UNITED STATES OF AMERICA

 COMMODITY FUTURES TRADING COMMISSION

 ENERGY AND ENVIRONMENTAL MARKETS

 ADVISORY COMMITTEE MEETING

 Washington, D.C.

 Thursday, February 26, 2015
 2

 1 A G E N D A

 2 Opening Remarks

 3 Commissioner J. CHRISTOPHER GIANCARLO

 4 Chairman TIMOTHY MASSAD

 5 Commissioner MARK WETJEN

 6 Commissioner SHARON BOWEN

 7 Current Conditions in U.S. Energy Markets

 8 ADAM SIEMINSKI, Administrator, U.S. Energy

 Information Administration

 9

 EEMAC Member Questions

 10

 Panel I: What Does the Data Show?

 11

 Witnesses

 12

 VINCE MCGONAGLE, Director, Division of Market

 13 Oversight

 14 STEVE SHERROD, Senior Economist, Division of

 Market Oversight

 15

 TOM LASALA, Chief Regulatory Officer, CME

 16

 ERIK HAAS, Director – Market Regulation, ICE

 17 Futures U.S.

 18 CRAIG PIRRONG, Professor of Finance and Energy

 Markets, Director of Global Energy Management

 19 Institute, Bauer College of Business,

 University of Houston

 20

 Open Discussion

 21

 22
 3

 1 A G E N D A

 2 Panel II: Designated Contract Market Experience

 with Position Limits and Trading Liquidity

 3

 Witnesses

 4

 TOM LASALA, Chief Regulatory Officer, CME

 5

 ERIK HAAS, Director – Market Regulation, ICE

 6 Futures U.S.

 7 Open Discussion

 8 Panel III: Bona Fide Hedging

 9 Witnesses

 10 VINCE MCGONAGLE, Director, Division of Market

 Oversight

 11

 STEVE SHERROD, Senior Economist, Division of

 12 Market Oversight

 13 JOE NICOSIA, Commodity Markets Council

 14 RON OPPENHEIMER, Commercial Energy Working

 Group

 15

 Open Discussion

 16

 Closing Remarks

 17

 18

 19 * * * * *

 20

 21

 22
 4

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

 2 (10:05 a.m.)

 3 COMMISSIONER GIANCARLO: Good morning,

 4 everyone. Welcome to the inaugural meeting of the

 5 CFTC's reconstituted Energy and Environmental

 6 Markets Advisory Committee, the EEMAC. I want to

 7 give a hearty welcome and a thanks for all of you

 8 to brave the snow; to come in either from in town

 9 or out of town. I don't know if this is the

 10 fourth or fifth snowfall we've had here in

 11 Washington this year, but it reminds me of a quip

 12 often attributed to Mark Twain, and that is that

 13 everybody complains about the weather, but nobody

 14 does anything about it.

 15 So the EEMAC has a broad mandate, but

 16 thankfully one of its tasks is not to do something

 17 about the weather. But we do have a very broad

 18 mandate. Congress as you know created EEMAC as

 19 part of the Dodd-Frank Act because Congress

 20 recognized a critical need, and that was a need

 21 for a dedicated forum in which exchanges, firms,

 22 end-users and regulators could advise the
 5

 1 Commission of their concerns regarding energy and

 2 environmental markets and their regulation by the

 3 CFTC. In fact Congress was so concerned that the

 4 Commission know the effect of its rules and

 5 policies and their effect on energy and

 6 environmental markets that it mandated that the

 7 EEMAC hold at least two public meetings each year.

 8 Disappointingly no EEMAC meetings have been held

 9 in almost five years. So as a new Commissioner,

 10 and as a sponsor of the EEMAC, I take the

 11 Dodd-Frank mandate quite seriously, and I'm

 12 pleased to convene the first of what I hope are

 13 many productive EEMAC meetings to maintain a

 14 healthy dialogue between the Commission and

 15 participants in U.S. energy and environmental

 16 markets.

 17 And that dialogue is especially crucial

 18 now because Commission policies have a

 19 significantly more profound impact on energy

 20 markets in the wake of Dodd-Frank. And at the

 21 same time global energy and environmental markets

 22 are undergoing the most sweeping technological and
 6

 1 structural changes in a generation or more.

 2 American technological leadership in horizontal

 3 drilling and hydraulic fracturing has transformed

 4 worldwide energy production. And as a result we

 5 have all noticed a dramatic fall in the cost of

 6 everyday fuel, with gasoline prices close to $2

 7 per gallon.

 8 In my first year as a CFTC Commissioner

 9 I have had the pleasure of meeting with coal

 10 miners in Kentucky, oil refiners in Texas, and

 11 natural gas pipeline operators in Louisiana. They

 12 all impressed upon me deep concern over the form

 13 and substance of the Commission's proposed

 14 position limits regime. The CFTC has already held

 15 two public events to solicit feedback from market

 16 participants on its current proposal. In view of

 17 the dramatic changes in U.S. energy markets a

 18 further session exploring the unique concerns of

 19 energy market participants regarding the position

 20 limits proposal is quite appropriate and I hope we

 21 can have a lively dialogue today.

 22 Our first panel will examine the
 7

 1 research and data supporting the proposed position

 2 limits rules. In 2011 when the Commission voted

 3 on its first proposal to implement the new

 4 Dodd-Frank Federal position limits regime former

 5 Commissioner Mike Dunn, who is with us here today,

 6 registered his belief that price volatility in

 7 physical commodities is primarily driven by

 8 changes to supply and demand. He asserted that at

 9 that point in time CFTC staff had been unable to

 10 find any reliable economic analysis to support

 11 either the contention that excessive speculation

 12 is affecting the markets, or that position limits

 13 would prevent excessive speculation. Well, fast

 14 forward to today, the current position limits

 15 proposal relies primarily on studies of two major

 16 market events dating to 1979 and 2006 to conclude

 17 that position limits are necessary to control

 18 excessive speculation. I hope that our first

 19 panel and subsequent Federal Register comments

 20 augment the Commission's assessment of the

 21 efficacy of position limits, especially in light

 22 of current conditions in U.S. energy markets.
 8

 1 The second panel will consider the experience

 2 of the two major U.S. futures exchanges in

 3 balancing position limits and trading liquidity.

 4 As I have noted in other contexts, liquidity is

 5 the vital component of healthy and vibrant

 6 derivative markets. Congress recognized this

 7 concern and in instructing the Commission to set

 8 position limits in a way that maintains liquidity

 9 for hedgers. The Commission should heed the

 10 prescription of Dodd-Frank and carefully analyze

 11 the effects of its rules on available liquidity.

 12 Today we will hear from folks with decades of

 13 front line experience administering position

 14 limits for energy markets while fostering vibrant

 15 trading liquidity.

 16 And last, but certainly not least, our

 17 third panel will tackle a critical component of

 18 the position limits rules: the bona fide hedging

 19 exemption. Congress instructed the Commission to

 20 write rules exempting bona fide hedgers from any

 21 position limits rules. Crafting proper bona fide

 22 hedge exemptions has long been a challenging
 9

 1 proposition with several Commissioners on both

 2 sides of the aisle expressing concerns that the

 3 Commission's definitions of bona fide hedging are

 4 too narrow. I and others have expressed concern

 5 that the proposed bona fide hedging rules not be

 6 structured in a way that imposes federal

 7 regulatory edicts in place of business judgment in

 8 every day commercial risk management. This

 9 afternoon's panel should give us a better

 10 understanding of the likely impact of the proposed

 11 rules on U.S. energy markets and whether those

 12 concerns are apt.

 13 As we get started this morning, however,

 14 I want to welcome Administrator Adam Sieminski of

 15 the U.S. Energy Information Administration who

 16 will give us an update on the current market

 17 conditions. I also thank other witnesses who have

 18 prepared thoughtful presentations that we will

 19 hear during the day. And in addition I want to

 20 thank all of the Commission staff and my fellow

 21 Commissioners who have worked so hard to arrange

 22 and support this meeting. And of course I'd like
 10

 1 to thank all the members of the EEMAC for

 2 volunteering their time and expertise; we are

 3 grateful to you for your service.

 4 Since the EEMAC has no statutory

 5 Chairman, each meeting will be chaired by a

 6 different member of the Committee. I'm pleased to

 7 announce that Jim Allison, an EEMAC member, has

 8 agreed to chair today's meeting. Thanks, Jim.

 9 All right, now I would like to recognize

 10 Chairman Massad and the other Commissioners to

 11 make their opening remarks.

 12 CHAIRMAN MASSAD: Thank you, Chris. I

 13 also want to welcome all of you here to this first

 14 meeting as Chris put it after a long hiatus of the

 15 Energy and Environmental Markets Advisory

 16 Committee. I'm very pleased that we're able to

 17 have this. I look forward first of all to meeting

 18 each of the members of the Committee individually.

 19 I got here just a few minutes ago so I didn't have

 20 the chance to do that with everyone, but I look

 21 forward to seeing all of you, and I also welcome

 22 all of our guests. You know, this meeting like
 11

 1 all of our Advisory Committee meetings is just a

 2 very important way for us to get input and so I

 3 really appreciate everyone taking the time to be

 4 here. I also want to thank Chris for his

 5 sponsorship of the Committee. And the way we do

 6 our Advisory Committees, each of us sponsors one

 7 of them and he's taken the lead in coming up with

 8 the agenda, and in this case reconstituting the

 9 Committee and identifying people who are willing

 10 to serve. So I really appreciate his effort in

 11 that, and also appreciate the work of his staff in

 12 making today's meeting possible.

 13 I look forward to the agenda. I think

 14 it will be a very constructive and interesting day

 15 for us. I think the sessions related to the

 16 position limits rule should be very helpful. As

 17 all of you know we did put forward a proposed rule

 18 to comply with the Congressional mandate that we

 19 implement position limits. I look forward to

 20 hearing the staff's presentations. I will just

 21 say the fact that we're reopening the comment

 22 period is really just a good governance, good
 12

 1 government kind of practice. Given that we're

 2 holding this meeting we want to the extent that

 3 there are people who want to comment on what is

 4 presented or said today, they can do that. So we

 5 want to make sure people have that opportunity. I

 6 don't believe it will affect however the timing of

 7 our overall process in terms of working our way

 8 through this. It's a complicated rule and staff

 9 has been hard at work at that.

 10 I also know the staff has worked very

 11 hard for this meeting, and I know they'll benefit

 12 from this. Of course they are not in a position

 13 to opine sometimes on some things, but I again

 14 thank them for the work they're doing. And again

 15 I know all the information that we get today will

 16 be very helpful.

 17 So with that, thank you again, Chris,

 18 and also thanks, Jim, for chairing the meeting.

 19 Or, Adam, I'm sorry. Chris, thank you.

 20 COMMISSIONER WETJEN: Thank you, Mr.

 21 Chairman, and thank you, Chris, for reviving this

 22 Committee. It's great to have it reconstituted
 13

 1 and in a position to help us through this

 2 particular rule making, which of course is the

 3 rule making that keeps on giving. And I've lost

 4 count on the number of round tables and meetings

 5 and the like we've had on position limits, but all

 6 of these gatherings are very, very important. We

 7 always learn something every time it happens and

 8 with the panel that's here today I know that's

 9 going to be the case.

 10 Before I turn it back over to Chris let

 11 me just say something about Commissioner

 12 Giancarlo. Chris has been such a wonderful

 13 addition to this Agency. He is such a

 14 professional, he is among the most courteous and

 15 polite people I've ever met, he's among the most

 16 conscientious people I've ever met, and it's just

 17 a real pleasure to have someone like Chris as a

 18 colleague here at the Agency. And I'm amazed and

 19 respect to a tremendous degree the level of

 20 commitment and contribution he has made to this

 21 place even in a short number of months. I know

 22 that's as I said going to continue here today and
 14

 1 into the future. But I just wanted to make sure

 2 we took a moment to acknowledge Chris and all his

 3 hard work since he joined the Agency. And we as

 4 an agency have benefitted, but the public of

 5 course I know is going to benefit as well. So

 6 thank you very much.

 7 COMMISSIONER BOWEN: Thank you. It's a

 8 privilege to be here today at the first meeting of

 9 the new Energy and Environmental Markets Advisory

 10 Committee. I want to commend Commissioner

 11 Giancarlo, the members of the Committee, and the

 12 Commission staff for the time you've devoted for

 13 today's meeting.

 14 As many of you know I'm particularly

 15 interested in the subject of position limits. I

 16 look forward to hearing your comments on how we

 17 can enhance this rule. A core principle of the

 18 futures market is that they are designed to allow end

 19 users to hedge. We need to make sure that the

 20 rule is not only faithful to this ideal, but that

 21 the rule also works.

 22 Since we have reopened the comment
 15

 1 period once again I want to encourage anyone who

 2 may be attending this meeting or watching this on

 3 line who has a unique perspective to please submit

 4 your ideas and comments. However, as I've said

 5 before we cannot remain in a listening mode

 6 forever. It's been nearly five years after we

 7 were required by Dodd-Frank to establish a

 8 position limits regime. Leaving this rule

 9 unfinished harms consumers and end users who are

 10 looking for protection against excessive

 11 speculation and market manipulation. It also

 12 deprives the industry of critical certainty as to

 13 the state of our regulations. I continue to

 14 believe that we can and should finalize this rule

 15 before the end of this year, and I really look

 16 forward to accomplishing that.

 17 Thank you.

 18 COMMISSIONER GIANCARLO: Thank you,

 19 Sharon. I'm going to now turn it over to Adam

 20 Sieminski, the 8th Administrator of the U.S.

 21 Energy Information Agency.

 22 MR. SIEMINSKI: Well, thank you very
 16

 1 much, Commissioner Giancarlo, thank you Chairman

 2 Massad, Commissioners Wetjen and Bowen. It's a

 3 real pleasure to be invited from the Energy

 4 Information Administration here to speak to this

 5 group. It's kind of interesting; I think the last

 6 time I was here was about two years ago, eighteen

 7 months ago, and I was asked to come over and

 8 explain why oil prices were so high. (Laughter)

 9 So I think there might be a lesson here. Very

 10 briefly, I applaud your idea of an Energy and

 11 Environmental Markets Advisory Committee. Within

 12 EIA we actually have an office of energy and

 13 financial markets, and Lynn Westfall and Bruce

 14 Bachs from that office are here with me today.

 15 Raise your hands guys. So if anybody wants to

 16 speak with them later, please do that. We are

 17 looking at a lot of these issues, position limits,

 18 hedging, high speed trading, speculation, and

 19 manipulation. And, Commissioner Bowen, I'm glad

 20 you separated those two words because I think

 21 they're very different, and I think that's

 22 important.
 17

 1 Now that's about as close as I'm going

 2 to come to saying anything about policy because

 3 EIA is a statistical organization. We try to be

 4 non-partisan and we'd like to remain independent.

 5 And one of the ways I do that is to not comment

 6 too much on policy. I'm about one policy remark

 7 away from returning to the private sector.

 8 (Laughter) When I was in the private sector I

 9 talked about this a lot, so I understand the

 10 issues, I understand the struggles that you're

 11 going through in trying to deal with it. And I

 12 applaud you for your efforts to bring together a

 13 group of people to discuss these issues.

 14 But what I'd like to do, and I'm going

 15 to watch the time here; I'm going to try to do

 16 this in 10 minutes. I know you had said there

 17 would be some more time, but maybe we could then

 18 get Craig Pirrong on. He's got a hard stop at

 19 11:00 and we'll try to go through that. I thought

 20 that what people might be interested in is how did

 21 we get into this situation with -- let's see, I'm

 22 going to make -- who knows how to make this work?
 18

 1 There we go; thank you. And maybe I can use the

 2 silver button to make it go again. This is not

 3 the first time, at least not in my career, that

 4 I've seen a drop in oil prices. So this chart

 5 shows you back to 1970. I actually started as an

 6 oil analyst back in the 1970s. And there were

 7 like two really big drops, one in 1986, another

 8 one in 2008, and now the one that we're going

 9 through today. There were a few smaller drops in

 10 there too, and then of course the increases. I

 11 counted them up and there were 12 or 13 times

 12 we've had fairly significant upward or downward

 13 moves in oil prices. So it's not like it's new.

 14 I think that what happens, and I'm trying to make

 15 a promise to myself that I'll get bearish the next

 16 time oil goes to $130 because I think that when

 17 anything that lasts for three years, and we had

 18 oil averaging -- let's go one more slide and we'll

 19 go back. Can you go forward one? Thank you. One

 20 more. There we go. I'm going to let the experts

 21 run that. We had that flat period there for $110

 22 Brent crude oil prices that lasted for nearly
 19

 1 three years. And I was doing some research on the

 2 psychology of events. Anything that lasts three

 3 years everybody begins to think it's permanent.

 4 Oil prices started going down. One of the things

 5 that you can see in this particular chart here is

 6 that despite EIA's forecasts that oil should

 7 average a little less than $60 this year and maybe

 8 $75 next year, the market implied -- and what we

 9 do is we use the futures and options prices, we

 10 use those prices to derive a range of volatility

 11 assessments for crude oil, and what we have come

 12 up with is that all the way through 2016 the

 13 market is implying or options prices are implying

 14 that oil could be as low as $35 and as high as

 15 $100 a barrel. That's a really wide range and

 16 I'll talk a little bit about some of the reasons

 17 behind that.

 18 Let's go to the next slide. First of

 19 all in our estimate this isn't driving our

 20 forecast, the recovery that we're talking about

 21 for prices doesn't look a whole lot different

 22 than the recovery that we saw in 2008, '09, and '10
 20

 1 for crude oil prices, so the upward movement. So

 2 getting back to $75 a barrel by the end of 2016 is

 3 not a huge leap of faith from the $55-$60 level

 4 that we've been trading at recently.

 5 Let's look at the next slide. Let's

 6 talk a little bit about supply and demand. In

 7 demand for oil the most important thing is what

 8 economic growth is going to be. Most of the

 9 economic forecasts for the world are looking for

 10 roughly four percent GDP growth year over year.

 11 That generally translates into a little over one

 12 percent per year growth in crude oil. So now

 13 let's look at the next slide. And one percent of

 14 ninety million barrels a day, you know, maybe a

 15 little bit higher than one percent, gives you

 16 about a million barrels a day of growth per year

 17 in crude oil on a global basis. So that's what

 18 you see there for 2015 and 2106, roughly a million

 19 barrels a day increment and oil demand on a global

 20 basis taking production on that left hand scale

 21 from the 90 million barrels a day or so that we

 22 had in 2014 to 92 to 93 million, 94 million
 21

 1 barrels a day in 2016.

 2 Let's look at the next slide. You can

 3 see from this slide, and this is growth in world

 4 crude oil and liquid fuels production, 2014 and

 5 then our forecast for 2015 and 2016, that yellow

 6 bit, North America, and that's the U.S. And

 7 Canada and Mexico included as well, but most of

 8 the growth is really coming in the U.S. and

 9 Canada, especially the U.S., especially shale oil.

 10 Over a million and a half barrels a day while oil

 11 demand globally is only going up a million barrels

 12 a day, we had shale oil, and oil sands coming on

 13 at more than a million and a half barrels a day.

 14 This was causing inventory to accumulate and

 15 created too much supply. So we had a lot of

 16 supply. In fact we had a three year experiment

 17 that -- and energy economists could only love --

 18 what is the elasticity of supply with respect to

 19 price, and what we discovered is $110 oil gets you

 20 a lot of supply. And it's not getting you enough

 21 demand, markets were out of balance, something had

 22 to happen.
 22

 1 Now what we're saying -- go back one and

 2 I'll just quickly finish up on this one -- is that

 3 the growth in North American supply will

 4 definitely slowdown in 2015. It will slow

 5 further in 2016. We'll get down below a million

 6 barrels a day. Total growth in world demand

 7 probably creeps up a little bit on lower prices,

 8 supply definitely gets constrained. Inventories

 9 which are building now start to get drawn down

 10 later this year and in to 2016, and that's what

 11 rebalances the markets.

 12 Now let's go forward one. The world

 13 that I came out of and when I look around the

 14 table many of the people in this room kind of

 15 think of low oil prices as being a problem. It

 16 certainly reduces the rig count; it's going to

 17 lower production. It creates economic issues in

 18 oil producing states in America like Texas and

 19 North Dakota and Alaska, Louisiana, Oklahoma,

 20 Wyoming, New Mexico, and so on. One thing to keep

 21 in mind is this is having a huge positive effect

 22 on consumers, and I think I heard that in the
 23

 1 opening remarks as these lower prices are

 2 definitely having a positive impact on gasoline

 3 purchases by households. And in the northeast

 4 where heating oil is a big fuel it's lowering

 5 heating bills there which I'm sure they're going

 6 to be very grateful for given the really cold

 7 temperatures and the extra fuel that they're going

 8 to be burning. EIA's calculations essentially

 9 suggest that the average household in the U.S. in

 10 2015 will probably save something like $750 a year

 11 in gasoline prices alone, and up in the northeast

 12 it might be a similar amount on heating fuels,

 13 particularly oil. That should help boost the

 14 overall economy in the U.S. Roughly speaking in

 15 the U.S. every $10 drop in oil prices translates

 16 into something close to .2 percentage points of

 17 increased GDP growth. So we've had about a $50

 18 drop in oil prices. That could actually add

 19 almost a percent to GDP.

 20 Let's take a look at the next slide.

 21 Here's how those numbers stack up. As you can see

 22 things really do get a whole lot better in 2015
 24

 1 especially on the transportation side, and that's

 2 mainly gasoline. This should help keep the

 3 economy going, should help strengthen household's

 4 ability to pay for the colder winter and that

 5 should be a real plus.

 6 I think we might be very close to the

 7 end. Let's take a look at one more slide. You

 8 know, a lot of presentations that I used to go to

 9 as an oil analyst, the companies would start off

 10 with a huge disclaimer slide that would say we

 11 want to be very careful about these forward

 12 looking statements that we're making and we want

 13 to let you know that there's a lot of uncertainty

 14 in this, and I want to end on uncertainties. What

 15 could make this forecast that we think that oil

 16 could get back to $75 next year when the market

 17 implied range itself runs from $30-$35 to a little

 18 over $100? How do you get to the top of that

 19 range, how do you get to the bottom of that range?

 20 Let's talk about how you might go to the top.

 21 Social unrest in a country like Venezuela which is

 22 producing more than 2 million barrels a day of
 25

 1 oil, exporting 800 or 900 thousand barrels a day to the

 2 United States, for example. Lots of problems down

 3 there with employment, inflation, the economy is

 4 in really bad shape. If there were to be strikes

 5 in the oil fields and oil were to be disrupted,

 6 that could have an upward impact. Similarly the

 7 rebel groups in Iraq could interrupt supplies

 8 there. Tightening of Iranian sanctions if the

 9 negotiations which are underway were to fail to

 10 make it through the next few months. Social

 11 unrest in other countries that are dependent on

 12 oil supplies. Let me just name a few, Nigeria,

 13 Russia, and Algeria; you know, the list is

 14 actually fairly long there. Or the possibility

 15 that OPEC gets together and decides that they've

 16 had enough of testing how low prices can go and

 17 tries to figure out a way to cut production.

 18 What could make prices go down even

 19 further than they are? World economic growth. We

 20 know that there are problems in China; the Chinese

 21 economy has been struggling. Oil prices rose

 22 actually the last couple of days mainly on the
 26

 1 back of statements that the Chinese economy looked

 2 like it was improving and that the Saudis thought

 3 that demand might be responding. But if we don't

 4 see that, that could be a problem to the

 5 downside. Saudi Arabia keeping production high,

 6 perhaps staying in line with the increases that

 7 we're seeing coming from Iraq. The Saudis don't

 8 want to give up market share in Asia to Iraq, and

 9 if the Saudis were to build production that could

 10 drive prices down even further. Reduction and

 11 unplanned outages. That's actually what happened

 12 in the summer with Libya coming back on line

 13 unexpectedly, adding almost a million barrels a

 14 day to the oil markets in a period where they

 15 weren't expecting it, and that's how prices

 16 started falling in August and September. That

 17 kind of thing. Another one -- and this would

 18 actually be the good news -- if Secretaries Kerry

 19 and Moniz who were over in Geneva just this past

 20 weekend are successful in bringing these nuclear

 21 negotiations with Iran to a positive conclusion,

 22 the sanctions on Iran would come off, Iran oil
 27

 1 production could go up and it could create another

 2 problem. There are lots of opportunities for the

 3 price to be different than the path that I set up,

 4 and I think one of the lessons that we probably

 5 learned here in the last six months is that the

 6 opportunities for further things to change and

 7 shift these prices around is pretty high.

 8 I went two minutes over the time that I

 9 said I would do, but I'm going to stop here,

 10 Commissioner, and turn it over to you. I'd be

 11 happy to let Craig go ahead, and if we wanted to

 12 do questions -- if you want to do some Q & A now,

 13 fine, or if you want to go to Craig that would be

 14 all right too.

 15 COMMISSIONER GIANCARLO: What I'd like

 16 to do if it's all right with you is we'll go to

 17 Craig because he has a hard stop at 11:00; have

 18 him give his presentation and then at that point

 19 perhaps we can take questions for you and Craig

 20 together before hearing from our other presenters.

 21 MR. SIEMINSKI: That would be fine.

 22 COMMISSIONER GIANCARLO: Okay.
 28

 1 Professor Pirrong?

 2 MR. PIRRONG: Yes, I'm here.

 3 COMMISSIONER GIANCARLO: Great. You

 4 have a rapt audience.

 5 MR. PIRRONG: All right. That's great.

 6 Well, I hope all (inaudible) much of a pleasure to

 7 be here; I appreciate the opportunity. And I'm

 8 sorry about the unconventional way of presenting

 9 here, but where there's a will there's a way.

 10 And so what I'm going to talk about is

 11 some of the academic research relating to

 12 speculation in position limits. And sort of the

 13 key issue is about detecting excessive

 14 speculation. Position limits are intended to

 15 prevent excessive speculation that causes

 16 unreasonable or unwarranted price fluctuations.

 17 But that raises the question, how do we know

 18 what's unreasonable or unwarranted and how do we

 19 attribute any such unreasonable or unwarranted

 20 fluctuations to speculation? It's a challenging

 21 issue because commodity prices are inherently

 22 volatile. As Mr. Sieminski just noted that just
 29

 1 look at the price ranges that the options markets

 2 are forecasting as being in a reasonable range.

 3 Essentially we have a 70 or so dollar range in

 4 prices over the next several months and picking

 5 out from prices that are that volatile, the

 6 impact of speculation is a challenging issue.

 7 To put it differently, you know, how do

 8 we know what the right price is? And, you know,

 9 in some respects if we knew that well we wouldn't

 10 need markets or we'd all be rich and (inaudible),

 11 and we're not there; we're in the snow and so we

 12 have this problem of identifying what are the

 13 causes of price loops. And even doing that after

 14 the fact is a challenge. I mean people are still

 15 redefining 2008 in terms of what caused price

 16 movement during that period of time. So looking

 17 forward and forecasting prices is difficult, but

 18 even looking back and trying to attribute past

 19 price loops to particular causes is not an easy

 20 task in itself.

 21 Now what economist typically do in order

 22 to try to perform this task is to use statistical
 30

 1 methods, econometric methods. And one of the

 2 challenges here is that econometric evidence in a

 3 non manipulative context -- and I'll second Mr.

 4 Sieminski's point that manipulation and

 5 speculation are very different things -- I do

 6 believe that statistical evidence can provide

 7 powerful means of detecting manipulation, but

 8 things are much more challenging when it comes to

 9 talking about speculation, and that's because of

 10 the fact that economists or econometricians can't

 11 observe the most relevant data on demand and

 12 supply. And in my view the best approach here is

 13 going to rely on quantity data, in particular

 14 inventory data as well. And the reason for that

 15 is that prices are signals, and prices provide

 16 incentives that lead people to make decisions

 17 regarding how much they consume and how much they

 18 produce, that is prices guide quantity choices.

 19 And so if prices are distorted, quantities are

 20 going to be distorted too.

 21 And so one of the things for example

 22 that you would expect in a commodity market like
 31

 1 an oil market, if speculators were indeed causing

 2 prices to be artificially high, what would happen

 3 is that those high prices would choke off

 4 consumption and they would also encourage

 5 additional production. What does that mean? less

 6 consumption, more production means that

 7 inventories would be accumulated. So inventories

 8 would be accumulating at the same time prices are

 9 rising. What's more, you would expect to see the

 10 inventories accumulating and the people that are

 11 allegedly willing to pay the excessive price at

 12 the margin, that is the speculators. So not only

 13 would inventories be rising, but the inventories

 14 would be not in the hands of commercials, but they

 15 would be in the hands of the speculators and they

 16 would have to accumulate this inventory in order

 17 to have the positive price effect.

 18 Now one complication is that what I've

 19 just said is that well one badge of speculative

 20 distortion would be that inventories and prices

 21 are moving in the same direction. So my academic

 22 research and some of the academic research that
 32

 1 other folks have done have shown that well we can

 2 have that positive co-movement between prices and

 3 inventories even when the market is functioning

 4 well. So for example, an increase in uncertainty

 5 can lead people to accumulate inventories and have

 6 prices go up. So one way of characterizing it is

 7 that, you know, sort of the positive co-movement

 8 between inventories and prices is probably a

 9 necessary condition for the existence of

 10 speculative distortion but it's not sufficient. I

 11 mean it is one of the things that good scholars

 12 have looked at.

