clarification Act will provide regulators with a clear expression of 

Congress’s intent to permit SEFs to use any means of interstate 

commerce to execute swaps transactions. We commend this Committee for considering these bipartisan proposals. Thank you for 

your time this morning. 

[The prepared statement of Mr. Giancarlo follows:]

PREPARED STATEMENT OF J. CHRISTOPHER GIANCARLO, J.D., EXECUTIVE VICE

PRESIDENT—CORPORATE DEVELOPMENT, GFI GROUP INC.; BOARD MEMBER, 

WHOLESALE MARKETS BROKERS ASSOCIATION, AMERICAS, NEW YORK, NY 

Introduction 

Thank you Chairman Lucas, Ranking Member Peterson, and Members of the 

Committee for providing this opportunity to participate in today’s hearing. 

My name is Chris Giancarlo. I am Executive Vice President of GFI Group Inc., 

a global wholesale broker of swaps and other financial products. I am also a member 

of the Board and former Chairman of the Wholesale Markets Brokers Association, 

Americas (the ‘‘WMBAA’’).1 I am testifying today on behalf of the WMBAA. 

I welcome the opportunity to discuss with you legislative proposals amending 

Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act 

(‘‘Dodd-Frank’’) from the perspective of the primary intermediaries of over-thecounter (‘‘OTC’’) swaps operating today here in the United States and across the 

globe. 

My company, GFI, and the other members of the WMBAA, each have generations 

of experience operating at the center of the global wholesale financial markets by 

aggregating and disseminating prices and fostering trading liquidity for financial institutions around the world. While I am speaking to you now, wholesale brokers, 

sometimes called ‘‘inter-dealer’’ brokers, are facilitating the execution of hundreds 

of thousands of OTC trades corresponding to an average of $5 trillion in size across 

the range of foreign exchange, interest rate, Treasury, credit, equity and commodity 

asset classes in both cash and derivative instruments. 

Our trading systems or platforms are the prototypes for ‘‘swap execution facilities,’’ or ‘‘SEFs’’ under the Dodd-Frank Act. There is a misconception that a ‘‘swap 

execution facility’’ is a new concept created by the Dodd-Frank Act. In fact, long before, during and after the financial crisis, GFI and my WMBAA brethren have been 

hard at work, employing thousands of people—many here in the United States—

executing swaps transactions that account for over 90% of intermediated swaps 

transactions taking place around the globe. 

54

2 Energy Metro DESK, February 7, 2011. p. 6. The article further states, ‘‘Chilton says his trip 

North to GFI changed his opinion about SEFs and OTC transparency in general. He says the 

hybrid broker model (voice and screens) for example, which actually is the rule and not the exception around the market, was news to him.’’ 3Wholesale brokers provide highly sophisticated trade execution services, combining teams of 

traditional ‘‘voice’’ brokers with sophisticated electronic trading technology. As in virtually every 

sector of the financial services industry in existence over the past 50 years, wholesale brokers 

and their dealer clients began connecting with their customers by telephone. As technologies advanced and markets grew larger, more diverse and global, these systems have advanced to meet 

the changing needs of the market. Today, these systems include fully electronic central limit 

order books, RFQ systems, automated ‘‘work up,’’ auction and matching sessions and pricing 

screens. The particular blend of human interaction and trading technology utilized is based on 

the unique liquidity characteristics and market dynamics of individual swaps products for the 

purpose of best enhancing trading liquidity. We refer to this integration of voice brokers with 

the range of electronic brokerage systems as ‘‘hybrid brokerage’’. 

CFTC Commissioner Bart Chilton had this to say about a recent visit he made 

to GFI’s New York brokerage floor, ‘‘I was surprised by what I didn’t know. GFI 

and others like them were always in OTC land. Why would I know about what they 

do? Well, these are big, dynamic operations, not just a couple of guys in a back room 

with a phone. I don’t think we have a full appreciation of the OTC markets yet.’’ 2

SEF Proposed Rulemakings 

In the past year, the WMBAA has carefully considered and publicly responded to 

the many SEF rule proposals announced by the CFTC and SEC. For your reference, 

I have included a recent comment letter as an appendix to this testimony that lays 

out our primary concerns and makes simple, straightforward recommendations for 

changes to the proposed rulemakings. 

The WMBAA appreciates the thoughtful approach of both Commissions and their 

staffs in implementing Dodd-Frank. It is clear that the two staffs have worked hard 

to generally try to balance the compelling interests of fostering growth in competitive OTC markets while ensuring that regulatory oversight will be in place to monitor for risks to these vital markets. 

The WMBAA generally supports the SEC’s interpretation of the SEF definition as 

it applies to trade execution through ‘‘any means of interstate commerce,’’ including 

the full range of request-for-quote (‘‘RFQ’’) systems, order books, auction platforms 

or voice brokerage trading that are used in the market today.3 Such an approach 

is consistent with the letter and spirit of the Dodd-Frank Act and ensures flexibility 

in the permitted modes of execution. 

On the other hand, the WMBAA is concerned with the CFTC’s proposed SEF 

rules that work to restrict trading methods that are not exclusively central limit 

order book or RFQ for non-block, cleared swaps. We believe this approach is inconsistent with the requirement in the statute that SEFs may utilize ‘‘any means of 

interstate commerce.’’ The CFTC’s proposed rule is a one size fits all approach that 

limits market efficiency and customer choice. 

Henry Ford famously told Model T buyers that they could have any color they 

wanted as long as it was black. Here, the CFTC is interpreting the Dodd Act to say 

that, for many trades SEFs can use any means of interstate commerce, as long as 

it is limited to RFQ or central limit order book systems. 

The commercial flaw with the CFTC’s approach is that it is largely the liquidity 

characteristics of a given swap product, not whether or not the instrument is cleared 

or part of a block transaction, that determines which blend of hybrid brokerage is 

most suited for trade execution. We know from decades of experience that, if a swap 

trades in high volume with great liquidity, then central limit order book systems 

may work fine. If, however, the particular swap instrument trades in lower volume 

with limited liquidity, then electronic order book systems will not succeed and other 

‘‘hybrid’’ methods are more suitable. For these reasons, it is the position of the 

WMBAA that hybrid brokerage should be clearly recognized as an acceptable mode 

of trade execution for all swaps whether ‘‘Required’’ or ‘‘Permitted’’ under the 

CFTC’s proposal. 

We believe this rule proposal is not supported by a plain reading or the legislative 

history of the Dodd-Frank Act. Worse, it will constrain the very ‘‘hybrid’’ systems 

that are currently relied upon for liquidity formation in U.S. swaps markets. In 

swaps markets without retail customer participation, the WMBAA questions what 

useful protections are afforded to swap dealers and major swap participants by regulations that would limit the methods by which they may execute their swaps transactions. 

These regulatory proposals need to be carefully considered not only in their own 

right, but more so for their snowball effect that could impact U.S. economic growth, 

competitiveness and, most critically, much needed American job creation. Getting 

55

those rules wrong will impact not just banks and investment managers, but thousands of American businesses that use swaps to hedge risk and better manage their 

capital for growth and reinvestment into the economy. 

SEF Clarification Act 

Mr. Chairman, introduction, consideration, and passage of the SEF Clarification 

Act will provide regulators with a clear expression of Congress’ legislative intent 

and ensure that the final rules remain within the framework of competitive OTC 

markets. The WMBAA commends this Committee for considering this very important bipartisan proposal. This hearing is sending a loud and clear message to the 

CFTC that its proposed SEF rule is inconsistent with the intent of the authors of 

Section 733 of the Dodd-Frank Act. 

The WMBAA appreciates the bipartisan efforts of Congressmen Scott Garrett, 

Robert Hurt, Gregory Meeks and Congresswoman Carolyn Maloney to try and make 

sure that the interpretations of the Dodd-Frank Act rules governing swap execution 

facilities foster competitive sources of liquidity for market participants. We agree 

with their concern to promote the transparent evolution of swaps trading on SEFs 

to ensure that a vibrant swap market continues to develop in the U.S. 

The WMBAA continues to work with the CFTC and SEC to help create a regulatory framework that promotes a competitive marketplace for SEFs. The WMBAA 

remains concerned, as it has expressed in its comment letters to the SEC and the 

CFTC, that limitations on permitted modes of trade execution or requirements to 

display or delay quotes will cause significant disruptions to OTC swaps markets 

with the potential to drive trading offshore. We question what substantive analysis 

has been done on the economic effects of the CFTC proposed rule, which could run 

up transaction costs in the U.S. swaps markets. 

Similarly, the WMBAA does not believe that there is any justification or legislative authority for the RFQ requirement of five possible respondents. Rather, consistent with the Dodd-Frank Act’s SEF definition, the threshold analysis should consider whether the system meets the ‘‘multiple to multiple’’ requirement set forth in 

the SEF definition. The WMBAA finds it inconsistent that the CFTC’s proposed 

rules permit a SEF to operate a ‘‘multiple to one’’ RFQ system, while at the same 

time (without clear explanation), impose arbitrary limits on the various multiple-tomultiple hybrid execution platforms utilized by wholesale brokers. By contrast, the 

SEC’s proposed rule merely requires that a RFQ system has the ‘‘ability’’ to send 

the request to many participants, but not an obligation. We believe that the SEC’s 

approach is more consistent with the statutory language of the Dodd-Frank Act. 

Just as regulators were intimately involved in the debate surrounding the legislation that resulted in the Dodd-Frank Act, we encourage Congress to remain vigilant 

in its oversight of the regulatory rulemaking process. We applaud legislators for providing additional guidance to a regulatory agency misinterpreting statutory language and Congressional intent. 

WMBAA Suggested Revisions to the CFTC SEF Rulemaking 

In our most recent comment letter to the CFTC, the WMBAA identified the following as highest priority issues for attention:

• ‘‘Permitted’’/‘‘Required’’ Transaction Classification System. The WMBAA 

does not believe that distinguishing between ‘‘Permitted’’ and ‘‘Required’’ swaps 

is beneficial to the continued operation of competitive, liquid OTC markets. 

Such artificial designations of swap transactions may result in perverse consequences to OTC swaps markets. Further, the proposed restriction for ‘‘Required Transactions’’ to only those traded on order books or RFQ systems is contrary to the Commodity Exchange Act (‘‘CEA’s’’) permitted transaction of swaps 

‘‘by any means of interstate commerce’’ (emphasis added). Under the current 

classifications, many hybrid brokerage methodologies may be prohibited or face 

an uncertain future, as each would require individual analysis by the Commission for compliance with the core principles. While certain requirements should 

be mandated during trade execution (i.e., audit trail, trade processing, and reporting), limitations on methodologies used in trade execution should be considered in accordance with Congress’ authorization of trade execution through ‘‘any 

means of interstate commerce’’ and weighed against any potential implications 

on liquidity formation and American market competitiveness.

• The ‘‘15 Second Rule.’’ The WMBAA believes that the CFTC’s proposed 15 

second timing delay before a trader can execute against a customer’s order or 

a SEF can execute two customers against each other is not contemplated by 

CEA, as amended by the Dodd-Frank Act, nor is it supported by legislative history. This concept, which seems to have originated in the futures exchange markets, will create uncertainty and risk in the swaps markets. This requirement 

56

4See, e.g., letter from Timothy W. Cameron, Esq., Managing Director, Asset Management 

Group, Securities Industry and Financial Markets Association, to CFTC, dated March 8, 2011.

does not appear to be consistent with the protection of investors. Even asset 

management firms, acting on behalf of state and local government pension 

funds, endowments, ERISA funds, 401(k) and similar types of retirement funds, 

all of whom have a statutory fiduciary duty to their clients, are opposed to this 

requirement.4 The WMBAA recognizes that this approach may work in the 

highly liquid futures market. However, the 15 second delay ignores the episodic 

nature of liquidity in the swaps markets and will have a detrimental impact 

on transactional efficiency, cost and market liquidity. The WMBAA questions 

what substantive analysis has been done on the economic effects of 15 Second 

Rule, which could run up transaction costs in the U.S. swaps markets frustrating American companies’ ability to hedge commercial risk, particularly endusers. 

• SEF Impartial Access. The WMBAA has requested that the CFTC delete the 

provision in the Proposed Rules providing impartial access to SEFs for independent software vendors (‘‘ISVs’’). The WMBAA believes this requirement is 

beyond the legal authority granted in the CEA and expands the impartial access statute beyond ‘‘market participants’’ to include entities lacking any intent 

to transact in swaps. There is no Congressional intent or legislative history to 

indicate that the term ‘‘market participants’’ should be read beyond the commonly understood definition as used by the industry today.

• Margin Assumptions. In the CFTC’s proposed rule for risk management requirements for derivatives clearing organizations (‘‘DCOs’’), DCOs must establish initial margin requirements that, in part, take into account the amount of 

time needed to liquidate a defaulting clearing member’s position. To that end, 

the DCO must use a five business day liquidation horizon for cleared swaps not 

executed on a designated contract market (‘‘DCM’’), but a one business day liquidation horizon for all other products that it clears. The result of this proposed 

arrangement would be that DCOs would impose higher margin requirements for 

swaps executed on SEFs than swaps executed on DCMs. This result would be 

inconsistent with the competitive trade execution landscape envisioned by the 

Dodd-Frank Act. Such a regulatory scheme may also violate specific provisions 

of the Dodd-Frank Act which require a DCO to adopt rules providing that all 

swaps with the same terms and conditions submitted to the DCO for clearing 

are economically equivalent within the DCO and may be offset with each other 

within the DCO. 

Harmonization 

While the substance of the proposed requirements for SEF registration and core 

principles are extremely important, it is equally, if not more, important that the 

final regulatory frameworks are harmonized between the two agencies. A failure to 

achieve harmonization will lead to regulatory arbitrage and unreasonably burden 

market participants with redundant compliance requirements. As the recent SEC–

CFTC joint proposed rule recognized, ‘‘a Title VII instrument in which the underlying reference of the instrument is a ‘narrow-based security index’ is considered a 

security based swap subject to regulation by the SEC, whereas a Title VII instrument in which the underlying reference of the instrument is a security index that 

is not a narrow-based security index (i.e., the index is broad-based) is considered a 

swap subject to regulation by the CFTC.’’ Any discrepancy in the Commissions’ regulatory regimes will give market participants incentive to leverage the slight distinctions between these products to benefit from more lenient rules. 

Similarly, in a world of competing regulatory regimes, business naturally flows to 

the market place that has the best regulations—not necessarily the most lenient, 

but certainly the ones that balance execution flexibility with participant protections. 

For example, GFI businesses are operating and subject to oversight in the UK by 

the FSA and globally by regulatory agencies in France, Singapore, Hong Kong, 

Japan and Korea. European and Asian markets are not imposing restrictions on 

methods of execution. U.S. regulations need to be in harmony with those of foreign 

jurisdictions to avoid driving trading liquidity away from U.S. markets to those offering greater flexibility in modes of trade execution. 

‘‘Rule of Construction’’—Pre-Trade Price Transparency 

Section 5h of the CEA, as amended by Section 733 of the Dodd-Frank Act, includes a ‘‘rule of construction’’ indicating that ‘‘the goal of this section is to promote 

the trading of swaps on swap execution facilities and to promote pre-trade price 

transparency in the swaps market.’’

57

This rule of construction, which was added during the House-Senate Conference 

Committee, is an aspirational and undefined goal. It must be considered subordinate 

to the required statutory provisions of the Dodd-Frank Act. According to a Congressional Research Services report, longstanding principles of statutory interpretation 

indicate that particular substantive requirements, such as the mandate that regulators consider the impact of certain actions on market liquidity, override general 

canons of statutory construction. There are no operative provisions for pre-trade 

price transparency in the Dodd-Frank Act that correspond to the non-binding rule 

of construction. However, there exist other substantive provisions which were designed to increase transparency in OTC swaps markets. 

For example, Section 2a(13)(E) of the CEA requires that, for rules providing for 

the public availability of transaction and pricing data for swaps, the CFTC shall 

contain provisions ‘‘that take into account whether the public disclosure will materially reduce market liquidity.’’ The same provision requires that the CFTC consider 

an ‘‘appropriate time delay for reporting large notional swap transactions (for block 

trades) to the public.’’ These post-trade reporting requirements are indicative of 

Congressional recognition that OTC swaps markets thrive when the need for transparency is balanced against the impact on market liquidity. Congress clearly sought 

to preserve market liquidity and protect businesses’ ability to hedge commercial risk 

and to appropriately plan for the future, promoting economic growth and job creation. 

Further, the SEF core principles in Section 5h(f) of the CEA require a SEF to 

make public timely information on price, trading volume, and other trading data on 

swaps and electronically capture and transmit trade information with respect to 

transactions executed on the facility. These statutory requirements precede any legislative ‘‘goals’’ that may be imposed by regulatory rulemakings. The SEF core principles ensure that market information is promptly and accurately reported to both 

regulators and to market participants without materially impeding liquidity formation. To impose requirements in any other manner would disrupt the competitive 

trade execution marketplace, where trading systems or platforms vie with each 

other to win their customers’ business through better price, provision of superior 

market information and analysis, deeper liquidity and better service. 

It is important to recognize that the ‘‘goal’’ of pre-trade price transparency is not 

inconsistent with the traditional operations of wholesale brokers. Because revenue 

is generated from commissions paid on executed trades, wholesale brokers seek to 

complete more transactions with more customers. It is in each wholesale brokers 

economic interest to naturally and consistently disseminate pre-trade price information—bids and offers—to the widest practical range of customers with the express 

purpose of price discovery and the matching of buyers and sellers. The trading systems and platforms employ a number of means of pre-trade transparency, including 

software pricing analytics, electronic and voice price dissemination, and electronic 

price work up technology. 

Wholesale brokers generally maintain extensive trade reporting systems supported by sophisticated technology that can provide regulators with real-time trading information, increasing transparency and providing critical information on financial conditions and market dynamics. Wholesale brokers also increase transparency in OTC markets by publishing market and pricing data and facilitating enhanced audit trails to monitor against market fraud and manipulation. 

Different Characteristics of Futures and OTC Markets 

While the relationship between exchange-traded and OTC markets generally has 

been complementary, each market provides unique services to different trading constituencies for products with distinctive characteristics and liquidity needs. As a result, the nature of trading liquidity in the exchange-traded and OTC markets is 

often materially different. It is critically important that regulators recognize the difference. 

Highly liquid markets exist for both commoditized, exchange-traded products, and 

the more standardized OTC instruments, such as U.S. treasury securities, equities 

and certain commodity derivatives. Exchange-traded markets provide a trading 

venue for the most commoditized instruments that are based on standard characteristics and single key measures or parameters. Exchange-traded markets with central counterparty clearing rely on relatively active order submission by buyers and 

sellers and generally high transaction flow. Exchange-traded markets, however, 

offer no guarantee of trading liquidity as evidenced by the high percentage of new 

exchange-listed products that regularly fail to enjoy active trading. Nevertheless, for 

those products that do become liquid, exchange marketplaces allow a broad range 

of trading customers (including retail customers) meeting relatively modest margin 

requirements to transact highly standardized contracts in relatively small amounts. 

58

5 ISDA & SIFMA, ‘‘Block Trade Reporting for Over-the-Counter Derivatives Markets,’’ January 18, 2011, (‘‘ISDA/SIFMA Block Trade Study’’). Available at http://www.isda.org/speeches/

pdf/Block-Trade-Reporting.pdf. 6See ISDA/SIFMA Block Trade Study. 7 Inclusive of all tenors, strikes and duration. 

8 ISDA/SIFMA Block Trade Study; Comment Letter of JPMorgan (January 12, 2011). 

9Kathryn Chen, Michael Fleming, John Jackson, Ada Li, and Asani Sarkar, An Analysis of 

CDS Transactions: Implications for Public Reporting (September 2011), available at http://

www.newyorkfed.org/research/stafflreports/sr517.pdf.

As a result of the high number of market participants, the relatively small number 

of standardized instruments traded, and the credit of a central counterparty clearer, 

liquidity in exchange-traded markets is relatively continuous in character. 

In comparison, many swaps markets and other less commoditized cash markets 

feature a broader array of less-standardized products and larger-sized orders that 

are traded by fewer counterparties, almost all of which are institutional and not retail. Trading in these markets is characterized by variable or non-continuous liquidity. To offer one simple example, of the over 4,500 corporate reference entities in 

the credit default swaps market, 80% trade less than five contracts per day.5 Such 

thin liquidity can often be episodic, with liquidity peaks and troughs that can be 

seasonal (certain energy products) or more volatile and tied to external market and 

economic conditions (e.g., many credit, energy and interest rate products). 

General Comparison of OTC Swaps Markets to Listed Futures Markets 6

Characteristic OTC Swaps Listed Futures 

Trading Counterparties 10s–100s (no retail) 100,000s (incl. retail) 

Daily Trading Volume 1,000s 100,000s 

Tradable Instruments 100,000s 7 1,000s 

Trade Size Very large Small 

Drawing a simple comparison, the futures and equities exchange markets generally handle on any given day hundreds of thousands of transactions by tens of 

thousands of participants (many retail), trading hundreds of instruments in small 

sizes. In complete contrast, the swaps markets provide the opportunity to trade tens 

of thousands of instruments that are almost infinitely variable. Yet, on any given 

day, just dozens of large institutional counterparties trade only a few thousand 

transactions in very large notional amounts. 

The effect of these very different trading characteristics results in fairly continuous liquidity in futures and equities compared with limited or episodic liquidity in 

swaps. There is richness in those differences, because taken together, this market 

structure has created appropriate venues for trade execution for a wide variety of 

financial products and a wide variety of market participants. But the difference is 

fundamental and a thorough understanding of it must be at the heart of any effective rule making under Title VII of the Dodd-Frank Act. The distinct nature of 

swaps liquidity has been the subject of several studies and comment letters presented to the CFTC and the SEC.8

The unique nature of swaps markets liquidity was recently analyzed by the New 

York Federal Reserve.9 Their study found that the most active of single-name CDS 

contracts traded a little over 20 times per day, and the majority of single name CDS 

contracts trade less than once a day, but in very large sizes. This is wholly different 

than the hundreds of thousands of trades that take place each day in many exchange traded instruments. 

It is because of the limited liquidity in many of the swaps markets that they have 

evolved into ‘‘dealer’’ marketplaces for institutional market participants. That is, 

corporate end-users of swaps and other ‘‘buy side’’ traders recognize the risk that, 

at any given time, a particular swaps marketplace will not have sufficient liquidity 

to satisfy their need to acquire or dispose of swaps positions. As a result, these 

counterparties may chose to turn to well capitalized sell-side dealers that are willing 

to take on the ‘‘liquidity risk’’ for a fee. These dealers have access to secondary trading of their swaps exposure through the marketplaces operated by wholesale and 

inter-dealer brokers such as GFI Group. These wholesale marketplaces allow dealers to hedge the market risk of their swaps inventory by trading with other primary 

dealers and large, sophisticated market participants. Without access to wholesale 

markets, the risk inherent in holding swaps inventory would cause dealers to have 

to charge much higher prices to their buy side customers for taking on their liquidity risk, assuming they remain willing to do so. 

59

1The Wholesale Markets Brokers’ Association Americas is an independent industry body representing the largest inter-dealer brokers (‘‘IDBs’’) operating in the North American wholesale 

markets across a broad range of financial products. The WMBAA and its member firms have 

Continued

American Capital Markets Risk Being Driven Offshore—Again 

In closing, it is clear that the U.S. over-the-counter swaps markets are on the 

cusp of seismic changes that could have unintended, yet far reaching, consequences 

if not enacted with prudence and common sense. 

We are reminded of the sensitivity of the regulatory process by the effects of a 

whole other set of U.S. financial market regulations that were put in place several 

decades ago. Those regulations remind us of the eternal law of unintended consequences. 

Many professionals in the swaps brokerage industry began work in the late 1970s 

and 1980s in London. In those days, London was the central marketplace for bank 

deposits of billions of U.S. Dollars held outside the U.S.—the so-called Euro-dollar 

market. The most critical stimulus for the development of the Euro-dollar market 

was Regulation Q promulgated under the Glass-Steagall Act. Under Reg Q, the Federal Reserve fixed maximum interest rates that U.S. member banks could pay on 

U.S. Dollar deposits. Because of these ceilings, Dollar deposits in non-U.S. banks, 

paying a higher interest rate, became more attractive than deposits in U.S. banks. 

As a result, the overseas Euro-dollar market grew rapidly. Combined with various 

U.S. foreign exchange controls, Reg Q led to the development of a major non-U.S. 

marketplace for deposits of U.S. currency. That non-U.S. marketplace stimulated all 

manner of economic development and job creation—NOT jobs here in the United 

States, but overseas in London and elsewhere. 

It is useful to keep in mind this ill-fated financial regulation in the course of today’s hearing of proposed U.S. regulations of SEFs. We must look carefully at these 

regulations not only in their own right, but also for their impact on U.S. economic 

growth, market vibrancy and, most critically, job creation. It is well worth our time 

to ask ourselves:

• Which regulations being proposed today will constrict liquidity tomorrow in U.S. 

swaps markets?

• Will the ‘‘15 second rule’’ be the new Reg. Q shifting U.S. markets offshore?

• Will regulatory bias toward electronic trading for clearable, non-block swaps 

drive markets to places that allow trading to be done through the greater flexibility of hybrid execution?

• Will certain rule proposals lead to the loss of jobs for U.S. hybrid brokerage employees and their replacement with workers abroad?

In posing these questions, we should be aware that the answers are not only important to us in America, but are also being weighed by the Lord Mayors of London 

and Geneva, the exchange operators of Singapore and the financial industrialists of 

Hong Kong and Beijing. Their gain is our loss. As American businesses and employers, we must get it right for the sake of the American economy and jobs. 

APPENDIX—WMBAA LETTER TO THE SEC & CFTC—JUNE 3, 2011

June 3, 2011

Hon. GARY GENSLER, Hon. MARY SCHAPIRO,

Chairman, Chairman,

Commodity Futures Trading Commission, Securities and Exchange Commission 

Washington, D.C.; Washington, D.C. 

Re: Implementation of the Dodd-Frank Wall Street Reform and Consumer Protection 

Act; Core Principles and Other Requirements for Swap Execution Facilities (RIN 

3038–AD18); Real-Time Public Reporting of Swap Transaction Data (RIN 3038–

AD08); Reporting and Dissemination of Security-Based Swap Information (File 

3235–AK80); Registration and Regulation of Security-Based Swap Execution Facilities (RIN 3235–AK93)

Dear Chairman Gensler and Chairman Schapiro:

As a follow-up to the participation of Wholesale Markets Brokers’ Association 

Americas (‘‘WMBAA’’) 1 members in the joint staff roundtable hosted by the ComVerDate 0ct 09 2002 15:26 Nov 29, 2011 Jkt 041481 PO 00000 Frm 00063 Fmt 6633 Sfmt 6621 I:\DOCS\112-25\70998.TXT BRIAN
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developed a set of Principles for Enhancing the Safety and Soundness of the Wholesale, OverThe-Counter Markets. Using these principles as a guide, the Association seeks to work with Congress, regulators and key public policymakers on future regulation and oversight of over-thecounter (‘‘OTC’’) markets and their participants. By working with regulators to make OTC markets more efficient, robust and transparent, the WMBAA sees a major opportunity to assist in 

the monitoring and consequent reduction of systemic risk in the country’s capital markets. For 

more information, please see www.wmbaa.org. 2See, e.g., letter from J. Christopher Giancarlo, Chairman, WMBAA, to SEC and CFTC, dated 

July 29, 2010; see also letter from Julian Harding, Chairman, WMBAA, to SEC and CFTC, 

dated November 19, 2010; letter from Julian Harding, Chairman, WMBAA, to SEC and CFTC, 

dated November 30, 2010; letter from Julian Harding, Chairman, WMBAA, to SEC, dated January 18, 2011; letter from Stephen Merkel, Chairman, WMBAA, to CFTC, dated February 7, 

2011; letter from Stephen Merkel, Shawn Bernardo, Christopher Ferreri, J. Christopher 

Giancarlo and Julian Harding, WMBAA, to CFTC, dated April 4, 2011. 3The WMBAA notes that, among the extensive Dodd-Frank Act rulemakings, the CFTC has 

not comprehensively addressed the regulation of brokers engaged in swap-related activities. Section 721 of the Dodd-Frank Act amends the definitions of ‘‘futures commission merchants’’ and 

‘‘introducing brokers’’ in the CEA to permit these intermediaries to trade swaps on behalf of 

customers. As of the effective date, these intermediaries may be required to register with the 

CFTC and become members of the National Futures Association. As such, these intermediaries 

would be subject to the National Futures Association’s rules and examinations, for example Series 3 examination, which is based on futures-related activity. The WMBAA urges the CFTC 

to provide clarity on this issue by delaying the implementation of swap introducing broker and 

futures commission merchant registration and issuing interpretive guidance to assist swap 

intermediaries in understanding what activities might mandate registration and the requirements for Commission registration. 

modity Futures Trading Commission (‘‘CFTC’’ or ‘‘Commission’’) and the Securities 

and Exchange Commission (‘‘SEC’’ or ‘‘Commission’’) on May 3 and May 4, 2011 

dedicated to discussing the implementation of the Dodd-Frank Wall Street Reform 

and Consumer Protection Act (‘‘Dodd-Frank Act’’), the WMBAA appreciates the opportunity to provide additional comments related to the importance of proper harmonization of and implementation by the two agencies as the rulemaking process 

advances. 

