```

[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]

   IMPLEMENTING DODD-FRANK: A REVIEW OF THE CFTC'S RULEMAKING PROCESS

=======================================================================

                                HEARING

                               BEFORE THE

                            SUBCOMMITTEE ON
                        GENERAL FARM COMMODITIES
                          AND RISK MANAGEMENT

                                 OF THE

                        COMMITTEE ON AGRICULTURE
                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                               __________

                             APRIL 13, 2011

                               __________

                           Serial No. 112-10

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]

          Printed for the use of the Committee on Agriculture
                         agriculture.house.gov

                  U.S. GOVERNMENT PRINTING OFFICE
66-248 PDF                WASHINGTON : 2011
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                        COMMITTEE ON AGRICULTURE

                   FRANK D. LUCAS, Oklahoma, Chairman

BOB GOODLATTE, Virginia,             COLLIN C. PETERSON, Minnesota, 
    Vice Chairman                    Ranking Minority Member
TIMOTHY V. JOHNSON, Illinois         TIM HOLDEN, Pennsylvania
STEVE KING, Iowa                     MIKE McINTYRE, North Carolina
RANDY NEUGEBAUER, Texas              LEONARD L. BOSWELL, Iowa
K. MICHAEL CONAWAY, Texas            JOE BACA, California
JEFF FORTENBERRY, Nebraska           DENNIS A. CARDOZA, California
JEAN SCHMIDT, Ohio                   DAVID SCOTT, Georgia
GLENN THOMPSON, Pennsylvania         HENRY CUELLAR, Texas
THOMAS J. ROONEY, Florida            JIM COSTA, California
MARLIN A. STUTZMAN, Indiana          TIMOTHY J. WALZ, Minnesota
BOB GIBBS, Ohio                      KURT SCHRADER, Oregon
AUSTIN SCOTT, Georgia                LARRY KISSELL, North Carolina
STEPHEN LEE FINCHER, Tennessee       WILLIAM L. OWENS, New York
SCOTT R. TIPTON, Colorado            CHELLIE PINGREE, Maine
STEVE SOUTHERLAND II, Florida        JOE COURTNEY, Connecticut
ERIC A. ``RICK'' CRAWFORD, Arkansas  PETER WELCH, Vermont
MARTHA ROBY, Alabama                 MARCIA L. FUDGE, Ohio
TIM HUELSKAMP, Kansas                GREGORIO KILILI CAMACHO SABLAN, 
SCOTT DesJARLAIS, Tennessee          Northern Mariana Islands
RENEE L. ELLMERS, North Carolina     TERRI A. SEWELL, Alabama
CHRISTOPHER P. GIBSON, New York      JAMES P. McGOVERN, Massachusetts
RANDY HULTGREN, Illinois
VICKY HARTZLER, Missouri
ROBERT T. SCHILLING, Illinois
REID J. RIBBLE, Wisconsin

                                 ______

                           Professional Staff

                      Nicole Scott, Staff Director

                     Kevin J. Kramp, Chief Counsel

                 Tamara Hinton, Communications Director

                Robert L. Larew, Minority Staff Director

                                 ______

      Subcommittee on General Farm Commodities and Risk Management

                  K. MICHAEL CONAWAY, Texas, Chairman

STEVE KING, Iowa                     LEONARD L. BOSWELL, Iowa, Ranking 
RANDY NEUGEBAUER, Texas              Minority Member
JEAN SCHMIDT, Ohio                   MIKE McINTYRE, North Carolina
BOB GIBBS, Ohio                      TIMOTHY J. WALZ, Minnesota
AUSTIN SCOTT, Georgia                LARRY KISSELL, North Carolina
ERIC A. ``RICK'' CRAWFORD, Arkansas  JAMES P. McGOVERN, Massachusetts
MARTHA ROBY, Alabama                 DENNIS A. CARDOZA, California
TIM HUELSKAMP, Kansas                DAVID SCOTT, Georgia
RENEE L. ELLMERS, North Carolina     JOE COURTNEY, Connecticut
CHRISTOPHER P. GIBSON, New York      PETER WELCH, Vermont
RANDY HULTGREN, Illinois             TERRI A. SEWELL, Alabama
VICKY HARTZLER, Missouri
ROBERT T. SCHILLING, Illinois

               Matt Schertz, Subcommittee Staff Director

                                  (ii)

                             C O N T E N T S

                              ----------                              
                                                                   Page
Boswell, Hon. Leonard L., a Representative in Congress from Iowa, 
  opening statement..............................................     3
Conaway, Hon. K. Michael, a Representative in Congress from 
  Texas, opening statement.......................................     1
    Prepared statement...........................................     2

                               Witnesses

Berkovitz, Dan M., General Counsel, Commodity Futures Trading 
  Commission, Washington, D.C....................................     4
    Prepared statement...........................................     5
Duffy, Hon. Terrence A., Executive Chairman, CME Group, Inc., 
  Chicago, IL....................................................    22
    Prepared statement...........................................    24
Scott, J.D., Hal S., Director, Committee on Capital Markets 
  Regulation; Nomura Professor and Director, Program on 
  International Financial Systems, Harvard Law School, Cambridge, 
  MA.............................................................    38
    Prepared statement...........................................    39
Overdahl, Ph.D., James A., Vice President, National Economic 
  Research Associates, Washington, D.C...........................    47
    Prepared statement...........................................    48
McMillan, Karen H., General Counsel, Investment Company 
  Institute, Washington, D.C.....................................    53
    Prepared statement...........................................    54
Greenberger, J.D., Michael, Professor, University of Maryland 
  School of Law, Baltimore, MD...................................    90
    Prepared statement...........................................    91

 
   IMPLEMENTING DODD-FRANK: A REVIEW OF THE CFTC'S RULEMAKING PROCESS

                              ----------                              

                       WEDNESDAY, APRIL 13, 2011

                  House of Representatives,
 Subcommittee on General Farm Commodities and Risk 
                                        Management,
                                  Committee on Agriculture,
                                                   Washington, D.C.
    The Subcommittee met, pursuant to call, at 10:00 a.m., in 
Room 1300, Longworth House Office Building, Hon. K. Michael 
Conaway [Chairman of the Subcommittee] presiding.
    Members present: Representatives Conaway, Neugebauer, 
Schmidt, Crawford, Gibson, Hultgren, Schilling, Boswell, 
McIntyre, Kissell, McGovern, David Scott of Georgia, and 
Courtney.
    Staff present: Tamara Hinton, John Konya, Kevin Kramp, Josh 
Mathis, Ryan McKee, Matt Schertz, Debbie Smith, Liz 
Friedlander, Clark Ogilvie, and Jamie Mitchell.

OPENING STATEMENT OF HON. K. MICHAEL CONAWAY, A REPRESENTATIVE 
                     IN CONGRESS FROM TEXAS

    The Chairman. Let's call the hearing to order. The hearing 
of the Subcommittee on General Farm Commodities and Risk 
Management entitled, Implementing Dodd-Frank: A Review of the 
CFTC's Rulemaking Process, will now come to order.
    Mr. Berkovitz, thank you for being here this morning.
    Today, we continue our series of hearings to review the 
CFTC's implementation of the derivatives provisions of the 
Dodd-Frank Act.
    The CFTC is currently engaged in what is easily said to be 
a pretty colossal effort to write dozens and dozens of new 
regulations for a market that is critically important to our 
economy. This effort is unmatched in its scope and implication 
for a domestic and global financial system. Yet, by all 
accounts, it seems the CFTC has placed speed over deliberation. 
Rules have been proposed in a sequence that has created 
confusion and made it difficult for the public to orchestrate 
their input. There has been a lack of consideration regarding 
costs and benefits of the Commission's proposed regulations.
    The CFTC has proposed rules that we believe exceed 
Congressional intent and demonstrate a lack of regulatory focus 
among a shortage of resources. It has made clear to me that the 
statutory deadlines for Title VII simply do not give regulators 
enough time to do this right. The old adage, there is never 
enough time to do it right, but there is always time to do it 
over seems to come to mind.
    It should be noted that the derivatives provisions 
contained within Dodd-Frank will impact thousands of end-users 
across the country that engage in hedging responsibly and who 
had no role in the financial crisis that Dodd-Frank seems to 
proffer to fix. Rushing to regulate will have a harmful and 
punitive impact on non-financial businesses if we don't get 
this correct.
    Moreover, the short timeframes have been exacerbated by the 
sequence of rule proposals and have had a negative impact on 
the ability of stakeholders to actually understand the impact 
of the regulations on their businesses, and to know whether or 
not they should comment or not.
    The cost-benefit analysis performed at the CFTC appears to 
be the bare minimum needed to comply with the CEA. To date, 
projections of costs have been vague and inaccurate; and in one 
instance, when the CFTC has tried to quantify them, they were 
4,000 times lower than the estimates performed by the 
stakeholders themselves. Yet when I joined with Chairman Lucas 
to ask Chairman Gensler to voluntarily adhere to the 
President's Executive Order that demanded a higher standard of 
regulatory review, I was told that the requirements of CEA were 
specific enough to preclude the CEA from adherence to the 
Executive Order.
    In addition, we have heard concerns from many stakeholders 
that several of the proposed rules exceed what is required by 
Dodd-Frank or intended by Congress. For example, both the 
proposed rules relating to ownership and governance of DCOs, 
DCMs, and SEFs and on position limits directed the CFTC to 
issue rules only after that review determined that they were 
appropriate. Yet the CFTC has dedicated significant resources 
to proposing these rules without such finding.
    In another example, the CFTC's proposed business conduct 
standard rules, that rule, according to the Department of Labor 
regulations, makes swap dealers fiduciaries to pension plans, 
despite Congress' specific omission of such a standard in Dodd-
Frank.
    Last, there are several areas in which the CFTC proposals 
are inconsistent with those of other regulatory agencies. Rules 
governing swap execution facilities, real-time reporting and, 
just yesterday, larger requirements for swap entities have all 
shown inconsistencies that will only make it more difficult and 
confusing to comply.
    I look forward to exploring these topics in more detail 
with our witnesses today.
    [The prepared statement of Mr. Conaway follows:]

  Prepared Statement of Hon. K. Michael Conaway, a Representative in 
                          Congress from Texas
    Today, we continue our series of hearings to review the CFTC's 
implementation of the derivatives provisions in Dodd-Frank.
    The CFTC is currently engaged in a colossal effort to write dozens 
of new regulations for a market that is critically important to the 
economy. This effort is unmatched in its scope and implication for the 
domestic and global financial system.
    Yet, by all accounts, it seems the CFTC has placed speed over 
deliberation. Rules have been proposed in a sequence that has created 
confusion and made it difficult for the public to provide input. There 
has been a lack of consideration regarding the costs and benefits of 
the Commission's proposed regulations. The CFTC has proposed rules that 
exceed Congressional intent and demonstrate a lack of regulatory focus 
amid a shortage of resources. Further, there are inconsistencies among 
regulatory agency proposals, despite Congressional directives to 
coordinate.
    It has been made clear to me that the statutory deadlines for Title 
VII simply do not give regulators enough time to get this right. It 
should be noted that the derivatives provisions contained within Dodd-
Frank will impact thousands of end-users across the country that engage 
in hedging responsibly and had no role in the financial crisis. Rushing 
to regulate will have a harmful and punitive impact on non-financial 
businesses that were not a part of the problem.
    Moreover, these short timeframe have been exacerbated by the 
sequence of the rule proposals that have had a negative impact on the 
ability for stakeholders to comment or to understand the impact it will 
have on their businesses and customers.
    The cost-benefit analysis performed by the CFTC has been the bare 
minimum simply to tout compliance with the CEA. To date, projections of 
costs have been vague and inaccurate; in one instance when the CFTC has 
tried to quantify them, they were 4,000 times lower than estimates 
performed by stakeholders. Yet, when I joined with Chairman Lucas to 
ask Chairman Gensler to voluntarily adhere to the President's Executive 
Order that demanded a higher standard of regulatory review, I was told 
that the requirements of the CEA were specific enough to preclude the 
CFTC from adherence to the Executive Order.
    In addition, we have heard many concerns from stakeholders that 
several of the proposed rules exceed what is required by Dodd-Frank or 
intended by Congress. For example, both the proposed rules relating to 
ownership and governance of DCO's, DCM's and SEF's, and on position 
limits, directed the CFTC to issue rules only after review by the 
Commission determined that they were appropriate. Yet, the CFTC has 
dedicated significant resources to proposing these rules without any 
such finding. In another example, the CFTC has proposed business 
conduct standard rules that would, according to Department of Labor 
regulations, make swap dealers fiduciaries to pension plans, despite 
Congress' specific omission of such a standard in Dodd-Frank.
    Last, there are several areas in which the CFTC's proposals are 
inconsistent with those of the other regulatory agencies. Rules 
governing Swap Execution Facilities, real-time reporting, and--just 
yesterday--margin requirements for swap entities, have all shown 
inconsistencies that will only make it more difficult and confusing for 
businesses to comply.
    I look forward to exploring these topics in more detail and to 
hearing from our witnesses today.

    The Chairman. I now turn to our Ranking Member for his 
statement, if any.

OPENING STATEMENT OF HON. LEONARD L. BOSWELL, A REPRESENTATIVE 
                     IN CONGRESS FROM IOWA

    Mr. Boswell. Thank you, Mr. Chairman; and I want to thank 
you and our witnesses for coming today to review the CFTC's 
rulemaking process for implementation of the Wall Street Reform 
and Consumer Protection Act.
    The law and regulation we are reviewing today, and in the 
future, are critical to Americans in all of our districts. More 
than 38 million U.S. citizens, whether they are farmers, 
manufacturers, accountants, or municipal workers, are employed 
with a business that uses derivatives to hedge risk and protect 
against market volatility.
    The reason this legislation, it would appear, was crafted 
today is to protect the pensions of hardworking Americans from 
vulnerability and ensure our market is protected against epic 
job loss like the eight million they lost in 1 year due to the 
financial crisis on Wall Street. It is not to penalize the end-
users who, like consumers, were victims in the financial 
crisis. Our efforts instead should focus on preventing the 
markets from enriching a few players and making sure that never 
again are American taxpayers left with the bill.
    To ensure greater transparency in the markets, we must 
provide an open process; and I want to thank the Chairman and 
my colleagues for working together with the CFTC, SEC, and 
market participants to provide a clear picture of our progress 
and shed light on areas that need more work.
    As you know, Members of Congress face important and 
difficult decisions regarding our nation's budget. However, we 
also have a responsibility to assess our nation's needs and 
priorities.
    I am particularly interested in the state of the 
infrastructure and technology in place for the implementation 
of the Wall Street Reform and Consumer Protection Act. Are the 
personnel and the tools available to implement this Act?
    I look forward to comments from the witnesses. I believe 
our partnership is crucial for the future of market 
regulations. I am committed to working with you to ensure this 
market is regulated with efficiency and transparency without 
hindering its practical uses. Your thoughts and comments are 
greatly appreciated.
    And thank you, Mr. Chairman, for having this hearing.
    The Chairman. Mr. Boswell, thank you.
    Members are reminded or asked to submit their opening 
statements for the record so that our witnesses may begin their 
testimony to assure that there is ample time for questions.
    So, with that, we welcome the first panel. I guess a single 
person can testify as a panel, Mr. Berkovitz. But at any rate, 
nonetheless, our first panel is Dan Berkovitz, General Counsel, 
Commodity Futures Trading Commission.
    We look forward to hearing your comments. Thank you for 
being here.

   STATEMENT OF DAN M. BERKOVITZ, GENERAL COUNSEL, COMMODITY 
                  FUTURES TRADING COMMISSION,
                        WASHINGTON, D.C.

    Mr. Berkovitz. Good morning, Chairman Conaway, Ranking 
Member Boswell, and Members of the Subcommittee. Thank you for 
inviting me to today's hearing.
    My name is Dan Berkovitz, and I serve as the General 
Counsel of the Commodity Futures Trading Commission. I am 
pleased to testify before you today regarding the CFTC's Dodd-
Frank rulemaking process.
    The CFTC is working deliberatively and efficiently to issue 
the rules needed to implement the Dodd-Frank Act. This process 
is guided by two basic principles: First, the CFTC seeks to 
ensure that its rules implement the substantive requirements of 
the statute and follow the intent of Congress. Second, the CFTC 
is relying extensively on consultation with other regulators, 
both domestic and international, and public participation.
    Rulemakings are conducted in compliance with the 
Administrative Procedure Act and other applicable laws. The 
CFTC is committed to an open and transparent rulemaking 
process. The staff has solicited written comments on 
rulemakings prior to the proposal stage. The agency has 
received thousands of written comments on proposed rules, 
issued several advance notice of public rulemakings, held 
public roundtables, met with hundreds of market participants 
and members of the public, and established comment mailboxes 
and files on the CFTC website.
    The Commission has held 13 public meetings to issue 
proposed rules. The CFTC has engaged in extensive consultation 
and cooperation with other Federal financial regulators, both 
foreign and domestic, to harmonize regulations.
    Domestically, the CFTC has worked closely with the SEC, the 
Federal Reserve, and other prudential regulators. The CFTC is 
consulting and coordinating with international regulators to 
harmonize the approach to swaps oversight globally. Discussions 
have focused on clearing and trading requirements, 
clearinghouses generally, and swaps data reporting issues, 
among many other topics.
    The CFTC has now issued proposals in most of the rulemaking 
areas. As the Commission receives comments from the public, it 
is looking at the entire mosaic of rules and how they 
interrelate. The Commission will begin considering final rules 
only after the staff can analyze, summarize, and consider 
comments; the Commissioners are able to review the comments and 
provide guidance to the staff; and the Commission consults with 
fellow regulators.
    The CFTC has certain flexibility to tailor the timing of 
the implementation of the rules to the ability of entities 
subject to the new Dodd-Frank regulations to develop the 
systems, processes, and capabilities necessary to comply with 
the new requirements.
    The Commission has been seeking comments from market 
participants and interested members of the public on the phase-
in of the regulatory requirements that will be established in 
the final rules. Yesterday, the CFTC and the SEC announced a 
joint 2 day staff roundtable discussion with market 
participants and interested members of the public on how to 
phase in implementation of the Dodd-Frank requirements. The 
staffs are seeking comments on: whether to phase in 
implementation dates, based on a number of factors related to 
the ability to transition into compliance with the new 
requirements including: the type of swap, the type of market 
participant, the speed with which entities can meet the new 
requirements, and whether market infrastructures such as 
exchanges or clearinghouses or swap execution facilities or 
participants might be required to have policies and procedures 
in place ahead of compliance with such policies and procedures 
by persons entering into transactions on such facilities or 
with such participants.
    In summary, the Commission has established a transparent 
rulemaking process to implement Dodd-Frank. The Commission 
encourages public comments on the rules and their 
implementation and will continue to consult and coordinate with 
other Federal regulators and our international counterparts 
prior to issuing final rules.
    Thank you, and I would be happy to answer any questions.
    [The prepared statement of Mr. Berkovitz follows:]

  Prepared Statement of Dan M. Berkovitz, General Counsel, Commodity 
              Futures Trading Commission, Washington, D.C.
    Good morning, Chairman Conaway, Ranking Member Boswell, and Members 
of the Subcommittee. I am Dan Berkovitz, and I am privileged to serve 
as the General Counsel at the Commodity Futures Trading Commission 
(``CFTC'' or ``Commission''). I thank you for inviting me to today's 
hearing on the CFTC's rulemaking process to implement the Dodd-Frank 
Wall Street Reform and Consumer Protection Act (the ``Dodd-Frank 
Act'').
The Dodd-Frank Act
    On July 21, 2010, President Obama signed the Dodd-Frank Act. The 
Act amended the Commodity Exchange Act (``CEA'') to establish a 
comprehensive new regulatory framework for swaps and made similar 
amendments to securities laws for security-based swaps. Title VII of 
the Dodd-Frank Act was enacted to reduce risk, increase transparency 
and promote market integrity within the financial system. To accomplish 
these goals, the Act:

    1. Provides for the registration and comprehensive regulation of 
        swap dealers and major swap participants;

    2. Imposes clearing and trade execution requirements on 
        standardized derivatives products;

    3. Creates robust record-keeping and real-time reporting regimes; 
        and

    4. Enhances the Commission's rulemaking and enforcement authorities 
        with respect to, among others, all registered entities and 
        intermediaries subject to the Commission's oversight.

    The Dodd-Frank Act brings to the swaps markets the same basic 
regulatory goals of transparency and risk reduction that have governed 
the regulation of the futures and securities markets since the 1930s. 
The measures provided in the Act to lower risk and improve transparency 
are intended to improve the ability of American businesses to use these 
markets and derivatives to reduce their risks and costs.
Rulemakings
    The Dodd-Frank Act generally requires the CFTC to issue rules that 
are required to implement the provisions of the Act within 360 days 
from the date of enactment. Under Dodd-Frank, the effective date of any 
such rule shall be at least 60 days after publication of the final rule 
implementing such provision.
    The CFTC is working deliberatively and efficiently to issue these 
rules. The rulemaking process is guided by two basic principles. First, 
the CFTC is working to ensure that its rules implement the substantive 
requirements of the statute and follow the intent of Congress. Second, 
the CFTC is relying extensively on consultation with other regulators, 
both domestic and international, and the participation of market 
participants and other interested members of the public. The 
Commission's rulemakings are conducted in compliance with the 
Administrative Procedure Act and other applicable laws.
Rulemaking Teams
    As the Congress was finalizing the Dodd-Frank Act, the CFTC formed 
30 rulemaking teams to begin to implement the Act's rulemaking 
requirements. Each team consists of a team leader from one of the CFTC 
divisions, as well as staff from the other CFTC divisions. Chairman 
Gensler held the first meeting with the 30 team leads the day before 
the President signed the Act into law.
    A number of months ago the CFTC created a 31st rulemaking team 
tasked with developing conforming rules to update the CFTC's existing 
regulations to take into account the provisions of the Dodd-Frank Act. 
The CFTC has thus far proposed rulemakings or interpretive orders in 28 
of the 31 areas.
Public Participation
    The CFTC is committed to a transparent and open rulemaking process. 
The Commission has encouraged public participation throughout this 
process. The CFTC's rulemakings to implement the Dodd-Frank Act have 
included the following opportunities for public participation:
    Public participation during rulemakings. Immediately after the 
Dodd-Frank Act was passed, the CFTC solicited comments from the public 
regarding the rules required to be proposed under the Act. These pre-
proposal initiatives included staff roundtables, meetings with market 
participants, several advance notices of proposed rulemakings, and the 
establishment of public comment mailboxes and files on the CFTC 
website. As of this past Monday, we had received 2,907 submissions from 
the public through these e-mail inboxes. The Commission also encourages 
the public to submit comments once rules are proposed, and provides a 
number of ways for comments to be submitted. As of Monday, we had 
received 8,991 comments in response to notices of proposed rulemaking.
    Transparency of all public comments and meetings. The CFTC posts 
all written comments received and summaries of all meetings with the 
public on Dodd-Frank Act rulemakings on the Commission's website, at 
cftc.gov. These summaries of meetings identify the participants and the 
issues discussed. Any written materials provided to the agency for 
these meetings are posted on the CFTC website. As of this past Monday, 
we have had 675 such meetings.
    Open meetings. The Commission has utilized thirteen public meetings 
to issue proposed rules under the Dodd-Frank Act. The meetings are 
broadcast live via webcast and a call-in telephone number is available 
for the public to connect to a live audio feed. Archived webcasts are 
available on our website as well.
Consultation and Coordination
    The CFTC has engaged in extensive consultation and cooperation with 
other Federal financial regulators, both foreign and domestic, to seek 
input on the rulemakings and to harmonize the regulations of the swaps 
markets to the fullest extent practical.
    Domestically, the CFTC has worked closely with the Securities and 
Exchange Commission (``SEC''), the Federal Reserve, the Federal Deposit 
Insurance Corporation, the Office of the Controller of the Currency and 
other prudential regulators. The consultation and collaboration with 
these agencies includes sharing many of the staff memos, term sheets 
and draft documents. The CFTC also is working closely with the Treasury 
Department and the new Office of Financial Research. As of last Friday, 
CFTC staff has had 598 meetings with other U.S. regulators on 
implementation of the Act.
    In addition to working with the agency's domestic counterparts, the 
CFTC has reached out to, and is consulting and coordinating with, 
international regulators to harmonize the approach to swaps oversight 
globally. As with domestic regulators, the CFTC is sharing memos, term 
sheets and draft documents with international regulators as well. 
Discussions have focused on clearing and trading requirements, 
clearinghouses generally and swaps data reporting issues, among many 
other topics.
    Specifically, the CFTC has been consulting directly and sharing 
documentation with the European Commission (``E.C.''), the European 
Central Bank, the United Kingdom Financial Services Authority and the 
new European Securities and Markets Authority. Three weeks ago, 
Chairman Gensler traveled to Brussels to meet with the European 
Parliament's Economic and Monetary Affairs Committee and discussed the 
most important features of swaps oversight reform.
    The CFTC also has shared documents with the Japanese Financial 
Services Authority and consulted with Members of the European 
Parliament and regulators in Canada, France, Germany and Switzerland. 
Through its consultation with these foreign regulators, the CFTC has 
sought to bring consistency to regulation of the swaps markets.
    In September of last year, the E.C. released its swaps proposal. 
Similar to the Dodd-Frank Act, the E.C.'s proposal covers the entire 
derivatives marketplace--both bilateral and cleared--and the entire 
product suite, including interest rate swaps, currency swaps, commodity 
swaps, equity swaps and credit default swaps. The proposal includes 
requirements for central clearing of swaps, robust oversight of central 
counterparties and reporting of swaps. The E.C. also is considering 
revisions to its existing Markets in Financial Instruments Directive 
(``MiFID''), which includes a trade execution requirement, the creation 
of a report with aggregate data on the markets similar to the CFTC's 
Commitments of Traders reports and accountability levels or position 
limits on various commodity markets.
    The CFTC has now issued proposals in most of the rulemaking areas. 
As the Commission receives comments from the public, it is looking at 
the entire mosaic of rules and how they interrelate. The Commission 
will begin considering final rules only after staff can analyze, 
summarize and consider comments, the Commissioners are able to review 
the comments and provide guidance to staff, and the Commission consults 
with fellow regulators on the rules. The Commission has stated that it 
hopes to move forward in the spring, summer and fall with final rules.
Administrative Procedure Act
    The Commission's rulemakings to implement the Dodd-Frank Act are 
conducted in accordance with the procedural requirements for informal 
rulemakings under the Administrative Procedure Act (``APA'') and other 
applicable laws. The Commission has provided opportunities for public 
comment in addition to those specified in the APA, such as providing an 
opportunity for public comment prior to the issuance of a notice of 
proposed rulemaking as discussed above.
    For most of the proposed rulemakings, the Commission has solicited 
public comments for a period of 60 days. On some occasions, the public 
comment period lasted 30 days. The Commission also has discretion to 
accept late comments. The CFTC website informs persons interested in 
submitting comments:

        ``The Commission invites comments on proposed rules. To be 
        assured consideration by the Commission, comments must be filed 
        prior to the close of the official comment period. Comments 
        filed after the close of the official comment period may be 
        considered, at the Commission's discretion. After the close of 
        the comment period, persons may continue to submit comments 
        through this website.''

    To date, the Commission has accepted and intends to consider all 
late-filed comments.
    The Subcommittee also has requested information regarding the 
standard for determining when a rule must be re-proposed. The 
Commission's actions in this respect also are governed by the APA. In 
general, the APA requires that an agency provide the public a 
meaningful opportunity to participate in an agency rulemaking. The 
first step in the rulemaking process is the publication of a notice of 
proposed rulemaking (``NPRM'') that includes the substantive terms of 
the proposed rule and informs the public of the issues that are likely 
to be significant to the agency's decision.
    The APA does not require the final rule to be identical to the 
proposed rule. Indeed, in issuing final rules, agencies are expected to 
consider and respond to comments on the proposed rule. When reviewing a 
final rule to determine if there was adequate notice and opportunity 
for comment, the courts will examine whether the connection between the 
NPRM and the final rule is sufficient for the final rule to be 
considered a ``logical outgrowth'' of the proposed rule. For example, 
courts consider a final rule to be a logical outgrowth if the NPRM 
expressly asks for comments on a particular issue or otherwise makes 
clear that the agency is considering a particular course of action.
Phased Implementation
    The Commission has specifically requested comment from market 
participants and interested members of the public on the phase-in of 
the regulatory requirements that will be established in the final 
rules.
    The CFTC has certain flexibility to set implementation or effective 
dates of rules promulgated to implement the Act, consistent with the 
Act's statutory deadlines and requirements. This flexibility allows the 
Commission to tailor the timing of the implementation of the rules to 
the ability of entities subject to the new Dodd-Frank regulations to 
develop the systems, processes, and capabilities to comply with the new 
requirements. Accordingly, the Commission is considering whether to 
phase implementation dates based upon a number of factors related to 
the ability to transition into compliance with the new requirements, 
including asset class, type of market participant, and whether the 
requirement would apply to market infrastructures or to specific 
transactions. The order in which the rules are finalized by the 
Commission therefore will not necessarily mean that the rules 
themselves will become effective in that same order, or that the 
implementation requirements will follow that same sequence.
    For example, the Commission may require one asset class or one 
group of market participants to comply with certain regulatory 
requirements before other asset classes or other groups of market 
participants. Similarly, the Commission may require market 
infrastructure facilities to be in compliance with certain regulatory 
requirements prior to requiring market participants to use those 
facilities. Effective dates and implementation schedules for certain 
rules may be conditioned upon other rules being finalized, their 
effective dates and the associated implementation schedules. For 
instance, the effective dates of some final rules may come only after 
the CFTC and SEC jointly finalize certain definitions rules.
    The Commission is examining issues related to the phasing in of 
regulatory requirements with respect to the entire set of rules that 
are being proposed, the regulatory requirements that would thereby be 
established and the degree of flexibility allowed by the applicable 
law. The Commission is seeking comments from market participants and 
regulators, both in the U.S. and abroad, regarding the phasing of 
implementation of these requirements.
    The Subcommittee has also asked about the potential circumstance in 
which various provisions of the Dodd-Frank Act may become effective 
prior to the promulgation of implementing regulations. The staff is 
evaluating these potential circumstances and developing for 
consideration alternatives within the Commission's authorities in order 
to ensure that transactions will not be disrupted solely as a result of 
such transition to the new regulatory regime.
Conclusion
    The Commission has established a rulemaking process to implement 
the Dodd-Frank Act in compliance with the Act's requirements and 
Congressional intent. The rulemakings are being conducted in an open 
and transparent manner. The Commission seeks, encourages, and considers 
public comments. The Commission also will continue to consult and 
coordinate with other Federal regulators and our international 
counterparts prior to issuing final rules.
    Thank you, and I'd be happy to answer questions.

    The Chairman. Mr. Berkovitz, thanks for coming.
    I will remind our Members that you will be recognized for 
questioning in order of seniority for those who were here at 
the beginning of the hearing. Others will be recognized in the 
order of arrival.
    We will start the 5 minute clock with me.
    Mr. Berkovitz, again, thank you for being here today.
    Up until about 3 weeks or so ago, it seemed to me that the 
Commission was continuing to bluff that they could get all of 
this done by July 15; and, since then, now it has been clear 
that that is not going to happen, that you are not going to 
make the deadline. And while we in Congress can't encourage you 
to disobey the law, as my opening statement, you were given an 
impossible task to get that done.
    I have a couple of questions in that regard. One, is it 
time now for the Commission to openly request additional time 
so that you can get this done under the law? Or should we 
just--is it your recommendation that you continue to ignore the 
law's July 15 date or July 21 date, whichever one it is, with 
respect to making these rules final?
    And the second half of that is, without rules being in 
place by that time frame, the law is in effect for those folks 
who participate in all these markets. So what guidance can you 
give them who have to obey the law without the regulations 
being in place, and what risks do they run during that gap 
between the guidance that you are intending to give them with 
respect to how the law should be implemented versus the law 
being out there and their risk that there are plaintiffs' 
lawyers all over the country just salivating at the opportunity 
to come after some of these folks because they are not in 
compliance with the law and the regulations out there?
    So could you give us quick comments on both of those?
    Mr. Berkovitz. Thank you, Mr. Chairman.
    As you mention, the law does establish a 1 year global time 
frame for our rulemakings, and the Commission is working 
diligently to meet that deadline. I think, as you recognize and 
the Chairman has stated, that there are going to be some 
rules--a number of rules that are going to be finalized after 
that deadline.
    The Chairman has established an overall goal to issue a 
number of the rules in final form this summer. So the goal is 
to have a number of these rules finalized by the summer, and 
then obviously there will be a number of them finalized after 
that.
    The Chairman has not asked for any statutory change to 
accomplish that. I think we can accomplish that within the 
current statutory authority and current statutory timetable. 
There is not going to be a penalty if we don't meet that July 
deadline for these final rules.
    Regarding the transition, I think the statute also provides 
the agency with sufficient flexibility to address that 
transition period between the time when certain provisions of 
the Act may be effective, and the time when certain other 
regulations may be effective. We believe the statute provides 
the agency with flexibility, both Dodd-Frank and the existing 
underlying Commodity Exchange Act, to address that interim 
period
    The Chairman. So you are saying that protects the industry, 
by and large, from the law being effective and the regulations 
not being there, that somehow they are protected through--that 
there is no risk of being out of compliance with the law itself 
during this time frame, that a cause of action can be brought 
against them that they are somehow protected by this cloak that 
you are referring to?
    Mr. Berkovitz. Well, we believe we have sufficient 
authority to address that situation. A number of market 
participants----
    The Chairman. I am not talking about the implementation 
phase-in. I understand you have the authority to do that. But 
how do you protect the industry? Do you then weigh in on their 
behalf if a court case is brought against them?
    Mr. Berkovitz. Well, we believe there is sufficient 
authority within the Commodity Exchange Act, as it currently 
exists, to address those concerns. We are looking at--we are 
examining a number of these specific instances, what happens 
before certain rules come into effect, and developing 
alternatives for the Commission's consideration, how to address 
that very concern.
    The Chairman. Most of us have been pretty dissatisfied with 
the cost-benefit analysis that we have been allowed to see, 
pretty cavalier statements that the costs are small and the 
benefits are great and so this rule goes forward.
    I guess the other question is, there are other agencies in 
the past who have been sued over their lack of proper cost-
benefit analysis work done. Is the Commission somehow protected 
under the CEA for those kind of causes of action being brought 
by folks who disagreed with your cost-benefit analysis work and 
that, if it was flawed, then the underlying regulation itself 
shouldn't have gone into place because you didn't really 
analyze what should have happened, or what was going to happen 
when you put it in place?
    Mr. Berkovitz. The guiding principles here, the statutes 
that guide us in the cost-benefit analysis are section 15(a) of 
the Commodity Exchange Act, and we believe that our proposed 
rules have been in compliance and our cost-benefit analyses 
have been in compliance with section 15(a).
    In terms of the rulemakings themselves, the other statute 
that would guide the agency in judicial review and where other 
agencies--we have looked at the cases--get challenged is the 
Administrative Procedure Act and ensuring that the rulemakings 
are based upon a reasoned and rational basis and the agencies 
are obligated to respond to comments and ensure that the 
decisions are based upon fact and reasoned analysis. And so the 
Commission is also guided by the Administrative Procedure Act, 
and we intend to follow that as well. And if we follow the APA 
and the Commodity Exchange Act, our rules should be found--
upheld.
    The Chairman. Okay. I will come back at you a little bit 
later on when it is my turn again.
    So, Mr. Boswell, for 5 minutes.
    Mr. Boswell. Well, thank you, Mr. Chairman.
    Kind of along that line, just to carry on a little bit, 
Chairman Gensler testified repeatedly about the Commission's 
requirement for cost-benefit analysis in his rulemaking. This 
requirement had been in place long before Dodd-Frank; and with 
regard to the Commission's efforts to meet this statutory cost-
benefit requirement, is the Commission staff doing anything 
different now with the Dodd-Frank rules than it did in the 
rulemaking prior to Dodd-Frank, or even different from when the 
Commission had their previous Chairman?
    Mr. Berkovitz. Congressman Boswell, we have adopted and we 
put to the statute--section 15(a) of the Commodity Exchange Act 
is really unaffected by Dodd-Frank. Dodd-Frank did not amend 
section 15(a) which governs cost-benefit analysis. So the 
underlying statutory requirement prior to Dodd-Frank is the 
same as after Dodd-Frank, and the agency has adopted the same 
cost-benefit approach.
    In Dodd-Frank, however, we have received a lot of comments. 
As I mentioned to Chairman Conaway's questions, we have 
received a number of comments on our cost-benefit analysis, and 
we are considering those comments in the context of the 
rulemaking, and the agency is evaluating the comments and would 
respond appropriately in the final rule.
    Additionally, the President, in January, issued an 
Executive Order regarding cost-benefit analysis.
    So, as the Chairman has testified, we are looking at the 
Executive Order and seeing what principles of that Executive 
Order can be included within our cost-benefit analysis 
consistent with the basic statutory requirements in section 
15(a).
    Mr. Boswell. Thank you.
    Your testimony states that the Commission tends to accept 
and I think, again along with some of the questions of the 
Chairman, consider all late-filed comments. However, it would 
seem at some point you have to stop. After all, how do you 
consider a comment if it comes in the day before the Commission 
is scheduled to vote on the final rule? And how late can 
comments be, and how can we and the comment offerer be sure it 
will be considered before it is submitted to the whole 
Commission for approval?
    Mr. Berkovitz. The Commission does have discretion to 
consider late comments. To date, the late comments that have 
been submitted have been accepted, and the staff intends to 
consider them. At some point, when we are--as you have noted, 
just before a rule is imminent, just before it goes final, it 
actually may be too late to consider a comment as a matter of 
practicality. In that situation, the Commission would be unable 
to exercise its discretion or would exercise its discretion not 
to accept the comment. It can't be an open-ended, never-ending 
comment period. But provided that it doesn't delay the 
rulemaking, the general practice has been to accept the late-
filed comment.
    Mr. Boswell. Thank you.
    In your written testimony, you talk about increased 
scrutiny by the courts of economic arguments about government 
agencies when proposing new rules. Has the CFTC seen such 
increased scrutiny by the courts and rules? Historically, have 
any challenges been filed against the Commission regarding 
rules or orders?
    Mr. Berkovitz. We have not had many challenges against 
rules or orders in the last few years. The amount of rulemaking 
under Dodd-Frank is significantly greater than what the 
Commission has experienced in previous years. So we are 
devoting significant resources to our rulemakings. We have 
rulemaking teams established for each of the rules, with a 
number of staff from the various divisions, from the Office of 
General Counsel in order to ensure that these rules follow all 
the requirements and are sound and will survive any review, any 
challenge that people may bring
    Mr. Boswell. Mr. Chairman, I will yield back. We are going 
to have another round probably. I yield back.
    The Chairman. The gentleman yields back.
    Mrs. Schmidt, from Ohio, for 5 minutes.
    Mrs. Schmidt. Thank you, and I apologize if some of these 
questions have been asked, since I was outside.
    I am concerned about the timing of the rules and how they 
are going to pan out in application. But, given the Dodd-
Frank's emphasis on consistency and comparability, do the CFTC 
and the SEC intend to adopt consistent and comparable 
schedules, both for promulgation and implementation of the 
rules for swaps and security-based swaps? In other words, is 
the timing going to be the same or is the timing going to be 
different? Because I don't know how it is going to interact in 
the real world.
    Mr. Berkovitz. We are coordinating with the SEC on that 
issue as well as on the substance of the rules themselves. We 
are coordinating both at the staff level and Chairman Gensler 
and Chairman Schapiro meet regularly and talk about these 
issues. So we are attempting to coordinate our schedules to the 
greatest extent possible.
    There are two different Commissions with various 
different--slightly different rulemaking responsibility. So I 
don't know exactly how it is going to turn out, but we are 
attempting to do that.
    Mrs. Schmidt. Well, if you can't get the timing together, 
how is it going to work?
    Mr. Berkovitz. Well, we are attempting to do it as closely 
as possible together.
    Mrs. Schmidt. Well, what happens if you don't? That is my 
question. What happens if you don't? How is it going to work in 
the real world if you have two different sets of rules out 
there?
    Mr. Berkovitz. Well, it would depend on the particular 
requirements. Our requirements would go to swaps. Their 
requirements would go to security-based swaps. To the greatest 
extent possible, we would like those to be at the same time, 
and we are trying to avoid any differences in those two types 
of instruments in terms of the timing or the requirements 
themselves.
    Mrs. Schmidt. Can you respond to concerns that the CFTC 
proposes to regulate swap dealers and major swap participants 
in the same fashion, even though one is the seller and one is 
the buyer? Take for example, sales practice rules applied to 
major swap participants when they are the buyer. I mean, aren't 
they two different groups?
    Mr. Berkovitz. The statute directs the agency to promulgate 
certain standards, business conduct standards, certain clearing 
requirements equally applicable to the swap dealers and to the 
major swap participants. To the extent that there are certain 
features about certain transactions or certain requirements 
that may be different, we are considering that in the comment 
period on the various particular requirements.
    Mrs. Schmidt. So what assurances are we going to have that 
buyers and sellers are going to be treated differently instead 
of in the same mold?
    Mr. Berkovitz. Well, it would depend again on the 
particular requirement what the particular standard is. We 
would have to consider that in the context of a particular 
requirement that may or may not be applicable to a buyer or to 
a seller as the case may be.
    Generally, the statute treats them the same. So any 
differences would come when we were looking at a particular 
requirement to implement that statutory direction.
    Mrs. Schmidt. But I think they are fundamentally different. 
It is like when you are buying a house or you are selling a 
house, there is a different set of rules out there for buyers 
and sellers with a realtor. So why would we have the same mold 
for a buyer and seller on these transactions?
    Mr. Berkovitz. Well, the statute generally would impose a 
duty, for example, on a counterparty. If you are in a 
transaction with a counterparty, this is when the transaction 
should be reported, what your duty of disclosure may or may not 
be to a counterparty, things like that.
    So if there is a particular instance when, as you have 
posed, that it really can only be done by a seller or really 
can only be done by a buyer, if it gets down to that level you 
would have to look at that, at the individual transaction 
level, which is what we intend to do.
    Mrs. Schmidt. Okay. And, finally, in the few seconds I have 
left, what authority does the CFTC have to address issues of 
extraterritoriality? Can the CFTC exempt from regulation an 
entity that is subject to comparable regulation in their home 
country?
    Mr. Berkovitz. We are looking at that issue also very 
closely. The Dodd-Frank Act states--the extraterritorial 
provision in Dodd-Frank states that it applies to an activity 
if there is a direct and significant connection with activities 
in or effect on U.S. commerce.
    So we are looking in evaluating at what type of activities 
that reaches overseas. We are talking to U.S. banks and U.S. 
institutions that have activities overseas. We are talking with 
foreign banks that do activities in the U.S., and we are trying 
to determine what type of activities and what that connection 
is and, therefore, what the requirements might be and which 
ones may or may not apply.
    Mrs. Schmidt. Okay. Thank you.
    The Chairman. The gentlelady yields back.
    Mr. David Scott, from Georgia, for 5 minutes.
    Mr. David Scott of Georgia. Thank you, Mr. Chairman. I 
appreciate your having the hearing.
    Mr. Berkovitz, I have had quite a bit of discussion with a 
number of industries and companies. I have been very intimately 
involved in Dodd-Frank. I serve both on the Financial Services 
Committee as well as here on the Agriculture Committee.
    The one chief concern that all of them have is the volume, 
the pace, and the phasing of the rules and regulations that the 
CFTC must create. And, very interestingly, none have complained 
about wanting to defund or repeal the law. They have invested 
in understanding that this is an important law, that we have an 
important issue here. But there are some major, major concerns 
and points that I would like to ask you on a number of issues.
    But, specifically, I want to ask you about the proposed 
rule on ownership of swaps execution facilities. What sort of 
weight are you giving to the Department of Justice's comments 
about aggregate ownership limits?
    Mr. Berkovitz. Obviously, the Department of Justice is a 
very significant commenter; and, given their significant 
expertise in antitrust issues, issues of competitiveness, this 
is something--when they send us a letter, as any Federal agency 
would send us a letter, we give it great consideration. We have 
also received comments commenting upon the Justice Department 
letter, so we are evaluating the comments in response. But they 
have written us a very thoughtful letter, and we are giving 
that letter very thoughtful consideration.
    Mr. David Scott of Georgia. Do you not feel that, given the 
large capital requirements for new entrants into the field, 
that placing such a requirement could serve as a barrier to 
entry and would stifle competition?
    Mr. Berkovitz. That is one of the factors that the agency 
is considering in determining where to come out on this issue.
    Mr. David Scott of Georgia. Mr. Berkovitz, what do you 
think? What do you think? Do you personally think it would 
stifle the competition?
    Mr. Berkovitz. I personally haven't examined that issue in 
that great a detail. And my role would be--there are other 
folks in the agency who would be probably better suited to 
actually evaluate the merits on the competitiveness argument 
than myself. So I personally haven't weighed in on that
    Mr. David Scott of Georgia. But don't you think on the face 
of it, just looking at it, that it could be a barrier to entry?
    Mr. Berkovitz. I am aware that that is one of the 
arguments; and we have arguments on the other side, too. So I 
personally would not be able to address that. The Commission 
itself is actually going to be addressing that very issue.
    Mr. David Scott of Georgia. Let me ask you one other thing. 
Can you say definitively that the CFTC has enough people and a 
sophisticated enough information technology infrastructure to 
do the work that you are tasked with under Dodd-Frank? I mean, 
we are in this era of budget cutting. But this is a very, very 
complicated field with an awful lot of different layers in the 
swaps and the derivatives and foreign markets. Our companies 
are having to compete with an array of rather fuzzy 
interpretations of what the rule might or might not say. So the 
question that I would like to get on the record from you is, do 
you feel that you need additional resources?
    Mr. Berkovitz. We are thankful that in the latest--if the 
current--if the numbers that we are hearing now are enacted, 
that we probably have sufficient resources, as I am talking 
about just over $200 million for the rest of this fiscal year, 
if the reports are accurate and that is indeed the number. We 
would have enough resources to get us through the rulemakings.
    Mr. David Scott of Georgia. Right now, with the budget as 
is?
    Mr. Berkovitz. Correct.
    Mr. David Scott of Georgia. Let's suppose--because we are 
moving through some very choppy waters as far as the budget is 
concerned. Let me ask you this. What would happen to your 
ability to properly regulate these markets if your budget was 
slashed?
    Mr. Berkovitz. Well, the President has requested--the 
budget request for Fiscal Year 2012 is $308 million. And that 
number is what the agency would really need to be able to 
effectively implement the Act.
    The $200 million again, if it is accurate, if the deal is 
as reported and that is approved by the Congress and signed by 
the President, would get us through the rulemaking stage.
    Mr. David Scott of Georgia. Before my time is up, so you 
are saying it would in effect affect your ability to do the job 
if your budget is slashed? Is that what you are saying?
    Mr. Berkovitz. Yes, Congressman, that is correct.
    The Chairman. Mr. Schilling, from Illinois, for 5 minutes.
    Mr. Schilling. Thank you, Mr. Chairman.
    Welcome. I appreciate you coming out today. I just have a 
couple of questions.
    Prior to the Dodd-Frank bill, I was told that the CFTC 
averaged about 5\1/2\ rulemakings a year; is that accurate?
    Mr. Berkovitz. I don't have the exact number, but it sounds 
about right.
    Mr. Schilling. Okay. And then, since this past October, I 
am told that the CFTC has proposed 43 new regulations to 
implement this law, and that is probably pretty accurate as 
well.
    Mr. Berkovitz. That is correct.
    Mr. Schilling. I think the one thing that I see--I am one 
of the new 87 freshmen Members coming into Congress, and as I 
have been out throughout the district, the big thing that we 
hear is the over-regulation and overreaching of the Federal 
Government is basically keeping a lot of our investors and 
people throughout the country sidelined; and that is one of our 
big concerns, of course. But can you respond to the concerns 
that the CFTC proposes to regulate swaps, the participants, the 
same, even though, one is a seller and one is a buyer?
    Mr. Berkovitz. Well, generally, the statute provides for 
swap dealers and major swap participants certain business 
conduct standards, certain capital requirements, certain 
institutional requirements that the institution has to meet, 
regardless of whether a particular transaction is a buy or a 
sell. These are very large institutions, so--and, generally, 
they are going to be doing both types of transactions. So our 
regulations are designed to capture the transactions that these 
institutions do.
    If there is a particular circumstance where a particular 
business conduct standard or a requirement may or may not be 
applicable to a seller or a buyer, we would look at that in the 
individual context of a particular rulemaking. But, generally, 
the swap dealers and major swap participants are very large 
institutions that do a lot of both buying and selling.
    Mr. Schilling. Okay. Very good.
    With that, I yield back.
    The Chairman. The gentleman yields back.
    The gentleman from Connecticut, Mr. Courtney, for 5 
minutes.
    Mr. Courtney. Thank you, Mr. Chairman; and thank you for 
this hearing. Again, I have great respect for your stewardship 
on this Committee, and I am glad we are holding this hearing.
    I have to say I look at it a little bit differently than 
some of the other questioners this morning.
    Yesterday, Reuters reported that Goldman Sachs analyzed oil 
prices and determined that the price per barrel was inflated by 
speculation to the tune of $27 per barrel. In Connecticut right 
now, we are paying $4 a gallon for gas. I mean, you can do the 
math pretty quickly, but that means basically motorists should 
be paying about $3 a gallon.
    People who are getting their home heating oil are also 
overpaying because of the fact that we have markets which I 
think are highly dysfunctional. You know, businesses in my 
district who sell home heating oil have basically refused to 
get into the business of hedging right now. They will not sell 
lock-in contracts for next winter because this market is so 
dysfunctional.
    And, frankly, CFTC had the authority to implement position 
limits back in January. And, if anything, from my perspective 
you are being too cautious in terms of moving ahead with what 
Dodd-Frank suggested.
    And I would just say, following up Mr. Scott's question, in 
terms of your budget, Secretary Mabus testified at Armed 
Services that every time a price per barrel goes up $10 the 
Navy's annual fuel costs go up $300 million.
    So, again, if you just do the math in terms of what Goldman 
Sachs reported yesterday, the taxpayer is paying double your 
budget that the President proposed because of the fact that we 
don't have a functioning system of rules in energy trading.
    I have just got to tell you, Mr. Berkovitz, the impact on 
the economy in terms of energy prices right now is just 
potentially catastrophic in terms of trying to get a recovery 
moving forward. I hope that you are going to move forward on 
those position limits on energy trading as soon as possible. I 
mean, people are, in my opinion, getting ripped off because of 
the fact that the markets are not functioning in a way that is 
connected to supply and demand.
