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EMERGENCE OF SWAP EXECUTION FACILITIES: 

A PROGRESS REPORT 

HEARING 

BEFORE THE

SUBCOMMITTEE ON 

SECURITIES, INSURANCE, AND INVESTMENT 

OF THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED TWELFTH CONGRESS 

FIRST SESSION 

ON 

A PROGRESS REPORT ON THE EMERGENCE OF SWAP EXECUTION 

FACILITIES 

JUNE 29, 2011 

Printed for the use of the Committee on Banking, Housing, and Urban Affairs 

( 

Available at: http://www.fdsys.gov/ 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

TIM JOHNSON, South Dakota, Chairman 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

SHERROD BROWN, Ohio 

JON TESTER, Montana 

HERB KOHL, Wisconsin 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

MICHAEL F. BENNET, Colorado 

KAY HAGAN, North Carolina 

RICHARD C. SHELBY, Alabama 

MIKE CRAPO, Idaho 

BOB CORKER, Tennessee 

JIM DEMINT, South Carolina 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

JERRY MORAN, Kansas 

ROGER F. WICKER, Mississippi 

DWIGHT FETTIG, Staff Director 

WILLIAM D. DUHNKE, Republican Staff Director 

DAWN RATLIFF, Chief Clerk 

WILLIAM FIELDS, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

SUBCOMMITTEE ON SECURITIES, INSURANCE, AND INVESTMENT

JACK REED, Rhode Island, Chairman 

MIKE CRAPO, Idaho, Ranking Republican Member 

CHARLES E. SCHUMER, New York 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

HERB KOHL, Wisconsin 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

MICHAEL F. BENNET, Colorado 

KAY HAGAN, North Carolina 

TIM JOHNSON, South Dakota 

PATRICK J. TOOMEY, Pennsylvania 

MARK KIRK, Illinois 

BOB CORKER, Tennessee 

JIM DEMINT, South Carolina 

DAVID VITTER, Louisiana 

JERRY MORAN, Kansas 

ROGER F. WICKER, Mississippi 

KARA STEIN, Subcommittee Staff Director 

GREGG RICHARD, Republican Subcommittee Staff Director 

(II)

C O N T E N T S 

WEDNESDAY, JUNE 29, 2011 

Page 

Opening statement of Chairman Reed ................................................................... 1 

Opening statements, comments, or prepared statements of: 

Senator Crapo ................................................................................................... 2 

Prepared statement ................................................................................... 36 

WITNESSES 

Kevin McPartland, Director of Fixed Income Research, TABB Group ............... 4 

Prepared statement .......................................................................................... 36 

Responses to written questions of: 

Senator Toomey ......................................................................................... 76 

Neal B. Brady, Chief Executive Officer, Eris Exchange, LLC ............................. 6 

Prepared statement .......................................................................................... 39 

Responses to written questions of: 

Chairman Reed .......................................................................................... 78 

Senator Toomey ......................................................................................... 80 

Ben Macdonald, Global Head of Fixed Income, Bloomberg, L.P. ........................ 8 

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

James Cawley, Chief Executive Officer, Javelin Capital Markets ...................... 10 

Prepared statement .......................................................................................... 59 

William Thum, Principal and Senior Derivatives Counsel, The Vanguard 

Group, Inc. ............................................................................................................ 27 

Prepared statement .......................................................................................... 60 

Stephen Merkel, Executive Vice President and General Counsel, BGC Partners, Inc. ............................................................................................................... 29 

Prepared statement .......................................................................................... 62 

Chris Bury, Cohead of Rates Sales and Trading, Jefferies & Company, Inc. .... 31 

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

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Statement submitted by the Investment Company Institute .............................. 85 

Paper submitted by the International Swaps and Derivatives Association ....... 93 

Letter submitted by Stephen Merkel, Chairman, Wholesale Markets Brokers’ 

Association ............................................................................................................ 114 

(III)

(1) 

EMERGENCE OF SWAP EXECUTION 

FACILITIES: A PROGRESS REPORT 

WEDNESDAY, JUNE 29, 2011 

U.S. SENATE, 

SUBCOMMITTEE ON SECURITIES, INSURANCE, AND

INVESTMENT, 

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, 

Washington, DC. 

The Subcommittee met at 9:32 a.m., in room SD–538, Dirksen 

Senate Office Building, Hon. Jack Reed, Chairman of the Subcommittee, presiding. 

OPENING STATEMENT OF CHAIRMAN JACK REED 

Chairman REED. Let me call this hearing to order. Senator Crapo 

and I want to welcome our witnesses. This morning we are going 

to focus on the topic ‘‘Emergence of Swap Execution Facilities: A 

Progress Report.’’ 

The financial crisis revealed some significant weaknesses in our 

financial sector. One of the most problematic was the over-thecounter derivatives market. As a result, the Dodd-Frank Wall 

Street Reform and Consumer Protection Act of 2010 developed new 

rules for the OTC market to insulate both the U.S. economy and 

the American taxpayer from any future extraordinary losses in this 

area. 

In particular, Dodd-Frank mandated that all cleared trades be 

executed either on an exchange or on a new trading platform called 

a swap execution facility, or SEF. The Dodd-Frank Act defined a 

swap execution facility as ‘‘a facility, trading system, or platform in 

which multiple participants have the ability to execute or trade 

swaps by accepting bids and offers made by multiple participants 

in the facility or system through any means of interstate commerce.’’ 

The development of SEFs should transform the current trading 

marketplace by providing significantly greater pre- and post-trade 

transparency for regulators and market participants alike. 

In addition, once a trade has been completed, a counterparty 

should be able to compare the price it receives on a particular trade 

with the price of similar trades that buy and force similarly standardized products. This information should also be useful to those 

analyzing the effectiveness of hedging strategies. Finally, increased 

transparency in the new trade reporting requirements will give 

regulators better information and additional tools to monitor the 

swaps market for possible market manipulation. 

2 

The Commodity Futures Trading Commission and the Securities 

and Exchange Commission have both proposed rules to implement 

the SEF provisions of the Dodd-Frank Act for swaps or securitybased swaps under their respective jurisdictions. 

In addition, because standardized swaps that are cleared must be 

traded on an exchange or a SEF, Dodd-Frank Act requires clearinghouses to provide open access to various execution venues. Both the 

SEC and CFTC have proposed rules that implement the open access requirements of the Dodd-Frank Act to encourage competition 

in the SEF and clearinghouse market. 

All of us have a vested interest in making sure these new derivatives swap execution facilities function safely, efficiently, and fairly. 

Hopefully, our hearing this morning will help us understand best 

how we can accomplish this objective. 

Senator Crapo and I have invited witnesses that represent a variety of opinions and perspectives to our hearing. Unfortunately, 

due to scheduling difficulties, the large dealer bank we invited was 

unable to appear before the Subcommittee today. Nonetheless, we 

hope the conversations we have this morning spur deeper thought 

on these complicated issues, and we encourage participation by 

written testimony or comments after the fact, and that both industry and policy makers continue to work together to make our swaps 

markets the most transparent, competitive, and efficient in the 

world. 

I look forward to hearing from our witnesses, and at this time 

I would like to recognize the Ranking Member, Senator Crapo. Senator Crapo. 

STATEMENT OF SENATOR MIKE CRAPO 

Senator CRAPO. Thank you very much, Senator Reed, and I appreciate the opportunity we have to work together on this Committee and also the fact that you have noticed this hearing with regard to SEFs. 

There are a number of different electronic trading models that 

could be potentially used for derivatives trading depending on the 

final rules the SEC and the CFTC and international regulators 

adopt. But I want to focus just on a couple of concerns that I see 

us facing right now in our current posture. 

While Title VII of the Dodd-Frank Act states that the SEC and 

the Commodity Futures Trading Commission shall consult and coordinate to the extent possible for the purpose of assuring regulatory consistency and compatibility, it appears that the lawyers for 

the two agencies, or maybe the other personnel at the agencies as 

well, have not been able to agree on what these terms mean. 

We should not then be surprised that the two agencies have proposed inconsistent approaches to the same rule sets. For the swap 

execution facility rules, the SEC approach, in my opinion, is a more 

principles-based approach and is in general far less prescriptive 

than that of the CFTC. While the Dodd-Frank Act missed a great 

opportunity, in my opinion, to merge the SEC and Commodity Futures Trading Commission and stop the bifurcation of futures and 

securities markets—we lost that opportunity then—we should at 

least continue to push for more coordination and consistent rules. 

3 

Swap execution facilities are likely to dually register with both 

agencies, and it makes a lot of sense for the two regimes to be consistent. 

While I applaud the SEC for taking a more flexible approach relative to the CFTC, both agencies need to make their rules more accommodative of the different types of SEFs to provide the maximum choice in trade execution to market participants. 

Under the current CFTC SEF version, the proposed rule requires 

swap users to request prices from no fewer than five dealers at a 

time. This is generating a lot of controversy from the end user community, which argues that it may ultimately serve to unnecessarily 

disadvantage end users by limiting their ability to chose appropriate numbers of counterparties and the mode of execution in the 

way that they deem to be the most efficient and effective to hedge 

their commercial risk. 

Since Dodd-Frank stipulates that the transactions required to be 

cleared must also be evaluated on a SEF or designated contract 

market, there is significant interplay between the clearing, trading, 

and definition of block trades. According to the end users, this 

could create a problem for some less liquid trades that would be 

suitable for clearing but not necessarily for trade execution. 

I have also been advised that the SEC’s SEF approach is more 

consistent with what the Europeans are looking at, but I have not 

actually seen the exact comparison. 

If we want to find a common international framework in order 

to avoid regulatory arbitrage and avoid competitive disadvantage to 

our markets, we need to provide greater coordination and harmonization to get the rules right rather than rushing them through. 

This is just a short summary of some of the issues that I am concerned about that I think we ought to focus on in today’s hearing. 

I also welcome today’s witnesses, and I look forward to what we 

will hear. 

Chairman REED. Well, thank you very much, Senator Crapo. And 

before I ask Senator Corker if he has comments, let me associate 

myself with your comments about collaboration, the joint regulation between the SEC and CFTC. I hope one of the results of this 

hearing is to be able to focus their attention on coming up with a 

consistent rule for both agencies rather than two distinct sets of 

rules. I think that is going to—the intent clearly, as you point out, 

in Dodd-Frank was to have one set of consistent, appropriate, flexible rules. And I, again, second your very insightful comments in 

that regard. 

Senator Corker, do you have any comments? 

Senator CORKER. Thank you, Mr. Chairman. I am looking forward, as usual, to the testimony, and I appreciate you having the 

hearing. 

Chairman REED. Thank you very much. 

Let me introduce the first panel. Our first with is Mr. Kevin 

McPartland. He is a principal and director of fixed income research 

at TABB Group. Mr. McPartland joined the TABB Group as a senior research manager in 2007 from a management consultancy, 

Detica, where he was a senior manager in the Global Financial 

Markets Division. Prior to joining Detica, he held positions at 

JPMorgan Chase in equities and futures and options, managing deVerDate Nov 24 2008 10:41 Mar 16, 2012 Jkt 048080 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 L:\HEARINGS 2011\06-29 AM EMERGENCE OF SWAP EXECUTION FACILITIES -- A PROG
4 

velopment, and implementation of electronic trading systems. 

Thank you. 

Our next witness is Mr. Neal Brady. He is the chief executive officer of Eris Exchange. Prior to cofounding Eris Exchange and assuming the role of CEO, Mr. Brady served as managing director of 

business development at CME Group, where he was responsible for 

the growth of the CME Group’s OTC and global business. Prior to 

CME, he founded and served as chief executive officer of Liquidity 

Direct Technology, a leading platform for interest rate derivatives 

trading that was acquired by CME in January 2004. 

Our next witness is Mr. Ben Macdonald. He is a naturalized U.S. 

citizen residing in New York City. Thank you for that, Mr. Macdonald. He is the global head of fixed income products for 

Bloomberg, L.P., a position he has held since May 2010, and in 

that capacity he heads up Bloomberg’s Swap Execution Facility Development Initiative. Prior to joining Bloomberg, he worked at 

Goldman Sachs managing the credit default swap operations team 

and at JPMorgan Chase where he held several positions in interest 

rates derivatives. 

Our final member of the panel is Mr. James Cawley. Mr. Cawley 

is the chief executive officer of Javelin Capital Markets, an electronic execution venue for credit derivatives and interest rate 

swaps. Javelin expects to register as a swaps execution facility. He 

is also the founder of the Swaps and Derivatives Market Association, an industry trade group of several dealer and clearing brokers 

that advocates for successful OTC derivatives clearing, open access, 

and transparency. Mr. Cawley has 20 years of derivatives sales and 

trading experience, working for many years in the credit markets 

for Salomon Brothers, Lehman Brothers, and Bank of America. 

Most recently, Mr. Cawley ran IDX Capital, a credit derivatives 

interdealer broker. 

I thank you all for being here this morning. Senator Merkley, do 

you have any opening comments? 

Senator MERKLEY. No. 

Chairman REED. Thank you. I would ask the witnesses to limit 

their remarks to 5 minutes. Your written statements will be completely incorporated into the record, so there is no need to read 

them. 

Mr. McPartland, if you would begin, please. Thank you.. 

STATEMENT OF KEVIN MCPARTLAND, DIRECTOR OF FIXED 

INCOME RESEARCH, TABB GROUP 

Mr. MCPARTLAND. Chairman Reed, Ranking Member Crapo, and 

Members of the Subcommittee, thank you for inviting me here 

today to discuss progress and concerns surrounding the creation of 

swap execution facilities. 

I am Kevin McPartland, a principal and the director of fixed income research at TABB Group. TABB Group is a strategic research 

and advisory firm focused exclusively on the institutional capital 

markets. Our clients span the entire investment landscape including investment banks, pension plans, mutual funds, hedge funds, 

high frequency traders, FCMs, exchanges, and clearinghouses. 

In order for this new market structure to be successful, swap 

execution facilities must be given broad latitude in defining and 

5 

implementing their business models. This includes, but is not limited to, the mechanisms used for trading and the risk profiles of 

their members. This will promote the innovation and competition 

that has made the U.S. capital markets the envy of the world. 

It is also critical that the mechanisms to move trades quickly and 

easily from execution to clearing are well defined. If market participants worry that the trade they have just executed on a SEF might 

later in the day be canceled due to a clearinghouse rejection, confidence in the entire market model will erode quickly and severely 

limit the transparency and systemic risk reduction the Dodd-Frank 

Act was intended to improve. 

Let us examine these points in detail. 

First, SEFs should not be driven to a particular trading model. 

Despite the inclusion of the Request for Quote model in proposals 

from the CFTC and SEC, regulators are still keen to have swaps 

trade through an order book with continuous two-sided quotes. 

TABB Group research shows that order book trading will emerge 

naturally; 81 percent of our study participants believe that we will 

have continuous order book trading of vanilla interest rate swaps 

within 2 years of SEF rule implementation. However, the existence 

of an electronic order book does not guarantee liquidity nor that 

market participants will trade there. 

For example, of the roughly 300,000 contracts available for trading in the highly electronic U.S. equity options market, trading in 

only the top 100 names makes up nearly 70 percent of the volume. 

The rest are seen as so illiquid that it is often easier to trade OTC 

with a broker rather than try and execute that same contract on 

the screen. Furthermore, despite the market’s electronic nature, 

TABB Group research shows that in 2010 as much as 97 percent 

of all options trading volume generated by asset managers was 

done over the phone. 

Second, we should encourage SEFs to set membership requirements to encourage a variety of liquidity pools. The U.S. equity 

market presents a good example. Thirteen registered exchanges 

and another 55 alternative execution venues exist to trade U.S. equities for a total of sixty-eight. Why are there so many? Because 

different market participants trade in different ways and have different needs. Some like to trade in large size, some small; some are 

very concerned about price while others are more concerned about 

getting a trade done quickly. Because of this, the equity market responded with new venues to meet those needs. 

In the current swaps market, a smaller player cannot trade in 

the interdealer market even if they had the capital and desire. In 

the new market, as long as a trading firm meets the requirements 

set forth by the SEF, they will be—and should be—allowed in to 

trade. The important point to note is that setting membership requirements for SEFs is not exclusionary, but instead intended to 

help market participants trade in the most suitable environment 

possible. 

Open access to clearing will play a huge role in the success or 

failure of all SEFs. It is central clearing, not the SEF construct 

itself, that will allow easier access to trading and new market participants to enter. But a clearinghouse providing only the ability to 

accept SEF executed trades is not enough. 

6 

SEFs are intent on providing click-to-trade functionality, that 

when you accept a price on the screen with a click of the mouse, 

whether in an order book or via a request for quote, the trade is 

done. However, a trade is not done until it is accepted for clearing—something the SEFs have little if any control over. That raises 

the question: Can a SEF ensure a trade will be accepted for clearing before it allows the trade to execute? And even if it can, is that 

the SEF’s responsibility? 

Either way, clearing certainty is crucial to the success of SEFs. 

If market participants do not trust that SEF-executed trades are 

firm, confidence in the entire market model will erode quickly. It 

is critical that a mechanism be put in place to formalize this process, ensuring the market can have full faith in the trades they execute on a SEF. 

There has been considerable speculation as to the number of 

SEFs that will exist. The wildest number I have heard is 100, 

which is simply unrealistic. If the U.S. equities market has 68 

venues and the U.S. futures market has three main players, the 

swaps market will fall somewhere in the middle. 

Our research shows also that nearly 60 percent of market participants believe the ideal number of SEFs per asset class is three to 

four, resulting in 15 to 20 SEFs covering interest rates, credit, FX, 

commodities, and equities. There will be many more than that to 

start but not 100. Our list at TABB Group shows as many as 40 

firms that plan to apply. But 87 percent of our study participants 

believe that SEF consolidation will begin 2 years or less from the 

date of rule implementation. 

We are now in the pre-SEF era. Business models and technology 

are still being finalized, but most SEFs are ‘‘registration-ready,’’ 

and trade flow is beginning to pick up on the screen as most everyone has accepted that these changes are inevitable. 

Even if trading mandates do not take effect until the fourth 

quarter of 2012—a timeframe that seems more and more realistic— 

the change is so enormous for most swaps traders that getting 

started now should present just enough time to make the switch. 

As rules are finalized, it is critical that while putting in place 

necessary oversight, new OTC derivatives rules encourage the innovation and competition that have made the U.S. capital markets 

the most envied in the world. 

Thank you for your time. 

Chairman REED. Well, thank you very much for your testimony. 

Mr. Brady. 

STATEMENT OF NEAL B. BRADY, CHIEF EXECUTIVE OFFICER, 

ERIS EXCHANGE, LLC 

Mr. BRADY. Chairman Reed, Ranking Member Crapo, Members 

of the Committee, thank you for the opportunity to testify on the 

implementation of the Dodd-Frank Act, specifically the development of SEFs. I am Neal Brady, chief executive officer of Eris Exchange, LLC. 

Eris Exchange is an electronic futures exchange that began offering the trading of a cleared interest rate swap futures contract in 

July 2010 in response to the passage of the Dodd-Frank Act. Since 

its inception, Eris Exchange has traded over $33 billion in notional 

7 

value of its interest rate swap futures which are cleared at the Chicago Mercantile Exchange. 

Eris Exchange filed an application with the CFTC in April of this 

year to be designated as a contract market, or DCM. A DCM is a 

traditional exchange in which regulated futures contracts have 

been trade for over 100 years. As a DCM Eris Exchange will be 

permitted to list both financial futures as well as swaps. As such, 

Eris Exchange will satisfy the Dodd-Frank execution mandate and 

will operate alongside SEFs in the cleared interest rate swaps base. 

My opening comments are focused on the regulatory incentives 

that can facilitate the successful development of SEFs. I will also 

comment on a few arguments heard in the industry recently related to perceived operational impediments to SEFs and how these 

concerns have already been solved for in the futures industry 

model. 

First, Eris Exchange believes that the most important regulatory 

incentive that the CFTC can provide for SEFs is to announce clear 

dates for the implementation of the clearing and trading mandates. 

The industry is ready to trade and clear interest rate swaps. SEFlike platforms and DCMs are already connected to the major clearinghouses and are operationally ready to transact swaps and equivalent futures contracts. The market is simply awaiting a clear 

timetable from the CFTC before committing the resources for final 

implementation. As soon as the timetable is announced, customers 

will select preferred clearing firms and trading platforms, complete 

documentation, and begin final testing. 

In announcing a timetable, one of the most market-based and 

competition-friendly actions that the CFTC can take is to implement the trading mandate soon after the clearing mandate. By 

mandating execution and ensuring open access to all clearing 

venues, regulators will foster true competition in swaps and create 

a level playing field for the emergence of new entrants and technology-driven innovation. 

If, on the other hand, there is a significant lag between the clearing and trading mandates, incumbent firms will be heavily motivated to direct clearing to their preferred clearing venue and will 

transact on closed platforms dominated by incumbent firms. Such 

a time lag runs the risk of severely constraining the ability of new 

entrants to effectively compete in the execution of cleared swaps. 

Second, I would like to address a few arguments heard in the industry today that are aimed at slowing down the implementation 

of the Dodd-Frank Act. Specifically, concerns have been raised that 

the documentation required for market participants to exit and 

clear swaps is so extensive that it will require untold hours of negotiation and impose burdensome legal costs on customers. This is 

an exaggerated concern. 

The futures documentation structure provides a model that 

should be utilized as a baseline for documentation in the cleared 

swaps market. In the futures model there is no need for each user 

to enter into detailed ISDAs with every other user. For example, 

to trade on Eris Exchange, a participant and a participant’s clearing firm need only enter into a single agreement totaling two 

pages, one time. 

8 

Another argument heard today in the industry is that it is impossible to trade interest rate swaps in an open, electronic order 

book and, therefore, the traditional OTC execution model must be 

maintained. Eris Exchange provides concrete evidence that this argument is flawed. Today Eris Exchange has a live, open, anonymous, electronic central limit order book offering trading for standard maturities of interest rate swap futures. Clearing firms guarantee each order and monitor risk using credit controls that are 

built centrally into our trading platform. 

I have submitted a screen shot of the Eris Exchange central limit 

order book, which shows live bids and offers on our screen that are 

fully transactable and for which users receive instant confirmations 

of cleared trades with the click of a mouse. 

In conclusion, it is worth noting that in the futures industry the 

migration from pit-based trading to screening-based trading unleashed a tremendous wave of innovation in which the U.S. derivatives industry emerged as a world leader. If regulators announce 

a clear timeline and apply the proper incentives, the implementation of Dodd-Frank has the potential to spur a similar technological 

revolution that will deliver on the real benefits of the legislation, 

bringing greater transparency and a wider variety of counterparties into the swaps market and thereby reducing systemic risk. 

Thank you for your invitation to testify here today. I look forward to your questions. 

Chairman REED. Thank you, Mr. Brady. 

Mr. Macdonald, please. 

STATEMENT OF BEN MACDONALD, GLOBAL HEAD OF FIXED 

INCOME, BLOOMBERG, L.P. 

Mr. MACDONALD. Good morning, Chairman Reed and Members of 

the Subcommittee. It is a pleasure to appear before you today. My 

name is Ben Macdonald, and I am the global head of fixed income 

products for Bloomberg, L.P., a privately held company based in 

New York. Bloomberg is dedicated to registering as both a swaps 

execution facility and a security-based swaps execution facility 

under Title VII of the Dodd-Frank Act. 

Bloomberg’s customer base is evenly distributed amongst the buy 

side and the sell side. Therefore, as an independent company, we 

are not beholden nor are we biased toward any particular element 

of the market. 

First of all, Bloomberg fully supports Title VII’s mandatory clearing and post-trade reporting requirements. Clear and specific rules 

for those provisions will serve as the most significant tools for reducing systemic risk and attaining needed transparency for a reformed and financially sound derivatives marketplace that benefits 

all participants. 

As with all new regulations, however, the devil is in the detail, 

and today we have concerns that these regulations will be promulgated in a way that inhibits market trading flexibility and raises 

the cost to the end user and, therefore, does not fully achieve the 

goal set out by Dodd-Frank. 

We know that the systemic risk threats that arose in 2008 and 

2009 were associated with insufficient clearing and post-trade price 

9 

transparency and were not the result of execution failures. Trading 

protocols were not the problem. 

We believe that Federal regulators should not go to extravagant 

lengths to define the most favorable terms of execution for trading 

for what can only be characterized as a market of sophisticated 

users. Rather, what should be incumbent on Federal regulators is 

to ensure that the market is fair and competitive and that participants themselves have enough information to assess whether they 

know they got a fair price or not. 

One of the risks that Federal regulators run in micromanaging 

execution protocols is that they would increase the direct cost of 

trading with no real compensatory benefit to customers. In addition, they would impose artificial constraints and significant indirect costs that incentivize market participants to revert to forms of 

trading that evade the excessive regulation and its unnecessary 

costs. Ultimately, the threat is that market participants will easily 

find alternative ways to conduct their trading in non-SEF environments, including taking their trading to foreign jurisdictions where 

U.S. rules do not apply. Rather, we believe that Federal regulators 

should instead use a principles-based approach that encourages 

flexible trading protocols by SEFs. 

Second, the difference in rules promulgated by the CFTC and the 

SEC will create significant compliance costs. Though the DoddFrank Act requires the two agencies to coordinate their approaches, 

it remains to be seen whether they will sufficiently do so in their 

respective final regulations. If they do not, an entity designed to 

operate as both a SEF and a security-based SEF will be compelled 

to create two separate companies to trade similar instruments. 

Please note that this affects each potential SEF and securitybased SEF but also their clients, many of whom currently use the 

same individual traders to execute both instruments. This barrier 

will drive a concentration in the SEF/security-based SEF space and 

could create a too-big-to-fail situation for the remaining SEFs in 

the marketplace, which is exactly the opposite of what Congress intended when it enacted Dodd-Frank. 

It is our opinion that costs can be reduced by providing the opportunity for SEFs to contract with third-party service providers 

for market surveillance and discipline duty as long as the SEFs 

meet the requirements within Dodd-Frank that they retain full, ultimate responsibility for decision making involving those functions. 

Practical, liberal utilization of third-party service providers would 

enable SEFs to reduce their capital and operational costs related 

to the infrastructure of those functions and thereby reduce the cost 

of entry into the SEF marketplace. 

In addition, SEFs should also be permitted to rely on the regulation and oversight performed by swaps clearinghouses rather than 

have to replicate essentially the same activity at the SEF level. For 

example, if a clearinghouse accepts a market participant or a swap 

for clearing, the SEF should be permitted to rely on that assessment for core principle compliance purposes under the SEF regulatory regime. 