 13 In terms of going to the current state

 14 of the debate, and -- sorry, I should be advancing

 15 slides here, so we're on the slide here, we're on

 16 current state of the debate. Dozens, hundreds of

 17 studies of this issue. I was asked to summarize

 18 them and, you know, in a few minutes that would be

 19 a challenge, even in a few days it might be a

 20 challenge. So I'll just try to summarize in

 21 relatively broad strokes what the empirical

 22 evidence says. I think it would be a fair
 33

 1 characterization to say that most empirical

 2 studies of recent commodity price movement fail to

 3 find evidence of distortions, or that speculators

 4 caused the distortions. In particular focusing on

 5 the 2008 issue, no spike in inventory occurred at

 6 the time that oil prices were spiked. In fact the

 7 reverse was true, inventories were drawn down to

 8 fairly low levels and that's exactly what you

 9 would expect during a situation where there is

 10 essentially a substantial demand relative to

 11 supply for the commodity. And that that's a

 12 fundamentally driven demand-supply balance. You

 13 know, there are very few things on which Paul

 14 Krugman and I agree, but this is one of them.

 15 That essentially if you look at the evidence, in

 16 particular the price and quantity evidence during

 17 2008 it does not support the view that prices were

 18 distorted through that period of time or that

 19 speculation caused prices to be excessively high.

 20 I should relate to that as well that what did see

 21 happen, well when prices collapsed post-Lehman we

 22 saw inventories accumulate in vast quantities.
 34

 1 And that's exactly what you would expect to see in

 2 response to a big decline in fundamental demand.

 3 Now there has been some contrary

 4 empirical and theoretical papers on this. The one

 5 empirical paper that has gotten the most attention

 6 is by a very well-known scholar named Kenneth

 7 Singleton. Unfortunately that paper had some very

 8 serious flaws. It relies on an improper method

 9 for inferring what speculative positions, in

 10 particular index trader positions, where if you

 11 correct that flaw the end result that he finds

 12 goes away. I've also documented that if you

 13 extend the sample period, or if you look at a

 14 broader sample of commodities and you measure

 15 index trading participation correctly you don't

 16 find the effect that he purports to find.

 17 In terms of theoretical papers there's a

 18 paper by Sockin and Xiong, and they claim that due

 19 to informational problems in the market place you

 20 can observe as a result of speculation, prices

 21 rising and inventories rising, and so that is

 22 not necessarily a good test of whether the markets
 35

 1 are distorted or not. And unfortunately, you

 2 know, there are some very serious problems with

 3 the model here. So even though it's been cited

 4 rather substantially, you know, I think that there

 5 are just fundamental flaws with that model.

 6 And I would just again reiterate that we

 7 have the knowledge problem. It's going to make

 8 definitive answers elusive and so this debate is

 9 going to be a hardy perennial. If you go back and

 10 you look, you know, in the late 19th century, in

 11 the 1920s, in the 1930s, you know, up to today,

 12 people have been making very similar arguments

 13 about the impact of speculation on prices. And

 14 the reason that that argument doesn't go away is

 15 that it's inherently difficult using statistics in

 16 order to prove one way or another what that impact

 17 is.

 18 Let's go to the next slide. Now

 19 whenever there are big movements in prices,

 20 commodity prices, energy prices, up or down, the

 21 blame is almost always cast on the speculators. It

 22 reminds me of the famous scene at the end of Casa
 36

 1 Blanca where Claude Rains shoots the Gestapo

 2 officer right in front of a bunch of witnesses and

 3 turns to his assistant and says, "Round up the

 4 usual suspects" -- or Humphrey Bogart shoots him

 5 and the policeman, Claude Rains, says, "Round up

 6 the usual suspects." So whenever prices move a

 7 lot, speculators are always the first suspect

 8 rounded up. And the recent decline in oil prices

 9 is a case in point. OPEC, Russia for example,

 10 Rosneft CEO Igor Sechin and others have pointed

 11 the finger at the speculators as has a somewhat

 12 hopefully less interested party, the Bank for

 13 International Settlements. Now in my view, and

 14 Mr. Sieminski and I are on the same page on this,

 15 is that I think fundamentals are clearly at work

 16 here. A combination of steadily growing supply is

 17 the result of the shale revolution in the United

 18 States combined with a slacking in demand growth

 19 in my view explains the decline in prices.

 20 And going back to the quantity

 21 information that I talked about before, if you've

 22 been following the news lately, there are all
 37

 1 sorts of stories about inventories accumulating,

 2 and storage filling up, and traders chartering

 3 tankers in order to store oil. And so this is

 4 sort of a classic example of a market response to

 5 a supply and demand imbalance, a fundamental

 6 supply and demand imbalance.

 7 Now the BIS study that I mentioned

 8 earlier tries mightily to point the blame at

 9 financialization and I would say that its

 10 conclusions are unsupported and implausible. It

 11 makes some sort of story about the large of debt

 12 taken on by shale producers, but how that relates

 13 to the speculation and even financialization is

 14 sort of difficult to see. And it also has some

 15 arguments in there about well, maybe if banks had

 16 withdrawn from the intermediating and the swap

 17 markets, then that's led to more activity in the

 18 futures market. And there's a lot of hand waving

 19 there and when you get past the hand waving and

 20 there's not much substance that really supports

 21 any implication that speculation or

 22 financialization is in any way a material cause of
 38

 1 what is happening in the oil market since the

 2 middle of last year. Next slide please.

 3 Then it turns us to our next question which is if

 4 the empirical evidence is hardly supportive of a

 5 view that excessive speculation has caused price

 6 distortions, but even if you accept that it can,

 7 will position limits be the efficient or effective

 8 way of deterring or preventing that sort of

 9 excessive speculation? Now the way that position

 10 limits are set up is that they constrain the

 11 positions of individuals and single firms. As

 12 Commissioner Giancarlo noted the CFTC NOPR

 13 -- and the rule basically points to two examples

 14 of single large traders that purportedly had an

 15 impact on the market, and that would be the Hunt

 16 Brothers in the early '80s, and Amaranth about

 17 going on 10 years ago, 9 years ago now. And

 18 position limits may work against those kind of

 19 market participants, but they would be ineffective

 20 against broad based speculative waves which are

 21 sometimes vying for distorted prices. So position

 22 limits wouldn't impact speculation involving a
 39

 1 very large number of modestly-sized market

 2 participants for example.

 3 What's more, limits may constrain

 4 efficient risk transfer by unduly restricting

 5 hedging or limiting risk bearing capacity. So

 6 maybe some of the big speculators whose activities

 7 are constrained, those folks are big because they

 8 are the efficient risk bearers in the market and

 9 constraining their activities limits inefficiently

 10 the risk bearing capacity of the market. Put

 11 differently, you know, position limits have the

 12 potential to be both over inclusive and under

 13 inclusive. They will constrain some efficient

 14 activity and may not effectively constrain some

 15 inefficient activity. What's more the limits

 16 impose substantial compliance burdens and so --

 17 and this is a compliance burden that often falls

 18 on folks that are essentially very unlikely to

 19 ever really come close to the speculative limits.

 20 And so, you know, the cost benefit here is

 21 clearly an open issue.

 22 And with that I'll finish my prepared
 40

 1 presentation here. And I have a few minutes

 2 before I have to run off to Court to take some

 3 questions.

 4 COMMISSIONER GIANCARLO: Thanks,

 5 Professor Pirrong. This panel does have to come

 6 three more presentations from Steve Sherrod of

 7 the CFTC, Tom LaSala, and also Eric Haas, but

 8 before we do I'd like to just turn it over to Jim

 9 Allison just to moderate a few questions from the

 10 Committee for Professor Pirrong and Administrator

 11 Sieminksi.

 12 MR. ALLISON: Thank you, Mr.

 13 Commissioner. Craig, Jim Allison; I'm going to

 14 start with one question. So you talked about the

 15 difficulty of full blown empirical analysis on the

 16 question of excessive speculation. Let me focus

 17 for a moment on half that question, the issue of

 18 false negatives. Given realistic assumptions

 19 about what data are actually available and

 20 assuming good econometric practices, if excessive

 21 speculation were present in a market how likely is

 22 it that we would fail to spot it? Is that a
 41

 1 question that can be answered?

 2 MR. PIRRONG: Well, I mean it is a

 3 question that can be answered. The statistical

 4 buzzword for that is what is the power of our

 5 test, what is the power of our statistical test,

 6 what is our power to detect excessive speculation.

 7 And essentially power would be measured on a

 8 continuum here. Now in my view, a rather extreme

 9 case, so for example like the Hunts, that is

 10 something that one could detect, you know,

 11 potentially the impact. You saw the Hunts, you

 12 know, essentially had a -- they were accumulating

 13 an inventory, inventories were growing

 14 dramatically. When they released their position

 15 prices feel dramatically. So certainly in some

 16 cases we probably -- some of the more extreme

 17 cases one should be somewhat confident that we

 18 would have the statistical power to detect these

 19 things.

 20 In other cases that are less severe our

 21 power is diminished accordingly and one could be less

 22 confident. Although I would say that the other
 42

 1 important thing to note is sort of from an

 2 economics perspective the social cost of a price

 3 distortion is related to the square of the size of

 4 the distortion. So missing small distortions is

 5 not really a big deal given that.

 6 MR. ALLISON: So if I can translate

 7 that, so the distortions that are likely to be of

 8 most impact on consumers are the distortions we

 9 are most likely to be able to find?

 10 MR. PIRRONG: That's correct.

 11 MR. ALLISON: Thank you. Other

 12 questions for --

 13 MR. PIRRONG: And I would say that going

 14 back in years of data, you know, essentially, you

 15 know, you can count -- Three Finger Brown, the

 16 former pitcher for the Chicago Cubs could count

 17 these episodes on one hand.

 18 (Laughter)

 19 MR. SLOCUM: Hi, Craig, it's Tyson

 20 Slocum with Public Citizen. Thank you very much

 21 for your presentation. So in your power point you

 22 wrote that you can't observe most relevant data.
 43

 1 And I assume this is tied to the knowledge

 2 problem.

 3 MR. PIRRONG: That's correct.

 4 MR. SLOCUM: So right now the primary

 5 data sets, it's my understanding, are the CFTC's

 6 Commitment of Trader Reports, which are very thin,

 7 and then there are some very expensive, non

 8 public, proprietary data sets out there which are

 9 kind of scattered. So the question is would your

 10 job be easier if the CFTC required more detailed

 11 disclosure in its Commitment of Trader Reports to

 12 the level where you could actually determine some

 13 of these missing data sets, more details on

 14 specific traders and positions for example? On a

 15 time lapsed basis.

 16 MR. PIRRONG: In my view the data issue

 17 is less related to our ability to measure

 18 futures positions or positions. In my view the

 19 big gap in our data relates to -- is data on

 20 fundamentals. So in particular we have really

 21 good data on the United States for example, in

 22 particularly due to Mr. Sieminski's organization,
 44

 1 but sort of looking for data on demand and supply

 2 from places like China is where we face a problem.

 3 But I would note that even if you had relatively good

 4 data, I mean essentially we would still be in a

 5 situation where it would be a relatively coarse

 6 representation of real supply and demand

 7 situations.

 8 MR. ALLISON: Commissioner Wetjen.

 9 COMMISSIONER WETJEN: Thanks, Jim.

 10 Professor, could you elaborate just a little bit

 11 more on your views as to why the financialization

 12 of the energy markets doesn't have quite the

 13 impact as suggested by this BIS study? Help me

 14 understand your view of that a little bit more.

 15 MR. PIRRONG: Sure. Well, I mean

 16 there's the specifics of the BIS study and there's

 17 the issue of financialization generally. I mean

 18 it's just -- you know, I have a post on my

 19 Streetwise Professor blog where I go into some

 20 detail critiquing the BIS study and, yeah, it

 21 doesn't measure what it's purporting to measure

 22 and it just doesn't really tell a coherent story
 45

 1 as to what they purport to measure could have

 2 such a substantial impact on prices.

 3 Speaking to the issue of

 4 financialization more generally, the way that I

 5 would characterize is that financialization is

 6 really about risk transfer. It's not in final

 7 analysis about supply and demand of the actual

 8 commodity, it's actually about the supply and

 9 demand for risk. And so that the relevant price

 10 that financialization is going to effect is going

 11 to be in risk premiums. And in fact there is

 12 considerable evidence that during the period of

 13 time when financialization took off in the mid

 14 2000s, that risk premiums in energy did come

 15 down. And that's actually a good thing because a

 16 risk premium is essentially a cost that hedgers

 17 pay in order to hedge their risk. And so I think

 18 that the data on financialization needs to focus on

 19 the real price that financial market participants

 20 affect, and that's the risk premiums or the price

 21 of risk associated with commodities.

 22 MR. ALLISON: Other questions for
 46

 1 Professor Pirrong? Tyson, go.

 2 MR. SLOCUM: Craig, one more question.

 3 So you indicated that the data issue is really

 4 more about supply and demand data. That is that

 5 contributes to this knowledge problem. Does that

 6 imply that traders themselves have inadequate data

 7 for their trading activity? How are they making

 8 the decisions if the analyses --

 9 MR. PIRRONG: That's part of the

 10 genius of the market. And actually these are

 11 price discovery venues where people with --

 12 where myriad numbers of individual traders and

 13 consumers and producers each with relatively noisy

 14 data, acting on that data together, interact in a

 15 way that produces a market price that effectively

 16 aggregates that information. And so that's sort

 17 of another aspect here is we don't want to put

 18 undue burdens on the market that can impede the

 19 price discovery process. And so the analogy that

 20 I like to use is that, you know, you think of the

 21 parable about the blind man and the elephant.

 22 Nobody sees the entire elephant, but the market
 47

 1 helps put those pieces together. So yes,

 2 everybody would prefer more data to less, but this

 3 is more of a statement about how econometricians

 4 after the fact can see whether that price

 5 discovery process has actually discovered the

 6 right price.

 7 MR. ALLISON: Let me pitch a variant of

 8 that question to Administrator Sieminksi. So we

 9 have far better data about U.S. markets than most

 10 parts of the world thanks in large part to what

 11 you've done over the last few years, so thank you.

 12 Do you have conversations with counterparts

 13 elsewhere, major supply and demand countries? Do

 14 we have much hope of better information about the

 15 rest of the globe?

 16 MR. SIEMINKSI: The year that I got to

 17 EIA we actually because of a budget cut -- I

 18 arrived at EIA in June of 2012 and in the prior

 19 year EIA had suffered a pretty severe budget cut

 20 and had to eliminate a number of reports. One of

 21 those was our international energy outlook. One

 22 of my first acts as Administrator was to figure
 48

 1 out a way to move money around internally so that

 2 we could start the international energy outlook up

 3 again and we've done that. I'm continuing to move

 4 funds internally to deemphasize some of the, I

 5 think superfluous, domestic reporting that we're

 6 doing so that we can continue to build on

 7 international efforts. Specifically, we've opened

 8 up a dialogue with several of the statistical

 9 agencies in China. I'll be in New York next week

 10 actually meeting with one of the heads of the

 11 Chinese energy statistics organizations. We are

 12 actively pursuing more knowledge of China,

 13 specifically Asia in general and the rest of the

 14 world because most of the growth and demand over

 15 the next 10 or 15 years is going to be coming from

 16 outside of the Organization of Economic

 17 Cooperation and Development, the OECD, the

 18 developed countries. So it's critically

 19 important.

 20 One of the other things that we're doing

 21 that is international in nature is trying to beef

 22 up work with Canada and Mexico so that we have a
 49

 1 broader understanding of North American energy

 2 flows, electricity, natural gas, oil, crude oil

 3 and products. For example, right now the EIA's

 4 energy infrastructure maps stop at the border to

 5 the north and south of us and I'm actually working

 6 with the energy secretaries of all three

 7 countries. Secretary Joaquin in Mexico, Minister

 8 Rickford in Canada, and Secretary Moniz here were

 9 actually building out a data reconciliation and

 10 mapping effort for all of North America that we

 11 should probably have done this year. So I think

 12 your question is actually really important, and I

 13 think understanding a lot of what's happening

 14 internationally is going to be critical to

 15 understanding U.S. energy activity going forward.

 16 MR. PIRRONG: I'm going to have to leave

 17 here. I have to go testify in a case here in

 18 Chicago. I would be (inaudible) to express my

 19 gratitude for having the ability to participate

 20 here. I look forward to continuing views and

 21 anybody can feel free to sort of get a hold of me

 22 if I can answer any other questions that you might
 50

 1 have.

 2 MR. ALLISON: Thank you, Craig. And

 3 thank you for taking the time to be with us.

 4 COMMISSIONER GIANCARLO: Jim, at this

 5 stage Administrator Sieminski has to leave and he

 6 wants to make final remarks.

 7 MR. SIEMINKSI: Just one last comment.

 8 On this is there more than we could know that

 9 could help answer some of these questions, the

 10 answer is always yes. You know, part of it, I think,

 11 could involve again looking for ways to save money

 12 at EIA. I'm not here rattling my tin cup. I

 13 think there are actually ways that we can improve

 14 some of our data collection efforts to reduce our

 15 own internal costs so that we can do more. The

 16 more that we're thinking very seriously about

 17 doing is railroad data. There's a million barrels

 18 a day of crude oil moving by rail now and the

 19 knowledge base on that is very, very thin. I

 20 think that's critically important. Policy makers

 21 are struggling with this idea of crude oil

 22 exports, and understanding that issue depends I
 51

 1 think on really having a good feel for what the

 2 growth in domestic shale oil production is going

 3 to be, and the quality of that oil. Things like

 4 API gravity which makes a big difference to how it

 5 gets refined domestically. And we are looking to

 6 expand our data collection and reporting

 7 capabilities in that area as well. So we will

 8 emphasize some of these international efforts, but

 9 there is a good chunk of new things that are

 10 happening right here in the United States or in

 11 North America that I think are going to be

 12 critically important to try to answer some of

 13 these questions.

 14 COMMISSIONER GIANCARLO: Thank you.

 15 Please join me in thanking Administrator Sieminski

 16 and Craig Pirrong for their presentations.

 17 (Applause)

 18 MR. ALLISON: Thank you, Mr. Sieminksi.

 19 I think we need to move now to the remainder of

 20 the panel for which Craig has already given us the

 21 first presentation. So we have Steve Sherrod, Tom

 22 LaSala, and Erik Haas. Steve, many of us have
 52

 1 worked with for several years, seemingly forever

 2 on some of these issues. Tom LaSala, CME, Erik

 3 Haas from ICE. And I notice they're sitting next

 4 to each other, so play nice guys. Who's going

 5 first? All right. Steve?

 6 MR. SHERROD: Thanks, Jim. I'm Steve

 7 Sherrod, an economist in the Division of Market

 8 Oversight. The usual disclaimer applies, the

 9 views I'm expressing today are my own and are not

 10 necessarily reflective of the Commissioners or of

 11 other staff.

 12 Today I'll cover three topics. First,

 13 I'll provide an overview of data collected by CFTC

 14 that we use in the surveillance program for

 15 derivatives on physical commodities. Second, I

 16 will review the limited amount of information the

 17 Commission collects regularly as to whether a

 18 trader is using a derivative to hedge or to

 19 speculate. And this limited amount of data in a

 20 regular collection for hedges is by design. It

 21 provides a low reporting burden on commercial

 22 enterprises that use derivatives to hedge. And
 53

 1 third, I'll review table 11A published in the

 2 notice, reopening the comment period. That

 3 table provides counts of unique persons over

 4 percentages of the proposed position limit levels

 5 for the calendar years 2013 and 2014.

 6 The Commission basically collects data

 7 on futures using the large trader reporting system

 8 that's codified in parts 15 through 19 of the

 9 Commission's regulations. For end of day

 10 reportable positions in futures the reporting

 11 entities, and those reporting entities are futures

 12 commission merchants, clearing members, and

 13 foreign brokers, they provide reports every day on

 14 reportable positions. When a trader first becomes

 15 reportable the reporting entity provides data on

 16 the identity of the larger trader with a

 17 reportable position, and we issue calls to those

 18 large traders to provide general data on the

 19 trader's use of the futures markets. Our

 20 regulation 15.03 lists the number of contracts that

 21 trigger reportable open positions. And for

 22 example, in light sweet crude oil an open contract
 54

 1 position at the close of the day of 350 contracts would

 2 make a trader reportable. So when we say a trader

 3 is reportable -- when a trader is a larger trader

 4 in crude oil, they have 350 or more contracts

 5 generally. And the reportable levels give us

 6 insight into for most markets 80-90 percent of the

 7 open interest.

 8 In terms of trading volume though as

 9 opposed to the end of the day positions, the

 10 futures exchanges provide a trade capture report

 11 for transactions every day. We're in the process

 12 of implementing rules called Ownership Control

 13 Reports, or OCR for short. That will enable the

 14 Commission to receive automated reports of the

 15 identity of traders that are in these trade

 16 capture reports. Currently this is a manual

 17 effort. The exchanges have facilitated that,

 18 working with the Commission staff, to obtain the

 19 name of a trader associated with the trader ID so

 20 that we can make use of that trade capture report

 21 and tie it back to the large position in the large

 22 trader reporting system. The volume quantity for
 55

 1 that OCR report is set at 50 generally. And on

 2 February 10 of this year, DMO issued a No Action Letter

 3 that extended the implementation periods for

 4 certain provisions of our OCR rules.

 5 So under Regulation 17.01 the reporting

 6 entities use Form 102 to identify large traders in

 7 futures that I mentioned. We'll ask the trader to

 8 fill out a Form 40. Question 19 on Form 40 asks

 9 the trader to indicate the business purpose or

 10 purposes for which the reporting trader uses

 11 derivative markets. If the trader identifies more

 12 than one business purpose for an individual

 13 commodity, they must indicate the predominant

 14 business purpose. So examples of business

 15 purposes including offsetting cash, or spot market

 16 input or output price risks, and offsetting cross

 17 price risks. So on the Form 40 a trader provides

 18 some indication of their general hedging use. The

 19 indication helps us classify the trader, for

 20 example, for purposes of the public commitment of

 21 traders report, but that indication is

 22 general, in the Form 40, and it doesn't
 56

 1 indicate for each specific trade or position the

 2 trader has whether it's hedging or speculation.

 3 So for traders filing a bona fide

 4 hedging exemption when they exceed the federal

 5 position limits in Regulation 150.2, they have to

 6 file appropriate 04 Series Report, and that's as

 7 of the last Friday of the month. So it's a once a

 8 month filing. If staff has concerns about a

 9 particular market, say because of a very large

 10 position held by one trader going into the

 11 delivery month, we may issue a special call to

 12 that trader for additional information about their

 13 use of futures for that particular time period.

 14 In the case of commodities that don't have federal

 15 position limits, Tom and Erik are here to talk a

 16 little bit about what they do and the next panel

 17 will address that as well. The Commission can

 18 access the applications and information that the

 19 Exchanges receive.

 20 So turning to swaps, Swap Data

 21 Repositories, SDRs for short, they collect data

 22 under our regulation Part 45. To use that data
 57

 1 for surveillance we first have to have reliable

 2 data, and then in order to understand a trader's

 3 position in both futures and swaps we have to link

 4 the counterparty name or legal entity identifier

 5 with the trader identification used in the large

 6 trader system for positions along with the trader

 7 IDs in the trade capture report. And further to

 8 combine swaps and futures, we need to convert

 9 swaps to a futures equivalent basis. So we're

 10 working on that complicated process, and in the

 11 meantime before we're able to fully utilize the

 12 SDR data, we can make use of data reported by

 13 clearing members of derivative clearing

 14 organizations, and swap dealers under Part 20.

 15 That data is submitted on a limited scope of 42

 16 physical commodities, and that swap data has been

 17 converted to futures equivalents by those

 18 reporting entities. They use a Form 102S to

 19 identify the traders and then we can issue a call

 20 with a Form 40S for the swap market participant,

 21 the counterparty to the reporting entity, to give

 22 us general information on the trader's use of
 58

 1 swaps.

 2 There is no regularly reported data to

 3 classify particular positions as speculative or

 4 hedging beyond the once a month form that I

 5 mentioned. We do not have a regular data

 6 collection that requires a large trader to

 7 classify a derivative position as speculative or

 8 hedge. Historically the Commission did. It was

 9 an O3 Series report and the Commission eliminated

 10 that routine filing in 1981 to reduce burdens on

 11 commercials. In the energy spaces the exchanges

 12 can talk about their spot month limits, and there

 13 aren't typically single month or all month

 14 combined limits. Neither the exchanges or the

 15 CFTC have a regular data collection to require

 16 large traders to classify their derivatives as

 17 speculative or hedging position by position, or

 18 trade by trade. And I'll note that the exemptions

 19 the Exchange typically request an application and

 20 those -- I guess, Tom, they're once a year updates

 21 typically?

 22 MR. LASALA: Typically.
 59

 1 MR. SHERROD: Typically. The statute

 2 does place a burden on persons to show that

 3 positions are a bona fide hedging position.

 4 Historically the Commission has imposed minimal

 5 regular reporting requirements on a person

 6 claiming a bona fide hedging exemption. And

 7 indeed as I mentioned, we currently have a once a

 8 month report for practically everything. We

 9 require only advance applications for unfilled

 10 anticipated requirements or unsold anticipated

 11 production. And as I mentioned, if we need more

 12 information, we'll ask for information under

 13 various different special call authorities.

 14 I'd like to mention briefly the Table

 15 11A that the Commission published. This is an

 16 update to a chart that was published in the

 17 December 2013 Notice of Proposed Rule Making. It

 18 provides summary statistical data that covers

 19 calendar years 2013 and 2014. And in the graphic

 20 that you see here, this is for NYMEX, Henry Hub

 21 Natural Gas, it's the core reference futures

 22 contract. So it covers all the referenced
 60

 1 contracts in natural gas. For the 2013-2014 time

 2 period table 11A, the first row for example, the

 3 percentage of the proposed level, in this case

 4 it's the baseline proposed level, the spot month

 5 baseline proposed level was 1,000 contracts.

 6 So there were 187 unique persons that exceeded 60

 7 percent of that 1,000 contract spot month limit,

 8 that's 600 contracts for those two calendar years.

 9 And you can see similar numbers for the spot month

 10 for the cash settled contracts, and very few traders

 11 that would have exceeded the proposed levels for

 12 the single month and the all month limits.

 13 I'd be happy to answer any questions

 14 about the table. And I look forward to the advice

 15 of the Committee on this.

 16 MR. ALLISON: I think we should hold

 17 questions until we've heard from the entire panel

 18 in the interest of our timing.

 19 So, Tom, are you next or is Erik next?

 20 All right, Erik next.

 21 MR. HAAS: First, I'd like to thank the

 22 Commissioners for the opportunity to present
 61

 1 before you today. My name is Erik Haas; I'm with

 2 ICE Futures U.S. Market Regulation Department.

 3 So our first slide -- I'm going to set a

 4 high level -- this depicts the U.S. natural gas

 5 pipeline network. It consists of 300,000 miles of

 6 interconnected pipelines capable of transporting

 7 natural gas essentially to and from every state in

 8 the U.S., in the lower 48. This is the U.S.

 9 Electric transmission grid. Again it's actually

 10 four major grids or interconnections. Each one

 11 ties together all the generation within it so that

 12 power can flow across the grid and fulfill demand

 13 load in other locations. The purpose of both of

 14 these networks by design is to facilitate the

 15 transportation of the commodity to other

 16 locations.

 17 COMMISSIONER GIANCARLO: Erik, pull your

 18 microphone a little closer to you so everyone can

 19 hear you. Thank you.

 20 MR. HAAS: At ICE Futures U.S. we list

 21 for natural gas 175 futures and options contracts

 22 across the network. We list 281 electric power
 62

 1 futures, and 119 environmental contracts. Unlike

 2 other commodities there is not one power contract,

 3 there's not one nat gas contract. There's Henry

 4 Hub, but there's 174 other contracts that while

 5 they all to a degree are tied to Henry Hub, they

 6 primarily fluctuate based on supply and demand

 7 fundamentals in all the different regions and

 8 locations of the U.S. I'm not going to go through

 9 500 slides showing each contract's price moves

 10 with the change in fluctuation on who the

 11 participants are, but I think after we go through

 12 this you'll see that based on the make-up of these

 13 markets it will alleviate any concerns of one

 14 specific category of market participant having an

 15 undue influence on these markets. None of these

 16 contracts are big names. If I were to rattle off

 17 some of these power contract names it would just

 18 sound like alphabet soup to most people here, but

 19 the fact of the matter is these are all futures

 20 and any regulations aimed at the big name

 21 products, crude oil, or the individual

 22 agricultural products directly impacts all of
 63

 1 these regional natural gas and power contracts.

 2 And anything that makes it harder to hedge is

 3 going to directly impact the price people pay to

 4 heat their homes. All of the electricity

 5 producers use these contracts to hedge where

 6 they're generating electricity and in different

 7 regions. If it costs them more to hedge, or their

 8 hedges become more difficult, like everything else

 9 it gets passed on to the end consumers of that

 10 service.

 11 So, the next slide I want to show is -- the

 12 next two slides will show open interest in our energy

 13 contracts for natural gas, that's essentially

 14 everything, other than Henry Hub, powers, just kind of

 15 grouped everything together. We used data from CFTC

 16 Commitment of Traders Reports; it's a historical 

 17 data, as much as available for these contracts.

 18 Full disclaimer, some of these are

 19 available to 2012-ish, because they were deemed

 20 significant price discovery contracts. Others,

 21 the data starts in 2012 or 2013 as they came

 22 about, but the extent of what's available is
 64

 1 covered here.

 2 The blue category reflects the open

 3 interest held by hedgers, which we've grouped

 4 commercial participants and swap dealers; and the

 5 green area will be a speculative category

 6 consisting of managed money and the other category.

 7 As you can see in our cash-settled Henry Hub

 8 contract, hedgers hold 71 percent of the long OI,

 9 on average, during this period, and about 94

 10 percent of the short.

 11 Commercials in these categories are 66,

 12 40 percent long-short. In other natural gas

 13 contracts, hedgers hold 91 percent of the long

 14 open interest, and 93 percent of the short, and

 15 commercials make up 80, 57 long-short. For power,

 16 hedgers hold 93 percent of long, 97 percent of

 17 short, and commercials are 80 and -- 88 percent

 18 respectively on the long-short. And environmental

 19 contracts hedgers are 88 percent long, 77 percent

 20 of short.