The WMBAA believes that it is vital to the stability and liquidity provided by 

OTC swaps and security-based swaps (collectively referred to as ‘‘swaps’’) markets 

to ensure that swap and security-based swap execution facilities (collectively referred to as ‘‘SEFs’’) are brought under the new regulatory regime in such a way 

that fosters the competitive nature of OTC markets and continues to provide a deep 

source of liquidity for market participants. 

In addition to the formal comments previously submitted with respect to the 

CFTC and SEC’s proposed rules,2 the WMBAA offers additional comments on the 

appropriate implementation of the proposed rules and substantive requirements 

that would pose significant burdens unless harmonized between the CFTC and SEC. 

The WMBAA also recognizes that certain provisions of the Commodity Exchange 

Act (‘‘CEA’’) and the Securities Exchange Act of 1934 (‘‘1934 Act’’), as amended by 

the Dodd-Frank Act, impose specific requirements on market participants as of the 

effective date, July 16, 2011. In particular, we note the statutory provisions could 

be read to require on and after July 16, 2011 the ‘‘trading’’ of swaps only on registered designated contract markets (‘‘DCMs’’), national securities exchanges and 

SEFs. 

Congress envisioned that the Title VII rulemaking process would move quickly 

and that all rules and regulations would be in place prior to the July 16, 2011 effective date. It is clear that final rules for the registration of SEFs will not be in place 

by the July 16, 2011 effective date. Further, the Commissions have not made any 

determinations about which swaps will be subject to the mandatory clearing requirement, which will dictate which swaps are required to be traded on a SEF. 

The WMBAA is concerned that, absent regulatory relief by the Commissions, existing trade execution systems or platforms such as those provided by WMBAA 

members, and the swaps transactions entered into thereon will be subject to significant legal uncertainty due to the incomplete rulemaking process. Further, we believe IDBs should not be required to register as futures commission merchants 

(‘‘FCMs’’), introducing brokers (‘‘IBs’’) or broker-dealers to ‘‘broker’’ swaps while the 

Commissions are in the process of finalizing the SEF registration and regulation 

rules.3 The WMBAA strongly encourages the Commissions to issue as soon as possible a legal opinion, no action position or guidance which clarifies that swaps entered into after July 15, 2011 are not required to be traded on a registered DCM, 

national securities exchange and/or SEF or brokered by a registered FCM, IB or 

broker-dealer until the Commissions have issued final rules which are effective regarding the registration of SEFs and issued final rules which are effective with respect to the mandatory trading of swaps. The WMBAA looks forward to discussing 

61

4Further Definition of ‘‘Swap,’’ ‘‘Security-Based Swap,’’ and ‘‘Security-Based Swap Agreement’’; Mixed Swaps; Security-Based Swap Agreement Recordkeeping, 76 Fed. Reg. at 29 845 

(May 23, 2011). 

the impact of the self-effectuating provisions in the CEA and 1934 Act with the 

Commissions. 

Importance of Harmonization between Agencies and Foreign Regulators 

While the substance of the proposed requirements for SEF registration and core 

principles are extremely important, it is equally, if not more, important that the 

final regulatory frameworks are harmonized between the two agencies. A failure to 

achieve harmonization will lead to regulatory arbitrage and unreasonably burden 

market participants with redundant compliance requirements. As the recent SEC–

CFTC joint proposed rule recognized, ‘‘a Title VII instrument in which the underlying reference of the instrument is a ‘narrow-based security index’ is considered a 

security-based swap subject to regulation by the SEC, whereas a Title VII instrument in which the underlying reference of the instrument is a security index that 

is not a narrow-based security index (i.e., the index is broad-based), the instrument 

is considered a swap subject to regulation by the CFTC.’’ 4 Any discrepancy in the 

Commissions’ regulatory regimes will give market participants incentive to leverage 

the slight distinctions between these products to benefit from more lenient rules. 

The Dodd-Frank Act’s framework was constructed to encourage the growth of a 

vibrant, competitive marketplace of regulated SEFs. Final rules should be crafted 

that encourage the transaction of OTC swaps on these trading systems or platforms, 

as increased SEF trading will increase liquidity, and transparency for market participants and increase the speed and accuracy of trade reporting to swap data repositories (‘‘SDRs’’). Certain provisions relate to these points, such as the permitted 

methods of trade execution, the scope of market entities granted impartial access 

to SEFs, the formulation of block trade thresholds and compliance with SEF core 

principles in a flexible manner that best recognizes the unique characteristics of 

competitive OTC swaps markets. 

Based upon its review of both the SEC and the CFTC’s Proposed Rules, the 

WMBAA suggests that the agencies consider the release of further revised proposed 

rules incorporating comments received for additional review and comment by market participants. This exercise would ensure that the SEC and CFTC have the opportunity to review each of their proposals and integrate appropriate provisions 

from the proposed rules and comments in order to arrive at more comprehensive 

regulations. Further, the WMBAA encourages the CFTC and SEC to work together 

to attempt to harmonize their regulatory regimes to greatest extent possible. While 

some of the rules will differ as a result of the particular products subject to each 

agency’s jurisdiction, inconsistent rules will make the implementation for SEFs 

overly burdensome, both in terms of time and resources. 

As an example, the WMBAA encourages the CFTC and the SEC to adopt one common application form for the registration process. While regulatory review of the application by the two agencies is appropriate, reducing the regulatory burden on applicant SEFs to one common form would allow for a smoother, timelier transition 

to the new regulatory regime. Because the two proposed registration forms are consistent in many respects, the WMBAA believes the differences between the two proposed applications could be easily reconciled to increase regulatory harmonization 

and increase efficiency. 

Similarly, there needs to be a consistent approach with respect to block trades. 

Not only should the threshold calculations be derived from similar approaches, allowing for tailored thresholds that reflect the trading characteristics of particular 

products, but the methods of trade execution permitted by the Commissions should 

both be flexible and within the framework of the SEF definition. 

U.S. regulations also need to be in harmony with regulations of foreign jurisdictions to avoid driving trading liquidity away from U.S. markets toward markets offering greater flexibility in modes of trade execution. In particular, European regulators have not formally proposed swap execution rules with proscriptive limits on 

trade execution methodology. We are not aware of any significant regulatory efforts 

in Europe to mandate electronic execution of cleared swaps by institutional market 

participants. 

In a world of competing regulatory regimes, business naturally flows to the market place that has the best regulations—not necessarily the most lenient, but certainly the ones that have the optimal balance of liquidity, execution flexibility and 

participant protections. In an OTC swaps market that excludes retail participants, 

the WMBAA questions what useful protections are afforded to swap dealers and 

major swap participants by regulations that would limit the methods by which they 

62

may execute their orders. U.S. regulations need to be in harmony with regulations 

from foreign jurisdictions to avoid driving trading liquidity away from U.S. markets 

towards markets offering greater flexibility in modes of trade execution. 

Implementation of Final Rules 

Compliance Timeline 

The WMBAA believes that the timeline for implementation of the final rules is 

as important, if not more important than, the substance of the regulations. The 

WMBAA members recognize and support the fundamental changes to the regulation 

of the OTC swaps markets resulting from the passage of the Dodd-Frank Act and 

will commit the necessary resources to diligently meet the new compliance obligations. However, the CFTC and SEC must recognize that these changes are significant and will result in considerable changes to the operations and complex infrastructure of existing trading systems and platforms. 

It is necessary that any compliance period or registration deadline provides sufficient opportunity for existing trade execution systems or platforms to modify and 

test systems, policies and procedures to ensure that its operations are in compliance 

with final rules. It is very difficult to determine the amount of time needed to ensure compliance with the rules until the final requirements are made available. 

However, providing market participants with an insufficient time frame for compliance could harm the efficient functioning of the markets if existing entities can no 

longer operate until they have built the requisite platforms to comply with every 

measure in final rules. 

The vast number of changes required to existing trading systems or platforms to 

register as a SEF will impose a substantial burden in the short term. Upon implementation of the Dodd-Frank Act and final rules, wholesale brokers that register 

as SEFs will be required to undertake activities that include, but are not limited 

to: (i) developing extensive rulebooks; (ii) meeting new substantive and reportingrelated financial requirements; (iii) implementing sophisticated trading, surveillance, monitoring and recordkeeping processes and technology; (iv) creating extensive self-regulatory capabilities and entering into arrangements with their customers setting forth the terms of this new arrangement; (v) potentially restructuring 

the governance structure of their companies, including identifying and recruiting 

independent board members and establishing required governance committees; (vi) 

potentially altering the mix of their existing customer base and adding new customers; (vii) implementing appropriate contractual and technological arrangements 

with clearing houses and SDRs; (viii) hiring staff and creating a compliance program structured to meet the Commissions’ specifications; and (ix) educating staff on 

the requirements relating to trade execution, clearable vs. non-clearable trades, 

blocks vs. non-blocks, bespoke and illiquid trades, end-users vs. non-end-users and 

margin requirements. 

As this list indicates, these undertakings are monumental. This burden is compounded when considering that the users of intermediary services will themselves 

be going through dramatic change, responding to new clearing, margin and capital 

requirements, new business conduct standards and changes to the means by which 

they are able to interact with their end customers. The WMBAA would suggest the 

SEC and CFTC consider the implementation of other regulatory regimes with lesser 

burdens than the Dodd-Frank Act, such as the introductions of TRACE reporting 

for corporate bonds and Regulations SHO and NMS in the equity markets. The imposition of these new regimes was far less drastic of a change to the markets and 

required participants to expend far fewer resources. Yet, the imposition of these regimes, particularly Regulation NMS, was conducted over a staged period to allow 

market participants sufficient time to comply. 

Appropriate ‘‘Phasing’’ of Final Rules 

Based upon the plain language of the Dodd-Frank Act, the mandatory trade execution requirement will become effective at the time that swaps are deemed ‘‘clearable’’ by the appropriate Commission. Accepting the premise that the mandatory 

trade execution requirement cannot be enforced until there are identified ‘‘clearable’’ 

swaps and swaps are ‘‘made available for trading,’’ the Commissions need to ensure 

that a functioning and competitive marketplace of registered SEFs exists at the 

time the first trade is cleared and made available for trading. As such, it is necessary that SEFs be registered with the CFTC or SEC, as applicable and available 

to execute transactions at the time that trades begin to be cleared under the new 

laws. The WMBAA estimates that its members currently account for over 90% of 

inter-dealer intermediated swaps transactions taking place around the world today. 

If the SEF registration process is not effectively finalized by the time various swaps 

63

5Statement of Jill E. Sommers before the Subcommittee on General Farm Commodities and 

Risk Management, House Committee on Agriculture, May 25, 2011, available at http://agriculture.house.gov/pdf/hearings/Sommers110525.pdf.

are deemed clearable, there could be serious disruptions in the U.S. swaps markets 

with adverse consequences for broader financial markets. 

Furthermore, requiring absolute compliance with final rules within a short time 

frame is particularly troublesome for likely future SEFs, as such a result may provide DCMs or national securities exchanges with an unfair advantage in attracting 

trading volume due to their ability to quickly meet the regulatory burdens. Congress 

distinguished between exchanges and SEFs, intending for competitive trade execution to be made available on both platforms. Congress also recognized the importance of SEFs as distinct from exchanges, noting that a goal of the Dodd-Frank Act 

is to promote the trading of swaps on SEFs. The phasing in of final rules for both 

exchanges and SEFs should be done concurrently to ensure that this competitive 

landscape remains in place under the new regulatory regime. 

Not only will implementation of the final rules impact market infrastructure, but 

the timing in which these rules are implemented could significantly impact U.S. financial markets. As Commissioner Jill Sommers recently remarked before the 

House Agriculture General Farm Commodities and Risk Management Subcommittee, ‘‘a material difference in the timing of rule implementation is likely to 

occur, which may shift business overseas as the cost of doing business in the U.S. 

increases and create other opportunities for regulatory arbitrage.’’ 5 If the U.S. regulations are implemented before foreign regulators have established their intended 

regulatory framework, it could put U.S. markets at a significant disadvantage and 

might result in depleted liquidity due to regulatory arbitrage opportunities. 

As the rulemaking process moves forward, the WMBAA suggests the following 

progression of rules be completed:

• First, finalize product definitions. Providing the market with certainty related 

to the scope of what constitutes a ‘‘swap’’ and ‘‘security-based swap’’ will allow 

market participants to accurately gauge the impact of the other proposed rules 

and provide constructive feedback on those rules.

• Second, implement final rules related to real-time reporting for regulatory oversight purposes. The submission of information to SDRs is an activity that takes 

place in many OTC markets today and will not unduly burden those who must 

comply with the requirement. Ensuring that the Commissions receive current, 

accurate market data is a cost-effective method to mitigate systemic risk in the 

short-term.

• Next, establish block trade thresholds and finalize public reporting rules. The 

information gathered by SDRs since the implementation of the mandatory trade 

reporting requirement, along with historical data made available by trade repositories and trade execution facilities, can be used to determine the appropriate threshold levels on a product-by-product basis. At the same time, public 

reporting rules can be put into place, including an appropriate time delay (that 

is consistent with European and the other major global market rules) for block 

trades.

• After the reporting mechanics have been established, the clearing mandate can 

be implemented. During this step, the Commissions can determine what swaps 

are ‘‘clearable’’ and subject to the clearing mandate, and clearinghouses can register and begin to operate within the new framework.

• Finally, once swaps are deemed clearable, the mandatory trade execution requirement can be put into place for SEFs and DCMs for those products made 

available for trading. The WMBAA believes that all clearable swaps will be 

made available for trading by SEFs, as these trade execution platforms compete 

to create markets and match counterparties. With the trade execution requirement’s implementation, it is imperative that rules for SEFs and DCMs are effective at the same time, as implementing either entity’s rules prior to the other 

will result in an unfair advantage for capturing market share of executable 

trades simply because they could more quickly meet the regulatory burdens. 

Flexible Approach to SEF Registration, Permitted Modes of Trade Execution, Impartial Access 

The WMBAA members have long acted as intermediaries in connection with the 

execution of swaps in the OTC market. While a regulated OTC market is new to 

the swap markets, the WMBAA members are already subject to oversight by financial regulators across the globe, including the SEC and the CFTC, for services ofVerDate 0ct 09 2002 15:26 Nov 29, 2011 Jkt 041481 PO 00000 Frm 00067 Fmt 6633 Sfmt 6621 I:\DOCS\112-25\70998.TXT BRIAN
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fered in a range of other products and markets. The WMBAA members have acted 

as OTC swap execution platforms for decades and, as a result, understand what is 

necessary to support and promote a regulated, competitive and liquid swaps market. 

Although a SEF might be a new concept originating in the Dodd-Frank Act, the effective role of existing intermediaries in the OTC swaps marketplace is not. 

The WMBAA supports a flexible approach to evaluating applicant SEFs. As Congress recognized and mandated by law, to promote a competitive and liquid swaps 

market, trade execution ‘‘through any means of interstate commerce’’ establishes a 

broad framework that permits multiple modes of swap execution, so long as the proposed mode of execution is capable of satisfying the statutory requirements. 

The WMBAA believes that any interpretation of the SEF definition must be 

broad, and any trading system or platform that meets the statutory requirements 

should be recognized and registered as a SEF. The WMBAA supports a regulatory 

framework that allows any SEF applicant that meets the statutory requirements set 

forth in the Dodd-Frank Act to be permitted to operate under each Commission’s 

rules in accordance with the Dodd-Frank Act. 

The WMBAA strongly supports the SEC’s interpretation of the SEF definition as 

it applies to trade execution through any means of interstate commerce, including 

request for quote systems, order books, auction platforms or voice brokerage trading, 

because such an approach is consistent with the letter and spirit of the Dodd-Frank 

Act and ensures flexibility in the permitted modes of execution. The WMBAA believes that this approach should be applied consistently to all trading systems or 

platforms and will encourage the growth of a competitive marketplace of trade execution facilities. 

Further, the WMBAA is concerned with the CFTC’s interpretation of the SEF definition, as it limits the permitted modes of trade execution, specifically restricting 

the use of voice-based systems to block trades. The SEF definition and corresponding requirements on the CEA, as amended by the Dodd-Frank Act, do not 

provide any grounds for this approach and will severely impair other markets that 

rely on voice-based systems (or hybrid systems, which contain a voice component) 

to create liquidity. 

Permitted Use of Voice and Hybrid Trade Execution Platforms 

The CFTC’s proposed mandate precludes the use of voice-based systems for ‘‘Required Transactions’’ without any explanation of why the permitted modes of execution should be more restrictive than the statute dictates. The WMBAA is concerned 

that such a rigid implementation of the SEF framework will devastate existing voice 

and ‘‘hybrid’’ systems (described below) that are currently relied upon for liquidity 

formation in global swaps markets. ‘‘Hybrid brokerage,’’ which integrates voice with 

electronic brokerage systems, should be clearly recognized as an acceptable mode of 

trade execution, for all swaps trade execution. The combination of traditional ‘‘voice’’ 

brokers with sophisticated electronic trading and matching systems is necessary to 

provide liquidity in markets for less commoditized products where liquidity is not 

continuous. Failure to unambiguously include such systems is not only inconsistent 

with the Dodd-Frank Act but will severely limit liquidity production for a wide 

array of transactions. The WMBAA remains concerned that such a restrictive SEF 

regime will lead to market disruption and, worse, liquidity constriction with adverse 

consequences for vital U.S. capital markets. 

What determines which blend of hybrid brokerage is adopted by the markets for 

any given swap product is largely the market liquidity characteristic of that product, 

whether or not the instrument is cleared. For example, a contract to trade Henry 

Hub Natural Gas delivered in Summer 2017, though cleared, will generally be insufficiently liquid to trade on a central limit order book. This is true the farther out 

the delivery date for many cleared products, where market makers are unwilling to 

post executable bids and offers in instruments that trade infrequently. In markets 

where price spreads are wide or trading is infrequent, central limit order books are 

not conducive to liquidity, but rather may be disruptive to it. 

Critically, what determines which blend of hybrid brokerage is adopted by the 

markets for any given swap product also has little to do with whether the size of 

a transaction is sufficient or not to be a block trade. Block trades concern the size 

of an order, as opposed to the degree of market liquidity or presence of tight bidoffer spreads. Depending on where block trade thresholds are set, block trades can 

take place in markets from very illiquid to highly liquid. Yet, central limit order 

book trade execution generally only works well in markets with deep liquidity, and 

such liquidity is not always available even within a usually liquid market. For less 

liquid markets, even non-block size trades depend on a range of trading methodologies distinct from central limit order book or request for quote. For these reasons, 

65

hybrid brokerage should be clearly recognized as an acceptable mode of trade execution for all swaps whether ‘‘Required’’ or ‘‘Permitted.’’

In addition, the regulatory framework for the swaps market must take into consideration the significant differences between the trading of futures on an existing 

exchange and the trading of swaps on SEF platforms. While it may be appropriate, 

in certain instances, to look to the futures model as instructive, over-reliance on 

that model will not achieve Congress’ goal. Congress explicitly incorporated a SEF 

alternative to the exchange-trading model, understanding that competitive execution 

platforms provide a valuable market function. Final rules governing SEFs should 

reflect Congressional intent and promote the growth of existing competitive, vibrant 

markets without impeding liquidity formation. 

Impartial Access to SEFs 

The WMBAA is concerned that the CFTC’s proposed mandate that SEFs provide 

impartial access to independent software vendors (‘‘ISVs’’) is beyond the legal authority in the CEA because it expands the impartial access provision beyond ‘‘market participants’’ to whom access is granted under the statute. Moreover, because 

SEFs are competitive execution platforms, a requirement to provide impartial access 

to market information to ISVs who lack the intent to enter into swaps on a trading 

system or platform will reduce the ability for market participants to benefit from 

the competitive landscape that provides counterparties with the best possible pricing. Further, given the lack of a definition of what constitutes an ISV and the significant technological investments made by wholesale brokers to provide premiere 

customer service, the ISV impartial access requirement leaves open the possibility 

that SEFs could qualify as ISVs in order to seek access to competitors’ trading systems or platforms. This possibility would defeat the existing structure of competitive 

sources of liquidity, to the detriment of market participants, including commercial 

end-users. The WMBAA strongly urges the CFTC to carefully consider the SEC’s 

impartial access proposal, which is well aligned with both the express statutory provisions and the broader goals of Title VII of the Dodd-Frank Act to promote a marketplace of competing swaps execution venues. 

The WMBAA also believes the SEC should review its proposed impartial access 

provisions to ensure that impartial access to the SEF is different for competitor 

SEFs or national exchanges than for registered security-based swap dealers, major 

security-based swap participants, brokers or eligible contract participants. Congress 

clearly intended for the trade execution landscape after the implementation of the 

Dodd-Frank Act to include multiple competing trade execution venues, and ensuring 

that competitors cannot access a SEF’s trading system or platform furthers competition, to the benefit of the market and all market participants. 

Interim or Temporary SEF Registration 

The implementation of any interim or temporary registration relief must be in 

place for registered trading systems or platforms at the time that swaps are deemed 

‘‘clearable’’ by the Commissions to allow such platforms to execute transactions at 

the time that trades begin to be cleared. Interim or temporary registration relief 

would be necessary for trading systems or platforms if sequencing of rules first addresses reporting to SDRs and mandatory clearing prior to the mandatory trade execution requirement. The WMBAA strongly encourages the Commission to provide 

prompt provisional registration to existing trade execution intermediaries that intend to register as a SEF and express intent to meet the regulatory requirements 

within a predetermined time period. To require clearing of swaps through derivatives clearing organizations without the existence of the corresponding competitive 

trade execution venues risks consistent implementation of the Dodd-Frank Act and 

could have a disruptive impact on market activity and liquidity formation, to the 

detriment of market participants. 

At the same time, a temporary registration regime should ensure that trade execution on SEFs and exchanges is in place without benefitting one execution platform 

over another. Temporary registration for existing trade execution platforms should 

be fashioned into final rules in order to avoid disrupting market activity and provide 

a framework for compliance with the new rules. The failure of the Commission to 

provide interim or temporary relief for existing trading systems or platforms may 

alter the swaps markets and unfairly induce market participants to trade outside 

the U.S. or on already-registered and operating exchanges. 

The 15 Second Rule 

Finally, there does not appear to be any authority for the CFTC’s proposed requirement that, for ‘‘Required Transactions,’’ SEFs must require that traders with 

the ability to execute against a customer’s order or execute two customers against 

each other be subject to a 15 second timing delay between the entry of those two 

66

orders (‘‘15 Second Rule’’). One adverse impact of the proposed 15 Second Rule is 

that the dealer will not know until the expiration of 15 seconds whether it will have 

completed both sides of the trade or whether another market participant will have 

taken one side. Therefore, at the time of receiving the customer order, the dealer 

has no way of knowing whether it will ultimately serve as its customer’s principal 

counterparty or merely as its executing agent. The result will be greater uncertainly 

for the dealer in the use of its capital and, possibly, the reduction of dealer activities 

leading, in turn, to diminished liquidity in and competitiveness of U.S. markets with 

costly implications for buy-side customers and end-users. 

While this delay is intended by the Commission to ensure sufficient pre-trade 

transparency, under the CEA, transparency must be balanced against the liquidity 

needs of the market. Once a trade is completed when there is agreement between 

the parties on price and terms, any delay exposing the parties to that trade to further market risk will have to be reflected in the pricing of the transaction, to the 

detriment of all market participants. 

Ensuring that Block Trade Thresholds are Appropriately Established 

As noted in previous remarks submitted to each Commission, from the perspective 

of intermediaries who broker transactions of significant size between financial institutions it is critical that the block trade threshold levels and the reporting regimes 

related to those transactions are established in a manner that does not impede liquidity formation. A failure to effectively implement block trading thresholds will 

frustrate companies’ ability to hedge commercial risk. Participants rely on swaps to 

appropriately plan for the future, and any significant changes to market structure 

might ultimately inhibit economic growth and competitiveness. 

Establishing the appropriate block trade thresholds is of particular concern for expectant SEFs because the CFTC’s proposal regarding permitted modes of execution 

restricts the use of voice-based systems solely to block trades. While WMBAA believes that this approach is contrary to the SEF definition (as discussed herein and 

in previous letters), which permits trade execution through any means of interstate 

commerce, this approach, if combined with block trade thresholds that are too high 

for the particular instrument, would have a negative impact on liquidity formation. 

With respect to block trade thresholds, the liquidity of a market for a particular 

financial product or instrument depends on several factors, including the parameters of the particular instrument, including tenor and duration, the number of market participants and facilitators of liquidity, the degree of standardization of instrument terms and the volume of trading activity. Compared to commoditized, exchange-traded products and the more standardized OTC instruments, many swaps 

markets feature a broader array of less-commoditized products and larger-sized orders that are traded by fewer counterparties, almost all of which are institutional 

and not retail. Trading in these markets is characterized by variable or non-continuous liquidity. Such liquidity can be episodic, with liquidity peaks and troughs that 

can be seasonal (e.g., certain energy products) or more volatile and tied to external 

market and economic conditions (e.g., many credit, energy and interest rate products). 

As a result of the episodic nature of liquidity in certain swaps markets combined 

with the presence of fewer participants, the WMBAA believes that the CFTC and 

SEC need to carefully structure a clearing, trade execution and reporting regime for 

block trades that is not a ‘‘one size fits all’’ approach, but rather takes into account 

the unique challenges of fostering liquidity in the broad range of swaps markets. 

Such a regime would provide an approach that permits the execution of transactions of significant size in a manner that retains incentives for market participants to provide liquidity and capital without creating opportunities for front-running and market distortion. 

To that end, the WMBAA supports the creation of a Swaps Standards Advisory 

Committee (‘‘Advisory Committee’’) for each Commission, comprised of recognized 

industry experts and representatives of registered SDRs and SEFs to make recommendations to the Commissions for appropriate block trade thresholds for swaps. 

The Advisory Committee would (i) provide the Commissions with meaningful statistics and metrics from a broad range of contract markets, SDRs and SEFs to be considered in any ongoing rulemakings in this area and (ii) work with the Commissions 

to establish and maintain written policies and procedures for calculating and publicizing block trade thresholds for all swaps reported to the registered SDR in accordance with the criteria and formula for determining block size specified by the Commissions. 

The Advisory Committee would also undertake market studies and research at its 

expense as is necessary to establish such standards. This arrangement would permit 

SEFs, as the entities most closely related to block trade execution, to provide essenVerDate 0ct 09 2002 15:26 Nov 29, 2011 Jkt 041481 PO 00000 Frm 00070 Fmt 6633 Sfmt 6621 I:\DOCS\112-25\70998.TXT BRIAN
67

tial input into the Commissions’ block trade determinations and work with registered SDRs to distribute the resulting threshold levels to SEFs. Further, the proposed regulatory structure would reduce the burden on SDRs, remove the possibility 

of miscommunication between SDRs and SEFs and ensure that SEFs do not rely 

upon dated or incorrect block trade thresholds in their trade execution activities. In 

fact, WMBAA members possess historical data for their segment of the OTC swap 

market which could be analyzed immediately, even before final rules are implemented, to determine appropriate introductory block trade thresholds, which could 

be revised after an interim period, as appropriate. 

Conclusion 

The WMBAA thanks the Commissions for the opportunity to comment on these 

very important issues. We look forward to continuing our conversations with the 

Commissioners and staff as the new regulatory framework is developed and implemented in a way that fosters competition and liquidity for market participants. 

Please feel free to contact the undersigned with any questions you may have on 

our comments. 

Sincerely,

STEPHEN MERKEL, Chairman.

The CHAIRMAN. Thank you. 

And when you are ready, Ms. Boultwood, you may begin. 

