UNITED STATES OF AMERICA 

COMMODITY FUTURES TRADING COMMISSION 

MARKET RISK ADVISORY COMMITTEE MEETING 

Washington, D.C. 

Tuesday, June 2, 2015 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2 

1 PARTICIPANTS: 

2 

3 

4 

5 

Panel 1: CYBERSECURITY - CONSIDERING BANK OF 

ENGLAND'S CBEST PROGRAM: 

Moderator: 

ANDREW GRAY 

Group Chief Risk Officer, DTCC 

6 Guest Speaker: 

7 

8 

9 

10 

11 

DAVID EVANS 

Senior Manager, Bank of England 

Panel 2: LIQUIDITY IN THE DERIVATIVES MARKETS: 

Moderator: 

SUSAN MCLAUGHLIN 

Senior Vice President, Federal Reserve Bank 

12 

13 

Panelists: 

ISAAC CHANG 

Global Head of Fixed Income, KCG 

14 

15 

16 

17 

18 

19 

PIERS MURRAY 

Managing Director, Global Head of OTC 

Derivatives Clearing & Prime Brokerage, 

Deutsche Bank 

THOMAS WIPF 

Managing Director, Global Head of Bank 

Resource Management, Morgan Stanley 

Associate Director, CFTC Division of Market 

Oversight 

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21 

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3 

1 P R O C E E D I N G S 

2 (10:02 a.m.) 

3 MS. WALKER: As the designated federal 

4 officer it is my pleasure to call this meeting of 

5 the Market Risk Advisory Committee to order. 

6 Before we begin this morning's panels I would like 

7 to turn to Commissioner Bowen, the sponsor of the 

8 Market Risk Advisory Committee to make some 

9 remarks. 

10 COMMISSIONER BOWEN: Thank you Petal. 

11 Good morning everyone and welcome to the second 

12 meeting of the Market Risk Advisory Committee of 

13 which I serve as sponsor. Before discussing 

14 today's topics, I will turn the podium over to the 

15 Chairman and Commissioner Wetjen just to see if he 

16 would like to make some statements. 

17 COMMISSIONER WETJEN: Thank you 

18 commissioner Bowen I just want to really be very 

19 brief -- we've got such a packed agenda today I 

20 don't want to take up any time away from that. 

21 But let me just say thank you to all of you for 

22 being here, particularly the members of the 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

4 

1 committee. I really appreciate your participation 

2 in these committees. They are extremely important 

3 to us -- it's a very very helpful way. Not just 

4 to get input to have a discussion of these issues. 

5 And I also want to thank in particular Andrew for 

6 moderating the first panel. I'll thank Susan in 

7 advance, I understand she's on her way down for 

8 doing the second panel. These are extremely 

9 important topics that we're taking up today --

10 they're big topics. And obviously we can't cover 

11 all the issues involved here but this should be a 

12 very productive session -- so again thank you. 

13 Let me also thank Commissioner Bowen and all of 

14 her staff and all of our staff for all the work in 

15 putting this event together. It's really very 

16 much appreciated. 

17 COMMISSIONER BOWEN: Thank you Sharon, 

18 thank you Tim. I'll keep my remarks very brief as 

19 well so we can get started but obviously 

20 Commissioner Bowens identified a couple of 

21 important topics. So looking forward to the 

22 discussion this morning and thanks again to all 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 the members for making their way to D.C. and to be 

2 with us today -- it's a real pleasure to have you 

3 here as always. And with that I'll turn back to 

4 Sharon, thank you. 

5 COMISSIONER BOWEN: Great, I want to 

6 thank you my fellow commissioners and I just want 

7 to note it's been a great year. Tomorrow will be 

8 officially, I guess the one year anniversary of 

9 our confirmation. So it's been a great first 

10 year. I also want to thank our MRAC members for 

11 bringing your passion and expertise to these 

12 important issues. I also want to express my 

13 appreciation and thanks to Kim Taylor for being 

14 such a tremendous resource. We wish for the best 

15 and we welcome Sunil Cutinho, who will be taking 

16 her seat on the committee. I'd like to thank the 

17 members of the staff from DCR, DMO, DSLO and OCO 

18 for the support that you've given us in preparing 

19 for today's meeting. And of course this would not 

20 be possible without the help of our logistical 

21 staff who work behind the scenes to make this 

22 meeting be a success, hopefully. 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

6 

1 As you know the purpose of MRAC is to 

2 provide the commission with market intelligence 

3 and recommendations from industry about market 

4 risk and market structure issues. Our first panel 

5 takes on an important market risk issue -- cyber 

6 security. The importance of having an effective 

7 cyber security measures cannot be overstated. 

8 Cyber-attacks on the U.S. businesses have become 

9 alarmingly increasing and it's critical that the 

10 financial industry have strong protections in 

11 place. Recently our staff held a round table at 

12 cyber security testing. After attending that 

13 discussion I became very interested in the Bank of 

14 England's use of the CBEST program to deliver 

15 targeted intelligence split cyber security tests. 

16 I wanted to have an opportunity and to present the 

17 commission with the opportunity to learn a little 

18 bit more about CBEST and also to hear our market 

19 participants' thoughts on that program. Thank you 

20 to David Evans and the Bank of England for your 

21 graciously agreeing to provide that opportunity 

22 today. 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 Our second panel addresses an important 

2 issue that deals with market structure -- and 

3 that's liquidity. Several market participants 

4 have noted there are significant liquidity 

5 movements in markets we oversee. It is important 

6 in order to regulate effectively that the 

7 commission get information from market 

8 participants about what is happening in our 

9 markets. MRAC offers a wonderful opportunity to 

10 do so as our membership is so diverse -- including 

11 end users, dealers, buy-side, (inaudible), 

12 exchanges, clearing houses and academics. And 

13 with our guest panelist today we also get the view 

14 of trading desks. Thus the purpose of our second 

15 panel is to answer a few questions. One is to 

16 understand what market participants are referring 

17 to exactly when they say liquidity, as they can 

18 have many different meetings. The second is to 

19 learn whether there has actually been liquidity 

20 movements and if so, which markets. The third is 

21 to determine the causes of changes in liquidity. 

22 And finally we want to know what actions if any 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 the commission should take. I will now turn over 

2 to Ms. Walker, who will introduce our first 

3 moderator to the panel. 

4 MS. WALKER: Thank Mr. Chairman, 

5 Commissioner Bowen, Commissioner Wetjen for your 

6 opening remarks. Before introducing our first 

7 panel moderator one note to MRAC members -- in 

8 your folders you'll find a complementary 

9 conference booklet from the Federal Reserve Bank 

10 of Chicago of the November 14th CCP resolution 

11 conference as well as a full biography of all the 

12 moderators and the guest panelists today and a 

13 copy of the Power Point. Importantly we also have 

14 a confirmation letter for your subcommittees, so 

15 if you could at some point just sign those and 

16 leave them on your desk, I'll pick up those up 

17 during the break. We can take care of that. 

18 As noted in today's agenda our first 

19 panel discussion is on cyber-security --

20 considering Bank of England's CBEST program. Our 

21 moderator for the first panel is Mr. Andrew Gray. 

22 We are privileged to have Andrew Gray as our 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 moderator who has decades of experience in these 

2 markets. Andrew currently serves as Managing 

3 Director and Group Chief Risk Officer at DTCC with 

4 global responsibility for DTCC enterprise risk 

5 management, operational risk management, and 

6 systemic risk as well as information security, 

7 technology risk management, business continuity 

8 management and global security management. Thank 

9 you. 

10 MR. GRAY: Thank you very much Petal. 

11 It is a pleasure to have the opportunity to 

12 moderate this first panel and it's a pleasure to 

13 introduce our guest panelist -- Dave Evans from 

14 the Bank of England. You have his bio in the 

15 packet, but just a few very quick words on Dave's 

16 position and background. Mr. Evans is a senior 

17 manager in the sector and supervisory cyber 

18 support for the Bank of England. He joined the 

19 sector cyber team in the beginning of 2015 and 

20 prior to that worked as part of the bank's sector 

21 resilience team since 2010. And Mr. Evans has had 

22 a number of years of experience in various 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

10 

1 positions in business analysis and security within 

2 the bank. So what I'd like to do for this first 

3 panel is break it up into two sections. The first 

4 section, Mr. Evans, Dave will present CBEST and 

5 basically answer the first five questions that are 

6 included on the agenda and then after he's had a 

7 chance to go through the presentation we'll open 

8 it up for questions. And in particular talk about 

9 what sorts of considerations we need to make in 

10 thinking about potentially applying CBEST to CFTC 

11 registrants. So with that I'll turn it over to 

12 Dave, Dave thank you very much for being here. 

13 And he'll kick us off with his presentation. 

14 MR. EVANS: Thank you Andrew, thank you 

15 Petal, thank you commissioners and thank you to 

16 committee members for providing me with this 

17 opportunity to come and talk to you today. So 

18 I've been involved with the CBEST program since 

19 the inception. So I could talk for far longer 

20 than the time that has been allocated, but in 

21 interests of brevity we will stick to an agenda 

22 we've laid out in the presentation. So I'll 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 provide an overview of the CBEST program -- its 

2 origins, why we felt we needed CBEST, talk about 

3 what it is and what it does. We'll also touch on 

4 a little bit of what it doesn't do as well. The 

5 overview will then include answers to the 

6 questions we've laid out in the agenda. So what 

7 types of financial institutions are participating 

8 in the CBEST program? How is the program 

9 developed and how is it maintained? So that's 

10 maintained as process. What is the scope of 

11 testing? So what are we wanting to test and why 

12 are we wanting to test those elements of an 

13 organization. We'll answer how CBEST accommodates 

14 the evolution of threats and the changing 

15 technology landscape and we'll look at how CBEST 

16 as a program remains up to date. And then 

17 remembering that CBEST as a program is only twelve 

18 months old since we actually launched it, we'll go 

19 through some of the lessons that we've learned 

20 from the experience so far. Experience in rolling 

21 out the program and also experience in building 

22 the program as well. So that'll answer the first 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 five questions of the agenda and then rather than 

2 me trying to list some of the costs and benefits 

3 it's probably best if we hand it back to Andrew to 

4 facilitate a Q and A session where we'll look at 

5 some of the costs and benefits of having a similar 

6 program here for CFTC registrants. 

7 So in June 2013, the U.K.'s financial 

8 policy committee issued the following 

9 recommendation. The recommendation was made to 

10 Her Majesty's Treasury, and Her Majesty's Treasury 

11 was to work with the relevant government agencies, 

12 the prudential regulation authority, the bank's 

13 financial market infrastructure supervisors and 

14 the financial conduct authority and they should 

15 work with the with core of the U.K. financial 

16 system and its infrastructure to put in place a 

17 program of work to improve and test resilience to 

18 cyber-attack. 

19 It's important to know that in that 

20 recommendation -- the recommendation was issued to 

21 the lead government department to the financial 

22 sector in the U.K. -- so recommendations are 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

13 

1 issued to the regulators on a complier explain 

2 basis but the financial policy committee does not 

3 have the power to issue complier explained 

4 recommendations to the non-regulatory bodies. But 

5 in there you'll also see some key points that 

6 financial policy committee acknowledged that as 

7 regulators on our own we wouldn't be able to 

8 address the issue. We needed the support of Her 

9 Majesty's Treasury but we also needed the support 

10 of the relevant government agencies and we'll 

11 touch on some of those as we go through the 

12 presentation. So following their recommendation 

13 in June 2013, the financial policy committee 

14 issued an update in September 2013. So just three 

15 months on, they issued the following public 

16 statement. And that was that it was important to 

17 ensure that the various institutions at the core 

18 of the financial system -- including banks and 

19 infrastructure providers had a high level of 

20 protection against cyber-attacks to ensure such 

21 attacks do not undermine the system. So this was 

22 the financial policy committee really saying that 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 in order to address this we need all of those 

2 organizations that constitute the core of the U.K. 

3 financial system to have a very high level of 

4 protection indeed. 

5 So that sent us on a journey then as to 

6 how do we measure, how do we ensure that there is 

7 a high level of protection? And so we reviewed 

8 testing practices across industry. And when we 

9 reviewed those practices we revealed that actually 

10 the variation in activities, and by that I mean 

11 the scope, the methodologies, the goals of 

12 testing, even the frequency of testing -- you 

13 know, that variation was just too large. Also we 

14 found very little insights into protective 

15 capabilities against likely attack methods. And I 

16 want to underscore that. We're talking about 

17 likely attack methods. Was enough work being done 

18 upfront for each organization to understand, or 

19 what are the threats that I need to concentrate 

20 on, not what are the threats generally to a system 

21 or to any organization. But what are the threats 

22 and likely attack methods that I might encounter 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 and how do I need to protect myself against them. 

2 So after we'd done this work we realized 

3 that actually without some sort of common 

4 framework it's going to be really difficult for us 

5 to answer the examination question if you like 

6 that was set by the financial policy committee. 

7 How could we assess the adequacy of cyber security 

8 capabilities for each of those institutions that 

9 were considered core? And therefore we couldn't 

10 provide assurance. If we couldn't assess the 

11 levels of protective capability then how could we 

12 provide any assurance that the core of the U.K. 

13 financial system had -- I'm putting there in 

14 brackets, or knew what it needed to do to achieve 

15 a high level of protection? There was an awful 

16 lot of testing going on, but none of them really 

17 gave us the answers to the question that had been 

18 set to us. So something needed to change and 

19 that's really where CBEST as a process started to 

20 evolve. So it's very important that we wanted to 

21 build something that was repeatable, something 

22 that was scalable, and something that would really 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 look at the heart and the vulnerabilities within 

2 an organization. So we put in place a program 

3 that would consider all of the variables and allow 

4 the regulators to reach a judgment on the adequacy 

5 of capabilities. At the end of the day we needed 

6 to build a process that would enable our line 

7 supervisors to take on board all of that 

8 information and then have informed discussions 

9 with each of the organizations they supervise and 

10 regulate so that we can agree on what the right 

11 steps to take were. 

12 And so we built CBEST around a number of 

13 unwritten principals if you like. But each test 

14 needed to include the same steps, no matter which 

15 organization was to be tested. So this utters our 

16 repeatable process. The test needed to be 

17 holistic in nature, ensuring that people, 

18 processes and technology were tested. We needed 

19 to move away from cyber being seen as a technology 

20 only issue. The content of each step however 

21 should be bespoke to each organization being 

22 tested. The steps are the same, the content of 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 the steps are unique to each organization being 

2 tested. Intelligence, and that's intelligence 

3 from commercial organizations but also from the 

4 U.K. government agencies was to influence the 

5 behaviors of the penetration testers. The 

6 penetration testers must act as threat actors and 

7 not to act as penetration testers. The test 

8 should provided an accurate understanding 

9 therefore of the threats faced by each 

10 institution. So that our understanding and 

11 industry's understanding of the threats is up to 

12 date. It's up to date and it keeps being updated 

13 as each organization undertakes one of these 

14 tests. 

15 The tests were to be conducted in 

16 partnership with the regulator. This is not 

17 something we wanted to do to industry. It's 

18 something we wanted to do with industry. There's 

19 an awful lot of learning that needs to go on in 

20 this process. That's learning for us as 

21 regulators; it's learning from the government 

22 agencies. It's learning from the institutions 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 that are considered core. And rather than doing 

2 something to industry, we felt that doing 

3 something with industry was a much better way to 

4 improve and foster that learning and a partnership 

5 approach. And we needed openness and transparency 

6 to be at the very heart of the CBEST program. 

7 Other risks that we ask organizations to manage 

8 are perfectly visible to the regulators. We can 

9 see them, we can ask for evidence. We can be 

10 given evidence, we can reach judgments. Cyber 

11 security is all too often hidden and if something 

12 is hidden -- if the risk management processes that 

13 support that risk are hidden, then we're really 

14 going to struggle to reach any useful judgments. 

15 They should benefit, or they would benefit from 

16 GTHQ inputs. That's the government communications 

17 headquarters in the U.K. -- that is United 

18 Kingdom's Signals Intelligence Authority. The 

19 resource commitment on both the regulators side 

20 and through the involvement of GTHQ would 

21 therefore limit participation in CBEST to the core 

22 institutions only. We would love to live in a 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 world where CBEST is available to any organization 

2 that requested it -- but it's just too resource 

3 intensive. However, and we will touch on this a 

4 little bit later on, the principals on which we 

5 built CBEST are scalable and repeatable. It 

6 stands therefore that you can tweak the scale, the 

7 size, the resource constraints -- yet still adopt 

8 CBEST methodology and roll that out to a much more 

9 wider constituency. But with some way of doing 

10 that I hasten to add. 

11 In continuing with the partnership 

12 approach we chose not to make CBEST mandatory. At 

13 the time we felt this would undermine that 

14 partnership principle and we truly wanted to 

15 foster this partnership model. And again 

16 mandating something would put it on the wrong 

17 footing we thought at the time. And by and large 

18 we still hold to that. We don't want this to be 

19 mandatory, there's benefits to all, we want 

20 industry to see the benefits, we want industry to 

21 reach out and want to undertake this. By and 

22 large we are seeing that from the organizations 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 being asked to undertake CBEST. 

2 The tests should provide an assessment 

3 of where each firm's current capability is versus 

4 where it needs to be. So we're not measuring in 

5 absolute terms. They do not all face the same 

6 threats -- so they shouldn't be required to have 

7 identical capabilities. They just don't need to 

8 be the same -- but it does need to be aligned to 

9 the unique threats that they are facing. 

10 We faced a challenge in issuing the 

11 CBEST program and not making it mandatory. How 

12 could we prove that this was a good thing. How 

13 could we demonstrate that it was a safe thing to 

14 do? So we piloted CBEST on the Bank of England 

15 itself. So the Bank of England -- not only is it 

16 a central bank but it's an operator of the U.K.'s 

17 high value payment system -- it is a piece of U.K. 

18 critical national infrastructure. We couldn't 

19 possibly -- we couldn't ask industry to undertake 

20 this new type of testing if it hadn't been proven 

21 on an organization. And of course as we were a 

22 piece of critical national infrastructure -- the 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

21 

1 easiest thing to do was to test it on ourselves. 

2 A small industry working group was then 

3 established to take development from the pilot 

4 phase to launch. And again we saw this as a very 

5 key step -- we needed to involve industry in 

6 building CBEST because again it wasn't something 

7 we wanted to do to industry -- it was something we 

8 wanted to do with industry. 

9 The working group included banks, it 

10 included infrastructure providers, penetration 

11 testers, threat intelligence providers, ourselves 

12 as regulators and government agencies. So 

13 everybody was in there, the list right at the 

14 beginning of who the financial policy committee 

15 asked to improve the resilience to cyber-attack. 

16 They were all represented on that working group to 

17 ensure that we built what was needed. 

18 New accreditation standards, including 

19 examinations for penetration testers and threat 

20 intelligence providers were created. This was the 

21 first time that we're aware of that commercial 

22 threat intelligence providers have been accredited 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

22 

1 in anywhere in the world. They're maintained by 

2 the Council of Registered Ethical Security testers 

3 on behalf of the Bank of England. 

4 Moving on to accreditation in a bit more 

5 detail -- to carry out CBEST tests, penetration 

6 testing, and threat intelligence companies must 

7 demonstrate to us, the Bank of England, by a 

8 written application process that they meet the 

9 correct criteria. They must be members of the 

10 Council of Registered Ethical Security Testers, 

11 and by that CREST will then evaluate that the 

12 company's operating procedures are sound, that 

13 they are following international standards on 

14 personnel security, on personnel development, 

15 their approach to testing is robust and secure and 

16 they are following data security, data handling, 

17 data destruction -- all of those standards are 

18 being met. And CREST has enforceable codes of 

19 conduct that it enforces on its members. 

20 We need to ensure that personnel are 

21 qualified to the right levels. We've developed 

22 new examinations for penetration testers and for 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 threat intelligence personnel. Personnel must 

2 have the minimum required experience. And these 

3 are extensive requirements -- for example we 

4 require penetration testers to have in the region 

5 of 14,000 verifiable hours experience before they 

6 are allowed to undertake CBEST testing on any of 

7 our core institutions. And they much have proven 

8 work history within industry, and then we, as the 

9 Bank of England will check those references to 

10 make sure that they are sound and they are as per 

11 the application process. We then undertake site 

12 visits to the penetration testing and the threat 

13 intelligence companies and this provides us -- our 

14 team an opportunity to interview the company 

15 staff. We clarify any anomalies that may have 

16 appeared in the written application form and we 

17 ensure that everything is as it should be. On the 

18 completion of the interviews we can then issue one 

19 of three recommendations. We can either recommend 

20 that a firm be accredited and they are clear to 

21 undertake CBEST testing. We can issue a 

22 recommendation that they be accredited, subject to 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 certain requirements being met. This might be 

2 ensuring that they have the fully qualified staff. 

