U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

For sale by the Superintendent of Documents, U.S. Government Printing Office

Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800

Fax: (202) 512–2104 Mail: Stop IDCC, Washington, DC 20402–0001

52–397 PDF 2009

THE EFFECTIVE REGULATION OF 

THE OVER-THE-COUNTER 

DERIVATIVES MARKET 

HEARING 

BEFORE THE

SUBCOMMITTEE ON CAPITAL MARKETS, 

INSURANCE, AND GOVERNMENT 

SPONSORED ENTERPRISES 

OF THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED ELEVENTH CONGRESS 

FIRST SESSION 

JUNE 9, 2009 

Printed for the use of the Committee on Financial Services 

Serial No. 111–41 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

BARNEY FRANK, Massachusetts, Chairman 

PAUL E. KANJORSKI, Pennsylvania 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

MELISSA L. BEAN, Illinois 

GWEN MOORE, Wisconsin 

PAUL W. HODES, New Hampshire 

KEITH ELLISON, Minnesota 

RON KLEIN, Florida 

CHARLES A. WILSON, Ohio 

ED PERLMUTTER, Colorado 

JOE DONNELLY, Indiana 

BILL FOSTER, Illinois 

ANDRE ́ CARSON, Indiana 

JACKIE SPEIER, California 

TRAVIS CHILDERS, Mississippi 

WALT MINNICK, Idaho 

JOHN ADLER, New Jersey 

MARY JO KILROY, Ohio 

STEVE DRIEHAUS, Ohio 

SUZANNE KOSMAS, Florida 

ALAN GRAYSON, Florida 

JIM HIMES, Connecticut 

GARY PETERS, Michigan 

DAN MAFFEI, New York 

SPENCER BACHUS, Alabama 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RON PAUL, Texas 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, JR., North Carolina 

JUDY BIGGERT, Illinois 

GARY G. MILLER, California 

SHELLEY MOORE CAPITO, West Virginia 

JEB HENSARLING, Texas 

SCOTT GARRETT, New Jersey 

J. GRESHAM BARRETT, South Carolina 

JIM GERLACH, Pennsylvania 

RANDY NEUGEBAUER, Texas 

TOM PRICE, Georgia 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

ADAM PUTNAM, Florida 

MICHELE BACHMANN, Minnesota 

KENNY MARCHANT, Texas 

THADDEUS G. McCOTTER, Michigan 

KEVIN McCARTHY, California 

BILL POSEY, Florida 

LYNN JENKINS, Kansas 

CHRISTOPHER LEE, New York 

ERIK PAULSEN, Minnesota 

LEONARD LANCE, New Jersey 

JEANNE M. ROSLANOWICK, Staff Director and Chief Counsel 

(III) 

SUBCOMMITTEE ON CAPITAL MARKETS, INSURANCE, AND GOVERNMENT SPONSORED

ENTERPRISES

PAUL E. KANJORSKI, Pennsylvania, Chairman 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

NYDIA M. VELA ́ ZQUEZ, New York 

CAROLYN B. MALONEY, New York 

MELISSA L. BEAN, Illinois 

GWEN MOORE, Wisconsin 

PAUL W. HODES, New Hampshire 

RON KLEIN, Florida 

ED PERLMUTTER, Colorado 

JOE DONNELLY, Indiana 

ANDRE ́ CARSON, Indiana 

JACKIE SPEIER, California 

TRAVIS CHILDERS, Mississippi 

CHARLES A. WILSON, Ohio 

BILL FOSTER, Illinois 

WALT MINNICK, Idaho 

JOHN ADLER, New Jersey 

MARY JO KILROY, Ohio 

SUZANNE KOSMAS, Florida 

ALAN GRAYSON, Florida 

JIM HIMES, Connecticut 

GARY PETERS, Michigan 

SCOTT GARRETT, New Jersey 

TOM PRICE, Georgia 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

FRANK D. LUCAS, Oklahoma 

DONALD A. MANZULLO, Illinois 

EDWARD R. ROYCE, California 

JUDY BIGGERT, Illinois 

SHELLEY MOORE CAPITO, West Virginia 

JEB HENSARLING, Texas 

ADAM PUTNAM, Florida 

J. GRESHAM BARRETT, South Carolina 

JIM GERLACH, Pennsylvania 

JOHN CAMPBELL, California 

MICHELE BACHMANN, Minnesota 

THADDEUS G. McCOTTER, Michigan 

RANDY NEUGEBAUER, Texas 

KEVIN McCARTHY, California 

BILL POSEY, Florida 

LYNN JENKINS, Kansas 

(V) 

C O N T E N T S 

Page 

Hearing held on: 

June 9, 2009 ...................................................................................................... 1 

Appendix: 

June 9, 2009 ...................................................................................................... 75 

WITNESSES 

TUESDAY, JUNE 9, 2009 

Callahan, Thomas F., Chief Executive Officer, NYSE Euronext ......................... 52 

Duffy, Terrence A., Executive Chairman, CME Group, Inc. ................................ 54 

Edmonds, Christopher, Chief Executive Officer, International Derivatives 

Clearing Group, LLC ........................................................................................... 56 

Ferreri, Christopher, Managing Director, ICAP ................................................... 21 

Fewer, Donald P., Chief Executive Officer, Standard Credit Group ................... 13 

Johnson, Christian A., Professor, University of Utah School of Law .................. 23 

Murphy, Timothy J., Foreign Currency Risk Manager, 3M ................................. 17 

Pickel, Robert, Chief Executive Officer, International Swaps and Derivatives 

Association (ISDA) ............................................................................................... 15 

Sprecher, Jeffrey S., Chief Executive Officer, IntercontinentalExchange, Inc. .. 57 

Thompson, Don, Managing Director and Associate General Counsel, 

JPMorgan Chase & Co. ....................................................................................... 18 

Thompson, Larry E., Managing Director and General Counsel, The Depository 

Trust & Clearing Corporation (DTCC) ............................................................... 59 

APPENDIX 

Prepared statements: 

Kanjorski, Hon. Paul E. ................................................................................... 76 

Garrett, Hon. Scott ........................................................................................... 78 

Callahan, Thomas F. ........................................................................................ 81 

Culp, Christopher L. ........................................................................................ 86 

Duffy, Terrence A. ............................................................................................ 132 

Edmonds, Christopher ..................................................................................... 139 

Ferreri, Christopher ......................................................................................... 147 

Fewer, Donald P. .............................................................................................. 156 

Johnson, Christian A. ....................................................................................... 161 

Murphy, Timothy J. .......................................................................................... 171 

Pickel, Robert .................................................................................................... 176 

Sprecher, Jeffrey S. .......................................................................................... 182 

Thompson, Don ................................................................................................. 189 

Thompson, Larry E. ......................................................................................... 195 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Adler, Hon. John: 

Written responses to questions submitted to Don Thompson ...................... 202 

(1) 

THE EFFECTIVE REGULATION OF 

THE OVER-THE-COUNTER 

DERIVATIVES MARKET 

Tuesday, June 9, 2009 

U.S. HOUSE OF REPRESENTATIVES, 

SUBCOMMITTEE ON CAPITAL MARKETS, 

INSURANCE, AND GOVERNMENT

SPONSORED ENTERPRISES, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The subcommittee met, pursuant to notice, at 10:40 a.m., in room 

2128, Rayburn House Office Building, Hon. Paul E. Kanjorski 

[chairman of the subcommittee] presiding. 

Members present: Representatives Kanjorski, Ackerman, Sherman, Baca, Lynch, Miller of North Carolina, Scott, Maloney, Bean, 

Klein, Perlmutter, Donnelly, Carson, Speier, Foster, Minnick, 

Adler, Kosmas, Himes; Garrett, Price, Castle, Lucas, Manzullo, 

Royce, Biggert, Hensarling, Bachmann, Neugebauer, McCarthy of 

California and Jenkins. 

Ex officio present: Representative Bachus. 

Also present: Representatives Waters, McMahon, and Lance. 

Chairman KANJORSKI. This hearing of the Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises 

will come to order. Pursuant to committee rules, each side will 

have 15 minutes for opening statements. Without objection, all 

members’ opening statements will be made a part of the record. 

I want to recognize and welcome Ms. Waters, a member of the 

full committee, participating in today’s subcommittee hearing. And 

I ask unanimous consent that Mr. McMahon be allowed to participate in today’s hearing. Without objection, it is so ordered. 

Today, we meet to consider another area of our capital markets 

woefully lacking in effective regulatory oversight, over-the-counter 

derivatives. Within less than 3 decades, over-the-counter derivatives have become a staggering $500 trillion market in notional 

value. This market also has the potential to cause considerable 

harm. Last year, AIG infamously came crashing down because its 

lightly-regulated Financial Products Unit engaged in credit default 

swaps in the over-the-counter markets without holding sufficient 

capital to hedge the risks. 

Since at least 1994, I have advocated for increased regulation of 

our derivatives markets. That year, I helped introduce the Derivatives Safety and Soundness Supervision Act, which sought to enVerDate Nov 24 2008 18:16 Nov 06, 2009 Jkt 052397 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 K:\DOCS\52397.TXT TERRIE
2 

hance the supervision of derivatives activities of financial institutions. 

In the years since then, I have backed other bills aimed at improving transparency in, and enhancing the oversight of, our derivative markets. While it has taken than I would have liked, I am 

pleased that we are now finally beginning to approach a consensus 

on these matters. The ongoing financial crisis has made it apparent 

to nearly everyone that we must move the over-the-counter derivatives market from one that takes place under the table to one that 

happens out in the open. In short, the time for common-sense regulation of this vast industry has arrived. 

In a letter to Congress last month, the Treasury Secretary outlined his regulatory proposals for increasing transparency and efficiency in the derivatives markets, reducing risks in the overall financial system and preventing market manipulation. I look forward to seeing the Administration’s legislative language, fleshing 

out its general principles in the very near future. 

While the Agriculture Committee is showing considerable interest, it is also important that our panel educate itself and act on 

these matters. The Administration’s outline recognizes this reality. 

Together, I believe that both committees can take action to implement the broad concepts contained in the Treasury Secretary’s 

plan. Moreover, we ought to move swiftly, yet deliberatively, on 

these matters in order to improve flagging investor confidence. 

As we move forward, we should remember that derivatives contracts are highly varied. Importantly, certain derivatives take the 

form of customized contracts that non-financial businesses employ 

to manage risks. By most estimates, more than 90 percent of Fortune 500 companies use over-the-counter, as do thousands of smaller businesses. Clearly, some of these customized contracts cannot 

easily fit within a mandatory clearing or exchange trading regime. 

We therefore must find a delicate balance. Subjecting all contracts 

to mandatory exchange trading may cast too wide a net. Yet the 

clearing of most products, not all, through a central clearing entity 

seems appropriate and should not impose an undue burden on the 

affected parties. 

However, carving out too many exemptions as we tackle regulatory reform could create widespread economic harm in the long 

term. At the same time, we cannot avoid the realization that products with unique features may require different treatment under 

whatever regulatory structure becomes adopted. 

At this point, I believe that the standardization of contracts 

where possible will produce smoother clearing and clearing both 

opens a window through which regulators and market participants 

can keep a closer eye on the dark corner of the market and reduces 

the risks posed through the contracts collectively. 

The debate about the extent to which clearing becomes required 

is of particular importance today. Even where clearing of contracts 

proves unfeasible, transparency can exist. By mandating the collection of relevant data in a repository, we can help to ensure that 

regulators maintain access to useful trading information and perhaps detect warning signs of systemically risky transactions. 

3 

Electronic trading also increases transparency. Further, electronic execution streamlines trading, minimizes mistakes, and enhances monitoring of the over-the-counter derivatives markets. 

In sum, we have assembled a number of parties interested in, 

and affected by, the actions Congress will take in the months 

ahead. As we consider legislation to regulate in this field, their testimony can help guide us toward achieving the appropriate balance 

as we impose a sense of order in what until now has truly been 

the wild west of the financial services world. 

I would like to recognize the ranking member, Mr. Garrett, for 

4 minutes for his opening statement. Mr. Garrett? 

Mr. GARRETT. Thank you, Mr. Chairman. Good morning to all 

the witnesses. Today’s hearing is called, ‘‘The Effective Regulation 

of the Over-the-Counter Derivatives Market.’’ I think it is important to keep in mind that it is not called, ‘‘The Most Politically Correct Sounding Regulation of Derivatives,’’ nor is it called, ‘‘Let’s 

Regulate the Heck Out of the Derivatives Market Because They 

Have Been Demonized and Let’s Ignore All the Positive Contributions They Make to Our Capital Markets Under Proper Management.’’ 

Unfortunately, with some of the regulatory proposals that have 

come forward in this area, you might think that is the approach 

that is going to be taken. 

Here are the facts: 94 percent of the 500 largest global companies 

use derivatives to manage risks. Congress therefore needs to tread 

carefully as it looks at regulatory options for these markets. Overly-regulated or improper regulations that might sound good politically could have major unintended negative consequences, not just 

for our financial markets but for our broader economy as well. 

Rather than reducing risk, poor regulatory reform could actually 

exacerbate it, so before we go any further, it is important to remember that derivatives did not cause our financial difficulties. In 

fact, they should be seen more as symptoms of the underlying crisis, rather than a reason for it. 

So while our overall financial service regulatory structure can be 

improved, it is important to preserve and protect the important 

benefits that they provide. Derivatives products provide firms with 

the ability to minimize risks. This obviously benefits individual 

firms but also benefits the broader market as well. 

For example, as Members of Congress consider reform proposals, 

we must not be overwhelmed by the fact that one high profile financial institution, AIG, made a bad investment decision. We must 

also keep in mind that this occurred while AIG was under the supervision of its regulator, the Office of Thrift Supervision, and was 

part of broader regulations as well. So greater expertise then in 

some cases is clearly required at the functional regulator level for 

the derivative dealers, but AIG was, as you know, a regulated entity. And the AIG case is a reminder that regulatory failure contributed to our financial crisis as much as anything else did. 

Furthermore, the vast majority of exposures in the CDS market, 

for instance, is contained within the already overly-regulated banking sector. Arguably, everything is in place already for regulators 

to appropriately regulate the bulk of this market and it is dominated by a small number of dealers. Regulators then already have 

4 

oversight responsibilities to ensure firms are taking appropriate 

risks and to set proper capital levels. So the power is there; regulators just need to do their job. 

Now, when there have been credit events, and there have been 

a number of them, with the Lehman failure being the most significant, in each case, the event has been handled in a very orderly 

fashion by the existing infrastructure. Now, as I look at some of the 

particular regulatory ideas that have been put forward, I am persuaded that essential counterparties and a clearinghouse hold 

promise, but I am hesitant to say that as far as they go, that they 

should be mandatory for all standardized products. 

The private sector has made significant progress in a relatively 

short period of time toward providing multiple clearinghouses for 

various derivative products, and I think we should look at this further. Inappropriate mandating of central clearinghouses will limit 

that ability to go further and manage risks. 

Another area I would like to look at is the proposal of the socalled ‘‘naked’’ swaps. It is concerning to me. It is important that 

legislators understand that significant negative consequences will 

arise if such a proposal is actually enacted. So the participants and 

infrastructure provided in the OTC markets have accomplished 

much in recent years to provide stability from the ISDA master 

agreement, to the recent so-called ‘‘big bang protocol,’’ to ongoing 

efforts to provide a more robust infrastructure for these products. 

So, in conclusion, I look forward to continued progress being 

made in regards to greater coordination between the sell side and 

the buy side participants as private sector efforts progress to increase efficiency and transparency and reduce the risk in the OTC 

derivative business. 

And, finally, as Congress pushes forward with further regulation 

in these markets, we need to guard against unnecessary, overly 

burdensome regulations that might cause the markets to move 

elsewhere, overseas, or would hinder or prohibit firms from providing themselves with superior risk management techniques that 

are so widely employed today and that could be enhanced by future 

innovation. 

Thank you, Mr. Chairman. 

Chairman KANJORSKI. Thank you, Ranking Member Garrett. We 

now have 3 minutes for the gentleman from New York, Mr. Ackerman. 

Mr. ACKERMAN. Thank you, Mr. Chairman. Today’s hearing is 

meant to focus on proposals for regulating over-the-counter derivative products, such as credit default swaps, but in this economy, 

with this market, and with our current fractured regulatory regime, we would be naive to consider proposals for regulating and 

clearing OTC products without also establishing a regulator to protect our markets against systemic risks. 

During previous hearings held by both this subcommittee and 

the full Financial Services Committee, several of our witnesses and 

a number of our colleagues remarked that systemic risk is a lot like 

pornography in that while difficult to define, you know it when you 

see it. In my view of the two, systemic risk is actually the more 

difficult to identify. At least with pornography, you have a general 

5 

idea of what it is you are looking for. I do not know what that 

means; somebody wrote that for me. 

[laughter] 

Mr. ACKERMAN. If we could step into our time machines and go 

back in time before the near collapse of AIG, I have little doubt 

that we would have near unanimous support for regulating credit 

default swaps. But of course we cannot go back in time, we cannot 

stop AIG from overextending itself, and the next crisis will not 

stem from AIG’s credit default swap portfolio. 

Our financial regulatory structure is like a tattered quilt made 

up of dozen of patches, each representing a State and Federal supervisor, agency, some patches overlapping, and we now know 

some areas completely bare. Preventing the next crisis will require 

more than simply sewing yet another patch onto the quilt. 

Regardless of how meritorious the proposals to regulate and clear 

out these derivatives may be, we need a regulator with the ability 

to see the complete picture, not just the OTC derivatives market, 

not just the exchanges, not just the banking system, but all of it. 

We need a regulator who has the ability to see trends in the OTC 

derivative markets that independently might not be worrisome but 

when paired with information pertaining to the reserves of our 

banks could be cause for concern. And we need the regulator to 

have the ability to act appropriately and expeditiously to address 

systemic risk. And so in my view merely granting the SEC or the 

CFDC the authority to regulate and to clear out these products is 

near-sighted and inadequate. If we are to learn from this financial 

crisis, any legislation that seeks to regulate OTC products must be 

paired with a systemic risk regulator. 

I thank you and I yield back the balance of my time. 

Chairman KANJORSKI. Thank you very much, Mr. Ackerman. We 

will now hear from the ranking member of the full committee, Mr. 

Spencer Bachus, for 3 minutes. 

Mr. BACHUS. Thank you, Mr. Chairman. Mr. Chairman, I would 

like to associate myself with the remarks by the subcommittee 

Chair. Derivatives do help companies manage risk, and I think 

they are a very valuable thing. Of course, the derivative market is 

valued notionally at $684 trillion, which is a tremendous amount. 

And the rapid growth of this market, coupled with the potential for 

widespread credit defaults and operational problems in the overthe-counter market have led many to conclude that derivatives 

pose a substantial systemic risks. Therefore, the Treasury released 

a comprehensive framework for over-the-counter derivatives. In 

that, they call for financial derivatives suitable for clearing by a 

federally regulated central counterparty to be placed on registered 

exchanges. 

I personally believe that most derivatives, if they are not too 

highly customized, should be placed in a clearinghouse situation. It 

helps you identify risk and define risk. And I think from talking 

to most financial institutions, they know what their risk is between 

two parties but they sometimes do not know what the party they 

are dealing with, what their risk with a third party is, and I think 

that is one of the values of a clearinghouse. You not only have to 

know what your exposure to each other is, but sometimes what the 

exposure they have to a third party. 

6 

The idea I think the Treasury has proposed is really an over-simplification of the use of an exchange and simultaneously may give 

unsophisticated retail investors a false comfort that their products 

are now safe for purchase because they have somehow been approved for exchange trading by a government agency. 

Furthermore, in testimony before the committee in March, the 

GAO pointed out that some credit default swaps may be too complex or they would be highly tailored even for a clearing, and therefore placing them on an exchange to me would be almost impossible. And it is in those highly complex derivatives that we are 

going to particularly have a problem. 

As we move forward with regulatory reform proposals, we should 

make every effort to strike the right balance between protecting investors and preserving innovation. I think that is where Mr. Garrett and I really agree, that there are already private sector initiatives well underway to clear a standardized derivative contract. A 

part of that is a response to what we have seen in the last year 

or two. Some of what we have seen I do not think will take place 

again because the parties are demanding that. And I think that 

these are efforts to remind us that market-based solutions are capable of generating the information that investors and companies 

need to make informed decisions. The last thing Congress should 

do is prevent new entrance into the derivatives clearing marketplace. 

In closing, Mr. Chairman, any ban on over-the-counter derivatives would likely harm responsible and well-managed U.S. corporations that use derivatives to hedge against business risks. Restrictions on credit default swap contracts will also limit the ability 

of investors to appropriately calculate risks as it has become apparent that CDS spreads have become a more accurate reflection of 

credit risk than even credit ratings. And that is one thing that we 

have learned in all this is that credit rating agencies were way behind what we were seeing on some of the credit spreads themselves. 

I appreciate our witnesses testifying. I have some of your testimony and I look forward to, over the next few days, reading the 

rest of it if I do not hear it. Thank you. 

Chairman KANJORSKI. Thank you very much, Mr. Bachus. And 

now we will hear from the gentleman from Georgia, Mr. Scott, for 

2 minutes. 

Mr. SCOTT. Thank you very much, Mr. Chairman. I want to 

thank you and Ranking Member Garrett for holding this hearing. 

As over-the-counter derivatives have been cause for concern with 

AIG’s near collapse, caused in large part by its portfolio of credit 

default swaps, the American taxpayer now owns most of this company as AIG has access now to nearly $200 billion in taxpayer support. 

I also understand the frustrations with my constituents, and the 

constituents of every one of us on this committee and in Congress, 

that our constituents are feeling as their money continues to go towards propping up Wall Street firms, all the while they are simply 

trying to stay afloat with unemployment numbers rising and people 

continuing to lose their homes. 

7 

However, today, I am interested to hear what the witnesses have 

to say about the varying regulatory proposals to reign in these financial services products. I am looking forward to hearing their 

thoughts on proposals for mandatory clearing of all standardized 

over-the-counter contracts and reporting of trades from non-standardized contracts to a qualified trade information repository. 

Furthermore, as a member of both the Financial Services Committee and the Agriculture Committee, I am interested to hear the 

opinions on legislation that would end the exemptions for swaps 

adopted in the Commodities Futures Modernization Act and assert 

new authority over the over-the-counter derivatives. And I would 

also like to hear their opinions and thoughts on the bill we passed 

in this committee in February, which would requiring clearing for 

all over-the-counter derivatives. 

Our economy continues to be extremely turbulent as weakening 

trends envelops us and the experts predict that the downturn 

might not end any time soon, or at least not until the end of next 

year. So the bottom line with this hearing is we must seriously discuss strengthening regulations, specifically over these over-thecounter derivatives, but I would put in there strengthening them 

but with flexibility so that this system can work with greater 

transparency and effectiveness. 

We must address concerns regarding current regulatory practices 

and how to further restructure them in a way that will provide for 

real reform. 

And, Mr. Chairman, while I have this opportunity, I would also 

like to welcome from Atlanta, Georgia, Mr. Jeffrey Sprecher, who 

is from my area in Atlanta, Georgia, as well as Mr. Price’s area. 

He is the chief executive officer of IntercontinentalExchange, which 

we refer to as ICE, from Atlanta, Georgia. 

Thank you, Mr. Chairman. I look forward to the testimony from 

our distinguished witnesses. 

Chairman KANJORSKI. Thank you, Mr. Scott. Now, we will hear 

from the second gentleman from Georgia, Mr. Price, for 1 minute. 

Mr. PRICE. Thank you, Mr. Chairman, I appreciate it. In a free 

market, over-the-counter derivatives provide an essential function 

by allowing companies to customize the way that they address 

their risks. Many companies have successfully used OTC products 

to help their consumers save money and to create jobs, including 

3M, which is testifying today, as an end user of derivatives. 

A market-based economy allows institutions to succeed and to 

fail. And they fail for a number of reasons: The business takes on 

too much risk; it may be under bad management; or it may have 

an ineffective business model. Despite the fact that credit default 

swaps have come under fire lately because of AIG’s remarkable 

over-exposure, when they are used appropriately, they can be a 

very effective risk management tool. Thus, we need to be extremely 

cautious and careful as we decide how to appropriately regulate derivatives. 

In fact, the market has already begun addressing some of the 

concerns that credit default swaps and OTC derivatives posed. So 

I look forward to hearing from the witnesses about what they are 

doing to make OTC and CDS trades more transparent. 

8 

In the end, however, regulation must not be a one-size-fits-all 

system. Such a system stifles innovation, raises prices for consumers, punishes entrepreneurs, and destroys jobs. 

Thank you, Mr. Chairman. 

Chairman KANJORSKI. Thank you, Mr. Price. Now, the gentleman 

from New Jersey, Mr. Adler, for 3 minutes. 

Mr. ADLER. Thank you, Chairman Kanjorski. I want to commend 

you and Ranking Member Garrett for holding this hearing today on 

this important but very, very complicated issue. 

Most people can agree, including the majority of industry participants, that over-the-counter, OTC, derivatives need to be safer. 