 21 So as you can see in all these products,

 22 there really is a small amount of speculative
 65

 1 interest, now a lot of this -- this is probably

 2 solely, because the makeup of these contracts,

 3 prior to 2012, these are all existed on an ECM

 4 exempt commercial market where you had to be

 5 pretty much an end user, or the category of who

 6 could participate in these markets, and it was

 7 primarily hedgers and swap dealers, and some

 8 pretty large funds maybe.

 9 But once we converted to futures, the

 10 makeup of these products didn't change. We didn't

 11 get an influx of retail traders. There is not

 12 really, you know, a regular person with a day job,

 13 sitting there, day-trading on his E- Trade

 14 account, power in the Northeast. In these markets

 15 the commercial traders, practically, a

 16 counterparty to every transaction, and many

 17 transactions have two different commercials as

 18 counterparties.

 19 The next slide reflects just a forward

 20 curve of open interest. We just used the recent

 21 day, and we compared Henry Hub and PJM West Hub,

 22 two of the bigger energy contracts, to ICE Futures
 66

 1 U.S., sugar and cotton. And what we want to show

 2 is that, these are unlike Ags, which pretty much

 3 every physically-delivered agricultural contract

 4 has relatively few contracts months with open

 5 interest, and the majority of that open interest

 6 is front-loaded in the first two or three contract

 7 months.

 8 So, you know, I'll just quickly go

 9 through this; on the bottom left sugar, on this

 10 day, had OI spread across 12 months, 12 contract

 11 months, and 75 percent of the total open interest

 12 is in the front three months. Cotton, had OI

 13 across 10 months and 83 -- or 84 percent of the

 14 open interest is in the front three months. In

 15 the upper left Henry Hub had open interest across

 16 142 different contract months, 20 percent of the

 17 total OI is in the front three months; when you go

 18 out the first year, and Henry Hub has a contract

 19 month each month of the year.

 20 Out the first year only 50 percent of

 21 the open interest exists, and to get to 99 percent

 22 of the open interest you are going out 70 months
 67

 1 out the curve. For power, it's a similar look.

 2 OI across 83 contract months; 15 percent of the

 3 total OI is in the front three months, 50 percent

 4 of that is out the front 12, and when you get to

 5 99 percent of open interest, you are going 60

 6 months out the curve.

 7 So clearly these are different. There's

 8 open interest much out the curve, much further out

 9 the curve, and there definitely is a need to have

 10 liquidity in the longer-dated months in these

 11 contracts.

 12 The next slide is -- in just depicting

 13 the number of unique market participants in each

 14 contract month. Again, it's just as of February

 15 20th, 2015. You know, nothing really great with

 16 this, I just want to show that again, out the

 17 curve we have multiple participants. It's a

 18 smooth downward trend, there are no abrupt drops

 19 in the number of participants across any month,

 20 and just active participants. Given our open

 21 interest makeup it exists out the curve, these are

 22 going to be 70, 80 percent commercial companies,
 68

 1 probably even more out the curve, so.

 2 This slide is -- reflects convergence

 3 which, as everyone knows, is the key measure of

 4 how well a futures contract is functioning. And so

 5 what we did here, is over the past four years we

 6 compared Henry Hub settlement price to the

 7 corresponding price for monthly physical gas

 8 deliveries. During this time the average price

 9 difference between those two, was 9/10ths of a

 10 cent or -- I'm sorry -- 0.25 percent of the cash

 11 price.

 12 Over this four-year period there are

 13 only six expirations where the difference was

 14 greater 2 pennies. We also looked at the Dominion

 15 South contract, and the PJM West Hub day

 16 ahead. Dominion South is essentially the Henry

 17 Hub of the Northeast, and in a lot cases it's

 18 bigger than Henry Hub, and a lot of talk about

 19 that, maybe even taking over Henry Hub as the

 20 primary index price of natural gas.

 21 During the period we looked at Dominion

 22 South had convergence of 9/10ths of a penny which
 69

 1 was about one-third of a percent of the cash

 2 price, and for our power contract average

 3 convergence was 50 cents, or just shy of 1

 4 percent of the cash price.

 5 So, what you should take away from this

 6 is that these are well-functioning markets, they have

 7 model convergence, primarily made up of hedgers.

 8 Every day transactions occur -- transactions occur

 9 out the curve which, again, is a sign of a healthy

 10 market in that market participants can enter and

 11 exit the market, not only in the spot month, but

 12 manage their risk out the curve.

 13 All right. Just again, using February

 14 20th pulling out the contract months that traded in

 15 Henry Hub; on this day there were 30 -- or 33

 16 different outright contract months, 4 long-dated

 17 strips, 3 Cals and four quarterlies. Again, this

 18 is a sign that participants, at any time, can

 19 enter and exit the market based on our markup, the

 20 participant categories, these are commercial

 21 companies, moving in and out of the markets because

 22 there's liquidity and they are able to enter and
 70

 1 exit out the curve.

 2 These contracts -- a typical minimum

 3 quantity for a trade is one month's exposure to

 4 gas and power. And as you can see, it's common to

 5 trade an entire year's worth of exposure in one

 6 transaction. We point out the makeup of these

 7 markets, primarily to show that any regulations

 8 aimed at excessive speculation is a solution to a

 9 nonexistent problem in these contracts. And if

 10 you are targeting that in other products, you have

 11 to keep in mind that those regulations are

 12 directly impacting these contracts. So we are

 13 happy to take any questions after the

 14 presentations.

 15 MR. ALLISON: Thank you, Erik. Tom?

 16 MR. LaSALA: Thanks so much, Jim. Thank

 17 you, to all the Commissioners certainly --

 18 MR. ALLISON: Tom, could you turn on

 19 your microphone?

 20 MR. LaSALA: Oh, I'm sorry. Sorry about

 21 that. So, Jim, thank you. Thank you to all the

 22 Commissioners present, certainly Chairman Massad.
 71

 1 I'm happy to present to you today on behalf of CME

 2 Group.

 3 For purposes of my presentation today,

 4 I've assembled a series of slides in this deck to

 5 address a number of matters that I think were

 6 front and center for this Panel. You know, the

 7 detection monitoring of the market, the

 8 composition, liquidity, and getting to the matter

 9 of, you know; is excessive speculation driving

 10 prices?

 11 So I'd like to take you through my first

 12 slide, if I may. What we have here is, I've

 13 chosen to focus this presentation entirely on the

 14 crude oil market for, you know, time-wise, I think

 15 it's front and center with this group. So this is

 16 a summary of the data harvested from CFTC

 17 Commitments of Traders, which as Steve explained

 18 earlier, comes from, effectively, you know, 102

 19 data; goes to CFTC and the exchanges every day.

 20 This is assembled weekly by the CFTC.

 21 This covers a three-year period. What we

 22 effectively did, was we averaged all the weekly
 72

 1 percentages and assembled both the long side and

 2 the short side of the market for that period, for

 3 you. We largely maintained the categories the

 4 Commission uses under commercial; included is

 5 producers, processors, merchants and users.

 6 I think what you see here is, in fact, a

 7 marketplace that is extremely diverse in so far as

 8 its participation on both the long and the short

 9 side, and I stress the latter point there, the

 10 long and the short side is clearly participation

 11 by these entities on both sides of the market, and

 12 it's a key concept that's critical when I get to

 13 the subsequent slides in this presentation.

 14 Move to the second slide. What I tried

 15 to capture for you to give some context about

 16 liquidity in the market is the number of users

 17 that we maintain on a -- this was one particular

 18 day, February 23rd, it was just a snapshot. We

 19 looked at the -- you know, the MPIs of the market

 20 participant IDs in the crude oil futures market on

 21 that day, and you can see the construct of the

 22 amount of participants in the market, ranging,
 73

 1 like you would expect, the greatest numbers on the

 2 front end of the curve, and broadly decreasing as

 3 you go further out the curve.

 4 Generally speaking we see open interest

 5 in futures ranging between 1.5 to 1.7 million

 6 contracts. And again, you would have -- I also

 7 will say to you, that curve would effectively look

 8 very, very similar to this.

 9 If we move to the next slide, what we've

 10 captured here is the following. The CFTC collects

 11 and publishes; I guess what emanated originally

 12 out of a special call some years ago, end-of-month

 13 data that they harvest from participants regarding

 14 index investment in the WTI contract. What I've

 15 done is mapped the -- and this is again, we chose

 16 the -- we did the net long, so you had to choose

 17 as they are, you know, both sides of the market.

 18 We looked at the longs; the short would

 19 certainly be the inverse, the same result. We

 20 chose the longs, mapped WTI index investment which

 21 is converted into contract equivalents for the

 22 period commencing June of '10, all the way through
 74

 1 December of '14. So this is the all month, WTI

 2 Index investment and, again, mapped with it, the

 3 front month price in the NYMEX WTI Futures

 4 Contract.

 5 So if I can summarize for you, the

 6 decline in the net long index investment began

 7 July of 2011. Prices began declining during June

 8 of 2014, three years later. If you look at that

 9 index investment, and look at the price line, you

 10 know, I would conclude to you, there is no clear

 11 correlation in so far as, you know, the index

 12 investment and the pricing in the marketplace. As

 13 a matter of fact, as you see in 2014, as prices

 14 went down, index investment actually increased

 15 very slightly.

 16 In the next slide we relied upon, again,

 17 another CFTC information output, the Commitment of

 18 Traders, which Erik also referenced. This is swap

 19 dealer open interest and, again, harvested. The

 20 swap dealer positions, you know, I say net long,

 21 but in this case, while they go at 1 point

 22 slightly long they, generally speaking, are net
 75

 1 short positions, and again mapped it against

 2 pricing in the spot months.

 3 So from January 2011 through June 2014,

 4 WTI prices basically stayed in a range of 85 to

 5 $105 per barrel, for the most part, while the swap

 6 dealer positions trended from approximately net

 7 long of zero to negative 400,000 contracts. I

 8 will say that, pretty clearly there is no

 9 discernible impact that flowed from the swap

 10 dealer positions as it relates to the price in the

 11 WTI contract.

 12 Since prices began declining in August

 13 of 2014, swap dealer positions, while still not

 14 short, have decreased their net positions by 200

 15 to 250,000 contracts. In other words, the net

 16 long positions of swap dealers have substantially

 17 increased while prices were dropping.

 18 If you can move to the next slide?

 19 Thanks. The next slide captured another segment,

 20 again mapping against the price of the NYMEX crude

 21 market. We are covering, again, the period

 22 January of 2011 through end of January 2015 here.
 76

 1 So between January 2011 and July 2014, prices

 2 fluctuated again between 85 and $105 per barrel.

 3 Money manager net long positions also fluctuated,

 4 approximately 250,000 contracts down to 100,000

 5 contracts, and then back up to 325,000 contracts.

 6 There seems to be no discernible influence evident

 7 during this period emanating from money manager

 8 positions to price.

 9 Money manager net long positions dropped

 10 sharply, about 125,000 contracts, just as prices

 11 dropped by about $10 per barrel. This is in the

 12 August through September 2014 period, but net long

 13 positions effectively still held steady as prices

 14 dropped another $47 per barrel, from October 2014

 15 through January 2015.

 16 I would conclude from this that the

 17 evidence is indicative that there were other

 18 forces in here, fundamental forces, that were

 19 indeed dictating the price, not in fact the

 20 activities and the investment, or the activities

 21 of the money managers in the NYMEX Crude Oil

 22 Contract.
 77

 1 If we could move next to the following

 2 slide, which is, again, harvested from the CFTC

 3 Commitments of Traders Report, here, what we've

 4 tried to capture is, you know, what's the

 5 commercial open interest doing during this period?

 6 Period, again, 2011 through 2015, so between

 7 January 2011 and mid-2013, these prices fluctuated

 8 again in that 85 to $105 range. Commercial net

 9 long positions rose by approximately 300,000

 10 contracts. You know, effectively going -- forgive

 11 me -- thereafter prices continued to fluctuate

 12 until July of '14. Net commercial positions

 13 dropped by approximately 200,000 positions.

 14 During this period there is no

 15 discernible influence emanating from commercial

 16 positions to price. Since prices began falling in

 17 August 14, commercial net long positions have been

 18 shadowing the decline, falling by approximately

 19 70,000 contracts. So it appears the commercials

 20 have increased their short hedges during this time

 21 period which actually makes economic sense.

 22 According to the price decline -- according to the
 78

 1 price decline it appears to have influenced

 2 adjustments to the net long positions of

 3 commercials.

 4 So, again, it seems that the

 5 commercials, in fact, reacted to the price

 6 decline, and again, what I'm trying to shape here

 7 is a marketplace, effectively, most affected by

 8 fundamental factors. What I didn't include, and I

 9 just want to air to the Committee, and I

 10 apologize. Erik had referenced a conversion rate

 11 in the natural gas contract. I did look at that

 12 for 2014, it was 99.39 percent.

 13 I'm certainly available to take

 14 questions but, again, I think the crux of what I

 15 want to put before the Commissioners and the

 16 Committee is a summary of the marketplace

 17 addressing the composition and comparing it into,

 18 in fact, pricing that occurred in the market. So

 19 I hope that this has been helpful, and I'm

 20 certainly happy to take any questions that you may

 21 have. Thank you.

 22 MR. ALLISON: Thank you, Tom. We are at
 79

 1 the appointed end of this session, and we are

 2 going to have Tom and Erik with us next session,

 3 so I'm going to suggest we hold our questions for

 4 Tom and Erik until then. I'm going to take a

 5 minute or two for questions for Steve, if there

 6 are any. So, Ron?

 7 MR. OPPENHEIMER: Would it be possible

 8 to put the slide 11A back up on the screen? All

 9 right. So, this obviously is just, you know, one

 10 segment of the entire Table 11 or Table 11A, but I

 11 look at the number 83 there of potential --

 12 individual unique entities that would have

 13 exceeded the spot physical position limit for

 14 natural gas at 100 percent of the level being

 15 suggested. And I think it was characterized as a

 16 small number, and frankly, to me, it looks like a

 17 pretty large number, but I think that's, you know,

 18 a difference in perspective.

 19 The question that I have, or it's

 20 probably more of a comment than a question, but

 21 if there's a response, that will be great too.

 22 Is, these are either hedgers operating under a
 80

 1 hedge exemption from limits, and part of what

 2 we'll discuss this afternoon is that there is a

 3 significant narrowing in the proposal of what

 4 constitutes a hedge exemption. And so these 83

 5 people may be hedgers who won't be able to

 6 continue with their hedging activities under the

 7 new proposal.

 8 Or, alternatively, I guess they are

 9 speculators and under the proposal, won't be able

 10 to speculate, but I guess, they must be hedgers

 11 actually, and I will take it back, because there

 12 are spot and physical -- spot limits for natural

 13 gas already. So, these are 83 hedgers that if we

 14 narrowed the definition of hedging, will be

 15 impacted, and not only will they individually be

 16 impacted, but the liquidity that they afford to

 17 the marketplace will disappear, and that will

 18 affect the ability of other hedgers to get their

 19 transactions done as well.

 20 MR. ALLISON: Stephen, any further

 21 comment on that point?

 22 MR. SHERROD: I think Ron is accurate.
 81

 1 And in terms of my comments earlier about the few

 2 people, I was referring to the right-hand column

 3 for single month and all month. Definitely this

 4 is about the spot month, where a lot of traders

 5 receive exemptions from the Exchanges currently.

 6 MR. ALLISON: Lael; and then Tyson?

 7 MR. CAMPBELL: I'm going to break your

 8 rule. I'm going to ask Erik a question, because

 9 it kind of follows up on a point that I think Ron

 10 was making. But, you know, Erik, in your

 11 presentation when you were talking about the power

 12 markets, you noted in the electricity market it

 13 was like 94 percent of some of these markets were

 14 hedgers, and that just seemed, I mean I've never

 15 seen that before, that seemed shockingly high to

 16 me. I guess a two-part question. Have you noticed

 17 speculators or non-hedgers becoming less of a

 18 percentage of the market over the years? And what

 19 impact have you seen that have on bid-ask spreads?

 20 MR. HAAS: There's definitely been a

 21 decrease in the number of speculators in the

 22 market, especially out the curve. Once we've
 82

 1 converted our cleared swaps to futures, that

 2 number went down. Liquidity out the curve is --

 3 at times it's, bid-asks are pretty wide. It's -- a

 4 complaint we hear a lot is that markets are too

 5 wide out the curve, there is not enough

 6 participation; what can you do to facilitate this?

 7 The sign showing open interest out the

 8 curve, and the number of participants, that's

 9 Henry Hub but, again, a lot of those power

 10 commercials are using Henry Hub to hedge their

 11 generations, so that's probably reflective of some

 12 power commercials as well, hedging out the curve.

 13 The fact there is still open interest out there

 14 shows that commercials need the hedge, needs to

 15 happen. The markets are illiquid. Bid-asks are

 16 wider, but they still have to do it. It's getting

 17 more expensive and harder to do, but I guess,

 18 what's the alternative, there isn't?

 19 MR. CAMPBELL: Well, I mean it's one of

 20 the 95 percent hedgers, I wish there were a lot

 21 more speculators in the market, because I mean, we

 22 -- it's not only about being able to hedge, it's
 83

 1 also the transparency that these markets provide

 2 us when we are trying to price contracts in the

 3 physical space, and so on and so forth. I mean,

 4 it sounds to me like we may have an excessive

 5 hedging problem. That's really causing some

 6 trouble here.

 7 MR. HAAS: And we do our best to

 8 facilitate participation out the curve, and we are

 9 trying to educate market participants on

 10 accountability levels. We have accountability --

 11 and this kind of gets into the next Panel, so if

 12 you guys want me to stop, we can stop, but --

 13 MR. ALLISON: Well, I think we can

 14 extend this session for a few minutes by taking

 15 the time out of our lunch break so, everything

 16 comes with a cost. But, Tyson, you've got a

 17 question?

 18 MR. SLOCUM: Yes, please. So, Steve, is

 19 it possible to tell us what proportion of the

 20 total market participants this 83 number is?

 21 MR. SHERROD: It's possible. Generally

 22 the Commission has been reluctant to release
 84

 1 summary statistical information in the spot month,

 2 reluctant because we don't want to paint a picture

 3 of how to manipulate the spot month, by showing

 4 how many people are at various sizes. So this

 5 summary data covers two years, and we haven't

 6 given granular data, we haven't, you know, broken

 7 it out by first, second, third day of the spot

 8 month.

 9 MR. SLOCUM: Mm-hmm.

 10 MR. SHERROD: That's something we do in

 11 our -- in our Energy Surveillance Program, and

 12 what -- and Tom does as well, and so does ICE.

 13 Watch the market, and watch participants every day

 14 during the spot period in particular.

 15 MR. SLOCUM: I guess, I think for the

 16 purposes of the comments to assess, you know, how

 17 onerous this position limit rule is, it's kind of

 18 important to quantify whether 83 is a big number

 19 as some say, or a small number, and that's

 20 relative to, you know, the total number of

 21 participants.

 22 I do have another question about data.
 85

 1 You had mentioned that, if I heard you correctly,

 2 that there are elements of the Commitments of

 3 Trader Reports, where the traders are filling out

 4 their designation. So it's not necessarily based

 5 upon their market activity but what category they

 6 fill out in the form. Did I hear that accurately?

 7 MR. SHERROD: Right. We don't know

 8 whether a particular trader's position today is

 9 hedge or spec. What we would know, for example,

 10 for a commercial participant, they may have

 11 indicated on their Form 40 that in general, they

 12 use the particular futures contract to offset

 13 price risks. And so they would be categorized

 14 on that predominant purpose of commercial.

 15 MR. SLOCUM: Okay. And one last

 16 question, if I may. On data, you had mentioned

 17 one issue with the trader IDs and that the CFTC or

 18 another entity was having to manually enter that

 19 data. Are there any other challenges that the

 20 CFTC has with receiving large volumes of data, and

 21 convertibility problems which affect the ability

 22 to analyze some of this? Without compromising any
 86

 1 market integrity issues, of course.

 2 MR. SHERROD: It's always a challenge to

 3 have enough information resources to process

 4 high-volume data. In terms of identifying

 5 traders, we've had a lot of assistance from the

 6 Exchanges over the years. They have an interest

 7 in knowing from the trader IDs, who is trading

 8 during the day, and so that's the process that I

 9 mentioned that has been mostly manual, to identify

 10 and link those trader IDs for the trade capture

 11 report back to the end of the day position reports.

 12 The OCR Rulemaking that the

 13 Commissioners have gone final with, is intended to

 14 try to automate, to a large extent, on our end, and

 15 it puts a -- it puts a significant burden on the

 16 industry to provide that information. But that's

 17 underway, and we've talked publicly a number of

 18 times about the challenges of trying to process

 19 the swap data.

 20 MR. ALLISON: Mr. Chairman?

 21 CHAIRMAN MASSAD: Thank you, Jim. I

 22 wanted to make sure I understand the tables, Erik,
 87

 1 that you presented, and this kind of relates to

 2 the question and the comment that Lael made. You

 3 -- if I understand it, you are saying you are

 4 taking -- you've looked at the open interest and

 5 categorized it by what positions are hedging

 6 positions, and what positions are speculative, or

 7 what amount of the open interest? Is that

 8 correct? And I just want to understand how you do

 9 that.

 10 MR. HAAS: We are using the

 11 Commitments of Traders categories, we are not -- I

 12 don't know, for the environmentals we adjust it a

 13 little bit, we thought a lot of companies were

 14 miss-categorized, and so as we --

 15 CHAIRMAN MASSAD: So, it's just from our

 16 report?

 17 MR. HAAS: This is straight from your

 18 report.

 19 CHAIRMAN MASSAD: So what it represents

 20 is saying, commercial -- anyone who is in the

 21 commercial category is hedging. Is that correct?

 22 MR. HAAS: Yes. For hedging we
 88

 1 included commercial and swap dealers.

 2 CHAIRMAN MASSAD: Maybe, Steve can you

 3 clarify -- I don't think that's the nature of our

 4 report, is it?

 5 MR. HAAS: Yeah, let me clarify. We

 6 are not saying that they are hedging or

 7 speculating, this is the makeup of the market

 8 participants. This is their category that they

 9 are in. This has not taken --

 10 CHAIRMAN MASSAD: I'm sorry. So when

 11 you say hedge is 94 percent, that doesn't mean 94

 12 percent of the open interest is hedging?

 13 MR. HAAS: No. That means 94 percent

 14 of the open interest is held by a company in the

 15 hedge category.

 16 CHAIRMAN MASSAD: So it's really hedge

 17 equals, if you designated yourself as commercial

 18 or swap, you are calling them a hedger, and if you

 19 designated yourself as the other categories, you

 20 are calling them a speculator. That's all this

 21 really says.

 22 MR. HAAS: Yeah that's --
 89

 1 CHAIRMAN MASSAD: Okay. Thank you.

 2 MR. HAAS: Yeah -- We are just taking

 3 it directly from the Commitment of Traders Report,

 4 to demonstrate the makeup of the participant

 5 categories. We are not saying that this is

 6 reflective of how anyone is trading.

 7 CHAIRMAN MASSAD: All right. Thanks.

 8 MR. ALLISON: And Paul Hughes had a

 9 question. I think this will be the last question.

 10 MR. HUGHES: Just real quick. And this

 11 is really for Erik or Tom. Great data obviously,

 12 but do you have any data that suggests kind of the

 13 overall growth of your markets or your Exchange

 14 when it comes to power or natural gas. In other

 15 words, are you seeing anything that would suggest

 16 a movement from the OTC markets, coming onto the

 17 Exchange?

 18 MR. HAAS: I would say recently what

 19 we are seeing, and could be troubling is,

 20 participants leaving the futures market. It's

 21 less liquidity, it's harder to trade, it's harder

 22 to get exemptions. And I was going to address
 90

 1 before, we'll hear from commercials, who are

 2 having a hard time hedging out the curve. What can

 3 we do to help? So we'll try and talk to other

 4 participants and say accountability levels aren't

 5 limits. You are able to exceed them, you know, as

 6 long as the markets are operating, and it's -- and

 7 we are undertaking an educational process with a

 8 lot of these participants.

 9 These aren't, you know, the traditional

 10 futures, players I guess that, kind of really

 11 understand what it means. We have -- you know,

 12 noncommercial companies call us and say I'm going

 13 to put on this position out the curve, it's going

 14 to exceed accountability. Is it ok?

 15 And it's tough, we try and tell them

 16 that, you don't have to call us, we don't want to

 17 -- we don't want to be the factor that disrupts

 18 the activity. If you have a well-intended

 19 position to put on, put it on. So getting back to

 20 your question, because of this, liquidity has

 21 dried up, people leave the market. We are seeing

 22 more and more participants exit the futures
 91

 1 market, overall, going to, I guess, bilateral

 2 exposures with the counterparty instead of having

 3 their risks covered on an Exchange and cleared.

 4 COMMISSIONER WETJEN: Have you guys

 5 looked at the reasons? So, it's one thing if they

 6 asked you how you can help as the Exchange

 7 Operator, but what do you speculate are reasons

 8 for the dry up?

 9 MR. HAAS: From what we hear, and

 10 again we are not -- a lot of times we are not --

 11 even if we ask we don't get the answers.

 12 Honestly, like, if they are going to take their

 13 business off Exchange. At least I'm (inaudible)

 14 on compliance, I'm not trying to kind of cross

 15 the line too much with how companies are operating,

 16 but their answer usually is; it's more expensive

 17 to trade futures right now. A lot of people would

 18 rather have the counterparty risk and deal with

 19 that, versus having to putting a futures position

 20 on out the curve.

 21 There not being liquidity when they have

 22 to get out of it. If they have to get out of it,
 92

 1 they are going to have to pay up considerably.

 2 Those are all risks that, I guess, these market

 3 participants are weighing and choosing to just

 4 have a bilateral exposure.

 5 MR. ALLISON: Mr. Chairman. Do you have

 6 another question?

 7 CHAIRMAN MASSAD: No. It's all right.

 8 MR. ALLISON: Okay. Knowing from -- Let

 9 me put an end to this session for now. It is by my

 10 watch 11:46, I want to start the second Panel,

 11 promptly at noon. We'll have Tom and Erik back

 12 with us. So, Tom, I know I didn't call on you,

 13 but if you need to roll that comment into your

 14 next comments, feel free. You see the --

 15 SPEAKER: (Inaudible) up until lunch.

 16 MR. ALLISON: By my watch it is

 17 currently 11:45 and we are starting the next Panel

 18 at noon, it would be 1:00 o'clock in some time

 19 zone, but not the time zone we are in, I think.

 20 Join me, please, in thanking this Panel.

 21 (Recess)

 22 MR. ALLISON: So as we regather. Mr.
 93

 1 Commissioner, I know we did not take time this

 2 morning to introduce ourselves around the table.

 3 I think that might be a good practice while people

 4 are gathering. I'm Jim Allison, with

 5 ConocoPhillips. And Ron, if you'll pick up; and

 6 we'll just rotate around the table.

 7 MR. OPPENHEIMER: Sure. Thanks. I'm

 8 Ron Oppenheimer; I'm representing the Commercial

 9 Energy Working Group.

 10 MR. McCOY: I'm Bill McCoy; and I'm

 11 representing the Futures Industry Association.

 12 MR. DURKIN: I'm Brian Durkin, and I'm

 13 representing the CME Group.

 14 MR. SLOCUM: Tyson Slocum; I direct the

 15 Energy Program at Public Citizen, a non-profit

 16 consumer advocacy group.

 17 MS. BROWN-HRUSKA: I'm Sharon

 18 Brown-Hruska, and I'm representing Tulane

 19 University's Energy Institute.

 20 MR. JACKSON: I'm Ben Jackson; I'm

 21 representing ICE.

 22 MS. SHARP: I'm Victoria Sharp, and I'm
 94

 1 representing Citigroup.

 2 MR. JOHNSON: Vincent Johnson, for BP.

 3 MS. WIGGINS: Dena Wiggins, with the

 4 National Gas Supply Association.

 5 MR. CAMPBELL: Lael Campbell, here; on

 6 behalf of Exelon Generation.

 7 MR. CREAMER: Rob Creamer, representing

 8 the Futures Industry Association Principal Traders

 9 Group.

 10 MR. CREEK: Todd Creek, with ICAP

 11 Energy.

 12 MR. GILL: Mike Gill, representing

 13 Independent Petroleum Association of America.

 14 MR. HUGHES: Paul Hughes, with Southern

 15 Company.

 16 MR. BRANDENBURG: Robert Brandenburg,

 17 with Peabody Energy.

 18 MR. WASSON: Russ Wasson, with the

 19 National Rural Electric Cooperative Association.

 20 MR. THORNHILL: I'm Herbert Thornhill,

 21 I'm with NRG Energy; a competitive power producer.

 22 MS. KELLY: I'm Sue Kelly, with the
 95

 1 American Public Power Association; and probably

 2 most relevant to this group, all my members are

 3 considered Special Entities, Units of State and

 4 Local Government involved in electric utility

 5 matters.

 6 MR. PROKOP: Mike Prokop, with Deloitte

 7 & Touche.

 8 

 9 MR. COSGROVE: I'm Michael Cosgrove,

 10 with Vectra Capital; we are a proprietary trader.

 11 COMMISSIONER GIANCARLO: And Jim, may I just 

 12 add that I -- I just want to recognize Professor

 13 Brown-Hruska, who is not only a Distinguished

 14 Professor, but is also a Former Commissioner and

 15 Acting Chairman of the Commodity Futures Trading

 16 Commission, and we are honored to have you with us

 17 today. Thank you very much.

