UNITED STATES OF AMERICA

 COMMODITY FUTURES TRADING COMMISSION

 MARKET RISK ADVISORY COMMITTEE MEETING

 Washington, D.C.

 Tuesday, April 26, 2016
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 1 PARTICIPANTS:

 2 Opening Statements:

 3 CHAIRMAN TIMOTHY G. MASSAD

 COMMISSIONER SHARON Y. BOWEN

 COMMISSIONER J. CHRISTOPHER GIANCARLO

Panel I: How Well Are Our Derivatives Markets

Functioning From Market Participants, Particularly

End Users?

JOHN NIXON, Group Executive Director at Americas

for ICAP

KRISTEN WALTERS, Managing Director, Risk and

Quantitative Analysis, BlackRock

RANA YARED, Managing Director Securities

Division, Goldman Sachs

LUKE ZUBROD, Director of Risk and Regulatory

Advisory, Chatham Financial Group

JERRY JESKE, Group Chief Compliance Counsel,

Mercuria Energy Trading

GLENN MACKEY, Chief Risk Officer, NRG Energy

TOM COYLE, Vice President and General Manager,

Chicago and Illinois River Marketing

ANGELA PATEL, Fixed Income Trading Assistant,

Putnam Investments

Panel II: How is the Market Using Portfolio

Compression Today?

 ED PLA, Managing Director, Head of Clearing

 Execution, UBS Investment Bank

PARTICIPANTS (CONT'D):

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 1 LUCIO BIASE, CEO and Founder and LMRKTS

 

 

 

 

 

 

 

 

CLAIRE LOBO, Global Head of Business

Development, Markit Trade Processing

DENNIS MCLAUGHLIN, Group Chief Risk Officer, LCH

Clearnet

MICHAEL MODLOCK, Head of triReduce North

America, TriOptima

KIM TAYLOR, President Global Operations,

Technology and Risk, CME Group

 Other Participants:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

VINCE MCGONAGLE, Director of Market Oversight,

CFTC

SAYEE SRINIVASAN, Chief Economist, CFTC

DANIEL BUCSA, Deputy Director of the Division of

Market Oversight, CFTC

LEE OLESKY, CEO Tradeweb Markets, LLC

NATHAN JENNER, COO Bloomberg Electronic Trading

Business

ANAT ADMATI, George G.C. Parker Professor of

Finance and Economics, Graduate School of

Business, Stanford University

MARCUS STANLEY, Policy Director, Americans for

Financial Reform

SEBASTIAAN KOELING, Managing Director, Optiver

US

RICHARD MILLER

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 1 PARTICIPANTS (CONT'D):

 

 

 

STEPHEN BERGER, Director, Government and

Regulatory Policy, Citadel Investment Group

SUSAN O'FLYNN, Managing Director, Morgan Stanley

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

 2 (10:04 a.m.)

 MS. WALKER: Good morning. As MRAC

designated federal officer is it my pleasure to

call this meeting to order. Before we begin this

morning's panel I would like to turn to

Commissioner Sharon Bowen, the MRAC sponsor for

the welcome. Chairman Massad, Commissioner

Giancarlo and Commissioner Bowen will then give

their opening remarks.

 COMMISSIONER BOWEN: Okay. I won't be

redundant but I will say welcome again. Mr.

Chairman, would you like to make a few opening

remarks?

 CHAIRMAN MASSAD: Sure. I will also be

very brief. Thank you all very much. I want to

thank Commissioner Bowen and her staff,

particularly Petal and all the members of the

Market Risk Advisory Committee for all the work

that's gone into today's meeting and for being

here. I'd like to also welcome all of you in the

audience as well as anyone listening on our

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 1 conference line.

 I'm certainly pleased to be here along

with Commissioner Giancarlo. You know, these

meetings are very, very valuable to us. They're

valuable not just for the input but also to have a

discussion and an exchange of ideas. And so I

know we're all looking forward to a very

productive meeting today.

 We'll consider two important topics.

The first one is how the derivatives markets are

functioning for market participants and in

particular, the commercial end users who use them

every day to hedge commercial risk. It's

obviously a big question to cover in less than two

hours particularly given that the markets are

different for different products. But I look

forward to the discussion. I'm sure we'll get

into a discussion of liquidity.

 It's an issue that's received a lot of

attention lately. In particular as to whether

post-financial crisis reforms how those might have

affected liquidity. I believe we must always be

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 1 willing to look at such issues and be willing to

make adjustments if necessary. And I've noted,

for example, my concern about the potential

effects of the leverage ratio on clearing.

But we must also recognize that there

are always many forces beyond regulation that

shape liquidity and market structure. And so we

must make sure any analysis is grounded in facts

and not just suppositions. I'm also pleased that

the panel will focus in particular in thinking

about these issues on commercial end users.

As commissioners, all three of us, I

 think have sought to be very attentive to the

 concerns of commercial end users. And since we

 all took office in June of 2014, the CFTC has

 taken a number of actions to ensure that those

 businesses can use the markets effectively and

 efficiently. We've also taken steps to improve

 trading and access to the markets generally

 including with respect to swap execution

 facilities.

To that end, we've recently permanently

 

 

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 1 registered SEFs and have fine-tuned some of our

trading rules and I hope that the Commission can

consider a codification of those adjustments as

well as potentially other changes to enhance SEF

trading and participation in the near future.

 We've also issued proposals on cyber

security and automated trading which go to broader

issues of market function and we are working on

finalizing rules on position limits. So I look

forward to continuing all this work and to the

input of market participants so that we can ensure

transparency, fairness and integrity in trading

and create conditions that attract participants to

our markets.

 Second, we will explore issues related

to the use of portfolio compression. This is an

important tool to manage risk but I would note

that as with the word liquidity, people can use

the term to mean very different things. These can

range from strategies that simply reduce notional

amount to those that change the risk profile and

may even increase notional amount.

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 1 So I look forward to hearing more about

the types of portfolio compression strategies

being used and the implications of those different

strategies. So again, thank you all for coming.

Thanks to my fellow commissioners and the CFTC

staff and I look forward to what I am sure is

going to be a very constructive exchange of ideas.

 COMMISSIONER GIANCARLO: Thank you,

Chairman, and thank you, Commissioner Bowen.

Market participants know that trading liquidity is

the lifeblood of healthy financial markets. Today

there are increasing concerns that trading

liquidity has been fundamentally changed in many

asset classes and many markets and not just

markets overseen by the CFTC.

 Accounts of liquidity constriction

extend from US Treasury securities to German bonds

to corporate bonds to equities to US and Euro

interest rate swaps, single name credit default

swaps, cross currency swaps, repos and energy

swaps and futures. I've been speaking about

diminished trading liquidity for well over a year

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 1 now but similar concerns have been voiced by the

IMF, the Bank for International Settlements, the

Bank of England, Fed Chair Janet Yellen, Stephen

Schwarzman of Blackstone and noted economists,

Nouriel Roubini and Mohamed El-Erian.

 While some central bankers voice

skepticism to a lack of quantitative evidence of

illiquidity, there is real concern amongst those

with financial market understanding and

responsibility. Quantifying liquidity is

certainly challenging but it's not impossible. It

is more easily qualified through a range of

characteristics such as market depth, width,

volume, resiliency, immediacy, participation and

turnover.

 There is only small comfort in accounts

of narrow bid offer spreads amid so much evidence

of deterioration in the quality of many of these

other fundamental liquidity characteristics.

Diminished trading liquidity and the sharp

volatility spikes that follow are rising threats

to the healthy functioning of our markets.

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 1 My informed and considered view is that

a significant, although not the sole, but a

significant cause of reduced trading liquidity is

the aggregate impact of uncoordinated regulatory

policies of US and overseas bank prudential

regulators imposed in the wake of the financial

crisis. Most of these disparate regulations have

the effect of reducing the ability of many small,

medium and large financial institutions to deploy

capital in trading markets.

 The question that must be asked is

whether the amount of capital constraint

prudential regulators are placing on financial

institutions is at all calibrated to the amount of

capital those institutions need to deploy to

support market health and vibrancy. Those of us

with daily responsibility for overseeing financial

markets need to ask that question.

 We must understand the full implications

of constrained capital on market health and

resiliency and the ability of financial markets to

underpin sorely needed US economic growth.

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 1 Vibrant capital and financial markets are

essential to American free enterprise. And free

enterprise is essential to American freedom and

prosperity.

 Needless to say, today's discussion is

very timely. Today's second panel will explore

portfolio compression. In my January statement on

the final rule for margin requirements for

uncleared swaps, I expressed some disappointment

that the Commission decided to treat the results

of portfolio compression of legacy swaps as new

swaps subject to the margin rule. I warned that

this may well discourage portfolio compression and

I urged the Commission to revisit the issue.

 In the preamble to the final rule, the

Commission expressed openness to further

consideration and I'd be pleased to know of any

progress in that regard. I believe that portfolio

compression is of great benefit to the safety and

soundness of the market. And I believe it should

be incentivized not penalized. Thank you all for

participating in today's very important

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 1 discussion.

 COMMISSIONER BOWEN: Thank you. Welcome

to the first 2016 meeting of the Market Risk

Advisory Committee. I'm excited to sponsor this

committee which is composed of a broad

cross-section of market participants. I'd like to

first thank the Chairman and Commissioner

Giancarlo for being here today and their support

for the work of this committee.

 I also would like to extend a thank you

to our MRAC members for bringing your passion and

expertise to these important issues. Thank you as

well to the staff, the Division of Market

Oversight and the Office of the Chief Economists

for providing technical support for this meeting.

And last but not least, thank you to the

logistical staff who worked behind the scenes to

put everything together today.

 One of the goals of MRAC, as noted in

our charter, is to assist the Commission in

identifying and understanding the impact and

implications of an evolving market structure.

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 1 This is a very important role for this committee.

Our markets have undergone a transformational

change in how they function today. So it is

extremely helpful to hear about the changing

structure of our markets for a cross-section of

market participants.

 To that end our first session focuses on

how well our derivatives markets are functioning.

We will hear directly from end users and other

industry representatives about things such as

their ability access liquidity, effectively hedge

and allow for price discovery.

 There are a number of questions that are

specifically on my mind. First as a commission we

recently permanently registered 18 swap execution

facilities. How are market participants using

these SEFs? What are the positives and negatives 

of SEF use? How can we improve the way SEFs

function?

 Second, the role of introducing brokers

appears to be undergoing major changes in our

markets. How are IBs being used today? Do our

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 1 rules, which were made for the IBs of the past,

fit the IBs of today?

 Third, how have changes in technology

altered the ways in which market participants

access the various markets? Have these changes

introduced new risk? And if so, how can our rules

better identify those risks and regulate

appropriately?

 And last, there has been a great deal of

discussion recently about the level of volatility

and liquidity in our markets. What are our market

participants experiencing in regard to volatility

and liquidity? I'm particularly glad that this

discussion is broken up by product class so that

we can get a more complete nuanced picture of the

different markets we regulate.

 I'm specifically interested in learning

more about how effectively our end users in

agriculture, energy and other commodities are able

to find counterparties for their vital hedging

functions. Our second session is also extremely

important.

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 1 Based on the data we have collected,

portfolio compression is widespread in our

markets. It is imperative that we learn as much

as we can about a practice that plays such a

significant role in our markets today. I look

forward to both of these panels and a constructive

discussion. And I will now turn it over to Ms.

Walker who will introduce the first facilitator in

the panel.

 MS. WALKER: Thank you for your opening

remarks. As noted in today's agenda our first

panel discussion will cover how well are our

derivatives markets functioning from market

participants, particularly end users?

 Before we begin, I would like to note

that we have members of our staff here on hand to

answer questions and clarify current law and

practice. Our director of the Division of Market

Oversight, Mr. Vince McGonagle, and our Chief

Economist, Sayee Srinivasan.

 I would also like to introduce Mr. John

Nixon, Group Executive Director at Americas for

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 1 ICAP, who will facilitate and help shape the

discussions during the first panel.

 MR. NIXON: Thank you, Petal. On behalf

of all the MRAC committee members, I would also

like to extend my thanks to Chairman Massad and to

Commissioner Giancarlo for participating today.

With particular thanks to Commissioner Bowen for

organizing the MRAC committee and, of course, to

Petal who's done an incredible job of putting this

all together and keeping everybody in line. So

thank you to all of you.

 A couple of logistical announcements

before we move on with the first panel. We'd ask

that anybody who is speaking to please make sure

that your mic is on and can you please make sure

that you are leaning forward speaking into the mic

so that people that are on the audio or Webcast

can actually hear you. When you finish speaking,

we'd ask that you please turn off your mic.

 If you would like to speak, please just

turn your card up and we will make sure that we

give you an opportunity to participate in any of

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 1 the discussions that you would like to be part of.

Today we have a lot on the agenda for

the first panel. I'm not going to go through all

of the questions that we have provided to some of

the speakers as Sharon has just spoken about a lot

of her interests and what she would like to hear.

And I am -- I will not go through each question

while we are going through the various segments.

But let me just start off by at least

thanking and introducing the people that we have

asked to speak today on the various products.

First of all, on the CDS and IRS section, Kristen

Walters is here from BlackRock. Rana Yared is

here from Goldman Sachs and Luke Zubrod is here

from Chatham Financial.

On the energy section, we have Jerry

Jeske from Mercuria, Glenn Mackey from NRG. On

the agricultural section, Tom Coyle is here from

Chicago and Illinois River Marketing. And for

foreign exchange we have Angela Patel who is here

representing Putnam.

So thank you to all of you for taking

 

 

 

 

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 1 the time to put some thoughts into these question

and helping us lead these discussions. As we

said, we have quite a bit to cover in a short

period of time. So I would ask that everybody be

as prompt as they can in responding to the

questions that they've been given to discuss so

that other people on the committee can actually

weigh in on their particular views.

s

 So let us start off with the IRS

section. As I said, everybody has the agenda and

the question and I'm going to turn the floor over

to Rana to start things off.

 MS. YARED: Thank you, John, and thank

you to the Commission for having us here. I want

to start by saying that Goldman Sachs has been a

supporter of electronic trading for many years.

Since 2010 we have been advocates here at the

CFTC, at other regulators and at industry forums

for the movement of the most liquid points, the 2,

5, 10, and 30-year in interest rates swaps and the

5-year point in the on the run CDS index to order

books be that in their native OTC form or in

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 1 futures.

 We have been users of SEFs since their

inceptions and used them both on an electronic and

voice basis. In the cases where we use the SEFs

on a voice basis, we are both intermediated by

introducing brokers and directly facilitated by

members of the staff. In the nearly two and a

half years since the inception of SEFs we have

seen markets evolve in a manner that is specific

to the products and the needs of each market

 We believe that a healthy market

structure requires our clients to be able to both

trade the most liquid products in a pre-trade

anonymous order book and to access dealer

liquidity on a disclosed basis for larger,

non-benchmark trades that do not facilitate

themselves for order book trading. It is this

point that has led us to work with market

infrastructure providers to create central limit

order books and RFQ platforms for interest rate

and credit products globally not just here in the

US.

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 1 participants.

We wish to note that we welcome the open

membership model of the SEFs and believe that in

certain respects it has been accretive to

liquidity in the market. We also wish to

acknowledge the burden that the commercial end

users who trade infrequently have by needing to

connect to some of these electronic SEFs.

In the CDS market specifically, we have

seen the market continue to evolve and respond to

SEF rules paired with its own market condition.

This evolution has included an increase in fully

anonymous order book trading. By that I mean

anonymous on both a pre and post-trade basis for

the on the run index five year point.

It's worth keeping in mind that unlike

the rates market, the credit market does not have

a liquid hedging instrument as a future. In the

case of the rates market, it's what we -- it's the

5 year and the 10 year on the CME known in the

industry as the FY and the TY.

The credit market also has more

 

 

 

 

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 1 concentrated market participants in terms of the

breadth of the user base and less structural

hedging where matching of exact cash flows is

needed by our clients. While SEF execution has

been beneficial in offering enhanced transparency

to the market in a more stable market environment,

we have noted that in more volatile conditions, we

have seen a drain or evaporation of liquidity even

in the credit market.

 We also think it's worth noting that

market adoption of order book trading has been

encouraging in the last few months. While we

don't feel comfortable sharing the exact numbers

as they belong to the market infrastructure

providers, we'll leave it to them to share those

with you. We would note that since about October

of last year to present we have seen an increasing

uptake of central limit order book trading and

credit index swaps. And that while that number is

still nominal, we believe that this is the start

of a greater trend. Again, a trend that is

specific the types of users and types of products

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 1 that exist in the credit market.

 Anecdotally, market participants have

told us in the credit market that they find SEF

execution complexities for packaged trades to be

incredibly challenging including for when you have

a MAT trade against a mandatorily cleared but not

MAT swap which is about two times the off the run

market versus the on the run market. And that

these complexities have been an impediment to role

transactions that used to be incredibly frequent

and routine in the pre-SEF world.

 Again, in the spirit of answering the

specific question about we believe this has

impacted commercial end users, we believe that

this reflection of challenges from our clients is

on such example. Turning to the rates market.

 Our clients continue to reflect to us

that they wish to trade in RFQ or RFS fashion in

order to obtain or hedge exact risk and because

they believe that there's a benefit associated

with the relationship that they have with the

various dealers with whom they transact. In

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 1 interest rate products, the dealer community has

historically tailored trades to the hedging needs

of clients and then, risk-managed those trades in

a more generic fashion in the inter-dealer market.

 We call it specific versus generic

trading. In this respect, we have seen the

inter-dealer brokers very naturally develop

central limit order books around, again, those

benchmark points. Because it's historically been

in that environment where market participants have

done their more generic hedging. And therefore,

it should be more conducive to order book trading

because the liquidity is congregated around

specific points. We have seen these order books

developed specifically at three of the

inter-dealer brokers, ICAP, Tradition, and

Dealerweb, a subsidiary of Tradeweb. And we

believe that the development of these order books

in more than one venue is a reflection of the

comfort which the dealers have in trading in a

central limit order book fashion for appropriate

products.

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 1 Again, we note that the open market

model has been accretive to liquidity and this

particular venue of trading, though, on the whole,

liquidity in the inter-dealer markets has

decreased in both the dollar and the Euro market.

To give a specific example which I've given before

and retested prior to coming to this meeting, if

you look at the interest rate market today of one

of our clients which is to trade 25K of DV01 they

have a wash of choice. 10 to 15 dealers or

market-makers are willing to make them a price in

that particular instrument.

I do want to take a moment to pause on

 We find that our clients are reflecting

to us that they are much more challenged in the

cases where they wish to do, let's say 250K of

DV01 which, for the professional traders in this

room will note, it's actually not that big of a

size. There they find that they either have to

break up their trade into multiple sizes or that

the price becomes enormously expensive versus what

they're used to having.

 

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 1 the European market to show that these phenomenons

(sic) are actually not unique in the US market.