STATEMENT OF BRENDA L. BOULTWOOD, CHIEF RISK

OFFICER AND SENIOR VICE PRESIDENT, CONSTELLATION 

ENERGY, BALTIMORE, MD; ON BEHALF OF COALITION FOR 

DERIVATIVES END-USERS 

Ms. BOULTWOOD. Good morning, Chairman Lucas, Ranking 

Member Peterson, Members of the Committee. It is a pleasure to 

appear before you this morning. 

My name is Brenda Boultwood and I serve as Chief Risk Officer 

and Senior Vice President for Constellation Energy. On behalf of 

Constellation, as well as the End-User Coalition, I am privileged to 

talk to you today about steps we believe Congress should take to 

fix three problems with proposed regulations implementing DoddFrank legislation. 

First, a proper swap dealer definition and de minimis exception 

are needed to ensure end-users are not regulated as swap dealers. 

Second, end-users should be allowed to continue to transact without the threat of large margin requirements and we believe interaffiliate swaps should not be subjected to these requirements as 

well. And third, the CFTC should have to follow the high standards 

for cost-benefit analysis. 

The End-User Coalition includes a diverse group of companies 

that make and produce goods and services including agriculture, 

manufacturing, vehicles, electricity and natural gas. Let me be 

clear from the outset: Our coalition is not opposed to greater transparency in these markets but end-users did not create systemic 

risk and none in our coalition was behind the near-collapse of the 

economy in 2008. 

I have been involved in risk management practices in a variety 

of capacities—academia, commercial entities, financial institutions 

and consulting—for more than 25 years. I serve on the boards of 

the Committee of Chief Risk Officers and the Global Association of 

Risk Professionals as well as serving as a member on the CFTC 

Technology Advisory Committee. Constellation Energy is a Fortune 


11225055.eps
68

200 company located in Baltimore, Maryland, and is the largest 

competitive supplier of electricity in the country with more than 

36,000 commercial and industrial customers in 36 states. We are 

the largest competitive supplier due to a variety of risk management tools we employ for the benefit of our customers. Because 

physical energy markets are volatile and unpredictable, we utilize 

exchange trading and over-the-counter derivatives to better manage our risks. These derivatives allow us to provide our customers 

with a low fixed price for the products and services they demand. 

Legislation will soon be introduced aimed at fixing the swap 

dealer definition. A proper definition of swap dealer is crucial to ensure that burdensome requirements such as mandatory margin 

capital and clearing are not improperly forced upon non-financial 

end-users. The de minimis exception must be set large enough to 

avoid capturing firms that had nothing to do with the financial crisis, that would never rise to the level of too big to fail simply because they are not and never were systemically risky. The CFTC’s 

proposed definition includes exemptions that are too narrow and 

would leave energy firms and other end-users to be unintentionally 

caught up in a swap dealer definition and rules that would require 

onerous margin clearing, real-time reporting and capital requirements. 

H.R. 2682 focuses on margin requirements for end-users. Today, 

an end-user decides whether to execute a derivative hedge through 

an exchange or over the counter. If the hedge is conducted through 

an exchange, initial margin is posted. If we transact over the 

counter, we may utilize unsecured lines of credit with 

counterparties and post margins when exposures exceed these limits. In other words, we navigate between liquidity risk and posting 

margins and counterparty credit risk. Today, this credit risk can be 

mitigated with all types of collateral—letters of credit, parental 

guarantees, asset liens, and sometimes even cash. At the time of 

the passage of the Dodd-Frank Act, the intent was that the enduser would be exempted from any requirements to post cash margin. Consequently, we need Congress to step in and clarify the ability of end-users to continue to manage counterparty risk without 

unnecessary margin requirements. 

Let me briefly offer my thoughts on the Stivers-Fudge bill. Constellation Energy, like many other companies, uses the business 

model through which we limit the number of affiliates within our 

corporation that enter into derivative transactions with external 

counterparties in order to more effectively manage our enterprise 

risks and to secure better pricing on our derivative transactions. 

We strongly support the Stivers-Fudge bill, which recognizes that 

inter-affiliate swaps are internal, largely bookkeeping in nature, 

and do not create systemic risk. 

Let me turn to H.R. 1840, which focuses on cost-benefit analysis 

for any proposed rules. We firmly believe that rigorous cost-benefit 

analysis creates better rules and helps avoid making the mistake 

of putting a rule in place that would create unintended effects. As 

we saw with the SEC’s proxy access rule, which was overturned by 

the courts, inadequate consideration of costs, benefits and comments made during the rulemaking process does not establish a 

foundation that can sustain rulemaking. The Conaway-Quigley bill 

69

would require the CFTC to undertake structured and rigorous costbenefit analysis. 

In conclusion, I want to thank you, Chairman Lucas, Ranking 

Member Peterson, and Members of the Committee for convening 

this hearing. Ensuring that Congressional intent is followed by the 

CFTC is critically important to the entire end-user community. 

However, if legislation is not passed to clarify the statute’s intent, 

end-users risk being caught up in the unintended consequences of 

the Dodd-Frank implementation. It is important to remember that 

end-users rely on derivatives to reduce risk, bring certainty and 

stability to our business, and ultimately to benefit our customers. 

We did not contribute to the financial crisis and we don’t pose a 

threat to the financial system. 

Thanks for your time, and I look forward to your questions. 

[The prepared statement of Ms. Boultwood follows:]

PREPARED STATEMENT OF BRENDA L. BOULTWOOD, CHIEF RISK OFFICER AND SENIOR

VICE PRESIDENT, CONSTELLATION ENERGY, BALTIMORE, MD; ON BEHALF OF

COALITION FOR DERIVATIVES END-USERS

Good morning, Chairman Lucas, Ranking Member Peterson, Members of the 

Committee, it is a pleasure to appear before you this morning. My name is Brenda 

Boultwood and I serve as Chief Risk Officer and Senior Vice President for Constellation Energy. I am here today in my capacity as an officer with Constellation; but, 

I am also here representing the broader end-user coalition, which is comprised of 

a variety of entities from agricultural interests, to manufacturers, car companies, 

airlines, and energy companies. While it may seem odd to have such a diverse and 

broad coalition coalescing around the same set of legislative proposals, I want to assure the Committee that we appreciate your hard work in helping to address some 

of the unintended consequences of the Dodd-Frank Act, as well as some of the 

broadly interpreted proposed rules that we believe go well beyond Congressional intent. Let me be clear from the outset, our coalition is not opposed to greater transparency in these markets. In fact, we are highly supportive of greater transparency. 

But, you achieve transparency through reporting, not classifying end-users as swap 

dealers. Simply put, end-users do not create systemic risk and none in our coalition 

were behind the collapse of the economy in 2008. Therefore, we are here today to 

offer our thoughts to several legislative proposals that we believe will help resolve 

those unintended consequences. 

Before I begin my testimony on the proposed legislation, I would like to give a 

brief background about myself, who Constellation is, and how and why we use derivatives to help manage our customer’s risk. 

I have been involved in risk management practices in a variety of capacities—academia, commercial entities, financial institutions, and consulting—for more than 

thirty years. I serve on the Boards of the Committee of Chief Risk Officers (CCRO) 

and the Global Association of Risk Professionals (GARP), as well as serving as a 

member of the CFTC’s Technology Advisory Committee. As you may recall, the 

CCRO began as a result of the accounting scandals from the early part of the last 

decade and is comprised of CRO’s across the entire energy spectrum. 

Constellation Energy is a Fortune 200 company located in Baltimore, MD, and is 

the largest competitive supplier of electricity in the country. We serve more than 

30,000 megawatts of electricity daily and own approximately 12,000 megawatts of 

generation that comes from a diversified fleet across the U.S. To put that in perspective, our load obligation is approximately the same amount of power consumed 

by all of New England on a daily basis. We serve load to approximately 36,000 commercial and industrial customers in 36 states and we provide natural gas and energy products and services for homes and businesses across the country. Finally, the 

company delivers electricity and natural gas through the Baltimore Gas and Electric 

Company (BGE), our regulated utility in central Maryland. 

One of the reasons we have been so successful in growing our competitive supply 

business is due in large part to our ability to win load serving auctions by being 

the low cost provider. We are able to be the low cost provider due to a variety of 

risk management tools we employ to the benefit of our customers. We utilize exchange trading, clearinghouses and over-the-counter (OTC) derivatives to help manage these risks. 

70

For example, electricity—it must be produced and consumed simultaneously; cannot be stored; and has some very volatile fuel exposure—coal, natural gas, and uranium. Furthermore, electricity gets delivered to thousands of points along the grid 

at a moment’s notice. Physical energy markets are volatile and unpredictable, but 

hedging with derivatives allows Constellation to manage these risks and provide its 

thousands of customers with electricity and natural gas at a low fixed price. 

Now, I would like to specifically address some of the proposed pieces of legislation 

that will help to resolve some of the unintended consequences that are emanating 

from the Commodity Futures Trading Commission’s (CFTC) proposed rules. 

For instance, H.R. 2682 is a bill that focuses on margin requirements for endusers. Today, an end-user decides whether to execute a derivative hedge through an 

exchange or over-the-counter (OTC). If it is conducted through an exchange, initial 

margin is posted and variation margin is required or returned depending on price 

fluctuations. If we transact OTC, we may utilize unsecured lines with counterparties 

and post margin when exposures exceeds the size of a credit line. In other words, 

we navigate between liquidity risk, or posting margin, and counterparty credit risk. 

Today, this credit risk can be mitigated with collateral of all kinds—Letters of Credit (LCs), Parental Guarantees (PGs), asset liens and sometimes cash. At the time 

of passage of the Dodd-Frank Act, we understood from the legislative language, as 

well as from letters and statements by the principal authors of the legislation, that 

end-users would be exempted from any requirement to post cash margin. Unfortunately, margin rules proposed by the prudential banking regulators this past summer create uncertainty by reserving to the regulators the authority to, de facto, impose margin on end-users by requiring that such margin be collected by our swapdealer counterparties. While the Coalition supports the Grimm-Peters-Owens-Scott 

bill, we are hopeful that, as it works its way through the legislative process, the 

bill can be expanded to cover financial end-users such as small banks, as well as 

non-financial end-users. 

We are also very concerned about the regulators’ proposed restrictions on using 

non-cash collateral to satisfy margin requirements. These restrictions could force 

companies to either abandon effective risk-mitigation strategies or critical capital 

expenditures. Furthermore, based on Federal Reserve data for bank lending (drawn 

facilities) in the U.S. of $550BN, additional interest charges passed on to corporations are estimated to be $2.8BN annually as a result of the Dodd-Frank Act. And, 

a survey conducted by the Coalition found that companies would have to hold aside 

on average $269 million of cash or immediately available bank credit to meet a 3% 

initial margin requirement. Though the rule proposed by banking regulators may 

or may not require this magnitude of collateral, in our world of finite resources and 

financial constraints, this is a direct dollar-for-dollar subtraction from funds that we 

would otherwise use to expand our plants, build inventory to support higher sales, 

undertake research and development activities, and ultimately sustain and grow 

jobs. The aforementioned study extrapolated the effects across the S&P 500 to predict the consequent loss of 100,000 to 130,000 direct and indirect jobs. The effect 

on the many thousands of end-users beyond the S&P 500 would be proportionately 

greater. We would also have to make a considerable investment in information systems that would replicate much of the technology in a bank’s trading room for 

marking to market and settling derivatives transactions, thus further depleting our 

working capital. A potential consequence of margin rules is liquidity risks for endusers that require us to increase debt levels and funnel cash from productive investments. In fact, a June 13, 2011, an Office of the Comptroller of the Currency (OCC) 

study provided an estimate of incremental initial margin requirements for large 

banks of $2TR, much of which we believe will be collected from their end-user 

counterparties. Consequently, we need Congress to step in and clarify the ability of 

end-users and banks to continue to manage counterparty risk without unnecessary 

initial and variation margin requirements. 

Now, let me turn to the not yet introduced legislative proposal that seeks to clarify the swap dealer definition. A properly-tailored definition of ‘‘swap dealer’’ is another crucial element to ensuring that burdensome requirements such as mandatory 

margin, capital and clearing are not improperly forced upon non-financial end-users. 

The Dodd-Frank Act regulates swap dealers and major swap participants differently 

than end-users and appropriately so. But it is very important that the definition be 

tailored to capture persons that are actually in the business of providing dealer 

services to end-users, not the end-users themselves. Furthermore, to the extent endusers engage in only a small amount of customer-facing swap activity that is tied 

to their core non-financial businesses (e.g., manufacturing, processing, marketing), 

and whose dealing does not create systemic risk, they should not be treated as swap 

dealers. To that end, the de minimis exception to the definition of ‘‘swap dealer’’ 

must be set in legislation at a reasonable level that protects end-users from being 

71

regulated the same as the largest swap dealers that are potentially systemically 

risky. In addition, a company should not be regulated as a swap dealer simply because it makes a market for its own affiliates. Inter-affiliate trades should not be 

subject to regulations designed for market-facing transactions, and should not be a 

factor for determining whether a company is a swap dealer. 

With that in mind, let me briefly offer my thoughts on H.R. 2779, also referred 

to as the Stivers-Fudge bill. Constellation Energy, like many other companies, uses 

a business model through which we limit the number of affiliates within our corporation that enters into derivatives transactions with external and other swap 

dealer counterparties. Rather than having each corporate subsidiary transact individually with external counterparties, a single or limited number of corporate entities face dealers and other counterparties in the market. This helps our company 

centralize risk taking, accountability and performance management. These entities 

then allocate transactions to those affiliates seeking to mitigate the underlying risk. 

This allocation is done by way of ‘‘inter-affiliate swaps’’—or swaps between commonly controlled entities. This structure allows us to more effectively manage our 

corporate risk on an enterprise basis and to secure better pricing on our derivatives 

transactions. The transactions are largely ‘‘bookkeeping’’ in nature and do not create 

systemic risk. Using affiliates to transact has always been a healthy part of the way 

many companies internally centralize risk and manage overall performance. For example, small farmers and ranchers, utilities, and car manufacturers, to name a few, 

perform their hedging transactions in this way. 

As we understand it, however, regulators are considering whether to subject interaffiliate swaps to the same set of requirements that would apply to swaps with external dealer counterparties—possibly including margin, clearing, real-time reporting, and other requirements. In my mind, this would be a mistake, imposing substantial costs on the economy and on consumers. That is why we strongly support 

the Stivers-Fudge bill, which recognizes that inter-affiliate swaps do not create systemic risk and that consequently, as a category, inter-affiliate swaps should not be 

subject to regulation as if they were outward-facing. The Stivers-Fudge bill would 

exempt a category of swaps, not a particular type of entity from regulation. That is 

precisely what the Administration did in exempting foreign exchange swaps and forwards and it is the right approach here as well. 

Finally, let me turn to H.R. 1840, which focuses on cost-benefit analysis for any 

proposed rules. We firmly believe that rigorous cost-benefit analysis creates better 

rules. By first analyzing how a regulation will affect individuals, companies, other 

stakeholders, and the integrity of the overall market, a regulatory agency can avoid 

making the mistake of putting a rule in place that has adverse and unintended effects. The CFTC is subject to a cost-benefit analysis requirement, but it does not 

require the regulator to consider such key factors as available alternatives to regulation, whether the regulation is tailored to impose the least burden possible while 

achieving its goals, and whether the regulation maximizes net benefits. These and 

other factors would be required to be considered under the Conaway-Quigley bill. 

The CFTC should conduct a rigorous cost-benefit analysis for each proposed rules’ 

impact on market liquidity, price discovery, as well as the potential costs to existing 

market participants and participants that may consider entering the market in the 

future. 

As we saw when the SEC’s proxy access rule was overturned by the courts, inadequate consideration of costs, benefits, and comments made during the rulemaking 

process does not establish a foundation that can sustain a rulemaking. The 

Conaway-Quigley bill would require the CFTC to undertake a structured and rigorous cost-benefit analysis when it promulgates rules; thus, ensuring a better process more likely to achieve statutory goals while limiting substantial societal costs. 

In conclusion, I want to thank Chairman Lucas, Ranking Member Peterson and 

Members of the Committee for convening this hearing and affording me the opportunity to testify. Ensuring that Congressional intent is followed by the CFTC is 

critically important to the entire end-user community. I had hoped after passage of 

the Dodd-Frank Act that future legislation would not be required to deal with the 

concerns I have outlined here today. However, if legislation is not passed to clarify 

the statute’s intent, end-users risk being captured as swap dealers and the end-user 

exemptions included in the bill would be null and void. It is important to remember 

that end-users rely on derivatives to reduce risk; bring certainty and stability to 

their businesses; and, ultimately to benefit their customers. We did not contribute 

to the financial crisis and we do not pose a threat to the financial system. 

I would like to leave you with this final comment. As you probably know, the electricity industry is comprised of a number of types of entities, which include electric 

co-ops; investor owned utilities, which could be vertically integrated or merchant 

generators; and, public power organizations. These groups represent every electric 

72

customer in the United States and rarely agree on any public policy. However, if 

these regulations are improperly implemented by the CFTC, then it could cause 

electricity prices to rise for every consumer in America. That is why when it comes 

to Title VII of the Dodd-Frank Act we are in 100% alignment that end-users must 

not be captured as swap dealers or forced to clear all of their transactions. 

Thank you for your time and I look forward to your questions.

The CHAIRMAN. Thank you. 

Mr. Thul, whenever you are ready, you may begin. 

STATEMENT OF TODD THUL, RISK MANAGER, CARGILL 

AGHORIZONS, MINNEAPOLIS, MN; ON BEHALF OF COMMODITY 

MARKETS COUNCIL 

Mr. THUL. Thank you. Chairman Lucas, Ranking Member Peterson, and Members of the House Committee on Agriculture, thank 

you for convening today’s hearing. I am Todd Thul, Risk Manager 

for Cargill AgHorizons, which offers a wide variety of marketing alternatives for producers of all sizes. I am testifying today on behalf 

of the Commodity Markets Council, a trade association that represents the exchanges and the industry. 

The CFTC has been implementing the regulations required 

under Dodd-Frank. Today, I would like to provide perspectives on 

a number of these issues. 

Issue number one: Many firms use inter-affiliate swaps to limit 

the number of entities transacting with external dealer 

counterparties. This structure allows the company to effectively 

manage risk on an enterprise basis and to secure better pricing on 

derivative transactions. The agreements are largely bookkeeping in 

nature and do not create systemic risk. Inter-affiliate swaps should 

not be regulated in the same manner as swaps with external dealers including margin, clearing and real-time reporting. These requirements would impose substantial costs on the economy, consumers and end-users. 

Issue number two: The CFTC has proposed that all members of 

a designated contract market capture and maintain extensive 

records of all communications related to commodity transactions. 

The proposal presents steep technology and cost challenges across 

the entire grain industry including country elevators who deal with 

producers in person and on the phone when executing cash contracts. This proposal raises anti-competitive concerns by creating a 

divided cash marketplace, imposing the requirement on some country elevators but not all. Dodd-Frank was intended to address concerns about systemic risks created by an unregulated over-thecounter market. The CFTC’s proposed recording and recordkeeping 

rule would add costs to the cash market that will ultimately be 

shared through the entire value chain. 

My final issue: Under Dodd-Frank, Congress created a statutory 

definition of bona fide hedge transactions, which enumerates various types of hedging, among them, anticipatory merchandising positions. An anticipatory hedge occurs when a commercial entity 

takes a position in the futures market to meet a physical need for 

a commodity it anticipates buying or selling in the future. Congress 

made clear in its bona fide hedge definition that companies engaged in the physical trade should receive an exemption for anticipatory merchandising positions. However, the CFTC through its 

proposed rules would deny companies the exemption and would reVerDate 0ct 09 2002 15:26 Nov 29, 2011 Jkt 041481 PO 00000 Frm 00076 Fmt 6633 Sfmt 6601 I:\DOCS\112-25\70998.TXT BRIAN
73

characterize them as speculative. This is not consistent with the 

law and has the potential to have negative effects in the cash commodity markets. 

The Act provides that a bona fide hedge may be defined to permit producers, purchasers, sellers, middlemen and users of a commodity to hedge their legitimate anticipated business needs. The 

CFTC’s proposed rule, which may be finalized as early as next 

week, would limit bona fide hedge exemptions to five specific transactions called enumerated hedges. This will greatly reduce the industry’s ability to offer the same suite of marketing tools to our invaluable farmer suppliers. 

Serious questions have been raised on how to provide bids for 

farmers overnight or through the weekend to manage risk appropriately. Merchandising of grain could be curtailed because of the 

inability to manage risk if the hedge is considered speculative and 

not bona fide under this rule. From a risk management perspective, a better limitation on anticipatory hedging would be annual 

volume. Unless revised, the CFTC’s approach will severely limit 

the ability of grain handlers to participate in the market and impede the ability to offer competitive bids to farmers, to manage 

risk, to provide liquidity and to move agricultural products from origin to destination. The irony is that limiting commercial participation in the market actually introduces volatility. Clearly, this is not 

what Congress intended. 

In summary, the proposed restriction on anticipatory hedging is 

not consistent with current commercial practice which did not contribute to the financial conditions that led to passage of DoddFrank. The modest proposals suggested to the Commission would 

allow farmers and the industry to maintain recognized risk management practice while remaining consistent with the statute and 

subject to CFTC oversight. This will allow the U.S. farmer to maintain access to risk management products, price discovery and competitive marketing options. Limiting anticipatory hedging will result in risk that must otherwise be managed, which could manifest 

itself in wider basis spreads, more volatile basis or limited bids, all 

of which run counter to the intent of Congress, the statute and the 

marketplace. 

Thank you. 

[The prepared statement of Mr. Thul follows:]

PREPARED STATEMENT OF TODD THUL, RISK MANAGER, CARGILL AGHORIZONS, 

MINNEAPOLIS, MN; ON BEHALF OF COMMODITY MARKETS COUNCIL

Chairman Lucas, Ranking Member Peterson and Members of the House Committee on Agriculture: Thank you for convening this hearing on various elements 

of the Dodd-Frank Act. I am Todd Thul, Risk Manager for Cargill AgHorizons. 

AgHorizons is our business that works directly with farmers. Many of them are your 

constituents and all of them are constituents of this Committee. We offer a wide variety of grain marketing options for producers of all sizes. We provide many forms 

of risk management and price protection that meet individual producers’ desired 

level of opportunity and control. We also offer agronomic services, seed, fertilizer, 

consulting services and crop input financing to help producers manage their operations. Our goal is to be the partner of choice for our farmer customers. 

Today, I am testifying on behalf of the Commodity Markets Council (CMC). CMC 

is a trade association that brings together exchanges and their industry counterparts. The activities of CMC members include the complete spectrum of commercial 

end-users of all futures markets including energy and agriculture. Specifically, our 

industry member firms are regular users of the Chicago Board of Trade, Chicago 

74

Mercantile Exchange, ICE Futures U.S., Kansas City Board of Trade, Minneapolis 

Grain Exchange and the New York Mercantile Exchange. CMC, in conjunction with 

the Coalition for Derivatives End Users, is well-positioned to provide the consensus 

views of commercial end-users of derivatives. Our comments represent the collective 

view of CMC’s members. 

The Commodity Futures Trading Commission (CFTC) has been working aggressively to implement the regulations required under the Dodd-Frank Act. Today, I 

would like to provide perspectives on a number of these issues. 

Inter-Affiliate Swap Transactions 

Many firms use a business model through which the number of affiliates within 

the corporate group that enter into derivatives transactions with dealer 

counterparties are limited. Rather than having each corporate subsidiary individually transact with dealer counterparties, a single or limited number of corporate 

entities face dealers. These entities then allocate transactions to those affiliates 

seeking to mitigate the underlying risk. This allocation is done by way of ‘‘inter-affiliate swaps’’—swaps between commonly controlled entities. This structure allows the 

company to more effectively manage corporate risk on an enterprise basis and to 

secure better pricing on derivatives transactions. The transactions are largely ‘‘bookkeeping’’ in nature and do not create systemic risk. Regulators are reportedly considering whether to subject inter-affiliate swaps to the same set of requirements 

that apply to swaps with external dealer counterparties—possibly including margin, 

clearing, real-time reporting, and other requirements. This would be a mistake and 

would impose substantial costs on the economy, on consumers and on end-users. Accordingly, the CMC strongly endorses the thrust of the Stivers-Fudge bill. It is the 

right thing to do. CMC understands the intent of the bill is to cover all business 

operating models that might be negatively affected by the inter-affiliate interpretation and therefore would like to work with the sponsors to be sure the proposed legislation accomplishes that objective. 

Bona fide and Anticipatory Hedges 

One area of ongoing rulemaking which has recently garnered a lot of attention 

by our industry is the CFTC’s proposed rules on position limits and, more specifically, the proposed definition of bona fide hedge transactions. 

Under Dodd-Frank, Congress for the first time created a statutory definition of 

bona fide hedge transactions. The statutory definition enumerates various kinds of 

hedging transactions, among them anticipatory merchandising positions. 

An anticipatory hedge occurs when a commercial entity takes a position in the 

futures market to offset a position that it anticipates taking in the cash market in 

the future. A simple example is the buying of corn futures now in anticipation of 

buying physical corn at harvest from farmers, or the selling of cotton futures now 

in anticipation of selling physical cotton at some point in the future. In these cases, 

a commercial entity is taking a position in the futures market to meet a physical 

need for a commodity it anticipates buying or selling in the future. 

While Congress made clear in its bona fide hedge definition that companies engaged in the physical trade should receive an exemption for anticipatory merchandising positions, the CFTC through its proposed rules would deny companies the exemption and would recharacterize them as ‘‘speculative’’. This is not only inconsistent with the law, but has the potential to have calamitous effects in the cash 

commodity markets in the physical commodity marketplace. 

The CFTC is taking a narrower view of bona fide hedging than that defined by 

Congress in the Dodd-Frank law. The CFTC’s proposed rules would limit bona fide

hedge exemptions to five specific transactions called ‘‘enumerated’’ hedges. The 

Commodity Exchange Act, as amended by the Dodd-Frank Act (‘‘Act’’) provides that 

position limits shall not apply to transactions or positions shown to be bona fide

hedges, as defined by the CFTC consistent with the purposes of the Act. Section 

4a(c)(1) of the Act also provides that a bona fide hedge may be defined to permit 

producers, purchasers, sellers, middlemen and users of a commodity to hedge their 

legitimate anticipated business needs. Thus the statutory language provides for 

hedges of legitimate business needs at each step as the commodity moves from producer to user, and recognizes that merchandiser are entitled to hedge anticipated 

needs. 

The Act [Sec. 4a(c)(2)] also provides its own definition of bona fide hedge, and 

states that the CFTC shall define what constitutes a bona fide hedge. This statutory 

hedge definition includes an anticipatory merchandising hedge, because it permits 

hedges of the potential changes in value of assets that a person anticipates owning 

or merchandising, as long as the transactions are a substitute for physical transVerDate 0ct 09 2002 15:26 Nov 29, 2011 Jkt 041481 PO 00000 Frm 00078 Fmt 6633 Sfmt 6621 I:\DOCS\112-25\70998.TXT BRIAN
75

actions to be made at a later time and they are economically appropriate to the reduction of risks in the conduct and management of a commercial enterprise. 

The Commodity Markets Council and the Working Group of Commercial Energy 

Firms filed public comments to the CFTC on June 5, 2011, urging the Commission 

to reconsider its proposed rules and, in particular, the proposed bona fide hedge definition. The CMC subsequently transmitted in a June 10, 2011 letter its concerns 

about these types of hedges to the respecting Chairs and Ranking Members of the 

House and Senate Agriculture Committees, Senate Banking Committee, and House 

Financial Services Committee. I would ask that copies of these letters be included 

in the hearing record. 

Through the summer, the CMC, its member companies and other interested parties also engaged in direct meetings with the CFTC to respond to requests for additional information about the relationship between anticipatory hedges and cash 

market efficiencies. 

We remain hopeful that the CFTC will take into account these comments and provide the commercial trade with a meaningful exemption for anticipatory hedges. 

However, recent press accounts suggest the final rule may disappoint in this area. 

We understand that the CFTC is considering limiting anticipatory merchandising 

hedging to unfilled storage capacities through calendar spread positions for one 

year. If this turns out to be the case, the CFTC’s action will reduce the industry’s 

ability to continue offering the same suite of marketing tools to farmers that they 

are accustomed to using because the management of the risk associated with those 

tools may be constrained if the hedge of that risk is deemed to be anticipatory. Serious questions have been raised about how to provide weekend bids for farmers going 

in to large harvest weekends, or manage risk associated with export elevators that 

might have limited one-time capacity but very large throughputs. Merchandising of 

grain could be curtailed because of the inability to manage the risk if the hedge is 

considered speculative and not bona fide under this rule. As serious as all these 

issues are for farmers, the implications are far broader with the potential to impact 

energy markets as well. 