    And I don't know if you would like to comment on that.
    Mr. Berkovitz. Thank you, Congressman. I will take that 
back and will consider those comments.
    I know that the Commission staff is devoting considerable 
time. We are receiving a lot--one of the most commented on 
rules--proposed rules we have out there is the position limits 
rule; and we have had thousands, literally thousands, of 
comments. Some of them are foreign comments, but, nonetheless, 
we have to go through and look at all of these. So we are going 
through those comments and evaluating that proposal very 
seriously.
    Yesterday, I would also note that the agency--Chairman 
Gensler and the agency announced a joint effort with the 
Federal Trade Commission to look at some of these issues where 
the FTC has oversight authority over oil and gasoline prices, 
the actual commodity itself, market oversight there; and so we 
have announced a cooperative effort with them.
    Mr. Courtney. Well, again, I just think it is important to 
also remember that there are end-users who now are shying away 
from getting involved in hedging. I mean, Hershey's announced 
the other day that it was pulling back because, again, the 
commodities market makes chocolate hedging almost impossible to 
really make an intelligent decision.
    Commissioner Chilton sent a letter to my office a couple of 
days ago sort of walking through again the sequence that took 
place as far as the energy position limits. I know he supports 
moving forward; and I, again, think his advocacy hopefully will 
be heard by the rest of the Commission. I really believe that, 
for the sake of the economy, we have to get some stability in 
energy prices, because it just ripples through from every home 
owner, motorist, small business on up. And it is really bad out 
there.
    Mr. Berkovitz. Thank you.
    Mr. Courtney. I yield back.
    The Chairman. Mr. Crawford, from Arkansas, 5 minutes.
    Mr. Crawford. Thank you, Mr. Chairman.
    Mr. Berkovitz, it seems to me the most commonsense approach 
to the rulemaking process would have been to start with 
defining swap. Yet you proposed nearly all of your rules but 
have not defined what a swap is, and I wonder why you have 
waited until the very end to define a building block of the 
entire title.
    Mr. Berkovitz. The swap definition in rulemaking is a joint 
rulemaking with the Securities and Exchange Commission. We 
hope--and we are working with the SEC staff very closely. We 
hope to have that proposed rule out very soon, in the next few 
weeks, actually, is our hope. I obviously can't guarantee that, 
but we do intend to get that out very soon.
    Mr. Crawford. Okay. I have some real concerns about what 
this excessive rulemaking might do for end-users in my 
district, for example, the farmers. That under extreme pressure 
the Federal budget is tasked with taking some of the support 
away from farmers, and so they are going to have to move into a 
free market approach to how they cash-flow their operations. My 
concern is that the rules that we are seeing right now may 
hinder, may actually make it less attractive for them to avail 
themselves of these free market tools. Can you explain how this 
is going to affect the average--say, the average cotton farmer 
or the average soybean farmer and how they implement a strategy 
for risk management under these excessive rules?
    Mr. Berkovitz. There are two possible risk management tools 
that people would use--or the ones that we would regulate that 
folks would use. That would be the futures market or the swaps 
market.
    Most of Dodd-Frank and the rules that we are doing go to 
the swaps market. There are some of the rules that we do that 
affect the futures side. But those rules shouldn't 
fundamentally affect the ability--on the futures side shouldn't 
affect the fundamental ability of the farmer to use our futures 
market for hedging.
    On the swap side, Congress has provided a number of 
exemptions for end-users, such as the exemption from clearing. 
So there wouldn't be--if a farmer were using a swap rather than 
a future--and, generally, the agriculture swap market is not--
folks use the futures market more than the swaps market. But if 
people didn't want to use swaps, didn't want to use these risk 
management tools, there would be the end-user exemption that a 
farmer, if they were using these for hedging, would qualify 
under.
    So we have met a lot with farm co-ops, organizations of 
end-users, hearing those concerns. We have put out a proposed 
rule to implement the end-user exception which we have gotten a 
lot of comments on. And so we are meeting and we are--we hear 
the, as I talked about in my statement, the intent of Congress 
that folks that are using these markets for hedging and to 
mitigate their commercial risks, that those typical end-users 
are the lower risk activities and that there should be much--
there should be less regulatory burden on those types of 
entities. And so we are meeting and trying to achieve that 
Congressional intent.
    Mr. Crawford. All right. Thank you, sir.
    I yield back.
    The Chairman. Mr. Kissell, from North Carolina, for 5 
minutes.
    Mr. Kissell. Thank you, Mr. Chairman. Thanks to the witness 
for being here today. I apologize for being late.
    But I want to follow up a little bit what my colleague, Mr. 
Courtney, was asking you about when he mentioned that Hershey's 
was pulling away from the market. Why do you think that might 
be? And what do you think it would take to calm those nerves so 
that people like Hershey's would have--get back in, have the 
confidence, so forth, so on? What are your thoughts on such a 
move?
    Mr. Berkovitz. I wouldn't know why in particular a firm 
would or would not be using the market less right now. I don't 
know whether that would be related to if there is an increase 
in the commodity price that would increase the margin cost of a 
futures contract or something like that, or if it is a 
different type of business decision.
    But, typically, when prices--in an area of higher prices, 
there might be higher costs for using these markets. But I 
don't know whether that is in fact the situation or not.
    Mr. Kissell. Okay. Mr. Gensler, when he testified, talked 
about, and Members talked a lot about, using the cost-benefit 
analysis to determine how certain things should be. But, that 
has been a requirement even prior to Dodd-Frank. I am just 
wondering if you see any different use of cost-benefit analysis 
and how they might be used to come up with some of the rules 
and how this bill moves forward.
    Mr. Berkovitz. Yes. Our fundamental approach to cost-
benefit analysis is still governed by section 15(a) of the 
Commodity Exchange Act. That is the section that directs us to 
do cost-benefit analysis. So it is not changed by Dodd-Frank. 
So, fundamentally, the agency's approach is the same under the 
statute as it had been prior.
    We have gotten a lot of comments in response to specific 
cost-benefit analysis in specific rules in saying you didn't 
consider this cost adequately, you didn't consider that cost 
adequately, you didn't provide enough detail. So we have gotten 
specific comments, and we are addressing the comments on a 
rule-by-rule basis as they come in on these specific analyses 
within the overall statutory framework.
    In addition, the President's Executive Order in January had 
a number of principles in terms of how to conduct cost-benefit 
analysis. We are also looking at that to see where those 
principles are consistent with our statutory direction, whether 
those can also be incorporated. Because that has been somewhat 
of an overarching comment that we have received. So the 
fundamental approach is the same. The statute is the same as it 
has been. But in response to these comments and concerns, the 
President's Executive Order we are seeing how we can adjust 
what we do.
    Mr. Kissell. Okay. Thank you, sir.
    Mr. Chairman, I yield back.
    The Chairman. The gentleman from New York, Mr. Gibson, for 
5 minutes.
    Mr. Gibson. Thank you, Mr. Chairman.
    Mr. Berkovitz, I appreciate your being here. I am learning 
from your testimony here.
    I represent a district in New York, and I am going to ask 
about a couple of different areas, the first one with regard to 
financial services and the other one with regard to our near 
and dear farmers.
    The first one is listening carefully and reading Mr. 
Gensler's speeches, one of the things that he has talked about 
is harmonizing, going forward, our rules promulgation with 
Europe and Asian markets so that we can synchronize our 
efforts. And I appreciate those remarks very much. But are you 
concerned that if we get out in front of Europe and Asia in 
terms of effectuating these rules that we will lose jobs in 
financial services overseas?
    Mr. Berkovitz. Congressman, as you mentioned, the agency 
and the Chairman have been spending a considerable amount of 
time on the harmonization and speaking with the Europeans. The 
potential job issue is one of a subset of the general notion 
that if the regulations are different that is going to affect--
people may trade in jurisdictions that have lesser regulations 
and that would have effects on jobs and have effect on 
potentially the safety and soundness of our system. So that, 
overall, plays into the rationale for trying to get 
harmonization. So----
    Mr. Gibson. Well, indeed. And I want to affiliate myself 
with that and just say that that is what concerns me about the 
timing of all this, is that in the effort to work with the 
Chairman, work with Mr. Gensler in terms of harmonizing 
efforts, that we ought to take that into consideration, Mr. 
Chairman, when we look at the timing of the promulgation of 
rules. Thank you.
    The second point, there is a perception back home among my 
farmers that how you make definitions and in particular--for 
example, an organization's co-bank, how they are defined will 
have an impact on farm credit and ultimately impact our 
farmers, restricting access to necessary credit. What would you 
say to me that I can carry back to them about how you would be 
sensitive to that so that our farmers will continue to have 
access to the credit they need, moving forward?
    Mr. Berkovitz. The issue of farm credit is being looked at 
in the context of one of our rules where we have asked for 
public comment on the end-user exception, and so we are 
accepting public comment on that very issue. So we have met 
with a number of farm cooperatives, smaller institutions, in 
terms of how the agricultural markets are structured and how 
farmers are able to hedge and use the markets to hedge and the 
institutions that are available there. So we have had a number 
of meetings with institutions, and that is a concern that has 
been brought to our attention, which we are considering in the 
various context of the rules.
    Mr. Gibson. Okay. I appreciate those remarks.
    Mr. Chairman, I will just sum up by saying that these are 
two areas I am going to continue to monitor very closely. I 
think we can agree that we are not really in a place of 
certainty, so that more work needs to be done. I do want to 
express that I am concerned about the timing of all these rules 
promulgation and want us to be sensitive of that going forward.
    And with that, Mr. Chairman, I yield back.
    The Chairman. The gentleman yields back.
    I have a couple of other questions as well. Let's do 
another round if folks want. So we will start another 5 minutes 
on me.
    The broad statement first in reference to some comments 
that our colleague from Connecticut made, is it the role of the 
CFTC to set prices for all these commodities?
    Mr. Berkovitz. We are not a price-setting agency. Our 
mission is to ensure the markets are fair.
    The Chairman. But he seemed to imply that somehow the CFTC 
could set the price for cocoa or gasoline or whatever. So I 
just wanted to make that clear.
    Is there anything in 15(a), the CEA, that precludes you 
specifically from folding in the President's Executive Order 
into your cost-benefit analysis work? What gets excluded? 
Because you make kind of a little reference to that.
    Mr. Berkovitz. Right. That is what we have been looking at 
to the extent that we can incorporate elements from the 
President's Executive Order into our analysis.
    The Chairman. Okay. Let me ask you a broader question. You 
will soon have most all the rules proposed. Is there under the 
Administrative Procedures Act or your rules that would allow, 
for lack of a better phrase, an interim final set that would 
allow the industry to look at the entire mosaic of rules that 
are there that they are going to have to comply with? This way 
they have some period of time that would allow them to make 
comments that would say here is an unintended consequence that 
would then allow the agency the time to be able to respond to 
that before we get too far down the road with this big brush?
    What I have heard the Chairman say, is that we have the 
rules out there and the industry can look at those, which 
implies that the proposed rules will be the final rules. And if 
that is the case, then all of this work that your testimony 
talks about--and the Chairman's done a great job of saying we 
are taking these comments, we are folding them in. Is there a 
way that, once the rules go final, that there will be a period 
where the agency can take account and the industry can show you 
where these things may have gotten cross-threaded because we 
have done them in various pieces? Is there something in the 
Administrative Procedures Act that you guys can avail 
yourselves of that would get them final but yet not so final 
that you have to go through an Act of Congress, so to speak, to 
address unintended consequences if those final rules do 
something that we don't want to be done?
    Mr. Berkovitz. I do think that the Administrative Procedure 
Act provides us flexibility for taking into account public 
comments as the process goes forward, and I think that is what 
we have attempted to do so far. We are nearing the completion, 
as I mentioned, of the proposed rule stage. We have three or 
four----
    The Chairman. This speaks to us about beyond that. When you 
do decide this is what it ought to look like and you have it 
done across the entirety of what you are trying to do, then the 
industry has a chance to know whether or not they were a swap 
dealer, whether or not they are a major participant, all these 
things to fit together. If we see a gap in the regulations, or 
regulations that overlap and do too much before those get so 
ingrained into the system and caused harm to it that you could 
address that quickly and nimbly.
    Mr. Berkovitz. I think so. I think the Act provides us that 
flexibility so that, as rules begin to finalize, if there is 
something in a final rule that affects--in one final rule that 
affects a rule that is still in the proposal stage, that people 
still would have potentially, depending on the exact sequence 
and the exact rule, the opportunity to comment and say, well, 
wait a minute. You just went final here. This affects something 
that is yet--that is still in the proposal stage.
    The Chairman. I guess I was trying look for something like 
that once it is all done, once everything is final. All the 
final rules are done, the system would have a chance to look at 
all of that, you as well.
    And I am apparently not being very articulate in asking the 
question, or you are being very artful in saying, no, there is 
no way that the agency can provide for an opportunity to look 
at all of these, once they are done. Is there a final rule--
that may be an inappropriate term--but to look at the whole 
thing other than just piecemeal it across. As you see the 
bullet box come in, in whatever order that they decide that you 
are coming in, your view is that that is adequate for the 
industry to be able to respond, to be able to put in place 
systems that they are going to have put in place, even in spite 
of the fact of knowing unintended consequences.
    Mr. Berkovitz. Well, I am not trying to avoid the question, 
but we are attempting to do that. What you have described is 
what the roundtables and the implementation roundtables are 
doing.
    The Chairman. Those are going to happen, though, before 
anything is final.
    Mr. Berkovitz. And whether a similar process would happen 
further down the road at the final stage, we could evaluate 
then.
    The Chairman. Okay. I am not trying to be argumentative. I 
am just trying to get the best answer.
    I mean, everybody knows that there is going to be some 
regulatory things that have to happen. But they ought to make 
sense, they ought to do the minimum damage, and they ought to 
cost--allow the industry to comply with them in the most cost-
effective manner possible. And so I think that is the goal.
    Mr. Berkovitz. If you are asking in terms of the 
Administrative Procedure Act is this something that 
procedurally would be permissible, I think the answer is, yes, 
and the Commission would decide at the time whether to do it.
    The Chairman. Okay. Thank you.
    Mr. Boswell for 5 minutes.
    Mr. Boswell. I yield.
    The Chairman. Anyone else?
    Mr. Berkovitz, thank you for coming today. We appreciate 
this open exchange. I didn't mean to imply that you were 
evading the question. I just couldn't get you to say what I 
wanted you to say. But thank you for being here today. I 
appreciate that.
    Hopefully, there will be enough difference between the 
proposed rules and the final rules that the industry can look 
at all those comments, the thousands of hours of work done and 
untold amount of lawyer fees invested in putting comments to 
you, that those had an impact, that had an effect on making 
these rules better as we move forward. So we continue to look 
forward to working with you on this whole process.
    Mr. Berkovitz. Absolutely. Thank you.
    The Chairman. We will now have our second panel, if you 
wouldn't mind coming to the table, and we will start our second 
round.
    I want to welcome our second panel of witnesses. This 
actually is a panel, since there is more than one of you.
    First up will be Terry Duffy, the Executive Chairman of 
CME, Inc., in Chicago, Illinois.
    We will then hear from Mr. Hal Scott, Director of Committee 
on Capital Markets Regulation, Nomura Professor and Director of 
the Program on International Financial Systems at Harvard Law 
School, Cambridge, Massachusetts.
    We will then hear from Dr. James Overdahl, the Vice 
President of the National Economic Research Associates here in 
Washington, D.C.
    Then, Ms. Karrie McMillan, General Counsel for the 
Investment Company Institute here in Washington.
    And then, Mr. Michael Greenberger, Professor, University of 
Maryland School of Law, Baltimore, Maryland.
    So, gentlemen, and lady, thank you for being here.
    Mr. Duffy, if you wouldn't mind starting us off, please.

 STATEMENT OF HON. TERRENCE A. DUFFY, EXECUTIVE CHAIRMAN, CME 
                    GROUP, INC., CHICAGO, IL

    Mr. Duffy. Well, thank you. Thank you, Chairman Conaway, 
Ranking Member Boswell, Members of the Committee. And I thank 
you for the opportunity to testify on the implementation of the 
Dodd-Frank Wall Street Reform and Consumer Protection Act.
    I am Terry Duffy, Executive Chairman of CME Group, which 
includes our clearinghouse and our four exchanges: the CME, the 
Chicago Board of Trade, New York Mercantile Exchange, and the 
COMEX.
    In 2000, Congress adopted the Commodity Futures 
Modernization Act. This leveled the playing field with our 
foreign competitors and permitted us to recapture our position 
as the world's most innovative and successful regulated 
exchange and clearinghouse. As a result, we remain an engine of 
economic growth in Chicago, New York, and the nation.
    The 2008 financial crisis focused attention on over-
leveraged, under-regulated banks and financial firms. In 
contrast, regulated futures markets and futures clearinghouses 
operated flawlessly before, during, and after the crisis.
    Congress responded to the financial crisis by reining in 
the OTC market to reduce systemic risk through central clearing 
and exchange trading of derivatives, to increase data 
transparency and price discovery, and to prevent fraud and 
market manipulation. We support these goals, but we are 
concerned that the CFTC has launched an initiative to undo 
modern regulation of futures exchanges and clearinghouses.
    We are not alone. Most careful observers and some 
Commissioners have concluded that many of the proposed 
regulations roll back principle-based regulation and 
unnecessarily expand the Commission's mandate. In so doing, the 
Commission acts outside of its rulemaking authority under the 
Dodd-Frank Act and, in many cases, undermines the intent behind 
Dodd-Frank.
    When Dodd-Frank passed, Congress specifically maintained 
principles-based regulation for the futures market. It extended 
that approach to the newly regulated swaps market. This would 
create core principles for swap execution facilities as well as 
swap data repositories.
    The intent of Dodd-Frank was not to fundamentally change 
the regulation of futures markets; rather, the primary goal was 
to close existing regulatory gaps. This would bring swaps which 
were largely unregulated into a regulated framework similar to 
that which was successful in futures markets. Instead, the CFTC 
has proposed to drastically alter the futures regulatory 
framework and create a parallel framework for swaps. The CFTC 
has proposed extraordinary prescriptive rules. This would, in 
effect, repeal the principles-based regulatory approach that 
has existed for more than a decade.
    In short, the CFTC is attempting to change its role. It is 
an oversight agency. Its purpose is to assure compliance with 
sound principles. Now it appears as if they are trying to 
become a frontline decision-maker, empowered to impose its 
business judgments on every operational aspect of derivatives 
trading and clearing. This role reversal is inconsistent with 
Dodd-Frank.
    The listed futures markets performed flawlessly throughout 
the financial crisis. Imposing needless regulatory burdens on 
these markets will create unnecessary strain on the 
Commission's staff and budget. It will also impose unnecessary 
costs on the industry and the end-users of derivatives. My 
written testimony includes numerous examples of proposed rules 
that exceed the boundaries of the Commission's rulemaking 
authority under Dodd-Frank.
    Further, in proposing rules, the Commission has 
consistently failed to conduct a proper cost-benefit analysis, 
as required by Section 15 of the Commodity Exchange Act. 
Congress should require the CFTC to operate within the 
limitations of its authority under Dodd-Frank. This means 
encouraging a full and fair cost-benefit analysis on every 
proposal.
    Also, by extending Dodd-Frank's effective date, it would 
permit a realistic opportunity to comment on a full package and 
its cost and benefits. Otherwise, we believe that the futures 
industry will be burdened by overly prescriptive regulations 
that are inconsistent with Dodd-Frank and sound industry 
practices. This will make it more difficult to reach Dodd-
Frank's goal of increasing transparency and limiting risk.
    Before I close, I would like to touch on one question that 
was asked by a Member about regulatory disparities amongst 
countries. The word we were looking for would be called 
arbitrage. And arbitrage means when there is one price at one 
particular place and one price at a different place. If we were 
to have regulations here in the United States somewhat 
different than is taking place in Europe or in Asia, that would 
be considered an arbitrage. People would go to the less-
regulated marketplace because the costs are much different.
    This will drive jobs away from the United States of America 
and drive capital and finance out of the United States of 
America. Mr. Berkovitz did not answer that question directly, 
but I would like to just, for the record, answer it. I do 
believe it will drive jobs out. Arbitrage is exactly what it 
is; it is inefficiencies. And if we have something and someone 
else doesn't, they are going to go to that platform.
    I thank the Committee for its time and look forward to your 
questions.
    [The prepared statement of Mr. Duffy follows:]

 Prepared Statement of Hon. Terrence A. Duffy, Executive Chairman, CME 
                        Group, Inc., Chicago, IL
    Subcommittee Chairman Conway, Ranking Member Boswell, Chairman 
Lucas, Ranking Member Peterson, Members of the Committee, thank you for 
the opportunity to testify on the implementation of Title VII of the 
Dodd-Frank Wall Street Reform and Consumer Protection Act (P.L. 111-
203, July 21, 2010) (``DFA''). I am Terry Duffy, Executive Chairman of 
CME Group (``CME Group'' or ``CME''), which is the world's largest and 
most diverse derivatives marketplace. CME Group includes four separate 
exchanges--Chicago Mercantile Exchange Inc. the Board of Trade of the 
City of Chicago, Inc., the New York Mercantile Exchange, Inc. and the 
Commodity Exchange, Inc. (together ``CME Group Exchanges''). The CME 
Group Exchanges offer the widest range of benchmark products available 
across all major asset classes, including futures and options based on 
interest rates, equity indexes, foreign exchange, energy, metals, 
agricultural commodities, and alternative investment products. CME also 
includes CME Clearing, a derivatives clearing organization and one of 
the largest central counterparty clearing services in the world; it 
provides clearing and settlement services for exchange-traded 
contracts, as well as for over-the-counter (``OTC'') derivatives 
transactions through CME Clearing and CME ClearPort'.
    The CME Group Exchanges serve the hedging, risk management and 
trading needs of our global customer base by facilitating transactions 
through the CME Globex' electronic trading platform, our 
open outcry trading facilities in New York and Chicago, as well as 
through privately negotiated transactions executed in compliance with 
the applicable Exchange rules and cleared by CME's clearing house. In 
addition, CME Group distributes real-time pricing and volume data 
through a global distribution network of approximately 500 directly 
connected vendor firms serving approximately 400,000 price display 
subscribers and hundreds of thousands of additional order entry system 
users. CME's proven high reliability, high availability platform 
coupled with robust administrative systems represent vast expertise and 
performance in managing market center data offerings.
    The financial crisis focused well-warranted attention on the lack 
of regulation of OTC financial markets. We learned a number of 
important lessons and Congress crafted legislation that, we hope, 
reduces the likelihood of a repetition of that disaster. However, it is 
important to emphasize that regulated futures markets and futures 
clearing houses operated flawlessly. Futures markets performed all of 
their essential functions without interruption and, despite failures of 
significant financial firms, our clearing house experienced no default 
and no customers on the futures side lost their collateral or were 
unable to immediately transfer positions and continue managing risk. 
Dodd-Frank was adopted to impose a new regulatory structure on a 
previously opaque and unregulated market--the OTC swaps market. It was 
not intended to re-regulate the robustly regulated futures markets.
    For example, while Congress granted the Commission the authority to 
adopt rules respecting core principles, it did not direct it to 
eliminate principles-based regulation. DFA rather reinforced the 
principles-based regime for regulated futures exchanges and clearing 
houses by adding new core principle obligations and extending this 
principles-based regime to swap execution facilities (``SEFs'') and 
swap data repositories as well. Yet the Commission has proposed 
specific requirements for multiple Core Principles--almost all Core 
Principles in the case of designated contract markets (``DCMs'')--and 
effectively eviscerate the principle-based regime that has fostered 
success in CFTC-regulated entities for the past decade.
    The Commission's almost complete reversion to a prescriptive 
regulatory approach converts its role from an oversight agency, 
responsible for assuring self regulatory organizations comply with 
sound principles, to a front line decision maker that imposes its 
business judgments on the operational aspects of derivatives trading 
and clearing. This reinstitution of rule-based regulation will require 
a substantial increase in the Commission's staff and budget and impose 
indeterminable costs on the industry and the end-users of derivatives. 
Yet there is no evidence that this will be beneficial to the public or 
to the functioning of the markets. In keeping with the President's 
Executive Order to reduce unnecessary regulatory cost, the CFTC should 
be required to reconsider each of its proposals with the goal of 
performing those functions that are mandated by DFA.
    Further, the principles-based regime of the CFMA has facilitated 
tremendous innovation and allowed U.S. exchanges to compete effectively 
on a global playing field. Principles-based regulation of futures 
exchanges and clearing houses permitted U.S. exchanges to regain their 
competitive position in the global market. Without unnecessary, costly 
and burdensome regulatory review, U.S. futures exchanges have been able 
to keep pace with rapidly changing technology and market needs by 
introducing new products, new processes and new methods by certifying 
compliance with the CEA. Indeed, U.S. futures exchanges have operated 
more efficiently, more economically and with fewer complaints under 
this system than at any time in their history. The transition to an 
inflexible regime threatens to stifle growth and innovation in U.S. 
exchanges and thereby drive market participants overseas. As further 
discussed below, this will certainly impact the relevant job markets in 
the United States.
    We support the overarching goals of DFA to reduce systemic risk 
through central clearing and exchange trading of derivatives, to 
increase data transparency and price discovery, and to prevent fraud 
and market manipulation. Unfortunately, DFA left many important issues 
to be resolved by regulators with little or ambiguous direction and set 
unnecessarily tight deadlines on rulemakings by the agencies charged 
with implementation of the Act. In response to the aggressive schedule 
imposed by DFA, the Commodity Futures Trading Commission (``CFTC'' or 
``Commission'') has proposed hundreds of pages of new or expanded 
regulations.
    In our view, many of the Commission's proposals exceed the 
boundaries of its authority under DFA, are inconsistent with DFA, not 
required by DFA, and/or impose burdens on the industry that require an 
increase in CFTC staff and expenditures that could never be justified 
if an adequate cost-benefit analysis had been performed. I will discuss 
below the Commission's failure to comply with the Congressionally 
mandated cost-benefit process, the need to sequence Dodd-Frank 
rulemaking appropriately, and the potential negative impact on U.S. 
markets of regulatory proposals.
A. Lack of Consideration of Costs of Regulatory Proposals
    The Commission's rulemaking has been skewed by its failure to 
follow the plain language of Section 15 of the Commodity Exchange Act 
(``CEA''), as amended by DFA, which requires the Commission to consider 
the costs and benefits of its action before it promulgates a 
regulation. In addition to weighing the traditional direct costs and 
benefits, Section 15 directs the Commission to include in its 
evaluation of the benefits of a proposed regulation the following 
intangibles: ``protection of market participants and the public,'' 
``the efficiency, competitiveness, and financial integrity of futures 
markets,'' ``price discovery,'' ``considerations of sound risk 
management practices,'' and ``other public interest considerations.'' 
The Commission has construed this grant of permission to consider 
intangibles as a license to ignore the real costs.
    The explicit cost-benefit analysis included in the more than thirty 
rulemakings to date and the Commission's testimony in a number of 
Congressional hearings indicate that those responsible for drafting the 
rule proposals are operating under the mistaken interpretation that 
Section 15(a) of the CEA excuses the Commission from performing any 
analysis of the direct, financial costs and benefits of the proposed 
regulation. Instead, the Commission contends that Congress permitted it 
to justify its rule making based entirely on speculation about 
unquantifiable benefits to some segment of the market. The drafters of 
the proposed rules have consistently ignored the Commission's 
obligation to fully analyze the costs imposed on third parties and on 
the agency by its regulations.
    Commissioner Sommers forcefully called this failure to the 
Commission's attention at the CFTC's February 24, 2011, Meeting on the 
Thirteenth Series of Proposed Rulemakings under the Dodd-Frank Act.

        ``Before I address the specific proposals, I would like to talk 
        about an issue that has become an increasing concern of mine--
        that is, our failure to conduct a thorough and meaningful cost-
        benefit analysis when we issue a proposed rule. The proposals 
        we are voting on today, and the proposals we have voted on over 
        the last several months, contain very short, boilerplate `Cost-
        Benefit Analysis' sections. The `Cost-Benefit Analysis' section 
        of each proposal states that we have not attempted to quantify 
        the cost of the proposal because Section 15(a) of the Commodity 
        Exchange Act does not require the Commission to quantify the 
        cost. Moreover, the `Cost-Benefit Analysis' section of each 
        proposal points out that all the Commission must do is 
        `consider' the costs and benefits, and that we need not 
        determine whether the benefits outweigh the costs.''

    Commissioner Sommers reiterated her concern with the lack of cost-
benefit analysis performed by the Commission in her March, 30, 2011 
testimony before the Subcommittee on Oversight and Investigations of 
the House Committee on Financial Services. Commissioner Sommers noted 
that ``the Commission typically does not perform a robust cost-benefit 
analysis at either the proposed rule stage or the final rule stage'' 
and noted that ``while we do ask for comment from the public on the 
costs and benefits at the proposal stage, we rarely, if ever, attempt 
to quantify the costs before finalizing a rule.''
B. Sequencing of Rulemakings Under Dodd-Frank
    Chairman Gensler has recently disclosed his plan for the sequencing 
of final rulemakings under DFA. He has divided the rulemakings into 
three categories: early, middle and late. We agree that sequencing of 
the rules is critical to meaningful public comment and effective 
implementation of the rules to implement DFA. Many of the rulemakings 
required by DFA are interrelated. That is, DFA requires many 
intertwined rulemakings with varying deadlines. Market participants, 
including CME cannot fully understand the implications or costs of a 
proposed rule when that proposed rule is reliant on another rule that 
is not yet in its final form. As a result, interested parties are 
unable to comment on the proposed rules in a meaningful way, because 
they cannot know the full effect.
    We agree with many, but not all aspects of the Chairman's proposed 
sequencing agenda and have recently proposed an alternative sequencing 
agenda to the Commissioners. We recommend that in Phase 1 (early), the 
Commission focus on rules that are necessary to bring the previously 
unregulated swaps market into the sound regulatory framework that 
exists for futures markets. This set of major rulemakings represents 
the largest amount of change for the industry and cannot be 
satisfactorily addressed in a timely manner if key elements of the 
regulatory framework for swaps clearing are not determined until the 
middle or late stages of the rulemaking process. Further, the 
regulatory framework for reducing systemic risk in OTC derivatives was 
the central focus of DFA and therefore should have the highest 
priority.
    We suggest that Phase II (middle) deal with exchange-trading 
requirements for swaps, including the definition of and requirements 
for swap trading facilities, business conduct standards for swap 
dealers and requirements for swap data repositories. While we support 
efforts to increase transparency in swaps markets, we believe these 
rulemakings are less critical in time priority than the clearing 
mandate and related clearing rules that will reduce systemic risk.
    Finally, we recommend that the Commission leave those rulemakings 
that deal with DCMs and position limits for Phase III (late). As I 
mention throughout my testimony, the exchange-traded derivatives market 
operated flawlessly during the financial crisis, and the proposed rules 
affecting DCMs and position limits, which as discussed below, often 
represent an overstepping of the Commission's authority under DFA, 
represent incremental changes to an already robust regulatory scheme.
    With respect to the phasing in of the mandatory clearing rules for 
swaps, some have suggested that the clearing requirement first be 
applied to dealer-to-dealer swaps and then later applied to dealer-to-
customer swaps. CME Group strongly disagrees with this approach insofar 
as it may limit clearing competition and customer choice and because, 
more importantly, it will disadvantage customers who are preparing for 
central counterparty clearing of swaps but are unable to complete their 
preparations due to the uncertainty associated with the lack of final 
rules. Sell-side and buy-side participants may elect to support or 
prefer different clearing solutions depending on how they are owned and 
operated, the membership requirements associated with each clearing 
house, and the risk management and default management features 
associated with each clearing solution. Different clearing houses have 
already adopted differing approaches to these features, enhancing 
competition and the proliferation of different business models. 
Sequencing dealer-to-dealer clearing prior to dealer-to-customer 
clearing lacks any rational justification and simply limits the 
availability of competing clearing models, potentially limiting 
competition, which Congress expressly provided for in DFA.
    The theory behind phasing in dealer-to-dealer swaps first is that 
dealers will be prepared to begin clearing swaps before buy-side 
participants are likewise prepared. This rationale, however, is not 
based in fact. An overwhelming number of buy-side participants are 
already clearing or ready to clear or will be ready to clear in the 
near future. Ten buy-side firms are already clearing at CME Group. 
Another 30 are testing with us and have informed us that they are 
planning to be prepared to clear no later than July 15. Another 80 buy-
side firms are in the pipeline to clear with us and would like to be 
ready to clear voluntarily approximately 3-6 months before mandated to 
do so. Also, UBS recently conducted a comprehensive study (March 10, 
2011) of OTC derivatives market participants to gauge the readiness on 
the buy-side for this transition. Their study found that buy-side firms 
are increasingly prepared to clear OTC derivatives, reporting that 73% 
of firms are already clearing or preparing to clear, 71% expect to 
begin clearing within 12 months, and 82% expect that the majority of 
their OTC businesses will be cleared within 2 years. Claims that buy-
side participants are not ready to clear are simply false and will 
disadvantage buy-side firms that wish to reduce bilateral clearing 
risks by adopting central counterparty clearing as soon as possible.
    We believe that the most efficient way to implement the clearing 
mandate is to phase in the mandate on a product-class by product-class 
basis. Once the CFTC defines ``class,'' it can mandate that large 
classes of instruments, such as 10 year interest rate swaps, be cleared 
regardless of the counterparties to the trade. This approach will (i) 
preserve customer choice in clearing, (ii) bring the largest volume of 
swaps into clearing houses as soon as possible, and (iii) allocate the 
Commission's limited resources in an efficient manner. CME Group's 
letter to Chairman Gensler, which discusses our position on both 
sequencing of rulemaking and sequencing of implementation of the 
clearing mandate in greater detail, is attached for your reference as 
Exhibit A.
    The Commission should avoid creating an un-level playing field 
among large swap market participants--both in terms of freedom to 
choose among competing clearing offerings and in terms of their ability 
to reduce bilateral credit risks in a timely fashion. Congress wisely 
recognized that major swap participants that are not swap dealers can 
also pose systemic risks to the marketplace; hence the Commission 
should sequence rules applying to swap dealers and major swap 
participants at the same time.
    This Congress can mitigate some of the problems that have plagued 
the CFTC rulemaking process by extending the rulemaking schedule so 
that professionals, including exchanges, clearing houses, dealers, 
market makers, and end-users can have their views heard and so that the 
CFTC will have a realistic opportunity to assess those views and 
measure the real costs imposed by its new regulations. Otherwise, the 
unintended adverse consequences of those ambiguities and the rush to 
regulation will impair the innovative, effective risk management that 
regulated exchanges have provided through the recent financial crisis 
and stifle the intended effects of financial reform, including the 
clearing of OTC transactions.
C. Impact of Regulatory Proposals on U.S. Markets
    Several Commissioners clearly recognize the potential unintended 
consequences and the potential detrimental effects of a prescriptive, 
rather than principles-based, regime upon the markets. Commissioner 
Dunn, for example, expressed concern that if the CFTC's ``budget woes 
continue, [his] fear is that the CFTC may simply become a restrictive 
regulator. In essence, [it] will need to say `No' a lot more . . . No 
to anything [it does] not believe in good faith that [it has] the 
resources to manage'' and that ``such a restrictive regime may be 
detrimental to innovation and competition.'' \1\ Commissioner O'Malia 
has likewise expressed concern regarding the effect of proposed 
regulations on the markets. More specifically, the Commissioner has 
expressed concern that new regulation could make it ``too costly to 
clear.'' He noted that there are several ``changes to [the] existing 
rules that will contribute to increased costs.'' Such cost increases 
have the effect of ``reducing the incentive of futures commission 
merchants to appropriately identify and manage customer risk. In the 
spirit of the Executive Order, we must ask ourselves: Are we creating 
an environment that makes it too costly to clear and puts risk 
management out of reach'' \2\
---------------------------------------------------------------------------
    \1\ Commissioner Dunn stated: ``Lastly, I would like to speak 
briefly about the budget crisis the CFTC is facing. The CFTC is 
currently operating on a continuing resolution with funds insufficient 
to implement and enforce the Dodd-Frank Act. My fear at the beginning 
of this process was that due to our lack of funds the CFTC would be 
forced to move from a principles based regulatory regime to a more 
prescriptive regime. If our budget woes continue, my fear is that the 
CFTC may simply become a restrictive regulator. In essence, we will 
need to say `No' a lot more. No to new products. No to new 
applications. No to anything we do not believe in good faith that we 
have the resources to manage. Such a restrictive regime may be 
detrimental to innovation and competition, but it would allow us to 
fulfill our duties under the law, with the resources we have 
available.'' Commissioner Michael V. Dunn, Opening Statement, Public 
Meeting on Proposed Rules Under Dodd-Frank Act (January 13, 2011) 
http://www.cftc.gov/PressRoom/SpeechesTestimony/
dunnstatement011311.html.
    \2\ In Facing the Consequences: ``Too Costly to Clear,'' 
Commissioner O'Malia stated: ``I have serious concerns about the cost 
of clearing. I believe everyone recognizes that the Dodd-Frank Act 
mandates the clearing of swaps, and that as a result, we are 
concentrating market risk in clearinghouses to mitigate risk in other 
parts of the financial system. I said this back in October, and 
unfortunately, I have not been proven wrong yet. Our challenge in 
implementing these new clearing rules is in not making it `too costly 
to clear.' Regardless of what the new market structures ultimately look 
like, hedging commercial risk and operating in general will become more 
expensive as costs increase across the board, from trading and 
clearing, to compliance and reporting.''
    ``In the short time I have been involved in this rulemaking 
process, I have seen a distinct but consistent pattern. There seems to 
be a strong correlation between risk reduction and cash. Any time the 
clearing rulemaking team discusses increasing risk reduction, it is 
followed by a conversation regarding the cost of compliance and how 
much more cash is required.''
    ``For example, there are several changes to our existing rules that 
will contribute to increased costs, including more stringent standards 
for those clearinghouses deemed to be systemically significant. The 
Commission staff has also recommended establishing a new margining 
regime for the swaps market that is different from the futures market 
model because it requires individual segregation of customer 
collateral. I am told this will increase costs to the customer and 
create moral hazard by reducing the incentive of futures commission 
merchants to appropriately identify and manage customer risk. In the 
spirit of the Executive Order, we must ask ourselves: Are we creating 
an environment that makes it too costly to clear and puts risk 
management out of reach?'' Commissioner Scott D. O'Malia, Derivatives 
Reform: Preparing for Change, Title VII of the Dodd-Frank Act: 732 
Pages and Counting, Keynote Address (January 25, 2011)
http://www.cftc.gov/PressRoom/SpeechesTestimony/opaomalia-3.html.
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    Additionally, concern has been expressed regarding unduly stringent 
regulation driving major customers overseas; indeed, we have already 
seen this beginning to happen with only the threat of regulation. For 
example, Commissioner Sommers has noted that she was troubled by the 
lack of analysis of swap markets and of whether the proposal would 
`cause price discovery in the commodity to shift to trading on foreign 
boards of trade,' and that ``driving business overseas remains a long 
standing concern.''
Conclusion
    Attached to my testimony are just a few examples where the 
Commission has proposed rules inconsistent with DFA or that impose 
unjustified costs and burdens on both the industry and the Commission. 
As previously noted, CME Group has great concern about the number of 
unnecessary and overly burdensome rule proposals aimed at the regulated 
futures markets. The goal of Dodd-Frank was to bring transparency, 
safety and soundness to the over-the-counter market, not re-regulate 
those markets which have operated transparently and without default. 
However, given the CFTC has determined to issue numerous rules above 
and beyond what is statutorily required by DFA, we ask this Congress to 
extend the rulemaking schedule under DFA to allow time for industry 
professionals of various viewpoints to fully express their views and 
concerns to the Commission and for the Commission to have a realistic 
opportunity to assess and respond to those views and to realistically 
assess the costs and burdens imposed by the new regulations. To this 
end, we urge the Congress to ensure that the Commission performs a 
proper cost-benefit analysis, taking into account real financial costs 
to market participants, before the proposal or implementation of rules 
promulgated under DFA. The imposition of unnecessary costs and 
restrictions on market participants can only result in the stifling of 
growth of the U.S. futures industry, send market participants to 
overseas exchanges, and in the end, result in harm to the U.S. economy 
and loss of American jobs. We urge the Congress to ensure that 
implementation of DFA is consistent with the Congressional directives 
in the Act and does not unnecessarily harm hedging and risk transfer 
markets that U.S. companies depend upon to reduce business risks and 
increase economic growth.
                                Appendix
Concerns Regarding Specific Rulemakings
    We are concerned that many of the Commission's proposed rulemakings 
go beyond the specific mandates of DFA, and are not legitimately 
grounded in evidence and economic theory. I will now address, in turn, 
several proposed rules issued by the Commission that illustrate these 
problems.
1. Advance Notice of Proposed Rulemaking on Protection of Cleared Swaps 
        Customers Before and After Commodities Broker Bankruptcies \3\
---------------------------------------------------------------------------
    \3\ 75 Fed. Reg. 75162 (proposed Dec. 2, 2010) (to be codified at 
17 CFR pt. 190).
---------------------------------------------------------------------------
    In its Advanced Notice of Proposed Rulemaking (``ANPR'') regarding 
segregation of customer funds, the Commission notes that it is 
considering imposing an ``individual segregation'' model for customer 
funds belonging to swaps customers. Such a model would impose 
unnecessary costs on derivatives clearing organizations (``DCOs'') and 
customers alike. As noted in the ANPR, DCOs have long followed a model 
(the ``baseline model'') for segregation of collateral posted by 
customers to secure contracts cleared by a DCO whereby the collateral 
of multiple futures customers of a futures commission merchant 
(``FCM'') is held together in an omnibus account. If the FCM defaults 
to the DCO because of the failure of a customer to meet its obligations 
to the FCM, the DCO is permitted (but not required), in accordance with 
the DCO's rules and CFTC regulations, to use the collateral of the 
FCM's other futures customers in the omnibus account to satisfy the 
FCM's net customer futures obligation to the DCO. Under the baseline 
model, customer collateral is kept separate from the property of FCMs 
and may be used exclusively to ``purchase, margin, guarantee, secure, 
transfer, adjust or settle trades, contracts or commodity option 
transactions of commodity or option customers.'' \4\ A DCO may not use 
customer collateral to satisfy obligations coming out of an FCM's 
proprietary account.
---------------------------------------------------------------------------
    \4\ See, Reg. 1.20(a).
---------------------------------------------------------------------------
    In its ANPR, the Commission suggests the possibility of applying a 
different customer segregation model to collateral posted by swaps 
customers, proposing three separate models, each of which requires some 
form of ``individual segregation'' for customer cleared-swap accounts. 
Each of these models would severely limit the availability of other 
customer funds to a DCO to cure a default by an FCM based on the 
failure of a customer to meet its obligations to the DCO. The 
imposition of any of these alternative models first, is outside of the 
Commission's authority under DFA and second, will result in massive and 
unnecessary costs to DCOs as well as to customers--the very individuals 
such models are allegedly proposed to protect.
    CME Group recognizes that effective protection of customer funds 
is, without a doubt, critical to participation in the futures and swaps 
markets. This fact does not, however, call for a new segregation 
regime. The baseline model has performed this function admirably over 
the years, with no futures customers suffering a loss as a result of an 
FCM's bankruptcy or default. There is no reason to believe it will not 
operate as well in the swaps market. DFA did nothing to change this 
segregation regime as applied to futures, and a focus of Dodd-Frank is 
to bring the OTC swaps market into a regulatory scheme similar to that 
which allowed the futures markets to function flawlessly throughout the 
financial crisis. To this end, it is nonsensical that Congress would 
intend to require a different scheme of segregation of customer funds 
and as a result, a different margining and default model than that 
currently used in the futures markets. Imposing such a conflicting 
model would complicate the function of DCOs intending to clear both 
futures and swaps. Indeed, the statutory language adopted in Section 
724 of DFA does nothing to compel such a result.
    The imposition of a different customer segregation system could 
undermine the intent behind DFA by imposing significantly higher costs 
on customers, clearing members, and DCOs intending to clear swaps and 
injecting moral hazard into a system at the customer and FCM levels. A 
change from the baseline model would interfere with marketplace and 
capital efficiency as DCOs may be required to increase security 
deposits from clearing members. That is, depending on the exact 
methodology employed, DCOs may be forced to ask for more capital from 
clearing members. Based on CME Group's initial assessments, these 
increases in capital requirements would be substantial. For example, 
CME Group's guarantee fund would need to double in size. Aside from 
these monetary costs, adoption of a segregation model would create 
moral hazard concerns at the FCM level. That is, the use of the new 
proposed models could create a disincentive for an FCM to offer the 
highest level of risk managements to its customers if the oversight and 
management of individual customer risk was shifted to the clearing 
house and continue to carry the amount of excess capital they do today.
    Imposition of the suggested systems could increase costs and 
decrease participation in the CFTC-regulated cleared-swaps market 
because customers may be unable or unwilling to satisfy resultant 
substantially increased margin requirements. FCMs would face a variety 
of increased indirect costs, such as staffing costs, new systems and 
compliance and legal costs and direct costs such as banking and 
custodial fees. FCMs would likely, in turn, pass these costs on to 
customers. Additionally, smaller FCMs may be forced out of business, 
larger FCMs may not have incentive to stay in business, and firms 
otherwise qualified to act as FCMs may be unwilling to do so due to the 
risk and cost imposed upon the FCM model by individualized segregation. 
This could lead to a larger concentration of customer exposures at 
fewer FCMs, further increases to margin and guarantee fund 
requirements, and further increased costs to customers. All of these 
consequences would lead to decreased participation in U.S. futures and 
swaps exchanges and result in loss of jobs in the United States.
2. Proposed Rulemaking on Position Limits \5\
---------------------------------------------------------------------------
    \5\ 76 Fed. Reg. 4752 (proposed Jan. 26, 2011) (to be codified at 
17 CFR pts. 1, 150-51)
---------------------------------------------------------------------------
    A prime example of a refusal to regulate in strict conformance with 
DFA, is the Commission's proposal to impose broad, fixed position 
limits for all physically delivered commodities. The Commission's 
proposed position limit regulations ignore the clear Congressional 
directives, which DFA added to Section 4a of the CEA, to set position 
limits ``as the Commission finds are necessary to diminish, eliminate, 
or prevent'' ``sudden or unreasonable fluctuations or unwarranted 
changes in the price of'' a commodity.\6\ Without any basis to make 
this finding, the Commission instead justified its position limit 
proposal as follows:
---------------------------------------------------------------------------
    \6\ My December 15, 2010, testimony before the Subcommittee on 
General Farm Commodities and Risk Management of the House Committee on 
Agriculture includes a more complete legal analysis of the DFA 
requirements.

        The Commission is not required to find that an undue burden on 
        interstate commerce resulting from excessive speculation exists 
        or is likely to occur in the future in order to impose position 
        limits. Nor is the Commission required to make an affirmative 
        finding that position limits are necessary to prevent sudden or 
        unreasonable fluctuations or unwarranted changes in prices or 
        otherwise necessary for market protection. Rather, the 
        Commission may impose position limits prophylactically, based 
        on its reasonable judgment that such limits are necessary for 
        the purpose of ``diminishing, eliminating, or preventing'' such 
        burdens on interstate commerce that the Congress has found 
        result from excessive speculation. 76 Federal Register 4752 at 
        4754 (January 26, 2011), Position Limits for Derivatives. 
---------------------------------------------------------------------------
        (emphasis supplied).

    At the December 15, 2010, hearing of the General Farm Commodities 
and Risk Management Subcommittee of the House Agriculture Committee on 
the subject of the implementation of DFA's provisions respecting 
position limits, there was strong bipartisan agreement among the 
Subcommittee Members with the sentiments expressed by Representative 
Moran:

        ``Despite what some believe is a mandate for the Commission to 
        set position limits within a definite period of time, the Dodd-
        Frank legislation actually qualifies CFTC's position-limit 
        authority. Section 737 of the Dodd-Frank Act amends the 
        Commodity Exchange Act so that Section 4A-A2A states, `The 
        Commission shall, by rule, establish limits on the amount of 
        positions as appropriate.' The Act then states, `In 
        subparagraph B, for exempt commodities, the limit required 
        under subparagraph A shall be established within 180 days after 
        the date of enactment of this paragraph.' When subparagraphs A 
        and B are read in conjunction, the Act states that when 
        position limits are required under subparagraph A, the 
        Commission shall set the limits within 180 days under paragraph 
        B. Subparagraph A says the position-limit rule should be only 
        prescribed when appropriate.

        ``Therefore, the 180 day timetable is only triggered if 
        position limits are appropriate. In regard to the word 
        `appropriate,' the Commission has three distinct problems. 
        First, the Commission has never made an affirmative finding 
        that position limits are appropriate to curtail excessive 
        speculation. In fact, to date, the only reports issued by the 
        Commission or its staff failed to identify a connection between 
        market trends and excessive speculation. This is not to say 
        that there is no connection, but it does say the Commission 
        does not have enough information to draw an affirmative 
        conclusion.

        ``The second and third issues relating to the appropriateness 
        of position limits are regulated to adequacy of information 
        about OTC markets. On December 8, 2010, the Commission 
        published a proposed rule on swap data record-keeping and 
        reporting requirements. This proposed rule is open to comment 
        until February 7, 2011, and the rule is not expected to be 
        final and effective until summer at the earliest. Furthermore, 
        the Commission has yet to issue a proposed rulemaking about 
        swap data repositories. Until a swap data repository is set up 
        and running, it is difficult to see how it would be appropriate 
        for the Commission to set position limits.''

    CME is not opposed to position limits and other means to prevent 
market congestion; we employ limits in most of our physically delivered 
contracts. However, we use limits and accountability levels, as 
contemplated by the Congressionally-approved Core Principles for DCMs, 
to mitigate potential congestion during delivery periods and to help us 
identify and respond in advance of any threat to manipulate our 
markets. CME Group believes that the core purpose that should govern 
Federal and exchange-set position limits, to the extent such limits are 
necessary and appropriate should be to reduce the threat of price 
manipulation and other disruptions to the integrity of prices. We agree 
that such activity destroys public confidence in the integrity of our 
markets and harms the acknowledged public interest in legitimate price 
discovery and we have the greatest incentive and best information to 
prevent such misconduct.