In addition, the SEC’s rules on governance and financial reporting should be strictly linked to the requirements in Dodd-Frank because extending the rules beyond the Act’s requirements effectively 

10 

inhibits the entry of new security-based SEFs. For example, an aspiring security-based SEF such as Bloomberg, who is already independently owned and controlled, could be discouraged if faced with 

SEC rules that would force us to cede control of our affiliated SB– 

SEF to an independent board. While SEC has suggested they may 

require this result, it is not required by Dodd-Frank, nor is that a 

requirement written into the CFTC’s proposed regulations. 

The goals of promoting competition among SEFs, lowering barriers to entry, and allowing a consistent trading environment demand that the two Federal regulators devise coordinated rules and 

not work in silos. It is our hope that Congress can assist in this 

process. 

In summary, we are concerned that we may be on the road to 

creating a too-big-to-fail and utility-style SEF landscape that would 

increase costs for the end user, encourage non-SEF trading, and ultimately reduce the benefits of central clearing and price transparency. 

Mr. Chairman, on behalf of Bloomberg, I want to thank you for 

this opportunity to share our views on this important issue, and I 

am happy to answer any questions that you may have. 

Chairman REED. Thank you very much, Mr. Macdonald. 

Mr. Cawley, please. 

STATEMENT OF JAMES CAWLEY, CHIEF EXECUTIVE OFFICER, 

JAVELIN CAPITAL MARKETS 

Mr. CAWLEY. Chairman Reed, Ranking Member Crapo, and 

Members of the Subcommittee, my name is James Cawley. I am 

chief executive officer of Javelin Capital Markets, an electronic execution venue of OTC derivatives that will register as a SEF or 

swap execution facility—under the Dodd-Frank Act. 

I am also here today to represent the interests of the Swaps & 

Derivatives Market Association, which is comprised of several independent derivatives dealers and clearing brokers, some of whom 

are the largest in the world. Thank you for inviting me here today 

to testify. 

Without a doubt, it is mission critical that central clearing, increased transparency, and broader liquidity is properly achieved 

under the act for the OTC derivative marketplace. Toward that 

goal, it is important that SEFs be allowed to properly function and 

compete with each other whereby Congress and the regulators ensure that such organizations and various execution models be neither discriminated against nor penalized by trade work flow or documentation efforts that show preference for one SEF over another. 

Only by access to a fair, level, and open playing field will SEFs 

be properly able to play their part in the lessening of systemic risk 

to which the derivative marketplace contributed during the global 

financial crisis of 2008. 

With regard to product eligibility, clearinghouses should recognize that the fair majority of interest rate and credit derivative 

products do qualify for clearing. 

Regulators should be mindful to ensure that clearinghouses do 

not favor acceptance of certain products that have built in trade restrictions that impede open access or customer choice. 

11 

While intellectual property rights may protect innovation in the 

short term, with regard to certain swap products or indices, they 

may restrict trade and liquidity in the long run. Market participants should be allowed to trade such products to meet their investor or hedging objectives. Intellectual property rights for such products should adapt with the post Dodd-Frank marketplace where 

anonymous and transparent markets flourish. 

Regulators should work with such IP holders to both ensure that 

their rights are properly protected but that the prudential need of 

the broader market is also addressed. 

With regard to SEF access to clearinghouses, clearinghouses and 

their constituent clearing members should do as the act requires— 

accept trades on an ‘‘execution blind’’ basis. DCOs should not discriminate against trades simply because they or they shareholders 

dislike the method in which such trades occur. 

Clearinghouses should refrain from using SEF sign-up documentation as a vehicle through which to restrict trade. As a precondition to access, clearinghouses should not require that SEFs 

sign ‘‘noncompete’’ clauses, such that a clearinghouse’s other businesses—be they execution based or not—are inappropriately protected from outside competition. 

Likewise, clearing firms should not require that SEFs contract 

with them to restrict the rights or privileges of end users as a precondition to SEF–DCO connectivity. Such requirements serve no 

prudential role with regard to risk mitigation and run contrary to 

the open access provisions of the act. 

Clearinghouses should not require that a SEF purposely engage 

in a trade work flow that adds latency or creates unnecessary steps 

in the post-trade settlement process. 

Instead, clearinghouses and their constituent clearing firms 

should draw from their own proven and well-tested experience in 

listed derivatives space. They should accept trades symmetrically 

and in real time. 

Immediate acceptance of swaps trades into clearing is critical to 

accomplishing the goals of the Dodd-Frank Act to reduce systemic 

risk, increase trade integrity, and promote market stability. 

Settlement uncertainty caused by time delays between the point 

of trade execution and the point of trade acceptance into clearing 

can destroy investor confidence in the cleared OTC derivatives 

markets. 

As the CFTC has correctly asserted, such a time delay or trade 

latency, which in the bilateral swaps markets can be as long as a 

week, directly constrains liquidity, financial certainty, and increases risk. 

Clearinghouses and their clearing members should do as the regulators have required and accept trades into clearing immediately 

upon execution on a SEF. 

Regulators should be wary of certain incumbent efforts that 

claim to bring execution certainty through documentation. Such 

documentation sets in place work flow that clearly favors Request 

for Quote execution models over exchange-like central limit order 

books. 

Such documentation denies the customer the right to trade anonymously with multiple counterparties because under such a work 

12 

flow, the dealer counterparty requires the identity of the customer 

be known before the trade occurs. 

This is not the case with documentation and work flow requirements in the cleared derivatives markets currently of futures and 

options. In those markets, buyers and sellers trade in multiple 

trade venues where trade integrity, counterparty anonymity, and 

optimal liquidity is assured through access to multiple counterparties. 

Such restrictive work flow and documentation should be seen for 

what it is—nothing more than a transparent attempt to limit customer choice, restrict trade, and drain liquidity. 

In conclusion, the role of the swap execution facility with regard 

to lessening systemic risk should not be understated. To fulfill the 

SEF’s role in fostering greater liquidity and transparency, Congress 

and the regulators should continue to be proactive and protect the 

market against Dodd-Frank implementation choke points. They 

should continue to ensure that all SEFs have fair and open access 

to clearing and the marketplace. 

I thank you for your time, and I am open to any questions. 

Chairman REED. Thank you very much, gentlemen, for your very 

thoughtful testimony. 

Let me just sort of lay out the logistics. We have a vote at 11, 

and we have another panel. I would propose 7-minute rounds, and 

I know we are not going to be able to ask all the questions we want 

to ask, so be prepared for additional questions following up the 

hearing. But let me begin again by thanking you for your insightful 

testimony. 

I will address a question to the whole panel, and it has been 

touched upon. Specifically, in response to the CFTC’s Notice of 

Comment, the Justice Department Antitrust Division raised some 

concerns about their proposed rules with respect to the ability of 

major dealers to control access to the markets unless there is—and 

the SEFs, unless there are some ownership limits, aggregate ownership limits or individual ownership limits, together with governance issues. I know you all have talked about it, but the goal I 

think we all share is to maximize competition while at the same 

time limiting barriers to entry into these platforms and into these 

processes. 

So if you might elaborate, starting with Mr. McPartland and 

down to Mr. Cawley. 

Mr. MCPARTLAND. It is important that we still have the major 

dealers involved actively. This is their market. If we talk in other 

areas of finance, we talk about having skin in the game. The last 

thing is we want are some of the biggest traders in these products 

not actively involved and invested in the success of these entities. 

I think the language of Dodd-Frank and some of the proposed 

rules will ensure that we will still have open access. The access to 

clearing is really what will open these markets up, because it takes 

out a good amount of the counterparty risk, whereas now in the bilateral world, a dealer could quite rightly choose to not trade with 

a counterparty if they felt their credit was not up to war. The clearinghouse helps to mitigate those concerns. 

But the short answer here is we need the dealers still involved. 

This is not about pushing them out. It is about keeping them in 

13 

the position they are in and then opening up the market to more 

competition beyond that. 

Chairman REED. Mr. Brady. 

Mr. BRADY. Yes. At Eris Exchange, we do not think research and 

ownership are going to do everything. The people most likely to actually be new entrants and provide a credible alternative and increase competition in the space are precisely those people like the 

founders of our exchange who are in the market and are able to 

drive forward with a platform like this. We think the focus instead 

should be on the issues like open access, real time trade acceptance, making sure the SEFs and the clearinghouses are open and 

available for people to trade on. 

Chairman REED. But just to follow up, so your notion is ownership is not the issue, open access. So the rules that SEC and CFTC 

have to come up with have to really provide an incentive for broadbased participation and prevent, regardless of ownership, so favoring one entity—I think I am restating what you said. 

Mr. BRADY. Yes. I mean, that is absolutely vital, to allow anyone 

who is qualified and fulfills certain requirements to have access to 

a cleared product and access on a SEF, whether the owner of that 

platform, yes, I think that is less relevant—— 

Chairman REED. One of the issues that has come up in the context of the presence sort of an ad hoc system is the requirements 

for capital to participate are being set by the big players, basically—— 

Mr. BRADY. Yes. 

Chairman REED. ——and there is at least some suggestion that 

these requirements are not necessary the market to function—— 

Mr. BRADY. Right. 

Chairman REED. ——but they are quite conducive to continued 

dominance. 

Mr. BRADY. Right. 

Chairman REED. Do you have any comments? 

Mr. BRADY. Yes. In our view at Eris Exchange and the partners 

that I represent, that is a much more critical issue than the actual 

ownership. It is the researchers on clearing or membership to 

clearing ought to be based on risk-based criteria and who can step 

in in the case of a default. In the case of the futures industry, the 

people who took care of the Lehman bankruptcy, for example, it 

was an open auction. A number of the players who actually ended 

up picking up the portfolio were not clearing members or non-clearing members. It was like a market-based solution, and criteria like 

that are much more important than ownership restrictions. 

Chairman REED. Let me go to Mr. Macdonald and Mr. Cawley. 

Mr. Macdonald, please. 

Mr. MACDONALD. Yes. I think this is a quite interesting question. 

From our perspective, we already are an independent company, so 

it is kind of disincentivizing, if you will, from a commercial perspective, to try and build a business in the SEF space that is competitive and then have to concede control of the board of that SEF. It 

does not really make sense. We understand and we recognize the 

need for governance and independence and we think that is a good 

thing. However, we also think there needs to be a mechanism for 

companies such as ourselves and other companies who are already 

14 

independent to operate in this space without being penalized for 

being independent, and I think that goes to the crux of our issue. 

I do think there is one other point which kind of touches on what 

Neal was saying, which is that SEFs have different models. In 

some cases, they take on principal risk because of the nature of 

their business and in some cases they do not, and I think, again, 

when we look at capital requirements, we need to make sure that 

they are commensurate with the style of SEF that we are talking 

about, because there clearly is not a one-size-fits-all in the SEF 

landscape, and there should not be. 

Chairman REED. I can presume, though, that you would not object to a certain number of independent directors, for example, in 

the governance of these—— 

Mr. MACDONALD. No, no—— 

Chairman REED. ——the control issue. 

Mr. MACDONALD. No, and we understand and we totally—I 

mean, we think it is a very good idea. We just think that there is 

a practical limit which kind of, you know, goes a little bit too far. 

Chairman REED. Mr. Cawley, please. 

Mr. CAWLEY. We think that whenever the dramatic change in 

market structure such that we are currently undergoing as a result 

of the crisis in 2008, one has to—the Government and regulators 

really should monitor and engage when necessary whenever you— 

when you have a marketplace moving from the haves to the havenots. So whereas the old market in the bilateral space had ten or 

15 dealers, I do not think anyone is trying to exclude them from 

the future. I think it is more a function of including another 25 or 

30 dealers and broadening the competitive range. 

And as you go and experience that change, it is important that 

any governance structure, whether it be at a DCO or clearinghouse 

or, indeed, at a SEF, have a fair degree of transparency and a fair 

degree of market participation on material committees that address 

the prudential issues concerning these organizations. It is not 

enough to come in and say, look, shareholders have a right, or the 

management have the right to enhance shareholder value. That is 

clear. 

But SEFs, and more specifically DCOs, share a broader prudential need to the marketplace and in so doing need to address that 

and have open governance, which you can separate from economic 

interest. We just ask that it be open, transparent, and be truly representative of the marketplace, not only in terms of dealers, but 

also in terms of clearing members and also market participants 

and end users. 

Chairman REED. Thank you all, gentlemen. 

Senator Crapo. 

Senator CRAPO. Thank you very much, Mr. Chairman, and in 

light of the time restraint we have, I am going to ask just one question and then try to give each of you an opportunity to comment 

on it, if you would like, so I encourage you also to be concise in 

your responses. 

My question relates to the fact that the end users have expressed 

concern to me that many of their large or less liquid transactions 

may not fit within the definition of a block trade that is being proposed because of its limited nature, and they are concerned also 

15 

with things like the requirement to bid trades to no fewer than five 

market participants or the delay built in in terms of the processing 

of blocked trades, and these things may create a dynamic in the 

market that will then drive up the cost of operations. 

I would like to know—my question is, do you agree with these 

concerns, and if so, what can we do to address them? 

Mr. CAWLEY. If I can—Kevin, do you want to go first, or—I think 

if you look at block trades, you have to consider the tension, Senator, on both sides. Whereas on one side there is the market need 

for transparency, the most important aspect or the most important 

information that any trader or any market participant can have is 

where the last trade occurred, at what price and at what time, and 

to go into a marketplace and not know that is putting that individual or that entity at a disadvantage. 

So on one side, the customer has the right to know, or should 

have the right to know, consistent with other markets, where the 

last trade occurred. But then on the other side, large dealers and 

large participants are less incented to create liquidity for block 

trades. 

So it really falls down, if you look to other markets, A, what 

should the size of a block trade be, and what should there be a 

delay, how long that delay should be such that the market maker 

has the opportunity to hedge their risk on such a block trade. If 

that time period is too short, then the market maker is loathe to 

make a market in such size. If it is too long, then the end user is 

disadvantaged. 

The way we have suggested you consider that is to look to other 

markets, especially in the interest rate futures swap context—or in 

the interest rate futures context, and set a rate or a block size notional that is consistent with those markets and also a timeframe 

that is consistent with those other markets, as well, as a base from 

which to go. 

Senator CRAPO. Thank you. 

Mr. McPartland, did you want to comment? 

Mr. MCPARTLAND. Sure. Information leakage is a big concern for 

all end users and by said market participants, and if we look at 

the swaps market, the size of the transactions and the infrequency 

that many of these contracts are traded makes it even more of a 

concern, and I think that echoes some of Jamie’s points. This is 

why—and again, it is sort of a parallel in the equities world—this 

is why crossing networks developed, for example. Buy-side firms 

that needed to do large-side trades had a hard time doing that in 

the open market, so they found a new mechanism. 

It goes back to my earlier comments that if we provide or allow 

latitude for SEFs to create market models that suit different market participants, we could end up with an environment that is suitable to doing those large-side trades. If we do not allow for that 

type of environment, you could force end users to look to more liquid products that they would have to do in smaller size to get their 

large size done. It could result in an imperfect hedge. An imperfect 

hedge then means more risk rather than less risk for those end 

users. 

Senator CRAPO. Thank you. 

Mr. Brady. 

16 

Mr. BRADY. Yes. We think this issue, it is a very important issue 

and we think it is an issue that really highlights the need for a 

principles-based approach to regulation because the issues are very 

interrelated, whether you should require five counterparties to be 

pinged on a request for quote and the block trade limit. If you set 

the block trade threshold correctly, you could have a stricter requirement to send the RFQ because if you believe in larger size, 

you have the flexibility to do the blocks. But every market is different. Standardized products are different than very bespoke products, and I think the futures industry is a great example of how 

this works. There are block trades allowed. They are set at a certain threshold that is principles-based and large size is able to be 

transacted when needed, but then the rest of the trades occur either in the central order book or through a very wide open request 

for quote process. 

Senator CRAPO. Thank you. 

Mr. Macdonald. 

Mr. MACDONALD. I would echo all of the points that have been 

made. I think the key point here is actually that the end user 

needs to have the flexibility of means of execution. I think for the 

same trade, the ability to get executed or get liquidity will vary depending on a given set of market circumstances. So it is very hard 

to put down a set of very defined rules and think that they will 

work in every circumstance. They will not. And I do think that the 

market will, as long as it is a principle-based approach and as long 

as there are guidelines around execution to manage that process, 

I think the market will, as Kevin pointed out, reach a medium 

where it provides the necessary means of execution for different 

circumstances. 

Senator CRAPO. Thank you. I will yield back a couple minutes to 

you, Mr. Chairman. 

Chairman REED. Senator, thank you very much. 

Senator Merkley, please. 

Senator MERKLEY. Thank you, Mr. Chair, and thank you to all 

of you for your testimony. 

I wanted to start, Mr. Brady, with your comments about the 

value of setting effective dates, for the CFTC to set clear dates for 

both trading and clearing, and I thought maybe I would just give 

you a chance to, if you wanted to advise the CFTC, what dates 

should be recommending that they set and why. 

Mr. BRADY. Yes. I mean, the general point that we would like to 

stress is we believe the marketplace is ready. I mean, you have examples of platforms and swap execution facilities that are ready 

and operational today, connected back to clearinghouses. In our 

view, the market is really looking for a clear signal to focus around 

and then motivate people to make decisions, commit resources, and 

a lot of the issues we are discussing today in the industry really 

can be settled with people who are highly motivated and with a 

deadline to reach a lot of sort of the documentation issues, the 

credit control issues, these sorts of issues. 

We have put forth in various comment letters a timeframe that 

talks about completing all the final rules through the end of this 

year, allowing provisional registration of SEFs so we do not slow 

down that process, you know, beginning with some clear mandates 

17 

starting first quarter, second quarter of next year, starting with the 

most sophisticated users, mandates on those users and then moving in sort of a sequenced process through the less sophisticated 

people who have more operational issues. So we think that is the 

type of time table. If it were laid out clearly from the regulators, 

you would see a tremendous amount of focus and innovation and 

sort of work toward achieving those goals. 

Senator MERKLEY. And do you picture between the sophisticated 

users and the balance of the marketplace a 3-month transition, a 

6-month transition, a year transition? 

Mr. BRADY. Yes. I mean, I think that is—we do not have a specific recommendation, but we think sort of quarterly rolling in different layers of participants would make some sense. 

Senator MERKLEY. So let us say the initial deadline on trading 

was, say, March 2012. Do you picture the clearing date being the 

same date, or a difference there? 

Mr. BRADY. You know, I think—we think some type of lag between those two would make some sense operationally, but not a 

significant one. So lagging it by a couple of months or a quarter 

could make some sense. We also think allowing for some voluntary 

compliance, maybe the first quarter of 2012 includes voluntary 

compliance with the clearing mandate. People work out the plumbing and test rates would certainly seem to make a lot of sense. 

Senator MERKLEY. Does anybody have a radically different opinion they want to share on this? 

So I wanted to turn, second, to a point a couple of you mentioned, which was a separation of the trading and clearing dates 

and the lack of confidence if your trade is not a trade until it is 

cleared at some future point. It is my understanding in the commodities market that these are done simultaneously. What is driving that separation and how long of a time lag are we talking 

about, and is it a startup problem to have those things happen simultaneously or some type of long-term structural philosophical 

fight going on here? 

Mr. BRADY. If I could, maybe I will just start by talking about 

how it works in the futures model—— 

Senator MERKLEY. Great. 

Mr. BRADY. ——and then hand it over to the other participants 

here. I mean, the futures model, the essence of it is that there is 

a pretrade credit check. So, for example, in the Eris exchange platform, there are credit controls on the platforms and if you see a bid 

or an offer for a 200-million size 5-year swap quote, that has been 

preapproved and there is a clearing firm standing behind that 

quote. In addition, when you submit a block trade, we have credit 

controls at the clearinghouse, I mean, on entry to the clearinghouse. So either the trade is submitted and it is good or the trade 

never existed. It is rejected for credit. 

The SEF model, and I will let the others comment on that, today, 

we are working through those issues where the SEF is not directly 

connected to the clearinghouse, and I will let others comment on 

how that is being worked out. 

Senator MERKLEY. OK. 

Mr. CAWLEY. So on its face, Neal is correct, Senator. Real-time 

acceptance of trades in the futures context works and has worked 

18 

well for many years, whether it be on an exchange or in the clear 

port example with CME in a more decentralized basis. That is 

something that the CFTC and regulators have called for with suggested rules for the OTC space and we do not see from where we 

sit a problem with that. The MFA has also come out in support of, 

as has the STMA, come out in support of real-time acceptance of 

clearing. 

And if you think about it, it is really mission critical to the success of clearing because it really comes down to the fundamental 

integrity of the marketplace. Whereas in the bilateral market 

space, trades would go unsettled a few years ago, even for as many 

as 3 or 4 years, now, that window is down to a few days or a week. 

But that is still, relative to other markets, quite a long time. So 

it creates an uncertainty between the SEF and the DCO and ultimately it ends up with a customer having lost faith in the marketplace. So the technology is there now to use and is available and 

people are working toward these. 

Senator MERKLEY. So I want to back up and see if I heard you 

correctly. You say that commodity trades in the near past sometimes were unsettled for 3 or 4 years? 

Mr. CAWLEY. CDS trades, certainly, yes. Back in 2003 to 2004, 

there were many trades that have been unsettled. Some trades 

have actually gone—had matured before they had settled. 

Senator MERKLEY. Hmm. OK. 

Mr. MCPARTLAND. So one of the big differences between the futures market and the new sort of SEF cleared swaps environment, 

in the futures market, you have one exchange feeding one clearinghouse. In the swaps environment going forward, we are going to 

have many execution venues feeding many clearinghouses. So that 

makes ensuring that the execution venues and the clearinghouses 

all have the most up-to-date information a much more complex 

process. 

Now, to Jamie’s point, the technology certainly exists to allow 

that. There are a few thoughts about how this would work. Some 

think that we should have a central utility that will look at all of 

the limits and the client accounts at the clearinghouse and hold 

that and feed that information out to all the SEFs and clearinghouses. There is also a thought that the clearinghouses, since it is 

about the clearing account, that they will hold the information and 

when they get a new trade they will broadcast that out to all the 

relevant SEFs and the other clearinghouses. 

Many of the dealers, though, are concerned that they do not want 

to have to give up essentially their risk models that they use to determine how much a client can trade to an outside party. So many 

of the big dealers would rather—as they say, we will tell you when 

to stop a certain client from trading. We will let you know. 

So, again, as Jamie said, the technology is certainly there, but 

I think it is more of an operational concern than it is a technology 

concern. 

Senator MERKLEY. All right. Thank you very much. 

Chairman REED. Thank you, Senator Merkley. 

Senator Corker, please. 

Senator CORKER. Thank you, Mr. Chairman, and I thank each of 

you for your testimony, and for what it is worth, I thought your anVerDate Nov 24 2008 10:41 Mar 16, 2012 Jkt 048080 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 L:\HEARINGS 2011\06-29 AM EMERGENCE OF SWAP EXECUTION FACILITIES -- A PROG
19 

swer to Senator Crapo’s question, considering that each of you sort 

of benefit from these new regulations, was pretty judicious, and I 

thank you for that and for being forthcoming in that regard. 

I would ask this question. Back home in Tennessee, people are 

saying, you know, we wish that you guys would quit helping us the 

way that you are in Washington. Who is it that we are actually 

helping with the creation of these SEFs? You know, we met with 

some of the big traders Monday and the big market makers obviously are not being helped by this in any way. So who is it that 

we are helping? 

Mr. BRADY. I would be happy to start with that. If implemented 

correctly—you know, it is a big if—we believe principles-based is 

the way to go. But if implemented correctly, we believe the ultimate end users, the asset managers, the people who are the end 

users of swaps products would have more transparency if these systems were able to connect correctly, there were real-time trade acceptance, and you had price feeds on which you could rely for 

transactable swap prices. 

Senator CORKER. So, I mean, I thought you all, again, judiciously 

answered the question, but when you have got a large block trade 

and you are used to dealing—your client, a BlackRock or a PIMCO, 

is used to dealing with a certain dealer and they want to unload 

a position and they are willing to take it, it does seem that this 

is a problem as it relates to people being able to front run, if they 

have got to report too quickly. I mean, that is a heck of a problem, 

is it not? 

Mr. BRADY. Yes, and that is why it is absolutely critical to get 

that block trade threshold right. And again, just to point to the futures market, the BlackRocks, the PIMCOs, those players are very 

active participants in the futures market and they use the transparent order book, and then when they need to—— 

Senator CORKER. Yes, but futures are a little bit different. That 

is a little bit more of a plain vanilla market than can happen with 

swaps, is that not correct? 

Mr. BRADY. Well, there are a number of standardized vanilla 

swaps that are actually very like futures. I mean, that is the issue 

of for standardized swaps. That is generally what we are talking 

about trading in a central limit order book or—— 

Senator CORKER. So let me ask you this question. So let us say 

that you are involved in a large trade and you are creating liquidity for a client, and right now, I know the CFTC is talking about 

reporting in 15 minutes. It is pretty hard to unload a big book in 

15 minutes. What is—why not end of day reporting? Why have a 

15-minute reporting guideline? 

Mr. BRADY. I mean, again, I think that is our position on that 

and the partners in our exchange would be that is where principles-based regulation is important—— 

Senator CORKER. So end of day would be fine on the large—— 

Mr. BRADY. I think it depends on the marketplace. I think every 

market is different. Different swaps require different treatment. 

Mr. CAWLEY. Senator—— 

Senator CORKER. I would love to have some other input here. It 

sounds like you all are actually in agreement that 15 minutes is 

way too short. 

20 

Mr. CAWLEY. Well, it really—we are not in agreement with that, 

Senator. I think 15 minutes for the futures market is pretty consistent with the liquidity that is offered within the interest rate 

swap market and certainly indices, which is 40 percent of the credit derivatives market. Fifteen minutes by certain market participants is viewed as too long. 

I think it really comes back to Neal’s point, which is it is specific 

to the liquidity in a particular marketplace. If you look to the futures world or the exchanges today, it is 15 minutes. At some point, 

it was an hour, and at some point, it was end of day when the markets were less liquid. 

So the key thing, then, is to measure the amount of liquidity 

within the marketplace that allows that market maker the opportunity to trade out of that position and to hedge it appropriately. 

And when you are talking about 2-year interest rate swaps that 

their average ticket size is $400 million at a clip, that is pretty 

good liquidity. 

Senator CORKER. So it is kind of interesting, do you not agree, 

that on one hand, we have castigated the heck out of high-frequency trading in equities and yet we are moving toward sort of 

algorithm-type trading on the swap side. I mean, is that an interesting—— 

Mr. MCPARTLAND. Yes. Well, I can comment on that, Senator. 

Senator CORKER. OK. 

Mr. MCPARTLAND. So the alternative, if the block trading rules 

are too onerous and the market sees that that will create too much 

information leakage, the alternative will be to then take your $400 

million and use an algorithm to split it up into—— 

Senator CORKER. Right. 

Mr. MCPARTLAND. ——400 trades and spread it all across a variety of SEFs, which is exactly what happened in the equities market 

and I think some feel that that has made the equities market more 

liquid, but others feel that it has made it much more complex to 

understand who is doing what and what is going on. 