Risk Magazine in September 2015 actually did a

study on the Euro swaps market to show that in

fact significant pressures had changed the nature

of that market. They posited that the pressures

from capital and reduced liquidity in the Euro

interest rate swap market and the future market

called the Bund in Europe, should suggest higher

prices for our clients and significant inability

to transact.

 Their studies showed that the size

available for Euro interest rate swaps was

actually one-half that which it was two years

prior at the touch. Meaning immediately

executable and that the depth in the Bund traded

on Eurex was one-half the size it had been in

their previous measurement period.

 Just to give the group a sense, the Bund

accounts for about 80 percent of all the initial

hedging that happens in the Euro interest rate

swap market. It's like losing the ability to

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 1 hedge with the TY or the FY here in the US. At

the same time, their study noted that clients had

reflected back to them that pricing had remained

largely unchanged which is good for commercial end

users but that they found that liquidity was very

challenged in the market which clearly is

something that we all wish to address and remedy

in a manner that is productive to the interest

rate market.

 Some would argue that the market

structure in rates has not been conducive to

liquidity improvement specifically because of the

lack of a fully anonymous central limit order book

both pre and post-trade. We believe that this

argument is a red herring and look specifically to

the experience that we've seen on Bloomberg where

a fully transpa -- fully anonymous pre and

post-trade order book exists in both interest

rates and credit derivative swaps but only volume

has picked up on the credit derivative swaps.

 We believe this is indicative of the

previous point that I had made which is that our

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 1 clients in the interest rate swap market largely

but not exclusively wish to match specific cash

flows and therefore, want to do specific and

(inaudible) trading which can only be facilitated

in an RFQ model.

 In closing, we believe that SEF

implementation has met the CFTC's goals of

enhanced electronic trading and we acknowledge

that the market's response to the rule set is

still ongoing and hope that we can be a productive

member of the ongoing response. Thank you.

 MR. NIXON: Thanks, Rana. Kristen, can

I turn it over to you?

 MS. WALTERS: Absolutely. Thank you

very much to the Commissioners for having us and

particularly to Commissioner Bowen. I am very

happy to be participating in MRAC, the committee.

I think that we have over the last 12 months

actually done some -- had some very important

dialogue around key topics that affect --

 COMMISSIONER BOWEN: Kristen, can you

just lean in a little bit closer? 

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 1 

 

 

MS. WALTERS: Sorry.

COMMISSIONER BOWEN: Thanks.

 

MS. WALTERS: Okay. Can you hear me

now? Sorry. Do I need to start over or did you

catch any of that? Anyway, my sincere thanks to

Commissioner Bowen.

I think that in a very collegial,

thoughtful and deliberate way, she has brought us

together as a group with varying views in a

collaborative fashion and allowed us to tackle

many issues affecting risk. Issues that, you

know, we're very concerned about from a BlackRock

perspective in a highly productive way and I would

say in general we concur, at least 90 percent with

some of the specific dialogue that we've had as

part of this committee. So thank you very much

Commissioner Bowen for all of your efforts and

ongoing efforts.

 I would like to start this session and

just speak briefly to BlackRock's views on market

liquidity particularly in the fixed income market

space. And I'd like to talk about both bonds and

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 1 derivatives because they are structural in the

sectoral changes in liquidity in both markets and

the two markets are juxtaposed and very dependent

on each other.

 From our perspective, many of the

changes are actually happening in bond markets but

the proper functioning of centrally cleared for

standard rates and credit products is absolutely

essential to the functioning of the bond market

itself. We use both rate and CDS extensively not

only as hedging instruments but also as risk

transfer mechanisms. So it's very, very important

that both of these markets operate efficiently and

in tandem.

 So I think we would agree that there has

been a very marked structural change in liquidity

markets particularly in the fixed income space

post-financial crisis. We view this as a direct

consequence to actually appropriate regulatory

changes to stabilize the banking sector and ensure

sufficient dealer capital liquidity and reduced

leverage. We do not feel that this has created a

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 1 liquidity crisis but it has fundamentally changed

the structure of both the bond and derivative

markets.

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 4 And we feel that it -- there are

necessary changes that have to happen from an

infrastructure perspective to support a very

discernible shift that has occurred from pure

principal trading in bond markets where dealers

essentially have balance sheets and inventory and

are able to intermediate risk and make markets to

much more of a hybrid agency principal market.

Not the same as the equity market because given

the differences in idiosyncratic nature and fixed

income products, we can't have a purely agency

model in fixed income. But we do need to be

supportive of changes that have to happen with

clearing of derivatives, with electronic venues,

all to all trading in order to support this

market.

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think we have an advantage here and I think Rana's

comments about smaller market participants and I

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 1 think the impact on smaller market participants of

many of the things that we're talking about today

is much more pronounced. And I think that's the

area of the market that we need to focus on to

make sure that we can have healthy liquidity in

the markets going forward.

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 7 So on a daily basis, we don't experience

liquidity issues in the market given our size and

our investment in infrastructure and electronic

trading and straight through processing systems.

What that means is that every day we're actually

-- our traders who we physically separated from

portfolio managers four years recognizing the

importance of focusing on trading and the evolving

markets, they are able to close each trading day.

And essentially with having all trades executed

effectively.

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 18 So we do not experience situations where

we are unable to transact in markets on behalf of

clients. However, we have had to fundamentally

change our trading approach including breaking up

our trades into smaller pieces and acting more as

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 1 a price-maker. And when I say that I don't mean a

market-maker, as well as a price-taker.

Historically, we were price-takers from Goldman

and Morgan Stanley and others.

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 5 And increasingly we reach out to

regional dealers, other market participants and we

are assertively making prices and we've

implemented technology to enable us to do that in

an efficient that we're going to keep investing to

make this happen. So given the shift in markets,

I do think it's more difficult for smaller market

participants. Clearly, we've invested in

technology over many years. That can create

significant barriers to entry to smaller players.

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 15 So I think we should be very mindful of

that when we talk about some of the issues today.

So again, derivatives are critical to the proper

functioning of the bond markets as a risk transfer

mechanism. BlackRock has also participated in

SEFs since inception. 100 percent we're mandatory

and in other instances we use a combination of

voice execution and SEF processing in

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 1 non-mandatory products.

 2 We appreciate the CFTC's efforts in

developing SEFs and related trade execution

regulatory frameworks particularly recently in the

available, sorry, particularly what's available to

the -- made available to trade determination

process. I think that progress has been made but

there's still work to be done. I would reference

that we participated in a letter that SIFMA

provided to the CFTC earlier this year on SEFs and

trade execution. I think in general it's

consistent with some of the comments that both

Chairman Massad and Commissioner Bowen have

recently made publicly.

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 15 And in particular, I would just like to

cite that broadly we're very much in agreement

with, Commissioner Bowen, your comments at George

Washington Law earlier this year and recent

comments by Chairman Massad. So I think we agree

whole-heartedly in the work that the CFTC is

trying to do in this space.

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 22 What I would say and I apologize, just
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 1 turning to my notes, that so the positive aspects

of SEF from our perspective is absolutely

improving transparency, encouraging broader market

participation and more at time of trade

transparency. I would echo kind of Rana's 

comments that the SEFs do add operational

complexity not necessarily for us because our

pipes are in place. But I think they do for

smaller players in the market.

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 10 The ability or the need to connect to

multiple SEFs and entities between SEFs and the

clearing house makes it more expensive to manage

from an infrastructure perspective. I think that

we have 18 registered SEFs today. Each SEF has

nuances and they are not the same. Also there are

a number -- there's only a very small number of

SEFs that have the sufficient levels of volume to

allow us to provide the level of liquidity in

markets that we think is required.

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 20 So I think and I believe Commissioner

Bowen and Massad have made comments on this. We

are 100 percent supportive of consistency and

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 1 standardization of trading at SEFs as well as the

overall SRO framework that's been discussed

recently. One issue that I will note we do not

connect to CLOBs today. We would like to. The

impediment is the average pricing that we have in

futures markets more broadly is not currently

available in swaps.

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 8 I think and this is cited in a very

detailed fashion in the letter to SIFMA that we

participated in but I think it's important to

mention and again, echoing Rana's comments that

package transactions are a very important part of

the swaps markets and for all firms to hedge and

allocate risk. So we're appreciative of the

CFTC's extension of the no action relief for

package trades and we agree with, we hope for CFTC

adoption of a permanent package transaction,

regulatory framework.

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 19 From our perspective, the packages

should not be subject to the trading mandates

solely because one or more of the swap components

meet the requirements for the MAT determination

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 1 process. And we do think that the RFQ to three

execution method may be inappropriate for package

transactions. So we would certainly like some

focus on the package transaction topic in general

and I think very consistent with the approach that

I believe the CFTC has been taking.

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 7 From a CDS perspective, we also use SEFs

for all of our index products and we are starting

to clear single name CDS and expect to do

significantly more in the third quarter. From our

perspective, it's very, very important for a

proper functioning credit markets to have both the

index and single name CDS when their standard

cleared in part of the SEF process. And we would

just state that without a single name market it's

very, very difficult for the credit markets to

function. And that's all for my prepared

comments. Thank you very much.

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 19 MR. ZUBROD: Hi, my name is Luke Zubrod

from Chatham Financial and let me just start by

framing the basis for Chatham's perspective on

interest rate markets. Chatham's the largest

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 1 advisor and technology provider to end users both

financial and non-financial end users. The common

theme for all of our 1,800 clients is that they

use derivatives for hedging purposes not for

speculation or trading.

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 6 In this capacity, we assist them in

hedging more than a billion and a half in notiona

per trading day. And in 2015, we provided advice

and services on approximately 17,000 transactions

a little more than half of which were interest

rate derivatives. We help our clients analyze

their risks, develop hedging strategies to

mitigate them and in most cases, execute

transactions to implement those strategies.

l

,

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 15 The functioning of the OTC derivatives

market varies based on factors such a regulatory

classification and the standardization of trades.

These factors give rise to different segments of

the market including those that use SEFs to

transact cleared swaps, those that transact

cleared swaps by voice and those that transact

uncleared swaps by voice. That is the traditional

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 1 bilateral swap market.

 2 My comments will be focused on two of

those segments, SEF-traded cleared swaps and

traditional bilateral swaps. With respect to the

former, for many of our clients, there are some

notable improvements in market function. Again,

we're talking about SEF-traded cleared swaps.

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 8 Bid offer spreads have narrowed

considerably. Prior to market structure changes,

some clients paid as much as two basis points in

transaction costs to establish and terminate a

substantially collateralized position. Now

clients can execute this combination of trades at

approximately.2 basis points.

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 15 This predominantly is a function of the

ease of competition facilitated through SEFs

including the ease of competition when terminating

transactions. In a recent transaction, for

example, we were able to simultaneously take off

two swaps and put on a new $500 million swap in

seconds with quotes from four banks. A process

that would have been more cumbersome and

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 1 inefficient in the past.

 2 This benefit does come at a cost and the

cost is largely a function of the cost of funding

initial margin and clearing related fees. The net

cost benefit is not the same for every market

participant and varies with factors like

transaction volumes. This cost-benefit is

overwhelmingly negative for market participants

that transact in small volumes creating

significant barriers to accessing the OTC

derivatives market for some market participants

including microfinance funds, real estate funds,

some leasing companies, credit card processing

companies and others.

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 15 Such entities face substantial minimum

fees roughly $100,000 per year to establish and

maintain a relationship with an FCM. Consider a

microfinance investment vehicle hedging interest

rate risk in connection with loans made to

institutions that in turn provide capital to the

world's poor. Now microfinance investment vehicle

is a financial entity subject to the clearing

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 1 requirements.

 2 However such an entity's transaction

volumes are often too low to justify for them what

is a substantial annual minimum fee amounting to

approximately half a million dollars over a five

year period. Such firms presently fact the choice

of not hedging or of hedging suboptimally, using

products that do not perfectly address their

needs, for example, Euro dollar futures,

standardized products that cannot be tailored to

perfectly offset the risk arising from common

forms of commercial financing.

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 13 The Commission could and should

intervene to address this concern by exempting

financial entities that transact a de minimis

volume of swaps, a so-called little guy's

exemption. I now turn to the traditional

bilateral swap market, largely comprised of

entities transacting under the end user exemption

from clearing and SEF trading.

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 21 End users have substantially adjusted to

 22 Dodd-Frank's administrative burdens. And they
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 1 continue to be able to efficiently execute many

common hedges including hedging shorter dated

exposures ranging from one to five years or more.

However, pricing for longer dated swaps has

materially increased. For example, the charges

applicable to a 20-year swap used to hedge an

investment grade corporate's fixed rate bonds has

more than doubled relative to precrisis levels.

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including bank funding charges contribute to this

increased cost. These costs encourage end users

not to hedge longer dated exposures or to consider

collateralizing trades that would otherwise be

eligible for the end user exemption effectively

partially negating that exemption. As margin and

capital requirements are fully phased in, end

users remain concerned about the impact on

transaction pricing, a concern that translates to

real economy impact.

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affecting the functioning of the market for end

users. However, like the cost impact on longer

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 1 dated trades, these concerns are generally not

those in which Commission intervention would

presently be fruitful. They are more likely the

product of Federal Reserve policy rather than the

derivatives regulation under Dodd-Frank.

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 6 In the interest of time, I'll highlight

one such issue negative interest rates as an

example but there are other issues including

negative swap spreads, the implications of which

are similar. In particular as it relates to the

need or not for Commission intervention.

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created unprecedented hedging challenges for end

users, in particular because bank stress tests

require banks to contemplate negative rates in

their models. Banks are putting zero percent

floors in commercial loans provided to end users.

In other words, if LIBOR goes below zero, the

LIBOR rate used to calculate the floating rate on

the loan will be fixed at zero.

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 22 floating rate loans to fixed must contemplate the
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 1 zero percent floors in their loans when trying to

construct a hedge that perfectly mirrors and

offsets the economics of their loans. They do so

by buying back the floors they are short in their

loans and embedding those floors in interest rate

swaps that then perfectly offset the risk profiles

of their loans and consequently achieve favorable

hedge accounting treatment.

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adding approximately 20 basis points per year to a

five-year loan. This amounts to approximately $1

million in additional cost over the course of a

five-year $100 million loan. This problem arises

from government monetary policy as well as bank

stress testing protocols not from derivatives

regulation.

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the CFTC would be fruitful in moderating the

negative outcome for end users. Nonetheless, we

mention it here as a point of interest on market

functioning for end users and to assert that not

all such market problems need be or can be

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 1 satisfactorily addressed by Commission

 2 intervention.

 3 As a consultant, I can't help but

suggesting a framework for considering how the

Commission might prioritize interventions to

address market functioning concerns. We might

sort any regulatory initiative focused on

improving market functioning into one of four

quadrants in a two by two grid where those

quadrants are expected and unexpected outcomes on

the vertical axis and costs and benefits on the

horizontal axis. And I submit that the Commission

might reasonably prioritize those initiatives that

address the unexpected costs of regulation.

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suggested, a financial entity's de minimis

exception fits squarely in this category. Thanks

for the opportunity to offer our perspective on

these issues.

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 20 MR. NIXON: Thank you, Luke, and thank

you to all of our speakers for taking the time to

put together their thoughts and sharing those

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 1 thoughts with the Commission. I'd like to

actually maybe take a couple of minutes right now

and open up the floor to other participants on the

MRAC and also to the Commissioners who might have

some questions either to any of the participants

but particularly to the participants that took the

time to speak to us today.

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 8 If I could throw out one question just

to get things started, Rana mentioned that most of

the trading that the end users have been doing on

interest rate swaps is really in the RFQ market as

opposed to the central limit order book. And

highlighted the need for matching cash flows on

their swaps and identified some of the reasons why

she felt that that was why that part of the

marketplace, the central limit order book, had not

taken off.

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 18 Kristen, I just wanted to see if you had

the same views. You mentioned average pricing was

one of the reasons that you weren't using the

CLOBs in interest rate swaps and I was just

wondering if you could just comment as to whether

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 1 or not that is the only reason, primary reason or

what you think it might take for central limit

order books to take off from an end user

perspective?

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 5 MS. WALTERS: Well, I mean, I think from

our perspective, and again, we're a very large

firm with a well-developed trading platform that

connects to many different trading venues. So for

us, yes, it's the average pricing that's the

issue. I would agree, I mean, I do agree for

other smaller end users there's operational

complexity there.

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connect to the CLOB. We're willing to make the

investment. We're waiting for the average pricing

but I can see how it could be -- there could be

significant barriers to entry for other end users.

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 18 MR. NIXON: Okay, thank you. Are there

some questions that the Commissioners would like

to start off with? And --

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 21 COMMISSIONER GIANCARLO: I have a

 22 question for Ms. Walters. You mentioned the
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 1 importance of a functioning single name CDS market

for a healthy corporate fixed income market. That

CDS market, single name CDS, has gone pretty quiet

in the last few years. What would you suggest

perhaps as a way of seeing some vitality come back

to that marketplace?

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 7 MS. WALTERS: I mean, my personal view

is that central -- encouraging central clearing

and execution via SEFs similar to the interest

rate markets is important. What's interesting,

there has been, given the low prevailing interest

rate environment due to monetary policy for so

many years now, there has been a tremendous amount

of or proliferation of an issuance in fixed income

markets and in investment grade and high-yield

bonds.

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perspective is that if you look at volumes, if you

look at a lot of traditional indicators around

market depth, immediacy, turnover, the numbers

actually look like they're fairly reasonable.

However, if you look underneath the covers a

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 1 little bit more fully, what you see is that there

are thousands of bonds in the corporate credit

market that are out there but the overwhelming

majority actually don't trade every day.

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 5 So the trading is almost entirely in a

very small number of large currently issued bonds.

So what that means is that if there's the desire

to trade, it actually may not be that easy to do

in a lot of the off the run issues. So the single

name CDS market becomes quite important as a

hedging vehicle to complement what's happening

from an index perspective.

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my personal view and I think we, as I mentioned,

are starting to clear which is the first -- is the

precursor to executing on a SEF but I think that

would be -- I think OTC, traditional bilateral

trading in these markets is potentially why there

hasn't been -- they've been quieter.

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 20 COMMISSIONER GIANCARLO: Do not those

same liquidity factors that you just described in

corporate fixed income, though, also apply to the

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 1 single name CDS, that is that only in a narrow

band do they trade with any degree of liquidity

and outside that band there's very infrequent

trading in most single name CDS?

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 5 MS. WALTERS: Yes, absolutely, I do --

it's, again, my personal view that if single name

CDS were clearing along with index CDS through 

exchanges that that might change liquidity.

Certainly, it's more difficult when the bonds and

the CDS aren't priced every day but on an exchange

mechanism you absolutely have the price

transparency which I think we've seen and the

rates market is good for liquidity.

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 14 I'm not sure what others would say. It

would be great to hear thoughts from my colleagues

but that's my personal view.