    It is important not to lose sight of the real economic cost of 
imposing unnecessary and unwarranted position limits. For the last 150 
years, modern day futures markets have served as the most efficient and 
transparent means to discover prices and manage exposure to price 
fluctuations. Regulated futures exchanges operate centralized, 
transparent markets to facilitate price discovery by permitting the 
best informed and most interested parties to express their opinions by 
buying and selling for future delivery. Such markets are a vital part 
of a smooth functioning economy. Futures exchanges allow producers, 
processors and agribusiness to transfer and reduce risks through bona 
fide hedging and risk management strategies. This risk transfer means 
producers can plant more crops. Commercial participants can ship more 
goods. Risk transfer only works because speculators are prepared to 
provide liquidity and to accept the price risk that others do not. 
Futures exchanges and speculators have been a force to reduce price 
volatility and mitigate risk. Overly restrictive position limits 
adversely impact legitimate trading and impair the ability of producers 
to hedge. They may also drive certain classes of speculators into 
physical markets and consequently distort the physical supply chain and 
prices.
    Similarly troubling is the fact that the CFTC's proposed rules in 
this and other areas affecting market participants are not in harmony 
with international regulators. International regulators, such as the 
E.U., are far from adopting such a prescriptive approach with respect 
to position limits. Ultimately, this could create an incentive for 
market participants to move their business to international exchanges 
negatively impacting the global leadership of the U.S. financial 
market. Furthermore, exporting the price discovery process to overseas 
exchanges will likely result in both a loss of jobs in the U.S. and 
less cost-efficient hedging for persons in business in the U.S. As an 
example, consider the two major price discovery indexes in crude oil: 
West Texas Intermediate, which trades on NYMEX, and Brent Oil, which 
trades overseas. If the Commission places heavy restrictions in areas 
such as position limits on traders in the U.S., traders in crude oil, 
and with them the price discovery process, are likely to move to 
overseas markets.
3. Proposed Rulemaking on Mandatory Swaps Clearing Review Process \7\
---------------------------------------------------------------------------
    \7\ 75 Fed. Reg. 667277 (proposed Nov. 2, 2010) (to be codified at 
17 CFR pts. 1, 150, 151).
---------------------------------------------------------------------------
    Another example of a rule proposal that could produce consequences 
counter to the fundamental purposes of DFA is the Commission's proposed 
rule relating to the process for review of swaps for mandatory 
clearing. The proposed regulation treats an application by a DCO to 
list a particular swap for clearing as obliging that DCO to perform due 
diligence and analysis for the Commission respecting a broad swath of 
swaps, as to which the DCO has no information and no interest in 
clearing. In effect, a DCO that wishes to list a new swap would be 
saddled with the obligation to collect and analyze massive amounts of 
information to enable the Commission to determine whether the swap that 
is the subject of the application and any other swap that is within the 
same ``group, category, type, or class'' should be subject to the 
mandatory clearing requirement.
    This proposed regulation is one among several proposals that impose 
costs and obligations whose effect and impact are contrary to the 
purposes of Title VII of DFA. The costs in terms of time and effort to 
secure and present the information required by the proposed regulation 
would be a significant disincentive to DCOs to voluntarily undertake to 
clear a ``new'' swap. The Commission lacks authority to transfer the 
obligations that the statute imposes on it to a DCO. The proposed 
regulation eliminates the possibility of a simple, speedy decision on 
whether a particular swap transaction can be cleared--a decision that 
the DFA surely intended should be made quickly in the interests of 
customers who seek the benefits of clearing--and forces a DCO to 
participate in an unwieldy, unstructured and time-consuming process to 
determine whether mandatory clearing is required. Regulation Section 
39.5(b)(5) starkly illustrates this outcome. No application is deemed 
complete until all of the information that the Commission needs to make 
the mandatory clearing decision has been received. Completion is 
determined in the sole discretion of the Commission. Only then does the 
90 day period begin to run. This process to enable an exchange to list 
a swap for clearing is clearly contrary to the purposes of DFA.
4. Conversion from Principles-Based to Rules-Based Regulation \8\
---------------------------------------------------------------------------
    \8\ See, 75 Fed. Reg. 80747 (proposed Dec. 22, 2010) (to be 
codified at 17 CFR pts. 1, 16, 38).
---------------------------------------------------------------------------
    Some of the CFTC's rule proposals are explained by the ambiguities 
created during the rush to push DFA to a final vote. For example, 
Congress preserved and expanded the scheme of principles-based 
regulation by expanding the list of core principles and granting self 
regulatory organizations ``reasonable discretion in establishing the 
manner in which the [self regulatory organization] complies with the 
core principles.'' Congress granted the Commission the authority to 
adopt rules respecting core principles, but did not direct it to 
eliminate the principles-based regulation, which was the foundation of 
the CFMA. In accordance with CFMA, the CFTC set forth ``[g]uidance on, 
and Acceptable Practices in, Compliance with Core Principles'' that 
operated as safe harbors for compliance. This approach has proven 
effective and efficient in terms of appropriately allocating 
responsibilities between regulated DCMs and DCOs and the CFTC.
    We recognize that the changes instituted by DFA give the Commission 
discretion, where necessary, to step back from this principles-based 
regime. Congress amended the CEA to state that boards of trade ``shall 
have reasonable discretion in establishing the manner in which they 
comply with the core principles, unless otherwise determined by the 
Commission by rule or regulation.'' See, e.g., DFA  735(b), amending 
Section 5(d)(1)(B) of the CEA. But the language clearly assumes that 
the principles-based regime will remain in effect except in limited 
circumstances in which more specific rules addressing compliance with a 
core principle are necessary. The Commission has used this change in 
language, however, to propose specific requirements for multiple Core 
Principles--almost all Core Principles in the case of DCMs--and 
effectively eviscerate the principle-based regime that has fostered 
success in CFTC-regulated entities for the past decade.
    The Commission's almost complete reversion to a prescriptive 
regulatory approach converts its role from an oversight agency, 
responsible for assuring self regulatory organizations comply with 
sound principles, to a front line decision maker that imposes its 
business judgments on the operational aspects of derivatives trading 
and clearing. This reinstitution of rule-based regulation will require 
a substantial increase in the Commission's staff and budget and impose 
indeterminable costs on the industry and the end-users of derivatives. 
Yet there is no evidence that this will be beneficial to the public or 
to the functioning of the markets. In keeping with the President's 
Executive Order to reduce unnecessary regulatory cost, the CFTC should 
be required to reconsider each of its proposals with the goal of 
performing those functions that are mandated by DFA.
    Further, the principles-based regime of the CFMA has facilitated 
tremendous innovation and allowed U.S. exchanges to compete effectively 
on a global playing field. Principles-based regulation of futures 
exchanges and clearing houses permitted U.S. exchanges to regain their 
competitive position in the global market. Without unnecessary, costly 
and burdensome regulatory review, U.S. futures exchanges have been able 
to keep pace with rapidly changing technology and market needs by 
introducing new products, new processes and new methods by certifying 
compliance with the CEA. Indeed, U.S. futures exchanges have operated 
more efficiently, more economically and with fewer complaints under 
this system than at any time in their history. The transition to an 
inflexible regime threatens to stifle growth and innovation in U.S. 
exchanges and thereby drive market participants overseas. This, I noted 
earlier, will certainly impact the relevant job markets in the United 
States.
(a) Proposed Rulemaking under Core Principle 9 for DCMs
    A specific example of the Commission's unnecessary and problematic 
departure from the principles-based regime is its proposed rule under 
Core Principle 9 for DCMs--Execution of Transactions, which states that 
a DCM ``shall provide a competitive, open and efficient market and 
mechanism for executing transactions that protects the price discovery 
process of trading in the centralized market'' but that ``the rules of 
a board of trade may authorize . . . (i) transfer trades or office 
trades; (ii) an exchange of (I) futures in connection with a cash 
commodity transaction; (II) futures for cash commodities; or (III) 
futures for swaps; or (iii) a futures commission merchant, acting as 
principle or agent, to enter into or confirm the execution of a 
contract for the purchase or sale of a commodity for future delivery if 
that contract is reported, recorded, or cleared in accordance with the 
rules of the contract market or [DCO].''
    Proposed Rule 38.502(a) would require that 85% or greater of the 
total volume of any contract listed on a DCM be traded on the DCM's 
centralized market, as calculated over a 12 month period. The 
Commission asserts that this is necessary because ``the price discovery 
function of trading in the centralized market'' must be protected. 75 
Fed. Reg. at 80588. However, Congress gave no indication in DFA that it 
considered setting an arbitrary limit as an appropriate means to 
regulate under the Core Principles. Indeed, in other portions of DFA, 
where Congress thought that a numerical limit could be necessary, it 
stated so. For example, in Section 726 addressing rulemaking on 
Conflicts of Interest, Congress specifically stated that rules ``may 
include numerical limits on the control of, or the voting rights'' of 
certain specified entities in DCOs, DCMs or SEFs.
    The Commission justifies the 85% requirement only with its 
observations as to percentages of various contracts traded on various 
exchanges. It provides no support evidencing that the requirement will 
provide or is necessary to provide a ``competitive, open, and efficient 
market and mechanism for executing transactions that protects the price 
discovery process of trading in the centralized market of the board of 
trade,'' as is required under Core Principle 9. Further, Core Principle 
9, as noted above, expressly permits DCMs to authorize off-exchange 
transactions including for exchanges to related positions pursuant to 
their rules.
    The imposition of the proposed 85% exchange trading requirement 
will have extremely negative effects on the industry. It would 
significantly deter the development of new products by exchanges like 
CME. This is because new products generally initially gain trading 
momentum in off-exchange transactions. Indeed, it takes years for new 
products to reach the 85% exchange trading requirement proposed by the 
Commission. For example, one suite of very popular and very liquid 
foreign exchange products developed and offered by CME would not have 
met the 85% requirement for 4 years after it was initially offered. The 
suite of products' on-exchange trading continued to increase over 10 
years, and it now trades only 2% off exchange. Under the proposed rule, 
CME would have had to delist this suite of products.\9\
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    \9\ More specifically, the product traded 32% off-exchange when it 
was first offered in 2000, 31% off exchange in 2001, 25 % in 2002, 20% 
in 2003, finally within the 85% requirement at 13% off-exchange in 
2004, 10% in 2005, 7% in 2006, 5% in 2007, 3% in 2008, and 2% in 2009 
and 2010.
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    Imposition of an 85% exchange trading requirement would also have 
adverse effects on market participants. If instruments that are most 
often traded off-exchange are forced onto the centralized market, 
customers will lose cross-margin efficiencies that they currently enjoy 
and will be forced to post additional cash or assets as margin. For 
example, customers who currently hold open positions on CME 
Clearport' will be required to post a total of approximately 
$3.9 billion in margin (at the clearing firm level, across all clearing 
firms).
(b) Proposed Comparable Fee Structures Under Core Principle 2 for DCMs
    In the case of certain proposed fee restrictions to be placed on 
DCMs, the Commission not only retreats needlessly from principles-based 
regulation but also greatly exceeds its authority under DFA. DCM Core 
Principle 2, which appears in DFA Section 735, states, in part, that a 
DCM ``shall establish, monitor, and enforce compliance with rules of 
the contract market including . . . access requirements.'' Under this 
Core Principle, the Commission has proposed rule 38.151, which states 
that a DCM ``must provide its members, market participants and 
independent software vendors with impartial access to its market and 
services including . . . comparable fee structures for members, market 
participants and independent software vendors receiving equal access 
to, or services from, the [DCM].''
    The CFTC's attempt to regulate DCM member, market participant and 
independent software vendor fees is unsupportable. The CFTC is 
expressly authorized by statute to charge reasonable fees to recoup the 
costs of services it provides. 7 U.S.C. 16a(c). The Commission may not 
bootstrap that authority to set or limit the fees charged by DCMs or to 
impose an industry-wide fee cap that has the effect of a tax. See, 
Federal Power Commission v. New England Power Co., 415 U.S. 345, 349 
(1974) (``[W]hole industries are not in the category of those who may 
be assessed [regulatory service fees], the thrust of the Act reaching 
only specific charges for specific services to specific individuals or 
companies.''). In any event, the CFTC's overreaching is not supported 
by DFA. Nowhere in the CEA is the CFTC authorized to set or limit fees 
a DCM may charge. To the extent the CFTC believes its authority to 
oversee impartial access to trading platforms may provide a basis for 
its assertion of authority, that attempt to read new and significant 
powers into the CEA should be rejected.
5. Provisions Common to Registered Entities \10\
---------------------------------------------------------------------------
    \10\ 75 Fed. Reg. 67282 (proposed Nov. 2, 2010) (to be codified at 
17 CFR pt. 40).
---------------------------------------------------------------------------
    The CFMA streamlined the procedures for listing new products and 
amending rules that did not impact the economic interests of persons 
holding open contracts. These changes recognized that the previous 
system required the generation of substantial unnecessary paperwork by 
exchanges and by the CFTC's staff. It slowed innovation without a 
demonstrable public benefit.
    Under current rules, before a product is self-certified or a new 
rule or rule amendment is proposed, DCMs and DCOs conduct a due 
diligence review to support their conclusion that the product or rule 
complies with the Act and Core Principles. The underlying rationale for 
the self-certification process which has been retained in DFA, is that 
registered entities that list new products have a self-interest in 
making sure that the new products meet applicable legal standards. 
Breach of this certification requirement potentially subjects the DCM 
or DCO to regulatory liability. In addition, in some circumstances, a 
DCM or DCO may be subject to litigation or other commercial remedies 
for listing a new product, and the avoidance of these costs and burdens 
is sufficient incentive for DCMs and DCOs to remain compliant with the 
Act.
    Self-certification has been in effect for 10 years and nothing has 
occurred to suggest that this concept is flawed or that registered 
entities have employed this power recklessly or abusively. During 2010, 
CME launched 438 new products and submitted 342 rules or rule 
amendments to the Commission. There was no legitimate complaint 
respecting the self-certification process during this time. Put simply, 
the existing process has worked, and there is no reason for the 
Commission to impose additional burdens, which are not required by DFA, 
to impair that process.
    Section 745 of DFA merely states, in relevant part, that ``a 
registered entity may elect to list for trading or accept for clearing 
any new contract, or other instrument, or may elect to approve or 
implement any new rule or rule amendment, by providing to the 
Commission a written certification that the new contract or instrument 
or clearing of the new contract or instrument, new rule, or rule 
amendment complies with this Act (including regulations under this 
Act).'' DFA does not direct the Commission to require the submission of 
all documents supporting the certification nor to require a review of 
the legal implications of the product or rule with regard to laws other 
than DFA. Essentially, it requires exactly what was required prior to 
the passage of DFA--a certification that the product, rule or rule 
amendment complies with the CEA. Nonetheless, the Commission has taken 
it upon itself to impose these additional and burdensome submission 
requirements upon registered entities.
    The new requirements proposed by the CFTC will require exchanges to 
prematurely disclose new product innovations and consequently enable 
foreign competitors to introduce those innovations while the exchange 
awaits CFTC approval. This, again, inhibits the ability of U.S. 
exchanges to compete, drives market participants overseas and impairs 
job growth in the United States. Moreover, given the volume of filings 
required by the notice of proposed rulemaking, the Commission will 
require significant increases in staffing and other resources. 
Alternatively, the result will be that these filings will not be 
reviewed in a timely manner, further disadvantaging U.S. exchanges. 
Again, we would suggest that the Commission's limited resources should 
be better aligned with the implementation of the goals of DFA rather 
than ``correcting'' a well-functioning and efficient process.
    First, the proposed rules require a registered entity to submit 
``all documentation'' relied upon to determine whether a new product, 
rule or rule amendment complies with applicable Core Principles. This 
requirement is so vague as to create uncertainty as to what is actually 
required to be filed. More importantly, this requirement imposes an 
additional burden on both registered entities, which must compile and 
produce all such documentation, and the Commission, which must review 
it. It is clear that the benefits, if any, of this requirement are 
significantly outweighed by the costs imposed both on the marketplace 
and the Commission.
    Second, the proposed rules require registered entities to examine 
potential legal issues associated with the listing of products and 
include representations related to these issues in their submissions. 
Specifically, a registered entity must provide a certification that it 
has undertaken a due diligence review of the legal conditions, 
including conditions that relate to contractual and intellectual 
property rights. The imposition of such a legal due diligence standard 
is clearly outside the scope of DFA and is unnecessarily vague and 
impractical, if not impossible, to comply with in any meaningful 
manner. An entity, such as CME, involved in product creation and design 
is always cognizant that material intellectual property issues may 
arise. This requirement would force registered entities to undertake 
extensive intellectual property analysis, including patent, copyright 
and trademark searches in order to satisfy the regulatory mandates, 
with no assurances that any intellectual property claim is discoverable 
through that process at a particular point in time. Again, this would 
greatly increase the cost and timing of listing products without 
providing any corresponding benefit to the marketplace. Indeed, the 
Commission itself admits in its NOPR that these proposed rules will 
increase the overall information collection burden on registered 
entities by approximately 8,300 hours per year.\11\
---------------------------------------------------------------------------
    \11\ 75 Fed. Reg. at 67290.
---------------------------------------------------------------------------
    Further, these rules steer the Commission closer to the product and 
rule approval process currently employed by the SEC, which is routinely 
criticized and about which those regulated by the SEC complained at the 
CFTC-SEC harmonization hearings. Indeed, William J. Brodsky of the 
Chicago Board of Options Exchange testified that the SEC's approval 
process ``inhibits innovation in the securities markets'' and urged the 
adoption of the CFTC's certification process.
6. Requirements for Derivatives Clearing Organizations, Designated 
        Contract Markets, and Swap Execution Facilities Regarding 
        Mitigation of Conflicts of Interest \12\
---------------------------------------------------------------------------
    \12\ 75 Fed. Reg. 63732 (proposed October 18, 2010) (to be codified 
at 17 CFR pts. 1, 37, 38, 39, 40).
---------------------------------------------------------------------------
    The Commission's proposed rules regarding the mitigation of 
conflicts of interest in DCOs, DCMs and SEFs (``Regulated Entities'') 
also exceed its rulemaking authority under DFA and impose constraints 
on governance that are unrelated to the purposes of DFA or the CEA. The 
Commission purports to act pursuant to Section 726 of DFA but ignores 
the clear boundaries of its authority under that section, which it 
cites to justify taking control of every aspect of the governance of 
those Regulated Entities. Section 726 conditions the Commission's right 
to adopt rules mitigating conflicts of interest to circumstances where 
the Commission has made a finding that the rule is ``necessary and 
appropriate'' to ``improve the governance of, or to mitigate systemic 
risk, promote competition, or mitigate conflicts of interest in 
connection with a swap dealer or major swap participant's conduct of 
business with, a [Regulated Entity] that clears or posts swaps or makes 
swaps available for trading and in which such swap dealer or major swap 
participant has a material debt or equity investment.'' (emphasis 
added) The ``necessary and appropriate'' requirement constrains the 
Commission to enact rules that are narrowly-tailored to minimize their 
burden on the industry. The Commission failed to make the required 
determination that the proposed regulations were ``necessary and 
proper'' and, unsurprisingly, the proposed rules are not narrowly-
tailored but rather overbroad, outside of the authority granted to it 
by DFA and extraordinarily burdensome.
    The Commission proposed governance rules and ownership limitations 
that affect all Regulated Entities, including those in which no swap 
dealer has a material debt or equity investment and those that do not 
even trade or clear swaps. Moreover, the governance rules proposed have 
nothing to do with conflicts of interest, as that term is understood in 
the context of corporate governance. Instead, the Commission has 
created a concept of ``structural conflicts,'' which has no recognized 
meaning outside of the Commission's own declarations and is unrelated 
to ``conflict of interest'' as used in the CEA. The Commission proposed 
rules to regulate the ownership of voting interests in Regulated 
Entities by any member of those Regulated Entities, including members 
whose interests are unrelated or even contrary to the interests of the 
defined ``enumerated entities.'' In addition, the Commission is 
attempting to impose membership condition requirements for a broad 
range of committees that are unrelated to the decision making to which 
Section 726 was directed.
    The Commission's proposed rules are most notably overbroad and 
burdensome in that they address not only ownership issues but the 
internal structure of public corporations governed by state law and 
listing requirements of SEC regulated national securities exchanges. 
More specifically, the proposed regulations set requirements for the 
composition of corporate boards, require Regulated Entities to have 
certain internal committees of specified compositions and even propose 
a new definition for a ``public director.'' Such rules in no way relate 
to the conflict of interest Congress sought to address through Section 
726. Moreover, these proposed rules improperly intrude into an area of 
traditional state sovereignty. It is well-established that matters of 
internal corporate governance are regulated by the states, specifically 
the state of incorporation. Regulators may not enact rules that intrude 
into traditional areas of state sovereignty unless Federal law compels 
such an intrusion. Here, Section 726 provides no such authorization.
    Perhaps most importantly, the proposed structural governance 
requirements cannot be ``necessary and appropriate,'' as required by 
DFA, because applicable state law renders them completely unnecessary. 
State law imposes fiduciary duties on directors of corporations that 
mandate that they act in the best interests of the corporation and its 
shareholders--not in their own best interests or the best interests of 
other entities with whom they may have a relationship. As such, 
regardless of how a board or committee is composed, the members must 
act in the best interest of the exchange or clearinghouse. The 
Commission's concerns--that members, enumerated entities, or other 
individuals not meeting its definition of ``public director'' will act 
in their own interests--and its proposed structural requirements are 
wholly unnecessary and impose additional costs on the industry--not to 
mention additional enforcement costs--completely needlessly.
7. Prohibition on Market Manipulation \13\
---------------------------------------------------------------------------
    \13\ 75 Fed. Reg. 67657-62 (proposed Nov. 3, 2010) (to be codified 
at 17 CFR pt. 180).
---------------------------------------------------------------------------
    The Commission's proposed rules on Market Manipulation, although 
arguably within the authority granted by DFA, are also problematic 
because they are extremely vague. The Commission has proposed two rules 
related to market manipulation: Rule 180.1, modeled after SEC Rule 10b-
5 and intended as a broad, catch-all provision for fraudulent conduct; 
and Rule 180.2, which mirrors new CEA Section 6(c)(3) and is aimed at 
prohibiting price manipulation. See 75 Fed. Reg. at 67658. Clearly, 
there is a shared interest among market participants, exchanges and 
regulators in having market and regulatory infrastructures that promote 
fair, transparent and efficient markets and that mitigate exposure to 
risks that threaten the integrity and stability of the market. In that 
context, however, market participants also desire clarity with respect 
to the rules and fairness and consistency with regard to their 
enforcement.
    As to its proposed rule 180.1, the Commission relies on SEC 
precedent to provide further clarity with respect to its interpretation 
and notes that it intends to implement the rule to reflect its 
``distinct regulatory mission.'' However, the Commission fails to 
explain how the rule and precedent will be adapted to reflect the 
differences between futures and securities markets. See 75 Fed. Reg. at 
67658-60. For example, the Commission does not provide clarity as to if 
and to what extent it intends to apply insider trading precedent to 
futures markets. Making this concept applicable to futures markets 
would fundamentally change the nature of the market, not to mention all 
but halting participation by hedgers, yet the Commission does not even 
address this issue. Rule 180.1 is further unclear as to what standard 
of scienter the Commission intends to adopt for liability under the 
rule. Rule 180.2 is comparably vague, providing, for example, no 
guidance as to what sort of behavior is ``intended to interfere with 
the legitimate forces of supply and demand'' and how the Commission 
intends to determine whether a price has been affected by illegitimate 
factors.
    These proposed rules, like many others, have clearly been proposed 
in haste and fail to provide market participants with sufficient notice 
of whether contemplated trading practices run afoul of them. Indeed, we 
believe the proposed rules are so unclear as to be subject to 
constitutional challenge. That is, due process precludes the government 
from penalizing a private party for violating a rule without first 
providing adequate notice that conduct is forbidden by the rule. In the 
area of market manipulation especially, impermissible conduct must be 
clearly defined lest the rules chill legitimate market participation 
and undermine the hedging and price discovery functions of the market 
by threatening sanctions for what otherwise would be considered 
completely legal activity. That is, if market participants do not know 
the rules of the road in advance and lack confidence that the 
disciplinary regime will operate fairly and rationally, market 
participation will be chilled because there is a significant risk that 
legitimate trading practices will be arbitrarily construed, post-hoc, 
as unlawful. These potential market participants will either use a 
different method to manage risk or go to overseas exchanges, stifling 
the growth of U.S. futures markets and affecting related job markets.
8. Anti-Disruptive Practices Authority Contained in DFA \14\
---------------------------------------------------------------------------
    \14\ 75 Fed. Reg. 67301 (proposed November 2, 2010) (to be codified 
at 17 CFR pt. 1).
---------------------------------------------------------------------------
    Rules regarding Disruptive Trade Practices (DFA Section 747) run 
the risk of being similarly vague and resulting in chilling market 
participation. The CFTC has recently issued a Proposed Interpretive 
Order which provides guidance regarding the three statutory disruptive 
practices set for in DFA Section 747.\15\ CME Group applauds the 
Commission's decision to clarify the standards for liability under the 
enumerated disruptive practices and supports the Commission's decision 
to refrain from setting forth any additional ``disruptive practices'' 
beyond those listed in the statute. We believe, however, that in 
several respects, the proposed interpretations still do not give market 
participants enough notice as to what practices are illegal and also 
may interfere with their ability to trade effectively.
---------------------------------------------------------------------------
    \15\ 76 Fed. Reg. 14943 (proposed March 18, 2011).
---------------------------------------------------------------------------
    For example, the Commission interprets section 4c(a)(5)(A), 
Violating Bids and Offers, ``as prohibiting any person from buying a 
contract at a price that is higher than the lowest available offer 
price and/or selling a contract at a price that is lower than the 
highest available bid price'' regardless of intent.\16\ However, 
certain existing platforms allow trading based on considerations other 
than price. Without an intent requirement, these platforms do not 
``fit'' under the regulations, and presumably will be driven out of 
business. Similarly, market participants desiring to legitimately trade 
on bases other than price will presumably be driven to overseas 
markets.
---------------------------------------------------------------------------
    \16\ 76 Fed. Reg. 14946 (proposed March 18, 2011).
---------------------------------------------------------------------------
    Further, the Commission states that section 4c(a)(5)(B), Orderly 
Execution of Transactions During the Closing Period, applies only where 
a participant ``demonstrates intentional or reckless disregard for the 
orderly execution of transactions during the closing period.'' However, 
the Commission goes on to state that ``market participants should 
assess market conditions and consider how their trading practices and 
conduct affect the orderly execution of transactions during the closing 
period.'' In so stating, the Commission seems to impose an affirmative 
obligation on market participants to consider these factors before 
executing any trade. This, first, directly conflicts with the scienter 
requirements also set forth by the Commission and thus interferes with 
the ability of market participants to determine exactly what conduct 
may give rise to liability. Second, such an affirmative obligation will 
interfere with the ability of market participants to make advantageous 
trades, especially in the context of a fast-moving, electronic trading 
platform. The end result of both these issues is that, if the 
Interpretive Order goes into effect as written, market participation 
will be chilled, participants will move to overseas markets and jobs 
will be lost in the U.S. futures industry.
    Section 747 of DFA, which authorizes the Commission to promulgate 
additional rules if they are reasonably necessary to prohibit trading 
practices that are ``disruptive of fair and equitable trading,'' is 
exceedingly vague as written and does not provide market participants 
with adequate notice as to whether contemplated conduct is forbidden. 
If the Interpretive Order does not clearly define ``disruptive trade 
practices,'' it will discourage legitimate participation in the market 
and the hedging and price discovery functions of the market will be 
chilled due to uncertainty among participants as to whether their 
contemplated conduct is acceptable.
9. Effects on OTC Swap Contracts
    DFA's overhaul of the regulatory framework for swaps creates 
uncertainty about the status and validity of existing and new swap 
contracts. Today, under provisions enacted in 2000, swaps are excluded 
or exempt from the CEA under Sections 2(d), 2(g) and 2(h) of the CEA. 
These provisions allow parties to enter into swap transactions without 
worrying about whether the swaps are illegal futures contracts under 
CEA Section 4(a). DFA repeals those exclusions and exemptions effective 
July 16, 2011. At this time, it is unclear what if any action the CFTC 
plans to take or legally could take to allow both swaps entered into on 
or before July 16, and those swaps entered into after July 16 from 
being challenged as illegal futures contracts. To address this concern, 
Congress and the CFTC should consider some combination of deferral of 
the effective dates of the repeal of Sections 2(d), 2(g) and 2(h), 
exercise of CFTC exemptive power under Section 4(c) or other 
appropriate action. Otherwise swap markets may be hit by a wave of 
legal uncertainty which the statutory exclusions and exemptions were 
designed in 2000 to prevent. This uncertainty may, again, chill 
participation in the swap market and impair the ability of market 
participants, including hedgers, to manage their risks.

    The Chairman. Thank you, Mr. Duffy.
    Mr. Scott for 5 minutes.

STATEMENT OF HAL S. SCOTT, J.D., DIRECTOR, COMMITTEE ON CAPITAL 
 MARKETS REGULATION; NOMURA PROFESSOR AND DIRECTOR, PROGRAM ON 
INTERNATIONAL FINANCIAL SYSTEMS, HARVARD LAW SCHOOL, CAMBRIDGE, 
                               MA

    Mr. Scott. Thank you, Chairman Conaway, Ranking Member 
Boswell, and Members of the Subcommittee, for permitting me to 
testify before you today.
    I am testifying in my own capacity and do not purport to 
represent the views of the Committee on Capital Markets 
Regulation. My testimony is focused on the implementation of 
the Dodd-Frank Act, with emphasis on the CFTC.
    The 44 rules that the CFTC--it was 46, actually, given 
yesterday--has promulgated so far and the rules that are yet to 
come will work a total revolution on the regulation of the 
over-the-counter derivatives market. I think we should 
understand the massive nature of the regulatory effort that we 
are engaged in here.
    The CFTC has finished proposing most of its rules, and we 
are just 3 months away from the July deadline, by which time 
many of the most important rules must be finalized. 
Unfortunately, the proposals have come out in a somewhat 
scattershot order. And, before we move forward toward 
finalizing and implementing the rules, we need to have a more 
comprehensive and rational approach.
    Once all of the rules have been proposed, CFTC should 
develop a public published statement as to how all of its rules 
fit together and in what order the final rules should be 
issued. The joint CFTC and SEC roundtable on implementation, 
planned for May 2 and 3, is a first step in that direction but 
only a first step.
    After it has put all this together, it then should do a re-
proposal of the entire package of rules and permit another 
round of comment on the substance of this package, which should 
include, as I said, plans for implementation.
    The Federal Reserve should play a key part in this 
rulemaking process, as it plays a large role in regulating the 
risk of the major participants in the derivatives 
clearinghouses as well as the clearinghouses themselves. A 
failure of a clearinghouse would be a major systemic shock to 
the financial system. Indeed, for this reason, in my view, the 
Fed should approve the substance and implementation of the 
plans of these Commissions.
    I should also emphasize the importance of the SEC and CFTC 
conducting proper cost-benefit analyses before finalizing these 
rules. Although neither agency is subject to the Executive 
Order President Obama issued in January, requiring review of 
the cost-benefit analysis by the Office of Information and 
Regulatory Affairs, OIRA, within the Office of Management and 
Budget, the heads of both of these Commissions have said they 
will comply with its principles. Neither has, however, in my 
view, come close.
    Without better cost-benefit analysis, these rules risk 
overturn in the D.C. Circuit. The D.C. Circuit has overturned 
other regulatory rules for lack of proper foundation. And it is 
not enough to consider cost and benefits. They have to be 
analyzed, and conclusions have to be made.
    I also want to talk a little bit about the international 
situation. As you know, other jurisdictions, and in particular 
the European Union, are working on a very similar regulatory 
overhaul of their over-the-counter derivatives regulation.
    Now, although the E.U. proposal is similar to the U.S. 
system, or system of proposals, with respect to its emphasis on 
central clearing, there are many important differences. For 
example, the European Union places less emphasis on exchange 
trading, on price transparency, and creates a broader end-user 
exemption.
    So, to some extent, these differences are a matter of the 
statutes, Dodd-Frank versus what this proposed directive of the 
E.U. is. But the CFTC does have the power to bring its 
regulation of clearinghouse risks closer to that of Europe. 
Both Europe and the U.S. will recognize a foreign clearinghouse 
for participation by the firms that it is regulating, but only 
if that clearinghouse is subject to similar requirements of 
those in its home country. So the E.U. is going to look at our 
rules and say, are they basically equivalent to the E.U. rules? 
And we are going to look at their rules and say, are they 
basically equivalent to our rules?
    Now, if they diverge too much, we are going to have a 
stalemate situation. Our firms aren't going to be able to be in 
the E.U. because those rules are not equivalent, and their 
firms aren't going to be able to be here because they are not 
equivalent. This is a very undesirable outcome. It would be, 
actually, better if we had a complete arbitrage than to have a 
stalemate. So, the point being that, in this whole 
consideration of the re-proposal, in my view, more has to be 
done to coordinate our approach with the E.U.
    Finally, I agree with Mr. Duffy that, overall, the approach 
of the CFTC, now and shortly, has been micro-management. I 
think what we need is more of a principles-based approach. And 
I actually congratulate the SEC on sticking to that approach.
    Thank you.
    [The prepared statement of Mr. Scott follows:]

   Prepared Statement of Hal S. Scott, J.D., Director, Committee on 
 Capital Markets Regulation; Nomura Professor, and Director, Program on
 International Financial Systems, Harvard Law School,\1\ Cambridge, MA
---------------------------------------------------------------------------
    \1\ Biography with disclosures on compensated activities available 
at http://www.law.harvard.edu/faculty/hscott.
---------------------------------------------------------------------------
    Thank you, Chairman Conaway, Ranking Member Boswell, and Members of 
the Subcommittee for permitting me to testify before you today on the 
implementation of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act (Dodd-Frank Act).\2\ I am testifying in my own capacity 
and do not purport to represent the views of any organizations with 
which I am affiliated, although much of my testimony is based on the 
past reports and statements of the Committee on Capital Markets 
Regulation.
---------------------------------------------------------------------------
    \2\ Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. 
L. No. 111-203, 124 Stat. 1376 (hereinafter Dodd-Frank Act).
---------------------------------------------------------------------------
    I will focus my remarks on the regulatory implementation of the 
portions of the Dodd-Frank Act relating to derivatives, with emphasis 
on the role of the Commodity Futures Trading Commission (CFTC). As you 
know, these rules will have a profound long-term impact on our 
financial system. It is important to get them right the first time, or 
else we risk making the U.S. financial system more risky and less 
competitive internationally.
    The Dodd-Frank Act requires many of its most important rules to be 
finalized by late July 2011, just over 3 months away. The CFTC has the 
major role in writing the rules governing derivatives and Chairman 
Gensler has stated that the CFTC is almost finished issuing its 
proposals--albeit some important ones remain. On the other hand, the 
CFTC has yet to issue a major final rule about derivatives and at least 
some major rules will likely slip past the July finalization deadline. 
I do not fault the CFTC for missing deadlines. In fact, in testimony I 
delivered in January before the Committee on Financial Services, I 
said, ``the most important objective should be to get the rules right, 
not to act quickly.'' \3\ I still believe this is the case.
---------------------------------------------------------------------------
    \3\ Promoting Economy Recovery and Job Creation: The Road Forward: 
Hearing Before the H. Comm. On Finc. Servs., 112th Cong. 14-15 (Jan. 
26, 2011) (testimony of Hal S. Scott) (hereinafter January Testimony).
---------------------------------------------------------------------------
    The proposed rulemaking process has unfortunately been scattershot. 
It was difficult for the public or markets to understand how the 
issuance of 44 proposed rules over 5 months would fit together. Before 
finalizing these rules the CFTC (as well as the SEC) should re-propose 
all of these rules and describe how they fit together to achieve their 
objectives, along with an analysis of their costs and benefits. It 
should then permit another round of comment on the rules as a whole. It 
should also make sure that the Federal Reserve concurs with its 
proposals and that they are coordinated with those of the SEC and other 
major countries. The CFTC should then, with the collaboration of the 
other agencies, sequence the implementation of these rules in a way to 
minimize transition costs.
I. The CFTC Implementation Process
    Of the 31 major rulemaking areas the CFTC identified, it has 
proposed rules in 28 areas. Appendix A shows the CFTC's rulemaking 
progress to date. Before it begins to finalize and implement these 
rules, however, it is important to consider whether any lessons can be 
drawn from the process the CFTC used to propose the rules over the last 
several months.
    Unlike the SEC, the CFTC has not published a clear timetable 
outlining which rules would be proposed when, and it is not obvious 
that much thought was given to which proposed rules should come first. 
I call this the scattershot approach. This has left the public in the 
dark about what was coming down the pipeline. The public and markets 
could not understand how the rules fit together before filing comments. 
Some of the CFTC's earliest proposed rules turned on important terms 
that had yet to be defined, such as ``major swap participant.'' It also 
issued optional proposals, not required by Dodd-Frank, such as those on 
segregation of collateral, before it proposed some of the major 
mandatory rules.\4\ It was also concerned with the governance of 
clearinghouses before addressing the relatively more important issue of 
risk management.
---------------------------------------------------------------------------
    \4\ See, e.g., Protection of Cleared Swaps Customers Before and 
After Commodity Broker Bankruptcies, 75 Fed. Reg. 75162 (Dec. 2, 2010); 
see also Sixth Series of Proposed Rulemakings Under the Dodd-Frank Act: 
Opening Statement of Comm'r Jill E. Sommers Before the U.S. Commodity 
Futures Trading Comm. (Dec. 1, 2010), http://www.cftc.gov/pressroom/
speechestestimony/sommersstatement120110.html (``a number of the 
regulations that we have already considered, and a number of 
regulations that we are considering today, are not required by Dodd-
Frank. Commission staff has spent months and months drafting proposed 
regulations that are purely voluntary'').
---------------------------------------------------------------------------
    Another general problem with the proposal process has been the lack 
of sufficient understanding of the industry in formulating the 
proposals. Showcase ``roundtable'' discussions and meetings with firms 
are not enough. Regulators need to gather information from the markets 
as to how they operate and then discuss their understanding of this 
information with industry and outside experts. The rush to propose 
rules generally did not allow this to happen. When the rules were 
proposed comment periods were far too short, usually only 30 days for 
the earliest proposals until the agencies yielded to pressure to extend 
the comment periods. This process can be compared to the deliberate and 
multi-year deliberation process the SEC went through before deciding in 
2007 that foreign companies could issue shares in the United States 
under international financial reporting standards without reconciling 
their statements to U.S. GAAP,\5\ a decision of relatively less 
importance than the entire transformation of the regulation of OTC 
derivatives.
---------------------------------------------------------------------------
    \5\ See, Acceptance From Foreign Private Issuers of Financial 
Statements Prepared in Accordance With International Financial 
Reporting Standards Without Reconciliation to U.S. GAAP, 73 Fed. Reg. 
986 (Jan. 4, 2008).
---------------------------------------------------------------------------
    Although the CFTC did not appropriately prioritize its rulemakings 
during the proposal stage, it now has the opportunity to prioritize the 
two most important parts of the rulemaking process, final rules and 
implementation. Chairman Gensler calls the CFTC's rules a ``whole 
mosaic.'' \6\ Once all of the rules have been proposed, the CFTC should 
pause and develop a public, published plan for how that mosaic fits 
together and in what order the final rules should be issued. It should 
then permit another round of comment on the rules as a whole. This is 
essential given the shortcomings of the piecemeal proposal process.
---------------------------------------------------------------------------
    \6\ Implementing the Dodd-Frank Act: Remarks of Chairman Gensler 
Before FIA's Annual International Futures Industry Conference (Mar. 16, 
2011), http://www.cftc.gov/PressRoom/SpeechesTestimony/opagensler-
73.html.
---------------------------------------------------------------------------
    The CFTC should then give careful consideration to the sequence of 
implementation. Chairman Gensler has already outlined a helpful broad 
tentative order.\7\ He has suggested that the final rules be grouped 
into three broad categories, beginning in the spring and ending in the 
early fall. While this timetable is too aggressive, some of the 
ordering is quite sensible: the rules involving definitions, 
registration, and mandatory clearing should come first. In other cases, 
however, the schedule is less justified. For example, Chairman Gensler 
mentions capital and margin as part of the last group, even though 
those rules are among the most important for risk management.
---------------------------------------------------------------------------
    \7\ See, id.
---------------------------------------------------------------------------
    The Federal Reserve should play a key part in the rulemaking 
process. The Fed should review and approve the substance and 
implementation of the Commission's plans. Under the Dodd-Frank Act, the 
Fed has a major role to play in monitoring and managing the systemic 
risk of clearinghouses, so it is important to have the Fed sign off on 
the rules before they are finalized. First and foremost, the Fed 
supervises the large dealer banks that do most of the derivatives 
trading, as well as other systemically important nonbank financial 
institutions that may be designated by the Financial Stability 
Oversight Council (FSOC). The Fed also plays a central role in the 
regulation of risk in systemically important clearinghouses. 
Furthermore, the Fed can extend discount window privileges to a 
clearinghouse in ``unusual or exigent circumstances'' \8\ subject to 
any conditions it prescribes, which could include conditions relating 
to risk management systems. The Fed may also object to the SEC and 
CFTC's rules concerning systemically important clearinghouses, in which 
case FSOC has the authority to resolve the conflict.\9\ Considering the 
major role of the Fed, the SEC and CFTC should make sure the Fed agrees 
with their final rules before they are implemented.
---------------------------------------------------------------------------
    \8\ Dodd-Frank Act  806(b).
    \9\ Dodd-Frank Act  804(a); see also Letter from Hal S. Scott to 
Chairman Gensler Regarding The Federal Reserve's Authority Over 
Clearinghouses 1 (Aug. 25, 2010), http://www.capmktsreg.org/pdfs/
2010.09.15_Genser_Letter_Release.pdf.
---------------------------------------------------------------------------
    With respect to implementation sequencing, a primary objective 
should be, as recommended by the Committee on Capital Markets 
Regulation, avoiding disrupting the markets.\10\ For example, rules 
concerning the threshold for publicly reporting details of block trades 
should be phased in so the Commissions can be certain that the rules 
will not dry up liquidity. The Commissions can start with broad, 
principles-based rules while they monitor the markets and collect the 
data necessary to determine whether implementation of more specific and 
limiting rules are necessary. This sequencing schedule should be 
disclosed to the public, and, ideally should itself be subject to 
comment. Although the proposed rules came out in an order that was more 
haphazard than necessary, the CFTC can avoid repeating that mistake in 
the coming months.
---------------------------------------------------------------------------
    \10\ See Comm. on Capital Mkts. Regulation, comment to Commodity 
Futures Trading Comm'n Notice of Proposed Rulemaking, Real-Time Public 
Reporting of Swap Transaction Data, 75 Fed. Reg. 76140 (filed Jan. 18, 
2011); Comm. on Capital Mkts. Regulation, comment to Securities 
Exchange Comm'n, Regulation SBSR--Reporting and Dissemination of 
Security Based Swap Information, 75 Fed. Reg. 75208 (filed Jan. 18, 
2011).
---------------------------------------------------------------------------
II. Cost-Benefit Analysis
    In my January testimony to the House Financial Services Committee, 
I emphasized the need for the independent regulatory agencies to 
perform sound cost-benefit analysis before proposing rules. The CFTC is 
required by statute to ``consider the costs and benefits'' of its 
rules, and the SEC is generally required to consider whether its rules 
``will promote efficiency, competition, and capital formation.'' \11\ 
In January, the President issued an Executive Order that reaffirmed the 
importance of conducting cost-benefit analysis when writing new 
regulations.\12\ Although the Executive Order does not apply to 
independent agencies such as the CFTC and SEC, the heads of both 
agencies have suggested they will comply with its principles.\13\
---------------------------------------------------------------------------
    \11\ 7 U.S.C.  19(a) (CFTC); 15 U.S.C.  78c(f) (SEC); see also 15 
U.S.C.  78w(a)(2) (SEC required to consider burden on competition).
    \12\ Exec. Order No. 13563,  1(b), 76 Fed. Reg. 3821 (Jan. 21, 
2011).
    \13\ See Public Hearing to Review Implementation of Title VII of 
the Dodd-Frank Wall Street Reform and Consumer Protection Act: Hearing 
Before the H. Comm. On Agric., 112th Cong. (Feb. 10, 2011) (testimony 
of Chairman Gary Gensler), http://www.cftc.gov/PressRoom/
SpeechesTestimony/opagensler-68.html (CFTC Chairman Gary Gensler: ``the 
CFTC's practices are consistent with the Executive Order's 
principles.''); Testimony of Chairman Mary Schapiro Before the Subcomm. 
on Fin. Servs.: Hearing Before the H. Appropriations Comm., 112th 
Congress (Mar. 15, 2011), http://appropriations.house.gov/_files/
031511SECFY12Budget TestimonyFINAL.pdf (SEC Chairman Mary Schapiro: 
``while the Executive Order doesn't apply to us, we're trying to act as 
though it does.'').
---------------------------------------------------------------------------
    The new Executive Order and the one that came before it subject 
agencies' cost-benefit analysis to review by the Office of Information 
and Regulatory Affairs (OIRA) within the Office of Management and 
Budget.\14\ OIRA has published, with an interagency group, a set of 
``best practices'' to guide those agencies bound by the Executive 
Order.\15\ Neither the CFTC nor the SEC comes close to observing this 
guidance.
---------------------------------------------------------------------------
    \14\ See Exec. Order No. 12866,  6(a)(3), 58 Fed. Reg. 51735 (Oct. 
4, 1993); Exec. Order No. 13563,  1(b), 76 Fed. Reg. 3821 (Jan. 21, 
2011).
    \15\ Office of Management and Budget, Economic Analysis of Federal 
Regulations Under Executive Order 12866 (Jan. 11, 1996), http://
www.whitehouse.gov/omb/inforeg_riaguide (hereinafter OIRA CBA Guide).
---------------------------------------------------------------------------
    The CFTC typically begins its cost-benefit analysis with 
boilerplate text explaining that under its interpretation of its 
statutory mandate, it is not required to quantify costs and 
benefits.\16\ It then usually devotes only a few paragraphs to 
identifying some costs and benefits of the proposed rules. Yet even 
this qualitative analysis falls short. Yesterday the Committee on 
Capital Markets Regulation filed a comment letter with the SEC and CFTC 
regarding its proposed rules on reporting by private funds (Form 
PF).\17\ In that letter, the Committee listed the three ``costs'' the 
CFTC identified in the single paragraph devoted to the subject. It 
identified the ``costs'' as: (1) ``Without the proposed reporting 
requirements . . . FSOC will not have sufficient information''; (2) 
``the proposed reporting requirements, once finalized will provide the 
CFTC with better information''; and (3) ``the proposed reporting 
requirements will create additional compliance costs.'' \18\ The first 
two points are asserted benefits, not costs. The reference to 
compliance costs is perfunctory and so general as to be meaningless.
---------------------------------------------------------------------------
    \16\ See, e.g., Reporting by Investment Advisers to Private Funds 
and Certain Commodity Pool Operators and Commodity Trading Advisors on 
Form PF, 76 Fed. Reg. 8068, 8087 (Feb. 11, 2011).
    \17\ Comm. on Capital Mkts. Regulation, comment to Commodity 
Futures Trading Comm'n and Securities Exchange Comm'n Joint Proposed 
Rules, Reporting by Investment Advisers to Private Funds and Certain 
Commodity Pool Operators and Commodity Trading Advisors on Form PF, 76 
Fed. Reg. 8068 (filed Apr. 12, 2011).
    \18\ Reporting by Investment Advisers on Form PF, supra note 16, 76 
Fed. Reg. at 8087.
---------------------------------------------------------------------------
    Sound cost-benefit analysis measures costs and benefits against a 
baseline. The OIRA guide of best practices instructs agencies to set 
the baseline as the world without the proposed regulation.\19\ Yet in 
most proposals the CFTC evaluates the overall costs and benefits of the 
system required by the Dodd-Frank Act, rather than the particular 
implementation the agency proposed. Likewise, OIRA instructs agencies 
to evaluate alternatives to the proposed regulations.\20\ This is 
especially important when, as in the case of rules requiring reporting 
of information, many different systems could satisfy the statutory 
requirement, perhaps with lower costs. Yet the agencies have not 
identified alternatives. Nor do the agencies engage in incremental or 
marginal analysis, which would consider whether the benefits of each 
element of the proposed rule outweigh its costs. Instead, they 
typically take a gestalt approach to the rules as a whole.
---------------------------------------------------------------------------
    \19\ OIRA CBA Guide, supra note 15,  III.A.1.
    \20\ OIRA CBA Guide, supra note 15  III.A.2.
---------------------------------------------------------------------------
    For the last 30 years, a period spanning nearly five Presidents, a 
series of Executive Orders has required non-independent agencies to 
comply with additional requirements to the rulemaking process, yet the 
independent agencies have not been covered by these requirements.\21\ 
Cass Sunstein, presently the Administrator of OIRA, has long called for 
subjecting the independent agencies to OIRA review.\22\ In my January 
testimony, I proposed a moderate system of OIRA review that would avoid 
any separation of powers issues involved with independent financial 
agencies.\23\ This approach would have OIRA file comments with the 
agency for important rulemakings. OIRA's comments would evaluate the 
agency's cost-benefit analysis.\24\ Although OIRA's comments would not 
be binding on the agencies, any final rules would still be subject to 
review in court. I also called for extending and strengthening the 
statutory provisions requiring the independent agencies to perform 
cost-benefit analysis so that each of the financial regulators is 
required to determine whether the costs of its rules exceed the 
benefits.\25\ The rules proposed in the last 2 months have only 
strengthened my opinion that the independent financial regulators, 
particularly the CFTC and SEC, need stronger external requirements to 
conduct sound cost-benefit analysis.
---------------------------------------------------------------------------
    \21\ See Exec. Order No. 12866,  6(a), 58 Fed. Reg. 51735 (Oct. 4, 
1993); Exec. Order No. 13563,  1(b), 76 Fed. Reg. 3821 (Jan. 21, 
2011); 44 U.S.C.  3502(5).
    \22\ See Robert W. Hahn & Cass R. Sunstein, A New Executive Order 
for Improving Federal Regulation? Deeper and Wider Cost-Benefit 
Analysis, 150 U. Pa. L. Rev. 1489, 1531-37 (2002); see also Richard H. 
Pildes & Cass R. Sunstein, Reinventing the Regulatory State, 62 U. Chi. 
L. Rev. 1, 4 (1995).
    \23\ For a discussion of these issues see Hahn & Sunstein, id., 150 
U. Pa. L. Rev. at 1531-37; Pildes & Sunstein, id., 62 U. Chi. L. Rev. 
at 24-33; see also Elena Kagan, Presidential Administration, 114 Harv. 