From a risk management perspective, a better limitation on anticipatory hedging 

would be annual throughput—or volume—actually handled on a historic basis by 

each company. For example, an export elevator may have 4 million bushels of physical storage capacity, but might handle 100 million bushels on an annual basis. If 

it is full, how will it establish a bid and manage the risk on the 96 million bushels 

of grain it has yet to purchase from farmers that it not only anticipates, but knows 

it will be exporting from that facility? Unless revised, the CFTC’s approach will severely limit the ability of grain handlers to participate in the market and impede 

the ability to offer competitive bids to farmers, manage risk, provide liquidity and 

move agriculture products from origin to destination. The irony is that limiting commercial participation in the market actually introduces volatility. Clearly this is not 

what Congress intended. 

Recording and Recordkeeping Requirements 

In a proposed rule described only as conforming amendments, the CFTC has proposed imposing expensive and burdensome recording and recordkeeping requirements across a broad swath of the cash grain marketplace. The proposal would require all members of a designated contract market (DCM) such as the Chicago 

Board of Trade, Kansas City Board of Trade or MGEX to capture and maintain extensive records of all communications related to a commodity transaction. Even 

country elevators operated by those firms would be required to record telephone conversations with producers when discussing cash sales or contracts. 

The proposal presents steep technology and cost challenges to small-town country 

elevators who deal extensively with producers on the phone when arranging cash 

sales and forward cash contracts. This proposal raises anti-competitive concerns because it could create a bifurcated cash marketplace by imposing the requirement on 

country elevators who are owned by members of DCMs but not on other companies. 

Who will the producer call to sell his cash grain: the elevator that has to inform 

him they are recording his phone calls, or the elevator a few miles down the road 

that is not required to do so? The CMC believes the proposal may prompt companies 

who are members of a DCM to reconsider their membership in order to avoid the 

regulatory burden. This result exposes not only the discriminatory application of the 

rule, but also highlights the fundamental question within the industry about the 

proposed rule. Dodd-Frank was intended to address concerns about systemic risks 

created by an unregulated over-the-counter market. The CFTC’s proposed recording 

and recordkeeping rule does not address any of those concerns. Rather it seems targeted at the cash market and the real commercial trade, neither of which were responsible for the financial crisis and both of which suffered because of that crisis. 

76

All this proposal will do is add cost to the real economy—costs that are ultimately 

shared throughout the value chain from farmer to consumer. 

Swap Dealer Bill (not yet introduced) 

It is important that end-users who engage in only a small amount of swap dealing 

relative to their non-dealing activities and whose dealing does not create systemic 

risk not be treated as swap dealers. As such, the de minimis exception to the definition of ‘‘swap dealer’’ must be expanded to a reasonable level that protects end-users 

from being regulated the same as the largest swap dealers. 

Cost-Benefit Analysis Bill (H.R. 1840) 

Rigorous cost-benefit analysis creates better rules. The CFTC is subject to a costbenefit analysis requirement but it does not require the regulator to consider such 

key factors as available alternatives to regulation, whether the regulation is tailored 

to impose the least burden possible while achieving its goals, and whether the regulation maximizes net benefits. These and other factors would be required to be considered under the Conaway-Quigley bill, which CMC strongly supports. 

Summary 

The proposed restriction on anticipatory hedging is inconsistent with current commercial practice which did not contribute to the financial conditions that led to passage of the Act. The proposed restriction significantly narrows the hedging definition 

included in the Act by Congress and without question will curtail our ability to 

serve farmers with risk management programs. The Act states that bona fide hedge 

term shall be defined by the CFTC consistent with the purposes of the Act. The proposed restriction is not consistent with these purposes:

(a) The express purpose of the position limits is to prevent excessive speculation 

which causes sudden or unreasonable fluctuations or unwarranted changes in 

commodity prices. [Act, sec. 4a(a)(1)]. An anticipatory merchandising hedge, 

done in accordance with current commercial practice, is not speculation and 

does not cause unreasonable or unwarranted price changes.

(b) The Act says hedges of legitimate anticipated business needs by middlemen 

are permissible hedging to be the subject of CFTC rulemaking. Under current 

commercial practice, anticipatory merchandising hedges are for the purpose of 

satisfying legitimate anticipated business needs for merchandisers, and it would 

be contrary to the purposes of the Act to prohibit them.

(c) Congress recognized in the statutory definition that anticipatory hedges can 

include those which hedge commodities that are anticipated to be owned or merchandised, and the proposed restrictions relating to dedicated unfilled capacity 

and calendar spreads undermine Congressional intent as reflected in the broader statutory definition.

The CMC along with the Working Group of Commercial Energy Firms has submitted specific comments and proposals for the CFTC to consider during its rulemaking. Absent the adoption of significant change, the new rules defining bona fide

hedging and by negative inference speculation will create cash market inefficiencies. 

Moreover, the proposed rule would make CFTC reports on market participation 

meaningless because they would no longer reflect real cash market activities. 

The modest proposals suggested to the Commission would allow farmers and the 

industry to manage risk consistent with longstanding practices while remaining consistent with the statute and subject to CFTC oversight. They will allow farmers and 

the grain industry to continue to have access to risk management, price discovery 

and marketing options that have long served the industry well. Limiting anticipatory hedging will result in risk that must somehow otherwise be managed. This 

risk was heretofore managed in the futures market—now the risk could manifest 

itself in wider basis spreads, more volatile basis, limited bids, or wider bid-ask 

spreads, all of which run counter to the intent of Congress, the statute, the interest 

of farmers, the marketplace, end-users and market participants. 

ATTACHMENT

June 10, 2011

Hon. DEBBIE STABENOW, Hon. FRANK D. LUCAS,

Chairman, Chairman,

Hon. PAT ROBERTS, Hon. COLIN C. PETERSON, 

Ranking Member, Ranking Minority Member,

77

Senate Committee on Agriculture, Nutrition & Forestry, House Committee on Agriculture, 

Washington, D.C.; Washington, D.C.;

Hon. TIM JOHNSON, Hon. SPENCER BACHUS, 

Chairman, Chairman,

Hon. RICHARD SHELBY, Hon. BARNEY FRANK, 

Ranking Member, Ranking Minority Member,

Senate Committee on Banking, Housing, 

and Urban Affairs, 

House Committee on Financial Services, 

Washington, D.C.; Washington, D.C. 

Re: CFTC Proposed Treatment of Bona Fide Hedging

Dear Chairmen Stabenow, Johnson, Lucas, Bachus and Ranking Members Roberts, Shelby, Peterson and Frank:

We are extremely concerned about the direction taken by the Commodity Trading 

Futures Commission (‘‘CFTC’’) in its proposed rules with respect to bona fide hedging. We believe the proposed regulations are unnecessarily narrow, impose onerous 

reporting obligations on commercial market participants, and lack the flexibility 

necessary to ensure that the legitimate hedging activities of corporations who carry 

cash market risks in physical commodities continue to receive treatment as ‘‘bona 

fide’’ hedges under the rules. Left unchanged, the current rules will adversely affect 

agriculture and energy commodity markets. 

Specifically, we fear the proposed rules may result in the following:

• Reduced liquidity in physical futures markets as a significant amount of trading 

currently considered hedging is recharacterized as speculative, and as the daily 

reporting requirements mandate a prescriptive accounting of total cash transactions on a global basis for commercial concerns of any significant size;

• Increased risk held by farmers and small and medium sized energy producers 

because transactions currently held as hedging positions by the commercial 

trade would no longer qualify, thus significantly reducing commercial firms’ use 

of those strategies as a way to provide attractive cash forward markets to market participants;

• Increased confusion among market participants and analysts as the rules would 

make public reports less transparent by requiring hedgers to report hedges as 

speculative positions, thereby decreasing ‘‘bona fide’’ hedging open interest and 

increasing ‘‘speculative’’ open interest in a misleading manner; and

• Increased hedging costs for all end-users resulting from decreased ability to 

robustly manage price risks inherent in physical commodity markets.

We believe the CFTC needs to seriously consider major structural changes in its 

approach, both in defining what constitutes a bona fide hedge, the process for making bona fide hedge determinations, and in its proposed reporting regime. We support regulation that brings transparency and stability to the agriculture and energy 

commodity markets in the United States. However, the CFTC proposal in its 

present form seems likely to achieve neither of these objectives, and instead will reduce liquidity, hamper legitimate risk mitigation activities, and generally increase 

the level of risk held by farmers, producers and commercial agriculture and energy 

companies that today provide a valuable service in getting much-needed agricultural 

and energy commodities from producers into the hands of end-users. This ironic outcome would be both unfortunate and completely opposite to the goals of the DoddFrank legislation. 

Attached you will find a comment letter jointly sent by the Commodity Markets 

Council and the Energy Working Group that details our specific concerns to the 

CFTC on the proposed rules. As CFTC’s rulemaking process continues forward, we 

would respectfully ask that you request from the CFTC briefings or status updates, 

as appropriate, with respect to this vitally-important issue. If you have any questions or need any further information, please contact me at [Redacted] or [Redacted]. 

Regards,

CHRISTINE M. COCHRAN,

President.


11225056.eps
78

1The Working Group is a diverse group of commercial firms in the energy industry whose 

primary business activity is the physical delivery of one or more energy commodities to others, 

including industrial, commercial and residential consumers. Members of the Working Group are 

energy producers, marketers and utilities. 2 CMC is a trade association bringing together commodity exchanges with their industry counterparts. The activities of our members represent the complete spectrum of commercial users 

of all futures markets including agriculture. Specifically, our industry member firms are regular 

users of the Chicago Board of Trade, Chicago Mercantile Exchange, ICE Futures U.S., Kansas 

City Board of Trade, Minneapolis Grain Exchange, and New York Mercantile Exchange. Please 

note that Hunton & Williams LLP is not counsel to CMC. 

Commodity Markets Council Membership 

Exchange Members 

Chicago Board of Trade 

Chicago Mercantile Exchange 

ICE Futures U.S. 

Kansas City Board of Trade 

Minneapolis Grain Exchange 

New York Mercantile Exchange 

Industry Members 

ABN AMRO Clearing Chicago, LLC 

Archer Daniels Midland 

Avena Nordic Grain 

BNSF Railway 

BM&F Bovespa 

Brooks Grain, LLC 

Bunge 

Cereal Food Processors 

Farms Technology, LLC 

FCStone, LLC 

Gavilon, LLC 

Gresham Investment Management, LLC 

Infinium Capital Management 

JP Morgan 

Kraft Foods 

Laymac, Inc. 

Lincoln Grain Exchange 

Louis Dreyfus Commodities 

Macquarie Bank Limited 

Mocek, Greg 

Penson Futures 

Pia Capital Management LP 

Rand Financial Services, Inc. 

Red Rock Trading, LLC 

RJ O’Brien 

Rich Investments 

Riverland Ag 

State Street Global Markets 

TENCO, Inc. 

The Scoular Co. 

Vermillion Asset Management 

ATTACHMENT

June 5, 2011

Via Electronic Submission

DAVID A. STAWICK,

Secretary,

Commodity Futures Trading Commission, 

Washington, D.C.

Re: Position Limits for Derivatives, RIN 3038–AD15 and 3038–AD16

Dear Secretary Stawick: 

I. Introduction 

On behalf of the Working Group of Commercial Energy Firms (the ‘‘Working 

Group’’) 1 and the Commodity Markets Council (‘‘CMC’’) 2 (collectively, the ‘‘CommerVerDate 0ct 09 2002 15:26 Nov 29, 2011 Jkt 041481 PO 00000 Frm 00082 Fmt 6633 Sfmt 6621 I:\DOCS\112-25\70998.TXT BRIAN
79

3The Commercial Alliance is a combined effort among commercial agriculture and energy 

companies to address significant issues under the Commission’s rulemakings to implement derivatives reform under Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (‘‘Dodd-Frank Act’’). 4Position Limits for Derivatives, Notice of Proposed Rulemaking, 76 FED. REG. 4752 (Jan. 26, 

2011). 5See Position Limits for Derivatives, Comments of the Working Group of Commercial Energy 

Firms (Mar. 28, 2011); Position Limits for Derivatives, Comments of the Commodity Markets 

Council (Mar. 28, 2011). 6See proposed CFTC Rule 151.5(a). The problems manifest themselves, in many circumstances, because cash settled swaps and DCM physically-settled futures do not offset each 

other in position calculations for purposes of these rules.

cial Alliance’’),3 Hunton & Williams LLP hereby submits these comments to supplement the individually filed comments of the Working Group and the CMC submitted 

in response to the Commission’s Notice of Proposed Rulemaking, Position Limits for 

Derivatives (the ‘‘Proposed Position Limits Rule’’).4 While the Working Group and 

the CMC individually filed comments in response to the Proposed Position Limits 

Rule, the Commercial Alliance is filing the comments set forth herein because further issues were discovered that had not previously been addressed. Specifically, 

these comments address the Commercial Alliance’s concerns with the bona fide

hedging exemption as set forth in the Proposed Position Limits Rule. 

II. Comments of the Commercial Alliance 

Participants in the Commercial Alliance share a common concern that the Commission’s proposed rules implementing Title VII of the Act, while primarily designed 

to address problems in the financial markets, will materially and adversely affect 

the commercial markets through which agricultural and energy-related commodities 

are ultimately delivered to United States consumers. The Working Group and CMC 

separately filed comments in response to the Proposed Position Limits Proposed 

Rule, presenting arguments opposing the imposition of position limits set forth in 

the Proposed Position Limit Rule.5

In this letter, we are not addressing whether the imposition of Federal speculative 

position limits is appropriate as a legal or policy matter. Rather, the Commercial 

Alliance seeks to focus the Commission’s attention on certain flaws in the proposed 

definition of a bona fide hedging transaction set forth in proposed CFTC Rule 

151.5(a), which, if adopted as proposed, will disrupt the use of commercial markets 

for hedging purposes. 

A. Definition of Bona Fide Hedge 

As addressed by CMC and the Working Group in their individually filed comments on the Proposed Position Limits Rule, the Commission has taken a narrower 

view of bona fide hedging than as defined by Congress in the Act. Specifically, the 

Commission has proposed to allow as bona fide hedges only transactions that fit 

within five specific categories of hedges, referred to as ‘‘enumerated hedges.’’

In addition, while Congress permitted the Commission to exempt ‘‘any transaction 

or class of transactions’’ from any position limits that it establishes pursuant to the 

Act, the Proposed Position Limits Rule has eliminated the opportunity for participants transacting in exempt and agricultural commodities to apply for exemptions 

from position limits for what have historically been known, and permitted, as ‘‘nonenumerated hedges.’’ As a consequence, certain traditional risk-reducing commercial 

transactions executed in energy and agricultural markets would not fall within the 

definition of a bona fide hedging transaction under the Commission’s Proposed Position Limits Rule.6 Such transactions include, but are not limited to, the following: 

• Unfixed price commitments in the same calendar month;

• Unfixed price commitments in a different commodity;

• Hedges relating to assets that a person anticipates owning or merchandising;

• Hedges of services;

• Hedges of ‘‘spread’’ and ‘‘arbitrage’’ positions;

• Hedging in the last 5 days of trading an expiring contract; and

• Hedges on assets.

The Commercial Alliance provides in Attachment A hereto specific examples of 

commercial transactions executed in energy and agricultural markets that would 

not fall within the definition of a bona fide hedging transaction under the Commission’s Proposed Position Limits Rule. 

80

7See Position Limits for Derivatives, Comments of the Working Group of Commercial Energy 

Firms at Part III.C (Mar. 28, 2011); Position Limits for Derivatives, Comments of the Commodity Markets Council at Part 4 (Mar. 28, 2011). 

B. The Commission Should Incorporate All of the Activities Described in the Attached Examples Into the Final CFTC Rule 151.5(a)(2)—Enumerated Hedges 

All of the examples in Attachment A represent commercial activities that fall 

within the definition of bona fide hedge set forth in Section 737 of the Act and 

CFTC Rule 151.5(a)(1) of the Proposed Position Limits Rule. Accordingly, they 

should be incorporated into the list of enumerated hedges to establish, beyond 

doubt, that such transactions would qualify as bona fide hedges under any final 

Commission rules. 

C. The Commission Should Retain the Flexibility of Former CFTC Rule 1.3(z)(3)—

Non-Enumerated Hedges and Related Processes 

In addition to providing certainty for the types of transactions set forth in Attachment A, the Commission should preserve the rule and process for obtaining exemptions for non-enumerated hedges. Markets are dynamic and are subject to change. 

The Commercial Alliance submits that it is neither in the public interest nor in its 

own interest as a market regulator for the Commission to adopt a rule that effectively eliminates its discretion and flexibility to grant an exemption for a bona fide

hedging strategy that it could not foresee today (or, for that matter, that was simply 

overlooked during this process). While the Commission would be permitted to 

amend CFTC Rule 151.5(a)(2) to accommodate any unforeseen bona fide hedging 

strategies, the Commercial Alliance submits that the process to amend such Rule 

would not be in the best interests of the markets or the economy, as it would effectively delay the applicant hedger from the opportunity to timely establish that legitimate hedge position. Therefore, the Commission should retain CFTC Rule 

1.3(z)(3) to give it the flexibility to adapt to changing market circumstances. 

D. Compliance With the Daily Reporting Requirement Will Be Unduly Burdensome 

As discussed in both the CMC and Working Group individual comments on the 

Proposed Position Limits Rule, requiring market participants to report daily on 

their cash market positions will be extremely and unduly burdensome and is not 

justified by any corresponding benefit.7 In addition to the operational burdens of 

building and maintaining a compliance system to perform such reporting, the process, or lack thereof, for applying for an exemption in advance of exceeding any position limit creates significant uncertainty for market participants seeking to accommodate both their short-term and long-term hedging needs. Accordingly, the Commercial Alliance requests that the Commission consider these concerns and provide 

market participants clear guidance on the process for applying for, and complying 

with, exemptions from speculative position limits. 

IV. Conclusion 

The Commercial Alliance supports regulation that brings transparency and stability to the agriculture and energy swap markets in the United States. The Commercial Alliance appreciates this opportunity to comment and respectfully requests 

that the Commission consider the comments set forth herein prior to the adoption 

of any final rule implementing Title VII of the Act. The Commercial Alliance expressly reserves the right to supplement these comments as deemed necessary and 

appropriate. 

If you have any questions, please contact Christine Cochran, President, CMC, at 

[Redacted], or R. Michael Sweeney, Jr., counsel to the Working Group, at [Redacted]. 

Respectfully submitted,

R. MICHAEL SWEENEY, JR.;

DAVID T. MCINDOE;

MARK W. MENEZES; 

on behalf of the Commercial Alliance.

CC:

Hon. GARY GENSLER, Chairman; 

Hon. MICHAEL DUNN, Commissioner; 

Hon. BART CHILTON, Commission; 

Hon. JILL SOMMERS, Commissioner; 

Hon. SCOTT O’MALIA, Commissioner; 

DAN BERKOVITZ, General Counsel, Office of General Counsel; 

BRUCE FEKRAT, Special Counsel, Division of Market Oversight. 

81

ATTACHMENT A

Examples of Transactions That Do Not Qualify as Bona Fide Hedging Under 

the Proposed Position Limits Rule 

The following provides examples of hedging transactions commonly entered into 

by commercial firms in agricultural and exempt commodity markets that will be effectively excluded from the definition of bona fide hedge as set forth under the Commission’s Proposed Position Limits Rule. 

I. Unfixed Price Commitments 

A. In the Same Calendar Month 

Proposed CFTC Rule 151.5(a)(2)(iii) would permit a hedge of offsetting 

unfixed price purchase and sale commitments only if they were based on 

different delivery months. The following example demonstrates the potential need to hedge basis risk in the same delivery month, but at a different 

delivery location. If one used a cash-settled swap in one location and a 

physical delivery futures contract at the other, these positions would not 

offset, and would not qualify as bona fide hedge positions.

Example: A natural gas (‘‘NG’’) wholesaler buys gas at (Point 1) and sells it 

at another point on the same pipeline (Point 2) to a different counterparty. Both 

contracts are at an index price plus or minus a differential. In order to lock in 

the current spread relationship between the prices at the two delivery locations, 

NG wholesaler sells a NYMEX Henry Hub futures contract and enters into a 

‘‘long’’ swap on the price at Point 2, hedging the risk that the price at Point 2 

will decline relative to the price at Point 1. Since the purchase and sale will 

occur during the same delivery month, this hedge would not constitute a bona 

fide hedge under proposed CFTC Rule 151.5(a)(2). 

B. In a Different Commodity 

Proposed CFTC Rule 151.5(a)(2)(iii) would permit a hedge of offsetting 

unfixed price purchase and sale commitments only if they were in the same 

commodity. The following example demonstrates the potential need to 

hedge basis risk between two different commodities.

Example 1: Power plant operator buys natural gas from which it generates 

and sells power. It buys gas from one party at an index plus or minus a differential and it sells power to a different party at an index plus or minus a differential. In order to lock in the basis between gas and power prices, it enters into 

a swap on the power price and Henry Hub futures contracts in natural gas, effectively hedging the risk that the price of power will decline relative to the price 

of gas. Since the two prices are referencing different commodities, this hedge 

would not constitute a bona fide hedge under proposed CFTC Rule 151.5(a)(2). 

II. ‘‘Anticipated’’ Transactions 

Although hedges of ‘‘anticipated ownership’’ and ‘‘anticipated merchandising’’ transactions would be bona fide hedges under the language in the 

Dodd-Frank Act and seemingly under proposed CFTC Rule 151.5(a)(1), they 

would not be treated as such because there is no provision for them as 

‘‘enumerated hedges’’ under proposed CFTC Rule 151.5(a)(2).

Example 1: Commercial entity X, a wholesale marketer of crude oil, has purchased a cargo of oil currently transiting the Atlantic from Europe to the U.S. 

at the price of ICE Brent futures plus or minus a differential. It is negotiating 

to sell that cargo in the U.S. gulf coast at a price of NYMEX WTI plus or minus 

a differential. Although it has not concluded negotiations on the sale, it believes 

that it will do so in the next several days. Believing that prices may fall over 

the next several days, it places a hedge in NYMEX WTI futures. Under proposed 

CFTC Rule 151.5(a)(2), this would not constitute a bona fide hedge. 

Example 2: In the example above, the parties have concluded their negotiations and, as is standard in the industry, agreed to the transactions subject to 

credit terms and legal review of documentation. Again, the NYMEX WTI hedge 

placed by Commercial entity X would not constitute a bona fide hedge under 

the proposed CFC Rule 151.5(a)(2). 

Example 3: Farmers Elevator, a grain merchandiser, owns a 3 million bushel 

storage facility in Farmville, a town surrounded by thousands of acres of growing corn, soybeans, and wheat. As part of its normal business practices, Farmers 

Elevator expects in the future to enter into forward contracts with area farmers 

under which Farmers Elevator agrees to pay farmers a fixed price for their grain 

at harvest. In order to hedge this risk, Farmers Elevator ‘‘goes short’’ on CME 

82

8 Note that this ‘‘value’’ exists whether commercial energy firm Z ever owns or intends to own 

the physical commodity. In some circumstances, the firm might choose to release the capacity 

to a third-party and realize the value of the transportation service from the capacity release 

transaction. 

by selling futures contracts. Under the proposed rule, this would not constitute 

a bona fide hedge since at the time of the futures position by Farmers Elevator 

there in fact is no underlying physical contract. The result would be that Farmers Elevator may no longer be able to provide attractive forward cash market 

contracts to its farm customers. 

Example 4: In February of 2011, prior to spring wheat planting, Elevator X, 

which has storage capacity that is currently sitting completely empty, locks in 

a spread of $1.40 on a portion of its expected throughput for the crop year by 

buying July 2011 Wheat futures and selling July 2012 Wheat futures. Regardless 

of whether Elevator X actually buys wheat in 2011, this transaction represents 

a hedge by Elevator X of its capacity (i.e., the value of its grain storage assets). 

If there is a crop failure during the 2011 harvest resulting in little to no wheat 

deliveries at Elevator X, the spread position hedge will perform by providing Elevator X the economic value of the position hedging against such an event. Alternatively if Elevator X (as expected) buys wheat, it will hedge these specific price 

risks by taking appropriate futures positions and reducing the July/July Wheat 

spread. This ‘‘hedging of capacity’’ strategy would not be a bona fide hedge 

under the proposed CFTC proposed Rule 151.5(a)(2). 

III. Hedging of Services 

Although hedges on the value of ‘‘services that a person provides or purchases, or anticipates providing or purchasing’’ would be bona fide hedges 

under the language in the Dodd-Frank Act and seemingly under proposed 

CFTC Rule 151.5(a)(1), they would not be treated as such because there is 

no provision for them as ‘‘enumerated hedges’’ under proposed CFTC Rule 

151.5(a)(2).

Example 1: Commercial energy firm Z is a wholesale marketer of natural gas. 

It has an opportunity to acquire one year of firm transportation on Natural Gas 

Pipeline (‘‘NGPL’’) from the Texok receipt point to the Henry Hub delivery point 

for an all-in cost of $.30/mmbtu. The ‘‘value’’ of that service at that time is $.33/

mmbtu, measured as the difference between the price at which one can sell the 

natural gas at the delivery point minus the price at which one can purchase the 

gas at the receipt point. At that time, commercial energy firm Z can enter into 

a swap locking in the calendar 2012 strip at Texok at a price of $4.00/mmbtu 

and sell a calendar strip of NYMEX Henry Hub natural gas futures contracts 

locking in a sale price at a weighted average of $4.33/mmbtu. Entering into 

those two separate transactions without having actually purchased or sold natural gas to transport has allowed commercial energy firm Z to hedge the value 

of the firm transportation service that it holds or can acquire.8 However, under 

the Commission’s proposal, the transactions would not qualify as bona fide

hedge transactions. 

Example 2: Natural Gas Producer X has new production coming on line over 

the next few years in the Gulf of Mexico. The production is located near Point 

A on Pipeline Y’s interstate natural gas pipeline system. Producer X has the desire to sell gas to customers in Region B as the price for natural gas in Region 

B is significantly higher than at Point A, where natural gas would currently be 

delivered into Pipeline Y’s system. Producer X contacts Pipeline Y and negotiates 

a Precedent Agreement with the pipeline under which Pipeline Y will build new 

transportation capacity from Point A to Region B. Under the Precedent Agreement, Producer A is obligated to pay demand charges to the pipeline for a term 

of 5 years from the date the pipeline goes into commercial operation, if Pipeline 

Y is able to complete a successful open season and obtains the necessary permits 

to construct and operate the new section or expansion of its pipeline system from 

Point A to Region B. The open season is designed to attract commitments from 

other potential shippers to help support the cost of building and operating the 

pipeline expansion. The schedule calls for a completion of construction and commercial operation of the pipeline expansion on March 31, 2013. 

Producer X is concerned that the natural gas price differential between Point 

A and Region B could collapse and is fairly confident the expansion project will 

be completed. In order to manage the risk associated with the 5 year financial 

commitment to Pipeline Y, i.e., pipeline demand charges, Producer X enters into 

swaps at Point B for a term of April 1, 2013 to March 31, 2018, to lock-in the 

price spread between Point A and Region B. Under the Commission’s Proposed 

83

Rule, the swap transactions would not qualify as bona fide hedges. In this case, 

the expansion of the pipeline system that would afford customers in Region B 

more access to lower priced gas might not occur without the ability to count the 

swaps associated with this transaction as a bona fide hedge. 

Example 3: Commercial energy firm A is an electric utility that owns coalfired generation facilities. Firm A enters into contracts with major railroads to 

transport coal from producing regions to its various generating facilities. One or 

more of these contracts are subject to a fuel surcharge, whereby rates paid by 

firm A to transport coal are indexed to the price of diesel fuel. As prices for the 

diesel fuel rise, the rate paid by firm A to transport coal also rises. To mitigate 

this risk, firm A could enter into a long position in futures contracts or swaps 

for the diesel fuel, whereby gains realized on these instruments should prices rise 

would off-set any increase in the rate paid by firm A to transport coal. Under 

the Proposed Rule, however, these transactions would not qualify as bona fide

hedge transactions since they would be entered into as a hedge of services—in 

this case, coal transportation services. 