3 They might need to provide further references or 

4 we will reject their application. In the 12 

5 months that we've been going with predominantly 

6 with accredited companies, but we have issued 

7 accreditations subject to requirements and we have 

8 rejected some applications as well. 

9 Before we set off on this journey we 

10 wanted to make sure that CBEST when it was 

11 developed -- when it was in place remained at the 

12 top of penetration testing schemes. So to that 

13 end, the Bank of England reserves the right to 

14 revoke anybody's accreditation and we reserve the 

15 right without question. If qualified personnel 

16 leave, we can remove accreditation. If the 

17 process is not followed as it should be we can 

18 remove accreditation. Even if marketing rules are 

19 not followed, or they're trying to gain too much 

20 market business or mis-selling what CBEST is --

21 then they can lose their accreditation. 

22 So how is CBEST as a process maintained? 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

25 

1 That falls to our team to maintain CBEST as the 

2 process. We do this by liaising very closely with 

3 our supervisory functions to ensure that it 

4 remains relevant. And it's a really simply 

5 test -- question that we ask to supervisors -- is 

6 CBEST providing them with enough to reach a 

7 judgment of security capabilities? If it is, 

8 CBEST is working. If it's not we need to go back 

9 and make some amendments. We consult with 

10 penetration testers, the threat intelligence 

11 providers and industry on its effectiveness. 

12 We're currently in our first round of receiving 

13 feedback from all of those stakeholders. And it's 

14 imperative that we take on board feedback. We 

15 don't hide behind potential lessons that we could 

16 learn to improve this important process. We 

17 maintain very close liaison with CREST for the 

18 accreditation standards. That's absolutely 

19 essential to the future of CBEST. And we promote 

20 CBEST by industry events. They can be through 

21 large seminars, events such as these, the round 

22 table I was invited to at the CFTC the other 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

26 

1 month. It's really important that we promote what 

2 CBEST is and we improve international liaison 

3 along the way. We also maintain a webpage -- a 

4 publically available webpage and there are details 

5 at the end of this presentation. And that's where 

6 we put as much information as possible about CBEST 

7 as a process, what it is and what it does, so that 

8 everybody can learn. 

9 So I want to touch just briefly on what 

10 the tests actually are. So threat intelligence 

11 will identify threat actors and the tactics, 

12 techniques, and procedures they would use for the 

13 test. This ensures that no matter which 

14 organization is being tested, or when its being 

15 tested, that the test is based on current threat 

16 intelligence. This also ensures that each test is 

17 being up to date -- it's not old news. It's being 

18 tested against very current threats to that 

19 organization. The scope of the test is agreed by 

20 the regulators and the financial institution that 

21 is being tested. For CBEST broadly we are looking 

22 at functions which if disrupted could have an 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

27 

1 adverse effect on U.K. financial stability. Once 

2 we've identified those functions we can then start 

3 to identify technology systems supporting those 

4 functions. They become our (inaudible). Target 

5 systems, but we also then need to discuss what are 

6 no go areas? Why should our testers not go, and 

7 we have to keep this to an absolute minimum. 

8 There should be good reason why certain things are 

9 out of scope but there is that opportunity. At 

10 the end of the day the threat actors perpetrating 

11 a real attack are not going to ask you if the 

12 certain areas they shouldn't be touching. So 

13 that's a kind of testing anomaly that we have to 

14 abide by. 

15 The goals of the testing are 

16 predetermined. So we don't actually want to 

17 compromise target systems, we don't want to be the 

18 reason for adversely effecting financial stability 

19 in the U.K., so we need to come up with ways that 

20 everybody can agree that should the next step be 

21 taken, a compromise would occur. Once we 

22 understand what the goals are, the penetration 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 testers and the financial institution that's being 

2 tested devise the robust control framework. It's 

3 very important that financial institution that's 

4 being tested is fully involved -- in fact leads on 

5 building that control framework. It's their 

6 network, it's their systems, it's their personnel 

7 that are all being targeted by this tester, so 

8 they need to lead on the development of this 

9 control framework. 

10 And during the test itself, the 

11 financial institution will be informed of each 

12 day's activity, ahead of it taking place. And 

13 they will give the go ahead or ask for it to be 

14 suspended. Reasons why tests might be suspended 

15 -- perhaps if there are unexpected business 

16 requirements, perhaps it's an unexpected large 

17 training day, and doing live testing on their 

18 networks would not be best suited. Or maybe 

19 there's some unplanned change, some last minute 

20 change, management needs to take place. Then 

21 CBEST can be temporarily suspended. And some 

22 penetration testers have even gone so far as to 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

29 

1 offer up a seat within their offices for somebody 

2 from the financial institution to actually sit 

3 alongside the penetration testers. 

4 Again valuable experience to understand 

5 what penetration testing actually is, what it 

6 looks like, how it works. But then you've also 

7 got a safe pair of hands sitting right next to 

8 the penetration testers to make sure that the test 

9 remains safe at all times. 

10 But once the test is concluded, that's 

11 really where we start to get to the meat of why 

12 we're here and at CBEST. And it's all about the 

13 post-test activity. So we have key performance 

14 indicators on both the process and that's for the 

15 penetration testers and the threat intelligence 

16 providers and the outcome that's captured. These 

17 key performance indicators help us to ensure that 

18 the program adheres to the agreed framework and it 

19 helps us in judging appropriateness of capability. 

20 So how do we do some measurements for the test 

21 itself but also the outcomes? We then have a 

22 workshop with all stakeholders to discuss the 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

30 

1 testing activity that's conducted. And I can't 

2 stress the importance of this workshop -- moving 

3 away from previous test results which penetration 

4 testers will provide well written, well thought 

5 out reports. But there will be a list of 

6 typically red amber green issues that need to 

7 addressed. Those red, amber and green issues have 

8 no context in which people can reach a judgment. 

9 How large are the issues identified compared to 

10 other risks the regulator is asking you to manage. 

11 How can a supervisor reach a judgment whether a 

12 red issue on a penetration test is more important 

13 than say building up larger capital requirements, 

14 looking at some of the organizational change that 

15 they might have requested you to as a priority in 

16 any given year? So we have the workshop where we 

17 discuss all of the testing activity and that's 

18 where we understand, are they big fixes that are 

19 required or are there some really simple quick 

20 fixes. Are there any quick wins in there? Are 

21 they expensive -- if they are expensive, how 

22 expensive or what might the timelines be. The 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

31 

1 penetration testers offer a fantastic wealth of 

2 knowledge. We need to leverage their experience; 

3 we need to get out of them as much information as 

4 we can. If they circumvented security controls by 

5 doing the penetration test, it's pretty sure they 

6 know how you can improve your security capability 

7 to prevent them from doing it again. We need to 

8 maximize the experiences that they bring to this 

9 process. 

10 Once we understand all of the issues 

11 then we can start building a remediation plan. 

12 And that's a remediation plan that's agreed to by 

13 both the regulators and the financial institution. 

14 And the plan will look to address the gaps 

15 identified and where they are versus where they 

16 need to be. So it's all routed in the context of 

17 what an organization actually needs versus 

18 arbitrary absolute measure. 

19 The progress against the agreed actions 

20 is then monitored via a routine supervisory 

21 engagement. This is very much supervision one on 

22 one. There's a list of issues that need to be 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

32 

1 identified with agreed timescales. Are those 

2 timescales and measures being implemented as was 

3 agreed? And of course a retest may well be part 

4 of a remediation plan. 

5 So we move onto the last slide before 

6 the Q and A. This is -- lessons today. And we 

7 are only one year in since launch. Some of the 

8 lessons here that you might want to be aware of is 

9 that CBEST attracted considerable media attention 

10 far more than we ever considered that it would 

11 meet. And periodically it keeps popping up again. 

12 CBEST will get a mention, we'll start press 

13 inquiries. It'll go a little bit quiet and it 

14 will rear its head again. So the media attention 

15 around the regulators taking an active engagement, 

16 an active role in cyber security was most 

17 definitely news worthy. 

18 Each test will take approximately six 

19 months from start to finish. It is a long testing 

20 program. The actual time of the test is roughly 

21 four to six weeks. But the preparation, the 

22 procurement stages can be quite drawn out. And of 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

33 

1 course the post-test activity takes another four 

2 to six weeks. So it's not long when you start 

3 adding up the stages and we've got more 

4 information on the website that has more detail on 

5 each stage. When you start adding it all up you 

6 very quickly get to six months. I've touched on 

7 procurement, being drawn out -- especially with 

8 threat intelligence providers. We found that most 

9 organizations that we asked to undertake one of 

10 these tests have an approved penetration test 

11 already on their books. They typically won't have 

12 a commercial threat intelligence provider. So 

13 they need to go through the whole of the 

14 procurement due diligence process. 

15 Outsourcing of the accreditation work 

16 massively reduced the burden on ourselves. We are 

17 a small team, trying to put in place -- trying to 

18 replicate the business that CREST does in the 

19 penetration testing world. We would not have 

20 launched CBEST if we couldn't have fallen back on 

21 CREST to do that burden of work on us. And ensure 

22 that those penetration testing companies and other 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

34 

1 threat intelligence companies are operating at the 

2 very highest of standards. 

3 Working with industry to finalize the 

4 tests helped achieve important buy in. We didn't, 

5 as I said at the outset, we didn't make this 

6 mandatory. We wanted everybody to see the 

7 benefits of the process and we had to work with 

8 industry in order to get their buy in. Arguably 

9 perhaps we could have done some more there. We 

10 could have looked at how do we achieve better 

11 board buy in within those organizations. We got 

12 the good technical support to build the CBEST. We 

13 got a certain level of board buy in, but perhaps 

14 we could have done a little bit more to achieve 

15 board level buy in. 

16 Nervousness within industry remains at 

17 some levels. We've seen this level of nervousness 

18 dissipate slowly. But we do believe that we get 

19 more organizations through the CBEST testing and 

20 as they talk to their peers about control 

21 frameworks, about how we didn't compromise their 

22 systems, we would expect this nervousness to 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

35 

1 dissipate. 

2 It does though raise questions about 

3 what are we doing for firms that are not core, 

4 especially when there wasn't a ready-made 

5 definition of who is a core institution. But some 

6 obvious institutions that were most definitely 

7 going to be classified as core, and then of course 

8 if you work your way down the list you then start 

9 to get a little bit fuzzier. And it's a little 

10 bit blurry as to whether somebody is core or not. 

11 And of course you have to draw the line somewhere. 

12 Those that are just below the line might still 

13 consider themselves to be nearly core -- so what 

14 do we do for those? But then there's everybody 

15 else that we regulate that we just don't have the 

16 supervisors -- the number of supervisors to do 

17 something as resource hungry as a CBEST. 

18 So we have had some inquiries and as I 

19 sit here today we have answers and what a smaller 

20 more confined testing program might look like. 

21 But we are looking to take the principals of CBEST 

22 and build something more manageable -- something 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

36 

1 smaller and less resource intensive. 

2 So I think that kind of wraps up my bit 

3 of talking. So I'm going to hand over to Andrew. 

4 MR. GRAY: Thank you very much Dave for 

5 that background. So we would like to open it up 

6 to general Q and A if there are any questions 

7 about anything that Dave has covered and then more 

8 specifically to get to the question on the agenda 

9 which is, what are some of the cost benefits --

10 challenges associated with potentially adopting 

11 the CBEST or something like CBEST for CFTC 

12 registrants. 

13 So some logistical things. First of all 

14 if you do want to speak please push the button on 

15 your microphone so that way people who are calling 

16 in can hear, and conversely, once you're done 

17 speaking please turn it off because we can only 

18 have so many microphones on at the same time. If 

19 you do want to be recognized and I see Kristen's 

20 already figured it out, please turn your temp card 

21 on its side and I will call on you. 

22 And then, finally there is WIFI 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

37 

1 available for those who need longer instructions 

2 -- it's available on the publically printed agenda 

3 on the site. So with that, Kristen would you like 

4 to ask the first question? 

5 MS. WALTERS: Sure just a quick 

6 question. Given the testing that you've done so 

7 far, could share any of the --

8 MR. GRAY: Can you speak up close to the 

9 mike? Thank you. 

10 MS. WALTERS: I'm sorry. Just given the 

11 testing that you've done to date, and I understand 

12 it's early days, I was hoping that you could share 

13 some of the findings or performance metrics that 

14 you found useful when actually conducting the 

15 tests and analyzing the results. 

16 MR. EVANS: So in terms of actual 

17 results, we haven't had sufficient organizations 

18 go through the test in order for us to publish 

19 results. It wouldn't be -- we haven't discussed 

20 the results of any the tests that have been 

21 completed so far, with other organizations. So 

22 unfortunately as I sit here today, I can't go into 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

38 

1 the specific results that have come out of it. 

2 We've received positive messages about the test as 

3 a framework. We've received positive messages 

4 about how it has revealed issues that perhaps 

5 firms weren't quite aware of. And some examples 

6 would be around -- we talk about people, 

7 processes, and technology. And understanding some 

8 of the examples we've had -- have been where 

9 people have got policies around the use of social 

10 media. And the staff will -- as seemingly just 

11 about everybody in the world is on social media 

12 these days -- organizations will have policies 

13 about how they're supposed to conduct themselves 

14 in relation to their working practices. People 

15 can't necessarily see the connection between -- if 

16 somebody's putting too much information on their 

17 social media accounts as it relates to the 

18 organization they work for. Is that really an 

19 issue -- can it be used to leverage access? And 

20 through the CBEST program, people are finding that 

21 actually social media is a rich source of 

22 information for our penetration testers. So it's 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

39 

1 a rich source of information for our penetration 

2 testers. It's a rich source of information for 

3 our threat actors. And that's something that, 

4 through the current testing practices is not 

5 always picked up. So we're learning lessons by 

6 that. As we go further through the process we 

7 want to publish as much as possible -- clearly you 

8 will have to anonymize results, so as and when 

9 they're available, we'll look to push those out on 

10 our public website. 

11 MR. GRAY: Richard. 

12 MR. MILLER: Just an information 

13 question -- did I hear you say the test takes six 

14 months? Is that right? 

15 MR. EVANS: So the whole, the whole 

16 process takes six months. The actual time of 

17 testing -- so where you would consider penetration 

18 testers being active on your networks is four to 

19 six weeks. It's the planning and the preparation 

20 and the post-test activity that means the whole 

21 process takes six months. 

22 MR. MILLER: And what do you think the 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

40 

1 shelf life is? How long is that test good for 

2 before you have to retest again? 

3 MR. EVANS: So we're yet to work out 

4 when it should be a repeat test. We're starting 

5 to work on some areas which would force a test 

6 sooner rather than later in a retest and that 

7 would be, are you as an organization -- have you 

8 acquired business that operates in another part of 

9 the world? Are you undertaking new business 

10 lines? Is there information either from threat 

11 intelligence providers, commercial or government 

12 -- that indicates that new threat actors with new 

13 processes on now interested in you. So the 

14 certain triggers that we could see bringing a 

15 test sooner rather than later but we haven't 

16 worked out sort of frequency and shelf life yet. 

17 MR. MILLER: Thank you. 

18 MR. GRAY: Joe. 

19 MR. CITADEL: Thank you. David, were 

20 you able to comment on the level of participation 

21 that you've had in the testing? Are they the 

22 largest of firms -- buy side, sell side, 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

41 

1 exchanges, kind of parties, clearinghouses, et 

2 cetera? 

3 MR. EVANS: Yes, so it's kind of all of 

4 the above. So we haven't limited it to just 

5 investment banks, or just retail banks or just 

6 clearing houses. Fundamentally, if as an 

7 organization you -- if you're disrupted, or if 

8 you're potentially disrupted, that would impact 

9 financial stability, then you will be considered 

10 core. And that does include wholesale banking 

11 organizations, retail banking, exchanges, clearing 

12 houses, settlement systems -- the whole range of 

13 organizations that we regulate. 

14 MR. GRAY: Mahi? Did you want to ask a 

15 question? 

16 MR. DONTAMSETTI: So David, a couple of 

17 questions I guess. Holistic approach is something 

18 that you mentioned that the CBEST takes. Which is 

19 --

20 MR. GRAY: Mahi can you move a bit 

21 closer to the mikes? 

22 MR. DONTAMSETTI: Yeah. 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

42 

1 MR. GRAY: Thanks. 

2 MR. DONTAMSETTI: And holistic approach 

3 is I think what you mentioned CBEST takes which is 

4 an external view and it also takes care of -- if 

5 we're looking at technology, people and processes, 

6 which is a good positive thing and is adaptive. 

7 Right -- because you are looking at threats. Can 

8 you maybe talk about what the specific learnings 

9 for BoE were from having the test connected 

10 against your institution and also, how do we 

11 ensure that one of the things missing from this 

12 framework is an internal view, right? You're 

13 looking at it from an external perspective but 

14 sometimes you can also gain a lot of insight by 

15 looking at internal set of actors. 

16 MR. EVANS: So much in the same way as I 

17 can answer the earlier question on specific 

18 learnings, it wouldn't be appropriate for me to 

19 discuss what the Bank of England found in terms of 

20 their own learnings. What I can say is, CBEST as 

21 a process didn't change a great deal from the 

22 pilot to launch. So as a process it was 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

43 

1 effective, so you can read into that whatever you 

2 will. But what we did against the Bank of England 

3 -- there was enough to see that there's real 

4 benefit in doing this as a testing program. In 

5 the interest of keeping a job I'm going to stop 

6 that there. 

7 And then the second question was, 

8 external view versus internal. So the internal 

9 threat, or the insider threat is one that gains a 

10 great deal of media attention. Our view is that 

11 the biggest threat to the organizations is from 

12 the external actor. If you peel away some of the 

13 media hype we've yet to see concrete figures that 

14 suggest that insider attacks are in anyway the 

15 same magnitude of risk as external threat actors 

16 so we want to focus our activities on the external 

17 threats. Of course, should that change then there 

18 would be no reason why we couldn't adopt CBEST 

19 methodology to then begin to look at insider 

20 threats -- but at the minute there's just not the 

21 data to support it. Additionally there should be 

22 other control frameworks -- personnel vetting, 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

44 

1 access to data centers, lease privilege access, 

2 all of those sort of controls should already be in 

3 place. But if we find they're not in place on an 

4 external threat -- you can make some pretty quick 

5 assumptions that if you're at risk from externals 

6 you're going to be at risk from insiders as well. 

7 MR. GRAY: Okay we have a number of 

8 cards up. Why don't we start with Anat, and then 

9 Andrew; then I'll go to Glen, and then Jerry. 

10 DR. ADMATI: I have the following 

11 question -- you mentioned that partnership 

12 principle and that you wanted it to be voluntary. 

13 But this is a safety thing fundamentally and so 

14 the question is what is your expectation that it 

15 would be a reputation thing, or that eventually it 

16 would be mandatory, that you're trying because 

17 obviously we want planes to be air worthy -- we 

18 want systems to not be compromised, this is just 

19 money but if somebody can expect that the problem 

20 would be solved. What's the incentive, et cetera? 

21 MR. EVANS: Just having a bit of a 

22 technology issue -- there we go. So will this 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

45 

1 become mandatory in the future? I honestly don't 

2 know. As we've gone through the process we've 

3 found some firms have taken more persuasion to do 

4 CBEST, but normally once we target the right 

5 person in the organization -- generally I think 

6 we're probably way over 90 percent of 

7 organizations that we want to undertake this are 

8 now fully committed to undertaking CBEST. I think 

9 the voluntary nature -- the way we released it was 

10 because it was a new step for us as regulators. 

11 We hadn't really moved into testing people's 

12 capabilities -- in what can be perceived as quite 

13 an intrusive way. Whether that change is over 

14 time -- I don't know, I suppose as we engage with 

15 more organizations if we roll out something to 

16 other institutions. The frequency of tests 

17 increase, if we have differences of opinion as to 

18 when a retest is required than that all points 

19 towards, well perhaps we do need to start looking 

20 at making this mandatory. But as I sit here today 

21 we stand by voluntary was the right decision. But 

22 yeah -- it's safety and security at its heart. 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

46 

1 And so that's a big question if there's committee 

2 and then the commission further decided to explore 

3 something then that voluntary versus mandatory I 

4 would expect to be a key discussion that would be 

5 needed. 

6 MR. GRAY: Andrew. 

7 MR. LO: So I want to start by thanking 

8 Mr. Evans for sharing this incredibly interesting 

9 and valuable information. It just raises a number 

10 of questions which you may not be at liberty to 

11 answer -- but if you don't mind I'll just ask them 

12 and feel free to put it off or maybe in the second 

13 half of the session we'll get to that. 

14 First question, can you share with us a 

15 number of firms that the Bank of England has 

16 accredited and the number that was not accredited? 