L. Rev. 2245, 2319-31 (2001).
    \24\ January Testimony, supra note 3, 10.
    \25\ January Testimony, supra note 3, 11.
---------------------------------------------------------------------------
III. Coordination
    In order to write the best rules possible and to avoid unnecessary 
friction in the system, the Federal agencies should coordinate with 
each other and with their foreign counterparts.
A. Domestic Coordination
    The Dodd-Frank Act anticipates that the SEC and CFTC in particular 
should work together to regulate the derivatives markets. So far they 
have not coordinated as much as they should. In many of the proposed 
rules, the CFTC and the SEC have taken different approaches to swaps 
and security-based swaps, respectively. For example, the Commissions 
took different approaches to rules concerning public reporting of swap 
and security-based swap transactions,\26\ conflicts of interest in 
ownership and governance of various swaps and security-based swap 
clearinghouses,\27\ and risk management in clearinghouses.\28\ The 
approaches of the CFTC and the SEC should diverge only when required by 
real differences between the types of derivatives they are regulating. 
If the Commissions do not take a unified approach, then they will 
unnecessarily raise compliance costs as market participants who are 
subject to two different regimes will have to comply with different 
rules governing similar conduct. Furthermore, it will not always be 
clear whether a swap falls with the jurisdiction of the CFTC or SEC--
different rules will encourage transactors to design derivatives to fit 
into the rules they like best.
---------------------------------------------------------------------------
    \26\ See, Real-Time Public Reporting of Swap Transaction Data, 75 
Fed. Reg. 76140 (proposed Dec. 7, 2010) (CFTC); Regulation SBSR--
Reporting and Dissemination of Security-Based Swap Information, 75 Fed. 
Reg. 75208 (proposed Dec. 2, 2010) (SEC). The Commissions use different 
fields for the reporting systems.
    \27\ See, Requirements for Derivatives Clearing Organizations, 
Designated Contract Markets, and Swap Execution Facilities Regarding 
the Mitigation of Conflicts of Interest, 75 Fed. Reg. 63732 (proposed 
Oct. 18, 2010) (CFTC); Ownership Limitations and Governance 
Requirements for Security-Based Swap Clearing Agencies, Security-Based 
Swap Execution Facilities, and National Securities Exchanges with 
Respect to Security-Based Swaps Under Regulation MC, 75 Fed. Reg. 65882 
(proposed Oct. 26, 2010) (SEC). The SEC Proposed Rules mandate that a 
higher percentage of board directors be independent but provides for 
fewer mandatory committees.
    \28\ See, Risk Management Requirements for Derivatives Clearing 
Organizations, 76 Fed. Reg. 3698 (proposed Jan. 20, 2011) (CFTC); 
Clearing Agency Standards for Operation and Governance, 76 Fed. Reg. 
14472 (proposed Mar. 16, 2011) (SEC). The CFTC takes a much more 
detailed approach to margin requirements.
---------------------------------------------------------------------------
    The legislative solution to this coordination problem is real 
structural reform. In 2009, the Committee on Capital Markets Regulation 
called the financial regulatory structure ``an outmoded, overlapping 
sectoral model,'' and called for its reorganization.\29\ I regard it as 
dysfunctional. The Dodd-Frank Act did little to solve the problem. 
Although it eliminated one agency, the Office of Thrift Supervision, it 
created three more: FSOC, the Federal Insurance Office, and the Bureau 
of Consumer Financial Protection.\30\ FSOC, the agency tasked with some 
oversight and coordination roles, is not a solution to the large 
structural problem. It has little direct supervisory authority and 
power over other agencies, in part because many of its actions require 
a \2/3\ supermajority vote.\31\ On the other hand, it is the only game 
in town and Secretary Geithner, its Chairman, needs to be more 
proactive in insuring agency coordination.
---------------------------------------------------------------------------
    \29\ Comm. on Capital Mkts. Reg., The Global Financial Crisis: A 
Plan for Regulatory Reform 1, 203 (May 2009).
    \30\ See Dodd-Frank Act  312(b) (eliminating the Office of Thrift 
Supervision), 111(a) (FSOC), 502 (Federal Insurance Office), 1011(a) 
(Bureau of Consumer Financial Protection).
    \31\ January Testimony, supra note 3, 18.
---------------------------------------------------------------------------
B. International Coordination
    International coordination is equally important. Last September, 
the European Union proposed regulations for its derivatives 
markets.\32\ Although the E.U. proposal and the U.S. system are 
similar, particularly with their joint emphasis on central clearing, 
there are many important differences, most of which can only be changed 
by bringing the U.S. and E.U. legislation closer. For example, the E.U. 
proposal has a much more generous end-user exception and puts less 
emphasis on exchange trading. Furthermore, the United States and 
European Union differ significantly when it comes to the regulation of 
trade repositories. The Dodd-Frank Act provides for detailed regulation 
of trade repositories, including specific mechanisms for the disclosure 
of information to U.S. and foreign regulators.\33\ The E.U. proposal, 
on the other hand, provides general requirements for trade repositories 
and does not specifically address disclosure of information to E.U. and 
non-E.U. regulators.\34\
---------------------------------------------------------------------------
    \32\ Proposal for a Regulation of the European Parliament and of 
the Council on OTC derivatives, central counterparties and trade 
repositories, COM (2010) 484 final (Sept. 15, 2010) (hereinafter E.U. 
Proposal).
    \33\ Dodd-Frank Act  728.
    \34\ E.U. Proposal, Article 64.
---------------------------------------------------------------------------
    But the regulation of clearinghouses provides a risk of conflict 
that is not inherent in Dodd-Frank. Under the proposed E.U. 
regulations, in order for a U.S. or other foreign clearinghouse to be 
recognized by the European Union, the European Securities and Markets 
Authority (ESMA) must determine that there is equivalent home state 
regulation, authorization, and supervision provisions, as well as 
cooperation arrangements with the ESMA.\35\ Similarly, under the Dodd-
Frank Act, U.S. regulators may exempt a foreign clearinghouse from 
certain regulations only if the foreign organization is subject to 
comparable and comprehensive home state regulation.\36\ These 
equivalence determinations may be difficult if E.U. and U.S. regulation 
divide on major matters like risk management and governance. Will the 
European Union permit E.U. firms to use U.S. clearinghouses that admit 
members with less capital than is required for E.U. clearinghouses? 
\37\ I am not suggesting that the CFTC abandon its approach to member 
capital, but rather that it detail how the clearinghouses can be 
structured to be as safe with such lowered capital requirements for 
members. Conversely, will the CFTC permit U.S. firms to use dealer-
owned clearinghouses in the European Union while insisting that there 
be limitations on dealer ownership in the United States? \38\ This 
would be unwise. Yet, not doing so could lead the major dealers to use 
European rather than U.S. clearinghouses. Or will the Fed permit U.S. 
banks to use E.U. clearinghouses that do not have access to the ECB 
discount window when the Fed permits such access here, albeit under 
unusual and exigent circumstances? These important issues must be 
resolved before going live with the new rules.
---------------------------------------------------------------------------
    \35\ E.U. Proposal, Article 23.
    \36\ Dodd-Frank Act  738(a).
    \37\ See, Risk Management Requirements for Derivatives Clearing 
Organizations  39.12, 76 Fed. Reg. 3698, 3719 (proposed Jan. 20, 2011) 
($50 million requirement).
    \38\ See Dodd-Frank Act  726(a); Requirements for Derivatives 
Clearing Organizations, Designated Contract Markets, and Swap Execution 
Facilities Regarding the Mitigation of Conflicts of Interest  39.25, 
75 Fed. Reg. 63732, 63750 (proposed Oct. 18, 2010) (imposing limits on 
ownership).
---------------------------------------------------------------------------
IV. Micromanagement
    Overall the SEC seems to embrace the principles-based approach of 
the Dodd-Frank Act more than the CFTC, which has tended to propose 
rules that would micro-manage the industry. For example, the CFTC 
proposed a detailed rule concerning block trades, while the SEC took a 
simpler approach.\39\ Similarly, the CFTC's rules about margin in 
clearinghouses are far more specific than the SEC's.\40\ When 
developing its rules for Swap Execution Facilities, the CFTC described 
a Request for Quote system that required sending requests to at least 
five members, while the SEC gave more freedom.\41\ In general, a broad, 
principles-based approach is preferable to an approach of 
micromanagement, unless there are specific reasons to think that a 
detailed rule is necessary. A broad approach is particularly important 
when, as here, dozens of rules will reshape an industry in ways that 
cannot be predicted. As I have described, a staged implementation 
approach could begin with broad, principled rules and gradually phase 
in more specific rules when they are necessary and after the 
Commissions can be more confident that they will not unnecessarily 
disrupt the market.
---------------------------------------------------------------------------
    \39\ See, Real-Time Public Reporting of Swap Transaction Data  
43.5, 75 Fed. Reg. 76140, 76174-76 (proposed Dec. 7, 2010) (CFTC); 
Regulation SBSR--Reporting and Dissemination of Security-Based Swap 
Information  242.902, 75 Fed. Reg. 75208, 75285 (proposed Dec. 2, 
2010) (SEC); see also Letter from the Comm. on Capital Mkts. Reg. to 
David Stawick, Sec'y of the Comm'n, Commodity Futures Trading Comm'n 
and Elizabeth Murphy, Sec'y, Sec. and Exch. Comm'n 4 (Jan. 18, 2011), 
http://www.capmktsreg.org/pdfs/
2011.01.18_Swaps_Reporting_Comment_Letter.pdf.
    \40\ See, Clearing Agency Standards for Operation and Governance  
240.17Ad-22(b)(2), 76 Fed. Reg. 14472, 14538 (proposed Mar. 16, 2011) 
(SEC); Risk Management Requirements for Derivatives Clearing 
Organizations  39.13(g), 76 Fed. Reg. 3698, 3720 (proposed Jan. 20, 
2011) (CFTC).
    \41\ Registration and Regulation of Security-Based Swap Execution 
Facilities  242.801, 76 Fed. Reg. 10948, 11054 (proposed Feb. 28, 
2011) (SEC); Core Principles and Other Requirements for Swap Execution 
Facilities,  37.9(a)(ii)(A), 76 Fed. Reg. 1214, 1241(proposed Jan. 7, 
2011) (CFTC).
---------------------------------------------------------------------------
    Thank you and I look forward to your questions.
                               Appendix A
---------------------------------------------------------------------------
    \42\ This table does not contain interim rules, corrections, 
extensions, or other variations.

 CFTC Proposed Rules to Date Concerning Derivatives under the Dodd-Frank
                                 Act 42
------------------------------------------------------------------------
  Proposed
    Date              CFTC Category                      Rule
------------------------------------------------------------------------
 10/14/2010   VII: DCO Core Principle        Financial Resources
               Rulemaking, Interpretation &   Requirements for
               Guidance                       Derivatives Clearing
              X: Systemically Important DCO   Organizations
               Rules Authorized Under Title
               VIII
 10/18/2010   IX: Governance & Possible      Requirements for
               Limits on Ownership &          Derivatives Clearing
               Control                        Organizations, Designated
                                              Contract Markets, and Swap
                                              Execution Facilities
                                              Regarding the Mitigation
                                              of Conflicts of Interest
 10/26/2010   XIX: Agricultural Swaps        Agricultural Commodity
                                              Definition
 10/27/2010   XXX: Fair Credit Reporting     Business Affiliate
               Act and Disclosure of          Marketing and Disposal of
               Nonpublic Personal             Consumer Information Rules
               Information
 10/27/2010   XXX: Fair Credit Reporting     Privacy of Consumer
               Act and Disclosure of          Financial Information;
               Nonpublic Personal             Conforming Amendments
               Information                    Under Dodd-Frank Act
  11/2/2010   XXIX: Reliance on Credit       Removing Any Reference to
               Ratings                        or Reliance on Credit
                                              Ratings in Commission
                                              Regulations; Proposing
                                              Alternatives to the Use of
                                              Credit Ratings
  11/2/2010   XXVI: Position Limits,         Position Reports for
               including Large Trader         Physical Commodity Swaps
               Reporting, Bona Fide Hedging
               Definition & Aggregate
               Limits
  11/2/2010   VIII: Process for Review of    Process for Review of Swaps
               Swaps for Mandatory Clearing   for Mandatory Clearing
  11/2/2010   XXIV: Disruptive Trading       Anti-disruptive Practices
               Practices                      Authority Contained in the
                                              Dodd-Frank Wall Street
                                              Reform and Consumer
                                              Protection Act
  11/2/2010   XV: Rule Certification &       Provisions Common to
               Approval Procedures            Registered Entities
               (applicable to DCMs, DCOs,
               SEFs)
  11/3/2010   XXIX: Reliance on Credit       Investment of Customer
               Ratings                        Funds and Funds Held in an
                                              Account for Foreign
                                              Futures and Foreign
                                              Options Transactions
  11/3/2010   XXIII: Anti-Manipulation       Prohibition of Market
                                              Manipulation
 11/17/2010   IV: Internal Business Conduct  Implementation of Conflicts
               Standards                      of Interest Policies and
                                              Procedures by Futures
                                              Commission Merchants and
                                              Introducing Brokers
 11/19/2010   IV: Internal Business Conduct  Designation of a Chief
               Standards                      Compliance Officer;
                                              Required Compliance
                                              Policies; and Annual
                                              Report of a Futures
                                              Commission Merchant, Swap
                                              Dealer, or Major Swap
                                              Participant
 11/19/2010   XIV: New Registration          Registration of Foreign
               Requirements for Foreign       Boards of Trade
               Boards of Trade
 11/23/2010   IV: Internal Business Conduct  Regulations Establishing
               Standards                      and Governing the Duties
                                              of Swap Dealers and Major
                                              Swap Participants
 11/23/2010   IV: Internal Business Conduct  Implementation of Conflicts
               Standards                      of Interest Policies and
                                              Procedures by Swap Dealers
                                              and Major Swap
                                              Participants
 11/23/2010   I: Registration                Registration of Swap
                                              Dealers and Major Swap
                                              Participants
  12/3/2010   VI: Segregation & Bankruptcy   Protection of Collateral of
               for both Cleared and           Counterparties to
               Uncleared Swaps                Uncleared Swaps; Treatment
                                              of Securities in a
                                              Portfolio Margining
                                              Account in a Commodity
                                              Broker Bankruptcy
  12/6/2010   XXV: Whistleblowers            Implementing the
                                              Whistleblower Provisions
                                              of Section 23 of the
                                              Commodity Exchange Act
  12/7/2010   XVIII: Real Time Reporting     Real-Time Public Reporting
                                              of Swap Transaction Data
  12/8/2010   XVII: Data Recordkeeping &     Swap Data Recordkeeping and
               Reporting Requirements         Reporting Requirements
  12/9/2010   XVII: Data Recordkeeping &     Reporting, Recordkeeping,
               Reporting Requirements         and Daily Trading Records
                                              Requirements for Swap
                                              Dealers and Major Swap
                                              Participants
 12/13/2010   VII: DCO Core Principle        General Regulations and
               Rulemaking, Interpretation &   Derivatives Clearing
               Guidance                       Organizations
 12/15/2010   VII: DCO Core Principle        Information Management
               Rulemaking, Interpretation &   Requirements for
               Guidance                       Derivatives Clearing
                                              Organizations
 12/17/2010   XVII: Data Recordkeeping &     Reporting Certain Post-
               Reporting Requirements         Enactment Swap
                                              Transactions
 12/21/2010   II: Definitions, such as Swap  Further Definition of
               Dealer, Major Swap             ``Swap Dealer,''
               Participant, Security-Based    ``Security-Based Swap
               Swap Dealer, and Major         Dealer,'' ``Major Swap
               Security-Based Swap            Participant,'' ``Major
               Participant, to be Written     Security-Based Swap
               Jointly with SEC               Participant'' and
                                              ``Eligible Contract
                                              Participant''
 12/22/2010   III: Business Conduct          Business Conduct Standards
               Standards with                 for Swap Dealers and Major
               Counterparties                 Swap Participants With
                                              Counterparties
 12/22/2010   XII: DCM Core Principle        Core Principles and Other
               Rulemaking, Interpretation &   Requirements for
               Guidance                       Designated Contract
                                              Markets
 12/23/2010   XVI: Swap Data Repositories    Swap Data Repositories
               Registration Standards and
               Core Principle Rulemaking,
               Interpretation & Guidance
 12/23/2010   XI: End-user Exception         End-User Exception to
                                              Mandatory Clearing of
                                              Swaps
 12/28/2010   IV: Internal Business Conduct  Confirmation, Portfolio
               Standards                      Reconciliation, and
                                              Portfolio Compression
                                              Requirements for Swap
                                              Dealers and Major Swap
                                              Participants
   1/6/2011   IX: Governance & Possible      Governance Requirements for
               Limits on Ownership &          Derivatives Clearing
               Control                        Organizations, Designated
                                              Contract Markets, and Swap
                                              Execution Facilities;
                                              Additional Requirements
                                              Regarding the Mitigation
                                              of Conflicts of Interest
   1/7/2011   XIII: SEF Registration         Core Principles and Other
               Requirements and Core          Requirements for Swap
               Principle Rulemaking,          Execution Facilities
               Interpretation & Guidance
  1/20/2011   VII: DCO Core Principle        Risk Management
               Rulemaking, Interpretation &   Requirements for
               Guidance                       Derivatives Clearing
                                              Organizations
  1/26/2011   XXVI: Position Limits,         Position Limits for
               including Large Trader         Derivatives
               Reporting, Bona Fide Hedging
               Definition & Aggregate
               Limits
   2/3/2011   XIX: Agricultural Swaps        Commodity Options and
                                              Agricultural Swaps
   2/8/2011   IV: Internal Business Conduct  Orderly Liquidation
               Standards                      Termination Provision in
                                              Swap Trading Relationship
                                              Documentation for Swap
                                              Dealers and Major Swap
                                              Participants
   2/8/2011   IV: Internal Business Conduct  Swap Trading Relationship
               Standards                      Documentation Requirements
                                              for Swap Dealers and Major
                                              Swap Participants
  2/11/2011   XXVII: Investment Adviser      Reporting by Investment
               Reporting                      Advisers to Private Funds
                                              and Certain Commodity Pool
                                              Operators and Commodity
                                              Trading Advisors on Form
                                              PF
  2/11/2011   XXVII: Investment Adviser      Commodity Pool Operators
               Reporting                      and Commodity Trading
                                              Advisors: Amendments to
                                              Compliance Obligations
   3/3/2011   XXXI: Conforming Amendments    Amendments to Commodity
                                              Pool Operator and
                                              Commodity Trading Advisor
                                              Regulations Resulting From
                                              the Dodd-Frank Act
   3/9/2011   XXXI: Conforming Amendments    Registration of
                                              Intermediaries
  3/10/2011   VII: DCO Core Principle        Requirements for
               Rulemaking, Interpretation &   Processing, Clearing, and
               Guidance                       Transfer of Customer
                                              Positions
------------------------------------------------------------------------

    The Chairman. Thank you, Mr. Scott.
    And now, Dr. Overdahl, your comments for 5 minutes.

STATEMENT OF JAMES A. OVERDAHL, Ph.D., VICE PRESIDENT, NATIONAL 
                 ECONOMIC RESEARCH ASSOCIATES,
                        WASHINGTON, D.C.

    Dr. Overdahl. Thank you for the invitation to appear here 
today and offer my perspective on the role of economic analysis 
in the rulemaking process of the CFTC. Because of the CFTC's 
important role in implementing Dodd-Frank, understanding this 
process is also important.
    My perspective is based on my experience as a former chief 
economist at the CFTC, as well as the SEC. My remarks today are 
my own and do not reflect the views of NERA or its clients.
    Several statutes include provisions that require some form 
of economic analysis or cost-benefit analysis in the CFTC's 
rulemaking process. First, Section 15(a) of the Commodity 
Exchange Act requires the Commission to, consider, cost and 
benefits in the rulemaking process. Second, the Paperwork 
Reduction Act also requires cost-benefit analysis; however, 
this analysis applies only to a rule's paperwork burden and 
does not include a broader analysis of the economic effects of 
the rule.
    Third, like other Federal regulatory agencies, the CFTC's 
rulemaking process is governed by the Administrative Procedure 
Act, which requires the Commission to justify its exercise of 
rulemaking authority and to avoid actions that are arbitrary or 
capricious. Recent court decisions citing the APA have turned 
on the adequacy of economic analysis considered by regulators 
when adopting new rules. The message from the courts is that 
regulators' economic arguments need to be adequately supported 
and that vigorous assertion is not a substitute for rigorous 
economic analysis.
    In sum, the statutory requirements for conducting economic 
analysis are fairly minimal and easily satisfied. In this 
respect, the CFTC is similar to other independent regulatory 
commissions across the Federal Government.
    Economic analysis can be used for more than just satisfying 
procedural requirements. It can help improve regulatory 
decision-making. I have found that data-driven economic 
analysis enhances the ability of Commissioners to ask better 
questions, better understand the tradeoffs and consequences 
associated with the proposed rule, and to make more informed 
decisions.
    In my view, economic analysis goes beyond what is readily 
quantifiable and includes consideration of unintended 
consequences and potential effects of regulatory actions, 
including identifying potential changes in behavior of market 
participants. It also is helpful at the very earliest stages of 
the rulemaking process by helping frame the problem that is 
being addressed by the proposed regulatory action.
    Internally, the CFTC requires the rulemaking divisions to 
consult with the Office of the Chief Economist. However, 
rulemaking divisions are not required to obtain formal sign-off 
from the office before proposing a rule. As a result, the 
economic staff is often used in the rulemaking process in a 
behind-the-scenes consulting role.
    One obstacle to effectively apply economic analysis to the 
rulemaking process is the lack of relevant data. The CFTC has 
often relied on public comments to supply data and analysis. 
Although these comments can be extremely valuable, they rarely 
include the type of data and analysis that can serve as a 
substitute for the Commission conducting its own thorough 
analysis.
    In closing, I would like to offer a few suggestions on how 
economic analysis can be better utilized at the CFTC.
    First, I believe that some type of formal requirement is 
necessary to institutionalize economic analysis at the CFTC. 
Such a requirement could be adopted by the agency itself 
through its own internal policies and procedures and add to 
consistency in the process not only across the rulemaking 
agenda but across time.
    Second, economic analysis needs to be included in the 
rulemaking process at an early stage, both for the proposed 
rules but also for the problem that the rule is aimed at 
addressing.
    Third, the process of collecting data for analyzing 
proposed rules needs to be improved.
    Fourth, I believe it would be helpful for regulatory 
agencies like the CFTC to have some very specific agency-
specific guide to help guide the process of using economic 
analysis in its rulemaking process, similar to what Britain's 
FSA uses.
    Fifth, experience has shown that the discipline, rigor, and 
overall quality of economic analysis improves when regulators 
know that their analysis will be reviewed by others. For 
Executive Branch agencies, OMB review serves this role. For 
independent agencies like the CFTC, there is no hardwired 
ongoing review of their analyses, and perhaps there should be.
    Economic analysis is necessary because it enhances the 
ability of the Commission to make informed decisions. An added 
benefit is it will help improve the overall transparency and 
accountability of the process. And for these reasons, economic 
analysis in the rulemaking process should be a high priority.
    Thank you, and I look forward to your questions.
    [The prepared statement of Dr. Overdahl follows:]

    Prepared Statement of James A. Overdahl, Ph.D., Vice President, 
        National Economic Research Associates, Washington, D.C.
    Chairman Conaway, Ranking Member Boswell, and other Members of the 
Subcommittee. I appear before you today in my current role as a Vice 
President of National Economic Research Associates, or NERA, and as a 
former Chief Economist of the Commodity Futures Trading Commission 
(CFTC). I thank you for allowing me a chance to share my observations 
about the role of economic analysis in the rulemaking process at the 
CFTC.
    In my testimony today I will address three topics. First, I will 
describe the current role and importance of economic analysis in the 
rulemaking process at the CFTC. Second, I will describe some of the 
obstacles limiting the effective application of economic analysis to 
the process. Lastly, I will offer suggestions on how economic analysis 
can be better utilized to help craft cost-effective regulations, help 
enhance the accountability of regulatory agencies to the public, and 
help improve the overall transparency of the rulemaking process.
I. The Current Role of Economic Analysis in the Rulemaking Process at 
        the CFTC
    The economics program at the CFTC is administered in the Office of 
the Chief Economist and staffed by approximately a dozen economists. 
Economists within this office perform the bulk of the Commission's 
analytical work with respect to policy and regulatory initiatives. 
Although these economists play a role in the Commission's rulemaking 
process, they perform other roles too such as providing litigation 
support in enforcement proceedings, gathering data and conducting 
analysis about emerging market issues, and responding to abnormal 
market events, such as the 2008 financial crisis, or last year's 
``flash crash.'' Outside of the Office of the Chief Economist, another 
four dozen or so industry economists are employed within the CFTC's 
operating divisions, primarily in the Division of Market Oversight, 
performing the day-to-day tasks of market surveillance.
    Determining priorities and allocating the resources of the 
economics program at the CFTC is the job of the Chief Economist, who 
must consider the Chairman's priorities, the complexity of analysis 
required, the urgency of the rulemaking calendar, litigation risks, and 
the staff-to-staff working relationship with the drafters of the rule. 
These considerations have contributed to the inconsistent application 
of economic analysis across the rulemaking agenda at the CFTC.
    The CFTC does not have a formal requirement for including economic 
analysis in the rulemaking process, aside from the requirements of the 
Regulatory Flexibility Act and the cost-benefit requirements of the 
Paperwork Reduction Act (PRA). However, the analysis required in the 
PRA applies only a rule's paperwork burden, and does not include an 
analysis of broader economic effects of a rule. The CFTC's authorizing 
statute, the Commodity Exchange Act, contains a provision in Section 
15(a) requiring that the Commission ``consider'' costs and benefits in 
the rulemaking process. Section 15(a) requires that ``[b]efore 
promulgating a regulation . . . or issuing an order . . . the 
Commission shall consider the costs and benefits of the action of the 
Commission.'' In addition Section 15(a) requires that:

        The costs and benefits of the proposed Commission action shall 
        be evaluated in light of (A) considerations of protection of 
        market participants and the public; (B) considerations of the 
        efficiency, competitiveness, and financial integrity of futures 
        markets; (C) considerations of price discovery; (D) 
        considerations of sound risk management practices; and (E) 
        other public interest considerations.

    The CFTC, like other Federal regulatory agencies, is subject to the 
Administrative Procedure Act (APA) which requires the Commission to 
justify their exercise of rulemaking authority and avoid actions that 
are ``arbitrary, capricious, an abuse of discretion, or otherwise not 
in accordance with the law.'' Although this language falls short of a 
formal requirement for the application of economic analysis to the 
rulemaking process, recent court decisions have turned on the adequacy 
of economic support considered by regulators before exercising 
rulemaking authority under the APA. The prospect of scrutiny by the 
courts has caused regulatory agencies like the CFTC to pay more 
attention to the quality of their economic arguments when proposing new 
rules--at least for those rules likely to be challenged in court.\1\
---------------------------------------------------------------------------
    \1\ See, Chamber of Commerce of U.S. v. S.E.C., 412 F.3d 133 (D.C. 
Cir. 2005), and 443 F.3d 890 (D.C. Cir. 2006); Am. Equity Investment 
Life Ins. Co. v. S.E.C., 572 F.3d 923 (D.C. Cir. 2009), and 2010 WL 
2813600 (D.C. Cir. July 12, 2010); and NetCoalition v. S.E.C., 2010 WL 
3063632 (D.C. Cir. August 6, 2010).
---------------------------------------------------------------------------
    Aside from requirements posed by statues and the courts for 
consideration of costs and benefits when proposing new rules, the CFTC 
has its own internal policies. Within the CFTC, Commission policy 
requires operating divisions to ``consult'' with the Office of the 
Chief Economist before proposing a new rule to the Commission. However, 
operating divisions are not required to obtain formal sign-off from the 
Office before proposing a rule.
    In sum, the requirements for conducting economic analysis in the 
rulemaking process are fairly minimal and easily satisfied. In this 
respect, the CFTC is not unlike other independent regulatory 
commissions (IRCs). A recent study of the economic analysis used by 
IRCs finds that ``the analysis conducted . . . is generally the minimum 
required by statute.'' The study also finds that:

        In many instances the IRCs appear to be issuing major 
        regulation without reporting any quantitative information on 
        benefits and costs--apart from the paperwork burden--that would 
        routinely be expected for Executive Branch agencies covered by 
        E.O. 12866. Instead, there is only a qualitative discussion of 
        the benefits and costs. The IRCs present this discussion 
        without any formal review of alternatives. Their analyses 
        generally do not consider behavioral change. They also do not 
        estimate possible unintended effects. And perhaps most 
        importantly, with the exception of the estimates of paperwork 
        burden . . . their analyses of economic effects are not 
        prepared to comply with any identifiable standards for such 
        analysis.\2\
---------------------------------------------------------------------------
    \2\ Arthur Fraas and Randall Lutter ``On the Economic Analysis of 
Regulations at Independent Regulatory Commissions,'' Discussion Paper, 
Resources for the Future, April 2011.

    Although the study does not directly address the CFTC (it is one of 
several IRCs reviewed in the study) the results ring true based on my 
experience at the CFTC. The CFTC has good economists and good 
capability to formally analyze proposed rules, but the economics staff 
is typically used in the rulemaking process only in a behind-the-scenes 
consulting role.
    Aside from the contribution economic analysis can have to 
satisfying procedural and statutory requirements, its broader 
contribution is to improving regulatory decision making. I found that 
Commissioners at the CFTC welcomed independent, data-driven economic 
analysis provided by the Commission economics staff. One reason for 
this welcoming attitude, I believe, is because interested parties 
constantly bombard Commissioners with iron-clad arguments on all sides 
of all issues. Transparent analysis, combined with high-quality data 
and rigorous analysis clearly enhanced the ability of Commissioners to 
ask better questions, better understand the trade-offs and consequences 
associated with a proposed rule, and make informed decisions. At times, 
Commissioners made decisions that more heavily weighed considerations 
outside the realm of economic analysis. Even in these cases, the 
accountability and transparency of the process was improved by having 
on-the-record economic analysis because it led Commissioners to 
publicly consider the economic evidence and then provide a reasoned 
basis for their decision.
    Economic analysis can be useful at all stages of the rulemaking 
process, including the very earliest stage of identifying, clarifying, 
and framing the economic issues that can possibly be addressed by a 
regulatory action. Once an issue is identified, economic analysis can 
be helpful in evaluating alternative regulatory responses and in 
determining whether these responses improve upon the existing situation 
or dominate market-based solutions.
    Within the regulatory process the role of what I am calling 
``economic analysis'' is often referred to as ``cost-benefit analysis'' 
or ``regulatory impact analysis.'' As Professor Chester Spatt, has 
observed, the meaning applied to these terms is not universally shared 
among regulators.\3\ On the one hand, a narrow interpretation would 
imply that economic analysis is limited to cases where regulatory 
impacts can be quantified in dollars, such as out-of-pocket compliance 
costs. Under this interpretation, the analysis would involve toting up 
and comparing dollar costs and dollar benefits attributable to a 
proposed rule. On the other hand, a broader interpretation goes beyond 
what is readily quantifiable and includes qualitative factors 
associated with a proposed rule. Under a broader interpretation, 
economic analysis can enhance the regulator's understanding of the 
trade-offs, potential effects and unintended consequences of their 
actions, including identifying potential changes in behavior by market 
participants. The value of economic analysis to the regulator derives 
from its capacity to provide a clear, credible, and coherent framework 
for articulating the reasoned basis for regulatory action.
---------------------------------------------------------------------------
    \3\ See Chester S. Spatt, ``Economic Analysis and Cost-Benefit 
Analysis: Substitutes or Complements?'' March 15, 2007. Available at 
http://www.sec.gov/news/speech/2007/spch031507css.htm.
---------------------------------------------------------------------------
    For the regulator, failure to adequately consider relevant economic 
evidence leaves an adopted rule vulnerable to a court challenge on the 
grounds that the agency's action lacked a reasoned basis under the 
requirements of the APA. In recent years, the courts have identified 
weaknesses in the application of economic analysis to SEC regulatory 
decisions, resulting in rules being sent back for further 
consideration. The message from the courts has been that regulators' 
economic arguments need to be adequately supported--that vigorous 
assertion is not a substitute for rigorous economic analysis. The SEC 
experience is relevant to the CFTC since its rulemaking process is also 
governed by the APA.
II. Obstacles Limiting the Effective Application of Economic Analysis 
        to the Rulemaking Process
    Although there currently are no formal requirements for including 
economic analysis in the rulemaking process at the CFTC, this has not 
always been the case.\4\ At one time the CFTC had a Division of 
Economic Analysis with full sign-off authority on proposed rules. 
However, as part of the CFTC's restructuring following the enactment of 
the Commodity Futures Modernization Act of 2000, the market 
surveillance portion of the Division was placed in a new Division of 
Market Oversight and the economic analysis function was spun-off into 
an independent Office of the Chief Economist. Although full sign-off 
authority for proposed rules resided with the new Division of Market 
Oversight, this authority was not retained for the new Office of the 
Chief Economist.
---------------------------------------------------------------------------
    \4\ At one point, in the early 1990s, three of the CFTC's five 
Commissioners were Ph.D. economists, who presumably conducted their own 
economic analysis of rules they proposed.
---------------------------------------------------------------------------
    Across time, individual CFTC Chairmen have created requirements for 
the use of economic analysis in rulemaking, but these requirements were 
not institutionalized. Since the requirements simply reflected the 
preferences of individual chairmen, when these chairmen left, the 
requirements were discontinued or simply forgotten. The absence of an 
institutionalized role for economic analysis in the rulemaking process 
has been one obstacle limiting its effective application at the CFTC.
    Another obstacle to applying rigorous economic analysis to the 
rulemaking process is that the rulemaking divisions of the CFTC have 
never fully bought into the idea. In some cases, particularly in cases 
where good working relationships existed between the economics staff 
and the staff of the operating divisions, the process worked well. 
Economists were routinely included at an early stage and their analyses 
were welcomed and integrated into the process. In other cases, those in 
the operating divisions who ``held the pen'' in drafting rules would 
take a proprietary view and regard the rules as their turf. In other 
instances the drafters of a rule would regard their product as an 
unassailable good work that could only be diminished by economic 
analysis. In these cases, intruders were not welcome until the process 
was sufficiently far along so that the rule would be recommended to the 
Commission with only superficial (and last minute) input from the 
economics staff.
    Another obstacle to effectively applying economic analysis to the 
rulemaking process has been a lack of relevant data. In my view, this 
problem is related to the fact that economists are often not consulted 
in the rulemaking process with sufficient lead time to locate or 
generate useful data. Without useful data, the power of economic 
analysis is severely degraded.
    Often, the CFTC has relied on public comments to supply data and 
analysis. Although public comments can be extremely valuable to 
providing some types of information, they rarely include the type of 
data and analysis that can truly inform the process and serve as a 
substitute for the Commission conducting its own analysis. Often, the 
most useful information from public comments is that which addresses 
compliance costs associated with proposed rules. To draw out this type 
of data, the CFTC will often pose specific questions on these topics in 
proposed rules. As with Commission staff, members of the public also 
require sufficient lead time to locate useful data and conduct 
meaningful analysis of proposed rules. The time constraints of the 
public comment process often limit the ability of the public to provide 
useful analysis for the record before the comment period expires.
    Another problem in obtaining useful data and analysis from the 
public are constraints imposed under the Paperwork Reduction Act (PRA) 
that limit the ability of regulators to survey members of the public 
who may possess useful data and information relevant to a proposed 
rule. The PRA requires OMB approval of surveys involving more than nine 
entities. The time required to gain OMB approval of a survey design 
that would include a larger group of respondents can take nearly as 
long as the Commission's rulemaking process itself. As a result, the 
CFTC rarely uses surveys of more than nine people in forming cost 
estimates for proposed rules. This limitation necessarily reduces the 
quality of cost estimates. The CFTC will rely on the public comment 
process to challenge the cost estimates published as part of the 
proposed rule. A related problem involves the confidentiality of cost 
data supplied to the regulator to inform the rulemaking process. 
Businesses in a position to supply useful data and analysis often do 
not do so because they do not want to publicly disclose information 
that could deprive them of a competitive advantage.
    I will note that there is evidence that the quality of information 
supplied through the public comment process has started to improve in 
response to recent court decisions. I have found that parties 
potentially affected by proposed rules now regard the notice and 
comment rulemaking process as if it was part of a legal proceeding. 
Affected parties are increasingly viewing the comment process as an 
opportunity to place on the public record factual information about 
likely compliance costs and suggested alternative means of meeting the 
objectives of regulators. Because of the potential for litigation, 
parties commenting on proposed rules are directing their comments not 
only to the members of the regulatory commission involved in adopting 
rules, but also to the judges who may be reviewing the public record 
for rules that are challenged through the courts. Because the outcome 
of recent court challenges to Federal rules have turned on the adequacy 
of the economic support considered by regulators when they adopted new 
rules, parties submitting comments to the public record are paying 
particular attention to the quality of their economic arguments.
III. Suggestions on How Economic Analysis Can Be Better Utilized to 
        Craft Regulations
    In closing, I would like to offer a few suggestions on how economic 
analysis can be better utilized to help craft cost-effective 
regulations, help enhance the accountability of regulatory agencies to 
the public, and help improve the overall transparency of the rulemaking 
process.
    First, economic analysis needs to be included in the rulemaking 
process at an early stage. It is at the early stages where a rule's 
``term sheet'' is developed by the rulemaking division. The term sheet 
is a high level overview describing the proposed rule and identifying 
the market problem the rule is designed to address. I believe it would 
be useful at this stage to also include a high level economic review of 
both the rule and the problem. This review would be performed before 
the term sheet advances outside of the division proposing the rule. 
This review should include some analysis indicating whether the rule is 
likely to be a major or minor rule in terms of its economic impact. 
Determining at an early stage whether a rule is likely to be major or 
minor can help devote sufficient resources to those rules likely to 
have a major economic impact. An early review would provide lead time 
for the economics team to assess the complexity of the analysis 
required and to begin gathering data that could be applied to analyzing 
the proposed rule.
    In my view, an early ``term sheet review'' will likely require a 
formal policy adopted by the Commission to guide the rulemaking 
process. A formal policy would add consistency to the process. Crafting 
such a formal policy holds the potential for making an already 
cumbersome process even more cumbersome. However, without sufficient 
lead times, regulators cannot effectively use economic analysis to help 
them identify and frame problems, evaluate alternatives, and have data-
driven analyses available to inform their deliberations.
    Another way to improve the quality of economic analysis is to 
improve the data collection process. One way to do this would be to 
streamline the process by which regulators can survey firms for 
information about potential compliance costs. Another way to do this is 
to allow a process where firms could confidentially disclose to the 
regulator cost information that would be useful in evaluating the 
potential impact of a rule. Another way to gather data is for the 
regulator, whenever possible, to run pilot programs that can generate 
useful data for analysis. In the past, such pilot programs have proven 
useful to the deliberations of regulators. One advantage of pilot 
programs is that data generated from the program can be made available 
to the academic community for analysis in addition to being available 
for the regulator's own staff. Finally, those providing public comments 
on proposed rules can improve the process by paying particular 
attention to the quality of their economic arguments and by providing 
data and analysis when appropriate.
    Experience has shown that the discipline, rigor, and overall 
quality of economic analysis considered by regulators as part of their 
rulemaking process improves when the regulator knows that their 
analysis will be reviewed by others.\5\ We see some evidence of this as 
a result of recent court cases. Congressional oversight can also play 
an important role. For executive branch agencies, OMB review serves 
this role. But for independent regulatory agencies like the CFTC there 
is no hard-wired, ongoing review of their analyses. It is not clear how 
such a review could be implemented for independent agencies or if a 
formal review structure is even desirable. One solution would be for 
independent regulatory agencies like the CFTC to make their analyses 
publicly available so that they can be reviewed and evaluated by 
professional peers.
---------------------------------------------------------------------------
    \5\ See, for example, Richard D. Morgenstern, ``Reflections on the 
Conduct and Use of Regulatory Impact Analysis at the U.S. Environmental 
Protection Agency,'' Discussion Paper, Resources for the Future, April 
2011.
---------------------------------------------------------------------------
    Even in a rulemaking process that includes rigorous economic 
analysis, there will always be considerable uncertainty about a rule's 
economic impact. Therefore, it may be helpful to have an ongoing post-
adoption review of rules to determine the actual economic impact of a 
rule's implementation.
    I believe it would be helpful for the CFTC to develop a guide for 
the use of economic analysis in its rulemaking procedures. Britain's 
Financial Services Authority (FSA) has produced such a guide that could 
serve as a useful starting point for developing a similar guide for the 
United States.\6\ I understand that the SEC has been working on 
developing such a guide for its internal use. I believe that such a 
guide would be more helpful that current OMB guidance or the guidance 
offered in current or past Executive Orders that are difficult to apply 
directly to financial market regulation. I believe that such guidance 
can enhance consistency in the process both across the rulemaking 
agenda and across time. Such guidance would need to be adopted in the 
CFTC's internal policies and procedures.
---------------------------------------------------------------------------
    \6\ See Financial Services Authority Central Policy, ``Practical 
Cost-Benefit Analysis for Financial Regulators'' June, 2000, available 
online at: http://www.fsa.gov.uk/pubs/foi/cba.pdf.
---------------------------------------------------------------------------
    In the end, economic analysis is more than about satisfying 
procedural requirements for regulatory rulemaking. Improving the power 
and consistency of economic analysis at the CFTC is important because 
it will enhance the ability of regulators to make informed decisions. 
An added benefit is that it will also help enhance the overall 
transparency and accountability of the rulemaking process.
    I look forward to your questions.

    The Chairman. Thank you, Doctor.
    Ms. McMillan for 5 minutes.

  STATEMENT OF KAREN H. McMILLAN, GENERAL COUNSEL, INVESTMENT 
              COMPANY INSTITUTE, WASHINGTON, D.C.

    Ms. McMillan. Thank you, Chairman Conaway and 
Representative Boswell, and thank you to the Subcommittee for 
the opportunity to offer the views of the Investment Company 
Institute on these important topics.
    My name is Karrie McMillan, and I am the General Counsel of 
the ICI. ICI is the national trade association of mutual funds 
and other investment companies, and our members are entrusted 
with managing $13 trillion on behalf of 90 million 
shareholders.
    The fund industry has long recognized that efficient, 
effective, and evenhanded regulation is crucial to protecting 
investors and the markets. We have a lot of experience with 
regulation. Funds are regulated by all four of the Federal 
securities laws.
    Developing effective regulation, however, can be very 
difficult. And that is clearly demonstrated by the rules that 
the CFTC and the SEC are developing now to implement Dodd-
Frank's provisions on derivatives. ICI and other trade 
associations have pointed out that the short and strict 
deadlines imposed by Dodd-Frank have made it difficult to fully 
analyze these very important rule proposals.
    Coming into compliance with these proposals will be equally 
challenging. If the rules are unclear or if they are overly 
restrictive, market participants could withdraw from the 
derivatives markets and have liquidity leave those markets, as 
well.
    A clear example of this sort of process is the agency's 
decision to propose requirements for swap dealers and major 
swap participants before even defining who those players are. 
It is awfully hard to analyze and comment upon rules when you 
don't know whether your business is in or out of the affected 
groups.
    The answer, we think, is for the agencies to take a 
somewhat slower approach to ensure that there is time for the 
thoughtful and comprehensive analysis that these important 
rules deserve. And a slower approach should give affected 
parties more time to comment on the proposals, and to comply 
with them when they are finally adopted.
    Surprisingly, though, the CFTC has chosen to make its own 
workload heavier by taking an expansive new rulemaking that is 
not mandated by Dodd-Frank nor, as far as we can see, based on 
harm to investors or to the markets. I am speaking of the 
CFTC's proposal to amend Rule 4.5, which currently exempts 
funds regulated by the SEC from a second layer of regulation by 
the CFTC if they use futures, options, and swaps as part of 
their investment strategy.
    The CFTC maintains that it needs to stop the practice of 
registered investment companies offering futures-only product 
without CFTC oversight. But the proposal goes far beyond the 
handful of funds that could reasonably be described as futures-
only products. Instead, the amendments are sweeping and could 
bring in hundreds, if not thousands, of funds.
    Clearly, we object to the substance of these rules. As I 
mentioned earlier, funds are already comprehensively regulated 
with regulation that ensures thorough disclosure to investors, 
limits their use of leverage, promotes diversification, ensures 
the safe custody of fund assets, and governs conflicts of 
interest.
    It is important to emphasize that, if this rule were to go 
forward, these two sets of regulation that would be imposed on 
funds would be both duplicative and contradictory. And the 
funds affected could include some as basic as S&P 500 stock 
funds or tax-exempt bond funds that are used by investors 
saving for retirement and other long-term goals, not the 
speculators in futures and options markets.
    So we have to ask, why now? Why, in the middle of this rush 
to implement Dodd-Frank, is the CFTC diverting its resources, 
and, honestly, those of funds in their shareholders, on a 
proposal with so little justification? Why does the Commission 
want to sweep hundreds of new registrants into an oversight 
system that is already strained and add a second layer of 
regulation?
    We also have to ask how the CFTC can impose costly and 
burdensome new regulation on funds with a cost-benefit analysis 
that is cursory at best. As both Chairman Conaway and Chairman 
Lucas previously observed, ``The CFTC is failing to adequately 
conduct cost-benefit analysis,'' a concern also shared by some 
Commissioners of the CFTC. This rule clearly falls into that 
pattern.
    Mr. Chairman, we recognize that the financial regulatory 
agencies are facing an unprecedented task in developing rules 
under Dodd-Frank. We commend them for their diligence and 
dedication. But we would urge them to make their own burden 
lighter by slowing down, getting the rules right, and not 
embarking on excursions into areas that are not mandated by the 
legislation.
    Thank you, and I look forward to your questions.
    [The prepared statement of Ms. McMillan follows:]

 Prepared Statement of Karen H. McMillan, General Counsel, Investment 
                  Company Institute, Washington, D.C.
Executive Summary

   Registered investment companies, or ``funds,'' use swaps and 
        other derivatives in a variety of ways. ICI and its members 
        thus have a strong interest in ensuring that the new regulatory 
        framework for the derivatives markets supports and fosters 
        markets that are highly competitive, transparent, and liquid.

   ICI commends the CFTC and SEC for their diligence and 
        dedication in the very difficult task of developing an 
        appropriate regulatory framework and avoiding unintended 
        consequences. We do, however, have concerns with the order in 
        which rules have been published for public comment and the 
        length of the respective comment periods. We also have urged 
        the CFTC and SEC to phase-in application of new regulatory 
        requirements over a reasonable period of time.

   ICI is particularly concerned with the CFTC's decision in 
        late January to issue a sweeping proposal to revise or rescind 
        several of its rules, including Rule 4.5, which currently 
        provides an exclusion for funds and certain ``otherwise 
        regulated'' entities from regulation as commodity pool 
        operators. The proposal is not mandated or even contemplated by 
        the Dodd-Frank Wall Street Reform and Consumer Protection Act. 
        And its issuance at this time is most unfortunate, because it 
        has diverted attention away from the effort to implement the 
        provisions of the Dodd-Frank Act.

   The proposed amendments to Rule 4.5 are premature and 
        insufficiently developed. For example, the CFTC proposes a key 
        trading restriction that would relate to margin levels on 
        derivatives positions. ICI and its members cannot assess the 
        full impact of this proposed restriction because it is not yet 
        known which swaps will be subject to central clearing, what the 
        margin requirements will be for cleared and uncleared swaps, 
        and whether foreign exchange forwards and foreign exchange 
        swaps will be exempted from the definition of ``swap.''

   If adopted in their current form, the proposed amendments to 
        Rule 4.5 would subject funds--which are already subject to 
        comprehensive regulation under all four of the major Federal 
        securities laws--to duplicative and fundamentally inconsistent 
        regulatory requirements. The CFTC has failed to demonstrate the 
        need for imposing a second layer of regulation on funds. 
        Moreover, its cursory cost-benefit analysis is wholly 
        inadequate to justify the costly and burdensome regulation 
        contemplated by the proposed amendments.

   Even if the proposed amendments to Rule 4.5 are 
        appropriately scaled back, there are likely to be some funds 
        (and their investment advisers) that would become subject to 
        CFTC regulation. It is essential that the CFTC work closely 
        with the SEC to reconcile the duplicative and conflicting 
        regulatory requirements to which these funds would become 
        subject, and to re-propose the harmonized regulations for 
        public comment.
I. Introduction
    My name is Karrie McMillan. I am General Counsel of the Investment 
Company Institute, the national association of U.S. investment 
companies, including mutual funds, closed-end funds, exchange-traded 
funds (ETFs), and unit investment trusts (UITs). For ease of 
discussion, we refer in this testimony to all registered investment 
companies as ``funds.'' Members of ICI manage total assets of $13.0 
trillion and serve over 90 million shareholders.
    ICI is pleased to offer its perspectives on rulemaking by the 
Commodity Futures Trading Commission (CFTC or Commission) to implement 
provisions of the Dodd-Frank Wall Street Reform and Consumer Protection 
Act (Dodd-Frank Act). We also provide our views on the CFTC's recent 
decision to issue a sweeping proposal to modify or rescind several of 
its exemptive and exclusionary rules, a proposal that is not mandated 
(or even contemplated) by the Dodd-Frank Act. The proposed amendments 
to one of those rules--CFTC Rule 4.5--are premature and insufficiently 
developed. If adopted in their current form, those amendments would 
subject a large segment of the fund industry--which is already subject 
to comprehensive regulation--to duplicative and fundamentally 
inconsistent regulatory requirements.
II. ICI Views on CFTC Rulemaking To Implement the Derivatives Reform 
        Provisions of the Dodd-Frank Act
    Like many financial institutions, funds use swaps and other 
derivatives in a variety of ways. They are a particularly useful 
portfolio management tool in that they offer funds considerable 
flexibility in structuring their investment portfolios. Uses of swaps 
and other derivatives include, for example, hedging positions, 
equitizing cash that a fund cannot immediately invest in direct equity 
holdings (e.g., if the stock market has already closed for the day), 
managing the fund's cash positions more generally, adjusting the 
duration of the fund's portfolio (e.g., by seeking to maintain a bond 
fund's stated duration of 7 years as its holdings in fixed-income 
securities age or mature), managing bond positions in general (e.g., in 
anticipation of expected changes in monetary policy or the Treasury's 
auction schedule), or managing the fund's portfolio in accordance with 
the investment objectives stated in its prospectus.