IV. Hedges of ‘‘Spread’’ Or ‘‘Arbitrage’’ Positions 

Although hedges on the value of spread or arbitrage positions would be 

bona fide hedges under the language in the Act and seemingly under proposed CFTC Rule 151.5(a)(1), they would not be treated as such because 

there is no provision for them as ‘‘enumerated hedges’’ under proposed 

CFTC Rule 151.5(a)(2).

Example 1: The business model of Company X is to import crude oil from Europe to the United States. On an average year it imports 48 million barrels of 

crude oil. Its purchases in Europe are generally priced against Brent oil and its 

sales in the United States are priced against WTI. Those prices are readily available across the price curve, more than a year in advance. There are times when 

Company X believes the differential for a particular month is favorable and it 

seeks to lock in that differential by buying Brent swaps and selling NYMEX WTI 

futures, knowing that it will ultimately buy the oil priced in Brent and sell the 

oil priced in WTI. Under the proposed rule, even though this transaction allows 

Company X to hedge the risk of its business strategy and expected transactions, 

this would not be a bona fide hedge under proposed CFTC Rule 151.5(a)(1). 

Example 2: Grain Merchandiser X is in the business of buying wheat in, 

among other places, North Dakota, using a Minneapolis Grain Exchange 

(MGEX) reference price. Grain Merchandiser X is also in the business of selling 

wheat to Italian flour mills, using a Euronext France (MATIF) price. These 

prices are readily available across the price curve, more than a year in advance. 

As such, there are times when Grain Merchandiser X believes the differential for 

a particular month is favorable and it seeks to lock in the differential by selling 

MATIF futures (or swaps) and buying MGEX futures, even though it will ultimately buy North Dakota wheat priced in MGEX futures. This transaction, 

which allows Grain Merchandiser X to hedge the risk of the expected transactions in its business strategy, would not be a bona fide hedge since it is not 

enumerated under proposed CFTC Rule 151.5(a)(2). 

V. Hedging in the Last Five Days of Trading an Expiring Contract 

The following examples illustrate the uneconomic consequences of prohibiting a bona fide hedge positions from being held in the last 5 days of 

trading. 

A. Unsold Anticipated Production—Proposed CFTC Rule 151.5(a)(2)(i)(B) 

Example 1: Company A anticipates producing 2000 barrels of crude oil in 

July. That production is currently unsold. To hedge its risk that the value of 

those barrels may decline prior to their sale, Company A will sell two July 

NYMEX WTI crude oil futures contracts, which represent delivery ratably during 

the month of July. The last trading day of the July futures contract is June 21st. 

The last day that Company A could hold the position as a bona fide hedge 

under the proposal is June 14th. This means that if Company A holds the contract from June 15th through June 21st and delivers its oil under the July futures contract, it could not treat those positions as a bona fide hedge during 

that period. Alternatively, in order to maintain bona fide hedge status, it would 

be required to roll its hedge into the August contract on June 14th, taking basis 

risk on the July/August spread for the additional 5 days. 

84

B. Unfixed Price Contracts—Proposed CFTC Rule 151.5(a)(2)(iii) 

Example 1: Company B has a contract to buy natural gas at the Henry Hub in July at NYMEX + $.10 and a contract to resell it at the Henry Hub in August 

at NYMEX + $.15. To hedge the basis risk, it sells NYMEX July futures and 

buys NYMEX August futures. Under the Commission’s proposal, this position 

would not be a bona fide hedge if it was carried into the last 5 days of trading 

of the NYMEX July futures contract. Company B would be forced to roll its position to a less efficient hedge. 

C. Cross-Commodity Hedges—Proposed CFTC Rule 151.5(a)(2)(v) 

Example 1: Commercial energy firm J supplies jet fuel to airlines at a variety 

of airports in the United States, including Houston Intercontinental Airport. It 

has a fixed-price contract to purchase jet fuel from a refinery on the gulf coast 

during early June. Because there is no liquid jet fuel futures contract, commercial energy firm J uses the June NYMEX physically-delivered WTI crude oil futures contract to hedge its price risk. Under the Proposed Rule, commercial energy firm J would be required to liquidate its hedge during the last 5 trading 

days of the June contract and either remain unhedged or replace its June hedge 

with a contract that represents a different delivery period and, therefore, a different supply/demand and pricing profile. 

Example 2: AgriCorp, a grain warehouse, grain merchandiser and feed ingredient wholesaler, buys wheat from farmers. At the same time, Agricorp enters 

into a fixed price agreement with a feedyard to supply feed (the exact components 

of which could be satisfied using wheat, corn, DDGs, or other ingredients). In 

order to hedge its risk, AgriCorp enters into a swap, hedging the risk that the 

price of wheat will decline relative to the price of corn (the corn futures price better correlates to feed prices, thereby providing a more effective hedge). Since the 

two prices are referencing different commodities, this hedge would not constitute 

a bona fide hedge if held in the last 5 days of trading. 

VI. Hedges on Assets 

Example: XYZ Corp. is planning on buying a liquefied natural gas (‘‘LNG’’) 

vessel. The value of that asset is based upon the spread between natural gas 

prices between and among various continents. XYZ will need financing in order 

to make the purchase. The lenders will only make a loan if XYZ can demonstrate 

a level of certainty as to its future revenue stream. As it negotiates with the shipbuilder and as it negotiates with lenders, the current differentials are favorable 

for robust demand for LNG. XYZ wants to enter into separate swaps and/or futures positions in the U.S., Europe and Asia to lock in the potential purchase 

prices in producing regions and the potential sales prices in consuming regions 

at current differentials. This will allow it to lock in the value of LNG transportation and satisfy lenders that this is a good credit risk for them to take on. 

Those swaps and/or futures positions would not be bona fide hedges under the 

Proposed Position Limit Rule because the ship-owner does not own or anticipate 

owning the underlying commodities.

The CHAIRMAN. Thank you, and the chair would like to remind 

Members that they will be recognized for questioning in order of 

seniority for Members who were here at the start of the hearing, 

and after that, Members will be recognized in order of arrival. I do 

appreciate the Members’ understanding, and just to provide a little 

clarity, on the majority side, the first three or so will be myself, Mr. 

Johnson, Mr. Conaway. On the minority side, it will be Mr. Holden, 

Mr. Peterson and Mr. Boswell. And with that, I turn to myself. 

Throughout this process, I have argued that regulation and a 

healthy economy can go together. A robust regulation, yes, and a 

healthy economy can go hand in hand. Unfortunately, we have not 

seen that balance, I believe, in many of the proposed rules. Certain 

regulatory proposals will impose costs to the real economy that 

may very well exceed the benefits achieved in Dodd-Frank’s objectives, and that is what we are here today to address. That is our 

job. 

Yesterday, the Chairman of the CFTC gave a speech before the 

Futures Industry Association in which he said, ‘‘It has been just 

85

over a year since Dodd-Frank reforms became law. There are those 

who might like to roll them back and put us back in the regulatory 

environment that preceded the crisis 3 years ago.’’ So I ask this 

first couple of questions to the panel, and anyone can answer that 

chooses to. Do you believe that if the proposals considered today 

were enacted, that they would roll back Dodd-Frank reforms, number one, and if the proposed changes were made, will your regulatory environment be the same as it was 3 years ago? Fair question. Do you believe what we are discussing today would roll back 

Dodd-Frank’s reforms, and if these bills were indeed to be signed 

into law, do you believe that the regulatory environment would be 

where it was 3 years ago? Whoever would care to step into that? 

Please. 

Ms. SANEVICH. Certainly, speaking for the ERISA plans, the regulatory requirement would indeed change even if the proposals 

that are presented today, at least as they related to ERISA plans 

were enacted, what these proposals would do in our view is really 

reflect better what the Congressional intent was. In some of the 

cases that particularly affect ERISA plans, the regulations that 

have been proposed currently are not within the spirit of what Congress intended and in some cases would essential eliminate the 

ability of ERISA plans to use swaps, which is clearly what Congress did not intend in enacting Dodd-Frank. So things would not 

be business as usual as they were 3 years ago but they would certainly clarify and move us closer to what we think Congress had 

intended with enacting certain provisions of the Dodd-Frank. 

The CHAIRMAN. Thank you. 

Anyone else wish to comment? Yes, Mr. Williams. 

Mr. WILLIAMS. Mr. Chairman, it appears to us that the implementation of the legislation considered today would only allow the 

practical implementation of Dodd-Frank as envisioned, and the regulatory environment compared to 3 years ago would be substantially different. 

The CHAIRMAN. Thank you. 

Mr. GIANCARLO. Mr. Chairman, these proposals are not meant to 

roll back Dodd-Frank, and I could say for the record, we are not 

in favor of rolling back Dodd-Frank. Dodd-Frank imposes substantial changes on the wholesale swaps industry, many of which in 

fact we were advocating for before Dodd-Frank, such things as 

moving to more of a cleared market structure. We wholly support 

that major accomplishment of Dodd-Frank and think that will improve transparency and access to the markets for many participants. 

The mandatory execution provision is also one that we are very 

supportive of but we are supportive of it if it is in accord with 

Congress’s clear intent that execution facilities could use any 

means of interstate commerce. So we see the Swap Clarification 

Act and these other bills as purely clarification and not a rollback 

of the operative provisions of Dodd-Frank. 

Ms. BOULTWOOD. So I will add to that answer. You know, DoddFrank was put in place as a statute to protect and control the economy against systemic risk and also create greater transparency 

with respect to Title VII and our world of derivatives. So neither 

of those would be lessened, if you will, by the rules that we are conVerDate 0ct 09 2002 15:26 Nov 29, 2011 Jkt 041481 PO 00000 Frm 00089 Fmt 6633 Sfmt 6601 I:\DOCS\112-25\70998.TXT BRIAN
86

sidering or the legislation that we are considering today. This legislation in fact ensures that those that created the systemic risk are 

treated under the rules from the SEC and CFTC and would exclude, for example, end-users who are well known through history 

of having not created, or are sources, of systemic risk. There are 

reporting provisions, even for end-users, that are a part of the rulemaking under Title VII which would be in place that really further 

that goal of transparency in the derivatives markets. I think the 

provision of clearing maintains a very new aspect of transparency 

that would be preserved even when these proposed legislative bills 

are approved. 

The CHAIRMAN. One last question, and I understand the answers 

to these from your comments but just for the record, do you think 

it is important for Congress to legislate in the areas proposed today 

or should we wait until the agencies finalize the rules? Yes, ma’am. 

Ms. SANEVICH. We definitely think Congress should act because, 

frankly, if the rules are adopted and finalized, by then at least for 

the ERISA plans, it would be too late. They will not be able to engage in swaps as of the time the rules are set for implementation 

and that would be a disastrous result for the millions of Americans 

that depend on defined benefit plans for their retirement security. 

The CHAIRMAN. Yes, Mr. Cordes? 

Mr. CORDES. Mr. Chairman, I would agree with that. The bills 

need to be enacted today. We need to get some clarification on 

some of these things. We have cooperatives today that are putting 

their businesses on hold from going forward, and part of that is the 

uncertainty. We need this clarification. Our concern is down the 

road if we don’t have that clarification, will we have the proper risk 

management tools to put through the cooperative network that ultimately get down to the farmer level? I don’t think it is any surprise today with the volatility in the markets out there, farmers 

are faced with greater challenges about protecting and managing 

their margins and their operations that will be subject to risk. 

Mr. GIANCARLO. Mr. Chairman, we operate global marketplaces 

in addition to Louisville, Kentucky, and Sugarland, Texas, that I 

mentioned earlier. We also operate marketplaces in London, in Geneva, in Dubai and Singapore and places like that, and with the 

restrictions placed on modes of execution proposed by the CFTC, 

the operators of markets in those jurisdictions are licking their 

chops as they are waiting for markets to migrate offshore. In the 

modern world of swaps, markets move at a flick of a mouse. It is 

not as if they have to move buildings or bridges. They can move 

to foreign marketplaces. If we set restrictions on the methods of 

execution that are unsuitable for the nature of the instruments, we 

will see those instruments trade in foreign markets almost overnight. It is very, very important that Congress’s intent that the 

mode of execution be suitable for the instrument and any means 

of interstate commerce be interpreted as it is meant to be, be enacted as soon as possible. 

The CHAIRMAN. Thank you. One last comment, and my time will 

have expired. 

Mr. THUL. Just to add on, Mr. Chairman, I would say that the 

comment that you made at the beginning of your questioning was 

just adding real cost to the economy and if this goes through as it 

87

is today, we have lack of clarity around what many of the definitions are and then also the potential to introduce a lot of added incremental costs to the commercial businesses that we are dealing 

with that are not in place today and could hurt the competitiveness 

of the United States. 

The CHAIRMAN. Thank you. My time has expired. I now recognize 

the gentleman from Pennsylvania, Mr. Holden, for 5 minutes. 

Mr. HOLDEN. Thank you, Mr. Chairman. 

Mr. Williams, to which Prudential Regulators does your bank answer to? 

Mr. WILLIAMS. To what regulators do we answer? 

Mr. HOLDEN. Yes. 

Mr. WILLIAMS. We have at least three regulators: the Georgia 

Department of Banking and Finance, the FDIC and the Federal 

Reserve System. 

Mr. HOLDEN. Now, if Dodd-Frank had never been enacted into 

law, would your regulators have the authority to require you to collect margin from your swap counterparties whether they be financial or commercial using their preexisting statutory authority to 

oversee your bank’s safety and soundness? 

Mr. WILLIAMS. They have the authority to oversee our safety and 

soundness. I don’t believe they have the statutory authority to 

specify specific margin requirements or collateral requirements on 

specific transactions. 

Mr. HOLDEN. Well, it is my understanding that the regulators do 

have that authority, so Mr. Chairman, I suggest maybe we can get 

the Prudential Regulators in here and get clarification on this. 

For other members of the panel, if we do discover the Prudential 

Regulators, as I understand it, can still require margin despite 

H.R. 2682, how do we address your concerns? In other words, I believe they can have you impose margins, if we find out that that 

is correct as they are telling me, what does this legislation do and 

how do we address your concerns? 

Mr. WILLIAMS. I am not familiar with the specific legislation you 

mentioned, and I don’t know about the Prudential Regulators’ specific authority to regulate specific transactions. I will be happy to 

get back to you on that. 

Mr. HOLDEN. Does anyone else care to comment? Because it is 

my clear understanding that they believe that they can have margins imposed. 

Ms. BOULTWOOD. Yes, that is correct, so they can either impose 

margin on counterparties, and that is initial margin and variation 

margin, and if they choose not to impose that margin, then they 

will be required to hold additional capital. So either presents a cost 

because this capital, if it is held by the bank, will be passed 

through as a charge, which would be reflected in the bid ask 

spread. That is the price of the derivative that is transacted. And 

if it is a margin requirement, initial margin and variation margin, 

then it is a direct capital cost to the counterparty. 

Mr. HOLDEN. Okay. Well, help me—this is complicated stuff, so 

you said they do have the authority, so if they do have the authority, how would H.R. 2682 if enacted into law affect the concern? 

They can do it anyway, correct? 

88

Ms. BOULTWOOD. That is a good question. I think it would require cooperation in kind of this unprecedented environment of regulatory change between authorities like the CFTC, the SEC and 

Prudential Regulators which, honestly, we haven’t seen before. 

How does that get legislated? I leave it to more experienced minds 

than mine, but I do think that there has to be a way to force the 

cooperation across Prudential Regulators and independent Commissions. 

Ms. SANEVICH. I guess I have a couple of observations. Obviously, 

I don’t know the jurisdictional lines between Prudential Regulators 

and Congress but the Prudential Regulators came out with these 

margin rules as a direct result of the Dodd-Frank Act. Something 

in the Act must have made them stop and think and go ahead and 

start regulating margin requirements. Moreover, the CFTC also 

has tacked onto the Prudential Regulators with respect to margin 

requirements for anyone who will not be caught by the Prudential 

Regulators. So certainly the CFTC since it is empowered under the 

Dodd-Frank Act to do what it is doing, there has to be some sort 

of cross-jurisdictional issue. 

And last, I believe the Chairman had mentioned and maybe the 

Ranking Member as well the cost-benefit analysis issue, and perhaps that is where some solution can be found, because with respect to the ERISA pension plans, they are called high-risk endusers by default. It is not like the regulators had thought about 

what pension plans do, how they manage their risk or what they 

use interest rate swaps for, they just said if you are not this and 

you are not this, you must be a high-risk financial end-user, and 

that is clearly a ludicrous result with respect to pension plans. 

Maybe that is a way to force the issue and make folks think about 

exactly how these margin requirements will be implemented and 

how they will affect the various end-users that will be affected. 

Mr. HOLDEN. Thank you. 

Mr. Chairman, based on the answer, it is just more apparent 

that we need to have the regulators come before us so we can have 

some clarity, and I yield back. 

Mr. CONAWAY [presiding.] One clarification. Ms. Boultwood, were 

you talking in your answer about the current regulations or the 

proposed regulations? 

Ms. BOULTWOOD. As Ms. Sanevich indicated, it is the regulations 

that have come about for banks as a result of Dodd-Frank. 

Mr. CONAWAY. Okay. So the proposed regulations? 

Ms. BOULTWOOD. Correct, and whether they are in—I don’t know 

the timeline for when they go into effect but they are proposed. 

Mr. CONAWAY. Mr. Tim Johnson for 5 minutes. 

Mr. JOHNSON. Thank you, Mr. Chairman. 

Let me address this to all the panelists, and I don’t need ad seriatim but maybe a select response. You are all in some form or another an integral part of the agricultural sector in the United 

States. How do you feel that the CFTC regulations as proposed 

without any guiding legislation will impact American agriculture? 

Mr. CORDES. I would say without some clarification on the rules 

as things are proposed, you are going to have agriculture not knowing exactly where they stand. They will be hesitant to offer some 

of the risk management tools that they do in the industry today. 

89

I would say if you get these volatile markets like we saw in 2008, 

which we are very close at today, some of the impact you will see 

in rural America, you will probably find that as farmers want to 

sell grain into the future, say 6 months to a year out or maybe a 

year and a half, won’t have that opportunity because there won’t 

be buyers there to post those bids because without these tools, they 

can’t manage that. So they need clarification so we can offer the 

proper tools. 

Mr. JOHNSON. So would the whole panel basically have a sense 

that a lack of certainty causes some degree of instability and lack 

of predictability in the process? Is that a fair statement? 

Let me ask Mr. Thul from Cargill, you are a major player in my 

district and the agricultural sector around the country. Your company is facing a significant number of new regulatory requirements 

that could greatly change—I think that is an understatement—

your risk management practices. What would be, in your judgment, 

the cumulative effect of those regulations, or these regulations, for 

Cargill, and more particularly for its customers? 

Mr. THUL. Thank you. I think it would be a drastic change for 

us. You know, if you look at the anticipatory hedging piece of this 

and even the bona fide hedge definition, it could greatly reduce our 

ability to be able to handle the grain crops and service our customers, and at its worst case, that could translate into not being 

able to accept nearby delivery in times when the marketplace absolutely needs it. So I think it could be——

Mr. JOHNSON. That is good. I appreciate that. 

The Ranking Member, my good friend, Mr. Peterson, has expressed some concerns about this series of three bills and three discussion drafts that they might be premature and that they not be 

geared in at least time-wise to what we need to do. Do any of you 

have any thoughts or response to that? Don’t all speak at once. 

Ms. BOULTWOOD. Also, it is in part related to the last question, 

just in terms of the costs we are already seeing. So behavior is 

changing. We have observed in the energy markets already decreases in liquidity in those markets. There could be a number of 

reasons to explain that, but certainly the uncertainty and potential 

for regulations, costly regulations, is one large reason. When we 

look at our costs internally, there will be significant costs of implementation if we don’t properly as proposed under this proposed legislation define the end-user and the appropriate size of its de minimis exception to the swap dealer definition. We will also have technology costs as well as those costs we see in the market. 

Mr. JOHNSON. I guess my last question is in the form of a comment. Ranking Member Costa and I recently held a field hearing 

in central Illinois with respect to rural development, broadband 

services and so forth, which really raises the larger issue of where 

rural America, where small-town America is going. I am presuming 

that the members of the panel here like most of the Members of 

the Committee would agree that there is going to be an impact on 

small-town America, rural America, particularly during an era 

when there is at best a decline and at worst a rapid decline in 

terms of the infrastructure and economic future of that area. Would 

you say that is a fair summation of the impact of the rules without 

any guiding legislation? 

90

Mr. THUL. I absolutely would agree with that, and I think that 

it is going to put unnecessary costs in an already low margin-type 

environment that we have in our agricultural system. 

Mr. JOHNSON. My time has expired. Let me just make a concluding remark. I think this has been a very instructive hearing so 

far, and a lot of good input, good witnesses and actually good proposals for change, but I would suggest that when we deal in a 

mega cosmic sense, we oftentimes have a microcosmic effect in 

terms of people’s real lives in the Central Valley of California or 

in Decatur, Illinois, and I am hopeful we as Members of Congress, 

the CFTC and you all are mindful of what the impact could be. 

Mr. CONAWAY. The gentleman yields back. 

Mr. Peterson for 5 minutes. 

Mr. PETERSON. Thank you, Mr. Chairman. 

Does anybody here remember Enron? You know, we had an energy company that became a financial trading company, and like 

a swap dealer, it served as a counterparty to a wide range of energy swaps with a wide range of customers and operated in the 

dark without oversight, without regulation, created separate entities and moved risk to those entities to hide it from its own balance 

sheet and again with little oversight. Out of that fiasco, that is part 

of the reason we got the Sarbanes-Oxley legislation, which typically 

overreacted and put costs on people that weren’t the problem, and 

some of the issues that you are raising here today, but as part of 

the cost of getting that done, we got rid of Glass-Steagall, which 

caused part of this problem. And then we in this Committee passed 

the CFMA in 2000, which further caused this problem, and I have 

to admit as a junior Member of the Committee, and for those of you 

that are new here, this might be instructive—I bought into this. 

The argument was, these guys are a bunch of rich guys that are 

gambling their own money and so it is none of our business what 

they do, and they almost took down the whole damn world economy. 

And the other thing that happened in the CFMA is that a lot of 

this swap business was gambling, especially these naked CDS’s, 

and so there was a question about whether there was legal backing 

of these contracts, and so in the CFMA, we gave legal certainty to 

these swaps, and at the time we had $80 billion in the swap market, and from 2000 to 2008, it went to $600 or $700 trillion with 

no regulation, nobody knowing who was doing what, and that is 

what we are trying to get at here. 

So today you come before us with one proposed bill that would 

give energy companies the ability to make markets and engage in 

dealing activities and energy swap with little or no chance of being 

designated as a swap dealer regardless of how much dealing businesses you do, and we know that some of you do a significant 

amount of dealing. 

Another bill would exempt even from the definition of swap those 

swaps conducted between affiliates of your company, and so there 

are Members who see what you are asking for and point their fingers and say Enron. Clearly, none of you are Enron, I understand 

that, I am not accusing you of that, but what do you say? What 

can I say to those that fear that these bills are going to reinstate 

91

the condition for the rise and subsequent collapse of another Enron 

kind of situation? 

Ms. BOULTWOOD. I can start the response. We all remember 

Enron. It is a great thing to discuss as we think about this proposed legislation, but Enron as well as certain telecom companies 

in that era, there were large accounting scandals and Enron had 

a lot to do with financing off balance sheet in entities that weren’t 

legitimate and didn’t have legitimate assets backing them. Now, 

Enron, at the same time they were perpetrating an accounting 

fraud were also transacting in derivative markets. That is true. 

They were dealing, they were market making often without physical assets to support that activity. 

Mr. PETERSON. Well, and so was AIG. 

Ms. BOULTWOOD. Well——

Mr. PETERSON. I mean, there were a number of people that were 

doing these swaps——

Ms. BOULTWOOD. And so——

Mr. PETERSON.—and not putting any money up, and that is part 

of what we are trying to get at here. I mean, you keep saying that 

this is going to add cost. Well, yes, it is going to add cost in some 

places that should add cost because people were operating and 

doing these deals and pretending that there wasn’t any risk and 

any potential problem, and the government ended up picking up 

the bill. And then Goldman goes over and makes this deal in 

Greece and now the taxpayers in Europe are going to pick up the 

bill for that, and we are still allowing people to do this stuff, and 

these are the major folks that are involved in this. So I said from 

the start that the legitimate end-users did not cause the problem 

and should not be swept up in this, but some of these bills create 

loopholes that are going to allow this stuff to go on, and I am just 

not going to stand for that. Maybe there will be some collateral 

damage in this but I am not going to be one that is going to sit 

here and have another collapse happen and happen the second 

time on my watch. I made a big enough mistake the first time by 

supporting the CFMA, so some of us that have been around want 

to err on the side of caution here. 

Ms. BOULTWOOD. Just on Enron, since we started there, I would 

just like to remind the Committee that never did any power or natural gas cease to flow. The end-using customers continued to receive their commodities and the collapse of Enron was a failure of 

a corporate strategy and, we can look back rightfully so, and so 

businesses take risks, they fail. 

Mr. PETERSON. The collapse of Lehman was a failure of a corporate strategy, and there would have been a lot more collapses if 

the government wouldn’t have come in and bailed them out, and 

so now we have just put in law the ability to have the government 

bail these people out no matter how stupid they are. That is part 

of what we did in Dodd-Frank. So that is my concern. We are letting people go out and do this stuff and then at the end of the day 

we are going to bail them out? I mean, the taxpayers are tired of 

this, and you see what is going on on Wall Street, and I don’t know 

that they are focused on the right things necessarily but I understand their frustration. I have the people in my district that feel 

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the same way, and if we don’t respond to this, that Wall Street protest is going to get bigger, not smaller. 

Mr. GIANCARLO. Congressman, the basic reforms of Dodd-Frank, 

of clearing, central counterparty clearing of greater transparency, 

of regulated execution, stands unchallenged by certainly my organization, myself and most of my fellow members of this panel. What 

these reforms that we are talking about today are about clarifications of issues, not about repeal, not about going back. And in fact, 

in some ways Enron was a very good model, what happened in 

Enron for the drafters of Dodd-Frank. I think a number of lessons 

were learned. The U.S. energy market as it exists today has very 

much risen out of the ashes of Enron. Following Enron, we went 

to a cleared environment where market participants have a choice 

of clearing entity. We went to a multiple execution environment 

where market participants have a choice of execution venue and 

they are not limited to a single silo as we have in a number of futures markets. And that is really the model for Dodd-Frank where 

market participants will be required to clear but they will have a 

choice of clearing venue. They will be required to execute through 

a SEF or an exchange, but they will have a choice of execution facility, and in the language I noted in my opening testimony, 

through any means of interstate commerce, market participants 

should have a choice of how to execute the trade. In the SEF Clarification Act, all that is being asked is that Congress’s intent be 

stated clearly so that regulators fulfill the intent of Dodd-Frank, 

which in a number of ways picked up on a number of the mistakes 

that were made in the Enron situation and are trying to get it 

right, and we are very supportive of that. 

Mr. PETERSON. Thank you. 

Thank you, Mr. Chairman. 

Mr. CONAWAY. I thank the gentleman. 

Turning back to the cost-benefit analysis rules and the procedure 

that were used with this current set, just for a point of clarification, my good friend from Minnesota bragged ever so briefly on the 

bill to clarify the rules on behalf of the CFTC. That is a prospective 

change to their cost-benefit analysis and would not affect anything 

that is going on right now, so it would just require the agency in 

the future to abide by the rules that even the President in his January letter set out. 

I would like each panelist to briefly talk about if the cost-benefit 

analysis that was done, how it would have changed perhaps the 

rules that you are interested as relates to each of your entities, so 

we will just come down the list and kind of briefly talk on how that 

might have impacted what you are worried about, what you are not 

worried about. 

Mr. CORDES. Yes, the cost-benefit analysis, if you get a good 

weighting about how disruptive to commerce and liquidity in the 

industry, in the cooperative world, what we are thinking about, 

and more importantly, closer to home I am thinking for my own 

company, CHS, where do these become and where you weight that 

out. We are not swap dealers yet we feel there is enough wiggle 

room in this language and that is what we are asking for clarification today: let us set that aside so we don’t get labeled into that 

category because there are costs along with being that. If you are 

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in that category, that is going to inhibit some things we can do, activities with our members through the local cooperative network 

down to the farmer network. What does that do for commerce in 

rural America? If you can get that balance right between there, I 

think that would make a big difference. 