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 17 MR. NIXON: We talked a little about

volumes or the lack of growth in volumes in some

of these marketplaces. So I thought I might turn

to a couple of the other members of the MRAC in

case they had any particular views as to whether

perhaps the lack of volume growth in the swap

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 1 market or in the CDS market, you know, was it tied

to the interest rate cycle? Is it tied to bank

capital requirements? Perhaps to the regulatory

rules of trading around the SEF markets. Is there

any particular major reason that sticks out in

your mind as to what could be impediment to volume

growth in the marketplace for CDS? And I know we

-- or sorry, or CDS.

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 9 I know we have a couple of the venues

here. Lee is here. Nathan is here. Don't know

if you have any particular comments but I'm sure

they'd be interested in your view on why you think

the marketplace may not be growing as it has in

the past.

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 15 MR. OLESKY: Yes, thanks, John. Rather

than dive into that, I think what I'd like to do

is just put a little perspective on what has

happened in the last two years post-SEF

introduction. So as much as the market has slowed

down, and I think there's a lot of reasons related 

to regulation, capital constraints, et cetera that

we could all talk about that are the main driver

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 1 of that, one thing we should take a step back and

put in context is how much volume has actually

migrated to electronic platforms that are now

SEF-regulated.

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 5 Those numbers have gone up many, many

fold. So if I look at the numbers on Tradeweb in

terms of either the rates market or the CDS

market, 10, 15, 20 times the amount of volume that

we saw pre-SEF is now trading in an electronic

environment with hundreds of customers doing

hundreds and hundreds of trades every single day.

So the transition onto the SEF environment has

actually, I think we should take a step back and

say that's gone incredibly well.

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 15 The issues of liquidity and volumes in

the market are really not tied to sort of the SEF

situation in and of itself. I think they're much

more tied to regulation, capital constraints, P&L

pressure, the incredibly low rate environment. I

mean those three right there are the big, big

factors.

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 22 But when we look at SEF implementation
 53

 1 and increased price transparency in the market,

increased stability for the market through 

centralized clearing and enhanced processing of

the entire trade cycle, I think we've done quite

well in the last couple of years as the

introduction of SEF has really taken hold.

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 7 MR. JENNER: I would -- oh, I'm sorry.

I was just going to agree on a couple of the

observations that were made. So I agree with

Lee's point. I think the introduction of a SEF 

model has made people think much more about

e-trading as an option for even other asset

classes that aren't necessarily mandated or made

available for trade.

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 15 So I think that's a positive. I also

agree with Rana's observation just based solely

upon Bloomberg SEF that we do tend to see much

more robust flow in the order book around credit

derivatives than we do for rate derivatives. It's

essentially the same product that we offer for

both markets but we have much less demand for the

rates order book. And I think Rana pointed out

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 1 some of the structural components related to the

instruments that may cause that index CDS

especially a fully fungible instruments with some

specific tenor points. Rates are not that.

 2 

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 5 So that's probably the most obvious

reason why that may be the case. I think the

third point that I'd make is I think one of the

goals of SEF implementation was to facilitate and

help more entrants into the marketplace. And at

least in our experience, we have seen

non-traditional liquidity providers participate

and make markets on our SEF as well as the sort of

usual constituency as well.

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 14 So we view all of those things as

reasonably positive or as sort of expected

behaviors.

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 17 MR. NIXON: I'm going to take one more

question then we're going to go on and hopefully

we'll have time to come back to some of the other

questions or we won't get, obviously, through the

four segments. Thank you.

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 22 MS. ADMATI: Okay. I just want to make
 55

 1 a quick comment and I'm speaking actually for,

well, I'm speaking for the people out there like

many of them. I'm not representing actually any

particular interest in these markets and I'm not a

participant in these markets but I am an academic

and I understand the markets, not necessarily the

details.

 2 

 3 

 4 

 5 

 6 

 7 

 8 I just wanted to comment on the point

about volume and about liquidity and that is just

the following observation. I understand that the

livelihood of some people and some people's

organizations has to do with the ability to trade

and that the livelihood of some people is about

volume of trade. But I don't take either of these

as a necessarily -- obviously everybody who wants

something wants to get it right away but usually

in economics we have prices for things.

 9 

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 14 

 15 

 16 

 17 

 18 So I just want to say that, you know,

the fact that there are a lot of securities out

there and that there are more securities that have

been created in this world and we study the world

of complete markets or incomplete markets and want

 19 

 20 

 21 

 22 
 56

 1 to have a lot of markets, does not imply that in

every given moment of time there has to be two

sides to a transaction that want to trade in a

particular thing at the price that each of them

feels is the right price.

 2 

 3 

 4 

 5 

 6 And so from the perspective of the

economy out there, the real economy, the

businesses, the individuals, I don't know that

it's a priority for the world that there is a

trade every second in every security in every

price that people feel like it. And so I just

want us to step back from the fact that somebody

wants to do something at a given moment and ask

ourselves what, you know, there are lots and lots

of bonds that are not trading at every second and

it's okay. Not every CDS that's anybody's come up

with needs to trade every split second.

 7 

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 17 

 18 So it's not for me an objective per se

that there is what somebody might call liquidity

which is they convert a piece of paper into cash

right now this minute at this price that they feel

is right for it. There are two sides to this

 19 

 20 

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 22 
 57

 1 transaction and they will evaluate it. And if

there's uncertainty by the value of it, the

liquidity will suffer and liquidity is something

that can exist one day and disappear the next day

for these risky securities.

 2 

 3 

 4 

 5 

 6 So I just want us to remember that

because it seems as if liquidity per se is like a

national objective here and we should remember

that we're just allocating, you know, resources to

things and trying to manage risk for the economy

as a whole through all these wonderful things that

we teach our students about how to use

effectively. And we want them to be traded.

 7 

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 12 

 13 

 14 To the extent that the regulation is

blamed, I just want to add this one comment and

I'm, of course, a big advocate of capital

regulations. I think everything that's bad about

the impact of regulation is because regulation

itself is badly managed and distorted. And so I

have a lot of criticism of capital regulation and

certainly, of liquidity regulations to the extent

that they are harming what should happen. Then

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 1 they are dysfunctional.

 2 MR. NIXON: Okay, thank you. We'll come

back to some of the others if I can after I turn

to the other segments.

 3 

 4 

 5 So if we can go to the energy, I think,

sector is next. Glenn, I think you were going to

lead off?

 6 

 7 

 8 MR. MACKEY: Certainly, thank you. Can

everybody hear me okay? I'd like to thank the

Chairman and the Commission for having the

opportunity to speak on behalf of some of the 

energy users. The light's on. Can you hear me

now?

 9 

 10 

 11 

 12 

 13 

 14 Just to start off, from our perspective

there has been a fundamental change in the way the

companies are accessing markets specifically and

including both physical and financial. Where we

once had banks as counterparties and financiers

that has gone away.

 15 

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 18 

 19 

 20 We're now seeing physical asset players

go back to bilateral arrangements in a lot of

situations. Well, that has also had a change on

 21 

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 59

 1 both our credit portfolio and the type of

counterparties and transactional entities that we

participate in.

 2 

 3 

 4 In the financial energy markets, the

market continues to place its risk on the

portfolios of a few clearing houses alone. Much

of the business is done on ICE for its liquid

markets, ease of use and variety of products. CME

is also getting a share of the market but in the

past few years, as well as others, they're trying

to define themselves to compete with the two

largest DCMs, that being the CME and ICE.

 5 

 6 

 7 

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 9 

 10 

 11 

 12 

 13 When Dodd-Frank was passed, regulators

and market participants had two primary concerns

and I think that one was that the business would

be forced to move offshore and secondly, that the

market would move into futures and put a financial

strain on the clearing houses. To some degree,

both instances have happened and by far, energy

swaps have largely moved into the futures market.

 14 

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 18 

 19 

 20 

 21 The futures market for this hedging

 22 activity provides a number of challenges, though,
 60

 1 such as the strict contract definition that

futures mandate. Swaps provided customized, more

comprehensive hedging opportunities because of

that and are still getting done in the marketplace

albeit more on a bilateral perspective.

 2 

 3 

 4 

 5 

 6 So from an end user's perspective, we're

generally accessing the financial energy market

via two constructs, the first being electronic

brokerage platforms such as ICE, NYMEX, Nodal.

And secondly, using introducing brokers over voice

lines associated with a clearing entity or FCM.

You know, typically, from my perspective and with

our firm, the majority of transactions are cleared

through the DCOs.

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 13 

 14 

 15 For energy, and I'm speaking only about

energy, SEFs, to some extent, are somewhat

redundant for us and create challenges such as

cost, operational complexity and more additional

risk as far as staffing as well. We do not

typically use SEFs because the transactions can be

traded and cleared through swap futures through

ICE. And any swaps elsewhere in the business are

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 22 
 61

 1 directly considered counterparty swaps for the

most part primarily because of the bulk and unique

nature of where we want to hedge or transact and

the nuances associated with that.

 2 

 3 

 4 

 5 With respect to access to the market,

what was once an over the counter market that

offered futures clearing such as ClearPort has now

transformed into classic futures market where

entities have been DCMs such as ICE. And this has

facilitated the change. No longer do we have

prime brokerage arrangements with banks which now

forces individual counterparties and smaller

entities into the markets.

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 Swaps done between individuals and swap

dealers will now be cleared with these dealers and

charged margin which increases the cost to the end

user and to market participants. As

electronification of the markets increase, the

need for brokers has decreased, while we

acknowledge that brokers still play an important

part in the options market since their products

are less standardized. 

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 62

 1 With respect to the comments made in

relation to liquidity, one of the comments I'd

like to make is that ultimately if there is a lack

of liquidity in the swaps market or the ability to

hedge whether it's production assets, load assets,

renewable assets, ultimately the energy companies

then wear more risk within their portfolio. And

the cost associated or the risk associated with it

ultimately gets passed on through to the end

users.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 So while academically there are some

comments that suggest that this is not necessarily

efficient, my primary concern there would be is

where we have an inability to provide liquidity to

properly hedge and manage the cash flow and the

anticipated cash flows of an organization such as

an energy company where you have extreme

volatility in the margins overall, ultimately any

change in the cost or added cost because we wear

risks that we don't want to warehouse and the

banks are not doing that for us, ultimately is a

pass through to the end user including myself

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 63

 1 personally from that standpoint.

 2 Jerry, I don't know if there's anything

 3 you want to add then?

 4 MR. JESKE: You can continue. I'll be

 5 jumping in there.

 6 MR. MACKEY: Sure, okay, thank you.

With respect to liquidity, you know, my

observation is that with few banks warehousing

risk market liquidity has deteriorated for us as

end users. From the perspective of are there

barriers to access? Essentially for larger

participants, I would say no but smaller players

and asset hedgers do have less access to the

market if they have or the inability to post the

appropriate collateral or meet the appropriate

credit thresholds requirements by the other market

participants.

 7 

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 14 

 15 

 16 

 17 

 18 With respect to recommendations on how

regulars can enhance market participant access to

markets, one of the things that would be helpful

is to remove the swap data reporting requirements

on the end users themselves. Albeit that's not

 19 

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 64

 1 necessarily probably where we're going but the

high credit requirements, exchange margining

mechanics limit the ability for smaller physical

asset owners to access markets as I mentioned

before.

 2 

 3 

 4 

 5 

 6 And the issue that for end users are

really related to access not through the FCMs or

the market that way but for things like the lack

of liquidity, fewer products and tenors being

offered by the exchanges, and the overwhelming

impact sometimes of some of the ETF money in the

market and the volatility it plays.

 7 

 8 

 9 

 10 

 11 

 12 

 13 MR. JESKE: So my name is Jerry Jeske.

I'm from the Commodities Market Council and I'd

like to thank the Commissioners and the staff as

well for being here. Folks that are in this room

who help craft the regulations that many of us

have to operate by.

 14 

 15 

 16 

 17 

 18 

 19 On behalf of the Commodity Market

Council I'd like to actually people use the word

end user a lot. But I think Anat from real

markets hit on a key concept here and that's the

 20 

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 65

 1 real businesses. So I'd like to speak on behalf

of the real businesses. Those businesses that

keep the lights on in this room, the businesses

that bring gasoline to the gasoline pump, the

businesses that raise food out on the farms and

bring it to people's tables, the real businesses

of this world.

 2 

 3 

 4 

 5 

 6 

 7 

 8 The real businesses have a place in the

markets and that's risk transference. We talk a

lot about liquidity. We're concerned about

liquidity and we're concerned about it for good

reasons. And that is without liquidity or without

the ability for people to transfer risk, there is

added risk for those real businesses. And those

real businesses may not hedge and if they don't

hedge, buy insurance, pass that on to others to be

able to take those risks, the whole system will

fail.

 9 

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 19 And so I think that's a great point,

Anat, from real markets, and I really want to be

able to address the fact that real businesses need

these markets and in a well-regulated fashion.

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 66

 1 What we're seeing, to answer some of the questions

that were put out here, are SEFs being utilized by

the energy markets and the agricultural markets

and the answer is no. And I'll say no because of

the 1.35 hangover.

 2 

 3 

 4 

 5 

 6 So essentially you had this regulation

out there for the last two and a half years, 1.35,

that put on extra cost and extra burdens on folks.

Since the relief that's been offered up by the

Commission thankfully in December, that has

changed things a bit. So a non-registrant now

doesn't have to face the prospect of added costs

through 1.35. I think that's a good outcome.

However, that was just December.

 7 

 8 

 9 

 10 

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 13 

 14 

 15 So the utilization of SEFs isn't going

to immediately occur in the energy and the

agricultural space because of the concern of

registration. Registration means cost. So

whether it's become a registrant in terms of a

swap dealer or a registrant in terms of 1.35, it

is about cost. You can't participate in the

markets if there's too much cost.

 16 

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 22 
 67

 1 Are there visiting introducing broker

concept? So I've been involved in the markets for

some time back in my days at the Chicago Board of

Trade up through various different positions in my

career and I've seen a transformation occur.

Introducing brokers were a concept as it relates

to access to pits. The pits aren't around

anymore. They're electronic marketplaces.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 Those electronic marketplaces are a good

thing for the most part because the middle man has

been taken out of the equation. So the

introducing broker concept, I would actually

change to say are there brokers whether it's ICAP

or Bloomberg or Tradeweb are essential to the

marketplace but from a bilateral standpoint not so

much from an access standpoint to CME, WebICE, CME

Direct, trading technologies. These platforms are

access to the market that many people do, in fact,

have and utilize.

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 So the concept of introducing broker I

think is a little bit misplaced and ought to be

thought of in terms of broker. And where is that

 21 

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 68

 1 broker facility happening? In the energy and the

agricultural space, it's with respect to

bilaterals. So when you participate direct with

the counterparty, you're looking to transfer risk.

And if you can't transfer that risk, whether it be

a swap or a physical asset, meaning a cargo, for

instance, you're looking for an ability to sell or

buy that commodity and move that commodity.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 So brokers are very helpful in that

space and very needed. When it comes to access to

futures, they're really not needed. You have the

direct pipe now to the exchange. Although, I

think Luke mentioned something that I think is

pretty important and that is what fees are

associated with that process? How do you get

electronic platform if you're a farmer sitting in

Iowa? Well, that's not so easy because you have

to have connections to the exchange. You have to

have a clearing account.

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 And I applaud the Commission

particularly for taking on Basel and the added

costs for FCM community. Those added costs are

 21 

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 1 being transferred onto others. My particular

organization, we've decided to try to get away

from that cost by go self-clearing. But going

self-clearing isn't easy. You need to have

critical mass to get there.

 2 

 3 

 4 

 5 

 6 So for the end users, the real

businesses out there, access to clearing is very

important. The ability to self-clear is a

wonderful concept. It's still very much in its

infancy. And I think it's something that the

Commission might want to think about.

 7 

 8 

 9 

 10 

 11 

 12 With regard to let's see, our next set

of questions, how the ways the market participants

access the market? As I was just mentioning, the

various electronic entry to the marketplace is a

wonderful thing. We've got a draft regulation out

there called Reg AT. Reg AT threatens some of

that. I would suggest that the comments that have

been registered by various industry participants,

by those end users out there, by those real market

participants, I would ask that the Commission take

a very good look at those comments.

 13 

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 22 
 70

 1 Because to overreach with regard to Reg

AT won't solve any problems particularly for those

that are using electronic markets not as algo

traders necessarily but to be as a conduit to the

marketplace. It's a wonderful thing and the costs

will go down as long as you're able to put that

infrastructure in place. Are there

recommendations for the Commission?

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 I think I've mentioned some and do

market participants see any inherent risk to the

markets that the Commission should address? One

of them is the $8 billion ratchet down. The $8

billion ratchet down December of 2017 is looming

on the markets. I think the folks that spoke

earlier talked about some of the deferred swaps

that are out there, the long-tenored swaps, the

10-year swaps and that costs associated with it.

 10 

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 17 

 18 I think I recall somebody saying they

doubled in value. Well, why do you think that's

the case? Because people can't predict whether or

not they're going to be a swap dealer two years

from now. They don't know. That's registration.

 19 

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 71

 1 That's regulation. That will cost people

tremendous amount of money if they become

registrants.

 2 

 3 

 4 That should be addressed sooner than

later. It hasn't been addressed and the ratchet

down to 3 billion will cost end users a lot of

capital. To be whether the capital rule takes

effect or not, it's going to be an added cost that

people can't determine. That's why the cost of

deferred swaps.

 5 

 6 

 7 

 8 

 9 

 10 

 11 So it's the same concept for those,

again, those folks in the real marketplace, those

real businesses. It's tantamount to not being

able to buy insurance. And that's not a fun

concept when you think about it because then

you're taking on risk that you really can't manage

very well.

 12 

 13 

 14 

 15 

 16 

 17 

 18 One last comment I would say is in

regard to the fees that have been discussed in

Congress and I know the Commission can only do so

much in this space. I would caution added fees

associated with transactions, I think we've gone

 19 

 20 

 21 

 22 
 72

 1 down this road many, many times in this history of

the CFTC and I think there's been good advocacy on

the Hill in connection with this but it always

comes up. And those fees are going to end on

those folks that use the markets. No two ways

about it. The fees increase, the costs increase

for everybody. So with that, I'll leave it to

you, John.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 MR. NIXON: Thank you, Jerry and Glenn.

First let me turn to the Commissioners. Is there

any particular questions that you might have for

any of the speakers? If there's some questions

from the other participants I'd be happy to take

them. I would ask -- can I ask one question of

perhaps Glenn.

 10 

 11 

 12 

 13 

 14 

 15 

 16 You mentioned that you don't really use

the SEFs that much anymore. Most of your business

is going through the exchanges directly using

direct access to those exchanges. Given the fact

that the OTC markets have a lot more venues to

operate on, a lot more flexibility on how you

operate in those marketplaces, is there concerns

 17 

 18 

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 20 

 21 

 22 
 73

 1 that the limited venues for trading on the listed

markets, is that a concern for any of the users?

