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53–020 PDF 2009

HEARING TO REVIEW PROPOSED

LEGISLATION BY THE U.S. DEPARTMENT 

OF THE TREASURY REGARDING THE

REGULATION OF OVER-THE-COUNTER 

DERIVATIVES MARKETS

HEARINGS

BEFORE THE

COMMITTEE ON AGRICULTURE 

HOUSE OF REPRESENTATIVES

ONE HUNDRED ELEVENTH CONGRESS

FIRST SESSION

SEPTEMBER 17, 22, 2009

Serial No. 111–29

(

Printed for the use of the Committee on Agriculture 

agriculture.house.gov 

COMMITTEE ON AGRICULTURE 

COLLIN C. PETERSON, Minnesota, Chairman 

TIM HOLDEN, Pennsylvania, 

Vice Chairman 

MIKE MCINTYRE, North Carolina 

LEONARD L. BOSWELL, Iowa 

JOE BACA, California 

DENNIS A. CARDOZA, California 

DAVID SCOTT, Georgia 

JIM MARSHALL, Georgia 

STEPHANIE HERSETH SANDLIN, South 

Dakota 

HENRY CUELLAR, Texas 

JIM COSTA, California 

BRAD ELLSWORTH, Indiana 

TIMOTHY J. WALZ, Minnesota 

STEVE KAGEN, Wisconsin 

KURT SCHRADER, Oregon 

DEBORAH L. HALVORSON, Illinois 

KATHLEEN A. DAHLKEMPER, 

Pennsylvania 

ERIC J.J. MASSA, New York 

BOBBY BRIGHT, Alabama 

BETSY MARKEY, Colorado 

FRANK KRATOVIL, JR., Maryland 

MARK H. SCHAUER, Michigan 

LARRY KISSELL, North Carolina 

JOHN A. BOCCIERI, Ohio 

SCOTT MURPHY, New York 

EARL POMEROY, North Dakota 

TRAVIS W. CHILDERS, Mississippi 

WALT MINNICK, Idaho 

FRANK D. LUCAS, Oklahoma, Ranking 

Minority Member 

BOB GOODLATTE, Virginia 

JERRY MORAN, Kansas 

TIMOTHY V. JOHNSON, Illinois 

SAM GRAVES, Missouri 

MIKE ROGERS, Alabama 

STEVE KING, Iowa 

RANDY NEUGEBAUER, Texas 

K. MICHAEL CONAWAY, Texas 

JEFF FORTENBERRY, Nebraska 

JEAN SCHMIDT, Ohio 

ADRIAN SMITH, Nebraska 

ROBERT E. LATTA, Ohio 

DAVID P. ROE, Tennessee 

BLAINE LUETKEMEYER, Missouri 

GLENN THOMPSON, Pennsylvania 

BILL CASSIDY, Louisiana 

CYNTHIA M. LUMMIS, Wyoming 

PROFESSIONAL STAFF

ROBERT L. LAREW, Chief of Staff 

ANDREW W. BAKER, Chief Counsel 

APRIL SLAYTON, Communications Director 

NICOLE SCOTT, Minority Staff Director 

(II) 

(III)

C O N T E N T S 

Page 

Thursday, September 17, 2009

Boswell, Hon. Leonard L., a Representative in Congress from Iowa, submitted 

material ................................................................................................................. 99

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

statement .............................................................................................................. 3

Peterson, Hon. Collin C., a Representative in Congress from Minnesota, opening statement ........................................................................................................ 1

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

WITNESSES

Hixson, Jon, Director of Federal Government Relations, Cargill, Incorporated, 

Washington, D.C. ................................................................................................. 4

Prepared statement .......................................................................................... 6

English, Hon. Glenn, CEO, National Rural Electric Cooperatives Association, 

Washington, D.C. ................................................................................................. 8

Prepared statement .......................................................................................... 10

Schryver, David, Executive Vice President, American Public Gas Association, 

Washington, D.C. ................................................................................................. 11

Prepared statement .......................................................................................... 13

Hirst, Richard B., Senior Vice President and General Counsel, Delta Air 

Lines, Minneapolis, MN; on behalf of Air Transport Association .................... 19

Prepared statement .......................................................................................... 21

O’Connor, Gary N., Chief Product Officer, International Derivatives Clearing 

Group, LLC, New York, NY ................................................................................ 50

Prepared statement .......................................................................................... 51

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

D.C. ........................................................................................................................ 55

Prepared statement .......................................................................................... 56

Duffy, Hon. Terrence A., Executive Chairman, CME Group Inc., Chicago, 

IL ........................................................................................................................... 60

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

Pickel, Robert G., Executive Director and CEO, International Swaps and 

Derivatives Association, New York, NY ............................................................. 71

Prepared statement .......................................................................................... 72

Supplemental material ..................................................................................... 121

Short, Johnathan H., Senior Vice President and General Counsel, 

IntercontinentalExchange, Inc., Atlanta, GA .................................................... 77

Prepared statement .......................................................................................... 79

Supplemental material ..................................................................................... 122

Budofsky, Daniel N., Partner, Davis Polk & Wardwell LLP, New York, NY; 

on behalf of Securities Industry and Financial Markets Association .............. 82

Prepared statement .......................................................................................... 84

SUBMITTED MATERIAL

3M Company, submitted statement ....................................................................... 150

Keating, Frank, President and CEO, American Council of Life Insurers, submitted statement .................................................................................................. 102

Menezes, Mark W., David T. McIndoe, R. Michael Sweeney, Jr., Hunton 

& Williams LLP; on behalf of Working Group of Commercial Energy Firms, 

submitted report ................................................................................................... 103

National Association of Manufacturers, submitted statement ............................ 152

Page

IV

National Association of Real Estate Investment Trusts; The Real Estate 

Roundtable; and International Council of Shopping Centers, joint submitted 

statement .............................................................................................................. 153

Plank, Roger, President, Apache Corporation, submitted statement .................. 123

Rathert, Terry W., Founder, Executive Vice President, and Chief Financial 

Officer, Newfield Exploration Company, submitted statement ........................ 145

Tuesday, September 22, 2009

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

statement .............................................................................................................. 156

Peterson, Hon. Collin C., a Representative in Congress from Minnesota, opening statement ........................................................................................................ 155

WITNESSES

Gensler, Hon. Gary, Chairman, Commodity Futures Trading Commission, 

Washington, D.C. ................................................................................................. 157

Prepared statement .......................................................................................... 159

Schapiro, Hon. Mary L., Chairman, U.S. Securities and Exchange Commission, Washington, D.C. ........................................................................................ 163

Prepared statement .......................................................................................... 165

SUBMITTED MATERIAL

Independent Petroleum Association of America, submitted statement .............. 201

(1)

HEARING TO REVIEW PROPOSED

LEGISLATION BY THE U.S. DEPARTMENT 

OF THE TREASURY REGARDING THE

REGULATION OF OVER-THE-COUNTER 

DERIVATIVES MARKETS 

THURSDAY, SEPTEMBER 17, 2009

HOUSE OF REPRESENTATIVES, COMMITTEE ON AGRICULTURE, Washington, D.C. 

The Committee met, pursuant to call, at 10:34 a.m., in Room 

1300, Longworth House Office Building, Hon. Collin C. Peterson 

[Chairman of the Committee] presiding. 

Members present: Representatives Peterson, Holden, Boswell, 

Scott, Marshall, Herseth Sandlin, Ellsworth, Walz, Kagen, 

Schrader, Dahlkemper, Bright, Kratovil, Schauer, Kissell, Boccieri, 

Murphy, Pomeroy, Minnick, Lucas, Goodlatte, Moran, Neugebauer, 

Schmidt, Smith, Latta, Roe, Luetkemeyer, Thompson, Cassidy, and 

Lummis. 

Staff present: Adam Durand, Scott Kuschmider, Clark Ogilvie, 

James Ryder, Debbie Smith, Tamara Hinton, Kevin Kramp, Josh 

Mathis, Mary Nowak, Nicole Scott, Jamie Mitchell, and Sangina 

Wright. 

OPENING STATEMENT OF HON. COLLIN C. PETERSON, A 

REPRESENTATIVE IN CONGRESS FROM MINNESOTA 

The CHAIRMAN. The Committee will come to order. This hearing 

of the Committee on Agriculture to review proposed legislation by 

the U.S. Department of the Treasury regarding the regulation of 

over-the-counter derivatives markets will come to order. 

I welcome everyone to today’s hearing to review the legislative 

language put forth by the U.S. Department of the Treasury last 

month regarding the regulation of the over-the-counter derivatives. 

We are beginning an important period in our attempts to bring 

much-needed transparency and more effective oversight to our financial markets, particularly for unregulated swaps and derivatives. 

Before the August district work period, House Financial Services 

Committee Chairman Frank and I released a concept paper outlining our shared principles on what over-the-counter derivative 

legislation should entail. We put out the concept paper before August so that Members could have plenty of time to review it, critique it, develop ideas, suggestions, thoughts, and comments in 

preparation of dealing with these issues this fall. 

2

With that said, I hope the Members of this Committee have come 

armed with good questions today for our industry stakeholders. 

Earlier this year, the White House presented broad reform proposals touching many sectors of the financial system. Included in 

those proposals were provisions to regulate the market for over-thecounter derivatives. Our Committee examined these principles in 

July. And when Secretary Geithner appeared before a joint hearing 

with the House Financial Services Committee, we heard their general views at that time. Secretary Geithner’s testimony that day 

was informative, and I was encouraged by his willingness to work 

with our two Committees in a bipartisan manner as we move forward. 

Following Secretary Geithner’s appearance, Treasury has filled 

in some of the blanks on their regulatory reform principles with 

legislative language. And that is the subject of today’s hearing. 

I am pleased to note that several of Treasury’s proposals are 

similar in concept to legislation that our Committee has already 

passed this year, including mandatory clearing of all standardized 

over-the-counter products and setting capital and margin requirements for dealers. 

Treasury’s language expands on some of these principles, and 

while I do have some outstanding concerns, such as the fair treatment for end-users in any regulatory overhaul, I think their ideas 

represent a decent beginning in the debate over legislation that 

gives the American people the confidence that our markets are 

being overseen and monitored by strong, effective regulators. 

This morning, we will hear from two panels of industry stakeholders representing exchanges, traders, and end-users. Next week, 

Commodity Futures Trading Commission Chairman Gary Gensler 

will appear before the Committee for the first time, and he will be 

joined by Securities and Exchange Commission Chairman Mary 

Schapiro. 

I look forward to hearing today’s witnesses give their thoughts 

on the central clearing model for OTC derivatives, along with 

issues like OTC product standardization, dealer regulation, and 

their thoughts on joint rulemaking between agencies of jurisdiction. 

Again, I thank today’s witnesses for being here. I look forward 

to their testimony. 

[The prepared statement of Mr. Peterson follows:]

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

CONGRESS FROM MINNESOTA

Good morning, and welcome to today’s hearing to review legislative language put 

forth by the U.S. Department of the Treasury last month regarding the regulation 

of over-the-counter derivatives. 

We are beginning an important period in our attempts to bring much-needed 

transparency and more effective oversight of our financial markets, particularly for 

unregulated swaps and derivatives. 

Before the August District Work Period, House Financial Services Committee 

Chairman Frank and I released a concept paper outlining our shared principles on 

what over-the-counter derivative legislation should entail. 

We put out the concept paper before August so that Members could have plenty 

of time to review it, critique it and develop ideas, suggestions, thoughts and comments in preparation of dealing with these issues this fall. With that said, I hope 

the Members of this Committee have come armed with some good questions today 

for our industry stakeholders. 

3

Earlier this year, the White House presented broad reform proposals touching 

many sectors of the financial system. 

Included in those proposals were provisions to regulate the market for over-thecounter derivatives. Our Committee examined these principles in July, when Secretary Geithner appeared before a joint hearing with the House Financial Services 

Committee. 

Secretary Geithner’s testimony that day was informative, and I was encouraged 

by his willingness to work with our two Committees in a bipartisan manner as we 

move forward. Following Secretary Geithner’s appearance, Treasury has filled in 

some of the blanks on their regulatory reform principles with legislative language, 

and that is the subject of today’s hearing. 

I am pleased to note that several of Treasury’s proposals are similar in concept 

to legislation that our Committee has already passed this year, including mandated 

clearing of all standardized over-the-counter products, and setting capital and margin requirements for dealers. Treasury’s language expands on some of these principles; and while I do have some outstanding concerns, such as the fair treatment 

for end-users in any regulatory overhaul, I think their ideas represents a decent beginning in the debate over legislation that gives the American people the confidence 

that our markets are being overseen and monitored by strong, effective regulators. 

This morning we will hear from a two panels of industry stakeholders representing exchanges, traders, and end-users. Next week, Commodity Futures Trading Commission Chairman Gary Gensler will appear before this Committee for the 

first time, and he will be joined by Securities and Exchange Commission Chairman 

Mary Schapiro. I look forward to hearing today’s witnesses give their thoughts on 

the central clearing model for OTC derivatives, along with issues like OTC product 

standardization, dealer regulation, and their thoughts on joint rulemaking between 

the agencies of jurisdiction. 

I thank today’s witnesses for being here and I look forward to their testimony. 

At this time, I would like to yield to my friend and colleague from Oklahoma, the 

Ranking Member of the Committee, Mr. Lucas, for his opening statement.

The CHAIRMAN. And, at this time, I would like to yield to my 

friend and colleague from Oklahoma, the Ranking Member of the 

Committee, Mr. Lucas, for an opening statement. 

OPENING STATEMENT OF HON. FRANK D. LUCAS, A 

REPRESENTATIVE IN CONGRESS FROM OKLAHOMA 

Mr. LUCAS. Thank you, Mr. Chairman. And I want to thank you 

for calling this series of important and timely hearings on the Administration’s proposal to regulate the over-the-counter derivatives 

market. 

I congratulate the Chairman on both the structure of the hearings and on the diverse and highly impacted list of witnesses. I 

hope they will be able to answer some of the many questions I, and 

my colleagues on the Committee, will have about the August 11 

proposal. 

At a time when all of America is being cost-conscious, the Administration, once again, proves perhaps they don’t quite get that. Regardless of whether you think the economy is improving or not, the 

Administration’s proposal to regulate the over-the-counter derivatives markets will do nothing but increase costs. 

The Administration’s proposals pile more regulations and requirements on legitimate business activity—activity that is aimed 

at controlling cost and managing risks. The increase in regulation 

will increase the cost of doing business, and that increase will be 

passed along to consumers. 

With all of the focus on unlocking the credit markets, this proposal, in my opinion, goes in the wrong direction. It takes capital—

capital that otherwise would be used for research and development, 

payroll, and other employee benefits—and parks it over at a clearinghouse where it will collect dust. 

4

I am concerned that the increase in cost will reduce, if not eliminate, the risk-management activity, which would only translate 

into higher price and volatility for consumers. Those businesses 

that decide that the new regulatory regime is too costly will go 

without mitigating the risk or move its very legitimate and necessary over-the-counter financial activities out of the country. In either scenario, the government loses any ability to oversee the activity, and we lose more jobs. 

Why do we need the requirement to move transactions into regulated exchanges? Where is the systematic risk that this proposal is 

solving? Why do we need to go beyond increasing transparency to 

government regulators? Instead of mandates and prohibitions, we 

should encourage people to trade and clear in healthy, liquid, 

American markets. 

Mr. Chairman, over the next few days, I hope to learn the answers to some of these questions. I look forward to hearing our witnesses today, and I thank you very much for calling this series of 

hearings. 

The CHAIRMAN. I thank the gentleman. 

And when this whole system collapses again, I hope people will 

remember the statement, because I am afraid we are heading in 

the same direction. 

So, anyway, I want to recognize John Riley, who left our Committee, went over to the CFTC. I don’t think we have publicly recognized him. Where is John? There he is. 

[Applause.] 

The CHAIRMAN. We miss him. He did a great job for many, many 

years on the Committee, and he is doing good work now over at 

the CFTC. And we look forward to working together with that 

agency as we move forward. 

We welcome the witnesses to the Committee. Our first panel of 

witnesses: Mr. Jon Hixson, the Director of Federal Government relations for Cargill; Hon. Glenn English, President of the NRECA 

and a former distinguished Member of this Committee and Subcommittee Chairman, who has worked on these issues for a long 

time when he was here; Mr. Dave Schryver, Executive Vice President of the American Public Gas Association; and Mr. Ben Hirst, 

the Senior Vice President and General Counsel for Delta Air Lines. 

So welcome, all, to the Committee. Thank you for making yourself available. 

And, Mr. Hixson, you can begin. 

Your full statements will be made part of the record, and feel 

free to summarize. We are going to try to limit the testimony to 

5 minutes so we will have time for questions. 

STATEMENT OF JON HIXSON, DIRECTOR OF FEDERAL

GOVERNMENT RELATIONS, CARGILL, INCORPORATED, 

WASHINGTON, D.C. 

Mr. HIXSON. Thank you, Mr. Chairman. My name is John Hixson, Director of Federal Government Relations at Cargill. I am testifying on behalf of Cargill, Incorporated, and I thank the Committee for the opportunity to testify today. 

Cargill previously testified before this Committee, in February of 

this year, calling for better reporting and transparency as well as 

5

enforceable position limits. We continue to support those views and 

appreciate the opportunity to discuss the Treasury Department’s 

proposal today. 

Cargill is an extensive end-user of derivatives on both regulated 

exchanges as well as the over-the-counter markets. Cargill’s activity in offering risk-management products and services to commercial customers and producers in the agriculture and energy markets can be highlighted with the following OTC examples: 

We offer customized hedges to help bakeries manage the price 

volatility of their flour so that their retail prices for baked goods 

can be as stable as possible. We issue critical hedges to help regional New England heating oil distributors manage price spikes 

and volatility on their purchases so they can offer families stable 

prices throughout the winter season. And we offer customized 

hedges to help a restaurant chain maintain stable prices on chicken so the company can offer consistent prices and value to their retail customers when selling chicken sandwiches. 

Under the Treasury Department’s proposal, it is highly likely 

that Cargill would be forced to greatly reduce, if not eliminate, offering our customers risk-management solutions like those described above. Under the proposal, the risk-management products 

that would remain in the market would dramatically increase in 

borrowing and working capital required for hedging. As a result, 

we expect prudent hedging of commodity, interest rate, and foreign 

exchange risk by end-users to decline significantly. With less hedging, end-users will be faced with more price risk exposure and volatility. 

We support the objectives of the Treasury Department’s proposal, 

which includes a recognition that traditional end-user hedging in 

the OTC markets can and should occur. However, we are concerned 

that several of the restrictions in the legislation could have many 

negative unintended consequences. 

Hedging is a valuable activity that is backed by an offsetting position. Such hedging does not create systemic risk and should be 

exempted from mandatory margining and clearing requirements. 

The Treasury Department’s proposal includes language to define legitimate hedging and exempt it. We support this view. 

However, the definition and available exemptions need to be 

clarified. The exemption from clearing should not be linked to the 

eligibility requirements set by a clearing organization. This would 

help avoid a conflict of interest. The exemption for margining 

should recognize the inherently balanced nature of hedges; for example, the offsetting position. 

We recommend that hedges recognized under the exemption 

meet a common sense definition. For example, that definition could 

include a three-part test like improved documentation, better 

transparency, and a measure to ensure the effectiveness of the 

hedge. The exemption should not be tied to accounting practices, 

which may not always account for bona fide hedging activity such 

as hedge on a physical commodity. In addition, the definition of the 

term major swap participant should be structured to exempt entities seeking to maintain an effective hedge. 

The Treasury proposal calls for higher capital charges for OTC 

products that are not cleared. In addition, the bill calls for capital 

6

and margin requirements for non-bank dealers that could be higher 

than for bank dealers. This requirement could make non-bank 

dealers uncompetitive against bank dealers. Non-bank dealers who 

are involved in hedging transactions have an important role to play 

in serving customers in many commodity markets. No non-bank 

dealer in the commodities markets required a taxpayer bailout or 

caused systemic risk due to offering commodity hedging products 

for their customers. 

We recommend that the transparency and market oversight proposals move forward, but that the regulatory agencies study this 

segment of the market prior to developing appropriate capital and 

regulatory guidelines. 

Much has happened in the last 18 months across the financial 

and commodities markets. The U.S. Treasury Department’s proposal calls for improved regulation, accountability, and transparency that will be helpful in preventing the build-up of systemic 

risk and allowing regulators to appropriately monitor speculative 

activity. However, actions that dramatically increase the cost of 

managing risk may ultimately have the unintended consequence of 

deterring prudent hedging. This could leave U.S. businesses overexposed to volatile market conditions. 

We appreciate the opportunity to testify before the Committee 

and look forward to working with you as this legislation continues 

to develop. Thank you. 

[The prepared statement of Mr. Hixson follows:]

PREPARED STATEMENT OF JON HIXSON, DIRECTOR OF FEDERAL GOVERNMENT

RELATIONS, CARGILL, INCORPORATED, WASHINGTON, D.C. 

My name is Jon Hixson, Director of Federal Government Relations at Cargill. I 

am testifying on behalf of Cargill, Incorporated and want to thank you for the opportunity to testify. 

Cargill is an international provider of food, agricultural, and risk management 

products and services. As a merchandiser and processor of commodities, the company relies heavily upon efficient, competitive, and well-functioning futures markets 

and over-the-counter (OTC) markets. 

Cargill is an extensive end-user of derivatives products on both regulated exchanges and in OTC markets, and is also active in offering risk management products and services to commercial customers and producers in the agriculture and energy markets. 

Examples of OTC Products 

Cargill’s activity in offering risk management products and services to commercial 

customers and producers in the agriculture and energy markets can be highlighted 

with the following OTC examples:

—Customized hedges to help bakeries manage price volatility, so that their retail 

prices for baked goods can be as stable as possible for consumers and grocery 

stores.

—Hedges to help regional New England heating oil distributors avoid price spikes 

and volatility, so that they can offer individual households stable prices 

throughout the winter season.

—Customized hedges to help a restaurant chain receive stable prices on chicken, 

so that the company can offer consistent prices and value for their retail customers when selling chicken sandwiches.

Under the Treasury Department’s proposal, it is highly likely that Cargill would 

be forced to greatly reduce, if not eliminate, offering our customers the risk management solutions described above. Under the proposal, the risk management products 

that would remain in the market would dramatically increase the borrowing and 

working capital required for hedging. 

7

In addition, we would expect prudent hedging to decline significantly in those situations where Cargill, like other end-users, manages its own commodity, interest 

rate, and foreign exchange risks, due to the imposition of mandatory margining and 

the drain on working capital. With less hedging, end-users will be faced with more 

price risk exposure and volatility. 

We appreciate the Treasury Department’s proposal and continue to support its 

stated objectives. The proposal includes recognition that traditional end-user hedging in the OTC markets can and should occur. However, we are concerned that several of the restrictions in the legislation could have many unintended negative consequences. 

Exceptions to Central Clearing and Margining Need to Be Clearly Defined 

Exceptions to clearing and margining requirements need to be clearly defined for 

hedgers. Hedging is a valuable economic activity which is backed by an offsetting 

position. Such hedging does not create systemic risk and should be exempted from 

the mandatory margining and clearing requirements. The Treasury Department’s 

proposal includes language to define legitimate hedging activity and to exempt it 

from certain requirements. However, this definition and available exemptions need 

to be clarified.

—The exemption from clearing should not be linked to the eligibility requirements 

set by the clearing organization. This would help avoid a conflict of interest.

—The exemption from margining should recognize the inherently balanced nature 

of hedges, i.e., the offsetting position, and should include an exemption for this 

category of end-users.

» The exemption should not be tied to accounting practices, which may not always account for bona fide hedging activity.

» Effective guidelines that improve documentation, transparency and ensure 

hedge effectiveness can be established as an appropriate alternative in defining this exemption.

—The definition of the term Major Swap Participant should be structured to exempt entities seeking to maintain an effective hedge. 

Capital Charges and Treatment of Non-Bank Dealers 

The proposed legislation calls for higher capital charges for OTC products that are 

not cleared by a registered derivatives clearing organization than those applicable 

to swaps that are centrally cleared. In addition, the bill calls for capital and margin 

requirements for non-bank dealers that could be higher than for bank dealers. This 

action could make non-bank dealers uncompetitive against bank dealers and is without sound justification for this disparate treatment.

—Non-bank dealers who are involved in hedging transactions have an important 

role to play in serving customers in many commodity markets. Since no such 

non-bank dealer in the commodities markets required a taxpayer bailout or 

caused systemic risk due to offering commodity hedging products to their customers, we recommend that the transparency and oversight proposals move forward, but that regulatory agencies study this segment of the market and develop capital and regulatory guidelines only to the extent appropriate for this 

type of hedging transaction.

Cargill has previously testified this year before the House Agriculture Committee, 

calling for better reporting and transparency, as well as enforceable position limits. 

We continue to support those views, and would like to call to the Committee’s attention a few regulatory steps taken in this area since we last testified.

—Commitments of Traders (COT) Report—On September 4, 2009, the Commodity 

Futures Trading Commission (CFTC) issued its first new COT that covers the 

major agriculture and energy contracts. The COT reports currently break traders into two broad categories: commercial and noncommercial. The new reports 

will break the data into four categories of traders: Producer/Merchant/Processor/

User; Swap Dealers; Managed Money; and Other Reportables.

—OTC Reporting and Transparency—The CFTC continues to collect data on OTC 

transactions through its Special Call authority. The CFTC will begin publishing 

this data, which highlights index fund activity, on a quarterly basis with a goal 

of eventually releasing this data on a monthly basis. 

Conclusion 

Much has happened in the last 18 months across the financial and commodities 

markets. The U.S. Treasury Department’s proposal calls for improved regulation, acVerDate 0ct 09 2002 11:29 Nov 04, 2009 Jkt 041481 PO 00000 Frm 00011 Fmt 6633 Sfmt 6621 I:\DOCS\111-29\53020.TXT AGR1 PsN: BRIAN
8

countability, and transparency that will be helpful in preventing the build-up of systemic risk and allowing regulators to appropriately monitor speculative activity. 

However, it is critically important that Congress and regulators take actions that 

focus on the areas of concern, while encouraging prudent risk management. 

Actions that dramatically increase the cost of managing risk may ultimately have 

the unintended consequence of deterring prudent hedging, and leaving U.S. businesses over-exposed to volatile market conditions. 

We appreciate the opportunity to testify before the Committee, appreciate the 

work of the Chairman, the Ranking Member, and all Members of this Committee, 

and look forward to working together as this legislation continues to develop. 

Thank you.

The CHAIRMAN. Thank you, Mr. Hixson. 

Mr. English, welcome to the Committee. 

STATEMENT OF HON. GLENN ENGLISH, CEO, NATIONAL 

RURAL ELECTRIC COOPERATIVES ASSOCIATION,

WASHINGTON, D.C. 

Mr. ENGLISH. Thank you very much, Mr. Chairman. I appreciate 

it. And, certainly, it is a pleasure to be back in the Committee and 

have an opportunity to testify on this issue. Thanks for inviting us. 

I am Glenn English, Chief Executive Officer of the National 

Rural Electric Cooperatives Association. And, as I think most of 

you know, we are a not-for-profit, owned by our membership, consumer-owned. And while we serve about 12 percent of the population of the country, some 42 million people, those people are scattered out over 70 percent of the land mass of the United States. 

We maintain about 42 percent of the infrastructure of this country. 

And so, as we look at the particular issue that we have before 

us, Mr. Chairman, I am sure some of the Members of the Committee are probably wondering what in the world we are doing 

here. This is a little different situation than they normally find us 

being engaged and involved in. 

But what it really comes down to is that hedging is becoming a 

much more important factor for us in managing risk for our memberships. And this world is becoming a good deal riskier, as you 

deal with any kind of production of energy and power, and as we 

move forward in dealing with the challenges of climate change. 

And whether it is coming through the Clean Air Act in the EPA 

or whether it is through legislation that passes the Congress, either way, it is going to be more costly and more risky. And hedging 

is going to play an even more important role, as we move forward 

in the future, in trying to maintain those risks, trying to keep 

those electric bills down and as affordable as we can possibly keep 

them. 

Now, we have, in the past, been engaged from time to time 

through a couple of organizations that we have to manage risk for 

electric cooperatives, most of it on the fuel side through the Alliance of Cooperative Energy Services Power Marketing, known as 

ACES Power Marketing. That is a group that we established and 

electric cooperatives own, and many of our generation and transmission organizations participate, and even some of the distribution cooperatives participate through this organization. And also 

through financing to help meet the financial needs of electric cooperatives through the National Rural Utilities Cooperative Finance Corporation; this is one that we use in conjunction with the 

Rural Utilities Service. So this helps us meet the infrastructure 

9

needs. Both of those organizations use hedging to a great extent to 

try to minimize the risks that they are facing. 

Now, the Treasury Department’s proposal, while the thrust of 

the effort we don’t really have an objection to, the problem we come 

down to is the cost and what it is going to mean as far as electric 

bills. The point that I am trying to make here, Mr. Chairman, is 

we kind of find ourselves between a rock and a hard spot on this 

particular issue. 

You know, we have no problem as far as additional scrutiny is 

concerned. We want to see transactions being open and clear. We 

want to see efforts made to deal with any kind of manipulation 

that might be ongoing. But, as we deal with this, we find ourselves 

in kind of a difficult situation from the standpoint that we are very 

small, and much of this is focused and addressed toward big traders with a lot of money. And we just don’t have that many trades, 

and we are not of that size or that magnitude. 

Now, as far as trading on the exchanges themselves, of course, 

we do have some trades that we do on exchanges. But, quite frankly, when you come to the issue of margins and having margin calls, 

that requires a huge amount of money. Now, most of you are familiar with your electric cooperatives back home. You don’t have that 

kind of resources; you don’t have that kind of money. We have equity, but we certainly don’t have the cash on hand. 

And so, as you move forward looking at issues like natural gas 

and other fuels, dealing with issues like carbon, if you get into the 

issue of carbon being traded on the exchanges, that becomes a 

much more expensive proposition for us, requiring a good deal of 

money. And that means we will have to go out and borrow that 

money. And that means that we have to show that cost. That cost 

will be reflected, then, as far as electric bills for the membership, 

for your constituents. 

And that is where our problem is with this particular issue. So, 

as we move forward here, we are hopeful, Mr. Chairman, that the 

Committee will search for a way for people like us, who need increasingly to hedge—legitimate hedges, not speculation, but legitimate hedges—that we can do that in such a way that we can keep 

the costs down, that we are not subject to the volatility of the marketplace as far as margin calls are concerned, as it affects people 

like us. 

And, if we can do that, that means that we can, obviously, continue to protect your constituents and protect their electric bills, 

and help minimize what we think are going to be increases, in 

some cases substantial increases, in electric bills. 

So, Mr. Chairman, I want to thank you again for having us here 

and giving us the opportunity to talk about this. I hope that we 

will come back and focus a little bit on making sure that folks that 

are not big traders, but, instead, have a need for a market, whether 

it is through the derivatives, through over-the-counter markets, or 

whether it comes back through the exchanges, that we can have a 

way in which we can do that affordably, and that whatever legislation moves forward from this body is one that takes that into account and continues to make that possible. Because that will make 

a big difference in electric bills for the future, as far as members 

of electric cooperatives and, I suggest, other utilities as well. 

10

Thank you, Mr. Chairman. 

[The prepared statement of Mr. English follows:]

PREPARED STATEMENT OF HON. GLENN ENGLISH, CEO, NATIONAL RURAL ELECTRIC

COOPERATIVES ASSOCIATION, WASHINGTON, D.C. 

Mr. Chairman, Ranking Member Lucas and Members of the Committee, thank 

you for inviting me to discuss the perspective of electric cooperatives regarding the 

U.S. Department of the Treasury’s proposal to regulate the over-the-counter (OTC) 

derivatives market. The National Rural Electric Cooperative Association (NRECA) 

is the not-for-profit, national service organization representing nearly 930 not-forprofit, member-owned, rural electric cooperative systems, 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. 

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 

most 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 in this 

very Committee. Accordingly, I am grateful for your leadership, in pursuing the reforms necessary to increase transparency and prevent manipulation in this marketplace. 

From the viewpoint of the rural electric cooperatives, the U.S. Department of the 

Treasury’s proposal to regulate the $600 trillion over-the-counter (OTC) derivatives 

market can be boiled down to a single, simple concern that I know you have heard 

me articulate before: affordability. 

NRECA’s electric cooperative members, primarily generation and transmission 

members need predictability in the purchase price for their inputs if they are to provide stable, affordable prices to their customers. Rural electric cooperatives use derivatives to keep costs down by reducing the risks associated with both volatile energy prices and financial transaction costs. It is important to understand that electric co-ops are engaged in activities that are pure hedging, or risk management. We 

DO NOT use derivatives for other purposes. We are in a difficult situation, but OTC 

derivatives are currently the best tool we have to manage risk. 

Most of our hedges are bilateral trades on the OTC market. Many of these trades 

are made through a risk management provider called the Alliance for Cooperative 

Energy Services Power Marketing or ACES Power Marketing, which was founded 

a decade ago by many of the electric co-ops that still own this business today. 

Through ACES, our folks make sure that the counterparty taking the other side of 

a hedge is financially strong and secure. 

Half of the electric cooperatives’ finance needs are met by private cooperative 

lenders, including the National Rural Utilities Cooperative Finance Corporation 

(CFC). Derivatives, specifically interest rate and currency swaps, are an important 

asset/liability management tool for cooperative lenders. As a cooperative lender, 

CFC is not a broker or dealer, nor does it invest in derivatives for trading or speculative purposes. It uses derivatives to manage currency and interest rate risk, and 

thereby affords our electric cooperative borrowers more loan options. 

While hedges are necessary for electric co-ops, they pose risks. If a counterparty 

does not pay up, there will be severe consequences for our members, so we are extremely careful about who we trade with and for how much. Our consumers expect 

stable, affordable electricity prices, and electric suppliers need the OTC markets to 

manage the price volatility risk for our consumer-owners. 

Even though the financial stakes are serious for us, rural electric co-ops are not 

big participants in the derivatives markets. I mentioned earlier that this market is 

estimated at $600 trillion. Our members have a fraction of that sum at stake and 

are simply looking for an affordable way to hedge. Because many of our co-op members are so small, legislative changes that would dramatically increase the cost of 

hedging or prevent us from hedging all-together will impose a real burden. 

11

Electric cooperatives are owned by their consumers. Those very consumers expect 

us, on their behalf, to protect them against volatility in the energy markets that can 

jeopardize small businesses and adversely impact the family budget. The 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. 

Our primary concern with the Treasury Department’s proposal is that it would 

require most of our transactions to be cleared since our natural gas trades likely 

would be considered ‘‘standardized’’. And, before going further, I want to remind you 

that we are NOT looking to hedge in an unregulated market. NRECA DOES want 

derivatives markets to be transparent and free of manipulation. The problem is that 

requiring all derivatives contracts to clear is just not affordable for most co-ops. 

That is because the initial and the ‘‘working’’ or ‘‘variance’’ margin we would have 

to provide would make hedging untenable for many of our members—we would have 

to come up with hundreds-of-millions of dollars in cash that we just do not have 

on hand. 

In general, co-ops are capital constrained due to other capital demands, such as 

building new generation and transmission infrastructure to meet load growth, installing equipment to comply with clean air standards, and maintaining fuel supply 

inventories, not to mention the fact that as member-owned cooperatives, we cannot 

go to the equity markets for additional resources. Maintaining 42% of the nation’s 

electrical distribution lines requires considerable and continuous investment. 

We have the same concern with Treasury’s proposal to require higher capital and 

margin requirements for non-standard products that are not cleared; it comes back 

to the need for predictable affordability. 

Clearing also presents a significant potential predictability issue. In case of a catastrophic event, the marketplace could change dramatically in a very short timeframe. If a catastrophic event triggered market concern over fuel supplies, ratings 

could shift and the prices for contracts could swing dramatically, triggering a sizable 

margin call for a reason unrelated to the original trade. A co-op in that position 

would not have the cash reserve to cover the margin call, leaving only one, unattractive option—to borrow a large sum at unaffordable rates. 

Rural electric cooperatives do trade on exchange (and thus have some trades 

cleared) when we can. Electric cooperatives customarily have a couple thousand 

trades at any given time on NYMEX, but due to the working margin requirements 

associated with clearing, most of our trades are made on the OTC market. We don’t 

like this situation, but we feel pushed into hedging on the OTC market by the cost. 

We would like to be able to trade everything on an exchange or go through a clearinghouse, but many of our members just cannot afford it. 

Another concern with the Treasury Department’s proposal is that for the electric 

power supply and natural gas business engaged in trading actual electricity or natural gas, the exemption for any transaction that is ‘‘physically settled’’ requires further clarification to exempt transactions already regulated by the Federal Energy 

Regulatory Commission (FERC), such as virtual bidding in day-ahead markets or 

the purchase or sale of Financial Transmission Rights, market capacity, and similar 

products in the organized markets. Importantly, many bilateral physical electric and 

natural gas transactions are ‘‘booked-out’’ before delivery, for physical scheduling efficiencies. These ‘‘booked out’’ transactions which are already regulated by FERC 

should not be subject to additional regulation. Absent this clarification, the proposal 

could accidently put such transactions within the domain of derivatives regulation. 

Mr. Chairman, at the end of the day, we are looking for a legitimate, transparent, 

predictable, and affordable device with which to hedge. I know there are many ideas 

under consideration, but regardless of what specific solution is arrived at, I know 

that you and your Committee are working hard to ensure these markets function 

effectively. The rural electric co-ops just hope that at the end of the day, there is 

a way for the little guy to effectively manage risk. 

Thank you.

The CHAIRMAN. Thank you very much, Mr. English. Appreciate 

it. 

Mr. Schryver, welcome to the Committee. 

STATEMENT OF DAVID SCHRYVER, EXECUTIVE VICE

PRESIDENT, AMERICAN PUBLIC GAS ASSOCIATION,

WASHINGTON, D.C. 

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

Members of the Committee, I appreciate this opportunity to testify 

12

before you today, and I thank the Committee for calling this important hearing. 

My name is Dave Schryver, and I am the Executive Vice President for the American Public Gas Association. APGA is the national association for publicly owned, not-for-profit natural gas retail distribution systems. There are approximately 1,000 public gas 

systems in 36 states, and over 720 of these are APGA members. 

APGA’s number-one priority is the safe and reliable delivery of 

affordable natural gas. If we are to fully utilize natural gas at longterm affordable levels, we ultimately need to increase the supply 

of natural gas. 

However, equally critical is to restore public confidence in the 

pricing of natural gas. This requires a level of transparency in natural gas markets which assures consumers that market prices are 

a result of fundamental supply and demand forces, and not the result of manipulation or other market abuses. 

Public gas systems depend upon both the physical commodity 

markets, as well as the markets in OTC derivatives, to meet the 

natural gas needs of their consumers. Together, these markets play 

a critical role in these utilities’ securing natural gas supplies at 

stable prices for their communities. 

APGA believes that the provisions relating to the unregulated 

energy trading platforms contained in the CFTC Reauthorization 

Act passed last Congress was, and is, a critically important step in 

addressing our concerns. And we commend this Committee for its 

work on the Reauthorization Act. 

In addition, the CFTC, under the leadership of Chairman 

Gensler, has taken many significant steps to address the concerns 

raised by APGA through exercising their new authority provided 

under the Reauthorization Act and using its existing administrative authority. 

However, APGA believes that significant regulatory gap still exists with respect to the over-the-counter markets and that Congress 

should provide the CFTC with additional statutory authorities to 

enhance transparency, limit excessively large speculative positions, 

and help prevent abuses in the markets for natural gas. 

The proposed legislation by the Department of the Treasury offers Congress a constructive basis for addressing many of the 

issues that remain open following enactment of the CFTC Reauthorization Act. APGA strongly supports many of the provisions 

suggested by the Treasury proposal, particularly those relating to 

the reporting of large positions and OTC transactions that serve a 

significant price discovery function. APGA believes that these regulatory tools to enhance transparency, and to limit excessively large 

speculative positions, are a critically important step in effectively 

addressing consumers’ concerns. 

APGA also supports the Treasury proposal’s nuanced approach to 

the mandated clearing of OTC contracts with certain clarifications 

to the exemption. We are concerned that certain recommendations 

to this Committee to require mandatory clearing of all standardized transactions would have serious negative consequences to public gas systems. 

Public gas systems purchase firm supplies in the physical delivery market at prevailing market prices and enter into OTC derivaVerDate 0ct 09 2002 11:29 Nov 04, 2009 Jkt 041481 PO 00000 Frm 00016 Fmt 6633 Sfmt 6601 I:\DOCS\111-29\53020.TXT AGR1 PsN: BRIAN
13

tive agreements customized to meet their specific needs, reduce 

their consumers’ exposure to future market price fluctuations, and 

stabilize rates. 

By using both markets, public gas systems are able to purchase 

firm deliveries of natural gas from a diverse set of suppliers, while 

hedging the risk of future market price fluctuations. Proposals that 

would require all standardized OTC transactions to be cleared 

would significantly impair the ability of public gas systems to engage in these gas supply strategies. 

Under current practices in the OTC markets, many public gas 

systems are not required to pledge collateral for transactions below 

agreed-upon levels based upon their very high credit-worthiness. In 

contrast, the mandated clearing of all OTC transactions would require public gas systems to post initial margin for all transactions 

and to meet potential margin calls whenever required and on little 

notice. This would constitute a significant financial and operational 

burden on these systems, their communities, and their consumers. 

It has been suggested that the clearing requirements would be 

less burdensome if some end-users are given the option of posting 

noncash collateral. Unfortunately, the alternative of using noncash 

collateral would not provide any relief to public gas systems. 

Noncash collateral would entail the deposit of liquid assets, and 

public gas systems simply do not maintain liquid assets in a quantity necessary to meet the requirements associated with clearing. 

APGA understands that provisions that require the clearing of 

all OTC transactions are intended to address issues related to systemic risk. However, the hedging of natural gas supply purchases 

by public gas systems using noncleared bilateral OTC derivatives 

do not present systemic risk to the market. In addition, a proposed 

mandate to clear all standardized OTC derivatives transactions 

would increase costs for public gas systems and their municipalities, an increase which would be borne 100 percent by their consumers. 

It is critical that the nation’s regulators have the tools that they 

need to detect and deter market abuses. APGA believes that the 

Treasury proposal provides this Committee with a very good foundation for achieving those goals. And we look forward to working 

with the Committee towards the passage of legislation that 

strengthens consumer confidence in the integrity of the markets’ 

price discovery mechanism. 

Thank you. 

[The prepared statement of Mr. Schryver follows:]

PREPARED STATEMENT OF DAVID SCHRYVER, EXECUTIVE VICE PRESIDENT, AMERICAN

PUBLIC GAS ASSOCIATION, WASHINGTON, D.C. 

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

appreciate this opportunity to testify before you today and I thank the Committee 

for calling this hearing to review proposed legislation by the U.S. Department of the 

Treasury regarding the regulation of over-the-counter derivatives markets. My name 

is Dave Schryver and I am the Executive Vice President for the American Public 

Gas Association (APGA). 

I testify today on behalf of the APGA. APGA is the national association for publicly-owned natural gas distribution systems. There are approximately 1,000 public 

gas systems in 36 states and over 720 of these systems are APGA members. Publicly-owned gas systems are not-for-profit, retail distribution entities owned by, and 

accountable to, the citizens they serve. They include municipal gas distribution sysVerDate 0ct 09 2002 11:29 Nov 04, 2009 Jkt 041481 PO 00000 Frm 00017 Fmt 6633 Sfmt 6621 I:\DOCS\111-29\53020.TXT AGR1 PsN: BRIAN
14

1Food, Conservation, and Energy Act of 2008, P.L. 110–246, 122 Stat. 2189, Title XIII. 

2See ‘‘Order Finding That the ICE Henry Financial LD1 Fixed Price Contract Traded on the 

Intercontinental Exchange, Inc., Performs a Significant Price Discovery Function,’’ 74 Fed. Reg.

37988 (July 30, 2009). 

tems, public utility districts, county districts, and other public agencies that have 

natural gas distribution facilities. 

APGA’s number one priority is the safe and reliable delivery of affordable natural 

gas. If we are to fully utilize clean domestically produced natural gas at long-term 

affordable prices, we ultimately need to increase the supply of natural gas. However, 

equally critical is to restore public confidence in the pricing of natural gas. This requires a level of transparency in natural gas markets which assures consumers that 

market prices are a result of fundamental supply and demand forces and not the 

result of manipulation, other abusive market conduct or excessive speculation. 

Over the past several years, and leading up to the passage of the Reauthorization 

Act, APGA has sounded the alarm with respect to the need for greater oversight 

and transparency of the over-the-counter markets (‘‘OTC’’) in financial contracts in 

natural gas. APGA previously testified before this Committee that APGA’s members 

have lost confidence that the prices for natural gas in the futures and the economically linked OTC markets are an accurate reflection of supply and demand conditions for natural gas. APGA further testified that restoring trust in the validity of 

the pricing in these markets requires a level of transparency in natural gas markets 

which assures consumers that market prices are a result of fundamental supply and 

demand forces and not the result of manipulation, excessive speculation or other 

abusive market conduct. APGA therefore strongly supported an increase in the level 

of transparency with respect to trading activity in these markets. For this reason, 

APGA strongly supported the recent enactment of the CFTC Reauthorization Act of 

2008.1

The Reauthorization Act 

APGA believes that the increased regulatory, reporting and self-regulatory provisions relating to the unregulated energy trading platforms contained in the CFTC 

Reauthorization Act of 2008 was, and is, a critically important step in addressing 

our concerns. We commend this Committee for its work on the Reauthorization Act. 

The market transparency language that was included in the Reauthorization Act 

will help shed light on whether market prices in significant price discovery energy 

contracts are responding to legitimate forces of supply and demand or to other, nonbona fide market forces. 

APGA notes that the CFTC, under the leadership of Chairman Gensler, has taken 

many significant steps to address the concerns raised by APGA, exercising the new 

authority provided under the Reauthorization Act and its existing administrative 

authority under the Act. For example, the CFTC has exercised the authority given 

it in the Reauthorization Act, finding that the LD1 natural gas contract traded on 

the Intercontinental Exchange, Inc. is a significant price discovery contract 2 and is 

thereby subject to the enhanced regulatory requirements of the Reauthorization Act. 

It also is providing enhanced transparency through its Commitment of Traders Report and is using its special call reporting authority aggressively in connection with 

OTC contracts. In addition, the CFTC has formed and continues to seek advice of 

an energy markets advisory committee. Many of these steps were first recommended 

by APGA. APGA believes that all of these enhancements have been important steps 

in addressing the problems faced by the markets in natural gas. 

The Treasury Proposal on Regulating OTC Derivatives 

However, we have also noted to the Committee in prior testimony that we believed that it was likely that it would be necessary for Congress to provide the 

CFTC with additional statutory authorities to respond fully and effectively to the 

issues raised by trading in the energy markets. We have expressed the view to Congress that additional transparency measures with respect to transactions in the 

OTC markets are needed to enable the cop on the beat to assemble a full picture 

of a trader’s position and thereby understand a large trader’s potential impact on 

the market. 

APGA believes that the proposed legislation by the U.S. Department of the Treasury, the ‘‘Over-the-Counter Derivatives Markets Act of 2009,’’ (‘‘Treasury Proposal’’), 

offers Congress a constructive basis for addressing many of the issues that remain 

open following enactment of the Reauthorization Act. Accordingly, APGA supports 

fully many of the provisions suggested by the Treasury Proposal, particularly those 

relating to reporting of large positions in OTC transactions and the application of 

speculative position limits to such contracts. APGA believes that these regulatory 

15

tools to enhance transparency, and to limit excessively large speculative positions, 

are a critically important step in effectively and fully addressing the issue we have 

raised with respect to pricing anomalies in the natural gas market. APGA also supports the Treasury Proposal’s nuanced approach to mandated clearing of OTC contracts. At the same time, we note that certain recommendations to this Committee 

with respect to mandatory clearing of all transactions would have serious, negative 

consequences to our members. We will address each of these issues in turn. 

The Treasury Proposal seeks to apply a regulatory framework to trading in OTC 

swaps. Many public gas systems use both or either the OTC derivatives markets 

and regulated futures markets to hedge their exposures related to their purchases 

and sales of natural gas. As publicly-owned distribution systems, the savings that 

public gas systems realize from hedging their purchases and sales of natural gas 

using exchange-traded or OTC derivatives directly lowers the rates paid by their 

customers. Thus, the proper functioning of the markets is important to public gas 

systems because well-functioning markets affect the rates that their consumers will 

ultimately pay. 

APGA believes that the goal of Treasury’s Proposal to close regulatory loopholes 

and bring needed regulatory oversight to the OTC markets is sound. In light of the 

importance of these markets to public gas systems, and ultimately to their customers, we endorse the goal of Treasury’s Proposal, generally, including the expectation that regulatory agencies will cooperate in overseeing the OTC derivatives markets. 

Mandatory Clearing. 

Section 713 of the Treasury Proposal requires the clearing of standardized swap 

contracts by a derivatives clearing organization except if no derivatives clearing organization will clear the transaction, or one of the counterparties is not a dealer or 

a ‘‘major swaps participant and does not meet the eligibility qualifications of a derivatives clearing organization. A major swap participant is defined as an entity 

that maintains a substantial net swap position other than to create and maintain 

a hedge under generally accepted accounting principles, or as the CFTC and SEC 

further define by rule.’’

APGA supports this exemption from the mandated clearing requirement. As hedgers, with very high credit ratings, assured collections from rate payers, and substantial assets in physical infrastructure, public gas systems under current practice in 

the bilateral swaps market often are not required to pledge liquid collateral for 

transactions below agreed upon levels. Moreover, adjustments to collateral levels are 

made on a pre-defined, periodic basis. This is particularly suitable to the routine 

funding and fee collection practices of public natural gas distribution systems. The 

customers of public gas systems reap the benefits of these arrangements through 

lower rates for the natural gas which they purchase. The hedging of natural gas 

supply purchases by public gas systems using non-cleared bilateral OTC derivatives 

do not present the types of systemic risks posed by some dealers of credit-default 

swaps, which is the impetus behind the proposed clearing mandate. 

Accordingly, APGA strongly supports the inclusion of the exemption for hedgers 

which are not major swap participants. The availability of this exemption is critical 

to our member’s ability to continue to bring natural gas to their customers at the 

lowest possible cost in a fiscally sound and operationally efficient manner. 

However, we suggest that the definition of ‘‘major swap participant’’ be revised. 

Currently, the definition is tied to a finding that the net position of outstanding 

swaps is an effective hedge under generally accepted accounting principles (GAAP). 

APGA members use the OTC derivatives markets to hedge their physical operations. We are concerned that an overly rigorous interpretation of this definition 

may require tying particular swaps transactions to particular physical requirements. We suggest that the definition of ‘‘non-major swap participant’’ address this 

concern by being revised to include a category for ‘‘an entity which is a commercial 

user, processor or distributor of the physical commodity that enters into swap contracts in connection with their purchase or sales of the physical commodity.’’

There have been some who have suggested that Congress should not include this 

exemption in a final bill, and mandate that all standardized OTC derivatives be required to be cleared regardless of the nature of the end-user counterparty. 

Public gas systems depend upon both the physical commodity markets as well as 

the markets in OTC derivatives to meet the natural gas needs of their consumers. 

Together, these markets play a critical role in these utilities securing natural gas 

supplies at stable prices for their communities. Specifically, natural gas distributors 

purchase firm supplies in the physical delivery market at prevailing market prices, 

and enter into OTC derivative agreements customized to meet their specific needs, 

reduce their consumers’ exposure to future market price fluctuations and stabilize 

16

rates. By using both markets, these public gas systems are able to purchase firm 

deliveries of natural gas from a diverse set of suppliers while hedging the risk of 

future market price fluctuations. 

However, proposals that would require all standardized OTC derivatives transactions to be cleared would significantly impair the financial ability of public gas 

systems to engage in these gas supply strategies. As noted above, under current 

practices in the OTC markets, many APGA based upon their very-high credit worthiness are not required to post collateral for an agreed upon number of transactions. In contrast, the mandated clearing of all OTC transactions would require 

public gas systems to post initial margin for all transactions and to meet potential 

margin calls whenever required on little notice. This would constitute a significant 

financial and operational burden on these systems, their communities and their consumers. 

It has been suggested that the clearing requirements would be less burdensome 

if some end-users are given the option of posting non-cash collateral. Unfortunately, 

the alternative of using non-cash collateral would not provide any relief to public 

gas systems. Public gas systems generally are prohibited by their constitutional documents from pledging as collateral the components of their physical infrastructure, 

such as pipelines. Accordingly, public gas systems would only be permitted to pledge 

non-cash collateral in the form of liquid assets. However, public gas systems simply 

do not maintain such liquid assets in the quantity necessary to meet the requirements associated with clearing. And maintaining this level of liquid assets would 

be at odds with their routine funding operations. 

Another result of mandatory clearing would be the de facto elimination of the use 

of tax-exempt financing for the prepayment of long-term natural gas contracts, also 

known as ‘‘prepays.’’ Prepays were endorsed by Congress as part of the Energy Policy Act of 2005 and have been a key tool that public gas systems, including ours, 

have used to secure long-term, firm supplies for terms up to 30 years. One critical 

component of the prepay is an OTC swap transaction that enables the public gas 

system to ultimately pay a price discounted below the prevailing spot market price. 

Importantly, the OTC derivatives utilized in prepays are ‘‘tear up’’ agreements, that 

is, they terminate at no cost in the event the prepay terminates. Because of their 

size and long-range nature, requiring clearing of the prepay swap would be cost prohibitive, thereby eliminating a tool public gas systems have utilized to lock into 

long-term supplies of natural gas and protect our consumers from price volatility. 

Accordingly, APGA strongly rejects the suggestion that all OTC derivatives be required to be cleared regardless of the nature of the end-user counterparty. That suggestion, if enacted into law, would constitute a significant financial and operational 

burden on publicly owned natural gas distribution systems, their communities and 

their consumers, and would not address any problem which has brought about the 

current financial crises. From our perspective, the continued availability of individually negotiated, non-cleared OTC transactions will provide our Members the widest 

range of tools to continue to offer natural gas at the best possible prices to their 

customers. 

Speculative Position Limits 

Section 723 of the Treasury Proposal would make the Commodity Exchange Act’s 

speculative position limit provisions applicable to any swaps that perform or affect 

a significant price discovery functions with respect to regulated markets. Such limits 

may be aggregated across positions held in designated contract markets, contracts 

on a foreign board of trade, or swaps serving a significant price discovery function 

with respect to a regulated market. 

As hedgers that use both the regulated futures markets and the OTC energy markets, our members value the role of speculators in the markets. We also value the 

different needs served by the regulated futures markets and the more tailored OTC 

markets. As hedgers, we depend upon liquid and deep markets in which to lay off 

our risk. Speculators are the grease that provides liquidity and depth to the markets. 

However, speculative trading strategies may not always have a benign effect on 

the markets. For example, the dramatic blow-up of Amaranth Advisors LLC and the 

impact it had upon prices exemplifies the impact that speculative trading interests 

can have on natural gas supply contracts for local distribution companies (‘‘LDCs’’). 

Amaranth reportedly accumulated excessively large long positions and complex 

spread strategies far into the future. The Report by the Senate Permanent Committee on Investigations affirmed that ‘‘Amaranth’s massive trading distorted natVerDate 0ct 09 2002 11:29 Nov 04, 2009 Jkt 041481 PO 00000 Frm 00020 Fmt 6633 Sfmt 6621 I:\DOCS\111-29\53020.TXT AGR1 PsN: BRIAN
17

3See ‘‘Excessive Speculation in the Natural Gas Market,’’ Report of the U.S. Senate Permanent 

Subcommittee on Investigations (June 25, 2007) (‘‘PSI Report’’) at p. 119. 4Many natural gas distributors locked in prices prior to the period Amaranth collapsed at 

prices that were elevated due to the accumulation of Amaranth’s positions. They did so because 

of their hedging procedures which require that they hedge part of their winter natural gas in 

the spring and summer. Accordingly, even though natural gas prices were high at that time, 

it would have been irresponsible (and contrary to their hedging policies) to not hedge a portion 

of their winter gas in the hope that prices would eventually drop. Thus, the elevated prices 

which were a result of the excess speculation in the market by Amaranth and others had a significant impact on the price these APGA members, and ultimately their customers, paid for natural gas. The lack of transparency with respect to this trading activity, much of which took place 

in the OTC markets, and the extreme price swings surrounding the collapse of Amaranth have 

caused bona fide hedgers to become reluctant to participate in the markets for fear of lockingin prices that may be artificial. 5The additional concern has been raised that recent increased amounts of speculative investment in the futures markets generally have resulted in excessively large speculative positions 

being taken that due merely to their size, and not based on any intent of the traders, are putting upward pressure on prices. The argument made is that these additional inflows of speculative capital are creating greater demand then the market can absorb, thereby increasing buyside pressure which results in advancing prices. 6See generally, PSI Report.

7 ‘‘Significant Price Discovery Contracts on Exempt Commercial Markets; Final Rule,’’ 74 Fed. 

Reg. 12178 (March 23, 3009). 

ural gas prices and increased price volatility.’’ 3 APGA believes that these price distortions directly increased the cost of natural gas for many of our member’s customer rate payers.4–5

Applying Aggregate Position Limits Across all Positions. 

The Treasury Proposal would apply speculative position limits across all economically linked instruments, regardless of whether they are exchange-traded or traded 

OTC. The determination of whether to apply position limits consistently across all 

markets and participants is perhaps the single most important issue for the energy 

market. As we noted above, the various market segments for energy contracts are 

economically linked, and actions in one market segment can affect prices in the 

other segments. Recent events in the economically linked markets for natural gas 

have shown the danger of traders being able to move positions from one market to 

another in order to evade application of a market’s position accountability rule or 

position limit.6 A unified limit administered by the Commission across all markets, 

including the OTC markets (in addition to the limits adopted and administered by 

each separate market) would effectively address this issue and provide an effective 

and meaningful limitation on the total size of positions that a trader could amass 

in the delivery month. 

APGA strongly supports the use of spot month speculative position limits as a 

proven and effective tool for addressing markets with constrained deliverable supplies, which is typical of the markets for natural gas. The CFTC recently promulgated rules implementing the Reauthorization Act’s provisions with respect to the 

oversight of SPDCs.7 APGA believes that the final rules are a very good foundation 

for addressing the issue, but recommends that the CFTC consider taking additional 

steps within its existing statutory authority to strengthen the effectiveness of this 

important regulatory tool. 

In this regard, APGA notes that the CFTC deferred action to make spot month 

speculative position limits or back month position accountability apply to both 

cleared and non-cleared transactions on a market that operates as a SPDC. Despite 

recognition of the important role that non-cleared transactions play in price formation, the speculative position limits that the Commission’s rules require apply only 

to cleared transactions and do not require that non-cleared transactions be included 

in calculating whether a trader has violated a spot month speculative position limit. 

This clearly and inexplicably weakens the prophylactic protection that spot month 

speculative position limits are intended to provide. Accordingly, APGA suggests that 

the Commission use its current statutory authority and include linked, non-cleared 

SPDCs within the speculative position limit requirement. 

The Treasury Proposal would address this regulatory gap by expressly providing 

that speculative positions limits shall apply to swaps that serve a significant price 

discovery function with respect to a regulated contract. APGA considers it vitally 

important that any legislative proposal include unified speculative positions limits 

for contracts that are traded and maintained OTC. Where such contracts are economically linked to contracts traded on exchange traded or exempt commercial markets, such OTC contracts may have an important influence on pricing and on the 

performance of other market segments. 

18

8See PSI Report.

Recent events in the economically linked markets for natural gas have shown the 

danger of traders being able to move positions from one market to another in order 

to evade application of a market’s position accountability rule or position limit.8 A 

unified limit administered by the Commission across all markets (including OTC 

transactions), in addition to the limits adopted and administered by each separate 

market would effectively address this issue and provide an effective and meaningful 

limitation on the total size of positions that a trader could amass in the delivery 

month. 

Large Trader Reporting 

Section 731 of the Treasury Proposal would add a new provision requiring persons 

holding swaps positions in swaps that perform a significant price discovery function 

in respect of a regulated market which exceed a stated size to report to the CFTC 

such information as the CFTC shall require. This mirrors the requirement which 

underpins the current CFTC Large Trader Reporting System. The provision includes a books and records requirement. 

The current lack of transparency with respect to large OTC transactions leaves 

regulators unable to answer questions regarding speculators’ possible impacts on 

the over-all market. Without being able to see a large trader’s entire position, the 

effect of a large OTC trader on the regulated markets is masked, particularly when 

that trader is counterparty to a number of swaps dealers that in turn take positions 

in the futures market to hedge these OTC exposures as their own. 

The primary tool used by the CFTC to detect and deter possible manipulative activity in the regulated futures markets is its large trader reporting system. Using 

that regulatory framework, the CFTC collects information regarding the positions 

of large traders who buy, sell or clear natural gas contracts on the regulated market. The CFTC in turn makes available to the public aggregate information concerning the size of the market, the number of reportable positions, the composition 

of traders (commercial/non-commercial) and their concentration in the market, including the percentage of the total positions held by each category of trader (commercial/non-commercial). 

The CFTC also relies on the information from its large trader reporting system 

in its surveillance of the regulated market. In conducting surveillance of the regulated natural gas futures market, the CFTC considers whether the size of positions 

held by the largest contract purchasers are greater than deliverable supplies not already owned by the trader, the likelihood of long traders demanding delivery, the 

extent to which contract sellers are able to make delivery, whether the futures price 

is reflective of the cash market value of the commodity and whether the relationship 

between the expiring future and the next delivery month is reflective of the underlying supply and demand conditions in the cash market. 

The CFTC Reauthorization Act, recently empowered the CFTC to collect large 

trader information with respect to ‘‘significant price discovery contracts.’’ However, 

there remain significant gaps in transparency with respect to trading of OTC energy 

contracts, including many forms of contracts traded on the Intercontinental Exchange, Inc. Despite the links between prices for the regulated futures contract and 

the OTC markets in natural gas contracts, this lack of transparency in a very large 

and rapidly growing segment of the natural gas market leaves open the potential 

for participants to engage in manipulative or other abusive trading strategies with 

little risk of early detection and for problems of potential market congestion to go 

undetected by the CFTC until after the damage has been done to the market, ultimately costing the consumers or producers of natural gas. More profoundly, it leaves 

the regulator unable to assemble a true picture of the over-all size of a speculator’s 

position in a particular commodity. 