Mr. CONAWAY. Mr. Williams, you mentioned $100,000 charge or 

fee for a clearing member for a small bank. Was that reflected anywhere in the CFTC’s analysis? 

Mr. WILLIAMS. That is not reflected in the CFTC’s analysis. That 

is the feedback we get from potential clearinghouse partners that 

we would work with. 

Mr. CONAWAY. The broader question is still for anybody. 

Mr. WILLIAMS. It is clear that small banks have a minuscule participation in the derivatives market. These costs that would be a 

result of the legislation would significantly increase the cost of participating in the market and probably make it prohibitive for us to 

participate. 

Ms. SANEVICH. Certainly with respect to the ERISA plans, the 

fact that there is an overarching regulatory scheme already in 

place certainly fits in within the President’s January letter as well 

as this cost-benefit issue in that the ERISA plans’ case, not only 

is there no benefit, there is a lot of cost, I mean, the cost is huge. 

In some cases, ERISA pension plans will be unable to in the future 

engage in these very important risk mitigation strategies. To take 

that authority away from those that manage the pension assets 

would be a grave mistake, and you can also easily see the lack of 

a thorough cost-benefit analysis. Back to this margin issue, I mean, 

anyone who would actually put an ERISA pension plan in the same 

bucket as a hedge fund and call an ERISA pension plan a high-risk 

financial end-user, I mean, clearly the uniqueness of an ERISA 

pension plan has not been taken into account. 

Mr. GIANCARLO. If I can use an analogy to describe global markets for swaps, it would be sort of like a balloon. If you squeeze 

it here, it pops out there. Markets can move around the globe, overnight, if they become too restrictive. The goal is not to find the lowest level of restrictions but in fact it is the right balance of restrictions and regulations for any given marketplace. The jurisdiction 

that has the right balance, the right balance of transparency and 

liquidity as Congress in Dodd-Frank said, liquidity must be balanced against transparency. The jurisdiction of the right balance 

are where markets move. Our concern with some of the restrictions 

coming out of the CFTC whether it is restrictions on mode of access, modes of execution, whether it is on something that has become known as the 15 second rule, which I won’t go into but it is 

addressed in my testimony——

Mr. CONAWAY.—in order to be respectful of the other panelists’ 

time. The point, though is——

Mr. GIANCARLO. The point is that there has not been a cost-benefit analysis for some of the restrictions, and my worry is that we 

don’t know what will be the effect. The effect could very well be to 

force markets offshore, which would be detrimental for American 

business interests, which would either not be able to source their 

hedging needs here or have to go offshore to find them. 

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Ms. BOULTWOOD. Can I add to that? Just in terms of the swap 

dealer definition if left as is will have an overly broad reach, and 

this will, to earlier points, limit market participation, increase the 

cost of hedging as market liquidity falls, and we will see those that 

can transact in other jurisdictions, other markets with certainty. 

You know, these contracts, whether it is when we are hedging oil 

or we are hedging gas, we can transact internationally, and if an 

entity has a capitalized sub in a foreign country, it is not a major 

issue to move to that other jurisdiction that has regulatory certainty. So the costs to the company, to the market as well as to the 

taxpayer just haven’t been assessed and set off against the benefits 

to society of all these controls to help mitigate systemic risk or the 

fear of a future bailout. 

Mr. CONAWAY. Quickly, Mr. Thul. 

Mr. THUL. One last comment. So in addition to the costs, which 

I don’t think we know what the true effect will be today, it is going 

to have the unintended consequence of pushing risk on to the actual end-users with more volatility in the markets and unduly creating speculation by default in a lot of these cash markets if we 

can’t get clarity around these issues. 

Mr. CONAWAY. I would like to ask unanimous consent to submit 

a statement from the National Rural Electric Cooperative Association. Hearing no objections. 

[The document referred to is located on p. 111.] 

Mr. CONAWAY. Mr. Courtney for 5 minutes. 

Mr. COURTNEY. Thank you, Mr. Chairman. I want to thank the 

witnesses for being here today. As the Member of Congress who 

represents Senator Chris Dodd, who last night former Speaker 

Gingrich said should be arrested for his work on this, I want to 

thank Mr. Giancarlo for at least acknowledging that this legislation 

was intended to deal with a problem which Mr. Peterson said almost brought the whole world down. When I listen to the complaints here today about the speculative ideas about where costs 

are going to be, Mr. Thul, you have customers in eastern Connecticut, farmers who buy Cargill products, and when I talked to 

them last spring and summer about their challenges that they face 

right now, it was the outrageous spike in energy costs which was 

completely indecipherable to them in terms of why it was happening. I just say to you, the notion that the status quo is something that end-users, real end-users like dairy farmers can count 

on in terms of having any kind of predictability or confidence in 

their own costs looking out on the horizon, I mean, it does not exist 

right now. You cannot find an oil dealer in Connecticut that will 

hedge for this winter’s fuel for their customers because they have 

totally lost confidence in energy markets. It is gone. They are totally hostile to it, let alone suspicious of it. And one of the rules 

that Dodd-Frank included was to try and put some position limits 

in terms of the traders that deal with this market. Chairman 

Gentzler has been here four times talking about the fact that they 

are trying to move this rule forward. They have had over 20,000 

comments. I am sure every single group here has had an opportunity to wade in just as administrative law allows for the public 

and for interested parties to have their opportunity to be heard. 

What I am hearing at home is, what is taking so long in terms of 

95

trying to stabilize a market that again people just have absolutely 

no confidence in right now and it is just killing them with real 

costs and real lives, which we have heard a lot of talk about here 

today. 

So I guess the question I want to ask is that the cost-benefit 

measure that is being proposed here, I mean, do you see that bill 

as basically restarting the regulatory process for the position limits 

rule, just to take one item out of Dodd-Frank that the Commission 

has been working assiduously on and some would say far too slowly 

on? I mean, is it your hope that if we pass that bill that we go back 

to square one and just start this process all over again? Again, if 

someone could help me in terms of their legislative interpretation 

of that measure. 

Mr. CONAWAY. If the gentleman will suspend, the proposed law 

is prospective. It would have nothing to do with anything that has 

been proposed so far. 

Mr. COURTNEY. So the bill that we have before us——

Mr. CONAWAY. It is not a restart. 

Mr. COURTNEY. Okay. Then I will change my question then and 

just ask whether or not any of you think that what has happened 

last spring when the price of oil per barrel went up to $115 a barrel 

had anything to do with over-speculation, and maybe our friend 

here from the energy association can answer that question. 

Ms. BOULTWOOD. It used to be that many commodity prices were 

set in the United States. We were the marginal buyer and it was 

our supply and demand that drove the price of a commodity whether it was oil, gas or copper. You know, the market has globalized 

and now the marginal buyers are often not in the United States, 

and you can have supply-and-demand factors in China and the 

Middle East and so on impacting the way those market curves 

shift, and it can seem inexplicable to Americans, rural Americans, 

Americans in big cities, but we are going through a globalization 

of these markets. We will not be able to explain based on domestic 

activity all changes in oil prices or all changes in gas prices. 

And to try to use a tool, in my view, to use a tool like position 

limits, that will limit activity in the United States and ultimately 

growth within our own country, but to think that it will limit activity in futures markets and in physical markets around the world 

is unlikely. 

Mr. COURTNEY. You know, it is sort of funny because you hear 

a lot of people in this town talk about American exceptionalism and 

how we should be a leader, but when we talk about, again, just trying to have, in my opinion, some commonsense regulation, then 

suddenly there is this feeling that we have to fear to sort of stake 

out a position. I mean, the fact is, as I am sure you know, G20 conferences, governments now are talking about trying to sort of harmonize regulation in this, and at some point, somebody has to 

move here in terms of trying to at least show the way that we are 

just not going to be powerless and helpless in terms of forces that—

again, small businesses and farmers are getting killed in terms of 

trying to keep up with costs that again just have nothing to do 

with real supply and demand, as you said. 

Mr. Giancarlo? 

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Mr. GIANCARLO. Yes. On the subject of harmonization, that is a 

great concern to us. The Europeans are not taking the approach 

that the CFTC is taking, that the modes of execution of swaps 

needs to be limited to electronic systems, and in fact, what we are 

concerned about is that they will allow these multiple modes of 

execution to be used and that may actually attract trading to go 

from U.S. markets to European markets where it may be a more 

natural form of executing these less liquid swaps products. So it is 

a great concern to us. 

Mr. COURTNEY. So when President Sarkozy and others have really publicly talked about the fact that they want to try and get some 

coherence internationally, I mean, how do we make that happen? 

Do we just do nothing here and go to meeting after meeting? 

Mr. GIANCARLO. Harmonization would be great, and some leaders 

talk about it, but at the underlying administrative level, it is not 

happening in a number of key areas. 

Mr. COURTNEY. Well, it is kind of a sad message to have to take 

back to real end-users who basically are looking to us to try and 

get some rationality in terms of these markets. 

Mr. CONAWAY. The gentleman yields back. 

Mr. Scott, 5 minutes. 

Mr. AUSTIN SCOTT of Georgia. Yes, sir. Thank you, Mr. Chairman. 

If you look at the CFTC website, it says that swaps were the center of the 2008 financial crisis, and I would think that maybe an 

improper use of swaps or abuse of swaps might be a better description of what happened there, but I have a couple of questions, and 

part of it gets back to the 15 second rule that has been discussed. 

Mr. Giancarlo, if you only trade one to 20 times a day, why does 

the 15 second rule cause a problem? I get calls from people all the 

time where just in the fraction of a second that a trade is executed 

on the stock exchange, you may see a 31⁄2, 41⁄2, 5 percent change 

in value just during the fraction of a second it takes to execute. So 

why does the 15 second rule cause problems? 

Mr. GIANCARLO. Let me try to just paint a little example. I used 

in my opening remarks an example of John Deere wanting to expand and calling a dealer to provide them with a hedge against foreign exchange risk. That dealer takes the call or receives the message or maybe electronic message from their customer, maybe 

through an RFQ system, and wants to serve their customer’s interest, wants to actually take on that hedge, but in so doing, they are 

taking balance sheet risks themselves. 

Mr. AUSTIN SCOTT of Georgia. Sure. 

Mr. GIANCARLO. So they are actually looking to the wholesale 

market to find a counterparty that they may be able to trade directly to, and they may actually find it, or maybe not a full hedge 

but a partial hedge. The 15 second rule says that when that dealer 

calls us in the wholesale market to take both sides of the trade, we 

are going to buy our customer’s need, we are going to sell it to another customer, we have to actually delay that. We can put one 

order in and wait 15 seconds during which time a competitor to 

that dealer may step in front and take the other side. So at the 

time of taking the customer order from John Deere, the dealer 

doesn’t know because of this 15 second rule whether at the end of 

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15 seconds he is going to actually have fully hedged the risk he is 

taking on. So when you have more uncertainty, you always have 

more cost, and that cost is going to get passed down the chain to 

the corporate end-user. So our concern with the 15 second rule 

is——

Mr. AUSTIN SCOTT of Georgia. Let me stop you. I am getting 

short on time. Would 5 seconds make a difference? 

Mr. GIANCARLO. You are adding risk. The markets in this regard 

work well today. There was nothing in the 15 second rule that addressed that was in the financial crisis that——

Mr. AUSTIN SCOTT of Georgia. All right. Let me stop you there 

because I am sorry but I am limited to 5 minutes. 

I want to go back to what we were talking about with the banking, Mr. Williams, and one of the things that I don’t—when we talk 

about exempting the smaller banks, I guess one of my questions 

would be some banks, the trading is as much as 60 percent of their 

revenue. 

Mr. WILLIAMS. That is right. 

Mr. AUSTIN SCOTT of Georgia. For your bank, as a percentage of 

revenue, what is it? 

Mr. WILLIAMS. It would be less than three percent or so, and we 

are not trading like the participants that you mentioned where 60 

percent may be a much more significant portion of their revenue. 

Mr. AUSTIN SCOTT of Georgia. Yes, sir, it truly is a hedging of 

risk. 

Mr. WILLIAMS. It is a hedging of risk related to specific loan 

transactions. 

Mr. AUSTIN SCOTT of Georgia. And I guess the question I have 

is, on average, as I understand it, it is less than five percent of revenue, but the rules are being drafted so that if it is 60 percent of 

your bank’s revenue, or of it is three percent of your bank’s revenue, you are going to have to abide by the same rules. 

Mr. WILLIAMS. That is right. 

Mr. AUSTIN SCOTT of Georgia. And so would we be better serving 

the public if we base the exemption on a percentage of revenue instead of on any individual dollar figure? 

Mr. WILLIAMS. I wouldn’t advocate a rule based on percentage of 

revenue because that would be a relative measure, and while the 

percentage of revenue for a given institution may be relatively 

high, that particular institution’s participation in the market may 

be very insignificant. So you would capture them despite the fact 

that they are not posing any particular systemic risk. 

I think the de minimis exemptions as proposed in the Small 

Business Credit Availability Act are good ones, and would create 

exemptions for institutions that are fairly insignificant players in 

the market overall and don’t pose a systemic risk. 

Mr. AUSTIN SCOTT of Georgia. If a small bank, though, say 50 

percent of that small bank’s revenue were from the trading, would 

you still think that they should get the same exemption that your 

bank does? 

Mr. WILLIAMS. I would think so. I don’t think there are any small 

banks that get 50 percent of their revenue from trading derivatives. 

98

Mr. AUSTIN SCOTT of Georgia. Thank you, Mr. Chairman. I just 

once again would like to point out that end-users didn’t cause this 

problem, and I hope that we are able to work in a bipartisan fashion to get the exemptions for the end-users. 

Mr. CONAWAY. Thank you. The gentleman yields back. 

Ms. Fudge for 5 minutes. 

Ms. FUDGE. Thank you, Mr. Chairman. 

Mr. Cordes, help me understand how if cooperatives are owned 

by local members and farmers, how can a cooperative be considered 

a swap dealer? 

Mr. CORDES. Some of the concern we have within that being 

owned where a swap dealer is, we don’t have common control all 

the way down, so the local level is owned by its farmers. That local 

cooperative then would have ownership in the higher structure up 

through the affiliated cooperative, so it would have some common 

ownership but doesn’t have control of it. When you do transactions 

with that affiliate to help them manage their risk, you need to 

write up a transaction, a contract, a swap. By doing that, you now 

put that—and some people look at it and say okay, are you dealing 

swaps or what are you doing. We would maintain that we are helping that local cooperative mitigate risk that they are passing on to 

help manage risk with their farmers. 

Ms. FUDGE. Okay, and just a question for the entire panel. You 

know, I am a cosponsor of H.R. 2779, which would exempt interaffiliate swaps from some, not all, some regulatory requirements 

instituted under Dodd-Frank. Given the diversity of the panel, I 

would like to hear from each of you about how internal risk management procedures would be affected, particularly can you discuss 

the differences between the different sectors that are seeking to 

hedge risks, for example, a manufacturing company versus a bank? 

Each one, wherever you would like to start 

Mr. THUL. Thank you. Within our organization, we are centralizing that activity and so we have businesses operating across multiple geographies and across multiple industries and so we are taking advantage looking at it as an enterprise, centralizing it so we 

can take advantage of a center of expertise in the marketplace and 

to try to leverage our costs of executing the transaction. So our argument, and we are in favor of the intent of the bill because we 

do think it captures the fact that we are going to protect what is 

truly something that is not individual and that can be looked at on 

an enterprise approach. 

Ms. FUDGE. Thank you. I am going to ask to kind of go a little 

quickly if you can so I can get an answer from everybody. Thank 

you. 

Ms. BOULTWOOD. At Constellation, we have a power plant in 

Canada, and when we hedge the output of that plant, we create exposure in Canadian dollars. We also, in different areas, have retail 

businesses and generate earnings in foreign currencies, mostly Canadian dollars, and what we do is, we need to pull that exposure 

from different entities to centralize the foreign exchange exposure 

because we are a commodities company and our expertise is in the 

commodities market, and we don’t want our exposures to be dispersed across the company. So this is one example of the risk management benefit of that centralization across affiliates so we can 

99

centralize risk-taking and bring the expertise in that foreign exchange hedging to one spot, but it also applies even in commodities. 

You know, we have transactors in different parts of the country 

transacting power and gas. We are not letting them face to the 

market in each of those regions. We centralize that activity so that 

we can get the best centralized risk management across the different commodities to execute most efficiently. 

Ms. FUDGE. Thank you. 

Mr. GIANCARLO. Congresswoman, we are an intermediary, a 

broker of swaps products, but we really don’t use swap products in 

our business themselves. The analogy would be to real estate 

agents, we match buyers and sellers of homes but we actually don’t 

own underlying homes ourselves. We are not in the business so we 

really don’t use swaps products. 

The bill that you are cosponsoring seems like a very sensible bill 

for those that have that area but it is not an area that we have 

taken a position on or that I can really sensibly comment to you. 

Ms. FUDGE. Thank you. 

Ms. SANEVICH. ERISA plans, as I mentioned, are already so 

heavily regulated that they are already prohibited and restricted in 

so many ways from doing anything with any affiliates. The affiliate 

issue is not an issue for ERISA plans because they have a whole 

body of regulations and laws preventing them from doing that kind 

of stuff. 

Ms. FUDGE. Thank you. 

Mr. WILLIAMS. Atlantic Capital Bank is the operating subsidiary 

of a one-bank holding company, Atlantic Capital Bank Shares, and 

we don’t conduct inter-affiliate transactions, swap transactions, and 

I think that would be true of most small banks. 

Ms. FUDGE. Thank you. 

Mr. CORDES. I can speak for the cooperative network. Most local 

cooperatives, their boards would have policies and procedures 

around position limits and risks that they can take. As they roll 

that up on a daily basis, they would look to lay off that risk. They 

would then look through the federated system to maybe aggregate 

that risk and then put on a swap or some transaction to manage 

that risk, so we would need to be able to handle that from interaffiliates as you go along that risk mitigation curve. 

Ms. FUDGE. Thank you, Mr. Chairman. 

Mr. CONAWAY. The gentlelady yields back. Mr. Crawford for 5 

minutes. 

Mr. CRAWFORD. Thank you, Mr. Chairman. I want to thank the 

panelists for being here today. 

I am going to start off real quick with Mr. Thul. Can you provide 

some examples of the types of hedges that would be restricted 

under CFTC’s position limits proposal? 

Mr. THUL. Yes. The best example of that, I mean, this comes 

down to the definition of what is a bona fide hedge and anticipatory hedges and so at the simplest level, it would be grain purchases over a weekend when the exchange is not open. We need to 

pre-position for that and put on a futures position in anticipation 

of handling the cash commodity; not being able to do that is how 

we are reading this as a potential limitation. 

100

Mr. CRAWFORD. How would you recommend the CFTC draw a 

line between hedging and spec trading for the position limits proposal? 

Mr. THUL. I think it comes down to just truly what is the definition of a bona fide hedger and are you involved in the commercial 

business or not. We are all for transparency as long as we are protecting the needs of the legitimate business, the commercial business. And so if you are tied to commercial operations and the underlying cash businesses, we feel that that should be exempted underneath the bona fide hedge. 

Mr. CRAWFORD. I am going to switch gears and go to Mr. Williams. My constituents in the 1st District of Arkansas almost exclusively use community banks to access credit, whether it be families, 

small business owners, farmers. In your testimony you note that 

absent changes to the legislation we are discussing today, you 

would have difficulty remaining competitive against larger financial institutions. Can you explain the impact on your ability to compete? 

Mr. WILLIAMS. Well, first of all, it would be the cost associated 

with being a clearinghouse member or affiliating with a clearinghouse member, and as I indicated, we think that cost may be north 

of $100,000 per year. If we compare that to the revenue we receive 

from doing interest rate swap transactions for our borrowers, it 

would impair the profitability of those activities significantly. 

Second, the current, the proposed de minimis exemption limits 

from the CFTC would even eliminate—the activity that my institution has conducted within the last 18 months—would be above 

those de minimis limitations. So we would be classified as a swap 

dealer or financial under the proposed regulations and would add 

significantly to our costs. 

Mr. CRAWFORD. Let me ask Mr. Cordes, what is the difference 

between the swap activities that your companies engage in and 

those engaged by swap dealers? 

Mr. CORDES. Yes, typically one would hold out a swap dealer 

makes a market. They are out there, they have a bid and offer-type 

thing. What our organization is doing is, we would be looking at 

our membership, we would be looking at, internally we would be 

looking at our customers, looking at how can we mitigate that risk, 

what risk do they have that they want to mitigate. Then, we would 

go find a product to manage that risk, so we would put that transaction together. So it is really mitigating risk versus making a market. 

Mr. CRAWFORD. Okay. And then I have this question for both you 

and Ms. Boultwood. Why does the broad definition of swap dealer

have a disproportionate impact on the energy and ag industries as 

opposed to other sectors? We will start with Mr. Cordes. 

Mr. CORDES. Yes, I would say for us in the cooperative world, I 

mean, we are in the business around agriculture of whether it is 

buying grain, processing grain products, whether it is on the energy side, distribution and fuel. It has a lot of bricks and mortar 

to it. It has got a lot of hard assets to it so a lot of your investment 

capital is tied up to run those operations. It also takes a lot out 

of working capital to run those operations. And now if you start 

throwing in a swap dealer portion of it with margin requirements 

101

and other capital requirements, it is just another burden on top of 

a big hurdle to get over that is already taking place around working capital and investment. 

Mr. CRAWFORD. Ms. Boultwood? 

Ms. BOULTWOOD. I think the story is similar. We have a lot of 

assets that generate revenues that are volatile because of changing 

commodity prices but also energy is subject to natural hazards like 

weather risks. It is through swap products that we are able to even 

when we have volatile commodity prices, you have unknown weather patterns, you are able to create stability in the pricing that you 

are able to offer your customers. 

Mr. CRAWFORD. Thank you. 

Mr. Thul, just a final thought from your perspective. Does lower 

liquidity increase volatility and vice versa?

Mr. THUL. Yes, we would agree with that, and part of what we 

are shooting for is to have liquidity in markets along with transparency. 

Mr. CRAWFORD. Great. Thank you. I yield back. 

Mr. CONAWAY. I thank the gentleman. 

The gentleman from New York, Mr. Owens, for 5 minutes. 

Mr. OWENS. Thank you, Mr. Chairman. 

I assume that most of you have the opportunity to interact with 

the CFTC on a fairly regular basis as you go through this process. 

Do you have any sense relative to the legislation that we are discussing today that those proposals will be ultimately included in 

the final regulations that will be issued by the CFTC? 

Ms. BOULTWOOD. I will just start. I would say, none of us has a 

crystal ball but I described the CFTC Commissioners as deeply divided on many of the topics that we are discussing today in terms 

of proposed legislation. For example, the swap dealer definition, 

there are Commissioners on record as saying it is overly broad, we 

need to better understand a de minimis exception in order to ensure that those that didn’t cause systemic risk in the past and really aren’t capable of it in the future are not subject to the same 

rules as the swap dealers that do hold themselves out for customers making markets and so on. So I would say that there are 

great divisions, and based on all the interactions, they seem to be 

headed down a path that will have rulemaking that will look very 

much like the drafts that we have all reviewed and commented on. 

To date, we haven’t seen the comments and all the interactions 

have much of an effect over the idea that there are fears of potential future bailouts or there are fears of loopholes, and this desire 

to create regulation and rulemaking to close any loophole, and then 

think about what does that cost in terms of business activities, and 

not only the markets themselves, but real costs to end-users in our 

economy. 

Mr. GIANCARLO. Congressman, a concern that we have in our 

conversations with the CFTC is their orientation is toward the futures markets, which they know well through their experience, 

which are markets that are very different than the swap markets. 

They are markets that have a single silo, monopolistic structure 

over the products they handle and they are markets that are not 

open to multiple execution venues or multiple clearing venues. 

There are also markets that have a retail component which is a 

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great concern to the regulators and ones that have highly 

commoditized instruments that trade in those markets. Those are 

very different characteristics to the swaps markets and so our concern is that this institution, which is very knowledgeable in the 

areas that it has historically regulated, is struggling to understand 

these aspects of the swaps markets that are very different, aspects 

of the swaps markets that Congress made very clear in DoddFrank that had to be handled separately than what was done in 

the futures market. They have to be more competitive for execution, more competitive for clearing and have to take account of liquidity while balancing that with transparency. 

Mr. OWENS. Thank you. I just wanted to make sure that as we 

move forward, we did it on the basis that you had some underlying 

belief that in fact these were not going to be addressed, because I 

think that that is important as a baseline for moving forward. 

The second question I have really is maybe more conceptual, but 

is there any risk associated with the end-user marketplace or do 

you completely discount end-user risk and its impact on the system? 

Mr. CORDES. I would say from our perspective, looking as an enduser that uses some swaps, the risk you need to understand as an 

end-user, yes, you are mitigating your risk. You have some other 

side of the ledger but you also need to be concerned with your 

counterparty risk that you are entering into, and lots of times we 

will use credit annexes to perform around those functions to make 

sure that we have security behind that, but it is not a margin, per 

se.

Mr. OWENS. But that is really what you are doing is you are netting your risk in that process? 

Mr. CORDES. As an end-user, yes, you would have some physical 

exposure that you are looking to mitigate. You would use a swap 

to offset that. 

Mr. OWENS. To go back to something that Mr. Peterson said before, is there any threat systemically that you could have someone 

who initially is not regulated growing in a fashion that would not 

bring them under the regulatory scheme? 

Ms. BOULTWOOD. I would say that to Mr. Peterson’s, to address 

his concerns, we remind ourselves that there was no bailout for 

Enron and the energy continued to flow. Everything was normal. 

A company did fail as did a few others in that period because of 

the broader accounting scandals. But, there are risks in an enduser and how you think about what is systemically important in 

the economy that could cause the broader marketplace to be at risk 

is really important as we consider here what a de minimis exception means to a swap dealer definition. When you think about the $3 billion proposal for initial derivative size in that proposed legislation, that is 1⁄1000 of the total size of the notional value of U.S. 

derivatives marketplace. We are talking $600 trillion globally—$3 

billion is really nothing in the scheme of that. So is it 1⁄1000 that 

isn’t systemic or 3⁄1000 or 10⁄1000? You know, there is probably room 

to move upwards because the risk to us right now is that you define a de minimis exception that is too narrow and you include so 

many firms and they have all the costs of implementing them, the 

Dodd-Frank swap dealer requirements, and then we find out they 

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are really not systemically risky and the costs in terms of the market liquidity that disappears, maybe a lot of activity moves offshore. The costs are much more significant than any benefit we got 

from capturing that entity. So it seems that the $3 billion, it can seem like a big number but 

relative to the overall size of the swap market, it is small and 

maybe it is a better approach to start higher and then if we find 

that there are those companies that grow, we can always reduce it. 

Mr. OWENS. Thank you. I appreciate that. 

I yield back. 

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

Mr. Randy Hultgren for 5 minutes. 

Mr. HULTGREN. Thank you, Mr. Chairman. 

Thank you all for being here and thank you for your input on 

this very important discussion today. I have been hearing from 

many of the co-ops in my district, heard from River Valley Cooperative in Geneseo and Patriot Renewable Fuels in Annawan, who are 

holding back with their business plans because of uncertainty 

while at the same time farmers are asking for ways to manage 

risk, so this is so important for us to be discussing this today. 

The first question I want to address to Mr. Cordes, if I could. I 

wonder if you would fall under the current threshold of $100 million, and if you know who else might? 

Mr. CORDES. Fall under $100 million? 

Mr. HULTGREN. Yes, under the current level of the $100 million. 

Mr. CORDES. I have to preface the answer a little bit. It partly 

depends. There is clarification of rules, what you are counting, 

what you are not. If it gets pretty broadly defined like it looks 

today, we would easily fall beyond the $100 million, and quite a 

few cooperatives in the network would as well. 

Mr. HULTGREN. So even at that level, there is still a large 

amount of uncertainty of actually what is counted and what isn’t? 

Mr. CORDES. That is correct. 

Mr. HULTGREN. I wondered if I could have others of you, Mr. 

Cordes and others, have just your thoughts, and if you could discuss why you think the swap dealer definition discussion draft proposal to increase the de minimis threshold to $3 billion is an appropriate threshold. So I wondered if you could maybe talk about that 

briefly. 

Mr. CORDES. I will take a first run at it a little bit. I think partly 

you need to look at the volatility in the marketplace, and we are 

not only talking about what should that threshold be today, we are 

looking at some legislation that is going to be talking for the future. You look at commodity levels today, I mean, it wasn’t that 

many years ago corn was at $2, $3. We are sitting at $6, $7, $8 

at times. So even if you look at the $100 million threshold, it only 

takes about 14 million bushels of corn to get to that level, which 

is a pretty small percentage in the big marketplace. It needs to 

have a discussion around size and scale. 