It sounds like most of the business that you're

doing is in the CME or on ICE. There are other

places I'm sure as well but I was just wondering

if you're concerned at all about the consolidation

in that marketplace and the potentially lack of

options over the course of being able to execute?

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 MR. MACKEY: Yes. I think the short

answer would be yes, we are concerned about that

because you're placing a lot of concentration and

very few number of market participants being the

exchanges. Having said that, the key to some

extent is adequate price and adequate liquidity.

So if it's through the swap dealers on the

bilateral side or if it's through the exchanges,

we're looking for a balance there that ultimately

at the end of the day provides us with the ability

to hedge and monetize where required the

portfolios that we have.

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 And at the same time, ensure that we've

 22 got a balance on potential exposure to market
 74

 1 events where the market events, if there is any

sort of meltdown, you've got a concentration there

with very few participants which typically in past

in the -- when the ISDA was a dominant agreement,

you could manage the exposures on a credit basis

through the portfolio with different contract

provisions. You don't have the ability to do that

now with some of the entities that are more

structured and centralized.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 MR. NIXON: Okay, thank you. Do you

 11 have a question?

 12 MR. STANLEY: I had a comment. I just

wanted to underline what I think for the

Commission what I think is the importance of doing

data-driven objective and universal analyses on

these issues as opposed to anecdotal analysis.

The input from market participants on this

committee is, of course, extraordinarily valuable

and I think it's great that we put together a

forum to do that.

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 But one thing, when we look back at the

 22 history of discussions about regulation over the
 75

 1 last couple of years, we find that analysis often

comes up with a different answer than some of

these anecdotes that you hear from market

participants. We heard from a long time from

market participants about declines in liquidity in

the corporate bond market.

 2 

 3 

 4 

 5 

 6 

 7 But recent work by the New York Federal

Reserve shows, I think, pretty conclusively that

liquidity in that market has not declined. This

is not simply based on bid-ask spreads as

Commissioner Giancarlo mentioned but also on price

impact, on price dispersion, on liquidity and

volatility risk. In fact, many of these core

liquidity metrics turned out to be at record lows

when they were measured.

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 Now there were some measures of

liquidity risk that increased in the Treasury

market but since the Treasury and corporate bond

markets are equally affected by regulation the

conclusion to be drawn there was that changes in

market-driven trading practices such as increased

electronic trading for treasuries were the source

 17 

 18 

 19 

 20 

 21 

 22 
 76

 1 of that divergence.

 2 Now there hasn't been that much, I would

say, definitive work on the liquidity of impact of

in derivatives markets of new regulation. But

earlier this year we did see, I think, the first

really high quality study on that, a Bank of

England study by Benos, Payne and Vasios, that

look at complete London clearing house transaction

date in the interest rate swaps market.

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 They used the difference between

transaction costs in the US dollar swap market

which is subject to the SEF mandate that you had

put in place and transaction costs in Euro markets

that were not subject to that mandate, to do what

I think is a very good estimate of the economic

benefits of pretrade price transparency. They

found those economic benefits were very large.

Reduction in execution costs of $20 to $40 million

daily and reductions and costs for end users of $7

to $13 million, again, daily. These are very

large benefits.

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 

 21 

 22 I don't believe they stratified by end
 77

 1 user size in their published paper but I think

their data should allow them to do so. And I

think that's something that the CFTC economists

should maybe contact them and ask about.

 2 

 3 

 4 

 5 So I think that I just want to encourage

the Commission to try to do similar objective and

universal data analysis on derivatives markets in

order to draw its conclusions about the impact of

its regulations on liquidity conditions and

hedging needs in these markets because I think

they can often show a different picture than what

you get from input of market participants.

Because it's interesting that the Bank of England

study did show a reduction in inter-dealer

trading, something that actually would reduce

profits for some market participants. But that

that produced benefits for end users.

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 I want to make one final additional

point regarding the results of data-driven

examinations of these markets, a point that may

not make me very popular here. There has been a

recent set of academic examinations of newly

 19 

 20 

 21 

 22 
 78

 1 mandated accounting disclosures on end user use of

derivatives. And these accounting disclosures

were only mandated in 2008. So they're only

becoming available now.

 2 

 3 

 4 

 5 These studies found -- examined a random

sample of energy company end users and they found

that two-thirds of those energy company end users

use swaps for non-hedging purposes. Mostly for

earnings management and that the use of those

non-hedging swaps were associated with increased, 

not reduced, earnings volatility. We should not

assume that all end user swaps are strictly

undertaken for hedging purposes although there is

no question, of course, that many are, many

perhaps most are.

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 We, you know, end user, real economy end

user companies that have been keeping the lights

on for well over a century in this country but the

increase in over the counter derivatives in swaps

markets, the great growth in over the counter

swaps markets dates back, I think, less than two

decades in terms of when these markets really took

 17 

 18 

 19 

 20 

 21 

 22 
 79

 1 off. So clearly there are mechanisms by which end

users can manage risks through futures markets,

through simply managing their own investment and

spending flows that don't only rely on these over

the counter derivatives markets.

 2 

 3 

 4 

 5 

 6 So anyway, as I said, I encourage the

Commission to look closely at this data and try

and do their own economic analysis.

 7 

 8 

 9 MR. NIXON: Tom, I can I turn to you?

 10 MR. COYLE: Thank you. Today I

represent the National Grain and Feed Association.

The NGFA represents members that provide prices to

producers for physical commodities and transport,

store, process and distribute that production to

end consumers.

 11 

 12 

 13 

 14 

 15 

 16 I also manage a company that operates

the largest Chicago Board of Trade delivery

facility for soybeans and corn in Chicago. It's

also one of only two facilities. It's regular for

delivery on corn, beans, wheat and oats.

 17 

 18 

 19 

 20 

 21 My comments today will provide the

 22 perspective of those that participate and handle
 80

 1 physical commodities. Specifically to your

questions that we'd received about market access,

today ag participants use the standard FCMs and

IBs and also direct electronic order entry. I

would say for commercial participants direct

orders to the pit have been replaced by an

electronic entry system.

 2 

 3 

 4 

 5 

 6 

 7 

 8 As for the use of SEFs, swaps are not

used in the mainstream for traditional ag

participants. Swaps are used primarily for

ethanol, for some innovative pricing contracts for

producers or end consumers and in transaction

design to secure financing. Use of IBs, IBs are

used primarily by smaller market participants,

current country elevators and end users. IBs tend

to be more service oriented.

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 IB activity has become more challenging

due to increased recordkeeping and cost which have

not been offset by increased fees, also by the

reduction in the number of FCMs many of whom will

not accept IB business.

 18 

 19 

 20 

 21 

 22 Next question, are there end users --
 81

 1 are the end users --

 2 MR. NIXON: Tom, can I just get you to

 3 move forward a little closer to the mic?

 4 MR. COYLE: Certainly, John.

 5 MR. NIXON: Thanks.

 6 MR. COYLE: Our end users, particularly

small end users able to access the market

effectively. Order entry has improved

dramatically for all market participants due to

the electronic advances. However, smaller end

users likely find it more challenging to support

-- to find support and advice due to the shrinking

pool of FCMs, many of which will not service IBs.

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 I understand that the FCMs have dropped

to 47 from 150 and I'm told only 12 of the 47 will

accept IB business. The primary reason I'm given

for the drop in the FCMs is the more stringent

regulatory requirements, increased oversight

requirements, risks of fines, legal fees,

cybersecurity and audits.

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 20 

 21 As far as the benefits and drawbacks of

 22 the current access, the benefits, the key benefit
 82

 1 is the efficiency of order execution. It really

is quite impressive. Also the CME has developed

tools to enhance the ability to tailor risk

management solutions. CSOs, calendar spread

options and short dated options have a range of

uses that have become quite popular.

 2 

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 5 

 6 

 7 The drawbacks, the advancements in

technology and the dramatic increase in new

financial participation, hedge funds, index funds,

ETFs have created a macro shift in market dynamics

that is truly concerning particularly for

traditional hedgers that produce, transport and

consume the underlying products.

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 12 

 13 

 14 Actual S&D and commercial hedging is

significantly less relevant to daily price

discovery. Overall, markets tend to seek fair

value particularly during the expiration process

but short term trends and daily movements are much

more influenced by money flows in and out of the

market.

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 20 

 21 There are other negative side effects to

 22 the electronic advances from microseconds to
 83

 1 nanoseconds. Commercial hedgers are at a

disadvantage as it relates to speed. Algorithmic

trading sends misleading indicators to the market

and, at times, are designed to push the market

into voids in liquidity. Things like spoofing

simply did not last in the pit environment because

there was real time enforcement.

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 5 

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 7 

 8 The electronic order systems also reduce

the amount of information because nobody knows

who's trading. In the past with manual order

entry and the pit environment, market participants

got at least an indication of who was trading the

market. Today, I would say technical or financial

trading leads the market more often than the price

activity of traditional hedgers.

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 15 

 16 As far as liquidity and volatility,

there is obviously a lot more volume which might

suggest more liquidity. But I would say that

order flow tends to be more one-sided and more

violent and creates more violent moves due to the

speed of the trading systems. I'm not sure if

statistics would confirm the reduced liquidity and

 17 

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 84

 1 the greater volatility but from a grain trading

perspective, I would say too often price movements

appear random which plays havoc on reliable risk

management.

 2 

 3 

 4 

 5 As far as barriers to access, there is

some loss in access due the drop in FCMS but

overall there are no real barriers. However,

balance in access has changed. Traditional

hedgers would historically have led the market now

find themselves one millisecond or many

nanoseconds behind financial market participants.

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 11 

 12 As far as recommendations, first more

transparency. More detailed and timely trade

data. The current commitment of traders report is

issued on Friday with information as of Tuesday.

With the current technology advances, shouldn't

such a report be issued daily or at least a Friday

report that has data as of Thursday?

 13 

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 18 

 19 The CME daily trade report shows the

previous day's trading, volume and open interest.

It would be a lot more useful if we knew who

traded that volume at the same time.

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 85

 1 Communication and oversight of the DCM trade

matching systems to assure that they are fair to

all users and that they're consistently applied.

 2 

 3 

 4 I would say consider implementing rules

that require a minimum of two to three second

duration for algorithmic trading orders so that

orders can't be pulled before they're executed.

Finally, for the Commission to embrace a broad

definition of bona fide hedge for participants

that are engaged in handling, processing, storage

and distribution of the underlying commodity. The

foundation of the ag markets depends on the

participation of those involved in the fiscal

market. This should be encouraged.

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 14 

 15 Risks that the Commission should

address. The Commission needs to be vigilant to

identify any process that systemically provides an

advantage or disadvantage to one market

participant over another. Such advances and

disadvantage represent a risk to an

early-functioning market. Also to watch the

changes in market participants that reduces the

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 1 relevance of hedging from producers, processors,

distributors of the underlining commodities. And

I'm happy to answer any questions.

 2 

 3 

 4 MR. NIXON: Thanks, Tom. Commissioners,

any questions from you directly? Any questions

from MRAC? All right, thank you very much, Tom.

 5 

 6 

 7 MR. STANLEY: Just a quick question. I

heard Jerry saying some things that were critical

of Rule AT (sic) and just heard Tom saying some

things that there were some real issues in terms

of algorithmic trading that we need more

limitations and controls in that market. So I was

just wondering about your view on Reg AT and

whether the Commission is moving in the right

direction?

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 16 MR. COYLE: I don't have a comment on

 17 that. I'm sorry.

 18 MR. JESKE: I'll be happy to clarify,

though, Marcus. If you read Reg AT which is a

pretty long regulation, the risk is overreach

because the way the markets work today, the way

access works today is through a computer. You

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 87

 1 don't go through the phone to talk to the broker

who sit/stands outside of the ring, who then

flashes an order to a guy standing with his back

to the ring who turns around and whispers to the

person who executes the order. That day is gone.

 2 

 3 

 4 

 5 

 6 It's not here anymore. So how do you

look at whether we want to vilify algo or not is a

political question. So put that political

question aside and focus on what is the issue as

it relates to access to markets with a computer

screen? Is there really an issue? That really

should be the question and that should be

something that I think everybody, you know, has a

stake in because that's how markets are traded

today.

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 16 And whether you're in energy, whether

you're agriculture, whether you're in CDS, you can

do it two ways on the phone or on a computer

screen. And there's some concerns, obviously,

people may have but to vilify the whole concept of

a computer screen I think is misplaced.

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 22 MR. STANLEY: Yeah I don't think our
 88

 1 organization or anybody else vilifies the concept

of computer access to the markets. I mean,

computer access to everything is fundamental part

of modern life. The question is are there forms

of market manipulation that have been facilitated

by this access and how should we regulate those

specific forms of market manipulation?

 2 

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 4 

 5 

 6 

 7 

 8 MR. COYLE: I guess I would add a

comment. You know, the electronic systems are

really supposed to replicate what we had before

but just more efficiently. I would say if you

look at the number of orders you have today where

you could have 30,000 contracts bid, you'd ask

yourself is that really 30,000 contracts bid?

 9 

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 14 

 15 If somebody was standing in the pit and

flashed a bid for 500 contracts and then, someone

said sold and then you said I'll take 20 that

would end immediately. I mean the person would be

shunned so that would go away. That doesn't

happen today, all right? So we don't know. We

don't see that information but you have to -- it

makes you wonder how reliable those bids and

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 22 
 89

 1 offers really are.

 2 MR. NIXON: Okay, thank you, Tom.

 3 Angela, can we turn to you?

 4 MS. TAYLOR: Thank you. I just wanted

to add a little commentary to the discussion about

Reg AT and I think that I would encourage the

Commission to approach with caution the idea that

you can legislate the risk-taking behavior of

people who are making markets for the risk

transfer. If you require people to put their

market exposure out into the marketplace for some

extended period of time, then what is likely to

result is that there will be fewer people making

wider markets and it could have a deleterious

effect on the price discovery function and the

availability of liquidity to the marketplace

overall. So there's two sides to the equation.

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 18 MR. NIXON: Thanks, Kim. All right,

 19 Angela?

 20 MS. PATEL: Thank you for having me

here. Today I am going to talk about currency

forwards. So the currency forward market is

 21 

 22 
 90

 1 liquid and deep. It is one of the simpler markets

in derivative space with most contracts averaging

a 60 to 90-day lifespan.

 2 

 3 

 4 The currency forward contracts are

governed by ISDA documents between two parties and

many buy side firms collateralize them under the

terms of a CSA. This is also one of the OTC

markets that has had a longstanding cash

settlement service in place designed to mitigate

settlement risk. Regulatory treatment of currency

forwards in the US technically distinguishes

between contracts that are cash settled or

non-deliverable forwards and physically settled or

deliverable forwards.

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 14 

 15 Because of this technical distinction, a

couple of interesting things happened once the

regulatory reform rules went into effect. First,

deliverable currency forwards were exempted from

many of the requirements of Dodd-Frank by Treasury

while non-deliverable forwards remained subject to

the full suite of rules including the potential

clearing and trading mandates.

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 22 
 91

 1 This created an unnecessary regulatory

distinction between the two as they are

practically indistinguishable as a portfolio risk

management tool. Non-deliverable forwards have a

feature that requires net settlement of the

contract while deliverable forwards can settle

both legs of the swap. In practice, however, many

participants generally will offset all of their

exposure for a value date by broker currency pair

to make one net wire movement.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 So while the technical distinction

exists, it is not a practical one as both types of

forwards behave the same from a settlement

perspective for a large percentage of market

participants.

 12 

 13 

 14 

 15 

 16 Two, in a footnote found in the core

principles, matters were complicated with the

requirement that a facility which operates in a

manner that meets the SEF definition, i.e. A

trading platform that provides all-to-all

capability, it must register as a SEF as of

October 2013. This had the presumably unintended

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 22 
 92

 1 consequence of then requiring asset managers to

evaluate and sign up with SEFs if they wanted to

continue to execute their NDF book electronically

on such a platform.

 2 

 3 

 4 

 5 Although electronic execution had not

been prevalent, only about 5 to 10 percent of NDFs

were executed electronically pre-October 2013,

this change underscored two things. One, the rule

books that were there were problematic to the

point that many asset managers, including Putnam,

who had previously executed electronically, chose

to move to voice trading for NDF trading. And

two, the technology was, and in many cases, still

remains SEF-like. With dealers streaming quotes

into a system that cannot interpolate the curves

properly or orders being set electronically, then

picked up by a person, walked over to another part

of the desk, manually priced, walked back and

reentered manually.

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 20 Clearly the market wasn't ready. In

fact, two and a half years later, the 5 to 10

percent number hasn't changed much. While not

 21 

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 93

 1 broken to the point of dysfunction, a once liquid

and robust part of the derivative market now uses

less efficient execution methods for one of the

most volume-oriented trading instruments.

 2 

 3 

 4 

 5 All of this was done to help make the

system safer. In the long run, that may be the

right outcome once the financial markets have had

enough time to adjust to the finalized regulatory

requirements. But the totality of regulation

isn't finalized. I would caution that forcing

regulatory change doesn't always end up with

immediate safety benefits. This is akin to trying

to repair a car while it is traveling on the road.

 6 

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 12 

 13 

 14 Now I will turn to the five questions

posed. How are market participants accessing this

market? From non-deliverable forwards

participants are accessing the market

electronically or via voice depending on a firm's

level of comfort with the technology and rule

book. Although there is no trading or clearing

mandate, trading on a SEF is required to execute

an NDF electronically. Likewise because clearing

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 22 
 94

 1 is not yet mandated, there is no real need for an

introducing broker or clearing firm. There are no

pre-trade credit checks on the NDF SEFs and all

trades still remain governed by the existing ISDA

documents.

 2 

 3 

 4 

 5 

 6 And they are settled bilaterally. If an

account can establish an ISDA with their FX bank

counterparty, they can access the market.

 7 

 8 

 9 Two, how have the ways in which market

participants access the market changed? Some

firms have elected to remain voice only even with

the rule book changes.

 10 

 11 

 12 

 13 Three, how what are benefits and

drawbacks of the current means of access? The

market remains liquid and deep but with different

capital requirements coming into effect over the

coming months, there are expected to be some

changes to the overall liquidity at the dealers. 

There are no unusual barriers to access in this

market.

 14 

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 18 

 19 

 20 

 21 Four, are there any recommendations on

 22 how the Commission could enhance market
 95

 1 participants' access to markets? If

non-deliverable forwards were not treated as SEFs

more participants may trade them. Some

counterparts that previously traded these with buy

side firms have limited their trading as they now

count toward the swap dealer limits. We have

experienced firms who have cut back on their

ability to trade NDFs with us such that they are

only trading deliverable forwards and we have had

to look for execution partners elsewhere.