However, Congress must be clear that the credit default swaps that 

damaged AIG’s balance sheet made up just a fraction of all OTC 

derivatives. Thousands of American municipalities, companies, and 

financial institutions rely on OTC derivatives to manage risks. Interest rate and equity derivatives allow entities to hedge against 

unexpected losses. It is my hope that our committee strikes the 

right balance between creating a safer process of overseeing derivatives while maintaining the flexibility within the marketplace so 

private and public entities have the ability to manage their interests. 

Standardized derivatives should be required to go through centralized clearing counterparties, but we should not create a process 

where all derivatives are processed through one CCP because it 

may actually increase the risk of bottle-necking the system. 

I hope to hear from our panelists today on how we can best arrive at a definition of derivatives that allows for smarter and more 

effective regulation while not enforcing a blanket, one-size-fits-all 

set of regulations. A standardization of derivatives cannot include 

all financial contracts because many are individually negotiated 

and offer parties the opportunity to balance specific risks in a way 

many other traded products do not. 

Clearly, Congress must prevent future activities from endangering our financial system, similar to what we witnessed with 

AIG, Bear Stearns, and Lehman Brothers last year. We have to implement safeguards to bring greater transparency not only to the 

public but also for our regulators. Marketplace participants have 

already started the process of moving towards greater transparency 

by creating and utilizing large electronic repositories. 

Today’s hearing will provide my colleagues and me with more information on the aggregate data that should be available to interested parties. 

Finally, Mr. Chairman, today our committee should discuss the 

layered jurisdictional issues preventing the efficient and effective 

regulation of OTC derivatives. 

Thank you again for the time. I yield back. 

Chairman KANJORSKI. Thank you, Mr. Adler. And now we will 

hear from the gentleman from Oklahoma, Mr. Lucas, for 1 minute. 

Mr. LUCAS. Thank you, Mr. Chairman, and Ranking Member 

Garrett, for holding today’s hearing. Serving on this committee, as 

well as being the current ranking member on the House Agriculture Committee, I have had the opportunity to examine the various issues surrounding the role derivatives have played in the current financial crisis and have worked to respond to the need for 

9 

more effective regulation. While better transparency and disclosure 

are needed within the industry, we must make sure that we create 

responsible legislation that does not impede appropriate legislation 

and risk management within the marketplace. 

Additionally, I believe we must work to ensure that the CFTC 

plays a leading role in appropriately regulating the derivatives and 

commodities market. The House Agriculture Committee recently 

reported a comprehensive bill aimed at addressing these regulatory 

concerns. I am prepared to use that experience to influence the discussion and the actions of this committee. I look forward to striking 

the proper balance as we craft the legislation that gives us that 

regulatory balance we need. 

I yield back, Mr. Chairman. 

Chairman KANJORSKI. Thank you very much, Mr. Lucas. Now, 

we will hear from the gentleman from Massachusetts, Mr. Lynch, 

for 1 minute. 

Mr. LYNCH. Thank you, Mr. Chairman, and thank you for having 

this hearing. I appreciate the witnesses coming forward. 

I get the sense I am in the minority, just from hearing the testimony on this side of the table. I do think that derivatives had a 

lot to do with the impact and the scope of the economic downturn 

that we are currently experiencing. And while I think our job 

should be regulating this industry, I just want to point out that if 

we are trying to set up a regulatory framework to contain some of 

the damage that has been caused, and nobody has mentioned that 

in their testimony, I think we need to give the tools to our regulators to do just that. 

And by allowing part or a significant part of the derivatives market to just go off unregulated, we have seen from our experience 

that is where the money goes. It goes to the unregulated portions 

of the market, the opaque areas of the market. 

We are setting ourselves up to fail. We are not going to regulate 

this, I get the sense of it right now, but we will be back here someday. It is just very unfortunate that we are not taking advantage 

of the, I think, desire in the financial world to really get at this. 

I think we are making a mistake on the part of the taxpayers and 

investors. I think we are making a terrible mistake here, Mr. 

Chairman, in taking a very soft approach. 

I get the sense of who is winning this fight, and I do not think 

it is the American taxpayer. 

I yield back. 

Chairman KANJORSKI. Thank you very much, Mr. Lynch. And 

now we will hear from the gentleman from California, Mr. Royce, 

for 1 minute. 

Mr. ROYCE. Thank you, Mr. Chairman. Certainly there appears 

to be a market consensus forming that highly standardized contracts can and should be sent through a central counterparty. However, I think it is worth noting that a portion of the derivatives 

market is highly customized and tailored to a specific institution, 

covering a specific risk. 

Over time, with calls for greater transparency, market participants will be best equipped to determine which instruments should 

be cleared and which should be traded on an exchange. If Congress 

missteps, we run the risk of driving this market overseas and limVerDate Nov 24 2008 18:16 Nov 06, 2009 Jkt 052397 PO 00000 Frm 00015 Fmt 6633 Sfmt 6633 K:\DOCS\52397.TXT TERRIE
10 

iting the ability of companies to manage risks associated with their 

business practices. 

In the case of AIG, it appears the failure came from a break 

down in counterparty due diligence, not simply the firm’s usage of 

derivatives. Market participants so reliant upon AIG’s triple A 

credit rating failed to see the extent to which AIG was overleveraged and their vast exposure to an eroding U.S. housing market. 

Deciphering this leverage in an opaque market is key. Information 

warehousing of the non-cleared customized trades for transparency 

would logically help in those cases that could not be handled by a 

central clearinghouse. 

Thank you again, Mr. Chairman. 

Chairman KANJORSKI. Thank you very much, Mr. Royce. And 

now we will hear from the gentlemen from California, Mr. Sherman, for 2 minutes. 

Mr. SHERMAN. Thank you. One of the arguments always made 

against regulation is, ‘‘Let the buyer beware.’’ The credit agencies 

were here saying, ‘‘Don’t regulate us, just don’t rely on our rating.’’ 

Now, we are told well, the counterparties should protect themselves. The fact is at best, these derivatives are insurance. At 

worst, they are a bet at the casino. Either way, we do not let you 

sell fire insurance on my house without setting up reserves. And 

that insurance policy on my house is basically for the benefit of my 

bank, you do not want to know how little equity I have in the 

house. 

Yet, you can go to a bank and say we will protect you not from 

Brad’s house burning down, but from the house declining in value, 

and Sherman defaulting on the loan, and it is not insurance, it is 

customized. Or you can sell that as a casino bet and go to somebody who does not hold my mortgage and sell them an insurance 

policy against me not paying my mortgage. Either way, there ought 

to be reserves. Anything else means you can sell an unlimited 

quantity and ultimately we are told, ‘‘Well, this is just a private 

market decision.’’ Tell that to the taxpayers who have bailed out 

AIG. 

And if this business goes overseas, there will always be an unregulated casino where you go and you put your money down on 

number 24 and you win and the bank does not pay off. Fine, let 

that casino be offshore. Let some other government have to bail out 

the next AIG. Let us not be told that the present system is fine 

so long as the taxpayers write the check. 

I yield back. 

Chairman KANJORSKI. Thank you very much, Mr. Sherman. And 

now we will hear from the gentlelady from Illinois, Mrs. Biggert, 

for 1 minute. 

Mrs. BIGGERT. Thank you, Mr. Chairman. To justify a curfew, 

some parents stated to their teenagers, ‘‘Nothing good ever happens after midnight.’’ I would argue that a similar adage holds true 

when it comes to elements of the derivative market. This is especially true of those riskier trades of credit default swaps and overthe-counter derivatives that were conducted in a kind of darkness 

and contributed to the collapse of major financial services companies and contributed to our current financial crisis. 

11 

I look forward to hearing suggestions regarding the increased 

capital rate requirements, centralized clearing and price discovery 

as part of the discussions of how to better manage risks within the 

market place. This could only lead to more robust competition, restored investor confidence, and healthier markets. 

At the same time, I think Congress must aim first to do no harm. 

While legislating, we must be careful not to sacrifice market efficiency and liquidity in the name of more transparent markets or 

to simply meet a goal of reducing omissions. The Waxman-Markey 

bill gives financial regulatory authority to the wrong regulator, 

over-restricts trading, and imposes a new futures transaction tax. 

A new tax adds to the cost of future transactions, which threaten 

the vitality of U.S. futures markets, especially those in Chicago and 

all who depend on them. 

We must strike the right balance. And with that, I look forward 

to hearing from our witnesses, especially my constituent, Mr. 

Duffy, who is the executive chairman of the CME Group. 

I yield back. 

Chairman KANJORSKI. Thank you, Mrs. Biggert. The gentleman 

from Texas, Mr. Hensarling, for 1 minute. 

Mr. HENSARLING. Thank you, Mr. Chairman. I appreciate the 

title of the hearing, dealing with ‘‘effective regulation’’ because I 

think there is a very big difference between effective and ineffective. 

Effective regulation helps make markets more competitive and 

transparent, empowers consumers with effective disclosure to make 

rational decisions, effectively polices markets for fraud, and reduces 

systemic risk. Ineffective regulation though can hamper competition, create moral hazards, stifle innovation, and diminish the role 

of personal responsibility within our economy. 

Now, with respect to more regulation of the OTC derivatives 

market, I come into this hearing with an open mind but not an 

empty mind. I remember that regulators and legislators do not always get it right, witness Fannie Mae and Freddie Mac; witness 

the credit rating agency oligopoly, and let us also remember that 

the former director of OTS said they had the tools to prevent AIG’s 

position in the CDS and simply did not exercise it. 

Now, perhaps we should look to more enlightened risk assessment for tools for regulators, appropriate capital standards and 

with respect to our OTC derivatives and current economic turmoil, 

let’s be careful we do not confuse the cause with the symptoms. 

With that, Mr. Chairman, I yield back the balance of my time. 

Chairman KANJORSKI. Thank you very much, Mr. Hensarling. 

And now we will hear from the gentlelady from Minnesota, Mrs. 

Bachmann, for 1 minute. 

Mrs. BACHMANN. Thank you, Mr. Chairman and Mr. Garrett, for 

holding this important meeting today. I am also pleased that the 

committee has invited Mr. Timothy Murphy to speak before us 

today. He is the foreign currency risk manager for 3M Corporation 

to testify about 3M’s use of these financial products. Headquartered 

in St. Paul, Minnesota, it is a hometown company we have been 

proud of for years. They provide 34,000 people with jobs, and more 

than 60 percent of the manufacturing operations are located here 

inside the United States. 

12 

With over 20 years experience in the over-the-counter derivative 

market, Tim presently manages 3M’s currency and commodity risk 

programs, as well as the share re-purchase program. He is personally responsible for the management and execution of the company’s foreign exchange hedging policy, including identifying the 

appropriate exposure estimates to be used as the basis of foreign 

exchange hedging activity and balance sheet hedging. 

Prior to joining 3M, he worked at U.S. Bank for more than 10 

years managing their foreign currency and trading relation with 

corporate mutual fund and banking clients. 

As our committee considers the future of over-the-counter derivatives, we must remember that many United States companies responsibly utilize these financial products to manage their risks and 

limit damage to their balance sheets. We need to ask the question 

of those before us today: How will jobs be impacted by the measures that are before us today? These are America’s job creators. 

Congress should be careful not to overreach and infringe on their 

ability to hedge risks responsibly. 

I look forward to today’s important discussion. I yield back, Mr. 

Chairman. 

Chairman KANJORSKI. Thank you very much, Mrs. Bachmann. 

And now we will hear from the gentleman from Texas, Mr. Neugebauer, for 1 minute. 

Mr. NEUGEBAUER. Thank you, Mr. Chairman. One of the things 

that we have sat here for several months talking about is the state 

of the economy, and I think if we went around this room today and 

asked everybody what they thought caused where we are, we would 

get many different answers, which is one of the reasons I have 

been very concerned about the road that we are going down. I do 

not know that we have adequately analyzed where in the system 

that we had the breakdowns. Instead, I think we have embarked 

on a road to throw a restrictive regulatory blanket over the entire 

financial markets. And what I think we may end up doing is in 

many cases, some of the people that we are ‘‘trying to protect or 

to help,’’ there may be unintended consequences for this very restrictive regulatory blanket that we are trying to throw over the financial markets. 

Derivatives and swaps are important tools, not only for discovering risk in many cases, but also for managing risk. We need to 

make sure that we do not destroy those tools simply because some 

do not understand it or some believe that possibly they could have 

been a cause of the financial breakdown. We do not know that is 

in fact the case. What we do know is many firms were able to manage their risk through this process by having some of these products actually in place. 

And so I look forward to the testimony that we are going to hear 

today, but I also caution my fellow committee members that let’s 

go down this road with thoughtful debate and discussion and make 

sure that we get it right because this is a very important issue to 

our country. 

With that, I yield back. 

Chairman KANJORSKI. Thank you, Mr. Neugebauer. And now we 

have for 1 minute, the gentlelady from Kansas, Ms. Jenkins. 

13 

Ms. JENKINS. Thank you, Mr. Chairman. This committee is being 

asked to consider massive regulatory reform in the financial markets. I hope that any legislation we consider will strike a balance 

between protecting the financial system and ensuring open and 

free markets. 

I have concerns with proposals like the one that is the focus of 

today’s hearing. I am eager to learn more during this hearing about 

all of these issues, and I am concerned about new entry participation barriers in the over-the-counter markets being discussed, such 

as capital requirements and the effects that they may have on competition. 

If this body is to create new regulations in the OTC markets to 

decrease the possibility of systemic risk and increase transparency, 

Congress must ensure robust competition and protect the ability of 

American businesses to use these markets to manage their energy, 

currency and other risks. 

As we take steps to emerge from the current recession and get 

our economy back on track, I, too, urge my colleagues to proceed 

with caution. 

I yield back. Thank you. 

Chairman KANJORSKI. Thank you very much, Ms. Jenkins. Now, 

we will have the first panel. I want to thank you for appearing before the subcommittee today, and without objection, your written 

statements will be made a part of the record. You will each be recognized for a 5-minute summary of your testimony. 

First, we have Mr. Donald Fewer, chief executive officer of 

Standard Credit Group. Mr. Fewer? 

STATEMENT OF DONALD P. FEWER, CHIEF EXECUTIVE 

OFFICER, STANDARD CREDIT GROUP 

Mr. FEWER. Chairman Kanjorski, Ranking Member Garrett, and 

members of the subcommittee, my name is Donald Fewer. I would 

like to thank the subcommittee for the opportunity to share my 

views on the regulation of the over-the-counter derivatives market 

and address the areas of interest outlined by the subcommittee. I 

have also submitted a larger statement for the record. 

Analysis of the credit crisis points to the need for enhanced regulation of the OTC market. Results from such analysis point to multiple, and sometimes conflicting, causes of the crisis and the role 

played by the OTC derivatives market. We suggest creating a cohesive regulatory regime with a systemic risk regulator that has the 

authority and accountability to regulate financial institutions that 

are determined to be systemically important. 

Regulation need not reshape the market or alter its underlying 

functionality. The U.S. share of global financial markets is rapidly 

falling and oversight consolidation should not create a regulatory 

environment that prohibits capital market formation, increases 

transaction costs, and pushes market innovation and development 

to foreign markets. 

The use of CCPs by all market participants, including end users, 

should be encouraged by providing open and fair access to key infrastructure components, including central clearing facilities, private broker trading venues, and derivative contract repositories. 

Central clearing will reduce systemic risk by providing multilateral 

14 

netting and actively managing daily collateral requirements. Mandated clearing of the most standardized and liquid product segments is congruent with efficient global trade flow. 

Given the size, history and global scope of the OTC derivatives 

market, migration toward exchange execution has been, and will 

be, minimal apart from mandatory legislative action. OTC derivative markets will use well-recognized protocols of size, price, payment and maturity dates. Because of these internationally-recognized protocols, OTC dealers globally are able to efficiently customize and best execute at least cost trillions of dollars of customer 

orders within generally acceptable terms to the market. There is a 

class of OTC product that is extremely conducive to exchange execution and can warrant exchange listing. 

The over-the-counter market has a well-established system of 

price discovery and pre-trade market transparency that includes 

markets such as U.S. Treasuries, U.S. repo, and EM sovereign 

debt. OTC markets have been enhanced by higher utilization of 

electronic platform execution. The unique nature of the OTC markets’ price discovery process is essential to the development of orderly trade flow and liquidity, particularly in fixed income credit 

markets. We are in a period of abundance of mispriced securities 

where professional market information and execution is required. 

OTC derivatives and underlying cash markets use an exhaustive 

price discovery service that can only be realized in the OTC market 

via execution platforms that integrate cash and derivative markets. 

Post-trade transparency for all OTC derivative transactions can 

be properly serviced by CCPs and central trade repositories that 

aggregate trading volumes and positions, as well as specific 

counterparty information. These institutions can be structured to 

maintain books and records and provide access to regulatory authorities on trade-specific data. 

I would not endorse OTC trade reporting to the level that is currently disclosed by trace. There is ample evidence in the secondary 

OTC corporate bond market that the trace system has caused dealers to be less inclined to hold inventory and to make capital to support secondary markets. 

Successful utilization of electronic trade execution platforms is 

evident in markets such as U.S. Government bonds and U.S. Government repo. I would caution against the mandated electronic execution of OTC cash-in derivative products by regulatory action. Effective implementation of such platforms should be the result of a 

clear demand made by market makers and a willingness by dealers 

to provide liquidity electronically. Our experience in North America 

is that the dealer community has refrained from electronic execution due to the risk of being held to prices during volatile market 

conditions. 

I would strongly endorse the hybrid use of electronic platforms 

where market participants utilize the services of voice brokers in 

conjunction with screen trading technology. 

Mr. Chairman, Mr. Ranking Member, and members of the subcommittee, I appreciate the opportunity to provide this testimony. 

I am available to answer any questions you may have. 

[The prepared statement of Mr. Fewer can be found on page 156 

of the appendix.] 

15 

Chairman KANJORSKI. Thank you, Mr. Fewer. 

Next, we will have Mr. Robert Pickel, chief executive officer, 

International Swaps and Derivatives Association, Incorporated. Mr. 

Pickel? 

STATEMENT OF ROBERT PICKEL, CHIEF EXECUTIVE OFFICER, 

INTERNATIONAL SWAPS AND DERIVATIVES ASSOCIATION, 

INC. (ISDA) 

Mr. PICKEL. Thank you, Mr. Chairman, Ranking Member Garrett, and members of the subcommittee. Thank you very much for 

inviting ISDA to testify today. We are grateful for the opportunity 

to discuss public policy issues regarding the privately negotiated or 

OTC derivatives business. Our business provides essential risk 

management and risk reduction tools for many users. Additionally, 

it is an important source of employment, value creation, and innovation for our financial system. It is one that employs tens of thousands of individuals in the United States and benefits thousands 

of American companies across a broad range of industries. 

In my remarks today, I would briefly like to underscore ISDA’s 

and the industry’s strong commitment to identifying and reducing 

risk in the privately negotiated derivatives business. We believe 

that OTC derivatives offer significant value to customers who use 

them, to the dealers who provide them, and to the financial system 

in general by enabling the transfer of risk between counterparties. 

OTC derivatives exist to serve the risk management and investment needs of end users. These end users form the backbone of our 

economy. They include over 90 percent of the Fortune 500 companies, 50 percent of mid-size companies, and thousands of other 

smaller American companies. 

We recognize, however, that the industry today faces significant 

challenges, and we are urgently moving forward with new solutions. We have delivered and are delivering on a series of reforms 

in order to promote greater standardization and resilience in the 

derivatives markets. These developments have been closely overseen and encouraged by regulators who recognize that optimal solutions to market issues are effectively achieved through the participation of market participants. 

As ISDA and the industry work to reduce risk, we believe that 

it is essential to preserve flexibility, to tailor solutions to meet the 

needs of customers. Efforts to mandate that privately negotiated 

derivatives trade only on an exchange would effectively stop any 

such business from being conducted. Requiring exchange trading of 

all derivatives would harm the ability of American companies to 

manage their individual, unique financial risks and ultimately 

harm the economy. 

Mr. Chairman, let me assure you that ISDA and our members 

clearly understand the need to act quickly and decisively to implement the important measures that I will describe in the next few 

minutes. 

Last month, Treasury Secretary Geithner announced a comprehensive regulatory reform proposal for the OTC derivatives 

market. The proposal is an important step toward much needed reform of financial industry regulations. ISDA and the industry welcomed in particular the recognition of industry measures to safeVerDate Nov 24 2008 18:16 Nov 06, 2009 Jkt 052397 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 K:\DOCS\52397.TXT TERRIE
16 

guard smooth functioning of our markets and the emphasis on the 

continuing need for the ability to customize derivatives for the specific needs of users of derivatives. 

The Treasury plan proposes to require that all derivatives dealers and other systemically important firms be subject to prudential 

supervision and regulation. ISDA supports the appropriate regulation of financial and other institutions that have such a large presence in the financial system that their failure could cause systemic 

concerns. 

Most of the other issues raised in the Treasury proposal and the 

questions you have asked of the panelists today were addressed in 

a letter that ISDA and industry participants delivered to the Federal Reserve Bank of New York earlier this month. As you may 

know, a Fed-industry dialogue was initiated under Secretary 

Geithner’s stewardship of the New York Fed nearly 4 years ago. 

This dialogue has led to substantial and ongoing improvements in 

the key areas of the OTC derivatives infrastructure, increased 

standardization of trading terms, improvements in the trade settlement process, greater clarity in the settlement of defaults, significant positive momentum toward central counterparty clearing, enhanced transparency, and a more open industry governance structure. 

In our letter to the New York Fed this month, ISDA and the industry expressed our firm commitment to strengthen the resilience 

and robustness of the OTC derivatives market. As we stated, we 

are determined to implement changes to risk management, processing, and transparency that will significantly transform the risk 

profile of these important financial markets. We outlined a number 

of steps towards that end, specifically in the areas of information 

transparency and central counterparty clearing. 

ISDA and the OTC derivatives industry are committed to engaging with supervisors globally to expand upon the substantial improvements that have been made in our business since 2005. We 

know that further action is required, and we pledge our support in 

these efforts. It is our belief that much additional progress can be 

made within a relatively short period of time. Our clearing and 

transparency initiatives, for example, are well underway with specific commitments aired publicly and provided to policymakers. 

As we move forward, we believe the effectiveness of future policy 

efforts will be driven by how well they answer a few fundamental 

questions. First, do they recognize that OTC derivatives play an 

important role in the U.S. economy? Second, do the policy efforts 

enable firms of all types to improve how they manage risk? Third, 

are the policy efforts based on a complete understanding of how the 

OTC derivatives markets function and their true role in the financial crisis? And, fourth, do the policy efforts ensure the availability 

and affordability of these essential risk management tools? 

Mr. Chairman and committee members, the OTC derivatives industry is an important part of the financial services business in 

this country and the services we provide help companies of all 

shapes and sizes. Let me assure you that we in the derivatives industry do recognize the challenges that we face as we seek to enact 

a comprehensive and prudent system of regulatory reform. 

17 

As I have indicated, we are fully committed to working with legislators, this committee, and supervisors to address the key issues 

ahead. 

Thank you for your time, and I look forward to your questions. 

[The prepared statement of Mr. Pickel can be found on page 176 

of the appendix.] 

Chairman KANJORSKI. Thank you very much, Mr. Pickel. 

And now we will hear from Mr. Timothy J. Murphy, foreign currency risk manager, 3M. Mr. Murphy? 

STATEMENT OF TIMOTHY J. MURPHY, FOREIGN CURRENCY 

RISK MANAGER, 3M 

Mr. MURPHY. Chairman Kanjorski, Ranking Member Garrett, 

and members of the subcommittee, thank you for inviting 3M to 

speak today on the importance of the over-the-counter derivatives 

market. Representative Bachmann, thank you for your kind introduction, as well as your kind words about 3M Company. 

As you know, my name is Timothy Murphy, and I am the foreign 

currency risk manager for 3M Company. As you now know, 3M is 

a U.S.-based employer headquartered in Minnesota. We are home 

to such well-known brands as Scotch, Post-It, Nexcare, Filtrete, 

Command, and Thinsulate. 3M has over 34,000 employees in the 

United States and operations in 27 States where over 60 percent 

of 3M’s worldwide R&D and where 60 percent of our manufacturing occurs. 

While our U.S. presence is strong, being able to compete successfully in the global marketplace is critical. In 2008, 64 percent of our 

sales or over $16 billion were outside the United States. And this 

number is expected to grow to over 70 percent by 2010. 

It is because of the global success of our brands that we need to 

manage foreign currency risks via the OTC markets. Likewise, our 

desire to officially manage our raw material and financing costs 

gives rise to our use of OTC commodity and interest rate tools. 

I want to stress that 3M, like the majority of corporate end 

users, does not speculate with derivatives. All of our hedge transactions are carefully matched with underlying risks from the operation of our businesses. 

I am here today to share 3M’s perspective on proposals to establish a regulatory framework for OTC derivatives. While 3M supports the objectives outlined in Treasury Secretary Geithner’s recent proposal, as well as many of the ideas put forward by Members in the House and the Senate, we have strong concerns about 

the potential impact on OTC derivatives and 3M’s ability to continue to use them to protect our operations from the risk of currency, commodity, and interest rate volatility. 

3M agrees that the recent economic crisis has exposed some 

areas in our financial regulatory system that should be addressed. 