Senator CORKER. But you would agree that we sort of have a bipolar way of thinking here. On one hand, we want to move away 

from that on equities, but on the other hand, we are driving toward 

that in swaps. 

Mr. MCPARTLAND. There is no question, and I am in the process 

of research now where we have been talking to a number of the 

proprietary trading firms about this issue. Now, let us remember 

that in equities, as well, they provide a lot of liquidity to the market and then it also brings—ensures that prices are much more in 

line. So futures prices, swaps prices, everything will line up much 

more closely than it does today, and that should ultimately result 

in better prices for the end user who needs to do an interest rate 

swap to hedge their loan book. 

Senator CORKER. So we actually watched—I watched one occur. 

It is not that interesting, actually. But we watched this occur a little bit on Monday, and it is kind of, like, if I am a client and I have 

been used to dealing with X dealer and now I have got to get five 

bids, if you will, that just seems ridiculous to me. I mean, if I want 

to—if you look at the spread difference, it is very, very minor in 

21 

these trades. Is that not onerous to make a client that does this 

on a daily basis have to get five bids? Is that not just ridiculous? 

Mr. MACDONALD. Senator, I think what we are really talking 

about here—we keep on going back to the point of flexibility. The 

reality is that in any given set of circumstances—— 

Senator CORKER. But the CFTC is not acting as if they are giving 

flexibility. They are talking 15 minutes and five bids. So you are 

saying that is wrong, is that correct? 

Mr. MACDONALD. Our thought currently is that it is very hard. 

Two things will likely happen if you are prescriptive about exactly 

what RFQ needs to do and about reporting deadlines. As the market evolves and liquidity changes, people may not actually be able 

to get execution or may not actually want to go out to that level 

of market players for their own shareholders’ reasons and dispute 

what we thought we are actually creating—we actually may be creating more risk by being prescriptive about protocols versus having 

a principles-based approach which gives people a framework to operate and gives them the flexibility to adapt to their business models. 

Senator CORKER. And just—I know my time is up—a lot of concern about folks with these new rules that we are putting in place 

with developing markets going elsewhere, not sort of the industrialized countries, but Latin America and other places, living, having 

to live by our rules, will go outside of the U.S. to execute. Do you 

all not have similar concerns based on, again, what CFTC and others have laid out thus far? 

Mr. MACDONALD. Well, I think, clearly, we operate in a very global market and a lot of entities are—there are a lot of U.S.-based 

entities, but there are also a lot of other regional entities, and I 

think that insofar as we create difference in regulation, although 

it exists, different regulation regimes, I think at the end of the day, 

entities will go to wherever they feel the regime is most appropriate for their activities. 

Senator CORKER. So the answer is yes. 

Mr. MACDONALD. Yes. 

Senator CORKER. So, Mr. Chairman, this has been a great hearing. I do hope, maybe—in listening to the testimony, these guys all 

benefit from what we are doing, I mean, and I am glad they are 

here. They are going to make a lot of money off what we have done 

and I am glad they are. But they themselves are talking about 

some of the frailties and maybe there is something we might do together letter-writing-wise to CFTC to make sure that what they do 

is not so rigid and prescriptive that we actually have unintended 

consequences. I thank you for the hearing and thank you for the 

time. 

Chairman REED. Thank you, Senator Corker. And just let me return to the point that Senator Crapo made, which is the idea of coordinating as much as we can imagine, a unified set of rules that 

apply to the SEC-regulated entities, which is our jurisdiction, and 

the CFTC entities, which is the jurisdiction of the Agriculture Committee, but I think one strong message that you want to send today 

based on this testimony and based on Senator Corker’s comments 

is a notion of sensible unified rules that our industries can profit 

22 

by, and not only industries, but the end users and the community 

at large. 

I think one of the points, and raise your hand if I am way off 

base, but we have seen in equity trading, because of the efficiencies 

brought to the market, that the spreads have come down considerably with the benefit of people who buy and sell stocks every day, 

and that is a lot of people, pension funds, all sorts of folks. And 

I think my sense is, based on your testimony, we will see the same 

thing if we get this right in terms of the swaps market, and that 

would be useful to the whole economy, a more efficient economy. 

But I think, Senator Corker, we certainly hope that our colleagues 

across the way in CFTC and SEC pay close attention to what is 

said today, and we can follow up with them. 

Senator Hagan, you have arrived. We have a panel. Your questions. 

Senator HAGAN. Yes. Thank you, Mr. Chairman. I appreciate 

that. 

Mr. Macdonald, in your testimony, you state that Bloomberg intends to be prepared to begin swap execution facility operations on 

the implementation of regulations by the CFTC and the SEC, provided that the two regulators create synchronized rules governing 

trading protocols, board composition, and financial reporting. 

Would you like to comment quickly on how that synchronization is 

progressing, and also, I would like to ask, why are trading protocols, board composition, and financial reporting important to your 

ability to begin operations, and can you address each one individually? 

Mr. MACDONALD. Sure. So from our perspective, we are ready to 

operate as both a swaps execution facility and a security-based execution facility. I cannot talk specifically to the cooperation between 

the CFTC and the SEC because obviously I spend most of my time 

in New York. That said, when we look at the facts as we know 

them today, there are a couple of areas that raise some concern for 

us when we look at becoming both a swaps execution facility and 

a security-based execution facility, namely the one that we will 

have to actually create two companies that have different board requirements in order to operate in markets that are very similar in 

terms of the end user base. So our concerns are really more 

around—and I will address, first of all, the governance and the 

independence, and then I will address the trading protocols. 

From a governance and independence perspective, we understand 

and we recognize the need for independence in both the kind of the 

company structure and the governance around the swaps execution 

facility for obvious reasons. Our point is that we are already an 

independent company, so forcing us to put independence on top of 

independence does not really make sense from both a commercial 

and a structural perspective, and that is one of the things we are 

looking at. We know that the CFTC has slightly different rules in 

that regard than the SEC. The SEC requires a majority of the 

board to be independent, whereas the CFTC only requires 35 percent. 

When we talk about trading protocols, our point is really that of 

our customers. We are, as an institution, just an intermediary between buyers and sellers, and our view from a very long experience 

23 

in this market is that it is very hard to have a one-size-fits-all 

when you talk about RFQ or, indeed, any trading protocol, and 

there are two main reasons for that. 

First, if you define a specific protocol, the issue that you will face 

is that as the market evolves and the liquidity does change in these 

markets, that protocol may become inappropriate and actually increase more risk in a given set of market circumstances than it 

would reduce risk. 

The other point that we would make is that by not using a principles-based approach and by being prescriptive about the types of 

protocols, what happens is that it will make the market less competitive and more utility style because people will not be able to innovate because they are constrained in terms of what they can do 

as a SEF. So those would be the points we would make. 

Senator HAGAN. Thank you. 

Let me ask also Mr. Macdonald, also in your testimony you noted 

that elaborate execution protocols will increase the direct cost of 

trading and could drive business off of the swap execution facilities 

or, what I would hate to see, into foreign jurisdictions. How would 

you judge the proposed rules that are coming out of the CFTC and 

the SEC against this standard? 

Mr. MACDONALD. Well, you know, we think—and, you know, 

when I talk about an RFQ, a minimum of five or in the SEC’s case 

an RFQ with resting orders for the winning bid. I think the issue 

with these is really what will happen is they can create direct costs 

for a number of reasons, firstly, because of this element of what 

people call the winner’s curse, i.e., the fact that I know that I have 

got four other people in competition with me on that trade means 

that people are not necessarily in every circumstance going to want 

to show the best price as possible because the result of four people 

knowing that that trade got executed in the market means when 

the entity that did win the trade has to turn around and go and 

hedge that out, then there are four people in the market who know 

that that hedge activity is about to happen in the interdealer market, and that will have an impact on price and, therefore, a direct 

impact on the end user. 

Another point which is perhaps a little bit less obvious is that 

what may happen in order to mitigate that risk is the execution 

size will get reduced, and so people will actually execute in smaller 

sizes in order for that kind of winner’s curse or information not to 

be as apparent in the market. What that has is a direct operational 

cost on the end user, so I will give you an example. If I am a fund 

manager and I have to do an allocation on a trade, so I may want 

to do a block trade for, let us say, 100 million and want to allocate 

that out to 50 funds, if I go out and I actually have to—instead of 

just doing one trade and one set of allocations, I actually have to 

go out and do five trades to reduce the size. I now have to do 250 

allocations, which significantly raises the cost on me as an end user 

in terms of processing that trade. 

So that is what we mean by raising the direct cost. 

Senator HAGAN. And how about the threat of sending those offshore? 

Mr. MACDONALD. Well, I think it is clear, you know, that this is 

a global market, and I think when we look at the regulatory proVerDate Nov 24 2008 10:41 Mar 16, 2012 Jkt 048080 PO 00000 Frm 00027 Fmt 6633 Sfmt 6633 L:\HEARINGS 2011\06-29 AM EMERGENCE OF SWAP EXECUTION FACILITIES -- A PROG
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posals that we see in the U.S. versus what we see in Europe and 

other jurisdictions, the risk that we highlight is one where different 

regions have different regulations, and then, you know, companies 

that are not subject to U.S. rules will make the decision as to 

whether they want to operate inside the U.S. or outside the U.S. 

for trading activity. And, you know, that I think is a valid risk. 

Senator HAGAN. Thank you. 

Mr. McPartland, you raised what I think is an important issue, 

and with the proliferation of SEFs and clearinghouses, how will 

credit risk be managed across entities? And do you see this as a 

potential source of systemic risk? 

Mr. MCPARTLAND. The technology certainly exists to manage the 

problems, but operationally it is very, very complicated when we 

have a number of different entities with different needs and different end games. We should not try to regulate how this should 

work; however, the industry needs to come to some consensus as 

to how these issues will be resolved before the market can move 

forward effectively. 

The faith in a SEF execution is very much based on the industry’s knowledge that it will be accepted for clearing, and that goes 

to the point of ensuring that the interconnectivity between the 

SEFs, the clearinghouses, the swap data repositories is all very 

well defined and available to the market participants. 

Senator HAGAN. And how will the industry come together to 

make these decisions? 

Mr. MCPARTLAND. Well, the industry has been working together 

for the last few years obviously on many of these issues through 

the industry bodies. It is in everybody’s best interest to ensure that 

this does work. The changes are coming. So, you know, to that, the 

more efficient that the process can be, the easier it will be for everybody to modify their strategies and their business approach to 

work in the new environment. 

Senator HAGAN. Thank you, Mr. Chairman. 

Chairman REED. Thank you very much. 

Please, Senator Toomey. 

Senator TOOMEY. Thank you very much, Mr. Chairman. 

I just have one quick question for any of the panelists who would 

like to respond to it. That is, the fact that the SEC and the CFTC 

have different rules, rules that are—especially with respect to, for 

instance, the number of dealers who would have to quote on a 

price, the timing that would be required to intervene before the disclosure of block trades, frankly it does not make a lot of sense to 

me. I understand they regulate slightly different kinds of contracts, 

but at the end of the day, is it your view that we ought to harmonize this and we ought to have the same requirements between 

the CFTC and the SEC? 

Mr. CAWLEY. Well, Senator, let me attempt to answer that. The 

SEC regulates credit derivatives, and the CFTC regulates interest 

rate swaps and indices. And I think when you consider those three 

different swap classes, there are different liquidity considerations 

in each. So consequently there should be different block size of 

block trade reporting requirements in terms of size and also in 

terms of time. So it is certainly consistent that they would have different views for each particular class, especially when you look to 

25 

other asset classes where similar rules exist, but be it in futures 

or options or even in the equity markets. 

With regard to your concern vis-a-vis RFQ and the potential limitations that that may have on liquidity, whereas on the one hand 

a customer is loath to put their name, size, and direction out on 

a particular trade to multiple counterparties, one also has to measure it against the tension by giving it out to too few. One of the 

suggestions from the SEC, for example, has required that an RFQ 

go out to one entity. We think that that is fraught with danger 

from a market manipulation standpoint, and we should protect 

against that. 

Our customers certainly have the ability to go out to five or three 

or whatever the number is. I do not think they are looking to go 

out to see 10 or 15 or 20. 

Under those certain rules, they do not necessarily have to show 

their name in addition to size and direction. They can initiate what 

are known as ‘‘anonymous RFQs,’’ and they can certainly access the 

central limit order book or the exchange marketplace as well so 

they can avoid the RFQ requirement altogether. So there are certainly many avenues for customers to come in and trade. 

Senator TOOMEY. Mr. McPartland, I wonder if you have a different perspective on this. 

Mr. MCPARTLAND. I think Jamie raises some very valid points. 

The credit market, the rates market are very different. They have 

very different users, very different uses for those products. 

However, I would suggest that the regulations should be considerably more harmonized than they are, and it would be left then 

to the SEFs and the market participants to ensure that the SEFs 

that are focused on trading credit derivatives are designed in such 

a way that it helps liquidity in those markets, and the same for 

the interest rate markets. So rather than regulatory differences, we 

would have differences in business models in the SEFs that are 

trading in those products. 

Senator TOOMEY. Mr. Brady, anything you would care to add? 

Mr. BRADY. I think we are returning to the theme, a number of 

us, of urging the regulators to take a principles-based approach. 

Certainly more harmonization between the CFTC and SEC is welcome. But I think we also recognize that markets are different, and 

both agencies should strive to take a principles-based approach. 

Senator TOOMEY. Thank you. 

Mr. Macdonald. 

Mr. MACDONALD. Sure. I think there are broadly three things 

here. The first is that as it pertains to block sizes and trade reporting requirements, I think clearly there are nuances between each 

element in these markets, and whatever the end regulations will 

be should be reflective of that. 

I think when we talk about execution protocols, you know, I 

would echo what Neal said, which is that it needs to be a principles-based approach. I think it is important to note that there is 

quite a strong correlation between the single-name space, which 

would be regulated by the SEC, and the index space, which would 

be regulated by the CFTC, and, therefore, it is important that 

users have a similar experience on executing on both of those platforms. 

26 

The last point I would like to make is really the one about governance within thesecurities-based SEF space. I think it is clear 

that the population and size of the market that will be regulated 

by the SEC is much smaller than the one which is going to be regulated by the CFTC. And I think that if the barriers to entry to the 

SB–SEF space and the governance rules that will be put in place 

by the SEC are prohibitive, I think what you may end up having 

is a mismatch between the platforms that operate in the index and 

swap space versus the platforms that operate in the single-name 

space, because it may not be commercially viable for somebody to 

build an entity or a company to operate in the SEC space. 

Senator TOOMEY. Thanks, Mr. Chairman. 

Chairman REED. Thank you, Senator. 

Thank you, gentlemen for your excellent testimony, and I will 

ask the next panel to come forward. Thank you. 

[Pause.] 

Chairman REED. I would like to recognize my colleague, Senator 

Toomey, to introduce Mr. Thum. Senator. 

Senator TOOMEY. Thank you very much, Chairman Reed, for giving me this opportunity to introduce Mr. William Thum, a principal 

of the Vanguard Group in Valley Forge, Pennsylvania. Vanguard 

is, of course, one of the world’s largest investment management 

companies, employing over 12,000 people in the United States and 

abroad. Mr. Thum is currently the senior derivatives transactional 

and regulatory specialist in Vanguard’s Legal Department. Try saying that five times fast. 

Prior to joining Vanguard in 2010, Mr. Thum was a partner with 

Fried Frank Harris Shriver & Jacobson, LLP. From 1998 to 2007 

he was an executive director and head of institutional securities 

documentation for the Americas at Morgan Stanley. From 1996 to 

1998 Mr. Thum was a vice president and head of derivatives documentation at UBS. He also worked at BNP Paribas in New York 

and at Dresdner Klein Ward in London as legal counsel. Mr. Thum 

has been an active contributor to industry efforts to develop market 

standard documents for derivatives trading. He is a frequent lecturer on legal and regulatory issues relating to derivatives and has 

participated in several joint CFTC/SEC public roundtables on 

Dodd-Frank Act-related rulemaking. 

Mr. Thum received his J.D. from the American University Washington College of Law and his B.A. from Bucknell. He is admitted 

to the bar in both New York and Pennsylvania, and I am very 

pleased that Mr. Thum could be with us today. I welcome his testimony, and I thank you, Mr. Chairman. 

Chairman REED. Thank you, Senator. Let me introduce our other 

panelists. 

Stephen Merkel is executive vice president, general counsel, and 

secretary of BGC Partners, positions he has held since the formation of BGC’s predecessor eSpeed in 1999. He is the current chairman and a founding board member of the Wholesale Market Brokers’ Association, Americas, the independent industry body representing the largest interdealer brokers operating in North America wholesale markets across a broad range of financial products. 

He serves as a member of the supervisory board of ELX Futures, 

L.P., a fully regulated electronic U.S. futures exchange. He is curVerDate Nov 24 2008 10:41 Mar 16, 2012 Jkt 048080 PO 00000 Frm 00030 Fmt 6633 Sfmt 6633 L:\HEARINGS 2011\06-29 AM EMERGENCE OF SWAP EXECUTION FACILITIES -- A PROG
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rently also executive managing director, general counsel, and secretary of Cantor Fitzgerald, L.P., which he joined in 1993. Thank 

you, Mr. Merkel, for joining us. 

Christopher Bury is a managing director at Jefferies & Company 

in the fixed income’s New York office and cohead of rates trading 

and sales. Under Mr. Bury’s leadership, Jefferies has expanded its 

global rates trading and sales capabilities, including attaining primary dealer status with the Federal Reserve Bank of New York as 

well as the equivalent dealer recognition in multiple European 

countries. Prior to joining Jefferies in January 2009, Mr. Bury 

spent more than 13 years in fixed income trading at Merrill Lynch, 

where he most recently headed Merrill Lynch Government Securities, Inc., and was trading manager of the USD agency desk. Prior 

to trading agency debt, Mr. Bury traded USD interest rate swaps 

and options for Merrill Lynch. 

Gentlemen, your testimony will be made part of the record. 

Please use your 5 minutes to make any comments that you would 

like. Mr. Thum, please. 

STATEMENT OF WILLIAM THUM, PRINCIPAL AND SENIOR 

DERIVATIVES COUNSEL, THE VANGUARD GROUP, INC. 

Mr. THUM. Chairman Reed, Ranking Member Crapo, and Members of the Subcommittee, thank you for having me here today. My 

name is William Thum, and I am a principal and senior derivatives 

counsel at Vanguard. 

Headquartered in Valley Forge, Pennsylvania, Vanguard is one 

of the world’s largest mutual fund firms. We offer more than 170 

U.S. mutual funds with combined assets of approximately $1.7 trillion. We serve nearly 10 million shareholders including American 

retirees, workers, families, and businesses whose objectives include 

saving for retirement, for children’s education, or for a downpayment on a house or a car. 

Vanguard’s mutual funds are subject to a comprehensive regulatory regime and are regulated under four Federal securities laws. 

As a part of the prudent management of our mutual funds, we 

enter into swaps to achieve a number of benefits for our shareholders including hedging portfolio risk, lowering transaction costs, 

and achieving more favorable execution compared to traditional investments. 

Vanguard has been supportive of the Dodd-Frank Act’s mandate 

to bring regulation to the derivatives markets to identify and mitigate potential sources of systemic risk. 

Vanguard supports a phased implementation schedule over an 

18- to 24-month period following rule finalization based on the following objectives: 

Number one, prioritizing risk reduction over changes to trading 

practices and market transparency; Prioritizing data reporting to 

inform future rulemaking related to trading practices and market 

transparency to minimize a negative impact on liquidity; Harmonizing overlapping U.S. and global regulatory efforts; and Allowing 

immediate voluntary access for all party types to the new platforms 

with mandated compliance to apply initially to swap dealers and to 

major swap participants. 

28 

In view of the time needed to digest the final rules and to develop industry infrastructure; to implement complex operational 

connections required for reporting, clearing, and exchange trading; 

to educate clients on the changes and to obtain their consent to 

trade in the new paradigm; and to negotiate new trading agreements across all trading relationships, Vanguard supports the following implementation schedule: 

Six months from final rules, the swap data repositories, derivatives clearing organizations, SEFs, and middleware providers must 

complete the build-out of their respective infrastructures. 

Six to 12 months from final rules, all participants should voluntarily engage in reporting, clearing, and trading platforms. 

Twelve months from the final rules, all participants should be 

mandated to report all swaps involving all parties. Dealers and 

major swap participants should be mandated to clear the first list 

of standardized swaps. 

Eighteen months from the final rules, all participants should be 

mandated to clear the first list of standardized swaps. SEFs and 

commissions can analyze SDR swap data for liquidity across trade 

types to make informed SEF trading mandates, block trade size, 

and reporting delays. Dealers and major swap participants should 

be mandated to trade the first list of standardized swaps made 

available for trading on SEFs. 

And 2 years from the final rules, all participants should be mandated to trade the first list of standardized swaps made available 

for trading on SEFs with delayed public reporting of block trades 

based on historical relative liquidity. 

The need for a phased implementation schedule is supported by 

studies which have identified significant differences in liquidity between the swaps and futures markets. While futures trading is 

characterized by high volumes of a limited range of trade types of 

small sizes and limited duration, the swaps market has an almost 

unlimited range of trade types of much larger sizes with a much 

longer duration. Swaps liquidity varies dramatically with high liquidity for 2-year U.S. dollar interest rate swaps and much smaller 

liquidity in credit default swaps on emerging market corporate entities. 

The potential negative consequences to liquidity are best demonstrated by the impact of the premature public reporting of largesized block trades. When quoting a price for a block trade, dealers 

typically charge a slight premium to the then current market price 

for a similar trade of a more liquid size. Once the trade is executed, 

the dealer executes one or more liquid-sized mirror trades at current market prices to lay off its position and to flatten the market 

exposure. 

The premature public dissemination of block trades will provide 

the market with advance knowledge of the dealer’s imminent trading and is, therefore, likely to move the market against the dealer. 

Fund investors will ultimately bear the increased price of relevant 

trades or the increased costs of establishing positions using multiple trades of liquid sizes. 

The CFTC’s proposed test for block trade size and the CFTC and 

SEC’s proposed time delay for the public dissemination of block 

trade data are too conservative and are likely to have a serious 

29 

negative impact on liquidity. Particularly as such proposals address 

market transparency and not market risk, the more prudent approach would be to make informed decisions based on a thorough 

analysis of market data with larger block trade sizes and more 

prompt public reporting for the most liquid products and lower 

sizes and delayed reporting for less liquid products. 

There are a number of other significant issues related to SEF 

trading mandates proposed by each of the CFTC and SEC which 

I am happy to discuss. Such issues include the CFTC’s proposed requirement for Requests for Quotes to be distributed to a minimum 

of five dealers, the CFTC’s and SEC’s mandate for participants to 

take into account or to interact with other resting bids and offers, 

the CFTC’s requirement for there to be a 15-second delay involving 

crossing trades, and the need for harmonization across the CFTC 

and SEC rulemaking to avoid unnecessary complexities. 

Thank you for the opportunity to share our views with the Subcommittee, and we will be pleased to serve as a resource for the 

Members with respect to the swaps rulemaking exercise. 

Chairman REED. Thank you very much. 

Mr. Merkel, please. 

STATEMENT OF STEPHEN MERKEL, EXECUTIVE VICE 

PRESIDENT AND GENERAL COUNSEL, BGC PARTNERS, INC. 

Mr. MERKEL. Thank you, Chairman Reed and Ranking Member 

Crapo, for providing this opportunity to participate in today’s hearing. 

My name is Stephen Merkel, and in addition to my role at BGC 

Partners, I am the chairman of the Wholesale Markets Brokers’ Association, Americas, an independent industry body whose membership includes the largest North American interdealer brokers. I am 

here today representing the members of the WMBA. 

The WMBA recently filed a comment letter to the SEC and 

CFTC summarizing the positions we have taken on several of their 

proposals over the last year. I would ask permission to submit this 

letter for the record. 

Chairman REED. Without objection. 

Mr. MERKEL. Thank you. 

Wholesale brokers are today’s marketplaces in the global swaps 

market and, as such, can be a prototype for prospective independent and competitive swap execution facilities, or SEFs. As we 

sit here today, interdealer brokers are facilitating the execution of 

hundreds of thousands of over-the-counter trades corresponding to 

an average of $5 trillion in notional size across a wide range of 

asset classes. Although the Dodd-Frank Act created the term 

‘‘SEF,’’ the concept of counterparties to a trade utilizing an intermediary to execute transactions has been around for a very long 

time. 

At the core of Title VII is a competitive marketplace. The DoddFrank Act specifically did not dictate that all mandatory trades go 

through monopolistic exchanges and instead permits these trades 

to be executed across an array of over-the-counter competitive 

SEFs. SEFs do not operate as siloed, monopolistic exchanges. Instead, we operate as competing execution venues where BGC and 

its competitors aggressively vie with each other to win their cusVerDate Nov 24 2008 10:41 Mar 16, 2012 Jkt 048080 PO 00000 Frm 00033 Fmt 6633 Sfmt 6633 L:\HEARINGS 2011\06-29 AM EMERGENCE OF SWAP EXECUTION FACILITIES -- A PROG
30 

tomers’ business through better price, provision of superior market 

information and analysis, deeper liquidity and better service. It is 

vital to ensure that SEFs are brought under the new regulatory regime in such a way that fosters the competitive nature of OTC 

markets and continues to provide a deep source of liquidity for 

market participants. 

WMBA member firms are currently fully functional, having the 

capacity to electronically capture and transmit trade information 

with respect to transactions executed on our trading platforms as 

well as the ability to execute or trade swaps by accepting bids and 

offers made by multiple participants through any means of interstate commerce, including use of electronic and voice trading platforms. 

I would suggest that there are four critical elements regulator 

need to get right. 

First, SEFs must not be restricted from deploying the many varied trade execution methods successfully used today. 

Second, regulators need to carefully structure a public trade reporting system that takes into account the unique challenges of 

swaps trading. If the rules do not properly define the size of block 

trades, information, and time delays, it will sure cause a negative 

impact on liquidity, disturbing end users’ ability to hedge commercial risk and to plan for the future. 

Third, the goal of pretrade transparency must be realized 

through means that are already developed by wholesale brokers to 

garner and disseminate pricing information, and not by artificial 

mechanisms that may restrict market liquidity for end users and 

traders. 

Finally, regulations should support the formation of a common 

regulatory organization for SEFs to implement and facilitate compliance with the new regulatory regime to prevent a ‘‘race to the 

bottom’’ for rule compliance and enforcement programs. As it relates to modes of execution, Dodd-Frank Act expressly permits 

swaps to be executed by SEFs using any means of interstate commerce. The WMBA believes the SEC’s interpretation of the SEF 

definition is consistent with the statute as it allows trade execution 

through any means of interstate commerce including requests for 

quotes systems, order books, auction platforms, or voice brokerage 

trading. 