 2 

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 10 

 11 Five, do market participants see any

inherent risks in this market that the Commission

should address? Again, this particular market is

not in need of enhancement by the Commission and

the inherent risks it faces are no different from

those faced in other markets. I would argue that

it needs less attention not more.

 12 

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 14 

 15 

 16 

 17 

 18 The currency forward market is one of

the most straightforward, pardon the pun, markets

in the OTC derivative space but its bifurcated

inclusion in the regulations has created a

situation that could increase risk and will

 19 

 20 

 21 

 22 
 96

 1 increase costs for the final investor. Further,

the lack of consistency regarding NDFs between the

European and US regulations is relevant here as

well. The lack of a crisp and harmonized

definition of spots versus forwards has created a

list of pending questions about margin

requirements and calculation of material swap

exposure, application of cross border

requirements, scope of the ISDA state protocol

adherence among other things.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 The issue with the definition and

application of the securities conversion

transactions remain. The CFTC should clarify the

application of this term which is contained in

just the preamble of the final swaps definition

rule and the EU should adopt the same policy so

that any FX transactions that are intended to

settle with the underlying transactions should be

treated as spot even if they settle later than T

plus two.

 12 

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 18 

 19 

 20 

 21 Finally, to be very clear, we are in

 22 favor of ensuring appropriate regulation and risk
 97

 1 mitigation for financial markets. The impact of

regulation on the markets is ideally meant to

increase transparency and safety while not

compromising liquidity. In the short run that

ideal is not being met in the FX market. The

regulatory uncertainty creates inertia in the

technological and functional evolution of the

market.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 The non-cleared swap margin rules that

will begin to come into effect in September of

this year will ultimately create a cost that will

be borne by the investor. This far outweighs the

benefit in the short run. While we remain in

favor of increased transparency into areas of the

market that were opaque, focus on a mature segment

of the market that already has procedures in place

to mitigate risk and promote stability seems

counterintuitive and counterproductive to the task

at hand. Thank you.

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 18 

 19 

 20 MR. NIXON: Thanks, Angela. Can I ask

 21 if there's any questions?

 22 MR. JESKE: John, can I add one thing?
 98

 1 I think Angela made a great commentary in regards

to FX but as it relates to any energy users that

are cross border particularly to Canada,

Commissioner Massad, I think I saw in the press an

MOU being signed with some of the Canadian

authorities. Thank you for that effort.

 2 

 3 

 4 

 5 

 6 

 7 I would point out that a lot of firms

have to manage the CAD versus US and as Angela

noted, the concept of forward spot and swap FX is

a bit muddled, to say the least, between the CFTC

regime and the Canadian regs. So just as a point

there. I know you mentioned Europe, completely

concur with that but I think this is something

facing firms that do business across the North

American borders presently and is a pretty big

concern, I think, for many.

 8 

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 14 

 15 

 16 

 17 MR. NIXON: Commissioners, any

 18 questions?

 19 MR. KOELING: Thank you, Commissioners.

I am here to represent the FAPGG which is a

proprietary traders group and I would actually

like to comment on a couple of things that Tom

 20 

 21 

 22 
 99

 1 said a couple of minutes ago. And I also had a

 2 couple of questions for him.

 3 I'm going to agree with quite a lot of

the things that were said there. Proprietary

trading firms are also in favor of fair and equal

access to everyone, making sure that it is

transparent, making sure that it's clear how you

can access markets, what kind of ways there are to

connect. I will totally agree as well things like

spoofing and layering are bad things. I think the

Commission has got rules out there for that. They

shouldn't be there. We're in total agreement on

that.

 4 

 5 

 6 

 7 

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 9 

 10 

 11 

 12 

 13 

 14 What market makers try to do, like

ourselves as well, is make markets for the end

users. And what is important for us is to make

sure that we have a market that functions well as

well. We are at the end of the day reliant on

these markets to exist to make sure that we can

actually execute our businesses as well. And we

end up on the same side of that equation rather

than on the opposite side of that spectrum.

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 22 
 100

 1 With regards to what you said on floor

trading, my particular firm, Optiver, is more

related to options market making and the things

that you quoted as showing a 500 bid and then,

getting hit for a 20, that happens all the time in 

options trading. I actually think in the

electronic markets hitting something on the screen

will guarantee that execution which I think is a

massive step forward as opposed to a step back.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 I could also see that this 30,000

contract on the screen might look weird but

actually hitting that bid would lead to an

execution as opposed to what actually happened in

the trading pit. So I would assume, I actually

think that that is progress rather than a step

back. I'm not sure if you think the same. And

one other question I had.

 11 

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 16 

 17 

 18 I was curious why you think it's

important to actually know who traded what because

I don't really understand how that is an important

thing. Thank you.

 19 

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 22 MR. COYLE: The basic premise is that
 101

 1 the commercial participants, all right, buyers and

sells physical commodity, are a smaller percentage

of the market today than they once were. That's

just part of the new environment. That's fine but

it's difficult to respond to that if you don't

know who's actually moving the market, all right?

 2 

 3 

 4 

 5 

 6 

 7 Historically, you would have a sense

that there's obviously some commercial activity

going on. You see the market move. People can

adjust.

 8 

 9 

 10 

 11 Today the trading and the financial

participants dwarfs the actual commercial trade.

And so it requires you to trade less, right? And

makes it more difficult, I think, to develop a

strategy where you can identify what is the risk

reward of that position you put on? We just see a

lot of those.

 12 

 13 

 14 

 15 

 16 

 17 

 18 I say random where you'll see nothing

happen in the cash market and somehow the market

moved 30 cents. I saw last week the bean spread

moved 30 cents. As far as I can tell not much

happened but that was a significant move. So

 19 

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 22 
 102

 1 these things happen, all right?

 2 Recognize that there's new participants

and the market adapts to it so we don't have an

argument with that. But having more information

isn't going to hurt anyone. We would have a

better idea how to respond and how to position for

that.

 3 

 4 

 5 

 6 

 7 

 8 MR. NIXON: On that note since it's

 9 11:45, Tim, do you want to?

 10 CHAIRMAN MASSAD: Yeah, let me just say

a couple of words. First just thanks to everyone.

It was a very, very good discussion. It was a lot

of very useful input. I think it's quite

interesting just to hear the different

perspectives.

 11 

 12 

 13 

 14 

 15 

 16 The markets, each of these markets is a

little bit different and plus having people who

had different perspectives on what is even going

on within in a single market was very useful. So

I'm not going to even attempt to draw any

conclusions other than to say I think it gave us a

lot to think about.

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 22 
 103

 1 You know, I guess the only things I

would note similar to what I said at the outset is

a discussion like this is incredibly useful. It

is also, though, important to try to make our

analysis of these things data driven. And I'm

sure we'll be continuing to do that and looking to

all of you for your input as we do that.

 2 

 3 

 4 

 5 

 6 

 7 

 8 I think it's also always important to

remember where we came from. We did come from a

crisis that was incredibly damaging to this

country in which in the fall of 2008 there was no

liquidity and a lot of these regulations weren't

in place then. So we do have to remember what, in

fact, is motivating a lot of things we're doing

and perhaps liquidity was underpriced previously.

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 I also just want to make a couple of

comments on Regulation AT. I appreciate the input

we've received on that. I think there are

sometimes some misconceptions about what we're

trying to do there. Obviously we can't turn the

clock back on the extent of electronic trading or

automated trading in our markets. Our focus,

 17 

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 20 

 21 

 22 
 104

 1 though, is really on the risk of disruption, the

risk that an untested algorithm or an errant

algorithm or something could cause a major

disruption in our markets.

 2 

 3 

 4 

 5 And in that sense, it's, I think,

complementary to what we're also trying to do on

cyber. And when we're here talking about

liquidity and the risks to liquidity, to me the

risk of a technological failure, an operational

failure, a cyber failure are some of the most

serious risks to liquidity that we face today.

And our rule is designed to require reasonable

risk controls, frankly, the same sorts of risk

controls that I think various groups like FIA PTG

and others have said are best practices.

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 And we're trying not to be prescriptive

about that. We weren't prescriptive and they

don't -- they're addressing the operational risk.

We're certainly not dictating how long people have

to keep a bid open or anything like that.

 17 

 18 

 19 

 20 

 21 And I guess the final thing I will say

 22 is I think there are some very, very good
 105

 1 questions as Jerry and others raised about the

scope of who should be subject to those controls.

That's a challenging issue. We had another

meeting of the Technology Advisory Committee

where we had a lot of participants, a lot of whom

are electronic traders saying well, you made the

scope too narrow actually. They wanted it even

broader because they are more concerned about the

risks that small participants pose than big ones.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 So there's a challenge for us in terms

of trying to strike the right balance there. I

appreciate the difficulties of that and the risk

that we don't want to overreach. We don't want to

impose excessive costs on the market but we do, I

think, need to address the risk that the high

degree of automated trading in our markets poses

today. Thank you.

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 MR. MILLER: I'd like to ask a question.

Thank you, John. At the risk of following the

Chairman's remarks, thank you. I want to go back

to something that was said earlier by Mr. Mackey

which resonated with something that I wanted to

 19 

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 22 
 106

 1 bring up. He suggested that there might be reason

to have some relief from the swap data reporting

requirements that are currently imposed

particularly with respect to end users.

 2 

 3 

 4 

 5 And that resonates with something that

is a concern that I wanted to mention today. The

part of the market that I'm familiar with is the

life insurance industry and they are very large

directional hedgers. And they execute complicated

hedges in a programmatic way that often takes days

in order to execute. And the fact that they have

to be reported episodically after the execution

results in an illiquidity in the market and a

gapping of prices.

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 So though you know what you're going to

do almost like a block trade, similar to a block

trade, but it's not, you end up losing the market.

The market moves away from you because they can

see what you're executing.

 16 

 17 

 18 

 19 

 20 And it's additional cost to the industry

doing these trades and they're not speculative

trades. They're really integral to the risk

 21 

 22 
 107

 1 management of the portfolio. And I'm wondering

whether there's a way of exploring some means of

getting some relief so that you can get, if you

come in with a block, with what is essentially

similar to a block, a program, and get some relief

from having to report those immediately, you know,

in the timeframe that's required to the swap data

repository and that make the market more

efficient.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 MR. BERGER: Thanks. I also just wanted

to provide a few comments on some of the

conversation that went on mostly hearkening back

to the discussion at the beginning around the

rates and credit asset classes and I'll be quick

since I know we might be past our time.

 11 

 12 

 13 

 14 

 15 

 16 First of all, I think it is important,

Marcus mentioned the Bank of England study, I

think it is a very good study. Researchers at

CLARIS have also independently validated the

results of that study. And actually, that study

only looks at data through the end of 2014 and I

think the progress that's been made and the

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 22 
 108

 1 benefits to pricing liquidity only grew if you

 2 extend the data out through 2015 as well.

 3 I think that's not to say that liquidity

conditions are perfect in all circumstances but I

think the challenges that exist with respect to

liquidity conditions also create opportunities for

innovation. And so one of the steps the Citadel

Securities in its market-making interest rate

swaps market-making business has made is to look

at areas that liquidity provision can be improved.

And three of the key areas that we believe we've

differentiated ourselves in is one, providing firm

prices. And the swaps market has had a legacy of

purely operating on an indicative price basis.

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 15 The second is providing firm quotes in

size. So we auto quote up to 700K of DV01. So I

mean statements have been made that clients can't

get even 250K of DV01 done and I just don't think

that's true.

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 20 And the third is being reliable in

volatile market conditions. So on days when

non-farm payroll data is released or F1C minutes

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 1 are released, we do see a lot of other liquidity

providers widen bid ask or step away and those are

the days we were see our hit ratios go up. So

providing firm prices, being there in size and

being there in volatile market conditions are

innovations that liquidity providers can bring to

the market and differentiate themselves with.

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 8 I think another innovation separated in

the marketplace that we've talked about some today

is whether central limit order book trading will

take hold in the interest swap space. And I think

the promise of that trading modality is that it

allows all-to-all liquidity provision. So it

removes dependency on the existing liquidity

provider community.

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 16 I think there are certain barriers. I

think there is a demand for it. There are certain

barriers that continue to exist. I think average

pricing was mentioned by Kristen and that's

certainly a valid for certain types of asset

managers who have to allocate to multiple 

accounts. I think it's false to post-trade name

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 1 give up a red herring.

 2 We had, I think this group met just

about a year ago and there was a broad

cross-section of market participants from

basically every corner who agreed that it's a

practice that is overdue in terms of needing to be

gotten rid of. And MFA, a major buy side trade

association, put out quite a detailed white paper

arguing why it's detrimental for the marketplace.

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 10 So there is promise to CLOB trading but

there are material barriers that I think still

need to be addressed to solve that issue.

Finally, I think the biggest barrier that I would

see is to market access is the economics of

clearing and that's one that I think a lot of

people have already identified and thank the

Commission for being an advocate on that fact and

we're glad to see that I guess there's a new

consultation out of Basel III to look at how the

supplementary leverage ratio works.

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 21 So hopefully there is some promise there

 22 in resolving that issue. Thank you.
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 1 MR. NIXON: Rana? We'll take one more

 2 question.

 3 MS. YARED: Thanks, John. I just want

to add to Richard's comments and note that in the

energy market you actually have a similar

phenomenon where power and gas providers, so the

real operators not like traders, do also tranche

their hedging exposure. And so the same

phenomenon that you reported in the life insurance

market which is highly directional is also seen in

the power and gas market not only here in the US

but actually more acutely in Europe where the end

user power and gas provider are themselves their

own hedger and trader. So I just wanted to add

that there's another market that suffers from the

same type of phenomenon that you described.

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 17 MR. NIXON: Okay. Let me just take this

opportunity, again, to thank all of you for

participating today particularly the speakers that

took the time to put together their thoughts.

We're going to bring this part of the panel to a

close and start off I guess pretty soon on panel

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 1 number two.

 2 If I could end with one remark, I would

say that, and Chairman Massad said this, that the

CFTC like all regulators have a very difficult

role of balancing safety with market efficiency.

And it's not always easy to come up with rules

that are going to make all of the market

participants happy. And as a matter of fact,

every rule is going to have an unintended

consequence to some market participant.

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 11 I would say, though, that all of our end

users in the marketplace need efficient

marketplace in order for them to transact and I

think it is a benefit to the American economy or

the global economy to have markets that people can

access and trade on. And I think that obviously

regulators need to be very careful that the

ruleset that is put in place does not smother the

opportunity for this efficiency in the marketplace

and while safety is important I think the

efficiency of how markets operate is probably

paramount to all of us that are in this economy.

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 1 So thank you very much to all of you

and, Sharon, thank you very much to you for

organizing this today.

 2 

 3 

 4 MS. WALKER: At this time in keeping

with the main agenda, I would like to thank John

Nixon for facilitating the discussion during our

first panel. The MRAC will take a 10-minute

break. We'll resume again at 12:05.

 5 

 6 

 7 

 8 

 9 (Recess)

 10 MS. WALKER: It is my pleasure to call

 11 this meeting back to order.

 12 COMMISSIONER BOWEN: Let's get seated,

 13 everyone.

 14 MS. WALKER: Okay. As noted in today's

agenda, our second panel discussion will cover how

is the market using portfolio compression today.

I would like to note that we have members of our

staff here on hand to answer questions and clarify

current law and practice. Our Chief Economist, Sayee

Srinivasan, and Deputy Director of the Division of

Market Oversight, Mr. Daniel Bucsa.

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 22 I would also like to introduce Mr. Ed
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 1 Pla, Managing Director, Head of Clearing Execution

at UBS Investment Bank and our representative of

the Futures Industry Association who will

facilitate and help shape the discussions during

the second panel.

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 6 MR. PLA: Thank you. I'd like to open

with a few thank yous on behalf of the panel and

the committee. Thank you to Chairman Massad and

Commissioner Giancarlo for your keen interest in

the topics covered by the Market Risk Advisory

Committee. To Commissioner Bowen, for your

enthusiastic sponsorship of the MRAC and to Petal

for your thorough and efficient management of all

the logistics that it requires to do these.

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 15 Second, just a few housekeeping

announcements, maybe to repeat some of the things

John said. If you would like to speak, please

press the button to activate your microphone.

Importantly, please turn it off when you're done.

Apparently, that's leading to some of the

feedback. And if you could like to speak, please

tilt your name card on its side and jump up and

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 1 down if I don't see you.

 2 Third, I'd just like to thank the panel

for their time, the thoughtful preparation that

went into this. There are some PowerPoint slides

that we'll be referring to throughout the

conversation. I think we recognize this is

somewhat of a technical service and so forth, a

subset of what happens in the market and we

thought it was important to have some data to

point to.

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 11 The panelists include Lucio Biase, CEO

and Founder and LMRKTS, Claire Lobo, Global Head

of Business Development at Markit Trade

Processing, Dennis McLaughlin, Group Chief Risk

Officer at LCH Clearnet, Michael Modlock, Head of

Trireduce North America at TriOptima, and Kim

Taylor, President Global Operations, Technology

and Risk at the CME Group.

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 19 We thought it would be -- we have seven

questions that we'll go through. We've got a

number of speakers lined up for each. We'll pause

at the end of question just to see if there are

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 1 questions and comments from the audience before we

move on to number two. We thought we'd start with

number one which is what is portfolio compression,

and, Claire, could you maybe get us started on

that general question?

 2 

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 4 

 5 

 6 MS. LOBO: Thank you very much and thank

you, Chairman and Commissioners for the

opportunity to be here. And thank you, Ed, for

all your effort in getting us organized and into

this panel and all the good work from the other

members of the team.

 7 

 8 

 9 

 10 

 11 

 12 So the first question we're trying to

answer for you is what is compression and also is

it the same thing as netting? Michael, if you

could take us to slide number two? That will do

it.

 13 

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 16 

 17 And just to remind you, we're going to

 18 go slide --

 19 MR. PLA: I think you need to speak up.

 20 MS. LOBO: Oh, sorry. Is that any

better? Yeah, that sounds better. Michael, just

to remind you, we're going to start on two, we're

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 1 going to go four and then, to three.

 2 So it's important when just before we

even say anything about compression to understand

that the goal of compression and netting is to

reduce risk overall in the market. So we're going

to spend a lot of time talking about risk

reduction and why that's good and the various ways

that people achieve that.

 3 

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 7 

 8 

 9 It is the process, if you're at all a

gardener, is it the season where you're supposed

to be out there doing those things. It's the

process of pruning trades from a portfolio in

order to mitigate these risks. Netting, one of

the questions is what is netting? Is it different

than compression?

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 16 Netting is most commonly thought of as a

type of compressing trades where you offset

equally in a risk-free manner trades that you

might have either cleared or uncleared.

Compression comes in many, many forms and we're

going to go through some of those. And we're

going to look at slide four to just go through

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 1 what compression is.

 2 So we're going to start with the

benefits of compression. So there -- compression

is really a way of, if we could just pop all the

bubbles up there, of managing all these different

types of risks. So one very important one is

capital usage.