Our members, and the customers served by them, believe that although the Reauthorization Act goes a long way to addressing the issue, there is not yet an adequate 

level of market transparency under the current system. This lack of transparency 

has led to a continued lack of confidence in the natural gas marketplace. Although 

the CFTC operates a large trader reporting system to enable it to conduct surveillance of the futures markets, it cannot effectively monitor trading if it receives information concerning positions taken in only one, or two, segments of the total market. 

Without comprehensive large trader position reporting, the government will remain 

handicapped in its ability to detect and deter market misconduct or to understand 

the ramifications for the market arising from unintended consequences associated 

with excessive large positions or with certain speculative strategies. If a large trader 

acting alone, or in concert with others, amasses a position in excess of deliverable 

supplies and demands delivery on its position and/or is in a position to control a 

19

high percentage of the deliverable supplies, the potential for market congestion and 

price manipulation exists. Similarly, we simply do not have the information to analyze the over-all effect on the markets from the current practices of speculative traders. 

Over the last several years, APGA has pushed for a level of market transparency 

in financial contracts in natural gas that would routinely, and prospectively, permit 

the CFTC to assemble a complete picture of the overall size and potential impact 

of a trader’s position irrespective of whether the positions are entered into on a regulated futures exchange, on an exempt electronic market or through bilateral OTC 

transactions, which can be conducted over the telephone, through voice-brokers or 

via electronic platforms. 

The Treasury Proposal addresses this regulatory gap by including all economically 

linked contracts that affect price discovery in the regulated market within a large 

trader reporting system. APGA strongly backs this proposal. We note that this is 

necessary in order to achieve meaningful transparency in the market. We believe 

that this would give the cop on the beat the tools necessary to patrol for manipulation, abuse, congestion, and price distortions. We urge that this provision be included in any financial reform legislation. 

* * * * *

In order to protect consumers the regulators must be able to (1) detect a problem 

before harm has been done to the public through market manipulation or price distortions; (2) protect the public interest; and (3) ensure the price integrity of the markets. Accordingly, APGA and its over 720 public gas system members applaud your 

continued oversight of the futures and related markets for natural gas markets. We 

look forward to working with the Committee to determine the further enhancements 

that may be necessary to address the remaining regulatory gaps, enhance enforcement and restore consumer confidence in the integrity of the price discovery mechanism. 

Natural gas is a lifeblood of our economy and millions of consumers depend on 

natural gas every day to meet their daily needs. It is critical that the price those 

consumers are paying for natural gas comes about through the operation of fair and 

orderly markets and through appropriate market mechanisms that establish a fair 

and transparent marketplace. Without giving the government the tools to detect and 

deter manipulation, market users and consumers of natural gas who depend on the 

integrity of the natural gas market cannot have the confidence in those markets 

that the public deserves. We believe that the Treasury Proposal provides this Committee with a very good foundation for achieving those goals.

The CHAIRMAN. Thank you very much. 

Your testimony, Mr. Hirst? 

STATEMENT OF RICHARD B. HIRST, SENIOR VICE PRESIDENT 

AND GENERAL COUNSEL, DELTA AIR LINES, MINNEAPOLIS, 

MN; ON BEHALF OF AIR TRANSPORT ASSOCIATION 

Mr. HIRST. Thank you, Mr. Chairman. My name is Ben Hirst. I 

am General Counsel at Delta Air Lines, but I appear today on behalf of the Air Transport Association, which represents the major 

passenger and cargo airlines in the United States, an industry 

which has been devastated in the past 2 years by the high price 

of fuel and volatility in the oil markets. 

We appreciate your determination to address the causes of these 

conditions, which have destroyed some airlines and deeply damaged the rest. We strongly support strengthened regulation of the 

oil futures market. 

U.S. airlines are suffering through a very difficult economic climate and have been forced to cut employees and air service. Unfortunately, the impact of the recession on the airlines has been exacerbated by a recent volatility in the fuel markets. In 2008 alone, 

U.S. airlines spent $16 billion more on fuel than they did the year 

prior, almost $60 billion in total, despite the fact that they actually 

decreased their fuel consumption by more than five percent. 

20

Because fuel is our largest single expense, we are particularly 

susceptible to the recent wild swings in fuel prices. At Delta Air 

Lines, we consume approximately 4 billion gallons of jet fuel annually, which makes us the second-largest consumer of jet fuel in the 

world, after only the U.S. Government. Jet fuel consumes 30 to 40 

percent of our total revenues. A $1 increase in the price per barrel 

of oil, annualized, increases Delta’s fuel cost by $100 million. 

The speculative oil price bubble that began in mid-2007 cost Delta approximately $8 billion in fuel expense and hedge losses 

compared with what we would have spent on jet fuel if the price 

of oil had remained where it was in mid-2007 at $60 a barrel. In 

addition, it forced Delta to reduce capacity by ten percent and 

eliminate 10,000 jobs. 

In the past 3 years, we have seen a significant increase in the 

volatility of oil prices. This increase in volatility has been associated with a massive increase in speculative investment in the oil 

market. The total value of investment in commodity index funds 

has increased tenfold since 2003, from an estimated $15 billion in 

2003 to around $200 billion in mid-2008. Over the same period, 

global demand for physical barrels of oil has remained static, virtually unchanged. 

For airlines, the volatility in oil prices associated with this increase in speculation creates three serious problems: First, it increases the costs and risks of hedging. As a result of last year’s oil 

bubble, for example, Delta incurred about $1.7 billion in hedge 

losses when the bubble burst and the price of oil fell precipitously. 

Second, speculative activity last year pushed fuel prices so high 

that capital within the industry has been depleted. And, finally, 

with each spike in oil prices, airlines ground aircraft, reduce air 

service, eliminate jobs, and defer capital expenditures. 

It is worth remembering that the ultimate purpose of commodities futures markets is to provide hedging opportunities for producers and end-users of commodities, not to provide a financial 

playing field for speculators. Speculators play a valuable role in 

providing the liquidity needed for hedging to occur; however, to the 

extent excess speculation destabilizes actual commodity prices and 

markets, Congress should provide the CFTC with adequate authority and resources to ensure that markets enjoy enough speculation 

to provide liquidity, but not so much as to create wild volatility and 

harm to consumers. 

Congress and the CFTC can look to the period before the explosion of index fund investment in the earlier years of this decade as 

a guide to appropriate speculative levels in relation to levels of volatility. 

About 10 years ago, when volatility was low, it has been estimated that only about 25 percent of the open interest in oil futures 

was held by speculators. Today, the percentage is estimated at 70 

to 80 percent. Unfortunately, the CFTC’s authority over the swaps 

in OTC markets, which have greatly expanded in the last decade 

as speculation has increased, is ambiguous, and it was weakened 

by loopholes in the Commodities Futures Modernization Act. 

The Treasury Department recently sent Congress proposed legislation that would give the CFTC clear authority to exercise oversight over the swaps and OTC derivatives markets. It would exVerDate 0ct 09 2002 11:29 Nov 04, 2009 Jkt 041481 PO 00000 Frm 00024 Fmt 6633 Sfmt 6601 I:\DOCS\111-29\53020.TXT AGR1 PsN: BRIAN
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pressly repeal the swaps in Enron loopholes and strengthen oversight of foreign boards and trades. It would increase transparency 

by requiring reporting of all derivatives and futures trades to a 

central repository, and by making available to the public aggregated data on all open positions in trading volumes. It would clarify the CFTC’s authority to deter market manipulation and to police conflicts of interest. And, most importantly from our perspective, it would give the CFTC clear authority to set position limits 

for OTC and swaps markets that perform a significant price discovery function. 

The airline industry would support legislation which requires the 

CFTC to set aggregate and individual position limits in the oil futures markets. Now, the Administration proposal does not go that 

far, but it does require the CFTC to set position limits—I am sorry, 

it gives the CFTC authority to set position limits across all markets, which is a very important step, where it determines that 

those markets would significantly affect price discovery. And, as a 

result, we strongly support these provisions. 

The current state of the oil futures market is completely unworkable for the airline industry, and that is not debatable. It is also 

harmful to our nation’s economy as a whole. We urge you to enact 

legislation to restore the proper balance between commercial hedging and speculative investment, to increase the transparency of 

trades and traders in these markets, and to close the loopholes that 

have hindered adequate oversight of these vital markets for years. 

Thank you very much, and I look forward to answering your 

questions. 

[The prepared statement of Mr. Hirst follows:]

PREPARED STATEMENT OF RICHARD B. HIRST, SENIOR VICE PRESIDENT AND GENERAL

COUNSEL, DELTA AIR LINES, MINNEAPOLIS, MN; ON BEHALF OF AIR TRANSPORT

ASSOCIATION

Introduction 

Good morning Chairman Peterson, Ranking Member Lucas, and Members of the 

Committee. I am Ben Hirst, General Counsel of Delta Air Lines, and I am appearing today on behalf of the Air Transport Association, which represents the U.S. commercial airline industry, an industry that has been devastated in the past 2 years 

by the high price of fuel and volatility in oil markets. We, and our employees, are 

grateful for your commitment to addressing the causes of these conditions, which 

have destroyed some airlines and deeply damaged the rest. 

Industry Conditions 

As an industry, commercial aviation helps drive $1.14 trillion in annual economic activity in the U.S., $346 billion per year in personal earnings, and 10.2 million jobs. 

It also contributes $692 billion per year to our nation’s gross domestic product—

roughly 5.2% of GDP.Unfortunately, U.S. commercial aviation is suffering through 

a very difficult economic climate. Recently, Merrill Lynch analyst Michael Linenberg 

was quoted as saying, ‘‘We are lowering our 2009.net income forecast [for the airline 

industry] . . . from a profit of $1.0 billion to a loss of $2.3 billion. While at the start 

of the year we were projecting a modest net profit for the industry despite the worst 

global economic downturn since World War II, our forecast has been stymied by the 

impact of the H1N1 influenza, creeping energy prices, and a revenue environment 

that is showing no signs of improvement.’’ Demand for air travel and air cargo is 

down sharply in 2009—by approximately 21 percent below the same period last 

year—and U.S. airlines expect 14 million fewer passengers in the summer 2009 

than we had in 2008. This has forced our industry to do the only thing it can to 

survive—cut capacity, ground planes, eliminate routes, and reduce the number of 

cities served. 

The number of full-time employees at passenger airlines is down 29 percent from 

our peak employment in May 2001—a total of 154,000 jobs lost in our industry. And 

22

1 An available seat mile (ASM) is one passenger seat flown one mile and is the standard unit 

of capacity in the passenger airline sector. 

airlines continue to cut. In the fourth quarter of this year, domestic seating capacity 

is expected to decline to levels we last saw in the fourth quarter of 2001, in the immediate aftermath of 9/11. In fact, by the fourth quarter of this year, U.S. carriers 

will offer almost 1.8 billion fewer available seat miles 1 every week than they did in 

the fourth quarter of 2007. And that figure represents the cuts on domestic routes 

only. When you add the cuts that have been made to international routes, the numbers are even larger.Unfortunately, all of these problems are being exacerbated by 

volatility in fuel markets. In 2008, U.S. airlines spent $16 billion more on fuel than 

they did the year prior—almost $60 billion in total—despite consuming more than 

five percent fewer gallons of fuel. 

We at Delta Air Lines employ over 70,000 people worldwide and offer service to 

more than 170 million passengers each year to 382 destinations in 69 different countries. We consume approximately 4 billion gallons of jet fuel annually, making us 

the second largest consumer of jet fuel in the world, next to the U.S. Government. 

Our business is dramatically impacted by volatility in the oil markets. Each $1 

change in the cost of a barrel of oil has an annual impact of $100 million to Delta’s 

bottom line. In 2008, as oil prices and volatility peaked, fuel expense (including the 

cost of hedging) consumed 40 percent of our total revenues directly resulting in the 

need to reduce our capacity by more than ten percent and eliminate nearly 10,000 

jobs.The financial health and security of the airline industry depends, in significant 

part, on a commodities market structure that is stable, rational and predictable. Today’s energy commodities markets, however, do not display these characteristics. 

Excessive Speculation Drives Volatility 

Since 2005 we have seen a significant increase in the volatility of oil prices. The 

increase has been particularly dramatic in the last 2 years. From 1999 through 

2004, the average annual variance between the high price of a barrel of oil for the 

year and the low price was about $16. From 2005 through 2008 the average annual 

per-barrel variance was about $52. In 2007 the variance between the high and low 

prices was $48 and in 2008 it was $111. Daily volatility in 2004 was generally under 

one dollar. In 2008, the price of a barrel of oil rose $10.75 in a single day (June 

6), and daily volatility of $3 or more became the norm. The average monthly difference in prices in 2008 was over $19 per barrel.

This increase in volatility has been associated with a massive increase in speculative investment in oil futures. A recent study by the Permanent Subcommittee on 

Investigations of the Senate Committee on Homeland Security and Governmental 

Affairs noted that over the last 6 years, financial institutions have aggressively marketed commodity index funds, which are heavily weighted to oil futures, as a way 

for hedge funds, pension funds, and other investors to diversify portfolios and speculate on rising commodity prices. The study noted that the total value of investment 

in commodity indexes has increased tenfold since 2003, from an estimated $15 bilVerDate 0ct 09 2002 11:29 Nov 04, 2009 Jkt 041481 PO 00000 Frm 00026 Fmt 6633 Sfmt 6621 I:\DOCS\111-29\53020.TXT AGR1 PsN: BRIAN

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2Total world demand for oil from 2005 to 2008 (in million barrels per day):

2005—84.00

2006—84.98

2007—85.90

2008—85.33

Source: Energy Information Administration. 

lion in 2003 to around $200 billion in mid-2008. During that period, the volumes 

of oil futures traded on the exchanges quadrupled despite the fact that, over the 

same period, global demand for physical barrels of oil remained virtually unchanged.2 Moreover, these indices tend to have a very heavy bias toward long investing, further increasing the upward pressure on energy markets. This increase 

in speculative activity is closely correlated with the increased volatility of oil prices, 

which has caused so much harm. 

For an airline, an oil market characterized by high volatility driven by speculation 

presents a number of serious problems. First, it increases the costs and risks of 

hedging. Second, in recent years this volatility has pushed prices to levels so high 

that they have depleted the capital of the firms in our industry. Third, with each 

spike in oil prices, airlines ground aircraft, reduce air service, and eliminate jobs. 

To be clear, we acknowledge that a certain level of speculative investment in commodity markets injects much-needed liquidity in those markets and positively impacts market functions. However, because excessive speculation clearly destabilizes 

commodity markets and harms consumers, Congress should provide the CFTC with 

the authority and guidance it needs to ascertain the proper level of speculative investment in the market while preventing volatility. The period before the explosion 

of index fund investment in the early years of this decade can serve as a valuable 

guide to appropriate levels of speculative positions in relation to acceptable levels 

of volatility. 

Oil Prices and Volatility Have Risen as Speculation Has Increased

We estimate that the speculative oil price bubble that began in mid-2007, peaked in mid-2008, and then plummeted abruptly, cost Delta $8.4 billion, compared with 

what we would have spent on jet fuel if the price of oil had remained at $60 a barrel. This includes $1.7 billion in hedge losses and premiums. At least we’re still in 


11129002
24

business. Other airlines without our financial reserves have not been so fortunate. 

Since December 2007, eight airlines have ceased operations.

In 2008 alone, some 28,000 pilots, flight attendants, mechanics, ramp workers, 

gate agents, reservation sales and service representatives, and office workers lost 

their jobs due to cutbacks in our industry, and air service was reduced at countless 

communities across the country. Further capacity reductions, layoffs, bankruptcies 

and liquidations will occur if oil price volatility is not reduced to more manageable 

levels. 

Solutions 

Delta Air Lines and the Air Transport Association strongly support reforms to energy market regulation that promote price stability, market integrity, and accurate 

price discovery. This is because the fundamentals of supply and demand alone, 

while certainly influencing the price of commodities, cannot explain the destructive 

volatility we have seen in oil markets over the past 16 months. The dramatic and 

devastating run-up in oil prices that we experienced last summer—and the almostas-devastating price crash last fall—was largely caused by a massive influx of speculative investment into commodity markets generally and energy markets in particular. Congress must provide the CFTC with the authority needed to prevent a 

recurrence of these devastating conditions by enacting bold commodity market reform legislation. The draft legislation recently released by the Obama Administration provides a strong blueprint for this reform and we urge congress to consider 

it in the coming weeks. 

Delta Air Lines and the Air Transport Association are pleased that the Obama 

Administration has taken an active role in advocating significant reforms to the 

laws governing the regulations and oversight of derivatives markets. We applaud 

the President for coming forth with a strong and detailed legislative proposal to deal 

with the many shortcomings we see in the current oversight framework and generally support the reforms that he is advocating. 

Furthermore, Delta Air Lines uses derivatives markets to hedge in both financial 

risk and commodity price risk, and we view both tools as valuable. That said, my 

company continues to be more concerned with the explosion of price volatility that 

we have seen in energy commodities in recent years than it is about increased costs 

for managing financial risks using financial derivatives. Excessive speculation in oil 

markets, and the volatility it foments, has been our focus throughout this debate 

and we continue to primarily advocate policies that reform commodities markets—

the portion of this provision that is the purview of this Committee. 


11129003
25

Now to discuss some of the specifics of the bill. The President’s proposal addresses 

most of the policy priorities the ATA has enumerated throughout this debate. It effectively closes the loopholes in the law that hamper the ability of the CFTC to effectively regulate the market—the Swaps Loophole, the ‘‘Enron’’ Loophole, and the 

foreign exchange loophole. It also has the potential to limit the massive influx of 

speculative dollars that we have seen flow into the markets in recent years by providing the CFTC the authority to impose speculative position limits, requires more 

transparency and reporting, implements conflict-of-interest rules in this area for the 

first time, and increases CFTC funding or staff. 

Regarding the imposition of aggregate position limits across all markets, one of 

the ATA’s highest policy priorities, the proposal gives the CFTC clear authority to 

set position limits for any futures transactions that ‘‘perform or affect a significant 

price discovery function.’’ This change will allow the CFTC to address the excessive 

speculative pressure—and the concomitant volatility—imposed on oil markets by 

massive pension funds, sovereign wealth funds, and other major market players 

that use index funds to trade immense amounts of commodity contracts. While the 

ATA would prefer language to require the CFTC to take such steps rather than the 

mere grant of authority contained in the Obama Administration proposal, we are 

confident that the current leadership of the CFTC would effectively use this authority to increase oversight and inject stability into these markets. 

By imposing consistent position limits on all non-commercial traders across all 

markets, traders will continue to have the opportunity to invest in energy commodities, but only up to the level necessary to ensure adequate liquidity in the market. 

This would prevent a recurrence of excessive speculative activity that created the 

2008 commodity bubble while ensuring that the markets continue to enjoy the liquidity they need to function efficiently. 

The Obama proposal also contains major improvements in transparency. It requires traders to report to the CFTC many types of transactions not currently reported and requires CFTC to aggregate that data and make it available to the public. The bill also would require most transactions not cleared or exchange traded to 

be reported to the CFTC. The collection and dissemination of this information would 

greatly enhance the ability of both the CFTC and public watchdogs to monitory market activity and maintain market integrity. 

The Obama proposal supports the harmonization of regulations regulating commodity and financial derivatives, and imposes conflict-of-interest rules on swap dealers and major swap participants. Swaps dealers would have to create ‘‘firewalls’’ between their market research arms the branch of the company that engages in trading. They also will have to disclose related conflicts, material risks, financial incentives, and other interests to counterparties. 

Finally, the proposal requires many transactions in standardized swaps be traded 

on a board of trade or cleared through an ‘‘alternative swap execution facility.’’ To 

ensure the integrity of these trades, margin requirements sufficient to cover potential exposure will likely be required. While Delta Air Lines and other ATA members 

are generally more concerned with market volatility than the potential burdens 

market reform impose, it is imperative that actual physical hedgers in commodity 

markets be allowed continued access to these risk management tools without significantly increased cost burdens. Commodity markets were created for the benefit of 

physical hedgers and they must continue to remain accessible to them. In a trade 

where at least one party is a legitimate physical hedger in a commodity, the Agriculture Committee should consider provisions that would enable these transactions 

to occur to with little additional financial burden on the parties involved. 

Conclusion 

Again, thank you for the opportunity to testify before the Committee on these 

vital issues. Fuel has become airlines’ single largest expense. The extreme volatility 

we have seen in these markets in recent months has made it impossible to undertake necessary corporate planning and has been devastating to our industry and the 

employees and communities that depend on us. The Obama Administration has laid 

out a workable blueprint and we urge Congress to take the significant steps needed 

to reform these markets. We in the airline industry, on behalf of our employees and 

the communities we serve, commend you for the leadership you are exercising on 

this critical issue. I look forward to answering any questions you may have.

The CHAIRMAN. Thank you, Mr. Hirst. 

And I thank all of the members of the panel. 

Part of what I was trying to do here today, and Tuesday, is to 

get to the bottom of this issue of how the proposal affects folks that 

26

use this in the real world that need to use this for their business. 

And they get tangled up in all these folks that are involved in this 

for other reasons, either making a lot of money putting these 

things together, or selling investments, or whatever they are doing. 

So part of what I was trying to do here with these panels is to 

kind of flesh out the concerns. And then hopefully on Tuesday we 

can get some more direct answers from Mr. Gensler and Ms. 

Schapiro about what they actually intend to do. 

I think some of the current concerns that people have are—I 

don’t get the sense that they are going to go as far as what some 

people think, and I think there is some lack of clarity in the proposals that have been put forward. But that is part of what I am 

trying to do here, is see if we can get that nailed down and figure 

out how to proceed. 

I am somewhat concerned that the big players in this are sending people over here to talk to Members to try to get exemptions 

for themselves again. And there is some of that going on, I am 

sure. And I want to sort all that out. But, I guess where I am coming from is we are not really here to put you guys in a tougher position, drive up your costs, screw up what you are doing. You are 

not the problem. But, in the process, I don’t want to leave a loophole that is going to get us back in this position again. And that 

is what I am trying to sort through here. 

You know, as far as I am concerned, we are not going back to 

the system we had before. And, in the big picture what I am trying 

to do is make sure that the risk that is out there is going to be 

borne by the people that are doing the business and not by the government. And, if you have a different way of covering the risk, then 

we should be able to accommodate that. But all we are trying to 

do is make sure that we are not setting up some big risk here that 

they are going to come back and try to get the taxpayers to take 

care of. 

So, Mr. Hixson, there was a concern about this exemption, I 

guess. For standardized swaps to become exempt, one of the swap 

counterparties must not be a swap dealer or a swap participant as 

defined, and then the additional condition is that the counterparty 

does not meet the eligibility requirements of any clearinghouse that 

clears a swap, even if the counterparty is not a clearing member. 

And if they meet the clearing member eligibility, then they would 

still be required to clear the swap. 

So this additional condition could reduce the number of end-users 

who could qualify for the exemption. Mr. Hixson mentioned this 

concern. 

Did anyone else have this concern? Do any of you know, generally, what is required to be a clearinghouse member and whether 

your company or members of your association would meet those requirements and, hence, would be required to clear all the standardized swaps? 

We know where Mr. Hixson is at. So, Mr. English? 

Mr. ENGLISH. Mr. Chairman, we do and are involved through 

NYMEX, as far as natural gas is concerned. And we anticipate, as 

we move forward, again, looking to the likelihood of dealing with 

the issue of climate change, that we will be even more heavily inVerDate 0ct 09 2002 11:29 Nov 04, 2009 Jkt 041481 PO 00000 Frm 00030 Fmt 6633 Sfmt 6601 I:\DOCS\111-29\53020.TXT AGR1 PsN: BRIAN
27

volved, as far as natural gas is concerned and the need for hedging. 

So, yes, that is an area that does concern us. 

The CHAIRMAN. Mr. Schryver? 

Mr. SCHRYVER. We are concerned, as well. We are concerned that 

we might be eligible as customers. If the intent is to exempt endusers from hedging, then we think there might be a better way to 

do it. 

The CHAIRMAN. Have you got language or a proposal of how—I 

met with some people yesterday that are getting us some language 

or ideas about how to deal with it. Maybe you are involved with 

those folks. 

Mr. SCHRYVER. We are not, but we would be happy to submit 

some language. 

The CHAIRMAN. Well, if you could get us that, that is what we 

need. We need ideas about how we can split this baby so that we 

get the right outcome here. 

Mr. SCHRYVER. We will do that. 

The CHAIRMAN. Mr. Hirst? 

Mr. HIRST. Mr. Chairman, most fuel hedging that airlines do is 

done on the swaps market in nonstandardized ways under conditions in which it is not necessary to post initial margin. And we 

would be concerned about provisions that would make that difficult 

and require us to operate on the exchanges where we would have 

to post initial margin. The expense of that might cause us to reduce hedging or not hedge at all. 

But, having said that, the issue of overriding importance to us 

is the actual price of oil and the effect that the futures markets 

have on that price. And if we had to choose between reducing volatility in the oil market and not hedging at all, we would prefer to 

reduce volatility in prices. 

The CHAIRMAN. Yes. Well, I am not sure I am totally up to speed 

on understanding the nuances of all of this. But where we are coming from, or where I am coming from anyway, is I am not that 

hung up on putting these on the exchanges. I am more focused on 

going to clearinghouses, which is a different level. 

And I believe that we can devise a system whereby, if the clearinghouse decides that it is not something that they can clear—and 

that is where I would be coming from for the standard—if they decide they can’t clear it, then it is going to go over into some other 

category. And then we would have to try to figure out what kind 

of collateral or what kind of backing is sufficient. And, it doesn’t 

have to be, necessarily, margins or Treasury bills or whatever. For 

myself, I think there are other ways we can make sure we have 

adequate backing. 

And that is where I am coming from, trying to find how we do 

that. But you get these folks involved in this thing that have a different agenda here. And, frankly, a lot of this fight over all of this 

has to do with how much money you make in the end. The more 

you standardize this stuff and the more you clear it, the more the 

margin narrows and the less money some of these big sell-side 

banks are going to make. So that is part of what is going on here, 

and I understand that. 

But, anyway, whatever you can do or whatever you can bring to 

us, ideas of how to deal with this so that we make sure that we 

28

are not creating some kind of risk out there that is not covered but 

works within your business model, that is what we are trying to 

find, the way to proceed on that, I would appreciate it. 

Mr. Lucas? 

Mr. LUCAS. Thank you, Mr. Chairman. 

And I would note, before I ask my questions to the panel, that 

your input today and the input to the Committee and the Members 

over the coming days and weeks, perhaps months, is critically important. There will be a bill. It is just how will it be structured, 

how will it be crafted, what will the net effect be? There will be 

a bill. So these issues, these nuances are so critically important. 

And, with that, I guess I would like to turn first to Mr. English 

and perhaps Mr. Schryver. Let’s discuss for just a moment this 

issue about collateral in the way the Treasury’s proposal seems to 

work. 

I mean, what do you gentlemen have, in particular in your areas, 

for use as collateral? I don’t think you sit on piles of cash. I am 

not sure how you mortgage the lines or the pipes. But let’s touch 

on that for a moment. What would be your base under the Treasury proposal for collateral to cover your margins? 

Mr. ENGLISH. Well, from our standpoint, you are right, we don’t 

have a lot of money. As I mentioned, we have a lot of equity; we 

don’t have a lot of cash on hand. So, basically, the more volatile 

this becomes, the greater the call, it means that our members are 

going to have to go out and borrow large sums of money. That is 

about the only way in which we can address it. 

And that is where our concern is, with regard to the cost. That 

is going to be a very expensive proposition. And we have no choice; 

since we are a not-for-profit, that will be passed on to our members. That goes directly to the electric bills. 

The CHAIRMAN. Mr. Schryver? 

Mr. SCHRYVER. We have pretty much a similar concern. Our belief is, by requiring public gas systems to post collateral, you are, 

in effect, punishing the victim. You know, our members have been 

victims of market volatility. 

And by requiring them to post collateral, they are either going 

to have to get a line of credit, with is going to affect their municipality’s credit rating; raise rates on ratepayers; or not hedge or reduce their hedging, which, in effect, would hurt their consumers as 

well. So any efforts to require public gas systems to post collateral 

would harm their consumers. 

Mr. LUCAS. And while we are on this point, gentlemen, explain 

for just a moment in greater detail how the regulatory regime that 

you are subject to from the Federal Energy Regulatory Commission, how this would be impacted by the proposal, as it now appears the White House has offered up. And would it, in effect, lead 

to double regulation or uncertainty in regulation, potentially? 

Could you expand on that for a moment? 

Mr. ENGLISH. I don’t think there is any question unless that is 

a very bright line that is drawn with regard to the exemption, any 

transaction that is physically settled, we would be uneasy, even 

given the language that is contained, that has been put forward to 

this point, we would feel uncomfortable that we are going to be regVerDate 0ct 09 2002 11:29 Nov 04, 2009 Jkt 041481 PO 00000 Frm 00032 Fmt 6633 Sfmt 6601 I:\DOCS\111-29\53020.TXT AGR1 PsN: BRIAN
29

ulated by both entities. Even though there is some language there 

that addresses that, we think that needs to be clarified. 

But, obviously, FERC already deals in this area, and we really 

find ourselves in a very difficult position if we get regulated by two 

Federal agencies. We have had that experience in the past, and 

that was not good. 

Mr. LUCAS. Mr. Hirst, you stated quite clearly you believe that 

the volatility, the price volatility that has been so devastating, so 

crippling to the airline industry—and this Committee has had various hearings on that in the past, your fuel cost—would cause problems with the swap activity. 

Would you say it was a greater issue in the swap activity or over 

the regulated exchange activity? Could you expand on that for just 

a moment? 

Mr. HIRST. Well, it is really hard, sir, to sort this out with precision because there isn’t transparency today into the level of activity 

in the swaps market. But we have seen a huge increase in index 

fund investment in the market. And that, in growing from $15 billion to $200 billion over the last 5 years, has clearly had an impact 

on futures prices, which is translated into pressure on the upside 

on oil prices. 

And we support the aspects of this bill that would extend CFTC 

jurisdiction into the swaps markets so that it can determine exactly 

how much activity is going on there and what ought to be done to 

it. 

Mr. LUCAS. My understanding is that one of the highest policy 

priorities you all have advocated, of course, are the aggregate position limits. Do you support the imposition of those position limits 

on all contract months, not just the nearbys, but all contract 

months? Could you expand on that for a moment? 

Mr. HIRST. Well, again, we strongly support extending the authority of the CFTC to the over-the-counter and swaps markets, 

clarifying that it has the authority to do what needs to be done 

there. 

We think that the CFTC should act with respect to all months 

that do have a significant price discovery function. You know, 

whether the outer months exert the same level of influence on spot 

prices as the close-in months is a fact question that probably ought 

to be left to them to determine. 

Mr. LUCAS. Thank you. 

And thank you, Mr. Chairman. 

The CHAIRMAN. I thank the gentleman. 

The gentleman from Iowa, Subcommittee Chairman, Mr. Boswell. 

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

doing this today. 

I wonder, Mr. Hixson, Cargill has such a big play in so many 

things because of your size, and we understand that, but could you 

explain a little more, if Cargill produces—the cost of the food products Cargill produces if costs imposed by the Treasury proposal actually would discourage prudent hedging, as you have suggested, 

leading to volatile market conditions, could you kind of expand on 

that a little bit? 

30

Mr. HIXSON. Sure. I think we have analyzed this as a company, 

and I think if—and I should state from the outset, we are huge 

fans of exchange traded markets. We use them extensively for our 

price discovery purchases. So whenever we are buying from farmers, that is typically hedged directly at an exchange. Sometimes 

there is an appearance of, kind of, a one or the other, which we, 

I don’t think, view it as that way. We kind of view it more symbiotic, that they really can work together and well between the 

OTC and the exchange traded markets. So we do rely heavily on 

the exchange traded markets. 

But, for example, if you go with the Treasury Department’s proposal, through our over-the-counter work, even though about 90 

percent or more of our trades are exchange traded, it would require 

us to take a billion dollars of capital and remove it from either 

building new facilities, new crush plants in Iowa and that sort of 

thing and putting it into margin accounts. And that would, obviously, change, kind of, our cost structure and our investment decisions on where we deploy capital. 

But probably more important is to understand the benefits as it 

moves down the supply chain, if you will. I think in my examples 

we talk about, kind of, both a bakery customer or more kind of an 

odd one for us, it might seem from an Iowa standpoint, but the 

hedge we do for a heating oil customer. Well, the initial margin on 

that heating oil would be about at ten percent. So if that contract 

now has to be margined, and you are a small jobber selling a million dollars of heating oil, you now have to come up with $100,000. 

That is a major change for a small player. 

So it affects us, and I hope that casts a little bit of light on how 

it treats us. But it is also important to look at it through the supply chain on where the ultimate beneficiary sometimes resides. 

Mr. BOSWELL. Anybody else want to make a comment on the 

panel? 

Mr. English, I appreciate that you helped us out when we 

worked on the, if you will, the energy bill. We thought we had 

worked out a pretty good—keep us whole. I say ‘‘us’’; I am a user. 

But then we go back out in our districts, and you need to communicate some more that we actually worked this out together. I just 

throw that in, a little extra here. And you don’t have to say a lot 

about it, but you are welcome to say what you want. But, nevertheless, it seemed to be a lack of appreciation that we did communicate and got a response from you in writing that we did okay; of 

course, you would like more. But at least we got to the table and 

got some resolve in that question. 

So I just want to throw that in. Maybe we could talk later. But 

I would just like for you to make sure they understand the effort 

that you made and that we made up here to make sure that no 

harm was done. 

Mr. ENGLISH. I appreciate that very much and certainly appreciate this Committee, appreciate the Chairman. And I think we 

made great progress. 

The point that I think a lot of our folks, your constituents, my 

members, probably view the process as the end. They consider the 

House legislation the end. And we have been trying to explain to 

them, this is only the beginning; we still have to go through the 

31

Senate and see what we can do with regard to a conference, and 

we expect this legislation will do far better. 

So I appreciate that. 

Mr. BOSWELL. We don’t have to belabor it. But, anyway, I just 

want to get the point across to give them a little reminder, please. 

Mr. ENGLISH. I will be going to a regional meeting this afternoon. 

So we will again underscore that. 

Mr. BOSWELL. I yield back. Thank you. 

The CHAIRMAN. I thank the gentleman. 

The gentleman from Kansas, Mr. Moran. 

Mr. MORAN. Mr. Chairman, thank you. 

I am sorry I heard only the testimony of two of the panelists before I had to step out, but I am looking for the kernel. What is it 

that we should—in your opinion, what problem are we trying to fix, 

and what is the solution? 

My guess is that the two panelists I didn’t hear—kind of, the 

typical testimony we will hear is that we have broad agreement 

that we need to make some changes, we are concerned about some 

specifics that are included in this legislation, please don’t do this. 

What is it that you would like to see or what do you believe is 

necessary for us to accomplish the goal of a fairer, freer market? 

Yes, sir, Congressman? 

Mr. ENGLISH. That is an issue that we were examining 15 years 

ago, so this is nothing that is new. I think the point that I would 

make, and I think that we all can agree on, is that there needs to 

be transparency in these markets. There is absolutely no question 

about that. I think we need to also be focused on manipulation, no 

question about that. And we do have those people doing it. 

It is a difficult challenge, as you look at both the exchanges 

under regulation with the CFTC and the derivatives, which don’t 

bear the same kind of scrutiny. And as I understand where the 

Chairman is trying to go, and what this is really focused on, is how 

we maintain that level of protection and enhance the protection to 

the government and to the American people, while, at the same 

time, understanding the fact that we want to continue the legitimate efforts of, in fact, allowing people to hedge and meet their 

needs. And we have to have speculation involved in that. 

And so it is a careful balancing act. I hate to say, before I left, 

I never did find that right balance, and I know the Committee is 

still searching for it. But that is about the best I can do for you. 

Mr. MORAN. Mr. Schryver? 

Mr. SCHRYVER. We also support transparency. We think it is important to help ensure that——

Mr. MORAN. Let me try to narrow that. When you say ‘‘we support transparency,’’ what does that mean we should do legislatively? 

Mr. SCHRYVER. I think enhanced large trader reporting. I don’t 

think you need clearing, at least as it pertains to public gas systems, to enhance transparency. We think position limits make 

sense for natural gas. You have a finite supply, few deliverable 

points, so position limits for natural gas make sense. 

But, again, our concern is that clearing is really intended to address systemic risk. And our APGA members, public gas systems, 

32

just don’t present a systemic risk to the market. And, in effect, you 

will be punishing the victims. 

Mr. MORAN. The typical painting-with-too-broad-of-a-brush approach. 

Mr. SCHRYVER. Yes. 

Mr. MORAN. Mr. Hixson? 

Mr. HIXSON. I think we share a similar concern on the transparency front. And maybe to give a tangible example of that, it has 

been mentioned the bid has spread the market efficiency on the exchange traded side. And we certainly see that, as heavy users over 

on that side. But, a lot of that can occur with more transparency. 

And, actually, we, as end-users, will benefit because we will see 

these situations where you have pockets of similarly traded contracts and see what the spreads are. It is better than likely that 

a exchange can develop a contract that will provide that efficiency. 

So, there are a lot of gains to be achieved from the transparency 

alone that probably aren’t truly recognized. 

Mr. MORAN. Mr. Hixson, you talk about mandatory margining 

and capital charges. If that is included in the legislation and becomes law, how do you see that playing out in the marketplace? 

Mr. HIXSON. I think you will see a couple of different changes. 

You know, already it kind of depends upon where you are in the 

marketplace, if you will. In the heating and oil example I used, you 

might see more fuel surcharges. I think there are multiple ways of 

handling risk. It can either be done through an efficient means of 

some sort of a hedge. The other way to handle it is to try to force 

that onto your ultimate consumers. And some industries do that 

and do that pretty well. So I think you will see, kind of, a drive 

for more surcharges and of that sort of nature. 

The real challenge is if you are perhaps an international manufacturer, where you are building a bulldozer in Illinois and you are 

competing with a firm that is building them and has a home in 

Japan. Well, if they can hedge all the risks in their supply chain 

and you can’t, you have to go to that end customer and say, ‘‘Well, 

I would like to sell you bulldozers, but I am going to need a rider 

on there for any steel volatility I may have and a surcharge for 

steel. And, oh, by the way, if your local currency goes down, I am 

going to need a rider for that, as well.’’

So, when you are looking at those two bids, it is going to be very 

challenging for the U.S. manufacturer to compete with that inherent level of uncertainty in the bid that they can provide compared 

to the international competitor. 

Mr. MORAN. Thank you very much. 

Thanks, Mr. Chairman. 

The CHAIRMAN. I thank the gentleman. 

The gentleman from Georgia, Mr. Marshall. 

Mr. MARSHALL. Thank you, Mr. Chairman. 

I really appreciate the Chairman’s very practical approach to 

this. None of us is as facile as any of you are with regard to these 

issues. You know, we dabble in them; you live with them. And so 

we have to take a lot of guidance from you. 

And the Chairman has asked that you give us language. In addition to giving us the language, if you could explain why that lanVerDate 0ct 09 2002 11:29 Nov 04, 2009 Jkt 041481 PO 00000 Frm 00036 Fmt 6633 Sfmt 6601 I:\DOCS\111-29\53020.TXT AGR1 PsN: BRIAN
33

guage works and it is not going to create a loophole, that would be 

helpful. 

And those who think that exceptions along the lines that you all 

are suggesting should not be granted—no doubt they are listening 

in to this hearing—they probably ought to look at the language 

that is submitted and start suggesting to us what sort of loopholes 

would be created if we adopted that kind of language. None of us 

wants to excessively burden you. 

I find myself wondering—it seems to me quite likely that there 

are a very small number of swaps dealers that provide the hedging 

that you all need, and that in some instances the hedge is pretty 

substantial. I mean, it is a big deal for your businesses. And say 

you are looking to cover the cost of jet fuel in February anticipating 

X, and you want to be pretty sure that you can pay X and get the 

jet fuel you are going to need, and something happens in the market and all of a sudden X is 4X. You are relying upon the solvency 

of the entity that you are dealing with, and if that entity goes 

under, if the entity turns out to not have the wherewithal in order 

to meet the obligation, then you are kind of in trouble. 

And it would be natural, under those circumstances, for you to 

want the entity to be putting up capital as the market starts moving, you would want the entity to be margining in some way, just 

to protect yourself. 

Now, from our perspective, while we care about each of our individual businesses, I don’t think—your failure doesn’t pose a systemic risk, really. So we could say, ‘‘Well, that is your business. 

You are big boys. Why should we insist that you insist on some sort 

of margining, some sort of capital exchange to assure that the deal 

is going to be doable as the price catastrophically moves higher and 

higher and higher?’’

What we are really worried about is, what happens with these 

big banks? Historically here, in part, I guess, because they figure 

we will bail them out—and that is the unfortunate part of having 

to step in and do things like TARP—and we will bail them out 

without insisting that the shareholders take the hit or the bondholders take the hit, as they should—they should be the first entities to step up—they take excessive risks. And so, they are guaranteeing your swaps and other swaps, et cetera, and they are not putting up enough to assure that they are actually going to be able 

to meet these obligations. Things aren’t sufficiently transparent. 

And the upshot is that all these entities that are dealing with 

them, they are afraid to deal with them and we have another credit 

freeze and it happens 2 or 3 years from now. 

So, I also think you need to be telling us how we get around that. 

Do we say, ‘‘Well, it is only one side that is going to have to put 

up some collateral, it is the big banks that are going to have to put 

up some collateral,’’ as price moves in a certain direction, to discourage their risk-taking? I don’t know, and it would be great to 

have some guidance along those lines. 

Mr. HIRST. If I could, Mr. Marshall, in the current world, when 

airlines hedge in the swaps market and if price moves against us, 

we have to post collateral. So there is some balance in that world 

from our perspective. 

The biggest issue for us——

34

Mr. MARSHALL. Could I interrupt? 

Mr. HIRST. Yes, sir. 

Mr. MARSHALL. So you are already posting collateral, both sides 

to the transaction? 

Mr. HIRST. Yes. 

Mr. MARSHALL. You know, I have a sense that there are people 

out there right now talking about how they are going to develop 

the entity that is going to be providing the $100,000 that your dealer needs in doing a hedge and collateral—in doing those loans. The 

cost will be cost to carry it, it would seem to me if the market is 

working appropriately. 

So it doesn’t sound to me like there is that much change if you 

are actually putting up collateral anyway. 

Mr. HIRST. The big issue for us is the impact of the futures markets on spot prices. And the most important aspect of the Treasury 

proposal, from our perspective, is the authority it gives to the 

CFTC to bring that back into balance. 

Mr. MARSHALL. As the Chairman has noted, we have had hearings on this. We are with you; we have to figure that one out. We 

would like to see something reasonable done in that regard, and we 

have proposed legislation here. 

But back to this concern that these margining requirements are 

going to somehow really kill the market and unreasonably so. 

Mr. SCHRYVER. Right now, public gas systems, they will engage 

in an OTC transaction, bilateral transaction, and they will have a 

built-in agreement within that transaction where neither party will 

have to post collateral. 

Having standardized clearing would eliminate that ability for 

them to do that and they, in turn, would have to post collateral; 

and as I said, that would eventually raise their rates or it would 

reduce their ability to hedge. 

Mr. MARSHALL. My time is up, Mr. Chairman. If we have a second round——

The CHAIRMAN. Yes. We will get through the Members and then 

we will see. 

The gentleman from Texas, Mr. Neugebauer. 

Mr. NEUGEBAUER. Thank you, Mr. Chairman. Thank you for calling this hearing. 

Mr. Hixson, you talked about in your testimony that there could 

be some unintended consequences of this legislation. One of the 

things I am always concerned about legislation is, sometimes we 

are trying to address one thing and we maybe make a dab at that, 

but then we end up with some unintended consequences. And particularly right now in our financial markets we don’t need any unintended consequences, because we have them under about as 

much stress as they probably need to be at this point in time. 

This exemption piece we have heard testimony about, you mentioned the baker on flour. We have heard from a lot of small, intermediate-size businesses that they are using OTC derivatives to 

manage risks, and that it is more important for their working capital to be working rather than sitting in a margin account somewhere. 

35

Would Cargill be considered to meet the eligibility requirements 

of a clearinghouse? And then would you be required to clear your 

standardized OTC contracts? 

Mr. HIXSON. Some of the definitions we are not quite sure on, 

but—I mean, let me explain a little bit more in a generic sense that 

might add a little clarity to what we view as the conflict of interest. 

And the example I have been using is, say you are the doorman 

at a night club, and you are paid a dollar a person if they come 

in the door. Well, no matter how full the room gets paid, you kind 

of have a dollar incentive to let a few more people in the door. 

So to the extent that you have an entity that is built upon collecting that dollar by determining that more people are eligible, we 

would suspect that the threshold for eligibility would be pretty 

modest. So, yes, we would think under that scenario we would likely be forced into that category. 

Mr. NEUGEBAUER. You know, one of the things that goes on in 

the OTC market, and the analogy I would use is, there is a lot of 

credit lending, as opposed to using margin for, and that basically 

in many cases that you may loan that banker—baker a position. 

He is buying a position from you, and you are loaning him the ability based on his financial statement to do that. 

Is that a correct assumption? 

Mr. HIXSON. That is a correct assumption, and maybe I should 

just set shed a little light on kind of how that transaction works, 

and that might address a few of Congressman Marshall’s concerns 

as well. 

So in the baker example, what Cargill would likely do is work 

with the customer and figure out what specific volume they want 

to cover, what specific time frame they want to cover; and then 

what is their risk tolerance, as well as kind of how financial well 

capitalized they are. 

You know, you can pay more or less, depending on how much volatility you want to take out of the system. If you want to narrow 

it down very tight, it costs a little more; if you have a little wiggle 

room, it costs a little less. So you design the specific product for 

their risk thresholds. 

Then we, as the dealer in this case, turn around and do go and 

park off as much of that risk into the exchange, which we think 

is an absolutely critical piece of this. You know, there is value in 

mutualization of that risk, and we want to make sure that is clearly understood that the baker has the inherent risk on their books 

already because they have to buy the flour. So they are inherently 

going to be long in flour, if you will. The hedge just allows them 

to help offset that risk. But then throughout the supply chain as 

it moves back, we then seek to hedge as much of that risk as we 

can. 

Certainly we keep working capital for any portion of it that we 

can’t hedge, but by and large we seek to lay off as much of that 

risk in the regulated exchange, which we think is absolutely the 

proper thing to do. So what the baker in this case is doing is focusing on baking and kind of outsourcing the service of designing the 

hedge to a trading company. And Cargill certainly has a background in hedging and trading. 

36

Mr. NEUGEBAUER. Mr. Hirst, I want to go back. In your testimony you indicated that Delta does use the swap market, I believe, 

to do your hedging; is that correct? 

Mr. HIRST. That is correct, sir. 

Mr. NEUGEBAUER. But you are concerned about the volatility of 

the exchanges and with the speculation. Your indication is that 

there is too much speculation in that market, and you believe that 

is impacting the price of the commodity; is that correct? 

Mr. HIRST. Well, we think that all the futures markets, both 

over-the-counter swaps and exchange-based markets, have a price 

discovery function in the oil market; that is, they influence the spot 

price of oil. And so if we have a single issue that is of overriding 

importance to us, it is the necessity of imposing position limits on 

speculative activity in these markets. 

Mr. NEUGEBAUER. Just a final question then. You said there is 

too much speculation. We have heard people say that testimony before. 

What is the appropriate amount of speculation in the market? 

Mr. HIRST. Sir, in our view, the appropriate amount of speculation is that amount which provides sufficient liquidity for hedging 

to occur, but not so much that it creates volatility in the market. 

And where that level is probably can’t be determined with scientific 

precision. 

But when we look at the history of oil prices in relation to the 

level of speculation, if you look back about 10 years, what you 

would see is that the level of speculation in relation to hedging by 

producers and end-users was about 25 percent or thereabouts. And 

it is currently about three times that. It is something on the order 

of 70 to 75 percent of the activity in the futures market, so people 

have estimated. 

And so we believe that is out of balance. 

The CHAIRMAN. I thank the gentleman. 

The gentleman from Georgia, the Subcommittee Chairman, Mr. 

Scott. 

Mr. SCOTT. Thank you, Mr. Chairman. 

I would like to get each of your responses to this scenario. Presumably we are working on increased regulation and improving 

transparency in the over-the-counter markets in order to protect 

end-users of commodities and, ultimately, consumers from excessive speculation, however you may define that, which may lead to 

unwarranted spikes in the prices of commodities. 

There is a real risk, however, that too much regulation—that is 

to say, too strict clearing requirements or capital requirements that 

are too high—could actually prevent end-users and legitimate 

hedgers from mitigating their risks. In fact, it seems the loosely defined end-user commodity, as diverse as it is, is not really of one 

mind on this issue, with some fearing the loss of their ability to 

hedge more than they fear the effects of speculators. 

So it would appear that the Treasury has recognized the risk to 

legitimate hedgers in its proposal, that its proposal may pose and, 

as such, they have tried to build in some exemptions to its clearing 

requirements. However, these exemptions are tied to what seems 

to be a long and complicated set of conditions placed on the contract participants. 

37

Now, many of you all have touched on this before, but I would 

like each of you to elaborate on, one, whether or not you think 

these conditions are overly stringent; two, whether or not you think 

you would qualify for these exemptions as they stand now; and 

three, if not, would exposure to these new clearing and capital requirements prevent you from doing the hedge your business needs 

to do either for financial or technical reasons? 

Mr. HIRST. I would be happy to start, sir. 

As I mentioned earlier, airlines generally, when they hedge, 

hedge in the swaps markets with nonstandardized instruments 

that don’t require posting initial margin, although if the price 

moves against you, then you do have to post margin. But you enter 

into an agreement with the swaps dealer that, in effect, extends 

you credit for that initial margin requirement. 

To the extent that the rules change and airlines are required to 

post initial margin in order to hedge, it would deter hedging. To 

the extent that we are able to continue hedging in other fora without having to post initial margin, we would welcome that. 

Mr. SCHRYVER. From APGA’s perspective, I don’t know if I would 

use the word—an overly stringent definition, but we think the definition—if the intent is to exempt end-users that don’t pose a systemic risk, we think the definition can be clarified. 

In terms of if we do qualify for the definition under the current 

language that is unclear to us, we are not sure if we would be exempted or not, which is one of our concerns. And that is why we 

support clarifying the definition. 

And third, if we did fail to qualify for the exemption and would 

be required to post collateral, it would certainly impact our members’ ability to hedge. 

Mr. ENGLISH. We believe that most of our contracts, as it applies 

to natural gas in particular, would be considered standardized. And 

as a result of that, that would put us in a position that the margin 

requirements would be such that it would be unaffordable for our 

members. And that is where our difficulty comes in. We have to 

keep it affordable and we have, in order to take care of risk, we 

have to hedge. So if this crowds us into a position that it becomes 

unaffordable for us to hedge, then obviously, the risks become enormous. 

Mr. HIXSON. I think we tend to agree. We would say the contingencies are a little too stringent. I think they can clarify. 

What we view as their intent was to try to remove hedgers from 

this obligation, and we think yes, we probably would be captured 

under this. There is an incentive to capture as many people as you 

can, and we think the ultimate end result of this would indeed be 

to have less hedging. 

Mr. SCOTT. Thank you. Your comments have been very helpful. 

Thank you, Mr. Chairman. 

The CHAIRMAN. I thank the gentleman. 

The gentleman from Virginia, Mr. Goodlatte. 

Mr. GOODLATTE. Thank you, Mr. Chairman. I want to thank you, 

as others have, for holding this hearing, in fact, a series of hearings 

which are very important as we work on this issue. I would like 

to ask anyone on the panel about the authorities that are proposed 

to be granted in this proposal. Everyone, well, I should say, almost 

38

everyone supports greater transparency, but transparency alone is 

not enough. Additional authorities need to be granted to the regulators so that the information that comes along with greater transparency is meaningful. What regulatory authorities that are in this 

proposal do you agree with? What ones do you disagree with? And 

are there others that are not in this proposal that you would consider? Anyone want to jump in there? 

Mr. HIRST. I would be glad to start. Really I am just repeating 

what I said earlier sir. But the most important issue from the airlines standpoint is position limits in the oil futures market. And 

this proposal clarifies the CFTC’s authority to impose position limits in all markets that have a price discovery function of significance, not just the exchanges. 

There is ambiguity largely because of the loopholes in the Commodity Futures Modernization Act; and we think the thrust of this 

bill, if it becomes a bill, would be very helpful in that regard. 

Mr. GOODLATTE. Anyone else? Mr. Schryver? 

Mr. SCHRYVER. We also support position limits. We think they 

need to be enforceable, as Mr. Hixson said. We also think they 

need to be aggregate, so you don’t have a case where an entity 

moves from one area to another to escape position limits. 

Mr. ENGLISH. Reporting and position limits. 

Mr. HIXSON. I think we are directionally okay on the transparency. But you have hit on probably—what we would probably 

view as the most complex part of the bill is truly understanding 

what the authorities are relative to the CFTC, SEC, and how they 

are split. I will have to just get back to you with a more detailed 

answer. 

Mr. GOODLATTE. Okay. Thank you. 

You know, this Committee has witnessed firsthand how poorly 

the CFTC and the SEC work together. The Commodity Futures 

Modernization Act passed by this Committee nearly 10 years ago 

charged them with a few joint rule-makings. We are still waiting 

for the two agencies to produce what the law mandated a nearly 

a decade ago. 

This proposal is replete with joint rule-making between the 

CFTC and the SEC, and I want to know if this causes any concern 

to anyone. Is anyone concerned that the Secretary of the Treasury 

will make the decision if the two independent regulators can’t? 

The gentleman from New York is concerned. Anybody on the 

panel? 

Mr. ENGLISH. I have a little history with that, and I think your 

concerns are very valid. I think you have to take that particular 

provision with an understanding of the history and the likelihood 

of not much improvement for the future. So it sounds good, it is 

a nice phrase, but the history kind of indicates it is not likely to 

take place. 

Mr. GOODLATTE. Is there anyone else? 

Let me also ask you—and again I will address this to the whole 

panel—what percentage of your current swap contracts would be 

considered standardized, and how much more do you think it will 

cost to trade those same contracts on-exchange and have the contracts cleared by a designated clearinghouse? Where will you get 

39

the money to cover the increased costs, and how will the trading 

and clearing mandate affect your risk mitigation strategy? 

Mr. HIRST. On behalf of Delta Air Lines, and I can’t really speak 

with precision for other airlines, virtually all our hedging activity 

takes place in swaps market. We do not have to post initial margin. 

If we had to transfer that activity into the regulated exchanges, 

post initial margin, a sort of back-of-the-envelope estimate that we 

made a couple of weeks ago was that it would cost us about $300 

million annually in liquidity. 

Mr. SCHRYVER. From APGA’s perspective, most of the contracts 

we engage in we believe would be considered standardized. It 

would have a significant cost upon our members at roughly $5,000 

a contract; it would certainly reduce their ability to hedge. 

Mr. ENGLISH. Most would be considered standardized. There is 

no question that it would cost us hundreds of millions of dollars, 

and we would just have to borrow the money. 

Mr. GOODLATTE. And Mr. Hixson. 

Mr. HIXSON. Well, that is an interesting question. Like I said, 

even though we trade the vast majority, some 85 to 90 percent, 

kind of, on the exchange already, the move to roll in these other 

products would cost us an additional billion dollars a year. 

Mr. GOODLATTE. That is pretty—collectively, you are talking 

about a couple of billion dollars or more. That is pretty stunning. 

Mr. Hixson, currently, when you enter into a swap, do you know 

who your counterparty is? 

Mr. HIXSON. Yes, we do. That is kind of the nature of the swap. 

It is a very bilateral transaction between two known 

counterparties. 

Mr. GOODLATTE. How much due diligence do you conduct before 

you enter a swap with most of your other parties? 

Mr. HIXSON. An enormous amount. It is a critically important 

component of what we do. 

First of all, we typically try to have a relationship with them and 

understand what their business model is. We generally offer most 

of our hedging activities in markets where we have some physical 

presence, so it is in the food and agricultural and maybe energy industry. So we do that. 

We also do margining with about 80 percent of our customers, so 

it is not like there is no margin that goes on, it is just set on a 

different parameter. And then we also have an independent credit 

department within the company as well. So we do margining, a lot 

of research on understanding their physical needs and their risk 

tolerances, and then also have credit analysis on top of that 

Mr. GOODLATTE. Mr. Chairman, I know my time has expired. I 

wonder if I could ask one follow up to Mr. Hixson about that. 

If you are forced to clear, does the increased cost of clearing pay 

for the benefit of not needing to know who your counterparty is, or 

is that just a cost that outweighs the benefit? 

Mr. HIXSON. Well, it probably outweighs the benefit because we 

use the markets for different purposes to some degree. Like I said, 

we trade extensively, and we are huge fans and just supporters of 

the regulated exchanges. For price discovery and for the bulk of our 

trading and hedging activities, they serve that purpose really well. 

40

But the expense you would be adding on the over-the-counter 

side for many counterparties and customers that don’t have that 

in-house trading and hedging expertise that would by far outweigh 

the benefit over there. 

Mr. GOODLATTE. Thank you. 

Thank you, Mr. Chairman. 

Mr. BOSWELL [presiding.] Let’s see. I am trying to fill in up here 

and see who we have up next. I believe it is Mr. Schrader from Oregon. 

Mr. SCHRADER. Thank you, Mr. Chairman. 

I guess a question for the panel as a whole is, a few years ago, 

the CFMA was passed; and I am curious how that changed your 

investment, your accounting and your hedging practices, and 

whether or not it affected the margins you are required to have. 

Mr. Hixson, I’ll start with you. 

Mr. HIXSON. Cargill has been in the risk management business 

offering customized risk contracts and the OTC product since 1994. 

So for the types of bilateral transactions we do, where we oftentimes have a relationship of selling the product—corn or beans or 

flour, for example—it didn’t really change much in the dynamics of 

the products that we tend to offer. 

Mr. ENGLISH. We created a group that I mentioned earlier known 

as ACES Power Marketing. It is owned by our members. It is there 

specifically for that purpose, to handle risk management, and to 

also do the kind of examination, as far as counterparties are concerned, that minimizes any exposure we might have. 

Mr. SCHRYVER. The CFMA did provide greater certainty to 

swaps, and as a result, more of our members are using them to 

hedge. 

Mr. HIRST. Mr. Schrader, our main concern with the CMFA is 

the effect it had on the CFTC’s jurisdiction over the nonexchangetraded futures markets and the impact that that has had, we 

think, on increasing speculative activity and causing volatility in 

the spot market for oil. 

Mr. SCHRADER. I tend to agree with Mr. Hirst. I would think that 

is a critical element that needs to be readdressed, and hopefully we 

get to, to some degree, in legislation here. 

Most of you have testified about the margin requirements being 

perhaps the most onerous of the potential changes you see coming 

down the road here, and some exemption for end-users. Could you 

define that a little bit more and assume you are trying to get to 

the middlemen that have no stake in the game, if you will, at any 

point in the process? Could you talk a little bit more about how you 

would exempt end-users? 

Mr. HIXSON. In our testimony, I think we kind of characterize 

what we think the intent of the legislation is, to go after the hedger, the classical definition of somebody, like I said, the baker who 

has the underlying flour coming into their business and they need 

to run their plant. So that is kind of how we structured our test 

for what would be the proper terms of the exemption, would be 

whether or not, kind of like the folks at the table, you are a classical hedger. You have an underlying commodity; you are just trying to lay the OTC hedge on top of that to take out the volatility 

and to address the risk. 

41

Mr. ENGLISH. I would agree. 

Mr. SCHRYVER. Yes, we would also support an exemption for 

hedgers. 

Mr. HIRST. I thought Mr. Hixson’s articulation was clear. We 

agree with it. 

Mr. SCHRADER. So you could come up with the language, I assume, to make that possible. I think the Committee would be interested in that. 

I yield back my time, Mr. Chairman. 

Mr. BOSWELL. Thank you. 

Mr. Roe. 

Mr. ROE. Thank you, Mr. Chairman. I have just a couple of quick 

questions. 

Everybody always hates to pick up the phone the day your 

broker is on the line to let you know your margin call is in. And 

I guess, Mr. English, I am going to you because I live in a rural 

area of Tennessee. I wonder about the costs of this, added costs, we 

have, potentially, the carbon tax that is going to add cost to our 

consumers in these rural areas and then across America. 

How much are you talking about for the individual customer or 

business out there? I mean, I know you are paying interest on the 

money you have to borrow and you have to find a line of credit and 

all that. 

The same thing I guess would go for Mr. Schryver, too. 

Mr. ENGLISH. I think you have to view this—what we are discussing here today is the world as it exists today. We would expect 

that you are going to see a significant change either through the 

Clean Air Act and the dealing of the issue of carbon through that 

mechanism or through any legislation. 

And as we move forward in trying to deal with that—for instance, a lot of our members are going to be looking to natural gas 

in the short term. That is good news for Mr. Schryver. He is very 

happy with that. 

But the point that I would make is, that brings a good deal more 

volatility in this whole issue, so there is a greater need to hedge. 

There is a greater risk that we are going to be facing. And depending upon how this legislation addresses this particular problem, obviously, it could very well be hundreds of millions of dollars very 

easily, just with regard to addressing this question. That’s not 

counting additional costs we might have as we have to make a conversion, which is going to be very costly indeed. 

Mr. ROE. If you are covering 12 percent of the population——

Mr. ENGLISH. That is correct. 

Mr. ROE. It would be more than hundreds of millions if you are 

hedging. 

Mr. ENGLISH. That is—again, it is difficult to estimate how risky, 

how much additional risk would be involved. But just looking at 

natural gas alone and the shift we would anticipate, obviously it 

is going to be far greater than what we are looking at today, without question. 

Mr. SCHRYVER. Actually—and in terms of climate change legislation, we are actually a little concerned. I don’t know how much 

Public Gas is going to benefit because we are concerned about more 

natural gas being used for electricity generation. 

42

As Mr. English said, it will become the fuel of choice; it is going 

to increase demand and drive up the prices. And our members are 

the direct users of natural gas. So that actually is one of our concerns, largest concerns, about climate change is the price of natural 

gas being driven up. 

In terms of the cost of margining, I will use one example. One 

of our members, that also generates electricity, will hold thousands 

of contracts at one time as part of a 3 year hedging program. They 

anticipate that it would increase their costs by about $25 million. 