 18 MR. ALLISON: Thank you, all. Tom and

 19 Erik. Erik?

 20 MR. HAAS: So our second presentation is

 21 going to focus a little bit more on how we

 22 operate, and our procedures. Starting out, you
 96

 1 know, we are asking; why is there a need for

 2 change? The existing regulatory regime for power

 3 and gas contracts works. Any undue influence on

 4 these markets, whether it's from regulations or

 5 market participants' activity, directly impacts

 6 commercial companies and end users; these markets

 7 are made up primarily of companies that operate in

 8 the energy industry, and the exhibit model

 9 convergence.

 10 The one-size-fits-all approach to

 11 futures does not work. Again, all 500 of these

 12 smaller contracts are now futures. They are not

 13 the big names that most people think of, but every

 14 regulation, all the proposed regulations directly

 15 apply to them. Single and all-month limits will

 16 only serve to eliminate already thin liquidity out

 17 the curve. Spot month limits must be updated, and

 18 set at realistic levels, and on top of that three

 19 longstanding commercial hedging practices are at

 20 risk of being eliminated.

 21 So can we start by explaining our market

 22 regulation process; to ensure our markets are not
 97

 1 subject to influence from market participants, we

 2 take a bottom-up approach. We start out, we take

 3 in a lot of data from audit trail, position data,

 4 social media and new sources. We try to

 5 understand how participants utilize the market so

 6 that we can offer better guidance on complying

 7 with our rules.

 8 We use all this data, and what market

 9 participants are doing, to try and identify

 10 indicators of market stress, whether it's in the

 11 current market or what could become stressful in

 12 the future. Our primary goal, since your

 13 compliance with the Exchange and CFTC rules, and

 14 proactively maintain the integrity of our markets,

 15 and confidence in our market participants; and to

 16 facilitate the price discovery and risk management

 17 process.

 18 At a high level, the single and all

 19 month combined reviews are aimed at gauging a

 20 position concentration's impact on the market.

 21 These were never intended to serve as a real-time

 22 market protection; it should not be implied in
 98

 1 such a way. To make a determination on the impact

 2 of a position concentration's influence on the

 3 market, takes a considerable amount of analysis.

 4 Many factors are considered, and rarely ever is

 5 the position itself, versus the level, the sole

 6 factor of determining whether it's going to have

 7 an impact on the market.

 8 We utilize position accountability

 9 instead of limits. And this gives us the ability

 10 to provide the necessary oversight on any market

 11 participant when needed, but to also ensure that

 12 there's sufficient liquidity so that market

 13 participants can operate, and enter and leave the

 14 market.

 15 We disagree with the 10 by 2.5 percent

 16 formula as a necessary level, and have honestly

 17 found that the level equal to the spot month's

 18 limit seems to work for these contracts, since --

 19 as an accountability level that is -- since that's

 20 always the backdrop to a position out the curve.

 21 So if we are looking at a position three months

 22 out the curve right now, we can determine, at the
 99

 1 current time, this position is not problematic,

 2 but our next question is going to be, as that

 3 position approach its limits, will that have an

 4 influence on the market? Will, unwinding or

 5 liquidating that impact the market?

 6 So accountability levels give us the

 7 flexibility to make these determinations. The

 8 rules themselves, give the Exchange the ability

 9 to determine that a market participant cannot

 10 increase their position any further. In extreme

 11 scenarios we can force a participant to reduce

 12 their position in an orderly manner. Or, we can

 13 make a determination that the position is not

 14 having an impact, and just maintain an open

 15 dialogue with them or the participant throughout

 16 the process that position comes into the limit.

 17 Next, we'll talk about deliverable

 18 supply estimates. We agree the spot month limits

 19 must be set based on updated deliverable supply.

 20 But critical to this is that the deliverable

 21 supply itself is calculated appropriately. Again,

 22 a one-size-fits-all approach does not work for
 100

 1 futures. And the basis for deliverable supply in

 2 agricultural commodities does not apply to energy.

 3 Given the interconnectedness of natural

 4 gas and power, as those maps on our first

 5 presentation show, we believe that the estimated

 6 deliverable supply needs to consider natural gas

 7 or electricity that are in a different location,

 8 but can still serve demand in a certain area

 9 through the transportation of that commodity.

 10 For natural gas, we believe that means

 11 an estimate based on pipeline capacity, as an

 12 indicator of how much gas can actually be

 13 delivered. And for power, estimates must include

 14 transmission. It cannot be based solely on load

 15 or generation at a certain area.

 16 So I'm going to go through a very,

 17 overly simplistic example of deliverable supply

 18 for natural gas. In this example, the supply in

 19 natural gas on the left is greater than both

 20 pipeline capacity and the demand. Peak demand is

 21 greater than pipeline capacity. Off-peak demand

 22 is generally less than capacity, but again, the
 101

 1 pipeline itself can also serve as a version of

 2 storage to hold gas until demand increases and

 3 therefore prices increase for someone to resell it

 4 at a later date.

 5 So this is, again, a very hypothetical

 6 example. During a period of peak demand using

 7 this example, the demand for gas is 650, it can be

 8 met given the supply is 1,200; however, the

 9 maximum amount of gas that actually be fulfilled

 10 or delivered to fulfill demand is only 600. At no

 11 point in this example, and this is typical in the

 12 Northeast, and that's why you see our polar vortex

 13 prices to heat your homes, and everything, go up;

 14 you are not going to be able to deliver the

 15 necessary amount of gas to meet that demand.

 16 So we believe that the best estimate for

 17 deliverable supply for natural gas would be the

 18 pipeline capacity, as that is -- serves to reflect

 19 only the amount of gas that actually can be

 20 delivered. And in these interconnected markets it

 21 is readily available.

 22 The next slide touches on bona fide
 102

 1 hedges, and the proposed rules putting at risk

 2 three longstanding commercial hedging practices.

 3 We strongly believe that cross commodity,

 4 anticipatory, and unfixed hedging must be

 5 recognized by the Commission, and the Exchange is

 6 given flexibility to review and grant exemptions

 7 based on exposures and where appropriate.

 8 Our approach to these is no different

 9 than how we approach any other bona fide hedge

 10 exemption. Market participants, we require that

 11 the market participants demonstrate that their

 12 futures position is economically equivalent to the

 13 underlying risk. Require that they demonstrate

 14 that risk. The participant has to justify the

 15 exposure and the level, and in the end, the

 16 Exchange makes the determination on whether the

 17 exemption, even if it can fully be supported, is

 18 appropriate for the market.

 19 And just because the full amount of

 20 what's requested can be justified based on market

 21 conditions, the Exchange can actually approve

 22 levels less than that, and step up the exemption
 103

 1 level as needed, as the market can handle it.

 2 Finally, I'll just say that we have --

 3 we feel that the core responsibility of the

 4 Commission is kind of missing in some of the

 5 rhetoric. The CFMA amended the Commodities

 6 Exchange Act to include a section titled, Special

 7 Procedures to Encourage and Facilitate Bona Fide

 8 Hedging. I'll admit it's geared towards Ags, but

 9 everything we deal with is geared toward Ags, so

 10 I'm going to say it still applies for energy.

 11 This section directed the Commission to

 12 consider rules that increased the ease with which

 13 producers may participate in contract markets.

 14 Provide flexibility and the minimum quantities to

 15 better allow producers to hedge risk, and most

 16 importantly, I think encourage contract markets to

 17 facilitate participation of producers.

 18 So it's clearly intended that not only

 19 is the Commission is supposed to police and

 20 regulate these markets, but there is a

 21 responsibility to encourage participation and make

 22 sure that producers can operate. And part of that
 104

 1 is making sure for someone to take the other side

 2 of the market.

 3 I think what's shown today in the

 4 proposed rules, show it's just getting harder for,

 5 not only producers to operate and get exemptions,

 6 but it's harder for the contract markets to

 7 maintain the participants to take the other side

 8 of these positions. I'm happy to answer any

 9 questions about this. These presentations are

 10 done.

 11 MR. ALLISON: Thank you, Erik. And

 12 again, I think it would be helpful to hear from both

 13 speakers before we take questions. So, Tom?

 14 MR. LaSALA: Thanks so much, Jim.

 15 Thanks, Steve. Very good. Thank you. So I'd

 16 simply like to begin covering a couple key topics

 17 here which will be accountability and the

 18 administration of hedge exemptions. Just a quick

 19 backdrop on market reg resources and

 20 responsibilities at CME Group, just very quickly;

 21 approximately 180 employees dedicated to market

 22 reg and surveilling all of our markets.
 105

 1 I'm going to focus in the presentation

 2 today on energy, so I'm focusing on the activities

 3 of our Market Surveillance Team, which is composed

 4 of 56 employees in total across two locations, 20

 5 of which are completely committed to energies and

 6 metals, and some of those is high- level duties

 7 they have.

 8 You've heard before, you know,

 9 monitoring large trader data, detecting and

 10 deterring, preventing market manipulation,

 11 real-time price aberrations to the point that came

 12 up in the prior Panel, about volume during --

 13 activities. Steve mentioned linking execution

 14 accounts to large trader accounts, just so the

 15 Committee understands.

 16 We do have a manual process for that,

 17 and currently we can -- we have linked in excess

 18 of 90 percent of the execution accounts to the

 19 large trader accounts; which effectively means, if

 20 there were in price aberration, at some point in

 21 the day we very quickly run an analysis and can

 22 see, with a 90-plus percent accuracy, who were
 106

 1 the accounts that were buying, selling trading

 2 during that price -- pricing period.

 3 Again, this group further looks to

 4 ensure the orderly liquidations, you know,

 5 compliance with Exchange-imposed position limits;

 6 exemptions, accountability levels, EFP

 7 transactions as well as overseeing the delivery

 8 process; again, the focus here in this

 9 presentation, in Panel 2; accountability across

 10 the curve and the long history of managing spot

 11 limits.

 12 So, first and foremost, position

 13 accountability. Most of you are familiar with it,

 14 and certainly many at the table, allows the

 15 Exchange to get more detailed information from the

 16 position holder. What's very special about it is

 17 we basically have the authority to order a trader

 18 not to increase the position, or to order a

 19 liquidation; if it's so appropriate.

 20 We manage that responsibility outside of

 21 the curve. There's some science here. Just to

 22 put some context. You saw the slide I put up in
 107

 1 Panel 1, showing, you know, the amount of traders

 2 across the curve. As you get further out the

 3 curve there's less -- there's naturally less

 4 liquidity, less players. You have to have some

 5 kind of flexible mechanism, of realizing that the

 6 first trade in contract month, you know, Tom and

 7 Erik can trade 500 contracts, we own 100 percent of

 8 the open interest.

 9 And you can't defer -- you know, you

 10 can't squash that; you need that liquidity to

 11 grow. But as we see open interest grow in these

 12 back months, we become more focused on those

 13 concentrations, and as you very well might

 14 imagine, our sensitivity around concentration

 15 changes along the curve. And I'll just give you

 16 some rough context around that. So in back

 17 months, we are looking at positions that are

 18 approximately, you know, 45 -- when you get to 45

 19 percent of the open interest we are taking an

 20 interest.

 21 In the third through the sixth month,

 22 you know, we are looking at them, at around the 30
 108

 1 to 35 percent level. Second month 20 percent to

 2 30 percent, and in the front month we are very

 3 focused at 15 to 20 percent. So it's a measured

 4 approach on how to monitor and intervene, and I

 5 will say that as we look further in this

 6 presentation, on this slide, I think we have to

 7 realize that the current accountability thresholds

 8 are set very, very low.

 9 I know in the past there have been

 10 presentations that the accountability regime has

 11 been termed as speed bumps with violations. And I

 12 think we need to get some context of what the bump

 13 is, and what the violation is. And so what I

 14 simply tried to map out for you, was looking at an

 15 average of what -- if you look at the front month,

 16 what that accountability trend level translates

 17 into, as an average percent of open interest; so

 18 in the front month, when it becomes spot, and

 19 let's look at crude oil, 10,000 contracts.

 20 Yeah. Someone can have more than 10,000

 21 contracts, it's generally going to represent 1.86

 22 percent of the open interest. If you were to look
 109

 1 at the crude oil again, the all-month accountability

 2 threshold, the 20,000-level, represents less than

 3 1 percent; so the point I'm driving at here, is

 4 that they are set very, very low to maximize our

 5 regulatory authority to, where appropriately,

 6 intervene, ask questions, and take action.

 7 And I'm going to get into some examples

 8 of what we've observed in 2014, with some

 9 specificity. I want to mention just additionally,

 10 that the accountability is applicable, not only on

 11 a futures equivalent basis, but on the futures

 12 only. And I note that was lessons learned from

 13 Amaranth, where, focusing a bit more on the

 14 futures only, you know, probably would have been

 15 effective a bit sooner in that process.

 16 So we modified our rules as a result of

 17 that lesson learned, and we do, regularly review,

 18 not only on a futures equivalent basis, but on the

 19 futures only. And you can imagine, obviously, in

 20 some context where there's options activity that

 21 compresses that view.

 22 Items considered on the next slide. In
 110

 1 terms of accountability, the size of the open

 2 interest, the nature of the customer's business;

 3 position relative to others, the type, where in

 4 the curve? What are the fundamentals? Is the

 5 market congested? Historical patterns, and is

 6 there some abrupt accumulation or uncharacteristic

 7 behavior by the participant?

 8 On the following slide, I tried to

 9 capture for you to demonstrate, in real terms,

 10 what we observed in 2014 across our four core

 11 markets. And, again, for purposes of time, I'll

 12 focus on crude oil. So this is the application of

 13 accountability in these four core markets, doing a

 14 snapshot of one day a quarter.

 15 What did we see? So, in crude oil, the

 16 range of the largest position in the front month

 17 was approximately between 10,000 and 62,000

 18 positions representing anywhere from 1.8 to 11.12

 19 percent; on average, 3.94. When you look at the

 20 all months, the range of parties in excess of the

 21 20,000 the positions would range from 20,000 to

 22 approximately 78,000; again, less than a percent
 111

 1 to 3.41 percent, or an average of 1.75. And

 2 again, there were 22 parties that were captured in

 3 the all, 18 in the front month.

 4 What I don't have here is -- but I'll

 5 state it -- you can imagine that during this

 6 period of time, these parties were over these

 7 accountability thresholds, at these low levels we

 8 did not necessarily see a problem with that, and

 9 they were over for multiple days, at these low

 10 concentration levels.

 11 So I'm going to, certainly limit the

 12 presentation to crude oil, but if anyone has any

 13 questions on the others, I'll certainly, later, be

 14 willing to respond to it. I will note to you that

 15 in 2014, we certainly did administer a host of

 16 holds. They were primarily in natural gas in

 17 single months.

 18 We compared this to previous periods.

 19 It was less, and I'll just simply add for the

 20 Commissioners and the Committee, I think the

 21 reason we observed less was the fact that we have

 22 been vigilant and very active in communicating
 112

 1 with market participants early in the process.

 2 Some of those horizons that I gave you in terms of

 3 open interest and concentration as to where we are

 4 going to get concerned. I think the market has

 5 come to understand those sensitive touch points,

 6 and before they get to a point of being

 7 significantly in concentration where we are

 8 reaching out and having to issue a hold, they are

 9 sensitive to that.

 10 If I can now move just very quickly on

 11 exemptions in the spot month, again, just opening

 12 statement on the exemptions. We obviously, as

 13 Erik has stated, we believe in position limits in

 14 the spot month. We have them in all our

 15 contracts; we have had for a long time. We do

 16 believe they are an extremely, extremely useful

 17 tool in managing concentrations, managing, you

 18 know, what could be excessive speculation and, you

 19 know, setting them properly is, in fact, critical.

 20 One set -- we've got three flavors, if

 21 you will, of exceptions, the straightforward

 22 1.3(z) bona fide hedging. Risk management which
 113

 1 is very much one that we are, here, on this Panel,

 2 focused on which incorporates some of the cross

 3 hedging, as well as the anticipatory

 4 merchandising, and arbitrage or spread exemptions.

 5 On the following slide, I've laid a very

 6 detailed map for you, of the type of exemptions

 7 that we currently have outstanding across our four

 8 core contracts. So, again, let's just quickly go

 9 through it, so that you have some context as to

 10 this with crude oil, hedge. There are three

 11 exemptions where someone's -- where their party's

 12 exemptions are solely 1.3(z), so they haven't put

 13 forward to us in the application process that they

 14 are seeking to do any type of cross hedging, any

 15 type of anticipatory merchandising, any type of

 16 inter-market arbitrage, NYMEX versus ICE, or ICE

 17 Europe, there are three.

 18 Then you see the different deviations,

 19 14 open where the parties are a combination of

 20 hedge and risk; 3 where they are already in all

 21 three, and the other blends, if you will. So

 22 there are 38 open, if I ask you to go over to the
 114

 1 total, so across all four, there are 154 flavors

 2 of exemptions open in the four core contracts.

 3 Eight-five unique entities, translation, there are

 4 obviously certain entities that have got multiple

 5 exemptions across the various markets.

 6 Some of the key components of the

 7 exemption approval process; first, people request

 8 size, and they are approved for a certain

 9 position. This is not an open-ended exemption, a

 10 party could have all the physical anticipatory,

 11 whatever exposure that might -- you know, it might

 12 be real, but we evaluate what the market can

 13 handle. Is that position, in itself, going to

 14 potentially cause the concentration, regardless of

 15 if it's bona fide?

 16 And we grant those exemptions, you know,

 17 based on serious consideration of not creating a

 18 concentration by size alone in any of these

 19 markets. We can certainly order a freeze or

 20 reduction in anyone's positions, even if they are

 21 subject to an exemption; we could modify those

 22 exemptions at any time. Steve mentioned earlier,
 115

 1 they are generally open for a one-year period. At

 2 any point in time there, we can interrogate those

 3 exemptions, terminate those exemptions, modify

 4 those exemptions.

 5 And again, all those deviations of what

 6 we can do, or on a case-by-case basis, based on

 7 the activity of the entity, market conditions, and

 8 so on. One of the points of key importance for us

 9 is, in the context of the exemptions which we

 10 administer in the spot month today, in the current

 11 proposal you've heard and know, there are certain

 12 types of exemptions that, seemingly, would cease

 13 to exist.

 14 We have those allowable today in the

 15 spot market. Those, you know, under the risk

 16 management and the arbitrage. You know, we manage

 17 what might be those exposures in the outer month

 18 through accountability. It's my position that

 19 tuning down, taking away those types of

 20 exemptions, would in fact be detrimental to the

 21 marketplace, and I'll give you an example.

 22 Cross hedging, someone cross hedging jet
 116

 1 fuel in the spot month using ULSD. You know, we

 2 have granted those kinds of exemptions, and it has

 3 been our observation that those commercial

 4 participants provide a valuable, valuable role in

 5 the price discovery process. If you take them

 6 out, you know, there's a -- I'm very concerned,

 7 that you will strip out some of that liquidity,

 8 the bid-ask will get wider, and in the end, I'm

 9 not sure what good we've served here.

 10 I know that administration of these

 11 exemptions is critical, we commit that time, but

 12 then, again, I would certainly caution the Agency

 13 to be very careful with how we handle the

 14 exemptions in a forward-looking kind of a way.

 15 Furthermore, to the extent that the Agency deems

 16 that a Federal structure for the spot month would

 17 be appropriate, on the topic of deliverable

 18 supply, and limits.

 19 You know, we would urge the Agency to

 20 conduct -- review the deliverable supply analysis

 21 that exchanges have conducted, and then -- if,

 22 again, if we were going to a Federal structure,
 117

 1 consult with those exchanges to, in fact, set

 2 position limits at an appropriate level up to 25

 3 percent. And I stress the "up to" because I don't

 4 think that just tuning numbers to the 25 percent,

 5 which we can argue is arbitrary; we can have all

 6 kinds of debate on what the right number is, but I

 7 think there needs to be proper regulatory

 8 discretion applied on a case-by-case basis.

 9 So, I wouldn't, hypothetically, although

 10 -- you know, deliverable analyses in these four

 11 core markets have been supplied. I wouldn't

 12 advocate in one fell swoop, moving and quadrupling

 13 limits. I think it would be an imprudent move on

 14 our part.

 15 Lastly, I'll conclude by saying that I

 16 think the way we have managed the exemptive

 17 process, and the accountability paradigm, has been

 18 one that's promoted liquidity. I think, as you

 19 saw from the first presentation, in crude oil like

 20 the other core markets, we have a very, very

 21 diverse makeup of participants, speculators which

 22 are providing, valuable, valuable, liquidity
 118

 1 across the curve, and it is valuable, and it has

 2 its place, that stated, the spot month period is a

 3 critical period, we need to have convergence, we

 4 think that that tool of limits is a very, very

 5 productive one.

 6 So, with that, I thank you for the

 7 opportunity to have spoken to you today, and

 8 certainly available to answer any questions.

 9 MR. ALLISON: Thank you, Tom. So we've

 10 heard from both Exchanges about the importance of

 11 accountability levels outside the spot month. The

 12 proposed rule instead calls for limits. And I

 13 know Bill McCoy has been looking at this issue

 14 including some legal analysis. So, Bill, can I

 15 call on you to talk about what you've been doing

 16 for FIA on that?

 17 MR. McCOY: Yes. Thanks, Jim. FIA is

 18 obviously, with its members, many of which include

 19 commercial market participants, but its

 20 intermediaries have many commercial market

 21 participants, their clients. We could echo the

 22 comments Erik and Tom have said, because we think
 119

 1 that position accountability in the non-spot

 2 months has proven to be really an effective and

 3 flexible tool, in terms of monitoring and

 4 preventing excessive speculation. And the two

 5 exchanges have had a long history in the success

 6 and how they've administered it.

 7 And so of course in discussing this, and

 8 the question ultimately about our Federal regime,

 9 before addressing, first an obvious point that we

 10 thought we'd make, is that the Commission,

 11 obviously, can first conserve resources and

 12 proceed as it's studying what impact of a position

 13 limit regime is, should it decide not to impose

 14 limits in the non-spot months, for various energy

 15 contracts, by delegating to the DCMs, the

 16 authority, to have their own position

 17 accountability regime as they have had, and to

 18 allow that to continue.

 19 Now obviously that would only be

 20 applicable with respect to the products on

 21 exchanges and such, so the real question is, what

 22 about the Commission's authority to adopt a
 120

 1 position accountability regime as opposed to the

 2 hard position limits in the non-spot months? So

 3 we've been giving it some thought through a group

 4 of us at FIA, and we would think of that, there

 5 are a number of provisions that the Commission can

 6 rely on, for its authority to establish a position

 7 accountability regime.

 8 And I would start by saying, it all --

 9 it's at the scoring a general theme that these

 10 provisions support the proposition that Congress

 11 having authorized the Commission with the

 12 authority to impose hard position limits, in order to

 13 deter and to diminish excess speculation, suggests

 14 that clearly that the Commission has authority to

 15 establish a less restrictive regime, where it

 16 thinks the hard limits are not necessarily, not

 17 appropriate, and therefore a less restrictive

 18 regime of position accountability levels. In

 19 light of the fact of the other part of the

 20 mandate, that the Commission consider the impact

 21 of any of these regimes on liquidity and the price

 22 discovery function.
 121

 1 So, these provisions, I'll start with

 2 Section 4a(a)(1), which is obviously the key

 3 provision, in which the Commission can

 4 determine that the position limits, they can make

 5 the determination under the provision that the

 6 position limits outside the spot months are not

 7 necessary.

 8 And in doing so, as I'll combine with

 9 the other provisions, reach the conclusion that in

 10 order to prevent excessive speculation outside the

 11 spot month, it could implement a Federal -- or a

 12 combined Federal and Exchange Administered

 13 Position Accountability Regime.

 14 The Commission could rely on its

 15 authority under 4a(a)(7), to exempt the non-spot

 16 month positions from hard position limits, while

 17 implementing the authority, which I'll speak of,

 18 regarding an accountability regime. Third,

 19 under Section 4a(a)(2), Congress has directed

 20 the Commission to establish limits on the amount

 21 of positions as appropriate, other than bona fide

 22 hedging positions, that may be helped by a person.
 122

 1 Well the Commission can, with

 2 discretion, well the provision provides the

 3 Commission with the discretion, to establish the

 4 most appropriate methodology to limit the amount

 5 of positions that a person may hold, so Congress

 6 repeated this authority in 4a(a)(3): "The

 7 Commission shall, as appropriate, set limits for

 8 the spot month, each other month, and the

 9 aggregate number of positions."

 10 So, at FIA we believe that the

 11 accountability levels are another means to prevent

 12 excessive speculation, and manage positions that

 13 may constitute disorderly trading or market

 14 abuses, and that the discretion that the

 15 Commission has to do so, where it deems that the

 16 need for hard limits are not necessary, would

 17 support its ability to do so.

 18 Once the Commission implements a Federal

 19 or Exchange Administered Position, Accountability

 20 Regime, it has the statutory and regulatory

 21 authority to direct market participants to reduce

 22 its positions if they should pose a threat of
 123

 1 excessive speculation. And I think here the key

 2 is Section 8a(5) of the Commodities Exchange

 3 Act, where the Commission has its general

 4 rulemaking authority to make and promulgate rules

 5 which, in the judgment of the Commission, are

 6 reasonably necessary to effectuate any of the

 7 provisions or to accomplish any of the purposes of

 8 the Chapter.

 9 So the authority to direct market

 10 participants to reduce positions above

 11 accountability levels, can be deemed to be

 12 reasonably necessary to effectuate the

 13 Commission's authority to prevent excessive

 14 speculation, under Section 4a(a)(1), and to

 15 administer a position accountability regime.

 16 So this discretion granted by 8a(5),

 17 combined with the other provisions, would, I

 18 believe, be supportive of a view that the Commission

 19 can reach, that to the extent that hard limits are

 20 not necessary in the non-spot month, and Congress

 21 has granted it, this tool which in position

 22 limits which is more rigid than the position
 124

 1 accountability that the -- that the Commission

 2 can, to address the issue of excessive speculation

 3 without impairing liquidity, and without

 4 disrupting the price discovery function, could

 5 adopt a Position Accountability Level Regime as a

 6 less restrictive methodology.

 7 MR. ALLISON: Thank you, Bill. And the

 8 details I assume will be in FIA's comments in the

 9 next 30 days?

 10 MR. McCOY: We are anticipating it.

 11 MR. ALLISON: Thanks. Questions for

 12 Erik and Tom? Dena?

 13 MS. WIGGINS: I just had a question for

 14 Erik back -- I believe it's on slide 6 -- on the

 15 deliverable supply estimate. And obviously, it's

 16 in our comments, we've said it many times before

 17 that we believe that if there are going to be

 18 limits, that should be based off of an updated

 19 deliverable supply estimate, so it's just --

 20 regardless of how it's done or whether it's phased

 21 in, or how it's updated, we obviously believe it

 22 ought to be updated.
 125

 1 But I just had a question on your

 2 proposal, and how you would update it, to use the

 3 simple diagram that you had up there, of the flow

 4 direction. Is that data taken from the FERC 284.12

 5 reports on pipeline capacity?

 6 MR. HAAS: Essentially, yes. We've

 7 gotten our data from -- not from FERC, from a

 8 third party taken for its data, Bentek, primarily

 9 from (inaudible), we recognize that that's

 10 interstate pipeline.

 11 MS. WIGGINS: Right.

 12 MR. HAAS: And it is excluding in-state

 13 activities, but it's publicly available, it's very

 14 complete, it's trusted, it's well-known, it's a

 15 standardized number. And is it the actual number

 16 of supply? No. But to get the actual number is

 17 not something that's easily replicated, and it's

 18 going to take a considerable amount of non-public

 19 data.

 20 MS. WIGGINS: So it strikes me this

 21 would be a somewhat conservative number?

 22 MR. HAAS: Yes. I mean -- you can look
 126

 1 in the example, if you could take supply, the

 2 actual supply of gas, even the local areas, and

 3 it's going to be greater than the pipeline

 4 capacity, so what we feel that this is, again, the

 5 amount of gas that's -- the best way to estimate

 6 the amount of gas that's readily available for

 7 delivery -- We are -- we have to meet the rules as

 8 to how we can estimate the deliverable supply.

 9 So, the supply -- this is a hypothetical

 10 example but it is realistic -- the supply is the

 11 supply, that's closer to the real number, but

 12 again, you can't take delivery of -- in this

 13 example, 1,200. You can only take delivery of

 14 600. So we wouldn't want to base our limit off of

 15 an amount that's not deliverable.

 16 MS. WIGGINS: Right. Thank you.

 17 MR. ALLISON: Rob?

 18 MR. CREAMER: Thank you. I just wanted

 19 to make a point. You know, obviously I represent

 20 the Principal Trading community, and largely the

 21 position limits really don't affect our business.

 22 I feel like we've solved many of the issues. It's
 127

 1 really concerning to hear from our perspective the

 2 impacts to the commercial and end user community.

 3 I'm looking at the data that you resented in the

 4 last session. There were, I believe, 83

 5 participants who would be at 100 percent kind of

 6 level of the position limits.

 7 Is there any effective way to model the

 8 impact of the market? I know we would say,

 9 quality markets would degrade, but how would you

 10 approach that to determine what the impact would

 11 be, you know, to the overall community?

 12 MR. HAAS: I think one example would be,

 13 or one way to witness it would be changes in

 14 liquidity, a lack of convergence and contracts.

 15 And if you start making participants exit the

 16 market it gets less liquid. Prices get more

 17 volatile, and then we start to -- the future's

 18 contracts starts to move away from the cash price.

 19 When that happens, we'll be back here explaining

 20 what's going on? Why are the futures markets not

 21 lining up, and why are they so volatile?

 22 MR. CREAMER: That's what I would
 128

 1 expect. I just -- I wonder if there's any way to

 2 look at it. I mean, it seems like a difficult

 3 challenge here. I feel like it's not right if

 4 we're going to see that number of participants in

 5 one contract that are going to be violating a

 6 level. But I don't know how you actually quantify

 7 the impact. It would seem like we've got to look

 8 at the overall kind of downstream and impact of

 9 firms like ours.