However, not all OTC derivatives have put the financial system at 

risk, and they should not all be treated the same. The OTC foreign 

exchange commodity and interest rate markets have operated 

largely uninterrupted throughout the economy’s financial difficulties. We urge policymakers to focus on the areas of highest concern. 

3M understands and respects the need for reporting and recordkeeping. Publicly-held companies are currently required by the 

18 

SEC and FASB to make significant disclosures about our use of derivative instruments and hedging activities, including disclosures 

in our 10-Ks and 10-Qs. We would like to work with policymakers 

on ways to efficiently collect information into a trade repository to 

further enhance transparency. 

3M opposes a mandate to move all derivatives into a clearing or 

exchange environment. One key characteristic of OTC derivatives 

for commercial users is the ability to customize the instrument to 

meet a company’s specific risk management needs. Provisions that 

would require the clearing of OTC derivatives would lead to standardization, thus impeding a company’s ability to comply with hedge 

accounting requirements for financial reporting, thereby exposing 

reported corporate financial results to unwarranted volatility and 

distracting from our operating results. 

While we are mindful of the reduction in credit risk inherent in 

a clearing or exchange environment, robust initial and variation 

margin requirements would create substantial incremental liquidity and administrative burden for commercial users, resulting in 

higher financing and operational cost. 

Scarce capital currently deployed in growth opportunities would 

need to be maintained as margin, which could result in slower job 

creation, lower capital expenditures, less R&D, and/or higher cost 

to consumers. The hedging of business risks could well be discouraged. 

3M thanks the committee for studying the critical details related 

to financial system reforms and for considering our perspective in 

this important debate. 

Again, 3M respectfully urges the committee to preserve commercial users’ ability to continue using OTC derivative products to 

manage various aspects of corporate risk while addressing concerns 

about stability of the financial system. 

3M looks forward to working with the committee as you craft 

this important legislation. 

Thank you. 

[The prepared statement of Mr. Murphy can be found on page 

171 of the appendix.] 

Chairman KANJORSKI. Thank you very much, Mr. Murphy. 

And next we will hear from Mr. Don Thompson, managing director and associate general counsel of JPMorgan Chase & Co. Mr. 

Thompson? 

STATEMENT OF DON THOMPSON, MANAGING DIRECTOR AND 

ASSOCIATE GENERAL COUNSEL, JPMORGAN CHASE & CO. 

Mr. DON THOMPSON. Mr. Chairman, Ranking Member Garrett, 

and members of the committee, my name is Don Thompson, and 

I am a managing director and associate general counsel at 

JPMorgan Chase & Co. Thank you for inviting me to testify at today’s hearing. 

For the past 30 years, American companies have used OTC derivatives to manage interest rate currency and commodity risk. Increasingly, many companies incur risks outside their core operations that if left unmanaged would negatively affect their financial performance and possibly even their viability. 

19 

In response to marketplace demand, risk management products, 

such as futures contracts and OTC derivatives, were developed to 

enable companies to manage risks. OTC derivatives have become 

a vital part of our economy. According to the most recent data, over 

90 percent of the largest American companies and over 50 percent 

of mid-size companies use OTC products to hedge risk. 

JPMorgan’s role in the OTC derivatives market is to act as a financial intermediary. In much the same way that financial institutions act as a go-between with investors seeking return and borrowers seeking capital, we work with companies looking to manage 

their risks and entities looking to take on those risks. 

A number of mainstream American companies have expressed 

great concern about the unintended consequences of recent policy 

proposals, particularly at a time when our economy remains fragile. In our view, the effect of forcing such companies to face an exchange or a clearinghouse will limit their ability to manage the 

risk they incur in operating their businesses and have negative financial consequences for them because of increased collateral posting. These unintended consequences have the potential to harm 

economic recovery. 

Let me first touch on some of the benefits of OTC derivatives. 

Companies today demand customized solutions for risk management and the OTC market provides them. Keep in mind that 

customization does not necessarily mean complexity. Rather, it 

means the ability to hand tailor every aspect of a risk management 

product to the company’s needs to ensure that the company is able 

to offset its risks exactly. 

For example, a typical OTC derivative transaction might involve 

a company that is borrowing at a floating interest rate. To protect 

itself against the risk that interest rates will rise, the company 

would enter into an interest rate swap. These transactions generally enable the company to pay an amount tied to a fixed interest 

rate and the dealer counterparty will pay an amount tied to the 

floating rate of the loan. This protects the company against rising 

interest rates and allows them to focus on their core operations. In 

addition, the company is often able to qualify for hedge accounting 

and thus avoid seeing volatility in its financial reporting that 

would obscure the true value of its business. 

OTC derivatives are used in a similar manner by a wide variety 

of companies seeking to manage volatile commodity prices, foreign 

exchange rates, and other market exposures. 

In addition to customization, the other main benefit of OTC derivatives is flexibility with respect to the collateral that supports a 

derivative transaction. In the interest rate swap example I went 

through before, the dealer counterparty may ask the company to 

provide credit support to mitigate the credit risk that it faces in entering into the transaction. Most often, that credit support comes 

in the same form as the collateral provided for in the extensions 

of credits by that dealer counterparty to the customer. Thus, if the 

loan is agreement is secured by property, equipment or accounts 

receivable, that same high-quality collateral would be used to secure the interest rate swap. As a result, the company does not have 

to incur additional costs in obtaining and administering collateral 

for the interest rate swap. 

20 

It is important to note that although derivatives are currently offered on U.S. exchanges, few companies use these exchange traded 

contracts for two main reasons: First, exchange-traded products are 

by necessity highly standardized and not customized. As a result, 

companies are unable to match the products that are offered on exchanges to their unique portfolio of risks. 

Second, clearinghouse collateral requirements are by design onerous and inflexible. Clearinghouses require that participants pledge 

only highly liquid collateral, such as cash or short-term government 

securities to support their positions. However, companies need 

their most liquid assets for their working capital and investment 

purposes. Thus, in the example I gave, if the company had actually 

hit its hedge on an exchange, it would have had to post cash or 

readily marketable collateral up front and twice daily thereafter. 

By transacting in the OTC market, the company is able to use 

the same collateral that it has already pledged to secure its loan 

with no additional liquidity demands or administrative burdens. 

This collateral is high quality, given that it is the basis for the extension of credit in the loan but posting it does not affect the company’s operations or liquidity. 

The flexibility to use various forms of credit support significantly 

benefits companies because without it, many companies will choose 

not to hedge risks because they cannot afford to do so. 

While we believe that exchanges play a valuable role in risk 

management, not all companies can or want to trade on exchange. 

Currently, companies have the choice of entering into hedging 

transactions on exchange or in the OTC markets, and we believe 

that companies should be allowed to have the choice to continue to 

use those competing products. 

The discussion of the benefits of OTC derivatives is not to deny 

that there have been problems with their use and it is essential 

that policymakers carefully examine the causes of the financial crisis to ensure that it does not repeat it. 

We have noted recent press reports indicating that banks are engaged in the concerted effort to avoid regulation. This is absolutely 

not true. For the past 4 years, major derivatives dealers, working 

in conjunction with regulators, have been engaged in an extensive 

effort to improve practices and controls in the OTC derivatives 

market. The letter referred to is just the latest quarterly submission outlining our efforts to enhance market practices, and we are 

committed to reforming the regulatory system and increasing confidence in the markets. 

To that end, we propose the following, which is consistent with 

the Administration’s position, and CFDC Chairman Gensler’s recent remarks on the issue: First, financial regulation should be considered on the basis of function, not form; second, a systemic risk 

regulator should oversee all systemically significant financial institutions and their activities; third, standardized OTC derivative 

transactions between major market participants should be cleared 

through regulated clearinghouses; and, finally, enhanced reporting 

requirements should apply to all OTC derivatives transactions, 

whether cleared or not. 

21 

JPMorgan is committed to working with Congress, regulators, 

and other industry participants to ensure that an appropriate regulatory framework for OTC derivatives is implemented. 

I appreciate the opportunity to testify and look forward to taking 

your questions. 

[The prepared statement of Mr. Don Thompson can be found on 

page 189 of the appendix.] 

Chairman KANJORSKI. Thank you very much, Mr. Thompson. 

And next, we will have Mr. Christopher Ferreri, managing director of ICAP. Mr. Ferreri? 

STATEMENT OF CHRISTOPHER FERRERI, MANAGING 

DIRECTOR, ICAP 

Mr. FERRERI. Thank you, Chairman Kanjorski, Ranking Member 

Garrett, and members of the subcommittee for allowing me the opportunity to participate in today’s hearing. I am Chris Ferreri, and 

I work for a company called ICAP. We are the world’s largest interdealer broker, employing more than 4,000 personnel worldwide, including New York, New Jersey, and the other major financial centers. Using a combination of voice and electronic services, our function is to match buyers and sellers, specifically banks and other 

large financial institutions, operating in the wholesale financial 

markets. 

On their behalf, we execute thousands of trades daily and a 

broad array of financial products, including U.S. Treasury securities, foreign exchange, commodities, and other financial derivatives. 

Products and trades in the OTC markets are simply products 

that do not trade exclusively on registered exchanges. It should be 

noted that included in these products are U.S. Treasury securities 

and foreign exchange, by volume of trade, the world’s two largest 

financial products. 

It should also be emphasized that for the most part institutional 

participants in these markets are currently subject to regulation by 

government authorities, specifically in the United States, the Fed, 

the SEC, and FINRA. 

During my testimony, I would like to emphasize the following 

three points: First, ICAP supports greater oversight of major participants in OTC markets, in particular to ensure the integrity of 

their capital base. We also support additional transparency through 

the increased use of electronic trading platforms and post-trade reporting facilities already available through companies like ICAP 

and others. 

Second, some have suggested that the solution to greater oversight with regard to the over-the-counter market should be to force 

much of the present activity on to existing exchanges. We do not 

believe this is necessary or indeed that it would accomplish its intended goal. Rather, we believe that better use of facilities that already exist, such as the electronic trading platforms, direct and immediate access to clearinghouses, and post-trade reporting and 

processing will lead to greater price transparency, more efficient 

markets, and additionally facilitate the oversight function of the 

regulatory authorities. 

Third, these products have increased in number and size so dramatically because virtually every major financial and corporate inVerDate Nov 24 2008 18:16 Nov 06, 2009 Jkt 052397 PO 00000 Frm 00027 Fmt 6633 Sfmt 6633 K:\DOCS\52397.TXT TERRIE
22 

stitution in the world needs and uses them to raise capital, to protect portfolio positions, and to mitigate risk. Whatever regulatory 

decisions are made, we must make every effort that they do not impair access to capital or the ability to hedge risk for private and 

public institutions alike. 

The subcommittee did give us seven points to touch on. I will address as many as I can in the time allotted. 

On the view for OTC regulation: ICAP favors changes to the regulatory framework supporting fairness and transparency. Interdealer brokers like ICAP are regulated by both the national regulators in each relevant market and by their overall lead regulator. 

There are many forms of regulation already in place that apply to 

the OTC cash and derivatives markets, in cases where the markets 

themselves may not be regulated but participants can be. 

How clearing will affect the OTC markets: Roughly 60 percent of 

the OTC markets we operate are cleared. We would expect that increased clearing can lead to increased liquidity in the OTC markets. 

The pros and cons of exchange trading: We must first underscore 

the distinctions between exchange trading and clearing. ICAP operates fully electronic marketplaces for many products and none of 

them are single silos of exchange trading and clearing but are traded electronically and cleared centrally. This one-size-fits-all approach is completely standardized, non-fungible contracts means 

that corporations, mortgage providers, bond issuers and others are 

unable to accurately hedge their risk exposures. It is for this reason that the OTC markets are both larger in scale and broader in 

scope than the exchange markets. 

The potential benefits of electronic trading: Electronic trading 

could provide more efficient price discovery; simplify trade capture; 

materially reduce operational risk; improve trading supervision; increase audit ability; and create processing capacity in the OTC 

markets. In addition, multiple trading venues increase competition, 

keep costs down, and provide security from failure of individual 

platforms. Migrating liquidity is difficult. The turnkey development 

of a completely new market infrastructure is unnecessary and will 

require significant implementation time and incur a high level of 

risk. Rather than rushing to develop new infrastructure, better and 

more extensive use should be made of the tremendous capabilities 

of the existing OTC market infrastructure. 

In summary, it should be clear that the over-the-counter market 

is not unregulated or even less regulated. Our electronic trading 

platforms are global, connect to thousands of customers in dozens 

of countries, as well as the world’s largest clearance and settlement 

systems. 

ICAP welcomes the coming reform, and we feel our goals of promoting competition, electronic trading, and clearing helps both our 

customers and ICAP. 

The OTC market has already invested significantly in developing 

this infrastructure for price discovery, trade execution and posttrade automated processing which contributes hugely to reducing 

risks, but it needs to be further developed and better leveraged for 

the benefit of all. 

23 

Once again, I think the committee for allowing me to speak on 

this topic, and I look forward to working with the committee on 

building a bridge for a better marketplace. 

Thank you. 

[The prepared statement of Mr. Ferreri can be found on page 147 

of the appendix.] 

Chairman KANJORSKI. Thank you very much, Mr. Ferreri. 

And, finally, we have Mr. Christian Johnson, professor, University of Utah School of Law. Mr. Johnson? 

STATEMENT OF CHRISTIAN A. JOHNSON, PROFESSOR, 

UNIVERSITY OF UTAH SCHOOL OF LAW 

Mr. JOHNSON. Thank you, Mr. Chairman, Ranking Member Garrett, and subcommittee members. As an academic, I thought I 

might take a moment to step back and try and provide some historical context as to why the over-the-counter derivative markets look 

like they do. 

The first OTC derivative that was publicly announced I believe 

was a cross-currency swap between IBM and the World Bank back 

in 1981. And there was probably activity before that but at the 

time there was tremendous legal uncertainty as to whether it was 

even legal to do over-the-counter derivatives. The biggest concern 

at the time was whether or not these over-the-counter derivatives 

were what we call illegal off-exchange future transactions and thus 

subject to CFTC regulation and could conceivably be held to be void 

by the courts. 

And what began then for a period of about 7 or 8 years, was a 

tremendous perhaps we call it turf war going on between the 

CFTC’s thoughts on asserting jurisdiction over this growing market 

and the large dealers pushing back, oftentimes with the help of 

regulators, to keep this as an unregulated and customized market. 

In 1989, the CFTC officially agreed to not exercise jurisdiction 

over the over-the-counter derivative market provided that the 

transactions were not standardized and provided that they were 

not cleared or did not enjoy exchange offset. And so essentially 

what happened is because of this legal uncertainty, the goal of the 

OTC market was to look as little as possible like exchange traded 

derivative transactions. 

In 1993, Congress gave the CFTC authority again to not regulate 

over-the-counter derivative transactions, provided that the transactions were not standardized. And so in the initial history of the 

over-the-counter derivative market, you have tremendous pressure 

to drive the over-the-counter activity away from what we appear to 

be trying to do today, to try to get them back to being more standardized and put back on to exchanges and traded in a way that 

might minimize the risks that we all have been talking about. 

So the problem we have now is we have a global industry that 

was initially driven by the efforts not to look like standardized 

transactions that could be cleared and traded over exchanges. And 

so you have a global market that has designed products, created infrastructure and to do all the things that we do not want them to 

do right now. And now we are trying to force them back into the 

model where they are standardized, where they are cleared and 

enjoy some of those different benefits. 

24 

The reason I bring this up is, one, again, because a lot of this 

situation we are in was caused because of I guess what you would 

call regulatory competition over who is going to take control over 

this particular market, and the problem we have is we have a very 

mature and developed market that does not operate in the way 

that we want it to at this particular moment. And it will probably 

take time and nudges from regulators and from Congress to start 

doing the kinds of things that we have been talking about today. 

When you look at Secretary Geithner’s May 13th letter where he 

talked about what we should be doing to regulate over-the-counter 

derivatives, his last paragraph is almost a throw away paragraph, 

and one of his last lines in the letter is, ‘‘We would like to promote 

the implementation of complementary measures in other jurisdictions.’’ And essentially what he is saying is that if we try and regulate here without getting similar regulation in Europe and Asia, 

that we run the risk that we are going to drive this market offshore. I am not trying to trivialize this point, but if you look at the 

OTC market, it is a bit like a big round children’s squishy ball. And 

when you grab it and you try and conform it, it pops out in funny 

directions. 

And, again, I am not trying to trivialize what we are talking 

about, but this is a truly global industry that will move quickly and 

easily from jurisdiction to jurisdiction, wherever it is easiest to 

trade and where we have the least regulation. The concern of 

course is that we do not do this, and that we are able to preserve 

the dominance that our institutions have developed and maintain 

some control here in the United States. 

Thank you very much for your time. 

[The prepared statement of Professor Johnson can be found on 

page 161 of the appendix.] 

Chairman KANJORSKI. Thank you very much, Professor. Now, we 

will see if we have any questions from our colleagues, and I will 

start off. First, let me ask a very obvious question, is there anyone 

of the six of you on the panel who feels that there is no corrective 

action that is necessary to be taken by the Congress in regards to 

derivatives? 

[no response] 

Chairman KANJORSKI. So I guess we have uniform agreement 

that there are at least some or many fixes that should be made in 

the field of derivatives to improve the situation as they presently 

exist. Is that correct? 

Mr. PICKEL. Yes, Mr. Chairman, I think that is correct. As I 

mentioned in my testimony, I focus on the efforts that have taken 

place over the last several years. In very close dialogue between 

regulators and the industry to identify some of these things, some 

of these issues. There are other parts of the proposal from Secretary Geithner, particularly on systemic risk and how you address 

that issue, that really cannot be addressed in that private/public 

dialogue. It really needs to be addressed by Congress. 

Chairman KANJORSKI. One of the issues that the professor 

brought up in terms of after the recession is over and after the recovery is had, the next natural pressure will be shopping for forums for the derivative industry and will be back in the competition. Is New York, is Chicago, is London or is Peking going to be 

25 

the capital where the industry goes? And it perhaps will be a race 

to the bottom of the least regulated area in the world. What could 

we do to create a position in the American market at least that 

would deny either getting the contract satisfied by assets held in 

the United States or some other means so that we would not 

change the forum of where these actions are taking place? In other 

words, can we in American law say any action taken in the derivative market in a foreign country that does not have an equal regulatory regime as the United States will not be actionable in the 

United States? Would that tend to be detrimental to their being 

trading abroad or in a different forum than they are now? 

Mr. DON THOMPSON. Mr. Chairman, I would like to take that 

question. First of all, I disagree with the premise that derivatives 

dealers will automatically be looking for jurisdictions to operate in 

which present the loosest regulation. It has become abundantly 

clear to us that even if our own house is in order, if our neighbors’ 

houses are not in order, that presents problems to us as an industry. So I would be careful about accepting the premise of my copanelists as being fact for all derivative dealers. 

Secondly, I do think one of the key unintended consequences that 

need to be avoided, and you used the word I believe ‘‘actionable’’ 

in your question, is creation of legal uncertainty about whether 

contracts are enforceable. These contracts are market sensitive instruments, which vary in value based upon the underlying market 

factors on which they are based. And I would urge Congress to 

avoid any formulation which calls into question the legality of existing contracts based upon any of a number of criteria which I 

think has the potential to be significantly de-stabilizing. 

Chairman KANJORSKI. So rather than provide for actionableness 

as the qualifying factor, do you think that by treaty or international agreement, we could stabilize a world market recognizing 

standardized conditions? 

Mr. DON THOMPSON. I think it would be much more effective and 

important for American policymakers to make sure that whatever 

steps we enact here in the United States are broadly consistent 

with the regulatory regime overseas as well to avoid any regulatory 

forum shopping of the nature you mentioned before. 

Chairman KANJORSKI. What portion of nations would have to be 

participants in that type of standardization, of a treaty or otherwise, to accomplish the end, do we have to get 75 or 80 percent of 

the countries, certainly not all, because we cannot get all of them? 

Mr. DON THOMPSON. No, I would imagine it would be, Mr. Johnson is right, this is a global business. It is a global business which 

is concentrated in regional hubs, New York, Chicago, London, 

Paris, and a number of Asian jurisdictions are the principal ones. 

I would not limit it to those, and I cannot give you a precise number. I think your instinct that you would not have to achieve unanimity in the international community but some reasonable number of major jurisdictions having the same regulatory framework is 

probably the right one. 

Mr. PICKEL. Mr. Chairman, I might also add that there are existing international groups that I am sure you are well aware of, like 

IOSCO, the securities commissioners, there is the Basel Committee, which is very important on the bank capital front and also 

26 

the newly formed Financial Stability Board, formerly the Financial 

Stability Forum, which provide frameworks for regulators across 

the major jurisdictions to coordinate. And also ISDA is actively involved in meeting with regulators around the world, getting the 

word out about for instance these commitments made to the New 

York Fed in the letter last week. I was just on a phone call with 

the Australian regulators last week, we had our meeting, our large 

annual meeting for members in Beijing in April, and we were addressed by senior regulators from the Chinese community. 

Chairman KANJORSKI. Thank you very much. I see my time has 

expired. Mr. Garrett, you are recognized for 5 minutes. 

Mr. GARRETT. I thank the chairman. I thank the panel. To Mr. 

Thompson or anyone on the panel, following the chairman’s comment, which was sort of going to the direction that if we do certain 

things in this country, we might push the industry offshore and 

your suggestion, and others may concur, that it may not be an 

issue of a race to the bottom. Maybe the flip side of that question 

is, is there something that we would actually do that would actually attract them back here to this market, and not just by having 

a proverbial wild west, as some would say, approach to it? 

Mr. DON THOMPSON. Yes, I think that if correctly done, this has 

the potential to make the United States a pillar of financial responsibility in the sense that regulation intelligently applied will reduce 

systemic risk and increase transparency. And if it is done in an intelligent fashion where it does not by virtue of unintended consequences restrict the ability of end-users, mainstream American 

companies and the like, to continue to access custom risk management solutions from the OTC derivatives market, I think it has the 

potential to make the United States a pillar of responsible financial 

regulation and perhaps enhance the image of this country internationally. 

Mr. PICKEL. I would also reference back to this whole discussion 

about legal certainty. The Act passed by Congress, the Commodity 

Futures Modernization Act in 2000, provided that legal certainty 

and Secretary Geithner’s letter makes it very clear, and you have 

heard from the panelists today, that we should not tinker with that 

legal certainty. In that situation, if the wrong decision had been 

made, the business would have almost by necessity had to move 

elsewhere. 

Here we are talking about aspects of regulation, it may on the 

margin increase the cost, it may in some cases decrease the costs. 

That will be a calculation in the decision as to where a transaction 

might be traded or booked, but we are not talking about undermining the fundamental enforceability. 

Mr. GARRETT. And following along that line, along the adding the 

cost, and maybe Mr. Murphy or others want to chime in on this, 

a couple of thoughts come to mind. One of the proposals that are 

out there is in regard to clearinghouses, right? And one of the ideas 

is you have one central clearinghouse and another is you have multiple clearinghouses. And one aspect of that is to force the mandatory use of the clearinghouse. So could we do more harm than good 

if we said—the first question would be is that we have a mandatory use, basically standardize the marketplace, would that attract 

or distract? 

27 

And along that line, we had a gentleman speak to us the other 

night, and he made this point, which very quickly, he said that it 

is almost counterintuitive that if you allow for the option on the 

clearinghouses, that in fact in order to gain the liquidity, like Mr. 

Murphy and other industries would want in the marketplace, you 

actually would be driven naturally to that clearinghouse because 

that is where you are going to find the liquidity as opposed to outside of such a clearinghouse mechanism? Is that argument correct 

and answer the first question as well? 

Mr. MURPHY. Well, let me if I can just back up on this international U.S. issue. 

Mr. GARRETT. Okay. 

Mr. MURPHY. From a business perspective, my concern—it is not 

this so-called ‘‘race to the bottom,’’ my concern is as a global company, 3M has competitors all over the world, Germany, Korea, 

wherever the case may be, so it is not a concern about business 

leaving the United States, my concern is if I have a competitor in 

Germany and he can call up his or her banker in Geneva and deal 

in the OTC market on a more or less unfettered basis, and we have 

to deal with a different, more stringent regime here in the United 

States, now we are at a competitive disadvantage in terms of our 

ability to manage risk. 

Mr. GARRETT. Right, so if you have a mandatory clearinghouse 

arrangement where you are required to have a cash or collateral 

backstop to that over here, that may create problems actually both 

over there and over here with that market. 

Mr. MURPHY. Yes, there are really two issues with the mandatory clearing. Issue one, you may notice this large book that I have 

brought today with lots of 3M products inside of it, this is FAS 133. 

This is the Financial Accounting Standards Board’s Ruling 133, 

which governs the accounting treatment for derivatives for corporations. As you might imagine, not a lot of pictures in here, not really 

very light reading. It is a very difficult standard, very stringent. It 

is getting harder to meet these requirements and not getting easier 

over time. 