WMBA believes that this approach should be applied consistently 

to all trading systems or platforms and will encourage the growth 

of a competitive marketplace for trade execution facilities. By contrast, the CFTC’s pending rule is much more restrictive than DoddFrank’s express language and prescribes specific modes of execution for different types of trades. 

In fact, the CFTC’s proposed rule would severely limit the ability 

of SEFs to communicate with their customers telephonically in the 

course of a transaction. Such a limitation of voice communications 

is completely inconsistent with the statute. 

I thank you for your time and look forward to answering any 

questions that you may have. 

Chairman REED. Thank you very much. 

Mr. Bury, please. 

31 

STATEMENT OF CHRIS BURY, COHEAD OF RATES SALES AND 

TRADING, JEFFERIES & COMPANY, INC. 

Mr. BURY. Good morning. My name is Chris Bury and I am the 

Cohead of Rates Sales and Trading for Jefferies and Company. 

Chairman Reed and Ranking Member Crapo, thank you for inviting me to testify this morning regarding the emergence of swap 

execution facilities, or as they have come to be known, SEFs. 

Jefferies is a full-service global securities and investment banking firm that, for almost 50 years, has been serving issuers and investors. We provide investment banking and research, sales, and 

trading services and products to a diverse range of corporate clients, Government entities, institutional investors, and high net 

worth individuals. Over the last 5 years, our firm’s annual revenue, 

equity market capitalization, and global head count have increased 

significantly, with now almost $3 billion in annualized net revenue, 

over $4 billion in equity market value, and soon to be 3,600 employees. 

It bears noting that during the same period, that is, during the 

financial crisis, at no time did Jefferies seek or receive taxpayer assistance. As a publicly traded company on the New York Stock Exchange, our capital comes solely from the markets, and Jefferies’ 

ability to persevere and emerge from the financial crisis positioned 

for growth and diversification can best be attributed to the firm’s 

focus on a strong capital position, ample liquidity, and sound risk 

management. 

There are a few key points that Jefferies would like to convey to 

the Subcommittee. First, we are ready to go. From our perspective, 

the architecture, infrastructure, and technology necessary to bring 

the over-the-counter derivatives markets into an era of transparency, disperse counterparty risk, and open access are in place. 

Just as we are a leading provider of liquidity and execution in 

stocks and bonds, we believe we can become a leading provider to 

buyers and sellers of derivatives. The market awaits the adoption 

of final rules. It is a fallacy to suggest that rules should be delayed 

to allow more time for this market structure to develop. 

Second, we believe that those sections of Title VII of Dodd-Frank 

pertaining to SEF trading of derivatives are necessary to remedy 

the artificial barriers to entry in the OTC derivatives market. 

Third, implementation time lines should be the top priority at 

this juncture. The proposed rules are generally clear and understandable. The market needs the certainty of when the rules will 

become applicable far more than it needs any more suggestions 

about how bilateral agreements offer an alternative to central 

clearing. 

Fourth, it is vitally important to guard against the development 

of market structures that enable opaque, bilateral contract relationships to continue to exist. Current standardized execution 

agreement proposals for centrally cleared swaps do nothing but 

preserve the closed and anticompetitive elements of these markets 

as they existed prior to the financial crisis. 

Fifth, the adoption of the rules and a clear time line for implementation for Title VII will bring to the markets the same clear 

benefits gained from similar developments in equities and futures 

markets: Increased access, expanded competition, improved price 

32 

transparency, and decentralized risk. For years, firms such as 

Jefferies were effectively locked out of being a dealer in the OTC 

market by virtue of a series of artificial barriers and requirements 

that perpetuated a closed system. The weaknesses and lack of true 

competition of that closed system exacerbated the credit crisis of 

2008 to the great expense of our economy. 

We support the implementation of SEF trading as quickly and 

responsibly as possible. We believe that these provisions will increase transparency, reduce systemic risk, increase competition, 

and broaden access to centralized clearing within the derivatives 

marketplace, all of which will benefit the American taxpayer. 

Our industry is approaching full readiness for standardized OTC 

derivatives contracts to begin trading on SEFs. If the proposed 

rules are implemented by the end of 2011, Jefferies would anticipate that trading volumes will begin increasing by the fourth quarter of this year, and then increase significantly into 2012 as we approach final implementation of mandatory SEF trading of standardized derivatives. A firm time for mandatory SEF trading on the 

most standardized swaps will be instrumental for the market to 

achieve its full potential. 

In conclusion, Jefferies believes that implementation of Title VII 

reforms will unless full market forces held in check by entrenched 

business models and we are ready and eager to compete in the derivatives marketplace. 

Thank you for inviting me to testify today and I look forward to 

any questions the Subcommittee may have. 

Chairman REED. Well, thank you, gentlemen, for your excellent 

testimony. 

Senator Toomey and I await momentarily a vote. We have a few 

minutes to get over there, but I think the best way to proceed 

would be to allow me to ask a general question to the panel and 

then recognize Senator Toomey for a question, and then be prepared for an avalanche of written questions because we, unfortunately, will not be able to explore in as much detail at this moment 

as we wanted to. 

But just picking up on something Mr. Bury said about these 

model contracts that are being developed that you suggest might 

be literally a choke point for access to the SEFs and the different 

trading platforms, can you comment further on that in terms of 

your experience or what you see, and then I will just ask Mr. 

Merkel and Mr. Thum to comment, too, about this, because I believe some of the major associations are beginning to develop these 

types of contracts as an alternative to wider use of the SEFs. I 

think it is an important question. Mr. Bury, please. 

Mr. BURY. OK. One example currently that is taking place in the 

marketplace is an execution agreement on cleared swaps. There 

has to be some market framework and work flow by which people 

can start to transact in the cleared environment. So there is currently an industry documentation effort that is underway where 

people can identify their counterparties and their clearing members 

for cleared derivatives. 

Unfortunately, at this point, we feel that it is overly complex and 

contains too many complicated built-in credit checking limits that, 

at the end of the day, somewhat limit people’s ability and potential 

33 

to transact on other venues or engage other counterparties. It is 

overly complex, and I think if the market shifts and market participants combined with regulators overseeing the effort and helping 

the process along focus on, I guess, the mandated clearing and acceptance, immediate acceptance of clearing of transactions, then 

you will not have to rely on a byzantine or complicated documentation framework. 

Chairman REED. Thank you. 

Mr. Merkel, then Mr. Thum, and thank you. 

Mr. MERKEL. I would agree that there are real pressures and 

forces that work against breaking the status quo and opening up 

areas for competition, whether it is in clearing, whether it is in 

execution, whether it is in modes of execution, and I think that 

those, in many cases, those barriers to changing the status quo are 

subtle and difficult to discern. I do think there is an issue that I 

do not think the agencies are as focused on as they might be, and 

I think that is a considerable problem. There are some protections 

in Dodd-Frank with respect to this issue, with respect to impartial 

access, with respect to nondiscriminatory clearing. I have not seen 

in the regulations that have come out much sensitivity to getting 

into that in detail. 

I have seen in the regulations, to the contrary, there are almost 

no references to them other than parroting what is in the statute, 

and what regulations we are seeing that come out in detail are not 

even part of Dodd-Frank. So I think the regulators are focusing 

very much on recreating marketplaces or reengineering marketplaces without regard to the effects on liquidity, but spending almost no time looking at trying to foster a competitive landscape. 

Chairman REED. Mr. Thum, please. 

Mr. THUM. Before you can have mandated SEF trading, you have 

to have mandated clearing. Before you can have mandated clearing, you have to have the documentation in place. Indeed, ISDA 

and the FIA are developing standard addendums to overlay over 

existing futures agreements which the market has in place. Unfortunately, there is no standard futures agreement in the market. 

Every dealer has its own unique futures agreement. Those futures 

agreements are developed for futures. They are not developed for 

swaps. 

There are business issues related to the trading of swaps, even 

clearing swaps, that are unique to swaps that are different from futures that will have to be addressed. There is an overlay that ISDA 

and the FIA have developed to supplement the existing futures 

agreement to allow central clearing. Unfortunately, those have to 

be negotiated bilaterally between every client and every clearinghouse and the existing futures agreement may have to be upgraded, as well. This is an enormous effort. 

Certainly, Vanguard is engaged in this at present, but the pipeline is limited in terms of the dealer’s ability to digest renegotiating 

all of their existing futures agreements and have the addendum 

put in place. This will be a big problem in terms of having a very 

condensed implementation schedule, which is one of the reasons 

why I have laid out the sequence of having, first, reporting to informed decision making on block trade size and delays, then have 

clearing layered in, first through swap dealers and major swap parVerDate Nov 24 2008 10:41 Mar 16, 2012 Jkt 048080 PO 00000 Frm 00037 Fmt 6633 Sfmt 6633 L:\HEARINGS 2011\06-29 AM EMERGENCE OF SWAP EXECUTION FACILITIES -- A PROG
34 

ticipants, then have clearing laid in for the rest of the market, allowing 18 months to get these documents signed up, and then, finally, SEF trading after that. 

Chairman REED. Thank you very much. 

Senator Toomey. 

Senator TOOMEY. Thank you, Mr. Chairman. 

Mr. Thum, I would like to follow up with you on this. First of 

all, I would like to commend you. I think this is a very sensible and 

very thoughtful proposal that lays out a phased implementation 

that makes a lot of sense and, frankly, is very helpful. My sense 

is that there is increasing consensus that there needs to be a 

phased implementation, but it is not yet clear to me that there is 

a complete consensus on what the sequence will be, nor necessarily 

on the overall timing. 

So you have touched on several reasons why this is important, 

the comments you just made about the necessity of getting the documentation in order. As I understand it, your testimony suggests 

that there could be a negative impact on liquidity if some of the 

rules, reporting rules, for instance, are not informed by the market 

data. Could you elaborate a little bit and maybe touch on other aspects, negative aspects that you are concerned about in the marketplace if there is not sufficient time for this implementation to 

occur? 

Mr. THUM. Sure, and I think that is an excellent question. I 

think that the problem is that, particularly as mandates are layered in place, you could have a situation where those that cross the 

finish line at an appropriate time consistent with the mandate are 

allowed to continue to trade swaps, clear and trade swaps, and 

those that do not get past the finish line, either because their business is not large enough to allow them through the pipeline at the 

dealer to get the documentation signed up, to have their infrastructure developed, to have all the operational connectivity in place, 

they will be effectively locked out of the market because of an arbitrary time line that does not take into consideration all the things 

that need to be done. 

In recent CFTC and SEC roundtables, a focus has been on SDRs 

and gathering information. Once the final rules are in place, the 

SDRs think it will be three to 6 months before they are ready to 

be collecting the data and then have the data to allow the commissions and the SEFs to make decisions on block trade size and 

delays. 

So there is a whole sequence of getting the data, having the 

SDRs set up, getting the data in the door, allowing time for the 

documentation to get clearing in place, and then once you have the 

data, analyze the data, assess liquidity, set appropriate block trade 

sizes and delays so that you can effectively allow for SEF trading. 

But all these things have to happen and they have to happen in 

sequence and they have to happen once the rules are finalized. 

Senator TOOMEY. And I gather the bottom line is your concern 

is if it happens on too compressed a schedule, then there are significant participants that could be actually just frozen out of the activity until they are able to get up to compliance, and I suppose, 

also, the danger of inappropriate rules because they would not be 

informed by sufficient history. 

35 

Mr. THUM. Exactly, and the largest players, some of which were 

mentioned today in the earlier panel, will probably get to the finish 

line very quickly. 

Senator TOOMEY. Right. 

Mr. THUM. But the rest of the market may be left behind. And, 

of course, the problem—the impacts on liquidity that have been 

talked about in the various panels will be significant. 

Senator TOOMEY. Thank you. Thank you, Mr. Chairman. 

Chairman REED. Thank you very much, Senator Toomey. 

Gentlemen, thank you for your excellent testimony. We have a 

vote that is underway, but again, we will, I am sure, be responding, 

not just Senator Toomey and I, but others with questions for you. 

I want to thank all the witnesses for testifying today. We appreciate both the time and effort you made to join us this morning, 

your excellent testimony. It has been thoughtful. It is also of great 

assistance to us, and I hope it is of great assistance to the agencies, 

the SEC and the CFTC, because one of the messages that has been 

consistent is coordination and accommodation and synchronization 

of their efforts to regulate the market. 

I would also like to submit, without objection, for the record a 

written statement from the Investment Company Institute, ICI. 

If Members of the Committee have their own written statements 

or additional questions for the witnesses, please submit them no 

later than close of business next Wednesday. The witnesses’ complete written testimony will become part of the hearing record and 

we are happy to include supporting documentation for the record. 

We ask that the witnesses respond to any questions within 2 

weeks, and note that the record will close after 6 weeks in order 

for the hearing print to be prepared. 

Without further business, I will call the adjournment of the hearing. Thank you. 

[Whereupon, at 11:16 a.m., the hearing was adjourned.] 

[Prepared statements, responses to written questions, and additional material supplied for the record follow:] 

36 

PREPARED STATEMENT OF SENATOR MIKE CRAPO 

Thank you, Mr. Chairman for holding this hearing on the development of Swap 

Execution Facilities (SEFs). 

There are a number of different electronic trading models that could potentially 

be used for derivatives trading depending upon final rules by the SEC, CFTC, and 

international regulators. 

While Title VII of the Dodd-Frank Act states that the SEC and CFTC shall consult and coordinate to the extent possible for the purposes of assuring regulatory 

consistency and comparability, the lawyers for the two agencies have not been able 

to agree what these terms means. 

We should not then be surprised when the two agencies propose inconsistent approaches to the same rule sets. For the Swap Execution Facility rules, the SEC approach is more principles-based and is in general far less prescriptive than that of 

the CFTC. 

While the Dodd-Frank Act missed a great opportunity to merge the SEC and 

CFTC and stop the bifurcation of the futures and securities markets we should continue to push for more coordination and consistent rules. 

Swap Execution Facilities are likely going to dually register with the two agencies 

and it makes a lot of sense for the two regimes to be consistent. 

While I applaud the SEC for taking a more flexible approach relative to CFTC, 

both agencies need to make their rules more accommodative of the different types 

of SEFs to provide maximum choice in trade execution to market participants. 

Under the CFTC SEF version, the proposed rule requires swap users to request 

prices from no fewer than five dealers at a time. 

This is generating a lot of controversy from the end user community which argues 

it may ultimately serve to unnecessarily disadvantage end users by limiting their 

ability to choose the appropriate number of counterparties and mode of execution 

in the way they deem most efficient and effective to hedge their commercial risk. 

Since the Dodd-Frank Act stipulates that transactions required to be cleared must 

also be executed on a SEF or designated contract market there is significant interplay between the clearing, trading, and the definition of block trades. 

According to the end users, this could create a problem for some less liquid trades 

that could be suitable for clearing, but not for trade execution. 

I have also been advised that the SEC’s SEF approach is more consistent with 

what the Europeans are looking at but have not acted upon. 

If we want to find a common international framework in order to avoid regulatory 

arbitrage and avoid competitive disadvantages we need to provide greater coordination and harmonization to get the rules right rather than rushing them through. 

PREPARED STATEMENT OF KEVIN MCPARTLAND 

DIRECTOR OF FIXED INCOME RESEARCH, TABB GROUP

JUNE 29, 2011 

Chairman Reed, Ranking Member Crapo, and Members of the Subcommittee, 

thank you for inviting me today to discuss progress and concerns surrounding the 

creation of swap execution facilities. 

I’m Kevin McPartland, a Principal and the Director of Fixed Income Research at 

TABB Group. TABB Group is a strategic research and advisory firm focused exclusively on the institutional capital markets. Our clients span the entire investment 

landscape including investment banks, pension plans, mutual funds, hedge funds, 

high frequency traders, FCMs, exchanges, and clearinghouses. We also operate 

TabbFORUM.com, a peer-to-peer community site where top level industry executives share thought leadership on important issues affecting the global capital markets. 

In order for this new market structure to be successful, swap execution facilities 

must be given broad latitude in defining and implementing their business models— 

this includes, but is not limited to, the mechanisms used for trading and the risk 

profiles of their members. This will promote the innovation and competition that 

has made the U.S. capital markets the envy of the world. 

It is also critical that the mechanisms to move trades quickly and easily from execution to clearing are well defined. If market participants worry that the trade they 

have just executed on a SEF might later in the day be canceled due to a clearinghouse rejection, confidence in the entire market model will erode quickly, and severely limiting the transparency and systemic risk reduction Dodd-Frank was intended to improve. 

37 

New Market Structure 

Despite these open concerns, industry sentiment toward the creation of swap execution facilities has turned positive. Based on a TABB Group poll published in April 

2011, of more than 140 market participants, 87 percent believe the creation of swap 

execution facilities will ultimately be good for the swaps market. Of course, everyone 

defines ‘‘good’’ differently—good for liquidity, for transparency, for profits. Regardless, this demonstrates how the market’s view that nearly every business model 

can—and most will—be adapted to work under the proposed SEF rules. 

That being said, no solution will satisfy all market participants—nor should it. 

Regulators should not try to appease everyone in the market but instead focus their 

efforts on creating a set of rules that work. 

To finalize the new swaps-market rules, regulators can either attempt to fit these 

products into old structures (such as a futures structure), or develop new mechanisms to manage these products. TABB Group believes regulators should look toward the new rather than wrap a new product in an old package. To that end, we 

are all presented with the rare opportunity to build up this market from scratch 

in such a way that it will function effectively for farmers who need to hedge crop 

prices and global financial institutions working to keep the world’s economy flowing. 

The exchange model was created over 200 years ago long before electronic trading 

and high-speed market data. Today we’re creating a new 21st-century market, but 

why would a paradigm from the 1800s make sense as a starting point? With little 

legacy legislation, rules can be written based on what we know now, not based on 

the structures developed in 1934 via the Securities and Exchange Act. 

Trading Style and Membership Requirements 

In order to develop the most suitable market structure for swaps, we must provide 

swap execution facilities with the freedom to utilize trading styles and different 

business models, ensuring every market participant has the most efficient access to 

liquidity possible. 

Firstly, SEFs should not be driven to a particular trading model. Despite the inclusion of the Request for Quote model in proposals from the CFTC and SEC, regulators are keen to have swaps trade through an order book with continuous twosided quotes. 

TABB Group research shows that order-book trading will emerge naturally—81 

percent believe we will have continuous order book trading of vanilla interest rate 

swaps within 2 years of SEF rule implementation. However, the existence of an 

electronic order book does not guarantee liquidity nor that market participants will 

trade there. 

For example, of the roughly 300,000 contracts available for trading in the electronic U.S. equity options market, only 100 of those make up about 70 percent of 

the volume. The rest are seen as so illiquid that it is often easier to trade OTC with 

a broker rather than try and execute that same contract on the screen. Furthermore, despite the market’s electronic nature, TABB Group research shows that in 

2010 as much as 97 percent of all options trading volume generated by asset managers was done over the phone. 

Second, we should encourage SEFs to set membership requirements to encourage 

a variety of liquidity pools. The U.S. equity market presents a good example. Thirteen registered exchanges and another 55 alternative execution venues exist to 

trade U.S. equities for a total of sixty-eight. Why? Because different market participants trade in different ways and have different needs. Some like to trade in large 

size, some small; some are very concerned about price while others are more concerned about getting a trade done quickly. Because of this, the equity market responded with new venues to meet those needs. 

Although the equities market is very retail focused and the swaps market is purely institutional, a similar dynamic exists. The trading style and needs of a mutual 

fund are very different from those of a major dealer or a hedge fund. We therefore 

should encourage swap execution facilities to develop business models that help all 

market participants, and allow SEFs to compete with each other for whichever client base they chose to serve. This means allowing SEFs to not only define the method of trading, but requirements for entry. 

For example, if you were willing to pay the membership fee, a restaurant supply 

store would be willing to sell you food for your family in the same bulk sizes they 

provide for restaurants. But since most American families do not need to buy food 

in bulk, we choose instead to shop at a local supermarket. The price per unit might 

be higher, but it is a more suitable way to shop for a family of four. Although the 

analogy might appear flippant, it explains why loosely defined tiers must still exist 

for trading swaps. 

38 

In the current market, a smaller player cannot trade in the interdealer market 

even if they had the capital and desire. In the new market, as long as a trading 

firm meets the requirements set forth by the SEF, they will be—and should be— 

allowed in to trade. The important point to note is that setting membership requirements for SEFs is not exclusionary, but instead intended to help market participants trade in the most suitable environment possible. 

Clearing 

Open access to clearing will play a huge role in the success or failure of all SEFs. 

It is central clearing, not the SEF construct itself, that will allow easier access to 

trading and new market participants to enter. But a clearinghouse providing only 

the ability to accept SEF executed trades is not enough. 

SEFs are intent on providing click-to-trade functionality, that when you accept a 

price on the screen with a click of the mouse, whether in an order book or via a 

request for quote, the trade is done. However, a trade is not done until it is accepted 

for clearing—something the SEFs have little if any control over. That raises the 

question: can a SEF ensure a trade will be accepted for clearing before it allows the 

trade to execute? And even if it can, is that its responsibility? 

Either way, clearing certainty is crucial to the success of SEFs. If market participants worry that the trade they have just executed on a SEF might later in the day 

be canceled due to a clearinghouse rejection, confidence in the entire market model 

will erode quickly and limit severely the transparency and systemic risk reduction 

Dodd-Frank was intended to improve. It is critical that a mechanism be put in place 

to formalize this process, ensuring the market can have full faith in the trades they 

execute on a SEF. 

Size of the Market and Open Issues 

There has been considerable speculation as to the number of SEFs that will exist. 

The wildest number I’ve heard is 100 which is simply unrealistic. If the U.S. equities market has 68 venues and the U.S. futures market has 3 main players, the 

swaps market will fall somewhere in the middle. 

Our research shows also that nearly 60 percent of market participants believe the 

ideal number of SEFs per asset class is three to four, resulting in 15 to 20 SEFs 

covering interest rates, credit, FX, commodities, and equities. There will be many 

more than that to start but not 100—our list at TABB Group shows as many as 

40 firms that plan to apply—but 87 percent of our study participants believe that 

SEF consolidation will begin 2 years or less from the date of rule implementation. 

Timing 

Rulewriting delays at the CFTC and SEC are unfortunate but necessary. The financial services industry is ready to move ahead to the next chapter, but it is more 

important that these rules are written properly rather than in haste. Despite the 

fact that so much uncertainty remains, the industry is moving ahead with preparations for SEF trading, central clearing, trade reporting and the myriad of other new 

requirements. 

We are now in the pre-SEF era. Business models and technology are being finalized, but most SEFs are ‘‘registration-ready’’ and trade flow is beginning to pick up 

on the screen as most everyone has accepted that these changes are inevitable. 

Tradeweb, a trading platform set to register as a SEF, tells us their trading volume 

is up 47 percent from last year. We see this level of growth happening with several 

of the existing platforms. Even if trading mandates don’t take effect until the fourth 

quarter of 2012—a timeframe that seems more realistic—the change is so enormous 

for most swaps traders that getting started now should present just enough time 

to make the switch. 

Winners and losers, however, will not be chosen until after regulatory mandates 

are in place. Too many market participants still exist and see little economic incentive to shift, in addition to those new market participants waiting in the wings. But 

even still, working together, regulators and the industry have made significant 

progress during the past year, clarifying the view of what the post- Dodd-Frank 

world of swaps trading will look like. 

As rules are finalized, it is critical that while putting in place necessary oversight, 

new OTC derivatives rules encourage the innovation and competition that have 

made the U.S. capital markets the most envied in the world. 

Thank you. 

39 

PREPARED STATEMENT OF NEAL B. BRADY 

CHIEF EXECUTIVE OFFICER, ERIS EXCHANGE, LLC 

JUNE 29, 2011 

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49 

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51 

52 

53 

1 Bloomberg employs over 12,900 employees around the world, including more than 2,300 

news and multimedia professionals at 146 bureaus in 72 countries, making up one of the world’s 

largest news organizations. 2Our reference to ‘‘SEFs’’ in this testimony is intended to include SB–SEFs as well unless 

otherwise indicated. 

PREPARED STATEMENT OF BEN MACDONALD 

GLOBAL HEAD OF FIXED INCOME, BLOOMBERG, L.P. 

JUNE 29, 2011 

My name is Ben Macdonald and I am the Global Head of Fixed Income for 

Bloomberg L.P., a privately held independent limited partnership headquartered in 

New York City. Bloomberg is not owned by any swap market participants and does 

not itself engage in trading of swap instruments on a proprietary basis. Our customer base for our information and news services, market analytics and data services, and for our platforms for electronic trading and processing of over-the-counter 

(OTC) derivatives is evenly distributed among buy-side and sell-side entities. We 

serve the entire spectrum of the financial market and, being independent, we do not 

have a bias toward nor are we beholden to any particular element of the market. 

Bloomberg’s core business is the delivery of analytics and data on approximately 

5 million financial instruments, as well as information and news on almost every 

publicly traded company through the Bloomberg Professional service. 1 More than 

300,000 professionals in the business and financial community around the world are 

connected via Bloomberg’s proprietary network. Over 17,000 individuals trade on 

our system across all fixed income product lines alone, with over 50,000 trading 

tickets a day coming over that network. Virtually all major central banks and virtually all investment institutions, commercial banks, Government agencies and 

money managers with a regional or global presence are users of the Bloomberg Professional service, giving Bloomberg extraordinary global reach to all relevant financial institutions that might be involved in swap trading. 

I lead Bloomberg’s team of professionals dedicated to establishing a registered 

Swaps Execution Facility (SEF) and Security-Based Swaps Execution Facility (SB– 

SEF) under Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. As the largest independent player in the market in terms of electronic trading and processing of OTC derivatives, Bloomberg has an extensive suite 

of capabilities, experience, technical expertise, infrastructure, connectivity, and community of customers that uniquely position our fIrm to provide unbiased, independent intermediary SEF and SB–SEF services to both the buy-side and the sellside in the domestic and international swaps market. All major swaps dealers utilize our platform. Over 600 firms use Bloomberg’s existing platform to trade interest 

rate swaps and credit default swaps. We provide connectivity for both the buy-side 

and the sell-side to multiple clearinghouses. We facilitate exchange-traded as well 

as voice brokered swaps on our system. 

Bloomberg fully supports the creation of the regulated swaps marketplace envisioned by Dodd-Frank. We believe that the Dodd-Frank mandatory clearing and reporting requirements will significantly mitigate systemic risk, promote standardization, and enhance transparency. We enthusiastically anticipate being a robust and 

capable competitor in the SEF and SB–SEF markets, and we believe our participation as an independently owned firm will bring innovation, reliability, efficiency, 

transparency, and reduction of systemic risk to the markets. 