    Implementation of the Dodd-Frank Act will dramatically change 
financial regulation in the United States by, among other things, 
establishing a new regulatory framework for the derivatives markets and 
participants in those markets.\1\ ICI and its members have a strong 
interest in ensuring that the derivatives markets are highly 
competitive and transparent, and that the regulation governing them 
encourages liquidity, fairness and transparency. ICI has therefore been 
closely monitoring the work of the CFTC and the Securities and Exchange 
Commission (SEC) as the agencies seek to develop this framework, and we 
have provided comment on a number of their rule proposals.\2\
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    \1\ ICI was an early supporter of Federal legislation to close this 
regulatory gap. See, e.g., Investment Company Institute, Financial 
Services Regulatory Reform: Discussion and Recommendations (March 3, 
2009), available at http://www.ici.org/pdf/ppr_09_reg_reform.pdf.
    \2\ See, e.g., Letters from Karrie McMillan, General Counsel, ICI 
to Elizabeth M. Murphy, Secretary, SEC, and David A. Stawick, 
Secretary, CFTC, dated Sept. 20, 2010 and Feb. 22, 2011 (regarding the 
definition of key terms in the Dodd-Frank Act related to the regulation 
of swaps); Letters from Karrie McMillan, General Counsel, ICI to 
Elizabeth M. Murphy, Secretary, SEC, dated Jan. 18, 2011 and to David 
A. Stawick, Secretary, CFTC, dated Feb. 7, 2011 (regarding real-time 
reporting of swap transaction data); Letters from Karrie McMillan, 
General Counsel, ICI to David A. Stawick, Secretary, CFTC, dated Jan. 
18, 2011 (regarding protection of customer collateral for cleared 
swaps) and Feb. 1, 2011 (regarding protection of customer collateral 
for uncleared swaps).
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    Developing the appropriate regulatory framework for derivatives and 
avoiding unintended consequences is a very difficult task. It is one 
that requires thoughtful and comprehensive analysis, a deliberative 
approach, coordination between the CFTC and SEC when possible and 
appropriate, and careful consideration of comments and recommendations 
from the public. From time to time, re-proposals of certain rules may 
be necessary to ensure that they are workable and do not impose costs 
that are not justified by their benefits.
    Getting the rules right is critical for protecting the swaps 
markets, market participants, and the broader financial system. And, in 
our view, the agencies have a much harder time getting the rules right 
if the public is limited in its ability to provide meaningful comment 
on proposed rules because of overly short comment periods or the order 
in which the rules are proposed.
    Last December, ICI joined with nine other trade associations in 
sending a joint letter to the CFTC and SEC on their efforts to 
implement the derivatives provisions of the Dodd-Frank Act.\3\ The 
letter began by commending the agencies ``for their diligence and 
dedication with regard to this unprecedented rulemaking endeavor.'' It 
noted, in particular, that the Dodd-Frank Act imposes ``short and 
strict deadlines'' on each agency, and that many of the required rules 
``concern activities and products that are complex and new to 
regulatory oversight.''
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    \3\ See Letter from American Bankers Ass'n, ABA Securities Ass'n, 
The Clearing House Ass'n, L.L.C., Financial Services Forum, Financial 
Services Roundtable, Institute of International Bankers, International 
Swaps and Derivatives Ass'n, Investment Company Institute, Managed 
Funds Ass'n and Securities Industry and Financial Markets Ass'n to 
Elizabeth M. Murphy, Secretary, SEC, and David A. Stawick, Secretary, 
CFTC, dated Dec. 6, 2010.
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    The joint letter did, however, raise concerns with aspects of the 
rulemaking process being followed by the two agencies and recommended 
certain changes. Among other issues, the letter expressed concern with 
the order in which the rules have been published for public comment. A 
prime example of this was the agencies' issuance of proposed 
requirements for ``swap dealers'' and ``major swap participants'' 
before they had proposed how these Dodd-Frank Act terms should be 
defined. Uncertainty regarding who might be covered by the proposed 
requirements made it very difficult for firms to know whether and to 
what extent the requirements might apply to them, and thus whether and 
how to provide meaningful comment.
    The joint letter also expressed concern that participants in the 
derivatives markets ``would be asked to do too much in too short a 
time'' in regard to implementing new rules. It cautioned that market 
participants might be forced to refrain from derivatives transactions 
for which compliance was not possible, which could in turn cause there 
to be little or no liquidity in certain segments of the market. The 
letter noted that the Dodd-Frank Act sets only a floor for the 
effective date for implementing rules (i.e., ``not less than 60 days 
after publication'') and, accordingly, called on the CFTC and SEC to 
use their discretion in order to ``phase-in the application of new 
regulatory requirements over a reasonable period of time, determined 
through discussions with the market participants that the agencies 
expect to be directly affected by those requirements.'' We are pleased 
that Chairman Gensler recently acknowledged that Congress ``gave the 
CFTC broad latitude in determining when final rulemakings under the 
Dodd-Frank Act would become effective'' and that the agency ``may give 
market participants more time'' to comply than the 60 day floor 
described above.\4\
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    \4\ See Gary Gensler, Chairman, CFTC, Remarks, Implementing the 
Dodd-Frank Act, at the Futures Industry Association's Annual 
International Futures Industry Conference, Boca Raton, FL (March 16, 
2011).
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    As this Committee continues to oversee the CFTC's implementation of 
the Dodd-Frank Act, we urge you to encourage the agency to facilitate 
meaningful public comment on these important rule proposals, to 
consider those comments fully in their rule-writing effort and, once 
those rules are finalized, to allow the private sector sufficient time 
to come into compliance.
III. CFTC Proposal To Modify or Rescind Several Exemptive and 
        Exclusionary Rules, Including Rule 4.5
A. ICI Views on the Proposal Generally
    In late January, the CFTC voted to issue a sweeping proposal to 
revise or rescind several of its exemptive and exclusionary rules, as 
well as adopt new disclosure requirements, in an effort to ``more 
effectively oversee its market participants and manage the risks that 
such participants pose to the markets.'' \5\ In particular, the 
proposal would rescind the exemptions from regulation as a commodity 
pool operator (CPO) on which sponsors of private investment funds 
typically rely, significantly narrow the exclusion from CPO regulation 
in Rule 4.5 under the Commodity Exchange Act as it relates to funds 
(discussed in detail below), and impose new periodic reporting 
requirements on all CPOs and commodity trading advisors registered with 
the CFTC.
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    \5\ See, Commodity Pool Operators and Commodity Trading Advisors: 
Amendments to Compliance Obligations, 76 Fed. Reg. 7976 (Feb. 11, 2011) 
(``Release'').
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    Not surprisingly, a proposal of this nature and scope, if adopted, 
would have significant implications for many asset management firms--
and this would be in addition to the many new obligations imposed on 
these firms by the Dodd-Frank Act. Because of this, ICI and other 
stakeholders have spent considerable time analyzing the proposal and in 
particular, the amendments to Rule 4.5, and have developed some 
recommendations for how it might be appropriately amended.
    For many reasons, the timing of this proposal is most unfortunate. 
The proposal is not mandated by the Dodd-Frank Act, although the CFTC 
attempts to describe it as being ``consistent with the tenor'' of that 
Act.\6\ Its publication for comment has required ICI and other 
stakeholders to divert attention away from analyzing and commenting on 
the many proposals from the CFTC, SEC and other agencies to implement 
the Dodd-Frank Act.\7\ The proposal has likewise been a diversion for 
the CFTC and its staff.
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    \6\ Id. at 7977.
    \7\ The CFTC first published a petition for rulemaking from the 
National Futures Association on September 17, 2010. See, Petition of 
the National Futures Association, Pursuant to Rule 13.2, to the U.S. 
Commodity Futures Trading Commission to Amend Rule 4.5, 75 Fed. Reg. 
56997. ICI and others commented extensively on that petition. On 
February 11, 2011, the CFTC published the proposal in question, 
seemingly without taking into account the commenters' myriad concerns 
raised during the first comment period.
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    It is also important to note that any adoption of the proposal in 
its current form would have considerable long-term implications for the 
CFTC. A host of new registrants would increase the agency's workload, 
and regulatory oversight of these new registrants would strain its 
limited resources, at a time when the agency acknowledges that it does 
not have the staffing or budget to meet new responsibilities under the 
Dodd-Frank Act.\8\ It likewise would strain the resources of the 
National Futures Association (NFA), which serves as the frontline 
regulator for CPOs.
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    \8\ See Testimony of Gary Gensler, Chairman, CFTC, Before the 
Subcommittee on Agriculture, Rural Development, Food and Drug 
Administration, and Related Agencies, Committee on Appropriations, 
United States House of Representatives, on the CFTC's budget request 
for FY 2012 (March 17, 2011) (stating that the Commission's current 
funding level is ``simply not sufficient for the CFTC's expanded 
mission to oversee both the futures and swaps markets.'').
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B. ICI Views on the Proposed Amendments to CFTC Rule 4.5
    Rule 4.5 currently provides an exclusion for certain ``otherwise 
regulated entities,'' including funds, from regulation as CPOs. The 
proposed amendments would condition eligibility for the Rule 4.5 
exclusion on compliance with certain trading and marketing 
restrictions.\9\ Funds unable to satisfy these conditions would be 
subject to regulation and oversight by the CFTC and the NFA. This would 
impose a second layer of regulation on such funds, which already must 
comply with comprehensive regulatory requirements under the Investment 
Company Act of 1940 (Investment Company Act) and other Federal 
securities laws.
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    \9\ The topics covered in this section are discussed in extensive 
detail in ICI's comment letter on the proposal. This letter was filed 
with the CFTC on April 12, 2011, and we will submit a copy of this 
letter to the Committee for inclusion in the hearing record.
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1. The CFTC Has Not Justified the Broad Scope of the Proposed 
        Amendments
    The Release states that the amendments to Rule 4.5 are intended to 
``stop the practice of registered investment companies offering 
futures-only investment products without Commission oversight . . .'' 
\10\ The Release fails to explain, however, why the proposed amendments 
are troublingly broader in reach. Specifically, the sweeping language 
of the proposed trading and marketing conditions would implicate a 
large number of funds that use futures, options and swaps simply as a 
means to efficiently manage their portfolios, rather than as part of 
operating a ``futures-only'' fund. It is difficult to justify this 
result at a time when, as noted above, the CFTC Chairman has stated 
that current funding levels for the agency are ``simply not 
sufficient'' and is requesting substantial additional resources from 
Congress.\11\
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    \10\ Release, supra note 5, at 7984.
    \11\ See, supra note 8.
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2. The CFTC Has Not Demonstrated the Need for Imposing a Second Layer 
        of Regulation on Funds
    In its Release, the CFTC provides no evidence that a ``futures-
only'' fund--not to mention a fund using futures, options or swaps for 
reasons other than providing exposure to the commodities markets--is 
currently subject to inadequate regulation, or that investors or the 
commodity markets generally have been harmed by their practices.
    In fact, funds are already extensively regulated. They are the only 
financial institutions that are subject to all of the four major 
Federal securities laws. The Securities Act of 1933 and the Securities 
Exchange Act of 1934 regulate the public offering of shares and ongoing 
reporting requirements, respectively. Funds must provide comprehensive 
disclosure to investors in plain English, including with regard to fees 
and expenses, the fund's investment objectives, and the risks of 
investing in the fund. The Investment Company Act regulates a fund's 
structure and operations, and addresses fund capital structures 
(including limits on use of leverage), custody of assets, investment 
activities (particularly with respect to transactions with affiliates 
and other transactions involving potential conflicts of interest), and 
the composition and duties of fund boards. A fund's investment adviser 
must register with the SEC and comply with the provisions of the 
Investment Advisers Act of 1940. Funds and their advisers are subject 
to antifraud standards. Finally, the Federal securities laws provide 
the SEC with inspection authority over funds and their investment 
advisers, principal underwriters, distributing broker-dealers and 
transfer agents. The Financial Industry Regulatory Authority (FINRA) 
also has oversight authority with regard to funds' principal 
underwriters and distributing broker-dealers.
    As a result, ICI questions why the CFTC believes it is necessary to 
impose an additional, costly layer of regulation on these already 
heavily regulated entities.
3. Because the Regulatory Regime for Swaps Is Still Being Developed, 
        the Fund Industry and Other Interested Parties Cannot 
        Adequately Assess the Impact of This Proposal
    It is difficult at this time to assess the full impact of, and 
meaningfully comment on, the proposed amendments to Rule 4.5. This is 
because one of the key conditions would relate to margin levels on 
derivative positions held by funds, and the regulators have not yet 
made critical determinations that relate to swap margin levels. 
Specifically, the CFTC and SEC have not finalized rules regarding which 
swaps will be subject to central clearing requirements. In addition, 
margin requirements have not been established for cleared or uncleared 
swaps (which could end up varying significantly based on the type of 
swap). Finally, we do not yet know whether the Department of the 
Treasury will exempt foreign exchange forwards and foreign exchange 
swaps from the definition of ``swap'' and, if no exemption is granted, 
what the margin requirements would be for these instruments.
    It is our strongly held view that the new regulatory framework for 
swaps must be put in place and margin requirements for both centrally 
cleared and uncleared swaps established before the Commission can 
propose any amendments to Rule 4.5 that implicate the use of swaps.
4. The CFTC Has Not Adequately Analyzed the Potential Costs and 
        Benefits of Its Proposal
    We believe that the CFTC's cursory analysis of the costs and 
benefits of the proposed amendments to Rule 4.5 is wholly inadequate to 
justify the costly and burdensome regulation they would impose on a 
large portion of the fund industry. The CFTC does identify a few costs, 
which it does not detail or quantify, but it fails to identify many of 
the major costs the proposal would impose on funds, some of which would 
inevitably get passed on to shareholders. The CFTC's analysis of 
benefits is even more abstract and does not appear to be focused on the 
proposed amendments to Rule 4.5. Importantly, the Commission fails to 
acknowledge in its analysis that any benefits that fund shareholders 
may receive as a result of these amendments would largely duplicate 
many protections they currently enjoy as a result of the Investment 
Company Act and other Federal securities laws.
    We have deep concerns whether the CFTC's cost-benefit analysis 
would satisfy the applicable requirements of the Commodity Exchange 
Act,\12\ and we believe that the agency should not adopt any amendments 
to Rule 4.5 without conducting a more comprehensive analysis. We 
further question whether it is even possible for the CFTC to conduct an 
adequate analysis until the status and margin issues regarding swaps, 
mentioned above, have been resolved, as the resolution of those issues 
could vastly impact the number of funds that may be swept into the 
CFTC's jurisdiction.
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    \12\ Section 15(a) of the Commodity Exchange Act requires the CFTC 
to consider the costs and benefits of its actions before issuing rules, 
regulations or orders. Section 15(a) requires the CFTC to evaluate the 
costs and benefits in light of the following five areas: (1) protection 
of market participants and the public; (2) efficiency, competitiveness 
and financial integrity of futures markets; (3) price discovery; (4) 
sound risk management practices; and (5) other public interest 
considerations.
---------------------------------------------------------------------------
    ICI is not alone in its concerns. The Chairman of this 
Subcommittee, together with the Committee Chair, recently raised very 
similar concerns in requesting that the CFTC's Inspector General 
undertake an investigation of the adequacy of the Commission's cost-
benefit analysis.\13\ We particularly agree with their observations 
that:
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    \13\ See Letter from Frank D. Lucas, Chairman, Committee on 
Agriculture, and K. Michael Conaway, Chairman, Subcommittee on General 
Farm Commodities and Risk Management, to A. Roy Lavik, Inspector 
General, CFTC dated Mar. 11, 2011.

        the CFTC is failing to adequately conduct cost-benefit 
        analysis--either as required by the [Commodity Exchange Act] or 
        the principles of the Executive Order [on Improving Regulation 
        and Regulatory Review]. . . . [p]articularly during tough 
        economic times, it is incumbent upon the CFTC to approach cost-
        benefit thoroughly and responsibly to understand the costs, and 
        therefore the economic impact any proposed regulation will have 
---------------------------------------------------------------------------
        on regulated entities and markets.

Even members of the Commission have raised concerns about the manner in 
which the agency conducts its cost-benefit analysis. Commissioner 
Sommers, for example, has observed that:

        the proposals we have voted on over the last several months [] 
        contain very short, boilerplate `Cost-Benefit Analysis' 
        sections . . . . how can we appropriately consider costs and 
        benefits if we make no attempt to quantify what the costs
        are? . . . Clearly, when it comes to cost-benefit analysis the 
        Commission is merely complying with the absolute minimum 
        requirements of the Commodity Exchange Act. That is not in 
        keeping with the spirit of the President's recent Executive 
        Order on `Improving Regulation and Regulatory Review.' We owe 
        the American public more than the absolute minimum.\14\
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    \14\ See Jill E. Sommers, Commissioner, CFTC, Opening Statement, 
Meeting on the Twelfth Series of Proposed Rulemakings under the Dodd-
Frank Act (Feb. 24, 2011).
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5. The CFTC's Proposal Would Impose Inconsistent and Duplicative 
        Regulation on Funds
    Finally, even if the restrictions in the proposed amendments to 
Rule 4.5 are appropriately scaled back, there are likely to be cases in 
which funds and their advisers would be unable to rely on the amended 
rule and thus would become subject to regulation by both the CFTC and 
the SEC. The Release specifically acknowledges that funds may have 
difficulty complying with some of the CFTC's regulations, yet it does 
not propose any solutions. As part of our analysis of the Commission's 
proposal, ICI and its outside counsel have compared the CFTC and SEC 
regulatory regimes under the Investment Company Act and the Commodity 
Exchange Act, respectively. This analysis is summarized in a detailed 
appendix to our April 12 comment letter.\15\ As this appendix 
demonstrates, many of the CFTC's requirements would be duplicative of 
the requirements to which funds and their advisers are already subject 
under the Investment Company Act or other Federal securities laws. 
Other of the CFTC's requirements would be fundamentally inconsistent 
with the requirements to which funds and their advisers are subject.
---------------------------------------------------------------------------
    \15\ See, supra note 9.
---------------------------------------------------------------------------
    For example, the SEC significantly limits the ability of a fund to 
include in its prospectus performance information about other funds or 
accounts managed by the fund's adviser.\16\ The CFTC rules, by 
contrast, require disclosure of such information in certain 
circumstances. A fund could not comply with the CFTC's requirements 
without likely violating the SEC's (and FINRA's) requirements. As 
another example, the CFTC rules regarding delivery and receipt of a 
commodity pool disclosure document are fundamentally different than the 
model under the Federal securities laws, and would not be practicable 
for funds, which generally offer their shares publicly on a daily basis 
though broker-dealers and other intermediaries.
---------------------------------------------------------------------------
    \16\ FINRA, which has oversight over fund advertising, similarly 
prohibits funds from advertising the adviser's other fund or account 
performance.
---------------------------------------------------------------------------
    The examples above illustrate why we believe it is absolutely 
critical that the CFTC, before imposing an additional regulatory 
requirement on funds, evaluate its regulatory purpose in doing so and 
consider whether a regulation to which funds and their advisers are 
already subject would be sufficient to satisfy that purpose.
    More broadly, it is essential that the CFTC work closely with the 
SEC before amending Rule 4.5 in order to reconcile the many duplicative 
and conflicting regulations to which a fund and its adviser could 
become subject. The harmonized regulations then should be re-proposed 
for public comment.
IV. Conclusion
    We appreciate this opportunity to testify before the Committee. The 
regulatory proposals discussed in our testimony have important 
implications for funds and the over 90 million shareholders who rely on 
funds to meet their retirement and investment goals. Continued 
Congressional oversight of the CFTC's work on these proposals is 
critical to ensuring that the regulatory scheme for the derivatives 
markets is appropriately established and that funds are not made 
subject to duplicative and fundamentally inconsistent regulatory 
requirements.
                               Attachment
April 12, 2011

David A. Stawick,
Secretary,
Commodity Futures Trading Commission,
Washington, D.C.

Re: Commodity Pool Operators and Commodity Trading Advisors: Amendments 
to Compliance Obligations (RIN No. 3038-AD30)

    Dear Mr. Stawick:

    The Investment Company Institute \1\ appreciates the opportunity to 
comment on the proposal by the Commodity Futures Trading Commission 
(``Commission'' or ``CFTC'') to modify or rescind several of its 
exemptive and exclusionary rules.\2\ Our comments focus on the proposed 
amendments to CFTC Rule 4.5 that would apply solely to registered 
investment companies (``Rule 4.5 Proposal'').
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    \1\ The Investment Company Institute is the national association of 
U.S. investment companies, including mutual funds, closed-end funds, 
exchange-traded funds (``ETFs''), and unit investment trusts 
(``UITs''). ICI seeks to encourage adherence to high ethical standards, 
promote public understanding, and otherwise advance the interests of 
funds, their shareholders, directors, and advisers. Members of ICI 
manage total assets of $13.0 trillion and serve over 90 million 
shareholders.
    \2\ Commodity Pool Operators and Commodity Trading Advisors: 
Amendments to Compliance Obligations, 76 Fed. Reg. 7976 (Feb. 11, 2011) 
(``Release'').
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    ICI and its members strongly object to the Rule 4.5 Proposal in its 
current form. While we respect the Commission's authority to 
``reconsider the level of regulation that it believes is appropriate 
with respect to entities participating in the commodity futures and 
derivatives markets,'' \3\ we do not believe the Commission has 
demonstrated the need for a second level of regulation on registered 
investment companies, which are already subject to comprehensive 
regulation under the Federal securities laws. We further believe that 
the Rule 4.5 Proposal is insufficiently developed and thus it is 
premature to adopt it at this time. It does not appear to reflect 
thorough consideration by the Commission of many critical issues, 
including how registered investment companies participate in the 
commodity futures and derivatives markets, the appropriateness of 
including swaps in the Rule 4.5 Proposal, the extensive regulation to 
which investment companies are subject under the Investment Company Act 
of 1940 (the ``Investment Company Act'') and other Federal securities 
laws, the overlapping and conflicting nature of many regulatory 
requirements that registered investment companies would face if they 
were regulated by both the Securities and Exchange Commission (``SEC'') 
and the CFTC, and the potential costs and burdens of dual regulation.
---------------------------------------------------------------------------
    \3\ Id. at 7977.
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    The Release states the Commission's belief that the text of the 
proposed amendments to Rule 4.5 is ``an appropriate point at which to 
begin discussions regarding the Commission's concerns.'' \4\ If, after 
reviewing the comments on the Rule 4.5 Proposal, the Commission 
nevertheless determines to proceed with amending Rule 4.5, we 
respectfully urge that the agency develop and issue a new proposal to 
amend the rule, taking into consideration the comments and 
recommendations that it receives in response to this Release. To assist 
the Commission in this endeavor, we have identified several critical 
issues that should be addressed in any proposal to amend Rule 4.5, and 
this letter sets forth our initial recommendations for how several of 
those issues might be resolved.
---------------------------------------------------------------------------
    \4\ Id. at 7984 (emphasis added).
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I. Executive Summary
    Last summer, the National Futures Association (``NFA'') submitted a 
petition for rulemaking that asked the CFTC to narrow significantly the 
Rule 4.5 exclusion as applied to registered investment companies, by 
requiring compliance with certain trading and marketing restrictions. 
In late January, the CFTC proposed amendments to Rule 4.5 that not only 
incorporate the trading and marketing restrictions suggested in the NFA 
petition but also extend those restrictions to a fund's positions in 
swaps. In the view of ICI and its members, the Rule 4.5 Proposal is 
overly broad in scope and would cause many registered investment 
companies to become subject to CFTC regulation, even though these funds 
do not raise the Commission's stated concerns regarding ``futures-only 
investment products.''
    The CFTC has provided little rationale for its sweeping proposal, 
including why it is necessary to impose a second, costly layer of 
regulation on registered investment companies, which are already 
subject to comprehensive regulation under the Investment Company Act 
and other Federal securities laws. Moreover, the proposal is 
insufficiently developed and adopting it without first resolving the 
many critical issues it raises would be premature. As a result, ICI and 
its members strongly recommend that, if the CFTC nonetheless determines 
to move forward with the Rule 4.5 Proposal, it publish for comment a 
revised version of the amendments that fully addresses these issues.
    Our comments, concerns, and recommendations, which we describe 
fully below, include the following:

   Including Swaps in the Rule 4.5 Proposal is Premature: The 
        Commission's inclusion of swaps in the Rule 4.5 Proposal has 
        broad implications for a wide variety of registered investment 
        companies, which may find it difficult or impossible to meet 
        the proposed trading and marketing restrictions. While we do 
        not question the CFTC's jurisdiction over swaps, we nonetheless 
        believe it has an obligation under the Administrative Procedure 
        Act (``APA'') to explain the reasoning behind its decision to 
        require these users of swaps to register. We also strongly 
        believe that application of the Rule 4.5 Proposal to swaps is 
        premature because the CFTC and SEC have not yet adopted rules 
        specifying which swaps will be subject to central clearing and 
        margin requirements have not been established for cleared or 
        uncleared swaps. It also is still unclear whether foreign 
        exchange swaps and foreign exchange forwards will be considered 
        ``swaps'' subject to CFTC oversight. As a result, commenters 
        are unable to provide meaningful input on this very critical 
        aspect of the proposal.

   Cost-Benefit Analysis: We believe the CFTC's cursory cost-
        benefit analysis of the Rule 4.5 Proposal is inadequate to 
        justify the costly and duplicative regulation that the proposal 
        would impose on a large portion of the investment company 
        industry. The analysis does not take into account many of the 
        significant costs the proposal would impose on investment 
        companies, and does not acknowledge the many protections 
        shareholders currently benefit from under the Investment 
        Company Act and other Federal securities laws. We question 
        whether the agency's analysis would satisfy applicable 
        statutory requirements, and urge the CFTC not to adopt any 
        amendments to Rule 4.5 without conducting a more comprehensive 
        analysis.

   Clarification Regarding Which Entity Would Register as a 
        Commodity Pool Operator: The Release does not state which 
        entity would register as a commodity pool operator (``CPO'') if 
        a registered investment company is unable to meet the criteria 
        for exclusion under amended Rule 4.5. Because the investment 
        company's investment adviser is typically responsible for 
        establishing the company and operating it on a day-to-day 
        basis, we request that the CFTC concur with our view that the 
        adviser is the appropriate entity to serve as the company's 
        CPO.

   Proposed Trading Restriction: The proposed five percent 
        limit on positions taken for non-bona fide hedging purposes, 
        especially as it would apply to swaps, futures, and options 
        used for non-speculative purposes, would result in a large 
        number of registered investment companies being unable to rely 
        on the Rule 4.5 exclusion. We believe that narrowing the scope 
        of the trading restriction would be more consistent with the 
        CFTC's regulatory goals, and offer the following suggestions: 
        (1) eliminating or significantly narrowing the application of 
        the proposed rule to swaps; (2) specifically referencing risk 
        management as an element of ``bona fide hedging'' in the 
        context of Rule 4.5; and (3) raising the threshold for 
        positions taken for non-bona fide hedging purposes. We note, 
        however, that it is not possible to comment on what the 
        specific threshold should be until margin levels for swaps are 
        determined.

   Use of Wholly Owned Subsidiary Structure: The Rule 4.5 
        Proposal would require that any instruments held for non-
        hedging purposes be held directly by the fund, and not through 
        a wholly owned subsidiary, as funds investing in commodities 
        often do today to avoid adverse tax consequences. We emphasize 
        that this subsidiary structure is used by funds for legitimate 
        tax purposes and not to evade regulation under the Investment 
        Company Act. To address any remaining concerns the Commission 
        may have, an investment company's adviser could make 
        representations that it would make the books and records of the 
        subsidiary available to the CFTC and NFA staff for inspection 
        upon request and provide transparency about fees, if any, 
        charged by the subsidiary.

   Proposed Marketing Restriction: The proposed language 
        seeking to restrict the ability of registered investment 
        companies to market themselves as ``otherwise seeking 
        investment exposure to'' the commodity futures and options 
        markets is phrased broadly and could pick up a wide variety of 
        registered investment companies that have only a modest 
        exposure to commodity futures, commodity options, and swaps 
        (e.g., asset allocation funds). We strongly believe this 
        additional language in the marketing restriction is unnecessary 
        and should be eliminated. In addition, we request clarification 
        regarding the scope of the marketing restriction and 
        confirmation that it would not be read so broadly as to apply 
        to risk and other required disclosures in an investment 
        company's registration statement or marketing materials.

   Areas of Conflict Between SEC and CFTC Regulation: Advisers 
        to those registered investment companies that would be unable 
        to meet the criteria for exclusion under proposed Rule 4.5 
        would be subject to both SEC and CFTC regulation, potentially 
        resulting in duplicative regulation in many areas, as well as 
        conflicting requirements in others (e.g., relating to 
        disclosure documents, delivery obligations, presentation of 
        performance data, and operational requirements). We strongly 
        believe that investment companies should not be subject to 
        duplicative regulation and that any conflicts between the 
        regulatory requirements should be resolved by the CFTC and SEC 
        before amendments to Rule 4.5 are adopted. In fact, to satisfy 
        the requirements of the APA, the CFTC must provide affected 
        entities with notice of how they would be expected to comply, 
        or how conflicting regulations would be resolved, and an 
        opportunity to provide comment before any amendments to Rule 
        4.5 are finalized.
II. The Proposed Amendments to Rule 4.5 are Insufficiently Developed, 
        and Adoption Would Be Premature
A. Background
    The term CPO is broadly defined in the Commodity Exchange Act and 
generally includes, among other things, any person engaged in a 
business that is in the nature of an investment trust who receives 
funds from others ``for the purpose of trading in any commodity for 
future delivery on or subject to the rules of a contract market or 
derivatives transaction execution facility.'' \5\ CFTC Rule 4.5 
recognizes the breadth of this definition, and provides an exclusion 
from CPO registration for certain persons operating ``qualifying 
entities'' that are subject to a different regulatory framework, 
including registered investment companies.\6\ Previously, the Rule 4.5 
exclusion was conditioned upon the entity satisfying certain conditions 
relating to its trading in commodity interests and the marketing of 
shares/participations in the entity. After lengthy consideration in 
2002-03 (which included an advance notice of proposed rulemaking and a 
public roundtable on the regulation of CPOs and commodity trading 
advisors (``CTAs'')), the CFTC determined to eliminate those conditions 
from the rule. In so doing, it cited, among other things, the fact that 
many qualifying entities avoided participation in the markets for 
commodity futures and commodity options because the Rule 4.5 conditions 
were ``too restrictive for many [of them] to meet'' and that 
facilitating participation in the commodity markets by additional 
collective investment vehicles and their advisers would have ``the 
added benefit to all market participants of increased liquidity.'' \7\
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    \5\ Section 1a(5) of the Commodity Exchange Act.
    \6\ Entities seeking to rely on the Rule 4.5 exclusion must file a 
notice of eligibility with the National Futures Association that 
includes certain representations.
    \7\ See, Additional Registration and Other Regulatory Relief for 
Commodity Pool Operators and Commodity Trading Advisors, 68 Fed. Reg. 
12622, 12626 (March 17, 2003) (``2003 Proposing Release''); Additional 
Registration and Other Regulatory Relief for Commodity Pool Operators 
and Commodity Trading Advisors: Past Performance Issues, 68 Fed. Reg. 
47221 (Aug. 8, 2003) (``2003 Adopting Release'')
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    Last summer, the NFA submitted a rulemaking petition to the CFTC to 
amend Rule 4.5.\8\ According to the petition, the NFA had concerns 
about the marketing practices of three registered investment companies 
offering so-called ``managed futures strategies.'' The NFA petition 
proposed that the Rule 4.5 exclusion should be significantly narrowed 
for all registered investment companies, leaving other ``qualifying 
entities'' unaffected. Specifically, the petition recommended that 
registered investment companies should be required to comply with 
trading and marketing restrictions that are based upon those in the 
rule prior to 2003, but are actually much broader in scope.
---------------------------------------------------------------------------
    \8\ Petition of the National Futures Association, Pursuant to Rule 
13.2, to the U.S. Commodity Futures Trading Commission to Amend Rule 
4.5, 75 Fed. Reg. 56997 (Sept. 17, 2010).
---------------------------------------------------------------------------
    Following publication of the NFA petition in the fall, the CFTC 
received considerable feedback from individual companies and trade and 
bar associations, including ICI (``October Letter'').\9\ Many of the 
comment letters expressed serious concerns about the scope of the NFA's 
proposed language, outlined the difficulties that registered investment 
companies would face in trying to comply with overlapping and 
conflicting requirements of the CFTC and SEC, and offered possible 
solutions.
---------------------------------------------------------------------------
    \9\ Letter from Karrie McMillan, General Counsel, ICI, to David A. 
Stawick, Secretary, CFTC, dated Oct. 18, 2010.
---------------------------------------------------------------------------
    In late January, the CFTC voted to issue the Rule 4.5 Proposal. The 
agency drew the proposed rule text almost verbatim from the NFA 
petition, but significantly also applied the proposed trading and 
marketing conditions to a registered investment company's positions in 
swaps. The Release contains little explanation for the proposed 
language, except to describe it as ``an appropriate point at which to 
begin discussions regarding the Commission's concerns.'' \10\ The 
Release also does not address the considerable comments the CFTC 
received on the NFA petition, except to the extent it poses specific 
questions for further public comment based on the responses it received 
regarding the NFA petition.
---------------------------------------------------------------------------
    \10\ Release, supra note 2 at 7984.
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B. The CFTC Has Not Demonstrated the Need for Imposing a Second Layer 
        of Regulation on Registered Investment Companies
    The CFTC provides little rationale in the Release for its sweeping 
Rule 4.5 Proposal. It is not mandated by the Dodd-Frank Wall Street 
Reform and Consumer Protection Act (``Dodd-Frank Act''), although the 
CFTC describes the Rule 4.5 Proposal as being ``consistent with the 
tenor'' of that Act.\11\ According to the Release, the proposed 
restrictions under Rule 4.5 are intended to ``stop the practice of 
registered investment companies offering futures-only investment 
products without Commission oversight'' and that ``such restrictions 
would limit the possibility of entities engaging in regulatory 
arbitrage whereby operators of otherwise regulated entities that have 
significant holdings in commodity interests would avoid registration 
and compliance obligations under the Commission's regulations.''\12\ 
The CFTC provides no evidence, however, that such registered investment 
companies are currently subject to inadequate regulation, or that 
investors or the commodity markets generally have been harmed by their 
practices. Nor does the agency explain why the Rule 4.5 Proposal is 
troublingly broader in reach than ``futures-only investment products,'' 
as it potentially captures registered investment companies with 
relatively little exposure to the commodity markets.
---------------------------------------------------------------------------
    \11\ Release, supra note 2 at 7977 (emphasis added). See Letter 
from Scott Garrett, Chairman, Subcommittee on Capital Markets and 
Government Sponsored Enterprises, to Gary Gensler, Chairman, CFTC, 
dated March 3, 2011 (``Garrett Letter'') (Congressman Garrett recently 
expressed concern regarding ``the CFTC in many cases . . . going even 
beyond what the [Dodd-Frank Act] requires.'').
    \12\ Release, supra note 2, at 7984.
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    As we discussed in the October Letter, investment companies are 
already extensively regulated under the Investment Company Act and 
other Federal securities laws. The protections afforded under the 
securities laws include, among others:

   Limits on the use of leverage

   Antifraud provisions

   Comprehensive disclosure to investors, including with regard 
        to:

    b Fees and expenses

    b The investment objectives and strategies of the investment 
            company

    b The risks of investing in the investment company

   Independent board oversight

    b Particular emphasis on potential conflicts of interest

   Restrictions on transactions with affiliates

   Requirements regarding custody of fund assets

    Importantly, the existing regulatory scheme for registered 
investment companies is, first and foremost, concerned with investor 
protection, and is administered by the SEC, for which the protection of 
investors is central to its mission. In addition, investment advisers 
to registered investment companies must themselves be registered with 
the SEC and be subject to regulation under the Investment Advisers Act 
of 1940 and related SEC rules, which also include antifraud 
protections. The Financial Industry Regulatory Authority (``FINRA'') 
also has oversight authority over an investment company's principal 
underwriter and distributing broker-dealers. Also, even though excluded 
under current Rule 4.5, registered investment companies are subject to 
CFTC large trader reporting requirements like any other trader, which 
enables the CFTC to obtain information from those entities that it can 
use to assess systemic risk.\13\ As a result, we continue to question 
why the CFTC believes it is necessary to impose an additional, costly 
layer of regulation on these already heavily-regulated entities.
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    \13\ See Parts 15-19 and 21 of the CFTC's regulations.
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C. The CFTC Has Failed to Justify its Proposed Disparate Treatment for 
        Registered Investment Companies
    Currently, the Rule 4.5 exclusion is available to a variety of 
``otherwise regulated entities.'' The increased restrictions 
contemplated by the Rule 4.5 Proposal, however, would apply only to one 
type of entity that currently may rely on the rule--registered 
investment companies. Under this proposal, the full range of CFTC and 
NFA rules and oversight would be imposed only on registered investment 
companies that engage in commodity trading and are unable to satisfy 
the heightened criteria under Rule 4.5.
    The Release offers no justification for imposing additional burdens 
on registered investment companies that, ironically, are subject to far 
more regulation and oversight than are other entities offered to, or 
operated for the benefit of, retail investors that may continue to rely 
on Rule 4.5 in its current form and thus be subject to only a single 
regulatory scheme. Such disparate treatment is an invitation to 
regulatory arbitrage, because there would be nothing in Rule 4.5 to 
preclude other qualifying entities from offering a ``futures only'' 
investment pool without CFTC oversight. The creation of this regulatory 
``gap'' would be wholly inconsistent with the tenor of the Dodd-Frank 
Act. It also would be completely at odds with the Commission's stated 
concerns in issuing the proposal.
    Should the CFTC determine to modify Rule 4.5 to treat registered 
investment companies differently than other regulated entities that 
qualify for the Rule 4.5 exclusion, it must issue a re-proposal that 
explain the basis for such disparate treatment as required by the 
APA.\14\
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    \14\ In The Connecticut Light and Power Company, et al. v. Nuclear 
Regulatory Commission, 673 F.2d 525 (D.C. Cir. 1982) (``Connecticut 
Light''), the Court of Appeals for the D.C. Circuit stated as follows:

      The purpose of the comment period [required under the 
Administrative Procedure Act] is
  to allow interested members of the public to communicate information, 
concerns, and criti-
  cisms to the agency during the rule-making process. If the notice of 
proposed rule-making fails
  to provide an accurate picture of the reasoning that has led the 
agency to the proposed rule,
  interested parties will not be able to comment meaningfully upon the 
agency's proposals. As
  a result, the agency may operate with a one-sided or mistaken picture 
of the issues at stake
  in a rulemaking. . . . An agency commits serious procedural error 
when it fails to reveal por-
  tions of the technical basis for a proposed rule in time to allow for 
meaningful commentary.
  (Internal citations omitted).
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D. The Proposed Inclusion of Swaps Under Rule 4.5 is Premature
    As noted above, the Release states that the language from the NFA 
petition is ``an appropriate point at which to begin discussions,'' and 
the text of the proposed amendments to Rule 4.5 is drawn almost 
verbatim from the NFA petition. The text differs from the NFA's 
language, however, in one key respect--by including swaps within the 
scope of the proposed trading and marketing restrictions. While we 
understand that the CFTC obtained jurisdiction over swaps as a result 
of the Dodd-Frank Act, its expanded jurisdiction does not relieve the 
agency of its obligation under the APA to explain the reasoning behind 
its proposal, including a clear rationale as to why users of swaps need 
to be registered.\15\ This includes the obligation to evaluate whether 
particular uses of swaps raise the concerns that Rule 4.5 is intended 
to address. Both analyses are entirely absent in the Release. As we 
cautioned in our October Letter, and as explained more fully below, the 
inclusion of swaps significantly expands the scope of the Rule 4.5 
Proposal and would create a host of (presumably) unintended 
consequences. Including swaps in the proposal also would increase 
significantly the number of entities that would become subject to CFTC 
regulation at a time when the Commission has expressed concern that its 
resources are inadequate to meet its expanded regulatory 
responsibilities for swaps under the Dodd-Frank Act.\16\

    \15\ See, id. Section 553 of the APA requires that an agency 
provide the public with adequate notice of the substance of a proposed 
rule and an opportunity to provide meaningful comment. If it fails to 
do so, the resulting rule may be struck down by courts on the basis 
that it is not a ``logical outgrowth'' of the agency's proposal. See, 
Kooritzky v. Reich, 17 F.3d 1509, 1513 (D.C. Cir. 1994) (court stated 
that ``agencies must include in their notice of proposed rulemaking 
`either the terms or substance of the proposed rule or a description of 
the subjects and issues involved' . . . [a]nd they must give 
`interested persons an opportunity to participate in the rule making 
through submission of written data, views, or arguments.' The Labor 
Department did neither.'' (internal citations omitted)) 
(``Kooritzky''); Shell Oil Co. v. EPA, 950 F.2d 741, 751 (D.C. Cir. 
1992) (``an unexpressed intention cannot convert a final rule into a 
`logical outgrowth' that the public should have anticipated. Interested 
parties cannot be expected to divine the [agency's] unspoken 
thoughts.'') (``Shell Oil'').
    \16\ See Gary Gensler, Chairman, CFTC, Remarks, Implementing the 
Dodd-Frank Act, at FIA's Annual International Futures Industry 
Conference, Boca Raton, Florida (March 16, 2011) (``Our current funding 
level of $169 million is simply not sufficient for the CFTC's expanded 
mission to oversee both the futures and swaps markets. Though we will 
work very closely with the National Futures Association, and they will 
take on as many responsibilities as they can, including those related 
to registration and examination of swap dealers, we will need 
significant resources to properly oversee both the futures and swaps 
markets.'') (``Gensler Remarks'').
---------------------------------------------------------------------------
    As described in more detail below, the Rule 4.5 Proposal includes a 
condition that a registered investment company may use commodity 
futures, commodity options or swaps solely for ``bona fide hedging 
purposes.'' It may, however, hold certain instruments not for bona fide 
hedging purposes, if the initial margin and premiums required to 
establish those positions do not exceed five percent of the fund's 
liquidation value.
    As applied to swaps, this is a clear example of ``cart before the 
horse'' rulemaking \17\ and could be subject to challenge under the 
APA. The CFTC and SEC have not yet finalized rules regarding which 
swaps will be subject to central clearing requirements. Margin 
requirements have not yet been established for cleared or uncleared 
swaps and, once they are established, could vary significantly based on 
the type of swap. Similarly, we do not yet know whether the Department 
of the Treasury will exempt foreign exchange forwards and foreign 
exchange swaps from the definition of ``swap'' \18\ and, if no 
exemption is granted, what the margin requirements will be for these 
instruments. Given these uncertainties about swaps, it is simply not 
possible for funds to evaluate in any meaningful way how they would 
fare under the proposed five percent trading restriction, which is 
calculated on the basis of initial margin, or to determine whether a 
higher percentage threshold might be more appropriate. The new 
regulatory framework for swaps must be put in place and margin 
requirements for both centrally cleared and uncleared swaps established 
before any amendments to Rule 4.5 that implicate the use of swaps can 
be considered. Adopting the proposed amendments prior to that time 
would not provide the public with adequate notice of the substance of 
the rule the Commission intends to adopt, or an opportunity to provide 
meaningful comment.\19\
---------------------------------------------------------------------------
    \17\ See Garrett Letter, supra note 11 (questioning the CFTC's 
``cart before the horse'' approach to rulemaking, and whether it 
``depriv[es] the public of the opportunity to provide meaningful 
comment on the CFTC's proposals . . .'').
    \18\ See Section 1a(47)(E) of the Commodity Exchange Act, as 
amended by the Dodd-Frank Act.
    \19\ See, Connecticut Light, supra note 14; Kooritzky, supra note 
15; Shell Oil, supra note 15.
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E. Harmonizing the Regulations That Would Apply to a Registered 
        Investment Company Subject to CFTC Oversight Must Be Done 
        Through Public Notice and Comment
    As we explain in detail later in this letter, adoption of the Rule 
4.5 Proposal could subject a large number of registered investment 
companies to regulation by the CFTC in addition to the SEC. As noted in 
our October Letter, this would make funds subject to many directly 
conflicting, or fundamentally inconsistent, requirements under the 
Investment Company Act and the Commodity Exchange Act. The Release 
states that dual regulation of registered investment companies ``may 
result in operational difficulties'' and seeks comment regarding 
``which rules and regulations are in conflict'' and ``how these could 
be best addressed by the two Commissions.'' \20\
---------------------------------------------------------------------------
    \20\ Release, supra note 2, at 7984.
---------------------------------------------------------------------------
    While we are pleased that the CFTC recognizes the need to work 
cooperatively with the SEC in order to determine how their respective 
regulations should be harmonized for dual registrants, we are concerned 
that the Commission provides no guidance in the Release on how that 
might be accomplished. In order to meet the notice and comment 
requirements of the APA, we strongly believe that the agency must re-
propose the rule to include a detailed proposal regarding how 
registered investment companies will be expected to comply with the 
CFTC's regulations, and how conflicting or inconsistent regulations 
will be reconciled.\21\ To proceed otherwise would deprive registered 
investment companies (and the broader public) of a meaningful 
opportunity to comment on the new regulatory requirements that would be 
placed on registered investment companies.\22\
---------------------------------------------------------------------------
    \21\ See, Kooritzky, supra note 15, at 1513 (``Something is not a 
logical outgrowth of nothing.''); Shell Oil, supra note 15.
    \22\ Id.; Connecticut Light, supra note 14.
---------------------------------------------------------------------------
F. The CFTC Has Given Inadequate Consideration to the Potential Costs 
        and Benefits of the Proposed Amendments to Rule 4.5
    In our view, the CFTC's cursory cost-benefit analysis of the Rule 
4.5 Proposal is inadequate to justify the costly and duplicative 
regulation that the proposal would impose on a large portion of the 
investment company industry.\23\ In terms of costs, the agency 
identifies only the following as being relevant to the Rule 4.5 
Proposal: (1) failing to adopt revisions to Rule 4.5 that are 
substantively similar to those proposed in the NFA's petition would 
result in disparate treatment of similarly situated collective 
investment schemes; \24\ (2) requiring the filing of an annual notice 
to claim exemptive relief under Rule 4.5 enables the CFTC to better 
understand the universe of entities claiming relief from its regulatory 
scheme; and (3) the proposed changes ``may result in additional costs 
to certain market participants due to registration and compliance 
obligations.'' \25\ We strongly believe that the Rule 4.5 Proposal 
would impose additional, significant costs on registered investment 
companies. These costs--some of which would inevitably get passed on to 
shareholders--would include, among others:
---------------------------------------------------------------------------
    \23\ Release, supra note 2, at 7988.
    \24\ It is highly perplexing that the CFTC specifically lists this 
as a cost, given that its Rule 4.5 Proposal fails to include all 
``otherwise regulated'' entities that are able to rely on the rule.
    \25\ Release, supra note 2, at 7988.

   The cost of registering the CPO with the CFTC, and preparing 
        for and taking additional licensing examinations (fund 
---------------------------------------------------------------------------
        distributors are already subject to licensing requirements);

   The cost of preparing and distributing required disclosure 
        documents and reports to investors (funds already provide 
        substantial disclosures to their investors; what would be 
        required by the CFTC's proposal would be different in form and 
        timing, but for the most part would not provide meaningful 
        additional information that investors currently lack);

   The cost of retaining counsel to attempt to reconcile and 
        satisfy inconsistent regulatory requirements;

   The costs to upgrade systems to produce reports, coordinate 
        and potentially develop new systems for vendors that currently 
        assist in distributing investment company reports;

   The costs of training salespeople;

   The costs associated with the hiring and training of in-
        house counsel and compliance professionals, and costs 
        associated with changes to fund compliance programs (both in 
        terms of time spent by in-house personnel and fees paid for 
        legal advice); and

   Even for those entities able to comply with the new Rule 4.5 
        restrictions on trading and marketing, the costs of having to 
        establish the monitoring and compliance controls necessary to 
        ensure their ongoing compliance with any trading 
        restrictions.\26\
---------------------------------------------------------------------------
    \26\ Based on registered investment companies' experience with Rule 
4.5 prior to its amendment in 2003, these controls would likely include 
consultations with legal counsel to determine whether or not a 
particular position would come within the applicable trading 
restrictions.

    With regard to benefits, the CFTC's analysis is equally 
insufficient, appearing to focus more on benefits stemming from other 
aspects of the Release rather than from the Rule 4.5 Proposal. 
Specifically, it notes the anticipated benefits of the increased 
information that proposed Forms CPO-PQR and CTA-PR would provide.\27\ 
These benefits do not make sense in the context of registered 
investment companies, which are already heavily regulated by the SEC 
and are required to provide extensive and detailed disclosure that is 
available both to the public and to regulators. Moreover, the CFTC 
fails to acknowledge in its analysis that any benefits that investment 
company shareholders may receive as a result of the Rule 4.5 Proposal 
would largely be duplicative of the many protections they currently 
enjoy as a result of the Investment Company Act and other Federal 
securities laws.
---------------------------------------------------------------------------
    \27\ The CFTC states that ``the proposed changes . . . will 
[provide] the Commission and other policy makers with more complete 
information about these registrants. . . . the Commission does not have 
access to this information today and has instead made use of 
information from other, less reliable sources.'' Release, supra, note 
2, at 7988.
---------------------------------------------------------------------------
    For these reasons, we have deep concerns as to whether the CFTC's 
analysis would satisfy the applicable requirements of the Commodity 
Exchange Act, and we urge that the agency not adopt any amendments to 
Rule 4.5 without conducting a more comprehensive analysis.\28\ We 
further question whether it is even possible for the CFTC to conduct an 
adequate analysis until the status and margin issues regarding swaps, 
discussed above, have been resolved, as the resolution of those issues 
could vastly impact the number of registered investment companies that 
may be swept into the CFTC's jurisdiction.
---------------------------------------------------------------------------
    \28\ Section 15(a) of the Commodity Exchange Act requires the CFTC 
to consider the costs and benefits of its actions before issuing rules, 
regulations or orders. Section 15(a)(2) requires the CFTC to evaluate 
the costs and benefits in light of the following five areas: (1) 
protection of market participants and the public; (2) efficiency, 
competitiveness and financial integrity of futures markets; (3) price 
discovery; (4) sound risk management practices; and (5) other public 
interest considerations. Both the CFTC's own Commissioners and Members 
of Congress have recently raised concerns regarding the inadequacies of 
the CFTC's cost-benefit analyses in its recent proposals. See, e.g., 
Commissioner Jill E. Sommers, Opening Statement, Meeting on the Twelfth 
Series of Proposed Rulemakings under the Dodd-Frank Act (Feb. 24, 2011) 
(``. . . the proposals we have voted on over the last several months [ 
] contain very short, boilerplate `Cost-Benefit Analysis' sections. . . 