17 Second, have you, as part of the penetration 

18 testing focused on social engineering, which by 

19 many industry accounts is actually a more 

20 important and easier way to penetrate a system 

21 than through systems technology? It's really 

22 human engineering and behavior. Third, it seems 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

47 

1 like software vendors have to play a big part in 

2 this because the threats often come from gaps in 

3 software. So have the software vendors agree to 

4 collaborate? And then fourth, what is the cost of 

5 testing and is that something that is going to be 

6 an issue particularly if you're going to have 

7 smaller firms having to participate. And finally, 

8 can you talk to us about the nature of the 

9 penetration and threats that you've examined? It 

10 seems like there are two classes. One is threats 

11 to disrupt market activity. And the second is 

12 threats that attempt to extract client information 

13 for purposes of fraud and theft. So I'd be 

14 curious to know what kinds of threats you focused 

15 on. Thank you. 

16 MR. EVANS: So in terms of the number of 

17 firms accredited -- I believe we have in the 

18 region of six penetration testing firms and four 

19 threat intelligence providers that have been 

20 accredited. And we have rejected applications 

21 from three to five organizations. Some of those 

22 organizations that were accredited benefitted from 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

48 

1 -- I was giving what we called grandfathered 

2 rights. So they weren't quite fully where they 

3 needed to be, but they provided us with sufficient 

4 assurances that by a specific date they would have 

5 everything in place. And in the interests of 

6 having a market for our organizations to go and 

7 receive tenders from, we felt that was an 

8 important process. But we find that that's 

9 moving. We've got information on which 

10 organizations are putting personnel through the 

11 relevant examinations which are a key part in 

12 order to receiving accreditation and the list of 

13 firms putting people through the examinations is 

14 much larger. So by the end of the year we'd 

15 expect there would be far more firms accredited. 

16 Moving onto your second question -- so you asked 

17 about social engineering. So social engineering 

18 has been used in some of the CBEST engagements to 

19 date, but social engineering will only be used if 

20 that's a technique used by the threat actors 

21 identified. So it's plausible that somebody might 

22 use something different in which case social 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

49 

1 engineering would not be part of it. But social 

2 engineering -- if that used -- (inaudible) spoke 

3 about it as one of the examples that we've seen. 

4 And people see through that testing mechanism that 

5 actually including social engineering as part of a 

6 wider test enables them to take away much more 

7 than if they just did an isolated social 

8 engineering component test. Because yes, you get 

9 a body of results -- but you can't see it in the 

10 context of -- so X number of staff were either 

11 misusing social media sites or they were 

12 spear-phished successfully or whatever it is. You 

13 just end up with a bunch of data that has no 

14 context. Taking that compromise and then using it 

15 to gain further access into the networks --that's 

16 when people start sitting up and realize that 

17 actually -- as you put it, the social engineering, 

18 the human engineering is really important. So we 

19 use wherever it's appropriate to use it. Software 

20 vendors is a really good question. So at the 

21 minute we don't have the data to support the 

22 software vendors and I use it in (inaudible) are a 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

50 

1 weak link. But we've had plenty of discussions 

2 that at some point if we start building a body of 

3 evidence through the CBEST testing program or 

4 other initiatives. But if we can evidence that 

5 50, 100, 200, 500 financial institutions in the 

6 U.K. are all suffering from software deficiencies, 

7 that's a really useful body of data to then take 

8 to those vendors. And it becomes a different 

9 conversation. We've got 500 of your largest 

10 clients are being compromised due to your software 

11 having deficiencies in it. Many we just hope the 

12 data is going to have those conversations -- but 

13 hopefully we'll reach a point where we will. 

14 So the cost of testing -- it varies 

15 depending on the organization and the duration of 

16 the test. We think it to be broadly in line with 

17 a more sophisticated penetration test. So it's 

18 not an astronomical amount of money -- so it's in 

19 line with what organizations are already spending 

20 in their penetration testing regimes. The more 

21 people we have accredited of course market forces 

22 should come into play and costs should come down. 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

51 

1 If we want to build something that's more 

2 accessible for smaller organizations then that's 

3 where we need to look at which bits can we trim 

4 down, so that the costs can come down without 

5 losing the effectiveness of the testing program. 

6 And types of threats -- you're going to 

7 have to remind me what you meant by that. 

8 MR. LO: One -- outright fact of 

9 (inaudible) information. The second is disruption 

10 market activity. 

11 MR. EVANS: Thanks for that. One notes 

12 when comprehensive enough. So predominantly we're 

13 looking for threats that can undermine financial 

14 stabilities. That naturally takes you into the 

15 destructive types of attack, either an attack that 

16 could destroy software and hardware -- or an 

17 attack that can compromise data in such a way that 

18 you no longer trust the data source. So they're 

19 the types of attack. We have looked at other 

20 parts of industry, and beginning to explore with, 

21 away from CBEST. And particularly this placed to 

22 insurance companies where personally identifiable 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

52 

1 information is really very key to them. So while 

2 CBEST from a financial stability perspective 

3 wouldn't look at personal identifiable 

4 information, there is still a very serious 

5 potential and threat that organizations holding 

6 that type of information may need something that 

7 can act in a CBEST like fashion. And we're 

8 beginning to explore what that might look like. 

9 MR. GRAY: Glen, did you want to ask a 

10 question? 

11 MR. MACKEY: Thank you. David, my 

12 question then -- you answered parts of it already. 

13 It's really two- fold. One, is CBEST exclusively 

14 oriented towards penetration testing or are there 

15 other sort of controls or control categories that 

16 are considered and if so which? And then how 

17 dynamic is that testing as we see the type of 

18 threats evolving more and more often and more 

19 frequently than six months in duration? 

20 MR. PERULLO: So CBEST is only 

21 penetration testing. In theory I suppose we could 

22 change that. We then need to look at which 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

53 

1 organizations could provide those services. But 

2 at the minute it's penetration testing. And then 

3 in terms of -- I suppose it's back to the 

4 evolution of threat really, and how do we keep up 

5 to date with the threats? It's early days. It 

6 takes us right back to the question on frequency 

7 of testing. We need a number of organizations to 

8 go through this process so that we can start to 

9 get a better handle on threat intelligence, threat 

10 information, the evolution of threats -- as we go 

11 through this first cycle and get all of the core 

12 institutions through CBEST, that should give us 

13 some indication of how can we keep on top of the 

14 threats. And maybe that's where we break the 

15 components down, and the minute we have threat 

16 intelligence and penetration testing just 

17 following each other maybe we look to break that 

18 down. It's just something we can do in the 

19 intelligence space that gives us a better 

20 indication of when the frequency of the retest 

21 needs to be. But really we just have to get 

22 through this first cycle and that will help give 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

54 

1 answers to those questions. 

2 MR. GRAY: Jerry. 

3 MR. PERULLO: Thanks, I'm Jerry Perullo, 

4 I'm the Chief Information Security Officer for 

5 Intercontinental Exchange. So in addition to 

6 several registrants under CFTC, my team is also 

7 responsible for information security over several 

8 U.K. subsidiaries. At least two of which have 

9 been deemed core. And so we certainly have a 

10 close relationship with the CBEST team, and are in 

11 discussions about the CBEST program. And we took 

12 off what we would call an arguably -- a CBEST 

13 light at the end of last year. Where we decided 

14 it's a great program and I still hold to that. 

15 And the methodology for a penetration test is 

16 really stellar. And the idea of incorporating 

17 threat intelligence and really gearing attacks 

18 that are modeled after those that have taken place 

19 in sectors really valuable. 

20 We had some questions and I'll present 

21 some of the challenges with having a regulator at 

22 the table for that. And I'll throw them out 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

55 

1 there, if nothing else there's a bit of devil's 

2 advocate, not that it's an indictment of the 

3 program. But what our experience was -- so we 

4 went through this. We contracted with a private 

5 company that was at the time one of the accredited 

6 providers. And we used the folks there that had 

7 been working on CBEST projects to conduct a 

8 penetration test. And it did take the full six 

9 months and it was very valuable and we received a 

10 lot of findings out of that have really directed 

11 our controls and changes in our program. And I 

12 encourage every organization that's serious about 

13 cyber security to do that. And that didn't 

14 require direct regulatory environment -- although 

15 we do appreciate that they codified a testing 

16 methodology and we certainly benefitted from that. 

17 So some of the challenges that we identified, and 

18 the reasons why went the route that we did and 

19 challenges are still ongoing today with the bank 

20 and will be with any other regulator, include the 

21 scoping, so with vulnerability assessment you 

22 scope the targets -- you say what entities do we 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

56 

1 want to learn about or ask questions about. With 

2 penetration testing on the other hand, you really 

3 just scope the sources. What are the types of 

4 threat actors we want to model our actions after? 

5 But the destinations you cannot scope very well at 

6 all, because as Dave mentioned, if someone were to 

7 try to target any of your organizations, they're 

8 going to go through any means necessary. And that 

9 means they're going to come in perhaps on a 

10 beachfront that's under a different regulatory 

11 jurisdiction. And we as a company can empower and 

12 contractually allow a private sector company to 

13 break into say, a Singapore subsidiary or a Dutch 

14 subsidiary. But when I invite in a regulator as 

15 well, a government entity in a specific 

16 jurisdiction, that presents some challenges. 

17 Another general issue is that, we've 

18 mentioned the holistic nature of the program. But 

19 on balance, penetration testing is not holistic. 

20 It's akin to trying to seeing what doors are 

21 unlocked in your house or what windows might be 

22 able to get jimmied open or can be broken. What 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

57 

1 you end up with as a result is not a holistic 

2 picture of the entire information security 

3 program, but rather specific issues. And so 

4 talking to the shelf life of it -- it's really an 

5 invalid concept, because it's not a blessing of 

6 the entire program. It's seriously three things 

7 that you need to fix. And then you do it again, 

8 and you'll find three different things. And you 

9 will every time. And that's a good thing but it's 

10 not meant to be a complete assessment of the 

11 security program. Then there's also some 

12 commercial challenges with this, when you have a 

13 government entity. You've heard about blessing 

14 specific private sector firms to perform this 

15 testing. I have some concerns about where that's 

16 going to head down the road. If some of the firms 

17 that are not blessed, they may have some very 

18 legitimate claims about a government endorsement 

19 of their services. And if not the actual testing 

20 providers, then what about the accreditation 

21 service itself. Why is that one better than 

22 another -- we haven't had issues of that yet and 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

58 

1 the firms that we have been working with are 

2 certainly of quality but I could project that, 

3 that could be a potential issue. 

4 And then lastly I'll note -- and I think 

5 this is a concern that's close to home for all of 

6 the regulators. Going through this exercise, we 

7 create a very high risk asset. We will create a 

8 scoping document that lists all of the critical 

9 functions of any given critical infrastructure 

10 entity. How to get in, what the capture the flag 

11 moment is. That's part of the CBEST parlance. 

12 And exactly what we would consider success for the 

13 bad guys. And does the CFTC want to be 

14 impregnated with that document. We certainly 

15 don't want any of our vendors to have any more 

16 information than necessary. We hate bringing 

17 regulators into that. And that doesn't 

18 necessarily even exist at this point, and when it 

19 does I'd really like to keep it under lock and 

20 key. 

21 MR. GRAY: Thanks Jerry. Any reactions 

22 to that, Dick? Before I turn to Jeremy? 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

59 

1 MR. EVANS: So thanks Jerry. I 

2 preferred the first half of what you said to the 

3 second, (laughter) but that's fine. And the 

4 challenges are all, as Jerry has laid them out --

5 they are all very valid challenges. I won't 

6 address all of the points that Jerry has made, but 

7 in terms of accreditation for commercial 

8 companies. I think Jerry's point is very valid. 

9 We went with CREST, we discussed with a few of the 

10 accreditation bodies with the U.K. as to what they 

11 could provide. We're still having discussions 

12 with other accreditation bodies. So at the minute 

13 we went with CREST, they're a means to an end. We 

14 needed somebody to do the accreditation for us. 

15 If somebody else comes along and they provide a 

16 better service then we will go for them. We're 

17 all about making sure that -- or wanting to ensure 

18 that CBEST really is best of breed in terms of 

19 testing. So we won't be married to CREST if they 

20 no longer provide the service. We try and be as 

21 impartial as we can when it comes to accrediting 

22 individual organizations. As Jerry mentioned, I 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

60 

1 don't think there's any issues yet, but you can 

2 see in a world where you don't accredit somebody 

3 for whatever reason and that has a knock on effect 

4 for other parts of business they do. But maybe 

5 that's not our concern, provided we can put our 

6 hands up and say -- we have acted with full 

7 impartiality and organization X just didn't quite 

8 make the grade. Well then we need to stand by the 

9 process. But it's certainly a challenge. 

10 And then really almost echoing what 

11 Jerry does is what Jerry said. CBEST is not 

12 holistic as in giving you a full assessment of all 

13 of your security capabilities. It's a methodology 

14 that looks at the holistic nature of an attack 

15 profile. People refer to something called the 

16 kill chain, which was coined by Lockheed Martin I 

17 think several years ago. And that is all the 

18 processes that a threat actor would undergo to 

19 carry out an attack on a system. The holistic 

20 part means just that. We're looking at the whole 

21 of an attack from start through to finish. Not 

22 holistic as in the whole of your defensive posture 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

61 

1 or the whole of your network. And then just to 

2 finish on a final point on that holistic nature, 

3 is we fully accept that many global organizations 

4 operate in areas around the world that could be 

5 used as a back door. It's the weak entry point 

6 and they won't be included in a CBEST test. That 

7 is an anomaly of the testing process. We can only 

8 engage with the subsidiaries of who we discuss 

9 with their regulators. And at the minute we just 

10 don't do that with everyone. Trying to do a 

11 global CBEST, I don't even know where you'd start. 

12 We're doing okay with U.K. U.S. relationships with 

13 some organizations. Expanding that globally, I 

14 don't know where we'd start and maybe that's a 

15 long term goal that we need to look at how to do 

16 that, but not one for the short term. 

17 MR. MUSSAD: Thanks Andrew. The United 

18 States has certain mechanisms for sharing threat 

19 intelligence among industry participants. We've 

20 got the FSISAC I guess. We've also got a financial 

21 sector body. That sharing isn't tied to a 

22 specific testing regime, but I wonder if I could 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

62 

1 ask you David, as well as maybe David Taylor and 

2 Bob to comment on, or just contrast the sharing 

3 that goes on in those bodies versus what you're 

4 doing through CBEST. Does that make sense? 

5 MR. EVANS: Yes, so we have similar 

6 sharing mechanisms. I think that's slightly more 

7 advanced in the U.S. than they are over in the 

8 U.K. but we have similar intelligence sharing 

9 mechanisms. And that's really peer to peer 

10 sharing of information that they've received that 

11 might be of use to somebody they've allowed to 

12 share it with or it goes into somewhere like 

13 FSISAC, is potentially anonymized and sent out to 

14 many people. And that's really invaluable and 

15 CBEST is not in any way trying to either undermine 

16 or replace or anything. This is all about looking 

17 at what information is out there in the wild, 

18 which threat actors are discussing you as an 

19 organization. What are their stated goals, their 

20 stated aims? How do they actually go about 

21 compromising entities and what would that look 

22 like if it was done against you? You could see in 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

63 

1 a world where -- I'd love for organizations to 

2 receive the threat intelligence product as part of 

3 CBEST and then decide that they're going to share 

4 some of that information through those sharing 

5 mechanisms. So I can only see that it could add 

6 to it rather than either undermine or detract from 

7 it. 

8 MR. MUSSAD: Maybe just to clarify David 

9 -- is more going to the quality of the threat 

10 intelligence that someone who is going through the 

11 CBEST gets by virtue of CBEST versus maybe the 

12 quality of the intelligence that you get through 

13 FSISAC -- if we can make a judgment about that. I 

14 don't know. 

15 MR. WASSERMAN: So on that point, I 

16 think I have a limited understanding of what's 

17 done on CBEST. I think on the one hand the CBEST 

18 is probably a bit more tailored to the individual 

19 organization getting the information -- whereas 

20 the FSISAC is a much more of a broad distribution. 

21 That said, one thing I should observe having been 

22 doing this now for, gosh, since 2001 -- the 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

64 

1 efforts that the US intelligence community have 

2 made to be able to get information -- actionable 

3 information in a form that it can actually be 

4 shared with the private sector, as opposed to 

5 merely shared among those with security 

6 clearances. 

7 So the ability to process then get it 

8 out has really in the past year or so grown by 

9 leaps and bounds. And so the efforts that have 

10 been made in that regard have been truly 

11 extraordinary and I think very successful as well. 

12 MR. WASSERMAN: I would add to that -- I 

13 think the two types of intelligence involvement 

14 would be mutually beneficial. It may be easier, 

15 Bob is quite right that getting actionable 

16 intelligence has vastly improved in just the last 

17 year. It might be still easier aimed at a single 

18 institution and the threats to that institution 

19 then trying to anonymize it enough to go more 

20 broad and another benefit of doing something like 

21 this in my view would be increasing the 

22 intelligence community's understanding of the 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

65 

1 financial sector and how it operates and the 

2 threats to it and increasing cooperation in that 

3 regard. 

4 MR. EVANS: Thank you David. Bob did 

5 you have another question as well? 

6 CHAIRMAN MASSAD: Yeah, I wanted to 

7 react I guess to two of Jerry's points very 

8 quickly. And the first is in terms of regulatory 

9 scope. And obviously, just because you have a 

10 number of affiliated entities does not mean that a 

11 regulator of one entity has jurisdiction over 

12 other affiliated entities. 

13 On the other hand, regulated entities 

14 frequently engage in outsourcing and have some 

15 very critical functions that are undertaken not 

16 within the regulated entity by -- by an 

17 outsourcing firm. Sometimes that outsourcing firm 

18 is external. Other times it may be an affiliate. 

19 And certainly the regulators' interest in how well 

20 the outsourced functions are being performed does 

21 not change because they're being outsourced, and 

22 does not change because they're being outsourced 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

66 

1 to an internal versus an external firm. 

2 And so I think there is in fact 

3 regulatory scope for understanding if penetration 

4 could be taking place through outsourced 

5 functions. And with respect to the critical 

6 functions document, that is quite important. 

7 Obviously the more -- the better it is, the more 

8 sensitive it is. That said I think it's fair to 

9 say that my colleagues who engage in examinations 

10 and other colleagues are very well aware of this. 

11 And we are here at the CFTC very well aware of the 

12 importance of security and keeping these kinds of 

13 critical information secure. Thank you. 

14 MR. EVANS: Thanks, Bob. So I'm just 

15 looking at the time and I think we're just over 

16 the time that we had allotted so. I know we had 

17 two more questions. Perhaps, Joe, Mahi, we can 

18 follow up separately, afterwards with those 

19 questions, unless you felt there was a burning 

20 desire to share something with the group? No? 

21 Okay, all right, great. So with that, I'd like to 

22 thank everyone for their participation, I'd like 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

67 

1 to thank Dave again for being here and presenting 

2 the CBEST framework. Joe this was very very 

3 helpful, a very critical topic for the industry. 

4 And I'm sure it will generate additional dialogue 

5 beyond this meeting. Commissioner, I don't know 

6 if you had anything else you wanted to say? 

7 COMMISSIONER: No. 

8 MS. WALKER: At this time, in keeping 

9 with the meeting agenda, we'll take about a ten 

10 minute break and resume at 11:25 for our second 

11 panel. 

12 (Recess) 

13 MS. WALKER: I would like to call the 

14 MRAC meeting back to order. As noted in the 

15 agenda, our second panel is on liquidity in the 

16 derivatives markets. We are privileged to have 

17 Susan McLaughlin moderating our next panel, who is 

18 Senior Vice President at Federal Reserve Bank of 

19 New York. With decades of experience in these 

20 markets, Susan has had a variety of analytical, 

21 operational, and managerial roles in the markets 

22 group, spanning the Foreign Exchange Portfolio 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

68 

1 Management and Open Market Desks, as well Central 

2 Bank Services. Susan has also led the Federal 

3 Reserve's Efforts on tri-party repo market reform. 

4 Thank you Susan. 

5 MS. MCLAUGHLIN: Thank you, Petal, can 

6 you hear me okay? All right so, today's 

7 discussion on market liquidity is going to focus 

8 on understanding the state of liquidity in the 

9 derivatives markets that are overseen by the 

10 commission. Our specific focus is on commodity 

11 derivatives -- on agricultural products, metals 

12 and energy, as well as fixed- income products, and 

13 credit default swaps. However, to the extent that 

14 the developments in other markets beyond those 

15 bear on liquidity in these markets, we want to 

16 wrap those into the discussion as well. 

17 We have three very distinguished guest 

18 panelists with us today, who bring considerable 

19 insight into this discussion. The way we will 

20 format this is, they're going to take the lead on 

21 each of the discussion questions, and then we'll 

22 open it up to the broader committee. So, first we 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

69 

1 have Isaac Chang, who is Global Head of Fixed 

2 Income at KCG Holdings, which is a large 

3 independent market-maker and provider of execution 

4 services to clients across equity, fixed-income, 

5 foreign-exchange, and commodities markets. Isaac 

6 is responsible for both the on-exchange and the 

7 client facing, fixed-income market-making business 

8 at KCG (sic). Prior to joining KCG, he held a 

9 number of senior roles in both Treasury and 

10 Derivatives trading in the interstate products 

11 group at Goldman Sachs. Welcome Isaac. 