Bloomberg’s Existing Electronic Swaps Platforms: Experience and Innovative Leadership 

Our views on the subject of SEF2 regulation are significantly informed by our 

long and successful experience derived from our existing OTC swaps trading platforms. We believe that body of expertise and experience provides Bloomberg the opportunity to engage the new world of SEF registration and operation from a considerable position of strength. Our current OTC derivatives trading platforms were 

built on the idea of adding transparency to the market by creating electronic functions that streamline trading in swaps and provide efficient, competitive access to 

swaps pricing, all of which aligns very well with the goals of Title VII of DoddFrank. 

Bloomberg’s current ‘‘single-dealer’’ and ‘‘multidealer’’ derivatives trading tools 

allow multiple participants to view and trade swaps with multiple dealers. In 

Bloomberg’s single-dealer page system, enabled participants are readily able to view 

different dealer pages (simultaneously if preferred) that display the price and volume at which each dealer has indicated it will trade. After reviewing the displayed 

prices a participant can then request to execute against a single-dealer page’s disVerDate Nov 24 2008 10:41 Mar 16, 2012 Jkt 048080 PO 00000 Frm 00057 Fmt 6621 Sfmt 6621 L:\HEARINGS 2011\06-29 AM EMERGENCE OF SWAP EXECUTION FACILITIES -- A PROG
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played price with the understanding that the dealer can accept, counter, or reject 

execution. Multidealer pages display a ‘‘composite price’’ reflecting the general market based on participating dealers’ respective price submissions. After reviewing the 

displayed ‘‘composite price’’ a participant can request specific prices from 3 dealers. 

The participant then has a limited time to accept or reject a trade with any of the 

dealers. Under both models, Bloomberg provides real-time trade reporting to warehouses, data repositories, and clearing venues. 

Bloomberg also has hosted various ‘‘request for quote’’ (RFQ) systems for OTC derivatives for the past 5 years. These RFQ systems allow entities seeking liquidity 

to secure bids and offers from particular market participants they would like to engage in a transaction. Our Bloomberg Bond Trader System, a competitive multidealer RFQ platform for U.S. and foreign government securities, has been active for 

more than 13 years. We are confident that these very successful RFQ models provide directly relevant experience and are the proper conceptual paradigm for establishing a SEF under Dodd-Frank. 

In addition to operating a very robust RFQ system, we also operate our ‘‘AllQ’’ 

system that shows market participants on one screen the stack of liquidity reflected 

in the range of streaming bids and offers from multiple dealers in the market. Users 

can perform their price discovery, and then click and trade with their dealer of 

choice. 

Both our RFQ and our AllQ systems empower properly enabled market participants to hit on executable bids and offers, or engage in electronic negotiation with 

counterparties on indicative bids. Our experience and success with our RFQ and 

AllQ platforms provide us confidence that we will be able to satisfy the operational 

requirements established by Dodd-Frank for SEF registration. We intend to be prepared to begin SEF operations on the implementation date of the relevant SEF regulations issued by Commodity Futures Regulatory Commission (CFTC) and the Securities Exchange Commission (SEC), provided that the two regulators create synchronized rules governing trading protocols, board composition and financial reporting. 

Responses to the Committee’s Specific Areas of Inquiry 

Bloomberg most certainly supports Dodd-Frank’s call for the emergence of SEFstyle trading, increased mandatory clearing and post-trade transparency through reporting. In particular, Bloomberg is very supportive of the Federal regulators providing clear and specific rules for clearing, and post-trade transparency, which together serve as the most significant tools for reducing systemic risk and attaining 

a reformed, financially sound derivatives marketplace that benefits market participants and the Nation as a whole. The systemic risk threats that arose in 2008–2009 

were associated with insufficient clearing and post-trade transparency and were not 

the result of execution failures. Indeed, market participants know very well what 

they want and need regarding fair and efficient execution on electronic platforms. 

Sophisticated market participants do not really need or want Federal regulators 

micro-managing execution protocols; no one should expect that market participants 

will necessarily want to trade the way the Federal Government prefers that they 

trade. It is also not the proper role of the Federal regulators to go to extravagant 

lengths to define the most favorable terms of execution for trading by sophisticated 

investors. Rather, while it is clearly a very important function, what is incumbent 

on Federal regulators is only to insure that the market is fair and competitive and 

that participants themselves have enough information to assess whether they know 

that they are getting a fair price. 

The risk that Federal regulators run in micromanaging execution protocols is that 

they will increase the direct cost of trading—with no compensating benefit to customers—and impose significant constraints and indirect costs that incentivize market participants to revert to forms of trading that evade the excessive regulation 

and those costs. It will not be difficult for market participants to find wholly lawful 

ways to conduct their trading in non-SEF environments, including taking their trading to foreign jurisdictions where the U.S. rules do not apply. 

Consequently, we do not believe that the same degree of regulation warranted for 

clearing and post-trade reporting is desirable from a public policy perspective with 

regard to trade execution protocols. Rather, in providing rules on trading protocols, 

Federal regulators should specifically avoid over-regulation and imposing ‘‘one size 

fits all’’ mandates, but should instead use a principles-based approach which encourages flexibility by SEFs that will maximize their innovation, competition and responsiveness to the needs of the market. Failure to invest SEFs with the ability to 

employ flexibility in their trade execution protocols actually jeopardizes the realization of the public policy objectives that Dodd-Frank seeks to attain. 

55 

3While not an exhaustive list, the large and complex range of documents that need to be negotiated and drafted include: derivative clearing organization agreements, swaps data repository 

agreements and protocols, platform participant agreements and end user agreements, independent service vendor agreements, and information sharing agreements with corresponding 

SEFs and Designated Contract Markets trading swaps to effectuate compliance relating to position limits and manipulation issues. In addition, SEFs will have to draft participant rulebooks, 

compliance manuals, connectivity agreements, antimoney laundering documentation, and numerous other vital documents. 

In his letter of invitation to this hearing, Chairman Reed outlined six specific 

areas of inquiry of interest to the Subcommittee. In response, Bloomberg offers the 

following views: 

Question 1: What is the status of industry readiness for trading on SEFs? What in 

your view is the timeline for the movement of substantial volumes of derivatives 

activity onto SEFs? What, if any, documentation is necessary for market participants to migrate their trading activity onto SEFs? 

There are different degrees of readiness for trading on SEFs among market participants and among products. Some market participants, including banks, hedge 

funds, insurers, and other sophisticated entities, are very eager and ready to begin 

trading on SEFs; other market participants will require more time to prepare themselves for SEF trading. The same is true with regard to the ‘‘readiness’’ of different 

products for SEF trading. The volume and liquidity of what are viewed as ‘‘plain 

vanilla’’ interest rate swaps, credit default and currency swaps make them prime 

candidates for early movement to SEF trading; but other products will take more 

time. The CFTC and SEC are currently engaged in the process of determining how 

to properly phase in participants and products as part of their effort to effectively 

sequence the implementation of the range of Dodd-Frank regulations and we believe 

the relative ‘‘readiness’’ of market participants and products ought to play a significant role in that phasing/sequencing determination. 

It is also worth noting however that if ‘‘readiness’’ is viewed in the context of capability to conduct the type of electronic trading envisioned for SEFs, Bloomberg in 

specific and the financial industry in general are very ready to commence SEF trading. The volume of electronic trading over the past decade has been enormous and 

the infrastructure to create the connectivity for SEF trading certainly exists. We 

have witnessed ever increasing migration of trading to a variety of electronic trading formats. Bloomberg itself has witnessed an accelerated use of our electronic platforms since the passage of Dodd-Frank a year ago. That said, SEF-style trading 

which entails multilateral trading and direct routing to clearinghouses remains rare 

since most current OTC swaps trading is bilateral and not submitted for clearing. 

We further note that if ‘‘readiness’’ is viewed from the perspective of the state of 

the legal framework for the clearing and increased transparency imposed by DoddFrank for SEF trading, there is considerable work still ahead for the industry. 

Clearing and transparency are certainly priority objectives of Dodd-Frank’s SEF regime as means to mitigate systemic risk, but those rules have not yet been articulated in final form by the CFTC and SEC. We expect those rules, once promulgated 

in final form, will be novel in many ways and costly, and it will take time for market participants to do all the things necessary to accommodate those rules in terms 

of legal documentation, installation of technology, and other critical responses. With 

regard to documentation alone, there is a significant number of necessary items that 

will require time for negotiation between interested parties and for careful drafting 

by lawyers. 3 Ultimately, how much swaps trading moves to SEF platforms will be 

influenced by the complexity of the agencies’ final rules and the cost of those rules 

for clearing, documentation, reporting and the like that must be borne by SEFs and 

their customers. The objective of those rules should be to minimize their cost and 

complexity in order to incentivize optimal movement of swaps trading to properly 

regulated SEF platforms and to minimize avoidance of those newly regulated SEF 

platforms. 

Question 2: How do you expect the open access requirements for clearinghouses to impact the development of SEFs? Are there any obstacles to clearinghouses meeting 

this open and nondiscriminatory access requirement? 

Bloomberg has been successful in securing access to various clearinghouses for its 

existing OTC trading platforms. While mandatory swaps clearing as envisioned by 

Dodd-Frank is not completely worked out in all regards, we are cautiously optimistic 

that in a reasonable time we will have no significant problems with clearing for 

trades on our registered SEF platforms. We believe that our connectivity to a range 

of clearinghouses will provide end users a desirable choice in where to clear their 

swaps, which effectuates one of the objectives of Dodd-Frank which was to empower 

56 

4So too, forcing a minimum number of dealers into the RFQ process will likely increase cost 

with no compensating offset or benefit. We observe that the SEC’s proposed SBSEF rules do 

not mandate transmission of an RFQ to a minimum or maximum number of liquidity providers. 

end users in that regard. It should be emphasized however that the cost and uncertainty of the rules on clearing swaps under the Dodd-Frank regime could be impediments to the proliferation of SEFs. 

Question 3: What regulatory and market-based incentives can facilitate the development and success of SEFs? 

Bloomberg believes that the Federal regulatory agencies should focus on creating 

well-articulated rules for clearing and post-trade market transparency, and to the 

maximum extent possible allow SEFs flexibility in fashioning their own trading protocols. In our judgment the most important incentive that can facilitate the development and success of SEFs is to give the SEFs significant latitude on the trading 

protocols they use. Maximizing the flexibility for SEFs to devise and implement 

their trading protocols will encourage innovation, competition and market responsiveness. In contrast, prescribing trading protocols by regulation will inhibit attainment of those public policy objectives and decrease overall SEF participation and 

market liquidity. It is noteworthy that the swaps market evolved to give swaps 

users highly customizable products that allowed them to meet specific investment 

objectives. Losing that tradition of flexibility to overly constrictive trading requirements would be destructive to the goal of encouraging a vibrant, competitive, and 

innovative SEF market. 

Question 4: Do any barriers currently exist in the derivatives market that would inhibit the entrance of additional SEFs into the marketplace? Are there ways to 

mitigate those barriers, and how would those changes impact the derivatives 

market? 

Given the technology afforded by the Internet and connectivity, technological barriers to entry are relatively low. However, we do perceive several elements of the 

Dodd-Frank regime that could create barriers to entry in terms of increased risk 

and cost for entities considering registering as SEFs. 

Micromanagement and Overregulation of Trading Protocols 

Central clearing ensures that there is sufficient capacity for the market to absorb 

losses within its own structure and trade reporting promotes price transparency 

which ensures price fairness. Both of these elements of Dodd Frank are beneficial 

to the market and ultimately to the individual investor and taxpayer. But trying 

to regulate with specificity the trading protocols may discourage the use of SEFs, 

and undermine the benefits that Dodd-Frank was designed to deliver through SEFs 

by reintroducing risk and removing liquidity. For example, mandating the use of a 

central limit order book would encourage the style of algorithmic and speculative 

trading that were at the center of the equities flash crash in 2010. Such an event 

would not be possible with today’s fixed income trading structure. 

Similarly, mandating the number of dealers that can participate in an RFQ may 

actually create liquidity risk because investors will only be able to trade if there are 

the mandated minimum number of market participants available. The proposed 

minimum requirement of having 5 respondent dealers for a SEF’s RFQ platform reduces the end user’s ability to achieve best execution because they will be forced 

to advertise their activities to a broader set of market participants than they may 

want. This problem is particularly acute with regard to block trades. The same can 

be said of imposing mandatory protocols that would require a block trade to interact 

with any resting interests on a SEF. 

Liquidity providers responding to a block trade RFQ need to factor in the size of 

the trade when quoting a price. Imposing a trading protocol that could materially 

alter the size of a block trade would inject uncertainty for the liquidity provider responding to an RFQ. Rather, liquidity providers should be given the option of interacting with resting bids (i.e., standing bids posted on platforms without reference 

to any particular RFQ) if it is consistent with their trading strategy and best execution, and SEFs should be allowed to offer that flexibility to the market. 4 Similarly, 

liquidity seekers tend to vary their strategies as to the number of liquidity providers 

they include in an RFQ. Their strategies typically depend on the particular instrument (and its relative liquidity), the direction (long or short), and the size of the 

transaction they are seeking to execute. Liquidity seekers should have the flexibility 

in any given transaction to identify the optimal number of liquidity providers from 

which to seek bids. 

57 

Nor should SEFs be limited to one model or methodology in disseminating composite indicative quotes to the market. Developing a meaningful composite is a complex process involving intricate proprietary algorithms and each SEF has a compelling reason to develop a composite indicative quote that represents the most accurate reflection of the markets that meets participant needs and expectations for accuracy. A SEF that offers a composite that is consistently ‘‘away’’ from the actual 

market will quickly be disciplined and marginalized by participants’ disuse of that 

SEF. 

There are other examples of the wisdom and value of allowing SEFs flexibility at 

the trading protocol level but the above illustrations convey the point that overly 

prescriptive mandates in this area are both unnecessary to the desirable functioning 

of SEFs and will effectively create barriers to SEFs coming into the market. 

Cost of Compliance 

The greatest current cost of compliance lies in the different rules promulgated by 

the CFTC and SEC. While Dodd-Frank requires these two agencies to coordinate 

their approach, it remains to be seen whether they will sufficiently do so in their 

respective final regulations. If they fail to do so, the result will be that to operate 

as both a SEF and a SB–SEF an entity will be compelled to create two separate 

companies to trade what in essence are the same type instruments. This not only 

affects each potential SEF and SBSEF but also their clients, many of whom use the 

same individual traders to trade both instruments types. The effective doubling of 

costs due to the inability of the two regulatory bodies to sufficiently coordinate their 

rules would not only be regrettable but creates a barrier to entry for the independent firms wishing to become SEFs and SBSEFs. It is fair to ask whether that 

may only auger concentration in the SEF space and a ‘‘too-big-to-fail’’ situation for 

the remaining SEF’s in the marketplace, which is exactly the opposite of what Congress intended when they included the idea of SEFs in Dodd-Frank. 

The creation of a complex set of overly detailed rules to manage trading protocols 

within the SEF market will generate significant regulatory compliance costs for 

SEFs which will have to be borne ultimately by the end users of the SEF platforms. 

Such costs can be mitigated by allowing the SEFs maximum flexibility to create 

their own trading protocols. 

Costs can further be reduced by providing a robust opportunity for SEFs to contract with third party service providers for such things as market surveillance, trade 

practice surveillance, real-time market monitoring, investigations of possible rule 

violations and disciplinary actions. In contracting for such services—while maintaining Dodd-Frank’s requirement that SEFs retain full, ultimate responsibility for decision making involving those functions—SEFs can avoid the capital and operational 

costs of creating the infrastructure of those functions for themselves internally and 

thereby reduce both the cost of entry into the SEF market and the cost of ongoing 

SEF operations. 

Beyond being allowed to use the expertise of third party service providers, SEFs 

also should be permitted to rely on the regulation and oversight of market participants and swap products by swaps clearinghouses rather than have to replicate essentially the same activity at the SEF level. For example, if a clearinghouse accepts 

a market participant for clearing purposes or accepts a swap for clearing, the SEF 

should be permitted to rely on that assessment for Core Principle compliance purposes regarding its obligation to establish that the market participant is an eligible 

swap participant or that the swap is not susceptible of manipulation under the SEF 

regulatory regime. 

Governance Constrictions 

Dodd-Frank requires the agencies to minimize opportunity for conflicts of interest 

in the governance of SEFs which would allow anticompetitive behavior injurious to 

other market participants. Both the CFTC and SEC have proposed regimes for mitigating conflicts of interests through ownership limitations and structural governance requirements. These rules were written to address risks arising from a situation where a SEF would be owned and controlled by other market participants who 

would be tempted to set SEF policy to advance their own interests and to the detriment of other market participants and the market in general. 

Requiring all SEFs to meet these ownership and governance constrictions is a serious and unnecessary barrier to entry in the case of SEFs whose ownership structure does not present the risks that Dodd-Frank’s conflict of interest provisions were 

58 

5While SEC has suggested they may require universal compliance with these conflict/governance rules even for independent entities, that view is not required by Dodd-Frank, nor is that 

interpretation a requirement written into the CFTC’s proposed rules. Beside being irrational because independent entities do not present the governance conflict risks the rules were designed 

to address, applying those rules would add unnecessary cost to independent entities operations 

without any countervailing public policy benefit. 

intended to prevent. 5 Bloomberg is an independently owned entity, meaning that 

other market participants do not have an ownership interest in the company. We 

are not beholden to either buy side or sell side interests. There is no public policy 

purpose in requiring Bloomberg or any other an independently owned firm to jump 

through unnecessary hoops and contort its governance to prescribed forms designed 

to prevent conflicts of interest risks that demonstrably do not exist due to their 

independent ownership structure and business model. We believe that where a SEF 

is not owned by its customer-members or other market participants and where the 

SEF can demonstrate a sufficient mitigation of legitimate potential conflicts of interests the agencies should permit that SEF an exemption from the governance restrictions which were designed to redress conflicts arising from cases where market participants own and control the SEF. Such an exemption would mitigate prospects 

that the governance rules would serve as an unproductive barrier to entry for independently owned SEFs who can bring to the market the competition that DoddFrank sought to generate in swaps trading. 

Extraterritoriality and International Harmonization 

The swaps marketplace is a global business. A large percentage of transactions 

on Bloomberg’s swap platforms involve non-U.S. banks and other foreign institutions. An entity seeking to register as a SEF desires to have consistent standards 

applicable to both SEFs and market participants across different jurisdictions. Without such coordination a SEF may be put in the untenable position of enforcing rules 

against certain participants that are inconsistent, or worse, conflicting with foreign 

rules. Moreover, without harmonized and consistent standards a SEF could be required to have one set of rules for U.S. participants and another set of rules for nonU.S. participants, with a further set of transaction-level rules based on the counterparties or underlying instruments. The resulting legal uncertainty associated with 

an uneven playing field and regulatory arbitrage can be a significant disincentive 

to becoming a SEF, to maximizing a SEF’s availability to market participants, or 

to the scope of the products offered for trading on the SEF. 

Question 5: How do you expect the SEF marketplace to develop over time? How many 

SEFs would you imagine operating in the United States and around the world 

5, 10, and 20 years after full implementation of the derivatives title? 

The existence of multiple SEFs will at least initially be a function of asset classes 

(credit, interest rates, currencies, commodities, equities) and market function (liquidity seekers versus liquidity providers). Initially, one can fairly assume that 

there may well be a larger number of SEFs in each asset class and market function, 

which over time may yield to consolidation based on the gravitation of the pool of 

liquidity to certain SEFs based on their superior performance and their more favorable system functionality. 

Having said that, predicting the number of SEFs globally is complicated by the 

fact that outside the U.S. there are no specific regimes to regulate swaps as SEFs 

are envisioned by Dodd-Frank. It can be said that in terms of U.S.-registered SEFs, 

the number of SEFs will be inversely proportional to the number and strength of 

barriers to entry. In this regard, the problem we foresee with unnecessary and unwise limitations on the flexibility of SEFs to determine their own trading protocols 

will be paramount. To the extent that SEFs are homogenous, required to fit a specific ‘‘one size fits all’’ regime on trading protocols, they will increasingly resemble 

cookie cutter utilities, providing less innovation and responsiveness to market participants’ evolving needs for those SEFs in the market and less incentive for new 

SEFs to enter the market to compete with incumbent SEFs. But the more flexible 

SEFs can be with their trading protocols the more incentive there will be for all 

SEFs to distinguish themselves with innovation, vigorous competition and increasingly more cost effective functionality for the market—all of which enhances the incentive for SEFs to come into the market in greater numbers. 

Question 6: What policy considerations, if any, should Congress or the regulators consider in order to better support the successful development of SEFs? 

The key public policy element we would suggest to Congress and the Federal regulators to better support successful development of SEFs relates to flexibility of 

trading protocols. There is little disagreement that clearing and transparency are 

59 

good for the market and will reduce systemic risk created by large concentrations 

of derivative positions. However, overly prescriptive methods of execution threaten 

market liquidity and create risks of unintended adverse consequences such as 

incentivizing trading that avoids SEFs (dark pools) and flight to less regulated foreign markets. Enabling SEFs to rely on aspects of the DCO compliance regime that 

would otherwise replicate compliance obligations imposed on SEFs would reduce 

SEF costs and incentivize SEFs to focus productively on their trading protocols 

which will maximize innovation, competition and market responsiveness. 

Conclusion 

SEFs represent a very valuable opportunity to achieve the reduction of systemic 

risk and transparency objectives of Dodd-Frank. Overly constrictive swaps trading 

rules will seriously diminish the contribution that SEFs can make to achieving 

those laudable public policy objectives. It is imperative, especially at the outset of 

the Dodd-Frank regime, that the regulations pertaining to SEFs do not mitigate the 

promise SEFs represent to achieve those legislative objectives which will keep the 

U.S. markets at the vanguard of international finance. In our view, this means the 

Federal regulators should not approach regulation of trade execution protocols from 

the same conceptual perspective as may be required for clearing and post-trade 

transparency. SEFs need operational flexibility at the trade execution level and 

without it one should not expect a robust emergence of SEFs or the ongoing innovation, competition and customer responsiveness they can bring to the market. 

On behalf of Bloomberg, I want to extend my appreciation for having this opportunity to appear before the Subcommittee to express our views. We are happy to 

be of further assistance to you as you continue your deliberations on these extremely important issues. 

PREPARED STATEMENT OF JAMES CAWLEY 

CHIEF EXECUTIVE OFFICER, JAVELIN CAPITAL MARKETS

JUNE 29, 2011 

Chairman Reed, Ranking Member Crapo, and Members of the Subcommittee, my 

name is James Cawley. I am Chief Executive Officer of Javelin Capital Markets, 

an electronic execution venue of OTC derivatives that will register as a SEF (or 

‘‘Swaps Execution Facility’’) under the Dodd Frank Act. 

I am also here to represent the interests of the Swaps & Derivatives Market Association or ‘‘SDMA,’’ which is comprised of several independent derivatives dealers 

and clearing brokers, some of whom are the largest in the world. 

Thank you for inviting me to testify today. 

Without a doubt, it is mission critical that central clearing, increased transparency, and broader liquidity is properly achieved under the Dodd-Frank Act for 

the OTC derivative markets. Toward that goal, it is important that SEFs be allowed 

to properly function and compete with each other whereby Congress and the Regulators ensure that such organizations and their various execution models be neither 

discriminated against, nor be penalized by trade workflow or documentation efforts 

that show preference for one SEF over another. 

Only by access to a fair, level, and open playing field, will SEFs be properly able 

to play their part in the lessening of systemic risk, to which the derivative marketplace contributed during the global financial crisis of 2008. 

Product Eligibility and Open Access 

With regard to product eligibility to clearing, clearinghouses should recognize that 

the fair majority of interest rate and credit derivative products do qualify for clearing. 

Regulators should be mindful to ensure that clearinghouses do not favor acceptance of certain products that have built in trade restrictions that impede open access or customer choice. 

While intellectual property rights may protect innovation in the short term, with 

regard to certain swap products or indices, they may restrict trade and liquidity in 

the long term. Market participants should be allowed to trade such products to meet 

their investor or hedging objectives. Intellectual property rights for such products 

should adapt with the post Dodd-Frank market place where anonymous and transparent markets flourish. 

Regulators should work with these IP holders to both ensure that their rights are 

properly protected, and the prudential need of the broader market is also protected. 

60 

1P. 13101. (Federal Register, Volume 76, No. 47, 3/10/11). 

Open Access to Clearinghouses 

With regard to SEF access to clearinghouses, clearinghouses and their constituent 

clearing members should do as the act requires—accept trades on an ‘‘execution 

blind’’ basis. DCOs should not discriminate against trades simply because they or 

they shareholders dislike the method in which such trades occur. 

Clearinghouses should refrain from using their SEF sign-up documentation as a 

vehicle to restrict trade. As a precondition to access, clearinghouses should not require that SEFs sign ‘‘noncompete’’ clauses, such that a clearinghouse’s other businesses—be it execution based or not—are inappropriately protected from outside 

competition. 

Likewise clearing firms should not require that SEF’s contract with them to restrict the rights or privileges of end users, as a precondition to SEF-clearinghouse 

connectivity. Such requirements serve no prudential role with regard to risk mitigation and run contrary to the open access provisions of the Dodd-Frank Act. 

Real Time Trade Acceptance 

Clearinghouses should not require that a SEF purposefully engage in a trade 

workflow that adds latency or creates unnecessary steps in the settlement process. 

Instead, clearinghouses and their constituent clearing firms should draw from 

their own proven and well tested experience in listed derivatives. They should accept trades symmetrically and in ‘‘real time.’’ 

Immediate acceptance of swaps trades into clearing is critical to accomplishing the 

goals of the Dodd-Frank Act to reduce systemic risk, increase trade integrity, and 

promote market stability. 

Settlement uncertainty, caused by time delays between the point of trade execution and the point of trade acceptance into clearing, can destroy investor confidence 

in the cleared OTC derivatives markets. 

As the CFTC has correctly asserted such a time delay or ‘‘trade latency,’’ (which 

in the bilateral swaps markets can be as long as a week) directly constrains liquidity, financial certainty, and increases risk. 1

Clearinghouses and their clearing members should do as the regulators have required, accept trades into clearing immediately upon execution on a SEF. 

Execution Documentation Efforts 

Regulators should be wary of certain incumbent efforts that claim to bring execution certainty through documentation. Such documentation sets in place workflow 

that clearly favors RFQ (Request for Quote) execution models over exchange like 

central limit order books. 

Such documentation denies the customer the right to trade anonymously with 

multiple counterparties, because under such a workflow, the dealer counterparty requires the identity of the customer be known before a trade occurs. 

This is not the case with documentation and workflow requirements in the cleared 

derivatives markets of futures and options. In those markets, buyers and sellers 

trade in multiple trade venues where trade integrity, counterparty anonymity and 

optimal liquidity is assured through access to multiple counterparties. 

Such restrictive workflow and documentation should be seen for what it is—nothing more than a transparent attempt to limit customer choice, restrict trade, and 

drain liquidity. 