. how can we appropriately consider costs and benefits if we make no 
attempt to quantify what the costs are? . . . Clearly, when it comes to 
cost-benefit analysis the Commission is merely complying with the 
absolute minimum requirements of the Commodity Exchange Act. That is 
not in keeping with the spirit of the President's recent Executive 
Order on `Improving Regulation and Regulatory Review.' We owe the 
American public more than the absolute minimum.''); Letter from Frank 
D. Lucas, Chairman, Committee on Agriculture, and K. Michael Conaway, 
Chairman, Subcommittee on General Farm Commodities and Risk Management, 
to A. Roy Lavik, Inspector General, CFTC, dated March 11, 2011 (``. . . 
recent public comments indicate that the CFTC is failing to adequately 
conduct cost-benefit analysis--either as required by the [Commodity 
Exchange Act] or the principles of the Executive Order [on Improving 
Regulation and Regulatory Review]. . . . Particularly during tough 
economic times, it is incumbent upon the CFTC to approach cost-benefit 
thoroughly and responsibly to understand the costs, and therefore the 
economic impact any proposed regulation will have on regulated entities 
and markets.'').
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III. The CFTC Must Address Many Complex and Interrelated Issues in 
        Developing a Proposal to Amend Rule 4.5
    As is clear from our foregoing comments, we strongly object to the 
CFTC's proceeding with the Rule 4.5 Proposal, as it has not 
demonstrated a sufficient need to capture a broad swath of already 
highly regulated entities and subject them to CFTC regulation. In the 
event the CFTC determines to pursue this concept, however, we offer 
below some suggestions for crafting the proposal to better fit the 
agency's stated regulatory goal of protecting investors in pools 
offering ``futures-only investment products.'' Any revisions to the 
proposal to make it consistent with that goal would need to be 
significant, and we respectfully request that the Commission provide 
the public with a meaningful opportunity to comment on such a revised 
proposal.
A. Clarification Regarding Which Entity Would Register as a Commodity 
        Pool Operator
    The Proposal is silent regarding which entity would register as CPO 
if a registered investment company is unable to meet the criteria for 
exclusion under amended Rule 4.5. In light of the structure and 
operations of registered investment companies, we request that the CFTC 
concur with our view that the registered investment adviser to such an 
investment company is the appropriate entity to serve as the company's 
CPO, and not the investment company itself or its directors (for a 
company organized as a corporation) or trustees (for a company 
organized as a trust) (together, ``directors''). We believe having the 
adviser register as CPO under these circumstances will satisfy the 
CFTC's regulatory interest in ensuring that investors receive 
appropriate disclosure and reports, and that adequate records are 
maintained and available for regulatory inspection.\29\
---------------------------------------------------------------------------
    \29\ We note that while a registered investment adviser serving as 
CPO for a registered investment company would also be the investment 
company's CTA, regulations under the Commodity Exchange Act 
specifically acknowledge that an investment pool's CPO and CTA can be 
the same entity. See Rule 4.14(a)(4) under the Commodity Exchange Act 
(exemption from registration as a CTA for a person that is registered 
under the Commodity Exchange Act as a CPO, where the person's commodity 
trading advice is directed solely to, and for the sole use of, the pool 
or pools for which it is so registered).
---------------------------------------------------------------------------
    The CFTC has indicated that the following factors may be relevant 
to determining who is acting as a CPO of a pool:

   Who is promoting the pool by soliciting, accepting or 
        receiving from others, funds or property for the purpose of 
        commodity interest trading;

   Who has the authority to hire (and to fire) the pool's CTA; 
        and

   Who has the authority to select (and to change) the futures 
        commission merchant (``FCM'') that will carry the pool's 
        commodity interest trading account.\30\
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    \30\ See, Commodity Pool Operators; Exclusion for Certain Otherwise 
Regulated Persons From the Definition of the Term ``Commodity Pool 
Operator''; Other Regulatory Requirements, 50 Fed. Reg. 15868 (Apr. 23, 
1985) (``1985 Adopting Release'').

    In applying these factors in the registered investment company 
context, it is apparent that an investment company's adviser is the 
primary force in establishing and operating the company and the most 
logical person to serve as its CPO. A registered investment company has 
no employees and relies on its adviser for the day-to-day management 
of, and decisions regarding, the company. For example, it is typically 
the adviser that makes the decision to establish the investment company 
and, as the investment company's initial shareholder, typically selects 
its initial board of directors. The adviser also selects and 
recommends, for the board's approval, the investment company's service 
providers, which may include sub-advisers, a principal underwriter, 
custodians, a transfer agent, and an audit firm. It is the adviser that 
has the authority to select and change the investment company's FCM. 
Although employees of the adviser cannot, in their capacity as advisory 
employees, solicit investors to invest in the investment company, this 
function is typically served by the investment company's principal 
underwriter, often an affiliate of the adviser.\31\ The adviser has a 
fiduciary duty to the registered investment company, and is required to 
act in the best interests of the company and its shareholders.\32\
---------------------------------------------------------------------------
    \31\ The principal underwriter is a registered broker-dealer. Its 
employees that engage in solicitation activities are registered 
representatives and hold appropriate licenses. As a result, an employee 
of the adviser that is also a registered representative of the 
principal underwriter can only engage in solicitation activities in his 
or her capacity as a registered representative, and not an advisory 
employee.
    \32\ See Sections 36(a) and 36(b) of the Investment Company Act.
---------------------------------------------------------------------------
    By contrast, an investment company's directors do not perform 
functions that should require them to register or be subject to 
regulation as CPOs.\33\ They serve an oversight role and are not 
responsible for the day-to-day management or operation of the 
investment company. The CFTC and its staff have recognized that 
registration of directors as CPOs may not be practicable or 
necessary.\34\ The directors do not solicit investors for the 
investment company. The board's role is to oversee the performance of 
the investment company's adviser and other service providers under 
their respective contracts and monitor potential conflicts of interest. 
Under the Investment Company Act, an investment company's board of 
directors must generally be comprised of a majority of ``independent'' 
directors. In order to be considered ``independent'' under the 
Investment Company Act, these directors generally may not have a 
significant business relationship with the fund's adviser, principal 
underwriter, or affiliates.\35\ As the Supreme Court has recognized, 
these independent directors are responsible for looking after the 
interests of the fund's shareholders and serve as ``independent 
watchdogs'' who ``furnish an independent check'' upon the management of 
the fund.\36\ While the directors have the authority to approve and 
terminate the investment company's agreement with its adviser, 
termination is a drastic step. Such an action is not only costly and 
disruptive, but also contrary to the investment company shareholders' 
express intention to invest with a particular manager. Requiring 
registration of directors would be fundamentally inconsistent with 
their oversight role; subjecting them to the requirements applicable to 
CPOs when they do not perform the functions of a CPO would be 
unnecessary and would not further investor protection.
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    \33\ See Letter from Dorothy A. Berry, Chair, IDC Governing 
Council, to David A. Stawick, Secretary, CFTC (Apr. 12, 2011).
    \34\ See, e.g., Commodity Pool Operators: Relief From Compliance 
With Certain Disclosure, Reporting and Recordkeeping Requirements for 
Registered CPOs of Commodity Pools Listed for Trading on a National 
Securities Exchange; CPO Registration Exemption for Certain Independent 
Directors or Trustees of These Commodity Pools, 75 Fed. Reg. 54794 
(Sept. 9, 2010) (proposing exemptive relief from CPO registration for 
directors of exchange traded commodity funds that were not registered 
investment companies) (``Commodity ETF Release''); CFTC Staff Letter 
No. 10-06 (March 29, 2010).
    \35\ An independent director also cannot own any stock of the 
investment adviser or certain related entities, such as parent 
companies or subsidiaries. See Section 2(a)(19) of the Investment 
Company Act.
    \36\ Burks v. Lasker, 441 U.S. 471, 484 (1979).
---------------------------------------------------------------------------
    We also believe that it is not appropriate for the registered 
investment company to register as CPO. The CFTC generally takes the 
position that a CPO and its pool must be separate legal entities.\37\ 
As noted above, a registered investment company has no employees and 
relies on its adviser for the day-to-day management of, and decisions 
regarding, the company. It is the registered investment adviser, not 
the investment company, which performs the functions that are key to 
being deemed a CPO and is responsible for the investment company's 
operations. It is appropriate, therefore, that the fund's adviser 
should register solely with respect to the funds it manages. This 
approach would be consistent with the CPO/pool model, in which it is 
the pool's operator that registers with the CFTC, not the pool itself.
---------------------------------------------------------------------------
    \37\ See Rule 4.20(a) under the Commodity Exchange Act.
---------------------------------------------------------------------------
    If you concur with our view that the adviser to a registered 
investment company is the entity that should register as CPO, only 
those registered investment companies or other pools managed by the 
adviser that are not eligible for exclusion under Rule 4.5 would become 
subject to CFTC regulation.\38\ In addition, if the CFTC deemed it 
appropriate, it could require an investment company adviser that must 
register as a CPO to amend its advisory agreement at its next annual 
contract renewal to state that the adviser will serve as the investment 
company's CPO and to notify investment company shareholders of this 
change in the investment company's next annual prospectus update.
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    \38\ We note that the CFTC has recognized that separate funds 
should be treated separately for purposes of determining whether the 
criteria for exclusion under the rule have been met. See, e.g., 1985 
Adopting Release, supra note 30, at II.B.
---------------------------------------------------------------------------
    The CPO registration process would provide the CFTC with additional 
information about the adviser, its principals, including any principals 
of the adviser that also serve as directors of investment companies 
managed by the adviser, and any associated person(s). An adviser 
registering as a CPO would include Form 8-Rs for its natural person 
principals and associated persons, including those investment company 
directors who are principals and/or associated persons of the adviser. 
The adviser also would submit, on behalf of those persons, a 
fingerprint card. We note that, under the Investment Company Act, all 
of the investment company's directors, including the independent 
directors, are subject to statutory disqualification provisions, which 
are similar to those under the Commodity Exchange Act.\39\
---------------------------------------------------------------------------
    \39\ See Section 9 of the Investment Company Act.
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    One of the adviser's executive officers would serve as the 
associated person of the CPO. We believe it is appropriate for an 
adviser CPO to have only one associated person for purposes of its CPO 
registration because, as discussed above, the adviser cannot solicit 
investors for the registered investment company. Instead, that function 
is performed by registered representatives of the registered investment 
company's principal underwriter, who hold Series 7 licenses.\40\ Rule 
3.12(a) under the Commodity Exchange Act generally requires that any 
person associated with a CPO be registered under the Commodity Exchange 
Act as an associated person, which typically requires passing the 
Series 3 examination. Rule 3.12(h)(1)(ii), however, provides that if 
the pool is offered by registered representatives that are associated 
with broker-dealers that are registered under the Securities Exchange 
Act of 1934, the registered representatives are exempt from the Series 
3 licensing requirement. The registered representatives of the fund's 
principal underwriter would rely on this exemption to sell the fund's 
shares. Because it is the fund's principal underwriter, and not the 
adviser, that offers and sells the fund's shares, we believe it would 
be appropriate for the associated person of the adviser to satisfy his 
or her licensing requirement by passing the Series 31 examination 
rather than the Series 3 examination, and plan to request such relief 
from the NFA.\41\
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    \40\ A Series 7 license is designed to ensure that the holder has 
an understanding of the concepts relating to solicitation, purchase, 
and/or sale of all securities products, including corporate securities, 
municipal securities, municipal fund securities, options, direct 
participation programs, investment company products, and variable 
contracts.
    \41\ We believe the Series 31 examination is better tailored to the 
adviser's limited activities in this regard than the Series 3 
examination, which requires knowledge of general commodity-related 
topics.
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B. Scope of the Trading Restrictions in the Rule 4.5 Proposal
    As indicated above, the overly broad nature of the Rule 4.5 
Proposal in its current form would implicate many registered investment 
companies beyond the ``futures-only'' funds referred to in the Release. 
This point is illustrated by preliminary data from several ICI member 
complexes, discussed below. In particular, the data suggest that many 
types of registered investment companies use swaps, futures, and 
options as a means to efficiently manage their portfolios, rather than 
as part of operating a commodity fund. As a result, we believe that the 
CFTC should revise the scope of the Rule 4.5 Proposal in a manner that 
acknowledges that registered investment companies' use of these 
instruments for non-speculative purposes does not raise the concerns 
that the Rule 4.5 Proposal is designed to address.
    We begin with a brief discussion of how registered investment 
companies use futures, options and swaps. Next, we present the member 
data described above. Finally, we offer several suggestions for how the 
CFTC might appropriately narrow the scope of the trading restrictions 
in the Rule 4.5 Proposal, including by: (1) eliminating or 
significantly narrowing the application of the proposed rule to swaps; 
(2) specifically referencing risk management as an element of ``bona 
fide hedging'' in the context of Rule 4.5; and (3) raising the 
threshold for the Non-Hedging Restriction.
1. Use of Commodity Futures, Commodity Options and Swaps by Registered 
        Investment Companies
    Registered investment companies use commodity futures, commodity 
options and swaps in a variety of ways to manage their investment 
portfolios, and many of these uses are unrelated to speculation \42\ or 
providing exposure to the commodity markets. Uses of these instruments 
include, for example, hedging positions, equitizing cash that cannot be 
immediately invested in direct equity holdings (such as if the stock 
market has already closed for the day), managing cash positions more 
generally, adjusting portfolio duration (e.g., seeking to maintain a 
stated duration of 7 years as a fund's fixed income securities age or 
mature), managing bond positions in general (e.g., in anticipation of 
expected changes in monetary policy or the Treasury's auction 
schedule), or managing the fund's portfolio in accordance with the 
investment objective stated in the fund's prospectus (e.g., an S&P 500 
index fund that tracks the S&P 500 using a ``sampling algorithm'' that 
relies in part on S&P 500 or other futures).
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    \42\ We use the term ``speculation'' to be consistent with the 
commodity industry's common understanding of the term. Registered 
investment companies, however, do not consider their investment 
strategies to be ``speculative;'' the substantive provisions of the 
Investment Company Act preclude their ability to engage in 
``speculative'' behavior (see, e.g., Section 18 of the Investment 
Company Act).
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    Swaps are a particularly useful portfolio management tool because 
they offer registered investment companies considerable flexibility in 
structuring their investment portfolios. We offer two examples to 
illustrate how a registered investment company might use swaps:

   Total return swaps provide an efficient means to gain 
        exposure (e.g., to particular indices, to foreign markets for 
        which there is no appropriate or liquid futures contract, to 
        foreign markets where local settlement of securities 
        transactions may be difficult and costly). A registered 
        investment company might use a total return swap based on a 
        broad market index in order to gain market exposure on cash 
        flows to the investment company until such cash flow is fully 
        invested. It is important that registered investment companies 
        be able to put cash flows ``to work'' immediately, for the 
        benefit of their shareholders.

   Interest rate swaps are commonly used by registered 
        investment companies that follow fixed income strategies. This 
        type of swap allows the investment company to adjust the 
        interest rate and yield curve exposures of the investment 
        company or to replicate a broadly diversified fixed income 
        strategy (which may be difficult to do solely through direct 
        purchases of bonds). For example, inflation protected funds are 
        now relatively common. To protect against inflation, these 
        strategies use Treasury inflation-protected securities 
        (``TIPS'') or an efficient substitute. Since the market for 
        TIPS is not especially deep, registered investment companies 
        may find it more efficient to achieve inflation protection 
        through interest rate swaps linked to the return on TIPS.

    The Commission has failed to justify its broad inclusion of all 
non-security based swaps in its proposal, despite the variety of ways 
investment companies may use these instruments, many of which are far 
afield of running a futures-only investment product. As previously 
discussed, a far more nuanced analysis of swaps usage by registered 
investment companies is necessary before this rule can proceed.
2. ICI Member Data Illustrates the Overly Broad Nature of the Rule 4.5 
        Proposal
    As indicated above, the broad language of the proposed conditions, 
together with the inclusion of swaps, would significantly expand the 
scope of the Commission's Rule 4.5 Proposal to an extent the CFTC may 
not have contemplated and well beyond the Commission's stated 
objective, which is to preclude the offering of ``futures-only 
investment products'' without CFTC oversight. The preliminary data 
outlined below serve to illustrate these points.
    Information provided by thirteen ICI member firms, which in total 
advise 2,111 registered investment companies (including SEC-registered 
open-end funds, closed-end funds (``CEFs''), and ETFs) whose assets 
total $2.9 trillion indicates that these member firms have 1,154 
separate funds that use or may use derivatives, of which an estimated 
485 funds potentially would be unable to meet the criteria for 
exclusion under proposed Rule 4.5 for various reasons (see Table 1).

 Table 1: Use of Derivatives by Investment Companies Managed by Selected
                           ICI Member Firms 1
------------------------------------------------------------------------

------------------------------------------------------------------------
Number of fund complexes providing information                        13
Total assets of open-end funds, CEFs, and ETFs managed by         $2,899
 these complexes ($ millions)
Number of open-end funds, CEFs, and ETFs managed by these          2,111
 complexes

  of which: 2

    Funds that use or invest in derivatives                        1,154

  of which:

   Funds that may be unable to rely on proposed Rule 4.5            485

  of which, funds that primarily: 1
    Pursue managed futures strategy                                   23
    Seek exposure to physical commodities or other                     6
     commodity-related strategies
    Are broad-based diversified funds                                190
    Are fixed-income funds or other funds using derivatives          160
     to meet investment objectives
    Use other strategies that could be implicated by                 102
     proposed Rule 4.5
------------------------------------------------------------------------
Source: ICI compilation of information provided by thirteen ICI member
  firms.

1 Includes registered investment companies that are open-end mutual
  funds, CEFs, and ETFs. All figures in the table refer exclusively to
  long-term funds. Funds of funds are included in the number of funds
  but are excluded from asset totals to avoid double counting total
  assets in these funds.
2 Total does not add to 485 because certain fund complexes felt that
  categorization was too uncertain in light of current lack of
  specificity in Proposed Rule 4.5.

    As Table 1 illustrates, of the 485 investment companies that may be 
unable to meet the criteria for exclusion under the Rule 4.5 Proposal 
for various reasons, only 29 investment companies seek returns 
primarily based on a managed futures strategy or by providing exposure 
to physical commodities or other commodity-related strategies. By 
contrast, 190 investment companies are broad-based diversified funds, 
such as index funds, asset allocation funds, target date funds, 
inflation-protected funds, or other funds that have exposure to 
physical commodities as a non-primary component in a broad-based 
investment strategy. Another 160 of the 485 investment companies are 
fixed-income or other funds that use financial futures or swaps to help 
achieve their investment objectives. The remaining 102 investment 
companies follow other strategies that could be implicated by the 
proposed rule.
    Our members' estimate of 485 investment companies in these 13 
complexes that could potentially be implicated by the proposed rule is 
based on a fair degree of uncertainty. As noted, the proposed rule at 
present lacks critical details, such as precisely how swaps will be 
treated, whether foreign exchange forwards and foreign exchange swaps 
will be included, and others. Our member firms have thus made a good-
faith effort to interpret how the proposed rule may affect the 
investment companies they advise. The total number of affected 
investment companies, however, could be either considerably higher or 
lower depending on the rule's final provisions. In addition, these 
estimates are only for the thirteen member firms that provided 
information. There are an additional 248 member complexes that either 
were not asked to provide information or were unable to provide 
information given the uncertainty inherent in the Rule 4.5 Proposal, 
including a few of the very largest complexes. Thus, the estimates in 
Table 1 should not be taken as an upper bound on the likely number of 
investment companies that could be affected by the Rule 4.5 Proposal, 
and likely understate the number of entities that could be subject to 
dual registration and regulation by the SEC and CFTC under the Rule 4.5 
Proposal. Nonetheless, the data clearly suggest that the rule, at least 
as proposed, would likely affect a large number and variety of 
investment companies, the vast majority of which pursue strategies 
outside the CFTC's intended reach, as stated in the Release.
3. Suggestions for Narrowing the Scope of the Trading Restrictions in 
        the Rule 4.5 Proposal
    The Rule 4.5 Proposal incorporates the trading restrictions from 
the NFA petition with the addition, as discussed above, of swaps. 
Specifically, a registered investment company would be required to 
represent, in its notice of eligibility for the exclusion, that it will 
use commodity futures, commodity options or swaps solely for ``bona 
fide hedging purposes.'' It may, however, represent that it will hold 
certain instruments not for bona fide hedging purposes, generally 
subject to representations that the aggregate initial margin and 
premiums required to establish those positions will not exceed five 
percent of the liquidation value of the fund's portfolio (the ``Non-
Hedging Restriction''). We are concerned that the Non-Hedging 
Restriction, especially as it would apply to swaps, futures, and 
options used for non-speculative purposes, would result in a large 
number of registered investment companies being unable to rely on 
amended Rule 4.5 and becoming subject to registration with, and 
regulation by, all of the SEC, the CFTC and NFA. We thus offer several 
suggestions for how the CFTC might appropriately narrow the scope of 
these proposed restrictions.
(a) The Non-Hedging Restriction Should Not Apply to Swaps, or Its 
        Application Should be Significantly Narrowed
    Based on data and other information obtained from many of our 
member firms, we have concluded that a wholesale inclusion of swaps in 
the Rule 4.5 Proposal could result in advisers to a large number of 
registered investment companies being unable to rely on the rule's 
exclusion, burdening the CFTC and NFA with a large number of additional 
registrants--entities already subject to comprehensive SEC regulation--
at a time when CFTC resources are severely constrained.\43\ Advisers to 
these investment companies would become subject to CFTC and NFA 
regulation, even if the investment company's uses of swaps would not 
raise the concerns that CPO regulation is designed to address.
---------------------------------------------------------------------------
    \43\ See, e.g., Gensler Remarks, supra note 16.
---------------------------------------------------------------------------
    The Commission also has not provided any analysis that would 
establish a basis for a wholesale inclusion of swaps in the Rule 4.5 
Proposal, and the Proposal's consequent broad reach. While we 
acknowledge the CFTC's jurisdiction over swaps as a result of the Dodd-
Frank Act, we believe its expanded jurisdiction does not relieve the 
agency of the obligation to provide a clear rationale as to why users 
of swaps need to be registered and to examine whether particular uses 
of swaps raise the concerns that the Rule 4.5 Proposal is intended to 
address. If the Commission does not eliminate or narrow the application 
of the Rule 4.5 Proposal to swaps, as we suggest below, we are 
concerned that some registered investment companies may choose to limit 
their use of swaps in order to avoid this second layer of regulation, 
with potential adverse effects on liquidity of the swaps markets.\44\
---------------------------------------------------------------------------
    \44\ See, e.g., Garrett Letter, supra note 11 (``. . . in none of 
the relevant notices of proposed rulemakings is there any discussion of 
the impact on liquidity.''); October Letter at n. 5 (stating that 
``should the CFTC decide to move forward with a rulemaking to amend 
Rule 4.5, we would urge the agency to consider carefully the effect 
that its proposed changes would have on market liquidity.''). The 
Commission's lack of discussion in the Release regarding the potential 
effects of the Rule 4.5 Proposal on liquidity contrasts with its focus 
on this issue in 2003 when it amended the rule to eliminate the trading 
restrictions, in significant part because of concerns about the effects 
they could have on market liquidity. See 2003 Adopting Release, supra 
note 7.
---------------------------------------------------------------------------
    For these reasons, we respectfully urge the Commission to 
eliminate, or at least narrow significantly, the application of the 
Non-Hedging Restriction to swaps.\45\ We believe such a result would be 
consistent with the fact that many registered investment companies use 
swaps for a variety of purposes in connection with the efficient 
management of their investment portfolios. Further, the use of swaps 
for these purposes is unrelated to the Commission's stated objective, 
which is to preclude the offering of ``futures-only investment 
products'' without CFTC oversight.
---------------------------------------------------------------------------
    \45\ The CFTC could do so, for example, by excluding swaps that 
provide exposure to the securities markets--markets over which the CFTC 
has no jurisdiction--or interest rate swaps.
---------------------------------------------------------------------------
(b) The Commission Should Specifically Reference Risk Management as an 
        Element of ``Bona Fide Hedging'' in the Context of Rule 4.5
    We recommend that the Commission specifically reference, in any 
amendments to Rule 4.5 that include a ``bona fide hedging'' test, risk 
management transactions that would encompass contemporary uses of 
swaps, futures, and options by investment company advisers, on behalf 
of their funds, for non-speculative purposes. The CFTC has explicitly 
recognized that hedging includes the concept of risk management and 
distinguished it from speculative trading. Specifically, in a 1987 
agency interpretation (``1987 Interpretation''), the Commission 
provided for risk management exemptions for commodity exchanges from 
speculative position limit rules.\46\ In the 1987 Interpretation, the 
CFTC discussed different non-speculative derivatives trading 
strategies, many of which are used by investment companies.\47\ More 
recently, the CFTC has applied the concept of risk management in 
proposing an exception from the mandatory clearing requirement for 
swaps subject to conditions including, among others, that the entity be 
using the swap to hedge or mitigate against commercial risk.\48\
---------------------------------------------------------------------------
    \46\ See, Risk Management Exemptions From Speculative Position 
Limits Approved Under Commission Regulation 1.61, 52 Fed. Reg. 34633 
(Sept. 14, 1987) (agency interpretation providing for risk-management 
exemptions, in addition to current exemptions for hedging, from 
speculative position limit rules of exchanges); see also Report of the 
Financial Products Advisory Committee of the Commodity Futures Trading 
Commission, The Hedging Definition and the Use of Financial Futures and 
Options: Problems and Recommendations for Reform (June 15, 1987) 
(``Committee Report'') (Committee's recommendations included, among 
others, revising Rule 1.61 and issuing guidelines that permit exchanges 
to exempt from speculative position limits transactions or positions 
taken for risk-management purposes, revising Rule 1.3 to include a 
definition of risk management, and revising Rule 4.5 to provide an 
exclusion from CPO regulation for otherwise-regulated entities that use 
futures and options for risk-management purposes).
    \47\ While the 1987 Interpretation specifically did not address 
Rule 4.5, it appears that may have been because the Committee Report 
included separate, specific recommendations related to Rule 4.5 and 
Rule 1.3(z). See 1987 Interpretation, supra note 46 at n. 3; Committee 
Report, supra note 46 (recommending revising Rule 1.3(z) to include a 
definition of risk management and revising Rule 4.5 to provide an 
exclusion from CPO regulation for otherwise-regulated entities which 
use futures and options for risk-management purposes).
    \48\ See, End-User Exception to Mandatory Clearing of Swaps, 75 
Fed. Reg. 246 (Dec. 23, 2010) (CFTC proposal for elective exception 
from mandatory clearing requirement for swaps subject to conditions 
including, among others, that the entity be using the swap to hedge or 
mitigate against commercial risk) (``Swaps Proposal'').
---------------------------------------------------------------------------
    We therefore request that the Commission state specifically that 
risk management will be considered as part of the bona fide hedging 
test (or as an additional category) in connection with any amendments 
to Rule 4.5. This would include transactions or positions taken by a 
registered investment company in futures contracts, options contracts, 
or swaps if used for the following purposes:

   As alternatives or temporary substitutes for ``cash market'' 
        positions;

   To mitigate or offset changes in the value of ``cash 
        market'' positions owned by the investment company or non-
        derivative liabilities of the investment company;

   To facilitate the investment company's management of its 
        cash and/or reserves;

   To adjust an investment company's duration; or

   To efficiently adjust a fund's exposure to one or more asset 
        allocation categories.

Such a Commission statement would be consistent with current and prior 
positions of the CFTC.\49\ Use of futures, options, or swaps in these 
and other ways that allow investment company advisers to manage the 
risks in their investment portfolios does not present the higher risks 
to commodity markets and investors that may be raised by speculation, 
and should not be subject to the Non-Hedging Restriction.
---------------------------------------------------------------------------
    \49\ See, e.g., id.; 1987 Interpretation, supra note 46; Committee 
Report, supra note 46.
---------------------------------------------------------------------------
(c) The Threshold for the Non-Hedging Restriction Should be Raised
    The threshold for the Non-Hedging Restriction is proposed to be 
five percent, the same threshold that was included in Rule 4.5 prior to 
its amendment in 2003. We note, however, that current margin levels for 
a number of derivative instruments in which registered investment 
companies invest now exceed five percent of contract value. Almost a 
decade ago, the CFTC acknowledged that margin levels for certain stock 
index futures significantly exceeded five percent of contract value and 
that margin levels for security futures contracts were 20 percent of 
contract value, which had the effect of limiting their use for non-
hedging purposes as compared to instruments subject to lower margin 
requirements.\50\ These concerns remain valid today, and would be 
exacerbated by applying the Non-Hedging Restriction to swaps, as 
contemplated by the Rule 4.5 Proposal.
---------------------------------------------------------------------------
    \50\ See 2003 Proposing Release, supra note 7. These concerns were 
made moot by the CFTC's adoption of amendments to Rule 4.5 that 
eliminated the Non-Hedging Restriction. See 2003 Adopting Release, 
supra note 7.
---------------------------------------------------------------------------
    In the Release, the CFTC requests comment on whether a higher 
threshold is appropriate. We believe it is, although due to the current 
high level of uncertainty regarding the regulatory treatment of swaps 
and the margin levels to which they will be subject, we are unable to 
recommend what that higher threshold should be. If the threshold for 
the Non-Hedging Restriction is not raised to reflect the realities of 
the financial markets in which registered investment companies invest, 
the result could be that investment companies may alter their 
investment strategies specifically to avoid exceeding the Non-Hedging 
Restriction, which would not be in the best interests of investors. We 
stress that a full analysis of the correct threshold for the Non-
Hedging Restriction should be undertaken only after further opportunity 
for public comment, following resolution of the regulatory issues 
regarding the status of swaps, foreign exchange swaps, and foreign 
exchange forwards.
C. Registered Investment Companies Should Continue To Be Permitted To 
        Use a Wholly Owned Subsidiary Structure
    The Rule 4.5 Proposal would require that any positions in swaps, 
commodity futures or commodity option contracts for non-hedging 
purposes would need to be held ``by a qualifying entity only.'' This 
language was added by the NFA Petition and was not included in Rule 4.5 
as it existed prior to 2003. The language is apparently directed at 
investment companies' use of wholly-owned subsidiaries to engage in a 
limited amount of swaps, commodity futures, and commodity options 
trading (i.e., no more than 25% of an investment company's investment 
portfolio, as disclosed in its registration statement and as 
specifically permitted by the Internal Revenue Service (``IRS'')) and 
would effectively preclude a registered investment company from using 
the subsidiary structure.
    We emphasize, as we did in the October Letter, that this subsidiary 
structure is used by registered investment companies for tax purposes 
and not to evade regulation under the Investment Company Act, which is 
focused on protecting investors. Under Subchapter M of the Internal 
Revenue Code of 1986, as amended, each registered investment company is 
required to realize at least 90 percent of its annual gross income from 
investment-related sources, which is referred to as ``qualifying 
income.'' \51\ Direct investments by a registered investment company in 
commodity-related instruments generally do not, under IRS published 
rulings, produce qualifying income. As a result, certain registered 
investment companies sought and received private letter rulings from 
the IRS that income from a wholly owned subsidiary that invests in 
commodity and financial futures and options contracts, swaps on 
commodities or commodity indexes and commodity-linked notes, fixed-
income securities serving as collateral for the contracts and 
potentially cash-settled non-deliverable forward contracts constitutes 
qualifying income.
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    \51\ Income from investment-related sources includes income 
specifically from dividends, interest, proceeds from securities 
lending, gains from the sales of stocks, securities and foreign 
currencies, or from other income (including, but not limited to, gains 
from options, futures, or forward contracts) derived with respect to 
its business of investing in such stock, securities, or currencies, or 
income from certain types of publicly traded partnerships.
---------------------------------------------------------------------------
    If the CFTC has any remaining regulatory concerns about the 
operations of these subsidiaries, we believe these concerns could be 
addressed effectively through representations made by the investment 
company's adviser that it would make the books and records of the 
fund's subsidiary available to the CFTC and NFA staff for inspection 
upon request and provide transparency about fees, if any, charged by 
the subsidiary. We strongly recommend that the CFTC make explicit in 
any re-proposal that use of the subsidiary structure as described above 
would continue to be permitted.
D. Restriction on Marketing
    In addition to the Non-Hedging Restriction, the Rule 4.5 Proposal 
would require that an investment company seeking to rely on the Rule 
4.5 exclusion represent that it will not be, and has not been, 
marketing participations in the fund to the public as or in a commodity 
pool or otherwise as or in a vehicle for trading in (or otherwise 
seeking investment exposure to) the commodity futures, commodity 
options, or swaps markets (the ``Marketing Restriction'') (emphasis 
added). The italicized language was not part of the Marketing 
Restriction in Rule 4.5 prior to 2003 but was introduced in the NFA 
petition. The CFTC fails to explain why it believes this language is 
necessary or to give any indication as to its intended scope, despite 
concerns raised by ICI and other commenters in response to the CFTC's 
earlier publication of the NFA's rulemaking petition. The NFA petition 
similarly failed to address these issues.
    As discussed in our October Letter, ICI and its members are very 
concerned that this new language could be interpreted broadly, even 
applying to registered investment companies whose investment portfolios 
(whether directly or indirectly through a so-called ``fund-of-funds'' 
structure) have only a modest exposure to commodity futures, commodity 
options, and swaps.\52\ The proposed language is also broad enough that 
it could apply to an investment company's use of commodity futures, 
options, or swaps for bona fide hedging purposes or within the Non-
Hedging Restriction, thereby rendering the trading exceptions within 
the Rule 4.5 Proposal effectively moot. The language even appears broad 
enough to capture registered investment companies that invest only in 
securities and not commodities--entities clearly outside the CFTC's 
jurisdiction--such as sector investment companies that invest in 
securities of oil or mining companies, or other registered investment 
companies that obtain commodity exposure through investments in 
securities. Clearly, investments in these securities products cannot 
result in CFTC registration. Finally, as drafted, the Marketing 
Restriction could be triggered by basic disclosures in prospectuses and 
marketing materials concerning the range of investments the investment 
company may be entitled to make. We outline below several 
recommendations intended to address these concerns.
---------------------------------------------------------------------------
    \52\ Many investment company complexes sponsor funds-of-funds for 
retail investors. These funds-of-funds are in many cases intended to 
provide retail investors with broad asset class diversification in a 
single investment vehicle. As part of that diversification goal, funds-
of-funds often invest a portion of their assets in other investment 
companies whose portfolios may include investments in non-traditional 
asset classes such as commodities and commodity-related products.
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1. The Reference to ``Otherwise Seeking Investment Exposure'' Should Be 
        Deleted
    We strongly recommend that the CFTC eliminate from the Marketing 
Restriction the ``otherwise seeking investment exposure'' language. We 
believe that this change would appropriately capture those registered 
investment companies about which the CFTC may have concerns--funds that 
are effectively holding themselves out as commodity pools. Adding the 
investment exposure language only creates ambiguity and would result in 
a significant number of registered investment companies that do not 
provide meaningful commodity exposure being unable to satisfy the 
exclusion and becoming subject to CFTC and NFA regulation, which 
neither serves the interests of the regulators nor those of investors.
2. Two Tier Registration System
    We recommend that advisers to registered investment companies that 
do not market themselves as commodity pools, according to the revised 
criteria we suggest above, but hold positions in commodity interests 
that exceed the threshold under the Non-Hedging Restriction (as we 
suggest it be amended) be, at most, required to register as CPOs, but 
not otherwise be subject to the requirements applicable to CPOs under 
Part 4 of the CFTC's rules. These investment companies, which may 
include, among others, fixed-income funds, index funds, inflation-
protected funds, asset allocation funds and balanced funds, do not 
raise the concerns the CFTC seeks to address in its Proposal. 
Registration of the investment adviser as a CPO would require 
membership with the NFA, and subject the adviser to examination by the 
NFA.\53\ We do not believe it is appropriate to additionally subject 
the advisers to these registered investment companies, which are 
already subject to comprehensive regulation under the Federal 
securities laws and rules, to the CFTC's Part 4 requirements, which are 
designed for CPOs that market their commingled vehicles as commodity 
pools or provide significant commodity interest exposure.
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    \53\ Please see our analysis above, at Section III.A., regarding 
CPO registration of the investment adviser.
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    Because registered investment companies are subject to extensive 
public disclosure and reporting requirements, the CFTC would have 
access to comprehensive and detailed information about, among other 
things, an investment company's risks, holdings, fees, performance 
information, financial information, and service providers, as well as 
detailed information about the investment company's adviser, all 
without applying the CFTC's Part 4 requirements.\54\ Furthermore, the 
SEC has proposed amendments to Form ADV that would expand even further 
the information that is required by the form, including disclosure 
about whether an adviser provides advice with respect to futures 
contracts, forward contracts, or various types of swaps.\55\ We also 
note that the CFTC would have antifraud and inspection authority over 
an adviser that is deemed to be a CPO even without registration. 
Imposing additional regulatory requirements on the advisers to these 
registered investment companies would not provide meaningful additional 
information to investors and, because of the inconsistent and 
duplicative information requirements of the two regulatory regimes, 
could instead cause confusion.
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    \54\ Please see the examples of fund disclosure and reporting 
requirements described in Appendix A to this letter. In addition, Part 
1A of Form ADV, the registration form for investment advisers, provides 
detailed information about the investment adviser and its business, 
including information about the types of clients it has, its advisory 
services, potential conflicts of interest, custody of client assets, 
any disciplinary history, its owners and executive officers, and 
information about certain service providers.
    \55\ See, Rules Implementing Amendments to the Investment Advisers 
Act of 1940, Investment Advisers Act Release No. 3110 (Nov. 19. 2010).
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3. Need for Clear Guidance
    We are aware that others are exploring approaches to the Marketing 
Restriction that would require registered investment companies to 
consider a variety of factors, such as how the investment company holds 
itself out to the public/its representations in materials provided to 
investors; the composition of the investment company's assets; the 
activities of its officers and employees; its historical development; 
and perhaps other factors, to determine whether the investment 
company's adviser should register as a CPO. If the CFTC determines to 
adopt this or a similar test, we believe it is absolutely critical that 
the agency provide clear guidance articulating what the relevant 
factors are, how they will be weighted, and how the agency expects 
industry participants to apply them. Certainty will be essential to the 
usefulness of any such test, both to the industry and to 
regulators.\56\ It is also critical that the public has an opportunity 
to comment on any test that the CFTC determines to propose.\57\
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    \56\ We also note that, to the extent applicability of the test is 
unclear, advisers that do not register as CPOs based on a good faith 
application of the enumerated factors nevertheless could be subject to 
the hindsight analysis used in some private lawsuits claiming that, in 
fact, the adviser should have registered.
    \57\ See, Kooritzky, supra note 15, at 1513; Shell Oil, supra note 
15, at 751.
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4. Other Clarifications
    Finally, we respectfully request that the CFTC clarify certain 
aspects of the Marketing Restriction. We specifically request 
clarification that the Marketing Restriction would not preclude 
registered investment companies from including in their registration 
statements (including prospectuses and statements of additional 
information), as well as in marketing materials, basic disclosure 
concerning the range of investments the investment company may be 
entitled to make as well as risk disclosures that may mention 
investment in commodity futures, commodity options, and swaps. Our 
requested clarification is consistent with the CFTC's past 
interpretations of the marketing restriction.\58\ We further request 
clarification that the Marketing Restriction would not preclude 
disclosures concerning the range of investments or risks of a fund of 
funds relating to its investments in underlying funds which may include 
limited commodity exposure, when those investments are made as part of 
an Investment Company Act-registered investment product, such as a 
target date or asset allocation fund.
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    \58\ The CFTC has previously stated that it will allow, within the 
Marketing Restriction, ``any promotional material required by and 
consistent with the policies of a qualifying entity's other Federal or 
state regulator,'' as well as permit ``a [registered investment 
company] to describe accurately in its sales literature the limited use 
of its commodity interest trading and how it believes that use will be 
beneficial.'' See 1985 Adopting Release, supra note 30, at C.3.
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IV. Registered Investment Companies Should Not Be Subject to 
        Overlapping and Conflicting Regulatory Requirements
    As noted above, investment companies are already extensively 
regulated under the Investment Company Act and other Federal securities 
laws. The protections afforded under the securities laws include, among 
others: limits on the use of leverage; antifraud provisions; 
comprehensive disclosure to investors, including with regard to fees 
and expenses, the investment objectives and strategies of the 
investment company, and the risks of investing in the investment 
company; oversight by an independent board of directors, particularly 
with regard to potential conflicts of interest; restrictions on 
transactions with affiliates; and requirements regarding custody of the 
investment company's assets. As we discuss above, we believe strongly 
that the Rule 4.5 Proposal is overbroad and would subject registered 
investment company advisers to CPO regulation in cases where a second 
layer of regulation is not necessary.
    Even if the trading and marketing restrictions in the Rule 4.5 
Proposal are appropriately scaled back, there are likely to be cases in 
which advisers to registered investment companies would be unable to 
rely on the amended rule and may have to comply with Part 4 of the 
CFTC's rules. For this reason, we believe it is critical that the CFTC 
work closely with the SEC before amending Rule 4.5 in order to 
reconcile the many conflicting and duplicative CFTC and SEC regulations 
to which these investment companies and their advisers would be 
subject. The harmonized regulations then should be re-proposed for 
public comment.
A. Reconciliation of Duplicative or Conflicting Regulatory Requirements
    Registered investment companies are subject to extensive disclosure 
and reporting requirements. Many of these are very similar to the 
requirements to which CPOs are subject, including the requirement to 
deliver disclosure documents to shareholders/participants in connection 
with offers and sales to investors, and requirements to provide 
periodic reports to shareholders/ participants, as well as reports to 
regulators. We believe that, in those areas where SEC and CFTC 
requirements are similar, requiring registered investment companies to 
comply with both sets of regulatory requirements would be burdensome 
and costly, as well as potentially confusing to investors; these 
largely duplicative requirements also would not provide meaningful 
improvement in the regulatory protections provided. Therefore, we 
recommend that, as to those matters, the relevant SEC provisions should 
apply. It is more efficient for registered investment companies to 
comply with provisions to which they are currently subject, and to 
which the other registered investment companies in their complexes 
would be subject. Those provisions, based on the similarities to the 
CFTC's requirements, would appear to satisfy the CFTC's regulatory 
interest.
    In other areas, the requirements under the Investment Company Act 
and the Commodity Exchange Act are wholly inconsistent and would 
require reconciliation or further guidance from the SEC and CFTC before 
an adviser to a registered investment company could comply. While the 
Commission requests comment in the Release regarding ``how these 
[conflicts] could be addressed by the two Commissions,'' \59\ it 
provides no guidance on how that might be accomplished. In order to 
meet the notice and comment requirements of the APA, we strongly 
believe the agency must re-propose the rule to include a detailed 
proposal for how conflicting or inconsistent requirements will be 
reconciled, or detailed discussion regarding the guidance it proposes 
to provide.\60\
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    \59\ See Release, supra note 2, at 7984.
    \60\ See, Kooritzky, supra note 15; Shell Oil, supra note 15.
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    We have compared the SEC and CFTC requirements that would be 
applicable to CPOs of registered investment companies subject to Part 4 
of the CFTC's regulations in Appendix A to this letter. In addition, we 
discuss below several areas in which we specifically request relief 
from the CFTC.
B. Areas in Which CFTC Relief is Necessary
1. Disclosure Document Delivery and Acknowledgment
    The disclosure document delivery and acknowledgment requirements 
applicable to commodity pools differ from the prospectus delivery 
requirements applicable to registered investment companies. 
Specifically, Rule 4.21(a) under the Commodity Exchange Act requires 
that a CPO deliver a disclosure document to a prospective pool 
participant ``by no later than the time it delivers to the prospective 
participant a subscription agreement for the pool,'' and Rule 4.21(b) 
states that the CPO may not accept money from a prospective pool 
participant unless the CPO first receives from the prospective 
participant a signed and dated acknowledgement stating that the 
participant received the disclosure document describing the pool that 
is required under the Commodity Exchange Act (the ``Disclosure 
Document'').\61\ Registered investment companies are required to 
deliver a prospectus to prospective investors no later than when a 
transaction confirmation is delivered.\62\ Delivery or use of a 
subscription agreement is not required for a registered investment 
company, nor is receipt of a signed and dated acknowledgement.
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    \61\ See Rules 4.21 and 4.24 under the Commodity Exchange Act.
    \62\ See Section 5 of the Securities Act of 1933 (``1933 Act'') and 
Rule 10b-10 under the Securities Exchange Act of 1934.
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    The CFTC has recognized that the prospectus delivery requirements 
under the Federal securities laws differ from CFTC regulations ``with 
respect to timing and other aspects.'' \63\ The CFTC has proposed, and 
its staff has granted, relief from the disclosure document delivery and 
acknowledgement requirement of Rule 4.21 for commodity exchange traded 
funds (``commodity ETFs''). As the CFTC has acknowledged for CPOs of 
commodity ETFs, ``simultaneous compliance with both sets of 
requirements [is] unnecessarily cumbersome, and would needlessly 
interfere with the established procedures for conducting a registered 
public offering of shares . . .'' \64\ The same would be true for 
registered investment companies and their advisers. The compliance 
difficulties are equally challenging regardless of whether a pool is 
listing its shares on an exchange or otherwise offering them publicly. 
We therefore request relief, on behalf of our members that could be 
subject to the Part 4 regulations, from the Disclosure Document 
delivery requirement of Rule 4.21(a) and from the signed 
acknowledgement requirement of Rule 4.21(b) similar to that which the 
CFTC recently proposed for commodity ETFs.\65\ In addition, we request 
relief from the requirements in Rule 4.26(d)(1) and (2) under the 
Commodity Exchange Act, which require a CPO to file the Disclosure 
Document and amendments with the NFA prior to use. In particular, the 
registered investment company's CPO would satisfy conditions analogous 
to those proposed for CPOs of commodity ETFs, including: \66\
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    \63\ See Commodity ETF Release, supra note 34.
    \64\ Id. at 54795.
    \65\ Because we are requesting relief based on conditions that the 
CFTC has proposed but not yet adopted, we request the opportunity here 
and below to revisit the conditions to the relief if the CFTC 
subsequently adopts different conditions for commodity ETFs.
    \66\ Proposed Rule 4.12(c)(2)(i)(A)-(D). Commodity ETF Release, 
supra note 34, at 54800.

   Causing the investment company's prospectus and statement of 
        information (``SAI'') to be readily accessible on an Internet 
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        website maintained by the adviser;

   Causing the investment company's prospectus and SAI to be 
        kept current; \67\
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    \67\ We would cause the investment company's prospectus and SAI to 
be kept current in accordance with the requirements of the Federal 
securities laws, rather than the rules under the Commodity Exchange 
Act. Please see our request for relief below.

   Informing prospective investment company investors of the 
        Internet address of the website and directing any broker, 
        dealer or other selling agent to whom the investment company's 
        principal underwriter sells shares of the investment company to 
---------------------------------------------------------------------------
        so inform prospective investors;

   Complying with all other requirements applicable to pool 
        Disclosure Documents under Part 4 of the CFTC's regulations 
        except (1) those with which the investment company should be 
        deemed to already satisfy (as described in Appendix A), and (2) 
        those with which the investment company would be unable to 
        comply (absent the CFTC's reconciliation of conflicting CFTC 
        and SEC regulations or obtaining relief as requested in this 
        letter).
2. Updating of Prospectus and SAI
    CPOs are required by the rules under the Commodity Exchange Act to 
update a commodity pool's Disclosure Document every 9 months.\68\ 
Registered investment companies, however, are permitted under the 
Federal securities laws to update their registration statements 
(including their prospectuses and SAIs) annually.\69\ Requiring 
registered investment companies to update their prospectuses every 9 
months would increase costs for registered investment companies whose 
advisers do not qualify for exclusion under Rule 4.5. Because the 
registered investment company's audited financial statements would not 
be completed when the 9 month update was due, the fund would be 
required to file supplemental/post-effective amendments with the SEC to 
add the audited financial statements. Such a requirement would also 
place those investment companies managed by an adviser subject to Part 
4 of the CFTC regulations on a different updating cycle than other 
investment companies managed by the adviser, which would be costly and 
inefficient. We therefore request that investment companies be 
permitted to satisfy the Federal securities law standard for updating, 
rather than being required to update every 9 months.\70\ We do not 
believe that requiring that prospectuses be updated more frequently 
would materially increase protections for investors, but would increase 
costs to them.
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    \68\ Rule 4.26(a)(2) under the Commodity Exchange Act provides that 
``[n]o commodity pool operator may use a Disclosure Document . . . 
dated more than 9 months prior to the date of its use.''
    \69\ Section 10(a)(3) of the 1933 Act states that ``when a 
Prospectus is used more than 9 months after the effective date of its 
registration statement, the information contained therein shall be as 
of a date not more than sixteen months prior to such use . . .''
    \70\ See, Appendix A. In addition, we request relief, above, from 
the requirement in Rule 4.26(d)(2) under the Commodity Exchange Act to 
file amendments to the Disclosure Document with the NFA.
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3. Shareholder/Participant Reporting Requirements
    The rules under the Commodity Exchange Act and the Investment 
Company Act impose similar obligations as regards periodic reports to 
be delivered to participants and shareholders, respectively. Both the 
SEC and the CFTC require the delivery of annual reports to shareholders 
containing audited financial statements.\71\ The SEC also requires the 
delivery of semi-annual reports to shareholders containing unaudited 
financial statements.\72\ The CFTC, however, requires that CPOs of 
pools with net assets of more than $500,000 at the beginning of the 
pool's fiscal year deliver to pool participants a monthly Account 
Statement that includes an unaudited Statement of Operations and a 
Statement of Net Assets.\73\ Complying with the monthly reporting 
requirement would be unduly burdensome and costly for the CPO to a 
registered investment company because registered investment companies 
are not currently required to create monthly reports, most registered 
investment companies redeem their shares on a daily basis, and shares 
are often held in book-entry form.\74\
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    \71\ See Rule 30e-1 under the Investment Company Act and Rule 
4.21(c) under the Commodity Exchange Act.
    \72\ See Rule 30e-1 under the Investment Company Act.
    \73\ See Rule 4.22(a) under the Commodity Exchange Act. Also see 
Appendix A for a detailed comparison of the reporting requirements.
    \74\ Most registered investment companies would meet the rule's 
$500,000 threshold.