The problem with a clearing or exchange environment is that by 

their nature, products must become more standardized to work on 

those environments. And when you have a specific business risk, 

you need to, per the standard, hedge it with a specific hedge that 

matches up very precisely with that risk. And so if you move to a 

clearing environment, which is standardized by nature, you end up 

with a mismatch. You cannot precisely manage the risk. And so 

what happens is as a corporation, you lose hedge accounting treatment, which means the mark-to-market on those hedges hit your 

P&L, your income statement every quarter. And that is definitely 

something as a corporation you do not want to have happen. And 

so what that would lead to frankly in my opinion is companies will 

probably do less hedging frankly. So that is sort of issue one is 

being able to meet this. 

The second issue is just a cost issue. We have done some studies, 

some of my colleagues and I, over the last month to say over the 

last 3 years, what would it cost 3M if we were in a mandatory 

clearing environment. And without looking at the administrative 

burden, without looking at any trading fees even, although the 

28 

trading fees are probably not a huge number, the margin required 

on average for 3M over the last 3 years would have been $100 million. At its high point in 2007, it would have been as much as $200 

million. So that is $100 to $200 million of our balance sheet which 

we would have to move into this clearinghouse account to essentially just sit idle. 

Now, 3M is a highly rated corporation— 

Mr. SHERMAN. [presiding] Mr. Murphy, the time has expired. 

Mr. MURPHY. Sorry. 

Mr. GARRETT. Thank you, Mr. Murphy. 

Mr. SHERMAN. I now recognize myself for 5 minutes. AIG was 

under the control of a ravenous and reckless management, a greed 

management, I am not saying there are not similar managements 

in control of other corporations. But in spite of that management, 

the regulated insurance companies did just fine because the regulation was the counterbalance to the ravenous, reckless and greedy 

nature of the management. The unregulated portion failed. And no 

one was hurt much except the taxpayer and the economy. The officers and directors seem to be doing just fine. And, more importantly perhaps, the counterparties have been insured to the last 

penny. What concerns me is that everyone in this room is just focused on how is it working for corporate America and not what is 

happened to the economy and the country and what risks have 

been taken by the taxpayer. 

Now, is there anyone on this panel who can say that your organization came to Congress a couple of years ago and said, ‘‘My God, 

you have to stop what is going on in our industry. It threatens the 

world economy. AIG has gone crazy. Other companies have gone 

crazy.’’ Is there anyone here who wishes to say that being on the 

front line, they looked, they saw, and they warned? 

[no response] 

Mr. SHERMAN. We are told that we could, through legal action, 

make it so that the next AIG was a foreign company. We are told 

that this is really an international business, which begs the question why is it that the United States had to bail out AIG and the 

foreign counterparties of AIG? And perhaps if bailing out is one of 

the responsibilities of the host government, would not we want to 

drive this industry overseas? 

Mr. Pickel, is AIG a member of your organization? 

Mr. PICKEL. Yes, AIG is a member of our organization. 

Mr. SHERMAN. When you saw them taking risks that could bring 

down the economy and force them to squeeze taxpayers for over 

$100 billion, did you demand that they take corrective action or 

kick them out of the organization? 

Mr. PICKEL. The nature of our organization is a member organization, we do not perform a self-regulatory function, so we do not 

enforce— 

Mr. SHERMAN. So if the devil wants to join your organization, the 

only question is, does his dues check clear? 

Mr. PICKEL. We have an extensive membership, including AIG, 

across the world, yes. 

Mr. SHERMAN. But if the devil wants to join the organization, the 

question is, does the dues check clear? 

Mr. PICKEL. We are involved in education and awareness. 

29 

Mr. SHERMAN. I am sure you do wonderful work. Now, I am told 

here we are losing the capacity to get the cheapest insurance most 

customized. Why can’t I buy a customized fire insurance policy for 

my house from an unregulated Cayman Islands insurance company? The answer is we have decided that we want secure insurance companies. We do not want to have to be bailing them out. 

And we want the consumer to be paid. 

Mr. Murphy, I assume that 3M has insurance, buyer and casualty and liability insurance. Do you buy any of that from unregulated companies with no known reserves? 

Mr. MURPHY. I will be honest with you, I am not in the insurance 

area at 3M. We do purchase insurance for our facilities, but I cannot really give any more details than that. 

Mr. SHERMAN. I have a number of other questions I will ask for 

the record. I see my time is nearly expired. I now recognize the distinguished ranking member of the full committee, Mr. Bachus. 

Mr. BACHUS. Thank you, Congressman Sherman. I guess if the 

devil wanted to run for Congress, we could not prevent that either. 

[laughter] 

Mr. SHERMAN. But we would kick him out, wouldn’t we? 

Mr. BACHUS. I am not sure we would. 

[laughter] 

Mr. SHERMAN. We would kick him out of the Democratic Caucus. 

I yield back. 

Mr. BACHUS. I am not sure you would. 

[laughter] 

Mr. BACHUS. What lessons has the financial services industry 

learned from the Lehman Brothers’ bankruptcy and from the near 

collapse of AIG, any of you? 

Mr. PICKEL. Let me comment briefly on AIG. They, through their 

credit default swaps, were taking exposure to subprime debt, the 

collateralized debt obligations, certain tranches of those obligations, 

so they had an appetite for subprime exposure. In fact, through 

their regulated insurance companies, as Mr. Polakoff testified in 

the Senate Banking Committee in March, they were also taking on 

exposure to subprime past the time that the financial products 

company stopped taking on exposure, well into 2006 and even 

2007. So that was the appetite that they had. 

They also looked at risk in a very narrow way. The head of FP, 

the Financial Products Division, was quoted as saying he could not 

imagine ever losing a dollar on these trades. And he was looking 

at that really only in respect to payouts on the transactions. He 

was not really looking at the mark-to-market exposure, which ultimately is what undermined AIG. 

They also traded on their triple A, which other institutions—in 

fact some of the institutions who have been the source of the greatest problems, Fannie and Freddie, some of the monolines, have 

traded on their triple A, resisted the providing of collateral, and 

even worse, agreed in certain circumstances to provide collateral on 

downgrades. And, frankly, ever since the Group of 30 Report published in 1993, it has been very clear that downgrade provisions, 

where you provide collateral on downgrades, are to be dealt with 

very cautiously because of the liquidity problems they can cause. 

In fact, the banking regulators discourage them, they do not preVerDate Nov 24 2008 18:16 Nov 06, 2009 Jkt 052397 PO 00000 Frm 00035 Fmt 6633 Sfmt 6633 K:\DOCS\52397.TXT TERRIE
30 

vent them but they do discourage the use of those types of provisions. So those are our observations on the AIG situation, and I 

think is very important as we look forward in reform. 

Mr. BACHUS. Okay, thank you. 

Mr. DON THOMPSON. Congressman, you mentioned Lehman 

Brothers as well, and I think it is important to realize that there 

were other entities besides AIG who have been part of the financial 

crisis that we are in and to recognize that not all of the financial 

difficulties which we have experienced have been a result of OTC 

derivatives. If you look at Lehman Brothers and you look at Bear 

Stearns, for example, you see the classic banking error being made 

again and again, which hopefully we will learn from, which is buying very long-dated assets that are somewhat illiquid, and funding 

them with overnight money in the wholesale money markets, which 

can go away at the drop of a hat. 

And I think that if you look at exactly what happened to Bear 

and Lehman, that was the paradigm. Although they were both 

major OTC derivatives dealers, their OTC derivatives operations 

were mere footnotes in the story of Lehman and Bear. It was really 

compiling a large volume of 30 year mortgage-related assets and 

funding them overnight in the repo market that did those firms in. 

Mr. PICKEL. I might also just add on the Lehman Brothers, it is 

a very effective example of a clearinghouse existing together with 

the bilateral. The clearinghouse existed for interest rate swap 

trades, and they settled out their trades very efficiently. And parties on the bilateral, as the master agreement relationship, moved 

to terminate and close out on a fairly reasonable time frame and 

crystallize those exposures. 

Mr. BACHUS. Okay, thank you. Mr. Johnson? 

Mr. JOHNSON. I think one last thing is that intellectually we always knew that a big dealer like a Lehman or Bear Stearns could 

go insolvent but given the amount of trading that was going on 

with those institutions, I am not sure that we expected it actually 

to happen and that it was sort of one of those 100-year events. And 

I think the reality has woken up a lot of people that how any 

counterparty can have these kinds of trouble. 

Mr. BACHUS. Thank you. Thinking about how AIG never imagined that these things could go down, I guess a lot of homeowners, 

a lot of people who bought commercial property and houses sort of 

assumed the same thing, obviously to their detriment. But I appreciate those responses, and I think they are very insightful. 

Dr. Johnson, you mentioned the turf battle here in Congress 

some time between CFTC and the SEC. Now, the Commodities Exchange Act actually excludes credit default swaps from jurisdiction 

of—well, they are excluded from the coverage of the Commodities 

Exchange Act, so the CFTC draws its jurisdiction from that Act. So 

if we were to give some function on credit default swaps, which are 

really meant to insure against default by a publicly-traded company I guess or a group of publicly-traded companies defaulting on 

their debt, if the CFTC was given that authority, would we have 

to amend the Act or would they have jurisdiction? 

Mr. JOHNSON. Clearly, there is going to have to be a lot of regulatory changes to do what we are trying to do based on the current 

structure that we have, and that becomes the real question as to 

31 

who we are going to give this regulatory authority to. And that has 

been the battle since the early 1980’s as to who gets to regulate 

this particular industry. 

Mr. BACHUS. Yes, and I am not advocating regulation. 

Mr. SHERMAN. I thank the gentleman. I recognize the gentleman 

from Massachusetts. 

Mr. LYNCH. Thank you, Mr. Chairman. At the outset, I would 

just like to say if we cannot fix this system, given the experience 

we have had with this, if we cannot fix it and allow all investors 

and institutions to I think readily rely on a derivatives system, it 

is probably better that it go overseas rather than put the stamp of 

this country and the full faith and credit of this Nation behind such 

a system if we do not think it is really sound. Now, I have heard 

that argument before from other firms within the financial services 

industry that if we regulate this industry, it will go overseas. Well, 

there are probably some folks over in London who sort of wish that 

type of dynamic had not been created. 

Now, a couple of observations that I want to make. Dimitris 

Chorafas wrote that, ‘‘Compared to horse-and-buggy classical bonds 

and equities, complex derivatives are supersonic engines.’’ And I 

just want to bring to mind the power of derivatives. I will readily 

admit there is some advantage to be had from their use, but I am 

very concerned about the idea that there would be customized derivatives outside of a regulatory system because I think there is a 

certain attraction to firms, such as 3M and others, to have a derivative customized to their very specific situation. I understand the 

attraction of that. I also understand that where AIG and some others got into some tough situations in terms of the derivatives they 

were holding is that they were not fungible. They were so uniquely 

crafted that no one could determine what the value of those derivatives were and there were just no buyers on the market, so it 

seized up. So there were advantages but it also created problems. 

Let me ask you this question: If we allow a customized derivative 

industry to operate outside of—just over-the-counter, without anybody knowing the details and the dynamic of those customized derivatives, and frankly stability has always been gained at some cost 

to innovation. That is just the way it operates. But if we are going 

to allow that to happen in this opaque and complex system, customized derivatives to be traded over-the-counter, how do the regulators protect the American system here, our financial system, if 

we do not know what is going on out there, the only limit is the 

creativity of some of those folks over at MIT, some of whom live 

in my district, how do we allow that to operate when all the good 

that your industry might do, you also have the ability to destroy 

the economy and bring the economy down, how do we balance that? 

Mr. DON THOMPSON. Well, I would like to address that. I think 

that the framework that we have been working on with the Fed 

and the other regulators provides a paradigm here where you have 

clear transactions between major dealers that are standardized 

being given up to a clearinghouse. And then with respect to transactions that are not cleared, you have central trade repositories, 

which contain all of the trade information of those non-cleared 

transactions, whether they be not cleared because of their degree 

of customization or because of the counterparties to the transVerDate Nov 24 2008 18:16 Nov 06, 2009 Jkt 052397 PO 00000 Frm 00037 Fmt 6633 Sfmt 6633 K:\DOCS\52397.TXT TERRIE
32 

action, which are accessible to regulators in whatever form and as 

frequently as they want it. 

Mr. LYNCH. Okay, I understand that part so far, but let’s go back 

to my point was if in the derivatives, you get a substantial number 

of derivatives that we call it, ‘‘the too many people on one side of 

the boat phenomena,’’ like we had with AIG and a lot of others 

where unbeknownst to us everybody had loaded up on the same positions, those positions went bad, everybody tried to liquidate at 

the same time and because we did not know what the counterparty 

risk was there, we could not do anything about it, and so the boat 

sank. How do we get at that when we have an opaque system of 

customized derivatives, how do we get at that problem? 

Mr. DON THOMPSON. Well, I do not believe you would have an 

opaque system of customized derivatives because all of the customized derivative trade level information would be in the trade repository and would be available to the systemic regulator on a 

more or less real-time basis. So to use your analogy, the systemic 

risk regulator sees who is going over to one side of the boat and 

is able to take preemptive action before everybody moves over to 

one side of the boat or before one major market participant, like 

an AIG, gets way over to the one side of the boat. 

Mr. LYNCH. I appreciate your attempt there but having looked at 

these derivatives and how complex they are, and if they are all 

carved out individually, customized to these firms and their situations, I do not think there is any systemic regulator who is going 

to be able to make that determination based on the instrument 

itself. These are very, very complex, it is mind-numbing how complex these things are, and I just do not think that is a realistic expectation. 

I think I have exhausted my time, Mr. Chairman. I appreciate 

your attempt to address that, and I appreciate the attendance of 

all the witnesses. Thank you. 

Mr. SHERMAN. I will ask you for the record to comment whether 

instead of just making this available to the regulator, every word 

should be put on the Web site of every one of these that are in the 

depository, but I have no time because I yield to the gentlelady 

from Illinois. 

Mrs. BIGGERT. Thank you, Mr. Chairman. My question is directed to all of you or whomever wants to answer. There has been 

much discussion or warning rather against a one-size-fits-all approach. So my question is, should we have three buckets of OTC 

products? For example, number one would be standardized OTC 

products potentially traded on an exchange; number two would be 

OTC products run through a clearinghouse or central counterparty; 

and number three would be customized OTC products that remain 

privately traded but are reported to a warehouse. So how would 

these be defined, how would you define these? And then second, 

should a trigger mechanism be established so that all OTC products clearly fall into one of these three buckets? 

Mr. PICKEL. If I could just comment, I think that is a very good 

division of how this market will evolve and is already in the process of evolving. You would have an exchange traded, or perhaps an 

electronically traded element, that would allow the highly standVerDate Nov 24 2008 18:16 Nov 06, 2009 Jkt 052397 PO 00000 Frm 00038 Fmt 6633 Sfmt 6633 K:\DOCS\52397.TXT TERRIE
33 

ardized trades to be traded that way. You would have this category 

of cleared trades and then you would have the customized trades. 

I think the question of where a product is in the standardization 

process is largely a function of how actively traded and how liquid 

the underlying market is because keep in mind a clearinghouse will 

need to at least daily, and sometimes twice daily, mark those positions to market and call for margin, and so it needs to have a liquid market for that project. An exchange needs an even higher degree of liquidity, market makers who are active in the exchange, 

ready to do a transaction at any time during the trading day. So 

that liquidity I think largely drives where the dividing line would 

be, but that is not an easy determination to make. 

Mrs. BIGGERT. And then what about the customized OTC products that would be privately traded, there would be no control over 

them except reported to the warehouse? 

Mr. PICKEL. Well, there would be the reporting to the warehouse. 

There would be most of the dealers who are engaged in these 

transactions and would continue to be regulated, primarily by the 

banking regulators. And then for those entities that would fall into 

this category of taking on significant exposure to counterparties, 

the systemically important entities, you would have the systemic 

risk regulator overseeing their activities. 

Mrs. BIGGERT. Could you suggest a trigger mechanism that 

would help to ensure that they fall into one of these buckets? 

Mr. PICKEL. Well, I think that is the important issue, and we are 

actively engaged in conversations with the Administration about 

how we would go about identifying what is sufficiently standardized to move to a cleared environment and then furthermore to an 

exchanged trade or an electronically traded environment. I think 

that is something that the Administration is wrestling with currently. 

Mrs. BIGGERT. Would anyone else like to—Mr. Thompson? 

Mr. DON THOMPSON. Yes, I would like to add that in addition to 

the measures that Bob mentioned about the customized bucket of 

OTC derivatives, we are broadly supportive of the steps that Chairman Gensler outlined in his recent testimony in terms of codes of 

business practices, increased capital requirements, strengthened 

anti-fraud and market manipulation, and trade reporting. So I do 

not think it is fair to say you would be relying entirely on the trade 

repositories as the only measure. I think there are a host of other 

measures that Chairman Gensler has thoughtfully outlined and 

that are broadly consistent with the Administration’s proposal as 

well. 

Mrs. BIGGERT. Okay, thank you. Another question is would any 

of you care to describe any issues that you may have with the Waxman-Markey bill and how do you feel about a new transaction fee 

or tax? No interest in that? 

Mr. PICKEL. Well, we have weighed in, we have worked with 

other organizations that are members to oppose those provisions. 

And I think that imposing a tax, just as has been debated over the 

years about imposing a tax on futures trading, I think harms the 

efficiencies of these markets. 

Mrs. BIGGERT. Okay. No one else? Well, then if it has been a concern that some of the OTC derivative products are not safe for reVerDate Nov 24 2008 18:16 Nov 06, 2009 Jkt 052397 PO 00000 Frm 00039 Fmt 6633 Sfmt 6633 K:\DOCS\52397.TXT TERRIE
34 

tail investors, should we simply restrict participation in these markets? We heard long ago that these were not for the people who 

were in pensions or whatever but for those who had the ability to 

take a loss on a large amount of money and somehow it seemed 

to have slipped from that. Is there any concern that we would go 

back to that? 

Mr. DON THOMPSON. Well, I think it is fair to say the over-thecounter derivatives market is already an institutional market. The 

eligible contract participant requirement in the Commodity Exchange Act restricts it from retail investors. Now, I guess one can 

quibble about whether that has been set high enough, low enough 

or whatever, but it is not, and has never been, a retail market, unlike the exchange traded markets. 

Mrs. BIGGERT. Okay, thank you. I yield back. 

Chairman KANJORSKI. The gentleman from North Carolina, Mr. 

Miller? 

Mr. MILLER OF NORTH CAROLINA. Thank you, Mr. Chairman. You 

all have spoken of derivatives as being a risk management tool but 

it appears that there is a great deal more in derivative contracts 

than there is risk to manage. Mr. Kanjorski estimated or repeated 

the estimate of $500 trillion in outstanding contracts. Mr. Bachus 

said $684, which is the number I have heard more often, trillion. 

Our GDP is about $14 trillion, so that it is a big number. I know 

it is not a real number, it is a notional value, it is both sides of 

the transaction, on and on, but it is still a big number. Do you have 

a sense of what percentage of the outstanding contracts actually 

have one of the parties to the contract with an interest in the underlying asset? I was hoping for a short answer, not an essay on 

that. 

Mr. PICKEL. We do not have a statistic on that specifically. In the 

credit default swap space, there is discussion about whether 10 or 

12 percent or something like that would have that underlying interest. 

Mr. MILLER OF NORTH CAROLINA. That is a small number, okay. 

There have been a lot of criticisms of naked derivatives, that it creates tremendous uncertainty about what the real economic consequences are for an event that would appear to be not that consequential. It creates an interconnectedness, it means that a great 

many institutions are too interconnected to fail. And some have 

even said that it means that there are a great many economic players who stand to profit from what appears to be an economic loss 

and have a power to make it happen. 

There was an article in the Financial Times about 6 weeks ago 

about a bank in Kazakhstan. I am sure you know about it. Times 

have been tough economically in the former Soviet space and the 

Kazakhstan government took over the bank. Morgan Stanley had 

debt. That bank owed Morgan Stanley debt, Morgan Stanley could 

call the debt due if there is a change of ownership. Morgan Stanley 

said initially, ‘‘No, no, go ahead, just keep making the payments,’’ 

and then they changed their mind and said, ‘‘No, come to think of 

it, we want you to pay it all,’’ which they could not. And shortly 

after that, or about the same time, they filed with the International 

Swaps and Derivatives Association to start the formal proceedings 

to settle credit default swap contracts with that bank, and the sugVerDate Nov 24 2008 18:16 Nov 06, 2009 Jkt 052397 PO 00000 Frm 00040 Fmt 6633 Sfmt 6633 K:\DOCS\52397.TXT TERRIE
35 

gestion, the Financial Times’ suggestion was that they actually 

made more money on their credit default swap positions than they 

would if they got paid by the bank. Is that concern a valid one? Is 

that something we should worry about? 

William Buiter, a prominent economist, despite my difficulty in 

pronouncing his name, has called for derivatives to become instruments of insurance risk management rather than instruments for 

placing bets, for gambling. What is the social value in allowing derivative positions when neither party of the contract has any interest in the underlying contract? There are obviously a lot of 

downsides to that, what is the advantage? 

Mr. PICKEL. Well, let me—there are a number of things to focus 

on there. One is this Kazakhstan situation where we as an organization and our member firms have been very sensitive to the issue 

of making sure that there is a Chinese wall, there is a division between the lending operation of a bank and the trading or CDS 

trading side of the bank. We have published a number of guidelines 

and rules. People follow those very closely. I think Mr. Thompson 

could elaborate on how that is addressed at JPMorgan, I am sure. 

So that is in place. 

Furthermore, yes, Morgan Stanley did present the question to 

our determinations committee at ISDA but that is a committee of 

15 firms represented, and they all agreed that what happened 

there was a credit event. So there was unanimous support in the 

marketplace. 

Mr. MILLER OF NORTH CAROLINA. But more fundamentally, why 

should there not be something resembling an insurable interest? 

Why should 200 people be able to buy insurance on someone who 

turns up the victim of foul play? Why should there not be a requirement of an interest in the underlying asset? If there is not, 

how is it risk management? 

Mr. PICKEL. Well, primarily because if you want to be able to 

have a product there for those who do need to hedge a risk, it is 

important to have a market there where people are willing to take 

a view on whether the pricing of that is cheap or expensive, so providing that liquidity. 

Furthermore, you have the traditional bond or loan holder, but 

you have other individuals, including the dealers who sell the protection to those people who hold the bonds and loans who will also 

need to manage that risk. So it is a complicated issue of many different types of risks even though the underlying bond and loan 

may be only held by 10 or 15 percent of the users. 

Mr. MILLER OF NORTH CAROLINA. I probably do not have enough 

time to ask another question, so I yield back. 

Chairman KANJORSKI. Ask your question. 

Mr. MILLER OF NORTH CAROLINA. Well, Mr. Murphy, you mentioned or you held up the FAS rule on how derivatives are treated 

in accounting. Insurance or re-insurance, we do not have much control over re-insurance companies. It is an international market, 

much of it is through the markets at Lloyd’s but American insurers 

only get safety and soundness—credit from their safety and soundness regulator, State insurance commissioners, if the parties with 

which they have re-insurance meet certain criteria. Why should 

there not be a similar requirement or is there a similar requireVerDate Nov 24 2008 18:16 Nov 06, 2009 Jkt 052397 PO 00000 Frm 00041 Fmt 6633 Sfmt 6633 K:\DOCS\52397.TXT TERRIE
36 

ment for safety—how are derivative contracts treated for safety 

and soundness purposes by financial institutions? 

Mr. MURPHY. I am not sure I have an answer for that. I think 

maybe Mr. Thompson might be better qualified. 

Mr. DON THOMPSON. Well, you used the— 

Mr. MILLER OF NORTH CAROLINA. Obviously, it is both an asset 

and a liability, how is it treated on the books, how is it treated by 

safety and soundness regulators? 

Mr. DON THOMPSON. So, how are our derivatives activities accounted for? 

Mr. MILLER OF NORTH CAROLINA. Right, how are they treated for 

safety and soundness regulation? 

Mr. DON THOMPSON. Okay, well, from an accounting perspective, 

we operate under a different regime than 3M has opted into with 

respect to its derivatives hedging activities. We as a dealer are subject to mark-to-market accounting with respect to our overall portfolio derivatives transactions. So everyday at the end of the day we 

total up all the gains, total up all of the losses, and those unrealized gains and losses, as they are called, are listed as assets or liabilities respectively on our balance sheet. 

Mr. MILLER OF NORTH CAROLINA. In any of that, do you take into 

account whether the counterparties can actually pay? 

Mr. DON THOMPSON. Yes, and in fact under so-called fair value 

accounting, there is something applied called a CVA, it is a credit 

valuation adjustment, such that if we, for instance, and 3M being 

the kind of credit that it is a bad example but I will use them anyway, if we have 3M as a counterparty and they owe us let’s say 

$100 million across 10 different derivatives contracts and 3M’s 

credit rating declines or actually we have keyed off their credit default spreads, if their credit default spreads indicate that they are 

a riskier credit, in effect we haircut the $100 million that 3M owes 

us, and we will claim it as an asset for let’s say $95 million instead 

of $100 million, applying a credit valuation adjustment of $5 million to reflect the riskiness of the asset that we hold with respect 

to which 3M is obligated. 

Mr. MILLER OF NORTH CAROLINA. I really have exceeded my 

time. Mr. Chairman, thank you for your indulgence. 