They also did a prepay, which is a tool Congress endorsed as part 

of the Energy Policy Act of 2005. It allows the use of tax-exempt 

financing for natural gas contracts to allow public gas systems to 

provide natural gas for their consumers over the long-term at a 

lower rate. 

And those prepaids are very large, over long periods of time, 

sometimes as long as 30 years. One prepay involved 15,000 contracts. And to clear that prepay at $5,000 a contract, you are talking $75 million, which, in effect, eliminates the ability of public gas 

systems and public power systems to do prepays. 

Mr. ROE. Well, we know that natural gas companies are going to 

pay, consumers are. I mean, that is who pays the bill. When you 

talk about paying it, that is who is going to pay it. 

And I guess what we want to do in the futures market—quite 

frankly, it seemed to work pretty well during this financial crisis, 

banking crisis and so forth that we had. It seemed to work fairly 

well because there is a buyer on each side of the trade. And I 

mean, it worked well. 

I guess putting those requirements so high on what you are talking about adds another cost to the consumer, along with other costs 

that are heading along. And I know the co-ops in our area work 

as hard as any business I have ever seen to keep the costs down 

for consumers since they are nonprofits. 

Thank you. I yield back my time, Mr. Chairman. 

Mr. BOSWELL. Thank you. 

Mr. Kissell. 

Mr. KISSELL. Mr. Chairman, the couple of questions I had prepared basically have been asked. I am going to yield my time to 

Mr. Marshall from Georgia. 

Mr. BOSWELL. Okay. Mr. Marshall. 

Mr. MARSHALL. Thank you, Mr. Kissell. 

You all can really help us out a lot, as you give us advice concerning how to modify the proposal so as not to unduly burden you, 

if you can really pin down what the cost of the burden would be. 

And I am certain there are folks out there, right now, working 

up a business model where they are going to lend margin money. 

And so it is a matter—obviously, I am asking you to assume that 

that market will be there; and so let’s say it is a billion dollars’ 

worth of margin money that is needed. 

What is going to be involved in the cost to carry for borrowing 

that money? What is the real cost of putting up margin? And then 

the typical swaps deal contemplates that as the price moves, money 

is going to get put up. 

So that is the other thing. If we require clearing and if, in essence, the clearing organization is going to require the exact same 

43

money to be put up as the price moves, that doesn’t really change 

anything at the moment. But what it would maybe tend to do from 

our perspective is give us greater comfort that there is less systemic risk on the other end since all this stuff seems to be packaged in just a few AIG-type entities. 

And if you could help us think through that, I think it would be 

enormously useful to us because we just don’t have the kind of expertise that you all have. 

Now, it may be we can avoid the systemic risk that is our real 

focus here. I mean, as I said before, we all think, the Chairman is 

absolutely determined not to put any burden on you, or on your 

customers, or on American consumers that we don’t view as really 

necessary to avoid systemic risk. So if you can come up with some 

other way that we can minimize the systemic risk that these big 

banks pose, that would really be helpful to us. And obviously to 

others who are listening in on the hearing with views on both 

sides, that would be enormously helpful as well. 

With that, Mr. Chairman, Mr. Kissell, maybe I should yield back 

to you if you have some additional thoughts along those lines. 

Mr. KISSELL. Thank you, Mr. Marshall. 

Mr. Chairman, I yield back. 

Mr. BOSWELL. Okay. I believe that you are next in line. Please. 

Mr. CASSIDY. I moved up here without a sign. I am Mr. Cassidy. 

You know, you guys think about this all the time, and I am trying to understand it now from your perspective. But in my mind, 

I think of those folks who would like to do an OTC, such as you 

collateralizing your capital to somehow interface with the folks that 

would do a monetized exchange. 

I think of that kind of Greek myth of Janus, the god that looks 

both one way and the other. This legislation obviously is trying to 

create something to interdigitate the two systems, OTC and an exchange. How would you do it? 

If you were running the exchange, Mr. Hirst, I guess Delta puts 

the value of their jets as collateral, I can imagine. How would you 

interdigitate this OTC market with the standardized exchange? 

Mr. HIRST. Well, sir, again, our major concern is in the price of 

the commodity itself. And hedging is a luxury for us in relation to 

actually buying oil, which is a necessity. 

The volatility that the market has experienced over the last several years has not only increased our fuel costs, but it has vastly 

increased our cost of hedging. And so my answer to that question 

really is to—is really the Administration’s answer here. I think it 

is to give the authority to the CFTC to think through how that relationship should be managed. 

Mr. CASSIDY. Mr. English, how would do you that? You have 

written legislation before, so——

Mr. ENGLISH. I think we are dealing with—and it was mentioned 

earlier—between the CFTC and the SEC. I haven’t examined recently what the budget is of the CFTC. But historically speaking, 

CFTC has been viewed more as a stepchild from the standpoint of 

appropriations and resources. It came into being at a time in which 

regulation was not in vogue, didn’t have the support, I don’t think, 

of the Congress, political community in general. 

44

I think, without question, in many of these areas, it is not just 

a question of what is in the law, it is a question of whether or not 

the regulatory agency is going to have the resources to be able to 

carry out the law in a fashion which is intended. 

Mr. CASSIDY. So, you are suggesting that you wouldn’t necessarily interdigitate the two. You would rather just strengthen the 

ability of the CFTC to monitor and create transparency and allow 

the market to continue somewhat as is? 

Mr. ENGLISH. I think that is an area that I would certainly examine carefully. And as I said, I haven’t reviewed where we are, 

from a resource standpoint, of what the strength is. And I am 

thinking about this from years ago, but I doubt that it has changed 

all that much, to be honest about it. 

But I think that as we move forward on this, we have to keep 

in mind, keep in view that people such as ourselves, we are looking 

for a way in which we can deal with the risk. 

Mr. CASSIDY. Let me move on just because I am going to run out 

of time. 

Mr. ENGLISH. Right. If the cost gets too high then we are out of 

it, so it would defeat the purpose. 

Mr. SCHRYVER. I believe Mr. Hixson discussed a dealer taking on 

that function, and that is something that we would support. 

Mr. CASSIDY. So will you repeat that, sir? 

Mr. HIXSON. I want to make sure I have clarity on your question 

too. If I understand it correctly, it is kind of what—how would you 

correlate the relationship, if you will, in the regulatory status of 

the over-the-counter side and the regulated exchange side? 

Mr. CASSIDY. As I understand, the end-user would be exempt unless somehow—but on the other hand when you transfer into the 

standardized exchange, the exemption becomes threatened, if you 

will. 

Mr. HIXSON. Correct. So that is why in our testimony and kind 

of our recommendation, what we—the modifications we made really steered it towards looking more at the what the transaction is. 

If it goes back to that classical sense of, it is a hedge and there 

is an effective hedge on an underlying risk, then that is the nature 

of the transaction that should grant the exemption. That is a more 

appropriate standard in terms of what you are trying to prevent in 

the over-leverage and the types of things that would capture those 

under that metric, but would kind of allow the conventional hedging that we are talking about to continue. 

So that is kind of how I think we——

Mr. CASSIDY. So would the utilities still be able to put up their 

capital assets as collateral for the purchase of a large amount of 

natural gas? 

Mr. HIXSON. To the extent that is appropriate. 

I mean, I guess the main kind of OTC contracts are generally secured in one of three ways. They either use a credit agreement, 

they use collateral or they use some kind of margining. And it is 

important to recognize that within the over-the-counter markets, 

the classical hedging side of the uses that were described here went 

through a very tumultuous year and performed well. 

So the challenging side of the market was where it gets kind of 

split, leveraged, sold, far removed from the underlying product; and 

45

it is a little bit of a strain in our minds to call that necessarily a 

pure hedge anymore. So that is why we choose that area to draw 

the line. 

Mr. SCHRYVER. Of those three options you laid out—collateral, 

margining—a public gas system, its constitutional documents 

would really prevent it from putting up its system as collateral. 

And I can’t think of any of the city councils that regulate our members that would allow them to do that. So it is really not an option 

for us. 

Mr. CASSIDY. Okay. Thank you. 

The CHAIRMAN [presiding.] The gentleman from Ohio, Mr. 

Boccieri. 

Mr. BOCCIERI. Thank you, Mr. Chairman. 

Just a quick question, specifically to the testimony of Mr. English 

from the Rural Electric Cooperatives. How will OTC reforms affect 

or not affect states that have a very solid regulatory authority like 

Ohio with the Public Utilities Commission? And how, somehow, is 

that managed with respect to the risk associated, taking on derivatives? 

Mr. ENGLISH. As far as the state regulatory body, I am not sure 

that that would have any impact. I am not sure on Ohio. I am not 

that familiar with it, but I don’t believe it would have any impact 

as far as dealing with the risk issue in any particular specific way. 

It wouldn’t vary from state to state whether regulated or not. 

As you are probably aware, some states’ electric cooperatives are 

regulated, other states’ are not. But I don’t believe in this case it 

would make any difference. 

Mr. BOCCIERI. So no risk decisions are made based upon states 

that have regulatory authority with respect to derivatives that they 

take on? 

Mr. ENGLISH. In this particular case, with regard to whether it 

is either dealing with interest rates or currency swaps done 

through our national association, or whether it is done through 

ACES, which your G&T in Ohio does participate in, if I recall correctly and is a member of, it would be done through that national 

association and not specifically through the local, I don’t believe. 

Mr. BOCCIERI. Specifically, I was referencing the section in your 

testimony that says, ‘‘OTC markets manage the price volatility risk 

for our consumers who expect affordable electricity prices and electric suppliers.’’ I was just curious how you were drawing the connection between the OTC markets and electricity prices in states 

that have regulatory authorities. 

Mr. ENGLISH. Well, what I was referring to and what the concern 

is, if we get into a situation between the regulatory body on the 

Federal level and FERC, we do have issues of concern with regard 

to getting regulated by two Federal bodies as opposed to state bodies. So that was a reference to FERC and the fact that they do, in 

fact, have jurisdiction over any physically settled transactions 

that—and under the Treasury proposal, as I understand it, there 

is an exemption, but it is not clear to our satisfaction that that 

would take care of the problem. 

Mr. BOCCIERI. Okay. 

46

I just want to be clear that I understand this. So you are suggesting that there would be an attempt to usurp state authority to 

help regulate and control prices? 

Mr. ENGLISH. Well, there very well could be, under these circumstances, depending on how this transaction played out. But jurisdictional questions obviously are always of paramount interest, 

and the thing that concerns us is if there is confusion with regard 

to jurisdictions or if we are, in fact, regulated by competing bodies. 

Mr. BOCCIERI. Okay. 

Thank you, Mr. Chairman. 

The CHAIRMAN. I thank the gentleman. The gentlelady from 

Ohio, Mrs. Schmidt. Did you ask questions already? No questions. 

Mrs. SCHMIDT. No, not at this time. 

The CHAIRMAN. Mr. Thompson. 

Mr. THOMPSON. Thank you, Mr. Chairman. 

I thank the panel for coming in and sharing your experiences. I 

want to back up a little bit for kind of a 35,000 foot look at this. 

We hear a lot about the driving force behind this; the keyword has 

been ‘‘volatility,’’ and I was really interested in getting your impressions of the situation from your—and your observations. 

In terms of trends by commodities, are there specific commodities 

that you see the risk of volatility? 

You know, sometimes we see a one-size-fits-all-type approach to 

addressing problems, and it has a lot of unintended consequences. 

We have also heard that word here in the hearing. And so I was 

curious to see if, in your observations, your experience, are there 

specific commodities that really are within this risk of volatility to 

be impacted that way? 

Mr. HIRST. Mr. Thompson, I don’t claim to be a commodities expert from the airline business. But we have been focused on the 

price of oil over the last 2 years because we have seen so much volatility in the price that we have had to pay. And as I have tried 

to study it, it has become clear that oil is a commodity that is highly susceptible to the levels of speculative activity in the futures 

market. 

Now, when I observe what is happening in other commodities, I 

can’t say that the same factors that are affecting the price of oil 

work exactly the same way in, say, the gas market or in other markets. So I tend to agree with your observation that one-size-fits-all 

approaches probably won’t work, and that there are different problems in different areas. There are different issues and different 

kinds of systemic risks presented by financial derivatives, financial 

markets versus derivative activity in commodity markets, for example. 

Mr. THOMPSON. And I bring that up, because in listening to you 

reading your testimony and listening to your remarks, I have heard 

you talk about—when we talked about commodities, we have been 

talking about energy, energy, energy. And even Mr. Hixson, part 

of the testimony was energy—not all, but part of it. And so I wondered if there were any observations of other areas of commodities. 

Mr. HIXSON. Maybe I could share one example, that it just highlights the challenge of tightly correlating volatility with speculation 

or whatever the activity is. And the example I would use is one of 

the more volatile commodity markets last year was the hard red 

47

spring wheat market in the Minneapolis Grain Exchange, not a 

large commodity market and has virtually no index money it. 

Wheat went to $25 a bushel last year and was by far one of the 

more volatile than probably Chicago or the other commodity markets that also traded other categories of wheat. 

So it is not always easy to correlate strictly volatility, per se, with 

distribution of participants in the market. 

Mr. THOMPSON. Thank you. 

We have talked about petroleum, and of course we have a couple 

of witnesses that deal directly with natural gas. And obviously, 

that is not a world market, meaning that we can significantly influence its price here at home through supply and demand. 

Mr. Schryver, in your view, what role has domestic supply played 

in the volatility of the natural gas prices? 

Mr. SCHRYVER. In going back to what you said earlier in terms 

of volatility, natural gas has been one of the more volatile commodities out there. I think last year the price hit $13, and now it is 

down below $4. We are not complaining about that, but unfortunately, some of our members did buy $13 gas, and they should 

have because their hedging strategies would entail them buying 

gas at certain times, and just hoping the price will come down is 

not a viable hedging strategy. 

And we are not opposed to all volatility. We understand commodities will have some volatility. It is just unwarranted volatility that 

has our members concerned. 

In terms of natural gas, as you mentioned, it is domestically produced. And as Mr. English stated, as Congress anticipates climate 

change legislation, that demand for natural gas is going to be driven up even more. And that is one of our concerns. We would certainly—we have pushed for and we would be very supportive of 

Congress opening up more areas for production and allowing more 

production of natural gas. The more supply you have, to some extent you are going to reduce the volatility of the commodity. 

Mr. THOMPSON. Well, I have 15 counties with Marcellus Shale I 

would love to offer for that. 

Congressman, it is good to see you again. Just real quick—final—

obviously, Pennsylvania relies really heavy on coal and oil and natural gas for energy demands. And I just wanted to get your impact 

on what effect this legislation, if it would go through, as it is at 

this point, would have on overall electricity costs. 

Mr. ENGLISH. Well, for our members, and again, looking to the 

future and taking into account climate change, we could think it 

could have a huge impact. We think it could, in fact, increase electric bills and increase them considerably. 

And we fully understand and appreciate where the Committee is 

going, appreciate the objective of the Committee, but this is a balancing act that we are looking at here. On one hand is the cost of 

the risk, on the other hand the cost of the regulation. And somewhere in here we have to find a way in which we can hedge and 

deal with the risk and still make it affordable for people like us. 

Mr. THOMPSON. Thank you. 

The CHAIRMAN. I thank the gentleman. 

The gentleman from Michigan, Mr. Schauer. 

Mr. SCHAUER. Thank you, Mr. Chairman. 

48

Mr. Hirst, I want to direct a question to you. Thanks for being 

with us. Thanks for all of you. Your airline has a major presence 

in my State of Michigan. I appreciate that. And I am studying your 

testimony very carefully. 

Your airline, it indicates, eliminated nearly 10,000 jobs in 2008 

as a result, at least in part, of oil price volatility. It is difficult to 

estimate how many jobs were lost overall in our country’s economy 

due to that price volatility and the market. Consumers certainly 

experienced that at the gas pump, certainly in the price of groceries 

and a number of other areas. 

You talked about how a certain level of speculative investment 

in commodity markets has the benefit of injecting liquidity into the 

market. But then you state that Congress should provide the Commodity Futures Trading Commission with the authority and guidance it needs to ascertain the proper level of speculative investment in the market. 

Give me the best guidance you can. What is that proper level? 

I am very concerned about the impact on speculation driving up 

prices, costing us jobs, and hurting our economy. So can you expand upon your written testimony and give us some more guidance 

on that proper level? 

Mr. HIRST. Well, I will do the best I can, sir. 

Ten years ago, if you looked at various measures of the volatility 

of oil prices, spot prices, you would conclude that the level of volatility was not high. From 1998 roughly through 2003–2004, the 

years’ high price versus the years’ low price varied about $15 or $16, typically. 

Since that time, as speculation in the market has gone from 

about 25 percent of the market, the oil futures market, to 70 or 75 

percent, volatility has increased. So, on an annual average over the 

last 3 years it has been over $50. And so I would say, at least as 

a starting point, one ought to go back to a period of time, not so 

long in the past, before index funds became a huge factor of the 

market, and look at what the level of speculative activity was then 

and use that as a benchmark. And our estimate is that that was 

in the 25 percent range. 

There was adequate liquidity. People who wanted to hedge could 

hedge. And airlines that needed to buy fuel could buy fuel without 

experiencing the kind of devastating impacts we experienced in 

2008 that led directly to the loss, as you said, of 10,000 jobs. 

Mr. SCHAUER. How do you do that from a regulatory standpoint? 

Do you set a cap? 

Mr. HIRST. Yes, sir. There are two ways, and both—we think 

both techniques should be adopted. It is possible to put an aggregate limit on the level of speculative activity that is financial activity as opposed to activity by commercial users and producers at a 

level. And when I was speaking earlier of 25 percent, I meant that 

as an aggregate limit. 

In addition, individual limits can be placed on participants in the 

markets to ensure that no individual participant has too much influence. 

And both approaches have been given a lot of thought by the 

CFTC and others. 

Mr. SCHAUER. Thank you. 

49

The CHAIRMAN. I thank the gentleman. 

The gentleman from New York, Mr. Murphy. 

Mr. MURPHY. I want to go in a little different direction. 

As we have seen so many of the banks pull back and some consolidation in the financial sector, has that impacted liquidity for 

you as you have been trying to hedge? Have you guys been having 

trouble getting the bilateral contracts or getting as aggressive a 

pricing? 

Mr. HIRST. We have had no problem hedging. 

Mr. SCHRYVER. We have not heard any concerns from our members. 

Mr. ENGLISH. We have heard concerns from our members about 

this, yes. 

Mr. MURPHY. So they are seeing spreads widen? 

The other piece that I hear a lot is, people say one of the problems with some of the bilateral stuff is that you may be able to get 

aggressive pricing getting in, but in a bilateral you don’t have the 

ability necessarily to get as aggressive a price in getting out. 

Do you guys see that if you ever tried to? Or maybe you guys 

don’t actually try to, if you are using these hedges, you may never 

try to get out of some of these transactions, but I am curious if you 

have seen spread problems when you try to get out. 

Mr. ENGLISH. Just about everything we are doing is hedging. We 

are strictly focused on hedging. 

Mr. HIRST. Sir, in 2008, when oil spiked at $147 a barrel and 

then in September dropped very rapidly, a number of airlines, including Delta, were unable to unwind hedges and experienced very 

significant hedge losses as a result. And that kind of volatility, 

while it hasn’t impacted the availability of hedging, has significantly increased the risk and the prices that we have had to pay. 

Mr. MURPHY. Mr. Hixson, did you want to get in on either of 

those? 

Mr. HIXSON. No, sir. 

Mr. MURPHY. Okay. So some of the people that we see testimony 

from—and this is more on the financial side, but I am curious 

about how it would impact you guys. If we went to a clearing system and got away from some of the bilateral stuff or more of a fungible clearing system, that that might help with that you describe, 

Mr. Hirst, and make some of this stuff more easily transactible 

with other counterparties. 

Is that something that you guys worry about at all? Or is that 

an issue that just doesn’t seem to apply? 

Mr. HIXSON. I don’t think that seems to apply in our case. I think 

we have said it before. We kind of welcome the moves on transparency, but the tradeoff that you would get on the cost structure 

and the challenges on working capital would be farther off-site. 

Mr. MURPHY. I follow that for sure. 

That is all. I yield my time back. 

The CHAIRMAN. I thank the gentleman. 

Anybody else? 

Mr. Marshall, do you have a follow-up? 

Mr. MARSHALL. Mr. Kissell was kind enough to yield me some 

time. Thank you, sir. 

50

The CHAIRMAN. Well, I think that will wrap it up for this panel. 

Thank you very much. I think we have gotten some good information that we need to focus on and figure out how we sort this out. 

So I thank the panel for your testimony. Send us your ideas, and 

we will take a look at them and see what we can do. Thank you. 

They were talking about having votes, but I guess we will call 

the next panel and, hopefully, see how far we can get here. And 

we have to switch around the nameplates, I guess, and so forth. 

But while we are doing that, and to save time, I will announce 

the panel, panel two, which is Mr. Gary O’Connor, the Chief Product Officer of the International Derivatives Clearing Group of New 

York; John Damgard, the President of the Futures Industry Association in Washington; Mr. Terry Duffy, Executive Director, of the 

CME Group of Chicago; Mr. Robert Pickel, Executive Director, 

Chief Executive Officer, International Swaps and Derivatives Association, New York; Mr. Johnathan Short, Senior Vice President, 

Intercontinental Exchange of Atlanta; and Mr. Daniel Budofsky, 

Davis Polk & Wardwell on behalf of the Securities Industry and Financial Markets Association. 

I think we have about 10 minutes, so we are going to have two 

of you give your testimony and then we are going to have to take 

a break to have votes and we will be back. 

Does anybody know how many votes we have? Nine to ten. Well, 

we will get a couple of you guys’ testimony in, and then it sounds 

like there will be time for you to go have lunch, because we have 

nine or ten votes, so it will probably be an hour before we get back. 

So let’s make use of the time. 

Mr. O’Connor, welcome to the Committee. We look forward to 

your testimony. 

STATEMENT OF GARRY N. O’CONNOR, CHIEF PRODUCT

OFFICER, INTERNATIONAL DERIVATIVES CLEARING GROUP, 

LLC, NEW YORK, NY 

Mr. O’CONNOR. Chairman Peterson, Ranking Member Lucas, my 

name is Garry O’Connor, and I am the Chief Product Officer of the 

International Derivatives Clearing Group, or IDCG. IDCG currently offers a cleared solution to the OTC interest rate derivatives 

market through a CFTC-regulated clearinghouse. I appreciate the 

opportunity to appear before you to discuss the legislation proposed 

by the Treasury. 

IDCG applauds the considered approach of all regulatory bodies 

who contributed to the proposed legislation. We believe that the 

goals of reducing systemic risk, promoting transparency and efficiency, and preventing market abuses are achieved by the proposed 

legislation without substantive change, but we think that they can 

made more effective in these three areas. 

First, we believe that the test that an OTC derivative is standardized for the purpose of clearing should be different from the test 

that an OTC derivative is standardized for exchange trading; second, how the definition of major market participant is used; and finally, the importance of governance independence of clearinghouses 

and exchanges. 

51

First, the issue of what is standardized: The term standardized

itself has led to some confusion as it suggests the customized aspects of the contract need to be stripped away. 

This is not the case. This has been particularly troubling to corporate America that sees tremendous value in these customized 

products. But if there exists a strong valuation backbone and sufficient liquidity to cure a default, then there is no good reason why 

these products cannot benefit from clearing. 

There are some products, however, that while suitable for clearing, do not lend themselves to exchange trading. Essentially, you 

need a certain velocity of transactions in order to get the price 

transparency and market efficiency that an exchange can deliver. 

We would suggest mandating exchange trading for an OTC derivative only if it is listed for trading by a regulated exchange. As 

with the presumption of standardized for clearing, this definition 

does not force the exchanges to do something they do not have the 

capability to do. It already is subject to regulatory overview and 

adapts dynamically to changes in the marketplace. 

Now, to major market participants, we would urge caution in allowing exceptions for those who do not qualify for this designation. 

Many of the problems of the current crisis were caused by activities 

of institutions that slipped through regulatory cracks, the obvious 

example being AIG. We worry that by introducing exceptions into 

the legislation that these same cracks may be opened up. 

Corporate America again has been very vocal to ensure their 

beneficial use of OTC derivatives is not impacted by regulatory reform. However, there is no reason, there is no technical reason why 

this legislation should curtail their use of these products. 

While it is the task of legislators and regulators to limit the impact of failure of a systemically significant institution in the future, 

it should also be the obligation of our industry leaders to ensure 

that their institutions, customers and employees are also protected. 

To simply assume that the government of the day will continue 

to support their counterparts in the financial system is not good 

enough. Central clearing is the tool that allows them to mitigate 

this exposure and to contribute to a stronger financial system. 

Finally, the issue of independence, given the important role that 

clearinghouses and exchanges have to play in facilitating the 

change in structure of the OTC derivatives market and their role 

in determining what is standardized, I would encourage their substantial governance independence from any participant or group of 

participants. This will be essential to the development of open and 

competitive platforms and, without it, confidence will be eroded 

and the value provided by these tools will be lost. 

Thank you, Mr. Chairman on behalf of IDCG and myself for the 

opportunity to appear here today. I would be happy to answer any 

questions you may have. 

[The prepared statement of Mr. O’Connor follows:]

PREPARED STATEMENT OF GARY N. O’CONNOR, CHIEF PRODUCT OFFICER, INTERNATIONAL DERIVATIVES CLEARING GROUP, LLC, NEW YORK, NY 

Chairman Peterson, Ranking Member Lucas, my name is Garry O’Connor, and I 

am the Chief Product Officer of the International Derivatives Clearing Group 

(IDCG). The objective of IDCG is to bring a centrally cleared solution to the largest 

segment of the over-the-counter (OTC) derivatives market, specifically interest rate 

52

derivatives. This is something that we do today through the operation of a U.S. 

Commodity Futures Trading Commission (CFTC) regulated clearinghouse. IDCG is 

independently operated with majority ownership held by the NASDAQ OMX Group 

and minority stakes held by Bank of New York, founders, and management. I have 

spent close to 2 decades in the OTC derivatives markets trading interest rate derivatives for large U.S. Investment Banks. IDCG appreciates the opportunity to appear before you and we look forward to discussing the proposed the Over-theCounter Derivatives Markets Act of 2009 (the Proposed Legislation) put forward by 

the U.S. Department of the Treasury on August 11, 2009. 

Today we will show our support for the form of the Proposed Legislation, highlight the urgency with which it should be introduced, and point out three areas 

where we feel that it can be made more effective. 

First and most importantly we want to point out the urgent need for regulatory 

reform. It is perhaps becoming a worn out point, but we now stand 1 year on from 

the collapse of Lehman Brothers and we cannot look back with pride upon the 

changes we have made. There is no doubt that these are complex issues that require 

due consideration but at the same time we hold grave concerns that the further 

away from the trauma of the financial crisis that we move the less urgency will be 

felt to address the underlying faults in our system of regulation. We must not fall 

into this trap. The OTC derivatives markets currently represent a greater risk to 

our underlying economy than they did before the financial crisis began. They are 

failing to effectively fulfill their role as a venue for the efficient pricing and transfer 

of risk, are further exposed by the attrition amongst major banks who act as the 

major liquidity providers, resulting in tremendous levels of concentration, and finally are dominated by the world’s largest banks, which are rapidly returning to the 

same levels of risk that drove them to the brink of collapse less than twelve months 

ago. 

The OTC derivatives markets are failing to provide a venue for the efficient pricing and transfer of risk. Reduced competition within the banking sector, the traditional providers of liquidity to these markets, has allowed the major banks to increase their price for liquidity. A number of much respected individuals within significant market participants have made this observation;

➢ Larry Fink, Chief Executive of BlackRock, has highlighted the ‘‘luxurious’’ 

profits being enjoyed by Wall Street banks, reflecting their ability to take advantage of diminished competition.

➢ Mohamed El-Erian, Chief Executive of PIMCO, pointed out ‘‘bid-offer spreads 

have remained unusually wide, notwithstanding the normalisation of financial 

markets’’.

➢ Ken Griffin, Chief Executive of Citadel, commented in his testimony to the 

Senate Banking Committee on the egregious spreads being charged by traditional liquidity providers on OTC derivative transactions, in part because of the 

lack of price depth.

While the commercial interests of the major banks are clear the market structure 

in which this situation has been allowed to develop needs to be addressed. End 

users are desperate for a more diverse base of liquidity providers to bring transaction costs back to pre-crisis levels and to provide a buffer to the extreme volatility 

that has been present in financial markets since the summer of 2007. Only by allowing new and existing participants access to these markets in an open and competitive manner can this be addressed. All to all central clearing and exchange trading 

are the tools to achieve this. 

In a market with a high concentration of participants, the risk of the failure of 

a single entity becoming a systemic event is increased. The Comptroller of the Currency indentified just such a situation in the OCC’s Quarterly Report on Bank Trading and Derivatives Activities (2009 Q1). It was shown that derivatives activity in 

the U.S. banking system is dominated by five large commercial banks which represent 96% of the total industry notional outstanding and 83% of the industry net 

current credit exposure. 90% of this derivatives activity was reported as being OTC 

in nature. IDCG’s own shadow clearing service, which has currently processed close to USD 600 billion in notional, has confirmed the presence of this 

kind of imbalance in the USD interest rate swap market. Further evidence of 

this concerning situation can be seen in the Bank of International Settlements (BIS) 

Semiannual OTC derivatives statistics (2008 Q4). The Herfindahl Index, which 

measures market concentration, is at its highest level in published history for USD 

OTC interest rate derivatives. Perhaps more concerning is how the U.S. market has 

fallen behind other major markets, notably Europe, in this regard and now demonstrates a higher concentration than much smaller markets such as Sweden and 

53

Japan where one would expect a natural bias towards a smaller number of participants. Only by allowing new and existing participants access to these markets in 

an open and competitive manner can this be addressed. All to all central clearing 

and exchange trading are the tools to achieve this. 

We can see through Regulatory Filings that Banks are increasingly and heavily 

reliant on their trading desks for revenue as their traditional banking revenues still 

struggle to recover from the financial crisis. Specifically, as Stevenson Jacobs has 

recently reported for the Associated Press, the same five largest banks which dominate the OTC derivatives markets average potential loss from a single days trading 

exceeded $1 billion in the second quarter. This represents a 75% increase over the 

past 2 years. When you consider large banks are taking more risk in markets that 

are more intertwined and less liquid than they were 2 years ago it is easy to see 

why we say the OTC derivatives markets currently represent a greater risk to our 

underlying economy than they did before the financial crisis began. Again the only 

solution is to allow new and existing participants access to these markets in an open 

and competitive manner. All to all central clearing and exchange trading are the 

tools to achieve this. 

Urgency aside, IDCG applauds the considered approach of all the regulatory bodies who contributed to the Proposed Legislation. The stated goals of; guarding 

against activities in OTC derivatives markets that would pose an excessive risk to 

the financial system, promoting the transparency and efficiency of OTC derivatives 

markets, preventing market abuses and the inappropriate marketing of OTC derivative to unsophisticated parties, are an appropriate response to the financial crisis 

that we have all faced over the past few years. We believe that these goals are 

achieved by the Proposed Legislation without substantive change but think that 

they can be made more effective in three areas:

1. The test that OTC Derivates is ‘‘standardized’’ for the purpose of clearing 

should be different to the test that an OTC derivatives is ‘‘standardized’’ for the 

purpose of trading on a regulated exchange or alternative swap execution facility,

2. The definition of Major Market Participants, and

3. The importance of the independence of clearinghouses. 

What is ‘‘standardized’’? 

The presumption in the Proposed Legislation that an OTC derivative that is accepted for clearing by a regulated central clearing house is ‘‘standardized’’ is a very 

simple solution to a difficult problem. The risk in a more traditional definition was 

a raft of unintended consequences and a definition which failed to adapt to changes 

in the marketplace. The term ‘‘standardized’’ itself however, can lead to confusion, 

as it suggests that the customized aspects of the contract need to be stripped away, 

which is not the case. This has been particularly troubling to corporate America who 

sees tremendous value in these customized products. In a traditional futures clearinghouse this may have been the case due to technology constraints, but as clearinghouses adapt OTC risk management systems and approaches they will be more than 

capable of offering cleared solutions for the vast majority of these products. If there 

exists a strong valuation backbone and sufficient market liquidity to cure defaults 

then there is no good reason why these products cannot be cleared. 

Some products however are not suitable for exchange trading, even if they can be 

cleared. There is little reason to force an infrequently traded customized product 

onto an exchange. Doing so will only result in wide prices and potentially erroneous 

price information, effectively the opposite of the price transparency and efficient execution that an exchange is designed to deliver. If the price of this customized product can be easily implied from a pool of deeply liquid instruments, which are suitable for exchange trading, then the benefits of price transparency and market efficiency are more easily reached through central clearing without the potential misinformation generated by forcing them to an exchange. 

We noted with interest the change in language from the original Administration 

white paper, which suggested the encouragement of exchange trading, to the final 

proposal which mandates it for all ‘‘standardized’’ contracts. There is no doubt this 

decision was not taken lightly, and motivated by significant benefits that exchange 

trading can bring and the difficulty in effectively defining what is suitable in legislation. We would discourage the mandating of exchange trading for products simply 

because they are suitable for clearing; we see this as restricting the amount of clearing that is done. Instead we would recommend a presumption of the same style that 

has been used to define ‘‘standardized’’ clearing products. If an OTC derivative is 

accepted for trading by a regulated exchange, then it should be considered 

‘‘standardized’’ for that purpose. In the same way as the original definition, this 

54

prevents forcing the exchanges and clearinghouses into something they do not have 

the capability for and remains flexible enough to adapt to changes in the marketplace. 

Who are Major Market Participants? 

We would urge caution in allowing exceptions for those who do not qualify for designation as Major Market Participants. Many of the problems of the current crisis 

were caused by the activities of institutions that slipped through the regulatory 

cracks, the obvious example being AIG. We worry that by introducing exceptions 

into the legislation these same cracks may be opened up. There is no way to identify 

who the next systemically devastating organization may be other than by throwing 

a wide and thorough regulatory net. Corporate America has been very vocal to ensure their beneficial use of OTC derivatives is not impacted by regulatory reform. 

However, as detailed earlier in this testimony there is no reason why central clearing should curtail their use of these products. Nor do we see why Corporate America 

should be immune from being part of the solution to the crisis we find ourselves 

in. 

One of the most frustrating aspects of the current financial crisis is that all the 

American people are paying the price for it, not just those who instigated the problem. While it is the task of Legislators and Regulators to limit the impact of failure 

of a systemically significant institution in the future, it should also be the obligation 

of our captains of commerce to ensure that their institutions are not exposed unduly 

to the same failure. To simply assume that the government of the day will continue 

to support their counterparts in the financial system is not good enough. Central 

clearing is the tool that allows them to mitigate this exposure and contribute to a 

stronger financial system. 

We would encourage the adoption of CFTC Chairman Gensler’s suggested enhancements to the Proposed Legislation which he outlined in a letter to the Chairman and Ranking Member of the U.S. Senate Agriculture Committee on August 17, 

2009. In particular the categories dealing with removing the suggested exclusion of 

foreign exchange swaps and the removing of exceptions to the mandatory clearing 

and trading requirements. This last section especially demonstrates the CFTC’s in 

depth understanding of the mechanics of the industry and how they impact the objectives of policy. As an aside, the major market participants that IDCG speaks to 

all identify a Futures Commission Merchant (FCM) cleared solution under the auspices of the CFTC as the most robust clearing model available and one that is easiest, cheapest, and fastest for them to adopt. This is something that the CFTC and 

its officers should take great pride in. 

Why is independence important? 

The final point we would make is regarding the independence governance of clearinghouses and exchanges. Given the important role that clearinghouses have to play 

in facilitating the migration of the OTC derivatives market into a centrally cleared 

and exchange traded environment and their role in determining what is ‘‘standardized’’ I would encourage their substantial independence from any single participant 

or group of like participants. This will be essential to the development, perceived 

or otherwise, of open and competitive platforms. Clearinghouses must navigate a 

fine line when establishing an appropriate price for risk. Charge too much and become uncompetitive, charge too little and fail at their mandate. When a market participant with a significant governance position has a clear interest for that balance 

to be tipped in their favor, regardless of how appropriate the price for risk is, confidence will be eroded and the value provided by central clearing will be lost. 

In conclusion, we have highlighted the urgent need for change in our regulatory 

system to correct the imbalances in the current marketplace and prevent a repeat 

of the financial crisis that we find ourselves in today. IDCG supports the form of 

the Proposed Legislation that is before you and offers three suggestions where the 

effectiveness of this proposal may be enhanced; standardization, exceptions, and 

independence. Thank you, Mr. Chairman, on behalf of IDCG and myself for the opportunity to appear here today. IDCG looks forward to continue working with all 

branches and agencies of government to help develop the strongest and most competitive market place possible. I would be happy to answer any questions you may 

have.

The CHAIRMAN. Thank you very much. 

Mr. Damgard. 

55

STATEMENT OF JOHN M. DAMGARD, PRESIDENT, FUTURES 

INDUSTRY ASSOCIATION, WASHINGTON, D.C. 

Mr. DAMGARD. Thank you very much, Mr. Chairman, for inviting 

me to testify. 

Mr. Chairman and Ranking Member Lucas, Members of the 

Committee, I am John Damgard, President of the Futures Industry 

Association, and I am pleased to be here today to discuss the 

Treasury’s proposals. 

As our name implies, FIA’s primary focus is futures trading. In 

last year’s credit crisis, futures markets performed superbly; and I 

might add, this Committee can take a lot of credit for that. All positions were cleared; all customers were paid; no one had any cause 

for concern. FIA, therefore, believes it would be a mistake to use 

last year’s crisis to increase regulation on futures markets. What 

has proven not to be broken under tremendous stress simply 

doesn’t need fixing. 

At the same time, last year’s crisis did reveal gaps in the swaps 

regulation, and FIA strongly supports Treasury’s efforts to close 

those gaps. While it is hard in 5 minutes to capture our views on 

over 100 pages of amendments to the Commodity Exchange Act, I 

would like to single out four areas for our comments. 

First, jurisdiction: FIA believes that the Treasury has proposed 

a workable jurisdictional division in the general outline of swaps 

regulation. The SEC should focus on security-based swaps, including those involving a single company or a small basket of companies. All other swaps should be regulated by the CFTC, including 

swaps on agricultural and energy products, interest rates and 

broad-based security products. 

Second, clearing: FIA is a strong proponent of the futures clearing system, as you might expect. Our member firms provide the 

capital that underwrites most of the credit risk in most futures 

transactions. Yet we do not recommend mandatory clearing for all 

so-called standardized swaps. 

Any legal definition of standardization will be inherently fuzzy. 

Mandates based on fuzzy definitions lead to legal uncertainty, and 

that uncertainty would lead many to shift their swap transactions 

to other countries. 

That migration could harm price discovery and the futures business in the United States. Worse yet, some businesses might simply not hedge their price risk. That could harm our economy in 

ways no one really wants to contemplate. 

Third, position limits: FIA supports the Treasury bill’s provision 

giving the CFTC standby position limited authority for certain OTC 

swaps. We believe this authority, if used wisely, could actually diffuse much of the misguided controversy surrounding speculation. 

Swap dealers and index funds: In FIA’s view, speculation doesn’t 

cause artificial prices, manipulation does. The CFTC has ample 

anti-manipulation tools in its arsenal already. 

And fourth, foreign boards of trade: My members compete every 

day in a global marketplace. Effective global regulation requires 

consultation and negotiation. 

Treasury’s bill takes a different stance. It imposes U.S. regulation on foreign exchanges. FIA believes that approach will booVerDate 0ct 09 2002 11:29 Nov 04, 2009 Jkt 041481 PO 00000 Frm 00059 Fmt 6633 Sfmt 6601 I:\DOCS\111-29\53020.TXT AGR1 PsN: BRIAN
56

1FIA is a principal spokesman for the commodity futures and options industry. Our regular 

membership is comprised of 30 of the largest futures commission merchants in the United 

States. Among our associate members are representatives from virtually all other segments of 

the futures industry, both national and international. Reflecting the scope and diversity of its 

membership, FIA estimates that its members serve as brokers for more than eighty percent of 

all customer transactions executed on United States contract markets. 

merang. It will harm U.S. firms and exchanges without increasing 

market surveillance or transparency in any way. 

FIA would prefer to see mandated negotiation by the CFTC and 

its foreign counterparts with linked contracts that are traded in 

different countries. Representative Moran’s proposal along these 

lines deserves considerable merit. 

FIA looks forward to working with the Committee to perfect the 

Treasury’s legislative proposals in these and other areas of concerns. I am happy to answer questions and once again thank you 

for inviting me to be here. 

[The prepared statement of Mr. Damgard follows:]

PREPARED STATEMENT OF JOHN M. DAMGARD, PRESIDENT, FUTURES INDUSTRY

ASSOCIATION, WASHINGTON, D.C. 

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

am John Damgard, President of the Futures Industry Association. Thank you for 

inviting FIA to testify on the legislation recently issued by the Treasury Department 

and entitled ‘‘Improvements to Regulation of Over-the-Counter Derivatives Markets.’’ 

FIA is the trade association for the futures industry.1 Our traditional focus has 

been on exchange markets because our regular members comprise the major clearing firms that underwrite counterparty credit risk for the futures clearing system. 

In other words, our member firms provide the capital that is the lifeblood of the 

futures clearing system. 

Some of our regular members are affiliated with swap dealers and SEC-regulated 

broker-dealers. Some of our regular members are not. Given the diversity of the 

membership we serve, FIA offers a broad perspective on the statutory changes embodied in the Treasury bill. In this testimony we will summarize our major reactions 

to the legislation, reserving the right to supplement the record after we have heard 

the views of the relevant regulators at next week’s hearing. 

Overview 

The regulated U.S. futures markets performed admirably during last year’s financial and credit crisis. This record is a credit to this Committee, the Commodity Futures Trading Commission, the futures self-regulatory organizations and our member firms. This record of success also supports retaining much of the existing regulatory mechanisms for futures. Treasury’s legislation, however, uses the existence 

of gaps in regulation of off-exchange swap transactions as a reason to revamp many 

aspects of on-exchange futures regulation. FIA believes that trying to fix what isn’t 

broke could actually weaken regulation in the U.S. We would urge this Committee 

to prune back the Treasury’s bill in many of those areas. The one exception would 

be the proposal to enhance the public process for CFTC review of certain rules of 

self-regulatory bodies, which FIA supports. 

Treasury’s bill also focuses on areas of perceived regulatory gaps or weakness for 

swaps. FIA supports closing genuine regulatory gaps. As we read the bill, all derivatives will be subject to meaningful Federal regulation, whether traded on regulated 

exchanges and cleared through a clearing system, or not. In general outline, futures, 

options and standardized swaps will be regulated alike, while non-standardized 

swaps will be subject, for the first time, to a major regulatory scheme that will include transparency, registration and sales practices. FIA fully supports these different regulatory models in concept as well as the jurisdictional lines of responsibility the bill would assign. 

As this Committee knows, futures regulation focuses primarily on promoting price 

discovery, preventing price manipulation, protecting customers and preserving financial integrity. Each of these goals would be undermined if, in attempting to fix 

regulatory gaps, Congress created inadvertent incentives for legitimate trading activity in any, or many, commodities, whether on exchange or OTC, to move overseas. 

57

Commodity and financial markets today are global, and much of the price discovery 

that today occurs in the U.S. could easily shift to foreign markets. To avoid that 

result, this Committee and Congress as a whole must establish a sensible balance 

in regulatory policy. We will identify for the Committee the major areas where we 

are concerned the Treasury’s bill fails to meet that standard and threatens commodity and financial price discovery in the U.S. 

One area the Treasury bill does not address is harmonization of securities and 

futures regulation. The CFTC and the SEC have held meaningful hearings to begin 

the process of reviewing the many complicated issues harmonization would entail. 

As this Committee stated 35 years ago, futures and securities regulation are ‘‘often 

erroneously viewed as twins.’’ The Commissions’ hearings confirmed that in many 

fundamental areas that statement is as true today as it was in 1974. Still each 

Commission can learn some regulatory lessons from the other in order to strengthen 

regulation, enhance competition and provide cost-efficiencies in both futures and securities markets. We are looking forward to working with the SEC and the CFTC 

as they move forward on the harmonization mission they have been assigned by 

President Obama. 

Jurisdiction and Regulatory Duplication 

Jurisdictional divisions are never perfect. Over time, however, even less than perfect jurisdictional divisions will work effectively if premised on generally sound principles. The Treasury bill’s jurisdictional boundaries for swaps are grounded in current law as embodied in the 1982 Shad-Johnson Accord, as amended in 2000, and 

should be workable. Trading in securities-based swaps where company-specific disclosures and insider trading might be implicated should be of regulatory concern to 

the SEC. All other swaps should be regulated by the CFTC. It has the experience 

and expertise in regulating trading in macro-economic derivatives markets from agricultural products and energy sources to governmental debt and broad-based security indices. 

Jurisdictional divisions of any kind may become problematic if combined with regulatory duplication and the threat of inconsistent regulatory standards. The Treasury’s bill addresses this concern by requiring that the regulatory standards for entities subject to regulation for their swap transactions—whether security-based or 

not—should be adopted jointly by the SEC and CFTC. We agree. FIA also would 

recommend strongly that the uniformity of regulatory standards should not stop at 

the agency level, but should apply to the self-regulatory organizations that operate 

subject to each Commission’s oversight. Otherwise the SROs could undermine the 

very uniformity of regulatory standards the Treasury sought to achieve for swap 

transactions. 

Under current law, FIA members and many others, have worked with the Commissions to try to adopt a market neutral standard for portfolio margining that 

would provide risk-based efficiencies with customer protection. Over the years, the 

difficulties in achieving a joint SEC–CFTC portfolio margining system have been, 

at least in some respects, exacerbated by differences caused by established historical 

practice and entrenched legal standards. The Treasury’s proposal tries to avoid that 

kind of difficulty by calling for joint regulatory action in implementing the new swap 

regulations. As the history of portfolio margining shows, it is easier to build that 

kind of common ground in a new regulatory system than an old one. FIA commends 

the Treasury for this important aspect of its proposal. 

Legal Uncertainty and the Standardization Mandate 

No regulatory system will be considered to be effective if there is no business activity to regulate. That may be the true definition of regulatory overkill. 

Treasury’s bill threatens to run afoul of this basic principle through its mandate 

that standardized swaps must be traded on regulated platforms (exchanges or alternative swap execution facilities) and submitted to regulated clearing organizations. 

Aided by modest statutory guidance, the bill assigns to the SEC and CFTC the 

task to come up with definitive swap standardization rules that would govern all 

swap market participants. The bill also allows the SEC and CFTC, in sum, to prosecute any one who violates the spirit of this mandate, if not its letter. 

There is no easily applicable standardization definition. No matter what words 

are used, the concept of standardization will be either fuzzy or elastic, depending 

on your perspective. The bill’s exchange trading and clearing mandate will therefore 

subject swap market participants to substantial legal risk from a government prosecutor or a reneging counterparty claiming that an OTC swap was standardized and 

should have been traded on an exchange and submitted to a clearing system. This 

kind of legal risk is good for lawyers, not for market participants or regulators. MarVerDate 0ct 09 2002 11:29 Nov 04, 2009 Jkt 041481 PO 00000 Frm 00061 Fmt 6633 Sfmt 6621 I:\DOCS\111-29\53020.TXT AGR1 PsN: BRIAN
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2FIA assumes the term ‘‘regulated markets’’ means designated contract markets or alternative swaps execution facilities as provided for in the bill. 

ket participants will be able to avoid this legal uncertainty only by trading on U.S. 

exchanges or outside the jurisdictional reach of the U.S. 

Treasury’s bill tries to address that problem in part by granting some market participants that are not swap dealers or major swap traders an exemption from the 

exchange-trading mandate. That carve-out is sound and should be retained. But 

CFTC Chairman Gensler proposes repealing the carve-out. His proposal should not 

be adopted. 

Some might say, Chairman Gensler is right, we don’t want most, if not all, swap 

transactions to be done in the U.S. unless they are on an exchange. Some might 

also see this as a windfall for the U.S. exchange business. FIA is concerned, however, that forcing market participants to chose from either on exchange trading in 

the U.S. or OTC swaps overseas will lead to most legitimate OTC swaps activity 

migrating overseas and that related hedging of risk through exchange trading will 

follow that migration. The result would mean less liquidity and more price volatility 

in the U.S. for both exchange and OTC markets, where price discovery and hedging 

also would suffer. 

The standardization mandate should be replaced by incentives to trade on exchanges and through a clearing system. But the bill should recognize that nonstandardized swaps serve a legitimate role by reducing the basis risk hedgers face 

in their businesses every day. Under the Treasury’s bill those non-standardized 

swaps would still, for the first time, be subject to substantial CFTC or SEC regulation in terms of registration, transparency and sales practices. That meaningful 

form of regulation should more than adequately protect the public interest. 

Market Surveillance and Position Limits 

Section 723 of the Treasury Bill expands the reach of the Commission’s position 

limit power to include ‘‘swaps that perform or effect a significant price discovery 

function with respect to regulated markets.’’ 2 FIA supports granting the Commission this authority and notes that as written it would apply whether a swap was 

standardized or not. This gives the CFTC adequate flexibility to apply its powers 

to preserve the integrity of the price discovery process as appropriate. 

Just as importantly, Section 723 affords the CFTC broad exemption powers to exempt conditionally or unconditionally any person or class of persons, or any swap 

or class of swap, from the position limits it might impose. Granting the CFTC this 

flexible authority is an important improvement over the provisions of H.R. 977 

which restricted the CFTC’s powers to exempt persons or transactions from position 

limits. The only curious aspect of this provision in the Treasury bill is that it extends to swaps and apparently not to futures or options traded on designated contract markets. FIA can think of no reason for this disparity and urges the Committee to make certain that the exemption power in the bill treats futures, options 

and swaps alike. 

The CFTC’s expanded position limit authority to cover some swaps should reduce 

the controversy over the current exemptions from position limits for swap dealers, 

a controversy FIA believes is not based on a full understanding of the facts in any 

event. 

First, swap dealers currently are not exempt for their speculative futures positions. Dealers are only currently exempt for futures positions they establish, like 

other hedgers, to reduce their price risks. Sometimes that price risk results from 

the net swaps positions dealers have established with OTC counterparties in various 

commodities. In other instances, some dealers incur price risks from existing or anticipated holdings of physical commodities or through complex hedge transactions 

for energy sources or materials that may be correlated with commodity prices, but 

are not traditionally understood to be commodities. In any event, dealers that have 

received those hedge exemptions still operate under specific position limits that are 

included as conditions for their exemptions. 

Second, by equating in some instances, OTC swaps and on exchange futures for 

position limit purposes, the Treasury bill would reduce the need for the dealer exemption at all. For example, dealers that are net long a crude oil swap and then 

offset that long risk with a short futures position will not need to worry about position limits if the swap and futures are considered to be part of the same position 

limit basket; the dealer should not have any price exposure following the offset and 

no net long or short position. Thus, the legislation may remove the need for the 

dealer hedge exemption and certainly should remove any controversy about it. 

As we have testified before, FIA continues to believe that speculation is essential 

to allow futures markets to serve their price discovery and hedging function. FIA 

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also does not understand position limits to have ever been a cure for higher prices 

or lower prices. Instead, position limits have always played an important role to prevent congestion or squeezes in physically-delivered contracts during the delivery period. FIA would expect the Commission to use its new stand-by position limit authority consistent with this unassailable role for position limits. Moreover, as under 

current law, unless the Commission finds that the absence of position limits would 

lead to ‘‘sudden or unreasonable fluctuations or unwarranted changes in the price 

of [a commodity],’’ FIA believes the Commission should refrain from imposing position limits under its new authority in Section 723 of the Treasury bill. 

Foreign Boards of Trade 

Section 725 has two problematic provisions for foreign boards of trade. 

First, if a foreign exchange provides U.S. persons direct access to its trading system, regardless of the nature of the contracts the exchange offers, the CFTC may 

require the foreign board of trade to register with the CFTC and comply with regulatory criteria the CFTC could impose at its discretion. For example, let’s say an 

exchange in Brazil wants to allow U.S. persons direct computer access to trade futures on Brazilian government debt, the exchange would have to register first with 

the CFTC and comply with its registration criteria. While this provision is permissive in nature, and the CFTC hopefully would never use it, even the threat of a new 

FBOT registration could have ramifications for foreign exchanges and U.S. firms. 

Rather than running the risk of triggering the CFTC registration requirement, a 

foreign exchange could simply and rationally say ‘‘no intermediary in the U.S. or 

market participant in the U.S. may have direct access to our exchange.’’ Foreign 

competitors and even affiliates of U.S. firms and market participants could access 

the exchange’s markets directly, but not their counterparts in the U.S. That result 

would seriously hamper business interests in the U.S. and could even lead to exporting price discovery in certain commodities to overseas exchanges. It is unclear why 

such a Draconian requirement is thought to be necessary. It is also unclear what 

the ramifications would be, other than substantially higher costs, if foreign governments retaliated and required U.S. exchanges to register in every country where 

those exchanges provide now or in the future direct access to its citizens. 

Second, Section 725 prohibits a board of trade located outside the U.S. from providing direct access to persons in the U.S. for contracts that settle against the price 

of futures contracts listed for trading in the U.S. unless the foreign exchange adopts 

U.S. mandated position limits as well as other substantial and invasive U.S. regulatory requirements. The Treasury bill does not have any provision for when a U.S. 

exchange seeks to compete with a foreign exchange by listing on the U.S. exchange 

contracts that settle against the foreign exchange’s futures prices. Yet competition 

among exchanges is a two way street. There are instances, like the NYMEX Brent 

Oil contracts, where the primary contract is a foreign exchange traded contract 

(with no position limits) and the U.S. exchange is trying to challenge that exchange 

dominance. If foreign authorities adopted the Treasury’s ‘‘our way or the highway’’ 

regulatory approach where the foreign markets are dominant, it could work to harm 

U.S. exchanges and their competitive interests. 

The Treasury bill’s failure to address this reciprocity ignores market realities and 

could spark trade war style retaliation or worse. The legislation proposed by Representative Moran in this area last year, H.R. 6921, offered a more balanced approach. Under the Moran approach, when a U.S. or foreign exchange link the pricing of a new contract to a contract traded on an exchange located in another country, the two country’s regulators would need to consult with each other to negotiate 

common methods for addressing market surveillance and other regulatory needs of 

the linked markets. FIA believes the Moran proposal would be less likely to lead 

to regulatory gaps and more likely to lead to cooperative, effective solutions adopted 

by the CFTC and its foreign regulatory counterparts. 

No one wants to see trading on foreign exchanges become regulatory escape havens. Everyone understands that the best regulatory solution for a global trading 

market would be uniform international regulatory standards fostered by international communication and mutual recognition. Treasury’s bill takes just the opposite approach. This Committee should review Representative Moran’s proposal and 

use it as a substitute for the Treasury’s unfortunate attempt to mandate U.S. regulatory standards for the world. 

Conclusion 

Treasury’s bill has many facets and would amend the Commodity Exchange Act 

in many different ways. In this testimony, we have touched on our major areas of 

current interest and concern. We look forward to answering any questions the ComVerDate 0ct 09 2002 11:29 Nov 04, 2009 Jkt 041481 PO 00000 Frm 00063 Fmt 6633 Sfmt 6621 I:\DOCS\111-29\53020.TXT AGR1 PsN: BRIAN
60

mittee may have and to working with the Committee as it fashions legislation to 

close regulatory gaps and enhance regulatory safeguards where warranted.

The CHAIRMAN. Thank you. 

I think we have time to squeeze you in, Mr. Duffy. We haven’t 

gotten to the 5 minute vote yet, so we appreciate you being with 

us. 

STATEMENT OF HON. TERRENCE A. DUFFY, EXECUTIVE 

CHAIRMAN, CME GROUP INC., CHICAGO, IL 

Mr. DUFFY. Thank you, sir. I am Terry Duffy, the Executive 

Chairman of the CME Group, and I want to thank you, Chairman 

Peterson, and Ranking Member Lucas for inviting us to testify 

today. 

You asked us to discuss the Treasury’s proposal, Title VII, Improvements to Regulation of Over-the-Counter Derivatives Markets. Of course, we were pleased that the proposed legislation preserves and extends to the OTC world the terms of the Shad-Johnson Accord. We also agree with the Administration’s stated goals 

which are, one, to reduce systemic risk through central clearing 

and exchange trading of derivatives, to increase data transparency 

in price discovery and to prevent fraud and market manipulation. 

While these goals are commendable, certain well-intended provisions of Title VII could have severe, adverse, unintended consequences for U.S. futures exchanges and clearinghouses. In the 

limited time available, I can briefly discuss only two of the many 

important issues raised by Title VII. 

First, constraints on current business models: Under the proposed legislation, the CFTC would gain new prescriptive authority 

over margins, position limits, new rules and contracts. This conflicts with the Treasury’s recommendation last year for the SEC to 

move towards the CFTC’s principle-based regime. It also overlooks 

repeated testimony at the joint harmonization hearings by market 

participants and industry experts that a principles-based regime 

presents the appropriate framework for regulating futures exchanges. 

We have said it before, but it bears repeating. Derivatives transactions conducted on a CFTC-regulated futures exchange and 

cleared by a CFTC-regulated clearinghouse did not—I repeat, did 

not—contribute to the current financial crisis. 

CFMA, or Commodity Futures Modernization Act, has allowed 

U.S. futures exchanges to innovate, grow and compete effectively 

on a global playing field. U.S. futures exchanges are more efficient, 

more economical and safer and sounder under CFMA than at any 

time in their history. 

Second, open access clearing for OTC versus mandated interoperability: Title VII prescribes that all swaps with the same terms and 

conditions are fungible and may be offset with each other. We understood that the purpose of this language was to ensure that 

clearinghouses for OTC derivatives would provide open access to all 

trading platforms and to privately negotiated OTC transactions. 

However, certain segments of the industry are lobbying to reinterpret the clause to force all clearing into a single clearinghouse or 

to force interoperability among clearinghouses. 

61

The ostensible goals of mandating interoperability are to reduce 

costs, encourage innovation and foster competition. Interestingly, 

the same demand for interoperability among futures clearinghouses 

was eventually rejected by the industry, the CFTC and the Congress just a few years ago. That is because a fair examination of 

the proposal revealed that forced interoperability created risk that 

was not cost effective. 

We do not want one clearinghouse having to assume another 

clearinghouse’s credit risk. This would stop innovation and put the 

entire system at risk. 

In contrast, all the benefits attributed to interoperability can be 

achieved privately at no cost and without creating individual or 

systemic risks for any participant in the system. CME Group proposed the following four principles to guide regulatory reform regulation respecting the CFTC, SEC and OTC derivatives. 

Recommendation one: The CFTC and SEC should jointly adopt 

regulations in accordance with Title VII of the Administration’s 

proposal, but a single agency should function as the primary regulator to administer those rules and regulations. Where an exchange 

clearinghouse or financial services enterprise is engaged in both 

commodities and securities businesses, its primary regulator should 

be based on a predominance test. 

Recommendation two: The CFTC and SEC should avoid jurisdictional conflict respecting novel contracts and products that include 

both commodity and security futures by institutionalizing last 

year’s Memorandum of Understanding for novel derivative products. 

Recommendation three: The principles-based regulatory regime 

adopted by CFMA should provide the model for the joint regulations adopted by the CFTC and the SEC. 

And finally, Recommendation four: The existing customer segregation regime for customers of a CFTC derivatives clearing organization should be preserved for all customers of that clearinghouse. The SEC’s SIPA, Securities Investors Protection Act, regime 

should continue to apply to securities account holders. Legislation 

should be adopted to rationalize the treatment of the separate 

classes of customers in the event of a bankruptcy of a combined 

broker-dealer FCM. 

My written testimony explains these recommendations in greater 

detail. And I thank you, Mr. Chairman and Ranking Member 

Lucas, for your attention today. 

[The prepared statement of Mr. Duffy follows:]

PREPARED STATEMENT OF HON. TERRENCE A. DUFFY, EXECUTIVE CHAIRMAN, CME 

GROUP INC., CHICAGO, IL 

I am Terrence A. Duffy, executive Chairman of CME Group Inc. Thank you Chairman Peterson and Ranking Member Lucas for inviting us to testify today. You 

asked us to discuss the Treasury’s proposed TITLE VII—IMPROVEMENTS TO 

REGULATION OF OVER-THE-COUNTER DERIVATIVES MARKETS, which I 

am sure we all recognize is far broader than its title implies. We will also discuss 

the ongoing efforts of the Securities Exchange Commission (‘‘SEC’’) and Commodity 

Futures Trading Commission (‘‘CFTC’’ or ‘‘Commission’’) to harmonize their regulatory regimes, as was suggested by the Treasury White Paper. 

CME Group is the world’s largest and most diverse derivatives marketplace. We 

are the parent of four separate regulated exchanges, including Chicago Mercantile 

Exchange Inc. (‘‘CME’’), the Board of Trade of the City of Chicago, Inc. (‘‘CBOT’’), 

62

the New York Mercantile Exchange, Inc. (‘‘NYMEX’’) and the Commodity Exchange, 

Inc. (‘‘COMEX’’). The CME Group Exchanges offer the widest range of benchmark 

products available across all major asset classes, including futures and options on 

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

CME Clearing, a division of CME, is one of the largest central counterparty clearing services in the world, which provides clearing and settlement services for exchange-traded contracts, as well as for over-the-counter derivatives contracts 

through CME ClearPort®. Using the CME ClearPort® service, eligible participants 

can execute an OTC swap transaction, which is transformed into a futures or options contract that is subject to the full range of Commission and exchange-based 

regulation and reporting. The CME ClearPort® service mitigates counterparty credit 

risks, provides transparency to OTC transactions and enables the use of the exchange’s market surveillance monitoring tools. 

The CME Group Exchanges serve the hedging, risk management and trading 

needs of our global customer base by facilitating transactions through the CME 

Globex® electronic trading platform, our open outcry trading facilities in New York 

and Chicago, as well as through privately negotiated CME ClearPort transactions. 