 3 

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 6 

 7 

 8 So the way that Basel III is being

implemented imposes leverage ratios on banks that

look at gross notional. This has been a very

large driver of compression in order to offset

trades that over the years have piled up, may not

be representing open positions anymore. They've

been closed off with each other but by reducing

those overall number of trades, thereby reducing

gross notional, you can reduce your leverage ratio

and get a more favorable capital charge against

those trades.

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 19 Next and really, really important is

margin management. This is true especially as the

non-cleared margin rules are ramping up. In

September we've seen a lot of aggressive

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 1 compression and netting around these margin rules

that are coming in and we expect to see more and

more as we near to September and as that phasing

goes on and on.

 2 

 3 

 4 

 5 Also very, very important especially on

the buy side is counterparty risk. Managing your

credit lines with your clearing brokers as well as

with your counterparties has always been something

that's been used by the buy side as well as the

sell side, swap dealers in the market for really

-- back since I've been in the market since 2003,

2004.

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 12 

 13 Operational risk is very, very important

as well. We saw in the Lehman default there were

about 120,000, 125,000 trades or more that needed

to be collapsed. Today, people have very actively

managed to get that number of trades lower so that

in a default scenario and also in just for making

payments and settlement, that process is

streamlined and it's much easier to manage the

overall book of trades.

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 22 Regulatory compliance, the CFTC rules
 120

 1 require swap dealers to establish and implement

written portfolio compression policies to offset

bilaterally and multilaterally compress uncleared

trades between its customers and it also

encourages compression and netting of trades

whether they're cleared or not.

 2 

 3 

 4 

 5 

 6 

 7 And then, the big one is to lower costs 

in this market. Having fewer trades on the book,

having less gross notional, having less

counterparty risk, all mitigate costs and engage

the market and more efficiencies. If we can go to

three?

 8 

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 10 

 11 

 12 

 13 So here we're going to talk about the

different types of compression that we have and

netting that we have in the marketplace.

Bilateral tear up of trades have been going on

since I've been in this market back into the

nineties. It's very, very typical and it's still

very, very useful especially in the uncleared

space. It's actually used across all markets, FX,

credits, rates primarily. And also in commodities

but I'm not an expert there so I'll leave that

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 1 some of my teammates to discuss.

 2 Trade collapsing within clearing houses,

this really took off in around 2009 and just to

demonstrate the extent of this, LCH published

their compression data on their Web site. It

shows that as of March 31 of this year there were

2.267 million trades that were actively open in

the clearing house. It also shows that the number

could have been as high as 8.137 million if

compression hadn't been used actively over the

last really five years.

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 11 

 12 Further, you can find out from that Web

site that in March 353,623 trades were cleared but

the outstanding notional, sorry, the outstanding

volume only increased by 26,069 trades. So you

can understand just from looking at those metrics

how much is really being compressed on a daily

basis. That was all about collapsing trades

within clearing houses.

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 20 Multilateral compression runs have been

used extensively since 2003. TriOptima has a

service called triReduce. It did its first run in

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 1 2003 and since then, it's compressed 768 trillion

of notional from these markets. And Michael can

tell us more about that in just a minute.

 2 

 3 

 4 Compaction is the last major type of

compression that's being actively used. And this

is a process where entire portfolios are optioned

in order to relieve that original counterparty of

that portfolio. And this happens in the cleared

and in the uncleared space.

 5 

 6 

 7 

 8 

 9 

 10 ISDA reported in their research note in

July of 2015 that compaction could be accounting

for as much as six to seven percent of the SEF

activity. I'm now to turn it over to Michael and

Lucio who are going to walk us through what

risk-free compression means and what

risk-constrained compression means. Thank you.

 11 

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 16 

 17 MR. MODLOCK: Thank you, Claire, and

also thanks again to the Commission for their

continued encouragement in these diverse topics.

So my name is Michael Modlock. The (inaudible)

compression, risk reducing business in North

America for TriOptima. What we'll cover just now

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 1 is the differences between the various forms of

 2 compression. We've got three examples here.

 3 Earlier on in the first panel, Rana had

observed that some of the clients were gravitated

towards executing swaps with particular cash

flows. And I think one of the reasons could be

that they're looking to find perfectly offsetting

trades in a clearing house so they can be

risk-free netted. And first example here we've

got the blue trades are blue. Sorry, the paid

trades are blue. The orange trades are received.

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 12 We've got an example where there's a pay

and a receive at two percent. The pay is 100.

The receive is 90. That pair would be eligible

for risk-free netting compression in the clearing

house. And the way that that would work is you

would net those down and you've got a residual

trade on the pay side of 10 million.

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 18 

 19 If we look at the next bucket, the

five-year bucket, we've got a similar but not

identical example. We've got 100 million pay

trade at 1.7 percent and that's offset with three

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 1 trades of 25 million each at different coupons.

So the fundamental difference between the first

and second example is that the cash flows match

but the coupons and the notionals don't.

 2 

 3 

 4 

 5 This would be an example of coupon

blending which is offered by the CCPs, various

methodologies and what you'd end up there with is

a residual or a remnant trade with a different

coupon. Next example is 1.6 percent of 25

million. Both of these approaches would fall

under what we define as risk-free compression.

 6 

 7 

 8 

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 11 

 12 The third example is what we do at

TriOptima which is multilateral risk-constrained

compression. And in this example, we've got our

familiar 100 million pay trade. It's at 1.5

percent. There's two trades that are offsetting

it and you can see that they're done on different

days so the 50 million received trade at 1.7 is on

a one day. The next trade is on the following

day, the payer, and the third received trade is

done at 1.6 percent. So we've got different

notionals, different cash flows, different

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 1 coupons.

 2 That example is not eligible for

risk-free netting or coupon blending. So what

you'd end up with there is the ability to remove

all of those trades. And the way that that would

work is that the participants would set what we

refer to as tolerancies for market risk and credit

risk and that enables the algorithm to compress

trades with different but similar characteristics

at the same time.

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 11 Lucio, if you want to add to that?

 12 MR. BIASE: I really don't have much to

add except while you spoke about various forms of

compression, I'd like to maybe touch on the

various goals. So in the examples that Michael

went through, it's really to reduce gross notional

and trade count. So operational risk, of course,

is the goal of that is to lower the amount of

trades you have and this touches upon Claire's

point, maybe proactively before crisis so it's a

manageable number of trades and you're assessing

the risk and the impact of the parties' failure.

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 1 As the incentive and how leverage was

charged was based on approximations based on the

gross notional of trades. The offerings would

focus on reducing gross notional. But that

wouldn't do so much to limit counterparty

exposure, risk or the impact of the party's

failure. And I think that may bring us to the

next topic.

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 6 

 7 

 8 

 9 MR. PLA: Thank you. Kim, I wonder if

you could touch on your definition or shed some

light on the notion of risk mitigation and how you

see it as being different from compression?

 10 

 11 

 12 

 13 MS. TAYLOR: Certainly. Claire

mentioned compaction and that is the term that is

frequently used for this type of compression.

Risk mitigation is another word for it and what

happens here, what tends to happen here is that a

party who has a package of trade exposures in a

selection of different trades will go to the

market and look for someone to trade an offsetting

package of trades.

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 22 So they're looking to create the
 127

 1 directly offsetting trades that can be netted and

then, a set of replacement trades that would tend

to be smaller, a smaller number of trades to put

-- to kind of reinstate the exposure. And perhaps

that additional new trades are somewhat different

in exposure from what the original package was.

 2 

 3 

 4 

 5 

 6 

 7 So this is a package that is put out to

the marketplace and in an auction type of format.

It's a trade for the package. And then, I think

one of the other features that is different about

compaction that it's important to note versus the

other types of compression that we have been

talking about is generally speaking the risk-free

and risk-constrained compression mechanisms,

everyone who participates in the process ends up

with a risk-reducing outcome.

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 17 Risk, you know, neutral or risk-reducing

outcome with this compaction type of transaction

that goes to the market as a package, it could be

an entirely new set of trade exposures for the

counterparty to the original portfolio. So it is

different in a couple of ways. One way is that it

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 1 involves soliciting current market prices so it is

-- we consider it a trade that is -- has a market

impact or a price discovery element to the

transaction. And it also a trade that is not

necessarily or package of trades that is not

necessarily risk reducing for all the participants

in the process.

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 3 

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 5 

 6 

 7 

 8 So that is a definition for you of

market compaction and drawing some of the

distinctions.

 9 

 10 

 11 MR. PLA: Thank you, Kim. Lucio?

 12 MR. BIASE: Yes. I view risk

mitigation, I understand compaction, bidless but I

view risk mitigation as a somewhat larger

application of portfolio compression. There was a

slide earlier where it was kind of put on top of

the pyramid. I don't view it as so much as a

separate but a crucial part.

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 16 

 17 

 18 

 19 It perhaps the most crucial way to

mitigate the impact of one's failure on others.

And let me try to relate the forms of compression.

So compression in its various forms should be done

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 1 periodically and proactively to promote liquidity,

promote better price discovery because people have

more capacity to trade with others, but most

importantly, ahead of a failure to limit

contagion, lower the severity and probability of

maybe another bailout.

 2 

 3 

 4 

 5 

 6 

 7 Traditional compression, line-item

termination makes the failure more

administratively easy to measure after it happens

but it does nothing to lower the exposure or

impact of that party's failure. Gross notional,

which isn't so separate, and again the question

was how is risk mitigation different or is it

different from compression?

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 Gross notional reduction was geared

towards leverage when leverage was used as the

best base or approximation of -- gross notional

was used as an approximation of actual exposures.

But the pendulum is swinging and leverage-based

calculations are moving more towards risk based

which is more in sync with, I think, the goals of

everyone around this table especially when you're

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 130

 1 onto the standardized approach and modified SACR.

 2 Risk mitigation, keep in mind that

parties do not selectively default. If I had a

portfolio with another bilateral party or even

with a CCP, when I fail, I fail on all those

positions. In the earlier slide, in the earlier

question where Michael ran through risk-free

compression, I'm trying to relate all three, you

saw that it doesn't actually lower the exposure

between parties but it lowers either the gross

notional and there's a leverage incentive to do

that, an economic incentive to do that, but it's

not actually lowering the risk between parties.

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 And that's where risk mitigation, I

think, complements and is really has its right

spot on the top of that pyramid in terms of what

the various forms of compression are. So in

summary, fewer trades means less items to value in

a default but lower exclosures means a smaller

impact of a party's failure. Thank you.

 15 

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 17 

 18 

 19 

 20 

 21 MR. PLA: Thanks, Lucio. Any other

 22 questions or comments on question number one?
 131

 1 Okay. Dennis, I'm wondering if you

could share your perspective on how widely market

participants are currently using compression and

risk mitigation services from your experience at

LCH Clearnet.

 2 

 3 

 4 

 5 

 6 MR. MCLAUGHLIN: Sure. Thanks for the

invitation to be here. I think slide five really,

if you could bring it to slide five, really sums

up what's going on.

 7 

 8 

 9 

 10 We see since the height around the June

of two years, June 2014, we've seen that the

compression has really reduced the amount of

notional outstanding clearing houses. And this

was from a BIS study. And it's driven, of course,

by the fact that the regulatory capital is

notional driven. And in this day and age, balance

sheet capacity is an extremely scarce resource and

banks have to be very, very careful about how they

use it.

 11 

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 19 

 20 The way this works is as was explained

the portfolio trays that a bank would have with

the clearing house is going to be replaced by

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 1 another portfolio with less notional but same cash

flows. So cash flow matching is really critical

here. So that means that the risk as far as the

clearing house is concerned is the same.

 2 

 3 

 4 

 5 Now to give you an idea of the extent of

this on the ground, we started this really about

two years ago in earnest, maybe slightly less than

two years. And the notional outstanding at LCH

went from 450 trillion to 250 trillion. That's

almost a 50 percent reduction.

 6 

 7 

 8 

 9 

 10 

 11 And accompanying that, the number of

trades on the books fell by 40 percent. So and

the idea is if we had a default then, the

portfolios have been cleaned up to a great extent

and we don't have all these superfluous trades

lying around the place that we have to manage.

 12 

 13 

 14 

 15 

 16 

 17 Now of course this activity continues on

and on. It's a very, obviously it's kind of odd

that some newspaper said we were having a decline

in business when in actual fact, our business is

going full steam. But they were just looking at

the gross notional falling but, in fact, things

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 1 couldn't be better in the sense that huge demand

 2 for this kind of activity.

 3 The other thing I would say is this is

CCP sees. But of course, it's not all trades in

the market. It's the mandated trades. So there's

other things going on here, cross-currency swaps,

swaptions, all this kind of activity for which

third party advisors are helping banks manage the

risk in their portfolios down. And it's only the

mandatory cleared trades that we see inside the

clearing house.

 4 

 5 

 6 

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 8 

 9 

 10 

 11 

 12 So there's a lot more activity there and

that creates a challenge for regulations is how do

you -- you only have one piece of the puzzle so to

speak. How do you get your arms around

everything? Because the swaps staying in a

repository will only give you a piece of it. But

the extent of this is quite substantial.

 13 

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 18 

 19 MR. PLA: Claire, what data elements do

you think we can use to try to gauge the extent of

the use of these services?

 20 

 21 

 22 MS. LOBO: I'll answer that in just one
 134

 1 minute but maybe I can help with what we see

outside of the clearing house just to give people

a flavor. In credit, where it's actually quite

hard to find any public data, which I tried, I

have to use our internal data and judging from the

first three months of this year, about a third of

the volume that we see is compression related.

And that's compression and netting together.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 The skew is slightly towards index and

slightly towards trades that are already in the

clearing house but we also see robust compression

occurring in a bilateral space and the

multilateral space outside of the clearing house

in credit. In rates, is just as that the market

would be 62 percent larger if compression was not

used.

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 17 We see less bilateral compression than

we do in the credit space but we see quite a lot

of it. And that, I think, is largely because the

compression within the cleared space is so very

successful. It's successful and there are so many

different ways to achieve the goals.

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 1 For things that are outside of clearing

and rates, as Dennis noted, there are many new

vendors that are spread across IDBs, third parties

as well as the participants themselves that are

coming up with many new initiatives, different

ways to achieve compression in swaptions and cross

currency but really in any product that there is.

But the focus has been on the high capital type of

product such as swaption and cross currencies.

And we see aggressive compression coming from both

the sell and the buy side around the rules that we

expect in Basel.

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 13 In FX, we see different kinds of

compression. We see presettlement compression

happening with the G10 dealers through CLS and

that compression, we believe, is compressing

trades mostly in the space of possibly more than

75 percent of the volume before it even gets

settled. In the FX space we also have Triana who

offers a service for pre-give up trade

aggregation.

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 22 So if a customer executes many trades in
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 1 a currency pair, and I think it was Angela who

mentioned this as well, as a customer executes

many different trades, many different venues but

is going to use a prime broker, they will actually

aggregate those trades with the executing broker

and give up one single trade to the prime broker

in that currency pair. And we see Triana moving

into the FX space as well for multilateral

compression.

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 10 In terms of how these trades are

identified, they are identified today by using the

bulk event ID. If it is a compression event that

is on a trade which is not a new, originating

trade or if it's part of a coupon blending,

typically the price forming flag will be ticked

off. And if it's a compaction type of trade that

has a third party that's involved in that risk

pool, typically the price forming flag will be

ticked on.

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 20 So between those two identifies, it is

possible to observe the trades that are going

through this process.

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 1 MR. PLA: Okay. Third topic question,

for you, Lucio. Some of the service offerings

obviously involve a tear-up of trades where the

goal is to reduce gross notional. At the other

end of the spectrum of complexity, the goal seems

to be risk reduction or risk mitigation. How do

those latter services differ from a low frequency

dynamic hedging strategy that's also meant to

manage risk?

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 10 MR. BIASE: Sure. The goal -- sorry.

The goal is shared. The means are very similar

but the efficiencies are very different. Initial

margin, often called IM, is usually a measure of

some of the counterparty exposure you have against

a party. When I traded on the buy side 13 years

ago, part of my job was to do these dynamic

hedges. Maybe there wasn't a term for it yet but

you would layer on trades to lower your exposures

to banks, A) for the benefit of lowering your

exposures to the various banks, and B) to reduce

the real cost of initial margin.

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 22 Where I see this compression different
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 1 is that it's done by a third party. And it's done

to a level of efficiency that the parties cannot

do almost by definition, right? So if you have a

third party with a holistic view of the exposures

parties have to each other, right, and this third

party should be independent. Then they are

uniquely positioned to find a series of dynamic

hedges to the parties' mutual benefit. Okay?

 2 

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 8 

 9 I don't want to dwell too much. I just

want to go through, I guess, the main points

there. And that is if it's coordinated by a third

party it's a level of efficiency because if you're

doing it on your own, you kind of have this myopic

view of the market. And while you may request a

trade to be novated or put on, novated between two

other participants or put on, you have

trade-specific hurdles that prevent this from

really happening when a single party looks to

dynamically hedge their book. 

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 20 In the case of novations, you don't know

the credit appetite between the two other parties.

It may be in their mutual best interest. It may

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 1 not be. But you're certainly going to get charged

for that. Beyond that, you're crossing bid-asks

and exposed to market risk as you're layering on

these trades.

 2 

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 4 

 5 I think the fundamental difference here

between compression, risk mitigation through the

form of compression, and individual parties doing

dynamic hedges is just the efficiency with which

it can be achieved. And that's why to this day,

even with the implementation of clearing and

dynamic hedges, backloading, the amount of total

counterparty exposure people have versus their

market risk is still rather significant. And

there's, I think, an opportunity and a need to

lower that amount. In deference to time, I won't

go deeper.

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 17 MR. PLA: Michael?

 18 MR. MODLOCK: So just to follow on from

that and first I'll answer the question

specifically. So the way that I would interpret

the dynamic hedging is that you've got parties

going out and bilaterally executing trades on an

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 1 iterative basis with the ambition to hedge market

 2 risk, basis risk.

 3 I think if you compare that to a

post-trade service, we operate an all or nothing

approach with more than two participants. And the

objective of that is to have a totally risk

neutral result across all parties. So I would see

that as one fundamental difference between the

two.

 4 

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 9 

 10 If you enter into dynamic hedging, you

are going to be adding or positively or negatively

market risk. So I think if, to Lucio's point, you

could look at that as a third party provider who's

delivering a service that could reduce credit risk

without increasing or decreasing market risk.

 11 

 12 

 13 

 14 

 15 

 16 What I would also add is if we just

maybe move to this example here. Compression risk

in other measures, you know, we talked earlier

about notional and line items and how that reduces

risk overall. You get to a point where if you

keep removing risk neutral pieces of the

portfolio, you end up with more directional

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 141

 1 portfolio certainly on the bilateral netting set.