12 Next we have Piers Murray, Managing 

13 Director and the global head of OTC clearing in 

14 prime brokerage at Deutsche Bank Securities. 

15 Prior to joining Deutsche Bank Securities, Piers 

16 headed OTC clearing in prime brokerage at J.P. 

17 Morgan. Piers has extensive experience across 

18 prime services, FX options trading, credit risk 

19 management, and credit portfolio management 

20 including unwinding derivatives portfolios in 

21 times of market and credit stress. Welcome Piers. 

22 And Finally we have Tom Wipf, a managing 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

70 

1 director and the global head of bank resource 

2 management at Morgan Stanley. Tom is responsible 

3 for the firms secured funding, securities lending, 

4 collateral management, and counter-party risk 

5 management businesses. Tom also serves on the 

6 firms risk committee, as well as the operating 

7 committees for the institutional securities group, 

8 and the finance division. Welcome Tom. 

9 So thank you, all the panelists for 

10 being here today, and let's get started. As a 

11 first question, I thought maybe we could start 

12 with Piers and then Isaac, and then open it up to 

13 the committee. Could we just talk a little bit 

14 about what we mean by market liquidity? 

15 MR. MURRAY: Certainly, first of all I'd 

16 like to thank the commission for inviting me to 

17 the panel and giving me the opportunity to present 

18 our views on this. I'm sure it will be an 

19 engaging dialogue. And as we discussed earlier 

20 I'm sure that the definition of liquidity could 

21 take many hours to finalize, but we don't have 

22 that much time so I'll try and be quick. One view 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

71 

1 of the standard definition of liquidity is to say 

2 it's the ability to transact an asset without 

3 affecting its price in a public marketplace. 

4 Another way of saying that, it's an asset with a 

5 high turnover, or a market that exhibits liquidity 

6 is a market that has high turnover of an asset 

7 within a narrow price band with a little bit offer 

8 spread. Another definition is the ability to 

9 trade blocks at discreet blocks without moving the 

10 market. 

11 Liquidity though, is in the eye of the 

12 beholder. I would say that someone who is 

13 transacting blocks is going to have a different 

14 perspective on liquidity than somebody who's 

15 trading single size transactions. And if you look 

16 at different types of markets, the FX and equity 

17 markets for example where liquidity is materially 

18 different from interest rate markets, partially 

19 because of the duration of the assets, but also 

20 because electronic markets have enabled additional 

21 pools of capital to access the market at 

22 relatively low cost. 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

72 

1 So you have different definitions of 

2 liquidity I think by the different types of 

3 market. I think it's probably important therefore 

4 to try and define the characteristics of a liquid 

5 market. Number one I'd say is low friction costs. 

6 And friction costs you can bundle up into a number 

7 of things. Another one is the availability of 

8 risk intermediaries to smooth timing differences 

9 between buyers and sellers. A third would be low 

10 barriers to entry. A fourth would be dispersion 

11 of positioning views in the market place. Another 

12 one which is partly topical and we'll discuss I 

13 think excessively at this meeting is the idea of a 

14 single market place for a certain type of asset. 

15 And the final one is a market that has few pricing 

16 constraints that have distorted the impacts. And 

17 I would describe those as, among those as the 

18 following -- a limit up or down, a type of feature 

19 in a market place, intervention, and of course I 

20 think again, topical is a zero-interest rate 

21 boundary. I think those are potential assets that 

22 has distorted, or potential features that have 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

73 

1 distorted impacts on liquid markets. 

2 MS. WALKER: Thank you Piers, Isaac 

3 would you care to make some comments? 

4 MR. CHANG: Sure, and I don't want to 

5 repeat what Piers went through. I think he 

6 certainly presented a very good conceptual 

7 framework for thinking about liquidity. Maybe let 

8 me address sort of the idea what metrics can exist 

9 to measure or monitor market liquidity. At the 

10 end of the day, the question I actually I would 

11 pose to the group is how can you make a statement 

12 about liquidity unless you can measure it in some 

13 form? 

14 And so, I think one of the points which 

15 is maybe obvious to market participants but is 

16 worth bearing is, those metrics then change based 

17 on the market structure, maybe broadly speaking of 

18 any particular asset class. And I also think it's 

19 worth noting particularly in the fixed income 

20 space, but this is true in other -- certainly the 

21 linkage between underlying and futures market --

22 list of futures markets and cleared swaps markets 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

74 

1 broadly. You can't look at -- I think it's 

2 misleading to look at liquidity of these products 

3 in isolation. And so, you know -- and the example 

4 I'm going to go through is -- maybe is a compare 

5 and contrast, let's look at the treasuries future 

6 market and then let's look at the OGC cash 

7 treasury market. 

8 So, in the listed treasury futures 

9 markets, market participants can observe and 

10 measure a variety of instantaneous quantities. 

11 You can measure the size available at the best bid 

12 and ask, the bid-ask with between those prices, 

13 the instantaneous price charged by the market for 

14 a given size, so if you wanted to trade size S, 

15 how far through the book would you need to go to 

16 transact that size? You can measure the volume 

17 traded over any given particular period of time. 

18 So, you can -- or at a particular price point. So 

19 for a given period of time, over these five 

20 minutes, how many can your contracts trade it? 

21 You can measure that and you can measure 

22 that on an ongoing instantaneous and historical 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

75 

1 basis. You can also measure at this price level, 

2 you know between -- between 20 and 22 on ten year 

3 contracts, how many traded? So, that gives you a 

4 sense for the quantity of risk that's being 

5 transferred between buyers and sellers. 

6 So, in contrast, and maybe this points 

7 to the challenges of actually I would say, not 

8 just defining but more accurately measuring 

9 liquidity. Let's examine the cash on the run U.S. 

10 treasury market. Which is, at least by popular 

11 media counts, and frankly I think market 

12 consensus, one of the most liquid markets out 

13 there, again, for some definition of liquidity. 

14 But let's think about the different ways that you 

15 can transact in the U.S. treasury market and how 

16 would you then gauge liquidity, depends on how you 

17 transact and what information you have access to. 

18 So, some market participants have access 

19 to platforms in the inter dealer space, like 

20 Broker Tech or eSpeed. These platforms provide 

21 participants market data in trade executions for 

22 on-the-run treasury trading similar to say what 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

76 

1 the CME provides for treasury futures, and similar 

2 metrics can be computed. Other participants have 

3 access to platforms and there are representatives 

4 from those firms here today like Trade Web and 

5 Bloomberg either as providers or takers. These 

6 platforms provide indicative prices prior to 

7 initiating a specific trade and the execution 

8 protocol is a one sided request for quote. So as 

9 a result, I'd argue, market participants that are 

10 limited to transacting on these platforms, 

11 liquidity is -- the way to measure liquidity has 

12 to be different. You just don't have the same 

13 information available. I'd actually argue it 

14 makes it more difficult. On one hand yes, you can 

15 transfer, you potentially can transfer a specific 

16 quantity of risk at a single price at a single 

17 chosen time, which is a convenience that has some 

18 value. But on the other hand, when computing, for 

19 example how far from the prevailing market price a 

20 trade occurred, one can only approximate that 

21 market price with the given platform's indications 

22 of interest, which are not actionable prices. 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

77 

1 Or, based on the responses from their 

2 RFQ, which are actionable prices, except that they 

3 have an embedded last look option for the 

4 liquidity provider. So, and those quotes, which 

5 are limited generally under five or under market 

6 participants, may or may not be representative of 

7 the marketplace as a whole. Then you throw in the 

8 added complexity that others may choose to deal 

9 via voice in which case they may rely on some 

10 market data feed or indicative price feed as a 

11 gauge for what the market price is, but not 

12 necessarily have the ability to trade on those 

13 platforms, and then -- and execute a trade in that 

14 manner. I think it also should be noted that 

15 those trades aren't disclosed to the broader 

16 marketplace as a whole, they're bilateral 

17 transactions. And then when you take a step back 

18 and then say ok, let's monitor the liquidity 

19 market in the treasury market -- cash U.S. 

20 treasury market as a whole, I'd say given all of 

21 this, it's at best complicated, I'd even argue 

22 potentially impossible to do given the limit --
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

78 

1 the lack of publicly availably pricing and 

2 transaction data. 

3 And so, while on one hand there's the 

4 treasury futures market which has a certain market 

5 structure for which there's a lot of information, 

6 on the other hand that's broadly -- strongly 

7 affected and influenced by the cash treasury 

8 market in which there's a completely different 

9 information structure. I would actually throw up 

10 my hands and say from a regulatory perspective, 

11 you're extremely challenged in being able to think 

12 about how to even measure or monitor liquidity in 

13 these marketplaces as a whole. And this is a 

14 theme I think that's going to pervade all of the 

15 questions that we'd ask. But this is you know --

16 I've said enough for now we should go on. 

17 MS. WALKER: Thank you, I'd personally 

18 agree with that last statement you made. Before 

19 we move on to the next question, is there anyone 

20 on the committee that would like to add these 

21 remarks? Okay seeing none, the next question I 

22 wanted to pose is just about the current state of 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

79 

1 liquidity in the markets that the commission 

2 specifically oversees and I wonder if we could 

3 begin with remarks by Tom and then we'll go down 

4 the panel. 

5 MR. WIPF: All right there we go, you 

6 know, I do, Susan, as well I think I would like to 

7 add in terms of the -- also in just the construct 

8 of liquidity, is I think it's very important to 

9 note that there's also from a plumbing perspective 

10 when we think about the infrastructure also on 

11 clearance and settlement as well and the financing 

12 markets and so I think as we proceed in this 

13 discussion I think we're going to see some pretty 

14 meaningful lines drawn between the effectiveness 

15 of clearance, settlement, central clearing, and 

16 the financing markets in these collateral markets 

17 as they feed upward through the assets into the 

18 cash and derivatives markets. 

19 So one thing we would note as an element 

20 of liquidity, it's very relevant to bring this up. 

21 I think we could draw on the example of the agency 

22 mortgage back market several years where there was 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

80 

1 certainly a perception of liquidity if you just 

2 looked at price. But with the amount of 

3 settlement fails that we were seeing, it clearly 

4 was just an exchange of price for systemic credit 

5 risk or counter party exposures. And I think when 

6 we look at this in today's discussion we can take 

7 that example as really where below the surface are 

8 the things that potentially could be driving some 

9 of the things that we're seeing upstream. So for 

10 example mostly, what we're seeing in the financing 

11 markets or the SFT markets and repo and securities 

12 lending, as the market begins to transition 

13 through the aggregate of regulation around some of 

14 these products and begins to optimize around these 

15 products on their balance sheet, what really will 

16 be the outcome and what does that mean to the 

17 assets that are being financed. So, when we look 

18 at what the -- what we're seeing in terms of that, 

19 there's a general reduction, and I think heading 

20 into some of these events we would have thought 

21 that perhaps there might have been price 

22 adjustments. But I think it's been a real 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

81 

1 trade-off between price and access and I think 

2 what's happening quickly as intermediaries are 

3 adapting to this, they're seeing a general rush to 

4 meet these optimization hurdles and in so we're 

5 probably going to capacity first before prices are 

6 being adjusted. So that's what we would call up. 

7 But definitely when we think about liquidity as a 

8 measure, clearance, settlement, financing and 

9 central clearing are very very relevant points. 

10 MS. WALKER: Thank you. Piers, any 

11 comments on this? 

12 MR. MURRAY: Turning mine off seems to 

13 have had a permanent effect. (laughter) So, in 

14 terms of the current state of liquidity, Tom's 

15 points are very relevant. I think there are some 

16 examples that we have seen in the marketplace 

17 recently where, for example in the aftermath of 

18 the Swiss devaluation we saw a number of clients 

19 reduce their risk taking appetite across multiple 

20 assets rather than just in the FX space. And 

21 there was certainly model recalibration at that 

22 point. I do think it's important, as I mentioned 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

82 

1 earlier, to emphasize that we've seen what I'd 

2 call a seminal shift in market views on the single 

3 pricing of the interest rate markets with the 

4 broadening of the spread between CME's prices and 

5 interest rate swaps and LCH's prices and interest 

6 rate swaps. And we need to really think about why 

7 that has happened. Pricing is a function of --

8 MS. WALKER: Piers I'm sorry, if you 

9 could bring the mike a little closer --

10 MR. MURRAY: A little closer? 

11 MS. WALKER: I think some of us are 

12 having trouble hearing, thank you. 

13 MR. MURRAY: Pricing is a function of 

14 positions. It's also theoretically a function of 

15 margin costs including the availability of cross 

16 margining and it's a function of clearing costs. 

17 And so we see that -- we see all of those having 

18 an impact in the current differential of pricing 

19 at LCH and CME. So I think it is as-we're all 

20 learning, I think all the market makers present 

21 are learning about the cost of dislocations like 

22 the one that we've seen rise in the past couple 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

83 

1 weeks. And I think another element is really to 

2 focus on the macroeconomic differences versus the 

3 micro -- what I'd call the micro differences. So 

4 we have in the macro sense an improvement in 

5 credit market quality, which has driven spreads to 

6 lows. We have a zero interest rate which has 

7 driven the absolute market cost of financing to 

8 lows and we have supply. Those are all macro 

9 circumstances that are unique or certainly 

10 relatively unique to the current state of markets. 

11 From a micro perspective I'd say the 

12 interest and CDS markets are still in evolution. 

13 Traders are still learning how to cope with these 

14 differential prices and that means that there will 

15 be temporary dislocations as people try to figure 

16 out the actual funding cost and whether there is 

17 an exit strategy for an existing position at a 

18 clearing house, or whether they can add new risk 

19 in a somewhat insulated fashion. 

20 I would say, a final point is that the 

21 capital methodology which Thomas alluded to, 

22 doesn't materially differentiate at this point 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

84 

1 between bilateral and cleared activity. So the 

2 cost of clearing has increased materially against 

3 the baseline forecast that we had in the industry 

4 in 2009 and 2010. So clearing access is becoming 

5 more expensive and balance sheets as Tom mentioned 

6 are being rationed prior to the price behavior 

7 actually functioning. So I think the important 

8 thing to start trying to discuss in the context of 

9 this meeting is not just the current state of 

10 liquidity but knowing that these constraints 

11 exist. What's a future state of liquidity and 

12 what is the state of liquidity in a potential 

13 stress event, both a macro stress event from 

14 interest rates moving as well as micro stress 

15 events from clearing members and others exiting 

16 the marketplace. 

17 MR. CHANG: So I'd like to give a 

18 perspective from a market maker to answer this 

19 question. So as Susan mentioned, KCG is a market 

20 maker in not just fixed income products but many 

21 products, which my (inaudible), but many products 

22 across the asset class spectrum and if broadly you 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

85 

1 think about what is the market making business and 

2 what effects a market making business. I think 

3 we've hit on a number of the points, but I think 

4 it becomes fairly obvious from changes in the 

5 market place what has to happen to liquidity or as 

6 -- to the extent we can actually define it. I 

7 guess which was the first question. 

8 So as a market maker, as volatility goes 

9 up, as a market maker we bear risk. We're not 

10 long-term positional players. We're not betting 

11 that the 30 years price is going to go up or down 

12 over months, but we stand ready to buy and sell 

13 and provide instantaneous liquidity, and we take 

14 the risk of holding that transaction until the 

15 opposite side appears in the marketplace. So, 

16 what are the factors then that affect the return 

17 that we need to generate for our shareholders or 

18 for those who give us capital, as market 

19 volatility has picked up, which over the last six 

20 months it certainly has after I would argue a 

21 pretty prolonged period of very low volatility. 

22 It's natural to see that a lot of these liquidity 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

86 

1 metrics should change. You shouldn't, in a more 

2 volatile period, you should not expect to see the 

3 same size atop a book or the same effective bid 

4 ask with. 

5 I would also say that as capital costs 

6 have gone up, and certainly, look from the 

7 perspective of banks, I understand the regulatory 

8 changes that have been going on. Consider KCG as 

9 an independent market maker. A, we're not 

10 investment grade rated and B, we depend on banks 

11 for financing, so assuming banks are rational in 

12 the way they allocate capital to their customers, 

13 there is no way our cost of funding is going to be 

14 anything but a lot more expensive than any of the 

15 banks represented at the table. 

16 So, so then, so, certainly as the cost 

17 of capital goes up, again, liquidity as measured 

18 either by -- has to go up, because, the returns 

19 that a market maker has to generate, are constant, 

20 but the conditions have changed. Right? 

21 Fundamental liquidity is a dynamic property. It's 

22 not something that is a static number I think that 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

87 

1 we can expect to say the same over time. Anyone 

2 who has lived in the marketplace for some amount 

3 of time I think realizes that. But, and so maybe 

4 that's belaboring an obvious point. But I just 

5 wanted to make sure to mention that. It's not, 

6 liquidity when the Fed is in play, potentially in 

7 the next meeting or two, versus when the Fed was 

8 on hold for seemingly forever could not and should 

9 not be expected to be the same. That's a healthy 

10 marketplace in my view. 

11 The last thing I'd like to kind of maybe 

12 address is just the CMELCH point that Piers 

13 brought up, because it has gotten a lot of 

14 attention in the marketplace. And as someone who 

15 started his career on the trading desk as an 

16 interest rate swap trader over 15 years ago. I 

17 find it funny actually that the CMELCH basis 

18 differential is getting so much attention now. I 

19 would only go back pre-crisis when it was that 

20 swap trading desk we're discovering that the 

21 collateralization that you had against each 

22 counter party actually determined the economic 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

88 

1 price of that swap. So rather than having two 

2 clearing houses where there were two, at least 

3 only two capital and collateral, funding 

4 differentials that you had to account for, every 

5 single bilateral collateralized trade was a 

6 bespoke instrument. 

7 This was a huge shock to many people in 

8 the interest rate swap market who thought that 

9 swaps were fungible. Turns out, if you have a 

10 different collateral agreement between counter 

11 party A and counter party B, even if it's a ten 

12 year swap with the same maturity, and the same 

13 coupon, for you as a bank, they're different 

14 instruments and they have different values and 

15 when someone comes in to unwind that trade, you're 

16 going to give a different price. 

17 So I'd actually argue the CMELCH 

18 differential, even though it does illustrate that 

19 the market needs to recognize and introduce, 

20 frankly is an improvement over the situation that 

21 existed pre central clearing, before the crisis. 

22 When actually, for people who really understood 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

89 

1 what was going on in the interest rate swap 

2 market, every trade with every counter party was a 

3 bespoke instrument. And so I think we've actually 

4 moved a long way and moved the market in a very 

5 positive way forward since then. 

6 MR. WIPF: Isaac, we certainly agree 

7 with that, we think that this has actually brought 

8 to the table an issue that has always been there 

9 but has manifested itself in a meaningful enough 

10 size now to get market participants to actually 

11 look at the cost of collateral, make those 

12 determinations at the point of execution and I 

13 think what we have seen is this has actually 

14 certainly created a general sense of good hygiene 

15 around these practices that didn't exist across 

16 many many bilateral counterparties, so the fact 

17 that these imbalances are there and there's a cost 

18 factor depending on where you determine to clear, 

19 or where your clients determine to clear, we think 

20 is actually-we agree with you, it's actually 

21 something good to bring that to the surface. The 

22 impact of that potentially will find its way into 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

90 

1 pricing, and that's probably quite appropriate as 

2 you mentioned. So I think the idea that that, 

3 because of the general nature and the size and 

4 scope of that collateral mismatch has brought real 

5 focus to an issue. It's not a new issue-it's a 

6 bigger problem, it's more centralized, but 

7 certainly it will find its way into the pricing 

8 models as we move forward. 

9 MS. WALKER: Thank you, that's really 

10 interesting and I think maybe we can open it up to 

11 the committee now, and I guess you know this kind 

12 of brings us to the issue of explainable versus 

13 less explainable sources of liquidity and I think 

14 one challenge we have as regulators is to 

15 understand the difference and to kind of know what 

16 we're seeing when we see it. So I'd be really 

17 interested in any comments or thoughts that others 

18 would like to bring, as well as the panelists. I 

19 think we have Rana. 

20 MS. YARED: Thank you Susan. I think 

21 maybe to our starting with the comment that 

22 liquidity in all the markets is not the same, so 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

91 

1 you know in the credit market for example we've 

2 noted that in the five year on the run index 

3 point, liquidity has actually improved in the last 

4 year, largely because of the structure of that 

5 particular market, which is a market where the 

6 congregation has happened around a particular 

7 point, because the occurrence of structural 

8 hedging, which we see in say the FX or rates 

9 market have substantially lessened so the need for 

10 a particular tenure or structure is less, thereby 

11 facilitating with a more order book, ready 

12 product. On the flip side of that we have the 

13 interest rate markets where we have really a true 

14 potential for a liquidity crunch based on a couple 

15 of factors. The first is that we're seeing that 

16 liquidity is really conditional, particularly in 

17 times of high volatility, but even just in more 

18 low or normal volatility moments. 