I. Introduction 

A. Title VII: The Department of the Treasury released the Administration’s legislative language as ‘‘TITLE VII—IMPROVEMENTS TO REGULATION OF OVERTHE-COUNTER DERIVATIVES MARKETS’’ (the ‘‘proposed legislation’’ or ‘‘Title 

VII’’). The heading is not fully descriptive of the proposed legislation. Of particular 

interest to this Committee, Title VII: (i) proposes a major restructuring of the classes of regulated and exempt futures exchanges; (ii) grants the CFTC authority over 

new contracts and rules; (iii) eliminates exemptions and exclusions for certain OTC 

contracts; (iv) weakens the principles-based regulatory regime created by Commodity Futures Modernization Act (‘‘CFMA’’); grants the CFTC authority over foreign boards of trade; and (v) more comprehensively and proscriptively, regulates the 

operation of clearing houses by means of an expanded list of core principles. 

The proposed legislation preserves the allocation of jurisdiction between the CFTC 

and SEC set forth in the Shad-Johnson Accord, and extends that allocation to credit 

default swaps (‘‘CDS’’) and other OTC contracts. This is accomplished by dividing 

the OTC world into swaps, which include swaps on broad-based security indexes 

and exempt securities, which are regulated by the CFTC, and security-based swaps, 

which include swaps on securities and narrow-based indexes and are regulated by 

the SEC. 

The Administration’s stated goals are to reduce systemic risk through central 

clearing and exchange trading of derivatives; to increase data transparency and 

price discovery; and to prevent fraud and market manipulation. We support these 

overarching goals. We are concerned, however, that certain well-intentioned provisions of Title VII could have severe, adverse, unintended consequences on U.S. futures exchanges and clearing houses, including the following:

• Constraints on Current Business Models. Under the proposed legislation, 

the Commission gains new, direct authority over margins, position limits, new 

rules and contracts. Enhanced authority over approval of new contracts unnecessarily decreases exchanges’ ability to be competitive in the global marketplace. Additionally, taking control of margin setting away from clearing houses 

and exchanges and placing it in the hands of legislators prevents those in the 

best position to make decisions about risk management from doing so and will 

potentially drive business to more favorable regimes. Similar concerns arise out 

of the Commission’s new authority respecting position limits. Further constraining existing business models is the proposed legislation’s move away from 

the CFMA’s principles-based regulation towards prescriptive regulation.

• Shifting Business Overseas. The efforts to drive OTC transactions onto electronic trading platforms and into regulated clearing houses may dampen OTC 

business in the U.S. in a manner that will deny U.S. exchanges and clearing 

houses the opportunity to serve that market. If the proposed legislation’s constraints—including the scope of mandated trading and clearing and increased 

capital requirements—are unacceptable to the major OTC dealers and hedge 

funds, they may choose to shift their OTC business operations overseas, substantially reducing the size of the U.S. OTC market and jeopardizing U.S. futures markets that are complemented by OTC markets.

• Engender Retaliatory Action from Overseas Regulators. The provisions to 

close the ‘‘London Loophole’’ require foreign boards of trade (‘‘FBOTs’’) to register with the CFTC if there is direct access from the U.S. to the electronic tradVerDate 0ct 09 2002 11:29 Nov 04, 2009 Jkt 041481 PO 00000 Frm 00066 Fmt 6633 Sfmt 6621 I:\DOCS\111-29\53020.TXT AGR1 PsN: BRIAN
63

ing system of such FBOTs. The definition of ‘‘direct access’’ is broad enough to 

permit the CFTC to capture every FBOT that can be accessed from the U.S. 

The proposed legislation does not include a carve-out from the registration requirements for exchanges registered and regulated in high quality regulatory 

venues. While the CFTC has discretion to exempt FBOTs from registration if 

certain conditions are met, this extension of U.S. jurisdiction could incite retaliatory actions requiring U.S. futures exchanges to register and be regulated in 

numerous jurisdictions.

B. Additional Harmonization Issues: Integral to the Administration’s efforts to 

reform regulation of the financial sector is its mandate to the CFTC and SEC to 

submit to it by September 30 a document detailing the differences in agencies’ regulatory regimes and including an explanation as to why these differences could not 

be ‘‘harmonized,’’ should that be the agencies’ determination. As part of this ‘‘harmonization’’ effort, the CFTC and SEC held joint hearings on September 2 and 3 (the 

‘‘harmonization hearings’’) to discuss the myriad of issues presented by the harmonization process. During the harmonization hearings, CFTC Chairman Gensler stated 

that three issues should be addressed during the process of harmonization: (1) eliminating gaps in the current regulatory system to reduce risk, protect market integrity 

and promote market transparency by adopting comprehensive regulatory reform for 

OTC derivatives; (2) limiting overlapping regulation by the SEC and CFTC to only 

where it is beneficial, and eliminating opportunities for arbitrage or regulatory uncertainty; and (3) eliminating cases in which the SEC and CFTC regulate similar 

products, practices or markets in a different manner when those differences could 

stifle competition, increase costs or limit investor protection. SEC Chairman 

Schapiro was less specific as to the goal of the harmonization process, stating that 

the agencies needed harmonized regulation for similar financial products, unless it 

could be explained why differences between the two agencies’ regulations were necessary. 

During the course of the harmonization hearings, Chairman Gensler also listed 

12 areas that he believes the two agencies should examine in their efforts to meet 

the harmonization goal, and then mentioned two more at the end of the meetings. 

These areas include: the process for approving new products; the process for approving new exchange and clearinghouse rules; the methods for setting margin in customer accounts (portfolio margining); market structure (fungibility and competition 

among exchanges); differences in manipulation standards; insider trading rules; customer suitability standards; the application of fiduciary standards to intermediaries; 

international mutual recognition; a review of the CFTC’s principles-based approach 

to regulation versus the SEC’s rules-based approach; differences in the two agencies’ 

approaches to regulating investment funds; and differences in the various definitions of sophisticated investors embedded in SEC and CFTC regulations. 

In addition to the harmonization hearings, the SEC and CFTC are meeting at the 

Commissioner and staff levels to further the harmonization process. We believe that 

a number of issues have surfaced to date in the harmonization process that pose 

potential risks to the U.S. futures industry. 

As we testified during the harmonization hearings, in our view, ‘‘harmonization’’ 

should be defined by its goal, and that goal should be to assure that the regulatory 

regimes for derivatives, securities and security options avoid costly duplication, 

work together to produce a net welfare gain through efficiently operating markets 

and clearing houses and eliminate regulatory gaps. One concern we have, which was 

shared by almost every one of the thirty witnesses who testified at the harmonization hearings, is that the real goal of ‘‘harmonization’’ will be lost and we will be 

driven toward a merger of the existing regulatory structures into a single set of onesize-fits-all rules administered by separate agencies or a super agency, a result that 

would undermine the integrity of both the securities and the futures markets and 

add nothing in the way of reducing systemic risk. 

We are also concerned that the harmonization process will invite each agency to 

attempt to expand its jurisdiction without warrant, although the public message is 

that the agencies will work together in a manner that serves the best interest of 

public customers, financial service industry intermediaries and other professionals 

and the market as a whole. 

II. Fundamental Distinctions Between Securities and Futures Markets 

Among other critical distinctions, futures markets and securities markets serve 

different purposes and different classes of customers. 

Futures markets provide price discovery and an efficient means to hedge or shift 

economic risk for sophisticated market participants. Information is disclosed to the 

market through the trading of market participants and not through a disclosure regime. 

64

In contrast, securities markets support capital formation by providing a secondary 

market for trading plain vanilla securities. Because the most relevant information 

is company specific, regulation focuses on creating a level playing field where insiders are precluded from taking unfair advantage of uninformed investors. 

Treatment of customer funds is another critical difference between futures and securities markets. The CFTC’s customer segregation rules and the consequent portability of customer positions in the event of an intermediary’s bankruptcy are essential for the class of customers and type of contracts traded on futures exchanges. 

SIPA would not provide protection for derivatives participants because of payment 

limits and because it does not focus on portability or customer positions in the event 

of an intermediary’s failure. 

The competitive environments in which futures and securities markets operate 

are distinct. Derivative markets face global competition. Inappropriate levels of regulation in the U.S. invites major market participants to migrate business to their 

off shore offices and off shore markets. On the contrary, competition among securities markets is local. Securities markets are inherently domestic. The only issue 

posed by overregulation of securities markets is whether the regulator creates a distorted playing field among its regulated entities; there is no threat that our securities markets will shift to jurisdictions with more rational regulatory regimes. 

These important distinctions between securities and futures markets are directly 

pertinent to the question of whether law or regulation ought to be directed at bringing the two regulatory regimes closer together, and are discussed in more detail in 

the testimony of CME Group’s CEO Craig Donohue, submitted in conjunction with 

the harmonization hearings. 

III. Title VII—Impact on Designated Contract Markets and Clearing Organizations 

Although Title VII proposes changes that impact all aspects of and participants 

in the derivatives market, our testimony focuses on the provisions of Title VII that 

most directly impact designated contract markets (‘‘DCMs’’) and derivatives clearing 

organizations (‘‘DCOs’’). Title VII grants extraordinary levels of discretionary authority to the CFTC and mandates that the CFTC and SEC jointly develop the regulatory regime applicable to trading and clearing OTC derivatives. This wholesale 

transfer of law making authority to the agencies makes it impossible to assess the 

consequences to the industry if Title VII were enacted. 

A. Clearing of Swaps (Section 713; Section 3B) 

Title VII divides OTC swaps into two categories—swaps and security-based 

swaps. It allocates jurisdiction of swaps to the CFTC and security-based swaps to 

the SEC. Although appealing on paper, we agree with the Futures Industry Association (‘‘FIA’’) that the proposed legislation will require some revisions to avoid being 

unworkable. Specifically, Title VII calls for dual registration with both the SEC and 

CFTC by clearing houses, trading platforms, swap dealers, major swap participants, 

alternative swap execution facilities (‘‘ASEF’’) and mixed swaps and permits each 

agency to fully and simultaneously regulate. Imposing duplicative and costly regulatory regimes on market participants without purpose, such as this, completely contradicts the purpose and intent of harmonization and is contrary to every reasonable 

principle of efficient regulation. Moreover, if this dual-regulatory structure remains 

in the final piece of legislation, we believe that it will perpetuate the continuing jurisdictional conflicts between the SEC and CFTC. 

As we have previously testified, we are proponents of eliminating jurisdictional 

wrangling over the undistributed middle between the Securities Acts and the Commodity Exchange Act (‘‘CEA’’). Rather than imposing unduly and unnecessary burdens on the markets, however, we believe that the correct approach to resolving this 

issue is to grant primacy to the regulator that has primary regulatory authority 

over other aspects of the regulated entity’s operations. The CFTC has effectively 

used its exemptive power to achieve such a result. Had the SEC granted a similar 

accommodation in respect of CME’s efforts to create an effective clearing solution 

for credit default swaps it would have facilitated the process of bringing our offering 

to market. The arguments usually advanced against this option—that there will be 

a race to the lowest regulatory standard—should not be a concern where both regulators are agencies of the same government and are enforcing identical, effective 

regulatory regimes, as the CFTC and SEC would be under Title VII. 

We believe that only minor revisions are necessary to correct the unworkable situation presented by the dual-regulatory regime embedded in Title VII. Indeed, the 

language of Title VII suggests that Treasury identified an effective means to accomplish the goals of harmonization, while permitting clearing houses to operate without costly, duplicative two-headed regulation. Specifically, Title VII requires the 

65

1 Notably absent from Title VII, however, is any explanation as to how regulatory principles 

that should/would be applicable to security-based swaps will work with respect to swaps that 

are not security-based, making it difficult to understand how a harmonization of rules for these 

two regimes will succeed. (Section 713(h), Subtitle A.) 

SEC and the CFTC to ‘‘jointly adopt uniform rules governing persons that are registered as derivatives clearing organizations for swaps under this subsection and 

persons that are registered as clearing agencies for security-based swaps under the 

Securities Exchange Act of 1934 (15 U.S.C. 78a, et seq.).’’ 1 Title VII also creates a 

uniform set of core principles under which both forms of clearing house must operate. With this framework, regulatory arbitrage and regulatory gaps are completely 

eliminated, and both CFTC-regulated and SEC-regulated clearing houses are permitted to clear both swaps (province of the CFTC) and security-based swaps (province of the SEC). Thus, legislators need only add a provision to Title VII that permits the regulator with the most existing contacts with the regulated entity to have 

primary regulatory jurisdiction over the regulated entity. Such a change will, among 

other things, reduce legal uncertainty, minimize regulatory inefficiencies and speed 

bringing new products to the markets. 

Finally, whether a drafting error or intentional, the CFTC is made the junior 

partner in this two-headed regulatory scheme. Specifically, Title VII authorizes the 

CFTC to defer to the SEC and exempt an SEC-registered clearing agency from registration with the CFTC. However, no comparable exemption authority is given to 

the SEC in Title VII. This uneven construct undoubtedly will steer clearing houses 

to ‘‘choose’’ the SEC as their regulator and seek an exemption from the CFTC, to 

avoid being dually regulated. Our preferred solution is to allocate responsibility to 

the primary regulator of the enterprise, as discussed above. 

B. Position Limits (Section 723) 

The CEA currently grants the CFTC sufficient authority to set limits for DCMs. 

Section 4a(a) of the CEA directs the Commission to fix position limits for a commodity traded on a DCM if it first finds that such action is ‘‘necessary to diminish, 

eliminate, or prevent’’ ‘‘sudden or unreasonable fluctuations or unwarranted changes 

in the price of such commodity.’’ However, the Commission’s direct use of the authority conferred in Section 4a(a) is neither required nor justified if the relevant 

designated contract market has acted effectively to avoid ‘‘excessive speculation.’’ Indeed, as the Commission has previously noted, the exchanges have the expertise 

and are in the best position to set position limits for their contracts. In fact, this 

determination led the Commission to delegate to the exchanges authority to set position limits in non-enumerated commodities, in the first instances, almost 30 years 

ago. 

Since that time, the regulatory structure for speculative position limits has been 

administered under a two-pronged framework with enforcement of speculative position limits being shared by both the Commission and the DCMs. Under the first 

prong, the Commission establishes and enforces speculative position limits for futures contracts on a limited group of agricultural commodities. Under the second 

prong, for all other commodities, individual DCMs, in fulfillment of their obligations 

under the CEA’s core principles, establish and enforce their own speculative position 

limits or position accountability provisions (including exemption and aggregation 

rules), subject to Commission oversight. 

Title VII permits DCMs and ASEF to continue to set position limits or position 

accountability levels, where appropriate. The core principles differentiate between 

the lead month and back months. (Section 719.) However, no guidance is provided 

as to how such limits or accountability levels should be calculated. (Section 

723(a)(1).) We believe that each DCM and ASEF should be required to set its own 

position limits based on and in proportion to its liquidity, volume, open interest and 

other factors respecting trading for which it is directly responsible. 

The proposed legislation also grants the CFTC authority to impose aggregate limits on contracts listed by boards of trade and on swaps that perform a significant 

price discovery function with respect to regulated markets; however, it does not provide clear guidance as to how aggregate limits will be calculated. (Section 723(a)(2).) 

We support the provisions of Title VII that expand the CFTC’s authority to impose and enforce position limits on positions taken in excluded commodities and 

other OTC transactions. We also agree with the elimination of the protected ECM 

category. 

We urge, however, that the CFTC’s power to set position limits be subject to explicit guidance comparable to the existing regime in that it should only act if the 

relevant regulated market has failed to act and only act for the purpose of avoiding 

‘‘sudden or unreasonable fluctuations or unwarranted changes in the price of such 

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2 ‘‘Direct access’’ is defined as an explicit grant of authority by an FBOT to an identified member or other participant located in the United States to enter trades directly into the trade 

matching system of the FBOT. (Section 725(b)(1), Subtitle A.) 3Section 5c(a)(2) is amended by striking ‘‘shall not’’ and inserting ‘‘may.’’ All of the new core 

principles included in Title VII are modified by language similar to the following: ‘‘Except where 

the Commission determines otherwise by rule or regulation, a derivatives clearing organization 

commodity.’’ It is critical that position limits do not become a political issue that 

are imposed in the hope of controlling the underlying prices in the cash market. 

First, it will not work. Second, it will have a devastating impact on the U.S. futures 

industry and participants that rely on these markets to manage risk. 

The United States has been the center of global futures trading because of its first 

mover advantage and its rational regulatory regime which has provided efficient 

and fair markets while encouraging innovation. If speculative traders and accumulators like swap dealers and index funds are restricted from trading global commodities such as oil and metals on U.S. exchanges and on the U.S. OTC market, their 

alternative is clear. They will turn to their foreign affiliates and the market will 

move offshore. For example, although Natural Gas delivered at Henry Hub is a natural U.S. product and it is not likely that that specific contract will move offshore, 

natural gas is a global product and it is certain that a new global benchmark contract will emerge on a foreign exchange if trading on U.S. markets is constricted 

by inappropriate limits. The likely chain of effects is predictable and unacceptable; 

liquidity of U.S. markets will be impaired, causing damage to the domestic natural 

gas industry and its customers. 

Even if Congress or the Commission could find a legitimate basis to restrict or 

impede U.S. firms from participating in offshore markets, the only consequence will 

be to disadvantage U.S. firms and U.S. markets. World prices would be set without 

U.S. participation. Thus, precisely calibrated and properly administered position 

limits on energy contracts, along with a carefully managed exemption process, are 

critically important to the preservation of properly functioning markets. 

C. Treatment of Foreign Boards of Trade (Section 725) 

Title VII imposes a number of registration and compliance requirements on an 

FBOT that grants U.S. users ‘‘direct access’’ 2 to its systems for trading. Section 

725(b)(1) provides, ‘‘The Commission may adopt rules and regulations requiring registration with the Commission for a foreign board of trade that provides the members of the foreign board of trade or other participants located in the United States 

direct access to the electronic trading and order matching system of the foreign 

board of trade, including rules and regulations prescribing procedures and requirements applicable to the registration of such foreign boards of trade.’’ The proposed 

legislation, however, fails to define any criteria for determining whether or not to 

require registration. If the CFTC does require such registration, FBOTs must meet 

all requirements of the CEA. 

Even if registration is not required, Section 725(b)(2) makes it unlawful for an 

FBOT to provide a member or other participant located in the U.S. with direct access to its trading and order-matching system with respect to an agreement, contract or transaction that settles against any price (including the daily or final settlement price) of one or more contracts listed for trading on a registered entity unless 

the FBOT complies with, among other things, information reporting requirements 

and positions limits requirements, which mirror those imposed on U.S. contract 

markets. There is substantial risk that if enacted as currently drafted, foreign countries in which U.S. DCMs and DCOs that have customers and physical facilities, 

may enact similar requirements that could subject U.S. DCMs and DCOs to registration and regulation in such countries. 

D. Principles-Based Regulation, Self-Certification Process (Sections 721, 724 

and 725) 

Despite Treasury’s recommendation last year that the SEC move towards the 

CFTC’s principles-based regime, and the repeated testimony at the harmonization 

hearings by market participants and industry experts that this regime presents the 

appropriate framework for regulating futures exchanges, Title VII of the Treasury’s 

proposal would grant the CFTC administrative authority to eradicate the advantages of the CFMA’s principles-based regime. Specifically, whereas the CEA currently prohibits the CFTC from providing that its ‘‘Guidance On, and Acceptable 

Practices In, Compliance with Core Principles’’ (Appendix B to Part 38 of CFTC’s 

Regulations) is the exclusive means to comply with core principles (CEA § 5c(a)(2)), 

Title VII expressly grants the CFTC the authority to state that an interpretation 

may provide the only means for compliance with core principles.3 By eliminating 

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shall have reasonable discretion in establishing the manner in which it complies with the core 

principles.’’

this option, Title VII substantially inhibits the ability of U.S. futures exchanges to 

develop innovative and potentially more effective ways of complying with the core 

principles. 

The CFMA has facilitated tremendous innovation and allowed U.S. exchanges to 

compete effectively on a global playing field. Principles-based regulation of futures 

exchanges and clearing houses permitted U.S. exchanges to regain their competitive 

position in the global market. U.S. futures exchanges are able to keep pace with 

rapidly changing technology and market needs by introducing new products, new 

processes and new methods by certifying compliance with the CEA and thereby 

avoiding stifling regulatory review. U.S. futures exchanges operate more efficiently, 

more economically and with fewer complaints under this system than at any time 

in their history. 

Unfortunately, instead of pursuing this successful regime, the reaction against excesses in other segments of the financial services industry appears to have generated pressure to force a retreat from the principles-based regulatory regime adopted by CFMA. The myriad of problems resulting in the financial services meltdown 

did not originate in futures markets and the exchanges performed impeccably 

throughout the crisis and should not be penalized by a return to a prescriptive regulatory regime. Moreover, this is exactly the regime that impaired the competitiveness of the U.S. futures industry pre-CFMA. 

The benefits of CFMA’s principles-based regulatory regime are easily overlooked 

in the turmoil following the collapse of the housing market and major investment 

banks. We have said it before, but it bears repeating: derivative transactions conducted on CFTC-regulated futures exchanges and cleared by CFTC-regulated clearing houses did not contribute to the current financial crisis. Moreover, it was not 

unintentional gaps in the regulatory jurisdiction of the SEC and the CFTC that 

caused the meltdown. To the extent that regulatory gaps contributed to the problem, 

those gaps existed because Congress exempted broad classes of instruments and financial enterprises from regulation by either agency. 

Another aspect of Title VII that adversely impacts innovation and puts regulators 

in the position of making business judgments for market participants is the proposed amendments to Section 5c(c)(1) of the CEA, which will require a time consuming justification process for every significant new contract and new rule. This 

proposed amendment steers the CFTC closer to the product and rule approval process currently employed by the SEC, the very process about which those regulated 

by the SEC complained at the harmonization hearings. Indeed, William J. Brodsky 

of the Chicago Board of Options Exchange testified that the SEC’s approval process 

‘‘inhibits innovation in the securities markets’’ and urged the adoption of the CFTC’s 

current certification process. 

E. Margin (Section 722, Subtitle A) 

Title VII includes explicit standards respecting the setting of collateral requirements, which are in accord with CME’s processes and procedures. However, Section 

722 of Title VII would amend Section 8a(7) of the CEA and grant the CFTC authority to alter or amend a DCM’s rules respecting margin requirements. Previously, the 

setting of margin (except for equity index margin) was excepted from the Commission’s authority to alter or amend exchange rules, but the Commission did have 

power to act in an emergency. We are deeply concerned that this grant of authority 

will politicize the process and move away from a regime where true experts in risk 

management are supplanted by an oversight agency with no experience and no incentive to set collateral requirements at appropriate levels. 

It has been clearly demonstrated that the setting of collateral levels for derivatives, both at the customer and at the clearing house level, is purely a matter of 

safety and soundness. The operators of clearing houses that mutualize risk among 

their member firms have the clearest incentives and are most capable of doing the 

job correctly. The record of futures clearing houses in this country is unambiguous. 

In this regard, it is worth noting that, over a history of continuous operation dating 

back more than 100 years, no CME customer has ever lost funds as a result of the 

failure of a clearing member firm. There is no benefit to transferring this responsibility to government employees, only potential harm to DCMs as this is an invitation to politicize the margin-setting process. 

F. Netting Swaps vs. Interoperability (Section 713(j)(1)(B)) 

Title VII prescribes that ‘‘all swaps with the same terms and conditions are fungible and may be offset with each other.’’ We understood that the purpose of this 

68

language was to insure that clearing houses for OTC derivatives would provide open 

access to all trading platforms and to privately negotiated OTC transactions and 

that identical swap contracts, regardless of the execution venue, would be deemed 

fungible and could be offset against one another if the positions resided at the same 

clearing house. We have since learned that certain segments of the industry are lobbying to reinterpret the clause to force all clearing into a single clearing house or 

to force interoperability among clearing houses. 

Mandated interoperability among swaps clearing houses is being promoted as a 

means to foster market entry by new clearing houses and encourage competition 

among existing clearing houses. Mandated interoperability forces all clearing houses 

to permit a customer with a position at clearing house A, for example, short a notional $1 billion in the XXX equity index, to direct that the position be transferred 

to clearing house B. Of course, in order to assure that the books of both clearing 

houses remain balanced, clearing house B must be substituted as the short on clearing house A’s books. Clearing house A also becomes the long on clearing house B’s 

books. Each of the clearing houses must post collateral with the other and each 

must make twice daily pays and collects. Each is exposed to the failure of the other. 

This system becomes increasingly complex as additional clearing houses are added 

to the chain, and ultimately, unworkable. 

The ostensible goals of mandated interoperability are to reduce costs, encourage 

innovation and foster competition. The same demand for interoperability among futures clearing houses was rejected by the industry, the CFTC and Congress because 

a fair examination of the proposal revealed that forced interoperability was complex, 

risky and not cost effective. Specifically, it was demonstrated that:

• the linkages would subject each of the linked clearing houses to the failure of 

any of them and that fire breaks that ordinarily contain or limit such failures 

would be eliminated, thereby effectively creating significant specific and systemic risks;

• time and cost to market implementation were significant;

• the theoretical savings that might be generated by competition were outweighed 

by the costs of operating the system;

• innovation would be inhibited in that each linked clearing house would be required to limit its pace of innovation to the ability of the weakest;

• changes in contract specifications would require the consent of each market and 

clearing house; and

• genuine competition among clearing houses and exchanges would be eliminated.

At the most basic, technical level, in order to make interoperability feasible, each 

participating clearing house must agree on an identical set of operating procedures 

to coordinate collateral, variation margin and settlement flows. Each clearing house 

should insist that each other participating clearing house has financial resources at 

least equal to its own and that each conduct regular detailed financial and operational audits of each other member of the interoperability circle. Finally, no clearing house can permit changes in contract specifications that will distort future cross 

clearing house flows. 

An important consideration is that the actual benefits of moving open positions 

among clearing houses can be achieved privately, at no cost and without creating 

systemic or particular risks to any participant in the system. The customer holding 

a swap position at clearing house A can close out that position and reestablish it 

at clearing house B in several ways. First, the customer can enter into an equal, 

but opposite swap position, on any swap platform or privately, and submit it for 

clearing to clearing house A. The customer’s swap position is netted to zero the moment the new trade is accepted. The customer can reestablish that position at clearing house B by means of a second swap that is submitted to clearing house B. Second, because the swap market is not subject to the CFTC’s wash trading rules, the 

customer can enter into a matched pair of swaps to move the position without market risk. Finally, if sufficient customer demand ever develops for the service, clearing houses can enter into agreements that permit the transfer of matched trades 

amongst themselves. In that case, any two traders with offsetting positions who 

wish to transfer could do so by means of an appropriate notification and fee. All of 

this can be accomplished without government intervention, without cost and without creating systemic risk. 

The immediate impact of mandated interoperability is to force regulated exchanges and their associated clearing houses to truncate the services that they offer 

to their customers by giving up control over the clearing function that provides the 

financial, banking and delivery services that guarantee performance of futures contracts. Exchange control of these services—either in-house or through a dedicated 

69

third party—is at the heart of current efforts to improve the value of exchange services by offering straight-through, integrated processing to clearing member firms 

and their clients. 

It is only through differentiation that product innovation is accomplished. Differentiation with respect to product and the delivery of that product has been a fundamental tenet of CME’s business strategy and, intuitively, a prerequisite for product advancement. CME opposes any suggestions to impede its ability to explore new 

opportunities in non-generic, unique products—accessible through unique value 

added trading platforms—cleared and settled on an essentially ‘‘straight-through,’’ 

integrated basis. 

G. The CEA’s Jurisdictional Preservation Clause 

The CEA’s exclusive jurisdiction provision mandates that CFTC regulation is the 

sole legal standard applicable to virtually all futures trading. This exclusivity provision was purposely included in the CEA decades ago to prevent duplication and inconsistency in regulating the industry; indeed, the phrase ‘‘except as hereinabove 

provided’’ was inserted in the original CFTC Act so that it would supersede all others in regard to futures and commodity options regulation. Despite the success of 

this jurisdictional delineation to date, Title VII proposes to disrupt it. Specifically, 

Section 712(b) states that the CFTC’s exclusive jurisdiction does not supersede any 

other authority’s jurisdiction under the proposed legislation and would be referenced 

in existing CEA Section 2(a)(1)(A) as an exception to the CFTC’s exclusive jurisdiction clause. Moreover, Section 728 appears to give CFTC ‘‘primary’’ enforcement authority over Subtitle A matters but permits other regulators to take action if CFTC 

does not, the effect of which would be to subject market participants to potentially 

conflicting standards and multiple regulators. We strongly believe that the CEA’s 

exclusivity provision should be retained as we move forward in the regulatory reform process. 

IV. Additional Items Raised by Chairman Gensler for Potential Harmonization 

As previously noted, Chairman Gensler raised a number of issues that he thought 

should be the focus of the harmonization process. Although CME has thoughts on 

each of those issues, we address only a few below. We are available at your convenience to discuss any of these further as well as those issues not addressed in this 

testimony. 

A. Manipulation 

Under the CEA, price manipulation constitutes acting with specific intent to create an artificial price. In the securities market, SEC Rule 10b–5, which applies to 

alleged manipulation, requires a showing of neither specific intent nor artificial 

price effects. Adoption of the specific intent standard of Rule 10b–5 would contradict 

the CFTC’s jurisprudence and impose a significant threat to the proper functioning 

of the U.S. futures markets in crude oil and gasoline. Indeed, when the CFTC was 

asked years ago to consider abandoning the specific intent standard as the required 

mens rea for finding manipulation, the CFTC responded that it was ‘‘unable to discern any justification for a weakening of the manipulative intent standard which 

does not wreak havoc with the market place.’’ In re Indiana Farm Bureau Coop. 

Ass’n, CFTC No. 75–14, 1982 WL 30249, at *5 (Dec. 17, 1982). Likewise, elimination 

of the requirement to show artificial price effects in the futures realm would seriously threaten the proper functioning of the U.S. futures markets. 

B. Insider Trading 

Adopting the SEC’s insider trading prohibitions in the commodities markets could 

impair price discovery and efficient markets. Insider trading prohibitions in the securities markets are based upon the premise that corporate executives and other fiduciaries should not use their privileged access to information to trade when such 

material information is not available to the broader marketplace. In the commodities derivatives markets, however, market participants typically trade based upon 

their own informed self-interest, often hedging price risks that are, by definition, 

based upon information that is not available to the broader marketplace and which 

contributes to the futures price formation process. The price discovery function is 

optimized when all market information known to hedgers or to speculators is reflected in the market price of a given contract. Moreover, hedging depends upon 

knowledge of cash market positions, physical market conditions, and other manner 

of information to determine the appropriate position to take or hedge to place on 

a futures market. If such information were required to be publicly disclosed in advance of trading on futures markets, hedging would be impossible. 

70

CFTC Rule 1.59(d) does, however, prohibit exchange governing board members, 

committee members, members, employees and consultants from disclosing or trading in any commodity interest on the basis of material, nonpublic information obtained through their official exchange duties. Furthermore, this rule also prohibits 

any person from trading in any commodity interest, whether for such person’s own 

account or on behalf of another person, on the basis of material, nonpublic information that such person knows was obtained in violation of the CFTC rule from an 

exchange governing board member, committee member, member, employee or consultant. 

C. Customer Suitability 

As the National Futures Association (‘‘NFA’’) testified during the harmonization 

hearings, in 1985 it adopted a Know-Your-Customer rule (NFA Compliance Rule 2–

30) that provides protections comparable to the Financial Industry Regulatory 

Authority’s (‘‘FINRA’’) suitability rule but that are tailored to the unique requirements of the futures industry. NFA explained the necessary distinction between its 

rules and FINRA’s: Since all futures contracts are highly volatile and risky instruments, a suitability determination should be made on a customer-by-customer basis, 

rather than trade-by-trade. We agree with NFA that it makes no sense to say that 

a customer is suitable for a recommendation to invest in heating oil futures but not 

in Treasury note futures. In general, NFA’s rule requires its members to obtain 

basic information about each prospective customer and determine whether futures 

trading is appropriate for each customer. The rule imposes an affirmative obligation 

to inform customers in appropriate circumstances that futures trading is simply too 

risky for that customer. 

IV. Guiding Principles of Harmonization 

CME Group proposes the following five principles to guide regulatory reform legislation respecting the CFTC, SEC and OTC derivatives: 

Recommendation One: The CFTC and SEC should jointly adopt regulations in 

accordance with Title VII of the Administration’s proposal, but a single agency 

should function as the primary regulator to administer those rules and regulations. 

Where an exchange, clearing house, or financial services enterprise is engaged in 

both commodities and securities businesses, its primary regulator should be based 

on a predominance test. Where no segment of the firm’s business clearly predominates, the firm should be free to pick its regulator. For example, the CME derivatives clearing organization should be primarily regulated by the CFTC even if it also 

clears security-based swaps. As many of the participants in the recent joint SEC/

CFTC hearings noted, a primary regulator should take front-line responsibility for 

the oversight of the regulated enterprise, including oversight of its SRO responsibilities, where applicable. This primacy should extend to audits and enforcement. 

Recommendation Two: The CFTC and SEC should avoid jurisdictional conflict 

respecting novel contracts and products that include both commodity and security 

features by institutionalizing last year’s Memorandum of Understanding (‘‘MOU’’) 

for Novel Derivatives Products. Such an approach would ensure the recognition of 

mutual regulatory interests while operating under principles designed to promote, 

among other things, innovation and competition as well as market neutrality. 

Recommendation Three: The principles-based regulatory regime adopted by 

CFMA should provide the model for the joint regulations adopted by the CFTC and 

SEC. No retreat from principles-based regulation should be accepted without clear 

justification. 

Recommendation Four: The existing customer segregation regime for customers 

of a CFTC derivatives clearing organization should be preserved for all customers 

of that clearing house. The SEC’s SIPA regime should continue to apply to securities 

account holders. Legislation should be adopted to rationalize the treatment of the 

separate classes of customers in the event of a bankruptcy of a combined brokerdealer/futures commission merchant. 

Recommendation Five: Interoperability among clearing houses should not be 

mandated by legislation or regulation. As has been previously demonstrated, forced 

interoperability is complex, risky and not cost effective. The actual benefits of moving open positions among clearing houses can be achieved privately, at no public 

cost and without creating systemic or particular risks to any participant in the system.

The CHAIRMAN. I thank the gentleman. 

And we are going to be gone for a while. I think it will be at least 

1 hour—we have a motion to recommit—so we will see the rest of 

you folks when we get back. Thank you. 

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[Recess.] 

The CHAIRMAN. The Committee will come back to order. And we 

apologize for that, but that is part of the deal. 

Mr. Pickel, welcome to the Committee. We appreciate your being 

here. 

STATEMENT OF ROBERT G. PICKEL, EXECUTIVE DIRECTOR 

AND CEO, INTERNATIONAL SWAPS AND DERIVATIVES

ASSOCIATION, INC., NEW YORK, NY 

Mr. PICKEL. Thank you, Mr. Chairman, Ranking Member Lucas, 

we appreciate the opportunity to testify here. 

ISDA, as you know, is an international trade association representing major dealers, end-users, government entities, investors 

in the privately negotiated derivatives business. We share the goals 

of the Administration and of this Committee for protecting the integrity of our financial system and promoting the stability of that 

system; and we support many of the principles contained in the Administration’s proposal. 

Specifically, we support appropriate oversight and regulation of 

all financial institutions that may pose a systemic risk to the financial system. We support stronger counterparty risk management, 

including clearing requirements, improved transparency through 

clearing and reporting requirements, and a resilient operational infrastructure that bolsters the system supporting the derivatives 

markets. 

An example of our commitment is the industry’s efforts to improve the clearing process by establishing counterparty clearing facilities. In the credit default swaps base alone, more than $2 trillion worth of contracts have been cleared, and early in this month, 

ISDA and 15 large derivatives dealers publicly committed to the 

Federal Reserve Bank of New York and regulators from other countries that the firms would submit 95 percent of new, eligible CDS 

trades for clearing by October 2009. Additional commitments have 

been made to clear interest rate swaps. 

Today, however, we draw the Committee’s attention to several 

provisions of the bill that are inconsistent with these goals. 

The scope of U.S. companies that would be subject to these regulations would be overly broad and would include firms that are in 

no way systemically significant. The definition includes all dealers, 

regardless of their size or trading volume. A firm that acts as a 

dealer in ten swaps a year is treated the same as a dealer that 

does 10,000 swaps. 

Major swap participants would include nonfinancial end-users of 

derivatives and financial firms that are not systematically significant. 

The proposal’s reliance on GAAP accounting for qualification for 

an exemption is misplaced. 

Many end-users enter into economic hedges that do not meet the 

strict FAS 133 definition of an effective hedge. 

The determination of when an OTC contract is standardized 

needs more scrutiny also. Standardization is an important goal, but 

equally important is the availability of customized derivatives products to end-users. 

72

The privately negotiated derivatives business has grown because 

standardized contracts are only of limited use in hedging. Initiatives that would seek to standardize the terms of all OTC swaps 

are counterproductive. So long as the risk that businesses face are 

not fully standardized, the tools that allow them to manage those 

risks will not be fully standardized. 

Product uniformity is not beneficial to American companies when 

they have risks unique to their business and need customized risk 

management tools to mitigate those risks. The industry is committed to standardizing the processes surrounding the product, 

such as clearing the settlement and confirmation. That will go a 

long way to reducing risk. 

A third point is that mandatory clearing and mandatory exchange trading are not feasible in many circumstances. Not all 

standardized contracts can be cleared because the ability of a central counterparty clearing facility to clear a contract depends on 

such factors as liquidity, trading volume and daily pricing. Standardized illiquid contracts are hard to price daily, making it difficult 

for the clearinghouse to calculate collateral requirements consistent 

with prudent risk management. 

Clearing of OTC derivatives contracts should not be mandatory. 

Nevertheless, commitments had been made regarding clearing, and 

the industry is delivering on those commitments. 

Mandatory exchange trading should not be required in any circumstance because it would restrict the ability to custom tailor risk 

management solutions to meet the needs of end-users. End-users 

should not be subject to mandatory clearing or exchange trading 

because they are not systematically significant, and regulations intended to improve stability and decrease systemic risk should not 

apply to them. 

Finally, the capital requirements in the proposal for cleared 

swaps are redundant. The proposal’s imposition of a capital requirement on cleared swaps does not reflect the capitalization requirements of the clearinghouse, or its imposition of collateral requirements on its counterparties. 

In closing, ISDA joins with thousands of American companies 

who rely on customized over-the-counter derivatives to manage the 

risks that they face in the normal course of their business. ISDA 

also will continue to work with this Committee, with Congress and 

the Administration, to ensure financial stability and reduce risk. 

Thank you for your time, and I look forward to your questions. 

[The prepared statement of Mr. Pickel follows:]

PREPARED STATEMENT OF ROBERT G. PICKEL, EXECUTIVE DIRECTOR AND CEO, 

INTERNATIONAL SWAPS AND DERIVATIVES ASSOCIATION, NEW YORK, NY 

Chairman Peterson and Members of the Committee:

Thank you very much for allowing ISDA to testify at this hearing to review proposed legislation by the U.S. Department of the Treasury regarding the regulation 

of over-the-counter derivatives markets. 

About ISDA 

ISDA, as you may know, represents participants in the privately negotiated derivatives industry. Today it ranks as the largest global financial trade association 

by number of member firms. ISDA was chartered in 1985, and today has over 850 

member institutions from 56 countries on six continents. These members include 

most of the world’s major institutions that deal in privately negotiated derivatives, 

73

as well as many of the businesses, governmental entities and other end-users that 

rely on over-the-counter derivatives to manage efficiently the financial market risks 

inherent in their core economic activities. 

A Broad Consensus for Key Reform Concepts 

Let me state very clearly at the outset of my remarks: Today, there is a broad 

consensus for a comprehensive regulatory reform plan to modernize and protect the 

integrity of our financial system. ISDA and the privately negotiated derivatives 

business support many of the key public policy concepts contained in the Administration’s proposal. This includes:

• Appropriate regulation for all financial institutions that may pose a systemic 

risk to the financial system;

• Stronger counterparty risk management, including clearinghouses;

• Improved transparency; and

• A strong, resilient operational infrastructure.

What’s more, we are not waiting for legislation or additional regulation to demonstrate our support and commitment to these principles. We are actively doing so 

today. One example can be seen in the use of central counterparty clearing facilities. 

To date, more than $2 trillion of credit default swaps contracts have been cleared. 

And earlier this month, ISDA and 15 large derivatives dealers publicly committed 

in a letter to the Federal Reserve Bank of New York that the firms would submit 

95% of new eligible credit default swap trades for clearing within 60 days, by October 2009. A copy of the letter is attached. 

Mr. Chairman and Committee Members, let me assure you that ISDA and our 

members intend to maintain the scope and the scale of the progress that we have 

made thus far. Since its inception nearly 25 years ago, ISDA has pioneered efforts 

to identify and reduce the sources of risk in the derivatives and risk management 

business. Our focus is on continuing—and enhancing—our efforts in this area as we 

move forward. The depth and breadth of our activities in derivatives documentation, 

netting, collateral, risk management, capital, operations and technology underscore 

our intense global commitment to further reducing risk. 

There are, however, certain aspects of the bill that work against its broad public 

policy goals. These include:

• The scope of firms that would be subject to the legislation;

• The parameters for determining when an OTC derivatives contract is standardized and when it can be cleared;

• Mandatory clearing and exchange trading of standardized OTC derivatives;

• Capital requirements for cleared swaps.

These provisions would reduce or restrict the availability of customized risk management tools without contributing in any significant positive way to the Treasury’s 

goals of reducing risk and ensuring financial stability. As a result, they would make 

it more difficult for American companies to effectively manage their business and 

financial risks. Resources that could have been allocated more productively to generate growth in revenues and profitability would instead be devoted to less efficient 

and effective risk management activities. 

The Need for Privately Negotiated Derivatives 

As Secretary Geithner has previously testified before this Committee, ‘‘One of the 

most significant developments in our financial system during recent decades has 

been the substantial growth and innovation in the markets for derivatives, especially OTC derivatives.’’ In his remarks, Secretary Geithner also noted that derivatives today play a critical role in our financial markets, and they bring substantial 

benefits to our economy by enabling companies to manage risks. 

Today, privately negotiated derivatives are widely used by American companies. 

According to research we have conducted, nearly all of the Fortune Global 500 companies based in the U.S. use derivatives to manage their risks. A broader survey 

of non-financial firms in 47 countries was conducted earlier this decade by professors at Lancaster University and the University of North Carolina at Chapel Hill. 

Of the 2,076 U.S. companies in the survey, about 65 percent used OTC derivatives. 

The reason why derivatives are so widely used is clear: American companies want 

and need these customized risk management tools to manage the risks that arise 

in the normal course of doing business. For companies that do business overseas, 

those risks include fluctuations in the relative value of foreign currencies. For companies that issue debt to fund their growth, the risks may include changes in interest rates and consequently in interest payments. For companies that rely heavily 

74

on commodities—such as airlines—those risks include changes in the current and 

future prices of fuel. 

Key Issues in the Treasury’s Proposal 

While there is consensus regarding many of the key concepts in the Treasury’s 

proposal, certain of its provisions raise serious questions for dealers in and users 

of derivatives. These provisions, as outlined below, would reduce or restrict the 

availability of customized risk management tools for American companies. At the 

same time, these provisions offer no significant offsetting benefit; in other words 

they would not meaningfully contribute to the Treasury’s goals of reducing risk and 

ensuring financial stability. 

(1) The scope of firms that would be subject to the legislation. 

The legislation defines two types of firms that would be subject to its provisions: 

‘‘swaps dealers’’ and ‘‘major swap participants.’’ Both definitions are overly broad 

and would include firms that are in no way systemically significant. In so doing, 

the legislation would penalize such firms and may well prevent them from either 

dealing in or using derivatives. 

Let me explain: in the proposal, a swap dealer is defined as including any person 

engaged in the business of buying and selling swaps for such person’s own account, 

through a broker or otherwise. This definition includes all dealers, regardless of 

their size or trading volume. It treats a firm that acts as a dealer in ten swaps a 

year the same as a dealer that does 10,000. 

Similarly, the term major swap participant is essentially defined as any person 

who is not a swap dealer and who maintains a substantial net position in outstanding swaps, other than to create and maintain an effective hedge under generally accepted accounting principles. This definition is so broad that it would include financial entities that are not systemically significant. 

It would also include non-financial end-users of derivatives. These corporate endusers would as a result be subject to the nation’s banking and financial regulatory 

framework, which would impose significant costs, divert key resources and decrease 

the competitiveness of such firms. 

(2) The parameters for determining when an OTC derivatives contract is 

standardized. 

A key component of Treasury’s proposal for OTC swaps is its requirement that 

standardized swaps be cleared. The proposal does not define the term standardized. 

Instead, it would require that, within 6 months of the proposal’s enactment, the 

SEC and CFTC jointly define ‘‘as broadly as possible’’ what constitutes a standardized swap. Additionally, the proposal provides that acceptance of a product by a 

clearinghouse for clearing would create a presumption that the relevant product is 

standardized. 

Both of the proposal’s methods for determining if an OTC derivatives contract is 

standardized are flawed and need to be revised. With regard to the former method, 

the need for consistency amongst policymakers regarding what is standardized and 

what is not argues for broader participation by Federal regulators in this process. 

Regarding the latter method, because of commercial considerations, the willingness 

of a clearinghouse to accept a transaction for clearing should not create a presumption of standardization. 

In addition, it’s important to keep in mind that while standardization is an important goal in the OTC derivatives world, it’s also important to retain customization 

of derivative products. American businesses pervasively use customized contracts to 

manage operational risks, and it is critical that Congress preserve these companies’ 

ability to do so. Customized products exist only because end-users find them useful, 

and indeed necessary, in their day-to-day operations. In fact, the privately negotiated derivatives business has grown because standardized contracts are only of 

limited use in hedging. Initiatives that would seek to standardize the terms of all 

OTC swaps are counterproductive. Product uniformity is not beneficial to American 

companies when they have risks unique to their businesses and need customized 

risk management tools to mitigate these risks, and when accounting rules require 

customized products that are closely tailored to an end-user’s specific risks. 

(3) Mandatory clearing and exchange trading. 

The Treasury proposal would require that standardized OTC derivatives contracts 

be cleared and traded on an exchange of alternative swap execution facility. 

Not all standardized contracts can be cleared. Contracts that are infrequently 

traded, for example, are difficult if not impossible to clear even if they contain 

standardized economic terms. That’s because the ability of a central counterparty 

clearing facility to clear a contract depends on such factors as liquidity, trading volVerDate 0ct 09 2002 11:29 Nov 04, 2009 Jkt 041481 PO 00000 Frm 00078 Fmt 6633 Sfmt 6621 I:\DOCS\111-29\53020.TXT AGR1 PsN: BRIAN
75

ume and daily pricing. Standardized, illiquid contracts are hard to price daily, which 

makes it difficult for the clearinghouse to calculate collateral requirements consistent with prudent risk management. As a result, clearing of OTC derivatives contracts should not be mandatory. 

To the extent that policymakers do adopt mandatory clearing requirements, ISDA 

and our members believe that a clearly defined framework for so doing is essential. 

This framework should be constructed by Federal regulators, who should proceed by 

notice and comment and endeavor to ensure that the requirement would promote 

consistent international standards, choice of clearinghouses, economic efficiency, 

fungible treatment of cleared contracts, and clearinghouse interoperability. The 

framework for a mandatory clearing requirement should only include standardized 

inter-dealer transactions in which at least one of the dealers is systemically significant. 

ISDA and our members believe that mandatory exchange trading should not be 

required in any circumstance. Mandating that OTC derivatives contracts trade on 

an exchange would undercut their very purpose: the ability to custom tailor risk 

management solutions to meet the need of end-users. 

In addition, exchanges provide three general purposes, all of which the OTC derivatives industry is meeting in other ways. First and most important is central 

clearing, which the industry is now well along on and is committed to continued 

progress. Second is position and risk transparency, which we are achieving through 

centralized trade repositories as well as central clearing facilities. And the third is 

price transparency, which is also being achieved through a combination of increased 

cleared trading volume and electronic platforms. 

Finally, ISDA and our members believe that end-users should not be subject to 

a clearing or exchange trading requirement, even if they are major swap participants or meet the eligibility requirements of a derivatives clearing organization. 

End-users are not systemically significant and regulations intended to improve stability and decrease systemic risk should not apply to them. 

(4) Capital requirements for cleared swaps. 

The Treasury proposal would impose a capital requirement on cleared swap transactions. ISDA and our members oppose this requirement for several reasons. First, 

the capitalization of the derivatives clearinghouse is designed to provide adequate 

protection to swap counterparties. That is the fundamental purpose of the clearing 

facility. In addition, the clearinghouse imposes its own layer of additional protection 

in the form of collateral requirements on its counterparties. So in effect there are 

already two layers of capital: that which with the clearinghouse is capitalized, and 

that which the clearinghouse imposes on its members when it trades with them. 

Conclusion 

Let me conclude by saying that ISDA and our members appreciate the opportunity to testify and answer your questions today. We recognize that policymakers 

today have real and legitimate concerns regarding their twin goals of ensuring financial stability and reducing risk. 

We in the OTC derivatives industry share these goals. We have moved very quickly in recent months in a broad range of areas to allay policymakers’ concerns. We 

know that we have more work ahead—and we are committed to taking on these 

challenges. 

At the same time, we believe—and we are joined by thousands of American companies who also believe—that the customized nature of OTC risk management tools 

provides a substantial benefit . . . a benefit to our firms, our economy and our country. We must not lose sight of the important role that OTC derivatives play as we 

work together on financial regulatory reform. 

Thank you. 

ATTACHMENT

8 September 2009

Hon. WILLIAM C. DUDLEY,

President,

Federal Reserve Bank of New York, 

New York, NY

Dear Mr. Dudley:

We are writing to inform you of our commitment to increase the usage of central 

counterparties for clearing, which we believe will significantly reduce the systemic 

risk profile of the OTC derivatives market. We have set the following initial perVerDate 0ct 09 2002 11:29 Nov 04, 2009 Jkt 041481 PO 00000 Frm 00079 Fmt 6633 Sfmt 6621 I:\DOCS\111-29\53020.TXT AGR1 PsN: BRIAN
76

formance targets as a demonstration of that commitment. We will increase these 

target levels, which are the first set for central clearing, as we improve our clearing 

capabilities. 

For Interest Rate Derivatives: 

• Each G15 member (individually) commits to submitting 90% of new eligible 

trades (calculated on a notional basis) for clearing beginning December 2009.

• The G15 members (collectively) commit to clearing 70% of new eligible trades 

(calculated on a weighted average notional basis) beginning December 2009.

• The G15 members (collectively) commit to clearing 60% of historical eligible 

trades (calculated on a weighted average notional basis) beginning December 

2009. 

For Credit Default Swaps: 

• Each G15 member (individually) commits to submitting 95% of new eligible 

trades (calculated on a notional basis) for clearing beginning October 2009.

• The G15 members (collectively) commit to clearing 80% of all eligible trades 

(calculated on a weighted average notional basis) beginning October 2009.

Furthermore, we will issue performance metrics that address both new transactions and the outstanding trade population on a monthly basis. The first report 

will be issued on the 10th business day of October 2009 and will be in respect of 

September 2009, and for each month thereafter, the relevant report will be issued 

as part of the monthly metrics we currently report. 

We will continue to work with the regulators to explore means by which we can 

look to improve submission levels and clearing yields. We will review the performance metrics and targets contained in this letter with the global regulators on a regular basis to ensure that the metrics and targets demonstrate the industry commitment to increased clearing of OTC transactions. 

G15 members commit to actively engaging with CCPs and regulators globally to 

broaden the set of derivative products eligible for clearing, taking into account risk, 

liquidity, default management and other processes. 

The G15 members also commit to work with eligible CCPs and regulators globally 

to expand the set of counterparties eligible to clear at each eligible CCP taking into 

account appropriate counterparty risk management considerations, including the development of buy-side clearing. 

Of course, successful expansion of the sets of eligible products and counterparties 

is necessarily dependent on several factors, including ensuring proper risk management, CCP capabilities and business choices, regulatory treatment and decisions of 

non-G15 firms. We commit to work actively with our supervisors and other regulators to remove any of these impediments to our efforts. 

Yours sincerely from the Senior Managements of:

Bank of America-Merrill Lynch; 

Barclays Capital; 

BNP Paribas; 

Citigroup; 

Commerzbank AG; 

Credit Suisse; 

Deutsche Bank AG; 

Goldman, Sachs & Co.; 

HSBC Group; 

International Swaps and Derivatives Association, Inc.; 

JP Morgan Chase; 

Morgan Stanley; 

The Royal Bank of Scotland Group; 

Socie ́te ́ Ge ́ne ́rale; 

UBS AG; 

Wachovia Bank, N.A.

Identical letters sent to: 

Board of Governors of the Federal Reserve System; 

Connecticut State Banking Department; 

Federal Deposit Insurance Corporation; 

Federal Reserve Bank of Richmond; 

French Secretariat General de la Commission Bancaire; 

German Federal Financial Supervisory Authority; 

Japan Financial Services Agency; 

New York State Banking Department; 

77

Office of the Comptroller of the Currency; 

Securities and Exchange Commission; 

Swiss Financial Market Supervisory Authority; 

United Kingdom Financial Services Authority.

Copies to: 

Commodity Futures Trading Commission; 

European Commission; 

European Central Bank.

The CHAIRMAN. Thank you, Mr. Pickel. 

Mr. Short, welcome to the Committee. 

STATEMENT OF JOHNATHAN H. SHORT, VICE PRESIDENT AND 

GENERAL COUNSEL, INTERCONTINENTALEXCHANGE, INC.,

ATLANTA, GA 

Mr. SHORT. Chairman Peterson Ranking Member Lucas, I am 

Johnathan Short, Senior Vice President and General Counsel of 

IntercontinentalExchange, or ICE. We very much appreciate the 

opportunity to appear before you today to testify on the Department of the Treasury’s Over-the-Counter Derivatives Markets Act 

of 2009. 

ICE has an established track record of working with market participants and regulators alike to introduce transparency and risk 

intermediation into OTC markets. Along with the introduction of 

electronic trading to OTC energy markets, ICE pioneered the concept of cleared OTC energy swap contracts in 2002. 

ICE recognizes that appropriate regulation of OTC derivatives is 

of utmost importance to the long-term health and viability of our 

financial system and to our broader economy. In this regard, the 

current Treasury proposal contains many provisions that will benefit both the derivatives markets and the broader economy as a 

whole. 

We cannot summarize all of our comments on the OTCDMA in 

this oral testimony, but we will highlight several points in the proposed legislation which warrant further scrutiny and consideration 

by Congress in order to strike the proper balance between needed 

market reform, while maintaining the usefulness of OTC derivatives to the broader economy. 

These three points in ICE’s recommendations for improvement 

are: 

One, while mandating clearing and electronic trading for most 

standardized swap transactions may be appropriate to achieve certain goals of the OTCDMA, Congress should consider appropriate 

exclusions for transactions involving commercial entities and transactions in illiquid contracts that may be difficult to clear. 

Two, clearinghouses should not be forced to make clearing of 

swaps fungible or be forced to provide margin offsets for positions 

held in other clearinghouses, as such a mandate could increase 

rather than decrease the potential for systemic risk. 

And, three, careful consideration should be given to the provisions requiring registration of foreign boards of trades and, in particular, the provisions giving the CFTC authority to set position 

limits on contracts traded on a foreign board of trade that do not 

have a linkage to a domestically traded contract. Such provisions 

will invite retaliation from foreign regulators and inhibit necessary 

global regulatory cooperation. 

78

To elaborate on these three points, the OTCDMA recognizes the 

benefits of exchange trading and clearing by requiring all standardized swaps to be exchange traded and cleared. The OTCDMA instructs the CFTC and SEC to define the term standardized as 

broadly as possible and includes a presumption of standardization 

for any contract that a clearinghouse is willing to accept. 

Clearing and electronic execution and trade processing are core 

to ICE’s business model, and ICE would clearly stand to benefit 

from legislation that required all derivatives transactions conducted in the U.S. to be cleared and traded on exchanges or electronic trading facilities. However, such a provision may result in 

significant unintended consequences by attempting to force transactions that are not readily amenable to clearing into clearinghouses, or by forcing commercial market participants who would 

rather outsource their risk management to an OTC swaps dealer 

to incur the costs of expensive trading and clearing standardized 

contracts that may not perfectly fit their risk management needs. 

Instead of forcing all derivative transactions to be exchange traded and cleared, Congress should require this for the segments of 

the market where risk is greatest like the inner dealer or major 

swaps participant derivatives market. 

Mandating that inner dealer or major swaps participant trades 

be cleared would eliminate much of the bilateral counterparty risk 

that was central to the financial crisis last year, and achieved 

many of the risk reduction and transparency goals that the Treasury is seeking. 

To address any potential for a gap in oversight, this step could 

be supplemented with enhanced prudential regulation of swaps 

dealers and major market participants to allow regulators to ensure that such entities were not engaging in trading conduct with 

commercial entities that exposed them to excessive counterparty 

risk. 

On the issue of fungible clearing for swaps, the OTCDMA includes a provision that requires clearinghouses to prescribe that all 

swaps with the same conditions and terms are fungible and may 

be offset with one another. This provision could be interpreted to 

force clearinghouses to treat standardized swaps as fungible with 

positions held in other clearinghouses, and to offer margin risk offsets against positions in other clearinghouses. Such a requirement 

would be very difficult to implement across multiple clearinghouses, making it more difficult for the clearinghouse to do what 

the proposed legislation intends for them to do, which is to properly 

manage risk positions held in the clearinghouse and mitigate systemic risk. 

A forced linkage of clearinghouses could perversely reintroduce 

the interconnectedness problem that we have all just experienced 

in the OTC markets among major financial institutions and allow 

problems in one clearinghouse to infect other clearinghouses. 

Finally, on foreign boards of trade, careful consideration should 

be given to the provisions of the proposed legislation requiring registration of foreign boards of trade, and the provisions giving the 

CFTC the authority to set position limits on any contract traded on 

a foreign board of trade that is offered to U.S. market participants. 

The provisions requiring registration are likely to result in similar 

79

1Title VII, Improvements to Over-the-Counter Derivatives Markets (August 11, 2009). 

requirements being imposed by foreign regulators on domestic markets. 

In addition, the provisions related to position limits are problematic as well. While placing position limits on U.S. market participants trading in a linked contract, one linked to a U.S. contract 

market are appropriate; providing that the CFTC could set position 

limits on other foreign contracts is not appropriate, would be repugnant to foreign regulators, and would likely inhibit the regulatory cooperation amongst regulators at a time when it is most 

needed. 

Mr. Chairman, thank you for the opportunity to share our views 

with you, and I would be happy to answer any questions that you 

may have. 

[The prepared statement of Mr. Short follows:]

PREPARED STATEMENT OF JOHNATHAN H. SHORT, SENIOR VICE PRESIDENT AND

GENERAL COUNSEL, INTERCONTINENTALEXCHANGE, INC., ATLANTA, GA 

Chairman Peterson, Ranking Member Lucas, I am Johnathan Short, Senior Vice 

President and General Counsel of IntercontinentalExchange, Inc., or ‘‘ICE.’’ I very 

much appreciate the opportunity to appear before you today to testify on the Department of the Treasury’s Over the Counter Derivatives Markets Act of 2009 

(‘‘OTCDMA’’).1

Background 

ICE launched its electronic OTC energy marketplace in 2000. The ICE OTC platform was designed to bridge the void that existed between the voice brokered OTC 

markets which were bilateral and opaque, and the open-outcry futures exchanges, 

which were inaccessible or lacked the products needed to hedge in the power markets. Since then, ICE has acquired and operates three regulated futures exchanges 

through three separate subsidiaries, each with its own governance and regulatory 

infrastructure. The International Petroleum Exchange (renamed ICE Futures Europe), was a 20 year old exchange specializing in energy futures when acquired by 

ICE in 2001. Located in London, it is a Recognized Investment Exchange, or RIE, 

operating under the supervision of the UK Financial Services Authority (FSA). In 

early 2007, ICE acquired the 137 year old ‘‘The Board of Trade of the City of New 

York’’ (renamed ICE Futures U.S.), a CFTC-regulated Designated Contract Market 

(DCM) headquartered in New York and specializing in agricultural, foreign exchange, and equity index futures. In late 2007, ICE acquired the Winnipeg Commodity Exchange (renamed ICE Futures Canada), a 120 year old exchange specializing in agricultural futures, regulated by the Manitoba Securities Commission, and 

headquartered in Winnipeg, Manitoba. ICE also owns and operates five derivatives 

clearinghouses, each serving a distinct part of its trading business. These clearinghouses include:

• ICE Clear U.S., a Derivatives Clearing Organization located in New York and 

serving the markets of ICE Futures U.S.;

• ICE Clear Europe, a Recognized Clearing House located in London that serves 

ICE Futures Europe, ICE’s OTC energy markets, and the European portion of 

ICE’s credit default swaps clearing initiative;

• ICE Clear Canada, a recognized clearing house located in Winnipeg, Manitoba 

that serves the markets of ICE Futures Canada;

• ICE Trust, a U.S.-based CDS clearing house which began clearing CDS transactions in March 2009, and which to date, along with ICE Clear Europe, has 

cleared over $2 trillion in notional value of credit default swaps; and

• The Clearing Corporation, established in 1925 as the nation’s first independent 

futures clearing house. It provides the risk management framework, operational 

processes and clearing infrastructure for ICE Trust. The Clearing Corporation 

also provides clearing services to the Chicago Climate Futures Exchange.

ICE has an established track record of working with market participants to introduce transparency and risk intermediation into OTC markets. We have also worked 

80

2Study by the International Swaps and Derivatives Association (April 23, 2009). http://

www.isda.org/press/press042309der.pdf. 3OTCDMA, Section 713(a). 

closely with regulators to improve supervision and access to information from the 

OTC markets. Along with the introduction of electronic trading to energy markets, 

ICE pioneered the concept of cleared OTC energy swap contracts. These changes to 

a traditionally opaque, bilateral market structure were made in response to a crisis 

in the energy markets in 2002, and have dramatically transformed the way energy 

derivatives are traded and risks are managed by market participants. 

Need for OTC Regulation 

Appropriate regulation of OTC derivatives is of utmost importance to the long 

term health and viability of our financial system and to our broader economy. The 

current financial crisis has exposed a significant gap in market transparency and 

regulation that has allowed systemic risk to grow and for its effects to be felt beyond 

Wall Street to Main Street. However, in considering the need for OTC derivatives 

regulation, it is equally important to understand the true size and nature of OTC 

derivatives markets and their importance to the broader U.S. economy. Derivatives 

are commonly thought to be complex financial instruments that are only traded between large investment banks and hedge funds. However, derivatives are central to 

the U.S. and global economy: 94% of the world’s 500 largest companies use derivatives to manage a broad variety of risks.2 Use of derivatives is not constrained to 

the financial sector, but cuts across the entire spectrum of business and government, including manufacturing, airline, health care and technology companies, as 

well as a variety of state and local governmental entities. It also bears emphasizing 

that derivatives—both futures and OTC instruments—could play a central role in 

any ‘‘cap and trade’’ program to combat climate change. 