 10 MR. LASALA: Yeah, again to follow

 11 Erik's point, I think you have to look at the bid

 12 ask, what changes there. To some extent some of

 13 those parties are going to get exemptions. Others

 14 aren't. So I don't think you can take it in its

 15 totality, that everyone is going to go out. But

 16 to the extent that some of them would be seeking

 17 exemptions for some of the things that will no

 18 longer be applicable. Again, you have that same

 19 problem. So it's going to be something that would

 20 have to be looked at very carefully.

 21 COMMISSIONER WETJEN: Rob, is it just

 22 because of the positions that you're not really
 129

 1 impacted? The positions you have as a firm, that

 2 you're not really impacted by the rule? Or is it

 3 for other reasons?

 4 MR. CREAMER: I think when we first

 5 talked about position limits with respect to my

 6 firm, originally we were looking at it and felt

 7 like they were very restrictive on a month by

 8 month level. And I think once we got to the point

 9 where the positions were netted across term

 10 structures, across curves, it really alleviated a

 11 lot of our concerns. So I think that that solved

 12 much of the issues.

 13 We are a firm -- as a market maker, we

 14 are largely neutral in the way that we trade. We

 15 don't have speculative positions. We hedge all of

 16 our activity in one way, shape or form.

 17 MR. ALLISON: Now Herbert.

 18 MR. THORNHILL JR: Thank you. I had a

 19 question for Erik. Erik, I know you were in

 20 conference. I wanted to ask you a question. It

 21 goes to deliverable supply of the power markets

 22 and the setting of measuring of the deliverable
 130

 1 supply and the setting of the speculative position

 2 limits. And I felt that your presentation was

 3 good. Obviously now factors that are considered

 4 in determining deliverable supply include load,

 5 they include generation. Those are all relevant.

 6 I thought your point about including transmission

 7 in and out of a zone where a contract is traded is

 8 also very instructive as well.

 9 I was wondering, even if there are

 10 additional factors that could be considered as

 11 well. So for example, if you had a contract that

 12 acted as a proxy for trading in other -- or power

 13 flow in another area and the fact that that

 14 contract might be, as you pointed out,

 15 interconnected. And I thought that was a very

 16 good point. It's kind of a subtle point, but it's

 17 a very important one. Whether that should be

 18 considered as well in setting the speculative

 19 position.

 20 MR. HAAS: The short answer is, it's not

 21 considered, given the way the appendix C dictates

 22 how we can set limits. We don't have flexibility
 131

 1 in the rules to consider that. I agree, it should

 2 be considered. You want to have the best estimate

 3 as possible. We don't set those restrictions on

 4 ourselves. We're abiding by the requirements.

 5 It's pretty much a strict requirement. You have

 6 to do a three year historical period. You have to

 7 quantify it. That's another kind of difficult

 8 thing with transmission, is how do you actually

 9 quantify transmission of power, things like that?

 10 And honestly, if it's not exact and we don't meet

 11 that exact obligation, our supply estimate, our

 12 position limits get rejected. There isn't a lot

 13 of flexibility.

 14 MR. THORNHILL JR: [Inaudible due to

 15 simultaneous dialogue] --

 16 MR. HAAS: I'm sorry. I say there isn't

 17 a lot of flexibility with what we can do.

 18 MR. THORNHILL JR: But you do see maybe

 19 other factors as being indicators of how the

 20 speculative position and limits might be set for

 21 other contracts. Maybe other factors beyond in

 22 the power space, generation, load, transmission in
 132

 1 and out of a zone, there could be other factors

 2 that could -- that should affect speculative

 3 position limits.

 4 MR. HAAS: Absolutely, we agree. I

 5 agree 100 percent.

 6 MR. THORNHILL JR: Tom, do you have a

 7 view on that?

 8 MR. LASALA: I think it would be

 9 similar. I think I'd have to take those on a case

 10 by case basis, yep.

 11 MR. THORNHILL JR: Yeah, I think that's

 12 right. I think that you have to look at each

 13 contract, each zone, how it interrelates with

 14 other zones and so forth in order to come up with

 15 a view. But just wanted to make the general point

 16 that I think that there are a lot of very valid

 17 factors that are considered in setting speculative

 18 position limits. But perhaps there are even

 19 additional ones that are relevant as well.

 20 MR. HAAS: Respond to that really

 21 quickly. Again, that kind of gets to our overall

 22 point that the energy markets are different than
 133

 1 agricultural commodities, which the guidelines for

 2 estimating deliverable supply are based off of. So

 3 kind of those rules are written with agricultural

 4 commodities in mind and not so much the

 5 transmission of electricity. So it's hard to

 6 shoehorn these into those requirements.

 7 MR. LASALA: And just to further the

 8 point though, is I think power and electricity is

 9 very unique. Very unique from agriculturals and

 10 I'd say further more unique than if you were

 11 talking about what the deliverable supply and what

 12 limits could be in some of the other markets.

 13 Like, for example, New York Harbor heating oil and

 14 RBOB, they're different. And I think it's

 15 a theme that resonates across so many different

 16 areas around the rule making.

 17 MR. ALLISON: I see lots of flags up,

 18 and I'm trying to recognize people in the order in

 19 which I've recognized the flag going up. So I

 20 will get to you eventually, although Mark may have

 21 to beat me over the head once in a while. Tyson.

 22 MR. SLOCUM: Thank you. So my question
 134

 1 is for both Tom and Erik. So is it fair to

 2 characterize from both of your presentations that

 3 you both have concluded that the CFTC proposed

 4 position limits would be detrimental to the

 5 market? Is that fair to conclude?

 6 MR. LASALA: Yes, I think that some of

 7 the restrictions on what is today recognizable and

 8 I'd consider viable hedging strategies, if those

 9 were not provided for, I think the net effect is a

 10 negative. Negative on the orderliness, the price

 11 convergence, liquidity in the markets. So I think

 12 that it potentially brings you to a less effective

 13 place. And furthermore, noting that even in the

 14 presence of a federal limit structure, the

 15 exchanges still have to do that accountability to

 16 satisfy their other core principal obligations. I

 17 have to look at those concentrations.

 18 So it's not -- while federally you can

 19 say that there are no collisions, no one's harmed,

 20 no one's over a limit in natural gas or no one's

 21 over the limit in crude oil, what I'm saying is

 22 that I fail if I don't exercise in tandem with
 135

 1 that structure, the accountability program that I

 2 operate today. I have to do it. So I'm not quite

 3 convinced holistically what the value added is by

 4 the structure.

 5 MR. SLOCUM: So now both CME and ICE are

 6 in effect market participants as well, right? You

 7 are for profit entities that earn revenues and

 8 profits off of service fees and selling data and

 9 so forth. So I'm interested to know not the

 10 characterization of what your -- in your

 11 presentations where you talked about the greater

 12 market impact. What is the impact of the CFTC

 13 position limit on your business models? On ICE

 14 and CME as for profit businesses?

 15 MR. LASALA: I'm a regulator. I'm not

 16 frankly focused on the bottom line of --

 17 MR. SLOCUM: But your -- but CME is.

 18 MR. LASALA: I wouldn't call myself --

 19 well, I wouldn't call ourselves a market

 20 participant. My primary responsibility to that

 21 for profit organization is to in fact ensure that

 22 everyone in the markets that we operate is
 136

 1 operating effectively, has integrity above all. I

 2 gave you examples where we held people from

 3 maintaining positions. Where we reduced people

 4 from maintaining positions. You might say I'm

 5 turning that business away. That's what I have to

 6 do to ensure the orderly of the market --

 7 orderliness of the market. And I think in the

 8 most holistic circumstance, that comes back as a

 9 benefit to the market that will hopefully benefit

 10 users of CME group markets on the most holistic

 11 level. So I'm not concerned about executing my

 12 regulatory authority to effect what I think is a

 13 proper regulatory outcome.

 14 MR. ALLISON: Vince, you had a --

 15 MR. JOHNSON: Part of it we've got --

 16 another question I had, I haven't really hard a

 17 lot about this is --

 18 MR. ALLISON: Vince, your mic's not on.

 19 MR. JOHNSON: Oh, it's on. Can you hear

 20 me now? Now in part I had a conversation -- I

 21 wanted to see if Tom agrees, and I don't know,

 22 Steve or Vince may answer. But part of the
 137

 1 historical perspective of the exchange is the

 2 dialogue that occurs. And when you're looking at

 3 the -- and this is kind of in support of the

 4 accountability levels, when you have certain

 5 market disruptions, whether it's Hurricane Sandy

 6 or a refinery out or something like that, part of

 7 it is -- and you have to take on additional

 8 positions, I know for BP who's been in the

 9 practice of having the communications with the

 10 exchange in advance and being proactive to have

 11 that conversation, to say this is going on.

 12 We want to let you know what's going on

 13 in the marketplace. And I don't know if Tom

 14 agrees with that. We had those conversations.

 15 But I wanted to see for Steve or Vince if there

 16 was a federal limit -- or a federal structure that

 17 was put in place and there was an accountability

 18 for the non-spot month limits. Do you

 19 envision -- how would you envision the Commission

 20 overseeing that from a dialogue perspective, from

 21 the marketplace communicating with the Commission?

 22 For more this is around normal circumstances when
 138

 1 something arises.

 2 MR. SHERROD: You know Vince, the

 3 exchanges have affected the accountability rules

 4 in place that they administer and the vision

 5 market oversight oversees rule enforcement review

 6 program, their administration, their rules. The

 7 surveillance department also works at this -- at

 8 the exchange level, whether it's ICE or the CME

 9 with the surveillance staff and the division

 10 market oversight. If we added a federal limit, as

 11 Tom mentioned, it's not mutually exclusive. So

 12 the exchange could continue to administer an

 13 accountability program with the trigger level much

 14 lower than the federal limit. So does that get to

 15 your question?

 16 MR. JOHNSON: Yeah, I mean, that was one

 17 part. So if I understand correctly, the exchange

 18 could still I guess have that -- you could still

 19 have those conversations with the exchange,

 20 specifically for referring to, again, like a

 21 market disruption or something else abnormal into

 22 the marketplace.
 139

 1 MR. SHERROD: Absolutely.

 2 MR. LASALA: Vince may put it another

 3 way. I don't think that the federal structure

 4 would trump the exchange's obligations and still

 5 monitoring its markets, having those kind of

 6 dialogues. That has to occur. I do think that

 7 there is an opportunity in a collaborative,

 8 cooperative way with the agency to get to an

 9 accountability structure where exchanges are still

 10 monitoring their markets independent where there

 11 is crossover that the agency is the one that

 12 possibly sees the positions across multiple venues

 13 where there could be collaboration.

 14 I frankly -- we've had -- that has

 15 occurred in the past without a federal structure.

 16 We've had specific engagements where there have

 17 been cross market circumstances. So it is not a

 18 concept that foreign or people are immune to. I

 19 think that there is a possibility to tighten that

 20 up in more of a formalized way. And again, some

 21 of that probably -- the foundation for my

 22 statement goes back to some of the points that
 140

 1 Bill McCoy made on the agency's potential ability

 2 to enact such a structure. But I think if we

 3 could, we likely leverage the resources that the

 4 exchange is already committing to this. And I'd

 5 like to think it to a better place.

 6 MR. ALLISON: Thank you. Sharon?

 7 MS. BROWN-HRUSKA: You kind of -- the

 8 last point really brings home a lot of memories

 9 'cause I do remember sometimes sitting on the

 10 phone with the exchanges when we'd have a major

 11 market move to discuss levels of -- sizes of

 12 positions. And I'm sure the current Commissioners

 13 are also -- have or will experience that same

 14 collaboration. And it's very positive I think.

 15 And so I would say that there is a couple of

 16 observations I had, and that is the question which

 17 is probably the most concerning is this sort of

 18 unified observation that we're seeing some

 19 degradation of liquidity and sort of speculative

 20 activity in the back months of some of the

 21 contracts. And wanting to, as a sort of practical

 22 matter, understand how that's affecting the
 141

 1 quality of the markets and hedgers' ability to put

 2 on their hedges.

 3 And I was reminded of a study that sort

 4 of -- that was done by the CFTC a few years ago.

 5 It was of the crude oil market. I remember Mike

 6 Haig -- Dr. Mike Haig as being one of the

 7 economists in the CFTC division, I guess chief

 8 economist's office that worked on that. And I

 9 recall that they found as index traders and

 10 managed money increased their activity in the

 11 crude oil markets, they were increasingly

 12 utilizing the back month contracts. And they

 13 actually found that this had a positive impact on

 14 the markets. That there was lower bid ask

 15 spreads. The prices would become more

 16 co-integrated and the liquidity had in fact

 17 increased. So that the price discovery function

 18 was performing better. And I wondered if there

 19 was any sort of interest in -- at the CFTC in sort

 20 of pursuing sort of a -- take another look at the

 21 markets and how they're performing and whether

 22 there's certain things that we could take away
 142

 1 from this sort of evolving market structure and

 2 how it may be impacting the participation of

 3 speculators and other generally folks that we

 4 regard as bringing important and valuable

 5 liquidity to the markets.

 6 MR. MCGONAGLE: Well, this -- Vince

 7 McGonagle. I appreciate the suggestion. We'll

 8 certainly carry that back and talk to our chief

 9 economist and see, as they think of macro issues

 10 and questions this morning surrounding degradation

 11 in the market are certainly important. Policy

 12 issues I think that the Commission considers

 13 separate from discussions around the position

 14 limits regime. So I think that is an important

 15 point and I appreciate it.

 16 MR. ALLISON: Russ:

 17 MR. WASSON: Thank you. Listening to

 18 the conversation this morning I couldn't help but

 19 think of the physician's creed. And that is --

 20 perhaps it would be appropriate for the Commission

 21 to adopt it, that is, first do no harm. And from

 22 the point of view of end users, which electric
 143

 1 cooperatives are, I just want to make the

 2 observation that it's dangerous to think in

 3 absolutes. And I'll give you an example of what

 4 I'm talking about.

 5 You know, the EPA has produced a

 6 proposal called the Clean Power Plan, which

 7 whether you agree with it or not, whether you

 8 agree with the timing of it or not, is going to

 9 have a profound impact on the electric utility

 10 industry because if we have to replace all the

 11 coal plants that the utility industry uses, in

 12 order to keep the lights on, we're going to have

 13 to shift to natural gas generation. Then the

 14 question of pipeline capacity is going to become

 15 paramount.

 16 So the Commission is going to have to be

 17 flexible in dealing with those kinds of things

 18 that we know are coming. It's a question of time

 19 and a question of magnitude. But we suspect that

 20 they are coming. And the industry as it exists

 21 today is not going to be the industry that we're

 22 going to be facing 5 years, 10 years from now.
 144

 1 MR. ALLISON: Michael, is yours quick?

 2 MR. COSGROVE: Yes. For Steve and

 3 Vince, in 2009 John Arnold testified -- or came in

 4 and spoke at a Commission proceeding. And he

 5 brought some evidence of the -- sort of the bias

 6 of small speculators in the market. And over a

 7 ten year period found that out of 520 samples, the

 8 small speculator, the non-reportable positions

 9 were short once. And I was curious to know first

 10 of all -- I'll ask my question, then I'm going to

 11 throw in an anecdotal and be done here.

 12 My question is, has the Commission sort

 13 of taken a look at that or updated that? I'm

 14 curious to know if by removing speculative

 15 capacity from the market with position limits,

 16 that will introduce either a bullish or bearish

 17 bias in any of these markets. And then finally my

 18 anecdote is that over 35 plus years, it's been my

 19 experience that the small speculators or the small

 20 participants in the market don't write options.

 21 They buy them. They don't go short. They go

 22 long. And it's the large speculators that have
 145

 1 had the capacity to actually provide some

 2 buffering in the market when we were seeing

 3 extreme volatility.

 4 So John Arnold's observation was

 5 entirely consistent with my experience. And I'm

 6 wondering if there's been any examination of the

 7 data in the intervening period by the Commission

 8 that would give an indication of whether any bias

 9 will be introduced as a result of the reduction of

 10 speculative capacity in large traders.

 11 MR. SHERROD: I think I heard a couple

 12 of different questions there. With respect to the

 13 non- reportable positions, so for crude oil, for

 14 example, it would be a trader that has a position

 15 of fewer than 350 contracts. And roughly

 16 speaking, in that market it's usually 10 percent

 17 or less of the long open interest, 10 percent or

 18 less of the short open interest that's in the

 19 non-reportable category.

 20 So I'm not aware that we've done any

 21 particular analysis about the role of those small

 22 traders, because they're well below any of the
 146

 1 proposed limits. None of the proposals would

 2 impact those non-reportable traders with respect

 3 to position limits. So we haven't proposed to

 4 aggregate or group them together in any form or

 5 fashion.

 6 MR. COSGROVE: So to clarify, my

 7 question was not whether the imposition of any

 8 regulations were being contemplated with that

 9 group. But rather that by reducing the

 10 speculative capacity for large traders, the

 11 resultant impact, which I would assume to be the

 12 increase in sort of the impact of the

 13 non-reportable interest. Whether that had been

 14 analyzed at all or considered.

 15 MR. SHERROD: I think what we tried to

 16 show earlier today when we showed table 11 from

 17 the proposal and the revised table 11A, is summary

 18 statistical information that we can reveal to the

 19 public, right. We don't reveal any individual

 20 trader's positions. And what that data showed

 21 basically for the single and all-month limits, is

 22 very few traders for natural gas approach the
 147

 1 levels of those proposed single and all-month

 2 limits.

 3 Anecdotally, and that's all we have, the

 4 non- reportable traders are not in the spot

 5 months. So to the extent very few traders would

 6 be impacted by the non-spot month limits, that

 7 would be the inference to draw that there wouldn't

 8 be a significant pull down of liquidity by those

 9 traders.

 10 MR. ALLISON: Let me turn to Dr. Sandor

 11 and we'll make this the last question.

 12 MR. SANDOR: Yeah, question first on

 13 those 83 or so exemptions, how many were in power?

 14 I think that was the number.

 15 MR. LASALA: In the summary that I

 16 supplied, none of them. They were -- my numbers

 17 were all focused on the core products. So none of

 18 them were power. They were just the core -- four

 19 core energies. There are definitely exemptions in

 20 power in the deck. They would have been somewhere

 21 incorporated in the additional 140 exemptions on

 22 my slide number 8. There were 154 exemptions in
 148

 1 total, 85 unique entities. But the bullet below

 2 it, additionally there were other exemptions, 140

 3 other energy and power. I can't give you the

 4 demographic there. But there certainly were some.

 5 MR. SANDOR: I just want to follow up

 6 with the colleague on the Advisory Committee who

 7 mentioned the EPA pending regulations. But not so

 8 much from generation or natural gas. I worry

 9 about transmission capacity. For 17 years I

 10 served on the board of directors of American

 11 Electric Power. And we built about 70 miles of

 12 transmission from Virginia to West Virginia, which

 13 took 17 years to build that capacity, 16 years of

 14 regulatory approvals and 11 months to build it.

 15 And with the shift that's going on in

 16 American power and with the fact that transmission

 17 is not treated like natural gas, the Commission

 18 might want to be in a closer dialogue with FERC

 19 and other people because one could conceive of a

 20 situation of brownouts and things like this. And

 21 I worry about the American consumer and how can

 22 FERC and the Commission work together to see how
 149

 1 the construction of transmission can be better

 2 integrated into the financial markets.

 3 MR. ALLISON: There are many open

 4 issues. However, we are beyond the appointed

 5 time. We will reconvene promptly at 2:00 because

 6 the next panel is the little issue of bona fide

 7 hedging and 90 minutes is not nearly enough time

 8 to cover that. So we need to be right on time at

 9 2:00, and we are adjourned for lunch.

 10 (Recess)

 11 MR. ALLISON: We're back. Third panel,

 12 Steve Sherrod is with us again, also Ron

 13 Oppenheimer and Joe Nicosia. Bios are in the

 14 package. I'm asked to make one announcement. So

 15 when you're speaking, make sure your microphone is

 16 turned on. You might also consider bending it

 17 down or moving your -- moving closer to it. I

 18 think the current reporter is capturing everything

 19 properly for the transcript, but sometimes it's

 20 been difficult to hear within the room.

 21 Second, the printed agenda says we end

 22 at 3:30. I've been advised that we can treat that
 150

 1 as an accountability level, not a position

 2 (inaudible) since we have demonstrated the ability

 3 to run a bit longer than the announced time, we'll

 4 certainly not run past 4:00. But that may run a

 5 little past the 3:30 printed on the piece of

 6 paper. Without further ado, let me turn it over

 7 to our panel Steve?

 8 MR. SHERROD: Thanks. Good afternoon.

 9 Again, the usual disclaimer applies. These views

 10 are my own and may not necessarily reflect the

 11 views of other staff or the Commission. I'll

 12 provide some historical perspective on the

 13 definition of the term "bona fide hedging." I will

 14 also highlight certain aspects of the proposed

 15 definition of bona fide hedging in the Commission's

 16 December 2013 notice of proposed rule making.

 17 There's a long history to the definition of

 18 bona fide hedging, both in the Commodity Exchange

 19 Act and in the regulation. Prior to 1974, the

 20 term bona fide hedging was defined in Section 4a(3)

 21 of the Commodity Exchange Act. For example, in

 22 1940 that section defined bona fide hedging with
 151

 1 some enumerated hedges, and it included unsold

 2 anticipated agricultural production.

 3 The Commission's predecessor had

 4 implementing rules that mirrored the statutory

 5 definition. For example, Congress amended this

 6 Commodity Exchange Act in 1956, and the

 7 Commission's predecessor undertook a rule making

 8 to add a bona fide hedging exemption for unfilled

 9 anticipated requirements. And these two specific

 10 anticipatory hedges continue to be in the

 11 statutory definition of bona fide hedging until

 12 Section 404 of the Commodity Futures Trading

 13 Commission Act of 1974 repealed the statutory

 14 definition and authorized the newly formed

 15 Commission to define bona fide hedging solely by

 16 regulation.

 17 In response to that 1974 legislation and

 18 before the new Commission began, the Commission's

 19 predecessor simply codified the previous statutory

 20 definition into Regulation 1.3(z) with only minor

 21 deviations from the statutory language. The

 22 Commission undertook a series of meetings and
 152

 1 public comments and after extensive public

 2 comment, in 1977 the Commission adopted a revised

 3 definition of bona fide hedging that largely forms

 4 the basis of the current definition of bona fide

 5 hedging.

 6 That definition in Regulation 1.3(z) is

 7 organized into three paragraphs, or you can think

 8 of it as three different concepts. The first

 9 paragraph is a general definition of bona fide

 10 hedging. It's very broad. The second paragraph

 11 retained the statutory enumerated lists of

 12 bona fide hedges, and it broadened that list. And

 13 I know at that time there was an existing

 14 Regulation 1.48, that's still in existence, that

 15 provides a procedure for traders to apply for

 16 hedges of unfilled anticipated requirements or

 17 unsold anticipated production. That was

 18 previously recognized by the statutory definition.

 19 The third paragraph that the Commission

 20 adopted in '77 provided a procedure for traders to

 21 apply for non- enumerated exemptions under our new

 22 Regulation of 1.47. So in the Commission in 1977,
 153

 1 added the term to the broad general definition,

 2 anticipatory merchandising. Basically

 3 since 1977, for the non-agricultural contracts

 4 subject to federal limits, I'm not aware of any

 5 applications to the Commission for a

 6 non-enumerated exemption for anticipatory

 7 merchandising.

 8 So in the Dodd-Frank Act it added

 9 Section 4a(c)(2), providing direction to the

 10 Commission in defining the term bona fide hedging.

 11 Congress used the general definition of bona fide

 12 hedging in the Commission's Regulation 1.3(z) as the

 13 basis of their statutory direction. However, in

 14 drafting that directive, Congress edited CFTC's

 15 regulatory definition and those edits appeared at

 16 least in part, designed to disallow an

 17 intermediary or risk management exemption for a

 18 commodity index swap entered into with a counter

 19 party who is not active in the physical marketing

 20 channel.

 21 And the Commission, beginning as early

 22 as 1991, had previously granted those
 154

 1 non-enumerated risk management exemptions to a

 2 number of financial intermediaries. However, that

 3 section, as I mentioned, appears to narrow the

 4 bona fide hedging definition with respect to pass

 5 through swap offsets. And that's what the

 6 Commission has proposed.

 7 The proposed new definition of bona fide

 8 hedging would be located in Regulation 150.1, the

 9 opening paragraph. The proposed definition would

 10 include the incidental tests and the orderly

 11 trading requirement down in the current

 12 regulation. The incidental test requires a

 13 purpose to offset price risks incidental to

 14 commercial cash, spot or forward operations, and the

 15 orderly trading requirement requires the hedge to

 16 be established and liquidated in an orderly manner

 17 in accordance with sound commercial practices.

 18 A temporary substitute test required by

 19 Section 4a(c)(2)(A)(i) of the Act, would replace the

 20 temporary substitute criterion in the current

 21 regulation. Congress omitted the word "normally"

 22 from the statutory directive and thus requiring a
 155

 1 bona fide hedging position in a physical commodity

 2 contract to represent a substitute for positions

 3 taken or to be taken at a later time in a physical

 4 marketing channel.

 5 The proposed new definition would also

 6 incorporate the economically appropriate tests of

 7 the Act. And again, that economically appropriate

 8 tests was in Section 1.3(z)(1) of the regulation.

 9 That test requires a hedge to be economically

 10 appropriate to the reduction of risks and the

 11 conduct and management of commercial enterprise.

 12 The change in value requirement also in that

 13 provision requires the hedge to arise from the

 14 potential change in the value of assets,

 15 liabilities or services. And merchandising and

 16 anticipatory merchandising is included in that

 17 list.

 18 A new hedge would be recognized for pass

 19 through swaps. The proposed definition would

 20 recognize as bona fide a commodity derivative

 21 contract that reduces the risk from a swap

 22 executed opposite a counterparty when that
 156

 1 counterparty at the time of the transaction would

 2 qualify as a bona fide hedging position. And that

 3 mirrors the provision in the Act.

 4 In addition to the existing enumerated

 5 exemptions in Regulation 1.3(z)(2), the Commission

 6 proposed new enumerated bona fide hedging

 7 exemptions, including for royalties, service

 8 contracts, and unfilled anticipated requirements

 9 for resale by a utility. And under the proposal

 10 more generally, other positions could be exempted

 11 under the provisions of Section 4a(a)(7) of the Act.

 12 And I look forward to the discussion and comments

 13 from the Advisory Committee today.

 14 MR. ALLISON: Thanks Steve. Ron?

 15 MR. OPPENHEIMER: So thank you Jim, and

 16 thank you to the Commissioner and the Chairman for

 17 having this meeting today. I think one thing

 18 Steve and I absolutely agree upon, and that's that

 19 we have to stop meeting like this. This is, as

 20 somebody else said, the proposal that keeps on

 21 giving.

 22 I'm going to use my time today to talk
 157

 1 mostly about some real life hedging examples that

 2 are used in the energy space and would not be

 3 granted bona fide hedge treatment under the

 4 proposed rule if it were finalized. I know that

 5 Steve said that there hasn't been an application

 6 for an exemption for anticipatory merchandising in

 7 the enumerated Ags. In the energy area, these

 8 types of transactions and the ability to hedge

 9 them has been going on and accepted, well accepted

 10 by the industry.

 11 Before I go to the examples, I want to

 12 try to just cover a couple of points. Most of

 13 them have been covered this morning, and so I

 14 won't spend a lot of time on them. But I think

 15 it's important to go back to first principles. In

 16 Dodd-Frank, adopting a position limit provision,

 17 the focus was on really two primary things. Not

 18 speculation, but excessive speculation. And

 19 secondly, bringing swaps into a position limit

 20 regime, OTC swaps that had not previously been

 21 subject to position limits.

 22 Dodd-Frank was never focused on
 158

 1 commercials engaging in hedging activity that was

 2 in fact speculation but hiding under the guise of

 3 hedging. That's never been the case. But the

 4 rule in many respects is focused on limiting the

 5 activities of commercials in hedging in the

 6 markets. The unintended consequence is

 7 significant. If risk reduction by commercials is

 8 curtailed or is more difficult, there's more risk

 9 in the pricing of commodities and that risk comes

 10 with a cost. And the cost is ultimately borne by

 11 consumers, and that's not a result that I think we

 12 want to countenance.

 13 I want to talk about the economically

 14 appropriate test. Steve brought it up. We'll

 15 talk about it more during the course of the panel

 16 I'm sure. The language of the economically

 17 appropriate test has been in the law and

 18 regulations for a long time. But there is an

 19 interpretation of what the economically

 20 appropriate test means in this proposal that's

 21 different than that which we had before.

 22 And the interpretation that's in this
 159

 1 proposal suggests that in order to qualify for the

 2 economically appropriate test, an entity has to

 3 consider all of its exposures in order to quality

 4 for the test, when doing a risk reducing

 5 transaction. And that says that the entity itself

 6 can't take into account exposures on a legal

 7 entity basis. They can't take into account

 8 exposures on a division basis, a trading desk

 9 basis, a trader basis or even on an asset basis.

 10 It has to all be lumped together and analysis be

 11 done as to whether or not it reduces the risk to

 12 the entire enterprise.

 13 There's two real problems with this.

 14 The first is that it substitutes a governmentally

 15 imposed one size fits all risk management paradigm

 16 for that of a company doing its own prudent risk

 17 management business in light of its own facts and

 18 circumstances. The second problem is that

 19 commercial entities would have to build a system

 20 to manage risk this way. We have no problem with

 21 having risk management systems. We have them in

 22 place currently. We don't have this risk
 160

 1 management system, and there's a reason. And that

 2 is that this form of risk management system

 3 doesn't provide what we perceive to be risk

 4 management value.