19 We are finding that for people who are 

20 trying to execute thematic trades, that getting 

21 size done is actually very challenging. So by way 

22 of a quantitative example, if a client or another 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

92 

1 dealer is trying to do 25k of DVL1 at any point, 

2 what we're finding is that it's between 0.2 and 

3 0.3 basis points across the spread and that that 

4 client will have the luxury of having let's say 10 

5 dealers in competition willing to show them a 

6 price. That could be in competition in order book. 

7 That could be in competition in RFQ. 

8 Let's just take that one step further, 

9 client wants to do 250k of DVL1, which you know, 

10 Isaac, Piers, Tom, professional traders in this 

11 room will tell you is not that big of a size, all 

12 of the sudden our clients are relaying back to us 

13 that getting that kind of size done is actually 

14 pretty challenging. So that makes us think, 

15 what's the cause here? And certainly from a 

16 Goldman point of view, the cause has to be the 

17 capital rules, SLR, and NFSR -- alphabet soup, 

18 which are causing substantial challenges on both 

19 the executing broker side and the clearing broker 

20 side. So of course both sides of the house are 

21 going through the logic -- where is the most 

22 economically efficient place to deploy my capital? 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

93 

1 And from our point of view one of the most 

2 inconsistent places where that decision making is 

3 taking place on the clearing side, and it's 

4 inconsistent because the treatment of the clearing 

5 -- cleared trades under all these capital and 

6 liquidity regimes are actually in contravention to 

7 the G20 desire to clear as much as possible. 

8 So you have very punitive treatment for 

9 clear trades against a desire to clear as much as 

10 possible which is leading to liquidity crunch not 

11 only in the executing broker side, but also a 

12 liquidity crunch because people who are not direct 

13 members of clearing houses are having to rely on 

14 clearing brokers to make those same kind of 

15 economic decisions. So that kind of underpins 

16 what we think is the greatest cause of the 

17 liquidity challenges in the market, and moving 

18 away from the CFTC products, it's certainly the 

19 repo and the funding markets that are having you 

20 know the greatest challenges at this particular 

21 moment as I'm sure Tom would elaborate in greater 

22 detail, given his expertise in those particular 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

94 

1 markets. 

2 And so against that backdrop, we're 

3 seeing a couple things happening. One the market 

4 is trying to aggressively lower the notional that 

5 we have outstanding through you know various 

6 mechanisms like those offered by tri-optima and 

7 their nascent competitor locked markets that are 

8 looking to do with multilateral risk reductions. 

9 I'm sure there will be others that come out that 

10 want to peddle those particular wares. On the 

11 broad sense, unless there's a change to the way 

12 that the capital treatment is done from any of 

13 these trades, we're going to find that it's fairly 

14 challenging and our greatest fear that two things 

15 happen -- one, that significant hedging that 

16 should happen remains undone in the market, 

17 although I'll note that a lot of substitute 

18 hedging is taking place, so if someone would 

19 traditionally hedge with an OTC product, maybe now 

20 the FY or the TY on the CME is good enough, and 

21 two a significant bifurcation in pricing between 

22 cleared and uncleared trades which could also 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

95 

1 potentially impact liquidity in the markets, so 

2 with those comments I'd leave the overarching 

3 point that I think Isaac made which is liquidity 

4 is not point in time measurable, it's -- I'm sorry 

5 it's not consistent, it's in fact point in time 

6 measurable and the greatest concern that has to 

7 exist is the ability to move risk and get trades 

8 done not only in times of normal market conditions 

9 but in times of stressed market conditions, when 

10 it is inconvenient to provide the liquidity in the 

11 balance sheets of clients and that's really kind 

12 of the overarching concerning question that we 

13 need to address. 

14 MS. WALKER: Great. Thank you Rana. 

15 Luke did you --

16 MR. ZUBROD: Yes thank you. I would say 

17 bringing the perspective of end users to the 

18 discussion, you know Chatham executes about a 

19 billion and a half notional each day of interest 

20 rate FX and commodity trades. And I would say 

21 broadly our interactions with banks are marked by 

22 what one colleague indicated to me was the absence 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

96 

1 of an outright competitive drive. Whereas bank 

2 marketers often used to tout their trader's 

3 ability to deliver efficient pricing on a trade, 

4 you know have conservations that revolve around 

5 sort of banks grousing about the various reasons 

6 why they can't deliver efficient pricing. 

7 I think the reasons for this are many 

8 fold, some of them perhaps regulatory, some of 

9 them not. I'd say the reasons tend to be more 

10 anecdotal than quantifiable. And I certainly 

11 share Isaac's point that it's difficult to 

12 quantify the issue of liquidity. But certainly I 

13 think regulatory issues do play a role. The cost 

14 of doing business for banks has increased, not 

15 just as a function of capital requirements but 

16 also as a function of things like KYC and 

17 pre-trade documentation, those sorts of things. 

18 Now, if you're a large, corporate for 

19 example, that has established trading lines where 

20 you do that process once and don't have to do it 

21 again, it's very easy to repetitively transact. 

22 But if you're a smaller or mid-sized entity that 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

97 

1 needs to establish a relationship with a bank in 

2 order to trade, that bank has to weigh the merits 

3 of going through the process-the regulatory 

4 process, the documentation, KYC process, LEIs, et 

5 cetera. And if they think there's a reasonable 

6 likelihood that they won't win the transaction, 

7 they don't want to go through the burden of 

8 getting that relationship established only to 

9 lose, because there's a cost of establishing that 

10 relationship. And so just yesterday on our 

11 internal network, someone posted this comment. 

12 Quote -- "Just spoke with such and such a bank. 

13 They are no longer bidding on caps and other 

14 options when they aren't the lender on the 

15 underlying loan being hedged, color from the 

16 marketer is they aren't winning enough. We're 

17 making enough on those. They win to justify the 

18 internal compliance, KYC exercises the trades 

19 require. They'll let us know if this changes, but 

20 for the time being they'll be passing on any such 

21 deals we show them." 

22 So this is fundamental. I think it's 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

98 

1 difficult to measure liquidity, but I think we 

2 know that it's not going to be there if the number 

3 of participants willing to quote prices decreases, 

4 particularly in times where markets are more 

5 volatile or stressed. The absence of a robust 

6 pool of counterparties will certainly adversely 

7 affect pricing outcomes for end-users. So I would 

8 say certainly for small and mid-size end-users, 

9 these are issues, they're again anecdotal. You 

10 know, it's hard to put numbers to them. And that 

11 tends to -- the un-cleared market is one realm 

12 where we're experiencing that. I would also sort 

13 of jump into the discussion on cleared U.S. 

14 interest rate swaps. We also work financial 

15 end-users who are clearing their swaps. The 

16 CMELCH basis -- the impact of that for an end user 

17 is that to transact a clear USD interest rate 

18 swap, a ten year swap would cost about two basis 

19 points more today as a result of that basis if 

20 it's cleared at CME instead of LCH. 

21 And that's a very substantial cost. 

22 It's a cost only for those who are subject to the 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

99 

1 clearing mandate and are clearing their 

2 transactions, and it's arguable whether or not the 

3 cost is necessary for all participants within the 

4 clear-who have to clear whether it's necessary 

5 that that cost should be borne. And so I think 

6 the scope of the clearing requirement is one issue 

7 that won't take the CMELCH basis away, but 

8 reducing the scope of the clearing requirement, 

9 which the CFTC has done in certain instances with 

10 central treasury centers for example and the 

11 clearing relief granted to such entities, but I 

12 think it could look more broadly at whether all 

13 entities who are subject to the clearing 

14 requirement indeed contribute meaningfully to 

15 systemic risk. Because if the conclusion is that 

16 not all of them do contribute to systemic risk, 

17 you can take that cost issue, that two basis 

18 points away for some subset of the population 

19 where arguably the clearing requirement is not 

20 necessary for carrying out the CFTC's systemic 

21 risk mitigation objectives. 

22 MS. WALKER: John Nixon? 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

100 

1 MR. NIXON: Thank you. First of all 

2 Sharon, I apologize for my tardiness, but one of 

3 the embedded rules in footnote 88 is that Delta 

4 doesn't fly in the rain anymore. (laughter) I'd 

5 like to make two comments. Actually the first 

6 comment I would agree with. I just make a comment 

7 with what Isaac and Rana said. You know there's 

8 no doubt that liquidity is episodic in every 

9 single market. Whether it is 1995, 2005, or 2015, 

10 you are not going to be able to come up with a 

11 single definition of what liquidity is in a 

12 marketplace. It changes every single second of 

13 the day. And so it is very hard to measure it, I 

14 think, from any quantitative perspective. But I 

15 would say one other thing. That prior to the 

16 financial crisis, I don't think that people 

17 recognized just how big the banks were in trading 

18 in the marketplace. I don't think people 

19 recognized -- and I'm not saying this was a bad 

20 thing, it was probably a good thing -- but they 

21 were a big part of the marketplace. I'm not sure 

22 we measured what that part of the marketplace was, 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

101 

1 but maybe it was 25, 30, I don't know what 

2 percentage it was. But it was a big part of the 

3 marketplace. And over the course of the last five 

4 or six years with the financial crisis and the 

5 changes that have come in place, and whether it's 

6 the cost of capital or it's the rigor around 

7 regulatory, legal and compliance, or whether it is 

8 the fact that you know the Volker rule is being 

9 implemented, or banks just do not want to take 

10 risk, because they don't feel they're getting 

11 rewarded for it. You have removed a big part of 

12 the liquidity that was in the marketplace. When I 

13 say -- the market is less liquid than it was 

14 before because there is an absence of a major 

15 player that was that there previously. If you 

16 have five men on your hockey team and you're 

17 playing against another five men, and you take two 

18 guys off the ice, and play four on four, the game 

19 changes. It gets faster. It gets more 

20 unpredictable. And I think that we have to 

21 recognize that the marketplace that you live in 

22 today is not going to be as deep and liquid as the 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

102 

1 marketplace that we lived in before, and the main 

2 reason is, the components and the ingredients that 

3 made that market liquid have gone. They've been 

4 changed. And the introduction of some market 

5 makers is very very welcome, as Isaac has said and 

6 others that are there. But they're not going to 

7 fill the void of what has been probably taken out 

8 of the marketplace. And therein will lie the 

9 problem, when you have to have hedging done over 

10 the course of the next couple of years when 

11 markets move. It will be more difficult than it 

12 was before because there will be less people that 

13 will stand in there and take the other side of the 

14 trade. 

15 MS. MCLAUGHLIN: Bill Hale? 

16 MR. HALE: Thank you. I can't really 

17 express the thoughts on market liquidity better 

18 than John just did, so I don't want to attempt to 

19 do that, although Delta does fly in the rain. It 

20 just takes 12 hours to make a two hour flight. I 

21 can tell you that from last night. (laughter) 

22 The area that I'm most familiar with are really 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

103 

1 the Ag markets and all I can say is, on a daily 

2 basis, from how we're able to manage our risk --

3 how we manage risk for our producers, or our end 

4 use customers and also provide price discoveries, 

5 I feel like the liquidity is there today in Ag 

6 markets to really do that and in a fairly good 

7 fashion. But we are becoming increasingly 

8 concerned about a number of rules and regulations 

9 that can affect liquidity of individual markets. 

10 One of them is the issue of the FCM market and 

11 Commissioner Giancarlo articulated very well -- I 

12 read his remarks this morning. I couldn't have 

13 written it better than he did. So that's a big 

14 concern. We also have lots of unknowns on the 

15 positional limits rule and some of the issues that 

16 FCMs are facing on capital regulation. So I think 

17 there's a lot of unknowns yet for the Ag market 

18 that are yet to be seen but I think today we have 

19 the price discovery and the ability to manage our 

20 risk on a fine basis at the moment now. Is that 

21 going to change? It's yet to be seen. 

22 MS. MCLAUGHLIN: Andrew Lo? 4: So I 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

104 

1 want to comment on a theme that's been raised by a 

2 few of the panelists as well as the committee 

3 members, which is the fact that liquidity is hard 

4 and perhaps impossible to measure. So I want to 

5 first start by agreeing with Isaac Chang that you 

6 can't manage what you don't measure. And so it's 

7 absolutely of paramount importance to measure 

8 liquidity, but where I'll push back on his and 

9 other comments is the claim that you cannot 

10 measure it. I strongly disagree with that and 

11 would be happy to volunteer the services of my 

12 students and colleages at MIT, if you send us the 

13 data. We will come up with measures of liquidity 

14 for you. The reason that I think there is a bit 

15 of a misunderstanding about the nature of 

16 liquidity is because liquidity is not a single 

17 concept. It's much like personal health. A 

18 person is healthy, is a very vague statement and 

19 it's because, from the academic perspective, there 

20 are three qualities of liquidity that really make 

21 up the definition. A security is liquid if it can 

22 be traded quickly, if it can be traded in large 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

105 

1 size and if it can be traded without moving 

2 prices. Those are the three characteristics that 

3 define liquidity -- price, time and size. That's 

4 it. And so, the reason that you have different 

5 definitions for liquidity, or so it seems, is 

6 because different markets have different 

7 characteristics of price, time and size. But it 

8 doesn't mean that it's hard to measure, it means 

9 that you have to use a three dimensional object as 

10 opposed to a one dimensional object. And it's 

11 paramount to use those three dimensions in 

12 different markets, because what we're seeing I 

13 think, is a change in the ecosystem of the 

14 financial markets with respect to liquidity, and 

15 Rana pointed that out by observing that some 

16 markets are becoming more liquid because other 

17 markets are less liquid and the capital is flying 

18 from one to the other. 

19 So I want to first offer that we, I 

20 think, can measure liquidity if we are willing to 

21 be a little bit more expansive in how we think 

22 about it. And if we have the data to be able to 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

106 

1 apply to it, and that Tom's comment is absolutely 

2 correct, that liquidity changes over time and 

3 circumstances. It doesn't mean it's impossible to 

4 measure. It seems that we just have to do a 

5 little bit more work and I think there are a 

6 number of us in academia that would be happy to 

7 help out. 

8 The second comment I want to make is 

9 about that eco system. I think that the 

10 characteristics of liquidity have changed. Part 

11 of it is intentional. The fact that capital 

12 requirements are higher, many would argue, is a 

13 feature, not a bug. However, there are some 

14 unintended consequences of the change in the 

15 eco-system and we've already heard some comments 

16 about how the sell side has changed thanks to 

17 Volker and the fact that now, we no longer have 

18 designated market makers. But I think a more 

19 important confluence of events is the combination 

20 of technology and how it's interacted with 

21 participants in the marketplace. It's true that 

22 we now have a larger proportion of counter parties 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

107 

1 that are trading as so-called fair weather 

2 friends. They can pull liquidity at a moment's 

3 notice. But part of the reason that that happens, 

4 is because we've got technology that really has 

5 facilitated the ability to be able to move 

6 liquidity around much more rapidly. And just like 

7 we have the flash crash, and now multiple flash 

8 crashes in different markets, that's a symptom of 

9 this fact that we can move liquidity at a moment's 

10 notice. So I think that it's important for us to 

11 study the entire ecosystem, to try to understand 

12 not only how to measure liquidity but who the 

13 participants are in the marketplace and what their 

14 incentives are for providing liquidity and how 

15 quickly they can withdraw it before we can 

16 understand whether or not liquidity is something 

17 that can be managed and what the appropriate 

18 remedies are for dealing with regulatory 

19 oversight. 

20 MS. MCLAUGHLIN: Thanks. Just following 

21 up on the point of the need and the importance of 

22 measuring liquidity, for those of you who do think 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

108 

1 about metrics of market liquidity in the markets 

2 that you're active in, I think it would be helpful 

3 for us to hear a little bit more about just the 

4 fact pattern on the ground right now, in terms of 

5 where is liquidity, maybe decreasing from recent 

6 past, increasing, whether how you see linkages 

7 between different segments of markets. So I think 

8 I'd particularly welcome any comments on that, 

9 because I think that's a question that we have, 

10 and it's very difficult, not as a practitioner to 

11 see exactly what's happening. 

12 MR. CUTINHO: I'm sorry, my name is 

13 Agenda for today (laughter) Because I don't have 

14 a name card. That was my joke. I don't have a 

15 Delta one. (laughter) So I don't think I --

16 before I answer your question very directly, I 

17 think I want to make a subtle point on two 

18 perspectives. One is we, while Professor Lo and 

19 his team are measuring liquidity, there's one 

20 thing we all can agree on, is we need to make sure 

21 that markets have a diversity of participants and 

22 access for these participants. I think to Rana's 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

109 

1 point, what has happened with some of the rules --

2 some are well intended, some have -- we don't 

3 understand what the intentions are. Well, what 

4 some of the rules have done is, for brokers or 

5 intermediaries that provide market participants 

6 access to markets, they have made it really 

7 expensive. In effect, some of these clients are 

8 losing their access to the markets. Now of 

9 course, we are asked questions, can you quantify 

10 it? There is news out there. There are changes 

11 in prices, one. You know there are institutions 

12 that have rejected about 100 of our hedge funds 

13 from accessing markets. That's another anecdotal 

14 evidence. Of course I think as a group we could 

15 work and we could give you a list of market 

16 participants who are rejected access, but that is 

17 one thing that we all have to worry about. If our 

18 intent is, you know, you want vibrant markets, 

19 with broad diverse participation, okay, of course 

20 you can measure these things, but we have to make 

21 sure that we don't put in rules or structures in 

22 place that limit participation. And we feel that 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

110 

1 some of the leverage ratio rules and the way it is 

2 applied for client clearing really impacts that. 

3 The second thing, I don't know where 

4 this discussion about CME, LCH basis is going, but 

5 some of this is an outcome and everybody is 

6 looking for a cause, right? And we don't know 

7 what the cause is. We've been told in some of our 

8 discussions that there is a general imbalance in 

9 clearing between payers and pay fixed and received 

10 fixed players. So issuers of debt are natural 

11 receivers of fixed rates. And one of the theory 

12 goes that since these participants do not have to 

13 participate in clearing, it creates a bifurcated 

14 market, a cleared market and an uncleared market. 

15 I don't know if that is the cause of this, but one 

16 thing that we have to -- I want to speak to, is 

17 essentially this. Client choice is of paramount 

18 importance, okay? And it has led to 

19 transformation in this market, as Isaac pointed 

20 out. It is a much better place than it was in 

21 2008. Even in the clearing world, things have 

22 transformed. Real time clearing is in place, and 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 non- enmity of execution code executing counter 

2 parties to clearing members is in place, netting 

3 compression or coupon blending, and transparency 

4 in the market. So all these are good things. So 

5 I don't think this should be a reason to start 

6 discussing better client choice, is the problem. 

7 So it is important for us to note that the basis 

8 is just an outcome. It's important to understand 

9 where it's coming from. I don't have all the 

10 answers to look at it. 

11 Now answering your question directly. 

12 I'm sorry I'm taking such a long time. As far as 

13 liquid central limit order books are concerned, 

14 there are things that Isaac mentioned that can --

15 that are measures. You have depth, size and 

16 prices. You can see all of them. If you look at 

17 all the three dimensions that Professor Lo pointed 

18 out -- time, size and price, you can see that very 

19 transparently in the market in real time. That, 

20 and that is basically what is attracting a lot of 

21 market participants. I think you have similar 

22 structures in non-central limit order book 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

112 

1 markets. We are not suggesting that all the same 

2 structure applies to everything. But the problem 

3 with measuring the impact is the question you're 

4 asking. The problem is, some of these impacts 

5 have taken several years to play out. So you have 

6 to go back in time and see what the implications 

7 are, the changes and trends are. It's very 

8 difficult to look on a real time basis and come up 

9 with -- this is the impact to liquidity and this 

10 is the cost. 

11 MS. MCLAUGHLIN: Kristen Walters? 

12 MS. WALTERS: Thanks, so just thinking 

13 about liquidity. So certainly we've seen the 

14 nature of liquidity change over time. I don't 

15 think that we've experienced as an asset manager 

16 significant changes in our ability to access 

17 markets. But certainly the way that we do it has 

18 changed. So in the context, while bid-offer 

19 spreads may not have changed as materially as we 

20 would have expected, we do have to transact in 

21 smaller lot sizes, and there are pockets of 

22 illiquidity and certainly vol a vol which is more 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 difficult to measure as a significant issue. 

2 We've adapted our trading infrastructure and 

3 process to address this and it works largely well, 

4 but I think it's very important to talk about 

5 capacity. From our perspective I think we think 

6 of capacity as being more of an issue than 

7 liquidity. 