ICE believes that increased transparency and proper risk and capital management, coupled with legal and regulatory certainty, are central to OTC market financial reform and to restoring confidence to these vital markets. In this regard, the 

current Treasury proposal embodied in the OTCDMA contains many provisions that 

will benefit the derivatives markets and the broader economy as a whole. However, 

several key points in the legislation warrant further scrutiny and consideration by 

Congress in order to strike the proper balance between needed market reform and 

maintaining the usefulness of OTC derivatives to the broader economy. 

Mandating Clearing and Electronic Trading 

The OTCDMA recognizes the benefits of exchange trading and clearing by requiring all standardized swaps to be exchange traded and cleared. The OTCDMA instructs the CFTC and the SEC to define the term ‘‘standardized’’ as ‘‘broadly as possible after taking into account’’ factors as (i) which terms of the trade, including 

price, are disseminated to third parties; (ii) the volume of transactions; (iii) the extent to which the swap is similar to other swaps that are centrally cleared; (iv) 

whether the swap is similar to other swaps in ways that are of economic significance; and (v) other factors that the Commodity Futures Trading Commission 

(‘‘CFTC’’) and the Securities and Exchange Commission think relevant.3 This broad 

definition is designed to capture most derivative transactions. 

Clearing and electronic execution and trade processing are core to ICE’s business 

model. As a result, ICE would clearly stand to benefit commercially from legislation 

that required all derivatives transactions conducted in the U.S. to be cleared and 

traded on exchanges or electronic trading facilities. However, the mandated electronic trading and clearing provisions of the OTCDMA may result in significant unintended consequences by attempting to force transactions that are not readily amenable to clearing into clearinghouses, or by forcing commercial market participants—including those who would rather, for a price, outsource their risk management to an OTC swaps dealer—to incur the cost and expense of trading in standardized contracts that may not perfectly fit their risk management needs. In addition, 

many commercial market participants will be forced to post significant cash collateral to margin cleared positions when they historically have been able to use illiquid 

assets to back OTC bilateral swap positions that they have entered into with swaps 

dealers. 

The critical factors for efficient clearing include not only the standardization of 

products, but also the availability of adequate pricing and market liquidity. Pricing 

is essential for the clearinghouse to mark open positions to market on a daily basis 

and to properly margin positions, which protects both the clearinghouse and market 

in the event of a clearing participant default. The depth of market liquidity and 

number of clearing participants or intermediaries impacts margin and guaranty 

81

4OTCDMA, Sections 713(a), 753(a). 

fund calculations, as well as the ability to efficiently mutualize risk across enough 

clearing participants to make clearing economically viable. Where market depth is 

poor, margin and risk mutualization cost is very high and can make it uneconomic 

from a market perspective for a product to be cleared given the necessary conservatism on the part of a clearinghouse. 

Thus, while ICE certainly supports clearing and exchange trading of as many 

standardized contracts as possible, there will always be products which are not sufficiently standardized or which do not possess sufficient market liquidity for clearing 

to be practical, economic or necessary. Pursuant to the OTCDMA’s broad definition 

of ‘‘standardized swap’’, many thinly traded instruments will be submitted for clearing and traded on exchange. This could increase risk to clearinghouses and to the 

financial system in general. 

Finally, forcing all derivatives transactions and all market participants to trade 

through exchanges and to clear through clearinghouses will greatly increase cost to 

commercial companies and ultimately to consumers. Currently, many commercial 

entities address their risk management needs through trading with swaps dealers. 

The swaps dealers offset the risk they undertake through internal offsets, trading 

with other swaps dealers, or through trading on exchanges. Under these arrangements the commercial entities have the flexibility to post illiquid collateral (such as 

a pledge of hard assets or a pledge of future production) that could not be accepted 

by a clearinghouse. Forcing these transactions into clearinghouses will cause these 

companies to post their most liquid assets, impairing their ability to operate efficiently. This will put U.S. firms at a severe disadvantage to foreign competitors. 

Instead of forcing all derivative transactions to be exchange traded and cleared, 

Congress should focus on the segments of the markets where risk is greatest, like 

the inter-dealer and major swaps participant derivatives market. Mandating that 

inter-dealer and major swaps participant trades be cleared would eliminate the bilateral counterparty risk that was central to the liquidity crisis that occurred last 

year, and achieve many of the risk reduction and transparency objectives that 

Treasury is seeking without impacting clearinghouse risk management and the competitiveness of U.S. commercial businesses. This step could be supplemented with 

enhanced prudential regulation of swaps dealers or major swaps participants that 

would allow regulators to ensure that such entities do not engage in trading conduct 

with other parties that poses any systemic risk. 

Fungible Clearing for Swaps 

The OTCDMA includes a provision that requires clearinghouses to ‘‘prescribe that 

all swaps with the same terms and conditions are fungible and may be offset with 

each other.’’ 4 This provision would force clearinghouses to treat standardized swaps 

as fungible with positions held other clearinghouses and offer risk offsets against 

positions held in other clearinghouses. This could make proper risk management by 

clearinghouses extremely difficult, and inadvertently increase systemic risk—the 

very thing that clearinghouses are intended to eliminate under the OTCDMA. 

Clearinghouses have been some of the few institutions that have operated well in 

the financial markets during this time of crisis. Clearinghouses perform a vital risk 

management function in margining derivative positions and performing real time 

risk management for their customers. Forcing clearinghouses to take contracts from 

other clearinghouses or to provide margin offsets with other clearinghouses could 

present significant systemic risk issues, making it more difficult to track positions 

and counterparty risk exposure, and creating significant problems in the event of 

a default of a major market participant. To understand this risk, consider what 

would have happened in the real world Lehman Brothers default scenario if Lehman’s positions had been spread across ten different clearinghouses, none of whom 

may have had the full risk picture and all of whom might have been dependent on 

the risk management practices of the weakest link in the ‘‘offset’’ chain. In this regard, interconnected clearinghouses might not have been very different from interconnected banks, with problems in one competing clearinghouse impacting other 

clearinghouses. 

Many important problems would need to be overcome to make fungible clearing 

and margin offsets workable. For example, what if rules at each clearinghouse are 

not exactly the same with respect to a default, which clearinghouses’ rules would 

have precedent? What if one clearing house chose to adopt more stringent margin 

requirements than the minimum legally required—would it have to provide a margin offset for positions held at a second clearinghouse that only chose to adopt the 

minimum margin standards that are legally required? 

82

5OTCDMA, Section 725. ICE’s London-based subsidiary, ICE Futures Europe, complies a 

similar requirement through its ‘‘no-action’’ letter. 6OTCDMA, Section 723. 

It is important to note that fungible clearing is currently allowed, but not forced 

upon futures clearinghouses, pursuant to Core Principle E of the Commodity Exchange Act. Thus, clearinghouses have the ability to create netting and offsetting 

arrangements with other clearinghouses on a voluntary basis, with appropriate risk 

management considerations in mind. Congress should eliminate the fungibility requirement from the OTCDMA before passage. 

Foreign Boards of Trade 

The OTCDMA gives the CFTC greater authority over foreign boards of trade. Foreign Boards of Trade will need to register with the CFTC in order to provide electronic access to U.S. participants. In order to register with the CFTC, the foreign 

board of trade must adopt position limits for contracts that are linked to a contract 

traded on a U.S. DCM.5 The OTCDMA goes further than linked contracts, however, 

and gives the CFTC the authority to set position limits on any contract traded on 

a foreign board of trade that is offered to U.S. market participants.6

While placing position limits on U.S. market participants trading in contracts 

linked to a contract traded on a U.S. exchange is appropriate, allowing the CFTC 

to place position limits on foreign exchange contracts that have no nexus or ‘‘linkage’’ to U.S. traded contracts presents serious issues. For example, if a foreign exchange offered access to U.S. market participants to a contract that was not linked 

to a U.S. traded contract, under the OTCDMA the CFTC rather than the foreign 

exchange regulator would set position limits. The provision would allow the CFTC 

to set aggregate position limits on traditionally sovereign contracts such as German 

bonds or Asian currencies. This would be unacceptable to the foreign government 

regulating a market, would invite retaliation by foreign regulators against U.S. exchanges, and would impede regulatory cooperation among governments in what is 

today a global financial market. Congress should eliminate this provision from the 

OTCDMA since it does not pertain to the stated goals of the proposal. 

Conclusion 

ICE has always been and continues to be a strong proponent of open and competitive markets, and of appropriate regulatory oversight of those markets. As an operator of global futures and OTC markets, and as a publicly-held company, ICE understands the importance of ensuring the utmost confidence in its markets. Subject 

to the foregoing considerations which should be addressed by Congress in any final 

legislation, the OTCDMA offers many improvements to the existing regulatory 

framework in enhancing market transparency and eliminating elements of systemic 

risk from the financial system. 

Mr. Chairman, thank you for the opportunity to share our views with you. I would 

be happy to answer any questions you may have.

The CHAIRMAN. Thank you very much Mr. Short. 

Mr. Budofsky. 

STATEMENT OF DANIEL N. BUDOFSKY, PARTNER, DAVIS POLK 

& WARDWELL LLP, NEW YORK, NY; ON BEHALF OF

SECURITIES INDUSTRY AND FINANCIAL MARKETS

ASSOCIATION 

Mr. BUDOFSKY. Thank you, Mr. Chairman. As you noted, I am 

Dan Budofsky. I am a Partner at the law firm of Davis Polk & 

Wardwell, and I am here today to testify on behalf of the Securities 

Industry and Financial Markets Association. 

Thousands of Americans companies use over-the-counter derivatives to manage the financial risks inherent in their businesses. 

Many SIFMA members have built successful businesses by offering 

derivatives products to these companies. It is therefore in their interest, as well as in the interest of their customers, to support legislative and regulatory measures to improve the integrity, soundness and efficiency of the OTC derivatives markets. 

83

There is much in the Act that SIFMA supports. SIFMA supports 

comprehensive regulatory oversight of systematically significant derivatives dealers. SIFMA also supports regulatory transparency as 

a means to facilitate oversight of derivatives markets and the activities of individual market participants. The Act would accomplish these goals by requiring that swaps either be cleared through 

a derivatives clearing organization, or be reported to a swap repository, the CFTC or the SEC. And standardized swaps would be required to be cleared. 

The Act goes much further than this, however, and I will briefly 

touch upon several aspects of the Act that concern SIFMA and its 

members. 

First, SIFMA does not believe that legislation should mandate 

exchange trading rather than over-the-counter trading for derivatives. The Act seems to reflect the view that transparency and risk 

reduction are best achieved through exchange trading. SIFMA believes, instead, that these goals are achieved through regulatory access to market information and clearing, regardless of the trading 

environment. For example, the U.S. bond market is overwhelmingly over-the-counter, yet it is transparent and well regulated. 

SIFMA is also concerned about the Act imposing burdensome 

regulatory requirements on end-users. For example, the Act could 

effectively force certain end-users to submit derivatives transactions to clearinghouses. Although there is an exception to the 

mandatory clearing requirement for standardized swaps, if one of 

the parties is neither a dealer nor a major swap participant, this 

is only available if that party also fails to meet the eligibility requirements of the clearinghouse, which could be unlikely for many 

large end-users. 

Moreover, the definition of major swap participant is so broadly 

and vaguely drafted that it could easily pick up many end-users. 

Either way, an end-user might be compelled to submit particular 

transactions through a clearinghouse, thereby incurring significant 

costs including the not insignificant opportunity cost of posting 

margin in the form of cash or cash equivalents. 

Another area of concern is margin. Under the Act, regulators 

may, but would not be required to impose a margin requirement 

on noncleared transactions, and would be required to if the enduser falls within the definition of major swap participant or the 

transaction does not qualify for hedge accounting under FAS 133. 

This means that an extension of credit created through a swap 

transaction must be collateralized under the Act even though most 

other extensions of credit between the parties could be made on an 

unsecured basis. 

SIFMA is also troubled by the Act’s requirements of additional 

capital for cleared transactions. Clearing reduces risk by creating 

a well-capitalized central counterparty and by requiring margin. 

Policymakers should be concerned about imposing unnecessary 

costs that could discourage prudent risk management. 

I would also like to point out that the Act is written to preclude 

any use of exemptive authority by the agencies. This is unduly restrictive and would mean that legitimate practices arising in the 

future that were never intended to be covered by the Act might be 

affected, leading to unintended consequences. A better approach 

84

1The Securities Industry and Financial Markets Association brings together the shared interests of more than 650 securities firms, banks and asset managers locally and globally through 

offices in New York, Washington, DC, and London. Its associated firm, the Asia Securities Industry and Financial Markets Association, is based in Hong Kong. SIFMA’s mission is to champion policies and practices that benefit investors and issuers, expand and perfect global capital 

markets, and foster the development of new products and services. Fundamental to achieving 

this mission is earning, inspiring and upholding the public’s trust in the industry and the markets. (More information about SIFMA is available at http://www.sifma.org.) 

might be to permit the agencies to grant appropriate exemptions, 

but regularly report to Congress to ensure that they are granted 

in accordance with the intent of lawmakers. 

Finally, SIFMA is concerned that the 180 day transition period 

would not give the market sufficient time to comply with the Act’s 

complex and far-reaching provisions. SIFMA believes that the effective date should be no less than 1 year after enactment. 

In conclusion, Mr. Chairman, I would like to reiterate the support of SIFMA and its members for legislation to address weaknesses in the current regulatory framework for derivatives. The 

events of the past year have made it clear that improvements are 

needed. 

However, derivatives have become an integral part of our economy, and they play an important role in the risk management efforts of commercial companies across the country. As such, it is important that legislation intended to improve derivatives regulation 

and reduce systemic risk does not unnecessarily impair the usefulness of derivatives, and thereby, increase the risk exposure of 

many of the companies that have come to depend on them. 

Thank you. 

[The prepared statement of Mr. Budofsky follows:]

PREPARED STATEMENT OF DANIEL N. BUDOFSKY, PARTNER, DAVIS POLK & 

WARDWELL LLP, NEW YORK, NY; ON BEHALF OF SECURITIES INDUSTRY AND

FINANCIAL MARKETS ASSOCIATION

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

My name is Dan Budofsky. I am a partner of the law firm Davis Polk & Wardwell 

LLP. I am appearing today on behalf of the Securities Industry and Financial Markets Association (‘‘SIFMA’’) 1 and its members. Thank you for your invitation to testify today. 

The membership of SIFMA is diverse and includes financial firms of different 

sizes as well as firms that are active in different parts of the financial services business. Although my testimony today is being presented on behalf of financial services 

firms, it also is focused on the interests and concerns of those firms’ customers, the 

thousands of American corporations that benefit directly from the broad availability 

of derivatives transactions to manage various risks that arise in connection with 

their day-to-day business activities. These companies also benefit indirectly from the 

availability of over-the-counter derivatives (OTC derivatives) such as credit default 

swaps, which make credit more readily available to them and at lower cost because 

it permits those who extend credit to those companies to hedge their risks as well. 

SIFMA’s members have built successful derivatives businesses by offering products 

that meet important needs of their customers, and it is in their interest to support 

legislative and regulatory measures that will improve the integrity, soundness and 

efficiency of the OTC derivatives markets on which their businesses are based. Such 

measures serve the interests of all market participants—the dealers and their customers—and the American public, as well. 

Indeed, fifteen major OTC derivatives dealers, in a recent letter to the Federal 

Reserve Bank of New York, committed to clear 90% of all new eligible interest rate 

derivatives and 95% of all new credit default swaps through centralized 

counterparties by December and October 2009, respectively. This, along with working with lawmakers and regulators, will help achieve the laudable goals of increasVerDate 0ct 09 2002 11:29 Nov 04, 2009 Jkt 041481 PO 00000 Frm 00088 Fmt 6633 Sfmt 6621 I:\DOCS\111-29\53020.TXT AGR1 PsN: BRIAN
85

ing regulatory transparency and reducing systemic risk in the OTC derivatives market. 

At the same time, SIFMA’s members are concerned about legislative proposals 

that would unnecessarily diminish the usefulness of available derivatives or limit 

the availability of useful derivatives by imposing significant new costs or limitations 

in connection with their use. 

There is much in the Over-the-Counter Derivatives Markets Act of 2009 (the 

‘‘Act’’) that SIFMA and its members support. In particular, SIFMA supports legislative proposals to ensure that systemically significant derivatives dealers are subject 

to comprehensive regulatory oversight. The lack of meaningful regulation of AIG’s 

derivatives affiliate allowed poor business practices to go unchecked and ended in 

a situation in which the Federal Government had to invest tens of billions of dollars 

in that enterprise. Legislation that implements comprehensive regulatory oversight 

of systemically significant firms would address this regulatory gap. 

SIFMA also supports measures that will improve regulatory transparency and 

thereby facilitate oversight of derivatives markets and the activities of individual 

market participants. The Act would accomplish this by requiring that swaps either 

be cleared through a derivatives clearing organization (a ‘‘DCO’’) (in fact, if they are 

standardized they would be required to be cleared through a DCO) or be reported 

on a post-trade basis to a swap repository or the CFTC. Similar requirements, including reporting to the SEC, would be imposed under the Act with respect to security-based swaps. SIFMA believes that by combining regulatory transparency with 

oversight of systemically important firms, the Act addresses the regulatory shortcomings that allowed the AIG situation to threaten the global financial system. 

The Act goes much further than this and, in so doing, could adversely affect the 

availability and usefulness of derivatives transactions. I will briefly describe several 

of the issues in the Act that SIFMA has identified as particularly problematic. 

The Act mandates that all swaps that are standardized be traded on an exchange 

or an alternative swap execution facility. SIFMA believes that the legislation incorrectly views transparency and risk reduction as being achievable solely through exchange trading, but these goals can be achieved through other means. SIFMA does 

not believe there is any reason for the government to mandate that business be 

transacted in this particular manner. In the equity markets we have both exchange 

trading and over-the-counter trading. The policy goals of transparency and systemic 

risk reduction are achieved by timely post-trade price reporting and clearance of 

transactions effected by broker-dealers through registered clearing agencies. It has 

long been recognized that while an exchange is a facility for transacting business 

that provides buyers and sellers with a place to meet, it is by no means the only 

way for transactions to occur. Highly liquid, frequently traded products may benefit 

from exchange trading, whereas it may be more appropriate for products that trade 

less frequently to trade over-the-counter. For example, the U.S. bond market is an 

overwhelmingly over-the-counter market, yet it is transparent and well-regulated. 

Bond transactions are reported to trade reporting facilities that make the execution 

prices available to regulators for surveillance purposes. Bonds clear through clearing 

agencies such as DTCC that provide a central counterparty, and this performs an 

essential risk mitigation function. 

SIFMA also is concerned about the application of the Act’s many regulatory provisions to the customers of derivatives dealers, the corporations that use derivatives. 

For example, the Act would effectively require corporate end-users to become members of registered clearing agencies. Let me explain why. The Act includes an exception to the mandatory clearing requirement for standardized swaps in the case of 

transactions in which one of the parties is not a dealer or major swap participant 

(i.e., is a corporate end-user), but only if that party also does not meet the eligibility 

requirements of the clearinghouse. The definition of major swap participant is so 

broad and vague that it could easily include many corporate end-users, and the eligibility requirements of clearinghouses will not necessarily constitute a significant 

hurdle, particularly insofar as they are profit-making entities eager to expand their 

businesses. If corporate end-users were required to clear their standardized swaps 

they would incur the very significant cost of posting margin in the form of cash or 

cash equivalents, which is the form of collateral required by clearing agencies. Because these funds would no longer be available for productive investment in the corporate end-user’s business, a clearing requirement would create a significant disincentive to use swaps to manage risk. Today, in the OTC derivatives world, corporate end-users may be required by their dealer counterparty to post margin, but 

that margin may be in the form of assets other than cash or cash equivalents. 

Although CFTC Chairman Gary Gensler recently suggested in a letter to Members of Congress that end-users could post margin in the form of assets other than 

cash, SIFMA does not believe that is a realistic or viable alternative, as it would 

86

expose the clearinghouse, which as the central counterparty must be highly liquid, 

to unacceptable levels of risk. 

Another example of the Act’s potential impact on end-users arises in connection 

with margin requirements. Although regulators are not required to impose a margin 

requirement on end-user transactions that are not cleared, the Act says they may

do so, and would be required to if the end-user falls within the definition of major 

swap participant or the transaction does not qualify for hedge accounting treatment 

under FAS 133. This means that an extension of credit created through a swap 

transaction must be collateralized, even though most other extensions of credit between the parties could be made on an unsecured basis. 

In short, SIFMA does not believe that corporate end-users, as opposed to professional market participants such as swap dealers, should be subject to burdensome 

new regulatory requirements in connection with their swap transactions. If they are, 

the result will likely be that they are exposed to more risk, not less. 

SIFMA members also are concerned about the imposition of incremental capital 

requirements with respect to their cleared swaps. The clearing process makes these 

transactions less risky. Market participants benefit by gaining a well-capitalized 

clearinghouse as a counterparty and by the clearinghouse’s requirement that all of 

its transactions be secured by margin. The addition of a further safeguard by imposing the requirement of additional capital for cleared transactions seems unnecessary, in particular because the cost of each of these layers of protection is directly 

borne by the dealers, and ultimately by their customers. Policymakers should be 

concerned about imposing a level of cost that discourages prudent risk management. 

Giving the CFTC, the SEC, and prudential regulators the general authority to establish capital requirements would seem to be sufficient. 

SIFMA also has a practical concern about the short implementation time provided 

in the Act. Its provisions are to become effective 180 days after the date of enactment. SIFMA does not believe this would give derivatives dealers and other swap 

participants sufficient time to comply with the Act’s complex and far-reaching provisions. SIFMA believes that the effective date should be no less than 1 year after 

the date of enactment. 

In conclusion, Mr. Chairman, I would like to reiterate the support of SIFMA and 

its members for legislation to address weaknesses in the current regulatory framework for derivatives transactions. The events of the past year have made it clear 

that improvements are needed. However, derivatives have become an integral part 

of our economy and they play an important role in the risk management efforts of 

commercial companies across the country. As such, it is important that legislation 

intended to improve derivatives regulation and reduce systemic risk does not unnecessarily impair the usefulness of derivatives and thereby increase the risk exposure 

of the many companies that have come to depend on them.

The CHAIRMAN. Thank you. 

I thank the panel for your patience in sticking with us here. 

Mr. O’Connor, I was reading your testimony. I want to try to understand better what you are saying. From what I can gather, you 

are saying that what we heard from the end-users on the first 

panel was maybe more dramatic than you think it really is. Am I 

right about that? 

You seem to think that clearing is not as big a problem as some 

people are make making it out to be. Am I reading that right? 

Mr. O’CONNOR. I think there are two issues that people have 

with clearing, and the panel this morning dealt predominantly with 

the cost of clearing. 

There is a cost to central clearing, but there is also great benefit 

to it. So, it is difficult to sit in this room and say, I would like to 

see more transparency in my markets, I would like to be protected 

from systemic risk, and I would like to see more done about abuses 

in the market that cause undue volatility, but I don’t want to pay 

anything for it. 

So there are benefits. 

The CHAIRMAN. Sounds like the health care debate. 

Mr. O’CONNOR. I will leave that alone. 

87

So that is one concern. But that comes down to an assessment 

of the cost in benefits. 

And the other concern you have heard, perhaps from this panel, 

is about concerns around standardization and the loss of the ability 

to use customized derivatives. That is what I spoke more to in my 

written testimony and—this morning that that is perhaps a historic perspective, and that as technology and talent is brought to 

bear on the problem by the industry, that what was once standardized is now a much broader aspect of the market. 

The CHAIRMAN. And so in other words you are saying it is not—

whatever the standardization, and I am not exactly sure I know 

what it is—but it is not as hard to do or complicated as some people make out? 

Is that what you are saying? 

Mr. O’CONNOR. It can be done. 

The CHAIRMAN. Can be done? 

Mr. O’CONNOR. Yes. 

The CHAIRMAN. And the way that the Treasury has put out this 

proposal in terms of standardization and so forth, you seem to 

think it might be workable or close to workable? 

Mr. O’CONNOR. I think it is a difficult thing to define in legislation, and you need to be careful that unintended consequences 

don’t happen. 

But, the presumption that if a regulated clearinghouse is able to 

offer a product for essential clearing, then it is standardized, I 

think is a good one. It doesn’t force the industry to do something 

they don’t feel they have the capability to do. It already falls within 

regulatory oversight, and it adapts dynamically to the marketplace. 

As new products comes on line and as new capability is developed, 

it tends to roll with the punches. 

The CHAIRMAN. And the clearinghouses, I guess they have a 

business model and they do things a certain way. From what I can 

tell, some of these end-users, they put up collateral, but they do it 

a different way than they do it in clearinghouses, and that seems 

to be the bigger part of the problem than anything. 

And that can’t be dealt with? 

Mr. O’CONNOR. I think it can be dealt with. There is a layer between the clearinghouse and the end-user. 

The CHAIRMAN. That is what I was wondering. Couldn’t you do 

that? 

Mr. O’CONNOR. Yes, there is a clearing agent within sort of most 

CFTC-regulated clearinghouses; that is the futures commission 

merchant. They are able to offer secured financing to their customers to support margin requirements. A good majority of those 

futures commission merchants are banks, so there is certainly capability there for the industry to respond to the needs for financing 

secured—to support those positions. 

The CHAIRMAN. So this idea that they are going to have to put 

up cash for the margins and that is inflexible is not necessarily 

true. There is some flexibility there; you could do it a different way. 

Mr. O’CONNOR. There is flexibility there, yes. 

The CHAIRMAN. It maybe isn’t done that much now, but it could 

be done. 

88

Mr. O’CONNOR. I think the people who participate in those markets, as they currently stand, probably are in a better position to 

provide cash. But secured financing does happen today, and there 

is no reason why that offering couldn’t be expanded. 

The CHAIRMAN. If they are making a deal in the swap market 

using this, and it works, and the people that are doing the deal 

think that they are covered, I don’t see why it couldn’t be done, or 

on a more organized clearinghouse order. That has been my question. 

So you say it probably could be done? 

Mr. O’CONNOR. Yes. There are a few more restrictions on it, so 

you can’t finance it outright. You can’t just lend them the money 

to support the transaction, but it is sort of a stronger system. 

The CHAIRMAN. And in your testimony you said that five of the 

banks are now doing 96 percent of this customized business; am I 

right about that? 

Mr. O’CONNOR. I think that the statistic is from the Comptroller 

of the Currency. In his latest statistical release it suggests that of 

the U.S. banking system, 96 percent of the current notional outstanding is held by the largest five banks. 

The CHAIRMAN. We have actually concentrated the risk now into 

fewer banks, and we have actually—it sounds to me like we have 

gotten ourselves in a worse situation than we were in before. 

Mr. O’CONNOR. I think that is true. I think that the OTC derivative markets pose a larger risk to our financial system now than 

they did before the crisis began. I think you have greater concentration in the markets; you have less liquidity in the market, 

some of which we have heard about this morning; and that is a bad 

situation. 

The CHAIRMAN. Mr. Pickel. 

Mr. PICKEL. If I may elaborate on that, the OTC’s statistics include the banks, so it includes JPMorgan and Citi, Wells, Wachovia 

and Bank of America and that is four of the five; I forget what the 

fifth one is. But that is the U.S. banks, so it doesn’t include 

Deutschebank, it doesn’t include the foreign banks. It actually 

doesn’t include Morgan Stanley or Goldman Sachs either, so there 

is a slightly larger—probably 10–12, especially in the interest rate 

swaps, where these banks are more than willing to step in and 

take over business from any of their competitors. 

The CHAIRMAN. So if you take out the interest rates, is it all 

right if I go? The interest rate swaps, that stuff is more vanilla 

than these other customized things, or more exotic things. If you 

set that aside and these other CDSs and so forth, I am more concerned about what is the percentage, what number of banks are engaging in that process. The same 10 or 12 entities? 

Mr. PICKEL. Yes, all of these institutions would be very active 

dealers in CDS, and CDS volumes are—we just published information this week—$31 trillion notional amount not the amount at 

risk, but the outstanding amount of trades, there has been a great 

effort to reduce those outstandings over the past year, year and a 

half. 

But that is the same universe of institutions that would be offering those trades. 

89

Mr. O’CONNOR. If I can just add something, I think Goldman 

Sachs, now that they are a bank holding company, they are in 

those numbers. 

But it is true that there are other international banks that aren’t 

captured by the OCC, but you see the same in the BIS statistics, 

which is—aggregation of all the central banking data on market 

concentration shows that concentration is higher than it has been. 

And of particular concern is, concentration in the U.S. market is 

much higher than it has been, and it has fallen behind other competitive marketplaces. So while it might overstate it slightly to talk 

just about U.S. banks, the U.S. market itself does demonstrate 

this. 

The CHAIRMAN. Thank you. 

The gentleman from Oklahoma. 

Mr. LUCAS. Thank you Mr. Chairman, and to continue for a moment along this line, does anyone else on the panel have any comments about this subject? 

Fair enough. Then let’s visit for a moment about the Treasury 

proposal granting aggregate position limited authority to regulators 

to impose limits across all markets. Provide me with your insights, 

gentlemen. How many of you support that? How many have opinions about that, how it would work or not work? 

It is a nice open-ended question, I promise. 

Mr. PICKEL. I will jump in here. 

Yesterday, the CFTC had their Energy and Environmental Market Advisory Committee meeting, and there was discussion of position limits there and obviously they are focused on that. As I pointed out, the OTC contract again is a bilateral contract tailored to 

the particular needs of the counterparty. To the extent it is mirroring an exchange traded contract, there may be some ability—effectively it is a look-alike contract, and you could aggregate those 

positions. But the reality is that the bilateral nature of it makes 

it very difficult, and the custom tailored nature of it makes it very 

difficult to compare it with the exchange trading contracts. 

And there are also issues in terms of how you would aggregate 

those with the exchange traded world. And, there have been suggestions that it would be aggregated with overseas contracts also. 

Mr. LUCAS. Anyone else? 

Mr. SHORT. Speaking on behalf of ICE, we would support position limits across various venues and markets. We do have a view 

that the Commission should be the body that administers that in 

order to have a fair and competitive landscape amongst trading 

venues. 

One particular piece of the proposed legislation that I think is 

problematic, I candidly think was an oversight. They actually had 

a provision that says that the CFTC could impose a position limit 

on a contract traded on a foreign board of trade that isn’t a lookalike that is linked to a domestic market, and I think that is problematic. 

Mr. DAMGARD. And I would agree with that. I think—we are 

going to need a lot of cooperation between foreign regulators, it 

seems to me. Both Europe and London have been on record as saying that they have a lot of different ways to detect manipulation, 

and they are pleased to know that the U.S. regulator is going to 

90

depend on position limits, but in each case they said that they are 

not. And it worries me that if we have position limits imposed on 

U.S. exchanges, but without the reach to do it outside the United 

States, we damage the opportunity for U.S. exchanges to continue 

to get the kind of business that they are getting today. 

Mr. DUFFY. Mr. Lucas, also on that point, position limits; the 

CME Group has supported aggregated position limits as long as 

there is a formula based on how you come to those position limits. 

We believe that it has to have, and we have it spelled out in our 

white paper, that it has to be based off of certain criteria of open 

interest, which are open positions on the exchange at the time. 

So the work that we put into development of all these products 

historically, just can’t—you can come up with an arbitrary number 

that everybody gets the same number, and then that would literally disenfranchise a group like CME Group that has worked 

very hard to put these positions on its books and serve its clients. 

So we would be at a huge disadvantage if the aggregation 

amongst position limits wasn’t done at least on a formula base 

which made sense from a business perspective. 

Mr. SHORT. I would just add that that is the issue that we think 

makes that proposal anti-competitive on its face, because if you 

were to apply an open interest test to the positions that could be 

held on an exchange, a new entrant to the market could never compete. It could never generate sufficient liquidity to compete with 

the incumbent. 

Mr. DUFFY. That is totally not true. There have been many examples, sir, historically of competing exchanges listing other exchanges’ product and becoming quite successful. 

One of them is the IntercontinentalExchange listing the WTI 

contract of the New York Mercantile Exchange and gaining a 30 

percent market share quite rapidly. 

So there are many examples how new companies can come into 

this space and become quite successful. But we don’t believe it 

should be at the expense of noncompetitive business. Thank you. 

Mr. LUCAS. You have both made your points very well and clear. 

Mr. Damgard, in your testimony, you mentioned about how the 

standardization mandate should be replaced by incentives on trade, 

on exchanges, and through clearing systems. Could you expand just 

a moment on this concept of incentives to cause behavior? 

Mr. DAMGARD. Well, I mean, for the most part, we believe that 

the exchange traded world works extremely well. And we know 

that it works well because it takes on an awful lot of risk that is 

done in the OTC market. 

Defining standardization is pretty tricky. What really constitutes 

standardization in a product is not something that we are totally 

comfortable can be done in a statute. We think the CFTC should 

have the authority to look at what is standardized and what is not 

standardized. 

But to the extent that an OTC product is accepted by a clearinghouse, that, we believe, is Treasury’s position, that therefore it 

should be considered standardized, and that is good enough for us. 

We are not sure that it is necessary to mandate that it be cleared, 

because, in some instances, clearinghouses and clearing members 

ought to be able to determine what they want to clear. 

91

I mean, these are voluntary organizations. And if, all of a sudden, the clearinghouses are forced to clear products that they can’t 

value and they can’t margin, it seems to me the clearing members 

have almost an obligation to their own stockholders to withdraw 

from the clearinghouse, which would be catastrophic in the long 

run. 

Mr. LUCAS. Thank you. 

Thank you, Mr. Chairman. 

The CHAIRMAN. I thank the gentleman. 

The gentleman from Iowa, Mr. Boswell. 

Mr. BOSWELL. Well, thank you, Mr. Chairman. I want to just 

take a moment and thank you and Mr. Lucas for the personal effort and attention you are giving to this business that has got a lot 

of concern. 

Earlier today, you made a comment, if I might remind us, not 

wanting to go back to the system that got us into the trouble that 

we are in. Last week, about a week ago Monday, talking to a constituent, a small-business owner, very successful small business 

but it is a small business, and talking about health care, and he 

said, ‘‘Well, are you aware that Wall Street is securitizing life insurance and doing a bundling, if you will, bundles of life insurance?’’ So we talked about it. I didn’t think he probably knew what 

he was talking about, but he seemed like he does about everything 

else, so we did a little checking up on it. And almost the same day, 

The New York Times came out with an article called, Wall Street 

Pursues Profit in Bundles of Life Insurance.

And the idea is that you can buy up somebody’s life insurance, 

a half-a-million-dollar policy or whatever policy for half or whatever they can agree on, and take the gamble that they are going 

to die, and then they can cash it in. But that is not good enough. 

That is good, just bundle them up and get a bunch of them. 

And I would like, I guess, to have you comment on that, what 

your thoughts of it are. I am going to ask to put into the record 

this article. 

But, the professor from Duke said, ‘‘It is bittersweet. The sweet 

part is there are investors interested in exotic products created by 

underwriters who make large fees and rating agencies who then 

get paid to confer ratings. The bitter part is it is a return to the 

good old days.’’

Now, I look at this panel—I was hoping Mr. Secretary would be 

here, but we will address this to him, too, I guess. But do you have 

an opinion on that? I would like to start with you, Mr. Budofsky, 

and just anybody else who wants to comment, and just tell us what 

you think about all that. 

Mr. BUDOFSKY. I don’t think that—well, I am not aware of 

SIFMA having a particular position on that particular instrument. 

So I would be happy to consult with them on that particular instrument. 

However, I would say that this is an example of why SIFMA supports general improved regulatory oversight over the types of entities that would be selling these products. And, to the extent that 

there are issues with that type of instrument, then regulatory oversight would be a way of having the regulators express a view. 

Mr. BOSWELL. Anybody else? Please. 

92

Mr. PICKEL. Yes, I saw that article. I read it with interest. 

I would point out that that is a—well, it is in the nature of a 

collateralized debt obligation, which is a security, not an over-thecounter derivative product, but a security that is bundled with taking those cash flows from those insurance policies and paying them 

out to the securities holders. So the securities laws would apply to 

the offering and distribution of those instruments. 

As it relates to OTC derivatives, and it wasn’t really discussed 

in that article, but there is an area, an emerging area of OTC derivatives that is potentially very useful for pension funds and insurance companies, and that is what are often called ‘‘mortality derivatives,’’ ‘‘life derivatives,’’ where there would be—again, there is 

the same concern. 

A pension fund has a certain horizon, in terms of the expectations about how long somebody will live, and they may live longer 

than that, so there is a risk there that they need to manage. An 

insurance company is expecting somebody to live a certain length 

of time, and they might die sooner, and they would have to pay out 

sooner than they expected. And there are these instruments, and 

they are very effective, and they are very tailored to particular 

needs that allow pension funds, insurance companies to manage 

that risk in a very effective way. 

Mr. BOSWELL. Good point. 

I would just say this, Mr. Chairman, the article goes on to say 

that oftentimes these life insurance policies lapse before a person 

dies, for a variety of reasons: their children grow up, no longer 

need the financial protection, or the premiums become too expensive. And sometimes when this happens, the insured doesn’t want 

to keep it going, so the insurer doesn’t have to make a payout. But 

if it is purchased and packaged into a security, investors will keep 

paying the premium that might have been abandoned. 

As a result, more policies will stay in force, ensuring more payouts over time and less money for insurance companies. And what 

does that do? Well, I guess, currently, when they set their premiums—and they have all these actuarial studies, which you know 

more about than I do—but they base them on assumptions that 

were wrong if this takes place. 

So I think this needs a little more look. So I would ask if we 

could enter this into the record, and I would like to do so. 

The CHAIRMAN. Without objection, so ordered. 

[The document referred to is located on p. 99.] 

Mr. BOSWELL. Thank you. I yield back. 

The CHAIRMAN. Thank you. 

The gentleman from Georgia, Mr. Marshall. 

Mr. MARSHALL. Thank you, Mr. Chairman. Thank you for holding the hearing, and thank you for a pretty practical approach to 

trying to get to the bottom of all this stuff. 

All of you heard the first panel testify, I think to a person, that 

they weren’t real thrilled by the notion of being forced to clear. 

And, Mr. Duffy and Mr. O’Connor, both of you were interested in 

clearing operations. And you heard them say that they just 

wouldn’t be able to fund it, they wouldn’t be able to finance it, they 

wouldn’t be able to get—if they were able to borrow the money for 

margins, it would be at a very onerous cost. 

93

And then you also heard the representative from Delta saying 

that, at least in the swaps area, as price moves, there are capital 

requirements, margining requirements. I guess I would like to hear 

your thoughts about how onerous this would be. 

And then I would like to hear a little bit about tailored swaps. 

It seems to me there are probably plenty of swaps where the parties agree that they don’t put up—it is individually tailored, so why 

would they be required to put up money as the price moves? 

You know, if I am dealing with Goldman Sachs, at least 5 years 

ago, I probably wouldn’t insist that they put something up. I would 

just assume that this is sort of like, they have the money. And that 

led us into the AIG mess. And that is the systemic risk we are trying to avoid here. 

So, what about the clearing being too onerous? I know you testified, Mr. O’Connor, that there is value to this. But they are 

grownups; they can decide whether or not they need to have some 

third party stand good for their swap. If they choose to do a swap, 

free market, why shouldn’t we just let them do a swap and just 

sort of try and deal with the systemic risk part of it? 

Mr. DUFFY. I don’t disagree with that. They are grownups, and 

they can do what they want as a third party. But, there are some 

misconceptions as it relates to clearing and the costs associated 

with clearing and collateral. 

First of all, the collateral that you put up for margin is not too 

dissimilar than the collateral you are going to put up for an OTC 

transaction. So if you put up zero for an OTC transaction, I am assuming the risk around that trade of one person not paying off at 

the time of maturity could be an issue or a failure in the system. 

In the regulated clearing model, you put up that margin money, 

and if the position goes obviously in your favor, you can take that 

excess funds and do with them as you see fit, as long as the position stays margined. So there are ways to utilize the capital in the 

clearinghouse during the point before maturity of the transaction. 

So, that is the first and second misconception of what kind of collateral can be accepted for trade, OTC versus an exchange. And, 

second, if you don’t put up any collateral for an OTC transaction, 

I am assuming that—what do you do at the end of maturity? How 

do you know that your counterparty is going to be good? 

Mr. MARSHALL. Well, the counterparty is AIG, so everybody 

knew it would be good. 

Mr. DUFFY. Right. That worked out well. 

Mr. MARSHALL. But that is exactly what we are trying to figure 

out how to avoid that. 

Mr. DUFFY. Well, basically, you need to have some kind of capital 

or margin up there to margin these positions. You just can’t have 

zero up there and then, at the point of maturity, have a default. 

And then if you do that multiplied by the amount of times, you can 

see where you are at. 

Mr. MARSHALL. Right. And forcing everything through clearing 

accomplishes that objective. 

Mr. DUFFY. No, not everything through clearing. 

Mr. MARSHALL. Well, obviously, you can’t do—you wouldn’t be 

able to force—but if you could put everything through clearing, you 

would accomplish the objective of making sure that people, as price 

94

moves, that they are required to follow that with appropriate experience. 

Mr. DUFFY. That is the risk-management system that the CME 

deploys, sir, yes. 

Mr. MARSHALL. Right. So we recognize that there will at least be 

custom swaps. It would be very helpful if you could help us understand what the real costs would be and whether or not there would 

be funding available for these businesses that don’t have a lot of 

excess capital. I mean, you heard that testimony repeatedly. They 

want to hedge; they don’t have excess capital to be tying up in a 

margin. 

Mr. DUFFY. So they are not hedging at all, I am assuming then. 

Mr. MARSHALL. No, they do hedge. They just don’t have to put 

a margin up if they are swapping, is what I thought the testimony 

was earlier. 

The CHAIRMAN. Would the gentleman yield——

Mr. MARSHALL. Yes, sir. 

The CHAIRMAN.—on that point, if anybody knows? 

So these guys that claim they don’t have the money and they are 

doing these hedges, I don’t know if they are putting up their equity 

or whatever they are doing. But the people that are doing the deal 

are going to, they are not going to do this for free. So what do they 

do? Do they charge a larger percentage fee then? Is that how they 

get their money out of this if they are not—how does that work? 

Mr. PICKEL. Well, typically, it is a credit relationship, so they 

would do a credit analysis and determine what type of exposure 

they are willing to have. There would probably be some pricing element that would reflect the fact that if they are a high-quality 

counterparty, the pricing would be tighter than a lower-quality 

counterparty. But I think——

The CHAIRMAN. But the counterparty is actually putting up the 

money. The person that is hedging is not putting up any money. 

So they are going to charge for that, too, then, I suppose. 

Mr. DUFFY. They are using the company’s balance sheet, and the 

company is charging more for the transaction. 

Mr. PICKEL. But I guess one thing, partly in response to you, Mr. 

Marshall, is that in situations where you have an active trading relationship, this two-way—this is in the bilateral world—the twoway movement of collateral back and forth is extremely common. 

So between dealers, between dealers and hedge funds, dealers and 

asset managers who are trading on a pretty regular basis, or even 

a company like Delta, which sounds like they are a pretty active 

user of the market, you would typically have collateral in the relationship. 

For the occasional user that is maybe accessing the interest rate 

swap market when it occasionally issues a bond, often the dealer 

is willing to do that on an uncollateralized basis, where neither 

party would post collateral. 

Mr. MARSHALL. I think the reason we are interested here is, we 

want to get a better handle on whether or not we actually are 

going to screw people up, somehow impair significantly their ability 

to hedge risk or burden them too much. And you can help us do 

that by helping us understand this. 

95

And if, in fact, in the swaps world, effectively the same level of 

security is presented, as a result of margining going back and forth 

or collateral going back and forth in order to secure performance 

in the event of price changes, as things move forward, that is happening anyway, then what does clearing add? And here is what I 

suspect: is that it happens depending upon who the parties are. 

I am Delta. It is 5 years ago or 10 years ago when Delta is blue 

chip, and I am dealing with AIG or I am dealing with Goldman 

Sachs, blue chip also. I am able to hedge at very little or no expense and with very little or no collateral moving back and forth 

as price changes. But I am able to say to my board or whoever, 

‘‘Yes, we have hedged that.’’

Am I right? It is really dependent upon what the parties wanted 

to agree to as between themselves? 

Mr. PICKEL. That is right. It is left to a bilateral negotiation. 

Mr. MARSHALL. So where the systemic stuff is concerned, our 

concern is that we are concentrating this risk in these large banks, 

5, 10, 12, something like that. You know, the sense that I get as 

I talk with the Chairman and others, and as we talk to our European regulators, all of us have the sense that there has to be something besides the inclination of the parties at that level to put up 

appropriate collateral, that we have to have something that assures 

that that occurs. 

Now, if we were able to force everything to be cleared, then the 

clearing agency would wind up making sure that appropriate flows 

of collateral go back and forth, so that there is not any AIG-type 

event. Everybody concedes, though, that we can’t do that, because 

there are just going to have to be custom swaps that won’t fit in 

a clearing setting, and we don’t want to force the clearing agencies 

to have to clear when they don’t want to. So there is going to be 

a bunch of stuff out there. 

So how do we, as regulators—how are we assured, as regulators, 

unless we have something like the President’s proposal, that, in 

fact, appropriate collateral is moving back and forth so that the 

systemic risk stuff doesn’t come up? 

Mr. PICKEL. I think one of the key definitions is the definition 

of major swap participant, which when we have been discussing 

with the Treasury earlier in the summer that was kind of intended 

to be the AIG provision, the one that would capture the next AIG. 

And I think, therefore, it is a very important definition. 

It is a bit unclear as to what it is intended to mean in the Treasury proposal, because it talks about a substantial net position. 

Well, AIG’s situation was, yes, they had a large net position, but 

really they were just taking on one-way risk, and that was really 

the problem. And they didn’t fully understand or analyze that risk, 

which augmented the problem. 

I think that is a pretty important definition. But it is important 

to get it right so you don’t sweep in institutions that really are just 

actively trading and may not be particularly long or short position 

at any particular point in time. 

Mr. DUFFY. Congressman, if I may add when this crisis all happened, I think that—and I am just talking as a citizen now and as 

a taxpayer—that these transactions were going to be required to 

have more collateral associated with them so we would not have 

96

the risk with it. We wouldn’t be using leveraged balance sheets for 

these transactions, as we have over the past, in the future. So I am 

assuming that is it. 

So if people want to continue to trade customized swap transactions, which I think they should be able to do, I am assuming the 

government is going to have different capital requirements for people that want to participate in that type of venue versus what they 

were doing before. 

And if you want to trade or clear your product on an exchange 

and let the exchange be the neutral facilitator or the buyer for 

every seller, the seller for every buyer, you could put up the margin 

and take the excess margin and do with it as you please to manage 

your business. 

So I assume that is what the path was going down when this all 

happened. 

The CHAIRMAN. Could I—we have Members who want to catch 

planes. So, the gentleman from Georgia, Mr. Scott 

Mr. SCOTT. Thank you very much, Mr. Chairman. And I appreciate the panelists coming and your holding the hearing. 

You know, we have basically three proposals here—you have 

Treasury’s proposal; we have our own, H.R. 977; and then, again, 

in my Financial Services Committee, we have another bill—all 

working to increase regulation, transparency, and oversight of the 

over-the-counter market. I want to try to narrow mine into an issue 

within the Treasury Department’s proposal. 

It seems that Treasury intended to give clearinghouses the ability to allow end-users to move swaps transactions from one clearinghouse to another. But, as it is done currently, the CEA gives 

clearinghouses the ability to treat transactions as fungible. So it 

seems no change to current law would be necessary. However, the 

language in Treasury’s proposal could be read to force—to force—

clearinghouses to treat transactions as fungible, which could have 

a negative systemic risk implication. 

Mr. Short, let me ask you—because I believe that you mentioned 

this as a part of your concerns over Treasury’s proposal, if I am 

correct—would you mind elaborating on this point? 

Mr. SHORT. Sure. I think the language in the Treasury proposal 

talks about fungible clearing and margin offsets for swaps. And I 

have heard some background information that that may not have 

been the true intent of that provision, that it may have actually 

just meant that if you were trading through one electronic avenue 

into a clearinghouse you could trade out on another. 

But that language, as written, could provide for or be interpreted 

to require one clearinghouse to provide margin offsets in another 

clearinghouse. And what you run into there is, kind of, the linkage 

problem. I have to be confident that Terry’s clearinghouse is run 

properly—not that I think his clearinghouse is a problem. But 

when you multiply that out over a number of clearinghouses, some 

of which may be domestic, some of which may be foreign, you can 

quickly see how this could, instead of isolating risk and allowing 

a clearinghouse to really do what it is supposed to do, it could actually increase systemic risk. And that is why I think that provision 

should be dropped or clarified. 

97

Mr. SCOTT. And so how would you say it would be clarified or 

dropped? Is there specific language? Is there something that you 

would suggest in that? 

Mr. DAMGARD. I actually think the language says that a clearinghouse has to accept trades from multiple execution facilities, which 

would create the fungibility at the clearinghouse. 

Mr. SCOTT. Do you agree with that, Mr. Short? 

Mr. Duffy, I would also like for you to comment on this. You are 

with the Chicago Mercantile Exchange. 

Mr. DUFFY. Yes, sir. 

Mr. SCOTT. So are you——

Mr. DUFFY. I agree with Mr. Short on this topic right now. And 

we actually have submitted language to the Committee, supplemental language, and to the Treasury on this issue because we 

agree with you, sir, it can be—I guess it is up to the person who 

reads it as to how they are going to determine it, and that is not 

good legislative language. So we think we want to have clarity. 

We do not want to put the CME Group’s clearinghouse at risk 

by accepting the credit risk of another clearinghouse, whether it be 

ICE or somebody else, as the same way they don’t want to accept 

the credit risk of the CME. 

So what the language says is, the fungibility should be amongst 

trading platforms, not among clearinghouses. But, as I said in my 

oral testimony, it could be interpreted that—and other people are 

trying to force it to a single clearinghouse, which is what Mr. Short 

is saying. 

So we would love to see the language changed. And we have submitted it, and we would be happy to send it to your office, sir. 

Mr. SCOTT. I agree with you. I think, Mr. Chairman, that that 

makes a lot of sense. I think you would agree to that. 

Was there something else you wanted to say there? 

Mr. DAMGARD. No, I understood the language, and I agree that 

it is confusing. But, what the Treasury was trying to do was say, 

any clearinghouse, not just one or not just two, but any clearinghouse would have to accept trades from all of the execution facilities if, in fact, it was the same product. And I am not sure if that 

is accurate or not. 

Mr. DUFFY. No disagreement, as long as it is from the trading 

facility, not from the clearing entity. And that is the big distinction 

that we need to have clarity here, sir, because it is very fuzzy, as 

Mr. Damgard said earlier in his testimony. 

Mr. SCOTT. Very good. 

Let me ask a follow-up, if I may, Mr. Chairman, one little thing 

here. 

The CHAIRMAN. We are running short of time, so be very brief. 

Mr. SCOTT. I will be very brief. 

Mr. Short, I believe you also expressed concern about the Administration’s proposal covering foreign boards of trade and how position limits would apply to certain contracts, particularly those that 

are not tied to United States-based contracts. 

Given your experience with foreign boards of trade at ICE, could 

you elaborate the concerns laid out in your testimony very briefly? 

Mr. SHORT. Yes. Very briefly, we operate ICE Futures Europe, 

which is a London-based exchange. It was the former International 

98

Petroleum Exchange. It is basically the European equivalent of the 

NYMEX. 

While we understand the need for position limits on linked contracts, which we have several in that there is a price linkage to 

contracts traded on the NYMEX. I think the language in the Treasury proposal doesn’t limit the CFTC’s authority to set position limits across venues to link contracts. 

So you could have, for example, our Brent Crude Futures contract subject to a CFTC position limit, and I think the FSA would 

have an issue with that, as the CFTC would have an issue with 

a foreign regulator attempting to set a position limit on a domestic 

contract. 

Mr. SCOTT. All right. Thank you, Mr. Chairman. I appreciate 

that. 

The CHAIRMAN. I thank the gentleman. 

We have to move it along. So we thank this panel for their patience and for their testimony and the answers to our questions. 

Now, before I adjourn, does the Ranking Member have any comments? 

Mr. LUCAS. No, Mr. Chairman. 

The CHAIRMAN. Okay. 

Under the rules of the Committee, the record of today’s hearing 

will remain open for 10 calendar days to receive additional material, supplementary written responses from the witnesses and to 

any question posed by a Member. 

And this hearing of the Committee of Agriculture is adjourned. 

[Whereupon, at 3:12 p.m., the Committee was adjourned.] 

[Material submitted for inclusion in the record follows:] 

99

SUBMITTED MATERIAL BY HON. LEONARD L. BOSWELL

Wall Street Pursues Profit in Bundles of Life Insurance 

The Wall Street Journal 

September 6, 2009

By: JENNY ANDERSON

After the mortgage business imploded last year, Wall Street investment banks 

began searching for another big idea to make money. They think they may have 

found one. 

The bankers plan to buy ‘‘life settlements,’’ life insurance policies that ill and elderly people sell for cash—$400,000 for a $1 million policy, say, depending on the 

life expectancy of the insured person. Then they plan to ‘‘securitize’’ these policies, 

in Wall Street jargon, by packaging hundreds or thousands together into bonds. 

They will then resell those bonds to investors, like big pension funds, who will receive the payouts when people with the insurance die. 

The earlier the policyholder dies, the bigger the return—though if people live 

longer than expected, investors could get poor returns or even lose money. 

Either way, Wall Street would profit by pocketing sizable fees for creating the 

bonds, reselling them and subsequently trading them. But some who have studied 

life settlements warn that insurers might have to raise premiums in the short term 

if they end up having to pay out more death claims than they had anticipated. 

The idea is still in the planning stages. But already ‘‘our phones have been ringing off the hook with inquiries,’’ says Kathleen Tillwitz, a senior vice president at 

DBRS, which gives risk ratings to investments and is reviewing nine proposals for 

life-insurance securitizations from private investors and financial firms, including 

Credit Suisse.

‘‘We’re hoping to get a herd stampeding after the first offering,’’ said one investment banker not authorized to speak to the news media. 

In the aftermath of the financial meltdown, exotic investments dreamed up by 

Wall Street got much of the blame. It was not just subprime mortgage securities 

but an array of products—credit-default swaps, structured investment vehicles, 

collateralized debt obligations—that proved far riskier than anticipated. 

The debacle gave financial wizardry a bad name generally, but not on Wall Street. 

Even as Washington debates increased financial regulation, bankers are scurrying 

to concoct new products. 

In addition to securitizing life settlements, for example, some banks are repackaging their money-losing securities into higher-rated ones, called re-remics (resecuritization of real estate mortgage investment conduits). Morgan Stanley says at 

least $30 billion in residential re-remics have been done this year. 

Financial innovation can be good, of course, by lowering the cost of borrowing for 

everyone, giving consumers more investment choices and, more broadly, by helping 

the economy to grow. And the proponents of securitizing life settlements say it 

would benefit people who want to cash out their policies while they are alive. 

But some are dismayed by Wall Street’s quick return to its old ways, chasing profits with complicated new products. 

‘‘It’s bittersweet,’’ said James D. Cox, a professor of corporate and securities law 

at Duke University. ‘‘The sweet part is there are investors interested in exotic products created by underwriters who make large fees and rating agencies who then get 

paid to confer ratings. The bitter part is it’s a return to the good old days.’’ 

Indeed, what is good for Wall Street could be bad for the insurance industry, and 

perhaps for customers, too. That is because policyholders often let their life insurance lapse before they die, for a variety of reasons—their children grow up and no 

longer need the financial protection, or the premiums become too expensive. When 

that happens, the insurer does not have to make a payout. 

But if a policy is purchased and packaged into a security, investors will keep paying the premiums that might have been abandoned; as a result, more policies will 

stay in force, ensuring more payouts over time and less money for the insurance 

companies. 

‘‘When they set their premiums they were basing them on assumptions that were 

wrong,’’ said Neil A. Doherty, a professor at Wharton who has studied life settlements. 

Indeed, Mr. Doherty says that in reaction to widespread securitization, insurers 

most likely would have to raise the premiums on new life policies. 

Critics of life settlements believe ‘‘this defeats the idea of what life insurance is 

supposed to be,’’ said Steven Weisbart, senior vice president and chief economist for 

100

the Insurance Information Institute, a trade group. ‘‘It’s not an investment product, 

a gambling product.’’

After Mortgages 

Undeterred, Wall Street is racing ahead for a simple reason: With $26 trillion of 

life insurance policies in force in the United States, the market could be huge. 

Not all policyholders would be interested in selling their policies, of course. And 

investors are not interested in healthy people’s policies because they would have to 

pay those premiums for too long, reducing profits on the investment. 

But even if a small fraction of policy holders do sell them, some in the industry 

predict the market could reach $500 billion. That would help Wall Street offset the 

loss of revenue from the collapse of the United States residential mortgage securities market, to $169 billion so far this year from a peak of $941 billion in 2005, according to Dealogic, a firm that tracks financial data. 

Some financial firms are moving to outpace their rivals. Credit Suisse, for example, is in effect building a financial assembly line to buy large numbers of life insurance policies, package and resell them—just as Wall Street firms did with subprime 

securities. 

The bank bought a company that originates life settlements, and it has set up a 

group dedicated to structuring deals and one to sell the products. 

Goldman Sachs has developed a tradable index of life settlements, enabling investors to bet on whether people will live longer than expected or die sooner than 

planned. The index is similar to tradable stock market indices that allow investors 

to bet on the overall direction of the market without buying stocks. 

Spokesmen for Credit Suisse and Goldman Sachs declined to comment. 

If Wall Street succeeds in securitizing life insurance policies, it would take a controversial business—the buying and selling of policies—that has been around on a 

smaller scale for a couple of decades and potentially increase it drastically. 

Defenders of life settlements argue that creating a market to allow the ill or elderly to sell their policies for cash is a public service. Insurance companies, they note, 

offer only a ‘‘cash surrender value,’’ typically at a small fraction of the death benefit, 

when a policyholder wants to cash out, even after paying large premiums for many 

years. 

Enter life settlement companies. Depending on various factors, they will pay 20 

to 200 percent more than the surrender value an insurer would pay. 

But the industry has been plagued by fraud complaints. State insurance regulators, hamstrung by a patchwork of laws and regulations, have criticized life settlement brokers for coercing the ill and elderly to take out policies with the sole purpose of selling them back to the brokers, called ‘‘stranger-owned life insurance.’’ 

In 2006, while he was New York Attorney General, Eliot Spitzer sued Coventry, 

one of the largest life settlement companies, accusing it of engaging in bid-rigging 

with rivals to keep down prices offered to people who wanted to sell their policies. 

The case is continuing. 

‘‘Predators in the life settlement market have the motive, means and, if left unchecked by legislators and regulators and by their own community, the opportunity 

to take advantage of seniors,’’ Stephan Leimberg, co-author of a book on life settlements, testified at a Senate Special Committee on Aging last April. 

Tricky Predictions 

In addition to fraud, there is another potential risk for investors: that some people 

could live far longer than expected. 

It is not just a hypothetical risk. That is what happened in the 1980s, when new 

treatments prolonged the life of AIDS patients. Investors who bought their policies 

on the expectation that the most victims would die within 2 years ended up losing 

money. 

It happened again last fall when companies that calculate life expectancy determined that people were living longer. 

The challenge for Wall Street is to make securitized life insurance policies more 

predictable—and, ideally, safer—investments. And for any securitized bond to interest big investors, a seal of approval is needed from a credit rating agency that measures the level of risk. 

In many ways, banks are seeking to replicate the model of subprime mortgage securities, which became popular after ratings agencies bestowed on them the comfort 

of a top-tier, triple-A rating. An individual mortgage to a home buyer with poor 

credit might have been considered risky, because of the possibility of default; but 

packaging lots of mortgages together limited risk, the theory went, because it was 

unlikely many would default at the same time. 

101

While that idea was, in retrospect, badly flawed, Wall Street is convinced that it 

can solve the risk riddle with securitized life settlement policies. 

That is why bankers from Credit Suisse and Goldman Sachs have been visiting 

DBRS, a little known rating agency in lower Manhattan. 

In early 2008, the firm published criteria for ways to securitize a life settlements 

portfolio so that the risks were minimized. 

Interest poured in. Hedge funds that have acquired life settlements, for example, 

are keen to buy and sell policies more easily, so they can cash out both on investments that are losing money and on ones that are profitable. Wall Street banks, 

beaten down by the financial crisis, are looking to get their securitization machines 

humming again. 

Ms. Tillwitz, an executive overseeing the project for DBRS, said the firm spent 

9 months getting comfortable with the myriad risks associated with rating a pool 

of life settlements. 

Could a way be found to protect against possible fraud by agents buying insurance 

policies and reselling them—to avoid problems like those in the subprime mortgage 

market, where some brokers made fraudulent loans that ended up in packages of 

securities sold to investors? How could investors be assured that the policies were 

legitimately acquired, so that the payouts would not be disputed when the original 

policyholder died? 

And how could they make sure that policies being bought were legally sellable, 

given that some states prohibit the sale of policies until they have been in force 2 

to 5 years? 

Spreading the Risk 

To help understand how to manage these risks, Ms. Tillwitz and her colleague 

Jan Buckler—a mathematics whiz with a Ph.D. in nuclear engineering—traveled 

the world visiting firms that handle life settlements. ‘‘We do not want to rate a deal 

that blows up,’’ Ms. Tillwitz said. 

The solution? A bond made up of life settlements would ideally have policies from 

people with a range of diseases—leukemia, lung cancer, heart disease, breast cancer, diabetes, Alzheimer’s. That is because if too many people with leukemia are in 

the securitization portfolio, and a cure is developed, the value of the bond would 

plummet. 

As an added precaution, DBRS would run background checks on all issuers. Also, 

a range of quality of life insurers would have to be included. 

To test how different mixes of policies would perform, Mr. Buckler has run computer simulations to show what would happen to returns if people lived significantly 

longer than expected. 