Chairman KANJORSKI. Thank you very much. And now the gentleman from Georgia, Mr. Price, for 5 minutes? Okay, you want to 

subvert the rules on the Republican side and honor—okay, very 

good, we will recognize Mr. Hensarling for 5 minutes. 

Mr. HENSARLING. Thank you, Mr. Chairman. Some of this may 

be a little bit of old ground, but I want to put a finer point on it. 

A Reuters article came across my desk a couple of weeks ago and 

it has this take away, I will quote from it, it is a May 14th article, 

‘‘The Obama Administration’s plans to move derivatives trading to 

exchanges could end up hurting companies that use the products 

because accounting rules often make customized off-exchange products a better choice for corporations. In the end, the Administration 

will have to limit the scope of the reforms it is looking for, press 

for new accounting rules for derivatives or risk killing the market 

for corporate derivatives, experts said,’’ whomever those experts 

may be. I have a panel of experts before me now. 

37 

Mr. Murphy, you have commented somewhat on this but could 

you put a fine point, is changing FAS 133 one of the potential answers to this dilemma? And I think you mentioned that already it 

is being somewhat moderated, if that is the proper term? 

Mr. MURPHY. Well, it is definitely not getting easier. This is a 

slope that I probably do not want to go down, but clearly if we 

move to an exchange or clearing environment, companies would 

have to re-examine whether they can continue to hedge under 

these regulations. So if you said that they were going to be relaxed 

somehow, could that possibly give kind of more running room to 

continue to hedge risk? I would say, yes, that is a possibility, but 

this is a big complicated document, and I think changing it would 

probably not be a slam dunk either, but it is a possibility. 

Mr. HENSARLING. Anybody else? Mr. Thompson? 

Mr. DON THOMPSON. Yes, I would like to address the question 

and maybe go through the accounting in a little more detail to 

make sure everybody understands it. Under the current accounting 

framework, the general rule for derivatives is they need to be 

mark-to-market. That applies to everybody, including 3M. And the 

rationale there is clear, their value changes day-to-day, your financial statements should reflect the value of your assets and liabilities, so to the extent that those assets and liabilities change day 

to day, that should be reflected in your financial statement. 

Hedge accounting reflects a very narrow exception to that and it 

generally goes like this: When you have a specific liability or a specific risk, and you have a derivative so closely associated with that 

liability, that they are essentially part and parcel of each other, 

and a gain in one will exactly offset a loss in the other, you can 

ignore both marking the liability and the hedge to market and ignore fluctuations in the derivatives value. 

To the extent that you relax FAS 133 and require a looser fit between the hedge and the risk that the hedge is hedging, you then 

do—you have a problem with respect to fair value accounting generally because you will allow people to avoid fair value accounting 

for things that are not a perfect hedge but only an approximate 

hedge. 

Mr. HENSARLING. Let’s talk about AIG for a moment since AIG 

really put credit default swaps on the public’s radar screen. I would 

think in any prudent system of risk management, that public policy 

would want to encourage the proper use of credit default swaps and 

their risk management. Clearly, in retrospect, AIG took oversized 

bets that ultimately someone decided the taxpayer must be compelled to bail out, and I assure you it was not me. But the acting 

Director of OTS, under oath in this committee, said that his regulatory body had the manpower, had the expertise, had the regulatory authority to curtail AIG’s CDS position, they just missed it. 

They just made a mistake. 

So I guess my question would be this, if we had this concept of 

a clearinghouse in place prior to AIG’s meltdown, what type of difference might it have made? And as we attempt to lessen the risk 

in the system, and clearly the flip side of risk is rate of return, but 

if all members of the clearinghouse are going to be responsible for 

the risk, does that not incentivize some to try to pawn the risk off 

to the larger group and have we not perhaps even created more 

38 

systemic risk and created the next big bailout with such a clearinghouse? Anybody who cares to answer, Mr. Pickel seems to be the 

first at the buzzer. 

Mr. PICKEL. Right, not playing Jeopardy, are you. No, that is certainly a concern with a clearinghouse, and it has been identified by 

regulators as a significant concern, which is why having the appropriate regulatory oversight, having requirements for capital up 

front, margin requirements, a reserve fund, all those things are 

critical components. And the dealers who have been active in putting these together, whether it is the existing clearinghouse in the 

interest rate swaps base or the more recent initiatives in the credit 

default swaps space, have focused on providing just those protections. But it is something that requires regular diligence to oversee 

and make sure that that clearinghouse does not in fact increase 

risk. 

Mr. HENSARLING. Thank you. I see my time has expired. 

Chairman KANJORSKI. The gentleman from Georgia, Mr. Scott, is 

recognized for 5 minutes. 

Mr. SCOTT. Thank you, Mr. Chairman. It seems to me that the 

issue here is the central clearinghouse, whether or not we should 

mandate it, and there have been some concerns raised that if we 

do that, that it will drive business overseas. Then there is also the 

issue of illiquid and unstandardized derivatives. And I would like 

for you to kind of explain to me how having a clearinghouse, as the 

Secretary of the Treasury, Mr. Geithner, has proposed, and which 

seems to be the drift here, would force this business overseas? Is 

that true first of all? And, if so, if you could explain how that would 

happen? 

And since derivatives are based on a value of something else, 

meaning stocks and so forth, which I think is liquid, what is an illiquid and unstandardized? And does that bring a greater risk 

itself? 

Mr. FEWER. Congressman, there is a class of—if we talk about 

credit, there is a class of credit product that is easily conducive to 

exchange listing. They are a family of a composite of index products 

that frankly account for a very significant portion of outstanding 

CDS contracts. And these are very, very standardized products, 

trade in very large size, high trading frequencies, an example 

would be a bespoke basket of credit default swaps. Dealers have 

huge portfolios of credit default swaps that they would like to customize and take some very difficult to trade names, put them in 

a basket and try to have the market price what actual protection 

on that bespoke pool. That would be a very difficult product to force 

through a central counterparty clearance. However, that does not 

mean that there could not be prudence from a risk-based capital 

standpoint. 

And Basel II has done a lot of work along these lines, but also 

the fact that a central counterparty clearer and a trade repository 

would be able to bring some information regarding that trade, not 

necessarily give the specific trades that would expose dealers to 

having their proprietary positions open to the market, but being 

able to give regulators the appropriate information and the ability 

to assess value of the very, very bespoke types of transactions. But 

that would be an example of a bespoke transaction as opposed to 

39 

an index trade, which is a very high volume type, very, very standardized transaction. 

Mr. PICKEL. I might add on the clearing point and whether that 

would encourage business to be done overseas, there is an initiative, which ISDA is involved in, as are our major members, with 

the European Commission to focus on establishing a clearinghouse 

over in Europe. There could be advantages to having a linkage between a U.S. and a European clearinghouse for the CDS product. 

But that is an ongoing discussion, so I do not see that—I do not 

see clearing as such as a driver for moving certain business—at 

least a market-driven reason for moving business here or overseas. 

It may be a regulatory-driven decision given the stance of the European Commission on that. 

Mr. SCOTT. Okay, yes? 

Mr. DON THOMPSON. I think that the moving business overseas 

argument is not one I am as focused on as the risk that companies 

such as 3M and other end users of derivatives, if they are forced 

into a mandatory clearing for everything or exchange trading platform, will simply choose to leave risks unhedged. And I think that 

is frankly the greater risk from a public policy perspective in the 

United States. 

Mr. SCOTT. Let me ask you, I have a little bit more time left, I 

remember when this whole issue of derivatives came up in the 

great financial mind that we all have great respect for, Warren 

Buffett, referred to them as ‘‘weapons of mass destruction.’’ Do you 

all think Warren Buffett was right? 

Mr. DON THOMPSON. I have read that quote as well, and after 

I read that quote, I continued to go through Mr. Buffett’s piece 

where he outlined his firm’s derivatives portfolio, which, as I recall, 

was a large portfolio of CDS index positions, a recent entrance by 

his firm into trading single name credit default swaps, and I believe a large portfolio of puts, long-dated puts on the S&P 500 Equity Indices. So after I read the whole piece, which is the case with 

everything with Mr. Buffett, very illuminating, I found it difficult 

to square the beginning characterization of derivatives with the detailed disclosure of his firm’s active participation in a number of 

OTC derivatives markets. 

Mr. SCOTT. I see my time has expired. Thank you, Mr. Chairman. 

Chairman KANJORSKI. The gentleman from Georgia, Mr. Price, is 

recognized for 5 minutes. 

Mr. PRICE. Thank you, Mr. Chairman. I appreciate that. The decisions that we make here are consequential, in fact the decision 

to do nothing is consequential. But my concern oftentimes here, 

and I know that many of my colleagues here, whatever we decide, 

we often do not look at the outcome or the consequences of the decision that we make down the line. So, Mr. Murphy, if I could ask 

you a couple of questions as again the only end user of CDS’s on 

the panel today. How has 3M utilized CDS’s to benefit your consumers. 

Mr. MURPHY. We do not use CDS products. 

Mr. PRICE. You do not? 

Mr. MURPHY. No. 

40 

Mr. PRICE. And so in the process of this discussion, do you have 

any thoughts about whether we mandate a clearinghouse in this 

arena or not? 

Mr. MURPHY. In the CDS arena? 

Mr. PRICE. Yes. 

Mr. MURPHY. I really do not have an opinion on that. 

Mr. PRICE. How about any over-the-counter products? 

Mr. MURPHY. Other over-the-counter products, absolutely. 

Mr. PRICE. And how is the use of over-the-counter products a 

benefit to your customers? 

Mr. MURPHY. Well, it benefits our customers because it allows us 

to go into markets, particularly overseas, and be confident our 

products competitively and then manage the risk of converting 

those funds back into U.S. dollars. They are really pretty simple: 

we sell goods into Thailand, and we enter into a very simple derivative that allows us to sell Thai bhat by U.S. dollar at a fixed rate 

at a date out into the future. So we are able to go into those markets and more or less know what we are going to get back, being 

able to bring back to our shareholders in the United States in the 

future. 

Mr. PRICE. Has 3M changed any of the policies that you have regarding OTC products since the financial meltdown last fall? 

Mr. MURPHY. No, we have not. We just continue to be mindful 

that we want to spread our business around to various counterparties, that we are not doing all of our business with one or two 

banks, so we have a half a dozen institutions that we deal with. 

But I would say we have not made any policy changes in the last 

year. 

Mr. PRICE. And the market for those products is the same, greater, less? 

Mr. MURPHY. It is really the same. It has continued to function 

very well all through last fall. 

Mr. PRICE. I want to pick up on some of the questions that my 

colleagues have asked about driving business overseas. Mr. Pickel, 

if I may, and I apologize for being out earlier, but in your testimony you note that, ‘‘Mandating that interest rate swaps and credit default swaps being traded on exchanges is likely to result in 

only higher costs and increased risk to manufacturers, technology 

firms, energy producers, utility service companies and others, who 

use OTC derivatives in the normal course of their business. It will 

put American businesses at a significant disadvantage to their 

competitors around the world.’’ And when you say ‘‘American businesses,’’ you do not mean the clearinghouses, you mean American 

businesses? 

Mr. PICKEL. I mean companies like 3M, Cargill, Boeing, others 

that have exposure either to interest rate fluctuations or currency 

fluctuations. 

Mr. PRICE. And in that risk to American business, you believe 

that would drive businesses overseas? 

Mr. PICKEL. It would, as I think Mr. Murphy has highlighted, increase their costs and decrease their competitiveness, so that would 

likely result in less business being done by U.S. companies. 

41 

Mr. PRICE. Do you know what other governments are doing to determine their systemic risk in the derivatives market or act upon 

their systemic risk in the derivatives market? 

Mr. PICKEL. Well, a lot of discussions are taking place over in the 

European Commission. It is now focused primarily on clearing, in 

establishing a clearinghouse for European credit default trades. 

The Commission is in the process, and we expect to see a report 

out of them in the next week to 2 weeks regarding OTC derivatives 

and how they might approach some of the issues. We anticipate it 

will touch on similar points to Secretary Geithner’s letter from a 

couple of weeks ago. 

Mr. PRICE. Mr. Thompson, I have just a few minutes left. You 

mentioned that if we mandated a clearing companies would ‘‘leave 

risks unhedged.’’ What is the consequence of that? 

Mr. DON THOMPSON. The consequence of that is that a company 

which is an exporter and is exposed to fluctuations in currency risk 

may incur losses as a consequence of currency exchange rates that 

it otherwise might not incur if it were enabled to hedge them in 

the manner that it wanted to in the OTC markets. 

Mr. PRICE. So a decrease in potential business viability? 

Mr. DON THOMPSON. It is generally being exposed to a risk that 

is not its core business. 3M is a great example. They make all these 

little things in the book and they do a great job, and we all use 

them. Their specialty is not forecasting interest rates or forecasting 

the exchange rate of the U.S. dollar versus the Thai bhat. They 

would prefer to hedge those risks away and focus on their core 

business, which is the attitude of many of our corporate clients. 

However, if they have to post liquid securities or cash to a clearinghouse or if they have to suffer income statement volatility because their hedges have to be on an exchange and thus do not qualify for FAS 133 hedge accounting, they face a difficult choice: Do 

I pay the increased cost? Do I suffer the increase income statement 

volatility and go ahead and hedge the risk anyway or do I not 

hedge the risk and hope it works out for the best? I am sure some 

companies will pay the increased cost. I am sure some companies 

will say, ‘‘No, we will leave the risk open.’’ I think in neither case 

is that good for American business. 

Mr. PRICE. Thank you, Mr. Chairman. 

Chairman KANJORSKI. The gentleman from Connecticut, Mr. 

Donnelly, for 5 minutes? I am sorry, from Indiana. I am always 

putting you in Connecticut. 

Mr. DONNELLY. You have me on a vacation, sir. Thank you, Mr. 

Chairman. I guess I would just like to ask following up, we heard 

about the risk to American business, I come from Indiana, and I 

will tell you what the risk to our business has been, it was the destruction of the credit markets. And we saw business after business 

fail because of what happened in the credit market. So when I 

think about risk to American business, I think about the entrepreneurs in my towns whose credit simply dried up on, who were 

unable to have their business function because of what happened 

in part in the derivatives market. So that risk comes in many different directions. 

With naked credit default swaps, in reading your testimony, we 

talk about enabling the transfer of risks between counterparties. 

42 

Now, if we have naked credit default swaps where Mr. Thompson 

is betting on Mr. Pickel’s package of securities, and someone else 

is insuring it, what risk are you transferring? Is not that just a 

straight bet? I mean you do not even own anything. You are just 

betting on somebody else’s judgment. Anybody can comment. 

Mr. DON THOMPSON. Okay, one thing I think one needs to keep 

in mind in the naked CDS debate is there are a number of different 

market participants who use the products for very different purposes. There are hedgers, small banks for example, who hedge 

their loan book or their securities holdings in a more traditional 

fashion. There are also investors, hedge funds, asset managers, 

pension funds and the like, who engage in credit derivatives activity as an alternative to other investments, either buying bonds or 

other funded financial assets, and they comprise a significant percentage of the over-the-counter CDS market. 

Mr. DONNELLY. But that is speculation, that is not a risk transfer. That is totally different. 

Mr. DON THOMPSON. You can assign it whatever term you would 

like. I prefer to think of it as investing in the hope of getting a return. If that equals speculation, so be it. 

Mr. DONNELLY. But risk do you have if you do not own the underlying assets to start with? You are not putting off the risk you 

have in owning those, you are simply speculating on somebody 

else’s judgment is all you are doing. 

Mr. DON THOMPSON. What that investor is doing is deciding to 

take credit risk in CDS form instead of taking credit risk in more 

traditional form, such as buying the bonds of a particular issuer or 

buying loans of a particular issuer. That also happens frequently 

in the financial markets. What we have seen with many investors 

is they prefer to take risk in CDS form because the CDS market 

provides diversified, lower risk forms of credit risks, such as the 

credit default swap indices, which are the most popular product in 

the over-the-counter CDS market. 

Mr. DONNELLY. But it is not the risk of them having anything 

underlying that they own? They are making a bet on someone 

else’s judgment. 

Mr. DON THOMPSON. If you think of a typical investor, they are 

typically long on cash and they need to invest that cash in an investment. That invest that cash in an investment. That investment 

could be a traditional investment product, such as a bond or a loan, 

or another form of funded financial instrument. Alternatively, 

many investors prefer to transact in the derivatives market in a socalled non-funded product whereby they get compensated for taking 

credit risk, often to a broad-based index of companies, such as the 

CDX index, which is the prominent index which trades in the 

United States. 

Mr. DONNELLY. Why would making those trades more transparent result in less competitive conditions for American companies, why would transparency harm their ability to manage risk instead of being stuck in a drawer at AIG that everybody in Indiana 

eventually has to pay for? 

Mr. DON THOMPSON. I think that is an excellent question, and 

I think that the first point I would make in response to it is we 

are broadly supportive of increased transparency in the OTC marVerDate Nov 24 2008 18:16 Nov 06, 2009 Jkt 052397 PO 00000 Frm 00048 Fmt 6633 Sfmt 6633 K:\DOCS\52397.TXT TERRIE
43 

kets generally and particularly in the CDS markets. We have been 

working actively with the Fed and other regulators for the past 4 

years to increase transparency, increase centralized clearing of 

standardized contracts, including many of the index products, 

which I mentioned to you in my earlier remarks, it is not at all the 

case that we are opposed to increase transparency in the OTC markets. We do think that one needs to be careful when making decisions about market structure as a public policy-maker, to consider 

not just the benefits of transparency but it does in certain cases 

have costs as well. And all we ask is that there be a thoughtful debate about the relative cost and benefit. 

Mr. PICKEL. I would also just add that the risk that AIG was taking on through their use of credit default swaps represented a very 

small portion of the overall CDS business and what they were 

doing was taking on exposure again to underlying subprime risk. 

And to the extent that, I think somebody said earlier, the CDS 

were hard to value, the CDS value is driven by the value of the 

underlying position. It was the CDOs that they sold protection on 

that were in fact hard to value. 

Mr. DONNELLY. You say it is a small portion of it, but that is like 

saying, ‘‘Well, it is a small natural gas pipe but it blew up the 

whole house.’’ We are in a position where we have business after 

business that folded and encountered extraordinary difficulty because of what happened based on the credit market actions that 

began in New York and in other places. 

Mr. DON THOMPSON. And no one is advocating another AIG. And, 

in fact, a key part of many of the proposals, which we as an industry do advocate, is a systemic risk regulator, which is professional, 

well-funded, and has a holistic view of risk across the entire risk 

spectrum. And the reason we advocate that is precisely to ensure 

that another AIG never occurs. 

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

Chairman KANJORSKI. Thank you. The gentleman from Texas, 

Mr. Neugebauer, for 5 minutes. 

Mr. NEUGEBAUER. Thank you, Mr. Chairman. Mr. Murphy, besides derivatives, are there other ways that you could hedge your 

current C positions in other ways or is that the sole way that is 

available to you? 

Mr. MURPHY. There are some operational things you can do in 

certain countries, for example, where we do not use derivatives, 

where the derivative markets are not developed, Latin America for 

example. You can change payment terms with customers, you can 

take out debt in certain currencies and match that against some 

of your assets in those currencies, but typically that takes place in 

those more Third World type markets. In G–20 countries where we 

have sophisticated competitors who have access to capital markets, 

we have to be more nimble, more efficient from a pricing standpoint, and so derivatives are clearly the number one way to go. 

Mr. NEUGEBAUER. Okay. Mr. Pickel, when you look at the market between what possibly products that could be standardized and 

then those that are a custom, and I think you have done a pretty 

good job earlier of kind of differentiating what those definitions 

44 

are. What today if everything was sorted into two stacks, customized and standard, what would the mix be? 

Mr. PICKEL. It really varies by product type. In the credit default 

swap space, especially with some steps taken earlier this year to 

standardize a couple of other parts of the trading terms, there is 

a high degree of standardization across index and single name 

products. So, again, it is hard to say exactly what that number 

would be but people throw out the number of 80 to 90 percent but 

there is still a decent portion that would be customized. 

In other product areas, for instance in the interest rate swap 

world where there is—there has been an existing clearinghouse in 

London for close to the past 10 years, they clear about a little over 

50 percent of inter-dealer trades, so not the customer trades and 

not all dealer trades but a significant portion, and there is probably 

more room there in the interest rate swap space to achieve more. 

And then also in energy areas, there is a fair amount of clearing 

through an ICE facility that is used and also the NYMEX 

Clearport Facility. Equity derivatives, there are some clearing options available. But it is hard to say exactly what that percentage 

would be. 

Mr. NEUGEBAUER. And one of the things that is being discussed 

is whether there should be one clearing or a multiple clearing. And 

just kind of going down the row there, kind of give me your perspective, one or many? Mr. Fewer? 

Mr. FEWER. Most likely it would probably make sense that there 

would be one or two global clearers. The issues in Europe I think 

surrounding what constitutes bankruptcy are probably being looked 

at and properly addressed so that there will be much more cohesion with U.S. interpretations, so certainly no more than two. 

Mr. NEUGEBAUER. Okay, Mr. Pickel? 

Mr. PICKEL. I think inevitably it will be many certainly to begin 

with but over time the market will determine, and I would not be 

surprised if we would move to two or one. 

Mr. NEUGEBAUER. Mr. Murphy? 

Mr. MURPHY. I would agree with the many answer, at least up 

front. I worry about from a band width standpoint, the size of the 

market, is there a player out there that is really able to take this 

all on in one big bang? 

Mr. NEUGEBAUER. Mr. Thompson? 

Mr. DON THOMPSON. I would echo Mr. Murphy’s comments about 

the band width restriction. These are incredibly complicated and 

difficult things to set up and get up and running. I also think it 

is worth pointing out that they are by their nature, especially if 

coupled with some form of mandated clearing requirement, anticompetitive in that you have no choice. So having some alternatives, in the sense of more than one, is probably a good thing 

from that perspective. 

Mr. FERRERI. I think it is going to wind up being no more than 

a handful. I do not see the benefits to a regulator to have to look 

at 30 or 40 or 50 different clearinghouses to try to find out what 

the repositories might be. Having said that though, I think the 

competitive nature of our business and having to keep cost down 

in an effort to handle a high band width needs of markets will 

mandate the need for two or three. 

45 

Mr. JOHNSON. There is some academic evidence that suggests the 

benefits start going down if you have more than one. 

Mr. NEUGEBAUER. And a follow-up question, what benefits start 

to go down if you have more than one? 

Mr. JOHNSON. I think it is efficiencies and competitiveness. I 

would be happy to get you a copy of some of the articles on that. 

Mr. NEUGEBAUER. I would like to see that. I see my time has expired. Thank you, Mr. Chairman. 

Chairman KANJORSKI. Thanks, Mr. Neugebauer. The gentleman 

from Illinois, Mr. Foster. 

Mr. FOSTER. Thank you, Mr. Chairman. Mr. Johnson, on the last 

page of your written testimony, you have a very interesting pie 

chart with the different components of the OTC derivatives market. 

And the most interesting number to me there is that credit default 

swaps are 7 percent, which is interesting considering the effect that 

they have had on our economy. But if you start with the big pieces, 

interest rate contracts are 71 percent. And it seems to me that they 

represent a rather small systemic risk and are already exchange 

traded and so on, and that really there is not a lot of action that 

is necessary from our point of view there. Is that something you 

would agree with? 

Mr. JOHNSON. Well, I think the pricing is more stable, although 

we had some wild gyrations that went on after the Lehman failure. 

I think the more stable and the more commodities and— 

Mr. FOSTER. Are they all standardized? 

Mr. JOHNSON. No, no, they are quite different from each other. 

I think one thing the market has done though is that the pricing 

of them is very easy to do in terms of everyone is able to price 

them and come up based on how LIBOR moves and come up with 

them. 

Mr. FOSTER. Similarly, the foreign exchange contracts, the transparency of those must be total essentially? 

Mr. JOHNSON. Well, it is the most liquid and largest market—the 

most liquid market is currency and so you do tend to get better 

pricing, although Mr. Murphy could probably explain better. 

Mr. FOSTER. Yes, so would you also agree that the systemic risk 

probably is not there if that is what we are worried about? 

Mr. JOHNSON. Oddly enough, we have had some terrible crises 

involving foreign currency issues. Back in 1998, we had our Indonesian crises, in Hong Kong and other places, where the problems 

keyed off of foreign currency problems. Mexico just recently has 

had tremendous problems with their bets made on foreign currency, that has bankrupted several companies there tied to the derivative industry and so it comes and goes depending on how they 

are structured. 

Mr. FOSTER. Are there specific motions that we can make that 

you find attractive to try to stabilize that or prevent that sort of 

mess in the future? 

Mr. JOHNSON. Well, I think what is interesting is the good work 

that is being done in the credit default swap market as the regulators have nudged participants to clean up the area and to try and 

reduce systemic risk. Some of the best practices, and it has almost 

become a model for what we could do in other areas as we move 

forward. 

46 

Mr. FOSTER. And if I go to the next smaller slice is credit default 

swaps at 7 percent. And a general question, would have forcing all 

of the OTC derivatives on to clearing or an exchange have prevented AIG financial products, at least the part that was not related to the mortgage lending or their securities lending business? 