 2 And what we're interested to look at

over and above the reduction of notional and line

items which, as we pointed out earlier reduces the

capital cost and actually improves the leverage

ratio for firms, we can also look at risk in other

measures. So let's take, for example, the DV01 in

interest rate swap. We've got a portfolio here

with peaks and troughs and you can see that the

blues offset the reds and it's actually red's

simply market risk flat.

 3 

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 11 

 12 But from a counterparty exposure basis,

you've got a series of extremes, positive and

negative, counterparty exposure. And to Lucio's

point, what are you are able to do with services

that do not necessarily remove notional but do

reduce risk is you can flatten out these peaks and

troughs.

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 19 So you're market risk neutral to start

with. You're market risk neutral at the end but

what you've changed in your counterparty credit

exposures. That can be done at a bilateral level.

 20 

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 1 It's more challenging at a more industry-wide

level. You can certainly achieve that for cleared

and uncleared exposures at the same time. If we

think about the number of clearing venues that

there are now compared to them in the crisis and

the number of market participants that have got

large exposures with each other, then this is an

opportunity over and above the traditional

compression as we've come to know it and as

defined in the CFTC rules.

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 9 

 10 

 11 MR. BIASE: Yeah, I would like to

piggyback off Michael's points. And maybe take a

step back and just because we're using the words

risk a few ways. And I think maybe the best way

to look at it is your market risk is the impact of

a movement in the market on your portfolio against

a specific party that's your counterparty credit

risk, okay?

 12 

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 19 Now to the extent that your compression

can be seen as a complement to Volcker, so Volcker

limits participants' ability to take market risk.

But in and of itself it may not be sufficient to

 20 

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 143

 1 lower contagion because you still have this

counterparty exposure that exceeds the net market

risk. And we call it redundant risk but you can

look at it as excess or systemic risk and that's

what this dynamic hedging or risk mitigation

services reduce.

 2 

 3 

 4 

 5 

 6 

 7 So you get the total counterparty

exposure down to the net market risk. And that's

a necessary complement, in my humble opinion, to

Volcker and that form of reform.

 8 

 9 

 10 

 11 MS. TAYLOR: If I could just add

somewhat of a clearinghouse perspective to this

part of the discussion? When clearinghouses

accept transactions there are some regulatory

requirements, actually, and then, some good risk

management practice requirements as well that

require clearinghouses to put some sort of credit

screen or limit on the change in exposure that

comes from a certain transaction.

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 20 So with these compression measures that

are changing the counterparty credit risk mix, if

the clearinghouses are one of those

 21 

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 1 counterparties, although I wouldn't say that these

trades have a market impact, they would have a

credit risk impact and would need to be --

clearinghouses would need to be allowed to have

risk controls or filters on these type of changes 

in the counterparty risk behavior of their

clearing members.

 2 

 3 

 4 

 5 

 6 

 7 

 8 So that's another kind of layer of

distinction in the types of transactions and the

types of market treatment that should be applied

to them.

 9 

 10 

 11 

 12 MR. MODLOCK: And if I could just add to

that, I think that's a good point from Kim. One

of the things that is going to change this year

for us at least is the ability to extend

compression services beyond the traditional sell

side dealer community and be able to involve the

FCMs, CCPs and see end users, at least the buy

side, who have got a relatively balanced portfolio

that would be eligible for compression on a

multilateral basis and be able to work with a

broader industry community. Naturally the FCMs

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 1 and the CCPs would have some kind of governance

around the amount of risk that could be changed.

And certainly that's something we expect to happen

this summer.

 2 

 3 

 4 

 5 MR. PLA: Rana?

 6 MS. YARED: Thank you, Ed. I just want

to add the dealer's perspective to it. We've

heard on a couple of occasions that one of the

reasons why we spend time talking about

compression as an industry is because it lets

these fine folks peddle their wares.

 7 

 8 

 9 

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 11 

 12 But this -- oh. I don't I'm ever

accused of being quiet. So here we go. But the

compression tools are actually incredibly

important from the dealer point of view. And I

just want to distinguish a little bit what's being

said.

 13 

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 15 

 16 

 17 

 18 So I would just set dynamic hedging

aside because for me that's a trade event. So at

the point of trade, one decides that I wish to

hedge my risk in the following way and then, you

do that in a programmatic fashion.

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 1 It's price formative by definition.

Everything that we think about as true

compression, again, I'd set compaction aside, is

by definition not price forming and is also by

definition a post-trade event. And it really

falls into three buckets in the dealer's mind and

I can't emphasize enough, like, how important

these three things are.

 2 

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 8 

 9 So one is gross notional reduction which

has been, I think, elaborated on extensively. The

second is exposure reductions. So to give a very

kind of concrete response to this. One of the

things that obviously weighs on our mind very

deeply is CCAR. And one of the items in CCAR that

weighs on our mind, specifically, is the concept

of large counterparty exposure. And as I think,

Lucio had said there can be a difference between

one's exposure and one's true market risk.

 10 

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 19 And of course, we're all benefitted by

bringing the two as close together as possible.

Well, one of the methods that one or more of these

individuals have suggested to us is a method

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 147

 1 whereby we would, with our other dealer

counterparts, submit our trades for a particular

product into a central service that's run by a

third party. And that third party would come back

and tell us, I'm going to use Morgan Stanley

because they're right across from me, Goldman and

Morgan Stanley, you need to put on the following

that collectively would reduce your gross exposure

to some other folks around the table.

 2 

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 8 

 9 

 10 Today that is an increase of trade.

It's a new trade. So therefore it's notional

increasing and we're not sure, based on the

guidance that we've received from your good

selves, that that trade actually falls inside of

the no action relief guidance because it's a new

trade. And because it's not gross notional

reducing.

 11 

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 18 But as is very clear, it is definitely

exposure reducing which is beneficial for systemic

risk. I hope that's an uncontroversial statement.

 19 

 20 

 21 The second type as it really relates to

 22 initial margin is what I would call delta
 148

 1 reduction. So again same as just like exposure to

a particular counterpart. It might be the case,

as I think Michael's slide shows really nicely,

that the portfolio in total could actually be

quite risk neutral. But to a particular

counterparty could not be and by getting many

counterparties to work together through a third

party, you get the benefit of triangulation and an

opportunity to reduce excess market risk as close

down to true market risk as possible, which in the

unfortunate and hopefully not coming event of a

default allows for systemic risk reduction.

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 11 

 12 

 13 Again, one method which one might do

this might be to add a trade which we are

concerned doesn't under the no action relief. So

the specific ask from the trading side of the

house would be to look at the no action relief

letter that you kindly issued us in 2013 which was

very helpful to us and see if there's an

opportunity within very constrained parameters

such as non-prize forming service provided by a

third party which means that like if the concern

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 1 is that the counterparties might game if it if

they work with one another, it's you can't game it

through a third party. And then, you know, report

it as such back to you guys.

 2 

 3 

 4 

 5 If there can be a way to expand that no

action relief to allow us to ultimately achieve

the goal of systemic risk reduction.

 6 

 7 

 8 MR. PLA: Thank you. Stephen?

 9 MR. BERGER: Thank you. I just wanted

to also chime in with a buy side market

participant's view of what we do in the

marketplace today with respect to portfolio

compression in our funds. And I'm going to talk

specifically about cleared interest rate swaps.

 10 

 11 

 12 

 13 

 14 

 15 I think as Michael just noted, to date

the multilateral compression facility provided by

TriOptima has not been available for buy side

market participants clearing through an FCM. So

that's -- when it is that may be something that

buy side participants look at. But to date, the

most common form of most common way to do

portfolio compression is, I think Kim alluded to,

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 22 
 150

 1 you go into the marketplace to execute what's

 2 called an offset or unlined package.

 3 So if you have 50 line items on your

books that you want to compress, you go find

somebody that will take the other side of those 50

line items so you then have 150 completely offset

the other 50 and then, through your FCM you can

take those to the CCP and get those extinguished

and you're left with a handful of line items that

were part of that offset package that have roughly

the same risk exposure as the 50 that you were

obtaining to compress.

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 11 

 12 

 13 That activity two years ago was entirely

done by spreadsheet. So you'd say -- you get a

spreadsheet of the 50 line items you wanted to

compress. You'd send that out to a dealer or two

to get priced up and they'd come back to you with

their suggestion of that. Today that process is

almost entirely done, at least for us, on SEF even

though those offset packages have no MAT

components. So it's an instance where people are

voluntarily using SEFs for the kind of STP and

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 22 
 151

 1 workload benefits they provide.

 2 And I mean, I think trueEX was a

well-known pioneer in that space with their PTC

tool but Bloomberg and Tradeweb now have basically

the same types of functionality. So I think a lot

of clients are now using SEFs to do their offset

packages. And I think the goals are, again, as

others have noted, line item and gross notional

reductions.

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 So anyway that's basically kind of how

 11 it's working for now from a buy side perspective.

 12 MR. PLA: Marcus?

 13 MR. STANLEY: Thank you. So this is

obviously a complex area and we're happy to learn

more about it. I have to say at this point we see

a pretty big difference between the gross notional

reducing form of compression, what was called the

risk-free compression and the risk mitigation or

risk-constrained compression.

 14 

 15 

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 17 

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 20 And the reason is that in terms of

risk-free compression or gross notional reduction

it seems like you're looking at two per --

 21 

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 1 essentially two trades that are identical except

they are in offsetting directions. And if you can

just get the counterparty risk out of there you

have essentially eliminated the risk in an

objective way.

 2 

 3 

 4 

 5 

 6 The problem to us with looking at these

risk mitigating or exposure reducing trades in the

same way is that these regulatory exposure metrics

are basically, they're basically risk adjustments

for capital. If there's one thing we learned in

the crisis, it's that risk-weighted capital is a

dangerous concept because it involves a whole lot

of assumptions about how things are going to

behave in a crisis. It's very model dependent.

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 

 15 And if you look at the SACR that is

going to be the measure of potential future

exposure that Basel is pressing for, you see a lot

of assumptions there both in terms of the netting

recognized within a netting set which, right now,

could look one way. But at a future moment could

look quite different because you might have very

different instruments within the netting set.

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 1 And you also see a lot of assumptions

about correlations within a hedging set. And

those correlations could also go wrong in the

future.

 2 

 3 

 4 

 5 So obviously in the background of this

whole discussion is are we going to grant

regulatory exemptions and I don't think there's

any question that when regulators put those

exposure metrics out there, people are going to

try to rearrange their trades to reduce their

exposures according to those metrics. I mean,

that is going to happen and it can't really be

stopped. But as that happens, it may well be that

people will find areas of risk, ways to do risky

trades where the risks are not reflected within

those models and within those exposure metrics.

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 17 That's exactly what happened prior to

the crisis. People found the weak points in the

risk adjustments for capital and they went there

and they pushed a lot of volume in there.

 18 

 19 

 20 

 21 And I think that if we want our market

 22 regulation system to sort of a separate protection
 154

 1 and a separate check that's different from just

our capital exposure metrics, our risk adjustments

in capital, we have to be careful about granting

too many exposures, sorry, too many exemptions to

sort of this model-based exposure reduction.

 2 

 3 

 4 

 5 

 6 I think that there are dangers there.

Although and one final point I would make is that

we are going to have a lot of consulting

organizations and a lot of third parties offering

to try to help people in various ways reduce their

capital exposure. And that's fine and that's

great. They're going to give advice.

 7 

 8 

 9 

 10 

 11 

 12 

 13 To the degree that we privilege a few of

these third parties by giving them special

exemptions in this area, there could be some

competitive issues in terms of how that advice is

provided. So just once again, bottom line to us,

the risk-free compression, the notional reduction

compression, it's not model dependent. It seems

like the model dependent risk mitigation kinds of

changes in trade seem to present some quite

different issues to us.

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 1 MR. PLA: Good. A number of things that

were said are probably a good segue to question

number four.

 2 

 3 

 4 Kim, how do you distinguish, when you

think about risk mitigation, to the extent that

there is or is not price discovery taking place,

could risk mitigations services in the limit be

considered order book trading? How are they

different?

 5 

 6 

 7 

 8 

 9 

 10 MS. TAYLOR: Yes. I think one of the

distinctions that we have been trying to make and

based on your comments, I think we haven't maybe

succeeded in making that distinction clear, is

that we're actually suggesting that compression,

the definition of compression include the types of

features that Rana was talking about. Where it is

provided by a third party, where it is not price

formative or it's not part of the price discovery

function so there's not a trade.

 11 

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 19 

 20 All of these compression services,

whether they are riskless or risk constrained that

we've been talking about actually do reduce

 21 

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 156

 1 notional exposure, transactionally are eliminated

and the distinction is basically that you get a

broader set of trades that you can work with to

execute that risk reduction than you would get if

you only did risk-free compression. So where we

see a distinction between something being a trade

and being a product of a compression activity is

that it is basically done at a stale price.

There's not a new pricing element to the

transaction.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 It actually does reduce open line items

or notional exposure and it can do that within

kind of a bilateral or unilateral universe or it

can do that across a multilateral set of

counterparties in some type of a third party

service. And I represent a company that provides

a clearinghouse. And as a clearinghouse, we can

actually be a provider of a compression service or

we can actually be someone who takes in the end

product of a compression service that happens at

another third party.

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 21 

 22 And as long as those are risk-neutral or
 157

 1 risk-reducing activities for both sides of the

equation, we would consider those to be defined as

compression transactions and we would consider

them not to be order book transactions.

 2 

 3 

 4 

 5 If they are brought to the market, even

if because of the circumstances that the gentleman

from Citadel was laying out because the kind of

broader compression services aren't readily

available to all elements of the marketplace as

yet. If there are trades executed with a price

discovery function in order to accomplish the

activity, then we would consider those to be order

book transactions or transactions that would be

trades and the services used to execute those

trades to be some type of an order book

transaction.

 6 

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 15 

 16 

 17 MR. PLA: Michael?

 18 MR. MODLOCK: Yeah, I have a couple of

thoughts on this. So from a service provider

perspective, we are regulated and as members of

the NFA, we operate within the CFTC rules

obviously as do our clients.

 19 

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 21 

 22 
 158

 1 When we think about the rules that are

attributed to SEFs, DCOs, DCMs, for example, we

don't provide a platform that bids and offers a 

meeting. The services that we offer are not real

time. They're not continuous. It's not an

all-to-all market where we're operating with

subsets of the industry here.

 2 

 3 

 4 

 5 

 6 

 7 

 8 So I think they're all good examples of

why we wouldn't need to be certainly registered as

SEF. In fact, the core principles back in June

2013 had said that multilateral portfolio

compression exercises are not viewed as involving

the execution or trading of swaps. Rather they

are viewed as netting mechanism and do not require

compression service providers to register as SEFs.

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 So I think the rules and the logic and

the common sense would support that. If we go

back to the concept of the risk reduction through

other means not just notional and line items, if I

was trying to reduce risk with you, I can only do

that with the compression of execution of a new

swap that rebalances the exposure that you and I

 17 

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 22 
 159

 1 have today. So it's no good me putting that out

in the clear wants to trade that swap with me

because that's not going to work for us in our

relationship.

 2 

 3 

 4 

 5 So there are already a very large number

of conditions and tolerances that the market

participants themselves dictate as part of using

the service. In addition to that, when we work

with clearinghouses and we're working with six of

them now on the compression of cleared swaps, the

clearinghouse needs to be absolutely cash flat per

day so there's no change of risk at all for the

CCP.

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 And the market participants set their

tolerances which are predefined. So this is

purely an analytical service.

 15 

 16 

 17 MR. PLA: Kim, maybe a follow up for

you. To the extent that these non-price discovery

services that are taking place also take place on

SEFs and DCMs and DCOs, what is the or is there a

policy justification for allowing these services

to take place in the realm of unregistered service

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 160

 1 providers?

 2 MS. TAYLOR: I think for me I think the

distinction comes back to is the activity that is

being performed creating a trade as the market

would define a trade and or not. And if it is,

then I think it's a registered activity and would

need to be performed by a registered provider.

And if it's not a trade, then I think there is a

lot of flexibility for that not to be required.

And I mean, I represent a company that basically

all we do is provide services through registered

entities. It would be very handy for me to be

self-serving about it and say that everything

should be done for a registered entity but really

these activities are -- the activities of

compression are truly risk reducing.

 3 

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 17 They're risk reducing for the market

participants. They're risk reducing, the way

they're being provided now, they're risk reducing

for clearinghouses. And they are risk reducing in

a broader, systemic way. I think everyone would

agree that the London Clearinghouse had a very

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 161

 1 successful default management exercise with the

 2 Lehman swap portfolio in 2008.

 3 But if you look into the details of it,

it was still successful but it took a lot of work

by the street overall, over a period of several

days maybe even a couple of weeks to do the

operational part of managing the book of

transactions. And now if it were to happen,

another type of event similar to that, the size of

the book that would be being brought to bear to

the market and that everyone would have to react

to and process, would be cut by at least half.

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 13 Actually, in terms of line items, it

would probably be cut by significantly more than

half. So I think it's a better, easier default

management is a byproduct of good access to

compression services. So we would be an advocate

of compression services being able to be broadly

available and actually even expanded beyond where

they are provided now so that it would be able to

include elements of the buy side for example.

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 22 MR. PLA: John?
 162

 1 MR. NIXON: What are your concerns about

potential rules going forward that could be put in

place that could impact the effectiveness of

either compression or netting?

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 4 

 5 MS. TAYLOR: I think one of the concerns

that we always have is that there will be

regulation that increases the cost without a

significantly corresponding decrease in risk.

 6 

 7 

 8 

 9 So kind of unnecessary costs and one of

the examples that I would put there, I think,

would probably be over-engineering of the trade

reporting requirements associated with

transactions that are not actually trades in the

general sense of the market. That would be one

example.

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 16 I think another example would be doing

things that would restrict the access to the -- by

market participants to these risk-reducing

services especially in the face of situations

where the regulatory capital requirements are very

punitive based on certain behaviors and these

compression services allow the market participants

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 1 to very transparently and safely reduce some of

those exposures. And it's not just a model-based

reduction.

 2 

 3 

 4 It's not just a point in time let's look

at the match and see if it works and the math

might not work next time because the output of

these processes is that transactions actually are

extinguished and no longer exist. So I would see

some of the same risks that you mentioned in your

comments about kind of mathematical exercises that

could be different over time. But these are not

-- these compression services are not just

mathematical exercises.

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 14 They're not just model-based exercises

even if there's a model that somehow was used to

create the output, the output is trades are

extinguished and replaced with sometimes newer,

fewer trades with a similar risk exposure.

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 17 

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 19 MR. STANLEY: John, if I can just add

 20 another response --

 21 MR. PLA: Please.

 22 MR. STANLEY: -- to your question there.
 164

 1 Certainly one of the other challenges to continued

efficiency and compression is the new rules for

the bilateral margin. It was very good to hear

Commissioner Giancarlo's comments earlier on

supporting the idea that the compression of legacy

swaps would not be treated as new swaps for the

purpose of the new bilateral margin.