But even with a math whiz calculating every possibility, some risks may not be 

apparent until after the fact. How can a computer accurately predict what would 

happen if health reform passed, for example, and better care for a large number of 

Americans meant that people generally started living longer? Or if a magic-bullet 

cure for all types of cancer was developed? 

If the computer models were wrong, investors could lose a lot of money. 

As unlikely as those assumptions may seem, that is effectively what happened 

with many securitized subprime loans that were given triple-A ratings. 

Investment banks that sold these securities sought to lower the risks by, among 

other things, packaging mortgages from different regions and with differing credit 

levels of the borrowers. They thought that if house prices dropped in one region—

say Florida, causing widespread defaults in that part of the portfolio—it was highly 

unlikely that they would fall at the same time in, say, California. 

Indeed, economists noted that historically, housing prices had fallen regionally 

but never nationwide. When they did fall nationwide, investors lost hundreds of billions of dollars. 

Both Standard & Poor’s and Moody’s, which gave out many triple-A ratings and 

were burned by that experience, are approaching life settlements with greater caution. 

Standard & Poor’s, which rated a similar deal called Dignity Partners in the 

1990s, declined to comment on its plans. Moody’s said it has been approached by 

financial firms interested in securitizing life settlements, but has not yet seen a 

portfolio of policies that meets its standards. 

Investor Appetite 

Despite the mortgage debacle, investors like Andrew Terrell are intrigued. 

Mr. Terrell was the co-head of Bear Stearns’s longevity and mortality desk—which 

traded unrated portfolios of life settlements—and later worked at Goldman Sachs’s 

Institutional Life Companies, a venture that was introducing a trading platform for 

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1These calculations are based on data from the NAIC and the U.S. Federal Reserve Board, 

Flow of Funds Accounts of the U.S. See American Council of Life Insurers, Life Insurers Fact 

Book (2009).

life settlements. He thinks securitized life policies have big potential, explaining 

that investors who want to spread their risks are constantly looking for new investments that do not move in tandem with their other investments. 

‘‘It’s an interesting asset class because it’s less correlated to the rest of the market 

than other asset classes,’’ Mr. Terrell said. 

Some academics who have studied life settlement securitization agree it is a good 

idea. One difference, they concur, is that death is not correlated to the rise and fall 

of stocks. 

‘‘These assets do not have risks that are difficult to estimate and they are not, 

for the most part, exposed to broader economic risks,’’ said Joshua Coval, a professor 

of finance at the Harvard Business School. ‘‘By pooling and tranching, you are not 

amplifying systemic risks in the underlying assets.’’

The insurance industry is girding for a fight. ‘‘Just as all mortgage providers have 

been tarred by subprime mortgages, so too is the concern that all life insurance companies would be tarred with the brush of subprime life insurance settlements,’’ said 

Michael Lovendusky, vice president and associate general counsel of the American 

Council of Life Insurers, a trade group that represents life insurance companies. 

And the industry may find allies in government. Among those expressing concern 

about life settlements at the Senate Committee hearing in April were insurance regulators from Florida and Illinois, who argued that regulation was inadequate. 

‘‘The securitization of life settlements adds another element of possible risk to an 

industry that is already in need of enhanced regulations, more transparency and 

consumer safeguards,’’ said Senator Herb Kohl, the Democrat from Wisconsin who 

is Chairman of the Special Committee on Aging. 

DBRS agrees on the need to be careful. ‘‘We want this market to flourish in a 

safe way,’’ Ms. Tillwitz said. 

PREPARED STATEMENT OF FRANK KEATING, PRESIDENT AND CEO, AMERICAN

COUNCIL OF LIFE INSURERS

September 17, 2009

Hon. COLLIN C. PETERSON, Hon. FRANK D. LUCAS,

Chairman, Ranking Minority Member,

Committee on Agriculture, Committee on Agriculture, 

Washington, D.C.; Washington, D.C. 

RE: Regulation of the Derivatives Markets

Dear Chairman Peterson and Ranking Member Lucas:

The American Council of Life Insurers (ACLI) respectfully provides its views on 

the important dialog in Congress about the appropriate regulation of the derivatives 

markets. Life insurers are significant end-users of derivative instruments and utilize them to prudently manage the risks of their assets and liabilities, as permitted 

under state insurance codes and regulations. The composition of life insurers’ assets 

reflects the long-term commitments and stability necessary for life insurers to provide products, such as life insurance and annuities. 

Life insurers’ financial products protect millions of individuals, families and businesses through guaranteed lifetime income, life insurance, long-term care and disability income insurance. The long-term nature of these products requires insurers 

to match long-term obligations with assets of a longer duration than most other financial institutions. Derivatives allow life insurers to prudently manage the credit 

and market risk of their significant portfolios, and concomitantly to fulfill their obligations to contract owners. The regulatory status of derivatives, therefore, is critically important to the life insurance industry. 

Some basic background reflecting 2008 data 1 may provide useful scope and context: 

• Life insurance industry assets were invested in: corporate bonds (42%); stocks 

(24%); government bonds (14%); commercial mortgages (7%); other assets (13%);

• Life insurers provide the single largest U.S. source of corporate bond financing;

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• Approximately 56 percent of life insurers’ $4.6 Trillion total assets in 2008 were 

held in bonds, with 42 percent composed of corporate bonds; and

• Over 41 percent of corporate bonds purchased by life insurers have maturities 

in excess of 20 years (at the time of purchase).

Through their investments, life insurers are indispensable to American businesses 

and governments in cost-effectively raising capital. Moreover, these investments 

support life insurers’ obligations to provide retirement and financial security for millions of Americans. The derivatives markets are instrumental to both of these functions. 

Accordingly, in legislative approaches to derivatives regulation, ACLI supports:

• Federal regulation of the derivatives markets and marketplace professionals;

• State insurance department (or any ultimate functional regulator) jurisdiction 

over life insurers’ use of derivatives; and

• Federal preemption of any conflicts in state regulation of the derivatives markets and marketplace professionals.

As a primary source of long-term capital for American businesses and governments, life insurers must be able to responsibly manage portfolio risks within a rational regulatory environment. Life insurers can continue to successfully serve the 

nation’s retirement and financial security with life insurance, annuities and other 

products through the implementation of a reasonable and responsible legislative approach to derivatives regulation. 

We greatly appreciate your attention to our views. Please let me know if you have 

any questions. 

Sincerely,

FRANK KEATING.

SUBMITTED REPORT BY MARK W. MENEZES, DAVID T. MCINDOE, R. MICHAEL

SWEENEY, JR., HUNTON & WILLIAMS LLP; ON BEHALF OF WORKING GROUP OF

COMMERCIAL ENERGY FIRMS

September 28, 2009

Hon. COLLIN C. PETERSON,

Chairman,

Committee on Agriculture, 

Washington, D.C.

Re: Comments on Hearing to Review Proposed Legislation by the U.S. Department 

of the Treasury Regarding the Regulation of Over-the-Counter Derivatives Markets

Dear Chairman Peterson:

In response to the request for comments made by the House Committee on Agriculture (‘‘Committee’’) at its September 17, 2009 hearing to review proposed legislation released by the U.S. Department of the Treasury reforming the regulation of 

over-the-counter (‘‘OTC’’) derivatives markets, Hunton & Williams LLP hereby submits the enclosed position paper on behalf of the Working Group of Commercial Energy Firms (the ‘‘Working Group’’). 

The Working Group is a diverse group of commercial firms in the domestic energy 

industry whose primary business activity entails the physical delivery of one or 

more energy commodities to customers, including industrial, commercial and/or residential consumers. The Working Group considers and responds to requests for public comment regarding legislative and regulatory developments affecting the trading 

and hedging of energy commodities, including derivatives and other contracts that 

reference energy commodities. 

The Working Group sincerely appreciates the opportunity provided by the Committee to present in writing as part of the public record the significant business and 

policy concerns raised by the Treasury Department’s proposed OTC derivatives reform legislation. Should Committee Members or staff have any questions, or if the 


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Working Group can be of further assistance in any regard, please contact the undersigned at [Redacted]. 

Sincerely,

MARK W. MENEZES,

DAVID T. MCINDOE,

R. MICHAEL SWEENEY, JR.,

Counsel for the Working Group of Commercial Energy Firms.


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ATTACHMENT


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SUPPLEMENTAL MATERIAL SUBMITTED BY ROBERT G. PICKEL, EXECUTIVE DIRECTOR

AND CEO, INTERNATIONAL SWAPS AND DERIVATIVES ASSOCIATION

September 23, 2009

Hon. COLLIN C. PETERSON, Hon. FRANK D. LUCAS,

Chairman, Ranking Minority Member,

Committee on Agriculture, Committee on Agriculture, 

Washington, D.C.; Washington, D.C. 

RE: Submission for the Record of the Committee’s Hearing on September 17, 2009.

Dear Chairman Peterson and Ranking Member Lucas:

Thank you for the opportunity to represent ISDA before the Committee at last 

week’s hearing on the U.S. Treasury proposals for the regulation of the OTC derivatives markets. Today, there is a broad consensus for comprehensive regulatory reform to modernize and protect the integrity of our financial system and we support 

many of the concepts for improved regulation of the derivatives markets. The Committee’s hearing highlighted several aspects of the Treasury’s proposal that need 

further consideration. One of these issues is the imposition of margin requirements. 

Thank you for the opportunity to represent ISDA before the Committee at last 

week’s hearing on the U.S. Treasury proposals for the regulation of the OTC derivatives markets. Today, there is a broad consensus for comprehensive regulatory reform to modernize and protect the integrity of our financial system and we support 

many of the concepts for improved regulation of the derivatives markets. The Committee’s hearing highlighted several aspects of the Treasury’s proposal that need 

further consideration. One of these issues is the imposition of margin requirements. 

During the hearing, the issue of requiring end-users to post margin as a result 

of mandatory clearing or as a result of the proposed requirement that regulators impose margin requirements on all non-cleared derivatives was raised. The suggestion 

that an end-user could enter into a margin financing arrangement whereby another 

firm, possibly a member of a clearinghouse, would lend the end-user the money to 

meet the clearinghouse’s margin requirements was offered as a possible response to 

the difficulties some end-users will have in meeting margin requirements. Margin 

financing was presented as a means to facilitate end-user access to clearinghouses 

so that more trades can be cleared.

(1) Margin financing does not eliminate or reduce the credit risk associated with 

the OTC derivative transaction, rather it simply shifts the risk from the OTC 

derivative to a debt instrument. Either the clearing member or the lender would 

be exposed to the risk that the end-user will not be able to repay the money 

borrowed to satisfy the margin calls.

(2) Margin financing would subject the end-user to additional clearing fees and 

fees associated with the borrowing. In some cases, borrowing end-users would 

be subject to a commitment fee whereby the end-user would pay even before 

drawing on the line-of-credit.

(3) Margin financing may entail a floating rate of interest on a line-of-credit, 

subjecting end-users to more interest rate risk. In most cases, it is the need to 

mitigate or eliminate interest rate risk that leads the end-user to use OTC derivatives in the first place.

(4) Margin financing would result in end-users taking on more debt, increasing 

their leverage.

(5) Margin financing loans would work like revolving credit facilities wherein 

the end-user would draw down amounts as its needs more margin and repay 

previously drawn amounts when its positions move back in the money. The loan 

to the end-user would be subject to greater risk in bankruptcy than an OTC 

derivative contract with the end-user. The bankruptcy code’s protections for 

OTC derivative contracts do not apply to credit facilities, leaving the lender 

more exposed to an end-user default.

Once again, we appreciate the opportunity to testify before the Committee on this 

important topic and to add to the hearing record these additional points. 

Please do not hesitate to call on us if we can be of further assistance. 

Yours Sincerely,

ROBERT G. PICKEL,


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1Section 15(b) of the Commodity Exchange Act, 7 U.S.C. § 19. 2Testimony of Benn Steil before the Commodity Futures Trading Commission (June 27, 2006). 

Executive Director and Chief Executive Officer,

ISDA.

Cc: Members of the House Committee on Agriculture. 

SUPPLEMENTAL MATERIAL SUBMITTED BY JOHNATHAN H. SHORT, SENIOR VICE

PRESIDENT AND GENERAL COUNSEL, INTERCONTINENTALEXCHANGE, INC. 

The IntercontinentalExchange, Inc. (ICE) respectfully submits the following to 

supplement the testimony of Johnathan Short before the Committee at the September 17, 2009 hearing on the Over the Counter Derivatives Market Act 

(OTCDMA). 

Position Limits 

On September 16, the Chicago Mercantile Group (CME) released its white paper, 

‘‘Excessive Speculation and Position Limits in Energy Derivatives Markets.’’ The 

paper made two recommendations for setting position limits: (1) Exchanges should 

set position limits; and (2) position limits should be set as a relative percentage of 

an exchange’s open interest. ICE disagrees with these recommendations. 

The OTCDMA properly gives the Commission the power to set position limits and 

accountability levels. ICE agrees with this provision of the OTCDMA as the Commodity Futures Trading Commission (CFTC) has the experience, systems, and budget to administer this regime. Only the CFTC would be in a position to have broad 

and regular access to all position data regardless of trading venue, and is therefore 

uniquely able to determine appropriate limits and monitor compliance with limits. 

It should also be noted that the CFTC has a similar regime in place for enumerated 

agricultural contracts that has proven to be effective.1 Furthermore, one of the most 

contentious issues surrounding position limits has been the circumstances under 

which hedge exemptions should be granted to market participants. Here again, the 

CFTC would be in a better position to administer such exemptions than individual 

exchanges given competitive considerations and the CFTC’s superior access to information. 

All position limits and accountability levels should be aggregate (market-wide) in 

nature. The limits set by the CFTC should not be exchange-specific, but rather 

marketwide to govern the sum total of all positions that a market participant may 

hold for all economically equivalent contracts, including those traded on a Designated Contract Market (DCMs), an Exempt Commercial Market offering significant price discovery contracts, Foreign Boards of Trade offering linked contracts, 

and other OTC market venues. The CFTC has already successfully implemented the 

most challenging aspect of such a system: collection and aggregation of daily position data from the first three of these sources. 

Imposition of position limits and accountability levels by the Commission should 

promote competition by being market and venue agnostic. Setting position limits in 

the manner suggested by the CME, as a percentage of an exchange’s open interest, 

would be contrary to the CFTC’s statutory mandate to ‘‘promote competition among 

exchanges and seek to regulate the futures markets by the least anti-competitive 

means available.’’ Imposing smaller limits for smaller exchanges by applying a ‘‘percentage of open interest’’ test for each individual exchange would restrict competition by making it difficult for competing exchanges to offer tight enough markets 

and build sufficient liquidity in a contract to compete with an incumbent exchange. 

End market users and consumers would ultimately suffer from the lack of competition, bearing increased hedging costs and a lack of new product innovation. 

It is important to note the significant benefits of preserving competition in the exchange sector. Competition in the futures industry has spurred significant product 

and technological innovation, including transparent electronic trading, straight 

through processing, the introduction of clearing for OTC swap products, and significantly tighter trading markets into which commercial entities can hedge their risk. 

As Benn Steil, Director of International Economics at the Council of Foreign Relations recently noted, ‘‘the U.S. activities of one [competitor] alone, Eurex (formerly 

DTB) have had a tremendous effect in accelerating the move to more efficient electronic trading, in motivating exchanges to demutualize, . . . in reducing trading 

fees, and in stimulating new product development.’’ 2

Today, futures markets are more robust and less susceptible to manipulation than 

they were a decade ago, greatly reducing transactional costs to market participants 

and the cost of risk management to commercial entities. Regulation to promote fair 

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and level competition for the benefit of end-users, rather than regulation that would 

entrench dominant incumbents, should be the goal of financial market reform legislation. 

ICE would be pleased to answer any questions of the Committee or staff on this 

important subject. 

SUBMITTED STATEMENT OF ROGER PLANK, PRESIDENT, APACHE CORPORATION

Chairman Peterson, Mr. Lucas and Members of the Committee, thank you for this 

opportunity to provide testimony regarding reform of the Over-the-counter (OTC) 

derivatives markets. I am Roger Plank, President of Apache Corporation, an independent oil and gas exploration and production company with operations in the 

United States and five other nations and estimated proved reserves of 2.4 billion 

barrels of oil equivalent. Apache, established in 1954, is listed on the New York 

Stock Exchange with market capitalization of approximately $30 billion. 

For the past fifteen years, Apache Corporation has been an outspoken proponent 

of greater transparency and a return to integrity in the natural gas markets, often 

finding ourselves at odds with significant portions of the oil and gas industry. I have 

attached as Appendix D the testimony of Apache Founder Raymond Plank, given 

to the U.S. House Committee on Energy and Commerce on February 13, 2002, in 

the wake of the Enron scandal. In his testimony, Mr. Plank made several statements that reverberate today.

‘‘. . . (many) have worked hard to introduce competition into the nation’s energy markets. But deregulation has been hijacked by traders, hedge funds and 

others who profit from volatility and scorn the hard-working men and women 

who produce these important resources.’’

‘‘. . . Enron is gone, but the damage has been done to a vital element of the 

nation’s economic security. In some ways, this is a homeland security issue: 

There is a ticking time bomb set to wreak havoc when the economy comes back 

and energy demand increases.’’

I hope you agree that those statements were remarkably prescient when they 

were made more than 7 years ago. Yes, Enron and others are gone, but problems 

in the energy commodity markets persist. Even with a serious recession, fundamentals of gas supply and demand cannot explain the wild ride of natural gas futures 

from $12.62 per thousand cubic feet (Mcf) in July 2008 to less than $3 per Mcf in 

recent weeks. 

So, as you can see Apache does not object to the regulation of OTC derivatives 

in philosophy or concept. In fact, we applaud the efforts of the Administration and 

of Congress to rein in the unwarranted and harmful speculation rampant in the 

markets. However, we believe the Treasury Department proposal is overbroad 

where it negatively impacts the legitimate financial transactions to manage the 

price risk inherent in producing or consuming natural gas, crude oil and other commodities. 

Apache, like most independent oil and gas producers and indeed most producers 

of tradable commodities, is not a ‘‘speculator.’’ Our job is providing natural gas and 

crude oil essential to economic growth. Independent oil and gas producers and other 

commodities producers did not contribute to the financial problems caused by the 

unchecked speculation that occurred in the derivatives markets—that was the realm 

of financial traders and middle-men speculators. Yet restricting producers’ financial 

flexibility could diminish our ability to help the nation achieve important objectives, 

including expanded use of natural gas to achieve our shared goal of reducing emissions of carbon dioxide and increasing our nation’s energy independence. 

This legislation, as proposed, will reduce access to customized transactions, will 

increase transaction costs and will impair, in Apache’s case, our ability to invest 

capital in finding additional natural gas and crude oil by requiring producers to tie 

up their capital unnecessarily in financial reserves or margins. We have worked exclusively with the draft bill circulated by the U.S. Treasury Department to simplify 

matters and preserve producers’ ability to manage risk as they seek to expand the 

nation’s resources. 

While we believe that an effort was made to exclude legitimate hedgers and legitimate hedges from the dragnet, we don’t believe the exclusions as defined in the 

Treasury bill quite accomplish that goal. 

We took a different and hopefully simpler approach to the problem by attempting 

to exempt specific transactions rather than to define broad categories of entities 

which would or would not be regulated. Our suggestion is to exempt transactions 

that involve at least one party that owns, produces, distributes, consumes, manufacVerDate 0ct 09 2002 11:29 Nov 04, 2009 Jkt 041481 PO 00000 Frm 00127 Fmt 6621 Sfmt 6621 I:\DOCS\111-29\53020.TXT AGR1 PsN: BRIAN
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tures, processes, or merchandizes a product from what amount to punitive margin 

requirements and from the requirement that the transaction must clear through an 

authorized exchange. 

We believe that this approach allows true industry participants to manage the 

risks inherent in commodity markets, while still allowing for appropriate oversight 

and regulation of the paper market that always follows physical transactions. By 

targeting these paper transactions, it is our belief that excessive speculation will be 

discouraged and price volatility dampened to the point that producers and consumers of all commodities will at long last be able to see real price signals from 

the market. This will improve our ability to make sound investment decisions and 

deliver the energy necessary for economic growth. 

Thank you for your time, and for seizing the initiative to rein in the excessive 

speculation and volatility that have plagued energy and other markets far too long. 

The following are Apache’s recommendations for specific changes to the Treasury 

Department’s proposed legislation: 

Proposed Change No. 1—Add definitions of ‘‘Bona Fide Hedges’’ and ‘‘Bona 

Fide Hedgers’’ and excepting Bona Fide Hedgers from the definitions of 

‘‘swap dealer’’ and ‘‘major swap participant.’’

Justification—The Treasury legislation contains definitions for ‘‘swap dealer’’ 

and ‘‘major swap participant’’ and excepts from these defined terms, persons who 

enter into hedges that are effective under generally accepted accounting principles 

(GAAP). This exception however is limited as some legitimate hedges may not be 

effective under GAAP. Apache proposes to expand the exception by adding an exception for persons who enter into ‘‘bona fide hedges’’. Generally, Apache would define 

a ‘‘bona fide hedge,’’ similarly to the definition used in H.R. 3300 as a hedge that 

arises from a potential change in the value of a commodity that is owned, produced, 

distributed, consumed, manufactured, processed or merchandized by the person entering into the hedge. Expanding the exception is important because the status of 

a person entering into a swap affects whether a swap must be cleared and traded 

on an exchange and whether margin must be required. A person entering into a 

bona fide hedge or a hedge that is effective under GAAP, should be excepted from 

being a ‘‘swap dealer’’ and ‘‘major swap participant’’ so that the swaps entered into 

by such person will not have to be cleared or traded on an exchange as Apache proposes in Proposed Change No. 2 below and such person will be excepted from the 

requirement that margin be posted as Apache proposes in Proposed Change No. 3 

below. 

Specific Amendatory Language—See the proposed definitions of ‘‘Bona Fide

Hedge’’ and Bona Fide Hedger) in Appendix A. Also in Appendix B and C, see 

changes to the definitions of ‘‘swap dealer’’ and ‘‘major swap participant’’ found on 

page 8, lines 3 through 15 of the Treasury legislation. 

Proposed Change No. 2—Except bona fide hedges and those hedges that are 

effective under GAAP from the mandatory clearing and mandatory 

trading requirements. 

Justification—The Treasury legislation requires that all ‘‘standardized’’ swaps—

a term the Treasury legislation says must be defined ‘‘as broadly as possible’’—must 

be cleared and traded on exchanges. 

There is an exception from this requirement when (i) no clearing organization will 

accept the swap for clearing or (ii) when one party to the swap is not a swap dealer 

or major swap participant and such party does not meet the ‘‘eligibility requirements’’ of any clearing organization that clears swaps. 

The Treasury’s proposed exception is unclear. If all swaps must be cleared and 

traded on exchanges, producers’ ability to enter into customized swaps will be limited and will result in less flexibility in their ability to meet risk management objectives in finding, developing and producing natural gas and crude oil. In addition, 

requiring that all swaps be cleared and traded on an exchange will increase producers’ transaction costs, including clearing and exchange-related fees and costs associated with the posting margins. 

Specifically, Apache proposes to change the Treasury legislation to expressly exclude from the definition of ‘‘standardized’’ swaps, both bona fide hedges and hedges 

that are effective under GAAP and expressly exclude bona fide hedges and those 

hedges that are effective under GAAP from the clearing and trading requirements. 

Specific Amendatory Language—To accomplish this objective, see Appendix B

and C for Apache’s propose 

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Proposed Change No. 3—Except bona fide hedges and those hedges that are 

effective under GAAP from the mandatory capital and margin requirements. 

Justification—It is not enough to except bona fide hedges and those hedges that 

are effective under GAPP from the clearing and trading requirements because the 

Treasury legislation requires the imposition of capital requirements and margin on 

all swaps not cleared by a clearing organization. 

Apache is a producer of oil and natural gas; its oil and gas assets have substantial 

value and require substantial capital to discover and produce. When Apache enters 

into a swap, it is not doing so as a naked speculator. The Treasury’s proposed legislation would require Apache to reserve capital in all cases and post margin unless 

Apache entered into a swap with a bank and the bank’s regulator did not require 

margin. If Apache is required to tie up its capital, Apache will have less capital 

available to invest in finding and producing oil and natural gas. There are no exceptions to the requirement that capital requirements be imposed. Our physical ownership of the commodity is our asset, our capital and our collateral. Physical ownership of the commodity should not be subject to this double hit when a producer enters into a legitimate hedge transaction. 

The Treasury’s proposal provides for one limited exception to the margin requirement which may apply when a bank is a swap counterparty and the other party 

is (i) not a swap dealer or major swap participant, (ii) is entering into an effective 

hedge under GAAP, and (iii) ‘‘predominantly engaged in activities that are not financial.’’ This one margin exception is not adequate. It does not apply when 

Apache’s counterparty is not a bank and even when Apache’s counterparty is a 

bank, the bank’s regulator may still require the bank to require margin from 

Apache. 

The mandatory nature of the capital and margin requirements is problematic to 

producers. Apache proposes that persons that enter into bona fide hedges and those 

hedges that are effective under GAAP be excepted from the imposition of capital and 

mandatory margin requirements whether the counterparty is a bank or non-bank. 

Apache proposes to make it clear that regulators may not impose capital requirements and margin requirements on persons that enter into bona fide hedges and 

those hedges that are effective under GAAP. Specifically, Apache proposes to add 

an exception to the requirement that capital requirements be imposed and expand 

the existing exception to include bona fide hedges and to apply this exception to 

non-bank counterparties. 

Specific Amendatory Language—See Appendix B and C for Apache’s proposed 

changes to page 39, beginning on line 13; page 39 at the end of line 17; page 39 

at the end of line 21; page 40, line 3; page 40, line 8; and page 40, beginning on 

line 16. 

APPENDIX A

Proposed Definition of ‘‘Bona Fide Hedge’’ and ‘‘Bona Fide Hedger’’

‘‘(51) BONA FIDE HEDGE.—The term bona fide hedge means a swap that—

(i) arises from the potential change in the value of physical assets that a person owns, produces, distributes, consumes, manufactures, processes, or merchandises as its primary business or anticipates owning, producing, distributing, consuming, manufacturing, processing, or merchandising as its primary 

business; and

(ii) is economically appropriate to the reduction of risks in the conduct and 

management of a commercial enterprise.’’

‘‘(52) BONA FIDE HEDGER.—The term bona fide hedger means a person that—

(i) owns, produces, distributes, consumes, manufactures, processes, or merchandises physical assets as its primary business; and

(ii) enters into bona fide hedges or other effective hedges under generally accepted accounting principles.’’

APPENDIX B

Apache Corporation Proposed Changes to the ‘‘Over-the-Counter Derivatives Markets Act of 2009’’ as Submitted by the Treasury Department 

August 11, 2009

The Treasury Department’s ‘‘Over-the-Counter Derivatives Markets Act of 2009’’ 

is amended—

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(1) by adding on page 7 between line 2 and line 3 the following:

‘‘provided the term ‘narrow-based security index’ shall not include the 

Henry Hub, West Texas Intermediate or any other price point or index for 

commodities.’’

(2) by adding on page 8 line 7 the words ‘‘bona fide hedger or’’ between ‘‘a’’ 

and ‘‘person’’ and deleting on page 8 line 9 the following:

‘‘but not as a part of a regular business’’ and replacing with the following:

‘‘provided such person is not buying and selling, quoting prices, and making 

a market in swaps.’’

(3) by adding on page 8 in paragraph (40) line 11 before ‘‘The term’’ the following:

‘‘(A) IN GENERAL.—’’

(4) by deleting on page 8 in paragraph (40) line 13 the following:

‘‘other than to create and maintain an effective hedge under generally accepted accounting principles,’’.

(5) by adding on page 8 into paragraph (40) at the end of paragraph (40) the 

following:

‘‘(B) EXCEPTION.—The term ‘major swap participant’ does not include 

a person that is a bona fide hedger.’’

(6) by adding on page 12 after paragraph (50) the following:

‘‘(51) Bona fide hedge.—The term bona fide hedge means a swap that—

(i) arises from the potential change in the value of physical assets 

that a person owns, produces, distributes, consumes, manufactures, 

processes, or merchandises, as its primary business or anticipates owning, producing, distributing, consuming, manufacturing, processing, or 

merchandising, as its primary business; and 

(ii) is economically appropriate to the reduction of risks in the conduct and management of a commercial enterprise.’’

‘‘(52) BONA FIDE HEDGER.—The term bona fide hedger means a person 

that—

(i) owns, produces, distributes, consumes, manufactures, processes, or 

merchandises physical assets as its primary business; and 

(ii) enters into bona fide hedges or other effective hedges under generally accepted accounting principles.’’

(7) by adding on page 17 between line 1 and line 2 the following:

‘‘; provided however, the term ‘standardized’ shall not include bona fide

hedges or other effective hedges under generally accepted accounting principles.’’

(8) by deleting on page 18 line 10 the following:

‘‘or’’.

(9) by deleting the ‘‘.’’ at the end of line 14 on page 18, and adding between 

line 14 and 15 the following:

‘‘; or (C) the swap is a bona fide hedge or other effective hedge under generally accepted accounting principles.’’

(10) by adding to page 39 between lines 13 and 14, at the end of lines 17 and 

21 the following:

‘‘provided however, capital requirements shall not be imposed for swaps 

that are bona fide hedges or other effective hedges under generally accepted 

accounting principles.’’

(11) by deleting on page 40 line 3 the following:

‘‘may, but are not required to,’’ and replacing with the following:

‘‘shall not’’

(12) by adding to page 40 line 8 after ‘‘part of’’ the following:

‘‘a bona fide hedge or’’

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(13) by adding on page 40 line 16 the following:

‘‘; provided however, margin shall not be required with respect to swaps in 

which one of the counterparties is—

‘‘(i) neither a swap dealer, major swap participant, security-based 

swap dealer nor a major security-based swap participant; 

‘‘(ii) using the swap as part of a bona fide hedge or an effective hedge 

under generally accepted accounting principles; and 

‘‘(iii) predominantly engaged in activities that are not financial in nature, as defined in section 4(k) of the Bank Holding Company Act of 

1956 (12 U.S.C. 1843(k)).’’

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APPENDIX C

Redline Changes


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APPENDIX D

Testimony of Raymond Plank, Chairman and Chief Executive Officer, 

Apache Corporation Before the Subcommittee on Energy and Air Quality, of the Committee on Energy and Commerce, U.S. House of Representatives, February 13, 2002

Mr. Chairman and Members:

Thank you for the opportunity to speak to the Committee today. 

My name is Raymond Plank, and I am founder and chief executive officer of 

Apache Corporation. Over 5 decades in the oil and gas business, Apache has grown 

from one of the smallest to one of the larger independent producers. 

Natural gas is the single most important domestic energy source—an abundant 

resource that warms millions of homes, fuels much of America’s industrial base and 

plays a large and growing role in the nation’s electricity industry. However, while 

many believe natural gas is the fuel of the future, I believe that future is in jeopardy because of the flawed structure of the natural gas market in this country. 

The fact is, the nation’s energy markets skated by and escaped a disaster in the 

wake of Enron’s collapse. Why? Certainly not because this market—in its current 

dysfunctional state—serves the nation’s needs. No, we avoided a supply crunch because the recession and one of the warmest winters in recent history combined to 

keep demand in check. If the economy had been more robust, or if weather conditions had been different, the story could have been far different. 

This is an issue that should be important to the other members of this panel because they have developed business plans, raised billions of dollars from investors 

and erected power plants based on the availability of reliable supplies of natural 

gas. The current market, roiled by excessive price volatility, has undermined the 

ability of Apache and other North American producers to meet their requirements. 

Mr. Chairman, I know you have worked hard to introduce competition into the 

nation’s energy markets. But deregulation has been hijacked by traders, hedge 

funds and others who profit from volatility and who scorn the hard-working men 

and women who produce this important resource. If you don’t fix the natural gas 

market, then all your efforts to bring competition to the electricity market will be 

for naught because natural gas is the fuel of choice for new generating capacity. 

The uncertainty in the gas market caused by excessive price volatility endangers 

the infrastructure required to explore for and produce natural gas. Every time the 

price goes down and Apache and other companies cut back, skilled workers—from 

roustabouts to engineers to scientists—leave the industry. Drilling rigs are taken 

out of service and cannibalized for spare parts and marginal wells are shut in, never 

to return to production. 

Right now, the industry is not drilling enough wells to maintain production at 

current levels. 

Yes, Mr. Chairman, Enron is gone, but the damage has been done to a vital element of the nation’s economic security. In some ways, this is a homeland security 

issue: There is a ticking time bomb set to wreak havoc when the economy comes 

back and energy demand increases. 

I’d like to give you some background on how we came to our position. 

For the last 10 years, our ability to find and produce the natural gas this country 

needs has been crippled by increasing price volatility. North America is a mature 

producing province, which means that while there is still a great deal of natural gas 

to be found, producing it requires better technology, better science, more time and 

more money. Most of these projects take from 12 months to 2 years to complete. 

It is harder and harder to commit capital to these kinds of projects when we can’t 

forecast what the price of our product is going to be tomorrow, much less a year 

from now. 

Natural gas prices, like all commodity prices, run in cycles. That’s been true as 

long as I can remember. Recently, however, as hedge funds and traders have come 

to dominate the market, the cycles have become shorter in duration and more pronounced. In press reports and presentations to analysts, these traders acknowledge 

that they derive their profits from price volatility. 

The casino mentality that has taken over the energy markets has a real impact 

on consumers as well as producers. 

Let me give you a real example that we all remember. 

In December 1999, we were paid less than $2 for a thousand cubic feet of gas. 

In January 2001, the price climbed to nearly $10, only to fall back below $2 by October. To put that in perspective, think about the impact on the stock market—and 

the American economy—if the Dow Jones Industrial Average took a trip from 10,000 

to 47,000 and back to 10,000 in a year and a half. What would your constituents 

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be telling you if the price of gasoline jumped from $1.20 per gallon to $6 and then 

back down to $1.20? 

Last winter’s price spike dealt a damaging blow to the industrial economy, which 

in total accounts for 40 percent of U.S. natural gas consumption. Natural gas-intensive industries like steel, plastics and petrochemicals significantly curtailed or shut 

in production in response to extremely high gas costs. Some of this demand has 

been permanently displaced. In addition, natural gas volatility played a key role in 

California’s energy problems. The consequences for the economy due to overheated 

gas prices are painfully clear. But when the price falls back to $2 per thousand cubic feet, the capacity of the 

industry to supply natural gas is diminished—permanently. One consequence is a 

brain drain in the industry. The average age of U.S. geologists and petroleum engineers is 48 years old. As young engineers and scientists seek opportunities elsewhere, the nation will lose its technological edge in this industry. 

When prices fall, companies like Apache reduce their drilling expenditures and 

seek more profitable avenues for investment, usually overseas. This year, Apache’s 

North American exploration and development budget has been cut by 70 percent. 

Other oil and gas companies are taking similar measures. 

As a consequence, I can assure you that the next price spike is just around the 

corner. It may not come until this fall or next winter, but it is inevitable and it 

could be severe. 

As much as we know about getting natural gas out of the ground, there are many 

things about this market that have been hidden from view by powerful insiders who 

profit from its opacity. We can’t find the answers because we don’t have subpoena 

power. It’s up to you to break through some of these Chinese walls and get to the 

bottom of this structurally flawed market. 

Now, I’d like to discuss some of the most glaring problems with this market and 

our suggestions for fixing it. 

Every month, the price we get for our natural gas production is based on indices 

published in one or more trade publications. The reporters who compile these price 

indices are generally hard-working, honest journalists, but their sources—the pipelines, utilities and marketers—are under no obligation to provide complete or even 

accurate information. Similarly, the American Gas Association’s weekly storage report became a major market event because it was a proxy for supply and demand 

data but it was based on voluntary, self-serving data.

In a market as important as the natural gas market, the government should collect and disseminate real-time information on natural gas supply and demand 

from market participants, with penalties imposed on companies that fail to file 

accurate reports.

Even some energy marketers acknowledge that the current rules give unfair advantages to integrated energy companies with their regulated pipelines, unregulated 

marketing affiliates and electric generating units. While allegedly separate, these 

people go to work in the same office buildings, share coffee—and benefit from the 

same corporate incentive systems.

The current rules governing the conduct of regulated and unregulated affiliates 

are weak and subject to abuse. To prevent the trading of insider information, 

these functions should be legally and geographically separated and their dealings limited to real transactions with real money changing hands. If companies 

abuse these rules, they should be required to divest their unregulated affiliates.

Online trading platforms, which operate outside the longstanding framework that 

regulates commodities exchanges, provide their owners with vast information about 

the trading positions of other market players which can be used to manipulate the 

market.

These online platforms are exchanges; they should be subject to similar regulation to ensure fair treatment of all parties. In the equities market, there is a basic 

rule that agents cannot put their trades ahead of their clients’ transactions; similar rules should guide the conduct of the energy markets.

The bright light of Wall Street cast on energy marketers in the aftermath of the 

Enron collapse revealed them to be over-leveraged. They rely on mark-to-market accounting of energy contracts that allows them to book the revenues and profits of 

long-term contracts up front, long before the revenues are collected and the profits 

realized. Though they appear profitable on the surface, a closer examination reveals 

that the profits may prove to be illusory. The current system incentivizes traders 

to book deal after deal, seeking profits from every move in the market and distorting legitimate supply and demand signals.

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End mark-to-market accounting and require traders to book their revenues and 

profits when they are realized. Impose capital requirements to assure customers 

that the traders will be there to deliver the gas and electricity.

Some would have you believe that the fact that a company as large as Enron 

could fail without causing any disruption in the energy markets is a signal that 

these markets are deep and liquid. I disagree. I think it demonstrates that Enron 

and others like it add no value. 

I also believe that failure to reform this market will cause lasting damage to the 

nation’s energy infrastructure and economic health. 

Mr. Chairman, you have before you the record of the fall of Enron—the self-dealing, the subterfuge and the apparent fraud. I think it’s fair to ask whether the same 

behavior permeated Enron’s biggest business—its natural gas and electricity trading 

operations. Once your Committee answers that question, I hope you will conduct a 

thorough examination of the structure of the energy market and make the changes 

necessary to ensure that there are not other Enrons out there waiting to happen. 

The task before you is clear: To introduce effective oversight and transparency in 

this market, eliminate the casino mentality that places price volatility above physical supplies and restore an environment that will encourage producers to make the 

investments to meet the nation’s vital energy needs. 

Thank you very much for the opportunity to be here today.

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ATTACHMENT


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SUBMITTED STATEMENT BY TERRY W. RATHERT, FOUNDER, EXECUTIVE VICE

PRESIDENT, AND CHIEF FINANCIAL OFFICER, NEWFIELD EXPLORATION COMPANY


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SUBMITTED STATEMENT BY 3M COMPANY

3M Company (‘‘3M’’) appreciates the opportunity to submit this statement for the 

record regarding the importance of the over-the-counter (OTC) derivatives market 

to the conduct of business at 3M. As you may know, 3M is a large U.S.-based employer and manufacturer established more than a century ago in Minnesota. Today, 

3M is one of the largest and most diversified technology and manufacturing companies in the world. 

3M thanks the Committee for studying the critical details related to reforms to 

the U.S. financial system and for considering our perspective in this important debate. In examining the concepts outlined in the recent U.S. Treasury proposal on 

financial system reforms, 3M respectfully urges the Committee to carefully consider 

the distinct differences among various derivative products and how they are used, 

and strongly encourages the Committee to preserve commercial users’ access to OTC 

derivative products to manage various aspects of corporate risk. 

Background on 3M 

In 1902, five northern Minnesota entrepreneurs created the Minnesota Mining & 

Manufacturing Company, now known today as 3M. 3M is one of the largest and 

most diversified technology companies in the world. 3M is home to such well-known 

brands as Scotch, Scotch-Brite, Post-it, Nexcare, Filtrete, Command, and 

Thinsulate. 3M designs, manufactures and sell products based on 45 technology 

platforms and serves its customers through six large businesses: Consumer and Office; Display and Graphics; Electro and Communications; Health Care; Industrial 

and Transportation; and Safety, Security and Protection Services. 3M achieved 

$25.3 billion of worldwide sales in 2008. 

Headquartered in St. Paul, Minnesota, 3M has operations in 29 U.S. states, including over 60% of 3M’s worldwide manufacturing operations, employing 34,000 

people. 3M’s U.S. sales totaled approximately $9.2 billion in 2008. While its U.S. 

presence is strong, being able to compete successfully in the global marketplace is 

critical to 3M. 3M operates in more than 60 countries and sells products into more 

than 200 countries. In 2008, 64% of 3M’s sales were outside the U.S., a percentage 

that is projected to rise to more than 70% by 2010. 

Ahead of their peers, 3M’s founders insisted on a robust investment in R&D. 

Looking back, it is this early and consistent commitment to R&D that has been the 

main component of 3M’s success. Our diverse technology platforms allow 3M scientists to share and combine technologies from one business to another, creating 

unique, innovative solutions for our customers. 3M conducts over 60% of its worldwide R&D activities within the U.S. 

Our commitment to R&D resulted in a $1.4 billion investment of 3M’s capital in 

2008 and a total of $6.7 billion during the past 5 years while producing high quality 

jobs for 3,700 researchers in the U.S. The success of these efforts is evidenced not 

only by 3M’s revenue but also by the 561 U.S. patents awarded in 2008 alone, and 

over 40,000 global patents and patent applications in force. 

Our success is also attributable to the people of 3M. Generations of imaginative 

and industrious employees in all of its business sectors throughout the world have 

built 3M into a successful global company. Our interest in speaking with you today 

is to preserve our ability to continue to invest and grow, creating substantive jobs 

and providing high quality products to a growing base of customers. 

Treasury Proposal. 

On August 11, 2009, the Administration submitted legislative language focusing 

on the regulatory reform of OTC derivatives. The Administration proposed the establishment of a comprehensive regulatory framework for OTC derivatives that is 

designed to:

1. Guard against activities in those markets posing excessive risk to the financial system.

2. Promote the transparency and efficiency of those markets.

3. Prevent market manipulation, fraud, insider trading, and other market 

abuses.

4. Block OTC derivatives from being marketed inappropriately to unsophisticated parties. 

OTC Derivatives: Helping U.S. Companies Manage Risk in a Competitive 

Marketplace. 

While 3M unequivocally supports these objectives, we have strong concerns about 

the potential impact of legislation on OTC derivatives and our ability to continue 

151

to use them to protect our operations from the risk of undue currency, commodity, 

and interest rate volatility. 

Derivative products are essential risk management tools used by American companies in managing foreign exchange, commodity, interest rate and credit risks. The 

ability of commercial users to continue to use OTC derivatives consistent with the 

requirements of hedge accounting rules is critical for mitigating risk and limiting 

damage to American businesses’ financial results in volatile market conditions. 

We urge policy makers to preserve commercial users’ access to existing 

derivative products as you design new regulations. We share the following 

comments with you in the spirit of working together to address the concerns about 

the stability of the financial system:

1. Guarding Against Activities Within OTC Markets From Posing Excessive Risk To The Financial System:

» We agree that the recent economic crisis has exposed some areas in our financial regulatory system that should be addressed. However, the vast majority of OTC derivatives have not exposed the financial system to excessive risk, 

and therefore regulation should be tailored. The OTC foreign exchange, commodity, and interest rate markets have operated uninterrupted throughout 

the economy’s financial difficulties, permitting corporate end-users to prudently manage business risks through a difficult economic environment. In 

the Administration’s proposal, the term ‘‘Major Swap Participant’’ should not 

include end-users that are using OTC derivatives for legitimate hedging activity only. We urge policy makers to focus on the areas of highest concern, such 

as credit default swaps.

» We would like to work with policy makers to address oversight where warranted, but recommend that it be targeted and not applied to all derivatives 

and market participants.

2. Promoting Transparency and Efficiency within the OTC Markets:

» We understand the need for reporting and record keeping. Publicly held companies are currently required by the SEC and FASB to make significant disclosures about their use of derivative instruments and hedging activities, including disclosures in their 10Ks and 10Qs.

» We would like to work with policy makers on ways to efficiently collect information into a trade repository to further enhance transparency. Guidelines 

which improve documentation, transparency and ensure compliance with 

hedge accounting rules should be considered as appropriate criteria for exempting end-users from margin requirements.

» We oppose a mandate to move all OTC derivatives into a clearing or 

exchange environment. The ability to customize the derivative to meet a 

company’s specific risk management needs is crucial. Provisions that would 

require clearing of OTC derivatives would lead to standardization, thus impeding a company’s ability to comply with the requirements of Financial Accounting Standard 133 (FAS 133). The inability to precisely hedge specific 

risks, whether currency, interest rates or commodities within the context of 

FAS 133, would expose corporate financial statements to unwanted volatility 

and uncertainty. Results could include lower capital expenditures and job 

growth as companies undertake fewer growth investments due to the need to 

maintain reserves for adverse impacts from unhedged financial risks.

» While we are mindful of the reduction in credit risk inherent in a clearing 

or exchange environment, robust margin requirements would create substantial incremental liquidity and administrative burdens for commercial users, 

resulting in higher financing and operational costs. Capital currently deployed in growth opportunities would be diverted into clearinghouse accounts. 

This could result in slower job creation, lower capital expenditures and R&D, 

and/or higher costs to consumers. Any exemption from clearing should not be 

linked to any eligibility requirements set by the clearing agencies.

Hedging in the OTC market is customized to fit the underlying business risks 

being hedged. The clearinghouse concept relies upon high volumes of standardized products, a characteristic that does not exist in the customized hedging environment of the OTC market.

By imposing initial and variation margin requirements, clearinghouses will 

add significant capital requirements for end-users, adding significant costs, 

discouraging hedging, and diverting scarce capital that could otherwise be 

used in further growing American businesses.

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3. Preventing Market Manipulation, Fraud, Insider Trading, And Other 

Market Abuses.

» We support the appropriate regulatory agencies having the authority to police fraud, market manipulation and other market abuses. The CFTC is utilizing its existing statutory and regulatory authority to add significant transparency in the OTC market, receive a more complete picture of market information, and enforce position limits in related exchange-traded markets. The 

comment period remains open on the CFTC proposal and this work should be 

allowed to continue.

4. Blocking OTC Derivatives From Being Marketed Inappropriately To 

Unsophisticated Parties.

» We support modifications to current law that would improve efforts to protect 

unsophisticated parties from entering into inappropriate derivatives transactions.

We thank the Committee for the opportunity to share our perspective as an employer interested in preserving and enhancing the global competitiveness of American businesses and workers. 3M looks forward to working with you as the Committee crafts legislation to reform the U.S. financial system. 

SUBMITTED STATEMENT BY NATIONAL ASSOCIATION OF MANUFACTURERS

Mr. Chairmen and Committee Members:

The National Association of Manufacturers (NAM)—the nation’s largest industrial 

trade association—represents large, mid-size and small manufacturers in every industrial sector and in all 50 states. The NAM’s mission is to enhance the competitiveness of manufacturers by shaping a legislative and regulatory environment conducive to U.S. economic growth and to increase understanding among policymakers, 

the media and the general public about the vital role of manufacturing to America’s 

economic future and living standards. 

The NAM appreciates and supports the Administration’s efforts to improve transparency, accountability and stability in the derivatives market. At the same time, 

NAM members have some concerns about the regulatory framework for over-thecounter (OTC) derivatives proposed by the Treasury Department. 

Manufacturers of all sizes use customized OTC derivatives to manage the risks 

of operating their businesses, including fluctuating currency exchange, interest rates 

and commodity prices. For example,

• Currency Exchange Rates: Companies that import or export may not want 

to bear the risk that the price of the dollar will fluctuate against the currencies 

they are using to buy or sell goods. In these cases, businesses can enter into 

a customized currency derivative that allows them to lock in the exchange rate.

• Interest Rates: Companies frequently borrow money at variable rates tied to 

an interest rate index. Businesses can manage the risk that the interest rate 

on their loan might increase by entering into a customized interest rate derivative and locking in a fixed rate for the entire maturity of the loan.

• Commodity Prices: Some manufacturers use large amounts of commodities in 

the production process, e.g., natural gas, corn, aluminum. In order to manage 

their operating risk and preserve their margins, these companies can lock in the 

price of these commodities by entering into a customized commodity price swap 

linked to the price of the commodity causing the exposure.

The ability of end-users of all sizes to continue to use customized OTC derivatives 

is critical for mitigating risk and limiting damage to the health of American businesses, particularly during these unprecedented economic conditions. Consequently, 

NAM members are concerned about proposals that would require OTC derivatives 

used by business end-users to be centrally cleared or executed on exchanges as well 

as proposals that would impose capital requirements or prevent end-users from 

using underlying assets as collateral. The proposals would significantly increase 

costs for companies seeking to hedge risks through OTC products and limit, or 

eliminate altogether, needed customized products used for risk management. 

A key benefit of OTC derivatives to end-users is the ability to customize derivatives to the specific risk management needs of the business. Provisions that require 

exchange trading of OTC derivatives would lead to the standardization of these 

tools, impeding the ability of companies to accurately hedge risks and comply with 

the requirements of Financial Accounting Standard 133 (FAS 133). Without the 

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ability to hedge specific risks, companies would be forced to shoulder greater risks 

in an environment already marked by high volatility. 

NAM members are also concerned about the onerous liquid collateral needs associated with OTC derivatives being exchange-traded or centrally cleared. Exchanges 

and clearinghouses insulate commercial participants from credit exposure by requiring the value of the derivative contract (mark-to-market) to be posted in cash or 

Treasury securities and for market moves twice a day. In general, a clearing requirement for customized OTC derivatives would result in an extraordinary drain 

on working capital for American companies by requiring significant amounts of liquid collateral to be posted. These margin requirements would create an additional 

administrative and liquidity burden for commercial users, resulting in additional financing and administrative costs. 

On a broader note, the NAM agrees with the Administration that the current financial crisis has exposed some areas in our financial regulatory system that should 

be addressed. Not all OTC derivatives, however, pose a risk to the financial system. 

NAM members welcome the opportunity to work with policy makers to identify 

where increased, targeted oversight is warranted. 

Similarly, the NAM understands the need for adequate reporting and record keeping. While corporations already provide reports to the Securities and Exchange 

Commission (SEC) and other government agencies, they would like to work with 

policy makers on ways to set up a trade repository to enhance further transparency 

by pulling together information already required under existing reporting requirements. 

In addition, NAM members believe that any reform plan should clearly delineate 

regulatory authorities and functions among the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC) and other agencies 

in order to provide certainty to the market and to ensure similar products are governed by similar standards. 

In sum, any reform effort should ensure companies’ continued access to OTC derivatives, providing them with greater financial certainty and allowing them to allocate resources to core business activities. Thank you in advance for considering our 

concerns. As this proposal moves through the legislative process, the NAM looks forward to working with you on legislation that encourages transparency and stability 

in the derivatives markets without sacrificing the ability of corporations to use these 

critical risk management tools. 

APPENDIX

How a Small Manufacturer Uses an OTC Customized Derivative 

Manufacturers of all sizes use OTC derivatives to manage risk in their day to day 

operations. According to the International Swaps and Derivatives Association, more 

than 90 percent of Fortune 500 companies use customized derivatives, as do half 

of mid-sized companies and thousands of small U.S. companies. Here is an example 

of how a small manufacturer uses OTC customized derivatives to manage currency 

exchange fluctuations:

Example: Company A, a U.S. exporter, sells heavy construction equipment to 

a buyer in Korea. The exporter will be paid upon delivery in South Korean Won.

In order to protect against the risk that the Won might decline in value, the 

exporter enters into an OTC derivative to hedge that risk. The OTC contract 

would sell Won, tailored to the exact value that the exporter is being paid, on 

the specific day that the exporter is scheduled to receive payment.

Under this example, the exporter knows the U.S. dollar value they will receive 

for the export, and the currency risk is effectively hedged. If the Won were to 

decline or increase in value after the time of the sale, but before payment is 

received, the exporter will be made whole through the settlement of the OTC 

derivative. In summary, the loss in the value of the goods sold would be offset 

by an increase in the value of the derivative. 

SUBMITTED JOINT STATEMENT BY NATIONAL ASSOCIATION OF REAL ESTATE

INVESTMENT TRUSTS; THE REAL ESTATE ROUNDTABLE; AND INTERNATIONAL

COUNCIL OF SHOPPING CENTERS

The National Association of Real Estate Investment Trusts (NAREIT), The Real 

Estate Roundtable (RER) and the International Council of Shopping Centers (ICSC) 

(the ‘‘Associations’’) thank the Chairman, the Ranking Member and the Committee 

for the opportunity to submit these comments for the record of the hearing held by 

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the Committee on Agriculture on September 17, 2009, regarding the proposed legislation by the Department of the Treasury to regulate over-the-counter (OTC) derivative markets. 

The Associations support efforts by the Administration and the Congress to enact 

financial regulations that enhance transparency and accountability while restoring 

stability to capital markets. The Associations believe it is possible to enact this reform and minimize systemic risk while still maintaining access to reasonably priced 

and customized OTC derivative products for business end-users that seek to control 

cost and manage the risk inherent to their day-to-day business operations. 

Commercial real estate companies rely upon low-cost, customized over-the-counter 

derivative products—such as interest rate swaps, forward starting swaps, and foreign exchange forward contracts—to mitigate risk and to manage the costs of their 

development and operational activities. By utilizing these products to minimize volatility and reduce risk, these companies can better manage their balance sheets and 

better serve their customers and shareholders. 

We support efforts to contain any systemic risk posed by derivative arrangements 

between two major market participants through reasonable capital requirements 

and through mandatory central clearing or exchange trading of standardized derivatives. 

However, proposals that would require OTC derivatives used by business endusers to be standardized, centrally cleared, executed on exchanges, or cash 

collateralized—or that would increase the cost of hedging through unreasonable capital charges—would create a significant drain on working capital and could prevent 

our member companies from accessing these important risk management tools. 

The Associations appreciate the collaboration between Agriculture Committee 

Chairman Peterson and Financial Services Committee Chairman Frank, and the 

work of the Treasury Department in the effort to craft proposals that attempt to 

reduce systemic risk, while also recognizing the particular concerns of business endusers that utilize derivatives to manage business risk in a responsible way. 

The Associations support these dual objectives, though we believe more must be 

done to ensure that the proposed legislation truly targets systemic risk and speculation without undermining legitimate risk management techniques for business endusers. We look forward to working with policymakers to achieve these goals.


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HEARING TO REVIEW PROPOSED

LEGISLATION BY THE U.S. DEPARTMENT 

OF THE TREASURY REGARDING THE

REGULATION OF OVER-THE-COUNTER 

DERIVATIVES MARKETS 

TUESDAY, SEPTEMBER 22, 2009

HOUSE OF REPRESENTATIVES, 

COMMITTEE ON AGRICULTURE, 

Washington, D.C.

The Committee met, pursuant to call, at 11:04 a.m., in Room 

1300, Longworth House Office Building, Hon. Collin C. Peterson 

[Chairman of the Committee] presiding. 

Members present: Representatives Peterson, Boswell, Scott, Marshall, Herseth Sandlin, Ellsworth, Walz, Kagen, Schrader, 

Halvorson, Dahlkemper, Markey, Kratovil, Schauer, Murphy, Pomeroy, Childers, Minnick, Lucas, King, Fortenberry, Smith, Latta, 

Thompson, Cassidy, and Lummis. 

Staff present: Adam Durand, Tyler Jameson, John Konya, Scott 

Kuschmider, Clark Ogilvie, James Ryder, Rebekah Solem, Tamara 

Hinton, Kevin Kramp, Josh Mathis, Nicole Scott, Jamie Mitchell, 

and Sangina Wright. 

OPENING STATEMENT OF HON. COLLIN C. PETERSON, A 

REPRESENTATIVE IN CONGRESS FROM MINNESOTA 

The CHAIRMAN. The Committee will come to order. 

Good morning, everybody, and welcome to the hearing. 

Today marks the second of two hearings to review the Treasury 

Department’s legislative proposals on over-the-counter derivatives, 

and I want to thank the Members for making it back to Washington early so you could attend this important hearing today. 

I want to welcome Chairman Gensler and Chairman Schapiro, 

each of whom is making their first appearance before this Committee since they were confirmed by the Senate earlier this year. 

Chairman Gensler has been extremely busy in his new role, and 

I want to commend him for the steps that he has taken, thus far, 

to promote market transparencies, specifically with respect to data 

reporting on index funds and swap dealers in the commodities market. This Committee held month-long hearings on this very topic 

and included similar data, disaggregation provisions in legislation 

that has passed earlier this year. 

We intend to bring Chairman Gensler back very soon to discuss 

other issues relating to the futures markets. I look forward to 

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working with him, as well as Chairman Schapiro, as we finish the 

job in passing long overdue legislation to bring order to the unregulated over-the-counter derivatives market. 

Last Thursday, this Committee heard from industry stakeholders 

about Treasury’s language as well their broader views on the practical effects of the major financial reform proposals that have been 

introduced. As I noted last Thursday, some of what has been proposed is similar to our line of thinking, which has been using the 

clearing model to mitigate the systemic risk of these over-thecounter products, which have grown exponentially in size and complexity. 

While I think there are concerns from this Committee on both 

sides of the aisle about some of Treasury’s language, the Administration, overall, has put forth some useful ideas that we can work 

with. 

In particular, one point of contention we heard from several witnesses last week was a potential negative impact on end-users. 

This is proving to be a difficult problem to deal with, as I said last 

Thursday, but it is imperative that commercial users are not treated unfairly by any statutory or regulatory changes. These entities, 

for the most part, already have effective risk-management methods 

in place and, by virtue of their size, do not pose a systemic risk on 

the economy, like some of the market-making large banks or other 

financial institutions. We shouldn’t throw the baby out with the 

bath water by hampering the ability of end-users to effectively 

hedge their price risk when it comes to regulatory reform. 

In addition, I hope Chairman Gensler and Chairman Schapiro 

can offer their thoughts on financial reform as a whole, particularly 

the idea of the systemic risk regulator and how such a position 

could affect or take away from the missions of their respective 

agencies. I have made my position clear that I do not favor a systemic risk regulator, particularly if it is placed in the hands of the 

Federal Reserve, which is accountable to no one and has enjoyed 

a cozy relationship for many decades with the institutions that are 

largely responsible for this mess that we are in, in the first place. 

I think that it is an important point to consider as we move into 

a crucial time in this debate, and I look forward to working with 

both Chairmen here today, as well as Ranking Member Lucas and 

other committees of jurisdiction to make sure that we don’t lose 

sight of what is at stake. 

There are a lot of big financial players who have a great deal of 

interest in maintaining the status quo, which is simply unacceptable to me and a lot of Members of this Committee. 

Once again, I welcome Chairman Gensler and Chairman 

Schapiro. I look forward to their testimony. 

And at this time, I would like to yield to the Ranking Member, 

Mr. Lucas from Oklahoma, for an opening statement. 

OPENING STATEMENT OF HON. FRANK D. LUCAS, A 

REPRESENTATIVE IN CONGRESS FROM OKLAHOMA 

Mr. LUCAS. Thank you, Mr. Chairman, and thank you for holding 

this hearing. 

I also would like to extend a warm welcome to both our witnesses today. You two are in high demand, and I have watched 

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with interest your appearance in front of other committees. Though 

this is your first time in front of the House Agriculture Committee, 

I trust and suspect it will not be your last. 

On August 11, 2009, the Treasury Department released the 

Over-the-Counter Derivatives Market Act of 2009. Since the release, we have met with the exchange community, the dealer community, the end-user community and our staffs trying to gauge the 

impact of this legislative proposal. Reactions from those in the proposed regulatory community we have met with range from general 

concern to downright opposition. 

Most believe, as I do, that the language is rather ambiguous and 

confusing. Some sections produce more questions than answers. For 

instance, the plan focuses on increasing transparency and standardization in the OTC derivatives market for all types of products, 

and recommends that all standardized OTC derivatives be cleared 

by a clearing organization or traded on an exchange. But the plan 

does not specify what would constitute standardized as opposed to 

customized derivatives. Also it does not mandate that all OTC derivatives be either traded on regulated exchanges or cleared 

through clearing organizations, only that as yet undefined standardized OTC derivative contracts be cleared. 

In addition, incentivizing people to use standardized swaps will 

increase capital margin requirements on customized swaps. Here 

again, the Administration’s proposal doesn’t provide much clarity. 

The Administration’s proposal is silent on how these increased 

costs will be calculated, who will be charged, who will charge the 

increased requirement, and who will hold the margin payment. 

By no means are these the only examples of ambiguity or concerns created by the Administration’s proposal, but they are the 

issues most frequently raised. I am anxious to learn from the regulators today, so that we might be able to get some clarity as the 

process moves forward. 

I congratulate the Chairman for not only all of his efforts on this 

subject, but for having the two most important people responsible 

for implementing this language in front of the Committee so early 

in the process, so that we can get a common understanding of the 

proposals and the intentions. 

Thank you, Mr. Chairman. 

The CHAIRMAN. I thank the gentleman and other Members’ statements will be made part of the record. 

So, again, welcome to the Committee Chairman Gensler, Chairman Schapiro. We very much appreciate you being with us. 

And with that, Mr. Gensler, I will turn the floor over to you for 

your statement, and then I think we have a lot of questions for 

you. 

STATEMENT OF HON. GARY GENSLER, CHAIRMAN,

COMMODITY FUTURES TRADING COMMISSION,

WASHINGTON, D.C. 

Mr. GENSLER. Good morning, Chairman Peterson, Ranking Member Lucas, Members of the Committee. Thank you for inviting for 

me here to testify on behalf of the Commodity Futures Trading 

Commission regarding regulation of the over-the-counter derivatives, and my full statement will hopefully, if I can ask that be in 

158

the record, but it represents the Commission’s statement on which 

I am testifying. 

One year ago at this time, the financial system failed the American public, and the financial regulatory system as well failed the 

American public. And I believe we must now do all we can to ensure that this does not happen again. As a critical component of 

reform, not the only component but a critical component, we must 

bring comprehensive regulation to the over-the-counter derivatives 

marketplace. We must lower risk, promote market integrity, improve market transparency, while still allowing for this market, 

this risk-management market to exist. 

Comprehensive regulation of the over-the-counter derivatives 

market, I believe, will require two complementary regimes: One, 

the regulation of the derivatives dealers themselves; these are the 

actors upon the stage. But also regulation of the key market functions or the stages themselves. This Committee took leadership on 

this important topic, derivatives regulation, when you passed H.R. 

977 in February. 