Mr. JOHNSON. I think a huge problem with AIG was their margin 

calls that they received as their credit rating slipped. 

Mr. FOSTER. Would that have been allowed if they had been on 

an exchange, at least of the kind I am familiar with? 

Mr. JOHNSON. They clearly would have been margined differently, and I defer to— 

Mr. FOSTER. Right, and so at some point the people who supervise the margins and the capital accounts here would have said, 

‘‘Okay, guys, you are trading on the good name of AIG, but we 

want to see the collateral,’’ and that is what would have stopped 

them, is that a fair guess as to how the scenario would have played 

out or are there more—do I not understand the mechanics of how 

AIG would have been prevented by putting it on the exchange? 

Mr. JOHNSON. So, Congressman, I think that at the time that 

what AIG was doing was selling default swaps on very complex 

CDOs. If those credit default swaps were then subject to some type 

of margining certainly earlier on, the dealers that were buying 

those credit default swaps, to hedge their own portfolios, would 

have looked at it and said, ‘‘This does not make sense. We would 

not be able to post a margin that the exchange would require in 

order for us to do this transaction.’’ And margin requirements, particularly in single name default swaps, is a complex issue because 

the default probability that the exchange would have to calculate 

to get the margin is something that needs work. 

Mr. FOSTER. So, again, the thing you would say is to actually 

have margining in collateral posting requirements— 

Mr. JOHNSON. Well, that is what it— 

Mr. FOSTER. —to prevent this sort of—that is what is actually 

more important than the transparency of exchanges, the transparency I take it was not an issue with AIG? 

Mr. JOHNSON. The transparency of the over-the-counter market, 

if it is really looked at, is generally healthy and the perception that 

would happen in AIG really reflected the transparency of the global 

over-the-counter market is not—there is not a direct relationship 

there. Certainly, if there was a central counterparty clearing facility in place when a dealer would have went to try to book a trade 

to hedge his or the CDO portfolio, the amount of margin required 

certainly would have— 

Mr. FOSTER. That would have triggered— 

Mr. JOHNSON. That would have— 

Mr. FOSTER. That would have stopped it? 

Mr. JOHNSON. —at least a question and turn around and say 

something is not right. 

Mr. FOSTER. In order to preserve that, you need to have that sort 

of margin requirement for both the customized and the non-customized things if you intend to use margining as the way of preventing future AIG’s? Okay, thank you. I yield back. 

Chairman KANJORSKI. Thank you very much, Mr. Foster. Now, 

we will hear from the gentlelady from Minnesota, Ms. Bachmann? 

47 

Mrs. BACHMANN. Thank you, Mr. Chairman. I had a question for 

Mr. Murphy, and I understand that earlier you had mentioned that 

3M would see anywhere between $100 million to $200 million, if 

that was accurate, should 3M have to post against their risk management activity. Is this impact unique to 3M or what are you seeing with other countries—other companies across the board? 

Mr. MURPHY. No, it definitely would not be unique to 3M. As we 

are a large company, those numbers are large probably relative to 

other companies, but it could be a smaller company, a mid-size 

company, a small company that is $50 million in sales and imports 

goods from Germany, they could be in the same boat. And, frankly, 

the smaller company is going to be even worse off because they will 

have fewer resources to credit than a 3M would. They may have 

a single bank and that bank may not—may have tighter covenants 

on their loan agreements and so that capital is even more valuable 

or more scarce to a smaller entity. So it would be very, very widespread. It would not be limited to a large multi-national like 3M. 

Mrs. BACHMANN. What about the issue of transparency, we hear 

that a lot and I am wondering, do you see transparency now being 

available on over-the-counter products? 

Mr. MURPHY. Well, certainly we have very lengthy disclosures 

that we have to make as a publicly-traded company. That is not 

the same for privately-held firms obviously. But we see in foreign 

exchange, for example, over 50 percent of the volume in foreign exchange is done on electronic platforms. We are definitely in favor 

of the idea of potentially the trade repository where that information gets delivered on a more real time basis. We would like to 

work with the committee on that effort. So we are definitely not opposed to greater transparency but I can tell you the market today 

is certainly much more transparent than it was 5 or 10 years ago. 

Mrs. BACHMANN. And what would your suggestions be on efficiency and transparency, that is where I think the committee 

wants to go with greater efficiency and transparency? You had 

mentioned a little bit of what your concerns were and maybe what 

your ideas were? 

Mr. MURPHY. Well, again, I think we certainly would have to 

work with the dealers. I think, again, this trade repository idea is 

the one that we would be most in favor of. We believe that the OTC 

market, as they are structured today, are very efficient for corporations, so I am not sure—we certainly do not believe that moving 

to a mandatory clearing or exchange environment would improve 

the efficiency of the market in any way. 

Mrs. BACHMANN. Mr. Chairman, I do not know if I still have 

time remaining but I would open that question up to anyone on the 

panel, your suggestions for improving efficiency and transparency, 

knowing that is where our body is hoping to go? 

Mr. FERRERI. If I could add just a comment. Many references 

have been made to the foreign exchange market. That 50 percent 

of foreign exchange trading, the spot foreign exchange markets 

happens at ICAP on screens and electronically. The transparency 

issues are price transparency, which is the over-the-counter interdealer market, wholesale market and the trade transparency which 

falls under the trade repository. So it is a twofold transparency 

issue. I also think it is important, I have not heard much about 

48 

this and the exchange concept but delineating between an exchange traded contract and an over-the-counter traded contract on 

an electronic mechanism, all right, that were not defined as electronic exchanges but these are fully transparent and in real time. 

So there are ways to enhance the transparency. They evolve over 

time. U.S. Treasuries, when I started in business a very long time 

ago, were barely onscreen. They were traded over telephones. 

Today, they are fully electronic with real time post-trade processing. So it is an evolutionary process. Mechanisms are in place 

to advance that and the ability to advance that frankly is based on 

the liquidity as it grows in the asset. 

Mr. PICKEL. I think to the extent that we can encourage various 

ways of trading, various ways of managing counterparty credit risk, 

clearing and a bilateral relationship, all of that generates information for the participants in the market. It generates information for 

the regulators and in many cases it generates information for the 

public generally. So I think to the extent we can encourage the 

clearing, the trade repository, electronic trading. And, of course, exchange trading exists in many product areas, not exactly to mirror 

the underlying or to mirror the OTC product but it provides an effective hedge, particularly for dealers who are looking to hedge the 

exposures they take on through their OTC risk. They can lay that 

off in many ways via the exchange trading of products. So the more 

variety we can provide here, I think the better transparency overall. 

Mrs. BACHMANN. Good. I yield back, Mr. Chairman. 

Chairman KANJORSKI. Thank you very much, Mrs. Bachmann. 

Now, we have the gentleman from New York, Mr. McMahon, for 

5 minutes. 

Mr. MCMAHON. Thank you, Mr. Chairman, and thank you for allowing me to participate in this hearing with you today as a guest 

Member. 

I want to first give a shout out to Mr. Ferreri. Chris, it is great 

to see you here, and I am proud to introduce you to my colleagues 

and to the chairman as a constituent and proud son from the great 

borough of Staten Island and New York City. And I have said here 

in my months in Congress, since January, New York City is the financial capital of the world, and when I tell my colleagues that I 

represent people from the executive level all the way to the back 

office and support services, certainly it is great to have you as an 

example of the people who make this industry run. 

I know that many of my colleagues feel some anger toward the 

financial services industry, but I just would like to caution that 

those who think it would be okay to let part or all of this industry 

move to other countries or not be successful would be a bad thing 

for our Nation, it certainly would be a very bad thing for the people 

whom I represent, more than 80,000, just in my district alone, who 

directly work in the industry and many as well. And certainly we 

look to bail out General Motors, but we do not say, ‘‘Let’s get rid 

of the automobile industry in this country,’’ and I think that is 

something that we have to be mindful about. 

As you know, Chris—Mr. Ferreri, when it comes to the practice 

of trading credit default swaps, the House and the Senate have approached this issue in different ways. The House bill, which passed 

49 

the Agriculture Committee, banned credit default swaps while the 

Senate bill did not. Yet, the Senate bill also goes a step further requiring exchange trading for all over-the-counter derivatives. So 

there is a blending here, and I even heard in the testimony, it may 

be in confusion, credit default swaps is that all derivatives, and I 

know Congressman Foster fleshed this out a little bit, but clearly 

the credit default swaps led to the downfall of AIG, as well as the 

financial instruments upon which they were based. But if you could 

just kind of flesh out a little bit more how much of the overall derivative market is credit default swaps and what role does it play 

in the overall industry? 

Mr. FERRERI. Dr. Johnson put together a very good summary 

that it is a small percentage of the overall derivative market. Interest rate swaps make up the largest portion of it. Interest rate 

swaps are on screens, a representation of those markets are on 

screens to hundreds of thousands of people worldwide to participate 

in the interest rate swap business. The ability to see a bid in an 

offer, someone willing to take risks, take a position on a product 

on a screen or through the inter-dealer market does enhance the 

information flow, it enhances the knowledge that people have to 

participate in these markets. The CDS market for ICAP is very 

small. For us as a company, it is less than 3 or 4 percent of what 

we do. So it is not this embedded CDS bias. I do think frankly that 

the ability to migrate products as they come on to screens, on to 

electronic platforms, is a natural progression toward liquidity. And 

I think as those markets become more standardized and the ability 

to clear them and to margin them, which is not talked about very 

much when we talk about clearing, to effectively margin them 

would make sense. 

Mr. MCMAHON. So are credit default swaps the problem in all 

that is going on here, and should we focus only on those and leave 

the rest of the derivative market alone and that would allow certainly Mr. Murphy, 3M, most of their derivative action seems to be 

with foreign exchange fluctuations? Do you understand my question? My fear is we are throwing the baby out with the bath water, 

can we separate the two here? 

Mr. FERRERI. It is effective derivatives regulation, right, so this 

is about the derivative market in general. CDS, CDOs, at the core 

of the AIG problems, and books are being written about the AIG 

failure, but I do think that from a broader perspective, the overthe-counter market in derivatives exist because there is a strong 

need and demand. These are not products that are built up and no 

one participates in. These are products that have been developed 

over time, have been developed to assist a hedge to a specific need, 

and as a result become a tradeable object. So I think as those 

tradeable objects become more liquid, we can see that the increased 

liquidity, it is an evolutionary process. 

Mr. MCMAHON. But can we remove anyone, can we remove the 

CDS’s out of this equation and leave the derivative markets alone 

and just deal with that one issue or you have to deal with it all 

together? 

Mr. FEWER. Congressman, I would try to look at the CDS market 

from a different viewpoint. The CDS market generally is made up 

of very liquid CDX index product, most of what is traded, and sinVerDate Nov 24 2008 18:16 Nov 06, 2009 Jkt 052397 PO 00000 Frm 00055 Fmt 6633 Sfmt 6633 K:\DOCS\52397.TXT TERRIE
50 

gle name product. That area of the credit link market is very, very 

conducive to central counterparty clearing. These instruments did 

not cause the problem of AIG. The collateralized debt obligations 

did, everyone knows that. It would be a fair comment to say that 

a proper postmortem of AIG, to really understand what the dynamics were between CDS and the actual CDOs, however, to parcel out 

CDS from the rest of the derivative world, we should be able to 

apply the same rules right across the board. And over a period of 

time, CDS happens to be in the major headlines but over a period 

of time, I think that the general public will see that whether it is 

a credit index or an equity index or a interest rate swap, these 

products can be very well harnessed and managed within the context of proper market protocols. 

Mr. PICKEL. I think the critical thing, building on the Geithner 

proposals, is the focus on an entity that builds up significant 

counterparty exposure. That is kind of, if you will, the AIG clause 

of the proposal. That is what AIG did. They happened to build that 

up via selling protection on the super senior tranches of these 

CDOs via credit default swaps. It is conceivable, although frankly 

not that hard to conceive, that somebody could build up that position in interest rate swaps or equity derivatives or something like 

that. It is possible, and therefore I think if you had the authority 

for someone to be able to identify that and step in and regulate 

that type of build up, then I think you deal with the AIG issue, 

whether that next issue is a CDS issue, an interest rate swap issue 

or some other derivative type issue. 

Mr. MCMAHON. That entity that would identify that, that is a socalled systemic risk regulator? 

Mr. PICKEL. Well, that is who would eventually, based on the information from these warehouses that would exist for the different 

product areas, that would be the entity that would step in and 

oversee that. I think that entity would also need to work very 

closely with the existing regulators of the banks and other institutions because the banks see that flow, they see that build up. Even 

in the situation of AIG, the regulators would have been able to see 

that the banks were taking on exposure to AIG. 

Mr. MCMAHON. My time is up, maybe you can end with this, Mr. 

Thompson, I call it my ‘‘Chicken Little question,’’ which is did not 

we have those checks and balances in place already and there is 

the Fed and there are all these other agencies, why was not that 

done in the past and why is the creation of a so-called systemic risk 

regulator would inhibit this from happening again when we really 

should have been inhibited this time around? 

Mr. DON THOMPSON. Fair enough, that is an excellent question, 

and I think when people are talking about the systemic risk regulator, the idea is not just another regulator. It needs to be a regulator who has market savvy across a wide range of financial instruments. 

When we think about the problem here, the problem is risk, not 

the form in which risk is taken. So you can look at AIG and say 

they piled up all of this risk in CDS form, ban CDS, but then my 

response in part would be look at Lehman Brothers and Bear 

Stearns who piled up billions of dollars of risk in the form of mortgage-backed securities, which in and of themselves are fine and 

51 

unobjectionable and serve a very valid commercial purpose, but the 

manner in which they finance them on very thin margins in the 

repo market meant that they were able to lever up 30 or 40 to one 

with obvious disastrous consequences. What you need is a systemic 

risk regulator who can look at the whole risk spectrum, understands all the products, and ensures against a reoccurrence of overleverage and excessive risk-taking in whatever form. 

Mr. MCMAHON. Thank you. Thank you, Mr. Chairman. 

Chairman KANJORSKI. Thank you very much, Mr. McMahon. We 

want to thank the panel for their participation, but if I may, before 

we close down the first panel, you really heard the questions of the 

committee members on both sides. We are not looking at just regulating for the sake of regulating. We are looking at what is the best 

thing to do under the circumstances, and I would just point out my 

observation on AIG. The reason why it is such a traumatic failure 

is that it represented a failure of the marketplace. Every person involved in those transactions with AIG should have been doing due 

diligence to see whether there were reserves, whether there were 

margins there, whether their counterparties were responsible to 

pay off. It shocks me that engaging in $2.7 trillion in derivative 

risk by AIG without any of the great companies of the world, calling their attention to AIG, that they did not have the support systems or reserves behind the products they were guaranteeing says 

to me the market failed. Now, why it failed, I do not know. Did the 

sellers of those risks or the traders of those risks think that they 

were too-large-to-fail and exactly what would happen, as did happen, that the government would come in and stand as a supporting 

party? And if that is the case, then what we see here is a total failure of the marketplace that needs great regulation. 

I do not happen to agree that we need necessarily great regulation, but what I capture from the testimony of all six witnesses 

today is that you obviously have greater knowledge than the members of the committee. I would like you to help us. We have to write 

some regulations, which we have probably identified. We need 

some requirements for reserves. We need requirements for transparency. We need some requirements that when we have a systemic risk evaluator, I will not call them a regulator, because if are 

going to have a systemic risk regulator, that has to be some super 

regulator that has authority over every transaction of commerce in 

the world. I do not think America wants that, nor an it afford it. 

And we are just putting off until tomorrow another disaster because they will not be testing the great institutions, like AIG, they 

will be going and looking at the questionable institutions. 

So, what we really want to get to is an efficient, effective way, 

call it regulation or call it watching, what you will, but the use of 

your knowledge, the members of this panel and maybe a few other 

experts around the country, to sit down and argue among yourselves if you will, and send us some of our regulations and your 

suggestions for regulation or oversight so that we can have that as 

we deliberate to right the new methodology of doing this. If you fail 

to do that, I think you can clearly see that there are no derivative 

experts on the Financial Services Committee. I have my fellow 

members here, and I think they will agree. So, we will be operating 

blindly. On the other hand, if we can get your suggestions and your 

52 

assistance, we probably could make a major attempt here to get 

this right. That is what I would like to see you help us do. 

So, before I dismiss the panel, is there any reason why any of 

you would not be willing to serve in advisory roles and perhaps collaborate among yourselves and perhaps over the next several 

months because that is all we have until we get to writing the comprehensive regulation that we are going to have, covering this field 

and many others, particularly in the derivative field, I think you 

have established to me that clearly it is a tool of great value. Listening to 3M’s testimony, I can imagine what it would take to do 

70 percent of your business worldwide and not have a tool of derivatives to guarantee the cost of your product and the value of the 

currency you are dealing in the sales contract of the future. 

So, that being the case, why do not the best minds in the country 

help out the Representatives of the people of the country to write 

the best rules and regulations to allow the markets of the country 

and the world to properly function? If I could indulge you on that, 

I would appreciate it. Is there anyone who would not be willing to 

serve? 

Mr. DON THOMPSON. I think we would all volunteer for that. 

Chairman KANJORSKI. Okay, well, consider yourself imposed in 

the army to solve the derivative problem. And thank you very 

much for your appearance and your testimony today, we certainly 

do appreciate it. Thank you. 

Thank you very much. We will now have our second panel. First 

of all, thank you all for appearing before the committee, and without objection, your written statements will be made a part of the 

record. You will each be recognized for a 5-minute summary of your 

testimony. 

First, we have Mr. Thomas Callahan, chief executive officer, 

NYSE Liffe. Mr. Callahan? 

STATEMENT OF THOMAS F. CALLAHAN, CHIEF EXECUTIVE 

OFFICER, NYSE EURONEXT 

Mr. CALLAHAN. Chairman Kanjorski and members of the subcommittee, my name is Tom Callahan. I am an executive vice 

president head of U.S. futures for NYSE Euronext. 

NYSE Euronext operates one of the world’s largest and most liquid exchange groups, bringing together seven cash equity exchanges and seven derivatives exchanges in six countries. 

In addition, in late May of this year, we received approval and 

principal from the UK’s FSA to launch NYSE Liffe Clearing and 

will shortly begin providing derivative clearing services for our 

London derivatives market. We also provide technology to more 

than a dozen cash and derivatives exchanges throughout the world. 

NYSE’s geographic and product diversity informs our views on the 

principal issue we are discussing with you hear today. 

I am pleased to appear on behalf of NYSE Euronext and its affiliated exchanges as the subcommittee considers the possible amendments to the various Federal laws that affect over-the-counter derivative transactions. NYSE Euronext has always been an advocate 

for fair, open, and transparent markets. Accordingly, our global exchange group has a strong interest in the appropriate regulation of 

OTC derivatives. A large number of our over 4,000 listed compaVerDate Nov 24 2008 18:16 Nov 06, 2009 Jkt 052397 PO 00000 Frm 00058 Fmt 6633 Sfmt 6633 K:\DOCS\52397.TXT TERRIE
53 

nies use OTC derivatives as fundamental hedging tools to manage 

the various risks incurred in connection with the conduct of their 

business. It is essential that these companies have confidence in 

both the integrity of the transactions they enter into and in the 

ability of their counterparties to perform their financial obligations. 

An appropriate and sensible regulatory regime for OTC derivatives 

is a necessary element in restoring and retaining this confidence. 

While it is essential that OTC derivatives be subject to greater 

regulatory oversight, it is also important that the regulatory regime not impose unnecessary requirements that greatly diminishes 

their value, or worse yet, drives these vital markets to opaque offshore jurisdictions. 

It is for this reason that we strongly support the proposed framework for the regulation of OTC derivatives that Treasury Secretary 

Geithner set out in his May 13th letter to the congressional leadership, which takes into consideration the differences amongst OTC 

derivative products and the legitimate needs of market participants 

that use these products to manage their business risks. In particular, we agree that to the extent OTC derivatives are standardized, they should be traded on a regulated exchange or a comparably regulated electronic trading system and cleared through a 

central counterparty. The clearing of OTC derivatives will reduce 

systemic and operational risks, increase market transparency, and 

create market surveillance databases from which regulatory authorities can audit for potentially fraudulent or manipulative activity. 

To the extent a limited class of OTC derivatives are sufficiently 

customized and therefore cannot be executed through an exchange 

or electronic trading system or cleared through a central 

counterparty, such transactions should be subject to public reporting via a tape mechanism, as well as record keeping requirements 

to a regulated trade repository. Importantly any trade that falls 

outside of the regulated exchange and central clearing infrastructure should be subject to robust risk-based capital regimes that appropriately reflect the risk to all counterparties in these transactions. 

A number of different bills have been discussed in Congress to 

address the identified deficiencies of the OTC derivatives market, 

some of which appear to be designed to force certain prescriptive 

solutions on the market. Some of these proposals include requiring 

that all OTC derivatives, standardized and non-standardized, be 

traded on an exchange in a central order book or requiring that all 

OTC derivatives be cleared through a CFTC-registered clearing organization regardless of the liquidity of the underlying instrument 

or prohibiting certain participants from acting in certain markets. 

As it undertakes the task of developing a regulatory regime for 

OTC derivatives, we encourage the subcommittee to strike a balance similar to that suggested in Secretary Geithner’s letter. NYSE 

Euronext believes it would be unhelpful to impose inflexible solutions that would mandate specific market structures in either execution or clearing. This could prove disruptive to markets, introduce unacceptable risks into central counterparties, and could have 

the unintended effect of designating winners and losers amongst 

54 

exchanges and clearing organizations and thereby decreasing needed competition. 

Consistent with Secretary Geithner’s proposed framework, we believe it would be appropriate for Congress to provide this newly 

regulated market and the authorities that will oversee it sufficient 

flexibility to evolve and adjust over time. We believe that the most 

efficient way to determine optimal market structure for the wide 

variety of OTC derivative products is to let market users and regulators decide as market conditions dictate. 

On behalf of NYSE Euronext, I want to thank the subcommittee 

for the opportunity to appear before you today. We look forward to 

working with you to implement an effective regulatory regime for 

OTC derivatives. 

Thank you. 

[The prepared statement of Mr. Callahan can be found on page 

81 of the appendix.] 

Chairman KANJORSKI. Thank you very much, Mr. Callahan. 

And now we will hear from Terrence A. Duffy, executive chairman, CME Group, Incorporated. Mr. Duffy? 

STATEMENT OF TERRENCE A. DUFFY, EXECUTIVE CHAIRMAN, 

CME GROUP, INC. 

Mr. DUFFY. Thank you, Chairman Kanjorski, for this opportunity 

to present our views on effective regulation of the OTC derivatives 

market. 

Treasury Secretary Geithner’s May 9, 2009, letter to Senator 

Harry Reid outlined the Administration’s plan for regulatory reform of the financial services sector. His plan proposed increased 

regulation of credit default swaps and other OTC derivatives. 

This committee posed seven questions for our consideration this 

morning. We agree with many of Secretary Geithner’s proposals. 

For example, we support position reporting for OTC derivatives 

and agree that enhanced price transparency across the entire market is essential to quantify and control risk. We believe, however, 

that the measure chosen to achieve these ends should be fine-tuned 

to avoid adverse consequences for U.S. markets. 

We are concerned that legislation mandating the clearing of all 

OTC transactions could well induce certain market participants to 

transfer this business offshore, resulting in significant loss of U.S. 

futures business. 

By reducing liquidity on U.S. exchanges, this would undermine 

the Congress’ attempt to establish greater transparency, price discovery, and risk management of U.S. markets. 

We applaud the Administration’s efforts to enhance transparency, stability, integrity, efficiency, and fairness in all markets, 

but we believe that with slight modifications to the proposal outlined by Secretary Geithner, and the inclusion of a few additional 

measures would complement the Administration’s efforts. 

We have responded to your specific questions at length in our 

written testimony. Let me offer a brief summary of our responses: 

First, we agree with the informed consensus that the financial 

crisis was attributable in part to the lack of regulation in the overthe-counter market, which was not subject to appropriate disclosure and risk management techniques. 

55 

Second, clearing should be offered to the OTC market in a form 

that makes a compelling alternative to the current model. Central 

counterparty clearing offers a well-tested method to monitor and 

collateralize risk on a current basis, reducing systemic risk and enhancing fairness for all participants. 

Third, we are not in favor of government-mandated clearing even 

though we are strong proponents of the benefits of central 

counterparty clearing. Central counterparty clearing serves as an 

effective means to collect and provide timely information to regulators. It also reduces systemic risk imposed on the financial system by unregulated, bilateral OTC transactions. 

Nevertheless, rather than compel clearing of all OTC transactions, we believe appropriate incentives should be put in place. 

The incentives could be in the form of reporting and capital charges 

for uncleared OTC positions and reduce capital charges for cleared 

OTC positions. We believe they would contribute both to the transparency and the reduction of systemic risks. 

Fourth, obviously, we are strong proponents of the benefits of exchange trading of derivatives, but we are also realists on the issue 

of whether exchanges can generate sufficient liquidity to make exchange trading efficient and economical for our customers. We are 

concerned that government-mandated exchange trading will be a 

massive waste of resources and capital. 