Mr. THUL. And I would just add to that that I think there are 

two other objectives that you can hit on on the de minimis ruling, 

and one of them is number of counterparties, and that would be extremely limiting for many people because it is either 15 or 25 

counterparties, which when you are dealing at a country facility opVerDate 0ct 09 2002 15:26 Nov 29, 2011 Jkt 041481 PO 00000 Frm 00107 Fmt 6633 Sfmt 6601 I:\DOCS\112-25\70998.TXT BRIAN
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eration, you are going to have many more participants than that. 

And more important, our objective is to just not be defined as a 

swap dealer and avoid de minimis altogether. 

Ms. BOULTWOOD. So I will go back to an earlier point. It is really 

important that we, in thinking about dealing, decide what do we 

mean by dealing, who is the dealer, and I joke sometimes that on 

the streets of Baltimore it is easy to know who is the dealer and 

who is the user for certain commodities, you could call them. But, 

when you are talking about a company, there are legitimate hedging activities. There might be some speculation. There might be 

markets we exist in where we have to be out there finding 

counterparties to transact with us, but both hedging and speculation we do with our own capital. We do that to preserve our own 

earnings or take the risks we want to take, and it is that third category of holding yourself out to a customer and saying look, we 

want to be your middleman, we want to earn the spread on a trade 

that will perform for you and we will go offset that risk potentially 

somewhere else, and so it is that customer trading that we are 

really focused on or transactions. And here then the question is, is 

$3 billion large enough, and, earlier I was saying that that is 1⁄1000

of the total size of the U.S. notional swap market. Is 1⁄1000 systemic 

to the economy? I would offer no. Is the right fraction 10⁄1000, 100⁄1000? You know, we have to draw a line somewhere. You would 

rather start higher, and if you find that there are firms that are 

doing things that should be considered dealing and they are finding 

a way out of that, we can always reduce it, but why start small 

and create the risk that so many companies get drawn in and either decide not to hedge, not to participate in markets, which 

would drive down liquidity, and find ourselves in a very different 

marketplace for our basic food, agriculture and energy commodities 

in America. 

Mr. HULTGREN. I wonder quickly if someone could address, what 

does aggregate gross notional measure? 

Ms. BOULTWOOD. Price times quantity. So if you have a contract 

that is covering 100 barrels of oil, there is the price of oil at the 

time you enter into that contract and then there is a quantity of 

oil, right, and that creates a value and that is your gross notional, 

and then someone mentioned earlier, commodity prices are highly 

volatile, you think about oil prices. There are risks in setting a 

static de minimis exception amount in that, if price levels doubled, 

for example, you could have firms that in one instance aren’t considered a swap dealer but then when price levels change, they are 

then a swap dealer and you see this idea of firms flipping in and 

out of this dealing definition which really would make no sense at 

all. 

Mr. HULTGREN. Thank you all again for being here. Thank you, 

Mr. Chairman. I yield back. 

Mr. CONAWAY. The gentleman yields back. 

Mr. Costa for 5 minutes. 

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

I want to kind of revisit some of the points that a number of my 

colleagues have raised here because there is an underlying theme 

here about the concerns of having the sort of regulatory framework 

that calls balls and strikes fairly and allows the economy to comVerDate 0ct 09 2002 15:26 Nov 29, 2011 Jkt 041481 PO 00000 Frm 00108 Fmt 6633 Sfmt 6601 I:\DOCS\112-25\70998.TXT BRIAN
105

pete in this global market that we all talk about, but at the same 

time doesn’t create circumstances as we all know that are still 

fresh in many of our minds in 2008, or going further back with 

Enron, and trying to get it right as we have all discussed here this 

morning is the challenge at hand. 

For me, you keep talking about systemic risk, but a former Secretary of the Treasury also commented at great length about the 

moral hazard, and I am not so sure where you folks think the 

moral hazard lies in terms of the responsibility, in terms of the 

conditions we create. Certainly we proved that we are willing to 

pick winners and losers if recent history demonstrates that, and I 

would like you to comment, but if I have a couple of specific questions that relate to the wild speculation and radical price swings 

that we have seen. 

Mr. Cordes, you talk about trading in the corn market a great 

deal, I believe, right? 

Mr. CORDES. That is correct. 

Mr. COSTA. We have been discussing here in the last several 

weeks about the whole use of ethanol from corn-based fuel versus

other alternatives, and a lot of the ethanol producers—and of 

course, I deal with my feed producers, the dairy folks, the cattle operations, the poultry, the pork, and they are very concerned that 

they think that ethanol from corn has had a factor. The ethanol 

producers tell me no, that is not really the case, that really the 

price has really been a result of speculators. Would you care to 

comment on whether or not you think that has been a factor? 

Mr. CORDES. I think to get to the correct answer, you need to 

look at the whole situation that is going on. The corn market is affected by many factors. 

Mr. COSTA. Of course, but how do you gauge those wild price 

swings based upon speculators versus the other factors? 

Mr. CORDES. Yes, the other factors we would look at, we look at 

the tight carryouts in this country that we have on corn, we do not 

have a lot of stock so we carry over from crop to the next. I think 

the other thing I would point out is, we have a robust livestock industry that has decent margins, that has an appetite for corn and 

probably has an appetite for DDGs that comes from the ethanol industry. We also have a world market. In the last few days we had 

have China looking to purchase corn as their economy continues to 

move along. 

Mr. COSTA. No, I know that, but I mean, I don’t—still, we can’t 

quantify, and to Mr. Courtney’s comments to the dairymen and to 

the other people, our constituents, they don’t get it. They see that 

a lot of folks are making money and they are not making anything 

except profits for themselves, and I don’t want to belabor that 

point. 

Mr. Giancarlo, you talked about, and all of you talked about the 

global markets, and some of us have spent some time with our European colleagues in Frankfurt and in London with clearinghouses. 

I am not so sure that your description of what is taking place there 

is the final word. They are still going through the vetting of their 

own efforts to develop a regulatory structure, as I understand it, 

and you talk about leadership. I think both sides are trying to figure out where that happy medium is. You seem to say that we 

106

have already preordained this to lose these markets. I don’t think 

that is the case. 

Mr. GIANCARLO. Thank you for the question. We follow the developments in the European market very closely, and clearly, we don’t 

have a crystal ball. In key areas, you are quite right. We are quite 

aligned with the Europeans. They are moving to a clearing environment as we are in the United States. They are moving to greater 

regulatory transparency and reporting as we are in the United 

States. They are recognizing in the regulation their version of swap 

execution facilities, what they call organized trading facilities, or 

OTFs, but where they are different, and at least everything I have 

seen in the regulations and we stay pretty close to it is, they are 

not mandating how those OTFs must execute swaps transactions. 

They are not requiring that it be done electronically only, and quite 

frankly, Congress did not require that they be done electronically 

only in Dodd-Frank. It says, ‘‘by any means of interstate commerce.’’ Our concern, and the reason we support the SEF Clarification Act, is to make Congress’s intent clear to the CFTC which 

alone, not the SEC, but alone the CFTC has taken the view that 

for cleared non-block swaps, they must be executed electronically 

only and that is not the direction the Europeans are going. We are 

truly concerned that if certain instruments need to be traded in 

other mechanisms other than purely electronic, they will migrate 

to Europe, which has not taken the same approach as the CFTC 

in that one regard. 

Mr. COSTA. Okay. 

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

Mr. COSTA. My time has expired, but I will submit further questions for the record. 

Mr. CONAWAY. Thank you. 

Mrs. Hartzler for 5 minutes. 

Mrs. HARTZLER. Thank you, Mr. Chairman. 

I would like to thank you for coming to discussed the proposed 

bills for today. I think the overriding principles of Dodd-Frank was 

supposed to reign in the big banks, risky derivative trading activities and reduce the concentration and consolidation for a financial 

system. My concern, however, is that the law imposes so many burdens on financial entities that they will not have the resources to 

comply and that therefore they will get out of the business of all 

but most vanilla loans. This would push any larger or more complex business up to the gigantic banks, thereby increasing concentration and consolidation even more. 

I don’t think there is a sole Democratic or Republican who believes that the 2,300 page bill can be drafted with no mistakes, no 

oversights and no tweaks or corrections needed, and I feel that 

these changes utilize common sense and do not put the system at 

risk, and specifically, I am going to be the sponsor of the Small 

Business Credit Availability Act. I wanted to ask you, Mr. Williams—and I apologize for missing your opening comments. I was 

at a House Armed Services Committee meeting at the same time. 

But I am reading your testimony and some of the questions I have 

I would just like to get on the record. How do you think this draft 

of the bill that we are going to put forth facilitates the availability 

of credit for businesses? 

107

Mr. WILLIAMS. Well, as you know, small banks are the primary 

lenders to small- mid-sized businesses across the country, and our 

ability to offer interest rate swaps, to offer fixed-rate financing or 

floating-rate financing as our borrowers may require is essential to 

our role as a financial intermediary and financing these small businesses. The Small Business Credit Availability Act raises the de 

minimis exemptions, changes the financial entity definition in a favorable way to us that allows us to continue to participate in the 

derivatives market and offer these important services to our borrowers. 

Mrs. HARTZLER. And that is important. I represent a very rural 

part of Missouri, and small banks are the backbone of most of the 

lending, and they are the ones that are doing a good job. They 

know the individuals who come in. They have a relationship with 

them. They know if they would be a good credit risk or not. They 

had the collateral required and yet they are being impacted by the 

Dodd-Frank bills. So I appreciate that. 

Let me continue, though. If small banks are provided the exemption proposed in the discussion draft, does that mean that they 

would be able to engage in speculative trading and still not be subjected to the clearing requirement? 

Mr. WILLIAMS. No, the intent of Title VII under Dodd-Frank is 

clear in limiting these exemptions to financing transactions, to 

credit transactions, and those are loan-level hedges. They are very 

specific to those transactions and I don’t think that would allow the 

opportunity for speculation. 

Mrs. HARTZLER. I think that is important to make clear and have 

that on the record because we are just trying to allow the small 

and regional banks to be able to continue to help the small businesses in their area and provide the services that they need in 

order to help their businesses expand and grow. How expensive 

would it be for you to comply with the swap dealer and clearinghouse regulations? I believe you said something about $100,000 for 

the clearinghouse. 

Mr. WILLIAMS. As we talked to potential clearinghouse partners, we think that $100,000 number is representative of the type of 

costs we would incur if we were not exempted from the swap dealer

definition. 

Mrs. HARTZLER. How would you recoup those costs if you were 

to have to participate in that? 

Mr. WILLIAMS. We would look for more profit from the spread income that we get from swap transactions to offset that cost, which 

would result in higher costs to the end-user. 

Mrs. HARTZLER. Very good. And just one more time, I believe you 

addressed this perhaps with Mr. Scott’s question, but could you explain the impact of the current regulations on your business if we 

don’t make these changes? How would it impact your ability to 

compete and to provide credit to small businesses? 

Mr. WILLIAMS. Under the CFTC’s de minimis rules as currently 

proposed, we would not be exempt and would incur the higher cost 

associated with being part of a clearinghouse. We would have the 

same regulatory burden and cost burden that a Wall Street dealer 

would have, and we are anything but a Wall Street dealer. We are 

a Main Street financier. 

108

Mrs. HARTZLER. Absolutely. Thank you very much, ladies and 

gentlemen. 

Mr. CONAWAY. The gentlelady yields back. 

Mr. Stutzman for 5 minutes. 

Mr. STUTZMAN. Thank you, Mr. Chairman, and thank you to the 

panelists for being here. I would like to follow up just a little bit 

on Mr. Costa’s comments with you, Mr. Cordes, about speculation 

being built in the market in ethanol. There is global demand and 

there obviously has to be supply, and we have had some rough 

yields this year and last year. I guess when we have these huge 

swings in commodity prices, it does create volatility. At $6, 25¢ is 

a big deal because we are used to $2, $3 corn and when 25¢ swung 

back then, that was a big, big deal. I guess I would just make this 

statement and ask if you would agree. I think it is easy to point 

the finger at the private sector and say there is speculation in the 

private sector but there is also speculation over at USDA in crop 

reports. Huge swings can happen in commodity prices just on 

USDA crop reports. Would you agree with that? We are all speculators to some extent. 

Mr. CORDES. Yes, I would say that the marketplace uses USDA 

reports as the benchmarks, so when those reports come out, they 

are going to react one way or the other, is it more or less than 

what we thought. The market participants in the marketplace will 

have their own opinion but ultimately they are going to go back 

and use it as the guidepost. I think if you want to look at past history, and it is pretty clear if you look back in the last 10 years, yes, 

we are living in much more volatile times today, but you can also 

go back, and I don’t have a chart with me today, you can go back 

and look at carryouts of the principal commodity in the crops—

corn, soybeans, wheat—and you will see volatility goes up when 

carryouts go down. There is a very strong correlation over time of 

what is driving that. 

Now, there are many factors going into what those carryouts are. 

You know, we can talk about speculation, we can talk about demand, we can talk about supply, but there is an interrelationship 

there as it goes on. 

Mr. STUTZMAN. I just think it is easy to point the finger at certain entities when in the big picture of everything, agriculture has 

changed, and in positive ways that we are trying to adjust. I know 

for us in our operation back in Indiana, these tools are important 

to us to cover our risk as we manage through some volatile times 

but there are some great opportunities at the same time. 

I would like to ask this question just of the entire panel. If we 

aren’t successful in changing the proposed Dodd-Frank regulations, 

how many of you will stop or at least greatly curtail your current 

risk management activities or the services that you provide to facilitate the risk management practices of other market participants? 

Mr. CORDES. Our concern here would be if it is not narrowly defined where it is, do we get caught up as a swap dealer, which we 

believe we are not. We are hedging; we are mitigating risk. If that 

becomes the case, as you mentioned rural America, they are looking for tools. There is more volatility out there. You have more at 

109

risk. We would have to curtail those offerings that we can give to 

rural America. 

Mr. THUL. And the other outcome from that could be just a cost 

going up dramatically, so if you decide to stay in the business, you 

could either increase your costs, as somebody else mentioned here 

earlier, or you are just going to transfer risk down the chain to the 

end-user. 

Mr. STUTZMAN. Could you just touch on that real quick, Mr. 

Thul? How does that impact the farmer? I mean, if you can’t have 

these tools, what does that do to the farmer? 

Mr. THUL. It exposes them completely to the volatility that you 

were talking about, that you were alluding to earlier, so they are 

not going to have any form of protection over what they are looking 

at. We are in a cyclical business to begin with and it is going to 

remove any opportunity to protect themselves from the risk. 

Mr. STUTZMAN. One last question, Mr. Chairman, and again, this 

is for any of you, but Mr. Thul maybe particularly. CFTC may finalize the position limits proposal before the EU even proposes 

theirs. Any comments? 

Mr. THUL. Yes, we feel very strongly that we need to have a good 

definition of—these things all work together—bona fide hedge, anticipatory hedge and the position limit, and so in order to have a 

firm ruling on what a position limit might be, we need to have definitions around bona fide hedge, swap dealer and anticipatory hedging, and it feels too early. 

Mr. STUTZMAN. Anyone else? 

Ms. BOULTWOOD. Well, while we are focused on Europe, there is 

a whole other marketplace in Asia and there are many jurisdictions 

in Asia that have been very public and said, ‘‘We are offering regulatory certainty today, we have no plan to change our rules, we are 

fine with the current regime.’’ Europe is potentially one area, but 

I would be more concerned about Asia and public announcements 

that have already been made there, and this is probably not an 

area where the United States necessarily needs to lead. 

Mr. STUTZMAN. Thank you, Mr. Chairman. I will yield back. 

Thank you to the panelists as well. 

Mr. CONAWAY. I want to thank our six panelists today. You guys 

did a great job. 

All actions have future consequences, and you can divide those 

consequences into those that are unforeseen and we don’t have a 

clue what might happen, and those that you can foresee. You six 

today have given us a good, clear understanding of the foreseeable 

consequences to the current regulatory scheme being proposed by 

the CFTC that is negative to a good swath of folks that had nothing to do with the circumstances that related to either the Enron 

wreck or the wreck in 2008. The most graphic example today is 

that the disruption caused by Dodd-Frank and the relationships between merchants and banks with respect to debit cards that was 

caused by that, we now see the hue and cry among the folks out 

there because banks are looking for another way to try to figure 

out how to make up for the costs, the differential in that revenue 

with debit card fees. So when the government steps into things, 

they should have known ahead of time, all of us could have predicted that if you disrupt that commercial relationship, and I am 

110

not picking sides between either one of them, there will be consequences that are foreseeable in this instance with a debit card. 

The consumer takes it in the pocketbook over and over when we 

don’t get this correct, and we are encouraging CFTC to take a look 

at these foreseeable consequences and the impacts they have on 

consumers as they finalize these rules. 

Again, I want to thank our panelists for coming today. Thank 

you for the prep work, clear answers and the travel that you did. 

Under the rules of the Committee, the record of today’s hearing 

will remain open for 10 calendar days to receive additional material and supplemental written responses from the witnesses to any 

questions posed by a Member. 

This hearing of the Committee on Agriculture is adjourned. 

[Whereupon, at 12:18 p.m., the Committee was adjourned.] 

[Material submitted for inclusion in the record follows:] 

111

SUBMITTED STATEMENT BY HON. K. MICHAEL CONAWAY, A REPRESENTATIVE IN

CONGRESS FROM TEXAS; ON BEHALF OF HON. GLENN ENGLISH, CEO, NATIONAL

RURAL ELECTRIC COOPERATIVE ASSOCIATION

Mr. Chairman, Mr. Peterson, and Members of the Committee, thank you for holding this hearing to review legislative proposals amending Title VII of the DoddFrank Wall Street Reform and Consumer Protection Act, including legislation to 

clarify the ‘‘swap dealer’’ definition. We appreciate the opportunity to again discuss 

how the implementation of the Dodd-Frank Act negatively impacts the rural electric 

cooperatives. Cooperatives use derivatives to help keep electric bills affordable for 

our consumer-members on Main St., and on the farm. Any costs for the rural electric cooperatives through the Commodity Futures Trading Commission’s (CFTC) 

regulatory overreach will come out of the pockets of our consumer-members who live 

in some of the poorest areas in the country. 

The National Rural Electric Cooperative Association (NRECA) is the not-for-profit, national service organization representing over 900 not-for-profit, member-owned, 

rural electric utilities, which serve 42 million customers in 47 states. NRECA estimates that cooperatives own and maintain 2.5 million miles or 42 percent of the nation’s electric distribution lines covering 3⁄4 of the nation’s landmass. Cooperatives 

serve approximately 18 million businesses, homes, farms, schools (and other establishments) in 2,500 of the nation’s 3,141 counties. Our member cooperatives serve 

over 17.5 million member-owners in the states represented on this Committee. 

Cooperatives still average just seven customers per mile of electrical distribution 

line, by far the lowest density in the industry. These low population densities, the 

challenge of traversing vast, remote stretches of often rugged topography, and the 

increasing volatility in the electric marketplace pose a daily challenge to our mission: to provide a stable, reliable supply of affordable power to our members—including constituents of many Members of the Committee. That challenge is critical 

when you consider that the average household income in the service territories of 

our member co-ops lags the national average income by over 14%. 

Mr. Chairman, the issue of derivatives and how they should be regulated is something with which I have a bit of personal history going back twenty years when I 

served on the House Agriculture Committee. Accordingly, I am grateful for your 

leadership in pursuing the reforms necessary to increase transparency and prevent 

manipulation in this complex global marketplace. 

NRECA’s electric cooperative members, primarily generation and transmission 

members, need predictability in the price for power, fuel, transmission, financing, 

and other supply resources if they are to provide stable, affordable rates to their 

members, including farmers in your state. As not-for-profit entities, we are not in 

the business of making money. Rural electric cooperatives use derivatives to keep 

costs down by reducing the risks associated with the necessary inputs for our operations. It is important to understand that electric co-ops are engaged in activities 

that are pure hedging, or commercial risk management. We DO NOT use derivatives for speculation or other non-hedging purposes. We do not ‘‘deal’’ in derivatives, 

buying and selling derivatives to make a profit. We are in a difficult economic environment, and we support additional regulation of the financial markets to protect 

against systemic risk, but over-the-counter (OTC) derivatives are an important tool 

for managing risk on behalf of our members. 

Most of our hedges are bilateral commercial transactions in the OTC market. 

Many of these transactions are entered into by cooperatives using as an agent a risk 

management provider called the Alliance for Cooperative Energy Services Power 

Marketing or ACES Power Marketing. ACES was founded a decade ago by many 

of the electric co-ops that still own this business today. Through diligent credit riskmanagement practices, ACES and our members make sure that the counterparty 

taking the other side of a hedge is financially strong and secure. 

Even though the financial stakes are serious for us, rural electric co-ops are not 

big participants in the global derivatives markets, which is estimated at $600 trillion. Our members participate in only a fraction of that market, and are simply 

looking for an affordable way to manage commercial risk and price volatility for our 

consumers. Because many of our co-op members are so small, and because energy 

markets are so volatile, legislative or regulatory changes that would dramatically 

increase the cost of hedging or prevent us from hedging all-together would impose 

a real burden. If this burden becomes unaffordable, then these price risks will be 

left unhedged and resulting cost increases will be passed on dollar-for-dollar to the 

consumer, where these risks would be unmanageable. 

Electric cooperatives are owned by their consumers. Those consumers expect us, 

on their behalf, to protect them against volatility in the energy markets that can 

jeopardize their small businesses and adversely impact their family budgets. The 

112

families and small businesses we serve do not have a professional energy manager. 

Electric co-ops perform that role for them and should be able to do so in an affordable way. 

The Definition of ‘‘Swap Dealer’’

The National Rural Electric Cooperative Association is concerned that the CFTC 

may interpret the statutory term ‘‘swap dealer’’ broadly enough to sweep in our electric cooperative members, which we believe could be one of the more damaging unintended consequences of the Dodd-Frank Act. Therefore, we appreciate the Committee and Representative Randy Hultgren’s (IL–14) work on legislation that would 

eliminate the rural electric cooperatives’ concerns with the CFTC’s interpretation of 

the Dodd-Frank Act. 

The definition of ‘‘swap dealer’’ is a relatively recent concern for the rural electric 

cooperatives. We have heard from CFTC staff over the past several months that 

they believe some of our members may be considered ‘‘swap dealers.’’ If this is the 

case, those cooperatives would be subject to a slew of new capital-draining registration and business practices requirements and financial markets regulations that 

Congress intended to impose on Wall Street derivatives dealers. To put it bluntly—

it would be an incredible regulatory overreach for the CFTC to apply the definition 

of ‘‘swap dealer’’ to rural electric cooperatives—who are obviously not in the business of derivatives dealing. Cooperatives are not-for-profit end-users hedging commercial risk and protecting consumers from price volatility in wholesale power markets. The rural electric cooperatives’ core mission is keeping the lights on for farmers, families and small businesses in rural America, not dealing in the global swaps 

markets. There are no ‘‘Wall Street derivatives dealers’’ in our membership. Our 

members keep the lights on on Main Street, and on the farm. We believe it should 

be obvious to the CFTC that Congress did not intend for end-users, particularly notfor-profit end-users, to be regulated as ‘‘swaps dealers.’’ We are happy to continue 

to explain our business to the regulatory staff, but we will also continue to urge the 

CFTC to keep a clear focus on legislative intent. 

Given the uncertainty of how broadly the CFTC may interpret the term ‘‘swap 

dealer’’ under Dodd-Frank, NRECA supports draft legislation authored by Representative Randy Hultgren that is under discussion today. The legislation as drafted states clearly the intent of Congress that commercial end-users, who use derivatives to hedge or mitigate the commercial risks that arise from their electric operations, are not ‘‘swap dealers.’’ Further, the legislation also unambiguously clarifies 

that all trading or transacting in swaps ‘‘for your own account’’ is not ‘‘dealing.’’

Importantly, the legislation also provides an increase to the de minimis exception 

to further protect energy end-users and maintain liquidity in the swaps markets. 

Even if the CFTC counted all swaps, not just swaps that are part of a ‘‘dealing business,’’ our members’ transactions would likely not reach the $3 billion de minimis

level. But energy end-users like electric cooperatives support this higher de minimis

notional level to encourage non-financial market participants, like natural gas producers, to continue to participate actively in regional electricity and natural gas 

markets. 

The initial CFTC registration as a ‘‘swap dealer’’ brings with it enormous and 

costly regulatory burdens like capital, margin, clearing, business conduct and documentation requirements. Energy end-users cannot allow the new CFTC regulatory 

costs to drive non-bank counterparties out of our markets, or deter others from 

starting to ‘‘deal’’ in these important regional markets. 

Given the illiquidity of regional power and natural gas markets, and the volatility 

of prices for long-term swaps on such commodities, the $3 billion notional amount 

is appropriate for long-term power or natural gas ‘‘swaps’’ in illiquid regional markets. 

The Definition of ‘‘Swap’’

While the purpose of our testimony is to express support for the Hultgren draft 

legislation clarifying the definition of ‘‘swap dealer’’, we would like to take the opportunity to discuss the most important term in the Dodd-Frank Act—‘‘swap.’’ As 

this Committee knows, the term ‘‘swap’’ defines the scope of the CFTC’s authority, 

impacts nearly every rule the CFTC has proposed to date, yet has not yet been finalized under the Dodd-Frank Act. In fact, the rule defining ‘‘swap dealer’’ is expected to be finalized before the CFTC even defines ‘‘swap.’’

NRECA is concerned that if the CFTC defines that term too broadly, it could 

bring under the CFTC’s jurisdiction numerous commercial transactions that cooperatives and others in the energy industry have long used to manage electric grid 

reliability and to provide long-term price certainty for electric consumers. It is our 

belief that the CFTC must acknowledge in its rules that a ‘‘swap’’ does not include 

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physical forward commodity contracts, ‘‘commercial’’ options on non-financial commodities, or physical commodity contracts that contain option provisions, including 

full requirement contracts that even the smallest cooperatives use to hedge their 

need for physical power and natural gas. Further, CFTC should acknowledge in its 

rules that ‘‘swap’’ does not include power supply and generation capacity contracts, 

reserve sharing agreements, transmission contracts, emissions allowances, renewable energy credits or other transactions that are subject to FERC, EPA, or state 

energy or environmental regulation. 

These instruments are non-financial transactions between non-financial entities 

that have never been considered ‘‘products’’ or ‘‘derivatives.’’ They were not created 

to ‘‘trade’’, they were developed to protect the reliability of the grid by ensuring that 

adequate generation resources will be available to meet the needs of consumers. 

These transactions do not pose any systemic risk to the global financial system. Yet, 

if they were to be regulated by the CFTC as ‘‘swaps,’’ such regulation could impose 

enormous new costs on electric consumers and could undermine reliability of electric 

service if the costs forced utilities to abandon these long-term arrangements. 

In the Dodd-Frank Act, Congress excluded from the definition of ‘‘swap,’’ the ‘‘sale 

of a non-financial commodity . . . so long as the transaction is intended to be physically settled.’’ NRECA asks Congress to insist that the CFTC read this language 

as it was intended—and insist that the CFTC draft clear rules to exclude from regulation these kinds of normal course transactions which utilities use to hedge commercial risks and meet the needs of electric consumers. 

Conclusion 

Mr. Chairman, at the end of the day, we are looking for a transparent market 

for standardized trading products, and continued, cost-effective access to the OTC 

transactions which allow cooperatives to hedge risk and volatility for our members. 

If we are to do that, the CFTC must define ‘‘swap’’ in clear terms to exclude those 

pure hedging transactions in non-financial commodities that the industry uses to 

preserve reliability and manage long-term power supply costs. The CFTC must not 

consider commercial end-users who hedge or mitigate commercial risks as ‘‘swap 

dealers.’’ And the CFTC must give real meaning to Dodd-Frank’s end-user exemption; limit unnecessary recordkeeping and reporting costs for end-users; and limit 

duplicative and unnecessary regulation of cooperatives and other electric utilities. 

Rural electric cooperatives are not financial entities, and therefore should not be 

burdened by new regulation or associated costs as if we were financial entities. We 

believe the CFTC should preserve access to swap markets for non-financial entities 

like the co-ops who simply want to hedge commercial risks inherent in our non-financial business—our mission is to provide reliable and affordable power to American consumers and businesses. 