Conclusion 

In conclusion, the role of the Swap Execution Facility with regard to lessening 

systemic risk should not be understated. 

To fulfill the SEF’s role in fostering greater liquidity and transparency, Congress 

and the regulators should continue to be proactive and protect the market against 

Dodd-Frank implementation ‘‘chokepoints.’’ They should continue to ensure that all 

SEFs have fair and open access to clearing and the marketplace. 

PREPARED STATEMENT OF WILLIAM THUM 

PRINCIPAL AND SENIOR DERIVATIVES COUNSEL, THE VANGUARD GROUP, INC. 

JUNE 29, 2011 

Chairman Reed, Ranking Member Crapo, and Members of the Subcommittee, 

thank you for having me here today. My name is William Thum and I am a Principal and Senior Derivatives Counsel at Vanguard. 

61 

Headquartered in Valley Forge, Pennsylvania, Vanguard is one of the world’s 

largest mutual fund firms. We offer more than 170 U.S. mutual funds with combined assets of approximately $1.7 trillion. We serve nearly 10 million shareholders 

including American retirees, workers, families, and businesses whose objectives include saving for retirement, for children’s education, or for a downpayment on a 

house or a car. 

Vanguard’s mutual funds are subject to a comprehensive regulatory regime and 

are regulated under four Federal securities laws. As a part of the prudent management of our mutual funds, we enter into swaps to achieve a number of benefits for 

our shareholders including hedging portfolio risk, lowering transaction costs, and 

achieving more favorable execution compared to traditional investments. 

Vanguard has been supportive of the Dodd-Frank Act’s mandate to bring regulation to the derivatives markets to identify and mitigate potential sources of systemic 

risk. 

Vanguard supports a phased implementation schedule over an 18- to 24-month 

period following rule finalization based on the following objectives: 

• prioritizing risk reduction over changes to trading practices and market transparency; 

• prioritizing data reporting to inform future rulemaking related to trading practices and market transparency (to minimize a negative impact on liquidity); 

• harmonizing overlapping U.S. and global regulatory efforts; and 

• allowing immediate voluntary access for all party types to the new platforms 

with mandated compliance to apply initially to swap dealers and major swap 

participants. 

In view of the time needed to digest the final rules and develop industry infrastructure; to implement complex operational connections required for reporting, 

clearing, and exchange trading; to educate clients on the changes and obtain their 

consent to trade in the new paradigm; and to negotiate new trading agreements 

across all trading relationships, Vanguard supports the following implementation 

schedule: 

• 6 months from final rules: Swap Data Repositories, Derivatives Clearing Organizations, SEFs, and middleware providers must complete the build-out of their 

respective infrastructures. 

• 6 to 12 months from final rules: All participants should voluntarily engage in 

reporting, clearing, and trading platforms. 

• 12 months from final rules: All participants should be mandated to report all 

swaps involving all parties. Dealers and major swap participants should be 

mandated to clear the first list of ‘‘standardized swaps.’’ 

• 18 months from final rules: All participants should be mandated to clear the 

first list of ‘‘standardized swaps.’’ SEFs and Commissions can analyze SDR 

swap data for liquidity across trade types to make informed SEF trading mandates, block trade size and reporting delays. Dealers and major swap participants should be mandated to trade the first list of ‘‘standardized swaps’’ ‘‘made 

available for trading’’ on SEFs. 

• 2 years from final rules: All participants should be mandated to trade the first 

list of ‘‘standardized swaps’’ ‘‘made available for trading’’ on SEFs with delayed 

public reporting of block trades based on historical relative liquidity. 

The need for a phased implementation schedule is supported by recent studies 

which have identified significant differences in liquidity between the swaps and futures markets. While futures trading is characterized by high volumes of a limited 

range of trade types of small sizes and limited duration, the swaps market has an 

almost unlimited range of trade types of much larger sizes with a much longer duration. Swaps liquidity varies dramatically with high liquidity for 2-year U.S. dollar 

interest rate swaps, and much smaller liquidity in credit default swaps on emerging 

market corporate entities. 

The potential negative consequences related to liquidity are best demonstrated by 

the impact of the premature public reporting of large-sized block trades. When 

quoting a price for a block trade, dealers typically charge a slight premium to the 

then current market price for a similar trade of a more liquid size. Once the block 

trade is executed, the Swap Dealer executes one or more liquid-sized mirror trades 

at current market prices to lay-off its position and to flatten its market exposure. 

The premature public dissemination of block trade details will provide the market 

with advance knowledge of the dealer’s imminent trading and is therefore likely to 

move the market against the dealer. Fund investors will ultimately have to bear eiVerDate Nov 24 2008 10:41 Mar 16, 2012 Jkt 048080 PO 00000 Frm 00065 Fmt 6621 Sfmt 6621 L:\HEARINGS 2011\06-29 AM EMERGENCE OF SWAP EXECUTION FACILITIES -- A PROG
62 

1 BGC Partners, Inc. (NASDAQ: BGCP) (www.bgcpartners.com) is a leading global intermediary to the wholesale financial markets, specializing in the brokering of a broad range of 

financial products including fixed income, rates, foreign exchange, equities, equity derivatives, 

credit derivatives, futures, and structured product markets. BGC offers a full range of brokerage 

services including price discovery, trade execution, straight through processing and clearing, settlement and access to electronic trading services through its eSpeed, BGC Trader and BGC Pro 

brands. On April 1, 2008, BGC merged with eSpeed to form a world-class provider of voice and 

electronic brokerage services in the global marketplace. The combined company is BGC Partners, Inc. Since its separation from Cantor Fitzgerald in 2004, BGC has expanded to 24 offices 

worldwide with over 1,700 brokers and approximately 2,700 employees. In 2005, BGC merged 

with Maxcor Financial Group, integrating two leading brokerage firms. This was followed by the 

acquisitions of ETC Pollak and Aurel in Paris. 2The WMBAA is an independent industry body representing the largest interdealer brokers 

operating in the North American wholesale markets across a broad range of financial products. 

ther the increased price of relevant trades, or the increased costs of establishing positions using multiple trades of liquid sizes. 

The CFTC’s proposed test for block trade size, and the CFTC and SEC’s proposed 

time delay for the public dissemination of block trade data are too conservative and 

are likely to have a serious negative impact on liquidity. Particularly as such proposals address market transparency and not market risk, the more prudent approach would be to make informed decisions based on a thorough analysis of market 

data with larger block trade sizes and more prompt public reporting for the most 

liquid products and smaller sizes and delayed reporting for less liquid products. 

In addition to the need for SDRs, DCOs, and SEFs to establish fully functional 

platforms, the central clearing of derivatives will require the negotiation (and possibly renegotiation) of all existing master trading agreements to establish the required clearing relationships for swaps. While ISDA and the Futures Industry Association are working on a standard form of addendum for cleared swaps to add to 

parties’ futures agreements, as there is no market standard form of futures agreement, and existing futures agreements may not address a number of key business 

issues related to the clearing of swaps, the futures agreement itself is likely to require significant renegotiation. 

Even if the larger market participants can promptly work through the process 

with dealers, many smaller participants could effectively be cut out of the swaps 

market altogether if the documentation process is not completed ahead of the clearing deadline. 

There are a number of other significant issues related to the SEF trading mandates proposed by each of the CFTC and SEC which I am happy to discuss in the 

question and answer period. Such issues include the CFTC’s proposed requirement 

for ‘‘Requests for Quotes’’ to be distributed to a minimum of 5 dealers, the CFTC’s 

and SEC’s mandate for participants to ‘‘take into account’’ or to ‘‘interact with’’ other 

resting bids and offers (including indicative bids and offers), the CFTC’s requirement for there to be a ‘‘15 second delay’’ involving crossing trades, and the need for 

harmonization across the CFTC and SEC rulemaking to avoid unnecessary complexities. 

Thank you for this opportunity to share our views with the Subcommittee and we 

will be pleased to serve as a resource for the Members with respect to the swaps 

rulemaking exercise. 

PREPARED STATEMENT OF STEPHEN MERKEL 

EXECUTIVE VICE PRESIDENT AND GENERAL COUNSEL, BGC PARTNERS, INC. 

JUNE 29, 2011 

Chairman Reed, Ranking Member Corker, and Members of the Subcommittee, 

thank you for providing this opportunity to participate in today’s hearing. 

My name is Stephen Merkel. I am the Executive Vice President, General Counsel, 

and Secretary for BGC Partners, a leading global interdealer broker of over the 

counter financial products. 1 BGC Partners was created in August 2004, when Cantor Fitzgerald separated its interdealer brokerage business to create BGC Partners. 

We are a leading global intermediary to the wholesale financial markets, specializing in the brokering of a broad range of financial products including fixed income, 

rates, foreign exchange, equities, equity derivatives, credit derivatives, futures, and 

structured product markets. 

I am testifying today in my capacity as the Chairman of the Wholesale Markets 

Brokers’ Association, Americas (the ‘‘WMBAA’’), an independent industry body 

whose membership includes the largest North American interdealer brokers: my 

firm, BGC Partners, as well as GFI Group, ICAP, Tradition and Tullett-Prebon. 2

63 

The WMBAA and its member firms have developed a set of Principles for Enhancing the Safety 

and Soundness of the Wholesale, Over-The-Counter Markets. Using these Principles as a guide, 

the WMBAA seeks to work with Congress, regulators, and key public policy makers on future 

regulation and oversight of institutional markets and their participants. By working with regulators to make wholesale markets more efficient, robust, and transparent, the WMBAA sees a 

major opportunity to assist in the monitoring and consequent reduction of systemic risk in the 

country’s capital markets. The five founding members of the WMBAA are BGC Partners; GFI 

Group; ICAP; Tradition, and Tullett-Prebon. More about the WMBAA can be found at: 

www.WMBAA.org. 

I welcome this opportunity to discuss with you the emergence of swap execution 

facilities (SEFs) under the Dodd-Frank Wall Street Reform and Consumer Protection Act (‘‘Dodd-Frank’’ or ‘‘DFA’’). I hope to share the perspective of the primary 

intermediaries of over-the-counter (OTC) swaps operating today, both here in the 

United States and across the globe. 

In my written testimony, I plan to cover the following points: 

• Readiness. In terms of readiness, BGC and its fellow WMBAA member firms 

are currently fully functional as market intermediaries in the OTC derivatives 

markets and will be ready to initiate SEF operations on day one. Wholesale brokers are today’s central marketplaces in the global swaps markets and, as such, 

can serve as a prototype for prospective independent and competitive SEFs. 

• Voice and electronic modes of trade execution. Wholesale brokers are experts in 

fostering liquidity and transparency in global swaps markets by utilizing trade 

execution methodologies that feature a hybrid blend of knowledgeable and 

qualified brokers, as well as sophisticated electronic technology. The CFTC’s 

proposed rules are inconsistent with the statute in the way that they limit how 

trades are executed, most particularly in how they limit trades that occur utilizing voice or telephonic communication. Such a limitation is inconsistent with 

the statute’s clear language that ensures that SEFs can utilize ‘‘any means of 

interstate commerce.’’ The SEC’s proposed rule is much more flexible and consistent with the statute. 

• Block trade size and preserving liquidity and anonymity in the market. Liquidity 

in today’s swaps markets is fundamentally different than liquidity in futures 

and equities markets, and the unique characteristics of this liquidity are what 

naturally determine the optimal mode of market transparency and trade execution. The CFTC’s proposal could jeopardize liquidity in the markets by relying 

on inappropriate factors to determine a block trade. This would harm the ability 

of investors to manage large positions, impact the ability of counterparties to 

engage in anonymous price discovery and, ultimately, increase the cost of risk 

management to end users. The definition of block trade must be based on hard 

market data to minimize unintended negative consequences. 

• Competition. It is vital that the rules be consistent with the clear and unambiguous provisions in the statute ensuring that clearinghouses provide SEFs ‘‘nondiscriminatory access’’ to clearing. To be consistent with the statute this must 

include direct and indirect actions that not only inhibit access to clearing, but 

also actions that would bundle the services of a clearinghouse that operates an 

execution facility (exchange or SEF), thereby providing favorable treatment to 

their own affiliates over their independent competitors. Another form of discrimination includes treating differently SEF traded contracts and those traded 

on exchanges in liquidation. The CFTC’s proposed rule needs to be changed to 

ensure that in liquidation there is identical treatment of the cleared contract 

regardless of the venue it traded. 

Essential Elements That Regulators Need To Get Right Under Title VII 

• The final regulations enacted by the Commodity Futures Trading Commission 

(‘‘CFTC’’ or ‘‘Commission’’) and Securities and Exchange Commission (‘‘SEC’’ or 

‘‘Commission’’ and, together with the CFTC, the ‘‘Commissions’’) must be consistent with the plain language of Dodd-Frank and allow for multimodes of execution as Congress intended. SEFs must not be restricted from deploying the 

many varied and beneficial trade execution methodologies and technologies successfully used today to execute swaps transactions. 

• There must be harmonization between the CFTC and SEC, as well as consistency in international regulation. 

• New regulations must be phased-in appropriately to prevent unnecessary disruption to the markets. 

• Regulators must use a flexible approach to SEF registration, permitted modes 

of trade execution and impartial access. Regulations should support the formaVerDate Nov 24 2008 10:41 Mar 16, 2012 Jkt 048080 PO 00000 Frm 00067 Fmt 6621 Sfmt 6621 L:\HEARINGS 2011\06-29 AM EMERGENCE OF SWAP EXECUTION FACILITIES -- A PROG
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tion of a common regulatory organization (CRO) for SEFs to implement and facilitate compliance with the Commissions’ rules. The CRO would ensure that a 

single, consistent standard is applied across multiple SEFs and prevent a ‘‘race 

to the bottom’’ for rule compliance and enforcement programs. 

Background on Wholesale Brokers 

In terms of actual operations, WMBAA members provide a marketplace for a relatively small number of sophisticated institutional buyers and sellers of OTC financial products where their trading needs can be matched with other sophisticated 

counterparties having reciprocal interests in a transparent, yet anonymous, environment. To persons unfamiliar with our business, I often describe interdealer brokers 

as a virtual trading floor where large financial institutions buy and sell financial 

products that are not suited to, and therefore rarely traded on, an exchange. 

As we sit here today, interdealer brokers are facilitating the execution of hundreds of thousands of OTC trades corresponding to an average of $5 trillion in notional size across the range of foreign exchange, interest rate, U.S. Treasury, credit, 

equity, and commodity asset classes in both cash and derivative instruments. 

WMBAA member firms account for over 90 percent of intermediated swaps transactions taking place around the world today. 

Wholesale brokers provide highly specialized trade execution services, combining 

teams of traditional ‘‘voice’’ brokers with sophisticated electronic trading and matching systems. As in virtually every sector of the financial services industry in existence over the past 50 years, wholesale brokers and their dealer clients began connecting with their customers by telephone. As technologies advanced and markets 

grew larger, more efficient, more diverse and global, these systems have advanced 

to meet the changing needs of the market. Today, we refer to this integration of 

voice brokers with electronic brokerage systems as ‘‘hybrid brokerage.’’ Wholesale 

brokers, while providing liquidity for markets and creating an open and transparent 

environment for trade execution for their market participants, do not operate as single silo and monopolistic ‘‘exchanges.’’ Instead, we operate as competing execution 

venues, where wholesale brokers vie with each other to win their customers’ business through better price, provision of superior market information and analysis, 

deeper liquidity and better service. Our customers include large national and money 

center banks and investment banks, major industrial firms, integrated energy and 

major oil companies and utilities. 

Increasingly, the efficiencies of the market have inevitably led to a demand for 

better trading technology. To that end, we develop and deploy sophisticated trade 

execution and support technology that is tailored to the unique qualities of each specific market. For example, BGC’s customers in certain of our more complex, less 

commoditized markets may choose among utilizing our electronic brokerage platforms to trade a range of fixed income derivatives, interest rate derivatives, foreign 

exchange options, repurchase agreements and energy derivatives entirely on screen. 

Alternatively, they can execute the same transaction through instant messaging devices or over the telephone with qualified BGC brokers supported by sophisticated 

electronic technology. It is important to note that the migration of certain products 

to electronic execution was not, and has never been, because of a regulatory or legal 

mandate but simply part of the natural evolution and development of greater market efficiencies in particular markets. Conversely, the persistence of customer preference for trade execution through telephonic communications for certain products, 

despite the apparent efficiencies associated with electronic trading in other similar 

products in the same markets, reflects those customers’ preference for the unique 

advantages that ‘‘voice’’ brokers can provide in liquidity formation with respect to 

less-liquid or more bespoke products. 

The critical point is that competition in the marketplace for transaction services 

has led interdealer brokers to develop highly sophisticated transaction services and 

technologies that are well tailored to the unique trading characteristics of the broad 

range of swaps and other financial instruments that trade in the OTC markets 

today. Unlike futures exchanges, we enjoy no execution monopoly over the products 

traded by our customers. Therefore, our success depends on making each of our 

trading methods and systems right for each particular market we serve. From decades of competing for the business of the worlds’ largest financial institutions, we 

can confirm that there is no ‘‘one size fits all’’ method of executing swaps transactions. 

Dodd-Frank Impact on Swaps Market Structure: Clearing and Competing 

Execution 

Title VII of Dodd-Frank was an earnest and commendable effort by Congress to 

reform certain aspects of the OTC swaps market. The DFA’s core provisions relating 

65 

3See, Commodity Exchange Act (CEA) Section 1a(50). 4 As the Justice Department observed in a 2008 comment letter to the Treasury Department, 

where a central counterparty clearing facility is affiliated with an execution exchange (such as 

in the case of U.S. futures), vertical integration has hindered competition in execution platforms 

that would otherwise have been expected to: result in greater innovation in exchange systems, 

lower trading fees, reduced ticket size and tighter spreads, leading to increased trading volume 

and benefits to investors. As noted by the Justice Department, ‘‘the control exercised by futures 

exchanges over clearing services . . . has made it difficult for exchanges to enter and compete.’’ 

In contrast to futures exchanges, equity and options exchanges do not control open interest, 

fungibility, or margin offsets in the clearing process. The absence of vertical integration has facilitated head-to-head competition between exchanges for equities and options, resulting in low 

execution fees, narrow spreads, and high trading volume. See, Comments of the Department of 

Justice before the Department of the Treasury Review of the Regulatory Structure Associated 

With Financial Institutions, January 31, 2008. Available at http://www.justice.gov/atr/public/ 

comments/229911.html. 

to clearing and trade execution are: (1) replacing bilateral trading where feasible 

with central counterparty clearing; and (2) requiring that cleared swaps transactions between swaps dealers and major swaps participants be intermediated by 

qualified and regulated trading facilities, including those operating under the definition of ‘‘swap execution facilities’’ through which ‘‘multiple participants have the 

ability to execute or trade swaps by accepting bids and offers made by multiple participants in the facility or system, through any means of interstate commerce . . . 

.’’ 3

These two operative provisions seek to limit the current market structure where 

swaps and the underlying counterparty risk may be traded directly between 

counterparties without the use of trading intermediaries or clearing and to replace 

it for most transactions with a market structure in which a central clearing facility 

acts as the single counterparty to each market participant (i.e., buyer to each seller 

and seller to each buyer) and where those cleared transactions must be traded 

through SEFs and other intermediaries and not directly between the counterparties. 

In enacting these structural changes, DFA wisely rejected the anticompetitive, 

single silo exchange model of the futures industry, in which clearing and execution 

are intertwined, thereby giving the exchange an effective execution monopoly over 

the products that it clears. 4 Rather, by requiring central clearing counterparties to 

provide nondiscriminatory access to unaffiliated execution facilities, DFA promotes 

a market structure in which competing SEFs and exchanges will vigorously compete 

with each other to provide better services at a lower cost in order to win the execution business of sophisticated market participants. In this regard, DFA preserves 

the best competitive element in the existing swaps landscape: competing wholesale 

brokers. 

BGC and the WMBAA members heartily support Dodd-Frank’s twin requirements 

of clearing and intermediation. Their advocacy of swaps intermediation is fundamental to their business success in fostering liquidity, providing price transparency, 

developing and deploying sophisticated trading technology tools and systems and operating efficient marketplaces in global markets for swaps and other financial products. 

Critical Elements To Get Right 

There are many things to get right under DFA. Given that DFA requires all clearable trades to be transacted through an intermediary (either an exchange or a SEF), 

it is essential that regulators get the following aspects of this new regime right: 

1. Permit multimodes of swap execution, consistent with Congressional intent. 

2. Ensure harmonization between agencies and foreign regulators. 

3. Allow for the appropriate implementation of final rules. 

4. Utilize a flexible approach to SEF registration, permitted modes of trade execution, and impartial access. 

5. Recognize the important role a common regulatory organization can play in ensuring the integrity of the SEF industry. 

1. Permitted Modes of Execution 

As previously stated, DFA defines SEFs as utilizing ‘‘any means of interstate commerce’’ to match swaps counterparties. This is an appropriate allowance by Congress, as the optimal means of interaction in particular swaps’ markets varies across 

the swaps landscape. Congress recognized that it was best left to the marketplace 

to determine the best modes of execution for various swaps and, thereby, foster technological innovation and development. Congress specifically did not choose to impose 

66 

a federally mandated ‘‘one-size-fits-all’’ transaction methodology on the regulated 

swaps market. 

As the swaps market has developed, it has naturally taken on different trading, 

liquidity and counterparty characteristics for its many separate markets. For example, in more liquid swaps markets with more institutional participants, such as certain U.S. Treasury, foreign exchange and energy products, wholesale brokers operate fully interactive electronic trading platforms, where counterparties can view 

prices and act directly through a trading screen and also conduct a range of preand post-trade activities like online price analysis and trade confirmation. These 

electronic capabilities reduce the need for actual voice-to-voice participant interaction for certain functions, such as negotiation of specific terms, and allow human 

brokers to focus on providing market intelligence and assistance in the execution 

process. And yet, even with such technical capabilities, the blend of electronic and 

voice assisted trading methods still varies for different contracts within the same 

asset class. 

In markets for less commoditized products where liquidity is not continuous, BGC 

Partners and its competitors provide a range of liquidity fostering methodologies 

and technologies. These include hybrid modes of: (1) broker work-up methods of 

broadcasting completed trades and attracting others to ‘‘join the trade;’’ and (2) auction based methods, such as matching and fixing sessions. In other swaps markets, 

brokers conduct operations that are similar to traditional ‘‘open outcry’’ trading pits 

where qualified brokers communicate bids and offers to counterparties in real time 

through a combination of electronic display screens and hundreds of installed, always-open phone lines, as well as through other email and instant messaging technologies. In every case, the technology and methodology used is well calibrated to 

disseminate customer bids and offers to the widest extent and foster the greatest 

degree of liquidity for the particular market. 

Permitted Use of Voice and Hybrid Trade Execution Platforms 

The WMBAA feels strongly that the CFTC’s proposed rules regarding SEFs do not 

reflect the DFA’s requirement that SEF transactions can be executed ‘‘through any 

means of interstate commerce.’’ Specifically, in restricting the use of voice-based systems for those clearable trades that must be executed on a SEF, the CFTC has proposed a more restrictive regime than the statute dictates. A rigid implementation 

of the SEF framework will devastate existing voice and ‘‘hybrid’’ systems that are 

currently relied upon for liquidity formation in global swaps markets. ‘‘Hybrid brokerage,’’ which integrates voice with electronic brokerage systems, should be clearly 

recognized as an acceptable mode of trade execution for all clearable trades. The 

combination of traditional ‘‘voice’’ brokers with sophisticated electronic trading and 

matching systems is necessary to provide liquidity in markets for less commoditized 

products where liquidity is not continuous. Failure to unambiguously include such 

systems is not only inconsistent with Dodd-Frank but will severely limit liquidity 

production for a wide array of transactions. BGC and our fellow WMBAA members 

are concerned that such a restrictive SEF regime will lead to market disruption and, 

worse, liquidity constriction with adverse consequences for vital U.S. capital markets. 

The WMBAA strongly supports the SEC’s interpretation of the SEF definition as 

it applies to trade execution through any means of interstate commerce, including 

request for quote systems, order books, auction platforms or voice brokerage trading, 

because such an approach is consistent with the letter and spirit of the Dodd-Frank 

Act and ensures flexibility in the permitted modes of execution. The WMBAA believes that this approach should be applied consistently to all trading systems or 

platforms and will encourage the growth of a competitive marketplace of trade execution facilities. 

What determines which blend of hybrid brokerage is adopted by the markets for 

any given swap product is largely the market liquidity characteristic of that product, 

whether or not the instrument is cleared. For example, a contract to trade Henry 

Hub Natural Gas delivered in Summer 2017, though cleared, will generally be insufficiently liquid to trade on a central limit order book. This is true for many cleared 

products with delivery dates far in the future, where market makers are unwilling 

to post executable bids and offers in instruments that trade infrequently. In markets where price spreads are wide or trading is infrequent, central limit order books 

are not conducive to liquidity, but rather may be disruptive to it. 

Critically, what determines which blend of hybrid brokerage is adopted by the 

markets for any given swap product also has little to do with whether the size of 

a transaction is sufficient or not to be considered a block trade. Block trades concern 

the size of an order, as opposed to the degree of market liquidity or presence of tight 

bid-offer spreads. Depending on where block trade thresholds are set, block trades 

67 

5Further Definition of ‘‘Swap,’’ ‘‘Security-Based Swap,’’ and ‘‘Security-Based Swap Agreement’’; Mixed Swaps; Security-Based Swap Agreement Recordkeeping, 76 Fed. Reg. 29,818, 29, 

845 (May 23, 2011). 

can take place in all markets—from very illiquid markets to highly liquid markets. 

Yet, central limit order book trade execution generally only works well in markets 

with deep liquidity, and such liquidity is not always available even within a usually 

liquid market. For less liquid markets, even nonblock size trades depend on a range 

of trading methodologies distinct from central limit order book or request for quote 

systems. For these reasons, hybrid brokerage should be clearly recognized as an acceptable mode of trade execution for all swaps whether ‘‘required’’ or ‘‘permitted.’’ 

In addition, the regulatory framework for the swaps market must take into consideration the significant differences between the trading of futures on an existing 

exchange and the trading of swaps on SEF platforms. While it may be appropriate, 

in certain instances, to look to the futures model as instructive, overreliance on that 

model will not achieve Congress’ goal. Congress explicitly incorporated a SEF alternative to the exchange-trading model, understanding that competitive execution 

platforms provide a valuable market function. Final rules governing SEFs should 

reflect Congressional intent and promote the growth of existing competitive, vibrant 

markets without impeding liquidity formation. 

While certain requirements should be mandated during trade execution (i.e., audit 

trail, trade processing, and reporting), limitations on methodologies used in trade 

execution should be considered carefully and weighed against potential implications 

on liquidity formation. A rules regime that is overly prescriptive will reduce the 

ability for SEFs to match buyers and sellers and restrict trading liquidity, to the 

detriment of all market participants, including end users. 