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    Accordingly, we request that investment companies that satisfy the 
periodic reporting requirements under the Investment Company Act be 
granted relief from the monthly Account Statement requirements under 
the Commodity Exchange Act.\75\ Requiring registered investment 
companies to create monthly reports only for those funds that would be 
subject to Part 4 of the CFTC's regulations would be very costly and 
burdensome. We believe that the semi-annual reporting requirements 
under the Investment Company Act provide comparable protections to 
investment company shareholders. We further note that rules under the 
Investment Company Act require a registered investment company to file 
a quarterly report 60 days after the close of the first and third 
quarters that contains a schedule of investments and other 
disclosures.\76\ This report is publicly available to investors.
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    \75\ We note that the CFTC has proposed, and its staff has granted, 
relief from the Account Statement delivery requirement for commodity 
ETFs. See Commodity ETF Release, supra note 34.
    \76\ See Rule 30b1-5 under the Investment Company Act.
---------------------------------------------------------------------------
    We agree that the relief would be subject to conditions analogous 
to those proposed for CPOs of commodity ETFs, including: \77\
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    \77\ See Rule 4.23 under the Commodity Exchange Act.

   Keeping the annual and semi-annual reports sent to 
        shareholders readily accessible on the adviser's website for a 
        period of 30 days following the date they are first posted on 
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        the website;

   Indicating in the investment company's prospectus or SAI 
        that the company's annual and semi-annual reports will be 
        readily accessible on the adviser's website; and

   Including in the prospectus or SAI the Internet address 
        where the investment company's annual and semi-annual reports 
        are available.
4. Books and Records
    CFTC rules require that a CPO maintain required pool books and 
records at its main business address.\78\ Rules under the Investment 
Company Act, by contrast, generally require that the books and records 
of a registered investment company be preserved for specified periods 
of time, with more recent books and records typically preserved in an 
``easily accessible place.'' \79\ These rules also permit a registered 
investment company to have a third party maintain the books and records 
on its behalf, if the investment company and the third party enter into 
a written agreement specifying that the records are the property of the 
registered investment company and stating that such records will be 
surrendered promptly on request.\80\ An investment adviser is also 
required to specify on its Form ADV each entity that maintains its 
books and records, including the location of the entity, and a 
description of the books and records maintained at that location.\81\ 
It would be burdensome and inefficient for CPOs to registered 
investment companies to develop different procedures and systems to 
maintain solely those books and records relating to their commodity 
trading.
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    \78\ See Rule 4.23 under the Commodity Exchange Act.
    \79\ See Rule 31a-2 under the Investment Company Act.
    \80\ See Rule 31a-3 under the Investment Company Act.
    \81\ See Item 1(K) of Form ADV and Section 1.K. of Schedule D of 
Form ADV.
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    We therefore request relief from Rule 4.23 on behalf of our members 
to permit a registered investment company's CPO to maintain the CPO's 
books and records required by the Commodity Exchange Act with 
professional service providers as permitted by the Investment Company 
Act. We note that the CFTC has proposed, and its staff has granted, 
similar exemptive relief permitting CPOs to commodity ETFs to keep 
books and records with certain professional service providers, rather 
than at the CPO's main business address.\82\ We believe compliance with 
the SEC books and records requirements would be fully consistent with 
investor protection, and would provide the CFTC with any information it 
may want about entities that maintain an investment adviser CPO's books 
and records, as those entities will be identified (and the books and 
records they maintain described) on the adviser's Form ADV.
---------------------------------------------------------------------------
    \82\ See Commodity ETF Release, supra note 34, at 54796. We note 
that professional services providers commonly used by registered 
investment companies are not limited to those the CFTC has included in 
its proposed exemptive relief (i.e., the pool's administrator, its 
distributor, or a bank or registered broker or dealer that is providing 
services to the CPO or the pool similar to those provided by an 
administrator or distributor), and may also include professional 
records maintenance and storage companies.
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5. Adviser CPOs Should Be Able to Provide SEC-Required Risk Disclosures 
        to Satisfy the CFTC's Proposed Swap Risk Disclosure Requirement
    In the Release, the CFTC also proposes to amend the mandatory risk 
disclosure statements under the Commodity Exchange Act for CPOs and 
CTAs to require disclosure about certain risks specific to swaps 
transactions.\83\ While we fully support strong risk disclosure to 
investors, we also believe such disclosure must be accurate in order to 
be effective.
---------------------------------------------------------------------------
    \83\ See Rules 4.24(b) and 4.34(b) under the Commodity Exchange 
Act.
---------------------------------------------------------------------------
    We are concerned that the CFTC's proposed language fails to capture 
the variety of ways in which registered investment company advisers 
that are CPOs and CTAs may use swaps, which we describe above, and 
that, as a result, the disclosure may provide investors with a 
misleading impression of the risks presented by an investment company's 
use of such instruments. We therefore recommend, in lieu of the 
proposed language, that if an adviser is a CPO or CTA to a registered 
investment company that engages in swaps transactions, the CFTC's 
proposed risk disclosure requirement would be satisfied by the risk 
disclosures that the SEC currently requires of registered investment 
companies, which are comparable and allow an investment company to 
tailor its disclosure to convey the particular risks presented by its 
use of swaps.\84\
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    \84\ See Items 4 and 9 of Form N-1A under the Investment Company 
Act, which require a registered investment company to disclose the 
principal risks associated with investing in the company, as well as 
Item 16 of the SAI, which requires additional information about the 
risks of investing in the company.
---------------------------------------------------------------------------
    Alternatively, we recommend that the CFTC require an adviser that 
is a CPO or CTA to such a registered investment company to omit the 
second paragraph of the proposed risk disclosure language. The second 
paragraph provides that:

        Highly customized swaps transactions in particular may increase 
        liquidity risk, which may result in a suspension of 
        redemptions. Highly leveraged transactions may experience 
        substantial gains or losses in value as a result of relatively 
        small changes in the value or level of an underlying or related 
        market factor.\85\
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    \85\ See Release at 7990-91.

This disclosure is inapposite to registered investment companies. 
First, most registered investment companies issue redeemable securities 
and are not permitted, under the Investment Company Act, to suspend 
redemptions without obtaining an SEC order.\86\ Second, the Investment 
Company Act does not permit registered investment companies to engage 
in ``highly leveraged transactions,'' as investment companies are 
subject to strict capital and asset coverage requirements.\87\ 
Requiring registered investment companies to make the disclosures 
quoted above would be tantamount to requiring them to make materially 
misleading statements.
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    \86\ See Section 22(e) of the Investment Company Act and Rule 22c-1 
under the Act. On rare occasions, the SEC has granted relief, either 
under Section 22(e) or Rule 22c-1, to investment companies experiencing 
``emergency situations'' that make it difficult to calculate their net 
asset values in order to meet purchase or redemption requests. 
Snowstorms, power outages, and similar events fall into this category.
    \87\ See Section 18 of the Investment Company Act.
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C. Request for Clarification Regarding Series Investment Companies
    We request clarification from the CFTC regarding the treatment of 
series investment companies. For reasons of efficiency, a registered 
investment company is frequently organized as a single corporation or 
statutory trust that has multiple ``series,'' each of which represents 
an interest in a separate pool of securities with separate assets, 
liabilities, and shareholders. While the corporation or trust is the 
entity that registers with the SEC, the registrant is required to amend 
its registration statement each time it creates a new investment 
company by issuing a new series. It is common practice for registered 
investment companies to use the series form, and there are mutual fund 
families that have single registered investment companies with over 100 
series. The courts have treated series investment companies as separate 
corporate entities for purposes of inter-series liability.\88\
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    \88\ See, Seidl v. American Century Companies, Inc., 713 F.Supp.2d 
249, 257 (S.D.N.Y. 2010) (stating that ``[t]he individual series of a 
registered investment company are, for all practical purposes, treated 
as separate investment companies . . . and therefore any recovery in a 
derivative suit would go to the shareholders of the [affected fund], 
not to the shareholders of [the investment company's] other funds''); 
and In re Mutual Funds Inv. Litig., 519 F.Supp.2d 580, 588-89 (D.Md. 
2007) (stating that the practice of establishing individual series of a 
registered investment company ``is entirely in accord with applicable 
rules of the SEC, which has expressly pronounced that under such 
circumstances each series is to be treated as a separate investment 
company''); see also Stegall v. Ladner, 394 F.Supp.2d 358, 362-363 
(D.Mass. 2005).
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    The CFTC, both historically and recently, has recognized pools 
organized in series form as separate investment pools. The CFTC 
explicitly recognizes series companies in its rules, and acknowledges 
that each series should be treated as a separate pool if it has limited 
liability.\89\ In addition, when the CFTC adopted the Rule 4.5 
exclusion, it specifically stated that it would treat each separate 
series of an investment company separately for purposes of determining 
whether the series satisfied the criteria for exclusion from the rule. 
In doing so, it noted approvingly its staff's statement from an 
interpretive letter that:
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    \89\ See Rule 4.7(b)(2)(iv) and 4.7(b)(3)(i)(D) under the Commodity 
Exchange Act (exemption for CPOs that offer or sell commodity pool 
participations only to qualified eligible persons includes periodic 
reporting relief and annual report relief that provides that, in the 
case of a pool that is a series fund with limited liability, the 
account statement or financial statements required are not required to 
include consolidated information for all series of the pool).

        . . . in light of the separate ownership in and identities of 
        the Fund's Portfolios--e.g., separate investment objectives, 
        net asset valuation and dividend policies--we believe it 
        consistent with the intent of proposed Rule 4.5 to treat as 
        separate entities each of the two Portfolios that intend to 
        engage in commodity interest trading for purposes of 
        determining whether the criteria of the proposal have been met. 
        Conversely, where such separate ownership and identities are 
        not present, we might find it more consistent with proposed 
        Rule 4.5 to aggregate all of the portfolios of a series 
        investment fund in determining whether the criteria have been 
        met.\90\
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    \90\ 1985 Adopting Release, supra note 30.

More recently, the CFTC has recognized series companies in its final 
rules for periodic account statements and annual financial reports, 
taking the position that series with limits on inter-series liability 
should be treated as separate pools for account statement disclosure 
purposes.\91\
---------------------------------------------------------------------------
    \91\ See, Commodity Pool Operator Periodic Account Statements and 
Annual Financial Reports, 74 Fed. Reg. 75785, 75786 (Nov. 9, 2009).
---------------------------------------------------------------------------
    We are aware, however, that the CFTC staff has recently taken the 
position that CPOs seeking to register new funds that are organized in 
series form may not use standalone prospectuses for each separate 
series but must instead include all the series in a trust in a single 
prospectus. We believe such a result is inconsistent with treatment of 
series investment companies both by the SEC, as discussed above, as 
well as the CFTC's own rules and prior positions, and request that the 
CFTC clarify that series investment companies should be treated the 
same as investment companies that are not organized in series form. 
This clarification would be fully consistent with CFTC positions, SEC 
treatment of series investment companies, and the decisions of courts 
that have considered the issue.\92\
---------------------------------------------------------------------------
    \92\ See, id.; 1985 Adopting Release, supra, note 30; Seidl, supra 
note 88.
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V. Request for Adequate Transition Period and Grandfathering
    If the CFTC nonetheless determines to proceed with amendments to 
Rule 4.5, we believe that, once any such amendments are adopted, it 
will be critical for investment advisers and investment companies to 
have adequate time to make the changes to their operations and policies 
and procedures necessary to comply with the amended rule. Given the 
many uncertainties about the rule at this time and the many changes 
that could be required if it is adopted, especially if rules of the SEC 
and CFTC are reconciled, we believe it will be essential for the 
Commission to provide a substantial transition period for compliance 
with any amended rule, although it is difficult at this time to 
estimate what that period should be. The length of such a transition 
period should be a specific request for comment in any re-proposal. As 
a matter of fairness, we also request that those registered investment 
companies that have previously claimed reliance upon current Rule 4.5 
be exempted from compliance with any amendments to the rule, as these 
funds are structured to rely on the exclusion in its current form.
          * * * * *
    As outlined above, we believe the Rule 4.5 Proposal is deeply 
flawed and requires significant additional modification before adoption 
is appropriate. We thus respectfully request that the CFTC fully and 
carefully consider all of the concerns raised in our letter and by 
other commenters and, if it continues to believe that amendments to 
Rule 4.5 are necessary, to re-propose those amendments, taking into 
consideration the views of commenters.
    ICI and its members stand ready to assist the Commission in this 
important and challenging effort. If you have questions or require 
further information, please contact me at [Redacted], Sarah A. Bessin 
at [Redacted], or Rachel H. Graham at [Redacted].
            Sincerely,

Karrie McMillan,
General Counsel.

CC:

Hon. Gary Gensler, Chairman;
Hon. Michael V. Dunn, Commissioner;
Hon. Jill E. Sommers, Commissioner;
Hon. Bart Chilton, Commissioner;
Hon. Scott D. O'Malia, Commissioner;
Kevin P. Walek, Assistant Director;
Amanda Lesher Olear, Special Counsel;
Daniel S. Konar II, Attorney-Adviser, Division of Clearing and 
Intermediary Oversight;

Hon. Mary L. Schapiro, Chairman, SEC;
Hon. Kathleen L. Casey, Commissioner, SEC;
Hon. Elisse B. Walter, Commissioner, SEC;
Hon. Luis A. Aguilar, Commissioner, SEC;
Hon. Troy A. Paredes, Commissioner, SEC;
Eileen Rominger, Director, Division of Investment Management, SEC.
                               appendix a

      Comparison of Requirements Applicable to Registered Investment Companies and Commodity Pool Operators

----------------------------------------------------------------------------------------------------------------
           SEC Requirement                      CFTC Requirement                     Recommended Result
----------------------------------------------------------------------------------------------------------------
                                             Disclosure Requirements
----------------------------------------------------------------------------------------------------------------
Disclosure Document--Form N-1A sets   Rules 4.21 and 4.24 together require  Registered investment companies
 forth the disclosure that a           a CPO to provide a single             should be deemed to have met CFTC
 registered investment company must    Disclosure Document to prospective    requirements if they satisfy SEC
 include in its registration           participants that includes certain    requirements and pre-clearance by
 statement and is divided into three   information describing the pool.      the NFA should not be required.
 parts--the Prospectus, the SAI and
 the Wrapper/Part C. While the
 Prospectus is generally the only
 document that a registered
 investment company must deliver to
 prospective investors, the SAI,
 which includes additional includes
 certain additional information
 describing the registered
 investment company, is available to
 investors upon request at no
 charge. These documents are subject
 to SEC pre-effective review.
Investment Program--Items 2, 4 and 9  Rule 4.24(h)(1) and (2) require a     Registered investment companies
 of Form N-1A require a registered     CPO to provide a description of       should be deemed to have met CFTC
 investment company to state its       ``the trading and investment          requirements if they satisfy SEC
 investment objective and to           programs and policies that will be    requirements.
 disclose the principal investment     followed by the offered pool.'' and
 strategies that will be used to       ``the types of commodity interests
 seek to accomplish that objective.    and other invests which the pool
 The SAI requires additional           will trade.''
 information about the investment
 company's investment program.
Principal Risks--Items 4 and 9 of     Rule 4.24(g) requires a CPO to        Registered investment companies
 Form N-1A require a registered        disclose ``the principal risk         should be deemed to have met CFTC
 investment company to disclose the    factors of participation in the       requirement if they satisfy SEC
 principal risks associated with       offered pool.''                       requirement.
 investing in the registered
 investment company. The SAI
 requires additional information
 about the risks of investing in the
 investment company.
Fee Disclosure--Item 3 of Form N-1A   Rule 4.24(i) requires a CPO to        These requirements are in many
 requires a registered investment      include in the Disclosure Document    respects duplicative and, in
 company to include in its             for its pool ``a complete             others, inconsistent. The formats
 Prospectus a fee table and expense    description of each fee, commission   for disclosing fees are different.
 example disclosing its fees and       and other expense which the           Requiring registered investment
 expenses. The fee table generally     commodity pool operator knows or      companies to comply with both sets
 discloses shareholder fees (maximum   should know has been incurred by      of requirements would be redundant
 sales charge imposed on purchases,    the pool for its preceding fiscal     and confusing to shareholders. We
 maximum deferred sales charge,        year and is expected to be incurred   therefore believe registered
 maximum sales charge imposed on       by the pool in its current fiscal     investment companies should be
 reinvested dividends, redemption      year, including fees or other         deemed to have met CFTC
 fee, exchange fee and maximum         expenses incurred in connection       requirements if they satisfy SEC
 account fee) and annual operating     with the pool's participation in      requirements.
 fund expenses (management fees,       investee pools and funds.'' The
 distribution and/or service fees,     rule includes a non-exhaustive list
 other expenses) on a percentage       of fees that must be described in
 basis. Items 10 and 12 require        the Disclosure Document, including
 additional disclosure regarding       management fees, brokerage fees and
 management fees and sales expenses.   commissions, fees paid in
 Detailed narrative and historical     connection with trading advice
 expense disclosure is required in     provided to the pool, incentive
 the SAI, including total dollar       fees, commissions that may accrue
 amounts of advisory fees for each     in connection with the solicitation
 of the last 3 fiscal years, fees      of participants in the pool,
 paid to other service providers for   professional and general
 management-related services for       administrative fees and expenses,
 each of the last 3 years,             organizational and offering
 distribution-related fees paid        expenses, clearance fees and any
 during the last fiscal year and the   other direct or indirect cost. The
 purposes for which such payments      disclosure must also include a
 were made, aggregate brokerage        break-even analysis that reflects
 commissions for each of the last 3    all fees, commissions and other
 fiscal years, brokerage commissions   expenses of the pool.
 paid to affiliates for each of the
 last 3 fiscal years, compensation
 paid to the investment company's
 principal underwriter and director/
 trustee compensation. Item 27(d)(1)
 of Form N-1A also requires an
 example of the effect of expenses
 on a shareholder account, and must
 appear in every annual and semi-
 annual shareholder report.
Performance Disclosure--Item 4 of     Rule 4.24(n) requires a pool to       These requirements directly conflict
 Form N-1A generally requires a        include past performance of the       and will need to be reconciled.
 registered investment company to      pool and in some cases of the CPO's   Registered investment companies
 include a bar chart showing the       other pools, as set forth in Rule     should be permitted to show only
 investment company's annual total     4.25, which requires a significant    the information required by Form N-
 returns for each of the last 10       amount of performance data that is    1A and related SEC and SEC staff
 calendar years, but only for          different from that required or       interpretations, including with
 periods subsequent to the effective   permitted under Form N-1A. In         respect to performance of other
 date of the registration statement.   addition to performance data for      pools and accounts. A registered
 Following the chart, the investment   the pool, the CPO must disclose       investment company is permitted to
 company must disclose the highest     information for the performance of    include in its registration
 and lowest quarterly return during    each other pool it operates (and by   statement performance data for
 the 10 years covered by the chart     the trading manager if the offered    other accounts only in
 (or since inception if less than 10   pool has a trading manager) if the    circumstances where the other
 years). Form N-1A also requires an    applicable pool has less than 3       account is managed in a
 investment company to disclose its    years of actual performance.          substantially similar manner, among
 average annual total returns for      Further, if the CPO (or the trading   other requirements. In addition,
 the last 1, 5 and 10 years (or        manager) has not operated for at      FINRA rules generally prohibit
 since inception if less than 10       least 3 years any pool in which 75%   broker-dealers from using sales
 years) and to compare its returns     or more of the contributions to the   literature for a registered
 to a broad-based securities market    pool were made by persons             investment company that includes
 index. An investment company is       unaffiliated with the pool            the performance of other accounts.
 permitted to include in its           operator, the trading manager, the    This approach is different than
 registration statement performance    pool's CTAs or their respective       that taken under Rule 4.25, which
 data for other accounts only in       principals, the CPO also must         in certain cases requires
 circumstances where the other         disclose the performance of each      performance of all pools (including
 account is managed in a               pool operated by and account traded   privately offered pools) and
 substantially similar manner, among   by the trading principals of the      accounts of the CPO or CTA, whether
 other requirements.                   CPO. The performance of any           or not they are managed in a
                                       accounts (including pools) directed   substantially similar manner.
                                       by a major commodity trading          Moreover, the inclusion of
                                       adviser must also be disclosed. The   performance information for a
                                       CPO also must disclose the            private fund in a prospectus for a
                                       performance of any major investee     publicly offered registered
                                       pool.                                 investment company, as may be
                                                                             required under the CFTC's
                                                                             performance disclosure
                                                                             requirements, could jeopardize the
                                                                             ability of the private fund to rely
                                                                             on the private offering exemption
                                                                             from registration that is provided
                                                                             pursuant to Regulation D under the
                                                                             1933 Act.
Management--Items 5 and 10 require a  Paragraphs (e) and (f) of Rule 4.24   Registered investment companies
 registered investment company to      require the Disclosure Document to    should be deemed to have met CFTC
 disclose the name and experience of   include, among other things, the      requirement if they satisfy SEC
 each investment adviser and           name and business background of       requirement.
 portfolio manager for the             each CPO, the pool's trading
 investment company. The SAI           manager, and each major commodity
 requires additional disclosure        trading adviser.
 about investment advisers and
 portfolio managers.
----------------------------------------------------------------------------------------------------------------
                             Disclosure Document Delivery and Updating Requirements
----------------------------------------------------------------------------------------------------------------
Disclosure Document Delivery--        Rule 4.21(a)(1) provides that ``each  We request that the CFTC grant
 Section 5 under the 1933 Act, the     commodity pool operator . . . must    exemptive relief to adviser CPOs
 primary provision governing the       deliver or cause to be delivered to   subject to Part 4 (similar to the
 receipt and timing of Prospectus      a prospective participant in a pool   relief that has been granted to
 delivery, does not necessarily        that it operates or intends to        CPOs of commodity ETFs) to permit
 require delivery of a Prospectus      operate a Disclosure Document for     advisers to make available fund
 prior to investment and also does     the pool prepared in accordance       prospectuses and SAIs on their
 not require delivery or use of a      with [Rule] 4.24 by no later than     websites. We believe that filing
 subscription agreement. Rule 10b-10   the time it delivers to the           with, and pre-clearance by, the NFA
 requires broker-dealers to deliver    prospective participant a             should not be required.
 confirmations of securities           subscription agreement for the
 transactions, and the Prospectus      pool.'' (Emphasis added.) The
 delivery requirements would ensure    Disclosure Document also must be
 that a Prospectus is delivered no     filed with and pre-cleared by the
 later than with the transaction       NFA under Rule 426(d)(1).
 confirmation.
Disclosure Document Updating--        Rule 4.26(a)(2) provides that ``[n]o  We request exemptive relief so that
 Section 10(a) of the 1933 Act         commodity pool operator may use a     registered investment companies may
 effectively permits an investment     Disclosure Document . . . dated       update based on the SEC
 company to update its registration    more than 9 months prior to the       requirements. We believe that
 statement annually. In particular,    date of its use.'' The updated        filing with, and preclearance by,
 Section 10(a)(3) states that ``when   Disclosure Document also must be      the NFA should not be required.
 a Prospectus is used more than 9      filed with and precleared by the
 months after the effective date of    NFA under Rule 426(d)(2).
 its registration statement, the
 information contained therein shall
 be as of a date not more than
 sixteen months prior to such use .
 . .''
Registered investment companies must  Rule 4.26(c)(1) requires a CPO to     Registered investment companies
 supplement their Prospectuses and     update its Disclosure Document to     should be deemed to have met CFTC
 SAIs to correct material              correct any material inaccuracies     requirement if they satisfy SEC
 inaccuracies and omissions, but, to   or omissions, and to deliver the      requirement.
 the extent supplements are mailed     updated information to existing
 to existing shareholders, the         pool participants within 21
 mailings typically are timed to       calendar days of the date upon
 coincide with other regular           which the CPO first knows or has
 mailings to manage costs. Some        reason to know of the defect.
 changes are so material that the
 investment company may mail
 supplements to shareholders
 immediately. In certain cases, an
 investment company may not deliver
 supplements to existing
 shareholders absent an additional
 investment.
Disclosure Document Acknowledgment--  Rule 4.21(b) provides that ``[t]he    We request that the CFTC grant
 There is no requirement under the     commodity pool operator may not       exemptive relief to adviser CPOs
 Federal securities laws that          accept or receive funds, securities   similar to the relief that has been
 investment company investors          or other property from a              granted to CPOs of commodity ETFs.
 acknowledge receipt of a              prospective participant unless the    Requiring an acknowledgment is
 Prospectus.                           pool operator first receives from     fundamentally inconsistent with the
                                       the prospective participant an        registered investment company
                                       acknowledgement signed and dated by   distribution model.
                                       the prospective participant stating
                                       that the prospective participant
                                       received a Disclosure Document for
                                       the pool.'' (Emphasis added.)
Additional Documents--The Federal     Rule 4.26(b) generally requires a     Registered investment companies
 securities laws do not require an     CPO to attach to its Disclosure       should be deemed to have met CFTC
 investment company to distribute      Document the applicable pool's most   requirement if they satisfy SEC
 its shareholder reports with the      current Account Statement             requirements.
 investment company Prospectus, but    (discussed below) and Annual
 require registered investment         Report.
 companies to disclose in the
 Prospectus how shareholders can
 obtain such documents at no charge.
----------------------------------------------------------------------------------------------------------------
                                 Participant/Shareholder Reporting Requirements
----------------------------------------------------------------------------------------------------------------
Rule 30e-1 under the Investment       Rule 4.21(c) requires each CPO to     We request that the CFTC grant
 Company Act requires a registered     ``distribute an Annual Report to      exemptive relief to adviser CPOs
 investment company to send to its     each participant in each pool that    (similar to the relief that has
 shareholders at least semiannually    it operates . . . .'' The Annual      been granted to CPOs of commodity
 a report containing financial         Report must include, among other      ETFs) to permit advisers to make
 statements and other required         things, audited financial             available annual and semi-annual
 disclosures. The annual report must   statements.                           shareholder reports required by
 contain audited financial                                                   Rule 30e-1 on their websites.
 statements. Rule 30b2-1 requires
 that the reports to shareholders,
 along with certain additional
 information, be filed with the SEC
 on Form N-CSR.
While the Federal securities laws do  Rule 4.22(a) generally requires       We request that the CFTC grant
 not require a registered investment   ``each commodity pool opera- tor .    exemptive relief to adviser CPOs
 company to distribute a monthly       . . [to] distribute to each           (similar to the relief that has
 report or account statement to        participant in each pool that it      been granted to CPOs of commodity
 shareholders, they require certain    operates, within 30 calendar days     ETFs) to permit advisers to make
 interim reports in addition to the    after the last date of the            available annual and semi-annual
 annual report noted above. For        reporting period . . . an Account     shareholder reports required by
 example, Rule 30e-1 and Rule 30b2-1   Statement, which shall be presented   Rule 30e-1 on their websites.
 cited above require filing and        in the form of a Statement of
 delivery to shareholders of a semi-   Operations and a Statement of
 annual report, in addition to the     Changes in Net Assets, for the
 filing and delivery of the annual     prescribed period.'' Rule 4.22(b)
 report. In addition, Rule 30b1-5      states that the Account Statement
 under the Investment Company Act      must be distributed at least
 requires a registered investment      monthly in the case of pools with
 company to file a quarterly report    net assets of more than $500,000 at
 on Form N-Q within 60 days after      the beginning of the pool's fiscal
 the close of the first and third      year, and otherwise at least
 quarters containing a schedule of     quarterly.
 investments and other disclosures.
----------------------------------------------------------------------------------------------------------------
                                        Regulatory Reporting Requirements
----------------------------------------------------------------------------------------------------------------
Form N-SAR--Items 1-6 require         Form CPO-PQR Schedule A, Part 1--     Registered investment companies
 information regarding the name of     Part 1 requests information that is   should be deemed to have met CFTC
 the investment company, its SEC       comparable to that requested in       requirement if they satisfy SEC
 file numbers and address, among       Form NSAR, Items 1-6 and 75. Part 1   requirement.
 other things. Item 75 requires        requires CPOs to report basic
 information regarding assets under    identifying information about the
 management.                           CPO, including its name, NFA
                                       identification number and assets
                                       under management.
Form N-SAR requires the name of each  Form CPO-PQR Schedule A, Part 2--     Registered investment companies
 series of the registrant (Item 7);    Part 2 would require a CPO to         should be deemed to have met CFTC
 the identification of key service     report information regarding each     requirement if they satisfy SEC
 providers (Items 8-15); information   of its commodity pools, including     requirement. While there are some
 regarding portfolio investments and   the names and NFA identification      differences between the
 positions (Items 67-70); and          numbers, position information for     requirements of Form N-SAR and
 information regarding subscription    positions comprising 5% or more of    proposed Form CPO-PQR, these
 and redemption activity (Item 28).    each pool's net asset value, and      differences generally reflect the
 Performance information is not        the identification of the pool's      fact that Form CPO-PQR is intended
 specifically required by the form,    key relationships with brokers,       to obtain information relating to
 but performance information is        other advisers, administrators,       systemic risk, a concern that in
 available in other reports and        custodians, auditors and marketers.   our strongly held view is not
 registration statements filed with    Part 2 also would require             raised by the activities of
 the SEC.                              disclosure regarding each pool's      registered investment companies
                                       quarterly and monthly performance     that are the subject of this
                                       information and information           letter. SEC proposed Form PF, which
                                       regarding participant subscriptions   the CFTC has stated solicits
                                       and redemptions.                      information that is generally
                                                                             identical to that sought by Form
                                                                             CPO-PQR, is specifically designed
                                                                             to address the potential systemic
                                                                             risk raised by activities of
                                                                             advisers to private funds, not
                                                                             registered investment companies.
                                                                             However, registered investment
                                                                             companies are subject to CFTC large
                                                                             trader reporting requirements like
                                                                             any other trader, which enables the
                                                                             CFTC to obtain information from
                                                                             those entities that it can use to
                                                                             assess systemic risk.
Investment companies must complete    CPOs that have assets under           Registered investment companies
 the entire Form NSAR regardless of    management equal to or exceeding      should be deemed to have met CFTC
 assets under management. In           $150 million would be required to     requirement if they satisfy SEC
 addition, the form must be            file Schedule B, which would          requirement.
 completed on a series by series       require the CPO to report detailed
 basis. In general, Form N-SAR         information for each pool. The
 requires the name of each series      required information is comparable
 (Item 7); information regarding       to that required by the
 each series' investment strategies    corresponding provisions of Form N-
 and positions (Items 62-70);          SAR for funds and includes
 liabilities from borrowings and       information regarding each pool's
 other portfolio management            investment strategy, borrowings by
 techniques (Item 74); and             geographic area and the identities
 information regarding brokerage       of significant creditors, credit
 transactions (Items 20-26).           counterparty disclosure, and
                                       entities through which the pool
                                       trades and clears its positions.
Form N-SAR generally requires a       Form CPO-PQR Schedule C, Parts 1 and  Registered investment companies
 registered investment company to      2--CPOs that have assets under        should be deemed to have met CFTC
 report investment and exposure        management equal to $1 billion or     requirement if they satisfy SEC
 information on a series by series     more would be required to file        requirement. Registered investment
 basis in all cases. It generally      Schedule C. Part 1 would require      companies are subject to CFTC large
 does not require an investment        certain aggregate information about   trader reporting requirements like
 company to report investment and      the commodity pools advised by        any other trader, which enables the
 exposure information on an            large CPOs, such as the market        CFTC to obtain information from
 aggregate basis or certain more       value of assets invested, on both a   those entities that it can use to
 detailed information required by      long and short basis, in different    assess systemic risk. Accordingly,
 Schedule C of Form CPO-PQR.           types of securities and               the more detailed information
                                       derivatives, turnover in these        requested by Form CPO-PQR, Schedule
                                       categories of financial               C should not be necessary for
                                       instruments, and the tenor of fixed   registered investment companies.
                                       income portfolio holdings. Part 2
                                       would require CPOs to report
                                       detailed information regarding
                                       individual pools with at least $500
                                       million in assets under management,
                                       including liquidity, concentration,
                                       material investment positions,
                                       collateral practices with
                                       significant counterparties and
                                       clearing relationships.
----------------------------------------------------------------------------------------------------------------
                                                Books and Records
----------------------------------------------------------------------------------------------------------------
Rule 31a-2 requires a registered      Rule 4.23 requires a CPO to maintain  We request that the CFTC grant
 investment company to preserve its    required pool books and records at    exemptive relief to adviser CPOs
 books and records for specified       its main business office.             from Rule 4.23 if they satisfy the
 periods of time, with more recent                                           requirements of the Investment
 books and records typically                                                 Company Act rules and Form ADV.
 preserved in an ``easily accessible
 place.'' Rule 31a-3 permits a
 registered investment company to
 use a third party to prepare and
 maintain required records. Reliance
 on the rule is conditioned upon
 having a written agreement to the
 effect that the records are the
 property of the person required to
 maintain and preserve them, and
 that such records will be
 surrendered promptly on request. In
 addition, Item 1(K) of Form ADV
 requires a registered investment
 adviser to indicate whether it
 maintains its required books and
 records at a location other than
 its principal office and place of
 business, and Section 1.K. of
 Schedule D of Form ADV requires the
 adviser to specify each entity that
 maintains its books and records,
 including the location of the
 entity, and a description of the
 books and records maintained at
 that location.
----------------------------------------------------------------------------------------------------------------

    The Chairman. Thank you, Ms. McMillan.
    Mr. Greenberger, 5 minutes.

 STATEMENT OF MICHAEL GREENBERGER, J.D., PROFESSOR, UNIVERSITY 
            OF MARYLAND SCHOOL OF LAW, BALTIMORE, MD

    Mr. Greenberger. Thank you very much, Chairman Conaway and 
Ranking Member Boswell. I am deeply appreciative to have the 
opportunity to talk to you today.
    I think I come at this from a slightly different context, 
and I may be so bold as to say a context that may be one of 
your typical constituents.
    We seem to, in this entire discussion, forget what we have 
just been through. We have been through a process where we 
deregulated a $100 trillion--over a $100 trillion industry, and 
it collapsed. And that led to the meltdown.
    The very reason this Committee so energetically and 
thoughtfully put its weight behind the derivatives section of 
Dodd-Frank was, everybody who is objective and honest said the 
failure of the swaps market--failure in the sense that people 
were placing bets, the casino never put money aside; when the 
bets were called, the casino, like AIG and others, didn't have 
money, the taxpayer had to make up the difference.
    In betting, there is usually a winner and loser. In these 
bets, there were two winners: the people who won the bets; the 
people who lost the bets got money from the American taxpayer. 
The American taxpayer, who wasn't part of the bets, ended up 
paying everything. We paid trillions of dollars to rescue the 
too-big-to-fail banks that are now reporting billions of 
dollars of profits.
    When you say, what is the cost-benefit analysis, talk to 
your constituents. Do they think they paid a cost for what 
happened back in September of 2008? They are either jobless, 
they have job insecurity, their pensions are down, their houses 
have lost value, they can't get loans from these banks even 
though the banks are very profitable. There was a terrific cost 
paid by the American taxpayer.
    The purpose of Dodd-Frank is to make sure that never 
happens again. And so, when you do your cost-benefit analysis, 
remember your constituent whose kid is sitting on a couch with 
a college degree and can't find a job with loans that can't be 
repaid. That has to be part of the cost.
    And, by the way, when the CFTC rules go into effect, it is 
only the swaps that succeed those rules that become regulated. 
The hundreds of trillions of dollars of swaps that are out 
there now that are being entered into today are not going to be 
regulated.
    The reason there is a July 21st deadline for these rules 
is, if we don't put some discipline into this system, history 
is going to repeat itself. Why will history repeat itself? 
European countries are facing sovereign defaults. Jamie Dimon 
just advised a group of investors, ``Don't worry about the 
municipalities. I only think about a hundred or so will default 
on their bonds.'' That is going to cause systemic risk if that 
happens. There is oil shock right now. We are talking about the 
possible default of the United States Government.
    That is going to trigger all the unregulated swaps out 
there. People are going to say, ``Oh, I won my bet,'' to the 
counterparty. ``Where is my money?'' And the money isn't going 
to be there. And you know who is going to be asked to pay that 
burden? The American taxpayer.
    So we can--all of this stuff about cost-benefit analysis, 
let's get all the rules out and have a new comment period--this 
is what used to be called the four-corners offense to prevent 
the agency from complying with its statutory mandate: to put 
protections in, to ensure capital adequacy, provide 
transparency, give pricing to the system to prevent the next 
default, the next meltdown.
    If any of these bad events take place--European default, 
municipal default, oil price shock--there is going to be a 
second dip recession, and people are going to say to you, ``How 
come there are no rules?'' And we are going to say, well, we 
wanted to have the Office of Management and Budget chief 
economists bring in new data and everything else.
    This is a bipartisan issue. Republicans and Democrats are 
laying flat on their back today because regulation failed. The 
CFTC should not only not be criticized--the people who work 
there have been there in the Reagan Administration, H.W. Bush, 
Clinton, W. Bush. These are career employees; they don't have 
an agenda. They are killing themselves to comply and save the 
American people from lack of capital that the taxpayer has to 
make up and lack of transparency.
    I just ask that the Committee please stand back and say, 
what is going to happen if we are analyzing this like our 
navels while the American public goes down for a second time 
and there are no bullets left? There is no money for stimulus, 
no money for TARP. And what did they say in September of 2008? 
If we don't have stimulus, we are going to go into the Great 
Depression. Well, if we have a second dip, there will be no 
stimulus.
    Thank you.
    [The prepared statement of Mr. Greenberger follows:]

Prepared Statement of Michael Greenberger, J.D., Professor, University 
                of Maryland School of Law, Baltimore, MD
    The Relationship of Unregulated OTC Derivatives to the Meltdown. It 
is now accepted wisdom that it was the non-transparent, poorly 
capitalized, and almost wholly unregulated over-the-counter (``OTC'') 
derivatives market that lit the fuse that exploded the highly 
vulnerable worldwide economy in the fall of 2008.\1\ Because tens of 
trillions of dollars of these financial products were pegged to the 
economic performance of an overheated and highly inflated housing 
market, the sudden collapse of that market triggered under-capitalized 
or non-capitalized OTC derivative guarantees of the subprime housing 
investments. Moreover, the many undercapitalized insurers of that 
collapsing market had other multi-trillion dollar OTC derivatives 
obligations with thousands of financial counterparties (through 
unregulated interest rate, currency, foreign exchange, and energy 
derivatives). If a financial institution failed because it could not 
pay off some of these obligations, trillions of dollars of 
interconnected transactions would have also failed, causing a cascade 
of collapsing banks throughout the world. It was this potential of 
systemic failure that required the United States taxpayer to plug the 
huge capital hole that a daisy chain of nonpayments by the world's 
largest financial institutions would have caused, thereby heading off 
the cratering of the world's economy.\2\
---------------------------------------------------------------------------
    \1\ See Ben Moshinsky, Stiglitz says Banks Should Be Banned From 
CDS Trading, Bloomberg.com (Oct. 12, 2009), http://noir.bloomberg.com/
apps/news?pid=newsarchive&sid=
a65VXsI.90hs; Paul Krugman, Op-Ed, Looters in Loafers, N.Y. Times, Apr. 
18, 2010, available at http://www.nytimes.com/2010/04/19/opinion/
19krugman.html?dbk. See, generally Alan S. Blinder, The Two Issues to 
Watch on Financial Reform--We Need an Independent Consumer Watchdog and 
Strong Derivatives Regulation. Industry Lobbyists are Trying to Water 
Them Down, Wall St. J., Apr. 22, 2010, available at http://
online.wsj.com/article/
SB10001424052748704133804575197852294753766.html; Henry T. C. Hu, Empty 
Creditors and the Crisis, Wall St. J., Apr. 10, 2009, at A13; Michael 
Lewis, The Big Short: Inside the Doomsday Machine (2010) [hereinafter 
The Big Short]; Simon Johnson & James Kwak, 13 Bankers: The Wall Street 
Takeover and the Next Financial Meltdown (2011) [hereinafter 13 
Bankers]; Michael Hirsh, Capital Offense: How Washington's Wise Men 
Turned America's Future Over to Wall Street (2010) [hereinafter Capital 
Offense]; Bethany McLean & Joe Nocera, All The Devils Are Here: The 
Hidden History of the Financial Crisis (2010) [hereinafter All The 
Devils Are Here]; Inside Job (Sony Pictures Classics & Representational 
Pictures 2010); Frontline: The Warning (PBS television broadcast Oct. 
20, 2009) [hereinafter The Warning]; Financial Crisis Inquiry 
Commission, The Financial Crisis Inquiry Report: Final Report of the 
National Commission on the Causes of the Financial and Economic Crisis 
in the United States xxiv (Jan. 2011), available at http://
www.fcic.gov/report [hereinafter FCIC Report].
    \2\ See Moshinsky, supra note 1; Krugman, supra note 1; Blinder, 
supra note 1; Hu, supra note 1; The Big Short, supra note 1.
---------------------------------------------------------------------------
    An Example of the Multi-Trillion Dollar Derivative ``Bets'' That 
Had to Be Paid by the U.S. Taxpayer. The then perfectly lawful ``bets'' 
that hedge fund manager John Paulson placed through this unregulated 
OTC derivatives market provide but a single example of how that market 
collectively misfired and--but for taxpayer bailouts--nearly imploded 
the world economy.\3\ From 2006 to 2007, Mr. Paulson with, inter alia, 
the assistance of swaps dealers, purchased synthetic collateralized 
debt obligations (``CDOs''), which were nothing more than the purchase 
of insurance on his selection of weak tranches of subprime residential 
mortgage-backed securities that Mr. Paulson himself did not own.\4\ In 
other words, through so-called ``naked credit default swaps (`CDS'),'' 
Mr. Paulson effectively bought insurance on his own selection of 
subprime investments in which he had no ownership and for which he had 
no risk, but which he believed would fail. Since the dawn of the 19th 
century, it has not been legal to buy insurance on someone else's risk. 
However, because these ``bets'' were categorized as OTC derivatives, 
they were expressly deregulated as ``swaps'' by Congressional 
enactment, and insurance laws were not applied.
---------------------------------------------------------------------------
    \3\ Complaint at 2, Securities and Exchange Commission v. Goldman 
Sachs & Co. and Fabrice Tourre, 2010 U.S. Dist. Ct. 3229 (S.D.N.Y. Apr. 
16, 2010) (``Undisclosed in the marketing materials and unbeknownst to 
investors, a large hedge fund, Paulson & Co. Inc. (`Paulson'), with 
economic interests directly adverse to investors in the ABACUS 2007-AC1 
CDO, played a significant role in the portfolio selection process. 
After participating in the selection of the reference portfolio, 
Paulson effectively shorted the RMBS portfolio it helped select by 
entering into credit default swaps (`CDS') with [Goldman] to buy 
protection on specific layers of the ABACUS 2007-AC1 capital structure. 
Given its financial short interest, Paulson had an economic incentive 
to choose RMBS that it expected to experience credit events in the near 
future.'') (On July 15, 2010, Goldman Sachs entered into a settlement 
without admitting or denying the SEC's allegations for the amount of 
$550 million.)
    \4\ Id.
---------------------------------------------------------------------------
    When subprime mortgage borrowers (i.e., those with various degrees 
of non-creditworthiness) defaulted and could not, as common sense would 
have suggested, sustain their mortgages, the tranches that Mr. Paulson 
insured (but did not own) failed, thereby triggering highly lucrative 
payment obligations to Mr. Paulson pursuant to his synthetic CDOs and 
naked CDS. Paulson ultimately made about $15 billion on these bets.\5\
---------------------------------------------------------------------------
    \5\ Svea Herbst-Bayliss and Kevin Lim, Paulson reassures on Goldman 
role, Reuters (April 21, 2010), available at http://www.reuters.com/
article/2010/04/21/us-goldman-paulson-redemptions-
idUSTRE63K0C620100421?pageNumber=1.
---------------------------------------------------------------------------
    Even though the purchasers of synthetic CDOs, such as Mr. Paulson, 
``profited spectacularly from the housing crisis . . . they were not 
purchasing insurance against anything they owned. Instead, they merely 
made side bets on the risks undertaken by others.'' \6\ In fact, 
because synthetic CDOs mimicked insurance, those who were ``insured'' 
through synthetic CDOs were only required to sustain their multi-
trillion dollar bets with insurance-like ``premiums,'' i.e., they were 
only required to pay about two percent of the total amount insured.\7\
---------------------------------------------------------------------------
    \6\ FCIC Report, supra note 1, at 195.
    \7\ See, The Big Short, supra note 1, at 51.
---------------------------------------------------------------------------
    Moreover, as has been widely demonstrated, investors ``creating'' 
their synthetic bets that the subprime market would fail often 
repeatedly insured against the same weak subprime tranches, i.e., many 
weak subprime tranches were ``bet'' to fail multiple times.\8\ In 
essence, therefore, once a borrower defaulted on a mortgage, the loss 
in the real economy was exponentially multiplied by the many side bets 
placed on whether that borrower would default.
---------------------------------------------------------------------------
    \8\ See, id.
---------------------------------------------------------------------------
    Mr. Paulson's investments are reflective of trillions of dollars 
bet on the subprime market, and the astronomical amounts owed to the 
holders of this unregulated ``insurance'' of the subprime market serve 
as a microcosm of the worldwide financial crisis.\9\
---------------------------------------------------------------------------
    \9\ See, generally, The Big Short, supra note 1; see also Inside 
Job, supra note 1.
---------------------------------------------------------------------------
    Most importantly, the ``insurers'' of the subprime market (some of 
the most prominent financial institutions in the world) were not 
required to have capital to sustain their insurance or to post 
collateral to ensure their payments. (Had these investments been 
governed by insurance or gaming laws, those betting that subprime 
mortgages would be paid would have been required to have adequate 
capital to ensure payments if the bet were lost.) And, when the 
``insurers'' were ``surprised'' to find that those without 
creditworthiness could not pay their mortgages, they did not have the 
ability to pay off their indebtedness to the holders of synthetic CDOs. 
However, what should have been a zero-sum game was converted from a 
lose-lose game into a win-win situation, i.e., the Mr. Paulsons of this 
world only got paid because ``insurers'' were subsidized by the 
taxpayer so that the ``casinos'' could make payment on the bets. Unlike 
regular gambling, no gambler lost--except the perfectly innocent 
bystanders: the U.S. taxpayer.\10\
---------------------------------------------------------------------------
    \10\ See, The Big Short, supra note at 1, at 256.
---------------------------------------------------------------------------
    As it now stands, the world is attempting to dig itself out of the 
worst financial crisis since the Great Depression of the 1930's--a task 
now aggravated, inter alia, by the burden of escalating energy and food 
commodity prices. Dozens of studies suggest that even those escalating 
commodity prices may very well be aided by betting on the upward 
direction of those prices through passive investments originated by 
U.S. financial institutions using unregulated OTC derivatives.\11\
---------------------------------------------------------------------------
    \11\ See, Commodity Markets Oversight Coalition, Evidence of the 
Impact of Commodity Speculation by Academics, Analysts and Public 
Institutions (2011), available at http://www.nefiactioncenter.com/PDF/
evidenceonimpactofcommodityspeculation.pdf; see also, Kenneth J. 
Singleton, Graduate School of Business Professor, Stanford University, 
Investor Flows and the 2008 Boom/Bust in Oil Prices (March 23, 2011), 
available at http://www.stanford.edu/kenneths/.
---------------------------------------------------------------------------
    Dodd-Frank Provides the Tools to Protect the U.S. Taxpayer. Title 
VII of the Dodd-Frank Act \12\ would make it very difficult to repeat 
the kind of undercapitalized, non-transparent, and economy-busting 
``betting'' mentioned above. That statute, if properly implemented, (1) 
requires all major players to have adequate capital to enter the market 
to sustain their potentially huge obligations; (2) requires that almost 
all of these kinds of investments be collateralized by counterparties; 
(3) requires almost all of these investments to be guaranteed and 
properly margined by clearing facilities, which, in turn, are subject 
to strict Federal regulation and oversight; (4) requires all of these 
transactions to be publicly recorded and, in many instances, traded on 
public exchanges or exchange-like environments; and (5) collectively 
places the CFTC, the SEC, and the members of the Financial Stability 
Oversight Council in a position to have full transparency of these 
kinds of investments with an eye to preventing the kind of systemic 
risk that threatened the world economy in the fall of 2008.
---------------------------------------------------------------------------
    \12\ Dodd-Frank Wall Street Reform and Consumer Protection Act, 
Pub. L. No. 111-203 (2010).
---------------------------------------------------------------------------
    It must be emphasized that Title VII exempts from the clearing 
requirement commercial end-users.\13\ Moreover, the CFTC and SEC have 
repeatedly said that uncleared swaps used by commercial end-users will 
be exempt from margin requirements both for the commercial end-user and 
for the swap dealer selling the hedging vehicle.\14\
---------------------------------------------------------------------------
    \13\ Dodd-Frank Wall Street Reform and Consumer Protection Act, 
Pub. L. No. 111-203,  723(a)(3) (2010) (``Clearing Transition Rules--
(A) Swaps entered into before the date of the enactment of this 
subsection are exempt from the clearing requirements of this subsection 
if reported pursuant to paragraph (5)(A); (B) Swaps entered into before 
application of the clearing requirement pursuant to this subsection are 
exempt from the clearing requirements of this subsection if reported 
pursuant to paragraph (5)(B).'').
    \14\ Written Testimony of Gary Gensler, Chairman, Commodity Futures 
Trading Commission, Hearing Before the U.S. House Committee on 
Agricultural to Review Implementation of Title VII of the Dodd-Frank 
Wall Street Reform and Consumer Protection Acton, February 10, 2011, 
available at http://www.cftc.gov/pressroom/speechestestimony/
opagensler-68.html (``Transactions involving non-financial entities do 
not present the same risk to the financial system as those solely 
between financial entities. Consistent with this, proposed rules on 
margin requirements should focus only on transactions between financial 
entities rather than those transactions that involve non-financial end-
users.'') [hereinafter ``Gensler Testimony'']; Written Testimony of 
Mary Schapiro, Chairman, Securities and Exchange Commission, Hearing 
Before the U.S. House Financial Services Committee on Implementation of 
Titles VII and VIII of the Dodd-Frank Wall Street Reform and Consumer 
Protection Act by the U.S. Securities and Exchange Commission, February 
15, 2011, available at http://www.sec.gov/news/testimony/2011/
ts021511mls.htm (``in proposing margin rules, we will be mindful both 
of the importance of security-based swaps as hedging tools for 
commercial end-users and also of the need to set prudent risk rules for 
dealers in these instruments.'') [hereinafter ``Schapiro Testimony''].
---------------------------------------------------------------------------
    Moreover, the statute expressly exempts from regulation all swaps 
in existence before the statute passed, as well as swaps executed 
before final rules are put in place.\15\ That means until the CFTC 
acts, hundreds of millions of dollars of swaps will continue to be 
unregulated with no provision for capital adequacy or transparency. 