 5 It's an important issue to us. I know

 6 Joe has something to say about it. So I'll leave

 7 it here. But I want to talk about the enumerated

 8 hedges. There are several problems with the

 9 enumerated hedges as proposed, and there's an

 10 important distinction to be made and that is that,

 11 to the extent the CFTC has administered enumerated

 12 hedges under the paradigm that Steve just went

 13 through, the markets are very different in energy.

 14 And I think the first problem with having an

 15 enumerated hedges list is that this proposal

 16 changes the current 1.3(z) which says, the

 17 enumerated hedges or bona fide hedges include but

 18 are not limited to the enumerated hedges. The

 19 proposal said, these are the only permitted -- the

 20 enumerated hedges are the only permitted hedges,

 21 and that's a big change.

 22 And there's also a problem with having
 161

 1 such a list. Having such a list in any

 2 circumstance is difficult because no one can be

 3 expected to understand or anticipate every type of

 4 hedge that can be done, that could fit all markets

 5 or fit all market participants. And it's true

 6 that you can't see it or express it today. It's

 7 even more true that we can't see into the future

 8 and identify those that will come up going

 9 forward.

 10 The second problem is that the

 11 enumerated hedges discount the importance of

 12 merchandising and anticipatory hedging. And as I

 13 said, we think the energy markets are different

 14 and have used them continuously throughout the

 15 development of the energy markets from the '70s to

 16 today. I spent a lot of time talking about

 17 anticipatory merchandising at the roundtable in

 18 June and I'm not going to do it here.

 19 But it's very important to understand

 20 the role of merchandising and not try to pin it

 21 into a category of these are merchants doing this,

 22 as though they're not other participants in the
 162

 1 marketplace. Producers engage in merchandising.

 2 Refiners engage in merchandising. Merchandising

 3 is a very, very broad concept, and it's an

 4 important concept because it connects the two ends

 5 of the value chain, production and consumption.

 6 Before I get to two examples, I want to

 7 make two more points to level set and make sure

 8 we're on the same page. There are two things that

 9 sometimes get overlooked when you're talking about

 10 hedging and risk management, and that is that the

 11 energy market prices transactions on a very routine

 12 basis on a floating price as opposed to a fixed

 13 price. And the concepts of the enumerated hedges

 14 focus much more on fixed price and probably

 15 inappropriately.

 16 The second thing is that energy

 17 transactions and associated risk management is

 18 generally done on a relative basis. I can buy it

 19 here, and I can sell it there. Or I can buy it

 20 today, and I can sell it another day. And those

 21 are very, very important concepts to keep in mind

 22 as we look at these two examples.
 163

 1 The first example, and this looks

 2 complicated, but it's not, and I will walk you

 3 through it and it's important to understand, this

 4 situation involves a commodity in one location

 5 that's being priced at a level in one area,

 6 demonstrating that the commodity is in greater

 7 demand in that area than it is in another area.

 8 And the commodity we're going to use in this

 9 example is gas oil, which is diesel. It's traded

 10 on the ICE in Europe as a gas oil contract and in

 11 New York Harbor as a ULSD contract. And if you

 12 look at the box on the left, you'll see that on

 13 the particular date we're going to focus on,

 14 January 19th, and I just want to say this is a

 15 simplified example, but it's based on real prices.

 16 So again, it's simplified. I think Joe will talk

 17 about some slightly more complicated situations,

 18 but this will help us go through the example.

 19 And if you look, on January 19th, gas

 20 oil was trading at about $1.51 in Europe, and

 21 diesel was trading at about $1.66 in New York

 22 Harbor. In our example on January 19th, an
 164

 1 importer would buy physical gas for forward

 2 delivery and he'd do it on a floating price basis

 3 against the ICE futures. And in this example he

 4 hasn't located yet a buyer for the product in New

 5 York, but he intends to ship the gasoline to New

 6 York and sell it on a floating price basis and

 7 capture that differential that we see in the chart

 8 on the left.

 9 And the way he does that is he locks in

 10 the ULSD gas oil differential, of 15 cents and

 11 change, by buying the ICE Feb gas oil futures at

 12 $1.51 and selling to NYMEX at $1.66. The short

 13 NYMWZ ULSD futures would not quality for bona fide

 14 hedging treatment under the proposed rule, even

 15 though it's an essential component of the

 16 transaction that allows the importer to take the

 17 gas oil from Europe where it's in relatively

 18 excess supply and bring it to New York where the

 19 prices in the market are dictating to it that it

 20 ought to be sold and delivered.

 21 Going down the calendar in this example,

 22 on January 26th he finds a buyer in New York
 165

 1 Harbor, and he sells it on a floating price basis.

 2 At that point he's got a floating price buy and a

 3 floating price sale, and the rules would permit it

 4 as a bona fide hedge. But for that interim period,

 5 which is a week in this example but it could be

 6 much longer, in other examples, for that week it's

 7 not a bona fide hedge.

 8 Continuing on down, on January 29th,

 9 both counterparties to the importer agreed to

 10 price the commodity, and they take the indexes

 11 that they agreed to use for pricing, and they look

 12 at the prices and they establish them as the

 13 prices for their physical transactions. So in

 14 this case, the importer could buy actual physical

 15 gas oil at $1.5268, sell physical in New York at

 16 $1.6184 and have revenue from that transaction of

 17 9 cents a gallon.

 18 At the same time, he'd liquidate the

 19 futures spread and in this case he'd recognize

 20 again on the futures transactions of 6 cents a

 21 gallon. The revenue of the two together is about

 22 15 cents, and when you take out the costs that he
 166

 1 anticipated, which are shown on the left hand side

 2 in the box of about 14.5 cents, yields the

 3 expected gain of about three quarters of a cent

 4 per gallon. Exactly what he had hoped to

 5 accomplish by hedging and moving the product where

 6 it was needed.

 7 So even though the price of ULSD dropped

 8 by about 40 percent relative to the price of gas

 9 oil in Europe, and even though it dropped by 5

 10 cents in absolute terms, through the use of this

 11 hedge, the importer was able to preserve the

 12 economics of his transaction and move the cargo.

 13 So what's important about this? The one

 14 week transaction that I was talking about before

 15 where he had an unfixed purchase in Europe and had

 16 not yet established his unfixed price sale in New

 17 York, should qualify as a bona fide hedge because

 18 it meets all of the statutory requirements. Okay,

 19 it was a substitute for a transaction to be made

 20 at a later time in a physical marketing channel,

 21 i.e. the sale of physical product in New York

 22 Harbor. It was economically appropriate to the
 167

 1 reduction of his risk in that the relative value

 2 of the product in New York Harbor could drop

 3 before he sold the product on a floating price

 4 basis. And it arose from the potential change in

 5 value of an asset, the gas oil, that the importer

 6 owned after he made the purchase in Europe.

 7 The consumer benefits from this

 8 transaction because gas oil was imported to the

 9 United States in response to market signals,

 10 ultimately reducing the cost of fuel in the US.

 11 And the importer would not have entered into this

 12 transaction without the ability to have hedged his

 13 risk. I'll take a pause to see if there's any

 14 questions before I move on to the next example.

 15 MR. SLOCUM: So is the analysis that

 16 this would not be covered confirmed by the CFTC?

 17 Was it something that you had negotiations or

 18 discussions with them? Or is this your internal

 19 analysis that it wouldn't comply?

 20 MR. OPPENHEIMER: So the commercial --

 21 after the, I was going to say initial, but after

 22 the rule was approved, a position limits rule was
 168

 1 approved in December -- or November of 2011, the

 2 working group submitted a petition. We felt this

 3 might not be included. We read it as not being

 4 included and we submitted a petition to the

 5 Commission concerning this need to have this as a

 6 bona fide hedge.

 7 The petition was never acted upon, but

 8 in the recent proposal it was addressed and

 9 bona fide hedge treatment was rejected for it. Any

 10 other questions?

 11 MR. ALLISON: Okay, Ron -- actually

 12 Steve, could you speak to that? Are you willing

 13 to speak to that point?

 14 MR. SHERROD: Ron's entirely accurate.

 15 COMMISSIONER WETJEN: Why was it rejected? 

 16 What’s the basis for the rejection of that as a bona

 17 fide hedge? Rationale?

 18 MR. SHERROD: You know, the petition is

 19 addressed in the preamble in my recollection, as

 20 basically that based on the generic fact pattern,

 21 we didn't have any, what I will refer to as plus

 22 factors that would indicate that we could
 169

 1 distinguish someone that buys unfixed price in

 2 Europe and re-sells in Europe and uses that as a

 3 pretext for an exemption. Versus something that

 4 Ron's describing, where a merchant's buying in

 5 Europe and they have a practice and pattern of

 6 importing into the US, and they perhaps has

 7 transportation arrangements in place. And it's

 8 the type of exemption that ICE or the CME would

 9 have considered those additional details. And in

 10 the generic fact pattern we just didn't see that

 11 level of detail. So we asked questions about what

 12 could make it a bona fide hedge.

 13 MR. OPPENHEIMER: So I'm a little

 14 confused because there aren't many more details

 15 here that aren't there. Would this be a bona fide

 16 hedge? And I don't mean to put you on the spot.

 17 I really don't, but if that's answerable.

 18 MR. SHERROD: It's an open comment

 19 period and we certainly hear what you're saying.

 20 You've provided a fact pattern. And in other

 21 places where we have Commission application

 22 procedures, someone would indicate, for example,
 170

 1 here is the last three years of my production.

 2 Here's what I anticipate in the next year and

 3 provide that additional level of information that

 4 would give us comfort in being able to recognize,

 5 you know, unsold, it just made production as a

 6 bona fide hedge.

 7 So we're certainly willing to listen to

 8 everything you have to say.

 9 MR. OPPENHEIMER: Appreciate that.

 10 Moving to the next hedge, unless there are other

 11 questions. This is the winter storage transaction

 12 okay, and this one has an interesting history too.

 13 The winter storage transaction was recognized as a

 14 bona fide hedge in the rule that was approved by

 15 the Commission in 2011. And in the proposal in

 16 2000 -- I'm losing my dates now, 2013, it's no

 17 longer recognized as a bona fide hedge. And it's

 18 another circumstance where we think it's entirely

 19 appropriate.

 20 And what we've got here is a natural gas

 21 supplier who in April of 2013 leases storage in

 22 order to store gas an provide it during the winter
 171

 1 season of 2015-2016. And again, this is based on

 2 actual prices. It's still in some respects got

 3 some rounding and it's representative. It's not

 4 an actual example, and as you'll see, from a

 5 timing perspective, it can't be an actual example.

 6 But assume that the supplier leased the

 7 storage and his expected cost for storage is 38

 8 cents per MMBTU. Okay, again, looking at the

 9 green on the left hand chart. But in June of 2013

 10 the market conditions are such that he is able to

 11 lock in a profit associated with that storage by

 12 using the futures markets. He can buy October

 13 2015 gas on the market for $4.299 per MMBTU. And

 14 he can sell gas which would come out of storage in

 15 January of '16 for $4.69 per MMBTU.

 16 So what does he do? He enters into that

 17 transaction on the futures markets. He buys

 18 October natural gas futures. He sells January

 19 natural gas futures, and he locks in that

 20 differential. Again, the important note is here

 21 that neither the October nor the January futures

 22 contracts would qualify for bona fide hedge
 172

 1 treatment under the proposed rule.

 2 So again following this one down the

 3 line and we pass where we are today

 4 chronologically, and so we don't have real numbers

 5 to assign to this one. But in September 2015,

 6 when natural gas is actually -- the physical

 7 market is active, supplier's going to buy the gas

 8 that he'll use to fill his storage in October of

 9 2015. And when he does so, he'll liquidate his

 10 October natural gas futures contract.

 11 And in December 2015, when he needs to

 12 supply local utilities or whomever his customers

 13 are with the natural gas, he'll sell the gas to be

 14 withdrawn from storage and liquidate the January

 15 natural gas futures contracts. Whoops, wrong

 16 button, sorry.

 17 Okay, again, why should this storage

 18 transaction be given bona fide hedge treatment?

 19 Well, the reason is, it satisfies the statutory

 20 standards established by Congress. It was a

 21 substitute for transactions to be made at a later

 22 time in a physical marketing channel, i.e. the
 173

 1 purchase of natural gas to fill storage and a sale

 2 to withdraw from storage. It was economically

 3 appropriate to the reduction of the supplier's

 4 risk, i.e. that it will be able to recover the

 5 cost of its storage obligation and separately that

 6 it can profit from its business of supplying gas

 7 in winter. And it arose from the potential change

 8 in value of an asset, the natural gas storage,

 9 that the supplier owned and the gas itself that he

 10 anticipated owning.

 11 Again consumers benefit from this

 12 transaction because it assures that gas will be in

 13 storage as you enter the winter heating season in

 14 '15-'16. And the supplier wouldn't have entered

 15 into the transaction to commit to storage without

 16 the ability to hedge its risk. It's very

 17 important to note that in this example, like many

 18 others, there are always two sides to it. In this

 19 one the storage hedge is equally applicable to the

 20 storage operator, the pipeline who owns the

 21 storage facility, the metal in the ground. And he

 22 wants to hedge the value of that storage that he
 174

 1 has not yet leased. If the prices move against

 2 him, he won't lease that storage, but the futures

 3 markets allow him to lock in the value of his

 4 asset by hedging in the futures markets.

 5 Do we want to entertain questions on

 6 this one Jim before I wrap up?

 7 MR. CAMPBELL: I guess I've got a

 8 question. This concerns me because the storage

 9 example is a physical asset. It's a lot like a

 10 generator. I own steel in the ground generation.

 11 At some point in time when the price signals tell

 12 me to, I'm going to buy my gas and sell my power.

 13 What changed between the CFTC's first

 14 interpretation that this was a bona fide hedge and

 15 the later interpretation that it wasn't? I don't

 16 know whether that's for Steve, Vince or you Ron.

 17 MR. SHERROD: Staff re-reviewed it. The

 18 original proposal was very broad. It would have

 19 provided, for example, that a storage bin that

 20 could have held corn or wheat or soybeans, someone

 21 could have claimed a bona fide hedge in any of

 22 those at their election with no requirement
 175

 1 necessarily to have shown a pattern of having been

 2 a merchant in those. So what the Commission did

 3 in its proposal was ask again, just like on the

 4 other issue, a series of questions about what

 5 would make this a bona fide transaction. What

 6 could be shown further? And it's the type of

 7 thing again that would be in an application to an

 8 exchange, showing specific detail about a past

 9 commercial practice that was expected to continue.

 10 MR. ALLISON: So are there questions

 11 about what does the example mean? Or are all the

 12 rest of the questions about why we believe the

 13 example represents an unwise decision? Questions

 14 about what the example means I think would be in

 15 order now, but let's hear -- I think we've got

 16 more examples.

 17 MS. SHARMA FRANK: Ron, one question about

 18 part C. Gas utilities either own their storage or they

 19 give up their capacity contracts to asset managers

 20 who either own their own storage or somebody else owns

 21 independent storage. Or they're contracting the

 22 pipelines, which are regulated the equivalent of
 176

 1 storage. Does changing the ownership in C affect

 2 your example in terms of its classification as a

 3 bona fide hedge?

 4 MR. OPPENHEIMER: No, not at all. And

 5 what I was trying to point out with the note at

 6 the bottom is that it really does apply to all

 7 sides of that equation when they hold that risk.

 8 MS. SHARMA FRANK: So in that case I'll note

 9 for the record, this is a bread and butter

 10 transaction that gas utilities regulated by the 50

 11 states rely on to manage commercial risk. That's

 12 very concerning, and I appreciate you bringing it

 13 up.

 14 MR. ALLISON: Vicki, is your question

 15 about what does the example mean or is --

 16 MS. SHARP: Well, it's actually about --

 17 ask for Ron about how Steve's comment that this

 18 would be handled through an application process,

 19 how would that work in the context of a commercial

 20 transaction?

 21 MR. OPPENHEIMER: That's a complicated

 22 question, and let me try it this way. If the rule
 177

 1 passed as drafted, there is, as I said, a change

 2 from the initial list of enumerated transaction

 3 being an included but not limited to list. And so

 4 no flexibility to say well, it may not be on the

 5 list, but it's still within the definition because

 6 it fits in that phrase. And so that's a problem.

 7 There is no Rule 1.47 process in this

 8 proposal, so there is no ability to apply for a

 9 non-enumerated exemption that way. There is 4a(a)(7)

 10 which is a broad provision that allows the

 11 Commission to basically exempt anything from the

 12 position limit rule and one might have to go that

 13 way. It's a fairly unsatisfying resolution for a

 14 couple of reasons. First of all, we've been

 15 talking about this particular example now for I

 16 guess three years. The petition is three years

 17 old, hard to believe. But to have a final rule

 18 come out that doesn't address it and leave you to

 19 using a 4a(a)(7) process, would be somewhat

 20 disconcerting.

 21 It took nine months up until the date

 22 that the other position limit was supposed to go
 178

 1 into effect, and the petition hadn't been ruled

 2 upon. So the industry was really in a state of

 3 concern and confusion that it might not ultimately

 4 be granted. And the last concern is, you know,

 5 again, this is pretty plain vanilla. And so maybe

 6 it can be addressed swiftly or whatever. But it's

 7 a real problem if the non-plain vanilla that's not

 8 addressed in an advance list comes up in a

 9 commercial context, and one then has to apply in a

 10 4a(a)(7) context. And in the meantime the economics

 11 or the counterparties or other parts of the

 12 opportunity disappear. That would be a problem.

 13 I just want to respond a little bit to

 14 what Steve said about the reason it was rejected

 15 being that a farmer might have storage that has

 16 the possibility of being used for a bunch of

 17 different commodities. And so that was a concern

 18 that the farmer might use that as an opportunity

 19 to speculate in a number of commodities. Natural

 20 gas storage to my knowledge is only usable for

 21 natural gas. And so that kind of fear of

 22 the flexibility shouldn't really be a reason to
 179

 1 reject this kind of a transaction in natural gas.

 2 I don't think it's a reason to reject it in the

 3 agricultural context either. Maybe Joe will

 4 address how it's used there. But that really

 5 doesn't seem like a good rationale to exclude it

 6 in the natural gas context.

 7 I do want to just wrap up here. These

 8 are two of many examples that the Commercial

 9 Energy Working Group has put forward. They're

 10 complicated. They're simplified for these

 11 purposes, but they're complicated. They're a lot

 12 to absorb. We've heard that this rule is likely

 13 to get finalized by the end of the year. We hope

 14 that we can use the full year to engage in a real

 15 dialogue and get into the economics of some of

 16 these transactions so that they're really fully

 17 understood. Because it's a big issue for us.

 18 I see there's a question, but let me

 19 just -- I got one more thing to say. And that is

 20 to go back to saying that we really want to be

 21 given the latitude to manage our risks prudently

 22 because not allowing us to do that increases costs
 180

 1 into the system, and those costs are borne by

 2 consumers. So thank you.

 3 MR. ALLISON: Mr. Chairman.

 4 CHAIRMAN MASSAD: Thanks Jim. Thanks

 5 Ron for the presentation. At the risk of maybe

 6 making -- oversimplifying this, let me just

 7 understand whether -- how much of this is really

 8 related when you say that the staff didn't accept

 9 this and it would have been accepted otherwise?

 10 As I understand it today, obviously the

 11 transaction might just fall underneath whatever

 12 the limit is, in which case you wouldn't need an

 13 exception. If you needed an exception, you would

 14 go to the exchange. You would present various

 15 facts about your business and Tom is -- I don't if

 16 Tom is still here or Erik. But I assume you guys

 17 ask about kind of past practice and the business

 18 and things like -- the kind of context, right?

 19 MR. LASALA: Absolutely.

 20 CHAIRMAN MASSAD: Right, and I take it

 21 when it's presented to you Steve -- when it's

 22 presented to you in the context of rule making,
 181

 1 none of that context is part of it. Is that

 2 correct? I mean, I thought you referred to it,

 3 well, when it's presented to us as something

 4 generic without that context, that's what we're

 5 ruling on. Is that accurate?

 6 MR. SHERROD: I think that's fair.

 7 CHAIRMAN MASSAD: And if I understood

 8 Ron, what you're saying is, yeah, okay, that's

 9 well and good. But you don't have a good process

 10 in the rule for dealing with things that aren't

 11 generically okay if you will. I mean, in other

 12 words, without all this context, without evidence

 13 of past practice, without evidence of who the

 14 business is, and you're saying you need a process

 15 for that.

 16 MR. OPPENHEIMER: A process would help,

 17 but I think it works even without a process. And

 18 the point is that, as drafted, the enumerated

 19 hedges would exclude it. If it were permitted as

 20 an enumerated hedge, that still doesn't give

 21 somebody the opportunity to use it for

 22 speculation. There are records that are kept.
 182

 1 You have to certify on a 204 form that you are

 2 actually using it for hedging purposes, and you do

 3 that under penalties of perjury. And the

 4 Commission has special call authority, as was

 5 identified this morning. So if it's misused, that

 6 can be reviewed after the fact with the

 7 Commission's authority.

 8 CHAIRMAN MASSAD: Right. Got it, thanks.

 9 MR. ALLISON: Ron, does that complete

 10 your presentation? Thanks. And I know there are

 11 many questions. But let's let Joe get his

 12 examples out, and try to take up the whole set at

 13 once.

 14 MR. NICOSIA: Okay, thank you. First of

 15 all I would like Commissioners Giancarlo as well

 16 as Chairman and the other commissioners for

 17 inviting me here today to participate in this

 18 important meeting. And although the focus is

 19 mostly on the energy issues, as an employee of

 20 Louis Dreyfus I've traded primarily agricultural

 21 commodities for 34 years, but our firm is involved

 22 in energy trading in many different locations as
 183

 1 well as products.

 2 But all commercial commodity traders

 3 today, whether they be Ag or energy, have the same

 4 concerns about the Commission's position limit

 5 rule, and particularly as it relates to bona fide

 6 hedging. The original intent of Congress had the

 7 direction for the Commission to expand its

 8 position limits regime to curb excessive

 9 speculation, not to curb hedging.

 10 Under the Commission's proposed rule,

 11 the practice of hedging would be curbed. There is

 12 no public benefit to the curbing of bona fide

 13 hedging. Merchants accept and manage several

 14 different types of risks in the supply chain that

 15 allow for higher producer prices and lower

 16 consumer prices. Examples of these risks are

 17 absolute price risk, otherwise known as flat price

 18 risk, relative price risk, which is basis or

 19 unfixed risk, as well as calendar spread risk,

 20 time risk, location, quality risk, execution and

 21 logistics risk, credit, counterparty risk, default

 22 risk, weather risk, sovereign risk, government
 184

 1 policy risk.

 2 It's important to recognize that all of

 3 these above risks directly impact the commercial

 4 operations of a merchant and ultimately affect the

 5 value of the merchant's commercial enterprises.

 6 It also ultimately affects the price that

 7 merchants pay or receive for their product. In

 8 each and every one of the transactions, the above

 9 identified risks are not the same, and thus the

 10 merchant must be able to make a decision on how

 11 not only to price these risks in a commercial

 12 transaction, but more importantly, how to manage

 13 these risks.

 14 For instance, in negotiating a forward

 15 contract with a potential counterparty, the

 16 merchant must take into considerations all of

 17 these above risks so will make the most

 18 appropriate decision on if, when and how to

 19 utilize exchange traded futures in order to hedge

 20 the multiple risks that are present. Each of

 21 these risks ultimately affect price risk. Meaning

 22 the price to the seller of the raw commodity and
 185

 1 the price to the consumer.

 2 In other words, hedging any or all of

 3 these risks directly affect and our hedging price

 4 risk. The Commission is taking a very narrow view

 5 of risk. By taking such a narrow view, the

 6 Commission is focusing solely on absolute risk,

 7 and absolute risk with a counterparty, and is not

 8 considering the multiple risks that exist in a

 9 commercial operation or enterprise.

 10 Commercial producers, merchants and end

 11 users have provided numerous examples to the

 12 Commission over the last three comment periods and

 13 have explained how detrimental it would be to

 14 constrain the market participants in bona fide

 15 hedging. By narrowly defining bona fide hedging,

 16 the traditional hedger will be compromised and

 17 thus will not be able to effectively manage its

 18 risks or the risks of its customers. If this

 19 happens, risk premiums will be going wider

 20 throughout the business channel, which will also

 21 be passed along to end consumers.

 22 Bid offer spreads will widen, credit
 186

 1 risks will widen and liquidity will be reduced.

 2 As a result again, the consumer will bear the

 3 brunt. To highlight several of these issues,

 4 first I would like to mention about the economic

 5 appropriate test. The Commission has imposed a

 6 new test for identifying bona fide hedges where the

 7 concept of gross versus net hedging has been

 8 addressed in the proposed rule.

 9 Merchants should be able to hedge

 10 inventory or purchase their sales contracts in a

 11 manner that reduces its risks. Some commercial

 12 transactions may be hedged, while others may

 13 not. Every transaction does not have a one to one

 14 offset or an equal risk exposure. Many merchants

 15 operate globally and manage their risks and

 16 associated with these global risks over

 17 merchandising projects in many different

 18 countries, qualities, times and locations.

 19 The merchant is uniquely positioned to

 20 decide which risks that it wants to take and to

 21 what degree they need to be hedged. All positions

 22 are not equal, and they are not able to be offset,
 187

 1 and a gross hedging approach is the most

 2 appropriate one to pursue. As far as unfixed

 3 price commitments, Ron - I think Ron's example

 4 just opened the door to one of the problems - one

 5 of the major problems that we have, which is

 6 unfixed price commitments.

 7 The Commission has failed to recognize

 8 the hedging needs of unfixed price contracts, or

 9 otherwise known as basis contracts as a bona fide

 10 hedge. The business of merchandising is conducted

 11 substantially in this form of basis contracts, and

 12 merchants must be allowed to utilize hedging

 13 strategies, including calendar spread hedging, to

 14 manage this risk. It should be noted that one of

 15 the main reasons for hedging is to turn flat price

 16 risk into relative risk.

 17 It is by taking flat price risk and

 18 offsetting that with a futures position, that we

 19 create exactly unfixed or basis positions, the

 20 same positions that the Commission does not want

 21 to recognize as a bona fide hedge. Although the

 22 basis risk is generally less volatile than flat
 188

 1 price risk, it is not always the case. Basis and

 2 unfixed positions still maintain risk, and they

 3 still must be allowed to be hedged, managed and

 4 recognized.

 5 Unfixed positions, and I think this is a

 6 very important point, unfixed positions being not

 7 recognized but fixed price sales with offsetting

 8 futures positions being recognized. A fixed price

 9 transaction with an offsetting future becomes an

 10 unfixed position or a basis position. Yet only

 11 one of them is being recognized. Unfixed

 12 contracts exist for several reasons. One is to

 13 minimize the transaction risk from the time that

 14 the original transaction is made in order to where

 15 it gets hedged. Instead of exposing both parties

 16 to the possibility of variances in prices, in

 17 order to establish the second leg to their hedge,

 18 an unfixed contract allows both parties to

 19 establish the relationship and move forward in a

 20 more orderly manner.

 21 But almost more importantly, another one

 22 of the things and reasons for unfixed purchases,
 189

 1 is that it provides for a much greater security

 2 with regards to counterparty risk, credit risk and

 3 default risk. By allowing to stay unfixed until a

 4 closer period for the final execution of that

 5 contract, we are able to minimize price variance

 6 that could take place.

 7 If these contracts were not allowed to

 8 be recognized, the Commission would be forcing

 9 commercial enterprises to move more towards a

 10 fixed price regime with offsetting hedges in the

 11 commodity market. Now I would ask the Commission

 12 to imagine the position today here amongst those

 13 around the table and especially in the energy

 14 market, if that were the case of what we've just

 15 experienced.

 16 Today we find ourselves with the crude

 17 oil market dropping over $50 a barrel. If today

 18 we were to look at our outstanding positions, we

 19 would see that on paper all of us being hedged

 20 would have a P&L statement that would show that we

 21 are completely covered. However, by forcing us

 22 into fixed price positions with offsetting hedges,
 190

 1 that wholeness that we would have would be totally

 2 dependent upon the credit worthiness of our

 3 counterparties.

 4 Today we would find ourselves in a

 5 situation where the majority of our contracts

 6 would have over a $50 variance against today's

 7 open market position. Therefore the ability in

 8 the future, and as we saw earlier, these contracts

 9 can extend for a long period of time, for several

 10 years, for months, would have counterparty risk on

 11 their books where your own solvency would be

 12 totally dependent on your counterparty's ability

 13 to be able to execute those contracts and be able

 14 to fulfill what would be some extreme mark to

 15 market differentiations.

 16 Therefore, to recognize unfixed

 17 transactions in the marketplace is not only right,

 18 it is essential to protect market participants,

 19 banks, consumers and producers. Another issue to

 20 highlight will be the issue of anticipatory

 21 merchandising. The Commission has omitted the

 22 concept of anticipated merchandising from the
 191

 1 proposed rule in spite of the statute which

 2 Congress clearly intended to include.

 3 Merchandising activity promotes market

 4 convergence, which is a crucial aspect of the price

 5 discovery function in the commodity markets.

 6 Allowing a full scope of hedging activity by

 7 merchants will promote more efficient

 8 marketplaces, transparent marketplaces and which

 9 ultimately serves the public good by providing a

 10 more reasonable price. Commodity cross hedging,

 11 cross commodity hedging, while the Commission

 12 recognizes commodity hedges as an enumerated

 13 hedging transaction in the proposed rule, they

 14 apply a new quantitative test that is being

 15 imposed. We believe a more reasonable test is

 16 appropriate.

 17 I would be happy to go into any of these

 18 issues in more depth as we move forward and answer

 19 any questions that the Chairman or the

 20 commissioners or any of the staff might have, and

 21 I appreciate the opportunity to be here. Thank

 22 you.
 192

 1 MR. ALLISON: Joe, let me start with one

 2 quick question. You've often used the word "basis

 3 contract." So in the natural gas business, the

 4 word basis contract has a very precise meaning.