The joint framework for OTC derivatives legislation announced 

in the summer by the Chairman and Chairman Frank also includes 

essential provisions to protect the American public, and the legislation proposed and submitted to Congress by the Treasury on behalf 

of the Administration, where both the SEC and the CFTC were 

able to contribute, I believe are important steps towards comprehensive regulation of the derivatives market. 

Regulating derivatives dealers is important because this financial 

crisis has taught us that the derivatives trading activities of even 

one firm can threaten the entire financial system and all Americans. Every taxpayer in this room, the Members of this Committee, 

your constituents, the audience, these gentlemen in front of me 

with their cameras clicking, all put money into this company that 

most Americans had never heard of, AIG; $180 billion of all of our 

money is right now in this institution, and it didn’t have effective 

Federal regulation. 

I believe we cannot afford any more multi-billion dollar bailouts 

of ineffectively regulated derivatives dealers. By comprehensively 

regulating the dealers, such as AIG, we can regulate the entire derivatives market, both standardized and customized products. The 

dealers should be required to meet capital standards and margin 

requirements to lower risk. I believe the dealers should also be required to meet business conduct standards to protect against fraud 

and manipulation and other abuses. And to promote transparency, 

the dealers should meet comprehensive reporting requirements so 

that the regulators can see all the trades and report those aggregates to the public. 

But I believe we need to do more than just watch the dealers 

themselves and bring them under regulation. Congress, I believe, 

should also mandate that the standard product in these markets be 

brought on to centralized clearing and on to exchanges. One of the 

lessons we learned through the crisis is that financial institutions 

were not only too big to fail, but also too interconnected to be allowed to fail. In that regard, moving bilateral trades into regulated 

clearinghouses will reduce the risk that a failure of one firm will 

cause other firms to fail. 

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To meet the requirements that all the standardized products be 

brought on to centralized clearing, end-users have raised some concerns, as the Chairman and the Ranking Member noted. But endusers, I believe, should be permitted to access this clearing, bringing all standardized products on to the clearinghouses, through a 

clearing member. An end-user could use a financial institution, and 

that financial institution could then bring it to the standard exchanges and clearinghouses. Thus, we would be able to achieve a 

goal of bringing standardized swaps into clearing, while at the 

same time allowing end-users to enter into appropriate individualized credit terms with those financial institutions who are clearing 

members. 

Transparency and efficiency would also improve for all end-users 

if we bring them onto regulated exchanges or trading venues. This 

would give both large and small end-users pricing, better pricing, 

both in standard and customized products. 

I would like to also mention that we have been working very 

closely with the SEC, and comprehensive regulation of these markets will require ongoing cooperation. I believe that we are very 

fortunate to have a great partner in SEC Chairman Mary Schapiro. 

Since our designations were jointly announced by President-elect 

Obama in December, we have had a strong working relationship, 

and I look forward to working together to implement the regulatory 

reforms of the derivatives marketplace, as well as bringing forth to 

you and the rest of Congress recommendations as the President 

has asked us to do on how we best can tailor our regulations in 

the interest of protecting the American public. 

Before I close, I would just like to mention, if Congress were to 

move forward, as I think we must, to regulate over-the-counter derivatives, the CFTC, and no doubt the SEC, will need additional resources for new staff and technology. 

In our case, since the late 1990s, the markets have grown fivefold; the number of contracts we oversee and regulate six-fold, but 

our agency staff was cut by over 20 percent. With Congress’s help, 

just this year, we are back to the staffing levels we were at in 

1999. Taking on this additional oversight responsibility, I believe 

we will need to work with this Committee and the rest of Congress 

for additional resources. 

So I look forward to working with Congress and other Federal 

regulators to bring this regulation forward for the American public, 

and with that, I look forward to questions. 

[The prepared statement of Mr. Gensler follows:]

PREPARED STATEMENT OF HON. GARY GENSLER, CHAIRMAN, COMMODITY FUTURES

TRADING COMMISSION, WASHINGTON, D.C. 

Good morning, Chairman Peterson, Ranking Member Lucas and Members of the 

Committee. Thank you for inviting me to testify today regarding the regulation of 

over-the-counter derivatives. 

One year ago, the financial system failed the American public. The financial regulatory system failed the American public. We must now do all we can to ensure that 

it does not happen again. While a year has passed and the system appears to have 

stabilized, we cannot relent in our mission to vigorously address weaknesses and 

gaps in our regulatory structure. As a critical component of reform, I believe that 

we have to bring comprehensive regulation to the over-the-counter (OTC) derivatives markets. We must lower risk, promote greater market integrity and improve 

market transparency. 

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The need for reform of our financial system parallels what we faced as a nation 

in the 1930s. In 1934, President Roosevelt boldly proposed to the Congress ‘‘the enactment of legislation providing for the regulation by the Federal Government of the 

operation of exchanges dealing in securities and commodities for the protection of 

investors, for the safeguarding of values, and so far as it may be possible, for the 

elimination of unnecessary, unwise, and destructive speculation.’’ The Congress responded to the then clear need for reform by enacting the Securities Act of 1933, 

the Securities Exchange Act of 1934 and the Commodity Exchange Act of 1936. 

We need the same type of comprehensive regulatory reform today. Just as we 

then brought regulation to the commodities and securities markets, we now need 

to bring regulation to markets for risk management contracts called over-thecounter derivatives. 

Comprehensive Regulatory Framework 

Comprehensive regulation of the OTC derivatives markets will require two complementary regimes—one for regulation of the derivatives dealers, or the actors, and 

one for regulation of the derivatives markets, or the stages. 

This regulatory framework must cover both standardized and customized swaps. 

This should include all of the different products, such as interest rate swaps, currency swaps, commodity swaps, equity swaps and credit default swaps, as well as 

all of the derivative products that may be developed in the future. We should eliminate exclusions and exemptions from regulation for OTC derivatives. Congress 

should extend the regulatory regimes of the Commodity Exchange Act (‘‘CEA’’) and 

the Federal securities laws to fully cover OTC swaps in all commodities. I believe 

that the law must cover the entire marketplace, without exception. 

Only with two complementary regimes that regulate both the derivatives dealers 

and the derivatives markets can we ensure that Federal regulators have full authority to lower risks, promote transparency and prevent fraud, manipulation and other 

abuses. 

This Committee took leadership on OTC derivatives regulation by passing H.R. 

977 in February. The joint framework for OTC derivatives legislation announced by 

Chairmen Peterson and Frank also includes essential provisions to protect the 

American public. 

The legislative proposal submitted to Congress by the Treasury Department on 

behalf of the Obama Administration is a very important step toward comprehensive 

regulation of the OTC derivatives markets. The CFTC and the Securities and Exchange Commission worked with the Treasury Department on many of the most important provisions of the Administration bill. 

Regulating Derivatives Dealers 

Only by comprehensively regulating the institutions that deal in derivatives can 

we oversee and regulate the entire derivatives market. Through regulating the dealers, we can ensure that regulations apply to both standardized and customized products. 

Derivatives dealers should be required to meet capital standards and margin requirements to help lower risk. Imposing prudent and conservative capital and margin requirements on all derivatives dealers will help prevent derivatives dealers or 

counterparties from amassing large or highly leveraged risks outside the oversight 

and prudential safeguards of regulators. Many of these dealers, being financial institutions, are currently regulated for capital. I believe, however, that we need to explicitly have in statute and by rule capital requirements for their derivatives exposure. This is even more important for those dealers who are not currently regulated 

or subject to capital requirements. 

Customized derivatives are by their nature less standard, less liquid and less 

transparent. Therefore, I believe that higher capital and margin requirements for 

customized products are justified. This Committee addressed the issue of standardized versus customized swaps in H.R. 977. 

Congress also should explicitly authorize regulators to require derivatives dealers 

and counterparties to segregate, or set aside, from their own funds the margin collected from counterparties. This would help ensure that counterparties are protected 

if either counterparty to the customized OTC transaction experiences financial difficulties. 

Dealers should have to comply with business conduct standards to protect market 

integrity and lower risk. The CFTC and the SEC should be authorized to apply the 

same enforcement authority that we currently have over the futures and securities 

markets to OTC derivatives and those who trade them. Both the markets and the 

public benefit when there is a cop on the beat. 

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Business conduct standards also should ensure the timely and accurate confirmation, processing, netting, documentation and valuation of all transactions. These 

standards for ‘‘back office’’ functions will help reduce risks by ensuring derivatives 

dealers, their trading counterparties and regulators have complete, accurate and 

current knowledge of their outstanding risks. 

To promote transparency and market integrity, a comprehensive reporting and 

record-keeping regime should be established for swaps, including swap repositories—for both standardized and customized products. This should include mandatory public disclosure of aggregate data on swap trading volumes and positions. A 

complete audit trail of all transactions should be available to the regulators. 

The financial crisis has taught us that the derivatives trading activities of a single 

firm can threaten the entire financial system. Every single taxpayer in this room—

both the Members of this Committee and the audience—put money into a company 

that most Americans had never even heard of. Approximately $180 billion of the tax 

dollars that you and I paid went into AIG to keep its collapse from further harming 

the economy. The AIG subsidiary that dealt in derivatives—AIG Financial Products—was not subject to any effective Federal regulation of its trading. Nor were 

the derivatives dealers affiliated with Lehman Brothers, Bear Stearns, and other investment banks. We must ensure that this never happens again. We cannot afford 

any more multi-billion-dollar bailouts. 

Regulating Derivatives Markets 

To effectively regulate OTC derivatives and protect the American public, Congress 

also should establish a comprehensive regulatory regime for the markets in which 

OTC derivatives trade. 

Centralized Clearing: All derivatives that are accepted by central counterparty 

clearing should be considered ‘‘standardized’’ and thus required to be cleared. This 

is important to lower risk. The CFTC and SEC should be granted rule writing authority to ensure that dealers and traders cannot change just a few minor terms 

of a standardized swap to avoid clearing and the added transparency of exchanges 

and trading platforms. This is a key component of the bill this Committee passed 

in February, the Treasury proposal and the regulatory framework announced by 

Chairmen Peterson and Frank. 

Requiring clearing of standardized products will protect the American public by 

lowering risk. One of the lessons learned from the crisis was that financial institutions were not only too big to fail, but too interconnected to fail. In that regard, moving bilateral trades into regulated clearinghouses will reduce the risk that a failure 

of one firm will cause other firms to fail. 

When a contract is submitted for clearing, the clearinghouse is substituted as the 

counterparty for both the buyer and the seller. The clearinghouse guarantees the 

performance for each counterparty, reducing risk for both the buyer and the seller. 

Clearinghouses should be required by statute and regulatory action to establish 

and maintain robust margin standards and other necessary risk controls and measures. It is important that we incorporate the lessons from the current crisis as well 

as the best practices reflected in international standards. Thus, the Treasury bill 

includes provisions strengthening the statutory core principles for derivatives clearing organizations. 

To promote transparency and competition, central counterparties should be required to have fair and open access criteria. First, to promote competition among 

exchanges and trading platforms, clearinghouses should be required to take on OTC 

derivatives trades from any regulated exchange or trading platform on a nondiscriminatory basis. Second, clearinghouses should accept as clearing members any 

firm that meets objective, prudent standards to participate, regardless of whether 

it is a dealer or another type of trading entity. Clearinghouses also should have 

open governance that incorporates a broad range of viewpoints from members and 

other market participants. 

To meet the requirement that all standardized products be brought into centralized clearing, end-users should be permitted to access clearing through a clearing 

member. This would establish a client relationship between end-users and clearing 

members whereby the clearing member would clear the transaction in a client account on behalf of the end-user. This is very similar to what currently exists in the 

futures marketplaces. I believe it would be appropriate for clearing members, most 

of whom would be financial institutions, to have the ability to enter into individualized credit arrangements with end-users that are not major market participants to 

satisfy the margin obligations of such end-users. Thus, we would be able to achieve 

the goal of bringing all standardized swaps to clearinghouses while concurrently allowing end-users to enter into appropriate, individualized credit terms with a clearing member. 

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Ever since President Roosevelt called for the regulation of the commodities and 

securities markets in the early 1930s, the CFTC (and its predecessor) and the SEC 

have each regulated the clearing functions for the exchanges under their respective 

jurisdiction. This well-established practice of having the agency which regulates an 

exchange or trade execution facility also regulate the clearinghouses for that market 

should continue as we extend regulations to cover the OTC derivatives market. 

Exchanges: I believe market transparency and efficiency would be further improved by moving the standardized part of the OTC markets onto regulated exchanges and regulated trade execution facilities. Exchanges greatly improve the 

functioning of the existing securities and futures markets. We should bring the 

same transparency and efficiency to the OTC swaps markets. 

Transparency in pricing is critical to economic activity. Increasing transparency—

including a consolidated reporting tape—for standardized derivatives would give 

both large and small end-users better pricing on standard and customized products. 

A corn or wheat farmer, for example, could better decide whether or not to hedge 

a risk based upon the reported pricing from the exchanges. As customized products 

often are priced in relation to standard products, I believe that mandated exchange 

trading will enhance the ability of all end-users to effectively manage their risk, 

whether hedging or trading with standardized or customized swaps. 

Position Limits: The CFTC should be granted statutory authority to set aggregate position limits across all markets and trading platforms on all persons trading 

OTC derivatives that perform or affect a significant price discovery function with 

respect to regulated markets that the CFTC oversees. This will ensure that traders 

cannot evade position limits by moving to a related exchange or market. Exemptions 

to position limits should be limited and well defined. 

Enforcement and Rulemaking Authority: The Congress should strengthen the 

CFTC’s rulemaking, oversight and enforcement authorities with respect to registered exchanges and clearinghouses. Further, the Congress should extend the 

‘‘Zelener fraud fix,’’ which was included in last year’s farm bill with respect to CFTC 

enforcement authority over off-exchange retail foreign currency transactions, to 

similar contracts in other commodities. I am pleased that these provisions are included in the Administration’s proposal. 

Foreign Boards of Trade: As part of regulatory reform legislation, the Congress 

should provide the CFTC with clear statutory authority to regulate U.S. traders on 

foreign boards of trade. Parties using terminals in the U.S. to trade a contract that 

settles against the price of a contract traded on a U.S. exchange should be subject 

to position limits and reporting requirements. Those limits would be consistent with 

limits that apply to the U.S. exchange. Such requirements were passed by this Committee in February and are included in the Administration bill. 

Working With the SEC 

Comprehensive regulation of OTC derivatives will require ongoing cooperation between the CFTC and the SEC. The President asked that our agencies provide recommendations to Congress and the Administration on how to best tailor our regulations in the interest of protecting the American public. We recently held two unprecedented joint meetings to look into the gaps that exist between the two agencies’ 

financial regulatory authorities, overlap of regulatory authority and inconsistencies 

when the two agencies’ regulate similar products, practices and markets. The President asked the CFTC and the SEC to propose legislative initiatives, where appropriate, to best harmonize our regulations. It is my hope that some of these proposals 

will be available to this Committee while you consider legislation regulating the 

OTC derivatives markets. 

We are fortunate to have a great partner in SEC Chairman Mary Schapiro. Since 

our designations were jointly announced by then President-elect Obama, we have 

had a strong working relationship. As Chairman of the SEC, former Chairman of 

the CFTC and CEO of FINRA, Chairman Schapiro brings invaluable expertise in 

both the securities and commodity futures areas. Our mutual understanding, dedicated staffs and respective Commission support gives me great confidence that we 

will be able to get the job done. 

Resources 

The CFTC will need additional resources for new staff and technology to effectively regulate the OTC markets. The Commission is just this year getting back to 

the staffing levels that it had in the late 1990s. Since then, the markets grew fivefold and the number of contracts grew six-fold, but the agency’s staff was cut by 

more than 20 percent. To take on additional oversight responsibilities, we will continue to work with this Committee, the Appropriations Committees, Congress and 

the Office of Management and Budget to secure additional resources. 

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Conclusion 

I look forward to working with the Congress and other Federal regulators to apply 

comprehensive regulation to both derivatives dealers and the markets in which they 

trade. The United States thrives in a regulated market economy. This requires innovation, competition and regulation to ensure that our markets are fair and orderly. 

We have a tough job ahead of us, but it is essential that we get it done to protect 

the American public. 

Thank you for inviting me to testify today. I would be happy to answer any questions you may have.

The CHAIRMAN. Thank you very much, Chairman Gensler. 

Chairman Schapiro, welcome to the Committee and look forward 

to your testimony as well. 

STATEMENT OF HON. MARY L. SCHAPIRO, CHAIRMAN, U.S. 

SECURITIES AND EXCHANGE COMMISSION, WASHINGTON, D.C. 

Ms. SCHAPIRO. Thank you very much, Chairman Peterson, Ranking Member Lucas, and Members of the Committee. 

It has actually been 15 years since I last testified before the 

House Agriculture Committee when I was Chairman of the CFTC. 

So I really do appreciate this opportunity to come back and testify 

on behalf of the Securities and Exchange Commission concerning 

the Over-the-Counter Derivatives Markets Act of 2009 proposed, in 

August, by the Treasury Department. 

I am especially pleased to appear with CFTC Chairman Gary 

Gensler, with whom I have worked closely over the last several 

months on a variety of issues. Indeed, our two agencies already 

have begun an ambitious program to better harmonize our roles 

and procedures, and we recently held joint hearings highlighting 

key differences in our approaches. Both of our Commissions are 

eager to address these issues and ensure that remaining differences are justified by meaningful distinctions between markets 

and products. 

As you know, the recent financial crisis revealed serious weakness in U.S. financial regulation, including gaps in the regulatory 

structure. Both the SEC and CFTC are fully committed to filling 

the gaps and shoring up the system. 

One significant gap is the lack of regulation of OTC derivatives, 

which were largely excluded from the regulatory framework by the 

Commodity Futures Modernization Act of 2000. OTC derivatives 

present a number of risks that can facilitate leverage, enable concentrations of risk, and behave unexpectedly in times of crisis. And 

while some derivatives can also reduce certain types of risks, they 

can also cause others. 

Importantly, these risks are heightened by the lack of regulatory 

oversight of dealers and other market participants, a combination 

that can lead to insufficient capital, inadequate risk-management 

standards and associated failures cascading through the global financial system. 

Last, the largely unregulated derivatives market can also undermine the regulated securities and futures market by serving as a 

less regulated alternative, facilitating a flow of funds out of regulated markets into shadow markets. 

The Treasury proposal is an important step forward in improving 

transparency and establishing the necessary regulatory framework. 

While it would go a long way towards improving the regulation of 

164

OTC derivatives, I believe it should be strengthened in several 

ways. 

First, to minimize regulatory arbitrage, regulate swaps like their 

underlying references. Market participants often use derivatives 

and the underlying assets they reference as substitutes. Whether 

to participate in the fortunes of a public company directly, as 

through the purchase of its common stock, or indirectly, as through 

the purchase of an equity swap or a credit default swap, this has 

become a matter of choice. Whether the participation is direct or 

indirect, the same or similar economic effects can often be achieved. 

As a result, even subtle differences in the regulation of economic 

substitutes can lead to gaming and advantages for any one participant. But that participant’s regulatory arbitrage activities, and a 

general migration to the less regulated derivatives market, can undermine the interests of other participants as well as everyone’s interest in minimizing fraud and systemic risk. 

Second, provide the tools needed to appropriately enforce the 

anti-fraud authority retained by the bill. Treasury’s proposal would 

retain the SEC’s existing anti-fraud authority over all securities-related swaps but, unfortunately, does not currently provide the tools 

needed to adequately police all of these swaps. To be effective, enforcement also requires examination authority over entities dealing 

in securities-related swaps, direct access to real-time data, and 

comprehensive anti-fraud and anti-manipulation rulemaking authority. 

Third, clarify that the definition of securities-based swap includes 

not only single- and narrow-based CDS but broad-based CDS 

where payment is triggered by a single security or small group of 

securities. For example, payment is triggered under many so-called 

index CDS by the event of default of a single security referenced 

in the index. These CDS raise the same policy concerns under the 

securities laws as single-named CDS. 

Fourth, clarify that a swap is not considered a mixed swap simply as a result of a swap having a floating interest rate component. 

Fifth, close the unregulated foreign bank loophole by identifying 

banking products. Treasury’s proposal inadvertently would exclude 

from the new swap regulatory framework OTC derivatives offered 

to U.S. persons by unregulated foreign banks and their subsidiaries 

if the products are characterized as bank products. 

Sixth, provide the CFTC and the SEC with clear authority to require that swaps intermediaries segregate counterparty funds and 

securities. Recent events have focused attention on bankruptcy protections with respect to resolution regimes for OTC derivatives 

dealers and other major participants in the market. Chairman 

Gensler suggests that legislation should provide for an insolvency 

framework that protects first and foremost customers, and I completely agree. 

And finally, direct regulators to adopt stronger business conduct 

rules to protect less sophisticated investors and end-users. 

In closing, the Treasury proposal makes significant strides towards addressing current problems in the OTC derivatives marketplace. I look forward to continuing to work with this Committee, 

the Congress, the Treasury, and the CFTC to enact strong legislaVerDate 0ct 09 2002 11:29 Nov 04, 2009 Jkt 041481 PO 00000 Frm 00168 Fmt 6601 Sfmt 6601 I:\DOCS\111-29\53020.TXT AGR1 PsN: BRIAN
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1 Commissioner Paredes does not endorse this testimony. 

tion in this area. Again, I appreciate the opportunity to be here, 

and I look forward to answering your questions. 

[The prepared statement of Ms. Schapiro follows:]

PREPARED STATEMENT OF HON. MARY L. SCHAPIRO, CHAIRMAN, U.S. SECURITIES AND

EXCHANGE COMMISSION, WASHINGTON, D.C. 

I. Introduction 

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

Thank you for the opportunity to testify on behalf of the Securities and Exchange 

Commission 1 concerning the regulation of over-the-counter (‘‘OTC’’) derivatives and, 

in particular, the Over-the-Counter Derivatives Markets Act of 2009, which was proposed in August by the Department of the Treasury. I am pleased to appear with 

CFTC Chairman Gary Gensler with whom I have worked closely over the last several months on a variety of issues. As you know, our two agencies have already 

begun an ambitious program of joint work to better harmonize our rules and procedures. Earlier this month, we held 2 days of joint hearings that highlighted some 

of the key differences in our regulatory approaches. We are eager to address these 

issues. Although some differences may remain over time, I believe this process will 

help ensure that any differences are justified by meaningful distinctions between 

markets and products and the others will be harmonized and improved. I also look 

forward to continuing our joint efforts to push for real regulatory reform. 

The recent financial crisis has revealed serious weaknesses in U.S. financial regulation. Among them were gaps in the existing regulatory structure; failures to enforce existing standards; and failures to adapt the existing regulatory framework 

and provide effective regulation over traditionally siloed markets that had grown 

interconnected through globalization, deregulation and technological advances. Fixing these weaknesses is vital, particularly in the current market environment, and 

it is a goal to which the SEC is absolutely committed. 

One very significant gap in the regulatory structure was the lack of regulation 

of OTC derivatives, which were largely excluded from the regulatory framework in 

2000 by the Commodity Futures Modernization Act. 

It is critical that we work together to enact legislation that will bring greater 

transparency and oversight to the OTC derivatives market. The derivatives market 

has grown enormously since the late 1990s to approximately $450 trillion of outstanding notional amount in June 2009. 

This market presents a number of risks. Chief among these is systemic risk. OTC 

derivatives can facilitate significant leverage, result in concentrations of risk, and 

behave unexpectedly in times of crisis. Some derivatives, like credit default swaps 

(CDS), can reduce certain types of risk, while causing others. For example, CDS permit individual firms to obtain or reduce credit risk exposure to a single company 

or a sector, thereby reducing or increasing that risk. In addition to obtaining or reducing exposure to credit risk, a CDS contract participant will take on counterparty 

and liquidity risk from the other side of the CDS. Through CDS, financial institutions and other market participants can shift credit risk from one party to another, 

and thus the CDS market may be relevant to a particular firm’s willingness to participate in an issuer’s securities offering or to lend to a firm. However, CDS can also 

lead to greater systemic risk by, among other things, concentrating risk in a small 

number of large institutions and facilitating lax lending standards more generally. 

These risks are heightened by the lack of regulatory oversight of dealers and 

other participants in this market. This combination can lead to inadequate capital 

and risk management standards. Associated failures can cascade through the global 

financial system. 

Moreover, OTC derivatives markets directly affect the regulated securities and futures markets by serving as a less regulated alternative for engaging in economically equivalent activity. The regulatory arbitrage possibilities can facilitate a flow 

of funds out of the regulated markets and into the unregulated shadow markets. 

The lack of transparency and oversight also enables bad actors to hide trading activities that would be more easily detected if done in the regulated markets. These 

issues must be addressed, and I am committed to working closely with this Committee, the Congress, the Administration, and the CFTC to close this gap and restore a sound structure for U.S. financial regulation. 

The Treasury proposal would establish a comprehensive framework for regulating 

OTC derivatives. The framework is designed to achieve four broad objectives: (1) 

166

preventing activities in the OTC derivatives markets from posing risk to the financial system; (2) promoting efficiency and transparency of those markets; (3) preventing market manipulation, fraud, and other market abuses; and (4) ensuring 

that OTC derivatives are not marketed inappropriately to unsophisticated parties. 

Importantly, it emphasizes that the securities and commodities laws should be 

amended to ensure that the SEC and CFTC, consistent with their respective missions, have the authority to achieve—together with the efforts of other regulators—

the four policy objectives for OTC derivatives regulation. 

The proposed legislation is an important step forward. It would bring currently 

unregulated swaps, swaps dealers, and swaps markets under a comprehensive regulatory framework, thereby improving transparency and regulatory oversight. It also 

would facilitate the standardization and central clearing of swaps, thereby fostering 

a ‘‘better’’ market and reducing counterparty risk. 

II. Strengthening Treasury’s Proposal 

While Treasury’s proposal would go a long way towards bringing OTC derivatives 

under a comprehensive regulatory framework, I believe it should be strengthened 

in several ways to further avoid regulatory gaps and eliminate regulatory arbitrage 

opportunities. I agree with Chairman Gensler that Treasury’s proposal can be enhanced to prevent the exclusions for foreign currency swaps and forwards from 

being used by market participants to avoid regulation and from undermining the 

CFTC’s enforcement authority over retail foreign currency fraud. I also agree that 

the proposal can be enhanced to bolster protections against insolvency risk, and on 

other matters. 

In addition, I offer the following suggestions: 

A. Minimize Regulatory Arbitrage and Gaming Opportunities by Regulating 

Swaps Like Their Underlying ‘‘References’’

Market participants often view derivatives and the ‘‘underlying’’ assets they reference almost interchangeably. Thus, a participant may well decide to take a position in the fortunes of a company by entering into transactions in OTC derivatives 

like equity swaps rather than through the purchase of common stock. When carefully structured, the economic payoffs could be similar, if not virtually identical. Yet 

the legal consequences attached to these alternatives may be different. 

Gaming—regulatory arbitrage—possibilities abound when economically equivalent 

alternatives are subject to different regulatory regimes. An individual market participant can have incentives to migrate to products that are subject to lighter regulatory oversight. 

Treasury’s proposal would for the first time bring the OTC derivatives market 

under a regulatory umbrella by establishing a new regulatory framework for OTC 

derivatives. Treasury’s proposal would divide regulatory responsibility for securitiesrelated OTC derivatives between the SEC and the CFTC, and provide regulatory responsibility for other OTC derivatives to the CFTC. Although we believe this approach would do much to eliminate differences within the broad and varied world 

of ‘‘swaps,’’ it could result in significant regulatory differences between ‘‘swaps’’ 

products and the currently ‘‘regulated’’ securities and futures products. For example, 

energy swaps would not be regulated in the same way as energy futures, and securities swaps would not be regulated in the same way as securities. This is significant 

because, in evaluating whether to engage in a swap transaction, market participants are far more likely to focus on the choice between a swap and regulated alternatives (e.g., between a Microsoft swap on the one hand and a Microsoft option or 

Microsoft stock on the other, or between an oil swap and an oil future), than between swaps involving different ‘‘underlying’’ assets (e.g., a Microsoft swap and an 

oil swap). Thus, these regulatory differences could perpetuate existing regulatory arbitrage opportunities that encourage the migration of activities from the traditional 

regulated markets into the differently regulated swaps market. 

In addition, Treasury’s proposal would create regulatory arbitrage between narrow-based security index swaps and broad-based security index swaps. For example, 

market participants could engage in the synthetic transactions in the swaps market, 

or craft swaps specifically to fall within the broad-based category instead of the narrow-based category. These risks are particularly high in customized over-the-counter 

transactions where individual market participants can self-select the particular securities in one or more swaps. 

Accordingly, Congress should consider modifying the proposal so that all securities-related OTC derivatives are regulated more like securities; and commodity and 

other non-securities-related OTC derivatives are regulated more like futures. At the 

core of this approach is the principle that similar products should be regulated similarly, or equivalently, if possible. This straightforward approach would result in seVerDate 0ct 09 2002 11:29 Nov 04, 2009 Jkt 041481 PO 00000 Frm 00170 Fmt 6601 Sfmt 6621 I:\DOCS\111-29\53020.TXT AGR1 PsN: BRIAN
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curities-related OTC derivatives—which can be used to establish either synthetic 

‘‘long’’ exposures to an underlying security or group of securities, or synthetic ‘‘short’’ 

exposures to an underlying security or group of securities—and the underlying securities being regulated consistently. Similarly, commodity-related OTC derivatives, 

such as swap contracts for oil and natural gas, would be regulated in a similar manner as the underlying oil or natural gas futures. 

This approach also would be simpler to implement. Congress should extend the 

Federal securities laws to all securities-related OTC derivatives and extend the 

Commodity Exchange Act to all commodity-related and non-securities related OTC 

derivatives. This would significantly reduce the arbitrage opportunities between the 

regulated markets (securities or futures) and the differently regulated swaps market, as well as between narrow-based security index swaps and broad-based security 

index swaps, while building off the existing regulatory framework. Although some 

differences would likely remain (as they currently do between the SEC and CFTC 

regimes), these differences could be addressed through the harmonization process 

that we already have underway. 

B. Strengthen Existing Anti-Fraud and Anti-Manipulation Authority 

Treasury’s proposal also attempts to retain the SEC’s existing anti-fraud authority over all securities-related OTC derivatives, even those securities-related OTC derivatives over which the SEC would not have regulatory authority. This authority 

is essential to policing fraud in the securities markets; to be effective, though, enforcement also requires: (1) examination authority over entities dealing in securities-related swaps; (2) direct access to real-time data on these swaps; and (3) comprehensive anti-fraud and anti-manipulation rulemaking authority for these swaps. 

For example, in investigating possible market manipulation during the financial 

crisis, the SEC sought to use its anti-fraud authority to gather information about 

transactions both in securities-related OTC derivatives and in the underlying securities. Investigations of securities-related OTC derivative transactions, however, were 

far more difficult and time-consuming than those involving cash equities and options. In contrast to the audit trail data available in the equity markets, data on 

securities-related OTC derivative transactions were not readily available and needed to be reconstructed manually. The SEC’s enforcement efforts were seriously complicated by the lack of a mechanism for promptly obtaining critical information—

who traded, how much, and when—that is complete and accurate. 

If Congress determines to split regulatory responsibility over securities-related 

OTC derivatives, Congress should provide these tools to help ensure effective antifraud enforcement over all securities-related OTC derivatives. 

C. Credit Default Swaps and Regulatory Arbitrage 

As we saw first hand during the financial crisis, trading practices in the CDS 

market have a direct effect on the underlying securities markets. Both narrow- and 

broad-based index CDS can be used as synthetic alternatives to debt—and even equity—securities of one or more companies. In addition, market participants may use 

CDS to establish a short position with respect to the fortunes of a specific company. 

In particular, a market participant may be able even to use a broad-based index

CDS that includes the company as a way to short that company’s debt or equity. 

In brief, debt and equity securities and single-name and narrow- and broad-based 

index CDS are all economic substitutes, and therefore ripe for regulatory arbitrage. 

Under current law, the Commission has stated that exchange-traded CDS on securities, whether on one security or a basket of securities, are securities. To avoid 

gaming by financial engineers under the new regulatory regime, Congress should 

consider clarifying that the definition of ‘‘security-based swap’’ includes not only single-name and narrow-based index CDS, but also broad-based index CDS, and other 

similar products, when payment is triggered by a single security or issuer or narrow-based index of securities or issuers. This also would be consistent with the approach advocated above to extend the Federal securities laws to all securities-related OTC derivatives. 

D. Business Conduct Standards and Eligible Contract Participants 

One of the lessons learned from the most recent financial crisis is that certain 

smaller and less sophisticated institutions need protections from abusive practices 

by their swaps intermediaries. There is a need for more stringent business conduct 

standards. This is an area in which I believe we and the CFTC are largely in agreement. Treasury’s proposal would require the SEC, the CFTC, and other regulators 

to adopt business conduct rules for dealers and major participants in the OTC derivatives markets. This is an important component of regulatory reform, and we 

fully support it. But these provisions should be stronger. We believe that Congress 

should strengthen this authority so that the SEC and CFTC may adopt stronger and 

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more protective rules in certain situations—for example, where a swaps dealer is 

selling OTC derivatives to smaller or less sophisticated participants, including certain municipalities, in the OTC derivatives market. 

In addition, Congress should consider revising the qualification standards for participation in the OTC derivatives markets. The standards for being an ‘‘eligible contract participant’’ (‘‘ECP’’) are important under Treasury’s proposal because only 

ECPs may trade derivatives over-the-counter. All other market participants must 

trade on exchanges, which provide better protections for less sophisticated participants. More specifically, Congress should consider raising the qualification standards for a governmental entity or political subdivision—such as a municipal government—to qualify as an ECP. Higher standards may also be appropriate for individuals, corporations and other entities. 

E. Protecting Customer and Counterparty Assets 

One key issue is how best to protect customer and counterparty assets in the 

event of insolvency. I agree with Chairman Gensler that it would be prudent for legislation to address this issue. Recent events have focused attention on bankruptcy 

protections with respect to resolution regimes for OTC derivatives dealers and other 

major participants in the OTC derivatives market. Chairman Gensler suggests that 

legislation should provide for an insolvency framework that protects, first and foremost, customers. I absolutely agree. I believe that a resolution regime should provide legal restrictions on how counterparty assets held by OTC derivatives dealers 

and other major market participants would be treated in the event of an insolvency, 

as well indicate the extent to which counterparties would have a prior claim on the 

other assets of the estate. Without legal certainty, the insolvency of an OTC derivatives dealer or other major OTC derivatives participant could result in further market disruptions and systemic risk. 

F. Ensuring That the ‘‘Identified Banking Products’’ Exception Is Not 

Abused 

Treasury’s proposal contains an exclusion from the regulatory scheme for OTC derivatives for products that are ‘‘identified banking products.’’ Although this exclusion 

may make sense for banks that are regulated in the U.S., we believe that this exclusion could allow foreign banks (and their subsidiaries) that are not subject to oversight by any Federal banking regulator, to offer OTC derivatives to U.S. persons in 

the guise of ‘‘bank products.’’ I believe this exclusion should be revised to make clear 

that it is not available to foreign banks or their subsidiaries that are not subject 

to Federal banking oversight. 

III. Conclusion 

The Treasury proposal is a significant step toward addressing current problems 

in the OTC derivatives marketplace. It provides a comprehensive regulatory framework that addresses risks to the financial system and promotes efficiency and transparency in the markets. I strongly encourage Congress to build off this proposal and 

enact legislation that will bring even more vital transparency and oversight to this 

market. 

Thank you for the opportunity to address issues of such importance for the 

strength and stability of the U.S. financial system, and the integrity of the U.S. capital markets. I look forward to answering your questions.

The CHAIRMAN. Thank you very much, Chairman Schapiro, and 

again, I thank both of you for being here. 

The Treasury proposal presumes a swap is standardized and, 

therefore, must be cleared if the clearinghouse will accept it. And 

then it layers on top of that presumption a joint rulemaking to 

come up with a definition of standardized, which is only effective 

if the clearinghouse is willing to clear the so-deemed standardized 

swap. 

So why shouldn’t the only standard be whether a clearinghouse 

will accept the swap products and can clear it in a safe and sound 

manner in the context of the agency’s role as safety and soundness 

regulator at the clearinghouses? Both of you. 

Mr. GENSLER. The benefit of bringing the marketplace into transparent exchanges and on to clearinghouses is very important, but 

it can be done only if we also make sure that the clearinghouses 

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have strong risk management. And so if a clearinghouse were able 

to accept a contract for central clearing, the Treasury proposal, and 

one that I support in this regard, would say that that should be 

on central clearing. But we would still allow end-users to tailor 

products that sometimes are not so standardized that they can be 

brought into this risk management of a central clearinghouse, and 

in that regard, that should be still allowed. 

But the Treasury proposal also adds one other thing which is 

rulemaking authority. So the presumption is, if a clearinghouse, 

not a mom-and-pop clearinghouse but a real clearinghouse, could 

accept a contract for clearing and they deem it to be a prudent 

under their risk management, it should be deemed to be standard. 

But also, then have a rulemaking, so if they were high-volume contracts or look-alike contracts that at least the regulators could look 

at it. I think it is similar to what you had in your bill, H.R. 977, 

in February, to still take a second look. 

Ms. SCHAPIRO. I would only add that we have to have an overriding concern that the integrity of a clearinghouse not be compromised by the acceptance of a particular contract for clearance 

and settlement if, in fact, they don’t have, as Chairman Gensler 

points out, the risk-management procedures to appropriately manage that contract, and be prepared if there is a default with respect 

to that contract. So, I think, it is more than just the acceptance of 

a contract that makes it susceptible to clearing. There is a layer 

of risk management and other protections that we, as regulators, 

need to be concerned about because the failure of a clearinghouse 

would really, potentially, be a catastrophic event. 

The CHAIRMAN. For a customized swap or a standardized swap 

that can’t be cleared, what does the Treasury proposal say will 

happen with regard to those swaps? 

Mr. GENSLER. They would still be fully regulated but regulated 

through the dealer regulation. They would be reported to central 

repositories and to the market regulators, so that the cop on the 

beat can protect against fraud and manipulation; and also to the 

bank regulator if it was by a bank. The bank or dealer would also 

have to have appropriate capital to mitigate against the risk at 

that financial institution. Finally, there would still be anti-fraud, 

anti-manipulation, other business conduct standards to protect 

against abuses. So fully regulated but allowed because it is really 

important that end-users be able to hedge even customized risk. 

Ms. SCHAPIRO. I think that is a very complete answer. The legislation actually lays out an entire list of actions that would need to 

comprise the dealer regulation component, and that is how we 

would approach the customized products, through dealer regulation. 

The CHAIRMAN. Who, if anyone, will check the financial integrity 

of the swap participants and ensure the proper risk management 

practices, margin capital, are applied? 

Mr. GENSLER. I think that the oversight of the financial institutions who are swap dealers would still be the traditional prudential 

regulators, whether that is a bank regulator, or the SEC, has prudential regulation. We, at the CFTC have a smaller role in that regard over futures commission merchants, but I think that most of 

these swap dealers would end up likely either under the bank reguVerDate 0ct 09 2002 11:29 Nov 04, 2009 Jkt 041481 PO 00000 Frm 00173 Fmt 6601 Sfmt 6601 I:\DOCS\111-29\53020.TXT AGR1 PsN: BRIAN
170

lator or the SEC with regard to what the Chairman asked about 

their risk management at that swap dealer. 

Ms. SCHAPIRO. The dealer obviously would have responsibility for 

ensuring the capability of their counterparty, who may well be a 

major swap participant, to ensure they can meet the terms and 

conditions of the contract into which they have entered. 

The CHAIRMAN. All right. Thank you. My time is up. Mr. Lucas. 

Mr. LUCAS. Thank you, Mr. Chairman. 

Along that general line, I am concerned about the Administration’s OTC derivatives proposal which would, seemingly, force nonfinancial dealers to meet certain capital requirements in order to 

provide legitimate risk services on the OTC commodity derivatives 

markets. Given that these non-financial dealers do not have deposits, unlike the large financial institutions, and in many cases no 

systematic risk profile, has the Administration considered what the 

consequences of that would be? 

And let me ask one more question and let the panel address both 

of them along that line. Are you concerned that such a requirement 

could unintentionally create a bank monopoly in the OTC commodity derivatives market and thereby, of course, reduce competition, reduce liquidity, raise prices, increase systematic risk? 

Mr. GENSLER. Congressman Lucas, one of the lessons out of this 

crisis is that there were significant gaps of institutions not covered 

like nondeposit institutions. AIG, as I referenced earlier, was not 

a deposit-taking institution. So the Administration approach, and 

I support this and believe we must cover anyone who holds themselves out to the public as a derivatives dealer, whether they are 

a traditional deposit-taking institution, whether they are another 

type of financial institution, or for that matter, even if it was a 

large oil company who actively holds themselves out to the public 

as a derivatives dealer. There is a difference between that and 

somebody who is just participating in the markets, to hedge their 

own risk, of course. 

So, it would consistently apply, and in fact, I believe there would 

not be a monopoly in the banks because you would have consistent 

regimes that others would participate, and be allowed to participate, in a nondiscriminatory way. 

Ms. SCHAPIRO. I would really agree with that. I think if we don’t 

cover all dealers regardless of whether they are deposit-taking institutions and, therefore, invoke the Federal Deposit Insurance 

Fund, we will see business migrate from well-regulated institutions 

to less well-regulated institutions. We won’t have solved the problem that we are all attempting to solve through this bill or through 

some similar approach to bringing all the players and the products 

under the regulatory umbrella. 

Mr. LUCAS. Don’t you think it is a fair statement, depending on 

what kind of capital requirements we put together, unintentionally, 

I will say, that we won’t ultimately drive this market into this one 

set of hands that have the deepest pockets to be able to manage 

the requirements, and consequently really dramatically shrink the 

competition out there? Isn’t that——

Mr. GENSLER. I actually—I understand that question, but I don’t 

see it that way, with all due respect. I think that if it is a bank, 

currently a financial institution, they have capital charges already. 

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If it is a non-bank and they are not setting aside any capital, yes, 

you are absolutely correct. But, I believe that we want to protect 

the American public, that non-bank derivative dealers do have 

some capital behind what they are doing. 

Mr. LUCAS. Considering the number and volume of non-bank 

dealers who participate in the OTC commodity derivative markets, 

should capital requirements at least be limited to firms whose failure would create systematic risk in the U.S. economy? And that is 

teeing off just a moment ago, I think, of where you have been headed, but let me ask one more in addition to that. 

What result does the Administration hope to achieve by imposing 

these capital requirements on these non-financial companies that 

use the markets to legitimately hedge their commodity risk and 

offer risk-management services to others? Doesn’t this still help reduce the overall risk to the economy? 

Mr. GENSLER. It most certainly does, in that there is a broad 

array of derivative dealers, but if a company holds themselves out 

to the public as a dealer, as actively trading these and risk management for others, they right now are unregulated. Their chief financial officers, their risk management, they put capital aside and 

may even be capital that is also committed to other things in that 

business. And so it is just important that they do have that buffer, 

that cushion, so we don’t find ourselves, again, if I can come back 

to AIG, where this market migrates to an unregulated participant, 

and there is then an advantage that the unregulated participant 

has to the regulated participant. 

Ms. SCHAPIRO. I would just add that even the failure of a nonsystemically-important institution creates a lot of havoc and harm 

in the marketplace for its counterparties and for other institutions. 

So I would be uncomfortable with limiting capital requirements to 

just those that are systemically important, because capital provides 

an important cushion against losses for all institutions. This is why 

we require, obviously, banks and broker dealers and futures commission merchants to have capital regardless of how large they are; 

although capital is geared towards the size and the risk of the institution. 

Mr. LUCAS. Thank you, Mr. Chairman. 

Mr. GENSLER. If I might add also, I know it is outside our remit, 

but the Administration has talked about those institutions that are 

so systemically relevant that they are called tier-one institutions. 

There may be other provisions that this Committee and Congress 

considers, that those might have additional capital. But what we 

are working with here is, if you hold yourself out as a derivatives 

dealer, there is some concept that there is capital or cushion there 

that is not necessarily as high as what might be there for these 

tier-one institutions. 

Mr. LUCAS. Mr. Chairman, indulge me for just one more moment. 

My concern is that we don’t, in the effort to be so protective and 

to avoid the tier-one, the tremendous institutions, that we strangle 

out the whole industry, the whole series of products that fall at 

that lower tier where a failure would be borne out by the company, 

not by the whole economy. 

Thank you, Mr. Chairman. 

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The CHAIRMAN. Well, if the Committee would indulge, I think 

this might be the right—it is just my understanding that these people are paying for this. Maybe they don’t put the margin up or the 

capital up, but somehow or another, they are paying for this. A 

counterparty isn’t going to give them that protection without extracting something for it, right? So, I mean, they are already doing 

it. If they don’t put the money up, then they are maybe getting a 

bigger spread or something to cover it. Isn’t that what is actually 

going on here? 

Mr. GENSLER. The Chairman is correct. The dealer currently 

charges counterparties for extending credit through these contracts. Whether it is 5¢ a million cubic foot or a few basis points 

on an interest swap, they certainly do. 

The CHAIRMAN. As you guys put this together, I mean, you are 

going to probably allow that to continue as long as you think that 

whatever they are doing is adequate to cover the risk, right? You 

are not going to be so prescriptive that you are going to force them 

to change? 

Mr. GENSLER. That is what we are recommending as relates to 

margin, that the end-users, not the dealers, but the end-users 

would be allowed to enter into arrangements with dealers, and the 

dealers could have individualized credit arrangements, but the 

dealer would still have to post margin at the central clearinghouse. 

Mr. LUCAS. Thank you, Mr. Chairman. 

The CHAIRMAN. All right, thank you. 

The gentleman from Iowa, the Chairman of the Subcommittee, 

Mr. Boswell. 

Mr. BOSWELL. Well, thank you, Mr. Chairman. I just say to other 

Members of our Committee that we all ought to appreciate the personal interest that our Chairman and Ranking Member put into 

this subject. You can tell that from what has already gone on. 

So not to repeat some of that, but I would like to add my appreciation to you both being here. You have an awesome responsibility, and the whole country is looking right over your shoulder. 

And I guess we are going to all get acquainted better as time goes 

on. So I appreciate your accepting the responsibility and what you 

bring to the table, and we look forward to that. 

I think I will digress a little bit because there are a number of 

Members here that will get into a lot of detail that I could as well, 

and I may yet. But last week, it was called to my attention by a 

constituent, which was most unexpected, some of the things that 

are going on in the life insurance side. And there was quite an article written on September 6 in The New York Times entitled, Wall 

Street Pursues Profit in Bundles of Life Insurance.

I trust you are familiar with that. I see you nodding your head. 

So, with that, I won’t read from it, but I could. I am concerned 

about it, and I would like to know if you are. 

The article says many things, but would you elaborate for me—

does this securitization of life settlements not only add another element of possible risk to an investor that was already in need of 

more transparency and consumer safeguard, but it is something 

that we should even allow? What are your thoughts? 

Ms. SCHAPIRO. It is a wonderful question. It is an area I am actually profoundly worried about. And about a month and a half ago, 

173

I asked the SEC staff to form a task force to explore all of the 

issues that surround the process of securitizing life insurance policies. It is becoming a very large business. It is a multi billion dollar 

business to sell life insurance policies for more than the surrender 

value but less than the cash value, and then bundle those up together and then cut them into pieces of securities and sell them. 

They raise all sorts of issues with respect to the Privacy Act because underlying information about the health of individuals whose 

policies are part of the securitized product may be made available 

to investors. They raise issues about the ability of the people who 

sold their life insurance policies, to ever get policies again. They 

raise tax implications for them. So there are multiple sales practice 

issues, and there are multiple issues around the whole 

securitization process. 

None of these securitized products have yet been registered with 

the SEC. They have been done with private placements, but we are 

aggressively exploring the issues. We are working with other interested parties, like the National Association of Insurance Commissioners, and we will proceed to take this process apart very carefully. 

Mr. BOSWELL. Maybe you could comment about why aren’t they 

regulated? What have you got in mind? 

Ms. SCHAPIRO. Well, we need to understand the full range of 

issues because, as I say, there are sales practice issues when people 

are convinced to give up their life insurance policies, and what is 

the price they are getting for that, and is it fair? 

Mr. BOSWELL. If I could, my time is going fast. I like what you 

are saying, and I want follow up on this. 

Ms. SCHAPIRO. Okay. I don’t know where we will land in terms 

of policy yet. 

Mr. BOSWELL. I am sure you don’t, but I want you to keep us 

very closely in touch of what is going on, and let’s keep this dialogue going. 

Ms. SCHAPIRO. I would be happy to. 

Mr. BOSWELL. Okay. And we put it into the record last week 

about this issue and made several points, but you know, some of 

these—this bittersweet side of it, kind of and others, maybe there 

is some opportunity for people who don’t need the insurance anymore, but they lapse in all these details. However, if it is put on 

the market and sold in a sense, then they are going to keep paying 

out the premiums. And maybe the criteria that the insurance company used to figure out what it is going to cost no longer is valid. 

So there are all kinds of possibilities here that needs attention, as 

I can say the least of. 

Mr. Chairman, with your concurrence, thus——

Mr. POMEROY. Would the gentleman yield just for a moment on 

that? 

Mr. BOSWELL. I will. 

Mr. POMEROY. There are tax incentives underwriting the fundamental life products, and I believe that when it is a securitized 

issue spread around with no remote concept of insurable interest, 

you raise profound questions about whether or not this tax incentive ought to apply anymore. I believe that they are placing the 

fundamental industry at risk with this whole track they have gone 

174

down, and it does deserve the kind of examination by regulatory 

authorities and Members of Congress alike. 

I thank the gentleman for raising it. 

Mr. BOSWELL. You are welcome, and I will just finish with this 

statement, which you already know. There are trillions of dollars 

invested out there. Possibly, some say $26 trillion, I don’t know 

what it is. It is humongous, and so it is very huge. So, it deserves 

your attention, and I appreciate what you have said, and so let’s 

keep in touch. 

I yield back. 

The CHAIRMAN. I thank the gentleman. 

The gentleman from Iowa, Mr. King. 

Mr. KING. Thank you, Mr. Chairman. 

And I thank the witnesses. 

As I listened to this discussion, I would like to return a little bit 

to the AIG, which was brought up a number of times. And I want 

to say the words out loud that you were talking about using different definitions, but improperly defined, too big to be allowed to 

fail. And so I think that the specter of that hangs over our discussion here. 

And I haven’t heard very much discussion about what you view 

the consequences might have been if we had not invested that huge 

sum of money into holding up AIG. How that might have broken 

out, and what would be the results today, short from the prediction 

of the global financial collapse, what would it look like in the 

United States today if we had just simply let them fail and let the 

markets do the adjustment? And I would ask first Chairman 

Gensler. 

Mr. GENSLER. Well, you ask a very difficult question because it 

is running history parallel in two regimes. I do think that what we 

were facing last fall was quite uncertain, that AIG had a book of 

business that was over $450 billion of just credit default swaps. 

They had other books of business, but it was with significant European banks, as well as about a third of that book was here in the 

states backing up mortgage securitization products, all very lightly 

regulated. If it had triggered, there was tens of billions of dollars 

that would have cascaded around the system and other institutions. 

Recall, also, that was the same week that Lehman Brothers 

failed. That was the same week that, for the first time in decades, 

a money fund was worth something less than a dollar; it broke the 

buck. So there was a run on money markets. There was a run on 

investment banks. There was a classic run on the whole financial 

system. I don’t know exactly what would have happened, but that 

run would have accelerated, in my opinion, over those next several 

days. 

Mr. KING. Mr. Chairman, would we have recovered, you believe, 

and would it have rearranged our financial markets in a fashion 

that would have sent a message out through the investment community to, let’s say, restrain their investments unless there was 

better capital behind the traders, rendered unnecessary by regulators? 

Mr. GENSLER. I was a private citizen and not a government official at the time, but I would certainly say it would have rearranged 

175

things. I am not sure if it would have rearranged things calamitously or not, but it would certainly have rearranged things. But 

these were very difficult decisions that the regulators at the time 

faced. 

Mr. KING. Thank you. 

Mr. GENSLER. And if I might say, we shouldn’t have to face those 

decisions again. That is why we are both here to say, let’s bring 

regulation to the over-the-counter derivatives. 

Mr. KING. I do hear that, and I thank you. 

And I direct a similar question to Chairman Schapiro. 

Ms. SCHAPIRO. Thank you, Congressman. 

I also was a private citizen last fall, so I have no particular insights other than those that I have gained at the SEC in the meantime. But I do think that given the number of counterparties that 

AIG had, there likely would have been multiple other failures in 

the system if they had collapsed. And the process that we have 

been going through painfully for the past year likely would have 

been prolonged and more difficult. It is hard to, obviously, say exactly. 

Mr. KING. Thank you. 

And the question I posed here really sets up the follow-up question, and I will come back to you, ma’am, and that is, is there any 

discussion about requiring reinsurance on the part of the traders? 

You know, I describe it as being bonded to do a certain dollars 

worth volume of business. If that discussion had a viable path that 

could be part of this dialogue, then how do we avoid the reinsurance companies from becoming too big to be allowed to fail? 

Mr. GENSLER. Well, I am intrigued by your suggestion. I think 

that is why we have proposed that there be capital, and capital by 

the dealers, as well as margin which is sometimes similar to capital by the counterparties, and so the concept of reinsurance is another concept one might add to this. But capital is a big cushion 

and important cushion to this and margin. 

Mr. KING. And Chairman Schapiro? 

Ms. SCHAPIRO. I agree with that. I think margin essentially 

collateralizing the positions in many ways, and can have the same 

impact without worrying about the further integrity of other financial institutions that have now become intertwined in the process. 

Mr. KING. Have either of you considered an alternative that 

might be more of a free market alternative that would not require 

the Federal Government to be the regulator of first resort and setting the standards of capital at the over-the-counter level, or——

Mr. GENSLER. Well, the American public benefits by a regulated 

market economy——

Mr. KING.—another alternative? 

Mr. GENSLER. Well, this is both—I think we need the regulation. 

The other alternative to me is more costly to the American public. 

Now, it is true that, just as we do in the securities and futures 

market, we do rely on some self-regulation of the exchanges, but 

if the regulators set the overall rules, exchanges can then help and 

clearinghouses, obviously, can help in implementing those rules. 

Mr. KING. Chairman Schapiro.

Ms. SCHAPIRO. The securities regulatory regime really relies very 

heavily on self-regulatory organizations, primarily the exchanges in 

176

this context. The key to which those are successful though is strong 

governmental oversight of the self-regulatory organizations so that 

they continue to act in the public interest. If they are publicly 

owned entities, as they are increasingly in both commodities and 

securities markets, they are not diverted from their public interest 

responsibilities by their desire for shareholder return. So, we can 

have reliance on clearing organizations to perform certain functions, but it has got to be under the oversight of the Federal Government. 

Mr. KING. Thank you. 

I thank the witnesses. 

Mr. Chairman, I yield back. 

The CHAIRMAN. I thank the gentleman. 

The gentleman from Georgia, Mr. Scott. 

Mr. SCOTT. Thank you, Mr. Chairman. 

I want to ask a question about the CFTC’s authority over foreign 

boards of trade, but before we do, a couple of my colleagues raised 

some points that I would just like for you to respond to. 

On the AIG situation, there is a question here that we need to 

examine and answer that has not been done, and that question is 

that for the Financial Products Division of AIG, there was no effective Federal regulation. That same situation was true for Bear 

Stearns, Lehman Brothers, all down the line. So the question is, 

why? Why was there not any Federal regulation? Who and how 

was the ball dropped there? Why didn’t we see this? Why wasn’t 

there effective Federal regulation? 

Ms. SCHAPIRO. Let me take the first stab at that. I don’t know 

the answer with respect to AIG and how it was structured. 

With respect to Lehman Brothers and Bear Stearns, there was 

ineffective, honestly, Federal regulation through basically a voluntary regulatory program at the Securities and Exchange Commission called the Consolidated Supervised Entity Program. And it 

was essentially voluntary for those institutions through their holding companies to be regulated in this way. 

The lessons learned coming out of that really suggest that the 

capital rules were not adequate to deal with the liquidity stresses 

that were created when these institutions began to fail. There was 

a lack of appreciation that secured funding; even that funding that 

was backed by high quality collateral such as Treasury bills, could 

become unavailable and really impair liquidity. Without liquidity, 

institutions couldn’t continue to do business. 

I think we learned that there is a much greater need at these 

financial institutions for supervisory focus on the quality of the assets they are holding and their liquidity. 

We certainly learned that valuation models that were relied upon 

for capital purposes and other purposes were wholly inadequate, 

not up to the task, and were not sufficiently stress-tested so that 

we could understand in a really bad situation how these institutions would perform. And it was a neglect of looking at the low 

probability but really extreme events to understand their impact. 

So, from my perspective, these are all lessons coming out of the 

failure of those institutions, and, hence, the need for regulators to 

have clear authority to require changes when necessary in the conduct of a business that is threatening systemic integrity. 

177

Mr. SCOTT. Okay. Well, thank you for that answer. I just think 

we should know the why. 

Let me go to another point. The Treasury proposal seemingly 

gives the CFTC authority over foreign boards of trade, which I am 

concerned may invite regulatory retaliation against U.S. markets 

and businesses by foreign regulators. Foreign boards of trade will 

need to register with the CFTC in order to provide electronic access 

to its U.S. participants. So, in order to register with the CFTC, the 

foreign boards of trade must adopt position limits for contracts that 

are linked to a contract traded on the U.S. DCM. But, the Treasury 

proposal goes further than limited contracts, however, and also 

gives the CFTC the authority to set position limits on any contract 

traded on a foreign board of trade that is offered to U.S. market 

participants, regardless of whether or not there is a linkage of a 

U.S. contract. So where does the Treasury derive their authority to 

regulate transactions on a foreign exchange? 

Mr. GENSLER. Maybe this one is for the CFTC. What we are trying to address is something that you all also addressed in your bill 

in February, that we have some foreign futures exchanges now—

but in the future, it may also be swaps markets—that access U.S. 

customers, also link those contracts, in what you may be familiar 

with which became known as the London Loophole. 

So we want to address that in statute, just as you did in February, so that if terminals are placed here or if they are not physical terminals but there is access to investors here, contracts are 

linked, then we bring that regime under regulation. 

We currently are somewhat limited in the statute, and we use 

something called No Action letters to do it. And that has been 

somewhat more effective. We have just revised such a letter with 

the largest foreign board of the trade, the ICE Europe, we did that, 

but we had to do it with a lot of diplomacy with foreign regulators, 

and I think it would be good to have it also in statute. 

Mr. SCOTT. Are you all concerned that these foreign regulators 

may retaliate against U.S. markets? 

Mr. GENSLER. That is always a legitimate concern. That is why 

we worked so closely with the FSA in London and have a very good 

relationship with the head of that, Adair Turner. We have just recently entered into two Memoranda of Understanding in those regards to oversee clearing and this ICE Europe in a more tight regulation because, as well, they also oversee some of our exchanges 

over there. 

Mr. SCOTT. Thank you, sir. 

I yield back, Mr. Chairman. 

The CHAIRMAN. I thank the gentleman. 

The gentleman from Nebraska, Mr. Fortenberry. 

Mr. FORTENBERRY. Thank you, Mr. Chairman. 

And I am sorry, I regret I didn’t have the benefit of your earlier 

testimony, but let’s go back to some fundamentals here. Let’s ask 

ourselves, what is the purpose of a commodities market? And then 

I want you to answer, what percent of people in the market now 

are hedgers, have commodity possession versus speculators? 

Mr. GENSLER. The commodity markets, which go back over 150 

years in regulated or in regular futures exchanges, help hedgers, 

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whether they be farmers or ranchers or, later on, oil producers to 

hedge a risk, and then speculators take on that risk. 

Mr. FORTENBERRY. I know the answer to this, this is just an exercise, as you understand. 

Mr. GENSLER. I understand, but I am trying to give you the best 

answer, and so they are both very important pieces of the market. 

Depending upon the underlying commodity, some markets are—

have significantly more hedgers; some more significantly speculators. We recently broke out more of our data between producers 

and merchants, what you might consider a traditional hedger and 

swap dealers, money-managed funds and the like. And generally 

speaking, less than half—but it depends on the market—less than 

half is usually the traditional hedger or producer merchant category. 

Mr. FORTENBERRY. Less than half since when? 

Mr. GENSLER. I am just—I am just referring to the most recent 

data. We can certainly follow up. 

Mr. FORTENBERRY. Well, the reason I ask is, the purpose of the 

commodities market clearly is to hedge risk, to decrease market 

volatility so that we have—the vagaries of the economy are 

smoothed out. That we have less potential disruptions because of 

the risky nature of growing crops or producing oil and the other 

production capabilities that we have in our country. If that system 

is broken and the market itself actually increases risk for the overall economy, do we have a fundamental problem here? 

Now, last year, when we were dealing with this issue and were 

going over and over it trying to figure out, where is the smoking 

gun? Why are oil prices shooting through the roof when the underlying fundamentals seem to indicate that supply-and-demand variables were not consistent with such a run-up in the price? And of 

course, that leads to an increase in price of the other commodities 

that are trailing behind, particularly agriculture commodities, 

which ends up turning hog markets and ethanol markets and all 

types of production capabilities upside down. Now we are back 

home dealing with farmers who are in very dire straits because of 

something that they had no control over. 

We have a fundamental crack or a problem in our foundation 

here in that the system designed to hedge risk, to ameliorate risk, 

actually has caused risk in the economy; what is the underlying solution to that? And I know you are talking about increasing capital, 

transparency in all swaps, all types of derivative markets that are 

out there, will that solve this problem? That is my point. 

I am sorry to be a little bit testy with you here. That wasn’t my 

intention, but just try to get to the fundamental point. 

Mr. GENSLER. I think you are right. All derivatives markets, 

whether futures or these things we call derivatives, OTC derivatives are risk-management contracts and price-discovery markets 

so people can discover the price of bearing that risk, the price of 

hogs or corn or wheat. 

We are recommending that we bring regulation and transparency 

to the big part of the market that doesn’t have it right now, the 

over-the-counter swaps marketplace, that we regulate the dealers 

and that we bring the standard part of the market onto transparent exchanges. 

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I think that goes a far way to the Congressman’s question but 

also to have the ability to set aggregate position limits, not only in 

the futures market, but across these markets where it affects the 

markets, particularly for products that have finite supply. 