2. Importance of Harmonization Between U.S. Agencies and Foreign Regulators 

While the substance of the proposed requirements for SEF registration and core 

principles are extremely important, it is equally, if not more, important that the 

final regulatory frameworks are harmonized between the CFTC and SEC. A failure 

to achieve harmonization will lead to regulatory arbitrage and unreasonably burden 

market participants with redundant compliance requirements. As the recent SEC 

CFTC joint proposed rule recognized, ‘‘a Title VII instrument in which the underlying reference of the instrument is a ‘‘narrow-based security index’’ is considered 

a security-based swap subject to regulation by the SEC, whereas a Title VII instrument in which the underlying reference of the instrument is a security index that 

is not a narrow-based security index (i.e., the index is broad-based), the instrument 

is considered a swap subject to regulation by the CFTC.’’ 5

Any discrepancy in the Commissions’ regulatory regimes will give market participants incentive to leverage the slight distinctions between these products to benefit 

from more lenient rules. Dodd-Frank’s framework was constructed to encourage the 

growth of a vibrant, competitive marketplace of regulated SEFs. Final rules should 

be crafted that encourage the transaction of OTC swaps on these trading systems 

or platforms, as increased SEF trading will increase liquidity and transparency for 

market participants and increase the speed and accuracy of trade reporting to swap 

data repositories (SDRs). Certain provisions relate to these points, such as the permitted methods of trade execution, the scope of market entities granted impartial 

access to SEFs, the formulation of block trade thresholds and compliance with SEF 

core principles in a flexible manner that best recognizes the unique characteristics 

of competitive OTC swaps markets. 

Based upon the WMBAA’s review of both the SEC and the CFTC’s proposed rules, 

the Commissions should consider the release of further revised proposed rules incorporating comments received for additional review and comment by market participants. This exercise would ensure that the SEC and CFTC have the opportunity to 

review each of their proposals and integrate appropriate provisions from the proposed rules and comments in order to arrive at more comprehensive regulations. 

Further, the CFTC and SEC are encouraged to work together to attempt to harmonize their regulatory regimes to the greatest extent possible. While some of the 

rules will differ as a result of the particular products subject to each agency’s jurisdiction, inconsistent rules will make the implementation for SEFs overly burdensome, both in terms of time and resources. As an example, the CFTC and the SEC 

should adopt one common application form for the registration process. While regulatory review of the application by the two agencies is appropriate, reducing the regulatory burden on applicant SEFs to one common form would allow for a smoother, 

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posed applications could be easily reconciled to increase regulatory harmonization 

and increase efficiency. 

Similarly, there needs to be a consistent approach with respect to block trades. 

Not only should the threshold calculations be derived from similar approaches, allowing for tailored thresholds that reflect the trading characteristics of particular 

products, but the methods of trade execution permitted by the Commissions should 

both be flexible and within the framework of the SEF definition. U.S. regulations 

also need to be in harmony with regulations of foreign jurisdictions to avoid driving 

trading liquidity away from U.S. markets toward markets offering greater flexibility 

in modes of trade execution. In particular, European regulators have not formally 

proposed swap execution rules with proscriptive limits on trade execution methodology. We are not aware of any significant regulatory efforts in Europe to mandate 

electronic execution of cleared swaps by institutional market participants. 

In a world of competing regulatory regimes, business naturally flows to the marketplace that has the best regulations—not necessarily the most lenient, but certainly the ones that have the optimal balance of liquidity, execution flexibility and 

participant protections. U.S. regulations need to be in harmony with regulations 

from foreign jurisdictions to avoid driving trading liquidity away from U.S. markets 

toward markets offering greater flexibility in modes of trade execution. 

3. Implementation of Final Rules 

Compliance Timeline 

The timeline for implementation of the final rules is as important as, if not more 

important than, the substance of the regulations. We recognize and support the fundamental changes to the regulation of the OTC swaps markets resulting from the 

passage of the Dodd-Frank Act and will commit the necessary resources to diligently 

meet the new compliance obligations. 

However, the CFTC and SEC must recognize that these changes are significant 

and will result in considerable changes to the operations and complex infrastructure 

of existing trading systems and platforms. It is necessary that any compliance period or registration deadline provides sufficient opportunity for existing trade execution systems or platforms to modify and test systems, policies and procedures to ensure that its operations are in compliance with final rules. It is very difficult to determine the amount of time needed to ensure compliance with the rules until the 

final requirements are made available. However, providing market participants with 

an insufficient time frame for compliance could harm the efficient functioning of the 

markets if existing entities can no longer operate until they have built the requisite 

platforms to comply with every measure in final rules. 

Appropriate ‘‘Phasing’’ of Final Rules 

Based upon the plain language of Dodd-Frank, the mandatory trade execution requirement will become effective at the time that swaps are deemed ‘‘clearable’’ by 

the appropriate Commission. Accepting the premise that the mandatory trade execution requirement cannot be enforced until there are identified ‘‘clearable’’ swaps 

and swaps are ‘‘made available for trading,’’ the Commissions need to ensure that 

a functioning and competitive marketplace of registered SEFs exists at the time the 

first trade is cleared and made available for trading. As such, it is necessary that 

SEFs be registered with the CFTC or SEC, as applicable, and available to execute 

transactions at the time that trades begin to be cleared under the new laws. As stated previously, the WMBAA estimates that its members currently account for over 

90 percent of interdealer intermediated swaps transactions taking place around the 

world today. If the SEF registration process is not effectively finalized by the time 

various swaps are deemed clearable, there could be serious disruptions in the U.S. 

swaps markets with adverse consequences for broader financial markets. 

Furthermore, requiring absolute compliance with final rules within a short time 

frame is particularly troublesome for likely future SEFs, as such a result may provide DCMs or national securities exchanges with an unfair advantage in attracting 

trading volume due to their ability to quickly meet the regulatory burdens. Congress 

distinguished between exchanges and SEFs, intending for competitive trade execution to be made available on both platforms. Congress also recognized the importance of SEFs as distinct from exchanges, noting that a goal of Dodd-Frank is to 

promote the trading of swaps on SEFs. The phasing in of final rules for both exchanges and SEFs should be done concurrently to ensure that this competitive landscape remains in place under the new regulatory regime. 

Not only will implementation of the final rules impact market infrastructure, but 

the timing in which these rules are implemented could significantly impact U.S. financial markets. As Commissioner Jill Sommers recently remarked before the 

House Agriculture General Farm Commodities and Risk Management SubVerDate Nov 24 2008 10:41 Mar 16, 2012 Jkt 048080 PO 00000 Frm 00072 Fmt 6621 Sfmt 6621 L:\HEARINGS 2011\06-29 AM EMERGENCE OF SWAP EXECUTION FACILITIES -- A PROG
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6Statement of Jill E. Sommers before the Subcommittee on General Farm Commodities and 

Risk Management, House Committee on Agriculture, May 25, 2011, available at http://agriculture.house.gov/pdf/hearings/Sommers110525.pdf. 

committee, ‘‘a material difference in the timing of rule implementation is likely to 

occur, which may shift business overseas as the cost of doing business in the U.S. 

increases and create other opportunities for regulatory arbitrage.’’ 6 If the U.S. regulations are implemented before foreign regulators have established their intended 

regulatory framework, it could put U.S. markets at a significant disadvantage and 

might result in depleted liquidity due to regulatory arbitrage opportunities. 

As the rulemaking process moves forward, we suggest the following progression 

of rules be completed: 

• First, finalize product definitions. Providing the market with certainty related 

to the scope of what constitutes a ‘‘swap’’ and ‘‘security-based swap’’ will allow 

market participants to accurately gauge the impact of the other proposed rules 

and provide constructive feedback on those rules. 

• Second, implement final rules related to real-time reporting for regulatory oversight purposes. The submission of information to SDRs is an activity that takes 

place in many OTC markets today and will not unduly burden those who must 

comply with the requirement. Ensuring that the Commissions receive current, 

accurate market data is a cost-effective method to mitigate systemic risk in the 

short-term. 

• Next, establish block trade thresholds and finalize public reporting rules. The 

information gathered by SDRs since the implementation of the mandatory trade 

reporting requirement, along with historical data made available by trade repositories and trade execution facilities, can be used to determine the appropriate threshold levels on a product-by-product basis. At the same time, public 

reporting rules can be put into place, including an appropriate time delay (that 

is consistent with European and the other major global market rules) for block 

trades. 

• After the reporting mechanics have been established, the clearing mandate can 

be implemented. During this step, the Commissions can determine what swaps 

are ‘‘clearable’’ and subject to the clearing mandate, and clearinghouses can register and begin to operate within the new framework. 

• Finally, once swaps are deemed clearable, the mandatory trade execution requirement can be put into place for SEFs and DCMs for those products made 

available for trading. All clearable swaps will be made available for trading by 

SEFs, as these trade execution platforms compete to create markets and match 

counterparties. With the trade execution requirement’s implementation, it is imperative that rules for SEFs and DCMs are effective at the same time, as implementing either entity’s rules prior to the other will result in an unfair advantage for capturing market share of executable trades simply because they could 

more quickly meet the regulatory burdens. 

Taking adequate time to get the Title VII regulations right will expedite the implementation of the worthy goals of Dodd-Frank: central counterparty clearing and 

effective trade execution by regulated intermediaries in order to provide end users 

with more competitive pricing, increased transparency and deeper trading liquidity 

for their risk management needs. 

4. Flexible Approach to SEF Registration, Impartial Access, and Other 

Areas of Concern 

We support a flexible approach to evaluating applicant SEFs. As noted above, 

Congress recognized and mandated by law trade execution ‘‘through any means of 

interstate commerce,’’ establishing a broad framework that permits multiple modes 

of swap execution, so long as the proposed mode of execution is capable of satisfying 

the statutory requirements. 

Moreover, any interpretation of the SEF definition must be broad, and any trading system or platform that meets the statutory requirements should be recognized 

and registered as a SEF. The new regulatory framework should allow any SEF applicant that meets the statutory requirements set forth in Dodd-Frank to be permitted to operate under each Commission’s rules in accordance with Dodd-Frank. 

BGC and the WMBAA strongly support the SEC’s interpretation of the SEF definition as it applies to trade execution through any means of interstate commerce, 

including request for quote systems, order books, auction platforms or voice brokerage trading, because such an approach is consistent with the letter and spirit of 

Dodd-Frank and ensures flexibility in the permitted modes of execution. The 

70 

WMBAA believes that this approach should be applied consistently to all trading 

systems or platforms and will encourage the growth of a competitive marketplace 

of trade execution facilities. 

Further, we are concerned with the CFTC’s interpretation of the SEF definition, 

as it limits the permitted modes of trade execution, specifically restricting the use 

of voice-based systems to block trades. The SEF definition and corresponding requirements in the CEA, as amended by the Dodd-Frank Act, do not provide any 

grounds for this approach and will severely impair other markets that rely on voicebased systems (or hybrid systems, which contain a voice component) to create liquidity. 

Impartial Access to SEFs 

The WMBAA is concerned that the CFTC’s proposed mandate that SEFs provide 

impartial access to independent software vendors (ISVs) is beyond the legal authority in the CEA because it expands the impartial access provision beyond ‘‘market 

participants’’ to whom access is granted under the statute. Moreover, because SEFs 

are competitive execution platforms, a requirement to provide impartial access to 

market information to ISVs who lack the intent to enter into swaps on a trading 

system or platform will reduce the ability for market participants to benefit from 

the competitive landscape that provides counterparties with the best possible pricing. Further, given the lack of a definition of what constitutes an ISV and the significant technological investments made by wholesale brokers to provide premiere 

customer service, the ISV impartial access requirement leaves open the possibility 

that SEFs could qualify as ISVs in order to seek access to competitors’ trading systems or platforms. This possibility would defeat the existing structure of competitive 

sources of liquidity, to the detriment of market participants, including commercial 

end users. 

The WMBAA also believes the SEC should review its proposed impartial access 

provisions to ensure that impartial access to the SEF is different for competitor 

SEFs or national exchanges than for registered security-based swap dealers, major 

security-based swap participants, brokers or eligible contract participants. Congress 

clearly intended for the trade execution landscape after the implementation of DoddFrank to include multiple competing trade execution venues, and ensuring that competitors cannot access a SEF’s trading system or platform furthers competition, to 

the benefit of the market and all market participants. 

Regulations Should Not Favor Execution on Particular Venues 

The WMBAA believes that it is critically important that the Commissions’ regulations not favor trade execution on exchanges over SEFs. An important part of the 

Dodd-Frank competitive landscape is that derivatives clearing organizations (DCOs) 

accept trades from all execution platforms and not advantage certain trading systems or platforms over others. 

WBMAA is concerned that certain proposed regulations will frustrate the development of a truly competitive landscape. For instance, one of the CFTC’s proposed 

rules (proposed Regulation 39.13(g)(2)) would require a DCO to use a five-business 

day liquidation horizon for cleared swaps that are not executed on a designated contract market (DCM), but would permit a DCO to use a one-business day liquidation 

horizon for all other products that it clears, including swaps that are executed on 

an affiliated DCM. 

The WMBAA believes that this disparity is ill-founded. In the case of two economically identical instruments—one executed on a SEF and one executed on a 

DCM—the liquidation horizon for each should depend upon liquidity characteristics 

such as average daily volume, standard deviation of average daily volume and open 

interest. To require a longer horizon simply because one of the two is traded on a 

SEF rather than on a DCM is harmful, discriminatory and based upon a flawed understanding of market dynamics. More fundamentally, the WMBAA believes that 

this disparity is inconsistent with the provisions of Section 2(h)(1)(B) of the Commodity Exchange Act. 

The WMBAA also believes that eliminating the disparity described above is consistent with the competitive landscape that Congress intended to establish for SEFs 

and DCMs. Dodd-Frank is designed to encourage competition between SEFs and 

DCMs with respect to the trading of swaps, in part by rejecting the ‘‘vertical silo’’ 

model that has traditionally been employed in the futures markets. 

Interim or Temporary SEF Registration 

The implementation of any interim or temporary registration relief must be in 

place for registered trading systems or platforms at the time that swaps are deemed 

‘‘clearable’’ by the Commissions to allow such platforms to execute transactions at 

the time that trades begin to be cleared. Interim or temporary registration relief 

71 

would be necessary for trading systems or platforms if sequencing of rules first addresses reporting to SDRs and mandatory clearing prior to the mandatory trade execution requirement. The Commission is strongly encouraged to provide prompt provisional registration to existing trade execution intermediaries that intend to register as a SEF and express intent to meet the regulatory requirements within a predetermined time period. To require clearing of swaps through derivatives clearing 

organizations without the existence of the corresponding competitive trade execution 

venues risks inconsistent implementation of the Dodd-Frank Act and could have a 

disruptive impact on market activity and liquidity formation, to the detriment of 

market participants. 

At the same time, a temporary registration regime should ensure that trade execution on SEFs and exchanges is in place without benefiting one execution platform 

over another. Temporary registration for existing trade execution platforms should 

be fashioned into final rules in order to avoid disrupting market activity and provide 

a framework for compliance with the new rules. The failure of the Commissions to 

provide interim or temporary relief for existing trading systems or platforms may 

alter the swaps markets and unfairly induce market participants to trade outside 

the U.S. or on already registered and operating exchanges. 

The 15 Second Rule 

There does not appear to be any authority for the CFTC’s proposed requirement 

that, for ‘‘Required Transactions,’’ SEFs must require that traders with the ability 

to execute against a customer’s order or execute two customers against each other 

be subject to a 15 second timing delay between the entry of those two orders (15 

Second Rule). One adverse impact of the proposed 15 Second Rule is that the dealer 

will not know until the expiration of 15 seconds whether it will have completed both 

sides of the trade or whether another market participant will have taken one side. 

Therefore, at the time of receiving the customer order, the dealer has no way of 

knowing whether it will ultimately serve as its customer’s principal counterparty or 

merely as its executing agent. The result will be greater uncertainly for the dealer 

in the use of its capital and, possibly, the reduction of dealer activities leading, in 

turn, to diminished liquidity in and competitiveness of U.S. markets with costly implications for buy-side customers and end users. 

While this delay is intended by the CFTC to ensure sufficient pretrade transparency, under the CEA, transparency must be balanced against the liquidity needs 

of the market. Once a trade is completed when there is agreement between the parties on price and terms, any delay exposing the parties to that trade to further market risk will have to be reflected in the pricing of the transaction, to the detriment 

of all market participants. 

Ensuring That Block Trade Thresholds Are Appropriately Established 

The most important aspect to ensuring that appropriate block sizes are set, is for 

the Commission to integrate the new reporting requirements first, and than establish block trade thresholds based on the comprehensive and reliable market data 

produced from these reporting requirements. From the perspective of intermediaries 

who broker transactions of significant size between financial institutions, it is critical that the block trade threshold levels and the reporting regimes related to those 

transactions are established in a manner that does not impede liquidity formation. 

A failure to effectively implement block trading thresholds will frustrate companies’ 

ability to hedge commercial risk. Participants rely on swaps to appropriately plan 

for the future, and any significant changes to market structure might ultimately inhibit economic growth and competitiveness. 

Establishing the appropriate block trade thresholds is of particular concern for expectant SEFs because the CFTC’s proposal regarding permitted modes of execution 

restricts the use of voice-based systems solely for block trades. While WMBAA believes that this approach is contrary to the SEF definition (as discussed above), 

which permits trade execution through any means of interstate commerce, this approach, if combined with block trade thresholds that are too high for the particular 

instrument, would have a negative impact on liquidity formation. 

With respect to block trade thresholds, the liquidity of a market for a particular 

financial product or instrument depends on several factors, including the parameters of the particular instrument, including tenor and duration, the number of market participants and facilitators of liquidity, the degree of standardization of instrument terms and the volume of trading activity. Compared to commoditized, exchange-traded products and the more standardized OTC instruments, many swaps 

markets feature a broader array of less-commoditized products and larger-sized orders that are traded by fewer counterparties, almost all of which are institutional 

and not retail. Trading in these markets is characterized by variable or noncontinVerDate Nov 24 2008 10:41 Mar 16, 2012 Jkt 048080 PO 00000 Frm 00075 Fmt 6621 Sfmt 6621 L:\HEARINGS 2011\06-29 AM EMERGENCE OF SWAP EXECUTION FACILITIES -- A PROG
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7See, Comment Letter from WMBAA (November 19, 2010) (11/19/10 WMBAA Letter); Comment Letter from WMBAA (November 30, 2010) (11/30/2010 WMBAA Letter); 1/18/11 WMBAA 

Letter; Comment Letter from WMBAA (February 7, 2011) (2/7/11 WMBAA Letter); and Comment Letter from WMBAA (June 3, 2011) (6/3/11 WMBAA Letter). 8SEFCON 1 was held in Washington, DC, on October 4, 2010. The keynote address was given 

by CFTC Commissioner Gary Gensler. 

uous liquidity. Such liquidity can be episodic, with liquidity peaks and troughs that 

can be seasonal (e.g., certain energy products) or more volatile and tied to external 

market and economic conditions (e.g., many credit, energy, and interest rate products). 

As a result of the episodic nature of liquidity in certain swaps markets combined 

with the presence of fewer participants, I and my fellow WMBAA members believe 

that the CFTC and SEC need to carefully structure a clearing, trade execution and 

reporting regime for block trades that is not a ‘‘one size fits all’’ approach, but rather 

takes into account the unique challenges of fostering liquidity in the broad range 

of swaps markets. Such a regime would provide an approach that permits the execution of transactions of significant size in a manner that retains incentives for market participants to provide liquidity and capital without creating opportunities for 

front-running and market distortion. 

To that end, we support the creation of a Swaps Standards Advisory Committee 

(Advisory Committee) for each Commission, comprised of recognized industry experts and representatives of registered SDRs and SEFs to make recommendations 

to the Commissions for appropriate block trade thresholds for swaps. The Advisory 

Committee would (1) provide the Commissions with meaningful statistics and 

metrics from a broad range of contract markets, SDRs and SEFs to be considered 

in any ongoing rulemakings in this area and (2) work with the Commissions to establish and maintain written policies and procedures for calculating and publicizing 

block trade thresholds for all swaps reported to the registered SDR in accordance 

with the criteria and formula for determining block size specified by the Commissions. 

The Advisory Committee would also undertake market studies and research at its 

expense as is necessary to establish such standards. This arrangement would permit 

SEFs, as the entities most closely related to block trade execution, to provide essential input into the Commissions’ block trade determinations and work with registered SDRs to distribute the resulting threshold levels to SEFs. Further, the proposed regulatory structure would reduce the burden on SDRs, remove the possibility 

of miscommunication between SDRs and SEFs and ensure that SEFs do not rely 

upon dated or incorrect block trade thresholds in their trade execution activities. In 

fact, WMBAA members possess historical data for their segment of the OTC swap 

market which could be analyzed immediately, even before final rules are implemented, to determine appropriate introductory block trade thresholds, which could 

be revised after an interim period, as appropriate. 

5. Wholesale Brokers, CROs, and the Responsible Oversight of SEFs 

The WMBAA members look forward to performing our designated roles as SEFs 

under DFA. The wholesale brokerage industry is working hard and collaboratively 

with the two Commissions to inform and comment on proposed rules to implement 

DFA. The WMBAA has submitted several comment letters 7 and expects to provide 

further written comments to the CFTC and SEC. The WMBAA has also hosted the 

first conference, SEFCON 1, 8 dedicated specifically to SEFs, and is currently making arrangements for a second SEFCON later this year. Further, the WMBAA has 

conducted numerous meetings with Commissioners and staffs. We and the wholesale brokerage industry are determined to play a constructive role in helping the 

SEC and the CFTC to get the new regulations under Title VII of DFA right. 

It is clear, however, that the implementation of Dodd-Frank will create a host of 

new obligations for both SEFs and regulatory agencies. These include requirements 

that are typical for exchanges and self-regulatory organizations, such as requirements to (1) establish, investigate, and enforce rules; and (2) monitor trading and 

obtain information necessary to prevent manipulation. 

Many likely SEFs are not currently regulated as exchanges, but rather as futures 

commission merchants (FCMs), broker-dealers or, where applicable, as alternative 

trading systems (ATS). As a result, these entities have familiarity with the rules 

of one or more self-regulatory organizations, such as FINRA or the NFA, which together with the Commission and the CFTC, will perform many of the regulatory 

functions assigned by the Dodd-Frank Act to SEFs. 

In order to facilitate the development and success of SEFs, the WMBAA proposes 

the establishment of a CRO that will facilitate all SEFs compliance with the core 

73 

principles. Membership in the CRO would be voluntary and open to any entity intending to register as SEF, though member SEFs would be contractually bound to 

abide by the rules. Further, as a voluntary organization, the CRO would not necessarily need legislative or rulemaking authority to proceed. The creation of a CRO 

would also prevent market participants from selectively choosing which SEF to use 

based upon the leniency of its rules regime. The WMBAA believes that an industrywide standards body would best ensure the integrity of the swaps market and protect market participants from abusive trading practices. Moreover, by acting as an 

intermediary for compliance by its members, the CRO would simplify the CFTC’s 

and SEC’s oversight responsibilities for SEFs. 

Conclusion 

Dodd-Frank seeks to reengineer the U.S. swaps market on three key pillars: 

record keeping and reporting; central counterparty clearing; and the mandatory 

intermediation of clearable trades through registered intermediaries such as SEFs. 

Wholesale brokers are today’s central marketplaces in the global swaps markets 

and, as such, can be the prototype of SEFs. 

Liquidity in today’s swaps markets is fundamentally different than liquidity in futures and equities markets and naturally determines the optimal mode of market 

transparency and trade execution. Wholesale brokers are experts in fostering liquidity in noncommoditized instruments by utilizing methodologies for price dissemination and trade execution that feature a hybrid blend of knowledgeable qualified 

voice brokers and sophisticated electronic technology. Wholesale brokers’ varied execution methodologies are specifically tailored to the unique liquidity characteristics 

of particular swaps markets. 

It is critical that regulators gain a thorough understanding of the many modes 

of swaps trade execution currently deployed by wholesale brokers and accommodate 

those methods and practices in their SEF rulemaking. Too many of the SEC’s and 

CFTC’s Title VII proposals are based off of rules governing the equities and futures 

markets and are ill-suited for the fundamentally different liquidity characteristics 

of today’s swaps markets. 

We appreciate the Commissions’ recognition of the deliberation and thought necessary to get these rules right, and are generally supportive of the phase-in approach being pursued. Rushing the rulemaking process and getting things wrong 

will negatively impact market liquidity in the U.S. swaps markets, disturbing businesses’ ability to hedge commercial risk, to appropriately plan for the future and, 

ultimately, stifle economic growth and job creation. Taking adequate time to get the 

Title VII regulations right will expedite the implementation of the worthy goals of 

Dodd-Frank: central counterparty clearing and effective trade execution by regulated intermediaries in order to provide end users with more competitive pricing, 

increased transparency and deeper trading liquidity for their risk management 

needs. 

With Congress’ help, and the input and support of the swaps industry, regulators 

can continue their dedicated efforts at well-crafted rulemaking. If we are successful, 

our U.S. financial system, including the U.S. swaps markets, can once again be the 

well ordered marketplace where the world comes to trade. 

Thank you for your consideration. I look forward to answering any questions that 

you may have. 

PREPARED STATEMENT OF CHRIS BURY 

COHEAD OF RATES SALES AND TRADING, JEFFERIES & COMPANY, INC. 

JUNE 29, 2011 

Good morning. My name is Chris Bury and I am the Cohead of Rates Sales and 

Trading for Jefferies & Company, Inc. Chairman Reed and Ranking Member Crapo, 

thank you for inviting me to testify this morning regarding the emergence of swap 

execution facilities or, as they have come to be known, SEFs. 

Jefferies is a full-service global securities and investment-banking firm that, for 

almost 50 years, has been serving issuers and investors. We provide investment 

banking, and research sales-and-trading services and products to a diverse range of 

corporate clients, Government entities, institutional investors and high net worth 

individuals. The last few years have been a pivotal time for Jefferies as we gained 

market share and built significant momentum by capitalizing on strategic opportunities to expand and diversify on multiple levels and across all business lines. Over 

the last 5 years, our firm’s annual revenue, equity market capitalization and global 

headcount have increased significantly, with now almost $3 billion in annualized net 

revenue, over $4 billion in equity market value, and soon-to-be 3,600 employees. 

74 

It bears noting that during that same period—that is, during the financial crisis— 

at no time did Jefferies seek or receive taxpayer assistance. As a publicly traded 

company on the New York Stock Exchange, our capital comes solely from the markets, and Jefferies’ ability to persevere and emerge from the financial crisis positioned for growth and diversification can best be attributed to the firm’s focus on 

a strong capital position, ample liquidity, and sound risk management. 