8 So Andrew talked about kind of the 

9 price, time, and size factors allowing you to 

10 measure liquidity and that's true. And we use --

11 you know we've developed transaction cost models 

12 as have others to use that information to 

13 determine market impact of trading, size that we 

14 can move, days to liquidate and so-on and 

15 so-forth. And those measures work very well in 

16 what we've called in previous sessions kind of 

17 peace-time or normal markets. What happens is 

18 they don't work very well at all when the market 

19 is highly illiquid. So, and at those times, 

20 capacity becomes a very major and I think from my 

21 humble perspective, difficult thing to monitor. 

22 So when markets are no longer liquid, 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 and they're very illiquid, capacity is something 

2 that is very difficult to quantitatively measure. 

3 So Andrew, certainly, if you have any ideas on 

4 that, we would welcome it. The other place where 

5 I think we see capacity as an issue and we talked 

6 about this in the inaugural discussion we had 

7 about you know CCP risk. So, absolutely there has 

8 been an impact on clearing members and FCMs from 

9 the capacity perspective of increased regulatory 

10 limits on liquidity, leverage, RWAs, and that 

11 impact is very real. I think Emily talked about 

12 the difficulty of a clearing member stepping in to 

13 support another clearing member in the instance of 

14 a default. Similarly, I think we believe there 

15 are similar issues around concentration of FCMs 

16 and the impact on liquidity. Absolutely, 

17 regulatory capital and other requirements impact 

18 the ability of large banks that are acting as FTMs 

19 to function in the market in a way where they 

20 actually earn sufficient return in capital to 

21 their business and have the balance sheet that is 

22 actually available and useable when there are 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 liquidity issues. So I would welcome other's 

2 thoughts on that, but it's certainly something 

3 that we're concerned about and spend a lot of time 

4 thinking about. 

5 MS. MCLAUGHLIN: Anat Admati? 

6 DR. ADMATI: Thank you, there are a 

7 number of terms that have been thrown around here. 

8 So I want to try and head back a few things. I 

9 actually spent a lot of the first part of my 

10 career thinking about market liquidity, and so 

11 this word, that's thrown around and then you have 

12 other related words, needs a little bit of a 

13 clarification. Why is size mattering? Why all 

14 these things? Well, the treasury market is very 

15 different than other markets because there's more 

16 uncertainty about the value, potentially by the 

17 counterparty, there's more potential for 

18 differences in beliefs. And stress time means 

19 people might get nervous about asset or 

20 counterparty and things change because there's 

21 different information and so counter parties are 

22 not willing to -- not agreeing quite on what the 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 thing's worth or having their own funding problems 

2 or some kind of credit crunch. 

3 So there are many reasons why liquidity 

4 might evaporate in a market. And they go to some 

5 level underneath some exogenous sudden thing. 

6 They have an economic meaning. So liquidity is 

7 something that everybody loves to have. But you 

8 have to think about what it must be at a given 

9 time, what it is, and it is what it may have to 

10 be. So that's a little bit about market liquidity 

11 and there's more there to discuss. Then you get 

12 to the point of liquidity requirements. And 

13 there, I'm not a big fan of those requirements. 

14 There are a lot of assumptions that are made and 

15 they're quite restrictive and costly. And so I 

16 can see that they would potentially distort what 

17 can happen in markets. One of the things that is 

18 definitely wrong in this discussion is that 

19 anything to do with leverage which is something 

20 that I focused on very strong the last six or 

21 seven years and actually beyond, which has to do 

22 with capital. That if any of that interferes with 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 liquidity at all, if anything that's done there is 

2 somehow seems difficult it's because it corrects 

3 something that was wrong before. Lots of 

4 companies in this economy work with virtually no 

5 leverage at all, but there's no reason that any 

6 company needs to work at the levels that we're 

7 talking about. 

8 The fact that dividends are being paid, 

9 rests the case entirely. There's nothing that 

10 can't be done with equity funding, so any 

11 connection that's made here between the ability of 

12 the market to provide liquidity, and the leverage 

13 of those providing it, is wrong to the extent to 

14 the policy context. So on that, I think the 

15 connections that are made are wrong. On other 

16 things there might be some points, but I think 

17 what we must recognize is that liquidity is not 

18 something that is a birth-right, it's related to 

19 something that we can just kind of demand the 

20 world to have. It's about market participants and 

21 how they're going to interact in a situation given 

22 their information and given environment and we've 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 got to treat it as something that does change with 

2 the situation and that's just the way it's going 

3 to have to be. 

4 MS. MCLAUGHLIN: Jerry Jeske? 

5 MR. JESKE: I'm here for the commodities 

6 market council which is comprised of a group of 

7 end users both in the Ag world and the energy 

8 world. The discussion thus far has focused on 

9 rates quite a bit and I know Bill mentioned the 

10 agricultural world a bit but I'd like to mention 

11 the energy world here for a moment and also speak 

12 to terms of end user participation in the 

13 liquidity pool. I think Susan, you asked a 

14 question about linkage and I think it's very 

15 important for the commission to see the linkage 

16 between of course the listed futures and that 

17 which they can't see which is our bilateral swap 

18 activities. A couple folks have commented so far. 

19 I think Isaac mentioned that linkage earlier, but 

20 certainly what took place in the over-the- counter 

21 market which today the commission still can't see, 

22 is very relevant in terms of liquidity. 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

119 

1 Juxtaposed to what is existing in the 

2 futures and I'll point specifically to Henry Hub 

3 for as an example, you look at 2013 Henry Hub open 

4 interest, immeasurable for our academics in the 

5 world, open interest has fallen from 2013 and 

6 Henry Hub to today. And you look at -- I don't 

7 think it's any coincidence the regulatory regime 

8 that has taken place, whether it's becoming a swap 

9 dealer, whether it's becoming under the auspices 

10 of the Volcker Rule, or our friends in the Basel 

11 Committee who have now added some constraints to 

12 the entire process. But that open interest figure 

13 is reducing. There may be other reasons for it, 

14 but I think that's just a fact that we have to 

15 consider. When you couple that with the swap 

16 activity which takes place down the curve, I'm 

17 talking, 2018, 2019, 2025. It just isn't there 

18 anymore. Talk to any of the energy participants 

19 who used to make markets or otherwise were willing 

20 to commit risk capital because oftentimes when 

21 you're building a power plant or when you're 

22 investing in infrastructure from the standpoint of 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 storage facilities, you have to make these 

2 long-term investment decisions. Certainly the 

3 liquidity or the ability of folks to take risk in 

4 that space is definitely impacted, over the last 

5 6, 12 months. 

6 I think a couple commenters mentioned, 

7 Luke and John, specifically spoke to the lack of 

8 bank participation. Well it's clear, many of the 

9 banks are no longer in those markets at all. So 

10 whether you're talking about long-term oil, 

11 natural gas, power markets, all of these long 

12 dated commitments that were out there aren't there 

13 anymore. So in terms of willingness of people to 

14 participate, I think the real concern then is how 

15 do we move into a cleared environment? And with 

16 the challenges and the lack of FCMs that are out 

17 there right now, and the capital constraints, 

18 there's some serious concerns I think and I think 

19 they're valid concerns when you -- you know you 

20 may have some opportunity to create access to 

21 clearing facilities that were no longer viable 

22 under the Basel Rules, sponsor principal is one, 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

121 

1 maybe we'll talk about that a little bit more, but 

2 certainly the market participants I think have a 

3 need to find different avenues in to a clearing 

4 house, and without the capital constraints. 

5 MS. MCLAUGHLIN: Glen Mackey? 

6 MR. MACKEY: Thank you, just to echo 

7 Jerry's thoughts a bit, and I look at it very 

8 simplistically. When and end user, whether it's a 

9 producer or an end user in a commodities space, 

10 looks at their hedging practices for example, 

11 typically you have market risk, in the form of 

12 price risk. You try to mitigate that, and 

13 historically that's been done by essentially 

14 transferring that to credit risk in a bilateral 

15 swap market or something of that nature. And 

16 then, typically if you're not comfortable with the 

17 credit risk, you mitigate that by moving into a 

18 cleared product where you essentially deploy 

19 additional capital to remove the credit risk. 

20 That's sort of the continuum of risk 

21 mitigation from an end user's perspective. The 

22 challenge is, is when we look at liquidity, as an 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 end user, we don't look at just time, size, and 

2 price. From a physical commodities perspective, 

3 specifically in the energies and the soft 

4 commodities, when there's a manufacturing 

5 component, we look at location, we look at time, 

6 we look at quality, because there's quality 

7 differences between the various commodities that 

8 we either produce or have to acquire as an input 

9 into another product. And then we look at the 

10 production or the production volumes. 

11 And any time you have a reduction in the 

12 number of market participants that will 

13 participate in a market, typically what happens is 

14 you find that you have to accept, as an end user, 

15 more risk. Whether that's volumetric risk, 

16 whether that's overall locational risk, because 

17 clear products don't trade at generation nodes, or 

18 at the wellhead for producers. So typically, it's 

19 really a function of what risks are you trying to 

20 mitigate and what are you prepared to trade off 

21 against? So that's the continuum that we see. 

22 The biggest sensitivity assets, and when 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 we look at liquidity, it's the ability to execute 

2 a hedge in a market at the location for the proper 

3 time period and also in the proper quality.i.e., 

4 in a light suite product, potentially not a WTI or 

5 a Brent or at a physical location in 

6 nonhomogeneous products. That's what we see 

7 happening in the market is, whether it's banks or 

8 other market participants or intermediaries that 

9 wear the risk between the producer and the 

10 ultimate end user, if they go away, liquidity is 

11 harmed in some form or fashion. And you'd have to 

12 take on other risk burdens to compromise for it, 

13 or account for that. 

14 MS. MCLAUGHLIN: Gerald Beeson? 

15 MR. BEESON: There's actually two 

16 different points I wanted to make. One was, and 

17 in the point that John made around the fact that 

18 the game is changing, I think actually ties in a 

19 bit to Andrew's point on transparency. So first I 

20 think when you look at from the changes in the 

21 marketplace there's been a lot of discussion 

22 around what's happened with capital rules, what's 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 happened with Basel, but the reality is there's 

2 also a change of business models afoot as well. 

3 So when you look at it in terms of the different 

4 divisions within the banks, they're going through 

5 this change from what was previously a voice 

6 brokered market, you're removing a level of 

7 opacity, spreads are compressing, and you have the 

8 cost structures that are involved with those as 

9 well. Because there's another component of 

10 rationalization of balance sheet that's made 

11 available on the back of looking at that, your 

12 return on equity. 

13 And so ultimately you've got this 

14 seismic shift I think happening within the banking 

15 community, but at the same time, with new entrants 

16 coming to the marketplace, I think there is 

17 technology available for newer entrants who are 

18 able to quote tighter spreads, to quote risk more 

19 actively, to be able to have more reliable and 

20 efficient during tighter periods. So when I look 

21 at our market makers, and example during the 

22 monthly nonfarm payroll for civil securities, we 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

125 

1 will continue through those, those periods of 

2 information to quote tight spreads on the screen, 

3 we'll often see our future competitors either 

4 widen or disappear. And some may argue it's 

5 because of a changing market dynamic. I would 

6 argue to Andrew's point, it's actually just what 

7 used to be a more opaque happening in the 

8 marketplace, now just happens on the screens now. 

9 And so ultimately I don't think you can 

10 just draw a necessary correlation that there's the 

11 transparency is causing different changes in the 

12 marketplace, ultimately it's just bringing light 

13 to something that was likely a historical practice 

14 in the past. The other point I think is that from 

15 a participant's perspective, we talked a lot about 

16 liquidity in terms of what's happening. I would 

17 argue liquidity still is significantly fragmented 

18 today. And so ultimately you have the dealer to 

19 customer community which largely operates in the 

20 same way it did before, just on an electronic 

21 platform. So you still have the -- in terms of 

22 multiple dealers to customers done through either 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

126 

1 Bloomberg or Trade Web and RFQ and you still then 

2 removed from that have the dealer to dealer 

3 community such as the two pools of liquidity 

4 aren't necessarily interacting with one another. 

5 And if the rules are designed to be able to have 

6 this open access, ultimately I think they're 

7 seeing more users have the ability to be in the 

8 anonymous central limit order books, or to be more 

9 involved and choose a trading across a broader 

10 spectrum of these pools that will ultimately I 

11 think give us a better measure as to actually how 

12 liquidity can be measured in the marketplace. 

13 I think with the current structure it 

14 would be difficult to just say, what is liquidity 

15 like when you don't have a true exchange of 

16 liquidity between all participants in the 

17 marketplace. 

18 MS. MCLAUGHLIN: Marcus Stanley? 

19 MR. STANLEY: Thank you, I feel like 

20 it's always my role at these kind of events to 

21 wave the bloody shirt of the financial crisis. 

22 But since no one has done it and it is in fact the 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

127 

1 reason and the motivation behind these new rules 

2 we're making I'm going to do it here. Over the 

3 period prior to the financial crisis we saw a 

4 period of very rapidly declining transacting costs 

5 and very rapidly increasing volumes. Someone 

6 mentioned vibrant markets. Markets could not have 

7 been more vibrant than they were over the period 

8 just prior to the financial crisis. Now this 

9 market vibrancy did not pay off in economic growth 

10 or investment, even in the years immediately 

11 before the financial crisis, and of course it 

12 resulted in a cataclysmic financial crisis that 

13 was marked by the very rapid disappearance of 

14 liquidity. Liquidity that people had thought was 

15 durable but was revealed as fragile. Why was it 

16 revealed as fragile? Because market makers were 

17 overleveraged and overexposed, and so they were 

18 crippled in their response to pricing changes and 

19 their ability to get into the markets and respond 

20 when markets were dislocated and in fact they had 

21 to contribute to market dislocation by selling 

22 rapidly in order to pay back and respond to the 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

128 

1 leverage pressures they were under. 

2 And these participants were frequently 

3 major banks, and because they were major banks 

4 their effective failure had disastrous effects on 

5 our broader economy. And this is the pattern of 

6 financial crisis. Financial crisis are not 

7 historically linked to moderately higher trading 

8 costs, or additional inconveniences for some 

9 additional inconveniences for market practitioners 

10 in normal times. They're linked to overleverage, 

11 to excess leverage by key market intermediaries 

12 and they're linked to fundamental -- to issues 

13 with fundamentals. 

14 So a number of participants actually 

15 have pointed, we just heard from Citadel and I 

16 think Isaac before that some of the things that 

17 we're seeing now are the surfacing of risks that 

18 were hidden before the crisis that the regulations 

19 are now sort of forcing people to deal with it in 

20 a more explicit manner. And I think that is going 

21 to lead to changes in market patterns, but I think 

22 it's healthy. 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

129 

1 A couple of other quick points, people 

2 have talked about the capital costs associated 

3 with clearing, I think that's a little ironic 

4 given that our committee is so focused on the 

5 risks to clearing houses. A very significant 

6 amount, the bulk of the loss absorbency for 

7 clearing houses is always going to have to come 

8 from clearing members. The only alternative is 

9 that it comes from client customers or it comes 

10 from the public. So I think that to the degree 

11 that capital costs associated with clearing are 

12 about improving the durability and loss absorbency 

13 for clearing houses I think that too can be 

14 healthy, although we do need to look at 

15 coordination of those costs. 

16 Another point, I think we're seeing an 

17 unfortunate sort of conflation here between the 

18 debate over electronic trading and the debate over 

19 bank capitalization and regulation of the big bank 

20 dealers. We're being presented with what I think 

21 is a false choice between the excessively 

22 leveraged over-the-counter intermediaries that we 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

130 

1 saw before the crisis, and some kind of electronic 

2 trading Wild West that we're being presented with 

3 as potential evolution of these current markets. 

4 I think regulators have got to be able 

5 to respond to the problems revealed in the last 

6 crisis, and regulate around new emerging issues 

7 that may be coming from electronic trading and 

8 computer technology at the same time. 

9 MS. MCLAUGHLIN: Susan O'Flynn? 

10 MS. O'FLYNN: Whoops, thank you. I just 

11 want to tie back to you know what we've observed, 

12 especially in the dollar rates market, and the 

13 CMELCH imbalance. And I think I want to tie it 

14 back to liquidity and capacity are effectively I 

15 think absolutely, they're partners. Because 

16 ultimately a dealer wants to create as much 

17 capacity to continue transacting with clients and 

18 that capacity will come from creating resource 

19 efficiencies by how you execute your business, 

20 clearing is obviously key to that. And obviously 

21 since the mandate we've seen huge -- you know the 

22 growth in clearing and the prime example being the 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

131 

1 dollar rates fixed float situation that we've seen 

2 evolve between CME and LCH. 

3 Now, the cost of obviously clearing are 

4 obviously different at two different CCPs and it 

5 comes back to Isaac, what you said at the very 

6 beginning, there is a different kind of price for 

7 each CCP, but historically that has probably not 

8 been passed on by the dealers to their clients or 

9 correctly assessed. So I think what you're seeing 

10 now with the emergence of the basis is, is 

11 reflecting how dealers are going to create more 

12 capacity to continue be able to trade with 

13 clients. And I think as well the market has its 

14 own way of evolving. Because we've seen the 

15 switch market evolve to effectively be able to 

16 manage and be able to understand what those margin 

17 costs are, and I think the market has a way of 

18 creating liquidity in another product, and we've 

19 seen the liquidity in that product evolve 

20 materially in the last couple of months. And I 

21 think that's an interesting thing to observe. 

22 We've also seen that clients are now looking to 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

132 

1 clear at alternatives to CCPs so you know I think 

2 it doesn't mean the shift of liquidity may be from 

3 one CCP to another, or change the price of 

4 executing swaps because there is a real liquidity 

5 price to the institutions who are on the other 

6 side of that trade. 

7 MS. MCLAUGHLIN: Emily Portney? No? 

8 Rana Yared? 

9 MS. YARED: You caught me off guard 

10 there. I want to pick up really on something that 

11 Susan just said which is that capacity and 

12 liquidity, they are sisters in this process. And 

13 one of the things that we have to worry about is 

14 that while liquidity, as Andrew has said is very 

15 measureable, capacity is a very private choice, 

16 right? Every bank makes a decision about the way 

17 in which they want to allocate the scarce 

18 resources which they have, and all kind of jokes 

19 aside, we're ultimately in the client servicing 

20 business, right? So we want to be servicing as 

21 many of our clients as possible and as many market 

22 conditions as exist. 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

133 

1 But the reality of the market is that 

2 diversity of views have gone down for all the 

3 reasons John Nixon had mentioned, and finding 

4 capacity has become increasingly challenging 

5 notwithstanding the evolutions in the dollar rates 

6 markets that Susan has just mentioned. And so one 

7 of the things that we're faced with is potentially 

8 different levels of service and different pockets 

9 of client basis by the banks, and notwithstanding 

10 the point that liquidity is not a God-given right, 

11 we should as a group of market participants 

12 trouble ourselves with the questions of do we 

13 really want to be creating call it multiple tiers 

14 of access in the market? 

15 And the independent part of GS which is 

16 our global institutional research arm, has spent 

17 some time thinking about what they're calling the 

18 tier, the two speed economy, which thinks about 

19 some of the impacts of having different types of 

20 access in different pockets of market 

21 participants. 

22 The last comment I just want to make 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

134 

1 before I close is that while we definitely welcome 

2 the participation of Isaac, and Citadel, and other 

3 market makers into the market because they are 

4 replacing some people who have exited. I want to 

5 emphasize that on a general basis, the compression 

6 in spread in small trades, while welcome in that 

7 particular segment of the markets, my earlier 

8 point has actually not been indicative of an 

9 increase in liquidity and greater access to 

10 markets as the size of trades get larger. So 

11 while the problem is being solved in smaller sized 

12 trades, it's not being solved in larger sized 

13 trades. 

14 And while clients may choose to change 

15 the style in which they trade as I think Blackhawk 

16 had pointed out, trading in smaller sizes, 

17 ultimately a lot of small risk equals big risk and 

18 we need people in the markets who are willing to 

19 take on the large risk of particularly structural 

20 end users who need to hedge? 

21 MS. MCLAUGHLIN: Thank you, Sebastiaan? 

22 MR. KOELIG: Thank you, I wanted to echo 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

135 

1 some points that Isaac made at the very beginning, 

2 I agree that actually I think measuring liquidity 

3 is definitely possible, I do also think it's 

4 different from a moment to moment basis. As a 

5 market maker typically you try to find the 

6 equilibrium, we're not taking positions for a very 

7 long period of time, as Isaac said as well. 

8 So you're trying to find an equilibrium 

9 between buyers and sellers, and in a time of 

10 uncertainty, it's harder to find that equilibrium 

11 which means given the limited amount of let's say 

12 capital and limits that we're allowed to work 

13 with, we're going to have to spread that across a 

14 larger amount of prices to provide the same amount 

15 of liquidity. If we were to continue to do the 

16 same amount of size on the prices that we show, if 

17 the markets indeed have that uncertainty, we won't 

18 be able to provide that liquidity any more once 

19 the markets move further away from where we 

20 started to trade at the time. So given that, if 

21 volatility goes up, and Gerald also mentioned this 

22 on nonfarm payroll figures. If there's less 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

136 

1 certainty as to what's going to happen in the near 

2 future, it's harder to provide the same amount of 

3 liquidity given that there's a constraint on 

4 capital as well as limits that you're available to 

5 trade. 