I thank you for your leadership on this important issue. I know that you and your 

Committee are working hard to ensure these markets function effectively. The rural 

electric co-ops hope that at the end of the day, there is an affordable way for the 

little guy to effectively manage risk. 

Thank you. 

SUBMITTED STATEMENT BY AMERICAN BANKERS ASSOCIATION

Chairman Lucas, Ranking Member Peterson, and Members of the Committee, the 

American Bankers Association (ABA) appreciates the opportunity to submit this 

statement for the record on legislative proposals amending Title VII of the DoddFrank Wall Street Reform and Consumer Protection Act. The ABA represents banks 

of all sizes and charters and is the voice of the nation’s $13 trillion banking industry 

and its two million employees. 

ABA appreciates the efforts of this Committee to ensure that implementation of 

the derivatives title of the Dodd-Frank Act agrees with the intent of the Congress. 

ABA has consistently supported the objective of increasing transparency and appropriate supervision of credit default swaps and other financial products of systemic 

importance. Several pieces of legislation being reviewed by the Committee today 

achieves that goal and also preserves the ability of banks to serve as engines for 

economic growth and job creation. 

The Committee is considering today multiple pieces of legislation that would further define and clarify elements of Title VII of the Dodd-Frank Act including the 

following:

➢ The Discussion Draft would clarify the definition of a swap dealer and the 

clearing exemption for certain banks, savings associations, farm credit system 

institutions, and credit unions. Among other things, it would mandate a clearVerDate 0ct 09 2002 15:26 Nov 29, 2011 Jkt 041481 PO 00000 Frm 00117 Fmt 6621 Sfmt 6621 I:\DOCS\112-25\70998.TXT BRIAN
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ing exemption for institutions with an asset threshold of $30 billion or less. It 

would also include an alternative clearing exemption for institutions with an aggregate uncollateralized outward swaps exposure plus aggregate potential outward swaps exposure that does not exceed $1 billion. Moreover, the legislation 

would modify the language for swaps made in connection with loans. ABA believes that the Discussion Draft’s small institution exclusion is a significant improvement, as is the clarity the legislation would provide for the 

existing exclusion from the swap dealer definition for transactions in 

connection with originating loans. We remain opposed to excluding the 

$230 billion Federal Farm Credit System from any provisions of Title VII 

of the Dodd-Frank Act because it is a Government Sponsored Enterprise.

➢ H.R. 2682, the Business Risk Mitigation and Price Stabilization Act of 2011, 

would clarify that end-users would not be subject to margin requirements for 

uncleared swaps. However, the legislation would limit the margin exemption to 

end-users that are not financial entities. ABA supports an end-user exemption from margin requirements for uncleared swaps and believes that all 

end-users—including banks that use swaps to hedge or mitigate risk—

should be exempt.

➢ A second Discussion Draft amends the Commodity Exchange Act to clarify the 

definition of a swap dealer would include additional criteria for determining 

which persons may be characterized accurately as swap dealers. Specifically, 

the legislation would exclude from the definition of a swap dealer those persons 

engaging in swaps transactions for the purpose of hedging or mitigating commercial risk or that are ancillary to a person’s regular business as a producer, 

processor, handler, or commercial user of certain products. The Discussion Draft 

also adds a specific gross notional amount threshold test to the existing DoddFrank Act de minimis exception from the definition of a swap dealer. ABA supports establishing clearly defined criteria for the de minimis exception 

and stands ready to work with the Committee to develop appropriate 

standards for this exception.

➢ H.R. 2779 would exempt inter-affiliate swaps from certain regulatory requirements put in place by the Dodd-Frank Act. H.R. 1840 would improve consideration by the Commodity Futures Trading Commission (CFTC) of the costs and 

benefits of its regulations and orders. ABA supports exempting inter-affliate 

swaps from many of the anticipated swap regulations, as failing to do 

so would undermine bank internal risk management procedures and 

distort market information. ABA also supports a stronger requirement 

for full assessment of the costs and benefits of CFTC regulations.

The remainder of this statement provides more detail on ABA’s position on these 

bills. 

Banks With Limited Swap Activities Should Be Exempt From Clearing Requirements 

ABA has a diverse membership including banks of all sizes that use swaps in a 

variety of ways depending on the complexity of their business activities. Hundreds 

of our member banks use swaps to mitigate the risks of their ordinary business 

activities. Margin and clearing requirements would make it difficult or impossible 

for many banks to continue using swaps to hedge the interest rate, currency, and 

credit risks that arise from their loan, securities, and deposit portfolios. Such requirements would increase the risk in the system, not reduce it, and reducing risk 

is the primary purpose of hedging. 

The vast majority of banks use derivatives as part of the delivery of fixed-rate 

loans or long-term financing to customers, not as a means for speculation. For example, a bank will use swaps to hedge the interest rate risk on its own balance 

sheet, thus lowering the bank’s risk in providing customer loans. Moreover, interestrate swaps help to provide long-term fixed-rate financing to manufacturers, small 

businesses, universities, not-for-profit organizations and other bank customers, thus 

helping customers safely manage their interest rate risk and focus on their core 

business rather than the prospect of rising interest rates. 

Many banks cannot afford the expense of establishing and maintaining a clearing 

relationship for the limited amount of swaps transactions that they undertake in 

the service of their customers. A costly clearing requirement imposed on these institutions would adversely affect them and their business customers as they try to 

weather an uncertain economy. Without passage of several pieces of legislation before the Committee today, or proper implementation of the Dodd-Frank Act by the 

regulatory agencies, the result will be reduced credit options for many businesses 

and organizations across the country that are working to create jobs. 

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As we have stated in previous testimony to this Committee, ABA believes that:

➢ Banks with limited swaps activities should be exempt from the new 

clearing requirements in the same way as other ‘‘end-users’’

➢ All common lending practices should be included in the exemption from 

the swap dealer definition for swaps entered into in connection with 

originating a loan

➢ End-users—including banks with limited swaps activities—should not 

be subject to margin requirements

The ABA believes that the Discussion Draft regarding the small institutions exclusion from clearing is a significant improvement to underlying law. The Discussion 

Draft recognizes that many banks use swaps in the same way as other end-users, 

to hedge or mitigate commercial risk. Moreover, banks using swaps to hedge or mitigate commercial risk have standard risk management practices that are subject to 

regulatory oversight (including on-site examinations every 12 to 18 months) and 

they have explicit legal limits on the overall credit exposure that they can have to 

any individual or entity. Banks engaging in these limited swaps activities should 

be exempt from the clearing requirements because they do not pose a risk to the 

swaps market or the safety and soundness of the banks. In fact, banks and savings 

associations below the Discussion Draft’s $30 billion asset threshold for a clearing 

exemption account for only 0.09 percent of the notional value of the bank swaps 

market as of June 2011. 

The Discussion Draft provides needed certainty to the underlying law for banks 

that enter into swaps transactions in connection with originating loans for customers. Banks commonly enter into swaps with customers so that customers can 

hedge their interest rate or loan-related risks. While some swaps are entered into 

simultaneously with loans, many swaps are entered into before or after a loan is 

made. For example, it is common for a customer to enter into a swap to lock in an 

interest rate in anticipation of a future loan. The Discussion Draft ensures that 

these essential risk-mitigating services conducted as part of the loan making process 

are not brought into the swap dealer definition. In this way, the Discussion Draft 

will protect a variety of credit options for businesses of all sizes working to create 

jobs and grow the economy. 

The ABA is concerned that the swaps exposure measurement alternative proposed 

in the legislation would constitute an undue administrative burden for banks. Although we agree that a risk-based measurement is appropriate for determining 

which institutions may qualify for the exclusion, we are concerned that the proposed 

measurement would be extremely cumbersome for banks to undertake. Banks with 

limited swaps activities are least able to afford additional regulatory or administrative burdens related to their swaps transactions and are likely to stop using swaps 

altogether if costs or complexities are significantly increased. As a result, they 

would lose an important risk management tool. The ABA will continue to work with 

the Committee on alternative risk-based measurements as the legislative process 

moves forward. 

The $230 Billion Federal Farm Credit System Should Not Be Given Special 

Treatment 

The ABA would like to reiterate that it strongly disagrees that the $230 billion 

Federal Farm Credit System (FCS) should be exempted from an asset test regarding 

their derivatives activities. We urge this Committee to reject its request for special 

treatment. The Federal Farm Credit System is a tax-advantaged, retail lending, 

Government Sponsored Enterprise (GSE). The Federal Farm Credit System suggested to this Committee that regulators ‘‘look through’’ their corporate structure to 

the smallest entities that make up the System, the retail lending associations. Each 

of these entities are jointly and severally liable for each other’s financial 

problems. The FCS proposes that the joint and several liability requirement be 

overlooked so that it may be considered a collection of small entities, when in fact 

this is not the case. 

The Federal Farm Credit System presents the same kind of potential liability to 

the American taxpayer as other GSEs. Taxpayers are the ultimate backstop in the 

event that the Federal Farm Credit System experiences financial problems. In fact, 

this has already happened. The near collapse of the Federal Farm Credit System 

in the late 1980s—which was a result of irresponsible farm lending by Federal Farm 

Credit System institutions—foreshadowed what taxpayers would confront more than 

twenty years later with the housing GSEs. At that time, the Federal Farm Credit 

System received $4 billion in financial assistance from the U.S. taxpayer. Therefore, due to its enormous size and the potential risk it poses to the economy, 

we urge this Committee to reject the Federal Farm Credit System’s arguVerDate 0ct 09 2002 15:26 Nov 29, 2011 Jkt 041481 PO 00000 Frm 00119 Fmt 6621 Sfmt 6621 I:\DOCS\112-25\70998.TXT BRIAN
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ments for exemptions from the derivatives title of the Dodd-Frank Act and 

ensure that the implementation of these requirements by regulators does not 

permit such a look-through. 

End-Users Should Not Be Subject to Margin Requirements for Uncleared 

Swaps 

The Dodd-Frank Act does not require regulators to impose margin requirements 

on end-users and the legislative history makes it clear that Congress did not intend 

to impose margin requirements on end-users. Nonetheless, end-users currently face 

uncertainty about whether they will be subject to margin requirements and this legislation would provide much-needed clarity. 

The margin requirements are intended to offset the greater risk to swap entities 

and the financial system from uncleared swaps. However, imposing margin requirements on end-users would discourage the use of swaps to hedge or mitigate risk, 

so it would both increase risk in the system and vitiate the end-user clearing exemption. 

Furthermore, the vast majority of banks use swaps to hedge and mitigate the 

risks of their ordinary business activities, just as other end-users do. Banks are also 

subject to comprehensive regulation and use swaps to meet regulatory expectations 

for asset-liability management. Adding initial and variation margin requirements 

and imposing clearing requirements would make it difficult or impossible for many 

banks to continue using swaps to hedge the interest rate, currency, and credit risks 

that arise from their loan, securities, and deposit portfolios. The result would increase risk in the system, not reduce risk, which is the primary purpose of hedging. 

If the Committee wants to make a distinction between the margin requirements 

for bank end-users and other end-users, then we urge the Committee to consider 

imposing only variation margin for end-user banks rather than both initial and variation margin requirements. Current market practice is for swap counterparties to 

negotiate whether any collateral or margin requirements should be required and 

banks are already required to periodically reassess changes in the value of their assets and liabilities. Accordingly, at most end-user banks should be subject to markto-market variation margin requirements as they reassess the value of any negotiated collateral. The ABA stands ready to assist the Committee if it decides to distinguish between margin requirements for bank end-users and other end-users. 

ABA Supports Clearly Defined Criteria for the De Minimis Exception 

The ABA believes that the Discussion Draft clarifying the definition of a swap 

dealer is an important step forward. The legislation proposes clearly defined criteria 

for the de minimis exception, a goal which ABA fully supports. It is important for 

Congress to give clear guidance to the regulators on this point to ensure that institutions presenting nominal risk to the system are not saddled with undue costs and 

complications. ABA will continue to work with the Committee on the criteria for an 

appropriate de minimis exception. 

ABA Supports Full Assessment of the Costs and Benefits of CFTC Regulations 

The ABA supports H.R. 1840, legislation providing for a full assessment of the 

costs and benefits of the Commodity Futures Trading Commission (CFTC) regulations. Regulatory burden on the banking industry has grown dramatically as a result of the Dodd-Frank Act and is stretching the resources of banks across the country. The median-size bank has just 37 employees and is struggling to pay for new 

auditing, legal, and compliance costs resulting from a mountain of new regulations. 

H.R. 1840 would ensure that the best possible assessment is made of the costs and 

impacts of new regulations so that regulated entities are not subject to unnecessary 

costs that outweigh any potential regulatory benefit. 

ABA Supports Exempting Inter-Affiliate Swaps From Certain Regulatory Requirements 

The ABA believes that H.R. 2779, legislation exempting inter-affiliate swaps from 

certain regulatory requirements, significantly improves underlying law. For certain 

financial institutions, inter-affiliate swaps are an important tool for accommodating 

customer preferences and managing interest rate, currency exchange, or other balance sheet risks that arise from the normal course of business. Inter-affiliate swaps 

do not create additional counterparty exposure and should not be subject to the 

same rules intended for swaps entered into with a third party. In addition, H.R. 

2779 would require reporting of inter-affiliate transactions. This requirement would 

not add relevant market information. Rather, it would be duplicative and 

would distort market information. ABA would like to continue to work with the 

Committee on this reporting provision going forward. 

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Conclusion 

ABA thanks the Committee for its strong leadership in this area. The Committee’s 

efforts will facilitate better functioning of credit markets and maximize credit options for businesses large and small that are critical to job growth. ABA believes 

that treating end-user banks the same way as other end-users is an essential component of this effort. ABA member banks, like commercial end-users, use swaps to 

mitigate the risks of ordinary business activities and should be exempted from mandatory clearing and margin requirements. 

SUBMITTED STATEMENT BY INDEPENDENT COMMUNITY BANKERS OF AMERICA

Derivatives Concerns of Community Banks 

Mr. Chairman and distinguished Members of the House Committee on Agriculture, ICBA is presenting this testimony for the hearing record to highlight important issues regarding title VII of the Dodd-Frank Act (DFA). As proposed by Federal 

regulators, these issues could have a significant impact on whether or not the 1,000 

community banks that currently utilize the swaps market will be able to do so. As 

regulators have previously stated, access to the derivatives marketplace is important to banks desiring to hedge their own interest rate risks or provide long-term, 

fixed-rate products to their customers. 

The Dodd-Frank Act includes provisions designed to create greater transparency 

and reduce conflicts of interests and systemic risks in the derivatives marketplace. 

ICBA agrees with these objectives but believes that proposed regulations by the 

SEC, the CFTC and the so called ‘‘prudential’’ regulators should not disadvantage 

community bankers’ participation in the use of derivatives, either in working with 

their borrowers or in hedging their interest rate risks. We will seek to work with 

regulators to address these issues and like-minded Members of Congress. 

Two specific proposals may profoundly impact whether our members can access 

these markets: (1) the prohibition against rehypothecation or transferring of margin 

to complete swap transactions; and (2) the potential to count all swaps used by commercial banks except those swaps completed only at the time of origination of a loan 

as counting toward the swap dealer definition, thus causing community banks to be 

classified as ‘‘swap dealers.’’ These and other issues are reflected in a comment letter to Federal regulators submitted by ICBA on July 11, 2011. 

Rehypothecation 

Community banks use low-risk interest rate swaps designed to hedge the underlying risk exposure associated with their balance sheets and/or to convert variable 

rate loans into fixed rate loans on behalf of their customers. These interest rate 

swaps are ‘‘customized’’ to meet the underlying characteristics of their customers’ 

individual loans in order to be an effective hedge and to meet GAAP accounting requirements. 

For example, these swaps are often much smaller than standardized swap agreements; or have repayment frequencies or other characteristics that differ from 

cleared swaps. Their risk levels are small. They are essentially the same as the 

plain vanilla interest rate swaps that are cleared by clearing houses but due to their 

customized nature are not at this time accepted for clearing. 

Therefore, the customization required for these swaps transactions means they 

are relegated to the over the counter (OTC) market. 

In their capital and margin regulations, regulators have proposed to prohibit 

rehypothecation of initial margin. The margin that many community banks now hypothecate to middle market swap dealers typically is rehypothecated upstream into 

a separate account, identified as belonging to the community bank that put up the 

initial margin, but available to their counterparties in the swap transaction to cover 

any losses. 

By prohibiting the rehypothecation of margin by the handful of middle market 

dealers that serve community banks, the regulators would be requiring these dealers to put their own capital into swaps transactions. This prohibition on 

rehypothecation will substantially and unnecessarily increase the amount of capital 

needed to complete these swap transactions. This will either result in making the 

cost of the swap transaction uneconomical or will cause the middle market dealers 

that community banks utilize to exit the market, thus denying access to the swaps 

market for community banks. 

We note that the Farm Credit Council (FCC) expressed very similar concerns in 

their July 11 letter to Federal regulators regarding the impact if rehypothecation 

restrictions are applied, in this case to Farm Credit System (FCS) institutions. FCS 

institutions, due to their status as a Government Sponsored Enterprises (GSE) are 

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granted the same credit rating as the U.S. Government. Due to this rating, FCS institutions apparently do not have to put up initial margin because their swap dealers are willing to have credit exposure to such highly rated, government-backed, entities. However, the FCC notes that having to now post initial margin will cause 

the swap dealers to, ‘‘in turn, be forced to recover those costs by raising prices’’ on 

FCS entities. By contrast, many community banks do post initial margin and do indeed face these higher costs in their swaps transactions. Community banks are already at a disadvantage in terms of the pricing they receive on swaps transactions, 

and by having to compete with a GSE with tax and funding advantages at the retail 

level in the agricultural marketplace. 

The FCC goes on to state that ‘‘Because swap entities often offset their own transactions with other swaps, they typically rehypothecate variation margin to other 

counterparties to satisfy their own variation margin requirements . . . prohibiting 

rehypothecation would therefore force swap entities to bear much higher costs and 

to pass those costs on . . . in the form of higher prices.’’

The prohibition on the reuse of the capital of community banks, whether initial 

or variation margin, to complete the swaps transaction would likewise raise the 

costs of those transactions for community banks. This outcome will force middle 

market swap dealers to come up with costly capital—hard earned, scarce resources 

set aside to cover potential exposure on the swaps transactions in addition to the 

margin already put in place by the community bank for the same swap transaction. 

This will dramatically increase the costs of swap transactions for those serving the 

community banking market. Either the cost of utilizing these swaps will be economically prohibitive or middle market swap dealers will be forced out of the business 

of facilitating swaps for community banks. 

One result is that risks to the community bank sector would increase as banks 

would have greater interest rate risks as they use short term deposits to fund long 

term, fixed-rate loans. The Savings and Loan crisis occurred because S&Ls borrowed 

short to lend long. Therefore, the ability of community banks to offer important 

fixed-rate products with longer maturities to their customers would also be placed 

in jeopardy. The amount of actual derivatives risk reduction in the OTC market 

would be insignificant if it occurred at all. 

Keep in mind that community banks use low risk interest rate swaps and do not 

and did not utilize the risky credit default swaps used by AIG and Lehman that 

resulted in causing panic in financial markets due to potential systemic risks. Moreover, the statute does not prohibit rehypothecation of initial margin as is being proposed by regulators. 

Contrary to the broad brush painted by some Federal regulators, not all swaps 

utilized in the OTC market pose greater risks than cleared swaps. Certainly, low 

risk interest rate swaps used by community banks do not put swap dealers at risk 

nor do they pose systemic risks. Therefore, regulators should make distinctions between products within the OTC market instead of assuming that all swaps in the 

OTC market are risky simply because they are not accepted for clearing by clearing 

houses.. 

For example, proposed regulations have noted the problems of AIG in the OTC 

market as a reason to generally assert that swaps traded in the OTC market are 

supposedly riskier than those traded in clearing houses. However, AIG’s problems 

resulted from using credit default swaps (CDS), an insurance-like product, not from 

the low-risk interest rate swaps used by community banks. 

These are important distinctions since the Dodd-Frank Act requires that margin 

requirements be based on the risks posed by the non-cleared derivatives. 

Therefore, if implemented as proposed, regulations designed to address the problems caused by a few very large financial institutions would have the perverse and 

unintended consequence of penalizing community banks, much smaller institutions 

which did not cause the financial crisis and which were not the intended target of 

title VII. 

Regulators have asked whether certain types of rehypothecation should be allowed. We believe that one option would be to provide an exemption to the prohibition on rehypothecation of margin associated with interest rate swaps entered into 

by a community bank with a swap dealer, where the swap is related to hedging the 

community bank’s interest rate risks or providing long-term, fixed-rate products to 

their customers. This would be appropriate since the capital or margin being rehypothecated will be used for the same swaps transactions. We have drafted narrow 

legislative language to accomplish this. 

Avoid a One-Size-Fits-All Approach 

We believe it is important to understand what is occurring through title VII and 

related regulations. Congress adopted title VII to address the risky activities of the 

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very large Wall Street investment firms and of the nation’s largest banks. It has 

been reported that only a handful of these mega institutions control roughly 95 percent of the derivatives marketplace. Therefore, Congress imposed title VII in an effort to force many swaps into clearinghouses where there will be little if any unsecured risk. However, due to the extremely large amount of capital and market resources required to become a clearinghouse member, several of the very large institutions (the member/owners) that were intimately involved in causing the financial 

meltdown and systemic risk issues in the first place will now also be the very institutions that reportedly will be the primary owners who control and profit most from 

the clearinghouses. 

The Federal regulators, not wanting these large entities to ‘‘game the system’’ by 

also placing risky swaps into the OTC market, are now attempting to overlay the 

clearing model onto the OTC marketplace and onto all or many of the minor and 

peripheral players involved in the OTC market. The proposed requirements and/or 

restrictions regarding margin, clearing requirements and rehypothecation are intertwined and driven by this attempt to impose the clearing model, with its high costs, 

onto the OTC marketplace. 

As noted above, many community banks post initial margin. However, whether 

or not initial margin is posted is often negotiated between counterparties within the 

ISDA master agreement. Regulators should not require initial margin, but rather 

allow for it to be negotiated between parties as needed. Likewise, whether 

rehypothecation is allowed is also an option within the ISDA master agreement. 

Further, requirements to clear would impose significant costs on community banks, 

even though their swaps are not clearable due to their customized nature, resulting 

in another example of why community banks would lose access to the swaps market 

for the limited number of swaps they engage in. 

These terms should not be dictated by Federal regulators who are proposing to 

impose the clearinghouse model onto the OTC market with few, if any, distinctions. 

By requiring initial margin, by requiring clearing and by prohibiting 

rehypothecation, either separately or in combinations, regulators are increasing 

costs upon all parties at every stage of OTC transactions. This will increase the 

costs of doing swaps, most likely making them uneconomical and unavailable. The 

end-users, whether farmers or small or large businesses and community banks will 

suffer the unintended consequences if the final regulations are not carefully and 

skillfully written. Otherwise, the result will be greater risks throughout various sectors of the economy—NOT—greater safety and soundness as intended. 

Swap Dealer Definition 

A second major concern rises from Dodd-Frank’s exemption of commercial banks 

being classified as swap dealers to the extent they enter into a swap with a customer in connection with originating a loan with that customer. Federal regulators 

have requested comments as to whether this exclusion should apply only to swaps 

entered into contemporaneously with the bank’s origination of the loan and how 

‘‘contemporaneously’’ should be defined for this purpose. 

Regulators and/or Congress need to ensure that this exemption applies to swaps 

entered into before, during or after origination of loans to provide enough flexibility 

to serve their customers’ timing and needs for swaps to facilitate fixed rate 

financings. Otherwise, community banks will be considered swap dealers and will 

stop using swaps. 

We appreciate legislation before the Committee that would help ensure this objective and look forward to working with Congress on this matter. 

Other Legislative Goals 

Prudential Regulators asked in their proposed regulations on margin and capital 

requirements for covered swap entities whether non-financial end-users should be 

exempt from mandatory clearing requirements. ICBA responded that they should. 

Prudential regulators then asked whether counterparties that are small financial institutions using derivatives to hedge their risks should be treated in the same manner as non-financial end-users for the purposes of the margin requirements. ICBA 

indicated that small financial institutions should receive the same exemption as 

non-financial end-users since community banks are basically end-users as well. 

ICBA supports legislation to ensure these goals are met. 

In addition, Congressman Conaway and several other cosponsors have introduced 

H.R. 1840, bipartisan legislation that requires a thorough cost-benefit analysis of 

CFTC regulations. ICBA supports such efforts and has indicated support for even 

broader legislation (e.g., S. 1615) as we believe that regulations must not be onerous 

or imposed on a one-size-fits-all basis. 

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Community banks contend with costly, unwieldy regulatory burdens that often 

jeopardize their capacity to raise capital, lend to small businesses and consumers, 

and support job creation. Similar to H.R. 1840, S. 1615 would require agencies to 

subject proposed new rules to a more rigorous, 12 point analysis to ensure that they 

are truly needed, are designed to pose as little burden and cost as possible, and pass 

a basic cost-benefit test. Importantly, the legislation would also require a retrospective ‘look-back’ every 5 years so that regulators could evaluate rules after they’ve 

been put in place. This concept may also be useful to incorporate into H.R. 1840 

due to the complexity and omnibus nature of title VII rulemaking. In this case, a 

2 or 3 year ‘look-back’ would be even more appropriate. 

In our current difficult economic environment, it is important to ensure a reasonable check on new regulations, ensuring that they do not jeopardize community 

banks’ viability by imposing costs that outweigh any benefit. This includes requiring 

Federal agencies to more fully analyze alternative approaches to new regulations 

and to determine ways to streamline existing regulations. 

Farm Credit System Exemptions 

The FCS has suggested that it be treated as small financial institutions although 

it is collectively over $200 billion in assets. The FCS has suggested that regulators 

‘‘look through’’ to their individual associations. This would be like looking at the individual branches of a large national bank and determining that the branches themselves are not swap dealers. However, FCS institutions have joint and several liability, making their institutions responsible for each other’s losses. 

CFTC Chairman Gensler stated in his statement on CFTC’s margin proposal: 

‘‘The risk of a crisis spreading throughout the financial system is greater the more 

interconnected financial companies are to each other. Interconnectedness among financial entities allows one entity’s failures to cause uncertainties and possible runs 

on the funding of other financial entities, which can spread risk and economic harm 

throughout the economy.’’

While the FCS does not share the blame of the nation’s largest banks and Wall 

Street firms in causing this recent financial crisis, their institutions were engaged 

in reckless lending that led to the 1980’s farm credit crisis and its resulting misery. 

As a GSE, the System is indeed interconnected and Congress would be tempted to 

step in and bail out the System if it were to once again fail as it did in the 1980s 

when the System was a much smaller entity. By contrast to the recent bailout of 

the nation’s largest banks and the FCS’s 1980’s bailout, hundreds of independent 

community banks—institutions that are not interconnected—have been allowed to 

fail during these different times of crisis. 

Therefore, the FCS should not be granted special exemptions or advantages over 

other financial institutions in the swaps marketplace. The System has tax; funding 

and other advantages as a privileged GSE that competes against private sector lenders in the retail marketplace and it receives lax oversight of its mission area by its 

charitable regulator, the Farm Credit Administration (FCA). 

Conclusion 

The low risk interest rate swaps being utilized by community banks pose no systemic risks to the financial markets. Due to the low risks involved, community 

banks’ customized swaps should not be subject to higher capital and margin requirements particularly compared to the plain-vanilla swaps that will be cleared. Banks, 

who utilize swaps to hedge their own interest rate risks and to serve the needs of 

their customers, should not be considered swap dealers. 

There should not be a prohibition on rehypothecation of margin when used to 

complete swap transactions. 

Otherwise, capital costs would become too great and the use of low risk interest 

rate swaps by community banks would be uneconomical. Farmers and small businesses would suffer. Risks within the banking sector would increase. 

A June 20 letter from the House and Senate Chairmen of the respective Agriculture Committees to Federal regulators states: ‘‘Lastly, we urge regulators to ensure that any new capital requirements are carefully linked to the risk associated 

with the uncleared transactions, and not used as a means to deter over-the-counter 

derivatives trading.’’ This would indeed be the unfortunate outcome if the prohibition on rehypothecation is allowed to occur.

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We urge Congress to ensure that rehypothecation of margin is allowed when necessary to complete swaps transactions and we urge careful consideration of legislative initiatives that would address the other issues referenced in our testimony. 

ICBA stands ready to assist Congress and regulators in these efforts. 

Thank you.

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