 5 It is literally the difference in price for

 6 natural gas between two locations. My sense was

 7 you were using basis more broadly than that.

 8 MR. NICOSIA: Yeah, basis is also the

 9 same thing as unfixed. It can be used as

 10 premiums. Sometimes it's used as on call. But

 11 it's a relationship between the price and the

 12 futures.

 13 MR. ALLISON: So thank you. I just

 14 wanted to get that clarification out there.

 15 Questions for any of the speakers? Mr. Chairman,

 16 do you still have your flag up?

 17 MR. BRANDENBURG: Thank you. Ron and

 18 Joe, you've done an excellent job of giving some

 19 examples. I just wanted to make sure that I

 20 understood them. As a producer, as a coal

 21 producer, so a single commodity producer, we

 22 market our coal to various different jurisdictions
 193

 1 and various different markets. Some of those

 2 markets buy it on a fixed price basis, long-term

 3 fixed price contracts. Some of those markets buy

 4 those on an index basis. In order to move our

 5 product from one location to another we often have

 6 to make very large capital investments in

 7 infrastructure. So what I understand Ron from

 8 your example, is that if I'm selling to -- if I've

 9 made a five year commitment, capital commitment or

 10 a throughput commitment for infrastructure, I

 11 would not be able to hedge those transactions into

 12 a market that buys on an indexed basis. I would

 13 not be able to sell those short contracts, have a

 14 short indexed exposure and be able to protect that

 15 and claim that as an exemption.

 16 MR. OPPENHEIMER: So if I understand

 17 your example, you would take production you

 18 haven't yet pulled out of the ground and your

 19 forward exposure would be unfixed price forward

 20 exposed.

 21 MR. BRANDENBURG: So I would have

 22 several exposures, as Joe mentioned. I would have
 194

 1 -- I would not yet have a counterparty buying my

 2 product. That counterparty would buy it -- in

 3 that particular market would buy it on an indexed

 4 basis 'cause that's the way that market works.

 5 And I would have a large capital exposure for an

 6 investment that I had made that I needed to

 7 guarantee the throughput for.

 8 MR. OPPENHEIMER: Right. So there are a

 9 couple of ways that has to be addressed, and it's

 10 funny that I'm answering these questions and not

 11 Steve. But let me take a crack at a few of them,

 12 and Steve can correct me where I get it wrong.

 13 You have a couple of different things there. As a

 14 producer, you have the ability to use what's

 15 called the unsold anticipated production hedge.

 16 And that would allow you to take certain futures

 17 positions as substitutes for the forward sale and

 18 treat those as exempt positions.

 19 But what you also said is that you've

 20 built some infrastructure, and it's another

 21 important point that's in the working group

 22 comments. It was in the working group petition as
 195

 1 well. And that is that the ability to hedge the

 2 value of that asset, steel or whatever it is, and

 3 Lael I think brought up the issue of a generator,

 4 in capital projects very often you won't get

 5 financing unless you have some hedge on the

 6 expected value of whatever the project is. Your

 7 capital project or the building of a generation

 8 facility.

 9 Those hedges would not be recognized as

 10 bona fide hedges under the proposal either.

 11 MR. NICOSIA: I think one other thing

 12 too, when you were starting to talk about having

 13 transactions in the future, whether they're index

 14 based but they're unfixed to where things are. I

 15 want to back up to one thing on Ron's opening

 16 statement on this example. And Steve, would the

 17 Commission's view of a bona fide hedge on Ron's

 18 first example have been changed if instead of

 19 buying it on an unfixed basis out of Europe, he'd

 20 have bought it fixed price and hedged it? Would

 21 you have then had a different answer of whether

 22 the rest of the transaction was a bona fide hedge?
 196

 1 MR. SHERROD: I like it when you ask

 2 questions you know the answer to. So when someone

 3 buys something, they have inventory or forward

 4 fixed purchase and that's the classic hedge.

 5 MR. NICOSIA: So the answer is yes to

 6 this then. So there -- that goes back to this

 7 unfixed issue that I think is critically important

 8 that we have to deal with. And that it wasn't the

 9 transaction in and of itself that was a bona fide

 10 hedge or not bona fide hedge. It was simply the

 11 form of the first transaction that was making it

 12 qualify for a bona fide hedge or not. And yet

 13 those two transactions, one with a fixed price and

 14 a hedge and the other in the unfixed position, are

 15 the exact same position. And yet one would

 16 qualify for a bona fide hedge and one would not.

 17 MR. ALLISON: Russ?

 18 MR. WASSON: Thank you Jim. I would

 19 like to give you all a different perspective on

 20 this, and let me just preference what I say by the

 21 fact that I'm a CPA, not an attorney. But

 22 electric cooperatives, there are approximately 900
 197

 1 electric cooperatives that serve areas from 300

 2 miles north of the Arctic Circle to Key West and

 3 from Hawaii to Maine. We are private

 4 corporations, but unlike traditional corporations,

 5 which must balance the interests of shareholders

 6 and customers, electric cooperatives’ owners are

 7 our customers.

 8 And so everything that we do that incurs

 9 an increased cost, flows through to them. So in

 10 let's say September of 2010 we filed 73 comment

 11 letters or participated with others in filing 73

 12 comment letters with the Commission. We view

 13 those as a hedge against the regulatory risk that

 14 the Commission is going to increase our cost. And

 15 the reason we're so concerned about that is

 16 because in that area I just mentioned, the median

 17 average household income -- or median average, the

 18 average household income is $68,000, 12 percent

 19 below the national average of $77,000.

 20 So when something happens to increase

 21 our cost and it flows through directly to our

 22 members, it has a dramatic impact on them. I know
 198

 1 if I told you your cost for electricity was going

 2 to go up by 10 percent, most of you wouldn't think

 3 anything about it. But for some of my members,

 4 that's a tragedy. So we are acutely aware of

 5 trying to protect them from increases in the cost

 6 of electricity. We are all end users. We don't

 7 hedge -- I'm sorry, we don't trade, we don't

 8 speculate. We are hedging our commercial risk,

 9 and by commercial risk, I mean operating risk.

 10 The risk of keeping the lights on, and the risk of

 11 protecting our members from upward price pressure

 12 primarily from fuels. But also from increased

 13 administrative cost that may come about by the

 14 Commission's actions.

 15 And I will say this in all due respect.

 16 We do not believe that Congress intended for the

 17 Commission to substitute their judgment for the

 18 reason business judgment of commercial end users

 19 who are trying to hedge their commercial risk.

 20 The passage of Dodd-Frank didn't change the

 21 physics of the electric business. And

 22 furthermore, we're using the same contracts that
 199

 1 we use to hedge our commercial risk, that we've

 2 used since 1930s, '40s and '50s. Our business has

 3 not changed.

 4 I don't know anyone with any electric

 5 utility that can even enumerate all the thousands

 6 upon thousands of ways that electric utilities

 7 have to hedge their operational risk. And the

 8 idea that the Commission could create a bona fide

 9 hedge that would cover all those, is impossible in

 10 our opinion.

 11 And so we -- in our comment letters we

 12 ask for an exemption under the statutory authority

 13 in 4a(a)(7). We ask for an exemption -- an entity

 14 based exemption, and barring that, we ask for a

 15 transaction based exemption. But I don't think

 16 that end users who are trying to hedge their

 17 operational commercial risk, should be second

 18 guessed or subject to being second guessed by the

 19 Commission, when all we're trying to do is keep

 20 the lights on. And actually, I mentioned this at

 21 lunch, we're not in the electric business. We're

 22 in the business of providing modern civilization.
 200

 1 That's out business. And those of you who have

 2 been without power, you know what I'm talking

 3 about.

 4 So that's really all I've got to say.

 5 MR. ALLISON: Lots of flags up, so I'm

 6 going to try to take you in the order in which

 7 I've seen them come up. So Herbert?

 8 MR. THORNHILL JR: Thanks very much for

 9 the time. One of the things I wanted to focus on

 10 is what Joe brought up about cross commodity

 11 hedging. And I like the fact that you brought up

 12 a lot of really real world examples because unless

 13 you have those real world examples, you really

 14 won't know how the proposed rules really will

 15 affect commerce on a day to day basis.

 16 And in the power space, it's a very

 17 common way to hedge your power length, by using

 18 natural gas, futures options and so forth. It's

 19 tried and true, whether you're a competitive power

 20 producer or you're a utility. It's a tried and

 21 true way of hedging your risk. And it's been done

 22 for decades. It's been accepted on the accounting
 201

 1 level. It's been accepted by the exchanges. I

 2 don't think it's been challenged legally in the

 3 past.

 4 However, if we get to the cross

 5 commodity hedging issue that Joe raised, you find

 6 out that there's a new mathematical correlation

 7 there. It's zero point eight. And suddenly

 8 because of a mathematical correlation, what would

 9 happen is, this tried and true method of hedging

 10 would disappear because, since you're going to be

 11 measuring that in the spot price period of time,

 12 the correlation between natural gas and power may

 13 not be zero point eight. It's very volatile,

 14 especially in the spot area where quite frankly

 15 prices are volatile and change day to day.

 16 But it doesn't only affect power, which

 17 is obviously essential, as you pointed out Russ.

 18 It affects many people. It affects everyone in

 19 this room, every business and so forth. The price

 20 of power is very important, and the ability to

 21 hedge risk associated with power is important.

 22 But this zero point eight correlation
 202

 1 also affects some other energy commodities that

 2 affect every one of us in this room. Let's take

 3 fuel oil, which is usually hedged with --

 4 oftentimes hedged I should say, with the crude oil

 5 contract. That correlation in the spot period

 6 just doesn't make the zero point eight test.

 7 So I think it's excellent that Joe

 8 raised his point about the mathematical

 9 correlation. I think it's something that should

 10 be examined. I think, based on what I've been

 11 told by accountants, it's based on not an

 12 accounting rule, but an accounting practice that's

 13 not used in every case. I understand it's related

 14 to cash flow accounting. Whereas there are other

 15 accounting standards that are equally viable, used

 16 on a day to day basis, where they use more of a

 17 substantial relationship test to see if it's

 18 viable from an accounting standpoint.

 19 They just really look at whether there's

 20 a meaningful commercial relationship between the

 21 underlying commodity being hedged and the futures

 22 contract that's being chosen to hedge the risk.
 203

 1 But I do think that the zero point eight

 2 correlation is something that is worthy of more

 3 examination. And I think that the ability of

 4 people here to offer more examples to the

 5 Commission of the impact of using that kind of a

 6 correlation, the impact it's going to have on

 7 commercial activity, is a very useful process to

 8 go through.

 9 MR. ALLISON: Let me exercise the

 10 Chair's privilege to inject one technical comment

 11 on Bill and Herbert's comment. If you are

 12 thinking about risk in the sense of standard

 13 deviation, then for any correlation other than

 14 zero, there exists a scale of the hedge such that

 15 the portfolio of the exposure plus the hedge, has

 16 lower risk than the exposure by itself. Any

 17 correlation. Zero point eight is completely

 18 arbitrary. And Dena, I think you were next.

 19 MS. WIGGINS: Thank you. Thanks

 20 Jim. Russ confessed to being a CPA. I will

 21 confess to being a recovering FERC lawyer, so I'm

 22 much more accustomed to being at the other end of
 204

 1 DC than I am to being at this end of DC. But

 2 because of that, I've spent a lot of time dealing

 3 and addressing issues in the physical market. And

 4 I think that part of what we need to keep in mind

 5 here is that the actions that this Commission

 6 takes can have an impact in the physical market.

 7 And last winter, for example, we heard

 8 in the gas industry a lot of hue and cry over the

 9 spot market price of natural gas. Now that was

 10 the spot price. It was up in the Northeast. As

 11 everybody remembers, it was very cold for an

 12 extended period of time. Spot market prices went

 13 up pretty high.

 14 Our response to that as natural gas

 15 producers and suppliers, was to say to people,

 16 please make your arrangements in advance. Go out

 17 commercially and make some arrangements so you're

 18 not trying to go into the spot market on the day

 19 that it's two degrees below zero in February. What

 20 I find troublesome now is to hear Ron, as

 21 confirmed by Arushi, saying that one of the, what

 22 I understand to be fairly standard ways that a
 205

 1 generator or a utility could go out and hedge and

 2 try to do some of what we've been advising people

 3 to do on that storage slide up there, would not

 4 necessarily be deemed a bona fide hedge.

 5 And I find that troublesome. And we put

 6 comments in the record previously that we think

 7 the list of bona fide hedges ought to be expanded

 8 and at a very minimum, there ought to be some

 9 fairly fast process for someone to get some

 10 clarification as to what kind of transaction this

 11 is and whatever this is. Whether it would be

 12 deemed a bona fide hedge, because as others have

 13 said, these decisions need to be made and they --

 14 I understand that there is a process for a

 15 regulated body to make a decision. But it needs

 16 to have some book ends on it so that people just

 17 aren't out there struggling and flailing around

 18 trying to figure out what to do.

 19 So as the Commission decides how to

 20 address this, I would just ask that you keep that

 21 in mind, that we are trying to help. We do

 22 understand you've got a regulatory job to do. But
 206

 1 we really want our customers to be able to engage

 2 in appropriate behavior to hedge their risks.

 3 MR. ALLISON: Lael?

 4 MR. CAMPBELL: Thank you. I'm chomping

 5 at the bit here, because I have a really good

 6 follow-up to that, with an example. It's the

 7 point I wanted to make and I wanted to steal

 8 Russ's quote because it was funny and we had a

 9 great conversation at lunch up on the ninth floor.

 10 And Russ said, "We're not in the business of

 11 delivering electricity. We're in the business of

 12 delivering modern civilization."

 13 And so much of the focus since last

 14 year's polar vortex and some of the issues we've

 15 had with in the physical gas and electricity

 16 infrastructure last year, have really turned the

 17 focus onto reliability. And to your point,

 18 generators will often secure their long-term gas

 19 contracts at an unfixed price, to make sure that

 20 they have that gas available to them and that gas

 21 is going to be delivered to them.

 22 So they're securing gas at an unfixed
 207

 1 price to secure supply. And this really gets back

 2 to Joe's point about the unfixed issue. Now my

 3 understanding is that you are allowed to hedge --

 4 bona fide hedge treatment for unfilled anticipatory

 5 fuel requirements. But if your requirements are

 6 filled, that doesn't necessarily qualify for

 7 bona fide hedge treatment.

 8 So I'm a generator. I'm concerned about

 9 reliability. FERC's told me I have to be

 10 concerned about reliability. I procure gas on a

 11 long-term basis at an unfixed price. All of a

 12 sudden when I go in and the market tells me now is

 13 the right time to go ahead and fix that price, I

 14 can't do that on a bona fide hedge basis. I am

 15 exposed to price risk. I have purchased my gas

 16 long-term. Market's going to go up and down. I

 17 would love to be able to manage that price risk if

 18 I could when I think the price is right and fix it

 19 for the time period. But my understanding is that

 20 under the current rules, I can't do that as a

 21 generator because I've already procured my gas. I

 22 have a filled fuel requirement, even though it's
 208

 1 unfixed.

 2 So again, this unfixed issue doesn't

 3 just impact merchants. It impacts us as well, and

 4 the ability to fixed unfixed price exposure should

 5 certainly be deemed as something that's

 6 economically appropriate to managing risk.

 7 MR. ALLISON: Ben?

 8 MR. JACKSON: Thanks Jim. Russ, you're

 9 going to be famous here today with some of the

 10 comments that you've made. And building on that

 11 civilization, modern civilization example, from

 12 the vantage point with ICE, I look after markets

 13 that range from the US energy markets to

 14 enumerated agricultural markets to also

 15 non-enumerated agricultural markets. And what

 16 would modern civilization be without products like

 17 chocolate and coffee?

 18 Those are also some of the products that

 19 trade on our exchange. And these rules, the

 20 issues that I'm hearing around the table here,

 21 that are relevant for energy market participants,

 22 are the exact same issues that agricultural market
 209

 1 participants are also arguing. It's going to

 2 impact their ability to hedge and mitigate their

 3 price risk.

 4 Just in the last comment period, ICE

 5 futures US submitted two different comment letters

 6 on these particular rules, talking about

 7 anticipated merchandising. The limitation on

 8 anticipated production and consumption down to 12

 9 months. Allowing the ability to only hedge flat

 10 price risk. We submitted comment letters that

 11 were co-signed by over 50 different commercial

 12 market participants in our markets. In our enumerated

 13 commodities as well as our non-enumerated

 14 commodities.

 15 So these issues are not unique to

 16 energy. It is shared by people that are

 17 manufacturing the clothing on our back and the

 18 food that we eat each day. Ron's examples that he

 19 went through are almost identical to the examples

 20 that sugar manufacturers, producers and refiners

 21 have. Same with coffee. We had the opportunity

 22 as well yesterday to bring a representative subset
 210

 1 of those 50 commercial entities that signed that,

 2 a major coffee roaster, a major chocolate

 3 manufacturer, producers, merchandisers, to walk

 4 through these exact same issues.

 5 The other thing I'd highlight is, when

 6 you look at what are these rules at the end of the

 7 day? You're trying to apply rules that today are

 8 in place for the enumerated agricultural

 9 commodities, across non-enumerated Ags and across

 10 the energy sector. As though that's the model for

 11 convergence and the model for liquidity and open

 12 interest out the curve.

 13 And I'd highlight for the record a

 14 couple of slides that Erik presented earlier,

 15 where he showed open interest in our enumerated

 16 agricultural commodity, namely cotton. And how

 17 it's primarily concentrated in the front couple of

 18 months, compared to our energy contracts, where

 19 open interest goes far out the curve. And

 20 thinking about a lot of the concerns that our

 21 commercial market participants are bringing around

 22 liquidity outside of those front months, brings
 211

 1 deep concern to me on what the impact of these

 2 could be on liquidity going out the curve for our

 3 market participants.

 4 Our energy markets are a model for

 5 convergence, which at the end of the day, enables

 6 our users to hedge their price risk and mitigate

 7 their price risk. And Russ, to another comment

 8 you made earlier, is actually the exact same

 9 comment I made on a panel back in June on do no harm.

 10 MR. ALLISON: Arushi?

 11 MS. SHARMA FRANK: Mr. Chairman, you

 12 made a point earlier in your discussion on Ron's

 13 comment with Steve that at some point in this

 14 rulemaking there has been a question by staff as

 15 to whether a fact pattern that's been presented on

 16 a bona fide hedge is sufficiently non-generic in

 17 order for staff to be able to make a reasoned

 18 determination on its status. And that was

 19 something in the discussion where you talked

 20 about, well, in 2011 a certain fact pattern was in

 21 fact considered appropriate for the hedge

 22 exemption and then in the other proposal, staff's
 212

 1 view changed.

 2 So, trying to watershed, and given the

 3 fact that we don't have a lot of time left, one of

 4 the reasons that we are all here is so that we can

 5 provide the commission well-articulated comments

 6 in this open comment period about what else staff

 7 needs to see in order to help resolve some of the

 8 problems that we've talked about today, especially

 9 on this last panel with the number and the nature

 10 of the types of transactions that we believe do

 11 not fit within the bona fide hedge exemption.

 12 Looking at it from the perspective of

 13 someone who represents gas utilities, I agree with

 14 everybody here who has spoken that there isn't a

 15 good way for me to develop a panoply of

 16 non-generic examples of what might be a bona fide

 17 hedge. And so my question for staff, I guess,

 18 Steve, maybe you could answer this, is, what do

 19 you expect from us as a follow on to what we've

 20 made today in comments? Do you expect that we

 21 could or should be putting forth a series of

 22 examples that could appropriately capture what we
 213

 1 think should be covered by this rulemaking? Or do

 2 you think we should be suggesting to you an

 3 appropriate alternative procedural mechanism,

 4 whether it's the 4a(a)(7) exemption route or

 5 something else as a way for us to move forward?

 6 Because, I think we all agree, at least

 7 on the basic notion, that there are some things

 8 that this rulemaking at this time does not cover

 9 that probably should be covered, and the question

 10 is, what do we need to do to get there?

 11 MR. SHERROD: I think you're doing it.

 12 You're providing oral input for the record, you

 13 provided comment letters. We appreciate those.

 14 We're carefully reviewing those, as the Chairman

 15 has said many times, and continue. We have 30

 16 more days in the comment period. We suggested it

 17 at last summer's staff roundtable that maybe one

 18 way forward on non-enumerated is to have the

 19 exchange process that Tom LaSala and I think it

 20 was Tim Berry from CME Group and ICE suggested

 21 they may be amenable to that.

 22 So, we're open to any sort of
 214

 1 suggestion, any comment, we're going to carefully

 2 consider all the many substantial comments that

 3 have been received and that we expect in the next

 4 comment period.

 5 MR. ALLISON: Sue?

 6 MS. KELLY: Thank you. I just want to

 7 associate myself with Russ's remarks and that he

 8 and I have been joined at the hip since the

 9 passage of the Act and all those comment letters

 10 that he's joined in, we have as well. Again,

 11 trying to reduce our regulatory risk. But we have

 12 found out the hard way that even when the

 13 commission intends to protect us, sometimes the

 14 doctrine of unintended consequences can come into

 15 play and we probably are the poster child for

 16 collateral civilian casualties when that occurs.

 17 We extremely very much appreciate the

 18 relief that the commission has granted us to kind

 19 of take back some of the worst impacts of

 20 Dodd-Frank regulatory regime on us, but as you can

 21 imagine, it's made us a little gun shy. And so

 22 when I sit here today and I hear that, you know,
 215

 1 transactions that I know my members use to try and

 2 reduce risk of prices to be able to provide

 3 electric service to our entities, you know, our

 4 members, who own us -- we are units of state and

 5 local government. You know, why we have to be,

 6 frankly, here at the CFTC seeking this type of

 7 exemption for that kind of hedge, I mean, it just

 8 makes no sense to me.

 9 So, the words that I would like to latch

 10 on to -- and what Russ said was "entity-based

 11 exemptions" -- is there any reason why

 12 not-for-profit, city and state owned utilities

 13 that, you know, are owned by their customers have

 14 to be here for this regime? Why is it -- why are

 15 they concerned about excessive speculation on our

 16 part?

 17 So, I would just like to put in a plea

 18 here that maybe we could somehow make being a

 19 special entity into a good thing instead of a bad

 20 thing. So, I just urge you to think about trying

 21 to figure out if there's classes of market

 22 participants that you might be able to, kind of,
 216

 1 let our people go, have some kind of relaxed

 2 regulatory regime, or whatever it is, I hope you

 3 will think about this in your next go around on

 4 this issue and I will stop there. Thank you very

 5 much.

 6 MR. ALLISON: I don't see any volunteers

 7 to respond to that, Sue. Paul?

 8 MR. HUGHES: Thanks. I want to perhaps

 9 -- I love the comments we've heard -- maybe change

 10 the direction just a hair based on something that

 11 we heard earlier from Joe, and it had to do with

 12 kind of the enterprise-wide approach to hedging.

 13 This is -- sometimes we call it the gross versus

 14 net, and viewing our overall view of risk across

 15 the enterprise, and for a company like mine, a

 16 southern company, we have multiple subsidiaries.

 17 We have four regulated utilities, one

 18 non-regulated utility, but each one of those

 19 regulated utilities where we hedge our natural gas

 20 on behalf of our customer base, every single one

 21 of those hedges fall under a PSC oversight and

 22 each state has their own set of rules, their own
 217

 1 set of circumstances, and their own governance to

 2 how we hedge.

 3 Now, the one thing that they all do is

 4 they all review, transaction by transaction, every

 5 one of those transactions for prudency. And so,

 6 trying to somehow combine four separate hedging

 7 programs into one and view that as an enterprise

 8 is problematic at best, and then if I throw in my

 9 unregulated utility then we have additional

 10 issues.

 11 And just from an operational standpoint

 12 and a feasibility standpoint, it's -- I'm not sure

 13 how, exactly, we get there to manage that.

 14 I will say, I do appreciate what the

 15 staff did and they included some language when it

 16 came to PSC regulations or PUC regulations and

 17 they included some language in the regs or in the

 18 proposal that talks about where PUC directs or

 19 encourages hedging and I appreciate that, but not

 20 all PUCs and PSCs work like that.

 21 A lot of PUCs say, hey, we're going to

 22 come back and do a prudency review of all your
 218

 1 costs. We expect you to do what is in the best

 2 interest of your customers regardless, if that

 3 means hedging, then we expect you to be hedging

 4 the best interest of your customers, and we'll

 5 come back and we'll review that for prudency.

 6 That doesn't necessarily mean that

 7 they're going to encourage us to hedge or

 8 discourage us from hedging. Some may provide us

 9 specific limits. Some may have more of a

 10 prescriptive program. But what we see in our

 11 companies, we have a very diverse set of public

 12 service organizations that we work with and they

 13 all look at things differently. And so to combine

 14 those together in an enterprise manner is very

 15 difficult to work with.

 16 And so, the language, while it's

 17 appreciated by the PSC, I would say it's

 18 problematic and I think some wording tweaks, I

 19 think, in the spirit of what you're trying to do,

 20 I think we can get there and I'm optimistic that

 21 will happen.

 22 Secondly, and I won't go into this
 219

 1 because I know I could cause an uproar, we'd all

 2 start jumping up and down, but just so that it's

 3 on the record, right now, position limit rule

 4 would include trade options. It can't include

 5 trade options. We cannot have trade options in

 6 the position limit rule. To try to include the

 7 calculations, trying to figure out how that would

 8 work, is almost impossible.

 9 You know, we're reporting trade options

 10 this week, but to somehow translate that into

 11 equivalent contracts, I would be looking to staff

 12 to tell me how to do it and I don't think staff

 13 could tell me how to do it either.

 14 I think everybody probably is on the

 15 same page on that. If anybody wants to talk about

 16 that further, I could talk about it for days, but

 17 I do think it pushes the line between -- it gets

 18 into our construct of having to be reliability --

 19 (inaudible) versus (inaudible) decisions. I think

 20 there's lots of things that causes problems in

 21 that regard, but I just want that on the record.

 22 The other thing, just maybe to pull back
 220

 1 a little bit, I think it's important that we

 2 recognize -- we started, everybody's talked about

 3 it, we've been doing position limits for a long

 4 time now. I think the order of the rules and the

 5 order that they're implemented matters because I

 6 think the market has changed since 2010 and when

 7 we started this.

 8 Where I look at today is -- just give

 9 you an example, so if I go back to January, I

 10 manage the risk operations group for Southern

 11 Company, so in January we had some folks in our

 12 company come say, hey, Paul, I want to sit down

 13 and let's see if we can figure out -- we have this

 14 risk, we want to figure out if there's a way to

 15 hedge around a specific facility.

 16 We sat down, we looked at it, and we

 17 came up with a plan. In the past, this is a risk

 18 that we could have hedged. We could have gone out

 19 to the marketplace. Now, I'll admit, we operate

 20 in some areas where it's not necessarily oceans of

 21 liquidity. And NYMEX Henry Hub is an ocean of

 22 liquidity. Perhaps PJM West, was mentioned on the
 221

 1 previous presentation, that's an ocean of

 2 liquidity.

 3 We operate in some areas where I would

 4 say, historically, I would describe more so as

 5 large ponds of liquidity. There may not be a

 6 super amount of depth there, but there's been

 7 enough to where I can offset my risk.

 8 Well, this January when I'm looking to

 9 go offset risks in the past I would have been able

 10 to do it, there's no more players out there.

 11 Those ponds have dried up. And I think you can't

 12 necessarily attribute that to one specific rule,

 13 and I think to do so would be unfair, but I do

 14 think if you look at the order of the rules, and

 15 it's just kind of the way it happened, I think if

 16 we ignore the fact -- I think Dodd-Frank has had

 17 an impact on the markets and we can't ignore that.

 18 I heard the guy from ICE this morning say

 19 that, hey, they're actually seeing people leave,

 20 they're seeing less liquidity in the electricity

 21 markets, I'm seeing less liquidity in the OTC

 22 market. And we're struggling. And so, from a big
 222

 1 picture perspective, I worry that we, as a hedger

 2 -- and that's what I am -- the transactions we go

 3 out and hedge, they're not that complicated. I'm

 4 probably closer to what Russ's group does than

 5 probably a lot of other folks. We keep it pretty

 6 simple.

 7 But all the sudden, we've got a whole

 8 lot of complexity we've got to deal with from a

 9 regulatory standpoint, and while I feel like we

 10 may have driven out maybe some of the swap dealers

 11 out of this market, for various reasons, now all

 12 the sudden I feel like we've got a whole bunch of

 13 hedgers. And what I really would like to see is,

 14 find me a way to get some more liquidity. I need

 15 some more people out there that can help offset my

 16 risk, because right now I'm sitting in a mud

 17 puddle that I used to could go hedge and now it's

 18 dried up and that's where I'm afraid that the

 19 burden of excessive speculation that we're trying

 20 to relieve, has now become a burden of illiquidity

 21 on the hedgers, and that's my biggest concern.

 22 MR. ALLISON: Commissioner Giancarlo.
 223

 1 COMMISSIONER GIANCARLO: Paul, thank you

 2 for that. I just wanted to ask you, you made the

 3 point about trade options and even though that

 4 wasn't on our agenda, I do want to ask, I think

 5 you said everybody here agrees, but I'd just like

 6 to test that out. Does anybody want to push back

 7 on that? Or is there anybody that would like to

 8 address trade options and its applicability for

 9 position limits?

 10 MS. SHARMA FRANK: So, one quick note

 11 about the impracticability of doing this. In the

 12 natural gas world, one of the ways that we're

 13 seeing more and more commodity option contracts

 14 built is physical delivery agreements off of the

 15 NYMEX futures without necessarily referencing the

 16 NYMEX Henry Hub as the actual contract on which

 17 the price is based off of once that option

 18 settles.