6 And I think to Dr. Admati's point, I do 

7 understand that maybe the leverage ratios in some 

8 of these markets might not have been where they 

9 should have been according to you, the fact that 

10 if they change, this is going to take away some of 

11 our possibilities as well. And I think Rana just 

12 pointed this out as well. If there's limited 

13 resources available to do things, if we lower 

14 those resources further it's going to be harder 

15 for us to do the same thing. 

16 MS. MCLAUGHLIN: Thank you, Commissioner 

17 Wetjen? 

18 COMMISSIONER WETJEN: I just wanted to 

19 follow up on a point Rana made. Is there, are 

20 there -- is there anything especially negative or 

21 disadvantageous about having to execute at a 

22 smaller size? Help us understand why that is an 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

137 

1 evolution that might not necessarily be a positive 

2 one, if I understood your remark correctly. 

3 MS. YARED: Sure, so I think my remark 

4 was that it's not prima facia of the positive one. 

5 In certain cases, it can be. In other cases, it 

6 cannot be. So some of the cases where our clients 

7 have observed to us that that is a disadvantageous 

8 moment would be in places where execution costs 

9 are charged by numbers of times which you execute, 

10 so let's say you have to execute 100 times to get 

11 what you would have done one off, you're not only 

12 paying the bid ask but then you're paying the 

13 execution charge every time. In that kind of a 

14 market it could be disadvantageous. It could also 

15 be disadvantageous in a market where the client 

16 wishes to transact in large size because they are 

17 not actually managers of let's call them, active 

18 moving markets. So they want the peace of mind 

19 of, I've executed once, dealer, market maker, 

20 whoever, has taken that risk off of my hands and 

21 now they're the professional risk manager who's 

22 going to manage the market moving because nonfarm 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

138 

1 payrolls happened, et cetera. 

2 So for people who aren't professional 

3 risk managers, being forced into a situation where 

4 they have to deal with the friction or the 

5 slippage as they dice up their order, could be 

6 very negative for them. So again it depends on 

7 the market participant. But we shouldn't rely on 

8 being able to chop up the order as a prima facia 

9 better way to transact, because again every client 

10 transacts and has set themselves up in a different 

11 way. 

12 MS. MCLAUGHLIN: Thank you, I think 

13 we're going to do one more question. I'd like to 

14 give Dennis an opportunity to speak and then I'd 

15 like to try to move to the next question, so my 

16 apologies to those with their tents up, but maybe 

17 you can get in on the next round. 

18 MR. MCLAUGHLIN: Thank you. I just 

19 might give the perspective from LCH on the 

20 liquidity. Because we have about 150 billion U.S. 

21 Dollars equivalent of margin that we have to place 

22 because people give us margin. And we operate 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

139 

1 under the Amir regulations, and the CFTC 

2 regulations, but in particular the Amir regulation 

3 says that no more than five per cent of that 

4 number can be invested unsecured. So that means, 

5 what do we do with the other 95 per cent. So that 

6 forces us to be a large repo player in the market. 

7 And we have found as well that the capacity for 

8 repo transactions is getting less and less. 

9 Obviously, this has been a theme that has 

10 reverberated around this table, but we feel it 

11 first-hand. 

12 The other part of this is that for 

13 client margins that come into us, they have to 

14 come back every day. The cash has to come back 

15 every day. Just the one day on it. So that puts 

16 further pressure on our repo capacity within the 

17 market. And as we all know, the regulations are 

18 pretty punitive now in terms of liquidity ratios 

19 and liquidity capacity. So that's drying up. 

20 So what we've seen is pressure now 

21 coming from end user clients to become members or 

22 to try and access clearing houses directly. And 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 that's created a few challenges because for one 

2 you have the credit challenge that was mentioned 

3 earlier. Because maybe not all of these people 

4 are prime and that creates an issue of introducing 

5 sub-prime risk into the clearing house which is 

6 not optimal. 

7 The second one I think is that, is a 

8 deeper one, which many of these players and many 

9 of these end users are not allowed to mutualize 

10 their risk. Now, as we know, the clearing house 

11 works on mutualized risks, which throws off a 

12 certain cash balance which is used to manage the 

13 liquidity. Should you then allow people to take 

14 advantage of that mutualized liquidity, if they're 

15 not actually mutualizing the risk -- that's a 

16 conundrum that we have to face. 

17 And the third biggest challenge I think 

18 is that there are certain sectors which are 

19 typically one directional. For example insurance 

20 companies, where the clearing model doesn't really 

21 work that well because they have -- if you to put 

22 them in clearing just as they stand, they would 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 have massive IM calls because they're not hedging, 

2 they're just straight IM risk. So we haven't 

3 really figured this out yet, but there are a lot 

4 of challenges to allowing the end users to operate 

5 and to try and compensate for the drying up of 

6 capacity that we're seeing. 

7 MS. MCLAUGHLIN: Okay, thank you. Just 

8 in the interest of time I'd like to try to get to 

9 our next question which is about the imp -- how 

10 market participants have responded to the changes 

11 that we have seen so far and I think any comments 

12 on implications for market functioning and market 

13 risk would be of great interest to us. Anyone? 

14 Isaac do you want to take that? 

15 MR. CHANG: Sure, first I'd like to 

16 actually thank Professor Lo for clarifying my 

17 comments. I hope -- perhaps it wasn't clear. My 

18 thrust wasn't that we shouldn't be trying to 

19 measure liquidity, I think absolutely we should, 

20 the point I was trying to make in the opening 

21 comment that I made is that we don't have the data 

22 today to be able to accurately to do that. I'd 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 actually, and I'm jumping the gun a little bit 

2 towards the question towards the end of the list, 

3 but I can see how engaged and how many questions 

4 come up so I'm going to run the risk of jumping 

5 the gun slightly and saying one of the things the 

6 commission should be focused on is increasing the 

7 level of market data, both on a pre and post-trade 

8 transparency basis so that we can do things like 

9 accurately and end-monitor liquidity. 

10 Maybe because I'm in D.C., but this 

11 analogy came to, but, echoing some of the thoughts 

12 that some maybe has come up already. Liquidity 

13 does not sit alongside life, liberty, and the 

14 pursuit of independence in the Declaration of 

15 Independence (laughter). Liquidity is, at the end 

16 of the day, liquidity provision is a service which 

17 needs to earn an economic rate of return. And as 

18 a market maker, you know it's obvious to us but 

19 sometimes when you talk about or where you hear 

20 discussions about liquidity in the marketplace, it 

21 sounds like almost as though it's somewhat of a 

22 public good. And you know there is an economic 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 rationale to say that maybe it is a public good 

2 and then it should be just subsidized by the 

3 government, and I'm not recommending that route at 

4 all, but that's what economic theory would say if 

5 it was a public good. 

6 I think it's worth seeing, it's worth 

7 pointing out that liquidity -- we need to 

8 understand what it is and isn't and what behavior 

9 can change and what can't change maybe to kind of 

10 get to your point of your question. And this 

11 comment hasn't come up but has come up a lot in 

12 the press. There's probably a Bloomberg story 

13 every other day about the oncoming onslaught of 

14 fixed-income selling that's going to happen once 

15 the Fed starts to raise rates. And certainly I 

16 don't underestimate the capacity issues, the size 

17 of issuance in the fixed income market, the 

18 shrinkage of dealer balance sheets, the size and 

19 asset managers. Assets and their management, 

20 that's all out there and I think pretty public 

21 information. My point is though that no amount of 

22 liquidity provision, no liquidity provider who's 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 economically rational is going to stand there and 

2 provide continuous liquidity in the face of new 

3 information which changes the fair value of an 

4 asset and I think that needs to be recognized. 

5 If, for example, the market prices that 

6 the Fed is not going to hike in September, and 

7 then all of the sudden new information comes out 

8 which leads the market to believe the fed is going 

9 to hike 200 basis points in September, no amount 

10 of liquidity -- I can tell you I sat pre-crisis on 

11 a bank desk. I would have gotten fired so fast if 

12 as the market was selling off all I did was sit 

13 there and buy from customers because we wanted to 

14 watch the position ride against me as the market 

15 sold off. 

16 In the face of newer information markets 

17 re-price, you can't avoid that. That's trading. 

18 Losing money in that situation is not no 

19 liquidity, it's you have a bad trade-on. I don't 

20 know how else to put it. I don't want people to 

21 think liquidity is a panacea that banks or frankly 

22 even having spent time on a market making desk at 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 a bank, even pre-crisis that that would have 

2 changed. The role of a market maker is not to 

3 stand in the way of a one-way freight train where 

4 you know where it's going. Your job is to make a 

5 market around where you think the fair value of 

6 the asset is, and that changes as newer 

7 information comes in the marketplace. So I just 

8 wanted to get that out there because I don't know 

9 -- I feel like sometimes I hear some of the 

10 comments and it feels like liquidity is this 

11 magical thing that's going to keep everyone from 

12 losing money. I've never traded in a market where 

13 that's the case. 

14 I would just say, I think in terms, yeah 

15 we are seeing changes in market behavior, I think 

16 we're in a transition period in the market 

17 structure, clearly, right? You have the 

18 pre-crisis, most liquidity in the over-the19 counter FIC markets were provided by a small 

20 number of highly concentrated systemically 

21 important institutions. Most of the post-crisis 

22 have been focused about reducing leverage in the 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

146 

1 system and reducing the systemic risk at the end 

2 of the day to the taxpayer. Put simply, you could 

3 argue I think, correctly that the liquidity that 

4 was observed pre- crisis was subsidized by the 

5 taxpayer. In our view it would be a mistake to 

6 roll back those reforms for the sake of re7 creating the same set of issues. That doesn't 

8 mean every role's perfect, that we should be open 

9 to modifying some of them as the panelists have 

10 suggested. 

11 But what I would say is we should be 

12 focusing on evolving market structure so that we 

13 have a broader and more diverse and a larger 

14 number of smaller liquidity providers to, in the 

15 system, where no one of them is systemically 

16 important. None of us, well, I don't think any of 

17 us want to go back to, who were active in the 

18 markets back in the fall of 2008 want to go back 

19 to what I think now is commonly referred to as 

20 another Lehman moment. And the way to do that is 

21 to encourage the development and the creation of 

22 new capital, and the way to attract new capital is 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 to -- A, eliminate artificial, arbitrary access 

2 criteria to the extent that Sneel already brought 

3 that up. I think it's to increase pre and 

4 post-trade price transparency so that there's a 

5 more even playing field and access to information. 

6 And it's to incentivize I think experimentation in 

7 market structure. Because the American economy 

8 over time has proven to be a largely free-market 

9 system, when stripped of anti-competitive or 

10 incumbent protecting type features, has generally 

11 proven to be pretty amazing about evolving to meet 

12 the needs -- a need in the marketplace. 

13 And we should be encouraging new models 

14 and new business models to spring up. Many of 

15 them will fail, but some won't. And it's not our 

16 job, or it's not the regulators, certainly the 

17 role of regulators to define what those new 

18 business models should be, but to set up the 

19 environment such that these new models can 

20 flourish. I'll give my other panelists a chance 

21 now, to respond. 

22 MS. MCLAUGHLIN: Thank you, thanks Isaac. 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

148 

1 No, I definitely think we're in a period of 

2 transition and we're definitely seeing the smaller 

3 pools of capital coming to the market. I think 

4 the point that the FCM committee is trying to make 

5 is, how do the FCMs support the market access that 

6 those smaller pools of capital need to have in 

7 order to be effective and that market access is 

8 something that for the moment has, under the 

9 current set of Basel capital rules, has some 

10 significant implications for the capital footprint 

11 of the FCM business and the ability to absorb, 

12 especially incremental activity, as a function of 

13 stress scenarios, so one of the questions later on 

14 in the discussion, if we end up having time is the 

15 concentration among the FCM community. 

16 I think by definition as you've gone 

17 from an FCM community of over 200 to something 

18 south of 100, definition- ally that means that the 

19 absence of one will incur a greater stress risk to 

20 the remaining community. And so I think the --

21 and if you look at the OTC markets, generally the 

22 concentration of FCM participants is that much 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

149 

1 tighter, or narrower, than the participation in 

2 the futures markets generally. So when you're 

3 looking or planning for a stress event, as an FCM, 

4 how do you apportion the appropriate amount of 

5 capital, put that appropriate amount of capital 

6 aside for a stress event, if you're operating on a 

7 fixed amount of capital. And so, as you analyze 

8 the risks associated with future crises, if your 

9 client community's already using a good portion of 

10 your asset and balance sheet, a capacity at a time 

11 of normal market conditions, as you enter a period 

12 of stress, the availability of additional balance 

13 sheet and additional capacity to give to clients 

14 who want to bring in additional business from 

15 their at-risk clearing member, is an unpleasant 

16 circumstance to have to face. So I do think that 

17 we need to very carefully look at some of these 

18 alternative models that are being highlighted by 

19 the clearing community. I think the sponsored 

20 access model which doesn't entirely eliminate the 

21 capital footprint that the clearing members have 

22 to provide but does mitigate to some degree some 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

150 

1 of the capital issues that clearing members have. 

2 I think those broadening -- those methods of 

3 broadening access do need to be looked at in the 

4 light of current constraints. 

5 MR. WIPF: And touching on market 

6 structure I don't think we can overemphasize the 

7 current impact on the collateral markets and how 

8 they flow through here. I think if we agree that 

9 some of the basic underpinnings of the liquid 

10 market are resilient clearance and settlement 

11 system and a durable financing market, I think 

12 that looking at the output of regulation it just 

13 means there's just a new framework. If we think 

14 that the LCR and the NSFR which do incent better 

15 asset liability management, although somewhat 

16 blunt and could be a bit more granular are 

17 absolutely fundamental to creating that durability 

18 and ensuring that there's not an over reliance on 

19 short term wholesale funding and you put that 

20 together with what the output is -- the fact is 

21 that under the SOR these intermediation activities 

22 for high quality collateral are treated very 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

151 

1 differently. And that's just a fact. And I think 

2 that's what the industry needs to think about is 

3 how do you address that particular item, 

4 particularly when we think about the need for high 

5 quality collateral. The requirements for that are 

6 going up while the intermediation capacity is 

7 going down. And I think that's just -- I think 

8 that what needs to be addressed really is in the 

9 construct of that framework what are the solutions 

10 that could get around that? And we think there's 

11 a fairly straightforward win as it relates to 

12 central clearing of securities financing 

13 transactions -- a very very reasonably vibrant 

14 interdealer market in central clearing for 

15 securities financing both repos and stock loans, 

16 and but the remainder we don't have an active 

17 participation from the buy side and that's been 

18 for a lot of reasons. That's particularly the 

19 sell side and the buy side failed to find middle 

20 ground on how to actually get into those settings. 

21 But that actually could create reasonable capacity 

22 in the current framework -- where to the benefits 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

152 

1 of netting, there will be some opportunity to 

2 replace some of the capacity that's being taken 

3 out of the system. The fact is that at the 

4 current price levels the intermediation of high 

5 quality collateral doesn't meet anyone's cost of 

6 capital. That's just a fact. But there are ways 

7 to actually recreate that capacity through things 

8 that actually are generally accepted as really 

9 good practices which is to get this activity into 

10 central clearing, free up that capacity and be 

11 able to intermediate what I think where the demand 

12 is coming from. Which is going to be continued 

13 demand for high quality collateral as it relates 

14 to the changes in money market regulation, as it 

15 relates to the demand that's going to come from 

16 the posting collateral on a cleared margin. So 

17 there's this increased demand -- it's just a 

18 reality of reduction and capacity. But there are 

19 things that are actually in the realm of the 

20 possible and there are some things well underway 

21 that could actually begin to free up some of that 

22 capacity. But I think when you take that through 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

153 

1 -- that capacity in the clearance settlement 

2 financing markets could have very positive and 

3 profound impacts on this discussion around 

4 liquidity as it relates to the assets and the 

5 derivatives rap. 

6 MS. MCLAUGHLIN: Thank you, Emily? 

7 MS. PORTNEY: Hi, thank you. A couple 

8 of things around just thinking about liquidity 

9 holistically, and the way I would think about it 

10 and maybe this is very simplistic. But the first 

11 part of our conversation was very much around an 

12 ability to get a trade done at a specific price 

13 and market liquidity from that perspective. We're 

14 also touching on and talking about -- and I think 

15 it's a very important topic is the ability to get 

16 a trade cleared based on the number of FCMs and 

17 consolidation in the industry. And by the way, 

18 it's no good if you can get the trade down, but if 

19 it's mandatory that you clear it, or you can't get 

20 it cleared, or if it's too expensive to clear it 

21 doesn't matter because it all goes back to the 

22 market liquidity that you just can't get the trade 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

154 

1 done. Because you ultimately can't clear it. So 

2 it's very interconnected. 

3 In terms of I think all of my colleagues 

4 have said it already but just at J.P. Morgan it 

5 wouldn't surprise you -- we measure market 

6 liquidity in terms of being able to get the trade 

7 done in terms of we think that you measure it in 

8 terms of inventory on dealer balance sheets and of 

9 course, you know, in terms of inventory of 

10 treasuries, inventory of corporate bonds have come 

11 down tremendously. And that's actually, 

12 especially with corporate bonds, supply has gone 

13 up by 50 percent. The inventory that's actually 

14 there for dealer activities has gone down 

15 tremendously. When you think about -- we look at 

16 market depth and that's about what the size of any 

17 trade you can do at any particular price point and 

18 I think as everyone alluded to that's come down 

19 significantly. We also look at inter-day 

20 volatility and in many markets that's gone up 

21 significantly. So those are kind of all of the 

22 different measures in terms of how efficiently can 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

155 

1 you get a trade done. In terms of clearing, I 

2 think it is without a doubt, the number of clears 

3 has drastically reduced over the course of the 

4 last several years. My colleagues have already 

5 said the numbers. When you think of clearing you 

6 basically need three things to make the clearing 

7 business make sense economically. You basically 

8 need operational scale, you need capital, and you 

9 need more capital now-a-days, especially if you're 

10 a bank holding company. As well as you need 

11 liquidity. And I think you need more of all of 

12 those things to really make it work. And yes, I 

13 do think it is more and more economically 

14 difficult to have the numbers make sense. I do 

15 think we are operating an environment that is much 

16 safer. Both dealers and clearers have more 

17 capital and one could argue that some of that was 

18 absolutely a purpose of the regulations. The 

19 regulators wanted to and frankly should have taken 

20 out some leverage in the system. And frankly I 

21 think there's a cost to liquidity that is now 

22 entering back into the system which is probably 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

156 

1 healthy. Having said that I think what everyone 

2 is just asking about is the culmination of all of 

3 the regulations at the end of the day are we going 

4 to go past the point where the markets are no 

5 longer healthy and you don't want to reach to 

6 point where end users are really -- you have to 

7 ask the question -- do I hedge at all? That's 

8 probably a pretty -- a dangerous spot to be in. 

9 SPEAKER: Jerry? 

10 MR. JESKE: Well that's a great segue 

11 because I couldn't completely agree on that one. 

12 But I think you mentioned operational scale, Emily 

13 just spoke of. And that's what I would like to 

14 point out. It think is an unintended consequence 

15 of -- I do keep pointing to the Basel III regs, 

16 but I think there's two issues with Basel III, as 

17 it relates to participation in a clearing 

18 facility. So if you have a choice of, pay those 

19 that are already in the arena of clearing more 

20 money. In the case of end users and I think you 

21 mentioned how does it flow down markets earlier 

22 on? It's flowing to the customers now. Four to 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

157 

1 six times is the cost. So if you want to continue 

2 to clear it's going to cost you four to six times 

3 more. Or go find some way other to do it. But 

4 the only other alternative that I'm aware of is 

5 self-clear. So if you go to self-clear, take 

6 yourself out of the bank models -- then you 

7 introduce operational risk. And if you don't have 

8 the scale to do that I think there's unintended 

9 consequences associated with it. 

10 To get to a point of hopeful regulatory 

11 relief, sponsor principal. I think some folks are 

12 talking about sponsored access model. I think 

13 it's the same thing. And to be able to avail 

14 those that aren't used to clearing to the ability 

15 and the functional expertise of those that can 

16 clear I think is very valuable to everyone. 

17 Sponsor principal model resolves the 

18 Basel III on balance sheet. The off balance sheet 

19 trade exposure concentration as to an FCM's 

20 guarantee -- I think is very similar to the repo 

21 market. And I think folks have commented about 

22 that and the treatment of that guarantee shouldn't 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

158 

1 be any different than the treatment of the repos. 

2 But I guess that remains to be seen. But I think 

3 there's some positives associated with that. 

4 Those that are on the European model might speak 

5 to more specifics as to how it's going on in 

6 Europe in hopes that this doesn't become a 

7 cross-border issue. But certainly it's something 

8 that might be of benefit to everyone. 