 2 

 3 

 4 

 5 

 6 

 7 

 8 And it's also gratifying to hear that

the Commission had considered this in their

preamble that it would be open for discussion. I

would also add that the Canadian regulator OSFI

last year had actually put out final rules that

said that the new swaps that came from the

compression of grandfathered trades would not be

treated as swaps for the purpose of the new margin

rules.

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 17 So if I would bring in an example here

of this, interdependencies, co-dependencies in the

market that we see whether it's a buy side

participant, sell side participant, a CCP, this

connection between the participants, the FCMs, the

members of the clearinghouses, the CCPs themselves

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 1 and that potential contagion which ultimately

 2 we're all trying to address systemic risk.

 3 So what tools do we need as an industry

to be able to address the bilateral portfolios,

the cleared portfolios, the needs of the buy side,

the needs of the sell side? So I think the

uncleared margin's certainly a challenge.

 4 

 5 

 6 

 7 

 8 MR. PLA: So, Claire, we may have

already covered some of question five in the

previous discussion but I think this relates to

information that related to compression services

being included in the SDR. Were those data

requirements from your perspective imposed burdens

that could, in any way, hamper/hinder the progress

of further compression in swaps?

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 16 MS. LOBO: Yeah, thank you. In the

question in the draft of the technical

specifications it's referenced in the question.

The question in the draft asked whether there

should be granularity with regard to the different

types of compression that should be included on

each trade that is compressed.

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 1 The comments that came back from ISDA

and others including ourselves is that it would be

an increased burden to be able to systemically

across everybody that touches compression today

label those trades appropriately. And I might

also point out that there would have to be a ramp

up if were to go towards something like that

because there is no field today that's commonly

used in the protocols that are out there.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 FIX or FpML, that would be convenient to

use so there would have to be something that would

be added and that would have to happen across

pretty much every market participant in order to

properly report. Especially given that these

trade compression activities come from SEFs, they

come from bilateral instances, they come from

within clearinghouses. They come from pretty much

all over the place.

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 19 The other concern that was noted in the

letters, the comment letters, was a concern that

perhaps global regulation wouldn't be coordinated

and the definition of these different types of

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 1 compressions might overlap or conflict leaving

people that are stuck in a multijurisdictional

reporting regime to have to come up with multiple

identifiers for just one type of trade that might

be compressed in some certain way.

 2 

 3 

 4 

 5 

 6 So those were some of the issues that

have been reported. I would -- I've had a

conversation subsequently with an ex-colleague of

mine and friend, Katrina Bell, and she did point

out that there had been a discussion with the FpML

working group some years ago about using the field

that exists today which is the bulk event ID and

creating some sort of a scheme inside of that

field that would be able to distinguish probably

between to two main types of compression that

we're really grappling with here which is ones

that have a price-forming component and ones that

do not.

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 19 And to be able to distinguish in that

ID, that identifier, in some way that this trade

was price forming or it was not price forming.

And I think that that might be a low cost actually

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 1 implementable solution that could be a global

 2 solution and it could get some traction.

 3 MR. PLA: Thank you. Stephen?

 4 MR. BERGER: Just want to chime in on

this kind of the reporting angle to this. And I

think there is a need to tailor the solution or

the requirement based on what type of compression

activity we're talking about.

 5 

 6 

 7 

 8 

 9 So first of all, if you think about it

from a part reporting perspective, i.e. what data

is disseminated publicly, today the offset

packages that buy side firms enter into are part

of the information that's publicly disseminated

though they're not identified as such, right? And

so you can kind of back them out from the publicly

reported data because you see a bunch of backdated 

swaps that all got executed at the same time and

there's like 50 line items with a bunch of strange

maturities and off-market rates like all happen at

the same time.

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 20 

 21 So you can kind of back them out but it

 22 would be much more efficient if in the real-time
 169

 1 public reporting of those offset or unwind

packages there was a package flag. And I think

that's something that is already being considered

based on the most recent consultation about

improvements to the data reporting.

 2 

 3 

 4 

 5 

 6 I view that bucket of offset unwind

packages separately from some of the other

activities that are being discussed. So if a buy

side participant has a portfolio of completely

offsetting swaps that they take to the CCP and

says extinguish these because I have these 10 that

offset perfectly these 10, I don't see that as

something that needs to be publicly reported in

part 43. Obviously there will be an update that

goes to the SDR that references the fact that

those positions are no longer on the books.

 7 

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 16 

 17 Similarly if a buy side participant goes

straight to a CCP and uses a coupon blending

mechanism at the CCP, again, I don't think that's

a publicly reportable event but obviously one

where the records at the CCP and the SDR will be

updated. And then, for the kind of inter-dealer

 18 

 19 

 20 

 21 

 22 
 170

 1 multilateral compression exercises, again, I don't

see those as publicly reportable events though the

results of those would obviously be reflected in

the updated registry at the CCP and by extension

at the SDR.

 2 

 3 

 4 

 5 

 6 So I think there's a distinction that

can be made in terms of what reporting

requirements need to be applicable to what types

of portfolio compression exercises.

 7 

 8 

 9 

 10 MR. PLA: Kim?

 11 MS. TAYLOR: I think I would just add a

general comment to the issue of the reporting

requirements. The TR and SDR regime, it is very

clear that regulatory objective is a very worthy

regulatory objective.

 12 

 13 

 14 

 15 

 16 Both ends, the real-time reporting and

then, also the ability to have the warehouse of

all the data that you will need to validate

someone's exposure in times of crisis, that's what

the TR/SDR element is supposed to be about. I

think what has happened is that there's kind of a

failure to apply the 80/20 rule.

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 171

 1 And so in trying to pursue perfection in

the type of data that is obtained and the way that

it's obtained and the way that it's held in those 

TRs and SDRs, I think what has been at risk is

that the data that you'll get, and I think we

clearly are still as an industry having a struggle

having the data that's in the TRs and SDRs be

correct, kind of fully correct. Because it is

very complex, very specific, very different across

jurisdictions and I think what I fear will end up

happening is that before we get it figured out and

get it cleaned up, you'll have a need for the data

and you will have data that you may think is

incorrect that is not actually representative of

the actual positions that the people have.

 2 

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 16 So I think I would suggest that in any

of the work with respect to the TR and SDR in the

reporting, to consider erring on the side of

under-engineering versus over-engineering the

exact specificity of every tiny little feature of

every trade that happens in the marketplace with

the goal of actually knowing the exposure that

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 172

 1 you're facing when you're trying to manage it.

 2 MR. PLA: Dan?

 3 MR. BUCSA: So just to simplify the

question and to build on what Stephen was saying

for the 45 reporting, not the public tape

reporting, would LCH CME TriOptima market agree

that the new swaps that are created, if there are

any as part of whichever exercise is conducted, or

the termination of the swaps that were compressed

would be reported to the part 45 means for the SDR

and for staff to know?

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 MS. TAYLOR: I would assume those trades

would be reported but I think what I'm suggesting

is that we not report with 17 different possible

fields about how they were extinguished or how

they were put on and just that it's -- keep it

simpler and it's extinguished from a compression

activity or it's a new trade resulting from a

compression activity without 27 subfields that

will be harder for people to comply in a way that

will be useful to you.

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 21 

 22 MR. PLA: I think in the interest of
 173

 1 time, let's park that and maybe we can come back

 2 to it in the lightning round at the end.

 3 Dennis, question six we've probably

covered in some of the previous discussions but

from your perspective, to what degree does

portfolio compression either add or remove risk

from the market?

 4 

 5 

 6 

 7 

 8 MR. MCLAUGHLIN: Thank you. Well, we've

heard that there are few kinds of portfolio

compression. There's notional reduction which is

clearly good. There is counterparty exposure

reduction which is clearly good. And then, the

third part was this IM reduction which is also

clearly good.

 9 

 10 

 11 

 12 

 13 

 14 

 15 So in none of those components is the

risk going up. It's coming down in a controlled

way. The other thing we heard about was the fact

that compression is a very, very big activity.

Somehow it's grown quite a lot and what's happened

is the market is being controlled in terms instead

of letting this growth get out of control, it's --

the garden has been weeded, so to speak. So there

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 174

 1 are now less line items and it becomes easier to

manage a default because you have physically

trades to move from one -- from a default in the

CCP.

 2 

 3 

 4 

 5 And you also can manage porting easier

because obviously less clients, sorry, less

capacity would be tune up in the actual reporting

process. So I think it's a good thing.

 6 

 7 

 8 

 9 The only thing you have to be careful of

is that the operational component of all this is

carefully controlled. So in other words, you're

not caught in a limbo-like state of trades which

should have been canceled, weren't quite canceled

before the new trades were put on. But as long as

that's taken care of I think it's a risk-reducing

activity.

 10 

 11 

 12 

 13 

 14 

 15 

 16 

 17 MR. PLA: I think in the interest of

time and to stay within our time budget we'll do

the last question as a lightning round. So if

it's okay, I'll pose it to each panelist and

they've have 60 seconds or less to add a final

comment.

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 175

 1 And the final question is in light of

the discussion we've just had, are there any

recommendations you can make to the Commission on

actions they should take or they should refrain

from taking regarding portfolio compression? And

why don't we just go straight in a row starting

with Dennis?

 2 

 3 

 4 

 5 

 6 

 7 

 8 MR. MCLAUGHLIN: Well, I think that

compression should be encourage at all costs

because otherwise without it you just get a market

which is growing and growing and growing and never

really declining. So it should be encouraged,

probably not mandated because it's up to

individuals in the marketplace what they want to

do. But certainly encouraged and not discouraged.

 9 

 10 

 11 

 12 

 13 

 14 

 15 

 16 MR. PLA: Kim?

 17 MS. TAYLOR: I sense there's going to be

duplication in the lightning round. Given that

the capital requirements are setup to really

penalize the growth of exposure and given that

there are systemic benefits to the reduction of

line items and counterparty exposures, I think the

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 176

 1 Commission should certainly not discourage

compression and actually should act to encourage

the broader use of these compression activities

that really do extinguish trades and reduce

exposures.

 2 

 3 

 4 

 5 

 6 MR. PLA: Thank you. Michael?

 7 MR. MODLOCK: I would say reiterate the

relief for the partially terminated swaps and

replacement swaps for the purpose of bilateral

margin.

 8 

 9 

 10 

 11 MS. LOBO: I would add that I think

innovation needs to be cared for with regard to

compression much like the discussion that's going

on in the block chain world. There are a lot of

new kinds of compression that are being thought

about and some that are coming to market and I

believe that that's a good thing.

 12 

 13 

 14 

 15 

 16 

 17 

 18 I don't see that compression or netting

really adds risk to the market. It does take it

out as Kim has eloquently pointed out. And I

would also add that with the issue of trying to

identify the price-forming trades that maybe

 19 

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 21 

 22 
 177

 1 they're in the context of compaction that a

thoughtful, and if I can say, low-budget solution

is found so that it doesn't raise the bar in terms

of meeting 43 or 45 reporting.

 2 

 3 

 4 

 5 MR. PLA: Lucio?

 6 MR. BIASE: I think you may already be

doing some of what Claire is suggesting. I mean,

we're a young firm and you've put us with some of

these stalwarts. We've been focusing currently on

reducing systemic risk. So I commend the

Commission for not letting regulation itself

stymie the goals of regulation and the safety and

soundness.

 7 

 8 

 9 

 10 

 11 

 12 

 13 

 14 More specifically and maybe to echo some

points made by my colleagues here, is that this is

really not a price discovery issue. It can be

done in a controlled environment with total

transparency to the regulators and it's not trade

execution but a post-trade process that helps

clean up whether it's gross notional or

counterparty exposure. Thanks.

 15 

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 17 

 18 

 19 

 20 

 21 

 22 MR. PLA: Susan?
 178

 1 MS. O'FLYNN: Hi. I just wanted to kind

of raise a point that I don't think's really been

touched on today. You know Morgan Stanley is very

supportive of portfolio compression and we are

active users of a number of the third-party

providers here both and including the

clearinghouses. I think what needs to be

recognized is the efficiency that exists in both 

CDS and IRS rent, netting and portfolio

compression. And it kind of links back to

Commissioner Giancarlo's original point around

liquidity in some of these markets.

 2 

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 Now obviously these businesses now have

to carry additional capital which is driving the

need for these compression services. However, and

it kind of links back to some of the points made

in relation to bespoke trades that compression

does not compress the entire notional of certain

trades especially when they tend to be less

standardized so that there is, and back to, I

think, to addressing some of Marcus' points,

institutions like dealers will have to carry more

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 179

 1 capital for trades which are more of a spoke.

 2 That is just a fact. Now these

portfolio compression services offer us some

ability to create capital efficiency. To be able

to recycle that efficiency back you need to offer

business to our clients but I just want to make

clear that these compression services work well.

But when there's a degree of bespoke nature about

certain trades, it's not 100 percent success rate.

So I just wanted to leave everyone with that

particular here because I think it's kind of been

missed.

 3 

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 

 12 

 13 MR. PLA: One more comment in the

 14 lightning round. Anat?

 15 MS. ADMATI: Well, I just want to echo

 16 --

 17 MR. PLA: Sorry, two more.

 18 MS. ADMATI: I want to echo what Susan

just said that let's not forget there are new

terms here, compression and it's all great because

it compresses risk and we like that. And to the

extent that it does and that you have to look at

 19 

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 21 

 22 
 180

 1 the whole portfolio to understand what a thing

 2 does, we definitely want that.

 3 So this notion of splitting up 

everything two million pieces and looking at them

separately doesn't make any sense in finance. But

let's remember the other term that we became kind

of we paid the price for which is called

regulatory arbitrage which sometimes did add risk

or did not eliminate or things that were thought

to eliminate risk weren't doing this fully.

 4 

 5 

 6 

 7 

 8 

 9 

 10 

 11 So I just warn that we don't rush into

just saying anything that has a label of

compression or whatever is definitely eliminates

risks and it's gone and all of that because

sometimes that's not true.

 12 

 13 

 14 

 15 

 16 MR. PLA: Marcus?

 17 MR. STANLEY: Just adding to what Anat

said, she said most of what I wanted to say but I

actually think this is complex because there's

something here that you definitely want to

preserve in terms of the ability to compress a

multilateral portfolio that can't be done unless a

 18 

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 21 

 22 
 181

 1 group of people get together to do it. But as the

same time you don't want sort of open the door

wide to an unlimited ability to rejigger your

portfolio outside of the CFTC ruleset as long as

you're reducing any regulatory exposure metric

even if it's highly modal and assumption based.

 2 

 3 

 4 

 5 

 6 

 7 So where you're going to strike that, I

 8 think, is not a simple question.

 9 MR. PLA: Chairman Massad?

 10 CHAIRMAN MASSAD: Well, it's a very,

very good discussion, very helpful. And I think

on these last points in particular the lightning

round was helpful. I might have, if we had time,

would want to maybe get into the more -- the

granularity of how exactly should we encourage or

discourage and which types of compression.

 11 

 12 

 13 

 14 

 15 

 16 

 17 Stepping back from that, we've got a

rule right now that says swap dealers should have

policies to periodically engage in compression.

And for that purpose, we've defined it very, very

broadly and we haven't said how often. We haven't

said what types. We've just -- and I think that's

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 21 

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 182

 1 appropriate -- we've left it very flexible and

 2 broad.

 3 When it gets in, though, to exemptions

from other requirements, I think that's where we

do have to get more specific. And we have.

Reference was made to the relief on clearing.

 4 

 5 

 6 

 7 You know, in that case we said it had to

be reduction in notional amount. It had to be

market-risk flat. It had to be same maturity.

 8 

 9 

 10 So I think it's -- this is a discussion

we should have going forward. We should think

about these different types. We should think

about how it relates to requirements on trading,

on clearing, on margin. But for example, on

clearing, it kind of ends up being a question on

legacy swaps, right? I mean, and once we're out

of the legacy world, our clearing requirement

won't matter to whether you engage in compression

or not, I think.

 11 

 12 

 13 

 14 

 15 

 16 

 17 

 18 

 19 

 20 To state it differently, had we said for

our clearing mandate not only must you clear new

swaps, you must put all the old swaps into

 21 

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 183

 1 clearing, you would not have needed an exemption

from relief for us to do compression. So I'm just

saying that I think we have to consider what we

do. As we consider what we do, we have to really

get into the particulars of this.

 2 

 3 

 4 

 5 

 6 And we also, of course, when it comes to

something like margin, have to also pay attention

to another goal that many of you are very fond of

which is regulatory harmonization because we have

to work with the Fed and the bank regulators. So

it was a very useful discussion. I look forward

to continuing to engage on it.

 7 

 8 

 9 

 10 

 11 

 12 

 13 MR. PLA: Petal, back to you.

 14 MS. WALKER: Okay. At this time in

keeping with the meeting agenda, I would like to

thank Ed Pla for facilitating the discussion

during our second panel. Commissioner Bowen will

now make closing remarks.

 15 

 16 

 17 

 18 

 19 COMMISSIONER BOWEN: Great discussion,

again, everyone and I was going to do a few

takeaways. So I think on the last topic, the

lightning round, was pretty comprehensive although

 20 

 21 

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 184

 1 the one takeaway would be not all compression is

 2 created equal. That's my one takeaway on that.

 3 I want to thank the Chairman and

Commissioner Giancarlo for being here. I want to

thank the members of MRAC, especially our

facilitators, John and Ed, and our key speakers

today. 

 4 

 5 

 6 

 7 

 8 Generally, I think the takeaway is that

our markets are functioning pretty well but not as

well as they could be for some of our small end

users. We heard today that SEFs are really not

used much or at all in the agriculture and energy

spaces but that they place a significant role in

the rates and credit markets.

 9 

 10 

 11 

 12 

 13 

 14 

 15 And I think one of my biggest takeaways

is that we need to continue to balance our

regulatory mandate but to do so in a way that

promotes efficient and innovative markets without

undue burdens and cost.

 16 

 17 

 18 

 19 

 20 And with that last thought, I want to

 21 thank you all again for attending today.

 22 MS. WALKER: The meeting is now closed.
 185

 1 (Whereupon, at 1:28 p.m., the

 2 PROCEEDINGS were adjourned.)

 3 * * * * *

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 1 CERTIFICATE OF NOTARY PUBLIC

 2 DISTRICT OF COLUMBIA

 3 I, Carleton J. Anderson, III, notary

public in and for the District of Columbia, do

hereby certify that the forgoing PROCEEDING was

duly recorded and thereafter reduced to print under

my direction; that the witnesses were sworn to tell

the truth under penalty of perjury; that said

transcript is a true record of the testimony given

by witnesses; that I am neither counsel for,

related to, nor employed by any of the parties to

the action in which this proceeding was called;

and, furthermore, that I am not a relative or

employee of any attorney or counsel employed by the

parties hereto, nor financially or otherwise

interested in the outcome of this action.

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 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