Fifth, in our view, electronic trading offers many benefits. It levels the playing field. It enhances price transparency and liquidity. 

It speeds execution and strengthens processing and eliminates any 

classes of errors of unmatched trades. Overall, it is an enormous 

benefit to the market and to our customers. Electronic trading 

when coupled with our intelligent audit and compliance programs 

allows us to better monitor our markets for fraud and manipulation. It also gives us the tools to effectively prosecute anyone foolish enough to engage in misconduct in a forum with a perfect audit 

trail and a highly skilled enforcement staff. 

Sixth, we believe that there is an appropriate balance between 

price discovery and liquidity that is effectively controlled by the 

current procedures to police excessive speculation. Regulated future 

markets and the CFTC have the means and the will to limit speculation that distorts prices or the movement of commodities in interstate commerce. 

Seventh, we operate trading systems in a clearinghouse in which 

every bid and offer, as well as every completed transaction, is instantaneously documented. In addition, those records are preserved 

for an extended period of time. 

We hope that our views on regulating the OTC market will be 

given significant weight based on our record and experience, and 

I look forward to answering your questions. Thank you, sir. 

[The prepared statement of Mr. Duffy can be found on page 132 

of the appendix.] 

Chairman KANJORSKI. Thank you very much, Mr. Duffy. 

And next we will have Mr. Christopher Edmonds, chief executive 

officer, International Derivatives Clearing Group. Mr. Edmonds? 

56 

STATEMENT OF CHRISTOPHER EDMONDS, CHIEF EXECUTIVE 

OFFICER, INTERNATIONAL DERIVATIVES CLEARING GROUP, 

LLC 

Mr. EDMONDS. Good afternoon, Chairman Kanjorski, and members of the subcommittee. I appreciate the opportunity to testify 

today on behalf of the International Derivatives Clearing Group. 

IDCG is an independently managed, majority-owned subsidiary of 

the NASDAQ OMX Group. IDCG is a CFDC-regulated clearinghouse, offering interest rate futures contracts, which are economically equivalent to the over-the-counter interest rate swap contracts prevalent today. 

The effective regulation of the over-the-counter derivatives market is essential to the recovery of our financial markets. And this 

is a very complicated area that is easy to get lost in. Let me summarize by emphasizing four points that go to the heart of the debate: 

First, central clearing dramatically reduces systemic risk. Second, if we do not make fundamental changes in the structure of 

these markets, we will not only tragically miss an opportunity that 

may never come again, but we will also run the risk of repeating 

the same mistakes. Half measures will not work. Specifically, access to central clearing should be open and conflict free. Third, the 

cost of the current system should not be understated. The cost of 

all counterparties posting accurate, risk-based margins pales in 

comparison to the costs we are incurring today for our flawed system. Finally, the benefits of central clearing, if done correctly, do 

open access and maximum transparency will benefit all users of 

these instruments and allow these financial instruments to play 

the role they were designed to play, the efficient management of 

risk, and the facilitation of market liquidity. 

While there is debate around the use of central counterparties, 

it is important to recognize not all central counterparties are the 

same. Ultimately, market competition will determine the commercial winners, but I encourage members of this subcommittee to stay 

focused on one simple point: All participants must play by exactly 

the same rules. This in turn increases the number of participants, 

which reduces systemic risk. Central clearing gathers strength 

from greater transparency and more competition. This is in contrast to the current bilateral world where all parties are only as 

strong as the weakest link in the chain. 

There has been much fanfare over the handling of the Lehman 

default. While it is true some counterparties were part of a system 

that provided protection, this system was far more of a club than 

a systemic solution. The Federal Home Loan Bank system in Jefferson County, Alabama, and the New York Giants stadium are examples of end users who suffered losses in the hundreds of millions 

of dollars. The current system simply failed the most critical component of user, the end user. 

These are real world examples of why new regulation needs to 

focus on all eligible market participants. This is the foundation of 

the all to all concept. As some have continued to confuse the true 

cost of clearing services, IDCG began to offer what we call ‘‘shadow 

clearing.’’ This is a way users can quantify the actual cost of movVerDate Nov 24 2008 18:16 Nov 06, 2009 Jkt 052397 PO 00000 Frm 00062 Fmt 6633 Sfmt 6633 K:\DOCS\52397.TXT TERRIE
57 

ing existing portfolios into our central counterparty environment. 

We now have over $250 billion in shadow clearing. 

Our data has shown significant concentration risk in the interest 

rate swap world. In fact, two of the largest four participants were 

required to raise significant capital as a result of the recently completed stress test. Just last week, before this same subcommittee, 

Federal Housing Finance Agency Director James Lockhart acknowledged a concentration of counterparties during the past year, 

along with the deterioration in the quality of some institutions has 

resulted in Fannie Mae, Freddie Mac and the Federal Home Loan 

Banks consolidating their derivatives activities among fewer 

counterparties. We must reverse this trend or we will continue to 

foster the development of institutions too-large-to-fail. 

IDCG provides a private industry response to the current financial crisis and our mission has never been more relevant than in 

today’s difficult economic environment. Today’s financial system is 

not equal. The rules of engagement are not transparent, and there 

are significant barriers to innovation unless the work of this committee, Congress, the Administration, and all of the participants in 

the debate yields a system that protects all eligible market participants in a manner consistent with the largest participants, the system will fail again. 

Mr. Chairman, thank you for the opportunity to appear as a witness today, and I am happy to answer any questions. 

[The prepared statement of Mr. Edmonds can be found on page 

139 of the appendix.] 

Chairman KANJORSKI. Thank you very much, Mr. Edmonds. 

And next we have Mr. Jeffrey Sprecher, chief executive officer, 

IntercontinentalExchange, Incorporated. Mr. Sprecher? 

STATEMENT OF JEFFREY S. SPRECHER, CHIEF EXECUTIVE 

OFFICER, INTERCONTINENTALEXCHANGE, INC. 

Mr. SPRECHER. Chairman Kanjorski, Ranking Member Garrett, 

and members of the subcommittee, my name is Jeff Sprecher, and 

I am the chairman and chief executive officer of 

IntercontinentalExchange, which is also known by our New York 

Stock Exchange ticker symbol as ICE. 

I very much appreciate the opportunity to appear before you 

today to testify on the over-the-counter derivatives regulation. And, 

Congressman Scott, thank you for your kind introduction earlier 

today. 

In the mid-1990’s, I was a power plant developer in California, 

and I witnessed the State’s challenge in launching a market for 

electricity. Problems arose from a complex market design and partial deregulation, and I was convinced that there was a more efficient and transparent way to manage risks in the wholesale markets for electric power and natural gas. Therefore, in 1997, I purchased a small energy trading platform that was located in Atlanta, and I formed ICE. The ICE over-the-counter platform was 

designed to bridge a void that existed between a bilateral, voicebrokered over-the-counter market, which were opaque, and open up 

futures exchanges, which were inaccessible or they lacked products 

that were needed to hedge power markets. 

58 

ICE has grown substantially over the past decade, and we now 

own three regulated futures exchanges and five regulated clearinghouses. Yet, we still continue to offer the over-the-counter processing along with futures markets. 

In discussing the need for the over-the-counter regulation, it is 

important to understand the size of the over-the-counter derivatives market and their importance to the health of the U.S. economy. 

In this current credit crisis, derivatives have been commonly described as complex, financially engineered products transacted between large banks. However, in reality, an over-the-counter derivative can encompass anything from a promise of delivery in the future between a farmer and his grain elevator, to a uniquely structured instrument, like an exotic option, and much of the Nation’s 

risk management occurs in between these two extremes. 

Derivatives are not confined to large corporations. Small utilities, 

farmers, manufacturing companies and municipalities all use derivatives to hedge their risks. Providing clearing, electronic execution and trade processing are core to ICE’s business model. As 

such, my company would clearly stand to benefit from legislation 

that required all derivatives to be traded and cleared on an exchange. 

However, forcing all OTC derivatives onto an exchange would 

likely have many negative and unintended consequences for our 

markets as a whole. In derivative markets, clearing and exchange 

trading are separate concepts. At its core, exchange trading is a 

service that offers order matching to market participants. Listing 

a contract on an exchange does not necessarily mean it will have 

better price discovery. Exchange trading works for highly liquid 

products, such as the Russell 2000 or standardized commodity contracts that appeal to a whole host of a broad set of market participants. 

However, for many other markets, exchange trading is not the 

best solution as the market may be illiquid, with very wide bid 

offer spreads, leading to poor or misleading price signals. Nonetheless, these illiquid products can still offer value to hedgers and thus 

they have a place in the over-the-counter deliberative market. 

Turning to clearing, this technique gracefully reduces 

counterparty and systemic risk in markets where you have standardized contracts. However, forcing unstandardized contracts into a 

clearinghouse could actually increase market risk. Where the market depth is poor or the cost of contracts are not accurate for price 

discovery, it is essential that the clearinghouse be operated so that 

it can see truly discovered value. So while ICE certainly supports 

clearing as much standardized product as is possible, there will always be products which are either non-standard nor sufficiently 

liquid for clearing to be practical, economic or even necessary. 

Firms dealing in these derivatives should nonetheless have to report them to regulators so that regulators have a clear and a total 

view of the market. 

ICE has been a proponent of appropriate regulatory oversights of 

markets and as an operator of global futures and over-the-counter 

markets, we know the importance of ensuring the utmost confidence, which regulatory oversight contributes to. 

59 

To that end, we have continuously worked with regulatory bodies 

in the United States and abroad to ensure that they have access 

to relevant information that is available from ICE regarding trading activity in our markets. 

We have also worked closely with Congress and regulators to address the evolving oversight challenges that are presented by complex derivatives. We continue to work cooperatively to seek solutions that promote the best marketplace possible. 

Mr. Chairman, thank you for the opportunity to share our views 

with you, and I will be happy to answer any questions that you 

may have. 

[The prepared statement of Mr. Sprecher can be found on page 

182 of the appendix.] 

Chairman KANJORSKI. Thank you, Mr. Sprecher. 

We will now and lastly hear from Mr. Larry Thompson, managing director and general counsel, Depository Trust and Clearing 

Corporation. Mr. Thompson? 

STATEMENT OF LARRY E. THOMPSON, MANAGING DIRECTOR 

AND GENERAL COUNSEL, THE DEPOSITORY TRUST & 

CLEARING CORPORATION (DTCC) 

Mr. LARRY THOMPSON. Thank you, Chairman Kanjorski, and 

members of the subcommittee. I am Larry Thompson, general 

counsel for the Depository Trust and Clearing Corporation, better 

known as DTCC. 

DTCC brings an unique perspective to your discussion as a primary infrastructure organization serving the U.S. capital markets 

with a 36-year history of bringing safety, soundness, risk mitigation, and transparency to our financial markets. Last year, DTCC 

cleared and settled in U.S. dollars $1.88 quadrillion in securities 

transactions across all multiple asset classes. That is the equivalent of turning over the U.S. GDP every 3 days. 

As an example of DTCC’s contribution to safety and soundness, 

following the Lehman bankruptcy last year, DTCC played a significant role in unwinding over $500 billion in open trading positions 

from trades in equities, muni bonds, mortgage-backed and U.S. 

Government securities without any loss to DTCC, any of its members or to the industry and obviously to the U.S. taxpayer. 

Today, I would like to share some insights gained from the financial crisis of the past year and emphasize one fundamental policy 

point: Fragmentation of data in the financial industry can impede 

the ability of regulators to protect investors and the integrity of the 

financial services system as a whole. These core policy goals are advanced when information on trades are held on a centralized basis. 

We believe maintaining a single trade repository for OTC derivatives contracts is an essential element of the safety and soundness 

for two primary reasons: First, it helps assist regulators in assessing systemic risk, thereby protecting consumers and financial markets. Second, as a practical matter, it provides the ability from a 

central vantage point to identify the obligations of trading parties, 

which can speed the resolution of these positions in the event of a 

firm failure. However, there is no absolute assurance a single trade 

repository for OTC derivatives will be retained unless that public 

policy objective is expressed in law. 

60 

While DTCC supports the role of central counterparties, CCP’s, 

in OTC derivatives trading to support trade guarantees, CCP’s do 

not obviate the need to retain the full details on the underlying 

trading positions in a central trade repository to support regulatory 

oversight and transparency in the market. 

DTCC’s primary mission is to protect and mitigate risks for its 

members and to safeguard the integrity of the U.S. financial system. We launched the trade information warehouse in November 

2006 to provide an automated repository to house all credit default 

swaps contracts. And, during 2007, working with the industry, we 

updated the warehouse with information on $2.2 million outstanding credit default swaps contracts. And our DTCC deriv/serv 

matching engine is now supplying to the warehouse more than 

41,000 trade sides daily. Today, our trade information warehouse 

is the only comprehensive repository of OTC derivatives activity in 

the world. 

Since last year, DTCC has seamlessly processed, or is processing 

through the warehouse, numerous credit events, including Lehman, 

Washington Mutual, as well as the conservatorships involving 

Fannie Mae and Freddie Mac. 

DTCC supports the public policy goals articulated in Secretary 

Geithner’s letter to the House and Senate leadership on a need to 

promote transparency in the OTC marketplace. However, we are 

concerned that regulatory calls to require the use of CCP solutions 

for standardized derivatives transactions could mislead some to 

think that this step alone would be sufficient to provide a complete 

cure for the problem. 

Our trade information warehouse connects and services 1,400 

market participants, providing a central operation infrastructure, 

covering 95 percent of all current credit derivatives trades. This 

trade repository is designed to be, and we recommend, that it be 

mandated to extend and include other OTC derivatives classes. A 

regulator charged with overseeing the financial markets from a 

systemic risk perspective needs a comprehensive view of where the 

risks and exposures lay to provide an advance warning to any problems that could jeopardize the stability of the system. Should there 

be a firm failure, knowing the underlying position of multiple 

transactions in a timely manner will be significant in providing 

transparency to regulators and in protecting confidence in the market itself. Therefore, we believe the role of having a central repository should be reinforced as a matter of public policy by Congress. 

We appreciate your time today, and I would be happy to respond 

to your questions. 

[The prepared statement of Mr. Larry Thompson can be found on 

page 195 of the appendix.] 

Chairman KANJORSKI. Well, thank you very much, gentlemen. As 

you can see, this is one of the most exciting issues to come before 

the Congress and that is why the exceptional turnout. Maybe that 

is the reason why we have not had the legislation move along a lot 

faster. 

[laughter] 

Chairman KANJORSKI. But I have just a few questions myself before I recognize my ranking member. Mr. Sprecher, you talked 

61 

about the clearinghouse operation, I was interested, your exchanges, are they for-profit owned or are they not-for-profit? 

Mr. SPRECHER. They are for-profit, and we are a New York Stock 

Exchange public company. 

Chairman KANJORSKI. And who is your regulator, the actual exchanges? 

Mr. SPRECHER. Well, we have three regulated futures exchanges, 

so one is regulated here in the United States by the CFTC, one is 

regulated in Canada by a provincial regulator and one is regulated 

in Europe by the London FSA. We have five regulated clearinghouses, two are regulated in the United States by the CFTC, one 

that is handling credit default swaps is regulated in the United 

States by the New York Fed as a trust bank. One is regulated by 

a provincial regulator in Canada and one is regulated by the Financial Services Authority in the UK. So that is the world I live 

in. 

Chairman KANJORSKI. I myself had some doubts about whether 

or not we should have had some of the major exchanges change 

from not-for-profit exchanges to for-profit. I anticipate there is a 

great temptation out there to use exchanges for various and sundry 

purposes that could constitute a scandal. That has not happened 

yet, but I am not certain it will not happen some time in the future. What provisions have you taken to make sure that will not 

happen on your three exchanges? 

Mr. SPRECHER. You have an interesting thought about this because one of the things that has happened in the world as we went 

from mutualized organizations that were memberships to public 

companies, which many of us represent, and when that happens, 

you sometimes disconnect from the interest of your members because they no longer are your bosses. And so all of us that run exchanges have a delicate balance, which is trying to be—act as a 

neutral counterparty and meet the needs of our members but still 

be beholden to stockholders and regulators. And so far I think it 

has worked quite well and it has created a lot of value within the 

exchange community but nonetheless it is incumbent on managers 

like myself to continue to poll the market and make sure we are 

serving the needs of the ultimate end user. 

Chairman KANJORSKI. You said you traded on the New York 

Stock Exchange. Does that mean that I could buy a controlling interest in any of your exchanges by purchasing stock on the exchange? 

Mr. SPRECHER. Technically, yes. 

Chairman KANJORSKI. So that if I wanted to invade the United 

States rather than doing it militarily, I could do it economically by 

taking control of your exchanges and then just closing them? 

Mr. SPRECHER. You would have to get through Senator Schumer 

but otherwise, yes. 

Chairman KANJORSKI. Charlie is a good man but he is not everywhere. 

Mr. DUFFY. Mr. Chairman? 

Chairman KANJORSKI. Yes? 

Mr. DUFFY. The CME Group is the largest publicly-traded exchange in the world today, and you cannot just come in here and 

take over a U.S. exchange. We have what is called a ‘‘poison pill,’’ 

62 

so anything over 15 percent ownership, you would be technically diluted down in value, so there is no way you could come in here and 

just buy a U.S. exchange that is listed. We are also a public company. 

Chairman KANJORSKI. So you do not think there is any way we 

could construct hidden trusts or other organizations that if I were 

representing the oil interests of the world, that I could come in and 

take control of your exchange? 

Mr. DUFFY. No, I do not. 

Chairman KANJORSKI. You are a real optimist. I think that someone could, by convoluted methodologies of using trusts, etc., you 

could do it in a successful way and never be detected unless you 

were to open up all the trust operations in the country, which obviously we do not do. I am not sure why we do not do it, maybe we 

need a clearinghouse for trusts to find out who really owns things. 

Anyway, that is another issue for another day. 

Obviously, you all agree that there is a role for Congress to play 

in the derivative market. I am curious, I asked a question of the 

prior panel, is there any of you who feel absolutely that operations 

are occurring in such a way in the derivative area that there is no 

role or need for Congress to take action or for the government to 

provide for regulation? Is there anyone who feels we are moving on 

the course and should stay there as the present law constitutes us 

to do? 

Mr. DUFFY. I will just say, sir, we have been on the record since 

the Modernization Act of 2000, that the loophole of 2(h)(3) should 

be eliminated, that there was going to be a problem with product. 

So here in the last panel, they asked, did anybody foresee this coming or if they would admit it. We are on record as saying we saw 

this coming and there was going to be problems with these unregulated markets. So, I think government has a role in these marketplaces, there is an integrity to them but at the same time, we are 

not talking about huge regulation for the over-the-counter market, 

we are talking about a few different things. 

Chairman KANJORSKI. But you definitely see a need for us to act 

now in some regulatory capacity, is that correct? 

Mr. DUFFY. I do. 

Mr. EDMONDS. I would just add to that I do not believe that you 

can continue the evolution that the market demands at the moment as these instruments continue to be developed and risk management tools continue to be used over time without an effective 

involvement from organizations and committees like this one. It 

will not reach the point of confidence the market can accept without involvement from the government. 

Chairman KANJORSKI. Why did the market fail, and this is open 

to any one of you who want to take it on, in terms of AIG for instance? Obviously, their counterparties positions were way outside 

their capacity to perform because they lacked the reserves to do 

that. Why did not the parties that were dealing with them see that 

and have the market in itself react or did they not know what their 

counterparty positions were and therefore the limitations they had 

or were they planning on the fact that there would be a too-largeto-fail resolve and that in fact the government was going to stand 

63 

in their position, so there was not any risk in finding out their due 

diligence, pursuing due diligence as to their capacity to perform? 

Mr. DUFFY. I will just say that I think that they had a huge bet 

that the housing market would never go down. I do not think they 

ever believed that that asset would go down, and they could leverage it as many times over as they want. And they were undercapitalized to write all these contracts. And when the market 

turned, you talk about an illiquid market, the housing market 

might be the most illiquid market in the world, so there is no one 

to take over the exposures. 

Chairman KANJORSKI. But you said you saw the risk? 

Mr. DUFFY. Pardon me? 

Chairman KANJORSKI. You said you saw the risk. 

Mr. DUFFY. We talked about the elimination of 2(h)(3), which includes credit default swaps, which was eliminated from the exchange. We said that they should be regulated back in 2000, and 

we said that in 2002 and in 2004 and as little as a year ago. That 

is what I was referring to. 

Chairman KANJORSKI. But you did not see the failure coming? 

Mr. DUFFY. I did not know what the leverage balance sheet of 

AIG was, sir, no. 

Chairman KANJORSKI. Well, that would have been interesting if 

we had had a clearinghouse operation going, like Mr. Thompson is 

saying, everybody in the world could have examined to see what 

their exposure was, is not that correct? And would that have afforded the opportunity for the market itself to do the corrective action and not accept them as a counterparty? 

Mr. EDMONDS. Well, it certainly would have highlighted the issue 

much earlier, so the default you dealt with or we continue to deal 

with in the fallout from the AIG default still a fairly—well, obviously, a very significant size. Well, had you had those mechanisms 

in place early on, you would have been able to detect that before 

it spiraled to that level. I am not going to say there would not have 

been a default because there was certainly behavior there that you 

had to deal with but the size of the default may have been mitigated far before it got to $170 billion of taxpayer money. 

Mr. LARRY THOMPSON. I think, Mr. Chairman, in fairness— 

Chairman KANJORSKI. Yes? 

Mr. LARRY THOMPSON. I do not think anybody has actually done 

a real study on the causes of the AIG failure. It could have been 

due to a number of reasons. One, it could be that the counterparties did not know what their full exposure was, they are relying totally on the fact that it was a triple A rated company and therefore 

did not think that they needed to take the same margin requirements. Some of them we know did hedge some of their positions 

though with AIG. We also know now that the particular regulator, 

who did regulate that particular section of AIG, perhaps did not go 

in and do the right kind of examinations. So I think what you had 

called for earlier in the first panel, which is really an examination 

of AIG to see what occurred, should occur before we begin to speculate as to what went wrong there. 

Obviously, we believe that having all of those contracts in one 

central location where regulators could have gone in, could have 

looked at what the positions were, would have been something that 

64 

would have been something that would have been very good from 

a regulatory standpoint. Thank you. 

Chairman KANJORSKI. I appreciate that, Mr. Thompson, but is it 

possible that we should recognize that perhaps the capacity of government regulators because of salary and other limitations in the 

field are really not adequate to make the type of analysis and regulatory positions that occur in industry because of the lopsided effect 

of salary and competency and size? 

Mr. LARRY THOMPSON. You hit upon a very excellent point, which 

is that one of the things that we have to do as part of reviewing 

the whole issue of what regulatory reform means, does it mean 

looking at whether the regulators have the right skill sets? Do they 

have the right band width to regulate the industries that they 

should be looking at? Is the pay comparable to retain seasoned veterans to look at those particular issues? I think all of those are 

very good things that should be approached and looked at by this 

Congress. 

Chairman KANJORSKI. Well, I just want to bring as a matter of 

fact that point up, in the Federal Home Loan Bank system, Senator Graham had been successful several years ago before he left 

the Senate of restricting the salaries and, of course, I have been 

very active with the Federal Home Loan Bank system because it 

fascinates me in a way, how it is a cooperative working with the 

private sector. And they came to me and said, ‘‘Well, what we have 

decided is we would like to specialize,’’ that is when we had appointments by the President of the members of the board, and they 

wanted to make a requirement that each board have at least one 

specialist in derivatives because they found it very difficult dealing 

with derivatives. And so the question that was posed in my office 

in a debate at that time was how difficult it would be to define 12 

specialists who were willing to work for $19,000 a year, which was 

the limitation of salary on a director to the Federal Home Loan 

Bank Board. 

Now, maybe some people who would be watching this hearing 

would say, ‘‘Well, why not?’’ But you and I know that specialists 

in the derivative field generally talk about starting salaries in excess of seven figures, going on up. And our problem is we have no 

way in government to match that type of salary, so how do we go 

about attracting the type of mathematical talent that is necessary 

to protect the hedging that occurs in these transactions? 

Mr. LARRY THOMPSON. Well, one way may be to use academia. 

The one thing that obviously academia would be able to do, professors love to get information and study it, to write their papers and 

to publish things. So, as a resource, and it is just a suggestion, 

there may be a way of getting resources through other neutral 

sources, even though they have an interest in publishing the information they gather as opposed to making it a government resource 

if it were the work of a government salaried employee. It is just 

a suggestion. 

Chairman KANJORSKI. I have exceeded my time, and I have been 

lenient with myself because considering we have a such a huge 

number of members here, I thought maybe we could by unanimous 

consent extend our questioning to 10 minutes each. Is there any obVerDate Nov 24 2008 18:16 Nov 06, 2009 Jkt 052397 PO 00000 Frm 00070 Fmt 6633 Sfmt 6633 K:\DOCS\52397.TXT TERRIE
65 

jection to that? There being none, let me move and recognize Mr. 

Garrett for 10 minutes. 

Mr. GARRETT. Well, I may just use a portion of that. 

Chairman KANJORSKI. That is okay, you can hand it back. You 

can give it as a present. 