9 Just one other comment. Commissioner 

10 Wetjen mentioned about size and ability to get off 

11 trades. I think the same is true in the energy 

12 and Ag markets as well. Slipperage is important. 

13 I can cite to a few different examples. You might 

14 have a very larger airline for instance that wants 

15 to engage in a hedging program and that airline 

16 may not have very many places to go these days in 

17 terms of dealing with their supply constraints. 

18 You have multinational organizations. You have 

19 various friends of ours to the south who have some 

20 very robust oil hedging programs, and when they 

21 have less places to go and the ability to not be 

22 able to do large size it is certainly concerning 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

159 

1 for anybody who's willing to raise their hand and 

2 get out in front of doing such a transaction with 

3 such large organizations. 

4 MS. MCLAUGHLIN: Thanks. Go ahead, 

5 John. 

6 MR. NIXON: I'd like just to pick up on 

7 that one point because I think there's an example 

8 of that right now in the U.S. interest rate 

9 markets and I say that in U.S. Swap markets. And 

10 I think if you speak to most of the swap dealers 

11 that are here, you would find that on large 

12 corporate issuance days, there is much more 

13 volatility and basis point slippage than there was 

14 in the past. And really, I think that boils down 

15 to, there is far less people, as you have just 

16 said, for them, and for those corporates to --

17 corporate issuers to go to. In the marketplace 

18 right now, there is probably a handful of five 

19 that you would really think are solid market 

20 makers to corporate institutions that will take 

21 down large size on corporate issue -- on corporate 

22 issuance. There is just not enough people in that 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

160 

1 marketplace to provide that liquidity. And while 

2 I do believe that the Getco's and the Virtues and 

3 the Citadels have done an incredible job with 

4 their organizations since coming back, it's pretty 

5 hard to replace a balance sheet of the sizes of 

6 some of these banks. I would also just make a 

7 comment that I thought Isaac was very right, that 

8 liquidity is not a God given right. And quite 

9 honestly, I would think that for a period of time 

10 in the corporate bond market, asset managers had 

11 almost too much liquidity. It was too good for 

12 too long. It's now going to be more difficult for 

13 sure. But the more market makers you have -- just 

14 because you're a market maker -- you know, if 

15 there's a light at the end of the tunnel, it could 

16 be a train. You don't just stand there and let it 

17 hit you. You get out of the way. But the more 

18 market makers you have, the more shock absorbers 

19 you're going to have of getting more people back 

20 in the marketplace, making prices, and having that 

21 rebound probably be more -- you know, better than 

22 you're going to have if there's only two market 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

161 

1 makers. And only the last point I would like to 

2 ask, and make or ask Andrew, and maybe you can 

3 tell me this, because I know you're a lot smarter 

4 than I am, and afterwards, that even if we have 

5 the data, and even if we can measure liquidity, 

6 and I don't argue with you that I'm sure the MIT 

7 graduates can measure liquidity. What I would 

8 like to understand from you and we can talk about 

9 it later is how relevant that measurement is, if 

10 it is changing all the time, every second of the 

11 day, the temperature outside today is immaterial, 

12 if it changes by 50 degrees every couple of 

13 minutes, so I'm not suggesting that if we have the 

14 data, that it can't be measured. I guess I would 

15 question is, is it relevant at any given time, and 

16 if you put on a trade with a measure of liquidity 

17 equaling X, when you get out of that trade, if it 

18 is 10 times X, you've got a different consequence 

19 to your position. 

20 MS. MCLAUGHLIN: Andrew did you want to 

21 respond briefly or? 

22 MR. LO: Sure. So, I guess the point is 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

162 

1 well taken, that if liquidity changes randomly, 

2 unpredictably and erratically, it's going to be 

3 very hard to make sure of it, but actually, to 

4 respond to the question that's before the panel 

5 now, what I think a lot of buy side firms are 

6 doing and certainly what we at Alpha Simplex, my 

7 other hat, at this asset management company are 

8 doing, is, we are being much more proactive about 

9 measuring liquidity and developing algorithms to 

10 be able to trade around these air pockets of 

11 illiquidity. So I think the answer is, you can 

12 measure it. You may not be able to get the 

13 perfect measure, but you don't want the perfect to 

14 be the enemy of the good. You can actually 

15 measure pretty reasonable measures of liquidity 

16 and now, what you have to do, is to be able to 

17 navigate around these rocky shoals. It's become 

18 more difficult. And I agree with you and Isaac 

19 that liquidity is not a God given right and there 

20 are economic incentives for providing liquidity 

21 and for withdrawing liquidity. But there is one 

22 aspect of liquidity that is a public good, and 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

163 

1 that is financial stability. Financial stability 

2 is clearly a public good and liquidity is 

3 absolutely central to financial stability. So 

4 while we may not be able to say, do we have too 

5 much or too little liquidity, and maybe the lack 

6 of liquidity or the lower liquidity is a feature, 

7 not a bug, nevertheless, the fact that the 

8 ecosystem has changed in terms of who provides 

9 liquidity, how they provide it and how quickly it 

10 can be withdrawn -- those are all issues that 

11 speak directly to financial stability and that is 

12 something that's in the purview of the CFTC. 

13 MS. MCLAUGHLIN: Thank you. Maybe I can 

14 go to Anat. 

15 DR. ADMATI: I agreed all the way until 

16 -- the liquidity is essential to financial 

17 stability. That I think I don't follow quite. 

18 You can have an appropriate amount of liquidity at 

19 appropriate prices and the financial stability is 

20 about something else. It's about the fragility of 

21 the system, the ability of the system to provide 

22 credit to the economy and appropriate services to 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

164 

1 everybody at appropriate prices. And I don't 

2 think liquidity per se is a thing. You know, we 

3 want to be able to trade at you know, not having 

4 too much differences of information that scares 

5 people and all of that. We want to have 

6 intermediation, be priced appropriately and people 

7 trading if they need to and even if they don't 

8 trade, prices can change without trade and this is 

9 different kinds of things going on here. So I'm 

10 not sure I see the connections. 

11 MS. MCLAUGHLIN: Marcus? 

12 MR. STANLEY: The way I report it is 

13 that a liquidity failure -- a sudden dramatic 

14 liquidity failure is characteristic of a financial 

15 crisis, or a disruption in financial stability. 

16 But that does not at all mean that higher levels 

17 of liquidity in normal times are beneficial to 

18 financial stability or even related to financial 

19 stability. They may have a negative effect on 

20 financial stability by kind of setting the table 

21 for a liquidity failure by over extended market 

22 participants in a crisis period. 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 MS. MCLAUGHLIN: Thank you. Sunil? 

2 MR. CUTINHO: Thank you. Actually I 

3 have two things to respond to. One is, I think we 

4 are talking about outcomes when we talk about 

5 liquidity, whether it's very liquid markets, some 

6 gaps in liquidity that are just outcomes. More 

7 importantly, you asked your question was how would 

8 people respond. So economics would indicate that 

9 if costs for some participants was higher and as a 

10 result they had quite a bit of, then others should 

11 be able to come in and compete those profits away. 

12 The problem we have, again going back, is access 

13 for market participants to markets. Then this is 

14 what our firms -- I'm speaking on behalf of our 

15 clearing firms and the community -- the ecosystem. 

16 This is the problem. I think we tend to confuse 

17 things. Just because we're talking about leverage 

18 issue, we seem to think that we are arguing 

19 against the intent, which is to reduce leverage in 

20 institutions. The problem is not about 

21 institutions acting as principle, the problem is 

22 institutions acting as agents. They are just a 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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1 conduit. They are providing our market 

2 participants access to markets. So they are not 

3 taking on any leverage. They're essentially 

4 allowing these unlevered market participants to 

5 access markets for hedging reasons as Dennis 

6 eloquently pointed out. Take for example an 

7 insurance company who has directional risk. They 

8 are putting up margin for it but they have 

9 directional risk. We have rules now, under Basel, 

10 supplemental leverage ratio for our clearing firms 

11 that dictate that all of that insurance company's 

12 risks have to be reflected on their books for 

13 leverage calculations without giving them the 

14 benefit of offsetting that with a margin that has 

15 been collected, segregated and in the U.S., passed 

16 on to the CCP. So this is what we're talking 

17 about. So we are not speaking to the principle 

18 side of the equation. We are speaking to the 

19 agency side of the equation. So if you have rules 

20 that prevent access to the market participants, 

21 and these are market participants who bring 

22 hedging interest, that will encourage more market 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

167 

1 makers to come into the market. So this is the 

2 problem we are talking about. So in essence, we 

3 have to just take a step back and look at the set 

4 of rules that we have, and see if our clearing 

5 members can actually provide services and then 

6 hence, bring in more market participants, diverse 

7 I might add -- some being market makers and some 

8 being price takers. So, that in essence is what 

9 we are speaking to, and we seem to confuse the two 

10 things. 

11 MS. MCLAUGHLIN: Chairman Massad? 

12 CHAIRMAN MASSAD: Thank you. I think 

13 it's on the agenda, we're going to, I think, cover 

14 some proposed solutions, so I'm happy to -- so I 

15 can wait, actually that's what I was going to ask, 

16 so if it's better to wait, I can do that as well. 

17 MS. MCLAUGHLIN: Yeah, you're actually 

18 anticipating what I wanted to kind of throw it 

19 open at this point to address the final two 

20 questions on the agenda, kind of collectively, 

21 since we are running out of time. The solutions 

22 to the liquidity challenges that you see, and then 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

168 

1 more specifically, are there things that you would 

2 recommend to the commission that they be thinking 

3 about looking at to address some of the challenges 

4 that we've discussed today? 

5 CHAIRMAN WETJEN: I'll just say it 

6 quickly. I'm hearing thematically in like three 

7 different things, but before I touch on those, a 

8 lot of the discussion has been around 

9 accessibility and it relates to capital 

10 requirements, which we have no control over here 

11 at the CFTC. Chairman Massad has spoken about 

12 that. I've spoken about that publicly. I think 

13 Commissioner Bowen has probably spoken about that 

14 too, so all three of us have expressed our views 

15 on that, and meanwhile, we have staff engaged with 

16 all the various prudential regulators around the 

17 globe, engaged on the matter as well. So we're 

18 working on that in any way we can, but at the end 

19 of the day, we don't have authority over that 

20 specific issue as everyone knows. Meanwhile we 

21 have a piece of legislation that we've been 

22 implementing and basically implemented, the point 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

169 

1 being, there are some limits on what we can do in 

2 terms of any perceptions that there's perhaps more 

3 regulatory burden than is what's necessary. So 

4 instead focusing on our existing authority that we 

5 have today and what it is we should be focusing on 

6 by way of policy making, thematically I'm hearing 

7 possibly increased transparency. Maybe there are 

8 rule makings or policy makings we can do along 

9 those lines. Maybe there's more to be done on 

10 accessibility to trading menus. I'm not sure what 

11 that would be. But I'd love to hear ideas on 

12 that. And then I'm also hearing the importance of 

13 the diversity of liquidity providers, again, 

14 something else I think a number of us on the 

15 commission have spoken about, and we have a couple 

16 of open ended, I think policy makings we could 

17 continue working on. But I'm curious to hear from 

18 the others, namely on that front, by the way, that 

19 floor trader exception I think is something we 

20 could -- we should revisit. And we've talked 

21 about other market structure changes on SEFS, but 

22 I think I'd be really interested in hearing 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

170 

1 whether there's anything specifically we should be 

2 looking at that would be based on our current 

3 authority under the client exchange act to pursue. 

4 CHAIRMAN MASSAD: Well first of all let 

5 me echo Commissioner Wetjen's comments and I think 

6 we probably need a whole 'nother program to go 

7 into the solutions. But I did just want to make a 

8 couple of general comments and reactions. First 

9 and foremost, just thanks to everyone for this 

10 very informed, intelligent discussion. We touched 

11 on quite a few topics, each, many of which could 

12 be explored for hours. You know at the same time 

13 I am reminded perhaps just to remember the context 

14 here and as Marcus reminded us earlier, you know, 

15 this is a pretty -- liquidity is a pretty esoteric 

16 discussion for most Americans. On the other hand, 

17 they experienced their own liquidity event in 2008 

18 and thereafter, when they couldn't sell their 

19 houses. Many of course would experience what you 

20 all refer to as solvency events, meaning they were 

21 unemployed, or they were foreclosed upon. So you 

22 know, we did make a decision, not only as a 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

171 

1 country, but as a world. The G20 made a decision 

2 to implement some reforms to prevent or at least 

3 minimize the risk of a financial crisis like this 

4 happening again. And so, you know, we are now I 

5 think, engaged in a process of looking at how all 

6 that is working, trying to calibrate it. As 

7 Commissioner noted, Commissioner Wetjen noted, 

8 some of us have noted things like the SLR, where I 

9 support very much what the bank regulators are 

10 trying to so in terms of having a back stop if you 

11 will to risk waitings, but we do want to make sure 

12 we try to balance that objective with the 

13 objective of clearing. We're trying to make 

14 adjustments to address end user concerns. If you 

15 followed what I said about the whole CCP 

16 equivalence discussion with Europe, you'll know 

17 that I'm trying to get to that place without 

18 increasing costs there. I also support very much, 

19 all of these things being explored in a data 

20 driven way. I think that's critical, to try to 

21 get beyond some of the buzz words and really get 

22 into what the data suggests, and I appreciate the 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

172 

1 suggestions for the various things we should do. 

2 I am of course very conscious of our limited 

3 resources. Keep in mind for example that this 

4 crisis that is the backdrop of all this, or in 

5 that crisis rather, there we spent an amount to 

6 rescue one firm, AIG, that would have funded this 

7 agency's budget for 700 years. So you know, we 

8 have to kind of keep the perspective here. But on 

9 FCMs which was mentioned, it's a very important 

10 topic. At the same time, as I looked at the data 

11 there, this trend of decline has been happening 

12 for many many years, well prior to the crisis. If 

13 you look more deeply at those numbers, you will 

14 see that many of the firms that have disappeared 

15 didn't even hold customer money. The decline 

16 among firms that have held customer money was 

17 actually quite smaller. The concentration among 

18 firms at the top 20 has remained essentially the 

19 same over 10 years. It's about 91 percent of all 

20 customer money. Now granted customer funds have 

21 gone up. The increase among the top 10 -- there 

22 has been an increase among the top 10 firms in 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

173 

1 terms of what they hold. But it's a more 

2 complicated picture I think, and it also has to do 

3 with changes in business models, a low interest 

4 rate environment, changes in their profitability 

5 for various reasons, customer preferences perhaps, 

6 as to what kind of firms they want to deal with. 

7 So there's lots of factors, and similarly, I think 

8 it's important that we keep in mind, there's other 

9 market structure factors that Isaac and Gerald and 

10 others have mentioned, that are affecting these 

11 markets. I appreciated John Nixon's analogy of a 

12 hockey game where we've removed one or two players 

13 on each side, so it's gotten faster. I also 

14 think, you know, the growth and automatic 

15 algorithmic trading is sort of like we were 

16 playing hockey on the driveway in our sneakers, 

17 and now we've really moved to the ice. It's a 

18 faster game because of other things as well. So 

19 my point is simply that all these issues deserve 

20 exploration. We do want to try to calibrate these 

21 various policy objectives. It's important that we 

22 do it in a data driven way and I look forward to 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

174 

1 all of your help in doing that in the days ahead. 

2 MS. MCLAUGHLIN: So I think we've run 

3 out of time. Let me just turn it back, yeah. 

4 SPEAKER: (off mic) 

5 MS. MCLAUGHLIN: Sure. I think there 

6 would be interest if our panelists have any ideas 

7 on suggestions or further action. We'd be 

8 interested in hearing those. 

9 MR. MURRAY: Okay, as we've all -- as a 

10 panel and other members have said, we're 

11 definitely in a period of market transition and 

12 one of the issues for the clearing community as a 

13 provider of clearing services and then therefore 

14 indirectly as a provider of liquidity because as 

15 Emily pointed out, we are supporting the end user, 

16 the business of those liquidity providers, is 

17 really to have some more -- to continue to have 

18 certainly or have more certainly, and longer 

19 periods of time to implement change, i.e. that 

20 change has to be recognizable earlier and we have 

21 the opportunity to go through an implementation 

22 phase and for a longer point in time. So we're 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

175 

1 going through, as we've mentioned the leverage 

2 capital issues for the clearing community as 

3 agency providers as having significant 

4 consequences down the road to our ability to 

5 continue to provide this service with the amount 

6 of scale that we have done in the past, and I 

7 think that necessitates other initiatives taking a 

8 longer horizon or having a longer horizon for 

9 implementation, therefore we can create some more 

10 certainty around the ability to provide those 

11 services. 

12 MR. CHANG: I realize I've touched on a 

13 broad number of topics. This might be a little 

14 bit frustration because of the directive I think 

15 from Commissioner Wetjen and the Chairman about 

16 what the CFTC can do under its specific mandate, 

17 but as I sit here and I reflect on what everyone 

18 said, I'm struck by the interconnectedness across 

19 not just the futures markets with and clear OTC 

20 derivatives markets with the underlying asset 

21 classes and frankly, in my mind, the need for the 

22 coordination and you know, maybe across the 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

176 

1 regulators that oversee all those markets, it's 

2 very difficult, again, like to go back to what I 

3 started, to talk about liquidity in Treasury or 

4 Euro Dollar futures, or even cleared swaps, and 

5 not talk about uncleared swaps, or not talk about 

6 the Treasury market. And figuring out a coherent 

7 way to tie all those things together, I think is, 

8 it's not an obvious -- there's no obvious, you 

9 know, change this, floor trader exemption point 

10 and there are certainly tweaks around there, but I 

11 think the bigger picture is to really address the 

12 liquidity issue. I do think we need a coherent --

13 a regulatory approach across all the markets and 

14 ignoring the interconnectedness is only going to 

15 lead to an incomplete solution. 

16 MR. WIPF: You know our two areas are a 

17 great focus around this in OTC client clearing and 

18 I think it's been touched on a number of times 

19 about the principle versus agent view and that 

20 from a regulatory perspective, and I think the 

21 other part really again, is, on these financing 

22 markets and SFT's, and their impact as it relates 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

177 

1 to the overall discussion, and I think that 

2 becomes really an industry take away to look at 

3 what are the things that can be done within the 

4 current framework that can actually serve to 

5 create some new capacity, knowing that there's a 

6 big call for high quality collateral and generally 

7 a reduction in capacities. So I think the take 

8 away there is, has the industry pushed hard enough 

9 on central clearing of SFTs? I think that's a 

10 take away, and I think on the principle agent 

11 discussion, I think clearly that's been touched on 

12 here and I think that's very important as well. 

13 MS. MCLAUGHLIN: At this point, to 

14 Commissioner Bowen, to make some closing remarks. 

15 COMMISSIONER BOWEN: Yes, I just want to 

16 thank everyone for attending today's meeting and 

17 particularly the chairmen and Commission Wetjen 

18 for your great questions. We tackled really two 

19 important issues today -- cyber-security, 

20 liquidity and obviously we didn't solve every 

21 issue, but I wanted to thank Andrew for presenting 

22 and moderating the first panel with David Evans, 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

178 

1 who present the Bank of England CBEST program. 

2 That discussion I think gave us some food for 

3 thought in terms of what we could look at in terms 

4 of our own market regulations. Susan, thank you 

5 so much for moderating this panel and our guest 

6 speakers today -- Isaac, Piers and Thomas. I 

7 think we learned a few things. Liquidity is 

8 conditional but can be measured. Liquidity and 

9 capacity are sisters. Liquidity is in the eyes of 

10 the beholder, but not a God given right. And 

11 finally, we need innovation and we need to 

12 encourage new business models and definitely we 

13 need coordination across regulators. So thank you 

14 so much everyone. 

15 MS. MCLAUGHLIN: The meeting is 

16 adjourned. Thank you for coming. 

17 (Whereupon, at 1:34 p.m., the 

18 PROCEEDINGS were adjourned.) 

19 * * * * * 

20 

21 

22 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

179 

1 CERTIFICATE OF NOTARY PUBLIC 

2 DISTRICT OF COLUMBIA 

3 I, Mark Mahoney, notary public in and for 

4 the District of Columbia, do hereby certify that 

5 the forgoing PROCEEDING was duly recorded and 

6 thereafter reduced to print under my direction; 

7 that the witnesses were sworn to tell the truth 

8 under penalty of perjury; that said transcript is a 

9 true record of the testimony given by witnesses; 

10 that I am neither counsel for, related to, nor 

11 employed by any of the parties to the action in 

12 which this proceeding was called; and, furthermore, 

13 that I am not a relative or employee of any 

14 attorney or counsel employed by the parties hereto, 

15 nor financially or otherwise interested in the 

16 outcome of this action. 

17 

18 

19 (Signature and Seal on File) 

20 -----------------------------------

21 Notary Public, in and for the District of Columbia 

22 My Commission Expires: March 14, 2018