This latter factor, in and of itself, justifies the timetable 
established in Dodd-Frank for implementation of the statute, which the 
CFTC is diligently attempting to follow. Until final rules are adopted, 
the American taxpayer, consumer and retiree are exposed to the same 
regulatory inadequacies that caused the fall 2008 credit crisis to 
begin with.
---------------------------------------------------------------------------
    \15\ Dodd-Frank Wall Street Reform and Consumer Protection Act, 
Pub. L. No. 111-203,  739 (2010) (``Unless specifically reserved in 
the applicable swap, neither the enactment of the Wall Street 
Transparency and Accountability Act of 2010, nor any requirement under 
that Act or an amendment made by that Act, shall constitute a 
termination event, force majeure, illegality, increased costs, 
regulatory change, or similar event under a swap (including any related 
credit support arrangement) that would permit a party to terminate, 
renegotiate, modify, amend, or supplement one or more transactions 
under the swap.'').
---------------------------------------------------------------------------
    One of the most important sections in Title VII of Dodd-Frank is 
Section 737 on Position Limits.\16\ It is designed to ban excessive 
speculation from the derivatives market, i.e., ban that speculation 
which exceeds the need for liquidity by commercial hedgers in the 
commodity markets. The CFTC, as Congressionally mandated, is currently 
in the process of implementing Section 737 through the rulemaking 
process and proposed rules on position limits on January 26, 2011.\17\
---------------------------------------------------------------------------
    \16\ Dodd-Frank Wall Street Reform and Consumer Protection Act, 
Pub. L. No. 111-203,  737 (2010).
    \17\ Position Limits for Derivatives, 76 Fed. Reg. 4752 (January 
26, 2011).
---------------------------------------------------------------------------
    However, in attempting to properly implement Section 737, the CFTC 
has faced massive opposition. Opponents have argued that Section 737 is 
not necessary to prevent volatility in commodity prices. First, as I 
have stated in my comment letter in response to the proposed position 
limits rules,\18\ Section 737 does not afford the CFTC discretion 
regarding the implementation of position limits. Rather, it imposes the 
statutory obligation to set position limits with the goal of limiting 
excessive speculation. In drafting this section, Congress purposefully 
replace the word ``may'' in the House version of the Dodd-Frank Act 
\19\ with ``shall,'' \20\ to ``strengthen confidence in trader position 
limits on physically deliverable commodities as a way to prevent 
excessive speculative trading.'' \21\
---------------------------------------------------------------------------
    \18\ See Comment Letter by Michael Greenberger, Professor, 
University of Maryland School of Law, Director, Center for Health and 
Homeland Security, to David Stawick, Secretary, Commodity Futures 
Trading Commission, Position Limits for Derivatives (March 28, 2011), 
available at http://www.michaelgreenberger.com/files/
Greenberger_PL_comment_letter.pdf.
    \19\ The Wall Street Reform and Consumer Protection Act of 2009, 
H.R. 4173, 111th Cong. (2009).
    \20\ Dodd-Frank Wall Street Reform and Consumer Protection Act, 
Pub. L. No. 111-203,  737 (2010).
    \21\ Official website of House Committee on Agriculture, House 
Passes Peterson-Frank Amendment to Strengthen Regulation of Over-the-
Counter Derivatives, December 10, 2009, available at http://
democrats.agriculture.house.gov/press/PRArticle.aspx?NewsID=207.
---------------------------------------------------------------------------
    Those who oppose position limits argue that there is a lack of 
empirical data demonstrating that excessive speculation has 
unnecessarily and dramatically increased the price of energy and 
agricultural commodities. For example, Terry Duffy of the CME Group 
stated during the March 3, 2011 hearing before the Senate Committee on 
Agriculture, Nutrition and Forestry that ``there's been absolutely no 
evidence that [speculators] have anything to do with the effect of 
price whether it comes from an academic, whether it comes from a 
government study or anything else. So just want to put that clear.'' 
\22\ This is simply incorrect. Even if, for argument's sake, the 
imposition of position limits is discretionary, many company/commercial 
end-users, including, inter alia, Starbucks, Hershey, Lindt & 
Spruengli, and Delta Airlines, have now come forward demonstrating that 
the futures market is in complete disarray because of excessive 
speculation.\23\ The Commodity Markets Oversight Coalition, an 
independent, non-partisan and nonprofit alliance of groups that 
represents commodity-dependent industries, businesses and end-users, 
has also adopted the position that commodity prices defy market 
fundamentals due to excessive speculation.
---------------------------------------------------------------------------
    \22\ See, Transcript of Implementation of Title VII of the Wall 
Street Reform and Consumer Protection Act, Hearing Before the Senate 
Committee on Agriculture, Nutrition & Forestry, 112th Cong. (March 3, 
2011) (Statement of Terry Duffy, Executive Chairman, CME Group); see 
also e.g., in the comment letter submitted by SIFMA Asset Management 
Group, which is comprised primarily of Chief Operating Officers and 
other senior executives at asset management firms, argued: ``The CFTC 
should delay adoption of position limits until an `appropriateness' 
determination can be made. Currently, there lacks insufficient evidence 
to suggest that speculation is affecting commodities markets.'' Comment 
Letter by Timothy W. Cameron, Esq., Managing Director, Asset Management 
Group of Securities Industry and Financial Markets Association (SIFMA) 
to David Stawick, Secretary, Commodity Futures Trading Commission, 
Notice of Proposed Rulemaking--Position Limits for Derivatives, March 
28, 2011, available at http://www.sifma.org/issues/item.aspx?id=24137 
(emphasis added).
    \23\ See, e.g., Howard Schultz, Chief Executive Officer of 
Starbucks, Inc., recently stated: ``I've been in this business for 30 
years. I can tell you unequivocally with every coffee farmer and 
resource that we talk to in which we have decades of relationships, we 
cannot identify a supply problem in the world where we're buying 
coffee. So one question is, `why are coffee prices going up?' and in 
addition to that, `why is every commodity price going up at the same 
time?' Why is cotton, corn, wheat, why? And I think what's going on is 
financial engineering; that financial speculators have come into the 
commodity markets and drove these prices up to historic levels and as a 
result of that the consumer is suffering.'' Josh Garrett, Starbucks CEO 
Points to Speculation as Cause of Rising Commodity Prices, 
heatingoil.com (April 6, 2011), available at
http://www.heatingoil.com/blog/starbucks-ceo-points-to-speculation-as-
cause-of-rising-commodity-prices0406/; see also e.g., The world's 
largest chocolate maker, Hershey Co. have announced that they have 
increased the price to ``offset the higher costs of ingredients such as 
cocoa and sugar which has doubled in cost over the last year.'' 
Moreover, Lindt & Spruengli, the Swiss chocolate maker, said that 
``they may well increase their prices to consumers in the second half 
of the year to offset the higher costs of Cocoa prices that the company 
have incurred after Cocoa costs rose following financial speculation 
and post-election violence in the Ivory Coast.'' Edward Buckley, 
Hershey's Raise Their Prices By Nearly 10% To Offset Rising Costs, 
newsdailybrief.com (April 1, 2011), available at http://
newsdailybrief.com/hersheys-raise-their-prices-by-nearly-10-percent-to-
offset-rising-costs/353628/ (emphasis added); Jim Spencer and Dee 
DePass, As we pay more at the pump, oil trading curbs still on hold, 
Star Tribune (March 20, 2011) (quoting Ben Hirst, Chief Counsel, Delta 
Air Lines: ``[S]peculators try to anticipate what other speculators are 
going to do, and the market overreacts. It's not as though there's a 
shortage of product that caused the price to move up. It's a casino 
process with financial players betting on where the price is going to 
go. But it has an effect on [current] prices.'').
---------------------------------------------------------------------------
    Notably, during the March 31, 2011 hearing before the House 
Committee on Natural Resources, three out of the four panelists (Bill 
Graves, CEO and President of American Trucking Association and former 
Republican Governor of Kansas, Don Shawcroft, President of Colorado 
Farm Bureau, and Michael J. Fox, Executive Director of Gasoline & 
Automotive Service Dealers of America, Inc.) supported the need to 
regulate excessive speculation with strict aggregate position limits as 
required by Section 737 across all derivatives markets and to provide 
necessary funding to the CFTC to implement that strict anti-speculative 
regime.\24\ In particular, Mr. Fox told the Committee: ``The fastest 
way to $6 retail gasoline price is to not fully fund the CFTC and not 
impose the Dodd-Frank regulations. That's the fastest way to get to $6 
gasoline.'' \25\
---------------------------------------------------------------------------
    \24\ See, Harnessing American Resources to Create Job and 
Addressing Gasoline Prices: Impacts on Business and Families, Hearing 
Before the H. Comm. on Natural Resources, 112th Cong. (March 31, 2011).
    \25\ Id.
---------------------------------------------------------------------------
    Overbroad exemptions from speculative position limits are wholly 
unjustified, as it has been repeatedly proven that the swap dealer 
exemptions have allowed those Too Big to Fail banks to enter into 
excessive speculative transactions in the commodities market. 
Specifically, the bipartisan Senate Permanent Subcommittee on 
Investigations Report on Excessive Speculation in the Wheat Market, 
which was released on July 24, 2009, found that ``four swap dealers 
selling index-related swaps currently operate with hedge exemptions 
that allow them to hold much larger positions on the Chicago wheat 
futures market than would otherwise apply under the CFTC's speculative 
position limits.'' \26\ Allowing these kinds of exemptions to continue 
would drive excessive speculation in all commodity markets, which is 
why we are in an inflationary food and energy bubble at this time.
---------------------------------------------------------------------------
    \26\ Permanent Subcommittee on Investigations of the Committee on 
Homeland Security and Governmental Affairs, Excessive Speculation In 
The Wheat Market 37 (June 24, 2009) [hereinafter ``Wheat Report''].
---------------------------------------------------------------------------
    We Are Not Home Free Yet. There is now a substantial question 
whether Title VII of Dodd-Frank will be properly implemented because of 
resistance by big banks and other financial institutions. According to 
the Comptroller of the Currency, five big Wall Street banks have 
controlled 98% of the existing (pre-Dodd-Frank) OTC derivatives market, 
thereby necessitating, for example, the Antitrust Division of the 
Department of Justice to intervene in one of the critically important 
CFTC and SEC proposed rulemakings concerning ownership of the major new 
financial institutions created by Dodd-Frank. The big banks want to 
keep these institutions within their control. Needless to say, if 
properly implemented, the huge profits of these and other banks will be 
diminished by the competition that a transparent market brings, in the 
words of Dodd-Frank, ``free and open access'' to what would be highly 
competitive derivatives markets.
    While each argument advanced by swaps dealers must be analyzed on 
its own merits, there can be no mistake that a unifying rationale for 
minimizing the impact of Dodd-Frank, either implicitly or explicitly, 
is that we are now out of the financial crisis and there is no need for 
change. Therefore, it is suggested that as much of the status quo ante 
as can be preserved should now be left in place.
    A subsidiary argument is that if Dodd-Frank is fully enforced, it 
will be a job killer. However, as shown above, the undercapitalized 
casino that unregulated derivatives fostered in the subprime housing 
market was the ultimate job and pension killer. The misery created by 
that unregulated market often gets lost in Wall Street talking points. 
Moreover, the economic gambling infrastructure built before Dodd-Frank 
around subprime mortgages exists, e.g., for prime mortgages, commercial 
mortgages, student loans, auto and credit card debt.
    We are presently in a jobless ``recovery.'' Moreover, the shock of 
rapidly escalating energy and food prices, as well as threatened 
defaults by municipalities and European Union sovereign states, can 
either individually or collectively create economic dislocations akin 
to that experienced in the fall of 2008. For example, there is almost 
certainly an untold number of grossly undercapitalized naked CDS on 
municipal and sovereign obligations. If there are widespread defaults 
in those areas, an untold number of undercapitalized ``insurance'' 
guarantees will be triggered.
    The loss of profits of ``Too Big to Fail'' financial institutions, 
which have fully recovered and may be stronger and bigger now than 
before the meltdown, must be balanced against the well being of the 
American consumer, worker and taxpayer.\27\ Rejecting Dodd-Frank on the 
assumption that all is now well is a dangerous strategy to follow 
legislatively or at the regulatory level.
---------------------------------------------------------------------------
    \27\ Karen Weise, Banks `Too Big to Fail' Could Get Bigger: Federal 
agencies putting mortgage and derivative reforms into force are writing 
rules that seem to have a big-bank bias, Bloomberg Businessweek (April 
7, 2011), available at http://www.businessweek.com/magazine/content/
11_16/b4224025246331.htm.
---------------------------------------------------------------------------
    There is another concern that the implementation of Dodd-Frank 
would add significant operation costs to commercial end-users. However, 
as shown above, the Act contains a statutory ``end-user'' exception to 
ease the burden on businesses using swaps to mitigate risk associated 
with their commercial activities.\28\ The legislative intent shows that 
the drafters of the Act unequivocally share this goal as well.\29\ 
Furthermore Chairman Gensler and Chairwoman Schapiro have said 
repeatedly that end-users will not have to post margin for uncleared 
swaps and that the swaps dealer counterparty will not have to post 
margin.\30\ Simply, this is a case of commercial end-users not taking 
``yes'' for an answer to their worries about having to post collateral 
for uncleared swaps.
---------------------------------------------------------------------------
    \28\ See Dodd-Frank Wall Street Reform and Consumer Protection Act, 
Pub. L. No. 111-203,  723 (2010).
    \29\ See, Letter from Christopher Dodd, Chairman, Senate Committee 
on Banking, Housing, and Urban Affairs & Blanche Lincoln, Chairman, 
Senate Committee on Agriculture, Nutrition, and Forestry, to Barney 
Frank, Chairman, Financial Services Committee & Colin Peterson, 
Chairman, Committee on Agriculture, (June 30, 2010), available at 
http://www.wilmerhale.com/files/upload/
June%2030%202010%20Dodd_Lincoln_Letter.pdf (explaining that the end-
user exception is ``for those entities that are using the swaps market 
to hedge or mitigate commercial risk.'').
    \30\ See, Gensler Testimony, supra note 14; see also Schapiro 
Testimony, supra note 14.
---------------------------------------------------------------------------
    Whatever new costs Dodd-Frank imposes (and those costs are greatly 
exaggerated by those seeking to deflate regulation) are minimal 
compared to the dire economic havoc that might be caused by under-
regulation, especially when Congress is now almost devoid of ``stimulus 
bullets'' to repair future economic ills.
    Funding for the CFTC and SEC. Severely hampering the CFTC's and 
SEC's ability to implement Title VII of Dodd-Frank are their 
challenging financial and staffing conditions. With regard to the CFTC, 
that agency's gross under-funding makes performing its new and complex 
functions under Dodd-Frank ``a Herculean task.'' \31\ Under the new 
regulations, the CFTC must examine a voluminous amount of data and 
information encompassing transactions that number in the millions.\32\ 
An $11 million slash in the technology budget has forced the agency to 
cease developing a new program that would scan the overwhelming number 
of trades to detect suspicious trading. Moreover, the potential long-
term effects of insufficient funding is severe; operating under its 
current budget will mean that applications, findings, and enforcement 
required by the new law would languish.\33\ As Commissioner Bart 
Chilton aptly warns, ``Without the funding, we could once again risk 
another calamitous disintegration.'' \34\ Lack of funds not only 
shortchanges the Commission, but it also risks another widespread 
financial crisis.
---------------------------------------------------------------------------
    \31\ Ben Protess, Regulators Decry Proposed Cuts in C.F.T.C. 
Budget, N.Y. Times (February 24, 2011) (quoting CFTC Commissioner 
Michael Dunn), available at http://dealbook.nytimes.com/2011/02/24/
regulators-decry-proposed-c-f-t-c-budget-cuts/?ref=todayspaper.
    \32\ Jean Eaglesham and Victoria McGrane, Budget Rift Hinders CFTC, 
Wall St. J. (Feb. 25, 2011).
    \33\ See, Transcript of the Congressional Hearing to Review 
Implementation of Title VII of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act before the H. Comm. on Agriculture (Feb. 15, 
2011) (statement of Terry Duffy, Executive Chairman, CEM Group).
    \34\ See, Statement of Bart Chilton, Commissioner, Commodity 
Futures Trading Commission, Risky Business (February 24, 2011), 
available at http://www.cftc.gov/PressRoom/SpeechesTestimony/
chiltonstatement022411.html.
---------------------------------------------------------------------------
    In this regard, the CFTC lacks an adequate number of personnel to 
perform its increased regulatory duties. From 1999 to 2007, the agency 
shrunk from 567 full-time equivalents (``FTEs'') to 437. By 2010, the 
number of FTEs had risen to 650, only a 30% increase in the number of 
personnel since the agency's establishment in 1975. Chairman Gary 
Gensler estimates that he needs an additional 400 people to meet the 
challenges of regulating the multi-trillion dollar derivatives 
markets.\35\ As Barbara Roper of the Consumer Federation of America has 
noted, for example, the ``Draconian cuts'' of the House of 
Representatives' proposed budget would ``decimate that tiny agency 
without making any meaningful inroads in the Federal deficit.'' \36\ 
Even the relatively fiscally conservative Financial Times has recently 
editorialized that the SEC and CFTC deserve the funding levels that 
were promised to prevent a future meltdown through proper 
implementation of Dodd-Frank.
---------------------------------------------------------------------------
    \35\ Ben Protess and Mac William Bishop, At Center of Derivatives 
Debate, a Gung-Ho Regulator, N.Y. Times (Feb. 10, 2011), available at 
http://dealbook.nytimes.com/2011/02/10/at-center-of-debate-over-
derivatives-a-gung-ho-regulator/.
    \36\ See, Statement of Barbara Roper, Director of Investment 
Protection, Consumer Federation of America, Feb. 14, 2011.
---------------------------------------------------------------------------
    It is one thing to attack Dodd-Frank frontally by seeking 
deregulatory action either through legislation or weakened rules. There 
can be little doubt, however, that starving financial regulatory 
agencies dependent upon appropriations is a de facto rescission of 
Dodd-Frank. It asks Americans to face yet another crisis under the 
guise of budget cuts--a crisis that may ``the next time'' drag the 
United States and the world into the next Great Depression.
    In making this point, I also want to commend the CFTC for its 
heroic work in meeting the necessarily rigorous deadlines imposed by 
Dodd-Frank for well over 60 new rules. I spent 25 years in a private 
law practice heavily devoted to rulemaking advocacy, and then 
involvement in the judicial review of those rules in virtually every 
Federal circuit court of appeals in the country and in the United 
States Supreme Court. I was also very proud of the many rules that were 
promulgated by the CFTC while I was the Director of the Division of 
Trading and Markets. However, the hard and productive work performed by 
the CFTC in implementing Dodd-Frank, especially with its small staff, 
is extraordinary. The quality of that work also meets the highest 
standards of public service. This Subcommittee as one of the key 
oversight bodies for the CFTC should be very proud of this effort. The 
agency has more than demonstrated that it will be a vigilant protector 
of the important markets it now oversees if it receives the financial 
support it needs from this Congress.
    This testimony is further supported in detail by my March 3, 2011 
written testimony before the Senate Committee on Agriculture, Nutrition 
and Forestry at pp. 6 to 25; \37\ my March 28, 2011 comment letter to 
the CFTC on Position Limits for Derivatives; \38\ my published article 
in the University of Maryland School of Law's Journal of Business and 
Technology Law; \39\ and a series of my previously published articles 
and testimony delivered to Congress and to the Financial Crisis Inquiry 
Commission.\40\ Links to those documents may be found in the margin.
---------------------------------------------------------------------------
    \37\ Written Testimony of Michael Greenberger, Hearing Before the 
U.S. Senate Committee on Agriculture, Nutrition and Forestry Regarding 
the Implementation of Title VII of the Wall Street Reform and Consumer 
Protection Act (March 3, 2011), available at http://
www.michaelgreenberger.com/files/110303-
Greenberger_Senate_Ag_Testimony2.pdf.
    \38\ Comment Letter by Michael Greenberger, Professor, University 
of Maryland School of Law, Director, Center for Health and Homeland 
Security, to David Stawick, Secretary, Commodity Futures Trading 
Commission, Position Limits for Derivatives (March 28, 2011), available 
at http://www.michaelgreenberger.com/files/
Greenberger_PL_comment_letter.pdf.
    \39\ Overwhelming a Financial Regulatory Black Hole with 
Legislative Sunlight: Dodd-Frank's Attack on Systemic Economic 
Destabilization Caused by An Unregulated Multi-Trillion Dollar 
Derivatives Market, 6 J. Bus. & Tech. L. 127 (April 2011), available at 
http://works.bepress.com/michael_greenberger/41/.
    \40\ Derivatives in the Crisis and Financial Reform, in The 
Political Economy of Financial Crises, Oxford University Press Handbook 
(Gerald Epstein & Martin Wolfson eds., forthcoming 2012); Is Our 
Economy Safe? A Proposal for Assessing the Success of Swaps Regulation 
under the Dodd-Frank Act, in The Future of Financial Reform: Will It 
Work? How Will We Know? (Roosevelt Institute 2010), available at http:/
/works.bepress.com/michael_greenberger/34; Out of the Black Hole: 
Regulatory Reform of the Over-the-Counter Derivatives Market, in Make 
Markets Be Markets 99 (Roosevelt Institute 2010), available at http://
works.bepress.com/michael_greenberger/35/; Out of the Black Hole: 
Reining in the Reckless Market in Over-the-Counter Derivatives, 
American Prospect (2010), available at http://works.bepress.com/
michael_greenberger/37; and Written Testimony of Michael Greenberger, 
Hearing Before the Financial Crisis Inquiry Commission Regarding The 
Role of Derivatives in the Financial Crisis (June 30, 2010), available 
at http://www.fcic.gov/hearings/pdfs/2010-0630-Greenberger.pdf.

    The Chairman. Well, I thank the witnesses for your 
comments. We will now go into the question period.
    In spite of those comments, I do think that cost-benefit 
analysis is an appropriate tool to use to make sure that we get 
the regulations right.
    So, Mr. Scott, Dr. Overdahl, do we need, looking forward--I 
know we don't have it in place right now, but looking forward 
with respect to the CFTC, do you recommend any specific 
legislative changes to 15(a), or whatever it might be, to 
require broader economic analysis of impact regulations would 
have for the good or for the bad on the folks who have to 
comply with those regulations?
    Dr. Overdahl, do you want to start?
    Dr. Overdahl. Sure.
    I think the obligation under 15(a) to consider is one that 
is pretty easily satisfied, and I can envision language that 
would go beyond that. I guess my preference would be that it 
would be a direction to the Commission to develop their own 
internal procedures on how to analyze rules, how to implement 
effective cost-benefit analysis.
    I think if they are doing that, with help, perhaps, from 
the OIRA at the OMB--the reason I mention them is because they 
have a lot of experience dealing with Federal agencies that 
have this very same type of requirement, that that could 
improve the process.
    And, if there was anything additional, it would be that 
somehow their analysis be reviewed by somebody. I don't think 
it really matters by whom, because just by the fact that 
somebody is looking, I think, will improve that process.
    The Chairman. Mr. Scott?
    Mr. Scott. I agree with what Dr. Overdahl just said. I 
think we need to impose a more demanding standard of cost-
benefit analysis on the CFTC--and, by the way, the SEC, as 
well.
    And I also agree that somebody should be looking at this 
analysis to check it out. So my proposal is that OIRA, within 
OMB, review the cost-benefit analysis of these independent 
financial agencies and make comments. Unlike with the non-
independent agencies, their comments would not be binding. 
Actually and technically, they are not even binding on the non-
independent agencies. But, practically speaking, since they are 
part of the Administration, they are.
    I think we need to respect the independent agencies and 
their independence. So I would not make the Office of 
Management and Budget's review binding on these agencies. But, 
it would add a lot to the process if they reviewed the cost-
benefit analysis and articulated what their opinion was. This 
would put pressure, obviously, on these agencies to do a better 
job.
    Dr. Overdahl. And could I just add one thing?
    I think there needs to be some distinction between major 
rules and minor rules. I don't think you would want to have the 
same level of scrutiny for every possible rule. But, certainly, 
for major rules I think it is a reasonable requirement.
    Mr. Scott. Major versus others, is that the issue? I am not 
sure.
    Dr. Overdahl. Yes.
    Mr. Scott. Well, of course, then we get into what is major 
and what is not, so it is difficult.
    But the spirit of your question is that the more important 
the rule and the more potential economic impact that it has on 
the country, the more stringent the analysis should be, because 
it matters more.
    So, in the operation of a cost-benefit analysis regime, 
what you are suggesting will happen, but I wouldn't, kind of, 
say major, yes, non-major, no----
    The Chairman. I guess that the struggle here is to write a 
principles-based requirement that is not so prescriptive that--
whatever. But that is the struggle we all run.
    Mr. Duffy, on the position limits, a lot has been said 
about that. We have a recent report from the Financial 
Services--something--that they don't think position limits 
work. I got folks on both sides of this.
    Is it your sense, from an international standpoint--Mr. 
Scott, you may want to pitch in on this, as well--that all 
these international folks are just waiting with bated breath 
for us to do position limits so they can flood in and do them 
themselves? I mean, they are really wanting to do this, but 
they are just waiting on the U.S. to lead in that regard?
    Mr. Duffy. I don't believe that the position-limits issue 
in Europe will take hold. They have basically said--I know that 
the French want more strict limits, the U.K. wanted no limits, 
so they came out with a compromise saying that if, in fact, 
they find an issue where they need to impose certain limits, 
they have the ability to do so. The study you are referring to, 
I believe, was the Chairman of the U.K. FSA and two other 
academics that came out and said they saw no correlation 
between speculation and the price of any particular product.
    And I do believe that they would love to see the United 
States of America act, put on prescriptive position limits on 
certain products and watch that business migrate over to London 
and other parts of Europe. This is something that is very 
attractive, very appealing.
    And you have to also--and I know you know this, Mr. 
Chairman. London is very much focused on financial services, 
and it is a big part of their economic fabric. And if they lose 
any market share, that puts them in a very difficult situation. 
So, without a doubt, they will not make a move until the United 
States of America does first.
    The Chairman. Thank you.
    Mr. Boswell for 5 minutes.
    Mr. Boswell. Well, thank you.
    Interesting points you have all made. Stimulating, for 
sure. Let's see where we can go here.
    But, Mr. Greenberger, you have heard your fellow panelists 
and others advocate for delaying implementation of the 
derivatives title of Dodd-Frank. Who do you think benefits the 
most from delay?
    Mr. Greenberger. There is no doubt that the big banks, who 
now have to face regulation that they didn't have before, want 
to see this delayed. Their profits are going to be cut. Does 
that mean the financial services industry, which now makes 33 
percent of all the profits of the United States, is going to be 
cut? No. It means the big banks will have to share those 
profits with banks in your jurisdiction. They won't hold an 
oligopoly anymore.
    They are desperate to, through budget cuts, procedural 
delays, slow this thing down. And you run the risk that while 
you are slowed down you are bareback; the protections are not 
there. If there is another crisis--and, believe me, if you had 
to bet whether there was or wasn't, from your instinct you got 
to worry about it--your constituents are going to want to know, 
where were you? This was your Subcommittee; why weren't the 
rules put in place?
    Mr. Boswell. I don't know about you, Mr. Chairman. My local 
banks, I hear a lot of complaints--and I have some great local 
banks, community banks, so don't misinterpret what I am saying. 
But I have producers out there, been at it a long time, pretty 
stable, that are having a hard time putting resources together.
    Do you think that because of what this whole picture of 
what we are talking about is what is running downhill, water 
and other things run downhill, is that why they are being so 
difficult to satisfy on any process of operational loans?
    Mr. Greenberger. Look, credit is tight out there. Jamie 
Dimon just got a $23 million bonus and a $600,000 payment for 
moving expenses. Your constituents cannot borrow money. The 
too-big-to-fail banks are too big to worry about loaning money 
to the average American, the average student, the average 
homeowner.
    And what do they want to do? They want to do proprietary 
trading. They want to deal with these swaps. They want to enter 
into the AIG transactions where they bet that something is 
going to happen. And when they lose and don't have the money, 
they will turn around to you and say, ``Hey, if we go down, 
everybody goes down. You had better rescue us.''
    Lord Turner has been mentioned here. Lord Turner has made 
the very famous statement that these big banks are societally 
useless. They don't help your constituents. To the extent you 
delay this rule, you are helping Jamie Dimon get a bigger bonus 
next year, more than $23 million. You are not supporting the 
average citizen in your constituency.
    Mr. Boswell. I still have a few moments.
    Mr. Scott, your testimony advocates consistency in 
coordination among the regulators with regard to Dodd-Frank, 
except when required by real differences. It appears the 
prudential regulators believe end-users should be required to 
post margin to better protect the banks overseen by their 
prudential regulators. Do you believe this difference is 
merited?
    Mr. Scott. I am a little hard of hearing, Congressman, and 
I didn't catch your question.
    Mr. Boswell. Okay. Your testimony advocates consistency in 
coordination among regulators with regard to Dodd-Frank except 
when required by real differences. It appears prudential 
regulators believe end-users should be required to post margins 
to better protect the banks overseen by the regulators. Do you 
believe this difference is merited?
    Mr. Scott. Sorry, Congressman. It is my fault, not yours.
    I guess the question is, when should there be differences 
between the CFTC and the Fed in particular. I don't think there 
should be differences. I think whatever the CFTC does should be 
consistent with preventing systemic risk.
    Mr. Greenberger talked about the crisis. A large part of 
the losses in that crisis were due to systemic risk. And it is 
the Fed's job, principally, under Dodd-Frank, to worry about 
that.
    So, there should be consistency, okay, not only between the 
CFTC and the SEC, but also with the Fed.
    Mr. Boswell. Thank you.
    I yield back.
    The Chairman. The gentleman yields back.
    Mr. Neugebauer from Texas for 5 minutes.
    Mr. Neugebauer. Thank you, Mr. Chairman.
    And I was pleased to hear--what we are hearing is a common 
theme. I had a hearing last week in Financial Services 
Oversight Committee, and we heard a lot about people saying 
that there wasn't appropriate cost-benefit analysis going on. 
And when you look at Dodd-Frank, for example, 240 rulemaking 
opportunities here, compared to Sarbanes-Oxley, which I think 
had 16 or 17. And the volume and the speed about which a lot of 
these were coming out is very concerning.
    In fact, Commissioner Sommers was one of the witnesses. And 
she said, ``we are voting on rules that contain very short, 
boilerplate cost-benefit analysis. And I think when you look at 
the size and the scope of the impact of a lot of these 
proposals, a boilerplate, short analysis doesn't seem to 
correspond with what the potential conflicts or potential 
outcomes of some of these changes are.'' So I concur with many 
on the panel that I think that process needs to take place.
    I think the other thing, Mr. Scott, you mentioned, and this 
is something else that I have actually said to Mr. Gensler, is 
that after all of these regulations are promulgated that, 
really, we need to then take a big-picture look at what--not 
only just being able to execute those from an infrastructure 
standpoint, but also the consequences of all of those 
regulations and how they not only impact the marketplace but 
also competitiveness, the cost, and, in fact, how much 
incrementally did we improve the system.
    A lot of people disagree that Dodd-Frank is the bill that 
is going to save the world. What I would say is we are not 
quite sure of that, because we didn't do the proper 
investigation and oversight in going in and looking at what did 
happen in the system before we implemented this very broad 
piece of legislation. In many cases, we had regulators that 
just weren't doing their job, not that they needed more 
regulation.
    Mr. Duffy, you talked a little bit about London. And, 
certainly, that is one--in a global marketplace, that is one of 
the places that we--but you didn't--and I apologize, I didn't 
get to hear all of your testimony--but there are other places, 
Asian markets, as well.
    Can you elaborate, when you look at the landscape that is 
going on now, European, because what I am beginning to hear is 
that the infrastructure is building up in the Asian markets to 
be very competitive.
    Mr. Duffy. There is absolutely no question about it. One of 
the largest competitors for CME's agricultural business is in 
Dalian, China, today under the Dalian Exchange. They are 
trading enormous amounts of grain products throughout--they are 
discovering price throughout Asia under a different regulatory 
regime.
    Hong Kong has become more and more focused on financial 
services. And, Singapore has become the haven for Asian 
institutions to do their business. And they do it completely 
different than we do here in the U.S.
    We are competing with the world, Congressman, as you know. 
I mean, our world has gotten so small, and it has no borders. 
So if we get--and I will say it again--a regulatory arbitrage, 
people will migrate to where they can do business in the most 
cost-effective way. And the way you do that is to have 
liquidity generate there in certain jurisdictions, and that is 
how you move the business.
    We are seeing a tremendous amount of liquidity throughout 
Asia. We don't talk about it as much here in Washington; we 
normally talk more about Europe. Asia is just, if not a bigger, 
threat to the U.S. financial services, because liquidity is 
building by the second over there. So we are very concerned 
with our Asian competitors, but we do work and compete globally 
over there also.
    Mr. Neugebauer. Thank you.
    Any other panelists want to comment on that issue?
    Mr. Scott. Well, I agree again with Mr. Duffy. But I 
articulated concern in my testimony that we could take measures 
actually that makes this worse. If the CFTC took the attitude, 
for instance, that European or Asian clearinghouses were not 
adequately regulated in its view--maybe their membership 
requirements were too high compared to Mr. Gensler's--then I 
think the CFTC actually has the power under Dodd-Frank to 
restrict use of those clearinghouses by U.S. firms, which would 
be a terrible result, because the E.U. would, possibly, 
retaliate, and then we would get into a conflict.
    So, as I said, regulatory arbitrage would be a better 
outcome than that kind of a stalemate. All to say that we 
should be doing a lot more than we are doing. It is not enough 
to go over to London and make a speech, okay? What you have to 
do is sit down with the E.U., the staffs, and work out these 
differences.
    Mr. Neugebauer. Thank you, Mr. Chairman.
    The Chairman. The gentleman yields back.
    The gentleman from Illinois, Mr. Hultgren, for 5 minutes.
    Mr. Hultgren. Thank you, Mr. Chairman.
    Thank you, all of you, for being here.
    Just a couple of questions. Mr. Duffy, I wondered if you 
could just comment briefly on Chairman Gensler's proposal to 
phase in the clearing requirements either according to the 
parties to the swap or by asset class.
    Mr. Duffy. Well, fading in the implementation, one of the 
things that we think is critically important--and I hope I am 
answering your question properly, sir--is there is a 
requirement to bring dealer-to-dealer and dealer-to-client on 
clearing of these products. What we feel is very important 
under the Dodd-Frank law, it said, give the customer the choice 
on where they want to clear their product. And if we just go 
ahead and lead with just dealer-to-dealer, the client will have 
no other alternative but to go to a particular clearinghouse.
    So we would like to see the implementation of the clearing 
coincide together, which we think makes the most amount of 
sense, to be with the spirit of the law, and also let the 
client make that choice.
    I hope I am answering your question properly.
    Mr. Hultgren. Yes, I think you are. Do you get the sense 
that they are open to that, from comments of Chairman Gensler 
and others? Are they----
    Mr. Duffy. I don't have any indication that they are not 
open to it, sir. I have been working with Chairman Gensler and 
other Commissioners to make sure they understand that point. It 
is a competitive issue amongst many different clearing 
entities. And, of course, the law would suggest that the 
customer has that right.
    And so, yes, I do believe we are making some headway, but I 
am concerned because of other things we have seen coming out of 
the agency.
    Mr. Hultgren. Yes.
    Switching gears just a little bit, also, Mr. Duffy, an area 
that hasn't been discussed at great length in the Committee are 
the rules proposed--the proposals aimed at market manipulation 
and anti-disruptive trading practices.
    While we certainly want to ensure bad actors cannot engage 
in manipulative or disruptive practices, we have heard concerns 
that vague terms of the rules may have a freezing effect on the 
market.
    I wonder about your view on that, if these rules do go too 
far. And, if so, how can the regulators strike that right 
balance of protecting from bad actors while at the same time 
protecting our markets?
    Mr. Duffy. First of all, market manipulation is something, 
obviously, we are very focused on. We are a publicly traded 
company. We are a 156 year old institution. We have never had a 
customer lose a penny due to a clearing member default, so we 
have all these great things that we have to make sure we keep 
ourselves at the highest standard. And if we don't have 
credible markets, we don't have a credible company. So market 
manipulation is something we spend a lot of time focusing and 
watching, and we feel very comfortable there.
    Anti-disruptive trading practices is something that, when 
you create a law as it relates to what is considered anti-
disruptive trading practices--I traded for 23 years of my life, 
sir, and the markets go up and they go down and they go fast 
and they go furious. In the day of ``electronification'', they 
go in milliseconds, not in 10 second time periods.
    So these are laws or rules that are being promulgated, 
putting forward, that could be so broad and vast that it would 
actually take a transaction that is absolutely, 100 percent 
legitimate that is done on the close of a trading session and 
deem that to be anti-disruptive. Many participants like to 
enter their orders on the close of business or the opening of 
business because that gives them a mark for the next day and 
they know where the market closed.
    So if you were to enter into that and that order actually 
moved the market, whether because of an illiquid time of the 
trading, you could be deemed as anti-disruptive trading 
practices. This is just too wide, too vast, and could 
absolutely kill liquidity, move it more to the over-the-counter 
market, move it to block, take it away from the central 
marketplace. And all the things that Mr. Greenberger doesn't 
want to see happen will happen if this rule goes into place.
    Mr. Hultgren. And that is my fear, and I think many of our 
fears, is that these broad responses here really could do 
exactly the opposite of what our hope was with so much of this.
    Last week, Chairman Gensler was asked about a letter he 
received from the UK's Financial Services Authority expressing 
concern about a CFTC proposal to cap the amount a capital 
clearinghouse can require of potential clearing members at $50 
million. FSA expressed concerns that the proposal may actually 
inject more risk into the system.
    I wonder if you could, Mr. Duffy, just respond quickly on 
that idea of would that potentially inject more risk into the 
system. And are there other CFTC proposals that you think might 
result in more instead of less risk to the system?
    Mr. Duffy. And I appreciate the question, sir.
    On the clearing requirement minimums, there are 
clearinghouses, as you know--how they work, they are 
capitalized by the members of the firms. And when there is a 
potential default or something goes wrong within one of the 
clearing members, they all participate in assuming that 
default.
    So if you are trading 4,000 to 5,000 transactions a day 
with a high notional value of over-the-counter swaps 
transactions and you have people that are involved in your 
clearinghouse for $50 million while the others are capitalized 
at $1 billion and one of them defaults, how are you going to 
get the $50 million participant to help in the default process? 
They absolutely cannot.
    Because what the Chairman is suggesting is, whatever you 
trade, then you can put a small amount of money just up to that 
limit, which would make sense from a perspective if the world 
was perfect, but if there are defaults, like we saw Lehman, 
like we saw Bear, like we saw all these other institutions, 
people have to participate to come together to help make up the 
difference. And if you have $50 million, I assure you will be 
out of money before the first transaction happens. You won't be 
able to help out in there.
    So I understand what the dealers are talking about, and I 
understand what the Chairman is talking about. I don't know if 
there is a good mix. But you have to have everybody be able to 
participate in the default process. That is what keeps the 
system sound and safe.
    Mr. Hultgren. Thank you.
    Thank you all for being here. I do have other questions. I 
am out of time, but hopefully we can present those to you. I 
also felt bad that I missed the first part of the hearing. We 
had some votes in another committee that I am on that I had to 
be at. But I do appreciate the work that you are doing. This is 
important right now for us to be discussing this.
    So I yield back my time. Thank you, Mr. Chairman.
    The Chairman. The gentleman's time has expired.
    We will go another round.
    I wanted to ask Ms. McMillan, you and I had a conversation 
yesterday about the impact that some of these rules would have 
on some disclosure requirements: the CFTC would force you to 
disclose, and the SEC would prevent you from disclosing.
    So can you talk to us a little bit more about this loss of 
the exemption of Rule 4.5, what it does to your industry and 
member companies? And what is your opinion that this proposed 
action by the CFTC will do?
    Ms. McMillan. Certainly. Thank you.
    The proposed removal of the exemption of Rule 4.5 by the 
CFTC would essentially require funds that are already regulated 
by the SEC to have a second layer of regulation by the CFTC if 
they trip over two different tests, which, the way that they 
are drafted very, very broadly, they are likely to do.
    One of the main reasons for that is that swaps are now part 
of the CFTC's jurisdiction and are included in this proposal. 
We don't think that the CFTC took adequate time to understand 
how registered investment companies use swaps. They are more 
for hedging, for risk management, not for what is typically 
viewed in this Committee as being speculative purposes.
    The other is that there is a marketing restriction that 
could prohibit investment companies from putting in the 
prospectus disclosure that they are required to put in by the 
SEC or risk management or risk disclosure that they are also 
required to put in if they engage even to a small extent in 
future options or swaps.
    The problem, then, is that if these companies then also 
have to be regulated by the CFTC, these are largely disclosure 
issues, and both agencies have different philosophies about how 
that disclosure should be done. Some are similar and could be 
reconciled fairly easily, but some are absolutely contradictory 
and kind of go to the fundamental nature of how these agencies 
think investors should get information.
    One good example is that the SEC absolutely prohibits 
registered investment companies from putting in performance of 
the advisor with respect to other pools that it manages, on the 
theory that that could mislead investors because the other 
pools may be very different from the one that they are 
investing in. The CFTC takes the opposite approach and says, 
well, that is valuable information for an investor because they 
should know how the advisors perform, particularly if the 
advisor doesn't have a long track record.
    If a company is required to comply with both rules, it is 
going to violate one of them; it simply cannot go forward. And 
while the CFTC in its proposal recognized that there are these 
contradictions, they did not offer up any solution to that, so 
the public doesn't have any opportunity of knowing what regime 
it may have to live under and to provide comments. And we do 
think that disclosure to investors of this and other issues are 
very important and we should have the opportunity to comment on 
it.
    The Chairman. All right. Thank you, Ms. McMillan.
    I yield back.
    The gentleman from Iowa, Mr. Boswell, for another 5 
minutes.
    Mr. Boswell. Thank you, Mr. Chairman. I don't think I will 
need that.
    I think I owe an apology to Mr. Scott. Am I speaking 
clearly? Can you hear me? No, I thank you very much for being 
here. And I want to make sure I am clear in our discussion.
    But prudential regulators, the Feds, say end-users should 
post margin. The CFTC says no. I think you say Fed views should 
trump CFTC views. Question: Do you agree with prudential 
regulators that end-users should post margin to better protect 
the banks?
    Mr. Greenberger. If I can answer that question, I think 
there has been a lot of misunderstanding about that. The FDIC 
published a rule yesterday. In fact, Commissioner O'Malia said, 
``Oh, the two Commissions couldn't be further apart.'' If you 
read what the FDIC said, it says that commercial end-users who 
have good credit do not have to post margin. And, as they said, 
even before we had Dodd-Frank, under the old thing, in a self-
regulatory sense, banks will not extend counterparty credit if 
the counterparty doesn't have good credit.
    If you read these carefully, the FDIC, representing the 
prudential regulators, and the CFTC both say they will not 
require end-users with good credit ratings to post margin. 
There is no difference between the two agencies. I can brief 
you on that. In the FDIC, page 7-8 of their summary says, we 
agree with Chairman Gensler and the CFTC staff; we want to do 
what they are doing.
    The end-user here is protected by statute, if it is a 
commercial end-user. The agencies have said they will not 
collect margin. There has been no issue that has been more 
carefully drilled into and more reassurances offered that end-
users don't have to clear and they don't have to post margin. 
And, as I keep saying, people don't want to take ``yes'' for an 
answer. They are out from under.
    Mr. Boswell. Well, thank you for that comment.
    Mr. Scott, would you like to--I pose the question to you.
    Mr. Scott. Well, maybe from Chairman Gensler's point of 
view, they are out. But the bank regulators have a concern, 
which I think was articulated in their proposal yesterday, that 
a bank could get overexposed to a counterparty. And so they 
want to set some limit on the unsecured exposure as net of the 
collateral protection that their counterparty has, whether that 
counterparty is financial or commercial.
    I think, in practice, this isn't going to be a big deal 
because the threshold will be set high. But to say that the 
regulators of banks would be totally unconcerned with the 
counterparty risk of commercial counterparties seems to me not 
the right solution.
    What the right solution is, is to recognize that commercial 
counterparties are different, they pose different risks, and we 
should have a very high risk limit; it shouldn't be infinite. 
And I think that is basically what the bank regulators are 
saying.
    Mr. Boswell. Thanks for the comment.
    Mr. Greenberger, do you have any response?
    Mr. Greenberger. Yes, the only thing I am going to say is, 
Mr. Scott said the Federal Reserve should be more involved in 
this, and the statute requires both the SEC and the CFTC to 
consult with the Federal Reserve. What we are beginning to see 
is the Federal Reserve and the prudential regulators saying 
they are going to be tougher than the CFTC.
    So if we criticize the CFTC, if we put them down, ``They 
aren't doing their job right,'' ``They aren't taking this 
seriously,'' ``They are using boilerplate explanations,'' you 
are going to so diminish them that two people are going to lose 
in this battle. This Committee is going to end up seeing these 
guys go over to prudential regulators, and they are going to 
lose the protection of this Committee. If you beat the CFTC 
down like this, you are just asking for someone to take them 
over. As you well know, that has been up in the air.
    I think the CFTC--they have not used boilerplate. They have 
busted their rear ends on this. They are not ideological. Some 
of those people were hired in the Reagan Administration, served 
under Wendy Gramm. They are trying to do their best. We hear, 
``They could do this. They could do that. They might do this.'' 
Let's see what they do.
    Then we are told on judicial review they are going to get 
killed. Judicial review is where this should all work out. If 
they are not doing their job right, we are being told the 
courts will reverse them. I have every confidence, because I 
have handled many judicial reviews, all the way up to the 
Supreme Court, that the CFTC will survive judicial review. They 
are doing this carefully, thoughtfully.
    And if their economic analysis is bad, as Mr. Scott has 
said, they will be reversed in the D.C. Circuit. I don't think 
they will be reversed; I think they can justify it.
    You have to ask yourself, do you want to take the place of 
a reviewing cost and unwind the 2,400 page statute or, as 
normally happens, let this work its way out in the normal 
process?
    Mr. Boswell. Thank you.
    I guess I should yield back.
    The Chairman. The gentleman from Illinois for a second 
round.
    Mr. Hultgren. Thank you. A couple quick questions.
    Dr. Overdahl, just a quick question. Do economists at the 
CFTC write the cost-benefit sections of the rules?
    Dr. Overdahl. When I was there, it certainly was not the 
case. It was the drafters of the rule who are in the rulemaking 
divisions, typically, the attorneys in those divisions that 
wrote the cost-benefit analysis.
    Mr. Hultgren. A quick question for Ms. McMillan. The CFTC's 
proposal says that Rule 4.5 proposals are intended to stop the 
practice of registered investment companies offering futures-
only investment products without Commission oversight.
    I wonder if you can tell us what the problems have been 
with those funds.
    Ms. McMillan. To be perfectly honest with you, I am puzzled 
as well. We have not seen those kinds of problems. They 
actually were not alleged in the rule proposal.
    We do understand that the CFTC has the right to take a look 
at practices that it feels may come within its jurisdiction, 
but the proposal that it has drafted goes well beyond even what 
its stated intent was.
    Mr. Hultgren. Thanks.
    Last question. Mr. Scott, you have done quite a bit of 
research and writing in the past as it relates to our financial 
regulatory structure and the competitiveness of U.S. capital 
markets. Many of your recommendations were focused on 
modernizing the regulatory structure to better reflect today's 
markets.
    In your view, has Dodd-Frank modernized the regulatory 
structure?
    Mr. Scott. The short answer is ``no.'' We needed much more 
than FSOC to rationalize our regulatory structure.
    You always talk about CFTC and SEC. As you know, at some 
point, the discussion of those agencies were up for merger 
through the Paulson blueprint. That never occurred.
    I think the fragmentation of our regulatory structure has 
made it dysfunctional. I am depressed by the fact that the 
biggest crisis since the Depression couldn't change it. It 
actually made it more complicated. You have FSOC, Office of 
Financial Research, Consumer Financial Protection Bureau. So I 
am about to give up hope for serious reform, Congressman.
    Mr. Hultgren. Just to wrap up, Mr. Duffy, I wonder, just 
from your thoughts and your view, has Dodd-Frank modernized the 
regulatory structure?
    Mr. Duffy. You know, the jury is still out on that, sir. I 
think we have to wait until all the rules get written, comments 
are in, and the implementation happens. I think that is even 
more reason to take pause and make sure we get it right. I 
think, in order to answer that question, only time will tell.
    So, hopefully everybody gets an opportunity to comment. I 
am hearing the amount of comments that are coming into the 
CFTC, the letters are staggering, in the thousands. And this is 
something that needs to be completely worked out.
    There are parts of Dodd-Frank that we are very, very 
supportive of, and there are other parts that we are not. And I 
am hopeful that Dodd-Frank can do what the CEA Modernization 
Act of 2000 did for our industry. So I am very hopeful that can 
happen, but, again, we have our concerns. But only time will 
tell.
    Mr. Hultgren. Yes. We do, as well.
    Well, thank you very much. I appreciate it.
    I yield back my time.
    The Chairman. The gentleman yields back.
    Before we adjourn, I will ask the Ranking Member if he has 
any closing remarks.
    Mr. Boswell?
    Mr. Boswell. No.
    The Chairman. Well, I want to thank our panel. Some diverse 
views. We appreciate that.
    I do think it is the role of this Committee, Subcommittee, 
to continue to watch what is going on. And an attitude that we 
are simply players in a Greek tragedy, that we can't affect our 
fate, is inaccurate. The fact that we question what is going 
on, we ask for things--that we are trying to get this thing 
done correctly, I think is the appropriate role of this 
Committee and this Subcommittee. It is one that we will 
continue to explore vigorously as we work with Chairman 
Gensler, with Dan Berkovitz, who testified earlier, to try to 
get the best regulatory scheme we can that allows these markets 
to continue to function in America, that allow American end-
users and producers across this country to get at the tools 
they need to mitigate their risks and deal with those risks in 
ways that make sense, and that allows the providers a scheme 
that they can comply with that is cost-effective and it gets 
done what we all want to have done.
    So, with that, we will adjourn the hearing. Thank you very 
much.
    Under the rules of the Committee, the record of today's 
hearing will remain open for 10 calendar days to receive 
additional material, supplemental or written responses from the 
witnesses to any questions proposed by a Member.
    This meeting of the Subcommittee on General Farm 
Commodities and Risk Management is adjourned.
    [Whereupon, at 12:00 p.m., the Subcommittee was adjourned.]

                                  
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