There are a few key points that Jefferies would like to convey to the Subcommittee: 

• First, we are ready to go. From our perspective, the architecture, infrastructure 

and technology necessary to bring the over-the-counter derivatives markets into 

an era of transparency, dispersed counterparty risk and open access are in 

place. Just as we are a leading provider of liquidity and execution in stock and 

bonds, we believe we can become a leading provider to buyers and sellers of derivatives. The market awaits the adoption of final rules—it is a fallacy to suggest that rules should be delayed to allow more time for this market structure 

to develop. 

• Second, we believe that those sections of Title VII of Dodd-Frank pertaining to 

SEF trading of derivatives are necessary to remedy the artificial barriers to 

entry in the OTC derivatives market. It is with the intention of enhancing market participation and fostering competition that we support prompt implementation of these requirements. 

• Third, implementation timelines should be the top priority at this juncture. The 

proposed rules are generally clear and understandable. The market needs the 

certainty of when the rules will become applicable far more than it needs any 

more suggestions about how bilateral agreements offer an alternative to central 

clearing. 

• Fourth, it is vitally important to guard against the development of market 

structures that enable opaque bilateral contract relationships to continue to 

exist. Current standardized-execution-agreement proposals for centrally cleared 

swaps do nothing but preserve the closed and anticompetitive elements of these 

markets as they existed prior to the financial crisis. 

• Fifth, the adoption of the rules and a clear timeline for implementation of Title 

VII will bring to the markets the same clear benefits gained from similar developments in equities and futures markets: increased access, expanded competition, improved price transparency, and decentralized risk. SEF trading will lead 

to lower transaction costs, greater liquidity, strengthened market structures 

and reduced implicit risks to market participants and the American taxpayer. 

For years, firms such as Jefferies were effectively locked out of being a dealer in 

the OTC markets by virtue of a series of artificial barriers and requirements that 

perpetuated a closed system. Market participants were reliant upon bilateral contract arrangements with a self-selected group of large interconnected banks, dealers 

and insurers. The weaknesses and lack of true competition of that closed system exacerbated the credit crisis of 2008 to the great expense of our economy. We support 

the implementation of SEF trading as quickly and responsibly as possible. We believe that these provisions will increase transparency, reduce systemic risk, increase 

competition, and broaden access to centralized clearing within the derivatives market place. 

From our perspective, the development of the SEF market and access to SEFs are 

fairly straightforward. In addition, the rules as jointly proposed by the Commodity 

Futures Trading Commission and Securities and Exchange Commission with regard 

to mandatory exchange or SEF trading are clear. 

Jefferies’ main concern, therefore, is not centered around a lack of understanding 

of the rules, nor around the notion that the rules are being implemented before the 

SEF market has developed. Quite to the contrary: Jefferies is concerned that a rule 

delay is one of the biggest risks facing this emerging SEF marketplace today. We 

believe the market will successfully transition to SEF trading once a timeline is established in terms of what types of swaps will be required to transact on a SEF. 

Another risk to the development of the cleared derivatives market is the potential 

for the handful of too-big-to-fail banks that were bailed out by taxpayers to undermine and delay implementation of derivatives reform. We believe that recent suggestions from those banks regarding alternative documentation and workflow issues 

are nothing more than an effort to stifle competition and maintain the status quo. 

We believe that the concern over these workflow issues and ‘‘what-if’’ scenarios 

will rapidly fade once the scale and scope of the technological investment in SEFs 

and a centrally cleared derivatives marketplace is better understood. Significant 

technological, financial and intellectual resources have been committed by a wide 

75 

variety of market participants to get SEFs up and running as quickly as possible. 

Those investments have paid off, as the Financial Times noted last month in its special report on derivatives: ‘‘[T]he main participants, banks, interdealer brokers and 

‘big end users’ are ready to go when it comes to electronic trading and clearing.’’ 

(Financial Times Special Report, May 31, 2011, as quoted in SDMA Letter to CFTC 

and SEC dated June 1, 2011.) 

The article went on to note that SEF-compliant trades between swap dealers and 

major swap participants have been reported on Javelin, TradeWeb, MarketAxess, 

and Bloomberg in both interest rate swap and credit default swap products. 

Our industry is, indeed, approaching full readiness for standardized OTC derivatives contracts to begin trading on SEFs. If the proposed rules are implemented by 

the end of 2011, Jefferies would anticipate that trading volumes will begin increasing by the fourth quarter of this year and then increase significantly into 2012 as 

we approach final implementation of mandatory SEF trading of standardized derivatives. A firm timeline for mandatory SEF trading of the most standardized 

swaps will be instrumental for the market to achieve its full potential. 

More importantly, delaying the implementation process will provide opportunities 

for entrenched interests to promote agreements that will degrade and deter free 

market forces from operating in the derivatives arena. The recently released Futures Industry Association (FIA) Cleared Swap Agreement is one such example. Although it is marketed as an industry-wide document developed by a variety of market participants, we are concerned that the published version, were it broadly adopted by market participants, would embed chokepoints into the system. Customer 

agreements that provide for either fallback provisions to bilateral relationships or 

workflows that require complicated credit limit checking arrangements, as the current FIA offering proposes, will not foster a fully transparent, open, and competitive 

market. Congress and the regulators should encourage market participants to adopt 

agreements and market frameworks that provide for immediate certainty of clearing 

in order to advance the open access provisions and central clearing mandate of 

Dodd-Frank. 

Conclusion 

Jefferies believes that implementation of Title VII reforms will unleash free market forces held in check by entrenched business models, and we are ready and eager 

to compete in the derivative marketplace. Thank you for inviting me to testify today, 

and I look forward to any questions the Subcommittee may have. 

76 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY 

FROM KEVIN MCPARTLAND 

Q.1. The reporting requirements that the CFTC/SEC has proposed 

for all SEFs transactions will require virtual real-time reporting of 

key transaction data. Won’t liquidity providers (i.e., dealers) increase their bid/ask spreads to reflect the increased risks associated 

with communicating key data to the marketplace (since dealers will 

not be able to hedge these positions before they are front-run)? In 

order to justify this risk, won’t liquidity providers necessarily pass 

these increased costs to end users? In your view, does moving to 

SEFs justify these increased costs and reduced liquidity? 

A.1. In the most liquid products reporting requirements will be of 

little long term consequence. To those in the market already, pricing data is in fact quite transparent and so additional dissemination will have little impact on spreads. For less liquid products 

however, it is very likely that a risk premium will now be embedded in the quoted price. However, even in today’s market brokers 

often hedge new positions using other instruments such as futures 

and bonds to avoid being ‘‘picked off’’ by other market participants 

who are aware a trade just took place. This approach will become 

more prevalent in the new world. 

It is important to note however that as the market becomes more 

electronic and more efficient, new liquidity providers will emerge to 

keep the prices between futures, bonds, and swaps very closely 

aligned. This will only make it easier to hedge a new swap position 

elsewhere with little market impact. 

Q.2. The CFTC’s proposed SEFs rules would require that market 

participants put out a minimum of five Requests for Quotes before 

they complete a transaction. Given that most of the OTC market 

currently trades in a nonstandardized form, wouldn’t this requirement to garner five RFQs cause participants to share important information to the marketplace, which the market could use against 

that participant? In other words, wouldn’t this requirement to 

trade with the RFQ model increase bid/ask spread for end users 

and potentially increase volatility? 

A.2. It is first important to note that the majority of trading in interest rate swaps and credit default swaps occurs on standardized 

contracts. Vanilla U.S. Dollar interest rate swaps of standard durations (2 yr., 5 yr., 7 yr., 10 yr., 30 yr.) and index credit default 

swaps are in fact viewed as quite liquid by market participants. 

TABB Group’s conversations with buy side traders, bulge bracket 

swaps dealers and midsized swaps dealers confirm this point. 

That all said, these same market participants all believe that requiring an RFQ to be sent to five market participants would in fact 

widen spreads, decrease liquidity and drive trading to other products that did not have the same requirement. TABB Group believes 

that five is an arbitrary number and one that is not supported by 

historical precedent in this or any other financial market. Yet although we firmly believe a principles based approach to SEF regulation, one in which they are free to compete with each other based 

solely on their merits is best, in keeping with the goals of DoddFrank changing the RFQ requirement to read ‘‘more than one’’ 

77 

would act as a reasonable compromise that would not impact the 

majority of RFQ trades done today. 

Q.3. If the CFTC defines the size of a ‘‘block trade’’ too narrowly, 

then very few trades will be permitted off the SEFs. Given that 

most of the interest rate and credit default swaps trade in blocks 

too small to qualify as ‘‘blocks’’ under the new rules, wouldn’t a 

phased-in approach be more appropriate than a cold-turkey move 

to the various SEFs rules? With regard to the CFTC’s block rules, 

does the CFTC’s one-size-fits-all approach make sense? Not all 

swaps have the same risk characteristics and lumping all interest 

rate swaps into one bucket for blocks (and similarly for CDS) does 

not seem consistent with market convention. 

A.3. Setting the block trade size as a multiple of the current average trade size is unreasonable. The majority of swaps trades done 

today are in fact block trades. The average size of an interest rate 

swap is $129 million—but that is because much of the trading in 

this market is done by financial and commercial end users hedging 

real positions. That is in stark contrast to the highly electronic futures market where most market participants are looking for short 

term exposure to a particular reference entity. One can reasonably 

conclude that once the vanilla interest rate swap market is centrally cleared and traded electronically the average trade size could 

decrease by a factor of ten. That said, block sizes must be forward 

looking and take into account how these products are used and by 

whom. 

Q.4. Do you envision that block trades will be treated differently 

by SEFs versus DCMs? If so, how and why? 

A.4. Block trade rules are and should be focused on reporting and 

not on method of execution. As stated in our testimony, TABB 

Group strongly believes a principals based approach is best for the 

swap execution space allowing SEFs and DCMs alike to compete 

for liquidity based on trading mechanisms provided, price, technology and other competitive factors. That said, the time delay for 

reporting a block trade as well as the size of a block trade must 

be consistent regardless of where a trade is done. If one venue sets 

the block size lower than another we will quickly see liquidity move 

to the venue with the lower threshold. So ultimately, execution 

method should be left open to the venue but the block definition 

must be consistent systemwide. 

Q.5. The margin calculation for SEFs (which requires a minimum 

5-day liquidation period) v. DCMs (1-day liquidation period) has a 

significant impact on required margin. Why were these arbitrary 

liquidation periods established? 

A.5. Market convention uses liquidation periods of between 1 and 

10 days. 5-day liquidation is not uncommon. The liquidation period 

used to calculate margin is influenced by liquidity. The lower expected or perceived liquidity of an instrument, the wider the liquidation period (up to 10 days.) But since margin can be changed 

often, it is not critical to fixate on a particular look-back period as 

long as it is in the acceptable range. Furthermore, it makes sense 

that margin levels for newly clearable products would start out at 

a conservative point. 

78 

The longer the duration of a contract the greater the risk to the 

clearinghouse. As swaps tend to be of much longer duration (the 

10-year interest rate swap is one of the most common) as compared 

to futures (often 3–6 months) the risk and hence the margin requirements are greater for swaps. TABB Group research has found 

that on the short end of the curve margin levels are in fact quite 

similar for swaps and futures. But as duration increases the gap 

widens considerably. 

Q.6. We understand the CFTC is considering a different segregation regime for customer margin for SEFs v. DCMs. Why? What is 

the benefit? 

A.6. Independent of the vernacular, there are two margin segregation schemes being contemplated. One is like the futures markets 

where customer funds are comingled in an omnibus account of the 

clearing member. The problem with this structure is that customers do not want to have exposure to one another for OTC derivative trades. The other segregation method is described as legally 

separated but operationally comingled. This format is intended to 

provide the margin benefits of the futures model without the exposure to defaulting parties. 

In all cases, the benefit of pooling more margin funds is that it 

gives the clearinghouse the potential to offer margin offsets between more products, such futures and swaps (which are often 

used to hedge one another). In short, fund segregation regimes can 

determine the level of margin offsets (offered to spread products), 

and margin offsets are the primary key to lowering and ultimately 

minimizing the oncoming burdens of initial margin requirements 

for OTC derivatives. 

Q.7. Why do the proposed SEF rules not allow for derivatives voice 

trading? 

A.7. Yes, and they should. Swap transactions are often complex 

and very large. Following TABB Group conversations with real 

money buy side accounts, it became quite clear that the ability to 

speak with a broker is critical in the trading process for many. As 

a case in point, there is a reason why your average retail investor 

is still willing to pay $50 per trade to call in an order even though 

trading online is available for under $10 per trade. That said, we 

firmly believe that even for transactions discussed over the phone 

prompt entry into an execution platform for reporting purposes is 

critical to the ultimately transparency and success of the swaps 

market going forward. 

RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN REED 

FROM NEAL B. BRADY 

Q.1. A number of participants have expressed concern about a potential lag between execution and clearing that could leave counterparties exposed to a trade that will be eventually unwound. Mr. 

Brady, in your testimony, you state that this concern ‘‘is exaggerated.’’ Would you go into more detail on your views regarding swap 

trades that fail to clear or so-called clearing ‘‘fails’’? 

A.1. Eris Exchange believes that concern about ‘‘fails’’ on SEFs is 

exaggerated and addressable by applying a futures industry soluVerDate Nov 24 2008 10:41 Mar 16, 2012 Jkt 048080 PO 00000 Frm 00082 Fmt 6602 Sfmt 6602 L:\HEARINGS 2011\06-29 AM EMERGENCE OF SWAP EXECUTION FACILITIES -- A PROG
79 

tion that has been in place for a long time; namely, pretrade credit 

checks and credit guarantees at the clearing firm level. By applying 

pretrade credit checks, the futures market model avoids the complexity of resolving post-trade operational issues that could result 

in a ‘‘fail.’’ In addition, by applying pretrade credit checks, the futures market model ‘‘prequalifies’’ individual participants to trade 

with each other as long as each participant is guaranteed by a registered clearing firm. This market model vastly simplifies documentation requirements for end users, eliminates the need for end 

users to enter into complex trilateral agreements, greatly expands 

access, and allows end users to transact cleared swaps while preserving anonymity. 

Under the futures market model, and, specifically, at Eris Exchange, clearing firms manage and administer pretrade credit 

checks themselves, and therefore there is no risk of trade rejection 

at the Clearinghouse due to insufficient credit or any other posttrade operational issue. The acceptance of a trade by the Clearinghouse occurs in milliseconds. Importantly, in the futures market 

model, executing brokers are also guaranteed by their primary 

clearing firm. Thus, at every point in the execution chain, a clearing member stands behind every futures contract trade. 

If SEFs were to conform more closely to the futures industry 

model, this would alleviate the need for end users on SEFs to enter 

into complicated trilateral documentation negotiations and would 

also address another significant concern raised by major buy side 

participants—end users’ desire not to reveal their identity—to remain anonymous—during the execution process. 

In the futures exchange model and at Eris Exchange, each participant enters into a single agreement totaling two pages with a 

clearing firm, one time, and then the participant is eligible to 

trade, anonymously, with any other participant backed by any 

other registered clearing firm. 

In sum, the futures model: (1) does not subject end users to 

‘‘trade uncertainty’’ and the potential for ‘‘fails’’; (2) greatly streamlines the documentation process; (3) opens up access to a much 

wider and diversified range of market participants; and (4) preserves anonymity during the trade process, therefore ensuring the 

most competitive and cost effective execution for end users. 

The CFTC has recently proposed rules in response to the ‘‘fails’’ 

and documentation debate that applies the futures exchange model 

to the execution of swaps. See, 76 FR 45724 (Clearing Member Risk 

Management) and 76 FR 45730 (Customer Clearing Documentation 

and Timing of Acceptance for Clearing). The proposed rulemaking 

on clearing member risk management would, among other things, 

require swap dealers, major swap participants, and futures commission merchants that are clearing members to use automated 

means to screen orders for compliance with the risk-based limits. 

The proposed rulemaking on customer clearing documentation and 

timing of acceptance for clearing would, among other things permit 

derivatives clearing organizations (DCOs) to screen trades against 

applicable product and credit criteria before accepting or rejecting 

them ‘‘as quickly as would be technologically practicable if fully 

automated systems were used.’’ Eris Exchange is supportive of 

80 

these proposed rules for the reasons set forth above, as well as in 

the Exchange’s testimony. 

RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY 

FROM NEAL B. BRADY 

Q.1. The reporting requirements that the CFTC/SEC has proposed 

for all SEFs transactions will require virtual real-time reporting of 

key transaction data. Won’t liquidity providers (i.e., dealers) increase their bid/ask spreads to reflect the increased risks associated 

with communicating key data to the marketplace (since dealers will 

not be able to hedge these positions before they are front-run)? In 

order to justify this risk, won’t liquidity providers necessarily pass 

these increased costs to end users? In your view, does moving to 

SEFs justify these increased costs and reduced liquidity? 

A.1. Eris Exchange strongly disagrees with the assumption embedded in the question above—that price transparency and real-time 

reporting leads to increased costs for end users. To the contrary, 

price transparency decreases end users’ execution costs. 

As has been empirically shown in cash Treasury markets, Treasury futures markets, Eurodollar futures markets, and a host of 

other asset classes that have evolved to screen-based trading, realtime reporting leads to narrower bid/ask spreads, greater price 

transparency, and therefore decreased costs for end users. Realtime reporting also leads to deeper liquidity from a more diversified 

pool of liquidity providers, and therefore spreads trading inventory 

across a broader range of counterparties, which decreases systemic 

risk. Furthermore, real-time price reporting substantially decreases 

systemic risk by providing clearinghouses, regulators, clearing 

firms and end user participants with the trade information necessary to monitor and manage intraday risk. 

As for the concern about ‘‘front running’’ of liquidity provider 

hedges, this is best addressed by an appropriate and flexible block 

trading requirement. The futures market is a great example of how 

bilateral block trades and a transparent Central Limit Order Book 

(CLOB) can exist and thrive operating side-by-side. In the futures 

markets, all trades below the block threshold are transacted centrally, and prices are reported instantaneously. Above the block 

trade threshold, where end user trades are large enough that liquidity providers have a legitimate concern about being ‘‘front run’’ 

on their hedges, market participants are allowed to transact bilaterally, and report these trades within an exchange-defined time 

limit. This framework has worked extremely well in the futures 

markets for many decades and has led to much tighter, rather than 

wider, bid-ask spreads. In other words, the efficiencies in the transparent, yet flexible, futures industry marketplace have allowed liquidity providers to pass on lower execution costs to end user clients. 

While certain flexibilities for block trades are appropriate, such 

rules must be balanced with the harm that can result from too 

many block trades. Specifically, an excessive number of block 

trades in a given market can impact the quality of the markets offered in the CLOB. In a market that has excessive block trading, 

liquidity providers active in the CLOB are forced to make markets 

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without access to critical price information. In addition, many of 

the trades that come into the CLOB are simply hedging activity resulting from block trades that have occurred outside the centralized 

market. In this market scenario, liquidity providers in the CLOB 

are forced to widen their bid/ask, which in turn results in more 

block trades. 

Given the potential for harm to the CLOB of excessive block 

trading, it is important to set block trade thresholds high enough 

so that the only block trades permitted are those that would have 

otherwise materially impacted the market. The CFTC’s proposed 

rule for futures block trades on designated contract markets 

(DCMs) provides guidance on how block size should be determined, 

including that the acceptable ‘‘minimum block trade size should be 

a number larger than the size at which a single buy or sell order 

is customarily able to be filled in its entirety in that product’s centralized market without incurring a substantial price concession.’’ 

See, 75 FR 80572, 80630 (Acceptable practices for block size determination). 

Q.2. The CFTC’s proposed SEFs rules would require that market 

participants put out a minimum of five Requests for Quotes before 

they complete a transaction. Given that most of the OTC market 

currently trades in a nonstandardized form, wouldn’t this requirement to garner five RFQs cause participants to share important information to the marketplace, which the market could use against 

that participant? In other words, wouldn’t this requirement to 

trade with the RFQ model increase bid/ask spread for end users 

and potentially increase volatility? 

A.2. When discussing the issue of appropriate market protocols, it 

is important to distinguish between standardized (liquid) products 

and nonstandardized (illiquid) products. Eris Exchange is live and 

operational today in a very liquid and standardized market for vanilla interest rate swaps derivatives. 

For highly liquid and standardized markets like markets in 

‘‘plain vanilla’’ interest rate products, which is estimated to account 

for more than 50 percent of OTC turnover, swaps or futures 

equivalents can be readily traded with a ‘‘5 RFQ’’ protocol, as well 

as a CLOB. Specifically, at Eris Exchange, which has applied to become a DCM, trades in the Eris interest rate swap futures contract 

can only be done via either the CLOB or an RFQ that initiates an 

all-to-all central limit order book. While some may view this DCM 

requirement for transparency as a deterrent for liquidity providers 

to publish tight bid-ask, the empirical evidence points to the contrary: transparency, open access, and protocols that create a level 

playing field for competition have historically resulted in lower 

costs for end users. For DCOs, transparency also means there will 

be ample data available that is necessary for valuing and settling 

contracts, which ultimately allows for lower margin and better 

management in default situations. And, finally, for regulators, 

transparency means better monitoring of the marketplace. 

While a CLOB represents the most developed trading platform, 

Eris Exchange believes that in this time of transition, ‘‘principlesbased’’ regulation—meaning the Commission provides concepts for 

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compliance with the Act—will permit SEFs with the flexibility to 

comply with the Act. 

As for nonstandardized products, there is still question as to 

whether or not such products will be subject to the clearing mandate. 

Q.3. If the CFTC defines the size of a ‘‘block trade’’ too narrowly, 

then very few trades will be permitted off the SEFs. Given that 

most of the interest rate and credit default swaps trade in blocks 

too small to qualify as ‘‘blocks’’ under the new rules, wouldn’t a 

phased-in approach be more appropriate than a cold-turkey move 

to the various SEFs rules? With regard to the CFTC’s block rules, 

does the CFTC’s one-size-fits-all approach make sense? Not all 

swaps have the same risk characteristics and lumping all interest 

rate swaps into one bucket for blocks (and similarly for CDS) does 

not seem consistent with market convention. 

A.3. As was stated in the Exchange’s testimony, Eris Exchange believes that (1) a one-size-fits-all approach to block trading rules 

does not make sense and (2) a principles-based approach works 

best. The principles-based approach to block trading limits has 

worked extremely well in the futures industry where DCMs determine their block trading rules. 

The challenge the CFTC and the industry faces is that there will 

be multiple SEFs offering the execution of the same swap, so there 

should be consistency across SEFs. The CFTC addresses this challenge by including a proposed rule that requires Swap Data Repositories to set block trading sizes based on a prescribed formula. Instead of this prescriptive approach, the CFTC should consider having the SDRs use a principles-based approach to set block sizes, 

which will eliminate the need for a phased-in approach. The Commission can then periodically review the block trade thresholds and 

require SEFs to raise or lower these thresholds depending on how 

the market evolves. 

As we also stated in our opening statement and in response to 

questions during the hearing, Eris Exchange believes that each 

asset class is unique and should have block limits that are tailored 

and appropriate for that particular asset class. Lumping interest 

rate swaps and CDS into a single bucket and treating these assets 

classes the same with regard to blocks is not consistent with market convention. 

Q.4. Do you envision that block trades will be treated differently 

by SEFs versus DCMs? If so, how and why? 

A.4. Eris Exchange believes that the Commission intentionally differentiated between the regulatory treatment of SEFs and DCMs. 

Specifically, SEFs and DCMs are held to very different standards 

of price transparency for swaps trades below the block trade 

threshold and therefore it makes sense to differentiate with respect 

to block trade thresholds and reporting requirements for swaps in 

these two very different types of markets. 

Q.5. The margin calculation for SEFs (which requires a minimum 

5-day liquidation period) v. DCMs (1-day liquidation period) has a 

significant impact on required margin. Why were these arbitrary 

liquidation periods established? 

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A.5. Eris Exchange does not believe that these proposed liquidation 

periods are arbitrary; rather, in proposing the rules related to minimum 5-day VaR for a SEF and 1-day VaR for a DCM, the CFTC 

clearly recognized the important distinction between executing 

trades on a DCM, as opposed to on a SEF. Specifically, DCMs are 

held to a higher standard of price transparency (i.e., a CLOB) and 

therefore, should be allowed to receive margining treatment more 

akin to standardized futures markets than to SEF markets with 

more opaque execution methods. Given the execution standards for 

a DCM, the DCO can better ensure a liquidation time due to the 

active CLOB trading on a DCM. The DCM, anonymous CLOB 

model allows participants to trade in and out of products in a costeffective and time-effective manner. The Exchange believes that 

the transparency of a CLOB-driven DCM swaps market is a very 

valuable addition to the post Dodd-Frank marketplace and a clear 

example of some of the benefits that will be delivered to end user 

clients as a result of the regulatory reform. 

Q.6. We understand the CFTC is considering a different segregation regime for customer margin for SEFs v. DCMs. Why? What is 

the benefit? 

A.6. As a futures market, Eris Exchange contracts will be placed 

in the traditional futures account, the 4d account. It is worth noting that the CFTC has proposed using different segregation regimes for swaps regardless of whether the transaction is executed 

on a SEF or DCM. Therefore, if a DCM offers the trading of futures 

and swaps, it is possible that a given client’s futures contracts will 

be in one account for futures (i.e., Futures or Baseline Model) and 

a different account for swaps (e.g., Complete Legal Segregation 

Model). 

In general, Eris Exchange operates under a futures margining 

framework and believes that this framework has worked extremely 

well for the futures industry. 

Q.7. Why do the proposed SEF rules not allow for derivatives voice 

trading? 

A.7. The proposed SEF rules do provide a role for voice trading; 

however, the proposed rules balance this role with the transparency requirements of the Dodd-Frank Act. As discussed in the 

CFTC’s proposal: 

While not acceptable as the sole method of execution of 

swaps required to be traded on a SEF or DCM, the Commission believes voice would be appropriate for a market 

participant to communicate a message to an employee of 

the SEF, whether requests for quotes, indications of interest, or firm quotes. For instance, voice-based communications in the proposed SEF context may occur in certain circumstances, such as when an agent: (1) assists in executing a trade for a client, immediately entering the terms 

of the trade into the SEF’s electronic system; or (2) enters 

a bid, offer or request for quote immediately into a SEF’s 

electronic multiple-to-multiple trading system or platform. 

[76 FR 1214, 1221] 

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It is also important to note that voice trading is permitted with 

regard to block trades or other ‘‘permitted Transactions’’ as defined 

in the CFTC’s SEF proposed rule. Id. at 1241. 

As an electronic futures exchange, Eris Exchange does not permit voice trading to execute standard/nonblock trades. However, 

the Exchange does have rules related to block trades, which can be 

voice brokered. 

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ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

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LETTER SUBMITTED BY STEPHEN MERKEL, CHAIRMAN, WHOLESALE 

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