Mr. FORTENBERRY. Do you think, applying a test backwards in 

time, that a regulatory framework that you just described with increased transparency and requirements on all trades, no matter 

how you define them, no matter how they are sliced up, no matter 

how they are derived, having them open and clear as to what is 

going on, would have actually prevented the type of run-up in oil 

prices and other commodities that went along with that? Because 

even though there are underlying supply-and-demand fundamentals, they didn’t indicate the need for such or indicate a future possibility of prices reaching that level. In other words, the market 

that is designed to hedge risk, to take care of market vagaries, actually caused the run-up in markets and the severe disruption to 

the economy. 

Mr. GENSLER. I think that given more tools, and this is true of 

both our agencies——

Mr. FORTENBERRY. Can you do that—I am sorry, I am out of 

time. Can you apply in real-time what you are projecting into the 

future back to the situation last year, would it have been prevented? 

Mr. GENSLER. I am not able to do the hypothetical. It is a good 

hypothetical, but I am not able to do that. I think we bring good 

transparency and lower risk to the system, and we have the tools 

to police against manipulation and corners and squeezes and other 

abuses that might be at the center of what you are saying. 

But we are also not price-setting agencies, neither of us. So there 

are going to be times that there are trends in investor psychology 

or in market psychology that also happens. We are there to make 

sure they are fair and——

Mr. FORTENBERRY.—you should try to get to that issue. 

Mr. GENSLER. Yes. 

Mr. FORTENBERRY. All right. Thank you, Mr. Chairman. 

Mr. MARSHALL. Thank you, Mr. Chairman. I guess picking up on 

where Mr. Fortenberry left off, the position limits authority that 

you would like the CFTC to have which would run across all markets. Do you plan to give the CFTC sufficient discretion to make 

judgments concerning limits that would vary from participant to 

participant? Those participants that in your judgment are really 

truly assisting with price discovery and market liquidity and those 

sorts of things, it seems to me you might at some point want to 

permit them to have larger position limits than other participants. 

And it is simply a matter of math, it is simply a matter of numbers. We have had that discussion before. I would be, interested in 

maybe a written response in this instance. 

My question actually today has more to do with this clearing 

process. You have referenced what others have already talked 

about, and that is this possibility that clearing members would provide financing that would assist end-users in using the new system. 

The pushback we have been getting, of course, is that end-users, 

folks who really need to hedge, just aren’t going to be able to do 

it, they are not going to be able to afford it. 

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And it would be helpful if, perhaps, the CFTC could get together 

with those who are proposing to have clearing operations and sort 

of flesh out how this would work and what impact—assuming that 

it works well and that financing is available for margining, et 

cetera—what impact this would have on end-users? Would we lose 

a lot of end-users or wouldn’t we lose a lot of end-users? And that 

will help us out a lot if basically there is a small additional cost 

but people are still able to hedge, and that additional cost is something that generally protects the system, that protects the public, 

then that is something we can live with. 

If, on the other hand, people aren’t going to be able to hedge, 

they are just going to not be able to have access to the market, 

then we are going to have problems. We are going to have to try 

to redefine who is going to be covered by clearing requirements. 

Mr. GENSLER. Congressman, it is good to be back with you. I 

think that end-users will benefit and actually take some of the cost 

out of the system for them by the transparency, that they will see 

the price as somebody else trades it. And that is the truth in securities and futures markets today. 

As it relates to the other question about central clearing, central 

clearing will lower risk, but many end-users have raised the question, well, does that apply to me? Does that mean that I, too, as 

a small company in Georgia or in Iowa or anywhere. I have to post 

margin. And what I believe we can do to satisfy both goals, to satisfy the goal that we bring everything into central clearing, is require the clearing member, the large financial institution, the dealer, to do so; but then they can enter into an individualized credit 

arrangement. And right now derivatives do have costs in them. All 

the end-users have a cost for credit extension. A credit extension 

is one of the two pieces of these risk management contracts. 

Mr. MARSHALL. It would be very helpful to us if you, your agency, maybe teaming up with the proposed clearing agencies, could 

help us understand what the real impact will be. We understand 

the theory, and that these folks will have help that they are not 

really mentioning when they object to the clearing requirement. 

It would be very helpful to us if you could sort of put some numbers down that might guide us. I don’t know whether you can do 

that, but it would be very helpful. I will just make that statement. 

Mr. GENSLER. I certainly would like to follow up with you on 

that. 

Mr. MARSHALL. That would be wonderful. 

Page 7, first full paragraph of your testimony, you talk about 

central counterparties being required to have fair and open access 

criteria, and that the clearinghouses should be required to take on 

OTC derivative trades from any regulated exchange or trading 

platform on a nondiscriminatory basis. 

As I think how this clearing process is probably going to evolve, 

I thought that it was probably going to—you know, exchanges 

that—or that clearinghouses would become familiar with particular 

kinds of trades, particular products, as has happened where exchanges are concerned. I mean that one exchange winds up being 

the main exchange for doing X. And the product consequently—and 

the reason it is is because of liquidity, or because of comfort, or 

something like that, there is a better deal to be offered. And I am 

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wondering whether or not that isn’t the same with these clearinghouses. Clearinghouses that are more familiar with a particular 

product are going to be able to offer a better price, better margining rules, those sorts of things. And if they are required to accept products that they are not familiar with, then they are going 

to be less likely, it seems to me, to offer those, be able to offer those 

products the same way that somebody else familiar with the product would, and costs would go up. 

Mr. GENSLER. It is actually the reverse we are trying to do. We 

are trying to promote competition amongst exchanges and trading 

venues. And so what we are saying is that a clearinghouse could 

not be vertically integrated in such a way with an exchange or 

trading platform so that the only product they accept is from that 

exchange or trading platform. And so thus we want to promote 

competition, somewhat like what is in the options market right 

now, where there is one clearinghouse but many exchanges. 

Ms. SCHAPIRO. I was just going to add, if I could, that there is 

a competitive clearing model where there are multiple exchanges 

and multiple clearinghouses, and there is competition to keep price 

down. The securities model really is a utility model of a clearinghouse, very much along the lines you suggest; the Options Clearing 

Corporation clears the options transactions for all of the options exchanges; DTCC in New York clears for all the securities exchanges. 

And it is a very efficient model because they become highly expert 

in handling the products, just as you suggest. 

Mr. MARSHALL. And I am not entirely sure that the models that 

you just offered will fit very well with these things that are essentially futures. And I worry that the organizations that are offering 

clearing are going to have to pay a lot more attention post the actual event, the actual purchase, the actual swap. And they know 

they are. They have to understand the market, and they are going 

to be worried about costs associated with that. And they are going 

to become familiar with particular products. 

So that is what I was worried about, and that they be able to 

offer better price and better service for particular products, and 

consequently you get concentration. 

Mr. GENSLER. And we would only recommend that a clearinghouse accept a contract that they can legitimately risk-manage and 

accept. But once they have accepted product A, from Congressman 

Minnick’s exchange, if I might say, if somebody wants to take it to 

Representative Lummis’ exchange, if you had a different one, they 

could take it off. But the clearinghouse would have to accept each 

of their exchanges once they have accepted a product for clearing. 

Mr. MARSHALL. I thank the Chairman for his indulgence. I am 

over my time. Thank you. 

The CHAIRMAN. I thank the gentleman. The gentleman from 

Pennsylvania, Mr. Thompson. 

Mr. THOMPSON. Thank you, Mr. Chairman. I am going to switch 

gears just a little bit and move to the other end of this process. 

Let’s assume the Treasury proposal becomes law. What will be the 

additional resource needs of your respective agencies in terms of 

personnel, equipment and other needs, and how much will that 

cost? Any estimates? 

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Ms. SCHAPIRO. We don’t have estimates at this point, though we 

would be happy to provide them to the Committee. I would say the 

rule harmonization process and the joint rulemaking initiative will 

require significant amounts of time and staff to build the joint rule 

through the rulemaking time frame that is laid out in the statute. 

Then, of course, there will also will be the process of approving 

clearinghouses, setting up the regulatory framework, overseeing 

them through an inspection program. And the same would be true 

with respect to oversight of the dealers either by the bank regulators, the SEC or the CFTC. So that is an examination program, 

although I don’t expect that there will be huge numbers of dealers. 

And then there will be the reporting capabilities that will have 

to be through a repository or other mechanisms, reporting systems 

that must be developed, that will collect transaction data and make 

it available to the public and to the regulators. 

And then, of course, once we have all that data, we have to be 

in a position to analyze it and understand what kinds of activities 

are taking place that may need a further response. 

So there is a lot to do here. We are creating an entirely new regulatory program around products that are valued at trillions and 

trillions of dollars. So I don’t have specific numbers for you, but it 

will not be insignificant, I don’t believe. 

Mr. GENSLER. And I was just going to say, though we don’t have 

a specific number because we don’t know the scope of the legislation. This Committee included, I believe in your bill in February, 

authorization for 100 new staff, if it were to move forward in that 

regard. And so we have been using your wisdom and guidance a 

little bit internally to think about how to do this. 

I don’t know if the 100 on top of—we have approximately 570, 

580 people now. We need to be much larger just to do our current 

mission. But it has given us some guideposts as we are thinking 

about this, your own guidance from February. 

Mr. THOMPSON. Thank you. Just recently, the power producers 

weighed in on the derivatives debate and expressed a fear that the 

proposed changes, as defined currently, would make it harder to 

protect against swings in commodity prices. And obviously commodities they are looking at are specific to energy. 

Do you in your view—I would offer this to both Chairmen—how 

will this legislation impact energy markets and overall prices? Do 

you share their concern or do you see the validity of their concerns? 

Mr. GENSLER. Well, I think that it will bring greater transparency to energy markets. One of the great challenges market 

participants have is that the over-the-counter derivatives market is 

opaque. And that may have developed by history, but there are 

many people that actually want to keep it opaque. They are many 

of the people who we are looking to regulate. They have advantages 

in keeping it opaque. So I think they and all of their associations 

would benefit by that transparency. 

They have also raised some concerns about would they have 

some costs with regard to posting margin. And then, as I tried to 

address in my written statement, there is a solution to that where 

clearing members would post margin and then enter into individual credit arrangements with these gas companies and utilities. 

183

Ms. SCHAPIRO. While it is not a perfect analogy by any means, 

it has been my experience when we have made markets more 

transparent, spreads have tightened, volatility has been less of an 

issue, because there is generally available information about the 

price, for example, of corporate bonds. So, again, not a perfect analogy, but I would agree with what Chairman Gensler has said. 

Mr. THOMPSON. Okay. Thank you. And my final question is just 

straightforward. Do you believe this legislation will cause additional drying up of liquidity in any way, or any threat of that? 

Mr. GENSLER. I think actually it will enhance liquidity. That 

when you bring transparency to markets, as was done through the 

Securities and Exchange Act in the 1930s and the Commodity Exchange Act that enhances market liquidity, it might take some of 

the advantages away from certain big dealers. 

Ms. SCHAPIRO. I would say that I think the facility of exchange 

trading has generally enhanced liquidity in markets. 

Mr. THOMPSON. Thank you. Thank you, Mr. Chairman. 

The CHAIRMAN. I thank the gentleman. The gentleman from Wisconsin, Mr. Kagen. 

Mr. KAGEN. Thank you, Mr. Chairman for holding this very important hearing. And I was very pleased to hear in your opening 

remarks that you were steadfastly against providing the Federal 

Reserve with the authority to be the systemic risk regulator. And 

I just want to confirm that our guests here would confirm that they 

would also agree with this. So I will give you an opportunity to say 

yes or no, that you would be in agreement in opposing the Federal 

Reserve’s opportunity to be the systemic risk regulator. 

Ms. Schapiro. 

Ms. SCHAPIRO. Well, like most questions, I can’t answer it yes or 

no. My perspective on this is slightly different than the Administration’s or some of the other proposals that you have heard. I 

think we do have a need for a systemic risk regulator, and it could 

be the Fed. But what is almost more important is that we have a 

very empowered systemic risk council that is comprised of the 

CFTC, the SEC, the Fed, the FDIC, OCC, the full panoply of regulators who can take on the role of really the macroprudential view 

of risk in a system, can set capital standards if they need to be 

higher than what the primary regulators have done, and can direct 

the systemic risk regulator to act in an emergency. 

I think the multiple perspectives that we can get from a council 

as opposed to a single all-powerful systemic risk regulator is going 

to be really important to the future of our system. Because we have 

very different products, as you have heard today; we have very different financial institutions under our different jurisdictions, depository institutions, broker-dealers, FCMs, and so we have regulators 

with very different expertise. And to bring all of that talent to the 

table to make some of the fundamental decisions about systemic 

risk regulation, I think is very important. 

That said, I do think at the end of the day some single entity—

it could be the Fed, it doesn’t have to be—needs to be in a position 

to be a second set of eyes over the roles of the primary regulators. 

Mr. KAGEN. Would you agree that if we eliminate those entities 

that are too big to fail, we may not require such a risk regulator? 

184

Ms. SCHAPIRO. I think it would be good to have a risk regulator 

that is constantly viewing the landscape and understanding where 

risks are beginning to build, but it is critical we eliminate the toobig-to-fail doctrine. 

Mr. KAGEN. Would you agree with me, if you are too big to fail 

you should not exist and you should be broken up into regional entities? 

Ms. SCHAPIRO. Let me say this carefully. I do believe that we 

cannot suffer under the too-big-to-fail doctrine as an economy for 

very much longer, that we must have in place resolution mechanisms or ways to keep institutions from becoming too big to fail for 

the future. 

Mr. KAGEN. Well, would you agree with the testimony offered 

here last week from Garry O’Connor that, ‘‘the OTC derivatives 

markets currently represent a greater risk to our underlying economy than they did before the financial crisis began.’’? Would you 

agree that we are in a position today, as you take a look at the Office of the Comptroller of the Currency’s report at the end of the 

first quarter of this year, that we have such a concentration of this 

activity that we are at greater risk today than a year ago? 

Ms. SCHAPIRO. I don’t know if we are at greater risk than a year 

ago. I think we are still at risk. I think it is a critical reason that 

this legislation has to move forward. We have to bring these markets under regulation. 

Mr. KAGEN. Mr. Gensler. 

Mr. GENSLER. There were four or five questions there. If I might 

address myself to the last question you just raised about concentration, I do think that these markets have become more concentrated. 

We see this in other industries as well: in the drug industry, in the 

auto industry and other industries, the movie industry. But the financial industry is increasingly concentrated. I think it is something appropriate for Congress to take up. And it also influences 

how we look at setting and thinking about position limits as to 

whether markets are better served if at least there is a minimum 

number of participants in a market promoting both competition 

and liquidity. And if it is highly concentrated to three or four or 

even five large financial institutions, they internalize the deal flow, 

they still provide important risk management but they internalize 

it, probably provide less attractive pricing, ultimately margins are 

a little wider, and the system as a whole is more at risk. 

Mr. KAGEN. Well, last week John Damgard from the Futures Industry Association expressed that their organization is against the 

idea of position limits in terms of trading swaps because it might 

push activity offshore and make things more opaque than they are 

today. Would you care to comment on that? 

Mr. GENSLER. I think that it is important for all of us to work 

very closely on the international side. I know that we can only give 

a small part of it to the Commodity Futures Trading Commission, 

but that all of the regulators, and even Congress, reaching out 

internationally, so that we do this in coordination and concert. 

I, though, believe as it relates to the authorities we are talking 

about for over-the-counter derivatives or even for position limits, 

we still have to foremost protect the American public, and that as 

we reach out to our colleagues in Europe and in Asia, that we still 

185

remind ourselves that we have to protect the investors and the 

markets here. 

Mr. KAGEN. Well, let me just in closing express the very sincere 

and earnest concerns of the people of Wisconsin that I represent, 

that one of the reasons that they have a lack of confidence, not just 

in the economy but in their government, is our inability to catch 

all the crooks that caused this economic mess. We haven’t cleaned 

it up yet, we are still at the systemic risk, and we haven’t yet finished our job here in Congress about rewriting the legislation to 

help prevent it from happening ever again. 

So I will end by asking you to respond in writing as to how successful the Administration has been thus far at catching the crooks, 

and the rest of it I will leave up to us here to rewrite the legislation. I yield back my time. 

The CHAIRMAN. I thank the gentleman. The gentleman from Oregon, Mr. Schrader. 

Mr. SCHRADER. Thank you, Mr. Chairman. I guess I am not as 

optimistic as most people here that we are going to be curing the 

problem. All the certified smart people prior to 2007 felt it was 

wise not to regulate swaps and stuff on the market, and we got rid 

of Glass-Steagall a few years before that. I think we are destined 

to repeat, unfortunately, the errors of the past. And I am a little 

concerned when I hear that liquidity is going to actually increase 

as a result of this legislation, when I argue respectfully we have 

way too much liquidity. And people began to think that risk itself 

was going to be solving its own problem just by spreading the burden around. 

So, we all should be thoughtful about where we are going to end 

up here. We can do a few things that make sense, trying to ensure 

the individual out there that doesn’t understand this, much like 

me, that there is some increased scrutiny going on. 

And the too-big-to-fail comments, I would associate myself with 

Representative Kagen. I guess I am mostly interested in how do we 

gauge whatever we come up with at the end of the day is actually 

performing correctly? What are our performance outcomes, short of 

failure or avoiding the failure; because we didn’t have a failure in 

5 years, therefore our regulations are perfect. How do we know, 

going forward? What are the outcomes you are envisioning? 

And I am not talking about just auditing more companies and 

clearing more trades, that sort of thing. How is the CFTC and the 

SEC going to report back to Congress and the American citizens 

that we are meeting our benchmarks, do we have certain benchmarks that even people back home would understand? How are we 

going to monitor success here? 

Mr. GENSLER. I think that is an excellent question. I think that 

for your constituents in Oregon that it is important that those who 

want to manage their risk or hedge their risk have transparent 

markets in which they can do that. And liquidity is part of that, 

but that they can actually, whether it is a small municipality or 

a company of some size, can see that and not—so spreads or the 

price they pay and the costs they pay would come down. That that 

is available risk management for them is key. 

I think as a nation it is that these large financial institutions are 

really setting aside capital for the risks that they are taking on in 

186

these marketplaces, and that we are able as regulators to police 

against the fraud manipulation, which is inevitable given human 

nature, that we can police against that effectively. 

Ms. SCHAPIRO. I would agree with all that and add just a couple 

of things. I think we will also be able to measure success if we can 

see that hedgers who have legitimate reasons to be in these markets have access to the markets on a free and competitive basis, 

that they are not being held to monopoly rents or put at a disadvantage by dealers. That the risk is well managed in dealers, 

which we should be able to determine through examination and 

oversight programs to understand exactly where the risks are; how 

they are managing them; and that the public has information 

about currently quite opaque markets and what the potential is in 

those markets for something to go wrong and to be able to see what 

the implications of a problem would be. 

So, it is a great question and we should think more carefully 

about it and come back to Congress with a report if this legislation 

is passed that explains exactly why we think it is or is not a success. 

Mr. SCHRADER. If I may, I just would urge that we have a set 

of performance measures included in whatever legislation goes forward so we can actually track what is going on and monitor the 

monitorees, if you will, or the regulators, to make sure we feel comfortable things are going on correctly. 

I yield back my time. 

The CHAIRMAN. I thank the gentleman. And I apologize, Mrs. 

Lummis. You were being locked out. Mr. Thompson has got wide 

shoulders and must have been a fullback or defensive tackle in his 

younger days. 

Mr. THOMPSON. Lineman. 

The CHAIRMAN. A lineman? So I apologize. 

Mrs. LUMMIS. That is quite all right, Mr. Chairman. 

Chairman Gensler, thanks for being here. I am from Wyoming so 

I come from an energy producing state. And like Mr. Schrader and 

Mr. Kagen, I have heard from my constituents. And both large and 

small energy producers in Wyoming are concerned about noncash 

collateral and the fact that it is an essential tool to them for legitimate hedging in the over-the-counter market. 

So my question is, how will restrictions on noncash collateral affect the energy company’s ability to manage financial risk? 

Mr. GENSLER. I, like you, have met with a lot of energy companies in these last 5 weeks, and I think that we can achieve both 

goals. We can bring this market onto exchanges and clearing, while 

at the same time allowing these energy companies to continue to 

actively use these risk management contracts. And what they have 

asked is, would they have to post cash collateral? And I think that 

we can have them set up clearing arrangements with the dealers 

where they could enter into other arrangements, noncash collateral 

as you said, to assure that they could meet needs if they run into 

bankruptcy but, short of that, that they can use their cash to drill 

more oil wells and so forth. 

Mrs. LUMMIS. That is exactly the concern they have, so thank 

you for that. 

187

My next question is for both of you. I know you have talked optimistically about harmonizing rulemaking, and that is a tough thing 

to do. It is easier in dialogue than in practice. Then we throw in, 

according to the Administration’s proposal, the Federal Reserve 

into the regulatory mix. Can you tell me how the Federal Reserve 

fits in this regulatory puzzle? 

Ms. SCHAPIRO. I think with respect to rulemaking, the Treasury 

steps in as the tie-breaker to the extent that the SEC and the 

CFTC are not able to conduct joint rulemaking—tell me if I am 

wrong—within specified time periods. I have some concern about 

that approach as an independent agency. 

Let me step back and say that I do think that while the harmonization and the joint rulemaking that is required under the statute 

by the SEC and the CFTC is not an insignificant task. There are 

at least a dozen areas where we have to engage in joint rulemaking 

from the definition of terms or business conduct standards, back office standards, dealer regulation, and so forth. And it will take an 

enormous amount of effort from the staffs of both agencies. 

But then the statute does provide for this tie-breaker—which I 

find, as an independent agency, to be a little bit of a concern—and 

creates the opportunity for industry or others who don’t like either 

the CFTC or the SEC’s approach on dual rulemaking to just go up 

to the next level and have the not yet tie broken. So I am a little 

bit concerned about that. 

We might offer as an alternative a provision that was actually 

in Gramm-Leach-Bliley that would allow either agency to petition 

the Court of Appeals for an expedited process where there was a 

breakdown between the two agencies, for example, in determining 

how particular rules should be made going forward. 

Mr. GENSLER. I am going to focus on one other piece because it 

is at the core of your question as well, is with regard to clearing. 

I think that since President Roosevelt and Congress laid out these 

two agencies, and our predecessors, that market regulators have 

overseen exchanges, clearing, customer protection, investor protection and that has worked fairly well. It is not without—it is not 

perfect but it has worked fairly well over these decades. And that 

as we enter into this new area of over-the-counter derivatives, 

clearing and exchanges, we should borrow from that model, and the 

SEC and CFTC, working with Congress, should find a way that we 

oversee both clearing and exchanges for this new area. 

And if we have joint rulemaking, which is going to be a challenge—Chairman Schapiro and I have a great relationship and it 

is working very well, but there will be other Chairmen after us, of 

course, that you have to consider. But it should be the SEC and 

CFTC that oversees market functions like clearing and exchanges. 

Mrs. LUMMIS. And I have one more question, Mr. Chairman. 

There was testimony last week from Terrence Duffy of the CME 

Group. And he argued that the best approach to harmonizing is to 

have the CFTC regulate products that are primarily commodities 

and the SEC regulate products that are primarily securities. 

In situations where neither securities nor commodities are primary, the firm could pick their regulator. His concern—and I share 

it—is that over-regulation on the commodity side will simply drive 

investors to more favorable regimes, and those were his words. 

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Do you share Mr. Duffy’s concern and what do you think about 

his suggestions regarding harmonizing? 

Mr. GENSLER. I think that our two agencies need to do a far better job where we have joint oversight. And certainly Mr. Duffy’s exchange is sometimes seen where we have some jointness that we 

could do better. 

I think with regard to the underlying theme, the Treasury has 

proposed joint rulemaking which will be a challenge, but an alternative would be where there is primarily an interest rate swap, or 

a currency swap, or commodity, or broad-based security swap, that 

you would have the CFTC take a lead, and where it was primarily 

the individual underlying security or narrow-based swap, the SEC. 

What we have proposed with the Administration right now is 

more joint rulemaking than maybe you have quoted the witness 

from last week suggesting. So the two alternatives would be that 

we do a lot of joint rulemaking, as we have proposed, or we narrow 

that joint rulemaking, and then you have a way to say, well, this 

agency takes the lead on these and this agency takes the lead on 

that. 

Mrs. LUMMIS. Okay. Thanks. 

Ms. SCHAPIRO. I would just add, I think we have some concerns 

with how you would determine what the primary component is of 

a mixed swap. And so, if that is the direction the Congress takes, 

we would have a lot of work to do to try to figure out what that 

primary component is and whether or not it changes on a daily or 

weekly basis and are we flipping jurisdiction back and forth. I 

think there are some mechanical issues to that approach, which I 

believe is why the Administration went with the concurrent jurisdiction for the mixed products. 

Mrs. LUMMIS. Thank you both. 

The CHAIRMAN. I thank the gentlelady. The gentlelady from 

Pennsylvania, Mrs. Dahlkemper. 

Mrs. DAHLKEMPER. Thank you, Mr. Chairman. 

Chairman Gensler and Chairman Schapiro, as we look at regulating systemic risk, how do you define systemic risk, and how 

much of this risk can we reasonably regulate out of the financial 

system without providing disincentives for risk management? 

Ms. SCHAPIRO. Well, that is a great question. I think it is a little 

of ‘‘you know it when you see it’’ kind of a calculation. But certainly 

the attributes of systemic risk regulation or systemic risk are obviously the ability of an institution to bring down other institutions, 

severely disrupt the financial markets, severely disrupt the economy, shut down the credit markets, or disrupt the orderly trading 

of securities and commodities. 

So I think it is a necessarily elastic and flexible term when we 

talk about systemic risk. But we mean activities or institutions 

that have the potential to harm the broader financial services and 

broader financial markets, and not just that single institution. So 

not just that bank, not just that broker-dealer, but the activities 

that have the potential to span across the financial markets and 

impact more broadly on the economy. 

Mrs. DAHLKEMPER. Mr. Gensler. 

Mr. GENSLER. I was just going to add, when Congress amended 

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thority over clearing organizations and the like, this is now about 

8 or 9 years ago, Congress also inserted in our statute part of our 

mission that the Commodity Futures Trading Commission, I believe is—I can’t remember the exact words, that is why I asked my 

General Counsel—but to protect against systemic risk. I mean that 

was one of the features that I am glad to have the right staff here. 

Mrs. DAHLKEMPER. Good staff is important. 

Mr. GENSLER. It is really important. In fact I want to thank the 

Chairman and the whole Committee for allowing me to have John 

Riley, speaking of good staff. But that one of the missions of the 

CFTC and the subject of this Act is the avoidance of systemic risk. 

Now, I think that we take that to heart every day as our oversight 

of clearing organizations. The futures commission merchants that 

we oversee generally are also overseen by others, and there is a 

focus on that, in that regard, more broadly. 

Mrs. DAHLKEMPER. I did want to, kind of switching back actually 

to Mr. Kagen, and this is to you, Chairman Schapiro. The recent 

SEC Inspector General report regarding the Madoff case did not 

really paint a very pretty picture of things at the SEC, and details 

how inexperienced lawyers with little or no industry experience 

were leading investigations into Madoff and missing red flags, that 

it could have been exposed as fraud decades earlier. Obviously 

many of our constituents have been angry watching this unfold 

through the media. 

And I just want to know what is being done to correct this problem with your investigatory and enforcement teams and bringing 

in personnel with more industry knowledge. Where are things at 

so that we can feel more comfortable going forward with the SEC? 

Ms. SCHAPIRO. Absolutely, I would be happy to answer that. And 

I also would point your staff to our website where we have put up 

a very detailed explanation of all the initiatives the agency has undertaken in the last 7 months since I arrived, that are very much 

focused on a response to the problems within the agency that were 

exposed by the failure to prevent the Madoff fraud and to detect 

it early on. 

But you highlighted a couple that are really critical: skills and 

training. We have made an enormous effort in the last 6 months 

to try to recruit new skill sets to the agency, not lawyers, not accountants, but others with experience in trading, financial analysis, 

derivative products, forensic accounting, to have much more current knowledge about new products and new trading practices on 

Wall Street. And we are having tremendous success now in our 

ability to recruit those kind of skill sets to the agency. 

We have also embarked on much more aggressive training programs. I was very surprised when I arrived at the agency to see 

the extent to which training was conducted that, in my view, is not 

nearly sufficient. So we are putting hundreds of people now 

through the Chartered Financial Analyst® program and the association of Certified Fraud Examiners program, as well as bringing 

in people to teach on, again, the latest products, product development and trading strategies. 

We have also reorganized our enforcement department. We have 

brought in new leadership across the agency, including the new enforcement director and new deputy, and the head of our New York 

190

office, and they have taken a very different approach to enforcement. They have eliminated a layer of management, put more 

front-line investigators on the job and moved people into specialized groups that can develop great expertise in particular areas of 

securities law enforcement, and so move more quickly and more effectively, we hope, to find the problems and bring cases. 

And I could talk about this forever. I won’t do that to you and 

take all of your time. But again, on the technology front, we are 

making changes throughout the organization, and those are, as I 

said, all posted on SEC.gov.

Mrs. DAHLKEMPER. I appreciate that. And I will go on the Web 

site and read all of that. Thank you very much. I yield back my 

time. 

The CHAIRMAN. I thank the gentlelady. The gentleman from 

North Dakota, Mr. Pomeroy. 

Mr. POMEROY. I just want to begin, Mr. Chairman, by thanking 

you for this hearing and commend this panel in particular. This is 

more horsepower than I have seen in these respective vital regulatory positions in quite a while, and I believe you are going to play 

critical roles in getting us back on track. It has just been a pleasure to listen to you this morning. 

The question I have is in terms of trying to get our—I am wrestling with how these clearinghouses are going to work with products that so many participants say are not standardized, they are 

uniquely tailored and therefore can’t be measured adequately on an 

exchange. 

Mr. Gensler, you have been collecting information on this since 

I believe June of 2008, your agency. Are you making headway in 

terms of determining the tradeable nature versus the unique characteristic of each swap, and do you have thoughts in that regard? 

Mr. GENSLER. I have anecdotal thoughts, if I might, if I am allowed to share. But I think that each of the markets, from interest 

rates all the way to credit default swaps, have a different proportion that is able to be brought into centralized clearing. And interest rate swaps, actually, there is a group right now, a clearinghouse, that is able to bring almost the entire interest rate swap 

market out to 30 year swaps. They are now working to bring the 

options on those on. 

Whereas in credit default swaps, if I can go to that, 40 percent 

of that market is on indices. That market is fairly standardized. 

The other 60 percent that is on individual credit names is more 

choppy, and some portion of that could be brought in. 

And the energy space, again, I have reached out anecdotally, and 

people have talked about any ratio from, I will say broadly, 50 to 

75 percent, which is probably standardized. Whether it is 50 percent or 80 percent that is standard enough to be brought into a 

clearinghouse, and whether these anecdotes will prove out to be 

correct, the markets benefit and the public benefits to bring that 

in. And even this customized product, somebody wants to hedge a 

risk in your fine state, North Dakota wants to hedge a risk in a 

customized way, they will benefit by being able to see the pricing 

on a real-time basis on something that is fairly similar because 1⁄2

or 2⁄3 of the market, maybe more, will be able to be standardized. 

191

Mr. POMEROY. That makes sense to me, contrary to what we 

heard last week. I believe there is much more that can be done 

here. 

I am interested in your thoughts, Chairman Schapiro, on a council of regulators. I worked as an insurance commissioner at an earlier time in my life, and across the states you would work on issues 

together, you would work with the Association of Insurance Commissioners, but we each had our state capital we were reporting to 

and where we derived our authority. You know, it wasn’t easy, it 

wasn’t pretty. But you can, regulators can work together across jurisdictional lines. 

But on the other hand, I don’t understand how what just happened in our economy happened. I can’t believe the chinks between 

regulators was so large that all of this activity could go virtually 

unnoticed by people with their eye shades or their blinders on. And 

so council regulators, I like the idea, I believe it can work but, boy, 

that certainly is in contrast to what we have seen. Why will it work 

going forward? 

Ms. SCHAPIRO. Well, I think it works in conjunction with a systemic risk regulator. I appreciate the Administration’s view that 

they don’t believe a committee can effectively make decisions in an 

emergency and effectively put aside their particular issues of jurisdiction. So we think that it does make sense to have a systemic 

risk regulator who can pull the trigger, so to speak, when it is necessary. 

We think the council is really important as a counterbalance, because residing too much authority in any single regulator creates 

risks and hazards of its own, particularly if that regulator has multiple responsibilities and may in fact be conflicted in carrying out 

those different responsibilities. So what a council can bring to a 

systemic risk regulator and to each of the functional regulators is 

a broad perspective of the marketplace. Garry may see risks developing in his part of the market that we are not seeing, but that 

may in fact very profoundly affect the securities markets. So the 

mechanism of a council allows us to share that information. The 

same would be true with the bank regulators. 

Mr. POMEROY. I also expect it might allow one regulatory authority to learn from another regulatory authority. An example here is 

brought to the floor this week by legislation introduced by Senator 

Cantwell relative to a standard for proving market manipulation. 

CFTC has a knowing standard, SEC has a knowing or reckless 

standard. Would that be one example of where you might learn 

from one another? 

Ms. SCHAPIRO. That is exactly right. And I would say that even 

in just the 2 days of joint Commission meetings we held for the 

first time ever, I think we walked away knowing so much more 

about how each other approached issues like new product approval, 

position limits, manipulation, insider trading, and came away with 

a lot of ideas about how we could each go back and do things a little bit differently and a little bit better by adopting some of what 

the other had done. 

I don’t mean to sound overly optimistic, but I think there is enormous benefit in it. 

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Mr. GENSLER. And if I might just say, on that very important 

narrower point about our manipulation standard, I do look forward 

to working with this Committee and coming back to you to ask for 

some ways to enhance what we have right now in our statute. It 

might not be exactly what is over at the SEC, because we also police and look out for corners and squeezes and trade practices that 

are a little bit different in the commodities markets and the securities markets, but we do think that there is time now to enhance 

our manipulation standards so we can better police these markets. 

Mr. POMEROY. Thank you. Thank you, Mr. Chairman. 

The CHAIRMAN. I thank the gentleman. The gentleman from New 

York, Mr. Murphy. 

Mr. MURPHY. Thank you, Mr. Chairman. 

In that same vein in terms of harmonization, Chairman 

Schapiro, I was very excited to see in your remarks, your comments 

about some kind of segregation of assets or protection in insolvency, because it was my sense that this was a huge part of what 

snowballed this financial crisis as all of our financial players, investors, and counterparties all ran away. 

Chairman Gensler, do you also agree that we need to really address this issue in the way that Chairman Schapiro does? 

Mr. GENSLER. There are many things that I would like to address here today around over-the-counter derivatives and the regulation of over-the-counter derivatives. I think our financial regulatory system failed, so I would look forward to working with however Congress addresses this issue of the broader regulatory oversight council, systemic regulator, and so forth. My main mission 

and goal here is to work with you and other committees to get the 

over-the-counter derivatives marketplace overseen and regulated 

under whatever structure, super-structure is addressed. 

Mr. MURPHY. Sure. Maybe I wasn’t clear or maybe you were just 

avoiding wanting to get into that. But the question—and I think 

it is very, very important for all the bilateral and potentially customized CFTC transactions out there—is: Is this issue of segregation of accounts or some protection of customer accounts—okay, you 

were talking to staff. I wasn’t sure you knew. 

So Chairman Schapiro commented that she thought that was 

something important. It is something that I don’t think we are 

doing enough of. 

Mr. GENSLER. I apologize. In terms of that I do believe that we 

need to do more on this regard, that customer accounts need, if 

they post margin, need to be properly segregated. It would also require some modest but important modifications to bankruptcy law 

as well. And I believe that we have actually shared with this Committee with the Chairman and Ranking Member, but we can make 

it available broadly to everyone, language to achieve that goal. 

Mr. MURPHY. I just want to reiterate, I think it is incredibly important, from what I hear from all the customers, that that was 

really part of the snowballing. So you testified about it seemed to 

be a little bit different understanding of the margin requirements 

for customers than what we are hearing from the Treasury. And 

I tend to agree that we want to come up with something where the 

customers can work out with their derivatives dealers what their 

issues, with respect to credit need, to be. 

193

What is your sense about—in terms of how we are going to work 

with the Treasury and some of the other agencies on that, because 

it feels like they are pushing a little bit more for harder margin 

requirements for customers, and you are hearing from us that we 

think there needs to be a little more flexibility for end-users. 

Mr. GENSLER. Well, the natural process of Congressional oversight is a good and healthy process. I have evolved on this as well 

over the last few weeks. I think that we can achieve both goals. I 

think we can achieve the goal of bringing all the standard products 

in the clearing, but at the same time allow end-users to have these 

individual credit arrangements with the clearing member. I think 

it would be a loss if we just exempted all of these transactions from 

the requirement of clearing or exempted all of the end-user transactions from the benefits of transparent exchanges or trading platforms. 

Mr. MURPHY. Okay. The last thing I will try to cover, I hear a 

lot, in the draft legislation, us talking about whatever the clearinghouses will take is the definition of standard. I am just curious 

practically how would that work, because if I am the customer I 

don’t want to have to go shop around every clearinghouse and get 

a sign-off that they refused my transaction before I can enter into 

it bilaterally. 

Have we thought through the mechanism for that, because it 

seems like that is a reasonable standard, but one that seems hard 

to implement. 

Mr. GENSLER. Well, I think that it should be very clear and 

transparent what transactions a clearinghouse accepts. It should 

only be a perspective. If you have entered into a trade and nobody 

is accepting it on Tuesday, and then the following Tuesday people 

are, to try to retrospectively grab that transaction would be one approach that would be healthy. 

Mr. MURPHY. That would still mean I have to go talk to all the 

clearinghouses on Tuesday to say that they turned me down. 

Mr. GENSLER. Well, we could do this through rulemaking, but 

that it should be very transparent and obvious which ones they accept. And the dealers would be required to know that, too. 

Ms. SCHAPIRO. I think the dealers are the key here. They have 

to take the responsibility, in my mind, of knowing what products 

have been accepted for clearing and in fact are being cleared, so 

that the end-user isn’t ultimately responsible for trying to figure 

that information out, and, potentially, entering into a customized 

transaction when they could have entered into a standardized 

transaction. I think the burden needs to be on the dealers to do 

that. 

I think the burden also needs to be, frankly, on the SEC and the 

CFTC to ensure that it is widely clear and transparent what is accepted for clearing and what isn’t, and perhaps even deemed so by 

either of the agencies. 

Mr. MURPHY. Okay. I appreciate that. Thank you. 

The CHAIRMAN. I thank the gentleman. The gentleman from Louisiana, Dr. Cassidy. 

Mr. CASSIDY. I am sorry, I had to leave, so it may be that Mr. 

Murphy and even Mr. Peterson’s earlier questions addressed this, 

so I apologize at the outset if it is redundant. But as I think about 

194

this—and you mentioned the benefits of transparency—as I think 

of the smaller end-users, it seems as if those folks are most vulnerable to this process. The smaller end-user is going to need a clearing party to, if you will, loan them the money to ‘‘monitorize,’’ if 

you will, their balance assets or their capital assets, their balance 

due to the capital assets. And I have to think that they are going 

to pay a higher cost for that than a major player, if you will. 

It almost seems like we are erecting barriers for smaller endusers to participate in the market, or at least we are going to end 

up penalizing them financially just by the nature of this. 

Mr. GENSLER. I actually think that an opaque system as we have 

now is the greatest barrier to the small end-user. The large sophisticated hedge fund, they get pretty good pricing out of the dealers 

right now. But the small commercial enterprise—it could be a parish in your state that has to hedge a risk, interest rate risk on a 

municipal bond deal—they generally, they don’t know. They might 

have to go out of the parish, might go out and spend $50,000 or 

$100,000 for a financial consultant so that they can discern what 

that is that those folks up in New York do. 

I think the greatest benefit is for the small user if we can bring 

the bulk of the market into transparent exchanges. 

Mr. CASSIDY. Can I just take off on that? One, thank you for 

knowing they are parishes and not counties. 

Mr. GENSLER. You are welcome. 

Mr. CASSIDY. That said, almost though what you just described 

could be done by transparency and not by requiring them to have, 

if you will, a margin. So we are mixing the two. 

Mr. GENSLER. But the two, you are right, I think the two come 

together, because that small end-user would also benefit, because 

today they already have the cost embedded in these risk management contracts. These derivatives are just a way to insure a risk, 

if I might, if Congressman Pomeroy will allow me to use the word 

‘‘insure,’’ if you insure a risk in these markets. But right now they 

are also an extension of credit. That parish or small company in 

Louisiana is also receiving an extension of credit; they are not 

sending in checks, but even the accountants make them put it on 

their balance sheet. 

Mr. CASSIDY. So this will just make overt which is currently embedded with the——

Mr. GENSLER. That is right, and more transparent as well. Right 

now on natural gas, the largest traders tell me it is probably $0.05 

a million cubic foot. A small utility might be more than that. The 

credit extension is right in that contract. 

Mr. CASSIDY. So just because I am learning from this, if I can 

continue to pick your brain, if you will, I have a letter from a major 

natural gas producer that says that they will, if you will—their collateral is their untapped reserves. Clearly this is something that is 

customized. So walk me through how that would work for them in 

this process. 

Mr. GENSLER. How it would work if it was a—they would enter 

into a derivative risk transfer contract with some financial, usually 

financial dealer. It might be a big multinational oil company as 

well. That dealer, if it was a standard contract, would have to bring 

it to a central clearing party. But that dealer would be allowed, if 

195

Congress went forward with its recommendation, to enter into a 

credit arrangement with that natural gas company where the natural gas company might be posting their gas reserves in the ground 

as security against that transaction, which many of them do. The 

largest natural gas companies do enter into these secured arrangements already. Smaller ones tend to have unsecured lines. 

Mr. CASSIDY. But still, inherently in that, there is going to be an 

increased cost for them, correct. Because if they are doing an overthe-counter now for this company, it is not necessarily embedded 

within their cost of doing business; rather, now what was formerly 

not there is explicitly there. 

Mr. GENSLER. Well, actually, it is there if they are currently 

using their physical assets in the ground and they are posting that, 

then that would not change, that would be similar under this. If 

currently they are not posting any margin or taking it out, it is already priced into the contract. It might be opaque, but it is priced 

into the contract. 

Mr. CASSIDY. Okay. Thank you very much. I yield back. 

The CHAIRMAN. If I could editorialize a little bit. It is my impression that some of the big financial players have sent a bunch of 

these end-users around to talk to you about this. But from what 

I can tell out of this, somebody that doesn’t understand it as much 

as Mr. Gensler does, that this is actually going to cost those big 

guys money and actually save the little guys money. I really think 

that is what is going on here. 

Mr. CASSIDY. If I can respond. Actually, I have not talked to a 

single one. It is just as I read this, I keep on thinking of Frederick 

Hayek who said that bureaucracies set up to regulate corporations 

end up protecting corporations. And it seems what we are doing is 

institutionalizing the fundamental role of these clearing parties as 

central to our entire system. 

The CHAIRMAN. But the thing is when you bring this out into the 

open and when you standardize this or clear it, you actually narrow the spreads. And that is why the big guys are fighting this, 

bottom line, because it is going to cost them money and it is going 

to help people that use it. I mean, that is where this is. I mean, 

that has been at the heart of this whole thing. 

When we went to Europe, this old saw that everybody is going 

to go to Europe if we get too tough, well, what we heard over there 

was the reason they didn’t regulate is they were told that if they 

got too tough, everybody is going to go to the U.S., and it was the 

same people that were telling both sides. So I mean this has been 

going on, and it is part of why we got into this trouble in the first 

place. 

So I am just saying I am with you, I am where you are, and we 

are going to get an outcome that is going to benefit these little 

guys. So just bear with us and we are going to sort through this, 

and I think we will be able to come to an agreement in the end 

and see the big picture. 

So anyway, I apologize for the editorializing. The gentleman from 

Idaho, Mr. Minnick. 

Mr. MINNICK. Thank you, Mr. Chairman. I continue to find it 

highly questionable, and personally disturbing, that both we and 

the Administration are putting you in a position where, with reVerDate 0ct 09 2002 11:29 Nov 04, 2009 Jkt 041481 PO 00000 Frm 00199 Fmt 6601 Sfmt 6601 I:\DOCS\111-29\53020.TXT AGR1 PsN: BRIAN
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spect to indistinguishably identical product we are asking—we are 

giving you joint authority and responsibility to establish regulatory 

oversight, not just of the product, but the dealers, the exchanges, 

and the clearing houses. And I am not particularly comforted by 

the thought that where a product originates originally should be a 

guide as to who should have primacy with respect to establishing 

the derivative regulation. 

I am also not enamored of the thought that it would be for two 

independent agencies, if you can’t agree, and it is absolutely foreseeable that you will not, and even if you can agree, your successors won’t, that it should go, two independent agencies should send 

their disputes to the Treasury, part of the Administration, for resolution. I think that will increase, in the future, with the areas 

where you choose not to agree. 

And I also question Chairman Schapiro’s suggestion that it ought 

to be a judicial body, which is apparently going to lack much expertise and not be current as the resolving authority. 

I am wondering if there might be a better solution in—could we 

ask you to, among yourselves, come up with a Memorandum of Understanding defining who has primacy, at least for some period of 

time, based upon some other criterion of your selection? I am 

thinking capital leverage, margin, collateral, those kinds of things 

that are more generic and unrelated to the character of the underlying security. Could you work out between yourself as to which 

agency would have primacy in establishing underlying resolution of 

these issues so that we could have, you and we, for the future could 

have a road map that would give some indication as to which agency was going to deal with which issues? 

Ms. SCHAPIRO. Let me take a stab at that first. Let me say that 

the reason we suggested the potential process through the Court of 

Appeals is that one existed under prior legislation, under GrahamLeach-Bliley, but only because I think that is a better approach 

than having these elevated to the Treasury Department. 

We would certainly be willing to try to work through, and we 

have MOUs ready under other circumstances, for example, with respect to the existing central counterparties that have been approved and so forth. But we would be more than willing to try to 

work through an MOU that might set out criteria to guide some 

of our decision-making as we go forward. 

I think a joint rulemaking authority, as I have said, will be enormously time-consuming. It will be very difficult; there is no question about that. But where to draw lines, once the decision was 

made not to merge these two agencies, even though they do regulate in some cases nearly indistinguishable products as you said, 

there are a thousand places to draw those lines. And the Administration chose the ones it did, and we think we can work through 

those very effectively with the CFTC. But I don’t want to underestimate for anyone the difficulty of our getting from here to the 

end in that process. 

Mr. GENSLER. I would just add to that, I think that your suggestion is a good suggestion. Congress is the first place actually to 

draw the lines effectively, but by the way, where there is still overlap, the suggestion of having a more explicit Memorandum of UnVerDate 0ct 09 2002 11:29 Nov 04, 2009 Jkt 041481 PO 00000 Frm 00200 Fmt 6601 Sfmt 6601 I:\DOCS\111-29\53020.TXT AGR1 PsN: BRIAN
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derstanding is a good one. There will probably still be some; we 

will narrow the gaps. 

Mr. MINNICK. Well, if we don’t do it for you, I think we are not, 

at least that is not our current disposition, I would feel much more 

comfortable, while we do have two people of your talent and your 

mutual goodwill, if you could work that out among yourselves in 

a way that would provide a template for future regulators. I think 

that would be extremely helpful. 

Mr. GENSLER. I think it is good suggestion. 

Mr. MINNICK. I yield back. 

The CHAIRMAN. I thank the gentleman. 

And Chairman Frank and I have made a commitment to try to 

narrow this gap as much as we can legislatively as we go through 

this process. I think we should settle this here, frankly, but there 

is some question about whether we can do that. There are some 

technicalities. But, I agree with the gentleman, and we are going 

to do everything we can to try to sort this out and not put them 

into conflict because that is not serving anybody well. 

The gentleman from Mississippi, Mr. Childers. 

Mr. CHILDERS. Thank you, Mr. Chairman. 

My questions have pretty much been answered, but I would like 

to say to both of the Chairmen that I certainly appreciate on behalf 

of all of our colleagues here this morning both of you being here. 

To use Congressman Pomeroy’s words, this is a lot of horsepower 

here this morning. Thank you very much for being here. Thank 

you. 

Mr. GENSLER. I thank you for that compliment and Congressman 

Pomeroy’s compliment. I have never been compared to a horse, but 

it is good. Thank you. 

The CHAIRMAN. I thank the gentleman. 

I have a couple more questions here. Both of you question the 

Treasury’s proposal to exclude foreign exchange swaps and forwards from this entire scope of regulation. Treasury argues that 

this exclusion is necessary to preserve the dollar’s position as the 

world’s leading currency. Can you explain Treasury’s argument of 

why you believe this class of derivatives should be regulated? 

Mr. GENSLER. I think as we move forward with Congress, we 

want to make sure that we cover the entire marketplace, and the 

Treasury proposal that was sent up, which we collaborated on, is 

very strong and covers interest rate and currency commodities, equity, credit default swaps. 

What we would want to assure is that any exceptions from that 

are clearly targeted and can’t be used somehow to avoid that oversight of interest rate swaps and currency swaps and the like. And 

this has been a challenge Congress has wrestled with, really, for 

35 years since our agency was set up; how does one sort of exclude 

forwards but cover futures? How do you exclude some aspect of currencies for the reasons that you just mentioned? 

Our concern is that we would not want to evade—be able to have 

market participants evade the oversight of these currency swaps 

and interest rate swaps, and also that retail foreign exchange 

transactions are fully covered. 

Ms. SCHAPIRO. This is not particularly an SEC issue, but recalling my days at the CFTC 15 years ago, while there has been enorVerDate 0ct 09 2002 11:29 Nov 04, 2009 Jkt 041481 PO 00000 Frm 00201 Fmt 6601 Sfmt 6601 I:\DOCS\111-29\53020.TXT AGR1 PsN: BRIAN
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mous change in the regulatory regime since then, the concern 

about retail forex transactions existed then. It exists today, and 

that was the reason we felt very strongly that Chairman Gensler 

has taken the right approach in trying to narrow this exception. 

The CHAIRMAN. At last week’s hearing, we heard testimony concerning the need for greater independence of clearinghouses from 

a single or a group of swap participants. In fact, the Justice Department is looking into whether dealers that have an equity stake 

in the market, which collects price information on credit default 

swaps, have an unfair advantage over other market participants 

relating to CDS price information. If Treasury’s proposal goes forward, do either of you have similar concerns regarding clearinghouse independence? 

Mr. GENSLER. I think it is a very important issue, the governance 

of clearinghouses, as current governance of clearinghouses, but that 

they have open governance and they hear from a wide range of 

membership, that they are not susceptible to control by one community, particularly the dealer community. I think we should have 

clear authority to be able to write rules and oversee those government features. 

Ms. SCHAPIRO. I would agree with that. I think it is critical that 

the governance structure includes a broad range of market participants and users, not just dealers, in order to ensure that the clearinghouses operate in the broadest public interest. I think it is also 

critical, as was said, that there be active Federal oversight of the 

clearinghouses and the government mechanism so that they do provide free and open access. 

The CHAIRMAN. Thank you. 

The gentleman from Georgia, Mr. Marshall. 

Mr. MARSHALL. Thank you, Mr. Chairman. 

In my earlier questioning, Mr. Gensler, I asked if you would be 

willing to maybe get together with the clearing community and 

come up with some concrete models of cost savings or costs, one of 

the two, with regard to clearing end-users, their concerns. You 

have heard their testimony already. So maybe you could just use 

them as examples and then run through a number of different scenarios to give us actual concrete numbers. You have described hidden costs of financing capacity that doesn’t really permit the enduser really to understand the costs that are associated with current 

hedging, and the advantages associated with certainty and price 

discovery and a lot of other things. If you could crank all that in, 

that would be enormously helpful to us, and so I guess my question, will you do that is my question right now, and could you tell 

us how quickly you can do it? 

Mr. GENSLER. I am certainly committed to meeting with the 

clearing members and users. I don’t know how susceptible it is to 

coming down to an analytic, or a specific pennies per million cubic 

foot or basis points for an interest rate swap. But I will certainly 

commit to meet with any community that you think would be appropriate for us to meet with. 

Mr. MARSHALL. Well, I can’t give you guidance on who to meet 

with. It is just this has come up in almost everybody’s questioning. 

It is the thing where we are really getting a lot of pushback, and 

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so it would really help us if you can narrow it a little bit because 

we get these dramatic statements that we won’t be able to hedge. 

The CHAIRMAN. Would the gentleman yield? 

Mr. MARSHALL. Yes. 

The CHAIRMAN. You know, I mean, we have contracts that were 

customized that ended up going to be standardized, and the margins narrowed when that happened. So the best way to do that 

would be to go back and just take some of these examples, because 

you can’t really tell what the market is going to do. But I can tell 

you that a lot of this stuff that has been ginned up around here 

has been by those guys that are on the other side of this. When 

this goes on a clearinghouse or exchange or is made transparent, 

their margins are going to narrow. 

Mr. MARSHALL. That is clear. 

The CHAIRMAN. So, Mr. Gensler, am I right? 

Mr. GENSLER. I couldn’t agree more with the Chairman. We are 

talking about a paradigm shift here. We are saying that, yes, we 

want to lower the risk to the American public. See, we have mutualized this risk right now. The American public bears a lot of risk 

in that crisis that we have lived through. It feels stable right now, 

but we shouldn’t forget, this was a very real crisis that we have 

lived through. And so the American public bears the risk. We are 

trying to take that and push that back into the dealer community 

through more capital, and yes, the end-users would be posting 

some margin on trades. 

Now, what we have recommended here today is that those endusers be able to enter into specific credit arrangements that would 

be less opaque because that is already in these contracts. But I 

agree with the Chairman that there will be some in the financial 

community who would prefer not to have this paradigm shift. 

Mr. MARSHALL. May I just, there is an obvious business opportunity here for folks to provide financing to facilitate this clearing 

process. It doesn’t necessarily have to be the clearing member. It 

could be some other entity that actually is formed specifically for 

this objective. 

But again, I say, these are not abstractions. I mean, fairly obvious things that you are talking about that are advantages to the 

process that is being proposed, and I think the Chairman is absolutely right. A lot of the pushback is because in an opaque world, 

a call-around market, et cetera, you make more fees. 

And so if we can cut back on the transaction fees, obviously it 

is going to benefit the general population that is trying to hedge. 

But if you could just give us some concrete examples, it would be 

great. And I think you can do that. It may be you have to go plus 

or minus, but it would really help us a lot in better understanding 

the numbers here and being able to respond to those who are saying this is really going to put me out of business, the business of 

hedging anyway, to respond, no, it is not; here is probably what is 

going to happen. Tell us why these numbers are wrong. 

Mr. GENSLER. We will do our best to do that, and I agree with 

you that this is at the core of some of this debate right now. So 

we would like to best respond to your question. 

Mr. MARSHALL. Thank you, sir. 

Thank you, Mr. Chairman. 

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The CHAIRMAN. I thank the gentleman. 

Anybody else got anything good? 

With that, we thank you very much, Chairman Gensler and 

Chairman Schapiro, for being with us today, for your patience in 

answering our questions, and we will continue to work on this 

jointly together so we can come up with the right solution for the 

American people at the end of the day, and hopefully sooner rather 

than later. 

Thank you very much. The Committee stands adjourned. 

[Whereupon, at 1:10 p.m., the Committee was adjourned.] 

[Material submitted for inclusion in the record follows:] 

201

SUBMITTED STATEMENT BY INDEPENDENT PETROLEUM ASSOCIATION OF AMERICA

Independent producers drill about 90 percent of American natural gas and oil 

wells, accounting for more than 80 percent of American natural gas and more than 

65 percent of American oil. The Independent Petroleum Association of America 

(‘‘IPAA’’) represents these thousands of independent producers. Many of these producers hedge their production to lessen the volatility in prices to better plan their 

budgets for finding and producing oil and natural gas, and in turn keep employment 

levels stable or growing. As end-users in the derivatives market, independent producers strongly support increased transparency and encourage adequate funding 

and authority for the Commodity Futures Trading Commission to oversee commodity markets and prevent market manipulation. 

However, increased transparency and stronger enforcement do not require that all 

trading be done through regulated exchanges. When producers hedge, they tend to 

rely on the over-the-counter (‘‘OTC’’) market, which enables hedging transactions to 

be customized, primarily to rely on the producers’ natural gas and oil reserves as 

collateral or the producer’s credit standing with its bank. Banks with loans to producers often require producers to hedge their production. The banks often perform 

this service for the producer, using the producers’ natural gas and oil reserves as 

collateral. 

The Treasury Department’s financial reform proposal recognizes the continued importance of the OTC market. Secretary Geithner has testified that ‘‘[d]estroying 

OTC derivates would leave U.S. companies with a terrible choice between either not 

protecting themselves at all against some of their financial risks or partially protecting themselves against financial risk with a standardized derivative and thereby 

damaging their financial statement.’’ IPAA is in complete agreement with the Secretary’s assessment and with the intent to distinguish between end-users and derivative dealers or major market participants. 

Without access to the OTC market, producers would have two choices. Producers 

could attempt to monetize their assets and hedge through an exchange, which would 

consume cash previously reinvested in exploration and production. Or producers 

simply would be unable to afford the exchange hedging requirements and would not 

hedge. This choice would subject producers to pricing uncertainty and the ensuing 

uncertainty to producers’ budgets for exploration, production, and employee salaries. 

How and Why Producers Hedge 

Many energy producers, who own the underlying physical commodities, use hedging as a primary risk-management tool to provide cash-flow certainty. These energy 

producers were not responsible for the recent swings in futures prices. In 2000, 

about 17 percent of independent producers used swaps to manage financial risk. 

That percentage increased dramatically to 41.5 percent in 2007, based on a recent 

IPAA survey, as detailed in its Profile of Independent Producers 2009.

Many independent producers hedge a significant portion of forecasted future natural gas and oil production volumes to reduce revenue risk related to ever-changing 

commodity prices. Wild swings in natural gas and oil prices impede the industry’s 

ability to stabilize revenues and prudently manage cash flow, which is used to fund 

development activities that produce vital energy resources and maximize value for 

stakeholders. For many independent producers, hedging is the primary method of 

ensuring that adequate cash flow is available to meet their financial obligations. 

They also hedge production to provide security to lenders that base producers’ credit 

on the value of their natural gas and oil reserves, reserves that are pledged as collateral on bank loans. Conscientious hedging programs provide significant protection 

for creditors. This protection, in turn, helps provide access to capital for the longterm survival of producers. 

Impact of the Proposed Reforms on Producers 

The Administration’s proposal appears to try to address the concerns described 

above. However, the push for standardized contracts to trade exclusively through 

regulated exchanges creates enormous uncertainty as to what will constitute a 

standardized contract. Equally important is the definition of major swap participant. 

The Administration’s proposed definition of ‘‘major swap participant’’ includes anyone who (1) is not a swap dealer, (2) maintains a ‘‘substantial’’ net position in outstanding derivative contracts, and (3) is not using the contracts to maintain an effective hedge under Generally Accepted Accounting Principles. Uncertainties associated with the second and third components of the definition are likely to undermine 

the deference the Administration appeared to give to end-users. A more clear-cut exemption approach is needed. 

Failure to address this uncertainty could require producers to trade on a regulated exchange where the contrast is stark with current hedging methods. CurVerDate 0ct 09 2002 11:29 Nov 04, 2009 Jkt 041481 PO 00000 Frm 00205 Fmt 6621 Sfmt 6621 I:\DOCS\111-29\53020.TXT AGR1 PsN: BRIAN
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rently, many independent producers hedge exclusively with the high-credit quality 

banks that are participants in their lending groups and hold the mortgages on their 

natural gas and oil properties. This arrangement eliminates the need for posting collateral between the producers and their banks. Producers enter into hedges and 

their banks hold those positions on their books through settlement, at which time 

either producers make a payment to the banks, or banks make a payment to producers, and the position is terminated. Under a broad interpretation of ‘‘standardized derivative contract’’ or ‘‘major swap participant,’’ producers could be prohibited 

from hedging with their banks and forced to trade directly with the exchanges, 

which would require producers to post cash collateral twice daily, based on the 

mark-to-market value of their hedges. 

The requirement to post collateral would effectively preclude the ability of many 

independent producers to hedge production and would imperil their business in 

many ways, leading to the destruction of relationships with stakeholders and harming the American consumers who depend on natural gas and oil products for food, 

shelter, transportation, medicine and other essentials of modern life. The inability 

to hedge would reduce the certainty in producers’ ability to forecast cash flow to 

cover obligations to debt and equity holders, including debt service and dividend 

payments, respectively. 

Furthermore, without the assurance of receiving a certain price for future production, creditors would lower their valuation of natural gas and oil reserves and reduce the amount of capital available to develop production and maintain, as well 

as increase, production volumes to meet consumer demand. Without development 

activities, natural gas and oil production volumes would decline, in some cases very 

rapidly—leading to a supply shortage in the market. The resulting spike in energy 

costs would have a decidedly negative impact on the American economy. 

The Treasury Department’s proposal is encouraging, in that the scope appears to 

address the importance of maintaining end-users’ access to the OTC market. The 

details will determine whether this intent is actually accomplished. We thank the 

Administration and the Members of the Agriculture Committee for their thoughtful 

consideration of how to implement reform without serious unintended consequences. 

Natural gas and oil are both vital components of our nation’s energy supply. In fact, 

as a resource that is clean burning, readily available and abundant in America, it 

would make sense for natural gas to be adopted as a major component of the Administration’s energy policy. America’s independent producers reinvest a majority of 

their free cash flow to supply the country with reliable energy that is vital to our 

nation’s energy security. Hedging through the OTC market helps producers reduce 

risk and plan for long-term viability in a highly capital-intensive business that depends on predictable cash flow and access to capital. 

Suggested Treatment of End-Users 

At the September 17, 2009 hearing, Committee Members engaged panel members 

to provide suggested language to clarify the exemption from mandatory clearing in 

the Treasury Proposal. In response, the American Public Gas Association (‘‘APGA’’) 

submitted a letter to the Committee on September 30, 2009. APGA suggested inclusion of an additional exception, in which mandatory clearing would not apply if ‘‘one 

of the counterparties to the swap is a producer, processor, merchandiser, distributor 

or a manufacturer of, or user of, a commodity and enters the swap to educe or manage risks in connection with the conduct or management of its commercial enterprise.’’

IPAA believes that this type of approach could address some of the end-users’ concerns with efforts to encourage mandatory clearing, such as those contained in 

Treasury’s proposal. IPAA will be giving consideration to this proposal within its 

membership, and encourages the Committee to take APGA’s proposal under serious 

review.

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