 19 So, we're looking at a situation where

 20 you have a group of stand-alone commodity trade

 21 options settling in the physical delivery of

 22 natural gas at different points around the country
 224

 1 or one utility doing it for different points on a

 2 system, and they don't necessarily all tie back to

 3 the same reference contract. And if they do, they

 4 tie back at a point in time that's very hard for a

 5 utility to figure out where and how all of it fits

 6 together and a lot of these contracts are also

 7 very open-ended, I mean, they're 10-year

 8 contracts, 15-year contracts, and the whole notion

 9 of the commodity option in the utility world is to

 10 hedge price risk and to hedge risk related to

 11 deliverability of supply.

 12 So, asking a utility to go through the

 13 monitoring and the other various very detailed

 14 record keeping reporting type requirements related

 15 with those positions, and compliance with basic

 16 position limits rules that are effectively

 17 impossible, for example, taking delivery into the

 18 spot month, which basically is the underlying

 19 characteristic of that type of gas trade option,

 20 effectively renders the trade option a useless

 21 tool that they could not use if they were subject

 22 to position limits and that takes out a good
 225

 1 chunk, 50 percent chunk, of what the utility can

 2 do to manage price risk for its consumers.

 3 So, the bottom line here, what I'm

 4 saying, is that by applying position limits to

 5 commodity trade options, you'd effectively be

 6 requiring natural gas end user consumers, retail,

 7 commercial, and actual customers to pay more for

 8 gas in constrained times of the years because

 9 utilities could not use those contracts in the way

 10 that they imagined in order to hedge those price

 11 risks.

 12 MR. ALLISON: Commissioner Wetjen.

 13 COMMISSIONER WETJEN: Thanks, Jim. Just

 14 to follow up with Paul. These ponds of liquidity

 15 that you referred to, it sounds like they might be

 16 in what you also refer to as the OTC space? So,

 17 just a point of clarification, OTC, because, as

 18 we've seen here at the meeting, these terms mean

 19 different things depending on what the context is,

 20 but when you say OTC, are you also including some

 21 of the electricity or power markets like RTOs and

 22 ISOs? Or are you referring specifically to, you
 226

 1 know, bilateral swap contract marketplace?

 2 MR. HUGHES: Truthfully, both. And my

 3 specific example would be more of a bilateral type

 4 market, but one of the reasons I was going to go

 5 to a bilateral type market is there wasn't enough

 6 liquidity in these areas on an exchange to do a

 7 transaction there, and that's just kind of the way

 8 it has been. But what I -- the situation we have

 9 now is where I used to maybe have eight or ten

 10 counterparties that were out there that I could

 11 call on and reliably expect to be there. Some of

 12 those counterparties have just left. Some of them

 13 have kind of left the marketplace, some of them

 14 got completely out of the business. Some of them

 15 have moved overseas.

 16 So, it's overall liquidity problem, but

 17 I think it highlights perhaps, that electricity is

 18 still based on regional markets and I don't -- you

 19 know, just because we're not in an RTO, I don't

 20 think that the rules should be -- have any bias

 21 against that.

 22 COMMISSIONER WETJEN: Right, but the --
 227

 1 just another point of clarification, the RTOs and

 2 the ISOs, those are essentially bilateral markets

 3 as well, correct?

 4 I mean, there's not a central

 5 counterparty involved, there's no clearing,

 6 correct?

 7 MR. HUGHES: Well, I think I'm probably

 8 not the best person to be an expert on the

 9 RTO/ISOs, but I would tell you that a lot of those

 10 agreements are actually -- you may not know who is

 11 on the other side of that. You bid in to a market

 12 that's administered by the RTO/ISO.

 13 COMMISSIONER WETJEN: Okay.

 14 MR. HUGHES: Lael maybe can follow up

 15 on me on that.

 16 COMMISSIONER WETJEN: I guess, you know,

 17 one comment I would make is that I don't know -- I

 18 don't mean this to be received as a defensive

 19 statement or anything on the part of the CFTC, but

 20 the fact is, we just have almost completed now

 21 implementing an entirely new regime, so -- and we're

 22 seeing this in the international context too in
 228

 1 thinking about -- in trying to analyze why global

 2 market participants and swaps want to be part of

 3 the U.S. market structure or not, and I do think a

 4 lot of this comes down to perceptions about legal

 5 and compliance risk.

 6 And the reason I was asking this

 7 bilateral question is I'm not intimately familiar

 8 with the RTO and ISO markets. We had a nice time

 9 talking about them yesterday. But I imagine

 10 there's probably some increased compliance risks

 11 there. I don't know exactly what FERC has done

 12 over recent years, but certainly on the

 13 enforcement spectrum they've become, I think it

 14 might be fair to say, fairly active or perhaps

 15 more active than they were a number of years ago.

 16 So, I just wonder to what degree that

 17 factors in, and in light of the fact we are all

 18 implementing statutes, you know, what can or

 19 should be done about it?

 20 MR. HUGHES: Yeah, I think maybe the

 21 last comment, and this comment maybe goes back to

 22 the order of the way things happen, if you go back
 229

 1 a few years ago and there was an RTO/ISO exemption

 2 that was put together for that group of

 3 electricity markets, at that time, I still

 4 remember discussions among trade associations,

 5 people in this room, well, we don't really have to

 6 worry about that because our transactions, they'll

 7 never be classified as a swap. I think had that

 8 been known at the time, there probably would have

 9 been a much more concerted effort -- group effort

 10 to say, hey, perhaps we all should be on board

 11 with this same type of exemption on the energy

 12 space because, you know, regulated utilities in

 13 particular, it's a unique commodity and it's a

 14 unique business, and it doesn't -- we don't

 15 exercise options based on price signals all the

 16 time. Sometimes we do it simply because it's cold

 17 outside, even if it's out of the money.

 18 So, you bring up great points. I think

 19 they're worth more consideration.

 20 MR. ALLISON: Tyson, you've been waiting

 21 patiently.

 22 MR. SLOCUM: Thank you so much. So, you
 230

 1 know, my organization, we receive funding from

 2 350,000 individual households across America, so

 3 the issue of bona fide hedging is very important

 4 to the folks that help pay my salary, and so we

 5 are extremely sympathetic to some of the specific

 6 examples that I've seen here where what appear to

 7 be legitimate hedging operations might be limited

 8 or prohibited under a rule, and Public Citizen is

 9 interested in making sure that legitimate hedging

 10 strategies can be utilized, that regulation

 11 doesn't go too far.

 12 But we have to remember that the reason

 13 that Congress addressed this, right, we're not

 14 talking about this issue in a vacuum, the lines

 15 between hedging and speculation had become

 16 intentionally blurred. We had almost every major

 17 Wall Street bank jumping in to acquire or lease

 18 energy assets to complement or expand their

 19 speculative activity that harmed consumers. We

 20 had issues where entities that everyone would

 21 assume was simply hedging their risk, a company

 22 like Chevron, that the only reason we know that
 231

 1 they were engaging in hyper speculative activities

 2 is because one of their PR people accidently sent

 3 a detailed spreadsheet, right, in July 2001 to

 4 reporters that show that they were making massive

 5 profits speculating in oil markets so that we need

 6 to understand that we've got to preserve the ability

 7 of legitimate hedgers, but when I hear some

 8 comments that we don't want the CFTC second

 9 guessing some of this -- we need the CFTC to be

 10 looking at it. Congress directed the CFTC to look

 11 at this because of widespread abuses that resulted

 12 in billions of dollars in thefts from consumers.

 13 You know, I was very proud to work with

 14 Natural Rural Electric Cooperatives when Glenn

 15 English was its CEO. Glenn English and I worked

 16 together during the California electricity crisis

 17 when we were chasing Enron around, and he was

 18 firmly committed to understanding the role that

 19 strong regulation over derivatives markets was

 20 essential in protecting consumers and so, again, I

 21 look forward to working with folks on these

 22 issues, but we just need some historical
 232

 1 perspective on why Congress addressed this in the

 2 first place.

 3 MR. ALLISON: Robert?

 4 MR. CREAMER: First of all, I just want

 5 to express to everyone who's given comments here

 6 that as a principle trading organization, I've

 7 really absorbed an enormous amount and have

 8 learned a lot from the conversation.

 9 We are market makers in some of these

 10 very liquid contracts and we are also very active

 11 in some areas, OTC and what we would call pond

 12 markets. I think the reality is for principle

 13 trading firms, our business is supported by a

 14 handful of individuals, it's our capital, we serve

 15 as market makers, we are trying to provide

 16 liquidity. It is not economical for us to

 17 participate in markets in which there is no

 18 hedging activity.

 19 When people don't show up into the

 20 markets and we're just casting bid and offers all

 21 day long and no one's there, we lose interest, it's

 22 not viable for us to do it, so whatever effects
 233

 1 the commercial hedgers and folks from entering the

 2 market, is going to have the impact of taking

 3 people out from actually hedging, and it's not

 4 going to provide incentives or the reasons for

 5 folks to step in and provide resources to support

 6 markets there.

 7 So, I just wanted to throw that out. It

 8 builds on itself.

 9 MR. ALLISON: Vince, are you seeking to

 10 be recognized? Robert, did you finish?

 11 MR. CREAMER: Yes, I'm finished. Thank

 12 you.

 13 MR. ALLISON: Vince?

 14 MR. JOHNSON: I was thinking, a quick

 15 question in a different direction, in

 16 conversations that we've had with commissioners

 17 and staff, we've been told on several occasions,

 18 with regard to hedging, and in light of the great

 19 examples that Joe and Ron brought up about the

 20 complexities, about a -- coming back with a bright

 21 line test on how to determine someone is hedging,

 22 coming back to your term, whether someone's
 234

 1 hedging or whether someone is speculating.

 2 And I guess my question -- I'm just

 3 throwing it out to the room just to see if that is

 4 kind of still the thinking -- it seems to me very

 5 difficult to draw up a bright line test and I know

 6 we had a conversation with the Chairman one time

 7 and I think we went back in our shop and worked on

 8 it for a long time, and just found it very

 9 difficult. And in light of the conversations I

 10 was just seeing if there are any other additional

 11 comments or thoughts around that.

 12 MR. HUGHES: I think it's easy after the

 13 fact to determine if you're hedging or not. It's

 14 the before the fact that I think that the

 15 Commission is having an issue with. But it's easy

 16 to prove that you've hedged. You can always show

 17 what you're offsetting.

 18 MR. JOHNSON: Yeah, but it is the aspect

 19 of prior (inaudible) to a transaction whether or

 20 not that was a hedge or not.

 21 MR. HUGHES: So, are you a speculator

 22 until you are proven a hedger?
 235

 1 MR. JOHNSON: I would say you're a

 2 hedger until you're proven a speculator.

 3 MR. HUGHES: I like that better.

 4 MR. ALLISON: Robert?

 5 MR. BRANDENBURG: Yes, I think that

 6 brings us back to what seems to be one of the

 7 fundamental points that we've been discussing

 8 today, which is, first of all, what is a

 9 speculator? Why is a speculator bad in the

 10 market? It seems to be that there's a lot of

 11 defensive conversation around speculation in the

 12 market.

 13 We as hedgers, we have said multiple

 14 times today, we need to have speculators in the

 15 market to have an orderly market. What we are

 16 interested in making sure happens is that we have

 17 an orderly market and that we don't have market

 18 manipulations. That it's not that we don't want

 19 speculators, we need speculators. Thank you.

 20 MR. ALLISON: Bryan?

 21 MR. DURKIN: I would just like to

 22 compliment Commissioner Giancarlo for bringing
 236

 1 this all together, a lot of enlightening

 2 commentary and reaffirmation of a multitude of

 3 comments that have come from many of us around

 4 this table, a reaffirmation that this proposal

 5 needs to be given reconsideration, so we

 6 appreciate the opening of the comment period to

 7 allow for further commentary to be placed in that

 8 regard.

 9 Let it not be lost that, you know,

 10 today, we confirm that there's a very strong

 11 regime in place through the CFTC as well as the

 12 SROs for maintaining and supporting position

 13 limits at the spot month level. That regime has

 14 been in place for many, many, many, many decades

 15 and for some of us that have been in this business

 16 for three decades, at least, I think the market

 17 system itself working in conjunction with the CFTC

 18 has worked very well.

 19 There is a solution that can be

 20 addressed to try to move things along and that is

 21 to refine where we are with spot month limits,

 22 give greater consideration to what both SROs have
 237

 1 pointed out in two terms of their rigorous

 2 monitoring of accountability and implying

 3 accountability regimes for non-spot contract

 4 months, allow the exchanges to continue to have

 5 the flexibility and the end users associated with

 6 the hedge regime that's been in place -- hedge

 7 exemption regime that's been in place today.

 8 You've heard a lot of concrete examples

 9 being presented that, you know, from users around

 10 this table that rely very heavily on the

 11 sustenance and liquidity associated with these

 12 markets that we all represent, saying to you today

 13 that if these examples of what we have always

 14 viewed as commercially reasonable examples of

 15 hedging go away, there's going to be very negative

 16 consequences to the efficacy and the efficiency of

 17 these markets.

 18 So, you know, I certainly hope that the

 19 Commission is taking all of this feedback into

 20 consideration and we welcome the opportunity to

 21 once again reaffirm these points during the

 22 comment period.
 238

 1 MR. ALLISON: Sharon?

 2 MS. BROWN-HRUSKA: Yeah, I think that's

 3 well said. I mean, I guess I was thinking, you

 4 know, in Tyson's cry for historical context and

 5 institutional memory, I mean, I think there is a

 6 lot of that here and part of the problem is that

 7 we've -- I think in some sense we've overreacted

 8 in an effort to deal with those sort of anecdotal

 9 incidences of excessive speculation or, I guess,

 10 largesse by banks, we've kind of pushed back and

 11 taken such a highly prescriptive approach,

 12 certainly when we discuss bona fide hedging that

 13 that's a perfect example where the Commission has

 14 taken it upon itself to define specific hedges,

 15 which makes it very difficult for the end user and

 16 intermediary community as well, to do business as

 17 usual, because you've got the cart before the

 18 horse, you've got to sort of get approval for a

 19 certain unique or innovative hedging that you want

 20 to undertake. By the time you can get Steve's

 21 sign off or the staff's sign off, you've -- the

 22 opportunity has passed.
 239

 1 And that kind of prescriptive model is

 2 not a good model, I think, for government to

 3 adopt. So, I guess I would say that I know it's

 4 hard to back away from the enumerated hedges and

 5 the exemptive process, but it would be nice if

 6 there were a mechanism for almost along the lines

 7 of certification that the exchanges have to try to

 8 -- when we talk about a process that allows firms

 9 and end users to sort of put forth what they intend to

 10 do and continue to do so without getting proactive

 11 approval by the Commission.

 12 MR. ALLISON: I think we've got time for

 13 two more comments, so, Russ and then Lael and --

 14 MR. WASSON: I just want to echo

 15 everything Arushi said with respect to trade

 16 options from the electric point of view, we agree

 17 with everything she said. We also do not believe

 18 that transactions that are physically settled can

 19 or should be considered swaps. And we've made

 20 that comment many times.

 21 And I also want to go back to something

 22 you said under the enumerated hedge exemption with
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 1 respect to entities that are regulated by public

 2 service commissions because electric cooperatives

 3 are regulated in a handful of states by public

 4 service commissions but we are governed by our

 5 democratically elected boards, primarily, and so

 6 if you want to cover utilities in that exemption,

 7 you're going to have to expand it to include not

 8 for profit utilities like electric cooperatives

 9 and municipal utilities are governed as well

 10 because our boards set our rates and they govern

 11 us typically.

 12 MR. ALLISON: Lael, I think we'll give

 13 you the last word.

 14 MR. CAMPBELL: Oh, wow. It's an honor.

 15 Thank you. I'm sure that probably won't be true.

 16 But anyway, I just wanted to follow up on

 17 something Sharon said, I wanted to make this

 18 point, but this started out as about being about

 19 excessive speculation and somehow we found

 20 ourselves to a point now where it's actual hedging

 21 activities are what's under the microscope, not

 22 excessive speculation, and I just kind of wanted
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 1 to also follow up on a point that Tyson made in

 2 that same regard is that, you know, you mentioned

 3 widespread abuse. Well, you know, widespread

 4 abuse may have come under the anti-manipulation

 5 rules, maybe even been excessive speculation, but

 6 I don't think there's ever been an example of

 7 widespread abuse of the bona fide hedging rules.

 8 And just think about that. Is this

 9 about speculation or is this about -- you know, I

 10 mean, it seems like the hedgers are who are under

 11 attack here and is that really where we should be

 12 focusing our efforts?

 13 MR. ALLISON: Mister --

 14 COMMISSIONER WETJEN: Sorry, I wasn't

 15 trying to have the last word, but I did have a

 16 question. Because I remember at the open meeting

 17 where we considered the last proposal we talked

 18 about this, the process by which we would consider

 19 other examples of bona fide hedging that weren't

 20 enumerated. And I think, Steve, you and I

 21 actually had an exchange about that at the

 22 meeting. But just remind me, we asked a number of
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 1 questions about that process in the release. So,

 2 just remind me where things stand in the proposal

 3 and give me a flavor, again, for the kinds of

 4 questions we asked. It's been some time now since

 5 we've done that.

 6 And just before you respond, Steve, I

 7 mean, I think it's become even more clear here at

 8 the meeting. I don't know how practical it's

 9 going to be for the CFTC itself -- people here in

 10 this building -- or the other offices, I suppose,

 11 to be the ones on an ad hoc basis reviewing

 12 example after example that comes in about a

 13 particular kind of hedge. I don't know that we're

 14 particularly well equipped to do that, but I'm not

 15 sure that's really what was envisioned, in any

 16 case, in the release.

 17 MR. SHERROD: I'm going to let the

 18 proposal stand for itself. We did have a

 19 conversation in the public meeting and I think the

 20 clearest statement that staff has made was at last

 21 summer's roundtable where we encouraged through a

 22 question some alternative process for allowing
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 1 non-enumerated bona fide hedges.

 2 MR. ALLISON: Mr. Commissioner, I might

 3 suggest we ask our panelists if they have any

 4 closing comments. We had a lot of comments from

 5 the table, but no questions, so we might ask Ron

 6 and Joe if they've got any closing comments.

 7 MR. NICOSIA: If I could just maybe try

 8 to highlight one thing and -- you know, the

 9 Commission's job is complex and there are reasons

 10 for certain decisions that are made as they try to

 11 address, whether it be excessive speculation or

 12 ability to try to get around some of the issues of

 13 what is a bona fide hedge and/or who is a bona

 14 fide hedger. What I would encourage is that the

 15 Commission not take such a narrow view in defining

 16 bona fide hedge that it affects bona fide hedgers.

 17 Part of the story here is to also be

 18 able to identify people who want to use bona fide

 19 hedges who are not bona fide hedgers. So, don't

 20 close the loop so tight that you remove real risk

 21 reduction normal activity of the bona fide hedger

 22 just to eliminate the inability to try to define
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 1 who is a bona fide hedger.

 2 MR. OPPENHEIMER: So, thanks, Jim, I

 3 wasn't quite prepared for this. Maybe I'll say

 4 one thing similar to what Joe said and it's in

 5 response to Commissioner Wetjen and that is that

 6 whatever the process is for non-enumerated hedges,

 7 we've had a lot of discussion over the many years

 8 of things that should go into the list of

 9 enumerated hedges if it's to be and I don't want

 10 that to get lost that we focus on how do we get to

 11 the ones that haven't even been part of the

 12 discussion. All of the ones that have been part

 13 of the discussion should be addressed in whatever

 14 final rule comes out so that the universe of

 15 what's outside of that is limited.

 16 The other thing, just as a general

 17 comment I would make, to tie in a few things that

 18 were said today, nobody cares more about

 19 well-regulated markets than the people sitting

 20 around this table. We're the users of the

 21 markets. Okay, if there is excessive speculation

 22 that affects pricing, it affects nobody more than
 245

 1 it affects us.

 2 So, regardless of whether it's the

 3 exchanges performing a self-regulatory function or

 4 the Commission's very important function in this

 5 space, we really support good regulation and well

 6 run markets because we want efficient pricing

 7 mechanisms to do our business. And so, that's the

 8 basic principle, but we're also very, very

 9 committed to continuing to work with the

 10 Commission and the staff to get this right,

 11 because that's the goal here.

 12 COMMISSIONER GIANCARLO: Thank you very

 13 much. I'm now going to close the committee

 14 discussion and ask my fellow commissioners to say

 15 a few closing remarks starting with Chairman

 16 Massad.

 17 CHAIRMAN MASSAD: Thanks, Chris. Let me

 18 first thank Ron and Joe for your participation in

 19 this last panel, and of course, Steve, as well.

 20 And let me thank Jim for chairing this. And I

 21 want to thank all of you for being here. And in

 22 particular I want to thank Chris for all his hard
 246

 1 work in putting this together.

 2 You know, our advisory committees are

 3 extremely important, as I was saying earlier, and

 4 what we do is each of us essentially takes one and

 5 runs with it. And these are just very useful

 6 forums for us to hear views of market participants

 7 and I appreciate again all of Chris's work in

 8 reconstituting the committee, getting all of you

 9 to serve on it and putting together the agenda. And

 10 thanks also to his staff.

 11 It's been very helpful to have the

 12 input. We are listening. We do take all this in

 13 and of course the comment period now is reopened

 14 for further written comments. And we've gotten a

 15 lot to date, and we are trying to work through all

 16 those.

 17 You know, no one is trying to attack

 18 bona fide hedgers. No one is trying to drive

 19 speculators out of the market. We are trying to

 20 carry out our statutory responsibility, which is,

 21 Congress has directed us to implement position

 22 limits to address the risk of excessive
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 1 speculation. And there were some comments made

 2 earlier about, well, can't you detect that without

 3 the limits, and, you know, in theory as, I guess,

 4 Professor Pirrong was suggesting, I suppose you

 5 can. It was kind of a theoretical economist

 6 answer from someone who probably doesn't know what

 7 my budget is or how much it costs to do

 8 surveillance.

 9 But, you know, we are -- and with

 10 respect to the data that we get, as was discussed

 11 here, our data does not come in -- our COT report,

 12 as we discussed earlier, does not categorize

 13 people by whether they are hedging or speculating.

 14 It does have categories of commercial and so

 15 forth, but I don't think anyone is suggesting that

 16 we go back to 1981 where we actually did try to

 17 ask people what they were doing. I'm not,

 18 frankly, sure how that worked other than Boy

 19 Scout's honor. But maybe within kind of -- ask

 20 them more questions, I don't know.

 21 But in any event, you know, I guess the

 22 other element of why can't you just detect this
 248

 1 after the fact, you often can, obviously, you can

 2 detect someone like the Hunt Brothers or Amaranth

 3 after the fact, it's just that Congress has

 4 directed us to say, let's try to prevent the harm.

 5 We don't want to end up with that kind

 6 of a situation where we have a bankrupt party,

 7 perhaps, that no one can recover from and we have

 8 the damage already done.

 9 So, that's what we're trying to do, but

 10 we are very committed to making sure these markets

 11 still work for participants. That, in my mind, is

 12 our job, it is part of our job to make sure these

 13 markets work for participants, not just to address

 14 risk to our economy or to consumers or to

 15 financial stability.

 16 And making -- you know, the importance

 17 of making sure that people can still engage in

 18 bona fide hedging is obviously a core piece of

 19 that and that's why all the comments are very

 20 helpful, the importance of trying to maintain

 21 liquidity -- and increased liquidity -- is very

 22 important, but as you all know, liquidity is also
 249

 1 something that's influenced by a lot of different

 2 factors and there are probably those today who

 3 think that despite what happened in the crisis, we

 4 shouldn't raise capital levels on banks because it

 5 might affect liquidity. Well, you know, we are

 6 trying to balance costs and benefits here.

 7 But the comments today were extremely

 8 helpful. I think we're taking in all that you've

 9 suggested. There were some comments made on

 10 deliverable supply and looking at, you know, our

 11 guidance there and the fact that these markets

 12 differ, we recognize, you know, that different

 13 products have different market characteristics.

 14 There were comments made on whether you're looking

 15 at the enterprise as a whole or whether the

 16 business units, we understand that, and we very

 17 much do want to benefit from the experience of the

 18 exchanges today and I really appreciate Tom and

 19 Eric being here. And, again, the idea of relying

 20 somehow on the exchanges’ experience with respect

 21 to non-enumerated hedges, as Steve pointed out,

 22 that was mentioned earlier, it was mentioned again
 250

 1 today.

 2 So, I just want to say thanks again.

 3 It's very valuable to have you all here. We are

 4 listening and I think all of us, you know, are

 5 simply trying to do the best we can to carry out

 6 what we perceive as our statutory responsibilities

 7 here and to continue to make sure these markets

 8 work for participants.

 9 COMMISSIONER WETJEN: Thanks, Chris, and

 10 thanks, Mr. Chairman. I would like to echo some

 11 of what the Chairman said. You know, it's been a

 12 windy road that has gotten us to where we are

 13 today as it relates to this rulemaking, but the

 14 Chairman put it very eloquently, we didn't really

 15 have a choice here. I think the best read of the

 16 statute -- and we haven't talked about -- we

 17 haven't done much legal analysis of the statute in

 18 terms of whether we are mandated to impose these

 19 limits or not -- the agency impose federal limits,

 20 but I do think the best reading and reasoning

 21 applied to the statute is that it is a mandate.

 22 There are other arguments as to why it
 251

 1 might not be, but I think the best reading is that

 2 it is a mandate.

 3 I alluded to this a year and a half ago

 4 when we did the re-proposal, I was a Senate aide

 5 when Dodd-Frank was passed and those most

 6 intimately involved in drafting the provisions

 7 that ultimately became the Revised Commodity

 8 Exchange Act and included the language on position

 9 limits, I can assure you, I don't think they were

 10 giving us an option when they were drafting that

 11 language.

 12 So, that's why I've always felt

 13 comfortable that we have to do this job, and just

 14 as the Chairman said, we have to do it

 15 responsibly. There are other competing interests

 16 that we have to balance and other statutory

 17 mandates we have to take into account when we

 18 implement this, but it's something that we have to

 19 do. But we just have to do it well and I think

 20 we're probably going to stand a better chance of

 21 doing that in light of this discussion and other

 22 public forums we've had.
 252

 1 So, it's been very, very beneficial and

 2 I also appreciate everyone's participation and

 3 their comments today. Thank you very much.

 4 COMMISSIONER BOWEN: I also want to echo

 5 thanks for the time -- Chris, it really shows how

 6 much work went into today, so I really do

 7 appreciate that.

 8 I've had the opportunity to meet many of

 9 you who are in the room today and I want to thank

 10 you for coming in and sharing your thoughts, even

 11 though the comment period is still open, my door

 12 also is still open. So, if you think there's a

 13 perspective that I have not heard before, I really

 14 do encourage you to just knock on my door and come

 15 by at any time. Thank you so much.

 16 COMMISSIONER GIANCARLO: Thank you,

 17 Sharon. And I want to say a few specific thanks

 18 here before we close. To division directors and

 19 staff members from the CFTC, Steve Sherrod and

 20 Vince McGonagle. They're truly dedicated public

 21 servants that are really working hard to get this

 22 right and their doors always remain open and their
 253

 1 minds remain open to a lot of these concerns, and

 2 so we thank you. And to our other panelists who

 3 shared such important data and insights today, it

 4 was very, very helpful, Tom and others, thank you

 5 very much. To all of you on the committee who

 6 took time away from your day jobs to come here to

 7 Washington to brave the snow and the weather, and

 8 good luck getting back to wherever you're going,

 9 but thank you very much. We were actually lucky,

 10 it could have been a lot worse, so thank you.

 11 And to my fellow commissioners who

 12 devoted precious time today -- you can see them

 13 taking notes, listening intently, the four of us

 14 -- I'm not sure what will emerge, but I can assure

 15 you that whatever emerges will be the result of a

 16 lot of give and take amongst the four of us, a lot

 17 of thoughtful consultation and professionalism

 18 amongst this commission, and I'm very proud to be

 19 a member of it, I'm proud to be working with them

 20 to try to get the best position limits proposal

 21 that we can put forward and I'm sure it will be.

 22 To Jim, a masterful job in managing
 254

 1 this. It's said to be like herding cats, but not

 2 at all. This was as smooth as silk, Jim, so well

 3 done. You're very skillful at that.

 4 And I really want to thank Ajay Sutaria,

 5 who many of you got to know in this process. All

 6 the compliments that came along for how well this

 7 was put together all go to Ajay who did so much

 8 work in talking with all of you and putting this

 9 together. So, my greatest thanks to him. And to

 10 other members of the CFTC staff and personnel

 11 organizing this room, organizing all the

 12 arrangements for today, they really are a great

 13 bunch of professionals, did a great job.

 14 And with that, I thank you all very,

 15 very much for a very professional, robust,

 16 expansive, and insightful day. Thank you very

 17 much.

 18 (Whereupon, at 3:59 p.m., the

 19 PROCEEDINGS were adjourned.)

 20 * * * * *

 21

 22
 255

 1 CERTIFICATE OF NOTARY PUBLIC

 2 DISTRICT OF COLUMBIA

 3 I, Carleton J. Anderson, III, notary

 4 public in and for the District of Columbia, do

 5 hereby certify that the forgoing PROCEEDING was

 6 duly recorded and thereafter reduced to print under

 7 my direction; that the witnesses were sworn to tell

 8 the truth under penalty of perjury; that said

 9 transcript is a true record of the testimony given

 10 by witnesses; that I am neither counsel for,

 11 related to, nor employed by any of the parties to

 12 the action in which this proceeding was called;

 13 and, furthermore, that I am not a relative or

 14 employee of any attorney or counsel employed by the

 15 parties hereto, nor financially or otherwise

 16 interested in the 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 31, 2017