Mr. GARRETT. I will yield to my colleague here. Thank you, gentlemen, for your testimony. I am taking a page or a comment out 

of the chairman’s comment, and may be playing off comments of 

Mr. Edmonds as well, the idea of trying to find regulators to be 

able to do some of these things. Now, just the other day, I had 

lunch with a gentleman who is a CEO of a smaller international 

company, an international company but a small one, not one of the 

big guys, and when we got into the aspects of the regulators coming in, he said, ‘‘Do you know how complicated it is within my own 

business for me to know exactly what is going on in my company 

and with my auditing departments and with my financial units in 

my company to have a clear picture or a snapshot, if you will, at 

any one point in time of how my company is doing?’’ He said when 

you talk about the regulators, regardless of how well we pay them, 

when they come in and try to take a look at it, we may be going 

down the wrong proverbial road if we ever really want to think 

that we can solve some of these problems by bringing some people 

in on a short-term basis to examine the books proverbially and get 

a good snapshot out of it. 

I know the chairman asked, I think it was the last panel, did any 

of you see this all coming and come back and tell us beforehand, 

and everybody sat mute, although I am sure some of them probably 

had some premonitions but just did not act on it. That same question could always be asked by that panel, and we have to be careful 

what we ask them because if they ever ask us that question, did 

we ever see any of this coming, and if we did, how come we did 

not say anything? Congress did not see a lot of it coming, otherwise 

the chairman and I would have stopped it. Some of it we did, some 

of it we did not, obviously with the GSEs. 

But just on that last note, I guess, Mr. Edmonds, you were saying with regard to we cannot get to where we all need to be or 

where you would like to be unless Congress steps and does some 

of this, you probably have a little more rosy view of the good works 

that Congress can do in some of these areas in light of our past 

track record of not providing the appropriate, this is what you are 

talking about, not providing the appropriate regulation in the past 

in some of these areas. Hopefully, that we will be able to do so in 

the future. Do you want to comment on that? 

Mr. EDMONDS. The issue at the end of the day that what Congress wants, I believe the answer to the question you fundamentally were asking the industry is what is something worth, whether 

you are talking about the salary of the regulator that is going to 

be there, but what is the value that you are going to receive for 

that? If we looked at the question of clearing across all of a number 

different products and asset classes at the end of today, there is 

some standard or accepted curve of what the value of an instrument is. We come to expect that as just it is going to be there as 

a constant. It is only when it is no longer a constant that we have 

a major issue in this predicament. And what we experienced over 

66 

the last year is we lost a constant. It was not a defined measure 

of value that the consensus of the market agreed upon. We spent 

a lot of time debating and a lot of time discussing data processes 

and how that process of determining what something is valued at 

impacts the marketplace. 

So when you have the right folks in the right positions at the 

regulators, paid the right amount, and the values received or 

whether or not it is subcommittees like this and others within the 

government itself producing that function, we all have to agree at 

some point in time that fair value is worth ‘‘X,’’ and when we lose 

that, we typically lose our way. I do believe, and my comment earlier was this is a point in time where I believe history says bodies 

as this one will step up and attempt to correct the show. 

If you look at the energy markets in the earlier part of this decade, which is where my career began, you had people take advantage of that in the fall of Enron and the energy emergent sectors, 

and there were certain rules put into place that both Mr. Duffy and 

Mr. Sprecher have great businesses from today, and this is another 

point in time where I believe we have to stand up and do that for 

other asset classes. And I believe those are the questions you are 

asking the previous panel and the one that we sit before you today 

of where does it start and how far can we go without going too far. 

Mr. GARRETT. Well, one of the proposals that’s out there from 

CFTC Chairman Gensler was that he said in his proposal, ‘‘We 

need to protect the public from improper marketing practices.’’ And 

I guess the one question that follows from that is that endemic in 

the system right now, we are talking about sophisticated firms that 

are out there, is improper marketing practices—you mentioned energy but is that something that is widespread in the industry. And 

if you put in mandates and what have you, a second part, and anybody can answer this, if you put in mandates to beyond exchanges 

and clearinghouses, is there a potential, and maybe not, maybe I 

am just not seeing this, exposing the average investor then to a 

higher risk at the end of the day? 

Mr. EDMONDS. Well, I will start in response to that. Our solution 

and others that are represented up here, have a certain mechanism 

that is not going to go down to the retail investor. They are eligible 

commercial participants. But even with that, and that defines some 

level of sophistication of the user of these instruments. But even 

with that definition there, the rules of the game are not the same 

for all the different participants. And depending upon where you 

are or how you behave, in the previous panel, Mr. Murphy from 3M 

spent a lot of time talking about his business as a corporate, and 

they have a very defined function in how that works. But in the 

world I live in, interest rate swaps, that type of business only represents sub-10 percent of the marketplace. So the other 90 percent 

are not playing by the same rules. And I believe if you are going 

to get to that point of fair value, at some point in time you are 

going to have to have consensus on what the baseline is. 

Mr. GARRETT. Thank you. Any other comments on that? 

Mr. DUFFY. Well, what I think Mr. Gensler was referring to was 

some of the marketing practices that have gone on historically that 

have targeted some of the uninformed people who may be in a retirement area, such as California, Florida, and others, trying to tarVerDate Nov 24 2008 18:16 Nov 06, 2009 Jkt 052397 PO 00000 Frm 00072 Fmt 6633 Sfmt 6633 K:\DOCS\52397.TXT TERRIE
67 

get them to solicit them to trade foreign exchange product, promising them 60 percent gains in 60 days. And the problem, what 

happened with the CFTC, most of their budget, I think it was 

roughly 70 percent was the number, was going to police off exchange fraudulent activity. And I think that is what Mr. Gensler 

is referring to, that it has to stop. I mean they have to either police 

it or they are not going to police it but that is a big part of what 

their budget was going towards. 

Mr. GARRETT. Can you stop that just by bringing it all on then? 

Mr. DUFFY. Well, I think there are other issues that they have 

to deal with. A lot of this going over the Web, a lot of this is going 

over cold calls. How do they get these people? They show up at a 

bucket shop and the bucket shop has four kids who never had a 

job before in their lives, but yet they are the four principals of the 

firm. So the real guy that is taking the money is already to the 

next city or the next village. It is very difficult to police. 

Mr. GARRETT. Right, and just one little question, Mr. Thompson, 

and if anybody else wants to. You were speaking when I came in, 

and I was watching you folks in the back room by the way, with 

regard to the repository facilities, how is this all envisioned as far 

as, I hate this word, but the granular aspect of it and the aggregation aspect of it, how much information is actually out there on the 

individual company and trade versus the aggregate aspect of it? 

Mr. LARRY THOMPSON. We publish at the moment, once a week, 

1,000 names, information on an aggregate basis in all of the indices. We do that on a public Web site that everyone has access to. 

We obviously give more granular information to regulators that 

would include position information by who is doing the trades. We 

also put trading information on an aggregate basis on our Web site, 

but we do give to regulators, including the Fed, the ECB, the FSA, 

very granular detail information as to what the positions are when 

they request it. 

Mr. GARRETT. Okay, great, I appreciate the information. Thanks 

a lot, gentlemen. 

Chairman KANJORSKI. The Chair recognizes Mr. Scott. 

Mr. SCOTT. Thank you, Mr. Chairman. I might say that this is 

absolutely stunning in its scope of complexity and challenge but as 

we try to grasp or get our hands around this, to try to figure how 

we regulate it, I think it would be very helpful, Mr. Sprecher, if 

you might share with us the description of the day-to-day Federal 

regulation of your clearinghouse and whether or not you can come 

to the conclusion that the Federal regulation that you are currently 

under. And in your opening statement and your response to the 

chairman, you reiterated several layers of Federal regulation. It 

might be well for you to kind of give us kind of an overview as to 

how effective if, in your opinion, this regulation has been? 

Mr. SPRECHER. Certainly. Well, we launched a credit default 

swap clearinghouse about 90 days ago and so far have done almost 

a trillion dollars worth of clearing in that market. And that particular clearinghouse is regulated by the New York Fed. First of 

all, we had a hard time—we wanted to be regulated and we had 

a hard time figuring out who should regulate us, there were some 

regulatory gaps in credit default swaps that I am sure many of you 

are aware of, and it did not look like it fell under the CFTC and 

68 

it did not look like a security that fell under the SEC. And ultimately in discussions with the Fed, it seemed appropriate to be 

under their jurisdiction, so we set up under the Fed, it is our first 

opportunity of working with the Fed. I am frankly very impressed 

with the quality of people that the Fed has. They are an amazing 

organization. They have a deep understanding of derivatives, and 

they are a very hands-on regulator. In fact today, they are doing 

I think their second audit of our clearinghouse, and we are only 90 

days old, and I think that audit goes all week long. 

But there are some regulatory voids that I think Secretary 

Geithner was trying to point out in his letter, things about how the 

FDIC would get involved in a wind up, for example, of a bank 

versus a clearinghouse, whether we would wind up the affairs or 

whether the Fed would be involved, so that there are some jurisdictional issues that we are trying to work out between agencies on 

a collaborative basis but ultimately I think Congress may have to 

step in and help dictate some of these. 

Mr. SCOTT. Let me pursue just a moment if I may, I am reading 

your statement and just to clarify, you state that, ‘‘Clearing all 

over-the-counter derivatives and the trading of over-the-counter derivatives on a transparent electronic platform may provide additional risk management and potentially additional price transparency. However, forcing all over-the-counter derivatives to be 

cleared and traded on the exchange would likely have many unintended consequences.’’ Can you give us a little clarity there? It 

seems as if you are saying on the one hand that it is good but on 

the other hand there are some bad things that will happen? 

Mr. SPRECHER. Yes, this is the dilemma that we are all in here, 

which is we all—all of us here believe in open, transparent, predictable markets but you all trying to regulate everybody into one of 

those could have unintended consequences. One unintended consequence, for example, may be what a number of us have heard 

you talk about today, which is the flight of some of this business 

overseas. We have 12 members of our credit default swap clearinghouse. They are the largest holders of credit default swaps in the 

world, probably could hold at least 80 percent of the open positions 

in credit default swaps. Of the 12 members, only four of them are 

U.S. companies. The other members have come here because they 

ultimately believe that we need to do clearing. They ultimately believe that it will be better for the marketplace but was the case 

where through some regulatory prodding and cooperation with industry and the aftermath of this terrible credit crisis, there is some 

voluntary work. But I do not know that we can always depend that 

foreign companies will cooperate with U.S. regulation. 

Mr. SCOTT. Mr. Duffy, I think you raised that point, and I asked 

that question earlier to the other panel because we really want to 

be I think very careful and judicious at what we do here. All of this 

is sort of new territory for us. Can you give us your rationale for 

your fears, you were pretty strong in your statements that we 

would lose business overseas. Would it be on overseas exchanges, 

would it be offshore accounts? Can you tell us exactly how we 

would lose overseas? 

Mr. DUFFY. Well, I think Mr. Sprecher said it correctly, you have 

to look at a lot of these dealers, there are 12 large ones in the 

69 

United States, of which they have operations throughout the world, 

and they can pass their book from one place to another so the book 

truly just travels along through the time zones. And that is a concern because they cannot operate outside the United States. Our 

concern with that aspect is if you take that market off of the 

United States, that hurts the regulated U.S. futures exchanges because we are really the price discovery mechanism for a lot of the 

look-alike’s that trade over-the-counter, so that is the price that 

they are looking to use for their risk management needs. So if we 

have less liquidity in the over-the-counter trading on our exchange, 

it is going to hurt the whole food chain. So it is a concern. 

So when we look at—I will go back to maybe your other question 

about why we cannot take some of these trades in our clearinghouse, they are so customized in nature where a dealer may be out 

looking for the other side of a trade for not 6 milliseconds, like we 

trade at the CME Group, he may be out and be looking for 6 hours 

for the other side of his one particular trade for his one particular 

client. That is why it is very difficult. So we cannot bring those into 

our clearinghouse and assume the risk associated with those transactions at CME Group because we just do not have all the information we have on a standardized futures contract. But I guess that 

is a long way of saying is we are concerned about the liquidity, 

which is the direct result that the futures exchanges get from the 

over-the-counter market. 

The last panel made a statement, they said that the OTC market 

is roughly several times larger than a regulated exchange model. 

It is 5 times larger. It is much larger than a regulated exchange 

model, so they work together. And the pricing comes from the exchange model. 

Mr. SCOTT. All right, so you say moving forward, we need to separate the requirement if we mandate the clearinghouse and separate illiquid and unstandardized derivative contracts from liquid? 

Mr. DUFFY. Yes, we do not believe that Congress should mandate 

it, we think they should use capital incentives for clearing and that 

is the way we approach this. We do not think a mandate is a good 

thing. 

Mr. SCOTT. Well, if we did that, would we not be having some 

sort of loophole that could allow a repeat of what AIG and what 

Enron— 

Mr. DUFFY. Well, I think you could have other reporting requirements that are not being put forth today for some of these transactions that would bring greater transparency to the regulator, 

whether it be the SEC, CFTC or the systemic risk regulator. 

Mr. SCOTT. All right. Thank you, Mr. Chairman. 

Chairman KANJORSKI. The gentleman from Illinois, Mr. Manzullo? 

Mr. MANZULLO. Thank you, Mr. Chairman. Let me ask a very 

basic question. I believe that we would not be in this crisis that we 

are today if the subprime market had not gone sour and thus tainted the basis of the investments, which grew, the investments grow 

obviously exponentially through derivatives. Does that statement 

make sense or am I missing something on it? 

Mr. SPRECHER. I believe it does. We develop in the world an unbelievable distribution system for syndicating risks with the idea 

70 

that people holding small amounts of risks, widely dispersed, is 

good risk management, but then we pump poison through that system and just kept pumping it and pumping and pumping it. 

Mr. MANZULLO. Because the underlying investment was destined 

to go bad. 

Mr. SPRECHER. Correct. 

Mr. MANZULLO. You just cannot sell homes to people who cannot 

afford to make the first installment. In fact, the attorney general 

2 years ago in Illinois, came out with her report on mortgages and 

she thought that the reason for the foreclosures were that people 

were not prepared to pay the increased rate on the variable rate 

mortgages when they begin to reset and then she shockingly found 

out that some people could not even make the first and second 

mortgage payments on the original mortgage. And the reason I ask 

that question is that what you gentleman do is to provide more liquidity in the market for good loans. That is really what you are 

doing, would that be correct? 

Mr. EDMONDS. I think that it may be more accurate to say that 

what each of us respectively represent are mechanisms that provide better transparency, whether it be through clearing or through 

execution services, and that transparency results in an increased 

confidence. So the increased confidence you have in the next product that is highly correlated back at this standard thing that trades 

on an exchange or is cleared in a clearinghouse is enough for people to take that additional risk. And I think what Mr. Sprecher was 

trying— 

Mr. MANZULLO. Because of confidence? 

Mr. EDMONDS. Because that increased confidence exists but then 

what you have to begin to question is the correlation method between what everyone understands and accepts as something of 

value and this thing over here that is not something of value, that 

you do not know until it is too late. 

Mr. MANZULLO. So the emphasis upon more regulation on the derivatives really has its genesis in the fact that the original investments themselves went sour, would that be correct? 

Mr. LARRY THOMPSON. I think that is correct, that when you 

have an underlying instrument, such as the subprime that went 

south, that causes pressure all along. The one thing that the U.S. 

markets have done is has brought capital here to the United 

States, which has made us the broadest capital markets and one 

of the reasons why so many foreign companies want to come here 

and invest in Mr. Sprecher’s company and be involved in it is because the U.S. capital markets have, one, been transparent; two, 

have been very liquid, and now what the worry is that has the regulation stayed in tune with what the instruments are all about and 

can they in fact continue to provide the same kind of transparency? 

I think they can. I think that the market participants have already 

started working in that regard. We, for instance, work very cooperatively with all of the members who are sitting here. We were 

instrumental in helping Mr. Sprecher’s company set up their CCP 

because they pull the trades on a credit default swaps directly from 

the Depository Trust and Clearing Corporation. 

71 

Mr. MANZULLO. The follow-up question would be based upon our 

discussion, do you believe that any derivative product that can 

clear through a clearinghouse can also trade on an exchange? 

Mr. LARRY THOMPSON. I think there is some confusion between 

clearing and what exchange traded means. 

Mr. MANZULLO. Please? 

Mr. LARRY THOMPSON. I think what we do at DTCC is clearing. 

We match the size of the trades. We actually net the transactions. 

We decide through our automated systems what the calculations 

are. We actually send those payments to CLS Bank to be settled. 

That is clearing. Trading is what takes place on an exchange when 

two sides who want to in fact do a trade decide to put it through. 

Clearing is all of the post-trade activity and making certain— 

Mr. MANZULLO. Selling of accounts? 

Mr. LARRY THOMPSON. Making certain the buyer got what he 

was supposed to get and the seller is getting the funds that he 

thought he or she should be getting. That is really part of the 

clearance system. And I think there has been a little confusion in 

today’s discussion, both in the first panel and to some extent perhaps here, as to what clearance and settlement has meant here in 

the United States. 

Mr. EDMONDS. I would add just a little bit to Mr. Thompson’s 

comments that when we talk about clearing, the next component 

of the clearing is whether or not you provide credit mitigation. Mr. 

Thompson is incredibly correct in the fact that there are certain 

processes that you can use to clear information, in some contexts 

are you also removing that credit exposure between the counterparties. But to your earlier question, I think it is incredibly important 

that until you figure out how to clear it, it is very difficult to move 

to how can you trade it on an exchange. And there are plenty of 

asset classes that we have not yet put into an essentially cleared 

model. 

Mr. DUFFY. Congressman, it is important to have liquidity to get 

price information so you can do risk management and clearing. 

That normally comes from trading and then it goes into the clearinghouse once the price has been established, and then the risk 

management process goes on until that position is liquidated. 

I think that you can do some clearing without trading the product, but you need to have some relevant information from some of 

the providers that are out there today that are giving you price information as relates to this. There are margin requirements. There 

are twice daily mark-to-market requirements associated with clearing, so there are some things that are not a custom to the OTC 

world today that will burden additional costs but will also protect 

the taxpayer from additional liabilities like they had in the last 

several months. 

Mr. MANZULLO. Thank you. 

Mr. DUFFY. Thank you, sir. 

Chairman KANJORSKI. Thank you, Mr. Manzullo. We could go on, 

but I know that on the Republican side of the aisle, they have a 

commitment for a 3:00 meeting, is that correct? So rather than 

holding our members here, we will wind this up. I just want to 

thank you first of all for appearing. Two, I asked the question of 

the first panel, would you all be willing to participate in giving us 

72 

your best thoughts as to what we can do eventually to do fair and 

effective regulation without smothering the derivative industry but 

on the other hand to avoid a reoccurrence of what has happened 

over the last several years. Is there anybody here who would not 

be willing to participate in the future in sort of an advisory role 

to accomplish that? 

Mr. DUFFY. I applaud you for doing it, sir. I think it makes a tremendous amount of sense. 

Chairman KANJORSKI. Well, we appreciate that. You can be of 

great assistance. And not only that, when mistakes are made in the 

future as a result of our legislation, we can point to the expert advisors and say that you all made the mistake. 

[laughter] 

Chairman KANJORSKI. No, we would appreciate it. I certainly invite it. There is nobody on the committee who has the expertise of 

the panels that we reviewed today, and if we can get your assistance in that, that will be extremely helpful over these next several 

months because that is the period of time in which some piece of 

legislation will occur. 

And I may caution also to take advantage of reviewing the drafts 

of that legislation as it starts to circulate and do not hesitate using 

that thing called a telephone and call any member of the committee 

or myself and let us know what a dastardly thing we are doing by 

even considering one part of the piece of legislation. I am not guaranteeing that we will respond positively to your critiques, but we 

would like to hear your critiques on all those issues. 

Mr. MANZULLO. Would the chairman yield for a second? 

Chairman KANJORSKI. Sure, I will. 

Mr. MANZULLO. I was just in Switzerland and met with the folks 

from FINRA. It took them 10 years, a 10-year study, in order to 

come up with their new regulatory body of all instruments of all 

categories of investments that might in their opinion come up with 

a systemic risk. And the first statement that came out of the 

mouth of the person with whom I spoke, he said, ‘‘Congressman,’’ 

he said, ‘‘Whatever system of regulation that you come up with, 

you must give companies the ability to fail.’’ He said, ‘‘If you do not 

do that, you will not have an investment system in your country.’’ 

And I want to commend you for the caution that I know that you 

are taking and also Chairman Frank for moving deliberately but 

very slowly into an area like this. 

Chairman KANJORSKI. Well, we thank you. Of course, we are 

much swifter than this place. 

Mr. SCOTT. Mr. Chairman, could you yield for one second, please? 

Chairman KANJORSKI. Yes. 

Mr. SCOTT. I would also like to just insert a word of caution. I 

want to certainly make the record reflect that I am very concerned 

about two major areas as we move forward because I think that we 

have received some good information from both of these panels that 

we want to make sure that we get our arms around, and that is 

the impact this has on foreign business going overseas. I think you 

made a good point that we need to be careful as we move forward 

on that. And the non-standardized derivatives as well, that we 

might have to do what Mr. Geithner suggested but to separate 

those two levels. 

73 

Chairman KANJORSKI. I appreciate that. Let me just add to the 

record because, Mr. Thompson, you made a statement, and I wanted to ask you the question, you said 95 percent, was that in volume 

or dollar value? 

Mr. LARRY THOMPSON. That is in volume at this point. That is 

what our belief is in CDS, in credit default swaps that we are talking about. 

Chairman KANJORSKI. Okay, they are equal, the dollar value and 

the volume? 

Mr. LARRY THOMPSON. It is approximately but it is based on 

what the dealers have told us of what they are doing at this point. 

Chairman KANJORSKI. Okay, very good. Thank you. 

Mr. DUFFY. Mr. Chairman, if I just may for the record, Mr. Scott, 

I am sorry earlier when you asked about the difference between 

standard and customized products, my comment was that we are 

not supporting mandatory clearing of either one. I am a supporter 

of standardized OTC contracts being cleared through a regulated 

exchange, just so I was clear on that point, sir. I apologize if I was 

confusing earlier. 

Chairman KANJORSKI. Well, very good. Again, I want to thank 

you very much for your testimony, gentlemen. And we will put you 

on our advisory committee and ask for anything that you can give. 

Mr. DUFFY. Thank you, sir. 

Chairman KANJORSKI. The Chair notes that some members may 

have additional questions for this panel which they may wish to 

submit in writing. Without objection, the hearing record will remain open for 30 days for members to submit written questions to 

these witnesses and to place their responses in the record. 

The panel is thereby dismissed and this hearing is adjourned. 

[Whereupon, at 2:50 p.m., the hearing was adjourned.] 

(75) 

A P P E N D I X 

June 9, 2009 

76 


52397.001
77 


52397.002
78 


52397.003
79 


52397.004
80 


52397.005
81 


52397.006
82 


52397.007
83 


52397.008
84 


52397.009
85 


52397.010
86 


52397.011
87 


52397.012
88 


52397.013
89 


52397.014
90 


52397.015
91 


52397.016
92 


52397.017
93 


52397.018
94 


52397.019
95 


52397.020
96 


52397.021
97 


52397.022
98 


52397.023
99 


52397.024
100 


52397.025
101 


52397.026
102 


52397.027
103 


52397.028
104 


52397.029
105 


52397.030
106 


52397.031
107 


52397.032
108 


52397.033
109 


52397.034
110 


52397.035
111 


52397.036
112 


52397.037
113 


52397.038
114 


52397.039
115 


52397.040
116 


52397.041
117 


52397.042
118 


52397.043
119 


52397.044
120 


52397.045
121 


52397.046
122 


52397.047
123 


52397.048
124 


52397.049
125 


52397.050
126 


52397.051
127 


52397.052
128 


52397.053
129 


52397.054
130 


52397.055
131 


52397.056
132 


52397.057
133 


52397.058
134 


52397.059
135 


52397.060
136 


52397.061
137 


52397.062
138 


52397.063
139 


52397.064
140 


52397.065
141 


52397.066
142 


52397.067
143 


52397.068
144 


52397.069
145 


52397.070
146 


52397.071
147 


52397.072
148 


52397.073
149 


52397.074
150 


52397.075
151 


52397.076
152 


52397.077
153 


52397.078
154 


52397.079
155 


52397.080
156 


52397.081
157 


52397.082
158 


52397.083
159 


52397.084
160 


52397.085
161 


52397.086
162 


52397.087
163 


52397.088
164 


52397.089
165 


52397.090
166 


52397.091
167 


52397.092
168 


52397.093
169 


52397.094
170 


52397.095
171 


52397.096
172 


52397.097
173 


52397.098
174 


52397.099
175 


52397.100
176 


52397.101
177 


52397.102
178 


52397.103
179 


52397.104
180 


52397.105
181 


52397.106
182 


52397.107
183 


52397.108
184 


52397.109
185 


52397.110
186 


52397.111
187 


52397.112
188 


52397.113
189 


52397.114
190 


52397.115
191 


52397.116
192 


52397.117
193 


52397.118
194 


52397.119
195 


52397.120
196 


52397.121
197 


52397.122
198 


52397.123
199 


52397.124
200 


52397.125
201 


52397.126
202 


52397.127
203 


52397.128